SAARC continues to be resilient amid turbulence

SAARC, as a regional bloc, was set up in 1985 with the aim of promoting the welfare of the people of South Asia, to accelerate regional economic growth, strengthen collective self-reliance and contribute to mutual trust, understanding and appreciation of one another's problems in the region. Since then, our nations have come a long way. They share a common goal of sustainable economic development, and face several similar developmental challenges. In terms of GDP (gross domestic product) based on purchasing power parity (PPP), SAARC's share in the globe has increased rapidly from four per cent in 1980 to nine per cent currently. However, SAARC nations also make up 24 per cent of total world population. We do need more growth, and do need to do more to support each other in this quest. Intra-regional trade accounts for a measly five per cent compared to 66 per cent within EU (European Union).

However, today, I will not be talking of SAARC alone but the challenges SAARC faces in the context of globalisation. The world has become increasingly interdependent, with the strengthening of economic and financial linkages within geographic regions and across regions. Globalisation has brought several economic gains and improved consumer welfare, but at the same time exposed economies to spillovers from disturbances in one part of the geography to another.

Amid such growing vulnerabilities and imbalances, SAARC region shows continued resilience in the face of turbulent international markets, maintaining its spot as the fastest-growing region in the world. Average growth in the region has outstripped the average growth of emerging market and developing economies throughout the post-crisis period. The outlook for the region has also improved as a result of significant disinflation in the region during 2014-16. However, within the region, growth trends have diverged temporally and spatially.

Moreover, the region is now facing newer challenges arising from uncertainties in other parts of the world. Possible moves by the US Fed, a potential rebound of oil prices, possible Brexit, geopolitical risks in the Middle East and volatility in financial markets due to risk-on or risk-off sentiment are some of the possibilities we have to anticipate. However, when we decided the theme of this conference, a common uncertainty that confronted us was the possible sharp slowdown of the Chinese economy.

Over the past two decades, China has emerged as a powerhouse of global production. China eclipsed the United States in 2013 to become the world's largest trading nation. As per WTO (World Trade Organization) data, China was the world's largest exporter and second largest importer in 2014 accounting for 12.4 per cent and 10.3 per cent share, respectively. The United States accounted for 8.6 per cent of the world's exports and 12.7 per cent of the world's imports. So it is clear that a slowdown in China will affect the global economy, including the SAARC region. The sharp contraction in China's imports over the past year has already led to spillovers through the trade, confidence, tourism and remittance channels. SAARC nations have not been able to avert its impact. More negative externalities could follow as Chinese economy adjusts to a more sustainable path.

Not only has China had to rein in production as a result of weak post-crisis industrial country demand, it has also suffered from weak aggregate demand of its own, as it shifts from an investment- and export-led growth model to a consumption-led model. Combined with the previous bouts of leveraged expansion, China now has a number of sectors that suffer from the twin ailments of overcapacity and high leverage. Bad loans in the banking system are likely to grow over current levels - stressed loans are estimated to be around 5.5 per cent of the bank loan book today. In addition, there may be serious weaknesses in the shadow banking system, which could feed back to banks. Clearly, cleaning up the financial system will be a challenging but necessary task.

Work at the IMF (International Monetary Fund) suggests that a one per cent permanent negative shock to China GDP caused by a one-off one percentage decline in its real GDP growth will knock off 0.23 percentage points from global growth in the short-run. A key question is whether we in the SAARC region are at significantly more risk than others. The answer probably is no because none of us is primarily commodity exporter to China, but it cannot be an unqualified one. Trade could be impacted due to second round effects - we export to those who traditionally export to China and have thus slowed down - and due to similarity in trade patterns with China we compete with those who now have excess production capacity.

On the financial side, exposure to China is large for the Asia-Pacific banks, especially for banks from Hong Kong, Singapore and Australia and much less for banks from our region. However, some of our countries, though not India, have significant borrowing from Chinese banks, and these borrowings could become costlier if Chinese banks turn inwards. Moreover, financial market losses in China can heighten the risk premia that industrial country investors will charge for investing in our region, and the result could be capital outflows of the kind that were seen last August and early this year.

Chinese growth will depend not just on its policies, but on growth elsewhere in the world. There appears to be a general consensus that global growth has been too slow for too long. The IMF downgraded its outlook for global growth in 2016 and 2017 by 0.2 and 0.1 percentage points, respectively. It is true that downside risks and uncertainties to the global outlook are large in the backdrop of event risks I have alluded to. However, a more careful look at the data suggests some care in jumping to the conclusion that growth has been slow. The fact is that after the small contraction in 2009, global growth has averaged 3.8 per cent during 2010-15 and is still expected to be 3.2 per cent in 2016.

What this means is that growth in the period before the financial crisis was perhaps goosed up by borrowing, and the post-financial crisis period is not so bad in comparison, especially if we account for the deleveraging that has taken place in industrial countries. The question of why underlying industrial country growth has slowed in recent years is still being debated, and the answer probably lies in the hard-to-understand effects of population ageing and productivity slowdown. While stronger global growth may be just around the corner, it may yet be some time in coming. It might therefore be optimistic to expect that China will be lifted by global tides, and it will probably have to undertake the needed policy adjustment without the tailwind of global growth.

Edited excerpts from Reserve Bank of India Governor Raghuram Rajan's address, "Impact of Chinese Slowdown on SAARC Region and Policy Options", at the SAARCFINANCE Governors' Symposium, in Mumbai, May 26