Despite repeated assurances by European Union leaders, after more than twoyears, there is still no light at the end ofEurope’s debt-crisis tunnel. Recently, thepresident of the European Commission, José Manuel Barroso, referring to a possibleGreek exit from the eurozone, told the European Parliament that there is no“Plan B.”

Barroso’s statement was meant to be reassuring. But, after so manydisappointments, China cannot accept at face valuethe assurances of European politicians, which even they themselves do not knowwhether they can redeem. China should haveits own Plan B in case Greece has to leave the eurozone.

Indeed, it is increasingly likely that Greece will renege on its bailout obligations. If that happens and the“troika” (the European Commission, the European Central Bank, and theInternational Monetary Fund) cuts offfinancial support, Greece’s exit from the euro will become

all but inevitable. Inthat event, China must be prepared for any ensuingglobal financial turmoil and longer-term consequences.

For starters, Chinese officials should be underno illusion that the country will be immune to financial contagion. A“Grexit” would hit European banks that hold peripheral eurozone countries’sovereign bonds. Shock waves from the deleveraging would, in turn, spread to emerging markets like China.

Although the exposure of Chinese banks and financial institutions toeurozone sovereign and banking-sector assets is negligible, post-Grexit capitalflight from risky markets could rival, or even surpass, that in the weeksfollowing Lehman Brothers’ collapse in September 2008. Compared to 2007 and2008, foreign investors’ holdings in emerging markets are much higher, owing tothese countries’ relative economic strength in recent years and rock-bottom returns on developed-market financialassets.

In fact, China already experienced the impact of deleveraginglate last year, when the European financial system seemedon the brink of collapse. With European banks hunkeringdown, the renminbi’s exchange rate fell for 11 consecutivedays, even though China was running a current-account surplus.

The performance of emerging-market currencies and other assets so far inthe second quarter suggests that deleveraging has begun once again. Disappointing first-quarter growth data have already ledforeign investors to have second thoughts about keeping money in China.A Grexit could prove to be the last straw,and would surely lead to a tightening in domestic monetary conditions at a veryprecarious point in the economic cycle.

As such, the timing couldnot be worse to float the idea of speedingup capital-account liberalization. On the contrary, the Peoples Bank of China(PBoC) and other relevant authorities should consider capital controls, marketsuspensions, and emergency liquidity provision.

These measures are not dissimilar tothose that the eurozone will pursue if Greece exits. Ideally, the responsewould be coordinated with China’s international partners in the G-20. Theinfrastructure for such cooperation has developed strongly since 2008, andChina must not shy away from advocating itsdeployment.

Moreover, China must have a medium-term plan to deal with the economic aftermath of a Grexit. Should contagion prove tobe limited, with Greece the only casualty, the drop in eurozone output may besevere, but not catastrophic. Nonetheless,the EU is China’s most important trading partner, and China must be braced for serious job losses in the export sector.

Japan’s experience shows that a recession that results from a financialcrisis can be extremely prolonged, because deleveragingis a long process. It is highly likely that today’s recession will drag on for many more years in both America andthe EU. So China’s government must have a medium- and long-term plan to addressproblems caused by a drawn-out global slump.

The problems include a surge inunemployment, and the need to reallocate fiscal resources to these individuals,whose welfare is critical to the preservationof social stability. More importantly, the Chinese government should notretreat from efforts to implement structural reforms aimed at shifting China’sgrowth model to one that places much greater emphasis on domestic demand.

In addition, net foreign capital inflows are likely to dwindle for several quarters at least, affectingdomestic monetary conditions while aggregate demand is weak. As such, the PBoC will need to maintain counter-cyclical policies in order to avoid a deflationary spiral.

Although bound to be controversial, especially in an election year in theUnited States, enough flexibility should be given to the renminbi in bothdirections when it is needed. One of the biggest failures of the eurozoneperiphery is a loss in competitiveness, hidden by a wall of credit that hasbeen leveraged from Germany’s balance sheet. This is always unsustainable. Anyloosening by the PBoC should not be used to avoid painful structural reforms.

Finally, China should be ready to extend a helping hand. To ensure thatthe post-Grexit eurozone’s integrity faces no further immediate threats, Chinamust join international partners in establishing a fully credible firewall, viathe IMF. However, the eurozone, and Germany in particular, must fullyacknowledge the fundamental causes of Greece’s exit and pledge to move towardsfiscal union, while acknowledging that an austerity-only approach towards otherat-risk members is a dead end.

An adequate firewall and a European commitment to structural reform would go far toward calming markets and reducing therisks to any Chinese contribution. In other words, any assistance that Chinaprovides must be “throwing good money after good potential results.”

Of course, IMF governance reform will also need to be part of thediscussion. Meanwhile, the eurozone will likely be more open to foreigninvestment out of necessity, and cash-rich Chinese companies should continue topursue opportunities via FDI or corporate acquisitions.

A potential Grexit will present entirely new challenges to China in thecoming months, and the country must avoid complacencyover its own exposure. A battle plan for both the present and the future isneeded now.