East Asia Growth Hardly a Time for Celebration — World Bank

Below is the executive summary of the World Bank’s “East Asia & Pacific Update” released April 2, 1008.

Executive Summary

Last year Developing East Asia recorded its highest growth rate in over a decade (10.2 percent), capping a decade of improvements following its home-grown financial crisis in 1998.1 Yet this is hardly a time for celebration, but rather one for concern. The global economy is once again facing a testing time, with soaring fuel and food prices, on the one hand, and, on the other, an unfolding sub-prime crisis emanating in the United States and spreading to other countries and asset classes, bringing in its wake a plunging dollar and a slowdown in global trade and growth.

Although East Asia will undoubtedly be affected, it is reasonably well positioned to navigate this crisis without incurring significant damage to its prospects. True, much depends on how the crisis unfolds, and of course, some countries in the region will be affected more than others. But, broadly speaking, the region’s investment in sound macroeconomic policies and structural reforms over the last decade has added economic resilience and flexibility that will help deal with these challenges over the next year or two. Foreign exchange reserves are at all time highs, non-performing loans of banks have been steadily lowered, external and public debt burdens are at acceptable levels, most governments have unused fiscal space, the real economy has momentum, and diversification of trade and financial flows provides some flexibility in adjusting to the impending global slowdown.

Yet the challenges ahead should not be underestimated. The crisis in the United States has deepened as asset prices struggle to find a new equilibrium and financial institutions go through a painful process of de-leveraging and recapitalization. Further surprises cannot be ruled out. Previous experiences of real estate price busts suggest they can last twice as long and twice as deep as equity price busts. And this is also the first financial crisis in the postsecuritized world, in which most intermediation is done through securities markets not depositary institutions — which means it could take even longer to resolve. Fortunately, the authorities of the affected countries have responded speedily to the crisis, lowering interest rates aggressively, providing fiscal stimulus, and using innovative approaches to inject liquidity and rescue failing financial institutions. But even if these interventions help stabilize the financial system and prevent a downward spiral in asset prices and asset values on balance sheets, the impact of the financial turmoil on global growth, trade, and financial flows will undoubtedly be adverse, although the magnitude of the impending effects remains highly uncertain.

This heightened uncertainty makes forecasting the impact on East Asia a particularly challenging task at this time. The latest data from the region indicates that the momentum of output and trade remains strong, but this is hardly surprising. The impact of a slowing US economy will take time to feed through trading and financial channels and its full force may only be felt in the second half of this year. Yet even in the first couple of months of 2008, data indicate adjustments in trade patterns that are suggestive of emerging trends that may become more evident with time. For example, export growth is shifting from the United States to other markets in industrial and developing countries, encouraged by the depreciating dollar and by continued strong momentum in the developing world (including East Asia itself), as well as in Europe.