TWN Info Service on Finance and Development (Mar08/05)
31 March 2008
Third World Network

“HEIGHTENED UNCERTAINTY” OVER CREDIT CRUNCH, US SLOWDOWN IN ASIA-PACIFIC

The Asia-Pacific region is entering a “phase of heightened uncertainty” in 2008, amid financial turmoil due to the fallout from the sub-prime credit crisis, the threat from rising inflation and a major slowdown in the US economy, the UN Economic and Social Commission for Asia and the Pacific (ESCAP) reported Thursday in its latest regional survey.

In its annual flagship publication, the “Economic and Social Survey of Asia and the Pacific 2008”, the Bangkok-based UN agency said that after having enjoyed their fastest growth in a decade, the developing economies in the Asia-Pacific region will see growth moderating to 7.7% in 2008, down from 8.2% in 2007. Developed economies in the region are expected to grow at 1.6% in 2008, slipping from 2% in 2007. According to ESCAP, the major downside risk to the 2008 outlook comes from outside the region, from possible spillovers resulting from the downturn in the US housing market.

Another main message highlighted in the Survey is that chronic neglect of the agricultural sector in Asia and the Pacific is condemning 218 million people to continuing extreme poverty, and widening the gap between the region’s rich and poor (see below).

Below is report of the ESCAP survey. It was published in the SUNS #6443, Friday, 27 March 2008.

With best wishes
Martin Khor
TWN

“Heightened Uncertainty” Over Credit Crunch, US Slowdown in Asia-Pacific

By Kanaga Raja, Geneva, 27 March 2008

The Asia-Pacific region is entering a “phase of heightened uncertainty” in 2008, amid financial turmoil due to the fallout from the sub-prime credit crisis, the threat from rising inflation and a major slowdown in the US economy, the UN Economic and Social Commission for Asia and the Pacific (ESCAP) reported Thursday in its latest regional survey.

In its annual flagship publication, the “Economic and Social Survey of Asia and the Pacific 2008”, the Bangkok-based UN agency said that after having enjoyed their fastest growth in a decade, the developing economies in the Asia-Pacific region will see growth moderating to 7.7% in 2008, down from 8.2% in 2007. Developed economies in the region are expected to grow at 1.6% in 2008, slipping from 2% in 2007.

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

Another main message highlighted in the Survey is that chronic neglect of the agricultural sector in Asia and the Pacific is condemning 218 million people to continuing extreme poverty, and widening the gap between the region’s rich and poor (see below).

According to ESCAP, the major downside risk to the 2008 outlook comes from outside the region, from possible spillovers resulting from the downturn in the US housing market.

The fallout from the sub-prime crisis did not, however, have a significant impact on the region in 2007. The main effects were increased volatility in domestic equity markets and widening yield spreads on external debt, but stock markets recovered rapidly, ending the year with gains.

The Survey however warned that the broader impact of the sub-prime crisis on the US is “yet to be seen.”

“The region is entering a phase of heightened uncertainty in 2008. The sub-prime crisis in the United States is still unravelling, and a significant slowdown of the United States economy and further turmoil in financial markets cannot be ruled out,” it added.

Under a worst-case scenario with the US falling into recession and a deeper depreciation of the dollar, “the impact on much of the region will be harsh,” the Survey cautioned, adding that the most vulnerable will be the exporters of high-technology products, such as electronics, to the US: Singapore, Korea and Taiwan Province of China.

A sharp downturn in the US would also hit exports from Indonesia, Thailand, the Philippines and Malaysia - although to a lesser degree. But China, said ESCAP, will remain resilient, as strong domestic demand should partly cushion the external shock. The impact is likely to be felt less in economies led largely by domestic demand, such as India.

The Survey pointed to Asia’s strong economies as being a buffer to a US downturn. The Asia-Pacific region’s strong macro-economic fundamentals and underlying regional domestic demand will act as a vital buffer to any significant US downturn.

The region’s resilience lies mainly in its healthy macroeconomic fundamentals, enabling countries to adopt supportive fiscal and monetary policies amid significantly declining export growth, financial market volatility or inflationary pressures from high oil and food prices. Large foreign reserves have added to this resilience.

