The old export-led model in EM Asia may now be fractured with domestic demand drivers, including financial conditions, playing a more significant role than external demand, notes JPMorgan.

Jahangir Aziz and Sin Beng Ong of JPMorgan in their July 2, 2015 research note titled: “EM Asia: Alice doesn’t live here anymore” point out that falling exports to the EM Asia region and other economies led the decline in overall exports.

Disappointing two quarters at EM Asia

According to the JPMorgan analysts, EM Asia’s GDP growth averaged only 5.2% q/q saar, 1.2%-pts lower than the 6.3% average of the last three years, which in turn, was markedly lower than the 9.3% pre-crisis average:

GDP Growth EM Asia

The analysts note a major contributor to weak DM growth in 1Q15 was a 1.5%-pts drag from net exports, which have led to exports declining 20% in dollar terms and 16% in volume. They note EM Asia’s venerated export-led growth model is undergoing fundamental changes and structural reforms are required to raise EM Asia growth to a higher medium-term path. The analysts point out that apart from China, economies in the region have been slow to reform since the 2008 crisis.

Aziz and Ong point out that despite declining in importance as export markets, DMs still constitute about 40% of EM Asia’s exports. However, their contribution to export growth, especially by the US and EU, has been modest in recent years with exports to other economies, including within the region, driving most of the fluctuations. As can be deduced from the following graph, the falling exports to the region and other economies (rather than the US and EU) led the decline in overall exports:

EM Asia-Exports by destination

They also note the correlation between exports from the region to China and China’s exports to the DM was high and stable, averaging around 0.8 until 2011. However, since then the correlation has dropped sharply, turning negative over the last three years with no sign of reversing:

EM Asia - Asia's supply chain

Technology as mainstay of EM Asia exports

Underscoring the importance of technology in EM Asia exports, the JPMorgan analysts note over 2003-2007, tech exports grew at a 21% annual average rate, though since 2011, this rate has dropped to just 5.3% with no reversal in sight. Interestingly much of this downshift trend has coincided with the slowdown of US tech demand:

US tech imports EM Asia

However, Aziz and Ong point out that since 2008, U.S. non-tech equipment spending has expanded in line with the economy, though tech spending has stagnated, likely reflecting the declining marginal productivity of tech relative to other equipment:

US equipment spending EM Asia

Aziz and colleague also note with tech capex languishing, the Mobile Computing Device (MCD) product cycle has become the dominant driver of EM Asia tech exports. Citing an example, they point out that Taiwan’s orders data, considered a bellwether for regional exports, is now remarkably closely correlated with sales of Apple products:

Taiwan export orders EM Asia

Highlighting the changes in the traditional drivers of growth in EM Asia, the JPMorgan analysts note DM growth has recovered, while EM Asia exports continue to flounder. To test the hypothesis of a structural shift in EM Asia’s exports driver, they estimated a panel regression for the economies in EM Asia over the period 1Q00-1Q15. As can be deduced from the following table, over the entire sample period both DM growth and real policy rate are statistically significant drivers of EM Asian growth. As can be inferred from the second row of the following table, instead of DM growth raising EM Asia growth, over 1Q11-1Q15, it in fact had virtually no impact:

Panel growth regressions EM Asia

Thus. Aziz and Ong conclude that domestic financial conditions rather than DM growth are now the dominant growth driver in EM Asia.