East & South Asia: ESA stands on guard in face of a possible trade war
March 23, 2018
The economy of East and South Asia (ESA) continues to fire on all cylinders on the back of the robust global trade cycle, largely accommodative monetary policies in the region and strong gains in labor markets, which is shoring up private spending. A complete estimate shows that ESA countries expanded an aggregated 6.3% annually in Q4 2017, matching both Q3’s print and a preliminary figure from last month.
India was the last large country in the region to disclose GDP data for the October–December period, and, against all expectations, the economy expanded at the fastest pace in over a year. While the Indian economy continued to recover from the implementation of the Goods and Services Tax (GST) and demonetization, GDP data nevertheless painted a mixed picture. While investment expanded strongly in the period, boding well for the economy’s potential growth, private consumption growth decelerated on the back of rising fuel prices, which is eroding consumers’ purchasing power.
More recent data suggests that the region’s stellar Q4 growth momentum is carrying over to this year. The main pillars of growth remain largely untouched: Healthy global trade is fueling activity in the region’s manufacturing sectors and boosting exports, amid improving job conditions and loose financial conditions. Against this backdrop, manufacturing PMI readings for the region stayed in positive territory in February, while new export orders in most countries were robust in the same month, suggesting that the global trade cycle remains in good health. Moreover, exports for the first two months of the year posted double-digit growth rates in East Asia’s economy. In South Asia, exports are expanding at a strong rate so far this year, but this robust performance is jeopardized by soaring imports, mainly due to higher costs for fuel and purchases of both consumer and capital goods.
While the ESA economy appears to have had a buoyant start to 2018, the prospect of a trade war is increasing, threatening to undermine the region’s economic growth. U.S. President Donald Trump decided to impose tariffs on aluminum and steel, effective on 23 March. The direct impact of the tariffs is expected to be limited in the region given the small share of these two commodities in ESA’s export mix. However, concerns that the U.S. could extend tariffs to other products has fueled instability, as this would likely trigger retaliation measures by other key players not only in ESA but worldwide.
An open trade war among major economic players would disrupt global commerce, which has been the main driver of growth in recent years. For now, China, Trump’s main target because of what he calls China’s “unfair” trade surplus with the U.S., has reacted cautiously to the U.S. tariffs on aluminum and steel, as they would have a negligible effect on its economy. However, China has a lot to lose should an open trade war with the U.S. materialize given the massive trade surplus that the country holds with the U.S. and the importance of the export sector to the economy. Recent news about the possibility that the U.S. could impose USD 60 billion in annual tariffs on Chinese imports as soon as 23 March added more fuel to the fire.
Despite mounting risks to the region’s economic outlook, our panel of analysts forecast that growth will remain stable at 6.3% in Q1 2018.
ESA’s 2018 economic outlook remains resilient despite rising trade protectionism
Although the winds of trade protectionism are blowing, the ESA economy is set to post another strong year of growth in 2018. Loose monetary policies in the region due to low inflation rates, resilient global trade and strong domestic demand will continue to propel growth this year. Moreover, many governments in the region are unveiling expansionary budgets for 2018 to keep growth on track in the face of mounting headwinds. Analysts expect Hong Kong’s recently announced budget for the fiscal year running from April 2018 to March 2019 to add half a percentage point to overall GDP growth this year, without threatening the island’s sound fiscal position. In March, China revealed the budget deficit target for this year. While it is lower than in 2017, Chinese authorities are expected to use untapped funds to spur economic growth. India, Korea and Taiwan also announced slightly more expansionary budget plans for this year.
FocusEconomics panelists expect the ESA economy to grow 6.1% in 2018, which is unchanged from last month’s estimate. Reflecting the ongoing economic transition in China and moderating growth in the more mature economies of Hong Kong, Korea and Taiwan, economic growth for 2019 is seen inching down to 6.0%.
This month’s stable outlook for 2018 reflects unchanged growth prospects for regional heavyweights China and India. Estimates for Bangladesh, Pakistan and Sri Lanka were also left unchanged. Growth forecasts for Hong Kong, Korea, Mongolia and Taiwan were revised upward, while no economy saw a downgrade this month.
The Indian economy is expected to be the region’s top performer this year, with 7.3% growth, followed by Bangladesh. The Chinese economy is expected to expand a solid 6.5%, while the economies of Hong Kong, Korea and Taiwan will likely be the region’s laggards, with growth rates between 2.6%–3.0%
CHINA | NPC approves unlimited terms for President Xi
The economy started 2018 on strong footing. Contrasting earlier expectations, data for January–February showed that the ongoing campaign to crack down on pollution did not hit industrial production growth, as solid global demand is fueling manufacturing activity. Despite tighter financial conditions, infrastructure outlays remained robust in January–February, propelling overall growth in urban fixed-asset investment. Retail sales were also strong in the first two months of the year, suggesting healthy private consumption. On 11 March, the National People’s Congress (NPC) paved the way for President Xi Jinping to stay at the country’s helm indefinitely with the abolition of the constitutional two-term limit. In the same venue, the NPC left economic targets mostly unchanged, while rolling out further economic reforms. While China responded with cautious criticism to U.S. President Donald Trump’s decision to impose tariffs on steel and aluminum imports, authorities did not rule out retaliatory measures against the U.S., and the prospect of a trade war looms.
