The risks are stacking up for Asia-Pacific's incipient recovery. The war in Ukraine, U.S. policy rate rises, spiking energy prices, and escalating COVID cases in China are complicating the outlook for what has been healthy expansion in regional economies. S&P Global Ratings believes these new risks will generally present as inflation, and that they will dent an otherwise strong rebound from the pandemic.

Most Asia-Pacific nations are moving to a stance of living with COVID, with robustly positive economic effects. Vaccination levels are typically high. Governments and businesses have become better at adapting to outbreaks. The mood in many nations is that the pandemic is manageable, and that people can resume normal activity.

China, of course, is the big outlier. The country has stuck with its low-tolerance COVID strategy. This involves strict social distancing restrictions and lockdowns. Spreading omicron infections are testing the sustainability of this policy. The possibility of rapid transmission of omicron in China is a key risk to its economy. Indicatively, mobility restrictions in Hong Kong amid an omicron surge have set back the territory's economic recovery.

We have generally lowered our growth forecasts across Asia-Pacific and raised our inflation expectations (see table 1). This reflects already-higher energy and commodity prices, an expectation of Fed interest rate increases, and the volatility and inflation effects of the Russia-Ukraine war. The biggest decline in our 2022 growth forecasts was for the Philippines, and the largest uplift in consumer inflation was for Singapore. We have also raised many policy interest rate forecasts for 2022 and beyond.

Chart 2

Nonetheless, we still forecast solid growth in 2022 and beyond. Our expectation for robust 5.1% growth in 2022 tracks our view that Asia-Pacific's COVID recovery is at an earlier stage than that playing out in the U.S. and Europe. While output will remain below the pre-COVID trend for a long time in several economies, our forecast for GDP growth of around 4.5% in 2023-2025 means Asia-Pacific will likely resume its status as the world's fastest-growing large region.

Table 1

China's soft recovery contains Asia-Pacific's rebound

China's GDP growth fell to 4.0% year on year in the fourth quarter of 2021 on subdued consumption and the downturn in real estate. The deceleration prompted policymakers in late 2021 to put more emphasis on growth. Increased economic activity in the first two months of 2022 tentatively suggests this is having an effect.

While China's stance of low-tolerance for COVID has prevented the spread of earlier variants in China, it has weighed on consumer confidence, spending, and growth. Moreover, a low infection rate and limited vaccination rates among elderly people has left communities exposed to the highly transmissible omicron variant.

Omicron outbreaks also led to a weakening of GDP growth in Japan and India in the fourth quarter. Growth picked up in the fourth quarter in Southeast Asia, Japan, South Korea, Taiwan, Australia, and New Zealand. Asia-Pacific GDP grew 6.7% in 2021, after shrinking 1.5% the prior year.

Regional export growth is moderating. Rapid gains in exports were a key contributor to growth in 2021. While headline export increases (in U.S.-dollar terms) remained solid in the first months of 2022, this involved rising prices, with volumes slowing since mid-2021. In South Korea and Taiwan, export growth declined to 6%-8% year on year in early 2022, from over 20% in mid-2021.

Chart 2

Producer prices were rising at the start of the year, and the outbreak of the Russia-Ukraine war has drastically amplified the trend. Consumer inflation is exceeding targets in Australia, India, New Zealand, the Philippines, Singapore, South Korea, and Thailand (see chart 2), and this is putting some central banks on a tightening path.

Inflation and financial stability considerations have led the Bank of Korea and the Reserve Bank of New Zealand to raise rates in 2022, adding to increases in 2021. The Monetary Authority of Singapore has twice tightened its policy since the fall of 2021. Taiwan's central bank in March raised rates in the same week as the U.S. Federal Reserve.

The U.S. Federal Reserve's shift toward faster interest increases in response to rising inflation is an important change in regional settings. The Fed hiked rates by 25 basis points at its March meeting but indicated aggressive policy to follow. We expect seven rate hikes in total in 2022 (including a 50 basis point hike), followed by four to five rate increases in 2023.

China is again the outlier. As part of the shift to a greater focus on growth, its central bank recently lowered interest rates, cut reserve requirement ratios, and called on banks to increase lending.

Ukraine Is The Wild Card

The war in Ukraine is perhaps the biggest X-factor in our economic outlook. As discussed in our preliminary global forecast of March 8, the effect of this conflict will largely be transmitted through global markets and international trade. Our new global forecast assumes the conflict will remain contained in intensity and geography, and will be limited in length. The war will continue for two quarters, in our opinion, with sanctions on Russia likely to remain in place after armed conflict has ended. Average oil prices in 2022 should be about one-third higher than what we assumed in November 2021.

