Commentary | 15 September 2015

Asian financial markets should keep calm and carry on

Asian financial markets should keep calm and carry on

Stephen Grenville

Nikkei Report

15 September 2015

Click here for the online text.

  • Stephen Grenville

Asian financial markets should keep calm and carry on

Stephen Grenville

Nikkei Report

15 September 2015

Click here for the online text.

  • Stephen Grenville

Executive Summary

Global financial markets are once again demonstrating their tendency to overreact to ephemeral news. The media are happy to join the collective panic, with every day bringing new stories of impending problems, perhaps even crises. Together, the drama queens of the markets and the media might end up confusing us about global economic prospects.

The current concerns focus on China's growth prospects and on the U.S. Federal Reserve's monetary tightening schedule. These concerns are also spilling over into hand-wringing about the knock-on effects on emerging economies.

It is certainly true that China now has such heft in the global economy that its prospects matter to the rest of us. However you measure it, China's gross domestic product is huge and its international trade is dominant enough to move world commodity prices. But recent headlines have focused on two rather minor short-term issues: a partial reversal of unsustainable equity euphoria and a minor adjustment to the exchange rate. The important underlying issues are much the same as they were a month or a year ago.

First among them is the rate of expansion of the economy, and whether China is still growing at somewhere around 7%, as it claims it is. Skepticism about official data is an old story among China watchers and in the past the skeptics have been confounded. Maybe this time will be different, but some of the best commentators, such as Nicholas Lardy at the Peterson Institute in Washington, remain unconvinced that China is far off its normal 7% growth track. If China maintains 7% growth, incomes there will double in a decade. If it slips to 6%, a doubling will take 12 years. This is still a healthy two or three times the pace of growth in advanced economies and ample to justify lots more investment.

Established norm

Second on the list is whether China can make a smooth transition from investment-led growth to consumption-led expansion. This path is tricky and probably not without some bumps, but the same data which give rise to concerns about its growth also suggest that this transition is underway. The recent rapid growth of the service sector (which is larger than manufacturing and construction put together) suggests there has been a shift to consumption. Services expansion does not require big capital expenditures but does employ a lot of people, so this would fit with apparent anomalies in current data, such as continuing employment growth while manufacturing remains weak.

Third, the 2009 stimulus package, launched to minimize the impact of the global financial crisis, not only boosted GDP growth, it also boosted debt levels. Thus the growth of China's debt remains a concern, and perhaps the level of it as well. It is also an established norm that countries going through financial regulation routinely suffer financial crises. Expect bumps along the path, but there is not much news to add to these old stories.

Lastly, did the Chinese equity market intervention of recent months demonstrate that policymakers have lost their sure touch or that their policy approach is no longer appropriate? Not really: They are, by nature, policy activists. Free-market commentators will disparage such intervention, but the ongoing consequences of this misstep are minor. It says little about underlying policy competence.

Financial markets have been on tenterhooks on and off since the first major Federal Reserve-tightening panic in May 2013 -- the so-called "taper tantrum," when financial markets pushed emerging economy exchange rates down sharply. In the event, the Fed did nothing, and when it ceased quantitative easing operations later that year, the markets hardly noticed.

The Fed's long-anticipated plan to raise the policy interest rate has once again put markets on edge. But what is there to get excited about here? The Fed has been explicit that the first move will be small and subsequent moves gradual. Exactly when it occurs does not matter much for the real economy. It will be "data dependent": In other words, if the U.S. economy appears to be recovering quickly, it will come sooner; if not, it will come later.

Of course, the Fed might make a mistake, moving too early or too late. That timing probably will not have a perceptible effect on the real economy, as the move will be tiny and correctable. In any case if it turns out that the Fed went too early or too late, many months will pass before it is clear that the Fed did not get it exactly right. Nor will the decision tell the markets much about whether the hawks or the doves on the Fed board are in the ascendancy. Fed Chair Janet Yellen has talked so often about the tightening that when it occurs it will not be seen as a defeat for her characteristically dovish views.

The combined concerns about China and the Fed have created a collective funk about emerging economies. Commentators cannot resist drawing parallels between current events in Southeast Asia and the 1997-98 Asian crisis.

True, the large capital inflows which came into these emerging economies when U.S. quantitative easing was active in 2009-11 have been reversing over recent months, driving down exchange rates. Special mention is being made in the media that the Indonesian rupiah is now not far from its disastrous nadir during the worst days of 1998, with the implication that a repeat of that crisis is imminent.

Indeed, the exchange rate is now 14,000 rupiah to the U.S. dollar, compared with 16,000 on several occasions in 1998. But in 1998 this represented a drop of 80% compared with a few months earlier. Those who had loans denominated in dollars suddenly found their debt had gone up seven-fold in terms of rupiah. The current rate is down around 10% so far this year and is around 25% below the average of recent years. This is not much different from the fall of the Australian dollar over the same period. This is an unhappy outcome for those who have borrowed in U.S. dollars, but it is not a national disaster.

"Business as usual"

It might even stir the Indonesian authorities to focus more on economic policy, where there is much that could be done to demonstrate to financial markets that this is a routine commodity cycle, not a crisis.

Officials in some emerging markets are now seeing this prolonged Fed-watching tension as being unhelpful. Speaking at international meetings, senior officials of both India and Indonesia have urged the Fed to get it over and done with. Any foreign investors who were concerned that the Fed's actions would be adverse for their balance sheet have already repatriated their funds.

What about the other emerging economies? Here the news is rather mixed, as usual. Brazil has flopped back into its traditional disappointing underperformance. On the other hand, India might grow as fast as China. Around the rest of Asia, China's reduced import demand will be a dampener on growth, but once again this is a matter of degree, not crisis.

The International Monetary Fund's latest World Economic Outlook forecast was issued in July, before the China excitement. In any case, bureaucratic constraints prevent the fund from ever forecasting a crisis. That said, the IMF's outlook is for "business as usual." The fund's commentary over the past three years has emphasized slowing growth, but its figures -- actual and forecast -- have shown a steady expansion (measured in terms of purchasing power parity) at around the long-term average: around 3.5% annually for the total world, with emerging economies growing at around 4.5%.

It is hard to fill the headlines with routine news. It is hard to make profits from financial trading if the markets are stable. So expect more of panic from the professional doomsayers.

 

Stephen Grenville, a former deputy governor and board member of the Reserve Bank of Australia, is a visiting fellow at the Lowy Institute for International Policy in Sydney and a consultant on East Asian financial issues.