Greece throws euro bailout into fresh crisis

 

Prime minister stuns fellow leaders with proposal that his country should hold referendum on landmark debt deal

Greek prime minister George Papandreou's proposal could scupper weeks of debt rescue negotiations. Photograph: Kostas Tsironis/AP

The Greek prime minister, George Papandreou, stunned Europe's leaders on Monday after he proposed that his country should hold a referendum on the landmark European debt deal reached last week.

A Greek vote against the deal could scupper weeks of negotiations over how to rescue the country's economy and prevent a debt crisis to match the Lehman Brothers crash of three years ago.

Stock markets, which have rallied in recent weeks after a sustainable deal looked more likely, reacted immediately to the news with a sell-off of shares. In New York, the Dow Jones index of leading companies fell sharply as Papandreou's plan was revealed. The euro fell 2% against the dollar and the US Volatility index – the so-called "index of fear" – climbed 22%, its biggest one-day rise since mid-August.

Papandreou gave no date or other details of the proposed referendum, though the interior minister, Haris Kastinidis, said it would most likely be in January.

Last week, under intense pressure from global leaders fearful of the repercussions of Europe's mounting debt crisis, eurozone members agreed to cut Athens's debts by 50% and provide €130bn (£112bn) in additional rescue loans to supplement a bailout fund put together with the International Monetary Fund last year.

Greeks have already registered their dislike for the package. Polling has shown that 60% thought it was bad for the country, making the referendum a high stakes gamble for the socialist government.

In most polls, voters have voiced their support for remaining part of the euro, but have increasingly vented their frustration at austerity measures. Cuts in the bloated public sector, reductions in pay and pensions, new taxes and privatisations of airports, state lotteries, the Greek water supply and the postal service are part of the deal agreed by Papandreou's government.

Unveiling his referendum plan, Papandreou said: "Citizens are the source of our strength and citizens will be called on to say 'yes' or 'no' to the agreement. It is not for others to decide but the Greek people to decide … we have faith in the people. We believe in democratic participation. We are not afraid of it.

"The people will be asked whether they want to adopt [the deal] or reject [the deal]. This vote of confidence will be a foundation stone on which we will build a new structure, a new Greece."

The Greek finance minister, Evangelos Venizelos, said the popular vote – the second to be held since democracy was restored to the country after the collapse of military rule in 1974 – would ultimately boil down to two choices. "Do Greeks want to remain in Europe, with the euro, in a country that belongs to the developed world, or do they want to return to the 60s? Do they think it is good to owe €100bn to the banks or do they not think it is good to live with such debt?"

Papandreou, addressing socialist members of parliament, also said he would seek a vote of confidence. His government has seen its majority reduced to three seats and its approval rating plummet amid harsh austerity measures that are likely to send the country into a fourth year of recession in 2012.

Greek opposition parties protested that the referendum posed huge risks: "Mr Papandreou is dangerous, he tosses Greece's EU membership like a coin in the air," said a spokesman for the main conservative opposition New Democracy party. "He cannot govern, and instead of withdrawing honourably, he dynamites everything."

Chris Williamson, of the analysts Markit, said: "A no vote would be a nightmare for the eurozone and in the meantime make everyone very nervous."

Raoul Ruparel, head of economic research at the anti-federalist thinktank Open Europe, said: "If the Greek public vote no in the referendum Greece could be left with no funds and no government, teetering on the edge of a disorderly default and a disorderly exit from the eurozone. It is only fair that the Greek people have their say, but the eurozone must begin preparing for a no vote and specifically how to handle a rudderless and broke Greece, which would probably include plans for allowing it to exit the euro."

Sony Kapoor, managing director of Re-Define, an economic thinktank, said: "With the scale of adjustment being asked of Greek citizens, a referendum would be good for democracy and legitimacy, but it's very hard to see how it can possibly be won."

During negotiations in Brussels last week between Germany, France and the other 15 eurozone members, workers across Greece held a general strike and hurled missiles at police.

European leaders had hoped to take an agreed deal to the G20 meeting in Cannes on Thursday. World leaders will gather there to discuss how to increase a global backstop fund to supplement the €1tn package to support Greece, Portugal and Ireland and insure against default by the other two most vulnerable eurozone countries, Italy and Spain.

Barack Obama has described the formation of the €1tn European Financial Stability Facility as a good start to resolving the debt problems that weigh on most eurozone members. The Chinese president, Hu Jintao, has expressed concern that the European deal remains fragile, though he is considering a request by Brussels to boost the EFSF with extra funds from Beijing.

Like the UK, Canada and most developing countries, the US and China have signalled their willingness to boost the International Monetary Fund's resources, but only in the event of a secure deal covering all 17 members of the euro. The prospect of a Greek referendum is likely to undermine efforts to forge an agreement.

Europe's creditors were already jittery following concerns that Silvio Berlusconi's government was unable to push through austerity measures demanded by Brussels. The Italian premier came under increased pressure to resign after the boss of carmaker Ferrari said he had lost the ability to push through measures needed to reduce budget overspends. Rome's cost of borrowing again jumped above 6%, which analysts regard as unaffordable for a country that has been growing at less than 1% for a decade and shows few signs of recovering in 2012. Italy has already borrowed heavily from the European Central Bank, after it became too expensive to borrow from foreign investors.

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