Asia Through the Crisis Report

8/9/2019 Asia Through the Crisis Report

1/128monitor group

Asia through the CrisisPERSPECTIVES ON EMERGING ECONOMIES IN THE GLOBAL ECONOMIC RECOVERY

Maarten Kelder Nikhil Prasad Ojha Victoria Barbary

SEPTEMBER 2009


2/128

FOR MORE INFORMATION PLEASE CONTACT:

Maarten Kelder, [email protected], +..

Nikhil Prasad Ojha, [email protected], +...

MONITOR GROUP IN ASIA:

BEIJING

Twin Towers No. B, Jianguomenwai Avenue, Beijing , +

HONG KONG

Shui On Centre, - Harbour Road, Hong Kong S.A.R., +

MUMBAI

Free Press House, Nariman Point, Mumbai , +

NEW DEHLI

Rectangle , Saket District Centre, New Delhi , +

SEOUL

CCMM Building, Yoido-dong, Youngdungpo-gu, Seoul -, +

SHANGHAIK. Wah Center, Middle Huaihai Road, Shanghai , +

TOKYO

Kandabashi Park Building, - Kanda-Nishikicho Chome,Chiyoda-ku Tokyo -, +

www.monitor.com


3/128

Executive Summary ............................................................................... 4

Introduction ............................................................................................... 8

Crisis and Response ............................................................................. 2

A Microeconomic Map of Asia ....................................................... 4

The Entrepreneurship Vertex .......................................................... 6

The Role of Sovereign Wealth ...................................................... 86

Conclusion............................................................................................... 11

ENDNOTES...................................................................................................117

ACKNOWLEDGEMENTS...............................................................................121

Asia through the CrisisPERSPECTIVES ON EMERGING ECONOMIES IN

THE GLOBAL ECONOMIC RECOVERY

Maarten Kelder Nikhil Prasad Ojha Victoria Barbary


4/128

AppendixExecutive Summary


5/128

Executive Summary

WITH THE GLOBAL ECONOMIC CRISIS of 2008-2009 entering a new

phase that portends recovery, at least in the short-term, we can begin to view it in

perspective. One point now seems clear: the still-current theory that emerging high-

growth economies, particularly in Asia, are decoupled from advanced economies

and can independently manage their own recoveries and contribute to the resolu-

tion of the global downturn, is being disproven. In fact, the world we live in is

more tightly intertwined than ever before and is advancing toward ever greater lev-

els of global integration and interdependence. The financial turmoil originating inNorth America quickly spread to the economies of Asia and the rest of the world,

underlining the close and tight interconnections linking emerging and advanced

economies. Similarly, signs of incipient recovery in the summer of 2009 are appar-

ent not only in the emerging Asian economies, but also in the advanced economies

of Europe, North America, and elsewhere.

Asia through the Crisisillustrates this lesson by considering how Asian countries

responded to the crisis in this connected global reality, how their responses fared,

and how their economies are positioned to move forward. While recognizingthat Asia is merely a geographical conceit in reality, it is a vast and diverse

territory the report focuses particularly on the critical emerging economies of

China and India, which commanded so much of the worlds attention before

the crisis and have so far performed remarkably well. This performance testifies

partly to the specific and quite different macroeconomic responses, the mix of

fiscal and monetary policies, as well as the sector- and location-specific policies

CALL CENTER, BANGALORE, INDIA

Call centers are part of Indias quickly growing services sector. Exports ofservices are expected to overtake exports of merchandise as early as .

1

MONITOR COMPANY GROUP, L.P. 2009

ASIA THROUGH THE CRISIS


6/128

Executive Summary

that China and India have enacted. However, Chinas and Indias performance

also reflects solid underlying economic fundamentals that will persist and under-

gird their growth in the years ahead.

Observers had presumed Asia would be relatively insulated from Americas sub-

prime mortgage debacle and the ensuing crisis of the financial sector, but the shock

arrived swiftly after the failure of Lehman Brothers. In Q4 2008, GDP in Asia

(excluding China and India) plummeted by almost 15 percent, with traded-mer-chandise sectors suffering particularly hard blows. In China, where annual GDP

growth had been running in double digits, economic expansion braked sharply to

6.8 percent. Indian growth slowed to 5.8 percent from 8.4 percent in Q3.

And just as swiftly came Asias response, in the form of monetary and fiscal stimulus,

led by China rolling out a $588 billion package in November and India commencing

the first of three smaller packages the following month. Chinese fiscal measures

poured money into fixed asset investment mostly roads, railways, housing, and

other infrastructure and into subsidies, tax breaks, and other incentives to spur

the purchase of big-ticket items like vehicles, white goods, and televisions. After

several quarters of tight money, loosened monetary policy swamped the economy

in liquidity; firms expanded, jobs were created, and consumer spending rose, but

much of the bank loans wound up in property, equity, and commodity speculation.

Indias three stimulus packages were scattered across a host of targeted beneficiaries

and interest groups and seemed devised with May 2009 national elections in mind,

in which the Congress Party and the governing coalition prevailed. The packages

contained $8.2 billion of new spending primarily earmarked for rural infrastructure

projects and additional guarantees to the housing, auto, and small and medium

industrial sectors. Other spending was directed to an expanded safety net for rural

poor and to civil service pay increases. The FY2010 budget included an additional

$65 billion of new spending, most of which will go to rural areas under the populist

2




7/128

Executive Summary

rubric of inclusive development apparently with an eye to consolidating the

political gains of Congress and its coalition partners.

The stimulus packages of both countries are generally credited with producing the

resumption of impressive GDP growth rates in the face of a global slump China

may see 9 percent this year, and India 6 percent. But overall, both efforts yielded

mixed results. In China, continued heavy stimulus in export-oriented sectors led to

concerns about overcapacity and insuffi

cient economic restructuring away fromtraded manufactures and toward domestic consumption. In India, the picture was

reversed: businesses were disappointed that most of the stimulus was directed to-

ward consumption and that the government had missed an opportunity to invest

massively in infrastructure and thus help businesses reduce their transaction costs.

As the region recovers from the global downturn, its continued growth and pros-

perity will rest on the strength of fundamentals that came through the crisis largely

intact. This report is based on Monitor Groups research in three topic areas cen-

tral to national and local economic performance: 1) the sources and determinants

of microeconomic competitiveness; 2) the contribution of entrepreneurship to

economic growth and prosperity; and 3) the deployment of capital by sovereign

investors. Observing the records of prominent Asian economies during the global

crisis through these three lenses, we draw the following conclusions:

Despite broad popular interest in decoupling the notion that

Asias business cycle is, or is becoming, independent from that

of the advanced economies the record shows that the Asian

economies are increasingly and inextricably interlinked with thoseof other countries in the global economic system. Asian econo-

mies were profoundly affected by the crisis and their recovery will

proceed in concert with recovery elsewhere in the world.

3




8/128

Executive Summary

The Chinese and Indian economies will emerge from the crisis

with microeconomic competitive advantages intact. Those clus-

ters that were performing strongly going into the crisis will almost

uniformly emerge in strong, and perhaps even improved, posi-

tions. In China, sectors such as electrical equipment and lighting,

textiles, and apparel will thrive despite the rise of down-market

regional challengers that were harder hit by the global slump in

orders. India seems likely to be one of the winners coming out ofthe downturn, as many of its most competitive clusters such as

software, IT services, and business process outsourcing will find

ready markets as firms worldwide look to cut costs.

The fundamental source of competitive advantage in both China

and India remains low-cost production or service offerings, pri-

marily based on labor-cost advantages. Neither country to date has

established an innovation capability leading to high value-added

product and service offerings competitive with global leaders. For

either nation to thrive as home to competitive clusters in automo-

tive, alternative energy, fast-moving consumer goods, or certain

other sectors, it will need to upgrade its capacity to innovate.

The regions microeconomic competitiveness receives a powerful

multiplier from Asias spirit of entrepreneurship, a vibrant force

throughout the region and, according to the Monitor Entrepre-

neurship Benchmarking Survey, particularly well established in

China and India. Although individual entrepreneurs may have

suffered setbacks, the abundance of entrepreneurial spirit is a par-

ticular regional resource that elsewhere is so unequally distributed.

