Ravi Menon: The global economy - securing a return to normalcy
Keynote address by Mr Ravi Menon, Managing Director of the Monetary Authority of
Singapore, at the Citibank 10th Annual Asia-Pacific Investor Conference, Singapore,
30 January 2013.
* * *
Mr Stephen Bird, Asia Pacific CEO, Citigroup,
distinguished guests, ladies and gentlemen, good morning.
The long shadow of the financial crisis
1. The global economy is stuck in a hesitant and uneven recovery. In a way, we should not
be surprised. The seminal work by Carmen Reinhart and Kenneth Rogoff suggests that exits
from severe financial crisis take at least a decade. By this metric, we have already passed
the mid-way point of the healing process. But the experience of countries emerging from the
long shadow of the 2008/2009 financial crisis has been different.
US: steady deleveraging plagued by fiscal uncertainty
2. The US economy has already exceeded its pre-crisis peak. This is encouraging,
considering that the recent recession was the deepest the country had experienced since the
Great Depression.
• Fiscal and monetary stimuli have been decisive, putting the US on a stronger
recovery compared with Europe.
• Private sector deleveraging has proceeded steadily. Household debt has come
down to 113% of disposable incomes in Q3 2012, from 134% in Q3 2007.
•
The biggest drag on the economy - the housing market - is turning around. House
prices have been rising steadily since February 2012 and new houses are being
built at a healthy pace.
3. Fiscal uncertainty has, however, emerged as the clear and present danger facing the
US economy. The partial deal in Congress earlier this month has prevented the economy
from falling over the fiscal cliff. But three inter-related fiscal challenges remain.
•
First, the deferred budget sequester or spending cuts that kick in from March this
year.
•
Second, the debt ceiling that needs to be raised, beyond just the next six months.
•
Third, and most important, a medium-term deficit reduction deal.
4. As it is, the partial expiry of previous tax cuts and exemptions could already be causing a
fiscal withdrawal of about 1-11⁄2 percentage points of GDP. If Congress fails to reach an
agreement, the automatic spending cuts could impose an additional drag of 0.4% of GDP.
Europe: strengthening the fiscal union while fighting a crisis
5. Europe has fared less well. As of 2012, the Eurozone economies have recovered less
than 60% of the output lost during the crisis. For the last two years, the Eurozone has been
caught in a vicious cycle between weak sovereigns and weak banks. The crisis has exposed
basic design flaws in the architecture of the European Monetary Union, chiefly the absence
of a fiscal union.
6. The challenges facing European policymakers are not trivial. They have to put in place the
structures and policies necessary to address the design flaws of the currency union, while at
the same time fight a recurrent crisis of confidence in the financial markets. Restoring market
confidence, in turn, requires achieving fiscal sustainability while spurring economic growth.
Some have described the task as akin to redesigning an aircraft in mid-flight amidst severe
turbulence!
7. Nonetheless, important progress has been achieved and the situation today is visibly
better than it was even six months ago.
• The European Central Bank's Outright Monetary Transactions programme has
materially reduced the tail risk of a disorderly breakup of the monetary union.
• Sovereign bond yields in Italy and Spain have come down, on average, some
200 basis points from their peak levels in the middle of last year.
• Bank deposits in the peripheral countries of Greece, Ireland, Portugal and Spain
have shown signs of stabilisation.
8. But Europe remains mired in recession. There is still no compelling growth agenda.
Domestic demand is weak amidst fiscal consolidation. Banks are not lending amidst an
uncertain investment environment. And several structural issues remain unresolved. It will
not take much to reignite financial market stresses. In short, the crisis in the Eurozone is not
over.
Japan: dealing with deflation, demographics, and a natural disaster
9. Japan has a different set of problems. Its economy has recovered less than two-thirds of
the output lost during the crisis. It has fallen prey to weak external demand and is still reeling
from the aftershocks of a major natural disaster.
10. Japan is caught in the pincer grip of prolonged deflation and unfavourable demographics.
Real interest rates in Japan are probably higher than warranted by the state of its economy.
But the effects of further monetary easing are not expected to be decisive. Nor is it clear that
fiscal stimulus will lift the economy on a sustained basis.
11. The biggest drag on the Japanese economy is its demographics. Japan's working age
population has been growing by just 0.2% per annum over the last ten years. Together with a
declining participation rate, the labour force has contributed negatively to GDP growth in
almost every year since 1998. A firm turnaround in the Japanese economy requires a
sustained increase in productivity, which entails structural reforms to enhance product
market flexibility and spur competition and innovation in the services sector.
