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Year of the Horse – Gallop, Trot or Stumble?

Publication Date : 17-01-2014

 

As we move into the Lunar New Year festivities, IMF Managing Director Christine Largarde is signalling that “optimism is in the air”.   In a speech on January 15, she claims that the global growth momentum will be strengthened further in 2014, mainly due to the advanced economies, but it is still stuck in low gear.
 
The good news is that the US economy is recovering confidence, helped by housing recovery and private demand.  Consequently, the Fed will begin its tapering exercise, albeit cautiously.
 
Although Lagarde says that the European economy is on the mend, the internal differences are larger than ever. The contentious global imbalances have now shifted from the shrinking current account surplus of China to the growing surpluses of Germany, which is almost three times larger than China’s surplus in terms of GDP. Europe as a whole has now moved into current account surplus, because Southern Europe, which used to be in deficit, has started to cut imports and push exports.
 
In short, it is now the emerging markets (excluding China) that are now running into current account deficits.
 
As the advanced economies recover and return to more normal interest rates, capital flows will flow out of the emerging markets. Hence, emerging markets are now staring at prospects of higher interest rates, lower exchange rates, and shortage of foreign funds to finance their own rising current account deficits.
 
Countries that had emerging asset bubbles and high household debt will need to deal with rising bank non-performing loans. For emerging markets in general, this inevitably will mean slower growth, rising unemployment and higher inflation, particularly if there are weather changes that affect food production.
 
As Largarde spun it more positively, “during the years crisis, we have relied on the emerging markets to keep the global economy afloat.  Together with the developing countries, they accounted for three-quarters of global growth over the past half decade.  However, a growing number of emerging markets are slowing down as the economic cycle turns.” 
 
Indeed, her caution is that global growth is still too low, too fragile, and too uneven. Inequality is getting more acute – since 2009, 95 per cent of income gains in the US went to the top 1 per cent of the people. 
 
In other words, the world is still teetering on a glass half full or half empty, depending on whether you are an optimist or pessimist. But the pressure is clearly on emerging markets on a number of fronts.
 
I would argue that the party for the emerging markets that everyone enjoyed during the period of quantitative easing is over. On January 2, reviewing 2013 in general, George Soros startled a number of people when he sounded a note of caution about the Chinese economy.  This week, Forbes magazine published a piece that linked Singapore with an Iceland-style crash. Singapore as Iceland?  How credible can that be? That piece went viral over social media.
 
In a follow up piece, Forbes columnist Jesse Colombo argued that it is not a bubble until it is officially denied. He pointed out that both economies are islands with finance and real-estate driven credit cycles, benefiting from a similar trend in neighbouring economies.   Specifically, he pointed out the risks posed by the bubbles in Asean economies and in China, including the higher correlation with Singapore investments in East Asia.   
 
These risks need to be assessed within the changing political environment in a number of emerging market economies. This year, there will be major elections in key emerging markets, specifically in India, Indonesia, Turkey, Afghanistan, Iraq, South Africa, Brazil, and Colombia. There may be another election in Thailand.  Election years almost always mean that economic policies to address the various risks are likely to be on hold till new governments are formed.
 
In the Middle East, as the US begins to become less reliant on imported oil because of the shale oil production at home, the political alliances are shifting in unfamiliar ways. Saudi Arabia is getting closer to Pakistan even as Iran begins to court the West, particularly since a new President was elected last year.
 
Just as Lagarde reminded us that 2014 is the 100th anniversary of the start of the first world war and 70th anniversary of Bretton Woods, we should recall that the Year of the Snake coincided with 1929 (the Great Crash) and 1941 (Pearl Harbour and Pacific War).   In that sense, the Year of the Horse has coincided with periods of great change.
 
Not being someone who believes that everything is written in the stars, the fate of the global economy is actually dependent on whether the policy makers are willing to take tough action to deal with the excesses of the last decade.
 
There is little doubt in my mind that the Chinese government is addressing these issues through the decisive decisions of the Third Plenum. But implementing these decisions will not be easy – reforming is never an easy task because all the critics will say it cannot be done and if it stumbles, they will say “I told you so”.
 
Because East Asia – China, Japan, South Korea and Asean – is de facto the world’s factory or core of the global production chain, its growth momentum will play a key factor in global growth in the run up to 2020. This means that regional cooperation, peace and stability will be crucial to the success of the regional reform efforts.
 
The global fund managers and analysts will be watching closely whether these efforts will falter, be disrupted by regional disputes or political events, and capital flows will once again be a complicating factor in policy calculations.

Whilst I am confident that the medium term outlook is still upward for the region, the bandwith of risk in Asia is widening and we will need cool heads and strong hearts to weather the choppy waters ahead.
 
Happy Lunar New Year to all.
 
Andrew Sheng is President of the Fung Global Institute.

 

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