Global: Pondering Asia
Stephen Roach (New York)
April 5, 2004
I was unprepared for what I found in Asia over the past two weeks. The role of China appears to be on the cusp of an important transition, as pressure builds on its leadership to confront the mounting imbalances of an overheated economy. With the exclusion of India — where I was stunned by the solid and increasingly powerful dynamic of its IT-enabled services transformation — the rest of the region is far too China-centric for my liking. A likely slowing in the Chinese economy could unmask a new instability in Asia — an outcome that could prove quite vexing for a still-unbalanced global economy.
Asia is a very big deal for those of us in the business of analyzing the global economy. Including Japan, the entire region accounts for fully 33% of the global economy, well in excess of the US portion (21%) and double the share of the Euro area (16%). These calculations are based on the purchasing-power parity (PPP) metric of the IMF, which attempts to strip out the impact of currency valuations in adding up the various pieces of the global economy. By abstracting from transitory trends such as an upside run in the “strong dollar,” an artificially “weak yen,” or the pegged Chinese renminbi, the PPP-based construct does a much better job in isolating the underlying real growth of economies. By contrast, the cross-border aggregation of nominal GDP at market exchange rates can often be dominated by sharp and volatile swings in currency markets.
By looking at Asia through the PPP-based lens, there can be little doubt as to the region’s newfound China dominance. The IMF puts China’s share in the world economy at 12.7%, well in excess of Japan’s 7.1% share and India’s 4.8% portion, the next two largest economies in the region. But there’s more to Asia’s China-centricity than its role as the region’s increasingly dominant producer. China’s voracious appetite for imports — up an astonishing 40% alone in 2003 — underscores the increasingly powerful trade linkages that China exerts on the rest of the world. Its Asian trading partners are the biggest beneficiaries of China’s external impetus. For example, over the 12 months of 2003, surging exports to China accounted for 32% of Japan’s total increase in exports; for Korea, the number was 36%, whereas in Taiwan, fully 68% of the last year’s export growth can be accounted for by surging shipments to China. China’s impact on global commodity markets is equally profound. Whereas this nation had a share of only about 4% of global nominal GDP in 2003, it accounted for 7% of the world’s total consumption of crude oil, 31% of coal, 30% of iron ore, 27% of steel products, 25% of aluminum, and fully 40% of the world’s total cement consumption. There can be no mistaking China’s ascendancy as the new engine of the Asian economy.
Yet China must now slow, and so all of the above are at risk. That message came through loud and clear on my first stop in Asia a couple of weeks ago (see my March 23 dispatch, “China — Determined to Slow”). In my opinion, China’s new leadership is facing a major test as it comes to grips with an overheated economy. The talk in “official Beijing” was very much focused on the mounting excesses and imbalances of a Chinese economy that is still probably growing well in excess of last year’s official 9.1% real GDP growth estimate. From Premier Wen Jiabao on down, China’s leadership was unanimous in sending a clear signal that it is utterly determined to engineer a slowdown. Yet the incoming data flow on the Chinese economy shows what they are up against: Fixed investment surged at 52% y-o-y rate in the first two months of 2004, and bank lending rose 6% over the same period after having decelerated in the final three months of 2003. The overheating of the Chinese economy is very much a by-product of the interplay between excessive bank lending and runaway investment spending. These are the sources of the problem that the Chinese leadership is now prepared to attack head-on.
That attack is now under way. The campaign of policy restraint was initiated last fall, with an increase in reserve requirements on bank deposits from 6% to 7% — announced in late August and made effective in late September. That measure apparently didn’t work in arresting the rapid growth of the real economy. And so Premier Wen was quite direct in warning at the recently concluded China Development Forum that I attended in Beijing that further forceful measures were being prepared (see my March 23 note referenced above). True to his word, the People’s Bank of China unveiled a second tightening in late March (see the March 25 dispatch by our China team, “The Second Tightening Move”). This underscored the increasingly urgent conundrum now evident in China. A failure to arrest the excesses of an increasingly overheated economy is a recipe for the dreaded hard landing. Quite simply, China cannot afford such a dire outcome. It would have serious implications for unemployment and nonperforming bank loans, thereby undermining the very reforms that are at the heart of the China miracle. The verdict, in my view, is clear: The Chinese leadership now senses a new urgency in bringing its economy under control. In my opinion, the late March monetary tightening measures should be viewed as a warning sign of more such initiatives to come.
Asia and the rest of the global economy need to take notice of what is about to happen in China. Yet in my travels in the region over the past couple of weeks, I don’t sense that realization has hit home. Japan is a case in point. As the latest Tankan survey of business confidence revealed, Corporate Japan is now brimming over with newfound optimism (see the April 1 dispatch by Takehiro Sato, “Tankan — An Effective Post-Bubble High”). But the impact of the China factor on Japan cannot be taken lightly. In the second half of 2003, our Japan team estimates that surging exports to China accounted for approximately 30% of the 4.5% annualized increase in Japanese GDP. Moreover, it appears that capital spending — another solid source of increasing growth in the Japanese economy — drew considerable support from capacity expansion by those industries that were befitting the most from expanded trade to China. As China transitions from boom to slowdown, a surprisingly large portion of Japan’s newfound growth dynamic could be at risk. With private consumption growth still hovering at 1%, that could prove to be a serious problem for the Japan recovery story. I would echo those concerns for Korea, where the private consumption dynamic is even weaker and the China factor may even be more important (see my March 26 dispatch, “Asia’s Recovery Void”). Nor would Taiwan, where China trade linkages are greatest, be spared.
India looks increasingly to be Asia’s “special case” — an economy that seems likely to emerge largely unscathed in a China-adjustment scenario. In large part, that’s because the Indian economy has a very different mix than the typical externally-oriented Asian economy. India’s growth dynamic is increasingly tilted toward an IT-enabled emergence of its service sector (see my April 2 dispatch, “India’s Awakening”). While this new portion of the Indian economy is very much externally oriented, it is more beholden to US-based outsourcing imperatives than to the ups and downs of the Chinese economy. Barring a politically-motivated protectionist disruption to such a trend — still a low-probability outcome, in my view — I see very little getting in the way of India’s increasingly powerful growth dynamic.
India’s just-related 4Q03 growth report — a 10.4% y-o-y surge in real GDP — underscores this extraordinary story. While this increase was artificially boosted by an unsustainable, 16.9% drought-related rebound in agricultural output, India’s new underlying growth trajectory now appears to be settling in the 7% zone. Rich in natural resources and with nothing but upside on the infrastructure and domestic energy production fronts, India looks to me to be one of the most compelling macro stories I have seen in a long time. The upcoming national elections are an important test of the new Indian economy, especially insofar as the risk of any potential setbacks on the road to deregulation and reform are concerned. But the inside line in India is that the incumbent BJP ruling coalition will prevail — good news for the continuity of reform.
Five years after the end of the Asian financial crisis, the region is very different. Current-account balances have gone from deficit to surplus, foreign-exchange reserves have been rebuilt, and dependence on short-term capital inflows has been sharply diminished. But the region is still lacking in autonomous support from internal demand. China has emerged as the unquestioned engine of pan-regional growth, but now the Chinese economy is in need of a major adjustment of its own. With the exception of India, most Asian economies are vulnerable to such an about-face. As I ponder the lessons of these past two weeks in Asia, that troubles me the most.
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