Foreign Correspondents' Club, Hong Kong, China
6 April 2011

Moderator: Omana Nair, Director, Department of External Relations, ADB

Hello and good morning. My name is Omana Nair, director for the Department of External Relations of ADB. I know many of you are already familiar with ADB, but for those of you who aren't, we are a multilateral development bank based in Manila. We're very pleased to have our global launch of the ADO at the FCC here in Hong Kong.

Those of you who follow the ADO will know that it is our flagship annual economic report that analyzes trends and forecasts in the Asia-Pacific region.

Today we're going to be looking at how economies performed last year, what we can look forward to this year and a little bit of how ADB foresees the region performing in 2012.

ADO 2011 actually comes in three parts. Part 1 looks at the global economic conditions underlying our assessments and projections for the region, and then Part 3 evaluates on a country-by-country basis the performance of 45 of our member-economies and also provides some macroeconomic projections.

Part 2 contains the theme chapter, and this year we focused on what we term as the South-South economic links, specifically, how Asia can benefit from the southward shift in the global economic center of gravity and what new opportunities for Asia's trade and investment will open up in these markets.

So, on this note, I would like to introduce our Chief Economist for ADB, Dr. Changyong Rhee, who will present to you the key findings of ADO. Let me hand over to Dr. Rhee.

Presentation Proper of Dr. Rhee

Thank you Omana.

It's my pleasure and my privilege to brief you on the ADO 2011. In my talk I'll first focus on the economic outlook of the global economy and then Developing Asia. And then I'll discuss two important policy challenges that Asia has to face this year, in the short run and in the long run, which is related to our theme chapter, which is South-South economic links.

Let me run through the key messages first. Asia's recovery is quite firm with growth rate nearing 8% in the next two years, more specifically 7.8% in 2011 and 7.7% in 2012 despite modest recovery in the major industrial countries. However, inflation pressure is building up and, considering the geopolitical risks in the Middle East and North Africa, we expect high oil prices is likely to continue which may make Asia -- home of 2/3 of the world's poor -- quite vulnerable to the inflation pressure, especially food price inflation. Therefore, we believe the first priority that policymakers this year should focus on is how to manage inflation expectation.

Over the medium term, the challenge for Asian economies is to sustain its high growth for the next decade. It has to find alternative and supplementary source of demand and new source of growth for the global economy as well as the Asian economy. It is very unlikely that major industrial countries will be the engine of growth for the global economy again any time soon. So, in order to take up the slack from the West, Asian economies have to find new and alternative source of aggregate demand. That is why we are looking at South-South economic link as an alternative.

It is encouraging to find that South-South economic links is expanding quite rapidly in this decade. For example, the share of south trade among world trade was about 7% in 1990 but has increased in two decades up to 17% in 2010.

But in order to maximize its potential, we find several structural weaknesses that need to be overcome. Let me explain those weaknesses later in my presentation that we will need to address to maximize the impact of the South-South link.

Let's move on to our findings on the economic outlook. First about the G3 countries, we expect the major industrial countries to continue its moderate economic recovery and they are expected to grow at 2.1% in both 2011 and 2012.

The moderate recovery in the United States and Eurozone are expected to continue and their growth rate will be quite similar to the current level. As you can see, the U.S. is expected to grow 2.8% in 2011 and 2.6% in 2012 and for Eurozone, the growth rate will be 1.6% in the next two years.

Japan had a relatively higher growth rate in 2010 because of the technical rebound from the very low growth in 2009 and, even without the earthquake, we expected Japan's economy to slow down a little because it rebounded quite quickly last year. In addition, they will have to face a new challenge from the earthquake. Overall, we expect Japan's economy to grow by 1.5% in 2011 and 1.8% in 2012.

Because of this modest recovery, even though oil and food prices are higher, we expect G3 countries' inflation rate will be between 1% and 2% in the next two years.

There are several risks remaining, though. One is the rising oil and food prices which I already mentioned. And in Eurozone, sovereign debt problems in several peripheral countries are still not fixed. In the US, labor market and housing market are still weak even if they are recovering. As I mentioned, Japan has to face a new challenge from the earthquake.

