Is China following in Japan’s footsteps?

8 Nov 2016

China and other Asian economies appear to be following the same path as Japan towards long-term deflation. Can they do anything about it? Emma Cusworth reports.

“Unless the authorities in the Asia-6, most crucially in China, react with an aggressive policy mix, deflation could become entrenched as it has in Japan, where it has persisted for nearly 20 years.”

Vilas Gadkari, Lombard Odier Investment Managers

Japan’s near two-decade deflationary spiral has served as a very long-standing reminder of how seriously policy mistakes can go wrong. Today, with Japan a long way from regaining growth, other East Asian markets, most notably China, appear to be on the verge of a similar journey. Experts have called for more aggressive action from authorities in the region to avert the threat of a multi-decade stagnation.

However, the future of China, in particular, is far from clear-cut and the structural reform that has eluded Japan for so long, could be the growth engine China needs to get back on track. Inflation may not be as far off as many investors expect.

IN THE FOOTSTEPS OF JAPAN?

On the face of it, there are a striking number of similarities between Japan in the 1990s and where some of the key East Asian economies find themselves today. They remain heavily export-driven, their demographic profiles look increasingly unfavourable, and the leverage-fuelled push to domestic demand has created
excess capacity and declining productivity.

China, which according to Julian Mayo, coCIO at Charlemagne Capital, has been “exporting deflation for decades”, is a key foundation stone in the East Asian economy as a whole. Looking at the statistics, there is plenty of evidence to suggest the Asia-6 economies (China, Hong Kong, Korea, Taiwan, Thailand and Singapore) are poised to follow Japan into a prolonged period of deflation.

The Asia-6 saw a sharp increase in their current account surplus between 2004 to 2007 from around 5% of GDP to just under 9% before the financial crisis hit, sending the surplus down to just over 4% by the end of 2011. According to Vilas Gadkari, cochief investment officer, global macro strategies at Lombard Odier, this was caused by an excessive reliance on exports, manufacturing and investment. He points to a similar jump seen in Japan between 1982 and 1986.

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