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Capital Markets

How a eurozone break-up would affect Asia

Credit Suisse estimates its potential impact on Asian GDP and trade dynamics, as risks rise.


Granted the timing is unknown but the neologism on everyone’s lips right now: ‘Grexit.’ This time last year, a Greek exit from the eurozone was mooted as one of the more bearish projections, rather than a viable solution to an escalating crisis. Today, Grexit is widely seen as a distinct possibility thanks to the math of macroeconomic adjustment. And, as is now-painfully apparent, fears are growing that the Spanish crisis could initiate the complete break-up of the eurozone.

After Asia-focused sell-side analysts initally struck a sanguine note after the Lehman collapse - citing the region''s attractive debt dynamics and growing intra-regional trade - they are now sounding the alarm about the eurozone''s potential to wreak havoc on emerging economies.

As Credit Suisse warned in a report published today: 


The report goes on to map out the two scenarios in detail: 


Under the first scenario [grexit], we assume that the level of euro zone GDP would fall 2% from peak to trough, while for the second [break-up of the eurozone], we assume that euro zone GDP could contract by 7%-10%. To put these numbers in context, the level of euro zone and US GDP each fell by around 5% during the global financial crisis.

Scenario one in a bit more detail:

 
 Source: Credit Suisse


In reality, the GDP effects shown... should be considered as the minimum that should be anticipated as we are only taking account of the hit to activity resulting from weaker external demand from the euro zone and US. Although we believe this is by far the most important transmission mechanism, there are likely to be other negative implications as well. These include a drying up of trade finance, as witnessed during the GFC, as well as a withdrawal of funds from the Asian region to shore up European balance sheets, in particular.
 

And the ever more encouraging scenario two:

 
 Source: Credit Suisse
 

Our second scenario... is built on a 25% drop in the level of euro zone imports and an 8% drop in US demand for Asian products. The same points as we made above regarding the likely aggregate impact are also applicable here...

In this case, we would likely see a deep recession in Singapore, Hong Kong, Taiwan and Malaysia, with Korean GDP growth also moving into negative territory on a year-on-year basis by the end of the year. The Philippines might just about escape a similar fate, as it did during the GFC, while it would probably feel like a hard landing in China and India, with growth slipping to roughly 6% and 5%, respectively, according to our estimates.  

So it could be worse that what we saw in 2008. But it’s not all bad news. According to Credit Suisse, some countries in Asia will fare better than others, though none will recover as fast as they did after the last global financial crisis:


While it is easy to imagine that the initial hit from a euro zone breakup could be at least as large as the global financial crisis (GFC), we suspect that the subsequent recovery in Asia would be less impressive. After all, the Western world has largely run out of policy ammunition, Asian interest rates are lower than they were in mid-2008 and budget deficits are generally higher in the region. In our view, Korea and Thailand would benefit the most from policy and commodity price reactions, with Malaysia and Indonesia at the other end of the spectrum.

Read elsewhere about Asia''s dependence on European bank finance.

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