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Greece faces recession warning as bailout talks set to open

Greece's most influential think tank warned on Thursday of a sharp drop back into recession in a report that came hours after parliament approved a second package of reform measures aimed at securing a new bailout from international lenders.

In its quarterly report, the IOBE institute said that capital controls imposed last month to stop a bank run pushing the financial system into collapse would exact a heavy toll across the economy.

Reversing a forecast for growth this year of 1 percent made as recently as April, it said the economy would contract by as much as 2.0-2.5 percent after growing 0.7 percent in 2014 and would remain in recession next year as well.

A street vendor sits behind used items for sale in Athens, Greece, July 7, 2015.
Christian Hartmann | Reuters
A street vendor sits behind used items for sale in Athens, Greece, July 7, 2015.

The report underlined the headwinds facing leftwing Prime Minister Alexis Tsipras, who must negotiate a bailout worth up to 86 billion euros with skeptical lenders, while struggling to hold his divided Syriza party together.

While his own personal popularity is high, a renewed drop into recession after a modest recovery last year would test his government's ability to push through the tough mix of tax hikes, spending cuts and economic reforms demanded by the lenders.

Formal negotiations with officials from the European Commission, European Central Bank and International Monetary Fund are due to start in Athens on Friday with the aim of wrapping them up by Aug. 20.

But already there have been doubts about whether the severely weakened Greek economy can support the program after a six year-long slump that has cut national output by a quarter and sent unemployment over 25 percent.

Banks have re-opened after the ECB restored emergency funding last week but capital controls remain in place, hobbling companies that deal with suppliers outside Greece and highlighting the fragile state of the financial system.

Syriza rebels

A senior Greek official said on Thursday that Greece would not reach a one percent primary budget surplus, net of interest rate payments, this year, missing a target agreed with the lenders prior to the imposition of capital controls.

The banks, which would collapse immediately without the ECB's emergency funding, face recapitalization but how much the operation will cost will only be known after banking stress tests due to start in August, the official said.

After debating the bailout reforms in parliament until near dawn, 36 Syriza rebels defied the government, forcing Tsipras to rely on pro-European opposition parties to pass the measure and raising the prospect of a snap election once the deal is sealed.

The rebellion was slightly smaller than in a vote on a first bailout bill last week when 39 Syriza lawmakers dissented. But it confirmed the deep split in the radical leftwing party, which won power in January vowing to end austerity.

State Minister Nikos Pappas, one of Tsipras' closest aides, told the semi-state Athens News Agency that the government would move to complete the bailout negotiations before taking a decision on its next political move.

"Unfortunately, a rupture has been confirmed but I think we will get the procedures for the deal concluded first and then we will look into all these things at the party," he said.

If the talks are not completed in time, European authorities who provided a 7 billion euro bridging loan to allow Athens to meet debt repayments this week, may have to provide further temporary financing.

European Economic Affairs Commissioner Pierre Moscovici said that a change in the rules governing the EFSM, an EU fund that was used to provide the first bridging loan, would enable the fund to be used for a second loan.

The new rules provide a guarantee to non-euro member states which had been concerned that the fund, intended for the full 28-member EU rather than the narrower group of countries in the single currency, was being diverted to bailout the euro.