South Asia and the financial contagion

Arif Zaman

Asia will not be immune from the economic weakness spreading through the world’s leading economies and can be expected to grow but it will be with less momentum than in the recent past because of rising inflation in the face of commodity price pressures.

There is not likely to be any let-up in the near term and it is unlikely that we have the full impact of deteriorating credit card and other consumer debt in the US and Europe and there will clearly be more financial institutions that fail in the US and elsewhere.

The nature of the credit crisis has gradually evolved over the past year from a pure liquidity logjam into a broader de-leveraging trend as solvency doubts rose and then, finally, into a broad real economy crisis, not just in the US but across the global economy.

Growth in emerging markets has weakened, partially in response to the weakness in the G3, but also partly because of the tightening of monetary conditions in response to inflationary pressures. Emerging markets face a cyclical slowdown but from very high levels of growth.

The longer-term outlook is still very positive, though. The secular shift of economic power from West to East will continue and the eventual end of the credit crisis will almost certainly leave Asia and much of the rest of the emerging markets in a much stronger relative position.

Financial flows

The subprime mortgage crisis in the US is not likely to seriously impact South Asian countries because of the structure of the region’s trade and financial flows and partly because of compensating effects.

Given the impact in the US and Europe, this can be seen as an opportunity for South Asia. The World Bank cites three factors that work well for the region; lack of exposure to US mortgage securities, availability of liquidity in domestic markets and the possibility that lower capital inflows could help countries such as India with macroeconomic management.

The share of South Asia’s trade with the US has been declining and China, not the US, is now India’s leading supplier. Sri Lanka, which used to rely on the US for its garment exports, has now increased them to Europe and other regions substantially.

On the other hand, a slowdown of economic growth in the US will moderate the increase in prices of oil and other commodities, which will have a favourable impact on South Asia. Since all South Asian countries are net importers of these commodities, such a slowdown will provide some relief in their balance of payments.

Inflation remains the predominant issue for emerging markets, mostly because of commodity prices. Inflation has hit many of these markets hard as their exposure to commodities, given their investment-intensive growth, is high and oil/energy-use efficiency is often low.

South Asian countries are facing more serious problems associated with global external shocks such as increasing oil and food prices, as well as country-specific ‘shocks’ such as escalating conflicts or political turmoil.

While the countries in the region may be only slightly affected by the subprime crisis, these critical issues need to be addressed if South Asia is to protect the gains in growth and poverty reduction of the last decade.

Financial meltdown

For South Asia the fallout from the financial meltdown should not obscure other issues on which action is urgently needed. Indeed contemporary challenges including food, fuel and financial turbulence underline the importance of more, not less regional cooperation and the building of cross-border resilience.

South Asia is growing, generally at high rates and steadily, which has helped reduce the percentage of people living on less than US$ 1 per day from 41 per cent to 32 per cent. Thus the region is on track to halve income poverty by 2015, although that still means about 273 million people living on less than US$ 1 per day in 2015.

There are also a number of threats to this positive outlook. Growth has often not benefited the poorest. Social exclusion, buttressed by gender, caste, class, ethnicity and religious divides, has been a very persistent problem in South Asia.

Insecurity

Insecurity has increased throughout the region. As Pakistan’s Foreign Minister reminded a London audience the week before the 2008 SAARC summit, there are common concerns for South Asians which include “poverty, food and energy security, rampant inflation, rise in oil prices, environmental degradation, illiteracy, unemployment, terrorism and extremism, regional rivalries and conflicts and nuclear non-proliferation” and “across South Asia poverty and social fragmentation impact on overall security.” Climate change is also increasingly affecting the region, and impacting a huge number of people.

The World Bank and the IMF in their latest review of progress towards the Millennium Development Goals in May 2008 highlighted that “shortfalls in human development areas are especially serious in South Asia.” Moreover, “population growth will cause per capita water resources to fall below critical levels in the very near future in South Asia.”

