Energy shock exposes asymmetries in Asia

The Asia-Pacific region is bracing for an economic shock from the Middle East conflict. While our base scenario remains that the conflict’s repercussions will stay manageable, uncertainties demand a closer examination of two risk scenarios. Here, we look at how China and other Asian markets – developed and emerging – are positioned to weather the effects.

The conflict has directly affected energy infrastructure in the Gulf, with strikes targeting facilities and transit routes, including the strategic Strait of Hormuz. In our base case, we anticipate an average Brent crude oil price of USD 90 per barrel over the next six months, with a modest reduction in global economic growth and a still-manageable rise in inflation.

A less likely but more damaging scenario would see the conflict escalate meaningfully, triggering a global inflationary slowdown, and oil prices averaging USD 115 per barrel over six months. To reach that level, we would have to see prices peak around USD 150 before easing. At the most extreme end of the escalation scale, a long war with oil prices averaging USD 150 over nine months – implying a peak of nearly USD 200 – would result in a ‘stagflationary’ shock that damages supply capacity and could, in such an extreme case, trigger export controls. Neither of these two escalatory scenarios are our base case, and they would imply a political setback for President Trump ahead of November’s mid-term elections.

A core question for investors is how China and the wider Asia-Pacific region absorb such pressures, given their deep dependence on imported energy and the importance of oil and gas in transportation, manufacturing and electricity generation.

Extreme scenarios: unavoidable short-term pain

In these extreme scenarios of oil prices averaging USD 115 or 150 per barrel for the next six or nine months respectively, the Asia Pacific region would undoubtedly experience a painful adjustment process. Together, the developed and emerging economies making up the MSCI Asia Pacific equity index source approximately a quarter of their annual energy consumption from foreign sources. However, for natural gas and oil, the dependence is significantly higher.

A drawn-out conflict… is certain to deliver large shocks to economic activity and drain national and private sector savings

In comparison, the US produces more energy than it consumes for all key sources. Due to Asia’s vulnerability, a drawn-out conflict that keeps energy prices at punitively high levels is certain to deliver large shocks to the continent’s economic activity and drain national and private sector savings. Headline consumer price inflation would also spike in such extreme scenarios and leave the region’s central banks with little choice but to fight above-target inflation and weaker currencies at the same time.

To mitigate potential shortages under extreme scenarios, the region’s governments have implemented product export restrictions, industrial rationing frameworks, or shorter working weeks in the public sector. Some are also switching back to coal-based thermal power generation to reduce the import needs for natural gas, while accelerating their searches for alternative sources of energy including renewables. Larger economies in the region have some options to preserve essential economic activities, although a degree of short-term hardship is unavoidable.

Our analysis suggests China is comparatively insulated from the full force of the shock. China’s strategic reserves allow it to draw upon as much as 100 days of oil supply, with additional buffers in refined products. The country’s relationships with alternative oil suppliers – including Russia – offer additional insulation, and Iran is allowing – for a fee – Chinese owned or China-bound vessels to transit the Strait of Hormuz, ensuring at least partial deliveries.

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Built-in resilience in China

China has also in recent years expanded its domestic renewable and potential coal-based power capacity, providing alternative energy sources as imported hydrocarbons become expensive, or less available. Since the drought-induced power shortage of 2022, China has been tolerating lower use of its expanding thermal generation – much of it still coal-based – to keep a contingency option, and it will likely increase utilisation if the energy crunch becomes more severe. The authorities’ long-term focus on electrification – particularly the shift from internal combustion engines cars to electric vehicles – adds further resilience by reducing exposure to price spikes. The country’s vast network of high-speed rail will also cushion a reduction in domestic flights in reaction to high jet fuel prices. These factors help explain why China’s inflation and growth outcomes deteriorate less than those of most developed and emerging Asian economies under equivalent oil price assumptions.

China’s long-term focus on electrification… adds further resilience by reducing exposure to price spikes

In our base case scenario, we anticipate China’s annualised real GDP growth falling to 4.2%, with inflation averaging 1.2% over 2026. At the start of March, China’s National People’s Congress set a target growth range for this year in line with this growth forecast. The country’s authorities also kept the fiscal deficit target at 4% of GDP, indicating limited additional fiscal support and still-constrained monetary easing, which allows greater flexibility to respond to shocks.

Nuances outside China

Australia, Indonesia, and Malaysia produce more energy than they consume, but they differ from one another in terms of reliance on imported petroleum products such as diesel. For Indonesia and Malaysia, we are watching the fiscal costs of maintaining fuel subsidies, but it is unclear if these governments would risk a potential political backlash to make retail prices fully market driven. Other Asian economies have substantially lower shares of energy consumption from domestic sources (see table 1, page 5), but many have higher levels of reserves or financial resources to shield themselves from short-term shocks. Japan and South Korea have, in particular, both built larger buffers of strategic oil reserves. That reflects their longstanding exposure to geopolitical risks.

