SOUTH-EAST ASIA: In the bag
Defying a global downturn, south-east Asia’s economies have boomed over the past year amid a surge in domestic and foreign investment. But the region’s fate is in large part dependent on forces beyond its control
Growth in south-east Asian countries has been impressive. But the countries in the region are in no way immune to two big risks, economists warn: spillover from the eurozone crisis and the danger of a marked slowdown in their biggest trading partner, China.
Investors see long-term growth potential in south-east Asia, with IMF forecasts before an announced downward revision for the world economy predicting growth of 6.1% in 2013 for Indonesia, Malaysia, the Philippines, Thailand and Vietnam. This compares to expectations of 3.9% for the global economy, pared back from a previous forecast of 4.1%. But the estimates depend largely upon what economists think might happen in the eurozone, with the debt crisis there having so far proved unpredictable in anything but its persistence. According to statistics from the Association of South-east Asian Nations (Asean) for 2010 issued earlier this year, the European Union is the regions second-largest trading partner, with a 10.2% share of total trade.
Larger Asean economies have benefited from capital flows in the past, but this is a key weakness if risk sentiment is spooked once more by events in China or the eurozone. Significant outflows would hurt growth.
Korn Chatikavanij, former Thai finance minister and current shadow deputy prime minister, says: We evolved very efficiently to the globalization of the world economy, and that means when the world economy weakens we are likely to be impacted the most, whatever central banks and governments do. We cant deny the reality.
The region is the least vulnerable emerging market to any shock from Europe but is unlikely to escape a downturn in the short term, says Nigel Chalk, head of emerging Asia research for Barclays Capital. Europe is a much more extreme possibility, says Chalk. You could have a significant downturn if things start to unravel there. Every policy statement from governments indicates that Europe is the first thing on their list of what they worry about. Theyre curious about China and how its slowing and whats happening there, but what theyre worried about is a collapse of general demand.
Chalk, previously China mission chief for the IMF, predicts the region will see GDP growth fall before entering a V-shaped recovery. Mild deflation could feature until 2013 when prices begin rising again. He anticipates a decisive response from policymakers, who will once again use foreign exchange reserves to help smooth the impact of sharp sell-offs in currencies, if they happen. Asean countries can resort to bilateral swap lines and add fiscal stimulus with supplementary budgets. Central banks also have space to cut rates.
Singapore is most likely to introduce the most aggressive fiscal stimulus, at close to 7% of GDP, as its economy is heavily exposed to global financial markets, says Chalk. The rest of the region is expected to respond with stimulus at about 24% of GDP.
South-east Asia has performed relatively well so far in spite of slowing growth worldwide, due partly to strong domestic demand, which is driven by resilient consumer spending and rising investment. GDP growth among the four largest members of Asean Malaysia, Indonesia, Thailand and the Philippines beat forecasts for the second quarter but also outpaced the rest of Asia, which slowed in the same period.
This stems from acceleration in investment, which is due to infrastructure spending, and inflows of foreign direct investment. Earlier this year, Asean launched an initiative to fund the development of regional infrastructure, which is estimated to need investment of $60 billion a year. With leverage, financing from the Asian Development Bank and plans for debt issuance, the initiative could hit over $13 billion.
What we have seen during this global slowdown has been the Asean region as a whole doing extremely well, says Chalk. They are getting a draft from the export sector, but domestic investment has been going gangbusters.
Real investment money put in tangible assets such as new factories, equipment, machinery has risen sharply in Malaysia, Indonesia, Thailand and the Philippines. Consumer spending has also proved resilient as central banks stay accommodative. Malaysia has benefited from an increase in infrastructure spending due to the governments extensive Economic Transformation Programme (ETP), in addition to expenditure on oil and gas. Real investment has soared 26.1% in the second quarter alone. Consumer spending has also increased over 2012, rising 8.8% in the second quarter from 7.4% in the previous period. This was aided in part by the countrys fuel subsidies.
Critics warn that oil-rich Malaysia is likely to be hurt if commodity prices fall, and that the government has embarked on its ambitious ETP and increased fiscal spending in the run-up to a general election as both public and consumer debt jumps. Household debt is currently at 76% of GDP while public debt is 57% of GDP.
Ong Kian Ming, elections strategist for the Democratic Action Party, an opposition party in Malaysia, argues that the public debt to GDP ratio would hit 65% if the budget included contingent liabilities for public projects being financed by government-backed bonds. This includes the MRT project, the largest infrastructure programme in the countrys history, which aims to add three train lines to Kuala Lumpurs public transport system. There isnt enough fundamental restructuring going on, Ong says. The economy is very much driven by big government projects. Over-reliance on government projects means the private sector is very stifled.
