OREI Senior Director Srinivasa Madhur (Presenter):

Good morning ladies and gentlemen. It is a pleasure for me to be here with the media and to launch this report that we bring out twice a year. I will walk you through the key messages of this particular report in about 20 minutes and then would be more than happy to answer any question that you may have on any of these issues.

We address basically four key questions in this report - How is the external environment evolving for emerging East Asia, as (Media Relations Specialist Ms.) Karen (Lane) has sought to define what emerging East Asia is, covering 14 East Asian countries excluding of course Japan, and how robust is the region's economic recovery from the sharp slowdown of a recession last year, which many of these countries faced. And three what are the major risks and policy challenges for the outlook for the region and for the policy makers in these countries. And finally we take up one particular policy issue here: should the region unwind its policy stimulus - the unprecedented monetary policy easing and fiscal stimulus measures many of the countries in the region have introduced in the aftermath of the global financial crisis to soften the blow from the crisis? So for this specific question, we have a theme chapter in the report on this issue: Is it time for the region to unwind its policy stimulus, and if it is, when and how?

Overall, the external environment remains positive for the region. Although of course as you all know the sovereign debt crisis in Europe does cast some doubts over the strength of the global recovery, over the strength of the advanced countries' recovery from the global crisis, and perhaps this is something that we have to keep in mind when we say that overall the external environment remains positive but there are these shadows on the horizon that perhaps is making the environment a little less favorable or uncertain.

Now down to the specifics of the advanced countries' recovery. Our assessment about the US economy is that the great recession in the US in the aftermath of the global financial crisis that actually emanated in the US in the form of the subprime crisis, that recession seems to have ended and a gradual recovery in the US economy is on the way.

Now, on the eurozone recovery, as you all know, the eurozone recovery is held back somewhat by the debt crisis from many of the eurozone and European Union countries. Our big assessment at this stage is that although recovery is taking place in Europe too, the recovery is somewhat fragile, not as robust as the US. However among the G3, Japan of course, we have much better news. After having one of the largest contractions last year our assessment is that Japan is and will return to solid growth in 2010.

Now one of the huge implications that emerging East Asia had in the aftermath of the global crisis was the collapse in world trade. This is a region which is very open to trade, which therefore was badly hit by the slowdown. So the crisis basically sent an external demand shock through the region's economies. The good news is that after really collapsing in the aftermath of the crisis, global trade has picked up sharply and we believe that global trade will normalize going into 2011.

So overall the external environment remains positive despite many of the clouds that are hanging on the horizon.

Going into the issue of inflation or deflation in G3 countries, yes, with the recovery inflation is also slowing edging up but it remains mild. So there's no huge concern. Some are talking about a decline in prices somewhere down the line. So our assessment is inflation is rising in advanced countries but it is not a huge problem as of now.

These are the charts. I don't want to go into details, I don't want to run a commentary on these charts but I'm sure you can see for yourself and if you got any questions on this I'd be more than happy to attend to them.

Here is the first chart. The eurozone remains fragile but the US and Japan are recovering quite well. This is an indicator of the tightness in the short-term money market, an indicator of the difference between the Interbank money market rates and the US Treasury bill rate. Yes it's slowly edging up in the aftermath of the European debt crisis yet it remains fairly low compared to the huge hike it had in the aftermath of the Lehman Brothers collapse in 2008. So it's still fairly low, a low rise.

Another indicator of what's happening in the global financial markets, the credit default swap. In a simple one-line it means the cost of insuring against defaults, against the possibility of default, this is the cost in one simple line. Again it has picked up a bit in the last couple of months yet is very low when compared to the highs we reached in the worst months of the global financial crisis.

Here it is US consumer confidence and business sentiment. Again we see some positive news there.

Debt problems in Europe, more on the eurozone economic sentiment index, is a mixture of consumer confidence as well as business sentiment, and again it is not sharp.

Here it is in Japan too. Work/business conditions and consumer confidence is improving and this is the chart that I want to develop on. Look at world trade growth... the slump in the aftermath of the global financial crisis, there you see almost a V-shaped recovery in the world trade.

The inflation in G3 economies is up but it's mild.

So what does it all mean for the region's recovery? Our one-line is that despite uncertainties emanating from the European debt crisis the emerging East Asia's sharp V-shaped recovery from last year is very much on track and we see fairly broad-based strong growth across the region in 2010. Going into 2011, we expect growth to taper off somewhat partly because the advanced economies will slow down a little bit but not hugely. US again I think after growing by about 3% will slow down to about 2.5%, 2.6%. That will happen partly because the US is already talking about slowly, steadily unwinding the policy stimulus, consolidating the fiscal position. Coupled with the unwinding of policy stimulus within the region itself including China, growth will taper off in 2011.

