LISBON (Reuters) – A potential political crisis in Portugal that would worsen the country's debt woes is looming larger as the minority Socialist government and the centre-right opposition engage in a game of chicken over the 2011 budget.

The risks of such an outcome have risen as the opposition Social Democrats (PSD) decline to say whether they will give the unpopular government the support it needs to pass the budget, due to be presented to parliament on Friday.

If the budget fails, it could plunge the country into months of uncertainty under a caretaker administration unable to take decisive action to curb the public deficit, alarming financial markets which see Portugal as a weak link in the euro zone.

Analysts have begun to doubt whether there will be a deal since the government announced last month that austerity measures will include higher taxes — something the PSD has consistenly opposed.

"We have never been as close to a political crisis in terms of having a budget rejected," said Marina Costa Lobo, a political analyst at the University of Lisbon. Prime Minister Jose Socrates has said he would resign if the budget is not passed — a step which would almost certainly trigger sharp selling of Portuguese bonds as investors doubt the country's ability to fix its deepening sovereign debt crisis.

The premium investors charge for holding Portuguese debt rather than benchmark German bonds hit euro lifetime high at the end of September on concerns over the large budget deficit. The spread eased slightly after the latest austerity promises but stood at 405 basis points yesterday, meaning Lisbon must pay four percentage points more than Berlin to borrow on capital markets.

Ahead of Friday's showdown in parliament, television stations are running live debates on the budget, asking viewers "will they, won't they (reach a deal)?"

A crisis would be complicated by the fact that under Portuguese law, the earliest a parliamentary election could be held is next May, because the country will elect a new president on January 23 — drawing out the uncertainty.

So if the budget fails, there could be a caretaker government, with limited powers, for several months. "We wouldn't have a proper government and it wouldn't have the political ability to discuss a bailout with the EU and IMF," said Viriato Soromenho Marques, a political commentator.

"This would turn the Portuguese situation worse than the Greek one, which is really frightening."

Greece received a bailout from the European Union and International Monetary Union in May but it had a majority Socialist government able to commit to and enact the austerity measures required to receive emergency loans.

Although Portugal's debt, at 83.5 percent, is a far smaller proportion of its economic output than Greece's at 132 percent this year, persistent budget deficits, dwindling revenues and a loss of economic competitiveness have raised doubts about the sustainability of its public finances.

PSD leader Pedro Passos Coelho has said he will only give his judgment on the budget after it is presented to parliament.

Some in his party have said they will not pass the budget under threats from the government, while a number of others, including former PSD leader Manuela Ferreira Leite, have said it should be passed to avoid a crisis.

Costa Lobo said she believed some compromise will eventually be reached. But Passos Coelho's message had become "erratic", making the outcome hard to predict.

"All of this could be a bluff to gain some compromise on tax," she said. "It is a risky game, holding the country breathless."

The government rushed through an austerity announcement at the end of September as Brussels piled pressure on Lisbon to ensure its hold this year's deficit to 7.3 percent of gross domestic product and further reduces it to 4.6 percent in 2011.

The package included a five percent civil service pay cut and a hike in value added sales tax to 23 percent from 21 percent.

Soromenho Marques said a compromise could be to raise VAT to 22 percent and make deeper spending cuts, as the PSD wants.

"It could be possible to exchange one percentage point of value added tax for a combination of spending cuts," he said. "That could be an elegant way of getting out of the situation."

Finance Minister Fernando Teixeira dos Santos said at the weekend that the government was open to negotiation.

At the very least, uncertainty will continue until October 29, when parliament is due to vote on the budget. In the meantime, the legislation will go through parliamentary committees where the PSD will doubtless want to make its mark.

Even if a compromise is found this time, analysts say it offers no long-term solution as the minority government remains dependent on the opposition. The PSD also backed government austerity moves in May.

"Anyone who thinks Portugal will get out of the crisis with the current political situation is fooling himself," columnist Joao Marques de Almeida wrote in business daily Diario Economico.

Socrates and Passos Coelho will be calculating whether they can score political points by blaming each other for the crisis. Currently, they are about level in opinion polls.

But voters may be losing patience with the Socialists, who have presided over several years of falling living standards and the highest unemployment in two decades at more than ten percent.

"If it does not pass, I blame the government," said Carlos Pereira, a salesman in Lisbon. "They should have been more attentive and ready about a year ago — they tried to fool us consistently (about the economic situation)."

"The situation is worrying but I think the government will give in on some points and the PSD will pass the budget."