The Global Setting: A Soft Landing In The U.S. And Europe

The U.S. saw progress in 2023 with reducing inflation even as economic growth remained solid. But that economic momentum and a tight labor market complicate further disinflation. Indeed, sequential core inflation has picked up again in recent months. The U.S. Federal Reserve is likely to be cautious. On current trends, our U.S. team expects the first 25 basis points (bps) rate cut in mid-2024, with two more this year, for a total reduction of 75 bps, to 4.5%-4.75%. We see the balance of risk as having shifted to fewer cuts.

Surprisingly strong growth in the fourth quarter of 2023 led our U.S. team in February to raise the forecast for whole-year 2024 growth to 2.4%, from 1.5%. But we expect a sequential slowdown in 2024, with average quarter-on-quarter growth this year about half of the pace in 2023.

Eurozone growth has been slower than in the U.S. We expect GDP to rise 0.4% in 2024. With inflation falling from earlier high rates, the European Central Bank is likely to implement its first rate cut in mid-2024.

For the Asia-Pacific region, risks around the U.S. economy are two-way. Yet risks of sticky U.S. inflation are now outweighing those of a sharper economic slowdown there. Higher U.S. interest rates exert greater capital outflow pressures in Asia, likely making central banks more cautious to ease policy. On the other hand, a sharp economic slowdown in the U.S. may test the region's growth landscape.

China's Economic Data For Early 2024 Point To A Solid Start

China met its growth target in 2023, but economic momentum was subdued at the end of the year.  The country reported 5.2% year-on-year real GDP growth in the fourth quarter and for the year as a whole. Yet, amid continued property strains and subdued confidence, consumption momentum was weak, and prices were under strain. Nominal GDP growth was only 4.2% in the fourth quarter of 2023.

The real estate downturn still weighs on the economy into early 2024.  Housing sales, starts, and investment continued to fall in the first two months of the year. This weakness affects the broader economy via backward and forward linkages, as well as confidence and wealth effects (from falling housing prices).

Overall fixed asset investment growth has held up well because of solid investment in infrastructure and manufacturing.  Excluding real estate, investment grew 11% in the first two months (see chart 1).

Consumer spending showed signs of improvement.  Chinese New Year travel and tourism spending was up strongly on 2023 and exceeded the 2019 level for the first time. Retail sales growth slowed year on-year in the first two months of 2024. But comparisons with the same month in 2019 suggest a pick-up in momentum.

Deflation Risks Hinge On Composition Of Growth

China's 5% growth target for 2024 is ambitious.  Announced at the National People's Congress meetings in early March, the target is harder to reach organically than a similar target in 2023 because the favorable impact on growth from the post-pandemic re-opening is largely over. That is true even as the drag on growth from the real estate downturn should be smaller this year.

The policy stance supports growth, but policymakers remain reluctant to pursue significant macroeconomic stimulus, especially toward households.  Fiscal policy is slightly expansionary and in the (few) provinces that have announced new minimum wages they increased significantly more than in recent years, supporting consumption. But the government has refrained from committing to material consumer-oriented stimulus. And the central government push to rein in infrastructure spending in highly indebted provinces will weigh on growth.

Two factors constrain interest rate cuts. The aim of policymakers to maintain banks' interest margins; and the high U.S. interest rates and their impact on the renminbi. Yet, the People's Bank of China (PBoC) received a mandate to ensure ample liquidity and target generous credit growth. Falling U.S. policy rates later in 2024 would provide some room for the PBoC to reduce interest rates--we expect a 20 bps cut.

We see GDP growth slowing to 4.6% in 2024 from 5.2% in 2023.  This takes into account the continued strain from the property weakness and modest macroeconomic policy support.

The key risks are weakness in property and consumption. They would lead to lower overall growth.  Moreover, policymakers have a tendency to respond to strains on growth by stimulating investment, including in manufacturing. This then further increases overcapacity in several goods markets and squeezes prices and margins.

