The mood among investors and businesses worldwide seems to be increasingly fragile, marked by growing despondency as a dark cloud of uncertainty hangs over many important issues. To clarify where the world is heading and what it means for us in Asia, we need to focus on the vitally important political and economic variables that really matter.
As we do that, the picture that emerges is that of possible short-term upsides. But, the medium-term outlook does not seem promising.
A decidedly mixed picture
Let us start with global political issues, where some critical turning points are approaching.
First, the big worry for many of us is the sorry state of US-China relations. An ill-tempered trade dispute between the two has morphed into a nastier strategic struggle. The US has hurled a series of charges against China — that it steals intellectual property, that it forces US companies to hand over their innovations to Chinese joint-venture partners, that China militarised the South China Sea even though President Xi Jinping had explicitly promised President Barack Obama that it would not do so, that it is using its Belt and Road Initiative to trap poor countries in debt to gain extra leverage over those countries. Basically, that China seeks to aggressively displace the US as a world power and does so using irresponsible and unfair methods.
That is why the forthcoming summit meeting between Xi and President Donald Trump on Nov 30 is so important: It will set the tone for much that will follow in global politics and economics. If we look at the statements that have been coming from each side as well as the preparations each side is making for the summit, we can draw the following conclusions:
• Both sides see an advantage in dialling back on tensions, at least for now. China has reportedly offered the US a set of 142 measures that it could take to assuage American unhappiness. Although Trump and his senior cabinet colleagues have complained that the concessions from China are not enough, that they seem to be part of a bargaining ploy, there does seem to be some movement in the right direction. China has just allowed US naval vessels to visit Hong Kong, after rejecting such visits a few months ago. There are indications that China’s highly influential economic policymaker, Vice-Premier Liu He, might visit the US soon to firm up an agreement. If Xi feels that his strong political position allows him to make concessions without risking his political position, he may go further than many of us expect and offer Trump some unexpected concessions. For Trump, an agreement in which China has given way to his demands would vindicate his tough approach on trade while preventing this critical relationship from spiralling downwards into a major conflict or Cold War;
• It thus looks like the Nov 30 Xi-Trump summit could result in an agreement of some kind. It would probably be a framework agreement that will set the general tone rather than one that resolves all the problems, but it will still be a good start; and
• The question then would be how sustainable any improvement in ties will be. It will be politically almost impossible for China to give in to all of the US’ demands, such as changing its economic model and withdrawing its military from the South China Sea. It is more likely, then, that any agreement that comes out of the summit meeting simply helps to prevent an escalation of tensions but does not resolve the more fundamental strategic disagreements.
In short, some good news is possible in the near term. An agreement covering trade and economic issues, with China making concessions on opening up its market to goods and services, is doable. But strategic disagreements between the two big powers will continue to create frictions that will affect East Asian and Southeast Asian countries for some time to come.
Second, investors continue to underappreciate the risks in the Middle East. There are too many regimes in the region that need to distract their populations from domestic predicaments for any of us to be complacent. For Saudi Arabia, for instance, the leaked assessment by the US Central Intelligence Agency of high-level involvement in the murder of Saudi dissident Jamal Khashoggi is unnerving members of the Saudi elite. This can only get worse as more embarrassing revelations about the Khashoggi murder emerge and result in Turkey and Western nations imposing more sanctions on Saudi Arabia. This could create tensions within the royal family or encourage some leaders to escalate tensions in other parts of the Middle East to distract attention from these problems. Similarly, leaders in Iran and Israel are also facing domestic troubles and would not be averse to diverting attention through risky political manoeuvres.
This is really important for Asia for two reasons. One is oil prices, as discussed later
here, and the other is that inflamed tensions in the Middle East could encourage religious extremists in our region.
Third, another area where we think risk is being underrated is Trump’s political position. Special Counsel Robert Mueller, who is investigating allegations of Russian involvement in the 2016 US elections, has already indicted several people who were once close to Trump. He deliberately avoided any action in the run-up to the mid-term congressional elections earlier this month, but he is likely to end this pause and resume his prosecutions. We suspect some of these new actions could be highly damaging to Trump and could cause convulsions in US domestic politics.
The global economy: Three reasons for concern
The global economy is showing signs of losing momentum.
