Asia FX 2025 Outlook Podcast Series #3: Outperformers and Vietnam as microcosm of China+1

Welcome to the MUFG Global Markets Asia podcast. I'm Michael Wan, Senior Currency Analyst in the MUFG Global Markets Asia Research Team. Today is December 16, 2024.

The following podcast is for informational purposes only. It is intended for professional investors and eligible counterparties, and not for retail clients. Any content should not be regarded as an offer to conduct investment businesses or investment recommendations.

Hi everyone, we recently published our AsiaFX Outlook for 2025, titled Navigating AsiaFX Markets in TRUMP 2.0. Among others, there were two key messages which stood out in our report which we will touch on in detail in this podcast. First, our expectation that the Philippines Peso, and to a smaller extent the Indian Rupee, would outperform in the context of swift tariff implementation by TRUMP 2.0.

Second, we think that the China-linked supply chain, and in particular Vietnam, will likely be a focus of the TRUMP administration this time around. As such, the Vietnam Dong could be somewhat more vulnerable, but we caution against being too bearish at this stage due to offsetting factors and structural advantages inherent in Vietnam's manufacturing sector. So first off, the FX outperformers in 2025, the Philippines Peso and the Indian Rupee.

For one, on the global front, the Philippines and India should be more insulated from TRUMP 2.0 in 2025 among AsiaFX. These countries are more domestic-oriented to begin with, and less sensitive to possible US tariffs, and also because they are less leveraged to the indirect impact of a global and China growth slowdown. In addition, the Philippines and India are less likely to be singled out by TRUMP for their trade practices, certainly relative to the likes of say Vietnam.

A broad 10-20% import tariff is of course a risk, but this would not be a factor specific to either the Philippines or India. Where the Philippines and India could be more negatively impacted is through TRUMP's immigration policies, especially on illegal immigrants. Remittances from the US to the Philippines makes up 3% of its GDP, the highest in Asia, but our assessment here is that the vast majority of immigrants from the Philippines to the US are permanent residents, and hence the direct impact of remittances should be quite manageable.

For India, remittances from the US makes up less than 1% of its GDP, but a key risk for India could potentially be materially stricter rules on H-1B visas, and the knock-on impact to India's IT services company. Again, our assessment here is that the impact should also be quite manageable, given that IT services firms have over time relied less on the H-1B for their projects based on our understanding. Of course, TRUMP is not the only factor at play here.

Beyond the global factors, local factors help to explain why, on a relative basis, we are more constructive on the Philippines Peso relative to the Indian Rupee. On India, we recently lowered our India GDP forecast to 6.1% for the FY2024-25 and 6.3% for FY2025-26, down from 6.9% and 6.7% previously. A less benign domestic growth environment for India will likely weigh further on portfolio inflows, but the good news for India is that the July-September quarter in our view should mark the 12th of activity, with several high-frequency indicators rebounding in October and November, helped by a rural economy recovery, faster disbursement of the government's operational spending, coupled with still strong corporate sentiment.

The bad news for India is that food inflation still remains rather elevated, and the RBI is likely to only have policy space to cut rates from the February meeting. The central bank's bevy of macroprudential measures on consumer loans could also weigh on economic activity, while government capital expenditure spending seems to be facing some operational hurdles to ramping up to target. So net-net for India, we are overall now forecasting a larger and deeper rate cut cycle by the RBI of 75 basis points, bring the repo rate to 5.75% by the 4th quarter of 2025.

And from a FX perspective, we expect USDPHP to trade closer to 59.7 by the 1st quarter of 2025, before moderating to 58.8 by the end of 2025. And so the Philippines Peso is one currency which we think over time will be relatively more resilient, certainly relative to the likes of the Chinese Yuan, the Korean Won or even the Thai Baht as well. We forecast USDINR to rise steadily to 85.2 by the 1st quarter of 2025, and 86 by the end of 2025.

So some outperformance for the Indian Rupee in the first half of next year, but with some scope for some potential underperformance in the second half due to the local factors which we mentioned. So let me touch on the second theme arising from our outlook report, which is we think the China-linked supply chain, and with that Vietnam, will likely be more vulnerable this time around. And if this one country which is the microcosm of the diversification of supply chains in Asia, it is Vietnam.

This process was already in place before Trump came in, given the fundamental drivers of supply chain diversification, but was certainly catalyzed and accelerated by US terrorists on China. Fast forward to today, our analysis shows that foreign value added from China, embedded in Vietnam's exports, surged from 12% in 2016 and 2017, up to 18% today, which is the highest among any Asian countries, and also the sharpest increase among all the Asian countries that we track. And ultimately, this indicates the central role that Vietnam plays in the China-plus-one supply chain.

Put it differently, looking from it from another perspective, Vietnam's bilateral trade supplies with the US has more than tripled to 100 billion per year, and the US is now the most important market of end demand for Vietnam, making up more than 10% of Vietnam's GDP. Moving forward into Trump 2.0, our assumption is that Trump will impose some sector-specific tariffs on Vietnam, and to tie tariffs to stricter rules of origin for Chinese products and exports from Chinese headquartered companies. The ultimate stated aim would be to decouple the US from the Chinese supply chain, but in practice, I think what's going to be most targeted in terms of practices, would be the plain diversion of trade through Vietnam in order to just avoid US tariffs.

Of course, there are many shades of grey over here in terms of how the tariffs will be implemented, how much they will be raised, and a broad-based 10-20% tariff may certainly also impact Vietnam more than other Asian countries, say the Philippines and India, given that Vietnam is much more export-oriented, and given that the US is also quite an important market of end demand for Vietnam. So taking all these factors into account which we mentioned, we forecast dollar VND to trade closer to 26,000 in 2025, with the Trump 2.0 administration likely to increase scrutiny on Vietnam's exports and the Chinese-linked supply chains. We're nonetheless hesitant to be too bearish on the Vietnam Dong and its economy, even as we acknowledge the left-heel risk and the uncertainty in regards to tariff implementation.

We list down a couple of reasons. For one, Vietnam has been gaining significant export market share, not just in the US, but also globally, in terms of markets outside of the US, and we think this indicates that there's some structural comparative advantage for Vietnam's manufacturing and exports that goes well beyond just the idea of reallocating trade and avoiding tariffs. And just to name a few, we think these structural advantages for Vietnam may include its multitude of free trade agreements, its productive and skilled labor force, its good geographical proximity to key supply chains, including to China, and its very supportive business environment and industrial zones that has been set up over time.

The second key reason why we are hesitant to be too bearish on the Vietnam Dong is that Vietnam's relationship with the US business community, and also in terms of managing its relationship with key trading partners, has historically been quite good, not to say that this won't change moving forward, but ultimately we think that negotiation is more likely than not. Third, we think Vietnam has already been increasing its domestic value added over time, and our analysis and data that we see suggest that it's been moving up the value chain, and we think will likely continue to do so moving forward. So the net impact to Vietnam will also depend on the relative cost of shifting production to other countries, versus further agglomerating within Vietnam in terms of the higher value added activities.

Last but not least, effective tariff rates by the US on China are likely to remain higher than Vietnam, and also likely to increase at a faster rate compared with what Trump may do on Vietnam, even under a range of scenarios that we can think of in Trump 2.0. Thank you for listening to the MUFG Global Markets Asia podcast. Rate, review and subscribe on Apple, Spotify, or wherever you subscribe to your podcasts.

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