India: East & South Asia
Trade tensions and financial volatility threaten to undermine ESA’s economic growth
The East and South Asia (ESA) region continued to expand at a robust rate in the second quarter underpinned by solid domestic dynamics and a resilient external sector. According to a complete estimate for the region, ESA countries expanded an aggregated 6.4% year-on-year in Q2, which was a notch above the 6.3% increase reported last month and in line with Q1’s result. The readings in Q1 and Q2 represented the strongest increases in over three years.
This month’s upward revision to the region’s economic performance for Q2 reflected India’s stellar economic growth, which was the fastest in over two years. While strong manufacturing and construction activities propelled the economy in the April–June period, the surge in the period is also attributable to a low base from last year, when the economy was hit by the twin shocks of demonetization and a goods and services tax (GST). Against this backdrop, analysts expect that, despite remaining robust, economic growth will decelerate in the quarters ahead owing to financial turbulence and global trade tensions.
Global trade uncertainties are largely related to U.S. President Donald Trump’s erratic foreign policy. On 17 September, U.S. President Donald Trump announced a 10% tariff on USD 200 billion of Chinese imports, effective 24 September, which will be raised to 25% on 1 January 2019. Moreover, Trump warned that his administration is ready to target the full value of the remaining Chinese imports—USD 267 billion—if China retaliates against “our farmers or other industries”. That said, the U.S. government removed about 300 products from its original list of goods to tax, which includes smartwatches, chemicals and safety products, among others. Against this backdrop, China will likely refuse to participate in a new round of trade talks scheduled this week by the United States. Moreover, the magnitude of the measure means that China will run out of U.S. imports to tax in retaliation. As a result, analysts are anticipating that, on top of tariffs, China will resort to other additional measures, such as export restrictions that would disrupt the U.S. supply chain.
In the third quarter, weaker global growth and an uncertain trade outlook have started to bite, with manufacturing activity stuttering. The manufacturing PMI readings have declined in the first two months of the quarter in China and Taiwan, while Korea’s remained in negative territory. While the external sector in the region is faring relatively well, this mostly reflects front-loading of shipping in anticipation of increasing trade tariffs between China and the United States. Furthermore, increased volatility in global financial markets is prompting most regional currencies to depreciate against the green back. While a weaker currency could spur export growth, it could also fuel inflationary pressures and put additional strain on countries with a high debt-to-GDP ratio. Against this backdrop, FocusEconomics panelists pencil in a deceleration in Q3, with growth in ESA seen slowing to 6.1%.
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ESA’s 2019 economic outlook remains strong but risks are skewed to the downside
Although economic growth in the East and South Asia region was resilient in the first half of this year, economic dynamics are expected to soften by the end of the year and beyond. That said, the extent of the deceleration and the various risks posed differ greatly within the region. China is facing an unpredictable trade war with the United States while dealing with an overleveraged economy, especially in the corporate sector. Meanwhile, Hong Kong, Korea and Taiwan are particularly vulnerable to a sudden economic slowdown in China and the global economy, given their significant reliance on the external sector to power growth. Nevertheless, these four countries enjoy resilient domestic growth and ample financial buffers which should shield their economies from a crisis in their balance of payments or a pronounced economic downturn. Moreover, strong budget positions is allowing the governments of these countries to resort to fiscal stimulus to shore up growth.
While momentum has picked up in South Asia, their economies appear to be increasingly vulnerable due to recurrent twin deficits amid higher interest rates in the United States. Despite the boost to international reserves over the last few years, India’s economic outlook is threatened by higher oil prices and a substantial public debt. Meanwhile, Bangladesh, Pakistan and Sri Lanka suffer from large fiscal imbalances and persistent current account deficits. Moreover, Pakistan is also grappling with low international reserves.
FocusEconomics panelists expect that economic growth in the ESA region will decelerate to 6.0% in 2019 (2018: +6.2%), which is unchanged from last month’s estimate. Despite the stable outlook, this would represent the weakest regional growth rate since 2001.
This month’s unrevised 2019 growth estimate for ESA reflects stable projections for the regional powerhouses China and India, as well as for Bangladesh, Mongolia, Pakistan, Sri Lanka and Taiwan. Forecasts for Hong Kong and Korea, however, were revised downward this month.
Bangladesh and India are expected to be the region’s top performers next year, with expansions greater than 7.0%. Meanwhile, China is seen expanding a healthy 6.3%, considerably below this year’s projected increase of 6.6%, with the more mature economies of Hong Kong, Korea and Taiwan predicted to record the weakest growth rates, at between 2.3%–2.7%.
