The European Union and IMF agreed on Tuesday to ease budget goals imposed on Portugal under a 78-billion-euro bailout, giving Lisbon more time to meet the targets as its economy slides deeper into recession.
A "troika" of inspectors from the EU, IMF and European Central Bank said Portugal's deficit targets had been revised to 5.0 percent of Gross Domestic Product for this year, and 4.5 percent for 2013. Previously, the bailout had envisaged deficits of 4.5 percent this year and 3 percent in 2013.
The move marks a climbdown for the centre-right coalition government which has single-mindedly concentrated on meeting the goals as justification for harsh austerity measures which have sent the economy into its worst recession since the 1970s.
The announcement that targets will slip, coupled with new austerity measures, could strain a political consensus in Portugal, which has so far been spared the street violence and popular unrest of other suffering euro countries such as Greece.
Finance Minister Vitor Gaspar said the fiscal deterioration was caused by a worsening of the euro debt crisis, including in neighbouring Spain, which is Portugal's biggest export market.
"We are living through some of the most difficult times of our democracy," Gaspar told journalists. "We want to guarantee that we can overcome our national emergency but also be capable of preventing successive periods of financial instability, economic recession and social deterioration."
The austerity imposed by the bailout has already led to cross-the-board tax hikes and spending cuts in Portugal and sent unemployment to record levels above 15 percent.
Portugal is one of several euro zone countries which have struggled to meet strict fiscal goals, including Spain and Greece, as austerity hurts economic growth. Financial markets have been buoyed by an announcement last week that the European Central Bank will buy bonds of hard-hit countries.
"These relaxed targets for this year and next will still be very hard to achieve," said Ralph Solveen, an economist at Commerzbank. "But the mood in the market is still that the ECB can fix the crisis, while the measures show Europe is changing the focus to get out of the crisis via growth."
Still, more austerity is coming. The Portuguese government already announced last Friday an increase in social security taxes paid by all workers in 2013 roughly equivalent to one month's salary. Gaspar announced other tax hikes on capital gains and property on Tuesday.
"Taking into account the announcement of new austerity measures just a few days ago, this will only create more problems for the government," said Viriato Soromenho Marques, a political analyst at the University of Lisbon.
"People have to know what they are making sacrifices for, and this easing of the targets sort of takes the sense out of their sacrifices. Also, the programme is extended by another year and nobody will bear another year like this."
Both of the country's top unions have announced they may step up protests or strikes and the main opposition party, the Socialists, has said it may vote against the 2013 budget proposal, which will be presented in coming weeks. Still, the government has a majority in parliament.
Gaspar said the eased deficit targets did not "imply any change to the programme's financial package" and Portugal still intends to return to bond markets as planned a year from now.
Gaspar said the recession would now extend into 2013, with GDP dropping one percent next year after shrinking 3 percent this year. The government had previously said 2013 would be a year of recovery.
Portugal's benchmark 10-year bond yields edged up to 8.45 percent on Tuesday from Monday's settlement level of 8.33 percent. Yields had slid from last week's levels of over 9.2 percent as the prospect of the ECB stepping in to buy bonds lowered the borrowing costs of troubled euro zone economies.
(Additional reporting by Andrei Khalip; Writing by Axel Bugge; Editing by Peter Graff)