How Can Asia Respond to Global Economic Crisis and Transformation?

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    How Can Asia Respondto Global Economic Crisis

    and Transformation?

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    How Can Asia Respondto Global Economic Crisisand Transformation?

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    ii

    2012 Asian Development Bank

    All rights reserved. Published 2012.Printed in the Philippines.

    ISBN 978-92-9092-646-7 (Print), 978-92-9092-647-4 (PDF)

    Publication Stock No. BKK124572

    Cataloging-In-Publication Data

    Asian Development Bank.

    How can Asia respond to global economic crisis and transormation?

    Mandaluyong City, Philippines: Asian Development Bank, 2012.

    1. Global economic crisis. 2. Asia. I. Asian Development Bank.

    Te views expressed in this publication are those o the authors and do not necessarily reect the views

    and policies o the Asian Development Bank (ADB) or its Board o Governors or the governments

    they represent.

    ADB does not guarantee the accuracy o the data included in this publication and accepts no

    responsibility or any consequence o their use.

    By making any designation o or reerence to a particular territory or geographic area, or by using

    the term country in this document, ADB does not intend to make any judgments as to the legal or

    other status o any territory or area.

    ADB encourages printing or copying inormation exclusively or personal and noncommercial

    use with proper acknowledgment o ADB. Users are restricted rom reselling, redistributing,

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    o ADB.

    Note: In this publication, $ reers to US dollars.

    Asian Development Bank

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    Printed on recycled paper.

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    iii

    Contents

    Foreword iv

    Section 1: Introduction 1

    Section 2: Impact o the Eurozone Debt Crisis on Asia 6

    2.1 Te Financial Channel 7

    2.2 Te Real Economy 13

    2.3 Estimating Crisis Impact 14

    Section 3: Policy Challenges 17

    3.1 Saeguarding Growth in a Crisis 17

    3.2 Keeping Economic ransormation on rack 20

    Section 4: Conclusion 29

    Appendix 30

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    iv

    Foreword

    Asias rapid economic and social development over the past several decades hasbeen an inspiration or all.

    Te region has signicantly boosted its share o global output and orged

    strong links with the global economy. Its success in economic growth andpoverty reduction has been among its greatest achievements. Yet, sustaining itsgrowth momentum while conronting new and existing challenges remains aormidable task.

    Since the onset o the global nancial crisis in 2008, developing Asia has provenits resilience. Nonetheless, some o the undamental structural weaknesses indeveloped economies are unlikely to be resolved soon, and the region might beexposed to nancial contagion. Developing Asia thereore must adapt to what

    could be a prolonged slowdown in mature markets.

    Currently, the ocus is on ways to contain risks emanating rom trade andnancial transmission channels. Tese include ensuring adequate availability otrade nance, sucient oreign currency liquidity, managing large and volatilecapital ows, and protecting the regions nancial stability.

    It is imperative to establish strong regional nancial saety nets to complementboth national and global nancial arrangements. I strongly believe regional

    collective actions can cement our past gains and bring uture shared prosperity.

    In this regard, I am happy to see the progress and discussions to expand andstrengthen regional saety netslike the Chiang Mai Initiative Multilateralizationand its surveillance arm, the ASEAN+3 Macroeconomic and Research Ocetoenhance crisis prevention and improve mitigation.

    Even as Asia deals with these immediate challenges, it must not lose sight o itslong-term development goals. o sustain its growth momentum and consolidate

    its economic and social transormation, Asia needs to re-assess its owngrowth model.

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    Foreword v

    With weak demand in traditional markets in advanced economies, Asianeconomies must rebalance the sources o growth toward domestic and regionalmarkets. Tis shi has already begun to happen. Regional cooperation andintegration are vital to this process. In addition, Asia should increase its economiclinks with Latin America and Aricaa process which has already started. Teseregions represent markets or diversication as well as sources o sustained uturegrowth, given their endowments o natural resources. I regional cooperationand integration initiatives are to succeed, whether within or across regions, theiroverall goal must be to increase the welare o people through shared prosperity.

    Te re-emergence o Asia as the worlds growth engine has brought enormousresponsibilities as well as opportunities. How Asia responds to the globaleconomic transormation is critical. Asia must pursue growth that is inclusive andsustainable, and above all, growth that enhances the welare o the people. Asiaalso must grapple with how to efectively balance environmental considerationsagainst its aspirations or growth.

    Tis monograph aims to stimulate debate on these issues. It is my hope that themeeting will provide us with a wealth o eedback and strategic considerations toguide ADBs urther analytical and operational work in these key areas.

    I would like to express my deep appreciation to Jefrey Sachs, Director o TeEarth Institute and and Proessor, Columbia University; Bindu N. Lohani,Vice President, ADB; Iwan J. Azis, Head o the Oce o Regional EconomicIntegration, ADB; Masahiro Kawai, Dean, ADB Institute; and their respectiveteams who contributed to the preparation o this study.

    .

    Haruhiko KurodaPresidentAsian Development Bank

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    1

    The global crisis is a wake-up call for Asia.Is its current resilience to be taken forgranted? Is the region adequately pre-pared to deal with the opportunities andrisks of the ongoing global rebalancing?Is there adequate policy coordinationwithin and across countries, to ensurethat key policy actions constantly improvepeoples welfare? Is regional cooperationa pursuit only in times of stress? Authori-ties in the region have begun asking thesequestions, recognizing that there is noroom for complacency. This monographis designed to stir debate. Answering thequestions could lead to well-articulatedstructural reforms that help sustain theregions growth.

    Section 1

    Introduction

    Asias ongoing economic transormation has captured the worlds imagination.Many marvel at the speed a diverse region packed with poverty has laid the

    groundwork or uture prosperity. Tey acknowledge the massive hurdles crossedto get this ar, but are nonetheless awed by those still to be surmounted. Asiasrole in the world economy is growing, but so too are the challenges in keeping itstransormation on track.

    Te genesis o Asias transormation is critical. History is undamental orthinking about the uture. Yet the goal o sustained economic growth equitablydistributed remains central to the debateand still elusive.

    With the recent economic crisis and renewed recession looming in Europeand the United States (US) economy growing but ragilehow can Asiaweather another global economic disruption? Is there sucient monetary andscal space to respond efectively? How will nance, production, and trade beafected? Is Asias structural reorm adequatenot simply to withstand anothercrisis, but to augment the drivetoward continued strong, yetmore inclusive growth?

    With the Peoples Republic oChina (PRC)and Indiaindisputably core players in theregion, how can their disparateyet undamental growthchallenges be met? o rise in theglobal economic rmament, howwill their trade and investmentstrategies meld with those o other

    economies or sub-regions such asSoutheast Asia, South Asia, andCentral Asia and other agendas?Is regional cooperation a canard?Or is there room or real synergy?

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    2 How Can Asia Respond to Global Economic Crisis and Transformation?

    Many speak o a seismic shi in economic gravity to rapidly developing andhighly diverse Asia. For the region to lead global recovery and meet the multiplechallenges o orming a strategy to sustain robust yet inclusive growth, is a newdevelopment paradigm needed? What are its components and do we have theinstitutional architecture to make it work?

    Tese are ambitious questions. Yet they are worth investigating.

    Tis monograph aims to build a oundation or discussion on how to conrontand use current events to clear a better path toward sustainable, inclusive growthand development in Asiaalways cognizant o the regions growing responsibilityto help build nancial and economic stability globally.

    People tend to orget that Asias much vaunted economic emergence over the pastew decades is a re-emergence. Prior to the Industrial Revolution, Asia accountedor 60% o the world economy. Tat share declined to 15% by 1950, when Japanbegan post-war reconstruction. Japan doubled its per capita income in a decade.

    As countries throughout the regionmost newly independentbegan to setnational agendas amid an evolving technological revolution in the 1960s, theseeds o transormation were planted. Te so-called Asian miracle acceleratedin the 1970s. Natural resource exploitation returned, but more in partnershipthe precursor to a more even playing eld. Easing the regulatory environmentallowed oreign direct investment to ourish. rade soon ollowed.

    Import substitution gave way to export promotion. Te private sector leapt to theore in building production networks and supply chainsas the 1980s turnedinto the 1990s. iger economies became industrial and nancial entrepts.And then Asias economic giantsthe PRC and Indiaentered the ray, usingmarket reorms to varying degrees to introduce millions upon millions o low-cost workers to the global labor pool, using globalization to speed economicgrowtheven i increasingly unequal.

    Te result so arAsias share o global gross domestic product (GDP) reached35% in 2010. Studies suggest it could reach as high as 52% by 2050.

    Te consequences o this growth have been dramatic. Not only has the middle-

    class grown to become a orce in the region, but hundreds o millions have beenlied out o extreme poverty. Yet Asia remains home to a majority o the worldspoor. Polarization and inequalities are also on the rise. While there is signicanteconomic momentum, Asia needs to do more in bringing opportunities orinclusive and sustained growth to the majority o its people.

