East and Southeast Asia rely heavily on exports to generate growth, which is why the past year has been a miserable one for Asia’s major trading nations. Had it not been for the post-pandemic release of pent-up demand in the domestic services sectors, Asian economies would have probably entered a recession.
Global demand had softened as geopolitical troubles, the steepest interest rate hikes in decades, a downturn in the electronics cycle and China’s faltering economy all took their toll. The proliferation of shocks, several of which came out of the blue, has undermined business confidence around the world. As firms became more cautious and cut back on hiring and capital spending, demand suffered and inevitably the trade demand also faltered.
However, there are now signs that a recovery is already taking shape and next year could see a decent upturn in demand for Asian exports. That should give the region’s economic growth a much-needed boost. Of course, this is all contingent on there being no further political or financial shocks. Taking stock of these potential headwinds, our overall view is that the worst effects can be contained and that we should not be overly pessimistic.
Lead indicators for trade are signalling a recovery
The World Trade Organization’s (WTO) global goods trade barometer, which has a good track record of detecting turning points in world trade, is now indicating that an uptick is nearing. Other leading indicators we look at concur and so a return to export growth is likely soon, perhaps even before the end of this year, with next year likely to see sustained growth. If the WTO is correct, growth in global merchandise trade volumes should rebound to 3.3% in 2024 after a desultory growth of 0.8% in 2023. The forecast sees Asia as the fastest-growing region for both exports as well as imports.
Already, the WTO has reported that the contraction in merchandise trade volume had begun to bottom out in the second quarter of this year when it fell just 1.0% after two quarters of much larger contractions.
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Other data also support the notion of a bottoming out. Air and sea cargo volumes, for instance, show early signs of a return to growth after contracting through most of last year. In fact, air cargo volumes expanded in August by 1.5%, its first foray into positive territory since February last year. What was also encouraging for this region was that the trade routes involving Asia such as Europe-Asia and Middle EastAsia, outperformed global averages. The data also showed that intra-Asian trade flows were also making a comeback.
Similarly, the data on container throughput is improving. An index monitoring this data surged in September to its highest level ever, with even Chinese ports registering good growth. Another positive indicator comes from shipping costs; the Baltic Exchange Dry Index is mounting a recovery after a steady decline since the pandemic-period highs, suggesting that demand by shipping companies is also improving.
Underpinning this recovery are rebounds in two crucial industrial sectors
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• The automobile industry is seeing a turnaround in sales and production. Activity in the sector has been on an upward trend for most of 2023. The easing of supply chain pressures, including an improvement in the supply of automotive semiconductors, means that vehicle production has improved after the disruptions of the pandemic period. A strong fillip has been given to the automobile trade by the rush by firms to establish their positions in the electronic vehicle market before their competitors overwhelm them. Government policies to promote the transition towards such vehicles are lending structural support for the sector and helping to offset the macroeconomic headwinds from higher interest rates and household belt-tightening. Notably, Chinese production of automobiles still registered positive growth for most of the year, defying broader macroeconomic difficulties. India, the second largest automobile producer, also saw healthy growth despite the high bases from 2022.
• Similarly, the semiconductor sector, which is of mighty importance to this region, is beginning a turnaround after declining through much of 2022–2023. The much-needed correction in bloated inventories is making good progress while sales of semiconductors are also picking up both in the US and the Asia-Pacific. With inventories heading towards healthy levels, medium-term sources of healthy demand can help regenerate the sector. The surge in spending on artificial intelligence applications is helping to boost the demand for high-performance chips while the rapid growth in demand for electric vehicles and computing devices with upgraded capabilities also contributes. Taiwan’s purchasing manager sub-index for new electronics orders returned to growth on Sept 23, giving us pretty good evidence that the worst is over for the sector.
The only cautionary data is in the S&P’s global purchasing manager’s export orders sub-index. October’s reading of 47.5 reflected continued declines in new business for the global manufacturing sector. In fact, manufacturers are still cutting workforces and have curtailed procurement of raw materials suggesting that they remain cautious about the near term.
Nevertheless, even here, the better performance in key Asian economies such as India, Indonesia and Thailand gives us hope that the weakness is mostly outside Asia, mainly in Europe. Our view is that trade in Southeast Asia and India will benefit from important structural changes that are underway.
