Who will benefit the most from the RCEP?

What is the Regional Comprehensive Economic Partnership (RCEP)?

After eight years of grueling negotiations, 15 economies in Asia inked the world’s biggest free trade agreement (FTA) this month. The Regional Comprehensive Economic Partnership, or RCEP for short, was signed on November 5th by China, Japan, South Korea, the ASEAN-10 (Singapore, Indonesia, Malaysia, Thailand, Brunei, Cambodia, Laos, Myanmar, the Philippines and Vietnam), as well as Australia and New Zealand. Together, these economies account for $26 trillion in GDP and 2.26 billion in population, roughly one third of the global total. Trade amongst signatories amounted to over $10 trillion in 2019, roughly 27% of global trade. Amidst a pandemic-induced global slowdown and concerns about ‘de-globalization’, the deal will help to sustain regional trade and economic growth. From a geopolitical perspective, it signals a move towards a more China-centric trade order in Asia and sends a strong message that Asia is willing to move ahead with further trade liberalization in the absence of the U.S. At this moment, nine out of the 15 members still need to ratify the deal within their respective domestic legal contexts before it can take effect. 

Why this deal matters

The deal will provide a modest boost to regional trade and income growth over time. According to the Peterson Institute of International Economics (PIIE), RCEP will add $186 billion to the world economy and 0.2% to its members’ GDP on a permanent basis. The same analysis also points out that the global income benefits of RCEP will compensate for two-thirds of the income losses caused by the U.S.-China trade war. Assuming the current U.S.–China trade restrictions are not removed, the economic benefits of RCEP will be 70% larger than the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP). So how are the gains distributed?  In absolute terms, China, Japan and Korea will see the largest estimated income gains of $85 billion, $48 billion and $23 billion, respectively. But as a share of national GDP, certain ASEAN economies, particularly Malaysia, Thailand, Vietnam, and the Philippines are also key beneficiaries (see chart 2). Much has been said about India’s decision to pull out last year, reportedly over concerns about the impact on domestic manufacturing and dairy industries¹. By not joining, India stands to see a modest loss of around -$6 billion (or- 0.01% of GDP), alongside Taiwan (-$3 billion or -0.4% of GDP), from shifting trade patterns in the region. 

From a sector perspective, manufacturing, particularly electronics, industrial machinery, and autos, will be the biggest winners from the RCEP. The signatories of RCEP have committed to lower their tariffs to 0% within 10 years, for more than 90% of their products. While some products are still left out, such as certain agricultural products, manufacturing goods are generally included. Although Asia already has several FTAs in place (for example, between China and ASEAN and between Japan and ASEAN), there is no trade agreement linking China, Japan, and Korea. Extending the coverage will help to boost the regional manufacturing supply chain, which increasingly features all three blocs—with Japan and Korea on the highest positions, China in the middle, and ASEAN occupying a mix of middle-to-lower positions on the technology value chain. In addition, it is common for companies with global supply chains to face tariffs within a free trade zone if their products contain components made elsewhere, because of restrictions around ‘rules of origin’. Apart from extending the coverage of the tariff free treatment, RCEP also uses a more flexible and cumulative approach to ‘rule of origin’. This helps to better realize the effect of tariff reductions.

In addition to boosting the Asia supply chain, China’s consumer market is likely another key draw. China has a trade deficit with the RCEP bloc, with most of the deficit coming from trade with Australia, Korea, Japan, Malaysia, and New Zealand. While processing goods is a part of it, China has been buying various consumer goods, such as food and beverage, cosmetics, consumer electronics, and commodities from these economies.  China has been lowering overall import tariff rates for consumer goods over the last few years, but the commitment to eventually set most of these to zero will likely still have a significant impact.

Last but not least, RCEP also holds some promise for investment and service trade liberalization. For services trade, seven members, including Japan, Korea, and Australia, have committed to using a ‘negative list’ for services trade (meaning trade is not restricted unless otherwise specified), while eight other members, including China, adopted a more restrictive ‘positive list’ (meaning trade is not allowed unless otherwise specified), with a promise to shift to the negative list system within six years. China committed to further liberalize trade in finance, business services, construction, etc. Outside of services, all members committed to a ‘negative list’ to further liberalize foreign direct investment rules in manufacturing, agriculture, and mining. Generally speaking, compared with the CPTPP, RCEP has a lower degree of services trade and investment liberalization requirements, such as intellectual property rights protection, the treatment of state-owned enterprises, and labor and environmental rules.

What does all this mean for investors?

The broader manufacturing supply chain is a clear winner in the RCEP deal. Companies with existing supply chains that fall within the RCEP realm will likely see a reduction of tariff rates. The eventual establishment of a tariff-free Asia supply chain will also alleviate pressures faced by companies who are currently caught between the U.S.–China trade war. In time, these companies will have opportunities to restructure their supply chains. Sectors like electronics, industrial equipment, and autos will likely see the most benefit. In the equity space, RCEP strengthens our convictions in cyclical sectors, such as industrials, in our preferred markets, including China and South Korea. Lastly, we continue to like Chinese central government bonds (CGBs) due to their attractive carry and low volatility, as well as the RMB against an overall softer U.S. dollar backdrop.

Footnote:
¹ Sourced from The Economic Times, November 2019

All market and economic data as of November 23, 2020 and sourced from Bloomberg Finance L.P. and FactSet unless otherwise stated.

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