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TRANSCRIPT
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IN
COLLABORATION
WITH
PROUDLYSUPPORTEDBY
ISSUE 30
7 JANUARY 2013
-SouthKoreaMorethanjustahorsedance?-IstheUSNaturalgasglutsettocontinue?
-Chinasmuchneededeconomicreform
TheFortnightInBrief(24thDecemberto6thJanuary)
US:PartialResolutionoftheFiscalCliff
OnNewYearsDay,theSenatepassedtheAmericanTaxpayerReliefActof
2013,partiallyavoidingtheFiscalCliff.Whilemanyissueshavebeenleft
unaddressed,thebillwillextendtheBush-erataxcutsformostAmericansandsavemillionsfromtheAlternativeMinimumTax.Worldmarkets
reactedfavourablytothepartialdeal,butthedebtceilinginUShasonce
againbeenhitandthebilldoesnotaddressthis.Despitetheuncertainty,
employersadded155,000jobsinDecember,holdingthejoblessrateat
7.8%,almostatthelowestlevelinfouryears.
AsiaPacificex-Japan:RobustdespiteGlobalEconomicUncertainty
TheregionalbenchmarkindexinAsiaposteditsseventhconsecutive
weeklyadvancewithUSbudgetdeal.SurveysofpurchasingmanagersinAsiapointtowardanacceleratingmanufacturingsector.HSBCsPurchasingManagersIndex(PMI)forSouthKorea,TaiwanandIndiarosefrom48.2,47.4and53.7inNovemberto50.1,50.6and54.7respectively.ThedataindicatesthatmanufacturinginAsiaremainrobustdespiteglobaleconomicuncertainty.EU:ThePainofReform
InEurope,MarkitsPMIfortheEurozonewas47.2,aninemonthhighandanimprovementfrom46.5inNovember,despitethefigurebeingindicativeofacontraction.WhileEuropecontinuestofixitsdebtproblems,GermanChancellorAngelaMerkelcautionsthatalthoughreformsarestartingtokickin,economicconditionsarelikelytobemoredifficultin2013.Herwordsarereflectedintheunemploymentrateofalmost12%acrossEurozone,withbudgetcutsandtaxincreaseskeepingspendingandconfidencelow.
SMU Political-EconomicExchange
ANSMUECONOMICSINTELLIGENCECLUBPRODUCTION
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SouthKorea:MorethanjustaHorseDanceByAdamTan,SingaporeManagementUniversity
PsysrecentKoreanpopsensationGangnamStyle,whichhasexceededmorethanonebillionviewsonYouTubeontheverydaythattheMayanspredictedastheendoftheworld,isyetanotherfeatthatSouthKoreanscanbeproudof.ThisisasignofhowmuchSouthKorea'sinfluenceintheworldhasgrownsinceitsrecoveryfromtheAsianFinancialCrisisin1997-98.
TheAsianFinancialCrisis,whichhadseenmillionsofcitizensdonatingtheirpersonalgolddowrytothenationaltreasurytoallowthegovernmenttonegotiateaUSD58.4billionbailoutfromIMF1,remainsapainfulchapterinthemindsofSouthKoreans.Sincethen,theSouthKoreanshavenotlookedbackastheirchaebols(SouthKoreanbusinessconglomerates)havegonefromstrengthtostrengthtoemergeasthegloballeadersinmainstreamelectronicsandlifestyleinnovation.ThroughonlySamsung,LGandHyundaigroups,thesechaebolshavebusinessesspanningmultipleindustriessuchaselectronics,insurance,construction,automotiveandevenshipbuilding.Youmustbewonderinghowthishasbeenpossibleinthespanoflessthan15years.ThisistheSouthKoreanmiraclewewillbeexploring.
