In an earlier blog “Iran: Assessing the Economic Fallout”, I identified Asia as the most vulnerable region to the war in Iran and the closure of the Strait of Hormuz. Subsequently, financial markets have reflected these risks. Indeed, countries from Pakistan to the Philippines have taken recent measures to cope with the economic fallout.

Now, I will explore two questions. First of all, what are the implications for the area’s near-term growth and inflation outlook? In part, of course, this will depend on how long the war continues. I still believe the initial combat phase will be about six weeks — much in line with POTUS 47’s recent, confused comments. Again, I could be wrong, and the damage to Asia’s economy will increase the longer oil prices remain elevated. And, given the destruction of the Middle East’s energy infrastructure, petroleum prices are likely to remain high even after a ceasefire. Indeed, futures markets suggest oil prices will still be 10% above pre-war levels even at the end of 2027.

Secondly, Asia’s vulnerability to the consequences of exogenous geo-political shocks highlights the urgent need to improve the security of its energy supplies. This may have important implications for the region’s pursuit of its Net Zero CO2 emissions targets. Indeed, prioritising energy security could come at the expense of its energy transition, unless renewable sources become more available.

Pre-War: Asia in Good Shape

In part, the near-term risks to Asia’s economy will depend on conditions prior to the outbreak of hostilities in the Middle East. Before the oil price shock, fortunately, Asia was in good shape (with some important exceptions, e.g. see my earlier blog on China). Indeed, rising household incomes have led to bouyant consumer spending, especially in India, Indonesia, Malaysia, etc (Chart above). Likewise, robust domestic spending has encouraged strong gains in business investment in most countries. The weakness of local demand in China is a noteable exception.

Meanwhile, despite the imposition of US tariffs, Asian exports still are expanding strongly (Chart above). Korea and Taiwan have benefited from booming global AI and tech spending. Vietnam and Thailand have benefited from falling Chinese sales to the USA. And, all have gained from the deepening of regional supply chains.

Likewise, prior to the US-Israeli attacks, Asian inflation remained low and stable.

Hormuz: Assessing Asia’s Vulnerability

Asia’s economic vulnerability to oil price shocks stems from its heavily reliance on foreign sources of energy. The Chart above illustrates the share of energy imports in many Asian nations is amongst the highest in the world. Japan, Korea, Thailand, and the Philippines are most at risk. Malaysia and Thailand enjoy domestic production of natural gas. However, these gas fields are already past their peak production, especially Thailand’s. As a net energy exporter, Indonesia is relatively safe.

In addition to its exposure to rising petroleum quotes, key Asian nations are vulnerable to the closure of the Strait of Hormuz. Indeed, the physical supply of oil from the Middle East accounts for over 50% of overall oil imports in China, India, and smaller Asian nations. Japan is especially at risk, as nearly all its imported oil comes from the Gulf nations (Chart above). Meanwhile, the region’s reliance on the Middle East for natural gas is also high, especially in India and China. Fortunately, however, Asia LNG supplies are geographically more diversified than for oil. In contrast, Europe and especially the USA are far less reliant on the Gulf states for energy supplies.

At this stage, I estimate the energy shock will reduce Asian GDP by roughly 1% over the next year. Korea, the Philippines, and Japan will be hit hardest followed by India, China, Taiwan, and Thailand. Indonesia and Malaysia are best positioned relatively. To be sure, the economic consequences will mount the longer oil prices remain elevalted, and the Strait of Hormuz is closed.

The inflationary impact is more complicated to project. To be sure, the price shock in Asia should exceed that in Europe and the USA. However, many Asian governments heavily subsidise households’ oil purchases. Asia’s relatively low level of public sector debt will allow governments to cushion the blow to consumers to a greater extent than in the advanced economies (Chart above). Relatively good public finances may help to limit the damage to Asian GDP as well.

Will Iran War Jumpstart Asia’s Energy Transition?

The Iran conflict brings into focus the often competing challenges of securing immediately needed energy supplies and pursuing the medium-term goal of reducing carbon emissions. To be sure, fueled by strong industry-led GDP growth and urbanisation, Asian CO2 emissions continue to grow rapidly compared to other emerging and advanced economies (Chart above).

