Asian aspect: red to green

Robert Gilhooly, Senior EM Research Economist
Sree Kochugovindan, Senior Research Economist, Research Institute
Yashaswini Dunga, Research Analyst, Research Institute


  • Export orders have recovered across Asia, potentially signaling manufacturing activity outside the region may have worked through the worst of its dislocations.

  • China’s plan for carbon neutrality by 2060 represents a revolution in energy provision. Can China deliver?

  • Japan’s economy continued to improve through September, as policymakers focused on reopening the economy while safeguarding public health.

  • In India, hard economic data may not live up to business optimism.

Asia: exports and outputs continuing to firm

Recent economic data from across Asia has been broadly encouraging. Asian purchasing managers’ indices (PMIs) continue to show manufacturing output at around pre-pandemic levels. Export indices have recovered more slowly but most regions returned to normal in September (Chart 1). Two countries stand out: India, where manufacturing has hit a record high and Indonesia, where the output and export indices both fell. The reinstated lockdown in Jakarta since September 14 could partly explain the modest contraction in Indonesian manufacturing output.

Chart 1: New export orders have recovered across most of Asia, catching up with output

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Source: Bloomberg, Tsinghua University Institute of Energy, Environment & Economy, Refinitiv, and Haver Analytics, October 2020

 

We focus on three economies — China, Japan and India — where the Covid-19 crisis could potentially catalyze some long-awaited structural and regulatory reforms.

In China, Japan and India, the Covid-19 crisis could potentially catalyze some long-awaited structural and regulatory reforms.

China: planning ahead

The Chinese authorities are gearing up for some very long-range planning. Between October 26-29, China’s Communist Party will meet for the 5th Plenum, which should give a first glance at the nation’s 14th five-year plan. This will set the blueprint for social and economic development targets for 2021-2025.  "Dual circulation" is expected to feature prominently. This involves reducing reliance on export-led growth, ensuring technological security and firing the engines of domestic consumption. Development targets for 2035 will also be discussed, likely a reaffirmation of previous aims to become a “moderately prosperous society.”

Modest reforms?

We don’t expect major new structural reforms to be announced but, rather, a continuation of current plans. However, some smaller steps that should help underpin growth are likely. These could include:

  • Hukou reform – allowing "official residency" (access to social services) in tier two and tier three cities.
  • Personal income tax reform – reducing some taxes and increasing tax allowances.
  • Rural land reform and property rights – for instance, allowing rural housing as loan collateral.

More significant reforms, which would do more to unlock higher long-run growth, seem unlikely. Progress on the issues below would make us more confident in China’s long-run growth trajectory.

  • Rolling back state involvement in the economy – reducing capital misallocation.
  • Fixing the fiscal transfer system between local and central government – allowing an eventual removal of implicit guarantees.
  • Transferring state assets to households – to help rebalance China from a production-oriented economy to one more reliant on household consumption.
  • Improving the social safety net – widening unemployment coverage and access to healthcare.

An interesting question is the extent to which other aims – specifically financial sector de-risking – could potentially generate meaningful change as a by-product. (De-risking aims to reduce the complexity and inter-linkages between banks and "shadow" banks. More broadly, it gives greater attention to financial stability risks.) If regulators continue to emphasize financial risk, as they have recently, the share of state-owned enterprises could decline faster than official announcements imply. The recent problems of China’s second-largest property developer Evergrande illustrate the considerable challenges in reining in risks, while balancing growth objectives. With the company struggling to service its complex web of over US$120 billion of debt, the authorities had to decide whether, and how, to intervene.

China as green energy pioneer?

Major reforms are not a zero-probability event. President Xi surprised at the United Nations (UN) with his announcement that China would aim to be carbon neutral by 2060. This is very ambitious and would require nothing short of a revolution in energy provision. There’s speculation it may require US$15 trillion of investment to achieve this goal.

