Developing nations must be ready for a financial market selloff if the Cypriot banking sector collapses, World Bank Managing Director Sri Mulyani Indrawati said on Sunday, urging a swift resolution to the crisis in Cyprus.
In an interview on the sidelines of a forum in Beijing, Indrawati said she is watching very closely the outcome of a plan to levy a one-off tax on Cypriot deposits as part of a deal to obtain a 10 billion euro bailout from the EU.
Her remarks contrast with those of German politicians, who have suggested contagion from Cyprus, an island of a million inhabitants, would be limited. Europe's financial markets have also traded in relative calm since the Cyprus crisis flared up.
Yet with attention on Cyprus, a poor reception from investors to the final plan to save the Cypriot economy may be contagious and could threaten other vulnerable nations, especially those in Europe, Indrawati said.
"The first impact on this global environment from this Europe situation comes from perception because it is psychological," she said.
"And that is contagious because it is coming from the capital market, from the equity market, from the financial sector."
Cypriot President Nicos Anastasiades is seeking a last-minute reprieve from financial meltdown at talks in Brussels on Sunday, racing against a Monday deadline to avoid a financial collapse and the nation's potential exit from the euro zone.
Cyprus' overgrown banking sector is suffering from investment losses in Greece, and the EU says the island must raise 5.8 billion euros on its own before it can receive a 10 billion euro bailout.
A Cypriot official said the government had agreed on a 20 percent levy over and above 100,000 euros at the country's largest bank. An earlier proposal that included a levy on small savers sparked public demonstrations and was rejected by lawmakers.
"We have to watch very carefully what is happening in Cyprus," Indrawati said. "Not only the psychology but ... settlement related to the banking system and the treatment of deposits," she said.
"The global economy cannot afford to have more volatility again. That is why policymakers need to do the right thing in a very quick way so as to reduce the volatility and the uncertainty," she said.
(Reporting by Koh Gui Qing; Editing by Giles Elgood)