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Greece - the price of salvation

Gavin Hewitt | 12:55 UK time, Sunday, 2 May 2010

Greek Finance Minister, George Papaconstantinou, 2 May 10ATHENS Greek cabinet ministers turned up for a Sunday cabinet meeting to learn the terms of their salvation. They have agreed to a rescue package of around £120bn. The country now, in effect, is a protectorate of the European Union and the International Monetary Fund. The Greek Finance Minister, George Papaconstantinou, said "the choice was between collapse and salvation".

The IMF and EU have set a hard bargain. In exchange for bailing Greece out they are demanding £30bn of new budget cuts over three years. This is on top of cuts already announced and this is a country already in severe recession. The economy will shrink by 4% this year.

This unprecedented rescue package is intended not just to save Greece but to prevent other eurozone countries, with large deficits, from facing similar crises.

The road to economic health will be long and rocky. It was revealed today that debt would soar to 150% of GDP. It would only start falling in 2014.

In order to reduce its deficit to 3% of GDP by 2014 Greece will have to implement deep spending cuts and tax increases. Salaries and pensions in the public sector will be frozen for three years. Annual holiday bonuses - so important for Greek income - will be capped. For higher earners they will be scrapped. There will be a 10% hike in fuel, alcohol and tobacco taxes. VAT will rise to 23%. Illegal construction will be taxed. Defence spending slashed.

The Greek Prime Minister, George Papandreou, said: "I want to tell Greeks very honestly that we have a big trial ahead of us."

The first test of these measures will be with Greek public opinion. A general strike is planned for Wednesday. Mr Papaconstantinou said: "The vast majority of the population is behind us because they understand that we don't want to tell people lies."

However, many public sector workers have already seen their take-home pay fall by 20%. The government has a big task in persuading the people that the choice is pain or bankruptcy.

The second big doubt is what this will do to Greek growth. The economy is already shrinking and the risk will be that these cuts will only reduce demand further, making it even more difficult for Greece to escape recession.

The funds are loaned to Greece for three years. Some will question whether the country will be able to pay back what it borrows. Some in Germany suspect the money will eventually have to be written off.

This package is not just about a financial bail-out. It is aimed at changing the Greek economy to make it more competitive. In the future it will be easier to hire and fire. Proper accounting methods will be adopted. This wholesale restructuring of the Greek economy is necessary otherwise Greece will be in the same position again in three years time. But make no mistake, it will be hard to change a culture where corruption and backhanders are rife.

One of the biggest questions relates to the European Union. This is a day of humiliation. It was never envisaged that a eurozone country would need bailing out. Today the EU had to launch one of the biggest financial rescues ever attempted. What the plan does do is to buy time and to shelter Greece from the fierce winds of the markets. What it doesn't do is to answer the questions of whether economies so fundamentally different as Greece and say Germany can be part of the same monetary union.

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