All of Asia feeling China's 'new normal'
China is facing risk of deflation, and the destructive cycle of declining prices is starting to spread all over the Asia-Pacific region.
After the bankruptcy of Lehman Brothers Holdings in 2008, China introduced bold pump-priming measures and rapidly increased its imports of raw materials. Its neighbors rode through the economic crisis by boosting exports to China. However, since last year, slowing demand in China has been putting these countries on the verge of deflation. In China, excessive supplies have held down prices of industrial products, and imports have been falling sharply due to prolonged production adjustments.
Speaking at the opening of the annual National People's Congress on March 5, Chinese Premier Li Keqiang reported on the government's activities and acknowledged slowing growth by stating that the Chinese economy entered a "new normal." He also said the country would aim to expand its economy in real terms by about 7% in 2015. The new target is lower than the actual growth of 7.7% in 2013 and 7.4% in 2014, underscoring that the era of China's double-digit growth is now a thing of the past. China's imports by value inched up by 0.4% on the year in 2014, marking the lowest growth since 2010. The downtrend continued in 2015, with the January and February figures down by 19.9% and 20.5% on the year, respectively. What China calls the new normal is thus starting to have serious effects on the economies of its neighbors.
The town of Sepang, in the central Malaysian state of Selangor, is surrounded by palm plantations. Drive on any street in the area for half an hour, and you still find yourself amid palm plantations with trees more than 5 meters tall. When this writer visited a palm farm recently, I saw workers picking up fallen branches as if they had nothing else to do. Loading of fruit onto trucks had been completed in about five minutes. "I've been doing this job for more than 10 years, but right now is the worst," said one worker. He had earned 2,500 ringgit ($678) a month until three years ago, but his income has been declining steadily and now he makes about 1,000 ringgit a month. Palm oil is one of Malaysia's main industries, the backbone of its economy, but it has been hit hard by significant cooling of demand.
Kelvin Lee is a palm fruit wholesaler in the Sepang area who makes his living buying up palm fruit from small and midsize farms and selling it to a local refinery. He used to own seven trucks but sold two of them last year because of slumping demand. Two years ago, he had no trouble selling 3,000 tons of fruit per month, but the amount he handled continued to shrink until it was only 600 tons in January. "I have heard exports are not going strong, and now I can't even go for a drink," he said.
Palm oil is drawing attention as a low-cost vegetable oil and production had been expanding in Malaysia and Indonesia. One driving force behind the increased output was exports to China and other emerging economies. However, demand in China, their largest customer, has been falling sharply. In 2014, Malaysia exported 2.84 million tons of palm oil to China, roughly three-quarters of the 3.7 million tons the previous year. In Malaysia's crude palm oil futures market, a global pricing benchmark for palm oil, the price sank below 2,000 ringgit per ton in 2014, less than half the level in 2011. In contrast, the planted area of palm trees totaled 5.4 million hectares at the end of 2014, an increase of 400,000 hectares compared with the end of 2011. Hoping to cash in on strong demand in China, farmers increased their capacity, but the move backfired.
A car dealership in Kota Kinabalu, a city in eastern Malaysia that relies heavily on the palm oil industry, saw its sales volume of cars fall by about 20% from a year earlier. The manager of the dealership said, "The business will be tough again this year unless palm oil demand makes a recovery."
About halfway into 2014, Malaysia's exports to China started shifting from year-on-year growth to year-on-year decline. Its overall exports in January were down by 0.6% on the year but its exports to China appear to have fallen much more sharply, by more than 20%. The more heavily countries rely on exports for their economic growth and the higher the percentage of their exports to China, the greater the effects they experience when those exports drop sharply. Some Asian countries, such as South Korea, Malaysia and Thailand, are more vulnerable than others, but Australia is also in dire straits, since more than 30% of its exports are to China.
Dark times for coal
Queensland, in eastern Australia, is known for its production of coal. Moranbah is a large mining town north of Brisbane, the capital of Queensland, but in recent years it has lost its vigor due to sluggish exports of coal to China. At the Drovers Rest Motel, a two-story wooden hotel in the center of the town, the lights in the guest rooms are rarely turned on now, as there are so few guests. Evan Hartley, who has run the place for 14 years, said business has been so slow lately that he was waiting for the hotel to be seized by the bank.
When the Drovers Rest Motel opened in the early 2000s, Moranbah was a bustling town, thriving on the brisk exports of natural resources to China and other countries. High-wage workers were eager to spend their money there, which boosted housing prices -- up to 1 million Australian dollars ($763,009 at current rates) for a typical home. But the situation has changed completely since the Chinese economy began to sputter in 2013. Many companies have frozen hiring, halting the rise in wages. Anne Baker, the mayor of the Isaac Regional Council, which oversees the region including Moranbah, expressed a sense of urgency, stating that many areas are now faced with an unemployment problem. Consumer spending driven by exports to China has lost steam quickly and housing prices have plunged to the A$200,000 to A$300,000 range.
