Friday, January 24, 2014

No bubble in region - just a realistic outlook

Jan 24, 2014

2014 looks to be a landmark year for global growth and for emerging Asia

By David Mann

Now that quantitative easing (QE) is coming to an end in the US, some say the emerging markets growth story is over. At Standard Chartered Bank, we disagree. In fact, the reasons why QE is ending are good news for emerging markets, especially emerging Asia, the region of the world most open to trade.

QE refers to massive purchases of private sector financial assets by the US Federal Reserve in order to lower interest rates and increase the money supply.

This year is likely to be the first year of truly better growth for the world economy since the global financial crisis. We expect global gross domestic product to expand by 3.5 per cent, with growth of 6.6 per cent in emerging Asia, 1.3 per cent in Europe, 7.4 per cent in China and 2.4 per cent in the United States.

For the first time in years, all major economies are set to grow at a reasonable rate. The world economy is at long last gaining a more solid footing, with multiple drivers of growth.

This is good news for growth in emerging Asian economies, which have increasingly used leverage to support their domestic demand in the post-crisis years. While leverage has become stretched in some economies, there is little reason to expect this - or external events in 2014 - to lead to a crisis.

The region is not in a bubble, and there is no "miracle economy" anywhere. A new, more realistic and balanced view of Asia is emerging among global investors. It is one in which local markets do not outperform year after year, regardless of the risks. It is also one where prices can adjust downwards when excessive optimism has crept in.

Many commentators are worried about the impact of higher global interest rates and tighter financial conditions on emerging markets. These markets have hitherto benefited from large inflows and easy financing conditions (since 2009, emerging Asia has seen gross inflows of about US$630billion - which equates to about S$800billion).

The sell-off in emerging markets last year - when investors were anticipating QE tapering - was just the beginning, these commentators argue.

At Standard Chartered, we agree that monetary policy changes in the US are critical. By our estimates they are twice as important for global liquidity as the next most important central bank, the European Central Bank. And the latter is twice as important as the next central bank, the Bank of Japan, which in turn is twice as impactful as the People's Bank of China.

At this point, however, unless inflation comes roaring back in the US, driven by a surge in credit growth - unlikely in our view - there is not a lot more left to be priced in for US rate-hike expectations. For this reason, we believe the stresses in emerging Asia should be less pronounced than was the case last year.

A key factor will be the timing of the rise in the short end of the US yield curve - something more likely to be an issue in 2015 than 2014.

The yield curve refers to the relationship between the yield on bonds and their respective maturity dates. An upcoming recession is often signalled if short-term yields are higher than longer-term yields.

While it is true that money is no longer flooding into emerging Asia indiscriminately, this doesn't mean that the structural story is over. In fact, clearer market signals will now be given to policymakers around the region that good policy - driven by growth-enhancing reforms - will be rewarded, and that complacency won't. In other words, the fact that we're coming out of the phase of indiscriminate inflows is a good, cyclical adjustment, not a cause for panic.

Current account balances, the net value of a country's trade in goods and services with the rest of the world, should also start to stabilise this year. This is another landmark point. The main reasons why we don't foresee major problems for emerging Asia this year is that no country is likely to see a dramatic increase in inflation, and few economies are afflicted with current account deficits. In aggregate, we expect a rise in emerging Asia's current account balance over 2014.

The three economies in emerging Asia with current account deficits - India, Indonesia and Thailand - all happen to be holding elections this year. In Thailand, the outlook is unclear, and the longer the policy paralysis goes on, the less likely it is that growth targets can be achieved. In India, coalition politics is the reality, and here we will be watching closely to see how the reform agenda is prioritised after the election. Indonesia, meanwhile, has already demonstrated its ability to go through the political cycle without it disrupting the sound economic policies that have been in place since the post-crisis reforms of the early 2000s.

The writer is regional head of research for Asia at Standard Chartered Bank

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