THE recent escalation in geopolitical tension in Russia and Ukraine and rising headwinds from Covid resurgence in China have raised debate about stagflation risks, and whether these risks portend the end of the expansion cycle for the economies in Asean, Korea and Taiwan.
Our base case view had been that the Asean region, Taiwan and Korea are likely to see steady-state expansion in 2022. In this phase, growth broadens out from exports to domestic demand; inflation rises without getting out of hand; while policy rates normalise without being disruptive for the growth cycle.
Admittedly, growth is now lower, and inflation, higher than we had earlier envisaged. After all, geopolitical tension is spilling over via higher commodity prices in energy, agricultural and metal products. South Korea, Taiwan and the Philippines tend to be more exposed to negative terms-of-trade shock from higher commodity prices.
Geopolitics and China's Covid resurgence also imply potential supply-side disruption which could impact manufacturing. The spillover from slower global demand and tighter financial conditions also weigh on growth. Singapore, Malaysia, Thailand, Taiwan and South Korea tend to be more exposed to slower global demand due to trade linkages.
Yet, we think these exogenous supply-side and demand-side shocks do not spell the end of the growth recovery. Steady-state expansion is likely still the right characterisation for those economies, given the room for fiscal policy to mitigate stagflation pressure; the improved starting point for macro stability; and the fact that monetary overtightening looks unlikely.
We estimate that every 10 per cent rise in food and energy prices would increase the cost burden on households and private sector to the tune of around 2 per cent of gross domestic product (GDP). This is not insignificant, but there is policy room to offset this.
GET BT IN YOUR INBOX DAILY
Start and end each day with the latest news stories and analyses delivered straight to your inbox.
Between fiscal and monetary policy, fiscal policy is the more effective tool to mitigate growth and inflation risks simultaneously. With public debt-to-GDP ratio remaining at relatively manageable levels of between 33 and 66 per cent across most of the economies, there is room for the public sector to lever up.
We think there is appetite for policymakers to provide fiscal support, and funding is not an issue, given that most of these economies run a current account surplus.
Already, measures such as diesel and petrol tax cuts, import tariff cuts and retail subsidy schemes are in place.
For economies running fuel subsidies, such as Indonesia, a concern has been whether this could lead to fiscal stress and inevitable price hikes, which could spill over to inflation and monetary policy. We believe the broad-based rise in the prices of commodities apart from oil, and the increase in commodity government revenue, suggest fiscal pressures are likely still manageable.
However, what could pose fiscal risk is a sustained sharp rise in oil prices in itself and also relative to other energy commodity prices. This is because the rise in energy subsidy burden could then become non-linear as a widening gap between market price and subsidised price increases arbitrage activity, and this could outpace commodity revenue growth from elsewhere.
On the monetary policy front, there may be concern about whether higher inflation could prompt monetary policy overtightening, which would compound growth pressure. After all, in the 1970s and 1980s, as supply-side shock pushed up oil prices, Fed Chair Paul Volcker tightened aggressively to rein in inflation pressures which had come unanchored from earlier loose policy, and the US economy fell into a recession.
We think monetary policy overtightening, which could disrupt the growth cycle, looks unlikely for Asean, Taiwan and South Korea.
This is because central banks typically do not respond to supply-side, cost-push inflation, unless there is evidence of second-round inflation due to strong demand. On the latter, demand-pull inflation pressure is likely still manageable, given the negative output gap in most of the economies.
Moreover, for those economies more advanced along the recovery path, the central banks there (for example, Bank of Korea and Monetary Authority of Singapore) have already embarked on policy normalisation last year ahead of the Fed. This buys them flexibility when it comes to managing inflation, reducing the likelihood of knee-jerk tightening.
For central banks focused on currency stability, such as Bank Indonesia, higher reserves and real rate differentials, as well as the positive commodity terms-of-trade impact on its current account balance, buy protection against disruptive hikes.
Overall, we expect the central banks in Asean, Taiwan and South Korea to continue with gradual policy rate normalisation, but not aggressive tightening.
Looking ahead, with macro risks likely still skewed to the downside, given uncertainty around geopolitical tensions, we think economies that are better placed are those that are net commodity exporters and, hence, offer a stagflation hedge, and/or those that have a domestic demand buffer. These include Indonesia, Malaysia and the Philippines.
On the other hand, Singapore, Thailand, Taiwan, and South Korea are likely more exposed to either the negative terms-of-trade shock from higher commodity prices, or the spillovers from slower global demand and tighter financial conditions.
The writer is Asia economist at Morgan Stanley.
Keyword added to your list