Deutsche's chief economist reports on Asia

Norbert Walter discusses Asia's on-going growth, the obstacles to further development, the subprime crisis, the bond market and the environment.
Norbert Walter, chief economist at Deutsche Bank, reports back from his fifteenth annual trip to Asia, sharing his observations on the region.

Among the main issues that booming Asian economies continue to face is recruiting and retaining talent, with wage pressures high across the board. Demographic issues, immigration, education remuneration systems and the quality of human resources are also major concerns, particularly in Shanghai.

Business concerns, therefore, focus on how to get hold of the necessary supply of labour and capital goods to meet demand. Even those countries facing military threats or political instability are displaying strong growth, and countries like the Philippines û which until recently suffered major fiscal problems û have made considerable progress in reducing their fiscal deficits. Malaysia has also posted vigorous growth, driven by increased momentum from its services sector. In general, all Asia countries û including Japan û are performing well.

ôCapacity utilisation has reached a new height, hiring is in full swing, investment activity and the securing of resources supply is on everybodyÆs mind,ö says Walter.

Nonetheless, political and security concerns remain in countries such as Sri Lanka, Pakistan, and Burma. Democracy and stability in Thailand are still not secured, despite the referendum after last yearÆs coup. The Pakistan/India conflict remains unresolved, while preferential treatment for Muslims and the dominance of Sharia law over state law is exacerbating ethnic tensions in Malaysia.

In terms of infrastructure, Walter is struck by the differences among the countries in the region.

ôWhile often per capita income explains these differences, there are many examples where it does not. The view from my hotelÆs gym in Shanghai showed the most modern skyline on the globe today (maybe excluding Dubai), and this is a country with a per capita income of only $2,600, i.e. slightly more than 10% of EuropeÆs level.ö

Walter argues that more attention should be given to the smaller, vibrant, growing countries in Asia, such as Vietnam, often overshadowed by China. Such negligence is surprising, says Walter, given the ease of travel, the convenience of e-mail and the need for a better division of labour.

Language barriers remain an important issue, he continues. Except for the Chinese, whose widespread lack of English skills is clearly not hindering their economy, English will play an increasing role if services become more important than manufacturing. India clearly has an advantage here, but so do the Philippines, Hong Kong and Singapore. Countries such as Indonesia and Thailand, however, face greater challenges.

Concerning demographic issues across the region, population aging and shrinking is already beginning in Japan, with Korea following close behind. Singapore is already implementing measures to encourage immigration. China is also discussing the issue, but it is low on the agenda compared to more pressing concerns such as creating jobs.

Walter observes that the region is not addressing the issue through the Asean+3. This is surprising, he states, since the considerable migration among Asian nations û often temporary - is an important part of economic improvement.

ôMigration countries enjoy high and stable remittances (Pakistan, Bangladesh, Philippines) and sending countries enjoy better services (Singapore, Hong Kong), or benefit from the supply of labour, for example, to the construction industry (Middle East countries).ö

As for the effects on Asia of a potential global slow-down, Walter is confident the region will be relatively unaffected. However, spillage into US consumer spending such as cars will affect suppliers and car producers elsewhere. Moreover, the recent devaluation of the US dollar will limit the price competitiveness of foreign companies.

However, the robust Chinese and Indian economies, which feed on domestic momentum, will ensure that Asia will be less affected than in earlier cycles. The continuing growth of emerging markets implies that demand for energy, metal and agricultural commodities will remain high. A shift towards animal protein in fast-growing countries like India and China, as well as the alternative use of agricultural products as biomass for energy is helping the surge of demand for agricultural products. This will benefit both farmers and forest owners as well as makers of machinery for the agricultural sector. Indonesia, Vietnam and Malaysia will get the biggest boost from this.

AsiaÆs strength is also allowing it to weather the on-going subprime crisis relatively well. Today, Asia is not over-indebted, having amassed a large buffer of sovereign reserves following the hard lessons of the Asian financial crisis. FX rates are far from being in danger of tumbling, and are in fact set to rise, while companies are currently posting their highest ever profits û as opposed to being overly leveraged as they were during the new economy crash of 2001. These are enabling them to make daring investments, including huge take-over bids.

Furthermore, stock valuations are at or below historical average level, indicating an ideal investment opportunity in Asia and worldwide.

ôThe only consistent explanation for the stockmarket correction under these circumstances was the urgent desire of companies to shield themselves from a liquidity problem in the period of turmoil by selling the assets that were considered liquid."

While Asia's growth story holds true for most of the region, Japan still remains unable to emerge from its deflationary bias. Suffering from weak domestic demand and no inflation, interest rates remain at 0.5% (in part due to the financial markets, but primarily due to the state of the domestic economy). The differential between Japan and the rest of the world is substantial, and still invites the carry trade of the type that contributed to the recent asset market bubbles.

ôOnly a very weak yen, which makes an appreciation likely, will discourage such carry trades if the interest rate differential persists, but a significant undervaluation of the yen pleases neither the US nor Korea, nor Germany. Therefore, there seems to be no way out of this 'cul-de-sac' ö.

As for the bond market, Walter sees two distinct trends: any risky issuers at this time will have challenges, although deals are still able to be done. However, low-risk securities like quality government bonds will continue to attract good demand.

Asia provides a welcome opportunity for investors to diversify their portfolios, since many own far too many US treasuries and Japanese government bonds, and can benefit from exposure to Asia's sovereign bonds. "People want to diversify in assets from countries with rock-solid economic policies and momentum, such as South Korea, Singapore and Malaysiaö, he continues

There is also stronger momentum in local currency deals. ôThe sub-prime crisis has turned out to be an unexpected catalyst for the domestic bond markets in Asia. With the dollar being weaker, investors are starting to look at other currencies. "

Finally, Walter ends his report with an encouraging assessment of AsiaÆs approach to environmental concerns. He observes that many Asian governments, particularly Singapore and China, are willing to tackle environmental and energy challenges.

These efforts, he concludes, will hopefully complement the successor to the Kyoto Protocol, currently being arranged by Germany and Japan. Meanwhile, JapanÆs G8 leadership may set the stage for an improved US attitude regarding its environmental policies.
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