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The mainland’s property market adjustment has been longer and sharper than expected. Photo: Reuters
Opinion
Macroscope
by Paul Gruenwald
Macroscope
by Paul Gruenwald

Hoping for slower but higher quality growth in Asia-Pacific

Asia-Pacific economies are limping to the finish line in 2014. Mainland China continues to be weighed down by its property sector. Japan has entered a technical recession. And in the trade-dependent economies, the hoped for pick-up in external demand has yet to materialise. Only India is bucking the trend.

However, all is not lost. Next year and 2016 are shaping up as pretty good years. Yes, we have shaved a bit off our baseline Asia-Pacific GDP growth numbers (to 5.3 and 5.2 per cent, respectively). But if we look past the headline figures there is an improvement in both the quality and composition of growth.

First, we hope that the mainland economy will decelerate to a more sustainable path. The property sector correction is ongoing, putting a damper on growth. And owing to a lack of data we do not know how large the problem is. But we do know its cause: the over-reliance on and mispricing of credit. The resulting supply overhang needs to be cleared. Moreover, with external demand and productivity growth still not rebounding to pre-crisis rates, a lower GDP growth target of 7 per cent or below next year is warranted, as are policies that fulfil the Third Plenum objective of giving the market a decisive role.

We should see less reliance on domestic demand — and hopefully credit

Japan is down but not out, as the recession has brought forth a strong policy response. The authorities now recognise the policy mistake of implementing the consumption tax increase too soon. Growth may be a meagre 0.5 per cent this year, but better policies should bring modest rebound in growth to 1.5 per cent next year. Once the economy is reflated to 3 per cent nominal growth, then tax measures can be relaunched to begin to stabilise the public finances.

Meanwhile, India seems to be regaining its mojo. After a cautious start, the Modi government has picked up the pace of reform. In a dramatic move, diesel prices were deregulated in October, there was some liberalisation for foreign investment into financial services and a 10 per cent cut in discretionary spending in the current fiscal year was announced. The economy has started to respond, and 6 to 7 per cent growth is in sight.

Looking across the region we should see less reliance on domestic demand — and hopefully credit — and a welcome rotation towards a larger external contribution next year as the US recovery takes hold. The recent steep drop in oil prices is a welcome boon for most of the region, equivalent to a tax cut. We expect the windfall to be used to both pay down debt and spur consumption.

Despite our sunnier disposition on the quality of growth, we continue to see the balance of risks as tilted to the downside. The mainland’s property market and the region’s ability to move to a more normal interest rate environment are top of our list.

The mainland’s property market adjustment, which began earlier this year, has already been longer and sharper than most had anticipated. So far, however, we have seen little stress amongst the 80,000-plus developers even though prices are falling, inventories are rising and sales and construction have slowed. In a downside scenario we would expect a noticeable pick-up in developer defaults and stress in their financiers. A full-blown crisis is highly unlikely given the macro cushions in the economy, but a short period of sub-5 per cent growth momentum strikes us as possible.

Rising US interest rates will also be a challenge. We all know that US rates will eventually normalise, but it remains to be seen if a new generation of Asian borrowers raised on ultra-cheap credit has factored this in. If not, then debt servicing will be higher than expected and this will dampen expenditure and growth. Our suspicion is that this would be more of a household than a corporate issue since CFOs and treasurers have a better idea of what is coming. We would be looking for stress in personal consumption spending (mainly durables) and declines in interest rate sensitive sectors such as real estate.

All told, we hope that Asia-Pacific is entering a new phase in thinking about growth. If there has been one policy lesson from the post-crisis period, it has been that trying to prop up growth rates through credit can be overdone. The domestic economy does not have to absorb all the drop in foreign demand. And not modifying growth expectations to align with external realities can be risky.

If consumers and firms in Asia-Pacific know that some day the low interest rate party will end and have spent and invested accordingly, then higher US growth should be welcome. If not, then the path back to normal may be bumpier than expected.

 

Paul Gruenwald is the Asia-Pacific chief economist at Standard & Poor’s Ratings Services

 

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