IMF says Cyprus at risk of even deeper recession

The IMF said Friday that substantial risks still loom for the Cypriot economy even after a multi-billion dollar international bailout aimed at averting a debt default.

A new IMF report predicted a deep recession in Cyprus this year and next and said there is a danger that the downturn could be even more severe if authorities do not adhere strictly to conditions imposed as part of the $13 billion bailout deal.

Cyprus became the fourth euro-zone country to tap IMF aid in Europe’s sovereign-debt crisis, which has entangled the finances of banks and nations in a mutually destructive spiral. Officials involved in the rescue have insisted that the plan, which taps Cypriot bank accounts to help plug the country’s financing needs, won’t set a precedent

Cyprus had to meet certain conditions to obtain the bailout funds. They included forcing depositors to take major losses on savings over 100,000 euros in the country’s two biggest lenders. Also the second-largest bank, Laiki, is being wound down and folded into the larger Bank of Cyprus. Laiki was hardest hit by its holdings of toxic Greek debt and bad loans.

The report served as a stark warning to Cypriot authorities not to slacken strict implementation of the bailout deal’s tough terms.

The IMF said there are substantial risks that the negative effects of the crisis could be even worse than what is currently anticipated. It said the impact of the banking crisis on economic growth is «highly uncertain» and an economic slump could result in a «vicious cycle» of bankruptcies, drops in real estate prices, bank losses, and unemployment. If that happens it «could also lead to a deeper recession than anticipated,» the report said.

It also raised the risk that a crisis of confidence could drive away investments by foreign banks and large depositors, further weakening the already imperiled banking system.

The IMF report projected that the Cypriot economy would shrink by 9 percent this year and another 4 percent in 2014 with unemployment forecast to peak around 17 percent in 2014. However, it said there is a risk this contraction could be even deeper.

Earlier this week, the IMF’s executive board approved a $1.3 billion loan for Cyprus as part of a larger bailout package. The IMF, one of the «troika» of international lenders behind the bailout, said Wednesday it had agreed to provide a 3-year loan of $1.33 billion for the small Mediterranean country, its contribution to a 10 billion euro ($13.3 billion) total bailout.

The approval allowed an immediate payout of $110.7 million.

The IMF said the loan was «intended to stabilize the country’s financial system … and support the recovery of economic activity.”