Emerging Asian economies: On the rebound


Asia’s emerging economies are recovering much more quickly than economies in other parts of the world. Can they keep it up?

Illustration by Bill Butcher

MOREgreen shoots have appeared in America in recent weeks, but they arenothing by comparison with the lush jungle sprouting in the East.Asia’s emerging economies probably grew at an average annualised rateof over 10% in the second quarter, while America’s GDP fell by 1%. In2009 as a whole, recent forecasts suggest that emerging Asia could growby at least 5%, while the G7 economies contract by 3.5%. The growth gapbetween the two has never been wider. How have these export-dependent economies managed to decouple from the developed world? And can theirrecovery last?

Averagegrowth figures conceal big differences within Asia over the past year.China, India and Indonesia were among the few economies in the worldthat continued to expand throughout the global downturn (though China’svirtually stalled late last year). But the smaller, more open Asianeconomies were badly hit. Between September and March real GDP fell byan average annualised rate of 13% in Hong Kong, Malaysia, South Korea,Singapore, Taiwan and Thailand.

Yet thecountries that have so far published second-quarter GDP figures show animpressive bounce. Comparing the second quarter with the first at anannualised rate, China’s GDP grew by 15%, South Korea’s by almost 10%,Singapore’s soared by 21% and Indonesia’s managed a respectable 5%.Other countries in the region are also likely to show a rebound. It istrue that output in South Korea and Singapore was still lower than ayear earlier, but quarterly changes are more useful for spottingturning points—and this is how growth rates are most commonly measuredin America.

The revivalin emerging Asia’s industrial production is even more impressive,jumping by an annualised rate of 36% in the second quarter. Accordingto Barclays Capital, emerging Asia is the only region in the worldwhere output has regained its level before the crisis (see chart 1).This is largely due to China, where industrial production rose by 11%in the 12 months to July, but all the Asian countries have seen astrong pick-up. In contrast, up to June, America’s production continuedto fall.

The sharp “V”shape of this cycle, and the fact that GDP started the year well belowthe average level in 2008, means that growth rates for 2009 as a wholecould give a misleading picture. Take Taiwan: JPMorgan predicts thatits GDP in 2009 will be 3.8% lower than in 2008, implying anotherdismal year. But this forecast also implies that GDP will grow by abrisk 5.4% in the year to the fourth quarter. By this measure, Asia’semerging economies are clearly leading the global recovery (see chart2). Even if America’s economy grows during the second half of thisyear, it is still expected to end the year smaller than it was at thestart.

Asia’s bouncehas taken many forecasters by surprise. In May, for example, the IMFpredicted that Asia’s recovery was likely to be “tepid” because thedeveloped economies—and hence demand for Asian exports—would remainweak. Forecasters always seem to underestimate the ability of the Asiantigers to rebound from recessions. During East Asia’s financial crisisin 1997-98, for example, countries across the region were forced todevalue as a result of large current-account deficits and speculativeattacks on their currencies. This caused firms’ foreign-currency debtsto swell in local terms, resulting in widespread bankruptcies and bankfailures. In 1998 the real GDP of Thailand, Indonesia and South Koreafell by an average of 10%.

Manyforeigners concluded that Asia’s economic success had been a completesham, based on governments pouring cheap money into favoured firms.Over-borrowing and over-investment had artificially boosted growth, itwas argued; doomsayers predicted a decade of lost growth. Instead, thetigers came roaring back. At the end of 1998 The Economist’spoll of forecasters predicted that South Korea would shrink againslightly in 1999. Its actual growth turned out to be a stunning 9.5%.It was true that Asia’s strong growth had concealed wastefulinvestment, inadequate bank regulation and corruption, but the keyingredients of growth—rapid productivity growth, relatively openmarkets and a high saving rate to finance investment—remained in place.That helps explain why the East Asian economies recovered more quicklythan many expected.

A case of Asia vu

Likewise,when the global information technology bust dragged Asia into recessionin 2001, forecasters turned out to be much too gloomy about Asia’sprospects. Once again, emerging Asia bounced back fairly briskly.Westerners have always been too quick to pronounce the death of theAsian economic miracle. This may be wishful thinking, but it alsoreflects some misunderstandings about the ingredients of Asia’ssuccess. This year it was widely predicted that Asia’s economies wouldnot recover until after America and Europe had revived. Yet Asia’ssupposedly export-dependent economies have resumed growth before therest of the world. How can that be?

Scepticsargue that the pick-up simply reflects a temporary boost fromrebuilding inventory, with no real increase in demand. Firms had cutproduction to below the level of sales in order to shed excessinventories, so now they need to reopen factories. This may be a factorin some countries, but in others firms are still running down theirstocks.

In SouthKorea the decline in inventories accelerated in the second quarter, andthe leanness of stocks bodes well for further gains in production overthe rest of this year. Instead, the recovery has been led by investmentand consumer spending. South Korea’s private consumption rose by anannualised 14% in the second quarter. In China fixed investment (on aGDP-consistent basis) is running more than 20% higher than a year ago,real consumer spending in urban areas is up by almost 11% and car saleshave surged by 70%.

