GLOBAL GROWTH ISSUES SPARK REFORMS
In recent weeks, there have been positive signs of future growth potential from Asia’s two main economies, China and Japan. Japan’s annualised GDP growth of 2.6% in the second quarter fell short of consensus expectations, held back by a small decline in capital spending, and GDP growth for the first quarter was revised downward. However, optimists argue that capital spending typically trails an upturn in economic fortunes and instead point to a strong rise in the value of exports and private consumption. Data showing increasing income also suggest that the prospects for the domestic economy remain good. Bank lending has been strong, while second-quarter profits of companies on the Tokyo Stock Exchange’s First Section were double those of a year earlier. Confidence in Japan’s ability to lift itself out of long-term stagnation has been further boosted by the victory of Prime Minister Shinzo Abe’s party in parliamentary elections in late July.
But optimism is also tempered by proposals to progressively double Japan’s consumption tax in 2014–2015 in a bid to deal with the country’s huge debt mountain, which is approaching 250% of GDP. From a long-term point of view, the effort to increase fiscal revenues are to be welcomed, especially if it helps Japan avoid a debt crisis. However, the fragility of Japan’s economy makes such an initiative fraught with danger. Memories are still fresh of the country’s last attempt to increase its consumption tax in 1997. The rise in the tax then was blamed, in part, for recession and a fall in government revenues that followed, thus making the debt problem worse. The rest of Prime Minister Abe’s reform agenda—the so-called “third arrow” of the radical policy moves termed “Abenomics”—will also prove both far-reaching and challenging. Abe’s government has set out its plans to create special, deregulated enterprise zones that seek to benefit from tax incentives, and it is committed to bringing Japan into the Trans-Pacific Partnership, an emerging regional free-trade group. But we think vested interests are bound to challenge government attempts to stimulate the Japanese economy at large through liberalisation and deregulation. Failure to open up the vast areas of the domestic economy that remain closed to outside competition or to deal with the decline in the working population are likely to prove at least as damaging to Japan’s prospects as a slip-up on the consumption tax issue.
Optimism about China has also started to re-appear. Thanks to a series of small, targeted measures by policymakers, the deceleration seen in the Chinese economy over the past two years would seem to have been stopped, at least temporarily, with official statistics recording a rise in industrial production, investment, employment and real-estate construction during July. China’s imports and exports both grew strongly in July as well. The strength of China’s imports is especially notable as it is an indication that Chinese domestic demand has been holding up well. Yet China’s growth remains disproportionately reliant on credit-fuelled infrastructure and property construction, underlying the importance of introducing reforms. The third plenary meeting of the 18th Central Committee of the Communist Party of China, the so-called “Third Plenum,” will take place in October. The plenum—historically a forum for the announcement of important economic reforms—may well see the unveiling of proposals to deal with looming long-term issues such as a shrinking working-age population, urbanisation, the regulation of financial markets, and the free movement of capital.
The economic picture in other large economies is mixed. Russian GDP growth for the second quarter was well below consensus expectations. The Reserve Bank of Australia has had to cut base interest rates to a record low in a response to the challenges posed by a fast-fading commodities boom, while there are fears rising US interest rates may squeeze credit in many emerging countries. India and Brazil are also looking at substantial current-account deficits, having suffered a decline in their growth rates, and find themselves having to deal with increased currency volatility. Not surprisingly, the latest set of composite leading indicators released in July by the Organisation for Economic Cooperation and Development pointed to strengthening growth in Europe, the US and Japan potentially in the months ahead, but continuing sluggishness in a number of large developing markets. However, the growth slowdown in emerging economies has been gentle, falling well short of an outright crisis. We think signs of stabilisation—or even a mild pick-up—in China should boost sentiment in a number of emerging markets where, in any case, growth rates (and potential) appear to remain much higher than in the western world or Japan. The slowdown is also giving a spurt to reforms. One notable example has been the decision by Mexico to liberalise its large energy sector, which, together with important labour reforms introduced last year, has the potential to lift Mexico’s sluggish growth rate.