At the start of 2008, the economic outlook for the Asia Pacific region is more uncertain than it has been since the 1997-98 Asian Financial Crisis. With the full consequences of the sub-prime loan problem in the United States still playing out, the potential for turbulence in the financial markets to spill over into the real economy remains a serious concern. Notwithstanding these and other risks, the economic outlook for the Asia Pacific region is cautiously optimistic.

We expect real GDP growth of 4.9 percent in 2008 for the region as a whole, picking up in 2009 to 5.2 percent.

The current slowdown in the United States is not expected to turn into a full-blown recession. Barring further shocks, a rebound in the US housing sector could begin as early as the second half of 2008. The Chinese economy will continue to expand at double-digit rates through 2009, led by private consumption and investment, while Japanese growth is expected to dip below 2 percent in the next two years.

Inflation is on an upward trend for the region as a whole, with prices in China showing the sharpest increase over the last year. Consumer prices for the region will climb a projected 2.5 percent in 2007, accelerating to 2.7 percent in 2008, in spite of falling US inflation and persistent deflationary pressures in the Japanese economy.

The external sector continues to be characterized by huge current account imbalances across the Pacific. The fall in the US dollar over the last two years is having an impact on the US external balance, with American imports in 2007 expected to have grown by only 2.2 percent. As a share of GDP, the US current account deficit is on a clear downward trajectory.

According to the 2007 PECC survey of opinion leaders, nearly half of respondents believe the Chinese economy will be larger than the US economy by 2020. Whether or not this is an accurate projection, the fact that opinion leaders have this sentiment indicates an important shift in the mindset of the region. A majority of respondents already believe that a slowdown in the Chinese economy would have a greater impact on East Asia than a slowdown in the US economy.

This report points to three sets of challenges facing the Asia Pacific region, and the potential for transpacific cooperation to address these challenges.

In the area of energy and the environment, including climate change, transpacific cooperation can play a special role in reconciling developed and developing economy perspectives, and in balancing short-term assurances about the cost of prevention against the need for long-term assurances that greenhouse gas emissions will be capped. APEC is well placed to make advances on these fronts precisely because it has a diverse membership that spans developed and developing economies, and encompasses a wide range of energy interests.

Despite repeated “last ditch” efforts on the part of the US, EU, India, and Brazil, the Doha Development Round appears to be no closer to completion at the end of 2007, more than a year after its scheduled completion date.

Respondents to the PECC opinion poll chose the Doha Round as the most important item for APEC Leaders to tackle at their recent Sydney meeting. The second most important issue was the establishment of a Free Trade Agreement of the Asia Pacific (FTAAP), suggesting that opinion leaders are pushing for more trade liberalization in the region, and that they do not necessarily see a contradiction between multilateral and regional efforts.

The US current account deficit and the corresponding surpluses held by Asian economies, especially China, continue to be top-of-mind in many policy discussions. The recent sharp depreciation of the US dollar may signal a new phase in the long-awaited unwinding of global imbalances – and the growing risk of a hard landing in the United States. Part of any solution to the transpacific imbalance is a shift towards greater consumption (and hence lower savings) in Asia. According to our survey, 80 percent of respondents believe that private consumption will become the engine of growth for Asia in the next decade.

The institutional landscape of the Asia Pacific has become more complex in recent years. The East Asia Summit and ASEAN Plus Three processes have added to the already numerous meetings of officials working on economic and non-economic issues affecting the region. Our survey of opinion-leaders suggests that there is considerable dissatisfaction with the current state of regional organizations at both the transpacific and sub-regional levels. In general, APEC and ASEAN come out better than their younger siblings the EAS and the ASEAN plus Three. Only 30 percent of opinion leaders agreed that competition from the EAS was an important or very important threat for APEC. They were split, however, on whether APEC is as important today as it was in 1989, and they see nagging problems in both the institutional structure and focus of APEC.

Our survey suggests strong support for greater institutional development of APEC. Nearly half of opinion leaders identified a “weak international secretariat” as a very important or important challenge for APEC. Further, when asked if the APEC Secretariat should be strengthened by appointing a multi-year fixed-term Executive Director and the recruitment of professional staff, respondents answered overwhelmingly in the affirmative. Indeed, respondents identified “Strengthening the APEC Organization” as one of the top five priorities for the grouping. ...

Download State of the Region: 2007-2008

PDF format, 323KB, 68Pages.

ISBN: 978-981-05-9048-2
Copyright © 2007 by the PECC International Secretariat

Editorial Committee:
Yuen Pau Woo (State of the Region Report Coordinator, President & Co-CEO Asia Pacific Foundation of Canada) Mark Borthwick (Director, US Asia Pacific Council) Gary Hawke (Head, School of Government, Victoria University of Wellington, New Zealand) Charles Morrison (PECC Chair, President East-West Center, USA) Eduardo Pedrosa (Secretary General, PECC International Secretariat) Jusuf Wanandi (Member, Board of Trustees, Centre for Strategic and International Studies, Indonesia) Soogil Young (President, National Strategy Institute, Korea)

State of the Region Report online: www.pecc.org/sotr
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The Pacific Economic Cooperation Council (PECC) is an independent, multi-sectoral organization committed to the promotion of cooperation and dialogue in the Asia Pacific.

Founded in 1980, PECC is a network of member committees composed of individuals and institutions dedicated to this mission. The Council is one of the three official observers of the APEC process.

