There is life after QE3
IT’S that time of the year again – to look back over the past 12 months, take stock and review, and assess the outlook for next year, especially for emerging Asia (EA) and Asean. The year 2013 was not a good one – most quarterly reviews ended with a downgrade.
In April last year, IMF’s (International Monetary Fund) forecast was for global GDP to grow by 4.1% in 2013; while GDP of advanced economies (AEs) was expected to expand at 2.0% and EA, 7.9%. Asean-5 (Indonesia, Malaysia, the Philippines, Thailand and Vietnam) would raise GDP by 6.2%. By June 2013, the outlook further dimmed.
In its October review, growth prospects were again downgraded (indeed, in 9 out of the last 10 updates) so that by this December, the consensus estimate was for the world economy to grow by only 2.9% in 2013; AEs by less than 1% and EA, 6.0% (with Asean-5 rising by only 5.1%). Much of the downward revision reflected continuing basic fiscal challenges and uncertainties in the United States and Europe, and the marked slackening of growth in the major emerging market economies (EMEs) and its spillover effects. Still, EA as a group managed to grow at 6 times the pace of AEs and Asean-5, five times. This significant growth-rate gap reflects poorly on the recovery process in AEs.
Similarly, it was a bruising year for Asian bonds, stocks and currencies whose markets were long one of the world’s hottest investment destinations. Foreign investors have since started to retreat. Bond prices are on course to fall as interest rate expectations rise, while stocks have underperformed its peers in the rest of the world. Most Asian currencies (except China’s renminbi or yuan) have tumbled – Indonesian rupiah was down about 20% and the Indian rupee 11% so far this year. This big shift reflected the gradually slackening growth throughout most of Asia and worries that US may soon trim its quantitative easing (QE3) efforts that have supported inflows of cheap funds into riskier markets.
Cumulatively, outflows from bond funds focused on emerging Asia markets have totalled US$22bil since May when talk of US tapering (slowing down of US Fed purchases of bonds) first began. Interest in Asian currency denominated bonds has since declined – most bond indices have dropped significantly for the first time since 2000. For stocks, 2013 has also been lacklustre. Benchmark for the region (MSCI Asia ex Japan index) was up only 2.2% to date, against a rise of 27% for US S&P 500 – even Stoxx Europe 600 index was up 11% to date. Gold price fell to a 3-year low at US$1,187 on Dec 20.
Emerging Asia 2013
Like everyone else, Paris-based OECD (Organisation for Economic Co-operation and Development – the “rich boys” club) cuts its December global growth forecast for 2013 as EMEs, including EA and Latin America, cool. The world economy will most likely rise by 2.7% this year (against 2.9% by IMF and ADB – Asian Development Bank). That’s down from 5.4% in 2007, before the global recession hit. Sure, EMEs (including China) have cooled off; Europe still remains fundamentally in the doldrums; and US continues to face fiscal uncertainties.
In the midst of it all, the world’s most powerful central bank (US Fed) has been contemplating easing-up on its extraordinary stimulative efforts, with potentially serious global ramifications. It finally decided to take its foot off the gas come January 2014. So, IMF says global growth is in “low gear,” with continuing high rates of unemployment especially among its youth. All these translate to lower living standards in the face of little inflation.
Collectively, growth among EMEs has fallen 3 percentage points since 2010 to only 4.5% this year, with Brazil, China and India accounting for two-thirds of the fall. Growth in EA was downgraded 2 percentage points this year alone, to 6% in 2013.
As I see it, global growth is still basically weak but its underlying dynamics are changing, with much downside risks. For EA, the risks that are now most worrisome include: (i) US Fed’s plans to taper and eventually exit its QE3 stimulus programme, (ii) China’s attempt to meet irreconcilable targets of stable growth and structural reform, and (iii) the China-Japan political “stand-off” dispute.
The mere talk of QE3 tapering had already sparked off increases in, and fuelled expectations of further higher, interest rates as well as slowing down of capital inflows to EMEs, especially EA. As for China, there is growing expectation that its economy will expand more slowly over the medium term, with widespread implications for commodity exporters and income growth among the EMEs. Finally, the territorial dispute between Japan and China is very real, with deep-rooted social, cultural and psychological underpinnings.
Outlook for 2014
Most expect a better 2014. From the US to Europe to Japan, monetary authorities have been pumping cheap funds into their economies and keeping loan rates at near zero. Once red-hot China has since revived, with the help of public funds invested in projects through easily available funds from state-owned banks. The world economy now appears to be improving, with growth forecast at 3.5% in 2014. Prospects in US and Japan look more upbeat, with Europe appearing to be recovering but at a tepid pace from depressed levels – my impression is for eurozone to face the prospect of a lost decade.
