24 March 2019
China's import demand accounts for only 0.42 percent of the US economy and 0.64 percent of the European Union's GDP. Photo: Bloomberg
China's import demand accounts for only 0.42 percent of the US economy and 0.64 percent of the European Union's GDP. Photo: Bloomberg

Asia’s hidden economic woes, and why China can’t help

Asia’s growth is slowing. Global liquidity is becoming less ample as the US Federal Reserve tapers its quantitative easing program, while China’s economic expansion, on which regional growth has become increasingly dependent, is sputtering as the country pursues structural reforms. 

There is a tendency to just blame these external factors. This is wrong.

Asia’s economic fundamentals have been worsening. Its productivity growth has slowed and debt has been climbing. Post-crisis demand recovery in the West is not strong enough to pull the East out of its malaise. However, optimists argue that as long as global interest rates remain low, the region will continue to see steady, if not so strong, growth.

True, Asia’s deteriorating fundamentals do not necessarily portend an imminent crisis. Where debt levels are high and rising, financial systems remain awash with liquidity. For the most part of Asia, current account surpluses provide a buffer to potential economic shocks. Though these surpluses have declined over time, implying that the gap of saving over investment has narrowed, most countries can still comfortably finance their investment needs on their own.

Countries running current account surpluses are far less likely to run into financial trouble than economies with deficits, though there are exceptions. Japan in the late 1980s is a prominent example of an economy where an external surplus did not prevent an assets bubble from bursting. But the implications for growth would arguably have been much more damaging if Japan had run a current account deficit, i.e., borrowed overseas to fund its boom. Its economy only stumbled into an outright recession in 1997.

While current surpluses give a measure of comfort that a collapse in financial systems is unlikely for the region, its economies are not immune from developments elsewhere. A rise in interest rates, for example, would weigh more on regional growth than in past, thanks to the rapid rise in debt-financed growth in recent years.

The outlook for global interest rates remains favorable — for now. In the United States, despite improving demand and a recovering labor market of late, they have declined sharply since their peak in the summer of 2013. Minutes of recent discussions among Federal Reserve officials suggest the central bankers do not intend to hike interest rates quickly. In Europe, demand for monetary accommodation has also become louder. In Japan, another round of easing still appears likely later this year.

Disinflation, and in some places deflation, partly explains the continuation of this low rate environment. For all the talk about recovery in the West, the possibility of rate hikes remains low for now. Meanwhile, growth in emerging markets has continued to slow. On some measures, they now account for half of the world economy, and even more in terms of incremental demand, exerting greater influence on the global disinflation trend than in the past.

So there appears little risk that global interest rates would rise precipitously in the short term. This allows growth in emerging Asia to tick along, if at a somewhat sluggish pace. This is only partly reassuring, however, as a big worry persists.

With growth at comfortable enough levels, officials in the region may not feel the urgency of implementing structural reforms to revive productivity gains. These reforms comprise unpleasant measures like curbing subsidies, removing protection for state-owned companies, and opening sheltered sectors to global competition. That is as true for China as it is for India and Japan and the smaller markets in between.

The hidden problem for Asia is the eventual rise in interest rates. That day may seem far off, but eventually, it will come.

Finally, one cannot expect China to replace the US as the world’s “consumer of last resort” to continue to support Asia’s economic growth.

For one, China’s demand impact on world growth, through its imports, is small. According to OECD estimates, the country’s consumption of exports accounts for no more than 5.5 percent of many regional GDP (see chart). Its import demand impact on the developed markets’ GDP growth is even smaller: only 0.42 percent of America’s GDP and 0.64 percent of EU’s economy. In other words, even if China boosts its import growth, the impact on world growth is small.

Beijing is in no mood to push for faster growth. The Chinese economy is suffering from growth fatigue, as seen in the diminishing marginal returns on investment. This has prompted Beijing to shift its policy objective from pursuing growth quantity to quality through the implementation of structural reforms. This will only constrain China’s positive impact on world growth further.

The bottom lines are 1) Asia has no one but itself to blame for the emergence of its hidden economic woes, and 2) China is the largest economy in the world that has an unfolding structural reform story. This makes China a unique spot for long-term investors to start gaining exposure to Chinese assets during its transition with short-term pain for long-term gains.

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Senior economist of BNP Paribas Investment Partners (Asia) Ltd. and author of “China’s Impossible Trinity – The Structural Challenges to the Chinese Dream”

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