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Credit risks will remain for Asia-Pacific in 2014

Standard & Poor's says credit conditions could tighten in 2014 and become more volatile as QE tapering impacts market interest rates.

What’s your outlook for Asia-Pacific economic growth in 2014? How will the major economies perform?

Although we recently maintained our  base-case growth outlook for Asia-Pacific as a whole, our confidence in the overall economic picture has improved. Regional growth has largely disappointed in the third quarter of 2013, although China surprisingly rebounded.

We continue to forecast an improvement in 2014, driven by slight pick-ups in US and European growth, but the extent of the rebound is now less than we initially thought given the strength of headwinds in the US economy. Overall, the region's GDP growth will continue to be slightly below trend in 2014 at about 5.4%.

China's economy is on track to grow by 7.6% in 2013 after its unexpectedly strong performance in the third quarter, and we forecast 7.4% in 2014.

The outlook in the more trade-dependent Tiger economies of South Korea, Taiwan, Hong Kong and Singapore continue to be more dependent on global economic conditions than other economies in the region.

We forecast real GDP for this group - which is led by South Korea - to grow by 3.5% in 2014. Structural rigidities and low investor confidence will likely hold India to a sub-par growth rate this fiscal year, but we expect the recent reform momentum to enable a return to about 6% moving forward.

Japan has been the major upside surprise this year but we expect the consumption tax hike to shave off some of this momentum. We are forecasting 1.4% growth in 2014, followed by 1.2% in 2015. Finally, Southeast Asian economies continue to have resilient domestic demand but recent market stress caused growth to ease by raising costs of borrowing for consumption and investment.

With China's growth more stable and European growth appearing to have bottomed out, have you seen any changes of major risks facing the region?

In Asia-Pacific, the two main macro risks to the region's economic growth over the past year have narrowed. First, China's growth appears to have stabilized at around the authorities' 7.5% target, and the risk of a hard landing in the near term appears increasingly unlikely. Second, financial market stress stemming from speculation about the US Federal Reserve's QE tapering has eased for now.

Nevertheless, capital outflows from Asia could return once the Fed does start to taper. In terms of global developments, weaker growth in the US will be partially offset by stable growth in China and slight improvements in Europe, resulting in a largely steady pace of external demand facing Asian economies for this year and next.

Nonetheless, structural risks remain in China, particularly in the financial sector. These appear manageable in the near term but we believe policymakers are serious about gradually shifting out of the investment/credit-led growth model to a more sustainable consumption-led growth path. As such, we believe that China's overall growth rate will continue to ease from this year to next.

Do you expect steady interest rates across the region in 2014?

We see very little impulse to move policy rates in either direction over the next year, with rates already very accommodative and inflation largely benign. The exception would be the Reserve Bank of New Zealand, which is likely to tighten settings steadily due to concerns about the possible overheating of the housing and construction market.

India and Indonesia have tightened ahead of the rest of the region, reducing the need to raise policy rates further. China will likely hold its main policy rate steady while increasing the relative importance of its open market operations within its policy toolkit.

Finally, we would not rule out the Bank of Japan increasing its rate of asset purchases to try to counter the effects of the consumption tax hike on disposable income and confidence.

However, we anticipate that market interest rates of longer tenors are likely to creep up in 2014-2015 as the US economy recovers and the Fed tapers its asset purchases. A critical part of this process will be the strategies of central banks in managing interest rate rises as they change the relative funding costs of issuers in the region.

What are the key risks to Asia-Pacific sovereign ratings?

Disorderly market responses or inappropriate policy responses to the withdrawal of quantitative easing remain a key risk to sovereign creditworthiness.

Relatively high levels of domestic credit in important economies - including China, Korea and Australia - constrain monetary policy as a counter-cyclical tool in another economic slowdown. Stimulating credit growth further with monetary easing could increase financial risks even if it lifts short-term growth.

And while China appears intent to keep annual real GDP growth above 7%, the risk that growth decelerates more sharply than policymakers expect - at least temporarily - cannot be ruled out. In this scenario, pressures on economic growth could spread across Asia-Pacific. This could have implications for the ratings of some sovereigns if the policy responses are insufficient to limit the impact on credit fundamentals.

Finally, a renewed global slowdown triggered by a deepening of Eurozone banking sector problems or further US fiscal policy uncertainties could bring downward pressures on sovereign ratings in this region. The impact would be magnified if global financial market instability develops at the same time.

As of end-November 2013, there are three long-term sovereign ratings with negative outlook and none with positive outlook in Asia-Pacific. All of the remaining 19 long-term sovereign ratings in the region carry stable outlooks.

Which sectors are most affected by the lower growth trajectory and which ones are better placed?

While Asia-Pacific's economic growth is steadying, the lower growth trajectory, coupled in some cases with cyclical downturns, is testing some sectors. Sectors that are most affected are those grappling with lower economic growth and, in some cases, cyclical downturns. These include: chemicals, building materials, metals and mining, public finance, and financial institutions. Other sectors facing strain include utilities, capital goods, retail, project finance, and transportation.

Somewhat better placed are the insurance, oil and gas, consumer products, and transportation infrastructure. Best positioned, although some still with some slight negative bias, are issuers in real estate development, diversified, automobile original equipment manufacturers and suppliers, gaming and entertainment, high technology, real estate investment trusts (Reit), and telecommunications.

What’s the credit outlook for the Asia-Pacific banking sector?

Compared with other regions, Asia-Pacific's banking sector shows resilient credit standings, demonstrated by no changes to the any of the region's respective economic and industry assessments under our Banking Industry Country Assessment (BICRA) in 2013. BICRA determines the anchor rating for all banks in the system which is the starting point in assigning an issuer credit rating.

Financial institutions in the region will continue to be challenged with downward pressure on asset quality. Sluggish economic conditions combined with high level of corporate and household debt in some major economies will impose stress on banks' asset quality. We expect credit costs would surge but not increase sharply and harm banks' capitalization.

The author of this article, Andrew Palmer, is Asia-Pacific regional criteria officer at Standard & Poor’s.

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