- Regional ratings have proven resilient through the global crisis. In the Asia-Pacific region, there were no downgrades originating from the crisis. Those countries which had improving credit fundamentals prior to the crisis and have demonstrated resiliency were upgraded -- Indonesia and the Philippines. China, Hong Kong and India (local currency) government bond ratings currently have positive outlooks.
- But some ratings are at risk. Three counties with negative rating outlooks either exhibited deteriorating fundamentals before the global financial crisis (Vietnam), or suffered an eruption of underlying political tensions (Thailand and Fiji) which were unrelated to the crisis.
- Growth potential in Asia-Pacific remains robust. The recovery is well entrenched, benefiting from intraregional trade and the lessons of the Asian financial crisis of 1997. Recovery from the global crisis is similar to previous recovery periods. Real GDP growth may rise to 4.9 percent in 2010. China is playing the lead role as a regional driver of growth. External strengths are unimpaired for most countries.
- Exit strategies have started to unfold as mild inflation returns. In line with the recovery in economic output in the latter part of 2009 and the return of risk appetite and associated capital inflows, all countries in the region – again, except for Japan – are moving at various speeds towards exit strategies. Inflation has reappeared but is, so far, relatively low and benign for most countries.
- Government debt accumulation is moderate. Most countries in the region entered the crisis with sound fiscal positions. The exception is Japan. Despite large stimulus programs, the build-up in government debt has been moderate for most economies and banking system contingent liabilities are manageable. A gradual increase in interest rates can be tolerated.
- Global risks for the region are muted over the near term. The resiliency to the 2008 crisis would likely hold should global downside risks re-emerge as identified in Moody’s 2010 Global Outlook, while we consider the risk of a collapse in China’s growth rate to be remote.
Robust Growth Potential
Asia-Pacific will continue to be the leader among global regions in growth. Weighted average real GDP growth will rise to 4.9 percent in 2010 from a post-Asian financial crisis low of 1.2 percent in 2009. The upturn mimics to a large degree the recovery path from the Asia Financial Crisis of 1997-98 and the US recession of 2001.
Excluding Japan, regional growth will rise to 6.6 percent in 2010 from 4.5 percent previously. In Japan’s case, a relapse into deflation and a severe collapse in exports has hobbled growth.
China and India, which together comprise about 40 percent of regional output, will likely grow the fastest at 8.8 percent and 8.1 percent, respectively. Fiscal stimulus programs have provided a key source of support, with China, Japan, Korea, Malaysia, and Singapore promulgating the largest packages in the region.
Economies that can benefit from growth driven by both domestic and external demand will perform best. This is not only the case for China and India, but also for Indonesia and Korea. Economies in the region have high savings rates and their banking systems have escaped much of the damage seen in the US and EU. As a result, household balance sheets remained relatively healthy during the crisis and credit growth was maintained, although at a subdued pace for most countries.
In China and Vietnam, however, government-directed bank lending spurred credit booms. Despite the rise in household debt in recent years, private consumption expenditure has supported overall growth in Korea, which may surprisingly eke out a slightly positive rate in 2009 and perhaps accelerate well within the potential 4-5 percent range forecast for 2010.
Inflationary pressures remain subdued for most economies. The global recession wrung inflation down to the low single-digit range or into negative territory across the board, even for the two countries with previously high double digit inflation — Vietnam and Mongolia. Price pressures are, however, increasing in line with the economic recovery for a number of countries, namely India, China, Korea, Thailand and the Philippines.
Future inflation will likely remain disproportionately affected by food and energy prices, but current account surpluses and exchange rate stability will buffer the effects of global cost-push inflation. It is noteworthy that all six regional central banks with formal inflation targets (Australia, Indonesia, Korea, New Zealand, Philippines and Thailand) are forecasting inflation to remain within their respective policy ranges in 2009 and 2010 — the first time this has happened.
In contrast, Vietnam is the one country in the region where inflationary expectations have already begun to set in again.
The recent rebound in exports is largely a regional phenomenon. The export-dependent newly industrialized economies or NIEs (Hong Kong, Korea, Taiwan and Singapore) and the ASEAN-5 (Indonesia, Malaysia, Philippines, Singapore and Thailand) are benefiting from demand from China, which now plays the key role previously held by the US.
Along with intraregional trade within ASEAN, this has underpinned a recovery in the region’s exports from the collapse in late 2008 and earlier in 2009. The year-on-year growth rate of Australian exports has remained positive through the global recession, while the rates of Korea and Taiwan returned to positive territory in the closing months of 2009.
