Asia-Pacific is managing the pandemic well. The health and economic effects have been far tamer in the region than elsewhere in the world. However, S&P Global Ratings believes the region's slack domestic demand and reliance on exports could restrain its recovery and inflame trade tension with the West.

First, let's recap some of Asia-Pacific's achievements. The region contained death rates due to COVID-19 to 81 per million people in early February, compared with 1,066 in the European Union, and 1,339 in the U.S., according to the University of Oxford. The decline in economic activity at the trough, compared with the pre-pandemic trend, was less than elsewhere. We expect the permanent damage to output to vary but on average be lower than elsewhere, at around 4%-5% of GDP. There are notable exceptions to this trend, especially India.

All along, we have said that jobs will drive the recovery. Not all economies publish detailed jobs data, including China. Still, from the places that do provide data, the narrative is once again one of Asia's resilience. Short, sharp lockdowns and policies designed to keep people employed, including wage subsidies, have limited job losses and fueled a rebound in hiring (see chart 1). This will support household income as stimulus inevitably wanes.

Chart 1

Factory Asia In Full Flow

Factory Asia has also benefited from surging export demand (see chart 2). The story is well known. Work-from-home measures have boosted electronics demand, consumers have switched some spending from services to goods, and demand for health-care equipment has risen. Exports, excluding fuel and measured in U.S. dollars, reached highs during 2020, propelling the region's export machine. China, Singapore, and Taiwan benefited most.

Chart 2

Asia's industrial supply chains are up to the task. The delivery of auto parts from Hubei province in China, or semiconductors from Taiwan, has seen some disruption. But Asia's industrial sector has largely scaled up supply to meet global demand. The region's manufacturing output has recovered strongly and is outpacing the major developed economies of the G-20 (see chart 3).

Chart 3

So, Asia Is Leading The Global Recovery? Not So Fast

The popular narrative is Asia is leading the recovery and digging the world out of a big hole. This is not quite right. Demand from the rest of the world is helping Asia out of the hole. This is mainly due to cautious Asian consumers despite the resilience of labor markets.

The spending rebound has been slower than in Europe or the U.S. (Australia is a notable exception). Retail sales at the end of 2020 were either still lower compared with a year ago or, in the case of China, growing more slowly than before the pandemic (see chart 4). There has been no sign of pent-up demand.

Chart 4

Sluggish domestic spending, especially compared with the rest of the world, is forcing up Asia's current account surplus. We estimate the region's surplus with the rest of the world has risen above 3% of GDP from well below 2% before COVID. In some cases, we expect higher surpluses to be temporary because they reflect exceptionally depressed imports. India is a good example of this. Asia's export boom also explains the surpluses.

Asia's Saving Has Soared, And It Is Being Sent Overseas

A more revealing way to think about the current account surplus is in terms of its definition as the gap between domestic saving and investment. Higher surpluses are telling us something important. Asia is saving more and investing less, relative to the rest of the world during the recovery. For Asia-Pacific excluding China, saving has risen and investment has fallen, as a share of GDP (see chart 5). We do not have a similar breakdown for China but its higher current account surplus tells the same story.

Chart 5

How is this working in practice? Look at chart 5 again. Investment needs fell by about 1 percentage point (ppt) of GDP in the second and third quarters of 2020. At the same time, saving has gone up by almost 2 ppts of GDP. This figure includes all types of saving: by households, corporates, and governments. We suspect that household saving rose and this was not offset by lower government saving. In other words, as households tightened their belts, governments loosened theirs. We do not have detailed household saving data for all countries.

If saving is higher and investment is lower in Asia-Pacific, the excess saving must go somewhere. It will go to fund investment in the rest of the world (RoW).

The RoW must absorb these savings from Asia somehow. Let's focus, for now, on Europe (the EU) and the U.S. Investment needs in Europe and the U.S., as a share of GDP, did fall in the second quarter but quickly bounced back. However, national saving fell as governments dissaved (again, this is a story of fiscal stimulus), helping offset the rise in household saving. This created a wider gap between investment needs and domestic saving that Asia helped fill.

This sounds like a good deal for the EU and the U.S. They get to use Asian saving to fill their financing needs. This is not the full picture. If Asia saved less and imported more from Europe and the U.S, incomes in these economies would also be higher. Higher incomes could be saved by households and governments (and therefore used for for even higher investment) or invested directly by more profitable firms. Alternatively, households outside Asia could spend their higher incomes, further supporting global demand.

Could Asia's Current Account Surplus Keep Rising?

Is this just temporary? The benefits of a well-managed pandemic for Asian consumers, including a steady jobs market, should fuel more consumption this year. Faster growing consumption in China, Japan, Korea, and elsewhere should mean higher imports. This excludes base effects that will distort early 2021 data.

However, there are two reasons to think that the effect on current accounts may be moderate.

First, Asia may prove slower than other regions to vaccinate. The region is off to a slow start. While a pickup in speed is likely in some countries, some estimates suggest China and Japan may fall well behind vaccination rates in the U.S. and Europe by the end of 2021. Both countries have been reluctant to set vaccination targets. Vaccination shortfalls should delay a full normalization of Asian economies. This will weigh on jobs, incomes, and domestic demand.

Second, global travel will likely remain depressed and this is especially important for China's contribution to global demand. For the first three quarters of 2020, travel-related outflows (including spending by Chinese tourists overseas) fell by US$93 billion compared with the same period in 2019. This is over three times larger than the decline in China's imports of goods of just US$31 billion.

Why This Matters--Global Growth And Trade Tension

Until Asia starts pulling its weight in the demand recovery, global growth will fail to live up to its potential. The recovery will remain over-dependent on stimulus and consumers in Europe and the U.S. Asia may see persistent economic slack, low inflation, and a steady turn lower in expectations for revenue growth for some firms.

We believe Asia can escape this trap. Our forecasts assume a rotation in Asia's demand will gain momentum in 2021, led by a pickup in consumer spending in China. This rotation may be slower than markets anticipate, however.

Asia's sluggish domestic demand recovery will also influence the debate over global trade. We anticipate the Biden administration will turn its focus from bilateral trade deficits (which never made much economic sense) to broader measures of demand imbalances.

The size and trend of current account surpluses are important. When a trading partner's current account surplus rises above 2% of GDP for a 12-month period, the U.S. Treasury adds this to possible evidence of "unfair" currency practice (such as intervening to keep the currency cheap).

Asia-Pacific's current account surplus, including China, rose above 3% of GDP in both the second and third quarters of 2020. If the region's current account surpluses remain high or rise further, the U.S. should adopt a tougher stance with some Asian countries. Concerns about external imbalances and currency undervaluation may broaden, reigniting the debate about currency wars.

The U.S. Treasury recently named Vietnam as a currency manipulator, and China, India, Japan, Korea, Malaysia, Singapore, Taiwan, and Thailand are all on the watchlist. Rolling back tariffs on China may be harder and more countries may also be at risk of being labeled currency manipulators.

There are good domestic and international reasons for Asia to find a solution to its domestic demand problem.

Related Research

• The Missing Factor In China's Remarkable Recovery, Jan. 18, 2021
• Global Economic Outlook: Limping Into A Brighter 2021, Dec. 3, 2020