Will weak external demand derail emerging Asia’s growth?

Standard & Poor’s Paul Gruenwald discusses the economic outlook for the region, concerns about a potential slowdown in China and key economic risks facing the region.

Will weak external demand derail emerging Asia’s growth?
Paul Gruenwald

Emerging Asia’s economic fundamentals remain strong but growth in some parts of the region remains reliant on demand from the developed economies. Paul Gruenwald, Asia-Pacific chief economist at Standard & Poor’s, analyses the outlook.

What’s your economic outlook for emerging Asia as a whole in 2013?
In our view, emerging Asia’s strong domestic fundamentals but weak external demand makes for a decent, but sub-par year in 2013. We liken the situation to flying an airplane without all the engines working. Put simply, the region as a whole (but not necessarily every economy) will struggle to attain its potential growth. But signs of a turnaround are already evident as activity indicators such as the purchasing manager’s indices have begun to rise again, and export growth has started to rebound. The issue is whether this momentum will continue.

We forecast a modest pickup in growth in emerging Asia this year (see table 1). The region as a whole is forecast to grow 6.5% in 2013, rising to 6.8% in 2014, as the recovery in the US gains momentum and Europe begins to emerge from its recession. China will lead the region with 7.9% growth this year and 8.0% in 2014.

Which economies in the region are leading the charge and which ones are struggling?
China again will lead the way in emerging Asia, with an assist from the ASEAN-5 countries (Indonesia, Malaysia, Philippines, Thailand, and Vietnam). Those economies are less open and more domestically driven, and therefore continue to enjoy relatively high and stable growth rates.

We believe the newly industrialised economies (NIEs) like Hong Kong, Korea, Singapore, and Taiwan, also known as tiger economies, will continue to struggle, as will India. The NIEs are more dependent on external demand for growth and are more exposed to global developments. Over the past five years, these economies have tended to outperform in strong global growth years and underperform in weak ones.

With the US economy gaining some steam but still growing below potential, Europe in recession, and China growing near trend, the global outlook for both growth and trade remains subdued. We would thus expect the less open ASEAN-5 economies to continue to outperform NIEs in the near term.

There have been some concerns about China’s slowdown. How is China’s economy faring?
China’s economic data for early 2013 strike us as consistent with steady growth. Despite the siren call of some in the blogging community to lower expectations for China’s growth, we maintain our baseline forecast of real GDP expanding at about 8% annually. We also expect moderately rising, but still-low inflation.

The reason for our relatively sanguine view is that Chinese growth continues to be investment led. And at the risk of being overly simplistic, the model is based on state banks lending to state-controlled enterprises implementing the state’s five-year plan. Moreover, China’s investment is entirely domestically financed. But the efficiency of that investment and the knock-on effects on bank balance sheets are certainly a legitimate concern.

We characterise the current policy stance in China as close to neutral. In our view, this stance makes sense, given that the economy is growing at trend and the output level is close to potential. A modest fiscal deficit of 1%-2% of GDP, a low debt-to-GDP ratio, and moderately easy monetary conditions suggest that the authorities are well-placed to respond should either downside or upside risks to growth eventuate.

You mentioned that India would continue to struggle. Can you provide more details on India?
India continues to struggle, grappling with low growth and relatively high inflation. GDP growth fell to barely 5% in 2012, from an average of more than 9% in the years leading up to the global financial crisis of 2008. Inflation in India remains the highest in the region. Wholesale price inflation, our preferred measure of price pressure, stood at 5.96% in March, down from 6.84% in February.

India’s relatively high inflation and loose fiscal stance complicate the policy response to slower growth. Rising spare capacity in the economy suggests that the central bank has room to ease further. Although the Reserve Bank of India cut its benchmark repo rate in March, that is still the highest nominal policy rate in emerging Asia. Given still-high inflation, the sizable central government fiscal deficit of 5.1% of GDP, and the resulting policy mix, the scope for aggressive rate cuts by the Reserve Bank seems limited.

As the global recovery struggles to gain momentum, do you see any downside risks to emerging Asia from the US and Europe?
Although our baseline forecast shows a pickup in growth, we see the balance of risks facing emerging Asia to be on the downside. Moreover, we see the following risks as emanating from outside the region:

US double-dip recession. This would lead to another possibly sharp downturn in emerging Asia’s export growth, which has just recently turned positive. The high-beta NIEs would take the hardest hit as they are most exposed to global growth and trade; Singapore and Hong Kong would likely slide into recession. We expect the ASEAN-5 countries and China to be relatively insulated from such an event. Pressure on asset prices and emerging Asian currencies could wane in this scenario.

Another eurozone debt-related flare-up. This risk, which we think has been contained for now, would almost certainly be a major “risk-off” event, with capital exiting emerging markets generally, credit availability drying up as investors seek liquidity, and global trade and growth slowing. In Asia, the countries with current account deficits—India and Indonesia—would find their currencies and, to a lesser extent, growth coming under pressure (both are domestically led economies). Activity would slow sharply everywhere, again concentrated in the higher beta economies.

What other potential risks could impact your baseline forecast for emerging Asia?
We see rising risks, though still manageable, in the nexus involving China’s wealth products, trust companies, and property sector. Should part of this nexus come under stress, the impact on the Chinese banking system and real economy could be significant; data to make an informed assessment are not available. We can conjecture that a hit to investment, confidence, and commodity demand would have material effects on Chinese growth, global confidence (given that China has been the largest contributor to global growth in recent years), and commodity demand. The impact of the latter would fall heavily on countries most exposed to China’s investment-related commodity demand — Australia and Brazil.

Another weakening in the Japanese yen is another potential issue we are watching. Unlike the recent 30% depreciation of the yen against the US dollar since last October, which effectively retraced its post-crisis rise, another sizable depreciation would entail a significant loss of competiveness in Japan’s major export competitors: Korea and China.

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