Hint of Menace Lingers Over Asian Recovery

Monday, 29 Mar 2010 01:41 PM

 

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When the head of the Asian Development Bank says his better-off members should become aid donors, not recipients, it's a good indication that the region's rise is not just a flash in the pan.

Asia's banks were scarcely touched by the global credit crunch and its economies are now recovering briskly. The ADB is poised to upgrade its growth forecasts next month.

The 9.5 percent expansion in global trade volumes that the World Trade Organisation is projecting in 2010 after the deepest contraction since World War Two will be led by China and India.

Fitch and Standard and Poor's have both upgraded Indonesia's credit rating this year, while the latter has changed its outlook on India to stable from negative.

So the time is ripe, ADB President Haruhiko Kuroda argues, for Asia to play a bigger global role in everything from shaping financial supervision to managing international financial institutions and digging into its pocket to help those worse off.

"Particularly for low-income countries, concessionary sources are absolutely necessary. The global donor community must be expanded. That means more and more Asian countries contributing, donating, to development assistance," he said in an interview.

If this were a movie, with everything going swimmingly, the star at this point would be struck down by a life-threatening illness or a menacing stranger would move into the neighborhood.

So what could go wrong for Asia?

An economic double-dip in the West is an obvious short-term risk. So is an implosion in China, now the biggest trading partner for many Asian countries.

Perhaps the biggest risk, though, is that governments fail to make hay while the sun shines.

In a recent study for Nomura, consultant John Llewellyn judges that Asia's medium-term prospects are bright if -- and it's a big if -- policymakers grasp the nettle of reform.

"Good policies do not guarantee good economic performance, but bad policies almost always result in poor economic performance," Llewellyn, a former senior official with the Organisation for Economic Cooperation and Development, writes.

Asia, he says, has considerable supply-side scope to keep expanding output at a fast rate: domestic savings are high; urbanization rates are still low; education and skills levels are low but rising; and there is a lot of potential for catch-up in Asia's inefficient service sector.

On the demand side, bigger economies like China, India and Indonesia must turn to domestic sources of growth, Llewellyn argues.

To that end, it is imperative for Asia to strengthen its social safety net to reduce precautionary savings and thus spur consumption. Developing the banking system so people can borrow to finance major purchases such as homes and cars will become urgent.

"Realizing this brisk growth of aggregate demand, in a sustainable manner, is perhaps the greatest economic policy challenge facing the Asian economies in the decade ahead," Llewellyn writes.

An early indicator of Asia's appetite for reform will come on Tuesday, when Malaysian Prime Minister Najib Razak is due to unveil a new economic model aimed at boosting growth.

One area where economists would like to see further progress across Asia is in dismantling trade barriers.

Malaysia, for instance, levies import tariffs of 30 percent or more on iron and steel, some construction materials and -- along with Thailand, the Philippines and Indonesia -- cars.

Still, Edward Teather, an economist with UBS in Singapore, said it was remarkable how successful the Association of South East Asian Nations (ASEAN) has been in implementing free trade agreements in recent years.

The latest one, with China, formally came into effect on January 1, although mutual tariff cuts have been taking place since 2005.

"Moreover, ongoing negotiations and agreements to further reduce tariffs mean liberalization momentum remains intact within ASEAN," Teather wrote in a report last month.

"All this is important. Increased trade improves income growth both directly and indirectly through improvement in productivity via competition and the distribution of knowledge and technology," he said.

A separate UBS report also gives Asia generally high marks for productivity.

Besides the capacity to innovate and harness technology, UBS finds productivity growth tends to go hand in hand with strong national balance sheets — a country's current account balance, its public sector balance and its level of private credit.

These factors determine whether consumers, firms and investors have the means and inclination to fund innovation-related investment.

As rich nations entered the 2008 crisis with the most severe economic imbalances in 50 years, while developing economies had never been under less strain, the latter should outperform the former by a wide margin in the period ahead, according to UBS economist Andrew Cates.

And Asia will be to the fore.

"Economies with recent records of low balance sheet stress and a high technology achievement include China, India, Indonesia, Thailand and the Philippines together with Brazil. These economies offer the greatest potential to achieve productivity-enhanced growth in coming years," Cates writes.

So will the movie of the Asian economy have a happy ending after all?

Perhaps, but a familiar menace still lurks: the menace of misaligned exchange rates, which is hampering economic rebalancing and, in the worst case, could touch off a trade war between the United States and China.

Llewellyn, reviewing the challenges he sketched out for Nomura, concludes: "Before substantial progress can be made with the majority of these various policies, however — both on the demand side and on the structural side — Asia's policymakers will have to deal with the exchange rate issue, which has been overshadowing policy discussion for many years."

© 2014 Thomson/Reuters. All rights reserved.

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