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    Introduction 3

    Te origin o the 2008/09 global nancial crisisthe worst since World War IIsets the stage.

    A long period o rapid credit growth, ush liquidity supported by easy monetarypolicies, and the growth o asset market bubblesnotably in real estatelednancial institutions to boost leverage that exposed both real and nancialsectors to sharp corrections in asset prices. As a result, the collapse o the USsubprime market, a small slice o the overall nancial pie, shook the edice othe entire nancial system and exposed long-gestating global structural aws.It laid bare the debated linkages between global imbalances and a potentialnancial meltdown.

    Its roots were seeded by global structural changethe integration o Asia intothe global economy, the dissolution o the Soviet Union, and most recently,the emergence o Arica. Tis wholesale liberalization more than doubled theglobal labor orce. Jobs, mostly unskilled, relocated rom developed countriesto emerging economiesprimarily the PRC and Southeast Asia. o compensateor lost competitiveness in low-end manuacturing and assembly, high-incomecountries ocused on boosting non-tradable sectors. Tis included mortgage andnancial deregulation to stimulate job growth.

    Low and stable ination reduced macroeconomic volatility. A Great Moderationled to expansionary monetary policy globally in the 1990s and early 2000s. Loosecredit plus nancial deregulation encouraged risk taking. Large real estate bubblesin Europe and the US meant new construction jobs or displaced industrial workers.But it also stimulated nancial innovation (like mortgage securitization) to hiderisk, supported by perverse incentives or credit-rating and deal-maker greed.

    ogether, the expanded global labor orce and shadow nancial system ledto severe global structural imbalancescurrent account imbalances, excessivedebt in advanced economies, over-reliance on assembled and low value-addedmanuactured exports in some emerging economies, and growing incomeinequality across the board.

    In its early days, the crisis squeezed liquidity and risk premia skyrocketed.Financial insolvency o several institutions suraced, but largely disguised thewider systemic risk. It was the collapse o Lehman Brothers in September 2008

    that lied the veil as condence evaporated, investors retreated, and marketstumbled. Recession ensued.

    When the global nancial system began stuttering in mid-2007, the impact onAsia was limited. Te region was neither highly exposed to the structured credit

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    4 How Can Asia Respond to Global Economic Crisis and Transformation?

    products that caused problems or the US and European nancial institutions,nor heavily dependent on global capital markets or unding, except or oneor two economies. Nonetheless, it was vulnerable to swings in global investorsentiment and increasingly cautious investor appetite.

    Te Lehman Brothers bankruptcy was the tripwire. Asia elt the liquidity crunch,markets plummeted, trade ell dramatically, capital ows reversed outward,and growth slowed markedly or contracted in several economies. Massive scalstimulus and accommodative monetary policy, liquidity injections, governmentguarantees, and local currency nancing helped the region stave of the liquiditycrisis and resuscitate growth.

    Recovery came rst and rapidly to emerging economies, and volatility spiked, withgrowth in advanced economies anemic. By the rst hal o 2009, condence hadreturned and portolio inows started trickling in. oward the end o 2009 andearly 2010, policymakers were increasingly condent o the recoverys tractionand turned their attention to exiting stimulus and normalizing monetary policy.Asias rapid recovery was helped as global nancial markets stabilized ollowingUS and eurozone government intervention to restore condence.

    But global economic growth has stalled since the crisis. And it has graduallyexposed the unsustainable scal policies in Europe and its ragile bankingsystema second and likely more prolonged phase o the global crisis.

    By 2010, important eurozonemembers were struggling. Greece,Portugal, Ireland, Italy, and Spainstruggled to convince investors theycould repay sovereign debt. Tepossibility o contagion spreadingrom escalating European debtproblems has kept nancial marketsand global policymakers on edge. A slew o political statements, bailouts, andausterity packages have struggled to restore investor condence or kick-start theeconomic growth needed to allow struggling economies a way out. o the end othis decade at least, global growthincluding Asiaswill likely be lower than thepast three decades. Short-term xes do not solve structural problems.

    Te Great Recession and current eurozone crisis lay bare the need or Asia toconront major challenges to its ongoing economic transormation. How shouldAsia position itselcrisis or not? Tis monograph analyzes these challenges andlinks the efects o a potential new crisis to the next steps in Asias continuing

    The global crisis showed that whileday-to-day fire fighting is needed inthe short-term, policy makers shouldalso take time to invest more capital

    in developing medium and long-termpolicy options.

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    Introduction 5

    economic transormation. Teglobal economy needs to readjust.And Asiaincreasingly centralto global economic growthmust contribute by diversiyingits sources o growth, allocate itslarge nancial resources moreefectively and eciently towardproductive and socially equitableinvestment, and bolster domesticand regional demand.

    Te next section briey examineshow a crisis would be transmittedthrough nancial and tradechannels. Te ongoing eurozonedebt crisis is taken as a point odeparture. Any contraction inexternal demand, tighter liquidity,rise in risk premiums, or a stricterregulatory environment willimpact Asias real economies, itscompanies and banking systems.Te section also provides anestimate o the impact theeurozone debt crisis might have onAsias economic growth in 2012. Itends with a list o potential risksand vulnerabilities or the regions economies.

    Te third section presents policy options on short-, medium-, and long-termstructural challenges central to the regions crisis mitigation and ongoingeconomic transormation, ranging rom rebalancing to trade policy to regionalnancial saety nets. A conclusion ollows.

    Developing Asia has certainly added

    resilience to the global economy to facefinancial shocks. Many countries havecomfortable current account surpluses,low external debt, and high foreignreserves. Most of the regions bankingsystems are sound with a high capitalbase and low nonperforming loan ratios.Many countries also have adequate fiscalspace should a reintroduction of fiscalstimulus be required.

    The ongoing global uncertainties haveforced us to reevaluate the role andstructure of global finance. At thesame time, we have seen the center ofeconomic gravity shifting gradually toAsia, implying more responsibilities forour region. The challenges we face arehuge. Asias role in sustaining globalgrowth is criticaland this will be best

    achieved by ensuring that Asias owngrowth remains strong and sustainable.For this, growth must be inclusive,balanced, and environmentally friendly.

    Excerpts from remarks made by HaruhikoKuroda, President, Asian DevelopmentBank, at the consultative workshop inNew Delhi on 1 February 2012.

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    6

    Section 2

    Impact of the Eurozone Debt Crisison Asia

    Europes sovereign debt crisiscould have strong repercussionson developing Asia. Both theUnited Stated (US) and eurozoneare major markets or the regionsexports and sources o nancialcapital and portolio investments.Memories o the sharp slowdownrom the 2008/09 Great Recession

    remain resh. Te regions nancialsector and stock markets werebattered as oreign investors edto sae havens elsewhere. ManyAsian economies sufered largedeclines in trade and output. Still,the region recovered quickly dueto prompt and efective scal andmonetary stimulus, airly healthy

    nancial systems, and stringentprudential regulations.

    Tus ar, the eurozone sovereign debt crisis has had limited impact on developingAsias growth. While the regions economic expansion has moderated, it remainsrobust, roughly in line with recent historical trends. Financial systems havebeen little afected by global nancial market volatility and have continued tochannel unds to support economic activity. Te economic resilience is partlydue to the ongoing process o rebalancing sources o growth rom external

    to domestic demand. For now, no large or mid-sized economies will likelyexperience a hard landing.

    However, i conditions were to worsen in Europe, the impact on the regioncould be more severe and the crisis could last longer. With advanced economies

    Asia is enjoying bright momentum ofeconomic prospects, with countriesmaintaining rapid economic growth,and becoming the major engine ofworld economic growth. At the sametime, with the uncertainty of externalenvironment increasing, as well as risksand challenges, Asian countries, invarying degrees, are confronted with thechallenges of economic restructuringand promoting sustainable andequitable economic growth.

    Excerpt from remarks made by ZhengXiaosong, Director General, InternationalDepartment, Ministry of Finance ofthe Peoples Republic of China at theconsultative workshop in Beijing on1 March 2012.

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    Impact of the Eurozone Debt Crisis on Asia 7

    sovereign credit ratings under scrutiny, the scope or rescuing troubled nancialinstitutions is limited. Tis may make it even harder to quickly resolve anynew crisis.

    Given Asias diversity, diferent sub-regions ace diferent priorities andchallenges. One common priority is how to sustain economic growth and boostpeoples welare. In East and Southeast Asia, the ocus is likely to be on tradeand nancial integration. For South Asia, boosting productivity and movingto higher value production and services, while ensuring adequate employmentopportunities, will be key challenges. In Central and West Asia, priorites includeeconomic diversication and overcoming geographic constraints throughgreater and ecient connectivity. Pacic economies ace unique challenges obalanceing growth, while adapting to and mitigating climate change. Te nexttwo sections on provide analysis ofer suggestions that can be applied acrossall sub-regions. More in-depth dialoguealong with research and analysisis required to establish specic sub-regional policy options to better deal withglobal transormation.

