SINGAPORE (Sept 16): In a global economy that is in constant flux, no one can be certain of where it is headed and what it has in store for the Asian economies. But some things are clear. One is that global economic activity has slowed to a pace where there is more downside than upside and where policy responses are unlikely to be fully effective. Moreover, growth in the large developed economies is more internally focused and so does little to support demand for Asia’s exports. This sounds bad for export-oriented Asian economies, and it is — but there are some silver linings that suggest that the region can still eke out modest growth and avoid a recession.

Dangers lurk in global economy: growth, currencies and financial risks

As far as growth is concerned, we know that the world economy is slowing. What is more interesting is to discern the patterns within this deceleration.

Across the board, the lead indicators are telling us that there will be more weakness ahead. But note that the Organisation for Economic Co-operation and Development’s tried and tested composite lead indicators do not suggest an outright recession in any major economy. Some analysts interpret the inversion of the yield curve in the US as a signal of an impending recession. We disagree — this indicator is not as accurate as some believe. But, more importantly, this indicator has been so distorted by the massive quantitative-easing policies of central banks that it can no longer serve as a reliable lead indicator today.

The two largest economies, the US and China, are holding up better than more trade-dependent economies such as in Europe and East Asia. In particular, their services sectors not only remain vibrant but even showed signs of picking up speed in August — their pipeline of new orders seems to be filling up and services businesses are stepping up hiring. The surveys show that, in the US, service providers seem little perturbed by the trade war, while in China their optimism for the future has risen to the highest level since March.

However, even in these giant economies, import demand is waning. Business surveys show new orders for imported inputs at a low ebb for manufacturers in both the US and China. Basically, what seems to be happening is that demand in these economies seems to be tilted in favour of domestically produced services rather than imported goods. There is a good reason for this. Generally, including in the US and China, businesses are holding back on capital spending as a result of uncertainty. While investment is growing more slowly in the US and China, it is contracting sharply in countries such as Germany, which are more dependent on the global trade cycle. Our analysis has found that Asian exports of manufactured goods are well correlated with capital spending in the big economies rather than consumer spending; so a dearth of investment spending is bad news for Asia.

Not surprisingly then, the lead indicator we use to forecast global demand for Asian exports has continued on a downward trajectory.

Another important change for Asia is the palpable rise in currency risks. There are two reasons for this:

  • First, China has signalled that it is prepared to let its renminbi weaken, giving up a long-standing policy of actively shoring up the renminbi at stronger than 7 to the US dollar. So, the renminbi will be more volatile henceforth. But it is also more likely to depreciate over time, as China’s large current account surpluses are now a thing of the past. While China is unlikely to suffer a serious current account deficit, the surpluses will be small and will no longer support the renminbi. A weaker renminbi also helps to offset the higher tariffs that the US has imposed on China — but it puts downward pressure on Asian currencies.
  • Second, the weaker global economy is hurting the more vulnerable emerging economies whose currencies have been depreciating. The most dramatic example is the Argentinian peso, which has lost a third of its value this year. Should things get worse in the world economy, other vulnerable currencies that have held up so far, such as the Turkish lira, could fall as well. As more emerging economies cut interest rates, their currencies could also edge down. Such currency concerns have an impact on Asia — they will limit Asian central banks’ freedom of manoeuvre in reducing interest rates to support economic growth.
Finally, financial risks are rising as lacklustre economic performance squeezes profit margins and depletes cash flows of highly leveraged companies. In the US, earnings growth is coming under pressure and there are small signs that highly leveraged companies are suffering. The total number of loans trading below 90 cents on the dollar, which signals elevated default risks, grew to 10% in August from 6% a year before. In China, three small city banks had to be bailed out in the past three months, with some reports suggesting that 20 more such banks may be in trouble. Local government finances in China are also under strain as the real estate-related revenues they depend on have fallen.

