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Economic Research: Asia-Pacific's Recovery Regains Its Footing


Asia-Pacific, after success in suppressing COVID-19 in the first stage of the pandemic, has stumbled in the shift to vaccination and reopening. Early success may have bred some complacency and the vaccine rollout was slow to start, as governments were late to secure supplies and residents were hesitant to get a jab, at least initially.

This has changed. Earlier defenses have been breached by new variants and pandemic fatigue. Intermittent and targeted lockdowns have returned. In response, governments sped up domestic production of vaccines or scaled up orders from abroad, and started to promote mass vaccinations. Perhaps even more important, rising infections appears to have reduced vaccine hesitancy among populations.

The vaccination gap with Europe and the U.S. should keep closing but a slow start has already affected the outlook. Many Asia-Pacific governments also appear less tolerant of new cases than in the U.S. and Europe, which should mean tighter social restrictions for a given vaccination rate and a lingering risk of lockdowns.image

Asia-Pacific’s patchy performance in the second stage of the pandemic will mean its recovery remains unbalanced for a while longer. Exports are contributing to some upward revisions to our growth forecasts for 2021, but as many trading partners reopen and consumers spend more on services, the impulse from exports will wane. Private consumption is exerting a drag and while we expect an improvement in the next few quarters, much depends on the pace of the vaccine rollout.

We have highlighted China’s unbalanced recovery from the start, but similar patterns are seen across much of the region. Chart 2 shows the breakdown of real spending in Japan and Korea. Exports have rebounded strongly, investment is picking up (especially in the manufacturing sector), but private consumption remains moribund. Our expectation is that reaching key vaccination thresholds–especially the 70% level identified by the World Health Organization–will determine how quickly consumption rebounds. For China, Korea, and Singapore, this may come in the third quarter. Australia and Japan should follow, perhaps in early 2022, while the emerging market economies will lag.imageimage

The recovery still has a long runway, except for a few cases where output is either close to or above the pre-COVID trend. Chart 3 shows that in most cases, activity remains well below our pre-COVID forecasts (which in normal times are often not far from the prevailing trend). This is a better measure of the recovery than comparing with the pre-pandemic level, since each economy’s trend growth rate is different. Economies with high trend growth will reach pre-pandemic activity levels faster but would still be far away from their pre-COVID trend levels. For example, while activity in India is back to pre-COVID levels, official data suggest it remains nearly 12% below where it would have been in the absence of the pandemic. There is much healing left to do.image

These gaps between activity and the pre-COVID trend also suggest that the rise of inflation across the region is, for the most part, transitory. Strong demand for durable goods globally should ease as economies reopen and people are able to spend on services, from hotels to restaurants. This effect has been powerful–for example, while overall real household spending in Korea was still soft in the first quarter, spending on durables such as laptops and washing machines was 25% above trend. The base effect due to plunging commodity prices in early 2020 will also wash out of the annual data later this year.

Passthrough from inflation in producer prices (including commodities and raw materials) to consumer prices has been weak in Asia-Pacific and we expect it to remain so. The main reason is that with private consumption and services activities still soft, demand for labor is weak, and firms will not need to hike wages to attract or retain staff. With labor costs accounting for a large share of final consumer prices, this should keep a lid on inflation. There are exceptions where labor markets are tightening much more quickly, such as Australia.image

Low domestic inflation should mean central banks keep policy rates low, but an uneven global recovery will make life difficult for some emerging markets. The Federal Reserve recently upgraded its growth and inflation forecasts and brought forward its calendar for hiking interest rates. For emerging markets, this is a doubled-edged sword because faster global growth could be accompanied by rapid exchange rate depreciation as interest rate expectations elsewhere re-price higher.

Across emerging markets, interest rate differentials with the U.S. are narrower now than the post-global financial crisis average. There are good reasons for this in some cases, including unusually low inflation (e.g., Indonesia). Still, these differentials can be important for capital flows and sensitivity to U.S. policy shifts could be high—a faster onset of policy tightening in the U.S. could trigger outflows from Asian emerging markets. For these economies, often more reliant on capital inflows and less tolerant of exchange rate volatility, central banks may raise rates, even though domestic fundamentals argue for no change. This could set back the pace of the recovery.image

Regional Growth Revised To 7.1% In 2021 From 7.3%

Our Asia-Pacific growth forecast is revised slightly lower to 7.1% from 7.3% in March. We previously characterized the risks to the outlook as balanced and this is borne out by our new forecasts, with a mix of upward and downward revisions, in large part reflecting progress in managing the pandemic.

