UPDATE 3-Cyprus says euro ministers could decide on aid in Dec

Thu Nov 29, 2012 7:58am EST

* Cyprus says loan deal possibly mid-December

* MOU to target primary budget surplus of 4 pct 2016

* Finishing touches being put on draft deal-minister

* Cyprus negotiating loan with 2.5 pct interest-minister

By Michele Kambas

NICOSIA, Nov 29 (Reuters) - Cyprus could agree a bailout deal with euro zone ministers by mid-December and get a first tranche of funds to shore up its banks by the end of January, its finance minister said on Thursday.

The island, whose banks are heavily exposed to debt-crippled Greece, has been discussing aid conditions with the IMF and EU institutions since June. It could need up to 17.5 billion euros ($22.6 billion), equal to its entire annual economic output.

Finance Minister Vassos Shiarly told lawmakers a preliminary agreement had been reached with international creditors, which needed to be supplemented with a definitive assessment of the banks' recapitalisation needs.

An interim assessment by consultants will be ready by Dec. 7, he said.

"There is a preliminary deal with the troika," Shiarly said, referring to lenders from the International Monetary Fund, the European Central Bank and the European Commission. "(But) I anticipate discussions over the next few weeks will be difficult, perhaps more so than before."

Cyprus had already been shut out of international capital markets by the time its banks turned to the government for help.

The four-year programme under negotiation with the 'troika' of international lenders envisages heavy spending cuts and targets a primary budget surplus - the balance before deducting debt financing costs - of 4.0 percent of gross domestic product (GDP) by 2016.

A finance ministry document submitted to parliament calls for a 6.5 to 12.5 percent cut in public sector salaries, a two-year increase in the retirement age for the public sector, an incremental reduction in the public sector workforce by at least 5,000 by 2016 and a suspension of wage indexation.

Shiarly said authorities were discussing an interest rate of 2.5 percent with lenders, which he described as "very good" under the circumstances.

Cyprus is now heavily reliant on short-term borrowing. It paid 5.0 percent in a private placement for 240 million euros in 30-day bills last month, and the equivalent for 13-week treasury bills worth 151.6 million euros maturing in January.

Lenders say a final agreement cannot be reached until there is more clarity on the capital needs of the island's banks.

Shiarly, speaking to parliament's finance committee, avoided specifying the banks' needs, saying these would be assessed by consultants.

"Many figures have been speculated, from 5 billion to 15 billion euros. Let's wait for the assessment, and even then, that could change," he said, citing the example of Spain, where recapitalisation assessments have moved significantly lower.

A working scenario was a conclusion on Cyprus by mid-December, with up to six weeks for a deal to be ratified by national parliaments. "That would bring us to the end of January for the first tranche," Shiarly said.

Once agreed, the bailout would make Cyprus the fourth euro zone nation to get a sovereign rescue after Greece, Ireland and Portugal. Spain has been granted financial aid to recapitalise its banking sector, but Madrid has not so far asked for money to cover state needs.