* Government should stay until end of term in 2015
* Analysts expect good market reaction, but situation still wobbly
* Proposed government reshuffle yet to be confirmed
By Andrei Khalip and Sergio Goncalves
LISBON, July 21 (Reuters) - Portugal’s President Anibal Cavaco Silva on Sunday ruled out a snap election and said he wanted the centre-right coalition government to stay in place to keep an international bailout on track.
Political turmoil had threatened to derail Portugal’s planned exit from the EU/IMF bailout in mid-2014, especially after “national salvation” talks between the two coalition parties and the opposition Socialists collapsed on Friday.
Lisbon has already been forced to request a delay in the eighth review of the bailout by its creditors, originally scheduled to start last Monday, until the end of August or early September.
“As the national salvation compromise was impossible to achieve, I consider that the best alternative solution is for the present government to remain in its functions, with reinforced guarantees of cohesion and solidity of the coalition, until the end of its term (in 2015),” the president said.
As president, Cavaco Silva has the right to seek to dissolve parliament and call early elections if he believes the government has lost its ability to govern.
But an internal rift within the coalition that triggered the crisis appears to have been resolved, and the government, which has a solid majority in parliament, last week easily defeated a no-confidence motion.
In his televised address, Cavaco Silva said the coalition presented him “guarantees of a solid understanding” on how to successfully complete the bailout programme and allow Portugal to return to full market financing.
“I think it’s a positive decision to calm down investors that removes uncertainty and maintains the drive of meeting the bailout goals,” said Rui Barbara, an economist at Banco Carregosa.
“In the eyes of investors, Portugal should return to the situation before the political crisis.”
The yield on Portugal’s benchmark 10-year bonds spiked to nearly 8 percent earlier this month over the crisis from three-year lows of 5.2 percent in May, but retreated last week on hopes of a solution.
Still, analysts warned that Lisbon’s ability to implement tough austerity measures needed to meet the bailout goals may now be more limited. The 78-billion-euro ($102.5-billion) bailout programme and accompanying austerity policies are associated with the worst recession in Portugal since the 1970s.
“It’s good news for the markets, but everyone gets out weakened from this crisis,” said Filipe Garcia, head of Informacao de Mercados Financeiros consultants in Porto.
The dispute within the coalition started when the junior coalition partner, the rightist CDS-PP party, objected to the appointment of former treasury secretary Maria Luis Albuquerque as finance minister to replace Vitor Gaspar - the architect of the austerity drive in the last two years.
Albuquerque’s appointment after Gaspar resigned on July 1 was well-received by Lisbon’s lenders as a sign of continuity.
Prime Minister Pedro Passos Coelho proposed to heal the rift by making CDS-PP chief Paulo Portas his deputy in charge of talks with the lenders, but Cavaco Silva rejected the plan and called instead for the “salvation compromise” and elections next year.
In his speech on Sunday, the president did not refer to any cabinet changes.
“It will be politically more difficult to implement unpopular measures, but as long as there is an understanding within the coalition there will be government,” Garcia said.
The bailout terms dictate that Portugal cut its budget deficit to 5.5 percent this year from last year’s 6.4 percent and then to 4 percent in 2014, although analysts expect some flexibility from the lenders due to a worse-than-expected recession in Portugal and Europe.
The government projects the economy will contract 2.3 percent this year after last year’s 3.2 percent slump, before returning to meagre growth next year.
Cavaco Silva said the government has vowed to outline its economic plans until the end of its term in 2015 to parliament and call a confidence vote in those policies, which it is likely to win.
The main ruling Social Democrats (PSD) has said the government will press on with meeting fiscal goals for Lisbon to exit the rescue programme by mid-2014 as planned.