Multilateral agencies such as the International Monetary Fund and the World Bank have updated their economic forecasts of late. In most cases, caution has dominated their perspectives, pre-occupied as they are with a range of risks, from the geopolitical to financial to nature-related risks. That overhang of fear carries over to how observers perceive this region’s prospects. So, Asean’s run of relatively good news in recent months only resulted in a modest upgrade to the growth outlook for this year and next.
No one should underestimate the potential pitfalls that our region faces. However, we veer to a more upbeat spin on the region, given the growth engines that are already evident and our assessment that the potential damage from possible risks can be deflected or managed.
Asean has started the year fit, and in fighting form
Although we are barely a month into the new year, much information has come out that sheds light on how well Asean could do this year. Not only are we likely to see a robust cyclical upturn in activity, but the more important long-term structural forces are also in the region’s favour.
The purchasing manager index (PMI) survey for January and the other data that has come out tell a good story for most of the region:
Overall, the PMIs depict a picture of a global economy that is steadying, with particular strength in the US. The capacity of the US economy to overcome the sharp monetary tightening of the past year as well as the rise in energy costs and geo-political uncertainties has been impressive. Even better, this strength is set to translate into demand for the region’s exports — the PMI sub-index for US import demand soared in January to its highest level in a year. Forecasters keep saying that the lagged effects of higher interest rates will eventually slow the US economy, but that has not happened yet. In fact, the latest “nowcast” estimate of growth for the first three months of the year made by some of the regional Federal Reserve banks shows the US economy roaring ahead, with some estimates as high as an astounding 4%.
And, why not? Unemployment remains at historic lows, which will keep wages rising ahead of inflation and ensure that job security is high. Consumer confidence has therefore picked up smartly in January. Business confidence is also rising, as shown in the PMI survey — which is why more American firms have been putting in orders for new capital goods. As capital spending in the US regains strength as 2024 progresses, there will be stronger demand for the region’s electronic and other components after a short lag. Elsewhere, although the European economy is far less vibrant, it is also showing signs of stabilising, which should help this region.
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Second, the lead indicators for our region such as the new orders pipeline and business confidence measure in the PMI surveys remain generally positive — domestic demand is in good shape in most of the region. Right now, lead indicators for domestic-oriented economies such as India and Indonesia are the most robust. But the export-oriented economies are also beginning to look better. There has been a strong turnaround in new export orders and business confidence in South Korea and Vietnam, for example.
Third, the recovery is coming through as inflationary pressures are coming under control. That is important because it means that central banks in the region need not tighten monetary policy further — and can start cutting rates in most cases once the US Federal Reserve begins to do so, probably by mid-year. That should give an added boost to the region.
More evidence that the long-term structural forces also favour Asean
The United Nations Conference on Trade and Development has just released its Global Investment Trends Monitor. While generally downbeat on the world as a whole, the report had good news for Asean. The preliminary data on foreign direct investment (FDI) trends in 2023 shows Asean and India as major winners. FDI into greenfield manufacturing operations in Asean leapt by 37% last year — this is the most valuable type of foreign investment because unlike mergers and acquisitions, greenfield investments create new industrial capacity and bring in new technology and skills. The South Asian region (mainly India) saw a 5% rise, but that was still a good figure because greenfield investments in most other regions fell.
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Within Asean, Vietnam, Thailand, Indonesia, Malaysia, the Philippines and Cambodia won most of the new investments in factories. This is significant because it tells us that global companies diversifying their supply chains by relocating production out of China are now looking beyond just Vietnam: a wider set of economies will now benefit from this trend.
Another set of data provided more support for the structural story. In parallel with the trends in FDI, there has been a shift in global trade dynamics in favour of Asean. The
Asean + 3 Macro-Economic Research Office recently investigated changes in trade flows and showed how Asean exports to the US have expanded to fill the gap created by the fall in China’s direct exports to the US as a result of the anti-China trade policy in the US. At the same time, China has also stepped up its imports from Asean, so much so that Asean is now China’s single biggest source of imports. While growing their trade links to the region, Chinese companies are also expanding their production footprint in the region. Chinese FDI into Asean has risen, although much of this was skewed towards Vietnam.
How concerned should we be about the risks?
