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"Asia's Recovery from the Global Financial Crisis-What It Takes and What Could ADB Do?"

Lecture by
Haruhiko Kuroda
President
Asian Development Bank

At the Institute of Southeast Asian Studies (ISEAS)

22 June 2009
Raffles Hotel, Singapore

I.  Introduction

Mr. Kesavapany, ladies and gentlemen,

Thank you for the kind introduction. It is an honor for me to be here this morning at the Institute of Southeast Asian Studies (ISEAS) public lecture series. This is one of our region's most important institutions. The research, debate and knowledge sharing promoted by ISEAS is key to strengthening Southeast Asian economies individually and collectively, and the integration of Asia into the global economy. At a time of global financial and economic crisis, it is critical that we come together to seek solutions. I would like to thank ISEAS for the efficient organization of this event and, more importantly, for having given the opportunity to share some of my thoughts on this important issue.

Today I will discuss how Asia is coping with the global crisis, and what we need to do to bring Asia back to its steady, consistent path of robust economic growth, increasing prosperity, and rapid poverty reduction. Singapore was immediately struck by the crisis, given its role as world class financial center, regional center of commerce, and high tech production hub. But Singapore is unique in the region precisely because of its openness, its high standard of living, and strong links with financial markets around the globe. For the rest of emerging Asia, the crisis has had myriad and varying effects. Given the vast differences in crisis impacts, how are governments responding? How can the region return to its traditional path of rapid economic expansion and use the opportunity this crisis provides to rebalance sources of growth? And of course, what is ADB doing to proactively help this process?

II.  Impact of the Crisis and Outlook

It is important to note, first, that developing Asia was rather lucky in some ways. Its financial systems had minimal exposure to the types of assets that characterized the financial meltdown in Wall Street and on the European continent. Although financial spillovers to Asia were indeed significant, the most severe have been limited to economies where financial markets are highly open and with strong financial linkages to the outside world-for example, here in Singapore, in Korea, and in Hong Kong-where a sharp reversal in capital flows and the drop in financial asset prices exacerbated the sudden dearth of external funding.

Overall, it seems that Asia had learned the lessons from the 1997/98 Asian financial crisis. Asian leaders reformed banking and financial sectors regulation, ensuring financial institutions remain sound with capital adequacy ratios well above international norms. They worked hard to develop financial systems beyond bank financing into, for example, government and corporate bonds, thereby improving financial resilience. In addition, savings accumulated from years of export-driven growth gave the region a comfortable cushion in the form of the large international reserves. It is remarkable that 46% of the world's total foreign exchange reserves are held in Asia. This implied that while external funding in US dollars, for example, was constrained, most banking systems within the region maintained sufficient liquidity and were able to provide credit for real economic activity.

Yet Asia-particularly emerging East Asia and Southeast Asia-has been hit by a sharp reduction in external demand. The region is known for its growth model built on exports, much of which are destined for markets in the G3 economies of the US, Europe, and Japan. As last year's credit crunch was tightening, the US was already technically in recession. The World Trade Organization expects global trade to drop 9% this year, the first contraction in 25 years, and a major one.

Many economies in Asia are either in recession or face significant growth slowdowns. Of course, a sudden and precipitous drop in external demand has hurt the region's exporters. But a sharp deterioration in consumer and business sentiment has also affected economies with large domestic demand that have grown rapidly in recent years-like China and India. As the world economy continues to contract, the region can expect additional factory closings, layoffs, and supply chain disruptions.

Several economies are also dealing with slowing remittances. First quarter growth figures (year-on-year) show that ASEAN economies contracted by 2%, and in the newly industrialized economies-which are more sensitive to export demand-GDP was down by an aggregate 6.7%. Although China still managed to grow 6.1% (year-on-year) in the first quarter this year, this is rather meager compared with the 10.6% recorded in the first quarter last year.

