If there is one thing we have learnt from the past year, it is that the world will always find ways to spring surprises. Rather than make specific predictions, it is more productive to get a grip on the forces working under the surface of the global economy and to work out how they could produce upside possibilities or downside risks. The really big forces that matter in 2023 include geopolitics, China’s changed approach to Covid-19 and central banks’ monetary tightening, which have caused anxiety. But we should also not forget potential positives such as new technologies that could create huge opportunities for growth.
As we work out how these forces might play out, what strikes us is that the risks are well known but there are also potential upsides that are not being given enough consideration. Certainly, the coming year will see a global slowdown and there could even be recessions in the more vulnerable areas. Our best guess is that the three major sources of risk — geopolitics, China and monetary tightening — will produce a rough beginning to the year. But as the year progresses, we will find that the downsides can be managed and that there will be profitable opportunities that can be exploited.
Geopolitical risks are real but are likely to be contained
The war in Ukraine will continue to dominate the headlines and world leaders will go on being troubled by developments around Taiwan. However, we suspect that these two flashpoints will be contained: if a political disruption were to erupt, it will probably emerge elsewhere, either out of North Korea or perhaps along the Sino-Indian border.
While bad things will persist in Ukraine from a humanitarian perspective, the spillover of that crisis into the global and Asian economies will probably be muted compared to 2022. The energy price shock, food price spike and supply chain dislocations caused by the Ukraine crisis last year will be less evident this year. Energy prices have fallen back, food prices have returned to pre-war levels and the worst of the disruptions to supply chains is over.
Similarly, while Taiwan is likely to face more pressure from China, there are reasons why even that will be managed. Statements by senior Chinese leaders in recent days reflect a desire to avoid escalating tensions with the US and the Americans seem keen to reciprocate. Both the Chinese and American leaderships have serious domestic issues to deal with and do not want an external crisis to aggravate their problems. Also, Taiwan has a presidential election in 12 months’ time and Beijing does not want to provoke Taiwan’s feisty voters into re-electing the independence-leaning DPP that is in power now.
Recent developments point towards an escalation of tensions in the Korean peninsula. The drone incursion over Seoul in December, the exchange of fire when a North Korean naval vessel entered South Korean waters in October and a flurry of missile tests show that the North Koreans are testing the US and South Korea. More such high-risk probing can be expected and if the North miscalculates, a clash could ensue.
Over in the high mountains of the Himalayas, China and India have amassed more troops than ever along their poorly defined border and are patrolling more aggressively. As the fighting in December in the eastern part of the border showed, the chances of clashes remain uncomfortably high. Neither country desires a fight but trust between the two governments has broken down. With India’s 2024 general election approaching and China’s President Xi Jinping on the back foot over his management of the pandemic, neither side will be willing to back down or appear soft should clashes erupt.
Still, overall, while there will be geopolitical stresses from time to time, we think that they are unlikely to be of the scale seen last year. And, if something untoward were to happen in the Himalayas or in Korea, we expect quick action being taken to limit the escalation in both cases.
We would go further to say that geopolitical trends could even produce some positive effects for our region:
• There is going to be a substantial increase in defence spending across the world. Much of that will be spent on high-tech defence equipment that will boost the demand for components that are manufactured in East and Southeast Asia.
• The poisoned relationship between the US and China will see more companies seeking to diversify their production from China. This reconfiguration of supply chains will see more foreign investment flow into Southeast Asia.
• Both the US and China are stepping up efforts to woo Southeast Asia. There could be many benefits from this — from better market access in China to more funding for infrastructure development to technological assistance in renewable energy.
Chances are that China could offer upside rather than downside to the world economy
With the abrupt U-turn in Beijing’s approach to managing the Covid-19 pandemic, China is suffering a terrible and very sad increase in infections and deaths. That has led to a great deal of pessimism over China’s economy. However, the analysis by several teams of epidemiologists suggests that the infections will peak soon and that things will get better as we move into February.
There are many reasons to expect a smart turnaround in the Chinese economy after that:
• High frequency data in cities where the infections appear to have peaked, such as Beijing and Shanghai, suggest that people are hungry to return to normal once the infection risks subside. Passenger movements in subways and airline searches and bookings all show consumers keen to catch up on travel, meetings with relatives and other activities that they have been deprived of for three years. The past three years have seen a huge increase in savings among ordinary folk — much of that was involuntary as Covid-19 restrictions limited spending. A huge amount of pent-up demand will now be released, which will fuel an acceleration in economic activity.
