APAC: Do­mes­tic strengths counter pol­icy un­cer­tainty

Financial Chronicle - - DEEP -

The out­look for sov­er­eign cred­it­wor­thi­ness in Asia Pa­cific (APAC) in 2019 is sta­ble over­all, re­flect­ing ex­pec­ta­tions for the fun­da­men­tal credit con­di­tions that will drive sov­er­eign credit over the next 12-18 months. Solid do­mes­tic fun­da­men­tals, in­clud­ing ris­ing in­comes and com­pet­i­tive­ness, gen­er­ally am­ple for­eign ex­change re­serves and of­ten size­able do­mes­tic sav­ings, will con­tinue to un­der­pin govern­ment credit qual­ity. How­ever, ten­sions be­tween the US and China could dis­in­cen­tivise in­vest­ment and weigh on growth po­ten­tial, while wider risk pre­mia would weaken debt af­ford­abil­ity and raise govern­ment liq­uid­ity risk, par­tic­u­larly for fron­tier mar­kets.

Shifts in do­mes­tic pri­or­i­ties away from fis­cal con­sol­i­da­tion, or in po­lit­i­cal ap­petite to ad­dress weak­nesses in the fi­nan­cial sec­tor, pose a risk to some emerg­ing and fron­tier mar­ket sovereigns' credit pro­files. In some ad­vanced economies, an in­creas­ing fo­cus on so­cial wel­fare and more in­clu­sive growth, while con­ducive to so­cial cohesion and pol­icy ef­fec­tive­ness in the longer term, could hurt near-term prof­itabil­ity and in­vest­ment.

Sta­ble out­look

As of Jan­uary 9, 21 of 24 rated APAC sovereigns have sta­ble out­looks, while three have neg­a­tive out­looks. Pos­i­tive and neg­a­tive rat­ing ac­tions were broadly bal­anced in 2018, and there were more up­grades than down­grades.

One down­grade in 2018, com­pared with two in 2017. The smaller num­ber of down­grades is con­sis­tent with the largely sta­ble credit en­vi­ron­ment pre­dicted for 2018. More rat­ing fac­tors also strength­ened in 2018 than in 2017. How­ever, in­creas­ing ex­ter­nal vul­ner­a­bil­ity and govern­ment liq­uid­ity risk drove a larger num­ber of neg­a­tive changes to sus­cep­ti­bil­ity to event risk scores in 2018 rel­a­tive to pos­i­tive changes and com­pared to 2017. This re­flected lim­ited prospects for strength­en­ing in liq­uid­ity and ex­ter­nal buf­fers for some sovereigns ahead of tight­en­ing global fi­nan­cial con­di­tions. This was the case for Sri Lanka (B2 sta­ble), where a po­lit­i­cal cri­sis has ex­ac­er­bated ex­ter­nal vul­ner­a­bil­ity and govern­ment liq­uid­ity risk, and raises un­cer­tainty over fis­cal and macroe­co­nomic re­forms. We down­graded the rat­ing in Novem­ber.

Per­sis­tent US-China ten­sions will weigh on re­gional growth, de­spite ro­bust do­mes­tic driv­ers. Re­la­tions be­tween the US and China are ex­pected to swing be­tween con­flict and com­pro­mise, in­volv­ing trade, in­vest­ment, tech­nol­ogy and geopol­i­tics. Ten­sions will weigh on ex­ports and GDP growth in APAC in the near term.

Risks to the re­gion's medium-term growth prospects have also in­creased, given trade ex­po­sure to China and in­te­gra­tion of man­u­fac­tur­ing sup­ply chains within APAC. While still open in 2019, the win­dow for ad­dress­ing long­stand­ing credit chal­lenges, rang­ing from ex­ter­nal to fis­cal and bank­ing vul­ner­a­bil­i­ties, is clos­ing as the eco­nomic out­look dims.

GDP growth in APAC will slow with global trade, but mon­e­tary pol­icy and do­mes­tic fun­da­men­tals re­main sup­port­ive. The pace of eco­nomic ex­pan­sion in APAC is likely to soften in 201920, with emerg­ing and fron­tier mar­ket economies likely to ex­pe­ri­ence the sharpest de­cel­er­a­tion. Moody’s fore­cast me­dian GDP growth rates of 5.5 per cent and 5.2 per cent in 2019 for APAC emerg­ing and fron­tier mar­ket economies re­spec­tively, while growth in the ad­vanced economies will likely slow to 2.5 per cent.

Gen­er­ally benign prospects for in­fla­tion will nev­er­the­less al­low mon­e­tary pol­icy to re­main ac­com­moda­tive in the ad­vanced economies. Longer term, ris­ing in­comes and a grow­ing mid­dle class, ex­pand­ing work­ing-age pop­u­la­tions and in­fra­struc­ture in­vest­ment en­hanc­ing eco­nomic com­pet­i­tive­ness will un­der­score out­put in the re­gion's emerg­ing and fron­tier mar­kets.

