The world now catches a cold if China sneezes, not the US
Economically, China accounts for 32pc of total regional trade and its economy is almost half of Asia (ex Japan)’s GDP
“When the US sneezes, the world catches a cold” is a common phrase used to describe the significance of the US economy in the global macro system.
But in recent years, more and more people have applied the same metaphor to China, as the latter grows in size and influence, and starts to project its economic power globally.
There is nowhere that China’s influence is better manifested than in Asia. Economically, China accounts for 32 per cent of total regional trade and its economy is almost half of Asia (ex Japan)’s GDP. For many countries, China is now their largest trading partner and a growing source of foreign direct investment.
China’s rising middle class, with a strong desire to spend, has unleashed a flood of tourists, helping to revive tourism and retail industries in countries like Thailand and Korea. Finally, financial market ties have been strengthened as China opens up its capital account and liberalises the yuan.
The close economic integration with China has brought clear benefits to many Asian countries by allowing them to access the biggest consumer market in the region.
But at the same time, it also makes Asia vulnerable to China’s economic slowdown. Slowing demand from China since 2011, when headline growth started to decelerate, was a key contributor to the sluggish export performance of many Asian countries in recent years.
One silver lining, however, is that not every sector in China is slowing at the same pace. As the economic rebalancing got underway, China’s consumption growth has outperformed investment handsomely, and will continue to do so in the years to come. Such an economic transformation will create new winners and losers among China’s trading partners, depending on the parts of the economy to which they are exposed.
A detailed analysis of value-added exports suggests that some economies, such as Hong Kong, Thailand and India, will stand to benefit from China’s growth rebalancing, as their exports are more geared towards consumption than investment. This gain from rebalancing can help to offset some of the first-round impact from slowing Chinese demand. For others, noticeably Taiwan, Malaysia and Korea, their exposures are tilted more towards investment, creating more pain for these economies.
In financial markets, China’s influence on the rest of Asia has also grown. Asset price correlations have risen across all markets, to the extent that Asian equities were more correlated with A-shares than the S&P 500 since mid-2015.
Our event study analysis confirms that such co-movements were driven by unique China-shocks, with the results being more pronounced in equity and currency markets.
Another channel of influence is via commodity prices. China accounts for more than half of global demand in some industrial metals, and its economic slowdown in recent years have depressed their prices. Being a net importer of commodities, Asia as a whole has benefited from these price declines by ways of improved current account balances and increased scope for monetary and fiscal easing.
But for a few commodity exporters in the region – Malaysia and Indonesia – falling commodity prices have only added to their economic malaise.
Putting together the economic and financial-market linkages, our estimates suggest that a 1 percentage point reduction in China’s GDP growth could lower Asia’s growth by up to 0.4 per cent.
The impact on developed-market economies is smaller, up to 0.2 per cent, but still statistically significant for the US and EU. These results tend to underscore the popular view that “when China sneezes, the chill does spread, at least in Asia.”
A number of implications can be drawn from this analysis.
First, China’s economic rebalancing is important. If an orderly economic transition can be achieved, coupled with successful reforms, the end result will benefit China, Asia and the world at large.
Second, China’s spillovers in trade and financial markets could spread the impact of Trump’s protectionist policies, even if they were targeted directly at China.
Finally, as asset prices become more correlated between China and the rest of Asia, the dominance of the US in the region will gradually give away to a dual influence, whereby both the US and China exert their appropriate weights. For a global investor, this means that avoiding China will become increasingly difficult, and understanding China will become more of a necessity. At the same time, as the Asian market “decouples” from the US, and “couples” with China, the diversification benefit for a developed-market-centric portfolio will rise. The last point is key to underpinning our constructive view on Asia on a long-term basis, provided that investors maintain a selective mindset.
Aidan Yao is senior emerging Asia economist of AXA Investment Managers