• First, both these regions are likely to be winners from the ongoing push for the reconfiguration of supply chains. Firms that had been mulling over relocating production out of China had probably delayed plans for new investment and new hires because of the great uncertainty induced by central banks’ raising rates so aggressively and the initial disturbances in energy and raw material costs induced by the onset of the Ukraine war. With the sharp monetary tightening by central banks now approaching its end, financial conditions are likely to improve as well, giving these firms more confidence to revisit those plans and ramp up capital spending which would then give further impetus to the trade recovery.
• In addition, the Southeast Asian and East Asian regions should also benefit as two major trade agreements — the Comprehensive and Progressive Trans-Pacific Partnership (CPTPP) and the Regional Comprehensive Economic Partnership (RCEP) — which took effect in recent years produce new trade synergies. Moreover, the promise of these synergies will also encourage more foreign investment into the region, raising its economic and trade growth potential.
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So, there is fairly compelling evidence to suggest that a decent recovery in trade will be underway soon in the Asian region. Still, a lot has gone badly wrong for the world in the recent couple of years. This has been made even worse by the additional horrors of the conflict in the Middle East. It is therefore prudent to consider the downside risks.
The immediate concern is the impact of the Middle East crisis. The greatest risk is that the war in Gaza broadens out in such a way as to disrupt the production or transportation of oil, causing energy prices to soar. In practical terms, this could happen if Iran were to be sucked into the conflict. So far, however, this seems unlikely. Iran and its allies such as Hezbollah have been relatively restrained in their reactions and the statements from both parties suggest a strong desire to avoid a direct clash with Israel or the US. So long as that remains the case, the risk of serious damage to an Asian recovery from events in the Middle East will be low.
Another source of concern might be that a deterioration in the US-China power struggle produces more restrictions on trade and investment. We see the two big powers engaged in a long period of contestation. But the evidence also shows that both powers are keen to contain the risks of escalation and are making progress in building the guard rails necessary to ensure this. There has been a flurry of high-level meetings between the two sides which will culminate soon in an imminent summit meeting between Chinese President Xi Jinping and US President Biden at the Apec Summit in San Francisco.
In this regard, it is interesting to see that the latest WTO trade update found little evidence of trade fragmentation following the intense competition between the US and China. The agency’s research found that Asia ex-China’s trade in intermediate goods with the US and Germany was still close to pre-pandemic levels. If the tit-for-tat trade and investment restrictions imposed by the two powers on each other were leading to a harsh “deglobalisation”, we would have seen intermediate goods trade weaken a lot more.
While the above concerns are manageable in our view, China’s shaky economic recovery does give us pause. There is a toxic mix of a deflating property bubble, worsening financial stresses in over-leveraged firms and declining confidence among households and private businesses.
The key to containing these risks is the policy response, which we notice has been growing in intensity. The authorities seem to have a plan to contain financial risks, basically by getting financial institutions to bail out the large property developers whose collapse could cause widespread damage. In addition, local governments — the other major area of concern — are also being given greater financial support by the central government which is also deploying more of its fiscal resources to boost the economy. All things considered, it looks like policy support will be further expanded. If this is executed efficiently — and the track record of the Chinese authorities is good in this regard — then the downside risks to Chinese growth can be contained.
Conclusion: the baseline scenario is of a decent trade recovery in Asia
The remarkable fact is that, despite a string of misfortunes on the global scene, Asian economies have held up reasonably well, attesting to the structural improvement in their resilience. Even on the currency front, while regional currencies have depreciated, they have done so against a rampant US dollar. Compared to previous economic downturns and rate hike cycles, Asian currencies have actually performed quite well.
Part of this has been due to the recovery in domestic demand as pandemic controls were released and services activities regained vigour. Tourism has also been regaining momentum, further aiding resilience. The region’s current account balances have also fared better than in previous cycles.
However, as we move into 2024, some of these tailwinds will not be as strong since most of the pent-up demand would have been released and the higher savings that households had set aside during the pandemic period would have been run down. Governments around the region have ambitious plans for investment — in infrastructure as well as in new industrial sectors such as nickel-related investments in Indonesia. As investment rates rise, imports of capital equipment could also rise, leading to a recurrence of current account deficits which could upset regional currency stability.
That is why a recovery in external demand is so important for these economies. If our baseline view above is validated, then Asian economies will see a much better year next year.
Manu Bhaskaran is CEO at Centennial Asia Advisors
