Annual Forecast 2016: East Asia

Dec 28, 2015 | 12:55 GMT

In East Asia, a new year will bring economic and trade agreements to the fore, the urgency behind which will be driven by events in China.

Pushback in Beijing

China's reform process has reached a precarious phase. The much-needed transition to an economy based on domestic consumption has been neither quick nor without cost. Divisions are already showing among China's regions: the services sector is bolstering the southern and coastal provinces, while weak housing and heavy industry sectors are dragging down the northern and inland provinces. The 2016 agenda includes state-owned enterprise reforms, with a particular focus on consolidating bloated sectors and imposing additional oversight on assets. This will likely involve issuing more crude oil import licenses to private refiners and spinning off the pipeline operations of China's national oil companies.

Government and industry leaders both will push for consolidation, while Beijing will impose reductions on metals production. This suggests that commodity consumption growth will remain sluggish in 2016. Rising corporate debt, exacerbated by slowing domestic economic growth, will generate further risks to the reform process. This does not mean, however, that Beijing will deliberately slow or reverse reforms, as such a decision would carry its own risks. Nonetheless, China's leadership is looking at a troubled year as it manages the economic and social impacts of economic change. The new year will also likely see further, cautious loosening of currency controls to further the internationalization of the yuan, as well as domestic fiscal reforms intended to boost the tax revenues of local governments.

China's policymakers will make it a priority to minimize social and economic disruption while moving forward with reform plans. As in previous years, resistance to change will manifest in bureaucratic inertia and political maneuvering. As President Xi Jinping's political consolidation and anti-corruption campaign intensifies ahead of the 2017 Party Congress, members of China's elite will band together in small factions to gain protection from the consolidated center. Competition for positions ahead of 2017 will accelerate this trend — a further sign of the shift away from the system of consensus rule that has been the status quo since the era of Deng Xiaoping. This transition will mean greater uncertainty in China over the next few years.

Beijing is also launching a long-awaited and ambitious series of military reforms. These will significantly alter the structure of the People's Liberation Army, ultimately bringing it more in line with Western military models. This will involve large cuts in personnel, reorganization of military regions, and the removal of a significant number of staff officers. Beijing will carefully match these changes with economic incentives for those who are demobilized or moved out of powerful positions. Beijing could also reduce the role of political commissars, at least at the lower levels, to allow for more flexibility in military operations, particularly at the tactical level.

Southeast Asia's Balancing Act

In Southeast Asia, the expected U.S. interest rate hike will place pressure on some of the regional economies, particularly Malaysia and Indonesia, both of which rely heavily on foreign lending. However, the Chinese economic slowdown will continue to be the single greatest source of economic difficulty in Southeast Asia, though impacted countries will still be compelled to balance their economic dependence on China with their growing security reliance on the United States. Even as China's economic growth slows, Beijing will use its heft to offer incentives to push Southeast Asian nations to cooperate, warning them of both economic and military consequences should they resist.

Efforts to establish or implement regional trade and economic agreements in Asia will accelerate in 2016. The U.S.-led Trans-Pacific Partnership will come up for ratification in several regional countries, while others petition for inclusion in the second round of membership. Negotiations toward the Regional Comprehensive Economic Partnership will intensify, as will moves by China, South Korea and Japan to create a trilateral free trade agreement. Members of the Association of Southeast Asian Nations (ASEAN) will begin implementing the blueprint for the new ASEAN Economic Community. None of these developments will radically alter the economic situation in Asia in 2016, but each will create new challenges and new opportunities for businesses in the Asia-Pacific region.

These deals will also provoke domestic challenges from players trying to defend their particular interests amid the changing environment. This will contribute to delays in ratification and implementation of new agreements. At times, this will yield short, but sharp political disruption, particularly in countries such as Japan, Malaysia, Indonesia and South Korea, which are already facing internal economic and political stresses.

