Asia decoupling? Not without more help from China

Asia's best hope for insulation against a worsening economic outlook in the United States and Europe rests on China, and it may not be willing or able to do the job.

With inflation running at a three-year high, Beijing has pulled every lever at its disposal to try to brake economic growth, yet price pressures persist. That argues against a repeat of 2008, when China ramped up government spending to counter the global recession, buoying Asia and the world.

As for the export linkages, China has supplanted the West as the largest trading partner for many Asian economies, but that doesn't fully protect them. Some of what China imports from its Asian neighbors goes into making other goods destined for U.S. and European ports.

"The question is whether the end demand really lies within Asia or not," said Vishnu Varathan, an economist with Capital Economics in Singapore.

Rising U.S. unemployment and weaker-than-anticipated growth have raised the specter of the world's biggest economy reverting back into recession. In the euro zone, investors have demanded higher returns for lending money to Spain and Italy, heightening concerns that the debt troubles won't stay confined to Greece, Ireland and Portugal.

Barring a full-blown financial crisis, Asia would most likely suffer modest bruising from a deepening global slump, with the pain concentrated in export-exposed countries such as Taiwan and South Korea.

A dig through the latest batch of economic data reveals a few optimistic signs, but considerably more causes for concern.

First, the bright side.

* China's official purchasing managers' index showed new orders grew in July, breaking a three-month streak of declines. Growth in new export orders faded for a fourth consecutive month. Taken together, those figures point to domestic demand holding up relatively well.

* South Korea's exports to China grew 19.4 percent year-over-year in July, accelerating from June's pace.

* China's industrial output surged 15.1 percent in June, exceeding the first-half growth rate of 14.3 percent.

Now for the bad news.

* Growth in China's services sector, a barometer of domestic demand, eased to a three-month low and job creation was at its weakest since May 2009.

* Taiwan, which counts China as its largest trading partner, recorded a 4.3 percent drop in month-over-month export orders to China in June.

* South Korea's July exports to the United States rose a paltry 1.9 percent, and shipments to the European Union fell by 8.7 percent. Even its strong exports to China may be flattered by rising commodity prices. The two fastest growing export categories were petroleum products and iron and steel.

* The global manufacturing sector expanded at its weakest pace since July 2009 last month, and new orders fell for the first time in more than two years.

* Part of Asia's resilience in the past two months may be tied to Japan's earthquake and tsunami, which forced some manufacturers to move production overseas. That effect may fade as Japan's factories come back online.

What to Watch

Frederic Neumann, co-head of Asia economics research at HSBC in Hong Kong, took some solace from the fact that new orders held up. His firm co-produces PMI indexes around the world, providing a real-time look at how regions stack up.

"Weakness in the West will weigh on exports in the coming months," he wrote in a research note entitled, "And so East and West diverge."

"Still, so far, domestic demand in the region is holding up well in the face of the brewing storm elsewhere. Don't mind the smoke," Neumann added.

Asia decoupling from the West has been a popular theme among economists for years, and the conventional wisdom is that the region inevitably will break away because its growth rate far outstrips that of the United States or Europe.

"This increasingly becomes a China-led regional engine," said Paul Schulte, global head of financial strategy at China Construction Bank International in Hong Kong.

But that is a longer-term view. For now, investors seem focused on the immediate risk of a slump.

South Korea's main stock index dropped nearly 3 percent on Wednesday, the biggest daily decline in more than two months. Taiwan's fell 1.5 percent to a 4-1/2 month low.

The data-based economic diagnosis will become a bit clearer over the coming week with the release of China's July figures as well as U.S. employment numbers.

Goldman Sachs economists argue that another tick higher in the U.S. jobless rate would send a strong recession signal. The July figures will be released on Friday.

China releases its suite of July data on August 9, which will shed more light on domestic demand and inflation. Economists polled by Reuters think the consumer price index will hold at a 6.3 percent increase, slightly below June's three-year peak.

Anything hotter than that will revive the debate over whether Beijing has clamped down hard enough to ward off a worse bout of inflation -- and cast further doubt on China's capacity and desire to propel Asia's growth.

For Asia's exporters, the most important numbers may be urban investment and retail sales. Both look likely to remain strong, although perhaps not quite as robust as in June.

A disappointment on those readings would darken prospects for the region even more, particularly among countries such as Australia and Indonesia that have benefited from supplying China with raw materials.

If there is a silver lining, it is that slower growth should give Asia's policymakers an assist on tackling inflation, perhaps allowing them to slow the pace of tightening.

"The balance of risks for Asian policymakers is slowly shifting to growth from inflation," said Prakash Sakpal, an economist with ING in Singapore.

[Source: By Emily Kaiser and Swati Bhat, Reuters, Singapore, 03Aug11]

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