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Economic Research:
Asia-Pacific's Growth Continues To Slow Along With China But Japan Looks Ready To Blossom
Credit Market Services: Paul F Gruenwald, Asia-Pacific Chief Economist, Singapore (65) 6216 1084; paul.gruenwald@standardandpoors.com Vincent R Conti, Asia-Pacific Economist, Singapore (65) 6216 1188; vincent.conti@standardandpoors.com
Table Of Contents
Slower Growth, Interest Rate Volatility: What's Happening To China? Japan: Asia's Bright Spot (No, That Is Not A Misprint) The Rest Of The "Trillion Dollar Club": Varying Shades Of Negative ASEAN Is Still Outperforming As The Philippines Takes The Lead Newly Industrialized Economies: Slow Growth But A Stronger Upside
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Economic Research:
Asia-Pacific's Growth Continues To Slow Along With China But Japan Looks Ready To Blossom
We are past the halfway mark of a year in which Asia-Pacific's growth has continued to decelerate. GDP for the region expanded 5% year on year in the first quarter, compared with 5.6% in the fourth quarter of 2012. Production and trade remained soft in the second quarter. China has slowed in both quarters, due largely to waning private and public investments. Emerging Asian economies fared slightly worse, with 6% first-quarter growth, down 0.7 percentage point from the final quarter of 2012. The more domestically oriented economies in the Association of Southeast Asian Nations (ASEAN) continued their trend after the global financial crisis by outperforming the trade-dependent Newly Industrialized Economies of Hong Kong, Korea, Singapore, and Taiwan. Japan leaped into the spotlight, with indications that the economy's initial reaction to "Abenomics" has been positive. Overview Asia-Pacific's growth continued slowing through mid-2013, led by a declining pace of investment in China and weak global trade. Japan has been the bright spot. We have lowered our growth forecast for Asia-Pacific by 0.2 percentage point in 2013 to 5.3% and by 0.4 percentage point in 2014 to 5.6%, with larger reductions for Emerging Asia. China's growth forecast is down 0.6 percentage point to 7.3%. We have also cut our forecasts for Australia and Taiwan, given their close links to China. In our view, the risks to regional growth remain skewed to the downside, but are now more balanced than our previous assessment because we have significantly lowered our China growth forecast. Most policymakers refrained from taking major measures to support their economies, preferring instead to lower growth expectations and focus on financial stability. The exceptions are India and Indonesia, where current account deficits and weakening currencies have resulted in tighter monetary policies.
We forecast a modest growth pickup in Asia-Pacific, stemming from an expected rebound in the U.S. economy later this year and in 2014. But economic activity in most of the region remains below trend, thanks mostly to Europe's growth being flat at best; Europe was Asia's biggest trading partner before the global financial crisis. The effect of slower demand from outside Asia-Pacific on growth in the region is amplified by a weaker expansion in China as the Xi Jinping and Li Keqing government appears to place more importance on financial stability than on achieving faster growth. The risks to our forecast for the region remain mostly external and tilted toward the downside. Slower growth in advanced countries from either a weaker-than-expected U.S. recovery or a further decline in Europe would hit Asia's smaller, more trade-dependent economies hardest. The other main external risk facing the region is bouts of risk aversion in global markets, which would hit the countries with current account deficits (India and Indonesia) hardest. Within the region, China has rising internal risks in its financial sector, although they appear to be contained.
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Economic Research: Asia-Pacific's Growth Continues To Slow Along With China But Japan Looks Ready To Blossom
Table 1
GDP Growth In Asia-Pacific, Emerging Asia, China, India, ASEAN, And Newly Industrialized Economies
Baseline (%) Asia-Pacific Emerging Asia Newly industrialized economies ASEAN 2013f 5.3 6.1 2.7 5.5 2014f 5.6 6.5 4.0 5.6 2015f 5.5 6.5 4.3 5.4 2013e 4.7 5.4 2.0 4.6 Downside 2014e 4.8 5.6 2.5 4.4 2015e 5.5 6.5 4.1 5.6 2013e 5.7 6.5 3.0 6.0 Upside 2014e 6.1 7.1 4.5 6.3 2015e 5.9 6.8 4.3 5.5
f--forecasts. e--estimates. Regional aggregates are calculated as a weighted average using 2012 GDP measured in purchasing-power-parity terms. Newly industrialized economies: Hong Kong, Korea, Singapore, and Taiwan.
Slower Growth, Interest Rate Volatility: What's Happening To China?

