William Bratton
One of the challenges when considering Asia's near-term outlook is that the trends shaping its economic, financial and political future are multi-decade affairs. They roll remorselessly forward irrespective of the constraints of the Gregorian calendar, and it is often misleading to assume that the trends over the next 12 months will be materially different from those that typified the years recently passed.
As such, although 2022 may see periods of volatility and heightened uncertainty, it is unlikely to witness substantial changes to existing trajectories. The four significant macro risks: the COVID overhang, higher U.S. interest rates, slower-than-forecast China growth and increased tensions over Taiwan will all prove relatively uneventful over the year, albeit for different reasons.
With respect to the COVID pandemic, for example, it has to be assumed that this will ease through next year, despite the different normalization paths across the region and the current omicron wave.
Although new variants may slow efforts to normalize and even result in another lost year for specific countries, there now appears to be a consensus that the earlier uncompromising travel and movement restrictions have become unsustainable given their social and economic costs, especially in a largely vaccinated population.
China remains the exception to this with its zero-COVID stance. This is likely to persist until after the 20th National Congress of the Chinese Communist Party and possibly well beyond. In fact, it is still unclear how China will extricate itself from this draconian policy. And although this isolation will have little impact on its own growth momentum, the continued absence of outbound Chinese travelers and their sizable wallets will be punitive for many of its neighbors.
But while COVID will recede in prominence, U.S. interest rates will become a bigger issue as they inch up in 2022. The markets currently expect the Federal Reserve to hike its targeted federal funds rate at least twice over the year by a cumulative 50-75 basis points while the end of its current quantitative easing measures will shut off the easy flows of capital that have benefited much of Asia over the last decade.
In the past, such Fed moves would have resulted in a degree of trepidation. This was vividly seen in 2013 when the taper tantrum sent tremors across the region and caused severe angst for both investors and policymakers alike. But the backdrop today has materially changed, and Asian countries are likely to prove more resilient to the U.S.'s tightening cycle than many other emerging markets.
To an extent, this reflects the region's stronger fundamentals, including improved external balances, higher foreign-exchange reserves, subdued inflationary pressures and stronger corporate balance sheets. There is also significantly better institutional understanding on the use of policy and regulation to control periods of financial stress, even if this lesson has often been learned the hard way.
There are admittedly exceptions to this benign view, for example, India's relatively high inflationary pressures. But overall, the growing regionalization of the Asian economic system, as seen in the growth of local currency debt markets and declining dependence on dollar financing, now insulates Asian countries from trends on the other side of the Pacific.
In fact, it is China's outlook, not the U.S.'s, which matters more. Current forecasts are for China's economy to grow between 5.3-5.6% next year, which will be a marked deceleration from the 8.0% achieved in 2021 and will no doubt prompt much excitement about the country's perceived loss of economic momentum.
The pandemic has, however, made year-on-year comparisons almost irrelevant. What is more salient is that China's 2022 gross domestic product in current dollar terms is expected to be 29% larger than it was in 2019, an increase only bettered within the region by Taiwan. This relative outperformance will further increase China's share of regional GDP, even though it already accounts for more than half of Asia's economic activity, and will further entrench its core status.
Furthermore, China's economy could surprise to the upside in 2022, given the desire for a positive backdrop into the CCP's National Congress. That suggests a move away from the regulatory shocks and fiscal tightening experienced over the last 12 months in favor of more positive and supportive policies. As such, the recent cut to banks' reserve requirement ratio may be a harbinger of a more benign policy environment, which would significantly diminish downside risks.
In contrast, the region's geopolitical risks will continue to escalate throughout 2022 since it is inevitable that as China's relative strength and influence continue to expand, clashes with the existing global hegemon keen to preserve its primacy will only increase.
In some situations, direct China-U.S. confrontations will be avoided by the development of parallel systems. For example, China's efforts to construct an alternative financial architecture around the digital yuan will be worth watching in 2022. Although such dual solutions may allow the two competing superpowers to coexist, they will force the rest of Asia to make very difficult choices between China's economic riches and the U.S.'s security umbrella.
The logo of digital yuan displayed during a trade fair in Beijing on Sept. 5: China's efforts to construct an alternative financial architecture will be worth watching. © APBut the real regional flashpoint will, of course, be Taiwan. It can be safely assumed that this will, at some stage, become messy given China's clearly stated intent. The only real question is the matter of timing.
Importantly, tensions are unlikely to ignite during 2022. It is not just that China will want a peaceful backdrop to the CCP's National Congress, nor that the country's military is probably not completely ready, despite its dramatic technological advances. But more fundamentally, China's integration into the global economy creates dependencies and vulnerabilities which, until mitigated, inherently constrain its scope for action.
There are two risks to this sanguine near-term view. First, the U.S. takes steps which force a response from China, for example, a more formal recognition of Taiwan's status; and second, if the West's response to a potential attack on Ukraine by Russia is weak and halfhearted, thereby emboldening China's perception of its relative strength. Either of these developments would materially change the 2022 risk balance. But in their absence, the Taiwan conundrum will be more of a longer-term issue than one for next year.
As such, none of the more significant risks facing the region over the next 12 months will substantially change the existing dynamics. Asia will continue to become more regional in orientation, as reflected by trade and financial flows, while China's status as the region's core will become more entrenched. In fact, certain developments next year could actually accelerate these trajectories, for example, if China is admitted into the Comprehensive and Progressive Trans-Pacific Partnership.
Barring any rapid escalation over Taiwan, therefore, 2022 is set to look very similar to 2021 in terms of the region's economic, financial and political trends. But as a result, Asia is still steadily marching toward various unavoidable realizations, confrontations, tipping points and difficult choices, which will only become more likely as each successive year rolls by.
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