BRUSSELS — Just on the day EU leaders were hoping to present the final version of their plan to solve the region's debt crisis, their summit in Brussels was overwhelmed Thursday by debate over Portugal's political crisis and Ireland's banking woes.
The meeting was supposed to be the event where governments signed off on closer economic cooperation and an overhaul of the size and powers of the region's bailout funds. Instead, all the focus turned to whether Portugal will take a bailout and how Ireland will cope with its banks' losses.
The defeat of Portugal's minority government over planned austerity measures puts one of Europe's most financially troubled countries into political limbo just as it faces huge debt repayment deadlines.
Pedro Passos Coelho, the leader of Portugal's main opposition party and the most likely candidate to become its next prime minister, said it was "impossible" to tell whether the country could avoid an international bailout like the ones taken by Greece and Ireland.
He said he didn't have complete information about public finances, but emphasized that the country needed "a stronger government, more committed to reducing the public deficit and controlling debt levels."
Passos Coelho's center-right Social Democratic Party and other opposition parties Wednesday night refused to endorse Prime Minister Jose Socrates' spending cuts and tax increases, triggering his resignation.
Passos Coelho was meeting other conservative EU politicians at a pre-summit meeting just outside Brussels, while Socrates represented his country at the actual summit. However, Passos Coelho said Socrates would not have a mandate to negotiate a bailout on behalf of his country.
Most analysts believe an international rescue is only a matter of time, as the EU's bailout fund is ready to be tapped.
Jean-Claude Juncker, the prime minister of Luxembourg, said EU leaders would hold talks with both Passos Coelho and Socrates to get a clear idea of the situation.
Some, like German Chancellor Angela Merkel, said they regretted Socrates' defeat over austerity measures.
"Portugal had presented a very courageous reform program for the years '11, '12 and '13," she said. "I think it will depend very much on everyone who speaks for Portugal feeling committed to the goals of that program. That is not only important for Portugal but also for the entire eurozone."
In an effort to finally get ahead of the crisis, eurozone policymakers over the past weeks reached deals on the size and powers of their provisional and future bailout funds, and committed to improve the competitiveness of their economies by targeting wage increases and unsustainable public pension systems.
On Thursday, six non-euro states — Poland, Bulgaria, Denmark, Romania, Lithuania, and Latvia — announced that they will also sign up to the competitiveness deal, which has been dubbed the "pact for the euro." Most of these countries are expected to adopt the euro eventually, so the pact gives them a chance to get their economies in the right shape.
But a growing unwillingness among taxpayers — and politicians — in some countries to bet solely on austerity measures to overcome the region's financial crisis was starting to put that strategy into doubt.
"The negative developments in Portugal are likely to crowd out the positive message of European leaders agreeing to the so-called comprehensive solution (to the crisis)," Sony Kapoor, managing director of economic think tank Re-Define, said in a note.
For the moment, market jitters appeared to be confined to the three most troubled countries — Portugal, Ireland and Greece. Elsewhere in Europe, markets were steady — even in Spain, which was considered the next weakest link in the eurozone after Portugal — suggesting investors believe the debt turmoil can be better contained now than in the past.
Still, the outlook for the three shakiest countries is grim.
Fitch Ratings promptly downgraded Portugal's credit rating, not even waiting for a new government or updates plans to cut spending, while few economists believe Greece will ever repay its mounting debts without some restructuring.
In Ireland, the new government is threatening to make senior bondholders take losses if stress tests next week reveal big capital holes in the country's banks. Irish Prime Minister Enda Kenny said he would not try to reach any new deals on his country's painful bailout with other eurozone leaders until he knows the result of the stress tests.
"From the Irish point of view I prefer to deal with substance rather than theory," he told reporters.
The stress tests will give a clearer picture of the state of the banks and the ability of the Irish government to continue shouldering their losses. But they will also show other eurozone governments, whose banks were prolific lenders to their Irish counterparts, how much they are involved in the problem.
If the Irish force losses on private bank bondholders that could cause huge trouble for banks in Germany, the U.K. and France.
The EU and the European Central Bank have so far ruled out letting big banks fail outright, fearing that it would cause panic on financial markets similar to what happened after the collapse of Lehman Brothers in 2008.Comment on this story
The unwillingness of citizens to continue paying for what many see as the excesses of financial institutions and politicians was visible in Brussels, where close to 20,000 workers protested against the economic measures envisaged by leaders in their drive for more competitiveness.
Police used water cannons and pepper spray to keep demonstrators away from the site of Thursday's summit and a dozen of police officers were injured in scuffles. The trade unions called the measures an unprecedented attack on Europe's welfare state, targeting workers with austerity measures while undermining cherished social benefits.
Raf Casert in Brussels, Shawn Pogatchnik in Dublin and Barry Hatton in Lisbon contributed to this story.