SEOUL – Emerging Asian countries should be proud of their economic resilience. Despite a global economy plagued by weak growth, persistently high unemployment, and heavy debt loads, the region’s emerging and developing economies grew at an average annual rate of 6.8% from 2000-2010, propping up global output and buttressing recovery efforts.
The region’s success has been underpinned by dynamic growth in China and India, which account for almost 60% of the continent’s total GDP in purchasing power parity terms. Furthermore, economic-policy changes and structural reforms that were enacted in the wake of the 1997-1998 Asian financial crisis significantly reduced the region’s vulnerability to financial shocks over the past decade.
But Asia cannot be complacent: financial systems remain fragile; economies are burdened with high fiscal and current-account deficits; and Asia remains too heavily dependent on North American and European export markets, increasing its vulnerability to external shocks.
Moreover, if conditions in the eurozone continue to deteriorate, Asia could be more severely affected. Already, spillover effects from trade and financial transmission channels are beginning to take their toll: China’s GDP growth rate in the second quarter of 2012 averaged 7.6%, reflecting a significant slowdown, and India’s growth rate is expected to decline to roughly 6% this year.
China’s potentially strong domestic-demand base and ample room for policy maneuvers can help it to avoid a hard landing. It has already aggressively loosened monetary policy, and it can employ further fiscal stimulus. But policy mismanagement and structural weaknesses in the financial sector and local governments could undermine efforts to safeguard growth.
Meanwhile, India, constrained by a high fiscal deficit and persistent inflationary pressure, has less scope for expansionary policies and faces significant challenges in pursuing credible structural reform.
This has serious implications for the rest of Asia. Over the last three decades, increased economic and trade integration has bolstered the region’s growth. For example, segmented production for global supply chains has stimulated trade in intermediate goods and promoted foreign direct investment. Now, however, closer economic integration means that sluggish growth in China and India will reduce job opportunities and slow the rate of poverty reduction throughout the region.
Faced with weak demand in advanced countries, Asian economies are working to rebalance their sources of growth by shifting toward domestic and regional markets. As a result, growth in intra-regional trade has outpaced overall trade growth, with intra-Asian trade now accounting for more than half of the continent’s total trade turnover.
But China’s established role as the assembly hub for the region’s production-sharing networks means that it is becoming a source of autonomous shocks – with a large and persistent impact on business-cycle fluctuations.
So, what policies must emerging Asian economies pursue to reduce their vulnerability to regional and global volatility?
The most immediate challenge is to safeguard the financial system’s stability against external shocks. Policy reform should aim to promote market transparency, improve risk management, and strengthen effective supervision and regulations.
Second, emerging countries must develop more effective macroeconomic frameworks, including better macro-prudential regulation and a broader monetary-policy framework that takes into account asset prices and financial-market stability. A wide range of official measures could be employed to support domestic demand while protecting medium-term fiscal sustainability. And, to address volatile capital flows, countries should increase exchange-rate flexibility, maintain adequate international reserves, and implement carefully designed capital controls.
Third, emerging economies must further rebalance their sources of growth. Reducing dependence on external demand – for example, by promoting private-sector investment and encouraging household expenditure – is crucial. Supply-side policies that promote small and medium-size enterprises and service industries accommodating domestic demand are also critical to ensuring more inclusive and sustainable growth.
Finally, enhanced regional and global financial cooperation – including closer policy coordination at the G-20 and International Monetary Fund – would help countries to respond more effectively to shocks and crises. A key regional initiative is the $240 billion multilateral reserve pool of the ASEAN+3 (the Association of Southeast Asian Nations plus China, Japan, and South Korea), which can provide short-term liquidity to members when needed. Institutional arrangements in regional liquidity provision and economic surveillance must be enhanced.
Asians need not be pessimistic; the perfect storm of a hard landing in China, a double-dip recession in the United States, and a collapse of the eurozone is unlikely. But they cannot rule out the downside risk of a synchronized global downturn. Only with preemptive policies designed to manage risk better can emerging Asian countries protect economic growth from the threat of current and future crises.