India Poised to Gain as China Troubles in South China Sea Escalate

The recent Philippine-Vietnam announcement on a coordinated response to China’s latest ocean drilling marks a significant shift in regional relations. Strains have been growing for some time. An unenforceable territorial dispute process has failed to resolve competing claims and anti-foreign sentiment is on the rise (in both Vietnam with riots against foreign factories and changing attitudes in China against buying foreign-made goods.) Any natural gas discovery will only exacerbate tensions.

This unprecedented level of public cooperation highlights a growing regional consensus. Years of China’s “peaceful rise” have ended and Southeast Asian countries appear to be gaining less and less from their trade-and-appease policies of the past.

Enter India, long the economic giant in waiting. While still a good two decades behind China in terms of overall development, the recently elected Modi government has pledged business reforms that could transform the country into a regional power. Re-kindling GDP growth rates of 7-10% could be a boon to resource rich southeast Asia eager to offset a slower-growth China.

With a near super majority Modi’s control over parliament can push change in ways that previous administrations could not. If he delivers, then significant trading and investment opportunities will follow. Average trade growth between Asean and India has already accelerated faster than Asean-China trade (25.5% vs. 15.1% from 2007 to 2011, the latest year available via Asean).

Still there are pitfalls along the way. Modi will need to steer the BJP party clear of its ultra-nationalist tendencies and historical anti-Muslim and anti-minority sentiment. His unresolved response to the slaughter of Muslim Indian citizens in 2002 while he was State Minister of Gujarat will surely be on the minds of Indonesia’s leaders. Competition may also hinder some opportunities where firms go head-to-head with each other (e.g. Thailand’s auto industry vs. southern India’s).

If India’s leaders can finally overcome decades of inertia and liberalize the economy they will find a region eager for a trade partner that doesn’t threaten their territorial integrity.

 

Asia Tensions Reach New Highs

North Korea’s rounds of provocation tempered with inaction continue to challenge regional powers. Sanctions appear to have had little affect on the new regime, but perhaps some additional pressure from China, one of their last remaining allies, has put the fear of complete isolation into the minds of Pyongyang’s leadership. Now that the new Kim has shown his father’s generals he’s no push over maybe he’ll move on to the real work at hand – the economy. After closing Kaesong (one of the few legitimate hard currency earners for the regime) the North now wants to talk with South Korea about re-opening the joint project.

Nothing coming out of the DPRK should be taken at face value, of course – the propaganda machine sounding war drums, or conciliatory economic gestures. The regime still has a horrible human rights record, continues to pursue a nuclear capability and remains a card carrying member of the pariah states club (including Iran and Syria), but in the world of international diplomacy, where there’s more gray than black and white, it’s high time for some serious talk. Bilateral, multilateral, whatever works. Talk is cheap and it isn’t a reward for rattling the region, but it may just create an opening for Kim to try out a new tactic – engagement. Missile firings along with the capture of an American citizen have failed to gain him the audience he wants, except for a repeat visit by Dennis Rodman scheduled for August.

China’s New Law of the Sea – but Might Still Doesn’t Makes Right

Meanwhile, China’s “take first, ask questions later” approach to territorial disputes in the shared waters of East and Southeast Asia continues to rankle its neighbors. We’ve reached a new low in regional relations. What started out as fishing boat bravado has escalated dramatically into full-scale military involvement. Now the cat and mouse game plays out around the Senkaku/Diaoyutai islands with Japan upping the ante, and military budget, to confront an increasingly aggressive Chinese navy. Southeast Asia hasn’t fared much better. No agreement has been reached, despite diplomatic overtures for two years running, on how to resolve overlapping claims now completely subsumed under China’s self-claimed control.

Risks of accidental firings aside its now clear to everyone in the region that China’s “peaceful rise” has given way to a long rumored, now actualized policy of regional dominance. It might not be the Cold War part 2, but it certainly looks a lot like back-to-the-future with a new Chinese imperial sense of historical retribution for past colonial ills. The rest of the world has since moved on. Perhaps the “China Dream” should include a broader vision of regional integration without any one country needing to dominate.

Unfortunately for Asia the moment for a regional security architecture passed decades ago (about when NATO was formed and former aggressor states like Germany sat down with Britain and France). Now it’s left to the U.S. and its Asia pivot to cobble together long historical “frenemies” into a semi-cohesive whole. That attempt runs head long into China’s economic leverage that so far successfully divides the region (and ASEAN in particular) by holding trade hostage (from Philippine fruit imports that suddenly show signs of infestation to rare earth metals vital to Japan’s high-tech industry).

