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Eurozone outlook 2012
Despite various policy steps to contain the euro area debt crisis and banking problems, risks to stability have increased manifold, while Sovereign financing continues to be a challenge with a great degree of downside risk. Worse, with the advanced economies being susceptible to spillovers from a potential intensification of the crisis, 2012 will remain a year of turbulence for the world economy.
Issue Date - 15/03/2012
CDS spreads continue to widen

With rating downgrades flowing in from all directions and pessimistic outlook persisting, yields on short to medium term maturity sovereign witnessed a sharp rise in the last quarter aggravating concerns about possible defaults in the euro zone. While foreign investors have already dumped these bonds, there hasn’t been much effort on the domestic front to save the day, allowing spreads to widen. As on end-2011, more than 70% of euro area sovereign debt had credit default swap (CDS) spreads of over 200 basis points and around 40% had spreads of over 400 basis points. Though there has been some improvement since then, the fundamental problems in the region are looking far from over, threatening the whole world with yet another recession.

Banks face spillover effect

Intensifying sovereign risk in the eurozone has already shown spillover impacts on the banking industry. Over the last two years while some of the funding channels for the eurozone banks have dried completely, interbank spreads have widened constantly. Banks’ access to term funding too has been curtailed sharply so much so that lending tenors in short-term market have come down from months to days. Adding to the woes, the US money market funds have withdrawn the credit to euro area banks significantly hurting the ability of these banks to access funds in the short to medium term. Such scarce funding is feared to propel negativity into the broader economy, as conditions for accessing bank credit are getting tougher.


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