Asia's Response to Export Shock is EncouragingRupert Walker
Which countries are most vulnerable to the global economic slowdown and, worse case, how might that vulnerability manifest itself?
Most vulnerable in Asia are economies that already suffered from domestic structural challenges going into this export downturn. This limits their ability to offset the external drag on growth with domestic demand. Northeast Asian economies appear more vulnerable on this count, with Japan and Taiwan already encountering lacklustre consumption and investment spending before the export crisis hit. These countries will likely see more vigorous pump priming as a result, but it is unclear whether this can overcome the double blow of faltering exports and structural domestic challenges.
Can Asian economies sufficiently boost domestic demand to compensate for the fall in export revenues as an engine for GDP growth?
Asian economies are mostly geared towards exports, a path that has led to spectacular growth results in the past. The region now needs to engineer a rebalancing whereby domestic demand takes over as a driver for growth. In practice, however, it is extremely difficult to retool entire economies over night. It appears somewhat misplaced to expect private domestic demand to compensate for the huge loss in export revenues. Therefore, aggressive government spending must fill the gap for a while to maintain growth. This, in principle, should be sufficient to cushion the blow from exports. But since it represents in a sense an artificial boost to domestic demand, questions over the sustainability of this strategy arise.
How effective will the various fiscal stimulus packages be?
For most Asian countries, the fiscal stimulus will prove quite effective. The critical issue here is the health of the financial system. Since the region as a whole has not seen the same financial sector dislocations as so spectacularly unfolded elsewhere, fiscal spending should prove relatively more effective. There are two ways to look at this. First, government expenditure is never enough on its own to carry an economy. Rather, what's needed is a private sector response to official pump priming—the famous multiplier effect of fiscal spending. This hinges importantly on the health of banks, which need to be in a position to supply credit to the private sector to amplify the effect of government spending. Since in most Asian countries the banks remain sound, there should also be an adequate multiplier effect.
Second, since banks are overall in better shape in Asia, governments do not have to divert resources to clean them up. During the Asian financial crisis, the region's governments ran large budget deficits; this wasn't the result of pump priming, but almost exclusively due to the fact that banks needed recapitalisation.
Are there any positive signs, or are most Asian economies sliding into ever deeper recessions?
So far, there is no hard evidence that Asia's economies have started to accelerate. We long anticipated the bottom of this crisis to be during the first quarter. However, the effects of government stimulus packages, lower interest rates, and fading inflation should only begin to get traction in the second quarter. So we expect high-frequency data to turn more positive only in about April or May, which should provide some relief to markets.
What more danger signals should we look out for?
For now, we require a little patience. There are powerful forces in play that should lead to a mild recovery in Asia in the second half. The policy responses marshalled by Asian governments are historically unparalleled. But, come the second quarter, we would look for signs that domestic consumption and construction activity is picking up. If it doesn't I would fear we would be in for a much more protracted contraction in output.
Can Asia insulate itself in any way from problems in the US and Europe?
The export shock for Asia is difficult to underestimate. Ultimately, the region requires a recovery in US and EU demand since the domestic Asian consumer is not yet in a position to carry the day. Our argument, however, is that temporarily, aggressive fiscal spending, and in some cases aggressive bank lending, can help bridge the shortfall of export demand. But this is not a sustainable position.
Is the International Monetary Fund still important, or has its role been taken over by cooperative arrangements, for example currency swaps, between Asian countries?
Fortunately, most Asian economies remain in a strong financial position, with foreign exchange reserves at very comfortable levels. There is therefore no imminent need for IMF financing. However, regional swap arrangements are only partially effective since they depend in many cases on an IMF program being in place. So we would not discount the importance of potential IMF funding entirely. Moreover, for a number of the smaller countries, the new IMF short-term funding facility serves as a potential weapon against excessive exchange rate volatility.
Are the policy responses by Asian countries appropriate and timely?
The speed of the policy response in Asia, as well as in the rest of the world, has been breathtaking. It is probably somewhat misplaced to expect these measures to work over night. Officials therefore face the difficult task of calibrating their policy response without knowing the exact effect this will ultimately have on growth and financial stability. We suspect that most policymakers are currently holding back in expectation that growth will indeed begin to recover in the second quarter. Otherwise, we would be in for another round of fiscal packages and perhaps rate cuts.
How much more deleveraging by investors, and hence exit from Asian stock markets, do you think will be done?
I suspect that a lot of capital has already left the region. This is not to say that more deleveraging might not occur, but the macroeconomic impact is likely to be less severe. For the remaining capital outflows, most Asian governments are still in a comfortable position to absorb these with their foreign exchange buffers. Moreover, most Asian financial systems are flush with liquidity—and I would ultimately expect this to be deployed in financial markets as well, once the outlook stabilises. In fact, I remain hopeful that Asian savers will become over time more diversified in their portfolios and thereby reduce the dominance of foreign investors as drivers of their stock markets.
Do you anticipate political or social instability anywhere due to rising unemployment?
Unemployment is on an upward trend across the region, driven in part by the tumble in export demand. But, it is important to remember that in many cases the majority of job losses have occurred in domestic sectors, and especially construction. This reflects Asia's domestic demand slowdown that was the result of last year's inflation surge and monetary tightening. To the degree that construction revives due to official pump priming, lower inflation and interest rates, we also expect some re-absorption of labour, helping to cap the rise in the unemployment rate. We therefore remain optimistic that the social and political fall-out can be contained as well.