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2009-04-16 | All chapters

From boom to gloom
David Pilling, Financial Times, 16th April 2009

British businesses hoping to escape recession at home might, until recently, have plausibly considered Asia a relatively safe haven from the global downturn. Until late last summer, companies would have looked smart if they had discreetly shifted resources to the one part of the world where exports were still flourishing and talk of recession seemed far-fetched. As recently as last autumn, the Asian Development Bank and others were projecting growth for this year of 7 per cent or above.

Those rosy forecasts proved flawed in two main respects. First, they misjudged the severity of the downturn in the west, as the credit crisis spread to the real economy. Second, they underestimated the strength of the links that continue to bind Asia to the rest of the world. True, Asia was no longer as dependent on global financial flows as it had been in the run-up to its own crisis in 1997-98. But it had replaced that with dependence on western demand for its manufactured products, making it even more vulnerable to an external shock.

“High value-added manufacturing is to Japan what financial services are to the UK,” says Peter Tasker of Dresdner Kleinwort, the investment bank, in a remark that could apply to many of Asia's export-oriented economies. While some in Britain have come to rue the perceived over-reliance on financial services to propel the economy, it is dawning on much of Asia that making goods for others to consume – without generating sufficient domestic demand – leaves their economies equally fragile.

Taiwan is a case in point. If Asia is the world's factory, then Taiwan is the factory's factory. Taiwanese companies produce the innards – the micro-chips and flat panels – that go into branded electronic products sold throughout the world. In the fourth quarter of last year, Taiwan's gross domestic product shrank at a savage 8.4 per cent year on year, the worst performance in its history. Exports fell by half almost overnight, as China and other assemblers of intermediate goods slashed their imports in the face of collapsing demand.

In Singapore, South Korea, Hong Kong and, importantly, Japan – alongside China, an Asian growth engine in its own right – the picture has been unpleasantly similar. The GDP of Japan, still comfortably the world's second-biggest economy, shrank 3.3 per cent in the fourth quarter of last year, about 12 per cent on an annualised basis.

The International Monetary Fund is just one institution that has been chasing its economic forecasts downhill: it now predicts that growth in Asia, excluding Japan, will fall to 2.7 per cent this year, a sorry number compared with the 9 per cent mustered by the region in 2007. Given this picture, the idea that Asia could be a motor of global growth is in the words of Stephen Roach, chairman of Morgan Stanley Asia, “pure fantasy”.

Amid the deepening gloom, there are two relative (if flickering) bright spots: China and India. Certainly, the speed of the downturn in China has taken the optimists by surprise, as an economy that was growing 13 per cent in 2007 slowed to a desultory 6.8 per cent in the fourth quarter.

However, China's response has been equally swift: it has announced a massive stimulus package of some Rmb4,000bn (£424bn) and is using the levers of a command economy to push credit into the market.

Andy Rothman, China economist at CLSA, the brokerage, is confident Beijing has enough fiscal firepower to achieve 8 per cent growth. He cites a leading indicator of manufacturing production compiled by CLSA which shows a small rise in February, for the third consecutive month.

Although it is still below the mark associated with a growing sector, he and others see the gradual improvement as evidence that China's economy may already have hit bottom.

Mr Rothman sees some hope even in exports, which have been contracting more slowly in recent months, he says. “We attribute this to what we've been calling the Wal-Mart effect: US and European consumers are buying much less stuff, but they are increasingly down-shifting to the lowest-priced good in every category, which is almost inevitably from China.”

Paul Fletcher, senior partner of Actis, the UK private equity group, argues that China will continue to be one of the world's brighter investment opportunities, though deals may be smaller and the classic exit, via initial public offering, may have to be modified. His group is looking at deals of £35m-£70m in manufacturing, consumer products, education, budget hotels and restaurants, all areas – with the exception of hard-hit manufacturing – that it considers more or less recession proof.

India is the other exception. Its economy is less exposed to exports than practically any in Asia. True, growth is already slowing as foreign investment dries up and funds pull their money from the stockmarket, triggering a shock to confidence. Tight credit markets have affected some businesses. But the government is still forecasting 7 per cent growth this year. This is probably on the high side, but even the pessimists are expecting expansion of at least 4.5 per cent in 2010.

