TWN Info Service on Finance and Development (May11/04)
9 May 2011
Third World Network

Asia-Pacific to remain locomotive of global growth
Published in SUNS #7144 dated  6 May 2011

Geneva, 5 May (Kanaga Raja) -- The developing economies of the Asia-Pacific region are projected to grow at 7.3% this year, thus continuing to be the growth driver of the global economy, the United Nations Economic and Social Commission for Asia and the Pacific (UN-ESCAP) said on 5 May.

UN-ESCAP however sounded a note of caution: the regional growth outlook for this year is subject to several downside risks including the return of high food and fuel prices, sluggish recovery in the developed countries, a deluge of volatile capital inflows and the after-effects of natural disasters.

In its "Economic and Social Survey of Asia and the Pacific 2011", UN-ESCAP noted that the regional economic impact of the earthquake and tsunami that hit Japan recently will be less severe than might have been initially expected.

"In sum, the Asia-Pacific region emerged from the global financial crisis as a growth driver and anchor of stability of the global economy," said UN Under-Secretary-General and Executive Secretary of UN-ESCAP Dr Noeleen Heyzer in a preface to the report.

"It now has the historic opportunity to re-balance its economic structure in favour of itself to sustain its dynamism with strengthened connectivity and balanced regional development and make the twenty-first century a truly Asia-Pacific century," she added.

The ESCAP region encompasses all the countries in the Asia-Pacific region including the Central Asian republics of Azerbaijan, Georgia, Kazakhstan, Kyrgyzstan, Tajikistan, Turkmenistan and Uzbekistan. The developed economies in the region are Australia, Japan and New Zealand.

According to the UN-ESCAP survey, the region witnessed a dramatic recovery in economic growth in 2010 following the 2008/09 recession. While large economies with significant domestic private demand weathered the crisis with only moderate decreases in growth, many export-oriented economies started moving into positive growth territory only around the third quarter of 2009.

Despite headwinds to growth emerging in 2010 due to the slow recovery in the developed world, growth for the ESCAP region as a whole remained impressive in global terms. As was the situation in 2009, the Asia-Pacific region was by far the fastest-growing region in the world, with close to double the growth rate of the next highest growth performers.

"This brings into stark relief the role of the region as a possible growth locomotive for the global economy," says the report, noting that the growth impact on other regions comes from Asia and the Pacific serving as a source of demand for the goods and, even more so, for the commodities of other regions.

General consumption and specifically demand for exports from developed economies continues to be restrained as the economies' recovery process continues. Growth in the United States in the fourth quarter of 2010 remained moderate at 2.8% (year-on-year). On a similar note, growth in the European Union in the fourth quarter of 2010 slowed from 2.1% in the previous quarter to 2.0%, with a wide diversity of performance among economies in the region.

"The growth prospects for Japan are subject to a great deal of uncertainty currently, as the longer-term repercussions of the recent natural disaster in the country become clearer."

According to the report, while there is the risk of slowdown in growth below baseline in Japan in 2011 due to the disaster, it is expected that the direct impact on the region will be limited. UN-ESCAP estimated that a 1.0 percentage point slowdown in Japan relative to 2011 baseline growth would result in only a 0.1 percentage point slowdown for Asia-Pacific developing economies as a whole.

The economies most adversely affected would be Singapore (an impact of 0.24 percentage point), Indonesia (0.16 percentage point) and Malaysia and Thailand (0.13 percentage point).

In terms of the direct impact on export growth numbers, it added, developing Asia-Pacific economies as a whole would see a reduction in export volume growth of 0.35 percentage point, with the economies most affected being Indonesia (an impact of 0.49 percentage point), Malaysia (0.46 percentage point) and China (0.42 percentage point).

"The economies experiencing the greatest impact on GDP growth are those with the strongest trade ties with Japan and those where their exports to Japan are a more important driver of overall GDP growth. In general, the lack of substantial impact on the region is related to the diminishing importance of Japan as an export market for the region," the report explains. It however cautions that the effect will be significant on select industries, such as automobiles and electronics, due to disruption of supply chains, although this will be for a limited period.

The report notes that the likelihood of further stimulus in the developed economies to support growth is limited due to growing concerns about fiscal sustainability. It warns that the Asia-Pacific economies should prepare for possible spillovers from the public debt crisis in a number of European economies. In recent months, the bailouts of Greece, Ireland and Portugal, as well as concerns about Spain, have led to credit downgrades across many European economies and increases in the debt servicing costs of those countries.

