Asia credit outlook: Asia & EM’s advantage from global monetary easing

Asia and EM will have to contend with conflicting dynamics of declining inflation and slowing global growth in 2024. The former is good for fixed income and the latter imposes a slowdown on corporate profitability and hence credit spreads, broadly speaking. However, various regions have now moved significantly out of phase economically.

In the second of a three-part series on the outlook for Asia fixed income in 2024, we analyse the region that we believe will benefit disproportionately in the coming years from lower global rates, improved liquidity and portfolio flows, and assess the outlook for China.

 

Need to know Inflation across Asia has been better managed than in the US and we expect the region’s fiscal deficits to show signs of improvement as time goes on It is our view that base rates for Asia ex-China and ex-Japan stand to be cut by 100-150 bps over the next two years We expect the Chinese economy to achieve stability in 2024

 

Centre of growth in Asia to gravitate away from North Asia to India, South Asia & Asia-Pacific belt

Asia is on track to deliver stronger growth in 2024 while developed markets (DM) brace for a slowdown. Economic fundamentals in the region appear solid. Inflation outside of China is dropping, there are growth stories underway including that of India and Indonesia, and China is on course for a cyclical rebound in 2024. We are also encouraged by signs of a consumer recovery as well as stability in financial sectors. Inflation across Asia has been better managed than in the US and we expect the region’s fiscal deficits to show signs of improvement as time goes on.

We also except a strong technical backdrop in 2024, amid lower gross supply, a strong Asia investment grade (IG) investor base, strong duration buying, and pick-up in spreads versus

 

India outlook – stars are starting to align for the next decade

India’s economic recovery is attributed to sound monetary policy, however, there are potential headwinds which include slower growth and uncertainties surrounding the upcoming election.

The foreign exchange (FX) reserves of India’s central bank, the Reserve Bank of India (RBI), have helped to mitigate the impact of a stronger US dollar as a result of the Fed’s tightening cycle on India’s economy. The RBI’s monetary policy ensured a strong Indian rupee (INR) as compared to other emerging market currencies.

This helped control India’s current account deficit, despite the fact that India is a commodity importer. Consequently, India was able to cope with higher dollar and commodity prices. Furthermore, the country benefited from discounted Russian oil imports due to the ongoing Russia-Ukraine war. The strong INR and discounted oil imports contributed to increased corporate margins as corporations faced lower input costs. In 2023, crude oil prices decreased further from their highs in Q2 2022, while the INR remained relatively steady, further amplifying the aforementioned effects.

Currently, inflation is within the RBI’s tolerance limits, with the latest CPI at 4.87%, close to the target of 4% (± 2%). The inflation control by the RBI has helped contribute to historically low policy differentials between the US and India. The RBI has had no need for large interest rate hikes, which, from a credit perspective, has maintained a favorable borrowing environment in INR compared to US dollar-denominated debt.

In 2023, India recorded strong GDP growth of 7.8% y/y in Q2 2023, following 6.1% y/y growth in Q1 2023. Looking forward, the anticipated slowdown in growth is attributed to factors such as a slowdown in government capex, reduced global economic growth which will affect demand for goods and services exports, and dwindling base effects arising from the trade shock due to elevated crude oil prices in 2022. Despite the expected slowdown, JP Morgan is forecasting growth of 6.2% in FY23E and 5.7% in FY24E, which positions India as one of the fastest-growing economies globally.

 

FIG. 1 ASIA COUNTRY FORECAST

Sources: Bloomberg, Goldman Sachs, Lombard Odier calculations. As at 2 January 2024. For illustrative purposes only.

 

FIG. 2 INDIA ECONOMIC DATA FORECAST

Sources: Bloomberg, J.P. Morgan, Barclays, Citi, HSBC, Morgan Stanley, and Goldman Sachs. As at 6 December 2023. 1Forecasted based on average of available forecasts by J.P. Morgan, Barclays, Citi, HSBC, Morgan Stanley, and Goldman Sachs 2Forecasted based on Bloomberg consensus data. For illustrative purposes only.

 

Besides slower economic growth, elections uncertainty can be a potential source of volatility in India. General elections are scheduled for May-June 2024, with the incumbent National Democratic Alliance (NDA) led by the Bharatiya Janata Party (BJP) competing for a third term against the newly formed Indian National Developmental Inclusive Alliance (INDIA) coalition, led by the Indian National Congress. The election results are expected to influence future economic policy, and any surprises arising from the elections could potentially lead to volatility in bond spreads.

We expect India to overtake China and become the growth engine of the world, with projected annual real GDP growth of 6-7%. The country’s fiscal budget for 2023-2024 contains 10 trillion rupees for infrastructure development, which is five times the amount that has been allocated over the last nine years. But despite large investments in infrastructure and renewables, India says it is on course to bring the fiscal deficit down to 4.5% by 2026. Rating agencies appear to agree with the fiscal plan and have posted stable outlooks for the sovereign. India is additionally projected to move from the fifth largest global economy currently to the third by 2030 (even then, it would still be only ~ USD 4,500 per-capita income).

