Portugal has broadly abided by its commitments to slash spending and reform the economy in return for last year's €78 billion ($98 billion) rescue. But falling tax revenue due to a recession means Portugal is likely to miss its budget deficit target of 4.5 per cent this year.
That means the bailout lenders may have to grant Portugal more time to meet its deficit goal — a concession they are hesitant to offer another bailed-out straggler, Greece.
Alternatively, the inspectors might demand more austerity, which could drive the weak Portuguese economy into a potential death spiral.
Though Portugal is one of the smaller economies among the 17 countries using the shared euro currency, its difficulties could open a new front in Europe's battle against the financial crisis that has gripped the continent for several years.
The three-year bailout program is supposed to restore Portugal's financial health, allowing it to recoup investor confidence and get funding on international debt markets from September 2013.
However, the interest rate on its 10-year bond — what it would pay to raise 10-year money on markets — stood Tuesday at 9.4 per cent, still prohibitively expensive and a sign that investors remain wary of its ability to repay its debts. In contrast, the yield on Germany's 10-year bond was 1.4 per cent.
Neither government officials nor members of the inspection team from the bailout lenders — the International Monetary Fund, the European Commission and the European Central Bank — commented to the media Tuesday. The inspection is expected to last at least 10 days, with a statement planned at its conclusion.
Portugal's centre-right coalition government faces mounting economic and political problems.
Amid a third recession in four years, with the government forecasting a 3.3 per cent economic contraction in 2012 and unemployment at a record 15.2 per cent, the Treasury collected around €2 billion less than expected in tax revenue through July. Government spending, meanwhile, fell 1.7 per cent, in line with its fiscal plans.
One of the main factors that compelled Portugal to ask for financial aid was the past decade of weak growth, when it ran up steep debts. The government hopes the recession will bottom out next year, when it forecasts unemployment will peak at 16 per cent.
The number of personal and company bankruptcies decreed by Portuguese courts jumped 77 per cent in the first quarter of this year compared with the same period in 2011, the Justice Ministry said last month.
The constitutional Court last month struck down a government plan to take away the Christmas and vacation bonuses of public employees and pensioners. The court said the measure was unconstitutional because it discriminated against a section of society.
The government has to decide whether to get around that prohibition by extending the cuts to the private sector, but such a move would encounter fierce political opposition.
The bailout agreement, containing conditions for the financial aid, was signed in May 2011 by the three main parties but there are signs the political unity could be unraveling.
The main opposition Socialist Party says it won't give its blessing to any more cuts. It says austerity is choking the economy. Lawmakers with the Popular Party, the junior member of the coalition government, have also balked at further cuts, as have grass-roots members of the Social Democratic Party which leads the coalition.
The austerity program, including tax hikes and pay and welfare cuts, has also angered trade unions, bringing a series of strikes and street protests.
That may force the government to look for a one-off measure to close this year's funding gap. That's what it did last year when it shifted €6 billion of private banks' pension funds to the Treasury, driving the deficit down to 4.2 per cent of gross domestic product from 10.1 per cent in 2010.
The bailout lenders have previously said that if Portugal complies with the terms of the financial aid but its recovery is thwarted by factors beyond its control, they will look kindly on the possibility of easing the conditions.
Such a decision, however, is politically sensitive now as eurozone ministers are balking at granting Greece — which is itself struggling to meet deficit targets — more time to complete its reforms.