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||Asean Affairs 6 April 2012
ASEAN - India - China Outlook
By Shayne Heffernan Ph.D.
Two ASEAN companies priced successful IPOs this week, taking advantage of an increasing desire among global investors to move away from China and India and get exposure to smaller countries in the region, this is a trend that is set to continue and lift ASEAN markets.
ASEAN +3 is the Association of Southeast Asian Nations (ASEAN), the People’s Republic of China (including Hong Kong), Japan, and South Korea.
Home to 600 million people, ASEAN has a combined gross domestic product (GDP) of US$1.8 trillion with total trade valued at $2 trillion among the countries.
ASEAN is set to explode as an economic force in 2015 as financial, trade and investment rules become integrated and seamless. Asean last year secured $78.5 billion in investments. Regional trade also increased by 32.9 percent to more than $2 trillion.
The Association of Southeast Asian Nations is beefing up various frameworks for cooperation and development within the region and with its trading partners, in preparation for regional economic integration by 2015.
The economy is experiencing gradually slower growth; the government is gradually easing monetary policy; the property market bubble is gradually deflating; and the headwinds from Europe are gradually having a negative impact on China’s economic performance.
Certainly, the Chinese authorities are comfortable with the term “gradual.” After all, one Chinese economist described the momentous changes in economic policy over the past thirty years as the “gradual revolution.” In a country whose history is strewn with words such as “disruptive,” “dramatic,” and “abrupt,” the word “gradual” is relatively reassuring. On the other hand, things are gradually moving in the wrong direction.
In January, for example, there was a decline in exports; a decline in the flow of foreign direct investment into China; a decline in manufacturing activity, according to a survey of purchasing managers conducted by the private sector (a government survey suggested that manufacturing activity expanded); and an increase in the rate of inflation.
Aside from the inflation data, all of this was due largely to the slowing of economic activity outside of China, principally in Europe. In response to this slowing, China’s central bank has twice lowered the required reserve ratio for commercial banks with the intention of boosting liquidity and credit market activity. Still, the combined drop in the reserve ratio of 100 basis points does not come close to offsetting the 600 basis point increase that took place over the past two years in order to fight inflation.
Despite the small increase in inflation in January, the fight against inflation has largely been a success. That is why the central bank is now comfortable engaging in a gradual easing of monetary policy. More is expected.
The successful easing of monetary policy is evident by the gradual nature of the slowdown — often known as a “soft landing.” Indeed, the Conference Board’s index of leading economic indicators for China actually rose in January, suggesting that prospects in the months ahead are fairly good. Equity market participants evidently agree, having boosted equity prices in the past few months. Market participants are also confident that the trajectory of policy will be accommodative in the months ahead.
The president of the World Bank agrees; Bob Zoellick recently said that China is headed for a soft landing and indicated confidence that China would avoid a more onerous slowdown.
In a year when political power will be transferred, the government is keen to avoid major disruption to the economy.
As such, it is likely that the government will utilize fiscal tools to boost economic activity in case the economy faces even more severe headwinds from abroad. In addition, the government is showing a desire to avoid, or at least postpone, the turmoil that might come from the unwinding of imbalances. Specifically, local governments have accumulated about $1.7 trillion in debts that many analysts deem unsustainable.
A loss of revenue from weak land sales has exacerbated the problem of servicing this debt. Many analysts were recently concerned about the possibility of an imminent crisis if banks were forced to write down these debts. Instead, the government has instructed banks to roll over the local government debt, thereby postponing the day of reckoning. As such, the threat of an imminent financial crisis is now gone, but the issue has not disappeared.
The World Bank president, Bob Zoellick, recently predicted a soft landing and suggested that China will have to make a number of changes if it is to avoid problems stemming from long simmering imbalances. He was in China to introduce a new World Bank report entitled “China 2030.” The report says that China’s current economic model is not sustainable and must be changed. It calls for more privatization, more reliance on market forces, the elimination of restrictions on internal migration, a boost to the social safety net, more transparent capital markets, and better fiscal controls for local governments, which are currently laden with debt. It will be interesting to see whether China’s new leaders will heed this call.