Slower economic activity threatens to significantly increase poverty throughout the region, at least until growth engines are restarted. The slowdown is impacting people's lives, especially the poor. Instead of breaking out of poverty, we expect that more than 60 million people in developing Asia-including 14 million in China and 24 million in India-will remain below the $1.25 a day absolute poverty line in 2009 as a result of the global recession. These people would have been freed from the shackles of poverty had economic growth continued at pre-crisis levels.?Economic growth in developing Asia was already beginning to cool last year from the record 2007 level of 9.5%. It fell three full percentage points to about 6.3% in 2008. And we expect it to fall another three percentage points this year to an estimated 3.4%, the region's slowest growth since the 1997/98 financial crisis. So whether or not we see a recovery next year is an important question, although much of that depends on what happens in the advanced economies.

III.  Where will the Recovery Come From?

Unfortunately, the world's major economies continue to decline. The good news is that the pace of the decline is easing in some of these economies. As you are aware, stock markets around much of the world have rallied in recent months. Since its trough in March, the Dow Jones Industrial Average is up by more than 30%, though still down about 3% since the beginning of the year. Emerging Asian markets¹ are up 68% since bottoming out in November. This compares with about 25% increase for mature markets², and indicates some return of risk appetite in favor of emerging Asian equities.

A series of data released in the United States (US) indicates that the slowdown in some sectors of the US economy is beginning to ease. This has brought some optimism among several economists that the worst might soon be over. Recent employment data showed the number of jobs lost in May was at its lowest in 9 months, leaving unemployment below 10%. There are other indicators that show the bottom may be approaching. The Baltic dry index-which tracks worldwide international shipping prices for various dry bulk commodities-has been rising steadily since the beginning of the year, although it remains roughly one-third what it was at its peak just over a year ago. The price of crude oil has begun to rebound, approaching $70 per barrel-about double what it was at its lowest last December. Other commodity prices such as metals and food have also begun to rise from their January or February lows, indicating some revival in demand for raw materials. It may be premature to say a revival in global trade is imminent, but we may see some signs of growth returning toward the end of the year.

It is important to say here that although the pace of economic decline may be slowing, it is a decline nonetheless. With many economic indicators still in negative territory, the global recession seems to have some way to go. What is encouraging, however, is that there are some signs that the economic recovery will have greater participation by emerging economies, particularly those with large domestic markets-China and India in Asia, and Brazil in Latin America. Indeed, these economies may lead the recovery. Industrial production in China, for example, while well off the growth rates of recent years, rose in April by 8.9%, up from its January trough of 3.7%. Growth in fixed asset investment topped 30%, also in April.

Asia's highly open economies react quickly to changes in the economic climate. Here, there are also some encouraging signs. Korea's GDP growth was positive in the first quarter, growing 0.1% on a quarterly basis after a 5.1% contraction in the last quarter of 2008. Export declines have stabilized across emerging Asian economies and, on a monthly basis, exports in fact grew in nearly all economies in the region in recent months. In Korea and Singapore, in particular, monthly exports have been rising for the past 3 months. Leading indicators such as the Purchasing Managers' Index (PMI) and consumer and business confidence indexes have also become positive across Asia. In some cases-such as Indonesia, Korea, Philippines, Taipei,China, and Thailand-industrial production has been rising on a monthly basis over the past 2 to 3 months.

Financial markets and currencies continue to stabilize throughout the region. The relatively rapid and orderly process of financial adjustment was due to flexible exchange rate regimes and the lack of domestic financial excess. This is a crucial difference from the situation a decade ago during the Asian financial crisis. Although access to credit has been tightened for riskier borrowers, relative financial health has allowed the region's banks to continue to provide credit to the private sector without major disruptions. Growth in bank lending, while off last year's peaks, remains healthy. Here in Singapore, lending was up 9% in April year-on-year. In Indonesia, it was up nearly 22%; the Philippines 19%; and in Korea and Malaysia lending was up 12%. These relatively favorable credit conditions are indeed encouraging.

