Macq-ro insights: Factory Asia’s 2018-20 outlook

Please refer to page 37 for important disclosures and analyst certification, or on our website www.macquarie.com/research/disclosures. GLOBAL Why this issue matters to investors 1) As the tailwind of global recovery abates, investors will need to focus back on trends. We forecast modest global growth and low nominal and real bond yields 17 May 2017 Demographics, productivity, and neutral rates 24 April 2017 Financial repression for decades 2) We forecast global real GDP growth will be less rapid in 2018 (+2.7% YoY) versus 2017 (+2.9% YoY). Our 2019 and 2020 forecasts are both +2.6% YoY For all our global forecasts, please see the 16 May 2017 The Global Macro Outlook: Beyond the cycle. Online access to our global macro forecasts is available on request 3) With growth scarce, investors will be seeking pockets of strength. India, not part of Factory Asia, is attractive, in our opinion 5 December 2016 Eastern Europe, ASEAN & India 12 May 2017 India: is it more than just liguidity? by Viktor Shvets 6 June 2017 India strategy: stay on the bandwagon by Inderjeetsingh Bhatia Analyst(s) Peter Eadon-Clarke +81 3 3512 7850 peter.eadon-clarke@macquarie.com Nara Song +81 3 3512 7878 nara.song@macquarie.com 8 June 2017 Macquarie Capital Securities (Japan) Limited Macq-ro insights Factory Asia’s 2018-20 outlook Over 2018-20, we forecast real GDP growth for Factory Asia at 3.7% pa, with 0.9ppt pa attributable to exports. The latter is consistent with Factory Asia export growth of 4% pa. We expect global export growth to average 3% pa. Factory Asia includes Japan. In comparison, export growth contributed 1.6ppt of the region’s 4.0% pa real GDP growth over 2011-15, when Factory Asia’s export growth averaged 8% pa. Our 2018-20 base case has an ongoing gentle fade in East Asia’s growth with the region’s deteriorating demographics, below, being one important factor. Growth in the labour force has decelerated to zero. The region’s home-purchasing demographic of 20-49 year olds is now shrinking at around 1% pa. Factory Asia: YoY % growth in 1) the working-age demographic, ages:15-64, and 2) the home-purchasing demographic, ages: 20-49 Note: Factory Asia is the aggregate of Japan, China, Korea, Taiwan, HK, and the ASEAN-5 Source: IMF, Datastream , Macquarie Research, June 2017 The risk of a larger step-down in growth relates to investment, both its rate and quality. MNCs and their FDI flows into greenfield projects was examined in the 11 January 2017: Following the new smart money. Their fading commitment to the countries of Factory Asia is a red flag. FDI: announced greenfield projects, % of GDP, a fading commitment Source: UNCTAD, Macquarie Research, June 2017 -2-1012319901995200020052010201520202025(%)15-6420-4901234562003200420052006200720082009201020112012201320142015(% of GDP)Factory AsiaFactory Asia ex Japan Macquarie Research Macq-ro insights 8 June 2017 2 Factory Asia’s 2018-20 outlook From both supply and demand approaches: 1) Supply: labour force growth, capital deepening, TFP (total factor productivity) 2) Demand: Consumption + Investment + Government + Exports - Imports ...the outlook for Factory Asia, the countries of East Asia, is fading, in our opinion. Fig 1 Section index Section title Pages Comment Factory Asia’s 2018-20 outlook 2 Executive summary Following the new smart money 3-4 A red flag for the quality of Investment, a headwind for TFP East Asia post Factory Asia 5-7 The correctly measured contribution of exports to East Asian growth A step-down in growth 8-13 Rare occurrences, we examine Japan’s real GDP growth transition of the early 1970’s Demographic headwinds 14-17 A red flag for labour force growth and for Residential Investment (a part of Investment) Global trade headwinds 18-20 Global ‘slow’ trade, the current cyclical recovery and the arrival of an activist US trade policy Lower trend growth in East Asia 21-27 Growth forecasts broken out by the supply approach Factory Asia trade databank 28-37 Trade and current balances, versus GDP, by country; trade and firm size Source: Macquarie Research, June 2017 The conventional demand approach, following GDP accounting, is to net imports off against exports. This leads to the common mistake of under-estimating the importance of exports to growth. Imports should be deducted where they are ‘consumed’, i.e. consumer imports against consumption, capital goods imports against investment, and reprocessed imports against exports. The following reflects these adjustments. For Factory Asia: 1) Over 2002-07, real GDP growth was 5.4% pa, with 2.7ppt pa attributable to exports 2) Over 2010-15, real GDP growth was 4.0% pa, with 1.6ppt pa attributable to exports With the fading commitment of MNCs via announced greenfield projects to the countries of Factory Asia, the arrival of an activist US trade policy could impact trade flows further via: a) US import tariffs, or voluntary export constraints (please see the 1980 to 1995 Japanese experience