May 2016

OUTLOOK FOR DEVELOPING ASIA-PACIFIC STABLE, BUT UNCERTAIN

The United Nations projected marginal growth in the region for the next two years.

By Kanaga Raja

            The economic outlook for the developing economies in the Asia-Pacific region is broadly stable, but clouded by uncertainty as a confluence of macroeconomic risks continues to buffet the region, the UN Economic and Social Commission for Asia and the Pacific (UN-ESCAP) has said.

            In its Economic and Social Survey of Asia and the Pacific 2016 released on 28 April, UN-ESCAP has forecast economic growth to increase marginally in 2016 and 2017, to 4.8% and 5% respectively, from an estimated 4.6% in 2015.

            (The developing Asia-Pacific encompasses all countries in the region minus Japan, Australia and New Zealand.)

            "The key macroeconomic risks faced by Asia and the Pacific in the next couple of years are: a somewhat uncertain outlook for the economy of China against the backdrop of fragile global economic recovery; volatility in exchange rates, including that due to low oil prices for commodity exporters; growing levels of private household and corporate debt; and an ambiguous path of interest rate increases that may be pursued by the United States of America," UN-ESCAP said.

            At a media briefing on 27 April, Alfredo Calcagno, Head, Macroeconomic and Development Policies Branch, UNCTAD Division on Globalization and Development Strategies, in presenting the report in Geneva on behalf of UN-ESCAP, said: "The prospect is basically a stable one with some improvements in 2016 and 2017."

            He noted that the region is clearly the fastest growing region in the world, growing faster even than the advanced economies. However, the concern highlighted in the UN-ESCAP report is that productivity is slowing down, from almost 6% to 4%.

            According to Calcagno, another concern is growing private debt - household and corporate debt as a percentage of GDP - which may hinder the expansion of household consumption and investment if it is not well-managed.

            Yet another element that is highlighted in the report is the question of what will be the driver of growth in the future. The report suggests that the region will have to focus more on domestic and regional demand, rather than on exports to developed countries.

            According to the UN-ESCAP Survey, in the developing Asia-Pacific, annual average growth of total factor productivity declined from 2.8% in 2000-2007 to just below 1% in 2008-2014.

            The productivity slowdown accounts for almost a fifth of the recent economic slowdown, from an average of 9.4% during 2005-2007 to an estimated 4.6% growth in 2015.

            It said that economic growth in China is forecast to continue its gradually moderating trend in coming years. On its own, this would be a positive development as it reflects that country's efforts to rebalance the economy in favour of domestic consumption.

            The concern, however, is whether the rebalancing can be managed in a manner that does not induce a shock to domestic macroeconomic stability and consequently to the regional and global economy given the country's considerable economic weight.

            As witnessed during 2015 and early 2016, differing views and uncertainty about the prospects for economic growth in China can lead to volatility in asset and currency markets in that country and beyond in addition to having dampening effects on growth in trade, thus creating uncertainty regarding global economic prospects.

            "In this context, the impact of monetary policy changes made by the United States vis-a-vis the outlook for the Asia-Pacific region will need to be well managed. For one, increases in interest rates in the United States could lead to increases in domestic financing costs in the region. Furthermore, uncertainty regarding the pace of increases in interest rates may act as another spur to outflows of portfolio capital, which would further dampen growth prospects."

            The report said that juxtaposing these developments against a strong rise in household and corporate debt in a number of developing economies in the region gives a better appreciation of underlying risks and their wide- ranging impacts. High levels of private debt, when compounded with declining exchange rates, rising interest rates and portfolio outflows, can threaten the solvency of domestic households, businesses and banks.

            Even if these risks do not materialize, there are concerns that the current moderate pace of economic growth has been accompanied by phenomena that are impeding the region's progress towards achieving the Sustainable Development Goals.

            For instance, economic growth has not translated into commensurate increases in decent jobs for most economies. This is one of the reasons underlying signs of a slowdown in the pace of poverty reduction in the region. Similarly, inequalities - of both incomes and opportunities - continue to flourish in much of the region.

            According to UN-ESCAP, more importantly, in broad terms the growth model being pursued in the region is underpinned by debt accumulation rather than productivity-driven increases in real wages.

            These developments imply that even the moderate growth occurring in the region is failing to benefit adequately those sections of society who most need it, namely the poor.

            "To ensure effective realization of the Sustainable Development Goals, economies in the region will need to strive both for higher economic growth and better-quality growth. As external demand is likely to remain weak in the near term, continued excessive reliance on exports to revive growth will not produce the desired results; economies will have to focus instead on boosting domestic demand."

            Similarly, ensuring that the quality of growth is beneficial will require internalizing various aspects of inclusiveness and sustainability in policymaking.

            "The key tool available to Governments to achieve these objectives is fiscal policy. Monetary policy is unlikely to play a significant role in promoting growth due to uncertain conditions in financial markets that call for a prudent stance."

            Government development spending is currently a viable option for many economies because fiscal space remains available. However, to ensure consistent effectiveness, fiscal policy will have to be undertaken judiciously, supported by reforms to expand over time the "resource envelope".

