Asia has rebounded fast from the depth of the global crisis. Initially, the region was hit extremely hard, with output in most countries shrinking by more than even those nations at the epicenter of the crisis. But starting in February, Asia’s economy began to revive. Exports and industrial production began to increase again, first slowly, then at a rapid rate. Now Asia is leading as the world pulls out of recession (Figure 1.1).

Asia has rebounded fast from the depth of the global crisis. Initially, the region was hit extremely hard, with output in most countries shrinking by more than even those nations at the epicenter of the crisis. But starting in February, Asia’s economy began to revive. Exports and industrial production began to increase again, first slowly, then at a rapid rate. Now Asia is leading as the world pulls out of recession (Figure 1.1).

Figure 1.1.
Figure 1.1.

Current Recession: Real GDP Growth

(In percent)

Sources: CEIC Data Company Ltd., Haver Analytics; and IMF staff calculations.1 Since these economies did not experience a recession, quarter-on-quarter seasonally adjusted growth between the first and second quarters of 2009 is plotted. See Regional Economic Outlook-Asia and Pacific, May 2009 on identification of business cycles in Asia.

Indeed, the “green shoots” of recovery appear more firmly rooted in Asia than in other regions (Figure 1.2). Not only are they more prevalent, but they have also appeared earlier (in April in many cases), and have progressed further. The progress made by China, in particular, is striking. Alone among major countries, its key growth indicators were expanding in August at rates that are above their long-term trend. In contrast, indicators in key Western economies, such as the United States and Germany, suggest that output was only stabilizing in August after months of severe contraction.

Figure 1.2.
Figure 1.2.

Assessing Global Growth Momentum1

Sources: Haver Analytics; Bloomberg LP; and IMF, Global Data Source database and staff calculations.1 The above chart is based on the four economic indicators, including industrial production, real retail sales, merchandise exports, and purchasing managers index (PMI). Some of the ratings—particularly for recent months—are based on both actual data as well as projections of the underlying variables.

Global conditions are expected to continue to improve in 2010, with Western economies progressing from stabilization to recovery. But the recovery is expected to be a sluggish one. Output in the large G-7 economies is forecast to grow by just 1¼ percent next year, insufficient to compensate even for half of the 3½ percent contraction estimated for 2009 (Figure 1.3). Essentially, the problem is that private demand remains hobbled by the legacy of the crisis. Households will find it difficult to spend and banks to provide credit, since they must focus instead on repairing their balance sheets after the sizable destruction of wealth that occurred during the recession. The problems are particularly acute in the United States, where household wealth declined by about US$14 trillion at the trough, an amount nearly equivalent to that country’s GDP.1 Aggravating the problem, U.S. unemployment has risen sharply, by more than 4 percentage points over the past year, to a 26-year high of 9¾ percent in September, undermining households’ current income and increasing risks to their future income as well. In the face of these difficulties, household saving rates have shot up and are forecast to continue doing so over the medium term, rising eventually by about 6 percentage points of GDP compared with a precrisis (April 2008 World Economic Outlook) baseline. With saving rates rising, U.S. consumption will remain subdued for some time.

Figure 1.3.
Figure 1.3.

World Growth

(Year-on-year; in percent)

Source: IMF WEO database.

The weak global outlook has significant implications for Asia. Not only is the region highly dependent on exports, but it is particularly dependent on U.S. consumption, which is responsible for about one-fourth of Asia’s export value added. Put simply, over the past decade, Asia has boomed as America’s consumption outpaced its income. If over the coming decade U.S. consumption slows dramatically, the impact on Asia’s growth could be sizable.

Is it possible that the threat from a weak global economy is overstated? After all, Asia’s quick rebound from recession seems to suggest that it has “decoupled” from the rest of the world. But careful consideration of the forces behind the rebound reveals that the opposite is true.

In fact, the primary driver of Asia’s recovery has been a return to normalcy following the abrupt collapse of global trade and finance at the end of 2008. Just as the U.S. downturn triggered an outsized fall in Asia’s GDP because international trade froze, now trade normalization is generating an outsized Asian upturn (Figure 1.4). Similarly, Asia’s recovery has been aided by a thawing of international capital markets, which has restored firms’ access to critical long-term debt and equity financing. In fact, Asia began to recover before other economies largely because trade and finance started to normalize in February/March 2009, well before overall economic activity stabilized in the West. Another reflection of this same phenomenon is that the rebound in economic activity has been fastest in the export-dependent Asian economies that were hit most severely at the end of 2008 (Figure 1.5). In sum, the events of the past year, far from demonstrating decoupling, actually show that Asia’s fortunes remain closely linked to those of the global economy.

Figure 1.4.
Figure 1.4.

World Trade and Asia’s Industrial Production

(3-month percent change of 3-month moving average, SAAR)

Sources: CPB Netherlands Bureau for Economic Policy Analysis; and IMF staff calculations.
Figure 1.5.
Figure 1.5.

Selected Asia: Industrial Production and Contribution of Final External Demand to Total Value Added

(In percent)

Sources: CEIC Data Company Ltd.; and IMF staff estimates.

This is not to say that external factors have been the only driver of Asia’s recovery. To the contrary, the region’s aggressive countercyclical response has also played a significant role. The response—both on the monetary and on the fiscal side—has been substantially stronger than in past recessions and in some respects greater than in other regions. In large part, this response has been dictated by the size of the policy challenge: for most countries, late 2008/early 2009 brought the worst recession they had seen in the post–World War II era. Equally important, the response was made possible by Asia’s relatively strong initial conditions: fiscal positions have been sounder, monetary policies more credible, and corporate and bank balance sheets sturdier than at any time in the past. These conditions have given Asia the space to cut interest rates sharply and adopt large fiscal stimulus packages. As a result, overall domestic demand has held up remarkably well, despite weak private demand.

Against this background, Asian policymakers face two major challenges:

  • In the near term, the key issue will be to maintain policy stimulus until the recovery becomes self-sustaining, but not long enough that it begins to threaten macroeconomic stability. Striking the appropriate balance will be difficult. But the key is clear: policymakers will need to assess the state of private demand, and the extent to which it can substitute for a withdrawal of public sector demand. So far, private sector demand remains weak and the outlook uncertain, both in Asia and abroad. Consequently, Asian countries will need to maintain policy stimulus for some time.

  • The other major policy challenge will be to devise a way to return to sustained, rapid growth. With the external environment likely to remain weak for some time, Asia’s growth prospects may be determined by its ability to diversify drivers of growth to allow domestic sources to play a more dynamic role. This type of rebalancing will require action across a broad range of areas—and a broad range of countries. Financial sector reforms and better social safety nets will be needed to boost private consumption, while structural reforms would raise productivity and substitute for the lost growth momentum from exports. Also crucial will be a willingness to live with smaller current account surpluses and more flexible exchange rate management.

This chapter examines the outlook for Asia. It first elaborates on the main factors that have led to the region’s fast economic rebound, and then considers the outlook for the remainder of this year and 2010. Finally, it turns to the key policy challenges.

What Has Been Driving Asia’s Recovery?

Asia’s economic landscape has changed significantly since the May 2009 Asia and Pacific Regional Economic Outlook. Throughout the region, industrial production has rebounded, financial pressures have eased, and confidence has largely been restored. The extent of this recovery, however, has varied significantly across countries.

  • Japan and the export-oriented emerging Asian economies have thus far staged a V-shaped turnaround from the sharp decline in economic activity (Figure 1.6). But even with this rebound, output remains well below potential.

  • Meanwhile, Australia and the three economies with larger domestic markets in emerging Asia—namely, China, India, and Indonesia—experienced smaller downturns and are now returning to their earlier, relatively high growth rates.

  • China’s recovery has been particularly impressive, as during the global boom the economy had relied on exports and associated investments as the motors of its expansion. When exports collapsed, however, the authorities were able to compensate for the loss of external demand by stimulating domestic demand through the lifting of credit restraints and an exceptionally large fiscal stimulus.

  • Finally, Asian low-income countries have generally weathered the global crisis better than emerging markets in the region, partly because of their smaller exposure to advanced manufacturing exports (Box 1.1).

Figure 1.6.
Figure 1.6.

Selected Asia: Real GDP Growth

(Quarter-on-quarter in percent)

Sources: CEIC Data Company Ltd.; and IMF staff calculations.1 Export-oriented Asia includes NIEs and ASEAN-5 (excluding Indonesia).

In addition to varying across countries, the strength of the recovery has also varied across four key economic dimensions: trade, public demand, financial, and private domestic demand (Figure 1.7).

Figure 1.7.
Figure 1.7.

Asia: Growth Momentum

Sources: CEIC Data Company Ltd.; Thompson Datastream; Haver Analytics; and IMF staff calculations.1 Three-month (or short-term) money market rate minus equivalent T-bill rate.2 See Balakrishnan and others (2009). The index comprises seven variables capturing developments in the banking sector, the securities markets, and the foreign exchange markets.3 Based on quarterly data.

Trade Normalization

To understand why trade has played such a large role in Asia’s recovery, it is necessary to take a step back and recall why the impact of the global crisis on Asia was so sharp. As discussed in the May 2009 Asia and Pacific Regional Economic Outlook, the global financial dislocation in September 2008 led to a near-complete paralysis in the production and trade of big-ticket, high-technology consumer durables—motor vehicles, electronic goods, and capital machinery—precisely the goods on which many Asian economies have built a comparative advantage.

The inventory cycle amplified this pattern. As demand fell and finance dried up, overseas importers decided to start running down their inventories, causing Asia’s export orders to collapse. As a result, industrial production in export-dependent emerging Asia (EEA) plunged a record 22 percent in January 2009 (Figure 1.8). In contrast, industrial production in emerging Asian economies with larger domestic markets (DEA) fell only by about 2 percent.

Figure 1.8.
Figure 1.8.

Asia: Industrial Production during 2008–09

(Percent change based on seasonally adjusted data)

Sources: CEIC Data Company Ltd.; and IMF staff calculations.

How Have Low-Income Countries in Asia Fared Amid the Global Crisis?

Asian low-income countries (LICs) have generally weathered the global downturn quite well.1 Although their growth rates have moderated, the declines have been much less severe than in the emerging economies of Asia, and in line with LICs in other regions. In part, Asian LICs have been shielded by their relatively limited integration into the global economy. In addition, proactive monetary and fiscal policy measures have also played an important role in supporting economic activity.


Real GDP Growth

(Year-on-year; in percent)

Sources: IMF, WEO database; and staff calculations.1 See footnote 1 for the Asian countries included in the low-income-countries (LICs).

Looking ahead, growth prospects for Asian LICs are generally favorable. However, the global environment remains highly uncertain, and a further round of adverse effects remains possible. In addition, overly accommodative policies in many countries could pose risks to their fiscal and external positions. To ensure long-term sustainable growth, Asian LICs will need to preserve macroeconomic stability by pursuing sound policies.


Selected Asia: Export Dependence and Impact on Real GDP Growth

Sources: IMF, WEO database; and staff calculations.

Trade Impact

When the export performance of Asian LICs is compared with that of emerging markets (EMs) since mid-2008, two salient facts emerge. First, Asian LICs’ exports held up somewhat better than those of EMs in G-3 markets, but performed similarly to those of EMs in Asian markets. Second, the fall in exports to the rest of Asia excluding Japan occurred immediately after the onset of the crisis, whereas the decline to the G-3 materialized only with a lag.

Asian LICs’ export resilience to the G-3 is explained by their product mix, partly reflecting their stage of economic development. They mostly export textiles and garments to the United States and European Union, and increasingly to Japan, while sending commodities to Asia excluding Japan. In the G-3 markets, demand for textiles and garments and low-end manufacturing appears to have been less affected during this downturn, with some garment exporters even managing to expand their sales, unlike the EM producers of medium- and high-end manufacturing products, which suffered a precipitous fall in demand.


Selected Asia: Value of Exports

(U.S. dollar basis, 3-month percent change of 3-month moving average, SAAR)

Sources: IMF, Direction of Trade Statistics; and staff calculations.

The earlier and sharper drop in exports to the Asian markets reflects the collapse in commodity prices in the second half of 2008. Asian LICs nonetheless managed to maintain their commodity export volumes to Asia, especially China. Accordingly, overall Asian LIC export volumes are likely to see only a slight decline this year, a much better performance than in the NIEs and ASEAN-4, where volumes are likely to be significantly down for 2009.

