Several Asian countries chalked up surprisingly strong economic data in the first quarter. But the region is not in the clear just yet. Our first story explains how the road to recovery remains dotted with hurdles. The second examines Europe's intensifying battle to open markets--a battle that some fear could harm struggling Asian companies.
Piyaporn Hawiset and G. Pierre Goad in Hong Kong
June 17, 1999
A recent raft of better-than-expected economic data has prompted many economists and governments to upgrade their forecasts for Asia's battered economies. After 18 months of pessimism, the optimists might finally have the upper hand.
In the alphabet soup of Asian growth projections, "V" is now the most popular letter--one that predicts a sharp rebound mirroring the precipitous fall that began in July 1997. But do not write off the U-shaped, W-shaped or even the dreaded L-shaped recovery scenarios just yet. In most cases, the rosy forecasts are based on just one or two months' worth of positive data. Even in South Korea, which can make the strongest case that a V-shaped recovery is under way, there is still plenty of bad news mixed in with the good.
The optimistic argument for Asia assumes that the region's economies will not stumble during the second half of 1999. But a closer look at the economic terrain suggests the hurdles looming in the second half of the year are high enough to delay the transformation of the current rebound into a sustainable recovery. Two of the biggest hurdles--the economic outlook in the United States and Japan--are dangerous because they could move suddenly and throw Asia off stride. Three made-in-Asia hurdles--bad banks, shaky confidence and weak domestic demand--are daunting because they are already high.
"The Asian recovery is in many respects built on sand," says Desmond Supple, chief economist at Barclays Capital in Singapore.
Rebounds in first-quarter GDP in South Korea, Singapore and the Philippines, and slower rates of contraction in Malaysia and Indonesia, were fuelled in part by government deficit spending. There is nothing wrong with such spending in theory. In practice, though, priming the pump with government money has a mixed record. Look no further than Japan for an example of what happens when it does not work. The Japanese government will run a budget deficit equal to 8 percent-9 percent of GDP in 1999 in hopes of producing GDP growth of 0.5 percent. Plenty of economists say the government will not hit that target and there is talk in Tokyo of yet another supplementary budget later in 1999.
In South Korea, a wide range of data have improved: GDP grew 4.6 percent in the first quarter of 1999; industrial production turned positive late in 1998 after almost a year of wrenching declines; retail sales rose in the first quarter of 1999; and exports are looking better in volume terms. (In value terms, though, exports lose some of their shine because world prices declined for many Korean exports such as steel and electronic components.) However, the key factor in South Korea's better-than-expected first-quarter performance may have been government spending.
The country's 1999 budget deficit was forecast at 5 percent-6 percent of GDP with most of the spending concentrated in the first half. Most forecasters expected South Korea's growth rate would slow later in 1999 and in 2000 in large part because of the waning effects of government stimulus. Goldman Sachs, for example, raised its 1999 GDP forecast to 5 percent from 3.7 percent in the wake of the surprisingly strong first-quarter numbers, but the increase in its forecast for 2000 was smaller--to 4 percent from 3.2 percent.
Another look at Japan, where government stimulus measures repeatedly failed to boost the economy, provides the main reason for concern: Government pump-priming across the region may fail to revive self-sustaining domestic demand. Even where consumer spending was showing signs of life there were fears that the rebound would tail off in the second half.
"At the moment in Asia two key factors are driving growth: Fiscal stimulus, which is due to fade out starting in the third quarter, and, secondly, a lack of corporate and banking reform," Supple said.
In South Korea, the recovery in consumer demand did not appear to be broad-based. The crisis prompted the top 20 percent of earners to curtail purchases in 1998 even though their incomes did not fall. The rebound in consumer spending in the first few months of 1999 largely represented pent-up demand from these top earners, helped by the feel-good factor of a soaring stockmarket, says Stephen Marvin, a veteran Korea-watcher and head of research at Jardine Fleming in Seoul. Convincing the other 80 percent of South Koreans that it was safe to start spending again may be more difficult because the unemployment rate, though down from its peak, remained high.
Business spending across the region also looked shaky--and with good reason. In most of Asia there were few compelling reasons to invest in new capacity. The investment boom that preceded the crisis left the region with more than enough restaurants, car factories and chemical plants to meet demand. The amount of factory capacity actually being used has improved slightly in 1999 in Thailand, for example, but remains below 60 percent. Using the broadest measure of overall economic capacity it is clear that there is plenty of slack in Asia. The output gap is the difference between what an economy could produce at full capacity and what it actually produces. Output gaps in Asia are huge. Stephen Yung-li Jen, a Hong Kong-based economist at Morgan Stanley Dean Witter, estimates that Thailand's GDP would need to grow 22 percent in 1999 and South Korea's 14 percent to fully close their output gaps. This, of course, is clearly impossible even in the best of times.
The yawning output gaps are the main reason economists are not worried that inflation will return to Asia anytime soon. They are also the reason almost everybody, including the International Monetary Fund, has been urging Asian policymakers to keep monetary policy loose.
"The imminent risk of inflation in Asia is very modest," Jen says. "In fact, there is still substantial risk of outright deflation."
Monetary policy, however, loses its punch if crisis-damaged banks will not lend. As government stimulus peters out, households and businesses would have a hard time picking up the baton if credit growth remains stalled. There were many encouraging signs that the region's banks are out of intensive care. However, credit growth--an essential fuel for domestic economic growth--has not recovered. Credit demand, too, has been weak in many countries. But as economies edge towards recovery, that demand will pick up and some people looking for credit will not find it. That will be a drag on the recovery process.
Mexico's bank-restructuring efforts after its 1994-1995 crisis suggest the credit mechanism takes a long time to heal. Mexico's government did almost all the right things. It took over the sickliest banks, allowed foreigners into the industry and set up an asset-management agency to deal with bad loans. Yet the banks remain a huge drag on the economy because they will not or cannot make loans.
"The banking sector, even four years after the 1995 recession and despite vigorous action by the authorities, is likely to remain an impediment to growth," the Organization for Economic Cooperation and Development says in its latest review of the Mexican economy released in April 1999.
The race to recovery looks even more challenging when the foreign hurdles are included. There is fierce debate over the how and why of the U.S. economic miracle of the past few years. There are two certainties, however: It's difficult to imagine how the situation could get much better for Asia in the U.S., the most important export market for most of the region's economies; but the risks that things will get worse increase with each passing month. The U.S. Federal Reserve signalled its concern that the economy is finally running ahead of itself with its May 1999 announcement of a bias towards higher interest rates. Opinions are divided on whether Asian interest rates would move higher if the Fed does raise rates. Still, higher U.S. interest rates would hardly be good news. One risk is the potential drag on U.S. demand for Asian exports if American growth slows. Another is the possibility that Asian stockmarket rallies that have done so much to inspire confidence would run out of gas if U.S. stocks take a dive.
In Japan, the immediate risk to Asia is the yen. Some analysts say a weaker yen is likely but add that that wouldn't necessarily be a bad thing. A weaker yen would help Japan's economy in the medium term by boosting exports, and a recovering Japan would in turn boost Japanese demand for the rest of Asia's exports. Others say a weaker yen is neither likely nor necessary for a recovery in Japan. Both camps agree that in the short term a significantly weaker yen would disrupt gun-shy Asian financial markets and could set off another round of currency devaluations.
Asia will recover. However, the recent flurry of good news has prompted many to look through their forecasting telescopes and see only the finish line. The problem with running while looking through a telescope is that distant objects appear closer than they really are.