Asia/Pacific (ex-China/Japan) Outlook: Asian Powerhouses Lead Post War and Post Pandemic Growth

Our Forecasts

Source: Continuum Economics

Risks to Our Views

Source: Continuum Economics

Regional Dynamics: Worsening External Demand To Be A Drag 

Slowing global trade and global economic growth will be drag on Asia’s growth story in 2023. Waning global demand for Asia’s key exports, especially for electronics will see the external sector stimulus wane, which was instrumental in driving post-pandemic recovery in Indonesian and Malaysian economies. However, given elevated inflation in the U.S., softer demand from China for commodities and slowing growth in Europe, export growth from Asia will dip through most of 2023. Slowing real growth in the U.S. and EU will be a drag for the region’s economies – as the two regions are Asia’s largest markets. China re-opening is expected to provide some support, but will not be enough to completely offset the trade slump. Recent export data shows a slowing trend since October (Figure 1).  One positive for these countries would be the continued improvement in the tourism sector, which is expected to support services exports and may partially offset the dip in goods exports. These economies will see an increasing number of tourist arrivals from Russia, and other Asian economies. 

Figure 1: Export Earnings Growth (% change value, y/y)

Source: Datastream, Reserve Bank of India, Bank Indonesia

Stubborn Inflation To Constrain Growth 

The start of 2023 has been a disappointment for Asian economies on the inflation front. Several Asian economies including India and Indonesia experienced higher-than-expected inflation in the past month or two. The most significant upset came for Australia, where monthly inflation rate rose to 7.8% y/y in the quarter-ending December 2022. Meanwhile, in India too inflation reversed its three-month downward trajectory of the last quarter of 2022, and trended upward to beyond the central bank’s upper target range of 6% in January and February. Indonesia showed a similar trend, driven primarily by elevated food prices; inflation accelerated to 5.5% y/y in February. Only the Malaysian economy saw no pick up in headline inflation, but continued to exhibit a sustained price growth. Containing price growth amid a volatile global environment will be a challenge for these economies, and will see policy divergence across Asia. Given the myriad causes for the persistence of high consumer prices across Asia, there is no single policy remedy or likely course of action for these economies in 2023. Central banks though will expect that the lagged effects of 2022 tightening will feedthrough with base effects to bring inflation down.  India is likely to hike its rate again in the second quarter of 2023 and hold until early 2024, while Indonesia has signaled the end of its rate hike cycle. Meanwhile, Malaysia is likely keep a hawkish bent and ensure a more calibrated approach in line with moving macroeconomic fundamentals. 

Figure 2: Consumer Price Inflation (% y/y)

Source: Datastream

Sign Of Fed Tightening Ending Provide Buttress

Amid the continued persistence of inflation in the U.S., the Federal Reserve has been raising its benchmark interest rate. Although signs of the Federal Reserve slowing its tightening have been observed, the last of the rate hikes is yet to come (here). Given the U.S.’s role in the global financial system, this has resulted in capital outflows from emerging markets, and some weakening of currencies. However, the capital flows remain volatile, and as seen in India’s case the foreign institutional investment flows have been alternating between net sales and buys for the past two quarters. A positive though for Asian economies is that the rate hikes were expected and have allowed Asian central banks to tightening but not be the same magnitude as the Fed. Indonesia is choosing to err on the side of caution, and has not raised its policy rates in line with the Federal Reserve. Bank Negara Malaysia is also likely to now change focus to prioritizing growth over inflation. Should consumer prices moderate by mid-2023, in line with our expectations, the current levels of monetary tightening in these countries should prove adequate, or even a little excessive. Therefore the prospect of rate cuts in the latter half of 2023 and early 2024 have risen. However, given the risks from evolving geopolitics and extreme weather events, further price shocks cannot be ruled out, and could prompt rate hikes. The end of the tightening cycle in the U.S. will allow for greater flexibility in Asian economies, which hiked rates not only to curb domestic inflation but also support their currencies. As the USD weakens, these economies are likely to see some inflows and currencies gains, which will provide a buttress to the regional economy. 

