The Netherlands appears to be heading for early elections after budget talks in the core euro zone member collapsed on Saturday, jeopardising its chances of meeting European deficit targets and of approving a broader fiscal responsibility pact.
Prime Minister Mark Rutte, who has led a minority Liberal-Christian Democrat coalition since October 2010, will first try to reach an agreement with the opposition, including the pro-Europe Labour Party, on crucial budget cuts after his ally Geert Wilders refused to do a deal.
But even if Rutte does manage to stave off an immediate budget crisis, the likelihood of elections within weeks or months has increased.
The uncertainty places a question mark over whether parliament will approve a new pact on fiscal responsibility in the euro zone, seen as crucial to stave off the wider debt crisis in the region.
Elections are to be expected now. I will talk to parliament (on) how to get through this situation, Rutte told reporters on Saturday after talks collapsed over how and where to cut about 14 billion (11.48 billion pounds) to 16 billion euros (13.12 billion pounds) from the annual budget in order to bring the deficit below 3 percent of gross domestic product.
The proposals up for discussion had included a broad pay freeze, higher value added tax, and cuts to subsidies on mortgages. Wilders, whose party opposes immigration, had objected to cutting mortgage subsidies and had pushed for the country's overseas development aid budget to be slashed by a quarter or more.
In the Netherlands' highly fragmented political system, coalition governments are the norm because no single party can muster a majority.
Rutte's Liberal Party, the largest in parliament, still has a narrow lead in the opinion polls, but both the Socialist Party, which opposes euro zone bailouts, and the pro-Europe Labour Party, which has a new leader, have grown in popularity recently.
Underlining the sense of crisis, Finance Minister Jan Kees de Jager said he would return to the Netherlands immediately from Washington where he had been attending International Monetary Fund talks.
De Jager, who has been an outspoken critic of the so-called budget sinners or euro zone peripheral members that have failed to meet budget targets, said the cabinet would try to muster a majority for its budget in parliament and that he would send details of a package of cutbacks to the European Commission as planned within days.
Rutte said the cabinet would meet on Monday to decide what to do next. He could offer his cabinet's resignation to the Queen, who could either accept it or ask Rutte to seek support from opposition parties to cut the budget deficit, Maurice de Hond, head of one of the country's polling agencies, said.
But many Dutch politicians and political analysts said the government should just cut its losses and call new elections sooner rather than later.
It should mean new elections, said Sweder van Wijnbergen, a professor at the University of Amsterdam.
That would be the wisest thing. They might try to carry on as a minority government, but that would just mean early elections in a few months' time rather than immediately. The idea is to have a strong, determined government carrying out reforms, but this government has been paralysed.
Uncertainty over whether the Netherlands can now push through crucial budget cuts and much-needed reforms of its labour and housing markets, as well as the prospect of elections, is likely to rattle financial markets, economists said.
This situation is very bad. We can't agree a budget, we can't restructure, neither in the short term nor in the long term. This is the worst-case scenario for the Netherlands, Jaap Koelewijn, an economist and professor of corporate finance at Nyenrode Business University, told Reuters.
Rutte's Liberal-Christian Democrat coalition government and its ally, Wilders' Freedom Party, had been in talks for seven weeks, trying to reach a deal to cut about 14 to 16 billion euros from the annual budget.
The cuts are seen as essential if the Netherlands is to bring its deficit back below the European Union's target of 3 percent of gross domestic product and ease concerns that it could lose its precious triple-A credit rating.
Earlier this week, ratings agency Fitch warned that the Netherlands, one of just four euro countries with a coveted triple-A rating, was on the verge of a downgrade in its credit status due to high debt.
In the next few weeks, I expect that the whole political landscape will come under pressure, within and outside the Netherlands, about what needs to be done, De Hond said.
With elections in France and in Austria later this year you can count on others wanting to get off the fiscal bandwagon. Look at the position (French presidential candidate Francois) Hollande has taken, De Hond said.
Rutte's government has drawn support from the left-leaning Labour Party in the past to pass legislation on euro zone issues. But he may find it harder to win support from the new Labour leader, Diederik Samsom.
Samsom told public broadcaster NOS that he would be willing to work with the current cabinet on cuts and reforms for 2013, provided the government agreed to call elections within a few months and cancel some other budget cuts which had been planned.
An outgoing cabinet with elections in September is a new situation where everyone, the whole parliament, has to take responsibility for the 2013 budget, Samsom told NOS.
But Samsom later told Reuters he wanted elections and saw no need to do any deal with the government.
Wilders, whose party opposes immigration and euro zone bailouts, also called for elections to be held as soon as possible.
I had hoped we would work something out, but this package is unacceptable for our party and the country, Wilders told journalists. It's time to go to the Dutch voters.
It took several months to form the current coalition after the previous government collapsed.
The fall of the government would be very worrying, said Andre Pieters, owner of a cheese shop in The Hague. With the economy the way it is, we needed a technocratic government like we have.
(Additional reporting by Anthony Deutsch; Writing by Sara Webb; Editing by Andrew Osborn)