By Patricia Kowsman and Gabriele Steinhauser 

The European Union's executive arm urged Portugal on Friday to take extra measures to keep down this year's budget deficit, but stopped short of demanding that the government submit an entirely new spending plan.

The decision by the European Commission follows a warning it issued last week that Portugal's draft budget wasn't in line with the bloc's fiscal rules. Officials said earlier this week that to bring government spending on to an acceptable path, the government would have to produce some EUR950 million ($1.06 billion) in extra saving.

During negotiations that lasted until late Thursday, Portuguese officials made further concessions which the commission believes will lead to some EUR845 million in extra savings, said Pierre Moscovici, the EU's economic and financial affairs commissioner. He added that the Portuguese authorities believed the extra measures would lead to some EUR1.12 billion in savings.

"Dialogue achieved more than a rejection," Mr. Moscovici said. "But we have to be very careful, those risks are not gone," he added.

Although it avoided a rejection, Portugal will have to take further steps to bring the spending plan fully in line with EU rules. Mr. Moscovici said that the commission would take another look the budget in May to make a final assessment. "It's still a long hard slog," he added.

Budget troubles could hit Portugal's credibility among investors less than two years after it exited a multibillion euro bailout from the International Monetary Fund and the other eurozone countries.

Canadian debt-rating agency DBRS Ltd. could be forced to downgrade Portugal's credit rating to junk, falling in line with the three other major ratings firms. If that happens, the European Central Bank would no longer be able to buy Portuguese debt under its bond-buying program, likely triggering a sharp rise in the interest rates investors charge to hold the country's debt.

The friction between the commission and the new Socialist-led government demonstrates the pressure that Portugal's Prime Minister António Costa is under to implement more austerity measures, while keeping his far-left allies in parliament happy. Mr. Costa's party lost elections in October, but was able to forge an alliance with three euroskeptic parties that have openly questioned Portugal's presence in the currency union.

On Friday, Mr. Costa struck a defiant tone following a meeting in Berlin with German Chancellor Angela Merkel. "I don't want to put Chancellor Merkel under pressure here, because surely she has enough on her plate with her own German budget, but Portugal has a readjustment phase behind it," he said at a joint news conference.

Mr. Costa has vowed to reverse some austerity measures imposed by the previous center-right government but nevertheless stick to EU budget requirements. He has said that the Portuguese must have more disposable income to boost economic growth and.

Under the budget plan presented last month, the government said it would reverse salary cuts in the public sector throughout this year and phase out a special tax on income. It also planned to cut the value-added tax for restaurants to 13% from 23%. To make up for the fall in revenue, it said it would increase taxes on some products including tobacco and oil.

It estimated a structural budget deficit of 1.1% of gross domestic product, and a growth of 2.1%, which was considered too optimistic by a budget watchdog and credit-rating firms.

Following the commission's criticism, the government made adjustments, mostly to increase tax revenues. The final budget plan is expected to be presented later on Friday.

Under new powers created during the eurozone debt crisis, the commission has the right to assess government spending plans to check whether they are in line with the bloc's debt and deficit rules.

So far, it has given negative opinions and demanded additional overhauls and cuts from several countries--most recently Italy, Spain, Austria and Lithuania--but stopped short of asking for a full new budget.

Part of the difficulty of taking a decision on Portugal's budget was because of the complicated nature of the eurozone's budget rules. Its most well-known stipulations--that government deficits can't be more than 3% of GDP and gross debt must be below 60%--are accompanied by a host of exceptions and alternative measurements which fiscal hawks such as Germany have blamed for creating unnecessary loopholes.

In Portugal's case, the focus has been on its structural deficit--a measurement that strips out the fiscal effects of a depressed economy and is supposed to identify a country's actual budget shortfall. But often, national governments and the commission disagree about how much of a country's deficit is down to the economic cycle and how much is ingrained in long-term spending habits.

Zeke Turner contributed to this article.

Write to Gabriele Steinhauser at gabriele.steinhauser@wsj.com

(END) Dow Jones Newswires

February 05, 2016 11:13 ET (16:13 GMT)