Although emerging markets came away relatively unscathed from the recent debt crisis in Europe, problems in advanced economy debt markets could very easily spill over to emerging markets, as we have already seen on numerous previous occasions. A sharp rise in investor risk aversion could lead to funding strains in emerging markets as European banks withdraw cross-border credit facilities.
Cross-border bank exposures can be the conduit for spillovers of sovereign risks to banks and for this to spread further to other banking systems in the region and beyond. Heightened uncertainty about financial sector exposure to sovereign risks and increased funding costs could curtail the supply of bank credit. Lower consumer and business confidence, together with fiscal consolidation, could suppress private consumption and investment.