This year has brought disturbing developments that have left many of us worried about what 2017 might have in store. Brexit; the election of unconventional leaders such as Donald Trump and Rodrigo Duterte; a China flexing its muscles; wild swings in equity prices, currencies and bond yields; corruption scandals of various kinds; and the horrors of war in Aleppo and elsewhere have all taken their toll on us. But, as we say good riddance to the year that is ending soon, we should also take stock of all the forces that will shape the coming year, good as well as bad. And, when we do that, the prospects actually appear quite promising.
The main reason to feel upbeat about next year is that the global economy is set to gain more momentum while fears of deflation will ebb. New technologies will start impacting our lives positively. Yes, there will be many things that could go wrong. We do not know exactly how President-elect Trump will conduct the affairs of state, for one. And, for another, while we think China’s leaders are likely to do enough to keep China on a stable growth track, the reality is that no one fully understands the challenges in that economy. But the larger point we must bear in mind is that most of the countries in this region have enough resilience to absorb a few shocks and will still come through in good condition.
Global economy: normalising after years of crises
This resilience will be all the greater if the global economy turns around. In fact, the forward-looking indicators for the world economy are finally looking more promising. The lead indicators of the Organisation for Economic Co-operation and Development — which have been reasonably accurate — show the big three economies of the US, Europe and Japan returning to trend growth rates. A separate measure of new business being received by companies across the world shows a clear pickup. Digging deeper into the data, we see underlying forces which are promising for economic growth.
First, the US is ending the year on a strong note in the key engines of its economy.
• Consumers and businesses in better shape: In the labour market, unemployment is down to pre-crisis levels, suggesting that wage growth will accelerate and boost consumer spending. Home prices have returned to where they were before the big crash that caused the crisis of 2008 — that should also help strengthen consumer confidence. Credit is flowing more easily to small and medium-sized enterprises, which are the biggest employers in the country, enabling them to step up hiring and investment.
• Fiscal support is growing: The economy is no longer suffering from drastic cuts in spending by federal, state and local governments. In all likelihood, the next Congress will take the cue from President-elect Trump and pass tax cuts and other fiscal reforms that will boost demand by late 2017. In addition, the new administration has vowed to cut red tape radically, which would make it easier for businesses to operate.
• The return of capital spending: We expect Congress to enact incentives to persuade US corporations to bring back profits stashed abroad in exchange for these firms raising investment in productive capacity. If this happens, the US economy would enjoy a nice burst of capital spending, the missing ingredient in the recovery. That would turbo-charge the US economy going into 2018. With so many new technologies coming on stream — from cloud computing to big data, and from new medical therapies and life-saving drugs to the development of new materials, and from robotics and driverless cars to 3D printing — technological advances are creating substantial new business opportunities which will also help raise capital spending.
Second, the eurozone is not doing too badly either, which is one reason why currency markets reacted to the failure of the Italian referendum by pushing the euro up. The latest purchasing manager surveys show a decent improvement in both services as well as manufacturing activity there. Like the US economy in the early stages of its recovery, the eurozone is seeing a very gentle recovery in credit flows while the worst of the fiscal austerity is now over. The much weaker euro is boosting competitiveness while low oil prices are also helping.
Third, in contrast to the gloom over a long period of deflation, we are seeing prices around the world begin to drift up gently. In China, producer prices have started rising after five years of contraction. Oil and commodity prices are gradually rising again. Surveys of purchasing managers across the world depict a consistent pattern of rising input prices. We are likely to see a Goldilocks period of not-too-low and not-too-high inflation in the coming years.
Fourth, after several years when global trade flows, Asia’s lifeline, grew more slowly than global output, we are likely to see more robust trade providing more of a boost to Asian exports. The lacklustre performance of global trade had two elements in it — a cyclical one and a structural one. At the very least, we are seeing the cyclical part of this slowdown turning around. Export orders, container and air freight and trade in electronics — all good predictors of world trade — are growing again. This means that the stronger world growth we expect should flow more strongly into more robust demand for Asian exports in 2017. In addition, capital spending in the US tends to spill over more into imports of components from Asia, and the stronger US dollar should also mean that Asian exports will be in demand in the US.
