Roundup of 2015 and future prospects for ASEANWelcome 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 largest economies of the Association of South East Asian Nations (ASEAN) – namely Indonesia, Malaysia, the Philippines, Singapore, Thailand and Vietnam.

Large economic changes lie ahead, with potentially serious implications for ASEAN2015 has been an eventful year for the world economy. In January, the long-awaited European quantitative easing (QE) programme gave the eurozone another false dawn of recovery, and since then things have faltered with key economies such as France struggling to grow. Syriza’s victory in Greece started a long game of brinksmanship that put the future of the eurozone in doubt, with many still believing the debt-ridden country will abandon the euro over the coming years.

The summer revealed a more immediate threat to world growth, with a torrent of weak economic data from China and the crash of the Shanghai stock market. There’s no doubt now that growth in the world’s second largest economy is decelerating, and a sudden slowdown may be on the cards.

The US has also been a source of uncertainty this year, with many expecting the Federal Reserve to start raising interest rates. It has yet to do so, but a rate rise, when it comes, risks pulling funds away from emerging markets and back into the US. A lot of Asian companies hold substantial sums of dollar-denominated debt and could be hard hit by a rate rise.

Overall, there are five main issues faced by policymakers in ASEAN which will affect growth rates. While all of these are already present, the questions are whether they will intensify, and how they will impact ASEAN members.

1 A continuation of low commodity prices.

2 China’s slowing growth rate.

3 Growth in other markets continuing to disappoint.

4 Generally weak world trade.

5 Uncertainty over when the US Federal Reserve will raise interest rates.

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All of these issues are a risk to economic performance in ASEAN – something we explore in detail in this report.

Turn of the commodity super-cycle already impacting ASEANRecently, no sector has fared worse than commodities. The end of China’s long investment and construction boom has reduced the demand for raw materials, hitting commodity exporters hard. Indonesia has seen a slump in coal exports of 18% so far this year, and Malaysia’s ringgit plummeted to a 17-year low in August as oil prices fell.

Diversification of these economies away from raw materials is now essential, since commodity prices are likely to remain subdued for some time. In the long term, diversification should lead to a wide range of benefits, including greater opportunity for product differentiation and lower volatility in export earnings. However, the temporary effects will be unwelcome for ASEAN economies, potentially triggering exchange rate crashes, holes in budgets and falls in creditworthiness.

Volatility in earnings is inescapable for commodity exporters in ASEAN, making it hard for governments to predict the future sustainability of the public finances. One factor behind this is that commodity extraction takes place with a lag. When prices are high, mining firms start new projects. These take some time to begin producing. Therefore when a crash in demand occurs, capacity creation is effectively still responding to prices that prevailed a year or more ago, causing production to keep rising. This creates a glut of raw materials and makes the downward swing in commodity prices more pronounced. For example, the Indian state oil producer still plans to invest in a petrochemicals plant in Iran.1

Another issue with commodity dependence is that raw materials are undifferentiated, meaning that exporters have to compete on price alone. If commodity-dependent countries in ASEAN diversified further into differentiated products, they could create more value and boost the size of their economies. Ultimately, dependence on a narrow range of products with low value added is not a traditionally successful development strategy.

Now is the time for these economies to continue to move towards knowledge industries, higher-skill manufactures and services. Policymakers know this and have exploited the period of high prices adeptly without neglecting investment into better long-term options.

For instance, Malaysia rose two places to 20th in the World Economic Forum’s 2015 Global Competitiveness Index, while the Philippines has risen more places since 2010 than any other country.2 This ranking compares countries on features critical to development such as institutions, infrastructure, business sophistication, health and education. Malaysia is highest among the ‘transition’ economies which are moving from being efficiency-driven to innovation-driven, and hopes to reach high-income status by 2020. Elsewhere, Singapore’s tech sector is currently booming. Against a backdrop of low inflation and wage growth, Singaporean knowledge workers’ wages are expected to rise by an annual 4.3% in 2016.3

Slowing global export markets hitting the regionThe South East Asian region has historically powered growth through exports. At present, its major export markets are growing at a lacklustre rate. Figure 1b shows that 31% of ASEAN exports go to the US, eurozone and Japan, down from almost 50% in 2000 but still important. There are concerns about the strength of all three markets – especially the eurozone and Japan.