In an energy crisis Japan has the option of boosting its nuclear and renewable energy output to reduce its reliance on fossil fuels. In the aftermath of 2011’s Fukushima nuclear accident, Japan significantly curtailed its nuclear power generation due to voters’ anxieties over nuclear safety. In a geopolitical crisis and with a more nuclear-friendly government in power, this restrictive stance may be reversed over time to compensate for lower imports of liquefied natural gas (LNG) in the next few years. Japan has the option to restart idled reactors with faster regulatory approvals; the current level of electricity generation from nuclear power plants – including those recently restarted under the Takaichi cabinet – represent a little less than one third of the peak generation in 2000. Meanwhile, renewables already represent about 27% of its power generation and could increase to 40% over the next decade.

India, Thailand, and the Philippines are also likely to be more exposed in the short-term since they are net importers of oil and gas with fewer reserves. For more vulnerable economies, rising prices are feeding quickly into transport, manufacturing and food production, and the difficulty is becoming evident in Asia’s ‘frontier markets’ such as Sri Lanka and Myanmar. Many of these economies will not be able to look past headline inflation as a larger share of consumption is in energy and food.

Monetary policy margins

The key risk today is that central banks raise rates into an energy-driven slowdown, amplifying the drag on economic growth

Without the conflict, central banks in major economies, including the Federal Reserve, European Central Bank and Bank of England would otherwise be cutting policy rates or keeping them on hold. Higher oil prices are already influencing central bank expectations with markets pricing in more restrictive policies, even as we expect policymakers to avoid a repeat of 2022’s tightening cycle. That increases the risk of a policy mistake if price pressures persist. The key risk today is therefore that central banks raise rates into an energy-driven slowdown, amplifying the drag on economic growth.

In Asia, the constraints facing monetary policy reinforce these pressures. Many central banks in the region must weigh the risk of imported inflation against financial stability considerations and external balance dynamics. With energy prices high and exchange rates sensitive to any perceived policy drift, the scope for easing is narrow. Indeed, in markets such as Indonesia, Thailand, and the Philippines, the margin for rate cuts diminishes significantly under prolonged war scenarios and their accompanying high oil prices.

Markets are already adjusting to these concerns and reflecting the risk that short-term inflation shocks drift into longer-term expectations for higher prices. In Australia and Japan, the crisis will prompt additional policy tightening in the remainder of the year. We now assume a final rate hike by the Reserve Bank of Australia in May, and two rate hikes by the Bank of Japan in April and October. 

Taking profit on emerging market exposure

The investment implications reflect this divergence within Asia. In China, the combination of relative energy resilience, additional fiscal capacity and attractive valuations continues to support the medium-term case for selected equity exposure. This is particularly true in technology sectors benefitting from policy support and the expansion of domestic computing capacity. We expect earnings growth in China to accelerate significantly in 2026, and valuations for many technology companies remain below their US peers’, even as the authorities’ push for technological self-sufficiency gains momentum. In Japan, short-term resilience will be underpinned by high oil stockpiles and its nuclear energy option, while corporate governance reforms remain a tailwind for equities. In South Korea, semiconductor producers remain well positioned despite market fluctuations, and the recent sell-off has opened opportunities at valuations substantially below long-term averages.

The challenges for emerging Asia outside China and South Korea … argue for a neutral stance

In contrast, the challenges for emerging Asia outside China and South Korea – which accounts for around a quarter of the emerging market equity index – argue for a neutral stance. We reduced allocations to emerging market equities in mid-March, taking profit to bring our exposure to neutral. Emerging equities’ sensitivity to the oil shock is greater than developed markets’, and so could see elevated volatility before the Iran conflict’s resolution becomes clearer. However, markets continue to price in more of an inflation shock than a growth shock, leaving the fundamental drivers of corporate performance intact.

This neutral positioning allows us to remain invested while preserving the flexibility to respond swiftly as events evolve. It also reflects the contained, but fragile, reaction in global financial markets so far. Corporate earnings remain resilient for now. This said, the possibility of further disruption at crucial energy choke points, together with the risk of export restrictions and the sensitivity of Asian economies to fuel costs, demands caution as long as visibility remains limited.

The Asia-Pacific region will remain central to the global response to any further escalation of the conflict. As conditions evolve, we continue to assess the implications for the region and maintain the flexibility to adjust our positioning.