Figure 3: Benchmark Policy Rate (%)

Source: Datastream

Fiscal Impetus To Drive Growth

Dipping external sector stimulus, and expectations of elevated price pressures eating into consumption will see Asian governments employ an expansionary fiscal stance to support growth. With national elections scheduled in Indonesia and India in 2024, the 2023 budget is the last full budget ahead of the elections and will focus on showcasing the governments in the best light. The expansionary stance is also expected to at least partially offset the fallout from the global slowdown. Although an expansionary stance will inhibit the monetary policy from delivering its full impact. With Malaysia’s unity government wanting to score big ahead of the six state assembly elections, the fiscal prudence is likely to be compromised. India’s latest FY24 budget also focusses on a high capex environment, which is directed to drive economic activity. With a 33% y/y increase in capex, India is focusing on improving its digital and transport infrastructure. Meanwhile, Indonesian government is targeting reducing fiscal deficit to below the 3% of GDP ceiling, with the spending set to fall by 4% y/y after a record high allocation in 2022. 

India’s infrastructure transformation fuels economic growth in 2023

India’s economy has begun to show early signs of losing growth momentum. Real GDP growth in the fourth quarter of 2022 slowed to 4.4% y/y. Private investment strengthened marginally during the quarter, while an 11.3% y/y increase in fixed capital formation drove growth. Private consumption weakened as elevated inflation drove down demand. As net exports diminished and consumer spending moderated, the authorities appeared to be re-arranging priorities and a growth focus returned to the forefront. Indian government expects real GDP growth to slow to 6.5% y/y in FY24, down from an estimated 7% y/y in FY23. While the loss in momentum is aligned with our view, the government forecast appears over-ambitious for now. Our expectation is that India’s growth will weaken to 5.7% y/y in FY23 (April 2023-March 2024). 

The early arrival of summer across North India is likely to dent agriculture output in the first half of 2023. The forecast of an adverse El Nino effect also lends credence to our expectation of a slight slowdown in output during the year. Manufacturing will see a massive push from the government with production linked schemes devised to support export oriented sectors boosting output and private investment. Additionally, business sentiment remains positive in India despite slowing global growth mainly on account of robust domestic growth. However, a key concern for the Indian government has been the slow recovery in rural demand, which continues to lag behind pre-pandemic 2019 levels on several fronts. As a consequence, the government’s focus in 2023, ahead of the up-coming elections will be to boost the rural economy, as it is a huge vote base and to ensure growth momentum. The latest budget focusses on infrastructure development – mainly transport, digital and rural infrastructure. The 33% y/y increase in capex to INR 10tn alongside allocations for the green hydrogen sector, renewable energy, transport and digitalization will drive growth in 2023. Even so, the authorities are conscious of waning urban demand as prices prove sticky and costs of borrowing rise (in line with increasing interest rates), and therefore, are seeking to support growth through fiscal measures. Services sector will be supported by the continued recovery in travel and tourism. India’s has been investing in its aviation sector given the travel boom in the post pandemic era. Trade, hotels, transport, and communication services recorded a 9.7% y/y growth in the fourth quarter of 2022. 

While India’s growth forecast is stronger than its regional peers, the country will continue to face twin deficits – current and fiscal accounts. The government has set a fiscal deficit target of 5.9% of GDP for FY24 to ensure progress on fiscal consolidation. However, in our view, the government is likely to miss it given increased fertilizer subsidy, a continuation of the free food grain scheme, low excise duty on crude and increase expenditure on populist policies ahead of the budget. While the expansionary stance may support growth, it threatens to derail India’s progress on the fiscal front, as the government has made little headway in its privatization and disinvestment plans. Revenue collection is predominantly supported by increased indirect tax collections (which may dip should the economy slow down). 

Weakening external sector too is going to be a drag on the economy. Waning external demand alongside the pressure on the INR from a widening current account deficit will be a concern. A positive though are the moderating crude prices and the deep discount on Russian crude import, which will be supportive of the sector. Furthermore, India’s signing several free trade agreements, the latest with the UAE, which will boost exports over the medium term. India’s exports to the UAE are expected to touch US$ 32bn in FY23. On the monetary front, price pressures will ensure that the Reserve Bank of India continues to prioritize inflation taming. However, growth prospects are no longer on the back foot and will also weigh on the central bank’s decisions. We expect another 25 basis point rate hike in April, before the RBI decides to pause and then subsequently cut rate in small quantum in early 2024. 