On the inflation front, it is up in most of the region but again our assessment is it is manageable with perhaps a few exceptions.

These are some of the indicators of recovery in the region. You can see for yourself, more or less mimicking the pickup in global trade, you can see exports picking up here. Again you see inflation heading up somewhat in the last year or so but still it's not a huge problem if attended to and managed well. That is why we are saying it is picking up but with policy action and a sensible response from governments the region can manage the inflation situation.

So this is the one-line that I mentioned, a V-shaped recovery for emerging East Asia very much on track. You can see in 2008 growth was about 6.7% on average for the region. It fell to about 5.2% last year and now we are seeing a very strong recovery from that slowdown. So in fact it's more than a V, if you want to call it. It's better than a V-shaped recovery.

And this is the table that gives all the numbers for the 14 countries and some of the sub-aggregates. Let me give you the key things that you may like to focus on. China of course, the largest economy in emerging East Asia, will continue its strong growth. This year we expect about 9.6% growth. And of course given the concerns of China's strong investment growth, quote, unquote - authorities will certainly normalize the extremely unprecedented easy monetary conditions in the country, and of course over time the fiscal position will have to be consolidated. So we think that growth will remain strong this year but would taper off in 2011, 9.6% growth this year and 9.1% next year.

For the newly industrialized economies - Korea, Hong Kong, Singapore, and Taipei will likely return to solid growth this year on the back of a strong recovery in global trade. These are small, open economies dependent on external demand and hence the good news from the world trade recovery will translate almost word for word for these countries in terms of a solid recovery this year and again moderates slightly in 2011.

Among the ASEAN countries, the four ASEAN middle-income countries of Indonesia, Malaysia, Philippines, and Thailand - quite open economies like the NICs - they had the worst economic performance last year since the 1997-1998 Asian financial crisis. They really posted their lowest growth rates on the average since the 1997-1998 Asian financial crisis, so they will get out of that worst year (last year) and growth will be solidly higher this year in 2010 and moderating in 2011.

On the back of the strong rebound in global trade and regional economies the smaller ASEAN economies of Viet Nam, Cambodia, and Laos, they will also stage a reasonable recovery. Overall, the NIEs' recovery is on track.

Having said that we want to point out three risks that the region faces in an otherwise positive economic outlook:

- Sudden disruption in the recovery of advanced economies is dangerous for the region. We see people talking about double-dip recession in the US, we see people pessimistic of both Europe and Euro. So we need to keep that firmly in our mind when reading the robust economic numbers that we have presented. US unemployment rate still remains high also in Europe. The housing market in Europe is still very weak. So some of these things we should keep in mind and one of the risks that we really think of is a sudden disruption in the recovery of advanced countries. Private demand in those countries may not pick up and take the slack that will be created by the withdrawal of fiscal stimulus in those countries in which case that is a possibility that we should look out for.

- Secondly of course with the region doing quite well, recovering quite nicely and of course risk appetite increasing, there is already a trend of increased capital flows into emerging East Asia and we all know how capital flows could be destabilizing although welcome overall, because there is a saying that capital flows are like rain, when it rains it pours. When it stops then of course there is a drought. There could be a sudden reversal, capital flows could go back, they will return, they can fly back as quickly as they flow in. So that is the major risk for the region, we need to therefore manage capital flows.

- And of course finally when countries unwind their policy stimulus in the region it's always possible there could be human errors. Countries may unwind policy stimulus either too fast or too slowly or time it wrongly or they may get the mix of policy unwinding in terms of monetary and fiscal unwinding quite wrong. So that is a third risk which will be considered finally and all these are the regional risks.

We have had a report on this, the Asia Capital Monitor in May which we launched in Korea and one of the key messages was exactly this, capital flowing in - welcome but beware, you have to manage it otherwise it could destabilize.

So what is the policy message from all this? The one-line policy message from our report is that with the region's recovery, the V-shaped recovery, firmly on track, for most of the region it is time to unwind the policy stimulus. We see that there are three elements to a well crafted, well designed exit strategy or unwinding strategy from the stimulus packages - timing, the policy mix, and of course the pace in which the unwinding is done, all very important to have a well designed exit strategy, unwinding strategy in terms of making sure that as countries unwind the policy stimulus we do not endanger the recovery process. So we need to sustain the recovery and at the same time exit from the unprecedented policy stimulus in the region. So as we said the timing is important and we believe that for most countries in the region the time is now. Those who have not started I think they should perhaps look at it sooner than later.

