The eurozone sovereign debt crisis erupted anew yesterday as financial markets and governments around the world scrambled to respond to the shock announcement of the Greek Prime Minister, George Papandreou, that Greece will stage a referendum on the bailout deal agreed last week in Brussels.
Stock markets plummeted yesterday as investors confronted the possibility that the Greek public might decide to reject the deal agreed by eurozone leaders last week and default on its entire £350bn debt mountain – a turn of events that could be pre-empted by a confidence vote that threatens to bring down Mr Papandreou's government later this week.
The shares of European banks exposed to Greek debt slumped in response to the news. Investor alarm at the prospect of losses also spread, with the interest rates charged by global markets on bonds issued by the Italian government hitting record highs.
Monday's referendum call was an attempt by Mr Papandreou to cement his domestic political authority in the face of a resurgent opposition party and widespread popular protests at the austerity policies he has been implementing over the past year. But the political gambit backfired yesterday as Milena Apostolaki, a delegate from Mr Papandreou's ruling Pasok party, resigned, cutting the government's majority in parliament to just two seats. Six members of Pasok also called for Mr Papandreou to resign in an open letter.
Adding to the sense of confusion in Athens last night, a state security council led by Mr Papandreou replaced the heads of the general staff, the army, navy and airforce, and discharged a dozen army and navy officers, the defence ministry said in a statement. A ministry source told Agence France Press that the reshuffle was previously scheduled and not linked to political developments, but opposition parties criticised the move as "undemocratic".
"This heightens the climate of uncertainty and concern among public opinion," said the Democratic Left party.
Meanwhile, the Greek Finance Minister, Evangelos Venizelos, was admitted to hospital with an inflamed appendix. A source told the Reuters news agency that Mr Venizelos had not been informed in advance of Mr Papandreou's decision. Considerable uncertainty now surrounds the outcome of the confidence vote, due to be held on Friday.
Mr Papandreou now nominally has the loyalty of just 152 out of 300 delegates. If the government does fall, the bailout package will be thrown into doubt, and delayed in its implementation at best.
It also emerged yesterday that other eurozone governments had been left in the dark about Mr Papandreou's intentions. The French President, Nicolas Sarkozy, and the German Chancellor, Angela Merkel, released a joint statement pledging the bailout package agreed last week would be implemented "in the quickest time frame" despite Mr Papandreou's move. After an emergency phone call, the two leaders reminded Athens that the package negotiated in Brussels last week contained a series of "gifts" to Greece, including €130bn in loans from the European Union and the International Monetary Fund and a 50 per cent write-down in the face value of its sovereign debt.
Mr Sarkozy, who held an emergency session of French cabinet ministers last night, was said to be incandescent.He had hoped to appear as the "saviour" of the single currency when he hosts the G20 summit in Cannes tomorrow.
"This is irrational and dangerous to the Greeks themselves," said a source close to the President. Mr Sarkozy and Ms Merkel also announced yesterday that they will meet Mr Papandreou in Cannes this afternoon.
There was consternation within British government circles at the Greek move. A Downing Street spokesman said that David Cameron only found out about the referendum plan when he saw news reports about it.
Yesterday morning the Cabinet discussed the crisis while one minister said it was likely to result in the Greece leaving the euro. "It's time Greece was either kicked out of the euro or leaves voluntarily," he said. In the House of Commons, George Osborne struck a more measured tone but added: "There's no doubt the decision of the Greek Prime Minister has contributed to instability in the eurozone."
He implored eurozone countries to adhere to last week's agreement, and claimed that a resolution to the crisis would be "the single biggest boost to the British economy".
Some German politicians suggested that the European Union and the IMF should withhold a €8bn bailout payment due to Greece this month and therefore push Athens into de facto bankruptcy. Rainer Brüderle, parliamentary floor leader for the Free Democrats, said: "If [Greece] doesn't fulfil the agreements, then the point will have been reached where the money is turned off".
The outcome of a referendum would be highly uncertain. Recent polls suggest that around 59 per cent of Greeks do not like the terms of the deal, but also reveal that 73 per cent still want their country to remain part of the eurozone.
Scenarios: What happens now if...
... the confidence vote fails
A confidence vote on the government of George Papandreou, below, will be held in the Greek Parliament on Friday. If the vote fails, early elections will be called, which would probably be held within two months. That could see the planned referendum put on hold or discarded altogether. But it would also create great uncertainty in financial markets since it would not be clear whether the new government would honour the commitments made by its predecessor.
... the confidence vote is won
If the vote goes the other way, there would be a national referendum in January on the terms of the bailout deal agreed by eurozone leaders in Brussels last week. If Greeks vote Yes, the bailout could proceed and the face value of Greece's sovereign debt would be written down by 50 per cent. But if they vote No, future bailout funds from the European Union and the International Monetary Fund might not paid, prompting a default by Athens on all its external loans.
This would blow big holes in the European banking system.
A "hard" default would also trigger credit insurance payouts on Greek debt, causing further losses across the global financial system. Asian investment funds would likely refuse to subsidise the European bailout fund under such circumstances. And a new financial panic could result in the interest rates of other struggling European states (including Ireland, Portugal, Spain and Italy) shooting up, threatening the existence of the single currency.
Reaction: How the world responded
Greece Papandreou's decision was a shock to everyone – he hadn't even informed his own Finance Minister. But with the government close to collapse, many are sceptical there will ever be a referendum.
France President Sarkozy wanted to use the G20 summit later this week to take credit for the bailout deal, a key part of his re-election plans. French banks' exposure saw stocks fall more than five per cent.
Italy PM Silvio Berlusconi said he will outline his economic reform at the G20 meeting, as Italy's borrowing costs soared and the centre-left opposition called on the President to name a new government.
Germany Chancellor Merkel said she was determined to implement the rescue package despite the Greek move. Michael Roth of the opposition Social Democrats said Greece was "playing with fire".
UK Despite better-than-expected GDP figures yesterday, ministers privately expressed their fury at the move as George Osborne used a commons statement to urge Greece to stick to the deal.
USA US stocks tumbled more than two per cent in early trade yesterday on news that Greece was to hold a referendum on the bailout deal, with analysts saying the move took the markets completely by surprise.
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