Where the shocks will come from: financial turbulence
If it is the case that growth in the US and elsewhere will surprise positively and powerfully, then it must also follow that the period of ultra-loose monetary policy in the US will soon end and that the eurozone may also begin the process of tapering its quantitative easing.
Markets are mostly expecting two rate hikes in the US next year — we think four rate increases are more likely and that long-term interest rates, already rising, will move up a lot more. That means that the US dollar could have further upside.
Such a scenario could spell trouble for emerging market (EM) assets. If yields on US dollar assets continue to rise and the US dollar is appreciating, even more capital will flow out of EMs back into the US, hurting EM equity and bond prices. That’s not all. Periods of rising rates tend to see financial turbulence as the excesses that typically build up when rates were low are exposed. For example, Asian firms that took on too much US dollar debt will struggle as the US dollar value of their repayment burdens grows. And, wherever asset prices have surged in the period of ultra-loose money such as real estate prices, there will be risks of prices correcting.
In other words, while Asian economies are set to enjoy stronger economic growth as the world economy revives, there is a strong possibility that several countries will endure financial stresses.
Where the shocks will come from: geopolitics
There are good reasons to fear political turbulence next year.
First, the incoming Trump administration is a much more disruptive development than other new US administrations. Two particular areas will affect Asia:
• Foreign policy — expect tensions with China: Trump’s unconventional approach to presidential matters was evident in his telephone conversation with Taiwanese President Tsai Ing-wen, which broke a long-standing agreement between the US and China. For now, China is holding back from retaliating, hoping that Trump will dial back on his support for Taiwan once he is better briefed. But US media outlets are reporting that this move had been planned in advance and was not the result of inexperience. There are many in the Trump team who want a tougher line with China and greater support for Taiwan — and it looks like they will get their way. Expect more US-China frictions next year.
• Trade and business policy: Trump seemingly won political goodwill by using strong-arm tactics to persuade Carrier not to move jobs out of the US to Mexico. He has promised more of the same — that could have a chilling effect on US corporations planning foreign investment in Asia. Similarly, he has lashed out against China’s economic policies and threatened to impose huge tariffs on Chinese imports into the US. Given his scepticism about the benefits of trade, we should expect a step up in protectionist measures, to the detriment of Asian exporters.
Second, a broader concern is that the Trump administration is likely to have limited bandwidth for Asia and much less for Asean.
• As Trump moves to make radical changes, there will be a huge pushback from his opponents, given his approach to hot-button issues such as Supreme Court appointments, immigration, abortion, climate change, business regulation and race relations. There is a high risk that Trump will become mired in domestic controversies and constantly too distracted by the domestic agenda to focus on foreign policy, especially Asia.
• Moreover, the Trump team does not appear to have deep Asian expertise. His foreign policy experts’ main preoccupation appears to be with the Middle East. While Trump will probably be careful not to upset the alliance with Japan and South Korea and is likely to face an early challenge of some kind from North Korea, the rest of Asia is unlikely to be a priority.
If all this produces a US that is unable or unwilling to intervene constructively in world affairs, it would be a loss for Asia, particularly given issues such as the South China Sea disputes, where smaller Asian nations benefit from having the US around to balance China.
The bottom line: The winners will be those who are more resilient
The coming year should see upside in economic growth but lots of financial and political turbulence. The countries best placed to benefit will be those whose economies are significantly leveraged to global demand, which have few financial vulnerabilities and which are diplomatically agile enough to contain the geopolitical risks. Within Asean, Malaysia and Thailand should benefit the most, as should Singapore.
Manu Bhaskaran is a partner and head of economic research at Centennial Group Inc, an economics consultancy
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