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Spectre of the euro crisis

Publication Date : 22-05-2012

 

No one dares predict the magnitude of the crisis likely to be set off by a Greek exit from the eurozone, but the recent analysis by the International Monetary Fund that hinted at such a horrible possibility has worsened the uncertainty in the international financial markets.

It is, we think, the financial market contagion of a Greek crisis, not trade links, that could adversely hit Indonesia’s economy in view of the likelihood of bank runs in other European countries such as Spain, Italy and even Germany.

If Greece indeed leaves and the drachma loses half of its value or more, it would become obvious to depositors in other parts of Europe that their deposits are at risk, setting off a bank run as one possible scenario.

If such an event occurs, it is possible that other euro-area economies perceived to have similar risk characteristics would come under severe pressure as well, with a full-blown panic in financial markets and depositor flight from several banking systems.

Such a panic could trigger the withdrawal of Western lenders from emerging Asia, leaving behind a huge trade-financing gap.

Asia, especially Indonesia with its big domestic market, did manage to ride out the 2008 global financial crisis, boosting intra-regional trade in the process, to offset diminished demand from traditional export markets in the US and Europe.

But many see today’s global economic slump as more insidious than before, threatening the solvency of developed economies and their financial sectors.

Indonesia, which has increasingly become a highly favoured place for both foreign direct investment and portfolio capital, could be greatly vulnerable to a sudden reversal of capital flows, in the case of a massive repatriation of Western banks’ assets to their home markets.

When capital is tight, banks focus on core markets, not the more challenging emerging markets as Indonesia, and on core large clients, not small- and medium-scale borrowers.

Asian Development Bank President Haruhiko Kuroda recently warned emerging economies of the big risks of the withdrawal of funding by European banks that could harm the Asian economy.

A withdrawal of European bank capital would negatively impact foreign-currency lending in the trade finance, derivatives and syndicated loan markets, reducing credit supply in Hong Kong, Singapore and Tokyo, in particular.

Some bank analysts have raised the alarm, pointing out that new syndicated bank lending to emerging markets dropped steeply to US$105 billion in the first quarter, a 50 per cent fall compared with the previous three months.

On top of that, European banks are under huge pressure to bolster their balance sheets to meet Basel III capital standards by reducing loans and raising new capital, reducing their ability to make new loans.

 The problem is that while Basel rules and the euro crisis have forced European banks to scale back their exposure in Asia, there seems no way Asian banks could have stepped in with the size that was needed to compensate for the shortfall.

Even though the withdrawal of European bank credits from Indonesia and Asia has not been as bad as we had feared, we cannot simply sit and relax. Our fiscal and monetary authorities should instead gear up for the worst.

The effective crisis management we put up in coping with the global financial crisis in late 2008 and early 2009 should strengthen our confidence in weathering the current financial market uncertainty.

 

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