China can't replace US as growth driver: trade ministry

Business Times - 12 Aug 2009

(SINGAPORE) It is unlikely that China's domestic demand can replace the US' private consumption as a driver of global or regional economic growth any time soon, Singapore's Ministry of Trade and Industry (MTI) says.

'US private consumption could be the linchpin for sustainable global recovery, if it is not weighed down by job insecurity, falling personal income and tight credit conditions,' MTI's Second Permanent Secretary Ravi Menon said at yesterday's quarterly economic survey press briefing.

'There will be some spillover from China's own recovery, which has been going on handsomely and above expectations. But, much of that recovery has been domestically driven. And, the impact on the rest of Asia is more limited than you would see from an increase in US private consumption expenditure,' Mr Menon added.

Some economists have in recent months put forth the opposing view, which is that China's demand shall increasingly be an engine of growth for the region.

For instance, DBS economist David Carbon has on several occasions voiced his view that it is China's domestic demand which will be the key driver of Asia's recovery.

'China is the driving force behind the collapse in Asian exports, not the US, either directly or indirectly,' Mr Carbon wrote in a June 11 report. Consequently, it is China which will be the driving force behind Asia's rebound, the same report had said.

Bernanke should be reappointed to Fed: Krugman

Business Times - 11 Aug 2009

(KUALA LUMPUR) Ben S Bernanke deserves another term as US Federal Reserve chairman based on his success in battling the financial crisis, said Princeton University economist Paul Krugman, a winner of the Nobel Prize.

'He's earned the right to a second term,' Prof Krugman, 56, said yesterday in an interview in Kuala Lumpur. 'He turned the Fed into the financial intermediary of last resort. When the banking system failed to deliver capital where it was needed, he put the Fed into the markets.'

Debate over the fate of Mr Bernanke, 55, is intensifying as he nears the end of his four-year term as chairman on Jan 31. While Prof Krugman and economist Nouriel Roubini have voiced support for the former Princeton economist, others including Anna Schwartz have said that a lack of transparency exacerbated the financial crisis.

'I think Bernanke has done a really good job,' Prof Krugman said. 'He failed to see this coming and he was behind the curve in early phases. But he's been really very good in the sense that it's really very hard to see how anyone could have done more to stem this crisis.'

As his terms draws to a close, Mr Bernanke has written in the Wall Street Journal and appeared on television to defend the unprecedented actions he took during the financial crisis.

'In a financial crisis, if you let the big firms collapse in a disorderly way, it will bring down the whole system,' Mr Bernanke said last month at a meeting in Kansas City, Missouri. 'I was not going to be the Federal Reserve chairman who presided over the second Great Depression.'

Under Mr Bernanke's stewardship, the Fed cut the benchmark lending rate to as low as zero and expanded credit to the economy by US$1.1 trillion over the past year.

Joseph Stiglitz, a Columbia University economics professor and another Nobel Prize-winning economist, said last week that he expects a 'very slow recovery' and that a replacement for Mr Bernanke should be considered.

'There are lots of potholes in the road,' Prof Stiglitz said in an interview. 'There are problems in commercial real estate. We know that there will be more foreclosures in the mortgage market' and 'we know we don't know the state of the banks.'

Prof Roubini and Dr Schwartz squared off in the New York Times last month over Mr Bernanke's fate. Prof Roubini, who predicted the credit crisis, voiced support for the central banker, while Dr Schwartz, co-author with Milton Friedman of a history of US monetary policy, wrote that the chairman should be replaced because of policy missteps and a failure to clearly articulate the bank's goals\. \-- Bloomberg

Impact of China's 'second rise'

Business Times - 11 Aug 2009

There're three possible scenarios for global economy and all will have considerable outcomes for South Asia

By SHAHID JAVED BURKI

THERE is now a consensus among policy analysts all over the world that China is well on its way to becoming a global economic powerhouse. Even if it does not become the world's largest economy in three to four decades - as some believe that it might - it will certainly be the second largest behind the United States.

The fact that the country's economy has begun to recover at a faster pace than was expected in the spring of 2009 is a testimony to its strength. At that time, the global economy was in a deep recession and the Chinese dependence on markets in developed countries was expected to hurt it badly. However, that does not seem to have happened. The World Bank has now forecast China's growth rate at 7.2 per cent in 2009.

This is a long way down from the 11.9 per cent in 2007 but it is still remarkable, given the sluggishness in other parts of the world. China is likely to achieve this impressive rate of growth in spite of a fall in the rate of real export growth from 20 per cent in 2007 to 8 per cent in 2008 and to a forecast of minus 10 per cent in 2009.

