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This new commercial building in Kepong -- not far from the heart of Kuala Lumpur -- has attracted few tenants due to high rents. (Photo by Shinya Sawai)
Asia Insight

Brisk growth conceals 3 risks for Asia in 2018

Beware of real estate distortions, high debt and sluggish spending

TAKASHI NAKANO, Nikkei staff writer | China

SINGAPORE -- The Asian economy has sailed smoothly into 2018, with healthy growth rates projected for a host of key countries. Snapshots from across the region, however, suggest there may be choppy waters ahead.

One warning sign takes the form of gleaming new buildings in Malaysia. In Jalan Kuching, a roughly 20-minute drive from the heart of Kuala Lumpur, banners seeking tenants flutter outside a commercial building a year after it was completed. The building's occupancy rate is only 10% because the landlord's rents are too high, according to a local real estate agent. Despite the area's close proximity to the center of the capital, foot traffic is sparse.

The facade of a building in Jalan Kuching, Kuala Lumpur, is plastered with banners advertising vacant space in December. (Photo by Shinya Sawai)

Meanwhile, a 29-story luxury apartment building stands half-empty just a 10-minute walk from Kuala Lumpur's landmark Petronas Twin Towers. Again, the rents are simply more than prospective tenants are willing or able to pay: The owner is asking for 8,500 ringgit ($2,120) a month for a 278-sq.-meter unit.

Next stop: South Korea.

Meet Lim Soo-hyang, a 37-year-old homemaker in Ilsan, north of Seoul. Last August, her family took out a mortgage from Shinhan Bank for a four-bedroom apartment, securing what she considered a low interest rate of 3.47%. But the rate is not fixed, and after the central bank raised its benchmark by a quarter of a point to 1.5% at the end of November -- the first hike in six years -- the family's debt burden is about to get heavier.

Property imbalances pose significant risks to the overall economy in the event of a shock

Bank Negara Malaysia

The mortgage is linked to the Cost of Funds Index -- an average of eight lenders' funding costs -- and is recalculated every six months. The index hit 1.77% in mid-December, up from 1.47% when Lim borrowed the money. This means the rate on the family's 200 million won ($190,000) debt is likely to rise to around 3.77% in February, resulting in an extra 600,000 won in annual payments.

Over in the Philippines, disappointing consumption growth is an issue. Personal spending grew 4.5% in the July-September period, falling short of 6% for the third consecutive quarter. It appears Filipinos are becoming increasingly budget-conscious -- people like Vincent Alidon.

This Manila mall may look busy, but Philippine consumption growth is not yet meeting expectations. (Photo by Ken Kobayashi)

The 27-year-old said he plans to maintain last year's spending level in 2018, even if his salary rises. "I usually have a reference budget that I follow per month, detailed in pesos per [item], such as food, transportation and entertainment," he said. "In the event that I overspend on one item, I usually compensate by saving on another. As much as 50% of my income goes to savings in some months."

These three cases encapsulate the main risk factors threatening the Asian economy this year: overheated real estate markets, swelling personal and corporate debt, and sluggish consumer spending. The adverse effects are not yet showing up in full force, but these problems could undermine the Asian economy if global pressures intensify.

Official warnings

Asian central banks and governments are well-aware of the risks. "Low-income families and borrowers aged 50 and over will suffer the most when their interest rates rise 100 basis points," the Bank of Korea, the central bank, said in its annual report to the National Assembly.

Bank Negara Malaysia, the Malaysian central bank, in November projected that the vacancy rate for offices in the Klang Valley, or Greater Kuala Lumpur area, would reach 32% by 2021, and warned that "property imbalances pose significant risks to the overall economy in the event of a shock."

Singapore's central bank, the Monetary Authority of Singapore, said in its financial stability review the same month: "Recent developments in the property market pose potential risks to stability. Market players should take a medium-term view of supply-demand dynamics and act with caution."

Judging only from global and regional growth forecasts for 2018, such warnings might seem overblown.

Rents have been rising in Jakarta and other big Asian centers.   © Reuters

The International Monetary Fund expects the world economy to expand 3.7% in real terms, up from the estimated 3.6% growth rate for 2017. In Asia, the Indian economy is expected to grow 7.4%, accelerating from 6.7% last year. Five major members of the Association of Southeast Asian Nations -- Indonesia, Malaysia, Thailand, the Philippines and Vietnam -- are expected to average 5.2% growth, maintaining last year's pace.