    For the most part, the regions nancial systems show limited vulnerabilityand appear able to weather any impact rom the eurozone crisis (barring a lowprobability perect storm collapsein which the euro tumbles sharply, yenborrowing rates rise, and growth alls sharply in the Peoples Republic o China(PRC), Japan, and other parts o Asia). Although Asias exposure to eurozone andUS banks is signicant, external vulnerabilities or the region are lower than in2007. In general, current account balances are healthy, and thus less susceptibleto the impact o tightening liquidity, as they are less dependent on externalborrowings. Also, the regions external debt exposure has improved rom 2008.For the most part, oreign reserves are more than adequate and can comortablycover imports and short-term external debt repayments. Te regions bankingsystems also remain sound with sucient capital adequacy ratios andor nowat leastlow levels o nonperorming loans. During the global recession, theregions banking systems remained largely unafected, and this overall soundnesscontinues (able 2: External Vulnerabilities).

    2.1 The Financial Channel

    With the global nancial system closely intertwined, any nancial systemdistress in Europe will have transmission efects on Asia. Over the past decadeor so, the regions economies have liberalized their nancial systems. Whilethis has beneted economies, it has also made the region more vulnerable toexternal shocks, given the efects o globalization and close integration with

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    8 How Can Asia Respond to Global Economic Crisis and Transformation?

    able 1: Risks and Vulnerabilities

    Risks Description Vulnerable Countries

    Trade openness Economies with large exportto GDP ratios could see severecontraction in exports shouldthe eurozone crisis suddenlydeepen, the US economicrecovery stalls, or a new globalcrisis develops.

    Peoples Republic of China;Republic of Korea; Malaysia;Philippines; Singapore;Sri Lanka; Taipei,China;Thailand

    Commodity

    price volatility

    Economies reliant on

    commodity exports, in particularoil and gas, could be severelyaffected by a contraction indemand for resources.

    Brunei Darussalam,

    Kazakhstan,Kyrgyz Republic,Turkmenistan, Uzbekistan

    Rising inflation Inflation from flow-on effectsof commodity price volatilityon agricultural and food prices,with others experiencing pricespikes from supply bottlenecksor weather-related disturbances.

    Bangladesh,Brunei Darussalam, PeoplesRepublic of China,India, Republic of Korea,Kyrgyz Republic, Lao PDR,Pakistan, Singapore,

    Sri Lanka, Thailand,Uzbekistan, Viet Nam

    Slowdownin overseasremittances orofficial aid

    Economies with largeremittances as a percentageof GDP could see personalconsumption weakenshould demand for overseaslabor wane. Also, countriesdependent on official

    development assistance couldsee donor contributionsdecrease.

    Bangladesh, Cambodia,Kyrgyz Republic, Philippines,Tajikistan

    Capital flowand exchangerate volatility

    Economies with large newforeign direct investments orlarge shares of foreign holdingsin portfolio investments andbonds are prone to capitalflight due to heightened riskperception or flight to quality.

    This could induce currencydepreciation, increase currentaccount deficits and foreigndebt values, as well as raiseimported inflation.

    India, Indonesia,Kazakhstan,Republic of Korea,Kyrgyz Republic, Myanmar,Turkmenistan, Uzbekistan,Viet Nam

    continued on next page

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    Impact of the Eurozone Debt Crisis on Asia 9

    Risks Description Vulnerable CountriesHigh householddebt

    Economies with high householddebt could see consumerdemand weaken if credittightens worldwide.

    Republic of Korea

    Limited fiscalspace

    Slippage in expenditures andrevenue weakness deterioratein net operating balances andincrease government debt.

    India, Indonesia, Malaysia,Myanmar, Pakistan,Philippines

    Excessive creditgrowth, assetprice bubbles,bankingvulnerabilities

    High credit growth contributesto macroeconomic instabilityand fans asset propertybubbles. Bank asset qualitycould deteriorate as creditgrowth also appears in risingnonbank or informal credit, oroff-balance sheet financing.Macroeconomic tightening andfalling asset prices after a credit

    boom adds stress on borrowersand lenders alike.

    Peoples Republic ofChina; Hong Kong, China;Kazakhstan; Singapore;Viet Nam

    Limited accessto finance

    Several countries have limitedprivate sector credit, with fundsgoing mostly to state-ownedenterprises.

    Lao PDR, Myanmar, andmost of South Asia

    Naturaldisasters

    Severe weather events,earthquakes, and other naturaldisasters induce shocks to

    domestic production andregional supply chains.

    Bangladesh, Cambodia,Lao PDR, Pakistan,Philippines, Thailand,

    Sri Lanka, Viet Nam

    able 1 continued

    global nancial markets. Tis became clear during the 2008/09 crisis whenboth Singapore and Hong Kong, Chinathe regions nancial hubshad thelargest drop in output as measured against trend. In contrast, countries withsmaller amounts o international nancial assets saw ar less disruption tooutput growth.

    Failure to resolve the eurozone crisis would likely result in accelerated capitaloutows similar to 2008, when, afer Lehman Brothers collapsed, capital exitedas a result o risk aversion and initial uncertainty over who held toxic sub-primeassets. Most capital outows were in bank lending and portolio investments,

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    Impact of the Eurozone Debt Crisis on Asia 11

    while oreign direct investmentremained relatively stable. Tissuggests that, in the event o adeeper eurozone crisis, the channelo transmission to the region willlikely be via a sudden drop in banklending and portolio investments.

    ighter global credit conditionswould return should the eurozonecrisis intensiy, bringing a knock-on efect to the regions bankingsystem liquidity. Politically,eurozone banks will nd it easierto cut lending abroad rather thandomestically; thus bank lendingto the region would drop. Banksincorporated in the US and theUnited Kingdom with close tiesto eurozone banks would likely behurt as well (able 3: Exposure to US and European Banks). It is not surprisingthat nancial centers such as Hong Kong, China and Singapore rely heavily onEuropean bank borrowings, while several other economies also have substantialEuropean bank exposure.

    A deeper or prolonged crisis in Europe would likely result in higher globalrisk aversion, drawing portolio investors away rom the region. Stock marketsindexes in several o the regions economies could plummet once more,reducing investor condence and hurt consumption through the wealth efect.It would also increase the cost o raising unds, thus depressing investment. Itmay also make raising capital in domestic nancial markets more challenging.Co-movements between the region's stock markets and major globalnancial markets are increasing. Since the start o the eurozone sovereign debtcrisis, Asian and eurozone stock markets have moved almost in lockstep. Apartrom the stock market impact, bond markets will likely be afected. A crisiswould likely push bond yields up in the region as oreign investors ee to saehaven assets. Tis could make it more dicult and expensive or companies

    to raise unds in bond markets, and rms could ace liquidity crises shouldnancingincluding trade nancingbecome more dicult. Countries withmore external bond holdings would likely be afected as und outows wouldhave greater impact. Among the regions economies, Malaysia and Indonesiahave large oreign holdings in government bonds.

    Thus far, Asias financial sectors have

    shown resilience, even if severaleconomies have seen a foreign currencyliquidity crunch for short periods oftime. Current resilience, however, doesnot mean low downside risks. Banks inmajor financial centers in the region relyon US and European banks for funding.Any credit tightening in advancedeconomies will affect banks in theregion. Likewise, monetary easing in the

    US and eurozone will have significantimpact for Asian finance. Corporatebond markets can be affected by capitalflight. These factors, coupled withregional stock market co-movementswith global markets, call for continuousmonitoring, vigilance, and timelypreemptive or remedial measures tomaintain financial stability.

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    12 How Can Asia Respond to Global Economic Crisis and Transformation?

    Table3:ExposuretoUSandEurop

    eanBanks(asofSeptember2011,%

    ofBorrowersDomesticCredit)

    Borrower

    Lender

    USBanks

    EuropeanBanks

    Total

    France

    Germany

    UK

    GIIPS

    Restof

    Europ

    e

    DevelopingA

    sia+J

    apan

    2.3

    5.1

    0.8

    0.5

    2.8

    0.1

    0.9

    Japan

    1.7

    2.3

    0.7

    0.3

    0.7

    0.0

    0.6

    DevelopingA

    sia

    3.0

    8.9

    0.9

    0.8

    5.6

    0.3

    1.4

    ASEAN-4+

    VietNam

    3.9

    9.8

    1.1

    1.2

    6.1

    0.1

    1.3

    Indonesia

    5.0

    12.1

    1.3

    1.9

    6.2

    0.1

    2.6

    Malaysia

    5.6

    14.9

    0.9

    1.4

    11.6

    0.1

    0.9

    Philippines

    6.8

    15.1

    2.4

    1.8

    7.1

    0.1

    3.7

    Thailand

    2.2

    4.5

    0.4

    0.7

    2.8

    0.0

    0.6

    VietNam

    1.2

    6.4

    2.4

    0.6

    2.

