- Just as signals of a bottoming out in Asian industry were coming in …,
- … the corona virus outbreak poses a new headwind to Chinese and regional growth
- We expect the impact from the corona crisis to be short-lived …
- … and regional growth to stabilise following a material slowdown in 2019
- Chinese authorities are frontloading monetary and fiscal support to offset impact corona crisis …
- … and we see room for further stimulus in other Asian countries as well
- Phase One deal reduces uncertainty, but tensions will linger and supply chains continue to shift
Looking back to 2019: regional growth drops to post global financial crisis low
Regional growth in emerging Asia has slowed materially since mid-2018. Our regional GDP growth index has dropped steadily from around 6.5% yoy in the first half of 2018 to a post global financial crisis low of 5.1% yoy in Q3-2019. Not surprisingly, this slowdown occurred in an episode of escalating US-China trade/tech tensions. This conflict has resulted in a stepping up of bilateral import tariffs (over around USD 360bn of Chinese goods, proportionally retaliated by China) and the US implementing restrictions on the export of strategic goods and direct investment. The tensions between the world’s two largest economies have proven a key headwind for the global economy, while affecting emerging Asia relatively hard given the impact on China and other highly export oriented economies. The installation of import tariffs had direct effects, such as a collapse of US-China bilateral trade and an acceleration of the shift in China-centered global supply chains. However, indirect effects on business confidence, financial markets and capital flows have also been significant. Other factors explaining the regional slowdown last year has been the sharp drop in Indian growth, driven by both domestic and external factors.
Regional slowdown broad-based, but with some winners too
The regional slowdown was widespread, with growth in most – but not all countries – coming down last year. Chinese growth slowed relatively sharp since mid-2018, with annual growth coming down from 6.7% in 2018 to 6.1% in 2019. India’s slowdown was even more pronounced, as growth fell from 6.8% in FY 2018-19 to an expected 5.0% in FY 2019-20. Growth also weakened materially in highly export oriented countries such as Singapore (from 3.2% in 2018 to 0.7% in 2019), South Korea (from 2.7% in 2018 to 2.0% in 2019) and Thailand (from 4.1% to an estimated 2.5%). In Hong Kong, the intensification of protests in the course of 2019 added to negative pressures from the trade conflict and caused the economy to go into a deep contraction in the second half of last year. Some countries, however, were able to hold up growth despite the trade conflict: Indonesia, Malaysia, Taiwan and Vietnam. These countries seem to have profited to some extent from the acceleration of shifts in global supply chains due to the US-China conflict.
While manufacturing PMIs point to bottoming out of industrial cycle in emerging Asia …,
With the US-China trade/tech conflict and the related drop in global GDP and trade growth being key drivers, obviously the regional slowdown is concentrated in the industrial sectors, while services have hold up much better. Illustrative for this has been the sharp drop in our regional manufacturing PMI index, from a cyclical peak of 52.2 in December 2017 to a post global financial crisis low of 49.3 in October 2019. This drop has to a large extent been driven by China and India, but also by other export oriented countries. The ongoing protests in Hong Kong drove the PMI to 38.5 in November 2019, the weakest level since April 2003. That said, with hopes of a US-China trade deal flaring up and stimulus policies filtering through, the industrial cycle in Asia has started to show more signs of bottoming out. Our regional PMI index has risen by almost two full points since October, to a 16 month high of 51.1 in December. Over the past months, manufacturing PMIs have improved in almost all relevant EM Asian countries. PMI export sub-indices also improved in most countries compared to mid-2019, illustrative for the de-escalation in the US-China conflict seen since late 2019. The bottoming out of the global IT cycle is also helpful, given EM Asia’s exposure to global supply chains in electronics.
… the impact from the corona virus is a new, but likely temporary, headwind
Over the past weeks, the spread of a deadly novel coronavirus originating in the Chinese city of Wuhan and the surrounding Hubei province has triggered sharp market reactions, while raising the question what the economic impact will be. The global death toll has quickly risen to currently 565 (mainly concentrated in China), with over 28.000 people infected in more than 25 countries and regions. The Chinese authorities have taken emergency measures to fight the spread of the virus, with around 60 million Chinese remaining under lockdown. International flights have been cancelled, several countries have tightened travel restrictions and foreign companies have closed shops in China.
Assessing the macro economic impact is challenging. It will depend on hard to predict developments such as the time it takes to get the virus under control and the extent to which it spreads in China and beyond, as well as the duration of various emergency measures. The main effect is likely to be on Chinese household consumption, as consumers avoid public spaces by choice, but also due to restrictions on movement and travel. On the output side, China’s services sector will likely be most affected (e.g. travel, retail trade, entertainment, catering). There will also be disruption to production capacity due to the extended post-LNY lockdowns of factories, offices and shops. Tighter financial conditions and a knock to consumer and producer confidence, reflecting heightened uncertainty, could also undermine growth. Still, higher health related government spending and frontloading of monetary easing could cushion the blow (see below).
Perhaps a good starting point to assess the impact is the effects of the SARS coronavirus in 2003, although China’s economic clout is much bigger now and the number of outbound Chinese tourists much higher. The impact of SARS was relatively short-lived. The fall-out in that case was mainly felt by services (through impacts on consumption and tourism) and these recovered strongly once the virus was under control. As the chart above shows, there was a sharp fall in GDP growth in the four economies most impacted (China, Hong Kong, Taiwan and Singapore) in Q2 2003, but a sharp rebound in the quarter thereafter. Assuming a transient SARS-like shock, growth in China and emerging Asia would likely be weaker in the first half of the year (particularly Q1), while the second half of 2020 could be stronger. So far, we have not adjusted our annual growth forecasts for China due to the corona virus. We did cut our 2020 growth forecasts further for Hong Kong (to 0%), partly reflecting the hit to tourism revenues from mainland China (after these already fell sharply last year due to the intensification of social protests). All in all, we expect regional growth to stabilise this year after the material slowdown in 2019, but downside risks have risen again due to the outbreak of the new corona virus.
