Greece's admission that it will miss its deficit target this year despite harsh new austerity measures sent stock markets reeling today and raised new doubts over a planned second international bailout.
The gloomy news from Athens brought the spectre of a debt default closer and will weigh on talks among euro zone finance ministers in Luxembourg later today about the next steps to try to resolve the currency area's sovereign debt crisis.
European bank shares suffered the heaviest falls on fears that private sector bondholders may be forced to absorb bigger losses than agreed in a July rescue plan for Greece, which was based on more optimistic growth forecasts.
The draft budget sent to parliament today showed this year's deficit would be 8.5 per cent of gross domestic product, well off the 7.6 per cent agreed in Greece's EU/IMF bailout programme.
Greek finance minister Evangelos Venizelos said in a statement that the 2012 fiscal targets would be met in absolute terms and Greece would have a primary surplus before debt service for the first time in many years.
However, next year's deficit is projected to be 6.8 per cent of GDP, rather than the 6.5 per cent EU/IMF goal, because the economy is set to shrink by a further 2.5 per cent after a record 5.5 per cent contraction in 2011.
A deeper-than-forecast recession means public debt will be equivalent to 161.8 per cent of GDP this year, rising to 172.7 per cent next year, by far the highest ratio in Europe.
Greek deputy finance minister Pantelis Oikonomou said the European Union and International Monetary Fund inspectors had "essentially concluded" negotiations to give Greece a crucial €8 billion instalment of aid this month to avert bankruptcy.
However, a source familiar with the review by the "troika" of international lenders said the talks were not over, and the inspectors were still examining both the budget numbers and other reforms required for the loan disbursement.
"Speculating about it in advance makes no sense," German finance minister Wolfgang Schaeuble said of the aid tranche. But Belgium's finance minister, Didier Reynders, was more optimistic, saying he hoped the money would be paid in days.
"I hope that today, or in the next few days, we will take the decision to disburse the next tranche (of money) to Greece. Greeks are making important efforts and the euro zone should also do its job and vote to approve the texts," he said.
The 17 euro zone ministers will not take any decision today on releasing the funds, needed to pay October salaries and pensions, since the troika has yet to report back. They are set to decide at a special meeting on October 13th.
The likelihood that Greece's funding needs next year will be greater than forecast when a second €109 billion rescue package was agreed in principle in July reopened a fraught battle over who should pay - taxpayers or financiers.
Uncertainty over the extent of damage to the already fragile European banking sector from a possible Greek default has been driving investors to take refuge in safer assets.
Yields on Spanish and Italian government bonds rose and the cost of insuring their debt against default spiked on the news from Greece, while money poured into safe-haven German Bunds. The euro fell to an eight-month low in Asia.
"The markets continue to conclude that a default for Greece is an inevitability and a question of when rather than if," said Nick Stamenkovic, strategist at RIA Capital Markets.
The euro zone ministers were expected to discuss ways to leverage their EFSF bailout fund, without reaching a conclusion today, and to put more pressure on Greece to implement agreed structural reforms and privatisations to try to get its economy growing again.
Economic and Monetary Affairs Commissioner Olli Rehn said Europe faced a triple challenge of "stalling growth, stressed sovereigns and still vulnerable banks".
Ministers would review options to enhance the financial firepower of the rescue fund, some of which involved leveraging with money from the European Central Bank, he said.
The debt and GDP projections illustrate how Greece has fallen into a vicious spiral of recession, falling revenues, soaring unemployment and declining consumer purchasing power.
Officials expect the next aid tranche will be paid, because the euro zone will not be ready to cope with the fallout of a Greek default until its bailout fund, the European Financial Stability Facility (EFSF), gets its new powers of market intervention ratified in the next two weeks.
Even then, however, while the €440 billion fund will be able to buy government bonds from the market, recapitalise banks and extend precautionary credit to sovereigns, it may not have enough cash to cope with all the financing needs.
The leveraging idea, suggested by the United States, has opponents in north European creditor countries, who fear it could lead to bigger liabilities beyond the €780 billion in current EFSF guarantees, or credit rating downgrades for either the AAA-rated rescue fund or its triple-A guarantors.
Among the ideas under consideration is allowing the EFSF to refinance itself at the ECB's liquidity operations for banks. The EFSF could also guarantee to cover a percentage of potential losses investors could incur in case of a hypothetical sovereign default.
Any solution, however, should not require another round of ratification, officials said, because policymakers realised how difficult and lengthy the process was given the growing opposition to bailouts in many euro zone countries.
Speaking outside the meeting Minister for Finance Michael Noonan said Ireland has met its third-quarter targets set by the country's bailout partners.
The troika will also "be looking for an economic and fiscal plan from 2012 to 2015" which will be completed "some time in late October," Mr Noonan also told reporters in Luxembourg.