UPDATE 1-Austerity to keep Cyprus in recession through 2013
* Cyprus will remain in recession in 2013-finmin
* Approval of austerity budget "crucial"
* Parliament to debate Dec 18-20
NICOSIA, Dec 6 (Reuters) - Cyprus's recession will extend through 2013 as austerity measures taken under an EU/IMF bailout weigh, even as they lay the foundations for future growth, its finance minister said on Thursday.
Vassos Shiarly said 2013 would also be "particularly difficult" because of a poor external environment and the need to recapitalise a banking sector exposed to Greece.
"This budget is probably the most crucial this body has been called to approve in the modern history of Cyprus," he told parliament in his annual keynote budget speech.
He forecast GDP would shrink 3.5 percent in 2013 after a contraction of 2.4 percent in 2012.
The Mediterranean island, one of the smallest states in the euro zone, sought aid this year after its banks reported huge losses on their exposure to debt-scarred Greece and turned to the state for aid to bolster depleted regulatory capital.
Cyprus says it has reached a preliminary deal with international lenders to cut salaries and pensions, increase taxes and introduce reforms to get aid estimated at up to 17.5 billion euros, virtually the same as its annual economic output.
A four-year austerity programme will generate savings of up to 1.3 billion euros, according to a draft leaked to media last week.
The island's precise funding needs will only be known once an audit is concluded of its banks. A rough working assessment specifies banks need 10 billion euros, though that is subject to review. The state will also require an estimated 6.0 billion euros to reschedule debt, and 1.5 billion to plug deficits until 2016.
Cuts have been incorporated into the 2013 budget. Expenditure has been cut 5.8 percent on an annualised basis to 7.01 billion euros and revenue is seen at 5.86 billion euros, a 1.3 percent increase over 2012.
Shut out of capital markets, Cyprus turned to the IMF and EU for aid after attempts to secure a new credit line from Russia - it borrowed 2.5 billion euros from Moscow in 2011 - failed.
Fiscal adjustments as well as the discovery of natural gas reserves off Cyprus in late 2011 were expected to boost future growth potential, Shiarly said.
Cyprus's leftist government does not have a majority in the 56 member legislature, though the budget is expected to pass. Parliament is scheduled to discuss it from Dec. 18, with a vote expected on Dec. 20.