Indonesia had record foreign direct investment in the second quarter, jumping 30.2% year-on-year to 56.1 trillion rupiah ($5.9 billion), with much of this directed towards the countrys mining sector, as companies prepare for new rules requiring they process ore or build smelters in Indonesia by 2014. The manufacturing sector has also proved a boon for the country, which recently lured Foxconn, Apples main supplier, to invest between $5 billion and $10 billion over the next five to 10 years. Since December 2011, the economy has also benefited from moves by two ratings agencies to grant it investment-grade status.
Hak Bin Chua, Asean economist at Bank of America Merrill Lynch, highlights Indonesias ballooning current account deficit which doubled to 3.1% of GDP in the second quarter from the first as a key point of vulnerability. The countrys fiscal deficit is also nearing the constitutional limit of 3%, and could likely narrow the options available to policymakers as growth dips. Export prices for certain commodities have also weakened in recent months due to declining demand from China, surprising coal and iron ore suppliers earlier this year when Chinese buyers broke with tradition and began renegotiating prices and deferring shipments. Indonesia and its large miners including Bumi Resources were badly hit as they are the biggest supplier of coal to China. However, China is still expected to import a record 210 million tons of coal this year.
Thailand, the regions second-biggest economy, exceeded expectations in the second quarter with growth of 4.2%. It benefited from an uptick in investor sentiment in recent quarters due to post-flood reconstruction. Foreign direct investment jumped 63% in the first half of 2012 from the previous year. Exports, which are equivalent to 72% of GDP, had contracted for four straight months by June. This is expected to halve to 7.3% from current levels due to weaker demand, the government warned recently.
The government is trying to boost local consumption with measures including a minimum wage of 300 Thai Baht ($9.7) a day, and infrastructure investment such as plans for a new terminal and runway at the countrys main airport. Kittiratt Na Ranong, the finance minister, is also pushing for a weaker currency and a change in central bank policy from inflation to exchange rate targeting.
Korn doubts the government will be able to move quickly with its policy response to a downturn and predicts GDP growth will be at the lower end of forecasts, but warns against knee-jerk policy reactions. I dont think we are in a crisis or going to be in a crisis unless there is a really sharp downturn from here in China or in the eurozone, Korn says. I dont think we should panic into using up our fiscal space unnecessarily. Im afraid that the government will spend the fiscal space we have and increase the level of public-sector debt to a level that reduces our options if and when action needs to be taken in the future.
The Philippines is one country so favoured by international investors that it had to take measures to limit the inflows of foreign capital, which were appreciating its currency. As the country is expected to gain investment grade by 2014, the Philippine peso has been Asias best-performing currency over the past year according to Bloomberg. Boosted by remittances from Philippines citizens working abroad, which make up a tenth of gross domestic product, the economy grew 5.9% in the second quarter as it benefited from increased public spending and consumption. Exports also jumped 7.8% in July, rising for a fourth month, although they have already begun to slow.
The performance of the peso is giving the central bank some headaches, as investors disappointed by the lack of yield in money-printing developed countries seek higher returns in emerging markets.
Given the more positive growth prospects as well as the more positive interest rate differentials, we continue to receive substantial capital flows, Amando Tetangco, the governor of the Philippines central bank, tells Emerging Markets. While this is good because it provides financing for the economy, it comes with its own separate challenges, and an important challenge related to this is the liquidity these flows generate.
Jonathan Mann, head of emerging market debt at Foreign & Colonial Investment Management in London, favours the Philippines in part because of its improved policy framework, as president Benigno Aquino has shown commitment to fighting corruption and tax evasion.
But Mann believes that the fate of south-east Asia is more dependent on its larger neighbour, and the approach Beijing will adopt as growth slows. He says: Everyone just looks at Europe, but thats just short-term volatility. Everything is relevant at the end of the day. A lot of countries in south-east Asia have strong ties to China so a focus on China is more relevant.
Last year 36% of Chinas imports came from the Asia-Pacific, as China has been south-east Asias largest trading partner since 2008. According to the Chinese government, Asean is its third-largest trading partner, with an expansion in trade of 7.7% to $252.87 billion in the first eight months of 2012. This relationship has enabled south-east Asia region to benefit from the growth of the Chinese economy in the past, but also leaves it perilously exposed to slowing growth in China. In the second quarter Chinas growth slowed to 7.6% year-on-year, its worst performance since the first quarter of 2009.
We know theres been a big build-up in debt, theres a bubble in the property sector, excessive spending on infrastructure [in China], Korn says. What we dont know is how it all comes home to roost and how effective the policy tools to be implemented in the near future to make sure any landing will be soft.
Economists believe south-east Asia will recover in 2013 and bounce back to levels of growth far beyond the reach of developed markets, as the fundamentals remain positive.
This includes strong domestic investment, increased capacity in their industries, and favourable demographics in countries such as Indonesia. But the key variable for this, as policymakers and investors recognize, is the policy response from China and the eurozone and for the moment they both seem unpredictable and opaque.