BRUSSELS (Reuters) - EU officials worked on a rescue package for Cyprus on Friday, hoping to get approval from the IMF and euro zone finance ministers later in the day.
Senior sources involved in the negotiations said the package is expected to contain a mixture of tax increases, one-off revenue raising measures, plans for privatizations and the overhaul of Cyprus's banking sector to ensure that funding for the bailout is sustainable.
It is possible Russia will help finance the program by extending a 2.5 billion euro loan already made to Cyprus and potentially reducing the interest rate, officials have said.
Cyprus, with gross domestic product of barely 0.2 percent of the bloc's overall output, applied for financial aid last June after its banks suffered huge losses following a European Union- approved writedown of Greek debt.
Progress was slow under a previous Cypriot government but without help Cyprus would slide into default, threatening progress made last year in convincing investors that the euro bloc can manage its debt problems.
The currency area's finance ministers, joined by International Monetary Fund chief Christine Lagarde, will meet in Brussels later on Friday. But even if ministers agree a plan it will not be definitive.
The troika of IMF, European Commission and European Central Bank has not yet presented a report on the state of Cyprus' banking sector, its economy and possible solutions, and a source said it would likely not do so on Friday either, making anything more than a political agreement impossible.
German Finance Minister Wolfgang Schaeuble on Thursday indicated, however, that he expected the troika report to be ready in time for discussions on a bailout.
Cypriot Finance Minister Michael Sarris will travel to Moscow for meetings on Monday, a Cypriot diplomat said, raising the possibility that an agreement on participation can be struck with the Russians that would be included in a final deal.
"I can't give a prognosis on how far the finance ministers will get," German Chancellor Angela Merkel told reporters. "Of course, swift negotiations are desirable, but things take as long as they do until they are solved with quality because we need a sustainable solution."
Cyprus originally estimated that it needed about 17 billion euros - or the size of its entire annual economic output - to restore its economy to health. Up to 10 billion euros of that were earmarked to recapitalize its banks and 7 billion required for servicing debt and running general government operations.
However, officials are working on a bailout of 10-13 billion euros, the chairman of euro zone finance ministers said on Wednesday, which should help ensure Cyprus's debt-to-GDP ratio is not pushed too high by the bailout.
The IMF has pushed the idea that depositors in Cypriot banks should bear some of the costs of bailing out the island, a process dubbed "bail-in". But that approach is rejected by Cyprus, the European Commission and some members of the ECB, so it remains unclear whether it will be part of the final package.
Instead, officials indicated a deal would comprise revenues from an increase in the corporate tax rate, income from a one-off tax on bank deposits, or alternatively a tax on income from deposits, and other steps such as privatization.
"There is movement now. I am quite confident we can achieve a political deal in the early hours of Saturday," said one source involved in designing a the framework of a deal.
Once the framework of the program is agreed, it will be presented to the Eurogroup Working Group at 1230 local time (07.30 a.m. EDT), officials said. The Eurogroup Working Group comprises senior treasury officials from euro zone member states and other experts and prepares meetings of euro zone finance ministers.
The group will assess whether the plan is politically feasible for member states, goes far enough in steadily cutting Cyprus' debt in coming years and ensuring that the bailout can be paid back - that it is, in EU and IMF jargon, "sustainable".
Euro zone finance ministers will then meet at 12.00 p.m. EDT to consider the package for what many expect will be discussions that will drag on into the early hours of Saturday.
Officials said the best that could be hoped for was a "political agreement" on the proposal, since there was no formal troika report yet and as input may still be required from Russia to finalize the terms.
Plans are already being made for another meeting of euro zone finance ministers next week, once the Cypriot finance minister has returned from Moscow and officials have a more precise idea of the shape of the rescue deal.
Writing by Luke Baker, editing by Jeremy Gaunt