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This quarter we find three clear and distinct trends in Asia: China in an economic quagmire; ASEAN benefiting from relocation of wealth and manufacturing; and India throwing everything into its stimulus.
The Chinese economy is in a fix and stimulus is urgently needed. As the official fiscal deficit is already 4.2% of GDP (possibly 10% of GDP if local government obligations are included), room for further fiscal measures is limited. The PBOC has cut reserve requirements for the banks substantially, but regulations which require banks to hold increased capital and further suppress alternative lenders are negating the benefit. A cut in interest rates of just 5bps and a statement from the Governor make it clear that the central bank does not want to encourage more lending. With national debt to GDP now over 300% and China’s annual debt repayment burden now standing at 39.9% of GDP, it is easy to see why growth in bank lending is dramatically lagging the rate of growth in nominal GDP. What tools remain at China’s disposal? Corporate capital is flowing out (to the benefit of ASEAN), rather than in, as the trade wars lay the final straw on a burden of environmental and corporate taxes, expensive labour and intensifying government surveillance. Inward capital flows look more promising. Stock market restrictions on foreign investors have been dramatically relaxed and MSCI has added both domestic A shares and Chinese bonds (corporate and government) to its international indices in ever larger weightings, unlike FTSE Russell, which, despite adding domestic A shares, chose not to include Chinese bonds in its indices just as defaults are rising at unprecedented levels. With rising index representation, forced flows of giant ETFs may be sufficient to stabilise the Renminbi. The currency would otherwise need to drop substantially to reflect the domestic economic risks, but this will not benefit exporters unless Presidents Trump and Xi can find a solution to the currently deepening trade wars.
In 2009, China galvanised the world by injecting 14.5% of its then GDP in bank lending to boost the economy and catalyse better sentiment. Having faced deep criticism for this measure in the intervening years, this time round, although it has already injected a similar amount, it has been spread between fiscal and monetary measures; and directed capex at State Owned Enterprises (SOE’s), over the months since June 2018. Consequently, most of the measures have failed to sustainably lift sentiment.
In India, however, Prime Minister Modi, has grasped that to turn the super-tanker that is India takes more dramatic moves. Roundly criticised for transferring USD20bn from central bank reserves to the Office of the President without appropriate explanation, the Rupee dropped sharply, giving exporters a shot in the arm just when they most needed it. The merger of ten public banks, which are responsible for 46% of national lending was announced this quarter. The paralysis this will induce should be sufficient for the Private Sector Banks to snatch vast market share and clean up the financial system.
Simultaneously, the RBI cut rates dramatically – by over 110bps YTD now, with possibly more to follow – and regulations on inward flows of capital have been relaxed. Lastly – utilising the whole of that $20bn in RBI reserves – Mr Modi announced a ten percentage point cut in the rates of corporate tax, to be applied retrospectively from April 2019. Each one a moon shot – and India has literally done that too this quarter, succeeding in uniting Indians in their pride and giving a real boost to sentiment across the nation.
China has now effectively maxed out its credit card, whilst India has a little room to spend more monetarily, but both have stepped into deeply murky waters on human rights; India in Kashmir, Assam and Karnataka and China in Xinjiang. Now, however, the media eye has swivelled to Hong Kong. What began as peaceful protests over a (now withdrawn) extradition bill, has erupted into a spiral of increasing violence and acrimony. With the investment industry pushing towards enhanced ESG monitoring of portfolios, how will this be treated in future?
Most investors had expected China to announce a major stimulus of some kind to coincide with the 70th anniversary of the founding of the PRC. In the event, in narrowing the focus onto the sheer scale of the National Day parade, Xi has given us another message: China has come of age. At 15,000, the number of troops marching did not exceed the 19,000 who marched for Mao himself in 1949, but in all other respects, this was the largest National Day parade ever seen.
In addition to ranks of domestic forces, the show also included a contingent from China’s 8,000 strong UN Peacekeeping force, emphasising the role China now plays internationally too and the parade was reinforced by attendance by military attaches from 97 Belt and Road countries. China has come of age and the world will now have to choose whether they are with it or not. Country by country, they are doing so. Many young people in Hong Kong, have chosen “anything but China”, as witnessed by pleas to the UK and US for help and citizenship. The price of non-compliance can be brutal, as witnessed by Cathay Pacific and the NBA. Swathes of companies moving their operations to ASEAN appear to have come to the same conclusion. ASEAN continues to benefit from the Sino-US trade war, as companies shift their manufacturing locations first to Taiwan, whilst new plants are built, and then to ASEAN – principally Vietnam and Thailand, where cumulative Foreign Direct Investment is up 364% and 160% respectively YTD.
