At long last, the world's most vibrant economic region has met gravity. This
week's economic news has been all negative around Asia - whether it's the
slowdown in Singapore's non-oil exports, the bleak economic assessment of the
Bank of Japan, Vietnam's continued slide into a meltdown and the continued
inflation shocks from around the region.
It has taken a while, but the scenario I painted for the region at the end of
last year has now begun to pan out, due to a combination of higher inflation
and lower exports around the region. (See
Storm warning for Asia, Asia Times Online, January 4, 2008).
Larger economies, such as those of Japan, China, South Korea
and India, are likely to fare better than the rest of Asia, if only because of
the economic momentum accumulated over the past few years. That said, both
Japan and South Korea appear like inevitable basket cases to me, with
policymakers lacking the will and ability to make much of a difference. At the
other end of the scale, the raft of policy mistakes by China and India mean
that the coming slowdown will be unnecessarily painful.
Australia has built an impressive war chest of domestic consumption that will
push its economy forward, even as the commodity bubble implodes. Unfortunately,
the country's financial sector is in bad shape as the recent travails of banks
such as National Australia Bank and other financial companies like Babcock
& Brown show.
More problems for the country's banks - ANZ is mentioned fairly regularly as
another bank with many problems rushing now to the surface - will mean a
cutback in lending to individuals and companies alike, in effect having the
effect of hitting a brick wall while traveling at 100 kilometers and hour.
Without a functioning financial sector, Australia will have to face up to a
double whammy of falling commodity prices and falling domestic consumption.
This will be deadly for the Australian currency and its financial markets over
the near term.
On the other end of the scale, smaller economies are likely to face up to
either indifference or even irrelevance as the larger economies fight for their
own survival. This is the basis of both political and economic adjustments (see
Vanishing Minnows, Asia Times Online, December 1, 2007).
The economies of Southeast Asia will face slowing exports to Japan and China as
a result of the reduction in end-consumer demand in the US and Europe; in turn
this means a substantial wipeout of intra-Asian trade that sustains their
overall production. To make matters worse, policy mistakes of countries like
Vietnam, where the central bank has effectively scared away portfolio investors
even as the rest of the government has scared away potential investors in
manufacturing and services, reduce any chances of a quick turnaround in the
situation for Southeast Asia.
Lastly, the increased political noises in countries like Thailand, Malaysia and
the Philippines mean that investors would much rather avoid the whole region in
the next few months, waiting for the dust to settle. Indeed, this is the entire
problem of being minnows in Asia; as these countries offer lower-quality
returns to investors to start with, any increase in volatility will drive away
If Southeast Asia is to fare this badly, one can only imagine the plight of
more peripheral economies in the region, such as Pakistan, the small island
nations between Indonesia and Australia and so on; these are likely to slip
into recession and stay there for a long time.
Worst affected in this slowdown across the minnows will be foreign investors in
assets such as property who will be hurt by rising interest rates even as both
asset values and currency rates decline, thus exposing them to multiple sources
of losses. As go the property investors, so will others.
Asian Big 4
Taking a look at Japan first, where reduced demand from the US and Europe has
so far been offset by continued demand from China and South Korea for its
products. However, a closer look at these products shows that the exports to
these two countries are actually high-value intermediate products that are then
exported to the US and Europe. To the extent that the order cycle of these
products lags actual sales by a few months, Japan's numbers will hold up, after
which there will be a downward correction, much like what is being seen out of
Southeast Asia already.
With a declining demographic profile, problems in its non-bank financial sector
(a large finance company called Aiful has been in the midst of a number of
market rumors as well as a nasty spat with a research analyst from Lehman
Brothers, who wrote a scathing report but had to withdraw it under pressure)
and export slowdown, there is no hope for Japan on the horizon. The best, and
indeed the only thing, for Japanese investors to do is to scour the rest of the
world for opportunities.
In the case of South Korea, the central bank has been so keen this year to
maintain industrial export competitiveness that it has effectively bought the
inflation bogey, perhaps the only such case among the world's largest
economies. The onshore shortage of US dollars exacerbated by the central bank's
policies has also helped to create increased volatility in domestic interest
There is also the issue of substantial foreign borrowing needs for Korean banks
and companies in the next few months. While the temptation to compare events to
those of 1997 are quite high, I don't expect a full-fledged economic meltdown
for South Korea just yet, even if increased volatility will hurt stock markets
and also substantially increase borrowing costs. Korean companies that depend
on the export markets - such as car companies - will fare badly, albeit with
the notable exception of companies that produce to specific orders, such as
China has been in the middle of a pitched battle with the US for more than two
years now, relating to its currency. The inability of Chinese authorities to
forsake the goal of harmonious growth for longer-term structural benefits has
meant a massive flow of funds into the country, in turn triggering bubble-like
conditions in property and stock markets until the end of 2007. The reaction of
the authorities this year has been to promote restrictive lending policies that
have started biting banks - and a number of consumers - quite hard.
Their inability to tackle the main problem of currency reforms and instead fire
broadsides at collateral targets such as property investors has meant a poor
operating environment for both domestic and foreign investors. It is rumors of
government assistance - such as this week - that helps to push stock markets
higher, rather than simple fundamentals. It is almost tragic in a country
growing at more than 11% that its stock market halved during the year and has
only recently edged up.
Until China accepts the "elephant in the room", that is, its currency reforms,
all other policy moves are likely to prove short term. For an economy that has
quickly become one of the world's largest to sit around pretending that
policies that may suit much smaller economies can still work is abysmally
In the face of a slowdown in exports that has hurt factories in southern China,
I expect a slew of new measures to push up some sectors of the economy. This is
the strange culmination of years of messing around with the economy that the
government has to provide assistance even when gross domestic product grows at
double-digit rates. My expectations for meaningful reforms from China remain
Then we have India. I have already addressed the key downside risks of the
country in a recent article (see
Incredible India indeed, Asia Times Online, July 1, 2008). What is left
to be added to all that is the observation that things have become worse.
Government employees last week got an ill-deserved pay hike (an average
increase of 21% backdated to January 2006), which will further add to
inflation, as will other sops such as the waiving of farmers' loans and other
messy subsidies that are being doled out by politicians keenly looking at next
The only way for India to reverse its decline is for the country to cut
wasteful spending on welfare and related inflationary areas, and instead focus
on building physical infrastructure. I am not holding my breath on that score
though, and neither should you.