In this issue ...

• East Asia - Big growth dents, but no crises
• South Asia - Global shocks expose domestic weaknesses
• Middle East - Comparatively resilient with some exceptions
• Africa - Commodity price slump takes continent by surprise

This month we review prospects for 2009 for selected countries and regions.

East Asia - Big growth dents, but no crises

While the financial crisis has rocked Asia's share and currency markets, impacts on 'Main Street' through trade and investment flows are only just beginning. In 2009, growth will slow sharply and unemployment rise. But emerging Asia will outperform other emerging markets and an outright crisis is unlikely thanks to strong external buffers.

 China

Economic outlook. Recent indicators suggest China has entered 2009 without much - if any - momentum. Growth in exports and industrial production has eased sharply (Graph) and the Chinese property market is weakening. A recent Q4 GDP number suggests growth has come to a standstill when measured on a quarter-on-quarter basis. Achieving Beijing's 8% GDP growth target for 2009 will depend on recent policy responses gaining traction (fiscal stimulus of 4 trillion renminbi planned for 2009-10, equivalent to 15% of 2008 GDP).

Political outlook. The Chinese government will pull out all stops to avoid a 'hard landing' (5% GDP growth or lower). President Hu Jintao and Premier Wen Jiabao may face criticism for their handling of the financial crisis if growth slows sharply, weakening their position.

Watchpoints

• Will a sharp drop in growth create civil unrest? Warning signs would be large-scale demonstrations and criticism directed at the central government - as opposed to mainly local governments as happens at present.
• Will the Chinese property market rebound? The data suggest that prices fell sharply in the second half of 2008. If the property market does not rebound, a hard landing in China is a distinct possibility.

Indonesia

Economic outlook. The slump in international commodity prices will hurt Indonesia's prospects for 2009. But Indonesia will suffer less than its neighbours since it is not as dependent on trade. Growth is projected to slide from 6% in 2008 to 4-5% in 2009. The government has been able to assemble a sizeable fiscal stimulus package to support growth thanks to three things: a recently announced $US5½ billion concessional financing facility to help fund the budget, better-than-expected tax collection, and lower-than expected fuel and food subsidies thanks to lower commodity prices.

Political outlook. Parliamentary elections are due in April and presidential ones start late July or early August. Recent polling suggests a strong showing for President Susilo Bambang Yudhoyono's Democratic Party (PD) in April and a strong likelihood of victory for Yudhoyono in the presidential elections. Significantly, most Indonesians see the PD as a capable economic crisis manager, with 85% of respondents telling a survey published in December that the government was doing a good job. Yudhoyono's personal approval rating rose to 69% in the survey, up from 45% in June 2008.

Watchpoints

• Will Indonesia avoid financial crisis? Indonesia's financial markets have stabilised for now. But the banking sector should be closely watched. Reforms initiated after the Asian financial crisis are incomplete, which will place the sector under pressure as the economy slows and non-performing loans rise.
• What will be the impact of a recently announced mining law? While its full impact cannot be assessed until additional implementing regulations are announced there are some initial concerns it will discourage additional mining investment. Some key concerns are
  • Potential adjustments to existing mining contracts
  • Shortening of permit terms
  • Smaller concessions
  • Issuing of permits by provincial and district administrations rather than the central government. Indonesia's lower tiers of government are generally viewed as 'harder to work with' than Jakarta.
  • Separate permits for exploration and production
  • Requirement to smelt and refine materials domestically and use local mining service companies
• Will slowing activity and rising unemployment stir unrest? Indonesia's labour unions are militant, increasing the possibility of unrest if unemployment rises.
• Could further economic deterioration undermine the currently favourable electoral prospects of Yudhoyo and the PD?

Other East Asia

Economic outlook. Growth in the rest of East Asia will slow sharply, led by reduced demand for exports. It is no coincidence that Newly Industrialising Asia (Korea, Taiwan, Singapore and Hong Kong ), where activity is very trade-dependent and global financial linkages are strongest, is already contracting. Elsewhere activity will be a little stronger, helped by more resilient domestic demand; growth between 2-5% is expected. Thanks to strong fundamentals, these emerging economies are able to provide support through lower interest rates and fiscal stimulus. The drop in commodity prices is a positive development for most countries in the region, with the notable exception of Malaysia , a large hydrocarbon and palm oil exporter.

