Asia Watch. Trade tensions risk to solid outlook. Group Economics Emerging Markets Research. Group Economics: Enabling smart decisions.

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1 Asia Watch Group Economics Emerging Markets Research 1 March 1 Arjen van Dijkhuizen Senior Economist Tel: arjen.van.dijkhuizen@nl.abnamro.com Trade tensions risk to solid outlook Growth EM Asia up in 17 on firmer and global trade, recovering Regional growth solid at.% in 1; to stay fastest growing giant drives spike in regional inflation, but some near-term moderation likely Monetary policy cycle has turned: cautious tightening on the cards Next to tighter financial conditions (Fed, risk aversion), hard landing and prevailing geopolitical risks (despite détente Korean peninsula) a trade war is currently key risk factor, as US shifts from talking to acting Regional growth edged up in 1 on firmer and global trade, with recovering 17 was a good year for emerging Asia. For the first time since, annual growth picked up, albeit moderately, to.% (1:.%). This was driven to a large extent by, accounting for around 5% of regional GDP. Chinese growth firmed to.9% last year, from.7% in 1. In addition, stronger momentum of global growth and trade played a key role as well for this highly export oriented region. That is illustrated by the sharp growth acceleration in trade hubs such as Hong Kong, Singapore and Taiwan and in other export oriented countries such as Malaysia and Thailand. In South Korea and Indonesia, growth rose only marginally last year, to 3.% and 5.1%, respectively. In the first part of 17,, the region s second-largest economy, was the outlier. Annual growth in has been slowing since early 1. Still, with the drags from the currency clean-up (late 1) and GST introduction (July 17) fading, growth picked up in recent quarters with growing faster than again for the first time since Q3-1. regained status fastest growing giant from Higher growth in export oriented economies Regional GDP growth, % yoy Regional PMI, 5 = neutral mark % yoy Hong Kong Malaysia Singapore Taiwan Thailand Source: ABN AMRO Group Economics, Bloomberg Source: ABN AMRO Group Economics, Bloomberg Group Economics: Enabling smart decisions

2 Asia Watch - Trade tensions risk to solid outlook 1 March 1 Growth and manufacturing PMIs have improved supported by the pick-up in global trade Regional GDP growth, % yoy Regional PMI, 5 = neutral mark % yoy, 1 months moving average Growth (lhs) PMI (CN NBS) PMI (CN NBS) Source: ABN AMRO GE, Bloomberg, Thomson Reuters Datastream World trade Asian exports Asian imports Source: CPB, Thomson Reuters Datastream Other activity data have improved, with some signs of recent moderation In the course of last year, hand in hand with the rise in regional GDP growth, the regional manufacturing PMIs have risen as well (to multi-year highs of around 5 in December). This indicator has dropped somewhat since, although there has been a sharp divergence between the regional index based on s official PMI and the one based on Caixin s PMI (see here for more background information). Meanwhile, there are signs that global trade peaked in late 17. Export growth of Asia s bellweather economies dropped in recent months compared to the peak levels seen in the course of last year, although these data can be distorted by Chinese New Year effects. The PMI export subindices dropped in February for most emerging Asian countries: this could also reflect the recent stepping up of protectionist measures by the US (also see our recent Global Trade Watch, Rising protectionism risk for global trade recovery). Emerging Asia: Economic growth (forecasts) % yoy Q-17 Q3-17 Q * 19* Hong Kong ^ Indonesia Malaysia Singapore South Korea Taiwan Thailand Regional average Source: ABN AMRO Group Economics, Bloomberg, EIU. * Forecasts 1-19 rounded. Arrows highlight forecast changes compared to previous Asia Outlook ^ : fiscal years We expect regional growth to remain at.% this year We still expect regional growth to remain solid this year, staying at.%. Compared to our previous Asia Watch published last December, we have raised our 1 growth forecasts for Hong Kong, Malaysia and Thailand. For 1, we expect an acceleration in (to 7.5%) and Indonesia (5.5%), stabilisation in South Korea (3.%) and Thailand (.%) and a slowdown in (to.5%), Hong Kong (3.%), Malaysia (5.5%), Singapore (3.%) and Taiwan (.5%). Our constructive outlook assumes the global picture to remain benign this year. In our base scenario, we do not expect a damaging trade war between US and or other key economies. With growth in the

