Sniffles heard in Asia as U.S. economy chills

By Richard Hubbard

HONG KONG (Reuters): Confidence in Asia's immunity to a cold if the U.S. sneezes from the chill of higher interest rates is starting to waver as analysts take a fresh look at the prospects for a hard landing in the American economy.

The once strong diagnosis that flexible exchange rates and current account surpluses would inoculate Asia from a U.S. slowdown is giving way to a cautious reassessment of the risks to the region, especially for next year.

The hard landing scenario for the U.S. increased last week after the Federal Reserve raised interest rates 50 basis points in response to strong growth and signs of rising inflationary pressures.

"A hard landing in the U.S. in 2001 could cut GDP growth in the (Non-Japan Asia) region by 0.3 to 2.8 percent," said Tim Condon, regional economist at ING Barings in Hong Kong.

But more importantly the slowdown in the U.S. will likely fall disproportionately on some of the weaker Asian economies.

Condon estimates the initial impact of a U.S. hard landing would be through the trade channel hitting Asian exporters. The impact would therefore vary according to the proportion of exports to the U.S. and on the share of exports in gross domestic product.

"In non-Japan Asia, Hong Kong and the Philippines have a high share of exports to the U.S., and Malaysia and Singapore have high export shares in their GDP."

"The giants, China and Indonesia are insulated from a downturn in the U.S. by their small export shares in GDP, and Indonesia is further insulated by the fact that it exports little to the U.S.," Condon said in a note to clients.

At Goldman Sachs, economists have scoured the data for signs that Asia is catching cold from the U.S. Fed tightening cycle and concluded that the evidence is weak so far.

But they did find the countries at greatest risk of being laid low are those whose fiscal balances were weakened by the financial crisis.

"Indonesia is the most extreme example of this fiscal sustainability risk, while Thailand and the Philippines are a more distant second," said Sun Bae Kim, senior economist in the Asia Economics Research Group at Goldman Sachs.

On the monetary policy side, Goldman Sachs believes Asian central banks are unlikely to slavishly ape the actions of the Fed and tighten liquidity.

But with higher U.S. rates available and investors becoming more risk averse, capital inflows into non-Japan Asia will begin to slowdown.

"We are confident that Asian central banks will do the right thing and not tighten domestic monetary conditions to defend their currencies amid this general trend of weakening capital flows," Kim said.

"As a result we have tactically reduced our three- and six- month forecasts for Asian currencies against the U.S. dollar."

However, Goldman Sachs has left 12-month currency and interest rate forecasts unchanged.

"We do not see large downside risks given non-Japan Asia still has a very strong basic balance of payments." Kim said.

One house which is making an early and clear call for significant cut in Asia's growth rates due to a U.S. slowdown is UBS Warburg.

"Our radar screen on Asia's growth prospects has been flashing yellow for some time," said Graham Courtney, executive director of Asian economics at UBS Warburg.

"And now the intensity of the cautionary signal has reached a point that we feel comfortable downgrading our 2001 growth forecasts quite significantly," Courtney said.

Courtney also singles out exports as the main culprit, but more specifically points to electronic exports.

"Asia is vulnerable to any slowdown in technology-related business investment abroad, or a moderation in consumer electronic demand," he said.

"A significant portion of U.S. (physical) investment is in technology and Asia's exports are geared to feed this phenomenon," Courtney said.