As he showed in the first part of this interview published earlier, Rajiv Biswas is more bullish than most on the regional and global economy. But the Chief Economist of IHS Global Insight, a New York-listed economic and financial information services provider, knows that there are risks that may be serious enough to upend his forecasts.
He disagrees with bears like Jim Chanos, who assert that China is on the verge of collapse because of imprudent lending by the banks that has resulted in a vast oversupply of property. “In Dubai it was a question of speculators, builders who were hoping that a lot of foreigners would buy into it and now of course that bubble’s completely collapsed,” says Biswas. “Whereas in China, you do have a very underlying strong demand and that growth is still continuing strongly.”
So what can derail the optimistic scenario? Biswas spoke to CFO Innovation’s Cesar Bacani about the problems in Europe, political and security issues in North Korea and Iran, and other regional and global risks that CFOs would do well to watch.
Overall, IHS’ baseline scenario for 2011 and 2012 is positive. What would be the risks globally and in Asia that can derail continued recovery?
For the moment, one of the biggest risks is what’s happening in Europe. The sovereign debt problems that we’re seeing there are a significant risk to the global outlook. Europe isn’t so important right now as a key market for Asia as it used to be, it’s still an important market. It is an important region of the market economy.
What we’re seeing right now is a kind of two-speed Europe. Germany’s doing very well; we’ve just seen the data for 2010 [showing] 3.6% GDP growth last year. It’s the strongest since the reunification of East and West Germany in 1990, so that gives you a sense of what an achievement it was, the rebound that we saw last year. This strong growth is expected to continue into this year, because the weak euro is helping Germany’s export sector. And North Europe generally is doing quite well, if you look at Switzerland, Netherlands, even France.
The problems are coming from smaller economies at Europe’s periphery – Greece, Ireland and Portugal – but there are concerns about some of the larger EU countries, too. Spain and the UK are two of the biggest economies in Europe and they both have significant debt problems.
There’s a lot of fears about the next country that will need bailing out. Will Spain need help? Will Italy? There was an important positive development in the last few days. Both Japan and China have indicated that’s they’re prepared to buy quite a lot of European bonds to finance some of the sovereign debt in Europe.
Nevertheless it’s still very unclear how this will evolve, which next country, if any, will need help, and whether one of the big countries will enter into difficulties and also need help. As a result of this two-speed story, we expect Europe’s growth at only about 1.5% in 2011.
Is there a danger of a default in Europe?
I think the risk at the moment is not so much the default; it’s more the need for a bailout. The EU recognises the kind of situation of one of their member countries entering into a default situation. They’re going to do everything they can to try to resolve this situation through a bailout package and restructuring. This is what they’re doing right now with Greece and Ireland and perhaps also [behind the scenes] with Portugal.
That’s why the EU is creating this global alliance with countries like Japan and China, which have massive financial resources. They can help underpin the stability of the global financial system to avoid such a risk. Plus, they’re going to increase the size of the EU’s own bailout fund.
Obviously, if a big country like Spain needs help, it will have a transmission effect [on the global financial system]. So all of these factors may help to mitigate that risk over the next few years, when at least countries like Spain, the UK should start to see some results from the various reforms that they’re making. Once you start to see fiscal debt being reduced, fiscal deficit narrowing, then the market will be more confident that they’re somehow going to be able to resolve the issue, even though it will take some years.
GETTING A SHOCK
But if the market, for some reason, suddenly decides that things are not working out and a sovereign debt default is imminent, the rosy scenario you have been painting will disappear?
There’s a risk that one of the EU countries that hasn’t gotten a bailout yet, say, could trigger a shock in the international financial markets, like we saw last year [with Greece and Ireland]. There will be heightened risk aversion, people move back to the USD and safe haven currencies again, and out of risky assets.
I think the bigger question is how long will [the shock and its effects] persist. Is it just going to be a spike and then is reversed? I think you could see a spike for a while, and then [the Europeans] will find another way to move forward, another package and so on. I do think that you could see such financial shocks this year.
If there’s a financial shock, will the corporate spending recovery in the US be held back as companies there reassess their plans?
I think they have seen the European ups and downs several times already, so it’s going to take something protracted before they change their investment plans. The US is pretty much very domestic driven-focus. The transmission effects from Europe are relatively less. I think now they’re a little bit used to that cycle [of financial shocks in Europe] and anyway it wouldn’t be so easy to change their plans if they see one weak shock.
