East and South Asia: Brexit & ESA: Region faces turbulent times exacerbated by Brexit
July 19, 2016
The United Kingdom’s staggering decision to leave the Euro area heightened volatility in the financial markets in the aftermath of the 23 June referendum and casted a long shadow on the global economy. Most of the currencies in the region weakened strongly in the days following the vote as investors fled to safe haven assets such as the Japanese yen, gold or U.S. dollar-denominated holdings. Equity markets followed suit and recorded sizeable loses. That said, all principal stock-exchange markets in the region recovered quickly from the plunge in the next few days. While the most of the currencies in the region followed the same pattern and strengthened in July, the Chinese yuan was the main exception as authorities seems to be weakening the currency in an attempt to shore up growth.
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At this stage it is difficult to fully assess the impact of the Brexit in the global economy and East and South Asia in particular as it will largely depend on the outcome of the negotiations between the EU and the United Kingdom. While the principal transmission mechanisms from the Brexit to the region will come from trade, the financial sector and economic confidence, the shockwaves will reach Asia mainly via secondary channels.
While trade ties between East and South Asia and the United Kingdom are relatively small (the United Kingdom accounts by less than 2.5% of total shipments from ESA), those from the rest of the Euro area are much more important (around 15.0% of ESA exports). Therefore, the expected slowdown in the Euro area, in particular from core counties such as Germany, following the Brexit will likely hurt ESA’s already-battered external sector.
The Brexit will be a prominent market mover in the months ahead and will likely heighten volatility in the financial markets. Against a backdrop of rising uncertainty, investors will tend to flee to safe haven assets when any turbulence occurs, which will have a negative impact in ESA’s financial markets. This situation will translate into rising pressure on some currencies in the region and also additional stress to the region’s financial sector. That said, most countries in ESA enjoy a strong financial positon due to their large foreign-exchange reserves and a relatively low external debt, which allows them to whether macroeconomic shocks relatively well.
Global contagion will also arrive through a significant reduction in economic sentiment. Unnerved financial markets, a somber outlook for global trade and the possibility that an entangled global economic context could reduce foreign direct investment into the region will weigh on business sentiment. Lower business sentiment could delay investment projects and slow down the pace of recovery.
On the upside, an uncertain economic outlook will likely force the United States’ Federal Reserve to postpone its tightening cycle, thereby taking some pressure off the ESA’s financial markets and allowing central banks in the region to adopt a more accommodative monetary policy. At its 30 June monetary policy meeting, the Central Bank of the Republic of China (Taiwan), cut interest rates citing negative implications from Brexit. Moreover, this situation will prompt some currencies in the region to depreciate, which can help bolster exports. In a context of weak global growth, some governments in the region could unveil new fiscal stimulus programs in an attempt to foster domestic spending. In this regard, China is already boosting infrastructure investment, while Korea announced a supplementary budget for this year. Finally, as the United Kingdom will have to diversify trading partners, some countries in the region could benefit from better trade deals with the country.
ESA economy remains robust in Q2; uncertainty looms on the horizon
A boost in both infrastructure and the real estate sector fueled growth in China in the April to June period and dynamics in India likely remained robust in the same period. This prompted growth in ESA to accelerate for the first time in two years in Q2. According to preliminary data, the region’s GDP likely expanded 6.2% annually in Q2, which was just above the 6.1% rise tallied in Q1. Results of note in Q2 include China’s steady growth rate of 6.7% resulting from a robust expansion in government-sponsored investment, which compensated for a sluggish performance among private companies. This is hardly a Chinese phenomenon. Although cheap funding is readily available, corporate investment remains weak in many countries in the region due to an uncertain regional and global economic outlook.
While Chinese authorities’ willingness to meet this year’s growth target of between 6.5% and 7.0% has alleviated fears over a sharp slowdown and bodes well for regional activity in the short-term, policy action that is too aggressive and goes on for too long has the potential to slowdown much-needed economic reforms, exacerbate macroeconomic imbalances and fuel overcapacity. This situation continues to spark concerns about the quality of growth in China and increases the risk of a bumpy landing in the near future, which would certainly reverberate across the region.
Overall, ESA continues to suffer from faltering global demand, which is dampening activity in the all-important external sector. Although exports have improved mildly, almost all of the countries in the East and South Asia region continued to post negative export figures in Q2. Subdued activity in the external sector will likely persist going forward as ripple effects from Brexit start to hit the region. While the principal transmission mechanisms will stem from trade, the financial markets and economic sentiment, they will be mostly felt through secondary effects. That said, there will be some positive effects, at least in the short-term. Global uncertainty will likely delay the United States Federal Reserve’s tightening cycle, allowing central banks in the region to adopt a more accommodative monetary policy stance.
In the coming months, growth will likely decelerate as government-led stimulus in China will gradually fade away and weak global demand will continue to drag on overall economic activity. Against this backdrop, FocusEconomics Consensus Forecast panelists see the ESA economy expanding 6.0% in Q3.
Still robust dynamics in China and India drive this month’s stable economic outlook for 2016
Despite rising economic uncertainty following the Brexit vote and mounting domestic challenges, an accommodative monetary policy and still robust growth in regional heavyweights China and India are shielding the region against an abrupt slowdown. As a result, the Consensus Forecast for the region’s 2016 growth projections remained unchanged at last month’s 6.0%. For 2017, the Consensus from our panel of analysts is for the ESA economy to moderate slightly to a 5.9% increase.
