Lee Heng Guie
Executive Director, Socio-Economic Research Centre (SERC)
THE world economy, which has reached its strongest point of expansion since the 2008/09 global financial crisis is growing less evenly and synchronised in advanced and emerging Asia. The US economy looks set to slow in 2019/20 as the fiscal stimulus fades and higher interest rates started to bite on interest rate-sensitive sectors. China’s growth continues to face hurdles from lingering uncertainty surrounding trade disputes. In our view, the odds of a global recession in 2019/20 are around 30% to 40%, while for the US economy, it may be towards end-2019 or in 2020.
High frequency leading and forward indicators, such as the Organisation for Economic Co-operation and Development leading indicators, Purchasing Managers’ Indices for services and manufacturing, trade and investment indicate that the global economic expansion has passed its recent peak and the growth momentum has eased and, more generally, there are escalating risks to the outlook.
The International Monetary Fund has marked down global gross domestic product growth estimates to 3.7% for 2019 (3.7% in 2018) from 3.9% previously, citing that the balance of risks is tilted on the downside. The OECD also slashed its estimate of global GDP to 3.5% for 2019 from 3.7% previously.
Gone are the days when accelerating and synchronised global economic expansion and financial market vibrancy were a given, thanks to a prolonged period of still accommodative interest rates, though the US Federal Reserve has been normalising interest rates in small steps since 2015, accompanied by an unwinding of quantitative easing.
We are now in an era of considerable economic uncertainty, geopolitical risks and political fluidity. The outlook for growth and global liquidity conditions, as well as foreign exchange markets, will likely become even more uncertain and divergent in advanced and emerging economies.
Bear in mind that global growth and equity markets, especially in the US, are running on a two-year stretched cycle, powered by President Donald Trump’s unprecedented tax cuts and spending stimulus, as well as his tariff war, which only yields short-term benefits.
The combination of trade, fiscal and monetary policies will be taking the foot off the accelerator and turning somewhat less friendly for growth next year. On a positive note, the current softening of commodity prices, especially crude oil, if it persists, will provide relief to consumer spending, although lower oil prices could presage slowing global demand.
Trade war troubles remain a big wild card. The escalation of the US-China trade war will surely pose significant risks to the global economy and trade via trade and financial channels. First, the spillover effects with the impact felt not only in the US and China, but across the value chains that span several countries. Second, the escalation effect, which has impaired trade flows and undermined global growth and, last, the uncertainty effect as it dampens business confidence, affects corporate earnings and unsettles financial markets.
While the US and China have agreed to a 90-day truce in the trade war starting this month, it prolongs investor uncertainty and cautious sentiment.
The devil is in the details. Lingering doubts remain on how comprehensive a new trade deal can be compromised. If no progress is achieved within 90 days, the US administration will proceed to raise the tariff rate to 25% from 10% on US$200 billion worth of Chinese goods. This may extend to cover the remaining US$257 billion worth of Chinese goods that are not currently subject to duties.
It is estimated that the intensified trade protectionism measures will slash world growth by 0.8 percentage points and world trade by 1.1pps. Asia’s economic growth could be lowered by 0.8pps in the coming years.
On the US economy, the fiscal stimulus boost will start to fade in the second half 2019. There are early signs that the US corporates’ capital spending has somewhat moderated. Likewise, consumer spending will slow following the lapsing of income tax cuts, tighter financial conditions and increasing borrowing costs.
Amid the seemingly dovish stance on future interest rate hikes, the Fed is facing a tough and delicate balancing act in navigating the course of rate hikes in 2019, which are neither too high to put the brakes on economic growth nor too low to cause excessive asset price imbalances.
The Fed’s future rate moves are expected to be data dependent and will likely to hit 3% by end-2019 in our baseline forecast (End-2018:2.25% to 2.5%), with the first rate hike probably in 2Q2019. If the worsening trade troubles threaten to undermine the US economy, the Fed may have to go slow on interest rate increases or even pause.
Emerging markets, despite their strengths, will get no respite. Countries with weak economic fundamentals will remain vulnerable to higher US interest rates, capital outflows and suffer exchange rate pressure.
Countries, notably in Southeast Asia, are still seeing a decent economic growth rate, albeit slower. Domestic demand continued to support growth amid slowing exports on the disruption caused by trade disputes. Some have fewer domestic imbalances, smaller budget deficits amid larger current account deficits for some (Indonesia, India and the Philippines). External debt levels generally are not alarming and, in some countries, debt burdens are lower than previously. Foreign reserves adequacy is being maintained at healthy levels to cushion against external outflows. The exchange rate flexibility allows domestic currencies to absorb the two-way capital flows.
Some central banks have tightened monetary policy to contain capital outflows and ease downward pressure on their currencies. So far, there is no risk of contagion to any other EM economy.
Another class of risks is geopolitical and political events or flashpoints, which are also becoming more of a worry and made forecasting difficult. These include the US’ and China’s economic and power plays; Middle East instability or sanctions; North Korea provocations; Russia’s political play; Brexit — can it be concluded by end-March 2019? These risks are often intertwined and can exacerbate financial and economic risks, increase uncertainty and may sap growth.