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2017 Second-Quarter Forecast: East Asia

Apr 10, 2017 | 09:32 GMT

Chinese President Xi Jinping's push to consolidate his grip on power will enter a critical phase in the coming months.

China in Transition

Globalization, Evolved

The New Silk Road

Coping With a Nuclear North Korea

Asia-Pacific: Among Great Powers

Southeast Asia: Burdened By Consensus

A Japanese Awakening

China in Transition

Chinese President Xi Jinping’s push to consolidate his grip on power will enter a critical phase in the coming months amid preparations for October's 19th Party Congress, the quinquennial meeting where senior party officials select the next Politburo Standing Committee, the country's top governing body. With as many as five of the current seven committee members expected to step down this year, the plenum will offer Xi a momentous opportunity to stack the country’s leadership with his supporters, fortifying his position as China’s most powerful leader in decades. In the lead-up to the congress, Xi’s core task will be to eliminate remaining checks on his influence, while reshuffling personnel to move allies into key posts. Broadly speaking, these efforts will be successful.

The stakes riding on the Party Congress will compel Chinese leaders this quarter to focus overwhelmingly on stabilizing the economy, sustaining low unemployment and avoiding social disruptions, meaning much-needed but risky reforms will take a back seat. Beijing will continue to push industrial restructuring and consolidation programs, environmental initiatives and limited financial reforms. Major new initiatives, however, that would threaten to erode business confidence or destabilize the economy are unlikely in the near future. And on existing issues that the government chooses to expand, such as corporate debt-equity swaps and bankruptcy tribunals and the introduction of a nationwide property tax, authorities will delay full implementation until after the congress. In the meantime, Beijing will maintain robust support for key industrial sectors such as home construction and manufacturing while introducing piecemeal measures to strengthen the economy's defenses against potential external shocks, especially those threatened by impending shifts in U.S. trade and currency policies.

Outside the mainland, Beijing will face a bigger challenge in managing persistent discontent in Hong Kong over China’s interference in the city’s political affairs, a situation that the recent election of its preferred candidate, Carrie Lam, as Hong Kong’s next chief executive will do little to alleviate. As the special administrative region prepares to mark the 20th anniversary of its reunification with China on July 1 (Lam’s inauguration date), conditions will be ripe for an escalation of protests.

Globalization, Evolved

The ongoing evolution in U.S. trade policy will continue to be felt across the Asia-Pacific and will pose the greatest potential threat to Chinese economic stability — and therefore to Xi’s drive to consolidate power — in the second quarter. In the next three months, Washington may not impose new barriers to trade with China beyond anti-dumping and countervailing duties, but Beijing will gird itself for the possibility that the Trump administration follows through on the new president's promises to name China a currency manipulator or levy new controls on U.S. imports of Chinese goods such as steel or automobiles. Chinese authorities will work to build up buffers against U.S. threats or punitive measures while seeking to deter Washington by outlining the retaliatory measures Beijing can take. China may also introduce its own anti-dumping measures. Beijing's most likely course of action, however, will be to try to use its influence on regional security matters as leverage in economic discussions with Washington. Toward this end, China may offer to cooperate with Washington on issues such as cybersecurity, military affairs and even North Korea — a rare area where U.S. and Chinese interests overlap. At the same time, it will become more openly confrontational in the South China Sea or on other regional matters.

Though China has been the primary target in Asia of Washington’s attacks on trade and currency manipulation, Japan and South Korea — the United States’ two most important security allies in Asia — have by no means been exempt from prospective U.S. policy changes. This will compel both countries to explore other options, including expanded investment into and potentially imports from the United States, to hedge against pressure from Washington and prevent economic frictions from undermining their security partnerships. Nonetheless, even rhetorical pressure from Washington on trade will be painful for South Korea as Seoul attempts to move on from the fall of President Park Geun Hye while also facing Chinese economic retaliation over the deployment of the Terminal High-Altitude Area Defense (THAAD) missile defense system. China may ease pressure on Seoul in an effort to open diplomacy with the next South Korean administration after the upcoming election. But the new president's attention will be divided between a range of priorities: not only the perennial North Korean threat but also reform of South Korea's scandal-prone chaebols (giant, family-run conglomerates) and broader economic restructuring.