Much of the regions entrepreneurial energy will be expended in

the true engines of economic growth, small and medium enter-

4




9/128

Executive Summary

prises China alone has some 36 million SMEs, a third more

than in the whole of the European Union. In India, 13 million

SMEs operate in the formal and informal sectors, with formal-

sector SMEs employing nearly a million people.

The sovereign wealth funds of Asia symbolize both the regions

outward-looking intent as well as its increasingly tight economic

linkages to the developed West and to the world. As diverse in

character and constitution as their parent economies, these deep

pools of liquidity played a vital role in the stabilization of the

global financial services sector at the end of 2007 and begin-

ning of 2008. As such, the Asian parent governments signified

their commitment to the global economic regime and a sense of

responsibility for ensuring its survival. SWFs hurt by the losses

incurred during the crisis nevertheless remain active investors, al-

though with an increased sense of caution and a new appreciation

for risk.

Our review leads us to expect that, as Asias economies emerge from the crisis,

they will:

Remain tightly coupled to the Wests advanced economies, by

both circumstance and choice. The national and economic inter-

ests certainly of China and India, as well as those of Japan, South

Korea, and Asias other strong economies, are heavily invested in

national economic models based to a great extent on traded mer-

chandise and services.

Manifest significant differences in terms of economic, politi-

cal, and social models, paths to growth, sectoral strengths and

weaknesses, and contributions to the stability of international

economic institutions.

5




10/128

Executive Summary

Remain competitive and entrepreneurial. The crisis has, if

anything, heightened the sense among Asian companies and en-

trepreneurs of their own vulnerability and expendability in the

fury of the creative destruction that characterizes innovation in

market economies.

Pay increasing attention to productivity. Despite a GDP of nearly

$8 trillion, Chinese workers generate only about $6,000 per capita,

less than that of Kiribati.* Nearly 30 percent of Indians live be-

low the official poverty line. Chinese and Indian economic policy

makers seem to recognize the primacy of innovation in increasing

productivity one senior Chinese official went as far as to pro-

claim, Innovation is the most critical issue facing China.

Strive to balance their economies, taking into account tradeoffs

between bolstering domestic actors and personal consumption

and looking outward with export-oriented industries and services

playing a productive role in the global economy.

Asias rebound and Chinas and Indias passage through the global crisis on a sus-

tained growth trajectory highlight the importance of the emerging economic giants

to the region and to the world at large, but it also raises the critical question of the sus-

tainability of regions recovery, particularly that of China. Different scenarios for the

global economy potentially lead to very different outcomes for the Peoples Republic.

Regardless of the picture that eventually materializes, Chinas transition to domestic

* For all comparative macroeconomic indicators included in this report for example, GDP and per capita GDP weuse purchasing power parity (PPP) rates. As IMF researchers explain, Purchasing power parity rates are an alternative

way of calculating the exchange rate between countries based upon the comparison of prices of similar goods andservices in different countries. The PPP rate is defined as the amount of currency that would be needed to purchasethe same basket of goods and services as one unit of the reference currency, usually the U.S. dollar. Selim Elekdag andSubir Lall, Global Growth Estimates Trimmed After PPP Revisions, IMF Survey Magazine (January 8, 2008) http://imf.org/external/pubs/ft/survey/so/2008/RES018A.htm (accessed August 15, 2009).

6




11/128

Executive Summary

consumption as the key driver of economic growth and prosperity promises to be

one of the governments key economic and social challenges in the coming decade

and a matter of keen interest to the region and the world.

In Asia as a whole, not just in China, higher and more distributed rates of domestic

consumption will be driven by both a relentless creation of new businesses and in-

novative steps to increase the productivity of existing enterprises. This is the province

of the entrepreneur and the innovator. Asia has traditionally competed on the basisof cost leadership, execution speed, and flexibility. Future productivity will be based

on a more diverse set of competitive advantages, such as strategic foresight and in-

sight; product, service, process and business model innovations; customer intimacy

and understanding; capability to internationalize and to understand foreign markets;

and world-class human assets.

Given this transition, we cannot expect Asia even with its mature economies on the

rebound and its emerging economies returning to blazing annual growth ratesto

serve as the worlds economic locomotive. Each remains reliant to varying extents on

foreign markets and foreign direct investment and depends upon a rising economic

tide that lifts all ships, including those of the advanced economies, still the worlds

dominant economic players.

7




12/128

AppendixIntroduction

photograph by Erik Charlton


13/128

Introduction

INSIDE A CHINESE FACTORY

Assemblies of manufactured goods account for a significantshare of Chinese exports, and hence of GDP growth.

ASIA IS THE LARGEST AND MOST POPULOUS CONTINENT

on earth, home to more than forty countries and 60 percent of humankind. Geo-

graphically it extends from the River Bosporus and the Ural Mountains to the

Baring Strait, and the Arctic Circle to the tropical regions south of the equator.

In economic and business literature, this vast and diverse landmass is frequently

reduced to the dragon and the elephant China and India with little acknowl-

edgement of the role of other advanced and emerging countries in the region.

Although this report focuses on the current and future role of China and India in

the global recession, we want to put them into perspective, and acknowledge the

important role played by other Asian economies in global trade, manufacturing pro-

duction, research and development, and financial markets. Where would the world

be without Singapores trade hub, Japanese cars, or Korean electronics? Neither

should we neglect the smaller emerging economies of Asia Indonesia, Malaysia,

the Philippines, Thailand, Vietnam, in particular that do not often make head-

lines but have played a vital role in meeting the developed worlds consumption

demands through export manufacturing and agricultural production.

In this report, Asia denotes countries east of Indias western frontier, south of

Chinas northern border, and north of Indonesia and East Timor. Adopting a con-

vention established by the Economist Intelligence Unit, we divide these into three

groups: 1) Emerging Giants: China and India; 2) Advanced Economies: Japan,

Korea, and Singapore; and 3) Smaller Emerging Economies: a large set including

Indonesia, Malaysia, the Philippines, Thailand, and Vietnam.

9




14/128

Introduction

Figure : The Economies of Asia

Emerging Asian Giants

Mature Asian Economies

Smaller Emerging Economies

India

Nepal

Bhutan

China

Burma

Bangladesh

Sri Lanka

Vietnam

Thailand

Laos

Cambodia

Malaysia

Singapore

East Timor

Indonesia

Philippines

SouthKorea

NorthKorea

Japan

These are an enormously diverse set of economies ranging from some of the richest in

the world such as Japan and Singapore to some of the most deprived Burma,

Laos, and Cambodia. Many of these countries, particularly the emerging economies,

have sustained significant economic growth over the past decade, increasing theirGDP and shifting the global economic balance eastward Asian economies now ac-

count for 31 percent of global GDP, compared to 26 percent in 2000.

10




15/128

Introduction

Without a doubt, however, the largest contributor to the rise of Asia as a glob-

al economic powerhouse in the past decade has been China. As the chart below

demonstrates, China has nearly doubled its share of global GDP in this period,

increasing its GDP by nearly three times and averaging growth of nearly 10 percent

annually. By contrast, the emerging Asian economies, like most other developing

regions, have held their share steady. India falls somewhere between these two sce-

narios, building its share of global GDP by a single percentage point since 2000

by more than doubling its total GDP. But while Indias annual growth rate acceler-ated markedly after 2004, the Indian economy has grown by an average of seven

percent per year over the last decade, which has left it some way behind China. Far

from being economic giants moving in tandem, therefore, the dragon is definitely

outpacing the elephant.

