NICOSIA, April 1 (Reuters) - Cyprus is making a comeback from near bankruptcy although its banks are still struggling with bad loans and political support may be waning for tough measures, an IMF report said on Tuesday.
The IMF, which together with the European Union bailed the Mediterranean island out a year ago, also flagged risks to Cyprus from its close business ties with both Moscow and Kiev.
"The Ukraine crisis may lead to capital flight from non-resident depositors of foreign banks in Cyprus, which may affect the business service sector," the International Monetary Fund said in an appraisal accompanying its third tranche of aid under the three-year bailout programme.
Some 40,000 Russians live in Cyprus out of a total population of 800,000.
Cypriot officials acknowledge risks if East-West tensions rise but say deposits have stabilised after a rout on its banking system last year. Cyprus had to seize money from big savers, many of them Russian, as a condition of its 10 billion euros ($14 billion) bailout. Capital controls are still in force.
EU/IMF aid is directed mainly towards supporting the island's fiscal needs.
Tuesday's report was the first since the collapse of a centre-right governing coalition in early February. Diminished political support for the programme, going forward, was a risk, the IMF said.
It noted non performing loans for the core domestic sector reached 50 percent of total loans - 22 billion euros, or 135 percent of gross domestic product (GDP). Parliament is debating the politically-sensitive question of how assets can be repossessed.
Cyprus defied lenders' projections with a shallower recession than anticipated in 2013. The economy shrank around 6 percent compared with initial forecasts of about 9 percent.
The IMF maintained its forecast of a further 4.8 percent fall in output in 2014, but said the island might instead be able to sustain a pick-up in economic activity which started in the second half of 2013.
Prospects for exploiting offshore gas reserves, and the reunification of the ethnically-split island could raise the economy's long term growth potential, the IMF said.
Last month Cyprus's parliament approved plans for privatisations, averting a showdown with international lenders who insist on state sell-offs. ($1 = 0.7256 Euros) (Reporting by Michele Kambas; Editing by Ruth Pitchford)