NS4053Winter 2014 Asia Assessment and Scenarios
Outline • Current World Economic Situation • Overview, Patterns of Recovery, and Forecasts • Major Themes Over the Next Several Years • Areas of Uncertainty • Eurozone - Continued Stagnation? • Emerging Economies – Slowdown Ahead? • Asia Overview • Recent Capital Outflows and Financial Stress • Economic Prospects • Areas of Risk • Key Issues • China’s Rebalancing • Implications of Global Trends for Defense Expenditures
Global Economy Overview I • Before the crisis the main feature of the global economy was its rapid integration – has continued at a slower pace since the crisis • Trade relative to GDP, capital flows relative to the global capital stock and so on are all rising • However, economic policies largely set at the national level to benefit domestic economy • These policies are increasingly affecting other economies • External effects particularly important in the financial sector due to potential for large and relatively abrupt changes in • Capital flows • Asset prices • Interest rates, exchange rates and • Credit availability.
Global Economy Overview II • The 2008-09 global economic crisis and its aftermath illustrate this new reality • Characterized by defective growth models in advanced economies based on excess credit and domestic aggregate demand • Complicated by structural flaws and limited adjustment mechanisms in Europe leading to • Instability • A crisis • Large negative shock to the real economy • Emerging economies were immediately affected by • Credit tightening (including trade finance) • Rapid declines in exports • Resulting in similar shocks there
Global Economy Overview III • This was followed by – extended version of the assisted growth model in the advanced countries • Unconventional monetary policy – United States • Lowered cost of credit for debtors and those seeking to borrow for business expansion • Came at the at expense of savers – lower interest rates • Did not work well because investment constrained by deficient domestic demand relative to capacity • Savers sought higher returns in emerging economies • Causing increases in credit and causing upward pressure on exchange rates and asset prices – responded with • Limits on capital inflows • Reserve accumulation and • Measures to restrict credit and restrain asset-price inflation
Global Economy Overview IV • Situation changed in May 2013 when U.S. Federal reserve indicated it might taper its purchase of long-term assets • Asset prices shifted and in emerging economies • Capital rushed out, • Caused credit markets to tighten and • Exchange rates to fall • At a minimum a short-term growth slowdown is nearly certain • The reversals may have longer term adverse effects – although not clear at this point • While China’s output is affected by advanced country economic performance – financial system largely isolated • Capital account less open, foreign currency reserves of $2.5 trillion mean exchange rate is controllable
Global Economy Overview V • Decentralized policy and growing externalities will result in a partial de-globalization • Not a good idea to run persistent current account deficits and become dependent on (temporarily) low-cost foreign capital • Open capital accounts may be replaced by rules-based constraints on financial capital flows • Lesson from crisis – substantial domestic ownership of banking sector is critical because multilateral resolution mechanisms in case of insolvency are largely non-existent • Pattern of accumulating reserves via current account surplus will be more pronounced in order to manage exchange rates • Public purchases of domestic assets to stabilize asset prices net capital flows will become increasingly common. • Successful countries will be those who learn to live with growing policy interdependency without much policy coordination
Today’s Global Themes • Growth Prospects Weak • DMs accelerating from 1.2% -- high debt, austerity • EM GDP decelerating below 5% • Private Sector deleveraging, lack of investment, financial sector undercapitalization • Long period of massive capital inflows into Ems (since 2003) slowing or even partially reversing • Tail Risks Remain (probabilities 10-30%) • Hard Landing in China • Disorderly events in EZ (more likely to be long stagnation) • Military conflict with Iran leading to oil supply shock (low but increasing in 2014 • Geopolitical Risks (North Korea, China-Japan, Egypt, Syria, Iraq
Eurozone Scenarios October 2013 • Base case (60%) • Muddle through in 2013 and beyond increasingly problematic as periphery governments under pressure to stop austerity/reform – incremental solutions found • Downside (30%) • Collapsing Italian government and doubts about ECB asset buying program • Member states fiscal and political resources further strained making future crises more difficult to resolve • Upside (10%) • Pro-reform governments are more resilient and world economy stronger • Progress towards true integration, banking union, common fiscal sharing inches forward
EMs Face Hurdles I • Not a “BRIC wall” but a range of factors at play – Weak financing, currency overvaluation or policy missteps will take toll on economic • Policy Induced Slowdown -- after some overheating, many EMS tightened monetary policy in 2011 • Lack of Full Decoupling – from slow-growing DMs (EZ, US) • State Capitalism – distorting economic activity absorbing resources leading to fall in potential growth • Fallout from Chinese Slowdown – China is negatively affecting growth across Ems (especially in South-East Asia, Latin America, metal exporters. • End of Commodities Super-cycle – many Ems affected – Brazil, Russia, South Africa in particular
EMs Face Hurdles II • Approaching end of US Federal Reserve QE and Easy Money – will slow if not reverse trillions of EM capital inflows • Increasing Frequency of Large Current Account Deficits –Many countries financing deficits in increasingly risky ways • Rising Political Risk in Many Ems – Busy electoral cycle in 2014 • Macro and Financial Fragilities in some Ems – handful of Ems have high and unsustainable debt rations that will require coercive debt restructurings, particularly if a sudden stop occurs. • The Risk of a Middle Income Trap – many Ems running out of easy sources of growth – have not laid a good foundation through improved governance for further growth
Asian Analysis • Asia Overview • Recent Capital Outflows and Financial Stress • Economic Prospects • Areas of Risk • Key Issues • China’s Rebalancing • Trans-Atlantic Partnership (TPP)
Asia 2013: Overview • 2013: Asia as along with other emerging regions has encountered a wave of capital outflows • Overall impact manageable – but some countries have been subject to greater stress • Tighter global credit and domestic impediments in some countries – will dampen growth • This may be offset by gradual pickup in exports to advanced countries and resilient domestic demand • However conditions tighten further likely to see greater variation across region • Those with strong fundamentals and policy credibility will be able to offset external developments • Others that have delayed reforms, left fiscal vulnerabilities, or tolerated too-high inflation may be forced to respond with policy tightening – austerity.
