The Australian economy will inevitably suffer spillover effects from the European government debt crisis, Reserve Bank of Australia deputy governor Ric Battellino says.
However, Mr Battellino says that with few direct trade links to Europe, strong government finances, and a resilient banking system the country is well placed to withstand the impact of the crisis on the global economy.
In a speech to the Australasian Finance & Banking Conference in Sydney today, Mr Battellino said it was possible eurozone nations would be able to resolve the worsening crisis, otherwise the continent could face dire economic consequences in the next year.
"Other outcomes, including deflation caused by prolonged fiscal austerity, inflation caused by large-scale debt monetisation, or some disruptive event such as a change in the composition of the euro area, cannot be ruled out at this stage," he said.
Mr Battellino said Australian banks had very little exposure to European sovereign debt, with government bonds from the nations most at risk of a default: Greece, Ireland, Italy, Portugal and Spain, accounting for only 0.2 per cent of Australian bank assets.
Australia also had limited trade exposure to Europe with just four per cent of Australian merchandise exports going to eurozone countries.
However, the country may still suffer the consequences of a European downturn through higher borrowing costs for Australian banks and a slowdown in Asian economies, including China and India, both of which have with strong trade links to Europe.
"The large size of the euro-area economy and the significant role played by European banks in global cross-border banking mean that it is inevitable that there will be spillovers to other parts of the global economy, including Australia."
But Mr Battellino said if global economic conditions worsened, it was likely the value of the Australian dollar would fall, providing a cushion for the local economy.
