Asia Should Act To Counter US Downturn

Source : The Business Times, October 24, 2007

VOLATILITY has returned to the financial markets, and chances are it will be with us for a while yet. The 50 basis point easing in the Fed Funds rate by the US Federal Reserve late last month did trigger the expected bounce, and for a while it seemed that calm might be restored. However, since then, equity markets everywhere have again been buffeted; here in Singapore, for instance, we have seen a swing of over 150 points in the Straits Times Index (STI) in just the last two days.

Amid the turmoil, there are now more voices warning of a US recession, among them, that of Stephen Roach, Morgan Stanley's influential chairman for Asia. It is now widely accepted that the US housing market has not bottomed out. The inventory of unsold homes is growing, and as higher interest rates on adjustable-rate mortgages start to kick in, there is the prospect of rising foreclosures and forced sales. Worryingly, there is evidence that the rot has spread outside the US mortgage markets, to auto sales and other consumer durables. Employment numbers are also looking weak. If these trends persist - and there is little reason to believe otherwise - US consumption will be badly hit. And given that consumption accounts for more than 70 per cent of America's GDP, it must be said that there is at least an even chance of a US recession in 2008. While the prospect of a global recession is unlikely, the so-called 'de-coupling thesis' - the idea that Asian economies will be relatively insulated from a US downturn - is fanciful.

Already, we have seen shocks transmitted in the financial markets. Real-economy effects will also be transmitted. So far, this transmission has been limited because the slowdown has not spread far beyond the US property sector. But in the likely event that it will, this will change. And while some economies may be better insulated than others, few will be spared. As the IMF's managing director put it during a speech at the annual meetings of the IMF and the World Bank two days ago: 'Those at risk are not just loan originators in the US, but banks in Germany and the UK, borrowers in eastern Europe, and, ultimately, exporters in Asia and Africa.' Asian exporters would, in fact, be among the most vulnerable to a consumer-led US recession. More than 20 per cent of China's exports, for instance, go to the US and most of them are consumer goods. And, while the US share of Asean's exports (13.6 per cent) is lower than China's, a lot of the intermediates that Asean exports to China (and other Asian countries) are ultimately destined for the US market.

While Asian economies are generally well insulated from a crisis, thanks to strong foreign exchange reserves and robust economic fundamentals, their growth is still very much driven by external demand. They will need to act soon to change this dynamic, by taking active steps to boost domestic demand, which would also help reduce global current account imbalances.

Fortunately, most Asian economies have the leeway for fiscal expansion. They should start using it now rather than waiting to be hurt by an almost-certain, and perhaps sharp, US downturn.