The European Commission said Monday it remains "confident" Cyprus can avoid resorting to a eurozone bailout if it keeps reforms on track, even as the island's central bank chief said a bailout request was a possibility.
"The Commission is in close contact with Cyprus, as with many other countries in the euro area," said senior economy spokesman Olivier Bailly. "We are indeed confident that Cyprus can overcome the current challenges provided it implements the reforms we set out last week."
Bailly was responding to reporters after central bank governor Panicos Demetriades told the Financial Times in an interview published on Sunday that Cyprus was nearing an EU bailout request to deal with the impact of the Greek crisis on its own banking system.
Demetriades acknowledged that with an end-June deadline to find at least 1.8 billion euros ($2.3 billion) to recapitalise the island's Marfin Popular Bank, the country was at "an important crunch time."
Cyprus's parliament on 18 May unanimously backed legislation to underwrite the bank's issue of 1.8 billion euros in new shares to help it recapitalise in the face of its large exposure to toxic Greek debt.
The island's CNA news agency reported that President Demetris Christofias has not ruled out turning to the 800-billion-euro European Stability Mechanism, which is due to become operational from 1 July.
"Government policy on supporting development, the social state and fiscal consolidation, coupled with a rejection of harsh economic measures, has been vindicated," Christofias insisted in a televised address over the weekend.
The communist president has repeatedly insisted that deficit reduction should not come at the expense of growth.
In its annual recommendations published last week, the Commission said Cyprus was facing "multi-dimensional challenges."
"The banking sector suffers from a large exposure to Greece, in terms of both the private sector and the sovereign, and needs to raise fresh capital," the Commission said.
Neither the Cyprus government nor its commercial banks have been able to borrow from international money markets since June 2011.
The commission said that having implemented previous recommendations "only partially," Cyprus must fix its public finances, recapitalise its banks, reform its labour and services markets,
education policy, pension and healthcare systems and energy sector.
The island's economy contracted by 1.4 per cent in the first three months of 2012, compared to the same quarter last year, according to official estimates. The dip marked the fourth successive quarter the economy has failed to grow.
The finance ministry predicts that the Cyprus economy will contract another 0.5 per cent in 2012, which is lower than the European Commission's 0.8 per cent forecast.
The Commission concluded that Cyprus experiences an "internal imbalance due to its banking sector and the indebtedness of the corporate sector and an external and an internal imbalance
on its fiscal dynamics and competitiveness, although not excessive."
It said the island had adopted a series of measures with a view to reducing its fiscal deficit and stimulating growth.
"Despite these efforts, Cyprus is affected by sizeable and persistent current account deficits, large amount of accumulated private sector debt, widening annual deficits of public finances and the large exposure to Greece of the banking sector," the Commission said.
It recommended that Cyprus take additional measures to achieve a durable correction of its budget deficit in 2012.
It said that Cyprus must "take measures to keep control over expenditure and implement programme and performance budgeting as soon as possible, improve tax compliance and fight against tax evasion."