Asia: A constructive growth story

We have been constructive on Asia's growth outlook, arguing that 2023 will be a year of rapid disinflation and growth outperformance. However, investors tend to view Asia as a derivative of the US business cycle due to its export dependency. They also tend to under-appreciate the domestic demand that Asian economies can generate in this cycle. In particular, one key difference is that unlike the United States, Asia does not face an intense inflation challenge and does not have to contend with an interest rate shock.

The disconnect between our and investors' views is most apparent for China and India. For China, we expect GDP growth of 5.7 percent in 2023. Investors' bullishness has given way to concerns about a faltering recovery, especially given what they perceive to be weak April data. Investors also worry that policy stimulus might not be as forthcoming.

Part of this disconnect is down to the nature of this recovery. Unlike previous cycles, this recovery will be driven more by consumption. The consumption recovery is organic and not driven by excessive transfers. This means middle- to high-income consumers will support the recovery initially, before job gains in the services sector boosts labor income for the low- to middle-income segments. Against this backdrop, we also expect services spending to drive the initial rebound before goods spending normalizes later as the recovery progresses. Indeed, this was what other economies in Asia outside of China experienced in 2022.

From this perspective, the April data did show a rebound in consumption that is driven by services spending, as mobility-sensitive segments within retail sales strengthened. This has been carried into May, as we saw in the data around travel and spending during the May Day holiday, with even international travel picking up. As for goods spending, we had expected it to improve a bit later as the recovery broadened. In early May, however, we saw early positive signs in car sales and durable goods like household appliances picking up.

While we do not expect investment to be a key driver of growth, our base case was that the drag from real estate investment would reduce in 2023. In that context, the deceleration in real estate fixed asset investment (FAI) does raise the risk that investment growth could re-emerge as a drag on growth. However, we do expect property sales to pick up again as more projects are launched, which will translate into an improvement in real estate FAI.

The biggest downside in the April data was from industrial production, which we attribute to an overhang of inventory — as was observed in the elevated levels of the inventory sub-index within the purchasing managers' index for both March and April. In this context, we see the evolution of the April data mix of strong consumption, modest growth in investment but downside in production as being still consistent with our growth outlook.

As for policy stimulus, we believe that the key anchor is the state of the labor market. While the overall unemployment rate has declined over the past three months, disposable income growth is still at just 5.1 percent year-on-year, well below where it was before the COVID-19 pandemic, suggesting that the overall state of the labor market is still relatively weak.

Moreover, the youth unemployment rate has risen, and is far above the level seen in 2019, which itself was not a strong year for growth. If growth momentum were to weaken, policymakers would take up easing in a way that would improve labor market conditions.

Turning to India, we project that GDP growth will average 6.2 percent this year, but investors are concerned about the current account deficit emerging as a constraint to this cyclical recovery. However, there has been a structural shift in India's balance of payments dynamics.

First, the boom in services exports (which rose by more than 80 percent from October 2020 levels to an annualized run rate of $360 billion as of April 2023) has supported India's current account balances. We expect the current account deficit to be below 2 percent of GDP over the next 18 months.

Besides, investors seem to be under-appreciating the strong string of supply-side reforms — introduction of a unified goods and services tax, reduction in corporate taxes, the launch of the production-linked incentive scheme over the last few years. Policymakers have already lifted public capital expenditure to GDP ratios to an 18-year high. This reform momentum, alongside very healthy private sector balance sheets, is catalyzing a strong upswing in the private capital expenditure cycle. More broadly speaking, capital deepening in an economy with surplus labor will be a key driver in lifting corporate profit to GDP.

With the sustained strength in domestic demand, we think that Asia will continue to build up growth outperformance against developed markets over the remainder of 2023, with its growth differentials rising to 460 basis points — its highest since 2017. In 2023-24, Asia will contribute 80 percent to global GDP growth, the strongest amongst all key regions.

The author is Morgan Stanley's chief Asia economist.

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