Financial sector reform must continue and deepen across Asia for prosperity to be sustainable in the region, says Tadao Chino.
It is almost seven years since the Asian financial crisis, and those years have proven to be one of the most economically turbulent periods in the region’s recent history. In the past two years alone, there have been uncertainties associated with the Iraq conflict and terrorism, high and volatile oil prices, and the SARS epidemic. Yet, through all of that, developing Asia has shown remarkable resilience, emerging as the fastest growing region in the world with overall economic growth accelerating to 6.2% in 2003.
In the medium-term, even stronger growth is projected. Aggregate GDP for the region is predicted to expand at an average rate of 6.5% in 2004-2005.
Developing Asia is a vast and diverse region, however, and the economic outlook varies widely between countries. Some countries – including poorer, isolated economies such as some of the Pacific islands – will continue to have slow income growth and high poverty rates. In contrast, many larger economies – such as Korea, India, the People’s Republic of China (PRC), Thailand and Vietnam – are expected to experience robust growth, close to their potential. And pre-1997 financial crisis growth rates are again on the horizon for a number of developing countries.
Growth drivers
A number of factors contribute to this bright outlook for developing Asia. As the recovery takes a firmer hold in major industrial countries, particularly in the US and in Japan, demand for the region’s exports will return rapidly. Stronger exports will also be supported by rising commodity prices.
Another key trend is the emergence of the PRC as a major growth engine for intra-regional trade. In the past two years, exports from east, south-east and south Asia to the PRC have been surging at rates of between 30% and 60% a year, and the share of the region’s exports to the PRC is now significant. Even if these extraordinarily high growth rates abate, intra-regional trade should remain buoyant over the medium-term. However, the importance of the PRC in developing Asia goes well beyond trade growth; for example, India, which is emerging as another main growth pole in developing Asia, views the PRC as one model to emulate as well as a major competitor.
Robust domestic demand will continue to buttress growth in developing Asia. In a major change throughout developing Asia, the importance of consumption demand in contributing to growth is increasing rapidly, and this is expected to continue.
Investment revival
Sustained growth in the past few years, improvements in the external environment and continued progress in improving the investment climate in most of the Asian economies will lead to a progressive revival of business investment. Such investment, particularly in crisis-affected countries and in countries where reforms have been slow, has been lagging since the Asian financial crisis. Overall, robust domestic demand will continue to be supported generally by expansionary fiscal and accommodative monetary policies.
The large volume of foreign exchange reserves accumulated in many countries of the region will help to cushion them against volatile external shocks, such as high oil prices, and contribute to containing inflation through relatively strong regional currencies and allowing low interest rates to continue.
Risk factors
Despite this optimistic outlook for developing Asia, there are a number of risks to sustaining such high growth. The most obvious is that if the recovery in industrialised countries falters, the impact on developing Asia would be significant: it would put more pressure on Asian countries to shift to stronger domestic and intra-regional demand-led growth. Another risk is the possible outbreak of another epidemic, such as SARS or avian flu. However, lessons have been learned from the 2003 SARS epidemic: safety mechanisms have been put in place to mitigate the effects of its recurrence.
Most other factors affecting the sustainability of Asian growth are in the hands of Asian policy makers, whose economic management tasks are becoming more complex. The strong growth in intra-regional trade and the significant advances in regional integration are positive elements in the medium-term outlook for Asia. In this context, improved interconnectivity within Asia and regional co-operation will be crucial for sustained high growth in the region.
Policy decisions
However, the new challenges will also place greater responsibilities on Asian policy makers, as their policy decisions will have more impact on the rest of the region. For instance, any overheating of investment in the PRC that requires strong policy responses to control domestic demand would have significant repercussions on many Asian economies because intra-regional trade could slow down dramatically.
A shift towards progressively stronger domestic demand-led growth in the region will have to be encouraged and closely managed. The strengthening of consumer demand is a welcome development. But, as South Korea’s experience in 2003 showed, household debt levels must be monitored and contained to avoid a resurgence of non-performing loans in financial systems that have not fully recovered from the 1997 crisis.
Improved prudential regulation will be paramount in this context but monetary policies might need to be tightened, too, which would lead to interest rate increases. The policy dilemma will be to mitigate the impact of higher interest rates on badly needed business investment, which has remained sluggish, particularly in southeast Asia.
This dilemma clearly highlights the centrality of deeper financial sector reforms in the overall reform process in all economies. This point cannot be over-emphasised. It is worrisome that financial sector reforms have been slowing down or have stalled in a number of Asian countries during the past two years, partly because strong growth performances masked the problems.
Whether or to what extent consumption demand reflects rapidly growing inequalities is an important consideration for Asian governments. Not only income growth but also job creation for large and rapidly-growing labour forces will be essential for growth to be sustainable. In this regard, labour market reforms and measures to lift the skills of the labour force will be critical for addressing rising inequality within and between countries of the region. Economic policies will thus need to emphasise how growth can be socially inclusive, benefiting progressively larger segments of the population. Increasingly, the development of safety nets will need to be a part of the core policy agenda. Also, in the context of greater participation of people in policy decision making in Asia in general, such inclusive growth will be important for people to ‘buy into’ the continuation of the reform process.
Financial sector reforms
In nearly all countries in developing Asia, economic reforms to improve the investment climate, including the provision of improved infrastructure, will be essential
for improving competitiveness, enhancing productivity and creating jobs in the context of rapid globalisation. Without such reforms, robust growth will not be sustainable in the medium term. These reforms will be particularly complex because they are needed at a time when the fiscal situation in many Asian countries needs consolidation. Ensuring greater efficiency of the public sector, competent public debt management and enlightened public-private partnerships will be key policy challenges in the medium term.
At Asian Development Bank (ADB), we are committed to helping Asia’s developing countries to address the many complex policy challenges they face. ADB will continue to support structural and sectoral reforms and investments, as well as regional co-operation and integration. We will also continue to foster socially inclusive and sustainable growth in the region. Such growth is a priority for the countries concerned and a key pillar of ADB’s Poverty Reduction Strategy because it creates jobs and income for all, and increases public revenues that can be invested in reducing poverty.
Asia’s rising aspirations, growing confidence and policy pragmatism have been the hallmark of the post-financial-crisis era. A continued and deepened reform process is key to sustaining high growth rates beyond the short term that can help to usher in a new era of hope and prosperity for the whole region.
Tadao Chino is president of the Manila-based Asian Development Bank
