The emergence of the Omicron variant of Covid-19 has dashed the hope of many that this would be the year we finally emerge from the pandemic. Infections are rising at an alarming rate in many countries, governments have had to reintroduce some restrictions and economic activity has slowed as workers call in sick or ordinary people go out less. Still, financial markets took the news calmly, believing the impact would be short-lived — though this pandemic has frequently angered optimists.
We believe markets are right to look past the Omicron infection spike. Furthermore, we believe that the eventual recovery in global activity will be much stronger than expected. This is not just because we are seeing the impact of the pandemic on the global economy becoming less and less malevolent over time. The added benefit comes from the growing impetus for companies to advance business development plans that have been suspended or delayed by the pandemic. This optimistic view does not ignore downside risks such as a sharp slowdown in China or the potential for economic tightening in the US and elsewhere to affect economic strength. These risks need to be carefully monitored, but we believe they can likely be contained.
The pandemic will weigh less on global economic activity
Throughout history, pandemics like the one we are experiencing now have a typical life cycle. They appear out of the blue, wreak havoc for a while, and then evolve into less and less harmful variants. Of course, there is no guarantee that this will always be the case, but in most cases this is the pattern. Fortunately, the behavior of this Omicron variant is in very good agreement with what the historical pattern of evolution would predict. It is easily transmitted, but significantly less harmful to health. In addition, experience in the countries first hit by the Omicron variant – South Africa and the UK – suggests that infections rise rapidly and then fall, as we are seeing in South Africa. After peaking at nearly 40,000 infections a day in mid-December, the latest figure is below 6,000. Hospitalization and death rates are also remarkably low. If this pattern is repeated elsewhere, the worst spike in Omicron infections will be over by late February or early March.
Based on this experience, our best guess is that even as more new variants emerge, chances are the same pattern will emerge – the virus will gradually evolve into a less malicious version. At the same time, medical science never ceases to amaze us with how quickly it can develop even better vaccines and better drugs to suppress the malignancy of the disease caused by the virus. All this makes the virus much less “scary”. That means health officials are less likely to have to resort to measures that undermine the economy. And consumers and businesses will not be afraid to limit their normal activities. The pandemic will not go away, but will gradually recede into the background and eventually become more of an irritation than a terrifying threat.
Why the economic implications for Southeast Asia are particularly positive
The pattern of economic activity will follow a shape similar to that of the virus. In the coming weeks we will likely see some challenges for the economic recovery. The large number of infections will mean that many workers will not show up for work. For example, one report estimates that three million Britons were unable to show up for work two weeks ago because of the surge in infections. Public health restrictions will limit the activities of consumers and businesses. Business leaders can take a wait-and-see approach to hiring and capacity expansion. The recently released surveys of purchasing managers are already picking up on some of the resulting slowdowns in activity and pointing to some disruptions in supply chains.
However, when the pandemic subsides, consumption, investment and attitudes should quickly collapse again. As a result, economic growth will pick up quickly, which the markets are pricing in. But our argument goes further. We expect additional demand stimuli that will spur the Southeast Asian economies to even stronger growth.
The main reason for our view stems from our expectations for capital spending by companies in the major developed countries. Recent data shows that US core capital goods orders continue to grow, while Germany are gaining momentum. In the US, a survey of small businesses showed a gradual improvement in investment-boosting plans, although small businesses were dissatisfied with many aspects of President Joe Biden’s economic plans.
There are several reasons why we believe the recovery in capital spending will be much stronger than expected:
First, in the past two years, as the pandemic rocked the global economy, many new technologies have reached the point where commercial applications are becoming feasible and in some cases imperative or even inevitable. Be it the cost savings promised by cloud computing or the productivity gains from the use of robots in factories, the decarbonization promises of renewable energies such as solar, wind, hydrogen and geothermal energy, or the revolutionary improvements in medical care provided by advances in the biomedical sphere, or the new opportunities that created by new materials such as graphene or composites, the scope for the profitable use of new technologies has exploded.