IV.  The Macroeconomic Response

Economies throughout the region have vigorously pursued expansionary monetary and fiscal policies in an attempt to boost sagging demand and growth. It remains to be seen whether these policies will translate into effective demand. But we should start seeing some positive outcome once second quarter data begin to trickle in.

Monetary policy was the first line of defense. With the global downturn and the precipitous drop in oil and other commodity prices, the inflationary concern-which preoccupied the region's monetary authorities as late as July last year-quickly dissipated. This gave monetary authorities plenty of room to reduce policy rates to support sagging demand. For example, Bank Indonesia has lowered its BI Rate seven times since its November 2008 peak of 9.5%, with the last 25 basis point drop announced 3 June to 7%. The Philippines repo rate eased from 6% to 4.25%. Since October, Thailand cut its 1-day repo rate four times, from 3.75% to the current 1.25%, while Malaysia's overnight policy rate has fallen from 3.5% to the current 2%.

In addition, continued payments surpluses and prudent fiscal management over the past decade-much in response to the Asian financial crisis-allowed plenty of fiscal space for budgetary pump-priming. These stimulus packages have been significant and are being implemented now. The largest package is in China, which has announced support of more than 15% of GDP to be spread over 2 years. Six other developing Asian economies have stimulus packages above 5% of GDP; eight are spending between 2% and 5% of GDP; while four will add between 0.5% and 2% of GDP. The important element, from our point of view, is that the stimulus is focused where it will do the most good-on "shovel-ready" infrastructure, small and medium-sized enterprises, rural economies, and social safety nets.

Governments are aiming their stimulus to be both timely and targeted where they can produce quick results. But they will also need to keep a watchful eye on medium- to long-term deficits and public debt, balancing fiscal stimulus with fiscal sustainability.

V.  Rebalancing Sources of Growth

As the region and the world at large cope and combat the challenges posed by the cyclical downturn, it is clear that the crisis should be taken as an opportunity for the region to move forward in its development paradigm. Export-driven growth has served the region well. But it has also contributed to the global payments imbalances that, in turn, contributed to the current crisis. Resolving the global economic crisis means the unwinding of these imbalances in an orderly manner. Unfortunately this will likely be a long and drawn out process. As the US economy deleverages by saving more and spending less, emerging Asian exporters will obviously suffer. It means that for emerging Asia, rebalancing the sources of growth is not an option but a necessity for sustained high growth. The region should promote balanced growth based on more domestic and regional demand, without turning its back on globalization. The region's savings must be channeled more effectively to meet its own development priorities. Broadening and deepening domestic and regional financial systems will ease the tensions emanating from cross-border capital flows. And deeper financial and trade integration will help strengthen regional demand.

As the region integrates further, increased domestic demand can give a large boost to intraregional trade, which has been growing steadily throughout the past decade. For example, about 51% of ASEAN exports today are with the economies of developing Asia. Increased domestic demand for final goods within the region will allow for more substantive intraregional trade. Consumers will demand more product variety, creating greater potential for intra-industry trade in differentiated products across the region. Consolidating the so-called "Noodle Bowl" of the region's free trade agreements into an inclusive free trade area will also accelerate the rebalancing process. A larger Asian market will allow for economies of scale and encourage greater specialization.

VI.  Regional Responses Taking Shape

As the crisis evolves, it becomes increasingly clear that in forging policy, the whole is greater than the sum of its parts. Common economic interests supersede differences between governments. The trend toward regional cooperation in Asia, particularly East Asia, is growing. And, as it did in the aftermath of the 1997/98 financial crises, the process accelerates during a downturn.

Closer cooperation within ASEAN+3, for example, can be seen in the recent expansion of the multilateralized Chiang Mai Initiative, the reserve pooling arrangement that can provide emergency liquidity for members in need. As part of the agreement, ASEAN+3 will establish a permanent independent surveillance unit to promote objective economic monitoring and operationalize the $120 billion reserve pool by the end of the year. National contributions to the pool have been decided and voting rights set. These are the seeds of institution-building, and could eventually pave the way toward greater regional cooperation for financial stability.