One reasonwhy Asia’s emerging economies have been able to rebound well beforethose in the rich world is that their downturn was caused only partlyby the slump in America. In 2008 domestic spending was squeezed byhigher prices for oil and food (which account for a much higher shareof household budgets than in other countries) and by tighter monetarypolicies, aimed at curbing inflation. China’s growth, for instance,began to slow well before global demand stumbled, as tight creditpolicies to prevent the economy overheating caused the property marketand construction to collapse.

Across theregion, aggressive fiscal and monetary stimulus has helped revivedomestic demand. Asia has had the biggest fiscal stimulus of any regionof the world. China’s package grabbed the headlines, but South Korea,Singapore, Malaysia, Taiwan and Thailand have all had a governmentboost this year of at least 4% of GDP. Most Asian countries, with thenotable exception of India, entered this downturn with sounder budgetfinances than their Western counterparts, so they had more room tospend. Bank of America Merrill Lynch forecasts that the region’s publicdebt will rise to a modest 45% of GDP at the end of 2009, only half ofthe average in OECD countries.

Moreover,pump-priming has been more effective in Asia than in America or Europe,because Asian households are not burdened with huge debts, so tax cutsor cash handouts are more likely to be spent than saved. It is alsoeasier in a poorer country to find worthwhile infrastructureprojects—from railways to power grids—to spend money on.

In China theeasing of credit has been even more important than its fiscal stimulus.Although lending slowed sharply in July, new lending by banks in thefirst seven months of this year was almost three times its level a yearearlier. And across the whole of emerging Asia, cheaper money has beenmore potent in lifting spending than in the West. This is because,unlike in America and Europe, local financial systems are not crippled,so banks are able to lend more. And since Asian households and firmshad not previously been on a borrowing binge (South Korea is anexception), they can afford to borrow more.

Growth rateswill almost certainly moderate after the second quarter’s astonishingbounce. Even so, Mike Buchanan, an economist at Goldman Sachs, hasraised his forecast for GDP growth in emerging Asia to 5.6% for 2009 asa whole and 8.6% in 2010. He expects China to grow by a breathtaking9.4% this year and 11.9% next.

India’s GDPis forecast to grow by a more modest 5.8% in this fiscal year (endingMarch 2010). Exports accounted for only 15% of India’s GDP in 2008,compared with 33% in China, so India should have been much lessaffected by the global downturn. But because of its dire fiscalfinances (a budget deficit of 10% of GDP last year), the government hashad much less room to spur growth. The poor monsoon rains are alsoexpected to reduce farm output this year. However, Mr Buchanan expectsgrowth to increase to 7.8% next year.

Bubbling up

Even thoughthese economies are only just starting to feel the upturn, policymakersnow face a difficult problem: how to sustain a robust recovery withoutblowing up bubbles. There are growing concerns that a flood ofliquidity is fuelling asset-price bubbles, which could destabiliseeconomies when they burst. In China share prices have almost doubledsince their trough last November, and most Asian countries have seengains of around 50% or more since the start of the year (see chart 3).After falling last year, house prices are now rising rapidly in HongKong, Shanghai, Seoul and elsewhere. Home sales have surged by 70% invalue in China over the past year. According to one estimate, one-fifthof all new lending this year in China has gone into the stockmarket orproperty.

Asset pricescould rise much further. Despite the recent gains, average house pricesin most countries are barely higher than a year ago. And althoughshares are starting to look pricey, China’s stockmarket is still 47%below its 2007 peak. But the lesson from America in recent years issurely that it is better to prevent bubbles forming. Asia’s monetaryconditions are too loose now that economies are reviving; central banksneed to raise interest rates. But with rates close to zero in the richworld, and likely to stay there for a while, this would lure in foreigncapital, adding to domestic liquidity. Capital is already rushing in,attracted by the region’s growth, which is faster than the rest of theworld’s.

The basicproblem is that although the Asian economies have decoupled fromAmerica, their monetary policies have not. In a world of mobilecapital, an economy cannot both manage its exchange rate and controldomestic liquidity. By trying to hold their currencies down against thedollar Asian economies are, in effect, being forced to shadow the Fed’smonetary policy even though their economies are much stronger.

Foreign-exchange intervention to hold down their currencies causesdomestic liquidity to swell. Consumer-price inflation is not animminent threat, because prices are falling in most Asian countries.Chinese consumer prices fell by 1.8% in the year to July. But assetprices look dangerously frothy. The obvious solution is to let exchangerates rise, but with exports still well below last year’s level,governments are reluctant to set their currencies free.

