The Boao Forum for Asia 2017
2017: A ray of hope amidst uncertainty
The latest trade data show China's imports and exports have rebounded strongly and the trade surplus remains high, proof of the economy's resilience.
Both the global economy and global trade look likely to outperform expectations in 2017.
The US economy is looking up, although where President Trump will find the funds for his ambitious agenda is still unclear. The stimulative impact of his tax cuts and infrastructure spending may combine with new trade restrictions to drive up inflation.
The latest trade data show China's imports and exports have rebounded strongly and the trade surplus remains high, proof of the economy's resilience. But the significant trade imbalance with US is a big potential source of conflict. China could mitigate this by offering the US greater market access and helping fund a part of the US's infrastructure projects.
In spite of uncertainties in the Sino-US relationship, the general economic outlook for ASEAN countries is positive this year. That is mainly because global demand will pick up, boosting export sectors, and domestic drivers of growth are likely to be more positive too. However, the prospect of protectionism in the US is a real threat.
The pick-up in commodities prices is already having a positive, visible effect on the Australian economy. However, there are some uncertainties: Australia's growth is tied to the Chinese economy, which is currently in a transition. And there is a risk of growing protectionism from the United States. But chances are that either these potential problems don't occur, or that they won't be big enough to derail the 2017 outlook for smaller developed economies such as Australia's.
The future looks brighter than it did a year ago – yet it is also much more uncertain. On the bright side, the world economy is in much better shape than it was, and this is likely to spill over into world trade. The US economy is also looking much stronger than it has been in a long time, and the surprise election of Donald Trump has had a positive effect on markets there. His stated intention of improving infrastructure in the US has also been received positively. On the other hand, his protectionist remarks have created worries among many countries (not just Mexico and China).
So what are the likely policy changes in the US? How will they affect Asia's economies which are critically dependent on China's growth?
The election of a new US president, particularly one of a different political party than the predecessor, comes with the expectation of a shift in policies. While the formulation and timing remain uncertain, the following broad policy changes are likely to be debated this year and possibly enacted given that the president's party controls both houses of Congress.
- Corporate and personal income tax reform—While the top rates for both types of taxes will likely be lowered, the details will determine what the final impact on individual tax bills will be. The details will also ultimately determine how stimulative to the economy (and how costly to the Treasury) the actual plan will be.
- A federal infrastructure spending program—No specific details of the spending program have yet been announced, but a spending program would spur economic growth over what it otherwise would have been.
- Review of existing trade deals and a move toward bilateral enforcement—The United States currently has free-trade agreements (FTAs) with 20 countries. In 2016, the United States had a trade deficit of USD 502 billion, comprised of a USD 750 billion deficit in goods trade partially offset by a USD 248 billion surplus in services trade. Any action by the United States to withdraw from or fail to abide by the terms of an existing FTA could invite counter- measures, putting at risk some portion of the USD 2.2 trillion in goods and services that the United States exports annually.
- Increased immigration enforcement and stronger border controls—Policies that former President Barack Obama put in place regarding enforcement under executive directives or executive orders are in the process of being rescinded. It is not certain what other actions will be taken to increase enforcement, but President Trump remains committed to building a wall on the US-Mexican border.
- Repeal and replacement of Obamacare—Popular provisions of the 2010 Affordable Care Act (Obamacare), such as the ability to keep young adults on a parent's health insurance plan until the age of 26 and guarantee of coverage for preexisting conditions, will most likely remain in the American Healthcare Act (ACA)
- Regulatory reform across agencies—One of the first actions in this area will likely involve substantial changes to the 2010 Dodd-Frank Wall Street Reform.
Following the election, the major US stock indices reached new heights on expectations of at least some of these actions actually being taken. But with the economy nearing full-employment, there is also an increasing awareness that some of these actions, particularly the stimulating impact of tax cuts and infrastructure spending, along with new trade restrictions may be inflationary.
We estimate that the Federal Open Market Committee (FOMC) will raise rates three times this year (25bps each). However, should inflation start accelerating at a rate that alarms the FOMC, rates might increase faster and possibly in larger increments than would otherwise be the case. This would negate some of the stimulus impact of lower taxes and increased government spending.
One of the biggest unknowns is how the new administration and the Congress will choose to pay for the tax cuts and infrastructure spending. Federal deficits will be significantly larger if Congress passes large tax cut and infrastructure spending bills without taking steps to curtail spending. Even without these changes, the budget deficit was on track to rise because of projected rises in social security and Medicare spending, reflecting an aging population.
Although the new administration may cut other entitlement programs such as medical care for the poor (Medicaid), changing the long-run path of the budget without reforming social security and Medicare will be difficult.