There are potential shocks that are not financial, for example, armed conflict in the Korean peninsula.
The military tensions in the Korean peninsula are clearly very significant risks for this year and has implications beyond [South Korea and North Korea]. I think the risk of conflict is low, but there’s a risk of some sort of border clash. It’s certainly a risk for Korean financial markets and the won.
The second political risk that I would point out is Thailand, which has parliamentary elections due this year. It could again have uncertainty and turbulence politically, which could unsettle investors in Thailand. But I think that’s going to be limited just to Thailand and doesn’t have wider implications.
The big fear would be North Korea deploying the nuclear option.
I surely hope not. I think North Korea is playing a game of cat and mouse a little bit here. They would, I hope, recognise [the nuclear option] is self-destructive for them. I think they’re playing a delicate game to try to extract concessions [from South Korea, the U.S. and China]. It’s a complicated game that they’re playing, which has a lot of risks around it.
INFLATION AND INTEREST RATES
What other risks do you see in Asia?
They’re more on the economic side. One is rising inflation. We do see some upturn in inflationary pressures in the last couple of months on food from rising oil prices. Obviously this has worried central bankers in Asia. As it is, their economies are strong and they realise they need to be tightening to take away some of that loose monetary policy during the global financial crisis. So the tightening cycle is likely to continue in many countries in Asia. In North Asia and Southeast Asia, some tightening is going to take place this year, and probably also in India,
Will interest rates remain relatively low compared to before the crisis?
It depends on which country, but in general we could say that at the moment it looks like the need for tightening would be moderate. However, the risk is somewhat a bit on the upside. The flooding in Queensland means a large source of coking coal supply for the global steel industry has been cut at least for a few months, and so you’re going to see higher input costs in Asia for steel, for construction and so on. You could have somewhat higher inflation people are expecting.
[Consumer] demand is also growing quite strongly. The economy is reaching capacity limits in some countries, which will also push up wage pressures, as we’re seeing currently in India and some other countries in Asia Pacific, at least for skilled labour. We’ve had a very strong [GDP] growth last year and this year it’s continuing, so all of these things mean that pricing pressures might be higher into this year.
Is there a risk of a miscalculation by central banks such that they would tighten too early and too much?
I think at the moment they are quite cautious about not tightening too quickly because up to now they’ve been very worried about the global outlook being weak. They’re also a little bit worried about hot money inflows into Asia. If they tighten rates too much, they’d push up the interest rate differential against the US and Europe, where there has been no tightening. Higher interest rate differentials in favour of Asia will push up [the value of local] currencies because investors will put their money into some of the Asian currencies.
MANAGING THE RISKS
How do you think can CFOs manage these risks?
There are instruments that companies can use to hedge their risk, whether it’s on interest rates or whether it’s on currencies. Rising commodity prices pushing up input costs, higher oil prices, higher steel prices – these are also the kind of issues that will be at the forefront for corporate financial management this year. How do you conduct financial management in this environment of rising inflation, rising commodity prices and also higher currencies in Asia? Managing wage costs is also certainly a big focus for corporates this year.
Do corporates in Asia have strong pricing power that allows them to pass on some of these increases to consumers?
They’re in an environment of continuing strong demand, so to some extent I think they have more pricing power at the moment. But I think they’re still very cautious about trying to contain their costs and not pass it on to the consumer.
Are things like outsourcing, and cloud computing, just all the tricks that are being done in high-cost countries like the US and Australia, can these strategies help companies in Asia manage rising costs?
I think there’s scope. If we look across the Asian landscape, we do see very different levels of wages from country to country. For example in Hong Kong, Singapore, they got very high wage costs, very high salaries compared to countries such as India. Maybe some of the big multinationals that have a lot of back office in Hong Kong and Singapore can think about using other locations.
They are already doing that. It’s not a new story that they are pushing some of their back office into India, also the Philippines, Malaysia. They all have very competitive back office centres. I think there’s a strong case for that to continue. China also actually developed some capability in back office; it’s quite a big back office centre in some areas such as IT.
I imagine in-county outsourcing can be done, such as a back office in Shanghai outsourced to an inland province in China where wages are cheaper.
Maybe the better example is Hong Kong, where things are extremely expensive. But you’re right, Shanghai is also becoming quite a developed city. Over time, that process will happen. In India also, the location of outsourcing is shifting away from traditional big hubs to second-tier cities because the costs are lower there and it’s probably easier to get the land [to build on]. The overall costs of the operation would be less.