Rescue creditors urge Cyprus to pursue agreed reforms as risks remain

International creditors praised Cyprus Wednesday for meeting the terms of its financial rescue but warned that the country mustn't slacken the pace of reforms to restore market confidence.

Six months after an acute economic crisis that saw its banks close their doors for around two weeks, the small island nation in the eastern Mediterranean is dependent on loans from its creditors, including the International Monetary Fund, in order to pay the bills.

In return for having access to a 10 billion euros ($13.4 billion) rescue pot, the government has to push through wide-ranging reforms, particularly to the banking sector, and strict austerity measures that come at a huge economic cost.

In a conference call with reporters, Delia Velculescu, the IMF's mission chief for Cyprus said the country has made "good progress" in meeting the fiscal targets outlined in the bailout deal. However, she said lingering uncertainty over the economy, especially over a shaky financial system, mean authorities mustn't waver in their plans to streamline the public sector, improve tax collection and sell state companies.

"With large uncertainty and downside risks, fiscal prudence and strong and timely policy implementations remain critical for the program's success," Velculescu said from her base in Washington D.C.

The Cyprus government has promised to adhere to the bailout's terms as the quickest way to get the economy back on track. Next year, it plans to cut spending by a further 700 million euros ($934 million), but says it won't impose new tax hikes.

Citing Cyprus' progress, both the IMF and the country's euro partners have approved installments from the bailout, worth a little more than 1.5 billion euros.

As well as getting a direct bailout from its creditors, Cyprus had to raise money on its own in March from a raid on bank depositors holding more than 100,000 euros in the two largest banks. The raid was the first for any euro-area country.

In addition, the second-largest lender Laiki was shut down and parts of it absorbed by bigger Bank of Cyprus which is undergoing a major downsizing.

The shock to the economy has resulted in a projected contraction of a combined 13 percent of annual gross domestic product this year and next.

Velculescu said a projected return to modest growth in 2015 depends on the government pushing ahead with reforms. Under the rescue plan, Cyprus must achieve a primary surplus — a surplus when interest payments are stripped out — of 4 percent of GDP by 2018. That, said Velculescu, should put Cyprus' debt — expected to peak at 126 percent of GDP next year — on a downward trajectory.

Amid ebbing confidence in the country's financial system, Cypriot authorities have restricted money transfers and withdrawals to head off a rush of depositors pulling their money out. Although restrictions have since been loosened, many remain including a ban on cashing checks.

The government repeated Wednesday that it wants to lift all restrictions "as soon as possible." Velculescu said the IMF expects more capital controls to be lifted this year and next according to a 'roadmap' which authorities are using to determine the appropriate time to do so.

But serious challenges remain for Cyprus' banks. Velculescu said the main problem that banks need to tackle is a rise in bad loans as more people find themselves out of a job. Unemployment is expected to peak at over 19 percent next year from 17 percent currently.

Another key obstacle is a liquidity crunch — especially for Bank of Cyprus — that's making it hard for small and medium sized business to access much-needed cash.