East & South Asia Economic Outlook November 2018

East & South Asia: Economic Snapshot for East & South Asia

October 14, 2018

Economic growth softens in Q3 amid rising trade tensions and market volatility

Economic activity likely lost steam in the third quarter due to softening external demand, higher prices for energy commodities and heightened volatility in the region’s financial markets. Nevertheless, domestic demand remained strong in the quarter, reflecting tight labor markets and still high levels of consumer confidence. According to an estimate for the region produced by FocusEconomics, ESA countries expanded an aggregated 6.1% year-on-year in Q3, which was below the 6.4% increase in the second quarter and in line with the estimate reported last month. If the preliminary figure is confirmed, it would represent the weakest expansion in over one year.

Available economic data for Q3 suggests that the trade spat with the United States has started to affect economic activity in China, especially within the manufacturing industry. This situation, coupled with lackluster investment, signals a further moderation in China’s economic growth in the third quarter. On the upside, export figures remained robust in Q3 due to the frontloading of shipments to the United States before the implementation of new U.S. tariffs. Moreover, recently adopted measures to support investment are expected to take effect in Q4, while bolder monetary and fiscal support should also help avoid a sharp slowdown.

Data for Q3 also suggests that growth in Hong Kong, Korea and Taiwan lost steam, mainly due to worsening external sectors. More specifically, Hong Kong’s dependence on China makes the island particularly vulnerable to slowing dynamics in the mainland, while Taiwan could be significantly affected by the trade war between China and the United States, given that the island is highly exposed to China’s value chain and the U.S. is a key export market for Taiwanese companies. On top of softening external demand, the unemployment rate in Korea averaged higher in Q3, which could hit private consumption.

India is unlikely to sustain the impressive year-on-year growth rate of 8.2% observed in the April–June period in the following quarters. A weakening currency is threatening to fuel inflationary pressures, while the banking sector—particularly the ballooning shadow banking sector—remains a significant concern. Pakistan, meanwhile, seems ever closer to a full-blown currency crisis due to the low level of intentional reserves and large twin deficits. Against this backdrop, on 9 October Finance Minister Asad Umar announced that the country would seek support from the IMF. While a loan will provide a much-needed respite for Pakistan’s external position, the financial aid will also be tied to bitter economic reforms, which could harm growth in the short-term.

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Growth patterns in East and South Asia will diverge in 2019

Economic trends in the East and South Asia (ESA) region are gradually decoupling, with growth remaining robust in South Asia while moderating in East Asia. Strong domestic demand is expected to maintain growth in South Asia in 2019, especially in India. However, fiscal adjustments in Pakistan and Sri Lanka related to IMF-guided economic reforms are expected to undermine economic growth in the short-term. Moreover, volatility in the global financial markets will continue to put pressure on the subregion’s financial and exchange rate markets, while high inflation will erode consumers’ purchasing power.

The economies in East Asia, with the exception of Mongolia, enjoy enviable financial buffers that shield their economies from external shocks and allow their governments to adopt more proactive fiscal policies without creating fiscal imbalances. However, the openness of their economies makes them vulnerable to weaker global growth, and especially a slowdown in global trade. Therefore, the trade spat between China and the United States, coupled with an uncertain global economic outlook for next year, represent major downside risks to the subregion’s growth prospects.

Against this backdrop, FocusEconomics panelists expect that economic growth in the ESA region will decelerate to 5.9% in 2019, which is down 0.1 percentage points from last month’s estimate. In 2020, the ESA region is seen expanding a slightly weaker 5.8%.

This month’s downward revision to the region’s economic outlook for 2019 reflects lower growth prospects for India and Sri Lanka. Estimates for regional powerhouse China were left unchanged, as were forecasts for Hong Kong, Korea, Mongolia, Pakistan and Taiwan. Bangladesh was the sole economy to receive an upgrade this month.

India and Bangladesh are expected to record the fastest expansions in the region next year, with growth topping 7% in both economies. Despite mounting economic headwinds, China is seen expanding a robust 6.3%, while the more mature economies of Hong Kong, Korea and Taiwan are predicted to record the weakest growth rates, between 2.3%–2.7%.

CHINA | Poor investment and subdued manufacturing activity weigh on economic growth in Q3

Available data suggests that economic growth decelerated in the third quarter, mainly due to lackluster infrastructure investment and negative spillovers from financial deleveraging. Surprisingly, export growth remained robust in Q3 despite the ongoing trade war between China and the United States. The September PMI survey, however, revealed that external demand is softening, which suggests export figures are likely to worsen in the next few months. In response, the government has reverted to old tactics, boosting lending and increasing fiscal stimulus. Although these initiatives are effective in supporting the economy in the short-term, they threaten the effort made in previous years to reshape the country’s economic model and allow the country to avoid the “middle income trap”.

