'Risks are all to the downside for Asia' is the view of UBS' global macro team. It appears the markets are pinning their optimism on growth and earnings over the next year on three hopes: that the US will not fall off its 'fiscal cliff'; that Europe will 'muddle through'; and that China will pull Asia out of the current morass. Duncan Wooldridge takes on each of these 'hopes' noting that he expects Asian exporters to be far more likely to pull back on investment and take a wait and see attitude than simply ride into the breach.
UBS: Asia and the Fellowship Of Hope
Hope number one is that the US will not fall off a “fiscal cliff” in early 2013.
The fiscal cliff refers to automatic spending cuts and tax hikes that are scheduled for 1 January 2013 that equal 5% of US GDP according to the Congressional Budget Office (CBO). The CBO believes this could cause the US economy to contract 1.3% in 1H13 and would result in the US growing just 0.5% next year. The only way the US can grow close to 2.5% next year is if US politicians renege on their prior policy commitments and that is the view UBS is taking. But it is important to understand that the uncertainty around this debate, as it heats up later in the year, will likely have a dampening impact on private investment in places like Asia because of the uncertainty the debate itself will generate for Asia’s export outlook. Asian exporters are far more likely to pull back on investment and take a wait and see attitude than simply ride into the breach.
Hope number two is that Europe can continue to muddle through.
Is the risk that Europe surprises on the upside or the downside? This depends critically on policy and what we arguably know is that European policy is reactionary; i.e., policymakers seem to only respond after the economy deteriorates. So for those who believe that in the end everything will work out for the best, one has to admit that further deterioration is probably a precondition for the sort of sea change in policy that markets want to see. Piecemeal policy measures in response to a gradually worsening scenario in Europe should not be cause for hope and optimism, at least from where we sit in Asia. If anything the risks in Europe are to the downside on the horizon. Again, not terribly helpful forgetting Asia out of her current funk.
Hope number three is China. Can China pull Asia out of the current morass?
In reality China has limited room to play global or regional saver this time around. In part, that’s because domestic debt is now driving toward 190% of GDP and it is especially high in the corporate sector. And as we pointed out several weeks a go pushing Chinese leverage higher from current levels will not have the same salubrious effect as in 2009. Credit expansions overtime tend to suffer from diminishing marginal returns. Debt can go higher, but it won’t feel as fun. The other issue is this. China’s domestic investment cycle is mainly driven by construction. China’s policy response to the global financial crisis was very successful precisely because credit poured into housing and infrastructure construction. But look at chart 2.
Chinese construction is now sitting at what can only be considered a cyclical peak as a share of GDP, around 7% on a value added basis or close to 14% if you prefer to think of this on an expenditure basis. Yes, China can do a little something, something with infrastructure spending per UBS China economist Tao Wang’s assertions, but that’s not going to compensate for everything else going on in the world. You really need to see another massive surge in Chinese construction activity to get bulled up on growth – and that would be very hopeful indeed.