SINGAPORE (Dec 24): After a year of wild gyrations in markets, shocking political developments and unexpected economic challenges, some analysts are even wondering whether there is any point in making forecasts for next year. Indeed, the margin of error is much higher around any judgement call on geopolitical risks, global economic growth, monetary policies of the major central banks, and how bad the trade wars might be. But these are the principal drivers of the global economy; like it or not, we have to get the best possible gauge of where they will head in 2019. So, here goes our effort.

Next year will see major geopolitical shocks

Pressures are building in key flash points, which means that there is a very high chance that one or more of these could reach breaking point.

First, in the US, special prosecutor Robert Mueller should complete his investigation of President Donald Trump’s 2016 campaign’s possible collusion with Russia to influence the presidential election that year. Recent court filings by Mueller’s team hint at awkward issues for Trump, potentially linking him to felonies committed by people acting on his instructions.

Our best guess is that while these may not warrant his removal from office, they would leave him politically wounded and too distracted to focus on running the country. The lower house of Congress will be under Democrat control from January: Not only will they limit Trump’s ability to push through any important legislation, the Democrats will also be able to conduct all manner of investigations into Trump’s conduct as president, further chipping away at his leadership.

Our concern for the impact on Asia is not so much what goes on in the US itself. The trouble is that its rivals will exploit the opening provided by a weaker US to make mischief — whether in parts of Asia, where the US and China are in a tussle, or in eastern Europe, where Russia might make an aggressive move in a place such as Ukraine. Either of this could cause turmoil in financial markets as global investors turn cautious and pull money out of risky asset classes.

Second, the Middle East is a seething cauldron of risks. The murder of a Saudi Arabian dissident in its consulate in Turkey’s main city of Istanbul has shaken the Saudi political leadership because of suspicions of high-level involvement in that act — Turkey and opponents of the current Saudi leadership will not allow this controversy to die, and there could be serious implications for political stability within Saudi Arabia. Not far away, Iran has been hit hard by US sanctions and efforts by its regional rivals to undermine its stability. It has responded by threatening retaliation, including disrupting shipping in the Strait of Hormuz, through which more than 30% of the world’s oil is transported — imagine what that could do to oil prices. Despite this threat, Israel is speculated to be preparing to attack Iranian positions in Syria or Iraq. There have been a number of terrorist attacks in Iran in recent months and, as economic conditions worsen under the impact of US sanctions, there could also be more street protests.

There is one thing that seems clear from this incomplete list of downside risks in the region: There is a good chance of a shock or crisis of some kind, which would drive up oil prices, with bad consequences for global economic growth.

There are many more places where political unpleasantness could erupt. Europe, for instance, has to deal with a chaotic Brexit as well as an Italian government bent on challenging the eurozone’s rules on budgets — if not resolved properly, either one could cause convulsions in equity and currency markets.

Global economic growth will slow, but just modestly

The growing pessimism about growth prospects in the world economy is understandable but probably exaggerated:

Lead indicators suggest that the US economy will continue to power ahead, growing at above 2%, well beyond the 1.7% to 1.8% pace that the Federal Reserve sees as sustainable and safe in the long term. Such over-rapid growth could persist even longer if two things happen, both with a reasonable probability. One is that Trump succeeds in persuading his Democratic opponents in Congress to support the one thing that both actually agree on — a big infrastructure spending push. And the second is if US companies ramp up capital spending — something that has been surprisingly weak despite the strong growth in the US and the expansion in profit-making opportunities created by the explosion of technological progress.

As we discussed in an earlier piece, the Chinese economy is facing strong headwinds. The data for November reinforces this view — risks are rising despite policymakers’ strenuous efforts to boost the economy. So, we expect the authorities to step up stimulus measures, which should maintain economic growth above 6%.

The eurozone and Japan economies are likely to slow but still turn in respectable growth rates.

The large emerging economies that had seen significant corrections in economic growth in recent years — India, Russia and Brazil — are set to regain momentum.

Reasonably good growth is clearly a positive for Asian exporting nations. But even in this “good” development, there are concerns.