Asia: Recent Developments I • Since April, U.S. Federal Reserve tapering has ignited capital outflows from many emerging markets • Equity prices have fallen in some countries as well as exchange rates falling – Indonesia hard hit – to support currencies have had to increase interest rates and tighten credit thus slowing investment.
Asia: Recent Developments II • While the reversal of capital flows has reflected increasing yields and more attractive investment opportunities in advanced countries – • Weaker growth prospects throughout Asia and country-specific vulnerabilities have played a role • Causes of weaker growth throughout emerging Asia • Weak external demand from advanced countries and a slowdown in China dampened industrial activity in region • Domestic demand has also softened • At same time a broader structural shift is underway with increasing supply bottlenecks in India and declining returns to investment in China • As a result, potential growth in the major emerging Asian economies has declined steadily
Asia: Vulnerabilities • Abundant global liquidity over last half-decade covered up some vulnerabilities that are now exposed • India and Indonesia are now running large current account deficits and facing high inflation (including food prices) • Some Indonesian inflation reinforced by a subsidized fuel price increase • Other concerns • Large fiscal deficits in Malaysia • Strong credit growth in recent years – Thailand, the Philippines and ASEAN more broadly • Overly simulative macroeconomic policies --Lao P.D.R, Mongolia
Variation Across Asia Region I • Generalizations difficult with considerable growth differences across region in 2013 and into 2014 • China • China largely isolated from recent financial market volatilities • Continued measures to slow credit growth and the excesses of recent years should put economy on slower growth trajectory • Growth projected to decelerate to 7.6% in 2013 and 7.3% in 2014 • Excess capacity in a number of industries and stable food prices should mean inflation will remain under control
Variation Across Asia II • Japan • Country’s growth upswing has been bright spot in region as Abenomics has reignited economy and is starting to lift country out of chronic deflation • Financial conditions have eased markedly as a result of exchange weakening and an asset price rally triggered by monetary easing • Inflation and inflation expectations have increased, but well below Bank of Japan’s target 2% • Growth likely to reach 3.5% a year by end of 2013 driven by weaker yean and recovering industrial demand • Growth forecast to decelerate to 1.2 percent in 2014 owing to waning reconstruction spending and the planned consumption tax increase • A new fiscal stimulus will be announced in December and may increase the growth forecast
Variation Across Asia III • Korea • Economy spurred by fiscal and monetary stimulus is set for modest recovery • India • Fallout from recent financial stress has contributed to greater vulnerability of corporate and bank balance sheets • Further IMF downward revision of growth forecasts which were already very low in historical context • Reflects persistent supply constraints and slow progress on structural reforms • In most ASEAN countries growth should pick up somewhat • External demand will improve while domestic demand is likely to improve reflecting stronger pubic infrastructure spending (Thailand)
Variation Across Asia IV • Indonesia • May be a slowing in first half of 2014 due to dampening domestic demand and weakness in external sector • Rapid IDR depreciation resulted in Bank of Indonesia raising interest rates – may slow down investment • Fuel price increases dampen private consumption • Growth forecast at 5.7% (2013), 5.5% (2014), and 5.9% (2015) • July 2014 elections critical in determining course of growth • Most likely high growth will return in the latter half of the decade
Risk Assessments I • Asian Risk Assessment
Risk Assessment II • Japan Risk Assessment
Risk Assessments III • Indonesian Forecast Risk Analysis
China’s Rebalancing I Overview: • China’s economy is currently going through a painful transition to a more consumption based economy • The days of double digit economic growth clearly over • In the short run, slower growth is generating concern about the nation’s near-and medium-term prospects • There is an up-side to the gradual slowdown over the past several years • Growth in the coming years will be both robust and more sustainable • The structural reforms that are central to the 12th Five Year Plan (2011-2015) will become somewhat easier to achieve • On balance it appears China’s economy is headed in the right direction, but still worrisome in the short-run • However, key economic and political risks – including corruption, social inequality and lack of progress in governance reforms – must be addressed in order to assure long-term economic growth.
China’s Rebalancing II China is making progress in other areas of rebalancing • Since the yuan was first unlinked from the dollar in July 2005, the nominal yuan-dollar exchange rate has appreciated by over 30% and the real rate by over 40% • China has recently widened the yuan’s trading band and has cautiously resumed many financial sector reforms that were stalled since 2004 • The country is also continuing to promote the international use of its currency for trade and investment purposes • China’s traditional east-west development gap is also shrinking as a result of the government’s “Go West” investment policies • In recent years, interior, not coastal provinces have grown most rapidly • Agriculture, main source of income for 30% population continued strong – per capita rural growth has exceeded urban growth • However, income and wealth inequality has increased.