Global: Asia's Recovery Void
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Stephen Roach (from Tokyo)
Morgan Stanley
Mar 26, 2004
There are two Asias these days — China and everyone else. China remains an overheated production story, in my view. And the rest of Asia remains very much an external demand story — driven in large part by the Chinese producer and the over-extended American consumer. If China slows, as I now suspect, Asia’s nascent economic recovery could be in serious trouble. That remains a key risk in the second half of 2004, in my view.
As I tour Asia, I find a much more fragile optimism than I had expected. That’s because it turns out that there is really no compelling internal demand story anywhere in the region. The region, in fact, is overly dependent on two major forces — a fragile external climate or unsustainable investment booms. Lacking in support from private consumption, Asia has yet to find to a recipe for sustainable economic recovery.
Japan is a case in point. Talk of long-awaited recovery is in the air out here in Tokyo. There’s even hope that deflation may at long last be coming to an end. Admittedly, this is the third attempt at economic recovery following the bursting of the bubble in 1990. However, while the first two efforts ended in tears — namely the upturns from October 1993 to May 1997 and the shorter rebound from January 1999 to October 2000 — this one feels different. While deflation has not slackened as measured by the GDP deflator, there has been a moderation of the rate of price decline as seen through the lens of the core CPI, which is now falling at “only” a -0.3% to -0.4% rate. With a surprisingly vigorous rebound in real GDP growth — now estimated by our Japan team at 3.7% in CY04 — resulting in a swifter-than-expected narrowing of the “output gap,” there is hope that the positive inflation is achievable by the end of 2005. Those hopes have been reinforced by the aggressive quantitative easing implemented by the new regime at the Bank of Japan under the leadership of Governor Toshihiko Fukui.
As always, the devil lurks in the detail. The latest revival in the Japanese economy is largely an external demand and investment story, lacking in any meaningful support from private consumption. On the heels of increasingly powerful trade linkages to China, the external sector accounted for an estimated 26% of Japan’s estimated 2.7% revival in real GDP in CY03. Our Japan team estimates this contribution will hold at about 24% of the 3.7% increase in GDP they are currently forecasting for CY04. Surging exports to China are obviously driving this dynamic. IMF data indicate that China accounted for fully 32% of Japan’s total export growth over the 12 months of 2003 (as measured in US dollar-based translations). Moreover, our Japan team makes the back-of-the envelope calculation that exports to China accounted for about 30% of Japan’s 4.5% annualized surge in real GDP growth in the second half of CY03. Nor is there any let-up in sight in early 2004. With Japan’s trade balance with China moving into surplus for the first time since early 1994, the overall Japanese trade surplus was just reported to have surged 51.7% y-o-y in February. Suddenly, the tables have been turned in Asia. Japan — long the engine of pan-regional growth — is now drawing support from Asia’s new engine of growth, China.
Yes, there is more to Japan’s nascent recovery than a China-led upturn. A vigorous rebound in business fixed investment has also played an important role, with capital spending rising at an estimated 9.5% average annual rate over the 2003–04 period, according to our latest estimates. For an economy that remains in deflation, I find this difficult to fathom. With the aggregate price level still falling — symptomatic of a lingering overhang of aggregate supply — why would Corporate Japan suddenly be adding to the economy’s supply curve? The Japanese I have met with cite three sources to the current capex rebound — capacity additions in export industries (i.e., a “China factor” hard at work here, as well), the replacement cycle, and the impetus from a long overdue IT-catch-up. I’m not convinced.
Meanwhile, the Japanese economy has failed to convert this upsurge in autonomous demand — exports and capital spending — into support from the internal demand of personal consumption. Notwithstanding the just-reported February surge in Japanese retail sales — a 1.7% monthly gain relative to January — our Japan team puts private consumption growth at just 1.4%, on average, over the 2003–04 interval; that’s less than half the 3.2% pace of real GDP growth over this same period. Therein lies the conundrum for the case for sustainable recovery in the Japanese economy: Without the consumer, revival remains all too dependent on tenuous support from China and capex. (Note: Takehiro Sato of our Japan team has discovered that the February sales data have been statistically distorted by the failure of the government to make an adjustment for the leap year; this bias will be corrected by a likely sharp downward revision on April 14).
