South-east Asia faces trade war fallout

FT Confidential Research | July 17, 2018

A US-China trade war risks doing severe collateral damage to south-east Asia’s biggest emerging economies.

As FTCR previously argued, the Asean 5 economies are better insulated against market squalls than they were during the “taper tantrum” of 2013, but they are unprepared for an extended period of reduced global demand as threatened by tit-for-tat protectionist measures initiated by the Trump administration.

While export-driven Vietnam is the most directly exposed to a global slowdown, the fragile current accounts of the Philippines and Indonesia leave these countries vulnerable to balance of payments crises.

The White House has so far imposed 25 per cent direct tariffs on $34bn in annual imports from China, and the Chinese government has immediately responded in kind. If this is the extent of the trade fight, then the Asean 5 need not worry.

However, these may be only the opening salvos. The US administration is considering levying duties on another $200bn of imports, and President Donald Trump has threatened to tax all $500bn in shipments from China. He has also picked trade fights with the EU and other US allies.

As bluster has given way to action, the threat of a global trade war is now being taken seriously. Few countries would be immune to its fallout.

Vietnam’s vulnerability

Vietnam’s roaring economy — it grew at an annualised pace of just over 7 per cent in the second quarter — is by far the most export dependent among the Asean 5. For the 12 months ending March 2018, the country shipped goods equivalent to 99.2 per cent of gross domestic product. 

Far more than its Asean-5 peers, Vietnam has relied on exports for growth over the past decade, nearly quadrupling its shipments between 2008 and 2017. The country’s annual exports have reached $226bn, just $17bn behind Thailand, the regional leader.

At $43.7bn, Vietnam’s annual exports to the US rank first among the Asean 5, making the country sensitive to softening US consumer demand. It is sales to the US, EU and other developed markets, and not to China, that have propelled Vietnam’s growth over the past decade.

Trump’s terrible timing

The threat of serious trade conflict is adding to the pressure on emerging markets caused by the strengthening US dollar. Although the Asean 5 have not been hit as hard as Turkey or Argentina, equities in all five countries have sold off sharply, with only Vietnam holding on to many of last year’s gains.

The Philippine peso has been the worst performer among the Asean 5 currencies, shedding more than 7.3 per cent year-to-date against the dollar, followed by the Indonesian rupiah at 6.1 per cent. Quietly, the Vietnamese central bank has devalued the dong, which is fixed to the dollar via a crawling peg. The dong is down 1.5 per cent so far this year, and the government could take more aggressive action if exports slow significantly.

Some currency weakness may help cushion export-focused economies such as Vietnam, Thailand and Malaysia. They could also benefit in the longer run if foreign direct investment shifts away from China as more companies hedge against the risk of trade action. Likewise, tariffs on goods produced within its border will encourage China to accelerate offshoring to less expensive Asean economies.

However, for the less export-reliant economies of the Philippines and Indonesia, whose currencies have declined the most rapidly, depreciation means faster-growing current account deficits and greater inflationary pressure.

Creaking balance of payments

The Philippines and Indonesia have been running persistent current account deficits, making them more susceptible to currency depreciation and — in extreme scenarios — balance of payments crises. For now, their import cover is sufficient, with foreign exchange reserves equal to 8.8 months of imports for the Philippines and 8.1 for Indonesia. 

The situation in the Philippines is the more precarious. As FTCR analysis has shown, the economy is being squeezed by a deteriorating trade balance and decelerating remittance growth. The country has run a current account deficit since late 2016, reducing foreign currency reserves by 10.7 per cent from their September 2016 peak. 

Worse, the trend is accelerating. Almost half of the country’s reserve losses have come in the past six months, a pace that could become unsustainable if external conditions worsen. The Philippines also has the Asean 5’s highest dependency on dollar-denominated energy imports, so a weaker peso is running up its import bill.

Inflation compounds such challenges. The consumer price index for the Philippines has increased every month so far this year because of rising oil prices and a rice shortage, increasing to 5.7 per cent in June from 3.3 per cent in 2017.

In Indonesia, inflation is currently under control, but the country has run the largest current account deficit among the Asean 5 since 2012, and its foreign exchange reserves dropped 8.1 per cent in the first half alone. Indonesia may have a low overall reliance on exports, but it ships huge amounts of coal, palm oil and other commodities, so a global demand shock would have an outsized impact on its trade balance.

In a full-blown US-China trade war, there will be nowhere to hide — but some Asean-5 countries are more exposed than others.

Source: FT Confidential Research