The leaders of debt-ridden Europe have got Asia on speed dial. The answers to the solvency nightmares of Greece and Europe’s other struggling economies, be they the purchase of bonds or contributions to the European Financial Stability Fund (EFSF), seem to European leaders like France’s Nicolas Sarkozy to lie at least in part in Asia’s cash-rich, high-growth nations.
Of course, the money trail that Greece and other eurozone debtors are now obliged to follow doesn’t only lead to Asia: the International Monetary Fund (IMF), the European Central Bank (ECB), the European Union (EU), the G-20 and the United States all have critical roles to play in restoring the economic equilibrium. There are many potential lifelines.
So where does Asia come in? Nowhere, many Asian leaders are arguing, pointing to the political folly of still predominantly poor countries like China or India spending their hard-earned reserves on restoring the comfortable lifestyles of better-off Europeans. However, a more self-interested approach would be to ask how vulnerable Asian economies really are to the eurozone’s potential failure, and to determine whether Asia, for its own sake, should take action to stop the European ship from sinking.Enjoying this article? Click here to subscribe for full access. Just $5 a month.
The global financial crisis of 2008-9 was instructive in revealing the extent to which Asia’s economic fate is still tied to that of the West. It became clear then that Asia wasn’t immune from catching the West’s colds, and that the continent was vulnerable through its reliance on a mixture of American and European trade and capital. Only a colossal stimulus package saved China, for example, from following the United States and Europe into crisis. So would things be any different this time around?
As of late 2011, Asia had only experienced marginal downgrades in expectations for the year ahead. The Asian Development Bank (ADB) has trimmed its regional growth forecast for next year from 7.8 percent to 7.5 percent; China is expected to grow by 9.3 percent, less than the 9.6 percent previously anticipated; and India’s growth outlook has dipped from 8.2 percent to 7.9 percent. These are hardly forewarnings of another 2009-style slump, never mind something even worse. Unfortunately, growth forecasts are fluid – and they could be revised much further downwards should Europe fail to effect a coherent rescue plan.
“If the current situation and political debate in Europe didn’t deteriorate further, Asian exports can continue to grow although with a bit of moderation,” explains Minsoo Lee, Senior Economist at the ADB. “In this case, the impact on Asian exports growth may still be kept limited. A slowdown in Europe and the U.S. can be compensated by healthy private consumption and investment, supported by growing intra-Asian trade. On the other hand, a disorderly resolution for the EU followed by another financial crisis could provoke a large negative impact on the U.S. and the world economy. In the case where the U.S. and EU slip into another recession, Asian exports will also be affected negatively.”
Rajiv Biswas, Chief Asia Economist at IHS Global Insight, subscribes to the view that Asia’s trajectory remains dependent on how Europe’s crisis plays out. Biswas regards Europe as being at a fork in the road, with the “muddle through scenario” on the one hand and the “chaotic scenario” on the other. “The muddle through scenario can enable Europe to have a mild recession and not a deep recession,” he explains. “In that scenario, Asia comes out fairly well, growth forecasts only slightly downgraded, they’re still relatively resilient.” This option is currently the more likely, Biswas believes, so long as the EFSF can be expanded beyond its current €1 trillion capacity, and provided the new Italian government implements convincing reforms. “However, if we go into the more chaotic scenario,” he warns, “bond yields rise, Italy starts to default, and you go into a more dangerous meltdown scenario. That would hurt Asia very badly.”
Where, then, does the greatest risk to Asia lie: a drop-off in trade, or the drying-up of lending as Europe’s problems cascade down through the financial markets?
First, trade. Asia’s reliance on exporting goods to the West is diminishing all the time. According to the ADB’s Key Indicators 2011 report, “intra-Asian exports accounted for nearly 54 percent of total exports of Asia and the Pacific in 2010,” thanks to fast-growing domestic demand in many Asian economies. However, the combined GDP of the United States and Europe, at 45 percent of the global total, continues to outstrip Asia’s share of around one third. Asia’s intra-regional trade in finished (i.e. value-added) goods is also still very low. So the “de-coupling” of the Asian and U.S./European economies about which academics have speculated for years isn’t really occurring. Rather, new linkages are forming between Asian economies and between Asian and other emerging market economies in places like Latin America at a faster rate than new linkages are forming between Asia and the West. It’s important to appreciate that the value of trade between the United States and Europe continues to rise – it’s only declining as a relative share of Asia’s total. In 2011, Asian exports to Europe still equated to 17.7 percent of total exports, and almost 7 percent of regional GDP.
