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18 Jul 2014

Asia will stretch only so far

Frederic Neumann

by Frederic Neumann

Co-Head of Asian Economic Research, HSBC

Asia will stretch only so far

Japanese companies have taken the fall in consumption in their stride, while the government has unveiled more reforms

It’s not as dire for Asia as many thought. A few months ago headlines suggested China was about to stumble, tripped up by defaults and plunging confidence. Japan’s economy was pummelled by a hike in consumption taxes. India looked paralysed by political gridlock.

Exports sputtered across Asia as the US took a dive. Australia watched aghast at tumbling iron ore prices just as mining investment slowed and the new government stepped on the fiscal brake. In Thailand, the generals again took charge. Even the Philippines, pulling ahead of most for the last several years, looked suddenly wobbly. Now things appear a lot brighter.

Over the remainder of 2014, activity across Asia should feel the lift of returning confidence

China, lifted by a mini-stimulus, seems to have found balance. Falling property prices still pose a challenge, but the broader slide has been arrested. Japanese firms have also taken the consumption plunge in their stride and the government has unveiled another stab at reforms. In India, the new Prime Minister Narendra Modi promises decisive action.

Exports across the region have picked up too, even if they are unlikely to drive overall prosperity as in decades past. In Australia, housing and construction are providing a counterweight to weakness elsewhere. The mood has also changed in Bangkok as a government returns to work. And the Philippines? Well, the doubts were always misplaced.

In short, growth should accelerate from here. Over the remainder of 2014, activity across Asia should feel the lift of returning confidence. Although we have shaved our growth forecasts for most economies this year, this mostly reflects slower past activity. Asia has again displayed an admirable resilience and next year might prove better still.

Still, there is this nagging feeling that something is amiss. Growth, even if recovering, is no longer what it used to be. By past standards, Asia might merely experience a mild cyclical lift. Rising debt masks deteriorating fundamentals. Productivity growth has slowed, necessitating ever greater leverage to support activity. This is not sustainable indefinitely. Fortunately, for now, little can derail the process and a window is open to implement the required changes before constraints begin to bite.

Higher interest rates pose the biggest risk. But these seem far off. Inflation, in most of Asia, remains contained.

Food prices could rise if El Niño suspends rains, and in India and some other countries. This may even lead central banks to respond. But these would be marginal hikes – not sufficient to knock out growth.

Further afield, monetary policy should also remain accommodative. US Federal Reserve tapering is more than halfway done and outright tightening may not occur for a while. The European Central Bank is moving in the opposite direction, with possibly more to come. While we don’t expect the Bank of Japan to ease further until well into 2015, plenty of liquidity is already spilling into the rest of the region. China’s central bank has also loosened the reins, tentatively but effectively.

What is perhaps most encouraging is that reforms are finally being tackled. It is always easy to dismiss the promises of politicians, but look closely: real changes are occurring among Asia’s three giants – China, Japan, and India. In Indonesia, a new government may stir things, and Vietnam is gradually but tenaciously progressing. It would be premature to claim success, but the first steps on a long and arduous road have been taken.

This research was first published on 10 July 2014.