LISBON (Reuters) - Bailed-out Portugal is likely to have met its 2013 budget deficit target of 5.5 percent of GDP "with some margin" after its economy started to recover, but it still faces "formidable challenges" and serious risks, the IMF warned on Wednesday.
Lisbon is due to exit its EU/IMF bailout in May and still has to meet a budget deficit target of 4 percent this year as well as start diminishing its high debt burden after last year's peak around 129.5 percent of GDP.
"The short-term outlook has improved and program implementation remains on track," the fund said in a staff report after its latest review of the country's economy in December.
But while it pointed out that domestic demand was now supporting a pick-up in activity and lower unemployment, it said the jobless rate remained at unacceptable levels while high household and corporate indebtedness "will continue to act as a brake on both consumption and investment".
"Risks to attaining the objectives of the program remain high," especially in the view of legal challenges to government austerity measures in the Constitutional Court, it said.
The Constitutional Court has in the past struck down several key austerity measures and is now evaluating spending cuts worth about 1 billion euros from the 2014 budget at the opposition's request.
"Successful legal challenges to the 2014 budget could undermine the quality of fiscal adjustment, with attendant negative consequences for the recovery of output and employment," it said, adding that high debt and refinancing needs made Portugal vulnerable to shifts in market sentiment.
It said the government remains committed to meet the fiscal targets in case of a negative court ruling, but said there was an "increasingly limited room for manoeuvre on the expenditure side".
The fund called for continued efforts to rationalize public spending, encourage orderly deleveraging, and promote growth and investment in the tradable sector.
"While there has been notable progress in fiscal structural reforms, important challenges remain in expenditure control and arrears," it said, explaining that expenditure arrears continue to accumulate, albeit at a slower pace, mostly in the health sector and some municipalities.
(Reporting By Andrei Khalip, editing by Axel Bugge)