The political and economic crises in the euro zone are threatening to prolong the economic slowdown across the countries. The uncertainty in Greece over its possible debt default and exit from the euro zone is driving down the euro and other major currencies against the dollar. The situation has influenced the global markets, which has remained volatile to the developments in the euro zone.
However, the euro zone situation would not be as dreaded for the Asian economies as expected to be for the emerging European countries, said an analyst report from the Capital Economics.
Asian economies can withstand the euro zone jitters because the emerging Asian countries have more room for government intervention to support growth while the public debts and trade deficits are relatively low and the region has strong economic fundamentals that can insulate the economy.
An analysis of the current situation clearly depicts that the euro zone crisis has its toll on the emerging European and Asian economies. However, the researchers say the impact on the Asian economies will not last long.
The Vicious Circle of Economic Slowdown
A major factor that triggers an economic slowdown is the fear psychosis among the investors who rely on a stronger dollar and safer bonds in an attempt to avert risks.
This in turn will lead to further weakening of the global currencies against the dollar and trigger further funds outflow from the markets, leading to depreciation of currencies while increasing the trade deficit and inflation. This vicious circle will further continue to push down the economies.
However, strong economies that have room for policy stimulus to break the vicious circle of recession can protect their economies from the impacts of a global economic crisis.
The analysts are comparing the current euro zone crisis to that of the 1997-98 Asian economic problems that affected the Asian countries but left the rest of the world unaffected.
According to the Capital Economics analyst, India is better placed to come out unaffected by the euro zone crisis if the policy makers take right steps to strengthen the economy.
The data in the report show that the Asian currencies have depreciated against the dollar, but the loss in value is less than what currencies from the emerging European and other markets have lost.
Australian and New Zealand dollars are the worst hit currencies in the Asia-Pacific region.
The Indian rupee has tumbled, but analysts believe the free fall of the rupee is due to the policy paralysis in the country than the euro zone crisis.
India's five major problems, widening fiscal and trade deficit, fall in the rupee, inflation and slow economic growth have its roots in policy gridlock in the country. Government policies are based on domestic political and social considerations more, and less on the economic goals.
According to a Crédit Agricole Corporate and Investment Bank research report, complicated and counter-productive regulatory measures and policy indecisiveness have forced the corporate sector to short-selling the Indian currency. Added to this is the frequent policy changes and uncertainty that have forced the foreign investors to stay out of the Indian economy. This has widened the current account deficit while affecting the capital spending on infrastructure.
The Crédit Agricole Bank investors believe that proper policy and corrective measures could take the rupee to 50-51 per dollar by the end of the year.
We see a two-thirds chance of appropriate policy and it being implementable: (1) selling FX directly to oil companies, (2) raising caps on foreign bond investment, (3) issuing foreign currency debt by the sovereign or highest quality borrowers - although weak demand for Indian paper abroad may complicate things, (4) caps on gold imports- although this would be very difficult politically, can take rupee to 50-51 per dollar by the end of year, the report said.
Euro Zone Impact on India
As expected widely, if Greece exits from the euro zone, it will affect the European and global economies. The impact will be severe on the emerging European markets like the Czech Republic, Hungary, Slovakia because they are depended on developed European economies apart from sharing a common currency.
Moreover, Greece exit will invariably lead to banking crisis and credit crunch in the region, resulting in a severe economic slowdown that might be extended to recession cycle.
Nevertheless, the impact of Greece's exit on Asian economies will decrease demand for exports, which will affect the export-oriented economies in the region.
A major impact on emerging Asia would come from the resulting weakness of export demand. Hong Kong and Singapore would be most vulnerable, as they are the region's most export-oriented economies. In contrast, Indonesia and India are the least trade dependent, said an analyst's report from the Capital Economics.
The same experts believe that the dollar will see further gains against other global currencies as investors will resort to risk aversion.
However, the tendency will change in long-term once the investors get used to the euro zone breakup and this will in fact benefit the Asian economies, as they would remain an attractive investment destination compared to the emerging Europe markets.
Even the credit crunch and possible euro zone bank crisis will affect Asian countries less as the data show that euro zone banks finance a negligible share of lending in Asia. Thus, if a credit crunch forces the euro zone banks to pull back funds, then the emerging European markets and other emerging regions are going to bear the brunt.
Most of the emerging Asian countries still have room for policy changes that can boost the growth and investor confidence. If countries like India push ahead its economic reforms and reassure the investors of clear policies, then they will be poised to break the vicious circle of economic slowdown.