Asia Showing A V-Shaped Recovery

Some emerging Asian economies posted robust growth in Q2 2009 after contracting or slowing sharply in Q4 2008 and Q1 2009. Aggressive fiscal and monetary stimulus, improving credit market conditions and positive wealth effects from rising asset markets have revived domestic demand. Lower leverage and better macroeconomic fundamentals are also a plus.

• China and India grew 7.9% y/y and 6.1% y/y respectively in Q2 2009, accelerated from 6.1% and 5.8% respectively in Q1 2009.
• Both Singapore and Taiwan grew over 20% q/q (seasonally adjusted). South Korea and HK grew 2.3% and 3.3% (sa) respectively. However, all tiger economies saw GDP contractions on a y/y basis.
• ASEAN: Indonesia's growth decelerated to 4.0% y/y in Q2 2009 from 4.4% in Q1, while Vietnam's growth accelerated to 4.5% y/y in Q2 2009 from 3.1% in Q1. Both Thailand and Malaysia posted positive quarterly growth in Q2 2009, with GDP contraction easing to 4.9% y/y and 3.9% y/y respectively from 7.1% and 6.2% respectively in Q1.
• Backed by aggressive fiscal and monetary easing policies, China and Indonesia have led the region's recovery, whereas Malaysia and Vietnam have lagged. While China introduced the most aggressive stimulus package, South Korea, Singapore, Malaysia, Taiwan and Thailand implemented fiscal stimulus packages that are at lease 4% of GDP. South Korea, India, Indonesia and China will lead the region in policy tightening in H1 2009.
  
• In February and March 2009, the pace of export contraction eased. But since Q2 2009, the pace of export contraction has been volatile, first accelerating and then decelerating in most countries. Demand from Chinese fiscal stimulus has not been strong enough to offset weak demand from G3 countries (though commodity exporters have enjoyed some benefits), but exports to the G3 have started to turn the corner. Export contraction is still sharp in most countries in the region, exceeding 20% y/y as of June 2009. Singapore and Hong Kong have shown some stabilizing indications, with exports now falling in single digits.
  
• Since March 2009, manufacturing activity has rebounded sharply, with the purchasing managers' index (PMI) rising above 50 for China, India and Singapore. In Q2 2009, industrial production surged 40% annualized and has recovered 65% of the ground lost since late 2008. Nonetheless, as of June 2009, industrial production was still falling about 10% y/y in Singapore, South Korea and Taiwan. Industrial production for Vietnam grew at an accelerating pace in Q2.
• Foreign direct investment (FDI) inflows are contracting. China and India have experienced over 20% y/y contraction in Q1 2009. Cutbacks in capex will hit economies highly dependent on FDI inflows, including Singapore, Malaysia, Thailand and Vietnam. In Q1, gross fixed capital formation contracted sharply in Singapore, Taiwan, Thailand and the Philippines, while that in Indonesia grew, though at a decelerating pace.
• Domestic consumption is weak due to strong ties of exports to investment and consumer spending. Aggressive fiscal spending is a plus, but increasing job losses, slowing income growth and negative wealth effects from 2008's asset market correction will weigh on the region's consumption. Starting in Q2 2009, private consumption has picked up in China, India, Indonesia and Vietnam, while it continues to contract in Hong Kong and Singapore.
• Though the pace of job losses has slowed in Asia in Q1 2009, the unemployment rate is likely to increase further to 5.1%-5.9% in 2009, up from 4.6% in 2007. The unemployment rates for Indonesia and the Philippines are among the highest in the region. Youth unemployment is a significant concern in Thailand and South Korea. China and Vietnam face the risk of social unrest from job losses among migrant and factory workers.
  
• The decline in resource utilization, increased excess capacity and lower oil and commodity prices compared to 2008 have caused deflationary pressures in the region. Consumer prices are falling in China, Malaysia, HK, Singapore, Taiwan and Thailand. But 2008's base effects might start fading in Q3 2009, leading to slower deflation or even inflation risks, which are emerging in China, India and South Korea. Capital inflows and asset market rallies might be fueling asset inflation.
• Commodity exporters like Malaysia, Indonesia and Vietnam have been hit by commodity correction, while the Asian Tigers and India have benefited. Rising oil and commodity prices since since February 2009 might be a risk for some countries.

