With the exception of China, Asia-Pacific is breathing easier than the rest of the world. Global obstacles have altered the outlook in the past three months. These include a longer-than-expected Russia-Ukraine conflict; higher energy and commodity prices; higher and more sticky inflation, especially in the US; faster monetary policy normalisation in the US and Europe; and economic damage from COVID-19 lockdowns and restrictions in China.
These hurdles led us to downgrade our 2022 global growth forecast in our interim update in May. We cut our GDP growth projections for the US, China, and Europe by 0.7-0.8 percentage points and raised consumer price index (CPI) inflation forecasts for the US, Europe, and some Asia-Pacific economies. In our current global forecast round we have further reduced our growth projections and raised our inflation projections for a range of economies.
For Asia-Pacific, the two key changes to the global outlook are the weaker growth in China due to stringent COVID restrictions and the higher projected US interest rates. Considering the slower-than-expected easing of COVID restrictions and shallow recovery of domestic demand in China, we have further lowered our baseline 2022 growth forecast for the country to 3.3% (compared to our interim update in May).
Despite the headwinds, Asia-Pacific growth prospects remain broadly favourable. Outside China, the post-COVID domestic recovery is mostly continuing. We expect solid economic growth in 2022-2023, especially in economies relatively led by domestic demand such as India, Indonesia and the Philippines.
However, rising inflation has been a key factor behind the start of the monetary policy normalisation in many economies: all but four central banks have started raising their policy rates. The other key motivation is staving off external pressure amid rising global interest rates. Capital outflows and currency depreciation against the US dollar have so far been contained. But we expect most central banks to continue to raise their policy rates to anchor inflation expectations and guard against external vulnerability.
China’s COVID weakness
In China, lockdowns in Shanghai and elsewhere have hindered the economy since end-March. Consumption and the service sector have particularly suffered (Exhibit 1), and more so than investment and industrial production. Nonetheless, because of the intricate supply chains in and around Shanghai, industrial production has been substantially disrupted.
Exhibit 1: The COVID lockdowns have hit China’s economy badly
Since May, restrictions and their economic impact have started to ease, but the recovery is shallow. Conditions in industry and exports improved significantly in May. And, as has been the case throughout the COVID period, the effects of China’s restrictions on global supply chains should remain manageable. However, consumption and service sector activity remained weak and the recovery is slower than in 2020. This is because the easing of restrictions on movement has been gradual, new restrictions have been imposed in other areas, and overall sentiment remains poor. In all, the economy is on track for a very weak second quarter, with little or no year-on-year growth.
On the policy side, the People’s Bank of China (PBOC) is using quantitative levers to support credit growth. In the fiscal area, China is advancing its infrastructure development and has implemented some tax cuts, while a cut in the mortgage rate provides some support to the property market.
A tepid recovery in China
Given China’s weak second quarter and with its COVID stance unlikely to change soon, we expect the country’s growth to fall well short of the “around 5.5%” target. In our new baseline, we project full-year GDP at 3.3%.
The key downside risk in China is new COVID lockdowns in one or more large, relatively developed cities with economic heft and connectivity.
China’s lockdown weakness has lowered demand for other countries’ exports. The fact that consumer spending is hit harder by the lockdowns than investment and industrial production mitigates the stress on other economies, as China’s consumption is less import-reliant. Nonetheless, China’s imports have weakened severely, in part because of the impact of the property downturn on commodity imports (Exhibit 2).
Exhibit 2: Housing market activity has remained very weak
Growth outlook for Asia-Pacific ex China remains solid
Economic growth generally eased in early 2022 after the rebound in 2021. With quarter-on-quarter growth falling to 0.7% in Asia-Pacific ex China, year-on-year growth slowed to 3.3%, compared with 5.4% in 2021. The slowdown was most pronounced in Hong Kong and least visible in Malaysia.
Export momentum has softened. This is in line with the slowdown in global trade we have been expecting for 2022 and a likely slowdown in major economies including the US. This will especially weigh on growth in relatively trade-sensitive economies such as South Korea, Taiwan, Thailand and Singapore.
