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Societe Generale optimistic on Japan, cautious on China

Taipei, 8 October – Societe Generale (SG) is optimistic about Japan's growth prospects for 2014 and beyond, spurred by the policies of Japanese Prime Minister Shinzo Abe, dubbed Abenomics. This was the view expressed by Guy Shear, Head of Research Asia at Societe Generale Corporate & Investment Banking. Shear was the guest speaker at a Premium Event lunch arranged by the European Chamber of Commerce Taiwan (ECCT) today.

Prime Minister Abe's easing of monetary policy is aimed at boosting demand and driving inflation to 2%. This will also help to depreciate the yen versus other major currencies and thereby benefit exporters. The second plank of his policy, a ¥10.3 trillion fiscal stimulus package is large but it is the sixteenth package since 1990 and there is a limit to how much this can achieve. Japan's debt to GDP ratio has risen the fastest since 2007 and is the highest in the developed world at over 200%. The third plank, structural reform has the most potential to boost income and increase competitiveness and productivity. However, what had initially been proposed (including a radical reorganisation of agricultural and employment rules) has been scaled down to just a creation of special economic zones.

Japan is already efficient in terms of industrial productivity but the agricultural sector and labour market are not. Most farms are too small to reach economies of scale while a third of farmers are semi-retired, according to Stear. Meanwhile, labour market rules are far too rigid. When the Trans Pacific Partnership (TPP), which includes opening up agricultural markets, comes into effect, this could cause a radical shake up of Japan's agricultural sector. While the impact on the overall economy would not be dramatic (given the fact that agriculture does not account for a large portion of GDP), the psychological impact would be significant. It would mark a break from the previous strong protectionism of the agricultural sector.

Another way to improve Japan's productivity would be to increase the participation of women in the workforce. Education and skills levels of Japanese women are comparable to other developed countries but their participation in the workforce is considerably lower. This can be partly attributed to historical and cultural reasons but there is growing awareness on the part of the government that encouraging more women to join the workforce would help to offset the unfavourable demographic trends (declining birth rate and aging population). Stear believes that the government will change tax rules (joint income rules) and improve child care options, two of the main factors discouraging women from joining the workforce. This in turn would increase women's participation in the labour force and boost productivity. Stear concluded that the combination of a weak currency, higher corporate profits and a rising stock market bode well for Japan's prospects.

Prospects for China are much less optimistic. SG believes that China is enjoying a cyclical rally that will not last into the fourth quarter of 2013 and that structural problems will likely return to haunt China next year, despite strong growth in consumption.

Asian corporate and regional government debt (which is hard to disentangle from corporate debt) has risen by half since 2008. To finance China's massive infrastructure investment, the Chinese banking system has grown too quickly. While China's big banks are well known globally, there are thousands of small regional banks (including around 3,000 credit cooperatives) that are not known outside China. However, it is the assets of these small banks that are growing the fastest. As many of the loans of these small banks are to a limited number of risky borrowers, the chances of default are quite high. SG therefore expects the number of non-performing loans and defaults to rise. Capital investments will slow down and this will result in a drop in China's GDP growth in the next few years.

The mood is South-East Asian is subdued but comparisons with the 1996 Asian financial crisis are exaggerated. The summer of 2013 showed what will likely happen when the US Federal Reserve (Fed) finally does tighten rates. The Thai, Indonesian and Philippines stock markets were up between 15% and 25% this year in May but they are now flat on the year. Currencies have also depreciated. The Indian rupee has fallen 13% this year, and the Indonesian rupiah has dropped 17%, despite interest rate hikes.

Investment is three quarters of what it was in the mid-1990s as a percentage of GDP. In addition, debt levels also are much lower than they were during the 1996 financial crisis and countries have much higher foreign exchange reserves. South Asia's biggest corporations are also in much better shape than they were in the 1990s.

SG believes that stock markets in the region look overbought. The group's analysts expect further depreciation of Asian currencies versus the US dollar given its expectations of a strengthening recovery in the United States, higher interest rates and an end to the Fed's third round of quantitative easing (QE3) in 2014. However, Stear believes that the renminbi, unlike other Asian currencies, will not depreciate versus the dollar and euro.

Stronger growth in the United States would benefit Taiwan since it remains an export-driven economy. Stear also does not expect Taiwan's currency to depreciate much compared to South-East Asian countries and Singapore's currency.

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