LISBON (Reuters) - Chasing deficit targets may no longer be Portugal's best policy if its economic slump deepens more than expected, the International Monetary Fund said on Thursday.
It stopped short of calling for targets set under an EU/IMF bailout to be eased, but signalled concern over waning external demand and the recessive impact of bailout austerity.
But it also said that this year's targets remained in reach.
Portugal's lenders from the European Union have so far said sticking to stringent fiscal targets and reforms is the answer to the country's woes.
In a staff report following last February's mission to Portugal, the Fund also agreed with the European Commission that the bailout's size of 78 billion euros was sufficient and considered Portugal capable of returning to the bond market in late 2013 as the programme envisages.
Some investors remain concerned that Portugal will have to follow Greece in seeking a further bailout that could involve losses for private sector creditors.
The IMF quoted its new mission chief for Portugal, Abebe Selassie, as saying that "the main risk is that the recession turns out deeper than projected", partly due to a mild recession in the euro zone where Portugal sells most of its products.
"In that case, we think that chasing after fixed nominal deficit targets may not be the best policy," Selassie said.
Still, Selassie made clear that Portugal could not afford to miss any targets due to policy slippages as that would damage the programme's credibility. Right now, he said, this year's targets of 4.5 percent of GDP deficit "remains within reach."
Portugal is in its worst recession since the 1970s, with the government and the lenders expecting a 3.3 percent slump this year and only meagre growth of 0.3 percent in 2013.
The IMF has said it will release 5.17 billion euros to crisis-stricken Portugal under the bailout program aimed at helping it come to grips with its high budget deficits, lauding good progress made already.
Selassie said markets were "not yet fully convinced" that the adjustment challenges can be met even though bond spreads have eased somewhat from the beginning of the year. But the Fund believed that "the challenges can be met as long as the government stays on course".
Portugal's 10-year bond yields have increased since last week to around 12.2 percent, but are a long way below 17.4 percent highs seen at the end of January.
Asked whether Portugal will need another bailout, Selassie said: "We still think the programme is of the right size."
"Certainly, regaining market access next year will not be easy. But building on recent success in lengthening T-bill maturities and the broader euro area-wide measures that have been taken, market access should still be possible in 2013.
"In short, there seems sufficient time to build a convincing track record of strong performance that regaining market confidence requires," he said, adding that European leaders had pledged to provide adequate support to Portugal if risks to market access materialize, as long as the programme is on track.
In terms of structural reforms, the IMF praised Portugal's progress, especially in making the labour market more flexible, but added that "the nub of Portugal's competitiveness problem, excessively high non-tradeable sector prices, still remains to be tackled fully."
Reporting By Andrei Khalip.Editing by Jeremy Gaunt.