The Asian economies are likely to be the first to pull out of the global recession

ASIA’S tiger economies have suffered some of the sharpest declines in output during the global recession, and some fear that, because of their dependence on exports, they will not see a sustained recovery until demand rebounds in America and Europe. However, their doughty resilience should not be underestimated. They came roaring back unexpectedly fast after the Asian crisis of the late 1990s. They could surprise again.

Across the region as a whole, the slump has been as bad as it was in 1998. China and India have continued to grow, but in the rest of emerging Asia GDP plunged by an annualised 15% in the fourth quarter of 2008. Only three economies have published first-quarter figures. China’s GDP growth accelerated to an annualised rate of over 6%, up from around 1% in the previous quarter. South Korea’s GDP expanded by 0.2%, after plunging 19% in the previous three months. But Singapore’s GDP fell by 20%, even more than in the fourth quarter.

More timely export figures suggest that the worst may be over. Although the headline numbers show that South Korea’s exports fell by 19% in the year to April, they rose by a seasonally adjusted annualised rate of 53% in the three months to April compared with the previous three months, Goldman Sachs estimates; Taiwan’s grew by an annualised 29% over the same period. China’s exports over the past few months have managed only to stabilise, but its industrial production jumped by an annualised 25% in the past three months.

Economists are revising up their forecasts for China’s GDP growth this year: 8% may now be possible even if American consumers remain frugal. There is a myth that China’s growth depends on American consumers. In fact, if measured on a value-added basis (to exclude the cost of imported components), China’s exports to America account for less than 5% of its GDP.

There is more argument, however, over the smaller, more export-driven economies, such as Hong Kong, South Korea, Singapore and Taiwan. Robert Subbaraman, an economist at Nomura, offers several reasons why they are likely to remain sluggish for the time being. The recent rise in exports and production, he argues, largely reflects the fact that firms are no longer running down stocks. This will provide only a temporary boost unless global demand picks up. Firms’ spare capacity also means that investment will continue to fall, while rising unemployment threatens to dent consumer spending. Nor is China’s stronger growth likely to save the region. Over 60% of China’s imports come from the rest of Asia, but about half of these are components that are assembled in China and then sold to the rich world.

In its latest economic outlook on Asia, the IMF forecast that the region excluding China and India would grow by only 1.6% in 2010, largely because it expects the American economy to be flat. However, Peter Redward of Barclays Capital argues that Asia can recover earlier and more strongly than elsewhere. In 2010, he reckons, the smaller Asian economies could grow by almost 4%, or close to 7% once China and India are added in.

One reason for his optimism is his explanation for why the Asian economies were hit so hard in the first place. Asians are often blamed for saving too much and spending too little, but Mr Redward argues that the main reason for their plight was that manufacturing accounts for a much larger share of GDP than elsewhere. Industries such as cars, electronic goods and capital machinery are highly cyclical. In rich and emerging economies, GDP fell furthest last year in countries with the largest share of manufacturing. This, in turn, could imply a sharp recovery.

A second reason for expecting a stronger bounce is that fiscal stimulus in Asia is bigger than in other regions (see chart). China, Japan, Singapore, South Korea, Taiwan and Malaysia have all announced fiscal packages of more than 4% of GDP for 2009, twice as large as America’s stimulus this year. The pump-priming should also work better in Asia than in America or Europe, because modest corporate and household debts mean that tax cuts or cash handouts are more likely to be spent than saved. Banks, moreover, are in much better shape and so have more freedom to support an increase in domestic spending.

As the world’s largest importers of oil and other commodities, the tiger economies have also benefited hugely from the fall in prices over the past year. This has acted like a tax cut, boosting real incomes and profits. Asia has enjoyed a gain from cheaper oil of almost 3% of GDP this year. Add in lower prices for food and raw materials and the total gain could match the governments’ stimulus (though the danger remains of a renewed spike in oil prices).

