Asia’s asynchronous recovery continues
Domestic demand is a key growth driver and India, Japan and Indonesia offer opportunities
IT USED to be the case that business cycles across Asia were in sync. But after the Covid-19 shock, global trade, as well as growth, have moved out of sync. Growth in Asia has diverged at times from global growth momentum.
Within Asia, the dispersion of growth outcomes should have narrowed by now. Instead, it has widened.
This asynchronous recovery will continue into 2024. Past synchronous recoveries tend to be driven by strong trade cycles, acting like the rising tide that lifts all boats. Those recoveries were accompanied by a strong pick-up in private investment and productivity growth. This backdrop helps policymakers pull back from expansionary monetary and fiscal policies, brings down leverage, and makes it easier to manage structural reforms.
While the worst of the trade cycle is behind us, we are expecting only a modest recovery. Returning inflation to target will need a period of sub-par growth, especially for developed markets. For the rest of the region, the marginally better growth trajectory in China that we expect will also mean that it will not be a significant source of support.
Without a single overarching growth driver, we look for idiosyncratic, economy-specific factors. Focusing on the four largest economies in the region, we continue to see domestic demand as the key growth driver, and we are most constructive on India, Japan and Indonesia.
China faces a challenge in managing aggregate demand and deflationary pressures emerging from the deleveraging of local government and property companies’ balance sheets. As investment growth slows due to concerns over misallocation, aggregate demand weakness leads to deflationary pressures persisting for longer. Coordinated monetary and fiscal easing will lead to a modest recovery and an exit from deflation.
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But the gross domestic product (GDP) deflator will remain lower than the 2 per cent to 3 per cent run rate that helps ensure a healthy environment for corporate profitability, given that there are few signs that rebalancing efforts, which we view as necessary to enable this transition, are materialising. In this context, we believe that the risks of a debt-deflation loop remain high.
India remains the best domestic demand alpha opportunity. The next leg of the cycle will be predicated on whether capacity expansions will be timely enough to uplift and sustain productivity growth. This, in turn, is dependent on a continued focus on supply-side reforms, requiring policy stability to keep domestic and foreign corporate sector confidence buoyant.
We remain optimistic about India’s growth and project a medium-term growth rate of 6.5 per cent. To the extent that policy stability is needed to continue to push through supply-side reforms, the general elections expected to be held between April and May 2024 will be an important event to watch.
Japan is seeing a momentous shift in its nominal GDP trajectory. Nominal GDP growth reached a 30-year high of 5.1 per cent in the second quarter of 2023, and we expect nominal GDP growth to be sustained at 3.8 per cent in 2024. While global inflation, the rise in US rates and weaker yen have helped, we believe the policy setup has played an important role in reviving inflation expectations sustainably.
We expect another round of strong wage growth in 2024 that would exceed the 2.1 per cent that we saw in 2023. While an exit from negative rates is likely in early 2024, we believe that Bank of Japan will not compromise on its inflation objective and tighten macro policies pre-emptively.
Indonesia’s orthodox and prudent policy mix has kept macro stability in check and the cost of capital on a structural decline. As we move into the next stage of the recovery, the growth drivers will shift more towards capex and consumption-led recovery.
While Bank Indonesia (BI) hiked interest rates at its October meeting, we are not expecting further rate hikes from here. Indeed, with inflation still well within the central bank’s target range, we expect BI will be able to cut rates from late Q2 2024 onwards and to lower real rates from the current elevated levels. We are also watching the outcome of the elections in February 2024 keenly to see if there will be a sustained push for policy reforms.
Overall, we see Asia’s growth remaining steady in 2024, with China’s growth momentum improving marginally on an underlying basis from 4 per cent on a two-year compound annual growth rate basis in 2023 to 4.2 per cent in 2024, and stable growth in Asia ex-China. The pace of gains in Asia’s nominal GDP has softened recently because of a strong dollar environment, but we expect that nominal dollar GDP gains will improve from the second half of FY2024 as the US dollar peaks with an increased contribution from India.
The risks to the growth and inflation outlook skew to the downside. A key downside risk is if China falls into a debt-deflation loop, which will weigh on the rest of the region’s nominal GDP growth. Potential policy uncertainty emanating from elections in India and Indonesia are key risk events to watch.
Chetan Ahya is chief Asia economist and Derrick Kam is Asia economist, Morgan Stanley
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