Most economies of the Asia-Pacific region are export-oriented and their gradual reopening after nearly two years of the pandemic has been an offsetting force to external economic challenges. Even China, which boasts a large domestic market, has seen exports carrying growth. But the region has been waiting with bated breath for the Federal Reserve (Fed) to convene its next Federal Open Market Committee (FOMC) meeting. In its last meeting, the FOMC hiked the interest rate by 75 basis points (bps), pushing it above the “neutral rate of interest” and further fueling the risk of a recession. Fed Chair Jay Powell had also hinted that rates could stay higher for longer, warning that economic pain could indeed lie ahead “until the job is done.”1 Such high US interest rates (two more hikes are expected during the remainder of 2022) have naturally brought back memories of the Asian Financial Crisis of 1997. Although emerging markets in Asia are much stronger today than 25 years ago, dealing with a rapid reduction of liquidity fueled by a hawkish Fed, coupled with a slumping yen and a slowing Chinese economy, will prove challenging.
China may have already emerged from its cyclical trough in Q2 of 2022, but the road to recovery has not been smooth. The summer heatwave led to electricity rationing in several major cities such as Chengdu and Chongqing, a booming economic area with a population of 50 million. Meanwhile, retail sales, a proxy for overall consumption, have maintained their steady pace of growth, while auto-sales figures for August provided a pleasant surprise (passenger car sales saw year-over-year (YoY) growth of 28.9%2). This has reinforced our long-held assertion that the Chinese consumers’ resilience is often underestimated.
As supply chain restrictions eased on the back of Shanghai’s reopening following a lockdown that lasted for more than 60 days between March and June, China’s export boom3 was further bolstered by both price effects (global inflation) and improved logistics. Such price effects were particularly evident in China’s surging exports to certain economies (e.g., exports to India grew more than 50% YoY in both June and July).
At present, however, the recovery faces three noticeable headwinds: 1) a struggling property sector; 2) financial stress brought about by global tightening, which has gathered momentum recently; and 3) the government’s zero-tolerance COVID-19 policy.
Property sector data for August effectively extended weak trends from previous months; this downturn began in September 2021. Sagging housing sales and investment levels (figure 1) have reinforced the bearish sentiment in offshore markets where bond yields of major developers such as Country Garden and Greentown are hovering at around 30% and 10%, respectively. Taken together, data around investment, land auctions, and home sales suggests that weakness in the property market is likely to persist beyond the short term. In other words, the property sector will likely be a drag on overall growth for the next few years. In the immediate term, the policy objective is to get developers to finish their incomplete housing projects (figure 2) and to prevent the mortgage boycott from spreading further. A relief fund of RMB200 billion4 was set up in late August with a stated mandate for developers to finish incomplete housing projects, but markets seem to have second-guessed its effectiveness. We are of the view that the government will not budge from its current stance that “homes are for living in, not for speculation,” but the reality is that local governments can only reduce their reliance on land sales in the medium term. Therefore, even in the absence of a potent stimulus to support the property sector, the policy mix will ultimately have to be aimed at preventing consumers from increasing their savings rate. Ideally, mortgage rates could be lowered, while developers could be incentivized to complete their projects. Most Chinese consumers view property in terms of both consumption and investment. Banks will therefore have to sacrifice some profits through a narrowing of interest rates to provide future homeowners with more sweeteners. The question is to what extent commercial banks have the ability to lower the cost of capital against a backdrop of global monetary tightening. In our view, the People’s Bank of China (PBOC) could nudge banks to bring down mortgage rates more, say to 100 bps, but ultimately, meaningful monetary easing could only be executed if the exchange rate is more flexible. The fact that major banks slashed deposit rates on September 15 by 10–15 bps,5 a preemptive move to lower lending rates, has highlighted widening interest-rate differentials between the RMB and the US dollar. Of course, China’s favorable balance of payments and relatively benign level of inflation will allow the PBOC to deviate from the Fed’s tightening, but the external environment still matters.
The message from Jackson Hole where the world’s biggest central bankers gather each year was unambiguously clear—major central banks such as the Fed and the European Central Bank (ECB) will have to continue their tightening crusade, even if the economy suffers. The latest move by the ECB of hiking interest rates by 75 bps,6 announced on September 8, has confirmed such policy bias. The euro has received a rare respite from the ECB’s hawkish signal and rallied above parity against the greenback, but an overwhelmingly bullish sentiment toward the US dollar remains intact, as evidenced by a further slide of the yen (USD/JPY has hit another 25-year high recently). If the US dollar stays strong due to the Fed’s tightening campaign and current woes in some emerging markets, more central banks will have to step up their monetary-tightening efforts. We expect many central banks in Asia to raise interest rates at least twice during the remainder of 2022.
China and Japan, two largest economies in the region, will have to reflate their economies, although for different reasons. For Japan, so long as domestic inflation is under control, a weaker yen will have no downside risk. Unlike 25 years ago, China, not Japan, is the largest trading partner of most regional economies, and a rapidly depreciating yen has had a relatively muted impact on regional currencies. The slide of the RMB7 against the US dollar to below the 7 threshold surprised the market but not us, although it has since climbed back above this level. Our 2022 USD/CNY forecast of over 6.9 at the beginning of the year was based on China’s need to improve the effectiveness of monetary policy, not competitiveness. The question is whether China should adjust its exchange rate more meaningfully in sync with other central banks’ competitive depreciation policies (e.g., Korea). In our view, the PBOC is unlikely to replicate the Bank of Japan’s reflation strategy on the grounds of stability. Meanwhile, rising interest rates globally may cause risky assets in most emerging economies to underperform until US interest rates peak. In fact, investors remain unconvinced that the Fed’s drastic rate hikes on September 21 would have arrested stubborn inflation, with the market expecting another 150-bps rate hike in the remainder of 2022.
Based on recent mobility data (passenger flows during Mid-Autumn Festival shrunk by 37.7% YoY8), travel-related sectors have taken an additional hit as partial lockdowns have been implemented across many cities. The dynamic zero-tolerance COVID-19 policy led to a recovery in Q3 more anemic than previously expected, and thus, the focus going forward will remain on further optimizing the current policy as we continue to learn how to better deal with the virus. Assuming lockdown measures would become more calibrated in Q4 and with the Fed entering its latter stages of tightening over the next couple of months, a recovery in Q4 remains on the cards. As such, we stand by our original 2022 GDP forecast of 3.5% with an asterisk.
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