According to one assessment: 'China may have accounted for as much as two percentage points of annualised growth in inflation-adjusted world output in the second quarter of 2009.' This was possible since the country is no longer as dependent on exports for growth as was believed before the present crisis hit the globe.

It may lead the emerging economies towards 'decoupling', a concept according to which these economies are no longer linked with the world's rich nations but move in tandem with them.

China's rapid recovery from the setback caused to its economy by the deep recession in the West, in particular the US, its largest trading partner, is owed to two facts - the aggressive response by the state to the decline in the rate of economic growth, and the rapid, but still not fully understood, restructuring of its economy.

In 2008, Beijing moved decisively to prevent a sharp decline in the gross domestic product (GDP) by injecting large sums of public funds into the economy. A stimulus package of four trillion yuan (S$843 billion) was launched largely to further develop physical infrastructure - roads, railways, airports, ports, bridges and tunnels. The money would flow from the federal budget to the state-owned agencies responsible for building and maintaining the infrastructure.

It would be spent quickly by bringing forward the projects that were already included in the current five-year plan or at the planning stages. Beijing's main concern was with rising unemployment. Some 20 million workers - mostly migrants from the countryside - were laid off by the industries in the private sector that depended almost entirely on exports to the West.

Under the Chinese system of human resource management, the unemployed workers were required to return to their villages. The Chinese were fearful that this return would make the countryside restive. Given the country's history, Beijing is always alert to the possibility of 'peasant rebellions'.

One consequence of this large stimulus to the economy would be a significant increase in the share of the public sector in the Chinese economic system. This would reverse the trend of the last two decades when the authorities encouraged the state sector to shrink in size in the expectation that people who lost their jobs in the state-owned enterprises would find employment in the rapidly expanding private sector.

This approach differed markedly from the one adopted by the countries that once made up the Soviet Union and those in Eastern Europe as they switched their ideologies. Communist Europe adopted capitalism by following the 'big bang' approach. The Chinese, ever pragmatic, opted for the gradualist approach.

One consequence of the way the Chinese have handled the current economic downturn was the interruption of the process of transferring workers from the public to the private sectors of the economy by creating space for them in the state sector. Another unintended outcome of this would be the strengthening of the state's role in the economy, which would be used to handle the opportunities created and problems posed by its unique urbanisation experience.

China's urban future will be shaped by the highly dense development all along the country's east coast, from Dalian in the north-east to Guangzhou in the south-east. Within the next few decades, we will probably see 500 million people living in this narrow strip of land with a combined income of US$10 trillion and a per capita income of US$20,000 in today's dollars.

What would turn into a ribbon of the national economy could later become multinational as the strip extends itself north to Korea and south to Vietnam and other countries in South-east Asia. With this development will come a massive structural change in the Chinese economy.

It will not be possible for the country to maintain land-intensive economic activities. Agriculture will become a smaller part of the economy as will the part of the manufacturing sector that needs a great deal of space. In a relatively new sub-discipline of economics - economic geography - focus has begun to be placed on the impact of density and distance on economic structures.

Some of the hypotheses being developed by those who have begun to practise this discipline will be tested in China, one of which is that with high density, distance also begins to matter. This would mean China's increased reliance on the countries that have the physical space to conduct the activities that would be expensive and difficult in China, and that are physically close to it. This should bring South Asia economically closer to China.

Global system

How will this new China affect the global economy and its political system? It is possible to contemplate three possible futures for the global economy and how these might shape the international economic and political systems. All three will have considerable outcomes for South Asia and less obviously for Singapore.

We can argue that the world is moving away from unipolarism when the US was the undisputed leader, and going towards bipolarism. That this may happen has led to some talk about the G7 or G8 being replaced by the G2 - the United States and China. This would mean slowing the move towards the creation of a multilateral system that receives direction from a much broader grouping than the G7 or G8.

In this context, the role played by the G20 was seen to expand. This group includes, in addition to the G8, the 12 largest emerging economies from all parts of the world. It has met twice since November 2008 and was supposed to come up with a new structure for managing the global economy. This would have led to the development of a new form of multilateralism.

This has not occurred and may not happen for the simple reason that the G20 was being built on top of a system that had an unstable foundation. The focus remained on the US and Western Europe. The latter, in particular - and for the reasons that will be later mentioned briefly - is no longer the most vibrant part of the global economy.

There may not, after all, be such a widening of influence and reshaping of the global economy as was believed would be the case only a few months ago. The G2 may emerge as the most important player in the new system. The slow move towards multipolarism may be pre-empted by the continuing strength of the economy of the US and what I have called the 'second rise of China'.

