Inner strength

PUBLISHED : Thursday, 04 August, 2011, 12:00am
UPDATED : Thursday, 04 August, 2011, 12:00am


The news on both sides of the Atlantic has been challenging of late, to put it mildly. In the Old World, more and more governments have struggled with growing deficits. For the moment, the Greek funding crisis has been defused. But Europe is clearly not quite out of the woods yet. In the New World, politicians grappled for weeks about the debt ceiling before finding a last-minute compromise. But a more fundamental issue looms: rating agencies are demanding that a more aggressive, long-term deficit reduction plan be implemented soon.

No doubt financial markets are uncomfortable with these lingering uncertainties. But it is important to keep things in perspective. Europe, eventually, will grind its way towards stability, most likely by edging into a closer fiscal union. The richer, more robust economies will end up supporting their weaker neighbours. The political implications of this are profound, and, therefore, a quick fix to the continent's fiscal problems always appeared unlikely.

In the United States, a rating downgrade, should it occur, will not signal an imminent default. Japan, for one, went on to faithfully service its debt for years after losing its top rating in the late 1990s and has even seen its funding costs decline since.

So the view that transatlantic debt wobbles will soon bring down the global economy is misplaced. The West, for now, has the means to avoid default. The current obstacles are to a large extent political: Europe needs to decide how to share the burden, while the US needs to decide on how to live within its means. Such decisions take time, and the process of political negotiation is never pretty. Still, in the end, some form of compromise is bound to emerge, as the alternative of inaction would prove decidedly unpalatable to all.

But, there are long-term implications of the current debt saga to heed as well. Even if an accident is likely to be avoided in the near term, the fact remains that both Europe and the US need to come to terms with excessive levels of public debt.

As budget deficits are reined in over the coming years, growth will suffer. Deleveraging, in fact, whether in the public or private sector, is usually a slow-grinding, and painful, process; deep, sharp recessions and financial crises are a far less likely result than many years of disappointing growth. And so it will prove in the West.

For Hong Kong, there are two major implications: one financial, the other economic, although both cannot always be so neatly separated. The first relates to capital flows. Amid slower growth in the West, rates of return will decline. Investors will thus increasingly search for other, more promising opportunities. These are to be found primarily in the East, and above all in China and India. As capital continues to pour into the region, Hong Kong stands to benefit the most, with investment and a thriving financial sector further boosting growth. Officials therefore need to remain mindful of the attendant risks of inflation and asset bubbles: paradoxically, the debt dilemma in the West, far from reining in growth, may in fact give Asia's economies another leg-up.

The second implication is that the structure of Asian growth will need to change. Exports to the West, long the fuel for the region's economies, will no longer drive prosperity. Sure, to some extent, shipments to China and India may fill the void for Asia's smaller export powerhouses, benefitting to some extent Hong Kong as well. Already, a new 'southern Silk Road' has started to emerge: trade among emerging markets, and not with the West, is now the key driver for global growth. This process is bound only to accelerate.

But Asia, as mentioned, cannot live by exports alone, whether to the West or to other emerging markets. Local demand will need to pull its weight as well. The temptation, of course, is to use cheap capital inflows from the West to boost local demand. But that is not a lasting proposition. Easy money is never a path to lasting prosperity - as indeed the West is currently finding out.

Rather, fundamental reforms are needed and the single-minded focus on competitiveness will have to be shelved. Rather, in the absence of strong demand from the West, what matters now is a single-minded focus on strengthening domestic growth and channelling the current spurt of energy into a lasting model of economic development.

For Hong Kong, this will include a search for new industries beyond logistics and finance. Creative services and research stand out as two niches where Hong Kong could make greater inroads.

Clearly, the essential ingredients of Asia's long-term prosperity are beginning to change. The region needs to stand on its own feet. This, at least, is the real message for Asia from all the trouble brewing in the West.

Frederic Neumann is managing director and co-head of Asian economics research at HSBC