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Hoping for slower but higher quality growth in APAC
Asia-Pacific economies are limping to the finish line in 2014. China continues to be weighed down by its property sector. Japan has entered a technical recession. And in the trade-dependent economies the hoped for pick-up in external demand has yet to materialize. Only India is bucking the trend, says Paul Gruenwald, Asia-Pacific chief economist at Standard & Poor’s
Paul Gruenwald 15 Dec 2014
 
   
Asia-Pacific economies are limping to the finish line in 2014. China continues to be weighed down by its property sector. Japan has entered a technical recession. And in the trade-dependent economies the hoped for pick-up in external demand has yet to materialize. Only India is bucking the trend.
 
However, all is not lost. 2015 and 2016 are setting up as pretty good years. Yes, we have shaved a bit off our baseline Asia-Pacific GDP growth numbers (to 5.3% and 5.2%, respectively). But if we look past the headline figures, there is an improvement in both the quality and composition of growth.
 
First, we hope that the Chinese economy will decelerate to a more sustainable path. The property sector correction is ongoing, putting a damper on growth. And owing to a lack of data we do not know how large the problem is. But we do know its cause: the over-reliance on and mispricing of credit. The resulting supply overhang needs to be cleared. Moreover, with external demand and productivity growth still not rebounding to pre-crisis rates, a lower GDP growth target of 7% or below in 2015 is warranted. As are policies that fulfill the Third Plenum objective of giving the market a decisive role.
 
Japan is down but not out, as the recession has brought forth a strong policy response. The authorities now recognize the policy mistake of implementing the consumption tax hike too soon. Growth may be a meager ½% this year, but better policies should bring modest rebound in growth to 1½% in 2015. Once the economy is reflated to 3% nominal growth, then tax measures can be re-launched to begin to stabilize the public finances.
 
Meanwhile, India seems to be regaining its mojo. After a cautious start, the Modi government has picked up the pace of reform. In a dramatic move, diesel prices were deregulated in October, there was some liberalization for foreign investment into financial services and a 10% cut in discretionary spending in the current fiscal year was announced. The economy has started to respond, and 6% to 7% growth is in sight. 
 
Looking across the region we should see less reliance on domestic demand—and hopefully credit—and a welcome rotation toward a larger external contribution in 2015 as the US recovery takes hold. The recent steep drop in oil prices is a welcome boon for most of the region, equivalent to a tax cut. We expect the windfall to be used to both pay down debt and spur consumption.
 
Despite our sunnier disposition on the quality of growth, we continue to see the balance of risks as tilted to the downside. China’s property market and the region’s ability to move to a more normal interest rate environment are top of our list.
 
China’s property market adjustment that began earlier this year has already been longer and sharper than most had anticipated. So far, however, we have seen little stress among the 80,000-plus developers even though prices are falling, inventories are rising and sales and construction have slowed. In a downside scenario, we would expect a noticeable pick-up in developer defaults and stress in their financiers. A full-blown crisis is highly unlikely given the macro cushions in the economy, but a short period of sub-5% growth momentum strikes us as possible.
 
Rising US interest rates will also be a challenge. We all know that US rates will eventually normalize, but it remains to be seen if a new generation of Asian borrowers raised on ultra-cheap credit has factored this in. If not, then debt servicing will be higher than expected and this will dampen expenditure and growth. Our suspicion is that this would be more of a household than a corporate issue since CFOs and Treasurers have a better idea of what is coming. We would be looking for stress in personal consumption spending (mainly durables) and declines in interest rate sensitive sectors such as real estate.
 
All told, we hope that Asia-Pacific is entering a new phase in thinking about growth. If there has been one policy lesson from the post-crisis period, it has been that trying to prop up growth rates through credit can be overdone. The domestic economy does not have to absorb all the drop in foreign demand. And not modifying growth expectations to align with external realities can be risky.
 
 
If consumers and firms in Asia-Pacific know that someday the low interest rate party will end and have spent and invested accordingly, then higher US growth should be welcome. If not, then the path back to normal may be bumpier than expected.
 
 
 
 

Paul Gruenwald is the Asia-Pacific chief economist at Standard & Poor’s Ratings Services 

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