Elsewhere in the Asia-Pacific, moderate recoveries in the global economy — particularly in commodity prices — will continue to provide much-needed relief for regional exporters. Nonetheless, countries such as South Korea and Thailand will struggle to regain their growth momentum because of internal political constraints, increased regional competition and regional geopolitical pressures. Moreover, few countries in the region will be immune to the long-term impact of the surge of protectionism across the globe or the potential fallout from a prolonged Sino-U.S. trade or currency spat. As major powers reconfigure their trade strategies, smaller economies will seek to insulate themselves from potential shocks by more proactively pursuing regional cooperation and economic diversification. In addition to Asia-centric multilateral frameworks such as the 16-member Regional Comprehensive Economic Partnership (RCEP), trade-dependent economies such as those of Malaysia, Australia, Vietnam and South Korea will explore free trade options farther afield.

The New Silk Road

Beijing will be well-positioned to exploit regionwide uncertainty over Washington’s potential retrenchment to press Chinese interests elsewhere in its periphery this quarter. In response to the Trump administration’s withdrawal from the Trans-Pacific Partnership trade pact, China will redouble its efforts to draw regional economies further into its orbit by touting regional trade initiatives such as RCEP.

In addition to trade, expanded investment, particularly in infrastructure, will be core to China's diplomatic outreach throughout its periphery, with Beijing using its One Belt, One Road summit in May to portray itself as an economic anchor and promote its vision for the region as a favorable alternative to the Western-led order. But its efforts to build out vast road and rail networks will be constrained by localized unrest and suspicions in target countries, particularly Pakistan and Sri Lanka, as well as at home in Xinjiang. Domestic economic pressures will also complicate implementation of Beijing's grand plans.

Coping With a Nuclear North Korea

The fraught efforts by China and the United States, as well as South Korea and Japan, to contain North Korea’s nuclear weapons program will remain a singular driver of regional dynamics in the quarter. As North Korea nears the successful development of an effective nuclear deterrent against the United States, Pyongyang will continue to use every opportunity to demonstrate its expanding defense capabilities. Another North Korean nuclear test would undoubtedly elicit heated rhetoric and defense posturing by Seoul and Tokyo, including moves that Beijing views as antagonistic. This will reduce room for diplomacy between Washington and Northeast Asia’s leading powers and intensify pressure on Washington to consider alternative measures to deter Pyongyang.

Direct, pre-emptive military action against Pyongyang — particularly its nuclear weapons infrastructure and arsenal — is possible but unlikely this quarter absent a complete breakdown of diplomatic efforts by the United States and China. Instead, Washington will most likely focus on pressuring Beijing to rein in Pyongyang. Beijing may use its economic pressure over North Korea to hedge against Washington’s agenda on other fronts, particularly U.S. pressure on trade. But Beijing will avoid fully severing North Korea’s economic lifelines in China or substantially undermining Kim Jong Un's rule in Pyongyang.

Asia-Pacific: Among Great Powers

Where possible, Beijing will work to separate its tension with Washington over trade and the Korean Peninsula from other pivotal issues in China’s periphery. Beijing will be particularly on guard against any moves by Washington to use Taiwan as a bargaining chip in other negotiations. Though the Trump administration reversed course and pledged in February to continue the “One China” policy, a long-standing diplomatic formula underpinning Washington's relations with Beijing and Taipei, the White House may still seek to boost arms sales or diplomatic contact with Taipei this quarter. Meanwhile, Taiwan will also expand its economic outreach to other countries, particular Japan, India and Southeast Asian states, to lessen the impact of diplomatic isolation by Beijing. China would heartily protest any new U.S. arms sales to Taiwan and possibly reduce military cooperation with Washington, but it will avoid inflaming cross-strait tensions in any way that would threaten Xi’s goals at the upcoming Party Congress.

Meanwhile, Beijing will further its evolving strategy for managing the backlash in Southeast Asia to expanding Chinese maritime activities in regional waters. Following last year’s international tribunal ruling invalidating China’s territorial claims in the South China Sea, Beijing has continued a carrot-and-stick strategy, paring maritime and economic concessions with coercive measures — all while continuing to build out its regional military presence. In recent months, this strategy has helped China and some South China Sea claimant states, particularly the Philippines, achieve a tentative conciliation, even as China’s broader confrontation with the United States has threatened its capacity to manage South China Sea affairs.

