Download economic insight SOUTH EAST ASIA Quarterly briefing Q2 2013 gloBal slowdown is catching

economic Insight
South East Asia
Quarterly briefing Q2 2013
Global slowdown is catching
up with emerging markets
Welcome to the ICAEW Economic Insight: South East
Asia, a quarterly forecast for the region prepared
specifically 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 South East 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 and Thailand.
The world economy remains fragile. The eurozone
is unable to shake off its recession and many of its
members are suffering extensive declines in national
output as economies adjust to the strictures of fixed
exchange rates. Public spending is being sequestrated
in the US, slowing a labour market recovery that
now depends heavily on the housing market for
momentum. Monetary policy has been the weapon
of governments’ choice in combatting the spectre of
deflation and recession.
Now, emerging markets are starting to show signs of
slowing as well. China has eased off its super-charged
growth trajectory, Brazil struggles to control inflation
and to raise industrial output, and even oil and gasfuelled Russia appears to lack the energy for further
growth. The deceleration of emerging markets in
conjunction with the travails of Western economies
has begun to pull commodity prices off their elevated
levels. The prices of energy, mineral commodities and
agricultural produce all appear set to lose ground,
affecting export earnings for their producers and
raising the possibility of a slump in some emerging
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markets. In summary, demand appears to be flagging in
most quarters of the global economy. In this report we
consider the impact that loose monetary policy abroad may
have on the stability of ASEAN’s growth and the region’s
asset markets.
The return on safe assets has
fallen to historical lows
During the ‘Great Moderation’ from the late 1980s to the
financial crisis, inflation targeting became the orthodox
policy approach among central banks across major markets.
The policy largely succeeded in driving down consumer
price inflation and contributed to a steady decline in
nominal interest rates. Figure 1 shows how the return on
long-term government debt fell since the late 1980s to
the present day. The long slump of Japan accelerated the
decline compared with the US and Germany, but the joint
direction of travel in all three countries is evident.
The yields discussed here are in non-inflation-adjusted
terms, but in the run-up to the financial crisis commodity
prices and inflation rose and price rises have remained high
since, mainly driven by the elevated cost of raw materials.
However, the return on government debt, which varies
inversely with demand, has continued to fall despite the
higher inflation rates. Essentially, loose monetary policy
is the key reason for this. The US Federal Reserve and the
European Central Bank have dropped their benchmark
interest rates to historic lows. When this policy tool was
exhausted, quantitative easing was used to further reduce
interest rates in an attempt to kick-start activity and avoid
deflation after the financial crisis. The result has been a
further decline in rates to unprecedented lows.
Global thirst for yield has
boosted regional stock markets
In financial theory, stock prices are solely determined by
the expectation of discounted future profits of the firms
in question. However, many practitioners recognise that
stock values are heavily influenced by the mood of the
market and that expectations of the future can often be
exaggerated – both on the upside and the downside as the
dotcom bubble and financial crisis have vividly illustrated.
Investor perceptions of the promise of different asset classes
plays a big role in determining prices, affecting demand
for shares irrespective of an individual firm’s business
prospects. The malaise of industrialised economies since
the financial crisis, combined with low interest rates on
offer, has increased the attractiveness of emerging market
equities, making them a major beneficiary of investment
inflows. ASEAN stock markets have ridden the wave of
capital flowing in.
The experiences of the different countries have diverged
considerably, but an overall upwards trend in stock prices
is clear. Figure 2 shows the rise in stock prices over the past
decade. Despite the financial crisis, the ASEAN nations
have achieved strong compound annual growth rates since
2003: 28.6% for Indonesia, 20.7% for the Philippines,
15.8% for Thailand and 12.9% for Vietnam. Though rising
less quickly than the others, stock markets in Singapore
with 10.1% and Malaysia with 10.2% still easily outpaced
the 4.5% compound annual growth rate of Japan (Nikkei
250) or the 4.8% of Europe (FTSE Eurofirst 300) or the US’
S&P 500’s 6.3%.
Very low interest rates mean that investors in this major
asset class are receiving meagre returns. The low return
on public debt in the run-up to the financial crisis pushed
capital into higher yielding assets, including sub-prime
mortgages and junk bonds. The current lows in asset
returns in government debt are again fuelling a hunt for
yield. Emerging market assets have been a beneficiary
and in the following section we look at the experience of
ASEAN stocks as an indicator of this.
