East Asia and Pacific Update, April 2009

First of all. let me welcome all of you to this online chat on the implications of the global financial crisis on East Asia. I look forward to interacting with you for the next hour and a half.

Resti raises an important question about incipient signs of protectionism -- important because if there is one thing we learnt from the 1930s Great Depression, it is that raising trade narriers compunds recessionary forces and prolongs the recovery process.

You probably know that at the G20 meetings in November last year and more recently in April this year, the leaders called to avoid protectionist measures. Unfortunately, 17 of the 20 countries present have implemented 47 measures (at last count) that in effect restrict trade at the expense of other countries (and I include among these, measures such a subsidies and other support packages).

There aren't too many signs of prtectionism in East Asia -- but there are some. For example, Indonesia now requires 5 categories of goods (garments, footwear, toys, electonics, food, and beverages) to pass through five ports or airports. China has also introduced a few import restrictions through tightening phytosanitary standards in food improts) and provided additional support to its car industry. And Malaysia has banned the hiring of foreign workers to preserve jobs for its own citizens.

But these East Asian actions are relatively few and minor compared to actions being taken in the advanced economies and in other developing regions. These include, for example, enormous subsidies for car manufacturing worldwide ($45 billion at last count, of which $43 billion is in the advanced economies).

Most important, however, is the point that the current contraction in global trade has little to do with protectionist measures -- and everything to do with global recessionary forces. Nevertheless, if such protectionist measures become more prevalent and widespread they will add to these cotractionary forces and prolong the recovery process.

I hope that answers your question, Resti.

Our projections are for economic growth in developing East Asia to slow to 5.3 percent in 2009 from 8 percent in 2008 because of the contraction in external demand and, in most countries, weak domestic spending. With China's economy bottoming out, and the likelihood that global demand will begin to firm in 2010, economic expansion in the region is likely to strengthen in 2010. There are substantial downside risks, especially to prospects for developed countries. Continued problems in commercial banks in developed countries, or renewed financial tensions, could delay global recovery further or, in fact, result in another year of contraction of global output.

Indonesia's slowdown came somewhat later compared with other countries in the region, and growth in 2008 slowed by a very small margin compared with 2007. The contraction in global demand, nonetheless, will cause growth to slow to perhaps 3.4 percent in 2009 from 6.1 percent in 2008.

Indeed, the Philippines has not been spared the global downturn and growth in 2008 slowed substantially after a period of robust expansion. With electronics accounting for 60 percent of exports, and global demand for electronics substantially depressed, Philippines' shipments have fallen sharply. Job losses have been large, notably in the export-oriented manufacturing sector. As of the end of March, there were the government reported 45,000 job losses from overseas workers, with further job losses likely in the near term. Inflows of remittances have weakened, and prospects are for these to actually decline in 2009. All in all, growth is projected to slow to 1.9 percent in 2009 from 4.6 percent in 2008 and 7.2 percent in 2008.

Frank asks a question that is often asked -- namely the respective roles of the World Bank and the the International Monetary Fund. These happen to be well defined and have been the subject of scrutiny by periodic international panels of eminent persons. Broadly, and without getting into too many details, the Fund is essentially concerned with helping countries maintain macroeconomic stability -- or regain macroeconomic stability -- and is the lender of last resort in the event of a macroeconomic crisis. In contrast, the Bank is a development institution that focuses on financing investments that assist a country in its long term development efforts.

But its only natural that the roles of the two institutions occasionally overlap. For example, for the Fund, problems of macroeconomic stability in a particular country may stem from underlying structural and institutional issues -- and getting the macro right often means improvements in policies that address microeconomic imediments or institutional weaknesses (areas that the World Bank is concerned about). And for the Bank, the success of development programs often need macroeconomic stability and a stable policy environments (issues that the IMF is concerned about).

For these reasons, the two institutions need to work closely together with one another -- as well as with other stakeholders in the development process in their client countries.