GDP growth in the third quarter of the current fiscal came in at a woeful 6.1 percent, marking a sharp drop from 7.7 percent in the first quarter and 6.9 percent growth in the second quarter. Manufacturing growth slipped to 0.4 percent compared to 7.2 percent and 2.7 percent in the first and second quarters, respectively.
The seventh successive quarterly slowdown — and the slowest growth in three years — has not only triggered fears that the economy will slow down further in the last quarter of the current fiscal (January–March 2012), but also that overall growth for the fiscal year could fall short of the downwardly revised target of about 7 percent.
Growth in the next fiscal year could stagnate at a “new normal” of about 6 percent, and employment generation could be significantly dented unless significant efforts are made toward improving credit conditions and resurrecting investments in the coming months.
The central bank, in a recent announcement, affirmed that Indian corporate houses were not optimistic about an improvement in their financial performance in the first quarter of calendar year 2012. It should, however, be noted that no significant slowdown in domestic demand and consumption is expected. Private consumption expenditure rose 6.2 percent in the fourth quarter of calendar year 2011 compared to a year ago.
Demand, although robust, is unlikely to positively affect the books of companies given the current interest rate regime and rising input costs. Growth data from India’s eight core infrastructure sectors paint a gloomy picture as well.
The core sectors grew only half a percent in January, signaling that companies are hesitating to make investments. Output improved only in four infrastructure industries, indicating that a broad industrial slowdown could be in the cards. Industrial output growth dropped to 1.8 percent in December from 5.9 percent in November.
Exports grew at 10 percent in January, following a declining trend in the previous months. Although cumulative exports from April until January grew 23 percent, weak demand from Western markets and global political developments are likely to exert a drag on exports in 2012. On the other hand, rising imports are exerting a negative pressure on the trade deficit.
Infrastructure development is paving the way for optimism in Indonesia. A longstanding lack of infrastructure has been a significant roadblock in the country’s attempts to achieve its full economic potential, but the Parliament has finally passed a land acquisition bill that will allow the government to expedite infrastructure development.
Although the bill is pending the president’s approval and the timeliness of implementation is widely speculated, it is likely a step in the right direction. The new legislation ensures speedier land acquisition for infrastructure projects and a fair sale price to landowners, and it will likely boost private sector involvement, which has been kept at bay by bureaucratic inefficiencies. Earlier this year, the country regained its investment grade rating for the first time since the 1997 Asian crisis.
This will allow Indonesia to borrow cheaply and attract more foreign investment into the economy. In fact, recent data released by the Investment Coordination Board indicates that despite global risk aversion, foreign investment in Indonesia stayed its course in 2011.
During the fourth quarter of 2011, total investment realization increased 19.2 percent from a year ago. Foreign investment surged 25.2 percent year-over-year to over $5 billion during the fourth quarter, taking the cumulative foreign investment to about $19 billion for the entire year. Foreign investors — especially from Singapore and regional economies — continue to pour money into Indonesia with transportation, communication, and storage garnering the largest share of foreign inflows.
Foreign investment is expected to play a critical role in bridging Indonesia’s investment gap, as the government has been conservative with infrastructure spending in a bid to limit its fiscal deficit. Indonesia’s infrastructure spending is equivalent to about 4 percent of GDP and is expected to rise gradually over the next few years.
This is still far less than India and China, which currently spend 8–10 percent. In 2012, the Indonesian government plans to boost its spending by 19 percent to $18 billion in an attempt to improve roads, airports, and railways, which will likely enhance the outlook for private investment as well.
The government is also thinking about reducing fuel subsidies and redirecting the resulting fiscal savings toward infrastructure development. Energy subsidies are currently estimated to account for nearly 20 percent of the government’s spending, compared to just 3 percent attributed to infrastructure.
The Parliament has not approved such a plan yet, but government officials say that Indonesia the hikes will be in place by April. It is widely speculated that if energy subsidies are removed, oil prices may climb by as much as 33 percent, thus exerting inflationary pressures.
