Asia, its dependence on trade and the crisis to follow

This blog has continued to emphasise that Asia is much more dependent on trade with the US and Europe than it or indeed most commentators seem to believe.

Only now is the reality beginning to bite. This was entirely predictable. The savings rates are simply too high in Asia for domestic to consumption to make up for the sheer greed of western consumers.

The Financial Times provides excellent coverage as always.

Asia and the crisis: Unlucky numbers [FT]

Not only Hong Kong, which as a port city and financial centre thrives on its openness to fast-dwindling world trade, but the whole of Asia is in trouble. All over the region, particularly in manufacturing-heavy south-east and north-east Asia, government statisticians have been summoning up evil-eye numbers of their own.

One of the worst came from Japan, whose conservative banks had been slow to buy toxic assets, making the economy seemingly less threatened by recession. That illusion ended when statistics showed that exports had fallen a shocking 35 per cent in December from a year earlier as demand for cars, electronics and precision equipment collapsed around the world.

That was followed by a stream of further bad data including a nearly 10 per cent month-on-month drop in industrial production, a sharp rise in unemployment to 4.4 per cent (see below) and a fall in headline inflation that suggests a return to deflation is just around the corner. So sharp has been the deterioration that the International Monetary Fund has forecast a contraction in gross domestic product of 2.6 per cent this year, suggesting Japan could fare even worse than the US, the origin of the credit crisis.

Singapore, South Korea and Taiwan vie with Japan for the swiftest downturn. Singapore, the canary in the coalmine of global trade because of its open economy, could contract by up to 5 per cent this year in what would be the deepest recession since the city-state’s birth in 1965. The IMF is predicting a 4 per cent contraction in South Korea, though the government in Seoul is sticking much more optimistic.

Nor is China, an economy that is at least expected to grow by a respectable 6-8 per cent this year, immune from heart-stopping statistics. Last week, the government estimated that no fewer than 20m rural migrant workers, 15 per cent of the total, had lost their jobs as export-oriented factories shut their gates. Blue skies in Hong Kong are testimony to the closure of polluting plants across the border in the Pearl River delta.

The speed and ferocity of Asia’s downturn has taken aback even the pessimists. “Whilst Asia was not the epicentre of the crisis it has been hit hard,” said Dominique Strauss-Kahn, IMF managing director, last week. His organisation expects regional growth of just 2.7 per cent, a fraction of the 9 per cent achieved in 2007 and a percentage point lower even than it managed during its own financial crisis a decade ago. That crisis was largely self-inflicted, the product of an overdependence on fickle flows of foreign finance. This time, the region’s balance sheets are in better shape and the crisis began elsewhere. So why does Asia appear set for an even harder fall?

The short answer is trade. As Mr Strauss-Kahn says, Asia is more intimately bound to the global economy than it was a decade ago. The region has grown spectacularly on the back of exports but the “bad side of the coin” is that this makes it more vulnerable now. At the time of the previous crisis, exports accounted for 37 per cent of developing Asia’s output, according to economists at Morgan Stanley. A decade later, that had risen to 47 per cent as governments sought to build large foreign currency reserves to protect themselves against the current-account shocks that had floored them before. The upshot was that Asia swapped dependence on external financing for dependence on external demand.

This matters hugely for a world that, until just a few months ago, had assumed that the financial crisis jolting the west would somehow pass Asia by. A corollary of that flawed assumption was that China – and to a lesser extent Japan and India – could somehow shoulder the global economic burden by substituting for fast-disappearing US and European demand. That hope ignored the fact that, with the exception of Japan, no Asian economy yet possesses anything like the scale to play such a role. But, more important, it missed the point of how entrenched Asia’s export-dependent model is and how difficult it will be to convert its economies into ones powered by domestic demand. As N.K. Singh, a member of India’s parliament, says: “It is not just a matter of hey presto.”

Indeed not. Cem Karacadag of Credit Suisse calculates that exports, net of their import content, account for as much as two-thirds of GDP in Hong Kong and Singapore, almost half of the output of Malaysia and Thailand and one-third for South Korea and Taiwan. He says the initial impact of a 10 per cent fall in exports – without taking into account secondary effects, including inevitable job losses and a fall in consumer sentiment – would cut 2 percentage points off growth in South Korea and Taiwan and leave Hong Kong and Singapore each 7 percentage points worse off.

Jong Wha-Lee of the Asian Development Bank says a sharp rise over recent years in intra-regional trade disguises the fact that 60 per cent of final demand for Asian goods comes from developed countries. As western consumers postpone purchases, a lot of intra-Asian trade – much of it components, inputs and capital equipment – has also evaporated. As if this were not bad enough, economies that rely on tourism are receiving an additional body blow as visitor numbers fall. Tourism makes up 5-7 per cent of GDP in Hong Kong, Malaysia, Singapore and Thailand. Moreover, if employment of foreign workers in the Gulf and elsewhere falls as fast as expected, then remittance-dependent countries from the Philippines to parts of India are also in for a shock.

At the other end of the development scale, Japan is undergoing factory closures as companies slide into the red. Toyota, the leading car manufacturer, has warned amid collapsing US sales that it would make an operating loss of Y450bn ($5bn, €3.8bn, £3.2bn) this year, its first since 1950. Just a few months ago it was predicting a Y600bn profit.

In China, the slowdown contrasts with breakneck 13 per cent growth in 2007. There are tentative signs – including a sharp recovery in bank lending – that growth, which slowed to 6.8 per cent in the fourth quarter, may have hit bottom as a barrage of government stimulus measures begins to take effect. Beijing was fairly quick to recognise the severity of the slowdown, announcing as early as November a Rmb4,000bn ($585bn, €447bn, £390bn) stimulus package. Many other governments are still playing catch-up. Last week, Australia became the latest to formulate a big stimulus package, announcing A$42bn ($29bn, €22bn, £19bn) in extra spending. Japan, whose deadlocked parliament is fighting over stimulus measures, has come up with a string of unorthodox actions, including the central bank’s decision last week to buy up to Y1,000bn of shares owned by banks.

Even if such moves help dull the pain of the external demand shock, the bigger worry is what comes next. Michael Pettis, a finance professor at Peking University, argues that China (and others) will have to engineer a massive rebalancing of their economies towards domestic-led growth if they are to adjust to a world in which US consumers must rebuild depleted savings.

“In the best possible world, Chinese consumption would rise by exactly the same amount as US consumption drops,” he says. But given that the US economy is more than three times the size of China’s, the magnitude of such an adjustment is likely to be beyond it.

“There is no longer any choice for Asia,” concurs Clyde Prestowitz, president of the Economic Strategy Institute who warned for years that global imbalances were unsustainable. “Asia has to start consuming more but I am not sure that the Asian leaders I have been speaking to get it,” he says, adding that this would require changes to credit provision, tax incentives and regulation. “The export-led model has outlived its usefulness.”

If Mr Prestowitz is right, the global crisis means more than a cyclical shock to Asian economies. Rather it signifies the start of a profound – and no doubt painful – transformation as they adjust to a world in which the US consumer is no longer the buyer of last resort. Whether Asian economies are up to that long-term challenge is something on which fortune tellers might usefully comment.

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