LISBON The Bank of Portugal slashed its forecast for gross domestic product in 2013 on Tuesday to a contraction of 1.6 percent and warned that the projection is "highly uncertain" due to the euro crisis and the impact of bailout austerity measures.
The downgrade of the economic outlook, from a previous forecast of flat output, is further evidence that indebted Portugal faces tough headwinds next year as the biggest tax hike in recent history erodes consumer confidence further.
The bank's forecast in its autumn bulletin kept this year's estimate of a 3 percent contraction in GDP, the deepest since the 1970s. The government expects a contraction of 3 percent this year and 1 percent in 2013.
"The current projection is subject to high uncertainty, associated with the evolution abroad, the impact of domestic economic policies, the response of economic agents and the medium- and long-term economic response to adjustment," it said.
The bulletin also included a warning that the government must redirect its budget adjustment towards cutting spending and not rely on increases in tax revenues. The country missed this year's budget goals under the bailout as tax revenues fell short due to the deepening slump.
"The strategy of budget consolidation must pass ... through a reduction of public spending," it said. "The option to meet budget goals by raising revenues reduces available resources in the public sector, with adverse consequences on investment decisions and future economic growth."
The government has faced sharp criticism from economists, and even from within the ruling coalition, of its decision to hike taxes sharply in next year's budget.
The bank forecast that domestic consumption will slump 4.5 percent next year after a decline of 6.8 percent in 2012.
It said exports would grow 5 percent next year after expanding 6.3 percent this year but warned that exports face risks because of falling foreign demand, especially in Europe.
(Reporting By Axel Bugge and Sergio Goncalves, editing by Andrei Khalip)