That this may be happening was demonstrated by the inaugural session of the Strategic and Economic Dialogue between Washington and Beijing held in Washington in the closing days of July 2009. Both sides fielded large delegations and the discussions covered a large number of issues of interest to both countries.

In his opening address, US President Barack Obama said that the US-China relationship will 'shape the 21st century'. With that, he launched the G2 without giving it that name. It can also be argued that what we are seeing is the emergence of a multipolar world. Such global configuration will reshape not only the global economy but also the international political system.

Systems with many poles are inherently less stable compared to those dominated by one or two powers, as was the case in the post-World War II period. We could see a global system with as many as seven centres of economic activity - the US, Japan, China, India, Brazil, South Africa and the European Union (EU).

The first six of these will try and create their own spheres of influence, while the EU is still in a formative phase with a considerable dispersal of power among the nation states that belong to it. For as long as it does not find a way of working as one entity able to pull its weight in unison, it will not be able to create much of an impression on other parts of the world.

Europe and Japan are also two parts of the post-industrial world that have as yet to find a way out of the demographic cul-de-sac in which they find themselves today. Declining population and an aversion to compensate it through immigration will inevitably produce less economic dynamism. India may not be able to match China's economic success any time soon.

The remaining six economic centres could, if circumstances permit, create their own spheres with a greater prospect of clashes than is likely in a bipolar world. These clashes will occur in the areas where the different spheres come into contact. The most likely places where this may occur are in Central Asia, South Asia and the Middle East.

Not only will this result in competition for geographic space - which was the reason in the past for clashes between centres of power - there will, in addition, be economic reasons for conflict. In a global system increasingly short of scarce resources vital for sustaining development, there will be immense competition for energy and water and possibly some minerals vital for development.

Three tiers

A third scenario is also possible. If the US and China become the two dominant powers, the global system will have three and not two tiers - the two global powers, four or five regional powers and the rest. In the former case, each major power will seek to circumscribe the other by creating economic and political alliances close to the other power.

This will create some tension of the type that characterised the 'Cold War' period in which the US and the Soviet Union challenged each other. The US then built a chain of alliances around the Soviet Union and China - this was when it regarded China as an extension of the Soviet Union - while Moscow tried to recruit Cuba and a number of small Central American states as partners.

Moscow also encouraged a number of developing countries to remain unaligned. The Non-Aligned Movement in which India played the role of leader had a consequence of limiting the reach of the US. However, America and China may not confront each other the way America and the Soviet Union did during the Cold War.

This is for two reasons, of which the first was that the US and China are economically much more dependent on each other than the Soviet Union and the US ever were. China needs the US' markets and technology, while the US requires Chinese surplus capital.

Furthermore, neither China nor the US has expansionary territorial ambitions. That was not the case with the Soviet Union, which was constantly trying to expand its sphere of influence, if need be by the use of military force.

This was what it did when it invaded Afghanistan in 1979. A G2 system, therefore, may be more stable.

The current thinking in the US emanating from a number of policy institutions on both coasts of the country sees the coming global arrangement from the bipolar perspective, in part because such a system is familiar to the policymakers as well as policy analysts.

This is one reason the administration of president George W Bush paid so much attention to cultivating a new relationship with India. There is a simple idea behind this.

Developing India as a counterweight to China will further the US' interests, particularly in Asia. It is difficult at such a fluid period in the world history to predict with some confidence as to which of these three directions the global system will go. That said, a somewhat higher probability can be attached to the third of these three scenarios. Nonetheless, it would be useful to study all three with greater analytical depth.

The author is a visiting senior research fellow at the Institute of South Asian Studies, an autonomous research institute at the National University of Singapore. He is a former vice-president of the World Bank and former finance minister of Pakistan

IBM sees big opportunity in water management IT

Business Times - 08 Aug 2009

DETROIT - IBM is pushing ahead into providing technology services to manage water, a market US$10 billion market that the company sees growing quickly.

'This to me is an area that's really going to explode in the next three to five years,' said Sharon Nunes, who heads IBM's Big Green Innovations initiative. 'People see it as a gap. The water market is transforming.'

Big Green Innovations, a play on IBM's nickname Big Blue, is part of IBM's so-called 'smarter planet' initiative that aims to apply information technology to efficiently manage electrical grids, transportation systems and other infrastructure.

'We are actually looking at three different markets - industrial sector, for example food and beverage companies ..., local and municipal governments, water utilities,' said Sharon Nunes.

Her group looks at business opportunities in sectors such as water, carbon management, solar technology and desalination.

