Asia's Answer to the Slump: Spend

Governments hope to build their way out of trouble

In early July, Singapore became the first Asian nation outside Japan to be shoved into recession by the global downturn. Days after announcing the sober news, the government--never one to sit on its hands--unveiled a $1.2 billion stimulus package, or 1.4% of gross domestic product. Singapore will spend on infrastructure, lower certain taxes, and allow citizens to temporarily cut payments to the state pension fund. Said Minister for Trade & Industry George Yeo: "If the global economic situation worsens, we have the resources to do more and will be ready to do so."

The urge to prime the pump is getting stronger in Asia. Several nations have been running deficits since the 1997-98 financial crisis. And now that the worldwide slowdown is hammering tech exports, governments from Taiwan to South Korea to Malaysia are requesting supplementary budgets in an effort to give growth a boost (chart).

SMALL MARKETS. The good news is that thanks to relatively low levels of sovereign debt, these governments can afford some stimulus. The bad news, says Jun Ma, a Hong Kong-based economist at Deutsche Bank (DTBKY ), is that government spending will have "only a marginal impact on these economies." While it's true that China managed to spend its way through the Asian crisis and add an estimated 2% to economic growth, it has an enormous domestic market that is ready to consume goods made locally. Thailand, Malaysia, and Singapore have small domestic markets that cannot generate much demand. Only a renewed American appetite for Asian tech exports will give these countries a real lift.

Pump-priming, of course, is smart politics even when it isn't great economics. Notes Craig Chan, regional economist for ING Barings in Hong Kong: "Governments can't just sit back and watch things sink."

Besides, deficit spending is about the only weapon left in Asia's recession-fighting arsenal. Although central banks have aggressively slashed interest rates in tandem with the U.S. Federal Reserve, the cuts likely will do little to stimulate capital investment or consumer lending. Why? The banks are sitting on so much bad debt that they're not acting the way banks should. "Banks aren't lending," says Chi Lo, senior economist at Standard Chartered Global Markets in Hong Kong, "so Asian governments need an alternative to boost growth."

For now, the region won't have much trouble raising money to finance these spending sprees. Savings rates average about 20%, so governments can tap local investment. Thailand is expected to sell $7 billion in domestic bonds this year. Nor are foreign investors punishing Asia for problems in other emerging markets. Asian companies may be having trouble issuing debt, but government bonds are still welcome to foreign investors. Malaysian debt sells for just 218 basis points over U.S. treasuries, Thai debt 140 basis points, and South Korean debt 135.

Foreign investors like Asian government debt because most of the governments still have manageable budget deficits. But the official deficit numbers don't include hidden costs, including the amount governments may have to fork over to bail out banks that are saddled with dud loans. If one assumes that half of nonperforming loans in Malaysia will never be repaid and that the government will have to support banks when they write these debts off, the additional cost comes to 6.5% of gross domestic product. And that doesn't include high-priced bailouts of politically connected companies such as Malaysia's Renong group, which governments won't allow to go under. Those costs may yet wound these countries as they seek to raise money.

The trick is to know when to turn off the tap. Japan has spent $1 trillion over the past decade in a futile attempt to goose domestic demand. Much of that money went into unneeded, politically expedient infrastructure. By contrast, Thailand, Taiwan, and Malaysia really need new roads, schools, and health-care facilities. But Japan once had a manageable budget deficit, too--and proceeded to spend itself into near ruin. If the region's economy stays stalled, the temptation to keep building regardless of need may prove too strong for politicians to resist.

By Bruce Einhorn in Hong Kong, with bureau reports

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