    8

    0.1

    0.6

    NIEs

    9.6

    29.9

    2.9

    2.1

    19.7

    0.4

    4.8

    HongKong

    ,China

    1

    0.4

    69.6

    4.8

    2.1

    54.7

    1.4

    6.6

    RepublicofKorea

    7.5

    13.9

    2.0

    1.5

    8.0

    0.2

    2.2

    Singapore

    2

    6.2

    71.4

    6.4

    8.2

    35.0

    0.8

    21.0

    Taipei,Chin

    a

    6.4

    12.1

    1.9

    0.7

    7.6

    0.0

    1.9

    PeoplesRep

    ublicofChina

    0.8

    2.6

    0.3

    0.2

    1.5

    0.2

    0.4

    India

    8.0

    17.3

    2.0

    2.4

    9.7

    0.4

    2.8

    Kazakhstan

    4.2

    17.0

    1.0

    1.4

    3.2

    8.7

    2.8

    UnitedStates

    na

    11.0

    1.7

    1.7

    3.3

    0.9

    3.4

    eurozone

    3.2

    26.8

    5.8

    4.9

    4.6

    4.3

    7.1

    eurozone=A

    ustria,Belgium,Cyprus,Eston

    ia,Finland,France,Germany,

    Greece,Ireland,Italy,Luxemb

    ourg,Malta,Netherlands,Portugal,

    Slovakia,Slovenia,andSpain;GIIPS=

    Greece,Ireland,Italy,Portugal,and

    Spain;na=

    notapplicable;N

    IE=

    newlyindustrializedeconomy;

    UK=UnitedKingdom;US=UnitedStates.

    Note:Bold-face

    dfigureimpliesanincreaseinexposurecomparedwithSeptem

    ber2008intermsofdomestic

    creditpercentagevaluegreaterthan

    $100million;it

    alicizedfigureimpliesadecreas

    einexposure.DevelopngAsiaincludesPeoplesRepublicofCh

    ina;India;Kazakhstan;ASEAN-4plus

    VietNam;andNIEs.Domesticcreditordomest

    icclaimsbasedonInternationalFinancialStatisticsdefinitionof

    InternationalMonetaryFund.

    Source:ADBcalculationsusingdatafromTable

    9D(Consolidatedforeignclaimsofreportingbanksultimater

    iskbasis)oftheBankforInterna

    tional

    SettlementsandCEIC.

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    Impact of the Eurozone Debt Crisis on Asia 13

    In sum, the transmission o an exacerbated eurozone crisis to emergingAsia through the nancial channel could be signicant. Due to longer lags indata availability compared with trade ows or instance, a crisis impact mayappear muted when in act it is simply delayed. Tereore, providing liquiditysupport remains important, as does bolstering existing bilateral and otherswap arrangements.

    2.2 The Real Economy

    Ring-encing the real sector against the impact o nancial market contagionshould the crisis escalate is critical.

    Te past our episodes o US or eurozone recessions show an increase in the impacto external shocks on Asia. As may be expected, the more export-oriented newlyindustrialized economies sufered more than the middle-income Association oSoutheast Asian Nations (ASEAN) economies during these periods. Moreover,the PRC economys sensitivity to recession in advanced economies has grown inconsonance with its export growth.

    A prolonged or deeper eurozone sovereign debt crisis will afect the regionthrough the trade channel as demand rom developed countries alls.Duringthe 2008/09 global nancial crisis, economic growth in the region collapsedas demand or Asian exports contracted due to weak global growth. Tis wasexacerbated by the collapse o trade nancing rom tight global liquidity. Asa consequence, economies with closer trade ties with the US and eurozonewere the most severely afected. Singapore; Hong Kong, China; Malaysia; andTailand recorded larger declines in gross domestic product (GDP) growth in2008 and 2009. In contrast, more domestic demand-oriented economiesthePRC, Indonesia, and Indiaremained resilient and had only minimal outputcontractions. Tis would likely repeat should the global economy slumpin 2012.

    Nonetheless, the trade impact would probably be less today compared with2008/09, as Asias export markets have diversied. For instance, the regionsexports to the eurozone and US have declined rom 33.8% o total exports in1999 to 24.5% in 2010. Te contribution o domestic and regional demand

    to export growth has also increased. Te share o intraregional exportsto total exports in emerging East Asia, or example, rose rom 36.9% to44.2% during the same period (Figure 1: Direction o Exports EmergingAsia). Te region has also developed stronger trade ties with Latin Americaand Arica.

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    14 How Can Asia Respond to Global Economic Crisis and Transformation?

    Figure 1: Direction o ExportsEmerging Asiaa

    (% o total exports)

    G2 = United States and eurozone.a Includes Brunei Darussalam; Cambodia; Peoples Republic of China; Hong Kong, China;

    India; Indonesia; Republic of Korea; Lao Peoples Democratic Republic; Malaysia;Myanmar; Philippines; Singapore; Taipei,China; Thailand; and Viet Nam.

    Source: ADB calculations using data from Direction of Trade Statistics, InternationalMonetary Fund.

    45

    40

    35

    30

    25

    20

    1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010

    Intraregional

    G2

    39.8

    36.2

    44.2

    28.8

    33.8

    24.5

    2.3 Estimating Crisis Impact

    Te crisis impact on European and US economic perormance will largelydetermine how it afects Asia. Should downside risks materialize, the eurozonecould all into a deep recession and drag the US economy to lower growth or evenrecession. A low-probability scenario would nd both the eurozone and the USin deep recession, with output reaching the economic troughs o 2009. Te threepossible scenarios or 2012 are

    a recession conned to the eurozone, with the economy contracting3.9% or 2012, with US economic growth slowing to 1.6% in 2012,

    a deep recession in the eurozone that drags the US economy intotechnical recession, contracting 0.1% in 2012,

    a renewed global crisis where output in both the eurozone and US allto 2009 troughs.

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    Impact of the Eurozone Debt Crisis on Asia 15

    Asias GDP growth will drop rom moderate to severe under the three scenarios,but even the outcomes o the low-probability scenario will still be better than the2008/09 impact.

    Under the rst scenario, Asias economies will see a drop in 2012 outputgrowth o between 0.4 and 2.0 percentage points withSingapore; andHong Kong, China worst afected, ollowed by the PRC; the Republico Korea; aipei,China; India; and nally Japan (Figure 2: Impact oeurozone and US Crisis on 2012 GDP Growth).

    Figure 2: Impact o Eurozone and US Crisis on 2012 GDP Growth(deviation rom baseline orecast,a percentage points)

    Indonesia

    Malaysia

    Philippines

    Thailand

    Hong Kong, China

    Korea, Rep. of

    SingaporeTaipei,China

    China, Peoples Rep. of

    India

    Japan

    Asia

    4.00 3.50 3.00 2.50 2.00 1.50 0.50 01.00

    New global crisis Severe recession Eurozone recession

    GDP = gross domestic product, US = United States.

    Eurozone, according to the Oxford Economic Forecasting model, includes Austria;Belgium; Finland; France; Germany; Greece; Ireland; Italy; Luxembourg; Netherlands;Portugal; Slovakia; and Spain.a ADBs baseline assumptions forecast 2012 GDP growth in the eurozone and the US

    will be 0.5% and 2.1%, respectively. Japan is forecast to grow 2.5%. For developingAsia, GDP should grow about 7.0%. These figures are based on ADB forecasts made inDecember 2011.

    Note: A eurozone recession exists when eurozone 2012 GDP returns to its 2009 trough.New global crisis comprises a eurozone recession plus US 2012 GDP returning to its 2009

    trough. Severe recession combines a eurozone recession and a technical recession in theUS for the first two quarters of 2012.

    Source: ADB calculations using the Oxford Economics Forecasting Model.

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    16 How Can Asia Respond to Global Economic Crisis and Transformation?

    Should the eurozone recession drag the US economy into technicalrecession, Asias output growth will drop between 0.5 and 2.5 percentagepoints, with the same order o severity among the regions economies.

    I a new global crisis drives eurozone and US output down to 2009 levels,the regions growth will all between 0.6 and 3.7 percentage points, stillwell below the 2008/09 impact.

    Tese projections likely underestimate the true efect o a new global crisis. Temoderate impact on East Asia can be explained in part by (i) increased intraregionaltrade as a share o total trade; (ii) understated nancial-channel transmission

    due to modeling limitations; (iii) the lack o an appropriate variable to capturecondence or expectations variablecondence was an important economic dragduring 2008/09; and (iv) Japans resilience due to post-disaster reconstruction.Realized economic growth can also vary depending on the nature and intensity opolicy responses.

