The coming year is going to be a rough one. The unexpected but dangerous upsurge in the Syrian civil war and the astonishing political convulsions in South Korea speak of a world that is structurally prone to downside surprises. This is because there are intensifying vulnerabilities in politics, trade, finance and climate but little capacity for the world to resolve them.
At the global level, we do not see the US and China being able to provide the leadership that only big powers can to resolve these issues. Where domestic politics is concerned — and as South Korea has shown — some countries have leaders who believe in radical measures that could be potentially destabilising.
This sombre global outlook is not ideal for our Southeast Asian region and neither does it condemn us to gloom and doom. If the region can get its act together, it can take advantage of some silver linings in the world and still maintain a degree of stability and economic vigour. Even if it is hurt by global developments, the region would be relatively better off than most other parts of the world.
Why the world will see more turbulence next year
When dry tinder is on the ground, it only takes a few sparks to set off fires. And there is indeed a lot of dry tinder. First, several geopolitical flashpoints are approaching critical turning points.
As Ukraine’s over-stretched forces wilt under Russian pressure, they are beginning to lose ground at an alarming rate. Ukraine could soon be forced into a ceasefire on unfavourable terms, particularly if President-elect Donald Trump pulls the plug on aid to it. In that eventuality, seeing that Russia had been rewarded for its “special military operation”, other countries with grievances against smaller neighbours will be emboldened to push their agendas more aggressively. There are many brewing conflicts where tensions could increase — whether it is further Russian activity in the Baltics, Ethiopia’s disputes with its neighbours, growing divisions in the Balkans or Venezuela against its smaller neighbour, Guyana.
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The Israeli degradation of Iran and Hezbollah’s military capacity has created a vacuum in the Middle East, which is why the Syrian civil war has been reignited. We may see further instability in Lebanon and Iraq and possible Israeli action against Iran.
South Korea will now enter a period of political uncertainty with President Yoon Suk Yeol facing impeachment. The worry is that North Korea will attempt to take advantage of this.
With Trump about to re-enter the White House in January, America’s rivals will be testing its resolve in various areas. China has resumed naval activities in waters claimed by the Philippines, for instance, and will do the same around Taiwan — probably to test how far the new US administration will be prepared to go to defend its allies.
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Second, trade tensions are reaching a breaking point. It is virtually certain that Trump will kick off the start of his presidency with new tariffs against China and other major trading partners such as Canada, Mexico and Europe. China’s massive investments in new industries are producing capacity so far in excess of domestic demand that export surges are likely to arouse protectionist backlashes all over the world — as we have already seen. As we explained in our previous column, a trade war is likely.
Third, financial vulnerabilities have not gone away even though financial markets are rising. Public debt has risen worldwide, and the sharp rise in global interest rates since 2022 will begin to hurt corporate borrowers as they come to the market to refinance their debt. Trump’s plans for tax cuts are likely to lead to higher fiscal deficits since it is unlikely that spending will be cut sufficiently to pay for the tax cuts, which could produce spikes in long-term rates, which could hurt markets.
Finally, the failure of the latest talks on a global approach to climate change and the impending American withdrawal from the Paris climate agreement will set back efforts to tackle climate change. More extreme weather is already evident and causing extensive damage — this can only worsen in the coming years.
The capacity of big powers to provide global leadership is limited
The two big trends that dominated the world in recent years — American exceptionalism and a rising China — are coming to an end. Both countries will remain much more powerful than others and can hurt other countries should they wish to. But both are likely to hit constraints as their structural weaknesses catch up to them.
The US has been on a roll. Its economy has far outgrown its peers, the broad value of the US dollar has been trading in its highest range in 20 years and American equities have produced returns well above other markets. Recent explanations for this outperformance — better productivity, outstanding innovation capacity, and a surge in oil production that has made it again an energy superpower — are all probably correct. However, a lot of good news has been priced in, and that makes American outperformance vulnerable to even small disappointments. As a new administration takes power in the US with radical policies and possibly overreach in its confrontation with trade and security partners, the scope for downside surprises has grown. Our view is that the coming year will expose the weaknesses in the US, such as its worsening fiscal trajectory and the failure of its political class to address its many social and economic problems.
China is likely to see a modest recovery from its recent slowdown. But it will never return to the heady days of double-digit growth. After all, there is little it can do to reverse its debilitating demographic decline. Policies favouring state enterprises over private ones and an unwillingness to pursue vitally needed reforms will hold back productivity growth. The lack of feedback systems that allow timely policy corrections will tend to aggravate these.