But numerous potential flashpoints in the second quarter will put this reconciliation to the test. For example, the upcoming fishing season will create ample opportunities for flare-ups between Chinese fishing fleets and coast guard forces and their counterparts from littoral states such as Indonesia and Vietnam. Perhaps the biggest test will be the joint fishing arrangement between China and the Philippines in waters around the Scarborough Shoal, a long-standing flashpoint some 200 kilometers west of Luzon. Though large-scale, sustained conflict in the disputed waters is unlikely, the growing number of civilian and naval ships on the seas raises the risk of accidents and miscalculations capable of spawning an international crisis.

Landmark bilateral Sino-Philippine maritime consultations in May will not fundamentally alter the dynamic in the region. With Philippine President Rodrigo Duterte’s erratic rhetoric and efforts to reorient the country's foreign policy toward China beginning to draw some pushback at home — and given China’s unwavering goal of cementing its regional maritime dominance — Sino-Philippine relations will remain fraught, creating opportunities for a warming of ties between Manila and Washington. This, in turn, could affect how other states in the region deal with Chinese assertiveness. Ultimately, claimant states will continue to pursue omnidirectional foreign policies marked by greater ties with a range of outside powers, including Russia and Japan. And Beijing will work to maintain its current strategy of balancing coercion with concessions and cooperation (including on energy development in disputed waters) to temper the sharpest tensions and limit opposition to its maritime actions.

Southeast Asia: Burdened By Consensus

China and the Association of Southeast Asian Nations (ASEAN) will likely make some progress in negotiations on a Code of Conduct for the South China Sea. But divisions within ASEAN over how to deal with Beijing, combined with deepening concerns over China’s growing military power and perceived assertiveness, will limit the negotiations.

Moreover, across Southeast Asia, domestic political factors will continue to hinder pan-ASEAN cohesion and complicate broader regional issues. Even as the Philippines’ temporary detente with China enters rough waters this quarter, for example, so will Duterte face new challenges to his initially unquestioned authority at home. As long as Duterte’s domestic popularity is high, he will face no serious threats to his power. But the threat of power struggles within the government and political establishment will grow as he pushes forward with contentious initiatives such as his violent war on drugs, peace talks with Muslim Moro and Communist rebels, and a plan to shift the government to a federal system — all while seeking to limit domestic backlash to his reorientation away from the United States, which retains deep ties throughout the Philippine defense establishment. A Duterte administration bogged down by domestic pressures would have less room to sustain a politically risky outreach to China or, as this year's ASEAN chair, steer the body toward a semblance of consensus on the South China Sea.

Meanwhile, in Cambodia — under the current government, China's most stalwart supporter in ASEAN — upcoming commune elections will test the public's support for Prime Minister Hun Sen and the grip of his Cambodian People's Party on power ahead of 2018 general elections. Similarly, an April runoff election for Jakarta governor will serve as a barometer of the ruling party's ability to solidify support to the degree necessary to expand substantial fiscal, regulatory and economic reforms and play a more decisive role in regional trade and security affairs.

A Japanese Awakening

Barring a significant change in U.S. policy toward the South China Sea, claimant states and U.S. allies alike will remain cautious about undertaking bilateral naval patrols with Washington or taking other actions that might antagonize Beijing. Such concerns will be unlikely, however, to deter Japan from deepening its diplomatic outreach to and defense cooperation with South China Sea claimant states. Tokyo will use arms sales and military aid to ASEAN states, along with joint exercises with regional navies and a generally increased regional maritime presence, to bolster its position as an increasingly robust check on Chinese influence in Southeast Asia.

Japan’s diplomatic, economic and security offensives in Southeast Asia are just one piece in its broader push to revive the country's standing and influence abroad. In the second quarter, Japanese Prime Minister Shinzo Abe will meet with Russian President Vladimir Putin as the two countries seek to improve ties and resolve a long-standing dispute over control of the South Kuril Islands. Even incremental progress here would help Tokyo hedge against Chinese influence in Northeast Asia. Meanwhile, Japan will continue with efforts to counter China's expanding presence in the East China Sea by increasing naval and coast guard patrols and research activities. But Tokyo's attention will be dominated by relations with Washington this quarter, with several meetings between senior Japanese and U.S. lawmakers on the docket, as the government seeks to build on the momentum generated by Abe's recent visit to Washington and Japan’s promise to invest in the United States.

The Abe administration will use political capital gained from its diplomatic successes here to push for structural reform legislation at home, along with a constitutional revision allowing the emperor to abdicate. The quarter will likely see concrete progress on reform legislation in areas such as agriculture and labor. Meanwhile, the Abe administration will rely on aggressive monetary and fiscal policy to sustain overall economic stability at home.

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