Asian recovery from economic crisis

Tissa Jayaweera Chairman - International Chamber of Commerce

Trade deficit of United States is expected to soar to a record $1.6 Trillion this year, more than three times higher than 2008 deficit of $455 Billion. From 2010 to 2019, deficit of US is expected to balloon to $7.14 Trillion as said by Congressional Budget Office, while the White House paints an even worse $9 Trillion for the same period. The national debt of US is $11.7 Trillion. While the danger of the economy immediately falling into a deep recession has receded, the American economy is still in the midst of a serious economic downturn.

Since the beginning of this decade, Asia has accounted for more than 1/3 of the world economic growth, raising its share of global gross GDP from 28 percent to 32 percent. The magnitude of the shocks that have struck advanced economies over the past two years, as well as their strong economic and financial links to Asia, it should not have been surprising that Asia was ultimately hit quite hard by the global downturn, even though the origins of the turmoil were elsewhere. Towards end of 2007, at about the same time that the United States entered a recession, the headwinds facing the Asian economies appeared to strengthen. By the second quarter of 2008, many of the region’s economies were slowing and growth in Hong Kong, Singapore, Taiwan slowing. Open economies particularly sensitive to shifts in global conditions ground to a halt.

In September and October 2008, the global financial crisis intensified dramatically and resulted in sharp declines in demand and production worldwide. Asian GDP growth slowed further in the second half of 2008. For the region as a whole, the economic contraction in the fourth quarter of 2008 was pronounced, with activity falling at an annual rate of nearly 7 percent.

The fourth-quarter declines were especially dramatic in Taiwan and Thailand more than 20 percent, South Korea and Singapore more than 15 percent at an annual rate. Among the major Asian economies, only China, India, and Indonesia did not contract during the crisis. Recent data from the region suggest that a strong rebound is in fact under way.

Although the regional economy continued to contract in the first months of 2009, it expanded at an impressive 9 percent annual rate in the second quarter, with annualized growth rates well into double digits in China, Hong Kong, Korea, Malaysia, Singapore, Taiwan. At this point, while risks to the economic outlook certainly remain, Asia appears to be leading the global recovery.

This brief review of Asia’s experience during the crisis raises a number of important questions: Through what channels were the effects of the financial crisis transmitted across the globe?

Virtually for all Asian economies, international trade appears to have been a critical channel. After a period of strong growth, international trade plunged about 20 percent in real terms from its pre crisis peak in early 2009 and about 35 percent in US dollar terms. Export dependent economies of Asia could certainly not be immune to the effects of such a decline. Why was Asia, whose financial systems largely escaped the serious credit problems that erupted in the United States and Europe, hit so hard by the global recession?

With trade falling sharply around the world, economies particularly dependent on exports were hit hard. Hong Kong, Singapore, Korea, Taiwan, Thailand, Malaysia, Japan suffered significant growth deficits and experienced declines in real GDP growth of about 13-20 percentage points at an annual rate during the last quarter of 2008 and the first quarter of 2009. Growth fell less severely in the Philippines. Real GDP growth remained positive throughout the crisis in China, India, and Indonesia but even those fast-growing economies experienced noticeable declines in growth relative to their earlier trends. Current account surplus of China fell from about 10 percent of GDP in the first half of 2008 to about 6 percent of GDP in the first half of 2009.

As international investors’ appetite for risk evaporated, the flow of capital shifted away from countries, including some emerging Asian and Latin American economies. Following the reversal in capital flows engendered by the crisis, strains in banking appeared across Asia, leading to severe credit tightening in some countries. Fears of counter-party risk disrupted inter bank lending in many countries, intensifying already existing funding difficulties.

Drying up of the wholesale funding market hurt banking system of Korea in particular; prior to the crisis. In Japan, some banks’ exposures to equity markets damaged their capital positions. Reversal in capital flows also caused rapid exchange rate depreciation in some countries, particularly Korea, Indonesia, and Malaysia. The Korean Won depreciated 40 percent against the dollar from the beginning of 2008 up to about March 2009 and it has only partially recovered. Over the same period, the Indonesian Rupiah fell 22 percent against the dollar. Trade and financial channels influenced other emerging markets as well, such as those in Latin America and Eastern Europe.

What enabled the Asian economies to bounce back so sharply more recently?

By and large, countries in Asia came into the crisis with fairly strong macroeconomic fundamentals, including low inflation and favourable fiscal and current account positions. Good fundamentals, in turn, provided scope for strong policy responses in many countries.

The Asian recovery to date has been in the result of growth in domestic demand, supported by fiscal and monetary policies, rather than of growth in demand from trading partners outside the region. Stimulus packages in China and elsewhere have lifted domestic demand throughout the region, boosting intra-regional trade. Industrial production in China, India, and Indonesia has already reached new highs.

Asian countries need to rely less on export-led growth and encourage their consumers to spend more, while the United States needs to trim its deficit to avoid pre-recession trade imbalances. Governments in trade surplus countries, most of which are Asian nations must act to cut the disparity between saving and investment so they can raise demand in their own economies.

There’s a stark contrast between savings among consumers in the United States and Asian countries. Consumer spending in China makes up only 35 percent of its gross domestic product GDP, half the amount of US. Chinese save an average of 35 percent of their income, while the US personal savings rate is single digit.