Our main assumption is that Asia-Pacific vaccine coverage reaches the 70% level identified by the World Health Organization as needed to call the end of the pandemic in three waves. The first group includes China, Korea, and Singapore around the third quarter of 2021. A second group includes Australia, India, and Japan in the first half of 2022. A third group includes most of the Southeast Asian economies which, at current vaccine run rates, may not achieve 70% until 2023 or later. Of course, the actual threshold for a full re-opening will depend on vaccine efficacy and the tolerance of governments for persistent cases.

Another key assumption is that monetary policy tightening in some Asia-Pacific economies will start in late 2021 and early 2022 but will remain gradual. In part, this reflects our assumption that the Federal Reserve’s tapering of asset purchases and the journey toward a late 2023 lift-off for the policy rate will be gradual, with manageable disruptions to financial conditions in Asia-Pacific.

A final key assumption is that oil price increases will moderate, and on average, prices will be about 10% lower in 2022 compared to the second half of 2021. Combined with the washing out of base effects, this will ease upward pressures on inflation.

Australia’s Growth In 2021 Revised Higher To 4.9%

The recovery continues to surprise on the upside, as powerful policy support adds fuel to a swift reopening. The engine of recovery has been the jobs market, with the measures of slack dropping much faster than we expected. The broad unemployment rate, including the underemployment rate, is now almost 1 percentage point below its average level for the decade before COVID-19. Together with rising home prices, this has boosted consumer confidence and lifted private consumption back to pre-COVID levels by the first quarter. Investment has been supported by tax policies and rising commodity prices. Private domestic demand is expected to outpace overall GDP growth this year as net exports drag, and public consumption growth slows.

Fiscal policy will now taper at a more gradual pace than we expected. The central bank has argued that it sees the conditions for lift-off on its policy rate only in 2024. With fiscal policy tightening less sharply and the unemployment rate falling quickly, we expect core inflation to be well within the target 2% to 3% range by early 2023. This should bring forward the rate hike cycle to late 2023, with risks of a move even earlier.

China’s Upped To 8.3% On Faster Vaccine Rollout

We edge our forecast higher to 8.3%, which still implies a cooling in growth momentum this year. While China suppressed the virus early and allowed for an almost complete domestic reopening, consumer confidence remains shaken. Saving has been persistently high and spending weak. A faster vaccine rollout may boost confidence, reduce saving, and help the economy rebalance. The recovery, until now, has been dependent on infrastructure investment, real estate, and exports, a combination that is not sustainable. As consumer spending picks up–we expect real spending growth more than 10% this year–policymakers can apply the brakes elsewhere while maintaining growth at or around potential.

Policymakers have continued to de-emphasize hard growth targets and are focusing instead on longer-term goals, including greater self-reliance in technology and reducing systemic risk. This is evident in the policy mix which shows up in tight to neutral financial conditions over recent months. We expect policies to remain broadly unchanged, albeit with some targeted tightening, especially in the property sector. We do not anticipate inflationary pressures will force policy rate hikes because the passthrough from high producer price inflation to consumer prices is typically weak, especially when private consumption and hiring in the service sector (evident from the purchasing managers’ index) has been weak.

Trade Is Driving Momentum In Hong Kong

We revise our 2021 growth forecast for Hong Kong higher to 6.5% from 4.2% earlier driven by a strong trade performance and resilient financial services activity. The city is a significant re-export hub for trade with mainland China and, as such, strong trade volumes have a large effect on overall growth. In 2022 we expect growth of 2.5%, down from 3.6% due to the higher base in 2021.

The structure of growth is still unbalanced. First quarter production GDP growth was a very strong 7.7% year on year, but the re-export business and financial services accounted for about 70% of that growth. Private domestic demand remains noticeably subdued and labor markets are weak. Employment levels are still about 6% lower than pre-COVID, which translates to nearly 250,000 jobs.

