Following the devaluation of over 1% in China's FX rate yesterday, we reiterate our view that in the near-term the damage from US-China friction – of which the trade war is one component and where this devaluation likely signals low expectations from the Chinese side of meaningful progress in negotiations – is negative for all markets in frontier and small emerging. Longer-term, there may be a silver lining for rival low-cost manufacturing exporters such as Bangladesh and Vietnam, the two equity markets we rank highest in our coverage. Below we present three charts that illustrate the change in the FX rate of China compared to Asian peers.
Year to date and 5-year changes imply some catch-up devaluation to maintain competitiveness is in order for Bangladesh and Vietnam, all other things being equal. This is not so clear-cut when looking at a 3-year horizon. Historical truth, and FX rate assessment, usually depends on when you start the story!
US-China friction casts a shadow for all, not Asia alone
US-China friction is, of course, concerning, in terms of the negative impact on global growth (exports) and competitive devaluations to match any Chinese FX rate weakness. But we are not so sure that this should be viewed as a risk more applicable to Asia than other regions. The impact on global (and Chinese) growth is something that affects almost all frontier and small emerging markets because they are almost all dependent, directly or indirectly, on either global exports or foreign investment, with material exposure to China specifically.
Agricultural exports from Argentina, copper exports from Peru and oil exports from Nigeria or the GCC are arguably as exposed to slower global growth resulting from a US-China trade war as electronic component exports from Malaysia. To the degree that the Asian exporters have more direct manufacturing supply chain integration with China, they are also likely to benefit proportionally from capital allocation away from China (ie relocating factories to countries with lower US tariffs).
Related reading: for more on the fundamental issues surrounding the trade war see these three reports:
G20 preview: Trade wars and the EM impact, June 2019
Vietnam company plays on the trade war, August 2019