Economic outlook Voice of Asia, March 2018

China

A stronger US economy and synchronised global recovery worked well for China in 2017, but the economy is likely to slow in 2018 for two reasons. First, having prioritised containing financial risks in the wake of the 19th Party Congress, the government is likely to restrain credit growth, which could hurt growth in the short term. Second, the excellent economic performance in 2017 (growth of 6.9 percent)¹ provides a high base, making it difficult to repeat that performance. However, such a slowdown will be welcome if policymakers succeed in reining in credit growth and meaningfully liberalising the financial sector so that foreign capital can help deleveraging. Given China's tight labour market and consumers' immense room for taking on debt, a lower GDP growth target is the best way to mitigate risks of a Minsky moment. The government is also expected to use the fiscal lever to alleviate poverty, as pledged in the 19th Party Congress.

The challenge is to stay the course on policy, especially with regard to deleveraging the corporate and local government sectors, and avoiding the temptation to extend stimulus at the first hint of a slowdown—say if housing cools abruptly. Another risk is that America’s tax overhaul diverts away foreign investment. Moreover, if the tax reform produces larger fiscal deficits, the US Federal Reserve would be prompted to be more hawkish, precipitating capital outflows from emerging markets, including China. Given these challenges and rising global interest rates, the best policy responses are to embrace a slower GDP growth target and to use the RMB as a shock absorber. The broad-based correction of the USD over 2017 has put the RMB at a two-year high, potentially giving authorities some leeway to permit the RMB to depreciate and delay interest rate rises amidst the US Federal Reserve's tightening cycle.

Hong Kong

Hong Kong’s economy has been supported by the synchronised recovery of the world’s developed countries and the stabilisation of the Chinese economy. Economic performance in 2018 is likely to be a continuation of 2017 as the global recovery broadens. Moreover, Hong Kong’s greater integration with China through the Greater Bay Area initiative will enhance economic prospects in the longer term.². Hong Kong will gain synergies from the strengths of cities such as Shenzhen, Guangzhou, Huizhou, and Zhongshan within the Bay Area, while demand for its services such as financial, public health, and transportation management will grow.

Given the HKD’s peg to the USD, local asset markets will be volatile, held hostage to perceptions of the trajectory of USD interest rates. However, even assuming four rate hikes in the United States in 2018, continued recovery implies that real interest rates could fall, as inflation will rise.

Housing affordability has become an increasingly acute issue for the SAR government in recent years, so higher interest rates will present less risk in 2018 than in the past. In fact, the SAR government could increase land supply if the housing market frenzy does not abate. In short, Hong Kong could well stay in a sweet spot in 2018.

The final challenge for Hong Kong remains the dilemma of how to integrate further into China’s economy while still maintaining the "one country, two systems" formula that has served it so well.

Japan

The Japanese economy is expected to stay buoyant during 2018, supported by strong external demand; record-breaking corporate profits, which will power higher capital expenditures; and improving household income, which will drive consumer spending.

The prospects for inflation remain uncertain though. With the labour market at full-employment levels, continued strong growth in 2018 should put upward pressure on prices. Also, the government is using tax incentives and moral persuasion to press corporations to accelerate wage rises. Much hinges on how Japanese corporations react to these pressures.

Structural reform and controlling the fiscal deficit are other important issues influencing the medium-term economic trajectory. Reforms such as loosening labour legislation, widening the range of households that qualify for free higher education, and facilitating access to childcare, aim to increase labour productivity and labour supply. However, the ballooning fiscal deficit remains a challenge; some combination of raising income and consumption taxes and reducing social security expenditures is needed.

Lastly, now that the Liberal Democratic Party (LDP) has secured more than two thirds of the seats in both the upper and lower houses, the Abe government is likely to propose constitutional changes through a national referendum in 2018 or 2019. The administration runs risks similar to those faced recently in the United Kingdom and Italy—with the government proposal being rejected by the populace and the sudden collapse of the ruling cohort. Long seen as a symbol of stability in Japan, the sudden collapse of the ruling Abe LDP government could be very destabilising for the country.