    Tus, the actual impact can be stronger than what is discussed above. In act,there is a worst case perect storm scenario that goes well beyond the modelsimulations here. Tis would be an extremely low probability case in which a

    real nancial crisis ignitessay, through a disorderly sovereign deault in onecountryand spreads across the European Union (EU). Markets begin toquestion whether the euro can survive and risk premiums on euro-denominatedassets rise sharply. Tis could be a shock worse than the 2008 Lehmans collapse.Markets could question the solvency o global nancial institutions, leadingto a dramatic credit squeeze. What happens should Japanese rates rise? Andwhat i the perect storm strikes the PRC hard, dropping its GDP growth belowsustainable levels? While this scenario is highly unlikely, it cannot be ignored.

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    17

    Section 3

    Policy Challenges

    As explained in Section 2, evenin the extreme scenario where

    eurozone and United States (US)gross domestic product (GDP)all to 2009 levels, the short-termimpact on Asia would likely bemuted compared with the 2008/09Great Recession. Asia should beable to weather another crisis ithe regions policymakers respondquickly, properly, and rmly by

    deploying nancial, monetary, andscal policies to boost liquidity,restore condence, ensure nancialstability, and support growth.

    o maintain long-term, sustainable,and increasingly inclusivegrowth, policymakers must avoidknee-jerk reactions that paper

    over structural issues. Regardless o whether a global crisis occurs, emergingAsia, however diverse, must stick to its tradition o medium-term nationaldevelopment plans and perspectives. It has the opportunity to ocus on a structuraltransormation that can bolster macroeconomic and nancial stability whileboosting human capital, supporting needed capital investment, and addressingenvironmental risks. All this will require active governments, committed togood governance and pursuing regional or global cooperation in addressingcommon challenges.

    3.1 Safeguarding Growth in a Crisis

    Asias most immediate challenge would be to contain risks emanatingrom nancial channels should the eurozone plummet into a ull-blown

    Asia needs to keep a medium- andlong-term perspective and not be too

    short-term focused. Avoiding financialbubbles should be the the principal focusof short-term policy making, involving:prudential regulation; maintainingadequate financial reserves; adequatebank capital; avoidance of high levels ofshort-term indebtedness. Asia learnedthe hard way about financial bubblesin 1997, while the US and Europe havelearned the hard way in 20082010.The lessons should give us pause ontoo much short-term macroeconomicmanipulation, and force us to thinklong-term.

    Excerpts from remarks made by JeffreySachs in preparatory workshops inNew Delhi and Jakarta.

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    18 How Can Asia Respond to Global Economic Crisis and Transformation?

    nancial and economic crisis.Te most important o these arerelieving pressure on oreigncurrency liquidity, managinglarge and destabilizing capitalows, and minimizing the risk ocontagion. Asia must also prepareor a possible slowdown indomestic demand.

    Financial policy must buttressthe oundations o nancialstability and avoid deteriorationin market condence. Te regionspolicymakers will need to ensureadequate and timely provisioningor oreign and domestic liquidity.In emerging East Asia, substantialoreign reserves could cushion theimpact o sudden capital outows.East Asia also has the option

    o tapping the Chiang Mai Initiative Multilateralization (CMIM), a reservepool or emergency liquidity, which may double in size this year. Nonetheless,bilateral swap lines may prove the rst line o liquidity insurance. Centralbanks have been active and several new lines have been arranged. In parallel,work is underway to design crisis prevention mechanisms. In this regard,to complement the International Monetary Funds (IMF) ex ante nancingmechanisms, the ASEAN+3 could explore the possibility o developing similarex ante liquidity support acilities. In act, ASEAN+3 nance ministers conrmedthe desirability o pursuing this option at their 2011 Ha Noi meeting. For theoption to be efective, several issues need to be examined: nancing mechanismsor such a acility; conditions under which it would be triggered; stipulationsover the amount o unding available to member countries, and; the nature oIMF cooperation.

    Monetary policy must remain exible to respond to extreme exchange ratevolatility. Where excess volatility and overshooting undermine currency

    markets and severely disrupt economic activity, there may be merit in oreignexchange market intervention and temporary capital controls. However,policy makers should be mindul that these measures are likely to orce a moredisruptive adjustment down the road, and should thereore only been seen asshort-term remedies.

    From the 1997 Asian currency/financial

    crisis, the region learned that self-insurance is critical. Amongst themeasures taken, two prominent oneswere building up foreign reserves andstrengthening of the financial sector.Both worked, and that is why we didnot have much of the financial channelspillovers in 2008/09. Despite a range ofcriticisms, accumulating foreign reservesturned out to be a good strategy. Moving

    ahead, continued accumulation maybe costly for some Asian countries. Analternative is the Chiang Mai InitiativeMultilateralization. The region shouldthink hard about using it effectively tosupplement self-insurance.

    Excerpts from remarks made by TakatoshiIto at the consultative workshop inJakarta on 6 February 2012.

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    Policy Challenges 19

    Investment in nancial instru-ments should not overshadowreal investment. In the short term,myriad problems with real invest-mentmostly investment climate-relatedhas led to over-invest-ment o Asias savings into nan-cial assets. Te margin at whichtighter credit (or more lax credit)afects investment must be the levelo small- and medium-sized enter-prises, as dominant corporationshold sucient cash to avoid seri-ous impact rom tightening credit.Tis needs to be considered rom amonetary standpoint.

    To restore the balance oinvestments, a nancial tax maybe appropriate on a case by caseor country by country basis.Tis would improve allocativeeciency in a second best worldwhere incentives to invest in thereal sector cannot be targeteddirectly, and raise additionalrevenue or scal targeting.

    Authorities need to be ready to use scal stimulus more efectively insupporting domestic demand. I spillovers rom the eurozone and US hit EastAsia once more, several economies should hold sucient scal and externalpositionsthough not as much as in 2008/09to reintroduce stimulus tosupport growth. At the same time, authorities should careully design targetedscal support to cushion the purchasing power o the most vulnerable romthe immediate efects o a potential global downturn. Several countries haveaced persistent ood ination, afecting the poor in particular. Central banksmay want to pay greater attention to a consumer price index (CPI) subset

    say, a CPI or the Poorto keep the impact o macro policies on the poorin the oreront o policy makers minds. oo much divergence could actas an early warning system against potential social or political tension.Saety net mechanisms will need to be strengthened, with targeted supportwhere easible.

    Effective inflation management is critical,

    and in a globalized world that requireseffective collaboration between centralbanks. In a world economy where thereare sufficient barriers across countries,the standard instrument of managinginterest rate works. But in a globalizedeconomy, where the patterns and chal-lenges faced in different parts of theworld happen to be very different, man-aging arbitrage possibilities becomes

    quite difficult, with industrialized coun-tries lowering interest rates as much aspossible to pump in liquidity and emerg-ing economies raising interest rates tofight inflation. Monetary policy has to becoordinated carefully, and there needs tobe greater collaboration between centralbanks across and also within regions,including Asia. We talk about coordina-tion on labor and trade matters, and we

    need to think more about monetary andfiscal coordination.

    Excerpts from remarks made byKaushik Basu, Chief Economic Advisorto Government of India at theconsultative workshop in New Delhi on1 February 2012.

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    20 How Can Asia Respond to Global Economic Crisis and Transformation?

    3.2 Keeping Economic Transformation on Track

    In the medium- to long-term, Asia must conront the more dicult task oadjusting to a new normal in the global environment to continue its ongoingeconomic transormationa new normal where both the US and the eurozoneace a prolonged era o structural weakness due to poor economic undamentals.Tis new normal comes with considerably increased responsibilities or theregion. More specically, Asia must conront three major challenges:

    (i) Asia must nally rise to the task o shiing to a more balanced growthmodel. Te shi toward a domestic demand-oriented strategy is

    appropriate or some countrieslike the Peoples Republic o China(PRC)but not or others, like India. Te other important aspect orebalancing is the changing trade pattern, where the share o Asias tradeintraregionally and with other emerging marketsin Arica and LatinAmericawill increase, while its share with traditional marketstheEuropean Union (EU) and the USwill likely decline. Indeed, althoughpolicymakers have come to accept the need or rebalancing whererequired, the risk o a meltdown in the US and eurozone adds urgency.

    (ii) Te region must strengthen its resilience to external shocks emanatingrom nancial channels, by improving regional nancial arrangementsand strengthening crisis prevention and mitigation. Tese can be donewith an eye to ring-ence or build a rewall against nancial contagion.Tese initiatives can help the region cope with nancial volatility byreducing both economic disruption rom sudden swings in capital owsand the perceived need or excessive reserve accumulation. Tey willalso play a critical role in supporting the regions eforts at rebalancing.

