LISBON (Reuters) - Portugal's economic adjustment under an EU/IMF bailout has "reasonably strong" chances of success, although rising challenges, mainly from the euro zone crisis, risk deepening its recession, the International Monetary Fund said on Tuesday.
In a staff report following last month's mission to Portugal, the Fund said "the extent of fiscal adjustment has been impressive" in the first year of the 78-billion euro bailout. It noted that a slightly milder 2012 economic contraction is now projected compared with the previous review.
The IMF said the external "challenges only reinforce the need for determined action in adherence to the programme", which it said could be refined. But the report appeared to reinstate its confidence in the original programme, while in April the IMF had said Portugal's recession may force it to alter fiscal goals.
The economy is still expected to decline 3 percent this year after last year's 1.6 percent decline. The previous 2012 contraction forecast was an even steeper 3.3 percent drop.
The Fund on Monday approved a 1.48 billion euro loan disbursement to Portugal, urging it to stick to strong economic policies and reforms so it can regain access to capital markets in late 2013 as the programme envisages.
"The authorities are building a convincing track record of meeting adjustment and reform objectives while preserving political support, and prospects of success for the program remain reasonably strong," the IMF staff report said.
But it warned of multiple risks to Portugal's performance from a European slowdown, growing debt woes at its neighbour and main trading partner Spain, as well as higher-than-expected unemployment at home. The jobless rate is at a record level of over 15 percent and still expected to rise this year and next.
It said market access "will depend on sustained program implementation and improved euro area financing environment".
"Staff nonetheless considers that market access can be regained within the period (by the fourth quarter of 2013) ... but risk remains of delay in market access, and euro area lenders may be called upon to provide adequate support to Portugal so long as performance under the program is on track."
It also said the country could accomplish a gradual return to the debt market by lengthening Treasury bill maturities -- a process already under way -- as well as issuing medium-term notes to specific clients. Such notes could serve as a bridge towards issuing longer-dated bonds further down the road.
EU officials have repeatedly said they will stand by Portugal if it sticks to the programme's targets and yet fails to fully finance itself in the debt markets after the end of the bailout. Most analysts expect that a second bailout will be needed, although the government says it will not request neither more money nor more time to meet the targets.
The IMF reiterated that this year's budget deficit target of 4.5 percent of GDP remained within reach but cautioned that a recent weakening in revenues spelt risks to the goal. The government has acknowledged there are budget risks, but vowed to tackle them so as not to jeopardize targets.
The IMF said that higher-than-expected joblessness and lower domestic demand were expected to generate a gap worth 0.5 percent of GDP with respect to the target, but this could be offset by re-programming of EU cohesion funds, lower-than-expected net interest payments and tight budgetary execution.
No new measures to achieve the 2012 target are required at this stage, it said, but did not rule out such a need if the situation deteriorates. (Reporting By Andrei Khalip. Editing by Jeremy Gaunt.)