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With the two major powers set back by internal weaknesses and likely to be distracted by a trade war against each other, the world needs other powers to be the adults in the room. But, Europe’s two giants, Germany and France, are embroiled in political gridlock. Japan’s government is also now a minority one whose leader, Prime Minister Shigeru Ishiba, may not last long in office.
How can Southeast Asia perform in such a messy world?
In the run-up to the IMF-World Bank meetings in October, the major global institutions published outlooks for 2025, which were relatively benign. Global growth is seen to be just a little slower next year, while inflation will fall, and other variables, such as commodity prices and current account balances, will not change very much. But our analysis above points to a more sober outlook. To start with, two of the most important things for Southeast Asia are at risk.
One of the most important factors for the region is the sustainability of the stability promised by the US and China in balancing each other. Under a re-elected Trump, the region will wonder about the dependability of the American security guarantee and its willingness and ability to provide a balance against China, Russia or other powers.
While this does not necessarily mean outright conflicts breaking out in flashpoints such as Taiwan or the South China Sea, we are likely to see a further rise in tensions in these areas. Japan and South Korea may have to fundamentally rethink their security underpinnings if their confidence in America’s security guarantee drops.
The next most important thing for this region is the outlook for the global economy — particularly the trade and foreign investment that it depends on. If our scenario of a trade war does materialise, along with financial stresses, then the region’s growth prospects will be compromised.
The trade war will probably knock off around one percentage point of China’s 2025 growth, with smaller damage to individual Asian countries depending on how much they export to the US and China.
Trump’s tariffs and promised deportations of immigrant workers could raise American inflation rates and cause the Federal Reserve to stop cutting rates. Global inflation could rise further if Middle East tensions disrupt the production and transportation of oil in that region.
The US dollar would initially appreciate, while the Chinese Yuan would tend to fall, placing immense pressure on Asian currencies. Asian central banks may be forced to raise interest rates to protect their currencies, which would slow their economies.
However, there are likely to be some offsetting factors.
First, the region can leverage some of its plus points to mitigate the impact of American tariffs. As this region is strategically vital for the US, it will be careful not to hit the area too hard with tariffs. Moreover, the region has been adept in the past at assuaging Trump with stepped up imports and other concessions. For example, during the first Trump term, Vietnam offered massive purchases of American-made aircraft to reduce the bilateral trade surplus it had with the US.
Second, the large number of China hawks in the Trump cabinet makes it likely that the basic policy thrust would be to promote decoupling from China. Global corporations with manufacturing plants in China have already begun to relocate production out of China. This is bound to accelerate in 2025 — investment approvals in most of the region have surged this year, so next year will see many of these proposed investments translate into factory construction and eventually increased manufacturing production. Southeast Asia has been a clear winner in attracting much of the resulting foreign direct investment in the past two years. The region has not only experienced a sharp rise in announced foreign investment projects but has also expanded its share of global FDI, particularly in key sectors like electronics, automotive, and renewable energy, where companies are seeking cost-effective and resilient alternatives to Chinese production bases.
Third, the region will continue to ramp up domestic investment. Government infrastructure spending and capital spending on the green transition will increase.
Fourth, the region has undertaken efforts to promote regional integration, which will also help buffer against a more protectionist world. The Regional Comprehensive Economic Partnership agreement has helped improve trade, and we expect efforts to broaden the agreement and strengthen some of its provisions. Regional integration initiatives such as the Johor-Singapore Special Economic Zone will also help by promoting economic growth.
Fifth, over time, the region has enhanced its resilience to external shocks through central banks that have built more credibility with financial markets, sound fiscal positions, better supervision of the financial sector, a more diversified economy and better external buffers such as large foreign exchange reserves. These factors make the region relatively more secure and stable compared to its competitors.
The region has to face the cold, hard reality of a world in political and economic convulsions. The end of American exceptionalism and China’s struggle with structural challenges will create new challenges and risks in the world economy. The critical ingredients the region needs — a balance of forces among the big powers within the region and economic openness that allows large flows of trade and investment — are at risk. Economic growth and currency stability within the region will be compromised as a result.
However, it is important to appreciate that the region has the agency to pursue mitigating strategies, has built resilience and has policy options that competing regions lack. This will help it leverage favourable trends, such as the growing trend of production relocation out of China.
It will be a difficult year for Southeast Asia but it need not be a bad year.
Manu Bhaskaran is CEO of Centennial Asia Advisors
