The next financial crisis may come from Asia, which is seeing a high volume of corporate debt, warns Simon Baptist, managing director and chief economist at the Economist Intelligence Unit (EIU) in Singapore.
“The high Asian corporate debt is posing another potential risk to the global economy … [Private companies] have loaded up on a lot of US dollar debts because [US] interest rates have been so low in the past few years,” he says in an interview with Personal Wealth.
Baptist says this is especially pertinent to China, whose corporate debt had ballooned to more than 200% of its GDP in the first quarter of this year. The country is a focus of the market as it is the second largest economy in the world after the US.
The International Monetary Fund (IMF) warned of China’s corporate debt in June, after its annual review of the Chinese economy. IMF deputy managing director David Lipton said the issue remains a serious and growing problem “that must be addressed immediately and with a commitment to serious reforms”.
“You might expect to see the next financial crisis ignited by Asian corporate debt, especially China, if the Federal Reserve raises interest rates more aggressively,” says Baptist.
This is amid a gloomy outlook for the global economy. The EIU has projected global economic growth to drop from 3.2% this year to 2.8% and 2.1% in the next two years. But Baptist does not see a recession yet, at least not for the next two years.
He says the weak global economy in 2017 and 2018 will likely be dragged by the UK, which will see a recession going forward. He says it will be mainly due to the Brexit impact and “shallow recession” in the US economy for one or two quarters.
He forecasts that the UK’s economic growth will be 1.8%, -0.7%, 0.7%, 0% and 1.7% respectively from 2016 to 2020, whereas the US will see growth of 1.6%, 2.3%, 2.3%, 1.1% and 2.1%.
The EIU is the research and analysis division of The Economist Group and a sister company of The Economist. It provides forecasting and advisory services.
Baptist says the UK economy may fall 0.4% at the end of the year from 2.2% last year. Its growth will continue to trend downwards over the next two years and the size of its economy will have shrunk 6% by the end of the decade.
“The total size of the UK’s economy in 2020 will be 6% smaller than what it would have been if Brexit had not happened. The UK economy is the sixth largest in the world. If it goes into recession, it will affect everybody in terms of trade and investment,” he says.
The UK recession is due to the loss of its largest export market, the European Union. Trade deals have to be renegotiated with the EU and it will result in a higher trade barrier, which will dampen the country’s economy.
“There is some false optimism among some people who supported Brexit. They think the UK will be able to cut more trade deals (with other export markets) that will result in a displacement of EU trade. But the EU is its biggest export market. The UK will not be able to offset the impact even if it has better trade deals elsewhere,” says Baptist.
“It will take at least 5 to 10 years to negotiate new deals. Then there is the implementation period, which will take a few more years. We aren’t optimistic until mid-2020.”
He adds that the depreciation of the pound sterling will cause inflation to rise, leading to lower consumer spending.
Elaborating on the US economy, Baptist expects it to fall into recession in 2019, albeit a “shallow one”, which will likely last for one to two quarters. The recession, he says, will be due to the Fed raising interest rates on the back of rising inflation. This will cause firms and households to hold on to their spending, which could lead to a short-term economic recession.
Although US inflation is low now, Baptist sees an upward trend going forward. This, he explains, will be partly due to a return to full employment, which drives up labour costs. He also sees higher commodity prices.
“The slowdown in the US will drag down other regions. Nonetheless, it is likely to be more a classic business-cycle recession, which translates into two quarters of negative growth. But not on a year-on-year basis,” he says.
Does he see a global recession? He does not, at least not in the near future. But he sees growing risks. One is the creation of asset bubbles due to excessive capital flows to regions with higher yields. Yields in the developed economies have fallen to negative, caused by central banks adopting a negative interest rate policy to boost economic growth.
“This is a big risk. You have so much capital moving around looking for returns that there is high chance of certain assets becoming overvalued. There are already some assets in markets looking for a correction. The UK property market is an example. And the Hong Kong property market has already started to come down.”
Growth spots still in Asia
Baptist says India, China and Southeast Asia will be the fastest growing economies. India is expected to grow faster than China in the next decade, but not as fast as China once did, posting growth rates of more than 10% in the past. “India’s transition is going to be slower, but it is certainly one of the economies to watch in the next few years.”
India’s infrastructure sector will remain robust as the country is still in the early stages of development. Arun Jaitley, India’s finance minister, said earlier this year that the government would increase infrastructure spending as well as implement structural reforms to accelerate its economic growth.
Baptist says export manufacturing, which is a focus of the Indian government to boost its economy, is another sector investors could look at. “Overall, it has not made much progress year to date. But if you look at it from a sub-national level, some states are doing quite well, particularly the states in the northern region as well as Gujarat, Maharashtra and Tamil Nadu.”
He believes that the implementation of the Goods and Services Tax (GST), which will unify India’s tax system, will also make the country more attractive to international investors.
Despite China’s economy slowing as it transitions from manufacturing and investment to services and consumption, growth is still relatively strong. The country’s service sector is currently benefiting from rising income.
“The China consumer story is still real and happening. If you talk to anybody who runs a business and factory in China, one of the first things they complain about is how fast wages have gone up. It has been rising at 10% to 15% a year for the last decade and that has created a massive wage increase,” says Baptist.
The sectors that are expected to benefit from rising income and stronger consumer spending include leisure, tourism, food and beverage, hospitality and accommodation, education and healthcare. The property sector, which many have projected to crash in the near future, continues to provide growth, says Baptist.
Southeast Asia will be the third fastest growing market behind India and China. In Asean, Vietnam, Myanmar, Cambodia and Laos can be expected to grow the fastest over the next five years, he says. “They are among the 10 fastest growing economies this year despite their size, which is quite small, and their impact on the global economy is low.”
In the Philippines, Thailand, Malaysia and Indonesia, growth is still higher than in most developed nations. They have continued to attract foreign capital to their stock and bond markets.
“We thought investors would lose their risk appetite after the Brexit vote. The risk aversion level would have gone up and money would have flowed out from emerging countries. But we have not seen that and capital continues to flow back into emerging markets such as Malaysia,” observes Baptist.
China and volatility
The liberalisation of China’s financial sector is expected to create volatility in the global markets by the end of this decade, says Simon Baptist.
A reason is China’s big savings. When the country opens up its borders, one can expect more dynamic capital flows into the global financial markets. Over the years, it has been seen that Chinese households save 20% to 30% of their income, considered a high savings rate from a global perspective. These funds have been kept in cash or deployed to invest in asset classes within the country due to the restrictions of its government policies.
“Right now, the capital cannot go out of the country. This is why the asset classes which households can invest in, such as stocks and properties, have seen greater volatility. Some of it is spilling overseas through the black market,” says Baptist.
“However, these funds are expected to be released into the global markets once the China government opens up its financial borders. The nation will then be an exporter of capital globally, causing fundamental changes to the global market.”
Notwithstanding the volatility, Baptist says there are upsides. For instance, the liquidity can be used to fund other countries’ infrastructure projects. This will generate potential returns for Chinese investors and help improve the economy of other countries.
“It will be a positive for the world if Chinese capital can be put to use in other developing countries, in Southeast Asia or Africa, to fund their infrastructure projects. It will also be a plus for Chinese investors and households as they will have more investment opportunities,” he adds.
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