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After rocky start to 2014, global outlook
calmer for the rest of the year
Economic Insight
South East Asia
Quarterly briefing Q2 2014
Welcome to ICAEW’s 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 economies
of the Association of South East Asian Nations
(ASEAN), namely Cambodia, Indonesia, Laos,
Malaysia, Myanmar, the Philippines, Singapore,
Thailand and Vietnam.
This year will be a challenging one for South East
Asian economies. Having recently weathered
January’s emerging markets sell-off – a rapid shift of
capital out of emerging market assets by investors
which had worrying similarities to the 1997 South
East Asian financial crisis – they now face a global
economic environment that presents further
uncertainty and challenges. The second half of
2013 and beginning of this year may be viewed as
financial markets starting to adjust to the ‘tapering’
of US Federal Reserve asset purchases. The tapering
was the signal for many investors that it was time
to move capital from emerging markets back to
the developed world – the US Federal Reserve had
hinted that a rise in interest rates might follow the
taper around 2015, meaning that it is becoming
possible to gain the safe investments that developed
markets offer without having to take ultra-low
yields. Those emerging markets affected by this
episode will be hoping that the adjustment has
largely been made, but there is no guarantee this is
the case.
At the same time, China, for so long the engine
of the area’s growth, is showing signs of slowing
as it struggles to change from an investment to a
consumption-led economic growth model. While
overall the global economy is improving, there
remain significant downside risks to economic
performance and South East Asia is more at risk from
these than many other parts of the world.
ASEAN’s less-developed economies still
struggle with commodity dependence
While there are great benefits to trading with other
economies, it exposes a country’s own economy
to problems in those of its trading partners. The
problems associated with this are magnified when a
country trades heavily in commodity exports.
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Commodities are more volatile in price than other
exports. As they are by definition a standardised
product, whether they sell or not largely depends on
price. Price in turn depends on exchange rates, which
as the recent emerging currency sell-off showed, is
influenced by factors outside a country’s own borders.
Even where a country has stable exchange rates, the
global market price may vary. Variation in supply may
create a shortage in one year and a glut the next,
playing havoc with foreign exchange earnings; variation
in demand may cause the same kinds of swings or even
amplify them.
Figure 1 shows the extent of commodity dependence in
the ASEAN economies, compared to the averages across
developed and developing economies. The ASEAN
groups are split into three groups by their development
status. Commodity dependence is on average linked to
low development, as both a cause and a consequence –
though there are notable exceptions to this rule, such as
Australia. The three moderately advanced economies of
South East Asia – Indonesia, the Philippines and Thailand
– do not have sufficient physical and human capital (ie,
skills) to produce as many high value-added goods and
services. The three least-developed economies produce
even more by way of commodities. For instance, in 2012,
33% of Indonesian exports consisted of fuels and related
materials and 12% consisted of animal and vegetable
oils, fats and waxes. On the other hand, 19% and 0.1%
of total Singaporean exports consisted of those two
commodities, respectively – and many of these exports
are simply passing through rather than produced by
Singapore, though trade statistics do not tend to make
the distinction.
Figure 1: Less developed economies tend to be more
dependent on commodities
%
80
60
40
d Vietnam
2005
d Thailand
The three large ASEAN economies that are striving
to make the transition from significant commodity
dependence to an advanced-economy mix of exports
could do worse than to look at Singapore and Malaysia’s
experience.