Figure : Share of Global GDP by Region

Note: Asia includes: Bangladesh, Bhutan, Burma, Cambodia, Indonesia, Japan, Laos, Malaysia, Nepal, Philippines,Singapore, South Korea, Sri Lanka, Thailand, Timor-Leste, Vietnam

* IMF EstimatesSource: IMF World Economic Outlook Database April 2009

0%

20%

40%

60%

80%

100%

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009*

UnitedStates

WesternEurope

Asia(excl. China &India)

India

Middle East &North Africa

Africa

Latin America andCaribbean

Others

China

24.0 23.0 23.0 23.0 22.0 22.0 22.0 21.0 21.0 20.0

22.6 22.6 22.3 21.821.2 20.7 20.3 19.9

19.4 18.9

7.2 7.6 8.1 8.6 9.09.5 10.1 10.8

11.4 12.1

8.8 8.7 8.5 8.4 8.5 8.5 8.5 8.6 8.6 8.6

4.0 4.0 4.0 4.0 4.0 4.0 4.0 5.05.0 5.0

3.0 4.0 4.0 4.0 4.0 4.0 4.0 4.0 4.0 4.02.7 2.8 2.9 2.9 3.0 3.0 3.0 3.0 3.0 3.2

15.0 15.0 15.015.0 15.0 15.0

14.014.014.014.0

13.0 13.0 13.2 13.3 13.5 13.6 13.7 13.8 13.8 13.8

11




16/128

Introduction

Despite this impressive performance, it is important not to overstate the global

impact of the Emerging Giants growth. The United States has a $14 trillion econ-

omy 21 percent of total global GDP in 2008 Chinas by contrast is only $8

trillion, and Indias $3 trillion. Moreover, many people in these countries are still

extremely poor; although China has lifted half a billion people out of absolute

poverty in the past thirty years, in 2007 average rural income in China was less than

$1,000 per year and total average annual income in China is less than $6,000. 1 In

India, average annual income is less than $2,800, with 27.5 percent of Indians livingbelow the national income poverty line.2 Moreover, consumer spending a pri-

mary driver of economic growth is not only absolutely lower in comparison to

the West, but also proportionately. Private consumption only accounts for less than

40 percent of GDP in China (but an average of 60 percent of household income).3

Consequently, while we are looking at the worlds most economically vibrant region

in the midst of the current global malaise, it is important that the size and ability of

emerging Asian nations to drive the global economy now, rather than in the future,

is put into perspective.

Popular views of economic growth in Asia, and in China and India specifically,

tend to miss or misread important aspects of the story. The Western media, for

example, has paid relatively little attention to the region and most of that to poli-

tics, natural disasters and other topics unrelated to economic performance. Among

economists and analysts, there is greater interest in decoupling, the notion that

business cycles in emerging markets such as China and India are moving indepen-

dently from those in the advanced economies that is, while fortunes in North

America and Europe are in decline, emerging markets remain relatively strong and

may even offer the prospect of leading the global economy out of the doldrums(see sidebar on page 17).

12




17/128

Introduction

In the first half of 2009, the Western

media largely ignored the impact of the

financial crisis on Asia. Data gathered by

Media Tenor International indicates that

business and economics subjects only

accounted for 10.4 percent of all West-

ern media coverage of the region 50

percent less than the proportion ofcoverage dedicated to business across the

world. Rather, attention was focused on

stories about security and political issues.

As a result, the coverage of Asia in the

Western news media has been predomi-

nantly negative, as issues such as the civil

war in Sri Lanka, corruption in Thailand,

Chinas ongoing mission to purchase

Australian natural resources, and the trialand imprisonment of Aung San Suu Kyi

in Burma have dominated the headlines.

The negative reporting of Asia was exac-

erbated by the fact that as the economic

crisis intensified the Western media

turned inwards, reducing their coverage

of Asia in favour of a focus on the ef-

fects of the crisis on domestic economies

and those closer to home. Nevertheless,

when Asian economies were mentionedin the Western news, mostly in passing,

there was a significantly positive view of

the fiscal stimulus measures being taking

by their governments.

Consequently, in the middle of 2009

coverage of Asian economies started

to pick up as the widespread economic

recovery in the region provided a sparkof good news and hope in an otherwise

bleak economic picture for the United

States and Europe. Although China

remains the focus of the Western news

medias coverage of Asia, with nearly

70 percent of the coverage, the Indian

election in May also garnered significant

positive coverage for India, particularly

in the European media, which perceivedthe re-election of the Congress Party as a

force for stability.

The low level of Western reporting on

Asia, particularly as regards economic

and business issues, as well as the high

level of negative press for the region,

WESTERN MEDIA COVERAGE OF THE GLOBAL ECONOMIC CRISIS IN EAST ASIA

Topic Structure of International TV News, -/

East Asia

14.5%

41.7%

10.4%

13.7%

10.6%9.2%

All Countries

5.7%

28.8%15.5%

20.0%

16.2%

13.8%

Domestic PolicyTerrorism/SecurityForeign Affairs/War

BusinessAccidents/Crime/Human InterestOther Topics

Source: Media Tenor International

13




18/128

Introduction

underlines that Asian countries, even

China, are not presented in the West-

ern media as key players in the global

economy. It is therefore important for

Asian countries to exploit the current

surge of interest in their economies to

ensure their growing role in the recov-

ered global economy and their position

in the G20 are better understood. This

is fundamental to renegotiating their

position in the global political and eco-

nomic balance of power.

Asia In Economic Coverage, International TV News, /-/

20%

15%

10%

5%

0%

Q1 2007

Q2 2007 Q4 2007 Q2 2008 Q4 2008 Q2 2009

Q3 2007 Q3 2008 Q1 2009 Q3 2009Q1 2008

Share of all foreign news stores

Source: Media Tenor I nternational

Visibility of Asian Countries, International TV News, /-/

China

70%

60%

50%

40%

30%

20%

10%

0%

Japan India

Indonesia South Korea Malaysia

Source: Media Tenor International

14




19/128

Introduction

This report takes a different view.Asia through the Crisisassesses the effects of the

global economic crisis of 2008-2009 on Asias economies, paying particular atten-

tion to China and India. It presents an analysis of why Asia was hit hard by the

crisis, how it has managed to rebound so quickly, and whether the recovery is sus-

tainable. The report draws on Monitor Groups research and expertise in three

topic areas central to national and local economic perfor-

mance: 1) the sources and determinants of microeconomic

competitiveness; 2) the contribution of entrepreneurshipto economic growth and prosperity; and 3) the deployment

of capital by sovereign investors. We expand on each of

these topic areas in the major sections of the report follow-

ing the next one, an overview of the macroeconomic and financial policy responses

by governments in the region, with an assessment of the results so far.

First, we penetrate beneath the discussion of national policy to examine the sources

of competitiveness in particular clusters and locations in ChIna and India. Data

from Monitors Global Cluster Mapping Dataset affords a clear picture of eachcountrys most competitive clusters prior to the crisis and the particular locations in

which these have been based. This forms the basis of an assessment of how these

clusters and locations will emerge from the crisis and what developments we can

expect to see in the future.

From there, we turn to entrepreneurship, one of the most powerful underlying driv-

ers of economic growth and prosperity in the modern global economy. Drawing on

the Monitor Entrepreneurship Benchmarking Survey, which has been conducted in

22 countries worldwide, including four in Asia, we compare and contrast China and

India on the key determinants of entrepreneurship, especially cultural attitudes and

mindset variables that are critical to long-term success. Both countries score high

on these important variables.

This report assesses the

effect of the crisis on Asiaseconomies, particularlyChina and India.

15




20/128

Introduction

Next, we examine the activities and behaviors of the regions sovereign wealth funds

as an indication of public investment strategy toward participation in the global

economy as well as in building stronger domestic economies. This section relies on

the Monitor-FEEM Transaction Database, the most complete source of publicly-

reported SWF investment activity available. This dataset enables an intimate view

of the critical role Asian SWFs played in attempting to stabilize the global economy

as the crisis began to unfold and a comparison of two funds, Singapores Temasek

and China Investment Corp., reveals the diverse impact of the crisis and the chal-lenges and opportunities it has posed.

Finally, this report concludes on an optimistic note, suggesting that while the Asia

economies are not yet strong enough to drive the world economy alone that they

are playing a more significant role than they have done for many years.

16




21/128

Introduction

March 2008: Decoupling is not a myth.

October 2008: That was then. Now the emerg-

ing markets are in big trouble.