Deflationary pressure is not limited to natural resources and products. If corporate earnings deteriorate due to a sharp drop in exports to China, companies have no choice but to reduce hiring and wages. In that case, consumer spending will shrink further and prices of consumer goods will decline as well. South Korea, whose economy is propelled by the manufacturing industry, is now on the verge of falling into this vicious circle. Its exports to China, including Hong Kong, slid by 0.6% on the year to $172.6 billion in 2014.
Chinese Premier Li Keqiang attends a press conference following the close of the National People's Congress in Beijing on March 15. (Photo by Takaki Kashiwabara)
China is South Korea's biggest trading partner, with its exports to China accounting for about 30% of the total by value. Because of sluggish demand in China, prices of South Korean products took a tumble, and as a result major petrochemical companies LG Chem and Lotte Chemical reported double-digit year-on-year declines in their operating profits for the year ended December 2014. South Korea's leading shipbuilder, Hyundai Heavy Industries, posted its largest operating loss in the year through December 2014, and is fighting a legal battle with its labor union, which is demanding wage increases.
South Korean companies have been working hard to squeeze out a profit by adjusting their workforce, and consequently the number of nonpermanent employees in the country topped the 6 million mark for the first time in August last year. It means that more than 30% of all workers in South Korea are now nonpermanent employees, and this is why consumers are keeping a tight hold on their purse strings. Lotte Department Store, a major South Korean retailer, is shifting its focus to the opening of outlet malls that sell off its remaining inventory from the opening of new department stores because high-end products, which department stores were good at selling, are not faring well now. In 2014, it opened three stores but all of them are outlet malls. South Korea's consumer price index went up by 0.5% year on year in February, marking the lowest level of growth since the Asian currency crisis in the late 1990s.
The downward pressure on prices that started with weakening demand in China is spreading quickly around the Asia-Pacific region. China's wholesale price index for February was down by 4.8% on the year, with the size of the fall growing for the seventh straight month. The country's consumer price index has not sunk below the previous year's level yet but has been hovering at an increase of about 1%. Meanwhile, Malaysia's producer price index for January declined by 4.8% from a year before, and Thailand's consumer price index has fallen for the second consecutive month since the start of 2015. If nothing is done about the current situation, disinflation -- a slowing in the rate of increase of general price levels -- might turn into full-blown deflation, with persistent declines in general prices.
To head off deflation, central banks in the Asia-Pacific region have started to take action. On March 11, the Bank of Thailand cut its benchmark interest rate, the one-day bond repurchase rate, by a quarter of a percentage point to 1.75%. On March 12, the Bank of Korea, South Korea's central bank, reduced its key interest rate by a quarter of a percentage point to an all-time low of 1.75%. The Reserve Bank of Australia made a similar move earlier this year, reducing its key interest rate by 25 basis points to a record low of 2.25% on Feb. 3. However, it would be extremely difficult to stimulate domestic demand and push up prices with these key interest rate cuts alone, as Japan's nearly two-decade struggle with deflation clearly demonstrates.
After the collapse of Lehman Brothers, many countries experienced economic downturns, but robust demand in China eased the pain somewhat. But now, there is no sign of an emerging economy that could take over the role of China and create strong demand. Countries in the Asia-Pacific region therefore need to find a way to generate demand by themselves, without relying on China.
"Southeast Asia has remained dependent primarily on export demand and lacked potential to shift to a domestic demand-driven economy," noted Takamoto Suzuki, a senior economist and expert on economic relations between China and Southeast Asia at Marubeni Research Institute. "The region has also depended on foreign companies for innovation and waited for money to pour in from outside. Exporters in the region used to depend on the U.S. and are now reliant on China. They are paying the price for such tendencies."
India might be the first alternative to come to mind, but the government there may be limited in its ability to act, despite Prime Minister Narendra Modi's promises of stronger public investment. "People may have become overly optimistic about such a prospect," Suzuki said. "India is a democracy and does not have the power to steamroll investment projects as China, which is controlled by the Communist Party, did by spending 4 trillion yuan ($639 billion) to stimulate its economy."
Resorting to makeshift solutions, such as economic stimulus measures that could snowball budget deficits and consumer debt, would only create new risks. In other words, there is no silver bullet to solving the problem at hand. What the countries in the Asia-Pacific region could do is continue to make small but steady efforts to create demand while clearing away obstacles in trade and investments and making sure not to discourage economic activities in any way. If they become caught up in a deflationary spiral as Japan has experienced, there will be no more economic miracles happening in Asia for a long time.
Countries in the region also face political risks from deflationary pressure as prices of natural resources such as palm oil and natural rubber head downward. In Thailand, farmers, who constitute half of the population, have played a central role in political unrest. In Indonesia, coal mine workers are protesting layoffs. The downsizing of the coal mining workforce is sure to continue amid the dullness of coal exports in Indonesia, and it could be a trigger of social unrest.
WATARU YOSHIDA, Nikkei staff writerNikkei staff writers Kaori Takahashi, Koichi Kato, Yuji Kuronuma and Yosuke Sato contributed to the stories.