Countries are already trying to diversify their export markets and sourcing while the infinite promise of a large and expanding Chinese market comes under new strains. If cooler heads prevail, then the benefits of a cooperative future and greater regional integration will win out over a divisive re-playing of threats and counter-threats in the age-old struggle for power and control.

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Asia Integration Leaves U.S. Behind

Asia Integration Leaves U.S. Behind

You can’t blame them for trying. U.S. trade negotiators have been at it for years but conclusion of the Trans-Pacific Partnership (TPP) keeps receding over the horizon. A June deadline was floated and then passed quietly by. The end of 2012 came next (here and almost gone). Japan and possibly even Korea thought of joining when news broke that Mexico and Canada, already NAFTA members with the U.S., were signing up. Neither has committed.

Meanwhile, Asia is moving ahead with its own far less stringent version of free trade in two proposals: the Regional Comprehensive Economic Partnership (RCEP) launched at the annual ASEAN gathering in late November; and a trilateral China-Japan-South Korea free trade agreement announced in May (negotiations started in November.)

Holding a press conference and successfully completing negotiations are, of course, two very different animals. No doubt recent regional tensions over disputed islands in the East and South China Seas involving mostly China, Japan, Vietnam and the Philippines make any agreement extremely difficult to achieve. Still, all countries involved appear to be forging ahead despite the obstacles in their way.

Asia has taken a decidedly different approach regarding free trade in the region from the U.S. Starting with the lowest common denominators (goods) and through successive agreements working their way up the value-added ladder (limited, then expanded services, broader non-tariff barriers to trade, rules of origin, etc.) This incremental approach, especially when economies at significantly different levels of development are involved, has worked especially well for both China and South Korea in their agreements throughout the region.

The U.S. on the other hand seeks “high standard” agreements encompassing a variety of non-tariff barriers to trade, intellectual property rights protections and labor and environmental standards, all in one comprehensive Free Trade Agreement (FTA).

These are noble goals and of particular interest to U.S. companies who have an enormous number of laws regulating their business at home and abroad. For many with extensive intellectual property to protect the graveyard of international business is littered with the remains of products that have been copied and sold at lower prices. To truly level the playing field they need the additional protections offered in high-standard FTAs.

The problem lies in strategy, not substance. This all-or-nothing approach leaves potential deals on the table while U.S.-based firms continue losing out to their counterparts based in Asia. U.S multi-nationals are increasingly incentivized to locate production overseas where they can source and sell within a tariff-free zone. Even a few percentage points off duties can have a tremendous effect on profitability.

No solution to this problem is in sight. U.S. trade policy has focused almost exclusively on the TPP and purely defensive measures (e.g. WTO cases to remedy unfair trade practices). Asia meanwhile forges ahead. When RCEP comes to fruition India, China, Japan, South Korea, Australia, New Zealand and the ten countries of ASEAN would become one integrated free trade zone. If current strategy doesn’t change soon (or the TPP keeps being delayed) the U.S. won’t even be on the map.

 

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Photo: Yang Shan Deep Water Port, China.

Asia by the Numbers

Asia by the Numbers

(UPDATE 10/8/12: Both the World Bank and Asian Development Bank have lowered 2012 growth forecasts for China and Asia.)

Remember those halcyon days of unending Asia growth and the re-birth of a Silk Road century? Cherish the memories.

Nothing but negative news keeps flowing out of regional giants these days. Expert debates rage on about China’s hard vs soft landing while recent data just keep disappointing. HSBC China Manufacturing Purchasing Manager’s Index wallowed below the critical 50 threshold again. Political intrigue aside, China’s next generation of leaders are facing significant economic headwinds and challenges unknown to their predecessors.

From the September 29th HSBC Purchasing Manager’s IndexTM:

 

“Data in September signalled a stronger decline in Chinese manufacturing output, as the volume of new orders fell for the eleventh consecutive month. New export orders declined at the sharpest rate in 42 months amid reports of weak international demand…”

 

 

Historical numbers show a long decline since late 2010 (and a wild ride starting with the 2008 U.S.-led financial crisis).

Japan’s Tankan business sentiment survey showed more general weakness (negative views of business for the past 12 months and worsening in the last quarter). Unsurprising considering the weak overseas demand, yen troubles making exports more expensive and now troubles with China over the East China Sea. ANA airlines reported 40,000 cancelled flight reservations for September through November sparked by dueling territorial claims and violence on the mainland targeting Japanese factories, stores and restaurants.

Add to that Australia’s struggles with shrinking exports and a surprise Reserve Bank of Australia rate cut to 3.25% (Philippine’s central bank has cut rates as well), Vietnam’s slowdown, and rising South Korean consumer debt.