Will Asian Asset Markets Continue to Rally?

• Domestic liquidity, capital inflows and diminished risk-aversion have boosted Asian equity markets since March 2009. However, the impact of slower sales on corporate earnings and external factors might pose risks to capital inflows.
  
• In 2009, Asian equity markets (excluding Japan's) have outperformed mature markets and are up 47.7% year to date as of August 6, 2009. Valuations and improving growth prospects are pluses for some countries, while capital inflows and market rallies might be making valuations expensive in some countries.
• Since March 2009, all major Asian currencies have been on an appreciation path, buoyed by capital inflows, improving trade balances, firmer signs of the bottoming of the industrial cycle and an overall bearish market view on the U.S. dollar.
  

Will Asia Continue to Show Robust Recovery?


• To achieve potential long term growth, export-dependent Asia needs a revival of external demand in G3 countries. Also, the drivers of growth need to come more from domestic demand by boosting private consumption and investment. Strengthening social safety nets and encouraging more labor-intensive services are necessary.
  
• The sharp contraction in Asian exports has moderated, helped by easy macro policies. Sound fundamentals are attracting large capital inflows. However, the recovery is still fragile due to high unemployment and overcapacity and risks of a double-dip in advanced economies and an exodus of foreign capital.
• The drop in both industrial production and exports was due more to 'one-off' and other temporary factors, and...the upturn is mainly a result of those factors fading from the picture. Asia's supply side is surging back in V-shaped fashion, and the region's exports are climbing strongly, thanks to improved demand from China.
• ASEAN countries, especially Indonesia and Vietnam, that can serve China's domestic demand for commodities will likely see a swifter cyclical recovery.

p/s photos: Fiona Sit Hoi Kei

European Union Financial System Might Be Even Worse Off

The media tend to focus on the credit crisis too much on just the US and maybe the UK. Even the secondary focus was largely on how China would figure in being a catalyst for recovery. There are pockets of the world that are facing the crisis with more devastation, and urgency for help. In a sense for them, its should be called a debt crisis rather than a credit crisis. We are talking of Eastern Europe, Western Europe, Russia and Ukraine... hey, basically the EU. Most of what's written below was taken from The Telegraph, UK.

In much of Western Europe, things are nearing boiling point. Austria's finance minister Josef Pröll made frantic efforts last week to put together a €150bn rescue for the ex-Soviet bloc. Well he might. His banks have lent €230bn to the region, equal to 70pc of Austria's GDP.

"A failure rate of 10pc would lead to the collapse of the Austrian financial sector," reported Der Standard in Vienna. Unfortunately, that is about to happen.

The European Bank for Reconstruction and Development (EBRD) says bad debts will top 10pc and may reach 20pc. The Vienna press said Bank Austria and its Italian owner Unicredit face a "monetary Stalingrad" in the East. Mr Pröll tried to drum up support for his rescue package from EU finance ministers in Brussels last week. The idea was scotched by Germany's Peer Steinbrück. Not our problem, he said. We'll see about that.

Eastern Europe has borrowed $1.7 trillion abroad, much on short-term maturities. It must repay – or roll over – $400bn this year, equal to a third of the region's GDP. Good luck. The credit window has slammed shut.

Not even Russia can easily cover the $500bn dollar debts of its oligarchs while oil remains near $33 a barrel. The budget is based on Urals crude at $95. Russia has bled 36pc of its foreign reserves since August defending the rouble.

In Poland, 60pc of mortgages are in Swiss francs. The zloty has just halved against the franc. Hungary, the Balkans, the Baltics, and Ukraine are all suffering variants of this story. As an act of collective folly – by lenders and borrowers – it matches America's sub-prime debacle. There is a crucial difference, however. European banks are on the hook for both. US banks are not.

Almost all Eastern bloc debts are owed to West Europe, especially Austrian, Swedish, Greek, Italian, and Belgian banks. En plus, Europeans account for an astonishing 74pc of the entire $4.9 trillion portfolio of loans to emerging markets. They are five times more exposed to this latest bust than American or Japanese banks, and they are 50pc more leveraged (IMF data).