Chart 3

• Higher costs for energy and other commodities will push up prices. This will challenge countries where consumer inflation has already exceeded central banks' targets.
• Higher energy prices will weigh on current-account balances and real purchasing power in the many net-energy-importing economies. This will be particularly true for South Korea, Taiwan, and Thailand, where net energy imports are the largest, compared with the size of the economy. High prices will be a plus for the region's net energy exporters--Indonesia, Malaysia, and, especially, Australia.
• The commodity price changes and volatility will likely weigh on the region's currencies and asset markets, in the context of rising global interest rates. Emerging Asian nations will feel this pressure most acutely if they are net energy importers and don't have a significant current-account surplus (see chart 3). These countries include India, the Philippines, and Thailand. As shown in the weeks after the outbreak of the conflict, the Korean won is also susceptible to such strains.
• Higher inflation, reduced purchasing power in most economies, and weaker export demand and confidence will weigh on economic growth; this accounts for much of the reductions in our growth forecasts, compared with November.

A key question is how central banks will respond to the Ukraine war (see "Ukraine Conflict Divides Asia's Energy Haves And Have-Nots," published March 9, 2022). Inflation or currency strains may prevent many central banks from easing their stances. But, where neither is a major issue--in China, Japan, Malaysia, and Taiwan--there may be scope for an easier monetary stance than what was planned before the conflict. Such easing would dampen any hit on growth arising from the conflict.

China: 2022 growth target will be hard to achieve

China announced an ambitious economic target for 2022. In line with efforts to improve the quality of growth and contain financial risks, its growth goal of "around 5.5%" was again lower than that of a year earlier. In a climate of a property downturn and escalating COVID cases, it is still an aspirational target. The level indicates that officials are focused on the economy--a shift from a prior emphasis on financial stability matters.

Following a tight fiscal stance in 2021, the country's fiscal deficit will likely rise this year as infrastructure investment picks up speed and taxes are cut. The rise in consumer inflation this year is unlikely to substantially challenge monetary policy. Nonetheless, rising U.S. interest rates limit the room for domestic rate cuts.

There will be a further modest reduction in the medium- and long-term financing rate, in our opinion. This will likely come on top of more cuts to the reserve requirement rate, more encouragement of bank lending, and further easing of policies on property financing and regulation.

The government will struggle to meet its GDP target, in our view, given the stresses of the property downturn, the war in Ukraine, and omicron. However, its efforts to achieve this goal lower the downside risks to our baseline forecast of 4.9%.

India: Price squeeze points to monetary normalization

We retain our November 2021 forecast that India's GDP will expand 7.8% in fiscal 2023 (ending March 2023). The third wave of COVID infections ended earlier and should cause only limited economic damage. However, the Russia-Ukraine conflict will likely weigh on the country's economy. The risks to growth are tilted to the downside.

Given our current oil price forecast, average consumer inflation is likely to stay firm at 5.4% in fiscal 2023 (see table 2). The rise in inflation should compel India's central bank to signal a neutral stance in its April review meeting, followed by a normalization of the policy-rate corridor (the gap between the repo and reverse repo rate). This will involve an increase of the reverse-repo rate.

After that, the central bank will likely raise the repo rate by at least 50-75 basis points through fiscal year 2023, and by another 50 basis points in fiscal 2024.

High inflation will dampen private consumption, the largest component of demand and the last to recover from the pandemic. The outbreak exacerbated the underlying weakness in private consumption seen in fiscal 2020. The government may end up using fiscal policy more aggressively than it laid out in its budget for fiscal 2023. This will help those most affected by the pandemic until investment-led growth lifts the labor market, and private consumption demand becomes self-sustaining.

Table 2

Southeast Asia: A strong recovery from COVID lows

The region made a strong recovery during the final quarter of 2021. Softening global demand growth and the Russia-Ukraine conflict will weigh on the region's economy in 2022. This should slow the expansion of exports and manufacturing, which were key growth drivers in 2021, while greater uncertainty and higher energy prices will weigh on domestic consumer sentiment. As a result, we lowered our 2022 growth forecast for emerging Southeast Asia to a still robust 5.0%, from 5.6% in November.

High energy prices will be a pain point for the region's consumers and will strain some nations' current-account balances. Malaysia is well positioned to weather higher energy prices as a net energy exporter, primarily of gas. Producers will not be able to fully benefit from energy price rises, because the government will likely limit the increases they can pass onto domestic consumers.

Indonesia is also a net energy exporter, but much of its surplus is driven by coal exports. The country is an oil importer. Oil product consumers will still feel the pinch of higher crude prices. The other economies in the region are net energy importers; higher energy prices will hit purchasing power and the current account in these countries.

Broadening inflationary pressure and rising U.S. policy rates are pushing regional central banks toward tighter policy. Weakening confidence and risk sentiment will weigh on growth. Southeast Asian central banks will cautiously raise rates in such an environment. Our baseline forecast is for less monetary policy normalization than in the U.S. However, if rates rise in the U.S. and deteriorating risk sentiment triggers capital outflows, Southeast Asian central banks may be forced to tighten monetary policy more than we now anticipate in our base case.

