Jan 05 - 18, 2009

How bad will it be in 2009, and will there be a recovery in 2010? These are the big issues discussed in detail by the researchers of the Standard Chartered Bank. In the present global financial meltdown scenario the emerging economies of Asian countries are positioned well as compared to the developed economies of the West.

The boom of recent years seems like a distant memory, with the world economy slowing significantly through 2008 and appearing to fall off the edge of a cliff in the last few months. The fallout from the US recession is now exacerbating the global financial crisis.

As a result, we head into 2009 with deteriorating data and poor economic and financial news across the globe.

It is easy to see why confidence, wherever it is measured, has collapsed.

Sometimes, there is a danger in extrapolating from the present and expecting things to continue as they are. But in current circumstances it is easy to see why so many forecasters are anticipating a bad 2009. Certainly, one should not be complacent about the downside risks.


The biggest recent problem is the slowdown in world trade, reflected in the decline of the Baltic Freight and other indices. In the last couple of months, the expectation of a US recession and global downturn has been exacerbated by a significant contraction in credit and finance for trade, having a profound and immediate impact. If this continues it will have a significant impact on export and trade flows. It will require not only a rebound in expectations about future growth but, more immediately, policy action to free up credit flows.

Yet there are some positives. These include the significant policy easing across much of the globe and lower official interest rates. Obama's planned fiscal boost not only makes sense but is a clear statement of intent by a president keen to make inroads into the recession from the beginning of his administration. The impact of the collapse in oil prices should also not be underestimated, and alongside the slowdown in private-sector demand, it looks set to turn the inflation risks the market feared in the summer into deflation in the West and disinflation in the East. The chances are, though, that these policy and commodity factors - as justified or as welcome as they are - will not reverse the present downturn trend. They will ease the pain but not prevent a global recession, in our view.


There are big differences between the advanced economies and some of the emerging countries, particularly in Asia and the Middle East. There are many structural problems in the West, such as the overhang of debt, that suggest the recession may not be followed by an early or strong rebound. In contrast, across many emerging countries, savings are higher and domestic imbalances are not seen, suggesting that this downturn may be more cyclical in nature than that in the West.

In that case, 2010 is likely to be a recovery year. In parts of Asia, there is more concern about Europe than the US, with many expecting the US to rebound sooner. Moreover, many in Asia lack the confidence to believe their region can rebound before the US. There is still a commonly held view that a US recovery is required before Asia can respond.

And based on events of the past few weeks and the recent loss of confidence, memories are shifting back to the Asian crisis and its aftermath, bringing a fear that it will be repeated. It shouldn't. Asia is in a very different space. Yet Asia needs to be clear about its policy response given the fact that Korea, for instance - despite a sound economy and savings - has found itself in trouble and that Indonesia, again with solid growth, has seen its currency weaken and in the process adds to problems for many corporations.

It was always the case that a US downturn would impact Asia, and this was evident both directly through slower exports and indirectly through equity markets and confidence. But Asia, including Korea and Indonesia, should have sufficient policy tools and resources to cope.

Further measures are still needed - at the macro level across the globe, and in the West, even more specific ones aimed at the financial sector. These measures will naturally vary from country to country but will share many similar characteristics: more fiscal boosts even lower interest rates, and in some Western economies, as is being seen in the US, greater use of central banks' balance sheets. As we saw in Japan in the late 1990s, it was necessary to move from traditional to so-called unconventional measures.

In addition, there is still a case for further measures aimed at addressing the liquidity and capital solvency issues that have overhung the banking sector for some time.

It is still important to add liquidity, and for central banks to accept an ever wider array of collateral. There is also a case for addressing a fundamental problem where the market wants banks to have sufficient capital, but this objective is at odds with a regulatory framework that seeks higher capital ratios. Basel II and higher capital ratios are counterproductive at this stage of a cycle, dampening lending.


It may be premature to suggest that we have been through the worst in the financial crisis, but it does seem that way, with clear statements from the G7 that no major financial firm will be allowed to go under and many market indicators, such as inter-bank rates, having shifted from where they were in the stressed conditions of only a few months ago. However, whilst we may be past the worst, the financial sector, certainly in the West, is in a fragile situation. And to say we may be past the worst does not mean we are about to recover. It could take years to work through the problems of various derivatives markets.

Furthermore, as Japan showed, the work-out phase from a financial crisis takes time. And to reinforce these messages of caution, we now have to cope with recessions in many countries. There is a saying that recessions uncover what the auditors missed. And it is quite possible, or even likely, that if the recession lasts longer or the recovery is muted, some financial players may witness further problems. The hope, though, is that whilst such problems are hard to avoid, they will not be system-wide. So we still have a fragile situation, especially as bad loans and write-offs rise, driven by the unfolding recession. Some banks and financial firms will cope better than others.