Spain is up to its neck in Latin America, which has belatedly joined the slump (Mexico's car output fell 51pc in January, and Brazil lost 650,000 jobs in one month). Britain and Switzerland are up to their necks in Asia.

Whether it takes months, or just weeks, the world is going to discover that Europe's financial system is sunk, and that there is no EU Federal Reserve yet ready to act as a lender of last resort or to flood the markets with emergency stimulus. The European Central Bank already needs to cut rates to zero and then purchase bonds and Pfandbriefe on a huge scale. It is constrained by geopolitics – a German-Dutch veto – and the Maastricht Treaty.

It is East Europe that is blowing up right now. Erik Berglof, EBRD's chief economist, said that the region may need €400bn in help to cover loans and prop up the credit system. Europe's governments are making matters worse. Some are pressuring their banks to pull back, undercutting subsidiaries in East Europe. Athens has ordered Greek banks to pull out of the Balkans.

The sums needed are beyond the limits of the IMF, which has already bailed out Hungary, Ukraine, Latvia, Belarus, Iceland, and Pakistan – and Turkey next – and is fast exhausting its own $200bn (€155bn) reserve. We are nearing the point where the IMF may have to print money for the world, using arcane powers to issue Special Drawing Rights. Its $16bn rescue of Ukraine has unravelled. The country – facing a 12pc contraction in GDP after the collapse of steel prices – is hurtling towards default, leaving Unicredit, Raffeisen and ING in the lurch. Pakistan wants another $7.6bn. Latvia's central bank governor has declared his economy "clinically dead" after it shrank 10.5pc in the fourth quarter. Protesters have smashed the treasury and stormed parliament.

In almost every way, this is much worse than the Asian financial crisis in the late 1990s, as indicated by the table below. There are accidents waiting to happen across the region, but the EU institutions don't have any framework for dealing with this. The day they decide not to save one of these one countries will be the trigger for a massive crisis with contagion spreading into the EU. The governments and ECB cannot risk NOT saving any one country or banking institution, but that strategy is drawing almost all the reserves and ammunition these institutions have.

Europe is already in deeper trouble than the ECB or EU leaders ever expected. Germany contracted at an annual rate of 8.4pc in the fourth quarter. Germany will have shrunk by nearly 9pc before the end of this year. This is the sort of level that stokes popular revolt. The implications are obvious. Berlin is not going to rescue Ireland, Spain, Greece and Portugal as the collapse of their credit bubbles leads to rising defaults, or rescue Italy by accepting plans for EU "union bonds" should the debt markets take fright at the rocketing trajectory of Italy's public debt (hitting 112pc of GDP next year, just revised up from 101pc – big change), or rescue Austria from its Habsburg adventurism.

Hungary’s forint fell to an all-time low in recent days, and Poland’s zloty slumped to the lowest in five years on plunging industrial output. Half of all loans to the private sector in Poland are in foreign currencies so borrowers face a severe debt shock after the 40pc fall of the zloty against the euro since August.

There are contagion worries for Western banks that have lent $1.74 trillion (£1.22bn) to the ex-Soviet bloc -- split between $1 trillion in foreign loans and $700bn in local currency debt through subsidiaries. Austria’s banks are the most exposed with the share of risk-weighted assets tied to the region reaching 54pc for Raffeisen and 38pc for Erste Bank. The exposure of Germany’s Bayern Bank is 48pc, Italy’s UniCredit is 45pc, and Swedbank is 29pc.

