Are Asia’s economic woes just beginning?

In Perspective - Baljeet Grewal


The risks of a deeper downturn are intensifying

WHEN written in Chinese, the word “crisis” is represented by two key characters: one represents danger and the other represents opportunity. Whilst Asia will remain best placed globally to take advantage of any potential upswing in fundamentals, the near term outlook remains desolate. The financial crisis has now unraveled into an economic crisis which it caused; and Asia gives the best evidence.

Asian banks did not, as a rule, purchase or invest in substantial toxic debt or subprime products. Leverage was readily available. And yet, the region will not remain unscathed from the ongoing crisis.

The global economy, now supported at its core by the overextended US consumer, finds itself stalling, susceptible to any number of potential external shocks. Ultimately, the economic malaise created by this convergence of events will take years to unwind.

Also, geopolitical events become volatile in a world of economic insecurity, leading to political upheaval and protectionism. A positive outcome to this process is dependent wholly on liquidation of excess credit and consumption.

In Asia, the prospect of sluggish growth and depleting consumer confidence now debunks any notion of “decoupling” from the United States. In fact, more and more, 2009 is seeing a ‘recoupling’ of Asian dynamics with the global economy, underlying similar economic traits of the West. Whilst governments in the region advocate that Asia is well-placed to withstand financial instability, the risks of a deeper downturn are intensifying.

In its economic evolutionary process, the boom bust cycles in Asia have been unprecedented in terms of volatility in the prices of commodities, currencies, real estate and stocks.

Although all global crises have been different, in terms of its impact on Asia, many have shared common features. They begin with capital inflows from foreigners swayed by tales of economic enchantment. This generates low real interest rates and a widening current account deficit.

As a result, domestic borrowing and spending surge, particularly investment in property. Asset prices soar, borrowing increases and the capital inflow grows. Finally, a correction occurs, capital floods out and the banking system is burdened with debt.

With variations, this story has been repeated time and again. It has been particularly common in emerging economies. But it is also familiar to those who have followed the US economy in the last eight years.

The case for a much more resilient Asia this time round has been conditional on strong domestic demand, and room for policy maneuvering to expand consumption and spending. But Asian countries are mostly net producers, while the US is a net consumer. A reduction in global demand means a reduction in global supply.

The credit crisis and the ensuing tidal wave of economic recession have triggered reduced global demand. With this, Asia could potentially bear the brunt of the problem through reduced global supply.

The US, as a consequence of the crisis, is currently undergoing a period of seismic economic adjustment in which consumption and investment relative to GDP are crash landing, and as a result, savings will increase (over time). This, in the long run will imply a reduction in the US current account deficit and, hence, a reduction in Asian current accounts and trade surpluses (read: reduction in exports).

Given that China is the US’s second-largest importer and the country with which the US has the largest bilateral trade deficit with, China – the bastion of Asia’s economic hope – is likely to bear a large part of the adjustment.

Other export driven economies like Taiwan, South Korea and Malaysia will see varying degrees of this adjustment impact trade and growth. The danger is that with the combination of external shocks, a fall in asset and commodity prices and demand shrinking, the Asian consumer is not able on its own to spend its way out of the crisis.

Faced with the daunting prospect of dismal growth, Asian economies have no other choice: with demand shrinking in Western markets, either domestic demand must compensate, or supply must shrink. Reflating domestic demand will mean entire export industries will have to turn inward and serve domestic sectors – a process which will take decades given that Asian industries are “intermediate” in nature. Above all, domestic demand cannot replace export demand given the relatively low per capital income in most of emerging Asia.

The key to a recovery lies with government intervention. Asia needs to spend its way out of a crisis. While no singular government spending will fill the gap to reflate an economy, a concerted effort by Asian governments to get fiscal, and collectively, may work. Policy measures have thus far been domestically driven and reactionary.

A more coordinated effort within the region in disseminating fiscal spending and its target sector will serve to boost confidence especially through fiscal measures that offer the prospect of resuscitating growth and disposable incomes. Close scrutiny will show that most crisis situations are either opportunities to advance, or stay stagnant. As such, the prospect for a collective Asian voice is now more pressing than ever.

The global economy is more than the sum of its parts – and so policy direction becomes crucial. It’s near impossible to predict whether policymakers will succeed in preventing the recession turning into a prolonged economic calamity, and lay the foundations for a sustainable recovery.

But what we can predict with near certainty is that policy will matter a great deal in 2009.