For the advanced economies, 2009 will be a tough year, notwithstanding all the stimulus measures. A deep recession is already underway in the US and UK, whilst Western Europe and Japan are in a recession which, though not as deep, still looks set to be long. As a result, low interest rates, quantitative easing, and other macro measures may become the norm.

It is against this backdrop that one needs to judge emerging markets. The contagion being felt across the emerging world has become more evident in recent weeks as the financial-sector fallout has spread. Whilst the picture varies greatly, heavily influenced by the degree of economic openness and the financial integration of various economies, it may be fair to say that the impact has been global. A slowdown in export growth has become a collapse in recent weeks, investment plans have been put on ice, confidence amongst businesses and consumers has been hit, it has become harder to access funding, credit spreads are high as risk aversion takes hold, and a mad dash for liquidity has seen previously well-regarded portfolio investments being closed. And there is a shortage of dollar liquidity in a number of emerging markets.


It is important not to be complacent about the outlook for emerging markets. And it is important that policy makers across the emerging world do not fall into the trap seen in the advanced economies over the past year or so, where many early warning signs of impending problems were ignored. It is remarkable that even during 2007, when the subprime housing crisis was unfolding in the US and Northern Rock had to be nationalized in the UK, in both countries the widely held view even early this summer was that the problems could be contained and the crisis was past the worst. It is important that emerging economies do not repeat this mistake. Markets in the West had early warning signs of problems to come, but they were not seen as a prelude to the system meltdown witnessed in 2008.

This needs to be taken into account when looking at the emerging market outlook in 2009. That being said, the emerging world is in better shape than the advanced economies. A cyclical downturn, even a severe one, in the emerging world contrasts with the need for structural change in the advanced economies - if not all of them, then certainly in the Anglo-Saxon ones. In looking at the emerging world, the same rules apply as in the West: namely, the outcome of a financial crisis depends on the interaction between the fundamentals, the policy response, and confidence. And the most encouraging aspect of the past few weeks has been the policy response in both China and India, which has clearly moved into a proactive phase?


Clearly one needs to differentiate significantly in terms of the outlook for 2009. Central and Eastern Europe is the biggest problem area by far, and the recent rating downgrade of Russia is perhaps a reflection of this. The imbalances within these economies are acute.

The most interesting area is Asia, not least because of its importance to the global economy, but also because it experienced its own financial crisis a decade ago, and since then, many countries across the region have ensured more policy ammunition to cope with shocks. Now, we are seeing their shock absorbers being tested to the full.

Although Japan is still Asia's biggest economy, the focus tends to be more on China. In Japan's case, the emphasis for 2009 appears to be more on prospects for vast domestic savings. For most of the past decade-and-a-half, markets have anticipated a vast outflow of household savings from Japan. We have seen spurts, only for a significant currency reversal to occur, dampening Japanese enthusiasm for investing overseas.

The recent strengthening of the yen may not have been on the same scale, but it may have a similar effect.

With the latest data showing that Japan's downturn is deeper than previously thought, and adding in deflation worries, it is perhaps no surprise that risk aversion has forced the yen to appreciate. Anything is possible.

Further appreciation looks like the norm until the Japanese decide to bite the bullet and invest overseas. This will be a key focus during 2009. The trigger that may encourage the Japanese to invest overseas is likely to be similar to that which entices investors back to equity markets - namely, genuine signs of a cyclical economic rebound across Asia.

Such a rebound is possible in 2010, and markets may anticipate this as we move through 2009. But first we need to be clear that the bottom has been reached, and where that is. China's prospects will have a significant impact on thinking. The important point about China is that a slowdown now is still consistent with a longer-term positive outlook. The slowdown in exports and the hit to investment have not only compounded a near-term slowdown - they have also already prompted rate cuts by the central bank and justified the government's huge fiscal boost.

China's policy stimulus is likely to be successful, allowing the economy to rebound next year. It is not just the size of the stimulus at CNY 4trn that is impressive, but also the areas that are being targeted. For instance, almost one-quarter is aimed at social housing, thus meeting both near-term and longer-term needs. The package also highlights the farmers - consistent with other recent measures aimed at encouraging more spending in agricultural areas - as well as taking account of social issues. China was able to implement its fiscal stimulus quickly during the Asian crisis, and although there seems to be some market uncertainty about this now, chances are that the boost will kick in during 2009.

