Challenges for Asia in post-crisis 'new world'

Exports boost our economy. Photo: Adnan/ driknewsAnoop Singh

ASIA is rebounding fast from the global financial crisis. Initially, the impact on the region was extremely severe, with output in most countries contracting by more than even those nations at the epicenter of the crisis. But now Asia is surging ahead as the world pulls out of recession. What explains this remarkable comeback? And what challenges does the recovery pose to Asian policymakers?

Asia's impressive recovery from the global downturn has prompted some observers to revive the notion that the region has "decoupled" from the rest of the world. The International Monetary Fund's latest Regional Economic Outlook for Asia and the Pacific examines this hypothesis and finds that the opposite is true.

Just as the US downturn triggered an outsized fall in Asia's gross domestic product due to the dropoff in international trade and the financial collapse, now the return to their normal condition is generating an outsized Asian upturn. For this reason, the collapse and subsequent rebound in economic activity has been fastest among export-dependent Asian economies that were hit most severely at the end of last year.

The other key driver of Asia's recovery has been the region's rapid, forceful and comprehensive policy response. In many countries, government fiscal positions were sounder, monetary policies were more credible, and corporate and bank balance sheets were sturdier than at any time in the past. These conditions gave Asia the space to cut interest rates sharply and adopt large fiscal stimulus packages.

What lies ahead for the region? As detailed in the Regional Economic Outlook for Asia and the Pacific, global conditions are expected to continue to improve in 2010. But the recovery is expected to be tepid.

According to the IMF's latest forecasts, output in the large G-7 economies is forecast to grow by just 1.25% next year, insufficient to compensate even for half of the 3.5% contraction estimated for 2009.

In essence, households cannot spend and banks cannot provide credit since they must focus on repairing their balance sheets after the sizeable destruction of wealth that occurred during the recession. G-7 consumption is consequently likely to remain weak for some time, limiting external demand for Asia's products.

As a result, the region's GDP growth is forecast at 5.75% in 2010, well below the 6.66% annual average recorded over the past decade.

Overall in Asia, policymakers consequently face two major challenges. In the near term, they will need to manage a balancing act, providing support to economies until it is clear that the recovery is sufficiently robust and self-sustaining. At the same time, they must ensure that programs are not maintained for so long that they ignite inflationary pressures or concerns about fiscal sustainability. Striking the right balance will be difficult.

Bangladesh faces a somewhat different challenge. Despite the slowdown in its major export markets, growth has held up remarkably well during the crisis due to continued strong remittance growth and good export performance. However, consequent robust inflows of foreign exchange have resulted in excess liquidity in the financial system.

Thus far, excess liquidity has not led to acceleration in inflation as private investment has been sluggish. But when investor sentiment improves, inflationary pressure may quickly rise. The challenge for policy makers is to encourage private investment -- indispensable for Bangladesh to achieve higher growth -- while keeping inflation contained.

The issue will become pressing from the middle of 2010 when we expect a return to higher garment export growth, and rising public and private investment as global uncertainty wanes. We commend the efforts being made by the Bangladesh Bank to absorb excess liquidity, and we support an enhancement of these efforts.

The other major policy challenge facing Asia in general will be to devise a way to return to sustained, rapid growth in a new global environment of softer G-7 demand. In this "new world," Asia's longer term growth prospects may be determined by its ability to recalibrate the drivers of growth to allow domestic sources to play a more dynamic role.

This type of successful rebalancing will require reforms on a broad front, a willingness to live with smaller current account surpluses and a more flexible exchange rate management.

Bangladesh is very fortunate in this regard: it has dual engines for growth already. While exports expanded rapidly in the years preceding the crisis, the lion's share of Bangladesh's growth has come from domestic demand.

To sustain this twin-engined growth in the period ahead, the key issue for Bangladesh is to further improve efficiency in financial intermediation. In addition, an increase in public investment in infrastructure will be key to enhance the country's growth potential.

The IMF has been helping countries to meet the challenge of boosting growth. For example, the IMF has responded to the needs of its low-income members by reforming its lending instruments to provide more flexible and less costly financing that is sensitive to individual country circumstances.

The IMF has also recently provided Asian central banks with $54 billion in resources, $700 million for Bangladesh, through our recent allocation of Special Drawing Rights, an artificial currency that serves as a supplement to official foreign reserves of the member countries.

Equally important, we are working hard on a global level to try to prevent such a crisis from happening again. For example, we are helping launch a mutual assessment exercise for the G-20 forum, so that the world's largest advanced and emerging countries can analyse the consistency of their policy frameworks with the requirements of balanced and sustained global growth.

The current crisis has demonstrated the resilience of Asia's economy, but it has also posed challenges. Now is the time to implement policies that can make domestic demand a second engine of growth, thereby paving the way for a strong and durable expansion.

Anoop Singh is Director of the Asia and Pacific Department at the International Monetary Fund.