• Measures taken by the government since late last year to boost the economy and stabilise the troubled property sector are also likely to feed into the economy in the coming months. Senior officials have hinted in the past few weeks that they will focus on improving confidence, and actively support consumer demand through measures such as cash transfers. The authorities have also moved vigorously to improve the animal spirits of entrepreneurs who were shaken by President Xi’s actions against the big technology platform companies and against the education sector.
It is true that China’s economy will be hurt by falling exports as global demand slows. It is also the case that its property sector will not turn around so easily, and that could hold back consumers. There will probably be financial stresses among over-leveraged real estate companies and others. Nevertheless, given the low base from 2022, policy support and the likely big increase in domestic demand, the global economy is set to gain from a sharp rise in Chinese growth, from around 3% in 2022 to above 5% in 2023.
Expect the lagged effects of tight money to produce stresses
The good news is that, as the global economy slows and as the food and energy price shocks of last year fade, global inflation is poised to fall more quickly than expected. Data on price pressures in Europe in the last few days supports this view. There is some worry that service sector inflation will remain high because tight labour markets will keep pushing up labour costs. However, our view is that wage inflation will be tempered as the distortions in labour supply caused by the Covid-19 pandemic are ironed out, and as demand for labour is reined in by a slower economy.
If that trend persists, we should see the major central banks pare back their rate hikes and other tightening measures. We see a small risk that central banks will over-tighten policy to the point that a recession is triggered.
This will be seen as good news in financial markets. As easing fears of rate hikes make global investors less risk averse, capital will flow more confidently into emerging markets such as those in our region. Another effect is that the US dollar’s extraordinary strength will be reversed — which will offer some respite to regional currencies.
Nevertheless, not everything will be hunky-dory.
• First, last year’s sharp increase in interest rates across the world will depress demand — Europe could be in recession and the US economy could slow drastically.
• Secondly, financial stresses are very likely. Many highly indebted emerging economies are teetering on default. Agencies that monitor financial risks, such as the Bank for International Settlements, are warning of potential liquidity problems in some parts of the financial system. Weakly managed companies that survived only because of low interest rates will now begin to fold up.
• Thirdly, and more fundamentally, it is now clear that the long era of easy money that has prevailed since the early 2000s is over. On average, interest rates will be much higher and central banks less disposed to step in to bail out financial markets with rate cuts. Asset pricing will have to reflect that: As valuations of equities and real estate may not have fully reflected this new regime, we expect continuing compression of valuations.
Structural forces could help as well
We have said it before but it bears repeating, that the immense possibilities being created by technological breakthroughs are being underestimated.
Progress has been rapid in diverse areas. The combination of improving computing power and speedier data communications is producing revolutionary changes in artificial intelligence, robotics and allied areas. Other segments in information technology continue to develop as well. The progress in renewable energy has been transformational: solar and wind power are now expanding rapidly with promising advances being reported in nuclear power and hydrogen. New materials are being invented which are changing our lives, such as composite materials that enable cheaper long-haul flights. Advances in the biomedical sciences have also produced remedies for cancer and other terrifying diseases.
What is more, the pace of change itself is accelerating. Breakthroughs in one area are helping speed up improvements in other areas — for example, progress in genomics would not have been possible without the rapid increases in computing power.
The long and short of it is that the promise of super-normal profits from these scientific leaps should encourage a boom in capital spending by companies, which should stimulate global economic growth.
Conclusion: what does it mean for our region?
The lead indicators are clearly showing that the early part of this year will see a slowdown in the global economy, which will inevitably hurt the region’s exports and commodity prices. Except where the rebound in tourism is salient (for example, Thailand) or the impact of easing Covid-19 restrictions is particularly strong (China and Hong Kong), economies will see slower growth in 2023.
So, there is no gainsaying that the coming months will be difficult. But that is mostly priced in. We suspect that the potential positives described above — the upsides rather than the downsides from geopolitics, a swift turnaround in China’s economy, an early end to monetary tightening and the benefits of new technologies — have not been given sufficient weight.
It is also the case that policymakers in the region have done well in building the region’s resilience against the potential negatives. Note, for instance, how Indonesia has bolstered its growth potential with recent reforms and a well-executed industrial policy to develop nickel processing and batteries.
In short, without underplaying what could go wrong, we believe that Southeast Asia can overcome the challenges reasonably well and emerge stronger as the year progresses.
Manu Bhaskaran is CEO of Centennial Asia Advisors
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