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US President Donald Trump has threatened to slap tariffs on imports from East Asia. Maulshree Saroliya considers how the region’s economies will fare in an environment of heightened trade protectionism.

Escalating tensions on the Korean peninsula have dominated discussions of US policy in East Asia in recent months. On April 27, US President Donald Trump warned that if North Korea presses ahead with its nuclear weapons programme, a “major, major conflict” is possible. He urged for a diplomatic solution to the standoff. 1

Pyongyang’s militaristic regime has distracted attention from another key threat to the region: protectionism. Soon after he took office, Trump signed an executive order removing the US from the Trans-Pacific Partnership (TPP), a trade agreement; ostensibly to protect working-class Americans in rust-belt communities who have suffered due to unfettered globalisation.

TPP would have reduced tariffs among the 12 member countries and given a “significant long-term boost” to economies such as Vietnam, Malaysia and Singapore, according to Fitch Ratings. The agency has warned rising protectionism presents a “credible downside risk to the economic outlook for the Asia-Pacific region”. 2

China has drawn the brunt of Trump’s protectionist rhetoric. During his election campaign, Trump threatened to brand China a currency manipulator and slap tariffs on Chinese goods, raising the spectre of a full-blown Sino-US trade war. The consequences of such a spat would be felt across East Asia, due to the myriad trade linkages between China and the region’s smaller economies.

Although Trump’s tone on China has shifted somewhat since a cordial summit with President Xi Jinping in early April, the country was included on a “monitoring list” of nations that maintain trade surpluses with the US issued later that month.3 Japan, South Korea and Taiwan also featured on the roster of countries that meet at least one of three criteria for suspected currency manipulation:  bilateral trade surpluses in excess of $20 billion, current account surpluses of more than three per cent of GDP or net foreign currency purchases of more than two per cent of GDP each year.

China, meanwhile, is keen to present itself as the new guardian of global free trade. Beijing has unveiled a rival plan to TPP, known as the Regional Comprehensive Economic Partnership (RCEP), that will enable smoother trade links between China, Southeast Asian nations and other economies including Australia, India, Japan, South Korea and New Zealand. And flourishing domestic demand in countries such as the Philippines and Indonesia provides further evidence that East Asia could prove resilient even if the global trade environment becomes more challenging.

In this Q&A, Maulshree Saroliya, Macro Strategist at Aviva Investors, explores the potential consequences of US protectionism for the region’s economies.

Which economies in East Asia would be most vulnerable in the event of a protectionist turn in the US?

Overall, protectionism is more of a problem for economies in Northeast Asia than Southeast Asia. While the likes of Singapore, Hong Kong and Malaysia are all small, open economies exposed to variations in world trade growth, South Korea and Taiwan are probably more vulnerable. This is because they have large trade surpluses with the US and are deeply integrated into global supply chains for high-value added products such as electronics, automobiles and semiconductors. For now, however, export data is encouraging. Both South Korea and Taiwan have seen a manufacturing rebound since mid-2016 and this is reflected in the recent PMI data. Export volumes are also recovering [see figure 1].

South Korea and Taiwan have been named on the US’ ‘currency watch’ list. What would be the economic implications if these nations were to be targeted for retaliation by a protectionist Trump administration?

Peter Navarro, the White House trade advisor, recently named South Korea and Taiwan, along with Vietnam, India and China, as the countries that account for the “lion’s share of the deficit problem”.4 And in an interview on April 27, Trump threatened to “terminate” the bilateral free trade agreement between the US and South Korea, arguing that it leaves the US at a disadvantage.5 The US trade goods deficit with South Korea totalled $27.7 billion in 2016, according to US government data.6

The economic implications of retaliation could be sizeable – trade as a proportion of GDP in Taiwan and South Korea is among the highest across industrialised economies. Over the past five years, Taiwan’s exports have amounted to around 70 per cent of GDP, while the figure in South Korea is about 50 per cent.7 Nevertheless, the share of overall exports sent to North America has declined in recent years [see figure 2]. The US accounts for about 15 per cent of South Korea’s exports – China receives 30 per cent – and about 12 per cent of Taiwan’s.

Could better trade links with China compensate for reduced trade with the US?

Intra-Asian trade has grown significantly since the financial crisis. Nevertheless, the volume of intra-regional trade would probably suffer significantly if the US imposed protectionist barriers. This is because most intra-regional trade involves intermediate goods, whereas a sizeable chunk of final goods are typically shipped to larger trading blocs such as the US and Eurozone. For example, Taiwanese manufacturers mostly produce in China and send these goods on to the US. To the extent that US import tariffs affect demand for final goods, this will also filter down the value chain and impact trade in intermediate goods.

How would the region’s small, open economies, Hong Kong and Singapore, fare if trade barriers are imposed?

Some commentators have expressed concerns about how Hong Kong and Singapore would suffer in a protectionist scenario. But both are major financial centres and their relative trade exposure to the US is smaller than is the case for South Korea and Taiwan. And Singapore, in particular, has the fiscal firepower to withstand any short-term economic impact from protectionism.

Will increasing domestic demand in East Asian economies help mitigate the risk of protectionism?

A strong domestic demand base will be an advantage when protectionism is on the rise and many countries in the region are well positioned in this regard, including the Philippines and Indonesia. While the Philippines still depends structurally on remittances from workers based abroad, its economy is now more domestic-demand oriented than is the case in South Korea and Taiwan. In Indonesia, the government is focusing on long-term growth by embracing reforms – it is cutting state subsidies, for example – and investing in infrastructure. This government-led demand is helping to boost domestic growth and reduce reliance on exports.

Are the risks of protectionism being priced in to investment assets in the region?

There is little evidence of the market pricing in the risks of protectionism. For example, the Korean stock market has just hit a multi-year high and the won and the Taiwanese dollar have actually strengthened against the US dollar in 2017. This is partly explained by the fact that growth in Asia remains strong. But more importantly, President Trump hasn't yet implemented any disruptive protectionist measures, not even against Mexico, which was the economy the market expected to suffer the most from a Trump presidency.

If Trump were to implement protectionist policies, what would be the implications for investors in East Asia?

The investment implications of protectionism could be significant. Global supply chains have generated a degree of ‘commonality’ in inflation – prices tend to move up and down in tandem across different markets – and protectionism could lead to rising inflation and slower growth across several major economies in East Asia at the same time. This scenario would be bad for government bonds globally, including those in Asia; long-end yields would rise and prices would fall.

Rising protectionism would not be good news for equities either. Companies in Korea and Taiwan would likely suffer the most from US protectionism and any subsequent retaliation by China. We would expect domestic-oriented equity sectors in these economies to outperform the more externally-exposed sectors, such as electronics and consumer goods.

But the US would not be invulnerable if Trump followed through on his protectionist threats. American companies in sectors such as technology, consumer discretionary, consumer staples, energy and industrials are all exposed to global trade and could suffer if protectionism rises.

Important Information

Unless stated otherwise, any sources and opinions expressed are those of Aviva Investors Global Services Limited (Aviva Investors) as at May 2, 2017. This commentary is not an investment recommendation and should not be viewed as such. They should not be viewed as indicating any guarantee of return from an investment managed by Aviva Investors nor as advice of any nature. Past performance is not a guide to future returns. The value of an investment and any income from it may go down as well as up and the investor may not get back the original amount invested.

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