Asia: What crisis?

Tuesday, July 22

The continuing global economic slowdown puts Asian countries in a position reminiscent of the run-up to the 1997-98 crisis.  As then, the region faces political uncertainty and slowing growth in major export markets:

• A democratically elected government took power in Thailand in February 2008 after over a year of military rule. However, the government has faced widespread street protests reminiscent of the run up to the 2006 coup.
• The party that has ruled Malaysia since independence suffered an unprecedented defeat in the March 2008 parliamentary election, raising the possibility of a difficult political transition in the year ahead.
• Governments throughout the region fix fuel prices using a combination of subsidies and price controls. Persistently high oil prices require adjustment of price caps. This has potential to generate widespread unrest, especially when combined with rising food prices.
• High oil prices and the declining housing market continue to act as a brake on US demand.
• Euro appreciation against the dollar and tighter credit conditions due to financial institutions' exposure to the US real estate market cloud the outlook for European economies.

However, there are a number of major differences between the situation now and in the 1990s. The Asia five in 1997 suffered from external imbalances that rendered them vulnerable when foreign creditors' sentiment shifted in response to negative political or economic news. These countries' external positions are now almost uniformly strong due to their current account surpluses and ample foreign reserves.

Regional dynamics

More fundamentally, China's economic expansion has drastically changed the region's economic dynamics.  In the late 1990s, export competition between China and the Asia five resembled a zero-sum game. More recently, expansion of Chinese exports has boosted demand for exports from other economies in the region.  The rise in intra-Asian trade has reduced the region's vulnerability to downturns in Europe, the United States, and Japan.

Persistent risks

While the countries most affected by the 1997 crisis have done much to improve regulation and supervision of banks and non-bank financial institutions, financial sector weakness persists in the region.  The fragility of China's financial system -- which Chinese government has been slow to clean up -- poses a risk to growth in China and the region as a whole. 

Nevertheless, the likelihood of a full-blown crisis remain small.  China's 1.8 trillion dollars in foreign reserves mean the government would have resources to deal with anything short of a massive banking crisis. Dislocations would reduce regional economic growth, but sound fundamentals mean that other Asian economies would not fall into crisis.