MySay: Economic, trade imbalances pose risks for emerging Asia’s policymakers

This article first appeared in Forum, The Edge Financial Daily, on September 3, 2018.
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In the past year, the global environment for Asian economies has grown ever more uncertain. The outlook for critically important drivers of Asia’s well-being — demand for its exports, prices of oil and other key commodities, geopolitical pressures, the functioning of the trade regime — are all subject to greater unpredictability. It might be useful therefore to identify the most important variables affecting the region’s prospects and work out as best as we can where each is headed.

What emerges from this analysis is that pressures are building up in key areas. These are likely to trigger events that will increase the downside risks for the region.


Global economic prospects: Only the US is up, maybe too strongly…

In our previous column, we argued that there was an unambiguous deceleration underway in global economic activity except in the US, where it was accelerating. This pattern has continued, with even greater evidence that the US economy could actually be overheating. In fact, recent data suggests that the US economy will see accelerating domestic demand accompanied by an increasing possibility that inflation and the external deficits could worsen:

• The Conference Board Leading Economic Index has been rising steadily, up a robust 0.6% in July alone after several months of steady increases: there is little sign that above-trend growth will reverse anytime soon. Rambunctious business confidence, a booming equity market and the unfolding effects of the fiscal stimulus tend to validate the lead indicator’s robust signal.

• Capital spending is gaining momentum, and this is a really big deal. When firms buy more equipment and expand factory space and production capacity, there are tremendous multiplier effects throughout the economy. There is every indication of accelerating investment — orders for core capital goods were rising at an annualised 11.3% in the recent three months.

• Consumer confidence is soaring — the Conference Board Consumer Confidence Index leapt to 133.4 in August, with confidence in current conditions at its highest level in 18 years. This confidence is percolating through to actual spending — core retail sales have been growing at above 4% in recent months.


In short, US economic growth is already too strong and is likely to get even stronger, raising the question of whether the economy might overheat. There are two areas of concern:

• First, most estimates place the US’ sustainable growth at around 2% but the economy is growing well above 3.5% with no let-up in sight. Unemployment is falling and we could soon come to an important inflexion point in the labour market, where wages start to accelerate at a pace that the US Federal Reserve will find unsettling.

• Second, when domestic demand exceeds domestic production capacity, an economy either suffers higher inflation or a larger external deficit, or both — and the excess demand has to go somewhere. Sure enough, the trade deficit is beginning to widen and we have little doubt that the broader current account deficit will deteriorate significantly in the coming year. Core inflation is already higher than the Fed’s 2% target and may edge up more if above-trend growth pushes wages and other input costs up — and if more tariffs are imposed by US President Donald Trump, as seems likely.

We think there is a high likelihood that unemployment, wage growth, consumer inflation and the external deficits will reach levels that force the Fed to shift from its cautious pace of monetary tightening to a faster one. That would be very damaging to emerging markets.


…while other economies, especially China, are slowing

What about the rest of the world? The Organisation for Economic Co-operation and Development lead indicators and other high-frequency indicators suggest that Europe and Japan will slow a tad. Forward-looking indicators we have developed to track future export demand for Asia are also pointing to weaker growth in Asian exports. More than that, a measure of global liquidity that we follow is now declining for the first time in almost a decade, a bad sign for asset prices in emerging markets, which suggests more wild swings in emerging market currencies, equities and bonds.

But the big swing factor in the world economy is China, so we should focus on that. Here, there is ample reason to worry because the key engines of growth are slowing:

• Investment at risk: Fixed asset investment — China’s most important growth engine — is decelerating sharply. Growth in July was the slowest ever recorded. This is a big worry because investment accounts for more than 40% of the economy.

• Flagging consumer demand: In July, we saw retail sales growing more slowly. More worryingly, consumer confidence has taken a beating in August, according to a Financial Times survey.

However, policymakers in China have recognised the risks and are easing policy, stepping up infrastructure spending and easing a little on monetary conditions. But unlike in previous periods of a slowing economy, their room for manoeuvre is constrained by the build-up of debt in the economy and their own fears that easing policy to support growth could easily lead to even more debt, which could destabilise the economy in future. This is particularly the case because the past few weeks have seen more evidence of financial stresses escalating, from the collapse of peer-to-peer lending platforms to a near default by a state enterprise and a rise in non-performing loans.  

Clearly, we are at a stage in China where even policymakers as astute as the country’s will struggle to get the exact balance right in this context. China is a growing risk for the world economy.

