This article first appeared in Forum, The Edge Malaysia Weekly, on July 11 - 17, 2016. 

After weeks of disheartening political and economic events, this may not be the best time to sound optimistic about the world economy. It is right to calculate the risks raised by the shocking British decision to leave the European Union (EU), otherwise known as Brexit, as well as the rash of terrorist attacks and wobbles in the Chinese economy. But it would be wrong to be so carried­ 

away by these that we miss possible turning points in the global economy which could give a much-needed uplift to Asian economies. Incipient signs of an uptick are indeed emerging. What we need to think through is: first, whether this recovery is sustainable and likely to gather traction; and, second, if a rebound is really emer-

ging, are the undoubted downside risks powerful enough to smother it before it has a chance to benefit this region? 

Something is stirring in global demand

There are some persuasive though tentative signs of an upturn in global manufacturing:

• American manufacturing activity at a 15-month high: The  Institute for Supply Management’s index of US manufacturing rose from 51.3 in May to 53.2 in June. A separate index by Markit also rose, confirming that there is indeed a turn for the better. There are several positive aspects of the trend in US manufacturing. First, the forward-looking components point to further growth. New orders are at their highest level since December 2014 and manufacturers are confident enough about future demand to raise employment for the first time since last November. Second, the data on inventories shows that the drag from inventory correction is dissipating. Third, new export orders were at a multi-month high des-

pite the relative strength of the US dollar: That could mean global demand is so strong that US manufacturers are able to shake off unfavourable currency movements. Finally, the rise in the import orders index, also to a multi-month high, points to strengthening US demand for Asian exports.

• Sure enough, there is rising evidence that new export orders are recovering around the world: The JP Morgan Global Manufacturing Index showed new export orders edging up close to the breakeven point of 50 in June. Several major exporting nations such as the eurozone, South Korea and Taiwan, and even smaller ones such as Vietnam also showed a strong rebound in June. A recent survey by the Chung-Hua Institute for Economic Research revealed that 59.8% of Taiwanese manufacturers expected a rebound in exports from 3Q2016 onwards — this is up from just 45.2% in the first quarter survey. Others such as Japan and India saw new export orders still falling but at a slower pace. China, however, has seen export orders fall at an even faster clip in June — perhaps reflecting the impact of rising costs in the country. Competitiveness issues could also be the reason why export orders for Singapore and Malaysia have not strengthened. 

• Japan’s manufacturing sector could be stabilising: While the overall Japanese economy is not doing well, the Tankan survey showed surprising resilience in the manufacturing sector, which is key to export prospects in other Asian economies. Major manufacturing companies are revising upward their expectations for output and prices. In addition, despite headwinds such as an overly strong yen and many global uncertainties, large manufacturers have raised their capital expenditures plans for this fiscal year. 

Are there strong underpinnings to this fledgling recovery?

There are several reasons to believe that these initial signs of recovery are not misleading. First, the US and eurozone economies are bouncing back: 

• In the US, personal spending in May continued the pattern of recent months, accelerating above its 12-month average. After a long period of stagnation, real disposable incomes are now rising at a healthy pace, up 3.2% y-o-y in May. This suggests that the weak demand for jobs suggested by the May payrolls report may have been misleading: Real wages would not be rising if demand for labour were really so weak. Indeed, the Conference Board Consumer Confidence Index rose to 98.0 in June, its highest level since October 2015, showing that households were in a reasonably sunny mood. The housing market remains buoyant, as seen in the continued rise in the Case-Shiller home price indices. US economic growth for the first quarter was revised up to 1.1% and we estimate second quarter growth will be more than double that, at above 2.5%.

• The eurozone was also putting the worst of the sovereign debt crisis behind, at least before the result of the Brexit vote was known. The June purchasing manager data showed manufacturing activity expanding in all countries except France. Some of the crisis-hit countries such as Spain and Italy are enjoying rising production and easing deflationary pressures. 

