- December 6, 2021
- Posted by: admin
- Category: Centennial Asia Insights
Highlights from the CAA Weekly Table:
Asian economic prospects improving but question marks remain over policy
- China’s rate cut shows that the economy is weaker than the authorities anticipated. Expect more easing measures, such as infrastructure spending and higher fiscal spending.
- India’s recovery continues but sustained higher growth needs a revival in capital spending which is not evident yet. The reform cycle appears to have stalled for now.
- Korea’s growth prospects are solid: expect the BOK to raise rates again. Indonesia looks set to out-perform. Despite a court ruling against it, Indonesia’s labour reforms remain on track. Malaysia is poised for a strong economic recovery while the Philippines’s prospects have also improved – so long as the omicron variant does not turn out to be deadly.
- Thailand’s heavily tourism-reliant economy is most at risk if the omicron variant spreads dangerously.
Geo-political risks: Taiwan a sticking point, not a danger point yet
- The US and Japan have issued a flurry of warnings to China not to step up aggression against Taiwan. Japan’s policy shift is particularly notable for its robust approach to China: higher defence spending and a more aggressive posture to defend against missile attacks.
- China’s strategic position in Asia has weakened as several key countries – Japan, India and Australia – have adopted a harder line towards China. Even the Philippines appears to be reverting to its traditional pro-US line. The latest Asia Power Index shows China’s position relative to the US weakening for the first time in years.
- These reverses could persuade China to review its approach. It might take advantage of forthcoming talks with the US to adopt a less provocative approach to its neighbours.
Covid-19: Omicron variant fuels uncertainty moving into 2022
- Under our baseline scenario moving into 2022, we expect global growth to ease a notch, but remain highly supportive of Asian economies, thanks to solid demand for manufactured goods and commodities, as the bevy of PMI figures goes to show.
- That has not changed, in spite of the emergence of the Omicron variant, which, anecdotally, appears to be more transmissible but less deadly. The incessant rise in caseloads and hospital admissions in South Africa serves as a foreboding of things to come for Asia.
- We outline two extreme scenarios, centred on the differing transmissible, mortality and resistance to vaccines. But there is reason to be upbeat, given that viable vaccines and prospective treatment options are in the pipeline. The hit to economic activity has also diminished with every passing wave as the world learns to co-exist with Covid-19.
- With the Fed set to accelerate the tapering of asset purchases with an eye on raising rates in mid-2022, there are no good options for policymakers if Omicron sparks a new wave of infections, particularly in economies where vaccination rates are sub-par, such as India, Indonesia and the Philippines. Both fiscal and monetary policy are at its limits. Asia could be in for a choppy ride, as it all hinges on the epidemiological behaviour of the new strain.
Key Drivers of Asian Economies
China: what does the cut in reserve requirement signal?
Central bank cuts reserve requirements
Assessment: worried policy makers will add further support to economy
India: Signs of sequential and cyclical moderation
Activity indicators point to robust though moderating growth
The policy side is mixed
Assessment: Three downside risks to watch for
Source: CEIC. FD = Fiscal Deficit; NT = Net Taxes
South Korea: On track for policy normalisation with growth on solid footing
Assessment: South Korea to end the year on a strong note
Indonesia: Primed to outperform in 2022
Source: CEIC. Target refers to the midpoint of BI’s inflation target corridor.
Assessment: Indonesia’s prospects look good moving into 2022
Malaysia: On track for a strong finish
Assessment: 4Q21 growth should surprise on upside
The Philippines: Modest upside surprise this year
Assessment: Modest upside surprise this year
Thailand: New variant could defer recovery by several quarters
Assessment: Timeline for recovery pushed back by several quarters
Vietnam: Economy remains fragile
Assessment: New wave of infections could weigh on incipient recovery
The manoeuvrings of the big powers in Asia in recent years have increased frictions and widened the scope for these frictions to escalate into more serious confrontations. Given its strategic value and the emotion it commands in China, Taiwan is the most likely spot where such tensions could intensify and possibly trigger a clash. Whether such risks materialise will depend on the judgements China, the US, Japan and Taiwan will make. Our view is that the net effect of recent developments will be a recalibration of strategy by the main players, which should reduce the chances of a clash over Taiwan for at least the next four to five years.