In very stylised terms, East Asian development can
be looked at as a series of waves of industrialisation,
where the current, third wave of countries undergoing
the most rapid industrialisation includes Thailand, the
Philippines, Indonesia, parts of China and, to a lesser
extent, Vietnam. Future industrialisation is likely to pass
onto economies like Laos and Cambodia. In the first
wave, Japan led the process of industrialisation in East
Asia, with the four ‘tiger’ economies – Singapore, Hong
Kong, South Korea and Taiwan – following in the second
wave shortly after. In developmental terms, Malaysia is
nearer to this second wave than to the current one. The
development of the third wave will be crucial for the
development of the South East Asian economy, as the
process is dynamic. Strong progress not only gives the
richer economies cheap productive capacity, but also
markets for products.%
10
The process is dynamic and interdependent: first, one
8
country – eg Japan, the prototype – has a competitive
6
edge in low-value manufactures,
but this rapidly moves
to another as soon as wages
in the first country rise. The
4
process is driven partly2 by the first country, as its native
firms shift from being low-value assemblers to high-value
0
assemblers, and finally up to research and developers
-2
of new products. As firms do this they are likely to
outsource the lower-value
activities to lower-wage
-4
Cebr forecas
economies: many Japanese
firms originally outsourced
-6
2011 in Taiwan
2012 or South
2013 Korea.
2014
2015
assembly to nearby economies
Japan now sits at the highest research and development
Indonesia
Malaysia
Philippi
(R&D) tier of the manufacturing supply chain, while the
‘tiger’ economies are now involved
in
both
R&D
and
Thailand
Singapore
high-value assembly. In 2012, 39% of Malaysian goods
exports were in high-skill and technology-intensive
manufactures (which tend to be high value), whereas
the corresponding figure for Indonesia was 11%.
Figure 2: South East Asia has moved towards
high-value exports, but clear divergence among
the area’s economies remains
20
0
Making the transition to high value-added
exports
2006
2007
2008
Cambodia, Laos
and Myanmar
Indonesia, Philippines
and Thailand
2009
2010
2011
2012
Developing economies
Singapore and Malaysia
Developed economies
Source: UN Conference on Trade and Development (UNCTAD) trade statistics
While exports of any sort are vulnerable to global
conditions, commodities can be particularly prone to
sudden changes. Having a strong commodity export
sector also tends to keep currency values relatively high,
which makes it harder for other sectors to compete.
This often makes it difficult for developing countries
to escape commodity dependence for higher valueadded exports. Indeed, as Figure 1 shows, commodity
dependence increased for ASEAN nations between 2005
and 2012, though this effect is partly driven by rising
prices, rather than volumes.
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High and medium-value manufactures in ASEAN economies,
as percentages of all merchandise exports
%
50
Indonesia,
the Philippines
and Thailand
40
30
Malaysia
and Singapore
20
Cambodia,
Laos, Myanmar
and Vietnam
10
0
High-value
Medium-value
Source: UN Conference on Trade and Development, Trade Statistics
Figure 2 compares three sub-groups, grouped by
development, within ASEAN by their shares of mediumvalue manufactures and high-value manufactures (as
shares of total merchandise trade).
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In all three sub-groups, high-value manufactures
account for a greater share of exports than mediumvalue manufactures. However, the middle three
economies export a smaller share of high-values than
the most advanced two, whereas the sub-groups rank
the other way around when it comes to medium-value
manufactures.
Two things must happen to allow this transition to highervalue manufactures. The first is investment in education
and skills, which is generally government-led. The second
is large-scale investment in production, which may be
government-facilitated but will generally be private sectorled, often by a foreign private sector.
and primary school enrolment’1 before going on to
acknowledge the challenges that have beset the resourcing
of higher education policies. Figure 3 partly corroborates
Hill’s judgement, but we should note it is more valid for the
five large economies than the four smaller ones.
In order to move up to the highest R&D tier of production,
economies need to have the requisite engineering and
science skills to master them. Good quality universities at
this stage become essential to a country’s development.
Figure 4 shows how the economies compare in terms
of total tertiary students, and in terms of those studying
engineering-related subjects.
Figure 4: In tertiary education, even the South East
Asian leaders have a way to go
Success in basic education has yet to
translate into export patterns
6
5
4
3
2
6
Enrolment in total tertiary as % of population
4
Enrolment in tertiary engineering, manufacturing
and construction as % of population
United States
Malaysia
Philippines
Singapore
Thailand
Indonesia
Vietnam
India
Cambodia
Laos
0
Myanmar
2
Average years of primary schooling, all those aged 15+
Average years of schooling, all those aged 15+
Source: World Bank
Obstacles remain in higher education and
creating a knowledge economy
Figure 3 represents the average number of school years
and the average years of primary schooling. The five
large ASEAN economies – Indonesia, Thailand, Singapore,
Philippines and Malaysia – have achieved good levels of
schooling, with average levels over eight years for each of
them. The US has only about six months’ more primary
education on average than the leading South East Asian
economy, the Philippines. Cambodia, Vietnam, Myanmar
and Laos do not have comparable data for total schooling,
but we see that these smaller economies lag behind. We
include India as an example of a country that has achieved
considerable success in high-tech industries, despite
relatively poor levels of overall education.