Harsh, thank you for your interesting question -- but one frankly that will take a long time to answer. So rather than answering the question directly, let me suggest that you take a look at the recent G20 communique and the accompanying documents. You can find it at the New York Times website: http://www.nytimes.com/2008/11/16/washington/summit-text.html

The communique gives a useful summary of the problems that led up to the crisis and the avenues that the largest and most important countries of the world are collectively pursuing to resolve them.

If after reading this, there is any further questions that you have, then please feel free to raise them with me.

David, China's bottoming out is a positive sign for the region. But this bottoming out results from the fiscal and monetary stimulus and has little to do as yet with exports. Indeed, in the first quarter, the contribution from net exports was actually negative, according to the just released national accounts data. A recovery in China's exports will clearly depend on global recovery, and prospects for such recovery are still uncertain. We are concerned about rising protectionism, although implementation of protectionist and trade-distorting measures in the region has been quite subdued so far.

The first priority for the countries in the region is to combat the slowdown, protect their financial systems and, most importantly, alleviate the impact of the crisis on the poor and vulnerable. But a recovery in global demand will come. Countries will benefit from that to the extent they have improved competitiveness, are in a position to extract more growth from the domestic economy, and whose companies are able to diversify exports across regions and products.

Howard, I don't believe the problems that arose in Thailand at the East Asia Summit of the ASEAN+6 leaders will necessarily slow the process of mutual help and support that ASEAN and its 6 regional partners have embarked upon. Indeed, I was present at the preceding ASEAN Finance Ministers Meeting held in Pattaya (prior to the Heads of State meeting) and the sense of common purpose and mutual support was palpable. Having said that, a key element in the program that has been laid out by ASEAN and its regional partners is the mulitlateralization of the Chiang Mai Initiative that will allow countries to obtain liquidity support in the event of another bout of uncertainty or capital flight. The details of this program are not known and these meetings in Pattaya were to have been an occasion where the process could have been advanced, These issues will now have to be discussed at some future opportunity and this could perhaps delay the process

Dollarization is large only in Cambodia, Lao and Timor-Leste.

Barbara: First of all congratulations. I had to look hard to find the number that you are alluding to! I eventually found it on page 67 (Appendix Table 4) in then last row and last column. It takes a diligent reader to go through the report in such detail and then ask a good question!! I should note a few key things about Vanuatu:

• Since 2005, GDP growth has hovered between 6 percent and 7.2 percent. The growth rate in 2008 was 6.3 percent. The strategy of the Goverment prioritizes private sector development, macroeconomic stability, good governance, and public sector management and reform.
• Growth in 2008 was driven by strong growth in tourism and construction.
• Inflation has been moderate -- around 5 percent -- despite high fod and fuel prices last year. Reserves have been high, and the fiscal accounts have been broadly balanced or in surplus (they recorded a surplus of 2.3 percent of GDP in 2008, thanks to better-than-expected VAT revenues).

The effects of the global financial crisis have yet to be felt in Vanuatu, but we can expect:

• a slowdown in construction activity (which is already happening), because capital flows from Australia and New Zealand are expected to ease.
• tourism and foreign direct investment inflows are also expected to decline.

But, at the same time, the government is in a relatively good position to respond to the slowdown with appropriate macroeconomic measures because:

• donor inflows are likely to remain strong;
• a more relaxed monetary stance can be supplemented by a more expansionary fiscal policy; and
• the authorities have the fiscal space and adequate international reserves to take these appropriate macroeconomic measures

For these reasons, we believe that a 3 percent projected growth for Vanuatu in 2009 is not unreasonable -- indeed, some may think this conservative.

Governments are acting to cushion the impact of the crisis on the poor. The policy response, however, is complicated by the lack of adequate social safety nets in many countries. Countries with safety nets, including China, have been able to provide assistance, but others are facing substantial challenges.

In the Philippines, the government is expanding social spending under the stimulus package and front-loading some of it in early 2009. Coverage under the government's conditional cash transfer program has been increased to 360,000 from 20,000 in 2007, and further efforts are under way to improve targeting and scope. In addition, the government has enacted a program to help returning overseas workers.

All in all, most social programs in the region are underdeveloped. Governments are likely to act with renewed urgency in the medium term and develop a more comprehensive approach to social protection, including by expanding the set of interventions to ameliorate the impact of adverse shocks.