Problematic deflation does not factor into our baseline, but it is a risk if consumption remains weak.  Pressure from overcapacity and declines in the prices of commodities, energy and food, especially pork, have weighed on consumer price inflation (see chart 2). Rising prices of services keep year-on-year inflation positive. But a combination of soft consumption and relatively strong manufacturing investment would aggravate the strain on prices and profit margins in goods markets (see "China Deflation Risks Hinge On Growth Mix," published on RatingsDirect, Jan. 29, 2024).

Chart 1

Chart 2

Other Asia-Pacific Economies Generally Entered 2024 On A Solid Footing

Domestic demand growth mostly remained solid in Asia's EMs in the second half of 2023, fixed investment in particular (chart 3). Domestic demand, and especially investment, was more subdued in Asia-Pacific's high-income economies.

An export recovery and an increasingly biting impact from restrictive interest rates affect growth in opposite ways. Across the region, whether economic momentum has accelerated or slowed depends on the type of economy.

In economies strongly dependent on external trade, sequential GDP growth accelerated in the second half of 2023.  This has been the case in Singapore, South Korea, and Taiwan (see chart 4). Growth also picked up strongly in the Philippines.

In largely domestic demand-led economies such as India, Japan, and Australia, the impact of higher interest rates and inflation on household spending power reduced sequential GDP growth in the second half.  Although in India that was after very strong growth in the first half of last year. Sequential growth also slowed in Hong Kong, Malaysia, and Thailand.

Chart 3

Chart 4

A few countries saw a weak end to 2023.  New Zealand's GDP stagnated in the fourth quarter after a contraction in the third. Japan's GDP rose a mere 0.1% in the fourth quarter, quarter on quarter, following a contraction in the third quarter. Investment was subdued and consumption weak as inflation eroded purchasing power. The Thai economy shrank in the fourth quarter, maintaining its relative weakness. Malaysia's economy contracted 2.1%, but that was after a 2.6% surge in the third quarter.

Electronics led the pick-up in exports.  By early 2024, year-on-year real export growth was rising across the region. However, sequentially, the recovery hasn't been strong, in recent months.

Growth To Remain Robust Albeit Lower Than In 2023

Export demand should slightly improve this year.  Given the moderate sequential export volume growth in early 2024 and our expectation of modest global demand prospects, we don't anticipate a vigorous export recovery.

Restrictive interest rates will continue to weigh on growth.  Assuming interest rates fall later this year, the drag on investment, housing, and the overall economy will lessen but not go away. Also, due to the lags in the transmission of monetary policy, most of the impact from lower rates on growth will appear only in 2025.

In export-dependent economies, the gradual export recovery should dominate and support a pick-up in GDP growth this year.  Where monetary policy has an especially large impact, the tight stance is more likely to drive GDP growth lower than in 2023, even as resilient labor markets help ease strains on growth and make soft landings likely.

We consequently forecast a pick-up in small, open developed markets this year but slower growth in some developed markets.  We project an improvement in exports to accelerate economic momentum in Singapore, South Korea, Taiwan. New Zealand's economy should also gain some pace. While we forecast Hong Kong's growth to ease from the 2023 pace, that is to a still above-potential 2.5%. We see Japan's growth slowing to 0.8% amid subdued domestic demand. In Australia, after a relatively resilient expansion in 2023, we expect the restrictive monetary policy to lower GDP growth to 1.4%.

Even as we expect a mild slowdown in Asian EM economies, we generally see solid domestic demand growth and a pick-up in exports to drive robust growth, with India, Indonesia, the Philippines and Vietnam in the lead.

After a better-than-expected 7.6% growth in fiscal year 2024 estimated by the National Statistical Office, we expect India's real GDP growth to moderate to 6.8% in fiscal year 2025 (ending March 2025).  Restrictive interest rates are likely to weigh on demand next fiscal year while regulatory actions to tame unsecured lending will affect credit growth. A lower fiscal deficit will also dampen growth.

Overall, we project 5.1% growth in 2024 in the region excluding China and Japan, the same as in 2023, and 5.2% in 2025.

Key growth risks include a sharper-than-expected slowdown in the U.S., weaker growth in China, and a pronounced slowdown in domestic consumption  (see "ASEAN's Consumer Activity Is Losing Steam," Feb. 20, 2024).

