Liquidity is likely to get tighter but it’s a sharp drop in exports across the region that will be most painful
By NICHOLAS KWAN 31 December 2008
Asia is heading for a hard time in 2009. The region’s economies are likely to get worse before they get better, but it is unlikely to be the worst-hit among the different regions, nor will this be the worst crisis Asia has ever seen.
In the longer run, Asia could even gain more than it suffers, coming out stronger, with more solid fundamentals and a heavier weight in the global economy, if it manages the adjustment right.
We have long argued that Asia cannot decouple from the current crisis, but it will be better insulated than others and than it was before, in our view.
This observation is likely to be fully appreciated in 2009, when the region gradually runs through the three different stages of direct impact from the sub-prime-triggered crisis.
The first direct impact - through which Asia surfed almost unscathed, reinforcing the decoupling argument - came from holdings of American toxic assets such as sub-prime debt, CDOs, and CLOs.
Unlike Europe, Asia was largely spared by its relatively small exposure. This is not because Asian investors are smart, but more due to their being too unsophisticated to understand these highly complex structured products, and too conservative (after the previous crises) to have the risk appetite to leverage up.
The second impact, through which Asia had a somewhat bumpy ride and which it is still struggling to overcome, is the liquidity challenge set off by the serious dysfunction of key financial markets and the sharp deleveraging of financial institutions in the West.
Aggravated by the bankruptcy of Lehman Brothers and subsequent credit market events, liquidity in many Asian markets, such as South Korea, was stressed.
Liquidity is likely to turn tighter as the year ends and the lunar new year looms in late January, and may remain stressed through at least first-half 2009, when the US dollar deleveraging process is expected to continue.
While Asia’s substantial forex reserves and aggressive monetary easing have helped to avert an acute liquidity crisis thus far, some countries may need to tap external liquidity supports such as bilateral central bank repo lines or even IMF facilities.
The Fed’s US$30 billion swap lines (currently extended only to Korea and Singapore in Asia) and the proposed US$80 billion multilateral repo line among the central banks of Asean+3 (China, Japan, and Korea) may need to be raised, expedited, or broadened to become a more comprehensive safety net.
We are optimistic that Asia’s huge foreign reserve holdings (over US$4 trillion) should spare it from any acute liquidity crisis, but the region needs to act together quickly.
Given the current level of market nervousness and the highly contagious nature of financial market crises, if a key member succumbed to liquidity distress, it would be hard to insulate the rest from a broader crisis.
The third and probably the greatest impact - which is likely to dominate most of 2009 - is the decline in exports. During the 2001-02 economic downturn, US and EU imports shrank for 2-2.5 years, both by about 30 per cent, compared to a 22 per cent drop in Japan’s imports. Given Asia’s heavy dependence on exports, it could be in a relatively vulnerable position.
In 2001-02, Asia managed to fare relatively well: US imports from Asia were down by 18.5 per cent, Japan’s fell by 20 per cent, and those of the EU fell by only 1.4 per cent. Thus far, US imports from Asia are still running at a single-digit growth rate, even though overall US imports dropped 10 per cent in the two months to September 2008.
Export crunch
In 2007, the US, the EU, and Japan accounted for 15 per cent, 16 per cent, and 8 per cent, respectively, of developing Asia’s US$3.3 trillion of exports. Assuming imports to these three markets from Asia were to drop by 30 per cent in 2009, much more than in the previous downturn, Asia’s total exports would fall by a proportional 12 per cent.
Assuming Asian exports have 30 per cent local content on average, this could translate into a US$115 billion direct income loss, or about 1.5 per cent of developing Asia’s aggregate GDP. Such a blow should be manageable, in our view.
There is obviously more downside risk in terms of both the depth and length of the export decline, as well as indirect income loss from export-related activities such as transport, finance, and other services.
To offset these factors, much will depend on Asia’s ability to stimulate its own demand and develop new markets. Here again, we are relatively positive given Asia’s solid economic fundamentals: strong fiscal positions, large forex reserves, unimpaired financial systems, limited leverage, and falling inflationary pressure.
It is these factors that differentiate Asia from the West. The former is facing a cyclical downturn, while the latter is suffering from a structural crisis.
Once the impact of the export decline becomes clear in late 2009, our argument that Asia is better insulated than other regions and than it was during previous crises will be better appreciated, in our view.
In fact, Asia could come out stronger once its cyclical excesses are addressed, and is likely to play a more important role in the world economy as the current crisis forces structural changes in global finance.
