Given the unpleasant trends in geopolitics, the global trading system and financial markets, the realistic conclusion should be that the region will face more difficulties in the near future. However, our view is that while conditions are likely to get rougher we should not be overly pessimistic. Remember that bad times tend to create pressures for changes, some of which could be helpful to our region. Policies in the US, China, Europe, Japan and elsewhere are likely to be recalibrated to accommodate the challenges that have emerged. Companies will also revise their business strategies to strengthen their resilience and to exploit new technologies.
The net result — slower growth and challenging times for policymakers and businesses but also some saving graces. Judging by the forward-looking indicators and the direction of major trends, the near future will be marked by the following themes.
Global economy is set to slow, deflationary pressures could grow
The usually reliable lead indicators have spoken out clearly — it would take a miracle to avert a global slowdown. Based on its tried and tested lead indicators, the OECD projects a step-down in global economic growth from 3.3% in 2024 to 2.9% in 2025 and 2026, which is below the long-term trend for the world economy. Other major forecasters such as the World Bank are also looking at slower growth. Purchasing manager surveys also show a decline in new orders across most economies, a sure sign of a coming slowdown.
This is not surprising given the direction that the major economies are taking. In the US, the Trump administration’s efforts to reshape politics and the economy have created great uncertainty which is depressing confidence among consumers and businesses. Moreover, the big fiscal spending push of the preceding Biden administration is fading and there are some early signs of financial stresses among segments of consumers and firms.
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China’s prospects are a bit better but headwinds remain. The OECD’s lead indicator for China actually points to a modest uptick. More supportive government policies and the impressive progress being made by the high-tech sectors in China should help boost growth. However, we see exports taking a hit from protectionist measures by the US and emerging economies.
Once the dust settles on the trade dispute with the US, we see the average tariff rate on Chinese exports to the US settling at around a still-high 35%. At the same time, Chinese exporters are likely to face a growing backlash in emerging economies where there is growing resentment against surging Chinese exports which are displacing local producers. We are likely to see more anti-dumping and other restrictions being placed on Chinese exports.
Chinese policymakers believe that their firms can eventually adjust to these export challenges because of their extraordinary cost competitiveness and nimbleness. But the adjustments will involve some pain such as reduced prices, depressed profitability and the squeezing of workers and component suppliers.
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In addition, the prospects for China’s domestic demand remain murky. The initial signs that the real estate sector might be bottoming out have not been validated by the most recent data. Private businesses remain wary of the future and there are signs of financial stresses in the small-medium enterprise sector.
Finally, the Trump administration’s tariff hikes will begin to feed into the overall global economy over the coming months. The scale of the tariff increases will probably render some existing business models redundant, forcing affected firms to shut down or downsize. For surviving firms, higher tariffs will raise business and living costs, requiring them to re-engineer themselves to protect their profitability — workers could be laid off and suppliers told to reduce prices of inputs.
There are several likely implications for Asia in this scenario:
The resilience that Asian economies demonstrated in the first half of the year will be tested in the second half. Economic growth is likely to slow in the second half and continue to be below-trend in 2026.
In addition, as economic growth goes below potential growth, inflation will slow. But this will be compounded by the adjustments to the tariff shock such as Chinese exports being diverted from the US to emerging economies and big firms squeezing their suppliers and workers to cut costs. We could see stronger deflationary forces as a result.
Slower growth and more deflation will consequently mean more monetary easing, not just by the US Federal Reserve but by central banks in Asia as well.
Trump administration may be forced to recalibrate its approach
Trump has created a great deal of turbulence with his moves on trade, domestic politics, China, and his treatment of America’s traditional allies. We suspect that the coming months will be when reality hits home and persuades his administration to moderate its approach. But this will only happen after hard truths hit home, some of them painfully.
What are these hard truths?
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First, the easy political ride that Trump has enjoyed will end soon. Domestic dissension is already growing as seen in the massive turnout for the “No Kings” protests at Trump’s policies. These protests will grow more forcefully in the coming months. Electoral trends will also undermine Trump. Of the roughly 30 special elections that have been held in recent months, his Democrat opponents have enjoyed a massive 16 percentage point swing compared to last year.
