Asia Pacific Economic Outlook

In thIs Issue:

China Japan Malaysia Taiwan Vietnam

February 2012

China

Chinas economy seems headed for a soft landing.

In the fourth quarter of 2011, real GDP was up 8.9 percent over the previous year. This was the slowest rate of growth since 2008, but it was relatively strong nonetheless. Further news in January showed an economy growing but at a more modest pace than before. During the Lunar New Year holiday in January, retail sales were up 16 percent over the previous year. This compares to growth of 19 percent during the Lunar New Year of 2011. The January 2012 figure was the slowest rate since 2009. The governments purchasing managers index for manufacturing was up slightly in January, reflecting a slight and modestly paced acceleration in manufacturing output. Finally, price pressures have diminished. In December, consumer price inflation was 4.1 percent, down from above 6 percent during the summer. This was the lowest rate of inflation in 15 months. It reflects the impact of last years tightening of monetary policy. It also reflects the effects of dampening global commodity prices. Remaining imbalances Despite the slowdown in growth, there remain some imbalances in the economy. In the fourth quarter, investment in fixed assets was up 23.9 percent. This means that investment continued to expand as a share

of GDP and accounted for a disproportionate share of the increase in GDP. It reflects ongoing local government spending on infrastructure and continued spending by state-run companies on expanding capacity. It also reflects a continued rise in property development. There are, however, indications that property investment is starting to diminish. In December, home sales were up only 10 percent, the slowest rate of increase since 2008. In addition, home prices were down 6.9 percent over the previous year, reflecting tighter credit conditions in the housing market. In any event, it is not possible for investment to sustain economic growth in the long term. Property investment is already decelerating, and it is likely that other forms of investment will likely decelerate in the near future. Instead, there may be a to boost consumer spending. It would also help if there were a boost to investment by private sector companies, especially smaller businesses. Consequently, the government has introduced incentives for bank lending to small businesses. It has also authorized banks to increase their overall lending, including lending to consumers. Although monetary policy has been loosened in recent months, the central bank has chosen to keep interest rates and the required reserve ratio unchanged during its most

Asia Pacific Economic Outlook February 2012

The IMF issued a warning that, should Europe sink into a deep recession, Chinas economic growth could drop by 4 percentage points. That would be catastrophic.
recent deliberations. The government appears to be in a wait-and-see mode, not wanting to curtail growth but still wanting to curtail inflation. In addition, the government remains interested in a gradual bursting of the property price bubble. House prices have fallen, but some officials have said that a further decline in property prices would be beneficial, enabling more households to afford a home purchase. Currency issues One of the more interesting pieces of economic data lately was the decline in foreign currency reserves in the fourth quarter of 2011. This was a surprise and was the first time since 1998 that reserves declined. The decline was small a drop of $3 billion out of a total of over $3 trillion in reserves. Still, it was significant. For the past decade, China has accumulated reserves in order to prevent the currency from rising in value. Rather than allowing currency appreciation, the central bank met the excess demand for renminbi by supplying that renminbi to the market. In exchange for supplying renminbi, China purchased foreign currency. Yet, in the fourth quarter of 2011, China accumulated no foreign currency, and still, the renminbi did not appreciate. That means that there was no excess demand for renminbi. It means there was no flow of hot money into China. Indeed, there was an outflow of capital. One of the problems with accumulating foreign reserves is that, in the process, China has been boosting its money supply. Thus, the focus on maintaining the exchange rate has interfered with Chinas ability to manage its own money supply and control inflation. Now, with the currency stabilizing, even in the absence of currency market intervention, China can focus on domestic considerations and leave the currency alone. Still, over time, it is likely that the renminbi will appreciate further in the absence of intervention. That would be a good thing in the long run as it would suppress inflation and boost Chinese purchasing power. It would also help to facilitate a transition away from export orientation. External headwinds Finally, China remains concerned about Europe. The leadership has indicated a willingness to participate in efforts to stabilize Europes financial system, probably through the IMF. The decline in European demand already had a negative impact on Chinas export growth. The IMF issued a warning that, should Europe sink into a deep recession, Chinas economic growth could drop by 4 percentage points. That would be catastrophic. Conventional wisdom holds that China needs to grow at least 78 percent per year in order to absorb new entrants and migrants into the labor force. For now, a deeper recession in Europe possibly the result of a collapse of the Eurozone seems unlikely. But such a scenario cannot be ruled out. The IMF also said that, should China face a serious decline in growth, a big fiscal stimulus would be warranted.