The World Bank has worked with governments in developing countries to support policies that improve the countries' defences against adverse shocks. The World Bank is also very active in helping countries deal with such shocks once they occur. The Bank has increased financial assistance; called for the development of a Vulnerability Fund to which developed countries could dedicate 0.7 percent of their planned fiscal stimulus, and the Bank is adapting its financial instruments to the specific needs of its clients. In addition, the World Bank is providing countries with access to diagnostic and capacity-building instruments to help improve policies and identify priority areas for government spending. The IFC, a part of the World Bank group, has expanded its support for trade finance through the Global Trade Finance Program and the $50 billion Global Trade Liquidity Pool, in addition to its support to developing countries through an infrastructure crisis facility, a bank recapitalization fund and a microfinance liquidity facility.

Amarkhuu, it is important to look at currencies' nominal effective exchange rates, i.e., their rates against the basket of currencies of their trading partners. Measured in effective terms, the renminbi (RMB) appreciated 12 percent in 2008, compared with an appreciation of 6 percent against the dollar. Under the 11th five-year plan, the authorities are committed to further appreciation of the currency.

Gregore: Thanks for your question -- which a number of people are asking these days.

Let me make some preliminary points before I answer your question.

First, it is important to recognize that East Asia's open trade policies have served the region well -- supporting rapid growth in trade and GDP over three decades and allowing capital to flow to countries where it could be used most efficiently . As the 2009 World Development Report has also noted, East Asia's rapid growth in trade has been, in considerable measure, within the region -- and the bulk of it has been intra-industry trade which has taken advantage of economies of scale, including agglomeration economies.

Second, all those calling for a review of East Asia's export-oriented development strategy are not advocating protectionism or a retreat to autarky. What they are asking is whether domestic market sources of growth can potentially replace export growth.

This is defintely possible -- but mainly for countries with relatively large domestic markets (China, Indonesia, Philippines, Thailand, and Malaysia). At the same time, it must be recognized that domestic markets give only limited possibilities compared to global markets.

So what could East Asia do differently that would give it greater resilience in the face of a crisis similar to the current one? In fact, there a number of things it could do. First and foremost, East Asian countries could diversify their export markets. The reliance on the US and European markets has proved to be a problem in this crisis. Second, some countries should reconsider any subsidies that export industries may receive -- but those aimed at the domestic market do not. These may include preferred access to capital and land, cheaper prices of inputs (including energy inputs), and quicker administrative approvals for licences and so on. Third, an improved environment for the private sector, and lower entry and exit barriers, will help industries develop that cater for the domestic market. In particular, government should encourage small and medium enterprises (SMEs) that cater mainly to domestic markets. Fourth, improved financial makets and banking systems that give broad access to finance will help provide for more balanced development, And finally, more flexible exchange rate regimes will ensure that adequate incentives are provided for non-tradeables sectors, just as much as for tradeables industries (exportables and import substitutes).

Dear Daisy, thank you for a very important question. I think there are two sets of issues: issues related to the current global recession, and then issues of more medium-term nature. Recall that before the current recession, PNG was enjoying the strongest period of growth since independence, with growth of 6.5 percent in 2007 and 7 percent in 2008. But as global demand weakened, PNG's exports - 95 percent of them copper, gold and petroleum - were negatively affected. Global demand will pick up and demand for these raw materials will recover. Developments in China are a bright spot, as the bottoming out in China and the likelihood that its demand for raw materials will rise could help PNG's exports recover as well. Another positive spot will appear when the $17 billion Liquified Natural Gas Project receives a go ahead in late 2009.

Over the medium term, the government needs to continue with the restrained fiscal policy of recent years and allow an adjustment in the exchange rate in order to limit a decline in reserves and maintain external sustainability. Management of the windfall revenues saved during the commodity boom also needs to be improved. Among the key structural challenges that remain, the key ones include ensuring the integrity of the public financial management, adequate expenditure mix for sectoral service provision, strict control over the size and performance of the civil service, and transparency and accountability in budget management.