Composition also explains the variation in 2009 export performance among Asian LICs.

  • In general, commodity exporters (Lao People’s Democratic Republic, Mongolia, Papua New Guinea, and Vietnam) have suffered the deepest declines in growth of export values.

  • Although food prices have also dropped significantly, the impact on large rice-exporting Asian LICs (Cambodia and Vietnam) has been partially mitigated by an expansion in export volumes.

  • Among large garment-exporting Asian LICs, the impact has varied. Bangladesh has been able to gain market shares in the G-3, owing to its lower labor costs and a more vertically integrated garment sector (that is, one with higher domestic content), compared with its low-income peers (Dunn, 2007), as well as its exchange rate depreciation relative to the euro as a result of its U.S. dollar peg. The longer-term shifts in strategic sourcing by multinational corporations (MNCs) toward lowest-cost producers starting several years back have benefited Bangladesh and Vietnam, allowing them to gain market shares, especially in the United States. By contrast, Cambodia’s garment exports appear to be suffering because of higher labor and utility costs, lower productivity, and lack of vertical integration (Baker, 2009).


Selected Asia: Volume of Exports

(Year-on-year percent change)

Sources: IMF, WEO database; and staff calculations.1 Excludes Nepal.

Financial Impact

The impact of the global crisis on capital flows to Asian LICs appears to have been modest, largely because these countries depend little on private portfolio flows. Gross capital inflows to Asian LICs are expected to decline only moderately in 2009, with a drop in foreign direct investment (FDI) being cushioned by steady remittances and aid flows.

The impact on FDI has varied by country and sector. Four Asian LICs (Cambodia, Lao People’s Democratic Republic, Mongolia, and Vietnam) are relatively large recipients of FDI in percent of GDP. In these countries, foreign investment is concentrated in resource-related industries, light manufacturing, real estate/construction, and tourism. Some of these sectors (such as tourism) have been hit hard by changes in external demand, whereas others (such as low-end light manufacturing) are benefiting from shifts in sourcing strategy. Resource-related industries continue to attract FDI, especially for those countries with projects already in train (Lao People’s Democratic Republic, Mongolia, and Papua New Guinea).


Asian LICs: Gross Foreign Capital Inflows

(Average; in percent of GDP)

Sources: IMF, WEO database; and staff calculations.

Remittances are expected to remain flat in relation to GDP. Among the four Asian LICs for which remittances are important, positive growth in these flows is expected in Bangladesh, Nepal, and Sri Lanka. Most of their migrant workers are employed in the Gulf Cooperation Council countries, where remittances will be supported by long-term employment contracts, despite the fall in oil prices since 2008 (Almekinders and Abenoja, 2009). Meanwhile, remittances to Vietnam are expected to be affected by the downturn in the United States.

With the ongoing global downturn, traditional bilateral donors may be financially constrained from scaling up aid. But recent initiatives from multilateral institutions such as the IMF, World Bank, and Asian Development Bank may help augment financing. In addition, some nontraditional “emerging” bilateral donors whose economic prospects remain robust (for example, China and India) may also step up their contributions.

Road to Recovery

As concerns over growth increased, Asian LICs responded proactively. Several countries loosened monetary conditions through reductions in policy interest rates and/or reserve requirements (Cambodia, Sri Lanka, and Vietnam), as well as unsterilized purchases of foreign exchange (Bangladesh). Some countries announced fiscal stimulus packages (Bangladesh, Sri Lanka, and Vietnam), which included increases in capital and social spending, tax measures, and interest and other government subsidies to designated sectors. However, the implementation of stimulus measures has been constrained by available financing and capacity limitations. There are also concerns about the size and speed, as well as the quality, of these measures.

Most Asian LICs are expected to record positive growth in 2009 and should see a further strengthening of activity in 2010 as global conditions continue to improve. A strong rebound in exports is unlikely, given that some of the Asian LICs’ export products (for example, agricultural goods and garments) have low responsiveness to global demand changes. However, dominant garment producers should continue to benefit from shifts in MNCs’ strategic sourcing. Large resource-related projects already in progress and the pickup in world commodity prices should provide some boost to growth in commodity-producing countries. Robust domestic demand, remittances, and FDI will also support growth in many countries.

Establishing a robust recovery in the Asian LICs, however, will depend on their ability to maintain macroeconomic stability. The threats to stability are many: fiscal deficits are large, credit growth and inflation are high, and in some cases international reserves are low. Accordingly, domestic policy adjustments will be required, and countries that are facing increasing fiscal and external pressures, as well as financial soundness issues, will require stronger and faster adjustments than others.

For most Asian LICs, this means that both fiscal and monetary policy will need to be less accommodative. Tighter monetary conditions would help rein in credit growth and alleviate emerging inflation concerns in Bangladesh and Nepal as well as mitigate risks to external stability in Lao People’s Democratic Republic and Vietnam. Asian LICs also need to take further steps to improve financial sector soundness, including by strengthening banking supervision. Fiscal adjustment will need to take the lead role in Asian LICs with pegged-like exchange rate regimes or those with limited operational frameworks for conducting monetary policy (Cambodia, Lao People’s Democratic Republic, and Vietnam).

Asian LICs need to develop medium-term budget consolidation plans to ensure fiscal sustainability. This will also involve shifting the focus toward enhancing revenue mobilization, providing adequate social safety nets, and improving the efficiency of public investment.

Over the longer term, more efforts to accelerate structural reforms and improve the business climate would also help increase Asian LICs’ competitiveness. The IMF’s new concessional lending facilities can help ensure a smooth transition for Asian LICs as they make the necessary policy adjustments to restore macroeconomic stability. IMF support can also assist Asian LICs in better guarding against future shocks and continuing on their high growth path.

Note: The main authors of this box are Ran Bi and Varapat Chensavasdijai, with assistance from To-Nhu Dao.1 The low-income countries in this analysis include Bangladesh, Cambodia, Lao People’s Democratic Republic, Mongolia, Nepal, Papua New Guinea, Sri Lanka, and Vietnam.

In recent months, this dynamic has shifted into reverse, sparking a nascent recovery. Industrial production in EEA has regained on average about 90 percent of the ground lost since September 2008, even returning to precrisis levels in a few countries. This rebound seems to have been driven by an equally sharp rebound in export volumes (Figure 1.9). Strikingly, however, the recovery in export values has been less pronounced—on average only about half of the ground lost since September 2008 has been regained in EEA (Figure 1.10). In part, this reflects the decline in global commodity prices, which has also reduced unit values of processed products, such as chemicals. But it also suggests that the global recession has forced Asian firms to cut their prices to regain sales, reducing their profitability.

Figure 1.9.
Figure 1.9.

Selected Asia: Volume of Exports during 2008–09

(Percent change based on seasonally adjusted data)

Sources: CEIC Data Company Ltd.; and IMF staff calculations.
Figure 1.10.
Figure 1.10.

Asia: Value of Exports during 2008–09

(Percent change; data on U.S. dollar basis and seasonally adjusted)

Sources: CEIC Data Company Ltd.; and IMF staff calculations.

A key role in the rebound has been played by the electronics sector, which accounts for about one-third of Asian exports. Indeed, until May, the export recovery in several Asian economies was explained entirely by this sector, whereas nonelectronics exports had continued to stagnate at low levels (Figure 1.11). At work has been a powerful inventory cycle. After September 2008, the ratio of U.S. electronics imports to final sales plummeted, as American firms initially responded to the greater uncertainty by suspending new import orders. But as uncertainty diminished, financing constraints eased, and U.S. inventories became depleted, retailers started to restock, sparking a boom in Asian electronics exports (Figure 1.12).

Figure 1.11.
Figure 1.11.

Asia: Electronics and Nonelectronics Exports1

(July 2008 = 100, seasonally adjusted)

Sources: CEIC Data Company Ltd.; and IMF staff calculations.1 Includes Japan, NIEs, Malaysia, Philippines, Thailand and China.
Figure 1.12.
Figure 1.12.

U.S. Retail IT Inventories and Asian Electronics Exports

(3-month percent change of 3-month moving average SAAR)

Sources: CEIC Data Company Ltd.; and IMF staff calculations.

In addition, a part of Asia’s export revival is due to the recovery of China’s domestic demand. Since early 2009, regional exports to China have rebounded much more strongly than those to advanced economies (Figure 1.13). In particular, commodity exporters (such as Australia and Indonesia) and to a lesser extent capital goods exporters (Japan, Korea, and Taiwan Province of China) have benefited from the surge in China’s infrastructure investment.

Figure 1.13.
Figure 1.13.

Emerging Asia (excluding China): Direction of Exports

(Left panel: 3-month percent change of 3-month moving average, SAAR; right panel: year-on-year percent change)

Sources: CEIC Data Company Ltd.; Haver Analytics; and IMF staff calculations.

Finally, the normalization of trade finance has also contributed to the rebound in trade. As the global financial crisis intensified in the final quarter of 2008, Asia experienced an unprecedented contraction in trade finance, which contributed to the double-digit year-on-year declines in exports. But as financial distress gradually abated and confidence in advanced economies’ banking systems returned, problems with the availability and cost of trade finance essentially disappeared, facilitating the resumption of trade.

An Unprecedented Policy Stimulus

At the same time as exports have been recovering, policymakers have been supporting domestic demand with an exceptional amount of policy stimulus. There is a critical difference, however, between these two drivers of the recovery. Whereas the export recovery can be interpreted as a correction from the abnormal contraction of world trade at end-2008, the aggressive countercyclical fiscal response of Asian policymakers (outside of China) represents a break from past crises. Previously, Asia had been reluctant to engage in significant countercyclical policy, fearing that it could aggravate capital outflows and thereby prove counterproductive. But this time the response was forceful. In particular, the fiscal packages have been larger than in the average Group of Twenty (G-20) country (Figure 1.14). On average in Asia, projected discretionary fiscal stimulus in 2009 amounts to about 2¾ percent of GDP, compared with about 2 percent on average in the G-20, though it should be noted that packages need to be large because automatic stabilizers in Asia are relatively small.2

Figure 1.14.
Figure 1.14.

Discretionary Fiscal Measures, 20091

(In percent of GDP)

Source: IMF staff estimates.1 Defined as fiscal impulse (i.e., change in structural fiscal balances relative to 2008, related to measures taken in response to the crisis).

In addition to its magnitude, Asia’s fiscal stimulus has differed from that in advanced economies along two other dimensions:

  • Greater reliance on spending than tax measures (Figure 1.15). Overall, Asian economies devoted about 80 percent of their discretionary fiscal stimulus to increasing spending, against about 60 percent in the G-20. A large component of this spending has been focused on infrastructure, especially in China. In addition, many governments have also tried to cushion the social impact of the crisis by allocating more resources to social safety nets—including rural pension reform and the provision of better public health, housing, and schooling in China; the expansion of employment guarantees and housing programs in India; and benefits to those unemployed who attend job training schemes in Singapore.

  • Faster implementation. Close to 50 percent of the stimulus has been implemented on average in Asian economies, well above the G-20 norm, driven primarily by strong implementation of spending programs. However, the speed of implementation has differed widely across the region, having been relatively slow for the industrial economies and fast for China, India, and the ASEAN economies (Figure 1.16).

Figure 1.15.
Figure 1.15.

Composition of Fiscal Stimulus Measures, 2009

(In percent of GDP)

Source: IMF staff estimates.
Figure 1.16.
Figure 1.16.

Asia: Fiscal Stimulus Implementation, 2009:H1

(In percent of full-year package)

Source: IMF staff estimates.

This strong fiscal response has played an important role in stabilizing Asian economies during the first half of 2009. Simulations using the IMF’s Global Integrated Monetary and Fiscal (GIMF) model suggest that fiscal stimulus accounted for on average about 1¾ percentage points of GDP growth in the first half of 2009 in Asia, when the stimulus measures from other countries (which created export demand for Asia) are also taken into account. In particular, the effect ranges from about 1 percentage point in Japan up to about 2 percentage points in China, Korea, Australia and New Zealand (Box 1.2).

Aggressive monetary policy easing by regional central banks has also contributed to Asia’s recovery.

  • The degree of interest rate easing in Asia stands out compared with that in previous business cycles (Figure 1.17). The median policy rate has declined by about 2¼ percentage points, about five times as much as in previous recessions. Lending rates, however, have declined by smaller amounts, raising questions about whether monetary transmission mechanisms have buckled under the strain of the global crisis (Box 1.3). IMF research suggests this is not the case. In fact, the pass-through coefficients and lags have been similar to those seen in the past, suggesting that Asian lending rates just tend to be sticky and slow to change.

