CFA Society Singapore
SINGAPORE (Feb 18): Despite the growing pessimism, we think that many of us could be underestimating the chances of a turnaround in the global economy. This is not to question the evidence that the global economy is slowing, which is real, as we discuss below. Nor is it meant to dismiss the downside risks that have emerged. Our view is that the risks can be contained and there are several countervailing forces coming into play that should help crystallise a recovery in global economic activity in the second half of this year.
Yes, the near-term deceleration is real…
Recent data shows that manufacturing activity around the world is not only slowing but that the slowdown could persist for a few months more. For example, the global manufacturing Purchasing Managers’ Index has fallen to near a 30-month low in January. Worse still, the sub-index for new export orders — which tells us what the pipeline of future exports will be — declined for the fifth straight month. Drilling down to the big developed economies, we see a significant loss of momentum in the eurozone (weakest manufacturing since November 2014) and in Japan (lowest PMI level in 29 months). In both regions, new export orders declined, with Japan’s decline the sharpest in a year and a half. Only in the US do we see manufacturing activity remaining quite vibrant. In fact, the US ISM manufacturing PMI rose to 56.6 on Jan 19 from 54.3 on Dec 18 — but even here, export orders have weakened.
As a result, world trade is also decelerating, which is not good news for us in Asia. World trade volumes are barely growing, up just 1.82% in November, its slowest pace in more than two years.
…but keep an eye on the big picture in the global economy, which contains many positives
First, it is important to recall a few characteristics about today’s global economy.
One is that we have seen a few mini cycles since the global crisis ended, when global activity abruptly slowed, only to revive later. This happened, for example, in 2016 to early 2017, after which we saw an unexpectedly vigorous recovery. This current slowdown is likely to be similar.
Furthermore, we need to appreciate the underlying processes within the global economy, three of which are actually quite positive:
• One such process is that, after a series of unusually severe shocks — the global financial crisis, a series of eurozone-related trials and tribulations, the abrupt shift down in China’s economic growth since 2015 and the consequent sharp falls in in the prices of oil and other commodities — the global economy is beginning to find a new equilibrium, to return to a more “normal” pace of growth. These shocks upended long-standing economic relationships and behaviours. But, now that these shocks are over and businesses and consumers have found their feet, they are getting back to a more “normal” level of spending, hiring and investing. This natural healing process is continuing throughout the developed economies despite their many challenges.
• Another underlying process in the world economy is that multiple new technologies are reaching take-off points almost simultaneously — artificial intelligence and robotics, biomedical advances such as revolutionary new treatments for cancer, advanced manufacturing processes such as 3D printing, the invention of new materials such as composites that enable transformational improvements such as non-stop long distance flights, and so on. All this generates new engines of growth and makes a compelling case for businesses to invest and grow.
• A third dimension is what is happening in large developing economies ex-China. Collectively, these economies represent about 15% of the world economy, actually larger than China. Here, in some cases such as Indonesia and the Philippines, internal reforms and a burst of infrastructure spending are boosting growth. Others such as India, Russia and Brazil, which endured several years of difficulty, are returning to growth. This is why the Organisation for Economic Co-operation and Development (OECD) lead indicator for these economies is signalling an upturn.
Moreover, the root causes of this slowdown suggest it can be contained
The global slowdown is the product of several factors, some temporary in nature and likely to be reversed but others that could persist for a while:
First, there were one-off factors in Europe and Japan: Germany suffered a fall in industrial production as a result of temporary factors such as new auto emission standards as well as a period of low water levels in the Rhine River, a major transport artery for its economy. Japan had to endure the after-effects of a series of natural disasters earlier. These factors will reverse in coming months, allowing some degree of rebound in these two major engines of global demand.
Second, China’s economy has lost momentum quite sharply: Manufacturing activity has weakened and the official estimates of economic growth for 2018 put it at the slowest rate since the global crisis. The suspicion is that the official figures hugely underestimate the plunge in economic growth. A Renmin University survey shows that demand for labour in the trade-related sectors fell 40% in 4Q2018, almost as bad as the 53% fall in 3Q2018. Anecdotal evidence suggests that some provincial economies such as Chongqing’s may even have contracted. China’s “general” imports, which reflect domestic demand within China, fell for the first time since 2016, a clear indication of lacklustre domestic demand.