After a troubled year deflating housing bubbles, stabilizing the currency and keeping a tight rein on the stock market, the latest trade data surprized policymakers. It showed that, not only does the trade surplus remain high, but also both exports and imports have rebounded strongly.
This strong performance on the trade front comes against the backdrop of (1) regional governments in Asia supporting trade liberalization and integration; and (2) leading indicators of global trade (such as container movements and port volumes in emerging Asian economies and China) have shown signs of recovery since last summer. China's trade surplus is also bolstered by the continuing depreciation of the RMB exchange rate against the dollar.
However, this large trade surplus has made trade imbalances between China and the US the single biggest sticking point (USD 250 billion in 2016, accounting for more than half of the total trade deficit of the US that year) in the Sino-US relationship. It is highly unlikely that there will be a full-blown trade war between the two largest economies in the world. Yet there is a high risk of developing trade "friction" as top leaders in both countries become more assertive. Already several leading domestic think-tanks in China have highlighted “external risks” (a euphemistic reference to the evolving and complicated Sino-US relation) as the top challenge of this year.
But China is not alone. a number of countries (Mexico, Japan, Germany and China) have also been singled out by the US president. Mexico has taken the brunt of US criticism so far resulting in the peso plunging by 16% since the US elections.
China is no Mexico however -- for several reasons:
- First of all, it is easier for the US to put pressure on countries that are smaller than them and which tend to benefit more from freer trade.
- Second, it is a well-known fact that China's large trade surplus with the US also reflects a complicated global supply chain which benefits many US companies (Apple is a primary example) far more than China itself.
- Third, it is almost certain that China would retaliate should the US actually start a trade war (for example, by adopting a sweeping increase in tariffs against Chinese imports). In addition, it is difficult for the US to accuse China of currency manipulation, because China has been trying extremely hard to push the RMB exchange rate higher for over a year, even at the cost of halting the RMB's internationalization and hurting domestic trading companies which rely on trade finance facilities.
If the chief objective of the Trump administration is to "bring back jobs to America" and substantially narrow the bilateral trade deficit with China, the mechanism cannot be a simplistic repeat of the 1985 Plaza Accord which resulted in a rapidly appreciating Japanese yen. A much stronger RMB would have a devastating effect on the Chinese economy. Although China's economy is quite resilient, it is still far from being balanced, with a number of looming challenges such as de- leveraging and maintaining financial sector stability.
Favorable liquidity is like anesthesia given to a patient who is undergoing surgery. In other words, structural reform cannot proceed smoothly without cheap money, and certain non-performing assets can only be turned around through reflation or inflation and economic growth. But as China is stabilizing the RMB exchange rate by allowing its reserves (USD 2.99 trillion by January 2017, down 7.2% from a year ago) to run down and tightening capital controls, liquidity conditions are worsening.
In theory, the current economic conditions in China call for a more accommodative monetary policy (meaning lower interest rates and cheaper RMB), but in practice this is less feasible due to domestic and international constraints. A stable exchange rate is seen by policymakers as a precondition of market confidence. This means more regulation at home.
For example, the latest development in the continuing saga of deflating bubbles is that the Government has announced a series of policies limiting real estate financing in 16 cities (including Beijing, Shanghai, Guangzhou, Xiamen, Nanjing and Fuzhou) where property markets are seen to be overheating. The rationale is that the bulk of such trust products originated from bank loans but have been subsequently repackaged. Regulators clearly view such "regulatory arbitrages" as reckless risk taking behavior which will undermine China's financial stability. The policy responses from the People's Bank of China (PBOC) are basically of the ''credit tightening without resorting to outright interest rate hikes'' type. That said, the bottom line is that it would be fundamentally against China's economic interests for the RMB exchange rate to be set at an artificially over-valued level and therefore China will probably not succumb to pressure from the US.
On the other hand, there are several measures that China could initiate to achieve a substantial reduction in the trade imbalance between China and the US. This could be achieved by greater US exports to China or less Chinese exports to the US or both. From China's perspective, the US has long blocked exports of its high-tech products to China. From the US's perspective, China has not opened up its domestic market adequately to American companies (for example, in health care, financial services and entertainment) and has not lived up to its pre-WTO promises. Under the Trump administration, we are unlikely to see an increase in exports of US high-tech to China if the latter does not significantly improve market access. Moreover, the US could argue that China should at least be reciprocal in terms of giving US Internet companies more access to the domestic market.
So what are China's bargaining chips? The Regional Comprehensive Economic Partnership (RCEP) is being championed by China, and it may gain acceptance by some emerging Asian economies. However, it has little appeal to the US. Can China help the US with President Trump's much- trumpeted infrastructure spending program? The answer is a resounding yes. China could easily help fund part of such an infrastructure program. It also makes economic and geopolitical sense for China to engage US companies in some of its Belt and Road related infrastructure projects as a trust-building effort. At present these projects are being undertaken in the typical Chinese way of "learning by doing and doing by learning".
