Luncheon lecture by ADB President Haruhiko Kuroda on the Economic Prospects and Challenges for Developing Asia on 17 March in Tokyo, Japan
Introduction
Distinguished journalists, guests, ladies and gentlemen:
It is pleasure to be back at the Foreign Correspondents Club of Japan. Since I last spoke at your club in July 2008, much has changed for the global economy, the economy here in Japan, and for the economies of developing Asia and the Pacific specifically. We read a lot of stories, many from your esteemed journals, about how developing Asia, and the People's Republic of China in particular, is leading the world out of recession.
Based on recent data, the recovery continues to gain traction in our region, and 2010 is looking to be a stronger year than previously expected. The challenge for developing Asia now is to ensure the recovery is sustainable, and that Asia assumes its appropriate role in helping guide the global reforms needed for future crisis prevention and management.
I will, therefore, touch on four main issues. First, what are the prospects for continued recovery in developing Asia? Second, what are the risks to that outlook? Third, what are the policy issues we need to confront as authorities shift from crisis management to reform of the global economic and financial architecture? And finally, why is cooperation globally and regionally so important?
Regional economic trends and 2010 Outlook
Much of Asias economic fate still relies on the prognosis for economic recovery in the advanced G3 economies. The collapse in global demand dealt a harsh blow to Asia's exports. Worst-affected were the most open, trade-dependent economies particularly the newly industrializing economies and several Southeast Asian economies. Much intra-regional trade is in parts and components supporting supply chains that feed into more complex products, and this only added to the vulnerability of the region's economy. Demand from Asias export markets is returning, perhaps not as quickly as we would like. But it is showing that the external economic environment facing our region is gradually improving, if unevenly.
In the US, the "Great Recession"as some call it appears to have ended. But after-shocks of the financial crisis are likely to continue to weigh on the US economy. Most important is the high unemployment rate and lower consumer spending as households reassess their balance sheets and trim debt. The eurozone has also shown some improvement. But the Greek debt crisis is casting some shadows on the recovery and shifting worries from bank risk to sovereign risk. Here in Japan, following the sharp contraction last year, I am happy that the outlook is for a return to growth in 2010, despite continued worries about deflation.
These generally positive trends in the G3, along with a strong rebound in world trade, have helped the economic recovery in developing Asia. I want to stress the word helped, because it was the rapid monetary and fiscal stimulus measures in Asias developing economies that really initiated and then gave traction to the regions economic recovery. ADB's growth forecasts show that we are amid a V-shaped recovery. From a high of 9.5% in 2007, growth in developing Asia dropped to just 5% in 2009. Last September we predicted gross domestic product in developing Asia would expand 6.4% in 2010. In December we revised the forecast upward to 6.6%. Our Asian Development Outlook 2010, due out next month, will likely further revise upward regional growth forecasts. It will also present our initial forecasts for 2011.
However, there is definitely a multi-speed recovery across developing Asia, with wide variations expected in economic growth rates. Authorities will be challenged to forge a policy mix that balances continued stimulus where needed with a process of returning the primary sources of growth to the private sector. This may be tricky.
For example, with macroeconomic policies remaining accommodative, economic activity in China is expected to maintain its growth momentum into 2010. China introduced a massive stimulus package of more than 15% of GDP including subsidies in rural areas for consumer products such as appliances, and lower taxes on purchases of fuel-efficient cars. As a result, after hitting a two-decade low of 6.1% growth in the first quarter of 2009, China's GDP expanded by 10.7% in the fourth quarter. But as we have already seen, authorities there are carefully assessing when, by how much, and where to fine-tune fiscal and monetary policies to avoid a return to overheating. India, too, appears to be on track for an upgrade in growth forecasts.
In the newly industrialized economies, which are highly dependent on exports, a return to rapid growth could be as quick as the contractions they suffered given the rebound in world trade. And, after suffering their biggest slowdown since the 1997/98 Asian financial crisis, the four middle-income ASEAN economies should return to robust growth in 2010. Indonesia has shown particular economic resilience.
Balances of payments are forecast to strengthen on the back of stronger exports and the continuing return of capital inflows. And luckily, inflation remains manageable in most cases, even though it has picked up from the low levels in 2009.
What to watch out for: Risks to the outlook
But we always need to keep a watchful eye on those things that could go wrong; that could slow the recovery or signal an increase in systemic risk, as occurred in 2008. That we certainly do not want.
The risks now to this year's outlook for developing Asia are relatively balanced. Should challenges arise, the region's authorities have the wherewithal and policy tools to handle some of them. Other obstacles would be harder to surmount.
For example, there could be a reversal in growth in advanced economies if deleveraging, for example, on US balance sheets, happens suddenly. Or the EU could suffer further difficulties, for example, from the Greek debt crisis. A default would certainly dent financial and consumer confidence in Europe, leading to slower growth. And the situation could rapidly escalate, should fear spread to other highly-indebted European economies.
In short, the recovery in developed economies may still falter.
