Portugal aid review starts; troika seen supportive

LISBON (Reuters) - Portugal's international lenders arrived in Lisbon on Wednesday to review the country's bailout, with soothing words of support likely to dominate as Europe gropes for success stories to counteract its interminable Greek headache.

As the euro zone's second weakest link, Portugal's ability to ride out its debt crisis will be key to Europe's claim that Greece is a unique case.

Despite a groundswell of concerns that Portugal - like Greece - may eventually have to restructure its aid programme, the third inspection of Lisbon's economic performance in the context of its ongoing 78-billion-euro rescue should make that contention clear.

"The review will be all about peace and harmony," said Filipe Garcia, head of Informacao de Mercados Financeiros consultants. "The important thing for Europe is to isolate Portugal from Greece, to put it out of Greece's way in case of a default or even an exit from the euro."

The troika of officials from the European Commission, European Central Bank and IMF are expected to stay in Lisbon for about two weeks.

Portugal was hit in January by a loss of confidence after its rating was downgraded to junk by all the major credit agencies, prompting fears it would need to seek more bailout funding or even be forced to restructure its debts like Greece.

The assumption was fuelled further by comments by German Finance Minister Wolfgang Schaeuble, who said last week Germany was ready to "adjust" Portugal's loan programme.

But the experts from the troika, fresh from encountering Athens aflame in protests against further austerity measures, are likely to emphasise Lisbon's success so far in cost-cutting and economic reform that have sparked a deep recession.

"A principle theme of this mission, in terms of communication, will be to underline that no renegotiation of Portugal's programme is on the table," said a source close to the troika.

Instead, the inspectors are likely to focus on economic reforms and efforts to restructure heavily-indebted public sector companies, especially in the transport sector.

They will also scour the books to ensure the country is on track with strict fiscal goals after last year's target was only met thanks to a one-off transfer of banks' pension funds to the state.

LITTLE VICTORIES

The troika officials highlighted during their last review the next key challenge was for the country to press ahead with reforms to make the economy more competitive, something Athens has fallen back on.

Lisbon can now point to one key victory - reaching agreement with a leading union and employers on labour reforms that will make it easier for companies to hire and fire, cut layoff compensation and reduce the number of yearly holidays.

The efforts are paying off for Lisbon, with some of the lenders viewing the labour reforms as a strong start and European paymaster Germany nodding in approval.

"We are impressed that as far as Portugal is concerned, we not only have negotiated agreements but that these agreements are being implemented, which is not the case everywhere," said Norbert Lammert, the conservative speaker of the lower house of Germany's parliament, during a visit to Lisbon this week.

Still, Portugal's challenges are remain formidable as sweeping austerity -- from deep civil servant pay cuts to across-the-board tax hikes -- has sent the country into its worst recession since the 1970s with record unemployment.

Portugal has been rewarded in the past two weeks with falling bond yields - after they hit euro-era peaks in January - and on Wednesday it carried out its largest debt auction since it first requested a bailout last year.

But the country's benchmark yields remain worryingly high, with 10-year bonds trading at a touch over 12 percent on Wednesday.

The troika will be mindful that if further austerity is foisted on Portugal, the relatively modest economic contraction seen at 3 percent this year could deepen, undermining fiscal improvements like in Greece.

(Reporting By Axel Bugge; Editing by John Stonestreet)