Update Country Report Maldives 29 May 2020

• The Economist Intelligence Unit expects Asian trade flows to weaken over the second quarter, despite some pockets of resilience registered in April.
• The re-opening of Western economies in May suggests that Asian trade flows should begin to rebound by the third quarter. However, trade performance will remain weak owing to significant disruption to employment and incomes across major export markets, which will put a ceiling on the recovery.
• The coronavirus (Covid-19) pandemic has exacerbated protectionist sentiment across most major markets, sparking calls ranging from supply-chain reshoring to further scrutiny of inbound foreign direct investment (FDI).

Protectionism is not a new feature of the international trade landscape, particularly following the US-China tariff actions of 2018-19. The coronavirus outbreak, however, has eroded whatever respite might have been gleaned from the pause in tariff hostilities. In response to the upheaval caused by the pandemic, governments are now questioning their exposure to global trade. Although we had expected the health crisis to spark a fresh wave of protectionism this year, the implications of these decisions will inevitably complicate the post-crisis recovery from 2021, both for Asia and globally.

A weak start to the second quarter

The pandemic's effects on regional goods exports had, for most markets, become more evident by April. This was largely in line with the expectations outlined in our previous regional trade brief, including our revised global forecast that international trade volumes will fall on average by 25% in 2020.

South Korea and Japan saw merchandise exports plunge by double digits in that month, owing to crumbling demand across key Western markets. In nominal US-dollar denominated values, Indian goods exports collapsed by 60.3% year on year, with Pakistan (down by 46.6%) and Bangladesh (down by 82.9%) also experiencing severe disruption to outbound shipments amid widespread factory shutdowns and quarantine measures. South-east Asia was also hard hit, with poor export performance registered in Vietnam (down by 13.9%), Indonesia (down by 7%) and Singapore (down by 16.8%).

There are important caveats to these data. The weak South Korean trade figures, for example, were underpinned by both a high annual base effect and a drop in export prices. The latter exceeded the fall in export volumes by a wide margin, suggesting greater strength in trade performance than suggested by nominal values. Price effects were also evident elsewhere: the weakness in Indonesian and Singaporean export data, for example, also reflected the fall in global energy prices. Singaporean non-oil domestic exports, by contrast, jumped by 9.7%, buoyed by strong growth in pharmaceutical demand.

Other markets saw less disruption. Surprisingly, Chinese exports rose slightly in April, bolstered by ongoing clearance of backlogged factory orders from the first quarter and a rise in external demand for personal protective equipment (PPE). This, in turn, helped to soften the blow to exports from Hong Kong (down by only 3.8%). Taiwan recorded only marginal weakness in exports that month, supported by continued demand for locally made electronics products. Thailand defied expectations, although this was also commodities-driven, with exports rising on the back of higher global demand for gold.

This resilience will not last. Historic drops in purchasing managers' index readings across Asia, Europe and North America point to an inevitable softening in future trade performance, while falling Chinese import growth will undermine intra-Asian demand prospects. Early indicators for May confirm this. South Korean goods exports for the first 20 days of the month fell by 20.3% year on year (although this marked a slight narrowing from April), while Vietnamese exports for the first half of May plunged by 15.4%. Malaysia and the Philippines (which have not yet released US-dollar denominated trade data for April) saw outbound shipments fall in March by 9.6% and 24.7% respectively; future exports are set to disappoint further.

Assuming no major future global disruption, goods trade performance should bottom out by June, as international economic activity starts to recover slowly. Western markets are beginning to reopen, which should reintroduce some consumer and investor demand. Nevertheless, the shocks wrought to consumption and investment by skyrocketing unemployment, falling disposable incomes and anaemic market confidence will linger through the remainder of 2020, capping the prospects for any wider Asian trade recovery this year.

Turning inwards, slowly but surely

Policy decisions will pose the biggest risks to trade recovery this year, however, even as the coronavirus comes under control. Many governments are re-assessing their approach to global trade, with the adoption of restrictions on PPE exports across some markets in March and April coinciding with calls to reduce supply-chain reliance on China (particularly for healthcare goods). These discussions have emerged in the EU and the US, as well as Japan, which recently unveiled a ¥243.5bn (US$2.2bn) stimulus fund to encourage Japanese companies to relocate out of China. Conversely, the pandemic has also pushed China to engage in similar protectionist behaviour: in May it imposed tariffs on Australian agricultural exports, retaliating against that country's calls for an investigation into China's handling of the pandemic.

However, policymakers have also moved more recently to restrict international commerce in other ways, particularly with regard to FDI. In late March Australia temporarily tightened its rules on foreign takeovers, and in late April the EU, India and Japan moved to enhance scrutiny of inbound FDI. In late May the US issued a draft rule proposing higher regulatory oversight over FDI into "critical technology".

Most (if not all) of these moves also target China, and almost all are enshrined under national security concerns. These fears are partly driven by concerns over the predatory acquisition of strategic foreign companies (such as healthcare firms) by Chinese state-owned enterprises (SOEs), particularly as corporate valuations fall. These concerns reflect the dynamics seen following the 2008-09 global financial crisis, and have been exacerbated by the diplomatic fallout from the coronavirus, as political frictions worsen between China and many Western governments.

Some of these concerns are overblown. We expect Chinese overseas direct investment (ODI) to fall by almost 30% in 2020 (on a capital-account basis), driven by domestic and global economic weakness. Moreover, separate annual data from China's Ministry of Commerce indicate that Chinese ODI has already fallen from its peak in 2015-16, owing to existing domestic policy restrictions aimed at curbing "irrational overseas investment", as well as existing US and EU pressure to blunt Chinese overseas expansion.

As a result, this policy tightening will not engineer immediate shifts in the global economic landscape. Beyond any hit to Chinese ODI, reshoring, for instance, will be costly to implement and is likely to be mostly unsuccessful. In the absence of explicit directives or prohibitions, multinationals will diversify their operations across regional markets to shorten supply chains and enhance their resilience, rather than bring these operations home.

The prospects are nevertheless worrisome, owing to the structural damage this could inflict on the global investment landscape. Over the past few decades, crossborder investment has helped to sustain job growth in overseas and domestic markets, while also opening avenues for international capital and technology flows. A retreat from this model would disproportionately harm emerging economies. An intensification of policy rhetoric-such as promoting forced reshoring-would be intensely disruptive for advanced Asian and Western economies, many of which have significant FDI stock across the developing world. This would also complicate any co-ordinated global post-crisis recovery effort, with rising protectionism eroding space for investor sentiment or global demand to rebound.

Developments from one country, even if targeted, may carry consequences for multiple markets. For example, the recent US restrictions on a major Chinese manufacturer of telecommunications equipment, Huawei, also carry implications for the technology industry in Taiwan. Huawei's ability to withstand US pressure, in turn, may delay or disrupt the global roll-out of 5G-a risk we have consistently highlighted. These trends will increasingly force global policymakers across all markets to confront the reality of rapid bifurcation between the world's two largest economies.