    (iii) Finally, Asia must ensure that its new growth trajectory is not only

    sustainable, but inclusive. Many o the policies in pursuit o rebalancingare consistent with and supportive o the broader objectives osustainable growth. However, rom a development standpoint, Asiasattempts at rebalancing need to impact social and environmental

    outcomes in a signifcantlypositive way in order or them tobe worth pursuing. Developinghuman capital to stay ahead othe industrial curve; harping on

    increasingly inclusive nancialsystem development; usingexisting and new technologies(IC, or example) or improved

    Asias great strength is that its emerg-ing economies have 5-year plans, anda 1020 year focus. Active governmentis essential in this regard, to ensure a

    strong vision with strong public invest-ment strategies, and policy frameworks.Asia needs to maximize its advantages onthis front.

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    Policy Challenges 21

    service delivery in education and health, or example; and innovatingor environmentally sustainable development are all eatures that needto coalesce at the top o public policy. Indeed, it presents Asia with theopportunity to think deeply and comprehensively reassess the entiredevelopment paradigmand how it should be implemented.

    A broad range o scal measureswill be needed to rebalancedemand toward domesticconsumption and investment.Governments can increase socialexpenditures and enhance accessto credit to moderate householdsavings and boost consumption.Again, this will be important onlyin countries that are heavily relianton external sources or growth.In these economies, prioritizingpublic investments with avorablesecondary efects can crowd-inadditional private investment orsupport sectors that produce ordomestic or regional markets.Tese scal interventions will notonly help strengthen domesticdemand, but also support theregions goal o improving socialoutcomes. Increased scalspending on health, education,and ood security, or instance, should substantially lessen poverty and hungerand lead to improvements in the productive potential o the poor. Meanwhile,higher public spending on inrastructure should create additional space or greeninvestment, with leadership in environmental technology and production nowshiing to Asia.

    Fiscal measures to boost domestic demand will have to be complemented byreorms to strengthen the nancial sector, improve nancial literacy, and osternancial inclusion

    . Tese reorms will be critical in creating an ecient nancialsystem that can efectively channel savings into productive uses, lower the costo borrowing, enhance economic growth by pooling risk, and boost eciencyand welare by providing nancial services to the poor and those unbanked.Currently, most policymakers in the region can consider these reorms in the

    In many countries, it is evident thatachieving economic growth is notsufficient to reduce poverty. The higheroverall economic growth has not always

    resulted in poverty and hunger reduction.Developing Asias rapid growthcomes at the expense of the damagedenvironment. Further, the depletion ofnon-renewable energy resources hasintensified global competition for seekingnew energy resources. We need to becautious that the impact of a commodityand food crisis would potentially be moredisastrous than the one of financial crisis.

    For that reason, the policies to cope withchallenges posed by climate changeremains a key to economic resilience.

    Excerpts from remarks made byAgus D.W. Martowardojo, Minister ofFinance of the Republic of Indonesia atthe consultative workshop in Jakarta on6 February 2012.

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    22 How Can Asia Respond to Global Economic Crisis and Transformation?

    context o continued robust growth. Tis is why strong prudential regulationhas worked ne thus ar in many Asian economies. Regulation works well whennations grow quickly. But once it slows, then bad credit allocation becomes moreapparent and burdensome, accompanied by huge pressure to ease regulation.Tis seems to be the case or Europe, Japan, and the US. One implication is thattougher regulation should be entrenched institutionally, making it harder to relaxwhen growth slows.

    Raising demand or investment will require policymakers to improve Asiasbusiness and investment climate. ogether with improvements in inrastructureand human capital, regulatory reorm will be needed to address demand-sideactors that limit the uptake o investments due to prevailing uncertainties.Among others, this will involve improving the quality o governance (and legaland institutional rameworks), minimizing unnecessary regulatory barriers,encouraging private incentives and market discipline, and creating a level playingeld across all sectors.

    Policies to oster domestic demand should be tailored to country conditions.Te reasons or weak domestic demand will be diferent or each country in theregion. In the PRC, or instance, high savings would be key, while in others, suchas the bigger ASEAN countries, poor investment has been a major constraint.For developing Asia as a whole, however, recent empirical analysis by ADB haspointed to savings as the main contributor to most o developing Asias largepersistent current account surpluses. More importantly, one must avoid thetendency or excess savings to be channeled more toward nancial assets thanreal investmenta trend which may have contributed to declining employmentelasticity and widening income disparity.

    Te composition o investment in current account surplus countries shouldshif rom exports to human capital ormation, appropriate industrial policy,and urbanization. Tere has been a gradual rebalancing in sources o growthrom external to domestic demand, with consumption and investment emergingas important drivers o growth. Tus ar, these changes appear to have amelioratedthe negative impact o the downturn in advanced economies in Asias real sector.However, there are indications that growth in consumption and investment hasbeen driven primarily by scal stimulus in response to the Great Recession, ratherthan any structural changes that would shi the composition o aggregate demand

    in a more permanent way. For example, in the case o the PRC, its new 5-year plansuggests a shi away rom investment-led growth toward more consumption.

    Global trade has played a pivotal role in Asias economic growth, and thisshould continue. Asia accounts or one-third o the worlds exports and almost

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    Policy Challenges 23

    one-third o the worlds imports.Growing intraregional trade isalso becoming a key acet o Asiasgrowth story. Intraregional tradehas grown substantially since the1997/98 Asian nancial crisis,acilitated by relative stabilityo intraregional exchange rates.Moreover, the private sector hasbuilt an extensive intraregionalsupply chain network that hasunderpinned growth in regionaltrade making use o individualcountry resource endowments.

    While the growth o intraregionaltrade is dramatic, globalizationcontinues to be important orAsia, especially or exports onal goods. For the regions activeindustrial networks, intraregionaltrade remains heavily dependenton demand or nal goods romthe US and eurozone. Since theGreat Recession, Asias exportmarkets have diversied withincreasing intraregional trade inEast Asia and the PRCs growingtrade links with Arica and LatinAmerica. However, whether this trend is cyclical (due to the current weaknessin the EU and the US) or structural (sustained export market diversication)remains to be examined.

    Remaining bottlenecks constraining greater intraregional and South-Southtrade should be removed. Although average tarif levels in the South have allendramatically over the past two decades, tarifs aced by exporters rom theseregions are, on average, higher than in the North. Non-tarif barriers are a growing

    problem, with gains rom tarif reductions outweighed by existing and newlyemerging non-tarif barriers. At the same time, many developing Asian economiescontinue to ace major hurdles in trade acilitation, though signicantly varyingacross countries. Special nancing mechanisms or targeted liquidity support maybe required to revive trade. Tere may also be the temptation, as there was in

    While intraregional trade and invest-

    ments can bolster Asias growth inthe years to come, the region also hastremendous potential to diversify itsexports to other regions, including toAfrica. Africa right now has 850 mil-lion people in the sub-Saharan regionand 1 billion people overallincludingNorth Africa; with a huge deficit of basicinfrastructure, but a huge potential inminerals, agriculture, and hydrocarbon

    development; and with a significantpotential for increasing in productiv-ity. Africa can become a main source ofglobal growth in the future. It is still avery poor continent but it is a continentin need of huge investments. Asia willhave real potential to lead a lot of thatinfrastructure investment and trainingand education investment as well. This isone heart of a diversificationa south-

    south diversification. It may also be theheart of Asias futurebecause Asia willbe a low cost provider of the worldof a lot of basic infrastructure thatAfrica needs.

    Excerpts from remarks made by JeffreySachs in the consultative workshops inNew Delhi and Jakarta.

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    24 How Can Asia Respond to Global Economic Crisis and Transformation?

    2008/09, to introduce temporary protectionist measures to saeguard employmentin sensitive industriesand this needs to be resisted.

    In the broader context o rebalancing, urther research is needed on thecomposition o Asian trade. Specically, rom a policy point o view, it will beuseul to know i the bulk o changing trade ows rom or within the region is dueto a realignment o production networks and product ragmentation. In parallel,urther work is needed to understand i the continuing increase in the number oree trade agreements (FAs) can support rebalancing by encouraging growth inintraregional trade. In particular, since FAs may not be boosting trade emanatingthrough production networks or product ragmentation,1 an important policyquestion will be how to improve the structure o FAs with the goal o promotingtrade in general. At the same time, it may be useul to examine more closely thelinks between the growth o production networks with a multilateral systemwhere most avored nation preerences are ofered more widely. Tis would helpminimize trade diversion and the need to implement rules o origin, as well asincrease the benets that ow rom non-discriminatory trade.

    In addition to rebalancing toward domestic demand in some countries and ashif in trade direction, Asia also needs to rebalance in two other ways. First,middle income Asian economies must diversiy their production base up the

    value-added chain. A well-designed structural transormation processguidedby public policyis essential. Second, as large economies like the PRC move intohigher value-added manuacturing and expand growth in services, other countrieswill ll in the production gap as intermediate products are urther outsourced.