The Chinese economy continues to decelerate, with growth at or below the authorities' official target of 7.5%. Unlike most of the region, China has released second-quarter data, and its growth retreated further to 7.5% year-on-year. The slowdown has been almost entirely investment-led. The picture is worse if we look at the quarter-on-quarter seasonally adjusted growth rate, which was just 1.7% in the second quarter--broadly unchanged from the first quarter. Using this less backward-looking measure, Chinese growth appears to be trending at about 7% on an annualized basis in the first half of the year, significantly below the government's target. Unless sequential growth climbs in the second half, the country will miss its annual target.
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Chart 1
Nevertheless, the Chinese government seems quite comfortable with current economic performance. No major fiscal or monetary stimulus plans are being discussed, at least not publicly. Where, then, is the pain threshold for growth? Standard & Poor's view is that if China's growth pointed significantly below 7%, it would spur a policy response. An important reason for the higher pain threshold appears to be the health of the labor market, where wages continue to increase at double digits. In the past, 7%-8% minimum GDP growth was generally seen as necessary to absorb the labor released from the agricultural sector, if wages remain flat. In addition to slower GDP growth, interest rate volatility and fears of a credit crunch have added to worries over financial sector stability following fast credit growth in recent years. Interest rates in the interbank market unexpectedly spiked in June, rising well into the double digits from their usual 3%-4% range. Although Standard & Poor's view is that the rate spike in June was a short-term liquidity issue, the market was surprised that the People's Bank of China allowed this to happen and that led to some dislocation (see "Credit FAQ: Top-10 Investor Questions On The Chinese Interbank Market And Financial Stability," published July 4, 2013, on RatingsDirect). The real issue ahead is how China will cope with a potentially large amount of latent bad loans from the previous lending boom as well as the explosive growth of off-balance-sheet activity and nonbank lending in the system.
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How do we explain the new economic landscape in China with slower growth and more volatile rates? Have there been policy mistakes? Are the authorities behind the curve? Are they losing control? Our view is that the policy responses on the economic and the financial front have been intentional, although not always well articulated. In our view, the Chinese government has the "policy space" to achieve higher growth through fiscal spending and keep a tight lid on interest rate volatility. But it has chosen to act minimally so far. We believe the new administration of President Xi Jinping and Premier Li Keqing has a good understanding of the trade-offs between higher growth and financial stability. Having state banks lend to state enterprises to accelerate investment in the Five-Year Plan may be good for generating short-term growth, but it could lead to higher nonperforming loans. With the financial sector still digesting the 2008-2009 lending boom, the government appears to prefer stabilizing the financial sector over spurring growth. We have therefore lowered our full-year GDP growth forecast for China to 7.3%, implying only a moderate pickup in economic activity in the second half, in line with our U.S. and global view. Unlike our previous forecast, which saw Chinese growth rebounding sharply to 8% and above, we project growth broadly flat at about 7.25% through 2015.
Japan: Asia's Bright Spot (No, That Is Not A Misprint)

In contrast to China, Japan has become Asia's bright spot. Growth in the first quarter rose 1.0% from the fourth quarter of 2012 (or 4.1% annualized). That was well above the consensus estimate, and rising domestic demand led the expansion. This trend continued in the second quarter with industrial production, retail trade, housing starts, capital expenditure, and Tankan survey of business sentiment numbers all coming in above expectations.
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Chart 2
These are still early days, but the economy's initial response to Prime Minister Shinzo Abe's policies (often referred to as Abenomics) seems positive. We have therefore raised our GDP growth forecast for Japan to 1.6% this year and next, compared with our previous forecasts of 0.6% in 2013 and 2.0% in 2014. However, this flat annual pattern masks a rise in the quarterly year-on-year growth rate to approximately 3% by the end of this year before stabilizing at about 1.25% through 2015. Standard & Poor's does not expect inflation to rise to the Bank of Japan's 2% target in our baseline scenario because of uncertainties over the pace of monetary policy implementation and the effects on spending when the government raises the consumption tax to 10% in October 2015 from 5% currently. We assume the hike will take place as scheduled (see "Economic Research: Reflecting On A Week In Japan," published June 25, 2013). However, our upside scenario assumes the Bank of Japan generates 2% inflation. Our downside scenario has growth and inflation reverting to levels before Mr. Abe took office. Overall, we believe the risks to our forecasts on Japan are broadly balanced around our baseline scenario. The relatively weak yen is a risk factor for the rest of the region. However, as we argued in a recent report, the net effect on most Asian economies will likely be positive (see "Is A Weak Japanese Yen A Problem For The Rest of Asia?" published June 6, 2013). Nevertheless, Japan's competitiveness versus Korea, Taiwan, and China would need to be
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re-evaluated if the yen depreciates sharply again.
The Rest Of The "Trillion Dollar Club": Varying Shades Of Negative