Enrolment in Indonesian primary schools now stands
at around 95%. Secondary school enrolment is also
rising, with levels at 68% and 46% for lower and upper
secondary school respectively. Development economist
Hal Hill of the University of Freiburg, looking at the ASEAN
economies’ development record, judges that ‘all [South
East Asian] countries have been reasonably successful with
the basic education strategies aimed at universal literacy
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United States
Singapore
Thailand
Malaysia
Philippines
8
Vietnam
10
Indonesia
0
12
Laos
1
Cambodia
Figure 3: South East Asian economies have achieved
impressive success in basic education
7
Myanmar
To move from commodities to manufactures and services
requires a sustained effort in building human capital ie,
the productive skills and know-how of the labour force.
While Indonesia, Thailand and the Philippines are yet to
accomplish this to a great extent, the two smaller nations
Singapore and Malaysia have achieved levels of human
capital that put them among the ranks of advanced
economies.
Percentqges of tertiary students, total and
engineering, manufacturing & construction
%
8
Source: UN Educational, Scientific and Cultural Organisation, World Bank. For the Philippines,
latest data point for total is 2009, while the latest data point for engineering, manufacturing and
construction is 2004
The smaller bars on the right of each pair show how
many students are enrolled in university degrees in
engineering, manufacturing and construction, per
capita, a field of study that is particularly relevant to this
discussion. Singapore scores .012, meaning that there
is one engineering student for every 81 inhabitants.
Malaysia is a little lower with one engineering student for
approximately every 121 inhabitants, and the other ASEAN
economies lag behind with one engineering student for
approximately every 250–300 inhabitants, or fewer. This
points to a clear opportunity for improvement for the latter
group of economies. The US, although a world leader in
high-tech fields, has relatively few engineering students.
The shortfall is made up by attracting skilled migrants
educated elsewhere. This option is not usually available to
developing countries.
The World Bank’s Knowledge Economy Index is a
composite measure constructed from four sub-indices –
1. education & training, 2. information infrastructure,
3. economic incentive & institutional regime, and
4. innovation systems. The overall measure summarises the
standard of these important determinants of a country’s
competitiveness in knowledge-intensive industries. It aims
to measure not just a country’s capacity for generating
and diffusing knowledge, but also for leveraging that
knowledge for economic development. It ranks the world’s
economies in a league table by this score.
ECONOMIC INSIGHT – SOUTH E A ST A SIA
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Figure 5: Education is just one component of
a knowledge economy
8
The latest emerging markets sell-off happened over January
and February of 2014. It had dramatic effects for certain
emerging markets, forcing Indian and South African
Reserve Banks to raise their interest rates, forcing Argentina
to devalue its currency and inducing Turkey to hike its
central bank rate by four percentage points to 12%.
6
4
United States
Singapore
Malaysia
Thailand
Philippines
Vietnam
Indonesia
Laos
Cambodia
0
Myanmar
2
World Bank Knowledge Economy Index 2012
Education and training sub-index
Source: World Bank
As Figure 5 shows, Singapore’s education ranking lags its
overall ranking by some distance – the other inputs into
the index pushed its overall figure up.2 Encouragingly,
Singapore’s February budget aims to boost enrolment
through providing bursaries for which two-thirds of
Singaporean households will qualify.
We include Vietnam in this figure due to a notable nineplace jump in its ranking compared to last year. This
accompanies encouraging recent news for Vietnam’s
knowledge economy, as investment from the government
complements that coming in from international tech firms.
For example, Ho Chi Minh City attracted investment for
a $1bn facility in 2010 for assembling and testing chips.
Vietnam has signed a Partnership Programme with Finland,
which has so far pledged €10m in funding for innovation.
By the end of 2013, nearly 80 Japanese IT companies had
invested in Vietnam. The Vietnamese Ministry of Science
and Technology (MoST) is trying to foster innovation
by establishing a ‘high-tech cluster’ of SMEs in the area.
From Silicon Valley to Bangalore to Cambridge, high-tech
clusters have been a way of developing knowledge and
innovation economies in many parts of the world.
If India, with lower scores on the World Bank’s Knowledge
Economy Index, can be an international high-tech
offshoring hub, so can South East Asia: to an extent this
transformation has already begun, looking at Singapore’s
established clout in innovation, or at capacity building
from low foundations in Vietnam. The question is therefore
one of extent: will high-tech firms thrive only in small
pockets – as in India’s booming software campuses, which
account for a small proportion of total economic activity
– or will it extend to become an employer of significant
numbers of the population in high value-added activity?
