Asia after the subprime crisis

Asia after the subprime crisis

Emerging Asia’s economies have been among the most dynamic in the world in the last decade. Today, the region accounts for almost half of global economic growth. Much of this success stems from broad reforms by these countries in the last 10 years. These have led to healthier financial and corporate sectors and more robust macroeconomic policy across the region. The recent financial turbulence, still playing out across the globe, highlights the question of just how vulnerable the region remains to developments in the US and other industrialized nations.

What, therefore, are the key strengths and vulnerabilities of the region today? And what challenges are Asia’s policymakers likely to face in the period ahead? The International Monetary Fund’s (IMF) Asia and Pacific department addresses these issues in detail in its Fall 2007 Regional Economic Outlook.

The region weathered well the recent global financial turbulence, when concerns over rising defaults in the US subprime market led to increased volatility in equity and credit markets worldwide. Its equity markets did initially decline along with other emerging markets. Asian currencies did experience downward pressure, and financial conditions did tighten. However, what is striking is the speed with which it recovered from this initial shock. Capital inflows to the region have returned, and its equity markets are now about 10% higher than before the summer’s turbulence. IMF foresees only a modest slowdown in 2008, to about 8.5%, resulting from lower external demand for Asia’s exports, and an assumed effective policy tightening in China.

The subprime crisis has, however, increased uncertainty about the outlook for the global economy—and for emerging Asia. First, it remains uncertain whether we have seen the worst of the global financial turbulence or if there are additional shocks ahead. The region’s apparently small exposure to subprime mortgages and structured products more generally has helped moderate the impact of the crisis on Asia. Another bout of global financial volatility could have significant spillovers for the region. It could reverse inflows and make financing more difficult for a number of sovereign and corporate borrowers.

But perhaps the main risk to the region is that of a sharp slowdown in the US and the euro area, resulting from the persistent US housing doldrums and associated global financial problems. Despite the view being expressed that Asia has “delinked" from the US and other industrialized countries, the truth is the region remains significantly dependent on exports to the rest of the world. While an increasing share of exports is within the region, much of this still reflects the integrated production processes within Asia, with much of the final demand still in the industrialized world. So, how big an impact would a US or global slowdown have on Asia? IMF staff estimates that a 1 percentage point decline in US economic growth could reduce growth in emerging Asia, through lower exports, by up to 0.4 percentage points. While sizable, this would not have a dramatic impact on these economies.

Overall, then, the outlook for emerging Asia remains positive, but the economic environment will, as always, present a number of policy challenges. First, policymakers need to be ready to respond to a slowdown in the global economy with a more accommodative monetary policy. Second, the volatile global environment has raised uncertainty regarding capital flows to the region. Countries will need to continue to be pragmatic and allow for greater exchange rate flexibility to create a two-way risk in foreign currency markets and promote a rebalancing of growth where necessary. This is pertinent in China, where the current account surplus has continued to grow and the currency remains considerably undervalued relative to medium-term fundamentals.

Finally, the subprime crisis, while so far largely skirting the region, will provide a number of lessons for Asia, as its financial systems become more sophisticated. This is likely to include the need for enhanced financial supervision. At the same time, countries will also likely need to strengthen reporting and disclosure requirements and pricing and provisioning rules to deal effectively with complex financial products, and the cascading system of risks they imply.

(David Burton is director of IMF’s Asia and Pacific department. Comments are welcome at