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Can a United Asia Overcome a Global Crisis?

One myth is that Asia’s emerging economies are disconnected from the business cycle in advanced economies.

HELP WANTED Indonesian workers protest layoffs in front of the Japanese embassy in Jakarta. The global economic crisis is testing Asian nations’ regional cooperation measures.
Photo by AFP

As the global economic crisis takes a mounting toll, Asian economies are building up mechanisms to boost regional cooperation—and even revisiting the idea of creating an Asian Monetary Fund—but analysts say there is no clear sign yet of consensus on a structure for Asian regionalism.

The crisis, which has triggered a global liquidity shortage and sharply cut back Asia’s economic growth, may provide fresh impetus for regional cooperation as countries realize the benefit of collective action. So far, however, practical steps toward that end have been minimal. Asian economies have shown little inclination to coordinate fiscal stimulus or exchange rate policies, for example. Some experts also question whether a regional response can have much impact anyway in the face of such a worldwide problem.

Nor is it clear whether Asian countries have an answer to a looming “implosion” of Asian trade, as exports plunge in tandem with diminished demand from the United States (US) and Europe amid the worst economic downturn since the Great Depression.

The result is that the region might enter what some analysts describe as a period of “deglobalization” marked by plunging exports, retreating labor migration, financial retrenchment, and rising protectionist pressures, with no end yet in sight.

Faced with these strains, Asian leaders are fortifying regional mechanisms such as the Chiang Mai Initiative (CMI), which dates from May 2000 when finance ministers of the 10-member Association of Southeast Asian Nations (ASEAN) plus the People’s Republic of China (PRC), Japan, and Republic of Korea—a group known as ASEAN+3—set up a network of bilateral swap arrangements designed to provide short-term liquidity when needs arise.

The impetus for the initiative was the 1997–1998 Asian financial crisis, during which the currencies of Thailand, Indonesia, and the Republic of Korea in particular came under speculative attack. The participating nations last year multilateralized the initiative, creating a regional reserve pool of $80 billion, of which 80% would be contributed by the “plus-three” countries.

Meeting in Phuket, Thailand, in late February, the group agreed to raise CMI funding to $120 billion and set up a robust and independent “regional surveillance mechanism” to conduct objective economic monitoring. But the members stopped short of clarifying eligibility criteria or implementation mechanisms for drawing from the pool, and critics said the funding may still be inadequate to deal with a major financial crisis.

When the Republic of Korea’s currency recently came under pressure, for example, Seoul bypassed the CMI and struck bilateral swap deals with the US, Japan, and PRC for about $30 billion each. The PRC’s central bank has also signed bilateral currency swap agreements in recent months with Malaysia; Singapore; Indonesia; and Hong Kong, China.

Last September, Thailand suggested increasing the CMI funding pool to $450 billion, or about 10% of the thenprojected total international reserves of the ASEAN+3 countries. (Because of the current crisis, those reserves are now estimated in the range of $3.5 trillion to $4.0 trillion.)

The decision to link the CMI to a credible regional surveillance mechanism was an important step, but the “markets may expect more from Asia in response to the ongoing crisis,” said Giovanni Capannelli, senior economist in the Office of Regional Economic Integration at the Asian Development Bank (ADB). “They didn’t proceed with a proper diagnosis of the crisis” and may have “underestimated the actual consequences of the crisis on their economies,” he said.

“They need to broaden and widen the scope of their concerted efforts,” Capannelli noted.

While the Asian crisis of 1997–1998 served to inoculate the region to some extent against the kind of excesses that led to the recent US financial meltdown, it may also have helped sow the seeds of the American crisis by promoting a spurt of exportled growth that built up massive foreign exchange reserves. Now there is widespread recognition that Asian economies have become too dependent on exports, making them more vulnerable to the West’s financial woes than they thought.

“Growth in Asia is falling off a cliff,” said Eswar Prasad, a professor of trade policy at Cornell University and a senior fellow at the Brookings Institution specializing in financial globalization. “Many of these countries are still reliant on exports for growth, and export demand is plummeting.”

Until late 2008, Prasad said, “Asian countries were largely of the view that this crisis was manufactured in the West, and that the West was going to bear the brunt of the crisis…The feeling was they were in much better shape in terms of financial systems and intrinsic macroeconomic strength.” But the crisis was so huge that it soon reached Asian shores, and countries in the region “are discovering that they’re more dependent on exports than they would have liked to think,” he said.

