Key takeaways
- Despite ongoing global trade uncertainties, Asia – particularly China – has shown adaptability by diversifying export destinations, while the 'China Plus One' strategy will continue to benefit other regional economies and drive growth.
- Asia’s domestic economies are better prepared for future shocks, with room for both monetary and fiscal policy support.
- China’s anti-‘involution’ reforms alongside rising credit impulse, and shift to consumption-boosting policy could position the economy for recovery and renewed growth.
Tariff impact on Asia’s growth and inflation outlook
While economists’ consensus expectations on global growth took a hit initially with fears that April tariffs would dampen economic expansion significantly, ongoing negotiations and strategic adjustments have tempered the impact. Growth forecasts have now been revised back up, and China, once seen as the centre of this storm, has demonstrated resilience, adapting its export strategies and seeking out new trading partners.
The impact on inflation has been more divergent. While the tariff shock will not likely bring an immediate hit to global growth, we expect its impact to be long lasting with the world becoming more divided. Fragmentation is the base-case scenario for our global outlook. China as a production centre will continue to struggle to find consumers and the Western bloc as a consumption centre will perhaps struggle to find producers. Investors should expect greater divergence in inflation and growth trajectories across the region.
World trade uncertainty but tariffs baked into reaction function
Our analysis suggests that US tariff rates will likely settle at about 16 per cent, with risks further skewed to the upside as sectoral tariffs and a final deal with China are still pending. In the martial arts world, the US’ tariff announcement is akin to Trump executing a Judo throw, aiming to instantly score by landing his opponents on their back. However, the rest of the world seems to be practicing Brazilian Jiu-Jitsu, where most of the combat takes place on the ground, and they are still wrestling to determine who emerges triumphant.
World trade uncertainty remains elevated, though it has eased somewhat from peak levels as verbal wrangling resulted in some major trade deals. Countries such as Japan, Korea and Europe have been hammering out deals with the US while China is holding a hardline stance and the rest of Asia are looking for alignment with ongoing negotiations.
The uncertainty has had an adverse impact on corporates’ capital expenditure (capex) decisions, a leading indicator of how corporates feel about all the political wrestling. US capex intentions for the next six months based on regional surveys are well below past corporate upcycles, though encouragingly, the data has ticked up in the last month after plunging in April as some of the extreme pressures have subsided.
Elsewhere, businesses have been managing the tariff uncertainty by either avoiding tariffs as much as possible or realigning their export destinations. In the first case, Canada has seen a significant increase in exports to the US over the last few months that tap on duty-free provisions. In the second instance of shifting export destinations, we have seen China’s share of US imports dropping significantly from June this year. Conversely, US imports from other countries like Mexico and India, which have earlier faced lower tariffs, have increased. Hence, the impact of tariffs has likely been baked into the reaction function for global trade outlook.
No retreat from ‘China Plus One’ strategy
Asia has experienced an increase in global exports since Trump’s first presidency (Trump 1.0), broadly due to China expanding overseas. The ‘China Plus One’ strategy of supply chain diversification where companies establish manufacturing or sourcing operations in an additional country alongside China to mitigate risks and reduce over-reliance on a single market will likely continue, buoyed by the added geopolitical tensions and trade frictions.
With cost being a major consideration for companies looking to diversify their supply chain, the increasing tariff differential between China and other Asian economies is magnifying the benefits of offshoring production from China. Countries with higher tariff differentials against China will likely be favoured, though the US’ plan to impose ‘transhipment’ levies of 40 per cent on goods that have been rerouted to avoid duties could spur a recalibration of this strategy.
Connector economies under Trump 1.0 such as Cambodia and Vietnam are now facing higher tariffs and production centres may shift broader across Asia. Countries including Thailand, Malaysia and Singapore will continue to thrive if costs make sense in China’s bid to go offshore for global production.
Domestic Asia has ammunition to react
Whereas export-dependent economies like Singapore, Vietnam, and Taiwan may be more vulnerable to future tariff shocks, domestic-oriented markets such as India, Japan, and the Philippines offer a buffer against these external pressures.
China has also been busy finding new trading partners with its export profile having changed quite significantly since the pandemic. Instead of exporting largely to the Western worlds in Europe and the US, China has been leaning towards the global south as export destinations. While some of the increased exports to Southeast Asia may eventually find their way to the US, other regions in Latin America and Africa represent new sources of organic demand. This is particularly in sectors like electric vehicles and machinery, which are needed for infrastructure development. Hence, we expect China to be more resilient now than during Trump 1.0.
The structural underpinnings of Asia’s domestic economies paint a sanguine outlook with policymakers having the ammunition to react in times of uncertainty. For the first time in decades, Asia is not facing heightened inflationary problems, offering room for monetary policy easing. The US Federal Reserve’s interest rate cuts could be the catalyst for Asia to continue or restart a new round of monetary easing.
At the same time, having gone through fiscal consolidation after the pandemic, policy makers in the region are now broadly exercising more fiscal discipline in their spending and have room to enact expansionary policies to support their economies.
China’s anti-‘involution’ campaign and policy pivot
Within China, while the growth picture is not rosy, the economy may be approaching a cyclical bottom. Domestic activity continues to move sideways, and the overall activity indicator shows China still experiencing a slightly negative output gap with mild deflationary pressures. The property sector has been a drag on the economy but that does not prevent other sectors from picking up and we predict that services and industrials will soon eke out a recovery.
Two important developments could provide firepower to boost the economy.
First, China’s recent anti- ‘involution’ campaign launched by policy makers to curb disorderly competition, most evidently in price wars, may help to stabilise the currently negative producer price index (PPI) and bring about mild reflation. Borrowing from its 2015 experience when China also faced overcapacity in sectors such as coal, steel and iron ore, aggressive government-directed capacity cuts and consolidation led to a significant rise in the PPI. The macro picture looks similar today though different industries are being affected such as in the emerging sectors of solar, electric vehicles and to some extent services. At the same time, demand-side credit, which is still a driver of the economy, looks promising. Credit impulse, which typically leads the PPI or inflation outlook by three to four quarters, has been rising. Overall, we expect the improvement in credit demand coupled with the anti-‘involution’ push to drive an upward movement in prices.
Second, policy easing in China has pivoted from supply side to demand side in recent months. Consumption-related subsidies have boosted the consumer goods sector as households snapped up washing machines, headphones and televisions being sold at a discount, subsidised by the government in the first half of this year. The policy is broadening out to areas such as childcare subsidies and free pre-school education, which the government hopes will boost household confidence and spur domestic spending on the services sector.
Hence China’s policy pivot to boosting demand, paired with its anti-‘involution’ campaign may well help its economy to find a cyclical bottom and investors will be well-positioned to ride the next wave of growth.