'We are in discussions with a lot of food and beverage companies and some of the industrial processing companies,' Ms Nunes said, referring to new water management contracts.

IBM is also in talks with 'a lot of utilities,' she added but declined to give details.

Government stimulus in the water sector China and the United States, estimated at around US$10 billion to US$15 billion, will help establish the market for water management, Ms Nunes said.

Governments, investors and human rights activists all see managing fresh water as key challenge in the coming decade.

Billions of people already lack access to clean water and development and climate change are expected to disrupt the supply of fresh water even more.

IBM estimates leaks account for up to 60 per cent of water supplied, costing water utilities worldwide US$14 billion every year.

Managing water resources would include monitoring rivers, water reservoirs and pipes. IBM also provides systems for managing water infrastructure, such as levee oversight and flood control, Ms Nunes said.

The technology company, whose products range from servers and software to consulting services, currently has a commercial deal underway with the Beacon Institute for Rivers and Estuaries in New York to build a monitoring and forecasting network for the Hudson River.

Also, IBM is working with researchers to monitor wave conditions and pollution levels in Galway Bay, Ireland, and is putting together smart water meters in Malta in cooperation with the utilities there.

The company's flood management and control system is getting a lot of attention from flood-prone countries in Asia.

'We are seeing some initial inquiries from a lot of smaller Asian countries,' Ms Nunes said. 'In areas where there is government stimulus packages, there's been a lot of outreach from some of the companies to IBM.' -- REUTERS

THE GLOBAL FINANCIAL CRISIS – IMPLICATIONS FOR ASIA

SPEECH BY DR TONY TAN KENG YAM, DEPUTY CHAIRMAN AND EXECUTIVE DIRECTOR, GOVERNMENT OF SINGAPORE INVESTMENT CORPORATION AT THE ANNUAL DINNER OF THE ECONOMIC SOCIETY OF SINGAPORE HELD ON THURSDAY, 6 AUGUST 2009 AT 8.00PM AT SWISSOTEL SINGAPORE

1. I would first like to thank the organisers for inviting me to speak at this year’s Economic Society of Singapore Dinner which is being held in conjunction with the Singapore Economic Review Conference. Well over 200 papers will be presented at the Conference, attesting to the breadth and richness of the discussions that took place today and will take place over the coming two days.

2. In 2008, the world went through an economic and financial crisis which was the most severe that we have faced in the last fifty years. What I will do in my speech this evening is first to provide an update on the crisis. I will then proceed to talk about the economic and financial outlook going forward and end with some thoughts on the implications and challenges the crisis poses for Asia.

Update on Crisis

3. First : An update on the crisis. There are signs that the global economy is stabilising after the shock late last year. The massive policy support provided by governments and central banks is beginning to work through the world’s economies. Confidence is returning and fears of a meltdown in global financial markets and banks have receded. The reaction to the stress tests of major US banks indicate that the markets believe that these banks, with the support of the US government, will be able to weather the economic storm and earn their way out of future prospective losses. This prognosis is far from certain but the markets have chosen to give the banks the benefit of the doubt. Reflecting this, one closely watched measure of confidence, the Treasury Euro Dollar (TED) spread, has recently declined to pre-Lehman levels. The normalisation in credit flows in turn is supporting the recovery in global industrial production.

4. The global growth recovery is being led by economies that are not leveraged and have room for large policy stimulus like China, Japan, India, and other Asian countries. So despite historic falls in real GDP growth in some countries over late last year and early this year – and therefore dismal growth rates for 2009 – the worst seems to be behind us in Asia. Asian Economies are now expected to see continued improvement through 2010.

5. The US and other major developed economies are also expected to register positive growth later this year. This may be augmented near term by inventory adjustment and pent up demand from extremely depressed spending and output levels. However, sustained OECD growth in 2010 and beyond has less visibility and is likely to be weak given de-leveraging headwinds in the key consumer, financial, and housing sectors that were at the center of this Great Crisis.

Global Economic Outlook

6. So, the good news is that we appear to have avoided a global depression. The global economy seems to be stabilising and is expected to recover, although slowly. Beyond this cyclical recovery, however, my sense is that the global economic and financial environment has changed in three important ways.

7. First, the developed world is likely to experience lower growth in the coming years. De-leveraging, de-risking, re-regulation and, on the margin, even some de-globalization are disrupting markets and dampening economies and could reverse some of the progress due to past liberalization, globalization, and reforms. At the same time, aging populations will increasingly be a drag on growth in the developed economies.