Inflation Is Receding But Interest Rate Cuts Will Take Time

Underlying inflation momentum has eased in almost all Asia-Pacific economies (see charts 5 and 6).  The reduction has been especially notable in EMs. Headline year-on-year inflation is already in or below the central bank target in Indonesia, the Philippines, and Thailand (Hong Kong, Malaysia, Singapore and Taiwan don't have an official inflation target).

In India, we expect consumer inflation to decline further to 4.5% on average in fiscal 2025.  While non-food CPI inflation softened about 250 bps, food inflation rose 40 bps in the first ten months of this fiscal year. In all, headline inflation fell to an estimated 5.5% this fiscal from 6.7% in fiscal 2023. Headline inflation is above the middle of the 4%-6% target band, due to elevated food inflation.

There are always upward risks around inflation. But, barring major global shocks, we generally think those risks are now moderate. The upward price pressure from recent international shipping problems appears insufficient to meaningfully affect overall inflation.

Chart 5

Chart 6

For now most Asia-Pacific central banks are reluctant to start cutting interest rates.  This is largely because they look at the U.S. Fed and want to avoid triggering capital outflows and currency turmoil by lowering rates significantly ahead of the U.S. central bank.

But high real policy rates choke demand and are therefore likely to strengthen the case for lowering rates.  Real policy rates are now above 3% in Indonesia, the Philippines, and Thailand. We would expect some Asia-Pacific central banks to start cutting rates in a few months even if the U.S. Fed delays its first cut further.

We forecast rate cuts of up to 75 bps (India, Indonesia, New Zealand, and the Philippines) this year (which for India is the fiscal year), with the median reduction 50 bps (see chart 7). In line with our projection for U.S. policy rates, we largely expect these moves to occur in the second half of the year.

In India, slowing inflation, a smaller fiscal deficit and lower U.S. policy rates will lay the ground for the Reserve Bank of India to start cutting rates. But we believe more clarity on the path of disinflation could push this decision at least to June 2024, if not later.

In Australia, where core inflation pressure has remained relatively high in early 2024, we expect the first cut only late in 2024. The likelihood of another policy rate increase has declined but cannot be ruled out.

The Bank of Japan (BOJ) increased its policy rate to between 0% and 0.1%, from -0.1%, its first increase since early 2007.  Weak data on economic activity and declining inflation are hurdles. Yet, in recent wage negotiations, unions and the first batch of large employers agreed to wage growth estimated at 5.3%. That was high enough for the BOJ to move (in 2023, this metric of wage growth was 3.6%).

The BOJ also relaxed its yield curve control arrangements.  It removed the upper band for 10-year government bond yields. Still, the central bank committed to make "nimble responses, such as increasing the amount of JBG purchases" in case of "a rapid rise in long-term interest rates."

We expect modest further increases in Japan's interest rates in coming years.  With Japan's price and wage-setting behavior gradually changing, we project medium-term inflation of 1.5%-2%, which should support positive policy interest rates. Still, Japan's interest rates should remain meaningfully lower than those in other major advanced economies.

Currencies To Appreciate

We generally expect Asia-Pacific currencies to appreciate modestly this year. Several factors support this. Growth in the region is solid and in the U.S. growth is likely to slow and interest rates to decline.

In early 2024, most Asia-Pacific economies saw their currency depreciate further against the U.S. dollar by up to 5% (in the case of Japan), largely as market expectations for U.S. interest rate cuts were pushed out in time (see chart 8). The exceptions were India and the Philippines. They did not lose ground, in part because they have positive policy rate differentials with the U.S.

Chart 7

Chart 8

In all, most Asia-Pacific economies should see meaningful growth in 2024. We expect the notably weak external trade conditions of 2023 to improve in 2024.Restrictive monetary policy will slightly slow growth in domestic demand. While the timing of the start of U.S. interest cuts remains uncertain, generally well-behaved inflation provides leeway for some regional central banks to cut rates, possibly before the U.S. Fed.

Editor: Lex Hall

Related Research

• China Deflation Risks Hinge On Growth Mix, Jan. 29, 2024
• ASEAN's Consumer Activity Is Losing Steam, Feb. 20, 2024
• Asian Emerging Market Currencies Will Chart A Comeback, Feb. 27, 2024

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