First is that the composition of growth — a strong US economy but less vibrant Europe and Japan — could drive up the US dollar. A strong US dollar is not necessarily good for Asian economies, which gorged on US dollar debt in the past decade.

Second, China’s efforts to keep its economy growing above what we consider to be a safe speed will come with a cost. Its current account surplus has effectively disappeared this year. If policies ramp up investment and promote consumption spending over savings, then axiomatically China’s current account balance will weaken further. That could pose difficulties for the Chinese renminbi — if expectations for renminbi depreciation rise, then emerging Asian currencies would quickly come under pressure.

Third, we think global liquidity will tighten as a result, as we argue below.

Financial conditions will continue to tighten

Investors have taken solace from indications that the US Federal Reserve Bank may slow the pace of its rate hikes. But they may be disappointed. The US economy as mentioned above is likely to grow above its sustainable growth rate for most of 2019 — that means unemployment will fall and the labour market tighten even more, raising inflation risks. Too-low interest rates in such a strong economy could also encourage speculation and create financial imbalances. So, we think there will be at least two more rate hikes next year while the Fed will continue unwinding its quantitative easing — something the European Central Bank will also embark on starting in January.

Moreover, with global economic growth likely to cool only modestly next year, demand from businesses and consumers for liquidity will grow, diverting liquidity away from financial markets.

There is no escaping it — the plentiful global liquidity that sustained financial asset prices will fall, and that is bad for markets.

Trade wars — no nice outcome

The US-China trade spat blows hot and cold but has mostly got hotter. We think it will get worse. Sure, there will be occasional pauses for talks, helped by concessions made by either side as we are seeing currently. But the bonhomie will not last:

•             First, the two big powers are engaged in a struggle for global power, with the US political and business elite more or less united in seeking to contain the “threat” posed by China, even if they may not always agree on the tactics. One key area of competition is technology, where the strides China has made have rattled the US elite. That is why the chief financial officer of China’s tech giant Huawei was arrested in Canada for allegedly busting US sanctions on Iran — just as Trump was about to sit down to dinner with Chinese President Xi Jinping. The US has now succeeded in getting its major allies to limit Huawei’s business dealings in their countries. Progress in trade talks or not, this scrap over technology will go on;

•             Second, the US now considers China not a friend but a strategic rival out to displace it as a global leader. Worse still, it sees it as one determined to offer the rest of the world — including some countries that have been longstanding allies of the US — a different model of political leadership that goes against the American dream of a world that becomes progressively more democratic; and

•             Third, Trump’s expansionary fiscal policies mean the US economy will probably continue growing above potential for most of 2019. That will drive up the US external deficit — much to Trump’s chagrin. As the US deficit grows, the US administration will ramp up protectionist measures, with China still a major target even if it makes concessions such as cutting tariffs on US auto exports to China.

Apart from the tit-for-tat escalation of tariffs, mainly between the US and China but also involving other trading partners of the US, there is a second threat to global trade: the US assault on the World Trade Organization. As the US keeps vetoing appointments to the WTO dispute settlement system, there will soon come a point when there will not be enough judges to form a quorum to adjudicate trade disputes. The key WTO function — of providing neutral arbitration for trade disputes so that countries do not have to engage in trade wars to settle disputes — will break down. If it does, it could mark a return to the law of the jungle in world trade, an outcome that would be terrible for us living in a region where trade is the lifeblood. Unless there is agreement on reforming the WTO, the US may well go the whole hog and render the WTO ineffective.

Conclusion: Get ready for a rocky year

Southeast Asia is at the mercy of the global forces we have described above. It is an arena for big power rivalry, so the US-China struggle raises risks in the region. Most of the region depends on trade, which looks like it will face challenges. Countries such as Indonesia or the Philippines, which are less export-oriented, still depend on capital flows from the rest of the world, which could be at risk because of tightening financial conditions.

The hard reality is that there are considerable downside risks and we will just have to get used to it.


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 861, week of Dec 17) which is on sale now. Subscribe here