This article first appeared in The Edge Malaysia Weekly, on April 18 - 24, 2016.
THE global institutions we look to for guidance on the world economy continue to sound distinctly downbeat. Forecasts for global growth have again been downgraded by the International Monetary Fund and the World Bank in their recent reports. Interestingly, the IMF upgraded the outlook for China but did not change its views for Asean economies — the main reason for their downgrades was greater caution on the US, Europe, Japan and some large emerging economies such as Russia, Brazil and sub-Saharan African economies.
On the trade front, the World Trade Organization sees the volume of international trade expanding by 2.8% this year, not very different from the desultory result in 2015. Moreover, the WTO cautioned that even this downbeat forecast might be too positive, given the many downside risks in the global economy.
Trends in recent economic data, however, persuade us to take a more optimistic view of our region. We see global demand beginning to recover, boosting the considerable export sectors around us. Within this development, China’s revivaal contains several positives as well for Asean, though there are some points of concern about how China might affect us. Moreover, we see the beneficial impact of low oil prices continuing and perhaps expanding. Finally, we think domestic factors within Asean economies are also likely to turn more positive.
Global demand may be recovering faster than expected
The past two weeks’ data releases provide support for our view that the global economy is doing a bit better than the consensus believes.
• We are seeing an across-the-board revival in manufacturing: The US ISM Manufacturing index increased to 51.8 in March this year, from 49.5 in February. Manufacturing purchasing managers’ indices in the UK and eurozone have also risen. Among the developed economies, only Japan’s manufacturing PMI showed declining activity. In China, it is now clear that the stimulus policies of the past few months are finally helping to revive manufacturing activity.
• This global improvement is filtering through to Asian manufacturing: Almost all Asian economies reported increases in manufacturing PMI. Notably, Taiwan’s manufacturing PMI increased to 51.1 in March, from 49.4 in February and Indonesia’s increased to 50.6 in March from 48.7 in February. Even India, which is less affected by global factors, has seen a sharp turnaround in industrial production.
• Services activities around the world are also expanding: The US ISM non-manufacturing index increased to 54.5 in March from 53.4 in February. The UK, India and China all saw their services PMI increase as well. The eurozone index fell slightly, but remains at a level that signifies moderate activity. Again, Japan was an outlier, where the services PMI declined to 50 in March from 51.2 in February.
• The Baltic Dry index, which reflects pricing of sea transport, rebounded to 560 in mid-April after collapsing to a low of 290 in mid-February. The index was at 1,200 last July. This suggests that global trade volumes could be recovering.
There’s good and bad news on China’s impact on the region
There is little doubt that the Chinese economy is reviving. The latest activity data is all rising; foreign exchange reserves are edging up, suggesting improving confidence in the renminbi; and foreign trade appears to be turning around smartly. This has improved the confidence of financial investors, contributing to a revival in Asian currencies as well as financial asset prices, helping in turn to revive business confidence.
Since China is now so important, it is worth examining the data, especially the trade data, in more detail.
• Export revival could indicate upside to global demand: Chinese exports in US dollar terms staged a dramatic turnaround in March, rising 11.5% on the previous year after a 25.4% fall in February. While some of this is explained by a low base in March 2015, underlying export activity does seem to be gaining momentum. The recovery in the Baltic Dry Index and in commodity prices are almost certainly a result of the Chinese economic rebound.
• But Chinese excess capacity is hurting: Not all of this export revival is good news though. Steel exports have surged as China steps up its exports of over-capacity sectors. With steel sectors in the UK, Europe and elsewhere already in pain as a result of Chinese competition, this pain can only get worse. The import data also shows the impact of China’s excess capacity — volumes of refined oil and fertiliser imports fell as local production displaced imports. There are several risks in these trends for Asean. The first is that protectionism will rise and that could affect all exporters. Second, as China exports its surplus production, there will be more deflationary pressures around the world. Several analysts have pointed to the growing correlation between Chinese producer prices and similar prices in major exporting nations.
In other words, China’s economic turnaround is set to help Asean economies, but there are risks from the way it is exporting surplus production abroad.