The desire for economic cooperation may rein in regional security competition. It will not, however, fully ameliorate political and territorial disputes. The South China Sea in particular will remain a central focus. China will continue asserting its claims over disputed territories, and the United States will continue freedom of navigation patrols around Chinese-occupied islets and expand its military cooperation with several littoral countries. Maritime tensions could flare up again as the Netherlands-based Permanent Court of Arbitration makes its initial findings on the Philippines' case against Chinese South China Sea claims. Although the court decision does not identify sovereignty issues, and though China is not participating in the case, the rulings nonetheless will add another layer of complexity to the maritime disputes and questions about whether the disputed islets even serve as legal bases for determining the extent of territory. The United States has budgeted for increased defense-related training and sales in Southeast Asia (and Taiwan) in 2016 and will expand defense cooperation with Japan and Australia.

Japan will continue to debate whether it is politically or militarily ready to join in South China Sea patrols, but no decision is expected until the second half of the year, after Upper House elections. Even then, Tokyo is more likely to limit its direct patrols to aerial reconnaissance rather than anything involving surface vessels. The United States will also push Australia to take on a more active role in the South China Sea. As with Tokyo, however, Canberra will find itself carefully weighing the costs and benefits of any significant action, given its tight economic relationship with China.

Despite continued U.S. activities in the South China Sea and an expected U.S. arms sales package to Taiwan, China is unlikely to significantly curtail bilateral military ties with Washington or threaten its standing invitation to join the Rim of the Pacific Exercise (RIMPAC), one of the world's largest multilateral naval exercises. Meanwhile, to shape regional perceptions and put the existing U.S.-Japan-South Korean alliance structure under stress, Beijing could make concessions in 2016 in negotiations on establishing a maritime boundary with South Korea.

Japan's Regional and Domestic Role

In 2016, Japan's "Abenomics" economic agenda will provoke growing criticism from a disillusioned public. The government could try to reshape the terms of the program's successes, shifting attention away from the monetary "arrow" — one of the three core aspects of the strategy — and toward structural reforms and the progress being made. Longer-term plans, such as a 2017 sales tax increase, could be delayed even further as the economy remains at the edge of recession. Should the Abenomics program officially end, government bond yields likely will not spiral to disaster, as others are predicting. Instead, Japan will take a path similar to the one it pursued before Prime Minister Shinzo Abe took power — increasing government spending, raising debt levels, and pushing the problems further down the road.

Japan's economic, political and security relations throughout Southeast Asia will spread in 2016, despite domestic economic constraints. Although Japan faces economic challenges at home and "Abenomics" is far from accomplishing its main goals, Tokyo still has a fair number of financial incentives it can offer Southeast Asia and will more actively pursue infrastructure contracts throughout the region, often going head-to-head with China. Southeast Asia will reap the benefits of increasing competition between the two powers as each seeks to expand regional economic cooperation, loans, infrastructure development and investment.

Notable Elections in the Region

Though Stratfor does not predict the outcome of elections, and though governments are constrained by geopolitical realities that limit their ability to radically alter policy directions, a handful of elections slated for 2016 are worth noting.

In January, Taiwan will elect a new legislature and president, and most polls suggest the opposition Democratic Progressive Party is poised to take over from the ruling Kuomintang. China will pay particular attention to this election; the Democratic Progressive Party traditionally is considered a pro-independence party, though its current platform asserts that it wants to maintain Taiwan's current relationship with China. Although we do not expect any radical changes in the first six months of the new government, there will be plenty of room for political miscalculation.

China will also be closely watching May's elections in the Philippines — a country at the center of the South China Sea dispute. Ahead of the vote, Beijing could make it a point to appear more cooperative on maritime issues and economically in hopes that a more conciliatory government will take over in Manila.

In Malaysia, the embattled government of Prime Minister Najib Razak could choose to call an election in 2016. The ruling United Malays National Organisation and Barisan Nasional will court the ethnic majority, potentially adding stress to increasingly unstable internal relations with the ethnic Chinese, a critical component of the Malaysian business community.

In South Korea, rising labor unrest will contribute to periods of public demonstration and occasionally violent protests leading up to the April parliamentary elections.

Although not truly a national election, North Korea's Workers' Party congress will mark the solidification of the rule of Kim Jong Un and could end the frequent leadership shuffles that have characterized the past few years. Additional nuclear and missile tests, driven more by technological than political requirements, cannot be ruled out.

And finally, in Myanmar the military will work to retain its place in the new government, adding uncertainty to the handover of power to the National League for Democracy.

All images are courtesy of Getty.

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