Figure 1.17.
Figure 1.17.

Asia Business Cycle: Nominal Policy Rates1

(Median, in percent; peak quarter of the cycles = zero)

Source: IMF staff estimates.1 See Regional Economic Outlook-Asia and Pacific, May 2009 for previous business cycle dates.

Fiscal Stimulus: Assessing Effectiveness and Sustainability

Asian countries responded to the global crisis with sizable fiscal stimulus measures. Together with the impact of automatic stabilizers, this response has been costly, contributing to a significant deterioration in fiscal positions, especially in advanced and export-dependent economies. Accordingly, it is important to assess the benefits of the measures, as well as whether the current fiscal positions are sustainable.


Asia: Change in Overall Fiscal Balance Relative to Precrisis1

(In percent of GDP)

Source: IMF staff estimates.1 Precrisis benchmark equals average balance between 2005-2007.

Selected Asia: Impact of Stimulus on 2009:H1 Real GDP—Multiplier Ranges

(Percentage deviation from baseline)

Source: IMF staff estimates.

What Has Been the Impact on Growth?

Two methodologies are used to assess the effectiveness of the fiscal stimulus so far in 2009:

  • Multipliers The first method consists of applying standard estimates of “fiscal multipliers.”1 Given uncertainty about these estimates, growth impacts are estimated using ranges of multipliers.2 Applying them to the different policy measures adopted in Asia suggests a significant impact of fiscal policy on growth during the first half of 2009, especially in Australia-New Zealand, China, and Korea. In particular, using the high set of multipliers, the fiscal stimulus measures are estimated to have raised GDP in the first half of 2009 by up to 3½ percentage points in Australia-New Zealand, 2¼ percentage points in China and 2¾ percentage points in Korea. The large impact for these countries reflects both the relatively larger size of their packages and their greater reliance on spending measures with large multipliers—especially in China, where most of the stimulus was focused on capital spending.3

  • Simulations: The second method of assessing the effects of the fiscal stimulus on growth is based on simulations using an eight-country block version of the IMF’s Global Integrated Monetary and Fiscal (GIMF) model.4 Two scenarios are considered: in the first one, only one region implements the fiscal stimulus—and the other countries remain inactive. In the second scenario, all regions implement the fiscal stimulus at the same time (including outside Asia). This approach produced broadly similar estimates of the growth impact of the fiscal packages in Asia, with an impact on GDP over the first half of 2009 of 1½–2 percentage points for Australia-New Zealand, 1½–2¼ percentage points for China and 1–2 percentage points for Korea. The relatively high estimated impact in these countries reflects again the significant size of the stimulus implemented, as well as the composition of the stimulus packages. The high end of these estimates is obtained when coordinated fiscal stimulus is implemented across countries, and thus reflects the positive spillovers on Asian economies from fiscal stimulus in other countries. The impact of the stimulus in ASEAN-4, Hong Kong SAR, and Singapore is estimated to be somewhat lower—¼ percentage point of GDP in the first scenario. This reflects the region’s relatively higher average reliance on fiscal measures with lower multipliers (such as revenues) and its higher openness—which means that more of the additional demand stimulated by the fiscal packages “leaks out” through imports. Indeed, the estimated growth impact for this group of countries climbs to nearly 1½-percentage points, once the benefits from the stimulus in the rest of the world are taken into account.


Selected Asia: Impact of Stimulus on 2009:H1 Real GDP—GIMF Simulations

(Percentage deviation from baseline)

Source: IMF staff estimates.

Medium-Term Fiscal Outlook—Mounting Challenges

The fiscal positions of most Asian countries are relatively sound, having benefited from years of fiscal prudence. Moreover, as the recovery becomes well established, the general government debt-to-GDP ratio is projected to decline for most countries.

Even so, by 2014 debt-to-GDP ratios are still projected to exceed precrisis levels for a majority of Asian countries. An intuitive way of assessing the “sustainability” of current fiscal stances in the region is to estimate the primary balance that would be required on average over the next decade to stabilize debt ratios at their 2011 levels, or to bring them down to lower levels if they are judged to be too “high.”5 This exercise suggests that further fiscal consolidation would be needed over the medium term in those countries that already have relatively high stocks of debt, such as Japan and India.


Asia: Fiscal Adjustment to Bring Debt to Sustainable Level

(In percent of GDP)

Source: IMF staff estimates.

While these estimates are only for illustrative purposes, there are at least three reasons why they may underestimate the degree of fiscal adjustment needed. First, many Asian countries, including Japan and some NIEs, face aging-related fiscal pressures that will require even more ambitious primary balance targets than implied by this exercise. Second, the exercise does not take into account fiscal contingent liabilities that have increased in the wake of the global crisis, especially in a few advanced economies in the region. And finally, as the risks to the economic outlook are generally on the downside, there is a greater chance that the debt dynamics implied in this exercise will turn out to be less, rather than more, favorable for some of these economies.

Note: The main authors of this box are Leif Lybecker Eskesen and Sonali Jain-Chandra.1 The applied multiplier ranges are taken from Horton, Kumar, and Mauro (2009).2 The low set included a multiplier of 0.3 on revenues, 0.5 on capital spending and 0.3 on other spending. The high set included a multiplier of 0.6 on revenues, 1.8 on capital spending and 1.0 for other spending.3 These numbers could overestimate the growth impact of the fiscal stimulus, as not all the transfers to budgetary units may have been spent during the first half of the year. At the same time, however, in China’s case, the stimulus only covers central government measures.4 Five of these regions are Asian: Japan, Korea, China, Australia, and New Zealand, and a group of Asian emerging economies (Hong Kong SAR, Singapore, Malaysia, Indonesia, the Philippines, and Thailand). The other regions are the United States, the euro area, and the rest of the world. For further details on this version of the GIMF model, please see N’Diaye, Zang, and Zang (2009).5 For advanced economies with debt ratios above 60 percent in 2011, the required primary balance will bring the debt ratio down to 60 percent in 2021. In Japan’s case, however, the debt ratio is assumed to be halved by 2021 to around 116 percent. For emerging markets with debt ratios above 40 percent in 2011, the adjustment will bring these ratios down to 40 percent by 2021. The only exception is Singapore, for which the required primary balance will stabilize the gross debt ratio at the 2011 level despite this being larger than 60 percent, given its very large net public asset position.
  • Regional central banks also took unprecedented actions to ensure that financial systems had adequate liquidity. Access to central bank facilities was eased, reserve requirements lowered, and required reserves remunerated, resulting in a significant expansion of banks’ excess reserves holdings with central banks—albeit a much smaller one than in the United States and Europe (Figure 1.18), reflecting the more limited impact of the crisis on Asia’s banking systems.

  • Measures were also taken to support domestic financial markets. Blanket guarantees on deposits, swaps to companies and banks needing foreign currency, guarantees on external bond issuance for banks, and expansions of guarantees to ensure that small and medium-sized enterprises (SMEs) could retain access to credit have all helped maintain confidence and sustain banking systems’ ability to play their intermediation function.

Figure 1.18.
Figure 1.18.

Deposit Money Banks: Excess Reserves at Crisis Peak

(2007 = 100)

Sources: CEIC Data Company Ltd.; Haver Analytics; and IMF staff estimates.

Normalizing Financial Markets

A third driver of Asia’s recovery has been the easing of financial tensions, both global and domestic. In September 2008, capital fled the region, putting downward pressure on reserves, currencies, and asset prices. But by mid-2009, with global risk aversion declining and Asia’s economic fortunes on the mend, capital began to return (Figure 1.19).

Figure 1.19.
Figure 1.19.

Emerging Asia: Net Capital Inflows1

(In billions of U.S. dollars)

Sources: CEIC Data Company Ltd.; and IMF, Balance of Payment Statistics.1 China’s semi-annual data are assumed to be equally divided between the quarters of a particular semi-annual period.

Monetary Transmission in Asia: Is It Working?

Central banks in Asia aggressively eased monetary policy as the global crisis unfolded. They cut interest rates to historically low levels, reduced reserve requirements, and introduced unprecedented measures to provide liquidity and encourage lending. There has been some question, however, about the extent to which these actions have been transmitted to the wider economy. Accordingly, this box examines the state of the monetary transmission mechanism, looking at the pass-through from policy rates to lending rates and the behavior of credit growth and money multipliers. It finds no evidence that the degree of the interest rate pass-through has declined since the onset of the global financial crisis. In contrast, private credit growth did initially slow and money market multipliers declined, but they have since rebounded, pointing to a normalization of financial conditions. The resilience of the transmission mechanism was likely aided by credit support policies, such as guarantees, directed lending, and central bank loan facilities.

What has been the effect of monetary policy on borrowing costs? Since September 2008, Asian countries have cut policy rates by a cumulative 250 basis points (on average). Yet borrowing costs have not declined by a similar amount. The average pass-through—simply measured as the ratio of the change in the short-term lending rate to the change in the policy rate since the beginning of the current easing cycle—has been about 60 percent, but there are striking differences across countries. Whereas lending rates have declined by nearly the same amount as the policy rate in Australia, they have remained relatively sticky in Indonesia.


Selected Asia: Interest Rate Pass-Through1

(In percent)

Source: IMF staff estimates.1 Pass-through is defined as the ratio between the change in the lending rate and the change in the policy rate since the beginning of the easing cycle.

Estimates from a regression model indicate that Asia’s average interest rate pass-through is comparable to that in the United States and the euro area, but there is substantial variation across countries. To obtain a more rigorous measure of the pass-through, a dynamic reduced-form relationship was estimated between interbank interest rates (empirical proxy for policy rates in the regression) and short-term lending rates using monthly data over the period 2001—09.1

The extent of pass-through in the short run (one month) is generally low, consistent with the fact that lending rates do not adjust instantly. The long-run pass-through estimate ranges from 0.3 to more than 1.0, with results being broadly consistent with those reported in the figure. The average long-run pass-through coefficient of 0.6 falls within the range of 0.6–1.0 estimated for the euro area and the United States (see Espinosa-Vega and Rebucci, 2003). The pass-through mechanism appears to be faster and more complete in Japan and the Philippines, whereas it takes about eight months to reach full pass-through in Korea and Malaysia.2

Two countries, Indonesia and India, display a relatively low degree of pass-through in the long run, reflecting less-developed debt markets and structural rigidities. In the case of India, with a long-run pass-through of about 0.3, the existence of small savings schemes that compete with commercial banks for deposits may have been partly responsible for the downward stickiness in lending rates.3 In Indonesia, banks’ high cost of funds, thin and fragmented interbank markets, and structural excess liquidity explain the low equilibrium pass-through.

Model estimates do not lend support to the hypothesis that the transmission mechanism has become less effective since August 2008. There is, so far, no strong empirical evidence that the spike in risk aversion and tightening in lending standards associated with the current crisis has affected the pass-through process, making lending rates stickier.4 Even in those countries that have displayed incomplete pass-through, the monetary transmission is not different from what has been observed in the past. For example, in Indonesia the estimated pass-through has increased to 0.4 (from 0.3) since the crisis intensified in August 2008, and in India the crisis long-run pass-through (0.25) is not different in a statistically significant way from that observed before the crisis.

The behavior of monetary aggregates—in particular, money multipliers—and private credit growth is also consistent with the view that the transmission mechanism in Asia has not been durably impaired. Across the region, money multipliers fell at the height of the liquidity squeeze in late 2008, as banks hoarded cash on increased risk aversion. However, multipliers have since increased and are currently above precrisis levels, except in Korea and New Zealand (see figure). Reductions in reserve requirements help explain part of the upward trend in the multipliers (India, Indonesia, Malaysia), but there is emerging evidence that broad money is accelerating as a result of the stabilization of financial markets and the resumption of bank lending. Indeed, recent data show that credit growth has started to rebound in ASEAN, Australia, and New Zealand. Nonetheless, some frictions in the money creation process remain in Korea and Japan, where large liquidity injections have led to rising excess reserves, but little credit growth.

Selected Asia: Estimated Interest Rate Pass-Through from Dynamic Regression Model

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Source: IMF staff estimates.