The answer to this will depend partly on the extent to
which investment catalyses high value-added sectors of the
economy.
Investment is not only necessary to fund the plant and
to cover wages until revenue starts to come in. It is also
necessary for a new sector to start operating in a country
because no matter how well educated its engineers are,
they will require experience to learn how to produce
high-value technology. This knowledge or skills transfer is
generally facilitated when a firm from a developed country
sets up assembly/manufacturing plants in a lower wage
country in which it is investing.
Foreign direct investment is returning to
South East Asia
For South East Asian economies it produced uncomfortable
echoes of the disastrous 1997 Asian Financial Crisis,
which shaped Asian attitudes to FDI, creating wariness
by showing that flows can leave as quickly as they arrive.
The episode also began with enthusiastic global FDI flows,
drove strong economic growth and was immediately
Average years of primary schooling, all those age 15+
heralded by a tightening of US monetary policy. Bangkok
was arguably the epicentre of that financial market tremor,
Average years of schooling, all those age 15+
from which it took the Thai economy the best part of a
decade to recover the lost GDP. Due to this harrowing
experience, South East Asian economies were not as
badly hit by the recent sell-off as in 1997, having used
the interim time to build up currency reserves, reform the
banking sector and move away from saving–borrowing
mismatches (risky practices such as borrowing and saving
in different currencies or on different timescales).
Nevertheless, the Indonesian rupiah and Malaysian ringgit
are still significantly lower compared to the dollar than they
were at the beginning of the year. Investors’ appetites for
those currencies may be somewhat sated for the time being.
The future path of US monetary policy and Chinese growth
prospects will clarify over the course of the year, meaning
markets will be less skittish over emerging economy
investments. We expect that Singapore and Malaysia
will finish this year with higher net FDI flows, driven by
confidence in Singapore, while the sub-group of Indonesia,
the Philippines and Thailand will stay on a slightly
downward path before taking off next year. Uncertainty
over future developments in Indonesia and Thailand means
that confidence will be slightly lower during 2014. Our
projections are that FDI will start to grow again during this
year for Singapore and Malaysia, and will return to growth
from 2015 for Indonesia, the Philippines and Thailand (see
Figure 6).
Figure 6: Turbulence in FDI flows expected to
die down
%
200
Inward FDI flows, percentage change year on year
Score on index
10
into South East Asia surpassed those into China last year.
This is especially important for the region as it does not
have savings rates as high as China and so requires foreign
investment to complement its own.
150
100
50
0
-50
-100
2005
2007
2009
2011
2013
2015
2019
Singapore, Malaysia
Cambodia, Laos, Myanmar, Vietnam
Analysis by Bank of America Merrill Lynch has found
evidence suggesting foreign direct investment (FDI) flows
Source: UN Conference on Trade and Development
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Indonesia, Philippines, Thailand
Q2 2 014
10
8
6
4
2
0
Myanmar
Cambo
Singapore has used its strong fiscal position from years
of surpluses to run an expansionary government budget
with a small deficit. This will support demand over the
year to come. Certain elements, such as extra student
grants, better healthcare coverage and grants for small
and medium-sized enterprises (SMEs), will have positive
implications for growth in the long term. However, as
a high-income economy Singapore’s growth rate will
naturally be lower than its neighbours’.
Political unrest pushed growth in Thailand to 0.6%
quarter on quarter during the last quarter of 2013, down
from 2.7% during the third quarter. A substantial fall
in tourism revenue is likely to have a wider economic
impact. Domestic consumption will be constrained by high
household debt levels, and investment will fall in turn due
to uncertainty over the eventual outcome of the turmoil.
The Philippines is facing some unemployment problems
apart from the aftermath of Typhoon Haiyan. Its close
trading links with the US will stimulate trade to an extent,
but unemployment will drag on its demand as well as
keeping investor sentiment lukewarm in the short term. We
have slightly pushed down this year’s growth projection
compared to our Q1 forecast, though still expect
reconstruction work to provide a boost.