Asia Pacific Economic Outlook February 2012

Japan

Japan experienced a troubling dearth of positive news in 2011.

In the first quarter, a devastating earthquake and tsunami resulted in widespread destruction in the northeastern part of the country. Natural disaster was promptly followed by the threat of a nuclear disaster, which resulted in industry shut downs, supply chain disruptions, and plummeting manufacturing output. The Japanese economy contracted during the first half of the year, but by the end of Q3 2011, it staged a remarkable but short-lived recovery before showing signs of a slowdown in the fourth quarter. Weak exports, an unfavorable job market scenario, and supply chain disruptions resulting from floods in Thailand were a drag on GDP growth in Q4 2011. The Eurozone crisis and the resulting repercussions on the world economy remain significant risks for the Japanese economy. Moreover, the outlook for the U.S. economy isnt very strong either. These external factors, combined with the yens relentless appreciation, may take a heavy toll on Japans export-dependent economy. Although an uptick in retail sales partially compensated for lower exports in December 2011, retail sales are unlikely to drive GDP growth in the coming months. As employment benefits expire, Japans labor market may also experience

higher levels of unemployment and wage loss. As a result, domestic demand may be sluggish throughout the year. A major problem that plagues the Japanese economy is the rise of the yen, the consequences of which have been several-fold. First, the appreciating yen has directly impacted Japans export competitiveness. Exports declined during Q4 2011, and this downward trend is likely to persist in 2012. Owing to declining exports and rising fuel imports, Japan is expected to run a trade deficit in 2011 for the first time since 1980. Second, the decline in exports has a huge impact on Japans economy and, in particular, the manufacturing sector. Finally, a rising yen accentuates Japans deflationary environment. Japans core CPI recorded a 0.1 percent decline in December 2011 after declining 0.2 percent in November and 0.1 percent in October. While mild inflation may help revive the Japanese economy, whether the CPI will experience an uptick in the near future remains uncertain. Furthermore, given the current state of the U.S. economy and the weak outlook for Europe, the yen is likely to continue on its upward path against the dollar and the euro. Meanwhile, the initiation of the Trans Pacific Partnership (TPP) between the United States, Australia, South Korea

Asia Pacific Economic Outlook February 2012

Owing to declining exports and rising fuel imports, Japan is expected to run a trade deficit in 2011 for the first time since 1980.
and other countries in Southeast Asia may be a bitter but helpful pill for Japan. The TPP has the potential to liberalize trade and bolster relations between member countries. However, Japans interest in joining the group drew mixed reactions domestically. Several industries within Japan are wary of losing protection against foreign competition and will likely lobby against Japans membership. The U.S. auto industry has also expressed its concern in allowing Japan to join the TPP, citing structural barriers in Japans economy that cannot be corrected through trade agreements. In their view, Japans membership will hurt the U.S. manufacturing sector.1 On the other hand, various businesses both within Japan and outside have welcomed the decision. While the move could benefit the Japanese economy, the Prime Minister will likely face several challenges in obtaining parliamentary approvals. On the upside, its possible that reconstruction activity could keep the economy afloat in 2012. Furthermore, Japans auto sector output is likely to accelerate. According to a poll conducted by Reuters, many analysts anticipate that the impact of reconstruction spending will wane as the year progresses. However, Chinas economy is expected to recover during the latter part of the year and may provide some support to the Japanese economy. Overall, growth expectations for 2012 are muted compared to initial forecasts. So far, Japans recovery isnt living up to expectations. Moreover, excessive reliance on exports does not augur well for the countrys economy. Inherent weaknesses in the global economy could potentially have negative effects on Japans export and financial sectors. The situation could turn for the worse if the external environment continues to deteriorate. While an uncertain global macroeconomic environment poses downside risks, news from Japan may improve in 2012.Reconstruction expenditure, including infrastructure projects and tax-breaks for companies will likely support economic activity, allowing Japans economy to grow 1.52.0 percent.

