China is coping while its neighbors step up. A property downturn is still a pain point for the Chinese economy, but growth momentum has slightly improved because of policy support. Outside of China, economies have generally held up well. Asia-Pacific as a whole continues to grow despite meagre support from external sources. Emerging market economies with solid domestic demand are posting the strongest growth.

We have raised our China growth forecast for 2023 to 5.4%, from 4.8%, and that for 2024 to 4.6%, from 4.4%. For the rest of the region, we have raised our growth outlook for 2023 somewhat to 4.1%, from 3.9%, while toning down our projection for 2024 to 4.2%, from 4.4%.

The Global Setting Is Tough

A soft landing in the U.S. and Europe is possible but not certain.  It appears policymakers in the U.S. and Europe can lower inflation without causing a substantial economic downturn. That said, growth in Europe considerably lags that in the U.S. Also, we expect the U.S. economy to slow from the fourth quarter onward, with very low positive quarterly growth until a mild pickup later in 2024.

Still, global interest rates are likely to remain higher for longer.  The decline in U.S. inflation toward the U.S. Federal Reserve's 2% target will be gradual. We expect another policy rate increase in December and the first policy rate cut to occur only in mid-2024. U.S. Treasury bond yields have also risen. In all, the strain from higher U.S. interest rates on Asia-Pacific markets and currencies will likely persist into 2024.

There are major risks around this baseline.  A more resilient U.S. economy would call for rates to be even higher for longer. On the other hand, the U.S. economy could slow more than economists expect, which would likely lead to faster policy rate cuts.

China To Grow In Line With Potential In 2024

Following a weak second quarter, growth improved in the third quarter.  China's post-pandemic recovery slowed in the second quarter as the property weakness re-emerged and confidence soured. After finding a trough in July, growth momentum has improved since August (see chart 1).

The pick-up in growth partly reflected a range of policy measures to support growth and boost confidence.  Fiscal and monetary easing has remained limited until recently. But the measures have started to add up, especially in real estate. Also, following ill-timed underspending by the government in the second quarter, fiscal expenditure picked up in August. In all, quarter-on-quarter GDP growth rose to 1.3%, from 0.5% in the second quarter.

A comparison of investment growth between real estate and the rest of the economy lays bare the gulf between the two spheres since late 2021. Whereas real estate investment shrank 11.2% year on year in the three months to October, investment in the rest of the economy grew by 7.6% on that metric, in our estimate (see chart 2).

Chart 1

Chart 2

In late October the government announced an uncommon 0.8% increase in GDP in the official 2023 government deficit. It is financed by additional issuance of central government bonds and will fund infrastructure spending by local governments. While it is too late to meaningfully affect growth in the fourth quarter, it should help support the economy at the start of 2024.

China's outlook has improved, but obstacles remain.  We have raised our 2023 GDP growth forecast to 5.4%. This follows the better third-quarter outcome and revision of the quarterly growth data for 2022 and the first half of 2023. Still, with the property sector struggling and confidence subdued, the growth outlook remains moderate.

Macroeconomic Stimulus Likely To Remain Contained

We expect policymakers to balance the desire for growth with a focus on containing financial risks and leverage.  Moreover, there are some constraints on monetary policy easing. Policymakers are keen to maintain banks' net interest margins at a level that keeps the banks sufficiently profitable. They are also reluctant to increase the interest rate differential with the U.S. too much because that encourages capital outflows and puts strain on the currency. This, in turn, limits the room for further interest rate cuts.

We nevertheless anticipate some additional policy easing in coming months. This includes a cut to the reserve requirement rate and a small reduction of the policy rate, as well as possibly a higher fiscal deficit and larger local government bond quota in 2024.

Our base scenario sees GDP growth in 2024 of 4.6%. A property-driven downside scenario (with a 20% probability) would drag growth down to 2.9% next year (see "China's Growth Could Fall Below 3% If The Property Crisis Worsens," published on RatingsDirect, Oct. 24, 2023).

We see sustained deflation as unlikely despite the recent low and even negative consumer inflation.  Sharp falls in pork prices have been a key driver of the consumer price weakness recently, while core inflation has remained positive. With services prices likely to continue to rise, we don't see persistent consumer price deflation.

