2017 fourth-quarter forecast

Sep 28, 2017 | 13:55 GMT

14 mins read

Asia-Pacific

The Asia-Pacific is home to more people than any other region. Centered on the western rim of the Pacific Ocean, this region includes the easternmost countries of continental Asia as well as the archipelagos that punctuate the coast. Several of these countries, most notably China, experienced rapid economic growth in the second half of the 20th century, giving the region a new sense of global economic relevance that continues today. That relevance, however, depends largely on China, a power in transition whose rise is testing the network of U.S. alliances that have long dominated the region. How effectively Beijing manages its transition will shape the regional balance of power in the decades to come.

Centered on the western rim of the Pacific Ocean, the Asia-Pacific region includes the easternmost countries of continental Asia as well as the archipelagos that punctuate the coast.
(Thoyod Pisanu/Shutterstock.com)
section Highlights
  • Heedless of the sanctions mounting against it, North Korea will continue to steadily conduct weapons tests while the United States pursues every economic and diplomatic tool available to stop it.
  • Next door, China will work to pre-empt the crisis in Pyongyang while fortifying its own administration in Beijing, completing a leadership transition within the Communist Party that will likely result in a strong show of support for President Xi Jinping.
  • Though China will focus on preserving its economic and social stability once the crucial party congress is over, the conclusion of its leadership transition will give Beijing greater flexibility in its foreign policy, making room for it to grow more assertive in South Asia and the South China Sea.
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War Looms Over the Korean Peninsula

North Korea will remain at the center of the region's — and the world’s — attention as the year comes to a close. Over the third quarter, Pyongyang made steady strides in its intercontinental ballistic missile (ICBM) and nuclear weapons  programs, even going so far as to conduct launches over Japanese territory. And as Pyongyang inched closer to fielding a nuclear device capable of striking the U.S. mainland, China's temporary detente with the United States on North Korea crumbled. Hoping to sever Pyongyang’s economic lifelines for good, Washington stepped up pressure on Beijing and, at times, Moscow by slapping their citizens and companies with new sanctions, both unilaterally and with the support of the United Nations.

North Korea's weapons tests will proceed apace in the coming quarter as the country closes in on a credible nuclear deterrent. The United States will exhaust every economic and diplomatic tool at its disposal to arrest Pyongyang's progress and to persuade China to step in on its behalf. Though Washington will also hedge its bets by continuing to build up strategic and tactical assets on the Korean Peninsula and in the Asia-Pacific, it will opt for an incremental expansion of its military footprint in the region to give its other sticks and carrots time to take effect. At the same time, the United States will strike deals with Japan and South Korea aimed at bolstering their defenses — especially their missile defense systems — over the long run.

North Korea's Arms Push

Determined to counter the U.S. military buildup on its doorstep, China will work to amass its own forces along the North Korean border. Pyongyang will also keep shoring up its defenses as it continues to test devices in accordance with its technical needs and in response to U.S. actions. Such tests may include firing ICBMs (perhaps even several at a time) to prove North Korea's ability to overwhelm nearby missile defense systems.

During the fourth quarter, the likelihood that these tests will trigger a conflict on the Korean Peninsula is greater than the possibility of a preventive military strike by the United States. Should a North Korean missile come perilously close to or break up over Japanese or South Korean territory, the United States and its allies would have to decide whether to try to shoot it down. The attempt would be costly, no matter the outcome: Success would risk retaliation from North Korea, while failure would undermine the credibility of the region's missile defenses. Pyongyang, moreover, may feel the need to counter the movements of U.S. air and naval assets in the region. Its responses could inadvertently lead to a rapid military escalation, as could a decision by Pyongyang to test a missile near the U.S. mainland. Another North Korean nuclear test cannot be ruled out either, and if that was an atmospheric test, Washington may feel the need to halt it by downing the missile carrying the test warhead.

It is possible (albeit unlikely) that the United States will use the forces it already has stationed in the region to launch a punitive or preventive strike against North Korea's nuclear and missile programs. Washington might resort to such drastic measures in response to an unforeseen crisis or to unexpected progress in Pyongyang's weapons development. However, the United States would be far more likely to preface an attack by deploying more military assets to the Asia-Pacific to better respond to any retaliation by North Korea.

Of course, the United States has many avenues it can pursue before turning to a military solution. To that end, Washington will continue to isolate Pyongyang economically and diplomatically, leaning on North Korea's dwindling trade partners to fall in line with the initiative. China may consider squeezing some flows of aid to North Korea in the interest of averting a U.S. intervention — a prospect it fears even more than the collapse of the government in Pyongyang. Russia, however, will work to undercut any endeavor that threatens to undermine the North Korean administration.

As China comes under mounting pressure from the United States to cut economic ties to North Korea, Russia will move to soften the resulting blow to Pyongyang's finances. In hopes of discouraging such behavior, Washington may pursue secondary sanctions against China and Russia in the months ahead. But as both countries distance their most important firms from North Korea, these measures will likely affect companies and individuals with relatively minor roles in the Chinese and Russian economies.

