Speech at Asian Financial Forum by David Lipton, First Deputy Managing Director, International Monetary Fund
It is my great pleasure to be here. I’d like to thank the Hong Kong government for inviting me to this important event and to all of you for taking the time to join us.
In this challenging time for the global economy, I can think of no better place than Asia for my first visit of 2012. Why do I say that?
Asia’s economies today are strong and showing great promise, in part because of the reforms introduced courageously, and not without painful consequences, when Asia faced its own crisis in the nineties.
But now it is problems in the rest of the world, Europe in particular, that pose a risk to Asian prosperity. Now, Asia has a stake in seeing Europe solve its problems and even in playing a role in that process.
Beyond that, Asia has its own challenges, both in the near and longer term.
By working together, more and better than in the past, Asia and the IMF can help ensure stability and prosperity for the region and for the world.
Today I would like to expand on these key messages by expanding on three key themes. I will start with the state of the European economy, trace its implications for Asia, and end with a few thoughts on the importance of revitalizing IMF-Asia relations.
Global Outlook and Policies
Only a few months ago, the IMF warned the global economy was entering a “dangerous new phase.” Sadly, that phase is no longer new, but it remains more dangerous than ever.
At the global level, the pace of economic activity is weakening. Although recent indicators in the United States have surprised on the upside and growth there is likely to continue, global economic activity has generally worsened in the last quarter of 2011, and the near-term outlook has deteriorated noticeably relative to our September projections. And, worse, the downside risks that we identified then have started to materialize during the last part of 2011.
The main reason is the escalating euro area crisis. Specifically, concerns about fiscal sustainability and banking sector losses have widened sovereign spreads to unprecedented levels for many euro area countries. Bank funding has all but dried up in the euro area, leading banks to delever by selling assets and restrict lending. Now deleveraging threatens to push growth below even the reduced forecast we will publish next week. The euro area crisis is spilling over and interacting with fragilities elsewhere, bringing risks to many others around the globe.
So, yes the European outlook is grim and the risks for Europe and the world are high. But rather than allow ourselves to be paralyzed by pessimism, it is time to focus on the more hopeful perspective of working our way through this crisis. If there is good news, it is that we know what policies are needed, and we are busy trying to muster the finance to support those policies. Provided political will can be found, there is a good chance to resolve Europe's problems, ward off the downside risks, and build a foundation for future growth.
What is that way forward?
The essential elements are the four "mores". More liquidity to manage the crisis—both for banks and sovereigns (including more resources for European backstops); more fiscal consolidation, with a prudent but credible pace that does not unduly hurt short-term growth; more growth to sustain adjustment and sever damaging feedback loops (which will require additional policy accommodation and putting more capital into banks to reduce the scale of deleveraging); and more integration—both fiscal and financial– to ensure the viability and stability of monetary union.
In recent months, Euro zone leaders have started to outline and indeed implement some of what is needed: they are acting to contain fiscal deficits and have agreed on a mechanism for future fiscal discipline. They established a trans-national safety net. They have taken a harmonized approach to recapitalizing banks, and a systemic risk board is now in operation. And recently the European Central Bank has unleashed impressive firepower to make long-term liquidity available to banks. The challenge for Europe in 2012 is to move ahead on all of those fronts, implementing, cooperating, but also making mid-course corrections as needed to strengthen each of those steps and ensure there is the firepower to do the job. The IMF is working with Europe, supporting its efforts to restore market confidence, rekindle growth and ensure the integrity of the common currency.
The stakes are high. Without bold action, Europe could be swept into a downward spiral of collapsing confidence, stagnant growth, and fewer jobs.
And in today’s interconnected global economy, no country and no region would be immune from that catastrophe.
Challenges for Asia
That is especially true for Asia.
Asia emerged from the 2008 financial crisis with its global standing strengthened, and is headed toward becoming the largest economic region in the world over the next two decades. On current trends, by 2030 Asia’s economy will be larger than that of the G-7 and will be half the size of the G-20. The center of the global economy is truly shifting from the West to the East.
That said, despite rapidly growing intraregional trade, and some economic rebalancing in the aftermath of the global financial crisis, Asia continues to rely too much on final demand from US and the Euro area. That is a vulnerability.
And Asia is vulnerable to financial channels of contagion. Deleveraging by European banks could have a significant impact on credit supply and asset prices in several Asian economies, as European banks have substantial claims on these economies. Trade finance could be particularly affected, as European banks are particularly important providers in Asia, and could be difficult to replace.
Given these acute downside risks, what can policymakers in Asia do to mitigate the impact on their economies?
On the macro policy front, staying on course with fiscal normalization would increase the ability to respond to the shocks, and restore the fiscal space lost after the 2008 crisis. At the same time, a pause in monetary tightening now looks appropriate, wherever inflation forecasts are within central banks’ targets.
But policymakers also need to make sure that banks remain liquid and have secure funding, and try and reduce external vulnerabilities by lengthening debt maturities, securing credit lines, and further expanding currency swap arrangements, either bilaterally or through the Chiang-Mai Initiative. Some may also wish to consider IMF support, including from our new Precautionary and Liquidity Line —I will return to this later.
Should downside risks materialize in force, policymakers in Asia would need to respond swiftly, as they did in 2008/2009. The response would have to include reversing fiscal consolidation, for those with sufficient space to do so, and aggressively easing monetary policy. This might require cutting policy rates but also adopting a range of non-traditional measures, including the introduction of targeted credit easing measures, for example on commercial paper, corporate bonds, and SME credit. Introducing guarantees for bank liabilities and supporting trade financing could also be considered. To do so, Asian economies could use their ample foreign exchange reserves and, if and where necessary, regional reserve pooling arrangements.
