ASIA’S ECONOMIC AGENDA
Change of focus in the US could affect the region this year, but the rebalancing of the Chinese economy is of greater importance in the longer term. By Pathom Sangwongwanich
As the euphoria of New Year celebrations fades, it’s time for a reality check as economies across Asia brace themselves for yet another year of macroeconomic and business challenges.
With global trade and consumer demand still in the doldrums, expectations for a return to business-as-usual in 2017 have been dampened, and economic growth targets might need trimming. To compound the discomfort, policymakers and analysts foresee more shocks. Last year provided more than its share, including Chinese stock market volatility, the Brexit vote and the election of Donald Trump, making a mess of many pundits’ predictions.
Looking beyond the next few months, US fiscal policy is expected to be much more expansionary as Mr Trump assumes the presidency and promotes his big-spending “Make America Great Again” agenda. The impact might not be seen for several quarters, but there will be growth momentum with underlying inflationary pressure pushing up US interest rates, said Santitarn Sathirathai, the head of emerging Asia economics at Credit Suisse in Singapore.
“In contrast to past cycles, we think this would affect Asia mainly through higher US interest rates, not through stronger exports and growth,” he said. “First, the import intensity of US economic growth has weakened in recent years and the share of Asian exports that go to the US has declined materially. Second, US trade policy seems likely to turn more hostile.
“In this scenario, we expect the economies whose interest rates are closely tied to the US, such as Singapore and Hong Kong, to be more vulnerable. Malaysia could also be exposed to capital outflows due to a high share of foreign holdings of bonds of over 50%.”
However, India and Indonesia, which suffered from large capital outflows during the 2013 “taper tantrum”, when markets fretted about whether the US Federal Reserve would pull back on its stimulus plan, should be better placed to cope with higher US yields. This is because their current account deficits are smaller, inflation is much lower, and their real interest rates are relatively high, said Dr Santitarn.
The rest of Asia, he said, was expected to use managed currency depreciation to absorb shocks from capital outflows rather than defending exchange rates with their foreign reserves. Inflation is low relative to targets in most countries, and weak exports provide grounds for a policy bias in favour of soft currencies.
Gross domestic product (GDP) in developing East Asian economies is projected at 5.7% this year and next, down slightly from 5.8% estimated last year, according to the World Bank.
Though domestic demand is expected to remain robust and commodity importers are benefitting from low prices, Asian economies still face a challenging global backdrop, including sluggish growth in the developed world, subdued prospects in most developing economies, and stagnant trade.
“Despite the favourable prospects, the region’s growth is subject to significant risks. A sharp global financial tightening, a further slowdown in world growth, or a faster-than-anticipated slowdown in China would test East Asia’s resilience,” Sudhir Shetty, the Washington-based chief economist for East Asia and Pacific at the World Bank, told Asia Focus.
“These uncertainties make it critical for policymakers to reduce financial and fiscal imbalances that have built up in recent years.”
The Chinese economic slowdown and rebalancing process remain important short-term risks for the region as China accounts for a large and rising share of demand for goods and services from the region, both to meet its own demand and as inputs for further exports.
But the ongoing transformation of China’s economic structure will also open up new opportunities for its trade partners through two important channels, said Dr Shetty.
“First, it will increase China’s consumption of and demand for many products, including agricultural commodities and services,” he said. “Second, it will create space for other countries to expand their production of labour-intensive manufacturing, including by encouraging relocation of existing factories from China to lower-cost regional economies.”
The World Bank also estimates that if US GDP growth is reduced by one percentage point, it could shave at least 1% off GDP growth in emerging economies globally, he said.
“It will be less than 1% [for emerging economies in East Asia], but there will be an impact. It will be more for a country like Cambodia that is more dependent in terms of trade.”
CREDIT BINGE
The prospect of rising interest rates, meanwhile, will concentrate the minds of policymakers, businesses and consumers. Regardless of how many times the Fed increases its benchmark rate, a rising interest-rate cycle is probably a given, and that equates to a greater debt burden shouldered by consumers and governments alike. This warrants significant concern, especially given how rapidly credit has expanded in regional economies since the 2008 global financial crisis touched off an era of cheap money.
The majority of that credit has been supplied by domestic banks, but there has been some diversification toward non-bank financial institutions, cross-border lending, debt issuance and shadow banking activity, said Dr Shetty.
Bank credit alone now stands at more than 100% of GDP in China, Malaysia, Thailand and Vietnam, the World Bank estimates.
Real credit growth in 2016 exceeded 15% in China and Vietnam and also accelerated in the Philippines. However, the figure decreased to 5% in Malaysia and Thailand where the stock of outstanding credit remained high.
Credit growth has been especially rapid in some smaller economies. In Cambodia, bank credit has been growing by close to 10% of GDP per year since 2011, while credit is also rising rapidly, albeit from a small base, in Myanmar.
Indonesia, Malaysia, the Philippines and Thailand saw a surge in the ratio of credit to GDP between 2010 and 2015 by 32.9 percentage points for households, 30.6 points for nonfinancial businesses, and 1.6 points for government credit.
