ADB Lays Out Rocky Climb Back Up The Cliff

NO ONE CAN say how widely the Covid-19 pandemic may spread, and containment may take longer than currently projected. The possibility of severe financial turmoil and financial crises cannot be discounted. Sharp and protracted declines in commodity prices and tourist arrivals will challenge dependent economies across [Asia].

On such a downbeat, but realistic note, the Asian Development Bank introduces its 2020 Outlook, published on April 3. Its underlying theme is that the nascent recovery from last year’s decelerating pace of growth because of US-China trade tensions and the related global manufacturing recession has been snuffed out by the pandemic, and then some. Growth will rebound next year, the Bank believes, but not before it declines steeply this year.

For China, the Bank is forecasting growth to tumble to 2.3% for the year, against 6.1% last year and 6.7% in 2018. The high-frequency indicators from the early months of the year showing double-digit contractions in industry, services, retail sales and investment imply that the economy could likely see a double-digit contraction reported for the first quarter. The GDP figures are due on April 17.

To put that into context, the likely impact of Covid-19 will be more severe for China than that of the Asian financial crisis in 1997–98, the SARS (severe acute respiratory syndrome) epidemic of 2003 and the 2008 global financial crisis.

However, the recovery in the second half of the year implied by the growth forecast for the full year is seen carrying into 2021. The ADB expects growth will rebound to 7.3% in 2021, helped not just by the return of regular commercial activity but also by easy monetary policy and hefty and probably repeated fiscal and infrastructure stimulus on the part of governments.

The knock-on effect across the region will be as severe, as trade growth weakens further on the back of waning domestic demand, a halt to tourism, and transport and other supply disruptions because of the pandemic. The ABD forecasts regional growth of 2.2%, down from 2019’s 5.2%, but then a recovery to 6.2% in 2021. Excluding Asia’s newly industrialised economies (South Korea, Taiwan, Hong Kong and Singapore), growth is seen to slow to 2.4% in 2020 from 5.7% in 2019, and then to pick up to 6.7% in 2021.

A further drag on growth in China and the region, noted by the United Nations Conference on Trade and Development (UNCTAD), will be the fall in profits for foreign affiliates of multinational enterprises operating in the region, which in turn will reduce funds available for direct reinvestment:

On average, the top 5,000 multinationals, which account for a significant share of global foreign direct investment (FDI), have now seen downward revisions of 2020 earnings estimates of 30% due to Covid-19, and the trend is likely to continue. Hardest hit are the energy and basic materials industries, (-208% for energy, with the additional shock caused by the drop in oil prices), airlines (-116%), and the automotive industry (-47%). The latter industry was fate first to see earnings revisions anticipating the supply chain shock. Industries now expecting to be hit by a global decline in demand are rapidly catching up.

UNCTAD Investment Trends Monitor, March 2020 Special Edition

As the reinvested earnings component of FDI in Asia was 41% in 2018, these substantial downward revisions foretell sizeable effects on FDI from earnings losses. Downward revisions to multinationals earnings in China average 21%, UNCTAD notes.

The risks to its forecasts, as the ADB acknowledges, are nearly all to the downside and substantial. The assumption that the pandemic will be contained globally this year and normal business conditions will return next is a ‘good-case’ one: vast uncertainty about the duration and severity of the pandemic remains. The potential for second and third waves of the outbreak exist.

Thus the ADB’s broad range for the total global cost of the pandemic of between $2.0 trillion and $4.1 trillion, equivalent to between 2.3% and 4.8% of global GDP, with China’s cost approaching 5% of GDP. As the ADB also says, ‘the possibility of a financial crisis cannot be discounted and the pandemic could also bring about fundamental changes to the global economy over the long term’.

Most notable of those would be a retreat from the globalization that has underpinned the rise of developing Asia, with multinationals repatriating production and shortening global supply chains.

However, it is not just the pandemic that hangs heavy over the outlook for the region. Trade conflict between Washington and Beijing remains a significant risk, especially if the pandemic causes China to fall short on its commitment to increase imports of US goods and services in 2020 and 2021 by $200 billion over 2017 values, as the Phase One trade agreement between the two countries requires.

As this Bystander has noted, this was always an ambitious target, as are its components for imports of agricultural, manufacturing and energy products and services. With the president of the United States facing re-election in November and the US economy already taking a severe hit from the pandemic, nothing adverse can be ruled out.

