TWN Info Service on Finance and Development (Jan08/02)

24 January 2008

DEVELOPING COUNTRIES FACE HARD TIMES AS US RECESSION LOOMS

It is a terrible time for the global economy. The latest sign of this is the deep plunge in the Asian and European stock markets on Monday, 21 January in response to the string of bad news last week in the United States, leading to the conclusion that the US has now slipped into recession. The markets also seem to have given a vote of no confidence to the US$150 billion economic stimulus plan of the Bush administration, announced at the end of last week, which is widely seen as being “too little, too late.”

At the start of the new year, the question was whether the US would have a soft landing or an outright recession. Now that the recession is imminent, or probably has already started, the question has shifted to how well or badly other countries will weather it.

In Asia, the debate is on the extent to which countries in the region have “decoupled” themselves from the US economy. The greater the dependence, the more severe will be the negative effects of a US recession. The greater the “decoupling”, the less will be the effects.

Below an analysis of the current global financial turmoil. It was published in SUNS # 6397, Tuesday 22 January 2008. This article is reproduced here with the permission of the SUNS.  Reproduction or recirculation requires permission of SUNS (sunstwn@bluewin.ch).

With best wishes
Martin Khor
TWN

Developing Countries Face Hard Times as US Recession Looms
By Martin Khor, Penang, 21 January 2008

It is a terrible time for the global economy. The latest sign of this is the deep plunge in the Asian and European stock markets on Monday, 21 January in response to the string of bad news last week in the United States, leading to the conclusion that the US has now slipped into recession.

The markets also seem to have given a vote of no confidence to the US$150 billion economic stimulus plan of the Bush administration, announced at the end of last week, which is widely seen as being “too little, too late.”

The Asian markets were routed today, with the key national indices falling sharply across the region. The falls were in Japan (3.9%), China’s Shanghai index (5.4%), Hong Kong (5.5%), South Korea (3%), India (7.4%), Indonesia (4.8%), Thailand (2.9%), Malaysia (2.2%), Taiwan (0.9%), Philippines (0.5%), Singapore (6%), Australia (2.9%).

In Europe, the falls in key capitals were just as sharp at lunchtime, with key indices down in the UK (by 2.9%), Germany (4.8%) and France (4.4%). There is a national holiday in the US, so the stock market there is taking a break.

Monday’s global stock market plunge follows from the ghastly economic news and performances of last week, which itself may be the turning point that tipped the balance between hope and fear into an emerging consensus that the United States and some other major economies are entering a recession.

The rest of the world will be caught in the effects. Whether these will be mere ripples or big waves remain to be seen.

In Asia, it is feared that the dismal stock market performance is a sign of bad times ahead for the real economy.

The news coming from Singapore is especially bad. In the last quarter of 2007, the GDP fell by 3.2% at an annualized rate as compared to the previous quarter, the first such fall in 4 years. However, compared to a year ago, the fourth-quarter GDP was still 6% up.

Singapore’s fall was led by manufacturing, with a drop in pharmaceutical drugs output. Exports have been affected by the US slowdown. Non-oil domestic exports fell by 4.5% in December from a year earlier after a 3.4% drop in November. Exports of electronics products have been falling each month since February 2006.

The Singaporean journalist, Seah Chiang Nee, writing in a Malaysian paper last Saturday painted a vivid story of Singapore consumers caught by high prices and a painful stock market decline in which many Singaporeans have lost many thousands of dollars.

The governments of both South Korea and Taiwan have also warned that lower demand in semi-conductors, mobile phones and computers will lead to lower growth this year.

In Malaysia, share prices at the Kuala Lumpur stock exchange went through a roller-coaster ride. Its share index soared to break the 1500 level on 11 January and went on to a historic peak of 1524 during last Monday, before sliding after that to 1439 at the close of trading last Friday and falling another 2% today.

At the start of the new year, the question was whether the US would have a soft landing or an outright recession. Now that the recession is imminent, or probably has already started, the question has shifted to how well or badly other countries will weather it.

In Asia, the debate is on the extent to which countries in the region have “decoupled” themselves from the US economy. The greater the dependence, the more severe will be the negative effects of a US recession. The greater the “decoupling”, the less will be the effects.

On one hand, many Asian countries that are export oriented, such as Singapore and Malaysia, are still highly dependent on the US market, especially for electronics products.

But they have also increased their trade with other Asian countries, especially with China, with other South-east Asian countries, and to a lesser extent India. With Asians trading more with one another, the dependence is less on the US, and thus there can be a cushion against the recession.

China is seen to have its own strong domestic engines of growth, even though it has increased its export orientation tremendously.

But even though other developing countries (not only the Asians but also African and Latin American countries) are hoping for China to take up the slack from a falling US market, the Chinese are themselves cautious about this role.

