Download economic insight SOUTH EAST ASIA Quarterly briefing August 2012 gLoBaL sLumP raises concerns

economic Insight
South East Asia
Quarterly briefing August 2012
Global slump raises concerns
for ASEAN
Welcome to ICAEW’s Economic Insight: South East Asia,
a quarterly forecast for the region prepared directly
for the finance profession. Produced by Cebr, ICAEW’s
partner and acknowledged experts in global economic
forecasting, it provides a unique perspective on the
prospects for Southeast Asia over the coming years.
We focus on the largest economies of the Association of
South East Asian Nations (ASEAN) – namely Indonesia,
Malaysia, the Philippines, Singapore, Thailand and
Vietnam.
The European economic situation is becoming bleaker
by the month, with falling output for the eurozone the
overwhelmingly likely outcome for 2012. Recession is
expected to carry on into next year and full recovery –
which may best be defined as reaching the pre-financial
crisis output level – a distant prospect. While long a
regional worry, concerns about the eurozone are now
cited by both official sources and public companies as
the main culprit of missed growth performances.
The ongoing slowing of major emerging markets
compounds the global economic distress. China is
coming off its supercharged growth trajectory, India is
seeing growth wilt amid a governance crisis and Brazil
is struggling to keep up its climb towards becoming
a major global economic player. Given such dire
developments around the globe, even the US appears
to have stalled in its recovery, with unemployment
stubbornly high and fears of recession raising their
ugly head. How will the ASEAN economies be affected
by the souring situation? What might be the impact
on financial markets? In this report we look at some
answers to these questions.
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Foreign business loses zest as trade
flows dry up
Falling prices for most commodities have resulted
from the slump, even though oil is staying surprisingly
expensive and unusual weather patterns are driving up
various agricultural commodities. A fall in global trade has
accompanied the slowdown and ASEAN cannot escape
this development. Figure 1 illustrates what’s happening
on the main Europe to Asia trade route that goes through
the Suez Canal: annual volume growth has been on
a downward trajectory since 2011 and it hit negative
territory in May 2012. Although this route doesn’t capture
all of world trade, the fact that most trade moves from
east to west points to a considerable demand drop in
Europe – unsurprising given the recession gripping hold of
the continent.
For the ASEAN nations this has differential impacts
depending on their export orientation. Singapore’s large
port and transhipment business will clearly be hit by lower
sea trade and exporters such as Malaysia and Thailand
are also in line for less foreign business as companies
scale back production in response to faltering demand.
For lower income member states, the impact should be
much less pronounced; Myanmar’s, Laos’ and Cambodia’s
limited industrial base comes as a blessing in this case.
With a limited export focus, Indonesia may escape to
some extent. Export dependence is one perspective; the
following section looks at a different measure of economic
relatedness.
A measure of concurrent changes is correlation, which
equates to 1 for two variables that move in exactly the
same direction, 0 for those that show no relation at all
and -1 for those that move in exactly the opposite way. In
our globalised world, we would expect markets to have
a positive correlation (ie, above zero) because they make
up part of the total but since country-specific factors
matter the ‘correlation coefficient’ should be less than 1.
The results of a statistical analysis presented in Figure 2 –
which looks at the correlation between ASEAN national
stock markets and a global measure of equity prices
(the MSCI World Mid & Large Cap Index) over the last
decade – confirm this supposition. In Brunei, Cambodia,
Myanmar and Laos markets are either non-existent or too
small to offer a reliable indicator of underlying economic
prospects.
Figure 2: Correlations of main equity index with the
MSCI World Mid & Large Cap Index
Singapore
(STI)
Vietnam
(VNI)
Thailand
(SET 50)
Malaysia
(KLCI)
Philippines
(PSE All Share)
Indonesia
(JKSE)
Figure 1: Suez Canal traffic, net tons,
monthly annual percentage change
0.0
%
30
20
10
0
-10
-20
-30
2007
2008
2009
2010
2011
2012
Source: Suez Canal Authority
ASEAN stock returns differ according to
global connectedness
Although far from foolproof and hardly efficient at all
times as recent history has decisively shown, financial
markets offer a useful forward-looking gauge of business
conditions. The stock market plays an important role for
capital allocation and the valuation of firms in countries
with developed exchange for the trading of business
ownership ie, shares of stock. Theory suggests that the
price of a business should be the current value of future
profits. The implication is that changes in stock indices
reflect changing expectations of future profits. When
stock markets move in line with each other, profits and
thus economic links should also move in tandem. The
empirical relation isn’t always so clear-cut, but it offers a
useful gauge of economic relatedness.
