The US Financial Crisis, Global Financial Turmoil, and Developing Asia: Is the Era of High Growth at an End?

Abstract

The global economy is threatened with a deep and prolonged recession as a consequence of the financial meltdown that began with the housing price crisis in the United States. The financial implications of the global macroeconomic imbalances that have persisted and enabled the housing bubble to develop with the spread of toxic mortgage-backed securities first became apparent in September and October 2008 with the collapse of major investment banks and mortgage loan institutions, and the credit freeze and the panic that ensued in global equity markets. This paper provides a summary of these events and the transmission of the crisis from the United States to United Kingdom, the eurozone, other industrial economies, emerging markets, and developing Asia. Financial and real economy effects of the crisis on Asia and various channels of transmission of the crisis are evaluated in some detail. In general, financial institutions, particularly commercial banks in developing Asia are well prepared to cope with this crisis as a result of reforms undertaken in response to the Asian crisis of a decade ago, and the fact that Asia has accumulated vast foreign exchange reserves through persistent current account surpluses. Still the real economy effects of the global downturn are likely to be severe. A major deterioration in economic growth in developing Asia in both the current and the coming year is in the cards. Growth in world trade is likely to stall making it difficult for export-oriented economies in the region to continue rapid growth fueled by external demand. Rebalancing Asia’s growth toward domestic demand led by consumption, infrastructure investment, and improved health and social security programs will be important in cushioning the impact of the recession taking place in the industrial economies. This paper sets the context for the Asian Development Outlook 2009 with an emphasis on rebalancing growth in developing Asia and, by implication, the world economy.