Then what about the mix of policies? Should countries first normalize monetary policy or should they normalize fiscal policy first and then monetary policy, or should fiscal and monetary policies normalize both hand in hand? Our assessment is that for the region as a whole a monetary strategy is perhaps more suited. What we mean by that is that countries normalize monetary policy first and then subsequently focus on fiscal consolidation, what we call the money-first strategy, normalizing monetary policy first and then consolidating fiscal positions. That seems to be an appropriate strategy for the region unlike of course in the advanced countries which focused on fiscal consolidation first while keeping interest rates low for long. What are the reasons for this? Just look at the fiscal positions in some of the advanced countries and here, the public debt to GDP ratio in many of the advanced countries is somewhere in the range of 75% to 100%, US is about 80%, and I think the eurozone is in the same range at 75%, actually Japan is 180%. So the public debt-income ratio is about 70, 80, 100% in advanced economies whereas in emerging East Asia it's lower, it's somewhere in the 30%-60% range except for Philippines at 165%. But generally speaking in emerging East Asia the public debt to GDP ratio is smaller in comparison to their incomes and of course the fiscal deficit is also smaller of the order of magnitude except perhaps for some of the smaller economies like Viet Nam.

So that's one of the reasons why we think that the region should really look at monetary normalization first and then fiscal consolidation next. And secondly of course we have already pointed out the kinds of risks the region's recovery faces so we believe that the region's policy makers need to be flexible, they need that extra degree of freedom in case something goes wrong while unwinding policy stimulus. One of those risks that I mentioned, sudden disruptions in the recovery in advanced countries for example. If that happens, the region can face a second external demand shock. So that's the reason why policy makers need flexibility. And as you know monetary policy is a much more flexible instrument of macroeconomic management than fiscal policy. Fiscal policy is known to be less flexible, more rigid in other words because getting public expenditure passed requires many countries' approval by parliament, you have the lobbying groups for programs, the budget. So it's a much less flexible tool of macroeconomic management compared to monetary policy where you can raise rates actually as the situation demands.

And finally monetary normalization itself, our assessment is that, as we all know from an inflation standpoint, monetary accommodations in most open economies can be controlled or can be changed either by raising interest rates on the one hand or by letting the currency appreciate. These are two ways of bringing about a monetary condition, normalization or contraction in monetary conditions. So we believe that the region overall should really look at bringing about a normalization of monetary conditions. A good mix of letting currencies appreciate on the one hand and raising policy rates on the other rather than by simply relying on policy rate hikes or interest rate hikes, bringing about the desired monetary tightening or monetary normalization. That is our second message. It's time to unwind, go for a money-first strategy. Within a money-first strategy, look at the mix of allowing currency appreciation and policy rate hikes rather than relying on mainly policy rate hikes.

And finally of course the pace at which unwinding should go. Of course it has to depend on the strength of the recovery. Countries where the recovery is very strong, output can expand rapidly, inflation is rising, they should go first.

We know that Korea, Malaysia, Singapore, Taipei, and Thailand have already started policy normalization, they've raised interest rates in the last few months, and we believe that they are in the right direction and the pace at which they are normalizing monetary policy, we believe they are using the right one. We think therefore that they should continue at the pace they seem to be comfortable with and we believe that this is quite appropriate given the strength of their recovery and other economic indicators in these countries which have already started policy normalization in the monetary area.

And getting to China, unlike these countries China hasn't really gone for monetary normalization through interest rate hikes but they have done quite a bit of administrative measures to rein in very strong growth in bank credit, they've even raised reserve requirements of banks. Now what we believe is that they've done the right thing. In addition, just about a month ago, they've also announced that they will go in for more flexibility in the exchange rate regime. So we believe all these things are in the right direction, and going forward, building on these measures, our assessment is that China perhaps will benefit if it speeds up this process of monetary policy normalization and of course among other things we believe that China would benefit also by letting more flexibility in its exchange rate and perhaps letting the currency appreciate some more along with other measures of raising rates for example, quite consistent, quite comfortable at the pace that is appropriate for the domestic economic conditions. We're not saying that China should just focus on currency appreciation and not do the other things. They are better off by having a mix of monetary conditions normalizing. But I think currency appreciation on the one hand and perhaps raising rates at the appropriate pace dictated by domestic economic conditions is the right approach.

What about those countries that have not yet started the policy normalization in emerging East Asia? We believe that countries such as Indonesia and the Philippines and even Viet Nam which have not started the process given that even in these countries recovered strongly perhaps we think they can't wait for too long. But they should start monitoring policy normalization sooner rather than later.

