Analysis: Greek referendum spooks investors, may chill economy

By Michael Dolan

For many global investors, it's hard to overestimate the impact of Greek Prime Minister George Papandreou's surprise decision on Halloween night to call a public vote on last week's latest and tortuously assembled European Union rescue.

Before money managers even begin to discuss the likelihood of Papandreou winning the vote - and most assume that will be a struggle at least - any hope of a year-end rally or even stabilization of world markets have now been doused.

One key issue for the world economy at large over recent months was whether dire readings of business and household confidence were overly pessimistic and too focused on volatile markets rather than the more robust real economic data starting to emerge, especially from the United States.

A brief stabilization of financial markets at the end of last month suggested a durable euro policy solution could allow sentiment to recover to reflect a more benign reality.

But as the referendum refuels bank and government funding concerns and shrouds Europe back in policy uncertainty for another two to three months at minimum, actual economic activity may again deteriorate in line with the surveyed gloom.

And the timing couldn't be worse. Global manufacturing surveys for October hover on the cusp of another major contraction that only needs another nudge to flag full blown recession. And the International Labour Organization warned on Monday of social unrest from a new global jobs recession as unemployment worldwide hit record levels.

"Grenade" was a word used widely by investors and other EU governments, such as fellow bailout recipient Ireland, to describe Monday's leftfield shock. Markets reacted accordingly.

Euro financial bellwethers, most of which had surged after last week's EU agreement on a 50 percent Greek debt writeoff and the bolstering of a central fund for bank recapitalization and sovereign bond backstops, have now fully reversed.

Euro zone bank stock indices <.SX7P> dropped up to 7 percent on Tuesday alone to levels of 10 days ago, as if the intervening EU summits never happened. The euro lunged back to levels of almost a month ago and 10-year Italian government borrowing premia rose to new euro-era records.

But this is not just euro specific. This is global. Despite weeks of impressive domestic economic data, U.S. stocks <.SPX> have lost more than 5 percent since the referendum bombshell to return to their lowest in 10 days.

That instant repricing makes clear that markets see the wait for the referendum, which would be expected to take place in mid January at the earliest, as putting all aspects of last week's stabilization plan on ice.

"As we near the referendum date, uncertainty over its outcome as well as the future of the euro zone as a whole can only increase and introduce increased volatility into asset markets," said Andreas Utermann, Global Chief Investment Officer at the $150 billion asset manager RCM.


The bigger problem for many investors is that the prospect of a make-or-break referendum doesn't merely return markets to pre-summit levels. It opens up a whole new can of worms.

A defeat in a popular Greek referendum on its bailout would almost certainly lead to a disorderly default on Greek debts as the Athens government would lose any mandate to persevere with the austerity required to secure debt-servicing rescue funds.

A forced default and subsequent bankruptcy of Greece would likely amplify internal and external calls for it to exit the euro. And a euro exit, for better or worse for Greece, would then foster waves of fear and speculation about the removal of other countries under extreme pressure financially.

And if a firewall can't be placed around Greece, where 50 percent debt writeoffs are already on the table, then the balance sheet speculation surrounding banks holding all other vulnerable euro zone sovereigns will spiral higher once again.

"A rejection of the EU-IMF program recently negotiated by the Greek government would increase the risk of a forced and disorderly sovereign default and ... potentially a Greek exit from the euro," Fitch credit rating agency said on Tuesday.

"Both ... would have severe financial implications for the financial stability and viability of the euro zone."

If a Greek bailout rejection ultimately led to a mutual agreement on the country leaving the euro, it would inadvertently draw a "euro exit roadmap" where none previously existed. And a vicious circle starts to form.

A threat to the very fabric of the euro would lessen the chance now of governments attracting investors -- especially, as planned, the big sovereign investors such as China, Brazil or Russia -- to either bolster the bloc's rescue funds or buy European government bonds directly.

And while some economists reckon the referendum gamble -- even if it was successful -- may have some chance of paying off for Greece over the medium term, they simply wince at the damage it causes to everyone else right now.

A "glance into the abyss" of national chaos may convince Greeks to vote in favor of the referendum, said Jan Poser, chief economist at Swiss Private Bank Sarasin.

"But the biggest downside is that he (Papandreou) is also taking fellow Europeans and financial markets to this abyss."

(Editing by Ruth Pitchford)