Cyprus has stunned EU officials by ordering a vote in its parliament on the terms of the "troika" bailout for the country, risking a rejection by angry lawmakers and a fresh eruption of the crisis.
Attorney General Petros Clerides said the assembly must have a say on the EU-IMF-European Central Bank accord, which will inflict huge losses on depositors at Laika and Bank of Cyprus.
The Orthodox Church of Cyprus expects to lose €100 million ($155 million), crippling its charities.
It is unclear whether the Government can muster a majority. The communists and socialists have been vehement critics of the deal.
Green MP George Perdikis told the Cyprus Mail he would vote against it to uphold the freedom of his country. "It is a crime to deliver Cyprus into the hands of the Troika and allow it to become a colony."
Parliament rejected the original plan for a levy on guaranteed deposits below €100,000.
Rejection of the final deal might exhaust patience in Berlin and Frankfurt. The country would be forced out of the euro within days if the European Central Bank cuts off support.
The pan-EU socialist bloc in the European Parliament said the "neo-colonial" handling of Cyprus had been a disgrace and called for the Troika to be disbanded.
Liberals demanded a probe to find out who made the "disastrous" decision to target small savers.
The latest twist came as Europe's top policy-makers vowed to continue their hard-line crisis strategy, brushing aside warnings of an economic debacle and ignoring a devastating challenge to austerity claims.
In a defiant statement, an alliance of the ECB, the Commission and Eurogroup said the "evidence is clear" that Economic Monetary Union crisis policies had succeeded and recovery was in sight.
"The eurozone has shown a degree of resilience and problem-solving capacity that many observers and policy makers would not have predicted even a year ago."
But the claims have been flatly contradicted by the International Monetary Fund, which warned this week that the eurozone remained "the epicentre of potential risk" in the world, and was endangering stability by dragging its feet on an EU banking union.
Saxo Bank chief economist Steen Jacobsen accused EMU leaders of dangerous complacency.
"Nothing they say is true," he said. "Reality has never been further away. It's scary.
"We think the eurozone is in far worse shape than they realise. We will see contraction of 1 per cent this year but it could be as bad as 2 per cent."
Citigroup cut its forecasts drastically, warning that the EMU will shrink this year and next and a quasi-slump would drag on until 2017.
It said Italy would contract 1.6 per cent in 2013 and 1.2 per cent in 2014, and manage growth of 0.2 per cent in 2015. By then, its public debt would have risen to 142 per cent of GDP.
"Some form of debt restructuring via maturity extension or interest rate reduction may be likely over time," said chief economist Willem Buiter.
The outlook is worse for Spain and worse yet for Portugal, where debt is forecast to spiral out of control to 154 per cent of GDP by 2015.
Buiter warned that a haircut for private creditors "may be eventually required" despite the pledge of EU leaders that there would be no repeat of losses inflicted on sovereign bonds in Greece.
Europe's policy elites are increasingly on the back foot after furious controversy this week over a Harvard paper widely cited as the intellectual justification for austerity.
The 2010 study by professors Carmen Reinhart and Kenneth Rogoff purported to show a cliff-edge fall in growth rates to -0.1 per cent once public debt reaches 90 per cent of GDP in rich countries.
An expose by the University of Massaschusetts found that there had been a basic Excel error and other slips in the study.
In fact, it said, growth falls slightly to 2.2 per cent.
The effect is less serious on states that have their own currency and monetary instruments.
The IMF has already warned eurozone leaders that the "fiscal multiplier" is much higher than originally thought in the EMU crisis countries, implying that austerity cuts have a much greater effect.
Greece, Portugal, Ireland, Spain, Italy and, most recently, France are caught in a vicious circle where economic contraction erodes the tax base, causing them to miss deficits targets.
They then have to cut deeper, fuelling a downward spiral.
The IMF said in its Global Financial Stability Report that the credit crunch in southern Europe was getting worse rather than better, and warned that a quarter of all bonds and debt issued by European companies was "unsustainable".
- Telegraph