Fiscal spending is budgeted to be about 6% lower this year than actual outlays last year, which marks a gradual consolidation of stimulus. Continued strong re-export activity could present a key upside risk to our growth forecast. The accelerated vaccination efforts could also boost consumer confidence and help drive a faster-than-expected consumption recovery. On the other hand, a persistently weak labor market could weigh on consumer demand and on the growth outlook.

India Growth Outlook Lowered On A Severe New COVID-19 Wave

A gradual revival is underway after a severe second COVID-19 outbreak in April and May led to lockdowns across much of the country and to a sharp contraction in economic activity. The lockdowns were more targeted compared with the blanket national lockdown seen last year but were still enough to lower discretionary mobility to more than 60% below normal.

Manufacturing and exports were less severely affected compared with 2020, but services were acutely disrupted. Consumption indicators such as vehicle sales fell sharply in May 2021 and consumer confidence remains downbeat.

The economy has turned a corner now. New COVID-19 cases have been falling consistently and mobility is recovering. We expect this recovery to be less steep compared with the bounce in late 2020 and early 2021. Households are running down saving buffers to support consumption and a desire to rebuild saving could hold back spending even as the economy reopens.

Monetary and fiscal policies will remain accommodative but new stimulus will not be forthcoming. The Reserve Bank of India (RBI) is likely to focus its policy efforts on quantity channels rather than interest rate changes. Inflation is now running hot at above 6%, the upper end of the central bank target range, meaning the RBI has no room to cut interest rates. Fiscal policy is constrained by limited policy space, particularly because the budget for fiscal 2022 (ending March 31, 2022), which was decided before the second COVID-19 wave, had already targeted a large general government deficit of 9.5% of GDP.

We forecast growth of 9.5% this fiscal year from our March forecast of 11.0%. In fiscal 2023 (ends March 31, 2023), growth will likely come in at 7.8%. Permanent damage to private and public sector balance sheets will constrain growth over the next couple of years. Further pandemic waves are a risk to the outlook given that only about 15% of the population has received at least one vaccine dose so far, although vaccine supplies are expected to ramp up.

Economic Recovery Underway In Indonesia But COVID Risks Lurk

The gradual economic recovery in Indonesia is now at risk as new COVID-19 cases escalate across the country. This will dampen the ongoing recovery in the second half of the year as voluntary social distancing increases, and targeted lockdowns may be required. We forecast growth of 4.4% this year followed by 5.2% growth in 2022. Vaccination efforts have been gradual so far, and new virus variants could complicate pandemic management and present downside risks to growth.

The economy recovered in the first quarter, expanding 1.5% over the previous quarter supported by foreign trade and a gradual recovery in private demand. Consumer activity indicators such as retail sales, vehicle sales, and consumer confidence are now looking stronger following sharp weakening in 2020.

There is still some weakness in the corporate sector. Funding access remains uneven and bank loans outstanding are still 2.4% lower than this time last year, and sequential growth slowed to 1.2% month over month in April in seasonally adjusted and annualized (saar) terms. This is well below normal lending growth, which averaged about 6% saar in 2019. In addition, loans under moratorium are still high at about 18% of loans, which casts a shadow on credit quality.

Monetary settings will remain on hold this year with the policy rate at 3.5% followed by policy rate hikes beginning 2022. There has been a recent uptick in core inflation, but the rate of core inflation at 1.4% year over year remains well below the longer-run average of 3% year over year. Broad inflationary pressures are still subdued. The exchange rate has steadied, but remains weak against a trade-weighted currency basket compared with pre-COVID levels. Further weakening of the currency, for instance due to expectations of earlier U.S. Fed tightening, could be a trigger for Bank Indonesia (BI) to tighten policy settings despite low domestic inflation.

BI has also expanded its balance sheet through its version of quantitative easing, and the balance sheet is now 21% of GDP compared with just below 10% of GDP before the program. One effect of this has been to keep longer term yields lower amid increased government debt issuance. It also lowers the long-term yield differential between the Indonesian rupiah and the U.S. dollar.