India, too, is experiencing a slowdown, with the central bank cutting rates sharply and the government cutting fuel costs. As our forecasts in this publication show, we are cautious about Asia's economic prospects in 2009, but at the same time we expect significant policy stimulus - as we are seeing in China and India - across the whole region.

All this suggests considerable uncertainty about the outlook, with the boost from huge policy stimulus and falling energy prices contrasting with the collapse in trade finance, deleveraging across the Western financial sector, and a general collapse in confidence. The loss of confidence in the economic outlook and the lack of trust in parts of the financial sector do not augur well for the near-term outlook.

The biggest immediate issue is trade, which is taking a double hit from a US recession and from the financial fallout. This will reinforce the case for surplus and high savings countries to stimulate their domestic economies and boost demand.


Asia is heading for a hard time in 2009. The region's economies are likely to get worse before they get better, but it is unlikely to be the worst-hit among the different regions, nor will this be the worst crisis Asia has ever seen. In the longer run, Asia could even gain more than it suffers, coming out stronger, with more solid fundamentals and a heavier weight in the global economy, if it manages the adjustment right.

We have long argued that Asia cannot de-couple from the current crisis, but it will be better insulated than others and than it was before, in our view. This observation is likely to be fully appreciated in 2009, when the region gradually runs through the three different stages of direct impact from the sub-prime-triggered crisis.

The first direct impact - through which Asia surfed almost unscathed, reinforcing the decoupling argument - came from holdings of American toxic assets like sub-prime debt, CDOs, and CLOs. Unlike Europe, Asia was largely spared by its relatively small exposure. This is not because Asian investors are smart, but more due to their being too unsophisticated to understand these highly complex structured products, and too conservative (after the previous crises) to have the risk appetite to leverage up.

The second impact, through which Asia had a somewhat bumpy ride and which it is still struggling to overcome, is the liquidity challenge set off by the serious dysfunction of key financial markets and the sharp deleveraging of financial institutions in the West. Aggravated by the bankruptcy of Lehman Brothers and subsequent credit market events, liquidity in many Asian markets, such as Korea, was stressed. Liquidity is likely to turn tighter as the year ends and the lunar New Year looms in late January, and may remain stressed through at least H1 2009, when the USD deleveraging process is expected to continue.

While Asia's substantial forex reserves and aggressive monetary easing have helped to avert an acute liquidity crisis thus far, some countries may need to tap into external liquidity supports like bilateral central bank repo lines or even IMF facilities. The Fed's USD 30bn swap lines (currently extended only to Korea and Singapore in Asia)and the proposed USD 80bn multilateral repo line among the central banks of ASEAN+3 (China, Japan, and Korea) may need to be raised, expedited, or broadened to become a more comprehensive safety net.

We are optimistic that Asia's huge fx reserve holdings (over USD 4trn) should spare it from any acute liquidity crisis, but the region needs to act together quickly. Given the current level of market nervousness and the highly contagious nature of financial market crises, if a key member succumbed to liquidity distress, it would be hard to insulate the rest from a broader crisis.

The third and probably the greatest impact - which is likely to dominate most of 2009 - is the expected decline in exports. During the 2001-02 economic downturn US and EU imports shrank for 2-2.5 years, both by about 30%, compared to a 22% drop in Japan's imports. Given Asia's heavy dependence on exports, it could be in a relatively vulnerable position. In 2001-02, Asia managed to fare relatively well: US imports from Asia were down by 18.5%, Japan's fell by 20%, and those of the EU fell by only 1.4%.

Thus far, US imports from Asia are still running at a single-digit growth rate, even though overall US imports dropped 10% in the two months to September 2008.


The agricultural complex is best positioned to outperform in 2009, given resolved funding issues, high fertilizer costs, and low stocks. With the exception of rice and coffee, we expect prices to start bottoming out for most commodities. While the market is focused on the poor outlook for demand, we believe that the potential impact of lower prices on supply is not being factored in. Grains demand is much less geared to the economic cycle, and demand for basic foodstuffs is even likely to benefit relative to higher priced products in times of economic adversity.

That said, parts of the agricultural complex, particularly palm oil, are now also closely linked to energy prices through the expansion of the bio fuel industry, and will likely be weighed down by crude oil prices in H1 2009. Overall, our agricultural forecasts show prices edging higher through the year, while on the whole averaging lower than 2008, and recovering more strongly in 2010.


The total liquid foreign reserves held by the country stood at $ 9,661.9 million on 27th December, 2008. The break-up of the foreign reserves position is as under: -

i) Foreign reserves held by the State Bank of Pakistan: $ 6,369.9 million.
ii) Net foreign reserves held by banks (other than SBP): $ 3,292.0 million
iii) Total liquid foreign reserves: $ 9,661.9 million