Asia Watch: Stimulus helps to keep regional slowdown gradual

by: Arjen van Dijkhuizen

  • Phase one, partial US-China “deal” does not mean tensions are over
  • Regional growth at 10-year low, driven down by US-China conflict
  • Sharp slowdown India means it lost status of fastest growing giant again
  • PMIs signal some improvement, but picture still quite mixed
  • Monetary and fiscal stimulus is being stepped up …
  • … keeping the regional slowdown gradual, although downside risks remain
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US announces Phase one, partial ”deal” with China

The escalation of trade/tech tensions between the US and China since early 2018 has proven a key headwind for global growth, including for China and emerging Asia. After a re-escalation of US-China tensions since May 2019 – with new tariffs introduced, existing tariffs raised and all kinds of non-tariff measures taken as well –, over the past month we have seen some goodwill gestures by both sides suggesting a potential shift in political calculus in both Washington and Beijing (see our latest China Watch here). Last Friday, US president Trump announced a preliminary ‘Phase one’ partial trade deal with China, that should be further worked out and concluded in a future Trump-Xi meeting at an APEC Summit mid November. Remarkably, China did not officially confirm a deal was reached, only that progress had been made. China also insisted that further talks should follow soon before president Xi would agree to sign anything.

 

… but this does not mean that strategic tensions between the two countries are over

This ‘handshake deal’ entails the US from refraining from a scheduled tariff hike per 15 October (from 25% to 30% on USD 250bn of Chinese imports) in exchange for China stepping up agricultural imports from the US. Crucially, the 15% on the remaining (up to) USD 175 bn of imports yet to be tariffed (scheduled for 15 December) remains on the table, as negotiating leverage. Moreover, the US and China will work on an agreement on exchange rate policies and the protection of intellectual property. The deal was initially welcome by financial markets, but that enthusiasm was quite short-lived. The deal by itself does little to change the macro scenario, with businesses likely having built in persistent uncertainty to trade policy into their baseline outlooks. As such, we expect the trade war to continue weighing on global (including Asian) growth. Even if a more definitive deal is reached in November, we think that that strategic tensions, particularly on the technology front, between China and the US will linger.

Regional growth at ten year low driven by US-China trade/tech conflict, …

The regional slowdown that set in since early 2018 has continued in the course of this year. Our regional growth index for EM Asia dropped further to 5.3% yoy in Q219 (Q1: 5.5%), reaching the slowest pace since the global financial crisis. The US-China conflict has been a key driver of this slowdown, next to other factors such as previous monetary tightening in the US and China. Since early 2018, uncertainty on the trade front has been a key drag for global manufacturing and trade, and that has hit highly export oriented EM Asia. Meanwhile, the shift of China centered supply chains has been accelerated, with a collapse in bilateral US-China trade indicating that decoupling between the world’s two largest economies has already started (also see our previous Asia Watch, Trade conflict hits Asian supply chains. Twists and turns in this conflict have also impacted portfolio flows to EM Asia. According to IIF data, these have fallen sharply throughout 2018, but partly thanks to the dovish turn of the Fed, ECB and EM central banks are expected to rebound somewhat. Over the past year, the performance of Asian stock markets has also to a large extent been driven by twists and turns in the trade conflict.

  

 

India loses status of fastest growing emerging giant to China again

Strikingly, economic growth in India – which is relatively shielded to the slowdown in global manufacturing – has been slowing sharply since mid-2018, reaching a six-year low of 5.0% yoy in Q2. This slowdown in India was primarily driven by domestic spending, with both private consumption and investment subdued, but the more challenging external backdrop did not help either of course. That implies that India has lost its status of fastest growing giant to China again. While China’s slowdown has continued, Beijing’s ongoing piecemeal fiscal and monetary stimulus has kept it gradual. Growth has also come down sharply over the past quarters in global bellwethers Hong Kong and Singapore, although in Hong Kong escalation of social unrest added to downward momentum as well. Over the past quarters, growth has proven more resilient in Malaysia, Taiwan and Vietnam, which seem to profit to some extent from the acceleration of shifts in global supply chains due to the US-China conflict.

