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Stephen Roach (New York) The Asian growth machine faces a potential double whammy. The combination of a China slowdown and higher oil prices could deal a tough blow to the world economy’s largest and most rapidly growing region. Barring the emergence of a new source of dynamism elsewhere in the world, an Asian slowdown would be a distinct negative for global growth. Such an outcome could have important implications for world financial markets -- underscoring downside risks to earnings, inflation, and interest rates. Asia accounts for 35% of world GDP, according to the IMF’s purchasing power parity metrics. Asia’s “big three” -- China, Japan, and India -- make up 74% of pan-regional output. In the aftermath of the region’s wrenching financial crisis in 1997-98, our estimates show Asia has grown at a 5.6% average annual rate; that accounted for 53% of the average increase in PPP-based world GDP growth over the six-year interval, 1999 to 2004. With such a contribution well in excess of the region’s PPP-based share in world GDP, it’s hard to envision how a major downshift in Asia wouldn’t have significant consequences for global growth. Given the region’s weight in the world, a two-percentage point downshift in Asian growth could knock 0.7 percentage point off world GDP growth. It would take offsets from the United States and Europe to avoid an Asian-led shortfall in global growth. But with the US near the top of its growth game and a struggling European economy unlikely to fill the void, such an offset seems highly unlikely. Consequently, there is good reason to believe that an Asian slowdown could quickly morph into a global slowdown. Asia is vulnerable to such a growth shortfall largely because it remains an externally-led growth machine that is lacking in autonomous support from domestic demand, especially private consumption. Over the past six years, 1999 to 2004, consumption growth in developed Asia (Japan plus the newly industrialized economies of Hong Kong, Korea, Singapore, and Taiwan) averaged only 1.75% per annum (in real terms). While comprehensive consumption data are not available for developing Asia, the experience of China -- the region’s dynamo -- says it all: The consumption share of Chinese GDP fell to a record low of 42% in 2004; reflecting the ongoing pressures of outsize headcount reductions associated with state-owned enterprise reforms, Chinese consumers are plagued by job and income insecurities and remain predisposed toward saving. China is fairly typical of the generic Asian growth model -- a region that remains largely a levered play on the global trade cycle. A China slowdown still seems likely over the next 12 months. You wouldn’t know it from the latest slug of data just released by Chinese statisticians -- especially the May reports of a further acceleration of industrial production (+16.6% y-o-y) and ongoing vigor in fixed asset investment (+26.4%). But there are plenty of early warning signs of slower growth ahead for China -- hints that are showing up in more reliable non-Chinese statistics. For example, the Baltic shipping index is down by 50% from its December 2004 peak; moreover, non-oil commodity prices have softened, with the Journal of Commerce composite index of spot industrials down about 7% from its late-March 2005 high. Perhaps the most telling sign of an emerging China-led slowdown comes from export trends elsewhere in Asia -- important cogs in China’s supply chain. A weighted average of export growth in Asia ex China shows a deceleration from 18% in early 2004 to about 7% in 1Q05. More recent trends in Taiwan, Korea, and Japan point to further export deceleration in the spring quarter. Interestingly enough, this matches up well with a sharp deceleration reported in Chinese import growth -- gains of 13.8% in the first five months of 2005 versus a 36% spurt in 2004. By using independent data on shipping activity, commodity pricing, and regional trade flows, it is possible to “triangulate” on the state of the Chinese economy; this evidence suggests that a China-led Asia slowdown may already be underway. But the backward-looking data may only be hinting at the main event. Two likely developments are key in that regard -- internal efforts to pop China’s property bubble and external efforts to slow the Chinese export juggernaut (see my 23 May dispatch, “What If China Slows?”). China’s latest actions to tame the speculative frenzy in coastal residential property markets seem to be working; anecdotal reports suggest that the 12 May initiatives aimed at tempering excesses on the demand side, the supply side, and mortgage financing have brought property transactions to a virtual standstill in Shanghai -- the center of this bubble. At the same time, Washington-led protectionist actions seem likely to take a toll on US-China trade. Whether the slowing comes about from US trade sanctions or a Chinese currency revaluation, shipments into China’s largest export market -- the US accounts for 33% of