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Frederic Neumann: Greek turmoil is not without risks to Asia

The coming weeks will prove critical for Greece's membership of the eurozone. For Asia, the immediate impact of a potential "Grexit" should be manageable. A powerful policy response by major central banks and comfortable reserve buffers in the region should cushion the blow. Still, risks remain: Asia's exports to Europe had just started to recover and a slide in EU growth could limit further gains. On the monetary policy front, Asian central banks were on course to deliver more rate cuts. Fresh financial volatility resulting from Greek turmoil could make this more difficult.

     Things are evolving fast. Greece's coffers are dry. This means it will likely remain unable to meet debt payment obligations, unless it is provided with a new bailout program. What happens next is not entirely clear. But one scenario is that Greece might be forced to leave the eurozone, readopting its own currency. This could have consequences far and wide, affecting in particular already brittle investor confidence in other emerging markets. Economists often worry about "contagion," the process by which financial turmoil in one economy can spill to others, even if they appear fundamentally more robust this time.

Bad timing

For emerging Asia, there are plenty of risks to consider. Renewed eurozone jitters come at an awkward time: Growth has already slowed, exports have been pummeled, leverage is high, and the prospect of rate hikes by the U.S. Federal Reserve is adding to uncertainty. Tightening financial conditions are not what emerging Asia needs. But it is important to keep things in perspective: It is difficult to see the Greek turmoil presenting acute financial stress. Unlike previous episodes when contagion fears swept emerging markets, most Asian economies possess a comfortable reserve buffer.

     Take India. The country was hit hard by the 2013 "taper tantrum" over fears that the Fed was moving to end its massive liquidity program. But its reserves are higher today than they were back then (and the current account deficit much smaller). South Korea, Taiwan, Thailand, and the Philippines look robust on this count as well.

     That leaves Indonesia and Malaysia. Here the cushion is a little thinner than elsewhere. But in the former, it is often forgotten, debt levels are among the lowest anywhere (less than 60% of gross domestic product by one measure -- and that is total debt). In the latter, growth concerns have mounted of late and leverage is high. But the trade balance has stabilized (thanks to import compression) and a good deal of financial adjustment (for example through foreign investor withdrawals) has already occurred. Should reserves run thinner still due to rising financial volatility, there are swap lines that could be drawn on. Outright balance of payments stress, it seems, should not occur in the wake of greater Greek turmoil.

     That is not to say that the region is entirely immune. There are three points to consider. First, tightening financial conditions would still present a major growth problem. Higher debt servicing costs and (even) slower credit growth would weigh on demand, especially investment and consumption, presumably less on government spending. That, in fact, could lead to an improvement in current account balances (think especially of Indonesia and Malaysia), which should help to ease worries about overall balance of payments positions. Of course, slowing growth in itself entails financial risks, such as rising nonperforming assets, but we are starting the process from a fairly benign level in most places and it would take time for these to materialize.

     Second, should Greece jitters weigh on eurozone growth, it would affect Asian exports. In volume terms, shipments to the EU had started to recover slightly in recent months -- although still well below the historical norm, at least the gradual improvement helped to counter greater weakness in other regions like China and other emerging markets. And even if demand in the eurozone proves resilient, there is a lingering risk that a weaker euro could dampen export revenues further.

     Third, weak domestic demand and the absence of inflation pressures should lead to more rate cuts in Asia. True, macroprudential concerns and expected Fed rate hikes limit the degree of accommodation that most Asian central banks are able to deliver, at least outside of China. If renewed eurozone jitters lead to greater financial volatility, however, even those limited cuts may be difficult to deliver. Again: an added growth problem for the region.

     Is there any silver lining? In some respects, yes. The fear of renewed global turmoil could prompt a powerful policy response by major central banks. It seems likely, for example, that the Fed may need to push back its expected first rate hike from September to December. In Europe, the European Central Bank has promised to do "whatever it takes" to keep financial markets on an even keel. And in Japan, where markets have pushed back expectations of further easing, the option to do more clearly remains on the table. Whether G3 policymakers will act preemptively to limit the potential fall-out from Greece remains to be seen. But, as shown by recent history, they have not been shy to act forcefully once financial turmoil erupts.

Frederic Neumann is co-head of Asian economic research at HSBC.

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