(Corrects 2nd paragraph to remove erroneous reference to Greek bonds losing investment grade)
By Lefteris Papadimas
ATHENS (Reuters) - Greece's prime minister vowed to do whatever it takes to check the country's vast deficit as European partners piled pressure on Athens to take action, a day after its credit rating was cut to the lowest in the euro zone.
Greek financial markets were hammered on Wednesday. The risk premium on Greek government bonds jumped and bank stocks tumbled, extending Tuesday's losses on Fitch Ratings' downgrade of its debt to BBB+.
Fitch also cut Greek lenders' ratings because of the government's diminished ability to support banks that have a large exposure to Greek sovereign bonds.
"We must close the credibility gap to survive as a sovereign and cohesive nation," Papandreou told a televised cabinet meeting on Wednesday.
The national debt is forecast to hit 125 percent of gross domestic product next year, which would be the highest ratio in the euro area.
The Athens Stock Exchange bank index lost up to 4.4 percent to trade 3.5 percent down at 9:44 a.m., shedding about 16 percent of their value in five days.
"The losses are due to the rating cuts, which have heightened uncertainty amid investors," said Joanna Telioudi, analyst at HSBC.
Yield spreads between Greek and German 10-year government bonds widened to as much as 252 basis points, the widest since March, reflecting risk aversion among investors. The cost of insuring Greek debt against default or restructuring also rose.
European partners kept up a drumbeat of pressure on Athens to put its house in order. French Finance Minister Christine Lagarde said she did not think Greece could go bankrupt but it must make a real effort to clean up its public finances.
"We (European finance ministers) have asked our Greek colleague to put a real, efficient plan to rebalance and rework public finances. We all expect him to do it, he has made commitments with us and of course he has to keep them," she told RMC radio.
The German finance ministry said there is no reason to doubt Greece can do this alone, backing similar comments from Greek Finance Minister George Papaconstantinou.
NO NEED FOR IMF
Influential European Central Bank governing council member Axel Weber of Germany said there was no need for the International Monetary Fund to help Greece out of its fiscal problems since the EU had its own set of rules.
"The ball is first of all in Greece's court," Weber told business journalists in Frankfurt, adding he expected a "painful and drawn-out" adjustment process in the years to come.
Finance Minister Papaconstantinou reaffirmed his pledge to cut the budget gap from an expected 12.7 percent of GDP this year to 9.1 percent in 2010.
One longer-range market worry is that if other rating agencies downgrade Greek debt below A grade, banks would no longer be able to use Greek bonds as collateral to borrow from the European Central Bank when exceptional liquidity measures are due to expire at the end of next year, analysts said.
EU Economic and Monetary Affairs Commissioner Joaquin Almunia said in a statement late on Tuesday that Greece faced very substantial economic and fiscal challenges, and Brussels was monitoring it closely.
"A difficult situation in one euro-area Member State is a matter of common concern for the euro area as a whole," he said. While Greece's draft 2010 budget was a good start, "more measures are required," Almunia added.
An EU official said the market pressure was useful to help the Socialist government explain to voters why it would not be able to fulfil pledges made before October's general election to spend more to improve the lot of the poor.
IRISH EXAMPLE
The EU official held up fellow euro zone member Ireland as an example of a country that was biting the bullet and making draconian spending cuts, including reducing public sector pay and pensions, to cope with the impact of the financial crisis.
Paul Rawkins, senior director at Fitch Ratings, cited the same model.
"Ireland is an example of what Greece should be doing, really ... Ireland continues to address its situation very aggressively," he told Reuters Insider in an interview.
The euro recovered against the dollar on Wednesday from its lowest in more than a month on the Greek downgrade, as investors sensed selling in the single currency had been overdone.
The euro fell as low as $1.4665 in early trade, its weakest since early November, but reversed those losses in Europe to trade at $1.4749.
"It could not have come as a major surprise that Greece has fiscal problems. While there is always the risk of another heavily-indebted country being downgraded this year...it looks like the euro will now stabilise at around $1.4700," said Stuart Bennett, senior currency strategist at Calyon in London.
(Additional reporting by Ingrid Melander in Athens, Andreas Framke and Krista Hughes in Frankfurt, Anna Willard in Paris and Angeline Ong in London; writing by Paul Taylor, editing by Andy Bruce)
