Portugal's financial collapse appeared inevitable on Thursday, as markets took the government's resignation as proof the debt-heavy country will lose its year-long battle to avoid an international bailout.
Investors pushed the interest rate on Portugal's 10-year bonds to a euro-era record of 7.71 percent — a level that is unsustainable and could force the country to ask for a rescue like Greece and Ireland did last year.
The government quit late Wednesday after opposition parties rejected its latest debt-reduction plan, generating a new bout of market jitters over the country's future.
It is unclear how soon Portugal could take a bailout, as experts say it is unlikely that an interim government will have the constitutional authority to accept a bailout on the country's behalf. Elections would not be possible before the end of May, leaving months of unwelcome — and costly — uncertainty ahead.
The upheaval in Portugal was a setback for European leaders who are trying to reassure markets about the soundness of the 17-nation eurozone.
A European Union summit in Brussels later Thursday will seek to finalize measures aimed at finally drawing a line under the sovereign debt crisis that has dogged the continent for more than a year.
Debt problems also brought down Ireland's government earlier this year after it took a bailout, forcing an election that was won by the main opposition party.
German Chancellor Angela Merkel, who has pushed her European partners to be more prudent in spending and change their economies with the times, said Thursday that "a consistent path of consolidation and reform is essential." Events in Portugal show "how much political courage is needed when things didn't go right in the past," she told German lawmakers.
Portugal's borrowing costs have risen steadily over the past year as investors demand a high return for the risk of granting loans to a country viewed as risky because of its high debts and low growth.
The government has fought to avoid asking its EU partners and the International Monetary Fund for a bailout because the package comes with fiscal conditions that limit a country's ability to set policy and decide its own fate.
However, Barclays Capital said that market pressure was unlikely to ease and "an EU-IMF program looks increasingly likely given (the) adverse market funding conditions" for Portugal.
"In the near term, we suspect bond yields will keep pushing higher, if only because uncertainty will prevail," Barclays Capital said.
The borrowing costs are critical as Portugal faces two major bond redemptions soon. The outgoing government has said Portugal has enough cash in reserve to meet a 4.5 billion euro ($6.4 billion) repayment next month, but a similar sum due in June could be harder to find — perhaps marking the time for a financial aid request.
It is unclear whether a bailout, should one be needed, could be negotiated by a caretaker government.
Under the Constitution, a caretaker government is confined to "acts strictly necessary to ensure the management of public business." The scope of those powers has been widely debated by experts, but it is unlikely to grant the authority to request a bailout unless mandated by Parliament and with the consent of the head of state.
President Anibal Cavaco Silva is scheduled to meet Friday with all political parties on Friday to decide the way forward.
He must also convene the Council of State, an advisory panel, before deciding an election date.
Markets may take heart from the commitment of Portugal's main opposition party, the Social Democratic Party, to austerity measures and fiscal restraint. The Social Democrats have recently been ahead in opinion polls.
Portugal's woes aren't confined to its deep debt, racked up during a decade of meager growth. The country's abiding problem is a reluctance to surrender entitlements and adopt reforms that would improve productivity and make it more competitive.
The EU has long pushed Portugal to introduce changes to its restrictive labor laws which protect jobs but stifle competition, reduce bureaucracy and trim overstaffed public services.
The Portuguese face a long road out of their economic doldrums. The Bank of Portugal predicts a double-dip recession this year as austerity measures bite into growth for years to come. Unemployment is already at a record 11.2 percent.
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