Director, Regional Office for Asia and the Pacific
International Monetary Fund

The Economist Conference: First Tokyo International Automotive Roundtable: addressing the global slowdown preparing for recovery
Tokyo, July 18, 2001

Mr. Chairman, I would like to talk about the outlook for Asian economies, deviating somewhat from the main theme of this session. My presentation on this broader topic will, I hope, provide some useful background to your deliberation of more specific issues surrounding the automobile industry.

I would also like to note, at the outset, that economic forecasting is always a difficult business, but is particularly so when forecasting involves a possible economic turnaround as at the present. It is more difficult, technically, to forecast a turnaround than simply to stretch trend lines. Also, it is difficult to convince people that things will change. For example, in the present context, people tend to think the prevailing weak economic situation will continue into the future, rather than believe the situation will turn around for the better. Given this general attitude, it takes a bit of courage for me to say that the global economic slowdown will soon come to an end and economic recovery will begin. Many of you may react suspiciously to such a forecast and I may not receive much respect. Nevertheless, that is exactly what I am going to do.

What I believe, and what I would like to argue this afternoon, is that the present economic slowdown will be short-lived. It will come to an end toward the latter part of this year, and thereafter growth will gradually accelerate to potential over the medium term. The fears of global recession or of another financial market crisis, expressed by some people, are therefore unfounded. Admittedly, the economic situation remains weak at present, and almost all incoming data point to further weakening, instead of a turnaround. So the situation is likely to worsen further before it starts improving, but it will improve.

In what follows, I will first review the recent developments—that is the continued weakening of the global and regional economies—and then discuss the likely developments in the remainder of this year and the next—that is the expected economic turnaround and a return to faster growth. I will also discuss risks to this scenario and policy requirements to cope with the risks. Finally, I would like to make a few brief remarks about the growth prospects for Asian economies over the medium term.

Recent developments

So, let me start with a brief review of key developments since the middle of last year. During this one-year period, equity prices, especially of IT shares, declined in both the U.S. and the rest of the world. The global electronics markets hit a cyclical downturn, with increasingly large inventories, a sharp drop in new orders, and similarly sharp drop in semi-conductor prices. More generally, demand growth slowed in almost all countries. The U.S. slowdown was much more pronounced than had been anticipated, and contrary to earlier hopes, Japan's recovery faltered, while Europe's growth did not pick up (Figures 1-4).

The slowdown has certainly been notable in the United States, where growth declined from over 5 percent in the first half of 2000 to an annualized rate only slightly above 1 percent in the second half of last year. Growth remained at that low level in the first quarter of this year and according to some private forecasters, may have declined further in the second quarter. Underlying this slowdown were sizable inventory contractions and a weakening of business investment, reflecting falling corporate earnings and weakening business sentiment. Private consumption has so far remained relatively strong, but many forecasters fear consumption growth too may slow, reflecting the negative wealth effect of weak asset prices.

Japan's growth, which has not been very impressive in recent years, turned negative in the first quarter of this year, and is likely to have remained so in the second. Among other things, this fall is attributable to declining external demand, and continuing weaknesses of investor and consumer sentiment. Prime Minister Koizumi has succeeded in improving the government's standing in the opinion polls—from 8 percent to over 80 percent—but this improvement has not yet been translated into a strengthening of private confidence.

Contrary to some people's hopes, Europe is not an exception to the present global economic slowdown. In recent months, Europe has seen falling domestic orders and, despite the weak euro, slowing export growth. This weakening growth in Europe has been accompanied by rising inflation. In part this seems to have reflected supply factors—higher oil and food prices—but it nevertheless complicates overall economic management.

Asian economies have been affected significantly by the adverse external developments, through two main channels. First, through equity markets. The strong presence of IT shares in many Asian stock markets made them vulnerable to the worldwide boom and subsequent bust in IT share prices. The consequent and almost simultaneous weakening in Asian equity prices has undermined investor confidence and thus investment growth. Second, and perhaps more importantly, through exports. The growth of Asian exports declined sharply reflecting the global slowdown, especially of the U.S., and the associated decline in the global sales and prices of IT and electronics products. The latter decline, which is to some extent cyclical, has had a significant impact as these products account for a large share of exports and output in many Asian countries.