Auto Industry Argues Against Including Japan in TPP, Highlights Currency. Inside U.S. Trade 30:3. 20 January 20, 2012.

Asia Pacific Economic Outlook February 2012

Malaysia

Asian economies have long been supported by two pillars of growth: exports and domestic demand. With weak export demand from the West and the possibility of another recession, the era of export-led growth may be coming to an end.
Malaysia is one of the most export-dependent countries among its Asian peers and thus remains vulnerable to headwinds from abroad. Exports have already begun to show signs of deceleration, and given weak global economic conditions, this trend is unlikely to improve in the months to come. In the light of dwindling exports, domestic demand may play a key role in propelling the economy in 2012. The Malaysian economy started the new year on a positive note. The central bank announced that, given stable price conditions, it will maintain its overnight policy rate at 3.0 percent to ensure liquidity in the economy. It also announced steps to liberalize its markets for domestic foreign exchange and interest rate derivatives. These measures include allowing residents to trade in foreign currencies through licensed onshore banks. Further, these banks will now be permitted to offer ringgit-denominated interest rate derivatives to non-bank non-residents.

According to the central bank, these measures are expected to increase the liquidity, depth and participation of a wider range of players in the domestic financial markets. Analysts regard this as a positive signal for the internationalization of the ringgit, which will likely also encourage foreign investment by allowing banks to offer innovative products. Aside from increased financial activity, infrastructure contracts and the completion of already-commissioned projects under the governments Economic Transformation Program (ETP) will likely sustain investment momentum this year. In the run up to elections, cash handouts, salary hikes, and subsidies will likely improve domestic consumption. The government announced a one-time cash handout of RM500 ($157) for households with incomes below RM3,000 per month. This is in addition to pay increments ranging between 7 and 13 percent for 1.4 million civil servants effective January 1. Moreover, the government has more than doubled its subsidy on sugar to combat higher import prices, pushing the total subsidy bill up to RM33.2 billion for this year. Private consumption accounts for more than half of Malaysias GDP, and a boost to consumer spending in 2012 will bode well for the economy.

Asia Pacific Economic Outlook February 2012

Unlike the heyday of export-led expansion, Malaysia and its peers will now have to turn inward in order to achieve economic growth.
Despite an expected boost to domestic demand, the outlook for the economy is mixed. The manufacturing sector has displayed weak performance in the last few months. Malaysia is widely regarded as a springboard for electronics and electrical goods (E&E) re-exports, which also make up a bulk of the local manufacturing industry. In November, industrial production growth slowed to 1.8 percent year-over-year from 2.9 percent during the preceding month. In particular, production of E&E goods contracted by 0.4 percent, following a decline of 1.0 percent in October. Analogously, exports of E&E goods dropped by 3.5 percent year-over-year during the same month. Exports on the whole have experienced a slowdown owing to slump in demand, especially in the global electronics industry. The aftermath of weather-related supply disruptions in Japan (an important market) made matters worse. In November 2011, export growth slowed down to 8.0 percent year-over-year compared to 15.4 percent recorded in October. Imports, on the other hand, were up 8.4 percent year-over-year, more than twice the 4.4 percent pace observed during the previous month. China, Japan, and Singapore are among Malaysias top trading partners, and recently, damp demand conditions in these countries have hurt Malaysian exports. Furthermore, since the EU and the United States together account for around 20 percent of Malaysias exports, worsening economic conditions in the West pose considerable downside risks to Malaysias external sector in the months to come. Thus, unlike the heyday of export-led expansion, Malaysia and its peers are now faced with the prospects of having to turn inward in order to achieve economic growth. Monetary policy remains accommodative of growth, and the government is taking certain steps to mitigate the adverse effects of an economic slowdown. While the pillar of export revenue may not offer much support, domestic demand will likely continue to drive the economy, which is expected to expand by around 4.0 percent this year.