    Also, as economic integration deepens,Asia must establish a more eectiveramework or policy dialogue and cooperation to mitigate political tensionsrom spillovers and to nd wider scope or collective action. Tere are at least ourkey areas where increased regional cooperation will be necessary: inrastructuredevelopment, exchange rates, trade credit, and nancial saety nets

    Narrowing the inrastructure gap could be key to maintaining rapidregional growth despite weak economies in Europe, Japan, and the US;and the threat o a global economic and trade slowdown. ADBI estimatesAsia needs to invest approximately $8 trillion in overall nationalinrastructure between 2010 and 2020$750 billion a year over the11-year period. It translates into a signicant boost in regional

    1 This is because most if not all product fragmentation trade already travels duty-free or atvery low tariffs across the regioneither because of the ITA agreement that covers trade inelectronics parts and components, various duty-drawback schemes, or the fact that mostmultinationals operate out of export processing zones, where they operate duty-free.

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    Policy Challenges 25

    domestic demand in aperiod when externaldemand becomes a lessimportant source ogrowth than over thepast decade. Improvinginterconnectivity raisesproductivityespeciallyin remote and low-income regionsandhelps in bolstering inclu-sive growth. As we knowrom past crises, short-term priorities generallyget more attention insituations o immediatecrisis management, withcritical medium-termissues either postponedor resources re-targetedto the most vulnerable.While such trade-ofsare inevitable, theyimpose high opportunitycosts on development.Te decline ininrastructure spendingaer the 1997/98 Asiannancial crisis is a goodexample. It took severaleconomies a decade to return to pre-crisis spending levels. As a result,inrastructure quality has worsened in the region. It is imperative not toallow an economic or nancial crisis to become a development crisis.o avoid this, policymakers could manage their scal space eciently.Specically, better scal risk management rameworks can be developedwhere large-scale investment can be shared efectively between publicand private sectors.

    Greater regional cooperation on setting exchange rate policiescould provide a transparent way to acilitate rebalancing andguarding against a currency war. A major risk to sustained regionaleconomic integration during global economic volatility could comerom competitive devaluation or a contagious exogenous shockas

    The main lesson from the Global Financial

    Crisis is that we need to keep unfetteredfocus on short-term challenges withoutlosing perspective on medium- to long-term issues. As markets and economiesbecome more integrated, crises areinevitable. In parallel, structural reformsare even more critical. Speaking forKazakhstan, we have dealt with short-term challenges from the 2008 globalcrisis effectively, and we need to stand

    ready in the future. As the recovery of theEurozone and US economies is likely tobe weak, it is critical for Kazakhstanandthis regionto reflect on the structuralweaknesses that have intensified thecrisis in the West. We need to diversifyour economy as well as ownership ofassets. Oil revenues will be directedat building both physical and socialinfrastructure, particularly human capital.

    Regional cooperation and connectivityare vital to convert the challengesof being landlocked to an ocean ofopportunities.

    Excerpts prepared by ADB staff fromremarks made by Kairat Kelimbetov,Deputy Prime Minister of the Republic ofKazakhstan at the consultative workshopin Astana on 12 April 2012.

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    26 How Can Asia Respond to Global Economic Crisis and Transformation?

    during the Asian nancial crisis.Moreover, since global rebalancingimplies a generalized exchangerate appreciation across mosto developing Asia, individualeconomies may be reluctant tobe the rst to let their currencyappreciateas this means losingcompetitiveness, especially inweakening global conditions.Greater regional cooperationon exchange rate policies canhelp. Tis would take intoaccount exogenous shocks to anyparticular economy (disasters,sharp deterioration in the termso trade, ination, among others)and thus would encompass exiblerate adjustments to avoid unduereliance on internal price and costadjustments in those economies.Also, by doing this Asia could playan important role in preventingcompetitive devaluations in theglobal context should, or example,a depreciating euro drive the USand others to attempt to ollow suit.Given the diversity in economicand nancial development inAsiaand the general desire toretain monetary (and scal) policysovereigntythe adoption o acommon exchange rate is clearlynot viable. Te region does notsatisy many o the conditionsrequired o an optimal currencyarea. In light o this, regional

    economies could instead agree on a gradual, cohesive adjustment otheir currencies toward equilibrium levels. Regional exchange ratecooperation can start rom inormal and institution-light arrangements.One possible approach would be inormal reerence or monitoringzones or regional exchange rates to reduce intraregional exchange rate

    No country or region is immune from

    the risk of a future crisis. New criseswill always be a reality, and each canbe different. An important lesson is theneed to have a robust financial safety netwhich can be provided, among others,through regional financial arrangements(RFA). The global nature of many crisesand the interconnectedness of thefinancial system call for coordinatedpolicy responses which may be done

    through RFA and, if and where necessary,together with the IMF. The provision of asafety net by RFA together with regionalsurveillance can be complementary todomestic and global financial reform.While global arrangements may bein a better position to mobilize largeamounts of resources (hence serving as abackdrop to regional pools), RFA has theadvantage of having stronger ownership

    and in-depth understanding of regionalissues. The working of RFA in Asia isstill far from what most analysts expect,and their effectiveness remains limited.From crisis after crisisthe eurozonebeing the latestwe have learned aclear lesson that the required amount ofliquidity support is large, and activationmechanisms need to be rapid in orderto be effective. Complacency should

    be avoided at all cost, since the currentresilience of the Asian financial sectormay ironically stand in the way of havinga stronger RFA.

    Excerpt from Iwan J. Azis, March 2012,Regional Financial Safety Nets andFinancial Stability, ADB, Manila.

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    Policy Challenges 27

    variability over time. Current arrangements in East Asia, such as theCMIM and Economic Review and Policy Dialogue, could support thiskind o inormal approach. I East Asian countries, or a subset, concludethat monetary and exchange rate cooperation ought to be strengthened,then they should begin taking more ambitious, but careully craed,steps in that direction.

    Te ability o countries to counter trade credit volatility is strength-ened by a strong reserve position and backup credit lines. Establishingand substantially expanding bilateral currency swap lines makes sense.Te PRC already has a policy to expand country coverage and swap

    lines to settle trade transactions in renminbi. Te PRCs intention to ex-tend credit lines and allow trade settlement through banks in ASEANcould provide an important reserve enhancement to oster trade andexchange rate stability.

    Tere is a major challenge in strengthening regional nancial saetynets to improve crisis prevention and mitigation. Financial saety netsgenerally come rom surveillance and nance mechanisms. Trough

    vigilant surveillance, a countrys vulnerability to crisis and the impacto policy adjustments on regional and global stability can be better

    assessed. In addition, nancing can be extended to address liquidityproblems particularly or crisis prevention or resolution. Tis way,nancial saety nets help countries cope with nancial volatility byreducing both economic disruption rom sudden swings in capital owsand the perceived need or excessive reserve accumulation. Althoughregional nancial saety nets such as the CMIM exist, their useulnessremains largely untested. I anything, more ambitious programs needto be explored. During the 2008/2009 global nancial crisis, the CMIMwas not used. Instead, the Republic o Korea conducted swaps with the

    PRC, Japan, and the US, while Indonesia did swaps with the PRC andJapan. Tere are two explanations or this. First, the reserve poolingarrangement was small and not multilaterlized until March 2009 (itwas a collection o bilateral swap arrangements beorehand)evenits current size is less than 3% o the $4.2 trillion ASEAN+3 reserves.Te second and more likely explanation is the stigma attached to IMFconditionality: prior to multilateralization, the CMIthen lacking adedicated surveillance secretariatrequired that nancing beyond 20%o the bilateral swap acility be available only to a country under an IMF-

    supported program. Now that the ASEAN+3 Macroeconomic ResearchOce (AMRO) has been established, this link is being reviewed. WithAMRO in place, the 20% limit could be increased or perhaps removedaltogether; otherwise the role o AMRO will be diminished. o establish

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    28 How Can Asia Respond to Global Economic Crisis and Transformation?

    an efective regional nancial saety net or Asia, two things are needed:adequate size/scope and credibility. As ar as the CMIM is concerned,there is clearly a need to boost its current size by encouraging membercountries to shi more unds toward the CMIM and away rom sel-insurance (oreign reserves). In this regard, discussions are ongoing ona possible doubling in size o the und to $240 billion, and a change inthe amount linked to an IMF program. Tere is also a need to considerwhether the CMIM should include other nancing mechanisms toimprove the timeliness o emergency nancing (as noted in Section 3.1).Most critical is the need to boost CMIMs credibility, which must relymore on its own assessments when making lending decisions, and aboutboth the amount and any conditionality. I the CMIM is to evolve into awider regional saety net, then membership may need to be opened upand expanded. Increased membership can add to und size, but againthe key challenge is establishing credibility to lead any rescue package.Greater human than nancial resources will be required or such anarrangement to work.

