EU warns Greece rejecting austerity means default

By Harry Papachristou and Philip Blenkinsop

ATHENS/BRUSSELS (Reuters) - The European Union warned Greek lawmakers on Tuesday their country faced immediate default unless they approve a hated austerity plan, as strikers began new mass protests against the EU/IMF-imposed measures.

With the Greek parliament debating a raft of spending cuts, tax rises and privatizations, the EU's top economic official, Olli Rehn, dismissed reports that Brussels was working on fallback options to keep Greece afloat if the plan was rejected.

"The only way to avoid immediate default is for parliament to endorse the revised economic program ... They must be approved if the next tranche of financial assistance is to be released," he said in a statement.

"To those who speculate about other options, let me say this clearly: there is no Plan B to avoid default," Rehn said.

The blunt alternative was underscored by Bank of England Governor Mervyn King, who told British parliamentarians that policymakers were working on ways to limit the damage from a potential default on Greece's 340 billion euro debt pile.

"What we're doing is to say there is sufficient concern in the market about the possibility of default for us to think about contingency plans and the consequences of this event," he said.

He urged greater transparency about sovereign exposures to prevent a sudden, broad-based loss of confidence in European banks in the event of a Greek default, which could trigger a new credit crunch.

With Greece close to bankruptcy, trade unions promised to fill the streets of central Athens and surround parliament from Tuesday to try to prevent lawmakers approving the painful measures in votes on Wednesday and Thursday.

"We expect a dynamic and massive participation in the strike and the march to the center of Athens. We will have 48 hours of working people, unemployed, young people in the streets," ADEDY public sector union leader Spyros Papaspyros told Reuters.

Some 5,000 police have been drafted into central Athens, mostly to protect parliament. Police fired tear gas to disperse a small group of youths throwing sticks and bottles on Tuesday during an otherwise peaceful protest by thousands in Syntagma Square outside the neoclassical legislature building.

MARKETS NERVOUS

The EU and IMF have said Greece must enact both the five-year austerity plan, with 28.6 billion euros in savings, and key implementing laws for structural reforms and state asset sales to secure the next 12 billion euro slice of aid in July.

Without that, Athens would run out of money within weeks.

The cost of insuring Greek debt against default and short-dated government bond yields rose on Tuesday as investors remained nervous before the parliamentary votes.

However the euro was broadly steady, with fears of a default offset by signs that euro zone authorities are making progress with banks on a voluntary rollover of Greek debt.

Prime Minister George Papandreou's Socialists hold a narrow majority with 155 seats in the 300-member legislature, but a handful of lawmakers have defected and others have threatened to vote against some or all of the measures, putting the outcome in doubt.

New Finance Minister Evangelos Venizelos, a PASOK party heavyweight, has tried to woo wavering backbenchers by promising a renegotiation of the balance of the program toward promoting economic growth in September.

Rehn offered some encouragement to Greece on that front, saying he would support the government's plan to reform the tax system later this year to broaden the tax base, simplify the tax code and reduce tax rates in a fiscally neutral way.

If Greece approves the legislation, euro zone finance ministers meeting in Brussels on Sunday are likely to agree to release the next aid tranche, with the IMF following on July 5.

Attention will then switch to putting together a second rescue package for Greece of about the same magnitude as the initial 110 billion euro bailout agreed last year.

The new program would involve some 30 billion euros in private sector participation via a "voluntary" rollover of maturing debt, a similar sum from privatization revenues and an expected 55 billion euros in new official funding.

Euro zone banks and insurers are considering a French plan outlined by President Nicolas Sarkozy on Monday under which private bondholders would reinvest half of the proceeds of maturing Greek debt in new 30-year bonds paying 5.5 percent interest plus a bonus linked to Greece's GDP growth rate.

Of the other half, 30 percent would be cashed out and 20 percent would be invested in zero-coupon AAA securities with deferred interest that might be issued or guaranteed by the euro zone rescue fund, officials and banking sources said.

French banks have the largest foreign private sector exposure to Greece, followed by Germany. German bankers voiced interest in the "French model," while credit ratings agencies withheld comment pending details of the scheme.

Standard & Poor's said on Monday it was too soon to judge the ratings impact of the private debt rollover being put together for Greece, which it had not yet seen, but did not rule out avoiding a downgrade to default.

"It is conceivable depending on the situation. That is why I say it is not possible at all to draw a final conclusion on this in the current situation."

In Berlin, visiting Chinese Prime Minister Wen Jiabao said Beijing had faith in the European economy and the euro and was optimistic that Europe could overcome its temporary challenge.

As in the past, he gave a vague commitment to buying euro zone debt without specifying countries or amounts.

(additional reporting by George Georgiopoulos in Athens, Marius Zaharia in London, Mike Shields in Vienna, Stephen Brown in Berlin; Writing by Paul Taylor, editing by Mike Peacock)