Political outlook. A presidential election is due in the Philippines in 2010. President Gloria Macapagal-Arroyo is ineligible to stand, due to term restrictions. In Malaysia the economic slowdown will favour the ruling coalition. Prime Minister Abdullah Badawi will step down in March, four years before his term is due to end, and is expected to hand power to his deputy, Najib Razak. Politics in Thailand remains uncertain. This is despite the recent appointment of Abhisit Vejjajiva as Prime Minister - ending a succession of governments aligned with deposed Prime Minister Thaksin Shinawatra - and the new government's strong showing in a set of by-elections held earlier this month. The polls selected replacements for 29 legislators banned in December when the courts dissolved the Thaksin-aligned People Power Party, which led the last government. Abhisit's Democrat Party took seven of the seats and his coalition allies another 13. The result is a setback for the opposition Puea Thai Party, which calls the new government illegitimate because it came to power through a popular protest movement, not the ballot box. While Abhisit has gained an electoral mandate of sorts from the by-elections, political divisions among Thais have become more entrenched in recent years.

Watchpoints

• How will the political stalemate in Thailand between 'yellow' (anti-Thaksin) and 'red' (pro-Thaksin) forces play out?
• Will there be a credit crunch in South Korea ? South Korean banks have been affected by financial crisis through their reliance on short-term foreign borrowing. While a systemic banking crisis appears unlikely, due to backstop funding by the government, the dislocation in the financial system will constrain credit and thus domestic demand in 2009.
• Will we see a return of hidden export subsidies and competitive currency depreciations in an attempt to support growth?

South Asia - Global shocks expose domestic weaknesses

International economic difficulties are exposing domestic weaknesses in India, Pakistan and Sri Lanka. Hopes have faded that India will shrug off the global downturn, though it is still likely to emerge as one of the strongest Asian growth performers. Though neither Pakistan nor Sri Lanka is deeply integrated into world trade or capital markets, both could succumb to financial crises.

India

Economic outlook. Export-oriented industries and 'flagship' companies listed on the New York and London stock exchanges are doing it tough, because of a combination of falling sales, rising debt service costs, debt rollover problems, and share selloffs. However, companies making domestic sales are to some extent cushioning the downturn. Countercyclical policy should also help: this has so far included 350 bp of official interest rate cuts, a US$4 billion public spending boost, and interest rate subidies and VAT reductions for exporters. The net result? Growth could slide below 5% from above 6% in 2008 and 9% in 2007. But this would still probably be the strongest performance among major Asian economies outside China.

Political outlook. Three main coalitions will probably contest a general election due by May - the ruling United Progressive Alliance led by the Congress Party, the National Democratic Alliance led by the BJP, and a 'third front' of communist and populist regional parties. The election looks as if it will be closely fought.

Watchpoints

• Will the third front win the general election?
• How will the BPO (business process outsourcing) sector fare? The reputation of the sector has received some dents lately, with several large American firms such as Dell cancelling contracts with Indian call centres because of concerns about service quality; then Telstra and Nestle saying that they are reviewing contracts with India's No 4 software firm, Satyam, after the revelation of a US$1 billion fraud at the company ('India's Enron'); and most recently, the World Bank blacklisting software companies Megasoft and Wipro. Then again, the international downturn could actually bolster demand for outsourcing as western firms seek cost savings to stay alive. BPO accounts for nearly one-third of Indian export revenues.

Sri Lanka

Economic outlook. Sri Lanka entered the global economic crisis with excessive 'twin' fiscal and current account deficits - of almost 8% and more than 4% of GDP respectively in 2007. Contributing to the rising fiscal deficit was a big increase in military spending intended by the government to equip the army to defeat the rebel Tamil Tigers - the government formally abrogated a ceasefire it had with the Tigers last February and for some time has been after an outright military victory. In addition, since 2004, the government has come to rely more and more upon short term foreign currency-denominated debt to finance its budget and support reserves, which has led to some bunching of debt repayments. These developments have left it ill-placed to weather the trade and credit shocks now coming from abroad. In recognition of these concerns, ratings agency Standard & Poor's cut Sri Lanka's credit rating in December to B. The central bank responded that S||P had overlooked such boosts as the recent oil price fall and elimination of fuel subsidies, both of which were stemming the external reserve drain. Better yet, the bank claims it still has external financing options up its sleeve, such as tapping remittances of overseas workers and arranging currency swaps with foreign central banks. As welcome as these developments are, however, there is a still distinct risk that Sri Lanka experiences external financing shortfalls this year that propel it into a balance of payments crisis.

