ASIA ECONOMY: A dream deferred?

02/05/2010 | Anthony Rowley

Asia emerged from the global economic crisis faster and more robustly than many expected. But the challenge for policy-makers remains how to rebalance the region’s growth model

Asia shrugged off the worst of the financial crisis and recession that plunged most of the world’s economies into turbulence during 2009. For much of the region the rebound that took hold last year looks set to continue, but the road ahead is hardly trouble free.

“In the space of a year, east Asia (excluding Japan) shifted from a collapse in exports and investment to leading the global rebound and returning to pre-crisis levels of real GDP growth,” according to the World Bank in its most recent East Asia and Pacific Economic Update released in mid-April.

Asia’s growth over the past year has been impressive, but it has been driven mainly by just three economies – China, India and Indonesia – and been based largely on fiscal and monetary stimuli.

The challenge now for the region is to rebalance from stimulus-induced to spontaneous demand, and between external and domestic demand. This could take many years to achieve, ADB president Haruhiko Kuroda tells Emerging Markets. Asia also faces the challenge of coordinating its scattered and diverse economies so as to produce more integrated and larger regional markets, he says.

What is remarkable is not just that “developing Asia” continued growing through 2009 but that it did so against a background of global economic contraction. This is the opposite of what happened after the Asian financial crisis in 1997/98 when Asian GDP contracted sharply even as the global economy expanded.

“Asia’s growth in the coming years may not reach the bull run average, but growth outperformance relative to the West will be higher than it was before the crisis,” notes UBS Asia chief economist Jonathan Anderson.

What the World Bank terms “emerging east Asia” (excluding Japan and south Asia) grew at a robust 7% in 2009 – well short of the 11% rate in the pre-crisis year of 2007 and down from 8.5% in 2008. But Asia’s growth was achieved against the backdrop of a 2.2% contraction in the global economy.

Growth last year was not exactly “balanced” throughout the region, says Vikram Nehru, chief economist for east Asia and the Pacific at the World Bank. Take China out of the picture, he says, and emerging east Asia’s overall growth rate in 2009 falls to 1.3%, showing how huge a weighting China has assumed in east Asia’s economy (again excluding Japan).

This year, emerging east Asia should grow at 8.7%, based on more balanced growth across countries of the region and also on a broader spread of domestic, regional and global demand than in 2009, when demand was generated chiefly by China, the World Bank said.

“Asia was hit by the trade channel and less through the financial channel,” says Hung Tran, head of the capital markets department at the Institute of International Finance (IIF). “There are signs that consumer demand is picking up, and China’s trade deficit in March is evidence of this. Asia’s shift in growth drivers in favour of consumption will lead the world’s global rebalancing efforts.”

Asia’s growth is partly a matter of definition. The ADB measures it across a different and wider group of Asian economies than does the World Bank. What the ADB terms “developing Asia” (meaning the 44 developing member countries of the bank – including those in south Asia) grew at a slower pace than what the World Bank calls “emerging Asia” in 2009.

“At 5.2% in 2009, developing Asia’s growth was its lowest in eight years,” says ADB chief economist Jong-Wha Lee. “Economies decelerated across the region, with the impact particularly severe in the more open economies. Stronger growth in some economies highlighted the importance of resilient domestic demand.

“Three large countries in particular supported developing Asia’s performance – China, India and Indonesia – standing out for their investment resilience, which contributed significantly to their GDP growth throughout 2009. Large fiscal stimulus packages and generally upbeat business sentiment supported corporate sectors, while consumption was also notably steady in all three throughout the year.”

The Philippines also enjoyed strong private consumption last year although investment contracted. “These four economies managed not only to avoid large fluctuations in GDP growth but also posted no single quarter of contraction,” says Lee. “Improved business sentiment and investment in the second half of the year, particularly in Hong Kong, China, Korea, Taiwan and Malaysia, also helped the region.

DOMESTIC DEMAND

Prospects for developing Asia over the next two years have improved as a result of better-than-expected growth in the second half of 2009. Lee says: “GDP is projected to grow by 7.5% in 2010, and edge back to 7.3% in 2011 as the effects of the emergency policy measures begin to fade.

“The lagged effects of the fiscal stimulus and the better external environment will drive economic growth this year. Investment is expected to remain strong as the 2009 stimulus measures continue to have a positive impact. At the same time, a moderate global recovery supports a modest revival in global trade this year.”

