Asia ran into several headwinds through the second half of 2011, and most economies will enter 2012 in the middle of a broad-based slowdown. The big question is whether policymakers and firms can negotiate the current global turmoil without slipping back into recession. We remain upbeat on Asia’s prospects, as domestic risk levels remain low and we expect Europe to muddle through with only a mild recession. Asia-Pacific economies will grow solidly in 2012, as the region’s fundamentals are sound, confidence remains firm, and policymakers still have ample ammunition to support growth.
Yet the region is slowing under tighter domestic monetary conditions and weaker export demand from Europe and the U.S. The slowdown is expected to persist through mid-2012, before a stronger recovery takes hold in the second half of the year.
The China outlook drives the regional outlook. China is the number one export destination for all regional countries except the Philippines and is the reason Asia will continue to grow faster than the rest of the world. Recent Chinese data confirm that the economy is slowing, but at a manageable rate. The government-engineered slowdown, driven by tighter monetary conditions and a range of fiscal tightening and property restrictions, is proceeding in line with expectations. There have been some signs of a sharper slowdown—namely, some weak purchasing managers' indices and a rapid cooling in the property market—but on the whole the Chinese data look solid. This is what a soft landing looks like. Our outlook for 8.7% GDP growth through 2012, driven by public infrastructure spending and domestic demand, remains intact.
With Chinese inflation trending lower, policymakers have scope to continue easing monetary policy, and we expect more aggressive moves through the first half of 2012. Yuan appreciation is likely to pause to support struggling exporters. Although 12-month forwards suggest a yuan depreciation in 2012, this seems unlikely. China will go close to running a balanced trade account in 2012 as domestic demand easily outpaces exports, though this may not be enough to mute U.S. calls for further yuan appreciation. Trade tensions between the U.S. and China may rise in the lead-up to the U.S. presidential election.
Downside risks to China have intensified but appear manageable. A credit crunch linked to a property market collapse remains the biggest risk and would drag much of the region into recession. China’s property market is overvalued and activity has already begun to slow, with prices falling in several tier-one cities. Besides hurting households and developers, a collapse would exacerbate local governments' fiscal stress and likely bring parts of China’s financial sector to a halt through rising nonperforming loans and banks’ growing reluctance to take on risk. This remains the region’s biggest risk.
Export manufacturers may struggle
Asia’s small, export-led economies remain vulnerable to a global slowdown. Taiwan, Singapore and Hong Kong are among the most trade-exposed and will tip back into recession if the global economy slows significantly in 2012. For most manufacturers, long supply chains mean they are still tied to demand in developed economies. Forty-two percent of Taiwan’s exports, for example, go to Mainland China, but Taiwan is still very much tied to the U.S. and Europe, as most of these products are simply shipped to China for assembly before being exported to the West.
South Korea is in the unique position of producing exactly what fast-growing emerging markets want and at a price point they can afford. Local manufacturing will slow in 2012, but not as much as in neighboring Japan, as Chinese investment spending lifts demand for Korean capital equipment. The outlook for the rest of Korea’s economy is mixed. Consumer spending held up through the second half of 2011 and is likely to be boosted by some pre-election sweeteners in 2012, but demand must inevitably slow under the weight of a weak housing market, elevated interest rates, and an enormous pile of household debt.
Thailand's floods a factor
Thailand’s fourth quarter floods knocked out autos and electronics production north of Bangkok, which caps our 2012 GDP forecast at 2.9%. This has knock-on effects for Japan, Thailand’s biggest foreign investor; many flood-affected firms are key suppliers for Japanese industry. Japan’s economy could grow 2.1% in 2012, assuming the post-tsunami reconstruction proceeds smoothly, but this outlook has risks. Export manufacturing will struggle in the face of a strong yen and deteriorating global outlook; the yen will remain a favoured safe haven as the U.S. and Europe struggle. Japan’s political situation remains highly unstable, which caps confidence and growth. Japanese consumers are again expected to struggle in 2012 under the weight of falling prices; a hike in the consumption tax, if implemented, would also curb demand.
Australia, Indonesia and, to a lesser extent, Malaysia will be lifted by Chinese commodity demand linked to their huge public infrastructure and investment projects. Soaring demand is driving an investment-led boom in Aussie mining that will drive GDP growth to 4% in 2012, but it has also driven up interest rates and sent the Australian dollar to record highs, crowding out other sectors. A slowdown in China would leave Australia highly vulnerable.
Rate cuts support domestic-led economies
Indonesia will remain one of the most favoured economies in the region among investors. Growth is broad-based, confidence is high, the politics are stable, and foreign investors are pouring in. The main risk to our 6.3% GDP forecast in 2012 is weak infrastructure and capacity constraints, though an 11.1% increase in fixed investment should help lift potential growth.
Inflation has peaked, and risks are receding in most economies, giving central banks scope to cut interest rates to support growth through the current downturn, especially in domestic-led economies. The rate cut cycle has already begun in Indonesia (75 basis points' worth of cuts since October) and Australia (two quarter-point cuts since November), with China now relaxing reserve requirements.
India, the other big domestically driven economy in the region, is in trouble, with production collapsing under the weight of 13 interest rate rises, falling confidence, political stasis, an outflow of foreign funds, and a weak rupee. The central bank will soon begin easing even as inflation remains at 9% y/y, but this won’t be enough to prevent a sharp slowdown. GDP growth is forecast at 6.6% in 2012, with growing downside risk.
A changing political landscape
Asia’s political landscape will look very different in a year. Scheduled elections in Taiwan and South Korea are still up for grabs, while Japan’s Prime Minister Yoshihiko Noda may call an early election to shore up his mandate and push forward with reforms. The handover to the fifth generation of Chinese leaders will begin next autumn with Xi Jinping set to take over from current President Hu Jintao. Xi is a protégé of Hu’s and is likely to provide policy continuity, implying gradual liberalization of the economy and retention of strong state-owned enterprises. The behind-the-scenes jostling for power in China is as fierce as in any open democracy, betraying the outward signs of stability. China’s top brass hit upon a formula for a smooth handover of power at the most recent transition, and they are likely to maintain stability this time around, though this is a risk that needs monitoring.
The biggest risks lie outside the region. Europe’s debt problems are already weighing on growth through weaker trade and investment flows, but the bigger risk is financial contagion and the potential to expose domestic weaknesses.
Asia-Pacific economies are moderately exposed to a shift in global investor sentiment and sudden capital withdrawals. Singapore and Hong Kong run small, open financial centres and so are highly leveraged to global capital flows; both would enter recession under a global credit crunch. Conversely, both China and Japan finance most of their lending domestically and so have limited exposure. New Zealand is exposed, and Australia, Indonesia, Korea and Taiwan also appear vulnerable to a global credit squeeze.
A global credit crunch or a sharp global slowdown could precipitate a much-feared Chinese property collapse. It might also be the trigger for a fiscal collapse in Japan. Japan’s gross public debt is more than 200% of GDP. Most of this is domestically held, and bond yields remain low, but unless it is reined in, Japan will have a fiscal crisis within a decade. It could be in 2012, possibly linked to Europe or ongoing domestic political problems.