According to a WHO report (2008), South Asia is not on track to meet the MDG sanitation goals. South Asia has the highest rate of open defecation in the world at 48 per cent and 63 per cent (750 million people) of all open defecation takes place in South Asia. It also has the lowest rural coverage in the world at 23 per cent and the largest urban-rural disparity in the world (57 to 23 per cent).

There are more than a billion people without access to improved sanitation which represents an increase of 200 million people from 2004. Against this the prognosis is that while “South Asia lags on most human development MDGs, it will likely meet the poverty reduction MDG (and) ...South Asia would contribute the most to global poverty reduction in the next decade.”

It is important to recognise that achieving the first MDG (to eradicate extreme poverty and hunger) would still leave millions of people in South Asia in absolute poverty and deprivation (estimates vary between 126 and 176 million people) many of whom will be chronically poor.

Progress

While inroads into chronic poverty have started and/or are well advanced elsewhere such as in East Asia, South East Asia and the Middle East, this has not yet been matched by progress in South Asia, where Bangladesh, India, Nepal, Pakistan and Sri Lanka are all defined as ‘partially chronically deprived.’

Growth is a crucial part of poverty reduction and the improvement of people’s lives. As the Commission on Growth and Development concluded (2008), it is impossible for poor countries to lift large populations out of poverty without growth.

Potential

International trade, and SAFTA, has immense potential to transform economies and lift people out of poverty. As the Commonwealth Secretary-General Kamalesh Sharma said on the occasion of the July 2008 setback in the Doha round talks, ‘trade is the acknowledged route out of poverty.’ However, benefits from trade can exclude chronically poor people, such as those who live in regions where possibilities for export-crop farming are limited (as many do).

South Asia’s rice-wheat systems, the bedrocks of food security, are already under threat with long-term experiments showing that crop yields are stagnating and that soil and water quality are in decline. South Asia’s poor are now at risk from the escalation in world food prices. World food prices have been increasing rapidly since 2006, and the rate of increase during 2007 has been much higher than average.

Most countries in South Asia are net importers of food and have suffered severe terms of trade shocks of 1 per cent of GDP. The foreign exchange earnings and international purchasing power for these countries have also decreased.

The World Bank has pointed to the likelihood of food prices continuing to increase in the near future due to raising standards of living in countries like China and India; increased use of food crops for bio-fuels and animal feeds; and increased oil and fertiliser prices.

In South Asia, which has the largest concentration of poor people in the world, the increase in food prices is particularly damaging since food accounts for a substantial share of poor people’s income. South Asian countries, however, have very few options available to deal with the challenge.

The issue of food shortages is exacerbated in South Asia where Afghanistan has already appealed for foreign help to combat a wheat shortage while Bangladesh recently warned that it faced a crisis over rice supplies.

The UN reported in June 2008 that Nepal, which imports much of its rice, has 2.5 million people in immediate need of assistance and 3.9 million more whose welfare may be compromised by rising prices. The paradox is that most of the economies of South Asia are agro-based economies, which have been suffering because of a shift away from agriculture.

Bangladesh, which imports a substantial portion of major grains consumed by its people, has been particularly badly affected by the continued increase in world food prices. Natural disasters in the past year, two major floods in July and August 2007 and a cyclone in November 2007, destroyed about 2 million metric tons of rice crops.

Bangladesh is currently importing rice from its immediate neighbours, India and Myanmar, to meet the shortage. This has already created a problem because, several times in past few months, India has imposed a ban on rice exports or has increased the minimum export price, and each time the price of rice in Dhaka spiked.

Subsidy

In Pakistan most families consume the same kind of wheat, making it difficult to target poor people and any subsidy on wheat will thus be an untargeted subsidy.

The Indian Government buys wheat from farmers at a Minimum Support Price which is highly distortionary and contributes to high costs for its budget.

Sri Lanka is also a net importer of food products, and food price inflation is estimated at 34 per cent however it is already facing high inflation with an average of 20 per cent independent of food prices.

Nepal also depends on food imports from India and other countries to manage its needs and has a limited social assistance programme to protect the urban poor.

The writer is Adviser of Commonwealth Business Council and SAARC Chamber