Portuguese leaders build faith in bailout exit

President Anibal Cavaco Silva thanked Portugal's patron saint for a long-delayed approval of Lisbon's bailout review last week, but the head of state could claim a share of the credit for himself.

The conservative president's role has grown far beyond his figurehead status in the past few weeks.

With the president on his side, Prime Minister Passos Coelho appears immune to opposition calls for an early election, despite a teetering coalition, record-low popularity in opinion polls and protests and strikes promised for late May and June.

Such resilience is helping to rehabilitate Portugal in the eyes of investors. This week, for the first time since 2010, it dropped out of the top 10 countries for default risk.

Its assumed chance of default in the next five years is still high, at 22.6 percent - but down from 65 percent in 2012.

Like other sovereign debtors, Portugal has benefited from the cheap money flooding into markets from major central banks and, more specifically, from the European Central Bank's pledges to defend the euro and support the bloc's economy.

Cavaco Silva can take credit for helping Passos Coelho overcome a rift within the ruling coalition and growing opposition to austerity after the rejection of some government measures by the constitutional court. The early April ruling had held up the bailout review by almost two months.

The president has the power to fire the government and call new elections, but has ruled out any such move as destabilizing.

That means the government can go ahead with spending cuts dictated by the terms of its EU/IMF bailout, supporting a return to bond markets after the mid-2011 rescue.

The economy could still undermine faith by shrinking more than the 2.3 percent the government expects or by extending its worst recession since the 1970s into 2014, but first-quarter data last week showed the contraction is easing.

"The president favors this government and his message is that it will stay on," said Marina Costa Lobo, a political scientist at the University of Lisbon. "Monday's State Council meeting was a show of support, typical of Cavaco who likes to act behind the scenes."

Cavaco Silva, 73, discussed what will happen at the end of the bailout in mid-2014 with the consultative council. Sources said most of its members agreed that an early election would only jeopardize Portugal's financing and growth.

It ended with a vague statement calling for "adequate balance between financial discipline, solidarity and economic stimulus", ignoring what the opposition says is a regime crisis.

EUROPE'S HELP

The first signs of such a balance cropped up on Wednesday, when Germany vowed to use its development bank KfW to give loans to small companies and help create jobs in Portugal, where youth unemployment has reached a record 42 percent.

"We've been in need of measures that are not just about budget consolidation and can generate fiscal revenues," said Filipe Garcia, head of Informacao de Mercados Financeiros consultants. "It's positive, if perhaps coming a bit late."

More European support could follow, analysts say, in the form of further relaxing of budget deficit targets if the economy underperforms. Portugal's goals have been eased twice already.

"Europe wants a success story, not another Greece, so one could expect some easing of goals possibly after the German elections" in September, Costa Lobo said.

Visiting Berlin, Finance Minister Vitor Gaspar brushed off criticism that the European Commission is too inflexible and said it was focusing on tackling the structural deficit rather than the nominal gap. That could give Portugal breathing space.

Last week, the European Union and International Monetary Fund accepted a rough spending cut plan when they sealed the review required to disburse the next 2 billion euro aid tranche.

The government promised to try to find alternatives to a levy on pensions after the junior coalition partner, the rightist CDS, said it would not support the measure.

The amount at stake is about 10 percent of the total 4.8 billion euros that Portugal has promised in savings up to 2015, and analysts believe the coalition will find compromises and lenders will make concessions rather than risk a split.

"A coalition breakup would make a scapegoat out of (CDS leader) Paulo Portas for things going wrong in Portugal. He will not allow this to happen," said Antonio Vitorino, president of Notre Europe think tank, adding that Cavaco Silva had "assumed the role of the guardian of the coalition's stability".

Investors seem to share the view that either the government will hit its budget deficit targets - 5.5 percent of GDP this year and 4 percent in 2014, from last year's 6.2 percent - or lenders will ease the targets again.

Portugal issued its first 10-year benchmark bond since the bailout on May 7 at a lower yield than its last pre-bailout issue.

(Additional reporting by Daniel Alvarenga; Editing by Ruth Pitchford)