LeaderinInnovationExportTherewasatimewherethewords"innovation"andhighqualityseemedsynonymouswiththelandoftherisingsun,Japan;andeveryonewantedtoownaJapaneseTV.Timeshavesincechangedasthaterahasmovedpastus.Asmarketsconsolidateandweakerplayersgetweededout,JapansEastAsianneighborhasdonemorethanjustcatchingupandreplicatingJapansinventions.SouthKoreanswentonestepfurthertoimprovetheirinventions.ThisneighborhasbeenoneofthecontributingreasonstowhyJapaneseconsumerelectronicswereunderperformingsincetheturnoflastdecadeandthattrendisexpectedtocontinue.Combiningsleekandergonomicdesignswithcutting-edgetechnology,Samsung&LGhavetakenmainstageintherecentyears.Thissurgeintechnologicalinnovationforsmart
householdappliancesandmobiledevicescoincideswiththerisingpurchasingpowerofthemiddleclassinAsiawhichhasspurreddemandforqualitySouthKoreanexportsglobally.China,forinstance,isoneofthelargestimportersfromSouthKoreaandthetrendisexpectedtocontinue(seeFigure1).
Figure1:KoreasExports(Asia/China)
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WithmajoreconomiesintheworldsuchastheUnitedStatesandEuropeslowlyrecoveringfromtheGreatFinancialCrisis,Iexpectpent-upconsumerdemandfromtheseregionstocontributetoSouthKoreasincreasinglypositivetradebalance2.ThiswillbethepillarofgrowthforthecurrentdecadeforSouthKorea.InvestmentsinGrowthMarketsBesidesbeinggoodatinnovatinganddevelopingcutting-edgetechnology,theabilitytocreatedemandisoneimportantlessontolearnfromSouthKoreans.Withthefinancialcloutgatheredthroughexportingproductsaroundtheworld,SouthKoreastartedinvestinginfrontiereconomies3earlierthanmanyotherdevelopedeconomies.Vietnam,oneofthefastestgrowingfrontiereconomiesinAsia,putsthecaseinpoint.TherelationshipbetweentheseformerbattlefieldenemieshasimprovedasSouthKoreahasplayedakeyroleinVietnamseconomicprogress.ThisallowedSouthKoreacompaniestooutsourceseveralfunctionsforlowercostofproductionandinturn,createdemandfortheirownproductsinVietnamasthemiddleclassmoveupthewealthladder.ThisisjustoneofmanyexampleswithothercountriesinASEANsuchasMyanmarandIndonesiaalsobenefittingfromjointventuresinenergy,electricityandconstructionprojects.WithanincreasingfocusonAsiaasanewenginetodrivegrowth,buildinglongtermsustainablerelationshipsearlywithneighborsisessential
andinthiscase,theSouthKoreanshavedonetherightthing.PossibleHeadwindin2013
TherearetwosidesofacointotheSouthKoreanmiracle.Risingtensionsincetherecentballisticmissiletestbytheirinfamousneighbour,NorthKorea,hasalwaysbeenathornintheirside.DoubtswereraisedbypoliticalanalystsafterNorthKoreanleaderKimJong-UnseemedtosignalthewilltoreducetensionbetweentheNorthandtheSouthinhisrecentNewYearpublicspeech.However,itisbelievedtobelinkedtoafurthercallforaid.Personally,Ibelieveittakesmorethanjustthewillbutalsoasignificantlylongperiodoftimetodissolvethelongstandinganimosity.Newly-electedPresidentParkGeun-Hyehasbigshoesleftbyherfather,formerPresidentParkChung-Hee,tofillastheworldkeeptheireyesonhowshewillattempttoengagetheircounterpart,KimJongUn.ThiscanpossiblyderailtherecentsurgeininvestorsconfidenceinSouthKoreancompaniesaspoliticalriskremainssomethinghardtodiversify.However,apartforthislongtermpoliticalissue,SouthKorearemainsasoneofAsiashopesofdrivingglobalgrowthandiscertainlymorethanjustafamoushorsedance.
Sources:IMF,Worldbank
1Internationalorganisationwhichaimstopromoteglobalmonetaryandexchangerate
stabilitytofacilitategrowthofinternationaltrade.
2Tradeaccountusedtotrackforeigntradevalueinflowsandoutflowsinanations
accounting.