Asia-Pacific's three other major economies with GDP of over a trillion U.S. dollars--India, Australia, and Korea--all face different near-term difficulties. India is Asia's most prominent deficit country with a current account deficit of about 4% of GDP and a sizable fiscal deficit (see "India's Current Account Gap: Narrowing But There's Still Some Way To Go," published April 22, 2013). In light of turbulence and risk aversion in global capital markets following the U.S. Federal Reserve's "tapering" announcement in May 2013, India has faced recurring pressure on its balance of payments, and the rupee weakened to all-time lows of approximately 60 per U.S. dollar. Moreover, the country's growth momentum remains weak, with slow mining and manufacturing growth as well as tepid consumption and exports. Importantly, the Reserve Bank of India is unlikely to cut interest rates further during the rest of the fiscal year, after the recent liquidity tightening aimed at supporting the currency. We have lowered our GDP growth forecast by about 0.5 percentage point to 5.5% this fiscal year (ending March 2014) and 6.5% in 2014, with greater risks on the downside than upside. Among Asia-Pacific economies, Australia takes the hardest hit from a Chinese investment-led slowdown. Australia is the largest supplier of iron ore to China, which is Australia's largest trading partner. Moreover, Australia's large and persistent current account deficit becomes more difficult to finance during global market turbulence, including periods of market volatility caused by uncertainties regarding China's growth decline. Although a weaker Australian dollar is clearly helping, the economy is still struggling to rotate investment toward the non-mining sectors. Therefore, we have lowered our Australian growth forecast to 2.5% this year from 2.9% previously, and approximately 3% in 2014 and 2015. As with China, Australia has greater risks on the downside than upside.
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Chart 3
Korea's softer growth recently is more because of a slowdown in advanced countries and flat global trade flows, even though trade links with China have grown quickly. As a major producer of durable goods and electronics, Korea looks better positioned than India and Australia to benefit from a rebound in U.S. growth. These goods have higher added value and are typically associated with discretionary spending. We therefore forecast Korea's GDP growth to accelerate to about 4% next year from 2.5% this year. As mentioned earlier, if the yen weakens significantly further, it poses a risk for Korea's competitiveness, although we do not view this as a major issue at current levels.
ASEAN Is Still Outperforming As The Philippines Takes The Lead

The major ASEAN economies we cover (Indonesia, Malaysia, Philippines, Thailand, and Vietnam) continue to outperform. These economies are more domestically focused than the Newly Industrialized Economies and therefore tend to do better when global growth is sluggish. We expect growth for ASEAN as a whole to remain steady at about 5.5% through 2015 in our baseline scenario. The Philippines, which Standard & Poor's recently upgraded to investment grade, has taken over the ASEAN growth leadership role from Indonesia. We project Philippine GDP to expand by almost 7% this year, moderating to 6%-6.5% in 2014 and 2015.
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Indonesia's growth momentum remains strong, but financing the resulting current account deficit has become increasingly difficult. Bank Indonesia raised the policy rate by 75 basis points over the past few months to contain inflation expectations after the fuel subsidy cut. The central bank's rate increase can also help support the rupiah and ease domestic demand to improve the current account deficit. Thailand lags in this group as it is relatively more trade-dependent. Malaysia is also relatively open, but strong private and public investments, including infrastructure spending, are supporting overall growth. Lastly, Vietnam's growth has fallen significantly below potential, as the economy struggles with the stock of nonperforming loans and slow credit growth. The risks to growth within the ASEAN group are tilted modestly to the downside, but in a tighter range than the NIEs.
Chart 4
Newly Industrialized Economies: Slow Growth But A Stronger Upside

The more open and trade-dependent newly industrialized economies (Hong Kong, Korea, Singapore, and Taiwan) continue to lag the region in growth. In addition to being open economies, Hong Kong and Taiwan depend heavily on trade with mainland China, and that pulls down further their near-term prospects. We forecast GDP growth in this
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group at 2.7% this year, only half the pace of ASEAN growth, before climbing to 4% and above in 2014 and 2015. The good news for these four economies is their positive risk profile. The goods they export typically have high added value. That puts them in a position to benefit significantly from a pickup in discretionary demand in the advanced economies, particularly the U.S. Overall, risks to Asia-Pacific growth remain skewed to the downside. A slowdown in China will have a ripple effect on Australia and other economies that export heavily to China. Two important risk factors are the pace of Chinese investment and real GDP growth, and the strength of the U.S. economic recovery.
Table 2
Asia-Pacific Economic Forecasts