To sum it up, the external environment remains positive. For emerging East Asia the region's V-shaped recovery is very much on track and therefore it's time to unwind policy stimulus. And a money-first strategy is the appropriate approach while unwinding the policy stimulus, and don't forget the issue of the policy challenge of managing capital flows effectively - they're welcome but beware so policy makers be prepared to manage them properly.

So last I want just to give you, not really to prove how good we were in our forecasting but at least how we are all not bad in forecasting, Forecasting is not rocket science, there are a lot of judgement calls. Here it is, in July 2009 around the same time last year our Asia Economic Monitor had a one-line message for the region: The region is entering a transition from recession to recovery. We saw the early signs of the region transiting from recession to recovery back a year ago in July 2009. And again in December when we brought our second issue of the Asia Economic Monitor we had better news for all of us. The region is having a V-shaped recovery. So seven months down the line our one-line message on the recovery story is that V-shaped recovery which we spotted very early in the day in December 2009 is very much on track and given all these things, the takeaway the last one-line, it's time to unwind the policy stimulus.

Q & A:

Media Relations Specialist Karen Lane (Moderator):

Okay, thank you. For anyone of you who doesn't know their way around the report the table that Srini pointed out with all of the forecasts for each of the economies for this year and next year is on page 35 of the report just in case you wanted a quick rundown of the forecasts for this year and next year as well as the performance in previous years. So that has all of the economies covered in the Asia Economic Outlook, 14 economies plus right on top of the table our new forecasts for Developing Asia, these are the 45 countries, plus at the bottom the Japan, US, and the eurozone.

Okay, I don't know if anybody has any questions or anything they just want to follow up at all for either Srini or Lei Lei. If you do just raise your hand wildly in the air and if you do, let me know who you are representing and we can take it from there.

Q: Why is inflation not a threat at this point despite the growth so far achieved by the region? (Straits Times)

A: Thank you for the question. That's a good one actually. When a region or a country is hit by a huge shock and demand shock and then it had actually caused a huge slowdown, then of course the first thing to recover is output because as firms start to see the more positive signs and pickup in demand they simply start producing more, start slowly using existing labor, existing capital, and therefore output recovers, and over time of course that also leads to fresh hiring, not just using your existing labor.

Once that starts, prices start adjusting upwards. Once wages start rising, unemployment declines in a big way. Generally the trend is therefore from a huge slump caused by an external demand shock output recovers quickly, fast, and then wages and prices recover, somewhat with some kind of lag, that's why we see inflation although rising but it's still manageable. But don't be complacent because that condition may not last long. As the labor market tightens many of these countries have firms and companies that start hiring in a big way in response to the pickup in the demand and recovery. Wages will go up and could put further pressure on prices and inflation. And that's why we are saying although you are not seeing a huge problem in inflationary pressures, the signs are there, you'll need to take this as a leading indicator. Given the strength of the recovery and the trend in prices for inflation although not hugely problematic at this stage, time to unwind now rather than wait for that evil day to arrive and then get panicked. Thank you.

Q: What are the factors that have led to the strong performance of the region? (Bloomberg)

A: As we have said in the report there are many charts and numbers that show the region's strong recovery is due to a combination of two things. One is of course a robust domestic demand.

In many countries even among the ASEAN 4 for that matter we see a very strong recovery in investment and that has contributed to the recovery along with the improvement in external economic conditions.

However the recovery in investment is primarily because of the need for restocking because in the worse of the economic crisis usually firms just draw down existing inventory, they just don't start production unless they realize that demand is picking up then they need to build up inventories and hence the component of investment has really shrunk. Upturn is basically the stock change. So it's not only fixed investment assets.

This is an issue on which we have returned a lot even in other reports. China is not a problem. Fixed investment is going at a very rapid rate actually. The issue there is slightly different. They need to balance the domestic demand growth more towards consumption away from investment. That's the challenge there. But in the ASEAN economies it is very well known that investment collapsed after the 1997-1998 Asian financial crisis and it's not really picked up in a big way and of course as things were changing for the better the region had the unfortunate thing of this global financial crisis on top of that.

Perhaps one of the things that the region at least for ASEAN is that in many of these middle-income countries they are really having a huge challenge in the years to come in terms of graduating from middle-income country status to more prosperous or higher-income countries, which they generally refer to as the middle-income trap. In that particular time investment tends to be a big problem, investment tends to stagnate because they are in the process of graduation. They have exploited the highly labor-intensive manufacturing assembly kind of production process. And now in the graduation to a more technologically advanced knowledge intensive skill production process they need to really look at a lot of things including improving the investment climate, investing in human resources - for example Malaysia has already realized that particular kind of thing.

