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China Faces Serious Deflationary Pressures: Morgan Stanley

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Asia experienced a further slippage of economic growth over the past 4-6 months, which led to intensification of deflationary pressures, notes Morgan Stanley.

Derrick Kam and team of Morgan Stanley in their April 29, 2015 research note titled: “Your Comprehensive Update on Asia’s Growth Story – April 2015” note while policy makers are reacting to these deflationary pressures, but more still needs to be done.

Asia experiences subdued domestic demand

According to the Morgan Stanley analysts, overall growth momentum in Asia, especially in China, weakened further in March. While domestic demand faces headwinds from high debt, elevated levels of real rates and sluggish wage growth, external demand has to grapple with declining exports growth, lower commodity prices and still elevated real effective exchange rate.

Highlighting the factors that led to a slowdown in domestic demand, Kam et al. note the environment of slowing corporate revenue and nominal GDP growth and higher real interest rates is adding to pressures on corporate balance sheets, which happens to be most levered in the Asia region.

The following table captures a summary of the analysts’ APXJ growth trend:

Taking a closer look at individual countries, the Morgan Stanley analysts point out that weakness in commodity-related capex and external demand remain the key problems in Australia, though consumer activity is improving at the margin. During March, Australia experienced sluggish growth momentum. Considering that commodity price trends will likely remain subdued due to weaker demand from China, they believe more policy support to boost the growth of non-commodity sectors is critical for the near-term growth outlook.

Summary - Australia Asia

Focusing on China, Kam and colleagues note sluggish capex and external demand are the key drags to its growth. The analysts expressed concern over the elevated real rates and anticipate this would weigh down China’s domestic demand, which will lead to intensified deflationary pressures and ultimately higher real rates. In the context of the deleveraging process, the MS analysts believe growth outlook will be dependent on the pace of NPL provision and clean-up of banks’ balance sheet, besides the pace of structural reforms.

China - Summary Asia

Lower interest rates and reforms are key

Turning their focus to India, the Morgan Stanley analysts point out that India’s overall growth momentum has weakened at the margin due to a further weakening of external demand and a gradual recovery in domestic growth, led by stronger capex growth. They believe government policy action and the trend in real lending rates will be key in reviving growth:

India - Summary Asia

As regards Indonesia is concerned, the analysts note the country experienced slight improvement in capex growth, while external demand is weakening further. Considering 59% of Indonesia’s exports are commodities, the analysts believe commodity prices will have a significant influence on overall export growth:

Indonesia-Summary Asia

Kam et al note Korea’s overall growth momentum has remained subdued, with weaker external demand the main drag. They argue that pace of implementation of fiscal measures to support growth will be one of the key indicators to watch in Korea:

Korea - Summary Asia

The analysts note Taiwan experiences continued slowdown in capex and exports. However, improvement in consumer activity will be a positive for Taiwan’s economy. Key indicators to watch in Taiwan are exports growth, fiscal spending, property market activity and wage growth:

Taiwan - Summary Asia

The Morgan Stanley team points out that Thailand’s underlying growth momentum is improving, though it is still sluggish. The pace of government spending on infrastructure and trends in real rates, REER are key to the near term growth outlook:

Thailand - Summary Asia

The MS aanalysts also note signs of growth weakness have emerged in both domestic and external demand in Hong Kong. Highlighting the headwinds in domestic demand, they note Hong Kong’s property transaction has remained supported by negative real interest rates. Moreover,  retail sales growth declined, reflecting weaker consumer demand on the back of sluggish real wages:

Hong Kong - Summary Asia

Weaker commodity price turned out to be a key drag to Malaysia’s aggregate demand. In terms of external demand, commodity exports have been the key drag, with growth slipping to post-credit crisis lows:

Malaysia - Summary Asia

While the Philippines’s domestic demand has remained robust thanks to double-digit growth in auto sales, its export growth has slipped into negative territory:

Philippines - Summary Asia

The analysts note Singapore experiences sluggish domestic demand due to elevated real rates, while its external demand growth has picked up in March due to low base. They are closely watching Singapore’s external demand growth trend to assess its near term growth outlook:

Singapore - Summary Asia

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