ASEAN+3 is also working with ADB support to accelerate establishment of a credit guarantee and investment mechanism, or CGIM. The CGIM will provide credit guarantees for domestic bonds to meet financing needs and help develop the region's local-currency bond markets. This is important to provide an additional avenue for channeling Asian savings effectively and efficiently into Asian investment. It is part of the roadmap outlined by the Asian Bond Markets Initiative, another long-term ASEAN+3 program.

There is also a need for more effective communication, if not coordination, on exchange rate policies. With the notable exception of the Japanese yen and the Chinese yuan, most Asian currencies tumbled against the US dollar during the height of the financial crisis. Heightened foreign exchange volatility can undermine Asia's banking and corporate sectors-especially where currency hedging remains difficult. While we all understand how sensitive this is, helping stabilize currency movements between trading partners in our region can further accelerate intraregional trade and investment flows. Countries should avoid competing against each others' currency depreciations (or appreciation in some instances). In fact, it would be useful to establish a mechanism to monitor intraregional currency movements. This is one reason why ADB has been promoting the establishment of an Asian Financial Stability Dialogue-among finance ministers, central bank governors, regulators, and private sector representatives-to effectively and harmoniously coordinate responses to financial crisis and promote financial stability in general.

Harmonized and coordinated regional responses are extremely important, particularly at a time of global financial turmoil and the generally accepted need for some major regulatory reform worldwide. For example, harmonizing prudential criteria and accounting standards, strengthening governance and transparency, and coordinating national regulatory and supervisory efforts will help ensure market integrity, build consumer and investor confidence in the region's financial systems and safeguard financial stability. The region also needs to translate its collegial stance on these issues into a stronger voice in favor of a new global financial architecture which is more in consonance with the economic reality of the day. On the back of successful responses to the crisis in East Asia, ASEAN+3 should be able to play an increasingly important role as partner in the global community working itself through the crisis impact.

VII.  What ADB is Doing

ADB stands firmly behind these efforts for regional economic cooperation and integration. It is one of three strategic agendas under our Strategy2020, the others being inclusive growth and environmentally sustainable growth.

As an immediate response to the global economic crisis, we have committed an additional $10 billion to supplement our assistance over 2009 and 2010 to member countries in need of extra support. This will help us ramp up our assistance to $32 billion over 2009 and 2010 from the $22 billion during the 2007-2008 period.

Up to $1 billion of this funding will support trade financing and is expected to generate up to $15 billion in much-needed trade assistance by the end of 2013. An expanded trade finance program is critical to fill the gaps left by a weak international financial sector, to build public-private partnerships and to promote regional integration. Our Asian Infrastructure Financing Initiative will dedicate productive investments to infrastructure, which is critical for long-term growth.

We have also established a fast-disbursing $3 billion Countercyclical Support Facility to meet urgent needs stemming from the crisis. The facility will support the expansion of domestic demand and production, strengthen social protection, and facilitate trade to protect against job losses in the region. In low-income countries, we are providing $3.4 billion this year by front-loading our available concessionary Asian Development Fund resources. We hope these efforts will help governments maintain or even increase public expenditure programs for financing education, health services, and public safety nets, especially for poor and vulnerable families.

VIII.  Conclusion

Let me conclude by saying that the challenges we collectively face in recovering from the global recession are significant. And Asia's contribution to the world economy will necessarily grow as global imbalances are worked out. As the world's financial architecture shifts in the crisis aftermath, Asia will also be asked to play a role commensurate with its contribution to the global economy. The region has actually done quite well thus far in staving off the worst of the global crisis. As countries with substantial domestic markets lead the way through sizeable stimulus packages, there should be indeed a light at the end of the tunnel. We must use this opportunity to better balance the sources of growth, and move steadfastly and vigorously toward greater regional cooperation and economic integration. That way, Asia will not only fulfill its growing role as a global economic player, but will also move more quickly towards prosperity and freedom from poverty.

Thank you.