3Subsetofemergingmarketeconomywithlowermarketcapitalizationsandliquiditythatoffersplentyofopportunitiestogeneratehigherexcessreturnsforinvestors.
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Figure2:IncreasingSpreadbetweenNYMEXCrudeOilandNaturalGasPrices
Source:ICIS
Sofar,themainimpactofcheapnaturalgasintheUShasbeenfordomesticelectricity
production.Coalfiredplantsarebeingclosedinfavorofnaturalgasfiredplantsatarapid
rate.From2007to2012,electricitygenerationfromCoalhasdecreasedby25%whileNatural
Gasincreaseditscontributionto35%.
TheFutureofNaturalGasExports
Figure3:December2012SpotPrice($mmBTU)
Source:FederalEnergyRegulatoryCommission
Inthenearterm,thebiggestquestiononeveryonesmindiswhethertheUSwillexport
naturalgas.Asthechartaboveshows,naturalgaspricesinothercountries(especiallyJapan)
areseveraltimeshigherthanintheUS.Japan,whichhasreliedonexpensiveLiquefied
NaturalGasimportsforelectricityproductioninthewakeoftheFukushimanuclearplant
incident,wouldbeaprimecandidateforUSgasexports.
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However,evenasdomesticproducersareprimingthemselvestoexportgas,theUS
governmenthasshownreluctancetograntexportpermits1becauseofpoliticalpressuresto
keeppriceslowforconsumers,domesticmanufacturers,andthepetrochemicalindustry.Only
onefirm,CheneireEnergy,hasreceivedapprovaltoexportLiquefiedNaturalGas(2billion
cubicfeet/day)andhasstartedbuildingamulti-billiondollarLiquefiedNaturalGasterminal
inSabinePass,Louisiana.Morethantenotherfirmsarewaitingforthegovernments
approvalandhaveappliedtoexportatotalof27.58billioncubicfeet/daytocountrieswitha
freetradeagreement2,whichismorethanthecurrententireoutputofUSshalegas.
Myviewisthatexportingnaturalgasisnotthesurearbitrage3opportunitythatmanywould
haveyoubelieve.Unlikeexportingoil,therearelargecostsinvolvedinprocessingand
transportingnaturalgas.Liquefaction,shipping,andterminalcostsarelikelytoadd$3.80and
$5.76tothepriceofgasexportedtoEuropeandJapanrespectively.Thismorethandoubles
thepricethatnaturalgastradesatintheUStoday.Furthermore,withnaturalpriceslikelyto
hoveraround$5whenexportterminalsbegintocomeonlinein2015andpriceofWTIcrude
tocomedowntoabout$80(moreinlinewithhistoricalratios),themarginslookincreasingly
small.InEurope,naturalgassuppliedbypipelinesfromRussiawillprovideseriouscompetitiontoAmericanimports.Exportsarestilllikely,particularlytoAsiancountrieslike
Japanwhowillwanttotiedownlong-termcontractsfornaturalgas.
PotentialRustBeltRevival
OneinterestingdevelopmentintheUSisthereturnofrustbeltmanufacturingandindustrial
firms.CompanieslikeShellhavestartedtoexploretheoptionofbuildingmultibilliondollar
chemicalplantswhichusenaturalgasasfeedstocktoproducefertilizersandchemicalsnear
naturalgaswellsinPennsylvania(hometotheMarcellusshalewhichcurrentlyhasthelowest
costofproductionandliquidrichgas).Energyintensiveindustrialactivitieslikealuminum
smeltingarealsooptionsthatcompaniesarehopingtoestablishneargas-producingregions.
Willproductioncontinuetoincrease?
ShalegasishailedinmanyquartersasthekeytoAmericanenergyindependenceandagame
changerfortheUSeconomy.Afterall,thegrowthinnaturalgasproductionoverthelastfew
yearshasheavilyreliedonshalerockplays,whichcurrentlyrepresentapproximately30%of
allgasproduction.However,evenaslargeinvestmentsweremadein2012foreignoilmajors
likeFrancesTotalandNorwaysStatoilinUSShale-rockformations,shalegasproduction
begantoplateauinearly2012,andtherearesignsthatitspotentialmaybeoverstated.