In addition to Asia’s general growth outlook, three key developments in 2009 will deserve attention:
• Deleveraging Unlike in the West, where huge asset and credit bubbles are undergoing sharp contractions, forcing rapid deleveraging of financial institutions and aggressive central bank easing to offset the liquidity crunch, Asia’s relative absence of asset bubbles and its relatively low leverage mean much of the deleveraging pressure is confined to the external financial sector.
For economies with relatively closed capital markets, monetary easing is largely in response to growth rather than liquidity concerns. This will make a difference in 2009 to the speed and extent of monetary easing, especially after the initial liquidity shock is largely absorbed.
For economies with weak domestic growth momentum, such as Thailand and Taiwan, monetary easing may be deeper and longer. For those where domestic demand is more robust, such as China and India, interest rates may reach their cyclical bottom earlier.
• Deflation With commodity prices falling and external demand weakening, the threat to price stability in 2009 will shift from inflation to disinflation, or deflation. Despite aggressive monetary easing by some governments, liquidity is likely to remain tight for some time due to the huge forces of global deleveraging, heightened risk aversion, and deteriorating credit conditions.
However, unlike in the previous crisis, when financial systems suffered severe damage and economies fell into deep recessions, the current deflationary pressure should be less entrenched. Once the high base effect and demand distress pass their peak in H1 2009, we expect prices to gradually revert to more normal levels.
• Depreciation Depressed demand and sentiment, US dollar deleveraging, and defensive policies may see the Asian currencies trade weaker in general during H1 2009. Some, such as the Korean won, may be under severe downward pressure if driven by carry trade unwinding, weaker fundamentals, and less-than-optimal policies.
Devaluation risk
The key here is to avoid competitive devaluation, which will depend heavily on the performance of the Chinese yuan given China’s heavy weight in regional and global trade. While the market is expecting the yuan to trade marginally weaker in 2009, we believe Beijing is clear about the importance of maintaining a stable yuan (versus the US dollar) so as not to destabilise the region.
In turn, the range of depreciation of Asian currencies should be limited, and may even reverse in later 2009 as the Asian economic outlook becomes more positive and the US dollar turns weaker.
The writer is regional head of research, Asia, Standard Chartered Bank (Hong Kong) Limited
1 comment:
Asia in for a Hard Time in 2009
Liquidity is likely to get tighter but it’s a sharp drop in exports across the region that will be most painful
By NICHOLAS KWAN
31 December 2008
Asia is heading for a hard time in 2009. The region’s economies are likely to get worse before they get better, but it is unlikely to be the worst-hit among the different regions, nor will this be the worst crisis Asia has ever seen.
In the longer run, Asia could even gain more than it suffers, coming out stronger, with more solid fundamentals and a heavier weight in the global economy, if it manages the adjustment right.
We have long argued that Asia cannot decouple from the current crisis, but it will be better insulated than others and than it was before, in our view.
This observation is likely to be fully appreciated in 2009, when the region gradually runs through the three different stages of direct impact from the sub-prime-triggered crisis.
The first direct impact - through which Asia surfed almost unscathed, reinforcing the decoupling argument - came from holdings of American toxic assets such as sub-prime debt, CDOs, and CLOs.
Unlike Europe, Asia was largely spared by its relatively small exposure. This is not because Asian investors are smart, but more due to their being too unsophisticated to understand these highly complex structured products, and too conservative (after the previous crises) to have the risk appetite to leverage up.
The second impact, through which Asia had a somewhat bumpy ride and which it is still struggling to overcome, is the liquidity challenge set off by the serious dysfunction of key financial markets and the sharp deleveraging of financial institutions in the West.
Aggravated by the bankruptcy of Lehman Brothers and subsequent credit market events, liquidity in many Asian markets, such as South Korea, was stressed.
Liquidity is likely to turn tighter as the year ends and the lunar new year looms in late January, and may remain stressed through at least first-half 2009, when the US dollar deleveraging process is expected to continue.
While Asia’s substantial forex reserves and aggressive monetary easing have helped to avert an acute liquidity crisis thus far, some countries may need to tap external liquidity supports such as bilateral central bank repo lines or even IMF facilities.
The Fed’s US$30 billion swap lines (currently extended only to Korea and Singapore in Asia) and the proposed US$80 billion multilateral repo line among the central banks of Asean+3 (China, Japan, and Korea) may need to be raised, expedited, or broadened to become a more comprehensive safety net.
We are optimistic that Asia’s huge foreign reserve holdings (over US$4 trillion) should spare it from any acute liquidity crisis, but the region needs to act together quickly.