8. The bulk of the globalised banking system consisting of major banks in the US and key parts of Europe are likely to remain capital impaired and subject to greater regulation. In the US, the banking sector is being supported by massive policy intervention and will likely be stable enough to support sub-par growth of 1-2%. However, it may not be strong enough to support credit needed for a sustained robust growth significantly above 2%. This is likely also true for UK and parts of Europe with banking and real estate sector problems.

9. US household consumption is unlikely to be robust as spending is being undermined by weaker income prospects, high unemployment, falling house prices and the need for higher savings rate to maintain long run consumption and repay debt. Household de-leveraging is likely to take a number of years, keeping overall recovery muted. As if these headwinds were not enough, re-regulation, higher taxation, government intervention and the pressing need for medium term fiscal consolidation will also constrain growth in the developed world.

10. In particular, the unprecedentedly large peace-time increase in public debt for many OECD countries from around 50% to over 100% of GDP could eventually put significant upward pressure on real interest rate over the next 3-5 years, potentially crowding out private investment and dampening growth and risk asset valuations.

11. The severe impact of this crisis on employment, household wealth, and public finances also raises difficult political and policy challenges in the West, especially in the US and UK. In the short-term, how governments deal with the continuing crisis will be of the utmost importance. As the troubled US and Japanese recoveries in the 1930s and 1990s demonstrated, policy errors could dramatically change the global economic and financial outlook for the worse.

12. Longer-term, the already difficult trade-offs between populist measures and economic efficiency will become more acute. It will require considerable skill by policy makers to assuage widespread concerns over job security, income inequality, healthcare, retirement, and environmental issues while maintaining a dynamic and open economy.

13. The second major change in the global economic environment is increased risk of both deflation and inflation, reversing a three decade decline in inflation and growth volatility and hence macroeconomic uncertainty. The golden age for asset markets that some have called “the great moderation” looks to have ended.

14. Given the weak economic recovery, excess capacity and high unemployment are expected to keep inflation under control over the next few years. Indeed, deflation remains a significant near term risk given extremely weak labour markets and downward wage pressure. With prolonged stagnation in employment and income growth, a vicious self re-enforcing downward spiral could easily develop.

15. However, once the recovery is in train, risks are ironically tilted towards higher inflation. Reversing unprecedented quantitative easing will be challenging. Given high unemployment and the risk of stalling a nascent recovery, central banks may be tempted to accommodate higher inflation. Governments may also be tempted to deal with higher fiscal deficits and debt accumulated during the crisis via higher inflation.

16. The global supply of commodities and labour could turn less friendly towards low inflation. Continued growth and urbanization in huge emerging economies will put pressure on food and energy prices, natural resources, and the environment. In addition, the slowing pace of global labour supply expansion will increase inflationary headwinds. This is because towards the end of the next decade, the pace of industrialisation will eventually slowdown in China, while the capacity for other large emerging markets, such as India, to replace China’s contribution to global labour supply remains uncertain. At the same time, developed countries will start to see significant declines in their working-age populations.

17. The third major change in the global economic environment is the increasing importance of the emerging economies, anchored by China and India. Emerging economies should continue to grow relatively robustly notwithstanding OECD weakness. Emerging economies are expected to account for more than half of the world’s GDP growth over the next decade. In 2000, for instance, emerging markets accounted for 20% of global growth, but over the coming decade this is expected to rise to about 60%.

18. Emerging economies are likely to displace the G-7 as the world’s largest economies over the next 10-15 years, even if per capita incomes will still lag behind the developed economies. This relative outperformance will be driven by

(i) larger savings and domestic demand potential,
(ii) relatively healthy public and private sector balance
sheets,
(iii) policy flexibility, and
(iv) room for significant productivity catch-up.

The current Great Crisis has markedly accelerated such trends.

19. Medium-term prospects for China and India are positive, even as they face difficult structural challenges going forward. For China, this would include successfully rebalancing its growth drivers, dealing with resource constraints, meeting the aspirations of an increasingly richer population, and reforming a tightly controlled monetary, financial, and exchange rate system.

20. With its fiscal and ideological constraints, India is somewhat behind China in terms of urbanization and economic liberalization but faster progress may be possible with the recently elected government. In addition, at the regional level, some states have been markedly more progressive while the rise of a larger middle class may reduce pressures for more populist politics and increase pressure for economic reforms.

21. Beyond China and India, prospects vary across Asia. Countries that are more dependent on exports and capital inflows, have less healthy balance sheets, and have significant structural impediments such as political uncertainty will fare less well. By contrast, economies with large potential internal markets and which are also more complementary to China and India will benefit. These would include the Greater China and Indochina regions, and Indonesia.