Given that China accounts for around one-quarter of global greenhouse emissions, this plan clearly has the potential to reduce emissions worldwide. But carbon neutrality is not the same as zero emissions. We must wait for details about the scope of the target. For example, is international aviation included, and to what extent might offsets be used to achieve neutrality?

An olive branch for strained relations?

Indeed, global climate issues could be one of the few remaining areas of international cooperation, potentially helping alleviate geopolitical tensions facing China. This has certainly been an area of discussion with the European Union. The degree to which tensions could ease will, of course, depend on the outcome of the U.S. election. Environmental issues could perhaps provide some common ground in the event of a Biden presidency.

As we have noted previously, U.S.-China tensions are likely to persist, regardless of who occupies the White House. Export controls ordered on China's largest chip manufacturer SMIC are a reminder that points of contention continue to morph from trade to technology and security. This serves to reinforce China’s long-run aims for self-sufficiency.

China’s economy perking up

Recent macro data has provided marginally positive news. Headline manufacturing PMI indicators were mixed: the National Bureau of Statistics of China manufacturing PMI rose to 51.5 in September (+0.5pts), while the Chinese media company Caixin was down marginally (-0.1pts). But both surveys show the output sub-index at a high level (around 54). Moreover, export orders have now recovered, a potential signal that manufacturing outside China has worked through the worst of the dislocations (Chart 2). And recent import data for September was particularly strong, up 13.3% year-on-year (versus consensus of only 0.4%), signaling continued recovery in Chinese domestic demand.

Chart 2: New export orders have now recovered

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Source: Haver Analytics, October 2020.

 

China’s third-quarter growth figures were due on October 19. We expect the official growth figure will come in at 3.5% quarter-on-quarter (5.2% year-on-year), broadly in-line with consensus expectations. A large gap is likely to remain between the official data and the growth implied by our in-house China Activity Indicator. As such, we would need to see a major data miss to take a strong signal from the official growth figures.

Japan: on track for a modest recovery

Japan’s government and central bank seem to be steering their policies in the right direction, albeit signs of improvement are tentative. Monthly activity data continued to recover through September. This signaled a small third-quarter rebound in growth, in line with our forecast (3.1% quarter-on-quarter). We expect a slower pace of growth over subsequent quarters.

Politically, the near-term focus remains firmly on reopening the economy while managing local viral hotspots. Chief Cabinet Secretary Katsunobu signaled elections were improbable this year because the key priority for the government is to contain Covid-19 and support the recovery. So, further stimulus measures and a supplementary budget are very likely before year end. However, election risks remain high for Spring 2021.

Cheaper phone charges will make the inflation target more elusive

The government has been pushing ahead with plans to lower mobile phone fees. Japan’s former state telecoms provider, NTT, announced a move to purchase the outstanding stock in the NTT DoCoMo mobile unit. This would strengthen NTT’s financial standing, putting it in a stronger position to lower fees and build out the next-generation 5G network. Other major telecom companies may follow suit, leading to broader price declines. Potentially, this could cause a significant but transitory negative hit to consumer price inflation over the next year.

Greater cooperation to support reforms

The Bank of Japan’s (BoJ) September monetary-policy meeting emphasized the need to support growth through the near-term Covid-19  challenges. The Bank’s forward guidance was clearly biased toward a continuation of easy monetary conditions. Also, the importance of the inflation target has been downgraded and delayed. There is greater emphasis on close cooperation with the government in order to support structural and regulatory reforms. The authorities hope this will eventually feed into growth expectations, in turn pushing up inflation.

One member suggested that, since the path to price stability is not in sight, the BoJ should reconsider its inflation strategy. This comment was placed at the end of the Bank’s statement, which implies there may not have been support from the other eight members. But it reinforces the view that 2% inflation is no longer a realistic target.

Modest relief after restrictions eased

The BoJ’s third-quarter Tankan survey of Japanese businesses showed that business conditions continued to return to normal from their trough in the second quarter. This reflected the lifting of emergency restrictions and a pick-up in external demand. However, the recovery is still modest for large firms and far weaker for small firms. This heralds only a sluggish recovery in corporate earnings, particularly for service sectors such as accommodation and restaurants, which have been worst hit by emergency measures.

