By Andrei Khalip and Axel Bugge
LISBON (Reuters) - Portugal's center-right Social Democrats (PSD) began forming a coalition government with their traditional rightist allies on Monday, promising to take tough austerity steps under the country's bailout program.
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 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.
"Portugal needs to return to creating a wave of confidence in the markets," PSD leader and prime minister-elect Pedro Passos Coelho said in an exclusive interview. "I think we can surprise and go beyond the (bailout) agreement."
He added that he aimed to form a majority government in coalition with the ultra-conservative CDS-PP "in record time" so that "all deadlines in the agreement can be respected."
Passos Coelho said his government would set an example by cutting costs in the administration.
President Anibal Cavaco Silva met the prime minister-elect on Monday and asked him to urgently start the process of forming a majority government.
"The preparations (for forming a government) must be conducted as quickly as possible," a spokesman for the president told reporters after the meeting.
He added that Cavaco Silva had asked for the preparations to be finalized by the time the full final results of the election are published, in about two weeks, after which the president can formally appoint Passos Coelho as prime minister.
"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," Passos Coelho told reporters.
Paulo Portas, head of the CDS-PP, has said he is ready to rule together with the Social Democrats.
Portuguese stocks opened higher on Monday, [ID:nLDE75508M] 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 the coalition to enact 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.
Political analyst Adelino Maltez said the PSD and CDS-PP should be able to agree on ministerial portfolios quickly, perhaps this week.
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 advocates a smaller role for the state in the economy, and privatizations of state-run companies. A sell-off of state assets is part of the bailout program.
"This victory will probably result in a more aggressive privatization program," BPI 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 neighboring Spain, but analysts say that could change as the recession deepens.
(Additional reporting by Sergio Goncalves and Shrikesh Laxmidas; editing by Andrew Roche)