Second, some of the larger emerging economies are enjoying better times. For example: 

• India’s prospects are beginning to look better. Initial worries that a poor monsoon would set India back have been proven wrong. The latest signs point to a reasonably good monsoon that would not only boost rural demand, but also keep food prices in check. The Indian government also appears to be stepping up its efforts to reform the economy, including liberalising foreign investment and making another push to get the Goods and Services Tax Bill passed by parliament. 

• Russia, an economy hit hard by the collapse in oil prices and international sanctions, appears to be growing again. The Manufacturing Purchasing Manager Index bounced up to its highest level since November 2014, while export orders are at a 19-month high.

Will the downside risks throw this incipient rebound off-track?

The first key question thus is whether the shock of the British decision to leave the EU could derail recovery. 

There is no doubt that businesses in Europe will be wary of raising capital spending and hiring, preferring to defer major expansion decisions until there is more clarity about two key issues — Britain’s future relationship with the rest of Europe and whether the EU as a whole will survive this shock. The Brexit vote could weaken the eurozone economy if the uncertainty were to last a long time. That could well be the case. It will be September by the time the UK has a new prime minister. It will be even longer before she starts negotiating exit mechanisms with her European counterparts (yes, the next British prime minister is likely to be a woman; it is going to take a woman to sort out this mess for us). The process will take more than two years and we expect it to be messy. 

However, we are more sanguine on the EU’s ability to weather this shock. We think businesses will conclude that the political ramifications for the EU as a whole can be contained as there is little appetite among national parliaments to allow more referenda in Europe. While antipathy towards the EU has grown in countries like France, it is highly unlikely that the French or any other major European country will risk throwing away the immense political and economic benefits of the EU. In fact, the shock of Brexit has had a salutary effect on voters. In Spain’s general election, held just days after the Brexit vote, voters surprised the pollsters by plumping for mainstream parties who hew to conventional views on the EU. We also expect EU leaders to adopt aggressive measures to placate angry voters and to buffer the economy against this shock. Thus, the damage to business confidence and spending can be contained in the EU as a whole, though it is likely to be greatly damaging in the UK. 

However, for the US and Japan, there are fewer reasons why the uncertainty of Brexit should have a prolonged effect on business confidence: Once the initial shock wears off, business spending is likely to regain traction. What is more, central banks in the US, eurozone and the UK have committed to keeping monetary conditions easy for some time to come. And, bond yields have also fallen sharply, lowering the cost of capital and making fixed investment somewhat more attractive. 

The second question is whether the Chinese economy might slow further and hurt global demand. The latest data depicts an economy that has stabilised but is not gaining the momentum one would have expected from the substantial monetary and fiscal stimuli that are under way. This is probably because the imbalances and distortions that have built up over the years are creating strong headwinds. Our view remains that as long as the political leadership is united in delivering well-calibrated and timely policy responses, there is little reason why the Chinese economy should go off the rails. The most likely scenario is a continuation of what we have seen in the past two years — episodic stresses that can be contained before they escalate into a crisis, but that cumulatively produce mediocre economic growth and occasional turbulence in global markets. 

The final issue that could stifle the emerging recovery in global demand is protectionism. We are seeing a significant increase in trade restrictions being imposed by both developed as well as developing economies in the past year. Given the growing mood of nationalism around the world, there is a clear risk that we could see more restrictions. Still, it is encouraging to see that most leaders do recognise the immense benefits from an open trading system and will not push protectionism so strongly that world trade suffers a decisive blow. 

Conclusion: The worst is behind us for Asian exports

In short, there are encouraging but tentative signs of a recovery in global demand that could boost Asian exports. While there are some good underpinnings to this rebound, it is hostage to many downside risks that are difficult to assess accurately — partly because much depends on the decisions made by political leaders. By and large though, we think the right policy decisions will be made, and the recovery should gain further traction.

Manu Bhaskaran is a partner and head of economic research at Centennial Group Inc, an economics consultancy

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