Asia’s strong recovery means that higher interest rates and stronger currencies will be two key features in 2010
ASIA is rapidly approaching the end of its sharpest V-shaped recovery on record. It’s been quite a ride on both sides of the trough: two quarters of double-digit GDP contraction for most countries (ending in 1Q 2009), followed by two quarters of double-digit expansion. We are now halfway through the second of the upside quarters with Singapore, China and Korea having reported double-digit growth rates (in q-o-q, seasonally adjusted terms) in 3Q 2009. Malaysia, Thailand and Taiwan will likely report similar numbers over the next two weeks.
If the end is nigh – and it is – let’s not rush there just yet. There’s plenty of time to prepare for what’s coming and there’s little to fear anyway. Let’s first take a minute to consider how extraordinary the recovery has been. One way to get a sense of it is to look at Singapore.
Back in January, most government and private sector professionals expected to see a 2.4 per cent contraction in the Singapore economy in 2009. By May, those expectations had plunged a full five percentage points to an alarming -7.5 per cent. But only five months later, in October, expectations were right back where they were at the start of the year: to a contraction of 2.6 per cent. That’s how convincing the downward head fake was, that’s how sharp the V-shaped recovery was. We all would have come closer to the truth if we had left our 2009 forecasts untouched back in January.
Naturally, the ‘thought leaders’ who led consensus in predicting Armageddon in the first half of the year had more backtracking to do later on. One lesson they and everybody else learned this year is that it’s not about being ‘ahead of the curve’; it’s about being right at the end of the day. Not many were this year.
For Asia overall, the roller coaster was almost as wild as it was in Singapore. Industrial production – Asia’s economic backbone – peaked in the summer of 2008; not surprisingly, just before the Beijing Olympics in August. But the downturn continued with the collapse of Lehman Brothers in September 2008 and by January 2009, industrial production in the Asia-9 had fallen by 14 per cent. That’s twice the drop that occurred during the financial crisis of 1997/98 or the high-tech global recession of 2000/01.
Not surprisingly, exports led the collapse on the demand side of the GDP equation. In US dollar terms, Asia’s exports dropped by 40 per cent between July 2008 and January 2009. Like the drop in industrial production, the export drop was twice as big as what occurred during the global tech recession of 2000/01 and four times bigger than the export contraction in 1997/98.
What continues to surprise is that Asia’s export collapse had almost everything to do with China and almost nothing to do with the US, either directly or indirectly. Between July 2008 (when exports peaked) and January 2009 (when they hit bottom), Asia-8 exports to China fell by 45 per cent. To the US they fell by less than half that, or 21 per cent.
But the percentage drops don’t tell the real story, because China is a bigger buyer of Asia’s exports than the US. And it’s the dollar changes that make or break a business. In revenue terms, Asia-8 exports to China fell by US$111 billion between July 2008 and January this year. To the US, they fell by US$27 billion. In other words, in the revenue terms that matter, the export shock delivered by China was four times greater than the shock delivered by the US.
This explains why the countries hit the hardest were those with the closest links with China. And it helps explains why Asia was able to bounce back with no help from the US.
And bounce back it did. Exports and industrial production hit bottom in January and by July, Asia’s industrial production had fully recovered its pre-crisis levels. Six months down, six months back up – the very definition of ‘V’. By September, though, output had advanced another 2-3 per cent. So it’s no longer just a V-shaped recovery. We’ve passed that. Now it’s a V+.
V, V+, no matter. What is so amazing, to some, is that Asia pulled it off with no help from the US. Think about it: Asia’s industrial output recovered to pre-crisis levels by July while US imports turned north only in June. It’s a big deal. But is it really so surprising? Not when you remember that Asia’s export collapse was related to China, not the US.
Moreover, it isn’t the first time this has happened. Back in 2000/01, Asia beat the US in getting out of recession by a good four months. This fact – and the reasons behind it – is what allowed DBS to say, way back in December last year, that Asia would pull the same trick this time, but even more forcefully. This was when everyone else was saying that Asia would have to wait for the US to recover before it could.
