Posted on Tuesday, June 13th 2017 at 01:20pm

An interview with Nordea Markets’ Chief Asia Analyst, Amy Yuan, about the impact of regional and global geopolitical uncertainty, declining Chinese growth and the threat of protectionism on the main Asian economies.



Market view: The outlook for Asian growth

June 02, 2017

An interview with Nordea Markets’ Chief Asia Analyst, Amy Yuan, about the impact of regional and global geopolitical uncertainty, declining Chinese growth and the threat of protectionism on the main Asian economies.

What is the general economic outlook for China and the main Asian economies in 2017?

The Chinese economy is expected to record solid performance in the first half of 2017, thanks to the housing market recovery in 2016. The manufacturing sector, especially heavy industries, has benefited the most. Demand has picked up in terms of volume, producers’ pricing power and profitability has dramatically improved. The housing boom has benefited not only producers but also consumers. The average Chinese homeowner saw in 2016 a larger wealth increase from housing than from salary income. This is expected to support household consumption. As the largest trading partner for most Asian countries, stable Chinese growth lifts exports from these countries.

The growth tailwind from housing will likely not last long. Driven by the fear of a housing bubble, Beijing has tightened mortgage policies and banned speculative buyers. This has cooled down the housing market and is expected to drag down Chinese growth in the second half of 2017. This is expected to put renewed downward pressure on Asian growth.

A growing number of Nordic corporates are looking to Asia for growth opportunities. What markets are likely to be the strong performers in the coming years?

One of the special characteristics of Asia is the vast population, which is becoming wealthier on average. This opens a huge opportunity for consumer goods and services, ranking from basic household appliances to holiday travels. The biggest potentials can be found in China, which is transitioning toward a consumption-driven economy, India and other lower-income countries. Developed Asian countries, such as Singapore and South Korea, will see lower consumption growth due to the already high level.

Another sector with large opportunity is infrastructure. Most developing Asian countries, such as India, Indonesia, Philippines and Vietnam, are underinvested. These countries plan to focus on investment in transportation and manufacturing in the years ahead to support economic growth.

What should Nordea corporate customers operating in Asia and especially China be most aware of over the next year?

One of the biggest risks faced by Asia in the coming year is rising protectionism, including trade tensions between China and the US. This would hurt Asia significantly as many Asian countries are suppliers to Chinese production.

Another risk in Asia is government bureaucracy, which can slow reform progress and the ability to realise the high growth potential. Countries like India, Indonesia and the Philippines have suffered from years of stalled reform progress, lost investor confidence and insufficient capital to invest in infrastructure.

Finally, geopolitical risks remain high in Asia. Although disputes in the South China Sea are not expected to escalate to a military confrontation between the countries, China’s growing military strength and ambition is a cause for concern for many of its neighbours. North Korea is another wild card in the region that could damage diplomatic relations.

With a new era of US protectionism a possibility under President Donald Trump, will China take advantage in both Asia and globally?

Yes, China has already used Trump’s controversy to its own advantage. Xi Jinping wants to picture himself as a mature and stable leader, the opposite of Trump. This is reflected by Xi’s unprecedented appearance at Davos in January 2017, promoting for free trade and fair currency management. Following the US’s withdrawal from the Trans-Pacific Partnership (TPP) in January, some TPP member countries urged China to fill the empty space that was left by the US. So far, China has voiced a lack of interest in a trade war with the US, because it would be a “lose-lose situation,” but it has stood its ground by saying that it would not hesitate to retaliate against any punitive actions from the US.

How much of a negative impact would high US tariffs have on the Chinese economy?

The extreme scenario is if the US placed a 45% tariff on all Chinese goods. In such a case, China’s total exports could fall by as much as 50%, since the US is China’s biggest export partner and accounts for nearly 20% of all Chinese shipments. In turn, this could reduce Chinese GDP growth by 2 points. We think this scenario is very unlikely. Since many Chinese imports into the US cannot be easily replaced by goods from other countries, this move would hurt US consumers badly by pushing up import and consumer prices. Higher inflation will take the largest tolls on low-income groups, the exact same voters that carried Trump to victory.