South Korea

In 2017, the Korean economy was in a recovery phase, driven by the global economic recovery and increased domestic demand. The Korean economy in 2018 is anticipated to continuously rise because of improving global economic conditions and the improvement of Korea-China relations, minimising the potential for economic damage caused by the THAAD missile issue. Additionally, the government's employment expansion policy, minimum wage hikes, prudent rate hikes, and Won appreciation are expected to help stabilise inflation and improve consumer sentiment. Consequently, a 2.5–3.0 percent GDP growth rate is expected in 2018.

In terms of industries, semiconductors will stay strong and contribute to the export market recovery. The automobile industry is expected to gradually recover after a tough period in 2017. The consumer goods and retail industries will grow as consumer sentiment improves. Nevertheless, the slowdown in construction and facility investment will bring negative impact to the construction, steel, and associated industries.

To continue strengthening and maintaining the economic recovery, it will be necessary for the government to foster high value-added industries, strengthen technological competitiveness, and diversify export markets. Additionally, the prevention of excessive inflation and the establishment of a social safety net through quantitative expansion and qualitative improvement of jobs are crucial to stabilise the domestic market. As North Korea's nuclear tests are recognised as the largest risk factor to the recovering economy, policies should be implemented to resolve market anxiety and stabilise the market.

India

In many ways, 2017 was a defining year for the Indian economy. India completely reset its indirect tax system to a comprehensive GST while still experiencing the impact of the demonetisation shock of November 2016. The spike in GDP growth from 5.7 percent in the third quarter of 2017 to 6.3 percent in the fourth quarter suggests that the initially negative impact of GST and demonetisation may be waning.

Growth in 2018 is expected to be 6.8-6.9 percent,³ putting India once again among the world’s fastest-growing economies. With higher growth, we expect inflation to increase. Growth will be driven by private consumption, both urban and rural. The massive bank recapitalisation announced by the government is expected to increase private investment and create much-needed jobs.

Major external risks include oil price shocks, tax rate competitiveness, and growing barriers to trade. However, the Indian economy remains predominantly a domestically driven one, so the major downside risks will be domestic in nature, such as continuing disruptions from the implementation of the GST. The high levels of air pollution experienced in 2017 may precipitate policy measures taken to counter the “smog threat” which, in the short term, could cause more regulatory uncertainty and disruption in the economy.

In summary, after a year of disruption in 2017, 2018 is expected to be a year of consolidating the gains from recent reforms.

Taiwan

GDP growth is generally forecast to be in the range of 2–2.5 percent in 2018,⁴ maintaining this year’s momentum and supported by vibrant demand for exports in all categories, especially technology, where the demand for next-generation electronics products is expected to be strong. However, given the lower-than-predicted demand for new Apple products (in particular the iPhone X) this year along with mounting competition from overseas, particularly China, in electronics manufacturing, Taiwan will need to considerhow to move up the industrial value chain.

There was good news in this respect when machinery, accounting for 8 percent of exports, saw big gains in 2017 for the first time in a few years. Indeed, September 2017 saw a 56.5 percent year-over-year rise in the value of overseas shipments. Other major export industries (chemical products, plastics and rubbers, base metals) have also rallied after a few years of stagnation. The shortage of industrial land will continue to impact Taiwan in the next five years.

Consumer spending will also support growth in 2018, boosted by the government’s plans to increase civil service salaries by 3 percent and lift the minimum wage by 4.7 percent. Low inflation and tax reforms will add further momentum to consumer spending.

China is Taiwan’s top export destination, taking about 30 percent of all its exports. Therefore, China's new policy directions following the 19th Party Congress, as well as potential trade tensions with the United States, will impact export-dependent Taiwan. Deepening trade and investment links with other Asian countries will be a priority to decrease its economic dependence on China.⁵

Finally, as a highly open economy, Taiwan is exposed to geopolitical instability, whether in the Middle East or in North Korea. As 30 percent of Taiwan’s raw materials come from the Middle East and major supply chains are located in countries close to North Korea, these potential flashpoints are risks to Taiwan’s prospects in 2018.

