Portugal clings to austerity on edge of abyss

LISBON (Reuters) - Portugal's traditional fado music is taking on new meaning with the country's economic crisis, as variants of the age-old melancholic songs offer an outlet for young people reeling from relentless austerity.

"I come from the generation with no income," blare the powerful lyrics of 'How silly I am' by popular fado-inspired band Deolinda, pondering the increasingly hopeless outlook for the one-in-three people under 25 who are out of work.

The euro zone crisis has led Portugal into its deepest recession since the 1970s, with overall unemployment at a record 15 percent as the centre-right government slashes spending under a 78-billion-euro bailout deal with the European Union and IMF.

Still, strikes and protests against austerity, which has included wage cuts of up to 20 percent for civil servants, have been low-key compared with places like Greece and Spain.

While die-hard leftists rail in parliament and the largest union organizes poorly-attended strikes, the general mood has, until recently, been best summed up by the fatalism expressed in songs like 'How silly I am'.

The government, elected a year ago with clear warnings of the hardship to come, is determined to meet fiscal goals under the bailout and sees no alternative to more of the same.

"We received a country on the edge of the abyss, our obligation is to do everything within our reach so that with the help of the Portuguese we will be able to reform it into a free, autonomous country," said Foreign Minister Paulo Portas.

Such unswerving commitment to reform means Lisbon scores high marks in Berlin and Brussels, but criticism of austerity is beginning to extend well beyond fado, and, more importantly, the abyss is still there.

CHOKED

"Nobody is turning against the single currency, but they are turning against (Europe's) austerity system," said Mario Soares, 87, Portugal's Socialist elder statesman, considered by many as the father of its modern-day democracy.

Business leaders are increasingly calling for budget targets to be extended or relaxed to avoid killing the patient with austerity and urging Europe to take action to end the crisis.

"I personally believe that the ECB should inject money into these countries," said Alexandre Soares dos Santos, Portugal's second richest man and chairman of Jeronimo Martins, the second biggest retailer in Portugal and biggest in Poland.

"Why three years and not five (to meet deficit reduction goals), if you can reduce the number of people unemployed?" he asked, saying the government needed more time to distribute its harsh medicine.

Jose Avelino, 45, who drives a tourist bus, said people were getting ever more desperate. "We have choked on the measures."

There are no signs yet of discontent fuelling big strikes or protests and no whispers of dissent within Prime Minister Pedro Passos Coelho's centre-right coalition, which has an absolute majority in parliament.

The previous Socialist government collapsed last year after Portugal became the third country in the euro zone -- after Greece and Ireland -- to seek a bailout, because its financing costs had soared due to its high debt levels.

The country has approved the "fiscal compact" for budget discipline in Europe and the government has said it would support closer political and fiscal union, though it is sees economic reform and fixing state finances as priorities.

"The first obligation of a country is to stick to its word, to honor and fulfill the terms of its (loan) program," the prime minister told parliament on Monday.

The problem is that despite Portugal's best efforts, it remains the second most risky country in the euro zone after Greece, in terms of bond spreads. Portugal's 10-year bond yields are at 9.7 percent, above neighboring Spain's 6.7 percent.

That makes it especially vulnerable to further flare ups in the euro zone crisis, whether in Greece or in increasingly troubled Spain, its biggest export market.

EURO FEARS

Most in Portugal believe it is unthinkable that such pressures could eventually drive Portugal out of the euro -- 80 percent back the single currency in polls. But Joao Ferreira do Amaral, professor of macroeconomics at Lisbon's School of Economics and Management, is one of those lonely voices and his view has only been reinforced by the crisis.

"I always had the view that we did not have a sufficiently strong economy for a strong currency," said Ferreira do Amaral, who is one of Portugal's most high profile Eurosceptics, having been an advisor to former Socialist President Jorge Sampaio.

"Even without the crisis that started in 2008, we were on an unsustainable path," he said, advocating a gradual exit with the euro and a new escudo functioning in parallel at first.

Debts and bank deposits should remain in euros, Ferreira do Amaral says, while the central bank would carry out "monetary financing" of a new escudo used for all other payments.

"Either we have debt forgiveness or inflation," he said.

Those views get little backing from the Portuguese, despite the country having experienced one of Europe's lowest growth rates in the run-up to the financial crisis.

"If we went back to the escudo we would be more competitive as a country but citizens would be subject to mass devaluation of everything they own," said Paula Fazendas, 42, a cardiologist.

"If I could, I would take my money, put it in Switzerland and leave the country, but I won't do it because I have kids."

Business leaders worry about Portugal's euro future.

"I am very much in favor of the euro, for me it would be an enormous disappointment if we were forced to leave," said Soares dos Santos. "Now, how can I invest in this country if I don't know if we remain in the euro or we go back to the escudo?"

For a country stuck on the edge of Europe with Spain on one side and the Atlantic on the other, joining the euro was always a way of joining the continent's mainstream.

As such, most Portuguese think lasting solutions to the euro crisis can only come from the centre.

"The day that the European Central Bank can print money the crisis will end, it's that simple," the veteran former prime minister Soares said.

The ECB has heard a chorus of such calls. Its reluctance to heed them means Portugal's hopes may go unrealized.

(Editing by Paul Taylor and Philippa Fletcher)

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