ECONOMY | Krisana Gallezo-Estaura, Singapore

Singapore to suffer much more than peers from a disorderly Greek exit

Moody's Analytics presents two worst-case scenarios and Singapore’s production sector is poised to fall by more than the Asian average.

In a research report titled ‘Asia’s Exposure to a Disorderly Greek Exit’ Moody's Analytics economist Fred Gibson mentioned that speculation is building that Greece could soon leave the troubled euro zone and that a so-called Grexit could spread contagion, toppling fragile banking sectors and exposing stressed European sovereign balance sheets.

 If Greece does leave, Mr Gibson warned that the chances are that the exit wil be disorderly. The severe financial ructions resulting from such a move, he said, would spread across the globe, with negative real economy effects across Asia.

In a separate e-mail sent to Singapore Business Review, Gibson noted that consistent with the scenarios outlined in the report, production in Singapore’s economy would fall by more than the Asian average.

“Indeed, during the 2008-09 global financial crisis, Singaporean production fell twice as hard as the Asian average. We expect this was primarily due to Singapore’s’ economy being substantially more reliant on trade, relative to the rest of Asia (exports are around 220% of GDP in Singapore compared to the Asian average of 37%),” he said

Here's how Greek exit would impact Asian economies based on two scenarios according to Moody's Analytics: 

The first assumes that European financial markets enter a period of heightened stress but that the fallout is restricted to Europe; the second assumes that the contagion spreads to the U.S. financial system. There is market contagion to U.S. stock, bond and credit markets—this is already showing up as stocks are down and credit spreads are blowing out—and there is the risk of contagion through the banking sector. European lenders account for one-quarter to one-fifth of U.S. commercial lending; so far U.S. banks are filling the gap, but that could change.
Our proxy for financial market health in the U.S. and Europe is the Bloomberg financial conditions monitor, which weights indexes and yields from bond, money and equity markets.

We use a binary measure of financial market stress. Months in which the financial conditions monitor falls more than two standard deviations below the average are deemed periods offinancial stress. We model a Greek exit through its effect on financial volatility which remains elevated for 12 months, first with the stress restricted to Europe and then with contagion to the U.S.

To capture both the direct and indirect effects of a financial shock on Asian production, we use a vector autoregression (VAR) model. This is the best approach because it captures hidden and second-round financial and demand effects. For example, a Greek exit affects European demand directly, which then affects U.S. activity, which in turn drives Asian demand. The VAR setup effectively captures these hidden linkages.

The model includes Asian industrial production, euro zone and U.S. industrial production weighted by GDP as a measure of export demand, and indexes of financial market health in the U.S. and Europe derived from the financial conditions monitors. Our model does not account particularly well for the foreign direct investment effect, as we are looking at Asian industrial production rather than GDP, though it does account for the other channels. The model’s baseline result broadly mirrors our official forecast, with Asian economies on a steady course as production recovers through the second half of 2012.

Under the scenario in which financial market contagion is limited to Europe, we see a mild downturn in production, bottoming out at 5% y/y growth in March 2013. But when we model financial stress in both Europe and the U.S., implying some sort of financial contagion to the U.S., Asian production troughs at -8.5% y/y, also in March 2013. Put another away, the affect on Asian production under the first scenario is a 4 percentage point drop below the baseline, while under the second scenario output falls 17 percentage points below the baseline.

When the U.S. is dragged into the financial turmoil, the impact quadruples instead of doubling, as might be expected given that the euro zone and U.S. economies are of similar size. How do we explain the nonlinear impact of contagion? One possibility is Asia's different linkages with Europe and the U.S. Europe is responsible for a lot of Asia’s export financing, as well as some final demand, whereas the U.S. provides only a modest amount of Asian trade financing but a lot of final demand. The results suggest that the export demand channel is three times as important for Asian manufacturers as the trade financing channel. This seems reasonable and aligns with previous studies on this issue.

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