22. But the shift in economic power to the emerging world will also likely increase geopolitical risks. For one, the emerging economies, especially the BRICs will become key global powers and increasingly demand more say on world affairs. An awkward transition is likely to occur: In terms of military power the US is likely to be dominant for decades to come, and will be called upon to carry out most of the heavy lifting in global trouble spots. However, the US would still be heavily dependent on foreign countries including key emerging geopolitical rivals, to finance its large public debt.

23. Conflicts could also arise over natural resources. Severe demand supply imbalances could lead to greater and more intense competition among nations for resources such as energy, arable land, and useful commodities. This could lead to higher commodity prices, or conflict, or both.

24. The future economic environment is thus fraught with higher macroeconomic, policy, and geopolitical risks. Growth is likely to be lower for a number of years given significant de-leveraging. Deflation risks are high in the near term with inflation risks rising in the longer term. The unprecedented peace-time increase in public debt in the developed countries especially the US and the UK will likely lead to significantly higher real interest rates which could dampen long-term growth. Global growth will recover, but will be skewed towards the emerging countries. The continued rise of emerging markets is positive but will bring increased geopolitical and inflationary risks.

Implications for Asia

25. What does this imply for Asia?

26. The first important implication is that, particularly for countries with large populations like China and India, Asia’s economic growth model will be re-oriented from depending largely on exports to a more balanced model that is dependent as much on domestic consumption as on export growth. Such rebalancing would be helpful in two ways. First, as growth in the developed world - hitherto underpinned by the US consumer - is expected to remain weak over the next few years, stronger domestic demand may help mitigate some of that weakness. Second, in so far as some of this rebalancing would be done through increased domestic investment, it could help improve productivity and an economy’s productive capacity. A more balanced growth could also help reduce income inequality by improving wage prospects for labour.

27. A strategy that mainly relies on cheap factors of production – labour and other inputs – is not likely to work as well going forward, especially outside excess labour economies like China, India, Indochina and Indonesia. Instead, the rest of Asia will need to look at its own institutions and markets to drive a more sustainable and higher quality growth via strong productivity improvements. In this economic environment, the winners will be those countries that can evolve to be among the world’s leading innovators and designers, rather than countries whose factory floors are buffeted by the volatility of structural change and intensifying competition from large labour surplus economies. Innovation driven economies require supply side nimbleness and strengths: investment in human capital (ie education, healthcare, and research) hard and soft infrastructure including competitive domestic markets; and an environment that will attract and retain talent, as well as foster creativity and entrepreneurship. Such an environment will not be compatible with low cost, production oriented strategies.

28. Rebalancing growth drivers will not be an easy process. China illustrates, on a large scale, the positive aspects of this adjustment as well as some of the difficulties. At one level, China is now drawing on its vast savings to help mitigate the impact of the decline in external demand. Some aspects of its fiscal stimulus such as public infrastructure investment will encourage and strengthen domestic growth. At the same time, short-term concerns over unemployment mean some measures - export rebates, for example - are slowing down adjustments that need to take place for rebalancing to occur. The Chinese authorities are walking a fine line between restructuring the economy for longer-term sustainability and attempts to mitigate short-term pain. It may be that some slowdown in growth is unavoidable in the short-term.

29. China also needs to, over time, bring about a better balance between consumption and investment in GDP. The decline in consumption as a share of GDP makes China vulnerable to external shocks. At the same time, growth has become reliant on investment and on markets to absorb excess supply. This cannot be sustained over the long term. Developing consumption will require more difficult and substantive medium to long term reforms that increase household wage income as a share of GDP and at the same time reduce corporate and household savings. This could include allowing more competition in service industries, recalibrating performance measurement for local officials to include employment and not just GDP growth, and improvements in social safety nets.

30. Understandably much of the focus has been on the negative aspects of this adjustment but I am optimistic that Asia will come out of this crisis in a stronger position. Asia’s fundamentals are generally sound, policy-makers have lots of flexibility, and the population is hard-working and educated. There will be bumps along the way, perhaps a few crises, but if we learn the right lessons from history, especially those of the recent Great Crisis, we can re-tool and re-orientate ourselves so Asia’s development is more balanced and therefore more sustainable.

31. This brings me to the second important implication for Asia arising from the economic crisis. Asian financial institutions and markets have been given tremendous opportunities over the next decade. The globalised Western banking system, hampered by capital constraints and re-regulation, will likely not be able to intermediate the massive capital demand needed to finance Asian growth. This leaves the playing field unusually open for Asian financial institutions and markets, particularly for the next 3-5 years.

