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By Dina Kyriakidou
ATHENS (Reuters) - Greece's new socialist government said on Friday the economic situation in the euro zone's weakest link was "explosive" and promised spending cuts to plug big budget holes.
Prime Minister George Papandreou, who won October 4 elections pledging to tax the rich and support the poor, as well as a stimulus package for the slowing economy, said restoring Greece's credibility was a priority.
"The Greek people trusted us to govern at one of the most critical moments in Greece's history," he told parliament as he outlined his main policy before a confidence vote on Sunday.
Burdened with the euro zone's second heaviest debt to GDP ratio after Italy, Greece has seen its economy turn negative after years of booming growth, unemployment rising and social unrest gripping its urban centres.
Papandreou's finance minister told Reuters earlier on Friday the deficit would skyrocket to more than 10 percent of GDP, above an EU ceiling of 3 percent and previous estimates of 6 percent.
"Our aim is to reduce the deficit with permanent and not one-off measures, in a balanced way on the revenue and expenditure sides, and accompany that with a significant programme of structural reforms," George Papaconstantinou said in an interview.
Despite the dire fiscal situation, Papandreou said he would keep pre-election promises of above-inflation pay rises and a freeze on utility prices for 2010 but made clear spending cuts will be have to be made.
"Today we face an unprecedented fiscal derailment," he said. "The deficit must be cut and we must start containing the public debt."
With a comfortable majority of 160 seats out of 300, Papandreou is sure to win Sunday's confidence vote.
Analysts said Papandreou's team faced a tough juggling act between convincing markets and fulfilling electoral promises to inject money in the economy.
"If they tighten the fiscal policy too much then the economy may suffer more than it is suffering at the moment," said Diego Iscaro, at IHS Global Insight. "But if they are seen as not doing enough, then the markets may start losing confidence."
BUDGET DEFICITS GROW
The premium investors seek to hold 10-year Greek government bonds over euro zone benchmark Bunds hit an 11-day high after Papaconstantinou said more borrowing was needed this year and bringing the deficit below 3 percent could take 3 to 4 years.
Greece's debt is estimated at 103 percent of its 250 billion euros (228 billion pound) GDP this year. Papaconstantinou gave no further details on Greece debt options.
A chronic budget deficit offender, Greece will find little sympathy in Brussels, where it will submit a three-year plan outlining fiscal consolidation and structural measures.
Papandreou blamed the outgoing conservatives, ousted after five years in power due to scandals and the economic slowdown, for plunging Greece into the worse economic situation since 1993, the last time it suffered a recession.
He said transparency and the drastic limiting of waste in the public sector would help fiscal consolidation.
Papandreou admitted Greece's international standing was hurt by unreliable figures and failure to meet targets and promised to follow a policy of dialogue and no negative surprises.
"Our first immediate goal is to restore the confidence of our European partners and international markets in our country. The blow we have suffered is great and negotiations with the EU will be hard," he said.
He outlined his vision for a "green growth" model based on renewable energy, promising that 20 percent of energy production will be green by 2020, a target Greece is far from achieving.
"Green growth is the passage to a new age of new technologies, with thousands of new 'green jobs' with decent salaries. It is the development model for our country that will bring wealth that will be equally distributed," he said.
(Additional reporting by Ingrid Melander and George Georgiopoulos; Editing by Angus MacSwan)