APAC Outlook : Surviving the Year’s Rocky and Uneven Start

Dhaka August 17 2022 :

Asia faces risks of further inflation and slow demand within China.

The Asia-Pacific economies have had a rocky and uneven start to 2022.

The greatest risks in the near term are rising inflation and uncertain demand for goods and services in China.

Regional currencies are generally holding up well against their peers in light of strong dollar demand.

It has been a rocky start this year for the Asia-Pacific economy through mid-2022. The delayed opening of economies following the Omicron wave of COVID-19 late last year caused recovery in the region to lag behind
Europe, the U.S. and elsewhere.

Russia’s invasion of Ukraine and China’s zero-COVID policy created supply-chain disruptions leading to inflation of energy and food prices. Most central banks reacted with rising interest rates. And China’s weakness in domestic demand caused by the downturn of its property development sector, its shifting regulatory environment, and the uncertain timing and severity of its zero-COVID policy has slowed China’s growth and reduced trade flows.

Volatility across APAC economies

Seven of the 14 major economies in the APAC region suffered a quarterly decline in GDP in either the first or second quarter of this year, including the two largest economies—China and Hong Kong—and others closely
linked to China through trade.

However, inflation of global commodity prices boosted the region’s commodity producers. Neither Australia, Indonesia nor Malaysia has suffered a weak quarter through midyear. Australia has been steady and Indonesia and Malaysia had very strong first quarters driven by the opening of their domestic economies and the dramatic rise of commodity prices in March.

Fortunately, supply-chain disruptions are beginning to ease as the implementation of China’s zero-COVID policy is adjusted to avoid the severe lockdowns experienced in Shanghai during the second quarter.

Indeed, the growth rate of China’s exports of goods held at a strong, steady pace through July, following a downturn in April due to local lockdowns. But imports into China have not shown the same resilience, posting declines since February. This indicates some inventory drawdown of commodities and intermediate inputs for manufacturing, but also the weak domestic demand that has been persistent despite some stimulus coming from fiscal and monetary policy in China.

A principal factor in China’s weak domestic economy is the faltering housing market. Demand has softened because of short-term labour market uncertainty as well as longer-term shifts in rural-urban migration and the ageing population. Property developers have defaulted on their debt and construction has slowed considerably.

Adding to this weakness is the boycott of mortgage payments by many households who face considerable and uncertain delays in the delivery of units they have purchased but are still under construction. Construction is
down by more than one-third from a year ago, reducing demand for steel, copper, cement, and other construction commodities.

Further, the median price of new-home sales is falling, leading to uncertainty of the value of household assets, which are highly concentrated in real estate.

Trade flows to China, which have supported the economies of the APAC region for more than a year, could weaken in the second half of this year. Not only is China’s import demand for goods weak, but demand from developed economies may also weaken.

Consumer demand in the U.S. has shifted from goods to services as nearly all COVID-19-related restrictions, including travel, have been lifted. High inflation and the prospect of high energy prices in the coming winter months in Europe limit consumer sentiment and demand. 

There are limited data available for exports from APAC economies in July, but the data that are available—for Korea, Taiwan and Vietnam—show a deceleration of exports from all three export-related economies. Demand
could stabilise in the U.S. as its labour market is quite strong. But the weakness from China and the potential for recession in the U.K. and Europe by late this year or early next year create downside risk for exports from the
APAC region.

Outlook

Weakened trade patterns and persistent inflation will dampen economic growth in the second half of this year, but 2022 will maintain its general pattern of economic recovery and expansion across the region.

The outlook for the remainder of this year has shifted the most for China and Hong Kong. Real GDP growth this year in China is now projected to reach only 3.4%. Our July forecast estimate of 4.3% was lowered by the lack of a significant impact from the housing market or consumer spending stimulus and the quarterly GDP decline in the second quarter.

The continuation of COVID-19-related local restrictions through mid-August added to this uncertainty, although current restrictions are limited and located inland, away from major manufacturing and shipping centrers.

Hong Kong’s expected decline this year is a function of its very low starting point. Following quarterly GDP declines in the first and fourth quarters of last year, the territory suffered an even deeper 2% quarterly decline in the first quarter of 2022 because of international travel restrictions and the closed border with the mainland.

The lifting of some of these restrictions supports a stronger forecast for Hong Kong in this year’s second half, but it won’t be enough to lift the annual GDP figure above 2021.

The only significant upward revision to 2022 GDP growth is for Vietnam. A very slow reopening of the economy earlier in the year has now turned into a rapid improvement in industrial production and export trade, supported by continued inward foreign direct investment.

The uncertainty of policy in China is directing investment toward Vietnam and other Southeast Asian countries. So, despite July’s moderation of exports from Vietnam, the outlook remains positive.

