Greece threatens the unity of the Eurozone

Following a European agreement last week to contain the sovereign debt crisis, Greek Prime Minister George Papandreou threw a bombshell by announcing that he would put the deal to a public referendum. If Greek citizens vote against the European bailout plan, Greece could default, leading to its exit from the European Union and to severe consequences on the bloc as whole.

Papandreou’s shock announcement has shaken financial markets especially because he did not coordinate with European leaders prior to taking the decision. On Thursday, the atmosphere during the G20 summit in Cannes is heating up over the Greek debt crisis. The summit turned into lengthy meetings between EU leaders and the Greek prime minister as they pressed him to cancel the vote or at least make assurances that the question that the Greeks will vote on will most probably yield a "Yes" for the rescue plan. It took EU leaders months of negotiations to come up with the bailout plan and it is not clear how they can resolve in a few days the emerging crisis over the Greece referendum.

The bailout plan that was approved in a European summit on Oct. 26 has three dimensions. First, it raised the amount of losses or haircut that private investors will accept on their Greek bonds from 21 percent to 50 percent. German taxpayers would not accept to fully pay for Greek's lack of discipline. But the process has to be voluntary, since credit rating agencies warned that if the haircut was not voluntary, Greece would then be in default and it would be considered a credit event. Since banks are the biggest holders of Greek bonds, EU leaders had to negotiate with them on accepting bigger losses on their bond holdings.

This is where the second dimension of the rescue plan comes in. Banks have to make sure that they are well capitalized to assume the losses resulting from the haircut. EU leaders agreed then to re-capitalize banks across Europe to be able to withstand other shocks.

The third part of the deal seeks to increase the Eurozone’s rescue fund from 440 billion euros to 1 trillion euros in case the contagion spreads to much bigger economies like Italy or Spain.

As for the reason for the Greek prime minister's referendum announcement, this could be more politically than economically motivated. By calling for the vote, Papandreou is either seeking to revive public confidence in him and gain legitimacy as a leader and hence be able to implement the required austerity measures, or he thinks that the EU-proposed austerity plan is not enforceable in light of the economic downturn and resorted to this move so that his government collapses and he quits his responsibilities.

Until Wednesday night, the European leaders remained firm that the only way out of the crisis was for Greece to implement the proposed EU rescue plan. This is actually the best scenario for Greece which can then stay within the EU bloc and reduce its debt by 50 percent. Waiting for several months until the referendum is held could further deepen the woes of the country, considering that a sizeable chunk of its debt payments are due this month. If Greece defaults, the consequences on the Eurozone as a whole are likely to be dire.

This article appeared originally in Arabic in An Nahar newspaper on Thursday, Nov. 3. Nadine Hani, a senior business news presenter at Al Arabiya, can be reached at [e-mail], and Twitter at: @Nadine_bn. The translator was Mustapha Ajbaili, who can be reached at: [e-mail]