Greek Prime Minister Geórgios Papandréou , the son and grandson of Greek prime ministers, greets a local in Kritsa, close to the north east coast of the Greek island of Crete, July 30, 2010.

Greece has made a "strong start" but still faces "key challenges" in responding to its public finance crisis, despite making "considerable progress" across a wide front, EU, ECB and IMF auditors said on Thursday. Meanwhile the Greek government said today that it is more optimistic than the EU and IMF on how deep its recession will be this year, Finance Minister George Papaconstantinou said on Thursday.

An EU-ECB-IMF review was carried out in the past two weeks, in advance of a second loan payment of €9.0bn due at the beginning of September, following an initial €20bn loan in May. A further €9.0bn payment is scheduled for December. Concluding the two-week inspection visit, the EU, ECB and the IMF said  on Thursday that they maintained their forecast the economy would contract by 4% this year. European Commission representative Servaas Deroose said after an audit mission: "Despite considerable progress in a vast array of areas, key challenges remain."

IMF mission's director Poul Thomsen said that "progress is off to a very strong start but there are pressure points, risk areas." These include the opening up of the energy sector and tackling the finances of the debt-laden state railway company OSE.

"We have discussed various options on the table (for national electricity company DEI) and for OSE, there is a deficit of €1bn every year and a debt of €10bn that needs to be addressed," Deroose said.

"I'm confident that (our chiefs in Frankfurt, Brussels and Washington) will be as impressed with the progress so far as we have been," said Thomsen.

"I'm confident they will see the risks also, but they will also see that progresses are in place to handle these risks. So I am definitely confident that we are going forward."

According to the the representatives of the three bodies, the contraction of the economy, with GDP expected to decline 4.0% in 2010 and by 2.5% in 2011, is in line with projections made in May.

However, the mission said inflation is "higher than expected".

It said: "We have revised our estimate for 2010 to 4.75% -- pushed up by indirect tax increases. With no signs of second-round effects, inflation is expected to decline rapidly."

"Our estimate is more optimistic," Finance Minister Papaconstantinou told reporters in Athens on the expectation of a smaller contraction in 2010, adding that Greece would revise how it calculates its GDP next year. Greece also is hopeful of improving on the target budget deficit to 8.1% of GDP (gross domestic product) this year despite lower-than-expected revenues in the first half. "On the basis of GDP development and higher-than-expected inflation ... we will have a deficit below 8.% by the end of the year," Papaconstantinou said, with no additional  austerity measures were planned after the EU/ECB/IMF visit. The minister said budget revenues would get a €2bn boost in the second half of the year due to a VAT hike.

"Six months have passed and we proved all Cassandras wrong, we will get the third and all remaining installments (of the EU/IMF loans) because the government is determined," Papaconstantinou said.

Papaconstantinou  said the government would extend a €28bn bank support scheme already in place, providing another €25bn of state guarantees to lenders issuing bonds to ensure the real economy is adequately funded.

"It was deemed necessary so that there will be smooth funding of the economy with banks making loans to businesses and households. Banks can issue bonds guaranteed by the state and submit them to the ECB for funding," the minister said.

Papaconstantinou confirmed that the government had no intention of reducing its stake in public utility PPC or sell production plants, denying press reports it was under IMF/EU pressure to do so.

"On PPC, we stick to our position, for the government holding a majority stake of 51% and our position that we have no intention to sell," he said

Statement by the EC, ECB, and IMF on the First Review Mission to Greece:

Staff teams from the European Commission (EC), the European Central Bank (ECB), and the International Monetary Fund (IMF) visited Athens during July 26-August 5 for the first quarterly review of the Greek government’s economic program, which is being supported by a €80bn loan from Euro area countries and a €30bn Stand-By Arrangement with the Fund. The strategy and key policies remain as described in the May 2010 Letter of Intent and Memorandum of Economic and Financial Policies..

Our overall assessment is that the program has made a strong start. The end-June quantitative performance criteria have all been met, led by a vigorous implementation of the fiscal program, and important reforms are ahead of schedule. However, important challenges and risks remain.

The contraction in the economy is in line with May program projections: GDP is expected to decline by 4% in 2010 and some 2½% in 2011. Inflation is higher than expected - we have revised our estimate for 2010 to 4¾% - pushed up by indirect tax increases. With no signs of second-round effects, inflation is expected to decline rapidly.

In the fiscal area, the authorities have kept spending significantly below budget limits at the state level. This has offset slippages caused by problems in controlling expenditures at the sub-national level (local governments, hospitals, social security funds), and the overall deficit target for end-June was met. Going forward, to address potential risks to fiscal targets, it is critical to tighten expenditure control and monitoring, in particular at sub-national levels. Another key challenge is to further strengthen tax administration, including to reduce tax evasion by high-income and wealthy individuals. This is essential to secure tax revenues and to promote the overall fairness of the adjustment program.

In the financial sector, there has been a moderate deterioration in capital adequacy as nonperforming loans have increased in line with expectations. Recently, the CEBS stress tests covered more than 90% of Greek banking system assets and all but one state-owned bank passed, thus helping to reduce market volatility. We welcome that the government has commissioned a strategic review for the banking sector and a due diligence for state banks. The Financial Stability Fund (FSF), which is soon to become operational, will provide an important backstop to deal with potential capital shortfalls. In our view, the 10 billion €o earmarked for the FSF under the program remains adequate. Continued close monitoring of the financial sector will be important in the period ahead.

Impressive progress is being made on structural reforms.The mission welcomes Parliament’s approval of the landmark pension reform, which is far-reaching by international standards.Substantive labor market reform is also well underway. Implementation of recent tax reform and budget reform is key in order to consolidate fiscal consolidation. Other reforms that are scheduled for early implementation are transportation, where important progress has already been made with liberalization of road haulage, and energy. Restoring competitiveness and boosting potential growth remains critical to the program’s success. The challenge facing the government in this regard will be to overcome resistance from entrenched vested interests to opening-up of closed professions, deregulation, implementation of the services directive, and elimination of barriers to development of tourism and retail.

The Greek government is still unable to access international capital markets except for placement of short-term T-bills. However, market sentiments appear now to be improving. Taking advantage of the breathing space afforded by the large-scale international financial support, the key challenge facing the Greek authorities remains to establish a strong track record of policy implementation in order to regain access to international capital markets.

Next Steps. The staff-level agreement reached with the Greek authorities will pave the way for the conclusion of the first review under the loan facility agreement (Euro area) and Stand-By Arrangement (IMF), subject to approval by the Commission, the Eurgroup, and the IMF’s management and Executive Board. Such approval will allow the disbursement of € 9 billion (€ 6.5 billion by the €o area Member States, and €2.5bn by the IMF).

The mission for the next program review is scheduled for October, 2010.