Following some uncertainty earlier in the year, exports have stabilized, and industrial production has improved in India, leading to some optimism for the rest of this year and into 2023. Similarly, the Philippine economy has come roaring back from a deep downturn in 2021, with prospects for further fiscal stimulus via the new government’s infrastructure programme.

Rounding out the regional leaders for this year, Malaysia and Indonesia will benefit from high commodity prices this year, even if many prices have already peaked or soon will. Australia and New Zealand are driven by strong labour markets and consumer spending. Taiwan, Korea and Singapore’s export-based economies may slow in the second half but will continue to expand moderately.

Across the region, the continued rebound of travel and tourism demand will drive the service and retail industries.

Growth in 2023 is expected to decelerate following similar slowdowns in North America and Europe as they absorb higher interest rates. Within the APAC region, only China is expected to improve significantly next year.
This assumes that policymakers will ease up on the dynamic zero-COVID policies so that the risk of local shutdowns will be greatly reduced, and international travel restrictions in and out of China will loosen.

There remains much uncertainty about the housing market, but current efforts at providing bailout funds for property developers should be felt next year as more units are completed and delivered to buyers.

Risks

The greatest uncertainty within the region is inflation. While global oil prices specifically, and commodity prices in general, have begun to ease over the past month, this trend is not yet reflected in consumer price inflation across the region. Inflation remains well above where it was at the beginning of this year and above most central bank target ranges. Among the higher-inflation countries of the region, only India’s CPI rise has moderated, finally coming in below 7% over the year in July.

Elsewhere, inflation is still rising, with higher rates for the food and energy components of CPI. Global crude oil prices peaked in the second quarter; the Brent crude price is below $100 per barrel and should fall further as some countries release from their reserves. Dollar strength, however, could
offset the near-term price impact for APAC economies.

Thus, inflation is expected to ease modestly in the second half of the year in the region. Any stress on transport or supply chains, however, could slow the improvement for the important food price component of inflation.

All central banks in the APAC region except for Indonesia, China and Japan have begun raising interest rates as inflation rises and as interest rates are rising quickly in North America and Europe. Indonesia is expected to
begin its process towards normalisation later this month. Only China and Japan will likely keep rates steady.

There is some risk, however, that policy normalisation will not keep pace with the U.S. Federal Reserve, creating downward pressure on local foreign exchange rates as interest rate spreads widen.

So far, however, most APAC currencies have held their value relatively well, especially when compared with high-yield emerging-market economies such as Turkey, Sri Lanka and Argentina.

The currencies of Japan and South Korea have moved similarly to the euro, and those of most other APAC economies have held firmer. The strong export base of the region has resulted in healthy current account balances in much of the region. Given that the APAC central banks are all in the process of normalising rates and the Federal Reserve is expected to slow its interest rate hikes to 50 basis points in September and 25 basis points in December and in subsequent meetings, interest.

Among the higher-inflation countries of the region, only India’s CPI rise has moderated, finally coming in below 7% over the year in July. Elsewhere, inflation is still rising, with higher rates for the food and energy components of CPI.

Global crude oil prices peaked in the second quarter; the Brent crude price is below $100 per barrel and should fall further as some countries release from their reserves. Dollar strength, however, could offset the near-term price impact for APAC economies.

Thus, inflation is expected to ease modestly in the second half of the year in the region. Any stress on transport or supply chains, however, could slow the improvement for the important food price component of inflation.

All central banks in the APAC region except for Indonesia, China and Japan have begun raising interest rates as inflation rises and as interest rates are rising quickly in North America and Europe. Indonesia is expected to
begin its process towards normalisation later this month. Only China and Japan will likely keep rates steady.

There is some risk, however, that policy normalisation will not keep pace with the U.S. Federal Reserve, creating downward pressure on local foreign exchange rates as interest rate spreads widen.

So far, however, most APAC currencies have held their value relatively well, especially when compared with high-yield emerging-market economies such as Turkey, Sri Lanka and Argentina. The currencies of Japan and South Korea have moved similarly to the euro, and those of most other APAC economies have held firmer. The strong export base of the region has resulted in healthy current account balances in much of the region. Given that the APAC central banks are all in the process of normalising rates and the Federal Reserve is expected to slow its interest rate hikes to 50 basis points in September and 25 basis points in December and in subsequent meetings, interest.

South and Southeast Asia face the greatest risk from a surprise in inflation. This could slow local demand for goods and services, including housing. Japan, South Korea and Taiwan are more highly exposed to further
supply-chain disruptions from China for electronics and components. A decline in commodity prices faster than expected would dampen the economies of Australia, Indonesia and Malaysia.

COMMENTARY by Steven Cochrane, Katrina Ell, Harry Murphy Cruise & Stefan Angrick on 15 August, 2022 .

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