Just when the market players were enjoying a nice rally from the debt deal that the European leaders presented last week, Greece Prime Minister George Papandreou threw a curveball and called for a referendum on the new plans.
As I mentioned last weekend, one of the main focuses of the European leaders’ meetings was handling Greece’s debt crisis. As it turned out, the 50% haircut on the banks’ Greek debt holdings wasn’t the only issue addressed in the EU meeting last week. The European leaders also agreed to create an additional bailout package that would support the Greek economy through 2014 instead of the initial 2013 target of the first bailout packages.
The problem is that the new package also comes with stricter austerity-related conditions, which will most likely require a majority vote from the Greek Parliament. And for a country with anti-austerity advocates filling up the streets, the possibility of more austerity is another headache that the government can do without.
Remember that a referendum is simply a process of asking the public to vote on a political question. The last time government called for a referendum was in 1974 when the Greeks voted to abolish the monarchy.
Papandreou caught the market off guard, as nobody was expecting him to suggest the referendum. Even members of Papandreou’s own party were blindsided, which is probably why not all of his homies initially pledged to his cause. The decision also surprised the markets, with sudden risk aversion sending EUR/USD down 500 pips over the past two days.
The bigger problem down the road is that if the referendum pushes through and the debt deal is shot down, the EU leaders may decide to play hard ball and cut off Greece from the much needed IMF funding. This would almost ensure a Greek default and possibly Greece getting kicked out of the euro zone.
Word on the grapevine is that Papandreou will be flying to France today to meet with EU head honchos Angela Merkel, Nicolas Sarkozy, and ECB President Mario Draghi to explain his plans. But until a clear decision is made among the leaders, we might see more uncertainty in the markets.