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2017 third-quarter forecast

Jun 26, 2017 | 13:52 GMT

14 mins read


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/
section Highlights
  • Ahead of a leadership transition at the start of the fourth quarter, infighting within the Chinese Communist Party will reach a fever pitch, complicating Beijing's efforts to preserve stability and political coherence.
  • North Korea will continue to regularly conduct missile tests in spite of the sanctions building against it, giving the United States an opportunity to pressure China on other fronts such as trade, the South China Sea and issues surrounding Taiwan.
  • The United States will keep its security commitments in the region, complicating China's attempts to seek conciliation with members of the Association of Southeast Asian Nations (ASEAN).
  • ASEAN states will work to forge coalitions among themselves and with regional actors in hopes of balancing against the power looming on their doorstep.
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China in Transition

In the Asia-Pacific, all eyes will be on China this quarter as the country's leaders prepare for the 19th Party Congress. Over the past three months, Beijing has made sure to prioritize economic and political stability over risky, if necessary, reform. To this end, Chinese President Xi Jinping has quietly backtracked on some of his more controversial economic initiatives; coupled with the United States' decision to ease up on its protectionist stance toward China, the move has given his administration some room to maneuver at home.

As Xi works to consolidate power beneath him, the approaching party congress will present both opportunities and threats to the leader. After all, the meeting will bring reshuffles throughout the ruling party, including in the Politburo Standing Committee — the party's top leadership circle and country's most important decision-making body. As the window closes for China's deeply intertwined political networks to cement their positions and defend themselves from an ongoing crackdown on corruption, intraparty competition will intensify.

The Communist Party's highest-ranking leaders will try to find consensus among themselves, and Xi's scheme to secure a lengthy stay in power will most likely proceed as planned. But changes in position and action against those at the top of the organization will continue to expose the internal rivalries and discord beneath Xi's anti-corruption campaign and political brinksmanship. Perhaps the most visible example of this is a probe into major financial conglomerates that is slowly encroaching on many of the country's entrenched power networks as Beijing seeks to re-establish control over the firms. Meanwhile, further revelations of misdeeds by anti-corruption chief Wang Qishan could result in his sidelining at the party congress — and in pushback to Xi's drive against corruption that could complicate his primary means of amassing power.

The pressing need to ensure a smooth leadership transition will make the ruling party far less tolerant of any action that threatens the nation's stability. Beijing will doubtless deploy preemptive measures aimed at preserving order and control while it continues to prioritize societal calm over economic reform. The government's most important objective will be to keep employment levels steady as it consolidates and restructures heavy industries such as coal and steel. At the same time, it will look to curb borrowing among highly leveraged companies in hopes of weaning the economy off investment-driven growth funded on credit. Though Beijing will continue to try to contain the risks associated with mounting debt, some companies — particularly those in heavy industry and construction — will be unable to avoid default, threatening jobs in the process.

At the same time, tight credit and local policies intended to discourage speculation will put pressure on China's already slowing real estate sector. Some companies in the construction industry will be squeezed particularly hard this quarter as they struggle to pay off maturing bonds. Consequently, real-estate companies that have ridden the credit boom of the past two years, especially those in third- and fourth-tier cities, may well find it increasingly difficult to pay their debts. (This quarter, the real estate sector owes 56 percent, or $5.1 billion, of its total $9.1 billion in bonds maturing this year.) Though Beijing may allow some companies in the private sector to default, it will do what it can to prevent a wider collapse of the real estate industry, pulling back on painful reforms and extending government credit and tax incentives in an effort to insulate the economy somewhat. But its attempts to restructure China's "zombie" corporations and address industrial overcapacity will have more success in some regions than others, and any tougher economic measures will have to wait until the party congress is over.

Some of the biggest threats to China's economy — and by extension, political stability — do not come from within, though. Toward the end of the quarter, the United States will have more opportunity (and perhaps greater incentive, given North Korea's persistent provocations) to take punitive action against China in the trade realm. The 100-day trade resolution that U.S. President Donald Trump struck with Xi in April will come to an end in mid-July, likely culminating in concessions by China on some uncontroversial issues, such as market access for U.S. beef, liquefied natural gas and financial services. But the Trump administration has many policy tools at its disposal to try to shrink the United States' $347 billion trade deficit with China, including the national security restrictions on key sectors and the proportional responses to trade abuses permitted by U.S. law.

Should Washington enact sweeping protectionist measures against China, it could throw a wrench in Beijing's plans for economic restructuring. Aware of this, the United States will use threats of such action to bring China to the negotiating table on other, more sensitive issues. Beijing, in turn, will seek to mitigate Washington's threats by emphasizing Sino-U.S. cooperation on North Korea — a matter both governments have now explicitly tied to trade — even though Pyongyang's continued belligerence could give Washington ammunition against Beijing on other security initiatives in Taiwan and the South China Sea.

