Theory buckles as slowdown strikes

The global downturn hit the decoupling theory as Asia\'s stockmarket plunged and exports slowed. But although even the most robust economies in the region will be affected, the outlook remains positive.


Not so long ago, there was hopeful talk in Asia that the region was capable of withstanding the global economic slowdown relatively well. But, as that slowdown bites ever deeper, the mood has changed in just a few months. The big concern is trying to figure out exactly how badly Asia will fare in 2009, as the fallout from the global financial crisis takes its toll the world over.

Stockmarket investors have already given their verdict, and they do not like what they see. The MSCI Asia-Pacific index fell 45% between the start of the year and November 10 – worse than the 42.5% fall in the World index. China and India, the one-time darlings of investors in emerging markets, fell 58% and 63% respectively over the same period.

Exports – a crucial contributor to Asian growth – are expected to slow next year, as are consumption and investment. Capital Economics, a consultancy, forecasts 5% GDP growth in Asia ex-Japan in 2009, the worst performance since the 1997-8 Asian financial crisis. And down sharply from 7.5% in 2008.

“So much for decoupling. With the world headed for its worst recession since the 1930s, even the most resilient economies in the region will slow,” says Alvin Pontoh, an analyst at Capital Economics.

“The most affected will be those with a high dependency on trade, such as Singapore. The region as a whole will continue to be weighed by the stress in global financial markets, as seen from the plunge in stockmarkets in October and continued downward pressure on currencies,” he adds.

Asian governments have taken steps to address the changed economic environment, including interest rate cuts and substantial fiscal stimulus packages. China, for instance, announced a two-year $586 billion (GBP 392 billion) stimulus package in November to be spent on items such as housing and infrastructure.

The reaction to the move was initially upbeat, including a brief stockmarket rally. Dominique Strauss-Kahn, the managing director of the International Monetary Fund (IMF), described the Chinese package as “huge”.

“It will have an influence not only on the world economy in supporting demand but also a lot of influence on the Chinese economy itself. And I think it is good news for correcting imbalances,” he was quoted as saying.

But as time passed, the initial enthusiasm waned. Questions were raised about how much of the stimulus package represented new money, or simply repackaged previously announced spending commitments. Fears grew too that China’s move would by itself be unable to rescue the global economy from a beating in 2009.

The IMF forecasts economic growth in China of about 9.3% in 2009, down from 9.7% in 2008 and nearly 12% in 2007. It sees GDP growth in India tumbling to 6.9% in 2009, from 7.9% in 2008 and 9.3% the previous year.

“The past few weeks of financial market developments have significantly increased the downside risks to our 2009 growth outlook [in Asia ex-Japan],” says Chetan Ahya, an economist at Morgan Stanley. “A high level of trade and financial integration in the region has meant a quick emergence of a vicious feedback loop.”

He lists four key risks: collapsing demand for Asian exports, a sharp slowdown in capital inflows and rise in the cost of capital, a currency shock, and the risk of increased financial instability.

“Many countries in the region have built large production capacities to feed global export demand,” he says. “A sharp slowdown in exports can cause a major dislocation in the balance sheets of regional companies. Corporate investment demand will be hit significantly, in our view.”

Ahya also points out that Asia suffered portfolio equity outflows of more than $24 billion between year start and early November. Foreign direct investment had begun to drop significantly, and external debt funding had reached a standstill, he adds.

The IMF said, in its World Economic Outlook report that – in retrospect – “the economic cycle in emerging Asia started to turn in early 2008, and more weakness is expected ahead in response to slowing demand from advanced economies and growing strains in regional financial markets.”

The IMF said that weaker external demand would hit Asian exports and that investment would also “moderate” because of the precarious export outlook. “Consumption will ease because of still-high fuel and food prices, although subsidies, which are common in the region, may cushion the impact on purchasing power. The risks to the outlook are firmly to the downside,” it added.

However, there have been some cheerier developments in the Asian economy over recent weeks, though not many. Regional inflation, in particular, looks to have peaked following the slide in commodity prices. This gives Asian governments more scope to pursue pro-growth economic policies. It is also worth remembering that Asia still has substantial foreign exchange reserves to call on.

Indeed, some fund managers remain optimistic that Asia’s long-term potential remains intact. But, while that may be the case for the region’s economy, it has become a more difficult claim to make about Asia’s stockmarket – at least based on performance. Following the recent rout, the MSCI Asia-Pacific index is down about 14% over the past two decades, whereas the World index is up 136% (see graph).

Consequently, investors are more circumspect and keen for some stability to return to the global financial markets in the near term. “Once the current capitulation phase is over, we can look forward to a period of greater stability, albeit in an environment of more pedestrian global growth,” says Adaline Ko, manager of the Lloyd George Eastern Opportunities fund.