Contrary to the modest recovery of the G3 countries, Developing Asia's recovery is firming. Asia has grown 9% last year, but they will continue with a 7.8% growth and a 7.7% growth rate in the next two years. This high growth is led by China whose growth rate last year was over 10%. The growth rate of China will slightly moderate but it will continue to have a higher than 9% growth. In 2011 it is expected to grow 9.6% and in 2012 it is expected to grow 9.2%.

India is also doing quite nicely. Their growth rate will moderate a little bit like China. Their growth rate will be above 8.2% in 2011 and 8.8% in 2012.

It's not just for India and China, actually the high growth in Asia is quite broad-based and other regions are actually doing well. Central Asia benefits from the higher oil prices, so it will actually have a higher growth rate compared to last years. The region will have higher than 6% growth rate.

East Asia, led by China, will still have above 8% growth rate. Southeast Asia, and if you look at Indonesia, it is doing quite nicely and its growth rate is projected above 6%. Malaysia, its growth rate will moderate but it will continue to have a growth rate higher than 5%.

The Pacific region will be led by the natural resource-rich countries such as Papua New Guinea. The region's growth rate will be above 5%.

Another important factor, unlike the past, the growth of Asia last year was led by domestic demand rather than external demand. Here (pointing to chart) the yellow bar means domestic investment and green bar means the private consumption. As you can see, except for Singapore, for most of the Asian countries the lion's share of the growth rate was due to the expansion of domestic consumption and investment, it was domestic demand-driven.

Because of that, Asia contributed a lot to the global recovery. This graph shows the average export growth rate of the four non-Asian developing countries, Brazil, Mexico, Saudi Arabia, and South Africa, we chose the larger ones, and also the advanced economies, France, Germany, Japan, and United States. This chart shows the average growth rate of export of these countries to the 10 large Asian countries versus the rest of the world. As you can see the blue bar indicates the growth rate of these countries' exports to Asia. Except for France, every country in the list exported significantly more to Asia during the period from the third quarter of 2008 to the third quarter of 2010. The export to other regions actually shrunk during this period.

It shows that Asia was the engine of global recovery in the last two years. It means, because of the appetite for more imports from Asia, the current account surplus of Asia is actually falling and this trend will continue in the next two years. The current account surplus in Asia in 2009 was 4.7%, now it is expected to go down to 3.3% in 2011 and 3.0% in 2012. Especially in 2011, due to the high oil prices, we believe the current account will shrink substantially. Whether this indicates the structural rebalancing, it is premature to judge. But, there is a trend that the current account surplus is going down.

However, inflation pressures are building up. The average inflation rate in Asia was 4.4% in 2010. It is expected to increase to 5.3% in 2011 and we assume the Asian governments will do monetary tightening and pursue anti-inflation policies. That is why we are expecting inflation in 2012 will moderate to 4.6%.

But, this average inflation rate actually undermines the differences across countries. If you look at the numbers, there are several Asian countries which have double digit inflation already. The inflation is increasing quite rapidly and there are some countries with signs of overheating too. Let me show you the real interest rates of several countries. As you know, Asian countries like other Western countries have relied on expansionary fiscal and monetary policies in coping with the crisis in the last two years. So, their policy interest rates have been quite low. With the start of increasing inflation, real interest rates of several Asian countries are negative and some show signs of financial repression indicating that monetary policies may still be too loose.

So it's not just average inflation rate. But also, when compared with their policy rates, there are some signs of overheating and the need for tightening more monetary policies in the future.

Inflation matters a lot more in Asia, especially the food price inflation. This chart shows that the average share of food items in CPI in Asia versus some advanced economies. If you look at the food share in CPI, United States and Eurozone are about 14%, Japan is exceptionally high at about 25%. But if you look at the food shares in the Asian countries, it's above 40%, and sometimes it's near 60%, which means, when food prices increase, the pass through from food price inflation to the general inflation is a lot faster in Asia. Also Asia is home of 2/3 of the world's poor, and the food is a major element in essential consumption of the poor so it has a larger impact on the poor and consequently inequality. That is why managing inflation is so important for inclusive growth in Asia and this point is well emphasized in the recent 12th 5-year plan of China.

