Asia: Will Global Growth Engine Outperform?

28 May 2023

The IMF’s recently released global forecast highlights that Asia will be the only region to experience stronger economic growth this year relative to 2022. Likewise, the Asian economy will outperform all other regions both this year and in 2024 (Chart above). Indeed, the following Chart indicates that Asia will account for over 70% of global growth in 2023.

Asia’s superior economic performance, however, has not resulted in financial market outperformance. To the contrary, Asian equities again have lagged global markets (and especially the USA) in 2023 — continuing the pattern of the past decade. On a micro-level, strong GDP growth has not been translated into attractive corporate returns on investment. Slowly but surely, however, both global and regional factors finally may be falling into place for a period of Asian market outperformance over the next 18-24 months. However, investors will need be more selective than in the past: I favour Vietnam, India, and Indonesia in particular; China, Korea, and Thailand less so (See previous blogs “Vietnam: Asia’s Rising Star” and “India: Geopolitics, Climate, and Growth Risks” for more details).

Global Factors: Better, but Not Out of the Woods Yet

Asian markets tend to perform best when world-wide economic growth is strong/steady, global interest rates (US bond yields especially) are low/declining, and the US dollar is depreciating. No surprise Asian equities have suffered in recent years as US monetary conditions tightened, the dollar appreciated, and global growth faltered. Some of these factors, however, are now changing. Recently, the US Federal Reserve has signaled monetary policy will remain steady for now. And, US interest rates are likely to begin declining in 2024. As a result, I expect the US dollar will weaken during the next 12 to 24 months.

However, Asian markets are not yet out of the woods. In particular, I still anticipate a mild recession in the USA and Europe later this year, and greater global market volatility in H2 2023. Bad news for the trade-oriented Asian economy. Indeed, the Chart above illustrates the continued slump in Asian exports, reflecting sluggish global economic activity.

Therefore, Asia’s economic outperformance (relative to the advanced economies) has relied on more resilient domestic demand, especially consumer spending (Chart above). It’s worth noting, however, Asian economies are not immune to rising global energy and food prices, especially given the region’s reliance on external energy sources. And, consumer spending may have decelerated somewhat recently in some countries, although several countries have boosted food/energy subsidies to cushion households from the price shocks.. Investors, therefore, should focus on countries with large, expanding consumer markets: India, China, Vietnam, and Indonesia.

Inflation and Interest Rates are Peaking

Asian central banks have juggled the objectives of normalising monetary policy and fighting inflation, even as the weakening global economy posed risks to the region’s recovery. The chart above illustrates Asian inflation now has peaked. Slowing inflation will contribute to the recovery in domestic spending, especially by consumers. Following the Fed’s cue, most Asian central banks have now paused. And, interest rates are likely to remain steady until the end of the year. However, additional rate hikes are still possible in Taiwan, Thailand, Malaysia, the Philippines, India. China is the exception: rate cuts are possible if the post-lockdown recovery falters.

Debt Burden May Be a Headwind

During the pandemic, firms and households in several Asian took advantage of low interest rates to increase borrowing. With real interest rates now higher (and likely to rise further as inflation declines), the burden of servicing this debt will increase. Deleveraging, therefore, may become an economic headwind in several countries, e.g. China (most importantly), Korea, Thailand, and Japan. Private sector balance sheets in India and Indonesia appear stronger.

China: Post-Lockdown Bounce Versus Secular Slowdown

China’s post-lockdown recovery alone will account for over one-third of global growth in 2023, and is responsible for much of Asia’s growth outperformance this year. However, reflecting poor demographic trends and a weak productivity growth, China’s long-term growth potential is slowing towards 3% (Chart above). Countries with strong trade ties with China will face new challenges, especially Hong Kong, Vietnam, Cambodia, Laos, Taiwan, and Korea (next Chart). China accounts for a smaller proportion of trade in India, Indonesia, and Japan. Investors should focus on beneficiaries of stronger Chinese consumption: reflecting both pent-up demand and China’s long-term plan to rebalance growth towards household spending (Vietnam, Hong Kong, Thailand, and the Philippines). (For a detailed discussion on China’s secular slowdown see “China: Population Decline = Growth Headwind”).

