Portugal's governing centre-right coalition on Wednesday sought a solution to a political crisis caused by the shock resignation of two ministers over its bailout reforms which has sparked cries of concern from European authorities as financial markets took fright.
Stock markets fell and bond yields rose as the crisis fed fears of a new wave of instability from the eurozone's debt-laden periphery.
Alarm spread after Foreign Minister Paulo Portas of the junior partner in the governing coalition, the small conservative CDS-PP party, resigned on Tuesday evening, a day after the shock departure of finance minister Vitor Gaspar.
The crisis came at a delicate time as Prime Minister Pedro Passos Coelho tries to fulfil the terms of the 2011 bailout that rescued Portugal from financial collapse.
Portuguese media reported Wednesday that the agriculture and social security ministers who belong to Portas' CDS-PP party were also likely to quit but chairman of the party's congress, Luis Queiro, said the two had decided to stay on in their posts.
The leadership of the party had designated Portas to hold talks with the prime minister "to together find a viable solution for the government of Portugal", Queiro added.
Passos Coelho on Tuesday refused to accept Portas' resignation and vowed not to resign himself.
"I am convinced that it will be possible to find the necessary conditions to ensure the stability of the government," he told reporters in Berlin at a top-level meeting on youth unemployment.
European officials urged the premier to settle the uncertainty as observers speculated that President Anibal Cavaco Silva would call a snap election.
"The political situation should be clarified as soon as possible," said the European Commission's Portuguese president, Jose Manuel Barroso.
Lisbon's key PSI 20 index of leading shares closed 5.31 percent lower, with leading exchanges elsewhere in Europe sliding too.
Portuguese borrowing prices soared with the yield on the benchmark 10-year government bonds spiking above eight percent for the first time since November 2012, before easing a little.
"The initial reaction of the markets shows the obvious risk that the financial credibility recently built up by Portugal could be jeopardised by the current political instability," said Barroso.
"If this happens it would be especially damaging for the Portuguese people, particularly as there were already preliminary signs of economic recovery."
Analysts warned that the political disarray could bring down his government and derail the country's recovery under the 78-billion-euro ($100-billion) international bailout.
"Portugal, under severe economic pressure from a lack of growth, a bloated public sector and more than a decade of non-growth, most likely will see its government fall inside the next 48 hours," Saxo Bank chief economist Steen Jakobsen said on Wednesday morning.
In his resignation letter, Portas said he disapproved of the prime minister's naming of Treasury Secretary Maria Luis Albuquerque to replace Gaspar. Her appointment was seen as an indication that Passos Coelho intended to push on with austerity despite protests.
Drastic cuts in spending and tax rises have plunged the country into a deeper recession with higher unemployment than had been expected.
Passos Coelho's government has just two weeks to come up with a new programme to reform the state before auditors for the IMF, European Union and European Central Bank arrive on July 15.
President Cavaco Silva was to meet with the prime minister and lawmakers on Thursday in a bid to settle the crisis, his office said.
"The situation is worrying. So I'm calling on Portugal to take responsibility," said Jeroen Dijsselbloem, the Dutch minister who heads the Eurogroup of eurozone finance chiefs.
Analysts warned that if the market tension continued, the country might not be able to return to normal borrowing on the markets next year as hoped.
"The most probable scenario seems to me to be snap elections," said financial analyst Paula Goncalves.
"The chances of a second bailout are increasing."