Regional Risk Management in East Asia and the Impact of the global Financial Crisis

"Regional Risk Management in East Asia and the Impact of the global Financial Crisis"
Keynote Address by
Haruhiko Kuroda
President
Asian Development Bank
At the 11th Convention of the East Asian Economic Association

15 November 2008
Manila Diamond Hotel, Philippines

I. Introduction

Ladies and gentlemen,

It is a great honor for me to address this distinguished audience at the 11th Convention of the East Asian Economic Association. Several months ago, when Professors Kohsaka and Abe approached me to discuss ADB's participation, there was no doubt in my mind about the relevance of your discussions to advance economic theory and policy debate. I am glad to see that you have just completed a very intense day of debates and discussions and that another challenging day is waiting for your tomorrow.

First, let me congratulate the East Asian Economic Association and the Philippine Economic Society for the excellent organization of the meetings and for their wisdom in choosing "regional risk management" as the theme of the convention. Given the still unraveling global financial crisis, I really cannot think of a better title.

A period of profound change is before us. Emerging markets have become a vital force in the world economy. And, despite all the projections of economic slowdown-which include Asia-our region nonetheless will likely remain a crucial engine of global growth. Both external and internal shocks threaten our region and the world. In my remarks this evening, I will discuss how regional cooperation can help weather the current crisis and why we should all join together to enhance the benefits of collective action.

First, however, let us look at the impact the ongoing financial and economic crisis is having on Asia.

II. Impact of the current crisis on Asia

When the US housing bubble burst beginning in mid 2006, it was difficult to imagine that it would have eventually turned into a financial and economic crisis of global magnitude. Many governments and central banks around the world have already introduced measures to stabilize markets and start rebuilding public confidence.

Nevertheless, the damage to global credit remains severe. And the crisis in equity and currency markets has spread to the real economy, pointing to a wider economic downturn. Recent data on unemployment, manufacturing orders, and trade flows, all point to the increasing likelihood of a global recession.

Asian banks are now experiencing acute scarcity of foreign currency, especially US dollars. Moreover, their access to international inter-bank markets remains limited. As most use swap markets, the cost of borrowing dollars has sharply increased. And the shortage of foreign currency has important implications for exporters who need liquid dollar supply for trade finance.

Trade links between Asia and major industrial economies remain substantial. Our internal estimates suggest that approximately two-thirds of the final demand for Asian goods originates from non-Asian countries, especially the US and Europe. That's why we think the impact on Asia's exports of the economic slowdown in the US and Europe will be significant.

But we have all learned much from the 1997/98 Asian financial crisis. The region today is much more resilient to shocks than it was a decade ago. With a few exceptions, the economic fundamentals across the region are sound.

First, governments have adopted sound macro policies. They now have fairly good external positions, and Asia's $4 trillion in foreign exchange reserves can help ward off the worst of the crisis fallout. Exchange rates are also more flexible and capital flows can now be handled more effectively than in the past. Moreover, as a consequence of continued policies of fiscal prudence, in many of the region's economies there is now enough room for some fiscal stimulus packages.

Second, reforms have improved the region's financial systems. Asian banks have drastically reduced nonperforming loans; their balance sheets are stronger due to better supervisory oversight; and their risk management practices have improved considerably. In general, Asian financial institutions have also relatively small direct exposure to US subprime mortgages and structured credit products. Third, a wide range of indicators suggest that the Asian corporate sector is quite healthy, as industrial firms have strengthened their balance sheets.

Therefore, it appears unlikely that a full-fledged financial crisis will hit the region this time around. But we need to remain alert. Continued financial instability or any further deterioration in global credit conditions could in fact weigh the system down and hurt broader economic activity.

In particular, tighter credit conditions could worsen Asia's investment climate. Because Asia continues to require substantial investment to finance development needs, the risk of a credit crunch poses a considerable threat to the region's long-term growth potential. This in turn will impact its ability to reduce poverty and increase development opportunities.

At times like this, forecasting growth rates is extremely difficult. With tightening credit conditions and the deteriorating world growth outlook, not only external demand but also domestic demand will slow. Developing Asia's 9% average growth rate in 2007 was the highest in many years. We expect aggregate GDP growth this year to be lower by around 1.5% than last year's record. And given the deteriorating global economic situation, a further 0.5 to 1% slowdown cannot be avoided in 2009.

III. Policy responses

To address the downturn, Asian economic authorities should provide appropriate and timely policy responses.

Some Asian economies are more vulnerable than others. Weaknesses are found in those with inefficient financial systems, fragile external positions and growing fiscal deficits, and in those which have experienced rapid credit growth and high inflation rates.

The slow down in GDP growth will inevitably result in a rise in corporate defaults and nonperforming loans. Developing robust credit risk management systems becomes ever more important to limit spillovers from the global liquidity crunch. This is especially true for those banks with relatively large exposures to housing and other vulnerable sectors.

To limit the impact of the global recession, national policies need to be carefully crafted to provide safety nets for the poor and those who are hardest hit. Financial systems should be strengthened to ensure continuous funding of priority needs.

