What Happens to Emerging Asia if the Euro Zone Breaks Up?

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Sept. 19 – While it is still difficult for most of people to picture the arrival of a post-Euro age, the break-up of the euro zone is not without possibility. A recent Reuters commentary points out that if the European Monetary Union does fail, emerging Asian markets may become more attractive and the Chinese RMB will likely accelerate its internationalization.

At an informal meeting of the Economic and Financial Affairs (ECOFIN) Council that took place at the weekend in Poland’s Wroclaw, European finance ministers imposed a two-week deadline to debt-ridden Greece to work on its deficit cutback so that a new EUR8 billion-bailout loan could be secured.

Although ministers claimed that they had not considered the possibility of any Greek default and Greece itself has firmly denied the speculation about it quitting the euro zone, speculation that Greece may just throw in the towel is still simmering. The market for credit default swaps is now betting on a higher than 90 percent-probability that Greece will default on its debt.

The division of opinion among European Union (EU) member countries has also fanned speculation of Greece’s default and exit. Germany’s idea to charge tax on financial transactions caused conflict within the EU and Finland’s demand for collateral from Greece on its portion of the bailout still saw no satisfying resolution after weeks of discussion.

Domenico Lombardi, an expert at the Washington think tank the Brookings Institution, says the potential Greek exit from the euro zone would open up a Pandora’s Box.

If one of the 17 members quit or was expelled from the bloc just because its debt conditions deteriorate, other debt-struck countries – such as Italy – could also potentially leave the euro zone. The major lenders in the region would then be faced with serious challenges due to their significant debt exposure to those countries.

“It would be almost impossible to draw the line. You could devise a framework for an orderly exit in normal circumstances, but we have gone much too far for that,” said Lombardi, who puts the chances of a euro zone break-up at fifty-fifty.

Citi’s chief economist William Buiter points out a Greek exit would benefit the euro’s exchange rate, but he agrees with Lombardi that such an act would be a financial and economic disaster for the whole euro zone.

The possible arrival of a post-euro age would also greatly impact the whole world and accelerate the global multi-polarization. As growth potential in Europe wanes, emerging Asia and other emerging markets will likely gain in attractiveness to cash-affluent Asian investors, said Rob Subbaraman, Nomura’s chief Asia economist based in Hong Kong.

However, the short-term impact of the euro zone’s disintegration on Asia could be negative, Subbaraman added. As Europe’s major trade partners, those countries may witness a painful decline in export volume and see a large scale credit withdrawal by European banks.

Among all the Asian emerging countries, most of them export more to Europe than they do to the United Sates, and the exposure of European banks to Asia ex-Japan is three times greater than of U.S. banks at US$1.4 trillion, according to Reuters.

However, what happened in the wake of the 2008 Global Financial Crisis indicated that large amounts of capital would finally flow back to Asia, as the region shows the brightest prospect for investment. Nomura statistics show that some US$80 billion worth of capital left Asia in late 2008 and the first three quarters of 2009, but nearly US$500 billion flowed back when the global economy started its recovery.

A larger reflow of capital to Asia is expected should history repeat, says Subbaraman.

The collapse of the euro may in return facilitate the strengthening of another local currency, the Chinese RMB. The Chinese government, which started encouraging greater RMB use in cross-border trade and investment after Lehman Brother’s bankruptcy, will likely see a new drive for the RMB’s globalization.

The 7 percent share of Chinese trading transactions conducted in RMB would jump if the euro zone broke up and traders needed to find an alternative currency. Although the U.S. dollar would remain to be the major candidate, the use of RMB would undoubtedly rise saliently.

Despite all the positive speculations on China, it remains unclear whether or not the Chinese government wants the RMB’s internationalization to proceed so fast. Ding Yifan, a deputy director of the Development Research Center, expressed such concern.

“This is an opportunity for China, but also a challenge, because China does not want to move too fast,” he said.

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