Viewpoint: US debt deal a positive move for Asia

An employee works at the workshop of a textile factory in China
Image caption A US debt default would have hurt growth in export-dependent Asian economies

The political agreement to lift the US government debt ceiling has been of critical importance, not only to the US economic outlook but also to that of the Asia-Pacific region, given the high dependence of East Asia on export-driven growth, with the US still a key market.

Had the US government been forced into a situation where it would have had to start to implement cuts to essential spending and perhaps to even default on interest rate payments on its debt, it would have substantially increased the downside risks to the global economic outlook.

With US economic recovery already relatively fragile, with annualised growth of just 1.3% in the second quarter of 2011, enforced cuts to government spending could have further weakened growth momentum as well as dampened consumer and business confidence.

A drop in consumer confidence would have a knock-on effect on demand from the US.

Therefore for Asian economies, the removal of this threat is a positive development, since the US is still the world's largest economy and a key market for Asian exports.

Furthermore, a default on US government debt would have also created turmoil in global financial markets, with heightened volatility in currency markets.

In recent weeks, investors have sought safe havens such as the yen and gold on fears that the uncertain US economic situation and the US debt crisis would damage global outlook.

A failure to reach a deal would have seen an even greater investment in safe havens, sending their prices higher.

A rising yen would have caused further damage to Japan's export sector, which has yet to recover fully from the aftermath of the 11 March earthquake and tsunami.

Ratings downgrade?

A large share of US government debt is now held by foreign investors, including a significant share by Asian central banks as a core part of foreign exchange reserves.

A default would have seen the US dollar weaken further, hence reducing the value of the huge amount of US assets held by the Asian central banks.

At the same, time confidence in US government debt would also have been shaken significantly by a US default.

That would have almost certainly triggered ratings downgrades on US sovereign debt by international rating agencies.

A downgrade would have pushed up financing costs in the US economy and further endangered growth momentum for both the US and, through transmission effects, the world economy.

However, signs of political agreement on the roadmap for significant cuts in US government spending of around $2.5tn (£1.5tn) over the next decade may stave off US sovereign ratings downgrades.

The debt deal has, therefore, taken one of the two key risks to the global economy in the second half of 2011 off the table.

This is one major piece of good news for the Asia-Pacific economies, which have been facing headwinds from the economic crisis in the US and Europe during the first half of 2011.

Of course, the European sovereign debt crisis continues to loom, remaining a key risk to the global economic outlook in 2011-12.

Growth drivers

However, there are two other important growth drivers for East Asia that should improve over the northern summer.

Firstly, the Japanese economy is recovering rapidly from the depths of the March earthquake and tsunami, with industrial production rebounding strongly towards pre-disaster levels.

The disruption of global supply chains will now enter a recovery phase, as Japanese plants rebuild both domestic and global inventories of auto, electronic and other industrial products.

With the first two supplementary fiscal packages for recovery already passed, implementation of reconstruction efforts should gather momentum in coming months.

Secondly, the Chinese economy is still showing considerable momentum, with industrial production up 15.1% and exports up 17.9% on a year ago in June.

With the world's second and third largest economies, China and Japan, expected to post strong growth in the second half of 2011, the outlook for the Asia-Pacific is for improving export-growth momentum, helped by a strong rebound in exports to Japan.

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