First, the good news. According to the latest World Economic Outlook report of the International Monetary Fund (IMF) released on October 1, the outlook for Asia’s economies has improved markedly in the first half of 2009. “The recent, swift turnaround of economic fortunes is remarkable,” says the IMF, given that Japan’s GDP, for example, contracted by more than 10% on an annualised basis in the two quarters after Lehman Brothers went under in September 2008.
But here’s the sobering news. “Questions remain about whether the rebound can become a self-sustaining recovery – ahead of a stronger growth pick-up in the rest of the world,” says the IMF. Asia’s CFOs, in other words, cannot afford to let down their guard. The cost-cutting and belt-tightening regime in most companies must remain in place while waiting for more clarity on the way forward for the region and the world.
At least, nowhere in the document does the IMF mention the dreaded phrase “double dip recession
,” something that less inhibited commentators like Nouriel Roubini, William White and Andy Xie have not been shy of proclaiming. While such an outcome is certainly a possibility, particularly if governments withdraw fiscal stimulus spending too early, the IMF is clearly in the cautiously optimistic camp.
“A sustained turnaround [in Asia] is not assured,” the report concedes. But the agency is confident enough in the short term to say that “growth momentum will build during the second half of 2009, forming the basis for a generally moderate recovery in 2010, as external demand from advanced economies strengthens.” What happens in 2011 and beyond, however, is apparently too murky for projections to be made.
The IMF’s moderate optimism on Asia is reflected in its growth projections for the region’s economies next year. It sees all Asia Pacific economies expanding in 2010, led by China at 9% and India at 6.4%. But the pain will continue for many countries this year. Hong Kong, Japan, Korea, Malaysia, New Zealand, Singapore, Taiwan and Thailand will see GDP shrink in 2009.
Real GDP in Asia, % change
2007 2008 2009f 2010f
Australia 4.0 2.4 0.7 2.0
Bangladesh 6.3 6.0 5.4 5.4
China 13.0 9.0 8.5 9.0
Hong Kong 6.4 2.4 (3.6) 3.5
India 9.4 7.3 5.4 6.4
Indonesia 6.3 6.1 4.0 4.8
Japan 2.3 (0.7) (5.4) 1.7
Korea 5.1 2.2 (1.0) 3.6
Malaysia 6.2 4.6 (3.6) 2.5
New Zealand 3.2 0.2 (2.2) 2.2
Pakistan 5.6 2.0 2.0 3.0
Philippines 7.1 3.8 1.0 3.2
Singapore 7.8 1.1 (3.3) 4.1
Taiwan 5.7 0.1 (4.1) 3.7
Thailand 4.9 2.6 (3.5) 3.7
Vietnam 8.5 6.2 4.6 5.3
The IMF ascribes Asia’s better-than-expected economic performance to three factors. The first is aggressive expansionary fiscal and monetary policy particularly in China and Japan, whose fiscal packages will each equal close to 5% of their respective GDP in 2009-2010. “Central banks provided ample liquidity (Japan) and lowered policy rates (India, Indonesia, Korea, Malaysia, Philippines, Taiwan Province of China, Thailand),” the report notes. “In China, a relaxation of credit ceilings and low interest rates buoyed credit growth (private credit grew by 24 percent during the first six months of 2009).”
The second reason is the rebound in equity markets and resumption of capital inflows to the region because of a decline in risk aversion. In the first eight months of 2009, Japan’s stock market rose 28%. Bourses in Hong Kong, Korea, Singapore and Taiwan jumped a collective 52% in the same period, while those in Indonesia, Malaysia, the Philippines and Thailand soared by 65%. “Sovereigns tapped international capital markets, and net equity inflows turned positive in the second quarter,” the IMF adds. “In addition, creditor banks in advanced economies stopped reducing their exposure in emerging Asia.”
The third factor is restocking. Companies in Asia sharply reduced production and inventories in the fourth quarter of 2008 in response to the precipitous fall in export demand as the economic crisis in the U.S. and Europe curtailed consumer spending. “By mid-2009, this destocking process was far advanced in Japan, Korea, and Taiwan Province of China, implying that the current rebound in external demand, together with progress in inventory adjustment, will provide impulses for increased production in the export sector,” says the report.
A common thread runs through these three drivers, and that is their general fragility. Can governments really afford to throw more money at the problem? How long before the deficit spending blows too big a hole in national finances? How much longer can interest rates be kept at ultra-low levels without triggering inflation? Will investor confidence hold up? Risk appetite can turn on a dime, so the decline in risk aversion that is fuelling stock market gains can easily reverse.