This month’s stable regional economic outlook for 2016 reflects that an upgrade to the forecasts for China was offset by sizeable downward revisions to the 2016 forecasts for Hong Kong, Korea, Mongolia and Taiwan. Growth prospects for India and Sri Lanka were left unchanged. Preliminary figures for the Bangladeshi and the Pakistani economies show that growth in FY 2016, which ended in June 2016, accelerated to 7.1% (2015: +6.6%) and 4.7% (2015: +4.0%) respectively.
India is expected to be the region’s fastest-growing economy in 2016 with a 7.5% expansion, followed by Bangladesh and China, with an expansion of 7.1% and 6.6%, respectively. The growth projection for China is in line with the government’s economic target for this year of 6.5%–7.0%. At the other end of the spectrum, Taiwan, Hong Kong and Mongolia, in that order, are projected to be the slowest-growing economies, with growth rates equal or close to 1.0%. Korea’s economy is seen expanding 2.5% in 2016,
CHINA | Authorities’ action continues to support growth in Q2
The economy was able to keep up its momentum in Q2 due to continued policy support. While retail sales suggested that private consumption was broadly stable in Q2, investment among state-sponsored companies soared in the same period, which partially compensated for poor dynamics in investment from private firms. Moreover, a large trade surplus in Q2 mainly due to a weakening yuan has likely improved the contribution from the external sector to overall growth. Although China’s exposure to the United Kingdom is limited, the impact of the Brexit decision is likely to be felt through a slowdown in external demand from Europe and heightened volatility in the financial sector. This situation could reinvigorate capital outflows and add further pressure on the yuan and domestic stock markets.
While authorities will resort to policy stimulus to avoid any sharp slowdown, credit-fueled growth has the potential to slow down China’s economic transition and exacerbate macroeconomic imbalances. Although the direct impact of Brexit will be limited, the negative spillovers will come from second-round effects such as weaker demand from Europe and turbulences in the financial markets. The analysts who participated in our survey this month forecast that the economy will grow 6.6% in 2016, which is up 0.1 percentage points from last month's projection. In 2017, the panel expects GDP growth to slow to 6.3%.
INDIA | Healthy monsoon set to shore up consumption
India’s economy picked up in Q4 FY 2015, driving growth for the full fiscal year to accelerate to a six year high. However, the economy remains hampered by falling exports and shrinking fixed investment, and concerns over the methodology of the GDP series have led many of our panelists to believe that growth is being overestimated. High-frequency data continue to paint a more subdued picture of growth: the manufacturing PMI picked up in June, while the services PMI fell. On a bright note, both rural and urban consumption are set to receive a boost after recent developments. A pickup in monsoon rains should support rural households in the second half of the year, while the government approved a once-in-a-decade increase to public sector wages and pensions on 29 June. Approximately 10 million people will benefit from the raise, which increases wages by 16.0% and pensions by 23.6% following the Seventh Pay Commission’s recommendations.
Tailwinds to consumption should drive another year of healthy growth in India’s economy. The country is in a solid position to withstand the economic impact of the recent global uncertainty caused by the UK’s vote to leave the EU and any subsequent effect as the Indian economy is driven mainly by domestic demand. FocusEconomics panelists expect GDP to increase 7.5% in FY 2016, which is unchanged from last month’s forecast, and 7.5% in FY 2017.
KOREA | Government implements fresh policy stimulus
Soft Chinese demand for Korean exports and sluggish growth in private consumption and fixed capital formation prompted economic activity to decelerate in the first quarter. However, recent data suggest that the economy shifted into a higher gear in the second quarter. Industrial production increased substantially in May and the manufacturing PMI registered another mild improvement in June. These developments suggest that Korean industries have likely left the tough times behind. The positive news was also shared in the external sector as the annual contraction in Korean exports in June was the softest in a year. Meanwhile, survey-based indicators regarding economic sentiment continue to show that confidence among businesses and consumers remains depressed. The government will implement a KRW 20 trillion (USD 17 billion) stimulus package this year, including a KRW 10 trillion extra budget in H2 to boost still sluggish economic growth and stabilize financial markets in the wake of the UK’s decision to leave the EU.
This year, the economy will continue to struggle with lethargic exports on the back of weak Chinese growth. Although the government announced a massive stimulus program to boost economic growth this year, analysts remain skeptical about whether the program will be successful. Forecasters predict that GDP will grow 2.5% in 2016, which was cut 0.1 percentage points from last month’s forecast. Next year, the economy is projected to grow 2.6%.
INFLATION | Inflation inches down in June
A sharp decline in prices for fresh vegetables in China drove inflation in East and South Asia to inch down from 2.5% in May to 2.4% in June. The gradual recovery in commodities prices, floods in China and the arrival of the typhoon season in the Pacific Ocean are expected to fan inflationary pressures going forward. That said, weak global demand and rising economic uncertainty promise to limit any upswing in prices.
The 2016 inflation estimate for the region remained unchanged at last month’s 2.4%. Looking at the countries in East and South Asia on an individual basis, analysts left the forecasts stable for Bangladesh and China, while projections for India, Taiwan and Sri Lanka were upgraded. Estimates for the remaining four economies surveyed, including Hong Kong and Korea, were revised downward. Our panel of experts expects inflation to rise to 2.5% in 2017.
Written by: Ricard Torné, Senior Economist