Fears of an imminent burst in the Chindian property bubble misplaced

We’ll spare you a recount of the miserable data that hit markets of late. There’s been plenty
of that, especially out of the US. But Asia had its fair share as well, not least in Japan in the
wake of the tsunami, but also in places like Taiwan and Thailand where production slowed
considerably in recent months. But, amid all the worries, it is also easy to overlook some of
the more positive signs.

First, whatever markets may be worrying about, we see few signs of a bust in either China or India at this stage. In fact, both economies started this quarter with quite robust releases on industrial production. Rather, the slowdown is concentrated among Asia’s smaller economies that are especially trade dependent.

Sure, Chindia is showing a little down-tick there at the end, but, overall, industrial output growth is extremely robust. The trouble, of course, is that Asia’s smaller dynamos, Korea, Taiwan, Thailand, have seen their combined output growth slow sharply. Others, notably Korea, the Philippines, Taiwan, Indonesia, and Thailand, are seeing output grow below trend.

Couple of questions, then. First, are China and India about to buckle as well? We don’t think so. Qu Hongbin, our Chief China economist, has long argued that China is heading for a soft-landing in response to government tightening measures. In fact, the current data flow from the country that suggests some weakening in real estate transactions and car sales reflect deliberate policy decision taken over the past six months, rather than indications of something more nasty.

Fears of an imminent burst in the property bubble, as some have termed it, appear misplaced: the top cities are cooling, but the country’s broader real estate market is holding up quite well. Similarly, in India, Leif Eskesen expects growth to slow, but not collapse. For example, there were lots of hoopla about the weaker headline number for first quarter GDP (it came in at 7.8% y-o-y vs. consensus of 8.1%). But, as Leif points out, that was almost entirely due to upward revisions to previous GDP data and, on a sequential basis, growth picked up sharply (from -0.1 q-o-q sa to 2.4%).

The second question is whether China, and to some extent India, can provide sufficient lift to the rest of Asia to prevent the smaller economies from tripping over. The question is an unequivocal “yes”. By our estimates, China alone now has equal pull on the region as the United States economy.

So any weakness in the latter should be offset by further strength in the former. Now, granted, should the US fall into a severe slump, the region will still feel some heat. But, the re-acceleration in Chindia that we highlighted in Chart 1 should soon enough feed into better production numbers in the smaller Asian markets, even if the American economy fails to rebound in the coming months.

This leads us to our third question. Why, if Chindia is going strong and matters so much, did some of the smaller Asian economies slow so rapidly in the first place? Two answers. For one, if you look closely again at Chart 1, you’ll see that Chindia did slow quite a bit in February and March. This was largely due to an inventory correction in China itself, which now seems to have faded. The sharp acceleration in import growth in May, for example, is further evidence that the local industrial sector has fired up again.

Therefore, the recent slowdown in peripheral Asia is simply a delayed response to China’s cyclical swings. More importantly, however, the Japanese disaster has knocked about factory activity in a number of smaller Asian economies, which are more trade dependent than Chindia. Thailand and Taiwan are good examples here: the former has seen big disruptions in its car sector, while the latter was affected by the lack of critical electronics components. There is mounting evidence that these effects are now passing.

In terms of Japan’s industrial production, assuming that their own forecast is realized - and there are reasons to believe that the corporate sector in Japan is bouncing back even faster than this - the total level of output should be nearly back to its first quarter peak by early July (at least in seasonally adjusted terms).

Beyond this, we expect a sharp acceleration in Japanese demand starting from the middle of the third quarter and lasting well into 2012 as reconstruction activity goes into full swing. This, in part, should help offset any further deterioration in US demand over the second half. In short, for us, it hardly looks as if Asia is cracking.