Given the current level of market nervousness and the highly contagious nature of financial market crises, if a key member succumbed to liquidity distress, it would be hard to insulate the rest from a broader crisis.
The third and probably the greatest impact - which is likely to dominate most of 2009 - is the decline in exports. During the 2001-02 economic downturn, US and EU imports shrank for 2-2.5 years, both by about 30 per cent, compared to a 22 per cent drop in Japan’s imports. Given Asia’s heavy dependence on exports, it could be in a relatively vulnerable position.
In 2001-02, Asia managed to fare relatively well: US imports from Asia were down by 18.5 per cent, Japan’s fell by 20 per cent, and those of the EU fell by only 1.4 per cent. Thus far, US imports from Asia are still running at a single-digit growth rate, even though overall US imports dropped 10 per cent in the two months to September 2008.
Export crunch
In 2007, the US, the EU, and Japan accounted for 15 per cent, 16 per cent, and 8 per cent, respectively, of developing Asia’s US$3.3 trillion of exports. Assuming imports to these three markets from Asia were to drop by 30 per cent in 2009, much more than in the previous downturn, Asia’s total exports would fall by a proportional 12 per cent.
Assuming Asian exports have 30 per cent local content on average, this could translate into a US$115 billion direct income loss, or about 1.5 per cent of developing Asia’s aggregate GDP. Such a blow should be manageable, in our view.
There is obviously more downside risk in terms of both the depth and length of the export decline, as well as indirect income loss from export-related activities such as transport, finance, and other services.
To offset these factors, much will depend on Asia’s ability to stimulate its own demand and develop new markets. Here again, we are relatively positive given Asia’s solid economic fundamentals: strong fiscal positions, large forex reserves, unimpaired financial systems, limited leverage, and falling inflationary pressure.
It is these factors that differentiate Asia from the West. The former is facing a cyclical downturn, while the latter is suffering from a structural crisis.
Once the impact of the export decline becomes clear in late 2009, our argument that Asia is better insulated than other regions and than it was during previous crises will be better appreciated, in our view.
In fact, Asia could come out stronger once its cyclical excesses are addressed, and is likely to play a more important role in the world economy as the current crisis forces structural changes in global finance.
In addition to Asia’s general growth outlook, three key developments in 2009 will deserve attention:
• Deleveraging Unlike in the West, where huge asset and credit bubbles are undergoing sharp contractions, forcing rapid deleveraging of financial institutions and aggressive central bank easing to offset the liquidity crunch, Asia’s relative absence of asset bubbles and its relatively low leverage mean much of the deleveraging pressure is confined to the external financial sector.
For economies with relatively closed capital markets, monetary easing is largely in response to growth rather than liquidity concerns. This will make a difference in 2009 to the speed and extent of monetary easing, especially after the initial liquidity shock is largely absorbed.
For economies with weak domestic growth momentum, such as Thailand and Taiwan, monetary easing may be deeper and longer. For those where domestic demand is more robust, such as China and India, interest rates may reach their cyclical bottom earlier.
• Deflation With commodity prices falling and external demand weakening, the threat to price stability in 2009 will shift from inflation to disinflation, or deflation. Despite aggressive monetary easing by some governments, liquidity is likely to remain tight for some time due to the huge forces of global deleveraging, heightened risk aversion, and deteriorating credit conditions.
However, unlike in the previous crisis, when financial systems suffered severe damage and economies fell into deep recessions, the current deflationary pressure should be less entrenched. Once the high base effect and demand distress pass their peak in H1 2009, we expect prices to gradually revert to more normal levels.
• Depreciation Depressed demand and sentiment, US dollar deleveraging, and defensive policies may see the Asian currencies trade weaker in general during H1 2009. Some, such as the Korean won, may be under severe downward pressure if driven by carry trade unwinding, weaker fundamentals, and less-than-optimal policies.
Devaluation risk
The key here is to avoid competitive devaluation, which will depend heavily on the performance of the Chinese yuan given China’s heavy weight in regional and global trade. While the market is expecting the yuan to trade marginally weaker in 2009, we believe Beijing is clear about the importance of maintaining a stable yuan (versus the US dollar) so as not to destabilise the region.
In turn, the range of depreciation of Asian currencies should be limited, and may even reverse in later 2009 as the Asian economic outlook becomes more positive and the US dollar turns weaker.
The writer is regional head of research, Asia, Standard Chartered Bank (Hong Kong) Limited
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