ATHENS/LUXEMBOURG (Reuters) - Greece is likely to get a vital slice of aid in July to avoid default, international lenders said on Friday, while the European Union raised the prospect of expanding the bailout of the euro zone state.
The European Commission, the European Central Bank and the International Monetary Fund, ending a month-long review of their 110 billion euro ($160 billion) bailout program, said Athens had made considerable progress toward repairing its finances but must step up fiscal and economic reforms.
"Once this process is concluded and following approval of the IMF's Executive Board and the Eurogroup, the next tranche will become available, most likely, in early July," they said.
Finance Minister George Papaconstantinou has said Athens will be unable to meet its obligations from mid-July if it does not get the next 12 billion euro tranche of bailout loans. The money was originally due for release on June 29.
Separately, the chairman of euro zone finance ministers held out the prospect of additional aid for Greece beyond the original bailout scheme, which was agreed in May last year.
"I expect the Eurogroup to agree to additional finance being provided to Greece under strict conditionality," Jean-Claude Juncker said after talks with Greek Prime Minister George Papandreou in Luxembourg.
The new plan will for the first time include involvement of private sector investors in helping Greece on a voluntary basis, Juncker said.
He did not elaborate, and sources close to the talks said the way in which private investors would be involved was still under intense debate among EU and ECB officials. Some form of debt rollover, in which investors would maintain their exposure through purchases of Greek bonds when existing ones mature, appears the most likely outcome.
Greek newspaper Kathimerini said a new three-year bailout package for Greece, to run until mid-2014, would total 85 billion euros, of which the EU and the IMF would provide less than half. The rest of the money would come from sales of Greek state assets and a private sector debt rollover, it said.
Greek and other high-yielding euro zone bonds rallied and demand for safe-haven German debt fell as markets anticipated policymakers would reach a fresh bailout deal for Greece. The euro hit a one-month high against the dollar.
Papandreou presented to Juncker a medium-term budget plan featuring deeper spending cuts, measures to boost revenues and a faster sell-off of state assets, to be managed by an independent privatisation agency.
EU Monetary Affairs Commissioner Olli Rehn said Greece's latest fiscal commitments were "essential" to restoring the sustainability of its finances, and could lead to additional aid for Athens.
Athens has veered off course in its current bailout program because of a revenue shortfall due to a deep recession and chronic tax evasion, requiring extra steps worth 6.4 billion euros or 2.8 percent of gross domestic product this year.
The Greek finance ministry said the government would finalize new fiscal measures in coming days, putting them to parliament after the cabinet approves them.
The new steps face rising opposition from trade unions and youth protesters, as well as from some back-bench members of Papandreou's governing PASOK socialist party.
Leftists staged a protest at the finance ministry in Athens on Friday, hanging a huge banner across the building to denounce policies which would "turn workers into modern slaves."
Meanwhile, increased European funding for Greece may face resistance in the parliaments of fiscally conservative northern states, especially Germany and the Netherlands.
Taxpayers in donor countries have so far borne the burden of rescuing Greece and fellow euro zone members Ireland and Portugal. EU officials now feel the participation of private investors is important to secure political support for fresh aid to Athens.
KICK CAN DOWN ROAD
Some European politicians and economists argue that investors in Greek government bonds must do more than simply accept a rollover.
Claudio Loser, a former director of the Western Hemisphere for the IMF, said the Fund should push harder for Greece to restructure its debt and negotiate so-called "haircuts," or reductions in the value of bonds, with investors.
But the ECB has fought that idea, fearing it would trigger a violent chain reaction in financial markets far beyond Greek borders, and provoke a crisis among European banks which hold large sums in Greek debt.
A source involved in the negotiations said the participation of private sector investors in the new deal would be limited to avoid causing a "credit event." That is an event which would inflict losses on holders of Greek bonds and lead to downgrades of Greece's credit rating or the triggering of insurance contracts on its debt.
Most market economists polled by Reuters, however, believe Greece's 340 billion euro debt mountain is unsustainable and will have to be restructured sooner or later. Without a restructuring, an expanded bailout of Athens may simply buy time without solving Greece's underlying problem.
"I think (official lenders) have a plan in their head that is reasonable for kicking the can down the road another three months," said Gianluca Salford, European fixed income strategist at JP Morgan.
(Additional reporting by George Georgiopoulos and Lefteris Papadimas in Athens, Marius Zaharia, Ana Nicolaci da Costa and Chloe Hayward in London; Writing by Paul Taylor; Editing by Ruth Pitchford and Andrew Torchia)