This report does not constitute a rating action.
Editor's note: Our forecasts were developed during a period of high market volatility and significant policy changes, and therefore have wider than normal confidence bands.
- We expect a largely organic recovery in China this year, led by consumption and services; our growth forecast of 5.5% exceeds the country's modest target of "around 5%."
- Other Asia-Pacific economies should slow but not stumble on weaker global growth, the receding of the benefits of domestic re-opening, and the impact of higher interest rates.
- Inflation is mostly manageable, with notable exceptions. But some central banks will need to raise rates to normalize interest rate gaps with the U.S. amid current account deficits.
We maintain our cautiously optimistic outlook for Asia-Pacific. China's economy is on track to recover this year. For other economies this will dampen but not offset the hit of slower growth in the U.S. and Europe, the fading impact of domestic re-opening post the pandemic, and higher interest rates.
We expect the region excluding China to grow at 3.8% in 2023, after 4.7% in 2022. In most economies, inflation should decline, although elevated core inflation will prod some central banks to raise rates further. External pressure from rising U.S. interest rates will likely push some others to lift rates further too.
Global Growth Risks Ease But U.S. Rates To Remain High
The U.S. and the eurozone are likely to slow significantly in 2023. We expect only 0.7% growth in the U.S. this year and 0.3% in the eurozone. This is up slightly from our November projection. Until recently, economic news and data in the U.S. and the eurozone had been favorable, on balance. But the recent banking sector turbulence is likely to weigh on confidence and tighten access to finance.
U.S. inflation is likely to decrease only gradually, and the U.S. Federal Reserve will need to raise policy rates further. The U.S. labor market is strong; unemployment remains low, and wages are rising briskly. As a result, core inflation picked up again in early 2023 on a sequential (month-on-month) basis. This makes a rapid decline in headline inflation unlikely.
We expect U.S. policy rates to increase by another 25 basis points (bps) to a peak of 5%-5.25% at the end of 2023 and to start to edge down only in early 2024. Taking into account the risk of larger U.S. rate increases, we expect the depreciation pressure on Asia-Pacific currencies to remain for much of 2023.
China's Economy On Track For Growth Rebound
We believe the recovery in China will be largely organic, led by consumption and services. Our GDP growth forecast of 5.5% this year, up from 4.8% in November, exceeds the target of around 5% announced at the National People's Congress (NPC) meetings in March. In our view, Beijing set that target at a relatively unambitious level to provide room for policy to respond to inflation or financial risks, if needed.
After the sudden removal of COVID restrictions, China quickly moved on from the pandemic, with mobility rising fast and confidence up. Better momentum in industrial production, investment and, especially, retail sales in the first two months confirmed the recovery (see chart 1).
As indicated at the NPC meetings, the authorities aim for macroeconomic policy to be supportive but not significantly expansionary. Policymakers are keen to contain macro leverage, and we would expect a swift rebound to lead to a faster policy shift toward reining in financial risk and inflation, thus limiting the upside risks to growth.
Conditions in the housing sector have brightened. Housing sales momentum improved, and house prices stopped falling in early 2023 (see chart 2). While we don't expect a V-shaped recovery, a turnaround in this important sector would help sustain growth and reduce downside risks.
Infrastructure investment growth should ease this year as policymakers aim at containing local public debt. Weak export prospects and supply chain adjustments will weigh on corporate investment. Nonetheless, following the initial bounce-back, growth should become more broad-based. Investment and industrial activity will make a meaningful contribution.
We expect GDP growth to ease to about 5% in 2024 as the post pandemic re-opening push recedes, slightly above (our estimate of) potential GDP growth, following the weak growth during the pandemic (see "China's Trend Growth To Slow Even As Catchup Continues," Nov. 9, 2022).
While China's re-opening will increase price pressures domestically and globally, its consumer inflation should rise much less than in the U.S. and Europe in 2022. The impact on global energy and commodity markets won't match that of the re-opening of the rest of the world and the Russian invasion of the Ukraine.
Domestically, most goods markets in China face oversupply, and the overhang of excess saving is smaller than in the U.S. and Europe.
China's Two-Way Risks
There are two-way risks to China's growth outlook for 2023 and 2024. After the initial bounce-back, the recovery may lose steam amid new setbacks such as housing or labor market weakness. Macroeconomic policy may turn restrictive earlier if inflation rises more than envisaged or policy focus shifts.
The key upside risk is that we underestimate the buoyancy of domestic demand following the shift in COVID stance or the vigor of the housing market. But a likely policy response would limit the upside risk to growth.
Beyond the immediate recovery it will become clear whether recent setbacks to rebalancing (to consumption and services) and import vigor are temporary, or intractable. We are cautiously optimistic, and expect "normal" imports--used in the domestic economy--to resume their growth path this year. But policy will matter, and we see risks, especially regarding rebalancing (see "The Case For Cautious Optimism On China's Rebalancing And Openness," March 13, 2023).