%
8
7
6
5
4
3
2
2014
2015
Vietnam
Laos
Cambodia
Myanmar
Thailand
0
Singapore
1
Philippines
As one of the so-called ’fragile 5’ nations – a group
which also includes Brazil, India, South Africa and Turkey
because they all have twin deficits on the current account
and government finances – Indonesia will struggle to
draw investment back in the short term. It is especially
vulnerable to a rise in global interest rates, expected to
come when the recovery has strengthened further in
advanced economies, as it will make it more expensive to
cover these shortfalls through borrowing. The rupiah has
stabilised and is now up 6% since the beginning of the
year to date, suggesting that the divestment passed its
worst in January.
Figure 7: Most economies set for better performance
in 2015 as FDI settles and exports pick up
Malaysia
Malaysia, after a difficult start to the year, is no longer in
current account deficit and its fiscal deficit has narrowed
recently. It is unlikely to face great outflows. However, it
will need to pay down some of its government debt if it
is to avoid facing the same situation in future; this will
mean low government spending will weaken demand.
Strong private sector demand will compensate, while
exports will gain a boost from recent depreciation of the
ringgit. Malaysia is projected to maintain solid growth of
around 5% per year over 2014–2016 (this section refers
throughout to Cebr GDP growth projections, shown in
Figure 7).
Cambodia, Laos and Myanmar are forecast to have higher
growth rates as their economies are very much smaller.
Laos is currently enjoying high demand for many of its
commodities which are feeding production elsewhere in
the region, particularly China.
Indonesia
Emerging markets sell-off should mark end
to large outflows in near term
commodities will continue in the short term.
Cebr growth forecast, year on year
As these economies grow wealthier, FDI will increasingly be
driven by a consumption rather than a production logic. It
is cheaper to produce near or within final demand markets,
and the large populations of South East Asia will provide
increasing numbers of affluent consumers. A recent study
found the ASEAN-5’s ‘aspirational class’, defined as those
who earn over $50,000 per year, currently had 20m
members and is set to grow by 25–50% over the next 5 to
10 years; meanwhile, the middle-income group, members
of which earn between $20,000 and $50,000 per year,
would grow by 16–28%.3
2016
Source: Cebr analysis
Main risks shift to domestic front as global
markets settle
The pattern of volatile investment flows and corresponding
currency instability for the ASEAN economies is likely to
continue, but it will be smoother than in 2013 and early
2014. The markets have now largely priced in the US
taper and China’s planned slowdown to their valuations
of emerging-market assets, so that the only way these can
derail the prospects for South East Asia is if they change:
if US monetary policy suddenly becomes more hawkish
– meaning its interest rates could rise – or China misses
its growth target for the year, South East Asia could suffer
further turbulence. Considering the recent mini-stimulus
package of construction and investment in China and more
‘dovish’ notes from the Federal Reserve Chair Janet Yellen
(which suggests the Federal Reserve is unlikely to rush into
raising rates), the latest signs from both are good, but
further changes are possible.
Domestic political instability is more likely to cause
problems now. The Indonesian election is set to happen
without major turmoil, but some risk remains; Thailand
however needs a new political settlement that will last.
The Philippines still has substantial reconstruction work
to repair the devastation caused by Typhoon Haiyan, as
well as elevated domestic unemployment. Singapore and
Malaysia are free of major risks for the moment.
Though Vietnam’s innovation economy activities
mentioned earlier are likely to fuel growth in the medium
term, at present they account for just 1% of national
output and do not significantly outstrip the economy’s
overall growth, which has been rapid. It still has significant
growth in the mining sector, suggesting dependence on
Having begun by considering the risks of commodity
dependence, it is necessary also to acknowledge the
risks of dependence on FDI flows, which are subject to
volatility in the same way as commodities. However, FDI
allows capital accumulation in a far faster way than can
be generated from domestic sources, and for that reason
offers a route to high value-added sectors of production –
and in turn higher living standards. When the next wave
of industrialisation occurs, in economies that are currently
underdeveloped in comparison to the ASEAN countries, it
may be that ASEAN firms are directing the flows of capital
rather than acting as recipients in the exchange.
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Q2 2 014
1 Hal Hill, ‘Is There a Southeast Asian Development Model?’ January 2014
2 For example, Singapore has the highest score in the world on the economic incentive sub-index, meaning that it has good
institutional characteristics such as rule of law and regulatory regime, and low barriers to trade ie, low tariffs.
3 The study cited was authored by financial services provider Macquarie Group. ASEAN-5 economies refer to the five largest
economies: Indonesia, Malaysia, the Philippines, Singapore and Thailand.
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