32. Fortunately, Asian banks generally came into this crisis much healthier than their global counterparts given the experience of the Asian Crisis in the 1990s. Capital, liquidity, and nonperforming assets were at healthy levels while exposures to toxic assets were limited. Asian household, business and government sectors are relatively un-leveraged with excess debt. In order to take advantage of this opportunity, however, Asian banks and capital markets will need to develop quickly to step into the breach.

33. In this context, the coming redesign of the global financial regulatory architecture will be a major and difficult exercise with its share of opportunities and risks. First, a lack of coordination in regulatory architecture and practice, together with the rising global unemployment in coming years, may lead to regional trading and financial blocs or at worst, a retreat to protectionism and nationalism. Second, the swing of the political and policy pendulum towards greater regulation may end up with overregulation which stifles financial sector efficiency, productive financial innovation and helpful market discipline. Regulatory and development authorities in the financial sector in Asia need to cooperate as never before with each other and with financial institutions to develop regional capital markets.

34. The third important implication for Asia arising from the global financial crisis relates to the issues policy-makers will face as low global interest rates combined with ample liquidity could give rise to volatile capital flows and asset bubbles across Asia. Across the region, we are already beginning to see significant rises in equity and some real estate prices on the back of domestic reflationary policies and some capital inflows. Low global interest rates combined with easy domestic monetary policies could lead to higher speculative asset prices. Like in the early 1990s, managing large capital inflows and prospective bubbles given managed exchange rates will be a major task for policy-makers.

Risks and Challenges

35. The greatest risk to the outlook for Asia is a global economic and financial environment that does not stabilize and recover by 2010. Downside risks remain high, despite signs of stabilization. If the US economy turns out to be worse than expected, requirements for banks’ capital will be higher and the US administration might need to go back to Congress to ask for additional funding.

36. A second risk is that US consumption fundamentals have deteriorated. Nominal incomes are contracting and the savings rate is rising. Income and spending are being supported now by tax rebates, benefits and transfer payments but it is not clear how sustainable these would be. Hence, weak demand and deflation risk are still significant problems. Sustained deflation could cause private consumption and investment to contract further due to higher real interest rates and real debt burdens. The US could relapse into recession and losses and capital needs escalate again.

37. A third risk is protectionism. In developed countries, chronically higher unemployment and a more receptive political leadership will increase pressures to protect domestic industries from Asian exporters. Policies such as subsidies to protect ailing industries could contravene world trade rules, potentially heightening trade tensions. But protectionism is not just a developed country phenomenon: several developing countries are using import restrictions to mitigate the impact of slowing global demand and weaker current account balances. Clearly there is a danger - probably highest if there is no recovery next year - that protectionism could rise dramatically.

38. A major challenge going forward is the uncertainty raised by the apparent failure of Western or American models which, at the extreme, put financial markets above other sectors of the economy. Will there be a structural change in how savings are mobilized and allocated in the West? Will the state guided models of the East do better? It will take time before we will know the answers to these questions but the balance between private and public sector as the prime economic driver is shifting towards the latter, likely in significant and long-lasting ways.

Conclusion

39. To sum up, Asia has experienced a dramatic slowdown but Asia’s fundamentals are strong. As the global economy stabilises, Asian economic growth will recover. China and India will do relatively better but cannot be the drivers for the world economy in the short-term. But over time, China’s and India’s growth will anchor both the region and a global economy that is likely to see more balanced and sustainable growth. The greatest risk to the region is a failure of policies in the developed world and a return to isolationism or protectionism. More generally, however, there are serious unanswered questions on the role of markets and the state, including the appropriate level of regulation and state intervention. In this environment, Asian banks and capital markets will face both a tremendous challenge and opportunity to intermediate huge regional savings to meet massive capital demand from Asian growth and the integration of major Asian emerging economies into the modern global economy.

RBS economist is a bear in the china shop

Business Times - 07 Aug 2009

By ARTHUR SIM

(SINGAPORE) China bulls should turn the page now. Ben Simpfendorfer, chief China economist at the Royal Bank of Scotland, is 'more bearish than most' on the China story. In fact, he believes it is more 'a story about excess capacity'.

As such, he also believes that there is a chance that the Chinese economy could suffer a 'double-dip' in 2010.

He is not too impressed by the second quarter's 8 per cent GDP growth either, and estimates that about half of that can be attributed to the government's two trillion yuan (S$420 billion) stimulus package, which focused on public infrastructure spending.

China may be the largest manufacturer in the world but its factories 'are suffering a sharp fall' in global demand that is not being substituted by local demand.

'Exports are not a big driver of growth because they rely on a lot of imported components and parts,' Mr Simpfendorfer said. 'What is driving growth is the construction of export factories and the purchase of equipment to manufacture export goods. And this is very weak because factories are running below potential.'