Pramod Bhasin, chief executive of Genpact, India's biggest business processing outsourcer, says the outsourcing businesses will continue to grow, though at a slower pace. Instead of 30 per cent expansion a year, he is predicting an average of 15 per cent over the next two years. As business conditions worsen in the US and Europe, he expects many companies to look to India to help them pare costs.

“Logic suggests we are part of the solution,” he says. But, like many, he admits it will be rough and unpredictable. He is also hedging his bets. His prediction for the outsourcing industry's next big growth opportunity: “How can we serve distressed asset buyers?”

Case study: China

China has been inundated with so much foreign direct investment over the past decade that it can often appear like a paradise for multinationals. In 2007, the country received a record $84bn, writes Geoff Dyer.

Companies from across the world have rushed to build new factories in China not just because of the plentiful cheap labour, but also because of the roads and ports that far surpass the facilities in most emerging markets.

When the wave of FDI started in the 1990s, the governments of provinces in the coastal regions of China were keen to attract manufacturing companies to set up operations. More recently, Beijing, Shanghai and other developed regions have shifted emphasis towards trying to bring research and development activities to China. Researchers estimate that more than 300 multinationals now have some form of R&D operation in China, even if the majority are adapting products for the local market.

Among UK companies, both AstraZeneca and GlaxoSmithKline – the two largest pharmaceuticals groups – have established research operations in Shanghai in the past two years.

Foreign companies often find they receive more encouragement from local governments if they are willing to invest in less well-known cities, especially in central and western China. Indeed, many of those inland cities are starting to become more attractive, in part because they are less affected by slumping exports and because they will benefit from the government's fiscal stimulus plans. “They are somewhat sheltered from the global economic storm,” according to Jones Lang LaSalle, the property consultancy.

However, the landscape for foreign groups in China is not as straightforward as the headline figures might suggest. For a start, in recent years the political climate has shifted somewhat against openness to foreign investment. A decade ago, the widespread view was that the country needed overseas skills and experience to develop its economy, but China now has a greater sense of self-confidence and this has shifted the debate.

High-profile deals have, at times, become caught up in nationalist backlashes. After announcing the planned takeover of a construction machinery maker in eastern China in 2005, Carlyle, the private equity group, found itself the subject of a fierce internet campaign and the deal was never approved. Coca-Cola's planned acquisition of Huiyuan, a fruit juice maker, has also encountered nationalist opposition and is still awaiting approval. The bid has become an important early test for China's new antitrust laws.

Many important industries are also either closed to foreign investors or under tight control. In banking, for instance, foreign groups are limited to purchasing 20 per cent stakes in local banks. Overseas banks have recently been allowed to open their own operations that conduct business in renminbi, but they are kept on a tight leash. Every new branch opening must be individually negotiated with the banking regulator and the relevant local government. Logistics, media and mining, three other areas of UK expertise, are also heavily controlled.

Multinationals operating in China complain that they are facing demands for greater technology transfer in return for winning contracts in China. Foreign companies are also worried that they will be squeezed out of contracts connected to China's fiscal stimulus programme.

"I have heard concern from members. They say that in this procurement mechanism they might be disadvantaged and that there might be a strong focus on getting the domestic companies basically preferred," says Joerg Wuttke, head of the European Union Chamber of Commerce in Beijing. "But I think that remains to be seen."

China's relatively high growth rate will continue to make it a target for FDI, but in many industries, the political and administrative obstacles are significant.

Case study: India

India's economic growth estimates have looked steadily less and less mouth-watering over the past six months, writes James Lamont.

Foreign investors now talk in terms of “the long term” rather than double-digit growth rates to rival China.

The last quarter of 2008, which recorded disappointing 5.3 per cent growth, has surprised many who felt sure India would be less affected by the global financial crisis than many emerging economies. Hopes were high that buoyant domestic consumption would protect an economy where exports are less than 20 per cent of gross domestic product and banks are largely in state hands.

Agricultural output is falling, alongside manufacturing, while the government is stepping in with higher spending to prop up growth, forecast at 7.1 per cent for the fiscal year ending March 2009.

The global financial crisis has temporarily ended the salad days of 9 per cent growth, enjoyed over the past three years. With parliamentary elections likely in April, India now also faces a policy freeze until a new government is formed in June.