Making it stick

Severalcentral banks in the region, including the People’s Bank of China, theBank of Korea and the Hong Kong Monetary Authority, have given warningsabout the risk of asset bubbles. But there is unlikely to be anysignificant policy tightening before next year, because boosting growthremains governments’ main priority. Indeed, the wealth effects ofhigher asset prices will help lift spending. Ample liquidity istherefore likely to continue to stoke asset prices. Andy Rothman, aneconomist at CLSA, a brokerage, predicts the “biggest round ofasset-price inflation China has experienced since the command economywas dismantled”.

Its creditboom is clearly unsustainable, but China is unlikely to hit themonetary brakes until inflation turns positive and its year-on-year GDPgrowth tops 10%. Instead, policymakers will try to contain the bubbleby tightening lending standards. For example, China’s banking regulatorhas warned banks to stick to rules on mortgages for second homes, whichrequire a down-payment of at least 40% of a property’s value. It hasalso ordered banks to ensure that lending goes into the real economy,not shares.

Fiscalstimulus and the wealth effect of rising asset prices can provide onlya temporary prop to domestic spending. Nor can Asia rely on a strongrebound in exports to America, where spending is likely to remainsluggish over the next few years as households are forced to save morein order to repay debt. In the longer term, Asia’s growth needs to comemore from domestic demand rather than exports.

However, thestandard policy prescribed by Westerners—Asian households must saveless and spend more—is too simplistic. In China private consumption isindeed unhealthily low, at only 35% of GDP. But the average for therest of Asia, at 58% of GDP, is not much lower than the OECD average of61%. South Korean households, which have reduced their saving rate from23% of disposable income in 1998 to only 3% last year, can hardly beaccused of being overly thrifty.

In Indonesia,Malaysia, the Philippines, Taiwan and Thailand it is instead investmentthat looks too low. Investment as a percentage of GDP is little higherthan in many rich economies, even though investment opportunities in adeveloping country should be far greater. For example, Malaysia’sinvestment has fallen from 43% of GDP in 1997 to only 19% last year,less than in the euro area or Japan and well below China’s 44%. Weakerinvestment is one reason why the trend growth-rates of some Asianeconomies have slowed over the past decade.

Theappropriate measures needed to strengthen domestic demand thereforediffer across the region. Although China’s goal should be to consumemore, some of the other Asian economies need to invest more. That willrequire an improved regulatory environment, a crackdown on corruption,better infrastructure and—not least—greater political stability.

Even incountries like China, where low consumption is the main culprit, thenecessary reforms are more complicated than the standard Western advicethat the government needs to spend more on health care and welfaresupport to encourage households to save less. Companies, nothouseholds, have accounted for the bulk of the rise in saving acrossAsia over the past decade. Households’ spending has fallen as a shareof GDP, not because they are saving a lot more, but because their shareof national income has shrunk as that of corporate profits has grown.

To liftprivate consumption, governments therefore need to increase households’share of national income by encouraging more labour-intensive services,rather than favouring capital-intensive manufacturing industries withsubsidies and undervalued exchange rates. Recent estimates suggest thatAsian currencies are among the most undervalued in the world. Strongerexchange rates would help shift growth away from exports and boosthouseholds’ real spending power.

Mind the gap


The gapbetween growth rates in emerging Asia and the G7 is forecast to rise toa record nine percentage points this year (see chart 4). But what ofthe future? Pessimists argue that Asia’s growth over the coming yearswill be much slower than before the global crisis because its mainengine of growth, exporting to America, has broken down and it willtake years to find a replacement. But this may overstate the importanceof America to the Asian tigers. Between 2001 and 2006 (when America’strade deficit peaked), the increase in emerging Asia’s trade surpluswith America accounted for only 6% of the region’s GDP growth. If thoseexports cannot be replaced by domestic demand, growth will be slower,but not massively so.

Besides,long-term growth depends on supply factors, not just demand. Acountry’s long-term “potential” or “trend” rate of growth—the speedlimit at which GDP can expand without igniting inflation—is determinedby growth in its labour supply and productivity. The global financialcrisis should not noticeably reduce productivity growth in emergingAsia. Indeed, recent increases in infrastructure spending across theregion could boost productivity by reducing transport costs, especiallyin places such as inland China.

In Americaand many other rich countries, by contrast, potential growth rates arelikely to fall over the next decade as soaring government debt andhence higher taxes blunt incentives to work and invest, the lingeringcredit crunch dampens investment, and increased government regulationdeters innovation. All this could reduce productivity growth at a timewhen labour forces in these countries will be growing more slowly oreven shrinking.

The tigersare unlikely to return to their breakneck growth rate, which averaged9% during the three years to 2007. But this exceeded their safespeed-limit. Emerging Asia as a whole might enjoy annual growth of 7-8%over the next five years, at least three times the rate in the richworld. The sharp downturn in Asia late last year painfully proved thatthe region was not immune to America’s downfall. But the speed andstrength of its rebound, if sustained, show that it is not chained toUncle Sam either. If anything, the crisis has reinforced the shift ofeconomic power from the West to the East.