WASHINGTON (Reuters) - The International Monetary Fund's executive board approved a $1.3 billion, three-year loan to Cyprus on Wednesday, part of a larger international bailout to help the Mediterranean country avoid defaulting on its debt.
But IMF Managing Director Christine Lagarde said Cyprus's bailout was subject to "substantial risks," as the economy is likely to contract for the next two years.
"The macroeconomic outlook is subject to high uncertainty and risks to the program are substantial," Lagarde said in a statement. "There is no room for implementation slippages. Full and timely implementation of the program is critical to maintain credibility and achieve the program's objectives."
Cyprus had to comply with certain conditions - including winding down its second-largest bank and imposing losses on large depositors - in order to receive the bailout from the IMF and the European Union, which totals 10 billion euros ($13 billion). The approval of the IMF's board means Cyprus immediately gets $110.7 million.
The Washington-based global lender said the financing package is meant to stabilize the country's financial system, achieve sustainable government finances and support economic recovery.
Lagarde said Cyprus's first priority must be to stabilize the banking system. The outsized banking sector led to the country's problems in the first place, after it was burned by losses on loans to crisis-hit Greece.
Independent auditors on Wednesday said the banking system is more vulnerable to money laundering than previously thought.
The government also must consolidate public debt to about 100 percent of GDP by 2020 in order to ensure it is sustainable, the IMF said.
The IMF said its projections for the program assume Cyprus's economy will contract 9 percent this year and 4 percent in 2014, before starting to recover in 2015, similar to falling economic activity in other countries with a banking crisis.
($1 = 0.7705 Euro)
(Reporting by Anna Yukhananov; Editing by G Crosse and Bill Trott)