Asia not immune to recession

With European markets still struggling, can China's export market save the region's economy?

Here's more from HSBC Research:

First, Asia is not immune to financial trouble elsewhere. The second half of 2011 was a powerful reminder of that. As European banks scrambled for dollars, they squeezed markets as far as Mumbai, Hong Kong, and Seoul. Things have stabilized of late, mostly thanks to LTROs, but another round of Eurostress would whip about Asian markets as violently as before. Volatility hasn't suddenly disappeared from the scene.

Second, as solid as growth currently seems, it remains sensitive to the global industrial cycle. The recent stabilization of output, especially in the smaller markets of Korea, Taiwan, and Singapore owes much to America's restocking bounce. This, however, may now fade. The hope is that China will fill the void, not least because Europe, Asia's biggest export market, is currently flat on its back. Recent export numbers have been better, but it will not take much to put another real dent into shipments.

Third, wobbly exports leave especially smaller economies highly exposed to any gyrations in financial markets: the weaker trade is, the more important is local demand, but this depends crucially on sentiment. Stronger markets help, weaker ones don't. In recent years, Asian growth may from time to time have decoupled from the West owing to tremendous local stimulus, but financial markets have remained tightly linked across the globe.

Fourth, inflation is bubbling away beneath the surface. Suppose Europe holds it together in the coming months, possibly with the help of further easing by the ECB. In this case, Asian growth and regional markets would again roar. But price pressures would explode as well. And more quickly so than in previous.

What's the most likely outcome? Our view is that strong growth, helped by China, will prevail and quickly lead to higher inflation and ultimately interest rates hikes. But, the downside risks are equally apparent. Another Euro-bust would quickly put the squeeze on Asia as well. Much depends on how you see Europe play out. On that, we'll leave you to judge. But one thing is clear: Asia will not stay dull for long. Why, then, is "vol" so cheap?