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Analysis: Trade war and the bumpy road to supporting growth
The global economy became suddenly more volatile in emerging markets this month as growing concerns over the escalation of the trade war between the United States and China dampened the positive market sentiment that had been in place since December, last year
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span>The global economy became suddenly more volatile in emerging markets this month as growing concerns over the escalation of the trade war between the United States and China dampened the positive market sentiment that had been in place since December, last year.
The source of the volatility is clear: the escalation of the trade war between the US and China. We believe that this will be the biggest risk to the global economy in the next three to six months if there are no positive moves from both sides to ease the tension.
The rising US-China trade tension has further added to the negative sentiment that has since last year affected global economic growth. The growing conflict has triggered foreign capital outflows from emerging markets.
The Institute of International Finance (IIF) reported that capital outflows from the Chinese equity market reached a total of US$2.5 billion or about $600 million outflows per day last week. Similar patterns occured in other emerging markets such as South Korea, India, Indonesia and Taiwan.
Even without the trade war scenario, with the current global economic situation, an economic slowdown will occur in the near future. Several leading indicators hint that there is more of a cloudy outlook across the globe rather than bright spots.
Since early 2018, the US was still the major hope for a better global economy while others become riskier, especially China and the eurozone. The sentiment was solid as reflected in the market expectation on a more “hawkish” policy tone to dampen the inflationary risk ahead.
However, the International Monetary Fund has projected that the global economic growth will moderate with a tendency of slowing down in the coming years. The flagging growth is led by the slowdown of the two largest economies, namely the US and China.
For Indonesia, the trade war may have a severe impact because China and US are its largest export market destinations, accounting for 15.1 percent and 10.2 percent of total exports in 2018, respectively.
Moreover, the impact of the trade war may affect emerging markets like Indonesia through direct and indirect channels. A clear example is soya beans, one of the US commodities affected by China’s high import tariffs. As a result, the soya bean price in the world has fallen because of a decline in Chinese imports.
This has also affected the crude palm oil (CPO) price as the two commodities are substitutes. This may indirectly harm Indonesia’s exports as CPO is one of the main export commodities. It could, therefore, further undermine the country’s current account position. In a broader picture, this may also indirectly threaten the banking sector as a huge number of debtors in Indonesia’s banking industry are related to oil palm plantations and CPO exporters.
In other words, the trade war may lead to lower commodity prices, causing a decline in commodity-related lending. Thereby, it becomes pivotal for the banking industry to manage its asset quality. The trade war may also affect export transactions causing fee-based income from commodity-related exports to decline.
We have seen the US and China have implemented reciprocal tariff policies to restrict imports from one another. The most recent issue is whether the trade battle between US and China will continue.
We think that the trade war could still escalate despite it not giving any benefit to either side for two reasons. First, the trade war will not result in any winner, meaning that all parties will suffer from lower trade volume and economic growth as well as rising short to medium-term inflation rates. Second, the trade war negatively impacts specific parties in the domestic economies, such as soya bean farmers in the US, which may then pull their support from the government.
Going forward, we should remain cautious and never underestimate the impact on domestic economic growth. The key to survival in the global volatility is policy consistency. Some positive factors in the Indonesian economy are that the government and monetary authorities are very responsive to the current situation and strive to be pre-emptive in every different business cycle.
We feel that Bank Indonesia and the government’s focus this year and ahead will be on managing the right balance between pushing economic growth and maintaining macro stability. Narrowing the investment gap by enlarging the foreign direct investment portion should be the main priority.
The objective of this attempt is not only to push economic growth, but also to get the current account deficit more sustainably financed as portfolio investment accounts for around half of the financing in the past years. But, the competition will get tougher in tapping the direct investment going forward, especially in the midst of rising global volatility. Only countries with better infrastructure, clear investment policies and stable macroeconomic landscapes can attract direct investors.
Thus, we believe that more incentives to attract investment will be introduced in the second half of 2019, specifically encouraging the flow to manufacturing export-oriented sectors.
The goals are to increase the contribution of net exports to GDP and to absorb more employment, achieving greater inclusive growth. There is still room for improvement in supporting the economy, such as making greater efforts at eradicating red tape, improving the clarity of regulation synchronization at both central and regional levels, revising the Labor Law to be more flexible and being more open to raw materials imports.
Last but not least, another way to support the domestic economy is by earnestly promoting the tourism sector to be one of the leading sectors for growth. This effort can be very effective in supporting the domestic economy as well as helping shrink the service balance deficit if implemented properly through robust coordination between central and local governments, as Indonesia already has competitive and comparative advantages in this sector.
In sum, the trade war will give us a bumpy road ahead as the volatility continues and the competition for gaining capital flows increases. Policy consistency across sectors and across government, central and local, will protect us from the worst impacts on the domestic economy.
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The writer is senior economist at Bank Mandiri.
