Update Country Report Maldives 29 Jun 2022

• In the EIU's mid-year forecasts for the Asia Pacific, regional real GDP growth slows to 3.9% in 2022, from our end-2021 projection of 4.5%, chiefly owing to a change to the China outlook rather than Russia's invasion of Ukraine.
• Inflation will accelerate across the region this year amid a jump in commodity prices, but its effects will be uneven and some economies, such as Malaysia, will be less exposed. Consumer spending will be more resilient in markets with stable inflation and real wage growth.
• Monetary policy tightening in Asia will lag behind that in the US, creating financial market and currency risks. The Philippines and Thailand are among those vulnerable, given low policy rates and changes in their current-account positions.

Weaker expansion in China reflects the impact of covid-19 lockdown measures in Shanghai and elsewhere in the country over the second quarter of the year. Although we expect China's economy to rebound in the second half of the year, anticipated annual real GDP growth of 4% will still fall far short of the government's target of 5.5% and our forecast of 5.2% at end-2021. The authorities are content to accept that as a consequence of containing the spread of covid-19, and are unlikely to unleash massive stimulus.

China downgrade has pulled down the Asia GDP forecast more than Ukraine war

Asia's limited trade and investment linkages with Russia and Ukraine means that the conflict has not had the same impact as in Europe, for example. However, it has had an indirect impact on the region, as jumps in the global prices of key materials have caused inflation to accelerate. This will weigh on Asian consumer spending, even if some buffer is provided by the savings built up by households during the pandemic, and will affect corporate investment appetite as higher input prices squeeze profits. Growth will also be hurt as monetary policy is tightened to suppress price gains, although the effects of this will be more apparent in 2023 than this year.

The economies most exposed are those reliant on imported energy and food. Downgrades to our growth forecasts for Japan and India; the second- and third-largest Asian economies, which are both heavily reliant on imported energy; reflect this. Japan is now expected to grow by 2.1% in 2022, compared with 3% pre-invasion, despite tailwinds from its removal of covid-19 restrictions. Meanwhile, India's GDP expansion will cool to 6.9% in fiscal year 2022/23 (April-March), down from above 7% previously, with annual consumer price inflation set to exceed 7%. This will still be the second-fastest growth within the G20, although this partly reflects India's slow recovery from the pandemic.

The most resilient economies in Asia include commodity exporters enjoying a lift from higher prices. Although goods export volume growth will, in general, be weaker this year than in 2021, the jump in commodity prices is such that exporters will enjoy higher earnings that will, in turn, be recycled into investment and consumption. Two of Asia's largest commodity exporters, Australia and Indonesia, are forecast to grow by 3.2% and 5.1% respectively in 2022-around as much as they were expected to do so before the invasion. However, with us not expecting a new commodities "super-cycle" to emerge, extractive sector reliance will later shift to being more a source of weakness than strength.

Trade-dependent economies have also proved quite resilient. South Korean GDP growth is barely changed at 2.7% this year, while that for Taiwan has been lifted to 4% (from 3.2% at end-2021) and the outlook for Vietnam remains stable. Global demand for electronics and semiconductors remains firm, supported by both corporate and consumer demand, and the oversupply we previously anticipated emerging in the sector is no longer set to materialise this year. Asia's exporters will face a more challenging outlook in 2023, as US and EU growth cools.

Higher commodity prices will affect the region unevenly

Higher global commodity prices will feed into consumer prices across the region, albeit unevenly. The extent of pass-through will depend, among other factors, on the level of reliance on imported food and energy; the extent of price regulation, especially of fuels; and whether imported inflation is accentuated by exchange-rate weakness.

The economies in Asia set to experience the strongest inflation are also among the poorest. Mongolia, Pakistan and Sri Lanka were struggling with structurally high inflation before the Russia-Ukraine war, and the additional rise in commodity prices; compounded by steep falls in the value of local currencies; is set to have a deep impact on local food and energy security. Extremely constrained fiscal circumstances provide little scope for their governments to soften price pressures. In Sri Lanka, we are forecasting consumer price inflation to average above 50% this year, as the country struggles with critical goods shortages born from the effects of the pandemic and policy mismanagement.

Some higher-income countries accustomed to low rates of inflation are also grappling with strong price rises. Inflation in Singapore is forecast to average 6% this year (versus 2.8% pre-invasion of Ukraine), while in Thailand, it is expected to be 5.7% (compared with 1.9% previously). Import reliance and a lack of countervailing fiscal policies are the main factors underpinning the acceleration in prices. In Singapore, as well as advanced markets such as Australia and New Zealand, there are indications that price rises are becoming sticky with wages also moving up rapidly alongside.

Consumer spending will hold up better in markets where a rate of inflation consistent with historical trends is maintained and wages still grow in real terms. Malaysia's fiscal earnings from its oil and gas exports have given its government the wherewithal to introduce measures to insulate households from cost-of-living pressures, and it has also-controversially-restricted some food exports to preserve domestic supply: as a result, consumer prices are forecast to rise by only 3.1% in 2022, only a little higher than the pre-invasion forecast. Bangladesh, the Philippines and Vietnam are among the markets where we project inflation to be relatively stable and for inflation-adjusted wages to rise.

China will also have low, stable inflation and real wage growth in 2022, but consumption will be affected by zero-covid policies (we forecast that real private consumption will grow by only 0.4%). Households will save their earnings rather than spend them, pushing the national savings rate up to 48.5%-the highest level since 2012.

Central banks that tightened early are best placed to weather Fed hikes

Aggressive monetary policy tightening involving a 300-basis-point policy rate rise in 2022 by the Federal Reserve (Fed, the US central bank) will present a huge challenge for Asian central banks. No major Asian economy is facing inflation pressures as intense as those in the US and, in most cases, the post-pandemic economic recovery is less advanced. However, most will face little option but to follow the direction set by the Fed, with a failure to do so risking financial market volatility as investors withdraw from local-currency assets in favour of US-dollar options producing higher yields.

The central banks in the region best prepared are those that began earlier adjustments to the accommodative monetary policy settings adopted at the beginning of the pandemic. New Zealand and South Korea began hiking their policy rates in the second half of 2021, meaning that they have space to adopt a more staggered approach to future hikes that ought to prove less economically disruptive. Earlier tightening will support local currency valuations, help in taming inflation and preserve demand for government bonds.

However, most central banks in Asia are playing catch up with the Fed. Those in Australia and India are among those to have been forced into significant increases in their policy rates, having failed to signal such intentions beforehand. Indonesia has traditionally been vulnerable to shifts in global investor sentiment, owing to its reliance on foreign capital inflows, but buoyant goods exports and anticipated rate hikes over the second half of the year will provide protection. Markets such as the Philippines and Thailand-where central banks have been reluctant to act, policy rates are relatively low and current-account positions have been eroded because of weak services exports-will be more vulnerable to the effects of Fed tightening.

Finally, some central banks in Asia will swim against the tide. China will keep rates unchanged over the remainder of the year, as it looks to shore up economic activity after drops caused by lockdowns. Through the country's foreign-exchange reserves, the central bank has sufficient arsenal to weather downward pressure on the renminbi, China's currency. Japan is also expected to remain attached to its ultra-accommodative policy settings, even as the yen plunges by about 15% this year to a 24-year low. Adherence to such policies, after nearly a decade during which they have failed to meaningfully lift GDP growth, will leave Japan as an outlier among developed economies and act as a drag on its long-term economic performance.