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GERARD LYONS: Asia’s degrees of freedom


Asia may not be decoupled from the West but it has plenty of room for manoeuvre

In recent years the annual Asian Development Bank (ADB) meetings have addressed some of the key issues confronting the region. Three years ago, in Indonesia, in the wake of the Western financial crisis, it identified that for Asia to switch from export-led to domestic-driven growth it needed: better social safety nets to discourage excess savings; help to small and medium sized firms to encourage employment; and deeper and broader bond markets. All were seen as important ingredients to boost consumption and to allow firms to raise finance.

The following year, at the annual meeting in Tashkent, the ADB’s focus was on the need for regional institutions. Then, last year, in Vietnam, attention was on avoiding the middle-income trap, with the release of a major report on Asia’s potential growth. As the World Bank has pointed out, of 106 economies across the globe that achieved middle income status by 1960, only 13 subsequently went on to reach high income levels and five of those were in Asia: Japan, South Korea, Taiwan, Singapore and Hong Kong.

This year, in Manila, attention is on inclusive growth, ensuring that more people share in the region’s success. This focus is necessary. But there are other important areas that also warrant immediate attention.

First, and foremost, is where is Asia’s economy heading? Latest data suggest a slowdown to a steadier pace of growth, as a result of previous policy tightening and as exports slow. Although some European banks are scaling back their lending in Asia, others are stepping in, and the region will cope. But Europe’s problems may reinforce Asia’s focus towards the US and other regions.

China’s economy is cooling, not collapsing. The good news for China, and for many other Asian economies, is that they have ample room for policy manoeuvre if needed.

That leads directly onto the issue of infrastructure. Usually attention is on hard infrastructure such as building roads and dams. The cost of Asia’s infrastructure needs is huge, estimated at $8 trillion over the next decade. Funding this raises many challenges, including building Asia’s institutional savings base so that domestic funds can be more easily directed into financing long-term projects.

But, in my view, infrastructure covers three areas: hard, soft and institutional. All are vital across Asia. Soft infrastructure is about building skills and educational levels, as this too is a key part of delivering potential across the region’s vastly different economies and moving them up the value-curve.

Building the institutional infrastructure is essential. This is particularly important in delivering China’s future growth. Across Asia, it is vital to address the independence, powers and accountability of institutions, both to eradicate corruption as well as to ensure difficult, longer-term issues are addressed. Having the right institutional infrastructure is as vital as having the right growth model in place and in ensuring that a middle-income trap is avoided, as well as helping those countries on even lower incomes to continue to develop. So hard, soft and institutional infrastructure are key.

The continued challenges confronting Western economies means that Asia needs to build domestic-driven growth. Yet, at the same time, with interest rates low in the West, Asia needs to keep on top of potential inflationary pressures.

A year ago, rising food and energy prices were a major concern. Both are still worrying factors. In addition, rising wages provide an environment in which firms can pass on higher costs and prices, creating a potential inflationary spiral.

Low interest rates in the US and Europe will provide another push factor for money to flow from the West to Asia, feeding asset price inflation across Asia, particularly in real estate and equity markets. All of this will add to pressure to further deepen Asia’s financial markets so that such inflows can be absorbed. And it will reawaken future concerns about currency wars and capital controls.

Overall, when one looks at Asia it is vital to appreciate not only the vast scale of the region but the diverse nature of the economies within it. The small and medium-sized open economies can be subject to volatile fluctuations in their growth rates, largely because of international trade. In contrast the larger economies tend to see more stable growth.

“Not decoupled but better insulated”. That is how I defined Asia ahead of the financial crisis. And so it proved. Asia was hit hard by the collapse in world trade but was able to rebound, helped by its policy response. Now, Asia is still not decoupled from the crisis in Europe and events in the West, but it is much better diversified. That diversification reflects both rising intra-regional trade and rising shares of domestic demand.

Dr Gerard Lyons is Chief Economist and Group Head of Global Research at Standard Chartered.