Despite global financial turmoil of the last 14 months, Asian economies have demonstrated remarkable resilience. Asian export growth surprised everyone by registering super-charged rates, with the exception of Singapore and the Philippines. Asian exporters were adept at switching from low-growth markets to higher-growth ones such as Russia and the Middle East. Asia’s banks also continued to expand, suffering just a few ripples from the global turmoil. Consequently, GDP growth rates were maintained at reasonably high rates, despite some deceleration.
Unfortunately, the credit crunch in the United States and Europe has now mutated into a full-blown global economic crisis. In this new, more dangerous phase, it’s unlikely that Asia can continue to remain insulated.
Asian economies face a new challenge, a downward spiral in the global economy – the seized-up financial sector is hurting economic activity in the developed economies, with weaker economic activity feeding back into the financial sector through rising default rates on loans and falling asset prices. Capital is fleeing emerging markets for safer havens, bringing the crisis closer to developing economies, including those in Asia. With market failures more apparent, such as the freezing up of inter-bank lending, the world economy cries out for effective government intervention to halt the downward spiral.
Unfortunately, political elites in the US, Europe and Japan were slow to understand the root causes of the crisis – nor did they appreciate the consequences of tardy responses. So far, they have not summoned the political will necessary to come up with timely solutions to the crisis. Therefore, Asia must ready itself for a substantial deceleration in global economic activity, with a growing risk that financial stresses will spread across Asian financial sectors as well.
What does this imply for Asia in the coming year?
First, we can expect an accelerating downturn in exports and then in industrial production. There’s little doubt that a synchronous slowdown is underway in the United States, Europe and Japan. Such a slowdown will damage prospects for the large emerging economies such as Russia, China, India, Brazil and Turkey. With global demand for manufactured goods likely to fall and commodity prices already falling, Asian export growth will certainly fall. As manufacturers cut back on production, jobs will be lost while those remaining in employment will see lower overtime and less income. Rural households which enjoyed record incomes due to high prices for rubber, palm oil, coffee, cocoa and other agricultural produce will cut spending as well. As the external sector weakens and costs of raising debt or equity rise, businesses will reduce investment, hiring and expansion plans. Domestic demand will therefore lose momentum.
Second, Asian financial sectors are likely to face stronger headwinds. Liquidity conditions are tightening for Asian banks. Recent inter-bank transactions have seen even blue-chip Asian banks paying several hundred basis points more for short-term money than a few weeks ago. As economic growth weakens and financial conditions tighten, asset prices will probably fall across Asia, especially in real estate. Loan delinquencies are likely to rise. Asian banks will hunker down and focus on containing the damage from the global crisis.
Third, Asian policymakers are likely to face new forms of challenges. In some countries, inappropriate external debt exposures are raising concerns in financial markets. For example, financial markets are concerned about Korea’s foreign debt and the exposure of some of its exporters and small/medium sized businesses to financial instruments which might entail large losses. Given Korea’s otherwise strong fundamentals, there’s no reason why Korea should face a crisis – but in today’s mood of risk aversion, even small bits of negative news can produce outsized reactions in financial markets. Another challenge is how far to go to protect local banks. With developed economies increasingly forced to offer blanket guarantees to depositors, Asian policymakers will soon be forced to match these guarantees – or face a shift of deposits out of their banking systems.
The big question is what happens to China. The consensus view projects China in an enviable position: GDP growth is slowing to a still-fabulous 9 to 10 percent or so, inflation is receding and the external accounts remain in healthy surplus.
However, some signs of trouble are ahead. Export growth is weakening: Tens of thousands of export-oriented companies in southern China have gone out of business as a result of falling demand, rising costs and the challenges of dealing with tougher enforcement of environmental and labor laws. Transactions in the real estate sector have fallen sharply, and there’s anecdotal evidence of distress in real estate in some locales although the national numbers do not reflect that. China’s largest banks were re-capitalised, with their balance sheets cleaned up several years ago, a large portion of the country’s lending market goes unregulated. It’s not clear how that unregulated lending market will hold up as asset prices tumble, economic growth decelerates and hot money stops flowing into China. Our view is that the risks in China are certainly higher than markets realize.
Despite these challenges, the developing economies of Asia as a whole are likely to remain on a sound footing and could find opportunities. Economic growth will slow, but there are enough engines of growth to keep GDP growth at reasonable rates for the next fiscal year. Since the 1997-98 Asian financial crisis, Asia’s banks remained cautious in the recent global boom. As a result, they have little exposure to the toxic assets that are bringing down their counterparts in developed economies. Asian sovereign wealth funds have grown in size as well and will be major players in global finance in coming years. Asia’s high savings rates mean that other Asian financial institutions will have cash to pick up assets in the crisis-hit developed economies.
The question remains on just how large a stake Asian financial institutions will acquire in US and European financial sectors. We have already seen Japan’s Nomura and Bank of Tokyo Mitsubishi-UFJ Bank making acquisitions. Sovereign wealth funds from Singapore and China have taken stakes in some large US and European financial institutions. However, we suspect that there’s a limit to what Asian financial institutions can do in this crisis. While they have access to large financial resources, most Asian banks lack the breadth and depth of management talent and the strong institutional processes needed to successfully take over large and sophisticated financial institutions in developed economies. More likely, Asian banks and sovereign wealth funds might be part of consortia that take over such institutions.
Economic conditions in coming months will be among the toughest Asia has had to manage since the Asian crisis a decade ago. But, Asia today is far more robust than in the 1990s, helped by strong external balances, massive foreign exchange reserves, more diversified export bases and reformed banking sectors. Sure, there will be one or two countries with financial vulnerabilities or with confidence-sapping political problems that could suffer more than others but by and large Asian economies will continue growing and rebound strongly once the global crisis ends.
Manu Bhaskaran is partner/head of economic research for the Centennial Group. Rights: © 2008 Yale Center for the Study of Globalization. YaleGlobal Online