A Perilous Outlook for Asia in 2016- Barron's

Seeing the back of 2015 suited many investors just fine. But what if 2016 is even worse? At the risk of tossing fuel on a raging fire, here’s an inventory of ways Asia could blindside the world.

INSTABILITY IN BEIJING

China’s 2016 is already off to a bad start, if last week’s nearly 10% plunge in the Shanghai Composite Index is any guide. We can debate just how far gross domestic product slipped last year—Lombard Street Research says to 3.7%—but the key indicators of the economy will be in the halls of Beijing power and on the streets of the country’s major cities.

A chill beyond anything China has seen since the 1990s is descending on living standards and corporate profits. At the same time, its share of the world’s most polluted skies, rivers, and food supplies is rising apace.

President Xi Jinping’s efforts to replace smokestack industries with a services sector independent from state-owned enterprises have been glacial. His go-slow approach could backfire and catalyze a bull market in protests—not of the magnitude of Tiananmen Square, perhaps, but enough pressure to spook markets and fuel power struggles between Beijing’s reformer and advocates of the status quo.

Xi’s most ambitious campaign has been policing chatter in cyberspace—including seven-year prison stints for “spreading rumors” and forcing companies to rat out users engaged in “security incidents.” Clearly, he’s afraid of his 1.4 billion people and running out of options to keep them—and vital allies in Beijing—happy. That could lead to missteps and misunderstandings that unnerve markets.

TERRORIST MAYHEM

In the weeks after the Paris attacks in November, Russia issued a sobering warning to Thailand: Islamic State sent a 10- member squad to kill tourists. Indonesia, site of a devastating 2002 attack in Bali, also is tightening security. But what if China is the real soft target? On Nov. 15, Foreign Minister Wang Yi framed China as an equally vulnerable victim of terrorism at a Group of 20 meeting. The fight against militant groups demanding independence in China’s northwestern Xinjiang region, Wang said, “should become an important part of the international fight against terrorism.” Imagine the political chaos a single suicide bomber on a bullet train could generate. Or what if Uyghur militants targeted the Three Gorges Dam? That would be CNN’s story of the year.

JAPANESE DEBT CRASH

Shorting Japanese government bonds has been the ultimate widowmaker trade; a country running out of people can’t manage the world’s biggest debt burden indefinitely. Could it pay off in 2016? For all his talk about fiscal austerity, Prime Minister Shinzo Abe is borrowing with abandon. In April, the Organization for Economic Cooperation and Development warned a debt-to-GDP ratio approaching 250% will swell to more than 400% by 2040 without reforms. Last year, Tokyo’s debt hit a high of 1.057 quadrillion yen (about $9 trillion). Japan has three options: Make more babies in a hurry, import millions of workers, or slash borrowing. Since this government is likely to do none of the above, Japan’s bond bubble will only grow—until it can’t any longer.

FIREWORKS AT SEA

That brings us to rising tensions over tiny islands, rocks, and atolls. Beijing claims pretty much all of the South China Sea, blowing off overlapping claims from Brunei, Malaysia, the Philippines, Taiwan, and Vietnam. Yet the plot is thickening now that the U.S. and Japan are increasing naval patrols in ways that enrage Xi’s government. Tokyo and Beijing are engaged in an escalating territorial tit for tat. And Abe just reinterpreted Japan’s war-renouncing constitution as Washington drives warships through contested waters, much to China’s chagrin. All this potential war gaming, coupled with Asia’s accelerating arms race, makes for dismal economics. You don’t need Tom Clancy’s imagination to see how two ships, or fighter jets, colliding could quickly escalate into full-blown conflict.

THERE ARE MYRIAD other wild cards to ponder, including Taiwanese voters this month electing Tsai Ing-wen as the island’s first female president. The return to power of her Democratic Progressive Party, which has long favored independence over rapprochement, deeply worries Beijing. Might Najib Razak’s party in Malaysia grow tired of the numerous scandals swirling around the prime minister and seek new leadership? Could Kim Jong Un do something crazy in North Korea—even beyond Wednesday’s alleged hydrogen-bomb test? How about the military junta running Thailand into the ground being challenged by another band of power-hungry generals? What if further declines in commodities pushed Australia into its first recession in two decades or destabilized President Joko Widodo of Indonesia? All we can say is, fasten your seatbelts.