In a report released 2nd October, the Asian Development Bank (ADB) cut its growth forecasts for the region in both 2013 and 2014. Slow growth in China and India as well as a reevaluation of the timing of the U.S. Federal Reserve’s reduction in asset purchases contributed to the lower estimates. Compared to April, the ADB revised its forecast for the region to 6.0 percent growth in 2013 from the previous 6.6 percent. Looking into 2014, the regional bank predicted a slight uptick to 6.2 percent, which was down from April’s 6.7 percent figure.
As the Chinese and Indian economies account for a sizable amount of the region’s economic activity, softer economic expansion in those countries brought down the regional forecasts. The ADB expects China to come in at 7.6 percent growth and India at 4.7 percent for this year. However, looking into the report, the ADB seems upbeat on the implications of a slower growth path in China: “Slower growth in the PRC is the price of structural reform for the long term.” China has been recently seeking to shift away from an investment heavy, export-driven economy to one where the domestic sector plays a more significant role. Holding growth to a still comparatively high 7.5 percent target helps China ease unsustainable asset price growth and excessive lending.
On top of weaker expansion in India and China, across emerging Asian markets the potential effects of a tapering in bond purchases by the U.S. Fed seems to have driven some investors away. In May, Chairman Bernanke and the Fed began signaling that a reduction in the pace of asset purchases might occur sooner than many had expected. Asset purchases have been a tool of the Fed’s unconventional policies, working to lower bond yields and boost economic activity.
While Fed officials argue that a reduction in the monthly purchase of Treasury bills and mortgage-backed securities would still amount to an accommodative stance, market participants have seen the announcement as an sign of tighter policy to come. According to the ADB, “prospective tapering of U.S. quantitative easing has destabilized financial markets in developing Asia and other emerging economies, in particular India and Indonesia.”
Following the Fed’s tapering signal, the Indonesian stock market fell 21.1 percent from May through August, while Thailand’s dropped by 20.3 percent and India’s by 11.7 percent over the same time period. As the Fed begins to decrease the pace of asset purchases, it signals to investors that its outlook for the U.S. economy is improving, leading to higher bond yields and eventually higher interest rates. With high potential returns in the U.S., investment reverses away from emerging markets, and the currencies and assets of those markets lose value.
From May to the end of August, the Indian rupee fell by 16.2 percent against the US dollar, and the Indonesian rupiah by 13.2 percent. With both countries running current account deficits (basically indicating they are debtor nations), India and Indonesia need to import goods and services, paying for them with foreign exchange reserves. The ADB report estimates India has seven months worth of reserves to finance this shortfall while Indonesia has enough to cover five months. India’s new Reserve Bank governor, Raghuram Rajan, has had to navigate this plunge in the rupee’s value while also managing lower growth.
Despite all the attention given to potential capital outflows, the ADB report moderates its risk assessment for Asia, noting “fears of a crisis recalling 1997 are unwarranted.” This time, Asian countries have stronger fundamentals. The ADB notes most countries in the region have a current account surplus or enough reserves to finance external debt. In the report, the ADB urges regional economies to allow exchange rates to adjust and work toward structural reforms, particularly in governance. Higher confidence in the public policy of the region could help investors view the region as more stable. Structural reforms might help open emerging economies, making them more attractive for more permanent investment. With the IMF and the World Bank meeting this week, there will no doubt be even more policy suggestions for Asia to come.
All quotations and figures cited are from the 2013 Update of Asian Development Outlook report, released by the Asian Development Bank.