By Padraic Halpin
DONEGAL (Reuters) - Irish voters prepared to punish the government in a by-election on Thursday for presiding over a financial crisis that threatens the euro zone and has forced the country into an age of austerity.
Prime Minister Brian Cowen's four-year plan for tackling the worst budget deficit in Europe has failed to impress investors and compounded a perception that taxpayers are being punished to bail out bankers and property developers.
Cowen and his Fianna Fail party have fallen to historical lows in opinion polls and there is widespread anger at his handling of the crisis.
Foreign Minister Micheal Martin, defending the government's sweeping cuts, told national broadcaster RTE "The plan hits everybody and will hit people on high pay."
But the axe has fallen particularly heavily on the poor -- nearly a third of the 10 billion euros of spending cuts will be sliced from social welfare -- and will weigh on voters in Donegal, where the poll for a vacant parliamentary seat is being held.
Cowen's Fianna Fail party had held the seat but is set to lose to the opposition Sinn Fein, cutting its parliamentary majority to two and increasing the possibility that the 2011 budget, the first step in the four-year plan, may not make it through parliament on December 7.
Failure to get next year's budget approved would deepen the crisis in Ireland and Europe and analysts have said the main opposition parties, center-right Fine Gael and left-wing Labour, may abstain to allow the budget to pass.
The two parties have not said they will abstain and instead have been making political capital out of Cowen's austerity measures, including a 1 euro reduction in the 8.65 euros an hour minimum wage.
Fine Gael, which is likely to lead a new government after a general election early next year, said it would not be bound by the terms of the four-year plan and would not cut the wages of the lowest paid.
Fine Gael also said it would be prepared to make senior bondholders in banks take some of the hit for purging the sector of years of reckless lending.
"We have to take the view that people who invested and invested unwisely have the consequences under capitalism of losing some or all of their investment," said Richard Bruton, Fine Gael's spokesman on enterprise.
Despite government assurances to the contrary, rumors persist that Irish senior bank debt may be restructured as part of negotiations with the IMF and the EU for a bailout package for Ireland and its banks, totaling around 85 billion euros.
A European Commission spokesman said on Thursday that those talks, which are taking place in Dublin, would be wrapped up by the beginning of December.
IRISH ISSUE NOT PLEASANT
Concern over the terms of any bailout and skepticism that the four-year plan can achieve its goals sent the cost of insuring Irish debt against default up 19 basis points on Thursday to 600 bps.
Irish borrowing costs remain elevated with the yield on 10-year paper over 9 percent, well over three times the rate on German paper.
Adding to the negative sentiment, European clearing house LCH.Clearnet increased the margin requirement on Irish government bonds for the third time in two weeks.
Euro zone policymakers are hoping that Spain and Portugal can stave off an Irish- or Greek-style debt meltdown and European Central Bank Governing Council member Jozef Makuch said that Ireland's problems could be fixed.
"The Irish issue is not pleasant but it can be solved," Makuch told a business conference.
A Reuters poll this week showed that 34 out of 50 analysts surveyed believe Portugal will be forced to follow Ireland and ask for help. In a separate survey only four out of 50 economists thought Spain would seek external aid.
Unlike Ireland and Portugal, Spain has its 2011 budget in the bag and its debt as a percentage of gross domestic product is estimated at 60 percent this year compared with Ireland's 100 percent and Greece's 145 percent.
Despite the prospect of years of cutbacks, there has been little sign of social unrest in Ireland and some Dubliners took a philosophical view of the situation.
"A lot of people are affected, and it puts pressure on them," said Mark O'Carroll, a 20-year old student. "But the best things in life are free, I enjoy the outdoors and you can't tax that."
(Writing by Carmel Crimmins; additional reporting by Lorraine Turner; editing by Tim Pearce)