US: Trump presidency in danger

Trump has suffered a series of setbacks in the past two weeks. His former lawyer, Michael Cohen, appears to be working out a deal with prosecutors to avoid a long prison sentence for various financial offences. In his court appearance, Cohen seemed to suggest that Trump had instructed him to make payments that may be deemed illegal under campaign financing laws. Two other key associates facing possible criminal charges have been given immunity, presumably in exchange for information that may hurt Trump directly or indirectly. These developments pose serious threats that could undermine his presidency and even lead to criminal charges in future.

There is one reason why this matters to the rest of the world — a president under siege domestically may well feel he has to create an international distraction to deflect attention from his problems and rally the people around him. This is where trade tensions and other geopolitical risks come to the fore.


Trade frictions will worsen in near term

Some observers have taken heart from the decision by the US and Mexico to reach a new agreement on their trading relationship. Certainly, this is good news and we may well see this agreement broadened to include Canada in a revised North American Free Trade Agreement. However, other developments on the trade front have been worrying:

• First, there was no meeting of minds during talks between the US and China over their trade disputes. There is now an increasing possibility that the US administration will go ahead with tariffs on a further US$200 billion (RM823.6 billion) worth of Chinese exports to the US. That would be on top of the US$50 billion that is already subject to higher tariffs.

• Second, we also think it likely that Trump will go ahead with tariffs on automobiles, something that is sure to anger close US allies such as Canada, Europe and Japan as well as China.

In short, there is going to be more uncertainty for businesses as trade tensions grow.


Geopolitical flashpoints — watch Iran

Trump has clearly shown his distaste for the Iranian regime by pulling the US out of the multilateral deal with Iran that persuaded it to give up its nuclear programme. Tough US sanctions on Iran have come into force, with more following in the coming months. Already, Iran’s oil exports have plunged in the first half of August and are set to fall further in the coming months. Even China and India

have chosen to cut back imports of Iran oil rather than risk their relations with the US.

As a result, prices of the benchmark Brent crude, which have already risen 43% over the past 12 months, could move up further. That would take them to a level that would damage many emerging economies, such as India, that depend on oil imports.  Their economic rowth would slow, inflation would rise and their current account deficits deepen.


Implications for Asia

There is more we can say of other geopolitical and economic risks, but the basic picture is clear — the world is not going to be a safe place for emerging Asian economies:

• Slower global demand for manufactured exports will mean some loss of economic growth momentum over the next few quarters. Outside oil, there could be downward pressures on other commodity prices.

• The respite from equity market falls and currency selldowns is not likely to last. As the environment turns more difficult, the weaker emerging economies will come under more severe pressure. Countries such as Turkey and Argentina that have been forced to jack up rates massively to defend their currencies will probably suffer recessions and rising financial stresses.  In another round of emerging market corrections, Asian currencies and equity markets will certainly fall as well.

Basically, Asian policymakers will have to be innovative in how to buffer their economies against these external headwinds because they will not be able to use traditional monetary and fiscal policy tools as easily as before.

• First, there are constraints on using monetary policy. Far from being able to cut rates, central banks in our region have had to build credibility with financial markets by raising rates to defend their currencies. Indonesia’s central bank, for instance, was proactive in raising rates aggressively and early. This has boosted its credibility with financial markets, providing the country with some insulation — but higher rates will slow the economy to some extent.

• Second, stepping up fiscal spending might be one way forward, but even this is proving difficult as investors are monitoring how rigorously countries manage their public finances as well. Indonesia is again an example of this — its proposed budget for 2019 was cautious and conservative. One option might be to make way for more private-public partnerships to promote more infrastructure spending so that the fiscal constraint does not hold back construction of roads, railways, ports and power stations. Another might be to relax macroprudential restrictions on lending and the real estate sector to provide some relief to economies.

• Third, it may well be that the region will have to focus on longer-term structural reforms to support their economies. More deregulation to improve the ease of doing business is likely. On the trade front, countries should move ahead on multilateral trade deals such as the Regional Comprehensive Economic Partnership. RCEP negotiations. The time has probably come for the majority of countries in the RCEP process to move ahead, if necessary without the countries holding up progress.

In short, the region is likely to face greater

headwinds and occasional financial stresses. Asian policymakers have to be prepared for a more difficult period and must think out of the box to insulate their economies against these challenges.

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

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