Third, uncertainty over basic issues has deterred global businesses and even consumers from spending: Distributors of luxury goods as well as consumer goods manufacturers are telling surveys that a broad slowdown in demand began in late 2018 and this seems to be continuing into this year. Measures of global business confidence such as the OECD’s Business Confidence Index have fallen back to the levels that prevailed during the period of slower growth in 2016 to early 2017.
This is not surprising. As businesses assess the risks and rewards of investing, they find too many things that can go wrong and that are fundamentally unpredictable — a downward spiral into a US-China trade war; growing strategic competition between the US and its allies against China and Russia; a possibly disorderly Brexit; and flashpoints in volatile regions such as the Middle East heating up. Their reflex action as a result is to delay major new expansion projects for a while to see how things pan out. Consumers take their cue from businesses and also defer spending, and the result is a generalised slowdown.
Fourth, there are also sector-specific drivers of this slowdown: An example is the maturing of the smartphone market, where slower demand is feeding through the entire global supply chain, which is largely in East and Southeast Asia. Another example is in the telecommunications industry, where China’s Huawei Technologies is under severe attack from the Western powers for alleged collusion with Chinese intelligence. This seems to be delaying spending on building 5G networks and thus feeds into slower demand for electronics components of all kinds, much of which is manufactured in Asia. Moreover, further uncertainty is added as businesses contemplate possible radical changes to their supply chains. For instance, Huawei has been reported to have asked suppliers such as Taiwan’s ASE Technology Holding and King Yuan Electronics to relocate production of critical components to China in anticipation of more restrictions on access to US technology that could potentially deprive Chinese firms of vital components.
The case for a turnaround
There are several reasons why we see global demand likely to enjoy a good recovery in the second half of this year.
First, signals from the US Federal Reserve and other central banks that they will go slow on raising rates have helped restore confidence to some extent. Some of the remaining dark clouds of uncertainty could also be lifted in two key areas:
• The next few weeks should see the US and China conclude a trade deal that will boost global business confidence. US Trade Representative Robert Lighthizer and Treasury Secretary Steven Mnuchin visited Beijing this week to continue talks with their Chinese counterparts. The fact that Vice-Premier Liu He has announced his intention to participate suggests that good progress is being made. Both President Xi Jinping and President Donald Trump see it in their interest to conclude a trade deal to avoid a descent into a trade war that will hurt everyone.
• Then there is Brexit. Our view is that neither the UK government nor Parliament want a no-deal Brexit, which could cause huge damage to the UK economy and would moreover destroy the standing of the ruling Conservative party with voters for a long time. Whether it is parliamentary passage of a compromise agreement with the EU or a delay to the date when Brexit takes effect, something will be done to avoid the UK exiting the EU without an agreement that will allow a smooth transition.
Second, policy reaction to reverse the slowdown will start having an effect. In China, policymakers are throwing everything they can at the economy — credit easing, targeted lending to small businesses, tax cuts, higher fiscal spending on infrastructure and social housing and deregulation. Early indicators such as the China contractors’ intake index have jumped, suggesting that the policy easing is working.
In emerging economies outside China, central banks have indicated that they will be leaning towards easier policies so as to support economic growth. The Reserve Bank of India has actually cut policy rates. Fiscal policy is also likely to become more supportive of growth. France has reacted to the gilets jaunes protest through looser fiscal policy. More such fiscal support measures are likely in Europe. South Korea is also pursuing a similar path.
Third, despite the rebound since December, oil prices are still down by about 30% since October last year. That should help oil-consuming economies. Since breakeven prices for oil producers have fallen in recent years, the impact of this fall on oil producers will not be as negative as in 2014 to 2016. The net effect is therefore likely to be positive for global growth.
The key takeaways
In other words, the global economy is slowing, and things may even appear to worsen in the coming weeks. However, greater clarity in some important areas where uncertainty prevails and a strengthening policy response will leverage off the positive drivers within the global economy to produce a tangible economic rebound in the second half of the year. That will spell good news for export-oriented Asian economies such as Malaysia and Singapore.
Manu Bhaskaran is a partner and head of economic research at Centennial Group Inc, an economics consultancy
This story appears in The Edge Singapore (Issue 869, week of Feb 18) which is on sale now. Subscribe here