U.S. troubles add fuel to financial fire in Asia

Battered by a blast of bad news from Wall Street last week, Asian financial markets are reeling from plenty of homegrown problems, too.

Across the region, stocks were having a bad year before the collapse of Lehman Bros., the fire sale of Merrill Lynch and the bailout of American International Group. From Seoul to Singapore, economic and political troubles are piling up.

Economies are slowing. The Asian Development Bank, a Manila-based development agency, recently predicted that economic growth in East Asia would slow from a torrid 9.6% pace last year to 8.0% this year and 7.7% in 2009.

Moody's Economy.com forecasts slowing growth this year in every Asian country except Thailand. The wealthy city-state Singapore will see economic growth brake to 4.2% this year from 7.5% last year. Even in booming China, growth will slow to 9.5% this year from 11.6% last year, Moody's forecasts. Japan and New Zealand will be lucky to "narrowly escape" recessions this year, Moody's analyst Sherman Chan predicts. Behind the slowdown: weakening exports to the powerful but stalling U.S., European and Japanese markets. Singapore, for instance, reported that electronics exports dropped more than 14% in July from a year earlier. The Asian economic slowdown has killed the notion, popular in recent years, that Asia's economic fortunes were no longer intimately intertwined with the U.S. and European markets, says Ifzal Ali, the Asian Development Bank's chief economist: "Uncoupling is a myth," he says.

The worst is yet to come, Moody's Chan predicts. Through the first half of this year, China was still sucking in supplies from the rest of Asia to manufacture products for the U.S. and European markets. "When China scales back demand for manufacturing inputs in the second half of the year," she writes, "the rest of Asia will feel the full weight of the global slowdown."

Inflation is simmering. The Asian Development Bank predicts that prices will rise 7.8% this year, up from its estimate earlier this year of 5.1%. And the bank foresees double-digit inflation in Cambodia, Indonesia, Laos, Vietnam and the Philippines.

The bank says the problem goes beyond sky-high energy and food prices, which are beyond the control of Asian central bankers. Low interest rates also fueled inflation and instilled in consumers self-fulfilling expectations of higher prices and higher wages. "Some (Asian central banks) may have let the inflation genie out of the bottle by doing too little, too late," the bank concluded. "Interest rates in most countries are still lower than inflation."

Rising prices put central banks in a bind: Should they cut interest rates to spur economic growth — or raise them to fight inflation? Economist Ali urges them to fight inflation first, even at the risk of hurting economic growth. "It's time to tighten our belts," he says.

Real estate prices look precarious. A weakening economy will push Hong Kong residential prices down 5% through the rest of 2008 and 10% in 2009, Goldman Sachs Global Investment Research predicted earlier this month, terming the decline a "slow death scenario."

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