LISBON Portugal is facing a potential political crisis if its constitutional court rejects government austerity measures, risking more euro zone turmoil on top of the Cyprus bailout this month.
Publico newspaper said on Thursday Portugal's premier Pedro Passos Coelho had told his closest colleagues his government may fall if the court rejects more than 1 billion euros worth of austerity measures from this year's budget.
Such a collapse, or a major failure in meeting budget targets, could derail Portugal's exit from its bailout program arranged by the European Union and International Monetary Fund in 2011, undoing attempts to regain full access to debt markets.
The court, expected to rule in the coming weeks, has been analyzing this year's budget since January. Opposition parties have argued that cuts to pensions, civil servants' salaries and welfare benefits undermine workers' basic rights.
A ruling against the budget could compromise around 2 billion euros out of some 5 billion euros in this year's austerity measures that include the largest tax hikes in living memory.
"If the government falls because of that, it's definitely not going to be nice for Portugal and for the euro zone, because Lisbon has moved closer to Ireland and is perceived as a tentative success of the adjustment program," said Giada Giani, an economist at Citi in London.
Portuguese 10-year bond yield jumped to 6.5 percent on Thursday from 6 percent at the start of the week mostly on concerns about the wider impact of Cyprus' bailout - the first in the euro zone to impose losses on bank depositors.
Publico said the prime minister had told the permanent commission of his center-right Social Democratic Party the government was unlikely to be able to find alternative measures to compensate for an unfavorable ruling from the court.
"I will not speculate or create expectations around possible (court) decisions. I won't contribute to instability," Passos Coelho told reporters when asked to comment on the report.
Filipe Garcia, head of consultants Informacao de Mecrados Financeiros in Porto said the "possibility of a political crisis" exacerbated already high risks of this year's budget execution stemming from the recession.
Citi's Giani said that even if the court rejects a large part of the measures - which is far from certain - the government should still be able to adopt additional steps to compensate without having to quit. "Comparatively, things are still pretty much contained in Portugal."
On Wednesday, Passos Coelho declined to predict the outcome, but told reporters "the court has to take responsibility for its decisions and for the impact they may have on the country". Last year, the court dealt a blow to government plans of more public sector wage cuts, forcing it to resort to tax hikes instead.
Antonio Costa Pinto, a political analyst at the University of Lisbon said the government was pressuring the court to uphold most of its measures, but he could not rule out a real crisis unfolding.
"I have no doubt it is a dramatization to pressure the court, but sometimes such dramatizations bring down those who dramatize things," he said
Moody's Investors Service on Thursday affirmed Portugal's Ba3 rating - which is three notches below investment grade and the lowest of the three major raters - but kept it on negative outlook, citing high public debt and the country's vulnerability to regional shocks such as the Cyprus crisis.
Standard & Poor's ratings agency has recently raised its outlook on Portugal to stable from negative.
(Reporting By Andrei Khalip. Editing by Jeremy Gaunt)