So on the trade side, several Asian economies are relatively exposed to European risk, and to volatility in global trade more generally. In 2009, according to Business Monitor International, the export of goods valued as a percentage of GDP was highest in:
· Hong Kong: 154%
· Singapore: 148%
· Malaysia: 82%
· Vietnam: 62%
· Thailand: 57%
· South Korea: 43%
By comparison, goods exports only amounted to 24 percent of the value of China’s GDP, 13 percent of India’s and 11 percent of Japan’s – making them better insulated against trade shocks. It’s also fortunate that none of the countries listed above export a large share of their goods to the eurozone, the highest proportions coming in South Korea (9.8 percent), Hong Kong (9 percent) and Malaysia (8.4 percent). So, while a eurozone crisis would also dent exports to countries in the rest of Europe and possibly also the United States, we are most likely looking at a downgrade of GDP growth, rather than anything more calamitous.
The trade dependency of Hong Kong and Singapore puts them at particular risk of recession – and signs of this can already be seen. The latest economic data released in November showed that Hong Kong narrowly avoided recession in Q3, as the economy grew just 0.1 percent following a 0.4 percent contraction in Q2. This prompted the SAR Chief Executive Donald Tsang to warn that there could be some “bad times” ahead, with Hong Kong now expected to grow at just 2 percent in 2012. After a stellar 2010, Singapore has experienced the same pattern of slowdown, contracting in Q2 and narrowly returning to growth in Q3. There, too, growth could fall below 3 percent in 2012.
Second, capital. Amid the prevailing image of Asia as banker to the West, it’s easy to overlook the large sums of Western – and in particular European – capital still in play in Asia. “The potential for Europe to deliver a liquidity jolt to financial markets might have been underestimated,” explains the ADB’s Minsoo Lee, pointing to the fact that European lending in Asia totaled over $1.5 trillion by September 2011. Lee lists the largest tranches of that lending as being in Hong Kong ($387 billion), China ($268 billion), Singapore ($205 billion) and Korea ($179 billion). Of the countries not on this list, Vietnam – its economy already struggling with high inflation and relatively high debt levels – is most dependent on European credit, and the precarious state of the economy could result in Vietnam suffering the most from any European slump.
More generally, the Bank of International Settlements (BIS), in its latest quarterly review, reckons that European banks account for almost 30 percent of lending in Asia, and over half of all foreign lending there. According to Morgan Stanley, Europe could cut its lending to emerging markets by $500 billion should its leaders worst fears be realized, with obvious implications for development and growth in a range of Asia’s emerging-market economies.
Asia is therefore at greater risk from a second credit crunch than from a cooling down of export activity. “In many ways the financial crisis is extremely dangerous because it’s very unpredictable,” says Rajiv Biswas. “A financial crisis has transmission effects to the global financial market. It could be extremely devastating. The trade shocks could be substantial, but the financial shocks would be systemic; it could bring the world economy to the brink of collapse.” Following on from this scenario is the potential prospect of contagion, with the default of one Asian economy leading to panic, and the demise of others. Minsoo Lee identifies this as the most dangerous possible outcome, though he believes “the probability of this scenario is very limited.”
The reality is that while Asia certainly stands to lose a little from the eurozone crisis, it may ultimately stand to lose a very great deal. And this brings us back to the question of whether Asia should concern itself with Europe’s rescue. On the one hand, the economic danger to Asia is real; on the other hand, the political barriers to Asian economies offering themselves up as European life rafts remains considerable.
China has already taken action, buying European bonds – this both helps fund Europe’s endangered economies, but it also inflates the value of the euro, which in turn helps to support Asian exports to the eurozone. Japan has also stepped in, acquiring 10 percent of the EFSF’s latest bond issue, though important developing economies, such as Brazil, India and Russia, declined to get involved. Should China, with its €3 trillion reserves, now do more? Beijing is reportedly weighing up the option of investing €100 billion in the EFSF, although Premier Wen Jiabao recently spelled out his government’s position that investment would only come in the wake of the implementation of credible reforms.
Despite its immense reserves, Biswas doesn’t believe that the onus for the rescue should rest with developing China. “It’s beyond the point where you can tell Europe to sort itself out,” he says. “But China can’t lead. It could take part in a G-20 response. You need the U.S. and Japan to be involved, for a G-3 response along with the EU. They can do a lot to intervene.” For Biswas, the bottom line is that “the [U.S.] Fed and Japan need to buy bonds”. Then the G-20, with the active involvement (in varying degrees) of its six Asia-Pacific members, needs to come in behind the U.S.-Japan-EU G3 because, Biswas adds, “financial markets want to see a coordinated global reaction.”
Asia’s response to the crisis could therefore be led by Japan, backed up by the region’s other G-20 members, including – but not only – China. And these, now, are the critical weeks, with Italy wavering close to the brink. The acceptance that Asian economies must play a role in Europe’s escapology is building. So too is the realization that the pain being felt in Europe could easily strike Asia too, unless the euro’s rot is stopped.