What lies ahead?
Is Asia feeling the pinch? Photo: Getty
WHAT a difference a year makes. Last May, Asia seemed to be in an enviable position, with its economies continuing to boom, even as the United States was becoming mired in recession. At that time, many analysts argued that this situation would continue, since Asia would "decouple" from the West. Things turned out quite differently. Instead of decoupling, some of Asia's key economies, including Japan, are experiencing recessions more severe than those at the epicenter of the crisis. How did this happen? And what does this experience imply for Asia's future?
At the time, the arguments for decoupling seemed plausible to many. After all, Asia was far from the center of the crisis, not just geographically but also in the sense that it had not engaged in the financial practices that led to such problems elsewhere. Its corporate and financial institutions were in robust financial health, and it had accumulated fiscal surpluses and high buffers of international reserves. So, if any region of the world seemed in a position to decouple from the United States, Asia was that region.
Or was it? In reality, as the IMF pointed out a year ago in its Asia-Pacific Regional Economic Outlook (REO), decoupling from the rest of the world was always an unlikely scenario. That's because Asia has long depended on exports as its engine of growth. As the new May 2009 REO shows, whenever exports have slumped, Asia has typically gone into recession. And Asia has not recovered until exports have started to revive. (See www.imf.org)
What was truly surprising, then, was not that Asia followed the West into a downturn. It was the degree to which Asia had suffered. The region suffered from an "accelerator" effect because its exports are concentrated on technologically sophisticated goods, such as IT products, for which worldwide demand has collapsed. As a result, GDP in emerging Asia, excluding China and India, fell at an astonishing 15% annual rate (seasonally adjusted) in the fourth quarter of 2008, and a further decline most likely took place in the first quarter as well.
What's next? In a new variant of the decoupling argument, some analysts are claiming that Asia has already turned a corner, and is poised for recovery. They make two main arguments. First, they claim that China will be able to act as a locomotive for the region, as its economy has begun to rebound. But this argument ignores the fact that the fiscal stimulus propelling China's growth has shifted the pattern of production towards infrastructure, which has relatively little import content. So, the benefits to the region are likely to remain small.
The second argument is that Asia's domestic demand is likely to revive because of the large stimulus that governments are providing. Governments are indeed making exceptional efforts, which in some cases may succeed in returning growth to positive territory this year. But by themselves they will not be able to regenerate sustained growth. As long as exports remain depressed, private investment will remain low. Meanwhile, consumption will be hampered by growing unemployment as firms retrench in order to restore profitability.
So a sustained recovery will once again need to await an improvement in the global economy. This will take some time. It will take more than a year for financial conditions in the U.S. and Europe to return to normal, and even then consumption will remain depressed since American households need to save more, rather than spend.
Consequently, the IMF does not expect these economies to recover until the middle of 2010. Accordingly, growth in Asia (from India in the west to Japan in the east, and including Australia and New Zealand) is forecast to decelerate to just 1.3% this year, before rebounding to 4.2% in 2010, still well below the region's potential and the 5.1% rate recorded in 2008.
What can Asian policymakers do to support economies in these difficult circumstances? They can continue to apply forceful counter-cyclical policies. In many cases, there is scope for reducing interest rates further, and for adopting unconventional policies -- such as flooding banking sectors with liquidity or intervening to support credit flows -- as done in advanced countries.
In addition, the fiscal stimulus provided in 2009 will need to be sustained into next year, while being placed in a medium-term framework that ensures a gradual return to fiscal rigour. Finally, authorities will need to maintain foreign exchange liquidity, drawing where necessary on bilateral swap lines or the IMF's new Flexible Credit Line, which provides qualifying countries with large upfront assistance with no policy conditions.
Policy makers also face a more structural issue; the need to reduce Asia's dependence on an export-driven model of growth. The past year has provided ample demonstration of the dangers of relying solely on one growth engine. Moreover, the export model may not pay the same dividends as in the past, for the era of "easy credit" in the West to finance purchases of consumer durables could well be over.
Asia thus needs to rebalance growth toward domestic demand, for example by reforming tax and financial systems, and building stronger social protection systems that will reduce the need for precautionary savings to meet health, education, and retirement expenses.
In short, Asia has not decoupled -- and should not decouple -- from the rest of the world. But neither can it continue to rely exclusively on exports for growth; it needs to develop its own autonomous sources of demand. A return to sustained rapid growth may depend on it.
Kalpana Kochhar is Deputy Director, Asia and Pacific Department, International Monetary Fund (IMF).
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