By Alan Wheatley and Daniel Alvarenga
COSTA DA CAPARICA, Portugal (Reuters) - Back in 2008, the 500 or so slum dwellers of Terras do Lelo were finally looking forward to a better life.
The authorities had decided where they would relocate the mainly Portuguese-speaking immigrants and Roma from their plywood and corrugated iron shacks that disfigure the fringes of one of south Lisbon's smartest beach resorts.
And then the financial crisis struck.
Five years on, as Portugal slashes its budget to please international lenders that provided a 78 billion euro bailout in 2011, there are no longer any public funds to erase the scar of shanties that would not look out of place in Mumbai or Soweto.
"Right now the state has no money to move people from here, but they should at least provide us with minimum conditions," said Euclides Fernandes, 33. The slums have no legal electricity, no sewerage and no running water.
"The emergency in the neighborhood is water," said Fernandes, who lost his construction job when the sector slumped. "With unemployment everything gets worse. We're feeling it. Families who were paying rent and now don't have an income are coming back here."
The poverty of Terras do Lelo may be extreme, but the one-two punch of budget austerity and recession is being felt across Portugal, a nation of 10.6 million.
Tiago Saraiva with the Lisbon architectural practice Ateliermob, which is working to improve conditions in the slums, says teachers at his daughter's school have to pay out of their own pockets to photocopy exam papers.
LOOKING FOR CUTS
More cuts are baked in the cake: the government is scrambling to come up with 1.3 billion euros in savings, amounting to 0.8 percent of GDP, after the constitutional court last week rejected plans to reduce public workers' benefits.
The finance ministry responded with a freeze on non-essential spending, generating front-page headlines on Thursday that everything from school lunches to police patrols and health inspections were being curtailed.
Under orders from its troika of lenders - the International Monetary Fund, the European Union and the European Central Bank - Portugal has to make 4 billion euros in permanent savings between 2013 and 2015.
What was already a huge task for Prime Minister Pedro Passos Coelho is now even more complicated due to the court's ruling that measures singling out civil servants are unfair.
"The cuts have to be done. It will not be easy. The job will have to be thorough and well thought-out," said Rui Constantino, an economist at Santander in Lisbon.
The public sector wage bill and pensions make up 60 percent of state spending, but analysts expect the government to find cuts that pass muster with the court by taking the axe to areas such as health and education.
The question for the government - and for financial markets, which have so far taken the court ruling in their stride - is how the next slug of spending cuts will be judged in the court of public opinion.
Hundreds of thousands of Portuguese have taken part in two anti-austerity protests in recent months. The demonstrations were peaceful but the message was clear: people are getting fed up with ever-rising unemployment - 16.9 percent last quarter - and never-ending cutbacks.
"The country is in chaos. It has hit rock bottom. There is little the people can do," said pensioner Manuela Ferreira, 67.
The consensus among political analysts in Lisbon is that Coelho, who survived a no-confidence motion last week, will soldier on. But his room for maneuver is shrinking.
Jose Augusto Silva, 64, head of a neighborhood association in northeast Lisbon, wishes his countrymen had more of a "culture of action" rather than passively accepting their fate.
"The situation is very hard. There are many pensioners on 200-odd euros a month here and now their children and grandchildren are unemployed and come and ask their grandparents for money," he said.
Like many people in bailed-out countries on the euro zone periphery, Silva is critical of euro zone paymaster Germany for the harsh terms of Portugal's bailout.
"Germany ended up beating us not by war but by the force of money," Silva said.
HOSTAGE TO FORTUNE
At a meeting in Dublin starting on Friday, euro zone finance ministers are likely to agree in principle to give Portugal - and Ireland - more time to repay loans from Europe's bail-out funds.
Stretching out loan repayments will help in the medium term but will not address the immediate imperative of growth.
The economy shrank 3.2 percent in 2012 and the troika has penciled in a further contraction of 2.3 percent this year.
Portugal hopes to regain full bond market access this year. But the unarticulated fear is that, without a return to vigorous growth, investors will baulk at the prospect that Portugal's debt, already 123 percent of GDP, will fail to stabilize.
Investment has fallen about 40 percent from its pre-crisis peak, while banks and households are paying down debt. With the public sector shrinking, the only bright spot has been exports.
Companies have done better than expected to diversify away from their home market, but exports need to be an ever-bigger driver of the economy, said Kathrin Muehlbronner, who covers Portugal for Moody's Investors Service.
Yet here too, Portugal is not master of its own fate.
"The export sector has to be the anchor to start a recovery, but for that you need a recovery in the wider euro zone and the global economy. That's very clear," she said.
Back in the waterless slums of Terras do Lelo, things are not looking up for Miguel Bemba da Silva. "We don't have work. Life is bad," the 43-year-old Zairean said.
Except da Silva does have work of sorts. He earns a few euros for hauling plastic jerrycans of water from a public fountain half a kilometer away.
"Water is what we miss," he said. "It's better to do this than going around thieving."
(Additional reporting by Sergio Goncalves; editing by Janet McBride)