Time for East Asia to Unwind Its Economic Policy Stimulus

Op-Ed / Opinion | 22 July 2010

EMERGING East Asia is virtually assured of a V-shaped recovery from last year's economic slump, though it is still too early to proclaim that the 'V' stands for 'victory'.

EMERGING East Asia is virtually assured of a V-shaped recovery from last year's economic slump, though it is still too early to proclaim that the 'V' stands for 'victory'.

But with the recovery on track, it is now time to unwind the policy stimulus that has helped power the recovery. Ensuring the recovery is sustainable will depend heavily on the timing, policy mix and pace at which economic stimulus is withdrawn.

As governments begin to unwind policy stimulus, a 'Money First' strategy - in which policymakers normalise monetary policy first and consolidate fiscal policy subsequently - is appropriate for most of emerging East Asia.

Considering the need to rebalance the region's sources of growth, there is merit in normalising monetary conditions through a judicious mix of currency appreciation and interest rate adjustments rather than entirely through policy rate hikes.

The pace at which economies unwind stimulus should depend on the speed of recovery as well as evolving risks. Governments must be sure the private sector is strong enough to take over the slack created by the withdrawal of policy stimulus.

In China, the authorities are carefully pulling back by putting a cap on bank lending, increasing bank reserve requirements and giving the yuan a bit more flexibility. The aim is to contain inflationary pressures, avoid overheating and keep potential asset bubbles (real estate) in check while maintaining robust growth.

In South Korea, Malaysia, Singapore, China, Thailand, and Taipei,China, normalisation has already begun, and should continue at what appears to be an appropriate pace. And in countries that have yet to begin, such as Indonesia, the Philippines and Vietnam, unwinding policy stimulus may need to start soon.

In every case, unwinding policy stimulus should be in step with the speed of the region's recovery, yet mindful of the risks facing the overall global economy.

With households, firms and even governments in advanced economies in North America and Europe deleveraging and restructuring their balance sheets, demand for the products 'Factory Asia' produces can no longer be counted on as a primary source of growth.

Without shunning globalisation or turning inward to a 'Fortress Asia', developing economies in the region will need to increase cooperation and deepen economic integration, using their huge savings to finance cross-border infrastructure, ease intraregional trade and investment, and develop more sophisticated financial markets.

The ultimate goal of this integration agenda should be to rebalance the sources of growth more towards domestic and regional demand while keeping the region firmly connected to the rest of the world.

The reason emerging East Asia has done so well in the face of global adversity is simple: It was not part of the problem; it had learnt its lessons well from its own 1997-1998 Asian financial crisis; its governments reacted quickly with monetary and fiscal stimulus; and both businesses and consumers retained confidence that the region would continue to prosper.

The Asian Development Bank (ADB) estimates the combined gross domestic product of the region will rise 8.1 per cent this year, much higher than last year's 5.2 per cent, and well above the 6.7 per cent growth the region posted in 2008.

That is quite credible considering the world is only gradually climbing out of its biggest financial meltdown and economic crisis since the Great Depression.

China, of course, has been at the epicentre of emerging East Asia's economic upsurge. Its policy stimulus package was by far the region's largest. First-quarter growth this year was a torrid 11.9 per cent. The second quarter was tamer at 10.3 per cent, with new investment last year accounting for nearly 90 per cent of growth. ADB predicts the trend will continue with economic growth this year at 9.6 per cent, and 9.1 per cent next year.

After being badly hit by the global economic crisis in the early part of last year, the newly industrialised economies of China, Hong Kong, South Korea, Singapore, and Taipei,China, are forecast to turn in 6.2 per cent growth this year, moderating slightly next year. And economic prospects of the four middle-income Asean economies - Indonesia, Malaysia, the Philippines and Thailand - look good this year after last year saw their worst performance since the Asian financial crisis.

Leading indicators continue to improve, with strong industrial production growth and rising consumer confidence. This is also true of most other Asean economies. Together, ADB expects Asean to expand by 6.7 per cent this year.

Emerging East Asia's 'V for victory' may still be a way off, but for the moment it is forging the right path.