The global economy is expected to continue to grow at a healthy pace in 2018 and 2019 but could be faced with three shocks: Energy prices, political uncertainty and interest rates. Euler Hermes’ Mahamoud Islam expects global corporate insolvencies to rise by 8%.
Asia-Pacific economic growth will depend on China’s ability to respond to the US and to keep domestic demand growth in check.
Global economy: we passed the peak, mind non-payment risk
Global economic growth is set to accelerate further in 2018 to 3.3% y-o-y, after growing by 3.2% in 2017. The global economic landscape remains good, despite the emergence of cycle de-synchronisation. Without a doubt, this phenomenon is crucial to understanding and anticipating the economic momentum. This de-synchronisation will result in asymmetric answers from national economies to three global-scaled shocks.
First, commodity prices, in particular oil prices, surged faster than expected. The Brent price reached the $79/bbl mark during May 2018. This general increase may favour exporting countries in the short term. It will also increase input prices and lead to a noticeable rise of global inflation in the upcoming months. However this hike should be temporary, and will not destabilise the global economy. We are forecasting stable oil prices around $69/bbl in 2019 – given that central banks are not likely to over-react to heightened inflation.
Then there is the interest rate shock, following a faster than expected monetary policy tightening in the US. Indeed, the fiscal stimulus initiated in the US in 2017 appears to be more powerful than previously thought, while recent measures of financial deregulation will further stimulate the economy.
In this context, increasingly resembling overheating, added to riskier behaviour around corporate debt and financial activity at large, the Fed will toughen its line. We expect two more rate hikes in 2018 and two additional ones in 2019.
Finally, there is global perturbation due to a shock of economic policy uncertainty, following protectionist moves and a historical overhaul of America’s foreign policy. The America First policy has already had, and will continue to have, deep consequences. One needs to analyse this new paradigm from an historical perspective, taking into account the traditional role played by the US as a supplier of public goods at the global level.
It has long been a purveyor of security through NATO and the UN, of free trade through multilateral rules under the WTO and an economic power with a big influence within the G7 and G20. At every level, one can foresee a disengagement from the US, thus redefining international talks.
The divide between economic and military rationales has blurred, with the Trump administration no longer hesitates to ask for commercial and financial compensation for its geostrategic contribution. Global multilateralism is clearly on the decline, triggering a negative shock of uncertainty around economic policy. The rise of populist regimes and their reaction to de-synchronised economic momentum will be the last source of asymmetries in the months to come.
Against this background, we expect our Global Insolvency Index to remain on the upside for a second consecutive year in a row in 2018 (to 8% from 6% in 2017) and to keep on increasing in 2019 (4%).
In Asia, resilience will stem from China
In Asia, non-payment trend will depend heavily on China. For now, insolvencies are growing in the mainland due to a clean-up of zombie companies (+50% y-o-y in 2018). Demand growth is expected to remain solid (GDP up 6.6% this year). To reduce protectionism risk, China will adopt a multifaceted strategy. In order to keep domestic demand in check, the country will rely on private buffers (eg, rising incomes) and government support.
A multifaceted strategy to respond to US protectionism
Firstly, China may adopt a gradual and measured approach to respond to US protectionist measures consisting in five types of policies. The objectives would be to force the US to negotiate and limit the impacts of the newly implemented protectionist measures on the Chinese economy.
1. The country could set a soft economic patriotism policy
This could include: (i) non-regulatory measures such as an anti-US campaign, a boycott of some US products; (ii) regulatory measures that affect American companies operations in China. The latter could consist in tighter regulation at customs, more difficult rules for basic and routine procedures (eg, set up of a company and revenues repatriation to the US).
China has already employed this strategy in the past when South Korea decided to install a US made terminal high altitude area defence anti-missile system (THAAD). At that time the Chinese government started a boycott against South Korea. This resulted in a drop of 48% of Chinese tourist arrival in South Korea in 2017 (after increasing 35% in 2016). Bank of Korea estimated that the THAAD backlash shaved -0.4 percentage points off growth in 2017.
2. Chinese authorities could increase strategic partnerships
With economic heavyweights such as Japan, ASEAN, India or the EU. This could kill two birds with one stone. A coordinated response could give more leverage against the US. Partnerships could open new avenues for trade especially when they result in free trade agreements.
China has already started to move on that front.
3. The mainland could implement protectionist measures on the balance of services
The country has a deficit with the US ($38bn). Both travel and financial services could be the target. This could be a huge blow to US corporates that are looking to tap into the growing (financial) needs of the new Chinese middle class.
4. China could use the RMB as a tool of retaliation
We expect the RMB to depreciate by 4% against the dollar in the second half compared with the first half. The recent depreciation of the currency and limited reaction of the PBoC suggest that the authorities are comfortable with a weaker RMB. This would help corporates absorb the rise of tariff through an improvement of their price competitiveness.
5. Lastly, we could see turbulences on the holding of US treasuries but not a major sell-off
As it could hinder investor confidence considerably and be in contradiction with the stability of the RMB. The objective could be to trigger a temporary rise in US yields in order to force the US to negotiate.
A more supportive policy mix
In parallel, measures to support domestic demand will likely be implemented. In the short term, increasing incomes (nearly 8% y-o-y growth for nominal disposable income) and rising industrial profits (up to 16.5% YTD y-o-y in Jan-May) should support private expenditures.
In the medium term, fine tuning macro-policies will be pivotal to keep growth in a decent range. We expect fiscal policy to be expansionary. Public infrastructure spending could pick up speed as part of the Belt and Road Initiative (BRI). On the tax side, cut in tariffs for some consumer goods (eg, automotive and agri-food), cut in income tax would likely boost consumption growth. A
Mr Mahamoud Islam is a senior Asia economist with Euler Hermes.