Portugal still faces some tough challenges but is on track to meet this year's budget deficit goal despite a shortfall in performance so far, officials from the European Union and IMF said on Friday.

The officials, who carried out the first review of Portugal's economy under a 78-billion-euro international bailout, said that they would recommend the disbursement of the second tranche of the rescue funds.

There is no doubt that while we are off to a strong start the most difficult challenges are still ahead, said Poul Thomsen, the IMF mission chief to Portugal.

He warned that if there was any serious weakening of the economic environment in core European states there would be a significant negative impact.

Portugal's economy is expected to contract by 2.2 percent this year and only return to growth in 2013 as the government enacts tough spending cuts and across-the-board tax hikes.

Europe's debt crisis has turned on Spain and Italy in recent weeks, heightening risks for the euro zone. But the officials said it was premature to talk about fresh rescue funds for Portugal, like Greece is set to receive.

I am confident that Portugal will return to the market at the end of the program, so it's too soon now to talk about new money, Thomsen said. Portugal is to return to the primary bond market in the second half of 2013 under the terms of the deal.

Portuguese 10-year bond yields were unchanged after the announcement at around 11.7 percent. But the PSI20 stock index in Lisbon was about 2 percent higher, also benefiting from overall firmer European markets.

Finance Minister Vitor Gaspar earlier on Friday said the government would bring forward hikes in value-added tax on gas and electricity to this year from 2012. The government already announced last month a one-off tax on year-end bonuses which will generate a total of 1.25 billion euros.

The government said earlier in the summer that there had been a shortfall in this year's budget inherited from the previous administration. Gaspar put the slippage at 1.1 percent of gross domestic product.

Despite the positive evaluation by the mission, the budget shortfall in the first half and the tough international situation shows that Portugal confronts an immense challenge, said Gaspar.

The government is still expected to announce additional spending cuts in September.

Still, the officials said they were confident that Portugal would meet this year's budget deficit goal of 5.9 percent of GDP.

Portugal's banks, which have depended on financing from the European Central Bank for over a year, appear likely to meet new minimum capital requirements, but deleveraging by the sector remains critical, the officials said.

Banks have to meet a core Tier 1 capital ratio target of 9 percent by the end of the year and then 10 percent by end-2012.

Portugal became the third country in the euro zone to seek a bailout, after Greece and Ireland, after its borrowing costs shot higher after the previous government failed to pass austerity measures. Its bond yields have retreated of late, but only after the ECB started buying them in the secondary market.

The new center-right coalition government has a large majority in parliament, allowing it to pass austerity measures.

The next review of Portugal's program under the bailout is set for November.

(Additional reporting by Andrei Khalip; writing by Axel Bugge; editing by Patrick Graham and Toby Chopra)

International Monetary Fund United nations Portugal