As can be expected, the impact of external factors has been stronger in those economies that are more open and more closely integrated into the global economy, and more specifically, in those that rely on IT and electronics exports to U.S. markets. In many Asian economies―Korea, Taiwan POC, Hong Kong SAR, Malaysia, the Philippines and Singapore―electronics account for one-third to two-thirds of total exports, and 10-20 percent of GDP. Accordingly, growth in these economies declined sharply in the first quarter of this year—to an annual rate of 2 to 4 percent—and are likely to have remained low in the second quarter. In contrast, China's growth has continued to be strong—at about 8 percent in the first quarter. So has been India's growth—at an estimated rate of about 6 percent, about the same as in the last few years.

It is worth noting that the availability of external funds does not seem to have been a factor responsible for the economic slowdown in most Asian economies. The recent slowdown in capital inflows appears to be a result—rather than a cause—of the economic slowdown.

Beyond the external factors that I just mentioned, there were some country-specific factors that have been responsible for the recent economic slowdown. These include, most importantly, uncertainties arising from political transitions, or potential transitions. This factor was significant earlier in the year in countries such as the Philippines, and is still crucial in some others, including Indonesia.

Outlook for the remainder of 2001 and 2002

As mentioned earlier, the global slowdown is, of course, something the world has been aware of and concerned about for some time. The IMF, for example, reflected the slowdown in its World Economic Outlook published last April. In that publication, the estimated global growth for 2001 was revised down to about 3 percent from about 4 percent that had been forecast in October last year. The estimated growth for the U.S. was halved from 3 percent to 1.5 percent, and that for Japan, from 1.8 percent to 0.6 percent. The growth of Asia outside Japan in 2001 was estimated to average about 6 percent, almost one percentage point lower than had been envisaged last October (Figure 5).

Despite these downward revisions, the World Economic Outlook in April forecast a rebound in the latter part of this year and a return to faster growth in 2002. As I mentioned repeatedly, I believe that the projected rebound will take place. Nevertheless, the sharper-than-expected economic weakening in the first half will require, in my view, a further downward revision in estimated growth rates for this year and perhaps for next year also. The IMF staff is currently working on these possible revisions, which will be included in its next World Economic Outlook paper, which will be made available to the public next September.

The projected rebound is based on two important premises. The first is a U.S. recovery, which, if it takes place, will induce a wave of rebounds elsewhere—a linkage that I am sure everybody would agree with in the present context. The U.S. recovery, in turn, is based on an assumption that policy adjustments undertaken so far to support demand growth will start showing their impact in the second half of the year. As is widely known, the U.S. authorities cut the Federal Fund rate aggressively—six times within the first six months of this year by a total of 275 basis points to 3.75 percent—and introduced income tax reduction measures effective from this July. The second premise, which is somewhat related to the assumed U.S. recovery I just mentioned, is that the present downswing in the IT cycle would be over by the second half of the year—downward adjustments of inventories and production capacities would be completed by that time, and the industry will resume expanding with a far-reaching positive impact on other sectors.

I should also touch on policy efforts undertaken outside the U.S.—in Europe, Japan, and other Asian countries. Monetary easing and other measures adopted in these countries to support demand growth have so far tended to be moderate. This may be attributed either to the limited scope available for policy adjustments, as in Japan, or to the concern that the policy easing may adversely affect price and exchange rate stability in many other countries. Although moderate financial policy easing, together with the ongoing efforts toward structural reform, especially in Asian countries, would help improve the investment climate and more generally the economic situation.

A key question that can be asked at this juncture is whether, in light of still weakening economic conditions, these premises still hold, and the economies will rebound as expected. There are plenty risks and uncertainties associated with the premises.

Most important, questions may be asked regarding the effectiveness of the supportive financial policies in the U.S. Some people point out that monetary easing has traditionally been most effective in stimulating demand for automobiles and private residences, the two sectors that are doing relatively well in the present slowdown. Whether the lowered interest rates can stimulate demand in other sectors is yet to be tested, including in highly leveraged corporate sectors. Some others argue that, given increased household debt, the recently introduced tax cuts are most likely to be saved, rather than spent on consumption. Perhaps for these and other reasons, monetary easing, and income tax cuts, have had no visible impact so far, but it is fair to say, I believe, they will in time provide a strong impetus for an economic rebound.

