Asia 'Shivers' as Fed Tapers, China Slows

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A slowdown in China and a pullback in liquidity from the U.S. will negatively impact growth in Asia as the region tries to cope without the boost provided by these two, says HSBC.

On Tuesday, the bank cut its gross domestic product (GDP) growth forecast for Asia ex-Japan from 7.2 percent to 6.1 percent for this year, while growth in 2014 was downgraded from 7.2 percent to 6.5 percent.

"After several years of roaring growth, fueled by cheap cash, central bankers in China and the U.S. sent a shiver through the region," Frederic Neumann, co-head of Asian economics research at HSBC said in a note. "Rates in the U.S. are on their way up as prospects of tapering move closer. In China, the spike in money market rates, even if temporary, signals the determination by officials to at least skim the froth off the top."

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A record liquidity crunch in China's money markets in late June lead the short-term borrowing costs to spike close to 30 percent as the central bank sent a message to overstretched banks that it was determined to bring risky lending under control.

In light of this, Asia's credit dependence has been "painfully exposed," according to Neumann, who says the region's governments need to deliver "far-reaching and politically unpalatable reforms" and until that's done, economic growth will suffer.

"To secure Asia's bright prospects and keep capital tied down, structural reforms are urgently needed. These, to be sure, are difficult to deliver," Neumann said. "Political obstacles abound. But, without them, Asia may not sustain its impressive run of recent years."

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GDP growth for Asia ex-Japan in 2010 was 9.4 percent, followed by 7.4 percent in 2011 and 6.2 percent in 2012. But, this year could mark the slowest GDP growth rate in three years at 6.1 percent, according to HSBC's forecast, which is below market consensus of 6.5 percent.

Evidence that Asian economies have already been severely impacted by the prospect of the U.S. Federal Reserve tapering its monthly $85 billion bond purchases can be seen in the withdrawal of capital from the region's currencies, equities and bonds.

Data from fund tracker EPFR Global showed investors pulled out a record $10 billion from emerging markets debt and equity funds in the week to June 28, Reuters reported.

Cushioning the Blow

While easing by the Bank of Japan (BOJ) and China's considerable fiscal buffer to support growth should help things tick along for a while in Asia, investor confidence in the region needs to be significantly boosted to bring growth back to its "customary pace," Neumann said.

"Easing by the Bank of Japan, and, indeed, the only gradual withdrawal of the Fed's stimulus, should also cushion the blow. Growth, therefore, might languish, but it shouldn't collapse," Neumann said.

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The BOJ is widely expected to keep its monetary policy steady this week by keeping its pledge of increasing cash and deposits with the central bank at an annual pace of $600 billion to $700 billion.

But, two major risks facing Asian economies as support from the U.S. and China is pulled is rising debt and falling productivity, Neumann said.

"Labor markets need a shake-up, whether through lower barriers to migration in China, or greater flexibility in Japan and India," Neumann said. "Lack of competition, reflecting often stifling regulation, also needs to be addressed, including by cutting back on the privileges of state owned firms or opening up more sectors to foreign investors."

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In much of emerging Asia, infrastructure is in urgent need of a major boost "ideally funded through savings and not additional debt. Subsidies may thus have to be pruned," Neumann added.

—By CNBC.com's Rajeshni Naidu-Ghelani; Follow her on Twitter @RajeshniNaidu