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This work proposes a novel scheme for lossy compression of an encrypted image with flexible compression ratio. A pseudorandom permutation is used to encrypt an original image, and the encrypted data are efficiently compressed by discarding the excessively rough and fine information of coefficients generated from orthogonal transform. After receiving the compressed data, with the aid of spatial correlation in natural image, a receiver can reconstruct the principal content of the original image by iteratively updating the values of coefficients. This way, the higher the compression ratio and the smoother the original image, the better the quality of the reconstructed image.