NICOSIA (Reuters) - The European Commission on Friday slashed its economic outlook for cash-starved Cyprus, doubling its recession forecast for the tiny Mediterranean nation in desperate need of a financial bailout.
The island will see its 17.9 billion euro economy contract by 3.5 percent this year, the Commission said in its winter economic forecast. The previous autumn forecast released in November had output contracting by 1.7 percent in 2013.
"Risks remain important and tilted to the downside," the Commission said. Conclusion of an adjustment programme would be of "paramount importance" in stabilising Cyprus's economy, it added.
The economy was expected to contract by a further 1.3 percent in 2014.
Cyprus, one of the smallest euro zone economies, has applied for aid from the International Monetary Fund and the IMF to deal with its worst economic crisis in more than four decades.
The island sought aid last year and needs up to 17.5 billion euros ($23.14 billion) to shore up a banking sector heavily exposed to Greece and to plug fiscal gaps.
But bailout talks have dragged on, complicated by debt sustainability concerns, German misgivings about the island's commitment to financial transparency and delayed by a presidential election the island holds this Sunday.
Out of pocket and shut out of markets since mid-2011, Cyprus has been increasingly relying on short-term expensive borrowing from domestic institutions until aid is released.
Nicos Anastasiades, a pro-bailout candidate who is the favourite to win Sunday's elections, told Reuters in an interview he had "sounded out" institutions, including governments, to give Cyprus a bridging loan before the conclusion of a bailout deal.
Much needed fiscal measures introduced by Cyprus in anticipation of a bailout, record-high unemployment and financial sector deleveraging would be affecting output, the Commission said. In addition, uncertainty was a drag on business and consumer confidence.
"The conclusion of a macro-economic adjustment programme would be of paramount importance in stabilising the economy, but risks would remain on both the external environment and the domestic front," it said.
Unemployment was set to worsen further in coming years to 13.7 percent in 2013, and to 14.2 percent in 2014.
(Editing by Jeremy Gaunt.)