Yet even with a more modest rate of growth and a possible change of government, India continues to have great appeal as a large market and one that offers low labour costs to multinationals.

“India is affected by the global financial crisis,” says Stuart Fraser, the chairman of the policy committee of the City of London Corporation. “But there is restrained optimism for the longer term. Emerging economies such as India's are modernising very fast. Cities are growing and millions of people are becoming more prosperous.”

Infrastructure projects, backed by government funding, now hold some of the greatest appeal. Investors have also been cheered by a relaxation of some of the complicated rules governing foreign investment. This could open up prized sectors such as retail and airlines. But opportunities in heavily regulated financial and professional service sectors, including law and accounting, remain meagre.

“We welcome a little easing [of regulation]. But we don't expect any large steps,” says Mr Fraser.

The company behind one of the largest foreign investments in India is bullish about the economy's prospects. Vodafone bought a controlling stake in Hutchison Essar, a mobile operator, for £5.7bn in 2007.

“India seems to be a bit more sheltered than other markets,” says Vittorio Colao, Vodafone chief executive. “In the financial sector the contagion has not arrived. There is probably some slowdown in the business process outsourcing business, but not a massive one.”

India has faced challenges on other fronts. A terror attack struck at the heart of Mumbai, the country's financial capital, in November. One of the leading IT outsourcing companies, Satyam, revealed a massive fraud earlier this year.

But these events have not made multinational companies less convinced about India's potential.

“The Satyam allegations have raised inevitable questions about corporate governance but do not appear to be representative of the sophisticated and mature business environment in which major corporates operate in India today,” says Guy Douglas, a Delhi-based executive with BAE Systems, the defence contractor.

Case study: Vietnam

In the past, investors have viewed emerging markets mostly as low-cost production bases, but in today's tough economic environment countries such as Vietnam – which has a population of about 85m – are coming to be seen as potential consumer markets, writes Tim Johnston.

“There are going to be two main value drivers in the current market: cost of production – Vietnam is increasingly on the radar for outsourcing, such as relocating factories from elsewhere in Asia – and for multinationals looking for a growth market,” says Warrick Cleine, managing partner in Vietnam for KPMG, the professional services group.

Few of Asia's export-dependent emerging economies have fared well as the downturn strangles demand in their most important markets, but Vietnam has come out fighting. It has stressed its low-cost production base, well-educated workforce and political stability.

There is anecdotal evidence that manufacturers are moving facilities to Vietnam from other parts of Asia: they say it is cheaper than China, more productive than some of its regional competitors, further down the development curve, and seemingly stable within the political boundaries set by the government.

The authorities have worked hard to erase the impression of being the wild eastern frontier of capitalism. Regulations have been streamlined, there has been a crackdown on corruption, infrastructure has improved – to a certain extent – and legal protection for investors is tighter.

“It is very regulation-light in terms of interfacing with the authorities. The main challenges are negotiating rents with your landlord and things like that,” says Mr Cleine.

The process has been helped by the government's hunger for membership of the World Trade Organisation. Vietnam gained entry in 2007 but, in return, the WTO demanded big changes, many relating to opening up domestic markets and liberalising export regulations.

But people such as Tom Siebert, chair of governors at the American Chamber of Commerce in Vietnam, say the government's willingness to improve the investment climate goes well beyond the WTO-mandated changes, and includes an ongoing analysis of how bureaucratic hurdles can be scrapped.

“It's getting much easier,” says Mr Siebert. “The structures have been simplified and it is now well known how the process works.”

Increasingly, foreign investors are coming to Vietnam also because of the attractions of its domestic market.

“There is an improving business environment with a vibrant market and a youthful population that is in a hurry for things,” says Mr Siebert.

But success has extracted its own price. Manufacturers are starting to encounter bottlenecks, particularly when it comes to finding qualified management and technical staff.

“There are capacity constraints around senior management positions, engineers, finance professionals,” says Mr Cleine. “You have to do an assessment of cost versus capacity.”

Some other concerns remain. Labour relations can be a source of trouble, but Mr Siebert says they are generally the result of bad communication between management and workforce rather than deeper problems.

And corruption can still be an irritant, but it is confined to petty officials and is no longer a big barrier to investment.

Source: http://www.ftchinese.com/story.php?lang=en&storyid=001025865