Emerging Asia: becoming less shock prone

Emerging economies, especially in Asia, have made significant progress on disinflation in 2023 and at relatively little cost in terms of forgone growth or employment. Having demonstrated greater resilience to external shocks, the region may be on the cusp of a virtuous cycle with enhanced economic credibility lowering long-term volatility of growth, inflation and interest rates. An attractive proposition for global insurers and investors alike.

• Core inflation has fallen significantly in many emerging Asia economies, allowing some to cut interest rates this year.
• Weaker China data and the Bank of Japan's decision to allow yields to rise have not had material impact on growth or asset prices in the region.
• In the near-term, the return of food price is a risk that warrants monitoring and cautions against too-large interest rate cuts.
• The relative outperformance of emerging Asian economies post-pandemic has increased credibility, and reduced "external dominance".
• The better growth and inflation trade-offs in the region are attractive for insurers and investors alike. 

Faster-growing emerging market economies are moving more to the beat of their own drums. We expect that emerging Asian economies' will outperform the rest of the world in terms of real GDP growth in the second half of 2023 and into next year. That's no mean feat given recent developments in the region's two largest economies. First, economic data from China remain weak. That said, we did not assume large growth spill overs from its reopening year, so disappointing economic data now is not a big drag on the growth outlook for emerging Asia either. And second, the Bank of Japan has recently relaxed its yield curve control by raising the cap on the 10-year sovereign bond yield from 0.5% to 1%. Yet, fears of a sharp correction of asset prices as returns on the lowest-yielding global safe asset rose, have also not come to pass.

Headline and core CPI inflation rates have fallen notably in many in emerging Asian economies, and are now close to or within central bank target ranges (see Figure 1). China and Vietnam have already eased monetary policy, and we expect Indonesia will also cut interest rates before the end of this year. Others will likely wait until 2024 to do so. Looser financial conditions and lower inflation should help sustain the domestic consumption growth that is shielding many emerging economies in Asia from weaker external conditions.

Figure 1: Headline and core inflation rates vs central bank targets/official forecasts (shaded)

By contrast, due to slower disinflation so far this year, policy easing in the advanced economies of the region (Australia, New Zealand, Singapore) is much further off. In the case of Australia, we expect that the central bank will raise its policy rate once more in November to counter still-high core inflation. Japan is in a different inflation cycle altogether: it is one of the few economies where headline and core CPI inflation increased in June, but we do not see the Bank of Japan exiting its negative interest rate policy before next year.

Strong labour markets in many Asian economies should support wage growth and consumer confidence. Whether the disinflation momentum on core and services CPI inflation continues depends on how labour market conditions evolve. In some emerging Asia economies, unemployment rates have fallen to their lowest in decades (see Figure 2). Yet we do not think central banks are "behind the curve". In general, lower average CPI inflation rates in emerging Asia since 2020 (around 2.5% year-on-year, compared with more than 4% in the US and Europe) mean consumers' real incomes have fallen by less. That should mean less pressure for higher-than-CPI wage demands to reclaim lost purchasing power.

Figure 2: Unemployment rates, latest vs historical

There are downside risks to our optimistic outlook for emerging Asia, first from potentially worse-than-anticipated slowdowns in major economies. The most uncertain factor in Asia is mainland China, where the youth jobless rate reached a record high of 21.3% by the end of the second quarter. Compared with previous periods of slowdown, the economic impact of the pandemic has been more persistent and unequal. Growth in disposable income per capita was 1.3% for the bottom 20% by income last year (versus CPI inflation of 2% in 2022), compared with 4.5% for the top 20%. More decisive fiscal policy support to boost confidence will likely be needed to stabilise GDP growth to meet the official target of around 5% in 2023.

A greater risk to Asia's consumption growth story may be the return of food price inflation due to supply shocks. The current lower-headline and higher-core CPI pattern may reverse next year. Extreme heat this summer and the impact of El Niño is bad news for global agriculture, as is the expiration of the Black Sea agreement to allow grain exports out of Ukraine. And in July, India imposed an export ban on certain types of rice. That's a concern, as India is the largest rice exporter in the world, and rice is the food staple for many Asian countries. The UN Food and Agriculture Organisation's rice price index rose 19.7% in July from a year earlier to its highest since September 2011.

On balance, in our view, the higher growth and lower inflation profile of emerging Asia this year and next implies that the "sacrifice ratios" (ie, the cumulative slowdown in GDP growth in return for cumulative disinflation), have been relatively low. In the past, an issue specific to emerging markets was sudden stops of capital inflows due to perceived institutional weaknesses (leading to "external dominance"). Low credibility in turn used to lead to slower convergence of inflation to target at higher cost to growth. Arguably, the return of food price inflation risk notwithstanding, emerging Asia has emerged from the pandemic with enhanced credibility. That should mean more independent economic cycles, and less volatile inflation, economic growth and interest rates in the long run – conditions all favourable for insurers.