Stagnatingproductionlevelsaremostlyduetorecordlowgasprices.At$3,itisunprofitable
toextractnaturalgasfromalmosteveryknowngasfield.Manyshalegasoperatorsare
drillingatbelowthe$5to$6necessarytobreak-even(costsalsoincludeleasing,exploration,
anddevelopment).Furthermore,simplykeepingoutputconstantrequiresconstant
explorationandproductionbecausewelloutputdecreasesbyabout50%afteroneyear.
Atthesametime,overstatedshalegaswellproductivitycastsdoubtuponclaimsthatthereis
aproven100yearsupplyofnaturalgasintheUS.Thefirstproblemisthatshalegas
extractionisrelativelynewandtherearefewcrediblemodelsaboutextractionvolumesinthe
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longrun.Producersoftenreportinitialextractionflowratesinsteadofaverageones,or
estimatelongerlifespansforwellsthanislikely.Furthermore,USEnergyInformation
Administrationdatashowsthatthereisonly11yearsworth(atcurrentconsumption)ofgas
inprovenreserves.Therestofitisfromprobable,possible,andspeculativeresources.
Sources:ConsumerEnergySolutions,Factset,FederalEnergyRegulatoryCommission,ICIS,
Forbes,PFCenergy,WSJAnalysis
1Alegaldocumentthatisnecessaryfortheexportofgoodscontrolledbythegovernment.
2Atreatybetweentwoormorecountriestoestablishafreetradeareawherecommerceingoodsandservicescanbeconductedacrosstheircommonborders,withouttariffsorhindrances.
3Takingadvantageofapricedifferencebetweentwoormoremarkets.
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ChinasmuchneededeconomicreformByWongShou,SingaporeManagementUniversityFinally,theglobaleconomiccrisishastakenatollonAsiasbiggesteconomy.Theongoing
EuropedebtcrisisandtheweakeningAmericaneconomyhavehamperedChinasexport
market,contributingtoitsdecreasingGDPgrowthratesover7consecutivequarters.Chinas
decliningperformance(9.8%y/yincreaseinGDPin1Q11to7.4%in3Q12),alongwithitsvulnerabilitytowardsexternalshockshassetalarmbellsringing.Tobettershelterthe
countryfromtheoverseasbrewingstorms,Chinarecognizesthatitneedstorebalanceits
economicstructure.Thisreformwillseeitseconomyshiftfromonethatreliesheavilyon
investmentandexports,toonethatsdrivenlargelybydomesticconsumers-anditsnew
leadershavetoactfast.
Figure1:ChinasActivitiesasaPercentageofGDP
Source:CEIC
Domesticconsumptionhasbeenonadowntrend,andin2011,itaccountsforonlyamere
34%ofChinasGDP.Chinaslowconsumptionandhighlevelofinvestmentshighlightthe
internalimbalancethatiscurrentlyplaguingthecountry.TheChineseleadershavelong
acknowledgedthisfundamentalproblemanddiscussionshavetakenplacewithinthepartyto
implementpoliciestodevelopamoremarket-orientedeconomy.Thisis,however,abig
challengeforthecountry,aswehaveseensomeresistancefrompoliticalfiguresandbusiness
elitestopreventlosingthecurrentmodelthathasbenefitedthemwellovertheyears.
OverinvestmentinGrossCapitalFormationinChina
At48%,ChinasinvestmentasapercentageofitsGDPisexceptionallyhighrelativetoboth
thedevelopingBRICcountriesandleadingdevelopednations.Thetwomainfactorsbehindits
highlevelofgrosscapitalformationinChinacanbeattributedtotheroleofstate-owned
enterprises1(SOEs),aswellasitsover-relianceoninfrastructureinvestment.