Japan’s Recovery Set Back To Later In 2021

We revise growth for 2021 lower to 2.5% from 2.7% as intermittent states of emergency dampen mobility and consumer spending. The outlook is brightening, though, with the vaccine rollout finally picking up steam. With household saving now high, this could be enough to tempt consumers to start spending after a long period of caution–indeed, in the first quarter of 2021, real private consumption was still 5% below levels recorded just before the consumption tax hike in 2019. External demand should provide a strong boost to the recovery this year, directly through net exports but also by encouraging manufacturing investment. The Olympics do little to change the picture, especially as foreign visitors are banned, and domestic attendance may be limited.

Expectations for a snap election in the third quarter of 2021 are building and will likely be preceded by a supplementary budget. This will likely taper, rather than reverse, fiscal tightening and would hit the economy just as vaccine coverage starts to reach important thresholds, further boosting confidence and activity. We expect the Bank of Japan to maintain a largely unchanged monetary policy although small tweaks to the tolerance range for 10-year government bond yields may come if global bond yields resume their upward re-pricing, led by the U.S.

Korea Emerges As A Regional Growth Leader

A potent combination of effective virus suppression, a delayed but now rapid vaccine rollout, and strong external demand are powering growth. We have been optimistic on Korea’s prospects but still see room to revise 2021 growth forecasts up to 4% from 3.6%. The one soft spot in the economy has been private consumption, but with the government targeting threshold vaccine coverage by early in the fourth quarter, restrictions easing, and the labor market recovery back on track, we anticipate consumption will take over from exports as the main driver of the recovery.

We expect a gradual tapering in fiscal stimulus ahead of next year’s presidential election. The Bank of Korea (BoK) appears to be edging toward policy rate hikes as the recovery matures, core inflation rises, and household borrowing remains robust. While the BoK may be the first central bank in Asia-Pacific to tighten later in 2021, we do not expect a sustained hiking cycle, in part because the economy’s neutral rate of interest–the level beyond which growth slows and inflation falls–has likely fallen substantially over recent years.

Tight Lockdown Taking A Chunk Out Of Malaysia’s Growth

COVID-19 restrictions gradually tightened until a full-scale lockdown (a Movement Control Order or MCO) was brought in late during the second quarter to bring the pandemic under control. The current lockdown will be costly for economic activity, but less so than last year’s full lockdown as the economy adapts to reduced mobility. We forecast growth of 4.1% this year, down from our March forecast of 6.2%, followed by 6.3% growth in 2022 from 5.6% earlier.

First quarter growth in Malaysia was stronger than market expectations supported by trade and a gradual recovery in private demand. Trade numbers look resilient and other high frequency indicators including retail sales and purchasing managers’ indices also pointed to ongoing recovery prior to the lockdown.

Inflation rose in April to 4.7% year over year partly due to base effects and partly due to rising energy prices. Although core inflation remains subdued at 0.7% year over year, the risk of passthrough from energy prices could mean that Bank Negara Malaysia holds off easing and looks past the demand drop from the lockdown. Once the recovery starts next year, we expect very gradual policy tightening with only a 25 basis point policy rate hike in 2022.

Faster than expected vaccination coverage is an upside risk to our forecast that could usher in a strong rebound by the fourth quarter of 2021. On the flipside, if the current lockdown has a deeper than anticipated effect on employment, manufacturing, and services, especially given limited fiscal stimulus this time, there could be a more restrained recovery.

COVID Restrictions Still Weighing On Activity In The Philippines

Since our last forecast, COVID-19 cases in the Philippines shot up to a daily rate far above what we saw last year and remain very high despite some recent easing. The country reinstated strict lockdowns around the capital and neighboring regions, and even as these are being eased, mobility remains very low. The vaccination effort is picking up but remains slow. As such, a good chunk of the substantial base effects that we had expected to boost domestic demand growth have likely been diminished, leading us to revise our growth forecast down to 6.0% from 7.9%.

Nonetheless, after a weak start to the year, exports are growing at a very high clip once again, suggesting that external demand remains strong and will provide a temporary boost to external balances. Meanwhile, we continue to see inflation as transitory, driven by base effects in oil prices and a sharp one-off supply-led spike in food prices earlier in the year. As such, we continue to see rate hikes as unlikely in 2021.

