* Bailout exit looming on May 17
* Govt to decide on strategy next month, EU still divided
* Benchmark bond yields around 4 pct, lowest since 2010
* Economy growing again after worst recession since 1970s
By Andrei Khalip
LISBON, March 28 Portugal's chances of making a
clean break from its international bailout in May are growing as
its economic outlook gradually improves, borrowing costs slide,
and some political dividends are seen for the government from
going it alone.
But any positive market impact of such an outcome may be
limited, analysts say. Some warn that the country's economy is
still too fragile and could only benefit from a precautionary
credit line after the end of the rescue programme.
Prime Minister Pedro Passos Coelho has said the government
will decide on what to do in April. He has not ruled out
following the footsteps of Ireland whose decision to dismiss any
further support after its EU/IMF bailout ended in December was
greeted with enthusiasm and a drop in yields in the markets.
Next week, Passos Coelho's cabinet will start a marathon of
meetings to discuss the budget strategy for the next few years
that needs to continue the course of deficit cuts, and the
bailout exit is likely to be among the themes.
EU economy and finance ministers will also debate Portugal's
bailout exit at an informal Ecofin meeting next week in Athens.
With the blessing from Europe's powerhouse Germany, Lisbon
could try to leave the rescue programme behind without a formal
stand-by agreement in place and see if it can stand on its own
in debt markets, analysts and some European officials say.
"The idea in Portugal seems to be skewed towards a clean-ish
exit, but knowing that the European support mechanisms are there
in case they are needed," said Antonio Costa Pinto, a political
scientist at the University of Lisbon.
One senior European Union source told Reuters he saw at
least a 70 percent probability of a clean exit for Portugal
thanks to benign market conditions, strong cash buffers at
Portugal's Treasury and the greater political attractiveness of
such an outcome both for Lisbon and the euro zone.
The leader of the main opposition Socialists has said that
anything but a clean exit would mean the government's failure as
its "obligation, after the heavy sacrifices imposed on the
Portuguese, is to create conditions for a return to markets
without the need for any support".
"From the point of view of internal politics a precautionary
loan would not look so good," Costa Pinto said.
Gilles Moec, an economist at Deutsche Bank, said a clean
exit was more likely as it would be "more palatable in Portugal
and Europe, with a spin as another success after Ireland".
"That's not necessarily a good thing though and appears a
bit short-sighted. I don't think it will have either positive or
negative effect on the market, while a precautionary line with
further conditionality would be an additional positive."
Still, a senior euro zone official pointed to existing
differences on the matter, saying that while Germany clearly
favoured a clean break, most other countries and the European
Central Bank "would prefer to see a precautionary line". But the
final decision is with the Portuguese, EU officials insist.
Comments by another European official appeared to support
the possibility of Lisbon ending its bailout on May 17 without
any new programme in place, at least for a while.
"There could very easily be a certain time lapse between an
expiring programme and a successor programme ... it's not that
the range of options is drastically narrowing down to one" as we
approach May 17, he said.
Analysts say any standby loan should be in excess of 10
billion euros to plug any potential funding holes for a year.
Credit ratings agencies also have different views on a
precautionary loan. Moody's has said it will not make much of a
difference on its rating. But Fitch has said that a
precautionary loan would be more supportive for its rating.
A one notch upgrade by Fitch could help Portugal back into
its investment territory.
Some of the arguments for a safety cushion are that
Portugal's bond yields still exceed Ireland's by around a
percentage point, that Portugal's economy is structurally weaker
and that its debt and financing needs are higher.
But there have been tangible improvements on practically on
all these fronts, especially in terms of 10-year benchmark bond
yields, that on Friday touched just below 4 percent for the
first time in four years.
That is a level Ireland, whose yield is now at 3 percent,
saw three months before the end of its bailout.
The Bank of Portugal on Wednesday upgraded its economic
outlook for 2014 and beyond, expecting a gradual recovery in
consumption and investment to stoke growth through 2016. In a
change from its previous warnings of downside domestic risks, it
now sees some potential for positive surprises.
"Portugal's outlook is improving significantly," said
Lefteris Farmakis, an economist at Nomura Securities in London.
"They expect to be pre-funded for 2015 at the end of this
year. At 6 percent borrowing costs you need both pre-funding and
a precautionary loan, but current yields allow to think in the
direction of a clean exit."
(Additional reporting by Paul Taylor, Jan Strupczewski and
Martin Santa; Editing by Alison Williams)