As the prices of oil and other commodities cool and global demand weakens, inflationary pressures across much of the region are receding. This leaves authorities more tools for monetary policy intervention, which may be needed especially where financial conditions are tightening due to the liquidity squeeze. In a few economies, however, inflation rates remain in double digits. In these cases, the scope for monetary easing remains limited, as high food prices will continue to add a significant burden on the poor.

With regard to regional policy responses, authorities should strengthen existing mechanisms for regional economic and financial surveillance. They could also pool together a portion of the region's foreign exchange reserves for emergency use.

Some Asian countries have called for the establishment of a new crisis management fund. However, a consensus is now emerging to strengthen existing mechanisms under ASEAN+3, in close coordination with regional and multilateral financial institutions.

At the ADB Annual Meeting last May in Madrid, and again in Beijing three weeks ago on the occasion of the ASEM summit, ASEAN+3 countries have already agreed to pull together 80 billion USD of foreign exchange reserves by multilateralizing the Chiang Mai Initiative. This is an important move through which existing bilateral swap agreements are to be gathered into a single fund.

These resources are not to be used to buy toxic assets, but rather to offer monetary injections to economies under urgent liquidity needs. Improved macroeconomic and financial monitoring, using early warning systems and other analytical tools, is also essential to quickly identify sources of financial vulnerability and appropriate policy solutions.

At the end of the month, ASEAN+3 finance deputies will meet in Hakone, Japan, to discuss these issues. Then in mid-December, Thailand will host in Chiang Mai the annual meetings of ASEAN, ASEAN+3, and the East Asia Summit. We are looking forward to the successful outcome of these discussions and the prompt policy actions that are likely to follow, particularly on the CMI multilateralization and its possible expansion.

Based on ADB's recent flagship study on Emerging Asian Regionalism, Asian countries should also consider creating an "Asian Financial Stability Dialogue". This new institution would not only include finance ministries and central banks, but also Asian market regulators and supervisors. An Asian Financial Stability Dialogue would be instrumental in applying regional surveillance and promoting dialogue to develop and coordinate a regional plan of action in response to the immediate challenges the financial crisis poses. In the longer term, it could be an important forum to support financial market development and help establish regional standards for governance and transparency. These measures, along with effective engagement with the private sector, could significantly improve investors' confidence.

Ultimately, of course, a global crisis requires a global solution. Aside from the immediate short-term actions for financial stabilization, we need a longer-term plan for reforming the regulatory and institutional framework of financial systems around the world. There have been lively discussions in recent global forums, and-as we speak-G20 leaders and finance ministers are meeting outside Washington.

Asian economies have an ever-increasing role to play in forging the global agenda. While growth will inevitably slow, developing Asia will remain the most dynamic center of the global economy, and will be crucial to its recovery. The G7 are increasingly looking to Asia as an economic anchor for the world during this difficult time. Asian leaders should actively contribute to the definition of the new global financial architecture, as it starts to take shape. Asian experience and wisdom has a lot to offer our global partners. Indeed, we, Asians, are now eminently poised to become important and vibrant partners to the global community.

IV. A role for ADB

ADB will also play its role as part of this process-helping to sustain the region's economic development. We are watching ongoing developments at global, regional, and national levels very closely. In addition to specific financial and technical assistance we can offer in response to the immediate needs of our developing member countries, our greatest cause for concern rests with the poor. Today in Asia there are some 600 million people living on less than one dollar a day. We should not forget that as a result of the 1997/98 financial crisis, millions were thrown into poverty almost overnight. We must do whatever we can to ensure that this does not happen again. In order to do so, we must substantially increase ADB's capital at the earliest time. In the long term, we need to bridge the widening gap between rich and poor, as inequality has also been increasing in our region.

ADB's recently adopted Strategy 2020 focuses on three main areas to assist developing Asian economies reach middle income status. These areas are inclusive growth, environmentally sustainable development, and closer regional cooperation and integration.

Let me briefly discuss this last, but not least, priority - regional cooperation. Asian economies are becoming more integrated through trade, direct investments, financial flows, and other forms of economic and social exchange. At the same time, Asia is strengthening its integration with the global economy, as "open regionalism" is a major characteristic of the Asian model. Our flagship study suggests that Asian regionalism is not only good for individual Asian economies: it is also good for Asia as a whole, and increasingly for the world.

Regional cooperation is not a goal to be pursued for its own sake, but a means for achieving fundamental objectives for national and global development. As Asian leaders implement pragmatic regional initiatives and develop a long-term vision for a single Asian market, enhanced regionalism will increasingly contribute to global prosperity as well.

V. Conclusion

Ladies and gentlemen, we live indeed in challenging times. The world's financial architecture is changing before our eyes. It will take time to settle into a new operating environment.

In the meantime, I am confident that Asian countries are strong and resilient enough to sustain the global economy in these difficult times. Our region will continue to grow and we at ADB we will do everything we can to sustain Asian economic development.

I hope you enjoy the rest of the evening. Best wishes for the continuation of the convention tomorrow.

Thank you.