Portugal's main opposition party met European and IMF officials on Wednesday and said they would consider whether to back a 78-billion-euro bailout after a source said the terms would propel the economy into two years of recession.
Caretaker Prime Minister Jose Socrates announced late on Tuesday that Lisbon had reached a three-year bailout agreement with the European Union and International Monetary Fund after weeks of negotiations, becoming the third euro zone country to secure foreign assistance, after Greece and Ireland.
With elections due in a month, the backing of the opposition Social Democrats, who are ahead in the polls, for the bailout is crucial to guarantee that the EU signs off on the deal.
Carlos Moedas, a Social Democrat official, said a meeting on with officials from the lenders went well.
We will now analyze what was handed to us and later today or tomorrow morning the party will announce its position, he said.
European officials want to ensure cross-party agreement by Portugal on the bailout in order to avoid the possibility of having to revisit terms of the deal after the June 5 election.
They are also worried that Finland, where an anti-euro party could form part of the next government, may hinder a deal.
I do not see problems with the PSD accepting the deal, which looks like the only possible option for Portugal right now, said Antonio Costa Pinto, a political analyst in Lisbon.
SHARP RECESSION LOOMS
Analysts say Socrates was eager to present the bailout terms first in an attempt to highlight the fact that it did not impose equally tough measures as those adopted by Greece and Ireland, hoping to gain an electoral advantage.
But an official source told Reuters the steps to be included in the deal, such as higher taxes, point to a contraction of 2 percent in gross domestic product in 2011 and in 2012.
That will make it yet more challenging for the heavily indebted country, which has had some of the lowest growth rates in Europe for a decade, to return to financial health.
The source told Reuters taxes will rise on cars and property and there will be cuts in health, education and housing.
Jonathan Loynes, chief European economist at Capital Economics, also forecast a two percent contraction this year.
Against this background, while the confirmation of the bailout should provide some reassurance that Portugal will be able meet its upcoming bond redemptions, it won't put an end to speculation that -- along with Greece and perhaps others -- it will sooner or later need to undertake some form of debt restructuring, he said.
The announcement did provide some relief in the bond market, where Portuguese 10-year yields fell for the first time in many weeks, to around 10 percent, from a euro lifetime record of 10.32 percent on Tuesday. The spread to German Bunds shrank to 677 basis points from Tuesday's high of 707.
Portugal was forced to seek a bailout after its government collapsed last month, sending its borrowing costs soaring.
In a reminder of the sharply rising rates Portugal faces in the markets, the country issued 1.12 billion euros in three-month treasury bills at 4.652 percent, far above a rate of 4.046 percent last month.
DEFICIT GOALS EASED
Lisbon won some leeway for its austerity drive from its lenders. This year's budget deficit target was raised to 5.9 percent of gross domestic product from 4.6 percent previously.
That still represents a sharp cut given the deficit totaled 9.1 percent of GDP last year and, under the deal, it must be lowered to 4.5 percent of GDP in 2012 and 3 percent in 2013.
The bailout deal includes up to 12 billion euros for the banking sector to recapitalize and orders banks to raise their core Tier 1 capital ratios gradually to 10 percent by the end of 2012, the official source said.
It also envisages 5.3 billion euros in privatization revenues until 2013.
The interest rate on Portugal's bailout loan is expected to be set at a meeting of euro zone finance ministers in mid-May.
Even though we have clarity regarding the amount, the more interesting detail will be the interest rate that Portugal will have to pay on the loans so we are still waiting for this, said WestLB rate strategist Michael Leister.
Portuguese agreement to the loan terms is needed by June 15, when Lisbon has to redeem 4.9 billion euros of bonds.
Officials from the European Commission, the International Monetary Fund and the European Central Bank have been in Lisbon for almost a month to hammer out the agreement.
(Reporting by Sergio Goncalves; writing by Axel Bugge, editing by Mike Peacock)