Will the global economy remain resilient and help asia?

This year has begun reasonably well in that the global economy has proven to be more resilient than many had thought possible. But if there is one theme that dominates discussions over what will happen for the rest of the year, it is how uncertain the experts are. Financial markets are pricing in rate cuts by the end of this year in the US because they think that a recession is likely there, one which could spread to other parts of the global economy. But other observers look at the same world economy and see good reasons for continued resilience – and they conclude that the international marketplace will not suffer a downturn of any meaningful scale.

The reason why there are so many contrasting narratives is because the world economy is going through an unusual cycle. As we discuss below, there are many abnormal features of the business cycle today. With little history to guide us, forecasters are unable to agree on how exactly all these myriad factors will play out and what bottom line they will produce for growth and inflation.

Still, our take is somewhat upbeat. If we lay out the known positives and negatives and make reasonable but defensible assumptions about the uncertain factors, further economic weakness is probably unavoidable in coming months, but that is likely to be followed by a recovery towards the year-end.

What are the known positive and negative forces operating on the world economy?

Our starting point is that economic activity around the world has been more resilient than feared. The OECD maintains a weekly GDP tracker that is the best indicator of the current pulse of the world economy that we can find. That metric actually shows a pickup among advanced economies after a slowdown for most of 2022. It also shows that major emerging economies such as India and Indonesia have maintained robust levels of economic activity. Surveys of purchasing managers across the globe also show recovering levels of business confidence in terms of output expectations for the remainder of the year. These surveys show that the services sectors in most major economies are expanding nicely, helping to offset the downbeat prospects in the manufacturing sector.

The world may be better than expected right now, but will that last? As a matter of fact, the traditional lead indicators are pointing to a worsening slowdown.

• The OECD leading indicator has been falling and so has the US composite lead indicator.
• That bad news is corroborated by other technical indicators such as the inverted yield curve – the yield on long term bonds being below that on short term securities.
• In addition, the outlook for the electronics sector, which is now so important to the world, remains under a cloud – inventories are building up and their ratio to actual shipments of products is at a level that in the past led to a worsening downturn. What we can glean from the statements released by tech companies during their earnings announcements is that a turnaround is likely only towards the end of this year.
• The data also shows that, outside travel and tourism, the tailwinds from the release of pent-up demand have largely played out and are not supporting global demand as they did in 2022 and early 2023. Most people have used up the excess savings that piled up during the pandemic when people were unable to spend.

But these traditional metrics may not be telling us the whole picture, for many reasons. Indeed there are many other factors at work which tend to be positive:

• China is now a much bigger part of the world economy than in previous cycles. The data through March show that China’s economy is recovering as a whole even though there are pockets of weakness, such as in real estate. More importantly, the lead indicators – such as the pipeline of new business and business confidence – tell us that the recovery will gain more momentum as the year progresses.
• Although oil prices are high by historic standards, they have fallen from year-ago levels, providing some relief to oil consuming economies. With OPEC’s recent cuts in production due to take effect, oil prices could rise in the second half of this year – but are unlikely to return to the damaging magnitudes of 2022.
• Oil exporting countries enjoyed a windfall last year and oil prices remain high enough to generate large surpluses for these countries. But it is important to point out the structural change in how countries such as Saudi Arabia and the United Arab Emirates are now spending more of their gains than before. As a result, they are recycling their profits back into the world economy and thereby supporting global demand. This is in contrast to the past where their surpluses took years to be spent.

In fact, we also see powerful secular forces that were not operating in the past and which we think will help support global demand in general, and capital spending in some cases, in the future:

• The Ukraine crisis and rising tensions in the Indo-Pacific region have encouraged many countries to commit to substantial increases in defence spending. Germany and many other European countries have done so as has Japan.
• The US and European Union are two among many other economies that are already implementing sizeable increases in infrastructure spending. After slowing during the pandemic, Asian countries are renewing their infrastructure push as well.
• The pressure to de-carbonise business operations and economies is unrelenting. That is also producing new capital spending – for example, on ultra-high voltage electricity grids needed for renewable energy, on charging stations for electric vehicles, and on windmills and solar panels.
• Advances in technology – whether in robotics or artificial intelligence or in the bio-medical area or in material sciences – are also generating compelling business opportunities and competitive pressures that are pushing companies to step up capital spending even at a time of rising borrowing costs.