First, while the US economy is currently growing strongly as a result of the fiscal stimulus, it is not clear what will keep driving the economy at this vibrant pace once the stimulus wears off by mid-2019. Indeed, capital spending — which many analysts had expected to replace the tax cuts and extra government spending as a source of growth — appears to have slowed. Wages are growing faster and could help boost consumer spending, but that alone may not be enough to maintain current exuberant rates of growth.
So, the US economy is in a phase where it is strong enough to keep the US Federal Reserve on track to raise rates and cut back on liquidity, even though there is a strong likelihood that economic growth will slow from the current pace of around 3% to less than 2% in 12 months’ time.
Second, there are clear worries about the Chinese economy, which appears to be in a more parlous condition than many thought. Over the course of the past year, both investment spending and inflation-adjusted retail sales have slowed to their slowest rate since good data has been available. This slowdown reflects some highly concerning trends in the economy:
• Confidence in the Chinese private sector has been undermined by a fear that the government’s approach has changed, from being supportive of private sector-led growth to preferring the state sector to lead growth. Some of Xi’s statements in recent years have given the impression that he is not keen to see private entrepreneurs gain more wealth and influence. Consequently, the private sector has been slow to invest in new capacity, and that has pulled investment spending, which accounts for more than 40% of the economy, down;
• Household debt has also grown and several analysts we spoke to believe that the actual burden of repaying debt is greater than the available statistics suggest. This is acting as a drag on consumer spending. A related concern is that much of this debt was taken to speculate on real estate — making consumer confidence hostage to property prices; and
• In the past, astutely timed and effective policy measures have succeeded in maintaining economic growth even as imbalances of various kinds were resolved. Lately, however, the effectiveness of policy responses to slower growth seems to have diminished. Some argue that the anti-corruption campaign has been enforced so ruthlessly that local government officials are scared to commit to awarding new contracts or implementing new projects.
In the past few weeks, China’s leaders have addressed these concerns with more forceful statements to boost confidence and ramped up policy measures to raise demand. The economy should turn around as a result. But, this rebound will come at a price — faster credit growth could aggravate financial imbalances, for example. In other words, China’s growth may well recover, but other stresses could well emerge, keeping the Chinese economy as a source of concern for some time to come.
Third, we are not convinced that the sharp fall in oil prices, which has helped consumers and energy-intensive economies, can be sustained. Saudi Arabia is trying to get oil exporters to agree to a substantial reduction in oil production, which should help stabilise prices. If the global economy slows as we fear, then demand for oil will also grow more slowly. But the biggest reason to expect oil prices to rise again is the Middle Eastern political risk we discussed earlier — more risks will translate into a higher risk premium in the oil price.
Conclusion: Where does this leave Asian economies?
In the near term, there are two potential pieces of good news — a possible pause in the trade spat between the US and China and further policy measures in China to boost demand. That should boost sentiment, relieving the pressure on currency, bond and equity markets in emerging Asia.
Beyond that short-term relief, however, there are many more things that can go wrong. In particular, we need to look out for:
• A recovery in oil prices as oil exporters cut back oil supply and political risks shake the market. Higher oil prices would bring back pressures on currencies such as the Indian rupee and Indonesian rupiah. Since these economies are big importers of energy products, they could suffer higher inflation and weaker external balances as a result;
• Continued stresses in the Chinese economy. As argued above, boosting demand in China will have costs in terms of financial and other stresses. Also, we do not see any lasting thaw in US-China relations — while both nations could avoid a full-blown trade war, their strategic tussle will continue and possibly even worsen. Concerns over China would pose several challenges for the rest of Asia — currencies would remain under pressure because the Chinese renminbi could depreciate further; commodity prices would weaken, since China is the single-biggest importer of most raw materials; China’s imports from the rest of Asia could fall, hurting Asian trade; and tourism out of China could also slow; and
• We see no relief yet from a further tightening in monetary conditions, as the Fed will continue raising rates while its European and Japanese counterparts will begin to cut back on their monetary largesse. As a result, liquidity conditions will remain a bugbear for Asian financial markets.
In short, Asian economies could enjoy a respite for a short while in the coming weeks, but it will probably not last.
Manu Bhaskaran is a partner and head of economic research at Centennial Group Inc, an economics consultancy