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    29

    Section 4

    Conclusion

    Tere is much odder or debate here.

    Tis year could prove critical or the world economy. Te nancial tensionsin Europe could still degenerate into a disorderly sovereign deault and ull-blown economic crisis. Contagion remains a real risk. While the United Statesrecovery keeps nudging orward, politics or a eurozone recession could reverseits momentum.

    And that could all spread to Asia.Te immediate challenge or theregions policymakers is to prepare

    options or responding to a suddeneconomic disruption, unnelinginto Asia through nancial andtrade transmission channels. Teregion should have the policytools available.

    But even more challenging isto deal with these immediate

    issues with a strategic eye onavoiding a disruption in theregions continuing economictransormation. Te debate mustinclude some discussion on how toadjust the development paradigmto better accommodate globaleconomic change while ensuringsustained growth is possible

    growth that is more inclusive andresponsible, ultimately boostingthe welare o the majority oAsias population.

    Given the complex range of issues, it isnot easy to summarize or be conclusive.The work on this monograph and the

    consultative workshops indicate wheremuch more work is needed:

    1. Are the transmission channels ofvarious policies fully understood? Cantrickle down be taken for granted?

    2. How can domestic, regional andglobal policy coordination be fostered,and what is Asias role?

    3. How should rebalancing be done toensure Asia sustains its contributionto global growth?

    4. How should Asia approach the growthversus inequality versus sustainabilitydilemma?

    5. With the center of economic gravityshifting to Asia, is there need for anew development paradigm? What

    are the areas where Asia can lead?

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    30

    Appendix

    Te monograph was produced by an ADB team led by Iwan J. Azis (head,Oce o Regional Economic Integration [OREI]). Members include NoritakaAkamatsu (deputy head, OREI), Ramesh Subramaniam (senior director,OREI), Jayant Menon (lead economist, OREI), Sabyasachi Mitra (principal

    economist, OREI), Tiam Hee Ng (economist, OREI), and Lei Lei Song(principal economist, OREI). Te study also benefted rom the guidanceo Masahiro Kawai (dean, ADB Institute) and Changyong Rhee (chieeconomist, ADB). James Villauerte and the ARIC team provided valuableresearch assistance. Guy Sacerdoti provided very able editorial assistance.

    Country consultations were organized with the assistance o Mitzirose Legal,Carol Ongchangco, Wilhelmina Paz, Jennier antamco, and Charisse ubianosa(staf); and Layden Iaksetich and Teresa Robles (consultants). Te list below

    acknowledges the contribution o the speakers and participants in the countryconsultations held in Delhi (1 February 2012), Jakarta (6 February 2012), Beijing(1 March 2012), and Astana (12 April 2012).

    Preparatory Workshops for the2012 ADB Annual Meeting Governors Seminar

    List of Participants

    Delhi (1 February 2012)

    1. Shankar Acharya Honorary Proessor, Indian Council orResearch on International EconomicRelations

    2. Puneet Agarwal Deputy Secretary (ADB II), Department oEconomic Afairs, Ministry o Finance, India

    3. Prema Chandra Athukorala Proessor, Australian National University

    4. Kaushik Basu Chie Economic Adviser, Governmento India

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    Appendix 31

    5. Peter Boone Associate, Centre or Economic Perormance,London School o Economics and PoliticalScience

    6. Hon Cheung Regional Director, Ocial Institutions, StateStreet Global Advisors

    7. Hal Hill Proessor, Australian National University

    8. Rajiv Kumar Secretary General, Federation o IndianChambers o Commerce and Industry

    9. Junkyu Lee Senior International Economic Advisor to theMinister o Strategy and Finance, Republico Korea

    10. Michael Plummer Head o the Development Division othe rade and Agriculture Directorate,Organisation or Economic Co-operationand Development

    11. Venu Rajamony Joint Secretary, Department o EconomicAfairs, Ministry o Finance, India

    12. M. Govinda Rao Director, National Institute o Public Finance

    and Policy

    13. Jefrey Sachs Director, Earth Institute; Proessor, ColumbiaUniversity

    Jakarta (6 February 2012)

    1. Prema Chandra Athukarola Proessor, Australian National University

    2. Bambang Brodjonegoro Head o Fiscal Policy Oce, Ministry oFinance, Indonesia

    3. Muhammad Chatib Basri Vice Chairman o the National EconomicCommittee o the President, Indonesia

    4. Peter Boone Associate, Centre or Economic Perormance,London School o Economics and PoliticalScience

    5. Stephen Grenville Visiting Fellow, Lowy Institute oInternational Policy

    6. Hal Hill Proessor, Australian National University

    7. akatoshi Ito Proessor, okyo University

    8. Agus D.W. Martowardojo Minister o Finance, Indonesia

    9. Mari Elka Pangestu Minister o ourism and Creative Economy,Indonesia

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    32 Appendix

    10. Anny Ratnawati Vice Minister I, Ministry o Finance,Indonesia

    11. Jefrey Sachs Director, Earth Institute; Proessor, ColumbiaUniversity (via videoconerence)

    12. Mahendra Siregar Vice Minister II, Ministry o Finance,Indonesia

    13. Wing Tye Woo Proessor, University o Caliornia, Davis

    Beijing (1 March 2012)

    1. Isher Judge Ahluwalia Chairperson, Indian Council or Research onInternational Economic Relations

    2. Narongchai Akrasanee Former Minister o Commerce, Tailand;Chairman o the Board o Directors, SeraneeGroup

    3. Peter Boone Associate, Centre or Economic Perormance,London School o Economics and PoliticalScience

    4. Ding Yian Director, Institute o World Development,Development Research Center o the StateCouncil

    5. Gao Haihong Senior Fellow, Institute o World Economicsand Politics, China Academy o SocialSciences

    6. Liu Erei Country Executive, Managing Director oBank o America, Merrill Lynch

    7. Liu Peng Deputy Director, International Department,China Banking Regulators Commission

    8. Lu Feng Deputy Dean, National School oDevelopment, Peking University

    9. Jefrey Sachs Director, Earth Institute; Proessor, ColumbiaUniversity (via videoconerence)

    10. Shi Zihai Deputy Director General, Policy ResearchDepartment, National Development andReorm Commission

    11. ang Min Executive Vice Chairman o Board oDirectors, China Social EntrepreneursFoundation

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    Appendix 33

    12. Wang Yida Deputy Director General, ComprehensiveDepartment, Ministry o Finance

    13. Yang Weiqun Director, Asian Department, Ministry oCommerce

    14. Zheng Xiaosong Director General, International Department,Ministry o Finance

    Astana (12 April 2012)

    1. Shigeyuki Abe Faculty o Policy Studies, Doshisha University

    2. Peter Boone Associate, Centre or Economic Perormance,London School o Economics and PoliticalScience

    3. Ralph Christy Proessor, Cornell University

    4. Oraz Jandosov Director, RAKURS Center or EconomicAnalysis

    5. Kairat Kelimbetov Deputy Prime Minister, Kazakhstan

    6. Sabit Khakimzhanov Head o Research, Halyk Finance

    7. Meruert Makhmutova Director, Public Policy Research Center8. Kairat Mynbayev Proessor, Kazakh-British Technical

    University

    9. Jefrey Sachs Director, Earth Institute; Proessor, ColumbiaUniversity (via videoconerence)

    10. Bakytzhan Sagintayev Minister, Economic Development and Trade,Kazakhstan

    11. Madi Umbetaliev Vice President, Economic Research Institute

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    How Can Asia Respond to Global Economic Crisis and Transformation?

    This monograph aims to stimulate debate on the measures available topolicymakers to dampen the effects of any abrupt economic shocks should

    recovery in the United States fail to gain traction or if the sovereign debtproblems plaguing Europe were to escalate into a full-blown crisis. Inaddressing current issues, it is imperative to also focus on pursuing thelong-term goal of sustaining Asias growth momentum and consolidatingits economic and social transformation. How Asia responds to the currentcrisis and ongoing global structural transformation is critical, including howit pursues inclusive and sustainable growth in a manner that uplifts thewelfare of the majority of its people.

    About the Asian Development Bank

    ADBs vision is an Asia and Pacific region free of poverty. Its mission isto help its developing member countries reduce poverty and improvethe quality of life of their people. Despite the regions many successes, itremains home to two-thirds of the worlds poor: 1.8 billion people who liveon less than $2 a day, with 903 million struggling on less than $1.25 a day.ADB is committed to reducing poverty through inclusive economic growth,

    environmentally sustainable growth, and regional integration.Based in Manila, ADB is owned by 67 members, including 48 from the

    region. Its main instruments for helping its developing member countriesare policy dialogue, loans, equity investments, guarantees, grants, andtechnical assistance.

    Asian Development Bank

    6 ADB Avenue, Mandaluyong City1550 Metro Manila, Philippines

    www.adb.org