The Rest of Asia-Pacific Will Slow
As we expected, most economies slowed in the fourth quarter, especially the ones most exposed to slowing global trade. South Korea and Taiwan clocked negative sequential GDP growth and Singapore zero.
In India, domestic demand has traditionally led the economy. But it has become more sensitive to the global cycle lately, in part due to rising commodity exports; and its year-on-year GDP growth slowed to 4.4% in the fourth quarter.
Growth held up better in the more domestic-demand led economies of the Philippines and Indonesia, which also still benefited from the re-opening impact (see chart 3).
Even as exports have remained poor, the S&P Global Purchasing Managers' Index showed some pick-up in confidence in early 2023 across the region. A contributing factor may be China's re-opening (see chart 4).
China's recovery won't fully offset the impact of the slowdown in the U.S. and Europe on the Asia-Pacific region. But it will alleviate it. The likely acceleration in China this year is broadly comparable to the likely slowdown in the U.S. and Europe.
For Hong Kong, Taiwan and, especially, Australia, the importance of China as a final market exceeds that of the U.S. and Europe combined (see chart 5) (see "Asia-Pacific In 2023: China Rebound Cannot Offset Western Slowdown," Feb. 23, 2023). For South Korea and New Zealand, China is about as important as the U.S. and the Europe together. But for most economies the China share is smaller.
Domestically, the boost to domestic demand from re-opening economies eased toward the end of 2022. Also, still sizable inflation and higher interest rates have started to weigh on household spending power in many economies (in real, price-adjusted terms and after debt servicing). That is especially true in the economies with the largest interest rates increase: Australia, Hong Kong, New Zealand, and the Philippines.
An important part of that squeeze takes place via the housing market, as mortgage rates rise and house prices fall. Housing and other household debt is particularly high in Australia, New Zealand, and South Korea. In all, higher interest rates have the greatest effect on Australia and New Zealand. Lower household debt and generally more modest interest rate increases mean a smaller impact in most Asian emerging markets, although household debt is appreciable in Thailand and Malaysia.
Overall, we maintain our outlook for a slowdown in Asia-Pacific excluding China to 3.8% from 4.7% in 2022. The deceleration will be more pronounced in economies exposed to slowing global trade and interest rate headwinds (see chart 6). In our view, growth should pick up to 4.4% in 2024 amid better global growth and easier monetary conditions.
Notable Trends Shape The Outlook
We highlight two trends that are important for our medium-term forecast.
First, COVID-induced output losses in emerging market economies are likely to be permanent. Let's compare actual GDP in 2022 with the size of the economy along the trajectory for current estimates of trend growth since 2019. In this exercise, we see large gaps in the Asian emerging market economies, particularly in India, the Philippines and Thailand (see chart 7).
Pronounced core inflation in India and the Philippines suggests little slack in these economies. Indeed, we consider these gaps basically long-term output losses; the gaps don't close in our medium-term projections. This setback notwithstanding, these and other Asian emerging market economies remain among the fastest growing ones in our global growth outlook through 2026. India leads, with average growth of 7% in 2024-2026.
The second key trend is a shift in export market shares among Asian economies. China's share of total Asian exports held steady in 2022, despite some multinationals moving export-oriented manufacturing production to other countries. This is in large part because of rising shipments from mainly domestic supply chains (see chart 8). Indonesia, Malaysia, and Taiwan increased their share. India more than recovered earlier losses last year, while Hong Kong, Japan, and Thailand lost market share (see chart 9).
Inflation And Interest Outlook In Asia-Pacific Remains Mixed
Unlike in the U.S. and Europe, core inflation has generally been modest, in sequential terms, in the past three months. This reduces the pressure on central banks to raise rates (see charts 10 and 11) (see "Asia-Pacific: It's A Mixed Bag For Inflation And Rate Implications," Feb. 6, 2023).
China's monetary policy is likely to remain accommodative until the recovery is well entrenched. With consumer inflation likely to remain contained in 2023, the central bank should have room to hold off on tightening monetary conditions for some time.
In Japan, we expect only a modest adjustment of monetary policy later this year, following a tweak of its yield curve control (YCC) policy in December. Cost increases caused sequential underlying inflation to rise, but it has fallen to a low pace again. The Bank of Japan expects consumer price index (CPI) inflation to fall below 2% around end-2023. It also takes into account subdued global growth in its rate decisions. That means the central bank is unlikely to meaningfully tighten monetary policy any time soon. The central bank may make some adjustments to its YCC arrangement in coming months and take more time before raising its policy rate.
However, Australia, New Zealand, and the Philippines are more prone to rate rises because of elevated core inflation. Underlying inflation also regained momentum in Singapore. Core inflation tends to be driven largely by wage costs. Indeed, in Australia, New Zealand, and Singapore, unit labor costs--wages adjusted for labor productivity--accelerated in the fourth quarter of 2022 amid tight labor market conditions (this data is unavailable for the Philippines).