The region needs to roll over $400bn in foreign debts this year, equivalent to a third of total GDP, raising concerns that it may need a massive rescue programme from the International Monetary Fund and the European institutions.

p/s photos: Elva Hsiao

Report Card For Asia

Impact of current crisis different from Asian crisis:
• Since the 1997-98 crisis, most countries have current a/c surplus and above-adequacy level forex reserves, lower govt deficit and debt, higher savings rate; currency and maturity balance sheet mismatches among firms and banks have declined; stronger corporate balance sheets and banking system. Banking, capital market, corporate reforms have been adopted though risk management, supervision and prudential norms are still far from international standards in most countries
• In spite of moving away from fixed exchange rates exchange rates, currencies are not yet fully flexible. Capital controls might contain risks of speculative attack on central banks have enough reserves to defend exchange rate and finance capital outflows and easing external balances. Some countries an also use excess reserves to finance counter-cyclical policies. As a result, forex reserve growth has been declining/reversing
  
  But Asia is still vulnerable:
  
• Exposure to exports has risen from 36% of GDP in 1998 to 46.7% in 2007. export contribution to growth along with impact on industrial production, investment, employment and consume spending) has increased in most countries. Exports and manufacturing, investment, GDP growth will contract in 2009 in excess of contraction in 1998 or 2001 on G-7 recession, slowdown in EM, intra-Asian trade (from slowdown in domestic demand and final exports to G-7), correction in commodity prices and demand
• Domestic demand is slowing as well and will not offset slump in external demand: Low share of consumer spending in GDP and consumption has been highly linked to recent external sector boom (exports, capital inflows). consumption is slowing (on job losses, slower income growth,high inflation and interest rates in 2008). Slowing industrial production and investment (high rates in 2008, global liquidity crunch, IPO slump)
• In spite of low direct subprime exposure, contagion from global credit crisis is leading to liquidity squeeze and jump in short-term borrowing costs, bank panics and deposit withdrawals, external funding crunch and shrinking profit margins for banks and corporates, declining asset quality, high exposure to correction in domestic stock and real estate markets
• Banks in Taiwan and South Korea have high leverage, growing instances of corporate and consumer default; thin regulation has also encouraged excessive risk-taking incl. short-term, foreign currency overseas investment (though much lower than in 1997), raising risks to external debt, currency; But stock of forex reserves and hedge against currency risk (lacking in 1997) this time will finance external liabilities in most countries
• Correction in asset bubbles like real estate (Hong Kong, Singapore, India), equity markets, electronics and semi-conductor sectors. Worsening stock market slide in several countries led by foreign funds sell-off on global risk aversion, domestic macro risks; bank guarantees in developed countries and a few Asian countries might also cause outflows in those w/o guarantees
• reliance on foreign capital (esp. short-term portfolio capital as a share of investment, stock market cap) has increased since 1997-98 crisis in most countries. Apart from capital flight from equity and bond markets, declining trade and current balance is leading to currency depreciation in most countries
• Given internal and external vulnerability indicators, India and Thailand most vulnerable to external uncertainty; Vietnam and S.Korea most vulnerable to sudden stops of capital flows; Indonesia and South Korea most vulnerable to sudden reversal of capital flows
• Trade and current account deficits rising in India, Vietnam, S.Korea, Indonesia, Pakistan on high oil import bill, slowing exports. Trade and current account balances easing in Singapore, Thailand, Malaysia, China and Taiwan
• Fiscal: Worsening in India, Indonesia, Pakistan, Thailand, Philippines, Vietnam due to food and fuel subsidy bill, fiscal stimulus, pre-election spending; ADB: Crisis will raise cost and access to capital esp. to finance govt spending
  
  Recovery:
• Pro-active govt role: Fiscal stimulus for firms and households, govt spending on infrastructure; as a share of GDP stimulus has been large in China, Singapore. stock market regulation (halt on trading, ban on short-selling, stabilization fund). Central banks have been cutting interest rates, injecting liquidity, entering into swap agreements with Fed and other Asian central banks, selling forex reserves
• Will need to improve safety-net (pensions, public services). Need to boost consumption by moving to labor-intensive manufacturing, service sector development to create jobs and higher wages. Credit access will reduce the need to save. Moving away from devalued currency (and eport growth model) will lead to cheaper imports for consumers. This will be helped by govt's rate cuts, infrastructure spending via fiscal stimulus, low public and household debt in most countries
• Economist: But recovery will be faster due to room for rate cuts, fiscal stimulus in many countries, stronger fundamentals compared to 1998

p/s photos: Janine Zhang

What A Difference 10 Years Make

Asia Times / Shawn Crispin - A decade ago, Western-led free marketeers derided Asia's lightly regulated economic and financial models for being riddled with corruption, cronyism and overall mismanagement. The only way out of the financial crisis, they argued, and on what the IMF predicated its bailout packages, was greater foreign participation and management in their economies through asset sales and privatizations.

