Asean shaping up for ‘double hit’
by William Baunton and Bronwyn Curtis
The 10-country Association of Southeast Asian Nations is one the world’s brighter regional growth areas. The IMF forecasts GDP growth at 5.2% in 2015, against 4.6% in 2014, well above the world average of 3.5%, as Chart 1 shows.
In spite of the generally positive outlook, the region is having to weather potential damage from a combination of the impact of the strengthening dollar on investment and capital flows and the slowdown of Chinese growth. Combating the implications of these ‘twin hits’ from the world’s two biggest economies will be a major task for Asean finance ministries and central banks in 2015-16.
Low oil prices have exerted a positive impact, reducing Asean inflation, as Chart 2 shows, and giving the region’s central banks more manoeuvring room in their monetary policies. Like China, with which Asean carries out 14% of total trade (a figure that stood at 9% in 2005, as Charts 3 and 4 show), Asean is shifting the emphasis of economic expansion efforts away from undue reliance on exports to more domestically and regionally generated growth and a build-up in much-needed infrastructure. Two landmark developments further enhance the medium- to long-term outlook. The establishment at end-2015 of the Asean Economic Community is intended to form a common market for goods, services and investment among the 10 member states. The establishment of the Asian Infrastructure Investment Bank, when it gets going, will add much-needed support to infrastructure efforts by other international institutions.
One potential difficulty comes from the strengthening dollar, which is both drawing capital away from the region and raising the value of dollar-denominated debt for corporate borrowers. The strong dollar was one of the key causes of the 1997-98 Asian financial crisis, raising debt payment costs for over-indebted enterprises and ultimately breaking exchange rate regimes pegging Asian currencies to the dollar.
Asean members have greatly improved their ability to withstand such shocks by raising the flexibility of their economies, modifying currency pegs and amassing sizable foreign exchange reserves for use in currency defence, as shown in Chart 5 on p.23.
Overseas dollar-denominated credit to overseas non-bank borrowers stands at $9tn worldwide according to the BIS, an increase of $3tn since the financial crisis. This creates potential debt service problems when the debt is unmatched by foreign currency receivables or existing assets. According to Morgan Stanley, Asian firms’ foreign currency debts have tripled since the financial crisis from $700bn to $2.1tn, finding that roughly 22% of their debt is dollardenominated.
Somewhat reassuringly, a similar percentage of their earnings are dollar-denominated. China is the exception, with 25% of corporate debt denominated in dollars versus just 8.5% of earnings in dollars, exposing a significant currency mismatch.
This may provide one of the reasons why the Chinese authorities have been keeping the renminbi steady against the generally appreciating dollar.
When the US Federal Reserve finally raises interest rates, currencies in the region will be exposed – a factor that has already sent destabilising ripples across the region when the first indications of the Fed’s reduction (and ultimate ending) of its government bondbuying programme surfaced in May 2013, with a particular effect on the Indonesian rupiah and Indian rupee.
As Chart 6 shows, some countries have allowed their currencies to fall since that time, although the rupee and rupiah have stabilised. A significant accompaniment to this is that some countries (Malaysia , Thailand, Singapore) have lost reserves as their central banks have sold dollars to damp the effect of their currencies’ decline, while others (Indonesia, India, Vietnam) have stabilised or gained reserves as their central banks have tightened foreign exchange to mitigate the effect of their currencies’ recovery. Central banks throughout the region can be expected to show a similar flexible response in 2015-16 in reacting to a probable further dollar rise and capital outflow.
Another potential headache stems from slower economic momentum in China. GDP grew at 7.4% in 2014, the slowest rate in 24 years. The Asian Development Bank believes this trend will continue, with growth projected at 7.2% in 2015 and 7% in 2016. The IMF predictions are even lower.
Asean will certainly benefit from higher US and European growth but Chinese headwinds need to be taken seriously in view of the strong trade links with the world’s second largest economy flowing from China’s rising demand in recent years for the region’s raw materials and semi-finished goods.
China faces rising deflation risks, with widening negative output driving real GDP growth to a six-year low and the GDP deflator to below zero. Nominal GDP was 5.8% in Q1 2015 (year-on-year) while real GDP grew 7%, marking the first time since the financial crisis that nominal GDP growth has fallen below real GDP growth. More decisive monetary easing is needed to contain these risks.
China’s trade with Asean tripled from 2005- 13 to $350.5bn according to Asean figures (Chart 3). However, indications that China’s demand has peaked increase Asean’s need to explore alternative sources of economic expansion, especially since domestic dynamism in these countries is starting to flag as a result of maturing growth patterns, ageing populations and lower productivity.
China has increasingly developed an integrated approach to managing supply chains with its trade partners, and the goods it needs for a domestically driven economy are less import-intensive than in the past.
There are similar structural changes afoot in Asean trade with the US. Before the financial crisis a strengthening dollar would have led to a flood of cheap Asian imports into the US, producing a fillip for Asian growth.
However, as Chart 3 shows, Asean reliance on US trade has fallen significantly and imports to developed countries in North America and Europe are less capital-intensive. In the US, for example, investment is being channeled into new areas like shale mining, where machinery and equipment is needed, and where Asean companies have less skill and expertise.
Despite Asean’s smaller dependence on the US and Europe than in the past, the region will profit from recoveries in these areas driven by lower oil prices and interest rates. If the fall in oil prices is sustained, global growth could be 0.5% to 1.0% higher according to the IMF. Growth potential has fallen across the world, but there is plenty of upside for Asia if countries in the region can improve business conditions with better infrastructure and a reduction in other bottlenecks.
The significant drop in oil prices is a mostly welcome development for economies in Asean, reducing inflationary pressure and costs for local businesses, offsetting the effect of the ‘two hits’, particularly in Thailand, Vietnam and the Philippines. Steady progress in disinflation (see Charts 7-8) has led to a lowering of inflation differentials across the region, providing favourable conditions for economic integration.
Although producer prices in parts of the region have been falling (mainly as a result of falling commodity prices and negative consumer inflation rates in Singapore, Taiwan and Thailand highlighted in Chart 8) there appears no threat of sustained deflation. Singapore briefly entered a period of threatened deflation at the end of 2014, partly due to measures to cool the property market.
Low oil prices enabled Indonesia to scrap or adjust most of its fuel subsidies, making nearly €15bn available to spend in priority areas such as infrastructure, as well as funding the budget deficit. Indonesia raised administered fuel prices in November, pushing the country’s inflation rate temporarily to its highest level in six years. Prospects for the region remain positive. The Asian Development Bank forecast emerging Asian economies to grow 6.3% in both 2015 and 2016, and has set it hopes on India, forecast to grow 7.8% in 2015 up from 7.4% last year.
A rebound in Indian growth together with moves for greater trade and investment cooperation and low oil prices represent healthy antidotes to lower Chinese growth.
Yet Asean countries will still need all their reserves of greater flexibility as well as their defensive mechanisms implemented since 1997-98 as they find the right tools to balance Chinese deceleration and Fed tightening in 2015 and beyond.
■ William Baunton is Economist and Bronwyn Curtis is Chief Economic Adviser, OMFIF. Back