The euro zone's overall budget gap fell last year but deficits in Greece and Portugal were higher than expected, underlining the challenges presented by their austerity programs.

The 17-member euro zone is struggling to restore confidence in its public finances and tackle a debt crisis that has forced Greece, Ireland and Portugal to seek emergency funding from the European Union and the International Monetary Fund.

The European Union's statistics office said the budget gap in the euro zone in 2010 was 6.0 percent of gross domestic product, down from 6.3 percent in 2009. Public debt, however, rose to 85.1 percent, from 79.3 percent in 2009.

The data from Eurostat showed that all euro zone countries except Germany, Ireland, Luxembourg and Austria improved their budget balance last year, even though debt rose in all euro zone countries except Estonia.

Collectively, the state of the public finances in the euro zone is not as bad as in the UK, the US or Japan. The problem, of course, is the huge divergence at national level, said Ken Wattret, chief euro zone economist at BNP Paribas.

Greece and Portugal were the biggest disappointments, with their budget shortfalls higher than government estimates.

Eurostat said Greece cut its budget gap to 10.5 percent of GDP from 15.4 percent in 2009. The European Commission and Athens had estimated the deficit at 9.6 percent.

Greek public debt rocketed to 142.8 percent of GDP, from 127.1 percent in 2009.

The Greek finance ministry said the higher deficit was a result of a deeper-than-expected recession and that Greece would do everything to meet targets under its EU/IMF program.

The fact that the Greek deficit ratio for 2010 is now also in double-digit territory should further fuel the debate about Greek sovereign debt restructuring, said Ralph Solveen, economist at Commerzbank.

Some German officials have said that a restructuring of the Greek debt could be supported by Berlin, although the official German government position is that there are no such plans.

Today's figures show that a sustained stabilization of Greek government finances is still a very long way off, Solveen said.

While last year, Greece managed to lower its deficit ratio by just under 5 percentage points compared to 2009, many observers doubt that such progress will be repeated in the years ahead, he said.

Eurostat said that Portugal's budget deficit was 9.1 percent of GDP last year, rather than the 8.6 percent forecast by the government. The final 2010 budget balance is also well above the initial Portuguese target of 7.3 percent of GDP.

Today's figures have reduced the chances for Portugal to in fact limit its 2011 deficit to 4.6 percent of GDP, Solveen said.

Further austerity measures and tax hikes will be necessary - something the IMF and the EU will likely also demand in turn for their financial support, he said.

Ireland saw its budget deficit more than double to 32.4 percent of GDP last year, from 14.3 percent in 2009, and its debt jumped to 96.2 percent from 65.6 percent as the country had to borrow to bail out its banking sector.

(Additional reporting by George Georgiopoulos)

(Reporting by Jan Strupczewski, editing by Rex Merrifield)