In Japan, Abenomics remains very much work in progress. While US is bouncing back, it is still blighted by polarised politics that could yet extract a heavy economic toll. Tiger (Tracking Indexes for the Global Economic Recovery) has shown improvement from its recent lows in mid-2012, pointing that the global economy is “being borne along by surging business and consumer confidence in advanced economies, and stabilisation in the growth of emerging markets.”
Consequently, I see 2014 as a year of broader economic recovery, but with more market volatility as global monetary conditions are tightened. AEs are forecast to grow somewhat stronger at just below 2% despite softening in the euro-area. Still, its pace is less than a third that of EA. China and others in EA are coming off cyclical peaks and are now projected to grow at 6.2% as a whole, below the elevated levels seen in recent years.
Despite uncertainties in the global environment, indicators in more dynamic east Asia are positive, boosting its growth rate in 2014 to 6.7% (same as in 2013) driven mainly by continuing strong performance in China and South Korea. Asean-5’s growth performance is likely to be maintained. While EMEs have regained some of the momentum they lost earlier this year, particularly China, many of them remain vulnerable to a loss of private sector confidence or capital flight.
To be fair, the volatility of capital flows engendered by the Fed’s vacillations on its tapering measures has added to the difficult external environment these nations continue to face. In addition, US political dysfunction leading to “mistakes” in fiscal policy can derail the fragile global upswing, as the recovery is still tenuous.
United States: A gradual acceleration of economic activity is in prospect for 2014, with GDP growth expected at 2.6% (after a strong 4.1% in 3Q’13 which brought unemployment down to 7% in November), with little inflation to speak of. Thank goodness the Fed’s tapering and support in Congress for a budget deal are on the way. Uncertainty over public policy that has overshadowed business and consumer sentiment since 2008 is now much reduced.
But, Washington politics will still remain uncertain. The Fed just announced plans to cut its monthly purchases of securities from US$85bil in December to zero by late 2014 in a series of small steps, starting with a US$10bil cut in January 2014. The tapering pace is notably slow. December marks the 5th anniversary of the Fed’s QE experiment in near-zero interest rates and other extraordinary monetary adventures. There are risks of course. Cheap cash that continues to be pumped into the global financial system will flow into stocks, bonds and commodities.
Already, Wall Street has become the world’s most expensive stock market. Their prices can escalate and become unsustainable, raising risks of a crash. Moreover, prolonged easy money can cause inflation over the long run. Overall, even at reduced levels, QE bond purchases will contribute to stimulate growth, and help offset spending cuts.
The Fed’s message is clear: (i) tapering does not change the outlook for interest rates – short rates will remain firmly anchored at near zero, and (ii) interest rates will start to rise only after the economy approaches full employment which will be beyond 2015.
These simply mean monetary conditions will remain stimulative for a while longer. Medium-term prospects thus look positive even though fiscal policy remains at risk. Based on latest indications, I expect a less destructive Washington political environment in 2014, with fiscal headwinds subsiding. After all, US can’t rely forever on monetary policy to save the day.
Europe: Frankly, economic conditions in the 17-nation eurozone are not good. After enduring two recessions since 2009, GDP rose 0.1% in 3Q’13 after rising 0.3% in 2Q’13. From a year earlier, the economy contracted 0.4%. GDP in 4Q’13 is expected at 0.2% so that the eurozone will contract 0.4% in 2013. Indications are that it will grow tentatively at 0.3% in 1Q’14 and by 1% for 2014 as a whole. This is optimistic since Europe still lacks a reliable engine of growth.
Indeed, there is even concern about the core-France, Netherlands and Germany. French GDP fell 0.1% in 3Q’13; in Germany, GDP rose only 0.3% in 3Q’13 (against 0.7% in 2Q’13) while the Dutch economy rose a mere 0.1%. The eurozone’s GDP, reflecting its southern peripheral, is still 3% below 3 – financial crisis level now in its 5th year.
Unemployment remained near record high of 12.1% in October, with a scant 0.7% inflation. The outlook for eurozone remains fragile; it is still being dragged down by fiscal fatigue because of aggressive fiscal tightening especially in the south that is front-loaded, and tight credit conditions reflecting heightened credit risks and poor bank balance sheets. Of immediate concern is the risk of deflation – a prolonged fall in wages, prices and value of assets (such as stocks and homes). The recent cut by ECB (European Central Bank) of its benchmark refinancing rate to a record 0.25% was meant to reduce any risk of the economy falling into deflation. Unfortunately, without cataclysmic policy change, the eurozone will muddle through in the foreseeable future. However, of late, I sense there has been a change in mood with the hope that Europe has turned the corner. Unfortunately, this still has not been translated into a self-fulfilling increase in spending.
