LISBON (Reuters) - The European Commission said on Thursday that Portugal's bailout programme remains "broadly" on track and its recovery is becoming more entrenched, but said the risks, mainly from pending court rulings on reforms, were significant.
The outlook was based on the commission's summary of the 10th review of Portugal's performance under the bailout, which took place December 4-16, and its release on Thursday coincided with the beginning of the penultimate review by creditors.
Portugal hopes to smoothly exit the bailout in May and the "troika" of creditors - the European Commission, the IMF and ECB - are hoping the country's improving short-term outlook will allow it do that even though economic challenges are still high.
"While the baseline projection implies that the recovery becomes gradually more entrenched, downside risks remain significant," the commission said.
The commission said the risks are "first and foremost of a legal nature", pointing to the Constitutional Court's pending decisions on a number of austerity measures from this year's budget that have been challenged by the opposition.
The IMF said separately on Wednesday that Portugal will have met its deficit goal for 2013 by some margin, but said the country still faced "formidable challenges", also pointing to the legal and economic risks.
Portugal's benchmark 10-year bond yield rose on Thursday from its lowest levels in almost four years earlier this week to 4.97 percent, but is well below 6 percent where it started 2014.
The government has not played down the challenges that remain although it is showing increasing confidence in leaving the bailout behind. It has issued two bonds this year and has covered all of this year's financing needs.
"The government was the first to warn about the risks given the country's level of debts," Cabinet Minister Luis Marques Guedes told journalists on Thursday when asked about the troika review, which should last about two weeks, and the warnings.
"Nobody should delude themselves - we do still have a demanding path of consolidation of public accounts ahead, which is not immune to risks," he said, adding that the creditors' assessment was not just warnings but also praise.
Ratings agency Fitch said this week Portugal was moving in the right direction but it was premature to raise its credit rating back to investment grade from "junk". It has also said Portugal would benefit from a precautionary credit line after the end of its bailout, unlike Ireland which made a clean exit from its rescue programme in December.
Prime Minister Pedro Passos Coelho has said the government and its creditors will decide in April on whether Portugal will need a precautionary loan agreement, which many economists still believe will be necessary.
Economic growth returned to Portugal in the second quarter of last year and continued through the rest of 2013 as unemployment began to fall, bond yields fell sharply and confidence has grown steadily.
The return to growth came after three years of recession - the worst since the 1970s - as the country implemented harsh austerity and structural reforms under the bailout.
In another sign of the economic improvement, Portugal on Thursday posted its first current account surplus for a full year in two decades for 2013 and a sizeable surplus in the combined balance of trade in goods and services.
The commission also said the country's budget goals for 2013 had been met and Lisbon needed to continue those consolidation efforts this year. "A rigorous implementation of the 2014 budget will be a decisive step in the transition to a post-programme environment," it said.
Portugal met last year's budget deficit goal of 5.5 percent of gross domestic product and this year must cut the deficit to 4 percent of GDP.
(Additional reporting by Sergio Goncalves and Andrei Khalip; Editing by Alison Williams)