There is an irony to the recent sell-off in emerging markets. It’s the result of a rare dose of uplifting news from the developed world: the US economy is showing enough strength to prompt the Federal Reserve to signal a paring back of its quantitative easing program.
In tumultuous times such as these we must look at the economic fundamentals to separate the ‘signal’ from the ‘noise’.
The key question today is: are the emerging markets fundamentally broken, or is this a brief phase where investors re-adjust their portfolios in light of the US recovery becoming more sustainable?
“It should not come as a surprise that economic reform, rather than economic stimulus, is all the rage in Beijing”
In Asia, the downward re-assessment of trend growth in China is seen as a potential trigger for a region-wide downturn. And rising debt levels among Asian governments, companies and consumers following the 2008-09 global financial crisis have raised concerns.
But how worried should we really be?
China is overseeing a soft landing
In China, the government is overseeing a so-called soft landing for the economy. Its aim is to restructure the economy from one which is driven by high levels of investment and exports to one driven by local consumption. China’s current model of growth has long been recognised as unbalanced, uncoordinated and unsustainable.
Therefore, it should not come as a surprise that economic reform, rather than economic stimulus, is all the rage in Beijing today. Policy makers have now set a 7 per cent annual growth target for the medium term. Unless there’s a significant deterioration in the economy, they are likely to focus on broader issues which include promoting urbanisation, fostering a level playing field for the private sector and upgrading social services such as education and health care.
So what of the concerns about debt levels across Asia?
A recent study by Standard Chartered shows the need for carefully nuanced analysis of this issue. Differentiation is vital; painting all of Asia with the same brush could lead to wrong conclusions.
Current leverage levels are broadly manageable
After years of rapid economic growth, Asia’s (excluding Japan) overall debt-to-GDP ratio has just reached the world average. However, our study of debt and solvency across corporate, household and government sectors in Asia demonstrates that current leverage levels are broadly manageable – with areas of concern and pockets where leverage can still rise to generate faster growth.
“Unlike most other major economies, China has sufficient financial means to inject capital and restructure its problem lenders”
China’s leverage is the most worrisome. However, the concern arises not from its overall credit-to-GDP ratio of 214 per cent, which places it only fifth among the Asian countries in our study. Rather, the concern is that debt is concentrated in the corporate sector.
The redeeming feature here is that the government has started to tackle this issue by slowing growth and curbing lending to industries facing overcapacity. In the event of a significant deterioration in the economy, problem loans are likely to surface and some banks may have to be recapitalised. But unlike most other major economies today, China has sufficient financial means to inject capital and restructure its problem lenders.
Household leverage is still low across most of Asia
There is also a longer-term positive story in Asia, which receives little attention, but will help the global economy to rebalance. Household leverage across most of Asia – particularly in China, India and Indonesia – remains low and has the potential for growth.
Indonesia’s credit expansion has recently accelerated, but the country still has a relatively low level of aggregate debt to GDP, giving it room to use leverage to boost growth. While India’s high government debt is a concern (which the authorities are addressing), household debt is relatively low. Taiwan’s total leverage is relatively benign.
In ASEAN (Association of South East Asian Nations) stresses are confined to household credit in some economies. Malaysia’s household leverage is high, as is Singapore’s on some metrics. However, the household sector in both countries has accumulated large liquid assets through mandatory savings. The Philippine economy – an outperformer in Asia – has plenty of room to expand its private sector leverage to boost domestic consumption and sustain growth.
Asia’s fundamentals are robust
Our study shows that while there are pockets of emerging concern, Asia’s fundamentals remain robust. Strong government and household balance sheets and still-high economic growth rates across most of the region provide sufficient flexibility to counter inevitable bumps as the economic cycle turns.
Learning from Asia’s financial crisis in 1997-98, governments in the region have been using macro-prudential policies since before they were considered to be best practice. Hong Kong and Singapore are prime examples of how such measures have been used to curb property price increases. We see scope for several Asian economies to increase borrowing to maximise their growth potential.
In light of this assessment, the current turmoil in the emerging markets should prove transitory for Asia. It does provide a timely opportunity for cleaning up stressed balance sheets in parts of the region, but it also sets the stage for the next phase of more durable and sustainable growth.
The recovery in the US, which has triggered the latest round of soul-searching, combined with Japan’s revival, should be seen as an added bonus, not a detraction, for emerging markets and the wider global economy.
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