This article first appeared in Forum, The Edge Malaysia Weekly on August 19, 2019 - August 25, 2019
The past week may have marked the juncture when the many stresses in geopolitics and the global economy reached a tipping point: It is now more likely that we will get a series of political shocks and an accelerated downturn in the world economy. Political hot spots — in Hong Kong, Italy, Brexit, Argentina and South Asia — are turning critical. New data suggests that the prospects for global economic growth have also taken a knock. Yes, the major central banks will now cut interest rates more aggressively, but monetary policy cannot alone overcome the headwinds. Therefore, the outlook for trade-dependent Asian economies cannot be good — unless their governments respond quickly and effectively.
What has changed — political flashpoints turning ugly
Anyone looking for good news in world politics is going to be disappointed. Tensions that have been simmering for some time could reach a critical point in several areas:
• Hong Kong — a crackdown is likely: The signs of impending security actions to end the protests could not be clearer. The protesters’ aggressive tactics are provoking the Chinese authorities, who are appalled at the blockades that have crippled the Hong Kong Airport and the proliferating instances of violence directed at police, which they have condemned as “sprouts of terrorism”. In her latest press conference, Hong Kong Chief Executive Carrie Lam made no concessions to the protesters, but instead warned emotionally of a Hong Kong that risked being “smashed to pieces”. The official Chinese newspaper People’s Daily asserted that the “sword of the law to stop violence and restore order is overwhelmingly the most important and urgent task for Hong Kong”. Chinese media have shown images of armoured vehicles in motion and security forces engaging in exercises on the border of Hong Kong.
While China will not rush into any action, the conditions for it to act are falling into place. It has been waiting for the protesters to over-reach and lose popular support, something that is beginning to happen. It also wanted to be sure that it could contain any foreign policy setbacks resulting from such actions — which is also increasingly likely, given US President Donald Trump’s publicly stated lack of concern over Hong Kong. China is probably calculating that it can absorb any short-term damage caused by such a crackdown because it probably will not need to use the People’s Liberation Army to suppress protests: The Hong Kong police remain able to carry out what is needed in a security crackdown such as enforcing curfews, suppressing efforts to resume protests without bloodshed and arresting protest leaders. While security measures could unnerve financial markets in the near term, the overall impact is not likely to be serious.
The long-term consequences for Hong Kong can be mitigated, but only if the Hong Kong authorities follow up a crackdown with real efforts to address the people’s grievances, such as anger at their lack of voice in governance and unaffordable housing. So far, the authorities have not come up with new thinking on such areas, aside from vague promises “to rebuild the Hong Kong economy”; and
• Threat from populism grows: The standoff between UK Prime Minister Boris Johnson and the European Union makes a disruptive no-deal
Brexit more likely, with grave consequences for the European economy. In Argentina, it now seems more likely that Alberto Fernández, the populist candidate opposed to President Mauricio Macri’s reform efforts, will win the presidential election in October, raising the risk of defaults and policies that could destabilise the country. That has caused the Argentinian peso to collapse, making trading in emerging-market currencies more nervous. In Italy, the hard-line nationalist leader, Matteo Salvini, is attempting to bring down his own government in order to force a new general election that he believes he will win. That could trigger off another round of jitters for the euro. In the meantime, other political tensions continue to simmer across the globe: The US-
China disagreements are proliferating beyond just trade, Indo-Pakistani frictions have intensified following the recent Indian decision to abrogate the special status of disputed Kashmir, North Korea continues to test missiles and the conflicts in the Middle East have heated up.
What has changed — economic downturn more likely
Looking ahead, business confidence will be the key to predicting how the global economy will unfold. But global corporations, already rattled by the geopolitical risks described above, will be further depressed by two key economic factors:
• No end to trade frictions: Trump is partially deferring the imposition of higher tariffs on Chinese exports notwithstanding. The fact is that the majority of Chinese exports will face substantially higher tariffs by Sept 1. China has made it clear that it will not back down in the face of Trump’s strategy of maximum pressure, so there is little likelihood of a trade deal in the next few months. Global trade volumes are likely to weaken; and
• China’s economy became even more fragile in July: Industrial production growth eased to the slowest pace in 17 years in July as a result of weakness in all the sources of demand — retail sales growth weakened sharply, expansion in fixed-asset investment was close to a record low, and export growth has also lost momentum. In particular, private companies seem to be in dire straits — growth in their capital spending has sharply decelerated while banks are leery of lending to them. But they are the most dynamic part of the economy, responsible for about three-fifths of total investment.