But managing inflation is not an easy task. Especially if you tighten monetary policy to fight inflation pressure, then inevitably it will invite more capital inflows especially now, since the interest rates in the advanced economies will be low. So when Asian countries tighten their monetary policies, the interest rate gap will widen and there is a risk of inviting more volatile capital inflows in the short run.

There can be many policy options to counter these capital inflows. For example, you can rely on the exchange rate appreciation or you can intervene in the exchange rate market. But when you intervene, that may inevitably increase your domestic credit, and that can be sometimes self-defeating. Some country can opt for capital controls, but we all know the advantages and disadvantages of capital controls.

So here, there is no one answer. But, we believe that coherent policy mix is the key to success because Asia will confront two problems: how to cope with inflation pressure and at the same time how to cope with subsequent capital inflows. We believe that, for countries with persistently large current account imbalances with some sign of misaligned exchange rate, probably allowing more exchange rate flexibility can be an answer.

But there will be several Asian economies that do not have a large current account surplus and no sign of misalignment of the exchange rate, which at the same time facing volatile capital inflows in the coming years. For those countries, we believe temporary capital controls, if that can be done in a carefully and internationally coordinated manner, can be an answer.

Actually, today there are newspaper reports that the IMF is considering some rules or framework for capital controls for those countries. We are in the same line and we are very glad that G20 actually is thinking about developing the practical indicative guidelines for measuring large current account imbalances and the principles for capital controls.

We believe that this is a very productive approach. Capital controls, if introduced unilaterally, may harm the countries which actually initiate these capital controls. At the same time, if you allow capital controls to be executed by individual countries, there is a risk of being protectionist. So, the best way to use this tool is through an internationally coordinated manner.

Let's move to the second part of my presentation, which is the theme chapter: The South-South link. Why are we looking at the South-South link? In the short-term, the important policy task of Asia is how to cope with inflation. But over the medium term, I think the most important policy challenge is to find new, alternative and supplementary source of aggregate demand for the global economy as well as for Asia given that we are expecting slow recovery of advanced economies.

It's very encouraging that the South-South economic link is expanding rapidly. By the South I mean Developing Asia, Latin America, Africa, and Middle East all together. The share of the South in the world GDP has increased from 27% in 1990 to 45% in 2010, and most of this increase is largely due to the rapid economic growth in Asia.

Together with the GDP growth, trade also expanded very rapidly. The share of the South-South trade as a percentage of the world trade was 7% in 1990 now it is 17% in 2009. Trade within Developing Asia was the lion's share of this increase. Interestingly, it's not just for trade. Developing countries are usually the recipients of the capital inflows but, thanks to the high growth, several high-savings developing countries became capital exporters too.

Together with the GDP growth, trade also expanded very rapidly. The share of the South-South trade as a percentage of the world trade was 7% in 1990 now it is 17% in 2009. Trade within Developing Asia was the lion's share of this increase. Interestingly, it's not just for trade. Developing countries are usually the recipients of the capital inflows but, thanks to the high growth, several high-savings developing countries became capital exporters too.

But this growing importance of South-South trade is driven mostly by rise of the factory Asia, which means Asian countries outsource parts and intermediate goods to other Southern developing countries and assemble them and export to the more affluent, advanced economies. So, it structurally depends on the final good demand of the advanced economies.

So, the growing importance of this trade and economic size in Asia does not necessarily translate to the growing independence of Asia from the West.

There are other structural weaknesses. If you look at the average tariff rate within the South, it is currently 9.3%. On the other hand, the average tariff rate within the North is about 3.2%. So, average tariff rate of the South is 3 times larger than the average tariff rate in the North.

There are evidences that non-tariff barriers are also high within the South than within the North. Trade related infrastructure and logistics performance of the South lagged considerably behind the North. We also examined the South-South FTAs. Even though there are many FTAs being agreed within the South, but usually the South-South FTAs are generally less consistent with WTO rules compared with the FTAs we made with the North. So within South-South, there are still higher non-tariff barriers.

Our study shows that by removing these barriers, the South can gain a lot. For example, by lowering the average tariff rate to the level of the North will increase South-South trade by 6%, and most gain will be attributed to the South.