In contrast, while China’s exports have strengthened in sequential terms over the second half of 2009, they remain relatively weak as final demand in the East Asian supply chain comes mainly from the still sluggish advanced country markets. Japan’s exports have suffered the most severe collapse of any regional economy and continue to underperform, owing to the high degree of durable goods in their composition and to the nominal effective appreciation of the yen against the currencies of its regional trade competitors.
External payments positions have strengthened, but renewed capital inflows present policy challenges. Current account surpluses and minimal exposure to the post-Lehman credit panic have boosted official foreign exchange reserves to record heights well above pre-crisis levels for most countries, notably China, Thailand and the Philippines. A notable exception is Vietnam, whose reserves fell in 2009.
Even Korea, whose banks along with Australia’s were hit hard by the dollar funding freeze in late 2008, now has higher official reserves than before the crisis. The swap lines between the US Fed and four of the regional central banks – the Reserve Bank of Australia (RBA), the Bank of Korea (BOK), the Reserve Bank of New Zealand (RBNZ), and the Monetary Authority of Singapore (MAS) – will likely not be re-extended when the arrangements expires in February as conditions in international, dollar funding markets have improved.
Large capital inflows into key Asian economies such as China and Korea are placing upward pressure on exchange rates. Some smaller economies, such as Indonesia, are also facing potentially destabilizing inflows, a situation which is in sharp contrast to the destabilization from de-leveraging outflows in 2008.
None have adopted capital controls, yet, to ward off adverse affects on export competitiveness and the asset prices. Floating and managed float exchange rate regimes, which characterize the region, should temper speculative inflows. China, however, has so far resisted returning to its pre-crisis crawling peg policy of gradual appreciation against the dollar
China as Lynchpin
China’s economic stimulus measures succeeded in achieving the 8 percent target growth rate and then some. Real GDP growth surged 10.7 percent year-on-year in the fourth quarter to boost annual growth to 8.7 percent in 2009. Most of the stimulus spending has shown up in infrastructure-oriented, government-led investment, much of which was in turn driven by the gargantuan surge in bank credit.
But some stimulus measures have been consumption-oriented, and domestic demand growth has consequently been broad based. Resurgent housing sales have started to feed through to construction activity.
Strong growth in domestic demand came from buoyancy in both consumption and investment expenditure. But slack capacity utilization and moderating commodity prices had slashed prices temporarily, which in turn served to boost retail sales. Nonetheless, in November and December 2009, Chinese CPI rose back into positive territory, signalling the end of the period of so-called technical deflation and prompting the initiation of monetary tightening measures.
The outlook for continued robust growth in 2010 will boost GDP to around $5.7 trillion, positioning China as the world’s second largest national economy and eclipsing Japan. The composition of growth will likely shift away from investment, and there are divergent scenarios among observers, with some seeing a return to double-digit growth. We think that real GDP growth will remain in the 8-9 percent range as additional policy tightening measures are taken and as export growth is held back by a sluggish recovery in the US and EU.
Central to our outlook is the premise that the Chinese authorities effectively scale back their policy stimulus, acting preventively to avoid systemically de-stabilizing bubbles from forming in the economy. A re-activation of the crawling peg against the dollar could accompany policy tightening. Foregoing double-digit growth may be a near-term cost well worth paying, given the long-term benefits of macroeconomic stability.
For the region, China’s robust growth has softened the effects of the global recession. Export performance has rebounded in line with the build-up in China’s growth momentum in the second half of 2009. Australia has escaped recession largely owing to its commodity exports to China. Korea’ surge in growth in late 2009 is also in part due to exports to China. Similarly, the likely expansion of cross-strait trade and investment ties will speed up Taiwan’s recovery in 2010.
The shape of the recovery among regional economies will vary, depending on factors such as policy support, trade openness, and the resilience of private consumption. Macroeconomic resiliency, benign inflation and sound financial systems, in general, will allow a gradual course of fiscal consolidation.
The return of risk appetite and strong capital flows to the emerging economies in Asia – with attendant effects on reserve accumulation and exchange rate appreciation – is making a shift towards policy tightening more acceptable and more urgent in the highly open countries and India.
Australia, Malaysia and China are leading the way out. There have been recent instances that may herald the possible commencement of exit strategies. The RBA) hiked its policy cash rate target three times in the fourth quarter of 2009. Malaysian Prime Minister Najib announced in October that his administration planned to slash operating expenditures by nearly 14 percent in 2010, lowering the deficit from 7.3 percent of GDP in 2009 to a projected 5.4 percent in 2010.