Formal signing of US-China Phase one deal will reduce uncertainty …
On 15 January, the US and China formally signed the Phase One trade deal, that had been announced in December. The details of the deal came in largely as expected. China has to step up imports of goods and services from the US (manufactured products, agricultural products, energy and services) by USD 200bn in two years compared to 2017 levels. This year, China has to increase imports from the US by USD 77bn from 2017 levels and next year by USD 123bn. That does seem ambitious compared to 2017 levels (more than 100%), and even more in relation to more current levels following the collapse in bilateral trade (+123% compared to the period Q418-Q319). Hence, there is a risk that China cannot meet its targets, although it may take a while before that becomes clear. Other Chinese commitments relate to the opening up of the financial sector to US firms, strengthening of intellectual property protection and exchange rate policies. These more or less fit in policies that China has already started to implement.
… although we expect strategic tensions to linger and shifts in supply chains to continue
The formalisation of the deal is a positive development for emerging Asia, as the truce will help to limit downside risks, reduce uncertainty and restore confidence. That said, the deal does not take away all uncertainty. We believe that the relationship between the US and China has seriously changed under the Trump presidency, suggesting that uncertainties regarding future trade and investment relations will remain and decoupling and shifts in supply chains are here to stay. Another uncertainty stems from China’s commitment to double imports from the US. That could lead to replacement effects, coming at the cost of Chinese imports from other countries. Regarding US trade policies, there is a risk that after dealing with China the US will now turn its eye on other Asian (or European) countries that have large bilateral surpluses with the US and are deemed to be ‘currency manipulators’. Last year, the US Treasury added Malaysia, Singapore and Vietnam to the ‘currency manipulation watchlist’. China has been dropped from this list after the signing of the Phase One deal; South Korea is still on there.
Headline inflation rises sharply as food prices jump; core inflation bottoming out
Over the past months, regional inflation has risen sharply. Our regional CPI index has risen from 2.6% yoy in May-September 2019 to 4.4% yoy in December. While the rise of inflation is visible in the majority of emerging Asian countries, the jump in the regional index is driven by China (CPI at 8-year high of 4.5% yoy in November/December 2019) and India (CPI at 5.5 year high of 7.4% yoy in December). Main culprit for this jump in headline inflation is the rise in food prices. In China, the impact of the swine flu related collapse in the country’s pig herd has driven up food price inflation to almost 20% yoy in late 2019. And in India, where food-related items account for more than half of the CPI basket, food price inflation rose to over 12% yoy in December. By contrast, core inflation (excluding for food and energy prices) in emerging Asia has fallen sharply since end 2018 in line with the regional slowdown, but seems to have found a bottom recently. Going forward, we expect food and CPI inflation to fade from current levels, while we expect core inflation to pick-up somewhat in line with the bottoming out of industrial activity.
Central bank embarked on a monetary easing path last year …,
To stem the regional slowdown, central banks in emerging Asia embarked on an monetary easing path last year, following the examples of the Fed, the ECB and the BoJ. In 2019, the PBoC continued with piecemeal easing, opting for mini cuts of several policy rates as well as more aggressive RRR cuts (200 bps since late 2018). The Reserve Bank of India slashed its key policy rate by 135bp last year, to 5.15%. Policy rates were also cut in Indonesia (100bp, to 5.0%), Philippines (75 bp, to 4.0%), South Korea and Thailand (50bp, to 1.25%) and Malaysia (25 bp, to 3.0%). Singapore also eased monetary policy a bit, as the MAS slightly reduced the slope of the exchange rate band.
… and we still see room for more stimulus to offset the impact from the corona crisis
The Chinese authorities have quite pro-actively taken easing measures in an attempt to offset the fall-out from the corona crisis. In early February, the PBoC cut its seven- and fourteen-day reverse repo rates by 10bp, to 2.4% and 2.55%, respectively, while adding around USD 175bn of fresh liquidity into China’s banking system. Moreover, Beijing announced various targeted fiscal measures such as tax breaks and subsidies to support corporates and household affected by the corona crisis. We expect Beijing to frontload further monetary and fiscal easing measures, including further interest rate and RRR cuts. In response to the previous raising and frontloading of local government bond quota to issue infrastructure bonds, local government bond issuance picked up significantly in early 2020. Elsewhere in EM Asia we think there is also room left for further interest rate cuts in several countries should rising drags from the corona crisis ask for that, although most of the interest rate cutting cycle is likely behind us. There is also room for fiscal support in many countries, reflecting generally favourable public finance indicators (certainly in comparison to other EM regions).
We expect regional growth in emerging Asia to stabilise this year, following a material slowdown in 2019. Following the spread of the corona virus, we have kept our annual growth forecasts unchanged so far (except for Hong Kong). Assuming a transient SARS-like shock, growth in China and emerging Asia would likely be weaker in the first half of the year (particularly in the first quarter), while the second half of 2020 could be stronger. That said, downside risks stem from a longer duration of the corona crisis that could lead to a sharper than expected slowdown in China, with contagion effects to the rest of the region. Other risks stem from a possible re-escalation of US-China tensions or new US tariffs/sanctions directed at other Asian countries, and from other geopolitical risks (Hong Kong, Taiwan, South China Sea).