There seems to be a bright potential for South-South cooperation, too. High-saving Asian countries once have received manufacturing industries from the West, and that actually was the main source of economic growth in the past. Now it may be time for these more affluent Asian countries with their high savings to promote industrial migration to some of the less developed Asian and African countries. That will enhance the growth potential of the less developed countries in Asia and Africa. At the same time, by channeling their savings into this type of investment rather than holding them in safe assets in advanced economies, they can contribute to rebalancing the global economy and to the stability of the world financial market.

So, we believe there is a large room for improvements in the South-South cooperation that does not necessarily compete with the South-North links. We believe the South-South economic link is currently the weakest link that has great potential to be a new source of global growth.

In sum, our ADO finds that the Asian recovery is quite firm, with the growth rate nearing 8% in the next two years. Asia will and is leading the global recovery but rising inflation is a concern and the policies will have to be quite coherent in coping with inflation.

Over the medium term, in order to continue this high economic growth in Asia, we have to find alternative and supplementary source of new growth. South-South economic link has a great potential. But several structural weaknesses have to be addressed.

Thank you very much.

Director, DER:

Thank you Dr. Rhee.

Let's now open the floor to questions. My colleagues will pass around the microphones. Please state your name and organization before asking your questions. Thank you.

Q1. Thank you. Tom Holland of South China Morning Post. Dr. Rhee, I may be missing the point here. You say that South-South trade could emerge as a major driver of global growth but you also say that a large part of it, I believe ADB research estimated 2/3 of intra-Asian trade is driven by final demand in the developed world, which you also say has seen weak demand so how given that demand comes from the developed world can sell South trade the driver of global growth, it simply doesn't work.

A1. What I'm saying is that within the South-South trade, within Asian trade is the lion's share at this moment. But Asia's trade with Latin America for example is growing quite rapidly, too. At this moment non-Asian South-South trade is about one quarter of the whole South-South trade and it's also growing. You are right that, if you look at the microstructure of the South-South trade, this growth is largely driven by the final good demand from the North. So, in the future, if the growth rates of the advanced economies slow down, the South-South trade may not be an independent source of new demand because of this structural weakness. That's why we are saying at this moment that, in order for South-South trade to be a new independent source of demand in the future, this weakness has to be addressed. That is why we're promoting more final good trade within South-South and South-North and the importance of reducing the tariff and non-tariff barriers within South. This will help the North too, since if South invest more in less developed other Southern countries rather than investing in safe assets abroad, definitely more capital goods will be imported not only from South but also from the North. We can have a virtuous cycle. The hard question may be how you can promote this kind of investment flows within the South even though the North is not willing to do it because of other risks. The same goes to the question how to promote final goods transactions, which how to increase domestic expenditure within South-South. But there is a growing sign, as the ADO report shows, that recent domestic demand-driven growth in Asia contributed a lot to the recovery of the North. That is why we are saying that there is a great potential for South-South cooperation.

Q2. My name is Kenjie Koasi, Nikkei. I have a question concerning the earthquake in Japan. You mentioned that regardless of the earthquake, the growth rate of Japan was heading down, could you please elaborate more on the impact of the earthquake to the Japanese economy and also to other economies as a whole in Asia please?

A2. First let me express my sincere condolence to the people in Japan and the Japanese government. This is really a big tragedy. As for the economic impact on Japan, I think we really have to differentiate its impact on stocks versus its impact on flow, which is the economic activity. When this natural disaster happens, it causes a serious damage to capital stock, infrastructure, loss of the people life, welfare and so on. Economic activity also, in the short run, in the next one or two quarters, can be significantly affected because of the production channel disruption and some other reasons. But past experience tells us that, over the medium run, the economic activity can catch up quite rapidly through the reconstruction process. So we believe that this earthquake in Japan, in the short term -- in the first or second quarter, will have significant negative impact on Japan's growth. But long-run growth prospect is less dire and we may see higher growth rate because of the reconstruction process. This does not necessarily mean that the loss is small.