"The worst-case scenario of sovereign debt defaults in one or more European countries at some point remains a concern," says the report, emphasizing that the risk for Governments in Asia and the Pacific lies in the possibility that any financial contagion would spark off another seizure in global inter-bank lending, arising from uncertainty regarding the extent to which banks in developed countries hold financial assets in the affected countries and the possibility of losses through default on some of these assets.

"The concern is that the scale of investments in financial products would be underestimated and that the full range of transmission mechanisms through which these products could spread contagion between financial institutions would not be recognized until it is too late."

According to the report, since their nadir in mid-2009, the exports of many Asian economies grew strongly until mid-2010, painting a picture of a V-shaped recovery. The rebound of exports that started in mid-2009 resulted in the quarterly value of exports returning to pre-crisis levels by mid-2010 in most developing economies of Asia.

As for the growth outlook for this year, the report forecasts growth in developing economies of the region to be 7.3% in 2011, representing a decline compared to 8.8% achieved in 2010. It explains that the 2010 growth rates were particularly high, partly because they represented a recovery from a low base or trough due to recession in 2009. Besides the base effect, the 2011 growth slowdown also reflects the effect of withdrawal of fiscal stimulus policies, of tighter monetary policy adopted in some countries to meet the challenge of rising inflation, and also that of sluggish recovery in the developed economies of the world.

The slower growth in exports driving some of the growth slowdown in developing economies began to become evident during the course of 2010 and this trend is expected to continue during 2011, with impacts on other components of GDP growth over time, thus driving some of the overall slowdown in growth in exporting economies.

"Despite the moderation in growth in 2011, the Asia-Pacific region will remain by far the most dynamic growth region in the world. As was the case in 2010, the Asia-Pacific region will remain the locomotive of global growth, with its growth rate being nearly one and a half times more than that of any other region of the world," the report stresses.

Subregions for which exports are a key driver of growth will experience the most significant moderation in growth, after the rapid increase of the previous year. South-East Asia is expected to experience the greatest moderation in growth, from 8.1% in 2010 to 5.5% in 2011. Similarly, the economic growth rate of developing economies in East and North-East Asia is expected to slow from 9.4% in 2010 to 7.9% in 2011.

Conversely, says the report, subregions where domestic demand is important will see relatively solid growth performance. The South and South-West Asian subregion is forecast to see growth decelerate slightly, from 7.5% in 2010 to 6.8% in 2011. Subregions where commodities play a substantial role are expected to experience robust growth in 2011. North and Central Asia are expected to see relatively stable growth at 4.8% in 2011. Pacific island developing economies are forecast to see higher growth at 5.5% in 2011 after having grown by 4.3% in 2010.

According to the report, large developing economies in the region will continue to grow strongly in 2011. The fastest-growing major economies in the region in 2011 are expected to be China and India, with estimated growth rates of 9.5% and 8.7%, respectively, followed by Indonesia at 6.5%.

"Factors that will contribute to their steady performance in 2011 include robust consumption and investment in India and Indonesia, both of which countries are characterized by the increasing wealth of their populations, and in China by gradually increasing consumption due to government measures to reorient the economy towards a more consumption-driven one."

After experiencing a strong rebound driven by export growth and fiscal stimulus measures, export-dependent economies will experience some slowdown in 2011. Some deceleration in the region in 2011 would be inevitable, given the especially high growth rates seen in 2010 due to the base effect of low to negative values of growth in 2009.

"However, the concern is that medium-term growth in the developed economies may remain moderate in coming years as the effects of stimulus end and the economies remain beset by low private consumption and high private and public debt. This indicates the risk that the previous growth model, which was dependent on exports to developed economies, may pose: a reduction in the growth trend for exporting economies in coming years," says the report.

To replace this loss, UN-ESCAP suggests that there is a compelling need to increase intra-regional exports in order to benefit from growth in large domestic demand-led economies, as well as in many cases to increase domestic demand in the exporting economies through investment, which has decreased substantially in many of these economies since the 1997 Asian financial crisis.

The report highlights a number of key challenges to the growth outlook in the region. One of these challenges is that inflationary pressures are rising in the region in 2011 due both to the growth recovery and to price rises for imported food and energy. Most economies are forecast to see an increase in inflation in 2011. External supply-led increases in food and energy prices are having a damaging effect on economies and on the lives of the poor and vulnerable.

"Furthermore, there are significant risks that the excess liquidity resulting from monetary easing in developed economies could spill over into speculative asset price bubbles, as well as general inflation and real currency appreciation due to incomplete sterilization of capital inflows."

