East Asia Growth Hardly a Time for Celebration — World Bank

In addition, the underlying trend in East Asia’s growth has long been much higher than the trend in industrial country growth, even as East Asian cycles around that trend have often been correlated with cycles in industrial countries, and may become more so as the region continues to integrate with the world economy. The region’s strong long run growth trend is not driven by year to year fluctuations in world demand, but, rather, by improvements in productivity, innovation, quality control, education and skills. These underlying sources of trend growth are unlikely to be affected by the financial turmoil or by a slowing global market – suggesting that, with continued prudent economic management, East Asia, and especially China, can continue to emerge as a growth pole in the world economy, providing a possible counterweight to the slowing industrial economies.

While the sub-prime crisis in the United States has had relatively little direct impact on banks and financial institutions in East Asia, perhaps the most immediate and visible impact of the financial turmoil in the United States has been the steep decline in securities markets across East Asia, especially equity and, to a lesser extent, offshore bond markets. This decline has been driven not just by uncertainty and the liquidation of portfolio holdings of foreign financial institutions, but also by a more realistic revaluation of risk in global financial markets as a whole and an adjustment in expected returns of the underlying investments. At the same time domestic credit — supported by ample domestic savings — continues to provide resources for investment even as portfolio inflows and loans from international banks taper off. More worrying would be if the decline in stock prices had a contagion effect through the balance sheets of corporations and/or banks, one among the many financial sector issues that the authorities in East Asia will need to keep a sharp eye on.

Building on our analysis of expected trade and financial flows, and the future course of key economic variables, we project Developing East Asian growth could decline by 1-2 percentage points to around 8 ½ percent in 2008 compared to 2007. While such a decline in growth is a matter of concern, especially for the poor in these countries for whom every percentage point of growth counts, the resulting growth rate is still significant and considerably higher than in other regions of the developing world. Of course, the US financial turmoil could still take an unexpected turn that may affect this outlook — especially if the contagion were to spread to other industrial countries in a major way — and this may require further downward adjustments in the forecast. But in such a circumstance, the strong fiscal situation in most East Asian countries will allow them the space to soften the blow by stimulating domestic demand through tax and public expenditure policies.

Quite apart from the challenge of growth, the East Asian countries also have to deal with current very high fuel and food prices. In virtually every East Asian country, inflation is climbing to uncomfortable levels due to these cost-push pressures, while monetary and credit growth is difficult to contain owing to substantial capital inflows. Some countries are resorting to price controls and other administrative measures to temporarily curb inflation, but these only distort market signals and encourage black markets over the longer term, and eventually have to be removed. In other countries, fuel subsidies have climbed to the point where they are becoming a large fiscal burden.