Selected Asia: Money Multipliers

(Ratio of M3 to M0)

Source: IMF staff calculations.1 Average of January 2008 to July 2008.2 Peak crisis period is defined as August 2008 to January 2009.3 Data presented on the right axis.
Note: The main authors of this box are Roberto Guimarães and Marta Ruiz-Arranz, with assistance from Shuda Li.1 The dynamic reduced-form relationship between market interbank interest rates and lending rates is an autoregressive distributed lag (ADL) model. The standard error correction econometric specification is given by lendingt = α0 + α1trend + α2markett + α3lendingt-1 + α4markett-1 + εt. In this model, α2 measures the degree of the pass-through from market to lending rates in the short term (one month), α2 + α4 / (1 – α3) measures the long-term pass-through, and 1 – α2/(α3 – 1) gives the average number of months to reach the long-term pass-through (mean lag). For most countries an ADL (1,1)—which contains one lag of each variable of interest—accounts reasonably well for the time series dynamics of the data.2 It is worth noting that a high degree of interest rate pass-through does not necessarily imply a corresponding high reaction in credit extended. For example, the declines in Philippine and Korean lending rates have not been associated with a significant increase in bank loans.3 Small savings schemes in India have administered interest rates.4 An interaction dummy is added to the baseline specification and the pass-through is recalculated.

The amounts have so far fallen well short of 2007 levels, but the reality that inflows have resumed at all is significant. In previous crises, capital was extremely slow to return, even when, as in this case, the recessions had originated from abroad. The rapid return of capital this time is thus a testimony to Asia’s improved resilience and economic framework.

These capital inflows, together with improving exports, have caused regional reserves and currencies to strengthen from their postcrisis lows. Policymakers in many economies have taken advantage of the inflows to rebuild reserves—while China, for example, has added to its holdings, which in September reached US$2.3 trillion. In addition, there has also been some currency appreciation, particularly in Australia, New Zealand, Indonesia, and Korea (Figure 1.20 and Box 1.4).

Figure 1.20.
Figure 1.20.

Selected Asia: Portfolio Inflows and Change in Exchange Rates

(February- September 2009)

Sources: Blommberg LP; and IMF staff calculations.1 Positive change implies appreciation.2 Equity market capital inflows data not available for Australia and New Zealand.

Despite these recent gains, however, most Asian currencies remain below their precrisis levels, both against the dollar and in real effective terms (Figure 1.21). A notable exception has been the yen, which has appreciated strongly over the last year mainly because overseas reductions in interest rates have prompted a repatriation of Japanese funds that had earlier gone abroad, seeking higher returns. For similar reasons (as well as the increase in risk aversion), carry-trade activities in which foreigners borrowed low-cost yen to invest in high-yielding assets overseas have also declined.

Figure 1.21.
Figure 1.21.

Asia: Nominal Exchange Rate against U.S. Dollar

(January 2007 = 100; higher values represent appreciation)

Sources: Blommberg LP; and IMF staff calculations.1 Trade-weighted average.

The return of foreign capital has also contributed to a strong rebound in regional equity markets. As portfolio capital has returned, equity valuations have increased, pushing many stock market indices back to 2007 levels and price/earnings (P/E) ratios closer to historical norms (Figure 1.22). With stock markets strengthening, initial public offerings (IPOs) have revived, giving companies access once again to equity capital to finance their planned investment projects, many of which had been disrupted by the crisis. Property markets have also begun to show signs of life, with transaction volumes picking up and prices recovering on a sequential basis. The increases in certain locations and specific segments of the housing market have been particularly noticeable in Hong Kong SAR, Singapore, China, Australia, and in Korea. Even so, viewed from a somewhat longer perspective, property markets remain subdued, with prices below year-ago levels in most economies.

Figure 1.22.
Figure 1.22.

Stock Markets

(Index; January 1, 2007 = 100)

Source: Bloomberg LP.

Capital Inflows and Policy Responses

Capital flows to emerging markets have been surging again since March 2009, as economic prospects have improved and global investors’ risk appetite has revived. Much of these inflows have been directed toward emerging Asia. The region has especially benefited from equity market inflows, which have not only exceeded those to other regions, but have also returned to levels prevailing before the crisis. External equity and bond issues by emerging Asian economies have also returned to precrisis levels, a much stronger rebound than in other regions. Even inflows of syndicated loans have resumed to emerging Asia—unlike elsewhere, primarily reflecting the healthier state of banks in the region.


Capital Inflows to Emerging Markets

(In billions of U.S. dollars)

Sources: Emerging Market Portfolio Fund Research Inc.; and IMF, Bonds, Equities and Loans database.1 Bond and equity issuances.

The rapid recovery of capital inflows has generated renewed upward pressures in currency markets. Emerging Asian economies have accommodated these pressures largely by accumulating reserves rather than by allowing exchange rate appreciation. From March through September 2009, emerging Asian countries accumulated US$510 billion in reserves, compared with US$69 billion in emerging Europe and US$17 billion in Latin America.1 As a result, emerging Asia’s stock of reserves stood at about US$3.9 trillion at end-September, up from about US$3.4 trillion at end-August 2008—much higher than in other emerging markets, not only in U.S. dollars but also as a share of GDP.


Foreign Exchange Reserves1

Sources: CEIC Data Company Ltd.; Haver Analytics; and IMF, WEO database.1 As of August 2009 for non-Asian economies and as of September 2009 for Asian economies.

By contrast, Asian advanced countries with floating currencies, Japan and Australia, and New Zealand, have experienced significant appreciation in their nominal exchange rates. Overall, most real effective exchange rates (REER) in the region have returned close to (within a 10 percent range) their precrisis levels, except in Japan, where the REER is 20 percent higher.


Asia: Change in Real Effective Exchange Rate1

(In percent; between August 2008 and September 2009)

Source: IMF staff calculations.1 Positive change implies appreciation.
Note: The main authors of this box are Benjamin Hunt and Sonali Jain-Chandra, with the assistance of Souvik Gupta.1 In addition to intervention, increases in reserves reflect valuation changes and earnings on reserve assets.

Foreign debt market funding has also improved significantly. For half a year, from the fourth quarter of 2008 through the first quarter of 2009, Asian companies were essentially shut out from international capital markets, placing strains on their cash flows and foreign exchange positions, since they still had large amounts of external obligations to service. But as global risk appetite has revived, access to international capital markets has been restored and spreads have narrowed to normal levels, close to trend but above the exceptionally low precrisis rates (Figure 1.23). Indeed, Asia’s spreads have fallen particularly rapidly compared with those in other regions, since, as global fear has receded, the region’s strong fundamentals have once again come to the fore. High-grade borrowers have been able to issue international debt at a record pace, much of which has been used to build up cash balances. Issuance by more risky borrowers has also recommenced in recent months, albeit at a much slower pace than in 2006–07, suggesting some lingering refinancing pressures.

Figure 1.23.
Figure 1.23.

Emerging Asia: External Bond Issuance by Sector and Rating

(In billions of U.S. dollars)

Source: Bond Radar.

The easing of external financial conditions and timely policy actions at home have been successful in normalizing domestic financial conditions. From September 2008 to early 2009, there was considerable dislocation in Asian markets, as domestic banks responded to their overseas funding difficulties and soaring risk aversion by curtailing interbank lending and credit to their customers, especially to SMEs. But now that overseas funding pressures have eased significantly, central banks have injected domestic liquidity, and governments have expanded SME credit guarantee programs, domestic conditions have normalized. Even in the markets most affected by the disappearance of overseas wholesale funding—foreign exchange and money markets—conditions have essentially returned to normal. For example, basis spreads on foreign exchange swaps and spreads in domestic money markets have receded to pre—September 2008 levels (Figure 1.24). At the same time, domestic Asian capital markets have begun to revive. Most important, the pace of bank credit has begun to quicken again.

Figure 1.24.
Figure 1.24.

Selected Asia: TED Spread1

(In percent)

Source: Bloomberg LP.1 Defined as the spread between 3-month interbank rate and 3-month risk free rate.

Indeed, taking the year since September 2008 as a whole, bank credit has been more resilient in Asia than in other parts of the globe. Whereas elsewhere credit growth has collapsed, in Asia excluding China it has slowed but it is still running at close to a 10 percent rate (Figure 1.25). Two factors explain why: the healthy financial position of Asia’s corporate sector and the strong capital position of its banks. Partly as a legacy from the lessons learned during the Asian crisis of the 1990s, large firms came into the downturn with low leverage, low debt service burdens, and high profitability. With sounder positions, their default risks were lower than in previous crises and have diminished rapidly as conditions have improved.3 Accordingly, banks have been willing to lend large firms the money needed to tide them over until conditions improved, though SMEs saw their access to bank credit more severely affected.

Figure 1.25.
Figure 1.25.

Emerging Markets: Bank Credit to Private Sector

(Six-month percent change, annualized rate)

Sources: IMF, International Financial Statistics; and staff calculations.

Apart from being willing, banks were also able to lend, because they had sufficient capital. Indeed, the financial strength of its banking systems has been central to Asia’s resilience during the crisis. Unlike in Europe, Asian banks had little exposure to U.S. toxic assets, and the rise in domestic nonperforming loans has been modest, so the damage to their capital positions from the crisis has been relatively small. Moreover, they have been quick to replenish their buffers, raising more than US$106 billion in capital since fall 2008. As a result, the declines in their capital-asset ratios have been negligible; in some countries, capital ratios have even risen compared with precrisis levels (Figure 1.26). So as liquidity conditions improved, Asian banks were in a strong position to resume lending.

Figure 1.26.
Figure 1.26.

Selected Asia: Bank Capital-to-Asset Ratios

(Change from 2005-07 average; in percentage points)

Source: IMF, Global Financial Stability Report, October 2009.

The story in China is even stronger. Credit growth there has actually quickened since the end of 2008. Indeed, the removal of existing informal quantitative limits on bank-level credit growth has perhaps been the most important element of China’s multifaceted response to the global crisis. This step triggered an exceptional credit boom: during the first half of 2009, the amount of net new bank credit was 50 percent higher than in 2008 as a whole. The expansion in credit has fueled a surge in investment, initially public, but then involving private investment too, particularly in real estate (about 40 percent of private investment in the first eight months of 2009 went into real estate) (Figure 1.27). Such a rapid pace of credit growth, however, runs the risk of creating asset price inflation and misallocating resources, risking ultimately worsening bank credit quality. Encouragingly, signs of a slowdown in credit growth are emerging.

Figure 1.27.
Figure 1.27.

China: Credit and Fixed-Asset Investment

(Year-on-year percent change)

Sources: CEIC Data Company Ltd.; and IMF staff calculations.

Private Domestic Demand: Still Cause for Concern

What about private domestic demand? This is a critical question, perhaps the most critical one for assessing the state of the recovery, for it is private demand that will eventually have to take over as a driver, once the impetus from trade normalization and macroeconomic stimulus has waned. On this count, there is some cause for concern. Both private consumption and investment have declined during the downturn, and prospects for a recovery remain clouded.

On the positive side, private consumption has fallen by less than in previous crises (Figure 1.28).4 One reason is that household incomes have been supported by the exceptionally large policy stimulus, which included an important component of transfers and tax cuts. But perhaps even more important has been the reaction of Asian firms to the global crisis. Despite the sharp contraction in new orders after September 2008—and in marked contrast to the reaction elsewhere—Asian firms did not immediately retrench their workforces. Instead, they hoarded labor while cutting back on hours worked. In large part, this decision may have been a reaction to the unexpected and swift collapse of trade: expecting that orders might soon rebound, they watched and waited to see what the longer-run change in demand might be. They also sustained employment because they received government subsidies for doing so, as part of the stimulus packages. As a result, employment has held up remarkably well, providing crucial support to incomes and consumption (Figure 1.29).

Figure 1.28.
Figure 1.28.

Asia Business Cycle: Real Private Consumption Expenditure1,2

(Percent change between peak and trough of the cycles)

Source: IMF staff estimates.1 See Regional Economic Outlook-Asia and Pacific, May 2009 for previous business cycle dates.2 Emerging Asia excludes China, India, Indonesia and Vietnam due to absence of a cycle and/or non-availability of quarterly data.
Figure 1.29.
Figure 1.29.

Asia Business Cycle: Employment1,2

(Average; peak quarter of the cycle=100)

Source: IMF staff estimates.1 See Regional Economic Outlook-Asia and Pacific, May 2009 for previous business cycle dates.2 Includes industrial Asia, NIEs and ASEAN-4 (excluding Indonesia).

