Asia/Pacific (ex-China/Japan) Outlook: Defying Global Headwinds

Our Forecasts

Source: Continuum Economics

Risks to Our Views

Source: Datastream

Regional Dynamics: Capital Spending to Buoy Economies 

As seen in 2022, emerging Asian economies will continue to outperform other emerging markets and prove to be more resilient than the developed economies. Asia is expected to contribute about 50% of global growth this year, a large of this will be from India, China and Indonesia. The emerging markets in Asia appeared to have weathered the Russia-Ukraine conflict and its fallout far better than the West. These economies have been ahead of the curve with their prudent policy measures (timely but moderate rate hikes) and sustained public spending. 

Inflation Woes Ease

While the West continues to battle with sticky inflation, Asian economies have been able to put a lid on their price pressures. Leading economies in the region have witnessed an easing of headline inflation (Figure 1) starting March 2023. This includes India, Indonesia, Vietnam, Malaysia and South Korea. Meanwhile, frontier markets in the region (Sri Lanka and Pakistan) have not been so lucky, and are reeling under the impact of the war; the commodity price boom and exposure to USD based lending. A positive for the emerging Asian economies was the energy mix, not entirely dependent on gas imports and with a switch to coal, which helped address inflation quicker. Meanwhile, easing global food prices have provided a buttress to these countries. The start of 2023 was a disappointment for Asian economies on the inflation front. Several Asian economies including India and Indonesia experienced higher-than-expected inflation at the start of the year. However, price pressures have trended downward significantly (and in some cases faster than anticipated) in the second quarter in these economies (Indonesia and India). The most significant gains were made by India, which saw headline inflation ease from 6.5% y/y in January to 4.3% y/y in May (Figure 1). Easing of inflation in these countries has created room for central banks in the region to consider trimming interest rates as early as the end of Q3-2023. 

Figure 1: Consumer Price Inflation (% y/y)

Source: Datastream

Meanwhile, Australia has made only minimal progress on this front, and the Reserve Bank of Australia appears to be finding controlling inflation a challenge. Although, inflation appears to have peaked, and is now easing in Australia, it remains too high (at 7% y/y in end-May) for RBA’s comfort. RBA hiked its interest rate by 25bps earlier in June (Figure 2), in a bid to rein in price pressures. Australia, it appears will remain on the monetary tightening path a bit longer than it other regional peers and we forecast one final rate hike in 2023. 

Figure 2: Benchmark Policy Rate (%)

Source: Datastream

The prospect of an end of the tightening cycle in the U.S. will allow also for greater flexibility in Asian economies, which hiked rates in 2022 not only to curb domestic inflation but also support their currencies. As the USD weakens against DM currencies, these economies are likely to see some inflows and currencies be well underpinned, which will provide a buttress to the regional economy. Although, containing price growth has been relatively ease for some of these economies, risks continue to persist to the upside. A volatile global environment alongside the potential risk of weather related events caused due to the El Nino pose a high risk. Therefore, it appears that while monetary tightening may have ended for some of these countries, the authorities will continue to remain hawkish for at least another quarter. 

Public Spending Will Drive Growth 

While easing inflation will likely be supportive of consumer demand (which is expected to have slowed in Q2 2023 as pent up demand waned), public spending will feature high on Asia’s 2023 growth story.  Even so, Asia will not escape the fallout from waning resilience of the Western economies slowing global growth. However, governments across the continent will strive to sustain the growth momentum. Increased public spending ahead of the up-coming elections across Asian economies will prop up headline growth numbers. Both Indonesia and India will be averse to heading into elections in 2024, with slowing economic activity. While private demand propped up economic growth in Asia in 2022, public investment has been instrumental in higher Q1-2023 growth figures in India and Indonesia. The Indian government is expected to push ahead with its high capital spending outlay, ensuring a pick up in infrastructure projects ahead of the national elections. Meanwhile, populist policies in India and elsewhere such as Malaysia will support household incomes and private demand. The rural economy in India is expected to see an infusion of cash, as the elections near and the government (central and regional) rolls out measures to support farmers, provides freebies and focuses on infrastructure projects. A similar trend is expected in Indonesia, which saw a 4% y/y growth in government consumption expenditure in Q1-2023. Given that the government saw its state budget surplus double in the Jan-Apr 2023 period, on account of higher revenue, public spending towards infrastructure is expected to be high. Indonesia allocated an additional USD1bn towards building of its new capital city. 

