Asia may face long depression

The following article is based on a presentation by Jean- Michel Severino, World Bank vice president for East Asia and the Pacific, in a business conference on East Asia's financial and economic turmoil. The conference, organized by the International Herald Tribune, was held in Melbourne on June 16. This is the second of two articles.

MELBOURNE: What should we do now? How do we get out of the balloon of the crisis and get back on the ground? I think there are three avenues we can pursue.

The first is obvious -- clarify the environment. It is absolutely critical to have a dynamic Japanese economy. Without an engine of growth in the region, the region cannot make it. Potential for exports in Europe and the U.S., provided these economies remain in acceptable shape, or dynamic as is the case of the U.S., cannot compensate in the short run for the decline in regional and Japanese markets.

It is not the only point. I think one has to be very careful about the Chinese factor; Mr. Tung Chee Hwa was correct to mention how critical it is that China should not devalue.

Our conviction at the World Bank is the Chinese government has chosen the right policy and made the right decision, focusing on one side on the implementation of the reform program and the implementation of the five major reforms that have been put forward, and the other in trying to boost domestic demand.

They have also, with Japan, presented a major package that will probably have an impact on the economy in the second half of the year.

There is some mixed news coming from exports and the foreign direct investment side in China but, frankly, this is better than one could expect in such a negative environment in the region. Our assessment is the Chinese economy is doing fine, even if its growth rate will undoubtedly be lower than 1997.

The market and the Chinese have a responsibility in that the market has to be convinced that China is going to stick to its policy and play the stabilization role it has started to take on. This is absolutely critical. If the World Bank is not in a position to have a role with Japan, which is not our client, the type of message we are sending to the Chinese government is very much along the line of what I have just said.

The second set of policy issues that has to be addressed is within the region itself and within the countries. The question is very simple, even if the answer is very complicated. How do we move an entire region up at the same time, given the fact there is no possibility of success for an isolated country in such a depressing regional environment?

There are three sets of answers. The first is about macro policies -- the World Bank believes there is no alternative to more expansionary micro policies right now. This is an issue that we have discussed quite intensively with our friends at the IMF and we are seeing a change in this environment.

Obviously, when you look at the programs, fiscal deficits that are accepted within the IMF programs are increasing and it is also true that interest rates are going down. Our message is very simple: every step in this direction right now is a good one. We have to inflate domestic demand. This is the only way in which we can break this vicious cycle of transmission of contagion from one country to the other.

We are lucky because these countries have very limited indebtedness so at the same time they can have higher deficits, thanks to the surpluses that had been accumulated for years, they can also go abroad to borrow and fund these deficits. This is a major difference with the Latin American crisis, where countries were extraordinarily constrained by huge deficits and public indebtedness accumulated over the years.

We are also fortunate because they are good possible users of the fiscal deficit. These countries have huge investment and infrastructure needs that can be partially fulfilled by private sector involvement; we should think deeper as to how to involve and use the private sector even at this juncture in the economic life of the countries. There are also many possibilities for wise public investments funded by government money.

The second important thing is there is room for major social programs in the region. These countries will not get through the crisis without strong, dynamic, well thought out social agendas. They will crash into the wall, because of political debates and difficulties if they do not implement this agenda.

This agenda may be worth two, three, or four points of GDP. This is money which is well invested and will pay off over the years, especially as these countries no longer have social safety nets. They relied for years on the solidarity of family in a dynamic context and now a lot of things have to be done in this area.

Finally, there is also a third good use of the money which is the recapitalization of the banking sector. We have to avoid the moral hazard problems. It is also clear that capitalization by public funds of the banking sector makes sense only if it is in order to have a successful privatization process when the economy improves.

This is also worth several points of GDP. So that is a good way to use the money that would be made available by larger budget deficits.

The second thing that we have to do -- this pushing ahead of the economic policy toward a more expansionary stand -- is finalizing the restructuring and rethinking the way we restructure the financial and the corporate sector.

Right now, it is very clear that the way that we have started to address the problems of the financial sector has been a contractionary one. We have -- I would put the World Bank in that bag as well, because we have been co-designers with ADB and the IMF of these restructuring of -- of these financial restructuring programs - but we have put a lot of burden on the shoulders of the banking sectors of these countries.

They have very ambitious targets to meet in terms of capital decreasing ratios, restructuring of the balance sheets, merging and strengthening the structures, even improving the capacity of the banking sector and changing the rule of the game and governance system.

One has to look at the consequences on the economy. It is clear that the credit crunch problem has partly to do with the monetary policy, but it also has a lot to do with the way the restructuring programs are being handled. Rethinking the pace of these programs, the nature of the measures and also the way they are funded, is something that we have to do.

Of course, we have also, all together, to address much more forcefully the issue of the corporate restructuring. This is an area of the restructuring that has lagged behind very obviously. Emergency thinking has been focused on the financial sector and one has missed the point that the real issue was the corporates that owed money to the banking sector.

It is even more critical at a stage where all these corporates have to go through a major industrial restructuring.

Beyond the clarification of the environment, beyond the rethinking of the policies in the region, there is the funding of the programs. Frankly, not much money has been disbursed from the major countries of the world in this region.

IMF has been a key provider of funding; ADB has also brought a major package. The World Bank has also contributed a major package. Regarding my own institution, we usually were lending about US$4 or $4.5 billion a year to this region. Since last July we have committed about $16 billion and by the end of June we will have disbursed about $11 billion.

So, it is a major participation that we have had into these programs. But, of course, when you look at these numbers, and you compare them with the $100 or $200 billion that is left with the region, they do not match. It is not enough. This is not going to reverse the situation of the region and it is not even enough to fund the additional budget deficits that are necessary to take a more expansionary stand in the region.

So there is a need, in a nutshell, for a globalization of the world around East Asia. Australia has participated quite a lot, and has been probably the most, with Japan and China, among the most active countries in terms of concrete disbursements in the region. But most of the other participants are far from having delivered and participated concretely in the funding of the program. We cannot and we should not dream.

Without this very practical external funding of the program it would be impossible to move the region quickly out of the crisis. We will have to accept if this does not take place, to go through a long cycle of recession. We will have to accept to go very deep in terms of minuses before the market starts creating the countermeasures.

I hope you will have understood that the World Bank is not talking wooden language, that we are worried but that we think that there is a way out of the tempest provided a mobilization intervenes and that the major countries of the world and the regional major stakeholders discuss together.

We are ready to participate in that effort; we have been very active in this crisis, sometimes in too modest a way. I hear here and there is a perception that the bank has been slow or has not been really visible. I can tell you that since day one in we have been present by our clients in a major way in terms of technical assistance and funding. However, it is clear also that there is one pilot in the programs and the name is IMF.

We are coming to a period where a longer term vision has to be taken, and we are willing to assume more responsibility in the long-term restructuring of the economies and in finding solutions for moving out of this big depression which is ahead of U.S.