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Asia Pacific Macro Are We Rebalancing Yet?

Paul Gruenwald

Managing Director

Chief Economist, Asia Pacific

September 2016

Copyright © 2016 by S&P Global.

All rights reserved.


Asia Pacific Macro Narrative Is Domestic, Credit-Led Growth The Best Path?

1. G2 Outlook Remains Sub-Par

• US struggles to reach 2% growth, Fed path not clear

• EU has identity problems, uneven recovery, QE mode

2. World Trade Remains Weak

• Partly due to weak global recovery (cyclical)

• Partly due to on-shoring by China and the US (structural)

3. Productivity Growth Remains Weak (less well understood)

• Reform efforts have flagged

• Measurement is tricky

4. China Is Wobbling

• No crisis yet, but we are not comfortable with the macro trajectory

• Rebalancing is happening and has implications beyond China


Export Growth Remains Sluggish Even In The Dynamic Tiger Economies

Private & Confidential 3

(20)

(15)

(10)

(5)

0

5

10

15

20

25

30

(y/y

, 4

qm

a)

Tiger Economies: Real Export Growth

HKG SGP KOR TWN

Source: Oxford Economics


Credit Growth Has Outpaced Nominal GDP Growth In The Post-Crisis Period


AUS, 150

CHN 258

IND 89

IDN, 33

JPN 189

KOR 172

MYS 129

NZL, 153

THA, 69

-5%

0%

5%

10%

15%

20%

25%

-5% 0% 5% 10% 15% 20% 25%

APAC: Credit Growth and Nominal GDP Growth (2010-15)

Sources: S&P Global, Bank of International Settlements.


Our Latest GDP Growth Forecasts India Has Bumped China To Head The Pack


Asia-Pacific Summary Baseline GDP Growth Forecasts

(Annual growth rates in percent)

2015 2016f 2017f 2018f

Asia Pacific 5.4 5.3 5.3 5.2

Japan 0.6 0.7 0.9 0.5

Emerging Asia 6.2 6.0 5.9 6.0

China 6.9 6.3 6.1 6.0

India 7.6 7.9 8.0 8.1

Tiger Economies 1.9 2.2 2.5 2.8

ASEAN 4.6 4.8 4.9 5.2

Source: S&P Economics,.


China vs. India: Different Directions?


• GDP growth trending lower

• Structural reform sluggish

• Banks hiding NPLs

• Confidence shaky

• Capital flowing out

• …

• GDP growth trending higher

• Structural reform picking up

• Banks reporting NPLs

• Confidence rising

• Capital flowing in

• …


But Let’s Not Get Carried Away …

India’s Economy Is A Fraction Of China’s


0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

China India

GDP Per Capita (2015)

0

2

4

6

8

10

12

China India

Exports: % of World Total (2015)

Sources: S&P Global, Oxford Economics.


China Macro View: What Is The Correct Narrative?

8 Private & Confidential


What Is The China Narrative?

Pick Your Poison

9

1. Hard Landing

• The “true” growth rate (based on Li Keqiang index) is 2% to 3%-ish.

• Official numbers can’t be trusted/are highly suspect.

2. Things Are Still Largely Under Control

• There may be problems, but the authorities have a great track record.

• Intensity inversely correlated with distance from the Mainland.

3. Manufacturing Growth: Extend And Pretend

• Growth is probably close to the official number, but being propped up.

• No big short-term macro risks, but the trajectory is unsustainable.

Private & Confidential


Our View: Extend And Pretend Balance Sheets Being Sacrificed For Growth

10

• Outlook: GDP growth is 6-ish%, but will be low quality!

• Hard landing fears overdone (for now) as they ignore two key points:

• Consumption is holding up well and HH balance sheets strong.

• Reaction Function: Authorities have lots of tools and are using them!: fiscal

spending, policy bank lending, propping up SOEs, local gov’t debt relief.

• The main macro risk is not a hard landing, but a period of propped

up GDP growth leading to more imbalances, requiring more

adjustment and lower GDP growth later.

• Solution: (i) lower, more sustainable growth; (ii) move to a range (maybe

5½% to 6½% over medium-term); and (iii) dethrone the growth rate.



China’s Debt/GDP Has Reached “First World” Levels: Room For Manoeuvre Not Unlimited


• “Wiggle room” (fiscal space) for debt-fuelled growth has clearly shrunk.

• Household balance sheets relatively strong.

• So is easing fiscal/monetary stance to achieve 6½%-7% GDP growth wise?

0

50

100

150

200

250

300

China 2007 China Korea Australia USA Germany

Debt/GDP Ratios By Sector (Q2 2014)

Government Financial Non-Financial Households

Source: McKinsey Global Institute, S&P Economics.


China’s “Credit Overhang” Continues to Grow As Credit Growth Runs Ahead of Nominal GDP


-10%

0%

10%

20%

30%

40%

50%

60%

70%

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

China: Credit Growth vs Nominal GDP Growth

Nominal GDP Aggregate Financing Cumulative Difference

Source: S&P Economics, CEIC.


Chinese Authorities’ “To Do” List Short Version

13

1. Lower GDP and Credit Growth /Increase Credit Discipline

• Credit Growth Is Still Running 2X Nominal GDP

• Allow more defaults? Develop “default transition matrices”

2. Reform SOEs

• Yes, employment in this sector helps social stability …

• But the sector is low valued added, sucking up resources

3. (Continue to) Reform the Financial Sector

• Are non-performing loans correctly reported?