The US and Japan have stepped up their warnings on Taiwan
In the past two weeks, important statements have been made by American and Japanese leaders, with a view to deterring China from stepping up actions against Taiwan.
- US officials issued a flurry of statements to warn China against stepping up aggression against Taiwan. Over the weekend, US Defence Secretary Lloyd Austin alerted US allies to the possibility that China’s air incursions into Taiwan’s air defence identification zone could be rehearsals for military operations against Taiwan one day. A day earlier, US Secretary of State Antony Blinken had warned that a Chinese invasion of Taiwan would have “terrible consequences”. But both he and Assistant Secretary of State for East Asian and Pacific Affairs Daniel Kritenbrink stressed that the US was committed to ensuring Taiwan could defend itself. While it is clear that the US is stopping short of committing US forces to the defence of Taiwan should it come under attack, these statements effectively hitch US interests more closely with Taiwan’s – and that makes it more difficult for the US to simply sit passively in the face of Chinese aggression.
- However, Japan seems keener to provide Taiwan with a clearer commitment and to send a sterner signal to China. Speaking in late November about the growing threats from both China and North Korea, Japanese Prime Minister Kishida ordered a review of Japan’s Medium Term Defence Programme as well as its national security and defence guidelines. He noted that “To strengthen defence capacity, we will not rule out options such as having enemy base strike capabilities…” For Japan, the development of hypersonic missiles by China and North Korea has undermined its security because existing missile defence defences will probably not offer sufficient protection for Japan: that means Japan would need the capacity to attack an enemy base as soon as the missile was fired. Kishida also complained about China’s efforts to “unilaterally change the status quo”. After he took over as Prime Minister, a supplementary defence budget raised total Japanese defence spending for the current fiscal year to 1.09% of GDP, the highest level in ten years. Kishida’s predecessor, Shinzo Abe, was more explicit in his remarks on 1st December. Abe said that “A Taiwan emergency is a Japanese emergency, and therefore an emergency for the Japan-U.S. alliance. People in Beijing, President Xi Jinping in particular, should never have a misunderstanding in recognising this,”
Why China might rethink its approach to Taiwan
There are a number of reasons why China may want to dial back its steadily increasing military and other pressures on Taiwan. First, these warnings by the US and Japan raise the risk for China of any unilateral move on Taiwan. Second, Chinese strategists must be aware that the past year has seen several key countries in the Asia-Pacific region become more actively concerned about China’s intentions – their responses have weakened China’s strategic position:
- India has decisively shifted against China. It has diverted military forces from confronting Pakistan to the border with China. It has also stepped up construction of roads and other military infrastructure along the Chinese border while acquiring more sophisticated weaponry such as Russia’s S400 missile defence system. India has adopted a hard stance with China in negotiations on easing tensions at their common border.
- Australia’s membership of the new AUKUS military alliance with the US and the UK is clearly directed at China.
- In the Philippines, public opinion has become more hostile to China following recent incidents where Chinese maritime militia fired water cannons against Philippine naval vessels attempting to resupply marines based on a reef that China also claims. President Duterte, despite his continuing preference for good relations with China, had little choice but to convey his “abhorrence” at the Chinese move in an ASEAN summit meeting with Chinese President Xi Jinping. The pro-American factions in the Philippines defence and foreign policy establishments have now been emboldened to push for closer ties with the US.
China’s setback was evident in the latest edition of the Lowy Institute’s Asian Power Index (see charts below). The report finds that “China’s comprehensive power has fallen for the first time, with no clear path to undisputed primacy in the Indo-Pacific.” The US has reversed its recent decline and gained on China in some key areas.
