Pedro Passos Coelho said in a somber televised address to the nation that his center-right government must slash public services because of a Constitutional Court decision to disallow some of its latest tax hikes.
A new crackdown on public spending will focus on social security, education, health services and state-run companies, he said. That is likely to bring more layoffs as Portugal scrambles to restore its financial health after it needed a 78 billion euro ($101 billion) bailout in 2011.
"Today, we are still not out of the financial emergency which placed us in this painful crisis," Passos Coelho said.
Portugal's worsening problems threaten to reignite the eurozone's financial crisis not long after Cyprus became the fifth member of the 17-nation bloc to require rescue.
The Portuguese economy contracted 3.2 percent last year and is forecast to shrink 2.3 percent in 2013 for a third straight year of recession. The unemployment rate, currently at a record 17.5 percent, is forecast to climb to 18.5 percent in 2014.
European leaders have for three years struggled to contain the financial crisis, and Portugal's ongoing problems illustrate the dilemma of finding a balance between austerity measures and growth policies. Many Europeans want to abandon the austerity path and start spending again to create jobs and wealth.
The Constitutional Court on Friday prohibited pay cuts for government workers and pensioners included in this year's state budget, leaving the government just nine months to make up for the sudden shortfall of 1.3 billion euros.
"After this decision by the Constitutional Court, it's not just the government's life that will become more difficult, it is the life of the Portuguese that will become more difficult and make the success of our national economic recovery more problematic," Passos Coelho said.
He noted that Portugal has made progress on reducing its budget deficit, which stood at 10.1 percent in 2010. Last year, it was 6.4 percent. Even so, the three main international ratings agencies still classify Portuguese government bonds as junk.
Passos Coelho said the court's decision was a setback for Portugal's hopes of returning to international financial markets soon. The ruling "introduces uncertainty into a process that is already very demanding," he said.
It also means the government will have to present new plans to the foreign bailout lenders the International Monetary Fund, European Central Bank and the European Commission who are monitoring Portugal's progress and disbursing the funds only when they are satisfied that appropriate debt-reduction measures are being implemented.
The prime minister said his center-right coalition government won't resign after just two years in power. It has a solid majority to enact its policies through Parliament, but more broadly it is on shaky ground. It is cornered by the austerity demands of the bailout lenders, public anger at those demands, and political opponents who want new elections.
Trade unions and business leaders also want an end to austerity measures, saying they are choking economic growth. Even senior members of the governing parties have expressed doubts about the country's path.
Furthermore, the bailout lenders want the government to come up with an additional 4 billion euros of savings over the next two years.
Portugal could be forced to ask the lenders to ease its budget deficit targets, though the creditors have already softened this year's goal to 5.5 percent of gross domestic product from 4.5 percent.
Alternatively, Lisbon may need more time to pay off its debts and, perhaps, more money to get by until it can, though Passos Coelho said his government does not intend to ask for a second bailout.