German chancellor Angela Merkel and French President Nicolas Sarkozy will meet on Wednesday in a desperate bid to keep the eurozone from collapsing. The emergency conference was called following the surprise announcement by Greek Prime Minister George Papandreou that his government will hold a referendum on proposed austerity measures.
Following Papandreou's unexpected move, six senior party officials from the ruling Greek Pasok party called on the prime minister to resign.
Papandreou threw European markets into turmoil by announcing that the last minute deal signed by eurozone leaders last week would go to a public referendum, giving the electorate the final say on an agreement that would cut the country's debt by 50% but bind it to difficult economic readjustment.
“We have faith in our citizens, we believe in their judgment and therefore in their decision. All the country’s political forces should support the [bail-out] agreement. The citizens will do the same once they are fully informed," Papandreou said.
The Greek cabinet unanimously agreed to the referendum plan late on Tuesday evening. Papandreou told his ministers a poll would offer them "a clear mandate" from the people to implement austerity measures .
Throughout the unfolding crisis, deputies from the prime minister's Pasok party have defected in protest at increasingly unpopular policies, and one more left today, leaving the party with 151 seats. With 300 available seats in parliament, Papandreou now has a majority of one. More defections, which are likely, could leave him without a clear majority.
The eurozone agreement, forged in the early hours of the morning of October 29, hinged on a rescue package for Greece, combining a "haircut" on the country's debt with strict reforms and bailout money. Markets had rallied strongly after the announcement, but today turned negative as Papandreou's gambit put the entire agreement back on the line.
The French CAC 40 had fallen by 5% by mid-afternoon, while the German DAX was down 6%. Shares in French banks Societe Generale and BNP Paribas, which are believed to be heavily exposed to peripheral eurozone debt, slumped 17% and 14%, respectively.
The government has been the target of extreme anger in the past few months, with persistent protests and strike action turning violent at times, and Papandreou's government has skirted close to collapse at times. The referendum move is a desperate attempt to remain legitimate in the eyes of the electorate, according to analysts. The other alternative would have been an early election, which the government may well have lost, causing yet more chaos.
The government faces a confidence vote on Friday.
"Papandreou's call for a referendum constitutes a huge political gamble aimed at silencing dissenters and seeking a fresh new mandate from the public," Wolfgango Piccoli, Eurasia Group's European practice head, said.
"Given the high level of polarization and a discontent prevailing in Greece - and the electorate's unfamiliarity with referendum - the announcement of a referendum is arguably the most dangerous course of action among all the available options," he added, saying that the government is now highly unlikely to survive long enough to see a referendum through.
The opposition New Democracy party oppose the referendum and have called for early elections.