Figure 1a: ASEAN exports by region, 1999

Figure 1b: ASEAN exports by region, 2014

Source: IMF direction of trade statistics, Cebr analysis4

The eurozone is the biggest concern among advanced markets. The currency area’s failure to achieve consistent and robust economic growth has exposed the flawed design of a currency union without a common fiscal policy or jointly held debt. Some of the largest economies in the eurozone, such as Italy, have struggled to grow at all.

For economies that would like to sell to Europe’s large consumer market, this creates problems as demand remains weak. The response of policymakers has exacerbated the problem, with an overemphasis on fiscal austerity, meaning that it’s very hard for a number of European countries to generate an economic recovery – such as Greece. Some economists have warned that

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the eurozone could suffer a ‘lost decade’ reminiscent of Japan’s 1990s. Parallels include banks’ reluctance to lend to the real economy, an ageing population and large levels of public- and private-sector debt.

Japan itself is facing challenges, which will hit businesses in ASEAN that export to it. In 2013, Prime Minister Shinzo Abe launched an ambitious strategy to reflate the economy involving government spending, monetary easing and structural reforms. The Bank of Japan launched an unprecedented third QE programme in 2014, intending to increase its balance sheet by 15% per year. While growth improved modestly, it faltered somewhat in 2014 and prospects of getting back onto a steady upward path remain doubtful. Negative inflation has returned for the first time since 2013, with headline prices falling 0.1% in August. The Philippines sends 22.5% of its exports to Japan, almost double ASEAN’s average. President Benigno Aquino’s administration has achieved generally strong growth up to now, but relying on slower markets means it exports significantly less of its economic output than it did. By necessity, it is increasingly reliant on household spending to drive growth.

Although the US saw a stronger and faster recovery than Japan and the eurozone, it has not been smooth, and remains incomplete until certain factors show improvement – such as the labour market participation rate and productivity. Recent job creation data from the US has been surprisingly negative, raising concerns that businesses in ASEAN exporting to the US may be in for a hard time. The Trans-Pacific Partnership (TPP), the largest trade deal in history recently signed by 12 Pacific Rim nations, may improve trade with the US somewhat: 53% of businesses in TPP countries surveyed recently thought the effect on jobs would be positive.5 However, as many signatories in the region already have bilateral deals with the US, the effect is likely to be relatively modest.

A common feature of the eurozone, US and Japan post-crisis is growth failing to reach potential. The US is closer to its long-term average rate, but its progress on productivity disappoints. This has raised the worrying possibility of a significantly slower growth rate in the medium term. As Figure 2 shows, the eurozone in particular is struggling to achieve average pre-crisis rates of economic growth.

Figure 2: US and eurozone growth rates and average of two economies, %, 1999–2015

Source: IMF, Cebr analysis 6

Even emerging markets are suffering at the moment. Brazil, for example, has slipped back into recession. The real concerns, however, centre on China, with new doubts over the ability of Chinese policymakers to manage the long-anticipated slowdown and prevent a sudden crash in growth rates.

Many were caught off guard by the inability of the Chinese authorities to fully prevent panic in financial markets over the strength of the country’s economy. With their infallibility now in doubt, Chinese policymakers, and their reported growth figures, are under scrutiny. Observers increasingly turn to alternative measures of output based on data such as freight and electricity use, which for a long time have indicated activity below officially reported levels, and suggest a sharper recent slowdown.7 For ASEAN, exports to China now account for 12% of total external demand, up from 3% in 1999, so China’s economic cooling is a major concern. As commodities feature heavily in these trade flows, volumes as well as prices will be hit in comparison to recent years.

ASEAN must refocus its export marketsFigure 3 shows potential post-crisis paths for world GDP and trade. Though not as pessimistic as the much-talked-about ‘secular stagnation’ hypothesis, these allow for slightly slower levels of expansion, compared to pre-2007, in major OECD economies. China’s slowdown constitutes the most pressing danger: exports to China were the main reason that ASEAN growth powered on while the advanced markets have remained weak. For the Philippines, China accounted for 29% of additional exports between 1999 and 2014; including Hong Kong (where goods often pass through en route to the mainland), the figure rises to 43%.