Looking ahead: US-China talks could be an opportunity for a temporary relief to rising tensions
Given the setback to China’s strategic position and the need to maintain external peace as China tackles its economic difficulties while preparing for the landmark 20th congress of the Chinese Communist Party, China could be more accommodating during forthcoming talks on strategic issues with the US. These talks could serve to produce a broad agreement between both big powers not to undertake actions that might be destabilising in Asia. The pause in rising tensions might only be temporary but it could buy time for future agreements that would build a more durable modus vivendi in Asia.
Covid-19: Omicron variant fuels uncertainty moving into 2022
Under our baseline scenario for 2022, we expect global growth to ease a notch, but remain highly supportive of Asian economies, thanks to solid demand for manufactured goods and commodities. That view has not changed despite the emergence of the omicron variant: as far as we can tell from current information, the omicron variant appears to be much more transmissible so infection numbers are likely to rise. But it also seems to be less deadly compared to the Delta variant. It also appears that high vaccination rates do offer protection against the variant causing severe illnesses. Add in the new drugs and therapies that are able to significantly reduce the dangers associated with the covid virus and we remain of the view that – omicron notwithstanding – the broad thrust of economic recovery is likely to continue.
A recovery that is broadening out across Asia
First, the current situation in Asia. The recently released purchasing manager indices (PMI) (Table 1) affirm our view for a strong finish to the year, as Covid-19 comes under control.
- Recovery is still strong, but the pact of recovery in Asian economies is starting to somewhat ease. India is the star performer, posting a strong 57.6 headline PMI in November, up from 55.9 in October. Japan (54.5), the Philippines (51.7), Malaysia (52.3), Vietnam (52.2), and South Korea (50.9) have all posted further expansions, but the rate of growth is rather marginal. Taiwan (54.9), Indonesia (53.9), Singapore (52.0) and Thailand (50.9) have posted weaker expansions, and Myanmar (46.7) trails the region with a contraction (albeit still an improvement from October).
- China’s manufacturing sector seems to be gaining steam – but only in the larger firms. China’s Caixin PMI (49.9), which is a gauge for the private sector, continued to post lower than the NBS measure (50.1), dipping into a contraction this time. It suggests that the large, government-backed, state-owned firms are performing better than the smaller players.
- Foreign demand decelerating: 5 out of 12 monitored Asian economies posted a contraction in new export orders – only Singapore and South Korea posted expansions. India, Vietnam, and Taiwan were positive, but eased, with Taiwan still managing to post a strong performance as well. Other economies cited raw material shortages and the lack of orders behind the contraction amid the global shortage of goods and workers.
- Manufacturers are feeling cost pressures. Out of the 12 observed Asian economies, 9 face accelerating input prices. China, Myanmar, and Singapore also experienced higher input prices, but its growth rate slowed. Notably, Beijing’s efforts to manage raw material shortages are paying off. The NBS index showed input charge decreasing from 72.1 in Oct 21 to a mild 52.9 in Nov 21. Output charge actually posted a contraction of 48.9 in Nov 21, significantly lower than Oct 21’s 61.1. On factory gate prices, all 12 economies posted higher prices, although only 8 posted an faster figure in November, compared to 11 in October.
- Instead of just raw materials, wage pressures seem to be increasing as well. Myanmar, Vietnam, Singapore, Hong Kong, Philippines, and Malaysia have all reported some staffing issues, labour shortages, or wage pressures. 8 out of 12 observed Asian economies have also noted dips in employment levels. Skilled labour in particular seems to be an issue for manufacturing firms, especially in Singapore and the Philippines.
In short, there has been a cyclical moderation in Asia’s manufacturing PMI, but the fact remains that every economy (save for conflict-ridden Myanmar) is still in expansionary territory. It helps that caseloads have practically collapsed in large economies such as India, Indonesia and the Philippines, while relatively elevated vaccination rates provide a key source of comfort for those that are experiencing fresh waves of infections such as Vietnam and Korea.
