Abstract

The European Union (EU) has traditionally been an important economic partner for Asia. In addition to absorbing a significant share of the region’s exports, the EU has been a major source of foreign direct investment and other capital flows into the region. In light of such close economic linkages between the EU and Asia, the euro crisis will undoubtedly influence Asia’s short-term macroeconomic outlook. The key question, however, is how big the impact will be. This paper tries to answer this by examining both the trade and financial channels of crisis transmission. The impact on developing Asia will fall primarily on trade but there are also significant effects on the region’s financial systems, especially its banking sector. However, overall, the magnitude of the shock from the euro crisis will be significantly smaller than the shock from the global crisis. A further cause for guarded optimism is that developing Asia still has relatively ample policy space to cushion a major external shock.

Highlights

  • Notwithstanding developing Asia’s ( Asia) growing weight and stature in the world economy, it is premature to talk of the region’s decoupling from the advanced economies

  • Our analysis indicates that the impact of the euro crisis on Asia via the trade channel will be tangible but not pronounced

  • The abatement of the risk of a euro financial meltdown due to decisive European Central Bank (ECB) action further reinforces the likelihood that the primary transmission channel will be the trade channel via a eurozone recession, and the financial channel will play at most a secondary role

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Summary

INTRODUCTION

Notwithstanding developing Asia’s ( Asia) growing weight and stature in the world economy, it is premature to talk of the region’s decoupling from the advanced economies. Mirroring Asia’s emergence as a third hub of the world economy as a result of its rapid growth, the region is an increasingly significant import market and source of investment for the EU In light of such close trade and, to a lesser extent, financial linkages between the EU and Asia, the euro crisis will undoubtedly influence Asia’s short-term macroeconomic outlook. This paper tries to answer this question by examining both the trade and financial channels of crisis transmission It looks at the effect of euro crisis on Asian exports and growth, contagion from EU financial markets to Asian financial markets, and influence of EU bank lending on credit growth in Asia. The paper concludes with an overall assessment of how Asia’s short-term economic outlook is affected by the euro crisis

TRADE CHANNEL
FINANCIAL CHANNEL
Impact of Euro Crisis on Asia’s Equity and Bond Markets
Impact of Euro Crisis on Asia’s Banking Sector
Developing Asia’s Exposure to Eurozone Lending
DEVELOPING ASIA’S POLICY SPACE TO COPE WITH THE EURO CRISIS
50 JanͲ11 MarͲ11 MayͲ11
Findings
CONCLUDING OBSERVATIONS AND POLICY IMPLICATIONS
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