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Prepared by PwC for APEC CEO Summit 2010 Yokohama

The Asian engine for global growth

We live in challenging times. From recession to recovery, from trade imbalances to Basel III, from fiscal stimulus to austerity and fiscal restraint – a dizzying menu of unfolding and contradictory events has fuelled uncertainty about the direction of the world economy and how global business leaders should react. There’ s no question that the optimism we felt in January about the global recovery has been dampened by a turnaround that is slower than expected. In North America and Europe, unemployment remains stubbornly high, housing markets are stagnant, and fiscal deficits are raging.

Yet those developments don’ t characterise the entire global business story. Many Asian companies are doing well; riding a

robust economic recovery in the region. Even in the West, corporate profits are up, financial stocks have rallied at the prospect of substantive reform, and deal-making is accelerating. So, businesses are not allowing a sluggish and uncertain recovery to derail their plans – and those plans invariably include changed strategic priorities in the Asia-Pacific region.

That most of the region defied economic contraction in 2009 helped vault Asian companies higher in global rankings: the largest banks in the world (by market cap) are based in China, for example, and Japan, Korea and China combined are now home to nearly the same number of Fortune Global 500 companies as the US. It’ s clear that Asia-Pacific is increasingly taking the lead.

Asian companies have taken up the mantle of leadership and are investing in growth initiatives. Asia-Pacific investment in clean energy rose in 2009, for example, while the economic crisis eroded similar investments in Europe and North America. These investments

To APEC CEO Summit 2010 participants,

1 　The Asian engine for global growth

could simultaneously build Asia-Pacific’ s position in a high growth, value-added sector, and play a vital role in addressing global climate change.

Over the past few months, my conversations with CEOs have borne out the growing focus on Asia as the source of future growth. Some companies are using the recession as a pretext to accelerate their strategic agendas. They are retooling to adapt to new circumstances and taking advantage of opportunities in technology, cost containment, talent availability, and global markets that didn’ t exist before the recession. This is particularly true here in Asia.

That’ s one reason why the theme of the APEC CEO Summit – Asia-Pacific as the Driving Force for Global Growth: Seeking Prosperity after Crisis – is so timely and important. With a growing middle class of consumers in Asia, new opportunities will bloom in a variety of sectors, from consumer electronics to natural resources. APEC plays an essential role in making sure trade and economic policies in Asia translate

the strong economic recovery in the region into sustainable growth globally.

I look forward to seeing you at the Summit to discuss these and other important topics.

Sincerely yours,

The Asian engine for global growth 　2

Dennis M Nally, Chairman, PricewaterhouseCoopers International

Over the past few months, my conversations with CEOs have borne out the growing focus on Asia as the source of future growth

Just a few years ago, the US economy was considered the locomotive of global growth, with US consumption said to fuel output from the rest of the world. Now, Asia-Pacific is in the lead position, while many other major economies still struggle with the after-effects of the economic crisis. Based on the most recent estimates from PwC, the United States is

forecast to deliver 2.4% growth in 2011, while the European Union will crawl along at 1.5%. By comparison, growth across APEC (which includes the US) will surge ahead at 3.8% in 2011. Driving growth in the region is the powerful momentum generated by China and the ASEAN economies: China is projected to grow 9.3% percent in 2011 while the six largest countries of ASEAN are forecast to grow between 4.3% and 7.1%. (See figure.) The only soft spot in Asia-Pacific is Japan. Even still, Japan’ s 1.7% growth forecast for 2011 seems like good news in that it’ s more than twice the average growth rate over the years 1992-2009.

The Asian engine for global growth


Most countries in Asia Pacific boast much stronger economic fundamentals and significantly improved supervision of their financial institutions

THAILAND

MALAYSIA

PHILIPPINES

CHINESE TAIPEISOUTH KOREA

JAPAN

AUSTRALIA

Forecast GDP growth, 2011

Russia4.5%

World3.1%

APEC3.8%

EU1.5%

Canada2.5%

US2.4%

Mexico3.7%

Peru5.7%

Chile5.9%

China9.3%

Brunei1.0%

Korea3.9%

Japan1.7%

Hong Kong SAR4.5%

Papua New Guinea5.5%

Philippines4.8%

Singapore4.8%

Thailand4.3%

Vietnam7.1%

Malaysia5.0%

Indonesia6.2%

Australia3.3%

Chinese Taipei4.2%

New Zealand3.2%

What has made the economic recovery in Asia-Pacific so fast and impressive?

