SINGAPORE (Apr 15): Gloom pervades the reports we read on the global economy. Data showing a slowdown is described breathlessly as the worst in so many months or years, giving a sense that things are just getting from bad to worse. Now, the International Monetary Fund has joined in and downgraded forecasts for global growth. But are things really that bad? In fact, we find five strong reasons why global growth could surprise on the upside, boosting prospects in our trade-dependent region. There are certainly a number of risks that we should be aware of, but our view is that the likelihood of these materialising is not great.
So, what are the positive drivers?
First, the US economy, still the biggest determinant of global activity, is gathering strength
It now looks as if US growth in the first quarter was not as downbeat as previously thought after all. Agencies that keep tabs on current growth such as the Atlanta Federal Reserve Bank estimate that, despite some weak numbers in early 2019, overall GDP growth is at a healthy pace of around 2% for the first quarter. Better still, the prospects are for a further rise in growth for the rest of the year, as seen in the improvement in the Conference Board lead indicator for the US economy. The most recent economic data backs this — manufacturing activity is bouncing back in March after a lacklustre start to the year while job growth, which fell sharply in February, reverted to strong growth in March. The American job machine is creating jobs at such a pace that the unemployment rate will keep falling, allowing wages to grow faster and boosting consumer confidence. Businesses also report a growing pipeline of new business that will keep them busy for a while.
This is important because a more confident consumer is likely to step up spending as the year progresses. The early months of this year saw an unusual rise in the personal savings rate, which slowed consumer spending. As consumers normalise their savings behaviour, we should see them buying more, adding to demand. Another drag on growth in the first quarter has been investment spending, which has been drifting. But business surveys find that firms are becoming more optimistic about overall business conditions and that their main concerns — labour shortages and capacity constraints — are the kinds of things that would prompt them to spend more to build new capacity and increase productivity.
Second, China’s economy — the biggest contributor to global growth — is improving
The most recent data shows manufacturing, construction and services activity gaining strength. Businesses are enjoying more new orders from domestic customers, although export business remains lacklustre. Particularly noteworthy was the rise in new orders for the construction sector, which surged to a 15-month high, a clear sign that the authorities’ efforts to stimulate the economy are finally working.
While that alleviates concerns that China’s traditional policy tools are not working as well as before, policymakers are not taking any chances. The State Council announced recently that they would be reducing banks’ required reserve ratios in a targeted way so as to encourage financing for small and medium-sized businesses while also helping the rediscounting of small bills that small businesses rely on for funding. This should further energise economic activity as these small, privately owned businesses are the most dynamic part of the Chinese economy.
Something about how policy works in China tends to produce over-shoots during stimulus and undershoots when the policymakers attempt to cool the economy — probably because of the blunt nature of the policy tools available. We would not be surprised to see an overshoot again, with the recovery well ahead of market expectations.
Third, global business confidence is likely to recover
If both the US and Chinese economies gain momentum, business confidence around the world will improve. This is really important — our view is that the dominant reason why the global economy slowed late last year was the damage done to entrepreneurs’ animal spirits as a result of so many areas of risk, including slower growth in the two key engines of the US and China, an ugly trade dispute between these two powers, worries that monetary policy in the US and eurozone might be tightening too fast and unease over Brexit.
Now we have a situation where not only are the two giant economies rebounding, many of the other risk factors also seem to be stabilising. Both the US Federal Reserve and European Central Bank (ECB) have stepped back from tightening monetary conditions. Following intensive negotiations, it looks like a US-China trade deal is taking shape and could be signed by early May. Brexit remains a source of great uncertainty but a damaging no-deal Brexit is now unlikely.
Fourth, emerging economies ex-China are improving
Not many realise that the largest emerging economies today collectively account for a larger share of global output than China. The good news is that the lead indicators are consistent in seeing a synchronised economic bounce in India, Brazil, Russia, Indonesia, Saudi Arabia and Vietnam. Even Turkey, currently in the throes of a deep downturn, looks poised to return to growth by year-end. Argentina, another economy suffering great distress, is expected to stabilise as well in the second half of the year.