Asian Development Bank Pushes Beijing On Tax Reform

CHINA’S ECONOMY WILL grow by 6.6% this year and 6.4% next, according the Asian Development Bank’s newly published Outlook 2018. That is pretty much in line with the most recent revised OECD forecasts from mid-March.

The ADB sees strong consumer spending, rising exports and steady public spending underpinning current growth. It also joins the chorus calling for tax and other structural reforms to ensure that growth is both inclusive and sustainable as it resumes its measured glide path of slowing under the effects of excess-capacity reduction, the gradual resolution of the debt problem and the shift of growth drivers from capital accumulation to total factor productivity, to give a more technical description of the rebalancing of the economy.

In summary, the ADB says:

PRC growth accelerated on strong demand from home and abroad. The service sector grew by 8% on buoyant domestic demand, and net exports expanded as trade in intermediate manufactures rebounded. Assuming mildly tighter monetary and fiscal policies in the PRC, growth is expected to moderate from 6.9% in 2017 to 6.6% in 2018 and 6.4% in 2019. Further progress on reforms such as strengthening financial sector regulation and supervision, and addressing debt issues would lay a foundation for solid macroeconomic stability.

The ADB highlights the importance of services to rebalancing. In 2017, it notes, services were already the main driver of growth, expanding 8%, up from 7.7% the previous year, and contributing 4.0 percentage points to GDP growth. In contrast, industrial growth slowed to 6.1% last year from 2016’s 6.3%, and industry’s contribution fell to 2.5 percentage points.

The services sector also kept the labour market buoyant, creating 13.5 million new urban jobs last year (exceeding the official target of 11 million). But prices in the service sector are rising, meaning that inflation did not cool as much as it might otherwise. Consumer prices rose 1.6% in 2017, against 2% a year earlier. The ADB thinks inflation will pick up this year, to 2.4%, as consumer demand strengthens.

The ADB also notes in passing that services comprise barely 51% of GDP, low by international standards. As investment, in contrast, at almost 40%, is comparatively high, there is ample scope for further ‘rebalancing’.

The risks to the ADB’s forecast are pretty straightforward: a trade war with the United States, which could undercut exports and investment. It is not particularly worried about the tariffs the Trump administration imposed on steel and aluminium imports, seeing an unintended benign consequence of measures to tackle the corporate debt issue:

Prices for aluminum and iron ore (iron being the bulk of stainless steel) rose by 23% in 2017. This raised profits in the producers’ home economies more than enough to offset the impact of tariffs, had they been imposed a year earlier. Profits in heavy industry, including large steel producers in the PRC, rose by 21% in 2017 thanks to higher prices and government-imposed production quotas, allowing these industries to service their debt and reduce borrowing while trying to shed excess capacity. Thus, these producers should be able to manage lower demand expected from the US, given the small share of exports to the US directly affected.

However, it is the United States’ next round of tariffs on Chinese exports of intermediate inputs, especially for renewable energy, electricity generation and electrical and optical equipment, that is the immediate concern as they could undermine the business and consumer optimism. Absent Trump’s ‘massive trade deal’ with China, these will take effect in the next few months and would play directly into investment intentions, and especially those connected to US firms’ links to Asian value chains in manufacturing.

The double risk is that a strengthening dollar on the back of rising US interest rates could also spur greater capital outflows, irrespective of authorities’ discouragement.

However, the ADB believes, the government’s fiscal strength and political will enable the economy to weather any squalls. The question for this Bystander is how stormy the trade can weather get.

The particular area for structural reform tha is exercising the ADB is tax:

[The] ratio of tax revenue to GDP has stagnated at 17.5%, with heavy dependence on indirect taxes in the PRC atypical at its stage of development. The authorities there should broaden the tax base while ensuring that the revenue system is progressive.

The average tax revenue to GPP figure for OECD countries is 25%, and even in the ten emerging economies of the G20 countries, it is 21%. The combination of falling tax revenue and rising expenditure translates into rising budget deficits for Beijing, more public debt and thus contingent liabilities.

The ADB suggests that there is there is substantial potential to raise more revenue from personal income taxes, which are now paid by fewer than one in five wage earners. Personal exemptions are twice the annual average national wage, and the top rate (45%) kicks in at 35 times the annual average national wage. OECD averages are for personal exemptions of one quarter the average annual national wage and top marginal rates starting at four times that level.

