On the economic front, the regional economies will certainly have to endure slower growth, higher inflation and downward pressures on their currencies in the coming year or so. Beyond those near-term difficulties, though, the economic changes unleashed by today’s war may not be all bad for Asia — the countries that are nimble and imaginative will find many opportunities to advance their interests.
An increasingly insecure geopolitical landscape
By intensifying trends that were already underway, the war in the Middle East will make for an uncomfortable geopolitical reset for Southeast Asia.
Most importantly, US credibility as a security and diplomatic partner for Asia has been shaken badly. The perception in Asia is that Washington rushed into this war without thinking through its strategy and with little preparation for what could go wrong. The closure of the Straits of Hormuz could have been foreseen — but it was not, and the result is substantial damage to Asia’s economic prospects.
Similarly, Iran’s attacks on US allies in the Gulf had been foreshadowed, but little was done to protect them. That leaves America’s partners in Asia wondering whether their interests would also be so carelessly sidelined should there be a crisis in Asia.
Neither does it help that, unlike its past interventions in the Middle East, the US seems to have taken the cue from Israel and appeared ready to go along with Israel’s campaign to comprehensively demolish Iran’s capacity to threaten Israel — at least initially.
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The current administration’s disdainful treatment of its European allies during this crisis has also shaken a NATO/Western alliance that was already faltering as a result of the administration’s scarcely disguised contempt for Europe and its desire to take over Greenland.
European countries are likely to step up efforts to reduce their dependence on the US. Not surprisingly, the European allies demurred on participating in military operations to force open the Straits of Hormuz.
Thus, this crisis has put a further strain on the alliances that once helped to stabilise the world. That is unhelpful for Southeast Asia, but there are also other, more specific areas of concern for the region:
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Forget about the US “pivot to Asia”. Asian countries seek a region where China, the rising power with territorial claims that unsettle many of its neighbours, can be counter-balanced by a strong and credible US military presence. Recent events have shaken that confidence. The pivot was first articulated by President Barack Obama in 2013, but since then, the US has been frequently distracted by Middle Eastern events. Worse still, US actions during the current conflict have reinforced these Asian concerns. The Koreans were disappointed by the US shifting some of its Terminal High Altitude Area Defense (THAAD) missile defence system to the Middle East. Taiwan is concerned about the depletion of US missile defence weaponry and what that could mean for Taiwan’s defence.
China is likely to gain strategically: China is having a good crisis. Despite its dependence on oil and gas imported from the Persian Gulf, it has substantial reserves that will help see it through the crisis. In the long term, the degradation of the network of US security alliances and the diminished credibility of the US following its misjudgments in the current conflict will help China strengthen its position in our region relative to the US: the region will have to learn to deal with a more powerful China.
A revolution in military affairs is underway: At one level, countries that once depended on the US will be less confident that the US can be relied upon as their security guarantor. They will therefore have to build up their defence capacity more vigorously. But the larger driver of higher defence spending will be the new defence technologies that both sides have used in the current conflict. The Council on Foreign Relations has noted how Iran’s tactics represent a new era of ‘precise mass’ in war: the high-volume use of low-cost, increasingly autonomous systems with high-accuracy guidance. Countries will need to develop defence systems against the waves of drones and missiles that Iran used to saturate and overcome defensive systems. The US and Israel are using AI on a significant scale for a range of use including decision support to autonomous systems, logistics, target identification, and data fusion from disparate sensor networks.
Global growth will take a hit
We now have a clearer estimate of where oil prices will settle — probably around 25%-35% above pre-war levels for at least six months. Economic modelling by various parties suggests that the hit to growth from just such a rise in oil prices would be around 20-30 basis points, i.e., growth will fall from an original estimate of around 2.8% to somewhere around 2.5%-2.6%, which is somewhat better than we had feared at the start of hostilities.
But the impact goes beyond just higher energy costs:
First, the Persian Gulf region is a major supplier of urea fertiliser, helium, sulphur, petrochemicals and aluminium as well. As supplies of these items have been disrupted, their costs have surged, exerting a further drag on growth.
