Why cautious optimism about the global economy is justified
How quickly has the gloom around the world economy lifted. Just a few weeks ago, many forecasters were warning that the year ahead would be fraught with challenges. Sentiments have now turned around, with financial markets surging as they priced in better economic outcomes.
The International Monetary Fund (IMF) has helped the mood by upgrading its expectations for global economic growth in 2023. The normally cautious IMF noted that while the risks had appeared to be all to the downside in late 2022, it now sees the risks as balanced between the upside and downside possibilities.
There are good reasons for the brighter outlook as the major economies appear to be weathering the multiple shocks that hit the world economy last year — sharp monetary tightening, the Ukraine war, China’s extreme zero-Covid measures and an energy and food price shock that sent inflation soaring. In particular, the latest data suggests that the US and European economies have been quite resilient and look set to avoid a major recession. This improvement in the global scene sets Asian economies up for better prospects this year.
But, first, expect a weak start to 2023
In the near term, we should not get carried away with the good cheer. The early part of this year will see economic weakness in much of the world. All the credible forward-looking indicators such as the OECD’s composite lead indicators point to slower growth in coming months, and perhaps even a recession in some economies.
Trade data from bellwether exporters such as South Korea show significant weakness. The plunge in new export orders received by Taiwan, another major global exporter, also foretells falling exports of manufactured goods across Asia. Purchasing manager surveys for January speak of business leaders expressing pessimism for sales in coming months. In the US, the Conference Board’s index of consumer expectations is at a level which in the past would predict a recession.
Thus, we should expect downbeat economic data in the US, Europe and other developed economies in the next couple of months. Inevitably, that must translate into declining exports for Asia’s trade-oriented economies. This is why the latest numbers for Singapore’s exports and industrial production were so weak. And it is probably why Malaysia’s manufacturing sector purchasing manager index fell to a 17-month low of 46.5 in January.
Beyond that, a rebound is likely
Nevertheless, there are compelling reasons why the global downturn that is currently underway is likely to be short and shallow.
The first reason is that the picture in China has brightened since its leaders abandoned their rigid zero-Covid approach which had severely undermined the economy. Moreover, despite
the rushed and ill-prepared manner of the policy reversal, China appears to have avoided the public health catastrophe that some had predicted. Hundreds of millions of people have been infected and many thousands have died, but the toll has been far less than feared.
As far as we can tell, these infections and fatalities, while very sad to read about, have not been on a scale that dealt a blow to consumer or business confidence. Indeed, high-frequency data on spending by ordinary Chinese during the Spring Festival showed a fair degree of “revenge spending” in some segments. The government estimates that spending during the holiday period surged 30% over the same period last year, with much of it being spent on retail, catering and domestic travel. The number of domestic trips rose 23% to 308 million this year over last year. Growth in spending on big-ticket consumer durables such as cars was, however, more subdued.
Nevertheless, there was enough of a recovery for a noticeable improvement in the purchasing manager indices for January. It is clear that conditions have perked up smartly, especially in the services sector — the official non-manufacturing purchasing manager index leapt to 54.4 in January from 41.6 in December. Things improved in the manufacturing sector but it looks like most of the uptick was among large enterprises, whereas small and medium companies have improved only modestly.
We think that the revival in China will gather more momentum as the year progresses. Policymakers have made clear their intention to further support spending. Prime Minister Li Keqiang has made boosting consumer spending a high priority, so we expect more measures to be rolled out in coming weeks to stimulate spending.
The government’s measures to stabilise the real estate sector are also likely to be stepped up as the sector remains a drag — home sales fell even more sharply in January than in December. As so much of middle-class Chinese households’ net worth is tied up in housing, a recovery in the property market should have an outsized impact on consumer confidence and spending.
A second reason is the unexpected degree of resilience in the US and Europe.
Europe’s economy actually expanded in the fourth quarter of last year, defying the consensus expectation of a contraction. The energy crunch did not turn out to be so damaging, partly because of warm weather that reduced demand for natural gas, but also because the authorities acted with impressive effectiveness to source new supplies
of gas to replace Russian supplies that had been cut. Europe still has a rough few months ahead, but the better-than-expected outcome is helping to steady confidence so that a decline in output can be minimised this quarter.
