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Asian Central Banks Keep Tight Watch as Credit Fears Rise

Asia Pacific central banks and financial chiefs kept a tight watch on money markets and attempted to reassure investors on Thursday as fears of a worsening global credit storm gripped the region.

"There's a degree of panic over the uncertainty induced by the subprime sector in the United States," said P.K. Basu, chief economist for Asia ex-Japan at Daiwa. "The economic fundamentals in Asia are very sound. However, the final residing place of these CDOs (collateralised debt obligations) and the derivatives issued on the subprime mortgages is difficult to predict."

The problems started when banks repackaged and resold risky subprime loans in the form of CDOs and other instruments to banks and funds around the world. As demand for the securities dried up, these banks and funds were unable to sell and had to mark down the value of their holdings.

That in turn spooked investors and caused credit markets worldwide to tighten. Central banks reacted by pouring cash into money markets to smooth out trading.

Australia's central bank added a larger-than-usual amount to the banking system on Thursday, which analysts took as an attempt to ease upward pressure on market interest rates. Australian Treasurer Peter Costello said the Australian banking sector was well capitalized and had sufficient liquidity.

South Korean Vice Finance Minister Kim Seok-dong said the government would collaborate with the central bank to inject funds into money markets through repurchase agreements on any signs of a squeeze.

And the Reserve Bank of New Zealand said it was closely monitoring markets but believed the level of cash within the banking system was adequate.

The comments came after St. Louis Federal Reserve Bank President William Poole said that financial market turmoil had not undermined the U.S. economy and there was no need for the central bank to ride to the rescue with an emergency rate cut.

Markets were anything but reassured. The region's stocks extended their decline, with Japan's Nikkei reaching 8-1/2-month lows. Heightened risk aversion propelled the yen to a near five-month high against the dollar and euro as investors unwound carry trades.

The low-interest-rate Japanese currency has been widely used by speculators as a cheap source of funds to buy higher-yielding and often riskier assets in other currencies.

As those trades were unwound, the Australian dollar briefly fell below 80 U.S. cents for the first time since March and the New Zealand dollar dropped sharply against the U.S. dollar.

Other Asian currencies extended recent losses and central banks in Indonesia, Malaysia and the Philippines were reported to have stepped into the market to support their currencies.

Countrywide Woes Sow Fear

In the latest scare for already jittery investors, a Merrill Lynch analyst flagged the possibility that Countrywide Financial, the largest U.S. mortgage lender, could face bankruptcy if liquidity conditions worsened.

Last week Asia Pacific central banks joined a global campaign by monetary authorities to calm panicky credit markets by pouring liquidity into banking systems. The situation appeared calmer on Wednesday, as central banks in Europe and Japan mopped up cash.

But North America's monetary authorities reopened the taps. The U.S. Federal Reserve added $7 billion in temporary reserves as losses in the U.S. subprime mortgage market sent Wall Street stocks slumping again.

And the Bank of Canada stepped in after a day on the sidelines, injecting C$350 million (US$330 million) of repurchase funds and leaving the banking system flush with cash.

The Reserve Bank of Australia (RBA) picked up the baton in its regular daily money market operation on Thursday, adding A$3.04 billion (US$2.49 billion) in cash to the banking system, above the A$2.5 billion estimated requirement.

"What's interesting is that they've added a generous amount, they're concentrating on money market debt and they've lent at rates below what the market was charging," said Matthew Johnson, senior economist at broker ICAP.

U.S. Treasuries, perceived as a safe haven in times of financial stress, were in high demand.

Investors are increasingly betting that central banks will have to do more than supply overnight markets with cash. Futures markets are pricing in a higher possibility of an interest rate cut from the Fed.

"I think the central banks are actually very well positioned to do a fair bit, given that real interest rates are quite high around the world because central banks were tightening in anticipation of stronger growth ahead," said Daiwa's Basu.

"So there is actually room for the G3 central banks to provide further additional liquidity, as they have done in recent days, especially given that inflation is very well contained."

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