Trade war fallout on Malaysia
The government and economists see minimal effects from the ongoing trade war between the US and China.
THE WORLD’S second-largest economic juggernaut is now walking a thin tightrope – economically speaking that is.
Touted as one of the fastest-growing economies post-millennium, China has been witnessing rising internal and external headwinds in recent times, even as its economic growth in 2017 outperformed expectations.
On one hand, United States president Donald Trump has unleashed his “trade bazooka” on China in his pursuit of fulfilling his populist MAGA or “Make America Great Again” campaign.
Trump has warned of slapping additional tariffs on US$550bil worth of imports from China, citing the latter’s unfair trade practices and the need to slash the US trade deficit with China, which stood at US$375bil last year.
To date, the Trump administration has enforced additional 25% tariffs on US$34bil worth of Chinese imports, with tariffs on another US$16bil imports to be imposed anytime soon.
In an apparent tit-for-tat response, China has retaliated with similar tariffs on US$34bil US imports, and has announced that tariffs on other imports worth US$16bil will be levied at a later date.
On the other hand, aside from the mounting trade hostilities, China has another ticking time bomb to worry about – skyrocketing debt levels.
Just earlier this month, the country witnessed one of its biggest corporate-debt defaults at a whopping 72.2 billion yuan (US$10.8bil). Coal miner Wintime Energy Co, whose debt quadrupled in less than five years, ran into problems repaying its obligations following the authorities’ measures to curb leverage.
Over the years, the country’s credit has grown at a considerably faster rate than its gross domestic product (GDP). Although debt levels in China have somewhat slowed down recently, they remain staggeringly high.
According to data from the Bank for International Settlements, China’s non-financial sector debt-to-GDP ratio stood at 255.7% as of end-2017, more than 100% higher than before the 2008 global financial crisis. The biggest portion of the debt, at nearly 160%, resides in the hands of Chinese corporations.
As comparison, Malaysia’s non-financial sector debt-to-GDP ratio was 185.2% as of Dec 31, 2017.
Clearly, China’s debt build-up over the last decade has been one of the largest in modern history. Earlier in 2017, the International Monetary Fund had cautioned China to accelerate its deleveraging efforts, as the country’s non-financial sector debt could likely exceed 290% of GDP by 2022, in the event of no serious action being taken.
One may argue that China’s debt level warrants no concern, as it is in fact comparable or even lower than that of the US, Japan and the United Kingdom. What they fail to notice is that China is still a middle-income country, with national level average income levels substantially lower than the other countries.
China’s GDP growth over the past years has been fuelled by cheap and extensive credit. Apart from the formal lending facilities from financial institutions, Chinese businesses have thrived on the country’s massive unregulated shadow banking.
Curbing borrowings to deleverage China Inc comes at a big cost, namely, a significant slowdown in the economy.
In its June 2018 Global Economic Prospects report, the World Bank projects China’s growth to slow from 6.5% in 2018 to 6.3% on average in 2019-20.
“Policy support is expected to ease, led by regulatory and macroprudential tightening. Fiscal policies are expected to become less accommodative to contain financial risks and encourage a continued rebalancing of the economy from investment to consumption and from industry to services,” the World Bank says.
As they say, every crisis needs a trigger. In the event of either a worsening trade war or the “super-high” debt of China turning into a trigger, the circumstances could be overwhelming.
Hence, this could also prove renowned economist Ken Rogoff correct, as he foresees China as one of the biggest risks to the global economy over the next four to five years.
Speaking with StarBizWeek, Malaysian Institute of Economic Research (MIER) senior research fellow Shankaran Nambiar, however, thinks that the threat of China’s systemic risks is probably not as bad as it is made out to be.
“While it is true that China has a debt problem, this is a problem that it has had for some years now and the Chinese government has had some time to look at it.
“They have introduced measures to alleviate household consumption and are likely to introduce more to safeguard any decline in domestic consumption,” he says.
Echoing a similar stance, AmBank Group chief economist Anthony Dass points out that China’s domestic fundamentals remain strong, with exports and investment acting as a complement.