CHINA | Economic growth remains resilient in August despite mounting economic headwinds
The Chinese economy held up well in August despite escalating trade tensions with the United States and a cooling domestic economy. Both retail sales and industrial production figures improved in August, while property sector activities—although cooling slightly—remained strong. On the flip side, infrastructure investment continued to drag on overall fixed-asset investment, suggesting that recent policy easing and increased infrastructure funding will take some time before they start to kick in. Meanwhile, ongoing trade disputes with the United States worsened on 17 September following U.S. President Donald Trump’s decision to impose a 10% tariff on USD 200 billion of Chinese imports, effective 24 September, which will be increased to 25% on 1 January 2019. Moreover, Trump warned that his administration will impose tariffs on USD 267 billion of additional imports if China takes retaliatory action. Against this backdrop, China will likely reject new trade talks scheduled this week by the U.S. administration. In addition, while China will ultimately run out of U.S. imports to target, the Chinese authorities are also expected to retaliate with other measures on top of the tariffs. This could take the shape of additional trade barriers against the U.S. such as through the imposition of export restrictions.
Despite mounting economic headwinds, the Chinese economy is expected to comfortably meet this year’s growth target of 6.5%. A full-blown trade war with the United States, a sudden slowdown in the property market and potential corporate defaults are the main downside risks to China’s economic outlook. Stronger-than-expected policy support, however, could push GDP higher in the coming quarters. FocusEconomics panelists see the economy growing 6.6% in 2018. In 2019, the economy is seen expanding 6.3%, which is unchanged from last month’s forecast.
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INDIA | Household spending props up growth in the April–June period
GDP accelerated at the fastest pace in over two years in the first quarter of FY 2018, which ran from April to June, buoyed by surging private consumption. Meanwhile, although growth rates in government consumption and fixed investment remained high, they fell from the previous quarter. The external sector dragged slightly on headline economic growth in Q1 but significantly less than in the previous quarter due to a stronger expansion in exports. Going forward, the economic picture looks mixed. On the plus side, business activity in the private sector increased in both July and August, although the pace of expansion in August slowed significantly from July’s 21-month high. However, as questions accumulated over the government’s ability to meet its fiscal targets and the rupee continued to weaken, the 10-year government bond yield hit a four-year high in August.
In FY 2018, which runs from April 2018 to March 2019, economic growth should accelerate thanks to fading disruptions from the demonetization of November 2016 and the launch of a goods and services tax in July 2017. However, risks of fiscal slippage in the run-up to next year’s general elections, increasing global trade tensions and higher oil prices cloud the outlook. Our panel expects GDP growth of 7.4% in FY 2018, which is up 0.1 percentage points from last month’s estimate, and 7.5% in FY 2019.
KOREA | Government presents the largest budget increase in nearly a decade
The economy appears to have taken its foot off the gas in July–September, after growth held steady for the second consecutive quarter in April–June. In August, consumer confidence fell into pessimistic territory for the first time since March 2017, primarily due to lower confidence regarding current and future domestic economic conditions. Moreover, the unemployment rate increased for the second month in a row in August to reach the highest in nearly nine years. These two developments pose downside risks to private consumption in Q3. Meanwhile, pending spending from the extra FY 2018 budget, which was approved in May and contained a total of USD 3.8 billion, should support government consumption. Looking further ahead, on 28 August, the Ministry of Finance proposed the largest budget increase in a decade for FY 2019, with an eye on shoring up an increasingly-shaky labor market.
Economic growth is expected to slow this year before remaining almost steady next year. During both years, the economy will benefit from higher government spending. Moreover, although monetary policy is set to tighten slightly next year, it will remain accommodative by historical standards. With that said, elevated household debt, rising global trade tensions, higher oil prices and signs of an economic slowdown in China cloud the outlook. FocusEconomics panelists forecast the economy will grow 2.8% this year and 2.7% in 2019, which is down 0.1 percentage points from last month’s forecast.
INFLATION | ESA inflation stabilizes in August
Inflation in East and South Asia stabilized in August following two consecutive increases, which reflected higher energy prices and an FX pass-through effect in some countries. Regional inflation was stable in August at July’s 2.5%, according to an estimate produced by FocusEconomics. There were stronger price pressures in regional behemoth China as well as in Sri Lanka, while inflation slowed in India, Korea, Mongolia and Taiwan, while it was stable in Bangladesh and Pakistan.
In recent weeks, the Bank of Korea (BOK) has been the sole central bank in the region to hold a monetary policy meeting. On 31 August, the Bank decided to keep its base rate unchanged on the back of low inflationary pressures and increased volatility in international financial markets. On 24 August, the People’s Bank of China announced the reintroduction of a “counter-cyclical factor” to its model to set the yuan’s daily official value. With this move the PBOC intends to stabilize the yuan in the foreign-exchange markets.
The general slide of the region’s currencies and high energy prices will support inflation going forward. Panelists polled by FocusEconomics project average inflation of 2.5% this year. Inflation is expected to average 2.7% in 2019, which is unchanged from last month’s estimate.
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Ricard Torné
Head of Economic Research