Country fundamentals and corporate earnings prospects
determined by these are the main driver of stock prices,
but low earnings prospects and unattractive fixed
income alternatives in industrialised countries are likely
to have pushed up ASEAN asset prices. As well as gaining
investment grade public debt ratings over the past year,
Indonesia and the Philippines have become stock investors’
darlings, pushing stocks up 19.9% in the former and 34.1%
in the latter in the 12 months to March 2013. Such growth
rates are unsustainable and they may be seen as evidence
of a bubble. We consider whether other indicators also
point in this direction in the next section.
Figure 1: 10-year government bond yields, %
Figure 2: Stock market indices (March 2003=100)
%
1,400
12
1,200
10
1,000
8
800
6
600
400
4
200
2
0
0
‘03
‘86 ‘88 ‘90 ‘92 ‘94 ‘96 ‘98 ‘00 ‘02 ‘04 ‘06 ‘08 ‘10 ‘12
United States
Germany
Japan
’04
‘05
’06
‘07
’08
‘09
’10
‘11
’12
‘13
Vietnam
Philippines
Malaysia
Indonesia
Thailand
Singapore
Japan
Eurozone
US
Source: Macrobond
Source: SGX STI, IDX JSE Composite, SET SET50, MYX KLCI, PSE PSEi, HOSE VNI, Cebr
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Singapore productivity
The ASEAN private sector is
leveraging up again
Singapore has been a remarkable economic success story
since independence in 1965 as it managed to sustain
high, if somewhat volatile, output growth even after its
industrialisation. Looking ahead, the growth outlook has
diminished so that a slower pace of expansion is expected.
In terms of underlying causes, growth theory suggests
that the amount of factors of production – labour, land
and capital – as well as their respective productivities
will determine output in the long run. To understand
Singapore’s prospects therefore requires an understanding
of these elements.
Strong returns in the equity markets are a sign of investor
confidence. For households and firms, a similar gauge of
confidence is the amount of credit that they take on. In
the run-up to the Asian financial crisis, credit growth was
running fast, both in domestic and foreign loans. The
market turmoil in the late 1990s led to an extended period
of deleveraging within the affected countries, especially
among firms which cut back their financial obligations to
protect themselves from the prospect of another sharp
downturn.
A glance at Figure 3 showing labour productivity (ie, how
much is produced per hour worked) by sector reveals
interesting trends. Looking at the three main sectors –
construction, manufacturing and services – we can see a
decline of labour productivity that is evident across the
economy. The fall is sharpest in the manufacturing sector,
which had exceedingly high annual labour productivity
growth rates in 2010. However, this was a fundamentally
cyclical event as output had plunged during the financial
crisis and the subsequent recovery boosted output per
worker. In construction the pattern is less clear, but rates
of -3.5% in Q4 2012 are well below the series average
of +2.0%. Services have also seen erosion of labour
productivity and for the economy as a whole output per
hour worked was down 3.5% year on year in Q4 2012.
Does this mean that Singapore has lost its edge and is
doomed to gradual decline? Given the long-term nature
of the productivity concept, such an interpretation would
be premature. Figure 3 shows that the numbers are volatile
in the short term and owe more to the business cycle than
to fundamental shifts that can only be discerned over a
longer time frame. Productivity will determine Singapore’s
prosperity in future years, but it’s best looked at as an
outcome of the economy’s structural transformation
than a determinant itself. If Singapore manages to grow
productive sectors with high value added then its overall
productivity will rise. The latest figures offer a positive
indication of this: the biggest improvement in Q4 came
in finance and ICT, both sectors that promise to add
substantially to the island nation’s productive capacity if
they keep growing.
Figure 4 shows that the amount of credit for the four
countries with the largest credit markets – Singapore,
Thailand, Indonesia and Malaysia – expanded faster than
their output until 1998 and then dropped sharply. The
leverage, or ratio of debt to income, largely declined until
2010 (with a short exception in 2008/09). With optimism
rife, deleveraging ended in 2011 and the private sector
has been raising its debt exposure again, a trend likely to
continue while the positive outlook persists. Due to a low
debt burden of about 34% (in 2012) in Indonesia, the
biggest ASEAN economies as a group have a moderate
debt ratio of roughly 76%. Due to limited data, the
Philippines are not included, but its private sector debt
burden is similar to that of Indonesia, while that of
Singapore, Thailand and Malaysia is in the region of 120130% of GDP – not low, but manageable if the good
growth prospect becomes reality.
A strong increase in credit is a warning sign as it often
results in inefficient investment in the hope of a rosy future
that turns out less bright than expected. For now, the debt
burden in relation to income stands slightly above half of
that reached during the pre-Asian crisis peak. However, if
credit continues to significantly outpace nominal GDP then
this may indicate trouble ahead.