From a longer-term standpoint, Asian policymakers also face the challenge of continuing structural reforms needed to ensure sustainable and strong medium-term growth, and reforms that make their economies less vulnerable to external shocks. These measures would also help alleviate widening income inequality in the region and support a sustained rebalancing of growth away from investment and exports towards private consumption.
IMF’s new Asia partnership
As Asia goes forward, the IMF stands ready to be a partner.
I realize that the potential for collaboration is clouded by memories of the Asian financial crisis of 1997–98. But now almost 15 years later, we all need to decide what lessons to draw. From the vantage point of 2012, one can see that the reforms taken during and after that difficult and traumatic period gave Asia the resilience to withstand the 2008 global financial crisis and are helping today.
In particular, the aggressive restructuring of bank NPLs, corporate debt and currency mismatches, helped Asia enter the global financial crisis from a position of strength. And more nimble macroeconomic policy frameworks gave Asian economies the room for a strong countercyclical response when the global financial crisis hit the region. But even more important, despite suffering from crisis spillovers, Asian economies have remained committed to free trade and closer financial and economic cooperation. It is thus not a coincidence, nor a surprise, that Asia has led the global recovery over the last three years.
We at the IMF also learned important lessons from Asia’s experience that we are now applying to programs across the globe, including in Europe. In particular, the Fund recognizes that while tough measures are needed to address deep economic problems, the conditions accompanying its programs need to be more focused on the problems at hand. And we are far more conscious of the importance of broad social support for the policies proposed and undertaken, and of the importance of protecting the most vulnerable parts of society, hence we place a greater focus on ensuring effective social safety nets in crisis cases.
Looking forward, two areas where our work can support this region’s interests are enhancing economic and financial surveillance for crisis prevention, and strengthening the global financial safety net:
Economic and financial surveillance. The global crisis has underlined the importance of looking at economic policies and conditions both in individual countries and globally, and at spillovers between countries. The global financial crisis also stressed the importance of macro-prudential oversight of the financial system.
The IMF’s analysis can play a useful role in this regard, including through a constructive collaboration with the ASEAN+3 Macroeconomic Research Office (AMRO.)
For example, we are focusing more on the spillovers into Asia from policies that are occurring elsewhere and, likewise, examining the global implications of policy decisions taken here in Asia. Our spillover reports on China, Japan, the U.S., the U.K., and the Euro Area are at the frontier of this type of integrated analysis.
At the same time, the Fund is stepping up its efforts to assess the health of Asian financial sectors, in close collaboration with the authorities. In the past two years, the IMF conducted its first-ever Financial Sector Assessment Program (FSAP) reviews of China and Indonesia, jointly with the World Bank. FSAP updates have been completed for Bangladesh, Cambodia, and the Philippines, and assessments are either underway or will soon be launched in India, Japan, Malaysia, and Australia.
Global financial safety net: As the crisis demonstrated clearly, capital flows can reverse very quickly in times of panic—even from countries with sound macroeconomic and financial conditions, such as many Asian economies. Developing an effective global financial safety net is therefore an essential element of a more stable global economy and can greatly help Asia withstand the risks of new external shocks.
To do so, and also building on the experience of the Asian crisis, the IMF initiated a reform of its lending toolkit after 2009 and introduced more tailored crisis prevention tools, including most recently the Precautionary and Liquidity Line (PLL), designed to meet the liquidity needs of “crisis by-standers”: member countries with sound economic fundamentals and policies but which have actual or potential balance of payment needs mainly because of crisis elsewhere in the world.
In this regard, in the coming weeks, we will be making the case for a step up in the Fund’s lending capacity. In doing so, let me stress that the goal is to be able to augment the resources Europe will be putting into tackling its problems, but also to be able to meet the needs of “innocent bystanders” around the world. In a globalized world, the need for firewalls is global.
Finally, we are also working to better integrate IMF resources with regional reserve pooling arrangements like the Chiang Mai Initiative and enhance our cooperation.
Needless to say, a stronger partnership between Asia and the IMF will also require a stronger role for Asia in the Fund. Given its rise as an economic powerhouse, it is only natural that Asia’s voice in our institution should become increasingly influential. This trend is already under way. In 2010, the IMF passed an important package of quota and voice reforms, through which emerging Asia’s representation in the Fund will increase by 27 percent. Thanks to the reform there will be three Asian economies (China, Japan and India) among the 10 largest shareholders in the Fund, with Japan and China being the 2nd and 3rd largest members respectively.
Asia’s links with the IMF are being strengthened also through the selection of key IMF personnel from the region. With the recent appointments of Naoyuki Shinohara, from Japan, and Min Zhu, from China, as Deputy Managing Directors of the Fund, Asian nationals are now 40 percent of the IMF’s management team. In addition, Singapore’s Deputy Prime Minister and Minister for Finance, Tharman Shanmugaratnam, became Chairman of the International Monetary and Financial Committee in 2011.
Last, but not least, the IMF/ World Bank 2012 Annual Meetings will be held in Tokyo, recognizing the critical role of Asia as a bulwark of stability in the world economy, as well as the IMF’s growing and constructive partnership with the region. I encourage all of you to join us there in October.
Let me conclude by stressing that these are highly uncertain times for the global economy, which is threatened by intensifying strains in the Euro Area and fragilities elsewhere. With decisive measures in Europe and global support, it is possible to avoid a new phase in the crisis that would have spillovers to countries all across the world, including in Asia.
The IMF stands ready to work with Asia to help make sure that the risks for the region are minimized, and that the challenges the region faces in the long run are successfully met. While all eyes are on Europe right now, the Fund is continuing in its efforts to make Asia one of its key centers of engagement, and looking forward to Asia taking a bigger role at the IMF.
Achieving both objectives will help achieve sustained economic growth, in Asia and the world.