Bloomberg News

Risk of Europe Contagion Becoming ‘Very Real,’ Nasution Says

December 01, 2011

(Updates with Nasution’s comments in third paragraph.)

Dec. 1 (Bloomberg) -- Emerging economies are facing the threat of a capital reversal as the risk of contagion from Europe becomes “very real,” Bank Indonesia Governor Darmin Nasution said.

An escalation of Europe’s sovereign-debt woes may prompt investors to allocate their assets into other currencies instead of putting them into the safest euro sovereigns, Nasution said in Bali today. A bout of risk aversion may result in investors avoiding emerging-market assets as well, he said.

“Despite a positive growth outlook, emerging economies like ours confront the risk of capital reversals and deleveraging processes,” Nasution said. “The ongoing reforms of financial sector balance sheets in many advanced economies will also play a major effect in the financial stability of our economies. We need to prevent the build-up of financial instability.”

Six central banks led by the U.S. Federal Reserve made it cheaper for banks to borrow dollars in emergencies in a global effort to ease Europe’s sovereign-debt crisis. Yesterday’s move echoed coordinated actions from the financial panic starting in 2007 to create and expand the currency-swap lines, whose use peaked at about $583 billion in December 2008.

Europe is seeing broad-based financial-market disruption and is undergoing a “true financial crisis,” Bank of France Governor Christian Noyer said in Singapore yesterday. The economic outlook in Europe and the rest of the world has “significantly worsened” in the past weeks, he said.

Supporting the Rupiah

Bank Indonesia plans to boost “intervention” in the market to support the rupiah from becoming “too weak,” Nasution said yesterday, a day after the currency reached a 17-month low. The currency reached 9,240 on Nov. 29, the weakest level since June 2010. It appreciated 1 percent today.

“Managing capital inflows has challenges,” Nasution said today. “In our economies, volatility of exchange rates attributable to substantial capital flows creates foreign exchange risks.”

The central bank is committed to buying government bonds in the secondary market, Perry Warjiyo, director for economic research and monetary policy, said Nov. 29.

“Capital markets in our economies are generally shallow and susceptible to sudden price movements,” Nasution said. “This creates greater disruption undermining the integrity of our financial system. When faced with negative investor sentiments, liquidity in those markets can dry up quickly, causing panic sales and contagion effects.”

Goldman Sachs Group Inc. cut its global growth forecast for 2012 today, predicting the euro area’s economy will contract 0.8 percent. Global gross domestic product may expand 3.2 percent next year, down from an earlier estimate of 3.4 percent, it said. It cut the forecast for the euro area from a previous prediction for 0.1 percent growth.

The Fed coordinated the move with the European Central Bank and the central banks of Canada, Switzerland, Japan and the U.K. The six central banks also agreed to create temporary bilateral swap programs so funding can be provided in any of the currencies “should market conditions so warrant.”

--Editors: Shamim Adam, Lily Nonomiya

To contact the reporter on this story: Widya Utami in Jakarta at wutami@bloomberg.net

To contact the editor responsible for this story: Stephanie Phang at sphang@bloomberg.net


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