Trade ten­sions pose pol­icy trade­offs in China; risk that pol­icy ef­fec­tive­ness di­min­ishes. In China, GDP growth is fore­cast to slow to 6 per cent in 2019-20 as trade ten­sions weigh on ex­ports and man­u­fac­tur­ing ac­tiv­ity, and ex­ac­er­bate the tight­en­ing of do­mes­tic credit sup­ply re­sult­ing from the govern­ment's delever­ag­ing and de­risk­ing cam­paign. Since mid-2018, China's au­thor­i­ties have eased pol­icy through tar­geted liq­uid­ity mea­sures, tax­a­tion changes and in­fra­struc­ture spend­ing, which will shore up growth.

How­ever, de­sign­ing and im­ple­ment­ing pol­icy that si­mul­ta­ne­ously buf­fers the shock of the US trade tar­iffs and po­ten­tial fur­ther re­stric­tions, while con­tin­u­ing delever­ag­ing and de­risk­ing with­out trig­ger­ing too sharp a slow­down in growth, poses com­plex trade­offs. The ef­fec­tive­ness of some of the pol­icy tools that the govern­ment is turn­ing to, par­tic­u­larly in fis­cal pol­icy, is untested and could prove lower than we cur­rently as­sume.

Sup­ply chain

Trade-ori­ented, sup­ply chain economies are par­tic­u­larly vulnerable to lower ex­port growth in China. Hong Kong is es­pe­cially vulnerable: while goods ex­ports to China are mainly trans­ship­ments with a lim­ited val­ueadded com­po­nent, China ac­counts for around 90% of to­tal ser­vices ex­ports. The bulk of these are fi­nan­cial and trade-re­lated ser­vices, de­mand for which would de­cline on lower trade flows. Ja­pan, Korea, Malaysia, Sin­ga­pore, Tai­wan and Viet­nam are also ex­posed, es­pe­cially given the in­te­gra­tion of their economies into the elec­tron­ics sup­ply chain through China, which is at the cen­tre of the trade and tech­nol­ogy dis­pute with the US.

These economies var­i­ously spe­cialise in the pro­duc­tion of com­puter and smart­phone com­po­nents, and semi­con­duc­tor chips. Our base­line fore­casts as­sume some lim­ited neg­a­tive im­pact on in­vest­ment in these economies, com­men­su­rate with di­rect trade ef­fects and in light of the de­cline in im­port in­ten­sity of Chi­nese elec­tronic ex­ports over the past two decades. A down­side sce­nario in­volv­ing the broad reeval­u­a­tion of pro­duc­tion and in­vest­ment across the re­gion's pro­duc­tion chain would have a large, longer-term im­pact on these economies.

Com­mod­ity ex­porters would be ex­posed to a sharper-than-ex­pected growth slow­down in China. Slower growth is un­likely in China to ma­te­ri­ally af­fect the coun­try's de­mand for com­modi­ties and other raw ma­te­ri­als, given a likely in­crease in in­fra­struc­ture spend­ing as the au­thor­i­ties aim to counter the trade shock. How­ever, a sharper slow­down in China than cur­rently pro­jected by Moody’s would likely weigh on com­mod­ity ex­porters glob­ally, whether through re­duced de­mand for their ex­ports or lower com­mod­ity prices.

Some APAC economies com­pete di­rectly with China on ex­ports of fin­ished goods in and/or parts of elec­tron­ics, elec­tric ma­chin­ery, au­to­mo­biles and tex­tiles, which are cur­rently sub­ject to US tar­iffs. Shifts in US de­mand could re­sult in higher im­ports of elec­tron­ics and au­to­mo­biles from Ja­pan and Korea, and elec­tron­ics from Tai­wan. Bangladesh and Viet­nam could re­ceive larger orders for ready­made gar­ments, given their abil­ity to scale pro­duc­tion. Even if there is some reshoring of pro­duc­tion to the US, pro­duc­ers along the sup­ply chain could also ben­e­fit from higher US de­mand for in­ter­me­di­ate goods, given their man­u­fac­tur­ing ca­pa­bil­i­ties and com­pet­i­tive ad­van­tages rang­ing from lower pro­duc­tion costs to pro­duc­tion ef­fi­cien­cies.

How­ever, sup­ply chains do not evolve overnight, and com­mer­cial re­la­tion­ships de­pend on a wide range of fac­tors. Any change would de­pend on the du­ra­tion of the tar­iffs, and the in­ten­sity and scope of ten­sions be­tween the US and China.

Bi­lat­eral trade pacts with the US would not shield APAC economies from the di­rect im­pact of global US tar­iffs. There re­mains a risk that the US will im­pose global tar­iffs, par­tic­u­larly on au­to­mo­biles and parts given their con­tri­bu­tion to the US trade deficit. Ja­pan and Korea would be most di­rectly ex­posed in such a sce­nario, given the size of their au­to­mo­bile sec­tors.

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