Meanwhile, Beijing and Moscow will continue to emphasize the importance of easing tension and diplomatically engaging with Pyongyang. The two will try to dissuade Washington from taking military action against North Korea, advocating dialogue between the North and South instead. The installation of the Terminal High-Altitude Area Defense (THAAD) system in South Korea, however, will feed tension between Seoul, on one hand, and Moscow and Beijing on the other. Eager to fortify its alliance with the United States, South Korea will remain broadly aligned with the White House's stance, temporarily shelving its own attempts to pursue a dialogue with North Korea for a more opportune time while reinforcing its indigenous defenses.

China's President Tightens His Grip

China, for its part, will have bigger concerns to grapple with at home this quarter. The Chinese Communist Party's careful preparations for a change in leadership will be realized in mid-October at its quinquennial congress. The event will bring reshuffles at the highest ranks of the party and serve as an important test of President Xi Jinping's attempts to consolidate power.

So far, all signs point to the president's success in tightening his grip over the country's top decision-making bodies. Xi has already secured the honored status of "core leader," not just of the Communist Party but also of the Chinese state and military. He has also managed to rapidly promote many of his associates to prestigious positions in recent months. Looking ahead, as many as 11 Politburo and five Politburo Standing Committee members are nearing retirement — vacancies that would give Xi the opportunity to fill the majority of seats in both bodies with political allies. Perhaps even more important, party members are likely to endorse the inclusion of Xi's guiding philosophy in the Communist Party Constitution at the approaching congress, allowing him to join the venerated ranks of Deng Xiaoping and Mao Zedong.

A graphic showing contenders for the Politburo Standing Committee

But the summit will also signal the lengths to which Xi must go to secure the political compromises he seeks. It remains to be seen whether the president will be able to break the ruling party's customary age limit to keep longtime ally and anti-corruption czar Wang Qishan on the Politburo Standing Committee. It is similarly unclear whether Xi intends to try to extend his presidency beyond the two-term ceiling specified in the Chinese Constitution.

Even so, Xi will likely emerge from the party congress with the political capital needed to see many of his grand visions through. But in the wake of widespread turnover among the Party's upper ranks, the president will focus his immediate attention on stabilizing the country. Xi will look to contain any socio-economic issues at home or diplomatic disputes abroad that could threaten the image of the Party or the president's status within it. This effort will include steadying China's precarious financial system and highly leveraged companies while mitigating the risk of external volatility. To that end, China has attempted to blunt the effect of U.S. trade measures, insisted on negotiation with North Korea while discouraging U.S. military action and struck a temporary deal with India to end their tense border standoff.

China's sensitive political environment will not cause its leaders to completely ignore economic reform, though. The party's newly instated officials, after all, will need to boost the public's confidence in the government as the economy remains stable but weak. Over the past few months, Beijing has combined broad-based structural reforms such as the consolidation of industries, production cuts and the enforcement of environmental regulations with renewed efforts to chip away at the mountain of debt crippling the country's state-owned enterprises, financial sector and local governments. These reforms will only accelerate in the coming quarter.

The Growing Mountain of Chinese Debt

Beijing, however, will have to hedge against the significant risks associated with the reforms. They include threats to corporate solvency and a slowdown in the all-important real estate market on which China's heavy industries and construction sector depend. Underpinning these problems are the long-term risks that the country's considerable debt presents to the Chinese economy, which will only become more fragile over time if it is not paid off. And though Beijing has the resources and fiscal tools with which to contain the danger of widespread default, relying on them will only exacerbate the government's debt problems in 2018 and beyond.

The global resurgence of protectionism, moreover, will run counter to China's desire to avoid upheaval outside its borders. Over the past few months, the United States has opened several investigations into China's technology transfer requirements as well as other matters related to the protection of intellectual property. In the months ahead, discord between the two countries will only worsen in the trade realm. Even if the United States chooses not to take action against Chinese practices, Washington will probably expand its investigations into critical Chinese industries, such as semiconductors. As it does, it will doubtless use the same justification — safeguarding U.S. national security — that it has used to target China's steel and aluminum sectors before. China, which is eager to dissuade the United States from targeting its economy, will ramp up its efforts to increase the protection of intellectual property at home while leveraging market access and investment in its negotiations with Washington. But the United States is not alone in its scrutiny of China: A recent decision by the European Union to deepen investigations into Chinese takeovers of high-tech companies on the Continent underscores the growing backlash against the country's overseas investment into crucial industries.

Despite the economic nationalism sweeping across the developed world, Beijing will continue its effort to upgrade its domestic manufacturing base and to invest in infrastructure in countries participating in the Belt and Road Initiative. It will, however, maintain close control over the outflow of capital into foreign industries it deems risky, including property, entertainment and sports. Countries whose property markets have been buoyed by China's previous spending sprees will feel Beijing's tightening grip most acutely.

Asia's Biggest Powers Square Off

China will try to ease mounting U.S. pressure on trade issues and North Korean threats where it can. But Beijing will be particularly wary of any attempts by Washington to raise the touchy subject of Taiwan's status before or during the Communist Party Congress. Once the summit is over, however, China will have more flexibility in its foreign policy.