Emerging Asia: the rise of domestic demand
12. In comparison, Emerging Asia has weathered the financial storm best, with the region's
total production now one-third higher than what it was in 2008.
13. China secured a quick and vigorous rebound from the depths of the global trade collapse
in early 2009. It has since reined in inflationary pressures and indications are that it has
achieved a "soft landing" of its economy, registering an estimated 7.8% growth last year on
the back of solid consumer demand and infrastructure investment. While China faces
significant economic restructuring challenges, its impressive growth trajectory appears intact
for now.
14. India too rode through the global financial crisis comfortably but is now going through a
weak patch. But if it regains its reform momentum and begins to address its infrastructure
deficit, growth should pick up to levels closer to those seen in the last decade.
15. In the ASEAN-4 economies of Indonesia, Malaysia, Thailand and the Philippines,
domestic demand has displayed surprising resilience. This has held up economic growth,
despite prolonged weakness in external demand and continuous terms-of-trade shocks.
16. But Emerging Asia is also not without its risks. While the advanced economies are
deleveraging, Emerging Asia is re-leveraging. Credit growth has been climbing steadily, from
an average 8% in 2009 to 15% in 2011, before easing to 12% in last year. The private
credit-to-GDP ratio for the region, at 120%, is higher than during the Asian financial crisis.
There is good reason for policymakers to be on their guard.
Macro policies: the unfinished agenda
17. So, where is the global economy on its post-crisis journey? While economic prospects for
2013 look slightly brighter and tail risks have diminished, the global economy and financial
markets remain fragile and vulnerable to shocks.
18. But this halfway point provides us, perhaps for the first time since the crisis, the
opportunity to look ahead and pose the question of what is required to ensure a smooth
return to normalcy.
•
The advanced economies need to achieve fiscal consolidation alongside economic
growth and chart an effective exit strategy from unconventional monetary policies.
•
The emerging market economies need to deal with a weak external environment
and incipient domestic cost pressures especially in the context of volatile capital
flows and asset market pressures.
•
And both advanced and emerging market economies must undertake structural
reforms to boost their economies' potential and create jobs for their people.
Let me elaborate on each of these three themes.
Advanced economies: restoring time-consistent macroeconomic policies
19. First, the advanced economies need to restore time-consistency in their macroeconomic
policies. Governments are borrowing money and central banks are printing money. This is
unsustainable.
Implementing growth-consistent fiscal consolidation
20. The choice in Europe and in America is not between growth and austerity. Debt
sustainability requires both a reduction in the numerator, by reducing deficits and borrowing,
as well as an increase in the denominator, by restoring economic growth. Focusing
excessively on the former will lead to an ever-deepening recession that will only make the
debt trajectory unsustainable. Equally important, fiscal consolidation should not compromise
long-term growth potential.
21. The debate on fiscal policy should focus on the pace and composition of fiscal
consolidation and not just its scale.
22. Pace matters. It is more important to reduce the fiscal deficit of 2016 than of 2013. But it
is equally important that something be done in 2013 that will reduce the 2016 deficit than to
leave it to 2016 to do so. Only then will markets have confidence that policies are
time-consistent. A growth-consistent fiscal strategy entails making binding commitments now
that will deliver medium-term fiscal savings rather than achieve immediate deficit reduction.
Tax and pension reforms are good examples.
23. Composition matters even more. Consolidation should focus on broadening tax bases
and cutting non-productive entitlement spending. Programmes that underpin future growth -
for example, infrastructure, education, and worker retraining - should not be cut sharply. It is
not just the macroeconomics of fiscal policy that matters but the microeconomics as well.
Unwinding unconventional monetary policies
24. The unprecedented crisis of 2008/2009 evoked an unprecedented response from fiscal
and monetary policy-makers around the world. This decisive response helped avert a global
depression. But five years after the emergency resuscitation measures, monetary policy
settings in the advanced economies are still in "crisis mode". Interest rates are close to zero
and central bank balance sheets have seen a relentless expansion.
25. Nearly every major central bank in the advanced world is buying non-traditional assets to
resurrect its domestic economy.
• The US Fed is buying mortgage-backed securities. Its balance sheet has more than
tripled to US$3 trillion, or 19% of GDP.
• The ECB has made long-tenured loans to banks through its LTRO programme and
is prepared to buy sovereign bonds through its OMT programme. The Eurosystem's
balance sheet has more than doubled to €3 trillion, or 31% of GDP.
•
The Bank of Japan is buying government bonds, but has also purchased corporate
bonds and real estate investment funds. Quantitative easing by the BoJ has
amounted to 100 trillion yen, or 21% of GDP.
