DUBLIN (Reuters) - Ireland's gradual recovery is fragile but signs of life in the domestic economy suggest it is capable of exiting its bailout on schedule at the end of this year, the International Monetary Fund (IMF) said on Wednesday.
Rescued by Europe and the IMF in late 2010, Ireland has consistently hit the targets set under its bailout and closed in on weaning itself off emergency assistance last month by raising 5 billion euros ($6.42 billion) in a landmark 10-year bond sale.
The IMF said positive indicators were emerging for a revival in domestic demand, employment, and credit extension, evidence of stabilization backed by exchequer figures that showed Ireland was 0.5 percent ahead of its revenue goal for the year at the end of the first quarter.
However the Washington-based body, one of Dublin's 'troika' of lenders, cautioned again that Ireland's prospects hinged on a recovery in the European economy and further help by European leaders to ease the burden of the country's banking debt.
"Recent positive financial market and real sector developments support Ireland's capacity to exit the EU/IMF-supported program at year-end," the IMF said in its latest review of Ireland's progress.
"However, growth is expected to remain sluggish in 2013 and the outlook for gradual recovery over the medium term remains highly uncertain."
The IMF kept its growth forecasts for the next two years unchanged, predicting the economy would expand by 1.1 percent this year and 2.2 percent in 2014 - the first time in six reviews that it has not marked down growth for 2013.
Ireland's economy has grown for the last two years but it contracted in the third quarter of 2012 and was flat in the fourth as weak external demand weighed on exports.
Wednesday's exchequer data also showed that spending by government departments was down 4.9 percent compared to a year ago while the finance department suggested that an underlying 7.9 percent year-on-year increase in income tax may reflect a stabilizing labor market.
The IMF said a deal struck with the European Central Bank in February to ease the burden of Ireland's bank debts provided a welcome easing in government financing needs, but that any gain that could potentially soften future budget plans would only be weighed up later this year.
The government promised voters a 20-percent reduction in the 5.1 billion euros of austerity measures planned by 2015 in the aftermath of the deal, a first easing of the regime of spending cuts and tax hikes in five years that the IMF did not rule out.
"We would take a fresh look but still would be looking to safely achieve the medium term targets," IMF mission chief to Ireland Craig Beaumont said in a conference call.
"There would be a need to look at fiscal performance in 2013 and also take a fresh look at the growth outlook and the potential for revenue growth."
Beaumont added that the troika had begun talks on how best to smooth Ireland's bailout exit, which include the possibility of extending a precautionary credit line, but that the parties had not got to the point of discussing potential amounts.
The IMF also reiterated that European leaders should allow its rescue fund, the European Stability Mechanism, to assume some of the burden of Ireland's bank recapitalizations, saying it could be invaluable to Ireland's debt sustainability.
While the ESM was expected to be able to directly aid euro zone banks that run into trouble from mid-2014, the head of the region's finance ministers told Reuters last month that the aim is for the ESM never to have to be used.
($1 = 0.7789 euros)
Editing by John Stonestreet