Asia Pacific Economic Outlook February 2012

Taiwan

The Taiwanese economy slipped into a recession after suffering a contraction of 0.3 percent in the fourth quarter of 2011.
This second consecutive quarter of decline was primarily the result of a sharp contraction in capital formation and sluggish exports. Private and government spending also disappointed during the fourth quarter. The crux of the problem was bleak exports. Traditionally, exports have fueled the Taiwanese economy by making up almost 70 percent of its GDP. Thus, a slump in exports is expected to have ripple effects throughout the economy. Recently, Taiwans exports, especially hi-tech goods for developed markets, have suffered because of the Eurozone crisis. During the fourth quarter alone, exports fell by 4.5 percent in U.S. dollar terms. Moreover, China accounts for around 40 percent of Taiwans exports, but its economic outlook is cloudy. While economic ties with the mainland are expected to strengthen, Taiwans export performance may hinge on final demand from China and its other trading partners in the West. Anemic exports had negative repercussions on the rest of the economy, especially manufacturing. Since the island economy is a hub for reassembling and re-exporting hi-tech goods, a bulk of the manufacturing sectors

output is designated for outbound shipments. Thus, the lack of overseas demand hurt local export-oriented manufacturing firms, which are struggling to break even. Following a 4.6 percent year-over-year contraction in November, industrial production dropped by 8.2 percent year-over-year in December the largest drop in the last seven months. Consequently, business sentiment has also deteriorated. Investors reacted to global uncertainty by holding back on private investment and scaling back plans for building capacity. From SeptemberDecember 2011, capital formation plunged by 19.2 percent year-over-year, dragging overall GDP growth into negative territory. Further, manufacturing inventory accumulated while export orders enjoyed only a marginal gain, thus foreshadowing a future slump. The overall composite leading indicator compiled by the Council of Economic Planning Development (CEPD) saw little improvement in December as it increased 0.5 percent from a month ago. Furthermore, the agencys Monitoring Indicators bemoan a sluggish economy. Subdued investment is expected to pose additional challenges to recovery this year, forming a vicious cycle. Recent data suggests that domestic demand has also been caught in this cycle, which may weigh heavily on growth.

Asia Pacific Economic Outlook February 2012

With investor sentiment restored to a certain extent, Taiwan will likely see some improvement during the first half of the year.

Perhaps, Taiwans widely anticipated elections in January 2012 and their possible impact on cross-strait relations increased uncertainty in the last few months of 2011. The stock market suffered from this uncertainty as investors pulled out in favor of more stable markets; market capitalization in December was about 19 percent lower than a year ago. Following the re-election of President Ma Ying-jeou, who favors strengthening ties with China where many Taiwanese have business interests, some stability may return to the Taiwanese stock market. With investor sentiment restored to a certain extent, Taiwan will likely see some improvement during the first half of the year. In December, the central bank chose to keep its policy rate constant, which has been unchanged since last July. Should demand conditions in the economy fail to sufficiently recover, the central bank may have to cut interest rates further, compromising price stability. The government may also have to consider boosting stimulus policies and increase spending, which has been lackluster in the last few quarters. With additional downside risks posed by global uncertainty, economic expansion will likely slow down from 4.0 percent in 2011 to a little above 3.0 percent this year.

Asia Pacific Economic Outlook February 2012

Vietnam

The Vietnamese economy is likely to face several challenges in 2012.

On the domestic front, the country is grappling with high inflation, persistent budget and current account deficits, falling foreign exchange reserves, and a weak currency. In addition, a host of external challenges emanate from an uncertain global macroeconomic environment. First, declining global demand could dampen Vietnams export sector growth which will influence employment and manufacturing sector output. Second, foreign investors may hold back on any further investments, which would in turn deprive the economy of capital, at least until economic conditions improve. While more aggressive measures to counter macroeconomic imbalances may need to be considered, it is unclear whether tougher policy choices will be made; especially, since some choices could lead to decreased domestic growth in an already-weak global economy. Vietnams GDP is estimated to have grown at 5.9 percent in 2011. Growth was broad-based with agriculture growing 4 percent, industry and construction growing 5.5 percent, and services recording nearly 7 percent growth. Furthermore, exports were robust, and tourism recorded increased footfalls. However, January provided mixed signals. While retail sales grew 22 percent compared to