 

 

 

PMIs show some signs of improvement, but picture still quite mixed

Asian manufacturing PMIs showed some improvement in September. These leading indicators dropped sharply since early 2018, but recently there are signs of a bottoming out. Caixin’s PMI for China for instance rose to 51.4 in September, its highest level since February 2018. Taiwan’s PMI also improved in recent months, rising back to the neutral 50 mark. Even Hong Kong’s index, which dropped sharply in recent months on the back of the escalation of social unrest, improved a bit in September although remaining at very low levels. As EM Asia produces and exports many electronic products, for instance related to the manufacturing of iPhones, the global IT cycle likely plays a role here as well. The PMI for global electronics equipment, an indicator for the strength of the global IT sector, looks to have bottomed. We should add that the signals from PMIs are still mixed, as China’s official PMI published by NBS improved only marginally and at 49.8 remains below the neutral 50 mark. And the manufacturing PMI for Singapore, a country that is also exposed to the global IT cycle, dropped back to 49.5 in September (August: 49.9), remaining in contraction territory. What is more, services PMIs for China and India also lost ground in September, signalling that weakness in manufacturing may is spilling over to services.

Asian central banks join monetary easing pack as inflation remains low …

Our GDP-weighted regional CPI index has risen by more than a full %-point since February, reaching a 19 month high of 2.8% yoy in September. This was primarily driven by China, where a swine-flu driven spike in pork prices has caused CPI to rise from 1.5% yoy in February to 3.0% in September. Meanwhile, excluding for volatile food and energy prices, average core inflation in EM Asia has fallen rapidly this year, to 1.0% yoy in September (the lowest level since May 2016). Against that backdrop and facilitated by the dovish shift from central banks in developed countries, EM Asian central banks have joined the global easing pack. The Chinese authorities have modified their interest rate toolkit somewhat, while cutting the 1-year loan prime rate a bit in the past months. The PBoC has also continued cutting banks’ RRRs (by a cumulative 150 bp this year), with additional cuts provided for certain city commercial banks that borrow a lot to private firms/SMEs. Elsewhere in EM Asia, we have seen further rate cuts in India (a cumulative 135 bp this year, to 5.15%), South Korea (25 bp to 1.50%; we expect another 25 bp cut, possibly already this week), Indonesia (75 bp, to 5.25%), Thailand (25 bp, to 1.5%), Malaysia (25 bp, to 3%) , Hong Kong (50 bp, to 2.25%) and the Philippines (75 bp, to 4%). Going forward, we still see some room for further easing and expect modest rate cuts in late 2019 and 2020.

  

… while fiscal support is also being stepped up

Meanwhile, with a global debate evolving about the boundaries of monetary stimulus and the need to resort to fiscal stimulus, Asian governments have shown their willingness to use fiscal space where available. In general, public finances in EM Asia are relatively in good shape. Over the past months, we have seen further piecemeal fiscal stimulus in China, where ongoing tax cuts go hand in hand with the frontloading and raising of special bond issuance quota for local governments to finance infrastructure projects. Meanwhile in India, the government last month announced a reduction in corporate taxes (with special preferences for new manufacturing companies) to create a level playing field with other Asian countries. We have seen recent fiscal support measures in Hong Kong, Indonesia, Thailand and South Korea as well.

Regional growth to stabilise around 5.5%; EM Asia remaining key growth engine

As we indicated in our previous Asia Watch we cut our EM Asia growth forecasts last spring, when our view on the development of the US-China conflict became more negative. More recently, we have cut growth forecasts further down for several countries. For India, we cut our FY 2019-20 forecast from 7.0% to 6.5%. For Hong Kong (where social unrest forms another drag to growth) and Singapore, we cut our 2019 forecast from 2.0% to 0.5% and our 2020 forecasts from 2.0% to 1.5%. By contrast, we raised our 2019 forecast for Malaysia from 4.0% to 4.5%.

In conclusion: stimulus helps keeping slowdown EM Asia gradual; downside risks remain

By EM Asian standards, we now expect regional growth to slow materially this year, from 6.1% in 2018 to 5.6% in 2019. For 2020, we expect growth to stay around 5.5%, as China’s ongoing gradual slowdown is projected to be partially offset by a pick-up in India. Moreover, as explained above, we expect easier monetary and fiscal policies to support regional growth as well. That said, downside risks to our outlook stem from a further escalation of the US-China trade/tech conflict, from other geopolitical risks (e.g. Hong Kong, Taiwan, Korean peninsula, South China Sea) and from a sharp slowdown in China reflecting the strong linkages (through trade and financial exposures, and financial – including commodity – markets) with the rest of the region.