With the U.S. caught in a “slow-growth” trap of its own making and greater Europe still flirting with renewed recession, trade is now a back seat driver for most of Asia. The slowdown in China is especially concerning for southeast Asia’s and Australia’s resource-intensive exports since China became their main market over the past several years.

Prospects aren’t all negative of course, though finding bright spots in an increasingly overcast night’s sky is tough. Indonesia keeps generating solid six plus percent growth. High investment and sustained consumer demand (accounting for over 32.9% of GDP last quarter ending in June) are driving economic expansion.

Jakarta has so far managed to avoid the massive over-building in China which will drag down the middle kingdom for some time to come. The infrastructure needs throughout the island nation of over 200 million people, if well managed, might provide sustained growth for a while.

Prognosis: Substantial western growth isn’t coming back anytime soon. For Asia to prosper domestic demand (read: consumers) has to expand and that means further market liberalization and access to capital that has often been denied, mainly for political reasons.

The China model of controlled growth and U.S.-style unchecked market excess both have their discontents, but policies favoring middle class growth and expansion remain key. Balance will be the buzzword going into 2013.

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Related posts:

 

Asia Slowdown Hits Vietnam

Asia Slowdown Hits Vietnam

You can’t argue with growth, until it slows, and slower it goes in parts of emerging Asia. Countries like Vietnam, long believed immune to the troubles of industrialized nations are now in the throes of their own domestic economic downturn. The culprit turns out not to be currency speculators or international financial institutions demanding draconian austerity measures, but greed, pure and simple.

The symbols of fast money were evident everywhere. Bicycles and mopeds that clogged roadways only few years ago now compete with cars. Malls sprang up in the capital city of Hanoi transforming the skyline from Stalinist heavy-slab concrete to glimmering glass. Residential and commercial real estate projects rose like plumes of mushrooms after a soaking rain.

All of this new wealth creation relied on easy money. An investment-led boom that rivaled the ages since Thailand and Malaysia took off over a decade ago now appears to be losing steam, and fast. Government officials have lowered 2012 GDP growth expectations by almost a full percentage to 5.2%. Back in 2010 growth had pushed 7%.

Many of those glimmering construction projects are left unfinished, construction companies are going broke and banks are left holding the bag. Foreign investment is dropping as well and the Ho Chih Minh stock index, has fallen nearly 25% since the beginning of 2010. The NYT’s Thomas Fuller highlighted the real costs of a slowdown:

“[Y]oung people are finding it harder to find jobs; nearly 20 per cent of small and medium-size companies have gone out of business during the past year; and municipal infrastructure projects are being delayed or cancelled.”

As with any simmering financial crisis on the verge of boiling over, warning signs were evident for years. Back in 2008 the main concern was a wave of foreign investment overflowing Vietnam’s fragile financial system, inflation and hot money running out of the country wreaking havoc with the currency. The inability of the country’s leadership to manage that situation pointed to problems at the top. The lack of monetary policy control has only grown worse over time. A lending frenzy to try and keep the good times rolling has now given way to talk of bail-outs.

In a 2008 Time magazine article Martha Ann Overland wrote:

“To tackle inflation, the government knows it needs to raise interest rates and rein in spending, particularly by state-owned enterprises that have used state financial institutions as their own piggy banks. But any sudden moves can also threaten to strangle businesses and scare away new investors, which Vietnam must avoid if it is to meet its revised 7% growth rate.” However, “Vietnam’s long-term economic outlook is good, says Tom Nguyen, head of global markets at Deutsche Bank in Ho Chi Minh City.”

That perpetual optimism may be in shorter supply these days.

Beyond Vietnam’s recent stumble the larger issue of whether the China model, long considered a rival to western free market ideals, is on the ropes as well. Top-down state-directed growth, primarily through state-owned companies or those closely associated with single party states, appear increasingly vulnerable not only to international financial crisis, but to their own lack of reform.

Of course greed and speculation was a hallmark of the global financial crisis as well. Raging free markets unhinged from regulations gave rise to the worst U.S. economic recession since the Great Depression.

At its root these problems, for both developed and developing economies, center on a misguided race to riches. All growth is not created equal. Policies need to focus first and foremost on building and sustaining a middle class which in turn drives balanced growth and stability for all.

Photo: Wikimedia Commons

South China Sea First Test for U.S. Shift – Business Insider Article

Tensions are rising again in Southeast Asia as competing claims over the resource rich South China Sea push closer to boiling point. One would hope that countries in the region would take concerted action. That hope would be misplaced.

