Southeast Asia's Policy Response to the Global Economic Crisis

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I. Introduction

This paper examines the impact of the global financial crisis on Southeast Asia, focusing on the policy responses of the various governments. The global financial crisis has had a nearly unprecedented impact on OECD countries with collapses in asset markets, failures of financial firms, and falling demand. As of January 2010, the threat of a true global depression appears to have receded, asset markets have stabilized, and some economies are showing slow recovery. There is, however, considerable uncertainty over the future course of the OECD economies and little hope of a quick rebound in employment: a "jobless" recovery is underway.

The initial section below provides a sketch of the crisis focusing on trade as the determining factor in bringing economic difficulties to Southeast Asia. The impact of the global problems on regional financial markets is reviewed in section III. Despite clear signals from OECD economies that a true crisis was developing, regional growth forecasts appeared to reflect the changing conditions only with a lag and this is reviewed in section IV. A note on the impact of this slower growth on poverty is section V. The remaining sections of the paper contrast the relatively quick response of monetary policy (section VI) with a tardy use of fiscal policy (section VII), and some final notes on trade policy (section VIII). A concluding note is section IX.

II. Southeast Asia's Reliance upon International Trade Left it Vulnerable

The collapse of asset markets and financial market failures in the OECD had echoes in Asia, but the major channel of influence for Southeast Asia was trade--a sharp fall-off in demand for exports. The OECD recession translated into a strong drop in imports from Southeast Asia, a region that had come to depend on trade to marshal robust economic growth. The OECD recession had all major economies in East Asia "suffering double-digit declines in exports". (1) The trade collapse was most evident in 2008-Q4 and 2009-Q1 with the pace of decline moderating by 2009-Q2. Figure 1 shows the situation in the Philippines.

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Although media headlines focused on the failures of iconic OECD financial market institutions and blockages in what had been normal financial market exchanges, it was the more plebian fall-off in orders for goods that transmitted the OECD crisis to Southeast Asia. In trade-dependent countries such as Malaysia and Thailand, the fall-off in exports led to lower private domestic spending, especially fixed investment. (2) That trade was the primary and lasting channel is clear. However, there were very complicated and inter-related movements in the various aspects of the different economies. Initially the freezing of short-term credit markets in the United States (3) had a sharp impact on trade finance and orders. This was exacerbated by outflows of capital, especially portfolio funds. (4) The subsequent downturn in aggregate demand in OECD economies confounded the initial shocks.

The channelling of the global crisis to Southeast Asia through trade reflects the historic dependency of this region on trade to spur growth. Especially the economies of Malaysia, Singapore and Thailand are keyed to international trade. (5) This reliance upon international trade to harness their growth potential left some countries particularly vulnerable to weaknesses in OECD outlet markets. As Figure 2 shows, it was the degree of trade dependency that explains the impact on growth of the global recession in Southeast Asia. (6) Singapore, as an economy centred on trade, showed the largest turnaround in growth with GDP falling 9.6 per cent, year-over-year in 2009-Q1. Indonesia and the Philippines, less dependent upon external demand, have skated through the crisis better than their richer neighbours. This is the double-edged sword of relying on external markets for development: it provides a tremendous boost to the efficiency of the economy and long-term growth, but increases short-term vulnerability to external shocks.

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Within the broad context of trade, country-specific issues affect the overall picture of the impact of the crisis on growth. For example, a counter-balancing force in Indonesia was the very robust growth in the agricultural sector, which protected some in the rural sector. (7) Election spending further cushioned Indonesia's economy. Some analysts estimate that election spending in 2009 could account for 1 per cent of total GDP. (8)

While the primary channel for the rollover of the OECD recession to Southeast Asia is the trade in goods, closely related activities including tourism and the international demand for labour services have reacted to the global downturn. Across Southeast Asia a crisis-related fall-off in global tourism weighs on economies. (9) The Philippines, for example, saw a fall of 6.3 per cent of tourist arrivals in the fourth quarter 2008, relative to the year-earlier value. Indonesia and Thailand also seem to be seeing a fall-off in tourism earnings. In the Philippines, inward remittances from workers in other countries have held up in 2009, boosting the economy, but growth in these income inflows was at a lower level through the first ten months of 2009 than seen in 2008. (10) The degree to which these remittance flows continue without significant weakening may be an important key to next year's growth in the Philippines.