Waning External Stimulus 

The Q1 2023 headline growth numbers were also supported by the external sector however, the coming quarters will see the loss of external stimulus. As Western economies slow and consumption patterns shift, Asian economies will see their growth weaken. Sustained private sector consumption and capital spending will not completely offset the fallout from declining commodity prices and global demand for these commodities. Contrary to our earlier expectations, a China re-opening has failed to provide any significant tailwinds to the export market in these economies, as it has focused on consumer services. As a consequence, higher inflation in the U.S., soft demand from China, slowing growth across Europe and easing commodity prices will be a drag. Further, tightening liquidity conditions will also weigh on capital flows. Recent export data shows a slowing trend (Figure 3). Meanwhile, a positive for these countries is a steady recovery in tourism, which may help offset at least some dip in goods export growth. 

Figure 3: Export Earnings Growth (% change value, y/y)

Source: Datastream, Reserve Bank of India, Bank Indonesia, Department of Statistics Malaysia

India: Tailwinds from Pre-electoral Spending 

After a stellar performance in Q1 2023 (Q4 FY23), India's economy is likely to lose steam over the coming quarters as the lagged effects of monetary tightening take hold, discretionary spending declines and exports falter. In Q4-FY23 (Q1 2023), real GDP growth surged to 6.1% y/y (Figure 4) driven primarily by government spending on infrastructure projects and a slight uptick in private consumption demand. The external sector too appeared to have contributed to the uptick in economic activity during the quarter. However, after recording an estimated 7.2% y/y real GDP growth in 2022, India’s economic activity is likely subside in the coming quarters. 

An 8.5% y/y growth in fixed capital formation and a 7.5% y/y growth in government spending drove growth in Q1-2023. The trend is expected to sustain over the next four quarters at least until May 2024, when the national elections are scheduled. Despite the tailwinds from pre-electoral spending, we expect India's growth to weaken to 5.9% y/y in the fiscal year 2023 (April 2023 to March 2024). Easing inflation as monetary tightening takes hold will support consumption. However, high interest rates will further defer private investment cycle (despite some industries operating a capacity).

Figure 4: India GDP Forecast  (% change, y/y)

Source: Continuum Economics, MOSPI

Risks to India’s growth forecast are heavily tilted to the downside. The delayed onset of the South West monsoon is likely to negatively impact agricultural output, as sowing is delayed. Additionally, the forecast of an adverse El Niño effect reinforces our expectation of a slight slowdown in output throughout the year. Meanwhile, the manufacturing sector is likely to face headwinds from the global slowdown. The government’s concentrated efforts to prop up the manufacturing sector (to create both employment and make India the next global manufacturing hub) will partly offset the impact of the global slowdown. The government through its production-linked schemes is boosting investment in the sector, which saw Apple make a move to manufacturing iPhones in India. Although, India is currently only manufacturing a small proportion of the company’s products, Apple is likely to relocate 18% of its total iPhone production to India. Business sentiment too remains positive in India, supported by strong services sector growth. While goods exports appear to be diminishing, India’s services exports remain broadly stable. A noteworthy point here is the shift in India’s services exports. With the U.S. slowing down, India’s services exports are expected to dip, but a pick-up in demand from the Middle East (particularly the UAE and Saudi Arabia) has provided a buttress. 