China's growth rate for 2018 is estimated at 6.5%, which is slower than last year's 6.8% but still quicker than the rates for advanced economies.

But if Asia is to keep up the momentum and overcome the trio of hazards, at least two things need to happen -- aside from managing geopolitical risks, such as high tensions on the Korean Peninsula.

Policy complications

First, countries need to switch their growth engines from exports to domestic demand.

In 2017, Asian economies rode a rapid export recovery. Increased shipments of electrical machinery and electronic parts played a big role, in particular, as global smartphone sales rose and semiconductors found their way into more devices, amid the growth of the internet of things. But according to World Semiconductor Trade Statistics, the global chip market will grow 7% this year to $437 billion -- a far cry from the 20.6% growth seen last year.

Ideally, economic growth would create new jobs and push up wages, boosting consumption. Yet only a few countries, Malaysia among them, have managed to spark such a cycle. Even in places with youthful populations, like the Philippines, spending lacks vigor.

"Employment generation would be the biggest challenge for the [Indian] government and biggest risk for the overall growth of the Indian economy, because jobs also [are] one way of creating consumption demand," noted N. R. Bhanumurthy, a professor at the National Institute of Public Finance and Policy in New Delhi.

Second, central banks need to raise their policy interest rates appropriately.

Many market insiders expect the monetary authorities in the Philippines, Malaysia, Indonesia and Singapore to consider raising rates and tightening their policies in 2018 to prevent their economies from overheating. The U.S. Federal Reserve, which raised its key rate three times in 2017, is apparently eyeing another three hikes this year.

Since a narrowing gap in rates with the West will pull capital out of Asia, the region's central banks will need to respond carefully to moves by the Fed and the European Central Bank. The trouble is, Asian central banks face unique circumstances and cannot simply operate in lock-step with the Fed.

In the Philippines, for example, an interest rate increase would give investors an incentive to buy the peso. A stronger peso, in turn, would blunt the benefits of dollar-denominated remittances from overseas migrant workers.

These remittances are a crucial contributor to the Philippine economy. And if overseas migrants send less money home due to unfavorable exchange rates, it would further dampen consumer spending. The central bank could wind up hurting the economy if it raises rates to try to curb inflation and stimulate consumption.

But inflation remains a worry, with crude oil prices on the rise due to coordinated output cuts by producing countries and instability in the Middle East.

The Reserve Bank of India, India's central bank, is concerned that inflation -- including food and fuel prices -- will surpass the medium-term target of 4% in the quarters through December 2017 and March 2018. As in the Philippines, though, hiking rates to stabilize prices is easier said than done.

India's oil demand recovered strongly in 2018, due in part to strong sales of commerical vehicles. (Photo by Mamoru Yago)

The Federation of Indian Chambers of Commerce and Industry's "business confidence survey shows that companies continue to face constraints from high rates of interest," said Pankaj Patel, president of the country's biggest industry group. "The RBI's excessive focus on inflation has led to a situation where real interest rates are much higher today, impinging on the growth performance of the economy."

The government, too, has been pestering the RBI to lower rates.

Debt trap

Cutting rates can lead back to other complications: real estate bubbles and surging debt.

Conversely, if real estate prices that have been rising in major Asian cities begin to fall, individuals and companies that have invested in property will suffer losses, making it harder for them to repay existing debt.

As things stand, debt in relation to gross domestic product is on a troubling trajectory. 

In the second quarter of 2017, China's household debt reached 46.8% as a percentage of GDP, according to the Bank for International Settlements. Its combined household and private nonfinancial sector debt reached 210.2%.

Debt in China has roughly doubled since 2007, before the global financial crisis, exceeding the levels in Japan, the U.S. and Germany.

In South Korea, the combined figure hit 193.9% in the second quarter of 2017.

Francois Villeroy de Galhau, the Banque de France governor and an ECB Governing Council member, sees global debt dynamics as one of the main risks to watch. "Debt levels have not been reduced as a proportion of GDP since the financial crisis," he said. "If you look at emerging economies, debt has increased significantly, especially corporate debt."

Nikkei staff writers Kim Jaewon in Seoul, Rosemary Marandi in Mumbai, Kiran Sharma in New Delhi, Jun Endo in Manila and Masayuki Yuda in Tokyo contributed to this report.

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