Asia's tectonic plates are shifting. For decades, the U.S. economy ruled supreme. American shoppers set the pace for Asian exporters and the U.S. Federal Reserve set the cost of money for Asian companies. Slowly, however, the center of gravity is shifting. While the U.S. dollar and American interest rates still determine funding conditions across much of the region, demand is increasingly powered by China.
This epochal shift is both exposing stresses and affording new opportunities.
Start with the positives. The Fed has signaled a halt to monetary tightening this year, projecting that it would keep interest rates on hold through 2019. That comes as a relief to hard-pressed Asian borrowers who had seen funding costs spiral up last year. At the time, the U.S. central bank's interest rate hikes not only lifted the dollar against local currencies but also prompted monetary officials from India, to Indonesia and the Philippines to raise policy rates as well. They pushed up market funding costs elsewhere, too.
Historically, a more accommodative stance by the Fed was a double-edged sword for Asian economies. Cheaper borrowing costs were certainly welcome, but these were accompanied by weaker demand for the region's exports. After all, the U.S. central bank would typically only relent if American demand was at risk of slipping. And that's true today as well: the more challenging outlook for the economy, stretching from a weaker housing market to softening consumer spending, has prompted Fed officials to shift their stance.
For many economies in Asia, however, wobbly U.S. demand is no longer as big a concern as in the past. China has stepped up in recent years to drive the regional trade cycle, replacing the U.S. as the number one export market nearly everywhere, except for the Philippines, India, and Vietnam. Not only that, but surging investment and tourism from the Mainland is further shoring up growth, from Korea to Thailand, and most places in between.
Since the 2008 Global Financial Crisis the region enjoyed the best of both worlds: for the most part a dovish Fed, yet sturdy demand from China.
This dependence on Chinese growth, however, has looked a little less enticing of late as the Mainland economy lost steam. Export growth in the rest of the region, as a result, has turned negative in recent months. Whether Japanese tech producers or Malaysian component makers, fizzling demand in China has left its mark. Worries about China's growth wobble have spread far and wide.
There are good reasons, however, to expect the growth engine to rev up again. First, the authorities are injecting a stimulus to lift demand. This largely centers on tax cuts, worth over 2% of gross domestic product, that were implemented largely on 1 April.
It's important to recognize, in fact, that the slowdown in Mainland demand over the past year was mainly the result of a deliberate policy decision to 'de-risk' the economy by curbing shadow bank financing. This hit infrastructure spending hard, but the sector has started to rebound. A more accommodative stance by government officials thus promises at least a partial reflation of demand.
At the same time, given the ever-expanding size of China's economy, it need not grow at the same pace year after year to impart the same demand impulse to the rest of the region. Roughly, even if growth slows by between 0.2-0.3 percentage points per year, the lift to neighboring economies would remain broadly unchanged.
Of course, a faster deceleration than that would stiffen headwinds. And that's exactly what happened in recent months. At the same time, the latest stimulus measures would not have to lift growth back up to a pace seen in recent years: since the economy grew on average 6.6% in 2018, a pace of around 6.3-6.4% this year would be sufficient to keep things on an even keel in the region.
That's an admittedly mechanistic approach. But if we consider the other channels through which China's growth affects the region, there are further reasons to remain optimistic.
For one, China's import penetration continues to climb: an ever-rising share of exports to the Mainland are consumed locally, rather than used for onward assembly and exported to other parts of the world. By some measures, in the mid-2000s, around 40% of Chinese imports were ultimately trans-shipped elsewhere. Today, that ratio is less than a quarter. The region's exporters thus enjoy an every growing exposure to China's local demand, offering expanding opportunities even if overall growth gradually decelerates over time.
And then there are other avenues. For example, Chinese tourists continue to pour into the region in unprecedented numbers, a process that defies slowing growth at home: the number of overseas trips rose over 13% last year, up from around 6% the year before, even as the broader economy slowed, spending some $240 billion.
For now, Asia's tectonic shift still works in its favor. Low U.S. interest rates and rebounding Chinese demand should offer plenty of opportunities.
Tremors, no doubt, would be felt if the process were to reverse in future: higher Fed rates coming amid slowing Mainland demand.
But that, surely, is still a long way off.
Frederic Neumann is Co-head of Asian Economics Research at HSBC.