By Lefteris Papadimas and Renee Maltezou
ATHENS/BRUSSELS (Reuters) - Greek Prime Minister Alexis Tsipras called a referendum on austerity demands from foreign creditors on Saturday, rejecting an "ultimatum" from lenders and putting a deal that could determine Greece's future in Europe to a risky popular vote.
The surprise call marked the most dramatic twist yet in five-month negotiations between Greece and its lenders, plunging the cash-strapped nation into uncharted waters and risking a default and capital controls as hopes for an aid agreement faded.
After a week of acrimonious talks in Brussels, Tsipras dismissed lenders' proposals as "blackmail" before flying to Athens to huddle with ministers. After midnight, he appeared on television to announce plans for a referendum on July 5.
"Our responsibility is for the future of our country. This responsibility obliges us to respond to the ultimatum through the sovereign will of the Greek people," Tsipras said in a televised address to the nation.
The 40-year-old prime minister said he would respect the outcome of the vote. But he argued the lenders demands "clearly violate European social rules and fundamental rights", would asphyxiate Greece's flailing economy and aimed at the "humiliation of the entire Greek people".
Government ministers emerging from the cabinet meeting said they were confident Greeks would vote no and reject the bailout demands, leaving open the question as to whether the country had other options beside leaving the euro in such an event.
The referendum call also throws the country's tottering banking system into focus, though a deputy minister said there were no plans to impose capital controls and banks would open as normal on Monday.
"The risk of Grexit has increased considerably, from previously 20 percent to at least 50 percent," Wolfgango Piccoli of Teneo Intelligence said in a research note. "Avoiding capital controls next week will be very difficult, if not impossible."
Soon after the address in the early hours of the morning, lines of up to 10 people were seen forming to withdraw cash from automated teller machines in some parts of Athens. Small groups of anti-establishment protesters threw petrol bombs and stones at police in an Athens neighbourhood where protests are common.
The euro zone had offered to release billions in frozen aid if Greece accepted and implemented pension and tax reforms that are anathema to its leftist government, elected in January on a promise to end austerity.
Without the bailout funds, Athens is due to default on 1.6 billion euros in repayments to the International Monetary Fund on Tuesday, pushing Greece closer to being forced out of the euro, causing chaos for its economy and financial markets.
A default would not necessarily lead to Athens leaving the 19-nation single currency area, but is expected to pave the way for it, worrying European leaders who fear it would undermine the principle that membership is irrevocable.
Greece's parliament convenes on Saturday at noon local time (0900 GMT) to approve the referendum plan, just before euro zone finance ministers are due to meet in Brussels to discuss an aid offer from European and IMF to Greece.
One European official said the ministers would discuss a "Plan B" on preparing to limit the damage from a Greek default to Greek banks and other euro zone countries and markets if Athens rejected their offer.
Tsipras said he would ask for an extension of the bailout ending June 30 by a few days to accommodate the referendum.
He also spoke with European Central Bank President Mario Draghi to discuss the referendum, and senior government officials were due to meet the ECB chief later on Saturday.
With Greece's stricken banking sector dependent on central bank funds to remain afloat, the ECB will play a vital role in keeping the system on its feet over the next few days.
"YES OR NO TO EUROPE"
Opposition parties attacked the government, saying the Tsipras's hardline stance had brought Greece to its knees.
"Tsipras brought the country to a total deadlock. Between an unacceptable agreement and a euro exit," former conservative Prime Minister Antonis Samaras said. The referendum question was effectively a "yes" or "no" to Europe, he said.
This is not the first time that Greece has flirted with a referendum in recent years. Former Prime Minister George Papandreou sought one in 2011 as he struggled to impose painful cuts demands by lenders, but was ousted over the call and his administration replaced by a government of technocrats.
The latest drama came after weeks of phone calls, face-to-face-discussions and several rounds of meetings among European leaders to sort out Greece's troubles. In the latest round, German Chancellor Angela Merkel and French President Francois Hollande met Tsipras on the sidelines of an EU summit to coax him to accept an offer to fill Athens' empty coffers until November in return for painful reforms.
But after months of fruitless wrangling, the patience of European partners with the leftwing government in Athens had grown thin and officials had indicated that there was little more room to manoeuvre.
Merkel said she and Hollande had urged him in a 45-minute private meeting to accept the creditors' "generous" offer.
"We have taken a step towards Greece," she said. "Now it is up to the Greek side to take a similar step."
Both she and Hollande said Saturday's meeting of euro zone finance ministers would be the decisive moment for a deal since time was running out to secure German parliamentary approval in time to release funds needed to avert a Greek default.
The creditors laid out terms in a document handed to Greece on Thursday. It said Athens could have 15.5 billion euros in EU and IMF funding in four instalments to see it through to the end of November, including 1.8 billion euros by Tuesday as soon as the Greek parliament approved the plan.
The total is barely more than what Greece needs to service its debts over the next six months and contains no new money. Further funding would require a third bailout programme, which is politically impossible for the moment in Athens and Berlin.
The lenders also made a gesture towards Tsipras' demands for debt relief by offering to reaffirm a 2012 pledge to consider stretching out loan maturities, lowering interest rates and extending an interest payment moratorium on euro zone loans to Greece, a senior EU official said.
But the demands come at the price of pension cutbacks, new reductions in public sector salaries, an increase in taxes on food, eateries and tourism, and elimination of tax breaks on tourist islands. That has sparked protests in Greece, where one in four people are out of work.
"The government and the Europeans, who we thought were our partners, have brought us to the edge of the precipice," said 65-year-old Maria Papaconstantinou in Athens central square.
(Additional reporting by Michele Kambas,; George Georgiopoulos and Lefteris Karagiannopoulos in Athens, Paul Taylor and Jan Strupczewski in Brussels, writing by James Mackenzie and Deepa Babington; Editing by Sophie Walker, Philippa Fletcher, Toni Reinhold)