Thailand

2017 was a remarkable year for Thailand as the economy clocked it’s highest GDP growth in more than four years. This was driven primarily by export vigour boosting industrial production, but it was also well-supported by a number of other economic pillars including tourism and public expenditure.⁶

Export strength in 2017 has persisted despite the rising baht (up approximately 8 percent in 2017)—this points to the inherent competitiveness of Thai exports vis-à-vis its trading partners and competitors. Strength will continue into 2018 as the global economy continues to gain momentum.

Private consumption will also shift into higher gear, as the mourning period for the late King Bhumibol Adulyadej has concluded. Furthermore, the reversal of farm income declines will add to steadily climbing levels of consumption. Private consumption will continue to be supported by robust tourism figures, with Thailand having welcomed 33–34 million international visitors in 2017.

A boost from the fiscal front will also materialise in early 2018 as large infrastructure projects, after some delays, are finally implemented. Rail, port and airport projects will commence in the months ahead, adding to cyclical investment and demand while raising the long-term potential for growth of the economy. Significantly, private investment has been on a nascent upturn after an extended period of sluggishness—a broadening of growth into capital spending and private investment will give the economic upswing an extra boost.

The Philippines

The Philippine economy was firing on all cylinders in 2017 and all the indicators point to this continuing in 2018. Solid growth in remittances and business process outsourcing will provide a continued boost to domestic demand as well. The government is also ramping up public investment in infrastructure to alleviate supply-side bottlenecks and allow businesses to tap into commercial opportunities in outer regions. The share of public sector spending on infrastructure has increased by one percentage point of GDP since the current administration took over, and private investment looks set to continue as well. For example, Metro Pacific Investments Corporation plans to invest as much as USD 16 billion through 2022 on road, water, and power projects.

Monetary policy remains accommodative as the central bank is confident it can contain inflationary pressures. High credit growth is not yet a risk to the economy as the Philippines remains a lowly leveraged economy.

The current account balance may turn into a small deficit in 2018, but it is well funded by rising inflows of foreign investment and is driven by productive spending. Having depreciated significantly in the past two years, the peso is now competitive and unlikely to further depreciate materially.

Political risks remain contained as well. President Duterte has sought to rein in vested interests that have held the country back while also working for peace agreements with Muslim and Communist insurgents in the south.

Malaysia

The economy is set to remain in a sweet spot and continue punching above its weight in 2018. As an open economy with a sizeable electronics footprint, Malaysia will be a clear beneficiary of the global cyclical upturn, which is expected to continue into 2018 with a pickup in capital spending. The government is also pushing ahead with ambitious infrastructure projects, which should improve competitiveness in the long term while providing the economy with considerable multiplier benefits in the next few years.⁷

The implementation of necessary, albeit unpopular policies such as the goods and services tax and subsidy rationalisation points to an economy that is competently managed by the government. Going forward, more certainty and policy clarity is warranted, particularly on the government’s blueprint for the future (that is TN50) to provide a clear policy direction to steer the economy.

As growth improves, monetary policy will probably be tightened. However, with price pressures holding steady and the current account remaining in surplus, there is little need for a sharp tightening.

Still, there are risks to monitor. Structurally, the government has to consider long-overdue reforms in addressing issues weighing on the economy’s competitiveness. The efficiency of government-linked companies (GLCs) needs to be improved while there is also a need to address human capital development to provide a fillip to productivity growth, particularly as Malaysia advances towards a high-income economy.

With general elections looming in 2018, there will be some uncertainty that could affect business confidence in the short term.

Singapore

The Singapore economy has enjoyed a tremendous rebound since late 2016 on the back of buoyant global demand and resurgent trade flows, underlining the high dependency this open and export-oriented economy has on the global economy, particularly the import demand of advanced economies. External drivers have boosted economic growth to its highest levels since 2013, with global manufacturing powering the upswing.

While proceeding at a gradual pace, external positives are increasingly spilling over into domestic sectors, pointing to a broadening of the economic expansion that makes it more sustainable.