It’ s hard to make broad generalisations across such a large and diverse region. Yet, some themes do emerge in the aggregate, even if different countries vary in their fit. And those themes may surprise those accustomed to the view that developing countries have weak fiscal discipline, loose supervision of financial institutions, and insufficient economic integration with one another. Notably, most countries in Asia-Pacific actually boast much stronger economic fundamentals and significantly improved supervision of their financial institutions.

Such strong fundamentals were achieved largely as a result of an expensive and painful lesson: the 1997-98 East Asian financial crisis that caused near meltdown of the financial system in the region, and a short but deep recession in some of the key economies in Asia-Pacific. In the wake of that crisis, governments in many Asia-Pacific countries undertook a series of steps that, in retrospect, made the region as a whole better prepared for the global economic crisis relative to many Western counterparts.

Specifically, many Asia-Pacific countries undertook combinations of measures including strengthening


government balance sheets, building up foreign exchange reserves to self-insure against external shocks, intensifying supervision of financial institutions, and deepening regional economic integration. As a result, when the global economic crisis broke out in 2008, the governments in Asia-Pacific had enviably strong fiscal positions; banks there had robust balance sheets; central banks in were in possession of trillions of dollars of foreign exchange reserves to stave off financial panic; and integrated regional trade compensated for some of the lost demand from the United States and Europe.

Source: IMF; PwC forecasts


Asia-Pacific entered the global economic crisis with relatively strong public finances. In 2004-08, fiscal balances in 10 major Asian economies (China, Hong Kong, India, Indonesia, South Korea, Malaysia, Taiwan, Singapore, Thailand, the Philippines) averaged -0.6%, compared with a -3.2% average for G-7 economies.*1 The overall level of public debt is similarly low.For example, public debt in China is under 20% of GDP (excluding non-performing loans in the banking system); Hong Kong has virtually no public debt, South Korea’ s public debt is 24% of GDP, Indonesia’ s is 27%, and Thailand’ s is 40%.*2 The health of public finance allowed governments in these countries to implement substantial fiscal stimulus packages to revive growth in the depth of the crisis without

Putting f iscal houses in order

experiencing the same level of debtor pressure that countries such as Greece and Ireland suffered. As growth returns, economies in Asia-Pacific are also reporting improved fiscal positions. In fact, on average, their fiscal deficits are shrinking at a much faster rate than those of many European economies.

One key lesson learned by policy-makers in the major economies in Asia-Pacific from the East Asian financial crisis is that they must have sufficient foreign exchange reserves to combat financial panic. Thus, through tighter financial management and pro-export policies, Asian economies have amassed more than enough reserves to prevent similar runs on their currencies. Hoarding low-yielding foreign exchange reserves is arguably not the most productive way of investing

Stashing rainy-day reserves

　The Asian engine for global growth 　6

1 : ADB, Asian Development Outlook 2010 Update.

2 : 2009 estimates from CIA World Factbook.

3 : Economist Intelligence Unit.


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scarce capital. But the crisis vindicated stability-minded policy-makers (even though they for the most part did not actually dip into reserves to prop up their currencies): most Asian currencies remained remarkably stable over the past two years.

Another source of vigour for the region is the overall low level of household debt. In Asia’ s most developed economies, such as Japan, Korea and Taiwan, household debt is roughly 70% of GDP (significantly lower than in the US and parts of Europe). In developing Asia, household debt is much lower (due to the limited availability of consumer finance), roughly 10% of GDP in China and Indonesia, for example.*3 Low household debt levels in these countries are one reason why consumer demand throughout the region has remained steady during the crisis. It also provides scope for faster growth in consumer spending in the coming years.

Long derided for having ‘under-developed’ (if not primitive) financial systems, countries in Asia-Pacific significantly improved the supervision of their financial institutions following the short but devastating East Asian financial crisis (which originated, in part, from massive borrowing by poorly supervised financial institutions in

Reining in household debt

Keeping close watch

South Korea, Thailand and Indonesia). Consequently, most financial institutions avoided high-risk financial engineering and deal-making before the crisis. Overall leverage was low, and direct exposure to risky financial instruments originated in the West was minimal. So, while many Western financial giants enfeebled by the crisis grew reluctant to lend, access to credit in Asia-Pacific remained largely unimpaired during the recession and recovery.