•
The Bank of England is buying gilts, and some commercial paper and corporate
bonds. Its Asset Purchase Programme is now £375 billion, or 24% of GDP.
26. Central banks cannot expand their balance sheets indefinitely. The incremental benefits
of further monetary easing are diminishing while the potential costs are increasing.
27. On the benefit side, it is not clear that additional monetary stimulus is an appropriate tool
at this stage of the cycle. We would do well to remember the words of John Maynard Keynes
in 1936, "If .... money is the drink which stimulates the system to activity, we must remind
ourselves that there may be several slips between the cup and the lip."
28. The problem is not liquidity but credit. Capital-strapped banks are unwilling to lend and
the private sector is unwilling to borrow, a reflection of uncertainty over fiscal policies, high
indebtedness, and low income growth.
29. And we should be vigilant of the potential costs of cheap money. As market stresses
subside and money multipliers recover, the abundance of liquidity could fuel a strong
monetary expansion with adverse consequences for prices, which would eventually require
large hikes in interest rates to counter. Easy money over a prolonged period can also lead to
a mispricing of risks and unsustainable asset prices, compromising both price stability and
financial stability.
30. Given the long lags in monetary policy, central banks must look forward now and prepare
a strategy for a smooth transition back to normalcy.
Asian economies: dealing with desynchronised global macroeconomic cycles
31. The second key aspect in securing a return to normalcy is the adjustment of
macroeconomic policies in the emerging market economies to spillovers from the advanced
world. I will speak with reference to Emerging Asia.
Continually shifting gears in monetary and fiscal policies
32. In the early stages of the financial crisis, most Asian countries responded with
expansionary macroeconomic policies to dampen the effects of a collapse in exports.
Between August 2008 and August 2009, policy rates across Asia were more than halved, on
average. Substantial fiscal stimulus was injected, ranging from higher investment spending in
China to significant tax cuts in Indonesia. Fiscal deficits across Asia widened from an
average of 0.6% of GDP in 2008 to 3.0% in 2009.
33. From 2010 onwards, a two-speed recovery took hold in the global economy, with
advanced economies growing sluggishly and Emerging Asia staging a vigorous rebound.
Incipient inflationary pressures prompted central banks in the region to raise policy rates from
mid-2010 onwards. Although renewed risks stemming from the Eurozone crisis led to a fresh
round of easing in some economies in late-2011, policy rates in Emerging Asia are on
average 75 basis points higher now vis-à-vis their troughs during the crisis.
34. Fiscal stimulus has also been withdrawn progressively. As of 2011, fiscal deficits in the
region have narrowed once more to an average of 1.1% of GDP.
35. Asian economies must continually recalibrate their monetary and fiscal policies, as
external demand conditions and domestic cost pressures pull in opposite directions.
Maintaining flexibility in macroeconomic policies must go hand-in-hand with reforms to
strengthen domestic demand.
Breaking new ground in macroprudential policies
36. The de-synchronisation of global macroeconomic cycles between the advanced
economies and emerging market economies poses more challenges for the latter than the
former. As long as monetary conditions in the advanced economies remain easy, emerging
market economies face the risk of misallocated resources and disruptive capital flows, which
in turn can affect both price stability and financial stability.
37. Low interest rates and abundant liquidity have contributed to asset price accelerations in
some Asian countries, especially in real estate markets. Residential property prices in Korea,
Taiwan, Hong Kong, and Singapore, for example, have increased by 35% on average since
2009, while nominal wages have risen by only 13%.
38. No doubt, increased capital flows to emerging market economies reflect the superior
growth prospects of these economies. There is a structural rebalancing of global investment
portfolios towards emerging markets in general, and Emerging Asia in particular. A
multi-pronged policy response is needed to ensure that inflationary pressures remain
contained in the face of this "wall of money" - including a gradual appreciation of nominal
effective exchange rates. And indeed, since mid-2009, when capital flows began to return to
Emerging Asia, most regional currencies have appreciated by 3-10% in nominal effective
terms.
39. But exchange rates alone cannot shoulder the burden of adjustment to low global interest
rates and large capital inflows. In fact, strong and sustained exchange rate appreciation may
well attract even more capital inflows. And excessively rapid currency appreciation runs the
risk of sharply curtailing exports and dragging down the economy. Nor is it clear that
exchange rate appreciation alone could have mitigated the increased demand for credit and
consequent surge in property prices that we have seen in Emerging Asia.
40. Likewise, interest rates are too blunt a tool to deal with sector-specific excesses, such as
in real estate. An interest rate policy that is sufficiently aggressive to affect credit conditions
and asset prices is likely to impose quite a high cost on the rest of the economy.