Another important question is related to the cyclical recovery in the global demand for electronics, which as I mentioned earlier would have far reaching effects on Asian economies. There are no signs yet of a bottoming out of the cyclical downswing, although adjustments of inventories and production lines have been quick and extensive. Some people believe that these extensive adjustments will enable a recovery in the not too distant future. I share this view, although there are plenty of uncertainties surrounding it.

Medium-term outlook

Let me now move to Asia's medium-term growth outlook. I must admit that I am a bit hesitant to do this, because the IMF is rather short-sighted and our forecasts usually cover only up to 18 months. But I believe that a discussion of the regional economic outlook would not be complete without going into the medium term. So let me make a few personal observations.

First, Asia's growth leaders have changed over the years—from Japan and the NIE's, to the NIE's and ASEAN countries, and now perhaps to China and India. Like their predecessors, accelerated growth in China and India has resulted from, among other factors, policy reform to stimulate private economic activity, including FDI, and more generally, to open up their economies and integrate them more closely into the global system. The reform, and the resultant rise in investment, have enabled the late starters, like China and India, to utilize the abundance of low wage workers, an advantage all late starters have, at least initially. Large inflows of FDI, and underlying relative exchange rate movements over the longer term, have also helped. So have the country specific factors, such as China's prospective entry to the World Trading Organization and India's emergence as one of the world's software centers. Consequently, I believe medium-term growth in both China and India will remain at the same high rates as in the last several years, if not higher.

Second, Japan is at the other extreme. Its economy in recent years has been characterized by, among other things, the loss of competitiveness as an investment destination, large FDI outflows, stagnant domestic investment, and weak growth. At the same time, it has been going through a market-induced process of downsizing and down-pricing, which will eventually help restore its competitiveness but is deflationary in the meantime. The Government of Prime Minister Koizumi seems to have public support for pushing ahead with reforms of highly regulated areas as well as the financial and corporate sectors. This will have positive long-term effects, but will also have a deflationary impact in the short run. So, Japan's growth, even after the rebound that I mentioned earlier, will likely remain low. The government has recently indicated that growth will be below 2 percent in the next few years and thereafter will rise to only 2-3 percent—and these projections appear to be accepted by an increasingly wide group of people.

Third, medium-term growth in most other Asian countries is likely to fall between these two extremes. This would imply that most economies would still enjoy high rates of growth—averaging perhaps 5-7 percent over the medium term. It may also imply, for a number of countries, a growth rate somewhat lower than that achieved before the Asian crisis. One important factor accounting for the lower growth will be the short-term negative impact of financial and corporate restructuring that these countries will continue to have to go through—a legacy of the crisis.

Conclusion

I would now like to conclude by pointing out two major policy challenges that I believe need to be addressed in order to achieve rapid growth in Asia.

The first is to ensure that the economic turnaround will take place as expected. Additional supportive policies must be considered, if the economies continue to weaken over the summer and the expected rebound later this year is delayed. Such additional policies would have to come primarily from outside the region, in particular, through further lowering of interest rates in both the U.S. and Europe. Within the region, the Bank of Japan could fully utilize its new policy framework and provide sufficient liquidity to prevent the economy from falling into a vicious cycle of deflation. For Japan and many other Asian countries, it is also essential to continue forcefully with financial and corporate restructuring, to restore and maintain investor confidence and to ensure the expected economic turnaround in the short run. The restructuring, and the resultant strengthening of the financial and corporate sectors, is also essential for sustained rapid growth over the medium term.

Second, it is important to maintain policies to facilitate free flows of goods and capital, and more generally to integrate the region's economies into the global system. As I mentioned earlier, the region has benefited from a process in which a group of countries adopted, in succession, these policies and emerged as the region's growth leaders. This process facilitated a sharp rise in interregional trade and improved region-wide allocation and use of resources. Clearly this process needs to be continued, including by resisting temptations to introduce protectionist measures.

I believe that the region will find ways to meet these challenges, and I remain cautiously optimistic about the region's future.

Thank you.