Japan: Recovery in Japan has been spurred by Abenomics (my column “Abenomics and Currency Wars” of May 4, 2013 provides interesting details). GDP rose 1.1% in 3Q’13 after a robust broad-based growth of 3.3% in 1H’13. The economy is expected to expand by 3.4% in 4Q’13 and then by 4.4% in 1Q’14 before contracting by 4% in 2Q’14 with the onset of higher VAT in April’14 and again in ’15.
But sustainability of the current cyclical upswing will depend on: (i) success at fiscal consolidation to reform Japan’s poor fiscal condition with the VAT hike, and (ii) implementing a credible package of structural reform measures to transform the economy with the aim of making it more competitive. A US$67bil stimulus programme was recently approved to help boost GDP by 1% and create 250,000 jobs. For 2014 as a whole, GDP is forecast to rise by 1.6% (1.7% in 2013), with 2% inflation (1.1% in November 2013).
China: EA has grown significantly becoming a force to be reckoned with globally. The improving global environment is good for Asia (which accounts for some 40% of global GDP) in the face of an expanding and stable China. I believe Beijing’s main policy objectives for 2014 are to promote stable output growth while pushing key structural reforms – two apparently mutually exclusive objectives. In practice, Beijing can have “the cake and eat it” over the next 10 years only if it is prepared to sacrifice faster growth for broad-based reforms – i.e. lower its sights on high growth while being relentless in its pursuit of reforms. IMF forecasts China to grow by 7.3% in 2014 (7.7% in 2013), below those by OECD (8.2%) and World Bank (7.7%) and ADB (7.5%). Realistically, I expect China to be prepared to go as low as 7%, while shooting for 7.5%, because it has to come to terms with its problems of high debt and excess-capacity as it switches to the new economic model driven by consumer demand.
The recent 3rd Plenum reforms set China’s economic direction for the next ten years (my column “China’s third plenum reforms are well received. But, the new deal flashes danger signals” of Dec 12, 2013 refers). I believe prospects for serious reform (briefly, letting the market play a decisive role in allocating resources, granting farmers property rights, introducing greater competition, forging urban-rural integration, elevating private sector’s role & expanding opportunities for SMEs, and setting-up a sustainable social welfare system) are now better than at any time since 1990s, for 4 reasons: (i) the leadership is committed to the new economic model based on consumption, (ii) its leadership is already well positioned to forge change, (iii) China can’t afford to delay reforms, and (iv) need to meet high expectations for a sustainable increase in income and a better way of life. With reform, China will emerge the better for it.
India: India’s outlook is more uncertain; its prospects being dependent on the outcome of the May 2014 elections. Much better global economic conditions and improved sentiment for exports are expected to support a gradual recovery in the face of a steadfast fight against inflation (11.24% in November 2013). GDP growth in 2014 is expected at between 5.1% (IMF) and 5.7% (ADB), against 4.7% in 2013 and a potential growth rate of 6%. The economy appears to have bottomed out, with many signs of “green shoots” springing up in industry.
Asean-5: Growth in South-East Asia moderated in 2013 reflecting political tensions in Thailand, the devastation wrought by Typhoon Haiyan on the Philippines, and the impact of widening current account deficit in Indonesia. Despite these setbacks, the outlook is for Asean-5 to pick-up & steadily expand at 5.5% in 2014, against 5.1% in 2013. Inflation would likely hold steady at 4.4% next year (4.8% in 2013).
What then, are we to do?
Looks like the world’s three largest economies – the United States, China and Japan, are all in decent shape to grow in 2014. How fast they will expand and how long it can last, nobody really knows. The past offers a clue. In the 1980s, world growth averaged 3.4%; in the 1090s, 3.2% – so it’s not unreasonable to use 3.3% as the plausible trend. Growth in 2001-2010 was well above this at 3.7% reflecting mainly the surge in commodity prices and abundant cheap money inflows or in short, a favourable external environment. In their book Who Needs to Open the Capital Account, author Arvind Subramanian, together with Oliver Jeane & John Williamson, concluded that over the medium-term (averaging over booms & slumps) “growth has little association with capital flows,” except for foreign direct investment.
Favourable external environment does fuel growth in the short-run, but its long-term effects are questionable. I believe the day of reckoning always comes. According to Subramaniam: “those that borrow most suffer the biggest growth collapses from ‘sudden stops’ of capital.” This is true in recent history and it’s true in the turmoil affecting EMEs today – those benefiting from the largest hot-money inflows (Brazil, India, Indonesia, Turkey and South Africa) experienced the greatest currency declines and market volatility. The impact of US tapering “withdrawal,” while significant in the short-run, should not “keep policy makers awake at night.” Lament over fleeing hot money & falling commodity prices is just over inconsequential “noise.” There is life after QE3!
Former banker Tan Sri Lin See-Yan is a Harvard educated economist and a British chartered scientist who speaks, writes and consults on economic and financial issues. Feedback is most welcome; email: email@example.com.