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Figure2:GrossCapitalFormationasapercentageofGDPbycountries(2011)
Source:Worldbank
RoleofSOEsinChina
Chinaisknowntobeagovernmentledeconomy,whereafewpowerfulSOEsdominatein
theirrespectivesectors.AccordingtoNomuraBank,theseSOEsemployabout21%ofthe
workforce,produced27%ofindustrialoutput,andcontrolamassive44%ofcapitalstocks,
despiteaccountingforonly4.7%ofthetotalnumberoffirmsinthecountry.Notonlydothey
receivehugesubsidiesfromthegovernments,thefinancialsystemalsoprovidesthemwith
preferentialcreditterms,givingthemaccesstocheapcapitaltofueltheirinsatiableappetite
forcapitalinvestments.TheauthorityandpoweroftheseSOEshavetobescaleddown,and
suggestionshavebeenmadetoincreasetherequireddividendpayoutsfromthesecompanies.
Thisis,however,easiersaidthandonegiventhatthepastdecadesofcapitalcronyism2and
nepotismhavecomplicatedtherelationshipbetweenthegovernmentandSOEs.Whether
Chinacansuccessfullyoverhaulthisinefficientmodelultimatelydependsonthepolitical
stomachofitsnewgenerationofleaders,andmanyobserverswillbemonitoringthe
leadershipofXiJinpingintheupcomingyears.
Over-relianceonInfrastructureInvestment
Asaresponsetotheglobaleconomiccrisisin2008,thegovernmentimplementedaRMB4
trillion(USD586billion)stimuluspackage,ofwhich38%ofitwenttopublicinfrastructureinvestment.Furtherexacerbatingtheimbalanceisthefactthatthebigcommodities,
transportationandconstructioncompanieswhobenefitedfromthisstimulusaremostly
SOEs.InSep12,withtheoutlooklookinggrimmerandtheimminentriskofahardlanding,
theChinesegovernmentannouncedanadditionalRMB1trillion(USD160billion)worthof
infrastructureinvestments.DespiteChinashighrelianceoninvestments,capitalformation
willbelikelytocontinueitsgrowthasthecountryacceleratesitsinfrastructureprojectsto
supportitrapidurbanizationprocess.Further,withglobaleconomicconditionsunlikelyto
improvein2013,Chinaisexpectedtocontinueitsinfrastructureinvestmentasameanto
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driveitseconomy.Unfortunately,itseemslikeChinasrebalancingprioritieswillbetakinga
backseatyetagain.
Consumptionasamainsourceofdriver
Figure3:ConsumptionasaPercentageofGDPbyCountries(2011)
Source:Worldbankdata
Withthelargestpopulationintheworld,itshardtofathomhow1.3billionpeopleconsume
only34%ofthecountrysGDP.Partofthereasonisduetothecountrysill-equippedsocial
welfaresystemthathasforcedhouseholdstoincreasetheirprecautionarysavingsforfuture
expenditure.Ontopofthat,Chinasimmaturefinancialsystemprovidesonlystingyreturnson
investments,anditsxenophobicpolicieshavelimitedcompetitionwithintheeconomyanda
misallocationofresourcesskewedhighlytowardslocalfirms.Allthesefactorshaveplayeda
partinincreasingdomesticsavingsaswellassuppressingthepotentialgrowthofhousehold
disposableincome-thetwomainreasonsbehindthecountrysdecliningconsumption.
Fortunately,therequiredreformstoempowertheChinesehouseholdsfacefewerheadwinds,
andthegovernmenthasbeenactivelyunravelingplanstoliberalizethefinancialsystem,
increaseforeigninvolvementintheprivatesector,andrestructurethesocialsystem.For
instance,ChinahaspledgedtoallowforeignfirmstoincreasetheirstakeinChinesefinancial
servicefirmsfrom33%to49%tointroducemorecompetitioninthesecuritiessector.Other
policiesthatareinthepipelineincludeanapprovaltoincreaseminimumwageatanannualgrowthrateof13%until2015.Suchinitiativeswillcertainlyseedomesticconsumers
benefitingfromamorecompetitiveandmarket-orientedeconomy,wherehigherdisposable
incomeandalowerpropensitytosavewilltranslateintohigherconsumption.