Going forward, growth is expected to be driven primarily by the continued strength in trade. Singapore will also be supported by second-order positives stemming from robust export growth and modest growth in services. The construction sector will gradually turn around as the Singapore government accelerates publicly funded projects to provide the beleaguered sector with some vigour.⁸

As the economy gathers greater momentum, inflation surprises to the upside could become a concern should economic slack diminish and growth improve further. This means that monetary policy will likely be shifted in the next policy meeting in April 2018, from a neutral to a hawkish stance with a gradually appreciating slope. This will prevent the economy from getting ahead of itself and rein in potentially intensifying inflationary pressures.  

Indonesia

The uplift in the global economy has not translated into a sizeable boost for the Indonesian economy, given that it is primarily driven by domestic demand. However, it has been helped by higher commodity prices. Lead indicators point to stronger growth in 2018, as improving business and consumer confidence as well as the cuts in interest rates over the past two years produce stronger domestic demand. Tourism is also likely to continue being a strong growth driver.

Foreign and domestic investment will also be helped by improvements in the business environment. The reformist government has been on the front-foot in improving the legal and investment climate, as evidenced by Indonesia’s quantum leap (19 places) in the World Bank’s “Doing Business” ranking.

The government is also developing alternative growth engines. In the tourism sector, the government is seeking to diversify its excessive dependence on Bali by building “10 Balis.” Infrastructure development—which, although at the heart of the government’s agenda, has been slow to take off—should begin to move faster in 2018.

Risks to domestic and external stability appear contained. Inflation remains at historically low levels. The current account deficit may grow as investment picks up but should be sustainably funded. The rupiah has remained remarkably stable as well.

While the next presidential elections are due in April 2019, the administration of President Joko Widodo has renounced populist measures whilst also clamping down on threats to secularism.

Australia

Growth in 2017 was disappointing, but looking ahead, the outlook is more positive. Stronger global growth, particularly among Australia’s major trading partners, and the boost from infrastructure investment is expected to drive a modest pickup in growth. Furthermore, the drag from declining mining investment has now mostly played out.

While employment growth has strengthened and is expected to be a little higher based on indicators of further momentum from the labour market, wage growth is likely to remain below trend, which will continue to weigh on household incomes and consumption.

At the same time, high household debt continues to be a risk to macroeconomic and financial stability. While prudential policies have played a role in slowing housing credit growth and managing the systemic risks to the banking sector, developments in the property markets remain a concern, particularly in certain inner-city apartment markets.

On the other hand, inflation is expected to remain contained, so if housing market pressures can be managed, there is scope for monetary policy to continue to be accommodative. This, in addition to the flow-through from expected public infrastructure spending, should provide support to nonmining business investment.

Australia will remain particularly exposed to downside risks from China.

New Zealand

Recent trends in global trade indicate New Zealand will remain in a sweet spot over the next year, with good prospects for trade as global growth picks up, almost a decade after the 2008 financial crisis. Overall, the Reserve Bank of New Zealand forecasts solid GDP growth (3.6 percent) in 2018, but efforts to cool the housing market and an expected reduction in net migration could potentially stall this progress. Additionally, a looming change in monetary policy away from solely targeting inflation could cause uncertainty in the outlook for the cash rate and inflation.

As the world’s economic centre of gravity shifts towards Asia, underpinned by an emerging middle class and consumption-driven growth, New Zealand’s relative proximity to Asia, combined with strong cultural and economic ties, will allow it to benefit through increased Asian spending on the following:

• Tourism is New Zealand’s largest export industry and is projected to be one of the fastest-growing industries in the world. In 2018, New Zealand is expected to see increasing demand for tourism from Asia and greater impact from the sharing economy.
• Agribusiness is also expected to be among the fastest growing industries globally. New Zealand can be a long-term winner in agribusiness by focusing its strategy more on growing value than on growing volume.
• Advanced manufacturing has experienced significant growth in export earnings in recent years. In 2018, further growth is expected to be driven by health technology, in large part due to an ageing population and increased demand in agricultural technologies and other scientific technology.