Oil price rise is temporary; low prices likely to remain a source of growth
Oil prices have risen sharply to their highest levels since early December. One reason is the hope that oil producers will deliver an agreement on production discipline, which could bolster oil prices at their forthcoming meetings. The recovery in prices has also been supported by expectations that American shale oil production will fall, helping to bring balance back to the oil market. Indeed, the number of active oil rigs in the US declined to its lowest level since 2009 in early April, having fallen 78% from the peak in October 2014. Similarly, capital spending in Canada’s oil and gas sector has fallen 62% since the 2014 peak.
However, while it is possible the major oil producers will somehow overcome their deep differences and reach a compromise, we doubt that will suffice to bring about a surge in oil prices that could undermine the global economic recovery which is underway:
• First, the interests of the major oil producers are so fundamentally incompatible that any compromise would struggle to survive. Now that sanctions on Iran have been eased, it is eager to make up for several lost decades of economic mismanagement and sanctions. It needs to pump out as much oil as possible to generate the revenues to help it diversify its economy beyond oil. Unlike major oil exporters such as the Gulf countries, Iran sees itself eventually as a major manufacturing and services-led economy, and not as an oil-dependent one. Similarly, Iran’s ally, Iraq, is determined to ramp up production as rapidly as possible — exports from its southern oil fields alone reached 3.5 million barrels a day in early April, compared with 3.3 million barrels a day in March. Moreover, if efforts to broker a peace accord in Libya continue to make progress, there will be renewed Libyan supplies to the world oil market since Libya, too, needs to make up for lost time. In short, we see more than enough increase in oil supplies to offset the decline in the US and the production quotas among the major oil exporters.
• Second, developments in the renewable energy space are also changing the dynamics of the oil market, much faster than we had expected. Bloomberg reports that recent solar and wind auctions in Mexico and Morocco produced “winning bids from companies that promised to produce electricity at the cheapest rate, from any source, anywhere in the world”. The technological breakthroughs in renewable energy mark a decisive structural shift against demand for oil, creating an overhang over oil prices which markets may not have fully factored.
In other words, any recovery in oil prices will be temporary and subdued, allowing the world economy to continue to benefit from lower energy and transport costs for an extended period.
Domestic developments within Asean are also helping economic revival
The past couple of years have truly been annus horribilis for Asean, when virtually everything that could go wrong went wrong. There were political convulsions, terrible weather, a weak global economy, falling commodity prices, and the short-term ill-effects of reforms that will boost economic growth in the long term, such as subsidy cuts and tax reforms in countries like Indonesia and Malaysia. Other necessary policy measures also hurt — such as those to rein back excessive loan growth and cool overheating property prices.
Given this context, just the absence of, or improvement in, some of these depressing factors will help economic recovery. The worst impact of low commodity prices and subsidy cuts is dissipating, for instance, with the decline in farm incomes bottoming out. While we are still experiencing drought across the region, Australia’s National Oceanic and Atmospheric Administration has forecast that the El Niño phase responsible for this will end by the middle of the year, allowing agriculture to recover.
Political factors may also be improving in some parts of Asean. Myanmar appears to have negotiated the transition to an elected government reasonably well. In Vietnam, the party congress is over and a new leadership has been installed, with reformists still holding key economic positions in the new cabinet. In Indonesia, the reformist President Joko Widodo is gaining strength and appears to be in a better position to implement reforms to improve the business environment. But the region is not entirely out of the political woods, with political uncertainty in Thailand and Malaysia still an overhang.
We are seeing stronger policy responses across the region as well, which are boosting economic growth. In Indonesia and Thailand, fiscal spending is being ramped up to generate a recovery in investment spending while helping rural households suffering from low prices for their products. Public spending should also boost the confidence of the private sector, thereby encouraging higher business spending. In addition, interest rates have been cut in Indonesia and that should help too.
The bottom line: rising hopes for Asean growth to rebound
The overall story is not a bad one for the region. Global demand is recovering, the growth dividend from lower oil prices will help and domestic factors in the region are on balance turning more positive. External risks remain, but improving policy responses in the region will provide some resilience to potential downsides in the global economy.
Manu Bhaskaran is a partner and head of economic research at Centennial Group Inc, an economics consultancy
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