To stimulate private sector investment and job creation, particularly outside the mining sector, the critical priorities are maintaining law and order, establishing a level playing field and improving the business climate, especially through opening more markets to competition, commercializing parastatals, reducing the regulatory and licensing burden, clarifying property rights (especially for land. Developing infrastructure – electricity, telecommunications, road and other transport – through private sector involvement and greater efficiency of public investment is also a crucial precondition for accelerated private sector-led growth.

Such divergence of views is observed both in and outside China, but recent developments are likely to shift views in favor of a bottoming out. The fiscal and monetary stimulus appears to be working, with sharply increased credit growth, purchasing managers index (PMI) at a level signalling expansion for the first time since the middle of 2008, car sales at record high, real estate transactions picking up strongly, and fixed investment accelerating robustly. The fiscal stimulus, in our view, is helping the economy bottom out while, at the same time, advancing the rebalancing of growth the authorities are committed to. With economic activity bottoming out, the authorities will also feel emboldened to press ahead with rebalancing by enabling the further development of the service sector, by encouraging private consumption, especially in the rural areas.

Ansan, you are right that according to our analysis, Cambodia is likely to be hit hardest by the crisis in East Asia. And the reasons for this are threefold. First, Cambodia was an economy that was already "overheating" just prior to the crisis -- thanks to large capital inflows which could not be sterilized by the central banks. As a result, credit growth was rapid, leading to rising real estate prices and generally higher inflation. So even in the absence of a crisis, it is clear that Cambodia growth and macroeconomic policies were not sustainable and slowdown was inevitable. Second, the crisis hit Cambodia hard because its main export industry, garments, relied heavily on the US market (80 percent of Cambodia's garment exports went to the US), which was at the epicenter of the global financial crisis. Tens of thousands of workers in garment factories -- many of them women -- have been thrown out of work. In addition tourism has been hit hard -- some suggest that advance bookings for hotels and trips to Siem Reap have decline by more than 40 percent.

Thus, Cambodia has the uneviable task of adjusting not only to the external crisis, but also has to cool its own internal macroeconomic "overheating" -- and both these adjustments means that its economy could possibly contract in 2009. Of course, we hope we are wrong -- because any recession in an economy has serious repercussions, but the implications are all the more serious in a low income country such as Cambodia.

Unfortunately, being a low income country, Cambodia has very few resources to combat the crisis. I hope that the international donor community, including IDA (the interest-free loan window of the World Bank), provide additional resources to Cambodia so that it can increase public expenditures on programs to protect the poor from the worst effects of the crisis. In addition, the authorities in the country need to make sure thay reorient their public expenditure program away from low-priority programs and toward social safety net programs targeted at the poorest groups in the population.

The bottoming out in China offers a glimmer of hope for commodity exporters in the region. Indications of strategic stocking in China have also helped support the price of copper over the last couple of months. While these developments should help recovery in Mongolia, the authorities' pursuit of the policies to which they have committed under the IMF-supported standby arrangement and World Bank-supported program will be important for setting the stage for sustainable growth over the medium term.

See figures released today from China's National Bureau of Statistics. While growth in real GDP slowed to 6.1 percent year-on-year in the first quarter of 2009, there are strong signs both in today's numbers and recent developments that the economy is bottoming out. Notably, industrial production expanded at a much faster pace in March than in January and February; car sales are at a record; real estate transactions have risen sharply; credit growth has accelerated; and the purchasing managers index is indicating an expansion.

As our report indicates, governments in the region are battling the forces of global recession. The authorities have eased monetary policy (including by cutting policy rates and injecting liquidity as needed) and are implementing fiscal stimulus packages. In fact, the size of the region's stimulus package at 3.6 percent of GDP (including government-influenced investment at about 9 percent of GDP) is one of the largest in the world, and is contributing to offset the sharp contraction in global demand. Thanks to policies pursued since the 1997-98 Asian financial crisis, banking supervision has been strengthened substantially and banks were in very good health before the financial crisis accelerated in late 2008. The solid buffers erected after the previous crisis and the proactive policeis ensured that East Asia emerged relatively unscathed from the financial crisis, with only two small banks failing.