An increasingly militarized land and sea grab continues despite calls for peaceful resolution. With the U.S. in full Asian tilt, the South China Sea dispute is shaping up to be the first major test of its Pacific re-engagement. What the U.S. can or should do remains woefully undefined.

Full article available here.

Radio Australia Interview on Myanmar Economy

Can Burma’s economy cope with sudden influx of foreign investment?

With the relaxation of western sanctions Burma, foreign business interests are pouring in, eager to take advantage of what the resource-rich, strategically located country can offer. Can Burma’s economy cope with the sudden influx of foreign investment?

But there are those, including opposition leader Aung San Suu Kyi, who have warned of “reckless optimism” about the development prospects and the country’s ability to cope with the sudden influx of foreign investment.

Presenter: Richard Ewart

Speaker: Brian Klein, former American diplomat and trade official

Streaming audio here.

Foreign Affairs Article – How Not to Invest in Myanmar

Foreign Affairs Article – How Not to Invest in Myanmar

(Re-printed from the original article here) Since Aung San Suu Kyi’s parliamentary election victory last April, Asian and Western businesspeople have flocked to Myanmar (also known as Burma), eager to take part in the re-emergence of a regional economic power. Over the last several months, Australia, Canada, the United Kingdom, and, as of May, the United States, have reopened some economic ties with Rangoon. U.S. sanctions that had long prohibited direct investment, development funding, and visas for military leaders have now been largely suspended.

Coca-Cola, GE, and oil and gas companies have already expressed strong interest in entering Myanmar. Hotels are filling fast, and rooms that rented for $60 six months ago go for $400 today. After several decades of isolation, Myanmar has moved to the center of frontier markets’ maps. But Myanmar’s potentially fractious political climate and dangerously fragile economy mean that a rapid opening may bring unsettling results along with sudden wealth.

Vast reserves of natural resources, including oil and gas, rice, timber, and precious gems, most of which are now exported unrefined, offer many opportunities to build up production capacity. Finished lumber, polished rubies, and even higher quality rice will attract investment opportunities in addition to tourism, energy, construction equipment, and manufacturing. Last year, more than $20 billion in foreign investment, mostly from China, Hong Kong, and Thailand, flowed into the country — more than all the foreign direct investment from the previous two decades combined.

Some have counseled caution, however, and rightly so. Aung San Suu Kyi, who spent most of the last two decades under house arrest before she was freed in 2010, recently issued a warning to eager investors. At a World Economic Forum event in Bangkok in June, she warned of “reckless optimism,” highlighting the need for transparency in the new government reforms that were making all the new economic activity possible. Otherwise, she said, the Burmese public would continue to lose out to the few in power.

There are many other reasons to heed her advice. With the global economy weakening, and even juggernauts such as India and China creaking, the lure of rapid growth will be hard for investors to resist. But waves of foreign direct investment chasing high returns have overwhelmed fragile, newly opened economies in the past. In these countries, which usually lack fiscal discipline and strong monetary policy controls, often times there are wild swings in exchange rates, money supply, and inflation. A lack of standards increases the likelihood of creating financial bubbles as banks race to lend. A raft of questionable real estate projects, a familiar problem for Thailand in the late 1990s, often follows. The sudden inflow of foreign direct investment may recede just as quickly at the first sign of instability.

The financial sector is only one problem area. Without adequate customs and border controls, imports — especially agricultural and low-end manufactured goods — can easily flood markets and out-compete domestic producers. More generally, without strong oversight, counterfeit products can also infect supply chains, leading to health and safety risks. Flows of arms, drugs, and people often increase with unmanaged economic growth, a problem Myanmar would share with Cambodia, Laos, and Vietnam.

Worse, newly exploited raw materials can throw an economy off balance. Rapid development financed from abroad can widen wealth gaps and enrich vested interests unchecked by governmental authority. Ignoring the development of government institutions has been a well-trod path in the developing world. Consider resource-rich African states, including Nigeria and Sudan, which have never approached middle-income status because oil wealth benefited only a few, depriving the economy of a robust middle class.

Strengthening courts, tax collection, border control, and transparency could form the basis of broad-based economic growth serving the greater needs of the entire country. But these concerns often take a back seat as the government continues to sell off national assets in ways that benefit the few, something Aung San Suu Kyi has mentioned repeatedly in her recent speeches. Mongolia faces similar challenges, with double-digit growth, mining resources that may reach $1 trillion, and rampant corruption that threatens stability and social equity.
In a positive step, Thein Sein announced additional reforms in June, including increasing openness to foreign aid and technical assistance. He also introduced an investment law to parliament (the details of which have yet to be released), expected to be passed by the end of July, that would relax land lease restrictions and provide tax incentives for foreign businesses. Although paper reforms are necessary, implementation, including adequate funding for new government mandates, remains key.