As for restocking, that is basically a limited process. Companies are filling up part of their warehouses in anticipation of the Christmas season, when consumers in the West traditionally go on spending sprees. But demand especially in the U.S. must first recover before the restocking in Asia becomes a sustainable, virtuous circle, and that is unlikely to happen in the near term. The American consumer simply does not have the desire and the means to buy as the unemployment rate continues to rise and house prices remain in the doldrums.
All these explain the IMF’s caution. “The pickup in activity is so far being supported by many factors that could turn out to be temporary: rebounding capital markets, inventory adjustment, and expansionary fiscal and monetary policy,” the agency points out. “These forces may not be able to bring about a self-sustaining recovery if activity does not strengthen in other regions” – meaning the United States and to a lesser extent in Europe.
Medium term moves
One bright spot is China, whose policy stimulus “could support recoveries in other parts of Asia,” says the IMF, which now expects the Chinese economy to expand 8.5% this year, up sharply from the 6.5% it forecast in April. For 2010, the IMF revised its forecast GDP growth for China to 9%. That’s still below the 13% recorded in 2007, but equals the growth rate in 2008 and a vast improvement from the forecast 7.5% the IMF made in April.
Even so, the IMF harbours worries about China. “Some caution is warranted about the sustainability of the rapid level of credit growth in a few countries, especially China,” says the report. “Maintaining credit growth at this level carries the risk of creating incentives for overinvestment, unsustainable asset price inflation, and a worsening of credit quality in the banking system. Recent monetary expansion should therefore be unwound as soon as there are clear signs that economic recovery is established.”
The IMF recommends that governments focus on “devising exit strategies from credit-guarantee programs for corporations, which were adopted in many parts of Asia during the crisis.” The experience of Japan and Korea in the past decade shows that programs like this can encourage too much risk-taking among the companies that enjoy such guarantees. But the IMF concedes that scaling these programs back can be challenging.
The agency urges a rebalancing of the Asian development model to pay more attention to domestic demand and focus less on investment and exports. It cites the example of Japan, Korea and Taiwan, which have notably been encouraging private consumption through fiscal support. But Japan, along with India and Malaysia, must also address concerns about fiscal sustainability by taking steps such as developing “credible medium-term consolidation plans.”
“By developing or improving social safety nets and health care systems, many emerging and developing economies can help reduce precautionary saving by households,” the IMF adds. “This would free up resources for consumption and create a larger market for domestic suppliers.”
The IMF also calls for more flexible exchange rate policies. “Appreciating exchange rates in economies where there is productivity growth would imply an increase in real household incomes as import prices decline, thereby strengthening domestic demand, and would also send a signal to businesses to shift supply toward the domestic sector,” it argues. “More flexible exchange rates would also allow Asian economies to develop monetary policy into an independent tool for macroeconomic management, which would help buffer the economic impact of external and domestic shocks.”
Finally, the IMF wants to see continued development of the financial sector, but in the context of proper supervisory and regulatory frameworks. “As financial markets become deeper and more robust, they can offer stable saving and investment vehicles, which would reduce reliance on foreign financing and make household savings a more important funding base for the financial sector,” it explains. “Easier access to market-based domestic financing for smaller enterprises may also help lower high corporate saving rates, help develop domestic services sectors, and support consumption.”
Staying the course
What should finance do? The IMF’s revised views, while cautiously optimistic, are by no means a signal that companies in Asia can now return to pre-crisis mode. Risks still litter the financial markets and the macro-economic environment. The improvements that the IMF acknowledges can turn on a dime because they are mainly based on ephemeral drivers, including a decline in risk aversion, an iffy stock market recovery, and temporary restocking of inventories.
For CFOs, the tasks of strengthening the balance sheet and managing the cost base remain as important as ever. It is not yet time for expansion heroics. The best course is to keep the company’s powder dry and continue taking advantage of improved sentiment in the financial markets to explore an initial public offering, make cash calls and lock in cheap bank credit. If you must spend, spend to save – on software-as-a-service solutions to enhance the accounts receivables process, for example.
It’s a time to wait for more clarity on the way forward, not just in terms of positive growth forecasts but the sustainability of the drivers fuelling that growth.
About the Author
Cesar Bacani is senior consulting editor at CFO Innovation. The latest IMF World Economic Outlook can be downloaded here.