However, the downward pressure on prices in many goods markets is a long-running feature of China's unbalanced economy, and is unlikely to dissipate in 2024.  Our GDP growth forecast for 2024 is broadly in line with our estimate of potential growth. This suggests the slack in the economy that is weighing on profit margins and prices in many sectors in China's economy will persist next year.

In this connection, the rebalancing of the pattern of China's growth from investment to consumption and from industry to services halted in 2016 and went into reverse during the pandemic (see "The Case For Cautious Optimism On China's Rebalancing And Openness," March 13, 2023). Better aligning supply and demand would require more policy effort to restart the rebalancing process.

Amid the interest rate gap with the U.S. and subdued confidence, the renminbi has faced depreciation pressure vis-à-vis the U.S. dollar this year. Indeed, with China's inflation much lower than that of most of its trading partners, the country's real effective exchange rate has depreciated considerably (see chart 3).

The authorities have since August dampened the currency weakness to contain capital outflows triggered by worries about currency depreciation. They adjusted the setting of the central rate for the currency's band, tightened regulation on capital outflows, and made shorting the offshore renminbi less attractive.

The pressure on the renminbi from high U.S. rates will likely persist into 2024. In our view, the authorities may continue to shore up the currency if they feel the depreciation pressure is too strong. When the pressure from U.S. interest rates recedes, we expect the renminbi to appreciate against the greenback.

Growth In Asia-Pacific Ex-China Remains Resilient

Our estimates suggest that seasonally adjusted monthly export volumes have bottomed out in Japan, South Korea, and especially in Taiwan (see chart 4). National account data also suggest an improvement in export volumes in the third quarter in several countries. However, given the moderate global economic growth prospects, the region's export recovery is likely to remain modest.

Chart 3

Chart 4

Asia-Pacific economies outside of China have generally held up well.  In developed economies robust labor markets and service sectors have buoyed growth. Emerging market economies have gained support from the post-pandemic resumption of the earlier robust domestic demand trend (see chart 5).

S&P Global purchasing managers' indices (PMIs) suggest Asia-Pacific economies have generally continued to expand. In October, manufacturing PMIs remained below 50 in developed economies, although they have risen in South Korea and Taiwan, reflecting stronger activity in the semiconductor industry.

In Southeast Asia, the manufacturing PMI mostly exceeded 50 in October, including in the Philippines, where it has jumped since September. Only in Malaysia did it remain below 50. While India's manufacturing gauge eased, at above 55 it remained strong. The services sector PMI has fallen in Japan and Australia, but it remained above 50 in Japan.

Overall, growth this year and next is on track to be the strongest in emerging market economies with solid domestic demand: India, Indonesia, Malaysia, and the Philippines.

We have revised up our projection for India's GDP growth for fiscal 2024 (ending in March 2024) to 6.4%, from 6%, as robust domestic momentum seems to have offset headwinds from high food inflation and weak exports. Still, we expect growth to slow in the second half of the fiscal year amid subdued global growth, a higher base, and the lagged impact of rate hikes. As a result, we have lowered our outlook for growth in fiscal 2025 to 6.4%, from 6.9%.

We expect growth to be the lowest in developed economies particularly exposed to the weak global trade conditions (South Korea, Taiwan, Singapore) or where the central bank has raised interest rates a lot to fight inflation (Australia, New Zealand). Still, we expect 2023 GDP growth to exceed 1% in all Asia-Pacific economies.

We project a modest pick-up in growth in 2024, due to a gradual improvement in external demand and some monetary policy easing. Overall, we expect the region excluding China to grow by 4.2% in 2024 and 4.4% in 2025, compared to 4.1% in 2023.

The composition of the recovery after the pandemic slump differs across the region. With the exceptions of Hong Kong, and Thailand, GDP exceeded the 2019 level by between 0.1% in Japan and 15.5% in India, in the first half of 2023. In Northeast Asia, India, Australia, and New Zealand, fixed investment has recovered considerably more than private consumer spending (see chart 6).

In Northeast Asia, this is partly because high-tech firms such as semiconductor producers are making large investments. On the other hand, in all Southeast Asia economies, the fixed asset investment recovery has lagged that in consumption.