Sharing resources, technology and know-how for building infrastructure might well prove to be a ''win-win'' situation for both parties. However, collaboration between China and the US on infrastructure spending (in both the US and emerging economies) cannot be expected to yield dividends in the short run. So, for a Trump Administration looking for quick wins, China's market access is indeed the most important bargaining chip. With China firmly in the category of "trade surplus countries", meaning that trade frictions will not vanish, and these will in turn exacerbate capital outflows, the best policy response for China to mitigate such "imbalances" is a meaningful market access which could also reignite reform momentum within the country.
Prospects for ASEAN economies are improving this year as global demand picks up, boosting exports.
Domestically, 2017 should see a partial reversal of the past two years which had seen the full contractionary effect of falling commodity prices – hurting rural incomes and purchasing power, and forcing ASEAN governments to rein in government expenditure as commodity-related revenues fell. But that cycle has since turned. For example, crude palm oil and rubber prices, which are key in Indonesia, Malaysia and southern Thailand, have risen sharply.
And it isn't just the business cycle that is lifting. Recent years saw reforms adopted. Even better still, the initial disruptions accompanying those policy changes have already settled, leaving the way clear for better structural policies to be supporting ASEAN growth in 2017.
For example, recent years saw ASEAN governments courageously push reforms whose short term effects harmed growth but whose long term benefits are now beginning to be more visible. Indonesia slashed fuel subsidies in early 2015 which depressed consumer confidence for some time. Malaysia introduced its goods and services tax in 2015 as well, with similar dents to consumer confidence while also cutting back on poorly targeted fuel and other subsidies. Several countries including Malaysia and Singapore introduced measures to rein in consumer debt which had been growing too fast while also putting controls on the runaway housing sector. The worst effects of all these have been absorbed by now.
Governments in almost every ASEAN country are now ramping up infrastructure spending – even in Singapore where infrastructure is already good. Thailand's mega transportation projects will also become operational this year. All this will boost growth directly – but the indirect effects of elevating business confidence and so "crowding in" private investment could be even stronger. As a result it is highly likely that in most countries, inflation will return, and deflation fears will ebb.
On the international front, global growth will be higher this year compared to 2016 and this will have a positive effect on trade, thereby also helping boost growth in ASEAN economies.
The US economy is now recovering strongly and is likely to accelerate further as growing business optimism fuels a comeback in capital spending, the missing ingredient in US growth so far. If the Trump administration and the US Congress follow through on tax cuts, higher infrastructure and defense spending and deregulation without sparking off a trade war through protectionism, the US economy will see a even stronger growth.
This US recovery is unfolding in conjunction with a firmer recovery in the Eurozone and Japan, helping to reinforce these latter recoveries as well. The Eurozone and Japan are also aided by oil prices remaining in a sweet spot and by weaker currencies. Add in the possible rebounds in large emerging economies such as India, Brazil and Russia and well above half of the global economy will be enjoying a better year in 2017 than they had in 2016. Provided we do not see a rise in protectionism, there will be a spillover from global output expansion into trade, and ASEAN countries will benefit directly.
That isn't, by the way, a mere hope. The data is already showing these uptrends, with visible signs of global trade picking up:
- Leading indicators for world trade – such as container and air cargo volumes, trade in electronic components and export orders – are already signaling a rise.
- Rising capital spending will boost trade with ASEAN economies as capital equipment manufacturing relies more on imported intermediate components.
But, there are significant uncertainties which could completely reverse the positive trend in trade.
- The Trump administration appears to be serious in wanting to shake up the way it approaches its allies and other interlocutors. What worries ASEAN leaders is a rise in protectionism against them. But, for now, most ASEAN economies do not see themselves at risk in the same way that China and Mexico might be as they are less prominent in terms of bilateral trade deficits or weak currencies.
- Given the uncertainty over what the Trump administration will do in terms of relations with allies or attitudes towards rivals such as Iran, it might be tempting for some of America's interlocutors to push the envelope in some areas so as to test the new administration's resolve. This could create unpleasant shocks to global business confidence.
As a result of trade tensions and rising uncertainty, financial conditions could become unstable, precipitating several shocks to markets.
There are several reasons to expect continued and perhaps more frequent financial shocks.
- First, the US central bank will almost certainly have to step up the pace of monetary tightening – as US bond yields rise and the US dollar appreciates further, financial conditions in emerging markets which raised borrowing substantially in 2008-2015 will tighten, hurting corporate cash flows. Capital will tend to flow out of emerging markets, causing disruptions in asset prices and further depressing local currencies.
