Q1 Asia Outlook: Fasten Your Seatbelts, We are About to Land

While our recent commentaries on the macro situation in the developed world have drawn the analogy of a plane flying on one remaining engine, Asia’s economies have the benefit of still flying on all engines but with tremendous hope placed in the hands of the pilot – the powers-that-be in China – to determine the smoothness of the next landing.

There is no doubt that the Chinese economy is coming in to land – export growth has been in steady decline since mid-2010 after the healthy rebound after the 2008 crisis as global demand falters. Import growth is dead in the water as manufacturing slows and both industrial production and PMI data echo the same theme. The much-vaunted switch to domestic consumption rather than reliance on export markets has yet failed to materialise as efforts to change a much-ingrained mindset make miniscule steps forward. Yet we are still talking of above 9 percent growth for 2011, though most of this was front-loaded into the first-half of 2012. From here on in, the outlook appears bleak and our analysis suggests we could face growth of a mere 5-6 percent for 2012, well below median market forecasts of around 8.5 percent.

With no change in the current dismal global outlook in sight, what are the authorities doing to mitigate the much-feared hard landing? The People’s Bank of China recently initiated a shift in monetary policy with the first easing step in three years announced end-November, a 50 basis point cut in the reserve ratio requirement, with more expected near-term (Note a 50 bp cut is expected to boost total liquidity by about Yuan 400 bn (USD 63 bn)). With time running out for an additional cut this year (though in the past the PBOC has announced moves during western market holidays) it is odds-on for further cuts - at least two we predict - during Q1 2012 with the first before the Lunar New year holidays in late-January.

What about the bubbles? Property-related bubbles were very much the talk of the markets in the first half of 2011 and the government has been consistent in applying measures to cool this sector (for example: higher lending rates, purchasing limits and a ban on mortgages for third homes). While there have been broad signs of a cooling off, latest data for November shows that there are still hotspots recording 6 percent annualised price increases so this issue is still not completely and uniformly resolved.

Another issue for China is the Yuan. Despite continued pressure from the US (and more lately from the European Central Bank), a resurgent US Dollar and a shift in investment flows have seen the Yuan weaken some 0.6 percent versus the US dollar from its peak mid-November. That month saw an almost 10 percent drop in Foreign Direct Investment (FDI), the first drop in 28 months, and most likely caused by the grim and complicated global outlook.  At the same time, Overseas Direct Investment in non-financial sectors originating from China rose to over $50 bn in the first 11 months of this year, an increase of 5.2 percent y/y, aggravating the negative impact on the currency of such portfolio flows. Given such flows it would take great effort to continue the so-called path of “slow, gradual appreciation of the Yuan” that has been advocated/demanded by the Western world (which leads to our Outrageous Prediction number 8 that USDCNY rises 10 percent to 7.00).

So what are the implications for the rest of Asia?
We all know how much the Australian resource sector depends on exports to China. Indeed the Chinese thirst for natural resources has produced one of the biggest mining booms in decades for the country. Unfortunately, if we take away the mining sector’s contribution to the economy there does not appear to be much left. The manufacturing sector has been struggling during the second half of 2011 (manufacturing PMI languishing below the 50 mark since July) and the service sector is dependent on the recycled dollars from the mining sector. A marked slowdown for China will undoubtedly cause issues for this one-trick pony.

Singapore has had a great emphasis on electronics exports in its strong growth history, but the roller-coaster nature of this sector since end-2008 is currently struggling for traction, especially given the backdrop of weak global growth. There has been some diversification into the pharmaceutical sector but the overall trend for non-oil domestic exports remains weak. With the global economy in dramatic slowdown, no change in this trend is expected in the near term. Indeed, Singapore’s PM Lee has, quite realistically, warned that growth of between 1-3 percent (compared with 5 percent on average over the last four years) may become the norm over the next few years.

As for Hong Kong, the question remains whether China leads Hong Kong or vice-versa. In November, Mads Koefoed’s research pointed out that the two economies are coincident and as such co-dependent. Our expectations of slower Chinese growth, mixed with independent external chatter of Hong Kong heading towards zero growth, suggests the prospects for Hong Kong are not healthy.

In the event of a hard or even crash landing, we will find out over the next few quarters if it matters whether you are sitting in first, business, or economy class with the risk increasing that we are all at the back of the plane.