Figure 4: Aggregate nominal USD credit to households
and non-financial firms and GDP growth at market
exchange rates for Singapore, Thailand, Indonesia &
Malaysia
%
30
20
Figure 3: Annual labour productivity growth in
Singapore’s sectors
10
0
%
55
-10
45
-20
35
-30
25
-40
‘92
15
’96
Credit
5
-5
‘00
’04
GDP
‘08
‘12
Difference
Source: IMF, BIS, Macrobond, Cebr
-15
-25
‘09
Q1
‘10
Q4
Q1
’11
Q4
Q1
Manufacturing
Total
Construction
Services
‘12
Q4
Q1
Q4
Source: Singapore Ministry of Manpower
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House prices are not booming
(yet)
In many financial crises, such as in the US and in several
European countries, house prices have played a significant
role in fanning the flames of an unsustainable boom. It
requires large increases in credit to enable households to
keep purchasing expensive assets that are growing in price
at a faster rate than incomes. The rise in household wealth
in such a cycle generally leads to rising consumption,
boosting the economy and further encouraging
speculation. Those prices can therefore be an indicator
of economic turmoil ahead – so is a house price boom
happening in South East Asia?
The official indices presented in Figure 5 suggest that this
is not the case. Since early 2008 prices have been rising
steadily in Indonesia, Thailand and Malaysia. The latter has
seen the biggest increases, though data are only available
until the middle of 2012 when a plateau appears to have
been reached. Singapore shows a more erratic pattern than
the other countries as prices dropped considerably during
the global financial crisis, but soon recovered to display an
overall rise in line with other large economies in the region.
These aggregate indices can be misleading, however, as
they mask diverse market dynamics within countries. For
instance, though restrictions on foreign buyers appear
to have put a lid on apartment prices, land prices in
Singapore have been rising sharply. In Indonesia, which is
experiencing fast loan growth – 23.7% in the year to Q3
2012, albeit from a low base – there is anecdotal evidence
of surging condominium prices. Below the surface there
may thus be localised bubbles emerging that can have a
destabilising impact. Rising house and equity prices often
go hand in hand and if credit growth persists at a rate in
excess of output growth then a bubble may develop in this
area. For now, however, a look at residential property prices
suggests that there is no overheating here and that the risk
of a housing bubble has not emerged, though it may in
future.
Figure 5: Residential real estate price indices (March
2008=100)
140
130
120
Investment inflows and
consumer demand to reduce
trade surpluses
The current account is one part of the balance of payments
and the capital account is the other. The capital account
consists of various forms of investment, be they in securities
such as equities, in the form of loans or direct investment in
productive assets. The trade balance is the most important
component of the current account that also includes factor
income such as foreign dividends and transfers such as
remittances or aid. A country’s trade balance is commonly
thought of as reflecting the success of local producers
of manufactured goods and commodities, with services
playing a role for some countries such as those dependent
on tourism, logistics or finance. On the demand side,
household demand is a key determinant of the trade
balance, but here, too, external factors play a big role.
As the name suggests, the balance of payments should be
zero overall. This means that investment inflows must lead
to an offsetting rise in the current account, for instance
through a rise in the trade deficit. As laid out above,
record low interest rates in markets such as the US and
Japan have resulted in a global hunt for yield which has
driven increasing flows of capital into emerging markets.
The stable growth performance of ASEAN has led to
significant investor interest and the projected continuation
of high GDP growth rates – see next section – should
support additional inflows. At the same time, household
consumption is rising as the middle class grows and
consumer credit increases at a substantial rate. Taken
together, it is likely that these factors will lead to higher
imports and thus a deterioration in the trade balance for
many countries of the region, as illustrated in Figure 6.
Singapore should be an exception to this pattern as it
stands to benefit from an uptick in global trade when the
world economy begins picking up speed towards the end
of the year and into 2014. Malaysia is projected to be more
affected by falling energy and commodity prices than some
of its neighbours and for Thailand a roughly stable trade
balance is expected to continue. For the lower income
countries, which are seeing strong rises in consumer
spending and elevated business investment, we expect
further falls in the trade balance that have already been
evident over the past years.