As for the impact on other Asian economies and the global economy, it is premature to judge them yet because the situation is still unfolding. However, under the assumption there is no further deterioration of the nuclear situation in Japan, we believe that the ripple impact on the rest of the Asian region can be limited. In theory, the impact can be transmitted through trade and finance channels. For trade, I think the production channel disruption can affect significantly other countries which have close ties with Japan especially in the short run, say in next one or two quarters. But most Japanese companies are multinational companies and they can have a flexibility to shift their production line abroad over the medium term. And customers of the Japanese goods also have the flexibility to switch their production lines over time. Immediate impact on export and import is not clear either. It can go both ways. For example, Japan may require some specific goods more during the reconstruction period. Countries which produce those kinds of goods may see their exports actually increase, not decrease. I do not mean the impact of Japanese earth quake will be small. But, I want to say that its impact on trade will be mixed. Likewise, in the short run, production channel disruption can be a serious problem, but with the flexibility I mentioned, the economy will rise quickly. If you look at the past history of natural disasters, we have observed the same pattern. They had an immediate negative impact. But growth rate rebound quite quickly. So, unless we see another disruption in the nuclear situation in Japan, I don't see why we have to assume differently this time.

Q3. I just wanted to move on to talk about natural disasters, losses. How do you see micro-insurance as a tool to combating natural disaster losses?

A3. We do not have those numbers to judge its effectiveness. I think the World Bank recently published the numbers about the private insurance companies' coverage for damage and loss, but I do not know well on how they did it. We ourselves do not have the data.

Q4. This is Osmond from ETNet. The Chinese government has several rate hikes this year and you mentioned that inflation problems would be a main concern this year. Do you think rate hikes would be a useful tool to control the inflation in China and how many times do you expect the rate hikes this year?

A4. I think China's recent monetary policy is going in the right and desirable direction. Rising inflation is a concern especially because the geopolitical risks heightened market expectation about higher inflation. So, in order to cope with inflation expectation, I think the recent tightening policy by China is timely. It's very hard to forecast how many times they will increase interest rates in the future, but I believe there is room to tighten monetary policy a little bit more given their policy rate is still at modest level compared to the inflation rate. China can also use several policy mixes – inflation and exchange rate appreciation for example. China has been quite practical, pragmatic in designing this mix. So, I think they will continue to do so.

Q5. Dr. Rhee, Alex Frangos from The Wall Street Journal. We've seen announcements of public sector minimum wage increases, specifically Viet Nam and the Philippines and elsewhere in Asia. Wage increase story had been a China story last year but it seems to be a more of a regional issue. Can you talk about how this impacts inflation and growth and other issues.

A5. You have to think of a minimum wage policy as a kind of micro tool to protect the poor from the rising inflation, especially food price inflation. Minimum wage has many pros and cons. Some economist doubt whether it can be an effective tool especially for the advanced economies' case. To judge the pros and cons we need to have more concrete evidence on how many workers are covered by the minimum wage laws, and how easily it will transmitted to the general increase of wages. So it's very hard to say if it's a good policy or it's a bad policy for a specific country without having detailed information. But given the current situation where there are many poor who will suffer from the high food inflation, you can understand why many government think minimum wage not as a part of macro policy but as a part of micro policy for the social safety net.

Q6. You mentioned that some countries might need to turn to capital controls in order to stabilize the exchange rate especially inflation. In the last 12 months we've seen countries like Korea, Indonesia, Thailand they have actually reverted to certain capital control measures in a limited way. How effective has these instruments been up to now and can you quantify a bit.