Policy responses seen so far unlikely to reverse global slowdown

Policymakers are relying mostly on monetary tools such as rate cuts and liquidity increases to offset the global headwinds. But there are problems with this stance:

  • The trouble is that these monetary responses do little to thwart the fundamental loss of business confidence caused by the trade wars, China’s economic deceleration and impossible-to-predict geopolitical risks such as the imminent Brexit or slow-burning crises such as the Middle East and Hong Kong’s protests.
  • Moreover, monetary policy seems to be less and less effective. In China, despite all the measures that the authorities have tried, the economy continues to slow. Over the past few years, China has needed stronger and stronger monetary growth to achieve a given growth rate. Similarly in the US, the evidence seems to show that each bout of quantitative easing had less and less effect.
Knowing this, we may see governments resorting to fiscal measures to boost growth. Even Germany, which has been extraordinarily conservative in government spending, is looking into a fiscal package of some kind. However, fiscal debt is already high in most developed countries, which places a limit on how far fiscal policy can be used to stimulate economic growth.

So, what should we expect for Asia?

We do not see much relief to the uncertainty that is insidiously undermining the global capital spending that drives much of Asian exports. Sure, there might be some progress in the trade talks between China and the US — probably by early 2020. But it will be a surprise to us if that deal — if it materialises — can really soothe the fears of global corporations. US-China frictions are the result of a contest for strategic advantage that will last many years and therefore go well beyond trade. Already, there are conflicts over technology and alleged currency manipulation. There will probably be lots of other areas in which the two countries will clash — for example, China buying Iranian oil in defiance of US sanctions. If anything, the other geopolitical concerns such as Brexit and the Middle East can only intensify. There will be many reasons therefore for corporate leaders to defer large new investments.

Consequently, global economic activity will slow further to a pace where any unexpected idiosyncratic shock could cause it to tumble into a recession. Experience shows that businesses and financial markets are slow to anticipate geopolitical and financial stresses that build up slowly under the surface, and when these risks eventually crystallise, the shock causes a sharp cutback in spending, which aggravates a slowdown.

Moreover, when growth slows and there is a large burden of debt — as is the case in the global economy — the chances are that some financial imbalances could be aggravated, resulting in a shock of some kind.

Clearly, all this means that the external sector will act as a drag on Asian economic performance well into 2020. Major exporting nations in the region — South Korea, Taiwan, Thailand, Malaysia and Singapore — will face slower economic growth, if not outright stagnation. Others such as India and Indonesia will be relatively insulated because of their lower exposure to exports but will be faced with other difficulties. For instance, currency volatility in emerging markets could bring pressure on their exchange rates.

Are there any silver linings?

Yes, there are three factors that help Asian economies.

The first is that Asia’s dependence on exports has actually declined since the global financial crisis, pretty much across the board in Asia. In other words, domestic demand has become more important as a growth locomotive, and that helps to contain the damage caused when the export engine is sputtering.

Another supportive factor is the wave of production relocation out of China. Initially, this was muted as companies made plans to move production but waited to see how the trade war panned out before actually pulling the trigger. Now, it looks like many companies are deciding that they can no longer wait and production is actually shifting.

Probably as a result, manufacturing investment approvals in emerging Asia have surged — in Taiwan by an astounding 275% and in Malaysia by 71.8%. There has been strong performance elsewhere as well — Vietnam, 54.2%; the Philippines, 58.2%; and Thailand, 23.7%. As investment approvals translate into actual construction of factories followed by expanded production from these new plants, economic growth will be supported. Stronger investment has already shown up in stronger-than-expected GDP growth in Taiwan in the second quarter.

A final silver lining is the emergence of alternative growth drivers that are less dependent on trade in goods. Infrastructure development is clearly a stronger engine of growth in many parts of the region. In addition, exportable services — such as business process outsourcing — continues to grow rapidly in India and the Philippines. In Singapore, the expansion of digitalisation and success of fintech start-ups have also provided some resilience to its economy.

The bottom line: Certainly, Asian economies will suffer slower growth this year and next, but we believe that there is enough resilience for the region to avoid a recession.


Manu Bhaskaran is a partner and head of economic research at Centennial Group Inc, an economics consultancy