Analysis: Greek referendum call blows hole in euro zone plan

PARIS Tue Nov 1, 2011 10:40am EDT

Stock prices are displayed inside the Athens Stock Exchange November 1, 2011.  REUTERS/Yiorgos Karahalis

Stock prices are displayed inside the Athens Stock Exchange November 1, 2011.

Credit: Reuters/Yiorgos Karahalis

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PARIS (Reuters) - Prime Minister George Papandreou's call for a referendum on the latest Greek bailout plan has blown a potentially fatal hole in the euro zone's strategy to overcome its sovereign debt crisis.

Whether or not a plebiscite takes place, and whatever the result, Papandreou's gamble guarantees long weeks of political uncertainty just when the 17-nation currency area was desperate for a period of calm to implement remedies agreed last week.

It will make it harder, if not impossible, to restore investors' confidence in most euro zone government debt in the short term and to lure Chinese and other wealth funds to pour billions into European sovereign bonds.

That may force the European Central Bank to get more deeply involved in crisis interventions to steady bond markets, just as Italy's Mario Draghi takes the helm of an institution yearning to return to its prime mission of inflation-fighting.

The immediate market backlash, with Italian and Spanish bond spreads widening close to their crisis peaks and the euro falling more than 2 cents against the dollar, underlined the heightened risk perception among investors.

Stunned reaction from political leaders in Germany and France told the same story.

Just when policymakers thought they had a breathing space to put in place a firewall to protect other troubled euro zone states from the impact of a possible Greek default, they have to cope with another political shock.

"The risk of a Lehman-style disorderly default now looms larger than before, including some risk that Greece may leave the euro zone if it rejects the offer of orderly debt relief in exchange for harsh new spending cuts and reforms," said Berenberg Bank economist Holger Schmieding in a note.

The chairman of euro zone finance ministers, Jean-Claude Juncker, said that if Greeks voted "no," the country could end up going bankrupt.

Papandreou made no mention of his intention to call a vote in many hours of talks with French, German and EU leaders last Wednesday in Brussels, he said.

EUROPE WRONGFOOTED

The announcement wrongfooted them three days before France hosts a G20 summit of the world's major economies in Cannes at which Europe was hoping for a global show of support for its efforts to draw a line under the debt crisis.

Instead, European leaders will have to hold frantic crisis consultations on the summit sidelines while the leaders of the United States, China, Japan, India, Russia and Brazil are reminded of the political frailty of each step the Europeans take to try to bring the debt inferno under control.

Papandreou's referendum gambit, which prompted a revolt against his leadership in the ruling Socialist party, threw into question the basis of last week's summit agreement.

The strategy calls for a reduction in Greece's debt under a second bailout package, with tougher international supervision of its austerity program and private creditors "voluntarily" writing off 50 percent on their Greek bond holdings.

It also involves recapitalizing European banks to cope with potential losses, and scaling up the euro zone's 440-billion-euro EFSF rescue fund to insure troubled states' bonds and attract foreign investors to special purpose investment vehicles that would buy European government bonds.

"This certainly destabilizes the situation and endangers all the decisions taken on October 26," said Janis Emmanouilidis, a German-Greek researcher at the European Policy Center think-tank in Brussels.

"How will it affect the talks to persuade the banks to take a voluntary haircut on their Greek debt? Some are bound to argue that it puts in question the entire compromise," he said.

EU officials said on the eve of last week's summit it was vital to avoid "ratification risk" by agreeing on measures that could be implemented more or less immediately.

"The lesson we learned from the July 21 agreement (to widen the scope of the EFSF) was 'no more ratification risk'," said a European official at the heart of the negotiations.

The July deal prompted a 24-hour relief rally on markets similar to last week's bounce, but investors quickly spotted that it would take several weeks for 17 national parliaments to approve the measures, and the risk of an accident was high.

Finland's demand for collateral on loans to Greece, and a revolt by a small liberal party in Slovakia's ruling coalition opposed to bailouts both caused delay. By the time the July accord was finally approved, it had been overtaken by events.

UNRAVELLING

The same political unraveling has already begun this time.

Germany's constitutional court put a first spanner in the works last week by suspending the work of a special parliamentary committee created to approve in secret market interventions by the EFSF.

The court issued the injunction pending a ruling on the legality of the special body, meaning that for now, Germany has no way of endorsing EFSF bond purchases without public disclosure and debate in a full session of parliament.

The Dutch minority government's hopes of securing majority support in parliament for the new rescue measures on Tuesday took a direct hit from Papandreou's referendum call.

The pro-European center-left opposition Labour party, whose support the center-right government sought, said the Greek move was a "deal breaker."

The European Union has a long and unhappy record with referendums, which critics say show that European integration is an elite project that does not enjoy popular support.

Denmark voted against joining European monetary union in 1992 in a major jolt to the EU system. Sweden also voted against joining the euro in 2000, and Irish, Dutch and French voters have all voted against ratifying EU treaties in plebiscites over the last decade -- twice in Ireland's case.

Political scientists say voters often use referendums to vent anger at the government posing the question, or with the entire political establishment, rather than voting strictly on the issue.

Given the depth of public anger over two years of harsh austerity and the prospect of a fourth year of recession in Greece, it may be hard for Papandreou's deeply unpopular government to secure a "yes" on any question.

(Additional reporting by Alan Wheatley and Jeremy Gaunt in London; Writing by Paul Taylor; editing by Janet McBride)

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