To be sure, most Asian countries not only have pledged to slow the growth in Green House Gases, but also have established Net Zero CO2 emissions targets by 2050 (China by 2060 and India 2070). In order to achieve these laudable aims, the region will need to undergo an enormous energy transition in coming decades. In particular, the electricity-generating sector will confront huge challenges. During the past decade Asian electricity demand has risen by nearly 5% annually, roughly twice the growth world wide. Driven by AI and overall economic growth, Asia’s demand for power is likely to continue to expand rapidly.

However, electricity generation in Asia remains highly reliant on fossil fuels (Chart above). Indeed, over 80% of electricity in India, Indonesia, Thailand, Taiwan, Malaysia, and the Philippines comes from these heavily-polluting sources. By comparison, only 29% and 59% of EU and US electricity is generated by fossil fuels. Even more worrisome, progress on reducing the addiction to fossil fuels has been very slow in most cases. Indeed, the share of power generated by fossil fuels actually has increased since 2010 in the Philippines, Taiwan, and Japan. China has been a relative success story; reducing the role of fossil fuels from 80% to 62% during the past decade.

The University of Notre Dame’s Climate Vulnerability Index rates 187 nations. Several Asian nations are already in the bottom half of the league table (Chart above); underscoring the urgent need for action.

Challenges, Opportunities, and Unintended Consequences

The top challenge in Asia’s energy transition is to reduce its reliance on heavily-polluting coal. Indeed, India, China, Indonesia, Vietnam, and the Philippines rely on the black rock for over 50% of their electricity (earlier Chart). Rapid change is possible. For example, coal accounted for nearly 50% of US electricity generation as recently as 2010; now its share is 15%. China has made progress: coal’s share has declined from 72% to 58% during the past 15 years. However, given the closure of the Strait and the need to secure energy supplies, the transition from coal may slow. Indeed, the usage of coal has actually increased in India, Indonesia, Japan, Vietnam and the Philippines, and Malaysia during the past 15 years.

Oil still accounts for 30-40% of Asia’s overall energy needs, and more than half of the region’s imports come from the Gulf. Securing supplies will need to be a top priority. Europe’s transition following the Ukraine war illustrates what’s possible. Since the invasion, Europe has nearly eliminated Russian oil imports compared to 25% of the total as recently as 2021. (Chart above). The USA, who only has a very small market share in Asia, could potentially benefit, along with African producers. However, given Trump 2.0’s trade polcies, American may not be seen as a particularly reliable partner.

Unintended consequences of the Iran war could be that Asia looks to Russia for oil supplies, as China and India have done already. Likewise, Asia might negotiate directly with Iran to allow safe passage of their energy needs.

At present, nuclear power only has a negligible footprint in Asia, with the exception of Korea. Indeed, nuclear’s role actually has declined sharply in Taiwan and Japan (following the 2011 Fukushima accident). This could be a huge long-term opportunity to create domestic energy supplies and cut carbon emissions. This would take time.

Likewise, renewable energy sources should be a key solution to the region’s energy security and transition. Unfortunately, Asia lags much of the world in the development of alternative energy (Chart above). However, China (and Europe) illustrates what is possible. Renewables now account for 20% of China’s electricity generation, up from only 2% in 2010. Hopefully, the war in Iran and other global geopolitical events will jump-start Asia’s efforts to reap the opportunities in this key sector.

Asia’s slow development of renewables and nuclear energy suggest fossil fuels will continue to play the dominant role for the foreseeable future. In this context, I believe natural gas will be vital to the region’s transition from coal, as has been the case in the USA. The role of NG differs significantly across the region; being extensive used in Korea, Malaysia, Taiwan, Japan, and Thailand (where 68% of electricity is generated by NG). On the other hand, China, India, Indonesia, Vietnam, and the Philippines use NG surprisingly little.

Fortunately, while Asia’s dependence on Gulf producers is significant, NG supplies are more diversified than for oil (Chart above). Especially with future production expected to decline in Thailand, Malaysia, and Indonesia, securing NG supplies will be crucial. Again, the USA LNG producers could benefit, although America’s credibility is damaged at present. Australia is likely to be the big winner. Already, Taiwan and Japan are big Aussie customers. Once again, India and China especially may look to Russia for NG imports, and negotiate directly with Iran to secure safe transport of this vital input….unintended consequences form the war in Iran.

All things considered, given Asia’s slow uptake of renewables and nuclear power, its reliance on coal, and the priority given to securing energy imports, I am not especially optimisitic the region will achieve its Net Zero aims.