While the major downside risk for the Asia-Pacific economies lies in the downturn in the US housing market, the region’s corporations are largely resilient to the unfolding credit crunch in the US. “At present, Asia-Pacific economies remain relatively immune to the credit crunch in the United States and European Union,” said the Survey, adding that the corporate sector is generally cash-rich and not highly leveraged.

Companies learning the lessons of the 1997 Asian crisis have been conservative in their borrowing. The region has so far had little exposure to sub-prime or other vulnerable debt, said ESCAP, noting that while banks in Japan, Singapore and China have revealed some losses, the size is dwarfed by their capital bases.

On the other hand, the Survey said that the sub-prime crisis may bring new opportunities for the region. There may be increased interest in Asia-Pacific’s assets due to the region’s relatively strong growth projections. If investors regard markets in the region as having decoupled, at least partly, from the US - through growth in exports to the European Union and Asia and stronger domestic demand - these markets may become attractive.

The Survey further said that Asia-Pacific investors are playing a key role in supporting developed countries during the current financial turmoil.

“Sovereign wealth funds and State investment institutions from the region have bolstered weakened banking sectors in the United States and Europe,” it said, noting that financial institutions have sought equity investment from investors in Asia and the Pacific to shore up their depleted capital bases.

Notable purchases include equity stakes for the Government of Singapore Investment Corporation in Citigroup and UBS, for Korea Investment Corporation and Singapore’s Temasek Holdings in Merrill Lynch, for the China Investment Corporation in Morgan Stanley and for Temasek Holdings in Barclays.

The Survey highlighted a “shifting balance of financial power”, evident in the dramatic rise in the overseas investments of the Asia-Pacific corporate sector. Companies from the region, both private and State-owned, have benefited from blistering growth in their home markets and are using their wealth to acquire major enterprises in developed countries and in other developing regions.

From 2005 to 2007, outward direct investments from India more than quadrupled, those from China more than doubled, and there were large increases in those from other major countries in the region.

Rising outward investment by State-owned institutions and private companies has generated controversy, provoking concerns about lack of transparency in strategies and portfolio composition. Regulators in target countries have been less than enthusiastic about foreign governments controlling national enterprises. In the US and the European Union, calls arose in 2007 to mandate greater regulatory oversight of sovereign wealth funds.

To make target countries “more welcoming to investments and to prevent a protectionist backlash”, ESCAP recommended that sovereign wealth funds take proactive measures to foster disclosure and transparency.

“The sub-prime crisis has opened eyes to the failure of the international financial architecture to address the risks of new financial instruments,” said the Survey, adding that action to regulate the new models of international finance must be global. Investment decisions in developed countries threaten financial disruption in developing countries, both in Asia and the Pacific and in other regions.

Measures by developing countries to increase transparency are ineffective when the executing institutions are in other jurisdictions. And measures by developed countries acting independently are also often powerless when investments cross borders.

Key measures are required through global cooperation among national supervisory institutions: Regulators need aggregate information on structured-finance-instrument holdings of financial institutions and on the concentration of risk to assist in the regulatory process; major central banks must cooperate more closely in dealing with liquidity shocks; and banks should be required to explain to investors in sufficient detail the complex structured products they design.

Regulators should also standardize the valuation and risk-assessment methodologies used by credit rating agencies and clarify conflict-of-interest issues, said ESCAP.

Developing economies in the Asia-Pacific region, having enjoyed their fastest growth in a decade, are expected to see it moderate to 7.7% in 2008, down from 8.2% in 2007. Developed economies in the region are expected to grow at 1.6% in 2008, slipping from 2.0% in 2007.

China and India, the region’s locomotives, are expected to grow at a brisk pace in 2008, boosting the rest of the region. China, beset by an inability to rein in its supercharged economy, is forecast to have its GDP growth moderate to 10.7% in 2008 from 11.4% in 2007. A slowdown in exports and the government’s measures to cool the economy are the main reasons for the moderation, said ESCAP.