“In Asia, it’s less a financial crisis than a macroeconomic crisis,” Prasad said. “Output growth and employment growth are taking a dive,” and regional countries do not seem able to stimulate their economies enough to take up the slack.

“What they’re discovering now is how dependent they are on demand from the industrial countries, especially in Europe and America,” said Raghuram G. Rajan, a rofessor of finance at the University of Chicago and a former chief economist at the International Monetary Fund (IMF). Asian countries are realizing that their emphasis on increasing regional trade and investment cannot make up for “the dramatic fall-off in demand from the West,” he said.

This underscores “a central weakness in the export-led strategies that have driven some of these countries,” Rajan said. “I think it will make them think about whether they should be focusing more on increasing their domestic demand. But they can’t do that overnight.”

Growing joblessness is particularly alarming in the PRC, where officials are said to be increasingly worried about the prospect of social unrest. According to Chen Xiwen, head of the PRC Communist Party’s office on rural policy, about 20 million migrant workers—nearly a sixth of the total—have lost their jobs in recent months as hundreds of thousands of factories have closed.

PRC authorities expect an additional 6 million to 7 million migrants to be looking for work this year, on top of about 9 million urban jobless people on government rolls and more than 7 million university graduates entering the workforce. Experts say these numbers, while staggering, could understate the problem, raising fears of urban unrest if too many people wind up in cities with no jobs and insufficient social services to support so many unemployed.

Contributing to the unemployment problems in the PRC and other Asian nations has been what analysts describe as a collapse in regional trade. According to the PRC customs bureau, imports from other Asian countries plummeted to $43 billion in December, down more than 38% from its record high of $70 billion in July 2008.

The steep plunge in intra-Asian trade has been a major factor pushing down the growth rates of Asian economies. According to the latest projections from ADB, economic growth in Asia’s developing countries will slow in 2009 to its most sluggish pace since the 1997–1998 Asian financial crisis. ADB’s Asian Development Outlook forecasts economic growth in developing Asia will slide to just 3.4% in 2009, down from 6.3% last year and 9.5% in 2007.

Being hit particularly hard are Hong Kong, China; Republic of Korea; and Taipei,China. A sharp drop in demand for exports will produce –2% growth in Hong Kong, China while the Republic of Korea sees –3% and Taipei,China records –4% growth, the report noted. Southeast Asia’s economic expansion is projected to dwindle to just 0.7% in 2009, down from 4.3% in 2008, and the three most export-orientated economies in the region—Malaysia, Singapore, and Thailand—will also contract, with the most open of these economies, Singapore, likely to shrink by 5%.

South Asia, though not as open to trade as other regional economies, is also expected to lose steam. India’s growth slowed to 7.1% for 2008, well below the strong 9% growth of recent years, and it is expected to fall further to 5% in 2009 as the intensifying crisis further dents business and consumer confidence and causes a major reduction in capital inflows.

Economists warn that these numbers could slip further as a worldwide recession takes hold. According to a World Bank report prepared for a Group of 20 finance ministers’ meeting in mid-March, global industrial production declined by 20% in the fourth quarter of 2008.

The IMF predicts that world economic activity would contract in 2009 for the first time in 60 years. It projected a shrinkage of 0.5% to 1% in global GDP this year before a gradual recovery in 2010, when world output is expected to grow by 1.5% to 2.5%. By comparison, global economic growth hit 5.2% in 2007, according to the IMF.

The Fund now predicts that US gross domestic product (GDP) will decline 2.6% this year, while Western Europe’s drops 3.2% and Japan’s contracts by 5.8%. The Obama administration, unveiling projections underlying a proposed $3.6 trillion federal budget for 2010, estimated in late February that the US economy would shrink 1.2% in 2009 before resuming its growth next year.

Addressing the Harvard Asia Business Conference in Boston on 14 February, IMF Deputy Managing Director Takatoshi Kato exploded “myths” about Asian immunity from the global financial crisis, which he said has “defied all predictions in its depth and reach.” One myth, he said, is that Asia’s emerging economies are disconnected from the business cycle in advanced economies, in part because of the rapid growth of intraregional trade in recent decades.

