This Roach article is important to my Great Reflux scenario, so I'm going to highlight some of it. I also noticed that China raised margin requirements on copper. In my view that's just a form of rationing.
Global: Asia?s Own Agenda
Stephen Roach (New York)
I spend a lot of my time these days in Asia. I am currently between trips to the Far East — having just returned from Hong Kong and India a couple of weeks ago and getting ready to go back out to Singapore, Japan, and China in early November. My fixation on Asia reflects my view that this region is now where the action is. Most things we buy these days are made in Asia. Most of the incremental funding of the West’s excess spending is also provided by Asia. Yet signs are increasingly evident that this symbiotic relationship could be changing. Asia is now paying greater attention to its own agenda — a refocusing that could have profound implications for the global economy.
A story in the weekend Financial Times (October 16/17, 2004) contained a fascinating glimpse of this shift in Asian thinking. The headline said it all: “India to dip into forex reserves for domestic infrastructure upgrades.” As I noted recently, India’s infrastructure gap is staggering — it represents a very serious constraint on any manufacturing-led development strategy (see my October 4 essay, “From Mumbai to Pune”). The new Indian government is under intense pressure to follow the lead of China in modernizing its antiquated infrastructure of roads, port facilities, and power distribution. But unlike China, which is awash in domestic saving to fund such efforts, India faces the serious twin constraints of a private saving deficiency and a budget deficit problem. So it has turned to some creative financing in order to meet this urgent need: According to the FT story, India has elected to put some $10-15 billion of its nearly $120 billion in foreign exchange reserves to work in funding this effort.
India is not alone in following this approach. At the start of this year, China led the way in deploying some of its foreign exchange reserves for domestic purposes — in this instance, injecting $45 billion of capital into two of its largest policy banks, the Bank of China and the China Construction Bank. Here, as well, the Chinese were earmarking a portion of what at the time was $415 billion in official currency reserves to deal with a major national issue — the deadweight of nonperforming loans. This recapitalization was also aimed at facilitating the proposed public offerings for both of these banks.
The China and India efforts have a number of important characteristics in common: First, both initiatives commit about 10% of the total reservoir of currency reserves to domestic needs — leaving an ample remainder for currency defense and other potential financial backstop measures. Second, both initiatives are not direct transfers of reserves from central banks to the private sector. For India, the reserves are reported to be earmarked for the backing of a $10-15 billion bond issue that would go toward setting up a public infrastructure fund. In the case of China, a similar bookkeeping transfer has taken place — using reserves to fund a new oversight body (the Central Huijin Investment Co.) that will then supervise the purchase of equity stakes in the two policy banks.
But there’s another aspect of these initiatives that has profound implications for the rest of us — the growing inclination of Asian financiers to divert their financial resources away from funding America’s open-ended consumption binge. There’s no great secret as to the massive dollar overweight in Asia’s foreign exchange portfolio. As of year-end 2003, the BIS reported that Asia held about 62% of all official foreign exchange reserves; moreover, our calculations suggest that so far in 2004 Asia’s FX reserves have increased by nearly $350 billion, or another 20%. At the same time, BIS data reveal that about 70% of the $3 trillion in official foreign exchange reserves are held in the form of dollar-denominated assets. In other words, Asian central banks are leading the way in dollar buying — a strategy that is aimed at preventing their currencies from rising and thereby impeding the region’s export-led growth models. Asia’s official appetite for dollar-based assets also fills an important hole in America’s massive external funding gap — a 5.7% current account deficit that now requires financing to the tune of some $2.6 billion of capital inflows each business day of the year. Without such generous Asian financing, the dollar would undoubtedly fall, and US real interest rates would most assuredly rise — classic characteristics of the time-honored current account adjustment.
It’s on this latter point that the alarm went off when I read the account of India’s infrastructure funding plans. The Financial Times story also quoted an unnamed Indian official as saying, “We are subsidizing the American economy. These are scarce resources that can be put to better use.” That’s been the biggest risk all along, in my view — that Asia would recognize that it has a greater role to play than simply subsidizing excess US consumption in order to keep its export machine fully employed. India’s intentions, in conjunction with Chinese actions earlier this year, hint at a reordering of Asian priorities — away from providing the “vendor financing” of a saving-short US economy and toward focusing on its own domestic development imperatives. To the extent that this puts a crimp in America’s low-interest-rate regime that has been so central in driving the demand side of the global economy, so be it. Asia now seems increasingly emboldened to take that risk — especially in light of daunting needs of its own.
That very point was underscored by Montek Singh Ahluwalia, Deputy Chairman of India’s Planning Commission and one of the top advisors to India’s new Prime Minister. In the weekend FT article, he was quoted as leaving little doubt of the wisdom of using FX reserves to backstop an infrastructure fund. He suggested that since India’s FX reserves are probably too high anyway, the government should use a portion of these proceeds to take the lead in stimulating a broad-based attack on the Indian infrastructure gap. I spent some time with Montek Ahluwalia on my recent visit to India. He is tough-minded and pragmatic — and utterly determined to lead the way on new economic policies for the new government. His message should not be taken lightly. It has important implications for India, the US, and the broader global economy. On balance, China and India are basically on the same page: They are no longer committed to open-ended dollar buying in their foreign exchange reserve management operations. Given America’s massive current-account deficit, at the margin this shift is negative for the dollar and for US real interest rates.
Meanwhile, the China slowdown — Asia’s main event — appears to be gathering force. Import growth slowed to just 22% Y-o-Y September — down sharply from the 36% gain in August and a 40% surge for all of 2003. Excluding distortions centered around the Lunar New Year, this was the slowest import comparison since mid-2002. The moderation occurred even in spite of surging demand for foreign materials and oil; mainly at work were outright contractions in imports of foreign manufactured goods, hinting at the first signs of the long awaited slowdown in Chinese domestic demand. The latest data on Chinese auto sales reinforce this possibility; sales in September were down slightly from the year-earlier pace — a dramatic reversal from the 50% growth comparisons in early 2004. Car loans have been hit especially hard since the spring by the clampdown on bank lending that has been central to the Chinese “cooldown” campaign. At the same time, the Shanghai Futures Exchange has just raised margin requirements for copper trading, triggering a sharp sell-off in materials prices late last week. This is just the latest example of China’s efforts to micro-manage the slowdown of its overheated economy.
Nor have the impacts of the China slowdown been lost on its trading partners. As I noted recently, export-led growth in Korea, Japan, and Germany — all heavily dependent on Chinese import demand — has slowed markedly in recent months (see my 8 October dispatch, “Canary in the Coal Mine”). In 2003, about 45% of the total growth in Japanese and Korean exports was traceable to surging exports to China; for Germany, the figure was 28%. Lacking in sustainable domestic demand and without another major trading partner to fill the void left by China, these three countries seem likely to see economic growth slip as the slowdown in the Chinese economy gains force. China’s sharp recent falloff in import growth, in conjunction with emerging export-led weakness of its major trading partners, confirms the global impacts of the China slowdown.
Asia is on the leading edge of many of the changes affecting the global economy and world financial markets. Yet the risk is that we take much of the Asian impact for granted in looking to the future. If Asia begins to rethink its forex reserve management practices, interest rates — and the interest-rate-led underpinnings — of the US economy could be seriously affected. At the same time, the China slowdown promises to have equally profound effects on the trade and commodity market linkages that now bind China to the rest of the world. As Asia progresses down the road of economic development, there will be greater urgency for it to tend to its own agenda. That day is now starting to come into clearer focus.
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