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Ten Asian risks to watch in 2008
Ben Ford, Senior Economist, Export Finance and Insurance Corporation*
21-05-2008
Re-coupling – So far, China, India and other economies in the region have held up fairly well in the face of turmoil in credit markets and US economic weakness. But this resilience will be tested in the months ahead if financial de-leveraging and risk re-pricing intensifies and/or US economic prospects deteriorate further.
However, in contrast with previous global slowdowns, many Asian economies are well-placed to ride out external growth shocks. Strong fundamentals, including external current account surpluses and substantial foreign-exchange reserves, provide scope for policymakers to stimulate their economies while avoiding balance-of-payments crisis.
Why rising inflation will test policymakers – Higher food and energy prices, which have recently risen to record levels, are helping push up inflation across Asia. Rising inflation will test policy-makers, especially central banks, which, because of a tendency towards heavily-managed or pegged exchange rates, will be reluctant to raise rates substanti-ally at the same time as the US Federal Reserve is cutting rates and the US$ is under pressure.
Instead, many countries are implementing price controls on food and energy products. This might keep a lid on prices, but the benefits could be outweighed by damage to efficiency and incentives.
Rising fiscal burden of food and energy subsidies – Many governments in the region implicitly or explicitly subsidise the consumption of food and energy products. These subsidies are especially pronounced on energy, and effectively limit the degree of pass-through of higher world oil prices to the domestic price of petrol, kerosene and diesel (Table 1). In the face of persistent high prices, these subsidies will become more and more of a fiscal burden, and reduce the funds available for more productive purposes. Moreover, any moves to reform subsidies will have political consequences.
Infrastructure deficiencies will constrain growth – Infrastructure quality varies substantially across the region, and deficiencies are obvious in many countries. They are especially acute in India and Vietnam, which are experiencing teenage growing pains as rapid growth tests the limits of their infrastructure.
Although many countries in the region have outlined ambitious plans to ease bottlenecks, some will inevitably run up against speed limits, crimping growth in the short term.
Resource nationalism – Against a background of higher commodity prices, regional governments have recognised they have more bargaining power and are seeking to renegotiate contracts and mining agreements to capture more windfall revenue. This should not be confused with Latin American-style resource nationalism, where oil assets are seen as a means of political and economic patronage, and government policies have hobbled private sector operators. So far, Asian governments have been relatively restrained in seeking to change royalty rates or contract terms in their favour, but there are signs of increasing assertiveness. In Indonesia, for example, the Government has been making noises about increasing royalties paid by the Freeport copper mine.
Country-specific risks
China: Macroeconomic stability is not assured – While underlying medium-term growth prospects are sound, the economy faces risks from significant domestic imbalances and distortions spawned by an inflexible exchange rate – excessive credit growth, over-investment and speculative asset bubbles. In addition, inflation, led by a sharp jump in food prices, is at its highest for about 12 years.
To counter these imbalances, the currency is being allowed to strengthen against the US dollar. The People’s Bank has also tightened financial conditions through a series of interest rate rises and higher bank reserve requirements. Although welcome, these are largely administrative measures, and are taking time to bite – the economy still has significant momentum.
Korea: Vested interests will resist pro-business President – Korea’s new President, Lee Myung-bak, came to power in February on a platform of boosting the economy through deregulation. He plans to lower taxes, promote construction, streamline government, and restructure the education system.
But he faces two big challenges – gaining control of the legislature in general elections in early April; and overcoming resistance from vested interests, who will be looking for opportunities to stymie his progress.
India: Naxalites threaten mining and industry – Maoist rebel groups, known as Naxalites, are increasingly active in the 'red corridor' running down the centre of India. They are also taking advantage of discontent with industrialisation to broaden their activities into urban areas and regional politics.
Naxalite attacks now claim more lives than any other form of political violence in India – 160 in 2007 alone, according to the Home Ministry.
Their resurgence could hinder the Govern-ment's ambitious plans to expand mining and heavy industry, especially since many of India’s prime, undeveloped, mineral deposits lie in traditional Naxalite strongholds (as do some larger industrial projects, such as iron ore and steel projects of India's Tata Group and Korea's Posco). Moreover, Naxalites have made a point of targetting mining interests, and many of their recent attacks have taken place in the resource-rich provinces of Orissa, Andhra Pradesh and Jharkand.
Malaysia: Political change in the winds – The recent election result could have far-reaching consequences for both politics and the economy, especially since the Government’s majority has been reduced below the two-thirds needed to make Constitutional changes, and the Opposition has gained control in five of eight States.
On the political front, the result has undermined the claim of the current Barisan Nasional Coalition Government to be the sole legitimate representative of all races. It has also paved the way for the political return of Anwar Ibrahim, already dubbed 'de facto Opposition leader'.
On the economic front, the election has thrown the future of some infrastructure projects into doubt in States where the Opposition will take control – they are likely to revisit contracts previously awarded and the national Government’s historically less-favourable investment allocations to Opposition-held States could see the overall level of investment scaled back.
Finally, the weakened Government may now think twice about reducing the US$12 billion-plus it spends annually on subsidies for things like fuel and cooking oil to avoid messy political protests. In the long run, the election result could have even deeper consequences, if it triggers a shift towards less race-based politics, a dismantling of affirmative action policies, and a more open tendering system for Government contracts.
Sri Lanka: Escalating conflict will have economic consequences – The Govern-ment’s withdrawal from the 2002 Norwegian-brokered ceasefire agreement in early January this year merely formalised what had been obvious for some time – repeated violations of the agreement by both sides had left it in tatters.
Sri Lanka has effectively returned to a civil war footing – the Government is apparently convinced that a military solution is achievable and the rebels have increased both the frequ-ency and breadth of their counter-attacks. The escalating violence will result in a growing fiscal and economic burden, which will be a further setback for a country already struggling with high oil prices, large fiscal and current account deficits and a less conducive external environment. The Government has already boosted the size of the military budget, likely to amount to around US$1.5billion in 2008, and there are signs that sectors of the economy which have been insulated from the fighting, such as construction, telecoms and export-oriented manufacturing, could be targetted by the rebels.
n Australia’s Export Finance and Insurance Corporation (EFIC) is a Government entity providing specialist financing support for Australian exporters and investors abroad. |
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