Challengesandoutlook
Atatimewheretheneedforeconomicreformisevermoresoimportant,Chinastillfacestwo
inherentchallengesinthisendeavor.First,thepoliticalreluctanceanddifficultiesthatofficials
faceintheirattempttorestructuretheSOEsandredefinetheirroles.Second,theincreasing
infrastructureinvestmentamidstthebleakeconomicconditionsandrapidurbanization
process.Itislikelythatinvestmentspendingwillcontinuetoremainhighintheshorttermas
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Chinacontinuestofenditselfagainsttheadversityoftheglobaleconomiccrisis.Aslongas
investmentsdonottaperoff,thegoalofachievingaconsumptiondriveneconomyremains
quiteadistanceawayevenifconsumersareincreasingtheirspending.Ultimately,consensus
amongtheChineseleaderswilldeterminetheoveralldirectiontheeconomyisheading
towards.Withanewleaderatthehelmoftheparty,politicalobserversareconfidentthatXi
Jinpingwillembarkonthiseconomicoverhaulsomethinghispredecessorhasfailedto
accomplish.However,thenewreignhasonlyjustbegun,andstrongerandmorepositivesigns
havetobewitnessedbeforetheeconomicintentionsofthenewgenerationofleaderscanbe
ascertained.
Sources:WallStreetJournal,NewYorkTimes,China2030WorldBankReport
1Alegalentitythatiscreatedbythegovernmentinordertopartakeincommercialactivitiesonthegovernment'sbehalf.
2Aneconomyinwhichsuccessinbusinessdependsoncloserelationshipsbetweenbusinesspeopleandgovernmentofficials.Itmaybeexhibitedbyfavoritisminthedistributionoflegalpermits,governmentgrants,specialtaxbreaks,orotherformsofdirigisme.
3China'srapideconomicgrowthinrecentyearshasoftengivenrisetospeculationaboutthepossibilityofahardlanding,inwhichtheeconomyslowsdownfromadouble-digitratetoagrowthpaceinthelowsingledigits.ThiscouldoccurifmeasuresbytheChinesegovernmenttotightenmonetarypolicyslowdowngrowthfasterthanitexpects,orwouldlike.
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TheS&P500isafree-floatcapitalization-weightedindexpublishedsince1957ofthepricesof500large-capcommonstocksactivelytradedin
theUnitedStates.IthasbeenwidelyregardedasagaugeforthelargecapUSequitiesmarket
TheMSCI Asiaex JapanIndex is a freefloat-adjustedmarket capitalization indexconsisting of10developedand emergingmarket country
indices:China,HongKong,India,Indonesia,Korea,Malaysia,Philippines,Singapore,Taiwan,andThailand.
The STOXXEurope 600 Index is regardedasa benchmark for European equity markets. It represents large, mid and small capitalization
companiesacross18 countriesof theEuropean region:Austria,Belgium,Denmark, Finland,France,Germany,Greece,Iceland,Ireland,Italy,
Luxembourg,theNetherlands,Norway,Portugal,Spain,Sweden,SwitzerlandandtheUnitedKingdom.
Correspondents
VeraSoh(VicePresident,Publication)Vera.soh.2011@economics.smu.edu.sgSingaporeManagementUniversitySingapore
JiaWeiNg(VicePresident,Operations) [email protected] SingaporeManagementUniversitySingapore
SamuelOng(PublicationsDirector/Editor)[email protected]
Singapore
ShreyaChatterjee(MarketingDirector)[email protected]
Singapore
YingyuZeng(LiaisonOfficer)Yingyu.zheng.2010@economics.smu.edu.sgSingaporeManagementUniversitySingapore
DarrenGohXianYong(Editor)Darren.goh.2010@business.smu.edu.sgSingaporeManagementUniversitySingapore
AdamTanKianHungadam.tan.2009@business.smu.edu.sgSingaporeManagementUniversity
Singapore
WongShouYeesywong.2010@business.smu.edu.sgSingaporeManagementUniversitySingapore
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