For India to be able to sustain domestic demand though, the sluggish rural economy needs to revive. The rural sector still lags behind pre-pandemic 2019 levels in various aspects, including two-wheeler sales, tractor sales, people travelling in domestic trains etc. Consequently, the government's focus in 2023, ahead of the upcoming elections, will be on enhancing the rural economy as it represents a substantial voter base and ensures sustained growth momentum. The latest budget emphasizes infrastructure development, particularly in transportation, digitalization, and rural infrastructure. 

As seen historically, India will continue to be plagued with the twin deficits in its current and fiscal account, which will be a drag on the economy not only in 2023, but over the medium term. Having set an ambitious fiscal deficit target of 5.9% of GDP for FY24, the government is likely to overshoot on this front, in our view. Increased subsidies for fertilizers, the continuation of the free food grain scheme, low excise duty on crude oil, and heightened expenditure on populist policies leading up to the elections will make it challenging for the government to meet its target. Additionally, the weakening external sector will also impede the economy's progress. Shrinking external demand, coupled with the pressure on the INR resulting from a wide current account deficit, raises concerns. 

On the monetary front, easing price pressures in recent months will provide the Reserve Bank of India with enough headroom for a rate cut by end-2023. However, growth prospects for now are not at a disadvantage and will also influence the central bank's decisions. Therefore, we anticipate three 25 basis point rate cuts in 2024, starting as early as Q1-2024. 

Figure 5: India Inflation and Policy Rate Trajectory (%)

Source: Datastream

Overall, India's medium-term prospects remain favourable, even with growth slowing to 5.9% year-on-year in the fiscal year 2023. Risks lean towards the downside, particularly with the turbulence observed in the banking sector of Western nations and uncertainty over the effects of tightening liquidity conditions. The country continues to be an attractive destination for foreign investment, primarily due to expectations of a strong government-led growth drive, policy continuity (with Prime Minister Narendra Modi likely to be re-elected with a majority in 2024), a favorable business environment, robust domestic demand and long-term diversification away from China.

Australia: RBA Keeping Doors Open

Slowing growth and a peaking labour market does not overshadow the strength of Australian economy as demand stays strong. RBA’s number one goal remains in the balance of inflation and economic growth. While the Australian economy remains healthy, the room for further tightening to tackle inflation without hurting the economy is decreasing. The Q1 2023 household saving ratio fell further to 3.7% from double digits in Q1 2022 as domestic demand elks out some final strength, but with signs on household cutting discretionary spending. The rising mortgage rate also put a strain on household finances. Negative real wages are going to weigh on private consumption in 2023/24 as wage growth is still outpaced by inflation. The re-opening of Australia has brought back international tourists and has been supporting private consumption, especially in the service area. While private consumption would remain positive (given employment growth and some further decline in household saving rate), it is inevitable to weaken in the coming quarters. The recovery of Chinese economic activities should increase the demand for Australian exports but a portion of it would be neutralized by falling commodity prices. Our central forecast assumes that Australian economic growth would begin to slow in Q3 2023 before rebounding in Q1 2024 as the damage to household consumption would be limited by inflation slowing below wage growth and a H2 recovery in global  trade flows. 

 Australian trade balance is AUD 11,158Mn for April 2023 with export falling by 5% m/m on lower commodity prices and import rising 1.6%. However, the trade balance is expected to grow at a healthy pace in 2023 with Chinese demand being sustained after the quick reopening, while tourism helps services. Overall, we look for a moderating 1.7% GDP growth in 2023 and further slows to 1.2% in 2024, as the cumulative impact of tightening would feed through the economy and limit the Australian economic growth.

