Greece's admission that it will miss its deficit target this year despite harsh new austerity measures sent stock markets reeling on Monday and raised new doubts over a planned second international bailout.

The gloomy news from Athens brought the specter of a debt default closer and will weigh on talks among euro zone finance ministers in Luxembourg later on Monday about the next steps to try to resolve the currency area's sovereign debt crisis.

European bank shares suffered the heaviest falls on fears that private sector bondholders may be forced to absorb bigger losses than agreed in a July rescue plan for Greece, which was based on more optimistic growth forecasts.

The draft budget sent to parliament on Monday showed this year's deficit would be 8.5 percent of gross domestic product, well off the 7.6 percent agreed in Greece's EU/IMF bailout program.

Finance Minister Evangelos Venizelos said in a statement that the 2012 fiscal targets would be met in absolute terms and Greece would have a primary surplus before debt service for the first time in many years.

However, next year's deficit is projected to be 6.8 percent of GDP, rather than the 6.5 percent EU/IMF goal, because the economy is set to shrink by a further 2.5 percent after a record 5.5 percent contraction in 2011.

A deeper-than-forecast recession means public debt will be equivalent to 161.8 percent of GDP this year, rising to 172.7 percent next year, by far the highest ratio in Europe.

Deputy Finance Minister Pantelis Oikonomou said the European Union and International Monetary Fund inspectors had essentially concluded negotiations to give Greece a crucial 8 billion euro installment of aid this month to avert bankruptcy.

However, a source familiar with the review by the troika of international lenders said the talks were not over, and the inspectors were still examining both the budget numbers and other reforms required for the loan disbursement.

Speculating about it in advance makes no sense, German Finance Minister Wolfgang Schaeuble said of the aid tranche. But Belgium's finance minister, Didier Reynders, was more optimistic, saying he hoped the money would be paid in days.

I hope that today, or in the next few days, we will take the decision to disburse the next tranche (of money) to Greece. Greeks are making important efforts and the euro zone should also do its job and vote to approve the texts, he said.

The 17 euro zone ministers will not take any decision on Monday on releasing the funds, needed to pay October salaries and pensions, since the troika has yet to report back. They are set to decide at a special meeting on October 13.

The likelihood that Greece's funding needs next year will be greater than forecast when a second 109 billion euro rescue package was agreed in principle in July reopened a fraught battle over who should pay -- taxpayers or financiers.

STEEPER HAIRCUT?

Deutsche Bank chairman Josef Ackermann, head of the International Institute of Finance (IIF), which negotiated a voluntary bond-swap by investors as part of the bailout plan, warned at the weekend against changing the terms now.

If we reopen the voluntary accord of July 21, we will not only lose precious time but quite possibly also private investor support, Ackermann told the Sunday edition of Greek newspaper Kathimerini.

The impact of such a move will be incalculable. This is why I am warning in the most forceful way against any material revision, he said.

Private bondholders agreed to a 21 percent write-down on their Greek debt holdings but EU and German officials have suggested the haircut may have to be increased in light of a new funding shortfall and changed market conditions.

Ultimately, Greece would need to see its debt written down by more and with that you need probably some kind of shoring up of the banking sector, said Alec Letchfield, chief investment officer at HSBC Asset Management.

Political resistance to pouring more public money into euro zone bailouts is growing across northern Europe.

Greece is bankrupt, said Michael Fuchs, a deputy parliamentary floor leader in German Chancellor Angela Merkel's Christian Democrats, reflecting a growing mood in Berlin.

Probably there is no other way for us other than to accept at least a 50 percent forgiveness of its debts, Fuchs told the Rheinische Post newspaper.

FLIGHT TO SAFETY

Uncertainty over the extent of damage to the already fragile European banking sector from a possible Greek default has been driving investors to take refuge in safer assets.

Yields on Spanish and Italian government bonds rose and the cost of insuring their debt against default spiked on the news from Greece, while money poured into safe-haven German Bunds. The euro fell to an eight-month low in Asia.

The markets continue to conclude that a default for Greece is an inevitability and a question of when rather than if, said Nick Stamenkovic, strategist at RIA Capital Markets.

The euro zone ministers were expected to discuss ways to leverage their EFSF bailout fund, without reaching a conclusion on Monday, and to put more pressure on Greece to implement agreed structural reforms and privatizations to try to get its economy growing again.

Economic and Monetary Affairs Commissioner Olli Rehn said Europe faced a triple challenge of stalling growth, stressed sovereigns and still vulnerable banks.

Ministers would review options to enhance the financial firepower of the rescue fund, some of which involved leveraging with money from the European Central Bank, he said.

The debt and GDP projections illustrate how Greece has fallen into a vicious spiral of recession, falling revenues, soaring unemployment and declining consumer purchasing power.

Officials expect the next aid tranche will be paid, because the euro zone will not be ready to cope with the fallout of a Greek default until its bailout fund, the European Financial Stability Facility (EFSF), gets its new powers of market intervention ratified in the next two weeks.

Even then, however, while the 440 billion euro fund will be able to buy government bonds from the market, recapitalize banks and extend precautionary credit to sovereigns, it may not have enough cash to cope with all the financing needs.

The leveraging idea, suggested by the United States, has opponents in north European creditor countries, who fear it could lead to bigger liabilities beyond the 780 billion euros in current EFSF guarantees, or credit rating downgrades for either the AAA-rated rescue fund or its triple-A guarantors.

Among the ideas under consideration is allowing the EFSF to refinance itself at the ECB's liquidity operations for banks. The EFSF could also guarantee to cover a percentage of potential losses investors could incur in case of a hypothetical sovereign default.

Any solution, however, should not require another round of ratification, officials said, because policymakers realized how difficult and lengthy the process was given the growing opposition to bailouts in many euro zone countries.

(Additional reporting by Ingrid Melander, Dina Kyriakidou and Lefteris Papadimas in Athens, Dominic Lau and William James in London, Annika Breidthardt, John O'Donnell and Robin Emmott in Luxembourg; Writing by Paul Taylor, editing by Mike Peacock)