Similarly, debt-to-GDP ratios have rocketed across the Asia-6, but especially in China, as those countries have tried re-inflate their economies by driving up domestic demand and capital expenditure though leverage. Debt-to-GDP rose from around 160% in 2007 to an estimated 255% in 2015. Again, Japan also saw a marked increase in its overall debt-to-GDP ratio from 1985
onwards, which has seen the ratio climb from 320% to just under 480%.
“This has created a build-up of excess capacity and decline in productivity,” Gadkari says. He points to weakening capital productivity growth over the last eight years for the Asia-6, where the incremental capital output ratio has jumped from 3.3 in 2007 to 7.3 in 2016.
Lombard Odier’s analysis indicates that a sharp rise in investment accompanied by moderating GDP growth points to excess capacity and loss of capital productivity. Japan saw a similar (albeit smaller) increase in leverage and worsening of productivity in the 1980s.
Maarten-Jan Bakkum, senior emerging markets strategist at NN Investment Partners says excess capacity in the industrial sector, after years of excessive investments and with the prospects for global trade still bleak, should continue to put pressure on inflation rates.
“Producer prices have been declining since 2012,” he says. “Consumer price inflation is positive, but low. The government’s economic policy approach of trying to manage fixed investment growth down only very slowly means that excess capacity problems will remain in the coming years. This should keep inflation negative or low.”
Demographics are also turning against the Asia-6. Anna Stupnytska, global economist at Fidelity International, says: “The demographic dividend has now turned into a growth drag, lowering potential growth rates.”
CHANGING COURSE
The annual growth rate of the working age population across the Asia-6 is now at an inflection point and will decline from 2015 onwards. Once again, the demographic
inflection was also a factor in Japan’s prolonged deflationary period as the growth of their working age population turned negative in 1996.
Faced with a similar deflationary outlook to that which has plagued Japan for two decades, experts are calling for more aggressive policy action from governments and central banks in the region.
Lombard Odier’s Gadkari warns: “Unless the authorities in the Asia-6, most crucially in China, react with an aggressive policy mix, deflation could become entrenched as it has in Japan, where it has persisted for nearly 20 years. This would have serious implications not just for the Asia-6 economies, but for the global economy.”
He points to the US where, faced with a similar deflationary outlook immediately following the financial crisis in 2008/09, the Federal Reserve cut rates sharply, pushing real interest rates well below real growth rates. This policy action, which Gadkari says was “exemplary”, created a transfer of profits that allowed the private sector to improve balance sheets, and reduced excess capacity in the system. The labour market subsequently reached near full employment, which helped the economy get back on its feet. Japan never managed to get real rates below real growth which, Gadkari says, is the “crux of their problem”.
While China is already beginning to create a gap between real rates and real growth, Gadkari believes the current policy mix will not be sufficient to alter the deflationary course China finds itself on. “If the Asia-6 economies are going to avoid a deflationary destiny, they will need to be much more proactive with their policy mix to bring real interest rates well below real growth rates,” he says.
