Dutch Prime Minister Mark Rutte tendered his government's resignation on Monday in a crisis over budget cuts, creating a political vacuum in a country which strongly backed an EU fiscal treaty and lectured Greece on getting its finances in order.
Rutte said he had offered his minority coalition's resignation to Queen Beatrix after a split with the populist Freedom Party, which had backed his government for the past 18 months, opening the way for elections possibly as early as June.
Turmoil in what is traditionally one of the euro zone's most stable and prosperous members jolted financial markets, already worried that the Socialist frontrunner in French elections has pledged to renegotiate the agreement to ensure fiscal stability if he wins the presidency next month.
Markets have punished Spain by pushing up its borrowing costs sharply after Madrid relaxed its targets for cutting the budget deficit.
Analysts said the Netherlands can avoid this fate, but only if parties in and outside the centre-right coalition can somehow agree on budget cuts. Anything less may threaten the Dutch government's AAA credit rating.
Rutte said the Queen was considering the resignation offer and had asked the cabinet to keep working for the country's good. However, government ministers openly speculated that new elections would be needed to break the impasse.
Finance Minister Jan Kees de Jager, who has taken a tough line with euro zone "budget sinners" such as Greece, tried to reassure markets that the country was not about to ditch its commitment to good housekeeping.
"The Netherlands will retain its solid fiscal policy and will also show the market it will lower its deficit and also have a path of sustainable government finances," he said.
De Jager, who in the past has said Greece should be denied international aid unless it got its fiscal house in order, dismissed suggestions that political paralysis would force the Netherlands into the ranks of Europe's sickest economies.
"There is no correlation whatsoever between the Netherlands and the countries of southern Europe. (Our) sovereign debt is in the region of 65 percent (of total economic output), which is way below the euro zone average," De Jager told Reuters.
Greece, by comparison, aims to cut its debts to 120 percent of gross domestic product by 2020 from a towering 160 percent.
Nonetheless, investors sold Dutch and peripheral euro zone bonds, driving yields on debt issued by struggling Spain above 6 percent. The premium investors demand to hold Dutch bonds rather than German benchmarks surged to its highest in three years.
Within a week, the Netherlands is supposed to tell Brussels how it will cut its budget deficit next year to meet EU rules, and it then faces months of uncertainty before elections, with the possibility that they produce a eurosceptic government.
The row erupted at the weekend when the anti-EU Freedom Party led by populist Geert Wilders refused to agree with Rutte's centre-right coalition on how to cut 14 to 16 billion euros from the budget.
The crisis in the Netherlands - perhaps Germany's closest European ally on budget discipline - risks undermining a drive led by Chancellor Angela Merkel to get new fiscal rules ratified by the end of this year, although only 12 of the 17 euro zone members have to ratify it to bring the pact into force.
"The collapse of Dutch budget negotiations ... poses a significant threat to effective ratification of the fiscal compact, a central plank in Angela Merkel's strategy for addressing the euro zone crisis," Alastair Newton at Nomura said.
"It would at best significantly damage the compact's credibility and at worst encourage other members to follow suit."
A junior minister suggested new Dutch elections were nearly certain. "I assume it is inevitable," deputy foreign minister Ben Knapen told Dutch news programme RTL Z.
Elections had not been expected until after the summer holidays - long after an April 30 deadline when the Netherlands and most other EU countries must tell Brussels how they will cut their budget deficits.
However, moves were afoot to call an early vote and avoid a potentially long and damaging period of uncertainty.
A spokesman for Rutte's Liberals Party said June 27 was one of the possible dates for elections. "It is in our country's interest to let the voters decide as quickly as possible and have a new government," the spokesman said.
Newton said negotiations to form a new coalition could take even longer than the four months or so needed to create Rutte's centre-right government which took office in October 2010. They could result in a "eurosceptic new government", he said.
European Commission President Jose Manuel Barroso made clear the Dutch had to meet their targets. "We fully expect that the Dutch authorities will find a solution that ensures the financial stability of the country and the wellbeing of its citizens," he told Reuters on a visit to Copenhagen.
Rutte may try to cobble together an agreement with opposition parties as a caretaker prime minister to meet Brussels' budget deadline at the end of this month.
Hans Stegeman, economist at Rabobank, said the government should be able to send a budget plan to the European Commission by April 30. "They'd rather have a plan than have nothing at all," he said.
It was less likely that De Jager could win support from opposition parties to cut the deficit to 3 percent of GDP next year, as required by the Commission, Stegeman said.
"It will be very difficult. Many opposition parties don't think it's that important, including Labour, which says reforms are most important," he said.
The Dutch crisis flared at a time of wobbling support for the EU fiscal pact.
The Socialist frontrunner to win the French presidential election runoff next month, Francois Hollande, has promised to renegotiate aspects of the agreement.
France has already lost its triple-A credit rating and the Netherlands may follow suit if it fails to make the budget cuts, a blow that would drive up its borrowing costs. (additional reporting by Sara Webb in Amsterdam, Lefteris Papadimas in Athens, Mette Fraende in Copenhagen and Robert Bartunek in Brussels; editing by David Stamp and Mike Peacock)
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