Demographics and Population Aging

However, China is not the only Asian country confronting demographic challenges. Indeed, weak population growth in Korea, Taiwan, Japan, and Thailand will continue to result in sharply rising dependency ratios in coming decades (next Chart). The aging of the population will create challenges for labour supply and public finances. Investors should concentrate on nations with healthy population growth — India, Indonesia, Bangladesh, and the Philippines — or countries with strategies to boost productivity growth — China, Korea, and Taiwan.

Deglobalisation Risks

Concerns are growing that the globalisation trend of recent years may be reversing, or at least slowing. Indeed, in reaction to the Covid pandemic, the Ukraine war, and the Global Financial Crisis, the expansion of world-wide trade and investment flows have has slowed (next Chart). The deterioration in the US-China geopolitical relationship has added to this risk.

The consequences of this shift are not clear yet. In order to secure supply chains, will countries strengthen ties with partners closer to home, e.g “near-shoring”? Or will nations deepen ties with similar geo-political values: liberal democracies versus more authoritarian governments?

Either way, Asia appears particularly vulnerable to these shifts, given the region’s reliance on global trade and investment. Picking winners and losers is complicated. The earlier Chart illustrates the dependence of the ASEAN nations, Taiwan, Hong Kong and Singapore on expanding global trade. India, Indonesia, and Japan are less impacked on this metric. The Chart above highlights the reliance of Thailand, Vietnam, and Malaysia on foreign direct investment inflows. On the other hand, Korea and Taiwan benefit from extensive region investments. I expect intra-Asian trade and investment links will deepen in the period ahead. Vietnam, India, and Indonesia may be prefered investment destinations (combining low costs and large internal markets). The expanding Chinese consumer market will be a key regional trade/investment theme.

Climate Change: Urgent Transition to Avoid Inequality

(For a full discussion of Asia’s climate challenge and transition, see my earlier blog “Asia: Urgent Climate Action to Prevent Inequality”).

Asia accounts for over 50% of the world’s annual carbon dioxide emissions. To be sure, per capita emissions in many countries are low compared to the advanced economies. And, the region’s historical impact on world-wide pollution pales in comparison to that of the richer nations. However, emissions per person are now declining in Europe and the USA, while in Asia the level is still rising rapidly (Chart above).

The region’s strong economic growth and rising population virtually ensures overall emissions will continue to ris unless urgent action is taken. Of course, transitioning from coal to less polluting energy sources is critical (renewables preferably, although natural gas will inevitably play an important role). Improving energy efficiency will also be crucial. Without meaningful progress during the next decade, both global and regional growth prospects will suffer. Who are the biggest losers? On a national level, China, India, Korea, Japan, Indonesia, and Taiwan are the biggest polluters. However, we know that the poorest nations (and the poorest groups within every country) will be the most adversely impacted. Therefore, urgent action is needed to prevent greater inequality.

Fiscal Space: Not What it Used to Be

To be sure, Asian governments confront numerous challenges which will require assertive policy action. However, countries will differ in the their ability to respond. It’s worth noting, first of all, Asian public sector debt is considerably lower than in advanced nations, which is a relatively strong starting point (Chart above). However, all countries, rightly, responded to the Covid pandemic by increasing government spending, which has lifted debt levels. However, China, India, and Japan will require fiscal belt-tightening to stabilise government debt ratios. Indonesia, Vietnam, Korea, and Thailand face challenges, but are in a better position.

Strategic Considerations:

  • The pieces are coming into place for Asian markets to outperform over the next 18-24 months. However, as advanced economies may slip into a mild recession in H2 2023, this story may take time to emerge.
  • If the US dollar weakens during the next 12-24 months, opportunites may occur for MYR, IDR, and KRW. I am less optimistic about THB, PHP, and CNY (next Chart).