On Sunday, a Chinese central bank official dismissed the hypothesis that the Chinese economy can decouple from the US in the context of crisis. Zhang Tao, deputy head of the People’s Bank of China’s international department said that “if US consumption really comes down, that’s bad news for us. That will have a pretty severe impact on our exports,” according to a Reuters report.

The chief of the China Society of Macroeconomics, Wang Jian, also said that China’s growing trade with Europe would not insulate it from falling US exports, as Europe would also export less to the US and this would cause Europe to buy less from China.

In Malaysia, there is still a fair bit of optimism. A slowdown in exports to the US can be offset by several factors including a very good performance in commodities (palm oil and petroleum prices are at all-time high levels), the expected continuing high growth in the Asian region (especially China and India) and the engines of domestic growth (including from government spending).

Malaysia’s central bank Governor, Dr Zeti Akhtar Aziz last week predicted 6% growth for the Malaysian economy in 2008, which can be considered high compared to other countries in a recession-laden world.

“Right now our economy is still on a steady growth path and we envisage this to continue in 2008 because of our strong domestic demand and strong inter-linkages with other Asian economies that are doing well despite the difficult environment,” she said.

In the western countries, pessimism is running deep. “This was the week when any lingering hope that the US and UK might somehow muddle through the crisis that has engulfed the international capital markets without undue damage to the underlying economy finally seemed to evaporate,” wrote business editor Jeremy Warner in The Independent (19 January) in an article entitled “The week the economy turned nasty.”

“Can we still hope for just a mild downturn, or will it be one of the big, searing ones like those of the 1970s and early 1990s? One thing seems certain: outright recession - with job losses, bankruptcies and home repossessions surging - looks a lot more probable this weekend than it did just seven days ago. It is hard to recall a week of such concentrated negative economic news.”

Among the recent bad news in the United States are the USUS$9.8 billion fourth-quarter loss by Citigroup, a loss of 3.9 billion sterling by Merrill Lynch for 2007, massive write downs by several of the biggest banks, as well as a deterioration in data on unemployment, retail sales and manufacturing.

The situation is even more worrying in Britain in some ways, says the London-based The Independent. The big retailers have reported their worst Christmas performance in more than a decade; shoppers are tightening their belts; British manufacturing output fell in November; employment is under pressure; house prices are falling and the Bank of England expects increasing household defaults on mortgage payments.

Three of the biggest drivers of economic growth in Britain in recent years - the credit-fuelled surge in consumer spending, soaring house prices, and the booming financial services industry - have been removed and it is not immediately obvious what might replace them.

As the governments and central banks of the developed countries have been reluctant to come to the rescue of the failing big banks, these banks have turned to several Asian and Middle-East sovereign wealth funds to keep them afloat.

These same sovereign funds had been much maligned by the same western countries only last year, with the European Commission and countries like Germany and France planning to take action to prevent them from operating freely.

The European governments were driven by fears of purchases of significant equity or even takeovers of their national companies by these funds. The investment activities of the funds were even labelled “cross-border nationalization”.

Ironically, the present financial crisis has now seen the troubled big banks seeking out the sovereign funds to inject massive amounts of capital to offset their billion-dollar write-downs and boost their depleted capital base and liquidity. The much-maligned sovereign funds of Asia and the Middle East have suddenly turned out to be the saviours of the Western financial system.

The sovereign funds of Singapore and Kuwait are the main contributors to the USUS$12.5 billion capital infusion to Citigroup announced last week, in addition to an injection of USUS$7.5 billion from Au Dhabi in November.

Singapore and a Middle East investor also pumped USUS$11.5 billion into the Swiss bank UBS. China’s investment corporation will invest USUS$5 billion or 9.9% of the shares in Morgan Stanley. Singapore’s Government Investment Corporation and China’s Development Bank were invited by Barclay to inject USUS$11.5 billion of capital.

The western governments have not responded to these recent actions with howls of protest. They are probably grateful that the government investment funds of the developing countries have infused so many billions of dollars to rescue the battered banks. This saves the governments of these banks from having to do the job themselves, thus sparing them from being accused by their own public of molly-coddling and subsidizing the giant banks.

In future, however, we can expect the 2estern governments or their public to accuse these “sovereign wealth funds” of taking advantage of the crisis to buy into such significant stakes in some of the largest banks in the world at basement prices.

However, given the uncertainties of the financial situation, it cannot be concluded that the sovereign funds made a wise decision, as they may also make losses if the position of the rescued banks does not improve.

Meanwhile, a credit crunch seems to be developing, that will deepen recessionary tendencies. A Reuters report last Friday said that US banks, stung by billions of dollars of bad debts are raising lending standards, making borrowing costlier for consumers and companies.

“It’s a vicious cycle,” Ray Soifer, chair of a bank consulting firm, was quoted as saying. “As banks tighten up lending standards, credit is harder to get, which is worse for the economy, which makes banks tighten up more.”

The US Federal Reserve is expected to make more cuts to the interest rate. But several economists are warning that there will be limited positive effects on the economy from these cuts, and that a recession is now on the cards.