By Lefteris Papadimas and Harry Papachristou
ATHENS (Reuters) - Greece vowed on Wednesday to do whatever it takes to check its vast deficit but took yet another beating on markets, as EU partners piled pressure on Athens to take action after its rating was cut to its worst in a decade.
The risk premium on Greek government bonds jumped and bank stocks tumbled on Wednesday, extending Tuesday's losses on Fitch Ratings' downgrade of its debt to BBB+, showing increasing risk aversion among investors.
Greece has faced harsh criticism over its credibility and increasing borrowing costs since the new Socialist government revealed the deficit was twice as big as previously forecast and would reach 12.7 percent of GDP this year.
"We must close the credibility gap to survive as a sovereign and cohesive nation," Greek Prime Minister George Papandreou told a televised cabinet meeting. "We are determined to do whatever it takes to control the huge deficit," he said.
The spread of 10-year Greek bonds over German Bunds narrowed by 20 basis points following his comments, after hitting an 8-month high of 255 basis points earlier in the day, but climbed again later in the day.
The Athens Stock Exchange bank index dropped nearly 6 percent in heavy trading on the day, shedding about 16 percent of its value in five days.
"The losses are due to the rating cuts, which have heightened uncertainty amid investors," said Joanna Telioudi, analyst at HSBC. Fitch also cut Greek lenders' ratings because of the government's diminished ability to support banks that have a large exposure to its sovereign bonds.
The cost of insuring Greek debt against default or restructuring also rose. Greece struggles with a debt set to become the euro zone's highest ratio in the euro area next year at 125 percent of GDP.
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 was no reason to doubt Greece can do this alone, backing similar comments from Greek Finance Minister George Papaconstantinou.
"NOT DUBAI"
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."No we are not a new Iceland, just like we are not the new Dubai," he told a news conference.
"We are a sovereign state which is part of the EMU (European Monetary Union,) which has a very clear understanding of the serious situation that it has inherited, and which is taking all the necessary measures," he told reporters, saying that although Greece benefited from the EU umbrella it needed no saviour.
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.
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.
While German bonds met firm demand, other peripheral spreads including Ireland's and Spain's widened in the fallout of Greece's troubles. "We're seeing a bit of contagion from Greece," said Wilson Chin, senior debt strategist at ING.
The premium investors demand to hold 10-year Spanish government bonds rather than euro zone benchmark German Bunds rose to the most since July on Wednesday after rating agency Standard & Poor's cut the country's outlook.
An EU official said the market pressure was useful to help the Greek 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.
(Additional reporting by Andreas Framke and Krista Hughes in Frankfurt, Anna Willard in Paris and Angeline Ong in London; writing by Paul Taylor and Ingrid Melander, editing by Andy Bruce)