Recovery outside Asia, says Lee, “is expected to be weak, leaving this region’s strong domestic demand as the key factor driving growth. Private consumption is projected to improve as income prospects pick up and unemployment continues to decline. But it remains to be seen whether domestic demand will be robust enough to compensate for waning public support.”

This is a critical issue for Asia’s continued growth.

Both the World Bank and the ADB are urging Asian governments not to withdraw fiscal stimuli until they are sure that self-sustaining private demand is strong enough to maintain GDP growth. (However, they warn that monetary loosening and strong external flows of capital into Asia are threatening to create asset bubbles in the region.)

“There are substantial downside risks to the recovery that could still see Asian regional and global growth falter in the near term,” ADB president Kuroda warns in a foreword to the bank’s latest Asian Development Outlook, published in mid-April. “A mistimed withdrawal of macroeconomic stimulus measures could derail the fragile recovery. A reversal of last year’s commodity price deflation and a sharp rise in international commodity prices could also thwart the global and regional revival.”

The Asian Development Bank Institute’s Masahiro Kawai warns that Asia has not “decoupled” from dependence upon exports to advanced nations, but the region’s “trend growth rate is stronger [than that elsewhere] and in that sense Asia has decoupled.”

SUPPLY-SIDE CHALLENGE

Yet coping with what analysts say is likely to be a prolonged drop in Asia’s exports to North America and Europe in the wake of the global financial crisis is not just a matter of finding new consumer demand within the region: supply-side changes are needed to switch Asia’s export-oriented production networks into meeting domestic and regional demand, says Kuroda.

“The supply response is the most challenging problem facing Asia as it seeks to come to terms with new post-crisis realities,” he says.

This is a message that resonates with business leaders from across Asia, as evidenced at a meeting in Tokyo this year for the first of a series of meetings designed to put pressure on Asian governments to come up with a road map for regional economic integration.

Teng Theng Dar, president of the Singapore Business Federation, complained at that meeting that business supply chains set up by companies in Asia can no longer operate at full efficiency, in the absence of a clear plan for integrating the region’s economies and creating an internal market to replace Asia’s dependence on external markets.

Leaders of a dozen business federations from China, India, Indonesia and other key economies (led by Japan’s Keidanren) called on governments to implement an ambitious plan for creating a region-wide integrated economic strategy. They demanded a comprehensive Asia development plan to include regional economic integration measures, opening up Asian markets, provision of regional infrastructure and measures to spur domestic consumption.

“For a long time, the West has led the global economy, but now the wind is blowing from the East,” said Fujio Mitarai, chairman of Nippon Keidanren. “Asia should be the leader in the 21st century.” Mitarai said businessmen from across the region were waiting for governments to take a lead in providing the environment in which Asia can assume this role.

Kuroda and others point to the lack of anything approaching a European-style single market in Asia, capable of absorbing the region’s production, and to the general lack of an infrastructure for economic integration – whether in physical connectivity, provision of common rules and standards or a network of institutions for aiding regional cooperation.

MANAGING THE UPTURN

ADB chief economist Lee points to shorter-term challenges facing Asian policy-makers. Most pressing, he says, is the fact that the region’s stronger recovery and higher interest rates relative to those in the major industrial countries are attracting potentially volatile capital flows, complicating macroeconomic management.

Large inflows of portfolio capital could have serious implications for exchange rates and money supply, says Lee. He adds that more flexible currencies and some capital controls could help limit the impact of such flows.

“In the medium to long run, there is plenty of scope for improving and strengthening Asia’s macroeconomic management, its monetary, exchange rate and fiscal policy frameworks. While price stability must remain the overriding objective of monetary policy, the global crisis highlights the need to prevent asset price bubbles, suggesting a need to improve coordination between financial regulation and monetary policy.”

The IIF’s Hung Tran agrees that asset price bubbles pose a major near-term challenge for Asia policy-makers. “Asia is now in the mature phase of the cycle, and now there are signs of overheating in the economy and potential bubbles in financial markets. There is a need to tighten stimulus policies now,” he says.

Lee says that “more flexible exchange rate systems are in the region’s own interest, and carefully designed capital controls that mitigate disruptive capital inflows may be desirable during the transition to greater flexibility, at least in the short run.

“In fiscal policy, while it is of paramount importance to safeguard sustainability with strong medium-term fiscal policy frameworks, a wide range of measures can contribute to more balanced growth by removing structural impediments to domestic demand.”

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