Analysis: Asia decoupling? Not without more help from China

By Emily Kaiser and Swati Bhat

SINGAPORE (Reuters) - Asia's best hope for insulation against a worsening economic outlook in the United States and Europe rests on China, and it may not be willing or able to do the job.

With inflation running at a three-year high, Beijing has pulled every lever at its disposal to try to brake economic growth, yet price pressures persist. That argues against a repeat of 2008, when China ramped up government spending to counter the global recession, buoying Asia and the world.

As for the export linkages, China has supplanted the West as the largest trading partner for many Asian economies, but that doesn't fully protect them. Some of what China imports from its Asian neighbors goes into making other goods destined for U.S. and European ports.

"The question is whether the end demand really lies within Asia or not," said Vishnu Varathan, an economist with Capital Economics in Singapore.

Rising U.S. unemployment and weaker-than-anticipated growth have raised the specter of the world's biggest economy reverting back into recession. In the euro zone, investors have demanded higher returns for lending money to Spain and Italy, heightening concerns that the debt troubles won't stay confined to Greece, Ireland and Portugal.

Barring a full-blown financial crisis, Asia would most likely suffer modest bruising from a deepening global slump, with the pain concentrated in export-exposed countries such as Taiwan and South Korea.

A dig through the latest batch of economic data reveals a few optimistic signs, but considerably more causes for concern.

First, the bright side.

Now for the bad news.

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"Still, so far, domestic demand in the region is holding up well in the face of the brewing storm elsewhere. Don't mind the smoke," Neumann added.

Asia decoupling from the West has been a popular theme among economists for years, and the conventional wisdom is that the region inevitably will break away because its growth rate far outstrips that of the United States or Europe.

But that is a longer-term view. For now, investors seem focused on the immediate risk of a slump.

South Korea's main stock index dropped nearly 3 percent on Wednesday, the biggest daily decline in more than two months. Taiwan's fell 1.5 percent to a 4-1/2 month low.

The data-based economic diagnosis will become a bit clearer over the coming week with the release of China's July figures as well as U.S. employment numbers.

Goldman Sachs economists argue that another tick higher in the U.S. jobless rate would send a strong recession signal. The July figures will be released on Friday.

China releases its suite of July data on August 9, which will shed more light on domestic demand and inflation. Economists polled by Reuters think the consumer price index will hold at a 6.3 percent increase, slightly below June's three-year peak.

Anything hotter than that will revive the debate over whether Beijing has clamped down hard enough to ward off a worse bout of inflation -- and cast further doubt on China's capacity and desire to propel Asia's growth.

For Asia's exporters, the most important numbers may be urban investment and retail sales. Both look likely to remain strong, although perhaps not quite as robust as in June.

A disappointment on those readings would darken prospects for the region even more, particularly among countries such as Australia and Indonesia that have benefited from supplying China with raw materials.

If there is a silver lining, it is that slower growth should give Asia's policymakers an assist on tackling inflation, perhaps allowing them to slow the pace of tightening.

"The balance of risks for Asian policymakers is slowly shifting to growth from inflation," said Prakash Sakpal, an economist with ING in Singapore.

(Editing by Vidya Ranganathan)