Because these innovations are game-changing, companies cannot afford to miss them, as failure to invest in these new technologies could render them obsolete. Additionally, leveraging these new technologies requires building new infrastructure, which in turn means more capital expenditures. For example, if electric vehicles are to be a way to reduce emissions, we need to build huge networks of charging stations in every city in the world. Enormous sums must also be invested in high-voltage grids in order for electricity from renewable sources to be profitable. Finally, new technologies also bring new overhead requirements, which in turn require large investments. An example is cybersecurity – companies cannot avoid investing in e-commerce, online payments and financial technology (fintech), but due to phishing, hacking, malware, ransomware and all these threats, they need to invest heavily in cybersecurity.
An increase in global capital spending will have a positive impact on Southeast Asia as the region’s manufacturers specialize in the manufacture of components used in machinery and other capital goods.
Second, there are developments in Southeast Asia that point to more reasons why we could see an increase in capital spending.
• The pandemic has prompted companies to rethink how they organize their supply chains. Over-reliance on China has proven risky. China’s zero-Covid strategy has led to frequent supply chain dislocations. In the months leading up to the outbreak of the pandemic, we had observed an increasing tendency to relocate production to Southeast Asia. This process was interrupted by the pandemic, but we believe it will vigorously resume once the pandemic has subsided.
• Over the past two years, the high tax spending needed to fund public health policies and provide social security to low-income groups has diverted funds from infrastructure spending, which has therefore slowed significantly. We expect spending on power plants, roads, railways, transit systems, ports and airports in the region to recover significantly over the course of the year.
• Over the past two years, countries in the region have introduced reforms to improve their attractiveness to foreign investors. Indonesia, for example, has passed a package of legal reforms that address problems foreign investors have had with Indonesia’s labor market regulations and foreign ownership caps.
What about the risks?
Our main concern is China, where a confluence of headwinds has emerged. The downturn in the real estate sector continues, exacerbating the financial difficulties of large borrowers, even those outside the real estate sector. Private entrepreneurs have been rocked by sudden regulatory changes that have clouded the outlook for many technology companies, as well as sectors like education. Therefore, if private companies avoid investment, the impact on the Chinese economy and the world economy could be severe, since investment accounts for more than 40% of the economy. China’s relentless zero-Covid strategy is also a risk – sudden lockdowns of entire cities, including ports and industrial zones, can disrupt supply chains that the world’s manufacturers rely on.
However, China’s highly respected policymakers are stepping up their support for the economy. Most recently, the State Council called for measures to boost domestic demand, while senior economic leaders called for measures to support employment. Over the past month, the central bank has increased support for vulnerable segments while working behind the scenes to ensure the fallout from defaulting real estate companies can be contained. In general, it’s a bad idea to assume that policymakers always get things right, but the impressive track record of policymakers in Beijing offers some comfort. The latest surveys of purchasing managers showed tentative signs that the economy is regaining momentum, so the measures taken are beginning to shore up the economy.
A second concern is the turnaround in monetary policy in the US and other developed countries. The US Federal Reserve has taken a rather dramatic turn in recent months. Not only will we likely see an end to quantitative easing, but an actual reduction in the liquidity provided by the Fed by March, when it also starts raising interest rates. The European Central Bank and Bank of Japan have both indicated that they will back off the ultra-loose stance of the past two years. There are no two ways to do this – tighter liquidity will eventually hurt financial asset prices. Financial markets have likely accumulated excesses in recent years, whether it’s the excitement surrounding cryptocurrencies, or the aggressive valuations of tech stocks, or the soaring real estate prices around the world. Still, central bankers seem well aware of the potential risks and are likely to be very careful in calibrating their monetary policy changes, which should help limit the damage from tighter monetary conditions.
The current difficult phase of the global economy is likely to be short-lived. It will likely give way to a period of robust global expansion. Patterns within this recovery should benefit Southeast Asia as risks such as the slowdown in China and the end of easy money are managed.
Manu Bhaskaran is CEO of Centennial Asia Advisors