Taking stock of Asia and Covid-19 – Where things stand
Before delving into the Omicron variant and its implications, it is prudent to take stock of the Covid-19 situation on the ground for Asian economies. A summary of the new restrictions induced by the variant is listed below:
- Broadly speaking, caseloads have trended downwards for most economies, save for South Korea and Vietnam which are combatting a fresh wave of infections. On a related note, the second column seeks to provide a more dynamic picture of caseloads, since daily caseloads only offer a static picture. Nevertheless, Korea (1.0) and Vietnam (0.8) stands out on this count, as caseloads are near or have broken fresh records.
- But death rates have been relatively low in Asia. Taiwan’s (5.1%) death rates appear to be uncomfortably high vis-à-vis the other Asian economies. Given Taiwan’s well-managed healthcare system, more likely than not, Taiwan’s underperformance on this count probably boils down to the accurate and comprehensive testing by the authorities, culminating in more statistical precision over the cause of fatalities. That said, Singapore’s death rate (0.3%) is the lowest in the region, thanks to stellar healthcare facilities in terms of quality (and less so on quantity when it comes to hospital beds). Given the rigorous testing by the authorities, the figure probably puts a floor on the actual death rate from Covid-19.
- Vaccination rates in the region are clearly converging on the 80%-threshold believed to confer ample protection on large swathes of the population, particularly those unvaccinated either by choice or necessity, from severe illness. Indonesia, the Philippines and India, which were laggards on this front, are playing catch-up while Vietnam, Thailand and Taiwan should be able to hit 80% as soon as 1Q22, supply permitting.
The Omicron variant – more questions than answers
With this backdrop in mind, the emergence of the new variant has fuelled uncertainty over the outlook for the global economy as well as monetary policy. At this point, there are more questions than answers, and we list the key parameters for the Omicron variant, before delving into two tail scenarios.
- The variant appears to be more transmissibility: Anecdotal accounts imply the new variant is exceedingly transmissible, compared to the Delta or previous strains of the coronavirus. Both caseloads and hospital admissions have risen faster than the Delta variant, and scientists have affirmed that Omicron is driving South Africa’s fourth wave at the moment. Estimates suggest the new variant will eventually account for more than half of all Europe’s caseloads in the coming months.
- But Omicron appears to be less deadly: The vast majority of caseloads in South Africa show few or no symptoms, reports suggest. But this has to be taken into consideration in tandem with the country’s demographic and genetic profile, which may differ compared to, say, an aging economy such as Japan or Singapore. Worryingly, reports point to a “sharp rise” in admissions of children under 5 years old, which, if true, could make a serious dent in consumer confidence.
- Risk of reinfection: While it is unclear if the new strain could evade vaccines, the multitude of mutations centred on the spike proteins – 32 out of 50 – has raised the prospect of re-infection. If true, this would be bad news for the poorer and developing parts of Asia, where the healthcare capacity was less-than-stellar to begin with. India and Indonesia’s harrowing experience of successive waves of infections comes to mind. Scientists have hypothesised that the Omicron variant would probably override protection by antibodies (i.e. protein molecules), but not that of T-cells (white blood cells). This has implications for the flurry of novel treatment options in the pipeline, as we detail next.
Clearly, it is not all doom and gloom, with some glimmers of hope as the scientific community learns more about the novel coronavirus.
- Start with the obvious – viable vaccines are available and governments are already delivering booster shots to ringfence the vulnerable segments of the population from Covid-19. In fact, it is demand that is the binding constraint across the world, such as anti-vaxxers who remain fervent holdouts. Even South Africa, which was ground zero for the new variant, turned away vaccines as early as late-November because of a flagging inoculation drive just before the new variant emerged.
- Besides, mRNA vaccines can be easily re-configured to address future mutant strains: Pfizer and Moderna have assured that their flagship messenger RNA vaccines can be retweaked in a matter of months if they so seek. It is this expeditious quality that sharpens the contrast with the traditional adenovirus vaccines manufactured by AstraZeneca and Chinese firms, which takes significantly more time to grow the cell cultures.