Political outlook. The government's recent capture of extensive Tamil Tiger-held territory has dealt a severe blow to the rebel group, but is unlikely to end the 25-year-old insurgency. The Tigers retain significant capabilities and will now probably step up their guerilla and terrorist attacks in the east and in Colombo, as well as harassing government forces from the thick jungles of the eastern Mullaitivu Province to which they have retreated.

Thanks to its military victories, the ruling Sri Lanka Freedom Party (SLFP) led by President Mahinda Rajapakse is poised to score well in provincial elections next month and in a likely general election later this year. However, the SLFP is lukewarm at best about the only course likely to end the conflict with the Tigers - a political settlement involving Tamil regional autonomy. So this result is likely to prolong the conflict.

Watchpoints

• Will the government manage to make external debt repayments on time?
• Will the drop in oil prices enable the country to make ends meet in its balance of payments? Or will there be destabilising capital outflows in response to some political or security incident?

Middle East - Comparatively resilient with some expectations

Like every other region of the world, the Middle East is suffering from reduced demand for its exports and tighter credit conditions. But it can cushion these blows by drawing upon ample reserves, sovereign wealth funds and fiscal and current account surpluses. The exceptions to this generalisation are countries that entered the crisis with large macroeconomic imbalances and political instability, notably Iran and Turkey. Both are looking decidedly crisis-prone.

Economic outlook. The GCC economies are facing a sharp slowdown in 2009, for the obvious reason of the oil price slump, but also because other industries into which they have diversified - tourism, property development, financial services, petrochemicals and aluminium smelting - are being hit severely by the credit crunch.

Dubai will feel the hardest knock, because its network of government-controlled companies - recently dubbed 'Dubai Inc' by ratings agency Moody's - went on an overseas borrowing spree that fuelled a large property bubble that has now burst. According to Moody's, borrowing by these companies has risen close to US$50 billion - more than Dubai's GDP. If these companies needed a systemic bailout, Moody's believes that Dubai would have to call on support from fellow UAE emirate, Abu Dhabi, or the UAE federal government. Fortunately Abu Dhabi has accumulated somewhere between US$700 billion and US$1 trillion in sovereign wealth funds and so has the ability to mount such a bailout.

More broadly, government and private investors in the Gulf are expected to draw upon their accumulated wealth and financial surpluses to partly compensate for the slowdown in external demand. According to consultancy firm Oxford Analytica, in oil, gas and energy alone, US$520 billion worth of projects are still planned for 2009-13; this is down from a projected US$650 billion before the crisis, but even if only US$400 billion is financed, US$8 billion-10 billion in investment a month will still take place. Even so, growth setbacks are likely to be severe. Standard Chartered recently cut its 2009 GDP forecasts for the UAE to ½% from 2.7%, for Saudi Arabia to 1% from 2%, and for Kuwait to 1½ % from 3%.

In Iran , the government faces the challenge of warding off a balance of payments crisis as oil prices fall. In the preceding period of high oil prices the government carried out excessively loose fiscal and monetary policies, which caused the economy to overheat, and sent inflation to 25% pa (average of the first three quarters of 2008). But now that oil prices have fallen sharply, the country is moving into external current account deficit, a position it won't be able to sustain because of its limited access to international financial markets.

Recent moves by President Mahmoud Ahmadi-Nejad to rein in the fiscal deficit suggest he is at long last grasping the gravity of the situation. After coming under heavy criticism for mismanaging the economy and squandering oil wealth, he presented on 30 December an economic reform bill to the parliament that proposes deep cuts to expensive fuel subsidies. However, with parliament unruly and an election approaching, his prospects for success are slim.

Tumbling exports and consumer spending plus slowing investments have already pushed Turkey into recession and its heavy dependence on external financing exposes it to the global credit crunch. Press reports suggest that the IMF is about to lend Turkey US$20 billion-25 billion over 18-24 months to help meet financing needs. Expectations of an IMF deal have already helped to stabilise the lira at 1.50-1.55 to the US dollar, following a slide in September and October. An IMF agreement will make it easier to maintain financial stability, but the economy is likely to remain stuck in recession till the world economy picks up.

Political outlook. The political influence of the capital-rich Gulf states will grow, as they take an increasing role in containing the regional impact of the global financial crisis. Already they have provided financial support to Pakistan. If Abu Dhabi moves to bail out Dubai, it will probably demand a greater say in UAE affairs in return.

