By Anthony Fensom
Asia is expected to enjoy stronger economic growth in 2018 as the world economy picks up speed. But there are still plenty of potential surprises that could rattle financial markets in the Year of the Dog, according to analysts.China has already followed the U.S. lead in tightening monetary policy, but the rest of Asia’s central banks are far from willing to follow the U.S. Federal Reserve in hiking interest rates given their diverging economic outlooks. Should the Fed increase rates more than the anticipated three or four times this year, Asia could suffer the fallout, particularly if a strengthening dollar drains capital from emerging economies. India, Indonesia, and the Philippines are considered the most exposed, based on their current account balances and levels of net foreign direct investment. Yet the eruption of private debt levels, which has reached more than 200 percent of gross domestic product (GDP) in China and nearly as high in South Korea, poses a high risk also, particularly for those companies with dollar-denominated loans.
Any major rise in the dollar could see China hit with a surge in capital outflows, causing the yuan to weaken further and exacerbating trade tensions with Washington, according to George Magnus, former chief economist at UBS.
WisdomTree Japan’s Jesper Koll has suggested that further weakening of the Japanese yen could force Beijing to devalue the yuan to maintain its competitiveness.
Koll argues that any slide of the yen past 140 to the dollar could spur a 30 percent yuan devaluation, sparking a potential currency war between Asia’s biggest two economies that could rock the region.
China Shock
China’s economic health is crucial to the outlook for the rest of Asia, given its position as not only the biggest economy but also the major trading partner for most of the region.
While the world’s second-largest economy is seen expanding at a pace of 6.5 percent in 2018, this would still be its slowest rate since 1990. Capital Economics argues the real GDP growth rate could be an even lower 5 percent, highlighting the extent of the slowdown.
Financial markets are particularly concerned over China’s escalating debt, which has nearly doubled since 2007 to reach an estimated 250 percent of GDP by June 2017, sparking warnings from the International Monetary Fund and prompting vows from Beijing to curb financial risks.
China’s explosive credit growth is seen by the IMF as unsustainable, “typically associated with a financial crisis and/or a sharp growth slowdown,” although others argue that Chinese companies have become more profitable and better able to manage their debt risks.
HSBC’s Frederic Neumann sees construction as the key fault line for China, with Beijing’s tightening of financial and environmental regulations to curb debt seen weighing on the sector, along with tightened credit. The major cities like Shanghai and Beijing are viewed as particularly vulnerable to a real estate slowdown, due to their weaker population growth, moderate wage rises, and elevated house prices.
However, a trade war with the United States or other external shocks could inflict irreparable damage on China’s economy, and with it the rest of trade-dependent Asia.
War And Peace
War on the Korean Peninsula could result in more than 2 million Korean casualties as well as inflicting massive damage on some of Asia’s largest economies. The Korean War of 1950-53 caused 1.2 million deaths in South Korea and saw the value of its economy slump by more than 80 percent, and another war could knock more than a percentage point off global GDP.
South Korea’s integration into regional and global manufacturing supply chains would also result into severe business disruption should hostilities commence. Capital Economics projects Vietnam as the most at risk, since it sources a fifth of its intermediate goods from South Korea, but China sources 10 percent and other Asian neighbors would also be hit.
Along with industries such as electronics, automotives and shipping, energy markets would suffer given that 65 percent of Asia’s oil refining capacity is located in Japan, South Korea, and China.
Asian stockmarkets that have largely shrugged off Kim Jong-un’s missile tests would likely slump, with a “flight to safety” to safe haven assets such as U.S. stocks and gold.
On the plus side for South Korea, reunification with the North could unlock trillions of dollars of energy and mineral resources, allowing Seoul to cut defense spending and also improving its demographics given the North’s younger population.
But given recent negotiations between the North and South, could détente be on the verge of breaking out? WisdomTree Japan’s Koll suggests one surprise move from Japan could be Japanese Prime Minister Shinzo Abe visiting Pyongyang and securing a “$1 trillion Japan-led infrastructure upgrade for North Korea.”
“From an economic development perspective, North Korea and Japan are a match made in heaven: an ample supply of natural resources and labor meets world-leading technology and capital,” Koll argues.
“Abe has an outstanding track record as a champion promoter of Japan-led infrastructure projects. Engaging North Korea constructively would not just boost Japan’s economic fortunes, but surely create a historic legacy for Abe worthy of the Nobel Peace Prize.”
Housing Market Bust
Hong Kong and Sydney, Australia have been rated as the world’s two most unaffordable cities to buy a home, and any bursting of the real estate bubble would inflict substantial economic losses.
Analysts at Deutsche Bank warn that Hong Kong property prices could fall by nearly half over the next decade due to an aging population and growing supply, with the city’s financial officials warning of overexuberance among buyers.
Hong Kong home prices have nearly doubled since their peak in 1997, and are also exposed to any slowdown in the mainland economy.
In Australia, investment bank UBS has declared the end of a recent housing boom in the nation’s two biggest cities of Sydney and Melbourne, pointing to a “persistent and sharp slowdown unfolding,” ending 55 years of growth that have seen prices inflate by more than 6,500 percent.
Slowing property prices are expected to weigh on consumer spending, with any major price slump risking the creditworthiness of Australia’s largest banks, which are heavily geared toward the property sector.
Chinese investors have also reportedly reduced their investment in Australian residential property due to credit restrictions and increased taxes imposed by Australian governments on overseas buyers. According to a recent survey, total residential sales to foreigners have fallen during the past three months in every Australian state except South Australia.
As the Asia-Pacific region enters 2018, there are plenty of risks to the apparently brighter outlook for the world’s most economically dynamic region. Will it prove a dog of a year for investors? Only time will tell, but policymakers will be hoping its bark proves worse than its bite.
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