This indicates some easy changes that could be made to broaden the income tax base and make it more progressive. (which are in train as was signalled at last month’s National Peoples Congress sessions). Structural tax reform is also central to tackling income inequality, a central concern of the Xi administration.

ADB Cuts China Growth Forecast

The Asian Development Bank (ADB) has cut sharply its forecast for China’s growth this year and next. In the latest half-yearly update to its annual regional economic outlook, it says it expects GDP growth to come in at 7.6% this year, down from its earlier forecast of 8.2%. It also cut its 2014 forecast to 7.4% from 8.0%. Both the new numbers are below last year’s 7.7% growth.

The ADB says the lower figures reflect “the authorities efforts to forge a more balanced and sustainable growth path than the familiar one led by exports and investment”. This has been evident in the recent efforts to rein in credit and tackle the burgeoning shadow banking system. Shadow banking, the ADB notes, “is is frequently associated with lending to the booming real estate sector and to infrastructure through the off-budget financing vehicles of local governments, many of which are believed to have accumulated high debt”. Taken in aggregate, the more problematic parts of the shadow banking system, including wealth management products as well as real-estate and off-balance-sheet lending,  equal 38.1% of GDP, or 18.7% of banking assets, by the ADB’s reckoning. Quite an overhang.

A slowing Chinese economy also casts a shadow over developing Asia’s economies. The ADB now sees regional growth slowing to 6% this year from 2012’s 6.1% but picking up to 6.2% next year, despite China’s expected continued slowing.

The ADB notes that China’s slowing growth accommodates structural reform in the long term, but also points out that it has been investment rather than an increase in consumption that has characterized the rebalancing of the economy since the 2008 global financial crisis. Investment contributed 5 percentage points to growth in 2008-2012; consumption contributed 0.1%. Some old habits die hard for all the reformist zeal.

Opportunity or challenge? The ADB says that “more robust growth in consumption would make rebalancing more sustainable”. To that end it  suggests expanding public social spending and safety nets to encourage a lower household savings rate.

ADB Holds China Growth Forecast Unchanged Even As Region Slows

In its latest quarterly update, the Asian Development Bank has left unchanged its growth forecast for China this year at 7.7%, with 8.1% growth still seen in 2013. The Bank says that October’s rebound in industrial production likely signaled the end to the third quarter soft patch. Retail sales also remained resilient.

Despite the weakness the Bank sees in the global economy, it expects China’s fourth quarter growth at 7.7% to exceed that of the second and third quarters, and that growth will again top 8% in the first quarter of 2013. The Bank sees growth in other East Asian economies slowing, however. It trimmed its 2012 forecast for the region to 6.4% from the 6.5% it forecast in October, and that for 2013 to 7.0% from 7.1%.

Disaster Recovery Lessons For Sichuan From The ADB

In a typical year, up to 200 million people are affected by natural disasters in China and 40 million hectares of crops are damaged. The average annual economic impact from disasters, be they earthquakes, typhoons and floods or droughts, is 100 billion yuan ($14.5 billion).

No natural disaster, by officials’ own admittance, has been more challenging to China than the 5-12 Sichuan earthquake of 2008, if nothing else than by dint of its sheer magnitude. The area affected was about the size of South Korea, the number of victims requiring resettlement more than the population of Spain  and the overall number of people affected more than the population of Canada. Similarly unprecedented was the scale of response required.

The National Development and Reform Commission (NDRC) asked the Asian Development Bank to see what best-practice recovery essons could be learned from such other large scale natural disasters such as the Kobe earthquake of 1995, the Aceh earthquakes and tsunami of 2004 and 2005 and Hurricane Katrina in the U.S. in 2005.

The ADB has just published its findings. It gives China good marks for its quick response to the disaster, noting that the capacity of policymakers to react quickly to natural disasters is important, as speed of response is a key for restoring market confidence and contributing to a feeling that pressures faced may be temporary. But it also questions decisions such as the one to relocate the county seat of Beichuan, 70% destroyed by the earthquake, to a new city 35 kilometers away. The report says that damaged cities are almost always rebuilt on the same site rather than relocated to safer territory, and that the relocation of a city after an earthquake is “not a simple concept”.

It also notes that the disaster literature abounds with examples of decision- and policy-makers at all levels of government failing to implement essential public safety measures, and then avoiding accountability when failure inevitably occurs. It says:

The PRC appears to be no different: as recently as August 2006, in a keynote speech to mayors at a China Mayors’ Association forum on urban development, Vice-Premier Zeng Peiyan warned that many municipal governments are weak in urban management and disaster prevention, and exhorted mayors to abandon “blind expansion of cities” and to focus on increasing disaster preparedness and prevention. The apparent failure to adhere to building codes for public buildings such as schools supports the Vice-Premier’s statement.

