Economic Letter From Asia: The Year in Review

In this week’s letter, we take the opportunity to reflect on the year, with a focus on key developments in the Asia Pacific region. We note that regional disinflation has finally materialized, aided by a decline in energy prices and as cumulative effects of past monetary tightening take hold. Further, we take stock of monetary policy in the region, with one camp of central banks potentially having concluded their tightening cycles, while another camp keeps policy easy, due to less-than-ideal economic conditions at home. Next, we evaluate regional currency performance, and with a nod to effects from monetary policy. We give a nod to equities in the region as well, noting however the headwinds that continue to drag on returns. We also examine shifting trade dynamics between China and other Asian Pacific economies, acknowledging continued export woes in South Korea, and increased shipments by Australia and Vietnam. Lastly, we delve into the state of tourism in the region, acknowledging the enduring gap left by Chinese tourists who have not returned and the measures being taken by regional governments to encourage their comeback.

Inflation developments Headline inflation in the Asia Pacific region cooled rapidly in early 2023, partly due to a sharp drop in energy prices (chart 1), while tighter monetary conditions weighed on domestic demand in some economies. Notably, both China and Thailand recorded their first post-pandemic deflation readings in July and October, respectively. Thailand’s headline inflation was dragged lower additionally by recent measures enacted by the new government, aimed at lowering living costs via diesel tax cuts, reduced electricity bills, and similar measures. However, apart from China and Thailand, relatively high headline inflation rates persist in the Philippines, India, Australia, and Singapore, despite easing price pressures. In the third quarter, there was a resurgence in inflation due to a rebound in crude oil prices, although a subsequent price correction suggests that these inflationary pressures may soon subside.

Central bank developments Throughout the year, the majority of central banks in the Asia Pacific region embarked on further monetary tightening (chart 2). This was driven by their ongoing pursuit of disinflation and the need to keep pace with the rate hikes initiated by the Federal Reserve. Thus far this year, the central banks of Australia (RBA), New Zealand (RBNZ), and Thailand (BoT) have each raised policy rates by 125 basis points, the most seen within the region. In contrast, the central banks of China (PBoC) and Vietnam have reduced interest rates due in part to a weak domestic environment, exacerbated by persistent challenges in the property sector. Despite their tightening efforts, only a few central banks, and specifically those from India, the Philippines, and Indonesia, have managed to set policy rates that are meaningfully higher than that of the United States. At this juncture, it appears that most regional central banks are nearing the conclusion of their tightening cycles.

However, there are exceptions, notably the Bank of Japan (BoJ) and the People's Bank of China (PBoC), which are currently maintaining accommodative policy settings. The BoJ has kept its policy rate steady at -0.1% throughout the year, making it the sole central bank with a negative benchmark interest rate. Nevertheless, the BoJ has recently adjusted its approach to yield curve control, redefining its upper 10-year government yield target of 1% as more of a reference point. The question that begs now concerns the potential repercussions of a comprehensive normalization of monetary policy in Japan, particularly given the country's significant holdings of foreign assets, including those in the United States (chart 3).

Currency and equity performance Asia Pacific currencies have experienced renewed weakness against the dollar this year, as evidenced in chart 4. This decline occurred despite their strong initial performance, as prospects of an extended Fed tightening cycle at that time weighed on them. Notably, the Japanese yen has suffered considerably, depreciating by more than 10% thus far. This depreciation can be attributed in part to its significant negative yield differential with the dollar. In contrast, the Philippine peso, Indonesian rupiah, and the Indian rupee have shown relative resilience, supported by their positive interest rate differentials with the dollar and interventions by their respective issuing central banks.

However, in recent weeks, regional currencies have found some relief, as investors partially unwound their dollar positions, believing that US interest rates may have already reached their peak. Regarding equities, the performance of regional assets has been relatively flat for the year so far. While there have been pockets of growth, persistent dollar strength and ongoing concerns about China's economic outlook have offset these gains. Notably, Taiwan, Japan, and India have displayed relative equity outperformance, with the former driven by chipmakers due to a global push for advancements in artificial intelligence. Additionally, Japanese equities have been supported by robust earnings, while Indian equities have benefited from foreign investor optimism. On the other hand, equities in China, New Zealand, and Thailand have struggled to gain momentum.

Trade balances with China Trade dynamics remained highly fluid in 2023, with China’s slowdown and reduced activity masking ongoing shifts in bilateral trade balances and global supply chains. In particular, South Korea’s trade balance with China has deteriorated much further over the year, with rolling 12-month trade balance readings logging deficits since January (chart 5). The worsening trade balance has been primarily driven by declining exports, particularly of electrical machinery and equipment (HS code 85), while overall imports from China fell at a slower pace. Meanwhile, economies like Australia and Vietnam have seen their balances with China improve on increased exports of mineral products, and of machinery and electrical equipment, respectively. Regardless, China’s imports from the world have moderated lately amid soft domestic demand, dragging on the export revenue of China-reliant economies.

Chinese tourist arrivals Expectations of a strong tourism recovery failed to materialize this year as the anticipated return of Chinese tourists did not emerge fully (chart 6). Instead, the traveling Chinese consumer has opted more for domestic tourism instead, with cross-border trips in China having reached 85% of pre-pandemic levels during the year’s Golden Week holidays. In contrast, Chinese tourist arrivals to other countries have now plateaued at between a third and about half of pre-pandemic levels following an initial surge in H1. In light of the underwhelming arrivals, several regional governments have taken steps to encourage a more pronounced tourism recovery, via the offer of visa-free travel for certain foreigners – as seen in Thailand and Malaysia – among other measures. With that said, whilst regional governments can employ various strategies to incentivize more inbound visitors, foreign consumers are still fundamentally bound to their respective domestic circumstances. As such, given the current comparatively soft state of the Chinese economy, it may be some time before arrivals from China experience a more robust and complete recovery.