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In the first of a four-part series, MICHELLE QUAH looks at how the regional economy will be affected by the fallout from the US crisis

THE sub-prime crisis in the United States has undoubtedly been the single largest shock to the global economy in the past year. But, crucially, it is also important to note that it is a crisis that is still unravelling and whose full effects may not yet be fully felt.

This first article in a four-part series on the risks and returns in such a volatile period examines the effects - current and future - of the sub-prime crisis on global markets, and how Asia will be affected by the fallout.

Ernst & Young’s (EY) country managing partner Steven Phan encapsulates recent developments as such: ‘The current global economic fallout was sparked off by the sub-prime mortgage crisis in the US. The credit crunch that followed caused the market to become more cautious and lending became more stringent.’

‘The weakening US dollar, coupled with housing issues, rising commodity prices and market volatility, dampened general consumer confidence and sense of job security and, as a result, curtailed consumer spending. This has had a wide impact on the global economy, given that the US is undoubtedly a major consumer market,’ he adds.

Despite the crippling effect of the sub-prime crisis, experts are divided as to whether the US is headed for a recession.

A US recession?

‘Some have argued that the US is already in a mild recession. Nonetheless, clearly, consumer confidence has been declining amidst the global slowdown and rising oil and food prices,’ says Mr Phan.

Tham Sai Choy, head of audit at KPMG in Singapore, says: ‘Whether technically a recession or not, there is clearly a marked slowdown in many of the economic indicators in the US.’

Peter Baldock, chief operating officer at Deloitte Global Corporate Finance, based in Singapore, believes that ‘the reality is that the US is moving into a period of stagflation where the economy moves sideways, probably not steeply downwards but at best zero to very modest growth’.

Goh Mui Hong, president and CEO of ST Asset Management, says: ‘Our view is that the US economy is still expected to experience a period of protracted weakness and possibly a recession under the weight of falling home prices, tight credit, rising unemployment and growing inflationary pressures.’

UOB economist Jimmy Koh believes the world’s largest economy could avoid slipping into a recession. ‘Our take is that while growth will remain weak, it should be able to avoid a recession. The question is the recovery process. Given that banks are still repairing their balance sheets, and the sub-prime effect is still working through the real economy, the recovery path is likely to be a fairly long U-shape.’

CIMB-GK Research head Song Seng Wun agrees that the US is unlikely to slip into a recession this year but warns it could happen next year. ‘The US economy this year is still being supported by contributions from net exports and private consumption. But it could slip into a recession next year, once the lift from the tax rebates have worked through. Consumer spending may fall, if oil and food prices stay high against a backdrop of a weak labour market. US exports may fall off more meaningfully going into 2009, if global demand is hit by high inflation.’

The impact on Asia

Asia, however, is likely to be shielded - to a certain extent - even if the the world’s largest economy does slip into a recession.
‘Some are worried Asia could be walking into stagflation. So far, most economies are running negative real interest rate. And many are assuming inflation, oil and commodities prices should eventually ease. The worry is, what if prices do not correct? Asian central banks could be forced to hike rates significantly, which would be detrimental to asset prices.’
 
- UOB’s Jimmy Koh 
 
 
 
‘One reason is that Asian banks have very reasonable exposures to such assets,’ says UOB’s Mr Koh. ‘Thus, the effect is likely to be via the real sectors of the economy. Also, we have seen emerging new economies - the likes of China and India. The ample global liquidity has also helped to mitigate extended downside.’

Deloitte’s Mr Baldock says: ‘Asia, particularly China, is not wholly dislocated from the state of the US economy but to the extent that the Asian domestic economies now have greater relative importance than in the past, they are not so dependent on their exports to the United States and Europe.’

CIMB-GK’s Mr Song says: ‘Asia is not protected if global demand were to slow sharply. But Asian governments and companies are generally in a stronger position now to ride through any slowdown because most companies’ and countries’ balance sheets are quite decent - for example, they have high forex reserves, low debt gearings, etc.’

ST Asset Management’s Mrs Goh says: ‘Another possible reason Asia could survive is that the bulk of borrowing needs could be supported by Asian banks. While global banks have been cutting down on investments and lending, the region has been fortunate that the Asian banks could continue to finance and support the local companies.’