A6. First let me emphasize that we are not promoting capital control without any qualification. As you can see in our slide and news from the IMF and G20, we believe that capital controls has to be used very cautiously. We are proposing capital controls for countries which do not have a persistently large surplus, which do not have any sign of misalignment in the exchange rate, and if they want to use capital controls, still it should be executed in an internationally coordinated manner. I think the past experience of the capital control in Korea, Malaysia, and other countries cannot be a good case study of what we are trying to achieve now. If the capital control is used unilaterally by one country, its effect can be quite limited and it may harm those initiating countries disproportionately because capital can leave swiftly and there is a stigma effect. And also there is a transparency issue, and IMF hasn't allowed any capital control previously. Now there seems to be a big change in their stance. By seeing the recurring financial crisis in the 1990s and now the subprime crisis, I am very happy that advanced economies are finally willing to listen to Asia's experience. We kept on saying that crisis is not just due to macro fundamental problems. Capital volatility can be a problem. We also say that individual capital control effort can be very fragile and ineffective. After the 1997 Asian financial crisis, ADB and most Asian countries wanted to raise these issues from our experiences. Now, finally, I think we are going in the right direction. When you ask me how we can quantify capital control's impact from previous cases, I think the past experience is not a good benchmark because at that time many countries were doing it unilaterally. But now at least G20 countries are getting together and are seriously discussing what should be internationally agreeable rules and framework for capital controls. It's not yet done but we are watching very closely and we expect it will be very good outcome for many small open economies. I'm sorry, it is very hard to quantify because the situation is very different.

Q7: Thank you for your presentation. (Canadian consulate). Could you say a few words, a bit of a general question of the overall role of the G20 since its birth four, five years ago, do you see this body has its place should be more formalized. Your views please.

A7: Before I became Chief Economist of the ADB, I was a Sherpa of G20 in the Korean government when we hosted G20 summit. So, probably I have to say not as a Chief Economist but based on my experience as a Sherpa. I think G20 is a belated response to the economic reality reflecting the importance of the emerging South. Now when you look at global issues, I don't think there is any issue which the G7 countries alone can solve at this moment – climate change, global rebalancing, you name it. That's one of the reasons why we look at the South-South economic link, too, in ADO. Asian issues are no longer Asian issues but are global issues. At the same time I think it's good that by having a G20, now G20 can require Asian and other emerging economies to share the responsibility too. As our economic size increases, the role of Asia in contributing or resolving global problems has to increase commensurate with our economic power.

I also think G20 is a good combination of efficiency and representativeness. They showed their effectiveness in fighting the global financial recession after subprime crisis. Whether the G20 will continue depends on the whether they can continue to show the effectiveness. So far, G20 did a good job in fighting the global recession and raising important global issues. But if they fail to deliver any concrete outcome in the future, people may seek an alternative forum. Maybe sometime in the future, the membership issue will rise again but, for the time being, I think the key for the G20 success is to show its effectiveness by showing deliverable outcomes to the world.

Q8: You mentioned that the Chinese government launched some mixed monetary policy to manage inflation. But we know that the rate hikes or adjusting the exchange rates will attract more capital inflows to the Asian countries. Can you give some suggestions how the Asian countries manage their inflation but not attract too much capital inflows to their countries?

A8: That will be very hard. And depending on what system, answer can be quite different. For example in Hong Kong, you are running a currency board system so independent monetary policy is quite limited. So when capital inflows, you have to think other way to control this flow and domestic liquidity by using financial policy, lending policy, for example. In general, you may rely more on flexible exchange rate, and that may contribute to reducing the inflation pressures from the high oil prices. But, for some countries which do not have any sign of currency undervaluation, policy makers worry about losing international competitiveness, and they may not be inclined to currency appreciation. In that case, they may rely more on monetary policy. What we're emphasizing is that there can be many policy mix but the final target should be clear in this year, i.e. to manage inflation rates. When you mobilize many policy tools you should avoid inconsistency. For example, when you tighten monetary policy and capital flows in, in order not to lose international competitiveness, if you intervene in the exchange rate market then your domestic credit will increase and this is an example of inconsistent policy.

Q9: Kelvin Chan from AP. The figure about the 2/3 of the world's poor being in Asia, do you have an absolute number for that?

A9: Around 900 million.

Closing Remarks of Director, DER:

Okay thank you very much Dr. Rhee.

Let me just quickly wrap up because we had a lot of very wide-ranging discussions and questions. We can say Asia's economic recovery is firm and is leading the global recovery with growth projections of 7.8% for 2011 and 7.7% in 2012. Obviously there are some risks and challenges and supplementary sources of growth should be developed such as the South-South trade links, which has been expanding rapidly, particularly in Asia.

Once again on behalf of the Asian Development Bank I would like to thank all of you for attending the press conference today. Looking forward to seeing you all again soon.