Rough landing ahead in 2008?

Business News - Saturday December 15, 2007

ASIA FOCUS

Rough landing ahead in 2008?

Asian economies face challenge as China's slowdown could hurt the region

POST REPORTERS

As Asia, the economies that drove the growth of the world in 2007, enter the new year there are fears appearing that the region could be heading for a softer growth and in some circumstances maybe even a harder landing.

Lehman Brothers says that whether the global economy is in for a soft or a hard landing matters greatly for Asia excluding Japan. If there is a soft landing, as is its baseline view is, then Asian central banks will likely fall behind the curve, with many Asian economies entering 2009 with all the hallmarks of overheating. On the other hand, if there is a hard landing, it doubts that the region could decouple - China could even face deflation.

The warning is similar to those issued by UBS, which says that the region could face a slowdown as many signs are already indicating of that move.

"Asian growth will slow but there will be no meltdown," says Duncan Woolridge, regional head of economic research with UBS, writing in a recent report.

"What will affect the region is not the slowdown in US growth but more so European growth."

Mr Woolridge believes that US weakness is already being felt across Asia but that the region's exports to Europe could be affected by the sharp drop in sentiment and leading indicators over the past few months.

He points out, however, that the impact of slower exports will have less of an affect on Asia than in 2001, when the US experienced its last slowdown.

"Look at Asia today. Debt levels in most economies are relatively low; there are no obvious credit bubbles in the region; and property prices are not in long-term decline," he notes.

China is likely to be least affected by the US and European slowdown and will continue to post growth rates of 10%. "Most of the slowdown we envision for China comes from a reduction in net exports, as import demand from G3 economies eases and peaking capacity pressures in China lead to stronger imports, which means Chinese exports will slow but Chinese imports accelerate," he said.

Asia is entering 2008 with strong economic fundamentals and growth momentum as the countries in the region see account surpluses and hefty foreign-exchange reserves; its balance of payments position has never been stronger. Corporate and banking-sector balance sheets are healthy, with low direct exposure to the US sub-prime market. Macroeconomic policies remain supportive and six straight years of strong export growth are feeding through to the domestic economy, boosting job and investment growth.

Lehman Brothers says that it is no wonder that the total GDP of Asia ex-Japan grew by a very strong 9% year-on-year during the third quarter of this year and a lot of the growth in the region was from domestic demand.

"Provided the global economy has a soft landing, we expect Asia ex-Japan's exports to avoid a major slump and the region's own demand to show resilience, buoyed by loose policies and strong capital inflows. Hence, our baseline forecast is that Asia ex-Japan's GDP growth slows from 8.7% in 2007 to a still-strong 7.6% in 2008," said Rob Subbaraman, Lehman Brothers' senior vice-president and chief economist for Asia (ex-Japan).

But he warns that a hard landing in the global economy could hit the region even harder.

The debate on "decoupling" suggests a yes or no answer is possible, when really it is a matter of degree, he says.

"We judge that Asia ex-Japan is well-placed to weather a moderate global economic slowdown, but not a sharp downturn, which we define as OECD GDP growth slowing below 1% in 2008," Mr Subbaraman says.

He says that with rising incomes, Asia ex-Japan's autonomous demand is gradually increasing, but the high level of intra-Asian trade (some 40% of the region's total exports) overstates Asia's resilience. About two-thirds of intra-Asian trade consists of intermediate goods - because of the region's highly specialised cross-country production network - and empirical studies show that about half of intra-Asian trade is driven by final demand from outside the region.

According to data available, the Asian countries continue to remain heavily dependent on exports. Chinese data are unavailable, but for the rest of the region, the aggregate volume of exports has surged 80% since 2000, more than double that of consumption and investment.

"The impact of a sharp global economic downturn is unlikely to be linear. Asia ex-Japan's investment and labour are heavily geared to the tradable goods sector. If exports slump, we would expect multiplier effects on the region's domestic economies as firms are forced to cut capital expenditure and jobs," he says.

He said Lehman Brothers was also concerned about the potential impact on the rest of Asia from the myriad macro risks stemming from China's unbalanced economy. A post-Olympics slowdown is one risk, but a far bigger one in Lehman's view is a slump in China's exports unmasking a severe oversupply problem and, possibly, spurring deflation.

UBS's Sakthi Siva, a strategist, also believes that investors need to be aware of the region's four key investment themes: overvaluation; the Shanghai bubble; switching from domestic defensives to exports; and the exposure of the materials sector.

"For the first time since 2000, Asia will enter the new year facing overvaluation both relative to history and relative to the world. We are looking for single-digit returns in 2008, with stronger gains in markets perceived to be exporters and negative returns in markets perceived to be domestically driven," Mr Siva says.

An equally important theme for the region in 2008 is whether the Shanghai bubble is going to start deflating and if it does, will the rest of Asia decouple from the valuation-driven correction in China?

"We believe the answer is yes," he says.

In addition, with US recession fears receding, UBS believes that a switch from domestic defensive markets, including China and India, to exporters, such as Korea and Indonesia, would be a strong move.

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