Today we present a preview from our global economic outlook for Q4, which will be released to RGE clients later this month. The full version of the outlook includes a more in-depth version of the following analysis as well as RGE’s country-by-country projections for economic growth.
Asian economies rebounded in Q2 2009 as aggressive monetary and fiscal stimuli cushioned domestic demand and quick inventory adjustment eased the downturn in industrial production. Capital inflows have buoyed the asset markets and net exports have contributed to GDP growth as imports have contracted faster than exports.
However, policy measures are inadequate to close the output gap emanating from sluggish private demand and sharp export contraction. All Asian economies will slow sharply in 2009 and grow below potential in 2010. RGE forecasts Asia to grow a mere 2.6 % in 2009 and 5.4% in 2010. Asia ex-Japan (AXJ) will grow 4.9% in 2009 and 6.6% in 2010. As the impact of policy measures fade in 2010, the pace of Asia’s recovery will hinge on the recovery of global export demand and continued risk appetite. RGE projects that Japan will contract sharply in 2009 and grow below 1.0% in 2010. Fiscal stimulus will push China’s growth to over 8.0% during 2009 and 2010. India will grow less than 6.0% in 2009 and below potential in 2010. The Asian Tigers (Singapore, Taiwan and Hong Kong), Thailand, Malaysia and New Zealand will contract in 2009 while the contraction in South Korea will be mild and Australia will barely grow. The Philippines, Indonesia, Vietnam, Pakistan and Sri Lanka will slow sharply in 2009.
Unlike 1997 or 2001, Asia cannot employ an export-led strategy to drive the economic recovery. As consumers in the advanced economies deleverage over the next few years and foreign direct investment (FDI) recovers slowly, attaining the pre-crisis GDP growth rates in Asian countries will largely depend on the governments’ ability to rebalance growth towards domestic demand and accelerate structural reforms. Government and private consumption and investment should be moved away from the export sectors. Reforms should increase government spending on safety nets and public services, move workers to the service sector, improve financial sector intermediation and diversify exports towards emerging markets. Since these reforms will take a few years, Asia’s growth in the short-term will remain tied to the U.S. economy via trade and financial linkages.
Under RGE’s baseline scenario, the U.S. economy will have a U-shaped recovery with anemic GDP growth and consumer deleveraging over the next few years. In that case, Asia, too, will have a U-shaped recovery. While Asia might have a stronger rebound compared to other regions, the strength of the recovery will vary across countries. Economies highly dependent on exports, such as Japan, the Asian Tigers and Malaysia, might witness a slower recovery and will take longer to go back to the pre-crisis growth rates. Countries with larger domestic demand, attractive asset markets, greater policy space and/or faster reforms, such as China, India, Indonesia, Vietnam and the Philippines, might witness a stronger recovery.
Export and Manufacturing Activity to Recover Sluggishly
Exports in most countries are rising on a month-on-month basis. Global inventory restocking and high base effects of 2008 will boost exports during H2 2009 and early 2010. Chinese commodity stockpiling and infrastructure spending, despite slowing from the recent highs, will benefit countries like Australia, Indonesia, Vietnam and India. Inventory restocking in China, the U.S. and EU will boost the exports of the Asian Tigers, plus Thailand and Malaysia. Exports of these countries might benefit somewhat if the Chinese fiscal stimulus boosts domestic consumption and import demand during 2010. A sustained improvement in Asian exports, however, will depend on the demand recovery in the U.S. and EU, and the revival of the global electronics cycle.
Fiscal stimulus, faster inventory adjustment and/or domestic demand recovery has revived manufacturing activity in China, India and Vietnam. Inventory restocking will boost industrial production in the export-dependent economies during H2 2009 and H1 2010, particularly in the technology sector. But the sustainability of manufacturing activity in these countries will depend on the strength of export recovery.
Domestic Demand Picking Up Slowly
Fiscal and monetary stimuli have improved mortgage conditions and retail and auto sales while the asset market rally has created some wealth. The job losses have slowed but weak hiring and wage pressures will lead to a slow recovery in consumption.
The export downturn, excess capacity and tight (albeit improving) credit conditions will keep investment sluggish until 2010, though government-led investment will pick up. Initial Public Offerings (IPOs) and M&A activity have picked up in many countries. But bank credit in emerging Asia (ex-China) is extremely sluggish, foreign bank lending is down sharply, and FDI is falling or slowing in many countries. Sluggish recovery in exports and global credit conditions will keep FDI inflows modest during 2010.
Policy Measures Will Remain Supportive
Inflation is picking up in many countries on a month-on-month basis. Most countries will exit deflation during Q4 2009 and Q1 2010 as the base effects of 2008 fade. Inflationary pressures will escalate in 2010, particularly in China, India, Indonesia and Vietnam, with the recovery in domestic demand, the closing of output gaps and low base effects of 2009.
Most central banks in the region will keep interest rates on hold through 2009 due to the fragile economic recovery and subdued core inflation. If continued capital inflows fuel asset bubbles and raise domestic liquidity, central banks will raise the bank reserve requirements, conduct open market operations and implement measures directly targeting the asset markets during H2 2009 and early
2010, before they start hiking interest rates. Countries witnessing faster economic recovery and/or vulnerable to asset bubbles and commodity prices, such as South Korea, China, India, Vietnam and Indonesia, will start raising rates in H1 2010. Countries experiencing a weaker recovery and larger output gaps, such as Malaysia, Singapore, New Zealand and Taiwan, will delay rate hikes until H2 2010.
Fiscal stimulus will be a major driver of growth in Asia, supporting consumer spending, slowing the pace of job losses and improving credit access for firms, especially the small and medium enterprises and exporters. But fiscal policy will be inadequate to close the output gap and will become a drag on growth in most countries over the course of 2010, especially if private demand is slow to recover. Fiscal concerns and inflation risk will constrain most governments from expanding the stimulus. High spending and waning tax and commodity revenues will erode the fiscal health of several countries, including Japan, India, Vietnam, Thailand and Malaysia, and cause the debt-to-GDP ratios to surge.
Sustainability of Asset Market Rally Depends on Risk Appetite
A quick economic rebound, capital inflows and better-than-expected corporate earnings have buoyed the Asian equity markets. Valuations have risen steadily though they remain below the peak levels of the boom years. The surge in markets like India, China, Sri Lanka, Vietnam and Indonesia has raised concerns that the rally might be getting ahead of fundamentals.
Asian currencies will continue to appreciate as global risk appetite buoys the asset markets, the trade balances are cushioned and the U.S. dollar remains weak. But central banks’ aggressive intervention in the foreign exchange market will limit currency gains until exports recover. In 2010, countries like India, Indonesia, Singapore and South Korea might allow currency appreciation to control headline inflation.
The real estate sector, especially housing, has picked up since Q2 2009 in countries like China, Hong Kong, Singapore, Vietnam and South Korea due to attractive prices, favorable borrowing conditions under stimulus measures, and speculative activity fueled by capital inflows and liquidity. However, slow improvement in labor market conditions, any slowdown in risk appetite and government measures to curb speculation will negatively impact the real estate sector and prolong its recovery.