total Chinese exports -- seem likely to slow appreciably over the next year. Collectively, fixed investment and exports account for 80% of Chinese GDP and are still growing at close to a 30% y-o-y rate. However, as the Chinese property bubble bursts and the West pushes China to a slower export growth trajectory, the China slowdown seems likely to gather momentum. Over the past six years, Chinese GDP growth has fluctuated in a 6-9% range. While it is currently growing at the upper end of that range, I wouldn’t be surprised to see the Chinese growth rate slip toward the lower end of that range by mid-2006. For a China-centric Asian economy, that would be a very big deal. The oil wildcard is an important new reason to worry about Asia. Developing Asia is not only the fastest-growing region in the global economy, but it is also the most inefficient consumer of oil in the world. For example, China currently requires about 2.3 times as much oil per unit of GDP as does the average developed country; for India, the ratio is 2.9 times the OECD norm. To some extent, this is understandable -- Asia is currently in the midst of what could well be the most energy- and materials-intensive phase of its development path. But the region also suffers from a failure to focus on energy conservation. Whatever the reason, Asia is especially vulnerable to a sharp run-up in oil prices. And that’s precisely what is now happening. Moreover, from Asia’s point of view, the current oil price spike is much worse than the one that occurred last fall. That’s because the price of “Dubai oil” -- Asia’s most important source of supply -- has moved up sharply along with WTI and Brent prices in recent weeks. That stands in sharp contrast with trends 8-9 months ago, when the Dubai price held relatively steady in the face of sharp run-ups in other segments of world oil markets. Asian governments generally tend to subsidize retail oil prices -- suggesting that even this recent run-up will not be fully reflected by prices at the pump. But that would then imply significant increases in the cost of government subsidies -- an increasingly serious problem for Asian fiscal authorities. One way or another, the current oil shock seems likely to hurt Asia a good deal more than the one in late 2004 (see Andy Xie’s 15 June dispatch, “Scary Oil”). A China slowdown and an oil shock are a tough combination for Asia. In the post-Asian crisis period, pan-Asian GDP growth has fluctuated in roughly a 4-7% range. In 2004, regional growth of 6.9% was at the upper end of that range -- fully 1.3 percentage point above its six-year average of 5.6%. Given the likelihood of a China slowdown, together with the impacts of higher oil prices, I would not be surprised to see pan-Asian growth slip well below trend over the next 12 months -- possibly into the 4.5 to 5.0% range. As noted, that could knock about 0.7 percentage point off world GDP growth -- about twice as much as that implied by Morgan Stanley’s current baseline forecast for the global economy. For financial markets, a potential global growth shortfall of this magnitude cannot be taken lightly. For starters, the direct effects of a hit on Asia will undoubtedly generate collateral damage elsewhere in the world. In the United States, for example, where exports amount to about 10% of GDP, fully 25% of total overseas shipments go to Asia. That means every 10 percentage point shortfall of exports to Asia would knock about 0.2 to 0.3 percentage point off US GDP growth. With our US team long maintaining that Corporate America’s profit margins have peaked, an Asian-led growth shortfall undoubtedly spells earnings disappointments -- running against the grain of the earnings optimism still embedded in US equity markets. Such an outcome also takes the heat off any cyclical pressures on inflation -- especially in the materials sectors, as a commodity-intensive Chinese economy takes the lead in driving the slowdown. With inflation capped and inflationary expectations always hypersensitive to the commodity cycle, pressures on long-term interest rates should remain muted. At this point, any hit to Asian growth seems likely to be cyclical and temporary. China’s assault on its property bubble is shaping up to be a classic fine-tuning of its investment cycle -- a downtrend for one or two years followed by a resumption of solid growth, driven by ongoing needs of urbanization, infrastructure, and industrialization. An Asian growth shortfall that hits the world’s most energy-intensive consumers could also eventually lead to a sharp cyclical decline in oil prices -- setting the stage for a global rebound, once the lagged effects of the current price spike run their course. Protectionism remains the biggest wildcard. In particular, a failure of the US and China to find common ground in their current trade dispute could leave externally-dependent Asia battered by aftershocks for years to come. That could turn any cyclical disruption into a far more worrisome scenario for Asia and the broader global economy. |