When economists talk about proliferating risks, what they are really saying is that they fear that the extraordinary resilience we have seen in the US and global economy since the pandemic ended cannot last. But our counter-point is this — it is not enough to just enumerate the risks. We also need to look at the probability of the risks materialising.
And we also should estimate the impact that these risks will really have on our region.
If we think through the likelihood and impact of these major risks, we find that while they should not be under-estimated, they need not be so frightening, at least insofar as the easily identifiable risks are concerned:
The first concern for many forecasters is the lagged effect of the higher interest rates and tighter monetary conditions we have today. There will be individuals, companies and countries that took on too much debt assuming that rates would remain low for much longer. There are also likely to be investors who were duped by overly easy liquidity into speculative or risky investments that are likely to fall apart now that the cost of funds is higher. In the US, commercial real estate is often mentioned as a big risk factor, for example.
However, while more episodes of financial stress are quite possible, it is also the case that central banks and other regulatory institutions have shown that they are alert to these risks and can quickly step in to contain risks. We saw this in last year’s short-lived crisis in US regional banks. And we also saw it in the Bank of England’s swift containment of the crisis in the UK gilts market in October 2022.
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Moreover, it is quite telling that consumer and business spending in the US are holding up better than expected despite higher borrowing costs. Clearly, consumers still believe they can afford to take on debt, given low unemployment and rising incomes. In addition, businesses are raising capital spending because they judge that technological advances can deliver high returns on their investment even when their cost of funding has risen. In fact, we think that the longer that tight labour markets, booming equity valuations and stabilising home prices persist, the bigger the buffers in balance sheets that can be built up to withstand the lagged effects of monetary tightening — or indeed any other shock.
A second issue is just how concerned we should be about geopolitics. If we take the case of the current Middle East conflict, we see that the main channel of impact for Asia — a sharp spike in oil prices — did not come about. This is because the oil supply has been growing in the US as well as in places like Guyana and Brazil, capping oil prices. At the level of big power relations, the bigger reasons why geopolitical risks have been contained so far is that the US and China believe it is in their interests to build guard rails around their contestation so that tensions do not escalate dangerously. This is one reason why the outcome of the Taiwan elections did not produce destabilising actions by China. And it is why China has been more restrained in recent months in its activities in the South China Sea or elsewhere. This is not to dismiss geo-political risks entirely, only that we should gauge how each risk could actually affect our region.
However, some risks are not so easily quantifiable or assessable. Take China’s economy, which matters a lot to us but which is becoming increasingly difficult to fathom. Politics and policymaking have become more opaque, while the rapidly changing economic structure makes it difficult to work out how imbalances in finance and real estate are interacting. There are also social changes affecting the sentiments of consumers and private entrepreneurs which few understand fully. It also does not help that there are question marks over key data releases.
Still, we can think of two reasons why things may not be so bad for the Asian region if something went wrong in China. One is that China’s policymakers have the resources and tools needed to prevent the economy from a crisis-type contraction. Another reason is that countries in Asia have been learning to live with weaker Chinese demand for their products for a couple of years now. Economies are diversifying away from Chinese goods demand, using new growth drivers such as infrastructure spending and supply chain reconfiguration. Major tourism centres such as Thailand and Indonesia are learning to diversify by developing other markets such as India and the Middle East.
Another example of an unknowable risk is North Korea. We know that its nuclear and missile capability has been strengthened greatly. But there is no way of telling whether its leadership’s aggressive rhetoric is a real threat or just posturing. Similarly for the challenges posed by climate change and the surge in technological innovation. All this brings us into uncharted territory. All we can rely on in these cases of unmeasurable risks is that there are buffers in the system to mitigate the worst-case scenarios.
Conclusion
In short, the Asean region has a lot going for it in terms of growth engines. But there certainly are risks, which we must not downplay. In cases where risks are quantifiable and assessable — as with the potential damage from higher interest rates — we believe that the downside can be contained. For other risks which are less open to being assessed rigorously, such as what could happen in China or with North Korea, we believe that there are sufficient buffers and the policy response capacity which give us some comfort that developing Asia ex-China can overcome these potential stresses.
Manu Bhaskaran is CEO of Centennial Asia Advisors