Consumption has also been helped by the absence of significant wealth effects—another major difference from the experience elsewhere. With stock markets and property prices essentially back to year-ago levels, confidence has rebounded, leading to a revival in retail spending (Figure 1.30). Meanwhile, the sharp reductions in policy interest rates have boosted disposable incomes of mortgage holders, since Asian housing loans are almost exclusively at floating rates.

Figure 1.30.
Figure 1.30.

Asia: Consumer Confidence and Volume of Retail Sales1

(January 2008 = 100)

Sources: CEIC Data Company Ltd.; Haver Analytics; Boston Analytics; and IMF staff calculations.1 Includes Japan, Australia, Hong Kong SAR, Korea, Taiwan Province of China, Indonesia, Malaysia, Thailand, China and India.

In contrast, private investment has declined sharply, in some economies by even more than it did during the Asian crisis. In many ways, this outcome has been surprising. After all, corporate balance sheets at the outset of the global crisis were much stronger than previously. Moreover, whereas a decade ago Asia was in the midst of a real estate boom, this time construction has formed a much smaller portion of investment and its impact on overall investment has been much smaller (Figure 1.31). Explanations for the sharp fall in investment remain unclear. To a certain extent, it reflects the fact that even with the rebound in production, there is still excess manufacturing capacity in the region. More fundamentally, however, weak investment probably reflects concerns about longer-term prospects. In the end, much of Asia’s rebound has been driven by temporary factors—a V-shaped bounce back in trade, policy stimulus—whose importance is bound to wane over time. Ultimately, Asia will need to see a recovery in private consumption, either foreign or domestic. In past recoveries, first consumption and, at a later stage, investment have typically revived when the income from booming exports started flowing through Asia’s economy. But this time, given the still weak external outlook, the traditional dynamics may not be as much at work.

Figure 1.31.
Figure 1.31.

Japan and NIEs: Real Private Capital Formation1

(Year-on-year percent change)

Sources: CEIC Data Company Ltd.; and IMF staff calculations.1 Excludes Singapore.

What Lies Ahead?


Over the near term, global and domestic restocking and macroeconomic policy support will continue to propel Asia’s recovery forward. As U.S. electronics retailers continue to rebuild their inventories, Asian exports will continue to recover—a process that could go on for some time, since U.S. imports are exceptionally low relative to sales, suggesting that retailers will need to step up their orders sharply to replenish their supplies (Figure 1.32). Meanwhile, the domestic inventory cycle, which had depressed growth through mid-2009, also seems set to turn. Inventories within most Asian economies were seriously depleted in the first half of 2009, which means that firms will soon need to replenish them by boosting production. This could set off positive feedback between strengthening economic activity, easing financial conditions, and improved consumer and business confidence, which may sustain a pickup in private domestic demand. In addition, fiscal stimulus is likely to keep supporting GDP growth over the next few quarters; as noted above, only about half of the stimulus contained in announced fiscal packages has been implemented so far, on average for the region.

Figure 1.32.
Figure 1.32.

United States: Ratio of Imports to Retail Sales—Electric and Electronic Products and Parts

(Index, January 2007 = 100; seasonally adjusted)

Sources: Haver Analytics; and IMF staff calculations.

These factors are temporary, and their impetus will inevitably wane. But provided global private demand starts to recover, Asia’s growth momentum should continue. Leading indicators of Asian exports, such as the manufacturing order indices in the United States and Europe, are already into expansionary levels, suggesting that export momentum is likely to remain even once the boost from global restocking has run its course.

Even so, Asia’s growth in 2010 will remain well below its precrisis average, reflecting the longer-term impact of the global crisis on both the demand for Asian exports and the region’s productive capacity.

  • Demand: As highlighted in the October 2009 World Economic Outlook, the global recovery is expected to be sluggish, with private demand in advanced economies likely to be restrained for some time by limited credit availability, households’ desire to rebuild balance sheets, and still-rising unemployment. External demand is thus unlikely to provide a strong boost to Asia, as it has typically done in past recoveries (Chapter 2, May 2009 Asia and Pacific Regional Economic Outlook).

  • Supply: In addition, it may take Asia some time to adjust to the supply-side dislocations caused by the global recession. Indeed, the crisis is likely to have damaged potential output in Asian economies, in particular by inducing a protracted decline in capital accumulation (Box 1.5). The output losses can be substantial—for Asia, IMF staff estimates suggest they may reach 10 percent of GDP relative to the precrisis trend in EEA, where private investment will be particularly discouraged by the ample spare capacity in the manufacturing sector (Figure 1.33).

Figure 1.33.
Figure 1.33.

Selected Asia: Manufacturing Capacity Utilization

(In percent, seasonally adjusted)

Sources: CEIC Data Company Ltd.; and Haver Analytics.

Projections for 2009–10

Against this backdrop, a modest recovery seems likely. Asia’s GDP growth is now forecast to be 2¾ percent in 2009 and 5¾ percent in 2010, about 1½ percentage points higher for both years than projected in the May 2009 Asia and Pacific Regional Economic Outlook (Table 1.1). Even so, growth in 2010 would still remain well below the average 6⅔ percent growth over the last decade. Indeed, most Asian economies will face a significant amount of economic slack in the near term, particularly in EEA and in Japan (Figure 1.34). In contrast, the output gap is expected to be much closer to zero on average in DEA.

Table 1.1.

Asia: Real GDP

(Year-on-year percent change)

article image
Source: IMF, WEO database.
Figure 1.34.
Figure 1.34.

Asia: Output Gaps

(In percent)

Sources: IMF, WEO database; and staff estimates.

Within Asia, there will continue to be significant differences in growth patterns. In particular,

  • China is expected to continue leading Asia, growing at 8½ percent in 2009 and 9 percent in 2010. Investment should continue to expand rapidly, propelled by multiyear public projects and the recovery of private investment. Fiscal measures to boost consumption and employment are also expected to continue to support private domestic demand, together with improved consumer confidence—reflected in the recovery of prices in key real estate markets (Figure 1.35). Over the medium term, the need to rein in rapid credit growth, not least to safeguard hard-won gains from years of bank restructuring, combined with the availability of a large fiscal space, will likely shift the weight of policy support to the fiscal realm.

  • India’s growth is expected to accelerate to 6½ percent in 2010 from 5⅓ percent in 2009, on the back of strong domestic demand. In particular, the normalization of financial market conditions is expected to support a rebound of private investment, sustaining demand even as the fiscal stimulus wanes.

  • The newly industrialized economies (NIEs), Hong Kong SAR, Singapore, Taiwan Province of China, and Korea are all projected to contract in 2009. But growth (3½–4¼ percent) is expected to resume in 2010, thanks to domestic inventory restocking, a rebound in private consumption linked to increases in consumer confidence, and continued buoyancy in exports (Figure 1.36).

  • Among the ASEAN-5, growth is expected to remain solid in the more domestically oriented Indonesia and Vietnam. Commodity exports and domestic demand are expected to sustain growth in Indonesia, with a modest pick-up in investment expected to offset the withdrawal of fiscal stimulus. In Vietnam, strong domestic demand, rapid industrialization, and relatively robust foreign demand should continue to underpin stable and high growth. Thailand and Malaysia are projected to contract at about 3½ percent in 2009, before returning to positive—though still anemic—growth in 2010. The Philippines is escaping contraction in 2009, thanks to the resilience of remittances and thereby private consumption, but growth momentum is expected to moderate somewhat in 2010 after the fiscal stimulus wanes.

  • In industrial Asia, GDP in Japan is expected to contract by 5½ percent in 2009 before recovering modestly by 1¾ percent in 2010. The economy will be lifted by the continued effect of the sizable fiscal stimulus, but private demand will likely continue to be weighed down by weak labor market conditions and excess capacity in the manufacturing sector. Australia is avoiding a contraction in 2009, thanks to its timely and forceful policy response and strong commodity exports, especially to China. In contrast, New Zealand’s economy will likely contract in 2009, reflecting the large decline in residential investment and private consumption that followed the sharp reversal of the housing market boom. Both Australia and New Zealand are expected to expand in 2010, as external demand strengthens in line with the global recovery and private domestic demand regains momentum.

Figure 1.35.
Figure 1.35.

Japan, China, and India: Contributions to Growth

(In percentage points)

Source: IMF, WEO database.
Figure 1.36.
Figure 1.36.

Selected Asia: Contributions to Growth

(In percentage points)

Source: IMF, WEO database.

Implications of the Global Crisis for Asia’s Potential Output

Historical experience suggests that returning Asia’s output to the precrisis trend is likely to prove challenging, as deep recessions usually have long-lasting effects on productive capacity.

“Deep recessions” are defined in this box as episodes with growth slowing by at least 5 percentage points within a year. This definition allows for the identification of 182 episodes since 1960, 27 of which were in Asia. These episodes were generally associated with either severe financial strains or significant reductions in external demand, and in about two-thirds of the deep recessions GDP never caught up to the precrisis trajectory. The average output loss amounted to roughly 10 percent across all episodes, and slightly more than that for the Asian cases.


Impact of Deep Recessions on Medium-Term Output

(Mean difference from year t = -1; first year of crisis at t = 0)

Source: IMF staff estimates.

Evidence also suggests that deep recessions can sometimes undermine medium-term growth rates. In Asia, for example, recessions in Japan, Korea, and Malaysia in the 1990s were all followed by significant reductions in annual average growth—by up to 4 percentage points in the case of Malaysia.1 In contrast, Chile, Finland, and Mexico experienced much better outcomes in the aftermath of their own crises in the 1980s and 1990s, in part due to significant liberalization measures and rapidly increasing openness of their economies (European Commission, 2009 and IMF, 2009c).

Outlook for Asia

Following the recent turmoil, medium-term output losses for Asian economies are likely to prove significant—both in levels and in growth rates. This expectation reflects the global nature of the slowdown, sluggish consumer demand in the main export markets, and the inherent challenges in rebalancing growth from export sectors toward domestically oriented industries, as potential growth of Asia’s traditional trading partners, in particular the United States, is estimated to have declined.

Assessing the output losses that the recent crisis is likely to impose on Asian economies over the medium term is, of course, a very difficult exercise—one that involves not only GDP projections over the next few years, but also an assessment of the precrisis trend growth for Asian economies. Staff estimates are based on current growth projections for 2009–14 and two different estimates of the precrisis trend—one based on the IMF staff medium-term GDP projections at the outset of the crisis, and one based on the linear GDP trend estimated during 2000–07. While the resulting estimates of medium-term output losses are only illustrative—and any cross-country differences should be interpreted with caution, as the forecasting errors are at present unusually large—they both point to nonnegligible medium-term output losses relative to the precrisis trend, ranging from 2–6 percent in China and India to about 10 percent in the NIEs.

While individual country experiences will undoubtedly vary widely, potential output will likely be reduced through several channels:2

  • Low investment. During recessions, private investment falls sharply, eroding productive capital stock. Indeed, fixed investment in advanced Asia fell by 15 percent between 2007 and 2009 and is projected to remain sluggish for some time given the large unused capacity in the corporate sector. Financial strains can further amplify the investment slump by constraining credit availability and raising financing costs, although their intensity has varied greatly across the region. However, public investment can partially (and temporarily) replace flagging private investment, possibly creating positive externalities for growth in the medium term—indeed, a number of Asian countries are currently implementing ambitious public investment programs. In some countries, such as China and India, fiscal and monetary stimulus has supported continued growth in total fixed investment (in China, fixed investment has even accelerated), helping to explain some of the cross-country differences in expected output losses.


Asia: Medium-Term Output Losses

(Deviation of 2014 GDP projections from two alternative counterfactual trends; in percent)

Source: IMF, WEO database.
  • Impaired labor market. Deep recessions typically keep workers out of jobs for prolonged periods, impairing their skills and discouraging some of them from seeking employment. At this juncture, this could particularly be the case in countries with less flexible labor markets such as Japan, where displaced workers may not easily move into new productive activities. Projections therefore build in a modest increase in medium-term unemployment, with negative implications for potential output. That said, the negative contribution to potential growth from diminishing labor inputs is generally projected by IMF staff as relatively small in Asia (especially in emerging economies), in part because fiscal stimulus packages in many countries have put emphasis on maintaining employment, while the initially strong balance sheets of Asian corporations have so far encouraged labor hoarding.


