LISBON (Reuters) - Portugal's president threw the bailed-out euro zone country into disarray on Thursday after rejecting a plan to heal a government rift, igniting what critics called a "time bomb" by calling for early elections next year.
President Anibal Cavaco Silva proposed a cross-party agreement between the ruling coalition and opposition Socialists to guarantee wide support for austerity measures needed for Portugal to exit its bailout next year, followed by elections.
The surprise move came just when conservative Prime Minister Paolo Passos Coelho thought he had overcome a cabinet crisis by reaching a deal to keep his centre-right coalition together.
The decision was a warning shot to all mainstream parties indicating the conservative president does not think any of them is capable of ruling effectively until the EU-IMF bailout is due to expire in June 2014.
"We are in a situation which demands that the political parties leave their comfort zone," said Marina Costa Lobo, a political scientist at the University of Lisbon.
It was hard to predict how political leaders would cope with the president's challenge until they held internal party meetings and consultations with the president, which started on Thursday.
Cavaco Silva was Portugal's longest-serving elected prime minister from 1985 to 1995 for the ruling centre-right Social Democrats and is seen by analysts as valuing political stability above all else. He has often said he does not want to use "the atomic bomb," referring to snap elections.
Under Portugal's constitution, the president has the power to dissolve parliament and call elections.
Cavaco Silva's move drew sharp criticism in a country that has descended into its worst economic slump since the 1970s under the weight of austerity imposed by the bailout.
Portuguese markets fell in reaction to the president's move. Stocks declined 1.7 percent and 10-year bond yields climbed eight basis points to 6.97 percent.
"The president of the republic decided to overcome the political stalemate between the parties in the ruling coalition by adding another problem to the one that already existed," wrote daily Publico in an editorial. "He decided to take power."
Such accusations are not made lightly in the country that had western Europe's longest dictatorship under Antonio Salazar.
The centre-left opposition Socialists, who lead opinion polls, face the toughest dilemma as they were in power when the country sought a bailout in 2011 and have demanded elections now.
The Socialists held a leadership meeting late Thursday, after which the party said it was ready to negotiate with other political parties to "find solutions." However, it made clear it would not enter into government with the current administration.
"It is not acceptable to delay elections and force a commitment from the Socialists on austerity policies that have led the country to a social, political and economic disaster," former Socialist leader Eduardo Ferro Rodrigues said earlier.
He said the president had put the Socialists between a "rock and a hard place".
Cavaco Silva said the coalition government remained in office but did not approve a proposed cabinet reshuffle by the Social Democrats and their junior partner, the rightist CDS-PP party. Passos Coelho was due to meet him later on Thursday.
The crisis was sparked by the resignation last week of Foreign Minister Paulo Portas, a critic of austerity, threatening the continuation of the government as Portas also leads the rightist CDS-PP.
Passos Coelho held emergency coalition talks and announced on Saturday he would promote Portas to deputy prime minister in charge of economic policy coordination to fix the rift.
The plan would have avoided the need for elections in the short-term and allowed the government to rule until its term ends in 2015. Analysts say elections now could have interrupted reforms mandated by Lisbon's creditors.
Still, they say Portugal could be forced to negotiate a second bailout if stability does not return quickly. A bailout review originally scheduled for next week by officials from the European Union and IMF was delayed until the end of August because of the crisis, the government said.
additional reporting by Shrikesh Laxmidas and Daniel Alvarenga,; editing by Janet McBride, Paul Taylor and Cynthia Osterman