(Adds finance minister)
By Andrei Khalip and Sergio Goncalves
LISBON, March 24 (Reuters) - Portugal slashed its budget deficit last year by more than half to 2.1 percent of gross domestic product, the lowest level since its return to democracy in 1974 and beating the 2.5 percent target agreed with Brussels.
Public debt rose, however, an issue of come concern in a country that only recently needed an international bailout to keep afloat.
Official data showed on Friday the budget gap ended for the first time below the European Union's 3 percent threshold, reinforcing the government's hopes to exit the bloc's excessive deficit warning procedure later this year as it expects the gap to narrow further.
"Portugal will finally leave the excessive deficit procedure behind. The exit will reinforce confidence in our economy at home and abroad, increasing our capacity to invest in reforms that boost our competitiveness," Finance Minister Mario Centeno told a news conference.
"In the years to come our deficit will remain clearly below what is required," he said, referring to the 3 percent limit.
The primary balance, discounting debt payments, was a surplus of 2.2 percent of GDP last year.
If Eurostat, the European Union's statistics agency, confirms the estimates, the European Commission is likely to discuss Portugal's case in April to see whether to end the procedure of strict deadlines and targets applied to countries that fail to comply with the gap limit.
Portugal's National Statistics Institute put this year's deficit at 1.6 percent, in line with the target set in this year's budget. In 2015, the deficit was 4.4 percent.
Still, the country's gross public debt rose last year to 130.4 percent of GDP from 129 percent in 2015, ending just short of 2014's record high of 130.6 percent. The INE said it expected it to fall to 128.5 percent this year.
"The headline (deficit) number is obviously positive... However, it is only when the debt-GDP ratio begins to decline that we can talk about an improvement in the country's economic and financial conditions," said Filipe Garcia, head of Informacao de Mercados Financeiros consultants in Porto.
The minority Socialist government, which came to power in late 2015 and is backed in parliament by the hard left, has managed to combine budget consolidation with a reversal of the austerity measures imposed by previous administration under the country's 2011-14 international bailout.
The deficit reduction came despite a slight deceleration of economic growth last year to 1.4 percent from 1.6 percent, while the statistics institute also said that a decline in gross fixed capital formation - a measure of investment in the economy - helped to lower the deficit.
"A further cut in public investment will be worrying if it continues to be needed for budget consolidation," warned Jose Cerdeira, an economist at Banco BPI.
But he was generally upbeat that the numbers are "certainly positive for the argument to drag the country out of the excessive deficit procedure, especially because further consolidation is projected in 2017... and because the debt ratio is expected to fall".
The debt level has been pushed higher by state rescues of two banks in 2014 and 2015. (Reporting By Andrei Khalip and Sergio Goncalves Editing by Jeremy Gaunt)