Yields on two-year Portuguese debt rose to a fresh record of 20.3pc on Monday, reflecting fears by investors that the country would struggle to pull itself out of downward spiral without some form of debt restructuring.
Mr Passos Coelho also appeared to caution the European authorities that his government will not tolerate heavy-handed interference in the country.
"We want to take part in an ambitious European project and make our contribution so Europe can confront its problems in the most ambitious way, but as prime minister I will not stand by and let Europe govern Portugal," he told a party gathering.
There is growing rancor in Lisbon over the term of the €78bn rescue by the EU and the International Monetary Fund, and the sweeping powers of the inspectors as they impose a "structural adjustment" on the economy.
The penal rate of interest charged by the EU is expected to top 5.5pc and risks trapping the country in debt-deflation. At the same time fiscal austerity, without offsetting monetary stimulus or devaluation, may tip the economy into an even deeper downturn.
EU officials are pushing hard for a 100 basis points reduction in rates on rescue loans, hoping to win backing from a reluctant Germany at an EU summit on Thursday.
The revelation of a budget hole in Portugal has echoes of what occurred in Greece in late 2009, when an audit by the new Pasok government exposed a budget deficit twice the level previously declared to the European Commission.
Portugal's government will have to cover the gap with another round of spending cuts, mostly in the civil service and state-owned industries. The sacrosanct Christmas Bonus is already being slashed, effectively cutting salaries.
Portugal is obliged to cut the budget deficit to 5.9pc of GDP this year under its rescue terms. This looks like a Sisyphean task since the deficit was still 8.7pc in the first quarter, and further austerity will have the side-effect of choking tax revenue. The experience of Greece is that the country can find itself chasing its tail, with the deficit remaining stubbornly high in a shrinking economy. Portugal's central bank said the economy will contract a further 1.8pc next year.
"There are limits to cutting: you can't just cut blindly," said Mr Passos Coelho.
The Telegraph
More:
http://www.telegraph.co.uk/finance/financialcrisis/8646189/Portugals-Prime-Minister-Pedro-Passos-Coelho-discovers-colossal-budget-hole.html
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