Portugal announced new spending cuts on Friday to try to restore confidence in its finances ahead of a euro zone summit that is likely to back a plan to boost competitiveness but defer decisions on a stronger rescue fund.
A German government source said there were positive signals that Greece and Ireland, which received EU/IMF bailouts last year, might also announce new moves at the summit, opening the way for EU paymaster Germany to offer them more help.
Chancellor Angela Merkel was ready to support some easing of the terms on their bailout loans ifz Athens speeded up promised privatizations and Dublin was more forthcoming on a common corporate tax base in the euro zone, the source said.
But new Irish Prime Minister Enda Kenny said Dublin would resist German efforts to introduce a common corporate tax base.
This would be a harmonization of tax by the back door, he said in comments broadcast by RTE state radio.
Greece said that weaker than expected revenues and higher spending had widened its state budget shortfall in the first two months of 2011, blowing it off course in its efforts to meet the tough fiscal targets set out by the EU and IMF.
Moody's slashed Athens' credit rating by three notches on Monday citing a heightened risk of default.
The euro, which suffered its biggest one-day fall against the dollar in a month on Thursday, languished near a one-week low and Portuguese bond yields rose despite the budget measures amid growing market doubts that leaders can bridge differences on how to solve the region's fiscal woes.
The slow pace of European crisis management has piled pressure on Portugal to seek an EU/IMF bailout. Prime Minister Jose Socrates has resisted, saying it would be a national humiliation.
In a last-ditch attempt to convince investors its finances are sustainable, his government announced new cuts worth 0.8 percent of gross domestic product this year and structural reforms that it said would push its deficit down faster.
The measures include cuts in spending on social welfare and infrastructure.
Changes to labor market rules are also planned, including a reduction in layoff payments.
European Monetary Affairs Commissioner Olli Rehn welcomed the clear and important Portuguese steps, which he said would help Lisbon regain control over its debt and end uncertainties.
This is Portugal still desperately trying to prove that it has the political will to push through these painful measures, said Colin Ellis, chief economist at BVCA in London.
Ultimately, however, the interest rates they are paying in the market are unsustainable. There's still a good chance they will need some support at some stage.
Austrian Finance Minister Josef Proell, in an interview with the Financial Times, urged Portugal to learn from the lessons of Greece and Ireland, saying Don't be too late. Make your decision soon: yes or no.
Germany doused market expectations of a breakthrough on the rescue fund at Friday's summit of the 17-nation currency area, saying the most that should be expected is an agreement on a competitiveness pact it put forward with France last month.
Bigger decisions to tackle the crisis -- such as whether and how to strengthen the euro zone's bailout fund -- will be handled at a later summit on March 24-25.
Berlin's aim on Friday was to get euro zone states to enshrine EU curbs on deficits and debt in national law -- effectively making it illegal for any euro zone member to exceed fixed deficit and debt limits in the future.
The EU's Stability and Growth Pact sets a government deficit limit of 3 percent of GDP and debt of 60 percent of GDP. Translating that into national laws would entail the adoption of a debt brake, similar to what German law requires.
Euro area member states commit to translating EU fiscal rules as set out in the Stability and Growth Pact into national legislation, the latest draft of the agreement reads.
Member states will retain the choice of the specific national legal vehicle to be used, but will make sure that it has a sufficiently strong binding and durable nature (e.g. constitution or framework law), the draft said.
If Germany and France can get the remaining euro zone members to sign up to the competitiveness pact -- which also includes moves to gradually raise retirement ages and work toward a common corporate tax base -- there is an expectation that Germany will agree to back a stronger bailout fund.
The European Financial Stability Facility, used to rescue Ireland, has an effective lending capacity of 250 billion euros ($345 billion), not its full 440 billion, because of guarantees needed to retain its triple-A credit rating.
Merkel told lawmakers in her party on Thursday that Germany would only increase its guarantees if non-triple A states put in more capital, according to participants at the closed-door meeting, something several of those states have opposed.
The debate will be taken up on March 24, but its outcome may depend on how much backing Germany wins for Friday's agenda.
Analysts see the competitiveness pact as a sideshow, saying it does nothing to tackle the fundamental problem of bad banking debts and highly indebted sovereigns with poor growth prospects.
(Writing by Noah Barkin and Paul Taylor)