BRUSSELS/LISBON Portugal promised on Friday to take all necessary steps to meet budget deficit goals under a 78-billion-euro EU/IMF bailout after the constitutional court ruled against a measure to cut civil servants' wage deals.
The court ruling marked another challenge to the center-right government's determination to reduce the country's budget deficit and prompted the European Commission to push Lisbon to come up with new cost-cutting plans next year.
On Thursday, a parliament body that monitors budget execution warned that Portugal risks missing its 2012 budget deficit target unless the recession-hit nation sees improved indirect tax revenues.
The court said late on Thursday that pay cuts to civil servants that the government planned cannot be applied just to workers in the public sector.
The cuts are a part of the government's austerity measures and apply to holiday subsidies, amounting to up to two months' wages. The court only challenged the validity of the cuts from next year.
"We note in particular that the court has explicitly left the measure in place for 2012, in order to avoid endangering the achievement of the fiscal target for this year," European Commission spokesman Simon O'Connor told a regular briefing.
"The target for 2012, although challenging in a difficult macroeconomic environment, remains therefore achievable." But Portugal would have to make new proposals for 2013 to meet its fiscal objectives and timeframe.
Prime Minister Pedro Passos Coelho said the government will now have to consider whether to apply the cuts to private sector workers as well as the civil service.
"Today I want to reiterate our determination to control the public deficit, to take all measures needed to guarantee our targets are met," Prime Minister Pedro Passos Coelho said in televised remarks on Friday.
Passos Coelho said the government will now have to consider whether to apply the cuts to private sector workers as well as the civil service.
The IMF's representative in Lisbon, Albert Jaeger, said it will "be particularly important to ensure that the 2013 budget is in line with program targets as well as this (court) decision". Portugal and its lenders will discuss the 2013 budget during the next review of the bailout program in late August and September.
"We note the renewed commitment of the Portuguese government to the fiscal deficit targets set out in its economic program," he wrote in a statement. "Portugal has a strong track record of implementing fiscal consolidation and structural reforms, and we continue to stand ready to assist the country in these efforts."
Portugal has already won praise from Brussels and Berlin for its determination to meet budget cuts and reform its economy. The country's debt crisis has sent Portugal into its worst recession since the 1970s.
SETTING GOOD EXAMPLE
Filipe Garcia, head of Informacao de Mercados Financeiros consultants in Porto, said the ruling should not knock Portugal's image as a steady reformer off course.
"It is not an anti-austerity move, but rather a legal matter of equality," he said. He added, however, that the quality of budget consolidation would suffer if the government compensates public sector pay cuts, which is state spending, with tax hikes.
Paula Carvalho, economist at Banco BPI, said it "makes sense that sacrifices are shared by all Portuguese, above all that those with higher incomes contribute more."
"But, the problem is that there should be action on public spending and a guarantee that the decline in spending is sustainable," she said.
Many economists have said Portugal will fail to meet budget goals and may have to seek more emergency funding. One key recent concern has been that unemployment has risen more than expected, undermining cost cutting measures as the government has to spend more on jobless benefits.
Garcia said he expected Europe's economic slowdown was likely to convince Portugal's lenders to eventually offer Portugal more time.
"I think it will be a natural decision coming from the troika itself, acknowledging the effort already made by the country. Europe is interested in having in Portugal a good example," Garcia said.
The government says that while it is focused on implementing all the austerity measures under the bailout and meeting its targets, its European partners have promised to stand by Portugal if it does not manage to fully finance itself in the debt markets towards the end of next year as planned.
Portugal met last year's budget deficit goal of 5.9 percent of gross domestic product, mostly thanks to a one-off transfer of bank's pension funds to the state. This year it must post a budget deficit of 4.5 percent of GDP and next year 3 percent.
Despite the court ruling, Portuguese 10-year bond yields only edged up 8 basis points to 10.33 percent on Thursday, staying way off January's record highs of over 17 percent.
(Reporting by Rex Merrifield in Brussels, Axel Bugge, Andrei Khalip and Sergio Goncalves in Lisbon, Editing by Jeremy Gaunt, John Stonestreet, Ron Askew)