- Things do not happen in a vacuum, as economic agents learn to co-exist with Covid-19: As economic agents update their information set with every successive wave of infections, this limit the economic damage wrought by the coronavirus and its mutant variants. The shift to e-commerce, and the growing digitisation drive, are some of the ways in which Covid-19 has expedited longstanding shifts that were already ongoing prior to the pandemic. The view is that stringent lockdowns are a thing of the past, so long as hospital and healthcare systems can withstand and weather the transitory rise in caseloads. If so, lockdowns and restrictions that disrupted supply-chains are unlikely to be repeated again.
- More treatment options should be available soon, further blunting the threat posed by Covid-19: As we mentioned previously, the missing ingredient in the fight against Covid-19 lies with viable treatment options. Even here, this is a distinction with a difference. Treatments that target the antibodies on the spike protein – these are made by Regeneron and Eli Lilly -will probably be less effective. On the other hand, treatment options that target the underlying enzyme key to the replication of the coronavirus will work regardless of the mutations – this apply to both Pfizer and Merck’s antiviral pill, though the downside is that both have to be administered within days of infection to be effective at keeping severe illness at bay.
We should stress that there is still a lot the scientific community does not know about the Omicron variant (i.e. the unknown “unknowns”) till it circulates more widely in the general population. In that vein, governments’ effort to stop or restrict international travel will probably buy them time to get protocols in place and prime healthcare systems for the new strain. But it also means it will take weeks or even months before scientists can get to the bottom of what it really means in terms of transmissibility, fatality and the prospect of vaccine resistance. Next, we sketch out two scenarios consisting of both tail outcomes – the optimistic and pessimistic view.
Optimistic Scenario – Business as usual and recovery continues without a wrinkle
Under this scenario, it is assumed that the virus is no more transmissible or resistant to vaccines vis-à-vis the dominant Delta strain. This will be in line with the evolutionary behaviour of viruses: to be less lethal, but more infectious so as to proliferate and propagate itself between hosts. Caseloads will probably rise sharply across the world, but come down as quickly, as the experience of the Delta variant illustrates. Assuming the variant is less deadly, governments, fully aware of the trade-offs between lives and livelihoods, eschew harsh lockdowns to keep economic activity going. The global economic upturn continues uninterrupted for the most part, and external demand for Asian manufactured goods remain robust.
In this setting, the Fed doubles down on its normalisation of monetary policy quite literally, starting with the dialling back of asset purchases, ending the program in March 2022, as opposed to June 2022. With inflation running way above the Fed’s 2% target, the central bank proceeds to tighten the monetary spigot with the first rate hike in June, followed by two more rate hikes in September and December. Asian currencies will probably wobble somewhat, as rising US yields trigger a bout of capital outflows and risk-off appetite. The Philippine Peso and Indian Rupee will probably be most at risk (Indonesia Rupiah less so, given the low foreign ownership of government securities as the mitigating factor).
Pessimistic Scenario – variant is resistant to vaccines, bringing the world back to square one
Under the downbeat scenario, the new variant is resistant to vaccines and antibodies, implying that past immunity cultivated by prior infection is next to useless. In effect, this brings the world back to square one, as economies have to go through the gruelling cycle of the rise-and-fall of caseloads. In this setting, vaccine makers will have to reverse course quickly and engineer a variant-specific vaccine, which is something they have refused to do, given the associated risks of putting all their eggs in one basket as well as the perpetual non-zero probability of future mutations down the line. It may take Pfizer and Moderna months before they can ramp up production, which implies the world is left in an awkward limbo as governments seek to maximise the roll out of booster shots in the interim. In the meantime, governments will lift up their drawbridges and put a stop to international travel, in effect gutting the tourism industry once more.
In this setting, governments will re-impose harsh lockdowns and restrictions, chilling economic activity and wiping out price pressures at one go, derailing the Fed’s timeline for monetary normalisation. The world’s lender of last resort will have no choice but to reverse course and embark on more extraordinary measures such as pumping more liquidity to safeguard global financial stability. This also provides the necessary cover for other emerging market peers to do the same. Governments will contemplate with more fiscal stimulus to tide their economies through this rough patch. Under this scenario, the USD will strengthen amid the flight to safety (i.e. the starting point of what is known as the Dollar smile), and all Asian currencies will be hit by capital flight and portfolio outflows.