The most devastating flood in over five decades inundated over two-thirds of Thailand, claimed more than 700 lives, and caused economic damages in excess of 328 billion baht. As a result, the Thai economy contracted for the first time since 2009 and shrank 9 percent year-over-year in the fourth quarter of 2011. Manufacturing and exports were severely hampered, and Thailand’s GDP grew by a modest 0.1 percent in 2011.
Manufacturing units, including textiles, automobiles, and electronics were forced to stall operations. Ebbing manufacturing output was accompanied by a significant decline in exports. Global supply chains, particularly in the automobile and electronics sectors, experienced major disruptions. In addition, household consumption and capital formation fell 3.0 and 3.6 percent, respectively in Q4 2011. Finally, declining tourism led to a lull in the restaurants and hotels sector.
However, the worst seems to be over. Several industries, including the auto sector, have staged a remarkable recovery. As the year progresses, reconstruction spending and improved domestic consumption will likely bolster the Thai economy. A weak external environment could present a host of challenges, but Thailand’s economy is expected to bounce back in 2012. The Thai Board of Investment (BOI) revealed that foreign direct investment increased in January by a staggering 60 percent compared to the previous year.
The BOI received investment promotion requests from foreign investors for 80 projects valued at 25 billion baht, of which 37 were for new investments. As several auto sector manufacturers resumed operations, Thailand’s automobile production and sales rose sharply in January.
While part of the increase can be attributed to base effects, the outlook for the sector is positive for the coming months. In addition, industrial confidence and consumer confidence rose over the past two months as factory operations and domestic demand increased. With inflation expected to remain relatively benign, the Bank of Thailand may adopt an accommodative monetary policy.
As a result, interest rates will likely be held at 3.0 percent, allowing businesses ample opportunity to kick-start the economy. Thailand’s exports are also likely to rise in the first quarter of 2012 thanks to several Free Trade Agreements with Southeast Asian nations, which are becoming the country’s largest export market. However, the consequences of weak external economic conditions may be felt as early as the second quarter.
A fragile U.S. economy and the debt crisis in Europe are casting a shadow on the Thai export sector’s growth prospects. Furthermore, mounting optimism around growth prospects in Thailand resulted in a surge of capital inflows. Thailand’s currency has strengthened to a two-month high after international investors increased their holdings of Thai assets. A stronger currency could compromise some growth in the export sector.
On the downside, rising oil prices and recent bombings could drag down GDP growth in Thailand. The tourism industry will likely be hit hardest, at least in the short run. Whether or not businesses will take a cautious stance and hold back investments in the coming months is unclear. The University of the Thai Chamber of Commerce (UTCC) projected that the bomb incident and rising oil prices will drag down GDP growth in the first quarter.
However, it maintained its annual growth projection for 2012 at 4.5–5.0 percent. Thailand’s economy is getting back on its feet. As factories become fully operational, employment and industrial output will likely improve. Private consumption could drive growth when the minimum wage hike takes effect on April 1, 2012.
The government is also likely to step up public expenditure on reconstruction and disaster relief. As a result, the Thai economy may experience higher inflation during the latter part of the year. Meanwhile, the volatile external environment remains a significant challenge. If the global economy stalls, developed countries along with many Asian economies may experience slower growth, in effect, lowering demand for Thai exports. On the other hand, improved external demand may bode well for growth.
During 2011–2012, the Australian economy will likely expand at a modest pace of 2.5–3.0 percent. The biggest downside risk to this estimate comes from a greater-than-expected slowdown in China as authorities try to tame inflation.
Developments in the Eurozone and the United States will also likely influence foreign investment, commodity export prices, and overall demand from Australia’s trading partners. Even as the economy undergoes structural changes and copes with global headwinds, the mining sector has stayed its course; a $34 billion LNG project was recently approved and will likely boost investments and exports. Thus, Australia’s mining sector — its star performer — is expected to bolster the economy in the face of external headwinds.
Shayne Heffernan Ph.D.
Linda Johnson, Business Development Director - Private Client Group, Heffernan Capital Management
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