• Credit needs to find new growth drivers (consumption, services)

4. Internationalize The Yuan

• Be as clear as possible with the markets, allow some volatility

• Earn the trust of the markets: increase “voluntary” demand for CNY



China’s Macro/Growth Challenge Political Promises vs Economic Reality


1. The 6½% to 7% GDP growth target derives from the “China Dream”,

which includes doubling per capital GDP between 2010 and 2010, but

the world has changed since then:

• World trade has slowed and now has zero contribution to growth

(not unique to China and largely beyond its control).

• Productivity growth has slowed (also a worldwide phenomenon, but

there clearly is a link to slow structural reform).

2. As a result, the growth target should arguably be lowered, but this

would entail a political climb down:

• The alternative is “extend and pretend”, with lower credit quality.

• Perhaps a change can be made at the 2017 Party Congress.


How Does China’s Rebalancing Affect The Rest Of Asia?



Consider the following:

1. Rebalancing requires a change in the mixture of consumption and investment.

2. Any change in spending patterns will have an external dimension unless it is exactly

matched by changes in domestic production. (Need not be symmetric across C and I.)

3. China is not a textbook small open economy or price taker. It moves (global) markets!

4. Global trade must balance.

Therefore, changes in Chinese imports and exports as it rebalances must be

exactly offset by exports and imports of its trading partners.

China Cannot Unilaterally Rebalance



China Is A Major Trading Partner Of Many APAC

Economies, But Details Differ: India Is Last!

Source: S&P Economics, UN COMTRADE.

0

5

10

15

20

25

30

35

AUS KOR NZL JPN MLY IDN THA PHP SGP VNM IND

Size And Composition of Exports To China in 2014

Raw Materials Intermediate Consumer Capital



18

(On Impact) GDP Growth Effects From Chinese

Rebalancing Reflect Trade Composition

-0.4

-0.3

-0.2

-0.1

0.0

0.1

NZL IND THA IDN VNM HKG JPN AUS PHL MYS SGP KOR TWN

GDP Growth Effects From Chinese Rebalancing (ppts)

Source: IMF.



1. Exchange Rate Depreciation (Dutch Disease in reverse)

• Lower Chinese demand leads to a terms of trade shock and a weaker

currency, bringing potentially new export sectors into play

2. Government Policy, Fiscal Space

• If fiscal space and policy effectiveness allow, governments can help cushion

the effects of the foreign demand shock, re-orientate markets

3. Flexible Factor Markets

• Labor and capital need to be able to respond to price signals and policy

initiatives (previous point) in order to migrate to new export sectors

4. Financial Market Nimbleness

• New growth sectors will need access to credit, so the financial sector needs

to have the nimbleness to respond

19

The Dynamics Of Rebalancing Around China

What Matters?



Services Trade In Asia Some Preliminary Results



Why Is It Important to Follow Services Trade Developments In Asia Pacific?


1. Rising Middle Class Story. As incomes rise, spending by the middle

class on services (as opposed to basic goods) should rise as well.

2. Chinese Rebalancing Story. China’s rebalancing means a shift away

from expenditure on manufacturing towards consumption and services.

3. Flying Geese Story Revisited. Just as we saw in manufacturing, will

countries follow Japan on services side and move up the value chain?

4. Global Trade Story. Can faster growth in services trade reflecting the

points above give a fill-up to sluggish global trade growth?



Is China’s Rebalancing Driving An Asia Pacific

Service Trade Revolution?

-200

-150

-100

-50

0

50

100

2000 2002 2004 2006 2008 2010 2012 2014

Tho

usa

nd

s

Asia Pacific: Services Trade Balance (US$mn)

CHN APAC ex-CHN APAC

Source: S&P Economics., COMTRADE



Decomposing China’s Services Trade Deficit

Travel (Tourism, Education) Is The Main Driver

(200,000)

(150,000)

(100,000)

(50,000)

-

50,000

2000 2002 2004 2006 2008 2010 2012 2014

China: Net Services Trade Balance (US$mn)

Other Biz Serv Transport Travel Residual



Services Trade Growth Has Been Very Uneven

Like Most Pan-Asian Stories!

-5

0

5

10

15

20

25

30

35

40

Asia Pacific: Services Trade Average Annual Growth

2001-07 2010-14


India Remains The Leader In Computer And

Information Services, China Gaining Ground


• Computer and information services account for 7% of Asia Pacific services exports and was the fastest growth component over 2010-14.

• India dominates this space (and also

runs a large overall services surplus).

• China has made some inroads of late and now has a 10% share. Singapore has gained a bit as well.

• These both came mainly at the expense of Japan.


At The High End (Royalties, Licenses), Japan Is

Still The Top Dog, With Korea Gaining Ground


• Royalties and licenses are about X% of Asia Pacific services trade.

• Exporting these services is a high value added space since others are paying for your brand and “IP”.

• Japan, not surprisingly has been the “Top Dog” in the region.

• More recent, Korea and Singapore have begun to make inroads


Guess Who Is Coming To Dinner?

China’s Outbound Tourism Is Surging


• Chinese outbound tourism has exploded, growing by 30% over 2010-14 (inbound grew 7½%).

• As a result, China’s share of the region’s tourism imports has tripled since 2005, pushing toward 50%.

• Japan, which accounted for about one-third of these flows early last decade, is not in single digits.

• Inbound tourism shares are more stable (combining China and HK) with Thailand the big winner, rising from 8% to 15% over 2005-13.


Questions And Answers



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