By Alan Wheatley and Daniel Alvarenga
LISBON (Reuters) - Austerity is grinding Portugal down. The economy is adjusting to past excesses and flourishing firms are not hard to find. But the overall picture, mirrored across southern Europe, is of a people losing confidence in the future.
With domestic demand depressed by deep public spending cuts and a slump in investment, the risk is that improving exports alone will not be enough to restore growth. That would trap the government in a vicious circle, forever needing fresh cuts to meet its deficit and debt targets.
Joao Leite, an economist with Banco Carregosa in Lisbon, said he used to have faith in the belt-tightening cures of the International Monetary Fund, one of Portugal's taskmasters, because of its long history of fighting financial fires.
Now, Leite is disillusioned.
"I thought that some of this austerity was needed. Maybe I innocently believed that this was the right path," he said. "But I honestly must say that I didn't see this coming like it did."
The economy shrank 3.2 percent in 2012 and Portugal's troika of international lenders - the IMF, the European Central Bank and the European Commission - expect a further fall of 2.3 percent this year. As recently as November they were projecting a drop of just 1 percent.
Unemployment last quarter was 16.9 percent, up 2.9 percentage points from a year earlier. Because the jobless rate is a lagging indicator, the government expects it to reach 18.5 percent in 2014. Some economists have pencilled in 20 percent.
The troika has granted Portugal an extra year to hit its bailout targets and Lisbon is hoping the European Union will agree next month to give it more time, up to 15 years, to repay an emergency loan it took out in 2011.
But Leite believes the austerity should be spread out over a decade, not compressed into three or four years.
"It's the right medicine, but we should be taking smaller doses for a longer period of time," he said.
Protests against spending cuts and higher taxes have grown in recent weeks but have remained peaceful. The centre-right coalition faces a no-confidence vote in parliament but it enjoys a solid majority, making the motion symbolic.
Paula Carvalho, chief economist at BPI bank, agreed that it would be very difficult for Portugal to avoid sinking into a recessionary spiral, with the risk that its fiscal targets will keep slipping, in the absence of an upturn in European demand.
"We are in the danger zone right now," she said.
There are grounds for hope. Bond yields have fallen sharply since last year. This permitted Portugal to successfully sell a five-year bond in January, its first issue since the bailout, and it aims to sell 10-year debt soon.
The issuance is part of a strategy to regain normal capital market access this year, possibly with the crutch of the euro zone's and the ECB's bond-buying programmes, as a prelude to graduating from the bailout programme by mid-2014.
And companies that have watched domestic demand shrivel are carving out new markets overseas. In the past four years, Portugal has turned in the fourth-best export performance in the euro zone after Germany, Ireland and Spain.
In the year since Reuters visited Bluepharma, a generic drugs maker in the university town of Coimbra, the firm has continued to prosper.
In 2012, revenues jumped to 29 million euros from 18 million in 2011; it has hired 108 workers - all graduates - to take staff numbers above 300; and it exported 82 percent of its output last year, compared with 73 percent in 2011.
"For us, emerging markets are getting hotter. But we look around and we see companies that remain dependent on the internal market going through great difficulties," said Maria Isolina Mesquita, a senior manager at the firm.
Call centre company Teleperformance Portugal is also doing well. It added close to 1,000 jobs in the past 12 months and is looking to hire another 400. Revenues rose 40 percent in 2012.
Chief executive Joao Antonio Cardoso says Teleperformance is benefitting from the recession as mltinationals streamline their customer help lines, driving business his way. "We have a huge opportunity ...in a market that is absolutely booming," he said.
The story is different at Volkswagen AutoEuropa, Portugal's second-largest exporter, which last year produced 15 percent fewer cars than in 2011.
The firm does not have enough work right now for about 600 of its 3,626 employees and so is assigning 200 of them temporarily to Germany and giving another 200 extra training. Thanks to flexible working practices, no one is being fired.
"We're facing a European crisis. Most of our customers are in recession with the exception of Germany," said Antonio de Melo Pires, the head of the plant, which exported nearly all of the 112,550 cars it made in 2012.
"There were hopes some months ago that things were going in the right direction, but lately it seems another crisis has sprung up," he added, referring to Cyprus's banking meltdown.
Indeed, the outlook for much of the Portuguese economy is so bleak that many businessmen fear their best employees will vote with their feet.
Tens of thousands of skilled youngsters have been emigrating in search of higher-paid jobs - either in Europe or in Portugal's former colonies such as Brazil and Angola, which is now the country's fourth-largest export market.
"There is always the concern that we will lose all these people," said Antonio Reis, technical director of Optimal Structural Solutions, a high-tech start-up near Lisbon that designs aeronautical parts and crash-tests Formula One cars.
Portugal is trying to pull up its socks. It plans to improve its port and rail infrastructure. It is playing to the strength of its links to Africa and Latin America. Its traditional textile and footwear industries are moving up the value chain.
Yet for all its resilience, Portugal is struggling to escape a past of poor competitiveness and low educational achievement. In the years after joining the euro, waves of easy credit masked these shortcomings. Now the tide has gone out.
"This will be the first generation whose children will live worse than we do," said Francisco Calheiros, president of the Portuguese Tourism Confederation.
(Editing by John Stonestreet)