Real GDP, July 2013 Baseline (%) Australia China India* Japan South Korea Hong Kong Indonesia Malaysia Philippines Singapore Taiwan Thailand Vietnam New Zealand Asia-Pacific Emerging Asia Newly industrialized economies ASEAN 2013f 2.5 7.3 5.5 1.6 2.5 2.7 6.1 5.3 6.9 3.2 2.8 3.9 5.3 2.5 5.3 6.1 2.7 5.5 2014f 2.9 7.3 6.5 1.6 3.9 3.6 6.2 5.6 6.1 3.8 4.3 4.1 5.5 3.1 5.6 6.5 4.0 5.6 2015f 3.1 7.1 7 1.2 4.7 4.2 6.2 4.7 6.5 3.6 3.8 3.6 6 2.8 5.5 6.5 4.3 5.4 2013e 2.3 6.8 4.5 1.3 2.1 1.7 5.5 4.5 6.1 2.1 1.9 2.3 4.5 1.8 4.7 5.4 2.0 4.6 Downside 2014e 2.1 6.8 5.5 1 2.9 1.3 5 4.7 5.1 2.5 2.4 2.5 4.6 2 4.8 5.6 2.5 4.4 2015e 2.7 7.7 5.7 0.8 4.6 2.6 6.3 5.6 6.9 4.1 3.9 4 4.8 2.4 5.5 6.5 4.1 5.6 2013e 2.6 7.6 6.5 1.7 2.8 3 6.4 5.7 7.2 3.5 3 4.4 6.3 2.9 5.7 6.5 3.0 6.0 Upside 2014e 3.3 7.9 7 2 4.5 4.4 6.7 6.3 6.5 4.2 4.8 5.2 6.5 3.5 6.1 7.1 4.5 6.3 2015e 3.5 7.5 7.6 1.4 4.7 4.3 6 4.8 6.5 3.5 4 3.6 6.9 2.9 5.9 6.8 4.3 5.5
*Fiscal year ending March. f--forecasts. e--estimates. Regional aggregates are calculated as a weighted average using 2012 GDP measured in purchasing-power-parity terms. Newly industrialized economies: Hong Kong, Korea, Singapore, and Taiwan.
Table 3
Inflation Forecasts For Asia-Pacific

Baseline (%) Australia China India* Japan South Korea 2013f 2.4 2.5 5.3 0.3 1.4 2014f 2.4 3.2 6 1.5 2.7 2015f 2.5 3.4 6 1.6 2.7 2013e 2.2 2.2 4.5 0.2 1.3 Downside 2014e 2.1 2.2 5 0.9 2.2 2015e 2.2 3.3 5 1 2.6 2013e 2.4 2.7 6.5 0.4 1.5 Upside 2014e 2.6 4 7 2 3.1 2015e 2.7 3.6 7.5 2.1 2.8
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Table 3
Inflation Forecasts For Asia-Pacific (cont.)

Hong Kong Indonesia Malaysia Philippines Singapore Taiwan Thailand Vietnam New Zealand 4.3 6.7 2 3.1 2.1 1.1 2.5 6.4 1.1 3.3 5.5 2.3 3.7 2.4 1.6 3.1 6.7 2 3.6 4.3 2 3.6 2.7 1.6 2.9 6.8 2 4.1 6.6 1.8 3 1.8 0.9 2.2 6.3 0.9 2.6 5 1.7 3.2 1.2 0.8 2.4 6.2 1.3 3.4 4.2 2 3.5 2.6 1.5 2.8 6.3 1.8 4.4 6.7 2 3.2 2.2 1.1 2.5 6.4 1.2 3.6 5.7 2.6 3.9 3 1.9 3.7 6.8 2.7 3.7 4.3 2.1 3.7 2.8 1.7 3 6.9 2.5
* Fiscal year ending March; Wholesale Price Index rather than Consumer Price Index. f--forecasts. e--estimates.
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Economic Research:

Slower Growth, Interest Rate Volatility: What's Happening To China?

Japan: Asia's Bright Spot (No, That Is Not A Misprint)

re-evaluated if the yen depreciates sharply again.

The Rest Of The "Trillion Dollar Club": Varying Shades Of Negative

ASEAN Is Still Outperforming As The Philippines Takes The Lead

Newly Industrialized Economies: Slow Growth But A Stronger Upside

Asia-Pacific Economic Forecasts

Inflation Forecasts For Asia-Pacific

Inflation Forecasts For Asia-Pacific (cont.)

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