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0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
Source: Macrobond, Cebr analysis
The largest economies have well-functioning stock
markets, and of these Singapore shows the highest
correlation of the ASEAN nations to global stock prices.
The high value of 0.8 is easily explained by two factors:
firstly, many Singaporean firms make products for
the global marketplace and secondly the local stock
market includes multinationals that have operations and
subsidiaries across the globe, directly exposing them
to the fortunes of other parts of the world. The high
correlation of Vietnam appears to be due to the specific
time period chosen – the past decade – with lower
correlations in other periods, albeit a fairly high one due
to many listed companies’ export orientation.
Malaysia and Thailand cover the middle ground with
readings near 0.5 (so half of the variation moves in
line with each other), with strong export links and
economies that depend on global industrial production
and commodity prices, but also significant countryspecific factors that affect profits independently – political
risk in Thailand is one example of such a factor. The
Philippines are more idiosyncratic with a reading of 0.4,
and Indonesia with 0.33 is the final country on the list.
This reflects the fact that the Indonesian economy is
driven by domestic consumption and investment, but also
that it has become a much more stable country with an
improving economic and thus profitable outlook while the
global economy has been hampered significantly by the
financial crisis.
Finally, in case there is a strong decline in global equity
markets, those stock markets with a high correlation
should move down further than others and rise more with
an upturn. However, stock price changes mainly depend
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AUGUST 2 012
on company-specific factors and whole markets may
well buck their previous correlation trend – this is not an
investment recommendation!
Bond markets suggest low perceived risk
in ASEAN investments
Apart from equities, fixed income markets are the
second pillar of financial markets. These have developed
substantially in previous years and they offer useful
comparative insights due to their global nature.
Government bonds form the foundation for these markets
that also include instruments for private sector borrowing.
Despite the eurozone sovereign debt crisis, public bonds
generally remain the lowest risk instruments available and
offer an indication of the price of money in a country as
well as the risk perceptions of investment there.
In a comparison across markets, Figure 3 shows 2-year
and 10-year government bond yields as an indication
of nominal interest rates ie, before inflation. In addition
the graph includes average expected inflation rates for
the next two years. When subtracting these from the
nominal rate, it shows the real return (ie, the gain in
purchasing power) that investors can expect from buying
the securities. The line in Figure 3 shows that investors in
Singaporean, Thai and Indonesian debt are willing to take
an expected loss over the two-year period in real terms. In
other words, money is cheap for governments as investors
have flocked to park their funds in public debt, mirroring
the situation in the US and the UK and making ASEAN
debt more highly priced in expected real return terms
than that of the BRICs. The Philippines are the exception,
but a recent improvement in its credit rating of the
agency Standard & Poor’s may raise investor interests.
The 10-year rates are included to give a perspective on
long-term borrowing costs and also to show the relatively
low level of rates when compared with those that are
currently much reported in the news: those of Italy
and Spain, which have recently been hovering above
6.0% and 7.0% respectively. In a remarkable reversal
of fortunes, formerly risky countries such as Indonesia
and the Philippines now pay less to borrow from the
international capital market than eurozone member states
that used to be considered fail-safe.
Figure 3: Government bond yields and approximate
two-year real interest rates
7
6
BRICS
Indonesia
Philippines
Malaysia Thailand
3
2
US
UK
Singapore
1
0
-1
-2
10 year yield
According to the preceding analysis, public debt markets
offer humble returns across the large ASEAN economies.
One reason for low rates is that yields have likely been
driven down by international investors hunting returns,
including those engaging in the ‘carry trade’. Carry
traders borrow money in a country with low interest rates
and invest the funds elsewhere at a higher rate, hoping
to profit from the spread in rates. That business depends
on a stable or appreciating exchange rate though, with a
devaluation wiping out profits and the mere expectation
of it chasing carry traders away. Falling demand for
export products can cause this and the result is not just
rising interest rates as capital becomes scarcer, but also a
further fall in exchange rates as investors look to sell their
exposure to the national currency for the one they initially
borrowed in. These flows of ‘hot money’ can quickly
turn cold, driving up borrowing costs and depressing the
exchange rate – thus raising inflation via import prices
– at a time of a cooling economy. The fickle verdict of
markets can turn quickly, causing volatility and potentially
becoming a self-fulfilling prophecy.