August 2009: decoupling is real but

Those commentsfrom TheEconomist,

columnist Paul Krugman, and PIMCO

CEO Mohamed El-Eriansummarize

the ebb and flow of the decoupling de-bate over the past 18 months. Although

this report takes the point of view that

decoupling is a misleading notion in an

era of continuing globalization, honest

analysts will in good faith disagree and,

like El-Erian, qualify their views with

nuance and caveats that move both sides

closer together.

Whats all the fuss about? We follow the

Asian Development Bank in technically

defining decoupling as the emergence

of a business cycle dynamic that is

relatively independent of global demand

trends and that is driven mainly by au-

tonomous changes in internal demand.i

But the real argument is chiefly over the

scenario many care most about: whetheremerging Asias business cycle is, or is

becoming, independent of, or decoupled

i Asian Development Bank, Uncoupling Asia: Myth and Reality,Asian Development Outlook 2007:Growth Amid Change(Hong Kong:ADB,2007) available at http://www.adb.org/Documents/Books/ADO/2007/default.asp (accessed August 30, 2009).

from, that of the G3the United States,

the Euro Area, and Japan. An essential

corollary posits a decoupled Asia will be

significantly less reliant on exports, more

driven by internal demand, and thus

insulated from external demand shocks.

By this logic, Asias emerging economies

would then be positioned to grow de-spite downturns in the developed world

and thus able to complement or even

supersede the G3 as the engine of global

economic growth.

Decoupling is thus akin to a partial

reversal of economic globalizationthe

integration of national economies into

the international economy through trade,foreign direct investment, transnational

supply chains, transportation, and flows

of short-term capital, human assets,

and technology.ii Paradoxically, decou-

pling is made possible by the progress

of globalization, and particularly Asias

export-led growth strategy, which con-

nects the emergent economies with their

developed G3 counterparts in robustexchange relationships. Decoupling in

effect requires the weakening of precisely

these seminal ties in favor of regional

ii Drawn, with modifications, from Jagdish Bhagwati, In Defense ofGlobalization(New York: Oxford University Press, 2004).

THE DECOUPLING DEBATE

17




22/128

Introduction

ones, proponents of decoupling generally

justify their view by citing this and other

empirical precipitants:

Trade flows between emerging-

market economies have increased,

more than doubling in the past two

decades, powered by the rise of huge

domestic markets in China and India.

Trade linkages between emerging

markets and the developed econo-

miesprimarily the G 3have

correspondingly contracted.

Demand for commodities from

large emergent economies like Chi-

na and India has bolstered growth

in commodity exporters like Brazil

and Russia.

Financial flows between emergent

economies have increasedChina

gets nearly two-thirds of its FDI

from other Asian countries.iii

iii M. Ayhan Kose and Eswar Prasad, The Decoupling Debate isBack! Foreign Policy Online(posted June 2009) http://www.for-eignpolicy.com/story/cms.php?story_id=5010 (accessed August28, 2009); M. Ayhan Kose, Christopher Ostrok, and Eswar S.Prasad, Global Business Cycles: Convergence or Decoupling?IMF Working Paper WP/08/143 (June 2008) http://www.imf.org/external/pubs/ft/wp/2008/wp08143.pdf (accessed August30, 2009).

Although proponents claim such forces

have already, or soon promise to, effect

Asias decoupling, they are also virtu-

ally unanimous in agreeing that Asia is

at present incapable of serving as an

engine of global growth or of leading

the world out of the downturn if the

United States cannot.

Those who resist the decoupling hypoth-

esis proceed from the baseline point of

view that:

The forces of globalization continue

operate as powerfully as ever, devel-

oped-country and emerging country

business cycles remain closely syn-

chronized across time, and external

demand remains a primary engine of

Asian economic growth.

Study after study has found, as did

the Asian Development Bank in

2007, that there is no evidence

pointing to Asias uncoupling

structurally or cyclically.

The evidence instead runs in the

coupling proponents favor. For

example, from January 2002 to May

2009, the Financial Times Stock Ex-

change (FTSE) All World Emerging

18




23/128

Introduction

index moved in the same direction

as the FTSE All World Developed

index on 75 months out of 89a

correlation of 84 percent.iv

That said, stock markets around the

world are increasingly more synchro-

nized, undermining the usefulness of

equity market performance as an indica-tor of coupling or decoupling. Economic

fundamentals such as GDP, investment,

and household consumption are more

stable and consequently more reliable

indicators. Here the research of Swiss

economist Sbastien Wlti is informa-

iv David Oakley, Decoupling gains new group of cheerlead-ers, Financial TimesJune 11, 2009 http://www.ft.com/cms/s/0/657bedc2-56ba-11de-9a1c-00144feabdc0.html (accessed

August 29, 2009).

tive: when he examined trend growth

rates rather than actual growth ratesv of

emergent and developed economies, the

trend rates exhibited a high degree of

market synchronization, tending to move

together in the same direction at approxi-

mately the same times.

In studying the actual trend growthdata from 1990 to 2007, Wlti found

an increasing degree of business cycle

synchronicity between emerging and ad-

vanced economies, thus concluding that

decoupling was always a mytha view

that we share.

v That is, the average sustainable rate of economic growth over agiven period of time, deriving average growth rates from peakto peak or trough to trough and fitting these into a smoothedgrowth curve.

GDP Trend Growth Rates

10

8

6

4

12

0

-2

1980

TrendG

rowthRates

1985 1990 1995 2000 2005 2009

Share of all foreign news stores

Source: Adapted from Wlti, The Myth of Decoupling, based on data from World Economic Outlook Update, IMF, 6 November 2008.

emerging and developing economies

advanced economies

19




24/128

AppendixCrisis and Response


25/128

Crisis and Response

MUCH TO THE SURPRISE of many seasoned commentators, the global

recession hit Asia hard and fast in the final quarter of 2008. Asia was not linked

directly to the epicenter of the financial crisis, a real estate collapse in the United

States that had begun a year earlier. Neither had Asian banks bought large quantities

of troubled mortgages or financial instruments derived from them. Furthermore,

before the crisis, Asia was in a strong macroeconomic position, and well placed to

resist pressures emanating from advanced economies, even after the ripples and

hiccoughs that had been felt in the financial sector during early 2008 turned intoa tidal wave in September following the collapse of Lehman Brothers, one of the

worlds biggest investment banks.

In the event, however, the impact on Asia was swift and sharp. In Q4 2008, GDP

in Asia excluding China and India plummeted by almost 15 percent on a seasonally-

adjusted annualized basis. In China, where annual GDP growth had been running

in double digits, economic expansion braked sharply to 6.8 percent, down from 9

percent in Q3 and 10.1 percent in Q2, while Indian growth slowed from 8.4 percent

in Q3 to 5.8 percent in Q4.

THE HONG KONG STOCK EXCHANGE

After Tokyo and Shanghai, Hong Kong is Asias third-largestexchange, with an August market capitalization of HK$ ,billion (US$ ,. trillion) and stocks listed.

21




26/128

Crisis and Response

Figure : Gross Domestic Product, Constant Prices, Annual Percent Change

-12%

-9%

-6%

-3%

0%

3%

6%

9%

12%

15%

2005 2006 2007 2008 2009

China

IndiaVietnamIndonesia

MalaysiaKorea

Japan

Singapore

Source: IMF World Economic Outlook Database, April 2009

Asia was hit hard partly because, far from being decoupled from the West, it re-

mains inextricably entwined with the global economy. Although intra-Asian trade

expanded rapidly during the past decade, a large proportion comprises intra-in-

dustry processing and assembly through vertically-integrated production chains.

Virtually all growth in intra-Asian trade in recent years can be attributed to parts and

components, which were re-exported in assembled goods to the West the Asian

Development Bank estimates that 60 percent of the regions exports eventually end

up in the advanced economies. Asian economies thus had full-frontal exposure to

the drying up of demand from advanced markets, particularly the United Statesand the Eurozone, as their economies were unsettled by the credit crunch and then

contracted sharply after the fall of Lehman Brothers.