Table 3

Advanced economies: Well-placed to weather shocks

Japan, South Korea, and Taiwan are likely to continue to grow significantly in 2022. Despite the shocks that have occurred recently, our growth forecasts for these economies have not changed substantially compared with November. Rising energy and commodity prices stemming from the Russia-Ukraine conflict will hit import bills and consumers, even if gasoline subsidies and tax cuts ease the effect somewhat in Japan and South Korea.

The recent economic hit of COVID has generally been milder than we had expected, and domestic demand should contribute more to growth this year. As major manufactured goods exporters, a dampening in global demand will hit the advanced economies. However, the gradual resolution of supply-chain bottlenecks will lift Japanese exports, notably in the car industry.

Japan's recovery from COVID has so far been muted, due to initial delays in its vaccination campaign and to the effects of supply-chain outages. Pent-up demand will likely surface this year, particularly as bottlenecks ease. As such, strong GDP growth is likely in 2022, even as expansions in South Korea and Taiwan slow.

Our base case is that Japan's consumer inflation will rise significantly this year amid higher energy prices, and as the effect fades of a prior drop in mobile phone charges. However, with wage growth unlikely to rise significantly, inflation should retreat in 2023 alongside lower energy prices. As a result, while the Bank of Japan has been able to taper its asset purchases, it will likely keep its policy rate at around zero in 2022 and 2023.

In South Korea, the hit from a fast-moving omicron outbreak to consumer confidence has remained contained as people are growing more comfortable with the disease. Given high vaccination levels and the government's shift toward living with COVID, the economic hit of the outbreak should be modest.

Inflation is set to further exceed the Bank of Korea's target, and the won is susceptible to capital outflow. The central bank will continue to raise its policy rate, in our view.

In Taiwan, household spending has been more sluggish, with consumer confidence remaining weak, in part due to intermittent lockdowns to curb the spread of COVID. Taiwan's large current account surplus and tame inflation should result in only modest policy rate increases in the rest of 2022, following the March move.

Table 4

The outlook for Australia and New Zealand is favorable. We forecast robust GDP growth for both in 2022. In Australia, this is building on strong growth in the fourth quarter of 2021. Following the relaxation of COVID containment measures, omicron's dampening effect on the economy should fade this year. Also, exports of raw commodities including energy (in Australia's case) will moderate the hit on growth exerted by the Russia-Ukraine conflict.

Although these economies stand to experience a favorable terms-of-trade effect from higher commodity prices, the cost rises will add to inflation. With labor market conditions in Australia still soft and wage pressure muted, the cash rate will rise only moderately this year, in our view.

Inflation strains are more pronounced in New Zealand, which has labor shortages. While house prices have eased since December 2021, they remain an issue for the central bank. We have raised our 2022 year-end policy rate forecast to 2.0% from 1.25%, and cash rates of 2.75% by year-end 2023 (up from our prior projection of 1.75%).

Key Risks Ahead: Ukraine, Inflation, Rates, And China Property

An escalating Russia-Ukraine conflict could rapidly increase energy prices, hitting demand and creating turmoil in financial markets. Asia-Pacific central banks may be forced to tighten monetary policy more aggressively. This could stop the region's post-COVID recovery in its tracks.

Rising global interest rates may also trigger capital flight in emerging Asia, hitting regional currencies and fixed-income markets. Those countries that are net energy importers with a slim current account surplus or a deficit are most exposed to this strain.

The region will also need to manage its exposure to China's economy, given its outsized influence. Rising omicron cases in China may lead to fresh lockdowns, hitting growth. Meanwhile, the country's policymakers are trying to steer property developers toward more deleveraging, and to reduce the reliance of the economy on this sector.

As they pursue these goals, they risk triggering a dramatic property downturn, which would bring systemic economic and financial stress. The government during the National People's Congress meetings in March did not outline any new bold plans for its "common prosperity" push, or to continue to clamp down on sectors where private firms dominate, such as technology. Nonetheless, the regulatory and policy uncertainties of such initiatives linger.

Editing: Jasper Moiseiwitsch

Related Research

• COVID And Conflict Strain Asia-Pacific Sovereigns, March 24, 2022
• Credit FAQ: How The Russia-Ukraine Conflict Is Affecting Ratings and the Global Economy, March 24, 2022
• Ukraine Conflict Divides Asia's Energy Haves And Have-Nots, March 9, 2022
• Global Macro Update: Preliminary Forecasts Reflecting the Russia-Ukraine Conflict, March 8, 2022
• Economic Outlook Q1 2022: Rising Inflation Fears Overshadow A Robust Rebound, Dec. 1, 2021
• Asia-Pacific: Ghosts of COVID Past Hover Over 2022, Nov. 30, 2021

Appendix

Table 5