The Vietnamese government has incorporated elements of both fiscal and monetary policy tightening: it scaled back its interest rate subsidy program at end-2009, three months earlier than planned, while the State Bank of Vietnam (SBV) hiked its policy rate in December. However, it remains to be seen whether such measures will be forceful enough to rein in macroeconomic imbalances and rising inflationary expectations.
China will likely tone down its gargantuan stimulus – largely implemented through the surge in state-owned bank credit expansion – in part to control asset bubbles. Its “moderately loose” monetary stance of 2009 was tightened somewhat in January 2010 with an increase in the People’s Bank of China’s (PBOC) reserve requirements and a rise in the auction yields of central bank bills.
Yet we expect a cautious unwinding of stimulus measures for most economies. Despite the positive macroeconomic developments of late 2009, most Asian policymakers have been reluctant to scale back their accommodative stances. Caution comes from the tenuous nature of the global recovery, but it may also reflect an ingrained expectation of rapid growth.
In light of persistent output gaps and muted inflation, most central banks in the rest of the region have chosen to keep monetary policy on hold for much of the second half of the year after slashing policy rates, in some cases to record lows, in late 2008 and earlier in 2009.
In addition to monetary tightening and fiscal consolidation, the extraordinary measures used to address the global crisis are expected to be unwound gradually over the next year or two. The Fed’s bilateral currency swap lines with regional monetary authorities are set to expire on February 1, 2010.
Similar arrangements secured on an intraregional basis vis-à-vis the Bank of Japan (BoJ) and PBOC, as well as other contingent lines of financing, will remain in force over a longer time horizon. The Chiang Mai Initiative Multilateralization is another, discussed later in the report. Deposit guarantees, where implemented, are also valid through to the end of the year or longer.
Japan is, however, the exception to a cautious unwinding of stimulus. In December 2009, Japan’s newly installed DPJ government announced a new fiscal stimulus package amounting to ¥7.2 trillion, 1.5 percent of GDP, pushing expected bond issuances for 2010 above revenues for the first time since 1946.
The resiliency to the 2008 crisis would likely hold should global downside risks re-emerge. Two of the downside risks identified in Moody’s 2010 Global Outlook are, (1) a disorderly exit from fiscal and monetary stimulus, leading to an abrupt increase in interest rates or sharp currency realignments, or both; and (2) renewed advanced country financial sector distress.
While Asia-Pacific would not escape contagion effects from higher advanced country interest rates and slower advanced country growth, their healthier government balance sheets and financial systems should provide some degree of immunity, perhaps enough to prevent a severe weakening of credit fundamentals.
One reason for this is that during the global crisis, the trade channel produced much of the economic havoc experienced in the Asia-Pacific region. However, compounding the trade effects were financial channel shocks from the post-Lehman panic freeze in offshore dollar funding and in advanced country bank credit. Actions taken by governments and their regulatory bodies, as well as the affected financial institutions themselves, should preclude another disaster of historical dimensions.
A third risk identified in Moody’s 2010 Global Outlook is a sharp fall in China’s growth rate. This risk is not new, and has been cited by the World Economic Forum every year since 2006. China would escape a collapse in economic growth, defined as below 6 percent over a multiyear period, if market diversification buoys its export sector and if inflation or the rise in asset prices does not prove destabilizing.
In the recent past, the authorities have acted effectively to dampen inflation. A property asset bubble may, however, present new challenges (previous stock market bubbles have had little direct impact on the real economy). The authorities seem mindful of this risk, and their success in cooling a bubble before a bust, or without inducing a bust, will have great bearing on whether the country’s growth dynamic can be preserved.
Our judgment is that the authorities will act pre-emptively, as inflation as much as unemployment poses a great threat to social stability.
Another risk, not cited in our 2010 Global Outlook, is a sharp rise in inflation. Some countries are experiencing large capital inflows, which if not sterilized or dampened by a flexible exchange rate policy, could present challenges. Commodity price inflation, however, seems unlikely in the year ahead, other than as a consequence of a political shock in the Middle East, given slack global demand.
Yet the region is not immune from a rise in global commodity prices. The investment grade governments have demonstrated capabilities in managing such pressures. But the non-investment grade countries would face greater social and fiscal pressures, as subsidies are more widespread.
About the Author
This article is an abridged version of the first edition of Moody’s Asia-Pacific Sovereign Outlook, published in January 2010.