Standard & Poor's Ratings Services covers 14 markets here, ranging from Vietnam, with its per capita GDP of about $4,000, to Hong Kong at $44,000 and China at about $2,400. The state of the region's financial sectors reflects the range, depth, and capabilities of the financial institutions and markets, and the status and efficiency of their regulatory frameworks.
Despite these differences, we believe there is strong justification for thinking about Asia-Pacific as a single region with financial and economic strategies that share several common elements. Many of the economies, particularly the less affluent ones, are expanding quickly. Among them are China and India, the two fastest-growing economies in the world.
Domestic factors are the primary growth drivers in Asia-Pacific, giving the region a substantial cushion against global turbulence and reinforcing the fact that its economies are integrating at a steady pace. The eagerness of virtually all the countries in the region to exploit the opportunities provided by their fast-growing neighbours is leading to harmonised trading practices, which we expect will evolve into greater access to a variety of services operating within an increasingly coordinated regulatory system.
In short, a regional financial strategy must take into account the forces bringing the region together, as well as the significant differences in the economic conditions that will persist, even at the end of the next decade.
A two-year perspective
The economic slump in the US will have a definite effect on the Asia-Pacific region, mainly by slowing export growth. But two factors ù decreasing inflation and growing integration ù are likely to offset this, at least in part.
Domestically, more or less across the region, the recent abatement of inflationary pressures has created the opportunity for monetary stimulus. The surge in inflation early this year was the result of a confluence of oil, commodity and food prices. All three have since dropped, the latter two as a result of more enduring forces than the first. Oil prices have come down considerably from their peak, but current levels reflect global growth pessimism, and prices could climb again. Production restraints by OPEC could add to the pressure. However, prices are unlikely to rise again to the levels reached earlier this year if the current global economic conditions persist.
Inflation is slowing sharply and will remain relatively moderate next year and beyond. Many countries in the region are already cutting their benchmark interest rates in addition to infusing large amounts of liquidity into their financial systems to support the overall economy as well as specific institutions or segments. These central banks will continue to ease monetary policy as inflation drops, and those that have not yet cut rates will almost certainly do so in the next quarter. We recognise that there are risks involved in this approach, but given the global situation, we feel that in most countries these risks are smaller than the risks of inaction.
Big and broad monetary stimulus, accompanied in some countries by fiscal stimulus, will keep growth from slipping too sharply. Although we expect expansion to slow a bit in 2009, monetary measures will likely stimulate a recovery in the second half of the year and keep it on track for 2010 ù reinforced by the recovery of the US economy that we expect by then. Macroeconomic indicators in 2010 should resemble those of the boom years of 2006 and 2007, although with slightly lower growth rates.
Growing regional integration, which at the moment emphasises commodity trade, is reinforcing the cyclical effects of monetary stimulus. Recent trade data show that exports to the US from most Asian countries have slowed, but exports to neighbouring countries have remained steady. The significance of the US market for exports from most of these countries, although still high, has declined.
The short-term implication of this is that the increase in regional trade will offset the effects of the slowdown in the rest of the world. In Asia, growth in China and India are the biggest factors. Because monetary stimuli in both countries will likely provide a boost, this should spill over into the performance of other economies, which are beginning to send increasingly larger volumes of goods to these two countries.
Although our baseline scenario indicates decelerating expansion in the region through 2009, growth rates will probably remain relatively stable by global standards. However, there are risks, mainly related to the state of the global financial sector. Virtually all Asia-Pacific countries have seen significant capital inflows in the past few years. But portfolio flows have slowed drastically, contributing to falling equity prices and depreciating currencies as funds are repatriated. As conditions stabilise, there may be some reversal of this trend, but it will take time for flows to return to the levels of 2006 and 2007, if they ever do.
The more serious threat comes from a potential slowdown in foreign direct investment, which has contributed to a considerable expansion of production capacity in these economies. Nearly all of them will see major reductions in their investment levels if foreign direct investment dries up as a result of financial constraints in the developed economies. For infrastructure-starved economies, notably India, these constraints could severely dampen growth prospects by shutting off the flow of resources into increasingly viable infrastructure projects. This will limit growth in both the short and long terms.
Looking farther out
The development of Asia-Pacific's financial sector and the business opportunities it provides can be viewed as the outcome of three mutually reinforcing factors: economic growth, demographic changes, and the initial conditions of the financial sector.
We expect China and India to contribute about 70% of the region's incremental GDP in the next 10 years, at a steady rate, and no other country to add more than 10% to the aggregate in that time. (We expect Japan to contribute about 11% between 2010 and 2015, but its contribution will likely decline in subsequent years.)
Meanwhile, transitions in the demographics of working-age people (ages 15 to 64) and senior citizens (65 and older) will have significant implications for financial requirements. It is clear that the bulk û about 62% û of the region's working-age population will come from India. Pakistan will be the next-highest contributor with about 11%, so the subcontinent will be the overwhelming source of working-age people in the region. But the distribution of senior citizens will be different: China will account for more than half of this group, while India will contribute 25%.
Based on the World Economic Forum's recently published "Financial Development Report 2008," which scored countries on multiple indicators of financial development, there is a great deal of difference across the region in the extent of financial sector development. Notably, about 95% of incremental economic activity will take place in countries with less-developed financial centres, and only 5% in economies at the higher end of the rankings. In short, the overwhelming proportion of the new opportunities emerging in the next decade will be in economies that have relatively less developed financial systems today.
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