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Taking the Long View in Asia as the U.S. Financial Crisis Unfolds

September 24, 2008

Over the past few weeks, as the U.S. financial system has reeled from a shocking series of major “adjustments,” Asia’s economists and bankers remind themselves of the key lessons — painfully taught — by the Asian financial crisis of the late 1990s:  (a) all markets are linked; (b) financial markets are much more volatile than others and thus require more stringent oversight and regulation; and (c) refocusing on economic fundamentals is key to long-term recovery and growth.

Taking the long view, the medium-to-long term impact of the U.S. financial crisis on Asia is likely to be muted. In the next 18 months or so we may expect a dip in aggregate economic performance in a period of international uncertainty, exacerbated by inflation in most countries due to higher fuel and food prices, and likely worsening existing welfare differentials within and across countries in Asia.

The impact of the current U.S. crisis is now spilling over into the broader world financial markets. Yet, it is still unclear how much of the volatility in the financial sectors will impact the “real” economic sectors ” housing, labor, and manufacturing. The U.S. government has implemented major rescue and corrective actions, but the adequacy of these still needs to play out over time and will need to be carefully assessed, particularly in the period around the U.S. Presidential elections.

Although Asia’s exports may suffer from the slower growth in the West, strong domestic demand ” driven by private consumption, investment in fast-growing countries, and fiscal accommodation ” underlies Asia’s growth and thus should mute the impact of Wall Street’s “meltdown” on Asia.   Unlike the build-up to the Asian Financial Crisis of 1997, there are currently no signs of excessive current account deficits. Countries in Asia have reduced their dependence on bank financing and improved the health of their banking sectors, particularly as oversight and regulation have been strengthened across the board.

Overall, consensus forecasts indicate that developing Asia’s economy grew 8.7% in 2007 but is projected to slow to 7.5% in 2008, and 7.2% in 2009. The slowdown is anticipated due to the combined effects of the downturn in the G3 (European Union, Japan and particularly the United States) economies, sustained high fuel prices, and the impact of inflation spiking at 3.9% in 2007 and forecasted at 6.1% in 2008 and 4.8% in 2009.

Asia’s currently healthy macroeconomic fundamentals underlie its resilience, enabling countries to adopt supportive fiscal and monetary policies and accumulate healthy foreign reserves. Government budget deficits throughout Asia have gradually declined — and in some countries have turned into surpluses.

Inflation ” not Wall Street — is clearly the major macroeconomic challenge that is foremost in the minds of Asia’s economic managers.  In the past year, China and Vietnam have already tightened their economic policies, helping moderate growth to a still rapid 10%.  Central Bankers across the region, while nervously watching developments in the U.S., are cautiously implementing various controls on financial transactions and instruments.

Export-dependent economies in East and South-East Asia will see their exports contribute less to growth, but on-going expansion in China and the Middle East will continue to offer opportunities for both foreign and domestic investment. South Asian economies are traditionally driven by domestic demand and will therefore benefit from strong private consumption and investment ” in addition to, in some countries, expansionary fiscal policy.

In the worst case scenario of a significant recession in the U.S. and a deeper depreciation of the dollar, the impact across Asia will be varied. Most vulnerable will be the exporters of high technology products, such as electronics, to the United States: Singapore, South Korea, and Taiwan. Also vulnerable are those countries with large garment and textile sectors whose main markets are the U.S. and the European Union. The anticipated lifting of restrictions by the European Union and the U.S. on some categories of garments and textiles produced by China will pose severe challenges to South Asia.

However, the Indian and Chinese economies will remain reasonably resilient, as strong domestic demand should partly cushion the external shock.

Overall, Asia is likely to readily weather the relatively short-term global uncertainty in 2008 and 2009.

Bruce Tolentino is The Asia Foundation’s Director for Economic Reform and Development Programs. He can be reached at btolentino@asiafound.org.

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