Asia’s mixed outlook for 2012

Author: Evan A. Feigenbaum, CFR

The year 2011 proved fascinating for Asia, with the region consolidating its role as the essential player driving global economic recovery.

But 2012 promises to be more fraught as domestic politics take command amid new challenges to growth. A number of risks, opportunities and emerging patterns will shape Asia during the next 12 months and beyond.

One lesson of Europe’s current struggles is that politics matters deeply to choices about the EU’s economic and financial future. Asia is not Europe, of course, but its politics will matter greatly in 2012. Electoral outcomes and succession arrangements are likely to roil markets, bring to power governments more (or less) committed to institutional, regulatory and trade-related reforms, and possibly yield greater international tension. Three elections — in the US, South Korea and recently in Taiwan — feature candidates and parties with distinct policies and priorities. China will also complete a scheduled leadership change. And North Korea’s elite, whose members aim above all to preserve their own power, must now navigate an earlier-than-expected transition that could yet produce infighting and vast new challenges for Pyongyang’s neighbours.

Thailand also bears watching, as former Prime Minister Thaksin Shinawatra looks to return from exile. Such political risks will likely intensify well into 2014, when India and Indonesia hold elections. A possible return to Golkar rule in Indonesia, in particular, could slow institutional and policy reforms there. The year 2012 should be another rough time for Afghanistan, Central Asia and Pakistan. War, terrorism, narcotics and weak political institutions continue to steal headlines. But the region’s future will depend as much on whether governments improve their poor macro- and microeconomic fundamentals and expand opportunity, although economic change will remain elusive unless these states better cooperate in 2012. Meanwhile, Pakistan’s economy has considerable potential. But the country lacks a credible growth strategy. Islamabad will remain burdened by a high debt-to-GDP ratio that crossed 60 percent in 2010, painful debt service obligations to its creditors, a large fiscal deficit, double-digit inflation, a depreciating rupee and a trade deficit worsened by high global commodity prices. These economic realities will compound intensifying political risks in Pakistan.

Much was made in 2011 of Washington’s supposed strategic ‘pivot’ to Asia. A bigger issue for Washington’s partners in Asia is that the US, for all its strengths, still does not have its economic act together. Thus the principal strategic issue for most in Asia is whether America restores its economy and addresses its fiscal deficit and growth outlook. The weaker America’s fiscal and economic position becomes in 2012, the less relevant the US will be to Asia’s future.

Asia even managed to sustain robust growth amid austerity in Europe and sluggish growth in the US. But new challenges are emerging for the region’s most export-dependent economies. The markets will watch China especially closely — along with the US and the EU — because the world economy can hardly afford to have its three principal growth engines facing a crisis simultaneously. Beijing’s landmark Twelfth Five-Year Plan deliberately aims to achieve slower but more balanced growth. But such structural adjustments will come only gradually, and, in the meantime, China’s economy continues to rely on exports and investment in fixed assets. Others, such as South Korea, will also be vulnerable in 2012. They have relied, in part, on Chinese demand to power their economies, so even a modest slowdown in China will have contagion effects elsewhere in Asia.

India will grow robustly, but more slowly, in 2012. This is only one of many sources of gloom. Tax, pension and FDI reforms have all stalled, and parliamentary business has been tied up in knots as the leading national and regional parties squabble. Mumbai’s SENSEX stock index was the world’s worst major performer in 2011, declining from 20,561.05 on 3 January to 15,175.08 on 19 December. And bellwether state elections, especially in Uttar Pradesh, are almost certain to make the major parties even more cautious when considering any major reforms. Similarly, slow progress on economic reform may limit other countries in Asia in 2012. In Vietnam and Indonesia, FDI, regulatory or financial reforms have largely stalled and show little sign of revival. Still, one bright spot in 2012 may be Malaysia, which has begun to shed elements of its 1970s-era ‘New Economic Policy’.

By far the biggest question mark about reform though is China, with resistance to change anchored in interest group politics. Chinese leaders, as cautious technocrats, tend to split the difference between competing groups in China’s increasingly pluralistic polity. The result has been a strong bias toward incremental policy change rather than bold reforms. We will also learn much more in 2012 about the sincerity of reforms in Burma. Another question mark will be ASEAN’s response to Burma’s apparent change of direction. Balancing the role of great powers to the north — China and Japan — has long provided an impetus to ASEAN community building, with founding members hoping for a cohesive force to help balance China in particular. But Burma has stubbornly resisted ASEAN ways. With Naypyidaw now scheduled to assume the ASEAN chairmanship in 2014, regional heavyweights will face tough decisions about how hard to push the regime.

In recent years, Preferential Trade Agreements (PTAs) have proliferated in Asia. The US entered the trade fray in 2011 by more fully embracing the Trans-Pacific Partnership (TPP). In my view, the TPP has considerable potential. Beijing has criticised the TPP as part of a US strategy to ‘contain’ China. Yet it has also promoted its own brand of PTAs across the region — with ASEAN, Pakistan, Singapore and others.

While protectionist pressures will likely rise in 2012, so too will the tolerance for trade conflict, particularly in Washington and Beijing. China has grown more comfortable with the WTO’s dispute-resolution procedures. And, having learnt to leverage the system to its own advantage, Beijing is vigorously fighting US suits in many areas. For their part, US political and business elites are certain to complain ever more loudly about Chinese currency, intellectual property, procurement and cyber-related practices. Most in Asia will watch warily, fearing greater protectionism. But some will jump on the bandwagon: India has already initiated 149 anti-dumping cases against China.

Politics, economics and security are increasingly in collision in Asia. The US continues to provide Asia’s principal security-related public goods through its forward-deployed military presence and role as a strategic balancer. But Asian economies will increasingly provide one another with their principal economic-related public good — namely, the demand that can provide a pathway to sustained economic growth. This collision between economics and security may well intensify in 2012.

Evan A. Feigenbaum is Adjunct Senior Fellow for East, Central and South Asia at the Council on Foreign Relations.

A version of this article was first published here on the Council on Foreign Relations Asia Unbound blog.