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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. BUSINESS WITH CONFIDENCE icaew.com/economicinsight 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. icaew.com/economicinsight cebr.com 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 economic insight – south e a st a sia 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 icaew.com/economicinsight cebr.com 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. icaew.com/economicinsight cebr.com 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. ICAEW ICAEW is a professional membership organisation, supporting over 138,000 chartered accountants around the world. Through our technical knowledge, skills and expertise, we provide insight and leadership to the global accountancy and finance profession. Our members provide financial knowledge and guidance based on the highest professional, technical and ethical standards. We develop and support individuals, organisations and communities to help them achieve long-term sustainable economic value. Because of us, people can do business with confidence. Cebr The Centre for Economics and Business Research is an independent consultancy with a reputation for sound business advice based on thorough and insightful analysis. Since 1993, Cebr has been at the forefront of business and public interest research. They provide analysis, forecasts and strategic advice to major multinational companies, financial institutions, government departments and trade bodies. For enquiries or additional information, please contact: Leisl Pillay T +65 6407 1554 E [email protected] icaew.com/economicinsight cebr.com economic insight – south e a st a sia AUGUST 2 012 ICAEW 9 Temasek Boulevard #09–01 Suntec Tower Two Singapore 038989 icaew.com/southeastasia ICAEW Chartered Accountants’ Hall Moorgate Place London EC2R 6EA UK icaew.com © ICAEW MKTPLN11530 08/12