UPDATE 3-Portugal passes bailout review, risks remain high

Mon Nov 19, 2012 3:47pm EST

* Next tranche is 2.5 billion euros

* Fiscal targets recently eased

By Sergio Goncalves and Daniel Alvarenga

LISBON, Nov 19 (Reuters) - Debt-laden Portugal has passed the sixth quarterly review of its performance under an EU/IMF bailout, opening the way for payment of the next 2.5 billion euro tranche of the loan despite growing economic risks, the lenders said on Monday.

The review, which lasted just a week, found the country was progressing in reforming its economy and the programme remained broadly on track to allow it to again finance itself in debt markets as planned next year. Previous reviews lasted two weeks.

The lenders and the government expect the economy, in its worst slump since the 1970s, to contract 1 percent next year after this year's 3 percent fall, unchanged from the forecasts in their last review in September. The economy should only return to growth, of 0.8 percent, in 2014.

"Confidence in Portugal's prospects continues to grow, both among its institutional partners and market participants," Olli Rehn, the European Commission's top economic official, said in a statement. "This bodes well for Portugal's full return to market financing."

Portugal's Finance Minister Vitor Gaspar said that after the next payment the country will have received 87 percent of the 78-billion-euro bailout.

But he said risks remained, not least from a recession in neighbouring Spain, Portugal's biggest export market.

"An emergency situation is characterised by innumerous risks and uncertainty, denying these circumstances is unrealistic. The challenges we face are very demanding, they will continue to demand sacrifices," Gaspar said.

He said Portugal was considering a cut in corporate tax, a move which could make it more attractive for foreign investment. Planned spending cuts of 4 billion euros in 2013-14 will be discussed with lenders in the next review, he added.

Under the bailout, Portugal must post a budget deficit of 5 percent of gross domestic product this year and 4.5 percent next year. The 'troika' of lenders - the European Commission, European Central Bank and IMF - said the outlook for the bailout plan remained unchanged.

"While downside risks to growth are significant, the program's macroeconomic framework remains appropriate," the troika said in a statement.

The deepening recession, which has undercut tax revenues, prompted the lenders to give Portugal some leeway on its tough budget goals at the last review in September.

The EU and IMF have previously warned of increasing challenges for Portugal's bailout, considering growing opposition to austerity measures that have sent unemployment to record highs at 15.8 percent. Next year, the Portuguese will face their largest hike in taxes in modern history to meet the budget goals.

Economists have warned the tax hikes could prompt a much bigger contraction than expected as consumer confidence suffers.

Portuguese workers staged a general strike on Nov. 14 which turned violent.

Rehn said he was "acutely aware" of how difficult the situation is for the Portuguese, especially those who have lost their jobs. Unemployment is expected to rise to 16.4 percent next year.

"The reforms under way are laying the ground for sustainable growth and job creation and the Commission will continue to stand by Portugal as it sees these reforms through," Rehn said.

German Chancellor Angela Merkel signalled her strong support for Lisbon's efforts during a visit to Lisbon last week.

The lenders and the government have said they remain confident Portugal will be able to return to bond markets as planned next year and bond yields remain far below highs reached early this year.

Yields on Portugal's 10-year bonds fell sharply to 8.5 percent on Monday from 8.75 percent on Friday, a far cry from highs around 17 percent in January.

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