Asia: Investment Slump and Recovery

(Fixed private and public investment; year-on-year percent changes)

Source: IMF, WEO database.
  • Lower productivity. Falling profitability and tighter lending conditions have made corporations slash their research and development spending, which could depress productivity. In addition, financing for SMEs or start-ups with large innovative abilities will likely be subject to more stringent credit conditions than before the crisis.3 More generally, service sector productivity stopped converging toward U.S. productivity levels in some Asian economies even prior to the financial turmoil, suggesting that making services the engine of growth will require significant reforms (IMF, 2006a).

Looking across Asia, this year’s GDP loss associated with the global financial crisis could reach about US$1 trillion in purchasing-power-adjusted dollars. Under the baseline scenario with lower potential growth in some Asian economies, the GDP shortfall could further widen to about US$2 trillion annually by 2014. The sheer magnitude of these negative effects underscores the importance of implementing measures that help raise potential output, in particular, reforms to facilitate the shift of resources across sectors and to boost domestic demand. Resisting protectionist measures, maintaining credible fiscal frameworks, and gradually phasing out emergency labor market interventions will also be important for mitigating the negative impact of the crisis on medium-term potential output.

Note: The main author of this box is Martin Sommer.1 In Japan and Korea, the reduction in annual average growth was about 1 percentage point. The reference samples are 1992–97 (precrisis) and 1999–03 (postcrisis). While the latter sample was influenced by the burst of the information technology bubble, growth in Korea and Malaysia remained below the precrisis (1992–97) levels even during the global boom of 2002–07.2 Potential output can be defined as the level of output consistent with stable inflation or, alternatively, the trend level of output around which the economy fluctuates over the business cycle. Recent studies of the linkages between crises and growth include Cerra and Saxena (2008), European Commission (2009), Furceri and Mourougane (2009), IMF (2009b), Organization for Economic Cooperation and Development (2009), and Reinhart and Rogoff (2009).3Estevão (2009) makes a similar argument about industries dependent on external financing.
  • A series of natural disasters in late September caused serious dislocations, loss of lives, and property damage in a number of countries. In some of the affected Pacific Island nations, notably Samoa, there has also been a sizable impact on economic activity (Box 1.6). In the larger economies of Indonesia, the Philippines, and Vietnam, however, the macroeconomic impact is expected to be minimal.

Meanwhile, inflation should remain generally subdued. In particular, inflation is projected to be negative in Japan and remain at minimal levels in EEA in both 2009 and 2010, reflecting sizable output gaps and well-anchored inflation expectations (Figure 1.37). In China, a fall in food inflation, high levels of investment in nontradables, and significant excess capacity are limiting inflationary pressures, despite the massive monetary (and fiscal) stimulus. In other DEA economies, however, the relatively smaller amount of economic slack implies a greater acceleration of CPI inflation. Indeed, a pickup in core inflation and inflation expectations suggest that demand pressures are already playing a role in pushing up inflation in India. Inflation expectations are also rising in Indonesia, related largely to the expected uptrend in commodity prices.

Figure 1.37.
Figure 1.37.

Asia: Consumer Prices1

(Year-on-year percent change)

Source: IMF, WEO database.1 Wholesale prices used for India.

Reflecting the still-tentative external environment, Asia’s current account surplus is expected to fall somewhat (from 4¼ percent of GDP in 2008) over this year and next, averaging a little over 3⅔ percent of GDP. Substantially weaker exports will reduce China’s and Japan’s current account surpluses. In particular, China’s current account surplus is expected to decline to about 7¾ percent of GDP in 2009 from about 10 percent in 2008, as a restocking of commodities has led to a strong rebound in imports (Figure 1.38). By contrast, current account surpluses are projected to increase for the NIEs, particularly in Korea where exports have been supported by recent gains in export market share and stronger capital goods demand from China.

Figure 1.38.
Figure 1.38.

Asia: Current Account Balances

(In percent of GDP)

Source: IMF, WEO database.


The exceptional uncertainty prevailing at the time of the May 2009 Asia and Pacific Regional Economic Outlook has receded, but risks remain tilted moderately to the downside (Figure 1.39).

Figure 1.39.
Figure 1.39.

Asia GDP Growth

(Central forecast and 50, 70, and 90 percent confidence intervals; in percent)

Source: IMF staff estimates.
  • The main downside risk to the baseline is that the incipient recovery in advanced economies will stall. As highlighted in the October 2009 World Economic Outlook, a premature exit from accommodative monetary and fiscal policies could undermine the nascent global recovery. In addition, there is still a risk that financial strains could linger or even intensify, particularly if efforts to restore bank balance sheets are not followed through forcefully.

  • If signs of renewed external environment weakness were to arise, the positive feedback loop triggered in Asia could shift into reverse. In particular, renewed foreign risk aversion could trigger another bout of capital outflows, with knock-on effects on equity valuations and confidence. In addition, renewed weakness in demand could induce Asian firms to shed their labor-hoarding strategy and cut jobs, leading to a sharper increase in unemployment rates than has been observed so far.

  • At the same time, an upside risk to the near-term outlook is a more rapid improvement in financial conditions, both abroad and in the region. The associated confidence effects could drive a larger-than-expected rebound in domestic private consumption and investment, helping to create conditions for a stronger recovery, especially in DEA. In particular, in India, there are upside risks to growth projections for both this year and the next as signs of recovery are broadening and the adverse impact of the monsoon is likely to be smaller than anticipated.

Economic Impact of Recent Natural Disasters in Asia

Several countries in Asia were severely affected in late September by a string of natural disasters. Indonesia, the Philippines, Samoa, Tonga, and Vietnam have all suffered damage caused by a typhoon and two earthquakes. While damage has been substantial, overall macroeconomic impacts are expected to be minimal, except for in Samoa. Impacts based on preliminary information are briefly summarized below.

Indonesia: A magnitude 7.6 earthquake struck Indonesia’s West Sumatra province, claiming more than 1,000 lives. The city of Padang (population 1,000,000) was severely damaged. Significant damage to infrastructure has taken place, which could affect palm oil and coal exports from Sumatra, although the three affected regions together account for only 3 percent of GDP. Estimates of the overall damage run in the range of US$200–300 million (less than 0.1 percent of GDP). To supplement aid from private and bilateral sources, the government has set aside US$25 million in emergency funds from within existing budget resources.

Philippines: More than 1 million people have been affected by a flood resulting from typhoons Ketsana and Parma. Initial estimates of the direct damage appear to be just under 10 billion pesos (0.13 percent of GDP), mostly from damage to crops (rice, corn, and vegetables), agriculture infrastructure, and businesses in metropolitan Manila. Damage to homes and other assets could also significantly dent household wealth. A supplemental budget of 0.15 percent of GDP is currently being discussed in the congress.

Samoa and Tonga: At least 143 deaths have been reported following a tsunami that struck Samoa, and about 2.5 percent of the population may have lost their homes. While still early to assess the full economic impact, initial official cost estimates stand at about US$150 million (25 percent of GDP). Samoa’s rapidly growing tourism sector (tourism receipts are about 20 percent of GDP) has been severely damaged. Australia, New Zealand, and France are providing emergency relief, and a strong response from overseas remittances (which in recent years were equivalent to 25 percent of GDP) is expected. Additional funding has either already been approved or likely to be approved by multilateral agencies (the Asian Development Bank and the World Bank). Damage to Tonga, which also experienced the tsunami, was less severe, with nine dead and serious damage to some outlying villages.

Vietnam, Cambodia, and Lao People’s Democratic Republic: Typhoon Ketsana also left a trail of destruction in Vietnam, Cambodia, and Lao People’s Democratic Republic. In central Vietnam, at least 163 people have died. Significant damage has occurred to homes, schools and public structures, and farmland, and their costs are estimated at US$785 million (0.8 percent of GDP). On top of the US$3 million international support so far, the government has set aside about US$28 million and 10,000 tons of rice for storm-hit provinces. Dozens more were killed in Cambodia and Lao People’s Democratic Republic. Several villages have been affected by flooding, although damage has not yet been fully assessed.

Note: The main author of this box is Uma Ramakrishnan.

Key Policy Challenges

The Near Term: A Delicate Balancing Act

Asia will need to deftly manage a balancing act in the period ahead. Policymakers will need to continue to provide support to economies until it is clear that the recovery is self-sustaining and sufficiently robust. At the same time, they will need to ensure that accommodative policies are not maintained for so long that they ignite inflation pressures or concerns about fiscal sustainability. Striking the right balance will be difficult. But the key is clear: policymakers will need to ascertain that private demand, both at home and abroad, is sufficiently strong to take over as a driver of the recovery if public sector demand is withdrawn.

This is no easy task, for the risk of “false dawns” is high. Chapter 2 considers the lessons from Japan’s “lost decade.” On two occasions in Japan over the 1990s and early 2000s “green shoots” of recovery emerged, allowing stimulus to be withdrawn. In both cases, however, the underlying corporate and financial problems had not been resolved, and the external environment deteriorated dramatically—first during the Asian financial crisis in 1997 and then the information technology bubble collapse in 2000. As a result, a more severe downturn ensued, necessitating renewed stimulus to support activity. The three main lessons are

  • Both domestic and international conditions are crucial to the prospects for recovery.

  • A durable recovery may emerge only when “green shoots” spread beyond industrial production and exports to employment and private domestic demand (Figure 1.40).

  • Achieving such a broad-based recovery, as Japan eventually did in 2003, requires advanced economies to address the balance sheet problems at the heart of the crisis.

Figure 1.40.
Figure 1.40.

Comparing Asia Now with Japan in the 1990s and Early 2000s

Sources: CEIC Data Company Ltd.; Thompson Datastream; Haver Analytics; and IMF staff calculations.1 Three-month (or short-term) money market rate minus equivalent T-bill rate.2 See Balakrishnan and others (2009). The index comprises seven variables capturing developments in the banking sector, the securities markets, and the foreign exchange markets.

In general, these conditions will not be met fully for some time. In a few special cases, however, the recovery is advancing so rapidly that output gaps are already starting to close and pressures are already emerging. In India, for example industrial production is recovering rapidly, and core inflation and inflation expectations are rising. In China, growth is accelerating, and the extraordinary pace of loan growth in the first half of 2009 raises the risk of future loan quality concerns. In Australia, the economy has rapidly regained strength on the back of surging commodity exports, mostly destined for China. Accordingly, in China signs of a slowdown in credit growth are emerging, while in early October the Reserve Bank of Australia became the first central bank in a major country to raise interest rates since the onset of the crisis.

Elsewhere, however, a tightening of monetary policy in the near future seems unnecessary, for several reasons:

  • The recovery so far remains tentative. In most countries, the pickup in activity has so far been supported by factors that either are temporary (inventory adjustment, policy stimulus) or could turn out to be so (rebounding capital markets and confidence). Especially in Japan and EEA, where the pickup in private domestic demand seems more tentative, these forces may not be enough for a self-sustaining recovery, if the rebound in other regions stalls.

  • The risks of inflation at present are low. In most countries, large output gaps are likely to persist for some time and are even expected to widen next year in many cases, as growth is projected to remain below potential. Also, there is little evidence of inflationary risk from cost push pressures—particularly important in Asia since nonmanufactured goods account for a large part of most CPI baskets. In particular, pressures from commodity prices are expected to remain moderate.

  • The increase in asset prices so far has been limited. For example, although stock market price/earnings ratios have rebounded, they remain near long-term averages. And although housing prices have rebounded quickly in some countries, by and large the increases have been limited, and the sharp increases have been confined to certain locales (Figure 1.41). If Asian central banks nonetheless respond by raising interest rates while Western central banks sustain theirs at low levels, interest differentials will rise, attracting “carry trade—type” capital inflows that could aggravate asset price pressures. For all these reasons, it would seem preferable, at least initially, to address incipient asset price pressures through targeted prudential measures rather than the blunt instrument of monetary policy. Indeed some central banks and financial regulators in the region have already done just that.5

Figure 1.41.
Figure 1.41.

Property Prices

(Index, 2006:Q1 = 100)

Sources: CEIC Data Company Ltd.; and Haver Analytics.

For exactly the same reasons, it will be important to ensure that fiscal policy remains stimulative next year. With Asia recovering, most governments are not planning new fiscal stimulus packages. Current budgetary figures imply a withdrawal of fiscal stimulus in many Asian economies in 2010 (Figure 1.42)—particularly in advanced and export-dependent economies, which have experienced relatively larger cyclical weakening of their fiscal positions. But with the boost from global restocking likely to wane in the coming quarters, anemic final demand in Western countries, and weak Asian investment, fiscal support will likely need to continue for some time. Also, some targeted fiscal measures will need to be retained for the time being, especially employment support measures, as labor markets remain fragile.

