We have just published our 4Q07 Eye on Asian Economies. As may be
guessed from the title: Apocalypse begins, changes in this quarter, are
typically downgrades. We have cut our projections for 2008 growth in all
but four countries. Across the ten Asia ex-Japan countries we forecast our
2008 growth forecasts are down 0.5ppts from the third quarter EoAE (our
Japan forecast has been cut 0.8ppts). For the same ten countries our 2008
GDP growth projections are 2.4ppts below consensus (we are 2% below
consensus for Japan in CY2008).
We have reinstated aggressive US rate cuts in our forecast, a decision
vindicated by the Fed’s 50bp cut on Tuesday. This creates the potential for
Asian rates to come down. However in a number of countries rates are
already so low, thanks to the liquidity inflows in the last two years, that it
is unrealistic to expect Asian central banks to match US cuts one for one.
On the contrary the reversal of these flows means that rate cuts in many
places will be limited (and we expect a small increase in T-Bill rates in the
Philippines). We see the greatest prospects for interest rate cuts in
Singapore and Hong Kong.
Last week’s Triple-A introduced the changes to our forecasts for the US, EU
Japan and China. Though there are few changes to our numbers for 2007 – a
sharp US slowdown has been in our forecast since the start of this year – the
scale of the credit unwind in the last quarter has caused us to move back the
point at which we expect the US economy to recover from 2H08 to 2H09. We
have made a similar change to our EU forecast, greatly moderated the upturn
we expect for 2008. Economic data have been softer than we expected in the
last quarter and the EU financial system is likely to be no less affected by the
credit and risk unwind than that of the US. Following the revision to 2Q GDP
Japan’s economy is already in reverse. Japanese cycles are short and we expect
a recovery to begin in 2H08. But this will be modest while other developed
markets are weak and, from an Asian perspective, Japan is not large enough to
act as an offset to weakness in the EU and US.
The absence so far of any meaningful slowdown in China has caused us to
increase our 2007 growth forecast to 11.5%; this implies no deceleration
compared with the second half of the year. For 2008 we have maintained our
expectation of 9% growth, with most of this front loaded into the first half
thanks to aggressive government infrastructure spending and the inevitable, but
temporary, boost to consumer spending that that will result from the Beijing Olympics. For the second half of the year we remain pessimistic about Chinese
growth. Its massive current account surplus (we estimate that the surplus will
be 12.1% of GDP this year) points to productive capacity having grown far
beyond domestic demand. This makes China vulnerable to a slowdown in its
external markets. And 23.5% of China’s exports go to the US with a further
22% to the EU. The 9% full year 2008 forecast implies a quite rapid
deceleration in the second half.
The Indian exception
The combination of weak US and EU demand throughout 2008, an anaemic
Japan and China slowing in the second half is a difficult one for most Asian
countries. The exception to the rule is India. Its economy is driven by domestic
forces. Growth in the second (calendar) quarter was stronger than we expected
thanks to robust performances from manufacturing, financial services and
community, social and personal services. The last of these is a category unique
to India and includes retailing and wholesaling. It accounts for 15% of GDP.
With finance and manufacturing also motoring ahead despite tighter monetary
conditions it is now difficult to see India recording less than 9% real growth in
2007/08.
We expect next year to be slower but India has a key advantage over China. Its
interest rates are much more appropriate relative to its trend rate of growth than
are those in the PRC. There has not, therefore, been the rapid overexpansion of
capacity that has ballooned out the Chinese current account surplus. While
global growth, liquidity and risk appetite has been abundant this difference has
been seen as an advantage for China allowing faster rates of investment, GDP
and asset price growth. But these have been achieved through an inadequate
discipline on investment. Indian businessmen have been kept on a much tighter
leash – the dependency on external demand to absorb incremental production
has not been developed and bad investments have been heavily discouraged.
India is an outperformer in our forecast; we expect GDP growth of 8.4% in
2008/09. By the end of 2008 this will make it the fastest growing economy in
Asia.
Don’t rely on OPEC
Outside of India however conditions will be difficult. The slowdown we expect
in the EU and US will directly affect the order books of Asian manufacturers.
The electronics industry is likely to be especially badly hit. China at this point
will still be acting as an offset but a rather smaller one than the share it takes in
each country’s exports implies. Intra-industry trade, whereby materials and
parts are shipped to China, assembled and shipped to their final destination, has
muddied the issue. In some countries, most conspicuously Taiwan and Korea,
parts (as best we can judge) have been the largest source of export growth to
China. Slowing US demand will hit these countries via their Chinese order
books.
Chinese growth in the first half is, however, likely to maintain demand for
commodities. In turn this suggests that demand for Asian goods from
commodity producers will remain firm. We see a more acute risk of falling
commodity prices in the second half of 2008 than the first. However, even
while Chinese demand remains strong, EU and US demand will be weakening
and rising risk aversion and contracting liquidity also suggests softer
commodity prices. In short we think that the peak has now passed for oil and
commodity prices and consequently for the export revenues of commodity
exporting countries. In Asia this has direct implications for Indonesia and,
especially, Malaysia but it also means that it is unwise to rely on current robust
exports to OPEC, Latin America and the CIS. Certainly such reliance flies in
the face of experience.
It is almost embarrassing putting Figure 1 into Triple-A again as it is a chart
that we have used repeatedly this year (most recently two weeks ago). It shows
which regions have driven extra-Asian export growth. We have included it
again because the high correlation of Asian export growth to all four trading
blocs – USA, EU, commodity producing countries and the rest of the world is
the clearest indication we know of why robust Asian exports to commodity
producers now is no indication that they will continue to act as an offset when
world growth slows.
A number of Pacific Rim countries showed robust domestic demand growth in
1H07. But we do not feel confident projecting that to continue in light of the
broad export slowdown implied by Figure 1. In some cases domestic spending
is weakening already. We believe that Korea’s consumer spending indicators
are looking tired and, though capital spending is stronger, we judge that it too
has passed its peak. Others will soften when the second round effects of a US
and EU slowdown develop. In the first half of this year Malaysia combined
decent consumer spending growth with lacklustre exports of goods. But this
says nothing about whether consumer spending can stay robust faced with falling exports of goods if commodity prices are also weakening (reversing
rural outperformance) and, thanks to falling oil prices, shrinking export receipts
are weakening Islamic banking’s primary market.
Soft domestic demand is the rule
But in truth more countries display fragile domestic demand stories than robust
ones meaning that a net export slowdown will bite directly. Taiwan is probably
the archetype here. Its domestic economy is weak and if electronics exports
slow growth will fall rapidly. Thailand is in the same position. Consumption
and investment are both presently soft and we are sceptical that a general
election will deliver the decisive result needed to support a rebound in
confidence and spending. Philippines consumption growth has been good. But
there is little capex and consumption is fragile, supported by a single – cyclical
– revenue source: overseas workers remittances. The downgrades to our extra-
Asian demand assumptions therefore imply cuts in our 2008 Asian growth
projections. Figure 2 shows the forecasts in the fourth quarter EoAE with the
3Q report for comparison.
Excluding India we have increased our 2008 growth projections in only one
country, Korea. This reflects the competitiveness gains that allowed it to live
with an appreciating won between 2003 and 2006. Our numbers for China and
Hong Kong remain unchanged. In all other countries we are less optimistic
about 2008 growth than we were three months ago.
The extent of the downgrade is broadly speaking a function of the openness of
the economy and the anticipated resilience of domestic demand. Hence
Malaysia and Singapore have received the biggest cuts in our forecasts because
these countries are most geared into world trade. Thailand and Indonesia
because weaknesses in their economies leave domestic demand vulnerable.
