The Year of the Horse will bring implementation of reforms in China, questions over execution for the third arrow of Abenomics and potential inflation in emerging markets, forecast economists.
Chinese stock markets suffered from volatility this year, primarily because of expectations the US Federal Reserve would begin curbing its quantitative-easing programme. China’s CSI 300 index is down 12% from its February high for the year.
China bears are plentiful. Some predict a recession is inevitable as Chinese corporates look to cut their debt levels. In September, economist Paul Krugman called China a giant ponzi scheme as it builds more capacity without the prospect of a corresponding increase in domestic consumption.
Yet details released from the Chinese Communist Party’s four-day plenary meeting in November have renewed confidence for some, with analysts arguing that mainland officials appear on the right path as the country transforms its focus from exports to consumption.
But implementing these reforms won’t be easy, and next year China will “continue to struggle with the trade-off between stimulating their economy now and having sustainable long-term growth”, notes Principal Global Investors.
“We’re excited about these announcements, but we really need to see whether they will be implemented and how,” Anna Stupnytska, executive director and macro economist at Goldman Sachs Asset Management, tells AsianInvestor. “This will be a main focus for us in the next two-to-five years.”
Analysts forecast that China's GDP growth will hover between 6% and 8% in 2014, down from double digits, although most maintain that lower growth should be welcomed.
“I would be more worried if the reforms were not targeting the quality of growth,” Stupnytska says. “We know that for China to continue growing, it has to be driven by domestic demand, particularly private consumption, move away from exports and liberalise [its economy]. Many of these aspects were addressed in the plenum and this is good news.”
The broad agenda set by Chinese officials includes price liberalisation measures for energy, resources and financial markets; opening up the market to private and foreign competition; and state-owned enterprise and fiscal reforms, among others.
These will take years to implement, although GSAM expects news on financial reforms as early as the first half of next year.
“I would focus more on the financial system and what reforms they will create to get shadow-banking under control, and [also how China will] try to manage non-performing loans and bad-quality credit that’s accumulated over the past few years,” Stupnytska says. GSAM expects some financial reforms to occur in the next three-to-12 months.
Although the mainland aims to shift from an export-driven economy, Markus Schomer, chief economist at Pinebridge Investments in New York, argues the anticipated pick-up in US and European economies should help Chinese exports throughout 2014, a trend that started in the second half of 2013.
Another topic dominating analyst reports is when the US Federal Reserve will begin tapering in its quantitative-easing programme. Consensus is early next year, although it will be determined by four factors – inflation, unemployment, the outcome of fiscal negotiations and the housing market in the US, notes Deutsche Asset & Wealth Management.
Then come the questions. “How will capital markets react after years of increasing stimulation? Could interest rates rise substantially above recent levels? How will that affect the cost of capital? Will the dollar appreciate significantly and suck money from emerging markets?” Deutsche AWM co-CIO Asoka Woehrmann ponders. “Getting the answers right will largely make the difference between success and failure in financial markets in 2014.”
The Fed ending its bond-buying programme may lead to tighter financial conditions globally, which will push up the costs of financing in emerging markets, constraining growth acceleration. This will hit economies suffering from inflation, including Indonesia and India, Stupnytska predicts.
PGI adds: “Creeping inflation in certain emerging markets could be a pernicious threat in 2014. Some emerging market central banks – such as the Reserve Bank of India – have begun raising interest rates to combat inflation and currency depreciation at a time when such action could also stifle economic growth further.”
Putting differences aside, few deny that the first two arrows – monetary easing and fiscal stimulus – have worked. The third and most important one, structural reform, however, “remains in the quiver” for now, says Deutsche AWM. Its forecast for Japan next year largely depends on implementation of reforms.
The main issues that Japan must face next year include liberalisation of its labour market, the health-care system and the agricultural market. It must also provide an outline for the country’s energy and immigration policies.
It won’t be simple. PGI notes that Abe has “faced opposition to many of the structural reforms that Japan really needs, such as labour market reforms, so the third arrow’s eventual success will play out over the coming year”.
Tax hikes are set to come into practice early next year, marking an effort by Abe's administration to tackle the nation's huge debt problem. Value-added tax will rise from 5% to 8% in April.
Deutsche AWM says raising VAT will drag the economy and stifle growth early next year. But PGI notes that to prevent the tax increase from being too much of a burden on the economy, it delivered another “round of stimulus to help take the edge off”, with ¥15 trillion ($146.5 billion) of direct government handouts promised and around ¥1 trillion ($9.8 billion) in corporate tax breaks.
“If the Japanese economy can withstand the sales tax increase without growth slowing too much, it would be another bulls-eye for Abe’s three arrows,” PGI says.
GSAM is cautious. “There are some encouraging signs in Japan but there are risks around the story for next year, particularly because we know in April we will see the consumption tax hike to 8% from 5%,” Stupnytska says. “We will be watching if the fiscal package will offset this and what kind of impact that will have on growth.”
GSAM, meanwhile, is keeping an eye on Korea. As the US and Europe will continue to recover next year, Korean exports should do well, argues Stupnytska. "We’re thinking about adding exposure to Korean equities - which are still attractively priced at this stage - to our portfolios," she says, noting this will likely include adding exposure to the major indices in the country.
Many argue that Korea’s ability to deliver decent GDP growth rates despite already being a wealthy country, as well as its technological advances in the LCD universe, make it a standout in Asia.
GSAM also expects stocks in Malaysia and Thailand to recover next year on the back of improving consumption from the US and Europe.