 

FIG. 3 IMF's INDIA GROWTH AND INFLATION FORECASTFOR 2023-2025

Source: IMF.As at 14 December 2023. For illustrative purposes only.

 

Our investment team has identified what we believe to be several structural tailwinds that are positive for India:

• The potential for the first new government since 2014 ahead of the upcoming election
• The ongoing digitisation of economy and overhaul of the tax system
• The government’s investment-related growth measures in power, renewable energy, infrastructure (roads, airports, tolls, digital, etc.)
• Strengthened fiscal discipline, external balance and investment climate
• Growth in manufacturing sector, with demonstrable shifts of the supply chain away from China
• Access to longer term capital

 

Southeast Asia outlook – beneficiaries of key supply chain shifts 

Indonesia’s economic growth is tapering especially in capital spending. Consequently, inflationary pressures are expected to be at the lower bound of the 2-4% year-on-year target range. Both core and headline inflation rates have slowed as a result of supply-side reforms that have impacted food prices. With low underlying inflation, Bank Indonesia (BI) consumer price index (CPI) target range is expected to fall in 2024. Indonesia’s trade surplus has remained elevated primarily due to the easing of imports and the resilient commodity export volumes, particularly in coal.

However, while there is benign core inflation, the tightening of external monetary policies, like in the US, has resulted in the Indonesian rupiah (IDR) coming under pressure. This has led to the central bank employing various tools to manage excessive volatility. It is expected to maintain its policy rate unchanged through 2024 while using other market measures. An example of this would be the recently introduced Bank Indonesia Rupiah Securities (SRBI) (BI paper) as an instrument to stabilise the currency. The unexpected rate hike on October 19 emphasises the central bank’s focus on FX stability. It was likely prompted by a drawdown of net FX reserves in September, reflecting the central bank’s reaction function sensitivity to changes in balance of payments (BOP) flows. If USD strength is not persistent, it is expected that the central bank will maintain rates. 

Near-term risks for Indonesia include the potential impact of lower commodity prices on the current account balance. Another potential risk is the upcoming presidential election. Voting will be held in February 2024 and the newly elected officials will be sworn in October 2024. The elections are not expected to derail the positive medium-term trajectory of the country. In the longer term, Indonesia is expected to benefit from higher foreign direct investments due to changes in the global supply chain as producers/manufacturers look to diversify their production base. 

Indonesia is on track to be one of the most successful EMs in terms of sovereign developments over next decade, as it has been over the previous 10 years. It continues to demonstrate a strong balance between growth and inflation, as well as fiscal discipline that should be maintained around -2.5 to 3% of GDP. The overall debt burden looks set to remain low at 40-50% over the coming years. This is also a country that has low contingent liabilities and hidden debt, as well as predictable and range-bound IDR via strong fiscal discipline, controlled monetary policy, low inflation and reasonably strong and stable growth. Indonesia is also well-positioned to capture growth opportunities associated with nickel.

 

Greater China outlook – stabilisation to be achieved in 2024

China is currently in the process of transitioning away from growth that is led by real estate and infrastructure, due to a combination of policy choice, an ageing population and slowing urbanisation growth. According to the authorities, China’s new economy model will be driven by domestic consumption and high-tech development industries. We expect China’s economic growth to normalise towards 3-4% per annum for the coming decade; up from 6% p.a. over the previous decade. We expect the Chinese economy to achieve stability in 2024 for a number of reasons: 

• The property segment is reaching a L-shape readjustment in 2024 
• Consumer sentiment looks set to bottom out in 2024 
• Wage growth is on course to stabilise at 4% (real salary increase) 
• The government has committed to more than RMB 2 trillion in additional fiscal stimulus to be spent in 2024. This includes issuance of RMB 1 trillion special local government bonds (LGBs) which will largely be spent in 2024 and upcoming roll out of the Pledged Supplementary Lending (PSL) scheme of ~ RMB 1 trillion 
• Infrastructure investment (non-residential market) to drive growth in 2024 

However, the domestic economy can expect to be constrained by several manifestations of structural drag: 

• Inflation to remain low, but gradually improve. The upside is that China provides goods deflationary pressure globally 
• The labour force and total population continues to shrink, and the median age currently stands at 41 
• Monetary policy is already relaxed with rates low; this leaves minimal room to cut rates further (the Required Reserve Ratio rate is already close to historical lows) 

Hong Kong – We expect an inflexion point in H2 2024 onwards into 2025

Hong Kong (HK) has experienced four years of deep decline, afflicted by the 2019 protests; Covid 2020-2022; reduction in expat population; departures of various global businesses. Going forwards, we expect the Hong Kong Interbank Offered Rate (HIBOR) to reduce alongside dropping USD overnight rates. This will support HK’s real estate sector recovery between H2 2024 into 2026. The anticipated stabilisation of China consumption stands to in-turn boost HK’s retail, tourism and financial sector into 2025.

The next in this series will focus on the Asia-EM credit technical we anticipate will undergo a key reversal in 2024.

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