Asia’s Faster Rebound from COVID-19, but Scars Remain

Key Takeaways

• Compared to the Asian Financial Crisis (AFC), the relatively bigger plunge and lack of comparable balance sheet vulnerabilities could lead to a sharper recovery by Asia this time.

• The world has gotten used to having Asia led by China as an engine for global growth. However, Citi analysts see five major sources of economic scarring that present themselves as potential hurdles for Asia to return to pre COVID-19 trend growth.

• Much of these are not unique to Asia and with parts of Asia better managing the pandemic and buffered by exposure to the dynamic technology sector, Asia as a whole is likely to fare relatively better.

Deeper fall, sharper rebound

As the ravages of the COVID-19 pandemic gradually wane in major parts of Asia, it begs the question – how much recovery can be envisioned? Once infection fears abate, how much pent-up demand can power a recovery? This needs to be balanced with the longer term scarring that may result from the impact of permanent losses of income/savings, lasting behavioral and policy changes and the transition costs incurred as some businesses lose out more permanently.

Global output is not expected to return to pre COVID-19 levels until 2022, but Asia is forecast to do so by Q4 2021. In Citi analysts’ view, countries like China, Taiwan and Vietnam could bounce back even faster having managed the virus well and as they retain competitive advantages in production of in-demand goods (e.g. electronics, medical equipment).

With Asia expected to return to pre COVID-19 levels within 2 years, the shape of the recovery is assumed to be less protracted than during the AFC, where it took an average of three years for crisis-hit economies to return to pre-AFC levels of output.

However, the size of the economic shock is analogous. Citi analysts estimate about 4.6% of lost annualized real output in Asia before returning to pre COVID-19 levels. But if outperformers like China, Taiwan and Vietnam are excluded, the real output loss is estimated at around 9%, which is slightly below the 10.3% real output loss among the five worse-hit economies during the AFC in 1997-2000.

Asia as a whole may be better off than during AFC, with Asia banks being significantly better capitalized, and an absence of balance sheet vulnerabilities.

Asia is also buffered by strong global technology demand. One sectoral winner of social distancing has been the consumer electronic exports, and thus EM Asia’s electronic exports – accounting for about 36% of exports (ex India and Indonesia) – have been outperforming.

Assessing Economic Scarring

While a faster rebound to pre COVID-19 levels output is expected, Asia may face significant hurdles to return to pre COVID-19 levels of trend growth. Citi analysts see five sources of lasting economic scarring either directly from the pandemic or exacerbated by it:

1. Long-term unemployment and underemployment that erodes skills, leads to withdrawal from the labor force.

Some job losses may be structural due to changing post COVID-19 behavior. Shifting of shopping habits online could be net negative for employment, alongside reduced retail margins. E-commerce take off in Asia this year appears highly uneven – more pronounced in economics with strong IT infrastructure (e.g. Korea, China, Singapore) – but less so in other countries like Malaysia.

Automation / Artificial Intelligence (AI) may also accelerate and post structural challenges. China, next to the US, appears to be at the forefront of competitiveness in AI breakthroughs, along more developed part of Asia (Japan, Singapore, Korea and Taiwan), and could benefit from their role in AI supply chains. However, while skilled labor, particularly those that collaborate with robots, may see improved productivity, some may see displacement.

2. Heightened uncertainty could drag down business investment. This could lead to both aging of capital stock and diminished labor productivity growth, in turn impacting wages and living standards. However, Asia’s bright spot is in the technology space, with much stronger demand driving renewed capital expenditure (capex) cycles.

3. Capital misallocation from prolonged low rates / loose liquidity. With the Federal Reserve (Fed) expected to keep rates near zero until 2023, this is likely to influence monetary policy in Asia through the channel of capital flows. Protracted monetary accommodation could potentially led to asset bubbles, particularly in the real estate sector, and the propagation of zombie firms that drag down productivity growth. There are various definitions on a zombie firm, but China’s State Council basically treats a firm as a zombie if it is has made three years of successive losses.

4. Increased de-globalization tendencies. Even prior to the pandemic, global value chain participation has largely trended down, partly reflecting China’s shift towards increased on-shoring and domestic value-added creation. US-China tensions and trade interventions has exacerbated this trend. Compounded by the pandemic, supply chains are now increasingly about resilience rather than focused on efficiency. Technology decoupling and export controls may lead firms to build bifurcated tech supply chains – one catering to China and another outside of China – at huge loss of efficiency and increased cost pressures.

5. An increased role of the Chinese state in the private sector, which could also be a source of diminishing productivity growth. Widening the role of state intervention in industrial policies or functioning of the private sector, could create risks if not properly formulated and implemented to address a specific market failure.

Conclusion – Lasting scars, but unlikely worse than other markets globally

The world has gotten used to having Asia led by China as an engine for global growth. But the lasting scars may lead to weaker post-pandemic trend growth beyond what Citi analysts have forecast without the pandemic.

Citi analysts highlight five sources of economic scarring. Much of these sources are not unique to Asia except for the last one.

The first two factors, labor slack and weaker investment are highly pro-cyclical, with parts of Asia better managing the pandemic and buffered by its exposure to the dynamic tech sector, Asia as a whole is likely to fare relatively better.