3 3 Asia Watch - Trade tensions risk to solid outlook 1 March 1 US and eurozone accelerating, we expect global trade growth to plateau at.5% this year. We also anticipate s slowdown to remain gradual. Last but not least, despite rising inflationary pressures, we expect central banks in advanced economies to stay cautious in tightening monetary policy. Last but not least, we believe emerging Asia is generally well-positioned to cope with higher (policy) interest rates in advanced economies and a potential tightening of financial conditions. drives rise in regional inflation, but some moderation likely in coming months Our GDP-weighted regional inflation index jumped to an estimated 3.% yoy in February (NB: some countries still have to publish inflation figures for last month), the highest level since August 1. That was mainly driven by a rise in s inflation, to.9% yoy (January: 1.5%). In our view, we should not read too much in that figure. Admittedly, we expect s inflation to rise from 1.% in 17 to.5% in 17. However, the February number largely reflects a Chinese New Year related spike in food prices, which we expect to fade in the coming months. Meanwhile, s producer price inflation which had risen since late 1 after being negative for four years continues its gradual slide, falling to 3.7% yoy (lowest level since November 1). Inflation has also picked up significantly in over the past months. We expect average inflation in to rise from 3.3% in 17 to around.5% in 1. Inflation spike in February caused by special factors Will financial conditions tighten this year? Regional inflation, % yoy index, January 1 = Index Asia ex Japan* % yoy Headline inflation (lhs) Core inflation (lhs) Brent oil price index (rhs) FAO food price index (rhs) Financial conditions index (lhs) Real GDP (rhs) Source: Thomson Reuters Datastream, ABN AMRO Group Economics Source: Bloomberg * Negative value points to tightening of financial conditions Given strong growth, rising inflation and Fed hikes, modest monetary tightening expected Against the background of solid growth, rising inflation and higher Fed rates (we expect three hikes this year), the monetary easing cycle in emerging Asia has ended. In fact, the cycle has already turned, although softly, since mid-17 (when Reserve Bank of and Bank Indonesia were the last regional central banks to cut rates). The Chinese started targeted tightening in late 1, aimed at financial deleveraging while keeping credit to the real economy flowing. The PBoC guided interbank rates higher by raising policy rates for its open market and lending facilities marginally, leaving the benchmark one-year lending rate unchanged at.35%. Meanwhile, the PBoC has continued safeguarding bank system liquidity and recently eased some NPL coverage requirements. In Korea, the BOK raised its key policy rate last November (to 1.5%). The HKMA, which tracks the Fed given its USD-HKD peg under the currency board, followed in December. Bank Negara Malaysia joined the camp in January (hike to 3.5%). Looking ahead, we expect to continue with targeted tightening. We anticipate modest policy rate hikes in South Korea and Taiwan this year, and possibly also in. Still, the regional monetary policy stance will also depend on broader movements in risk tolerance/aversion and dollar movements versus Asian FX.

4 Asia Watch - Trade tensions risk to solid outlook 1 March 1 All in all, while the room for monetary stimulus in the region has narrowed, we think there is still sufficient room for fiscal stimulus if needed given that public finances in the region are generally pretty sound. Next to tighter financial conditions, slump and geopolitics, trade war is key risk There are several risks to our positive outlook. Such as a potential tightening of financial conditions, following e.g. from (faster than expected) Fed rate hikes or growing risk aversion as trade tensions rise. Emerging Asian countries, some of which do have high debt levels, are vulnerable to currency and interest rate shocks. Next to Hong Kong and Singapore, South Korea and have the highest debt levels in the region. Still, foreign debt is generally low except for financial hubs Hong Kong and Singapore, while Indonesia has a relatively high external debt to exports ratio. Current USD weakness is a mitigating factor, as is the ongoing cautious approach towards normalising monetary policy by ECB and BoJ. Other key risks to our outlook would stem from a sharper than expected slowdown in and from geopolitical shocks. The détente on the Korean peninsula seems to have gained in substance, following a reapprochment during the Winter Olympics in South Korea s Pyongcheang (see our special report here). Guided by a more dovish approach of South Korea, US president Trump and North Korean leader Kim Jong-un are supposed to talk about denuclearisation in May. Still, many geopolitical risks remain, such as the growing rivalry between the US and. as (US) protectionism dog starts biting after barking In recent months, the US has shifted from mainly talking about protectionism to taking action. In January, the US announced import tariffs on solar panels (3%) and washing machines (-5%). Soon, the US will install tariffs on steel (5%) and aluminium (%) imports, under the Section 3 national security cases, although Washington seems willing to provide exceptions to strategic allies under certain conditions. Meanwhile, under the Section 31 investigation on forced technology transfer and intellectual property theft, the US is still considering taking further measures regarding. has by far the largest bilateral surplus with the US (around USD 35 bn), but is also advancing rapidly as a tech giant. Japan, Vietnam, Malaysia, and South Korea also belong to the top ten of countries with whom the US has the largest bilateral deficits., Japan and South Korea are still on the US Treasury s Watchlist regarding FX policies (although the CNY has appreciated by almost % versus USD since end-1). Korea, Taiwan,, in top steel exporters to US US steel imports by country, 17, % Exports to US, % GDP, 1 Exports to US relevant for many Asian economies Canada Brazil South Korea Mexico Russia Turkey Japan Germany Taiwan Others Vietnam Hong Kong Singapore Malaysia Thailand South Philippines Japan Indonesia Source: Reuters Source: Thomson Reuters Datastream, EIU