Chart 5

Chart 6

High U.S. Interest Rates Prevent Policy Rates From Decreasing Soon

Underlying inflation has continued to ease despite recent energy and food price increases.  In 2023, sequential core price increases have tapered in most Asia-Pacific economies, paving the way for headline year-on-year inflation to continue to decline. There are some food price risks on the horizon in Asia due to the prolonged El Nino event. However, the impact of recent increases in international prices of oil and food has so far generally remained modest.

This should reduce the need for renewed monetary tightening.  Following a round of policy rate increases since early 2022, rates have largely been on hold since May 2023.

However, there are exceptions.  Amid a tight labor market, Australia's sequential core inflation momentum has picked up again to an uncomfortably high pace (see chart 7). This led the Reserve Bank of Australia in early November to raise its policy rate by 25 basis points (bps) to 4.35% and we expect another increase, probably in early 2024. In the Philippines, hefty food price increases, particularly rice, spurred the Bangko Sentral ng Pilipinas to raise its policy rate by 25 bps to 6.5% in October.

In India, there was a transitory spike in food inflation in the July-September quarter, but it appears to have had little effect on underlying inflation dynamics. Still, headline inflation remains above the Reserve Bank of India's (RBI) target of 4%, suggesting it will be a while before the rate cycle turns.

Chart 7

Chart 8

The recent increase in Bank Indonesia's policy rate underscores the influence of the high U.S. interest rates in the region.  Inflation is manageable in Indonesia. But the central bank wanted to support the rupiah amid capital outflow pressure and increased its policy rate by 25 bps to 6%. Bank Indonesia and the RBI have also tightened domestic liquidity to support exchange rates.

While policy rates in most economies have been on hold in these conditions, we don't expect them to fall much in the next six months.  This is partly because of inflation but mainly because we foresee no fall in U.S. interest rates in the first half of 2024. Central banks want to limit capital outflows and depreciation, particularly in the region's emerging markets (see "Emerging Markets In Southeast Asia: The Forces Shaping The Outlook For 2024," Oct. 16, 2023). We expect policy rates in the region (excluding Japan) to fall later in 2024 by between 25 bps in Taiwan and Thailand, and 100 bps in India (in the case of the latter, the reference is to the fiscal year, ending March 2024.)

The Bank of Japan Is Likely To Tread Cautiously In Normalizing Policy

Despite higher inflation, wage growth, and global interest rates, the Bank of Japan (BOJ) is very careful and gradual in normalizing monetary policy.  It fears that rapid tightening would unduly hurt economic growth and possibly strain government finances. It will only increase interest rates meaningfully if it thinks inflation is on track to remain at about 2% in the coming years, with the support of higher wage growth amid solid demand in the economy.

While there are tentative signs that underlying wage growth and inflation are picking up, the BOJ wants to ensure wage growth is strong and sustainable. It wants to see more evidence before moving significantly. In late October the central bank adjusted its yield curve control arrangement. It changed a strict upper bound for the 10-year bond yield of 1%, which previously triggered unlimited BOJ purchases, into a reference point, implying less of a commitment to defend it. We expect a small increase in the policy rate to 0% in 2024.

External And Domestic Risks Call For Caution

Key risks to growth stem from possibly slower growth in the West and China. Unexpected increases in inflation in the U.S. may force policy rates there to be even higher for longer, exacerbating the pressure on Asian currencies and markets. Further big increases in global energy and commodity prices would stoke inflation and external deficits and possibly put even more depreciation pressure on currencies.

Other risks are more domestic in nature. In Australia, India, and the Philippines, lingering inflation risks are keeping central banks occupied. Government plans to expand fiscal policies in several countries could complicate central banks' policymaking.

Risks remain but so too does the potential for growth in the region. In coming months, the spotlight may shine a little more brightly on emerging markets where domestic demand is strong.

Editor: Lex Hall

Appendix

Table 1

Table 2

Table 3

Table 4

Table 5

Related Research

• Federal Reserve Holds Rates Steady For Now On Tighter Financial Conditions, Nov. 3, 2023
• China Growth Could Fall Below 3% If The Property Crisis Worsens, Oct. 24, 2023
• Emerging Markets In Southeast Asia: The Forces Shaping The Outlook For 2024, Oct. 16, 2023
• Japan Will Tread Carefully In Its Likely Tightening, July 17, 2023