Figure 3: Projection for world trade against GDP, 1991=100

Source: CPB World Trade Monitor, IMF, Cebr analysis 8

Raising trade within the region could offset the risk that ASEAN exports will suffer from a Chinese slowdown. It would also suit the region to export more to India, a rare example of a major economy whose growth has sped up recently. As a net importer of commodities, Indian consumer confidence has been buoyed by recent increases in spending power, making the large consumer market more attractive than usual. India’s share of ASEAN’s exports has already expanded rapidly, from 1.5% in 1999 to 5.0% in 2014. Much of the extra demand has come from Indonesia and Malaysia, which supply India with commodities such as coal and palm oil.

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Diversification away from trade in goods is also importantAs relatively trade-dependent economies, a risk for ASEAN’s performance over the coming years involves developments in the growth of trade. Over time, ASEAN’s specialisation has evolved from assembly of inexpensive, labour-intensive goods to products requiring higher skill levels. The region is important to Japanese and Chinese companies as a manufacturing hub, many of whom set up factories in Vietnam, Thailand and Indonesia. Production, therefore, takes place across different economies. These arrangements make ASEAN highly dependent on trade.

As manufacturing has become more complex and modular, supply chains now spread across the world. The trend towards offshoring meant that global trade grew significantly faster than output before the crisis, and shrank faster when it hit. Each extra item demanded by a final consumer generates a series of transactions – extra trade in inputs, extra manufacturing of parts, extra assembly and then shipping to the consumer. Where these take place between different countries, they count towards global trade. The spread of supply chains across countries led to a boom in trade during the 1990s and 2000s, also years when ASEAN economies grew rapidly.

The acceleration of trade took off when China integrated itself into global supply chains and the World Trade Organization (WTO) was formed in 1995. Between 1994 and 2006, world trade increased at more than double the speed of GDP.

Now China is undertaking more activity domestically, replacing many inputs that other economies would have produced and bringing the supply chain into a single country. Instead of multilateral trade agreements, negotiations have fragmented into regional arrangements, which tend to be ad hoc, fairly politicised and less ambitious than the policies that the WTO pursued. As a result of these changes, annual growth in trade between 2012 and June 2015 has been 25% slower than growth in the world economy.

On the other hand, trade grew significantly faster than GDP throughout the 1990s and early 2000s. This opens two potential scenarios for the coming five years, given the projection for world growth.

• Optimistic scenario: if world trade returns to the previous rate of increase of around double GDP, it would be 14% higher than under the pessimistic scenario and ASEAN need not adjust its export-led development model in order to maintain growth.

• Pessimistic scenario: if world trade does not pick up from its current path of growth which is slower than that of GDP, South East Asian economies need to find new sources of demand to sustain rapid economic expansion.

This introduces a range of possibilities for trade, with ramifications for ASEAN in terms of policy choices. An estimate of ASEAN’s band of likely performance is shown in Figure 3. The pessimistic scenario would require it to find new sources of growth.

One source of demand that is yet to be fully tapped is domestic consumption. Rates of saving in ASEAN are higher than those elsewhere, with spending correspondingly lower – for example, Singaporeans save around 45% of GDP. Improving social security coverage for citizens may encourage consumer spending, by reducing the need to save for old age.

If households spent more, the region would be less reliant on exports. But policymakers in ASEAN must be careful to

avoid the other extreme; in the US and UK, policymakers encouraged debt-fuelled consumption which contributed to the global financial crisis.