The survey also signaled that capital expenditure plans remain weak — companies still prefer to hold onto cash rather than invest, given the uncertainty. However, there are plans to increase software investment, as the pandemic and the shift toward working from home have encouraged firms to upgrade their traditional technology and cloud infrastructure.

Retail sales recovered in August following the weakness that ensued from the summer virus resurgence. Spending on leisure activities was subdued. However, mobile spatial data indicated an increase in movement in September, boosted by the Go To Travel campaign. This suggests spending should continue to recover. So far, the trend in spending data is in line with our outlook for a gradual recovery in consumption.

Meanwhile, August industrial production data showed a continued recovery in the manufacturing sector. This was driven primarily by autos and pent-up demand for cars. Manufacturer surveys point to increased production in September, partly reflecting the rundown in inventories.

In August, the unemployment rate ticked up 0.1% to 3%. Government support measures have helped contain labor market distress. There are lingering concerns of a sudden drop-off in government support. However, we expect the employment adjustment subsidy, due to expire in December, will be extended further.

India: premature optimism?

In India, the hard data may belie Indian business managers’ upbeat view of the economy. Indian PMIs for the month of September surprised on the upside. The manufacturing PMI rose from 52 to 56. The output sub-index was particularly strong at 65. But, while the PMI readings imply business optimism for a strong recovery, we believe the hard data may not match up. For instance, in August, the manufacturing PMI improved from 46 to 52. In the same month, the "eight core infrastructure" index, which measures the production of eight core inputs (such as steel and cement) into infrastructure, dropped 3.3%.

Indian industrial production has already made up most of the ground it lost during the lockdown. But mobility is still down about 50% compared to pre-Covid-19. Despite India’s limited progress in curbing the rise in infections, restrictions continue to be relaxed. So, it’s possible consumption and services-led sectors could see some recovery in coming months.

On the policy side, the Reserve Bank of India (RBI) appointed three new members to its Monetary Policy Committee. The new committee decided to keep the policy rate unchanged, while reiterating that they will be looking through the current bout of high inflation. We think the headline inflation numbers will move back into the RBI’s target range over the next six months. Food price rises should moderate and some bottlenecks in the food supply chain should ease as restrictions continue to be lifted. There is scope for the RBI to provide further support next year, but we’re not expecting any major change in its policy stance.

A raft of reforms

A range of reform bills pertaining to the agriculture sector and the labor market were passed in the Indian parliament. This is part of the government’s agenda to make it easier to do business in India. Worth mentioning are the reforms in the agriculture sector. These allow farmers to sell their produce in markets outside government-mandated markets. The move is supposed to help farmers find the best buyer for their produce and get a higher share of the price ultimately charged in retail markets. However, we’re skeptical of the gains that will trickle down to India’s marginal farmers. It will certainly take some time for private markets to establish themselves. Until then, the price volatility associated with the existing food supply chain will continue.

On the labor reform side, the government passed a bill allowing companies with 300 workers or fewer to hire and fire workers without government approval. This is a threefold jump from the previous limit of 100 people. Other labor reforms passed imposed stricter rules on the recognition of trade unions. They make it mandatory for unions to represent at least 10% of workers in a given sector, and prohibit them from striking without prior notice. We think the ability to hire and fire with greater flexibility will make smaller firms more efficient and improve resource allocation. However, these moves will do little to encourage foreign multinationals — who operate at much larger scale — to invest in India.

Summary

Asia’s economic recovery may be due in part to the region’s relative success in containing the virus, particularly in China. It is also uniquely placed to benefit from a rotation of consumption in the West from services to goods. Indeed, the latest data suggests the rest of the world may be through the worst of the manufacturing supply chain disruptions. As Covid-19 cases continue to rise in Europe, the U.S. and elsewhere, we will be looking to see whether these favorable trends can be sustained.

 

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