5 5 Asia Watch - Trade tensions risk to solid outlook 1 March 1 Uncertainties remain, but risks from protectionism are rising Obviously, it is still uncertain to what extent these trade tensions will escalate (that will also depend on potential retaliation and on potential second or even third round effects). In any case, the US is an important direct trading partner for many Asian countries, with US trade exposure being the largest (in GDP terms) in Vietnam, Hong Kong, Singapore, Malaysia, Thailand, South Korea and. There are also indirect linkages: for instance is being accused of shipping steel to the US through other countries. In general, the growth models of many Asian countries are built on global supply chains and protectionist measures risk derailing such chains. Some of these effects will be offset by stronger regional cooperation, along strategic initiatives such as One Belt, One Read and new regional and bilateral trade agreements. All in all, while in our base scenario we expect (emerging) Asia to remain the global engine of growth, a rise in protectionism and a further escalation of trade tensions clearly poses downside risks for this highly export oriented region. Main economic indicators/forecasts GDP growth (%) 1 17e 1e 19e Inflation (%) 1 17e 1e 19e Emerging Asia Emerging Asia Emerging Europe Emerging Europe Latin America Latin America** Emerging markets total Emerging markets total Eurozone Eurozone US US World World Budget balance (% GDP) 1 17e 1e 19e Current account (% GDP) 1 17e 1e 19e Emerging Asia Emerging Asia Emerging Europe Emerging Europe Latin America Latin America Eurozone Eurozone US US Source: EIU, ABN AMRO Group Economics * figures Emerging Markets regions are rounded **Inflation Latin America and World without Venezuela This document has been prepared by ABN AMRO. It is solely intended to provide financial and general information on economics. The information in this document is strictly proprietary and is being supplied to you solely for your information. It may not (in whole or in part) be reproduced, distributed or passed to a third party or used for any other purposes than stated above. This document is informative in nature and does not constitute an offer of securities to the public, nor a solicitation to make such an offer. No reliance may be placed for any purposes whatsoever on the information, opinions, forecasts and assumptions contained in the document or on its completeness, accuracy or fairness. No representation or warranty, express or implied, is given by or on behalf of ABN AMRO, or any of its directors, officers, agents, affiliates, group companies, or employees as to the accuracy or completeness of the information contained in this document and no liability is accepted for any loss, arising, directly or indirectly, from any use of such information. The views and opinions expressed herein may be subject to change at any given time and ABN AMRO is under no obligation to update the information contained in this document after the date thereof. Before investing in any product of ABN AMRO Bank N.V., you should obtain information on various financial and other risks and any possible restrictions that you and your investments activities may encounter under applicable laws and regulations. If, after reading this document, you consider investing in a product, you are advised to discuss such an investment with your relationship manager or personal advisor and check whether the relevant product considering the risks involved- is appropriate within your investment activities. The value of your investments may fluctuate. Past performance is no guarantee for future returns. ABN AMRO reserves the right to make amendments to this material. Copyright 1 ABN AMRO Bank N.V. and affiliated companies ("ABN AMRO ).