Asia weighs euro impact as global economy rebalances

The eurozone weighed on the minds of policy-makers at this year’s Asian Development Bank (ADB) annual meeting in Manila in May, as participants considered Asia’s role in the context of a changing global economy. While the shifting of economic gravity in Asia’s favour could be grounds for optimism, ADB delegates were instead focused on Europe’s impact on the region and debated whether Asia needs a new model for its long-term growth. Attendees were warned not to underestimate the potential for contagion from the eurozone crisis and the possibility that something worse than the ‘Lehman shock’ of 2008 and subsequent slump in output could be lurking around the corner. 

“There continues to be the risk that the financial crisis in Europe and slow growth in the high-income world will jeopardise Asia’s growth,” said Jeffrey Sachs, economics professor and director of Columbia University’s Earth Institute. 

Mr Sachs, who was in the running for the World Bank presidency, added that the current global economic environment is not merely a business cycle or the consequences of the global financial crisis. “It is something more structural. The world economy is changing, growth prospects have slowed. Global growth depends more than ever on Asia.” 

“There is a new normal,” continued Mr Sachs, adding that the new normal of structural weakness in the US and Europe is based in poor economic fundamentals. He added that the developing world needs to grow faster, but Asia faces a number of challenges. The first is how to protect the region from Europe’s problems. And looking to the long-term, the second challenge is how to maintain rapid and sustainable growth. 

The issue of sustainability – a core theme of ADB discussions – prompted questions of whether Asia needs to consider a new growth model. “Asia’s need for a new growth paradigm is absolutely real,” said Mr Sachs, who also commented that there is the potential for a home-grown bubble in the region. 

Been there, fixed that

Asia has ridden the global financial crisis quite well so far, in part because of the lessons learned from the Asian financial crisis of 1997 and 1998. “Everybody who had a prior crisis came out of this well – they had already put their houses in order,” said Douglas Peterson, president of ratings agency Standard & Poor’s.

The flip side of this, however, is that the optimism over Asia’s growth could mean that the seeds are already being sown for Asia’s next financial crisis. Ritesh Maheshwari, managing director of financial services ratings for Standard & Poor’s, warned about complacency: “The whole pride in Asian growth and the view that the current crisis is a Western problem and ‘we are fine’ is taking such a strong foothold that we are at risk of ignoring the risks emerging in the region.” Mr Maheshwari added that the younger demographic profile of managers at Asian banks means that “those with experience of going through a crisis is getting thinner and thinner”.

“Banks have had a good run for several years – almost a decade,” said Mr Maheshwari, although he noted that they had a difficult six months between 2008 and 2009. “They have good balance sheets, good domestic economies and business, and even if there is bad news from Europe, it would still be absorbable by most banks.”

Eurozone fallout

Asia is defined by diversity, ranging from the immaturity of markets such as Myanmar and Laos to the sophistication of Hong Kong and Singapore. Because of this, the impact from events in the eurozone will be varied on Asia, according to Mr Maheshwari. “It is the export linkage that is the risk carrier to Asia,” he said. 

According to estimates from Standard & Poor’s, China’s exports, for example, as a percentage of gross domestic product (GDP) at the end of 2011 were 28.9%, and 19.1% of those exports were to the eurozone. Vietnam’s exports by comparison accounted for 76.48%, and 17.2% of those exports were to the eurozone. 

When assessing the risk in Asia, Mr Maheshwari, who is also lead analytical manager at the credit ratings agency, said he monitors the signs of an export slump, and also indicators of a hard landing in China. 

Asia is also considering the impact from European banks deleveraging in the region, which is difficult to assess because of the limited available data. “It is a question of how soon and how severe,” said Mr Maheshwari, adding that in December 2011, before the EU’s Long-term Refinancing Operation (LTRO), there was a much bigger prospect of a larger deleveraging impact. “The liquidity and funding situation is not a key driver of deleveraging now – it is more the European banks’ capital position and regulation.”  

European banks have been particularly active in trade finance as well as infrastructure and project finance in Asia. “In the wake of the crisis, trade finance was hit hard,” said Dr Gerard Lyons, Standard Chartered’s chief economist. In a sense, he noted, Asia’s “innocents” – those who were not responsible for the crisis – were impacted more than those in the West. 

Standard and Poor’s notes that from October 2008 through to January 2009, international trade finance dropped 37% and 14% in emerging east Asia and south Asia, respectively. 

Iwan Azis, head of the ADB’s office of regional integration, agreed with others at the conference that Europe’s impact on Asia comes in two forms: the trade channel and the financial channel. He said that the region’s reliance on exports is a concern for policy-makers, as well as the financial impact that comes from the deleveraging of European banks. 

And from the long-term developmental perspective of the ADB, there are other ‘black spots’. Mr Azis pointed to rising inequality, explaining that in the past it was seen as a
 by-product of growth and that it was inevitable that as GDP increased, the gap between the rich and poor would also increase. “Now the new thinking is that an increase in inequality can jeopardise the growth. Higher inequality implies great social and political uncertainty and translates into lower investment,” said Mr Azis. “The short-term challenge is the crisis in Europe and the US. We need to avoid the financial crisis becoming a development crisis.” 