Fifth, the global electronics cycle, so important for Asia, could soon turn around
Electronics production, an important part of manufacturing in East and Southeast Asia, has been held back since mid-2018 as businesses chose to run down inventory to meet demand, thus cutting back on current production. Of late though, there are more reports suggesting that this inventory adjustment is reaching an end. As demand continues to grow and inventories reach a level that producers are satisfied with, production will grow again and that will flow through to stronger growth in Asia.
What could go wrong?
Sadly, the world is not short of flash points that could upset the global economy. There are two areas that we are most concerned about.
First, oil prices have been rising gradually, but persistently, in recent months. So far, they remain within a sweet spot — high enough to keep the oil exporting nations in good shape but not yet high enough to damage the majority of countries, which are consumers. The risk that a spike in oil prices would take us out of this sweet spot to levels that would slow global growth is rising because of political convulsions that threaten the supply of oil reaching consuming countries — or the transportation of oil to consuming countries.
The past week has seen a series of incidents that highlight this escalating risk. In Libya, fighting has intensified and the capital city is under attack. Opposing militias are countering this by threatening oil terminals under the control of their opponents, directly threatening the supply of Libya’s highly-sought “sweet” oil that European refineries rely on. A terrorist attack in Saudi Arabia’s eastern province — where much of its oil is produced — was another reminder of how parlous the supply of oil could be.
And if all this was not enough, Iran’s Revolutionary Guards have warned of retaliation following the US decision to label them as terrorists. The Guards had in the past warned that they could target shipments of oil through the Straits of Hormuz. The Hormuz Straits may seem very far away to us, but about a third of the world’s oil trade passes through these straits, so anything that disrupts these shipments would cause mayhem in the oil market.
Our view is that in the case of a crunch in oil supply, there is enough spare capacity in Saudi Arabia, Russia and elsewhere to allow supply to be ramped up quickly, thus limiting the damage these political risks could inflict on global growth. So, while these are certainly salient, the chances that a politically induced spike in oil prices will send the global economy reeling are low.
Second, could protectionism still hurt world trade even with seeming progress towards a US-China deal? Regrettably, the answer is yes. Despite the recent progress in trade talks, US President Donald Trump could still calculate that a harder line with China could force the latter to make even more concessions, which he needs to show his electorate that his strongman tactics work. After all, campaigning is already starting for the US presidential elections although they are a year-and-a-half away.
And, even if the US and China strike a deal, we could still see an upsurge in trade frictions hurting other regions. For example, Trump has threatened to impose restrictions on European exports because of a dispute over aircraft manufacturing. He has already said he would consider raising tariffs on European, Japanese and other auto exports — and Europe has warned that it would not hesitate to retaliate robustly against the US.
It would be a big mistake to underestimate this risk. Still, Trump wants a strong economy and lots of fizz in financial markets to sweeten the mood of his voters. That puts a limit on how far he would go with protectionism. Every time there is a material risk of trade frictions, stock markets seize up and business leaders warn of a slowdown — and the US president is very sensitive to these moves.
The bottom line: A stronger-than-expected turnaround in global trade will boost our region
All things considered, our baseline view is that global demand will pick up steam more strongly in the coming months. This will reinvigorate the regional economies through many channels.
First, as global demand improves, the manufacturing sectors will see stronger demand. We could also see more confident consumers willing to travel abroad for tourism, stimulating a sector that is important all across Southeast Asia. Second, the prices of economically sensitive commodities such as coal, rubber and base metals will rise, yielding more income and stronger exports. Third, better business confidence should result in more investment including foreign investment.
On the other hand, stronger growth could persuade some central banks to start raising interest rates again. However, having only recently shifted their policy stances, we cannot see the US Fed or ECB in a hurry to tell us that they are making yet another U-turn in policy.
In short, we should see the pessimism over economic prospects giving way to renewed optimism by the middle of this year.
Manu Bhaskaran is a partner and head of economic research at Centennial Group Inc, an economics consultancy