Figure 4: Annual growth in real investment across
ASEAN economies, percentage change
15
10
5
0
-5
-10
2009
2010
Vietnam
2011
Thailand
2012
Singapore
2013
2014
Indonesia
Source: National Statistical Agencies, Cebr analysis
Low real interest rates in financial markets should promote
investment in real assets. The public sector should be
more inclined to borrow in order to fund investment
when it gets money for free in real terms. This is indeed
expected for countries such as the Philippines and
Indonesia as well as the lower income countries that are
also sorely lacking in transport links, power lines and
education systems that allow economic growth to take
place without driving up prices to levels that require a
step on the monetary brake.
15
5
4
Incentives for investment remain strong
2 year yield
2 year yield less inflation
Source: Cebr analysis, Macrobond, IMF
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At the same time, the private sector should be willing to
invest in machinery, technology and skills when financial
10
markets offer little prospects of getting substantial returns.
Amid
a positive outlook for consumer expenditure for the
5
region, firms should be able to turn a profit from investing
in0 the future and we generally expect this tendency to
survive the challenging global economic climate.
-5
Looking
at the different countries, Thailand is expected
to raise investment by 6.1% in 2012 while reconstruction
-10
after
last year’s
floods
takes place.
For02/01/2017
Indonesia,
public
02/01/2013
02/01/2014
02/01/2015
02/01/2016
02/01/2018
investment, investment in the mining sector and also in
sectors serving household consumption should lead to
strong investment growth of 9.1% on average between
2012 and 2014. As confidence in the country’s strong
fundamentals returns despite sub-optimal economic
economic insight – south e a st a sia
AUGUST 2 012
Vi
Th
Si
In
A globalised industrial sector comes at a
price when trade partners sag
The opening of Myanmar is proceeding at an
encouraging pace. The likely removal of trade sanctions in
the foreseeable future should give GDP a boost and moves
towards bringing regional dissidents into the fold of a
more inclusive and demographic state offer the prospect
of more widespread growth. Strong foreign investment,
both from China and increasingly from other countries,
as well as a strong export performance, are expected to
boost growth in coming years. For 2012, GDP should rise
by about 5.7%, rising to 6.3% next year and 6.6%
in 2014.
In line with evaporating confidence in the world economy,
growth prospects for ASEAN have fallen substantially.
Previous sections illustrated that various channels are
likely to affect companies and markets in the region. As a
general rule, the more closely linked to Western markets,
the more affected a given Southeast Asian economy
should be by events in the industrialised world. We now
proceed to take a look at what this means in practice.
Slowing inflation has allowed more stimulatory monetary
policy in Vietnam, although concerns remain about the
commitment to macroeconomic stability. Beyond the
temporary slowing, foreign investment should still flourish
as the country becomes a major manufacturing hub and
local consumers see their purchasing power grow. For
2012, growth should average 5.1%, rising to 5.4% in 2013
and 5.8% the year after.
governance, Vietnam’s annual rate of investment growth
should rise from 6.3% in 2012 to 9.3% by 2014. The
lowest investment growth is predicted for Singapore,
which already has a high capital stock which will suffer
more from the global economic downturn than its lower
income neighbours, although an average annual rate of
4.8% growth is still substantial.
In spite of its export dependence, the economy of
Malaysia is still going fairly strong as domestic demand
remains relatively buoyant. However, international
headwinds should lower growth in the second half of
the year, resulting in an annual average of about 3.8%.
Elections this year or next year bear some political risk, but
in the event of a peaceful outcome growth should rise by
3.5% in 2013. A recovery of its trading partners should
see the country’s GDP rise by 4.0% in 2014.
Regardless of the strong domestic focus of the
Indonesian economy and an improving perception by
the international financial community, Indonesia may be
hit by falling commodity prices. Its low-cost position in its
major export, coal, should provide some buffer against
global volatility though and public as well as private
investment will support rising domestic consumption.
