Will the threat of a Greek bailout referendum spark a global economic meltdown?

‘A surprise decision by Greek Prime Minister George Papandreou to put the nation’s latest bailout plan to a referendum renewed fears of a potentially messy default and sparked a global market rout on Tuesday as investors again questioned Europe’s ability to contain its debt crisis.

The announcement — on Monday evening in Europe — of the referendum and plans for a confidence vote took investors and Greece’s euro-zone partners by surprise.

It injected new tensions into government bond markets, with Italian government bond yields rising sharply toward euro-era highs.  Equities tumbled in Europe and on Wall Street even as the ink was barely dry on a three-pronged rescue effort hammered out by European leaders in a marathon summit early last Thursday morning.

The euro traded at $1.3677 versus the dollar, plunging from $1.3908 in North American activity late Monday.

‘As if last week’s half-baked euro summit deal hadn’t left enough questions unanswered about the policy response to deal with the crisis, [the referendum announcement] adds a further, very significant layer of uncertainty to the outlook,’ said Chris Scicluna, an economist at Daiwa Capital Markets in London.

Austerity fatigue

The move is a high-stakes gamble by Papandreou, who is seeking to shore up support for further austerity and economic liberalization measures amid mounting public dissatisfaction, wrote economists Fabio Fois and Julian Callow at Barclays Capital.

The confidence vote is expected this week, while a referendum appears likely to take place in January, analysts said.

Polls published over the weekend found that around 60% of Greeks were unhappy with the latest bailout package.  The Greek government won approval last month of a fresh round of austerity measures in return for the disbursement of its latest aid round from the troika of international lenders made up of the International Monetary Fund, the European Union and the European Central Bank.

‘The limits to austerity were always one of the major unknowns in the debt crisis and it appears that they may have been reached in Greece.  We may have to wait until January . . . to find out,’ said Gavan Nolan, director of credit research at data provider Markit.

While plenty of economists had viewed last week’s summit agreement on European debt as falling short of a permanent solution, the Greek uncertainty could mean the deal provides even less respite from the crisis than anticipated.

Leaders agreed to a three-pronged plan that will see private investors take a 50% writedown on Greek government debt, recapitalize European banks and boost the firepower of the euro-zone bailout fund to 1 trillion euro.

The referendum appeared to take Papandreou’s fellow European leaders by surprise.  European Commission President Jose Manuel Barroso and European Council President Herman Van Rompuy, in a joint statement, said they had been in contact with Papandreou and that they expected Greece to abide by commitments made at last week’s summit.”