Asian economies: swapping one dependency for another?
Tuesday, 27 May 2008

REUTERS, BEIJING- The Asian economy has shown a remarkable immunity to slowing U.S. growth, so it would be richly ironic if the region were to trip up now over a byproduct of its resilience -- sky-high oil and commodity prices.

A long period of turbo-charged growth, led by China and India, has boosted global energy demand, helping to drive crude to record highs above $130 a barrel. Metals and grains, most recently rice, have also been on a tear.

Producers of natural resources have spent a chunk of their windfalls on imports from Asia, replacing demand from America that has been ebbing for more than a year as the subprime mortgage meltdown ripples through the economy.

The United States, Europe and Japan still bought just over 40 percent of Asian exports in 2007, but that was down from nearly 50 percent in 2000.

Exports to Russia, meanwhile, are growing about 60 percent a year and sales to the Middle East are rising at a 35 percent clip.

As for China, Andy Rothman with CLSA in Shanghai calculates that Africa, the Middle East and Latin America now buy more of its goods than Japan and account for 20 percent of the country's export growth -- four times more than the United States.

This is a boon to companies like Fuda Faucet Works Inc, a Chinese maker of brass bathroom fixtures that sells 85 percent of its production overseas, mainly to the emerging middle class in markets such as the Middle East, Russia and Nigeria.

"We are very confident in our business model," Wu Yiting, the Jiangxi-based company's chief executive, said last month as she reported a doubling of sales and profit in 2007.


For the region as a whole, though, the growth/inflation equation is changing. Oil prices in particular have risen so high that governments are now capitulating and risking unrest by making consumers -- that is, voters -- pay more for fuel.

Indonesia cut fuel subsidies at the weekend, while Sri Lanka raised fuel prices; India gave notice on Friday that a rise in the price of petrol and diesel was on the way and Taiwan's new government has said it will scrap price controls on June 1.

China and Malaysia have ruled out raising pump prices for now, but the inevitable outcome will be another leg-up in inflation across the region, which is at the highest level since the 1997/98 Asian financial crisis.

"The longer inflation stays high in Asia ex-Japan, the more negative it is for growth," said Rob Subbaraman, chief non-Japan Asia economist for Lehman Brothers based in Hong Kong.

If governments absorb the costs of dearer oil and food, trade and fiscal balances will deteriorate; if firms do so, profit margins will be squeezed. If companies pass on the bill, consumers' purchasing power will be eroded. If workers demand higher wages to compensate, inflation could spread through the economy, triggering tighter monetary policy, Subbaraman said.

"The risks to growth are stacked to the downside. Asia ex-Japan is on a knife-edge," he said.

The inflation challenge coincides with a spreading slowdown in the industrial world. The European Union is a big worry.

German business surveys released last Friday pointed to the sharpest drop in outstanding business since July 2003, while French consumer spending unexpectedly fell in April for the second month in a row.

"The key at the moment is how much Asian exports to the EU slow down because they're still growing around 20 percent," said Garry Evans, HSBC's Hong Kong-based regional equity strategist.


The International Monetary Fund said on Friday that it expects growth to slow in Japan, too, because of the weakening global trend and deteriorating terms of trade.

Tellingly, though, Daniel Citrin, deputy director of the IMF's Asia and Pacific Department, singled out emerging markets as the most promising crutch for Japan's important export sector.

"We still think exports to not only China but emerging market countries, more generally the Middle East, Russia and elsewhere, will help to support export performance in Japan," he said in Tokyo.

Also on the positive side of the ledger, Asia's robust economic fundamentals should enable domestic demand to cushion a swoon in export orders from the developed world.

Most countries are running fat current account surpluses and have big stockpiles of reserves to offset any exodus of capital; many firms have slashed debt levels since the 1997 crisis and banking systems are also more solid now: witness how the subprime crisis has barely flickered on the radar of emerging Asia.

So the central case of a modest, manageable growth slowdown this year in Asia looks plausible -- on the crucial assumption that commodity and oil prices fall back enough to cool inflation but not so far that demand from producing countries dries up.

Evans said the stock market still expects earnings per share at non-Japan Asian companies to grow six percent this year, albeit down from 20 percent in 2007.

He said EPS forecasts had been scaled back by 7 percentage points since regional stock markets peaked in November.

By comparison, looking back at the 2001 recession brought on by the bursting of the dotcom bubble, earnings forecasts six months after the market peak had been cut 15 percent, he said.

"The answer on decoupling is that it's not black and white. Asia is not going to avoid slowing down completely, but it may not slow all that much," he said.

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