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International Monetary Fund (IMF) executive director Christine Lagarde attends a news conference at the end of a Eurogroup meeting at the European Council building in Brussels, March 25, 2013. REUTERS/Sebastien Pirlet


NICOSIA (Reuters) - Bailed-out Cyprus is making good progress in an economic adjustment programme but its outlook is tempered by high nonperforming loans, which could crimp output, and uncertainty over Russia, a key business partner, the IMF said on Wednesday.

Cyprus's level of nonperforming loans (NPLs) is the highest in Europe at almost 140 percent of GDP, and this is curbing credit to the economy, feeding into a negative growth loop, the International Monetary Fund said in a staff report.

Cyprus, one of the smallest economies in Europe, took a 10 billion euro credit line from the EU and the IMF in March 2013, bringing it back from the brink of bankruptcy.

It is now following a three-year economic adjustment programme involving fiscal reform, a banking sector overhaul and privatisations.

While both the IMF and the EU have praised Cyprus for its progress in meeting targets, the IMF did note that following commitments could become more challenging as the island moves away from crisis management and into restructuring and reforms.

It said the authorities were committed to bringing in reforms to foreclosure laws by the end of 2014, a key policy action required to bring NPLs down, the IMF said.

More resilient public consumption meant a recession on the island in 2014 would be shallower than anticipated, at 4.2 percent, from an initial projection of 4.8 percent.

But an anticipated recovery in 2015 could be slower to manifest, the IMF said, cutting its growth forecast to 0.4 percent, half the rate that it predicted earlier this year.

"Staff analysis suggests a slower turnaround of private consumption than previously projected, as households deleverage and adjust to a lower net wealth," the IMF said.

Risks were also tilted to the downside by the Ukraine crisis and its impact on Russian business with the island, even though the fallout had to date been limited, the IMF said.

(Reporting By Michele Kambas; Editing by Kevin Liffey)