Most multinationals go where the money is and the rest of Asia has long discovered practical ways to live with a rising China. For the rest of the world, struggling to choose sides, the following chart should suffice. The Asian countries whose economies depend on the continued goodwill of China surpassed the GDP of the US at the end of 2018. Even allowing for the current slowdown, they should be 12% larger than the US by the end of 2020.
Asia has poured stimulus into its economies, but China and India have now reached their limits and must sell the family silver to re-fill fiscal coffers while they wait for it to work. ASEAN still retains room to help its economies. Ironically, the region best placed globally to add fiscal stimulus now is Europe. The accession of Christine Lagarde and Annegret Kramp-Karrenbauer may allow the political will to do so.
Elsewhere, a weak global outlook points to oil remaining relatively low in 2020 (geopolitical shocks aside), which is supportive for Asia, especially India, Indonesia, Taiwan and Korea. Additionally, we find a few, very nascent, signs that the infrastructure spending started in 2018 might be starting to feed through to genuine improvements. Market valuations in Asia are generally not stretched, leaving room for upside if the political outlook can be clarified.
Positive – and vast – upside from a sudden resolution of the Sino-US trade war is increasingly becoming a wild-card, but an opening of North Korea remains a possibility, as do better relations between Japan and Korea. With the US slowing and Europe in paralysis, Asia, with its supportive governments and a tailwind from oil looks increasingly attractive.
This quarter, with wealth preparing to leave Hong Kong, we highlight the Singaporean economy.
Economic spotlight on Singapore
GDP for the second quarter rose by just 0.1%, lower than consensus estimates of 0.2% and the 1.1% reported in the previous quarter. The slowdown was widespread, but was driven mainly by sharp contraction in the trade balance. Private consumption growth remains positive, but decelerating from 5.5% registered previously, as unemployment amongst residents ticked up a little to 3.1%.
Government spending picked up by 3.1%, this is a touch higher than 3% reported previous quarter, leaving Singapore running a very small budget deficit to GDP, of c.0.6%. There remains plenty of room for further fiscal expansion.
Reflecting the situation regionally, trade continues to deteriorate. In Q3, the deceleration was led by the contraction in global refining margins. Non-oil exports continued to fall but at a slower rate than petroleum products, dropping 8.9%, versus over 10% at the aggregate level vs 6% in July. However, as 2020 approaches and the new regulatory requirement on low-sulphur oil usage in the shipping industry comes into force, it is possible that refining margin may start to pick up or at least remain stable.
Import growth contracted by 6.4%, in tandem with exports and reflecting slowing domestic and global demand. September data are likely to be slightly distorted by Mid-Autumn Festival, so we would anticipate a slight optical improvement in the next month, but this may not reflect any fundamental change to the underlying economy.
Industrial production continues to contract and declined by 8% in August after a small 0.1% pick up in July. Both overall manufacturing PMI and Electronics sector PMI remain in contraction mode, 49.9 and 49.4 respectively. Despite this, however, there seems to be a small tick up in sentiment comparing to previous months.
Against this gloomy backdrop, the protests in Hong Kong are starting to catalyse an increasing flow of money from Mainland China and Hong Kong residents to Singapore. Construction has been picking up and reported the second consecutive quarter of growth, seeing 4.3% yoy growth vs 4.1% in the previous quarter. As the Government are now holding off any further tightening measures, the property market is starting to pick up. Developers sold 1122 units in August, up 82% yoy despite it usually being a seasonally weak month. Coinciding with the start of the HK anti-government protests, the 3-month rolling monthly take-up ratio is ticking up, making September one of the best months for property sales since 2016. HK banks are also reporting a rapid increase in the number of HK-based Chinese and HK nationals opening Singapore Dollar bank accounts at their HK branches, although they also point out that so far, those account holders have moved only c 1% of their assets.
Still in a slowing trend, headline inflation picked up by 0.5%, from 0.4% registered previous month and core CPI remained around 0.8%.
The Singapore Dollar continues to weaken against the USD but continues to strengthen against the CNY. As inflation remains below the MAS target of 2% and the Fed cut rate in the summer, it is likely that MAS will loosen its policy stance in the form of a flatter appreciation profile for the SGD NEER at its next meeting in October.
As an open economy, Singapore faces immense challenges, given the weak global outlook, but backed by immense reserves and with its political stability is proving highly attractive at present, Singapore has turned into a major refuge for Hong Kong and Chinese wealth enhancing its status as the Switzerland of Asia.
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