Times change, and the biggest change underway in the global economy today is how much Asia contributes to global growth each year relative to how much the US does, or did. This structural shift – it’s been going on for 20 years and will go on for the next 20 – explains much of why Asia was able to pull off the V-shaped recovery with no help from the US.
The question now is, will Asia’s double-digit GDP growth continue? The answer is, of course not, for any of a thousand reasons. Double digit growth will soon give way to sideways movement in output levels. Asia’s V-shaped recovery will turn into a ’square root’ shaped recovery: that is, a sharp drop, a sharp rise, and then a palpable turn sideways.
When will Asia hit the kink in the square root sign? Probably by the end of the year or early 2010. In terms of GDP growth, Asia will experience a second quarter of double-digit growth in 3Q 2009 that should drop to high single-digits (6-8 per cent) in the fourth quarter. By 1Q 2010, growth should be back to normal.
Three things will constrain growth very soon: demand, supply, and policy. On the demand side, growth is running at double-digit rates now only because it fell at double-digit rates earlier on. What Asia is experiencing is the snapback from a series of four to five one-off events in late 2008 that included, perhaps most notably, the shock from the collapse of Lehman Brothers in September 2008. That sharp downturn had a bottom. The sharp upswing will have a top. With speeds on both sides of the ‘V’ about equal, the upswing will last for as long as the downswing: two quarters. But only as long as the downturn, because the upturn is nothing but its flipside.
And if demand does manage to surge for longer, there’s the supply side to contend with. Output can grow as fast as demand does when there is excess capacity, as there is today. But with demand soaring back, excess capacity will soon vanish. And once demand hits the brick wall of capacity constraints, output can grow only as fast as those walls can be moved.
Finally, policy will have a hand in slowing growth, and probably sooner than most imagine. Because once excess capacity is exhausted – and it will be by year-end – double digit demand growth starts to imply double digit inflation in most countries. That’s too high. Policies will change.
Throughout Asia, monetary tightening will be a key feature of 2010, with higher interest rates and stronger currencies expected to share the burden about equally. In general, we expect tightening will begin in earnest around 2Q 2010, with a few exceptions. On the tighter side, Korea and India will move sooner, probably in January or February. On the slower side, Thailand seems unlikely to tighten until the third quarter.
For Asia overall, much will depend on China, where we expect rate hikes and currency appreciation to begin in 2Q 2010. We look for the benchmark one-year lending rate to rise by 81 basis points (to 6.12 per cent) by the year-end. We also expect the yuan to resume its appreciation vis-a-vis the US dollar in 2Q 2010 and to strengthen to 6.61 per dollar by the end of 2010. This will set the stage for currency appreciation elsewhere in Asia, allowing other currencies to rise more comfortably than if they went solo. Asia’s currencies have risen by 6-7 per cent on average against the dollar since the start of this year and we expect to see another 6-7 per cent appreciation by the end of 2010.
Other things being equal, currency appreciation and higher interest rates will help cool regional economies and keep a lid on imported inflation as well. The trouble is, higher rates and the prospect of local currency gains have the tendency to attract foreign inflows. And inflows have the tendency to wreak havoc with the best laid monetary plans. They drive interest rates back down and push currencies further north than authorities might have wanted. Raise interest rates again and you just get another round of inflow: Asia-vu.
The only ’solution’, if you can call it one, is to control inflows. Nobody likes controls and for good reason. They are clumsy and messy and have the awful tendency to change from week to week. But they do afford central banks a greater ability to control interest rates and currencies at the same time. And for this reason the controls debate always comes back when inflows are pounding on the door. Asia’s strong recovery means that higher interest rates and stronger currencies will be two key features of Asia in 2010. Capital inflows and another debate over controlling them seem likely to be two more.
DAVID CARBON – MD, Economics & Currency Research, DBS Bank Ltd
Source: Business Times, 1 Dec 2009
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