41. Asian policymakers have therefore been experimenting with a variety of so-called
macroprudential policies, to rein in asset price inflation and avoid a build-up of imbalances
amidst a low interest rate environment. Macroprudential measures as practised in Asia fall
into two broad categories:
•
One, prudential measures to restrain credit extended to the property market. These
include loan-to-value ratios, debt service ratios, and caps on property lending.
•
Two, fiscal measures to discourage property transactions of a speculative nature.
These include transaction taxes, such as stamp duties and capital gains taxes.
42. With multiple policy objectives and a challenging economic environment, macroprudential
tools have given additional degrees of freedom to Asian policymakers who want to avoid a
build-up of financial imbalances and unsustainable asset prices, but do not want to give up
domestic monetary sovereignty, allow excessive exchange rate appreciation, or impose
capital controls.
43. While these targeted interventions have achieved a measure of success,
macroprudential policies in Emerging Asia have been deployed in a relatively eclectic and
even ad-hoc manner. As these countries return to more normal times, there is a need to
formalise and institutionalise the modus operandi of these policies, for greater transparency
and policy effectiveness.
Reforms to strengthen the underlying potential of economies
44. Let me now turn to the last, and perhaps most important, set of policies that will
determine how successfully the global economy secures a return to normalcy. These are the
structural reforms needed to strengthen the underlying potential of economies. Let me
highlight those which I think are most important.
Advanced economies: labour reform, tax reform, pension reform
45. In the advanced economies, I would put labour market reform, tax reform, and pension
reform at the top of the list.
46. Labour markets need to become more flexible, especially in Europe. Even in the US,
production patterns are changing rapidly, increasing skills mismatches and generating
structural unemployment. Labour market policies must seek to facilitate the shift of workers
from domestically-oriented sectors facing weak demand to export-oriented sectors, and from
depressed regions to resurgent ones. And wages must become more flexible, so that firms
can ride out cyclical downturns without losing competitiveness.
47. Next, tax reform. The debate needs to shift from the rate of taxation to the structure of the
tax system. The US could do with a broader tax base, simpler tax codes, and less
exemptions. In Europe, similarly, there are opportunities to increase the efficiency of the VAT
system including in broadening its base.
48. Lastly, pension reform. Government spending in many advanced economies needs to be
overhauled in the face of impending demographic challenges. Effective pension reform
requires a judicious combination of increases in the statutory retirement age and reductions
in the generosity of benefits, with the balance varying from country to country.
Emerging Asia: domestic demand, financial deepening, productivity
49. In Emerging Asia, the key structural reforms are in the areas of boosting domestic
demand, deepening financial markets, and raising efficiency and productivity.
50. Boosting domestic demand is perhaps the most important medium-term imperative for
Emerging Asia. Public and private sector deleveraging in the advanced economies has at
least dented, if not extinguished, the export-powered growth model that has been largely
responsible for the "Asian Miracle". Reforms are needed to stimulate private consumption in
some Asian economies, and investment in others.
51. In China, the issue is consumption, not investment. China needs to lift its consumption
ratio from its current low of 36%. Ongoing efforts to bolster the social safety net, enhance
consumer protection, reform tax systems, and liberalise interest rates, are steps in the right
direction.
52. In India and the ASEAN economies, the challenge is to increase investment spending,
especially in infrastructure. This will not only generate indigenous demand, but also alleviate
supply-side constraints that have become increasingly evident in recent years.
53. Second, Asia must deepen and broaden its financial markets. Asia needs to do a better
job in efficiently intermediating its large savings pool, as well as directing capital inflows
towards more productive investment in the region. Asian financial systems are still too
dependent on banks. Deep corporate bond markets can play a complementary role in
enabling private and institutional investors to invest for the long term.
54. Third, increasing productivity. Countries in Emerging Asia are still far from the
technological frontier, and there is ample room for gains in productivity. However, unlocking
these gains will require different policies across the region.
55. China can unleash higher productivity by removing inefficiencies and distortions in its
economy. The prescriptions are well-known - overhaul state-owned enterprises, liberalise
the financial sector, instil cost of capital discipline. But delivering them will take determination
and political will. In India and the ASEAN countries, improvements in governance and
regulation will be key to attracting investments that can raise supply capacity and
productivity.
Conclusion
56. Let me conclude. The world has coped relatively well with the numerous shockwaves that
have rocked the global economy in the wake of the financial crisis. Now that we are
advancing on the road to recovery, policy-makers must lay the ground for a return to
normalcy. We would do well to recall the words of Winston Churchill, "Success is not final,
failure is not fatal: it is the courage to continue that counts".
Thank you, and I wish you a successful conference.