Investors sold off stocks in Portugal, Spain and Greece and the euro plunged as market fears over the fiscal problems of debt-laden southern members of the euro zone widened.
The head of the International Monetary Fund called for painful steps to cut huge fiscal deficits across Europe, saying no country should be under the illusion it was possible to escape the financial crisis without paying the cost.
The Portuguese government's defeat over a regional finance bill, a climbdown by the Spanish government over pension reform, and protests by tax officials in Greece added to the woes of states struggling to cut budget shortfalls bloated by recession.
IMF Managing Director Dominique Strauss-Kahn said his organization was ready to help Greece, which is under more pressure over its finances than any other bloc member, but expressed confidence the government would take the “very difficult measures” needed to deal with its fiscal crisis.
The Greek government reiterated on Thursday that it had no plan to seek assistance from the IMF.
The euro plunged to a seven-month low against the dollar as traders took the view that dismal public finances in the single currency area may hamper the region's economic growth prospects.
Spain's Ibex 35 stock market index fell 5.9%, while Portuguese shares fell 5%, led by a 7.5% slump in Millennium bcp, its biggest bank. The Athens stock market shed 3.3%, with the Greek banks index down 5.4%.
European Central Bank President Jean-Claude Trichet said deficit-cutting measures announced by the Greek government were “steps in the right direction” and the ECB approved of the goals which Greece now has to meet.
He stressed that all states must meet the terms of Europe's pact on budgets and debt, and underlined that help Greece receives as a euro zone member is subject to that condition.
Greek Finance Minister George Papaconstantinou said public sector pensions would increase by 1.5% this year, just above the government's inflation forecast of 1.4%.
The announcement came amid strong EU pressure for Greece to cut its public sector wage bill and two days after the prime minister pledged tough cost cutting measures.
Portugal's minority Socialist government lost a key parliamentary committee vote passing a bill allowing regional financial transfers, which it said would add €100 million in debt and make it harder to cut the budget deficit.
“Approval brings problems for governability and will have serious political consequences,” Portugal's Parliamentary Affairs Minister Jorge Lacao said before the center-right opposition and the communists combined to defeat the government.
Finance Minister Fernando Teixeira dos Santos said the regional financing bill would raise this year's projected budget deficit of 8.3% of gross domestic product.
“We could not send a worse signal at this moment,” the minister said. “I want to make it clear that I will use all legal and political instruments within my reach to preserve the budget consolidation objectives for the period of 2010 to 2013.”
The government has pledged to cut the budget gap to below 3% of GDP by 2013.
A spokesman for Prime Minister Jose Socrates denied a report he had threatened to resign over the issue.
Amid an outcry from labor unions and media, Spain withdrew a line on pension reform plans from an official document sent to the European Commission. It had suggested an increase in the number of years Spaniards would have to pay contributions.
The largest Spanish union confederation, Comisiones Obreras, said it would organize protests against the government's proposal to raise the retirement age to 67 from 65.
Spain admitted on Wednesday that its budget deficits for the next three years would be higher than previously forecast. Debt markets worry the government will struggle to cut spending at a time when unemployment is nearing 20%.
Strauss-Kahn said he understood Spanish Prime Minister Jose Luis Rodriguez Zapatero's dilemma over pension reform, but warned the Spanish “really need to make a considerable effort.”
The premiums that investors demand to hold Portuguese bonds rather than benchmark German Bunds widened on worries that Greece's problems could be mirrored by other euro zone states.
However Spain did manage to sell €2.5 billion ($3.47 billion) in 3-year bonds in a move that Calyon strategist Peter Chatwell said should quell some jitters.
Greece has the highest debt ratio of any euro zone country, expected to reach 120% of gross domestic product this year. Portugal's debt is expected to reach 84.5% of GDP and Spain's just 66.3%, below the euro zone average. However both countries' debt stock is rising fast.
Greece won heavily conditioned EU approval on Wednesday for a three-year plan to cut its budget shortfall from 12.7% of GDP in 2009 to below the EU ceiling of 3% by the end of 2012. Brussels placed Athens under unprecedented close surveillance, out of mistrust of its economic statistics.
Highlighting the risk of social unrest, Greek tax officials staged the first of a series of public and private sector workers' strikes that will affect Greece this month. (Reuters)