Europe Economy

Portugal back in the spotlight as bailout risks return

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As Portugal's international creditors return to begin their delayed review of the country's economy, there are increasing concerns that Portugal could need yet another bailout.

"Portugal's finances remain in a very precarious state. The limits of austerity are starting to be felt," Michael Hewson, senior analyst at CMC Markets told CNBC on Thursday, following a stark warning to Portugal about its economic outlook from ratings agency Standard & Poor's.

The agency said late Wednesday that it could cut Portugal's credit rating and placed it on a shorter-term negative outlook, citing rising risks to the economy from its program of tax rises and spending .

(Read more: Portugal's political strainremains despite growth)

Portugal's international creditors – its fellow euro zone countries, the International Monetary Fund and the European Central Bank – have insisted on austerity measures and reforms as part of the 78 billion euro bailout the country received in 2010.

S&P warned that Portugal was in danger of slipping back in its bailout commitments. The agency highlighted the government's problems with its Constitutional Court, which has blocked previous reforms; weaker-than-expected economic performance; and a resurgence of political tension that could delay 2014 budget or program reviews.

The country was once seen as a model for the euro zone's rescue program and looked set to exit its bailout in 2014 and return to the international bond markets. In the second quarter, the country escaped recession with a 1.1 percent jump in gross domestic product.

However, in July, political crises and government resignations over austerity measures threatened to derail not just the government but the country's economic recovery, causing the Portuguese stock market to tumble over 5 percent and borrowing costs to spike.

(Read more: Portugal's bondmarket tanks as crisis deepens)

The turmoil forced the government to ask the officials from the "troika" of international inspectors representing the euro zone, ECB and IMF to delay their bailout review.

Portugal's economic woes have not been lost on investors with the yield on the country's benchmark 10-year bonds steadily rising to 7 percent and beyond since the start of September -- suggesting investors believe the country could in fact need another bailout rather than exiting its current one.

(Read more: Portugal Fires Warning Shot for Austerity in Europe)

At a bond auction on Wednesday, the country's borrowing costs rose to a 10-month high when the government sold €750 million ($1 billion) of 18-month bills.

"A level of 7 percent (or higher) illustrates that it will be very hard for Portugal to return to bond markets next year when the program is supposed to expire," Carsten Brzeski, senior economist at ING, told CNBC this week.

"As in all other countries, the biggest challenge is to balance between further austerity measures and growth. To find the right balance, Portugal will probably need more time. As a consequence, the discussion on a second bailout package should become the next big thing soon. In this context, the interesting issue will be whether such a second package comes with or without haircuts for private investors," he noted.

Further to risks from within the country, political and economic events in Europe and the U.S. would weigh on Portugal's economic outlook, CMC Market's Hewson noted.

"The outlook remains difficult for Portugal and one of the most pressing matters for Europe after the German elections is what to do about further help for Greece and Portugal. Last night's Fed decision won't help these countries as the euro gets increasingly stronger."

- By CNBC's Holly Ellyatt, follow her on Twitter @HollyEllyatt. Follow us on Twitter: @CNBCWorld