            The report further said regional cooperation initiatives also provide domestic initiatives with valuable support to spur higher economic growth and achievement of the Sustainable Development Goals, especially for poorer economies with lower domestic capabilities.

            One promising area of regional cooperation is in new initiatives for the financing of infrastructure projects, with emphasis on physical infrastructure in the least developed economies.

            "Such spending will contribute to increasing the long-term potential growth of these economies by positively influencing productivity as well as boosting short-term growth. Critically, infrastructure spending will also improve the inclusiveness of growth by providing job-rich growth."

            According to the report, against an estimated growth rate of 4.6% in 2015, the rate in 2016 and 2017 is forecast to increase marginally to 4.8% and 5%, respectively. Among the sub-regions, either declines or only moderate improvements in growth are expected to be seen in most of them over 2016 and 2017.

            The major positive change in forecast for those years concerns North and Central Asia owing mainly to the economy of the Russian Federation contracting by a smaller magnitude compared with contractions in the previous few years.

            The report underlined that the reason for the lack of a significant up-tick in growth forecasts is the expected continuation of a number of factors buffeting the region.

            Chief among them are: fragile global economic recovery in most developed economies; a continued moderation in the Chinese economy; weak consumption and investment trends in major Asia-Pacific economies; and declining trends in labour and total factor productivity.

            One important factor hindering faster economic growth of developing economies in Asia and the Pacific is the fragile recovery in the advanced economies. Despite a slightly rising trend since 2013, the growth outlook for advanced economies remains essentially flat.

            "With the outlook for the European Union and Japan continuing to remain weak, alongside somewhat stronger growth performance expected in the United States, the prospects of an export-led recovery in developing Asia- Pacific economies will remain broadly subdued."

            Economic growth in global developed economies stood at about 2% in both 2014 and 2015, with only a minor increase expected in 2016. Within developed economies in the Asia-Pacific region, the most disappointing outlook remains that of Japan. Its growth is expected to pick up modestly in 2016, albeit at the low rate of 1.1%.

            The report said the outlook for the developed economies is expected to translate into further weakness in global export demand, thus negatively affecting manufacturing exports from the Asia-Pacific region.

            "In taking into account the fact that the European Union is a leading export destination, capturing more than 16% of merchandise exports from Asia-Pacific economies, the grouping's persistently sluggish demand is a major factor explaining its modest trade growth."

            More recently, the report added, global and regional demand has been further weakened by the moderation in growth of the Chinese economy, which has not only become a major exporter and importer in its own right but has also become a major trading partner for the rest of the region.

            UN-ESCAP forecasts that the region is likely to stabilize its modest rate of trade growth at between 2% and 3% in 2016 for exports as well as imports in volume terms.

            On the positive side, despite the weakening of the prospects for trade growth, the Asia-Pacific region still holds on to its position as the largest merchandise trading region in the world, with its share of 40% in global exports and imports.

            Economic growth in China is forecast to be around 6.5% for 2016 and 6.3% for 2017, continuing the moderating rate of economic expansion from an estimated increase to 6.9% in 2015.

            "The growth moderation in China is being driven partly by a much-needed rebalancing to sustain growth in the medium term, away from investment and net exports and towards consumption, as well as away from manufacturing and towards services."

            According to UN-ESCAP, it is expected that the Government will maintain its policy focus on rebalancing in coming years, provided that the growth moderation remains gradual, which would imply that monetary policy as well as fiscal policy will remain relatively restricted with regard to supporting investment.

            Given the large weight of China in the GDP of the developing Asia-Pacific region - 40% of the total - even a small change in its GDP growth estimates would result in a considerable impact on the region's growth outlook.

            China has surpassed the United States to become the largest individual trading partner in the Asia and Pacific region, absorbing 13% of merchandise exports from the region as a whole.

            Taken together, growth moderation in China and overall weak global economic growth have had a particularly strong impact on commodity-dependent economies in the region. Global commodity prices have declined to levels last seen at the time the global financial and economic crisis started in 2008, with the most dramatic reductions being observed in the case of oil.

            "Domestic demand in developing Asia-Pacific economies, with rising incomes and a younger population in most sub-regions, has more potential to support future economic growth than reliance on demand from developed economies," said the report.

            However, under the baseline scenario, the role of domestic demand is expected to remain relatively constrained.

            For instance, growth in domestic consumption and investment in some economies is likely to be negatively affected by the relatively high levels of household and corporate debt which have been accumulated over recent years, such as in Malaysia, the Republic of Korea and Thailand.

            In going forward, a larger share of household incomes and corporate profits will be directed towards debt payments, constraining further impetus to domestic demand.

            The report also highlighted the risk emanating from gradual yet expected increases in interest rates in the United States.

            "Such increases will put pressure on capital to flow out of the Asia-Pacific region and, as a consequence, could lead to higher interest rates in the region. The prospect of increases in domestic financing costs does not bode well for fixed investment growth. If economies choose to maintain their interest rates, they may experience higher exchange rate pressures. It is this tension in policy considerations that is increasing uncertainty - the ultimate deterrent to private investment."

