By Andrew Marshall, Asia Political Risk Correspondent
SINGAPORE, Dec 21 (Reuters) - Asia weathered the economic storms of 2009 remarkably well, but the performance of regional markets next year depends heavily on whether the continent can steer a course through some treacherous political risks:
THE DIFFICULT RELATIONSHIP BETWEEN WASHINGTON AND BEIJING
China will face intensifying pressure in 2010 to let the yuan appreciate. But Beijing will not want to put economic growth at risk by letting the currency rise too quickly, and does not appreciate being told what to do by Washington or anyone else. In the United States, meanwhile, yuan weakness is regarded as a protectionist policy that threatens the U.S. recovery.
Washington may retaliate by imposing more trade restrictions, like the tariffs on Chinese tyres announced in September, sparking a tit-for-tat trade war. And there is also the danger that Beijing's backing of regimes that Washington finds unpalatable flares up into a political confrontation.
Most analysts say Washington and Beijing are painfully aware of the risks and would step back from the brink before any dispute threatened the global economy. But the two countries have yet to find a way to communicate comfortably as partners. The risk of a misunderstanding or sudden chill in relations is real.
What to watch:
-- The battle over the yuan. Will Beijing let it appreciate, and if not, will Washington throw a tantrum?
-- Protectionism and trade tariffs. If President Barack Obama imposes more tariffs, under pressure from Congress and domestic industry, expect sparks to fly.
-- Any disputes arising from China's dealings with North Korea, Myanmar, Iran and other "rogue states".
POST-STIMULUS HANGOVER: ASSET BUBBLES AND CAPITAL CONTROLS
Asia is leading the world out of recession, which means Asian governments are among the first to confront a key policy problem -- how to time their exit from the vast stimulus packages that helped keep them afloat during the global economic crisis.
If governments withdraw stimulus too soon, they could topple back into stagnation. And if China falls into this trap, the impact on the global economy could be dire.
But keep policy too loose for too long and they risk not just resurgent inflation but also potentially catastrophic asset price bubbles, as plentiful credit sparks a scramble for property and equities. The danger of China's economy being derailed by a burst property bubble is a key concern for 2010.
Another risk for investors is that countries trying to prevent bubbles and control inflows of "hot money" tighten capital controls and try to lock in foreign cash.
Two more political issues complicate the dilemma.
First, unless governments coordinate their exit plans, there is a major risk of unexpected spillover effects. But the crisis demonstrated the lack of global governance bodies able to handle international policy coordination, and while G20 members have promised to move in step, it is more likely their stimulus exit will be dictated by national interest alone.
Second, disagreements could also erupt within countries, between governments focused on safeguarding growth and central banks fearful of inflation and bubbles. That could lead to bad decisions, and make policy hard to forecast.
What to watch:
-- All eyes are on China, key engine of global growth since the financial crisis hit. Can it steer a course through the policy perils? If it stumbles, the tremors will be global.
-- Much of Asia faces property bubble risks, with Hong Kong and Singapore particularly in focus.
-- India and Indonesia are two key countries where capital controls could be tightened, spooking investors.
-- The next G20 summits are in June in Canada and November in South Korea. Coordination of exit strategy will be a key theme.
-- Disagreements between the government and central bank are already an issue in Japan. South Korea and India, among others, may also see policy friction in 2010.
THORNY POLITICAL TRANSITIONS
In 2009, Asia smoothly negotiated several potentially tricky elections and transitions of power, although the victory of the Democratic Party in Japan's elections after decades in opposition produced some market volatility. Things may be tougher in 2010.
Australian Prime Minister Kevin Rudd is widely expected to win another term, with the only question being the timing of the election. But elections in the Philippines and Sri Lanka are harder to call.
Moreover, two important Asian heads of state are ailing and there is no certainty who or what will come after them.
Thailand's 82-year-old King Bhumibol Adulyadej has been in hospital since September, another complication in the long-running political crisis that has riven the country. Many analysts expect instability to get even worse after his reign ends -- giving Thai markets a rough ride. But most say there is little risk of contagion in other markets.
If North Korean leader Kim Jong-il dies in 2010, by contrast, the tremors will be felt in South Korea, Japan and beyond.
Many analysts say Kim's death could herald the collapse of the regime in Pyongyang, leading possibly to prolonged civil war in North Korea, aggressive moves against the South, or the sudden reunification of the Korean peninsula. In all of these cases, the likely market reaction would be strongly negative.
What to watch:
-- The health of North Korea's Kim and Thailand's king will be closely watched, and could unsettle markets.
-- Populist pre-election pledges in Sri Lanka and the Philippines may result in economic problems later in the year.
AFPAK TREMORS START TO TROUBLE INVESTORS
Long-running instability and widespread violence in Afghanistan and Pakistan rarely register on the radar screen of investors. But that may change in 2010.
Firstly, with Obama facing mid-term polls in November, and with effective defeat in the war in Afghanistan still possible in 2010, his strategy may become a central campaign issue and could even cost him a majority in the House of Representatives if things go badly.
Secondly, the decisive victory of the Congress party in India's 2009 elections was another good-news story for markets that could be threatened if militants based in Pakistan provoke a confrontation again, following the bloody 2008 Mumbai attacks.
Analysts expect al Qaeda and its allies to again try to spark conflict between the nuclear-armed neighbours. And Pakistan's weak government, under threat on several fronts, may have its own reasons to focus popular anger on India.
What to watch:
-- Evidence of whether Obama's troop surge is making a difference, or whether his Afghan policy comes to be regarded as an expensive failure. In the latter scenario, he will be highly vulnerable going into the mid-term elections.
-- The state of India-Pakistan relations, and the risk of conflict if Pakistan-based militants once again launch a major attack on Indian soil.
SOCIAL UNREST PACKS A BELATED PUNCH
Many analysts predicted that the global economic crisis would unleash mass unrest in several countries around the world, with the potential to topple governments. They were mostly wrong. In particular, forecasts that China's leadership could be shaken by serious unrest proved to be way off the mark.
But unemployment is a lagging indicator. Even as the global economy moves out of crisis, many countries will see jobless numbers and social hardship continuing to rise.
Another spark that could ignite unrest would be inflation in food and fuel prices. The global crisis put the brakes on a dramatic surge in commodity prices that is likely to resume as global growth resumes.
What to watch:
-- The doomsday scenario for markets would be mass unrest across China that threatens to topple the government. Most analysts see the possibility of this as extremely low in 2010, but any upsurge in unrest in China would rattle investors.
-- India, Indonesia, Thailand and Vietnam are other key emerging markets where unrest could hamper economic reform and dent markets if instability flares in 2010. (Editing by Mathew Veedon)