Friday, 20 April 2012

Shaky economies closer to home

Fault lines appearing in Asia-Pacific region must not be ignored
By Andy Mukherjee, The Straits Times, 19 Apr 2012

INVESTORS must not get so caught up with the risk that Europe's single currency may collapse or the United States may tip into another recession that they totally ignore the fault lines in the Asia-Pacific outside of Japan. There are several of them, from Shanghai and Seoul to Melbourne and Mumbai.

Some that need to be monitored especially closely:

China's property bubble

Oversupply of Chinese residential real estate is the No. 1 concern. At the end of last year, China had about 2.5 billion sq m of property under development, which would take developers 30 months to off- load. By the end of this year, the inventory is expected to rise to 38 months of normal sales, according to Morgan Stanley.

By starving builders of the money they need to roll over their stock, it should be possible for the government to engineer fire sales that will bring the inventory down to 23 months - the 2009 level. But that will mean squeezing new housing starts this year to less than a sixth of last year's level. That's a sacrifice of about US$93 billion (S$116 billion) in investments, or 1.5 per cent of China's gross domestic product.

A shock of this magnitude will have ripple effects. Fiscal policy can be loosened this year, and the yuan will likely be allowed to weaken. But interest-rate cuts, which will keep the property time bomb ticking away before it explodes at a future date, may not be acceptable to the incoming Chinese leadership. It would prefer that President Hu Jintao and Premier Wen Jiabao defuse the threat.

India's deficits

In India, the annualised current account deficit - excess of import of goods and services over exports - is approaching 4 per cent of GDP. The gap, which must be filled by fickle-minded foreign investors, is large enough to revive unpleasant memories of the balance-of-payment crisis the country suffered in 1990-1991, when the central bank had to pledge its gold to pay for imports.

The excess domestic demand in India is at least partly a result of fiscal profligacy. The government is cornering savings to finance its own expenditure, the quality of which is so poor that it does little to improve the future productive capacity of the economy. Therefore, foreigners will baulk from financing the deficit.

Since the Indian government is unlikely to mend its ways, the only possible adjustment is for private investments to collapse in India. That's not acceptable to Indian politicians and policymakers, but there are few good alternatives. The surprise half-percentage-point cut in interest rates this week is probably the maximum the Reserve Bank of India can do this year to give a leg-up to private investments. Without fiscal consolidation, further rate cuts may lead to a capital flight.

Australia's resource bust

India's troubles are casting a shadow over Australia. If China and India slow down at the same time, who will buy all the iron ore and coal that Australia has been selling to the world at exorbitant prices over the past decade? Monetary easing by developed-country central banks may keep prices of industrial commodities artificially inflated for some time still, but in the absence of user demand, the threat of a 'resource bust' is quite real.

South Korea's growth desperation

South Korean President Lee Myung Bak came to power four years ago on the wings of '747' - promising 7 per cent economic growth, US$40,000 per capita income and Korea as the world's seventh-largest economy.

With none of those promises fulfilled, his New Frontier Party may try to use the time it has before December's presidential election to inflate growth, which slumped to 3.3 per cent in the last quarter of last year, the slowest in nine quarters.

The Bank of Korea should resist pressure to ease up interest rates now that the government has controlled inflation by capping college tuition and expanding a free-meal programme in schools.

An interest-rate cut at this stage may spook investor confidence in the won, which has been stable since February after getting pummelled in September. A weak won may boost Korean exports, but it will increase the cost of imported petroleum products, compounding the inflation challenge. A rate cut may also prompt Korea's over-extended households to borrow more. As a share of national income, household debt is now almost double the pre-Asian crisis level.

Indonesia's subsidies

Indonesia's failure recently to increase the state-controlled retail fuel price has merely postponed the day of reckoning when the economy will have to absorb the full inflationary shock of high global prices for petroleum products. If international oil prices stay high, government subsidies may swell the budget deficit, pushing it close to the legal limit of 3 per cent of GDP. Low pump prices create incentives for smugglers to resell internationally, adding 'arbitrage' demand to legitimate demand for petrol. Result: Indonesia ends up importing more refined products, putting pressure on the currency to slide.

This is how the fuel-subsidy story usually plays out in Indonesia - as a threat to macro-economic stability. It will take deft footwork by the government to ensure a happier outcome this time around.

It's easy to lose track of many of these maladies when Spain is looking like it's about to blow up and drag the euro down with it. But tremors closer to home must not be dismissed lightly.

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