Turmoil in US Financial Market Roils East Asia — World Bank

Below is the introduction of the World Bank’s “East Asia & Pacific Update” released April 2, 2008.

Introduction

Despite falling growth in exports to the US, rising volatility in global financial markets, high and volatile international commodity prices, and an increasingly clouded outlook for the world economy, economic activity in most East Asian economies continued at strong rates through the end of 2007 and into early 2008. Fortunately, the countries of East Asia are generally better prepared than ever to deal with the vicissitudes of the global economy in this more uncertain time. Reflecting lessons learned from the East Asian financial crisis of a decade ago, today most economies in the region have strong external payments positions and large international reserves, prudent fiscal and monetary policies, better regulated banking systems, and profitable and competitive corporations. East Asia’s trade and financial relations with the rest of the world have become steadily more diverse. The region is becoming more of a growth pole in the world economy, proving to be a force for stability at a time when the industrial economies are slowing.

This is not to say that East Asia is immune from developments elsewhere. On the contrary, its increased integration in the world’s trading and financial system makes it sensitive to global economic conditions. Whether the unfolding turmoil in US and other financial markets will gather force or start to abate, and how large its impacts on world economic activity will be, is still uncertain. On balance, however, the financial turmoil has substantially increased the likelihood of a US recession and a significant slowdown in world growth in 2008, including in East Asia. Economic cycles in East Asia have indeed often been correlated with cycles in the industrial countries. But these have generally been cycles around an East Asian trend rate of economic growth that has for many decades run at 4–5.5 percentage points faster than trend growth in industrial countries. High trend growth has been driven by fundamental factors such as robust productivity gains, ability to absorb knowledge from abroad, high savings, and growing education and skills. And these fundamentals are unlikely to be displaced by the present financial turmoil and cyclical slowdown.

Looking forward, growth in Developing East Asia in 2008 is expected to come down from 2007’s exceptional pace of over 10 percent by a hefty 1.5 percentage points. Nevertheless, that decline still would leave regional output expanding by a healthy 8.5 percent or so (table 1). Growth in China is expected to come down by 2 full percentage points to 9.4 percent. A further slowing in export growth will likely be a leading element in the impending East Asian slowdown. One of the striking features of the past six months has been how modestly East Asian exports have decelerated, as weaker exports to the US by have been offset by increasing exports to Europe, other East Asian economies, and––a notable development––surging exports to other developing regions, especially those benefiting from high oil prices. It is nevertheless likely that exports will turn lower more distinctly in coming months, as US imports themselves begin to fall (rather than merely growing more slowly or stagnating), and as the US downturn and financial market turmoil begin to affect more decisively other regions that are East Asian export markets.

The US financial market turmoil has already led to increased volatility in East Asian equities markets and to rising offshore bond financing costs. However, given that lending by domestic banks–– the main source of financing in the region––has been little affected so far, the impact of these developments on domestic activity may be limited. Rising oil, metals, and food prices will also impose a loss of income on East Asia of perhaps close to 1 percent of GDP. (Of course, the region contains a number of net commodity-exporting economies that will enjoy gains in national income due to higher commodity prices.) Rising food prices are exacerbating headline inflation and hurting the incomes of the poor. These developments could stall or even set back the progress made in reducing poverty over the last decade while heightening political tensions.