We expect the Reserve Bank of India to raise its already high policy rate further following a recent upside surprise to inflation. In our view, India's Consumer Price Index (CPI) inflation should moderate to 5% in fiscal year 2024 (ending March 2024) but we also anticipate upside risks, including from weather-related factors.
External Pressure Likely To Persist
A relatively benign inflation outlook doesn't necessarily mean central banks are finished raising rates. Under our forecast of a further rise in U.S. interest rates, pressure on capital flows and currencies will remain for most of this year.
This external pressure was visible in 2022 and early 2023, largely in the form of exchange rate depreciation. Asia-Pacific currencies depreciated by between 3.5% in Thailand and 13.4% in Japan against the U.S. dollar between end-2021 and mid-March. In addition, foreign exchange reserves fell in the first half of last year. While this stemmed largely from valuation changes, in India and South Korea central bank intervention added to the reduction in foreign exchange reserves.
The balance of payment developments behind the external pressure differed across the region in 2022. China's current account surplus rose, despite sharply higher energy and commodity prices. But it continued to see large net financial outflows, which we estimate rose to US$350 billion last year from US$335 billion in 2021.
The current account balances of other energy-importing economies in the Asia-Pacific have deteriorated. In India and Thailand, the external deficit reached about 3%-3.5% of GDP in 2022; in the Philippines about 5%; and in New Zealand 7.5%. South Korea's surplus shrank to 1.8% of GDP.
Looking ahead, current account deficits in these countries are unlikely to rise much, barring hefty hikes in energy and commodity prices. However, in many Asia-Pacific economies interest differentials with the U.S. are unfavorable, from a historical perspective. Financing of external deficits may face challenges as U.S. interest rates rise further. Therefore, we expect some central banks in the region to raise policy rates to normalize the differentials.
Adding up the domestic and external considerations, we expect the largest further rate increases this year to occur in New Zealand, the Philippines, and Thailand. Thai inflation has remained modest, but rates have so far risen only 100 bps since end 2021, calling in our view for further normalization.
Macroeconomic Risks To The Outlook
A key risk is that global growth slows more than we expect. Notable potential causes include a substantial weaking of the U.S. economy, for instance via major spillover into the economy of the turmoil in the banking sector, if that were to intensify. Setbacks to China's recovery would also affect the growth momentum in Asia-Pacific.
Another risk is major currency depreciation pressure. This could stem from the U.S. Federal Reserve deciding to keep interest rates higher for longer if inflation there falls even more slowly than we expect. It could also be the result of premature monetary easing in the Asia-Pacific.
The overall picture is of a regional economy at a point of equilibrium. A pick-up in China but a concurrent slowdown in the U.S. and eurozone. Core inflation likely to fall enough in most places to ease pressure on central banks. But remaining persistent enough to prompt further rate rises in some economies. Growth won't stall but it will be a slower march than last year.
|Real GDP Forecast||Change from prior forecast|
|(% year over year)||2022||2023||2024||2025||2026||2023||2024||2025|
|Note: For India, 2022 = FY 2022 / 23, 2023 = FY 2023 / 24, 2024 = FY 2024 / 25, 2025 = FY 2025 / 26, 2026 = FY 2026 / 27. S&P Global Ratings Economics.|
|Inflation (year average)|
|Note: For India, 2021 = FY 2021 / 22, 2022 = FY 2022 / 23, 2023 = FY 2023 / 24, 2024 = FY 2024 / 25, 2025 = FY 2025 / 26. Source: S&P Global Ratings Economics.|
|Policy Rate (year end)|
|Note: For India, 2021 = FY 2021 / 22, 2022 = FY 2022 / 23, 2023 = FY 2023 / 24, 2024 = FY 2024 / 25, 2025 = FY 2025 / 26. Source: S&P Global Ratings Economics.|
|Exchange Rate (year end)|
|Note: According to FX market convention, for Australia and New Zealand exchange eates are shown as U.S. Dollars per local currency unit. For all other currencies, exchange rates shown as local currency units per U.S. Dollar. Historical values are fourth quarter averages. For India, 2021 = FY 2021 / 22, 2022 = FY 2022 / 23, 2023 = FY 2023 / 24, 2024 = FY 2024 / 25, 2025 = FY 2025 / 26. Source: S&P Global Ratings Economics.|
|Unemployment (year average)|
|Source: S&P Global Ratings Economics.|
Editor: Lex Hall
- The Case For Cautious Optimism On China's Rebalancing And Openness, March 13, 2023
- Asia-Pacific In 2023: China Rebound Cannot Offset Western Slowdown, Feb. 23, 2023
- Asia-Pacific: It's A Mixed Bag For Inflation And Rate Implications, Feb. 6, 2023
- Economic Research: China's Trend Growth To Slow Even As Catchup Continues, Nov. 9, 2022
|Asia-Pacific Chief Economist:||Louis Kuijs, Hong Kong +852 9319 7500;|
|Asia-Pacific Economist:||Vishrut Rana, Singapore + 65 6216 1008;|
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