With interest rates expected to rise in response to Fed moves, regional central banks need to ensure proper monitoring of the quality of consumer loans, while keeping track of borrowers’ debt-servicing ability to safeguard financial stability, said Dr Shetty.
Immediate priorities include advancing reforms in the corporate sector and bringing credit growth under control in China, reducing the buildup of domestic and external financial risks in other large economies, maintaining fiscal buffers and broadening revenue sources across the region, particularly for commodity-producing nations, he said.
Not everyone shares the World Bank’s outlook. Some see a prolonged spell of low interest rates in Asia Pacific economies given low inflation expectations and the need to provide an impetus to the economic recovery. Among them is Hamza Ali Malik, officer-in-charge of macroeconomic policy and financing for development at the UN Economic and Social Commission for Asia and the Pacific.
“However, there are risks of financial instability in some countries, although many countries in Asia and the Pacific region are taking a lot of measures to strengthen [financial stability], such as non-performing loan provisions and [cushioning] capital flow volatility,” he told Asia Focus.
In contrast to past cycles, we think [expansionary US policy] would affect Asia mainly through higher US interest rates, not through stronger exports and growth” SANTITARN SATHIRATHAI Credit Suisse
There is a potential risk, he added, that further interest rate cuts could widen the rate differential and induce undesired volatility. As the Fed lifts rates — two or three quarter-point moves are predicted this year — more capital is expected to leave emerging markets for the US, and this may have an impact if there are policy surprises or large and sudden capital flows.
“In such cases, monetary authorities might be forced to intervene in foreign-exchange markets and consider tightening capital flow management measures,” said Dr Malik.
Although central banks intervene in foreign-exchange markets to stabilise domestic currencies, competitive devaluations to shore up export growth are not recommended because this is a zero-sum game, whereby no party will make any gains in the long run, he said.
“They are all in it together so [competitive currency devaluation] does not serve any purpose [as] we are all going to lose out,” said Dr Malik.
“There were concerns at the end of 2015 and early in 2016 because there was a lot [currency] depreciation happening, but since then things are looking a little more stable.”
SHADOWS OVER TRADE, INVESTMENT
While the policies of the incoming Trump administration are still taking shape, it is clear based on the billionaire’s campaign — and recent market-moving tweets — that there will be a shift toward lower US imports and foreign direct investment (FDI), while curbs on immigration cannot be ruled out.
If demand from the US, the largest importer globally, were to slow markedly and for a long time, the economic impact would be amplified through international and intraregional trade. The countries that are most reliant on exports of high-value-added goods and services would be the most vulnerable.
Asia Pacific tends to be more exposed to a global slowdown in trade than countries in the Americas, Moody’s Investors Service said in a report.
“In particular, Cambodia, Hong Kong, Malaysia, Singapore, Taiwan, Thailand and Vietnam, where global exports account for 50% to 150% of GDP, would be most vulnerable,” it said.
The implications are enormous because the US continues to account for a major portion of merchandise exports from emerging Asian economies, said Deutsche Bank chief economist Taimur Baig.
“Except for Singapore, the US comprises 9-19% of the region’s total merchandise exports. Most directly exposed to the US are Vietnam (19%), followed by China (17%) and the Philippines (15%),” he said.
An environment of trade protectionism would put the heavily export-dependent economies in the region at risk.
Except for China, India, Indonesia and the Philippines, the rest of the economies in Asia derive at least 40% of their GDP from exports, said Dr Baig. Hong Kong and Singapore lead with exports exceeding 130% of GDP, but the shares of Malaysia, South Korea, Taiwan, Thailand and Vietnam are not small.
Although Mr Trump might not live up to his campaign rhetoric, Moody’s also expects tightening immigration rules in the US would over time curb growth in remittances from foreign workers, which are significant for some economies in Latin America and Asia Pacific.
Remittances provide a stable source of foreign-currency earnings that support current accounts and underpin domestic economic activity by bolstering consumption spending.
Remittances from the US are the largest for Vietnam, at 3.8% of GDP and 4.1% of the current account, and the Philippines at 3.3% of GDP and 9.2% of the current account, Moody’s noted.
“The two countries’ current account surpluses and ample foreign-exchange reserves would buffer any loss in remittance revenues,” it added.
Looking at Europe and the financial volatility that has persisted since the surprising outcome of the UK referendum last June, the World Bank’s Dr Shetty says direct impact on developing East Asian economies from any recession in the UK is likely to be minimal. He points to limited direct trade and FDI links, in which Britain accounts for less than 2% of total exports across most regional economies
Brexit will, however, imply a renegotiation of trade and investment agreements made between Asian economies and Britain, which may also affect their trade relations with the EU, he said.
“Further, there is a risk of sustained financial market stress around key decision dates in the upcoming Brexit process, which could affect countries with large foreign participation in financial markets, such as Indonesia, Malaysia and Thailand,” he said.