Inflation has peaked at end 2022 and we forecast headline CPI to continue moderating throughout 2023 with occasional hiccups before flattening out in H1 2024. Despite supply chain disruption having dissipated and RBA and global monetary tightening feeding through, core inflation remains sticky and we have revised 2023 and 2024 CPI higher at 5.9% and 3.3% respectively. RBA kept the inflation forecast unchanged in June by expecting inflation to remain above target range and only be back to target range in mid-2025. The transitionary inflation factors, for example high energy price triggered by Russia-Ukraine conflict and supply chain issues, has mostly dissipated yet it would take an extended period of time for sticky core inflation to rotate lower from such high levels. The high housing cost is correcting as mortgage rate have risen significantly, with housing investment having also dropped from high levels.  The potential housing fallout would still bind RBA’s hands from further aggressive tightening in 2023. Wage inflation is being outpaced by inflation currently, despite the labor market being at maximum capacity. RBA is recognizing the peak in the labor market and slower than forecast pace of wage inflation, which may translate to lower inflation in a medium run. 

The RBA is keeping both doors open on holding and hiking rates as well in the forward guidance. They will continue to try to balance inflation and the Australian economy by tightening only whenever inflation spikes and wait for the lagged effects of previous tightening to curtail core inflation. It is wise for the RBA to be cautious with its tightening step as not only it takes time for the cumulative effect of hiking interest rate to feed into the system, but a potential crash in the housing market from aggressive interest rate increase would create more trouble for the central bank. While a combination of aforementioned factors would underpin the inflationary pressure in 2023, the RBA would likely bring rates to 4.25% by year end 2023 before pausing to allow previous tightening be digested and assess inflation dynamics from there. As inflation comes down further in 2024, we see the RBA moving back towards neutral policy rates and see 3.0% rates by end 2024.

Indonesia: End of Commodity Windfall 

Although easing from its 2022 high, Indonesia's real GDP growth will remain strong over 2023; real GDP growth will decline from 5.3% y/y in 2022 to 4.8% y/y in 2023. Firming household demand as consumer price inflation continues to edge downward will help offset the fallout from the weakening external sector. Tailwinds from the commodity price rally in 2022 are rapidly dropping out of the growth equation in Indonesia. The external sector is now becoming a point of concern, as export earnings have been contracting on a Yr/Yr basis over the past three months. Thus the trade surplus has been steadily diminishing (Figure 6). 

Figure 6: Indonesia Current Account (in US$ bn)

Source: Bank Indonesia

While moderating global commodity prices have dented trade metrics, Indonesia’s major economic concern going into 2023 - its elevated inflation, has eased. Bank Indonesia’s tight monetary stance has also supported in reining in price pressures in the country. Inflation eased to 4% y/y in May (Figure 7), and is likely to trend downward to within Bank Indonesia’s target range (3% +/-1%) from June. Moderating food and transport prices have been instrumental in driving down the headline number and consumer price inflation is forecast  to average 4% y/y in 2023, moderating further to 2.9% y/y in 2024. 

Figure 7: Indonesia Inflation, Core Inflation and Main Policy Rate (%)

Source: Datastream

Looking ahead, lower inflation is likely to be supportive of household spending, which we expect will firm over H2-2023. Retail sales growth has been choppy over H1-2023 (Figure 8), but Bank Indonesia’s consumer confidence index indicates sustained m/m improvement in consumer sentiment and outlook, which lends credence to our view of improving private consumption levels and retail sales over the remainder of 2023. 

Figure 8: Indonesia Retail Sales Growth (% y/y) and Consumer Confidence Index 

Source: Bank Indonesia

Having hiked its policy rate by 225 bps over 2022 and early 2023, BI has signaled the end of its tightening cycle. The central bank although exercising caution will turn its focus towards ensuring sustained economic growth. Bank Indonesia was among the first to signal an end to tightening stating that at 5.75% the policy rate is adequate to rein in prices. Now as growth moderates, and higher borrowing costs hinder private investment, BI will likely cut rates as early as end-2023. We expect a 25 bps rate cut in Q4 to 5.5%. Two further rate cuts of 25 bps each are projected in H1 2024. Noteworthy is BI's expending mandate to include maintaining stability in payment and financial systems, which poses potential risks to price and exchange-rate stability. 

