RGE Wednesday Note: Too Soon to Call for Asian Decoupling
We’re pleased to announce the release of the September update to our 2010 Global Economic Outlook, available exclusively to clients. Since our July update, we have increased the probability we assign to a U.S. double dip to 40%, which prompted us to consider how such an eventuality might impact Asia.
We still see emerging Asia outperforming other regions in 2010-11, but with exports accounting for around 46% of Asia’s GDP, the region is unlikely to “decouple” from weaker-than-expected recoveries and deleveraging in the U.S. and EU. In most Asian countries, consumption and capex—key growth drivers in 2009-10—as well as labor markets, manufacturing and services remain structurally tied to exports destined for the U.S. and EU. As a result, domestic consumption and regional and emerging market (EM) trade will only deflect the blow from a global slowdown in the coming months while failing to shield Asian growth entirely. A U.S. double dip would result in larger-than-expected declines in Asian capex and exports, dampening momentum in labor markets and consumer spending (though cautious hiring during 2009-10 would prevent drastic layoffs and wage cuts). Though the consequent fiscal and monetary stimulus across the Asia/Pacific region would depend on the extent of each country’s trade and financial linkages, the size—and effectiveness—of such measures would likely be smaller than in 2008.
Intra-regional trade and exports to other EMs have contributed a greater share of Asia’s exports in recent years, yet the U.S. and EU together still comprise over 30% of the export market. Plus, around 40-50% of intra-Asia trade is meant for re-export outside of the region, and over 60% of the exports from Asian Tigers, Malaysia and Thailand to China—their key export market—ultimately are bound for the U.S. and EU. Moreover, EM growth also is likely to moderate in H2 2010 and H1 2011, resulting in weakened demand for Asian exports.
While the foundations for trade decoupling are in the making, financial decoupling remains distant. The U.S. and EU are Asia’s key sources of foreign investment, while intra-Asia and EM investment remains in nascent stages. A U.S. double dip and wave of risk aversion could correct Asian asset and real estate markets and weigh on business sentiment and investment by raising the cost and reducing the availability of external financing for governments and corporations, making the Asian Tigers, India and Indonesia particularly vulnerable. Our research suggests increased correlations and betas between the S&P 500 and Asian equities and currencies since 2009. Moreover, EM Asia receives close to 50% of its external bank loans (mostly in the form of wholesale funding) from the EU’s vulnerable banking sector, with Singapore, India, Hong Kong and South Korea particularly exposed.
Even without a double dip, weak U.S. and EU recoveries will cause export-dependent Asian economies to grow below their 2003-07 trends in the coming years. Policies proposed by countries like Singapore, Malaysia and China to rebalance economic activity toward private consumption are only the beginning of a multi-year process and need greater political will. Economies with sizeable labor forces and/or rising domestic demand—like China, India, Indonesia and Vietnam—will outperform those with higher export-dependence or aging populations, like the Asian Tigers, but will require politically difficult structural and financial reforms and liberalization to increase their potential growth.
Nonetheless, we remain optimistic that widening growth differentials with the G7 countries and healthy public- and private-sector balance sheets—along with rising incomes and expanding middle classes—in the coming years will drive economic growth and foreign investment in Asia and increase intra-Asia and EM trade and investment.
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