The shaky isles
I have been on the road in New Zealand this week. Although New Zealand is the most remote advanced economy in the world, it is deeply exposed to key global dynamics. New Zealand – sometimes called the shaky isles because of its seismic activity – offers a useful perspective on the impact of moving global tectonic plates; from monetary policy normalisation, to the rise of China, and the impact of trade wars.
As with other small economies around the world, QE in the US has had a material impact on New Zealand. Despite policy rates being cut to historic lows, the NZD has faced sustained upward pressure, inflation has been low, and house prices have appreciated strongly. But as the pace of normalisation picks up in the US, and the yield differential between New Zealand and US government bonds continues to widen, these forces are likely to work in reverse. This is becoming evident, with the NZD retreating by over 10% since February and inflation rising.
More broadly, Asian economies are exposed to a strengthening USD. Several Asian currencies have come under significant pressure and there are concerns about the amount of USD-denominated borrowing accumulated in a low interest rate environment. The normalisation process will have significant impacts on borrowing costs, currencies and asset prices across the region.
The New Zealand experience also highlights the increasingly dual exposure to both the US and China. Decisions made in DC have historically exerted a dominant pull on New Zealand, but increasingly it is developments in China that matter. This reality reflects China’s increasingly central role in the global economy. China now accounts for 15% of global GDP (in USD terms) and about 11% of world trade flows. Economies in Asia, from South Korea and Singapore to Australia, have been acutely exposed to this change.
But New Zealand is particularly instructive in illustrating China’s rapid economic rise, particularly over the past decade. New Zealand’s export share (of goods and services) to China was 20% in the year to Q2 (22%, if exports to Hong Kong are included), having risen from a 5% share in 2008. Over half of New Zealand’s export growth since 2012 has been due to growth in exports to China, largely driven by tourism and dairy exports.
As with other Asian economies, this deep economic integration means that New Zealand’s economic performance is increasingly sensitive to variation in the strength of the Chinese economy. This exposure to China is likely to increase, particularly for Asian economies (as a more regional global economy emerges) but also around the world. Trade and investment flows with China are supported by a growing web of institutional arrangements, from FTAs to RCEP to the BRI projects. Note that New Zealand was the first advanced economy to sign a bilateral FTA with China (in 2008), which was a catalyst for a surge in exports.
This growing exposure to China of New Zealand, and others, creates a meaningful exposure to the bilateral trade tensions between the US and China. The imposition of tariffs on Chinese exports to the US (and the real possibility of further escalation) is creating a drag on the Chinese economy. Last week, the IMF marked down China’s forecast GDP growth for 2019 by 0.2% (to 6.2%) on the back of trade-related costs and uncertainties. Together with the pre-existing slowdown in China’s growth, this will have a negative impact on China-exposed economies: New Zealand’s export growth to China has slowed over the past several months.
Of course, China has a range of policy instruments that it can use to respond, such as fiscal stimulus and loosening financial conditions – although its policy space is increasingly constrained. One additional policy measure that is being used to offset the economic costs of the tariffs is the exchange rate. The CNY has depreciated by about 10% since the US tariffs began to go live, from under 6.30 USD in March to over 6.90 USD currently. To the extent that trade headwinds continue to increase, which I expect, the CNY may depreciate to 7 and beyond over the next several months.
China’s increasingly central role in the regional economy means that these policy responses will also have an impact on other economies. Increasingly, New Zealand – along with many other Asian currencies – is becoming part of a de facto ‘RMB zone’: currencies of countries such as New Zealand, Korea, Taiwan, and Singapore, have been trading in an increasingly tight range against the CNY over the past several years. One reason for this is that the exchange rate relative to the CNY is increasingly important for the competitive position of Asian economies. The implication is that a marked depreciation in the CNY is likely to lead to depreciation in other Asian currencies.
In addition to New Zealand (and others) having to manage through economic cross-winds of US normalisation and Chinese economic risks, there are also political dynamics at work. The US is looking to decouple its economy and supply chains from China in an increasingly explicit way, and is also beginning to exert pressure on others to do likewise (note the terms of the revised NAFTA deal). This will be a challenging balance to strike for Asian countries that are increasingly integrated into China and yet also want to maintain strong links with the US. Tough choices are looming.
The exposure of New Zealand to these moving economic and political tectonic plates makes it a good place to understand how these forces will play out in Asia and beyond.
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Dr David Skilling
Director, Landfall Strategy Group