Figure 1.42.
Figure 1.42.

Fiscal Impulse in 20101

(In percent of GDP)

Source: IMF staff estimates.1 Change in structural fiscal balances relative to 2009, related to measures taken in response to the crisis.

That said, it is not too early to plan for a gradual, measured exit from the exceptional levels of policy support:

  • Monetary stimulus: Although the wide range of monetary measures adopted in the region has helped normalize credit markets, its legacy is an unusually high amount of liquidity lingering in the banking system and government intervention in credit allocation (Figure 1.43). This will need to be unwound gradually, at a pace reflecting the strength of economic recovery in individual countries. Initially, measures that have become redundant, such as government guarantees for domestic or external bond issuance, could be allowed to lapse. Then, countries could move on to measures that are still being utilized, where their removal could potentially affect private sector activity. The pace of exit will need to be coordinated with fiscal policy, since, in mopping up excess liquidity, authorities could place undue stress on bond markets at a time when government debt issuance is increasing. In addition, in some cases, exit strategies will need to be coordinated within the region, so as to minimize the threat of destabilizing capital flows (see the October 2009 Global Financial Stability Report). In this regard, Singapore, Malaysia, and Hong Kong SAR have announced the creation of a working group to map out a coordinated strategy for the unwinding of the deposit guarantees by end 2010.

  • Fiscal stimulus: Only a few Asian countries have so far announced specific medium-term consolidation plans. But these will be needed in some countries, for several reasons. To begin with, well-articulated plans to ensure fiscal solvency would bolster the effectiveness of the remaining stimulus, by reducing uncertainty and the risk of rising interest rate premiums. Indeed, concerns about the fiscal outlook have already led to rising long bond rates in many countries this year. In fact, even though economic recovery should allow fiscal deficits to subside, the debt-to-GDP ratio is projected to remain above precrisis levels in 2014 for most Asian economies, exceeding sustainable levels in a number of cases (Box 1.2). The size of the adjustment will need to be larger for those countries that are starting from relatively higher levels of debt (like Japan, India, and Malaysia) or are facing looming aging-related fiscal pressures (Japan and some NIEs).

  • Other policy support: Particular attention should also be given to devising exit strategies from the SME credit guarantee schemes that have been adopted or expanded in many parts of Asia during the crisis. Aside from their potential fiscal costs, they also distort the playing field for firms and reduce incentives for firms to improve their financial performance. Even so, unwinding this form of support has typically proved difficult. Over the past decade, the generosity and coverage of credit guarantee programs has tended to be enlarged with each downturn, but only partially pared back during upturns. The present crisis provides an opportunity to establish more effective ways of addressing market failures that may constrain the availability of credit to SMEs, while minimizing the cost to taxpayers (Box 1.7).

Figure 1.43.
Figure 1.43.

Asia: Difference Between Broad Money Growth and Nominal GDP Growth

(In percentage points; year-on-year)

Sources: CEIC Data Company Ltd.; and IMF staff calculations.

The Medium Term: Asia Rebalancing

The key medium-term challenge for Asia is to put in place policies that will allow it to restore sustained, rapid growth. With the external environment likely to remain weak for some time, demand from the West for Asia’s advanced-technology manufacturing exports may not be as strong as in the past. This will have a significant impact on Asia because, despite the rapid rise of intraregional trade over the past decade, Asia remains relatively dependent on external demand (see the May 2009 Asia and Pacific Regional Economic Outlook). Indeed, the share of value added produced in Asian economies that can be attributed to final demand outside Asia has remained relatively constant over time, at about 30 percent on average in the region, with a peak of about 50 percent in Singapore (Figure 1.44).

Figure 1.44.
Figure 1.44.

Selected Asia: Contributions of Final External Demand to Total Value Added

(In percent)

Sources: Institute of Developing Economies, Japan External Trade Organization, Asian Input Output Table, 2000; and IMF staff estimates.

The near-term scope for China to offset sluggish demand from advanced economies appears limited (Box 1.8). Certainly, China has recorded very high import growth rates for consumer goods—about 15 percent per year over the last 15 years, compared with a world average of 10 percent. Even so, it remains a relatively small importer of consumer goods, accounting for just 3 percent of global imports in 2008, with an even smaller share of consumer durables (Figure 1.45). As a result, its contribution to global import growth in consumer goods has also remained small. Moreover, despite China’s rapid increase in per capita income, the composition of its imports remains very different from those of major import markets, suggesting that it may be difficult for global suppliers to switch rapidly from supplying advanced markets to meeting the needs of Chinese consumers. Among export-dependent Asian economies, only Korea and Taiwan Province of China have been able to gain significant market shares in the Chinese consumer market over the last two decades.

Figure 1.45.
Figure 1.45.

Contributions to Growth in World Imports: Consumer Goods

(In percent over previous five years; excluding intra-group trade)

Sources: United Nations, Comtrade database; and IMF staff calculations.

Exit from SME Support Measures

Small and medium-sized enterprises (SMEs) in Asia have been hit hard by the global slowdown. Shrinking cash flows and tighter financial conditions have put a strain on SMEs, forcing many to slash production or exit. In many Asian countries, SME bankruptcies and nonperforming loans have risen faster than those for larger firms. The impact on activity has been significant, as SMEs in Asia account for more than 90 percent of firms, three-fourths of total employment, and one-third of exports.1 SMEs cover almost all sectors and play a critical role as suppliers to large export manufacturers.


Selected Asia: Outstanding SME Credit Guarantees, 2007

Sources: Annual Reports of Credit Guarantee Institutions and Asian Credit Supplementation Institution Confederation; and IMF staff calculations.

Given SMEs’ importance as a source of jobs and spending, Asian countries have responded by establishing or expanding various SME support schemes. Measures include subsidized lending and tax breaks, but the most common form of support is through public guarantees on bank lending to SMEs.

SME credit guarantee programs have been around for some time in Asia. Guarantee programs have a long history—dating back to the late 1930s in Japan and the 1960s in India and Korea—and were used extensively during the Asian financial crisis to support the corporate sector. Compared with other regions, Asia relies more on SME credit guarantees—about 2 percent of GDP in 2007, compared to 0.6 percent of GDP for a sample of 46 developed and developing countries (Beck, Klapper, and Mendoza, 2008). Schemes vary in size—from 5.7 percent of GDP in Japan to less than 0.1 percent of GDP in India and the Philippines—with the relative size of the SME sector explaining only part of the variation.


Selected Asia: Crisis Response

(In percent)

Source: IMF staff estimates.

In addition to expanding the size of guarantees, policymakers have also made their coverage and terms more generous. Japan, Malaysia, and Thailand have more than doubled funding for their SME credit guarantee programs, and Korea announced a 50 percent increase, although only part of the additional amount has been used so far. In addition, many countries have increased the guarantee coverage, with four countries (Indonesia, Japan, Korea, and Malaysia) now guaranteeing 100 percent of certain loans, thereby eliminating any credit risk for banks. Other measures include raising the maximum guarantee amount per enterprise (India, Korea, and Taiwan Province of China), extending the maturity (Korea, Taiwan Province of China), relaxing credit standards (Korea), and reducing guarantee fees (Taiwan Province of China).

An evaluation of past performance suggests that a rapid expansion in guarantees can be very costly. Although up-front costs are low and liabilities contingent, guarantee programs seldom come cheap. The financial performance of most schemes has been poor, with profitability generally lower for those that are more leveraged and with more generous coverage (Shim, 2006). Revenues from guarantee fees, ranging from 0.25 to 3 percent of the principal, typically cover less than three-fifths of outlays, but risks can be high, especially in Japan, Indonesia, and Taiwan Province of China, where the schemes are leveraged at close to 20 times capital. To compensate for losses—which tend to escalate during major downturns—governments have been forced to find budget space to replenish their capital.


Selected Asia: Performance of Credit Guarantee Agencies

(In percent; latest year available)

Sources: Reports of credit guarantee agencies; and Shim (2006).1 Recovery-to-payments.2 Outstanding guarantees-to-capital.3 Profits-to-outstanding guarantees.

Moreover, unwinding such support has proven difficult. The size and coverage typically rise with each crisis, but are only partially pared back during the subsequent recovery. As a result, costs tend to be recurring. For example, in Korea after the financial crisis, the two major guarantee programs reported annual losses of almost 4 percent of outstanding guarantees between 2001 and 2005 (Shim, 2006). In Japan, a program that started in 1998 extended nearly ¥29 trillion in credit guarantees with 100 percent coverage over about three years, resulting in net losses to the government of about ¥2 trillion.


Selected Asia: SME Credit Guarantees

(In percent of GDP)

Source: IMF staff estimates.

Asia’s experience with generous guarantees highlights the need to design an effective exit strategy that both supports restructuring and minimizes fiscal risks.

  • In the short-term, credit guarantees could be redesigned to better align incentives and facilitate an unwinding of support once the crisis abates. For instance, blanket guarantees could be replaced with partial coverage (as was done in Japan in 2001) and set at a level more in line with the international average of 60–80 percent. Guarantee fees could also be adjusted based on risk to offset credit costs and provide stronger incentives for banks to restructure their problem borrowers. Charging higher fees based on the duration of the loan or coverage of the guarantee, as is done in Brazil and Colombia, could have similar benefits. Consideration could also be given to including a sunset clause for schemes implemented during the crisis, contingent on economic developments, as is done in Korea.

  • Over the longer term, attention should shift away from relying on guarantees to addressing the root cause of SMEs’ limited access to credit. Research suggests that improvements in the financial infrastructure can expand credit availability, such as by liberalizing the interest rate regime, expanding credit information sharing, and improving the tax, regulatory, and legal environment (Beck and Demirgüç-Kunt, 2006). Some promising policies already underway in Asia include expanding credit bureaus, allowing the securitization of movable assets, and developing venture capital markets for SMEs. New institutions to encourage markets, rather than the government, to provide insurance could also be considered; in China, for instance, credit guarantees are largely privately provided.

Note: The main authors of this box are Erik Lueth, Chad Steinberg, and Murtaza Syed.1 Although definitions differ across the region, more than 95 percent of SMEs in the region employ fewer than 100 people (Harvie, 2004).

Global Shifts in Demand: Making Up for Weaker Consumption in the United States

By any measure, Asia is highly dependent on external demand. A compelling metric comes from an input-output analysis that traces indirect trade linkages to final demand without double-counting the cross-border flows of intermediate goods. Detailed input-output tables for the largest Asian economies show that value added in export-related activities exceeds one-third of GDP in many countries—substantially more than the average for advanced economies.1 The data also show that the bulk of exported value added is in most cases linked to destinations outside Asia.

Asia depends primarily on consumers in the large advanced economies. Gross trade data give a distorted picture of the nexus between Asia’s exports and U.S. consumption, since they do not properly capture China’s role in the supply chain for consumer goods exports from Asia. Taking into account intra-Asian production linkages, the United States has consistently accounted on average for about one-third of Asia’s exported value added. The bulk of this exported value added is traceable to demand for consumer goods—about 70 percent in the case of ASEAN and China, and about 60 percent for Japan and Korea.


Asia: Exported Value Added versus Exports to U.S.

(In percent of total to non-Asian destinations; simple average)

Sources: Institute of Developing Economies, Japan External Trade Organization, Asian Input Output Table, 2000; United Nations, Comtrade database; and IMF staff estimates.

In light of this dependence, what are the implications for the region of weak consumption in the United States? In particular, can China’s consumers alone make up for the faltering demand of consumers in the United States and thus sustain regional growth? There are at least two reasons for thinking that such an offset is not likely.

First, China’s economic size is small compared with that of the United States. GDP at current exchange rates is about one-fifth of that in the United States—and private consumption is just over one-eighth of that in the United States.

Other indicators reinforce the point: China’s share in world imports of consumer goods is about 3 percent, and its share in world import growth has averaged only 4 percent in recent years. Just because of the smaller economic footprint, the demand adjustment needed in China to compensate for a pullback by U.S. consumers is unlikely without, among other things, sweeping adjustments in the allocation of resources. This would take time under the best of circumstances.