Second, financial stress could be triggered. The crisis has reduced the risk appetites of global investors, causing capital to flow out of risky assets. Emerging economies with weak fundamentals are coming under pressure. Türkiye has burnt through US$30 billion ($38.4 billion) of foreign exchange reserves to defend its currency. At some point, Türkiye or some other emerging economy might find it impossible to continue, at which point we could see many other emerging economy currencies, including those in Southeast Asia, come under severe downward pressure. Another area to watch would be where strains were already evident in developed markets — for example, in private credit. Or, with the Pentagon asking for US$200 billion more in defence spending, we could see investors start to worry about the US fiscal position, which has already been weakened by the loss of anticipated tariff revenues and President Donald Trump’s expansionist budget act last year.
Policy responses will be awkward
A lot can go wrong in the global economy. But the policy response will be complicated by the fact that higher prices of oil and other commodities could raise inflation even as economic growth weakens. Traditional policy tools are also not likely to be as effective as before. Cautious central banks may choose not to cut interest rates as they will not want to aggravate inflationary pressures.
That would leave the authorities with fiscal stimulus as the only other recourse. Governments will be pressed to shield citizens from higher energy prices through more subsidies and pump-priming. But most countries were already facing large fiscal deficits, so any additional spending could make the public debt position worse and cause long-term interest rates to rise.
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Short-term damage
The global economy has been buffeted by a series of crises of various kinds over the past 20 years and has somehow bounced back each time. This record of resilience gives us confidence that policy makers and companies have learned to adapt and adjust to major shocks, whether financial, as in the global financial crisis, a pandemic, as in the Covid-19 shock, or geopolitical, as in the Ukraine crisis.
A likely scenario is that the global economy sees through the short-term damage and then moves on. There will be some impairments — for example, the increased emphasis on national security could lead to economic efficiency being sacrificed for greater resilience. Countries will build their own supply chains for items that matter for security, foregoing cheaper alternatives that are imported. For Southeast Asia, with its high trade orientation, this will not be a great outcome.
Still, there will be lessons learnt from the recent crisis, which will lead to new trends and new opportunities to exploit. First, regional economies will find opportunities in the accelerated shift to renewables and nuclear power that is now more likely: The lesson from this crisis is that countries should work harder to reduce reliance on fossil fuels, which are subject to political risk.
One sign of how seriously countries are taking this issue is the evidence that countries that moved away from nuclear power are now returning to it.
For example, Taiwan is reactivating two nuclear plants that had been shut down. Japan is also likely to quicken the pace of restarting nuclear plants shut down after the 2011 Fukushima disaster. It is almost certain that countries in Southeast Asia will now seriously consider developing nuclear power generation capacity.
Vietnam has just inked an agreement with Russia to help it build nuclear power stations. Regional economies can benefit from this — there will be new investments in renewable energy power generation and other infrastructure. Also, the increased demand for intermediate goods and components used in renewable energy will boost the region’s manufacturing sectors.
Second, relative to its competing regions, Southeast Asia appears relatively stable. It is also a region that has maintained a good balance between the US and China. Most countries in the region handled the threats to trade reasonably well, placating the US without alienating China.
Thus, it will be seen by global corporations as a neutral place to locate production and so hedge against geopolitical and trade war risks. We continue to believe that supply chains will be reconfigured at an even faster pace than before and that this region will be a major beneficiary.
The global economy’s dependence on the Persian Gulf region for so many intermediate goods is now seen as a mistake — there will now be a push to diversify production to new locations, and Southeast Asia could benefit from that.
Already, data on foreign investment show this region enjoying increased commitments to build greenfield plants in 2025, attesting to the region’s attractiveness. While the Middle East conflict may cause businesses to delay plans this year, we are likely to see a pickup next year.
Third, the Middle East conflict again reminds us in Asean about how important it is to integrate so as to gain strength from numbers. The reality is that divergent development levels and different views on how open their economies should be will still limit the chances of all-Asean agreements to deepen economic integration.
However, we see the countries that are confident about benefiting from trade — Vietnam, Malaysia and Singapore — doing more together rather than waiting for the whole of Asean to forge a consensus.
The coming year will be rough for regional economies as higher energy costs begin to hit home. As a negotiated end to the war looks more achievable, disruptions to oil and gas supply should be limited, allowing the region to regain its balance by year-end.
At the political level, the region will need to strengthen security alliances with like-minded partners in Asia to manage a likely diminished American presence.
Over the longer term, there will be economic opportunities for the taking — provided policymakers ensure that the region’s fundamentals remain strong enough to attract foreign investment.
Manu Bhaskaran, CEO, Centennial Asia Advisors
