Key Trends for the Quarter
China Weathers a Trade Storm
This quarter, China has set its sights on convincing the United States to cut a trade deal. Beijing will maintain its offer of increased purchases of U.S. goods and greater market access while making measured structural changes in the realms of forced technology transfers and intellectual property protection. These efforts, however, won't be enough to satisfy the full extent of Washington's demands. Still, Beijing will use Western pressure to spur domestic reforms — particularly when it comes to easing market access restrictions and giving preferential treatment to state-owned enterprises. For example, Beijing will try to fast-track the process to shut down problematic state-owned zombie companies at the local level and cut overcapacity in China's coal and steel industries. The process — which broadly entails trimming economically unproductive capacity from the economy — will last far beyond the quarter because the overall cost to China's slowing economy and effect on the jobs market will weaken Beijing's resolve to enact far-reaching reforms. For more background on Beijing's approach to dealing with the U.S.-China trade dispute, read our latest assessment.
Asia Embraces China's Economic Discomfort
An extended U.S.-China trade truce or easing of tariffs will lessen China's economic pain, albeit only to a limited degree. Stress in China's coastal economic powerhouses — including Guangdong and Zhejiang — liquidity constraints in the private sector and employment challenges will compel Beijing to shift toward pro-growth policies. In the coming months, Beijing will expand credit and government bonds to spur infrastructure spending while introducing more drastic tax cuts that will benefit individuals and the private sector. Although Beijing will refrain from pumping up the real estate market — which could increase the number of people living in mortgage debt, thereby constraining their purchasing power — it may selectively loosen restrictions in small and midsize cities.
As the effects of the U.S.-China trade dispute ripple across the Asia-Pacific, some countries stand to gain, and others to lose.
Some Southeast Asian economies, such as Vietnam and Malaysia, are positioned to capitalize on the low-end manufacturing opportunities created by the U.S.-China trade war. But weak global demand and the residual strength of China's export sector will drag down these smaller countries. Electronics-driven economies such as Taiwan, South Korea, Japan and Singapore will continue to be hard-hit this quarter, reviving the call for Association of Southeast Asian Nations (ASEAN) countries to diversify away from China in the long run. Meanwhile, Indonesia will struggle to manage increased trade volatility due to its dependence on commodity exports and its current account imbalance. To learn more, have a look at our assessment on the impact of the U.S.-China trade dispute on the wider Asia-Pacific region.
China, Infrastructure and Great Power Politics
Amid the U.S.-led global campaign against Chinese tech companies, such as Huawei, and efforts to counter China's regional territorial claims, Beijing will use its economic and diplomatic leverage to coerce Washington's allies. China has used intimidation to influence Canada, the United Kingdom and Australia in the past. Closer to home, Beijing will play the economic card to encourage Taiwan's supporters to veto Taipei's bid for World Health Assembly observer status and any attempts to apply for membership in the Comprehensive and Progressive Trans-Pacific Partnership (CPTPP).
China will not sit idly by and allow the United States to corral it. Instead, Beijing will use its significant economic heft to influence perceived U.S. allies and potential regional partners, charming or coercing them to accede to its ultimate desires.
China's overseas infrastructure projects will encounter local obstructions and increased competition from the United States and its partners. This will not, however, discourage Beijing from redoubling its efforts on the Belt and Road Initiative. In the coming quarter, concerns over enduring financial sustainability will result in a review of the initiative's projects in countries such as Pakistan, Indonesia and the Maldives. An increasing number of countries will try to negotiate better terms, much to Beijing's consternation. Yet, as the Belt and Road Summit in April will show, China's approach is flexible, particularly given its interests in making its state-owned investors more financially prudent in their spending. Read our most recent assessment of China's cat-and-mouse approach to dealing with overseas investment opportunities and challenges.
Progress on North Korea Remains Elusive
Following an abrupt end to the Hanoi summit between the United States and North Korea, the two countries will spend much of the second quarter attempting to tailor expectations and demands. Washington and Pyongyang will both attempt to push the other beyond its current position, but a return to a default stalemate is always likely. Other countries will take a more prominent role in attempting to put the two sides back on track, with China and South Korea — two neighbors that are acutely aware of the stakes — stepping up.
It remains to be seen just how far the United States and North Korea are willing to go diplomatically, given the entrenched mistrust between them.
The United States will not fully dismiss sanctions against North Korea, and Pyongyang will not do anything to jeopardize the completion of its nuclear deterrent. Washington will, therefore, prioritize mitigating the perceived nuclear threat to the continental United States. North Korea will focus on sanctions relief to ease its ailing economy and open up prospects for inter-Korean cooperation. But any U.S. sanctions relief will be tethered to direct concessions from North Korea, and even then, the respite will be incremental and provisional in nature. In spite of setbacks, we will not see a return this quarter to the spiraling escalation that typified 2017. Learn more about the next steps in the ongoing U.S.-North Korea dialogue.
- In an attempt to manage a tough economic quarter, China will temper infrastructure spending and credit expansion while offering financial incentives to drive consumption.
- In the U.S.-China trade war, Vietnam stands to gain a share of the region's low-end manufacturing industry, but the country's lack of skilled labor and mature industrial base will continue to hamper its bid to attract value-added investment.
- In an attempt to mitigate the effects of the U.S.-China trade conflict, Asian economies will advance regional free trade agreements such as the Regional Comprehensive Economic Partnership (RCEP). The self-imposed deadline for ratification is this fall, but because India remains wary of China and is resistant to the RCEP, Beijing will likely grant concessions to New Delhi to encourage it to join the partnership and finalize the deal sooner, rather than later.
- An opposition victory in Indonesia's nationwide presidential elections could result in Jakarta following in Kuala Lumpur's footsteps by initiating its own re-examination of Belt and Road projects with China.
- Despite Tokyo's best efforts, a peace treaty with Moscow to formally acknowledge the end of World War II — along with any resolution on the status of the disputed Kuril Islands — will encounter Russian resistance.
Key Dates to Watch
- April 17: Indonesian presidential and parliamentary elections.
- April: Second Belt and Road Summit.
- May: U.S. President Donald Trump may pay a state visit to Japan to meet the new emperor, who will assume the throne in April.
- May 18: Last possible date for the U.S. president to make a decision on the Section 232 U.S. national security report on auto tariffs.
- Before May 18: Australian federal elections.
- May: Philippine Senate midterm elections.
- June 28-29: G-20 Summit in Osaka, Japan.