However, the recovery in domestic demand from COVID is largely intact, so overall growth has softened only modestly. This is especially so in Australia, India, Japan, Indonesia and the Philippines where growth is more domestic demand-oriented.
Overall, we revised down our GDP growth forecast for Asia-Pacific ex China in 2022 by a modest 0.1 percentage point.
Exhibit 3: Real GDP forecast
Output will remain below its pre-COVID trend for a long time in several Asia-Pacific economies. We currently expect that as of 2022 this “scarring” will be the largest in the Philippines, India, Malaysia and Thailand (Exhibit 4). Nonetheless, our forecast for Asia-Pacific GDP growth of about 4.8% in 2023-2025 would mean the region will resume its status as the world’s fastest growing.
Exhibit 4: COVID has hit several Asian emerging market economies hard
Inflation and external pressure demand central banks’ attention
Inflation has risen and is likely to increase further. We have raised our projections for inflation in several economies, especially in Australia, India, Indonesia, New Zealand, Singapore, South Korea and Thailand. Driving these revisions are higher energy and commodity prices and, in a few cases, larger pass-through as economies recover and core inflation picks up amid decreasing slack.
Government policy matters. While energy price inflation generally remains high, that is not so in Malaysia and Indonesia. The two economies are net energy exporters and are not passing on some of the energy commodity cost increases to consumers. In Asian emerging markets food price inflation is generally not as serious as in other emerging market regions, but it is rising.
The spectre of capital outflows
Meanwhile, the US Fed’s policy tightening raises the potential for capital outflows from Asia’s economies—especially its emerging markets. We now expect the Fed to raise the federal funds rate above 3.5% by mid-2023. As some capital is attracted by higher US interest rates, Asia-Pacific currencies and asset markets are affected.
However, capital outflow pressures have so far remained moderate. In China, “net financial flows” have been large in the first five months of 2022, but they don’t point to a major shift compared with 2021. There have been appreciable equity outflows out of India and the Philippines, but other portfolio outflows are limited.
While we have seen Asian emerging market currencies depreciate vis-à-vis the US dollar and the euro in the first half of the year, the depreciation has been modest and has been more a result of a divergence in monetary policy and energy price increases rather than potential emerging market vulnerability.
Exhibit 5: A more hawkish US Fed puts pressure on currencies
Notwithstanding the absence of major pressure so far, rising US interest rates could force capital outflow—emerging market central banks will want to guard against this.
Central banks face a balancing act
Against this backdrop, Asia-Pacific central banks are weighing the desire to support growth against the need to tighten policy to anchor inflation expectations or to head off financial instability.
Many central banks are on course to tighten substantially because of higher inflation. Where CPI inflation is already exceeding targets significantly and is bound to rise further, central banks will seek to tighten monetary policy and maintain their credibility.
Central bankers in emerging markets that are vulnerable to capital outflow in the context of an increasingly hawkish US Fed have little policy room, and will likely need to tighten. This is especially the case for net energy-importing emerging markets without a current account surplus to start with. The reason is that their current accounts will turn into significant deficits in 2022 due to higher energy prices. This points to India, the Philippines and Thailand.
Where neither inflation nor external pressure is a major constraint on monetary policy, central banks will focus on supporting growth, in our view. Where possible, central banks will want to tighten policy as little as possible, or not at all.
Louis leads the Asia-Pacific macro team and its research. He contributes to S&P Global Ratings’ macro-credit narrative and represents the firm in events, conferences, and the media, delivering its insights and thought leadership to the marketplace. Before joining S&P Global Ratings in 2022, Louis held senior positions in both the public and private sectors, including at the International Monetary Fund (IMF) in Washington DC, the World Bank in Beijing, and at the Royal Bank of Scotland and Oxford Economics in Hong Kong. While with the World Bank, he led the China Quarterly Update, headed the Bank’s mid-term review of China’s 11th Five Year Plan, and led research on China’s saving and investment, rebalancing, and long-term growth and structural change.