What is the net result? Some financial indicators such as the gap between short and long-term interest rates are signalling a possible recession. We do not think a recession is likely — the most recent Organisation for Economic Cooperation and Development lead indicator for the rich economies signals moderately weaker growth in the months ahead, not a recession. This is supported by purchasing manager surveys, which showed the pipeline of new business shrinking but not at rates consistent with a recession. Moreover, data in the past week on capital spending in the US, Japan and Germany was better than expected: Businesses are not enthusiastically raising investment, but there is modest growth at least. So, while the risks are clearly up, a recession remains unlikely.
Do not expect the major central banks to help much
Financial markets have taken solace from the hope that central banks will ramp up monetary stimulus and so stave off further economic weakness. This is overly optimistic. The root causes of the current global slowdown are not factors that can be easily mitigated by a rate cut here and a monetary easing there. Global businesses that confront the uncertainties created by grave political threats, the trade war and Chinese economic fragility are not likely to return to investing and hiring simply because central banks use more monetary firepower. Here’s why:
• In the US, for instance, the latest survey of loan officers shows banks willing to step up lending, but are unable to because business demand for credit remains lacklustre. The problem is not interest rates being too low;
• In Europe, interest rates on many instruments are already negative. The European Central Bank can make rates a bit more negative, but the resulting boost to demand will be miniscule compared with the downward pressures created by Brexit and the growing worries about Italian politics;
• Similarly, in China, it is of great concern that the aggressive policy stimulus put in place has not been able to prevent the economy from weakening further; and
• In Japan, it will be difficult for Prime Minister Shinzo Abe to step back from the sales tax increase he has already postponed once. Thus, any easing by the Bank of Japan will, at best, only help alleviate the hit to consumer spending resulting from the higher tax.
What can Asian governments do as the world economy slows?
What will be the impact of all this on our part of the world? There are roughly three categories of economies:
• First, there are the heavily trade-dependent economies such as Hong Kong and Singapore, where domestic demand plays a relatively small role. Hong Kong’s political crisis will compound its difficulties. For Singapore, the 2Q economic performance numbers showed how weak the economy is, and the government has cut its forecasts for 2019 growth. However, there have been pockets of resilience in the economy — new areas of growth such as digital services are emerging while the economy could benefit from a revival in regional demand. Thus, we do not expect any rush into an easier monetary policy when the Monetary Authority of Singapore conducts its next policy review in October. Neither is there a need for a fiscal package for now; we expect the government to wait till the budget statement in February for that. Should the global environment turn bad, Singapore has the policy firepower to respond forcefully;
• Second, there are the export-oriented economies such as Thailand, Malaysia, Korea and Taiwan, where domestic demand plays a substantial role, or a country such as Vietnam, where other factors are supporting growth. Malaysia’s economy has been better-positioned to withstand the global weakness because of domestic developments such as the Goods and Services Tax rebates, the recovery in natural gas production and the production start-up in two massive complexes in the new Pengerang petro-chemical complex. Thailand is set to ramp up public spending as planned, but the troubles in the coalition government could delay budgetary approval needed — that makes Thailand more vulnerable. South Korea’s government is already rolling out stimulus measures as is Taiwan in a measured way. Vietnam is turning out to be a big winner from production relocation out of China, so the potential hit to its economic prospects is less; and
• The third group comprises countries that, while exposed to global demand, are largely domestically driven — China, India, Indonesia and the Philippines. China is almost certain to announce more vigorous policy stimulus once the annual meeting of its top leaders in
Beidaihe ends. In India, recent heavy rains mean that the monsoon will be within the normal range, which is positive for the agriculture sector. The central bank has been cutting rates and will continue to do so. Indonesia and the Philippines should benefit from two big positives — renewed business spending now that elections are over and a continued ramp-up in infrastructure spending.
In conclusion, the risks are rising for Asia. The proliferation of political and economic risks makes for a troubled environment just as the policy tools in the larger economies seem to be less effective. That means that there is a greater burden on the region’s policymakers to respond in a proactive manner.
Manu Bhaskaran is a partner and head of economic research at Centennial Group Inc, an economics consultancy
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