If the abovementioned outflow of foreign funds can be
avoided while macroeconomic stability is kept, GDP
growth is anticipated to expand by about 5.6% this year
and a slightly lower 5.3% next, but 2014 should again see
a pickup of growth to 6.1%.
Falling remittances from overseas citizens of the
Philippines are likely to depress 2012 GDP growth
somewhat, but domestic consumption should still rise
considerably and support annual growth of 4.1%. A
strong electoral mandate for the new Aquino government
should encourage investor interest in an ambitious
infrastructure programme that should help the country
achieve output expansions of 3.7% in 2013 and 4.2% the
year after, even if exports don’t give much impetus to
economic development over the forecast horizon.
After the floods of 2011, Thailand has quickly recovered
its previous industrial production and looks likely to
achieve strong growth of 5.2% in 2012. The boost in
growth is likely to be temporary though, with the weak
trade outlook bringing down the forecast to 4.2% next
year. Given political stability, the country should make
better progress in 2014 as it grows at about 4.8%.
After a contraction of output in the second quarter,
Singapore’s outlook for the year has been downgraded
significantly. For the year as a whole, average growth
of 2.2% is expected, rising only marginally to 2.5% in
2013. This is despite strong government investment and
a positive impetus from the surrounding countries for
which the city state provides business services and acts as
a transport hub. Further ahead, output should rise above
the 3.0% mark as the world economy picks up again.
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Figure 5: Forecasts for annual gross domestic product
growth rates, %
%
7
6
5
4
3
2
1
0
Indonesia
Malaysia
2012
Myanmar Philippines Singapore
2013
Thailand
Vietnam
2014
Source: Cebr analysis
China slump, eurozone implosion or global
recession could wreck ASEAN growth
To sum up the previous analysis, we can conclude that the
major economies of Southeast Asia will be impacted by
the deterioration of global growth prospects. However,
the impact is projected to be less severe for ASEAN than
for other parts of the world. Growth should be much
stronger than the global average and outpace the US and
the eurozone.
While investment prospects are somewhat diminished by
a lowered profit outlook for exporters, the basic story of
rising middle class incomes in Malaysia, Indonesia and the
Philippines persists. Further, the growing attractiveness of
Vietnam as a major manufacturing base and the move to
Myanmar, Laos and Cambodia into the global value chain
should boost regional prospects for the foreseeable future,
ultimately boosting Singapore’s role as a business hub and
central operations base for regional business operations.
Growth will be pushed down, but return to its high
trajectory in time.
However, as elsewhere nothing is certain in economics.
The drought-ridden American corn regions and Indian
farm plots are a reminder that nature can strike not just
with earthquakes and tsunamis but with a wide range
of developments that hamper growth. These risks are
difficult to gauge with economic statistics, but identifiable
risks loom large enough as things stand.
economic insight – south e a st a sia
AUGUST 2 012
The investment boom sustaining China’s growth is
vulnerable to the world economy as business profits
create the financial space for new capacity. Although
the public sector may fill the shoes of some firms in
so-called fixed capital accumulation, it cannot – and
should not – substitute for a widespread fall in private
sector investment. The global recession adds to an
investment slowdown already taking place and the two
may become mutually reinforcing. A collapse of Chinese
growth would be a disaster for ASEAN as it has become
the dominant trading partner in many sectors.
Meanwhile, the eurozone troubles are spreading to
more countries, validating earlier concerns about Spanish
property loans and pointing more and more to Italy as
a potential flashpoint. Here and elsewhere, this topic
has been discussed at length. Suffice it to say that
Southeast Asia is still too closely linked to the Western
world to escape unharmed from a messy break-up of
the currency union.
Fragile growth around the world means that a global
recession has become a non-trivial possibility. If the US
also moves into contraction, many developing countries
are likely to follow suit, including various ASEAN
economies. Finally, it is worth bearing in mind that any
of the three events discussed (China, eurozone, global
recession) would make the eruption of any of the other
two much more likely. Given the weak state of bank
reserves in the aftermath of the financial crisis and tighter
regulatory requirements, even renewed panic in financial
markets and the banking sector could occur. The central
scenario is still for decent growth, but risks loom large.
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