- Second, global inflationary pressures are rising and this could also feed through to expectations of faster monetary policy normalisation even beyond the US.
- Third, while the Chinese economy is stabilising, it will experience ups and downs in the near future. Investor speculation about the trajectory of its economy and currency could create further volatility especially in the currency markets.
- Speculation of Chinese yuan devaluation or its actual weakness will certainly create downward pressures on ASEAN currencies such as the Indonesian rupiah, Philippine peso, and Thai baht. But these currencies have become more resilient over time due to improving fundamentals such as strong external accounts, growing credibility of their central banks and much better overall policies
But ASEAN economies have improved their resilience to such shocks.
- The key elements of resilience – economic diversification, strong financial buffers, room for policy response – have improved in most cases.
- Compared to the sharp swings in equity, bond and currency valuations during the taper tantrum of mid-2013, volatility in ASEAN financial markets has been more restrained in 2016. The Indonesia rupiah for instance has been a relatively good performer despite the series of shocks which caused other emerging market currencies to take severe hits.
- Greater integration with likeminded countries. Given the US pullout of TPP, ASEAN nations will explore other options, including pushing a bit more aggressively for RCEP to be concluded and for it to be more comprehensive in scope than some other nations, like India for example, might wish for. Since they are likely to fail in that, and since RCEP is not likely to have much economic punch, the other option is to consider more bilateral deals with each other and other major partners such as Europe. But that too has a limited effect given Europe's pre-occupation with Brexit and its own troubles. Bilateral deals with a bullying Trump administration may not work either. The greater likelihood is that likeminded economies in ASEAN such as Malaysia and Singapore cut more bilateral deals between each other.
Until now the TPP has been the main game for Australian trade policy, with the RCEP seen merely as ''TPP-lite''. But if the TPP is soon seen as dead in the water, then Australia's obvious Plan B is to consider joining the RCEP. So far, however, Australia hasn't given up. The response of the Australian Prime Minister to the withdrawal of the US from the TPP was that "Certainly there is the potential for China to join the TPP … There is also the opportunity for the TPP to proceed without the United States". Australia has also been pushing for Indonesia to join a revamped TPP process as well. Yet, provided it doesn't rapidly slide into a tariff war, this new round of diplomatic manoeuvring over trade isn't really a risk to Australia's 2017 outlook.
Why not? The world and Australian economies faced some major shocks over the past decade, including a range of economic upheavals and political storms. That perspective is important, because it is a reminder that the risks to the 2017 outlook may well not be triggered or – even if they are – that they will not be as bad as some of the tempests of the past decade. Sure, it is relatively easy to conjure up scenarios in which the dry underbrush of the moment is set alight.
Yet the most likely set of outcomes around the globe in 2017 is actually happier news than is generally recognised:
- President Trump has inherited an economy with a degree of momentum. Moreover, if the new President prioritizes infrastructure spending, trade will get a boost.
- And China's economy has also gathered speed in response to a range of stimulus measures.
- Even more importantly, across the last nine months – a period in which global politics has been compelling theatre – there have been growing signs of economic improvement.
The IMF sees faster global growth this year than last year. In fact its latest forecasts, issued in January (http://www.imf.org/external/pubs/ft/weo/2017/update/01/index.htm), upgraded its global growth forecasts for 2017. In addition, a range of leading indicators already pointed to developing momentum for global trade.
These cross-currents may already be seen in the Australian economic landscape. The earlier phase of slowdown in China's economy combined with a pickup in global supply of resources saw industrial commodity prices fall sharply from their 2011 peaks. This in turn led to a sharp squeeze on Australian national income growth. Subtract inflation and population growth, and what one got was real living standards in Australia dropping between late 2011 and mid-2016.
But that ''income recession'' is already fast disappearing. Better commodity prices have seen national income growth rebound sharply, and there appears to be more good news on the income front for Australia in the pipeline. Australia's trade balance moved out of its customary red ink firmly into the black in late 2016, and it seems set to stay there through 2017.
And with incomes finally growing for the first time in a while, that should underpin solid growth outcomes.
That said, the boost to Australian growth from lower interest and exchange rates is starting to lose steam – housing construction is nearing its peak, and retail's run is moderating.
On balance, that mix should keep the home fires of growth in 2017 burning by enough to leave unemployment relatively steady, and by enough to see Australia move past the Netherlands to record the world's longest ever spell without a recession.
i.Bureau of the Census and Bureau of Economic Analysis, US Department of Commerce, "U.S. international trade in goods and services, November 2016," http://www.census.gov/foreign-trade/Press-Release/current_press_release/ft900.pdf.