Social Democratic Prime Minister Anibal Cavaco Silva has embarked on a program to end state domination of the economy, which he blames for putting Western European living standards beyond the reach of most Portuguese.

Three months after breaking out of a coalition with the Socialists of former prime minister Mario Soares and then defeating them in an October election, Cavaco Silva expressed confidence that Portugal can begin to match the economic performance of its highly industrialized partners within three years of joining the European Community next month.

"Nothing justifies our remaining on the bottom rung in Europe," he told parliament when his center-right government presented its program of sweeping changes. "We are determined to put an end to the resignation and impotence imposed by our giant state machine," he said.

Finance Minister Miguel Cadilhe illustrated the new government's ambitions at a press conference where he plotted a graph showing inflation falling from its current 20 percent to the European Community average of 5 percent in three years. He sketched similarly abrupt recoveries for production and the Portuguese currency, the escudo.

The promise of turning over control of the economy to private enterprise has been welcomed by a business community whose confidence was weakened by two years of harsh recession. But despite its hopes for a turnaround, the odds appear stacked against the government.

Commanding only 83 of the 250 seats in parliament, the Social Democrats are in a smaller minority than any of the 15 previous governments that have fallen before their term since a leftist Army coup restored democracy in 1974.

"Running this minority government will be like riding a bicycle," said a top civil servant. "It will take a lot of skill and stamina to travel any distance."

A second threat to the government is the possibility of a left-wing candidate being elected Jan. 26 to succeed President Antonio Ramalho Eanes. The election is shaping up as a major political battle between forces that want to put Portugal back on the socialist course begun in 1974 and those on the right and center.

Cavaco Silva's toughest challenge will be the gradual dismantling of the mammoth state-controlled sector. A Communist-led wave of nationalizations in 1975 gave the state control over 244 companies from banks to breweries. Low productivity and bad management have turned state industries into a drain on the country's resources. But to organized labor and the pro-Soviet Communist Party they remain "conquests of the revolution" to be staunchly protected.

The process of reprivatization will be slow and painful. The government needs the support of both parliament and a sympathetic president to revise the constitution, which defines Portugal as a state "in transition to a society without classes" and enshrines the nationalizations as "irreversible." Inevitable factory closures and layoffs could renew labor unrest.

Beyond breaking what he calls the state's stifling hold on the economy, the 46-year-old premier's plan is based principally on a series of incentives for capital investment, which fell a sharp 27 percent in two years under the previous Socialist-led administration.

Three economics professors -- Cavaco Silva, Cadilhe and Planning Minister Luis Valente de Oliveira -- form the heart of the new Social Democratic government that, despite its name, aligns more closely with Europe's conservative Christian democratic parties than with liberal social democrats. An opposition commentator, disparaging the technocratic propensities of the Cabinet, said it was more set on earning a reference to itself in economic textbooks than a page in history.

Nevertheless, business has hailed the government's first moves. It cut 4 percentage points off credit rates of 30 percent and higher, which have been blamed for a serious slump in investments. Simultaneously, it suspended a monthly 1 percent devaluation of the escudo, a measure that should slow inflation by lowering the cost of imports. Portugal imports nearly 90 percent of its energy needs and half its food.

Other spurs to an economic pickup pledged by Cavaco Silva include tax cuts, reviving the stock market and revising rigid labor laws, a legacy of the revolution that employers say makes it almost impossible to dismiss workers. Real earnings are to be allowed to increase for the first time in three years in an overall strategy that targets an annual economic growth rate of 4 percent.

An austerity drive by the previous government cost the Socialists votes but brought the balance-of-payments deficit down from $3.2 billion in 1983 to about $150 million this year, laying a foundation for Cavaco Silva's planned recovery. The premier has said he will allow the deficit to climb back to about $1 billion to boost investment-linked imports and spur demand.

The Social Democrats hope to trim inflation to 14 percent next year, then 10 and 5 percent in 1987 and 1988. But opposition economists said the government has failed to forecast the effects of joining the EC and of introducing a value-added tax next month.