Downside risks around our forecasts remain higher than normal. Uncertainties around the extent and duration of low public mobility due to the pandemic will continue to be the primary concern for growth. There is also the risk of higher interest rates globally, which could spill over into financing costs for domestic firms, further eating into the domestic demand recovery. These fundamental risks are compounded by uncertainty around the timing of this year’s cyclical trough, which would have additional implications for the growth rate via the size of the base effect.

Strong Exports Offsetting Lockdowns in Singapore

Second quarter GDP growth in Singapore will be weaker due to the recent COVID-19 restrictions to combat a spike in local infections that will depress private consumption spending. Job hiring is expected to remain subdued this year despite the rebound in labor market in the first quarter as various pandemic-related restrictions remain in place. The border reopening will likely to be gradual and will delay the recovery of tourism and aviation related sectors.

Inflation should pick up gradually, primarily driven by transitory factors including a rise in commodity prices and higher transport costs. Wage growth will likely remain soft this year and keep a cap on core inflation. The government has announced a modest stimulus this May of Singapore dollar 800 million to support businesses and individuals affected by recent restrictions. We expect the Monetary Authority of Singapore to maintain the current policy settings unchanged this year with a flat policy band on the effective exchange rate.

Strong external demand, robust semi-conductor demand, manufacturing and rising oil prices will remain the key offsetting factors supporting growth for 2021. These factors drove strong economic growth in the first quarter. Private consumption is likely to pick up gradually if the recent tight restrictions are not prolonged further. Ongoing fiscal consolidation and dampened activity due to recent restrictions remain the key downside risks to growth. We forecast growth of 6.2% in 2021 and 3.8% in 2022, compared with our earlier forecasts of 5.8% and 3.7%.

Taiwan’s Tech Sector Will Drive Growth

Taiwan had been successful in preventing local COVID-19 outbreaks through 2020, but the pandemic escalated recently and led authorities to impose mobility restrictions. The services sector could be hit by these lockdowns. However, the technology sector will continue to show resilience. The economy grew strongly in the first quarter due to exports and manufacturing, particularly in electronics. Export growth is likely to be robust as Taiwanese manufacturers increase production to meet the global shortage of chips. We raise our growth forecast for 2021 to 5.6% from 4.2% while retaining our 2022 forecast for 2.7%.

Household consumption will recover slower than expected due to new COVID related restrictions. Inflation rose steeply in recent months due to base effects from last year and higher energy prices. We raise our inflation forecasts for 2021 to 1.4% from 1.2% and 2022 to 1.1% from 1.0%.

We expect the central bank to keep interest rates unchanged at 1.125% and maintain accommodative policy stance, despite high M2 money growth that the central bank watches. Policymakers are set to double the special budget for pandemic relief to 4.2% of GDP. The COVID pandemic presents a downside risk if cases are not brought under control and restrictions are tightened. Vaccination progress has been slow but should speed up as new supplies arrive.

Tourism Outlook Still Grim in Thailand

Lockdowns in Bangkok will weigh on second quarter growth in Thailand. First quarter economic activity showed modest growth as private consumption remained weak. In addition, inventory buildup was a driver for growth in the first quarter, which is unlikely to be sustained through the year.

Merchandise trade is resilient and mobility is now normalizing following a month of lockdown in Bangkok to contain a rise in COVID-19 cases. Thailand has not been hard hit by the pandemic so far, and the latest lockdown was also effective in reducing the virus spread. There has been effort from authorities to speed up vaccinations, but limited vaccine supplies are hampering efforts for now. As global vaccine supplies ramp up, the local vaccination drive will accelerate.

We forecast a recovery in tourism only around the third quarter of 2022. At the end of our forecast horizon in 2024, we forecast Thailand’s real goods and services balance as a share of GDP at about 3.3%, compared with an average of 7.8% between 2015 and 2019. This reflects persistent damage to the tourism sector and potential for delayed normalization in global travel.

Our GDP growth forecast for 2021 is 2.8%, down from our March forecast of 4.2%, and in 2022 and 2023 we forecast growth of 4.9% and 4.6% respectively. Earlier tourism normalization than forecast could boost the recovery and push growth higher.
Source: Platts





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