When the US subprime crisis first broke in spring 2007 there were expectations that the impact on Asia would be milder as the continent “decoupled” on the back of a sound banking system with low exposure to “toxic” assets, growing intra-region exchanges, healthy corporate balance sheets and overall strong external balances. These expectations, however, overlooked that growth in the dynamic Asian economies relied increasingly and excessively on over-consumption in the advanced economies, and notably in the US. With the US and Europe gripped by the most severe post-war recession, Asia is facing a very severe downturn. Beyond the short-term buffering of the downturn via policy accommodation, the real challenge for Asian policy makers today is to build a new growth model to secure sustainable growth for future generations. In our opinion, Asia has good foundations to build on, but now needs the right policies to secure results.

TIGERS OF MANUFACTURING EXPORTS

Asia has a long track record when it comes to manufacturing exports starting with Japan’s phenomenal success of the 1960s and 1970s, with Hong Kong, Singapore, Korea, and Taiwan taking on a leading position in the 1980s and the manufacturing export model spreading throughout Southeast Asia. In the 1990s, China joined the model and while India is most renowned for its service sector, its importance to the region’s manufacturing hub should not be overlooked. As the different stages of production value added migrated throughout Asia, production processes have become vertically integrated, fuelled not only by relative labor costs and specialization, but further aided by modern production, communication and transport technologies. The final link in this impressive model is policy regimes that secure a favorable operating environment for producers of manufacturing exports. The Achilles heel of this model resides in the fact that with around 70% of fi nal goods produced sold outside the region; it is thus highly dependent on the stance of consumers in the advanced economies.

IN SEARCH OF NEW CONSUMERS

Over the past three decades, the US consumer has willingly taken on more debt to consume. Between the late-1970s and the late-1990s, US households debt levels increased by around 1pp per annum. From 2000 until 2006, debt as a percent of GDP skyrocketed by just under 4.5pp per annum on average, bringing household debt to close to 100% of GDP today. The crisis put an abrupt end to this model, and US households now need to embark on what is likely to prove a multi-year deleveraging process. In Europe, consumers were on average less aggressive in taking on debt than in the US, nonetheless, a clean-up of household balance sheets is due here too. Moreover, with populations ageing quickly and pension system under pressure, more savings will be required to protect standards of living in old age. Of course, both the US and Europe will remain important markets for Asian exports over the coming years, but they will no longer serve as engines for the impressive growth rates that Asia enjoyed in the pre-crisis period. For such rates to be maintained, Asia needs to look elsewhere.

LOOK TO POLICYMAKERS

In the short-term, relief will come from policy accommodation. Central banks across the region have eased monetary policy and governments have implemented important stimulus plans. China tops the list, promising an impressive USD 586bn in stimulus. When it comes to policy stimulus, however, such measures can only offer temporary relief and will need to be financed in the future. For domestic demand to prove a sustainable engine of growth, it must be driven by the private sector. This will not come automatically, and nor will it come quickly. Indeed, the fine-tuned export engine that Asia has spent the past four decades building now needs to be rebuilt with emphasis on domestic demand. Such change can only come with structural reform, and several areas are in need of attention:

• social infrastructure
To meet future costs of education, health care, unemployment and pensions, Asian households hold high levels of precautionary savings. Developing social infrastructure would allow such risks to be mutualised and lower precautionary savings. Public spending on education also enhances the supply of qualified labor further promoting economic development.

• Financial infrastructure
Many young Asians, moreover, save for big ticket items with access to consumer finance in many Asian countries still sparse. Furthermore, the removal of interest rate controls and other factors favouring large manufacturing industries would prove supportive in providing capital to companies in other industries, and notably SMEs. A more efficient financial infrastructure would also secure better remuneration of capital.

• transfer of corporate profits
While household saving ratios are high, Asia’s “savings glut” is driven primarily by corporates. Policies that encourage payment of dividends and/or redistribution of profi ts via the tax systems would allow households to take greater benefits from corporate profitability.

• Domestic goods and services markets
Red tape governing domestic goods and service markets needs to be cut to foster competitive and efficient domestic markets.

• climate change
Finally, there is the challenge of securing that economic development does not come at a severe cost to the environment. In this context we note that a significant share of the current fiscal policy stimulus is directed at climate, and notably in building transportation networks (i.e. rail).

The good news is that Asia today holds a solid position from which to embark on an ambitious program of reform. This rebalancing of the Asian growth model towards domestic demand will not come overnight and Asia is likely to see slower growth over the coming years as the adjustment process is put in place. Asian growth rates will remain, however, the envy of the advanced economies and we expect Asia’s share of global GDP to continue to expand from 25% today (ex-Japan). Moreover, the transition process will create significant opportunity for Asian corporations at the micro level. For investors, Asia should thus be kept on the radar screens.