Stagflation risk rising, but growth in Asia is still the base case scenario

AS inflation continues to climb and global growth is crimped by slowdowns in China and the United States, Katrina Ell, senior Asia-Pacific (APAC) economist at Moody’s Analytics, described the risk of stagflation in major economies as “its highest in decades”.

Natixis Investment Managers warned in an outlook report this month that “‘slowflation’ is becoming a reality”, where the world economy escapes recession but faces a sharp slowdown.

Still, Ell and other economists told The Business Times that stagflation is not a baseline scenario for APAC as economic growth is expected to stay positive on a rebound in domestic demand, especially in the Asean region, despite rising higher prices.

Even though the Russian invasion of Ukraine has forced commodity costs upwards, Ho Woei Chen, an economist at UOB, said of APAC: “Fundamental economic indicators such as flush savings during the pandemic years, monetary and fiscal stimulus programmes and labour market tightness are still supportive of the economic expansion.”

Sonal Varma, chief economist for India and Asia (excluding Japan) at Nomura, also told BT that “we are still far from a recession, higher unemployment rate and double-digit inflation”.

Deyi Tan, Asia economist at Morgan Stanley, told a briefing that Singapore, Malaysia, Thailand, South Korea and Taiwan have higher exposure to a slowdown in China, but added, when asked by BT, that “stagflation is not in our base case” for the APAC region in the next 12 to 24 months.

That’s as domestic demand is expected to drive growth, especially in places such as Asean that “were quite badly hurt last year with the recurring Covid waves”, but which are now reopening.

“The higher cost-push inflation may soften the domestic demand recovery that we expect, but we don’t expect the recovery to be derailed, because we believe that pent-up demand will certainly need to be satisfied as economies reopen,” she said.

Priyanka Kishore, head of India and South-east Asia coverage at Oxford Economics, added that – in contrast with markets such as the US – domestic recoveries in Asia should be supported by an expected rise in real incomes in 2022, “albeit at a very meagre pace”.

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To be sure, Asian stagflation risks are mounting, especially as major world economies look to be running out of steam.

Goldman Sachs last week cut its full-year US gross domestic product (GDP) forecast to 2.4 per cent in 2022, from 2.6 per cent before, while analysts believe successive lockdowns in key Chinese cities are imperilling China’s 5.5 per cent growth target.

Kishore noted that “growth has been downgraded across Asia following rising risks of a hard landing in the US and China”, which account for a large share of final demand for Asian exports.

In particular, Covid-19 lockdowns in China could worsen global supply-chain issues and “pose direct downside risks to domestic industrial production in several Asian economies” that depend on China for intermediate goods, such as Vietnam, South Korea, Japan, and India.

UOB’s Ho estimated that a 1-point slowdown in China’s GDP growth will shave nearly 0.2 percentage point off global growth, as the downturn leads to “negative spillovers into global demand and production which will compound the overall impact” and hit trade-dependent Asia.

Meanwhile, analysts from Natixis predicted that economic growth in Singapore, Thailand, and Malaysia will be most affected by weaker Chinese import demand, while Australia, South Korea, and Malaysia will face the largest negative impact on their currencies.

Indeed, some economies are at higher risk of stagflation, with Ell noting that India, Thailand, and Vietnam “have particular lasting scars from the pandemic as well as high inflation”.

How the macro situation develops “depends on the interplay between demand, supply and central bank responses”, noted Varma, who said stagflation will also hinge on whether central banks respond appropriately if inflation expectations rise and a wage-price spiral develops.

Still, Nomura’s Asia ex-Japan GDP forecast for 2022 is 4.6 per cent – after a 0.4-point downgrade in recent months on the back of tighter global financial conditions, the Russia-Ukraine war and the economic slowdown in China. Such a level of regional growth “is reasonable”, and inflation, while picking up, is not running as high as elsewhere, said Varma.

Though the conflict in Ukraine has driven up energy prices amid global reliance on the oil supply from sanctions-hit Russia, Ho also told BT that conditions differ from the stagflation caused by an Organization of Petroleum Exporting Countries (Opec) oil embargo in the 1970s.

This time round, “Opec still has some capacity to increase supply if they need to and major countries are also maintaining substantial reserves that can be released into market”, she said.

Ho added that ongoing inflationary pressure is also driven by pent-up demand and supply-chain disruptions, and “not entirely due to the oil and gas supply restrictions from Russia”.