MAS Fears Asia Will Hurt If US Engine Seizes

Source : The Business Times, February 20, 2008

A sharp and deep recession in the United States will hit Asian economies, warned Heng Swee Kiat, managing director, Monetary Authority of Singapore (MAS), yesterday.

And in his first public comment on the global financial turmoil, Mr Heng said the credit crisis has now started to have an impact on the real economy.

Wading into the debate on whether Asia has de-coupled from the US, Mr Heng said the region has significant links with the world's biggest economy through trade, investment and finance. Only if these linkages are significantly weakened can Asia be said to have de-coupled from the US, he said yesterday at a fund management conference.

Still, the short-term outlook for Asia remains generally positive barring any sharp deterioration in the global economy, he noted. The current forecast is for Asia ex-Japan to grow at a fairly healthy pace of around 7.8 per cent in 2008, one percentage point lower compared to last year.

Structural changes have taken place in Asian economies over the last 10 years, he pointed out. 'Certainly, the fundamentals of the economies and financial markets in Asia have improved significantly since the Asian financial crisis,' he said.

Most Asian economies have large foreign reserves and current account surpluses. There is a sizable educated and skilful labour force, and a growing middle class that forms a broad consumer base, he said.

Asian corporates and households are doing well after four years of robust growth. Asian capital markets are better developed. Asian banks are better capitalised, have less bad loans, and are better supervised and managed.

'These are significant changes. However, a long-term or structural de-coupling of Asia from the US is possible only when the economic linkages through trade, investment and finance are significantly weaker,' said Mr Heng.

Studies by MAS, and other economists, show that this is not the case at this stage, he pointed out.

What we are likely to see, however, is the weaker synchronisation of business cycles, he said.

'The underlying momentum in the Asian economies will allow Asia to ride out the slowdown in the US if it is mild and short-lived. But a sharp and deep contraction will trigger the threshold where all economies will be affected, albeit in different degrees depending on their reliance on external demand,' said Mr Heng.

On the global financial turmoil, Mr Heng said the credit crisis has now started to have an impact on the real economy.

Policy makers are facing the challenge of how to contain the spread of the credit crisis to the real economy, he noted.

'What is striking is that the securitisation of loans was meant to be a mechanism for risk transfer. Instead, it became a channel through which shocks are amplified and transmitted throughout the system in unpredictable ways. These shocks have now started to have an impact on the real economy,' he said.

In the US, the housing-sector correction is leading the slowdown in the economy. Consumer spending is constrained by high debt levels. Financial institutions have sustained large losses. And this is driving the turn of the credit cycle, which means restraint on both consumer spending and corporate investments.

Indeed, at this point there is a risk of being caught in a negative spiral involving tighter credit standards, reduced credit availability and slowing down of the macro economy.

'The extent to which this spiral takes hold determines the extent of the US slowdown, and the extent to which the rest of the world will be affected,' said Mr Heng.

'Hence, the immediate challenge for policy makers is to contain the spread of the credit crisis to the real economy, to prevent this spiral.'

The full extent of the exposures is not yet known and central banks face different degrees of slowdown and inflationary pressures in their economies, he explained.

According to Mr Heng, a multi-pronged approach coordinated across jurisdictions, where necessary, was needed to tackle these challenges. 'The situation is fluid, and we need to remain vigilant.'