22




27/128

Crisis and Response

The spillover was exacerbated by Asias product mix: high-and medium-technology

manufacturing exports such as motor vehicles and automotive equipment, elec-

tronic goods, and capital machinery. These sectors generally exhibit a stronger

cyclical response, owing to the products high value and reliance on financing. As

credit and income streams dried up in advanced economies at the end of 2008,

demand for high-end manufactures collapsed Japanese car exports, for example,

fell by nearly 70 percent between September 2008 and March 2009.

Asias tightly integrated supply chain caused a chain reaction that spread the de-

mand shock rapidly across the region. Between September 2008 and February 2009,

exports fell at an annualized rate of about 70 percent in emerging Asia about

one-and-a-half times more than during the dot-com and

ICT crash in the early 2000s and almost three times more

than during the 1997 Asian financial crisis.

Chinas role as an assembly hub for final products in Asian

production networks meant that exports to China from the

rest of emerging Asia declined particularly rapidly as global

demand dried up, falling 80 percent between Q4 2008 and Q1

2009. The result was that companies across Asia cut production and reduced inven-

tories. In the first two months of 2009, industrial production in Japan, Hong Kong,

South Korea, and Singapore fell more than 50 percent on a three-month annualized

rate basis a record decline.

The Asian DevelopmentBank estimates that percent of the regionsexports eventually endup in the advancedeconomies.

23




28/128

Crisis and Response

Nor was Asia insulated from the financial side of the crisis. On the whole, Asian

banks were better capitalized and less exposed to bad debt than those in the United

States and Europe. However, economies across the region suffered significantly

from the side effects of international credit markets seizing up. During the prior

decade Asias financial institutions became increasingly embedded in the interna-

tional financial system: Asian governments borrowed on international bond markets

and the regions banks used wholesale funding to support

growth, while the globalization of equity markets increasedinternational equity holdings in the region. This exposed

the economies to the effects of deleveraging and recapital-

ization in the United States and Europe: financing dried up

as LIBOR increased; capital fled back to the West as glob-

al institutional investors tried to reduce their exposure to

riskier assets in emerging markets; and reduced global risk appetite caused regional

currencies to depreciate the South Korean won was particularly badly hit, depre-

ciating by 20 percent against the dollar between in the first three months of 2009,

although it had recovered its value by June as the fiscal stimulus package stabilizedthe economy.4

Other Asian economies less tightly linked to the global supply chain, such as India,

fared better. Unlike China, where overseas sales have been a main growth driver over

the past three decades, exports account for less than a fifth of GDP in Indias still

relatively inward-looking economy, particularly in its dominant informal economy.

Moreover, less than a third of the workforce is employed in Indias primary export

industries: manufacturing, trade, transport, communications and services. India also

has a vast domestic market of nearly 1.2 billion people, whose household consump-tion of 60 percent of GDP is a substantial growth driver. This has insulated India

from the worst of the global economic turmoil: manufacturing remained healthy

despite exports plunging for a ninth straight month in June 2009 as global demand

fell for Indian-made goods from jewelry to garments. This reflected strong domes-

During the first sixmonths of , Asias

economies showedencouraging signs of

recovery.

24




29/128

Crisis and Response

tic demand, particularly for cars Indias largest car manufacturer, Japanese-owned

Maruti Suzuki, announced a 33.4 percent jump in sales in July.

India was also insulated from financial exposure to the crisis as the Reserve Bank of

Indias Governor Y.V. Reddy had maintained a very conservative position prior to

the crisis. He prohibited the use of bank loans for purchasing undeveloped land to

discourage the formation of a real estate bubble, curtailed the use of securitizations

and derivatives in the Indian economy, and increased risk weightings on commer-cial property construction. Despite criticism from the countrys financial sector at

the time, Reddys stance has ensured that no Indian banks came close to failing,

required emergency capital injections, or had to write down their assets.

Bouncing is What Tigers Do Best

A recent Economistbriefing noted that Forecasters always seem to underestimate

the ability of the Asian tigers to rebound from recessions.5 It noted that within

twelve months of the 1997-98financial crisis in Asia, the Asian tigers had surged to

9.5 percent growth in 1999. Likewise, after the dot.com bust of 2001, Asian econo-

mies quickly regained their footing to dominate global economic growth before the

current downturn.

Today, the scenario appears similar. During the first six months of 2009, Asias

economies showed encouraging signs of recovery. Comparing Q2 2009 with Q1 at

an annualized rate, South Koreas GDP grew by almost 10 percent (though it is still

down 2.5 percent on Q2 2008), and Singapores by 20 percent (3.7 percent down

on the year). China does not publish quarterlyfigures, but experts estimate that

GDP jumped to 7.8 percent for the quarter (a percentage point increase from Q1).

Other economies in the region have not yet published their GDP figures, but are

also likely to indicate incipient recovery. Even Japan may have enjoyed robust GDP

growth: its industrial production rose by an annualized 38 percent.

25




30/128

Crisis and Response

Figure : Export Growth Relative to Same Month Previous Year(Percent Change in U.S. Dollars)

-50%

-40%

-30%

-20%

-10%

0%

10%

20%

30%

Sep 08 Oct 08 Nov 08 Dec 08 Jan 09 Feb 09 Mar 09 Apr 09 May 09 Jun 09

Korea

China

SingaporeJapan

Source: Adapted from Caroline Freund and Matias Horenstein July Trade Watch, World Bank 2009

The collapse in output was exacerbated by destocking; with stocks now wound

down, orders are picking up. Export demand has remained sluggish across the re-

gion, although some green shoots are appearing particularly in ICT. Exports from

Japan rose a seasonally adjusted 1.1 percent in the same

time frame. These figures come as world trade appears to

have bottomed out and the World Bank detected a spark

in international trade in data for June. This might indicate

some initial inventory undershooting, but once these stabi-lized at a lower level, some recovery would likely follow.

Alternatively, it could reflect a real turning point, which will see the economies of

Asia, particularly Singapore, South Korea, and Japan pick up. Indeed, there are signs

that global demand is recovering and aiding Asian economies: Japans exports in

There are signs thatglobal demand is

recovering and aidingAsian economies.

26




31/128

Crisis and Response

June fell by the smallest margin in six months, with exports to Asia and the United

States showing the clearest recovery, reflecting the performance of the regional

economies, most notably China, and the incipient revitalization of global produc-

tion chains.

Meanwhile, economies across Asia displayed increases in domestic demand re-

sulting from fiscal stimulus packages. Chinas huge RMB4 trillion ($587.7 billion)

countercyclical stimulus package has been the most widely discussed initiative inthe region. Announced at the beginning of November 2008, this vast infusion of

investment pumped into infrastructure including roads, railways, and low-cost

housing was designed to create jobs and keep consumers spending. Six months

earlier, concerned about the breakneck pace of growth, Chinas government had

halted many infrastructure projects under way. Now, in the face of a too-rapid

slowdown, the government turned the spigot back on. It also loosened monetary

policy, with a bank lending goal of RMB5 trillion ($588 billion) in total for 2009, a

total reached by June. Lending rates also were slashed to encourage companies to

take out loans and expand their operations.

27




32/128

Crisis and Response

The result has been a surge in domestic economic activity while exports remain

in the doldrums. Across China, steelmakers, cement producers, and construction

companies are seeing sales soar as Beijings stimulus plan funded railways, airports,

and power plants. In July, for example, Chinas manufacturing sector expanded for

a fifth straight month as companies rushed to provide machinery and parts for the

public works program. Chinas Purchasing Managers Index a 100-point scale

where figures above 50 indicate an expansion rose in July to 52.8 from 51.8 in

June.6

It was also the third consecutive month that it had increased only slightly,showing that the recovery had steadily found firmer footing.

