Saturday June 16, 2012

Asia feels the heat


Europe's woes deepen amid rising risk of a Greek exit from the euro

THE eurozone crisis has been hitting Asia. It has since escalated sharply. Asian economies are hit hard in multiple ways, including slackening external demand, sluggish trade, weakening financial and supply chain linkages, volatile markets and deteriorating risk appetite.

Developments in Greece and talk of a Spain bailout have been negative. Concerns over the future of the euro and the rising possibility of “Grexit” (Greece exit from the euro) deepened on new evidence of policy inertia and a fresh spate of dire economic news that point to whatever remaining support for business activity in the eurozone splintering away.

The strong headwinds from Europe coupled with fresh signs of a slowdown in US, China and India, have since effectively erased whatever gains global stock markets had gathered since end 2011. The huge market declines have raised anxiety for investors who are now girding for a world-wide slowdown. It is nave to expect Grexit to resolve Europe's problems. As a result, Asia's emerging markets are under rising pressure to stimulate their economies just as investors, banks and enterprises are moving in the opposite direction, scaling back on lending and investing on new projects, fearing a turn for the worse in Europe. There are worries that excessive stimulus will be counterproductive in the face of serious fiscal and political constraints.

Downswing in sync

Latest reports are disturbing, indicating a new threat is emerging: activity appears to be slowing in sync around the world. Europe, struggling with the rising risk of a Greek default and broader growth problems, is now the epicentre of global concern. But reports of slowdown are turning up in the US, the BRICS (Brazil, Russia, India, China and South Africa) and elsewhere.

As in a boom, global contraction can become interconnected and self-reinforcing, and likely to spread deep and wide. Eurozone's downturn deepened with business activity falling at its steepest rate in nearly three years. The PMI (purchasing managers index) fell to 46.0 in May (less than “50” indicates a month-on-month contraction in both manufacturing and services), against 46.7 in April, the 4th consecutive decline and lowest reading since June 2009 when the eurozone was last in recession.

This is consistent with expectations of a fall of at least 0.5% in GDP in Q2 2012 official data showed the economy had flattened in Q1 2012, after falling by 0.3% in Q4 2011. Signs of weakness in business activity are also reflected in the same index for Germany (49.6) and France (44.7). The Ifo Institute's confidence index for Germany fell to 106.9 in May (109.9 in April), indicating it is no longer growing fast enough to keep the wider eurozone out of trouble.

Industrial production fell 2.2% in April (+2.2% in March) and construction output lost 6% (+26% in March), raising the risk of recession, with uncertainty weighing on sentiment. The outlook doesn't look good. Order books fell for the 10th straight month hit by heightened political uncertainty. The European Union is in a state of flux, apart from indicating that its priority remains in keeping Greece in the currency bloc. But there is a lack of strategic positioning to prevent the crisis from spiralling downwards in the absence of a clear mandate to issue euro-bonds, or for the European Central Bank (ECB) to be the lender of last resort. Also, there are no signs ECB will do more to support growth and restore overall health to the fragile state of banking.

The yield on 2-year German bonds is close to dipping below zero (now trading at below 0.1% but on the plus side). This unique occurrence simply means investors are prepared to take a capital loss as trade off for safety and liquidity. The euro sank to US$1.2455 against the US dollar on June 6, its lowest level since July 6, 2010; it also lost ground against sterling & yen. Indications are that in the event of Grexit, its new currency is likely to immediately depreciate 60% against the euro, unleashing massive contagion. Citigroup now puts the probability of Grexit, by the start of next year, at 50%-75% (from 50%).

US growth corrects

US economy has been expanding at an average 2.4% annual rate since the recovery in mid-2009. The weakest recovery on record continues to lose steam in Q1 2012, now estimated at just 1.9% (2.2% previously), down from 3% at end 2011. A string of soft US data and lack of Fed resolve kindled renewed investors' focus on broader global concerns. Risk appetite of investors had turned more negative. Over 60 years, the US recorded 11 recessions and 11 recoveries; this recovery ranks near the bottom. Job growth was just 1.9% after 34 months into recovery, below the average of 6.5%. Cumulative GDP growth was 6.8% after 11 quarters into recovery, less than half the average (15.2%), the worst of all 11. Recent growth deceleration reflected sharp cutbacks in public spending and weaker business investment (-2.1%).

However, consumer spending accelerated (+2.9%) in Q1 2012 while the moribund housing showed positive signs. More damaging was the 3rd slower-jobs report in a row, raising the jobless rate to 8.2% (from 8.1%), marking three years of unemployment at or above 8%. It is clear consumers can't keep on spending if investments are not forthcoming to raise productivity. Current unemployment also reflected the entry of 642,000 into the labour force, so its participation rate rose to 63.8% still two percentage points (three million fewer workers) below the norm.

Of concern is the report by the non-partisan Congressional Budget Office (CBO) that the economy will likely fall into recession in the first half (1H) of 2013 if the large tax increases and scheduled budget spending cuts (popularly known as the “fiscal cliff”) are allowed to come into effect in January 2013. This has the desired effect of sharply reducing the fiscal deficit but would hold back economic recovery.

CBO projected GDP would contract by 1.3% annual rate in 1H 2013 (i.e. falling into mild recession), and then stabilise in 2H 2013. Unemployment would rise to 9.3% at end 2013. If none of these happened, the economy could expand 4.4% in 2013, adding another two million jobs. Early action including Fed support is needed to avoid the “fiscal cliff”. To complicate matters, the government will hit its US$16,394 trillion borrowing limit later on this election year; the ceiling must be raised to avoid default. Gridlock poses a real recession risk.

