June 23, 2014

Beyond China: Where Asian Growth Is

For investors and deal-makers, there is ample opportunity beyond China and India. Changyong Rhee of the IMF identifies the upside and the risk.

Sharon Kahn

Asia is revving its engines again.

Even taking China and India out of the equation, “Asia will remain the world's most dynamic region,” Changyong Rhee, director of the International Monetary Fund’s Asia and Pacific Development department, said in a recent talk before Columbia Business School students and faculty. To underscore his point, Rhee cited GDP growth forecasts for the region as a whole of above 5 percent for the next few years, and emerging Asia besting 6 percent.

Among the usual suspects, Japan is expected to continue along its sluggish growth path, while India renews its growth spurt and China busts its 7.4 percent target.

Introducing this year's “Regional Overview and Frontier Perspectives” report by the IMF, Rhee indicated: “Risks have receded and emerging economies in Asia are doing relatively better than those in other regions.” He credits swift economic responses to the recession and vigilance regarding investor reaction to US quantitative easing and tapering. In addition, the American and European recovery kick-started Asia’s resurgence as developed countries again turn east for exports and investments.

Still, Rhee warned “now is not the time to be complacent” and cited seven risks that could derail Asia’s momentum.

Risk #1: Rising Interest Rates & Tighter Money

The challenge here is twofold: Investors who once chased emerging market returns could rotate into (presumably safer) developed country debt once it pays higher yields. And, for Asia’s sovereigns, corporations, and households, more expensive borrowing could jack up debt/equity ratios.

However, these risks aren’t severe, he noted. In fact, orderly tapering in conjunction with developed market growth will likely have a positive effect, causing the United States and Europe to import more Asian goods.

As far as borrowing goes, corporate leverage has remained stable throughout Asia in recent years, putting the region in better shape than some other parts of the world. Still, Rhee estimated that about 20 percent of corporates shoulder much of Asia’s borrowing burden. Should interest rates rise by a basis point, Rhee calculated, 10 percent of corporate borrowers would see their debt/equity ratio balloon to 40 percent. Household debt could also increase, particularly when it comes to home prices.

Risk #2: China Slowdown

China’s double-digit growth rate has given way to a 7.4 percent target this year — and the contagion affect means the rest of Asia could catch the flu. The correlation between the Chinese economy and greater Asia is decidedly growing as China becomes less an assembly hub and more an importer, trading especially with its neighbors. Rhee calculated that the spillover effect of every 1 percent reduction in GDP Chinese growth translates to a 0.3 percent decline in the rest of Asia.

But wait. The IMF is applauding China’s slower-growth policies, indicating that a 10 percent growth rate was simply not sustainable. What’s more, such a sizzling pace required government stimulus and the buildup of debt. “It’s not the rate of growth but the quality,” said Rhee.

Risk #3: The Waning of Abenomics

By most accounts, the economic policies of Shinzō Abe have reignited internal investment in Japan. The IMF forecasts a respectable 1.4 percent GDP growth for 2014. But, as the major stimulus wanes, Japan faces the prospect of falling back into barely perceptible growth and deflation.

That stuck-in-the-mire outcome is less crucial to the rest of Asia than it was not too long ago, though. As China's influence grows, Japan’s is fading.

Rhee also pointed to some risks for specific countries.

Risk #4: Korea

Managing just 2.8 percent growth GDP increase in 2013, South Korea, has not shone as brightly as it did early in the 2000s. The country faces rising household and corporate debt, income inequality, and an aging population.

Still, Rhee predicted increasing exports and prudent management will keep Korea on the path to 3.7 percent growth this year, followed by several years of 3.8 percent GDP increases.

Risk #5: ASEAN Economies

The Association of Southeast Asian Nations (Indonesia, Malaysia, Philippines, Singapore, and Thailand) represent “a new growth pole,” achieving a stable 5 percent growth in 2014, Rhee forecast. The trajectory would be even higher if Thailand were out of the mix. That country’s political tension is dragging growth down to near zero, although Thai potential is in line with the rest of the ASEAN bloc.

Risk #6: Myanmar

The new darling among investors, Myanmar has a positive outlook — but buffers are thin, Rhee warned. Reforms need to stay on track, the revenue base needs to broaden, and the country needs to reduce reliance on natural resources.

Risk #7: Frontier Economies

Challenges faced by Mongolia, Lao PDR, Cambodia, Sri Lanka, Bangladesh, and Vietnam are to avoid overheating and curb imbalances.

Rhee was optimistic that Asia will continue to wield economic weapons wisely. “Macro-prudential policies should be part of the tool kit to deal with risks and external shocks,” he said. Although India’s economy doesn’t overly influence nearby countries, he is optimistic that new Prime Minister Narendra Modi’s policies will help point that country toward stronger growth.

Rhee warned that a one-size-fits-all policy can’t work in a region as diverse as Asia where inflation, for example, rages at 8 percent in some countries while deflation cripples others. Overall, he suggested, Asian countries should maintain a relatively accommodative monetary policy stance, although China needs to rein in credit expansion.

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