Journalists call it a buried lead. It is when the real story is below the newspaper fold and drowned out by a tidbit that seems more sexy or appealing. Such is the case with the Asian Development Bank's latest outlook. Markets moved on the headline: the ADB upgraded its 2010 forecast for 14 East Asian economies to 8.1 per cent from 7.7 per cent projected in April. Buried was the news that three major risks must break Asia's way to keep prosperity alive: a double-dip global recession, destabilising capital flows and the successful unwinding of stimulus measures.
"While most emerging East Asian economies are assured of a sharp V-shaped recovery this year, it's too early to say that the V stands for ‘victory'," Srinivasa Madhur, a senior director at the Manila-based ADB, said on July 20.
Asia has had an impressive crisis, and China's rapid growth is bolstering confidence in the region. China's dynamism even prompted Goldman Sachs Group to raise its targets for a key index of Asian stocks. Yet Asia is moving into a precarious period, arguably the most challenging since the late 1990s.
Goldman's V stands for "valuations", and its bet on Asian shares makes perfect sense in the short run. In a July 14 report, analysts led by Timothy Moe raised their three-month forecast for the MSCI Asia-Pacific excluding Japan Index to 425 from 405, increased their six-month target to 440 from 430 and maintained their 12-month target of 485. The index is now 395.
Protracted sluggishness
The V may really stand for "vulnerable" as US growth disappoints, investors poke and prod Europe to assess default risks and Japan's woes deepen. Whether healthy growth can be maintained will depend on the decisions that policy makers take today about Asia's three big challenges.
First, the global economy. The historic wave of debt issuance over the last two years stabilised growth. It did not stimulate it as hoped, and economists are talking about a return to recession. The same goes for unprecedented interest-rate cuts. Free money helped banks get back on their feet, but did little to create new jobs or encourage increased consumption.
The trouble is, leaders are applying conventional thinking to very unconventional situations. Calls in Washington for deficit reduction ignore how comatose the biggest economy remains. Concerns in Europe that inflation is just around the corner overshadow the odds of deflation. Talk of recovery in Tokyo defies reality on the ground.
All the stimulus Asians threw at their economies means little if Stephen Roach, Morgan Stanley's non-executive chairman for Asia, is right that the US faces a period of "protracted sluggishness". Export-dependent Asia can live for a year without help from a $14-trillion (Dh51.49 trillion) economy. Three or four years would be another story. Sure, China is booming, yet a $4.3-trillion economy with an undervalued currency is no replacement for the US economic-growth engine.
That gets us to challenge No 2: hot money. Zero-interest-rate policies in Washington and Tokyo are ricocheting around Asia and increasing inflation risks. The US, Europe and Japan are putting off finding exit strategies from post-crisis growth stimulants. Asia does not have that luxury.
As inflation pressures mount, countries from South Korea to Malaysia are letting currencies strengthen. That approach is more palatable for politicians since China's move last month to scrap its peg to the dollar.
"Now that the Chinese yuan is moving again, they can afford stronger currencies and it's less damaging than interest- rate hikes," says Simon Grose-Hodge, a strategist at LGT Group in Singapore.
The dynamic may lead to additional obstacles. Overseas investors seeking profit from the trend may rush to Asia, swamping the region anew with short-term capital. Managing the cash glut will not be easy. Handled poorly, it will add to asset-price inflation that Asia will find difficult to control.
The third risk — unintended policy errors — also looms. This one may say the most about whether Goldman's present optimism translates into enduring gains for Asia's economies and investors in them.
Right balance
It would be challenge enough if it were just a matter of unwinding fiscal measures. Central banks also need to mop up untold amounts of liquidity — much of it flowing their way thanks to ultra-low rates in the world's biggest economies. Politicians and monetary officials need to work together to get the balance right.
On the one hand, inflation risks are heating up. On the other, the bulk of the world's poor live in Asia. Getting this mix right is much easier said than done. Asia has never faced such a delicate process of recalibrating drivers of growth. After Lehman Brothers Holdings collapsed in 2008, policymakers turned on the stimulus and left things on autopilot.
That was the easy part. The hard part comes as officials work to move back to normalcy. That time is now, and getting from "vulnerable" to "victory" could be a bumpy ride for those depending on Goldman's "valuations".
William Pesek is a Bloomberg News columnist. The opinions expressed are his own.