Looking ahead, economic growth is expected to decelerate. This reflects China’s more mature economic cycle and the impact of previous economic reforms, as well as the tit-for-tat trade war with the United States and the cooling housing market. However, a looser fiscal stance and a more accommodative monetary policy should cushion the slowdown. FocusEconomics panelists see the economy growing 6.3% in 2019, which is unchanged from last month’s forecast. In 2020 the economy is seen expanding 6.1%.           

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INDIA | Government acts to reduce trade deficit amid rising fuel imports

The economy had a mixed second quarter this fiscal year, which runs from April 2018 to March 2019, after GDP accelerated at the fastest pace in over two years in the first. On the plus side, business activity in the private sector increased in Q2 at a faster rate than in Q1. However, given that India purchases about 80% of the oil it consumes from abroad, recent increases in oil prices caused the merchandise trade deficit to widen through to August. To help reduce the growing external sector imbalance, the government raised import tariffs on USD 12 billion worth of imports on 26 September. In addition, excise duties on gasoline and diesel were cut on 4 October to lessen the impact of higher fuel prices on consumers.

Economic growth should accelerate in FY 2018, due to fading disruptions from the demonetization of November 2016 and the launch of a goods and services tax in July 2017. However, recent signs of fiscal slippage in the run-up to next year’s general elections, escalating global trade protectionism and higher oil prices weigh on the outlook. Our panel expects GDP growth of 7.4% in FY 2018, which is unchanged from last month’s estimate, and 7.4% again in FY 2019.

KOREA | Economic conditions soften in Q3

The economy appeared to decelerate in the third quarter. Consumer and business confidence trended lower in Q3 compared to the second quarter. Moreover, the merchandise trade surplus shrank in Q3 compared to the same quarter a year earlier due to higher energy imports. This comes after economic growth held steady for the second consecutive quarter in Q2. Meanwhile, the government announced new measures to limit house price growth in early September, after household debt growth continued to significantly outstrip income growth in recent months. These include restrictions on mortgage lending and scrapping tax incentives for owning multiple homes. On the diplomatic front, President Moon Jae-in and the leader of North Korea agreed on 19 September to take steps to reduce the risk of war, increase economic cooperation and achieve denuclearization on the Korean peninsula.

Economic growth should remain broadly steady next year. Higher government spending should boost activity. Moreover, although monetary policy is set to tighten slightly, it will remain accommodative by historical standards. Elevated household debt, rising global trade protectionism, higher oil prices and an economic slowdown in China, however, weigh on prospects. FocusEconomics panelists forecast the economy will grow 2.7% in 2019, which is unchanged from last month’s forecast, and 2.6% in 2020.

INFLATION | ESA inflation increases to seven-month high in September

Inflation in East and South Asia resumed its upward trend in September following a stable print in August. Regional inflation inched up from August’s 2.5% to 2.6% in September, according to an estimate produced by FocusEconomics. The print marked the highest rate since February and was driven by higher price pressures in India, Korea and Taiwan. Conversely, inflation decelerated in Mongolia, Pakistan and Sri Lanka. That said, with September inflation still outstanding for China, the preliminary regional estimate should be taken with a pinch of salt.

In recent weeks, the State Bank of Pakistan hiked its main policy rate by 100 basis points to 8.50% on the back of rising inflation, a sliding currency and large twin deficits. Conversely, the People’s Bank of China (PBOC) lowered the reserve requirement ratio (RRR) for banks by 100 basis points (effective 15 October) in order to shore up economic growth amid cooling domestic growth and rising trade protectionism. With this decision, the RRR now sits at 15.50% for large lenders and 13.50% for smaller financial institutions, marking the lowest levels in eight years. As expected, on 27 September, the Hong Kong Monetary Authority (HKMA) adjusted the base rate upward by 25 basis points to 2.50%, following a similar move by the U.S. Federal Reserve the previous day. Moreover, the Reserve Bank of India left interest rates unchanged at the 3–5 October meeting, while Taiwan’s Central Bank of the Republic of China left the discount rate steady for the ninth consecutive quarter at its 27 September meeting.

Closing output gaps in some countries, a broad currency weakening in the region and higher energy prices will propel inflation going forward. Panelists polled by FocusEconomics project average inflation of 2.7% in 2019, which is unchanged from last month’s estimate. In 2020, the panel sees regional inflation stable at 2.7%.

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Ricard Torné

Head of Economic Research

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