“In reality, global demand still represents a major factor behind Asia’s export growth,” Kato said, citing the nature of intra-Asian trade. Because exports represent such a large share of Asia’s GDP, he said, “the region is actually more exposed to shocks in advanced economies than other regions.”

The problem is that much intra-regional trade is actually geared toward assembling products that are ultimately exported to the US or Europe. In effect, when it comes to economic strength, the global crisis has exposed Asia’s highly touted regional trade as something of a mirage because so much of it depends on final demand in the West.

“Some people call it Asia, Inc.,” said ADB’s Capannelli, referring to the integration of production networks in the region.

In a study published last year entitled Emerging Asian Regionalism: A Partnership for Shared Prosperity, ADB highlighted the example of a company in Thailand that uses parts and components made locally and imported from eight other Asian economies, as well as the US and Mexico, to assemble computer hard-disk drives that are then shipped to electronics firms elsewhere in sia. The final products (computers) that use these hard-disk drives as intermediate goods often are exported to the West. The PRC “is increasingly at the hub of such production networks, but all economies participate,” the study says.

Using 2006 figures, ADB estimated that intra-regional trade accounted for about 55% of Asia’s total trade. But about 68% of the trade in Asia revolves around making final products for export to the US and Europe.

As a result of lowering final demand from the US and Europe, said Capannelli, “this crisis will entail an implosion of Asian trade.” Already, he said, Japan’s exports have dropped by nearly 50% compared to a year ago. Why should Asia produce parts and components when there is no more demand for final goods?

Singapore, a shining beacon of prosperity during the heyday of globalization, saw its total exports decline 35% in January compared to the same period a year earlier. Indonesia’s exports were down 36%, and Thailand’s fell 26.5%.

“Unless a big final market for exports like the United States or Europe steps up, it’s going to be very difficult for [Asian economies] to get the right sort of growth, and the United States right now is in no position to play this role,” said Prasad.

According to the IMF’s Kato, other Asian myths debunked by the crisis are that Asian economies were insulated from the global financial turmoil and that the region’s huge foreign exchange reserves provided effective insurance against a capital account crisis. Because foreign investors ramped up their holdings of Asian assets during the boom years, “the outflows during the crisis have been quite substantial,” Kato said.

Even though Asian financial institutions have had limited exposure to the kind of subprime-related securities involved in the US meltdown, investors pulled an estimated $70 billion out of equity markets alone in emerging Asia last year, Kato said.

CHANGING MONEY AND MINDS Proponents of an Asian Monetary Fund say such an institution could promote exchange-rate stability.
Photo by AFP

How Asia landed in this predicament is the subject of contentious debate. Asian leaders tend to blame the US and its excess consumption financed by debt, saying Americans have spent too much and saved too little. But some US officials, notably Federal Reserve Chairman Ben S. Bernanke, point to the impact of the huge reserves Asia accumulated from its exports. Over the last decade, for example, the PRC put more than $1 trillion into US government bonds and mortgage debt, which helped reduce interest rates and contributed to a massive US housing bubble.

“Excessive US consumption was in fact a problem, but it is also true that Asia benefited from it,” Akira Kojima, a senior fellow of the Japan Center for Economic Research, told a recent symposium in Tokyo. “It is also true that the US economy would not have been able to go on without an inflow of funds from Asia, which it accuses of saving too much.”

The Asian crisis of a decade ago made the region “very nervous about international financial flows and whether they had any backstop they could go to,” Prasad said. “So they decided to self-insure and built up vast amounts of reserves.”

“You might argue that the very desire to build up reserves led them into this mode of export-led growth that led to excess US consumption,” he said. “The paradox is that the virtue of the Asian countries has fanned the flames of the crisis and come back to bite them.”

One who rejects this argument is Matthew Daley, president of the US–ASEAN Business Council. “I don’t subscribe to the idea that China enabled poor policy in the United States,” he said. “I just don’t buy into that.”

A danger now is that Asian countries, their reserves diminished by the current crisis, could again attempt to export their way to surpluses—and manipulate their currencies as a way to gain an edge.

“This gives other countries incentive to try to subsidize their exports or hold down their currency,” said the University of Chicago’s Rajan. “It’s a version of a beggar-thy-neighbor policy.” This situation “could be averted if, as a region, they agree it’s not in their collective interest and put pressure on each other that other countries cannot put,” he said.

