BRUSSELS Portugal's political crisis and the resignation of the prime minister dominated the agenda of an EU summit Thursday, further complicating efforts to solve the euro zone's debt problems.
Prime Minister Jose Socrates quit Wednesday after parliament rejected new austerity measures that he had hoped would allow the country to avoid following Greece and Ireland in needing to seek EU/IMF financial assistance.
He is the second euro zone leader to fall victim to the rolling sovereign debt crisis after Ireland's prime minister was booted out of office last month.
Despite stepping down, Socrates came to the two-day summit. He remains adamantly opposed to requesting aid and has made it clear he intends to hold that line, at least until a new Portuguese government is formed, probably after early elections in about two months' time.
"The government will continue to fight against the possibility of resorting to foreign aid," cabinet minister Pedro Silva Pereira said in Lisbon.
The fall of the government prompted Fitch to cut Portugal's credit rating by two notches to A-, saying risks to the country's financing had risen after parliament failed to pass fiscal consolidation measures.
The ratings agency warned further downgrades are likely in the next three to six months in the absence of a "timely and credible" EU/IMF support program.
European Central Bank President Jean-Claude Trichet told reporters as he left the summit that it was crucial for Portugal to stick to the fiscal austerity measures Socrates had proposed.
EU diplomats said Socrates had privately reassured other leaders that no matter which government emerges after new elections, it would stick to the austerity program.
The Portuguese upheaval underscored the wealth of political obstacles the single currency bloc faces in trying to solve a debt crisis that has deepened over the past year.
Only a few days ago, the summit had been expected to deliver a "comprehensive package" of new measures that would reassure financial markets, but now leaders have been thrown onto the defensive and could struggle to show unity and resolve.
IMF CONTAGION WORRIES
Senior euro zone officials said Portugal was likely to need 60-80 billion euros in assistance from the EU rescue fund and the International Monetary Fund. No talks have begun yet and will anyway have to wait until a new government is formed.
Portuguese benchmark 10-year bond yields hit new highs on Thursday, climbing to 7.90 percent, far above levels that economists say would allow Lisbon to service its debt on a sustainable basis.
The euro has remained strong through the latest bout of turmoil, rising steadily for much of 2011. It was hovering just under four-month highs at $1.4170 Thursday.
Lisbon needs to refinance about 4.5 billion euros of debt in April and a similar amount in June, which may prove a trigger for finally making the request for aid. One problem is that any bailout request would have to be approved by parliament and the majority is opposed to asking for help.
With Portugal widely expected to seek assistance, attention could soon shift to Spain, which has gradually won back the confidence of investors in recent months by unveiling reforms of the labor market and pension system, as well as a plan for shoring up its ailing savings banks.
In a sign that contagion worries remain, however, sources told Reuters in Washington that the head of the International Monetary Fund (IMF) would seek approval from member countries next week to activate a $580 billion crisis fund.
"The biggest worry is the high risk of contagion from Portugal and general global uncertainty will trigger a new wave of borrowing from the fund," one source said, noting that Spain held one-third of Portugal's public debt.
European leaders surprised markets with what looked like a strong agreement at a March 11 meeting on a range of anti-crisis measures that they were expected to rubber-stamp at the summit this week. But key elements have been unraveling ever since.
A decision on how to increase the effective lending capacity of the bloc's current bailout fund -- the European Financial Stability Facility -- is now expected to be delayed until mid-year.
Finland is the main obstacle to a decision, since it has dissolved parliament ahead of elections on April 17 and therefore cannot sign off on a deal.
A new Finnish government is only likely to be formed by May at the earliest, and that government may include the eurosceptic True Finns party, which wants to renegotiate the EU's proposed crisis steps, further complicating the outlook.
In addition to the EFSF impasse, there are also differences about how member states should finance the 500 billion euro European Stability Mechanism (ESM), the fund that is to replace the EFSF in mid-2013.
Merkel is demanding changes to an ESM funding deal that her finance minister signed off on at the start of the week because that deal would have limited her ability to push through tax cuts before the next federal election in 2013.
The German U-turn, Finnish EFSF roadblock and delays in providing debt relief to Ireland pending stress tests for its stricken banks have contributed to a sense in financial markets that EU member states are endlessly at odds over how best to handle the debt crisis.
(Reporting by Marc Angrand, Rex Merrifield, Jan Strupczewski)
(Writing by Noah Barkin, Luke Baker and Paul Taylor)