India, largely insulated from weaknesses in the international environment, is projected to maintain growth at 9.0% in 2008 - unchanged from 2007. Investment in booming manufacturing and services will remain the main driver. Private consumption will also remain healthy.

The Survey noted that least developed countries in Asia and the Pacific, having grown at 6.5% in 2007, are expected to have growth slow to 6.4% in 2008. Cambodia grew at 8.5% in 2007, followed by the Lao People’s Democratic Republic (7.4%), Bangladesh (6.5%) and the Solomon Islands (5.4%). High oil prices pose major challenges to oil-importing least developed countries, but they also increase demand for foreign workers in some of the oil-rich countries in Western Asia.

Asian and Pacific least developed countries have been largely unaffected by the US sub-prime meltdown because they have little exposure to the global financial system. A significant slowdown in the US, however, could be damaging, particularly for Cambodia and its apparel exports.

In 2008, said ESCAP, domestic demand in the region will continue to sustain growth as exports decline. Robust private consumption and investment growth, supported by fiscal policy accommodation, are the keys. The strong fiscal position of many countries is likely to enable accommodative policies that compensate for weak external sectors. And the accumulation of foreign reserves has curtailed a more effective use of savings in the region.

Policymakers may want to make a conscious effort to sustain the rise in domestic demand in order to reduce their economies’ dependence on the external sector, which is becoming increasingly unpredictable, the Bangkok-based UN agency said.

Inflation in the developing ESCAP economies was 5.1% in 2007, up from 4.4% the previous year. Currency appreciation in most economies moderated the impact of high international oil and food prices. With the exception of East and North-East Asia, all ESCAP sub-regions had lower inflation in 2007 than in 2006.

Inflation is projected at 4.6% in 2008 for the developing economies of Asia and the Pacific, with currency appreciation cushioning high oil and food prices, said the Survey, adding that inflation is expected to edge up in 2008 in South-East Asia and Korea. But it should moderate in China, Hong Kong-China, India, and the Russian Federation.

Food prices are likely to remain high. The rapid rise in 2007 was partly the result of drought in Australia, flooding in China and dry weather in Europe. Added pressure came from biofuels. With grains and oil seeds the key feedstuffs for biofuels, the oil price rise exerted a strong push on agricultural commodity prices in 2007, which enjoyed their best performance for almost 30 years.

As oil hit US$100 per barrel in January 2008, soybean prices jumped to a 34-year high, corn prices approached their recent 11-year high, wheat prices were just below their recent all-time high, rapeseed prices rose to record highs, and palm oil futures hit a historic high.

With the march towards biofuels apparently unstoppable, the region has to prepare for imported inflation through higher food prices. Governments need to carefully consider the impact of biofuels on the poor, cautioned ESCAP.

The currencies of the region have appreciated dramatically over the last two years on a tide of huge global liquidity. Since 2006, all major currencies in the region have risen against the dollar, a trend expected to continue in 2008, driven by the unwinding of large US imbalances with the rest of the world and the turmoil in global financial markets.

On sub-regional performance, the Survey said that East and North-East Asia grew at 9% in 2007, despite slower growth in the US and sluggish performance in Japan and the European Union. Domestic demand, largely from investment and private consumption, proved effective in taking up the slack from slowing exports.

For the economies of North and Central Asia, 2007 marked another year of strong growth performance due to large external surpluses and increasing international reserves. As in other recent years, high oil and commodity prices were key.

Economic growth in the Pacific region was uneven in 2007. Papua New Guinea more than doubled its growth from 2.6% in 2006 to 6.2% in 2007, on the back of high petroleum and mineral prices. But civil unrest in Tonga in November 2006 and a coup d’etat in Fiji in December 2006, caused a decline in tourism to both countries during 2007, lowering their GDP growth.

South Asia’s strong aggregate economic growth rate of 7.4% for 2007 was spearheaded by India, which grew by 9% and appears to be moving on to a new, high-growth phase as rates of investment in the economy rise sharply, said ESCAP.

Strong domestic demand helped South-East Asia’s economies continue their robust growth performance of 2006 into 2007. In all the South-East Asian countries with data available, except Thailand, domestic demand grew more rapidly in 2007 than in 2006.