The stimulus package also sought to encourage individuals to spend. China has one

of the lowest household consumption rates in the world: in 2008 private consump-

tion in China only made up between 35 and 40 percent of GDP (falling from 46

percent in 2000), compared with 70 percent in the United States and a pan-Asian

average of 50-60 percent. To persuade Chinese consumers to open their wallets, ru-

ral residents received subsidies for buying vehicles and consumer durables such as

televisions and refrigerators, as well as electronic non-durables PCs and mobilephones. Urban residents have incentives to trade in their cars and home appliances

for newer models, while taxes on low-emission cars have been cut. Such subsidies,

particularly those in rural areas, have huge potential to increase consumption: less

than a third of rural Chinese households possess a refrigerator, for example. The

government also hopes that such measures will complement stimuli in other sec-

tors; tax breaks on autos apparently helped the domestic vehicle manufacturing

sector grow by 4.4 percent December 2008-January 2009, while sales increased by

over five percent in the same period. Moreover, by focusing on low-emission cars

for urban areas the Chinese government hopes to bolster manufacturers such asChinas largest privately owner car firm, Geely, which is looking to put its Gleagle

EK2 a small battery-powered hatchback into production later this year.

28




33/128

Crisis and Response

CHINAS REBALANCING ACT

Chinas growth as an economic power

has been driven largely by its ability to

produce goods to meet the growing

credit-fueled consumption in the West.

The collapse of this equilibrium in 2008

led many economists to examine how

economies with large trade surpluses, like

Chinas, can save less and liberate their

surplus to balance out the global econo-

my and set it on the road to recovery.

The stimulus package and loosening

of credit is allowing China to shift its

engine of growth from exports to do-

mestic demand. But there are concerns

that although domestic consumption

is now driving growth in China, the

combination of consumption and

investment is unbalanced. Much as has

been the case for the past decade, the

bulk of Chinese government spending

is going into infrastructure and state-

owned heavy industries, increasing

investments share of GDP and run-

ning the risk of producing overcapacity,

particularly in chemicals and automo-

tive manufacture. By contrast, Chinese

household consumption has shrunk dur-

ing the last decade as investment-based

industrial growth has not created jobs in

labor-intensive service industries, pre-

venting employment keeping pace with

GDP growth. Consequently, house-

holds share of GDP has fallen, while

the proportion going to the government

as tax revenue and to corporates as prof-its and retained earnings has risen.

The fiscal stimulus has boosted Chinese

households purchasing power by creat-

ing jobs, improving the welfare system,

and creating tax breaks and subsidies

for purchasing some types of goods.

But these are not long-term measures

that can be sustained indefi

nitely. Thereal driver of household consumption is

private enterprise and entrepreneurship,

which increases income at the grassroots

and pushes wealth upwards. But the

countercyclical measures being enacted

by Beijing are largely being channeled

through state-owned enterprises, sidelin-

ing private enterprise, much of which

was focused in the export-manufactureindustries hit hardest by the global

economic slowdown. Neither has pri-

vate enterprise benefitted from the huge

expansion of credit; in the first half of

29




34/128

Crisis and Response

2009 bank loans were mainly provided

to SOEs, leaving SMEs struggling to

stay afloat as they try to navigate their

way around international credit terms

and difficult-to-obtain bank loans in a

climate of high risk. Indeed, in July, a

report by the Chinese Academy of Social

Sciences showed that roughly 40 percentof Chinese SMEs have been forced out

of business during the current financial

crisis, with another 40 percent in danger

of going bankrupt.

Without attention, this situation could

undermine the inroads that China has

made into rebalancing its economy. The

Chinese government should liberal-ize financial markets and extend credit

to SMEs throughout China, not just in

urban areas, and take a more hands-off

approach to the financial system. This

may appear counterintuitive at a time

when governments worldwide are in-

jecting money into the banking system

and considering more regulation, but in

a centrally-directed economy the statemust take care not to stifle indigenous

entrepreneurship while leading economic

recovery from the top.

30




35/128

Crisis and Response

Providing cheaper products for Chinese households to buy, however, is only half

the battle. Household consumption is so low in part because the Chinese save to

provide for their old age, education, and healthcare, which are not adequately pro-

vided by the government. Part of the stimulus has therefore been to improve the

social safety net. In January, the State Council passed a medical reform plan that

promised to spend RMB850 billion ($123 billion) by 2011 to provide universal

medical service to the countrys 1.3 billion population. In June, the Chinese govern-

ment ordered all listed state-owned firms to transfer 10percent of their shares to the National Social Security

Fund to bolster its assets. The short-term impact of these

measures may be modest at least, but may ease households

worries about future pensions and healthcare and encour-

age more spending and less savings.

These steps appear to be working. The World Bank raised

its 2009 growth forecast for China from 6.5 percent to 7.2

percent in June on the back of promising results: Chineseretail sales increased a hefty 15 percent in May; consumer goods are flying off the

shelves sales of furniture rose 33 percent and jewelry 29 percent, while passenger

car sales surged 47 percent in May from a year earlier. Per capita consumption in

Chinas urban areas, a key measure of consumer spending, rose 8.9 percent in the

first half of 2009 compared to a year earlier. Three-quarters of Chinas consumers

plan to maintain or increase their spending next year, nearly double that of America

and the European Union. But China still has a long way to go before household

consumption matches that of its Asian counterparts, let alone the United States.

Household consumptionis so low in part becausethe Chinese save toprovide for their oldage, education andhealthcare, which arenot adequately providedby the government.

31




36/128

Crisis and Response

BUBBLE, BUBBLE TOIL AND TROUBLE?

Loose does not begin to describe Chi-

nese monetary policy this year. Chinese

banks were urged to lend RMB5 trillion

($588 billion) in 2009 as the government

eased lending restrictions to counter the

export collapse. In the event, data from

the Peoples Bank of China reveal that by

the end of June the total lent by Chinese

banks exceeded this by almost half again

to RMB7.4 trillion ($870 billion).

The lending boom has led to concerns

that the excess liquidity will fuel specula-

tion and cause asset bubbles, wasteful

investment, and high inflation. Chinese

companies received so much cheap

financing that they started buying equities

and real estate for a lack of alternatives.

2009 has seen the benchmark Shanghai

Composite Index gain 85 percent in the

year to August, with daily turnover on the

Shanghai Stock Exchange in July soaring

above RMB200 billion, the level reached

when it was about to crash at the end

of 2007. Whats more, Chinas housing

sales surged 45.3 percent in the first five

months of 2009 as stimulus spending

stoked investment and domestic demand.

In the wake of the U.S. subprime mort-

gage crisis, some observers worry that

eased lending standards have increased

likelihood of default and a reprise of the

U.S. housing bubble when the stimulus

wears off at the end of 2010. The likeli-

hood of such a situation is increased by

the fact that over-reliance on governmentspending for growth may undermine a

sustainable rise in households share of

GDP and thus increase the occurrence

of default.

Chinese authorities are well aware of

the potential danger. In July, regula-

tors ordered banks to ensure that

new loans are channeled into the realeconomy rather than being diverted

into equity or real estate markets. This

requires banks to monitor how their

loans are spent and came as auditors

found evidence of lending irregulari-

ties in the books of the Industrial and

Commercial Bank of China, China

Construction Bank and China CITIC

Bank. News that monetary policymight be tweaked caused investors on

the Shanghai Stock Exchange to worry

that tightening credit conditions would

hinder the flow of liquidity into the

32




37/128

Crisis and Response

stock market, resulting in falls in the

index in August. The end of July also

saw the property market moderate as

tightening monetary policy curbed

available financing for developers and

buyers of second houses.

Similar concerns have been voiced acrossthe region, most notably South Korea,

where the government is taking steps

to cool a real estate bubble, and Viet-

nam, where the government has ordered

state banks to cap new lending to head

off inflation. This may result in Beijing

increasing the amount of banks tier one

capital, which was slashed at the end

of last year along with interest rates.The central bank has also ordered 10

banks, including Bank of China, to buy

RMB100 billion of central bank notes

with a maturity of one year and a return

of just 1.5 percent. This move is seen as

a warning to banks that have been the

most active lenders that they should now

start to rein in their excessive behavior.

33




38/128

Crisis and Response

The other giant of the region, India, also moved quickly off the mark to protect its

economy from the worst of the recession. Between December 2008 and February

2009, the government announced three fiscal stimulus packages and six interest

rate cuts worth a combined $85 billion, or seven percent of GDP. Given that In-

dias economy is less than a third the size of Chinas, its stimulus was considerably

smaller and scattered across a host of targeted beneficiaries and interest groups.