The president’s polling numbers will turn even more negative as the economy slows and tariffs raise the cost of living. This will give moderate Republicans who are uneasy with his policies but have kept quiet so far the leeway to push back on his policies. Court rulings will reverse many of his signature policies. Thus emboldened, state governments opposing Trump will find more legal avenues to stymie Trump.
Second, trade negotiations will show Trump how wrong his assumption was that the US held all the cards and that other countries would have no choice but to concede to his trade demands. Already China’s export restrictions on rare earths have been a surprise to the US — it is the US which has backed off in its trade clashes with China despite all the cards that Trump thought the US had. Europe is sticking to its tough line while offering the US selective concessions in a few limited areas. Japan has been surprisingly robust with the US — it postponed a high-level meeting of defence and foreign ministers with the US and is insisting that the US reverse its hiking of tariffs on Japanese auto exports to the US. India has also chosen to stick to its red lines as it negotiates with the US.
Third, a stronger reaction against his fiscal policies in bond and currency markets will also force a rethink of policies. His “One Big Beautiful Bill Act” is likely to be passed by mid-July and will increase America’s public debt by an estimated US$2.4 trillion ($3 trillion) over ten years. Hopes in financial markets that the Senate will water down the version of the bill passed by the lower house are likely to be disappointed — there is very little political will to cut spending in line with reduced taxes. The result could be another move up in bond yields and more downward pressure on the US dollar.
In coming months, therefore, there is a good chance that these pressures persuade Trump to temper his approach on domestic and international affairs. If there is a more reasoned American stance on trade, the 10% “reciprocal tariff” rate may still be unavoidable but there will be a better scope for deals that Asian economies can live with it. As trade agreements are finalised, the uncertainty that currently depresses business spending should diminish and global economic activity improve as a result.
Likely shifts in how capital is allocated around the world
The movement of foreign direct investment as well as portfolio capital could see some important changes in coming months.
First, foreign direct investment should recover if trade uncertainty diminishes. It is reasonable to assume that tariffs and other restrictions on exports will be more onerous for China than for other emerging economies given the geopolitical considerations and the growing trade tensions over Chinese exports. If so, then there will be a strong case for more production to be relocated to competitive emerging economies such as Southeast Asia, Mexico and India.
Second, despite the uncertainty and the cyclical slowdown, some types of capital spending will hold up and perhaps even accelerate. In coming months, businesses will gain more clarity on whether the progress in artificial intelligence is sufficient to open up profitable applications for them. If, as we assume, faster-than-expected progress in AI convinces firms that AI is more than hype, capital spending in AI-related areas will likely accelerate from its already robust pace.
Third, we believe China will continue to surprise the world with faster progress in high-technology areas. We all know the story on electric vehicles and AI. The next big area could be in bio-pharmaceuticals where China has invested massively and breakthroughs are said to be imminent. In a world of big power competition, China’s progress will arouse concerns in the US, Japan and Europe which will respond with initiatives to retain competitiveness in key areas of high technology — the result will be more investment in R&D.
Fourth, geopolitical and financial market turbulence will persist, sparking off even greater search for safe havens. Flows into places such as Switzerland, Hong Kong and Singapore will grow, posing significant challenges to policy makers there because hot money will complicate exchange rate management and increase risks of speculation and asset price surges. Policymakers in these jurisdictions may have to resort to new macro-prudential tools to slow these inflows or to mitigate their impact. But since the demand for safe haven assets is likely to persist and grow, it would not surprise us if ever-innovative financial markets create synthetic safe haven assets — but such innovations could also create risks as we have seen before.
Conclusion: challenges as well as opportunities for Asia
Asian economies can expect slower economic growth and more deflationary pressures. However, these can be managed because there are also opportunities that can be exploited — such as more production relocation from China — as well as offsetting factors such as monetary easing. A more nuanced American approach on trade, if it materialises, would reduce business uncertainty as well.
In short, the global environment will probably continue to be a rough one for our region but the downside risks can be contained.
Manu Bhaskaran is CEO of Centennial Asia Advisors
