Portugal's share prices plummeted and borrowing costs soared to danger levels Wednesday as Prime Minister Pedro Passos Coelho's government tottered close to collapse after top ministers quit.
Markets reacted severely after Foreign Minister Paulo Portas resigned the previous evening, a day after the shock departure of Finance Minister Vitor Gaspar.
The political crisis in recession-wracked Portugal spread fears in world markets of a new wave of instability from the bailed-out nation on the eurozone's debt-laden periphery.
The Lisbon stock exchange's main index plunged 5.99 percent to 5,199.01 points in the first half hour of trade. As concern spread to other markets, share prices in Madrid tumbled more than three percent.
The yield on benchmark 10-year Portuguese government bonds spiked above eight percent for the first time since November 2012, hitting 8.023 percent before easing a little. It closed the previous day at 6.720 percent.
The sharp rise in the bond yield indicates that the government will have to pay exorbitant rates if it wants to sell newly issued bonds to the financial markets.
Investors were unconvinced by the Portuguese premier's vow to stay on.
"Portugal, under severe economic pressure from a lack of growth, a bloated public sector and more than a decade on non-growth, most likely will see its government fall inside the next 48 hours, despite assurances from Prime Minister Pedro Passos Coelho that he will not resign," Saxo Bank chief economist Steen Jakobsen said.
"The coalition is falling, and falling soon," he said in a report.
Jakobsen said he expected a new election to be called with a huge drive against austerity measures.
"The big loser this morning is Portugal as a country. I see Portugal doing second bailout inside the next six months as the reality of economic non-progress will ultimately weigh higher than the political ability to buy time," he said.
On Monday, the Portuguese finance minister, architect of the country's reforms under its EU-IMF bailout, which has triggered calls for an early election, announced his departure.
The foreign minister declared his resignation Tuesday, saying he disagreed with the premier's choice of Treasury Secretary Maria Luis Albuquerque, who has managed the country's privatisation efforts, as the new finance minister.
The prime minister said in a televised address that he had not accepted his foreign minister's resignation and had no intention of leaving himself.
"I'm not resigning. I'm not abandoning the country," he said.
The government, which came to power in early elections in June 2011, is increasingly isolated. It faced a fourth general strike organised last week by trade unions.
Drastic cuts in spending and tax rises have plunged the country into a deeper recession, and with higher unemployment, than had been expected.
At the end of March the budget deficit amounted to 10.6 percent of annual output. The target set by creditors, already relaxed twice, is for a deficit of 5.5 percent at the end of the year.
Passos Coelho's government has just two weeks to come up with a programme to reform the state before auditors arrive on July 15 to examine progress on reforms for the IMF, EU and European Central Bank.
The government expects the economy to contract by 2.3 percent by the end of the year while the unemployment rate has soared to a record 18.2 percent.