Cyprus says suggestions of a haircut on its debt are unfounded

NICOSIA (Reuters) - Cyprus dismissed as unfounded on Thursday any suggestion the IMF is seeking a writedown of the island's debt before it agrees to participate in a multi-billion euro bailout.

Finance Minister Vassos Shiarly was responding to a German media report that the International Monetary Fund had advocated a haircut on Cypriot bonds as a condition for IMF participation in an aid program for the euro zone member, which is heavily exposed to debt-crippled Greece.

"It is an unfounded allegation on which I do not wish to comment," Shiarly said.

"There is no issue of a haircut. These reports are allegations of a position allegedly taken by the IMF. The IMF has never made such a reference and it is unnecessary to even comment on it."

Cyprus, one of the smallest states in the euro zone, reached a preliminary deal with international lenders last month to get up to 17.5 billion euros in aid, equivalent to the entire annual output of its economy.

The bulk of that amount, or up to 10 billion euros, would go towards recapitalizing banks badly hit by a restructure of Greek sovereign debt earlier this year, according to the draft of the deal.

Germany's Suddeutsche Zeitung newspaper said on Thursday that the IMF was concerned about the sustainability of Cyprus's debt and wanted to see private sector involvement in dealing with it.

Shiarly said the level of aid to Cyprus would only be definitively clarified by mid-January, when consultants complete an assessment of the island's banking system.

"It would be premature at this stage to discuss an issue of debt sustainability or not," he said, adding he expected it to be discussed at a euro zone finance ministers' meeting on January 21.

Cyprus approved on Wednesday its 2013 annual budget which calls for sweeping spending cutbacks and tax increases. The island says it plans to save up to 1.3 billion euros over a four-year adjustment period as its part of the bailout deal.

Austerity measures will keep the island in recession through 2013, with the government forecasting the economy will shrink 3.5 percent in 2013 after an expected 2.4 percent contraction this year.

(Editing by Stephen Nisbet and Susan Fenton)