The past year has been unsettled, but there is more to come that could rattle us. The near miss we just had with another financial crisis was a warning. Financial markets may seem to be calming down now after the latest upheaval, but let’s not forget that the sharpest monetary tightening in recent times has up-ended the world of finance: as rates continue to rise, more convulsions could well be triggered. And, because the war in Europe has made the world a more unstable place, there is likely to be more political turbulence as well.
In short, global politics and finance remain in a fluid condition. The straws in the wind point to impending changes, in geopolitics, policy-making, and the economy that could keep us all on edge.
Potential political discontinuities
We have two major political concerns — Ukraine and North Korea. As winter gives way to spring in the Ukraine theatre of war, the stalemate of the past few months is likely to break — and a more dangerous phase of the war could be upon us. Ukraine’s leaders and their Western backers fear that the longer the stalemate lasts, the greater the risk that political backing for Ukraine in the US and Europe could weaken. Hence their sense of urgency to quickly put Russia on the defensive.
Ukraine has begun receiving more modern tanks and higher-precision artillery from its allies who are also training thousands of fresh troops. At the same time, it appears that Russia has exhausted itself in a so-far failed effort to take the town of Bakhmut from Ukraine. It has lost thousands of troops, consumed considerable stocks of ammunition and suffered considerable damage to its tanks and other equipment — all for nothing.
Thus, within the next few months, Ukraine is likely to see a sweet spot for it to launch a counter-offensive that could put Russia on the back foot. A military setback that undermines Russian President Putin’s position could encourage him to undertake desperate measures such as hitting targets in Ukraine’s allies or deploying tactical nuclear weapons to the front lines. After that, the situation could become unpredictably dangerous.
Closer to home, there are growing risks in the Korean peninsula, after a year in which the pace of North Korean missile tests has been ramped up. It is not for nothing that the country’s leader Kim Jong Un is conducting these tests and demonstrating new weapons such as underwater drones that could apparently be armed with nuclear devices. Kim senses an opportunity to pressure the US and perhaps subvert South Korea at a time when the US is distracted by Ukraine. America’s bad relations with China mean that China is not restraining North Korea as it used to.
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Confident that its nuclear capacity and new weaponry protect it, North Korea could launch a major provocation in the coming months. It could be a reprise of what they have done before — shelling a remote South Korean island or sinking a South Korean naval vessel, or it could be something more dramatic. Kim may hope that these actions would pressure the US into negotiations with his regime on terms he favours and which would provide his regime with legitimacy and greater security. But that would probably be a severe miscalculation. The Korean peninsula remains one of the most dangerous spots on earth.
More financial thunderstorms ahead
The sharp corrections in equity and bond prices and the speed with which confidence in some financial institutions collapsed did not happen simply because of panic or irrational nervousness. Instead, they are the outcome of a new asset pricing regime that is becoming entrenched as interest rates return to normal and central bank liquidity tightens. Investors, savers, bankers and commercial businesses are adjusting to this new normal which makes them re-assess their willingness to take risks. Basically, they are becoming more risk-averse.
Now, financial assets will be priced in a more questioning manner: that is why cryptocurrencies have seen their values shrink and why valuations in the hyped-up parts of the tech sector have plunged. Bankers will also adopt more conservative lending standards so credit will not flow so easily. Savers will be more careful about where they deposit their money — with deposit rates now returning to decent levels, they have less need to place their money in riskier assets in order to obtain higher yields.
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As these behavioural changes accumulate and gather more force, more financial stresses may appear. For example, there are already tremors of concern in commercial real estate in the US. Close to US$400 billion ($532 billion) of debt in this sector is maturing this year. After the failure of Silicon Valley Bank and Signature Bank, small US regional banks are under pressure and facing withdrawals of deposits. But these institutions are major sources of funding for commercial real estate so there are good reasons to worry about how these maturing loans will be re-financed.
Moreover, small and medium businesses also rely for funding on these regional banks whose depleting deposit base limits their ability to provide credit. There are also many emerging economies that are teetering on the edge of defaulting on their loans. If financial conditions tighten further, more of them could slip into a financial crisis.
There is one saving grace which could, however, help mitigate financial risks. With demand cooling, more concerns over financial stability and inflation likely to come off the boil, central banks across the world are likely to end their rate hike cycle soon. The US Federal Reserve probably has one or two more 25 basis point hikes left. Most central banks in our region have indicated that they have done enough in terms of tightening monetary conditions.