Indonesia's economic growth in 2023 is expected to remain robust, although challenges lie ahead with risks tilted to the downside. While the external sector's contribution to growth may dwindle, domestic consumption is expected to counterbalance any negative impact. However, there is a small risk of weaker exports leading to a current account deficit by the fourth quarter of 2023, which could put pressure on the Indonesian rupiah (IDR). Additionally, political instability given the approaching parliamentary and presidential elections in February 2024, will weigh on the economy. There is a chance of a diverging policy focus between the government and the central bank poses another challenge to Indonesia's growth. As the 2024 elections approach, the government is likely to prioritize populist measures, while Bank Indonesia will prioritize price stability. These conflicting priorities could impact the overall economic outlook. Conversely, the populist policies could support private consumption, and align with BI’s push for growth.

Over the medium term, our expectation is that investments in Indonesia's downstream metal processing sector are expected to support growth. The investment in these industries began in 2022, and after a slight lull in 2023, this is likely to pick up as interest rates decline over 2023-24. Although, the reopening of China's economy was expected to generate increased demand for commodities, providing a boost to the sector, recovery there has been disappointing so far. Meanwhile, the ongoing recovery in the tourism sector, coupled with fresh private investments, will help mitigate the impact of monetary tightening this year and support medium term growth. The implementation of the Omnibus Law on job creation will also stimulate investment through increased construction and mining activities in the medium term.  We forecast 5.1% GDP growth in 2024, after 4.8% forecast for 2023.   

Malaysia: Rapidly Losing Momentum 

Malaysia is expected to follow a similar trajectory as that of its Asian peers such as India and Indonesia. After a robust Q1 2023 performance of 5.6% y/y real GDP growth, economic activity will weaken over the remainder of the year. Signs of slowing growth have already begun to emerge, as global headwinds will be a drag on the country’s economy. As in Indonesia, the trade sector in Malaysia too is weakening. Export volumes registered a 17.4% y/y decline in the month of April, with exports of electrical and electronic products (key export commodity) declining by 6.4% y/y. The merchandise trade surplus nearly halved (declining by over 45% y/y in April) to USD 12.8bn. On a cumulative level, trade surplus registered a 12.7% y/y decline in the Jan-Apr 2023 period. As the developed economies witness a slowdown, and an associated shift in consumption pattern, domestic growth is expected to soften. 

Further, as external stimulus wanes, the domestic economy is likely to experience a fall in growth for private consumption, investment and employment levels. Elevated inflation and weakening external sector have had an impact on the domestic retail trade growth, which has been trending downward. Retail trade growth dipped to 10% y/y in April, declining significantly from over 17% y/y in December-2022. Additionally, industrial output contracted by 3.3% y/y in April, lending credence to our expectation of slowing economic activity. 

On the price front though, CPI inflation has been steadily declining for the past eight months, trending down to 3.3% y/y in April, indicating that Bank Negara Malaysia’s (BNM) monetary tightening measures have begun to show results. BNM raised its benchmark policy rate by 25bps in May to 3.25%, after two meetings of holding steady, bringing it in line with our expectations. The ongoing heatwave in Malaysia, which is likely to impact food output, and spike inflation, is what prompted the central bank to carry out the rate hike. As the risk to inflation remain on the upside, we expect BNM to hold rate for the remainder of the year. The provisioning of a targeted fuel subsidy could also prompt inflation. Inflation therefore is expected to average 3% y/y in 2023, before declining to 1.8% y/y in 2024.  This should allow a rate cut in Q4 2023 and then an additional 25bps down to 2.75% in 2024.  

In the near term, given tighter financial conditions, weakening Western economies, and slowing global trade, Malaysia’s real GDP will grow by 4.4% y/y in 2023, before firming to 5% y/y in 2024. Persisting political instability (as the coalition government finds it challenging to pass legislation) will be a drag on the economy in the medium term. However, Malaysia’s prospects remain bright. The government has several megaprojects in the pipeline, which would support growth, alongside a recovery in foreign direct investment inflows.