Asia Pacific Economics: Rise in Real Rates + Slowdown in China = Slower Growth
Asia Pacific Economics: Rise in Real Rates + Slowdown in China = Slower Growth
Where are we in the growth cycle? After a short-lived growth recovery late last year, GDP growth for the region decelerated again, averaging 6% in 1H13 compared to 6.6% in 4Q12. The deceleration in economic growth was reflected across both domestic and external demand. Exports for the region continued to decelerate sequentially almost all throughout 1H13, which led to weaker production activities. Moreover the weak external demand affected corporate sentiment, which had the added effect of slowing capex activity across the region. Consumption growth, as proxied by retail sales, has since stabilized at lower levels after decelerating earlier this year.
Pro-cyclical rise in real rates since May-13 have brought more downside to region’s growth outlook: Since May, the headwinds to the region’s growth outlook have intensified due to the pressures arising from the rise in the US dollar /real rates and the impact of the growth slowdown in China.
First, the recovery in the US and accordingly the market’s expectations of reduced monetary accommodation by the Fed has pushed up US bond yields. This then had the spillover effect of a simultaneous upward pressures on the region’s interest rates and depreciation pressures on the region’s currencies. Since then, the region has had to either tighten monetary policy explicitly (as in the case of India and Indonesia) to prevent a further aggressive depreciation of their currencies or see their market interest rates rise. We believe that this constitutes a pro-cyclical monetary tightening for the region and expect that each and every country in the region will be affected by the rise in real interest rates. Rising real rates in the context of a slowing GDP growth environment will not only slow down the pace of credit growth but will also increase the risks of a build up in banking sector non-performing loans (for a more detailed discussion, see Asia Pacific Economics: Rise in Real Rates - What Does It Mean For AXJ?, May 29, 2013, Asia Pacific Economics - Understanding AXJ's Exposure to Rising Dollar and Real Rates, June 21, 2013, and Asia Pacific Economics: Rise in Real Rates - Why It Feels Like the 1990s, August 22, 2013).
Second, as policymakers in China tighten credit growth via a tighter regulatory environment for inter-bank assets and wealth management products and address the concerns over excess investment and overcapacity, it will slow down growth in China. With the region’s increasing dependence on China as a key source of end demand, a growth slowdown in China will have implications for the region’s growth outlook, which will be transmitted largely via trade flows and weaker commodity prices (For more details, see Asia Pacific Economics: Asia Insight: What Could the Risk of a China Slowdown Mean for Asia?, June 28, 2013).
What are our forecasts now? Given the headwinds from higher interest rates and slower growth in China, we have cut our AXJ GDP growth forecasts for 2013 and 2014. We now expect GDP growth for the region at 6.0% (6.4% previously) in 2013, 5.9% (6.7% previously) for 2014 and 6.1% for 2015. Taken together, this implies that the region will be facing a period of four years of weak growth from 2012-15.
Some of the key changes for GDP growth forecasts for 2013 include downgrades for India, Malaysia and Thailand. For 2014, we have cut our growth forecasts across the region.
We expect headline inflation to be higher at 4.4% (4.1% previously) in 2013 compared to 4.1% in 2012. However, this reflects largely an upward revision in India and Indonesia’s inflation while most other countries are expected to see lower inflation in 2013. As growth decelerates going into 2014, we expect inflation to moderate as well, averaging 3.3% in 2014.
On monetary policy, we are expecting rate hikes to take place in 2013 in Indonesia and Taiwan. In 2014, we are expecting rate hikes to take place in Korea, Taiwan and Thailand. In contrast, we expect China to cut rates by 50bps in 2014 and a further 25bps in 2015.
US bond yields and China’s growth trajectory to drive the bull-bear scenarios: Our bear case assumes that bond yields in the US will rise quickly to 4% and that the growth in China decelerates sharply. This will have the effect of pushing the region’s GDP growth and inflation down to 4.5% and 1% respectively in 2014. In contrast, our bull case builds in continued accommodation by the Fed and also a soft acceleration in China’s growth, helped by selective stimulus and also the announcement of structural reforms. Under this scenario, GDP growth will be lifted to 6.4% in 2014 and inflation will be 100bps higher at 4.3% for 2014.
Rise in Real Rates + Slowdown in China = Slower Growth: In sum, we think that the growth outlook for the region remains quite challenging. With domestic demand growth likely to be constrained by higher real interest rates and a slow pace of structural reforms, the growth outlook for the region will hinge on external demand. To improve the growth prospects for the region, policy makers will need to embark on structural reforms to improve productivity growth to ensure that their economies will be able to withstand the effect of higher real rates and to offset weaker demographic trends. Policy reforms to rebalance the economy towards more sustainable growth drivers will also be much needed. In this context, we will be closely watching the pace of exports growth, particularly out of Korea and Taiwan, and also the pace of policy reforms.