Another option is to diversify exports into sectors such as services, trade in which is not so subdued. In services, growth opportunities are abundant and potential gains from liberalisation are also higher since less progress has been made to date. The trend complements China’s own rebalancing, which otherwise threatens to damage economies that have evolved to feed its industrial sector. Refocusing will help to cushion ASEAN against the slowdown in world trade. For example, China Daily reported that ASEAN–China e-commerce was $480bn in 2014 and should rise to $1 trillion by 2020.9

The illustrative trajectories for ASEAN shown in Figure 3 are not far apart – the optimistic scenario for GDP being only about 4.5% higher than the pessimistic scenario by 2020. This is because South East Asian nations appear to be adapting to this new reality already. They have redirected trade post-crisis to China from Europe, Japan and the US, as Figure 1b shows. A further redirection towards services will help. The ASEAN Economic Community contains measures to expedite this: for example, mutual recognition arrangements (MRAs) make certain qualifications better recognised across borders. Companies will find it easier to spread across ASEAN and professionals will face fewer barriers to practicing in different economies in the region.

As Figure 4 shows, ASEAN’s share of services in exports rose from 14.2% in 1999 to 22.3% in 2015. The Philippines’ service exports have risen by 380% in cash terms between 1999 and 2014, with increasing business process outsourcing from China. The balance of trade shifted by 12 percentage points from manufacturing towards services.10

Figure 4: Services as % of all exports, total ASEAN, 1999–2014

Source: IMF, Cebr analysis11

This demonstrates that the trade slowdown is not the greatest danger faced by ASEAN at present. As long as ASEAN can keep adapting its trade patterns to the relatively fast-growing sectors and parts of the world – such as India, or intra-regional trade within ASEAN itself – it stands in good stead to cope with this potential problem. In the long term, the goal of the ASEAN Economic Community is to see members invest and build productive capacity within the area themselves, rather than Japanese and Chinese firms dominating investment in the region. With some powers in the region well-endowed with capital, and others with labour, cooperation could turn the area into a true single market with firms spread across ASEAN economies.

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The US Federal Reserve – will they, won’t they?Question marks over the timing of an interest rate rise in the US have been a huge source of global economic uncertainty.

The US Federal Reserve held back on raising its benchmark rate (currently set at between 0% and 0.25%) in September, but is likely to raise it within the next few months. Last time a similar move happened in the mid-1990s, South East Asian markets were the epicentre of a financial crisis from which some countries took the better part of a decade to recover. A repeat is unlikely as ASEAN is now much more resilient. In late 2013, the US Federal Reserve moved towards tighter monetary policy, sparking a chaotic reaction – the so-called ‘taper tantrum’ – in emerging markets. However, this did not turn into a crisis. Countries with budget or current trade deficits at that time have worked hard to reduce them. Nevertheless, a rate hike will still precipitate capital flows from emerging economies towards the US and these will depress emerging-market currencies.

The currency set to suffer the most turbulence may well be the Malaysian ringgit. Several factors have led to the ringgit falling to levels last reached during the 1997 Asian financial crisis. First, Malaysia has a relatively large share of oil and gas exports and has been negatively impacted by recent price developments. Second, it has increased considerably its dependence on trade with China. Third, the political establishment is in difficulty due to allegations of impropriety concerning the Prime Minister. But the government is aware of potential dangers and recently pointed out two offsetting factors: public debt is below its self-imposed limit of 55% of GDP, and the recently introduced Goods and Services Tax broadened the tax base away from oil and gas revenues.

Of course, the dangers of increased interest rates and hence borrowing costs, do not apply just to public-sector debt. Corporate debt has risen to high levels in both Malaysia and Thailand. Much of this, especially in Malaysia, is externally held – meaning that it is likely to have been drawn in by higher yields. This increases the risk of an outflow if the Fed raises rates and there is a return of capital to the US. Another issue is indebted firms: currency mismatches, where debts are in dollars and revenues in local currency, make rises in the dollar potentially damaging. This is a particular issue for sectors that trade mainly locally such as utilities and construction.12 On the other hand, commodities and manufacturing firms tend to earn revenues in dollars, making mismatches less likely. Malaysian debts are held across the whole economy and so some mismatches are inevitable.

The ASEAN region will not suffer from secular stagnation, and should be able to withstand the US interest rate rise, though this will present some problems. The region’s challenge will be to adapt to slower growth in its main export destinations through increasing domestic demand and moving towards higher value products. Historically, ASEAN has been very adept at the latter. It has had less success in encouraging households to spend more. This is essential to make South East Asia’s growth sustainable, rather than reliant on foreign economies.