There are also risks closer to home. China's strong growth, which has played a large role in the region's recovery, might lose momentum for a variety of reasons. There is concern that the large increases in bank lending in 2009 may be creating asset bubbles, particularly as property prices continue to soar. And, there is always the possibility that, in their eagerness to extend loans, banks in China may have unwittingly relaxed underwriting standards. This could result in larger write-offs or nonperforming loans in the future, if asset prices go down sharply. This, of course, could then dent consumer confidence and dampen investment, especially in construction.
The strength of Asias recovery itself, or the shift away from stimulus, could cause sudden destabilizing capital flows, as interest rate differentials rise compared with more advanced economies. The region could attract more "carry trades," where investors borrow a low-yielding currency such as the US dollar to invest in higher-yielding currencies elsewhere. These could significantly complicate developing Asias macroeconomic management. Authorities may be wary of letting currencies appreciate, fearful of undermining competitiveness. Furthermore, excessive inflows could cause the region's currencies to overshoot their long-run equilibrium rates.
Policy issues and challenges
The global economic crisis showed plainly that the industrialized world, the US in particular, has too much debt, while emerging economies, including those in Asia and the oil exporting countries, have too many savings. Asia's excessive dependence on external demand from a narrow range of countries jeopardizes steady growth. Rebalancing the sources of growth toward greater domestic and regional demand is therefore key in sustaining the regions future development, and in helping resolve the large global payments imbalances that helped spawn the crisis.
While the export-led model has contributed to Asias impressive growth over several decades, slowing or uncertain demand from advanced economies implies that the region must strengthen its domestic and regional demand to fill the gap. To do this, authorities should continue with deeper, more comprehensive structural reforms while further developing their financial sectors. This could include reducing borrowing constraints, particularly for households and smaller companies, and allocating financial resources more efficiently.
Augmenting domestic demand requires a mix of optimal policy measures, which will differ from country to country, given the diverse current account positions. It could involve demand-side policies that encourage households to spend more and companies to invest more, as well as supply-side policies that promote small and medium sized enterprises and service industries catering to domestic demand. More broadly, Asian authorities should continue to remove barriers to intraregional trade, particularly behind-the-border obstacles to freer trade in goods and especially services; and promote regional cooperation.
Critically important at this juncture of the regions economic recovery is the timing and, perhaps even more importantly, the composition of stimulus exit strategies. Premature policy exits could jeopardize a return to sustainable growth. On the other hand, holding on too long could cause distortions or unsustainable fiscal deficits. It is thus paramount that national authorities coordinate closely with one another. Monetary and fiscal measures must be closely aligned so authorities do not create unwitting policy errors; working at counter-purposes as stimulus is unwound.
And, further to their potential risks to the growth outlook, capital flows must be managed judiciously. They can be both geographically unbalanced as well as functionally unbalanced. For developing Asia, it is essential to direct foreign capital to less volatile longer-term investments. It can be done using a three-part approach. First, Asian countries need to improve the investment climate. Second, they need to strengthen domestic financial markets within a proper regulatory environment and maintain appropriate levels of foreign reserves. This is especially true for those economies with managed exchange rate systems. And third, they need to support the establishment of regional capital markets. This will better tap and mobilize the regions ample resources.
The need for global and regional cooperation
One of the most positive responses to the global economic crisis has been the willingness for policy coordination and cooperation among economies across the globe. The rise of the G20 and Financial Stability Board gave great impetus to managing the crisis. But now we need to move forward with greater earnest to the crux of the issue. And that is the goal of ensuring global financial stability. Managing crises is one thing; preventing them is essential. A global system where cooperation can occur quickly and with sufficient flexibility can work. I just came from a conference discussing reforming the global reserve system. These are the more holistic issues that need to be part of the agenda.
Asia needs to contribute more to the reform of the global economic architecture. It is a balance of thinking globally and coordinating regionally. Integrate regionally, but stay globally connected.
Regional cooperation is almost a precondition for workable global reform. And Asia is working to bring regional policy coordination and cooperation to the next level, while remaining cognizant of global concerns. The crisis has made the benefits of the regional cooperation quite clear. The crisis also provides the impetus for deepening cooperation on trade, finance, economic surveillance, and monetary cooperation. The opportunity to move to a much higher level of development is there for those who will think globally, cooperate regionally, and act nationally.
I am pleased to note that Japan will chair the Asia-Pacific Economic Cooperation (APEC) in 2010, and host a number of APEC meetings, including the Economic Leaders Meeting in November. Aside from addressing the most obvious challenges, such as the threat of protectionism and the lack of trust in financial institutions, these meetings should recognize that 2010 is the deadline for industrialized economies to achieve APECs Bogor Goals. The goals were set in 1994 to establish free trade and investment in the region, but progress for the past 10 years has been limited. Addressing the quality and quantity of investment will substantially raise the region's medium-term growth prospects.
Conclusion
In conclusion, developing Asia has done well in handling this severe global financial and economic crisis. It continues to strengthen. But its diversity leaves many risks and challenges to building sustainable growth. One is to shift of the sources of growth more toward domestic and regional demand without losing export momentum or openness. Others include the timing and composition of stimulus exit strategies. Others still involve avoiding destabilizing capital flows. Asia also must acknowledge it has growing global responsibilities. And through greater regional cooperation, we can all do our part to help ensure greater financial stability and increased prosperity in the region and around the world.
Thank you.