KPMG’s Mr Tham believes the slowdown in the US could even present opportunities for this region. ‘Asia’s developing economies are seeing a strong momentum of growth,’ he says. ‘Compared to the last time the US was in recession, they also have stronger reserves to buffer themselves against external shocks and are seeing improvements in governments, infrastructure, markets, education and security.’

‘In addition, slower growth in US markets may push along the development of new trade flows within the Asian region, and increase the economic opportunities for countries in Asia,’ Mr Tham adds.

This doesn’t mean, however, that Asia is out of the woods. The full extent of the sub-prime crisis has yet to play itself out, and new challenges are threatening the stability of global markets.

Mak Yuen Teen, director of the Asia-Pacific Research and Innovation Centre of Watson Wyatt, believes the still-unravelling sub-prime debacle poses significant risks: ‘A key challenge is that the sub-prime crisis is very different and the full effects are still anybody’s guess. Its impact may be more severe, systemic and global than many other crises. And we now have issues of high inflation, high oil prices and high food prices. So, it may require a lot of stamina and resources to get through this one.’

New threats

EY’s Mr Phan notes: ‘Inflation has increased, reaching an all-time high and, in some parts of Asia, these escalating costs have caused certain levels of socio-political tension.’

He also points out that foreign exchange rates, market volatility and rising costs of raw materials will create additional burden and threats to businesses.

Deloitte’s Mr Baldock believes the greatest challenges for most Asian economies will come from inflation and access to basic resources - ie oil and gas, minerals and food. ‘To contain inflation and rocketing real estate prices, interest rates will rise and that will impact on their relative exchange rates to the US dollar. Hence, there will be a loss of cost competitive advantage with regard to the US.’

CIMB-GK’s Mr Song warns that Asia is also facing increasing competition, as trade barriers are being lowered.

UOB’s Mr Koh believes the new threats will pose significant challenges for the region’s economies. ‘Some are worried Asia could be walking into stagflation. So far, most economies are running negative real interest rate. And, many are assuming inflation, oil and commodities prices, should eventually ease. The worry is, what if prices do not correct? Asian central banks could be forced to hike rates significantly, which would be detrimental to asset prices.’

The new threats will not only affect economies as a whole, but individual businesses as well.

Need to be vigilant

KPMG’s Mr Tham cautions: ‘Businesses will need to be more careful in analysing the risks that they are exposed to, and be better prepared for them. They may have to be prepared that banks might fail, high-quality rated investments might lose their value overnight, and historical patterns might not even apply any more.’

‘Moving forward, organisations should be more vigilant in their risk management procedures, paying attention to risk identification, and embark on a strategy to diversify and manage these risks,’ Mr Tham adds.

Deloitte’s Mr Baldock says: ‘At the corporate level, the key risks are the volatility of supplies of inputs, both in terms of quantities available and prices paid, including forex volatility exposure. This uncertainty makes business planning and investment very difficult. Corporates will therefore attempt to take control of their supply chains.’

ST Asset Management’s Mrs Goh warns that the slowdown in US consumer spending will affect companies that cater to the consumer sector. She also cautions: ‘US and European property markets have been negatively impacted by debt re-pricing. This will affect real estate developers and agents.’

‘Businesses will also have to find cost-efficient ways to move from obsolete technologies to new technologies that are more energy efficient or use alternative sources of energy. And employers will have to handle wage expectations given current food and property price pressures,’ she adds.

EY’s Mr Phan believes new threats will also throw up new opportunities for businesses which are well-equipped to seize them. ‘Companies who continue to focus on empowering their people and attract and retain the right talent will be the ones who are able to execute and perform better during trying times.’

This is the first of a four-part series brought to you by CPA Australia and the Institute of Certified Public Accountants of Singapore (ICPAS), in conjunction with the CPA Forum 2008 ‘Risk and Return’ on Aug 15 - which will focus on issues surrounding the current economic climate, and strategies to help businesses navigate through the storm.

Next week, we will look at how businesses can cope with the challenges posed by the new risk environment

Source : Business Times - 23 Jul 2008