He said Greece was at risk of bankruptcy if it did not take radical extra measures to cut its debts.
The comments come as Mr Papandreou is set to chair a cabinet meeting, expected to announce big budget cuts.
The government in Athens has pledged to reduce its deficit from 12.7% - more than four times the limit under eurozone rules - to 8.7% during 2010.
It also also seeking to reduce its 300bn euros ($419bn; £259bn) debt.
'Blow to wallets'
"We find ourselves in a wartime situation, faced with the negative scenarios affecting our country," Mr Papandreou told the parliamentary group of his Socialist Party (Pasok).
He said that Greece had to avoid "a nightmare of bankruptcy" in which the state would not be able to pay salaries or pensions.
Mr Papandreou has used some dramatic phrases to describe Greece's fiscal problems over the past few months, but this was his most alarmist to date, the BBC's Malcolm Brabant in Athens says.
The prime minister was effectively telling Greeks to prepare themselves for another blow to their wallets, our correspondent adds.
On Wednesday, the prime minister is due to announce a series of new austerity measures at a cabinet meeting.
It's almost certain that sales tax will rise by 2%, that petrol and diesel tariffs will be increased for the second time in a month and that luxury goods will be subject to a special duty.
What's uncertain is whether the government will do the European Commisson's bidding and scrap the annual holiday bonus paid to civil servants, our correspondent says.
Although the cabinet accepts the inevitability of slashing the state budget still further, some members, such as the Economy Minister Louka Katseli have warned that the measures have to be socially just.
Trades unions have warned that removing the bonus will be a declaration of war.
Businesses in Greece are likely to react badly to further tax increases, as they see them as being counter-productive, discouraging consumer spending and contributing to a further downward spiral, our correspondent adds.
