HSBC’s senior economist Frederic Neumann has joined the growing list of market observers raising questions over the sustainability of credit-fuelled growth in Asia.
In his latest research note, Asia’s Inconvenient Truth, Neumann points to a huge rise in debt in recent years that has masked deteriorating growth fundamentals, most notably a reduction in productivity.
If Asia growth is predicated on pumping economies full of credit, investors should be worried on three fronts, he argues. Firstly, existing growth looks pretty vulnerable. Secondly, future growth looks even shakier (it turns out that Asia’s economies are becoming increasingly desensitised to credit). And finally, even if there is no bursting of an Asian credit bubble, the fact that Asian economies are now less productive means it will take them longer to pay back everything that has been borrowed.
Neunmann’s argument has three pillars. Firstly, because Asian productivity growth is declining, the Asian GDP growth we have seen since 2010 is structural, not cyclical. The efficiency gains that won Asian industries and services their global supremacy are on the wane; productivity growth has slowed steadily from 2.5% in 2006 to 1% in 12 years (he uses a five-year moving average, see red line in graph below).
At the same time – Neumann’s second pillar – credit has grown. Here his measure is the ratio between bank credit and GDP. In 2010, at precisely the time when productivity growth started to wain, credit growth started to increase (see black line in graph).
So it looks like a lot of the GDP growth we have seen since 2010 was based not on the economy becoming more productive, but on increased borrowing. How much is hard to say, Neumann admits, but he suggests it’s clear that “the rise in debt flattered growth to some extent in Asia”.
“Slowing productivity growth amid rising leverage is not a terribly sustainable proposition,” he notes. And – further worries here for investors – there are signs that the ability of leverage to drive GDP is decreasing, the third pillar of Newmann’s case.
The amount of new credit needed to generate a unit of GDP – what Neumann calls ‘credit intensity’ – is increasing (see bar chart, below). Having steadied in the early noughties, it has jumped since 2007 – a worrying echoe of the years before the Asian financial crisis.
He concludes: “Asia is in a credit trap of sorts: a lot more debt is needed to generate GDP."
Some countries are deeper into the trap than others. Credit intensity provides a measure of an economy’s insensitivity to further lending-fuelled growth, so investors – especially those in Asian debt – may be alarmed to see the four names that lead the credit intensity table: Hong Kong, Singapore, Taiwan and China. And for each of these four countries, the measure has shot up over the last two years, compared with 2005-2007.
This has implications both for the pricing of new debt and for investors’ broader economic analysis since these four markets are most sensitive to a credit wobble.
Neumann’s argument indicates that what is now needed is not further credit priming, but more productive economies. “Structural reforms are needed – urgently – to push productivity growth back up,” he notes. This will be a bitter pill for Asia’s politicians.