Among the developed economies of the region, Australia and New Zealand saw growth accelerating in 2007 compared to the previous year, while Japan grew at 1.8%, down from 2.4% in 2006.

Highlighting the neglect of agriculture in the region, the Survey said that 218 million - a third of the region’s poor, largely living in rural areas - could be lifted out of poverty by raising agricultural productivity. It called for a comprehensive liberalization of global trade in agriculture, as this would take a further 48 million people out of poverty in the region.

ESCAP said that its focus on the agricultural sector comes amid signs of rising food prices, pressured by soaring demand for biofuels. The Survey said that biofuels are not only hurting poor consumers in Asia and the Pacific through high food prices, but they are also failing to help the region’s poor farmers who do not have the resources to adapt their land to the biofuel crops.

While the Asia-Pacific region is at the forefront in reducing poverty, cutting the number of poor living on less than US$1 a day from 1.25 billion in 1981 to 641 million in 2004 (a decline of around half), the decline in poverty has slowed since the late 1980s. The slowing poverty reduction is a result of the neglect of agriculture, which is the focus of the rural sector.

A study by ESCAP on the impact of agricultural trade liberalization on poverty shows poverty reductions in some countries but increases in others. The region could take 5 million people living on less than US$1 a day out of poverty through Doha agricultural trade reforms in the short run, possibly increasing to 7 million in the long run.

China appears to gain the most, reducing the number of poor people by 10 million, mainly in rural areas, due to an increase in real wages of unskilled workers. Thailand and Viet Nam would also reduce the prevalence of poverty, as would Indonesia and the Philippines.

Poverty would increase, however, in Bangladesh, India, the Russian Federation and Sri Lanka in both the short and long runs. India would suffer the most, with 7.2 million new poor due to the negative impact on the real wages of unskilled labourers, said the Survey.

If the world goes beyond the Doha reforms and undertakes comprehensive agricultural liberalization - eliminating all tariffs, export subsidies and domestic support for agricultural and food products - the Asia-Pacific region could take 48 million people out of poverty in the short run, increasing to 51 million in the long run.

According to ESCAP, all countries except Sri Lanka would see a reduction. Rural China would see nearly 25 million people come out of poverty, and India 12 million.

In terms of aggregate welfare effects of agricultural reforms, ESCAP estimates the aggregate welfare effects under Doha would be modest annual gains of US$4.6 billion globally in the short run, increasing to US$5.2 billion in the long run. Two-thirds of the total gains would accrue to Asia, with Japan gaining the most. Developing countries in Asia would gain a modest US$365 million (8% of the total) in the short run, rising to US$640 million (12%) in the long run.

The Republic of Korea, Thailand and India appear to gain the most from agricultural trade liberalization under Doha, due mainly to gains in the terms of trade. China, which stands to gain the most in poverty reduction under Doha, appears to lose in overall absolute welfare gains.

Many others will also lose, though marginally, mainly due to a terms-of-trade shift. The small aggregate gains reflect the relatively small degree of reform anticipated, if the proposal on agriculture remains in its current form, said the Survey.

(The survey does not appear to explain clearly the seeming contradiction between welfare gains, for example, for India as a result of the Doha agriculture reforms, and at the same time increase in poverty; nor, the gains to China from poverty reduction while at the same time losing overall absolute welfare gains.)

Under comprehensive agricultural trade reforms, said ESCAP, both regional and global welfare gains increase several times. Global welfare gains exceed US$23 billion in the short run, increasing to US$37 billion in the long run. Developed economies in Asia and the Pacific as a group - Japan, Australia and New Zealand - gain the most under Doha and comprehensive reforms. Developing country gains in the region also increase nearly 10 times to US$3.3 billion in the short run, rising to US$3.5 billion in the long run.

Many countries that could suffer welfare losses under Doha reforms turn out to be net gainers under the comprehensive reforms, with China, Bangladesh and the Philippines the exceptions. Korea, Malaysia, Thailand and India would gain the most in absolute terms. Malaysia and Sri Lanka would turn losses under Doha into gains under comprehensive reforms, of 1.5% and 0.7% of GDP, respectively, said the Survey.