Governments in the region resisting IMF neo-liberal orthodox prescriptions and market-determined asset fire sales to foreigners were widely derided in the Western press. Many rang the "moral hazard" alarm bell, warning that unpunished profligate borrowers would be prone to return to their risky behavior on the expectation of future government bailouts.

Thailand's (and Malaysia) interventionist move in 2001 to establish a state-led rescue facility for non-performing assets held at banks, known as the Thailand Asset Management Company (and Danaharta), was likewise derided for being too little, too late, and ultimately a doomed-to-fail interventionist attempt to put off market-led asset price clearing.

And when Asian countries raised the idea of establishing an Asian Monetary Fund, to rival the IMF and stave off future regional financial crises without the perceived pro-Western conditions imposed by IMF-led bailouts, the US balked at the concept and lobbied against it until it was finally scrapped.

Ultimately Southeast Asia emerged stronger from its financial collapse, seen today in its low sovereign and corporate debt profiles, high levels of foreign reserves and reformed and recapitalized banks. That restoration was led mainly through market-driven depreciated currencies, improved terms of trade and eventually renewed capital inflows.

Now many of the same pro-market stalwarts who criticized Asia's half-market, half-interventionist response to the 1997-98 financial crisis are among the strongest proponents of the US government's proposed US$900 billion Wall Street bailout package. Rather than advocating for a market-price clearing of distressed assets and foreign buyouts of homegrown assets, as they did for Asia, many Western commentators have taken Wall Street's side in its plea for a government bailout of banks and bankers on the grounds that the US is simply to large too fail and without government intervention the entire US - if not global - economy is at risk.

The hard truth America is now so desperately trying to avoid is that US economic, financial and human resources - once considered the cream of the global capitalist crop - are in the new market reality worth a fraction of what they were previously priced. US policymakers deliberating the proposed interventionist bailout would be wise to revisit their economics text books and the historically overlooked but now highly relevant factor-price equalization (FPE) theorem.

Simply put, as the world economy becomes more integrated, free trade and capital flows tend to equalize relative prices and real wages across the world. Astronomically high US asset prices and wage levels have long represented the biggest pricing distortion in the global economy, one that until now has allowed Americans to consume a far greater percentage of the world's resources than their Asian counterparts.

Financial services were perhaps the US economy's chief value-added comparative advantage in the global economy and with their demise the US's overall terms of trade will inexorably decline. Regardless of how much good money the US Congress eventually throws after bad to restore confidence, Wall Street's debt-driven meltdown will inevitably lead to a lower US standard of living. That spiral will intensify if and when Asian and Arab investors opt for suddenly safer investment options closer to home rather than committing their capital to underwrite US government-propped, artificially high-priced US assets. A debt-ridden US can also expect to lose out to cash-rich China and others in the mounting global competition for the scarce natural resources and commodities needed to fuel and feed their domestic economies.

Others, reflecting on past Western criticism of Asian crony capitalism, wonder why the US media has not asked harder questions about a potential conflict of interest in former Goldman Sachs investment banker turned US Treasury Secretary Henry Paulson's lead role in devising a bailout package for his former Wall Street associates. They suspect it could be partially explained by much of the US media's reliance on investment banks for their advertising revenues.

With Wall Street's collapse, the global capitalist order has reached a watershed moment, one that will fundamentally affect how the US engages with Asia. US trade policies that previously promoted, above all else, opening markets for US banks and financial institutions in Asia's developing markets will now shift in a new and potentially more protectionist direction. That the US is opting to bail out its bankers rather than allowing the market forces it championed during the Asian financial crisis to determine the value of its debt-ridden assets represents more than an extreme case of moral hazard. Rather, it undermines global faith in the capitalist model the US once promoted, and from a Southeast Asian perspective, marks the end of what now seems a highly hypocritical US-led era.

p/s photos: Sonja Kwok Sin Ney