Figure 4: India Inflation and Policy Rate Trajectory (%)

Source: Datastream

Overall though, the medium-term prospects for India even with growth slowing to 5.7% y/y in FY23 remain bright. The risks are tilted to the downside, especially with the banking sector in the West experiencing turbulence. But given India’s banking sector remains robust and well-capitalized, any impact from the crisis would be limited. The country remains a favorite destination for foreign investment, especially given expectations of a strong government push for growth, policy continuity (Prime Minister Narendra Modi likely to be re-elected with majority in 2024), a favorable business climate and robust domestic demand. 

Australia: RBA to End Tightening

Resilient domestic demand, favourable commodity export prices and a tight labour market mark the cornerstone for a healthy Australian economy in 2023. The health of the Australian economy gave RBA some breathing room to balance between tackling inflation and further tightening financial condition too much. The pent-up demand built in the COVID era had been fully released into private consumption as the household saving ratio fell to 4.5% from double digits in 2022. Falling real wages will weigh on consumption in 2023 after further depletion of saving as wage inflation has been slower than estimated. However, the re-opening of Australia has also brought back international tourists and is supporting private consumption. Overall, though private consumption would remain positive, it would be showing signs of weakness after Q2 2023. 

Global demand for Australian commodities is solid and the resumption of Chinese economic activity in Q2 2023 would provide more wind to the sail. Australian trade balance is AUD 11,688Mn for January 2023 despite import outpacing export with a double digit jump in consumer and capital goods. The trade balance is expected to grow at a healthy pace in 2023 with Chinese demand recovering after the messy reopening. Additionally, geopolitical tension (i.e. diversifying away from Russia) remain supportive for the Australia mining industry and thus export growth is solid. The drag on the economy will come from residential investment, which is being hurt by the fall in property prices and higher mortgage costs. Overall, we look for a moderating 2.2% GDP growth in 2023 and further slows to 1.7% in 2024 as the cumulative impact of tightening would feed through the economy and limit the Australian economic growth.

Inflation looks to have peaked by year end 2022 and we forecast headline CPI to begin moderating in Q1 2023 and accelerate the fall throughout the year of 2023 before flatting out in 2024. We expect supply chain disruption to be resolved and global monetary tightening being felt so 2023 CPI would be slowing to 5.8% with a further fall to 2.8% in 2024. RBA has revised the inflation numbers higher for 2023 and is now expecting inflation 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 has begun correction as interest rate led mortgage rose and the potential fallout would bind RBA’s hands from further aggressive tighten in 2023. Wage inflation is being outpaced by CPI inflation at the moment despite tight labor market at maximum capacity. RBA is forecasting such to slow in Q3 2023, seems to suggest it will not consider stronger wage inflation a tightening factor for now.

The RBA is being data dependent in policy decision as we see how they swing between dovish/hawkish stance in the past two meetings. They are also trying to balance inflation and the Australian economy by tightening only when deemed necessary. 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 rates 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 3.75% in Q2 2023 before pausing their tightening steps 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: Private Consumption To Lift The Economy 

Keeping in line with the rest of the region, Indonesia's real GDP growth is also expected to moderate but still post solid growth; real GDP growth will decline from an estimated 5.3% y/y in 2022 to 4.6% y/y in 2023. Challenges to Indonesia’s growth remain high stemming from diverging policy focus. The government is likely to focus on populist measures ahead of the 2024 elections, while price stability will dominate Bank Indonesia’s moves. BI expects Indonesia to clock a growth rate of 4.5-5.3% y/y in 2023 on the back of sustained private consumption, investments and exports. However, our view is that elevated inflation in the first half of 2023 will undermine private consumption, while lower global demand will weigh on the export sector stimulus. Consequently, we expect growth to come in at the lower end of target range. 