Asia buckles under

The impact of the global slowdown, especially the effects of Europe's woes, is felt all across Asia, including its most important industries ranging from finance and services to trade and shipping to technology to mining. As a result, the International Monetary Fund (IMF) now sees the global economy moving more slowly than 2011's 3.9%, reflecting new weaknesses and significant downside risks in 1H 2012.

Emerging and developing economies, as of now, will expand 5%-5.5% in 2012 (down from 6.2% in 2011), with significant slackening in China, India, Russia, Brazil and Asean. What matters is that the weakening, in turn, means investors are taking it on the chin where it hurts most, i.e. in equities. The MSCI World Index for stocks, which track global markets, is down more than 10% since mid-March. In Asia, the trade cycle is hitting home: globally, new export orders have since started to contract. The flight to safety is boosting the allure of Asian sovereign bonds.

The yield on 10-year Japanese bonds fell to a low of 0.79%, the lowest since 2003. Investors are abandoning equities with recent sell-offs. Leading the decline early last week was Taiwan's Taiex (-3%); Shanghai Composite (-2.7%); Japan's Topix (-1.9%); and Malaysia's KLCI (-1.2%). The Japanese Nikkei is down 19% from March's peak and the Hang Seng, 16% below the February 2012 high. From year-to-date highs, South Korea's Kospi was down 11% and Australia, down 15%. Despite a recent solid bounce back, weak exports, growing uncertainty and lower risk tolerance are expected to further slowdown Asian expansion.

China out of steam: The Chinese economy is losing steam in Q2 2012 based on a slew of disappointing indicators. China's official PMI fell to 50.4 in May (from 53.3 in April), close to “50”, which separates growth from contraction. Its Q1 2012 GDP rose 8.1%, its slowest pace since the spring of 2009. Based on current data, growth in Q2 2012 will dip below 8%, down from 8.4% before the April data release; for 2012 as a whole, expect GDP to rise 8.2% and in 2013, 8.6%. Growth in industrial production fell to 9.3% (from 11.9% in March), the lowest level since May 2009, reflecting broad based weakness across two main drivers of growth investment and consumption.

Investment rose 18.7% in January-April 2012, down from 23.5% in Q1 2012 while exports rebounded to 15.3% in May, against 4.9% in April. The prime minister has since directed for “more priority to maintaining growth.” It is now likely Beijing will front-load spending after easing monetary policy on May 7, running a budget deficit of 1.5% of GDP for 2012. It has scope to ratchet up spending or cut taxes to support growth. China's debt to GDP ratio was 25% in 2011; adding on local government debt, it's 47%. Expect more spending on social welfare, and quicken construction of social housing and infrastructure ahead.

Japan growing again: A nascent recovery is at last on the way. Japan is headed for a moderate recovery as rebuilding from the March 2011 earthquake and tsunami gets into full swing and government subsidies for low-emission vehicles support demand for cars. Latest data point to a 4.1% GDP growth in Q1 2012; private consumption (70% of GDP) rose 1.1%, while exports were 2.9% higher. Public investment jumped 5.4% on mainly reconstruction work. Corporate capital spending, however, fell 3.9% reflecting the shift of production offshore in the face of the strong yen.

Bank of Japan's tankan survey showed business sentiment had remained at a pessimistic -4 in March, against December (calculated by subtracting the percentage of companies saying business conditions are bad from those saying they are good). Businesses are still concerned with power shortages and the strong yen amid a highly uncertain outlook for exports to the eurozone. Overall, GDP would grow 2% in the current year.

India's self-inflicted slowdown: GDP rose 5.3% in Q1 2012, slowest in nine years, from 9.2% in Q1 2011. Inflation is at 7% and the rupee is Asia's worst performing (depreciated 25% against US dollar since Q3 2011). India's predicament is largely of its own making: (i) central bank kept interest rates high for two years to keep a lid on inflation (with little impact since prices were driven by supply constraints in food and energy, not demand); (ii) did little to encourage foreign investment; (iii) suffered political paralysis; (iv) subjected to widespread corruption; (v) lacked business confidence; and (vi) stalled reforms. For the year, GDP is expected by IMF to grow up to 7%, but it's likely to fall far short.

Asean pushes forward: Asean-5 (Indonesia, Malaysia, the Philippines, Thailand and Vietnam) is particularly vulnerable to European uncertainty, but strong domestic demand helped to cushion the impact of falling external demand, especially Indonesia. Growth in Q1 2012 averaged about 6%, with a strong Thai recovery as it rebounded from the flooding devastation last year. Consumption remained the dynamic stabilising force. Growth for 2012 should be robust enough to average 5.5%-6%, with GDP expanding 6% plus in Indonesia and 5.6% in Thailand, while Vietnam struggles to grow. Indonesia is best insulated against external shocks because of its large domestic market, extensive natural resources and limited reliance on European and US demand.

What, then, are we to do?

Emerging Asia needs to brace itself to manage risks posed by global uncertainty to safeguard regional growth that, despite recent gains, still remains home to most of the world's poor. For the second time in four years, Asia is hit with an external demand shock emanating from recession in Europe which could turn ugly and become something far worse, triggered by contagion arising from a possible Grexit. Their impact cannot be taken for granted or even lightly. The best defence remains supporting and expanding internal demand just as economic rebalancing is the only sensible way out for China, this must be so for its partners in the Asian supply chain. Few realise private consumption fell to a record-low 45% of developing Asia's GDP in 2012. This won't do. Asia's intra-regional exports trade flows within the region have expanded sharply in recent years: from 36% of total exports in 1998 to 44% in 2012. This trade needs to be actively promoted to bring about an increasingly more autonomous Asia, especially in final goods and services, not just intermediate inputs. Therein lies the challenge, and China definitely holds the key.

Former banker, Dr Lin is a Harvard educated economist and a British Chartered Scientist who speaks, writes and consults on economic & financial issues. Feedback is most welcome; email:

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