The ADB derives scores of specify lessons from the disasters that it has studied that could be applied to the recovery from the Sichuan cake. All should be required reading for any official and civic leader in any part of China where natural disasters threaten, i.e. pretty much everywhere.

They can be summarized:

• Inter-governmental coordination is vital:  Each level of government has specific responsibilities in every aspect of disaster management (hazard mitigation, disaster preparedness, disaster response, disaster recovery). Overall effectiveness, however, can be measured by the degree to which these various components are integrated:
• Timing is important: Recovery actions initiated too early or too late can have significant downstream implications. Hasty decisions on what and where to relocate typically fall in this category. Similarly, some decisions that are delayed, such as victim compensation measures or new building codes may interfere with smooth recovery procedures.
• Recovery implies physical, economic and social integration: The desire for rapid physical structural results must be balanced against the need for equitable and sustainable long-term economic and social solutions. Aspects such as livelihood assistance and social integration programs need to be dealt with concurrent with the quality reconstruction of damaged structures.
• Process and participation is as important as the physical: Disaster recovery is all about re-building communities. Who decides and how decisions are arrived at with respect to physical recovery is of utmost importance.
• Focus on content as well as construction: Too often the onus is placed on the rapid physical reconstruction of structures, such as school, hospitals and critical service infrastructure, without decisions being made to re-visit content, such whether the school curriculum or teacher training was adequate to meet the wider needs of society, or if underground cabling is better for ‘all-hazards’ risk reduction than overhead wiring, for example, in seismic areas also prone to high wind/severe storms.
• Incorporate disaster risk reduction components: Disasters do strike twice! Rebuilding after a disaster is an opportunity to get things right the second time around and to “build back better!”

China’s Economic Rebalancing Act

The Asian Development Bank’s latest update to its quarterly economic outlooks leaves China’s gross domestic product growth for the year unchanged at a forecast 9.6%. But it notes that the pace of growth has started to moderate and will continue to do so as the effects of the government’s fiscal and monetary stimulus wears off and recovery in China’s export markets in the developed world stays sluggish.

Despite exports being a net contributor to GDP in the second quarter this year for the first time since the onset of the global recession, the ADB is forecasting that China’s GDP growth in 2011 will slow by half a percentage point to 9.1% as those trends continue.

The ADB also reiterates the need to shift the economy from being driven by investment and exports to domestic demand.

Longer term, failure to decisively implement the agenda to rebalance the PRC economy risks jeopardizing the sustainability of growth. A greater emphasis on private consumption demand, as against the current investment-driven economic growth model, would promote longer-term growth and raise living standards. Growth in consumption has been limited by the declining share of household income in total income, while the shares of enterprises and the government have increased.

ADB economists believe that China won’t be able to sustain its current pace of growth over the long-term with its current development model under which a rising rate of investment is needed to maintain its target rate of economic growth. At some point investment will stop rising (even China will eventually run out of money) and growth will slow unless another source of demand replaces it. The ADB expects China’s average annual GDP growth over the two decades to 2030 to be 5.5%, compared to the annual average of 9.4% between 1981 and 2007, though it could average 6.6.% growth in 2010-2030 with greater rebalancing of its economy.

China’s growth since Deng Xiaoping opened the economy at the end of the 1970s has been a remarkably success, though its growth rates have been much the same as those of Japan and South Korea at similar stages of their economic development. China’s economy, however, is on a different scale to those of both its neighbors, which is what really makes the achievement so impressive. It is investment that has got it there, but won’t be able to keep it there alone. As even Prime Minister Wen Jiabao has said recently, “In the case of China, there is a lack of balance, co-ordination and sustainability in economic development.” How China finds its balance will shape the global economy over the next two decades.

Melting Glaciers: A View From Mt. Everest

Our man on Mt. Everest — actually that is a bald-faced lie, it is the Asia Society’s man on Everest, mountaineer and filmmaker David Breashears — provides some beautiful and disturbing shots of the melting glaciers of the Himalayas. We’ve noted before the environmental threat to China’s rivers, but on the basis of a picture is worth a thousand words, we thought we’d share. This video was the Asia Society’s entry in an Asian Development Bank video competition on climate change.