Inclusive growth

Discussions about a model for sustainable development did not just focus on the inclusiveness and longevity of economic growth, but also the impact of the growth on the environment. “Growth must be inclusive, it must be environmentally sustainable,” said the ADB’s president, Haruhiko Kuroda, during the conference. And in his closing statement of the 45th annual meeting of the ADB’s board of governors, he said: “While following an inclusive and environmentally sustainable development path, Asia needs to also recognise the critical importance of knowledge-led growth. Of course, regional co-operation and integration will help the region meet its challenges.”

Reducing poverty and environmental damage have long been themes of the ADB, but this year was notable because of the awareness of the need for increased co-operation among the countries in the region. The short-term challenges from the eurozone brought a sense of urgency to the meetings, and was apparent from the progress that the central bank governors and finance ministers from the region made during their meetings that ran parallel to the ADB conference in Manila. 

The grouping of the Association of South-east Asian Nations and China, Japan and South Korea (Asean+3) announced that it would be doubling its emergency financial safety net to $240bn. The changes to Chiang Mai Initiative Multilateralisation (CIMM) – an emergency liquidity fund for Asean+3 economies – were timely because of increasing concern about the impact of Europe’s crisis on Asia. South Korean finance minister Bahk Jaewan noted that previous Asean+3 meetings had not resulted in such changes and the announcement at this meeting was “quite remarkable”. 

Such co-operation within the region falls in line with a recognition that Asia is becoming increasingly important in the global economy and has more responsibility in its policy-making. 

Path to the top

In another regional grouping, Asean, China and India (ACI) economies together account for a significant portion of the world’s economic growth. ADB research notes that the ACI countries are on a path to becoming the world’s leading consumers, producers, savers, investors and financiers by 2030, while their GDP could quadruple to exceed that of the US and the EU combined. The ADB research projects that the ACI’s GDP per capita will rise from $4936 in 2010 to $16,803 in 2030, in purchasing power parity terms. 

GDP numbers, however, are not just the only indicator of economic development and the research notes that “enhancing the quality of life needs to become the principal measure of success of ACI development”. 

The report, entitled ‘Asean, the PRC and India: The Great Transformation?’ concludes that a “great transformation” is possible for the ACI region, but “it requires a paradigm shift towards inclusive, green and knowledge-led growth”. 

The study highlights the issues that ACI economies must address to raise the quality of life for its people. These include improving productivity through innovation and technology, building infrastructure, managing key resources such as energy, food and water, protecting the environment, and developing the financial sector. 

On the development challenges, Philippines finance secretary Cesar Purisima explained what this means for his country: “We need to continue to invest in people – not all of Asia is properly equipped to deal with the new global realities. Asia has to look at its people for the engine of growth. The export model will no longer work as it did in the past. We have to find a way to make our own people the consumption engine of Asia.”

Mr Purisima pointed out that a significant proportion of the Philippines’ population still lives in poverty, and a key challenge for his country is to ensure that these people can participate in the nation’s future
 economy. “We need to continue to invest in them,” said Mr Purisima. We need to continue innovating so we can challenge the more advanced economies.” 

Capital market deepening

Another area that needs attention is the capital markets, according to Mr Purisima, who said that they need to become deeper and rules and standards need to be harmonised. 

The ADB estimates that Asia needs to invest approximately $8000bn in overall national infrastructure between 2010 and 2020. The financial system in Asia, however, relies on banks to fund such investments and many observers, backing up the words of Mr Purisima, point to the urgent need for Asia to develop its capital markets. The ADB’s report on the ACI economies states that while the private bond markets are expected to grow, they are projected to only account for 13.7% of the world total by 2030, a relatively small proportion given the expectations for the region’s weighting in the global economy. 

“The region is far too slow in opening its market,” said Mr Lyons at Standard Chartered. “Bond markets are growing but not quickly enough. We need to see a greater speed of movement.” 

In an indication of the growth of the bond markets since the Asian financial crisis, John Chu, chief investment officer of AIA Group, said that it was only after 1997 that the bond markets in Asia began to develop. He added that before that era it was common to see only one-month bonds in Thailand, or three-month bonds in Singapore. 

Long-term investments in life insurance or pensions will become more significant as Asia builds its social safety net. The emerging economies of Asia for now have the demographic dividend on their side as their relatively younger population is able to fuel the country’s growth. However, developed markets in Europe by comparison are burdened with an ageing population and the strain of funding social welfare payments. However, if economic success is measured in terms of quality of life and not GDP growth figures, developed markets have been successful in the development of their social welfare programmes, an area that Asia has yet to develop. Participants at the conference pointed out that Asia needs to invest in its long-term social safety net now, which would in turn aid the development of the region’s capital markets. 

Such issues are long-term challenges, of which there are many for Asia in terms of building sustainable growth for the region. The immediate challenge for now, however, remains on monitoring events in the eurozone and assessing the impact they will have on Asia’s prospects for growth.