A worrying rotation has occurred in Asia’s growth process over the last five years. Productivity gains have slowed and credit intensity has jumped. Sustainable growth requires the former, while the latter can lead to wobbly growth.
This need not necessarily portend an imminent crisis. Where debt levels are high and rising quickly, financial systems remain awash with liquidity. China’s investment amounted to almost 48 per cent of GDP last year, according to the International Monetary Fund, but its saving rate was nearly 50 per cent, for instance. Over time it may be desirable to reduce both, but with savings exceeding investment, the economy is more resilient to financial shocks than sceptics claim.
Elsewhere in Asia, current-account surpluses provide a buffer. Their decline implies that the margin of saving over investment has narrowed, but most countries can still comfortably finance their investment needs on their own. India and Indonesia are exceptions, but the latter has the region’s lowest total debt-to-GDP ratio while India’s net funding needs have dropped sharply over the past year.
With growth at comfortable levels, officials may not feel the urgency to implement reforms to revive gains in productivity
Countries with current-account surpluses are far less likely to run into financial trouble than economies with deficits. Japan was an exception, but the implications for growth might have been much more severe if it had borrowed abroad to fund its 1980s boom: it stumbled into outright recession only in 1997.
But although a collapse in financial systems is unlikely for now, Asian economies are not immune from developments elsewhere. A rise in interest rates would weigh on growth more than in the past, reflecting both higher leverage and a greater reliance on credit to drive local demand. Higher funding costs would be a growth problem for emerging Asia, but not necessarily affect financial stability.
But emerging markets have continued to slow, even though they may now comprise half the world’s economy and even more in terms of incremental demand. They exert increasing influence on global inflation trends and China’s price statistics show persistent disinflation.
However, with little apparent risk of global interest rates rising precipitously, growth in emerging Asia can tick along, if at a somewhat disappointing pace. Given these economies’ credit dependence, debt will also continue to climb. Tighter regulations may slow the build-up – or at least avoid further excesses developing in speculative areas – but the tap cannot be turned off entirely without further harm to demand.
So even if stable for now, a big worry persists. With growth at comfortable levels, officials may not feel the urgency to implement reforms to revive gains in productivity. Reform would mean unpalatable things like curbing subsidies, removing protection of 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 region needs to prepare for the day that interest rates climb.
This research was first published on 14 April 2014.