Global financial turmoil has intensified in recent weeks and the world economy is entering a deep and protracted slowdown.
Despite emerging Asia’s strong fundamentals—notably its substantial cushion in official reserve and robust corporate and banking sector balance sheets (and limited exposure to US subprime mortgages and structured credit products)—any hope that the region would escape the crisis largely unscathed has evaporated. Weak global growth will depress demand for Asia’s exports; indeed, a significant export slowdown is already under way. And the global financial turmoil is making itself felt strongly in the region, including through much tighter funding conditions, more volatile capital flows, sharply depressed equity prices, weakening currencies and higher sovereign and bank spreads. Looking ahead, slowing domestic economies (and, in some cases, cooling housing markets) will likely raise pressures on companies, contributing to a rise in bad loans and credit costs for banks, and risking an adverse cycle of tightening credit conditions and deteriorating economic growth.
The International Monetary Fund’s (IMF) Asia and Pacific Regional Economic Outlook, forthcoming early this week, projects a significant slowdown across the region, with growth falling well below the trend in almost all countries. While emerging Asia is expected to escape the sort of full-fledged recession now expected for the US, the EU, and Japan, risks—notably from the global environment—are large and clearly to the downside.
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Policymakers in the region have responded to the worsening economic environment with a range of measures. Several governments have broadened or increased guarantees on bank deposits or other liabilities, while central banks have taken steps to provide both domestic and foreign currency liquidity on an emergency basis. The focus of monetary policy in the region has been shifted decisively to supporting growth, and a number of fiscal stimulus packages have been adopted or announced.
These efforts should help limit damage to the region, but going forward, more will need to be done at both the global and national levels.
First, Asian policymakers need to continue to focus on ensuring financial stability and the functioning of credit markets. Despite the financial stresses, conventional bank lending in the region has held up reasonably well so far and policymakers need to stand ready to minimize the tightening of overall credit conditions and its spillovers to the economy. Monetary authorities will need to continue to supply their banking systems with adequate domestic and foreign exchange liquidity, develop contingency plans to extend guarantees and recapitalize banks, if necessary, and consider steps to support trade credit should serious difficulties emerge. In all this, transparency and communication will be the key to allowing both citizens and global investors to understand what is being done and why.
Second, monetary policy in almost all countries in the region should maintain an accommodative bias. With weakening domestic demand and lower commodity prices contributing to sharply reduced inflation risks, monetary policy should now be aimed squarely at supporting growth. However, with inflation rates still above target in some countries, communication by central banks regarding the economic outlook and the expected path of inflation will play a key role in anchoring expectations.
Third, fiscal policy can play a key role. Given the progress with fiscal consolidation in the region, most countries have room to use fiscal policy to support growth, albeit to varying degrees. While the best approach will differ across countries, fiscal stimulus is most effective when it is timely, temporary and targeted to purposes providing the biggest “bang for the buck”. Infrastructure spending can be part of the mix provided projects are high quality and can begin to be implemented quickly.
Fourth, intervention in the foreign exchange markets should be limited. A number of regional currencies have weakened sharply since September. While some intervention may be warranted to smoothen excess exchange rate volatility and to address possible overshooting, sustained one-sided intervention may backfire, resulting in larger and more disruptive adjustments later. Moreover, given the potential need for further foreign exchange liquidity provision in some countries, international reserves should be marshalled for their most critical purposes.
Finally, despite Asia’s generally strong fundamentals and appropriate policy response so far, it cannot be ruled out, especially if the global financial crisis intensifies, that some Asian economies may experience liquidity difficulties. The international community needs to stand ready to provide large-scale and rapid financial assistance in those circumstances. IMF is ready to do just that, and has already moved quickly to help emerging-market countries in other regions.
So while the period ahead will undoubtedly be a difficult one, Asia’s strong fundamentals, coupled with a focused and proactive policy stance, should limit the damage. Given Asia’s role in recent years as a global engine of growth—the region contributed at least half of global growth in recent years— an effective policy response will be critical both within the region and for the global economy.
David Burton is special adviser to the IMF managing director and former head of its Asia and Pacific department. Comment at email@example.com