The Chinese government could, of course, introduce a second stimulus plan to maintain growth at the current level. But Mr Simpfendorfer, who has lived in Hong Kong for 10 years and speaks Mandarin, said: 'The chance of a second stimulus plan is not high enough to make a significant change in my forecast.'

And while he believes investment in public infrastructure projects and a recent increase in private residential investment could support growth over the next two years, there will be an 'imbalance'.

He also questions the wisdom of simply targeting a percentage rate of growth, because if growth does slow, 'the temptation is to say, OK, we need more stimulus when the question (the government) should be asking is why growth is slowing'.

He wonders whether China is ready for a structural shift in global demand. 'If foreign consumers do not spend as much as before, China will need to respond - it needs to say some of these factories will never open again,' he said. 'When you talk to SMEs, anecdotally, a lot are really struggling, but this does not get captured by official figures because they are small and private.'

But Mr Simpfendorfer qualifies that while he believes growth in China may slow, 'it won't contract'. 'Maybe it slows to 6 per cent. Relatively it's still pretty good,' he said.

But the days of double digit growth are probably over and the sooner China and rest of of the world realises this, the better, it seems.

China may be the factory of the world, but he reckons that China should move out of manufacturing.

'When I say China should move out of manufacturing, what I am saying is that the east needs to produce less manufactured goods and more service goods.'

He hopes that this will result in better pay, working conditions and ultimately help drive private consumption too.

And it would also be good for the rest of the world. 'China's exports to the Middle East have now replaced the US,' he said. 'But this has led to job losses as a result, which is bad for social stability. If China does re-balance (its economy), some of the manufacturing would leave and go to Syria, for instance.

'If Syria were to capture just one per cent of the increase in China trade with Europe over the past five years, each year could add half a percentage point to its GDP growth.'

However this plays out, Mr Simpfendorfer said: 'I think the whole story about China propping up the global economy is false. The irony is that as the world's largest manufacturer, China produces most of what it needs. What it imports are raw materials to produce manufactured goods, and countries like Malaysia and Indonesia may benefit. For countries like Singapore, Thailand and Korea, the benefits aren't huge.'

Need to reassess market optimism

Business Times - 04 Aug 2009

WHILE the market rallies over the past few weeks have certainly lifted sentiment, it may now be time for a serious reality check. If anything, the main headlines of the previous week added up to just one word: caution.

The growing confidence in the market, and indeed generally, was driven by several factors. For one thing, there was the feeling that the economic decline has bottomed out and that job losses would not be as severe as feared. Second, asset prices are seen to be undervalued and due for a rebound. And corporate earnings so far have also not been as bad as some had expected.

But there was enough evidence last week to suggest that such optimism should be reassessed. New figures released by the Ministry of Manpower showed that 5,500 people were retrenched or had their contracts terminated prematurely in the three months ending June. This is less than half the 12,760 redundancies recorded in the first quarter. That is good news. But it may be less rosy in coming months. Labour chief Lim Swee Say revealed that a number of unionised companies, mostly from the manufacturing sector, have plans to retrench more than 1,500 employees in the coming October-December period, due to falling global demand and high operating costs. This led the ministry to warn of a W-shaped economic recovery, in which the recent improvements are followed by a second dip.

If the economic and jobs situation is less certain than it appears, then the present buoyant mood in the asset markets should be questioned. And this is what Minister for National Development Mah Bow Tan did last Wednesday, when he warned that there are signs of speculation in the property market, and that the government will act if it overheats - despite the insistence of property market players that this is little speculative activity still. The uncertain jobs outlook, however, necessitated the caution - the rebound in asset markets is simply out of step with an economic situation that remains highly fluid. And although corporate earnings have not shocked so far, companies clearly aren't out of the woods yet. Last week, blue-chip Singapore Airlines posted a loss of $307 million for the first quarter ended June 30, its first set of quarterly losses in six years, and warned that it could post its first full-year loss since it was formed in 1972.

On Friday, Great Eastern said it is making a one-time redemption offer to buy back structured investment products, which will negatively impact its Q3 2009 financial results by $250 million. This in turn may lead to a negative impact of $218 million on the earnings of its parent, OCBC Bank, in the third quarter. Singapore corporates clearly still face a painful period of unwinding from the financial crisis. Yet, stockmarket values hit a 12-month high in July. Not surprisingly, a DMG Research technical report yesterday described the overbought condition of the benchmark Straits Times Index as 'a worrying phenomenon'. The amber lights are flashing everywhere, and they should be heeded.