Also important will be some clarity on the broader development path that Myanmar might take. The export-led model that many of its neighbors followed half a century ago, when Western and Japanese markets were growing, no longer exists. Myanmar has a rare opportunity to create an economy driven by domestic demand rather than on manufacturing for export. With a large population, vast natural resources, and increasing capital inflows, the country already has the basic foundation needed for an economic renaissance. Now it needs to improve access to capital for small and medium-sized enterprises and to develop legal protections to really succeed.

Yet for all those cautions, it is with good reason that international executives are booking rooms in Rangoon into next year. The winding-down of sanctions didn’t come out of nowhere: Myanmar complied with many of the West’s preconditions for normalizing relations. Free and generally fair elections were held for a limited number of open parliamentary seats this April (the majority are still reserved for the military and military-backed parties). The government released many political prisoners (though their sentences were technically suspended, not commuted).

Rangoon also revalued its currency. In April, the kyat, which had formerly traded at six to the dollar, was trading at 800, near the previous black market rate. The currency reached 840 by early June. The jump raised potential investor confidence in the currency, and now the Tokyo Stock Exchange and Japan’s Daiwa Institute are helping to develop a Burmese bond market. India announced a $500 million credit line in May. But the value of high finance in a fledgling economy remains questionable. Cambodia created a functioning stock market last year; there are only a few listed government companies, and share prices have fluctuated wildly. It operates more like a casino than an exchange. One may write off the problem as a risk of investing in a frontier market, but more time and resources spent building key infrastructure and effective rule of law would attract far more beneficial capital.

Unless the transition from pariah state to fledgling, albeit limited, democracy is well managed, Myanmar may end up dominated by oligarchs. A host of hard-to-control problems that only exacerbate social and economic inequality would follow. Myanmar has arrived at the crossroads where fast growth and balanced growth diverge. If the former military leaders who dominate the government, many in their fifties and early sixties, have their country’s future in mind, then policies focusing on supporting a vibrant middle class will help Myanmar far more than a short-term race to riches.

Tensions Rising Again in South China Sea

Tensions Rising Again in South China Sea

The ASEAN Regional Forum meets in Phnom Penh, Cambodia against the back-drop of increasingly militarized territorial disputes in the South China Sea. “Combat-ready” patrols by Chinese ships, Vietnamese military overflights of the Spratly’s, and the Philippines seeking U.S. reassurance that their Mutual Defense Treaty remains intact all point to rising risks of confrontation. In perhaps the boldest commercial move to date, China began offering disputed ocean blocs for sale to within 42 miles of the Vietnamese coastline, well within internationally recognized exclusive economic zones.

That any foreign oil or gas company would enter into such a hotly contested region remains unlikely. CNOOC, a state-controlled Chinese firm, however began deep water drilling over 200 miles from Hong Kong. This advance means rich deposits throughout the area are now within technical reach.

Provocations have occurred fairly regularly over the past several years, mostly over rich fishing grounds. Boats joust with coast guard cutters. Flags are planted on rocky outcroppings to lend a shaky credence to antiquated claims of sovereignty. China and the Philippines faced off for over a month at the Scarborough Shoals until cooler heads prevailed.

While ASEAN continues talking about peaceful resolution a major sea grab is underway. Despite international norms and a 2002 “Declaration on the Conduct of Parties in the South China Seasforce majeure rather than the power of the pen has been defining new boundaries over contested territory.

A unified voice (or military coalition) from the region to counter China’s more aggressive stance won’t come anytime soon. Many countries within ASEAN have no direct stake in the outcome. Singapore, Thailand, Indonesia, Cambodia, and Laos remain on the sidelines. At the same time southeast Asia pursues lucrative trade ties to their top export destination China they remain wary of China’s regional ambitions.

Government leaders repeatedly say they want balance (meaning more U.S. military presence, investment and trade) but they don’t want to choose sides. That becomes a harder bargain to sustain if China continues to take while forums only talk.

A year ago the Indian naval vessel INS Airavat, while making port calls to Vietnam within 45 nautical miles of the coast, was passively confronted over the airwaves by China regarding its presence. In June of this year the INS Shivalik along with three other Indian ships were physically “escorted” through international waters en route from the Philippines to South Korea by a People’s Liberation Army Navy frigate. They were hailed over the airwaves with “Welcome to Chinese waters.”

Full Map of the Contested Area