Exports drive economies in Southeast Asia, but in some cases in late 2008 as OECD purchases fell, imports adjusted faster than exports, limiting the drag on aggregate demand and on the economy generally (Figure 1). The link between imports and exports reflects the fact that trade in Southeast Asia has increasingly been in processing: imports are for re-exporting with regional trade often in intermediate goods. However, that imports moved so quickly testifies to the responsiveness of the business community. Managers understood what was happening in the OECD and immediately adjusted their expectations for sales. Figure 1 clearly shows the situation in the Philippines, but a similar picture can be found across the region. (11)

The near synchronization between exports and imports meant that the recession had little overall impact on the balance of payments, foreign reserves (Figure 3) and exchange rates (Figure 4). This is the judgement looking back from the vantage point of early 2010. The picture is complicated in that, depending on the period, Southeast Asian countries had different experiences relative to the U.S. dollar through the first two-thirds of 2008. By August 2008, however, all currencies were depreciating; a trend that quickened in the wake of the global trade collapse. The period of depreciation lasted generally until April 2009 when the five currencies we are looking at stabilized and started a rebound. This rebound is testimony to how different this crisis was than the 1997/98 traumas--Southeast Asia is viewed as suffering "collateral damage" from someone else's problem.

Indonesia had a more severe experience than others in the region with a large slide in the rupiah-U.S, dollar exchange rate of 19.7 per cent in just a few weeks in late 2008. Similarly, Indonesian bond yields remain higher and appear to have been more volatile than regional comparators. Part of the explanation may lie in the generally high inflation seen in the country. But there is anecdotal information that Indonesian currency and credit volatility was exaggerated by the marketing of "complex foreign exchange derivative instruments". (12)

The Indonesian experience may reflect in a smaller fashion the kind of mismatch between market expectations and actual market movements seen in the 1997/98 crisis. This kind of "disorderly" market is very sobering to those holding the wrong positions and poses systemic risks if not contained. On balance, in Southeast Asia, "disorderly" markets were seen in relatively few instances and were short-lived. This situation is dependent upon the nature of any recovery. A prolonged worldwide depression could disrupt the fragile stability found in 2009.

III. Financial Market Stability Helped Cushion Southeast Asia

Although the conclusion that Southeast Asian financial markets suffered relatively little disorder compared to OECD markets is generally correct, this is from the perspective of hindsight. Stock markets in Southeast Asia did fall over an extended period of time (Figure 5), and in some countries the value destruction was close to what occurred in the financial crisis of 1997/98. (13)

The IMF (2009b, pp. 14041) concludes that, for a brief period of time at the end of 2008 and into 2009, emerging Asia (including Indonesia, Malaysia, the Philippines, and Thailand) suffered "historic levels" of financial stress. The IMF uses a measure that aggregates indices across both financial and foreign exchange markets. As one aspect to this, credit availability and credit costs did weigh on non-financial firms. (14) In Thailand, the credit squeeze had considerable impact on small and medium-enterprises. Indonesia also saw banks generally tightening lending conditions. The Philippines may be an exception, as liquidity appears to have increased throughout 2008 and into the first two months of 2009. Even here it is likely that credit conditions have tightened with banks reviewing their lending conditions.

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Reflecting global capital flows, with OECD banks and other financial institutions rebuilding their reserves, bond spreads in Southeast Asia widened sharply in 2008-H2. (15) But the ability of Indonesia and the Philippines to issue sovereign bonds in 2009-Q1 may be considered to mark the end of this period of market uncertainty. (16) Successful bond placement indicates that markets saw that the crisis is not one of policy in Southeast Asia.

The non-financial corporate sector has escaped the kind of widespread insolvency seen in 1997/98 partly because in most countries there is simply less of a general slump in economic activity (Singapore is an exception) and most companies entered the present crisis with …