            The report further found that the prospects of stable international financial flows are riddled with uncertainty.

            Global emerging markets suffered a net outflow of capital in 2015 for the first time since the 1980s, with the total outflow being $735 billion.

            Net short-term debt and bank outflows from China, combined with broad-based retrenchment in the Russian Federation, accounted for the bulk of the total outflow from the region in absolute terms.

            Even without these two economies, in 2015 Asian economies as a group also recorded the first net capital outflows in 10 years. China posted record capital outflows of $676 billion in 2015.

            "Divergence in economic growth and interest rate prospects of many regional economies with those of the United States are the key factors responsible for capital outflow from the region," the report said.

            Although financial markets had for some time already factored into their calculations the initial impact of the increase in the interest rate by the United States Federal Reserve in December 2015, uncertainty regarding the timing of further increases is likely to lead to volatility in financial markets in the region.

            "Given the gradually declining trend in economic growth in developing economies in the region, countercyclical fiscal policy, unlike monetary policy, potentially can play a more supportive role for growth," said the report, noting that the stance of fiscal policy in the region in 2015 was largely countercyclical and expansionary.

            China pushed ahead with large infrastructure projects and provided tax breaks and other relief measures for corporations.

            India adjusted its fiscal consolidation path to allow for more capital expenditures, while Indonesia reallocated most of its savings from a fuel subsidy cut to infrastructure and social spending.

            UN-ESCAP said whether fiscal policy is aimed at stabilizing the economy or supporting national development, an important consideration has to do with fiscal sustainability. By and large, most developing countries in the region have relatively low government debt as a percentage of GDP, which fell significantly during much of the 2000s due to the implementation of prudent policies as well as rapid economic growth.

            On average for the region, the general government debt level is estimated to have increased to a still manageable 42% of GDP in 2015 compared with 36% in 2007.

            According to the report, an important consideration beyond stabilization is the potential impact of fiscal policy on the distribution of income and opportunities and on long-term economic growth.

            Spending on education, health and infrastructure are particularly important in this regard, and countries are trying to scale up such spending by phasing out inefficient and regressive expenses.

            For instance, India, Indonesia and Malaysia implemented fuel subsidy reforms, often accompanied by targeted mitigating measures, such as cash transfers for low-income households.

            For long-term growth, public infrastructure outlays are particularly important, the report emphasised. It noted that several Governments are scaling up capital expenditures, including through debt financing or the sale of certain State assets, as well as the reallocation of expenditures and improved revenue collection.

            For example, Indonesia also recently re-capitalized several State-owned enterprises for infrastructure investment.

            Malaysia has successfully attracted private participation under its Economic Transformation Programme, which helped create a pipeline of bankable projects, while India and Thailand are launching new infrastructure funds to attract long-term private financing from sovereign wealth funds and pension funds.

            "The risks for the region due to slowing growth as well as capital outflows have been heightened in some economies due to high levels of household and corporate debt, which have increased significantly in a number of countries in the past decade. Those levels are being driven by low interest rates, ample liquidity and increased access to cross-border loans and international capital markets," the report noted.

            Compared with the situation at the time of the 1997 Asian financial crisis, the region's financial system is now stronger and backed by sizable official reserves.

            However, debt servicing capacities of the private sector may be more constrained at this time in view of the economic slowdown and subdued earnings.

            The latest available data show that household debt is as high as 86% of GDP or 164% of disposable income in the Republic of Korea and also quite high in Malaysia and Thailand.

            Corporate debt is as high as 163% of GDP in China, although firm-level indicators of leverage and debt-servicing capacity suggest that firms in India, Indonesia and the Russian Federation may be more vulnerable to shocks.

            "Although debt may eventually boost incomes and assets if it is effectively invested, the immediate implication of higher and rapidly increasing debt is a rise in the private sector's debt service ratio, with a higher share of household incomes and corporate earnings going to debt servicing. If deemed unsustainable, this situation may encourage some deleveraging and act as a drag on domestic demand."

            Alternatively, debt levels may increase further to sustain high levels of spending, in which case sustained economic growth would come at the cost of increased financial risks and a potentially sharper slowdown in the future.

            The report however highlighted two caveats to this growth-instability nexus. First, if debt accumulation is used productively and increases the region's capital stock, both growth and stability may be achieved. Nevertheless, history suggests that financial booms tend to go hand in hand with significant resource mis-allocations.

            Second, if countries manage to restructure debt efficiently, by lowering refinancing costs and lengthening maturities, a more gradual deleveraging with relatively low financial risks may be achieved. China, Malaysia and the Republic of Korea seem to be taking this path.

            However, said the report, this strategy also could result in the encouragement of even more borrowing. – Third World Network Features.

-ends-

About the author: Kanaga Raja is the Editor of the South-North Development Monitor (SUNS).

The above is an abridged article which first appeared in SUNS #8232, 29 April 2016.

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