Asia decoupling is a myth

Asia is still linked to the G3, says Deutsche Bank in a new market outlook for 2011.

Forget decoupling. East Asia will remain tied to demand in the US, Europe and Japan in 2011, according to Taimur Baig, Deutsche Bank’s chief economist for India, Indonesia and the Philippines.

And, “since we don’t expect much vigour in the G3, there should not be much in the way of spectacular performance in this region either”, he wrote in Deutsche Bank’s Markets in 2011 report, an inaugural publication that reviews the health of the global economy and makes predictions for the coming year. The report was released yesterday.  

Baig argues that there are still “remarkably close linkages between regional exports and [external] consumption”. Even investment follows the export cycle closely, and this connection hasn't waned in recent years “underscoring why the East Asia region remains a strong beta to G3 growth".

The majority of respondents to last week’s FinanceAsia poll agreed.

Three years ago, the decoupling argument seemed compelling. While the credit-fuelled US and European economies imploded, many Asian economies could boast low fiscal deficits and debt (both public and private), generous reserves cover, sound banks, manageable inflation, and high savings. Analysts also pointed to a big pick-up in intra-regional trade.

“The expectations turned out to be premature,” said Baig.

Excluding China and India, Asia’s real GDP grew by 3.3% in 2008, followed by almost zero growth in 2009, and is expected to grow by 7% in 2010. This means, he wrote, that “through the course of this crisis, East Asian economies have revealed themselves to be tightly coupled with the fate of the G3”.

Deutsche Bank’s GDP forecast for the G3 countries is lower for 2011 than for 2010 (US: 3%, EU: 1%, Japan 0%), so it has also revised down its growth forecast for Asia – to 4.6%. “Despite the US forecast being essentially the same as the expected outcome for 2010, Asian economies will find external demand weaker because of the other two parts of the G3,” said Baig.

The close ties are, apparently, unsurprising. Simply, so many countries in the region are open and trade-oriented. Strong domestic fundamentals are insufficient to break those links.

Baig acknowledged that there is “substantial heterogeneity among the countries in the region”.  For instance, Singapore, Hong Kong and Taiwan are especially export-dependent, so their growth is largely reliant on G3 consumption. Malaysia, Thailand and Korea follow, with substantial but smaller correlations to industrial country demand. Indonesia is an exception, with domestic consumption a significant component of its GDP, but its fortunes are also “tied to the commodity price cycle to some extent”.

Baig also dismissed the notion that the region can be divided between southeast and north. Those distinctions “dissipate under closer scrutiny”. “Whether exports are going to China or elsewhere, the export dynamic of Asean [Association of Southeast Asian Nations] and North Asia remains remarkably similar,” he said.

He attributed this to China’s role in Asia as still largely a processing location for the rest of Asia’s exports – goods are exported to China, processed (often with little marginal value added) and re-exported from China (mainly to the US and Europe).

Despite the prospect of slower growth, Baig believes that inflation risks will resurface in Asia next year. Commodity prices are set to rise, pushing up the cost of food. However, only Indonesia seems vulnerable to over-heating; most Asian countries have already raised interest rates, so further hikes are likely to be gradual.

On the other hand, “the region will likely continue to struggle with managing capital inflows in the new year”, he said. Liquidity-driven surges in flows have already caused complications with regard to reserve accumulation, exchange rate appreciation, asset price spikes, and lending booms.

Baig’s conclusion is, at best, neutral.

“All in all, 2011 should not look a whole lot different from 2010. In our view growth will slow and inflation will rise, but only somewhat,” he said.

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