Many of the middle-income countries do face that challenge, which is not a challenge that can be solved in the next year, in the next two years. It's a more medium- to longer-term challenge of how to bring about a solid recovery in fixed investment among the ASEAN countries.

So of course we always said that there are many things that the countries can do at the national level, but along with that we believe that ASEAN should also focus on completing the ASEAN economic community by 2015 so that we have an integrated ASEAN. Put together ASEAN becomes a larger market, a solid market that foreign investors will look at much more favorably. Today despite the ASEAN integration process everybody thinks it is a collection of 10 different countries, with different investment climates with different investment procedures and administrative requirements. So once integration takes place on top of national level policies that should also help the ASEAN countries.

Q: Is the pace of the yuan appreciation appropriate?

A: It's a good question. I think nobody would be perhaps able to give you the right answer for this question. As to whether the pace of depreciation is right or wrong our assessment is that the authorities in China know very well. They appreciate the point that the Chinese currency needs to be more flexible and that's why after having been tightly managed for 2 years now in the aftermath of the global financial crisis they announced it already a month ago that they will now follow a more flexible exchange rate.

Now the pace at which this appreciation of currency flexibility should continue is something I think should depend on the domestic economic condition. You don't want to let the currency appreciate too much too quickly and then get into all kinds of problems. But on the other hand you don't want to manage it so tightly that you then develop another set of problems on the other end of the equation. So the challenge for China is basically to balance these requirements of letting the currency appreciate at the pace that is comfortable and consistent with economic growth and financial stability conditions.

It's most impossible to say whether it should appreciate by 10%, 15% in the next 5 months, 6 months. What's important is you do need to eliminate the chance for a one-way bet on the currency in the foreign exchange market. If you tightly manage it for a long time currencies then run the risk of the one-way bet because the market knows that the only way the currency will move in the future will be in one direction if you tightly manage it. They know that whatever you do the currency will only appreciate. Hence at an opportune time markets could actually make the situation very dangerous, very vulnerable. So I think the authorities in China have recognized that, appreciated it and that's why they said "we now will allow more flexibility in the currency, in the exchange rate."

How fast it should go? Well I think the authorities know it better I'm sure and I'm sure they will have a right pace, they will certainly follow that. After all they've done it in the two years before they tightly managed it, they've done it very appropriately and the speed was very nicely managed, the way it was let flexible from 8.3 or 8.2 to closer to below 7 so you know that. Although there are many of these econometric and model-based estimates, you know take all these with a pinch of salt the authorities need to do what is feasible, they're on the ground, they're not in a model-building exercise, so they need to do it at a pace that they think is right at a particular economic situation.

Q: The forecast for 2010 for the emerging East Asian economies have all been, you probably noticed, increased, versus the previous report on developing East Asia. I don't know if you want to quickly mention why you upgraded the forecast?

A: Actually for emerging East Asia our forecast, the average growth forecast for the region in last December 2009 was 6.9% or 7%. Now in April we bring out what's called the Asian Development Outlook from Asian Development Bank. There we had the rising up from 6.9% to 7.7%. From this report, in a matter of three months we have again revised it upwards to 8.1%.

The reason why we have done these upward revisions, it's fairly easy to see. First of all growth in the last quarter or in the first half of this year in many emerging East Asian countries has been much better than expected. You all know how Singapore posted a record growth in the first half of something like 18% or 19% which I believe is a record since 1975 when national income statistics started to be published regularly.

We have seen the same thing for many other countries in the region - record growth and therefore we have upgraded it. The real reason behind why the region has performed far better than people expected just about 6 or 7 months ago was that as I said a combination of factors. The region responded to the huge negative external demand shock it received from the global crisis in a very swift manner. Monetary policy in many of the countries was eased quickly in time and by large amounts, and along with that, countries also responded quickly with fiscal stimulus packages. So the policy response has been very swift and in time and that's one of the reasons why I think the recovery has been stronger than many thought even a year ago, even 6 months ago. Coupled with that policy response to which of course we need to give the credit to policy makers, the external environment also improved quite a lot. You saw the sharp rise in global trade, that chart I showed you about global trade growth. So being open economies, these countries also benefited from the improvement in the external economic environment.

So it's a combination of doing the right things at the right time in terms of policy response and of course being very lucky in that the external environment improved quicker and far more than people thought in the worst months of the crisis.

Moderator:

Okay we'll then wrap it up there. Thank you very much for coming. As I said if you've got any more questions we'll be around for a little bit longer but I think everything probably should be pretty clear from the Asia Economic Monitor at the beginning where there are highlights which run through the main points of the whole report, the main section on growth and also the special section on the unwinding of the policy stimulus. Thank you.