In all likelihood, our baseline scenario veers closer to the view espoused by optimists, and the reality is likely to fall somewhere in between. What is key here, is the ability of Asia to manage the inevitable wave of caseloads. Recall the false sense of calm in India, when caseloads practically collapsed in February 2021 before rearing its ugly head two months later.
Preliminary studies peg the relative risk of reinfection for the Omicron variant at 25%, double that of the Beta variant (12%) or even the Delta variant (9%). In other words, the mutations imply natural immunity will not count for much, leaving vaccination rates to do the heavy lifting. As such, economies where the rate of inoculation are way off the 80% required to keep deaths to a minimum, will be most at risk – this is particularly true for India, Indonesia and the Philippines. When push comes to shove, policymakers in the trio may be left with no choice but to re-introduce restrictions that hit economic activity and defer the recovery to 2H22 or 1H23 at worst.
Policy Implications – No good options for Asia if caseloads surge
First, there is simply less policy space for Asian central banks to cut rates again without imperilling currency stability if caseloads revive with a vengeance. Save for Korea, policy rates are at record-lows across Asia, with little room to dig further into the unconventional toolkit, unless the Fed provides cover by doing the same. All eyes are now turning to the G3 central banks, particularly the Fed, which will convene for the final meeting in mid-December; prior to that, November’s CPI print for the US will be released on coming Friday. Our view is that the Fed will accelerate the tapering of asset purchases and bring forward the end of the program by March/April 2022, leaving the Fed with a clear pathway to raise rates, if it so desires.
To be sure, this hinges on the impact of Omicron on the US economy and global supply chains. But if the new strain proves to be more transmissible but less deadly, as is the consensus’ view, the Fed will likely persist with its plans for normalisation, particularly after a jobs report that pegged the unemployment rate at 4.2% with just 3.9 million unemployed workers, down from a crisis peak of upwards of 20 million. In this instance, central banks in Asia would be hard-pressed to keep conditions accommodative even as the economy feels the chills of a new wave of infections. Policy dilemmas and the trade-offs involved would be extremely salient.
Second, highly-indebted governments may have to resort to further fiscal largesse. Taking the cue from the US, Asian governments went on a spending spree to shore up growth and doled out fiscal largesse as far as possible to enforce social distancing measures and keep workers at home. Fiscal deficits and debts have ballooned across this region and elsewhere (see Charts 1 and 2), with some going so far as to amend the laws just to permit a temporarily relaxation of budgeting rules (e.g. fiscal cap in Indonesia, escape clause in India, debt ceiling in Vietnam, Malaysia and Thailand etc).
This time is different, however. The mood in the US has clearly moved on from another massive relief package, particularly with inflation on the up-and-up. Governments in this region are also thinking of life post-pandemic. Singapore and India, which will table their budget in February 2022, will outline plans for fiscal consolidation moving forward. Indonesia has approved a set of tax reforms that will enable it to keep the deficit under the 3% cap by 2023. If Asia were to be buffeted by a new wave, governments will no good options to keep economic activity going with public purse-strings ravaged by previous waves of infections and depressed economic activity.
There is considerable uncertainty over the landscape for global growth and inflation. On the one hand, chilling activity from future lockdowns will dampen price pressures. But it also exacerbates the shift in spending from services to goods, straining supply chains further. Workers, wary of contracting Covid-19, stay away from their workplaces or quit en masse, entailing significant shortages in the labour market.
It all hinges on the epidemiological behaviour of the new strain. Going by the experience of South Africa with the new strain, which is confronting a fourth wave of infections, and the implications for Asian policymakers are clear – fiscal and monetary policy are already at its limits, and raising the vaccination rate will be the most cost-affordable option to mitigate the fallout from the new strain.
Table 2: Summary of new restrictions spurred by Omicron variant