* EU, ECB sanctions would be damaging if applied
At stake is whether the 16 countries that share the European Union's currency can make a wayward member with a weak economy take drastic measures to cut its budget deficit without calling in the International Monetary Fund or sparking a social revolt.
This will involve an unprecedented level of EU tutelage over a sovereign state's finances, but without the IMF's leverage of disbursing or withholding loans in tranches.
Unless Athens takes swift action to slash spending and raise revenue, it risks costly EU sanctions and further downgrades by credit ratings agencies that would sharply raise its borrowing costs and deepen its economic recession.
EU officials say Greece has only itself to blame.
The country cheated its way into the euro in 2001 by fiddling its statistics and failed to curb its budget shortfall in the boom years. It will have the highest debt level as a proportion of economic output in the euro zone this year.
Years of concealment led to last October's admission by the newly elected Socialist government that the 2009 deficit would be a stunning 12.7 percent of gross domestic product, more than twice the level forecast by its conservative predecessor.
"Because of the history, there is not much sympathy out there for Greece," said an European Commission official involved in the drive to enforce fiscal discipline. "There is a very strong determination to apply the rules."
Prime Minister George Papandreou has promised to bring the deficit down to the EU ceiling of 3 percent of GDP in 2012, starting with a giant cut of four percentage points this year.
But financial markets and many EU officials don't believe he can achieve that based on budget plans announced so far and are pressuring Athens to make deeper spending cuts.
The government is due to submit a new three-year fiscal plan to the European Commission this month and EU finance ministers are likely to issue a virtual ultimatum in mid-February giving Greece four months to take corrective action or face sanctions.
Papandreou has so far rejected market pressure to cut public sector wages and pensions, which he fears would trigger social unrest in a country with a tradition of violent protest.
The government has said it will propose a pensions reform to parliament in April and a corrective budget if needed.
Euro zone countries are determined to avoid recourse to the IMF for reasons of political prestige, although non-euro EU newcomers Hungary, Latvia and Romania were all sent to the IMF. They also want to avoid having to bail out Greece themselves.
European Central Bank executive board member Juergen Stark, a German deficit hawk, said bluntly last week that markets were deluded if they thought other member states would put their hands in their wallets to save Greece.
German and French leaders have sounded less gruff, hinting that Greece could ultimately receive help from its euro zone partners -- at a price -- if its debt problems get out of hand.
"I am confident that with proper peer pressure and support from members of the euro zone, Greece will find its way back to where it should be," French Finance Minister Christine Lagarde said last week.
Ireland, a fellow peripheral euro zone state hard hit by the financial crisis, and non-euro EU member Latvia have achieved similarly drastic deficit reductions by cutting public sector pay and benefits. But neither has Greece's powerful trade unions and history of civil unrest.
A source close to Papandreou, who spoke on condition of anonymity, said that if Greece were to attempt such draconian cuts at once, it would face the kind of social disorder that hit many states implementing IMF adjustment programmes.
"We're going to have to salami-slice our way into it," the source said. "The EU pressure is helpful to provide an alibi for the next round of measures, because everyone in Greece realises that the EU is our lifeline."
The source said Papandreou would face down leftists in his PASOK party who oppose austerity but needed to take time to persuade non-communist public sector trade unions that the pain was being shared fairly.
The two main sanctions that could hit Greece would be deeply counter-productive if applied.
The EU could force Athens to make a huge deposit with the European Commission, which would be lost as a fine if the excessive deficit was not corrected. But that would sap market confidence and deepen Greece's economic woes.
Further downgrades by credit ratings agencies would mean Greek government bonds were no longer eligible as collateral to borrow cheap ECB funds from 2011. That would raise government borrowing costs and hit Greek banks particularly hard but also hurt other holders of Greek debt and spark a chain reaction.
Neither measure makes economic sense. But failure to enforce the rules on Greece could harm the credibility of the euro area.