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Asia's post-crisis challenges

By Anoop Singh
November 12, 2009 12:13 IST
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Asia is rebounding fast from the global financial crisis. Initially, the impact on the region was extremely severe, with output in most countries contracting by more than even those nations that were at the epicentre of the crisis. But now Asia is surging ahead as the world pulls out of recession, writes Anoop Singh.

For India, we expect the recovery to strengthen in the coming quarters, led by private domestic demand as investment should be boosted by rising business confidence and favourable financing conditions, and private consumption benefits from reduced uncertainty and an improving employment outlook.

While exports are also expected to revive, the Indian economy depends on the recovery of global demand to an extent smaller than what the rest of the region requires to revive.

Asia's impressive recovery from the global downturn, even as output elsewhere remains sluggish, has prompted some observers to revive the notion that the region has "decoupled" from the rest of the world.

The International Monetary Fund's latest Regional Economic Outlook (REO) for Asia and the Pacific finds that the opposite is true. In fact, the primary driver of Asia's recovery has been a return towards normalcy following the abrupt collapse of global trade and finance at the end of 2008.

Just as the downturn in the US triggered an outsized fall in Asia's Gross Domestic Product (GDP) due to a drop in the international trade and the financial collapse, now the return to their normal condition is generating an outsized Asian upturn.

For this reason, the collapse and subsequent rebound in economic activity have been the fastest among the export-dependent Asian economies that were hit most severely at the end of last year.

The other key driver of Asia's recovery has been the region's rapid, forceful and comprehensive policy response. In many countries, government fiscal positions were sounder, monetary policies were more credible, and corporate and bank balance sheets were sturdier than at any time in the past.

This gave Asia the space to cut interest rates sharply and adopt large fiscal stimulus packages. As a result, overall domestic demand has held up remarkably well, despite weak private demand.

In India too, policies reacted quickly. Monetary and fiscal easing, together with the fiscal stimulus already in the pipeline and a faster-than-expected normalisation of financial conditions, has supported growth. And, looking beyond the dampening effects of the scarce monsoon, several indicators suggest that industrial and services activities are gathering momentum.

Dual challenge

According to the IMF's latest forecasts, output in the large G-7 economies is forecast to grow by just 1.25 per cent next year, insufficient to compensate even for half of the 3.5 per cent contraction estimated for 2009. In essence, the problem is that private demand in these countries remains hobbled by the legacy of the crisis.

Households cannot spend and banks cannot provide sufficient credit since they must focus instead on repairing their balance sheets after the sizeable destruction of wealth that occurred during the recession - in the US, household wealth declined by around $14 trillion at the trough, an amount nearly equivalent to the US' GDP. G-7 consumption is consequently likely to remain weak for some time, limiting external demand for Asia's products.

As a result, the region's GDP growth is estimated at 5.75 per cent in 2010, well below the decade's average of 6.66 per cent.

All across Asia, policy-makers consequently face two major challenges. In the near term, they will need to work out a balancing act, providing support to economies until it is clear that the recovery is sufficiently robust and self-sustaining.

At the same time, they must ensure that programmes are not maintained for so long that they ignite inflationary pressures or concerns about fiscal sustainability.Policy-makers will need to assess the state of private demand, and the extent to which it can serve as substitute for a withdrawal of public sector demand.

So far, private demand remains weak, and the outlook is far from encouraging, both in Asia and elsewhere.

India is very fortunate in this regard: It has a dual engine for growth already. While exports expanded rapidly in the years preceding the crisis, the lion's share of India's growth came from domestic demand and investment in particular.

Hence, the key issue for India is sustaining the expansion in capacity, especially in infrastructure, so that supply-side constraints can be overcome. At the same time, as the RBI Governor has highlighted, India is likely to face some difficult trade-offs sooner than other countries.

First, inflationary pressures are likely emerging and this is not only because of rapidly-rising food prices. Second, given India's weaker fiscal position, a detailed plan to underpin the authorities' commitment to fiscal deficit reduction is likely to further help the recovery.

Growth engine

The other major policy challenge will be to devise a way to return to a sustained and rapid growth in a new global environment of softer G-7 demand. In this new world, Asia's longer-term growth prospects may be determined by its ability to recalibrate the drivers of growth to allow domestic sources to play a more dynamic role.

This type of successful rebalancing will require action on a broad front. Reforms to strengthen financial intermediation and better social safety nets will be needed to bolster private consumption, while structural reforms will raise productivity and allow for a smooth reallocation of resources across the economy to compensate for the lower momentum from exports.

Also crucial will be a willingness to live with smaller current account surpluses and a more flexible exchange rate management. The G-20 nations, which include six countries in Asia, have agreed to work together to promote domestic demand as a way of ensuring strong, sustainable and balanced growth at the global level.

The IMF has been helping countries to meet these challenges. For example, it has responded to the needs of its emerging market members in creating a new, more flexible lending instrument for crisis-prevention, and more generally our programmes have become more flexible and sensitive to individual country circumstances.

India has played an important leadership role by providing a $10-billion loan to bolster the IMF's lending capacity. The IMF has recently provided Asian central banks with $54 billion in resources through its recent allocation of Special Drawing Rights, an artificial currency allocated to member countries that can be converted into international currencies so they serve as a supplement to official foreign reserves of the member countries.

Moreover, we are working hard on a global level to prevent such a crisis from happening again. We are sharpening our Financial Sector Assessment Programs, and have launched an Early Warning Exercise to focus on systemic risks. In addition, we are helping launch a mutual assessment exercise for the G-20 forum, where India will play an instrumental role, so that the world's largest advanced and emerging countries can analyse the consistency of their policy frameworks with the requirements of balanced and sustained global growth.

The current crisis has demonstrated the resilience of Asia's economy to the biggest financial shock since the 1930s. But it has also posed challenges, foremost among them being the need for the region to recalibrate its growth model. Now is the time to implement policies that can make domestic demand a second engine of growth, thereby paving the way for a strong and durable expansion.

(The author currently serves as the director of the Asia and Pacific Department at the International Monetary Fund.)

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