Asia Eyes ‘yo-yo’ Economy in 2012

Asia's economic growth looks set to stumble over the next few months, prompting a flurry of interest rate cuts and a spike in stimulus spending that may ultimately pave the way for a strong recovery in the second half of 2012.

The catch-phrase for 2012 is the Asia yo-yo, said Rob Subbaraman, chief Asia economist at Nomura in Hong Kong. The harder Asia's economies are hit, the stronger the tailwinds for a bounce back.

The idea that bad news would beget good news was a recurring theme in economists' year-end outlooks.

India, Indonesia, Thailand and the Philippines are widely expected to lower interest rates next year. Elections in Taiwan, Malaysia and South Korea may shake loose even more government spending. China will most likely continue cutting banks' reserve requirements to try to spur more lending.

But beyond the basic premise that Asian policymakers will be in easing mode, there was little consensus on how each country would weather the turmoil. Between Europe's simmering debt troubles, concerns about a housing downturn in China, and an uncertain U.S. growth trajectory, there were too many wild cards.

CAPITAL FLIGHT FRIGHT

European banks' claims on Asia, excluding Japan, amount to $1.4 trillion, according to data from the Bank for International Settlements. If Europe's debt problems intensify and its banks retrench, they may pull back some of that credit with little warning, leaving Asia vulnerable to a sudden exodus of capital.

Singapore stands out among the most heavily exposed, with European bank claims amounting to 83 percent of the country's gross domestic product, said Chua Hak Bin, a Bank of America-Merrill Lynch economist based in Singapore. For Malaysia, they add up to 25 percent of GDP.

It is difficult to predict if, when or where European banks will pull the plug.

Foreign investors have yanked money out of Indonesian bonds and Indian equities in recent months, evidence of a global bout of risk aversion. But it is harder to track how much bank deleveraging has actually occurred. BIS data, considered the most reliable, comes with about a six-month lag.

Nomura's Subbaraman said based on anecdotal information gleaned from market sources, it doesn't feel like there's been wholesale withdrawals from European banks. He added, however, that there was a lot of scope for such withdrawals.

WILL CHINA LAND WITH A THUD?

For some Asian economies, it is China rather than Europe that will most influence 2012's course. China is the largest trading partner for many Asian countries, and it is no longer simply an assembly point for goods destined for export.

Nomura's data shows that 58 percent of China's imports served domestic demand in the third quarter of 2011, up from 44 percent at the start of 2007. That means what happens inside China matters a great deal for the rest of Asia. The biggest domestic worry centers on China's cooling property market, and the repercussions for bank lending and local government borrowing.

Beijing orchestrated a real estate slowdown this year to try to avoid a damaging property boom and bust. But the side effect has been a rise in troubled loans to developers, and a drop in land sales that has cut off a vital source of revenue for heavily indebted local governments.

Credit Suisse, which has been among the more bearish in its forecasts on China's housing sector, predicted property prices would fall 10 percent in 2012, bringing the cumulative decline to 20 percent from a mid-2011 peak.

China's central bank said on December 2 that home prices were at a turning point and banks were concerned about a possible chain reaction if prices were to fall by 20 percent. Many market watchers took that as a signal that Beijing would ease some of the restrictions it placed on home purchases.

China has already reduced the amount of reserves that big banks must hold, a measure that freed up an estimated $55 billion to $63 billion in lending capacity. Economists expect China to continue lowering banks' reserve requirements. That in turn should help spark stronger growth in the second half of 2012.

Zhu Haibin, JPMorgan's China economist, thinks the second-half recovery will be so robust that Beijing may resume raising interest rates toward the end of the year.

Basically our view is that China's interest rates are still behind the curve, Zhu said. We don't think that the policy normalisation was complete before it came to a halt.

WAKING THE INFLATION DRAGON

The policy-induced second-half bounceback assumes that inflation remains subdued. That appears to be a safe bet, at least in the near term. Commodity prices have come down sharply since May, helping to bring down inflation in China, Indonesia, South Korea and elsewhere.

But the same forces that are likely to propel stronger second-half growth could also revive price pressures. A flood of easy money, coupled with renewed economic strength in commodity consumers like China, may stoke inflation.

Barclays economists warned that the inflation dragon is resting for a while and could wake with a vengeance in late 2012.

One can envisage a scenario in which a bottoming out in global growth and the combined effects of past liquidity injections feed into global commodity prices and inflation at exactly the same time, risking a repeat of what occurred at the beginning of 2011, Barclays wrote in a research note.