Pessimists maintain that Asia has always been pulled out from previous recessions, such as the 1998 financial crisis, by strong exports to the West. However, a recent analysis by Frederic Neumann and Robert Prior-Wandesforde, both of HSBC, finds that, contrary to received wisdom, Asia’s recovery from its 1998 slump was led not by exports, but by consumer spending. Exports to the West did not surge until 2000. The region’s current-account surplus actually shrank between 1998 and 2001.

Thanks to a large fiscal stimulus and the healthier state of private-sector balance-sheets in most economies, domestic spending (consumption and investment) should revive earlier in emerging Asia than elsewhere, rising by perhaps 7% next year, up from 4-5% this year. America’s domestic demand is expected to remain weak in 2010 after falling sharply this year. Indeed, add in Japan and total Asian domestic spending (at market exchange rates) looks set to overtake America’s next year.

But what of emerging Asia’s longer-term prospects? Much of the increase in Asian domestic demand this year and next will come from government investment. Unlike rich countries, emerging Asia has room to keep investing in infrastructure for several years but governments need to encourage more consumption to fill the gap after the infrastructure projects are completed. Asian households’ low rate of consumption and borrowing means that they have huge scope to spend more. Better social safety-nets might encourage Asians to save less. Governments also need to lift households’ share of national income by reducing their bias towards capital-intensive manufacturing and encouraging more labour-intensive growth.

Ultimately, relatively robust expansion in domestic spending should help most Asian economies to keep growing faster than the rest of the world. But the tigers are unlikely to return to their heady growth rates of recent years. Nor would that be desirable given the impact on inflation and the environment.

Suppose that net exports contribute nothing to growth, and that domestic demand grows at roughly the same pace as it has in the past five years. Then emerging Asia could see annual growth of almost 7% over the next five years (around 8% in China, a more modest 5% in the smaller economies). That might sound disappointing for economies that enjoyed average growth of 9% in the three years to 2007. But it would still be around three times as fast as in the rich economies.

Source: The Economist ( May 16-  May22 )

Using market signals to gauge a bank’s health

AS THE tab for bank bail-outs rises, the notion that a firm can be “too big to fail” has become almost too much to stomach. What is needed is a regulatory regime that disciplines banks without forcing them to the wall in such a way that their demise wrecks the payments system. One way is to make banks hold so much equity, and so little debt, that even huge losses would not lead to insolvency. Debt has its advantages, however. For instance, it can be cheaper than equity finance, thanks to tax breaks.

In new research, Oliver Hart, of Harvard University, and Luigi Zingales, of the University of Chicago, argue that the mix of debt and equity should fluctuate according to the risk of bank failure. Banks should hold less capital in good times and reduce leverage when losses loom. This could be achieved in the absence of an all-wise regulator by using the cost of credit-default swaps (CDSs), which insure against default, as a guide to the right capital structure.

In their scheme, when a bank’s CDS price stays above a certain threshold, the regulator forces managers to inject enough equity capital to cushion bondholders against losses. If the bank does not act swiftly to push the CDS price back down, the regulator seizes the assets, wipes out shareholders and sacks the management. The bank is recapitalised as a going concern and later sold. Creditors get some of the proceeds, but would not be made whole.

The appeal of this kind of capital regime is that regulators would be less prone to capture. The market does the monitoring job: CDS prices act as a check on excessively risky business strategies. But banks are opaque outfits and markets prone to panics, so CDS prices could easily be wrong. To counter the risk of a false alarm, the regulator would reserve the right to declare a bank solvent after an audit. That would give lobbyists an opening to sway the outcome, but the process would at least be transparent.

The idea’s main strength is that it creates a trigger for action. Banks are forced to raise equity, and regulators to intervene quickly, before trouble spreads. A rule based on CDS prices would have forced earlier interventions in this crisis—though perhaps not early enough. For such a scheme to work, everyone needs to believe that banks would be allowed to fail. The trouble is, who would credit that now?

Source: The Economist ( May 16 - May 22 )

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