Contagion-wary lenders may cut Portugal some slack

* International 'troika' starts bailout review on Tuesday

* May reward Portugal for hitting fiscal targets

* Should ensure 'austerity doesn't kill patient' - analyst

* Timing of any fiscal easing or aid boost is uncertain

* Austerity vs growth debate stoked by Greece, Hollande

By Axel Bugge

LISBON, May 22 (Reuters) - Portugal may be rewarded with looser budget targets as its international lenders look to shore up the country's slumping economy and the wider euro zone against contagion from turmoil in Greece.

The troika of lenders start their quarterly review of Lisbon's economic performance under its bailout programme on Tuesday, having praised the country on previous visits for sticking to an increasingly onerous deficit-reduction target.

A raging European debate about how to combine growth and austerity stoked further by political deadlock in Athens means that this time they may also ease Portugal's ambitious fiscal goals.

"It makes perfect sense to offer some relief to ensure that the austerity does not kill the patient," said Rui Barbara, asset manager at Banco Carregosa.

"I think the troika realize that Portugal is doing everything it can," added Lorne Baring, managing director at wealth manager B Capital in London. "I think it will get as much leniency as possible from its northern paymasters."

Lisbon will also be mindful of flexibility granted to other nations at the sharp end of the debt crisis, with fellow bailout recipient Ireland having seen the cost of its official funding cut and neighbour Spain given more leeway on cutting its deficit.

In terms of debt spreads, Portugal is the second most vulnerable country in the euro zone after Greece, so the risks it faces in case of a market flare-up caused by a potential euro exit by Greece are great.

"It would be a significant, negative event for Portugal if Greece left (the euro), which could lead Portugal to be driven by markets to do the same," B Capital's Baring said.

REFORMS TAKE TIME

Officials from Portugal's troika of lenders -- the European Commission, European Central Bank and IMF -- will likely spend around two weeks in the country.

Economists have been saying for many months they expect Lisbon to need more bailout funds at some stage.

Many now also expect the troika to approve looser fiscal goals, especially since Socialist Francois Hollande's election as president of France and confirmation earlier this month that the continent is on the brink of another recession pushed the growth debate much higher on Europe's agenda.

Under its 78-billion-euro bailout, Portugal's centre-right government has introduced sweeping austerity measures that include wage cuts and across-the-board tax hikes as it battles to hit budget deficit goals of 4.5 percent of gross domestic product this year and 3 percent in 2013.

Last year Portugal only met its target of 5.9 percent thanks to a one-off transfer of bank pension funds to the state.

Under the bailout, Portugal also has to introduce structural reforms including changing its labour laws and legal system, which it has won praise for doing at a fast pace.

The government says its efforts in meeting the bailout terms are paying off and has been steadfast in ruling out either a request for more emergency funding or a relaxation of fiscal goals. It has changed its forecast for this year's contraction to a more moderate 3 percent from 3.3 percent previously.

But it is mired in its deepest recession since the 1970s, reforms take time to pay off and the outlook is gloomy - a public finances watchdog saying this week the government's economic forecasts may be overly optimistic.

Unemployment is rising and hit a record high of 14.9 percent in the first quarter, putting more pressure on fiscal accounts as the government will have to pay higher jobless benefits.

FORCE MAJEURE?

The OECD said on Tuesday Portugal will be stuck in recession for longer than expected and that it will need more fiscal measures to meet the bailout goals. The Paris-based group now expects the economy to contract 0.9 percent next year rather than grow by 0.5 percent.

For the government, any about turn on its pledges not to relax targets or seek more bailout funding would be a big defeat. But it has also consistently warned that it cannot control outside events, serving as a sort of escape clause.

"If they (the troika) say Portugal is missing fiscal goals because of an external event Portugal does not have control over, then they are likely to be willing to be flexible," said Diego Iscaro, an economist at IHS Global Insight.

"So far, in terms of what theyve been asked to do they have done, so its very different (to Greece)."

Also unlike in Greece, where rattled depositors have been withdrawing money from banks, deposits at Portuguese lenders have risen to record highs as locals continue to place trust in their banking system.

The timing of any loosening of Portugal's fiscal goals or any additional rescue funds remains highly uncertain.

Iscaro said he expects a decision on a second bailout only in the last quarter of this year or early 2013 - though if Greece leaves the euro it is likely to happen sooner.

Other economists say Europe is likely to wait until after the second election in Greece, which will be key to whether it stays in the euro, before any big decisions on bigger firewalls or more bailout funds for a country like Portugal. (Reporting By Axel Bugge; Editing by John Stonestreet)