EU approves permanent bailout fund amid fears over Portugal

European leaders agreed Friday to set up a permanent $700-billion rescue fund to try to contain the continent’s debt crisis as fear mounted that Portugal will soon be forced to seek a bailout.

Wrapping up a two-day summit in Brussels, the European Union hoped the announcement of the permanent safety net after weeks of haggling would boost investor confidence and demonstrate the bloc’s commitment to ensuring the survival and stability of the euro.

But the meeting was overshadowed by political turmoil in Portugal, where lawmakers’ rejection of new austerity measures caused the government to collapse Wednesday and pushed Lisbon closer to asking for emergency aid. Many economists now feel it’s only a matter of time before underperforming, debt-ridden Portugal becomes the third EU nation to require an embarrassing financial bailout.

The new rescue fund — dubbed the European Stability Mechanism, or ESM — is to debut in 2013, replacing a temporary bailout program cobbled together last year when the debt crisis exploded. Since then, the euro has endured a whipsaw year in the exchange market, and both Greece and Ireland have had to turn to their neighbors for emergency loans.

“This doesn’t mean the ESM is something we want to be used all the time; quite the contrary,” said Chancellor Angela Merkel of Germany, Europe’s economic powerhouse and the largest contributor to the rescue fund. “We just want to demonstrate that we are well prepared.”

Separately, the 17 countries that use the euro, plus several other EU nations outside the Eurozone, also signed a pact to harmonize some of their fiscal policies and increase economic coordination to prevent more crises.

But leaders put off a deal to increase the lending capacity of the temporary bailout fund, which analysts say would have further soothed market jitters. That decision has been postponed till June, sparking criticism that the EU continues to act in belated and piecemeal fashion despite the biggest test of the euro since the single currency was launched 12 years ago.

The attention of investors in Europe is now focused on Portugal, which has insisted for months that it is capable of staying financially afloat without a lifeline from its neighbors.

To keep a bailout at bay, the shaky minority government tried this week to push through its fourth round of austerity measures within a year, to convince international markets that it was serious about cutting public spending and reducing its budget deficit. But the parliament shot down the plan, prompting Prime Minister Jose Socrates to resign Wednesday.

Portugal’s borrowing costs are now punishingly high, which could force Lisbon to tap into the temporary bailout fund to continue paying its bills. A rescue package for Portugal would probably range from $85 billion to $115 billion.

But the political uncertainty has compounded the problem. If no new government is formed to replace the one that just collapsed, Portugal would be ruled by a caretaker administration without the authority to negotiate a bailout. An election probably would not be held until early June, by which time the Iberian nation’s financial crisis might have spiraled out of control.

Socrates, who is continuing to represent Portugal for the time being, told reporters Friday in Brussels that he would keep fighting for his country to solve its problems on its own.

He has so far successfully resisted pressure from some fellow European leaders who want Lisbon to apply for a bailout, in part to calm investors and keep the debt crisis from spreading to Spain, whose economy is far larger.

“Let me say it once again: Portugal does not need rescuing, does not need a rescue fund, and I will continue defending my country and ensuring that doesn’t have to happen,” Socrates said. “I know what it meant to the Greeks and the Irish, and I don’t want the same to happen to my country.”

henry.chu@latimes.com