09/07/2015
Asia / GDP
How much capital flows out of Asia in the near future will depend on the strength of the US economy, the weakness of the Chinese economy, and how close Asia is to the realities of 1997.
Much of the financial market’s recent turmoil is due to fears and uncertainties related to the state of the real economy. The 14-month ‘collapse’ of Asian currencies, the miniscule 2% devaluation of the Chinese yuan, the rout in global equity markets it wrought, and the inevitable fears of another Asian Financial Crisis (AFC) of 1997 – all owe to real economy fears and illusions.
In our view, these fears and uncertainties boil down to three questions: How strong is the US? How weak is China? And how much does the rest of Asia today resemble the Asia of 1997?
Our answers are straightforward: not very strong, not very weak, and not very much.
Fear 1: The US is too “strong” and rates there are going up. In reality, US GDP growth has averaged 2.1% year-to-date, not too far from the 2% pace averaged over the past three years. Yes, the labour market slack is being mopped up. But not fast enough to prevent core personal consumption expenditures inflation – the US Federal Reserve’s favoured gauge – from continuing its 3.5 year decline. Recent market turmoil may delay rate hikes by a few months but the most important fact is that the Fed was never going to take rates very far very fast to begin with. Against this backdrop of unchanged growth and falling inflation, the September versus December debate on Fed rate hikes grows increasingly irrelevant.
Fear 2: China is too “weak” and rates there are going down. In reality, the 50% crash in equity markets since June doesn’t reflect a crumbling economy any more than the 100% rise earlier this year reflected a booming one. Markets and the economy have never marched to the same drum in China and they are no more correlated today. The economy has indeed slowed, but the big downshift came three years ago. Since then, the economy has run more sideways than downwards. China does have a debt problem. And growth has slowed by more than authorities might have wished a year ago. How China deals with the bad debt – or, more precisely, how and whether it prevents such episodes from happening again – will have a direct impact on the quantity and quality of China’s longer-term growth.
Fear 3: The rest of Asia is caught in the middle and a catastrophic 1997 scenario is just around the corner. In reality, Asia looks less like 1997 every time the question comes up. The main reason has to do with external balances; for the ten years leading up to 1997, Asia ran large current account deficits – it borrowed a lot of money from abroad. The money wasn’t invested very wisely and when it became apparent that some were not going to get their money back, everyone ran for the door and the rest is history. But here’s the thing. When the bubble burst in 1997, Asia’s big deficits turned immediately into big surpluses. Asia began paying down the debt built up prior to the crisis. For the last 18 years, all Asian countries, save for Indonesia and India, have continued to run large surpluses. Thailand, Malaysia, Indonesia, South Korea – the worst-hit countries during the AFC – saw external debt (minus foreign exchange reserves) drop to 11% of GDP from 60% back in 1997. In India and the Philippines, it has fallen to 6% of GDP from 35% in 1997.
At the end of the day, though, it’s not about the current account surpluses or the external debt or any other statistic that says risk today is lower than it used to be. The 1997 question is first and foremost a question of cyclical dynamics – ups and downs, inflows and outflows, inflation and deflation. Are economies careening ever faster towards a point of no return? Or are they quietly pulling back from one? From this perspective, the cycle is clear: For the past four years, Asia’s economies, including China’s, have been backing away from the edge, not accelerating towards it. Risks remain, but the odds of a 1997-style implosion are lower than they were four years ago, not higher. Much of this owes to China’s intentional decision four years ago to sharply cut growth targets and start focussing on structural reform and “quality over quantity”.
