How Asia Will Fare if Europe Cracks

Posted on June 20, 2012

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June 19, 2012, 5:59 p.m. ET

By ALEX FRANGOS

As the Euro Zone Flirts With Disaster, Asian Economies Stand at Varying Degrees of Preparedness

HONG KONG—Greek elections may have assuaged fears of a European financial contagion spreading to Asia, at least for the moment. But as troubles brew in Spain, where borrowing costs shot up again Tuesday, and as Greece faces more painful cuts to meet bailout targets by September, many wonder who in Asia is most exposed should Europe’s economy and financial system finally crack.

In Case of Euro Emergency

The financial health of Asian economies in the event of a euro-zone meltdown can be gauged by several indicators.

 

Counting Contagion

Asia will not be spared the fallout of an intensified euro crisis. See an economy-by-economy assessment of exposure to euro pain.

 

Lessons from the 2008 financial crisis show that while all of Asia tends to get hit when the world economy shudders, the severity differs depending on which countries have the biggest trade and financial linkages to the rest of the world, and which are best-prepared with big currency reserves, flush government coffers and central banks with room to cut interest rates.

In general, Asia has more room than the West to react with interest-rate cuts and government spending. But there are new wrinkles since 2008, and some countries, notably India, Vietnam and Japan, are in worse shape to weather a storm.

“As we saw with Lehman, when you get a seizure in the global financial system, nobody can hide from that in the short run,” says Richard Jerram, chief economist at the Bank of Singapore.

In such a scenario—which analysts say could still occur if Greece falls short of its commitments and leaves the euro, or Spain and Italy wind up requiring a bailout Europe can’t afford—Asian stocks and currencies would fall, shipping lanes would empty out, and lending to consumers and businesses would dry up, slowing economies.

Asian economies that rely most heavily on trade—such as Singapore, Hong Kong, South Korea, Japan, Taiwan, Thailand and Malaysia—are likely in for a bigger blast in the event of a European meltdown. South Korea’s prowess in exporting things like cars and smartphones makes up 50% of its gross domestic product. For Taiwan, it is 70% of its economic activity.

“The EU remains a formidable export market for the region and cannot be easily replaced by other export markets, at least in the short run,” says Sanjay Mathur, an economist at RBS.

Economies that rely on international bank finance and investment also will feel the pinch. The International Monetary Fund estimates that during the 2008 crisis, for every 1% pullback in loans from foreign banks to Asia, domestic banks followed suit, contracting lending by 0.6%, starving credit to small businesses and exporters.

As financial centers, Singapore and Hong Kong stand out in terms of their exposure to EU banks and would see big banks cut back on jobs. Malaysia has bank loans from Europe equal to 20% of its GDP, which is high for the region. A place like China, with a closed financial system, is more immune.

Some of the economies most exposed through trade and finance have lots of ammunition to fight off a slump. Hong Kong and Singapore maintain massive rainy-day funds to keep households and businesses afloat.

Other countries have taken steps since 2008 that should help them if conditions worsen. After suffering a run on its financial system and a 50% drop in the value of its currency in the last global economic crisis, South Korea now has more reserves, and its banking system relies less on short-term foreign funding. Thailand, meanwhile, has boosted minimum wages and farm incomes to protect households if exports dry up.

But many other Asian nations have fewer options than they did in 2008 and 2009, when countries such as India, China and Indonesia relied on stimulus or large domestic consumer markets to help them power through. Japan is constrained by government debt levels that total more than 200% of GDP, as well as limited room for monetary-policy moves, given its ultralow interest rates and the central bank’s already large bond-buying program. Japan also fears its currency will get even stronger during a panic, hampering exports at the same time European demand for Japanese goods wanes.

India also is more vulnerable than in 2008. It runs a higher current-account deficit, which means its financial system needs more capital from abroad to stay afloat. That is tough to get when global markets seize. Government debt also is higher, which makes it harder for New Delhi to implement a stimulus package. The central bank is caught between slowing growth and persistent inflation, limiting how much it can cut interest rates. Currency reserves are smaller than in 2008.

Vietnam, meanwhile, is struggling with slow growth and high inflation (though it has eased some lately), and unlike India, it relies heavily on exports to Europe, which make up 13% of its GDP. Its banks are weighed down by a huge increase in lending in 2009 that makes new stimulus hard to pull off.

China, while it has deep pockets to launch another round of big-bang stimulus, has indicated it may not want to be so bold, preferring slower, more sustainable growth. If China doesn’t open the stimulus floodgates, that would mean less of a boost for its neighbors, including commodity exporters such as Australia and Malaysia.

Of course, a euro disaster could be averted, as the Greek elections illustrated. The euro lives, the uncertainty remains, Europe continues its recession and the world avoids a financial apocalypse. If that scenario continues to hold, economists say, Asia likely marches on. “Asia is very well positioned for a muddle-through scenario in Europe,” says Mr. Jerram. “A moderate recession in Europe doesn’t pose serious hazards here.”

Write to Alex Frangos at alex.frangos@wsj.com

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