Asia-Pacific has earned a reputation as the world’ s most dynamic exporting economic zone, with the US and Europe accounting for 46% percent of Asia’ s total exports in terms of final demand.*4 Yet the region is also becoming a more closely integrated economic bloc,

Working together

Asia-Pacific has earned a reputation as the world's most dynamic exporting zone, yet it is also becoming a more closely integrated economic bloc

thanks mostly to growth in intra-regional trade and investment. In the early 1990s, Asian economies had few linkages with one another. Since 1997, economic integration in Asia (as measured by the correlation of output) has approached intra-European levels.*5 Greater intra-Asia interdependence helped cushion the region from the fall in global trade during the crisis. Seen another way, multinationals from Asia are confident of their growth prospects going forward – but they expect their growth to come from within the region. Four out of five Asia-Pacific CEOs expect their Asian operations to grow in 2010, while only two of five believe their European operations will expand.*6 An unsung hero in Asia-Pacific’ s economic integration is Japan. Even though the Japanese economy has stagnated since the early 1990s, large Japanese companies have been pioneers in not only technological innovation at home, but also expansion of off-shore investment and production.

Those economic fundamentals, products of both fortuitous circumstances (such as high savings and restrained public spending) and effective government policies, have made most economies in Asia-Pacific resilient and dynamic. But to maintain their momentum, they need to address both short-term risks and long-term constraints on growth.

Among the short-term risks, the most prominent is that posed by large capital inflows (driven by low interest rates and anaemic growth in developed economies). Such inflows could fuel inflation, generate asset bubbles, and put upward pressures on exchange rates. China, for instance, is now combating both rising inflation and a significant real estate bubble. Trade protectionism is another risk. As trade surplus nations, often with artificially under-valued currencies, countries in Asia-Pacific, especially export powerhouses like China and South Korea, are facing a backlash from their trading partners in the West. A third risk is that of financial contagion originating in renewed financial panic caused by the debt crisis in the Eurozone. Asia-Pacific may be resilient, but it is not entirely immune to such external financial shocks.

Longer-term challenges for Asia-Pacific are more daunting.


Asian economies have grown accustomed to unlimited access to the markets in developed economies. But their export-dependent growth model has to change as part of the global economic re-balancing process. Exports to developed economies are bound to slow or fall, so Asian countries might choose to boost domestic demand, especially household consumption, to generate new sources of growth. A second long-term challenge is investment in human capital. Asian countries have done relatively well in their accumulation of physical capital, but to sustain growth and avoid the so-called ‘middle-income trap’ (a term referring to economic growth stalling before per capita income reaches US$ 10,000), broadly speaking, the region might need to boost productivity and build growth on knowledge and innovation, not on investment in capital stock.

Asia-Pacific’ s leaders seem acutely aware of these challenges, and are certain they can manage them. Chief executives from the region, for example, are simultaneously more concerned about a greater range of threats to that growth and more confident than their global peers.*7 Lessons learned from past crisis have served the region well to date. Still, the region may not be able to rely on the same tactics forever. For example, measures that allowed exporters to

build large reserves are considered unsustainable. In October, G-20 nations agreed to “pursue the full range of policies conducive to reducing excessive imbalances.”

Indeed, the more Asia-Pacific’ s economic clout grows, the more attention there will be on its integration in global economic governance. It is hard to imagine that the world will regain its pre-crisis prosperity without leadership from the rising economic stars in Asia-Pacific. But Asia-Pacific can’ t lead the world through a fragile recovery by itself; the region and the rest of world have to agree to get on the same track together.


6 : PwC 13th Annual Global CEO Survey (2010)

7 : PwC 13th Annual Global CEO Survey (2010)

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Chief executives from the region aresimultaneously more concerned abouta greater range of threats to growthand more confident than their global peers

Asia-Pacific can't lead the world through a fragile recovery by itself; the region and the rest of the world have to agree to get on the same track together

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Developing economies carry on powering the growth of the global economy,whilst some developed economies continue to exhibit weakness. Confidenceamongst consumers and businesses is weak, but increasing levels of exportsshould create growth opportunities.

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Economic growth for BRIC economies is likely to accelerate in 2010, boostedby the global recovery as well as monetary and fiscal stimulus measures.The key medium term challenge for the BRICs will be to gradually re-balancegrowth towards domestic demand and away from reliance on exports todeveloped markets - where only muted growth expected.

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