What about the uncertainties and downside risks?

So far, so good. But what about the downside risks? There are indeed several areas of concern:

• We have had the sharpest pace of monetary tightening the world has endured in about 40 years. In addition, the recent turmoil in the banking sectors in the US and Europe have made banks more conscious of the risks of lending – so they are making conditions for loans tighter, deterring borrowers. Even less predictable is the lagged effect of higher interest rates – history tells us that long periods of excessively low rates and ultra-easy money leads to speculative excesses and imbalances which only appear with a lag. The housing sectors in many countries have seen huge price increases, these could well unravel and undermine confidence. There are growing fears, for instance, also about commercial real estate in the US. Others point to the massive amounts of money that have gone into private equity investments where plummeting valuations have almost certainly not been fully divulged by fund sponsors.
• While China’s economy is recovering, it is burdened by imbalances, especially in real estate. Because this sector is highly indebted, further problems there could spark off financial stresses as well. The lack of data here makes this a major source of uncertainty.
• The outlook for inflation also remains unclear. The worry is that if core inflation resists policy efforts to cool it, we could see central banks confound current market expectations and raise rates aggressively again. That could spark off nasty corrections in bond and equity markets that would undermine the global rebound.
• Finally, there is the unpredictable direction of geo-political tensions among the big powers. Just as the Ukraine war dealt a punishing blow to the world economy, there could be another crisis of similar magnitude that does the same in the future. We simply do not know.

These are material concerns which cannot be lightly dismissed. The only point we will make as a source of comfort is that policy makers have demonstrated an ability to act swiftly to mitigate the impact of totally unexpected shocks. That was seen in responses to the Ukraine war whose impact has been less damaging than it could have been. And that is also why the financial shocks that have erupted every few months in the past year have also been contained. Sure, there is no guarantee that this capacity to contain crises will always prevail but the success so far provides us with some confidence.

What then is the bottom line for our region?

In the near term, Asian economies should not count on significant support from international trade. The net effect of all the arguments above is that the global slowdown will persist through much of 2023. It will be internal sources of growth instead that will be needed to ride out in 2023. The good news is that there are several such drivers in the region:

• Infrastructure spending is being boosted: We see infrastructure spending returning to a healthy pace as countries make up for delays during the pandemic. India, Indonesia, and Thailand, among others, have allocated increased budgetary resources for infrastructure.
• Foreign direct investment is another reason for optimism: A good portion of the foreign direct investment commitments made in 2022 will start materializing this year. This region will continue to benefit from the domestic policy flaws and geo-political frictions that have undermined China’s relative attractiveness to foreign investors.
• Supportive fiscal policy: While Asian governments are unwinding the large deficits generated by the pandemic-era stimulus packages, they are doing so at a cautious pace. Cost-of-living assistance measures in countries such as Malaysia’s Rahmah initiatives and Singapore’s GST vouchers are attempts to better target fiscal resources towards intended beneficiaries, without overstimulating the economy with large-scale spending.
• The political cycle could also help domestic demand in some countries: This year and next will see a series of elections, the most imminent one being parliamentary elections in Thailand next month. Indonesia will see campaigning ramp up for presidential polls in Feb 24, while Malaysia and India will see a series of important state-level elections. In India’s case, these will end up in national parliamentary elections in mid-2024. Political motivations will thus lean towards fiscal looseness both in the period before the polls, as well as the short-term after as the new governments attempt to bolster their position.

Our outlook for specific countries varies with the degree of their dependence on global demand and the electronics cycle:

• We see China’s economic growth accelerating modestly in the coming quarters. However, more policy action is needed to manage the headwinds from the real estate sector and to boost the confidence of private entrepreneurs who remain nervous after the regulatory crackdowns in recent times.
• The larger economies such as India and Indonesia where domestic demand plays a primary role, will see their growth outlooks remaining mostly intact. There, the export slowdown, including in commodities, will play a secondary role and its effects masked by continued resilience in domestic activity.
• The export-heavy economies of South Korea, Singapore, Thailand and Taiwan will continue to suffer slowdowns. The rebound expected later this year will probably come too late to alter the dismal prospects for 2023 as a whole, though an outright recession still remains unlikely.
• The other highly-open economies such as Malaysia and Hong Kong will see a fuller post-pandemic recovery and resilience in domestic economic activity offset the slowdown in trade.