Think Tank

Asia Macroeconomic Update: Growth and Policy Outlook

Richard Martin, Managing Director, IMA Asia
Globally and in Asia, economic growth is reviving and stock markets are surging. 55% of S&P 500 shares have a net ‘buy’ recommendation, while in Europe, the gap between ‘buy’ and ‘sell calls is at a 12-year high. Yet there are also major challenges ahead, most obviously the Delta variant of Covid-19, which has triggered a third global wave. Rising economic nationalism, heightened geopolitical risks and major supply-chain disruptions are key issues. Together, these factors are spurring a new bout of reshoring and near-shoring and causing organisations to restructure. However, globalisation remains a potent force, driven by the logic of trade and unfettered capital flows. At a recent webinar of the India CEO Forum, Richard Martin, Managing Director of IMA Asia, took stock of Asia’s medium-term growth prospects.

Four, inter-connected factors will drive demand and economic growth in the coming years

A strengthening outlook…

Compared to IMA Asia’s last round of regional forecasts, which were run in March 2021, the economic outlook has brightened. This year and next, growth at the country level will depend on four, interlinked factors that drive demand:

  • Government capacityto stop the spread of Covid-19, get people vaccinated, and support the economy.
  • Sustained cash flowsfrom wages and employment, consumer spending, and export and tourism earnings.
  • The strength of household, corporate and government balance sheets.
  • The ability of capital marketsto support equity- and debt-raising.

Post-Covid, Asian economies can be bucketed into three broad groups

The major Asian economies can be broadly categorised into three groups on the basis of their performance in 2020:

  • Strong:China, Taiwan, Vietnam and Bangladesh.
  • Middling:Japan, Korea, Malaysia, Thailand, Singapore, Hong Kong, Australia and New Zealand.
  • Weak (‘at risk’):Indonesia, Philippines and India.

Today, the first two groups are seeing falling Covid-19 cases, rising rates of vaccination and a rapid economic reopening. In contrast, the ‘at risk’ economies continue to face Covid-related risks and have little room for fiscal stimulus. The hope, however, is that so long as global capital markets can provide some support, they should be able tide through this year.

America, the EU and China are all recovering strongly…

…powered by 3 engines…

The world’s three biggest economies – the US, EU and China, which together account for ~60% of global demand – are seeing an upsurge in growth. America is on track to grow by 7% in 2021, up from -3.5% in 2020, and to sustain 3%+ growth rates for the next 2 years. Vaccination rates have risen fast, with over 50% of the population fully vaccinated, though there is also a spike in Covid-19 cases, mostly in Republican-leaning states, which are lagging behind on vaccinations. The EU is doing even better on vaccinations, and is also seeing fewer daily new cases than the US. The Euro-zone area is projected to grow by 4.8% this year and 4.5% in 2022, up from -6.6% in 2020. Finally, China – which is on course to have 85% of its population fully vaccinated by October – is recording less than 120 cases a day. It is on track to grow by 8.5% in 2021, up from 2.3% last year, slowing to 6.2% in 2022.

…spurring an Asia-wide export boom

A recovery in the ‘big 3’ has driven up export growth across Asia. On an annualised, 3-month rolling-average basis, exports are in record territory. China, India, Indonesia and Taiwan are exporting well above their 2019 monthly-averages: ~USD 220 billion, ~USD 27 billion, ~USD 14 billion and ~USD 27 billion, respectively. Japan and South Korea are also doing much better than they have in the last two years but the monthly figures today are about where they were in 2018, which was a high-water-mark for both countries. The one key difference between India and these 5 East Asian economies is that India is seeing a widening trade deficit, while the others are enjoying rising surpluses. However, India’s deficit is being driven by rising IT and capital-equipment imports, which is indicative of strengthening domestic demand.

The US growth outlook is not as assured as many think

…but how secure is the US outlook?

One big risk to the global outlook is that assumptions around the strength of the US economy may prove optimistic. For one, the excess savings that households built up last year, and which are key to sustaining demand, have been largely run down. Today, US savings rates remain higher than normal, but household demand may not hold up in the face of rising Delta cases. This puts a question mark around the assumption of a consumption boom next year. Second, Joe Biden’s massive infrastructure bill, which could trigger a construction super-cycle, still needs to navigate its way through Congress – which is far from assured. Third, with inflationary pressures mounting, the Federal Reserve will start to pull back on its QE programme later this year. This could lead to a correction in stock prices, which, according to the S&P 500’s current PE ratios, are well into record territory. All of these factors make it unlikely that 2022 will be a ‘boom year.’

QE’s unwinding will cause some hiccups, but capital flows are likely to sustain

An unwinding QE – which could take 18 months or more to complete – could set off another taper tantrum and cause a temporary pull-back of capital from markets like India. However, it is unlikely to drive up interest rates, which have remained low despite rising inflation, for the last 12 months. There is a huge pool of global capital that will continue to seek returns, and the current low-yield conditions are likely to sustain for another decade. Emerging markets like India may be ‘riskier’ than the US, but they also offer higher returns. The implication is that businesses will be able to continue tapping global markets for funding at relatively low rates for years to come.