As fears recede of ever higher interest rates, confidence could return to financial markets — and that could help mitigate the risks described above.
Prospects for global growth
The consensus seems to be somewhat gloomy about the global economy. Certainly, demand conditions have weakened. We see this in the trade data as well as in the surveys and industrial production numbers. The recent financial shocks have also increased fears of a recession. Despite these very real concerns, we believe an upside surprise is possible.
Note the resilience that the global economy has been demonstrating in recent months. Just before the banking shenanigans erupted in March, the world economy was defying prior expectations of a global recession. Despite some loss of momentum, economic activity has actually held up remarkably well in the face of one of the most aggressive monetary tightening cycles in recent memory. In fact, the latest available OECD high-frequency growth tracker — released just before the banking crisis — actually showed activity picking up across advanced BLZ economies.
Moreover, the flash purchasing manager surveys for advanced economies hinted that the better-than-expected economic performance in February persisted through March even as the financial stresses unfolded. Note that these surveys were conducted after the crisis broke out — around the second and third weeks of March — and so took in the early effects of the financial shock on business confidence.
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Quite tellingly, firms told the surveyors that they maintained an optimistic stance overall: this was because they still expected customer demand to improve and they were also relieved that supply chain disruptions would continue to ease. Survey respondents did mention the banking woes among the list of their concerns but were not unduly flustered by the financial mess.
Part of the reason for this positive sentiment could be that the indicators of financial stress that had spiked up when the bad financial news first broke — such as high-yield spreads and credit-default-swap spreads — have eased, providing some reassurance to companies that the worst risks can be avoided.
How will Southeast Asia fare?
In terms of the economic outlook, there are grounds to believe that the region will hold up well relative to the rest of the world. There are specific factors in the region’s favour:
The first is that the impact of China’s rebound on the region following the easing of severe pandemic restrictions is only just beginning. The latest data on retail sales and fixed asset investment showed a pick-up in activity in China. As consumers and businesses gradually get over the psychological damage they suffered in the past year, the recovery in spending will gather momentum. This is all the more likely as the authorities are casting aside their reservations about stimulating the economy. China’s new Prime Minister Li Qiang has been doing the rounds in the provinces, signalling that the government would support economic growth. The financial authorities are indicating that they will ensure that the real estate sector will not continue to drag down the overall economy. The authorities are also playing nice with the private sector, cutting back on regulatory crackdowns so as to boost capital spending by entrepreneurs.
The improvement in Chinese tourist spending is also likely to help Southeast Asia. Indeed, indicators of potential travel demand have been healthy: Search interest in China for travel-related services such as accommodation and flights has been resilient after a year-end boost. This is why surveys of travel experts show optimism for the Asia-Pacific region which had the highest percentage of expert respondents expressing strong confidence in the region’s tourism prospects for 2023.
Second, with the pandemic over, companies are dusting off their long-term plans. We believe that supply chains will be reconfigured at a faster pace as a result. Vietnam, Indonesia, Thailand and Malaysia will see some production being relocated from China. The relatively good performance of foreign direct investment approvals across the region probably reflects this trend as well as the progress the region has made in building better infrastructure, cutting red tape and reforming labour laws.
What about the political risks? More intense fighting in Ukraine will not be a nice thing but the spillover effects for this region are not likely to be far-reaching. Another sharp spike in food and energy prices like what happened after last year’s outbreak of war does not seem probable, given that alternative supplies are now available.
The region was relatively insulated from previous bouts of tension in the Korean peninsula. However, events in North Korea could be of greater consequence to Southeast Asia if a new provocation triggers an escalation of tensions. Currently, with China’s backing and its own military deterrence, it is likely that the US or South Korea will respond to North Korean actions with restraint.
While there is much uncertainty over how scenarios will actually pan out, what is clear is that we face a period of turbulence in global security affairs as well as in finance. Southeast Asia should be able to maintain its relative resilience in economic activity so long as major political or financial shocks can be avoided. But, policymakers and businesses should build whatever buffers they can now so that if severe shocks do flare up, the region is able to ride through them with little damage.
Manu Bhaskaran is CEO at Centennial Asia Advisors