Second (and more subtly), even if a large demand adjustment took place in China, the current composition of its consumption suggests that regional spillovers would be limited. The import content of domestic consumption in China is significantly smaller than that in the United States. Moreover, the consumer goods imported by China are very different from those imported by U.S. households. Measured by an import similarity index for more than 300 types of consumer goods, the consumer goods basket imported by China overlaps by only about 35 percent with that in other advanced economies.2


Import Similarity with U.S.—Consumer Goods1

(100 indicates perfectly matching import structure)

Sources: United Nations, Comtrade database; and IMF staff estimates.1 Based on 303 SITC 5-digit line items for durable, semi-durable, and other consumer goods.

These observations are supported by model-based analysis. Simulations from the IMF’s GIMF model show that the negative impact on Asian exports of a rise in the saving ratio in the United States could not be offset by an equal decrease in that ratio in China. In this scenario, positive spillovers to the region from greater Chinese demand would at best mitigate one-third of the adverse shock from lower U.S. consumption. In fact, once confidence effects and financial linkages are taken into account, the impact of an adverse shock emanating from the United States could be much bigger—as recent experience shows.


Export Impact from Changes in U.S. and China Savings Rates1

(Percent difference from baseline)

Source: IMF staff calculations.1 Assumes U.S. (China) private savings increases (decreases) by 2 percentage points of GDP.

Thus, a broad array of policies would be needed in the region to ensure sustained strong growth in an environment of weak export demand from advanced economies. As highlighted in the October 2009 World Economic Outlook, these policies would entail reforms in the provision of public goods (for example, education, health, and social protection) and financial services to lower precautionary savings, as well as measures to boost productivity in the nontradables sector. More flexible exchange rates would over time also help in allocating resources toward domestic-demand-oriented industries.3

Note: The main authors of this box are Sanjay Kalra, Adil Mohommad, Papa N’Diaye, and Olaf Unteroberdoerster.1 Using the methodology in Peltonen and Pula (2009), input-output tables have been constructed for 1995—2008 based on the 2000 Asian Input-Output Table provided by the Japan External Trade Organization.2 Based on SITC-5 digit data comprising over 300 line items for consumer goods, the import similarity index between two economies j1,2 is 100Σis(i,j1)s(i,j2)/(Σis(i,j1)2Σis(i,j2)2) where s(i, j) is the share of good i in country j’s imports.3 See N’Diaye, Zhang, and Zhang (2009).

All this means that Asia’s growth prospects may be determined by its ability to diversify the drivers of growth to domestic sources. This will require structural reforms across a wide range of fronts.

  • Chapter 3 shows that financial sector and corporate governance reforms will be needed to address issues relating to the region’s corporate savings. Over the past few years, Asia has witnessed a sharp increase in corporate savings, even as investment has remained subdued (Figure 1.46). This unusual combination has posed two puzzles. Why did corporations not pay out their profits as dividends, if they did not have suitable investment projects? And why did households not respond to the increase in corporate wealth by increasing their consumption? The chapter finds that financial and corporate governance reforms are the keys to solving the puzzle and addressing the underlying problems. Greater financial development could increase access to capital for a greater number of firms and reduce firms’ need to retain earnings in order to self-finance profitable investment projects. Meanwhile, improvements in corporate governance could impose greater discipline on corporate managers and create incentives for them to retain earnings only insofar as their firms have profitable projects in which to invest.

  • Reforms would also be needed to raise household incomes and reduce the relatively high level of precautionary savings. For example, many countries still lack comprehensive systems of social insurance that cover health care expenses, education, and retirement. Some progress has been made recently on this front; China for example, has approved an ambitious plan to develop a national health care system over the next three years. However, more reforms are needed. Moreover, these reforms are likely to have a long gestation period and should therefore be put forward quickly and decisively.

  • Finally, measures will be needed to encourage resources to move to the sectors of the economy with greater potential, especially nontradables sectors like services. Such a shift would be facilitated by greater flexibility in exchange rates.

Figure 1.46.
Figure 1.46.

Selected Asia: Private Savings—Changes in the Share of Household and Nonhousehold Savings in GDP

(In percentage points; difference between the average during 1990-96 and 2003-most recent)

Sources: CEIC Data Company Ltd.; and IMF staff calculations.

The Role of the IMF during the Crisis and in the Post-Crisis World

The IMF has mobilized on many fronts to support its member countries during the economic crisis. It has stepped up emergency financing dramatically, with commitments amounting to over twice as much as during the Asian crisis. The capacity to extend concessional loans has been scaled up to US$8 billion in the next two years—more than triple what was available before the crisis—and up to US$17 billion through 2014. The IMF has also drawn on its cross-country experience to advise on policy solutions, boosted global liquidity, increased its lending resources, and introduced reforms to modernize its operations and become more responsive to member countries’ needs. There has also been a historic agreement to strengthen IMF governance by shifting quota shares toward underrepresented members.

In particular, progress has been made in the following areas:

  • Surveillance. The IMF’s monitoring, forecasts, and policy advice, informed by a global perspective and experience from previous crises, have served as important inputs for the policy deliberations of the G-20 and of the entire IMF membership. The G-20 has given the IMF an important new multilateral surveillance mandate, by asking it to support the G-20’s mutual assessment efforts.

  • Global liquidity. An allocation of US$283 billion in Special Drawing Rights (SDRs, the IMF’s reserve currency) has boosted member reserves. Central banks in Asia have received about US$54 billion through the SDR allocation.

  • Lending resources. The IMF’s lending resources are being tripled, to US$750 billion. Asia-Pacific is contributing significantly to this financing effort, providing US$178 billion through the New Arrangements to Borrow, a credit arrangement between the IMF and a number of member countries and institutions, and Note Purchase Agreements, which allows members to invest in IMF paper.

  • Lending facilities. The IMF has overhauled its general lending framework to make it better suited to country needs. Several changes have taken place. First, the Flexible Credit Line (FCL), a precautionary facility, has been launched. It provides financial insurance for countries with very strong fundamentals, policies, and track records of policy implementation. Disbursements are not phased, and there are no conditions to meet once a country has been approved for the FCL. Second, borrowing limits have been doubled for all countries. Concessional loans will be interest-free through 2011. In Asia, Mongolia and Sri Lanka have already received new, high-access financing from the IMF (Box 1.9). Third, conditionality has been streamlined, to focus only on core policy measures that are critical for macroeconomic stability and growth. The IMF is also accommodating higher budget deficits in both concessional and nonconcessional lending programs and IMF programs now have special provisions for protecting the poorest and most vulnerable.

  • Governance. The IMF membership has agreed to a shift in quota shares to dynamic emerging markets and developing countries, of at least 5 percent from overrepresented to underrepresented countries. This shift should give Asia a greater voice in the IMF, in accordance with its weight in the global economy. It will come on top of the 1.6 percentage point shift in quota shares to emerging market and developing countries that was agreed in April 2008.

Macro-Stabilization in Mongolia: An Emerging Success Story

The global economic crisis hit Mongolia hard, in large part as a result of a precipitous drop in copper prices. The Mongolian authorities’ strong policy implementation, however, supported by an IMF program and with timely support from donors, has helped it weather the worst of the global storm and put its economy back on a path to sustainable growth with low inflation.


Mongolia: Mineral Revenue

(In percent of GDP)

Source: IMF staff calculations.

The collapse in global commodity prices hit both the country’s fiscal position and its balance of payments. The price of copper, a key export for Mongolia, fell precipitously in 2008, dropping over 60 percent from its peak. This led to a sharp drop in export earnings and a loss of 5 percent of GDP in fiscal revenue. Making matters worse, macro policies during the boom years had been excessively procyclical, which meant that Mongolia entered the crisis with inflation reaching as high as 30 percent and an overvalued currency. The boom in credit has also swelled bank balance sheets, and insufficient attention to prudent risk management within the banks exposed their balance sheets to the deterioration in market conditions.

By late 2008 the economic situation was becoming critical. International reserves were being depleted amid outflows from the banking system, despite the authorities’ allowing the exchange rate to depreciate substantially. The nominal depreciation, while needed, also served to weaken bank balance sheets. In October 2008, the fourth-largest bank was hit by a bank run and was taken into conservatorship by the central bank. The situation was precarious, with confidence in the banks, the currency, and the wider economy sliding fast.

An IMF-supported program was quickly agreed and implemented. The IMF approved an exceptional-access Stand-By Arrangement on April 1, 2009, for US$235 million. This catalyzed other donors and the World Bank, with the authorities holding a donor conference shortly prior to the IMF Executive Board meeting that secured pledges for some US$200 million in budgetary support—primarily from the Asian Development Bank, Japan, and the World Bank itself.

The authorities’ economic program focused on the key priority areas. First, the government aimed to restore health to public finances, starting with passage of a revised 2009 budget.

Second, with more than one-third of the population living below the poverty line, it was imperative to take urgent steps to address the economic downturn and protect Mongolia’s most vulnerable citizens. As part of the economic measures taken, social transfer programs were protected, and the government began to design a comprehensive overhaul of these programs, to improve targeting and raise the level of social support to the very poor. Third, the central bank raised interest rates and introduced a transparent mechanism for auctioning foreign exchange in order to safeguard international reserves and steadily lower inflation. Finally, the economic program sought to bolster confidence in the banking system, including by improving the deposit guarantee system and enhancing bank supervision. Its conditionality was parsimonious and entirely focused on these priorities.

The authorities’ strong policy implementation and strong ownership of fiscal and monetary policies served to stabilize financial markets quickly. A front-loaded increase in the policy rate, in combination with a flexible exchange rate, worked to stem capital outflows and ease pressure on the currency. Passage of a revised budget enhanced fiscal credibility. Improvements to the deposit guarantee system bolstered confidence in the banking system. Finally, IMF financial support and the catalytic impact that it had on donors increased confidence. The combination led deposits to flow back onshore and into the financial system, easing pressures on the banks and allowing the central bank to begin rebuilding its international reserves.


Mongolia: Inflation, Interest Rate and Exchange Rate

Source: IMF staff calculations.

The quick turnaround in confidence allowed economic policies to be adapted to improved market conditions. With pressure on the currency easing faster than expected, international reserves being rebuilt, and inflation coming down, within a couple of months of program approval, the central bank already had scope to begin a gradual easing of monetary policy. Further, as financing constraints eased, the program’s fiscal targets were recalibrated to provide additional support to the economy and allow greater room for automatic stabilizers to operate. Moreover, the IMF’s recent SDR allocation provided US$75 million in additional resources that have been deployed to finance the fiscal position for this year and next.

Looking forward, the outlook for the Mongolian economy is encouraging. The economy stands to benefit enormously from its mineral wealth. Indeed, agreement on major investments in one of the world’s largest copper-mining projects has recently been reached and looks set to generate significant economic benefits for Mongolia in the coming years. Managing this wealth will present its own challenges. However, the Mongolian government is fully aware of the need to improve Mongolia’s institutional structure and is in the process of designing a comprehensive Fiscal Responsibility Law that will promote prudent fiscal management, carefully manage the country’s resource wealth, and help contain the past tendency toward procyclical fiscal policy. This and other reforms that have been under the umbrella of the IMF program should be able to steer the economy down a path of strong, sustainable, and equitable growth with low inflation and improving living standards for all of Mongolia’s citizens.

Note: The main author of this box is Steven Barnett.

Note: The main authors of this chapter are Roberto Cardarelli, Leif Lybecker Eskesen, Meral Karasulu, Uma Ramakrishnan, Marta Ruiz Arranz, Romuald Semblat, Olaf Unteroberdoerster, and Harm Zebregs, with assistance from Souvik Gupta.


With the stock market recovering, a portion of this wealth has now been recouped—an estimated total of US$4 trillion during the second and third quarters of 2009.


These figures refer only to on-budgetary measures from central or general governments. They do not include off-budgetary or quasi-fiscal measures, including support measures to financial systems. For example, for China they only refer to support from the central government, which is about only one-third of total stimulus there.


For example, contingent claims analysis methodology shows that the share of publicly listed firms (weighted by assets) with a significant default probability (greater than 5 percent one year ahead) fell to less than 5 percent in August 2009 from 14 percent in March 2009.


A notable exception is Japan, where consumption has fallen by more than in the past, largely because there has been a significant rise in unemployment and decline in wages.


In Korea, for example, the authorities have recently tightened prudential measures to cool the housing market, including by lowering maximum loan-to-value ratios and tightening debt-to-income ratio requirements. At the same time, Singapore eased its supply of land, and the Hong Kong Monetary Authority warned about excessive competition in mortgage lending.