by NR INDRAN / INT

How Can Asia Insulate Itself?

Weakening export momentum could have spillover effects. With most countries exhibiting a more pronounced slowdown in export growth, our team believes that there could be spillover effects of global growth risks to domestic demand. The first round of manufacturing weakness would likely be seen in inventory de-stocking and a slowdown in export-related investment activity, with Thailand, HK, Malaysia, Taiwan, Korea and China looking the most vulnerable. Domestic growth could also eventually spillover to consumption if we see labor market deterioration.

Financial Linkages to European Banks. Asia’s external liquidity position appears relatively strong compared with EM peers. However, given the growing pressure on European banks to tighten their lending standards and shed assets, we look at how Asia may be impacted. Hong Kong, Singapore and Malaysia look most exposed to European bank claims; although in the case of HK and MY; ~78% of claims are from UK banks, while SG is extremely well-capitalized.

How Can Asia Insulate Itself from Global Uncertainties?

1. Letting monetary policy be a ‘bit’ more accommodative: We expect Asian central banks to either remain on hold or modestly ease policy stance. While for India, Korea and Taiwan; its likely the end of the tightening cycle this year; Indonesia and Singapore have begun explicitly easing; and Thailand could follow. China could fine-tune policy via a combination of a policy rate hike and RRR cut.

2. Lean on fiscal policy to support demand. Most Asian countries have sufficient fiscal firepower if growth deteriorates. China’s fiscal stance would likely be the most important driver for regional growth and risk sentiment.

3. Pursue structural reforms to create regional growth drivers.  Consumer re-balancing, as in the case of China, would lead to sustainable growth by expanding the services sector, boosting social safety nets, reforming the income tax system and continued RMB appreciation. In other parts of Asia, structural investment stories remain at play; and in Vietnam and India there is a dire need for an infrastructure upgrade.

4. Pooled reserve insurance to strengthen external buffer. While some Asian economies have substantial precautionary reserve position, others like Korea, India, Indonesia and Malaysia are not as bullet-proof. To offset risks from dollar liquidity, pooling forex reserves via currency swap arrangements would be helpful and bolster confidence.

5. Facilitate regional integration. Increased financial integration and reduced reliance on capital from the West could help insulate Asia from contagion.

Also included are quick econ overviews on key countries across the South Asian region:

India: While the RBI has said that the likelihood of rate action in Dec is relatively low, if an expected deceleration in inflation does not play out, risks on further monetary action coupled with deteriorating global prospects and domestic policy issues add downside risks to our FY12 GDP estimate of 7.6%. In FY13, a deteriorating macro environment coupled with aggressive rate tightening could result in GDP coming off to 7.5% . The government’s borrowing calendar for 2HFY12 was Rs530bn higher than market expectations, suggesting that fiscal slippages are likely (p. 26)

Pakistan: Recent floods have resulted in damage to standing crop, although the extent is limited. While we are maintaining our 3.5% GDP estimate for FY12, flat agri growth could result in GDP coming off to 2.9%.With still no clarity on the IMF program as well as other multilateral sources of lending, we could see a drawdown to reserves to the tune of US$2.9bn. Also key to track is the fiscal situation, where deficit slippages are likely. (p. 38)

Sri Lanka : With GDP during 1H2011 at 8%YoY, we maintain our 2011 growth estimate of 7.9%. While the recent gas discovery bodes well for the hydrocarbon sector, near-term risks include lower-than-expected agri growth and a deteriorating global environment. The 2012 Budget, due to be announced on Nov 21st would likely peg the deficit at a higher-than-expected 6.2%, vs. ~7% estimated for 2011. Central Bank FX intervention remains closely tracked. Our team believes that Vietnam cash bonds could still underperform Sri Lanka a bit more.

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