Investment in Indonesia’s downstream metal processing sector will be supportive of growth over 2023 and the medium term. China re-opening will see some increased commodity demand, which is expected to provide a boost. High level of commodity prices in 2022 were supportive of business expansion and this is likely to push industrial investment in 2023. A tourism sector recovery is in full-swing and given China’s reopening, the sector is likely to outperform. Services rebound together with fresh private investment will help offset monetary tightening fallout. Furthermore, the Omnibus Law on job creation will also boost investment through a construction and mining activity push. As the exports push fades, Indonesia’s trade surplus will diminish over 2023. Early signs of the slowdown have begun to emerge, as Indonesia’s export growth has weakened. Moderating prices of coal and palm oil, which continue to decline substantially from their 2022 highs will result in lesser export earnings. Overall though, the trade surplus continued to rise in February, it was mainly reflective of a smaller import bill. 

Figure 5: Indonesia Current Account (in US$ bn)

Source: Bank Indonesia 

Inflation is expected to remain beyond Bank Indonesia’s 4% target range for most of 2023 and will be driven by food and fuel prices. Moderating global commodity prices (especially fuel) will help ease price pressures, alongside the rate hikes brought in by BI. As inflation moderates, a pick-up in demand will support growth. BI is confident that the current level of policy rate is adequate to rein in prices and therefore has signaled the end of its tightening. We are of the view that more hikes are unlikely unless prompted by sticky core inflation or another price shock. BI will likely cut rates in early 2024 to support domestic investment activity. Further, expected weakening of the USD in H2 2023 alongside modest trade surpluses will be support of the IDR and provide BI with enough room to retain interest rate at the current 5.75% level. 

Figure 6: Indonesia Inflation, Core Inflation and Main Policy Rate (%)

Source: Datastream

Following these dynamics, it appears that Indonesia will see robust growth in 2023, but challenges will persist. While the external sector boost will no longer be available, domestic consumption should offset some fallout. There is a small risk of weaker exports resulting in current account moving into the negative territory towards Q3 2023. This could add some pressure to the IDR. 

Malaysia: Electronic Exports to Sustain Momentum 

Our forecast for Malaysia indicates that real GDP growth will decelerate from 8.8% y/y in 2022 to 4.3% y/y in 2023. The deceleration is likely to result from a sluggish global economy. China, Malaysia's leading export partner, will see a recovery in economic activity during the year, and thus exports are likely to see some support. Recent trade data indicated that unlike its regional peers, Malaysia saw a rise in exports. Merchandise trade exports experienced a 9.8% y/y growth in February, accelerating from January's growth of 1.4% y/y. The recent increase in merchandise trade exports in Malaysia, particularly in the month of February, is a positive sign for the country's economy as the external sector is a significant driver of economic growth. The data indicates that the manufacturing sector, particularly the electrical and electronic products and petroleum products segments, contributed significantly to the growth in exports, offsetting the decline in agricultural products such as palm oil and its derivatives. An inflow of tourists from China will see Malaysia’s services boost. 

However, a decline in the economic growth will also be driven by the impact of monetary policy tightening, which will weigh on local activity and private investment.  Additionally, subdued business environment in the West, and a slow recovery in China will see Malaysia’s industrial sector slow down, as overseas orders take a dive. Higher costs of borrowing and higher operating costs will also be a drag on the manufacturing sector during the year. 

On the inflation front, headline inflation will ease from an average of 3.4% y/y in 2022 to 2.8% y/y in 2023. The government is likely to keep in place fuel and electricity subsidies in 2023, as several state elections are lined up and therefore utility prices will remain low. Food prices could stoke inflation over the course of 2023. A targeted fuel subsidy withdrawal could see headline inflation pick-up, but the chance of this being passed by the government remains low. Bank Negara Malaysia will sound hawkish over 2023, and employ a calibrated approach. Price stability will remain a focus for the most part, but in our view only one small rate hike of 25 basis points to 3% is likely over the next quarter, but cumulative tightening has been less than the Federal Reserve’s. There is little potential for rate cuts in 2023 even if global economic conditions deteriorate as the policy rate will still be at levels with the pre-pandemic 2019 level, rather than restrictive. The current monetary policy conditions are deemed to be accommodative by the BNM, and therefore rate cuts are ruled out for 2023.