(Reuters) -- Ireland may need to make further changes to its budget this year if the economy continues to deteriorate, the European Commission said on Wednesday in a draft of a report obtained by Reuters.
Halfway through an unprecedented austerity drive, Ireland is implementing 3.8 billion euros ($5.08 billion) worth of tax hikes and spending cuts to reduce its budget deficit to 8.6 percent of gross domestic product (GDP) this year.
Weaker than expected growth has forced Dublin to increase the target to 3.8 billion euros from the 3.6 billion initially proposed, and the commission suggested for the first time that further revisions to the government's target may be required.
Although the fiscal forecasts incorporate some small buffers, a further deterioration of the macroeconomic backdrop could require additional fiscal tightening later in the year, said the draft of the report.
Commission officials cut their Irish gross domestic product growth forecast for 2012 last month to 0.5 percent from around 1 percent previously forecast. The government is still holding to its forecast of 1.3 percent.
The International Monetary Fund (IMF), one of Ireland's so-called Troika of lenders, also has predicted growth of 0.5 percent for 2012 but has argued that Dublin should not adjust its fiscal plans for this year, even if growth targets fall short of expectation.
The government suggested earlier this month that it may have to increase its planned tax increases and spending cuts for 2013 as the global economic slowdown hurts Ireland's growth forecasts.
The draft report, obtained in Berlin, follows a political storm caused last year by the leaking of confidential Irish budget information by German lawmakers in similar documents first revealed by Reuters.
New German laws give its parliament the right to be fully informed about the progress of countries in EU/IMF bailout programs before new tranches of funds are paid out.
SENTIMENT REMAINS FRAGILE
The EU commissions' document said that it expects Ireland to return to the financial markets for funding later this year although it warned that developments outside Ireland could put Dublin's plans at risk.
Dublin aims to return to the markets this year to help it prepare for the end of an EU/IMF bailout program at the start of 2014, when it expects its borrowing needs to come to about 20 billion euros.
In the draft report, the Commission said for the first time that it assumes that Ireland will return to the markets this year, due partly to a successful 3.5 billion euro debt swap in January and the fact that it avoided a ratings downgrade last month, unlike some other euro zone countries.
The program assumes a gradual return of the sovereign to market funding from the second half of this year, with a return to the bond market in the course of 2013, said the report. Yet the incipient improvement in market sentiment vis-à-vis Ireland remains fragile, and could evaporate in case of adverse developments elsewhere, putting at risk a return to market funding.
Irish banks' ability to deleverage, another target under the bailout program, was also seen in the report as a risk due to the weak market environment. The Commission said it could potentially choke off domestic lending and put a further drag on growth.
The report was also written before Ireland's decision on Tuesday to proceed with a referendum on an EU new fiscal treaty, a move that may muddy the waters for the country's long-term funding plans.
A 'no' vote would prevent Dublin from using the European Stability Mechanism, the permanent successor to the euro zone's current rescue fund, which Ireland is tapping as part of its current bailout.
With such tall borrowing requirements in 2014, most acutely with an 8.3 billion euro bond redemption due at the start of the year, most analysts believe Dublin will need more official funding to meet some of these commitments.
(Reporting by Matthias Sobolewski, Writing by Lorraine Turner and Padraic Halpin in Dublin; Editing by Carol Bishopric)