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Speed bumps ahead as Asia's economy picks up

Publication Date : 07-01-2014


The global economy rang in 2014 on a festive prophecy of a better performance this year.

Growth in the developed world is picking up pace, buoyed by still-low interest rates, with households and companies enjoying their healthiest finances in years.

This is helping to moderate the slowdown in emerging economies. As a result, global indicators of business health - such as surveys of factory purchasing managers and company and consumer confidence - are mostly on the rise.

Inflation, the usual flip side of higher growth, is also expected to stay subdued this year owing to stable commodity prices. This will allow policymakers to keep credit conditions loose a little longer, fuelling borrowing and spending.

Another cause for champagne: Tail risks, which refer to unlikely but significant shocks, will be less salient this year, said economist Nouriel Roubini, who is credited with predicting the recent global financial crisis.

"The threat, for example, of a euro-zone implosion, another government shutdown or debt-ceiling fight in the United States, a hard landing in China, or a war between Israel and Iran over nuclear proliferation, will be far more subdued," he said last week in a commentary for online think-tank Project Syndicate.

Still, the stars are not all perfectly aligned. Global growth is expected to improve from last year, but will still likely undershoot its pre-global financial crisis levels.

China, which has been in the driving seat of the world economy, struck an inauspicious note in the first days of the new year. Gauges of both manufacturing and services activity fell to four-month lows, underlining the world No.2 economy's struggle to keep its economic engine humming while trying to plug its structural gaps.

Complicating matters is the United States, whose central bank this month starts the delicate task of unwinding its unprecedented monetary stimulus. Ripple effects are expected around the globe.

The US taper and China slowdown will be two major economic themes this year, but they are not the only ones. Here are four other areas to keep an eye on as well.

Asia's year of reckoning

Asia's key challenge this year will continue to be adjusting to the fact that the days of easy money lubricating the wheels of economic growth are over.

Countries that have been over-reliant on plentiful external funding or cheap debt to fuel growth will have to prepare for the pain of less liquidity and rising interest rates, as the developed world weans itself off extraordinary monetary stimulus.

So far, Asian economies have got off to a good start. The US Federal Reserve last month announced its long-dreaded decision to start injecting less money into the financial system and, despite pronouncements of doom, the impact was not serious. This was partly due to the Fed's assurances that US short-term interest rates will stay low for some time, helping to slow the reversal of money flows from emerging markets back to the US.

Vulnerable countries such as India and Indonesia have also put in place measures to reduce their reliance on inflows of foreign capital. But this may not be enough, especially if the US economy grows faster and interest rates rise more quickly than expected.

"The biggest risk to Asia is an unexpectedly strong performance of the US economy that would force the Fed to act more aggressively," HSBC economist Frederic Neumann said last week.

India, in particular, has shown less commitment to reforms than its peers in the region, China and Japan, which are both embarking on significant structural changes. Among other things, it needs to reduce food and fertiliser subsidies, accelerate infrastructure projects and slash business red tape.

For other Asian policymakers, different adjustments are on the cards - such as corrections in property markets, where asset values have jumped the most since the global financial crisis.

This is already playing out in Singapore: Private home prices fell in the last quarter of last year in their first decline since 2009. Going by market oracles, Hong Kong will be next in line.

China's credit crunch

As Asia prepares for the slow drying up of global funds, China is already in the throes of a liquidity crunch that is likely to remain a recurring theme this year.

Over the Christmas period, the interest rate that Chinese banks charge to lend short-term funds to one another hit a six-month high, capping a year of spiking rates amid a credit shortage.

The underlying problem is that banks have become reliant on the unsustainable practice of using short-term interbank borrowings to finance long-term lending, HSBC economists Qu Hongbin and Sun Junwei said last week.

To discourage banks from piling on more debt, Beijing has held back pumping money into the financial system, regardless of demand for capital. This move towards a tighter monetary policy, without a clear signal of and support for a desired short-term interest rate, has resulted in huge volatility in rates.

"Until policymakers start to target a short-term interest rate and underwrite it, we are likely to see more of such episodes," said RBS economist Louis Kujis.

The worry for the rest of Asia is whether this credit crunch could further damage growth in China, a key export market.

China's growing shadow banking sector - lending by trusts that fall outside the heavily regulated banking sector - relies to varying degrees on market interest rates. Such rates now have a greater influence on households and companies' borrowing costs than before, when interest rates were mostly determined by individual banks, Mr Kujis said.

"This, in principle, means China's monetary policy transmission mechanism is moving in the right direction. However, unnecessary spikes are now more damaging to the economy than before."

Disinflation and deflation

Halfway across the world, the central banks of the West are facing a different problem.

Despite flooding their financial systems with money, inflation remains at surprisingly - some say maybe damagingly - low levels.

"In the US and Europe, in particular, central banks are faced with a troubling dilemma: Even as activity has picked up, disinflationary pressures appear to be building," said HSBC economists Stephen King, Karen Ward and James Pomeroy.

"Should central bankers consider a tightening of monetary policy in response to the better real economy data or, instead, should they keep policy loose in response to an increasing threat of deflation?"

Disinflation is a slowing of price increases. Deflation, a problem associated with the Japanese economy in recent years, refers to a situation where prices actually fall.

The disinflationary trend raises two issues, said HSBC's Neumann. If prices and wages rise too slowly or not at all, profit growth suffers, as does a borrower's ability to repay his debt over time.

Across much of Asia, inflation is also generally expected to stay low and steady as commodity prices remain weak. Notable exceptions are India and Indonesia.

But Moody's economist Glenn Levine said there is little risk of deflation in most of the region. "Central bankers will remain relaxed about inflation, with most looking to begin lifting rates towards the end of 2014," he wrote last month.

Crunch time for Abenomics

The one major developed country bucking the disinflation trend has its own set of concerns this year.

Japan's economic comeback was a major theme last year, thanks to its leaders' vigorous efforts to throw off the country's endemic deflation and weaken the yen, giving a boost to exporters.

Tokyo celebrated the new year with its highest inflation in five years, just days after its Cabinet said it would drop the word "deflation" from its economic reports for the first time in four years.

Last month, the powerful Keidanren business lobby agreed to recommend raises in Japanese workers' base pay for the first time in six years, plugging some of the gaps in Japan's recovery.

But Prime Minister Shinzo Abe's economic revitalisation policies of "Abenomics" face a crunch this year as the impact of a weaker yen wears off. To avoid leading Japan into "Abegeddon", he must step up his economic reform momentum, get consumer demand over the economic bump of the April sales tax hike and not be distracted by a nationalist security agenda.

Meanwhile, other risks dot the horizon. This year will see its fair share of political uncertainties, arising from elections in India, Indonesia and Thailand.

The euro zone, while relatively disaster-free last year, is also still struggling to get back onto a sustained growth path.

Still, for now, there is more to cheer than to worry about. The worst of the global financial crisis has faded into the background, conditions are ripe for growth without overheating, and policymakers remain vigilant. This may be the year the world economy finally lives up to its optimism.


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