By Andrei Khalip
LISBON (Reuters) - Portugal's centre-right Social Democrats (PSD) began forming a coalition government with their traditional rightist allies on Monday, calling on the Portuguese to muster their courage as a tough austerity plan is rolled out.
The PSD's convincing victory on Sunday with 39 percent of the vote ended months of political uncertainty following the collapse of the minority Socialist government in March, when it failed to pass its latest austerity package.
Submerged in an acute debt crisis, Portugal received a 78 billion euro (69 billion pound) bailout last month from the European Union and IMF. The terms include higher taxes and tough spending cuts that will weigh on an economy already deep in recession.
"I will have important contacts today that have to be made to form the government, namely contacts with the CDS-PP," the Social Democrat leader and prime minister in waiting, Pedro Passos Coelho, told reporters as he left home on Monday.
"There are many difficult measures planned that will be taken. All the Portuguese will need a lot of courage, and I'm sure they'll have enough."
Paulo Portas, head of the right-wing CDS-PP, had already said he was ready to rule together with the Social Democrats.
Portuguese stocks opened higher on Monday, but later followed European stocks lower. The 10-year bond yield was steady at around 10.4 percent, but analysts expected investors to react positively and bring the yield down.
"BIGGEST RISK OUT OF THE WAY"
"The biggest risk, of a hung parliament is out of the way, so we should have a rather safe government, a coalition government. I'd say it is as good as it gets -- there should be positive underlying impact from the election," said David Schnautz, debt strategist at Commerzbank in London.
The PSD won 105 seats while the CDS won 24, giving the two parties, which have a record of working together in coalitions, a clear majority in the 230-seat parliament.
This should allow it quickly to enact the reforms and austerity measures included in the bailout, such as sweeping tax rises and deep spending cuts, to reduce Portugal's large deficit and debt.
"The next thing to see will be, obviously, how quickly do we get some unpopular decisions, and how big is the backlash in society," Schnautz said.
Adelino Maltez, a political analyst in Lisbon, said the election "puts Portugal in the normal European groove of centre-right governments, which deserves more investor confidence."
He said the PSD and CDS-PP should be able to agree on ministerial portfolios quickly, perhaps this week.
But he said a new government might have a better chance of riding out a popular backlash over the austerity measures if it was broadened out to include the outgoing Socialists, and this might take longer.
"The solution should go via a regime pact with the Socialists, the party that negotiated the bailout. Maybe the government could include one of their ministers, say Luis Amado staying on as foreign minister," Maltez said.
Analysts say President Anibal Cavaco Silva may push for such a solution during talks with the parties this week.
DEEP RECESSION
Portugal faces its highest level of unemployment in three decades and the economy is expected to contract 2 percent both this year and next, presenting the new government with tough challenges as disposable incomes fall.
The PSD has long argued for cuts in government spending, which the Socialists have managed to reduce only slightly.
The PSD also advocates a smaller role for the state in the economy, and privatisations of state-run companies. A sell-off of state assets is also part of the bailout programme.
"This victory will probably result in a more aggressive privatisation programme," BPI bank analysts wrote in a research note.
Filipe Garcia, head of the consultants Informacao de Mercados Financeiros in Porto, said the clear election result would help investor sentiment, but that Portugal's economic problems could not be solved quickly.
"This major result will allow the right to pass more unpopular measures," Garcia said. "But the pact does not solve the country's problems, does not bring growth, and the success of the government's economic policy will depend very much on the Europe-wide sovereign debt crisis."
So far there have been few strikes or protests against austerity measures in Portugal, in contrast to Greece and neighbouring Spain, but analysts say that could change as the recession deepens.
(Additional reporting by Shrikesh Laxmidas; Editing by Kevin Liffey)