It’s not any better in Korea, barely behind India as the third-largest economy in Asia ex Japan. In my visit to Seoul earlier this week, I found that conviction levels on sustainable recovery fell well short of the 3.1% increase in real GDP growth that was just printed for 2003. That’s not surprising, since fully 90% of that increase came from the external sector, with domestic demand having risen by just 0.1% for the year as a whole. The mix of Korean domestic demand was even more disturbing, with such growth entirely accounted for by 3.6% average gains in government consumption and fixed investment. By contrast, reflecting the unwinding of the Korean credit bubble, private consumption fell by 1.4% in 2003 — yet another example of an Asian consumer that is all but missing in action. Meanwhile, Korea was also heavily dependent on the China-led boost to external demand; by our calculations, China accounted for fully 36% of Korea’s total export growth in 2003 — even larger than the China-led impetus evident in Japan.
As I made the rounds in Tokyo and Seoul, there was considerable interest in the “China slowdown” message that I brought from my five-day visit in Beijing (see my March 24 dispatch, “China — Determined to Slow “). It was clear to me after extensive discussions with senior Chinese officials that actions were being prepared that would be aimed at slowing the excessive growth at what has been judged to be an overheated economy. The ink was barely dry on my latest piece when the People’s Bank of China (PBOC) unveiled a series of tightening measures aimed explicitly at tempering the excesses of bank lending and fixed investment (the March 25 dispatch by our Greater China team, “The Second Tightening Move”). I view these actions as but a warning shot. There is great concern in Beijing about the mounting imbalances stemming from excessive growth in the Chinese economy. Not only are the risks of bottlenecks rising, but there are also worrisome indications of mounting inequalities in the income distribution — warning signs that the Chinese leadership always take seriously.
China also suffers from the Asian disease of favoring investment over consumption. But in this case, the potential imbalances dwarf those evident in Japan and Korea. Fixed investment surged to an estimated 45% of GDP in 2003, up more than ten percentage points alone since 1998. As Andy Xie notes, if current trends continue, the investment share could exceed 50% of GDP within a couple of years (see his March 22 dispatch, “China: Focus on Sustainability”). The mirror image of this trend is a saving-focused Chinese consumer; Andy notes that China’s household saving deposits increased by 19.2% in 2003; that took such saving above 90% of GDP in February 2004 — an astonishing surge from the 60% share prevailing as recently as 1997.
With high consumer saving rates fueling excess investment spending, macro imbalances in the Chinese economy can only get worse if current trends persist. The latest data flow on the Chinese economy only heightens concerns in this regard — total fixed investment surged at a 53% y-o-y rate in the first two months of 2004. Little wonder that Beijing is now focused on slowing an overheated Chinese economy. I continue to believe that China will be successful in achieving a soft landing in 2004. While I was in Beijing, the leadership reiterated its convictions to take forceful actions to hit a more sustainable 7% growth target for this year. On the surface, this doesn’t seem like much of a downshift from the 9.1% gain recorded in 2003. But most concede that China’s official growth figures were seriously understated last year, with actual GDP growth probably at least 12%. As such, a slowdown to 7% would mark a much more abrupt downshift than the official data might otherwise indicate.
In my years as a China watcher, I have learned to take the message from Beijing very seriously. In this command economy, rhetoric and the administrative actions that accompany such talk count for much more than the adjustments of the conventional fiscal and monetary policy instruments that we tend to focus on in the West. That’s why I believe that the PBOC’s latest moves are but the first step in the China slowdown campaign. And that brings the story full circle to a now China-centric Asian economy. As I travel throughout the region, there is only talk of China. Asia knows full well what’s at stake if China slows. Lacking in autonomous consumer demand and having only just discovered the power of the Chinese growth engine, there is now good reason to question the staying power of Asia’s latest economic revival. China needs to slow, and slow it will. But for the rest of Asia, that leaves a growth void that could well pose the biggest problem of all.
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