“A high debt-to-GDP ratio is of concern apart from the trade war. To address these issues, I expect a slight weakening of the yuan to support export competitiveness and slow down the deleveraging process.
“I foresee the Chinese economy growing around 6.5% this year,” he adds.
The effects on Malaysia
China may be a distant neighbour of Malaysia, but both countries are intertwined closely, particularly in terms of economic relations and trade.
China continues to be Malaysia’s largest trading partner for the ninth consecutive year since 2009, although Malaysia has a trade deficit with the country.
In 2017, Malaysia’s exports to China were valued at RM126.15bil, an increase of 28% year-on-year (y-o-y), mainly on the back of electrical and electronic (E&E), petroleum and rubber products, among others.
Meanwhile, imports from China into Malaysia rose by 15.5% y-o-y to RM164.5bil, largely supported by E&E products, machinery, equipment and parts as well as petroleum products.
Rising trade tensions between the US and China have led towards increasing concerns on Malaysia’s external trade and the related domestic sectors which depend substantially on exports.
Such worry among market observers is rather justified, given Malaysia’s nature as one of the most export-reliant economies in the world. In 2017, the country’s exports of goods and services represented nearly 71.5% of its GDP, although the figure has fallen over the years from 120% in 2000.
The key question is, as the two elephantine economies fight, will Malaysia be caught in the middle?
Newly-minted Deputy International Trade and Industry Minister Ong Kian Ming does not think so.
When contacted by StarBizWeek, he says that while China is the largest trading partner, trade volume with China is not even half of Malaysia’s total trade volume.
“With the impending trade war, Malaysia can perhaps benefit from any trade diversion from other countries, including the US, China and the European Union.”
Ong also adds that the International Trade and Industry Ministry recently established a task force to coordinate all efforts relating to the impact of the US-China trade war.
“We are monitoring the situation very carefully and will take the appropriate steps to mitigate any possible impact of the US-China trade war on Malaysian companies,” states Ong.
Meanwhile, World Bank Group lead economist and acting country manager Richard Record says that “like any highly open economy, it is natural for Malaysia to face risks relating to uncertainty in the external environment”.
“Escalation of protectionist tendencies would have a disproportionate adverse impact on Malaysia, given its high level of integration with the global economy and financial markets, and its dependence on global value chains as a source of growth.
“Elsewhere, the possibility of financial market disruptions has increased amid shifting monetary policy expectations in advanced economies, which could spread across emerging economies including Malaysia, through heightened financial market volatility, reversals in capital flows, and pressures on exchange rates,” he says.
In the event Trump keeps to his word and bulldozes tariffs on US$550bil worth of Chinese imports by year-end, it is likely to open a floodgate of protectionist measures and continue to rile financial markets globally.
China has sent a strong message to Trump that it will not remain muted against the US’ trade provocations. As demonstrated recently through its tariff retaliation on US$34bil worth of imports from the US, China could go on to impose additional tariffs on over US$500bil worth of imports, to match Trump’s possible actions.
The fact that Trump’s top economic adviser, Larry Kudlow, recently said “I think (Chinese President) Xi is holding the game up, indicating that the high-level trade talks between the US and China may not yield positive results as expected”.
If the trade row goes full-blown, AmBank’s Dass projects the impact on China to be about 1% of its GDP. As for Malaysia, the indirect effect on the country will be even smaller.
“Malaysia’s exposure to China is about 13% and US about 8%. Being a trading nation, it can slice our GDP around 0.5%,” he says.
For context, based on Malaysia’s 2017 GDP of RM1.35 trillion at current prices, 0.5% would translate to about RM6.8bil.
However, in a more cautionary view, Socio-
Economic Research Centre executive director Lee Heng Guie said earlier last week that Malaysia’s GDP growth rate could fall to below 4% in 2019 if the US and China continue to hike tariffs on over US$1 trillion worth of imports, cumulatively.