Of course, neither the United States nor China will neglect other trade opportunities as they arise. Beijing, for its part, will continue its economic outreach across the Asia-Pacific by promoting its Regional Comprehensive Economic Partnership (RCEP) and Xi's signature Belt and Road Initiative, whose biggest projects will make steady progress in the months ahead. Chinese lobbying in Europe, moreover, has begun to bear fruit as the European Union weighs the option of granting market economy status to China. (The country's nationalist trade agenda and the perception of unfair investment and trade practices by Beijing, however, have caused concern among the bloc's core powers, making further progress on this front unlikely.) Meanwhile, in keeping with the Trump administration's strategy, the United States will take incremental steps toward striking a free trade deal with Japan and possibly revisiting trade ties with South Korea as Washington reviews its trade deficits.

Coping With a Nuclear North Korea

Not to be left out, North Korea proved in the second quarter that it, too, is still a central driver of the changing geopolitical dynamics in the region. Over the past few months, Pyongyang has made visible strides in its nuclear and missile programs, triggering a rare moment of rapprochement between the United States and China as Washington dubbed Beijing's cooperation crucial to reining in its bellicose neighbor. The Korean Peninsula will continue to provide a measure of common ground for the two larger powers — and simultaneously test how long their nascent detente can last.

North Korea, however, will forge ahead with its nuclear and missile programs according to a schedule dictated by technical requirements, despite the threat of new sanctions and deepening international isolation. But barring the demonstration of a credible long-range missile capability — something that is likely still a year away — the United States probably won't deviate from its current policy course on North Korea. Instead it will stick to slapping new sanctions on Pyongyang, further isolating it internationally, and increasing its military presence in and around the Korean Peninsula.

The United States will also enlist China's aid, willing or not, in keeping North Korea in check. In the steady drumbeat of Pyongyang's rhetorical provocations and nuclear tests, Washington will find plenty of opportunities to gradually ramp up pressure on China in other areas, including trade, maritime disputes and the issues surrounding Taiwan. (The United States, for instance, could introduce secondary sanctions against Chinese entities that trade with North Korea.) China, concerned about its own stability above all else, will cooperate with the United States to the extent that it can, perhaps even abiding by measures such as a temporary cutoff in oil supplies in the event that Pyongyang conducts another nuclear test.

But Beijing will remain wary of any attempt by Washington to elevate its relationship with Taipei ahead of the 19th Party Congress. China has already used its diplomatic heft to ensure that smaller countries sever their ties to Taiwan, a strategy it will maintain in the coming quarter. But as Taipei turns to Washington for security assurances, perhaps in the form of substantial arms deals — for example, the transfer of F-35 aircraft — the United States' relationship with China would be dealt a serious blow, possibly even prompting Beijing to cease its cooperation with Washington against Pyongyang while taking aggressive economic and military action against Taipei.

Barring a breakdown in Sino-U.S. ties, however, China will work with the United States to rein in North Korea. Yet at the same time it will take care not to jeopardize the stability of the government in Pyongyang. In this way, Russia's economic outreach to North Korea and the rise of a new government in South Korea, which has taken a softer stance toward the North, will suit China's interests well. To ensure that the latter's position does not harden over time, Beijing will seek to improve its relationship with Seoul — something South Korea's recent decision to suspend the deployment of a Terminal High-Altitude Area Defense system will certainly make room for.

Meanwhile, the emerging alliance among the United States, South Korea and Japan will endure as Seoul and Tokyo (albeit reluctant partners) communicate and cooperate with each other to some degree. It will not, however, function as the robust trilateral framework Washington would like it to be. For one, the South Korean administration's stance on North Korea will present challenges to the United States' strategy in dealing with Pyongyang. For another, questions persist regarding Washington's commitment to its friends in the Asia-Pacific. Nevertheless, the mounting threat emanating from the North will prevent South Korea from backing away from its relationship with Japan amid controversy over a contentious deal on "comfort women" struck in 2015. In fact, South Korean President Moon Jae In is scheduled to meet with Japanese Prime Minister Shinzo Abe on the sidelines of the G-20 summit in early July.

Asia-Pacific: Among Great Powers

China, too, will concentrate on reshaping its relationships in the region. In the second quarter, Stratfor's forecast that Beijing would sustain its carrot-and-stick approach to influencing the behavior of other claimants in the South China Sea proved accurate. In much the same way, China will continue extending offers of conciliation while maintaining its massive military buildup and coercive tactics in the coming quarter.