The PECC provides a forum through which its members and broader stakeholders can influence the development of policies affecting the Asia Pacific region.

The State of the Region Report is a product of a task force established by the governing body of the PECC. While efforts are made to ensure that the views of the PECC’s membership are taken into account, the opinions and facts contained in this report are the sole responsibility of the authors and editorial committee and do not necessarily reflect those of the member committees of the PECC nor their individual members.

We would like to acknowledge the support of the Japan Pacific Economic Outlook team at the Kansai Institute for Social and Economic Research (KISER) especially Mr Hiroshi Isono for his support of the economic outlook section. Our deep appreciation goes to the Asia Pacific Foundation of Canada team especially Mr Keisuke Sato and Ms Alexandra Ho for their efforts on the survey on the State of the Region and the economic outlook.

Message from the Chairman of PECC:

On behalf of the 26 member committees of the Pacific Economic Cooperation Council, it is my pleasure to present our second annual report on the State of the Region. This report provides an assessment of the key challenges affecting the Asia Pacific region.

Our report is based on three main elements: the views of our panel of forecasters, the results of an annual survey of opinion leaders, and discussion between the members of the editorial team on key regional issues and institutions.

None of these elements would be possible without the generous contributions of all of our member committees who support the work of the forecast group as well as tap their extensive networks to access the views of senior policy-makers, scholars, business people and the media throughout the region.

This year's report presented the PECC editorial team with special challenges because of the great uncertainties regarding the future outlook. There is uncertainty about how the ongoing sub-prime mortgage crisis will affect the United States economy and the rest of the region and world. There is uncertainty over whether the broader Asia Pacific region is sufficiently resilient to withstand a potentially sharp slowdown in the region's biggest consumer market. And there is uncertainty over whether the societies or the region have the political will and the appropriate institutions to face up to the many challenges associated with rapid growth and globalization. The failure to reach a conclusion of the WTO's Doha Development Round, and the inability so far of domestic and global financial systems to adequately contain the volatility in financial markets are just two examples of complex issues that the regional and global communities are facing.

Aside from the theme of uncertainty, three substantive areas stand out throughout this report: the growing concern over environmental challenges (including climate change) and energy security; the future of the region's trade system in the wake of the stalled Doha talks and the proliferating bilateral trade arrangements; and the continued risk of persistent transpacific imbalances. PECC work will be continuing on these and other important challenging facing the region.

I would like to express appreciation to everyone who has contributed to this report, especially Yuen Pau Woo, Gary Hawke and Jusuf Wanandi who launched our discussions on the trends affecting the region in March 2007. I would also like to thank the Japan PECC committee who have played host to our forecasting panel for many years. Finally, we are grateful to the almost 400 citizens of the region who have responded to our questionnaires in each of the past two years.

I look forward to your views on the report and on how PECC can continue to provide useful and timely information on the Asia Pacific region.

Charles E. Morrison
International Chair
Pacific Economic Cooperation Council

SUB-PRIME MORTGAGE CRISIS AND ITS IMPACT ON ASIA

The sub-prime mortgage crisis in the United States highlights the dangers of unregulated, high-risk financial transactions; the interdependence of Asia Pacific capital flows, and the need for international cooperation to resolve structural imbalances.

The Asian financial crisis of 1997-98 called attention, among other aspects, to the problem of unregulated lending by banks and finance companies, supported by collateral that was inflated by a vicious cycle of borrowing and speculation and credit ratings that were unreliable.

The sub-prime mortgage fiasco in the United States was not generated by a currency crisis but it does appear to be rooted in the excesses of poorly regulated aspects of the mortgage market, compounded by the complex securitization of those and other loans, extending the risk to a much wider set of investors.

Because of the difficulties in unbundling and re-pricing the affected asset-backed securities, the full extent of the damage is yet to be known, but some estimates put it as high as US$300bn. While there should be ample scope for financial innovation, the sub-prime crisis is likely to result in greater regulation and transparency in the United States, and getting the right balance of regulation is always a challenge.

The sub-prime crisis affects Asia in several ways. A large share of the subprime mortgage market may be held (directly and indirectly) by private sector and public sector investors from Asian countries. These investors have seen an impairment in the quality and value of their holdings. At the same time, they have taken the additional hit of a falling US dollar. Asian central banks are obviously unhappy to see the value of their dollar denominated reserves fall, but they are also concerned that massive withdrawals from US dollar assets could lead to domestic currency appreciation and a loss of export competitiveness.

With the Federal Reserve expected to cut interest rates at its forthcoming meetings, Asian central banks will face conflicting pressures to either follow suit - and thus hold back the upward pressure on their currencies and the costs of sterilization activities - or to keep domestic interest rates high in order to restrain inflation and to cool overheated property markets even at the expense of export competitiveness.

The sharp decline of the US dollar in recent months will add momentum to the shrinking of the US current account deficit, as a percentage of GDP if not in absolute terms. The unwinding of the "global imbalance" problem may in fact have begun, but no one on either side of the imbalance wants to see a swift correction and "hard landing" in the United States.

Nevertheless, if confidence in the US dollar as a reserve currency continues to be undermined, the markets will dictate the pace of dollar depreciation, and it could be a very rough ride indeed. Hence the need for international cooperation in managing an orderly adjustment of exchange rates, especially in the Asia Pacific region, and in addressing the structural changes that are needed on both sides of the Pacific - a greater role for domestic demand in Asian economies and higher savings (public and private) in the United States.

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