last year, Vietnams IIP dropped 2.4 percent. The floods in Thailand are likely to boost Vietnams rice exports, and manufacturers are expected to shift production to Vietnam. However, these factors will only have a temporary effect on Vietnams economy. Declining commodity prices may also result in lower export revenues in 2012. In 2011, an 18.7 percent inflation rate, which resulted in lower consumer and business confidence, was a major downside for the Vietnamese economy. The price rise was induced by supply-side factors, elevated commodity prices, and domestic credit growth. Inflation appears to have peaked, and forecasts for 2012 are benign. However, inflation is expected to continue at double-digit levels. The downward trend in inflation is a welcome sign for the Vietnamese economy and may prompt the central bank to adopt a more accommodative monetary policy to spur GDP growth. However, easy monetary policy would be a risky decision, and policymakers may take a more cautious approach. Moreover, inflation forecasts may be revised upward if the recent hike in the minimum wage exerts upward pressure on overall price levels in Vietnam. In addition, the central bank has devalued the currency four times since November 2009. In 2011 alone, the dongs value has eroded by nearly 10 percent against the

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The governments ability to usher in reformist policies and provide some stability to Vietnams domestic economy may be a critical factor in the coming months.
U.S. dollar. In 2012, Vietnams currency will likely continue its decline against the dollar due to persistent fiscal and current account deficits. Furthermore, Vietnams dwindling foreign-exchange reserves mean that the State Bank of Vietnam (SBV) will not be able influence the slide by intervening in the currency markets. On the contrary, the central bank may resort to currency devaluation yet again during the first half of 2012. Meanwhile, the government is looking to pursue policies that create favorable opportunities for foreign investors. Foreign inflows have been a major source of capital in Vietnam, accounting for nearly 25 percent of the countrys investment needs. However, FDI inflows recorded a 26 percent decline in 2011 caused partly by a global economic slowdown and weak macroeconomic fundamentals in Vietnam. FDI flows can address some concerns around Vietnams weak foreign reserves situation. Furthermore, with domestic investment likely to dip significantly, foreign capital can potentially bridge the investment gap. The governments ability to usher in reformist policies and provide some stability to Vietnams domestic economy may be a critical factor in the coming months. Finally, Vietnams troubled banking sector is poised for a wave of M&A activity. The proportion of bad debts at Vietnamese banks has risen, and many smaller banks are unable to repay their debts to the larger domestic banks. Small banks in distress are likely to be acquired by larger players while some may opt for mergers in a bid to strengthen their balance sheets. Vietnam plans to narrow its banking sector to 15 large commercial banks by 2015. The restructuring is expected to begin in the first quarter of 2012.In the interim, credit growth, especially to the real estate sector, may be limited. The SBV is expected to continue its tight monetary stance and limit credit growth to 1517 percent. However, the central banks policies will face stiff opposition if the cost of credit rises significantly. Overall, GDP growth is likely to slow down in 2012. Owing to the governments tighter monetary stance, both private consumption and investment will likely be weaker. Furthermore, external factors could add to macroeconomic instability and dampen exports and foreign investments. GDP growth is expected to moderate to between 4.7 and 5.2 percent in 2012. Surprises, if any, are more likely on the downside.

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About the Economists

editor Dr. Ira Kalish Deloitte Research Deloitte Services LP Tel: +1 213 688 4765 E-mail: ikalish@deloitte.com Dr. Ira Kalish is Director of Global Economics at Deloitte Research. He is an expert on global economic issues as well as the effects of economic, demographic and social trends on the global business environment. Managing editor Ryan Alvanos Deloitte Research Deloitte Services LP Tel: +1 617 437 3009 E-mail: ralvanos@deloitte.com Contributors Pralhad Burli Deloitte Research Deloitte Services LP India Tel: +91 40 6670 1886 E-mail: pburli@deloitte.com neha Jain Deloitte Research Deloitte Services LP India Tel: +91 40 6670 3133 E-mail: nehajain59@deloitte.com

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