October 6, 2016 / 2:31 PM / 10 months ago

EXCLUSIVE-Portugal targets ambitious 2017 deficit cut to below 2 pct

LISBON, Oct 6 (Reuters) - Portugal aims to narrow its budget deficit to just under 2 percent of gross domestic product next year, its top finance official said on Thursday, in an effort to convince credit rating agencies to maintain their ratings.

Heavily indebted, slow-growing Portugal needs to maintain at least one investment grade rating from a recognised rating agency to keep receiving funding support from the European Central Bank.

That lifeline could be at risk on Oct. 21 when a rating update is due from DBRS, because Standard & Poor's, Moody's and Fitch all have Portuguese sovereign debt one notch below investment grade.

The minority Socialist government's deficit goal is more aggressive than the forecasts of its two main creditors, the European Union and the International Monetary Fund, which see its budget gap next year coming in at 2.3 percent and 3 percent respectively.

"I'm confident that this budget ... will leave the ratings agencies, not just DBRS, comfortable with the current ratings," Secretary of State for Finance and Treasury Ricardo Mourinho Felix told Reuters by phone from New York, where he is trying to drum up investor interest in Portugal.

Lisbon's borrowing costs have jumped since DBRS warned in August that sluggish growth put pressure on the country's creditworthiness.

But Mourinho Felix said that after contacts with the agency, the government was convinced that "no changes are at stake on Oct. 21" although DBRS still wants to see the budget. The budget bill and its concrete targets will be unveiled on Oct. 14.

"Next year, with the economy picking up steam, we can talk about changing the ratings, but upward", which would bring more investor cash and support growth, he said.

Portuguese debt has been rated as junk by the three largest agencies since its 2011 debt crisis and EU/IMF bailout.

The reduction in the deficit will come from growth but also from "very strict control of spending by the state and public companies", Mourinho Felix said.

On the revenue side, the government plans some tax cuts counterbalanced by changes to some deductions and tax benefits.

Mourinho Felix said the country's banking system is stabilizing after two state rescues of lenders in 2014 and 2015 that undermined investor confidence.

Portugal in August agreed with Brussels a recapitalisation of its largest bank, the state-owned CGD, and last month moved to take pressure off the system by extending maturities on state loans to the bank resolution fund.

"After the banking system problem is resolved... and some international risks like the U.S. election and the referendum in Italy abate, leaving fewer uncertainties - all that should benefit Portugal and bring its bond spreads lower," he said.

Mourinho Felix said the government did not see the slowing pace of Portuguese bond purchases by the ECB as a serious problem since the bank still has room before reaching its limit on such purchases.

The Treasury will keep a liquidity buffer covering its financing needs for at least six months ahead in case of an increase in market volatility, he said.

The government aims to narrow the budget gap this year to below 2.5 percent from 4.4 percent in 2015 despite slowing economic growth and scepticism from the IMF, which projects a deficit of 3 percent. The European Commission sees the gap at 2.7 percent in 2016, above the 2.5 percent goal it has set Lisbon.

Mourinho Felix said the country was on track to meet its deficit target this year and will stay the course in 2017.

"To meet our European commitments we have to ensure in 2017 a structural adjustment of over 0.5 or 0.6 percent, which will be done and will imply a budget deficit slightly below 2 percent," he said, also expecting economic growth to pick up.

Prime Minister Antonio Costa last week acknowledged the economy will grow slightly above 1 percent this year in a slowdown from 2015's 1.6 percent and below the original government forecast of 1.8 percent.

The budget will be presented after talks with the government's far-left allies in parliament, who are expected to support the deficit cuts as long as the government vows to gradually continue returning more income to households after years of bailout austerity.

He said the government's support in parliament was solid and "compatible with meeting the European commitments". (Reporting By Andrei Khalip; Editing by Hugh Lawson)

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