Cyprus should return to growth in 2015 after three years of deep recession, the International Monetary Fund said on Friday, but will need to ensure that its sweeping austerity programme does not slip off the tracks.
The IMF agreed in March to provide Cyprus with some 1 billion euros in aid, along with another 9 billion euros from the European Union, to stave off a meltdown of the cash-strapped economy.
A staff report issued on Friday backed that decision, praising the government for the steps it has taken to restructure the economy but warning that it must go even further to achieve long-term stability.
The report said real GDP should grow by a modest 1.1 percent in 2015, after plunging 8.7 percent this year and a further 3.9 percent in 2014.
At the same time, it forecast that already high unemployment should reach 15.5 percent in 2013 and peak at 16.9 percent next year before easing to 14.6 percent in 2015.
The IMF's forecasts for 2013 and 2014 are virtually the same as those in the European Commission's recently published spring outlook, which did not give estimates for 2015.
On April 30, the parliament in Nicosia narrowly approved the 10-billion-euro ($12.9-billion) bailout, in the form of a low-interest loan, agreed with the IMF, European Commission and European Central Bank.
Cyprus will have to raise another 13 billion euros through a wide range of measures, most already adopted, that include a restructuring of the bloated banking sector, tax increases, spending cuts and the part privatisation of state companies.
The IMF report praised the government of President Nicos Anastasiades for having showed "exceptional resolve in addressing the crisis", which it said "averted a potential accident with unknown consequences for the euro-zone".
But it said "time will be needed for the economy to adjust to the deep structural changes to its financial sector and adapt its business model".
And it said the "macroeconomic risks remain unusually high, given the uncertain impact of the banking crisis and fiscal consolidation on economic activity and the adaptation of the business model.
"Financial sector risks to the programme are particularly acute, including lingering concerns about the high reliance of the largest bank (Bank of Cyprus) on central bank support, the system's rising non-performing loans and the future impact of administrative restrictions, but also the potential consequences of their premature lifting."
It also said "political resolve to implement all aspects of the policy programme could falter, adding to risks".
In that case, the country's debt situation could deteriorate, "leading to the need for additional financing measures to ensure debt sustainability".
The IMF said Cyprus faces two major challenges going forward -- the need to stabilise the banking sector and to put public finances on a sustainable path.
It said the newly restructured Bank of Cyprus "needs to be put on a sound footing by completing an asset valuation and ensuring sufficient capitalisation.
"Other banks and the cooperative sector, which were found viable but undercapitalised, will be recapitalised with public funds, and restructured as needed."
The report also referred to emergency capital controls that were imposed, saying they were "inevitable to avert a meltdown of the financial sector".
But it said they could "choke real activity if prolonged", and that it is "paramount to monitor (them) and relax them in line with the capacity of banks to build liquidity buffers."
The IMF also encouraged the government to strengthen banking supervision and reg
As for public finances, the IMF applauded the government's "impressive steps" by passing a budget with measures for the next three years, but said further steps will be needed, with a focus on reduced spending.
It also said that "privatisation will not only help to reduce financing needs, but will also enhance economic efficiency".
In the end, it said "there is no room for implementation slippages".
"The recession could be deeper than projected, which could put debt sustainability at risk. The banking sector could come under renewed pressure, if asset quality deteriorates more than expected and liquidity pressures mount."
And if the programme is not timely and comprehensively implemented, and risks to debt sustainability materialise, "additional financing measures may be necessary".