Economic Outlook – Searching for Growth
Summary
- The risk of a US debt “armageddon” is receding following a tentative bipartisan agreement to raise the US debt ceiling. Likewise, concerns over inflation are also reducing alongside heightened expectations of an imminent end to the tightening cycle. Yet, the stickiness of core inflation could mean a longer delay before interest rates start to come down.
- Developed markets still need to be made clear of recession risks. Near term, Asia will likely act as the powerhouse of global growth.
- However, taking the pulse of the Chinese economy is challenging, with mixed signals coming from a slew of recent economic readings. Our prognosis is a hesitant recovery that is slowly getting on firmer ground.
- Given its recent solid economic performance and more proactive government policies, India is rightly considered another major contributor. Japan can also surprise on the upside as the country looks finally managed to lift itself out of a deflationary spiral.
Asia is projected to contribute around 70% of global growth in 2023[1]
The near-term global economic outlook hinges on the risk of inflation (receding) and contagion from the US banking crisis (limited so far). Headline CPI inflation is decelerating in most markets, alongside lower commodity and energy prices. Notably, there are scant signs of wage-price spirals in major markets, though the stickiness of core inflation is fast becoming the key driver of inflation (see Box on Wage-price spirals). At the same time, while confidence in the US banking sector has been dented by a series of failures of mid-sized financial institutions, there is yet no indication of spillovers to the global financial system.Wage-price spirals
One of the concerns about inflation is the risk of wage-price spirals. Higher inflation could drive more aggressive wage demand from workers and unions. Higher wages directly contribute to rising operating costs and factory-gate inflation. Furthermore, wages are more sticky to downward adjustments than headline consumer prices. The evidence so far has been inconclusive. Tight labour market conditions, partly a legacy of the pandemic and supply chain disruptions, have pushed up wages in major markets. However, there are no conclusive signs of the type of wage-price spirals as in the 1970s.Figure 1: Relative increase in wage and price indexes in the UK, US and Japan
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Source: CEIC
Even if there are signs of wages and inflation both moving up, anecdotal evidence is more cautious about the duration of such spirals. For example, a study by the IMF found “only a small minority of such episodes were followed by sustained acceleration in wages and prices”.[2] Indeed, the authors argued that previous wage-price spirals were typically short-lived, and the recent acceleration in nominal wages does not necessarily foretell the forming of a wage-price spiral. In other words, nominal wage increases will help to compensate for the real wage losses due to inflation, while wage growth tends to stabilise at a level consistent with inflation and labour market conditions.As the growth of key advanced markets slows,[3] there is increasing expectation that Asia will help to drive world growth this year. According to the IMF, growth in Asia and the Pacific will accelerate to 4.6% in 2023 from 3.8% in 2022, and the region will contribute around 70% of global growth this year. Specifically, China and India are forecast to generate half of world growth in 2023. Given that we are halfway through the year, how are things holding up? China reopened to the world in late 2022 after abandoning its previous tight lockdown measures. Yet, the recovery has focused on the mobility, hospitality and entertainment sectors while having thus far limited positive impact on fixed asset investment (FAI) or real estate activities. The latest economic data are painting a mixed picture. Growth of retail sales accelerated further to 18.4% year-on-year in April, though probably exaggerated by a low base last year. On a month-on-month basis, however, growth slowed in April from March. Industrial production also fell month-on-month in April (-0.47%) but rose 5.6% over the same month a year earlier. Other indicators like new renminbi loans and new housing starts are also showing similar trends. Meanwhile, exports recovered to positive year-on-year growth in April-May, but the wobbliness of overseas demand is increasingly threatening this. Overall, the Chinese economy still maintains a steady growth momentum. For instance, the unemployment rate fell further to 5.2% in April, from 5.6% in February and 5.3% in March. Furthermore, there are multiple options for government policies to boost growth, particularly in view of the lack of headline inflation in China. Despite the prospect of a soft patch in the second quarter, China is on track to achieving its target of 5% growth this year. This, in turn, means China could contribute around one-third of global growth in 2023.