Ahmadi-Nejad is the favourite to win the upcoming Iranian presidential election. He may be challenged by the popular former president Mohammed Khatami, but Khatami could be handicapped by Ahmadi-Nejad's abilty to engineer a result.

Tensions continue between the ruling, mildly Islamist Justice and Development Party (AKP) and the nationalist-secularist establishment in Turkey . That establishment narrowly failed in 2008 to have the courts ban the AKP on the grounds that it was undermining the secular foundations of the state. In response, the AKP has arrested around 30 people who it accuses of plotting to overthrow it.

Watchpoints

• Will the heavily-geared 'Dubai Inc' need a financial bailout?
• Will Iran's recent economic reform bill ward off a balance of payments crisis?
• Similarly, will Ankara obtain IMF support and will that ward off a Turkish balance of payments crisis?
• Will the new Obama administration deal with Tehran differently from the Bush administration?

Africa - Commodity price slump takes continent by surprise

Hopes that Africa would be able to defy the international economic downturn thanks to its negligible links with the world economy have been dashed. The commodity price slump in particular is hitting the continent hard.

Economic outlook. As late as last October the IMF was forecasting that Sub-Saharan Africa would be able to grow faster in 2009 than in 2008, even as the rest of the world was slowing dramatically. However, the slump in commodity prices between August and October, which brought the five-year rally to an end, has undermined that forecast completely. The continent now faces a decidedly bleaker outlook.

Countries in central and southern Africa are now witnessing a sharp contraction in investment plans as both junior and major resource companies rush to scale back, postpone and cancel exploration and development projects. Even those that still want to press ahead are having a harder time tapping the debt and equity markets for capital.

• DR Congo. Most of the 61 foreign companies that returned to the DRC after the 1998-2003 conflict are retrenching, including reportedly Chinese investors. Beijing pledged Kinshasa US$9¼ billion in resource-for-infrastructure deals last year before the price slump got underway, but this number is reportedly now being pared back. It is also believed that Freeport McMoRan, the world's No 1 publicly traded copper producer, will postpone the start-up of production at its giant Tenke Fugurume copper deposit, on which it has already spent US$1 billion. There is growing concern that a World Bank-supported government mining review, which has sought to recalibrate contracts with mining companies in the government's favour, may prompt companies to walk away from investments now that times have changed.
• Zambia. Unlike the DRC, which hasn't yet managed to lock in much investment, Zambia has seen a strong revival of its copper industry this decade, encouraged by a regime of low royalties and taxes. More than US$3 billion has been invested in the industry since 2000. It is now Africa's leading copper producer and exporter. In April the government announced a set of tax and royalty increases to capture a greater share of windfall copper revenues. Now that the copper price has fallen 60%, it has said that it is prepared to negotiate with investors on those increases. It is also reportedly considering temporary nationalisations of troubled mines to protect jobs.
• Guinea. According to the IMF, international mining companies were planning US$27 billion in investment in Guinea before the price slump. Two major investments are the Sangaredi alumina refinery, in which BHP Billiton had a one-third interest, and the Rio Tinto-owned Simandou iron ore investment, each with development costs around of several billion dollars. Much of this investment will now be under review. Most uncertain is Simandou; half of this concession has reportedly been confiscated recently and given to Israel's Benny Steinmetz Group. Also hindering investment will be the recent coup following the death of President Lansana Conte. The military junta now in charge has promised to renegotiate all mining concessions, though to what extent this is just populist grandstanding remains to be seen. It has also ordered the cessation of all gold extraction.
• Botswana. Falling demand for diamonds is reportedly hitting government revenues in Botswana severely.
• South Africa. Gold prices have reportedly sunk below the cost of production of US$850 an ounce for South Africa's top three gold producers, Anglo Gold Ashanti, Goldfields and Harmony. Platinum producer Lonmin has announced mine closures along with 5000 job losses following the more than halving of the platinum price. The South African mining industry as a whole is now preparing for more than 10,000 layoffs in the coming months. Many mining deals involving BEE - black economic empowerment - companies are reportedly now in trouble because they are over-geared.

Political outlook. The big political development overshadowing the continent is the forthcoming South African general election. The ruling ANC alliance will likely win that election, but will come under strong challenge in several provinces from the new breakaway party, the Congress of the People.

Watchpoints

• To what extent will governments give up their previous push for better fiscal terms from mining companies now commodity prices have slumped?
• How many projects will survive the comprehensive investment review now being undertaken by companies?