By Daniel Alvarenga
LISBON (Reuters) - Portugal's parliament started a key debate on Wednesday on government austerity measures which opposition parties were expected to reject, setting the stage for the possible collapse of the minority Socialist administration a day before a European summit.
Prime Minister Jose Socrates has said he will resign if the plan is defeated. He has said its rejection would force the debt-laden country to follow Greece and Ireland and seek an international bailout, which he opposes.
The euro was 0.6 percent lower at $1.4110 from Tuesday's 4-1/2 month high of $1.4249 on wariness before the Portuguese vote and on news of a delay in increasing a euro zone bailout fund. Portuguese stocks fell and bond yields shot up.
Finance Minister Fernando Teixeira dos Santos opened the debate, warning that a refusal to approve the measures "will provoke an immediate rise in the country's risk and immediate consequences in terms of credit ratings."
Socrates sat through Teixeira dos Santos' speech but then left parliament.
All opposition parties have proposed resolutions calling for the rejection of the measures, which reduce pensions and state spending.
The main opposition Social Democrats, who have previously backed austerity, have begun talking about a snap election.
"If all these positions that now seem irreversible are confirmed, then yes (the government will step down)," Francisco Assis, Socialist bench leader in parliament, told reporters.
The Socialists have 97 of parliament's 230 seats and have no allies on whom they can rely. The plan needs at least 116 votes to pass.
A last-minute intervention in the crisis by President Anibal Cavaco Silva has appeared less likely since he said his "room for maneuver to act preventively" was limited.
The parliamentary debate began shortly after 1500 GMT and the vote is expected later in the afternoon. Socrates is due to hold a regular weekly meeting with the president at 1900 GMT.
The government had hoped to obtain support for its plan before Thursday's EU summit, to reduce market pressure on Portugal's sovereign debt.
A spokesman for Socrates said the prime minister would go to the EU summit in Brussels regardless of the outcome of the vote.
The EU leaders, however, look set to disappoint investors by delaying any approval of a beefed-up euro zone rescue fund till June.
BOND YIELD UP
Portuguese markets fell as investors grew more nervous.
The Portuguese benchmark 10-year bond yield rose to 7.83 percent on Wednesday from Tuesday's 7.68 percent and the spread over safer German Bunds rose 14 basis points to 457 bps. Many economists see borrowing costs above 7 percent as unsustainable and say Portugal will have to resort to the rescue mechanism.
Shorter-dated bonds were harder hit, with Portugal's five-year bond yield at a euro lifetime high of 8.3 percent.
The stock market was down 1 percent with banks among the hardest hit shares.
"If these measures are not agreed it seems more and more likely that Portugal will need some kind of support," said Charles Diebel, head of market strategy at Lloyds Bank.
"Is this already reflected in the price? To a large degree yes it is, but there are also good causes for concern that this is not going to stop here."
The Social Democrats, ahead in opinion polls, are broadly committed to reducing the budget deficit.
The constitution stipulates that the country can hold a snap election no sooner than 55 days after the president calls one. The outgoing government remains in office as a caretaker administration with limited powers.
"My worry is the period of inaction before a new government takes over," said Silvio Peruzzo, an economist at RBS in London. He did not expect decision-making to come to a standstill, preventing the country seeking a bailout if necessary.
Political analyst Antonio Costa Pinto said a caretaker government would have its hands tied.
"Although a caretaker government cannot take major autonomous initiatives, it could take a decision on resorting to aid if it is backed by parliament," Costa Pinto said.
Whatever the outcome, opposition to austerity may increase as the Portuguese face lower wages and higher taxes, and the country returns to recession.
Large protests have been held against austerity on the past two weekends and on Wednesday train drivers went on strike to demand higher wages, creating traffic chaos around Lisbon as commuters were forced to take their cars to work.
(Additional reporting by Daniel Alvarenga, Shrikesh Laxmidas, Sergio Goncalves; writing by Axel Bugge; Editing by Tim Pearce)