27 Feb 2018
The developed Asian industrial cycle appears to have hit a soft patch, with activity moderating in the fourth quarter in key economies such as Korea, Taiwan and Singapore. An industrial wobble would be particularly untimely given expectations for a healthy developed market cycle lifting activity and driving investment across the region.
So, is the recent moderation temporary or is there something more alarming going on? The first thing to point out is that the recovery in industrial activity has been heavily dependent on buoyant semiconductor shipments. This reflects the preponderance of Asia in global technology supply chains, with the region accounting for approximately 60% of global semiconductor sales. However, it has also been driven by weakness from other key sectors, noticeably autos and machinery. The thinness of the cycle has also been borne out in industrial profits, with corporates earnings outside key tech names failing to keep up with market expectations. Without a broadening of the cycle, we suspect it will continue to be vulnerable to headline fluctuations. That said, we would warn against excessive pessimism.
For a better understanding of the durability of the current cycle, we prefer to focus on capex dynamics. Corporate investment tends to be the most volatile component of the economic cycle and, as such, is a useful barometer of its health. Furthermore, investment plays a relatively large role in aggregate demand creation in the region, while also driving productivity trends. The good news here is that the omens for investment are brightening. First, corporate credit demand appears to have turned a corner. In Korea, the growth of loans to enterprises has rebounded, while lending to corporates in Taiwan has also strengthened of late. Importantly, although the hiking cycle has been kicked off in places such as Korea, the adjustment in policy rates has so far been modest (see Chart 8). We suspect policymakers will begin to recalibrate more quickly if confidence in the cycle recovers. Even so, monetary conditions are likely to remain favourable in the absence of a dollar rally.
Given low interest rates and the ease of funding, the critical swing factor will be expectations of return on investment. Typically, higher returns have been driven by the region’s manufacturers. Markit publishes a useful sentiment reading for Asian industrial sectors. A look at the technology equipment index highlights rising optimism. This reflects a broadening base of end-demand due to chip adoption in new sectors – although recent price weakness in key categories does indicate potential oversupply. The mood away from technology is far from downbeat too, with consumer goods and industrial output PMIs also way above the 50 threshold (see Chart 9). Stronger external demand may not be the only factor driving investment, though. Companies in Japan are embracing labour and energy saving capex, while capex in service sectors is rising as policymakers push for more income-led growth. Although the conditions are in place for a capex improvement, we would be cautious about calling for a boom just yet giving utilisation rates have only started to tick up in technology and continue to fall elsewhere as economies deal with capacity issues. Signs investors are willing to reward firms for ambitious capex announcements would also provide further reassurance.
Govinda Finn is Japan and Developed Asia Economist for Standard Life Investments.
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