While the economy is successfully moving towards more sustainable growth levels, risks from a potential trade war with the U.S. are clouding the economic outlook for China. Moreover, tighter financial conditions to ensure financial deleveraging could dent domestic economic activity. FocusEconomics panelists forecast that the economy will grow 6.5% in 2018, which is unchanged from last month’s forecast. In 2019, the economy is expected to grow 6.3%.
INDIA | Financial sector distress threatens to undermine growth
Incoming economic data remains largely encouraging, with GDP growth picking up more than expected in the October-to-December period, and leading indicators showing the recovery carrying over into the final quarter of the fiscal year. The robust GDP print reflected higher government consumption growth and increased public capital outlays, which more than offset a moderation in private spending growth. That said, consumption indicators have mostly bottomed out and are now gaining traction: In February, passenger and two-wheel vehicle sales rose robustly, and consumer goods production expanded at its strongest pace in over a year. The economy is, however, far from being out of the woods. Recent developments in the banking sector, including stricter non-performing loan resolution processes and large-scale fraud scandals in public sector banks (PBS), pose a sizeable downside risk to growth. This is compounded by rising yields, which are putting pressure on PBS profitability.
A cyclical economic recovery has taken hold as the effects of demonetization and the Goods and Services Tax ebb. This trend is seen extending into FY 2018—running from April 2018 to March 2019—with growth benefitting from higher public capital spending and recovering private business sentiment. Recent developments in the banking sector, however, cloud the outlook. Our panel expects growth of 7.3% in FY 2018, which is unchanged from last month’s estimate. In FY 2019, panelists see a GDP expansion of 7.4%.
KOREA | Relations between North Korea and South Korea warm
Recent indicators point to an economy in good shape so far in 2018, following the slowdown in year-on-year growth in the fourth quarter last year. In February, consumer confidence declined month-on-month, but continued to indicate healthy optimism. Moreover, although annual export growth decelerated in February due to fewer working days, it nonetheless beat market expectations. Meanwhile, on 15 March, the government announced it would submit an extra budget bill to parliament for this fiscal year in April. The bill will include USD 3.8 billion in additional spending aimed at reducing youth unemployment. On the diplomatic front, there has been a flurry of activity in recent weeks concerning the Korean Peninsula. For the first time ever, the North Korean leader met with senior South Korean officials earlier this month. He also reportedly agreed to meet with the South Korean president in April before attending a tentatively-scheduled meeting with the U.S. president in May.
Increased government spending should boost the economy this year. Moreover, reduced geopolitical tension on the Korean peninsula could also translate into improved consumer and business confidence. However, high household debt and recent government measures to tame rising housing prices could weigh on economic prospects. FocusEconomics panelists forecast the economy to grow 3.0% in 2018, which is up 0.1 percentage points from last month’s forecast, and 2.8% in 2019.
INFLATION | Lunar New Year holiday sends regional inflation to a multi-year high in February
Inflation in East and South Asia jumped from 2.1% in January to 3.0% in February, according to an estimate by FocusEconomics. The print represented the highest rate since July 2014 and reflected higher price pressures in China, Korea and Taiwan due to the Lunar New Year; the festivities boosted demand for a wide range of products and generated a base effect due to a difference in timing. The holiday fell in January last year, compared to February this year. Conversely, inflation in South Asia fell, mostly due to improved food supply thanks to healthy harvests in 2017.
Lower inflationary pressures led the Bank of Korea to leave its key interest rate unchanged at the Bank’s 27 February meeting, despite robust economic growth. On 2 March, President Moon Jae-in reappointed Governor Lee Ju-yeol for a second term. In Taiwan, Yang Chin-long took the reins of the Central Bank on 26 February, ending the two-decade mandate of Perng Fai-nan. The governors of both central banks will have to keep a close eye on rising trade protectionism, which could seriously hit economic growth in the two countries. On 20 March, Yi Gang unexpectedly replaced Zhou Xiaochuan as the new governor of the People’s Bank of China. Governor Yi stated that he will continue the policies implemented by his predecessor Zhou, who has been in the post since 2002. Strengthening financial oversight, further reforms in the financial sector and limiting financial risks will top Yi’s agenda.
Inflation will likely recede from current levels as the impact of the Lunar New Year holidays fades. The recent surge, however, is a warning signal that reduced economic slack, a potential rise in commodity prices and/or a low base from previous years could push inflation up in the region, forcing central banks to tighten their monetary policies. Panelists polled by FocusEconomics project average inflation of 2.7% this year, which is unchanged from last month’s estimate. Inflation is expected to stabilize at 2.7% in 2019.
Head of Economic Research