A more plausible option is for Trump to use targeted protectionist measures on selected goods from China, likely products with strong unions in the US, such as steel and tires. Here the impacts on the Chinese economy would be much smaller.

Another implication is the possibility for China to export to the US via a third country to avoid the tariffs. In fact, China is already suspected of using Vietnam as a middleman for steel exports to the US to get around the anti-dumping duties on Chinese steels.

Trump seems to have very slightly softened his stance towards China – but the China-US relationship is likely to remain strained at best for the foreseeable future. What impact will this have and how is this new state of affairs seen in China?

China’s strategy is clear: wait for Trump to take the first move. So far, China has tried to portray itself as a diplomatic counterpart, interested in maintaining a good relationship with the US. This message was reiterated in early April even after Trump tweeted that he expected a “difficult” meeting with Xi on 6-7 April in Florida.

To the world’s relief, the summit between Trump and Xi went well. Trump has softened his tone toward China and even said that he had established a “friendship” with Xi. This suggests that the Sino-US relationship will likely remain status quo for the foreseeable future.

Geopolitical tension remains high elsewhere due to concerns such as North Korea missile testing (and the resulting deployment of THAAD in South Korea) and the South China Sea Disputes. How is geopolitical instability currently affecting the region? And how is it likely to impact economic growth and foreign corporates active in Asia?

As mentioned above, disputes in the South China Sea are not expected to escalate to a military confrontation. In fact, the Philippines, Malaysia and Vietnam, which have been long-term US allies, have softened their attitudes toward China due to economic benefits. One example is president Duterte of the Philippines, who changed his hostile position toward China in exchange for a bilateral trade agreement and foreign direct investments from China.

Still, China’s growing military strength and its large economic power, such as the ability to boycott a country like South Korea, are a cause for concern for many of its neighbours. For this reason, these countries are highly interested in continued US engagement in the region, which we think is the most likely. Thus, geopolitical tensions will remain a concern for many years to come.

What do you feel are the main trends in foreign exchange that corporates should be aware of and look to protect themselves against?

One of the big trends in the medium term, i.e. within five years, is a break of the soft dollar peg in Asia. Although most Asian currencies are officially floating or managed floating, they remain highly correlated to the USD. Given falling trade exposure to the US and rising exposure to China, it is only a matter of time before Asian currencies start to peg themselves to the CNY.

Another trend is that under the current circumstances with rising protectionism, no country will be interested in blatant currency strengthening. Discrete currency manipulation, via monetary policy, seems to have become acceptable.

Finally, corporates should be aware of the potential risk of capital control in Asia. Driven by the fear of a repeat of the Asian crisis, many Asian countries are firm believers that capital controls are the only solution to stop the vicious circle of devaluation pressure and capital outflows. Within the past two years, Indonesia, Malaysia and China have all introduced different degrees of capital controls.

What are the main challenges specifically facing China in 2017 (credit-driven investment bubble, pollution, slowing growth rate, etc.)?

One of the main challenges is trade tension with the US. Although the risk seems to have reduced after the summit between Trump and Xi, it cannot be completely written off. Slowing economic growth, whether it is due to contracting exports or deteriorating domestic demand, is another concern. It is very important for the government to maintain growth stability this year, ahead of a twice-a-decade political reshuffle in the autumn. Finally, capital outflows will have high policy priority this year. It has proven to exert large devaluation pressure on the currency, which starts a vicious circle of more outflows and more devaluation pressure.

What advice would you give any corporate thinking of starting up a Chinese or Asia unit over the next couple of years?

Proper due diligence of the market (country and sector) is very important. Although the growth potentials are large in China and Asia in some areas, the competition is also fierce. In China, the central government is interested in promoting domestic production in high-technology manufacturing and services, so competition will be toughest not with other foreign companies, but with Chinese competitors, which may get unequal support from the government.

In most Asian countries, government regulation can be high, changeable and not always transparent. Having a local cooperation partner could in some cases be a good idea, but there are also risks involved.

 

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