Thefi

rst of these measures came in December, when the government promised tospend an extra Rs200 billion ($60 billion) on the schools, roads, power plants and

other development priorities set out in its latest five-year plan. It also authorized the

India Infrastructure Finance Company (IIFC), a government-owned financial com-

pany, to sell bonds worth Rs400 billion ($8 billion). IIFC is lending this money to

banks, which then pass it on to infrastructure projects worth as much as Rs1 trillion

($20 billion). A second stimulus package in February pro-

vided IIFC with access to a further Rs20 billion ($400

million) worth of tax-free bonds to expand its programs.

Far from being bridges to nowhere, infrastructure spend-

ing in India is sorely needed, even more so than in China, if

economic growth is to continue. During the boom, Indias

industry expanded faster than the electricity grids capacity

to power it; its air traffic outgrew its airports; and cars rolled off production lines

faster than roads could accommodate them. The result has been that Indias GDP

growth is being pushed back every year by about two percent because of lack of

adequate infrastructure. The stimulus saw the infrastructure sector in India increase

by nearlyfive percent in Q2, up from 3.5 percent in Q1, with the best performances

coming in the coal, cement, and electricity generation sectors. As such, India seems

to be moving in the right direction, albeit slower than most private sector partici-

pants would wish, to enabling sustainable, long-term economic growth.

Indias GDP growthis being pushed back

every year by abouttwo percent because

of lack of adequateinfrastructure.

34




39/128

Crisis and Response

In the first stimulous package, the Indian government sought to aid exporters by

providing a two percent interest subvention on export credit for labor-intensive

sectors, giving additional allocations for export incentive schemes and a full refund

of service tax paid by exporters to foreign agents. In the second, it extended the

duty-entitlement passbook scheme. This reimburses excise duty if the exporting

manufacturer uses partly or fully domestic inputs. It also enhanced duty drawback

benefits on items like knitted fabrics, bicycles, farm hand tools and some categories

of yarn. However, with global trade in its worst slump in generations, Indias ex-ports declined for a ninth consecutive month in June, with Q2 exports down 31.3

percent to $35.4 billion from a year ago. This has resulted in companies cutting

500,000 jobs in 10 industries in 2009. That said, in contrast

to other Asian countries, exports from India are not a ma-

jor driver of growth, and thus the dip in exports has not

been as great a drag on the economy.

The government coordinated each of its stimulus packages

with the Reserve Bank of India (RBI), which took simulta-neous aggressive steps to ease monetary policy, lowering Indias prime rate six times

through the first quarter of the newfiscal year. In doing so, Indias central bank,

like Chinas, reversed tight-monetary policies through which it had sought to ease

inflationary pressure. RBI took steps to expand rupee liquidity, including a signifi-

cant reduction in the cash reserve ratio the amount of bank reserves mandatorily

held with the central bank and a reduction in the statutory liquidity ratio the

portion of funds that banks need to keep invested in government bonds. The ef-

fectiveness of RBIs steps remains inconclusive; Indias financial press expressed

disappointment at lackluster efforts to expand credit as of the end of June 2009,according to RBI data, outstanding bank credit had risen 15.8 percent (some $2.7

billion) year-on-year.

With global trade inits worst slump ingenerations, Indiasexports declined for a ninthconsecutive month.

35




40/128

Crisis and Response

The 2009-2010 Union Budget announced on July 6, 2009 is the most recent install-

ment of government stimulus efforts. Despite the global slump, the Indian economy

grew by 6.7 percent in the year to April 2009. The 2010 budget departs somewhat

from the three earlier stimulus packages in its even more pronounced turn toward rural

India and what can only be characterized as a market-building bottom of the pyra-

mid approach to stimulus. Under the rubric of inclusive development, the proposed

budget represents the fulfillment of electoral promises to low-income segments and

almost seems more pitched to expanding and consolidating Congress Partys politicaladvantage and that of its United Progressive Alliance coalition government than

to building on and augmenting the three previous stimulus packages.

On the whole, the results of the fiscal stimulus appear to be encouraging. In July,

the IMF improved its forecast for Indian GDP growth to 5.4 percent for 2009,

while the RBI slightly improved its growth outlook. It now expects GDP growth

at six percent with upside compared with around six percent in April. The

first quarter results of most manufacturing companies have been good, and many

companies have registered a healthy growth over the previous quarter. This is dueto declining input costs as international commodity prices are running at levels far

below the peaks of 2007, while the stimulus has boosted capital expenditure. Indian

companies are expected to invest Rs10.5 trillion ($215.25 billion) into industrial

expansion over the next three years, particularly in infrastructure such as power

generation and telecommunications.

Across the region Asian governments acted quickly to shield their economies from

the worst of the fallout from the economic crisis. Although many experienced swift

and steep declines in GDP growth, exports, and tightening lending conditions, the

stimulus packages enacted appear to have staved off the worst of the impact, at

least for now.

36




41/128

Crisis and Response

In the last quarter of 2008, the bellweth-

er index on the Bombay Stock Exchange,

the Sensex, lost 60 percent of its value.

Like many emerging economies at the

time, Indian companies were hit by capi-

tal flight from Western investors as they

sought to reduce the risk profile of their

investments and deleverage their portfo-

lio. Having languished near the bottom

of the curve during the first quarter of

the year, the index showed a marked im-

provement April to June, rising from just

under 10,000 points at the beginning of

April to 14,645 on 1 July.

There are fundamental reasons why

investors have rediscovered equity

investing: risk premiums have reduced,

there are some signs that economies are

stabilizing and corporate results in India

have been surprisingly good. Three

quarters of the 30 Sensex companies

reported year-on-year increases in net

profits of an average 36 percent after

three quarters of weak earnings, beating

analysts expectations.

The recent surge in share prices has

helped the Indian economy in two ways.

First, a soaring stock ticker helped clear

away the glum mood in urban India,

where pessimists assumed the economy

was in worse trouble than it actually was.

Second, companies have used higher

share prices to raise capital, cut leverage,

and repair balance sheets, setting them-

selves up for a healthier future.

That said, most of the current surge in

share prices is due to the flood of global

liquidity that has been released by central

banks since September 2008 to prevent a

full-scale meltdown of the global finan-

cial system. Much like in China, India will

have to be careful not to foster a stock

market bubble on the back of an influx

of cheap money. However, stock market

growth has been checked by fears that a

ROBUST PERFORMANCE ON THE STOCK EXCHANGE

37




42/128

Crisis and Response

poor monsoon rainfall was 29 percent

below normal as of August 12 will

slow domestic consumption and eco-

nomic performance in Indias agriculture

sectors by reducing farm output and

rural consumption, which are vital for

maintaining strong economic growth.

Bombay Stock Exchange: SENSEX Closing Trades August -August

8000

10000

12000

14000

16000

8/1/08 9/1/08 10/1/108 11/1/108 12/1/08 1/1/09 2/1/09 3/1/09 4/1/09 5/1/09 6/1/09 7/1/09

Source: Source: CEIC Data Company Ltd., Daily Database

38




43/128

Crisis and Response39




44/128

AppendixA Microeconomic Map of Asia

photograph by Erik Charlton


45/128

A Microeconomic Map of Asia

THE REACTIONS TO THE CRISIS CONSIDERED so far in this re-

port focus on high-level, macroeconomic policies the mix offiscal and monetary

policies, stimulus packages, and investments that central governments and agencies

have pursued to curtail damage and regenerate growth. Its worth noting, however,

that in the modern global economy, the determinants of rising prosperity are not

macroeconomic but microeconomic competitive companies rooted in competi-

tive clusters.7

A microeconomic map of Asia looks less like a political map of the continent than

the night-time satellite photograph on the cover of this report. The bright lights

along the eastern and central spine of Honshu, Japans largest island; South Korea,

especially around Seoul; the Hong Kong-Shenzen-Guangzhou conurbation, and

areas around Shanghai and Beijing in China; Singapore and Bangkok in Southeast

Asia; and areas around Mumbai and New Delhi in the West and North of India:

these locations generate an overwhelming proportion of the continents wealth.

