Chief Economist for Asia Pacific at NATIXIS and Senior Advisor at TABF

(Senior Research Fellow at Bruegel/Adjunct Professor at HKUST)

After a fast technical rebound in the first half 2021, Asia GDP growth quickly sagged in the second half of the year, as Covid-related suppression measures were tightened and  supply chain constrains continued to bite. The power crunch in China and the several defaults of real estate developers and the forced deleveraging also pushed down growth in China, with reverberations for the Asian region. Still, external demand helped both China and the region, as a whole, to keep a moderately high growth during the year. This, however, might be much harder in 2022 as global growth is expected to decelerate even more so in the light of a new Covid mutation, omicron, which could expand even faster than previous variants. All in all, weighted average GDP growth for the Asian region should end at around 6.1% in 2021, from -0.8% in 2020 and land at 4.7% in 2022.

Growth consolidation in 2022 hinges on a number of assumptions, namely the steady exit from Zero-Covid policies in Asia although not yet in Greater China but also the easing supply shocks, as well as supportive fiscal policy, especially in China and Japan. The outlook is clouded by slower external demand, impacting export-driven economies, such as South Korea, but also new cross-border restrictions which could create additional hurdles for the good functioning of the global value chain. As if this were not enough, global financial conditions are bound to tighten, led by the US, which will put pressure for central banks. As the FED’s tapering gets into full wind in 2022, it will leave the door open to interest rate hikes thereafter. The market is already discounting two hikes of 25 basis points by the end of 2022, which is bound to push Asian central banks to follow. For some, the process has already started, such as in South Korea but also in Australia. China, however, is on a clearly different path, namely on an easing path, in order to cushion the cyclical deceleration. In fact, the People’s Bank of China has already started to ease by cutting the reserve requirement ratio and more cuts are expected in the coming year. The Bank of Japan is not expected to make any change to its current monetary strategy as inflation remains muted. More generally inflation is expected to raise in the region from the rather moderate levels in 2021, especially when compared to the US and Europe but not to the point of breaking the boat and forcing Asian central banks to overreact. All in all, their responses are expected to be gradual, keeping monetary conditions accommodative, even if tighter, except for the case of China and Japan. In the case of China, monetary easing will not be enough to avert a rapid deceleration of the economy and, therefore, fiscal stimulus will need to take place, through the fastest and most effective means that China has long followed for such endeavor, namely infrastructure investment. In fact, we are starting to see a turnaround in the amount of local government debt issued to finance infrastructure.

Our baseline scenario is not without risks. The first which has already been mentioned, is that Asia backtracks on its opening progress in response to a new Covid-19 threat. Omicron is clearly the first of these threats and perhaps relevant enough on its own, but it is too early to tell. The second risk, which is related to the former are renewed supply chain disruptions which could stem from border closures in Asia but also domestic lockdowns in Asia or elsewhere. This second risk is not only a problem for growth, as it makes manufacturing production more difficult, but also for inflation as has become increasingly clear this year.  By the same token, Asia's awakening to the need to push for energy transition in the light of their climate commitments is positive in its own right but can have unintended negative consequences, both on growth and inflation, that need to be factored in. In fact, much bolder commitments to reduce emissions are bound to prolong the energy crunch experienced by several Asian countries, notably China, into 2022 and beyond. The next risk relates to spillovers from China’s deleveraging drive, especially in the real estate sector. This bloated sector, which accounts for a third of China’s growth directly and indirectly, will need to shrink with an obvious negative impact on fixed asset investment. In addition, plummeting housing transactions and land sales are going to put some real estate developers, but also some local governments, in trouble requiring a masterful monitoring by Chinese policy makers. Finally, US-China strategic competition remains a key risk. Notwithstanding the renewal of high-level meeting, they should only be read as de-risking device while the US economic containment on China continues as well as China’s continued push to gain global influence. With such high stakes, growing disagreement and selective decoupling remains a major risk.