Seoul may be the most poignant place one could pick in Asia for a spectator seat at Greece’s economic implosion.

South Korea’s crash in 1997 turned a regional financial crisis into a global one, as a Greek exit from the euro is sure to do. The difference might be that South Korea came back strong, while it’s hard to see how Greece could do the same.

There’s another difference: What is happening in Europe has the potential to be far more disruptive to Asia than its own crisis was for the rest of the world 15 years ago. If Greece exits the euro region, it may well take Spain, the world’s 12th-biggest economy, with it.

And that raises a question: Is Asia even close to being ready for a meltdown that might dwarf its own? It doesn’t look that way.

“The key for Asia isn’t whether Greece leaves, but how,” says Simon Grose-Hodge, head of investment strategy for South Asia at LGT Group in Singapore. “A disorderly exit raises the chance of contagion and more widespread risk aversion, which hurts the more volatile markets, like Asia. As we saw in 2008, the bigger the shock, the bigger the stampede to exit all risky assets, regardless of merit.”

First, the good news. Korea has some latitude to throw up defenses should European contagion head east. The Bank of Korea’s benchmark interest rate of 3.25 percent leaves plenty of room for cuts to stimulate the economy. The government also would have little trouble borrowing to support growth.

In a report on Asia’s exposure to a chaotic Greek divorce, Moody’s Analytics economists Fred Gibson and Glenn Levine found some room for optimism. Asian businesses and policy makers, they said, are in a better position heading into a new crisis. The credit crunch of 2008 and 2009 led Asia’s central banks to increase swap lines, and companies have mapped out alternative sources of capital and supply arrangements to better cope with disruptions.

The bad news is twofold: First, the euro mess, of course, might be more destabilizing than anything we’ve seen before. Second, the main engine of Asia’s growth ― China ― has less ammunition than in the past. In the last global crunch, after Lehman Brothers Holdings Inc. collapsed, China engineered near-epic fiscal and monetary responses and managed to beat all the odds with rapid growth rates. China expanded 8.1 percent in the first three months of this year.

It is doubtful that China can do as much again, though it does seems to be trying to prepare itself with last week’s cut in interest rates. In a recent report, economists at the nation’s biggest investment bank, China International Capital Corp., said fallout from Greece could reduce China’s expansion to 6.4 percent this year, the slowest in two decades. For a nation at China’s level of development, that poses all kinds of risk, not the least of which is social unrest.

Japan is vulnerable, too. Japan’s status as a haven has driven the yen higher against the dollar and the euro, sapping the vital export sector and hindering the recovery from last year’s earthquake and tsunami.

Talk about the “Lehman shock” of September 2008 still pervades Japan. Japanese banks had avoided bets on the toxic assets that savaged Wall Street, at first leading some to think that the country would weather the crisis with minimal harm. Over time, though, Japan was hurt by its reliance on exports and its system of cross-shareholdings. The interlocking relationships, designed to fend off takeovers, ended up spreading the damage as financial markets plunged. This will happen in the months ahead, too.

The real drama will be seen first in Asia’s most open economies because they are so dependent on exports and have few regulations on capital markets. Fresh contagion means a “renewed, deep recession would be highly likely in Hong Kong, Singapore, Malaysia, Taiwan and Korea,” says Robert Prior- Wandesforde, Singapore-based director of Asian economics at Credit Suisse AG.

The progress Asia has made strengthening its banks and amassing currency reserves might limit the worst of the damage. But credit markets, demand for exports and foreign-investment flows ensure that Asia will get its share of turbulence. Depending on the shockwaves Greece causes, each of these channels will pose challenges to policy makers.

Central bankers and government finance officials must act to protect Asia’s economic gains over the last decade and a half. If that means increased borrowing to boost growth, then so be it. Lower rates may be necessary in a world in which the risks of deflation outweigh inflation. Capital controls may also be necessary, provided they are implemented prudently.

An added test will come if the Federal Reserve unleashes a third round of quantitative easing as U.S. growth disappoints. Asian policy makers have gotten creative about mopping up excess liquidity that tends to fuel asset bubbles. The challenge is more about control, ensuring that financial systems aren’t overwhelmed by hot money.

As Europe crashes, Asia risks being tested as rarely before. It’s great that Asia is better positioned to withstand the ramifications 15 years after its own near-collapse sent shockwaves around the globe. It just isn’t clear that will be enough as the West returns the favor. 

By William Pesek

William Pesek is a Bloomberg View columnist. The opinions expressed are his own. ― Ed.

(Bloomberg)