By Axel Bugge and Andrei Khalip
LISBON (Reuters) - Portuguese consumer confidence is at record lows, unemployment at all-time highs and the country has launched the largest tax rises in living memory. Yet investors are snapping up its bonds and its international lenders are full of praise.
In perhaps the starkest example of the gap between renewed investor appetite and languishing economies, Portugal has started 2013 on its strongest footing since it was bailed out in mid-2011, with confidence boosted by hopes it will relinquish its lifeline from the European Union and IMF as scheduled.
Investors bought 2.5 billion euros of Portuguese 5-year bonds last week in the country's first issue since its bailout, returning it to the market many months earlier than planned. Struggling Spain and Italy have benefited from similar bond market largesse.
Yet on the streets people are braced for severe hardship in 2013 as they lose up to two months' wages to the tax man after years of grinding austerity.
With almost a sixth of the workforce unemployed and shops and restaurants shut down in record numbers, selling bonds or improving the current account deficit is meaningless to ordinary people.
"The government bangs on about a lot of stuff but down on the ground things are different. The return to the (bond) markets was a farce, it means nothing to me," said Adelino Santos, 54, who works for Portugal Telecom in Lisbon.
"I am bracing myself for the hammering of the tax hikes when they kick in. Unfortunately, I think 2013 is going to be even worse than 2012."
LA VIDA LOW-COST
Fast food chain McDonald's may have best summed up the mood with a new campaign titled "Living La Vida Low Cost" that offers cheap burger meals.
The centre-right government argues that tough austerity, including massive tax hikes this year, is the only way the country can ride out its debt crisis.
It says the medicine has begun to pay off, pointing to sharply improving trade and fiscal accounts, despite the deepest recession since the 1970s promising to drag the country through its third year of contraction in 2013.
Bond investors, responding to the European Central Bank's pledge to backstop the euro zone, are on board, buying Portuguese 10-year debt which a year ago yielded around 18 percent compared with 6.2 percent now. That culminated with last week's 5-year bond issue at a yield of 4.891 percent.
Finance Minister Vitor Gaspar said the bond was issued to show "we have the financial ability to exit the (aid) program successfully. Our view is that at rates of about 5 percent we are comfortably sustainable."
The government hopes the improving financing conditions will gradually trickle down to companies, allowing 2013 to be a turning point and for growth to return next year.
But there are large risks on the horizon, perhaps the most obvious being the yawning gap between the government's and most economists' forecasts for economic output, which could have a big impact on fiscal performance.
"Our baseline scenario is that things will get worse economically for Portugal and market sentiment across the euro zone will get worse, and then Portugal will need a new rescue program when it runs out of money by mid-2014," said Giada Giani, an economist at Citi.
Giani sees a 2013 contraction of 3.7 percent of GDP, far deeper than the government's forecast of a 1 percent fall. The Bank of Portugal expects a downturn this year of 1.9 percent, after contraction of 3 percent in 2012.
If GDP falls short, it could compromise the goal of cutting the budget deficit to 4.5 percent of GDP this year from 5 percent in 2012, which could lead to the EU and IMF demanding more spending reductions as a result.
The government hopes tax revenues will rise more than 10 percent this year thanks to income tax hikes on virtually all workers and on pension income. But last year tax revenues slumped 6.8 percent as the economy contracted more than expected.
"The key worries are the budget execution, the extent to which revenue targets may be missed this time, the extent to which the 'troika' will demand compensation in spending cuts and the political implications of that," said Lefteris Farmakis, an economist at Nomura.
Still, Farmakis thinks Lisbon will not need a new bailout as it is in Europe's interest to push it back to the market, possibly with support from the ECB.
Further threatening fiscal performance is a looming decision by the Constitutional Court on tax rises in this year's budget. Several challenges have been lodged with the court by opposition parties and by the country's president.
Antonio Barroso, an analyst at Eurasia Group, said a negative decision by the court was one of the biggest risks going forward. Last year, it ordered the government to reverse planned cuts in civil servants' twice-yearly holiday payments, blowing a hole in the government's accounts and forcing it to hunt for alternative austerity measures.
If the court rules against the government, "what can they do?" asked Barroso. "They have tried everything. On the other hand, if the court delivers a good judgment, it will be a big boost."
It is not clear when the court will rule, dragging out uncertainty.
The government faces another big challenge with a plan to carry out 4 billion euros of spending cuts in the public sector in 2013-14 in order to put state finances on a stable footing for the long-term after the country exits its bailout.
Opposition parties have refused to join a parliamentary committee to discuss the cuts, which many Portuguese see as a further threat to an already diminished welfare state.
"They just asked where to cut. This is not a debate, it is simply imposition," said Armenio Carlos, head of the country's largest union, the CGTP.
But investors have so far shrugged off such concerns, emboldened by the view that Lisbon will not veer off its bailout austerity course. Internal fractures in the main opposition party, the centre-left Socialists, have also dimmed political opposition to the government.
Equally important, a sharp rise in strikes and marches against austerity in the second half of last year appears to have tapered off with no indication of social protests turning into something more serious or becoming violent like in Greece.
"I think they have reached the tipping point, if it hasn't happened now, it won't happen," Barroso said, referring to protest intensifying.
(Additional reporting by Daniel Alvarenga, editing by Mike Peacock)