"Testing Times Ahead" is the title of the World Bank’s just released April 2008 East Asia and Pacific Update. As one of the team that put it together, I thought – before tottering off to bed – that readers might like a quick take - and a chance to comment - on some of the findings.
Economic outlooks are always uncertain, to be sure, but the level of uncertainty about prospects for the world economy just now is extraordinary. That matters in a region as highly globally integrated as East Asia. Forecasts for the US economy have been sliding lower for months but what’s less clear is how deep and protracted the downturn will be – underlying which are uncertainties about how much more widespread and intense the global financial turmoil that began last August will get.
Although the crisis started as a plain old housing bust leading to bad debts in the US sub-prime mortgage market, the report notes that recent changes in financial markets like securitization and the growing role of highly leveraged financial institutions are transmitting and magnifying the effects in ways that are still poorly understood. Add to this the extraordinary recent volatility in oil, metals and food prices – which could pose an even bigger challenge to East Asian economies – and the challenge of forecasting is daunting indeed.
But - if this sounds a trifle gloomy – the report also finds some reasons for what it calls “guarded optimism”. One point is that most East Asian economies look better prepared than ever before to handle the potential ups and downs of the world economy in this very uncertain time. Most of the larger economies have strong balance of payments positions and large international reserves – over $2.8 trillion in total – that will help accommodate sudden swings in international capital flows. Government fiscal positions have become stronger over recent years, creating some room for more fiscal stimulus, should that be needed. Local banks and corporations are more profitable and financially healthy.
Another point is that most East Asian economies have been bearing up rather well so far under the already unfolding impacts of the global financial turmoil, as a close look at the data for recent months suggests. At the financial level, it’s true that most stock markets have plunged (a median 19 percent), while offshore borrowing costs have risen. But, on the other hand, the cost and volume of lending by domestic banks – the main source of finance in most economies – seems little affected. Weaker exports to the US have been partly offset by – a notable development this – surging exports to other developing regions, as well as to other East Asian economies and Europe. GDP growth was actually accelerating into the fourth quarter in several economies, while in China it was decelerating only very gently, remaining over 11 percent in the fourth quarter.
So what does it all add up to? Despite recent resilience, East Asia will likely feel the impact of the slowdown in the industrial countries and in world trade more fully in coming months. High oil and other commodity prices will take a bite out of income in what is overall a commodity importing region. (Rising inflation and the impact of high food prices on the poor are already emerging among policy makers’ top worries.)
The report sees these factors pushing growth in the developing counties of East Asia lower by around 1 ½ percentage points to about 8 ½ percent in aggregate, while growth in China is expected to fall a full 2 percentage points to around 9 ½ percent. These would be the lowest growth rates since 2002. But of course they remain rather high compared to growth in other regions.
The report notes that this combination of cyclical swings with a high underlying trend rate of growth is rather typical of East Asia. Over the last 40 years trend growth in the region has averaged 4 – 5 ½ percentage points more than in industrial countries, driven by fundamentals such as ability to absorb knowledge from abroad, high savings, and growing education and skills. These fundamentals are unlikely to be displaced by the present financial turmoil. But cycles around that high trend are often – though not always - correlated with cycles in the industrial countries. That’s the kind of down-cycle we’ll likely see in East Asia in 2008. Could the cycle be steeper than we have projected here? Quite possibly. Shallower? What do you think?