ATHENS - Greece was pushed to the brink of a financial abyss and started dragging another eurozone country - Portugal - down with it Tuesday, fuelling fears of a continent-wide debt meltdown.
Stocks around the world tanked when ratings agency Standard & Poor's downgraded Greek bonds to junk status and downgraded Portugese bonds two notches, showing investors that Greece's financial contagion is spreading.
Major European exchanges fell more than 2.5 per cent, and on Wall Street, the Dow Jones industrial average finished down more than 200 points. The euro slid more than one per cent to nearly an eight-month low.
"We have the makings of a market crisis here," said Neil Mackinnon, global macro strategist at VTB Capital.
Greece is struggling with massive debt, and with prospects for economic growth weak it could end up in default. Its 15 eurozone partners and the International Monetary Fund have tried to calm the markets with a euro45-billion rescue package, but it hasn't worked.
Standard & Poor's warned that holders of Greek debt could take large losses in any restructuring, but a greater worry is that Greece's debt crisis is mushrooming to other debt-laden members of the eurozone.
One bailout can be dealt with but two will be stretching it, and there are fears that other weak economies could be pulled down in the Greek spiral - including Europe's fifth-largest, Spain. Can Germany, Europe's effective paymaster, continue to bail out the weaker members of the eurozone?
The crisis threatens to undermine the euro and make it harder and more expensive for all eurozone governments to borrow money.
It has also disrupted co-operation between eurozone governments, with Germany resisting the idea of bailing out Greece unless strict conditions are met.
Many investors think Greece will have enough money to avoid default in the coming weeks, but the future is cloudier.
Both Standard & Poor's and the Greek finance ministry insisted that the country will have enough money to make the euro8.5-billion bond payments due on May 19.
Even if it does, Greece faces years of austerity with living standards sharply reduced. Standard & Poor's warned that the Greek economy was unlikely to be as big as it was in 2008 for another decade.
Junk status sinks Greece's hopes even deeper. Losing investment-grade status for its bonds means that Greece will have to pay higher costs to borrow if it taps debt markets again, and increases the chances that existing debt will have to be restructured.
"The latest developments mean that the chances of Greece solving this situation without restructuring its debts are now dim," said Diego Iscaro, senior economist at IHS Global Insight.
German Chancellor Angela Merkel reiterated her position that Greece should first conclude the current negotiations with the IMF and the European Union about austerity measures for the coming years before receiving the international loan package.
Speaking at an election rally Tuesday afternoon, Merkel said it is appropriate to tell Greeks, "You have to economize, you have to become fair, you have to be honest; if not, nobody can help you," according to the German news agency DAPD.
A government spokesman said Tuesday evening he could not tell if Merkel was at that point aware of the latest downgrade. He declined to be named in line with government policy.
The FTSE 100 index of leading British shares closed down 2.6 per cent, Germany's DAX slid 2.7 per cent and the French CAC-40 in France ended 3.8 per cent lower.
Greek and Portuguese stocks were pounded - down 6.7 per cent and 5.4 per cent, respectively - while their market borrowing costs went through the roof. The interest rate for Greek two-year bonds jumped to a massive 18 per cent.
The interest rate gap, or spread, between Portugese and benchmark German 10-year bonds rose about half a percentage point Tuesday to reach its highest point since the euro came into circulation. The higher the gap, the less confidence in Portugal; its bonds on Tuesday had an interest rate 5.86 percentage points higher than German bonds.
Both the Portugese and Greek governments have imposed budget cutbacks against political resistance from unions at home. Markets have been skeptical that they can push through enough cuts, given political resistance, to put their finances in order.
Both governments responded with alarm at the downgrades.
"This decision will not help markets to calm down, but will, on the contrary, contribute for their turbulence," Portugese Finance Minister Fernando Teixeira dos Santos said.
Greek Finance Minister George Papaconstantinou said the downgrade "does not reflect the real state of our economy, nor the fiscal situation, nor the ongoing negotiations which have the very realistic propects that they will be completed successfully in the next few days."
Papaconstantinou said Greece will pull through.
"One wishes that Europe had acted a little differently. Three and four months ago we were saying that the mechanism must be ready and it must be detailed, that the markets must know what exactly is going. Unfortunately, for a series of political reasons, we are down to the wire," he said.
The crisis has highlighted the eurozone's inability to keep governments from undermining the euro by running up big debts. Rules that limit deficits to 3 per cent of gross domestic product have been widely flouted, and EU officials are talking about ways to strengthen them.
AP Business Writer Pan Pylas contributed from London.