In this increasingly difficult context, the idea of setting up an “Asian Monetary Fund” as a regional version of the IMF has been gaining traction, although it still faces hurdles and skepticism about its effectiveness. Japan first proposed creating an Asian Monetary Fund more than a decade ago in response to the 1997–1998 crisis, but the US and the IMF opposed it on the grounds of moral hazard, and the PRC—perhaps concerned about Japanese domination of such a fund—showed little enthusiasm.

Now the US is poorly placed to block it, even if inclined to do so. The US Treasury Department, preoccupied with domestic financial recovery and G-20 matters, has not taken a position. And in any case, the key player now is the PRC, which holds the political and economic leverage, as well as the international currency reserves— estimated at about $2 trillion—to decide the fund’s fate.

A leading promoter of an Asian Monetary Fund this time is Masahiro Kawai, dean of the Asian Development Bank Institute and a former University of Tokyo professor and Japanese finance deputy vice-minister for international affairs. He told reporters in February that such an organization could serve to manage the funding pool of the Chiang Mai Initiative (CMI) and help Asian economies protect their currencies from speculative attacks, enabling them to avoid the strict conditions associated with borrowing from the IMF. Other expressions of support have come from the finance ministries of Malaysia and Thailand.

Financial analysts say an Asian Monetary Fund could promote exchange rate stability, gather other programs such as the Asian Bond Markets Initiative under one roof, and project an “Asian voice” on financial matters. But it would also represent a regional approach to a global crisis, which some critics see as an inherent weakness.

“The discussions will start again, but the issue will once again come to whether an Asian Monetary Fund will have enough resources to protect the region from crisis,” said Prasad. “The problem is, if you have the entire region going into a near crisis, then it’s unlikely an Asian Monetary Fund will have enough resources.”

In Rajan’s view, the IMF should be “reformed in such a way that it’s palatable to the Asian economies, rather than create another regional entity.” Institutions such as an Asian Monetary Fund “could reduce the effectiveness and draw away from the need to reform the international entity,” he said. “I would rather see an IMF that’s strong, but also legitimate and welcomed by countries around the world.”

WOE IS ME A man watches prices fall at the Bombay Stock Exchange.
Photo by AFP

Regardless of whether an Asian Monetary Fund comes to pass, the region still needs structures to promote stability and help deal with crises, advocates of regionalism say.

In its Emerging Asian Regionalism study, ADB advocates opening a high-level Asian Financial Stability Dialogue to bring together finance ministry officials, central bank authorities, and market regulators and supervisors to “address financial market vulnerabilities” and establish an effective dialogue with the private sector. It would help harmonize financial regulations and banking supervision, strengthen regional surveillance, and expand the Asian Bond Markets Initiative and the Asian Bond Funds.

The report also proposed creating an Asian Secretariat for Economic Cooperation, a body envisaged as a “new regional entity”—a sort of Asia Commission to monitor and potentially coordinate macroeconomic and exchange rate policies, among other things. The ADB study said ASEAN+3 is a “logical venue” for the secretariat since it would incorporate ASEAN, which already has its own small bureaucracy, plus three of the region’s largest economies.

But that would mean including tiny economies such as those of the Lao People’s Democratic Republic and Myanmar, while leaving out Taipei,China which has the sixth highest GDP in Asia and the world’s fourth-largest foreign exchange reserves (nearly $300 billion at the end of 2008). It would also exclude India, the world’s fourth-largest economy and holder of the fifth-highest foreign exchange reserves (about $250 billion).

Because of Beijing’s sensitivities, nothing much can be done about including Taipei,China, regional experts say. But a potential vehicle for broader Asian regionalism could be the East Asia Summit, a forum that encompasses ASEAN+3, as well as Australia, India, and New Zealand.

As a result of the crisis, “the impetus for regional integration is going to increase enormously, but the inadequacy of regional integration will also become apparent,” Prasad said. “Almost certainly there will be more regional integration— with the recognition that it isn’t enough…While regional integration can be helpful, I don’t think it can be a substitute for broader mechanisms for insuring emerging markets.”

According to Rajan, “regionalism, while good, should not subtract from internationalism, which I think is the real need.”

“I wouldn’t hold my breath for an Asiawide entity any time soon,” he said. “But what I would hope is that as the economic ties build up, the countries feel the need to have a regional dialogue, so they create meeting places where all the important countries can get together to ensure they don’t stand in the way of economic growth.” •