As the United States disengages from Southeast Asia, China will continue its amicable outreach to the members of the Association of Southeast Asian Nations (ASEAN), offering to negotiate a code of conduct in the South China Sea and to formalize discussions with the Philippines on joint energy development in the disputed waters. But Beijing will also keep its coercive options open in dealing with states that prove uncooperative, increasing the likelihood of new spats emerging between China and Vietnam.

The Philippines, for its part, will try to strike a balance between its relationships with China and the United States. Manila hopes to secure its maritime boundaries by maintaining its detente with Beijing, but it also relies on the assistance of the U.S. military to combat militants linked to the Islamic State in the restive region of Mindanao. Once the few insurgent pockets left in Marawi City fall, the Philippine military will have the opportunity to clear the region of any remaining fighters. But Manila will also face the challenge of reconciling with the mainstream militant Moro Islamic Liberation Front, which has assisted military operations in Marawi City and will expect political concessions in exchange for its help.

Meanwhile, China's foray into South Asia through the Belt and Road Initiative will continue to inspire similar projects among Beijing’s regional rivals, including India. New Delhi already has entered the proposal stages of the India-Japan Freedom Corridor and of the joint construction of ports by India, Japan and the United States. None of these undertakings, however, will notably progress during the fourth quarter.

As China builds up its infrastructure and troop presence along its contested border with India, New Delhi will follow suit, blazing its own roads while seeking out new defense relationships with Asian partners such as Vietnam, Mongolia and Australia. Chief among them, however, will be Japan. The common ground that New Delhi and Tokyo find in maritime security and in their mutual aspirations in Africa and Southeast Asia could drive Beijing to expand its own outreach in India's backyard. If it does, states like Nepal, Bhutan and Sri Lanka will have to find a way to juggle their relationships with India and China. In much the same way, China will work to solidify its security and economic ties with Pakistan amid the United States’ calls for India to play a larger role next door in the stabilization of Afghanistan.

The Tale of Two Trade Deals

Scrambling to account for the recent swell of global protectionism, countries in the Asia-Pacific will feverishly negotiate deals to increase their connectivity with international markets. The 11 members left in the Trans-Pacific Partnership will try to pick up the pieces of the crumbling pact as tension rises between its more- and less-developed signatories. Pressure to reach an agreement will only grow as the rival Asia-Pacific Economic Cooperation bloc prepares to meet in November. Nevertheless, states will have a tough time finding a compromise on thorny issues such as data exclusivity, investment regulations and copyright protections.

The outlook of another major Asian trade pact under negotiation — the Regional Comprehensive Economic Partnership — is even less promising. Its members are largely split into three camps. Developing nations, many of which belong to ASEAN, are interested in discussing little beyond tariffs on goods. By contrast, developed countries such as Japan and Australia aim to hash out a more comprehensive pact. Caught in the middle, India is reluctant to discuss measures to ease the trade of goods but is keen to liberalize the trade of services. These stark differences are guaranteed to lead to dysfunction in talks regarding the deal.

Proposed Trade Agreements Centering on the Pacific

All the while, the United States will continue to hassle Asian exporters — particularly South Korea and China — to change their trade policies. Though Washington will not take any concrete steps to revamp the United States-Korea Free Trade Agreement in the coming quarter, Seoul suspects that it will eventually, regardless of how much South Korea cooperates with U.S. attempts to rein in North Korea. Seoul will likely try to pre-empt any punitive measures against the South Korean electronics and automotive industries by agreeing to some concessions in its trade arrangement with Washington.

Japan's Ruling Party Makes a Bid to Preserve Power

Like China, Japan will concentrate on the political changes underway within its borders this quarter. Over the past few months, few challenges have arisen at the national level to the rule of the Liberal Democratic Party (LDP) as its opponents have remained in disarray. But Prime Minister Shinzo Abe's approval ratings have dipped repeatedly amid a series of scandals and his use of the LDP's majority to ram unpopular bills through the legislature. The public made its growing dissatisfaction clear in Tokyo elections on July 1, dealing the LDP a humiliating blow with the victory of a right-wing contender backed by the capital city's governor, Yuriko Koike.

On the heels of a Cabinet reshuffle and a rebound at the polls, Abe recently decided to take advantage of lingering disunity among his opponents by calling for snap elections in late October. The vote will bring Koike's new political party to the national stage for the first time. It will also test the popularity of Abe's ambitious proposal to revise the Japanese Constitution to pave the way for the normalization of the country's military and for a massive economic reform package. North Korea's persistent weapons tests, particularly those that involve launching missiles over Japanese territory, will certainly drum up support for the prime minister and his party.

If the LDP sweeps the elections on the promise of constitutional revision, the win would give Abe a broad mandate to pursue his reform agenda. On the other hand, a loss of seats would jeopardize the ruling party's plans, particularly if coalition ally Komeito or the opposition party led by Koike — both of which are ambivalent to the prime minister's proposals — carve out a bigger share of seats. And though the opposition has long been disunited, there is a risk that it will start to coalesce into a more coherent force. More important for Abe, however, the snap elections will serve as a bellwether of the prime minister's political future as his party nears a leadership transition scheduled for late next year.

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