Published January 30, 2009

Asia can expect rebound in 2010

Deleveraging, deflation and depreciation are likely to be key themes for the first half of this year


THE world economy is in bad shape. 2008 was the year of financial crisis. 2009 will be a year of global recession. And 2010 is likely to be a year of recovery in the East and stagnation in the West. But for now, 2010 seems like a long way off.

No one should underestimate the immediate downside risks. As recent data has shown, the recession has not only deepened in the West, but the slowdown has filtered to all corners of the globe.

Even ahead of the financial crisis last autumn, the US was already two years into its downturn and was in recession. The advanced economies were slowing and this had already started to filter across the emerging world, with equity markets hit hard and exports slowing.

Autumn's financial crisis moved us into a different space, leading to a loss of trust within the financial sector, a collapse in confidence across the globe, and deterioration in expectations about economic and financial prospects. The impact in recent months was particularly evident in trade flows, as a double whammy of US recession and a tightening of credit conditions led to a drying up of trade finance.

Indeed, in recent months, we have seen the heat taken out of commodity markets and global trade slow.

So many offsetting factors are now playing out. Inventories, for instance, which were built up in anticipation of strong demand and high commodity prices are now being run-down as demand and prices fall. Deleveraging in the financial sector and balance sheet adjustment across the private sector look set to weigh on advanced economies for some time.

A key feature of this recession will be how the adjustment of global imbalances works out. In recent years, an imbalanced world economy has seen savings flow 'uphill' from surplus economies, across the Middle East and Asia, to the consumer spending deficit economies - with large trade deficits - in the West. In recent months, there has been some criticism that the surplus countries were thus in some way partially responsible for this crisis.

This is not a view we share. The flow of savings in recent years did not trigger the crisis, yet a shift in savings is part of the solution. There is no doubt that we need to move to a more balanced global economy, and this adjustment eventually requires deficit economies in the West to spend less and save more, surplus countries in Asia and elsewhere to move more of their savings into spending, along with some currency adjustments. Yet in this global downturn, it is premature to expect a balanced economy; instead, there is a need across all regions for increased spending.

If not, then the large trade deficits in the West are more likely to correct via weaker demand rather than stronger exports.

It is important to differentiate between the financial crisis and the economic problems that we now face. The impact of the financial crisis will linger for some time, particularly as the banking sector normally goes into a downturn in much better shape than it is in now.

The fragile position of the global banking sector leaves it vulnerable as growth slows and as write-offs and bad loans increase. The outcome of a financial crisis depends on economic fundamentals, the policy response and on confidence. Whilst the fundamentals in the West are poor and confidence has collapsed, a big positive feature of this crisis is the scale and speed of the policy response.

Lessons from Japan

The US and the UK, in particular, appear to have learnt from Japan's experience and have forced through aggressive monetary and fiscal measures in a short space of time. These policy measures will not be enough to prevent recession but they will ease the pain.

Yet the scale of economic problems is likely to feed concerns about the financial sector's ability to cope.

Instead, as we move through the year, greater attention will turn to the economic crisis. Here, it is important to differentiate between the advanced and emerging economies. Advanced economies are set to witness their worst performance since World War II, with growth falling this year. The worst hit will be the US and the UK, both of which face similar challenges, as people and firms need to get their balance sheets back into shape by spending less, saving more.

Banks are also deleveraging, selling assets and restricting lending. This points to weak domestic demand, justifying present policy easing.

But the eurozone also faces big challenges, with many economies suffering. Even the German economy is being hit, as its capital exporting industries slow. The strength of the euro is adding to competitiveness problems for Portugal, Italy and Greece, whilst Ireland and Spain are also suffering from the collapse of housing markets. All of this will add to strains within the eurozone, adding to the pressure for even the European Central Bank to cut rates aggressively.

By year-end, it is likely that official interest rates in the US, UK, eurozone and Japan will all be 0.5 per cent or below. In this environment, it is easy to understand why the US dollar may be gaining. The desire for liquidity around the world, particularly in emerging economies, has led to a flight of quality into the US dollar, despite the US's problems.

Unlike previous cycles, the rebound after this recession will not be strong. The scale of the debt overhang means that, even with the huge policy stimulus, in the advanced economies recovery will be very weak in 2010. It will feel more like a period of stagnation.

What then of emerging economies? The downturn in the West is already impacting them, with trade, confidence and demand slowing. Also, a flight to quality has added to problems for emerging economies which have found it hard to attract investment in recent months. In addition, in recent months, tighter financial conditions have reduced trade finance. Yet it is vital to differentiate across the emerging world.

Vulnerable regions

Regions such as Central and Eastern Europe look vulnerable, as do economies that saw housing booms such as Dubai, or which have large trade deficits. In contrast, those economies with large savings, healthy surpluses or with plenty of room for policy manoeuvre look in good shape. A number of these economies are in Asia.

And the biggest is China. But China, like the rest of Asia, will be hit hard this year, justifying aggressive rate cuts and fiscal boosts across the whole region. China's huge fiscal boost should start to feed through in the second quarter, allowing a strong rebound in the second half of the year.

Whilst India does not have the scope for such a fiscal boost, it has already cut rates sharply, and should also benefit, as will many others, from the recent weakness in energy prices. Asia has the ability to rebound strongly but only provided that action is taken now.

We expect Asia to get worse in 2009, but not worse than after the Asian crisis. Deleveraging, deflation and depreciation are likely to be key themes for the first half of this year.

Emerging economies proved to be the victims and not the culprits of the financial crisis. Equally, the economic outlook may also be different. As it is, emerging economies are likely to rebound sooner and stronger from this recession. But even they cannot avoid a downturn. Yet whereas the West faces recession followed by stagnation, Asia's downturn this year will be followed by a strong rebound in 2010.

The writer is the chief economist and group head of global research, Standard Chartered Bank, United Kingdom