Similarly, in the US, while there are unambiguous signs of a weaker economy, things are not as bad as feared. Consumer spending and investment activities by companies certainly lost vigour as last year ended. The housing sector is also showing signs of weakening.
Still, there are some compelling reasons why the US economy can hold up. One is the tight labour market. Although the number of new jobs created each month has been diminishing, demand for labour is still expanding and job vacancies vastly exceed the number of people looking for jobs. Wages are rising as a result — and with inflation coming down, that means that workers’ real spending power is improving. In fact, the last six months of 2022 saw real disposable incomes growing after a weak first half of the year.
There are also signs — although tentative — that the housing market is stabilising rather than plunging as feared. Home builders’ confidence has improved, while new home sales increased in December.
Third, financial conditions have eased of late.
Estimates of global inflation showed that it began to ease in December. Forward-looking indicators that predict inflation such as inflation expectations of consumers suggest that the worst is over and that inflation will fall as the year progresses, a much better outcome than many had expected. This is why the Federal Reserve Bank is willing to slow down the pace of its rate hikes. That in turn has allowed bond and equity prices to recover, which has led to financial conditions easing. Higher equity valuations help to bolster confidence among business leaders as well, helping to support a recovery in capital spending later in the year.
What can go wrong?
Still, we are not entirely out of the woods yet. There remain many flash points that could turn out badly and hurt the world economy. But, for now, our judgement is that these downside risks can be managed.
Geopolitical hot spots remain a worry. It is possible that the war in Ukraine might take a turn for the worse. It looks like Russia is preparing for a new offensive with the large number of fresh troops that it has mobilised. Ukraine is getting better weaponry from the US, Europe and other allies. So, the fighting could intensify.
But, we would still argue that the main channels through which Asian economies might be hurt — another food or energy price shock or dislocations in supply chains — do not seem likely to operate the way they did last year. Food and energy prices have fallen back as the world adjusted to higher prices while producers have managed to diversify away from relying on supplies of key materials from Ukraine or Russia.
And, as far as risks of conflict over Taiwan are concerned, we assess that apart from an accidental clash, there is little likelihood of a major military clash — both the US and China are keen to avoid that risk at least for now. Political risks do remain in North Korea and the SinoIndian border, but there are no signs of any imminent shocks there.
Could global inflation surprise on the upside?
Some fear that China’s unexpected recovery could spark off higher inflation as its massive economy starts to increase consumption of raw materials and consumer goods. We are less concerned. We think that China’s growth will improve from around 3% in 2022 to around 4.5% in 2023. Even with China contributing 18% of the world economy, the additional Chinese demand is only around 0.3 percentage points of global output, not large enough to add enough demand to cause overall prices to rise.
Financial dislocations could be a concern.
We are witnessing an unusually rapid rise in global interest rates and liquidity being withdrawn by central banks, after a long period of extraordinarily low to zero interest rates and plentiful liquidity. History is replete with examples of financial imbalances and bubbles bursting when rates rise and easy money is taken away. So, while it is always hard to pinpoint where the financial shock could come from, we know from experience that the coming year or two could see a fair share of financial sector difficulties.
Implications for Asian economies
The pattern in recent months has been that the more advanced economies in the region which are significantly exposed to the electronics cycle — South Korea, Taiwan, and Singapore — are losing momentum. This is likely to continue in the near term.
However, it has been quite striking how economic vigour has remained in other economies. The purchasing manager indices for India, Indonesia and Thailand showed strength in these countries’ manufacturing sectors in December. This resilience stems from several factors: these included the release of pent-up demand as covid restrictions ended, the rebound in cross-border tourism, which is likely to strengthen greatly as the year progresses, and rising domestic and foreign investment.
If the global economy regains momentum in the second half of the year as we expect, then this resilience will continue. Thailand, in particular, is likely to see higher economic growth this year compared to last year, given its large exposure to the likely revival in Chinese tourism. The other economies in Southeast Asia are set to perform reasonably well, slowing only a tad from last year. Because of its high gearing to global demand and electronics as well as a strong base last year, Singapore will probably see a marked slowing this year but can still avoid a recession.
All in all, a relatively good outcome, given the fears we had as last year ended.