The report notes that in response to growing inflationary pressures, several economies across the region started to tighten monetary policy over the course of 2010. In economies where inflation is a pressing concern, such as China, India and Viet Nam, rates have been raised in recent months. However, for many other economies, such as Malaysia, the Republic of Korea and Thailand, inflation has not yet become a major issue; nevertheless, to counter growing price pressures, those economies also started to raise interest rates.

Such monetary tightening will place added pressure on growth in 2011, especially for strongly export-oriented economies that will also see their growth affected by relatively weak demand from the developed economies, the report cautions.

The report further says that rising food and energy prices are emerging as an issue of serious concern across much of the region in a manner reminiscent of the 2007-2008 period just before the onset of the financial crisis.

UN-ESCAP estimated that rising food and oil prices could lead to 42.4 million additional people in poverty, joining the 19.4 million already affected in 2010. In a worst-case scenario with food price inflation doubling in 2011 and average oil prices at $130 per barrel, the achievement of the Millennium Development Goal for poverty could be postponed by up to half a decade in some developing countries in the region, it said.

It also estimated that high energy prices would lead to a significant adverse impact on growth, that is, up to 1.0 percentage point in some developing Asia-Pacific economies, as well as upward pressure on inflation and a deterioration of current accounts. It said that the impact of oil prices on growth in Asia-Pacific is significant due to high energy intensity of production in the region.

Apart from supply-side shocks due to adverse weather events and the conversion of food into bio-fuels as being among the causes of rising food prices, the report also points to the role of financial speculation, saying that it is now "increasingly clear that a significant portion of the increases in the price and volatility of food and energy commodities can only be explained by the emergence of a speculative bubble."

Another key challenge highlighted by the report is that the Asia-Pacific region is being buffeted by the impact of the accommodative monetary policies undertaken by developed economies as part of their programmes to recover from the recent crisis.

The resulting low interest rates in those economies are pushing investors towards developing economies, including those in this region. These economies are attractive because of the better yields offered by their currencies owing to the comparatively high interest rates in the region, as well as the potential capital gains to be realized from asset investments due to the relatively better growth prospects of Asia-Pacific economies.

The report notes that the scale of potential pressure for regional economies can be seen from the disproportionate size of the global fund management industry as compared with the size of most regional economies. The quantum of total global funds under management was estimated at $61.6 trillion in 2008, representing about 100% of global GDP.

Other than reallocation of existing funds by financial institutions, there is once again the burgeoning "carry trade", using borrowings in foreign currencies, such as the Japanese yen, the Swiss franc and to a certain extent the dollar, to invest in higher-yielding currencies in both developed and developing countries. While the size of the current carry trade is difficult to measure with certainty, the report says that estimates put it at around $750 billion, approaching the size of the previous carry trade at its peak between 2004 and 2007.

It notes that apart from a pure carry trade to take advantage of yield differentials, investment in financial assets in the region is also being driven by prospects for increases in asset values due to comparatively higher economic growth in the region, and expected gains from appreciation in exchange rates. Foreign investor interest in equity markets of the region is reflected in booming inflows to Asian equity funds (excluding Japan), which stood at $45 billion in 2010, with the greatest interest being in China and India, while developed market equity funds saw an outflow of $62 billion.

UN-ESCAP said that its analysis of the impact of short-term capital flows indicates the role of such flows in building up possible asset bubbles. Another asset class which has seen steep rises is property, both in emerging economies such as China, as well as high-income economies, such as Hong Kong-China; and Singapore.

According to the report, the immediate impact on economies in the region of the deluge in foreign capital flows has been steep rises in currency values. While many economies in the region have current account surpluses which would put upward pressure on exchange rates, economies are experiencing additional currency appreciation pressure due to capital inflows.

The report says that economies in the region have attempted to insure themselves against the risk of sudden capital outflows by building up foreign exchange reserves which can be used to defend currencies suffering from capital withdrawal. Despite the high level of reserves in many economies in recent months, there remains the possibility that the quantum of reserves may not be sufficient to defend currencies in the case of sudden capital outflows, it adds.

The report underscores that economies in the region are becoming receptive to the view that another solution to managing the deluge of inflows and the consequent risks of outflows lies in various forms of capital controls, as recommended by ESCAP, which alerted policy-makers to the incipient capital heading for the region's shores and recommended the application of controls.

It finds that a number developing economies as well as multilateral institutions, both within and outside the region, have now realized the value of such controls and have imposed various forms of capital restrictions in recent months.

Apart from capital controls being seen as an important element in the policy toolkit for reducing the volatility of inflows, the report also recommends that in the medium-term, the region must also generate more aggregate consumption and investment demand to sustain dynamism and reduce poverty. +