The IMF warned on Thursday that risks to Portugal's rescue programme have climbed significantly as Lisbon fights to curb a stubborn deficit and street protests mount.
Portugal had made "good progress" after securing a 78-billion-euro ($100-billion) International Monetary Fund-European Union bailout in May 2011, IMF staff said in a progress report.
"But after a strong start, the programme has entered a more challenging phase," they said.
"Risks to the attainment of the programme's objectives have increased markedly," said the review, released a day after the Fund unlocked a 1.5-billion-euro installment from the bailout.
Portugal now had a large and "durable" public deficit, it said, blaming a drop in tax income as Lisbon's economy relied more on exports rather than domestic demand.
"And, politically, the broad-based consensus that has buttressed the programme to date is being tested," it added. "Social and political resistance to adjustment has heightened."
Tens of thousands of Portuguese have spilled into the streets in past weeks to protest the painful spending cuts and tax increases.
The unions have also called a new general strike for November 14, coinciding with similar action elsewhere in the eurozone including in struggling neighbour Spain.
A recent opinion poll showed that about 70 percent of people are now hostile to the austerity policies.
Under a draft budget presented last week to find 5.3 billion euros in savings, a range of taxes are to be raised, and the basic rate of income tax will go up from 9.8 percent this year to 13.2 percent in 2013.
Partly as a result, Portugal's government and the IMF agree that output will shrink by 1.0 percent in 2013 after contracting by more than 3.0 percent this year.
Slowing eurozone economies and Portugal's austerity measures were combining to brake activity, said an assessment by IMF staff, pushing up unemployment, which is forecast to near 16 percent at the end of this year.
"An improvement in the broader euro area economic environment will be critical to the programme's success," the IMF warned.
Public debt would peak at 124 percent of gross domestic product next year, it forecast.
IMF staff said that the so-called troika of the IMF, European Union and European Central Bank, which are overseeing the bailout, had already agreed to relax Portugal's deficit-cutting targets.
Under the new regime, Portugal must curb the public deficit to 5.0 percent of GDP rather than 4.5 percent in 2012, to 4.5 percent instead of 3.0 percent in 2013 and then to 2.5 percent in 2014.
The IMF said the targets were relaxed in part because it recognised that the impact of deficit-cutting measures on the economy was greater than originally believed.
The Fund had previously calculated that deficit-cutting measures would have a "multiplier" effect of 0.5 percent on economic growth, meaning that a one percentage point cut in the deficit would slow economic growth by a half a percentage point.
But, as the IMF admitted in Tokyo meetings this month, the actual impact of austerity measures on the economy has proven to be larger than earlier believed.
IMF staff and the Portuguese authorities had now agreed to apply a new multiplier of 0.8 percent for austerity measures in 2013, leading to the lower estimates of economic activity next year.