India, Indonesia and the Philippines are Asia’s three ‘at risk’ economies

Asia and the Delta variant

For the three ‘at risk’ Asian economies, the Delta variant poses significant challenges. All three saw a spike in cases in recent months, though the situation has now improved somewhat. With vaccination rates still very low – 10% or less of the population is full vaccinated – the only way they can contain another wave is by imposing lockdowns. Indonesia’s relatively mild restrictions (it never went into a full-fledged lockdown) have proven ineffective, while the Philippines is facing serious vaccine shortages. In India, the number of daily cases has levelled off but remains high, and there are genuine fears of a third wave.

Malaysia, Thailand and Vietnam also face Covid-related issues

Delta is a major concern even for some of Asia’s stronger economies – particularly Malaysia, Thailand and Vietnam. Full-vaccination rates are relatively high in Malaysia but remain below 10% in the other two. In all three countries, the number of daily cases has jumped in recent weeks, and it has soared in Malaysia. Going forward, this could trigger new restrictions on activity, impacting factory and port operations – and therefore exports.

The over-hang of Covid is likely to be long and painful

The three ‘at risk’ economies face the possibility of contracting ‘long Covid,’ where the pandemic becomes a long-drawn economic and medical issue. This is already visible in the Philippines, which is showing signs of household distress. The Philippines runs regular income/expenditure surveys, which offer a real-time view of on-ground conditions. According to recent surveys, the share of households with any savings fell from 38% just before the pandemic to 25% in December 2020. It will take 5-7 years to rebuild these savings. In the meantime, households will pull back on spending on housing, cars and other durables. At the same time, not only is the volume of consumer loans falling, but credit cards defaults have soared. It is likely that the situation is as bad, or worse, in India and Indonesia. Indicatively, automobile sales have fallen sharply in all six countries – and for the Philippines, sales last year were their worst in a decade.

Most of East Asia will enjoy stable sovereign ratings, but India could see a downgrade

‘Long Covid’ could also impact countries’ sovereign ratings. India, which is currently at the lowest rung of investment grade, is one downgrade away from speculative/junk-bond status. A downgrade would have little impact on government borrowings, which are mostly domestic, but it would impact corporate/project loans that are dependent on ratings. In comparison, other Asian countries enjoy either higher ratings, a positive/stable outlook, or both. This is thanks to strong alignment between each country’s political leadership, and its Central Bank. This has helped ensure strong capital flows as well as generally-low costs of borrowing.

Asia will under-shoot IMF projections…

A multi-track Asia

Rising infections and relatively low vaccination rates – many Asian countries will only achieve an 85% rate by mid-late 2022 – could undermine the IMF’s latest growth projections. In April, the IMF forecast that the ASEAN-6 would return to pre-Covid growth rates by 2022-25. However, IMA Asia’s projections are more cautious, and below the IMF’s estimates for all countries (except Taiwan) for both 2021 and 2022-25. The ‘at risk 3’ are expected to under-perform in 2022-25 relative to their 2009-19 decadal average, though India will be more resilient than most ASEAN countries on account of its political stability and large domestic market, which will help it attract significant capital inflows.

…but it is the ‘at risk 3’ that could see the sharpest impact

In 2022, Covid will pose the biggest risks to growth in the ‘at risk 3’, while Singapore and China lie at the other end of the spectrum. At the same time, India and Vietnam will face mildly higher risks in terms of capital flows on account of their lower-than-average sovereign ratings. From a medium-term perspective, the outlook for domestic demand growth and capex varies sharply across the region. 6 countries – China, Taiwan, Singapore, Vietnam, Australia and New Zealand – are likely to out-perform the rest of the region. 4 countries – South Korea, Hong Kong, Malaysia and Thailand – are forecast to take a 5-10% demand-side hit relative to pre-Covid levels. However, in India, Indonesia and the Philippines, demand is expected to be 10-15% lower than in the decade to 2019, largely on account of damaged household balance sheets.

India has an opportunity to boost its manufacturing sector, but also some drawbacks

Indian manufacturing: Taking stock

As factories continue to leave China on account of its rising costs and geopolitical risks, India has an opportunity to attract manufacturing investments. India’s prime attractions are its large domestic market, favourable demographics, low labour costs and its recent manufacturing policy-push. Yet, while India can hope to raise its manufacturing/GDP share, it is unlikely to match East Asia’s ~25% rates. Indian labour is cheap but it is also poorly educated. Moreover, there has been a push towards inward-looking policies that could prove detrimental. Going forward, India will need to try and ensure, as it has for the last few years, to limit the Rupee’s depreciation to no more than 2-4% a year – which is roughly equal to the India-US inflation differential – and to maintain policy stability, which helps businesses make long-term commitments.