Recent economic newsMost countries’ growth projections have been reduced modestly due to the Chinese slowdown. The regional economic growth forecast stands at a fairly slow 4.6% for this year. Nevertheless, many ASEAN economies look relatively healthy domestically. As mentioned earlier, 12 Pacific Rim economies signed the Trans-Pacific

Partnership at the beginning of October. This has an impact further out in the forecasts – from 2017 – as it will now take participating countries some time to ratify the deal. Although internal opposition in South East Asia is generally weaker than that in the US, there are high-profile detractors in Malaysia, including former Prime Minister Mahathir, and polling found the rate of scepticism was highest there.

Indonesian growth has faltered as commodities exports dropped, though it stands at a respectable 4.7% for the first half of 2015. To maintain momentum, the government has announced a cut in corporation taxes from 25% to 18% by 2016, with more investor-attracting policies planned soon. Cebr expects an interest-rate cut in 2016 as inflation eases further.

The Malaysian ringgit is approaching levels last seen during the 1997 Asian financial crisis as Prime Minister Najib Razak faces corruption allegations, which he denies, over the country’s investment fund 1Malaysia Development Berhad (1MDB). We expect monetary policy to stay unchanged over the short term. The central bank is treading a fine line between supporting the currency and keeping borrowing cheap to stimulate activity.

The Philippines experiences continuing strong growth held up by domestic demand while exports slow. Still, prospects to 2020 are among the best in ASEAN as ratings agency Fitch has improved its outlook for government debt.

Singapore re-elected the People’s Action Party on 11 September with an increased vote compared to recent polls. But challenges remain: industrial output, for example, has contracted year on year since February. The Monetary Authority of Singapore is likely to ease monetary policy soon, as the Singapore dollar is appreciating.

In August, Thailand suffered its eighth consecutive month of year-on-year export contraction, led by falling exports to developed markets. Though related to global slowdown, this owes more to Thailand’s own problems following 2014’s military coup. For example, overseas investment approvals have slowed down while talks with the EU regarding a free-trade area have stalled.

Vietnam is maintaining stronger performance than its neighbours, as well as the highest growth forecasts of the major ASEAN economies. Reforms allowing greater foreign ownership of companies will spark inward foreign direct investment.

Figure 5: GDP growth projections for ASEAN-6 and whole region, 2015–2020

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ENDNOTES

1 Bloomberg, August 2015 (http://www.bloomberg.com/news/articles/2015-08-30/indian-oil-said-to-plan-3-billion-petrochemicals-unit-in-iran)

2 World Economic Forum, Global Competitiveness Report, 2015 (http://www3.weforum.org/docs/WEF_GlobalCompetitivenessReport_2014-15.pdf)

3 Towers Watson survey, October 2015, reported by MSN Money (http://www.msn.com/en-sg/money/technology/workers-in-singapore%E2%80%99s-high-tech-sector-enjoy-fastest-rising-paydays/ar-AAfoHjV)

4 Note: any ‘world’ exports that could not be apportioned to any destination country are excluded.

5 Poll by Edelman, reported by PRWeek, October 2015 (http://www.prweek.com/article/1368049/public-opinion-tpp-odds-global-press-backlash-edelman-finds)

6 Note: Japan excluded from chart, as it experienced a slowdown in growth far before 2007.

7 The reason for this is a source of debate – rival explanations emphasise structural changes in the economy.

8 Note: ‘trade’ refers to goods only here.

9 China Daily, September 2015 (http://www.chinadaily.com.cn/business/tech/2015-09/22/content_21948860.htm)

10 Statistic refers to 2014; 2015 shows 19-point rise but only Q1 available so far, which may be anomalous.

11 Malaysian statistics for this series are unavailable for 2014 and 2015.

12 Chui et al., ‘Risks related to EME corporate balance sheets: the role of leverage and currency mismatch’, September 2014 (http://www.bis.org/publ/qtrpdf/r_qt1409f.pdf)