At NUS Business School in Singapore almost two years ago, we identified the causes of the crisis in the eurozone as overleveraging and overspending, and argued that a period of belt tightening was necessary for Europe to survive the crisis.
Then a year and a half into the crisis, we noted that no effective fiscal disciplinary measures had been undertaken in Europe. The logical roadmap to recovery which had been identified, and which we had endorsed — namely a supra-national policy of solvency measures in Europe similar to the Brady plan for Latin America in the 1980s, coupled with economic growth-boosting policy reforms and innovation-fostering measures, as recommended by MIT’s Daron Acemoglu for the US’ recovery — is yet to be implemented.
The outcome has been as expected: Two years into the crisis, at the mid-year mark in 2012, Europe is indeed in deep denial and recession, and uncertainty looms large in both its policy spheres and decision-making ability.
In Asia, economic performance during this period has been mixed. On the positive side, China’s growth is still relatively robust, if one factors in the reduced capacity of the developed markets over the last two years. This has been aided by growth-oriented policy coordination, exemplified by the recent judiciously-timed rate cut, along with slowing inflation and the continuous and gradual winding down of real estate prices.
China has been impacted only modestly by the slowdown, and is now positioned to begin a consolidated phase of growth leadership in Asia. It will see more overseas direct investments by capital-rich Asian entities, while attracting foreign direct investments (FDI) into the region on a renewed basis once the crisis abates. This will continue to be very good for Asia as a whole.
On the other hand, India has had a difficult year with some observers criticising the Indian government’s competence (or lack thereof) to overhaul the economy through much-needed reforms and liberalisation. Some have referred to this economic and bureaucratic malaise as the harbinger of “India’s Lost Decade”.
However, we feel that this is merely an interruption, not a derailment of its growth story. In the short term, it has witnessed a dramatic fall in its currency to nearly 40 per cent off its 2007 peak, with an exodus of investor capital from its equity markets. Since the Indian economy is not export driven, especially on the industrial output side, the rupee’s precipitous decline has not resulted in huge orders. This, coupled with depressed demand from Western markets for services and outsourcing, has left it in a position where it gains no advantage from the depreciation in the value of its currency.
Though it had grown robustly all through the past decade and dramatically post-2005, the problem facing India since 2009 has been stubborn cost-push inflation. This was driven, ironically, by improved efficiencies in rural supply chains, increased incomes and income expectations in rural areas, improved negotiating skills applied to these supply chains, and consequently, sharply increasing costs of goods, including food prices.
The Reserve Bank of India, India’s central bank, had few options but to raise interest rates, which would have been effective had the inflation been demand-pull. The consequence of the continuous rate hikes for the last two years has been logical — no significant mitigation of inflation but the short-term dramatic slowdown of growth to less than 5.5 per cent. The equity market has responded negatively to the slowdown in the real economy, driving itself to nearly 25 per cent off its 2010 high and continues to do so.
On the bright side, however, none of the problems that India faces are structural, institutional or insurmountable. A few judicious fiscal and monetary policy realignments should bring the Indian growth story back on track by next year. It would necessitate rate cuts, coupled with the softening of the commodity market and a timely monsoon, which has already commenced. This will attract the portfolio investor back to India by 2013-14, who will participate in the market’s second secular bull run.
Singapore is ideally positioned to benefit from both these phenomena in China and India. Singapore’s real estate market should gradually rationalise, in line with the gradual winding down of real estate prices on the Chinese mainland and Hong Kong. The domestic banking sector is in the process of building and consolidating its market share in the presence of weakened global competition.
Looking ahead, the financial services sector in Singapore will be robust and ready itself for its role as the managing hub for renewed capital flows into the region. Additionally, the Association of Southeast Asian Nations (ASEAN) continues to demonstrate economic resilience throughout the post-financial crisis era, remains attractive as a low-cost destination for investment and production, and now contributes over 2.5 per cent of global GDP with 10 per cent of the world’s population,
In summary, with private equity continuing to be focused on China, portfolio investment returning to India, and ASEAN’s good prospects, we expect 2013-14 to be a banner year for the markets across Asia.
The worry, however, continues to be the eurozone. In light of recent events, there seem to be three terminal policy options developing in Europe: Robust survival, anaemic survival or breakup of the eurozone.
Let us consider each:
Currently, the option of robust survival is still viable. However, the priority needs to be refocused on solvency and growth instead of liquidity. In that context, one or two country-guaranteed structures must be speedily replaced by an overarching supra-national guarantee structure, the most obvious being an International Monetary Fund (IMF) structure. We again endorse a debt restructuring program under the aegis of the IMF or a similar body.
In that event, we anticipate a robust European inter-country credit spread market to develop on the back of formerly nonperforming sovereign fixed income assets restructured into tradable securities. This option, if assiduously pursued, would organically deliver policy coordination, and importantly, orderly and relatively painless recovery similar to the Latin American experience. The restoration of robust markets and demand would be an excellent situation for investment cash flows finding their way back into Asia.
In the event that the eurozone does not break up, and neither decisive fiscal discipline nor economic growth policies are introduced, we can expect to see its anemic survival. This will mean a situation with continued weakening and contagion, with funds moving decisively away from the uncertain investment terrain of the eurozone. The beneficiary of this capital flight must necessarily be Asia, given the relative growth and returns that it will continue to deliver.
The final option, that of the breakup of the eurozone, would leave two clearly demarcated groups in Europe: developed and emerging.
The former, which would be highly rated, well capitalised, with a strong set of currencies, would invest in returns-generating assets worldwide all over again. The second group would be in the nature of the higher-rated emerging markets, and compete with countries like China and India for investment funds.
The result may not be the best option for Asia because a good portion of the funds destined for Asia may find their way into emerging Europe instead. However, in terms of the real economy, it may be a positive development for both China and India, as demand for both manufactured goods and services should pick up, and hence deliver returns, market growth and both private equity and listed equity portfolio investment to the region.
At the vantage point of mid-year 2012, our review of the policy responses to the eurozone crisis shows that Asia’s preferred option would still be the robust survival of the eurozone, albeit the other (dominated) options need not be too large a cause for concern either, both from an FDI and portfolio investment perspective.
In summary, Asia should remain resilient through the scenarios that will unfold through the rest of 2012 and into 2013-14.
This commentary first appeared in the China Daily Asia Weekly, June 15-21 2012