In recent months, China and the Association of Southeast Asian Nations (ASEAN) have ostensibly made progress toward settling a common code of conduct in the South China Sea, talks that will almost certainly continue in the months ahead. Beijing will use the long-delayed agreement as an incentive to keep ASEAN states like Vietnam from trying to draw external powers into the maritime dispute. But enduring divisions within the bloc, competing strategies among claimants and relentless military assertiveness by China will limit just how far negotiations can progress this quarter.

Beijing's other ambitions in the South China Sea will be difficult to realize as well. U.S. freedom of navigation patrols that began in the waters during the second quarter will continue at a steady clip. And though the United States lately has been distracted by North Korea, its attention is slowly turning back to the rest of the region as the White House's Asia-Pacific policy begins to take shape. Washington will start to re-engage with its Southeast Asian allies and partners ahead of Trump's visit to the region in November, when he will attend the U.S.-ASEAN and East Asia summits in the Philippines, as well as the Asia-Pacific Economic Cooperation summit in Vietnam. This effort will entail a combination of diplomatic and defense cooperation, enabling countries like Vietnam to keep using U.S. ties as a counterweight to Chinese influence in the face of Beijing's overtures. However, the lasting perception of U.S. inattention will also encourage ASEAN states to align with neighbors that share their interests. For instance, closer defense and maritime cooperation can be expected among Japan, India, Australia and Vietnam.

All of these moves will take place during the high season for fishing, a time when the disputed waters will be crowded and the risk of skirmishes will be high. Clashes between fishing vessels would further strain relations between their countries of origin, and should the Philippines and China be dragged into a dispute, their newfound partnership would be put to the test. Either way, Manila will continue to look inward this quarter as Philippine President Rodrigo Duterte grapples with security issues in the restive southern province of Mindanao, which have led to renewed counterterrorism cooperation between the Philippines and the United States. Additionally, disputes between China and Vietnam over energy exploration could increase the chances for tension.

In its ongoing bid to counterbalance China and boost its own role in regional security, Japan will make an effort to keep reaching out to ASEAN states this quarter. As Beijing's Belt and Road Initiative proceeds apace in South Asia — much to the chagrin of India — Tokyo and New Delhi will work together to offset China's growing clout. One way they will do this is by enhancing their maritime and defense cooperation with each other and throughout the region, in addition to joining economic development projects in and beyond the Asia-Pacific.

On the whole, Asian leaders will try to sustain the now-flagging momentum behind free trade. Regional states engaged in talks on the Trans-Pacific Partnership (TPP) will work to salvage the pact in the wake of the United States' withdrawal from it. New Zealand and Japan have ratified the deal, something signatories can build on to solidify an alternative. New Zealand's general elections in September, however, could still derail its involvement in the trade agreement if either the Labour Party or the New Zealand First movement gain electoral ground.

China will not wait for the deal to stumble again before pushing its own alternative, the Regional Comprehensive Economic Partnership. Though Singapore will throw its weight behind the China-led pact in hopes of expediting the talks, India will remain hesitant to sign onto it, given the agreement's emphasis on tariffs instead of the services that drive its economy. Japan, hesitant to forge closer links with China, will hang back from the bloc as well, opting instead to try to revitalize the TPP.

For the most part, changes in Southeast Asian states' diplomatic relationships will be more pronounced than shifts in their domestic politics this quarter. In Thailand, the junta will keep tightening its grip on power as the yearlong political hiatus triggered by the king's death comes to an end. And as the country prepares to hold elections in 2018, its deeply rooted political divides will start to resurface — as will violence perpetrated by Muslim insurgents in the restive south. Meanwhile, the Cambodian government will move to shore up support following recent communal elections. The Malaysian administration of Prime Minister Najib Razak will do the same ahead of approaching elections after weathering a tumultuous corruption scandal by appealing to the public's support of political Islam. But none of these developments will have a marked impact on regional politics.

A Japanese Awakening

Japanese politics, on the other hand, may. In the past few months, Japanese Prime Minister Shinzo Abe has used the political capital gained amid mounting tension with North Korea to push through landmark legislation allowing the emperor to abdicate the throne. Abe will try to build on this success in the next quarter by advancing his ambitious reform agenda, including a framework for constitutional change, in the hopes of securing its approval by the end of the year. Though the Tokyo First movement will challenge Abe's party in the Japanese capital's municipal elections on July 2, the ruling Liberal Democratic Party will not see a similar challenge at the national level for some time.

Meanwhile, Abe will take any North Korean posturing as justification to allow the Japanese Self-Defense Forces to exercise their newfound powers, granted in a historic security law passed in 2015. In doing so, he will test the waters for his plan to normalize the country's military when the National Diet resumes session in the next few months.

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