According to Maybank Investment Bank group chief economist Suhaimi Ilias, it is impossible for Malaysia to “totally shield itself from a ‘China crisis’, given its close relationship with the Malaysian economy.
“A ‘China crisis’ will trigger a global economic downturn and recession, as well as global financial market volatility and correction.
“A sharp economic downturn or recession in China is negative for sectors and industries that benefit from exports to and demand from China such as palm oil, electronics and petroleum products. We estimate that a one percentage point drop in China’s real GDP growth will shave off 0.7 percentage point of Malaysia’s real GDP growth,” he points out.
Some pundits believe China would try to beat the US’ trade hostilities in the way it does best - suppressing its currency.
In order to support its export competitiveness, China may weaken the yuan further, therefore making its exports cheaper amid rising tariffs.
However, this could have unintended effects on Malaysia as local exports into China, particularly those denominated in the US dollar, would become more expensive in turn.
The yuan, which is directly managed by the People’s Bank of China, has in fact continued to depreciate further.
Barely three days ago, the yuan tumbled to a one-year low in an unsurprising turn of events, after falling by nearly 8% in the last three months.
A bigger concern now is whether the US would retaliate and open the door to a wider “currency war”.
It is worth noting that Trump on July 19 had expressed concerns on a strong US dollar, describing it as “putting us at a disadvantage”.
Currency war
Trade spat and currency war concerns aside, Malaysia has another issue to take into account, namely, China’s ballooning debt predicament.
The Chinese government is fully cognisant of the country’s debt levels and has undertaken measures to taper credit issuance within the domestic economy.
For businesses which have been reliant on borrowings for expansion, lower credit could mean a slower rate of widening their presence, including into Malaysia in the form of foreign direct investment.
However, with businesses being a key enabler of the Chinese economy’s growth, the government will likely have other arrangements to continue supporting the expansion of the country’s private sector.
Apart from its aim to deleverage China, particularly its booming businesses, the government is also trying to shift the country’s economic growth from being more trade- and investment-driven to being more domestic demand-driven.
When asked whether China would reduce its imports from Malaysia in its attempt to become more domestic demand-driven and boost local industries, Ong believes it is unlikely.
“In fact, as China moves towards boosting the share of consumption as a percentage of GDP, I expect there to be more opportunities for Malaysia to increase our exports to China in consumer goods, food and beverage prod- ucts and also tourism,” he says.
It is imperative for Malaysia to have a sound game plan to weather any potential external shocks, particularly from the country’s largest trading partner, China.
Ong, for one, talks about diversification in trade destinations.
“Moving forward, there are many other markets which are under-explored including Asean, Africa and South America which Malaysia and Malaysian companies need to penetrate into,” he says.
Echoing a similar stance, MIER’s Shankaran says “the advance reconsideration of China’s investments in Malaysia is, inadvertently, a good move to avoid excessive dependence on one country”.
AmBank’s Dass suggests India for Malaysia to focus more on trade relations in the long run.
“We need to build our domestic base economy to become more resilient and at the same time diversify our exports. Besides we need to reduce our over-reliance on China by focusing on growth countries like India, for instance,” he says.
Meanwhile, World Bank’s Record advocates that Malaysia strengthen its regional multi-lateral trade cooperation, as compared to strong dependance on several limited number of individual countries.
“With continued threats to the global trading system, Malaysia and other developing economies can respond by deepening their own trade integration and facilitation, through such mechanisms as the Asean Economic Community and the Comprehensive and the Progressive Agreement for Trans-Pacific Partnership (CPTPP). These measures will be even more important as countries adapt their manufacturing-led development strategies to the emerging challenges of labour-saving technologies and automation.
“The approval of CPTPP offers opportunities to strengthen trade links with emerging and advanced economies outside the region. As a result of its implementation, Malaysia, as a signatory, is expected to experience income gains of around 1.9% by 2030,” says Record.
The general consensus, at least for now, is that Malaysia will be able to weather any adverse external effects, buttressed by its sound domestic economic fundamentals. However, only time will tell.