Looking at the two fastest-rising economic powers in the region, amid all the focuson rapid development it is easy to overlook that these countries are not monoliths

with evenly distributed patterns of growth and prosperity within them. In fact, in

both countries, growth rates vary dramatically by location and cluster. As noted ear-

lier, the crisis did not manifest much effect on the microeconomies of India, which

either were shielded from the worst effects of the recession or, like its vaunted soft-

ware and business process outsourcing clusters, poised to rebound quickly. China is a

AT BAOSHAN IRON & STEEL

Visitors tour a facility of Baosteel Group, Chinas biggeststeel producer, the sixth-largest in the world.

41




46/128


different story, however. Its growth before the crisis depended more on exports ulti-

mately to the advanced economies. As foreign demand dissipated, China accelerated

its turn away from an export-driven to a consumption-driven economy. At the same

time, Chinas regional policy moved its focus from development along the coasts and

northeast interior to its western interior. How effective these policies will prove is an

open question, especially with the recovery of the developed economies and the re-

turn of high demand for Chinese exports produced mainly in coastal areas.

Asian Economies and Global Competitiveness

To perceive the contours of Asias post-crisis economy, it is necessaryfirst to under-

stand the sources and drivers of competitiveness across the region. In the modern

global economy, the primary instrument of competition is not the country but

the company. Companies occupy the front lines, and when they thrive in competi-

tion, they produce a host of benefits to their constituencies: products and services

valued by their customers; profits for reinvestment and distribution to owners;

rising wages, increasing employment, and increasingly attractive opportunities foremployees, partners, and suppliers; tax revenues for government; innovation, phi-

lanthropy, volunteerism, and other benefits to society.

The segmentation of the Asian economies according to their competitiveness and

prosperity is apparent in Figure 5, which arrays GDP per capita, the best single

measure of a nations prosperity, against the Business Competitiveness Index, a

now-standard metric established by the World Economic Forum to measure the

competitiveness of enterprises operating in particular countries.8 As the figure re-

veals, for all the progress India, China, and other emerging markets are making, they

must still travel a long distance to catch up to the most prosperous countries in Asia

and other parts of the world.

42




47/128


The progress achieved so far is the result of historical increases in competitiveness.

Looking ahead, the Asian economies must constantly improve their competitive

performance, and they must move beyond reliance on existing sources of competi-

tiveness to create and sustain new ones.

Figure : The Relationship Between Business Competitiveness and GDP per Capita

Brunei DarussalamSingapore

Japan

Korea, Rep.

Malaysia

ChinaThailand

Sri Lanka

Indonesia

IndiaVietnam

Cambodia

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

2.5 3 3.5 4 4.5 5 5.5 6

United States

Luxembourg

Norway

Kuwait

ChadBurundi

VenezuelaAlbania

Slovenia

Italy

Poland

South AfricaChile

Iceland

Ireland

Israel

Denmark

GreeceTrinidad &

Tobago

Estonia

Philippines

Business Competitiveness Index

2008 GDP perCapita US$

(PurchasingPower Adjusted)

Source: World Economic Forum, Global Competitiveness Report 20082009

Many factors affect the competitiveness of companies, including the macroeco-

nomic environment, the liberalization of trade and investment, the condition of

physical infrastructure, and the willingness of people to work hard and contribute

their energy, ideas, and enthusiasm. The strongest Asian economies have performed

well in these respects. But competitiveness is ultimately a local phenomenon. In

large nations, some regions and communities are more competitive, and hence

more prosperous, than others because they have supportive local environments

apart from geographical or other natural advantages. Competitive companies in

such environments operate not as isolated actors, islands unto themselves, but as

part of clusters networks of interdependent, interrelated companies and institu-

tions supported appropriately by government and societal policies and agencies.

43




48/128


Competitiveness is thus rooted in specific locations, and it is important for gov-

ernments and companies to work together to build and maintain vibrant these

competitive clusters.

All competition is based on the cultivation and deployment of assets. In the mod-

ern global economy, sustainable competitive advantage is shifting from a base in

physical and financial assets toward a base in human assets and knowledge assets.

In recognition of this trend, governments and companies must work together tomake three commitments: to increase the quality and supply of specialized human

assets, to support innovation in its broadest sense, and to

promote entrepreneurship. We portray these commit-

ments as the vertices of the Triangle of Competitiveness

(Figure 6), a simple graphic that depicts the drivers of

prosperity.

Specialized human assets are people with particular

characteristics and skills that enable them to thrive in or-

ganizations and contribute to their competitive advantage.

Low-cost, unskilled labor is not an enduring source of

competitive advantage because it is widely available in too

many locations. Specialized human assets, in contrast, are

a major source of sustainable competitive advantage because of the investment

and attention necessary to develop them and keep them at the frontiers of practice.

Innovation includes not only creativity and invention, but more importantly, the

capacity for rapid commercialization. What is often lost in discussions of research

and development is the great importance of development in the pairing. Innova-

tion extends beyond products and services to include best demonstrated practice

in processes, management, and organization. The need to innovate applies across

all areas of the value system, from suppliers through companies, partners, and dis-

Competitive companiesflourish as part of

clusters networksof interdependent,

interrelated companiesand institutions

supported appropriately

by government andsocietal policies and

agencies.

44




49/128


tributors, and it involves not only what companies strive to do by themselves but

also what they do in partnership with outside actors and institutions.

Figure : The Triangle of Competitiveness

SPECIALIZED

HUMAN

ASSETS

INNOVATION

ENTRE-

PRENEURSHIP

Entrepreneurship provides the means by which economies constantly generate

progress and ultimately renew themselves. The growth and prosperity of particu-

lar economies correlate highly with their encouragement of entrepreneurs. Most

new jobs are created by entrepreneurs and small and medium size enterprises.

Similarly, most innovations originate outside of big companies in small entrepre-

neurial organizations.

Competitiveness in China

By any measure, Chinas growth before the crisis was astonishing, averaging 9.63

percent per year from 2000 to 2008. Before the crisis, exports of goods account-

ed for a significant portion of this growth. China is the third-largest exporting

country in the world, after the United States and Germany. Looking at a cluster

map of China, one sees why. As Figure 7 reveals, China possesses many large and

globally competitive clusters in textiles and apparel, plastics, metals and machinery,

45




50/128


automotive equipment, lighting and electrical equipment, information technology

products, and communications equipment. The size and strength of these clus-

ters is extraordinary, with few precedents in industrial history, perhaps rivaling the

United States in about 1950, West Germany in the 1960s, or Japan in the 1980s.

On the other hand, China was not at this time globally competitive in clusters such

as agriculture and agribusiness, heavy machinery, construction, or education and

knowledge creation.

Figure : Employment Specialization of the Economy:China Compared toGlobal Economy for -

Note: Global economy = 95% of world GDP; Clusters Air Transportation; Aircraft, Aerospace, & Defense; BusinessServices; Communications Services; Financial Services; and Hospitality & Tourism omitted for lack of data; Datasetgives total 2007 traded employment for China as 65MM and is directional in nature only given lack of data for smallbusinesses with


51/128


HOW TO READ A CLUSTER MAP

The cluster mapsi of China and India in

this section may require brief explana-

tion for some readers. Every nation has

some employment in nearly every cluster,

though clusters that are traded across bor-

ders provide a better indication of global

competitiveness given their high degree of

specialization across geographies. The the-

ory is that rising employment in a nations

traded clusters is a sign of a competitive

economy, although cluster employment

specialization in populous emerging

economies such as China and India should

be treated carefully since many clusters in

these nations compete on low labor costs

relative to advanced economies and gener-

ally are not as concerned with increasing

labor productivity.

The cluster maps here portray traded

clusters of goods and services. Each

bubble on the chart is a traded cluster,

with its size proportionate to the number

of employees reported to the govern-

ment and recorded in official statistics.

Each map has two axes: 1)percentage share

of cluster employment, which represents

i The Monitor Cluster Mapping Dataset covers more than 94

percent of global GDP. The database uses official employment,

establishment, average wage, export, and patenting statistics pub-

lished by national governments as well as information reported