Asian Industrial Production and Exports relative to Pre Crisis Peak

Growth in domestic demand, rather than growth in exports, was the predominant driver of increases in domestic production. Revival of demand in Asia has, in turn, aided global economic growth.

One crucial lesson from crisis is that financial institutions must be carefully regulated, transparent, and sufficiently well capitalized and liquid to withstand large shocks. Reforms put in place after the crisis of the 1990s, along with improved macroeconomic policies, Asian banking systems were better positioned to handle the more recent turmoil.

Why did some countries around the world and within Asia suffer much deeper contractions than others?

Too great a reliance on external demand pose problems. In particular, trade surpluses achieved through policies that artificially enhance incentives for domestic saving and the production of export goods distort the mix of domestic industries and the allocation of resources, resulting in an economy that is less able to meet the needs of its own citizens in the longer term.

The United States has benefited significantly from Asia’s rapid development and integration into the global economy.

The financial crisis has starkly demonstrated the extent to which the fortunes of the United States, Asia, and the rest of the global economy are intertwined. These powerful economic linkages underscore the need for consultation and cooperation in addressing common issues and concerns.

Asian countries are weathering the current storm. In part, their successful responses reflect the lessons learned during the Asian financial crisis of the 1990s, including the need for sound macroeconomic fundamentals. With the increased prominence of the Group of Twenty G-20 as a forum for discussing the global responses to the crisis, emerging market economies, including those in Asia, will play a larger role in the remaking of the international financial system and financial regulation.

Reasons China will lead the Global Economic Recovery

China’s fundamentals are sound. Chinese consumers are accelerating their purchases, exports are growing and Chinese GDP is on track to grow 7.9% by year-end. HSBC China economist Qu Hongbin, forecasts that the Chinese economy will grow 8% this year and expand to 9.5% in 2010. This impressive growth comes not only from China’s massive $586 Billion fiscal stimulus package but from strong growth in consumer demand.

While the US had to print Trillions of dollars to stimulate its economy, China with $2.3 Trillion dollars in reserves, has been able to maintain its economy without deficit spending. Even though its $586 Billion Chinese stimulus package passed in November 2008 represents 16% of the country GDP. China hasn’t had to go into debt or print money like US. This gives China an incredible opportunity to restore its economy without damaging its future economic prospects. When IMF announced issuing $50 Billion in bonds to better finance aid to countries struck by the global financial crisis, they turned to China to purchase them.

Two decades ago, IMF would have been calling the US to help fund the recovery. China is the only industrial economy in the world that has enough reserves to actually do anything. As IMF Managing Director Dominique Strauss-Kahn said, “The crisis is certainly an opportunity to reshuffle the IMF governance, to see the new balance of powers in the world.” Clearly, extensive reserves of China give the country the opportunity to exert its power over the entire new world economy. China is taking advantage of its economic strength to gain leverage in the IMF, it is also pushing for a move away from the US Dollar as the world reserve currency.

In an effort to diversify away from the US Dollar, China has been buying gold, oil and other Dollar denominated commodities necessary for its growth. Since December 2008, Central Bank of China has signed bilateral currency swap agreements with six different countries including Argentina, South Korea and Indonesia worth 95 Billion Dollars.

China will likely continue to extend these swap agreements with as many countries as it can, until one day the world wakes up and realizes China has created a global marketplace for its currency without playing by the rules. China is now, not some backward third world economy. It is currently the third largest economy in the world. China’s economy will surpass that of the United States by 2035 and be twice its size by mid-century, according to the Carnegie Endowment for International Peace.

GDP share move from the west to Asia is led by China. US, Canada, and Europe will only account for 49.4 percent of global economic output in ‘09, according to the Center for Economics and Business Research.

Not only that, Western economies will decline to just 45 percent of global economic activity by 2012, far ahead of the original estimates that predicted the West wouldn’t fall below 50 percent until 2015 As China’s share of global GDP rises, so does its share of the global markets. From the end of 2003 to the end of July 2009, the NYSE share of global market cap shrunk 29 percent, according to the World Federation of Stock Exchanges. Over the same time, the Shanghai Stock Exchange increased its share of global market cap by 636 percent. In addition, by 2020, just 11 years from now, China’s share of global consumption will be equal to that of the United States.

Fastest Action to be taken by Sri Lanka to recover

To achieve more balanced and durable economic growth and to reduce the risks of financial instability, we must avoid ever-increasing and unsustainable imbalances in trade and capital flows. The Asian recovery to date has been in significant part the result of growth in domestic demand, supported by fiscal and monetary policies, rather than of growth in demand from trading partners outside the region.

One crucial lesson from crisis is that financial institutions must be carefully regulated, transparent, and sufficiently well capitalized and liquid to withstand large shocks. Too great a reliance on external demand pose problems.

In particular, trade surpluses achieved through policies that artificially enhance incentives for domestic saving and the production of export goods distort the mix of domestic industries and the allocation of resources, resulting in an economy that is less able to meet the needs of its own citizens in the longer term.

Reduce consumer borrowing rates to encourage our own citizens to buy capital goods produced in Sri Lanka. Other than for mobile phones our per capita ownership of capital goods is way below countries in the region.

Encourage listing of at least 30 Private Companies in Colombo Stock Exchange in 2010 to encourage money circulation within the country.