Asia is down, but not out

Asian economies will suffer as exports decline, but they are in better shape to ride out a recession û both compared with the rest of the world and their own situation 10 years ago.
As indicated by the multitude of depressing data released over the past few months, AsiaÆs economies are in for a rough ride this year and most countries will see a significant slowdown in GDP growth compared with 2008. But, says Dong Tao, chief economist for non-Japan Asia at Credit Suisse, itÆs not all doom and gloom as Asia ex-Japan will still outperform the rest of the world, growing at a weighted average of 5.2% this year and 6.5% in 2010.

A large part of the growth will be the result of various fiscal stimulus packages û especially in China û but Tao also argues that Asia is better positioned than the rest of the worldÆs emerging markets to ride out the recession because the region is rich in capital, meaning its funding needs are not that great. Countries like Indonesia, the Philippines, India and Korea will be more vulnerable, but overall the region is in okay shape. That said, Asia will still go through a rather painful time due to the decline in exports and it will not be spared the negative wealth effect caused by slumping financial markets and asset prices, as well as upcoming salary cuts.

Even at Goldman Sachs, where the economists are more pessimistic about the level of growth over the next couple of years, there is a general recognition that Asia is in a better position now than at the beginning of the Asian financial crisis in 1997. Importantly, most countries now have a current account surplus and regional currencies arenÆt overvalued. In addition, the proportion of short-term debt to reserves has improved dramatically since the 1990s and, except for Korea and India, the loan to deposit ratios are lower.

However, these improvements will matter little, GoldmanÆs chief economist for Asia ex-Japan, Michael Buchanan, argued at a separate press briefing, if there is no confidence to lend and spend.

ôWhatever these risk metrics tell you, this really is a confidence game. There are no magic thresholds,ö he says, noting that reserves are still less than half of deposits in all Asian countries. Even in China they are only about one-third.

Tao also notes that the downturn is nowhere near over. ôFor the financial markets perhaps the worst is behind us and the risk of falling off a cliff has receded. But the global recession has barely started,ö he said at a press conference yesterday.

Both Tao and Buchanan project a rebound in growth in 2010, but say it will be driven by fiscal spending both in Asia and the US. Both banks expect a 1.6% contraction in US GDP in 2009, but while Credit Suisse is projecting 3.5% growth in 2010, GoldmanÆs less optimistic projection calls for only 1.3% growth. Goldman also expects Asia to grow at only 4.4% in 2009 but to pick up to 6.8% in 2010.

China, which announced a Rmb4 trillion ($587 billion) fiscal stimulus package in November, will be aiming for 8% growth, but Tao says it will be a battle to keep the economy ticking over at just 7% as there is unlikely to be any new ôsuper factorsö to drive the growth, like the WTO entry and housing boom which have been key drivers of the economy over the past five years. Still, Credit SuisseÆs official forecast is that China will grow at 8% this year and at 8.5% in 2010 û significantly more optimistic than GoldmanÆs projection of just 6% growth this year. However, the US investment bank does see the potential for 9% growth in 2010, although much will depend on continued government support.

ôTimely and effective fiscal and monetary stimulus in China and the rest of the world will be essential to reach these growth rates, given extremely weak near-term momentum,ö Buchanan says.

Tao acknowledges though that this will be lower quality growth, and with regard to the US, the fiscal spending planned by president-elect Barack Obama will primarily be in areas such as alternative energy and construction û none of which will have much impact on imports from Asia. It remains to be seen whether the public spending will help jumpstart the private sector. ôUntil then, this growth is artificial,ö Tao says.

The key problem is that banks, despite the large bailouts, are still not interested in bailing out the real economy by lending to companies and consumers. Whether or not they decide to start lending in bulk again will be crucial for how the global economy will develop over the next 12 months, Tao says. With interest rates close to zero in large parts of the world, there is massive liquidity in the system but if the banks donÆt start lending the most likely scenario is a global version of JapanÆs last 10 years when asset prices failed to go up despite huge liquidity.

If they do start lending again, the global economy is more likely to return to the situation during GreenspanÆs final four years when the threat of inflation disappeared and asset prices went through the roof. For that to happen, Tao notes, the equity base of the financial industry first needs to be repaired and the banks will also need to have more visibility with regard to bad loans. At the moment, the credit default swaps market is projecting that a quarter of all companies will fail, which makes the banks uncomfortable to lend to anyone. However, while the latter scenario (a resumption of lending) is clearly more desirable, there is a risk that it could lead to a repeat of the asset bubble, Tao warns.
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