Japan could surprise on the upside
It is not typical to mention Japan as a growth driver, given the country’s history of deflation and timid GDP reading over the past decade. Yet, there are more positive signs of late. For instance, the country reported better-than-expected first-quarter GDP growth of (annualised) 1.6%, easily beating the market consensus of 0.7%. More importantly, core inflation has exceeded 2% since April 2022, underscoring the broadening of inflationary pressure. During the first quarter, faster growth in private consumption (+0.6% QoQ) and fixed asset investment (+0.9% QoQ) are the key growth drivers, indicative of firmer consumer and business sentiment in Japan. The combination of rising price pressure and improving market sentiment have led the Bank of Japan (BoJ) to commission a review of its monetary policy and drop the language around “future interest rates remaining at current levels”.[4] Yet the fact that net exports were a drag on growth in Q1 (-0.3%) indicates the dependence of Japan on external trade and the headwinds of slowing demand from Western markets (see Figure 2). The Bank will also need to see strong demand-driven inflation before it acts to normalise its monetary policies. There are concerns that the recent yen weaknesses will drive higher imported inflation, but which will not be sustainable.Figure 2: Japan’s quarterly GDP growth and contribution by sectors
Source: CEIC
The economic rebound in Japan is welcoming but would not be sufficient to compensate for a slowdown in the US or China. Given that Japan accounted for only 4.2% of global GDP (2022, compared to the shares of the US and China at 25.4% and 18.1%, respectively)[5], a one-percentage point deceleration in growth in China will need to be compensated by a four-percentage point acceleration in Japan.India’s increasing global profile
Expectations on India remain sanguine despite having tampered from the height in the past two years. The Asia Development Bank, for instance, sees India notching up growth by 6.4% and 6.7% in this and the next (fiscal) year, respectively. Strong consumer demand continues to underpin growth, while exports, particularly services, have performed well in recent quarters. Corporate profits are increasing, while the nonperforming loans ratio has continued downward since it peaked in 2018. At the same time, India is actively gearing up to benefit from the restructuring of the global supply chain, which is seeing more manufacturing establishments being set up in India. Compared to the prophetic pronouncement by the World Bank of a potential “lost decade”, there is also increasing evidence of a coming “India’s decade”.[6]Figure 3: Economic growth of Asian markets
Source: Asia Development Bank, Outlook April 2023
*South-East Asia includes Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, Philippines, Singapore, Thailand, Timor-Leste and Vietnam
Nevertheless, the realisation of India’s potential growth is not guaranteed. For example, while being the world’s most populous nation bestows the nation with a huge “demographic dividend”, this can only benefit society if millions of young people find fruitful employment.A summer surprise?
Near term, the balance of risks is still tilted towards the downside on account of the still-evolving banking crisis in the US, heightened geopolitical tensions, debt overhangs in emerging and frontier markets, and increasing concerns about the outlook of property markets across the globe. The interlinkage of inflation and debts warrants further elaboration. Since the Global Financial Crisis, a period of ultra-low interest rates has encouraged leverage by households, corporations and governments. As central banks shifted monetary policies in 2021 to tackle rising inflation, debt servicing became more arduous, and we already see signs of stress, noticeably in some frontier markets. Furthermore, some government policies implemented during the pandemic to forestall insolvency are also expiring.[7] This could herald a period of rising default. On the other hand, Inflation can have material impacts on the real value of debts. Higher inflation and negative real interest rates would help, over a longer period, to reduce the real value of debts. Tax revenue, for example, will increase unless tax brackets are inflation-adjusted, while the present value of debts due in future will shrink in value. This holds mainly for domestic debts, though.Figure 4: Domestic and foreign debts for selected markets
Source: Bank of International Settlements
Note: Total debt securities include general government debt, financial debt and non-financial debt securities, categorised by the residence of the issuer.
A relief to the high debt burden will not materialise anytime soon. Indeed, near-term financial institutions remain exposed to the property sector that is experiencing corrections. Traditionally, Asian banks have relatively high exposure to properties. For example, in the case of Malaysia, Singapore and South Korea, banks have >20% of their assets exposed to the property markets. At the same time, with the fast urbanisation of Chinese cities, Chinese banks saw their real estate exposure rising to 15% of bank assets from ~8% in 2012. The outlook could brighten over the summertime if core inflation finally yields to unrelenting central bank tightening. That would be the strongest signal of an imminent Fed pivot that will start to underpin a swift recovery in sentiment, particularly since there is no conclusive evidence of wage-price spirals in major markets.[1] “Asia Poised to Drive Global Economic Growth, Boosted by China’s Reopening”, IMF Blog, 1 May 2023. [2] Jorge A Alvarez et al., “Wage-Price Spirals, What is the Historical Evidence?”, IMF Working Papers No. 2022/221, 11 November 2022. [3] For instance, Germany recorded two consecutive quarters of negative GDP growth in Q4 2022 and Q1 2023. The US economy grew at a 1.1% annual rate in the first quarter, slowing from 3.2% in Q3 and 2.6% in Q4 of 2022. While the Federal Reserve acknowledged a higher risk of recession due to the series of banking failures in early March, it nonetheless kept raising interest rates, the latest by a quarter percentage point in early May. [4] The Bank of Japan kept interest rates unchanged following its meeting in April but announced a broad review of the impact of its monetary policy over the past 25 years. At the same time, the Bank dropped its usual guidance on future interest rates remaining at current levels or being lowered if deemed appropriate. [5] Source: IMF World Economic Outlook database, April 2023. [6] See also “China and India Economic Outlook”, 29 December 2022, Peak Re [7] A World Bank study showed that in over 80% of the economies surveyed, some forms of debt repayment emergency measures were implemented following the outbreak of the pandemic. Apart from support for credit insurance schemes, other actions include prohibiting the acceleration of contractual terms, eliminating interest and penalties, or banning the repossession of property. These measures are gradually expiring or being rescinded. See “The Claim Before the Storm: Early Evidence on Business Insolvency Filings After the Onset of COVID-19”, COVID-19 Notes, The World Bank Group.
