* IMF official says Icelandic recession less severe
* Iceland economy seen shrinking 7-7.5 pct in 2009 -official
* Outlook for public debt slightly better-official
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REYKJAVIK, Dec 14 (Reuters) - The International Monetary Fund (IMF) said on Monday it could complete a second review of its aid to Iceland in January next year and that the crisis-hit island's recession would be less severe than previously seen.
Iceland's top commercial banks were brought down by the global financial crisis last October, plunging the economy into deep recession and forcing the nation to seek billions of dollars in aid from the IMF and neighbouring countries.
IMF mission chief to Iceland Mark Flanagan told a news conference that the fund's board could vote on continued aid for the North Atlantic island nation early next year.
"Assuming that some actions can be put into place in the next couple of weeks, and assuming that we can have financing assurances in place in that time period, we could bring this review forward for the consideration of the IMF executive board by January," Flanagan said.
The IMF said the outlook for Iceland's economy had improved in recent months and that the economic contraction was now expected to be less severe than originally forecast.
"We are projecting growth now in the 7-7.5 percent negative range -- in the original programme we expected a decline of 10 percent," Flanagan said.
"And we continue to perceive the economy will begin recover in 2010 (and that) growth will resume at that point."
The financial meltdown triggered a collapse in the Icelandic crown, forcing authorities to push interest rates into double digits and put sweeping capital controls in place to shelter the domestic economy
The central bank has started cutting interest rates and a first step in easing the controls was carried out earlier this year.
Flanagan said he expected there would be room for further liberalisation of the controls next year.
After two weeks of talks with Icelandic authorities, the IMF said the country's overall external debt is now expected top be slightly higher than previously assumed, due to larger private sector debts. However, the level is still sustainable, Flanagan said.
The outlook for public debt has improved due to lower than expected costs to recapitalise the shattered banking system. This will allow the fiscal tightening needed to restore public finances to be slightly more gradual than originally forecast, the IMF said.
"We agreed that we should target a slightly lower adjustment of the general government primarly balance than we had targeted in the first review --- about (a) 4.5 to 5.5 percent of GDP adjustment," Flanagan said.
(Reporting by Robert Robertsson; Editing by Victoria Main)