Figure 6: Trade balance, dotted line for forecasts
110
%
100
30
90
25
80
20
70
‘08
’09
‘10
Malaysia
Singapore
Indonesia
Thailand
’11
Source: Valuation & Property Services Department of Malaysia, Bank of Indonesia,
URA Singapore, Bank of Thailand, Cebr
‘12
15
10
5
0
-5
-10
‘00
’03
‘06
’09
Singapore
Malaysia
Thailand
Philippines
’12
‘15
Indonesia
Source: Singapore Department of Statistics, Bank of Thailand, BPS, Malaysia Department
of Statistics, Philippines National Statistics Office, Cebr
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The growth outlook remains
healthy despite some concerns
Credit growth, capital inflows and strong imports lead
to economic problems if the positive expectations that
they’re based on fail to materialise. On the other hand, if
judged correctly and avoiding excess these developments
can grow the economy and lay the foundation for future
prosperity. The analysis laid out above suggests that
international factors have helped support markets and may
have a role in supporting investment and consumption, but
there is no clear evidence of a credit or house price bubble
at this point. Provided that commodity prices that support
export earnings and local currencies remain elevated,
the economic outlook remains positive: ASEAN GDP is
projected to expand by around 4.9% per annum between
2013 and 2015.
The quick emergence of a trade deficit amid elevated
commodity prices suggests that Indonesia may be most
at risk of a further fall in its export revenues. If the global
environment stays stable then low private sector leverage
and the potential to develop domestic demand as well as
abundant resources should further support growth in the
country. That is the central scenario at present and for 2013
GDP growth of 5.7% is expected. The downward trend of
mineral and agricultural commodities is projected to reduce
the growth rate to 5.5% in 2014 and to 5.4% by the end of
the forecast horizon in 2015.
Malaysia has enjoyed a period of low inflation and strong
growth, aided by elevated energy and other commodity
prices as well as fast increases in domestic spending. A
distinct slowing in the latter has been evident and tax rises
should put additional pressure on the economy, resulting
in growth in 2013 of a comparatively low 4.4%. Further
ahead, growth is currently expected to decrease slightly
to 4.2% in 2014 and 4.1% in 2015, as monetary policy is
tightened to counter rising inflation.
The island and trading nation of Singapore is feeling the
effects of subdued global trade, manifesting itself in a drop
in industrial production that is unlikely to be reversed very
soon. This year output is predicted to grow by about
2.3%, with most of the positive impetus coming towards
the end of the year. Unemployment remains low and
provides a good basis for rising domestic demand
alongside an expected revival of industrial production
growth that should foster a return to faster growth next
year. For 2014 GDP is expected to rise by 3.6% and by
another 3.8% in 2015.
Closely integrated into the global manufacturing value
chain, the economy of Thailand was strongly affected by
floods and recession in the eurozone. However, a minimum
wage should support broad-based consumption growth,
while buoyant business confidence is likely to provide
another domestic boost, lifting GDP growth to 4.8% this
year. Output expansion is predicted to moderate to 4.4%
in 2014 and 4.5% in 2015.
Figure 7: Forecasts for annual gross domestic product
growth rates, %
%
6
5
4
3
2
1
0
Indonesia
2013
Malaysia
2014
Thailand Singapore Philippines
ASEAN
2015
Source: Cebr
Unorthodox monetary policy
could come to haunt investors
In terms of risk factors, the soft landing underway – but
not yet completed – in China poses risks if it becomes
less smooth. Excessive credit creation is likely to prove
disruptive at some point and may lead to a slump if
enthusiasm turns to fear. ASEAN would not escape the fallout. The perennial threat from the eurozone, where Cyprus
once again demonstrated a lack of crisis management
ability, could also hurt the region. Though this is widely
known, it’s worth bearing in mind that this risk will persist
for the period of restructuring in the common currency
area, and another slump in the eurozone may still happen
for another five or so years.
Massive monetary stimulus in Japan points to another
concern. The distortion of money markets that has
pushed sovereign yields down but failed to revive activity
may well lead to trouble down the road. Quantitative
easing is distorting market signals and leads to the mispricing of risk, meaning that many investors will face
unexpected losses when the next significant downturn
comes. Commodity price inflation may be another sideeffect of the masses of cheap money available, hitting the
purchasing power of households the world over. Though
the latter may have reversed the money will flow to where
returns are highest, further exacerbating the perilous
allocation of capital. So far ASEAN has benefitted from this
trend, but if it suddenly reverses the impact may be dire.
In this light, high equity prices both in the region and
further afield look premature.
The Philippines looks to be doing exceptionally well as
the government spends heavily on infrastructure and
confidence about governance and business prospects
abounds. Strong exports and booming household
expenditure are adding to the positive picture, resulting
in the prospect of a 5.1% growth in 2013, followed by
5.4% in 2014. Eventually, capacity constraints are likely
to catch up with the success story, leading to higher
inflation, tighter monetary policy and a fall in growth to
about 4.5% in 2015.
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