The ICAEW Economic Insight: South East Asia, is a quarterly forecast for the region prepared directly for the finance profession.
Economic growth edged lower in Q2 across most of the South-East Asia economies, with average GDP growth for the region as a whole easing to 5.2% year-on-year, down from 5.4% in Q1. Indonesia was the exception with GDP growth accelerating 5.3% on the year, up from 5.1% in Q1.
Amid increasing global headwinds, including escalating US-China trade tensions, and the added pressures of a stronger US dollar and rising US interest rates, we expect economic growth across the region to cool further in the second half of 2018 through to 2019.
Indeed, while recent regional trade data suggests some resilience in external demand, forward indicators do point to softer export momentum in the coming months. Our aggregate measure of South-East Asia PMIs moderated to 50.9 in July, from 51.1 in June.
Moreover, we expect the export environment will become more challenging for the region amid cooling Chinese import demand and rising protectionism. On 23rd August the US and China imposed further 25% tariffs on $16 billion of bilateral imports– the second leg of previously announced tariffs on $50 billion of imports.
These new tariffs indicate still-elevated tensions between the two and we assume that US-China trade tensions will escalate further with a 25% and 10% tariffs implemented on a cumulative $150 billion of imports from China, and China retaliating in kind. And while our baseline is that the US will remain focused on trade with China, higher US tariffs on Chinese imports will indirectly impact the region. Many of the region’s economies are small, open and heavily dependent on exports, with a high level of exports to China. Added to this is the high import content of many Chinese exports, which means that some economies such as Malaysia and Singapore indirectly export to the US a large volume of their exports via China.
Overall, we forecast the region to grow by 5.1% this year from 5.2% in 2017, with economic growth moderating to 4.8% in 2019 as cooling Chinese import demand and increased trade protectionism increasingly weigh on exports and investment. And while macroeconomic policies in most economies will remain supportive of domestic demand, notably in Malaysia and Thailand, tighter monetary policy in Indonesia and the Philippines is expected to gradually weigh on household spending and business investment. Among the SEA economies Vietnam is expected to continue to outperform the region with the economy forecast to grow by 6.7% in 2018 and 6.3% in 2019. Meanwhile, we expect a more evident slowdown in the Singapore economy reflecting its heavy dependence on exports (around 174% of GDP). We forecast GDP to grow by 3% in 2018, moderating to 2.4% in 2019.
The risks to our economic outlook are however tilted to the downside. We continue to view strong ideological beliefs and non-negotiable strategic ambitions as key factors that could lead to an escalation of trade tensions, and possibly a trade war between the US and China.
An escalation in the US-China trade tensions, a slide in CNY, and more recently the Turkish lira crisis has led to most EM currencies weakening against the US$ this year. However, the Asian ones have generally remained robust and weakened only moderately. This is because in general Asian countries have more solid macroeconomic fundamentals than other EMs, and hold current account surpluses. However, a few Asian countries are not in as strong a position as their regional peers and have therefore also been vulnerable to market pressures. In particular, India, Indonesia and Philippines are experiencing twin deficits (fiscal and current account deficits). Looking ahead, EM currencies will likely see more volatilities to come given our expectation of further near-term strength in the US dollar, rising US interest rates and the eventual tightening of monetary conditions globally. Oil price movements, the evolving US trade policies, as well as the unfolding of major geopolitical events (such as Iran sanctions, political uncertainty in Europe, etc.) will only add to this volatility.
But most Asian currencies are likely to remain relatively robust compared with other EM currencies, given ongoing solid current account balances and macroeconomic fundamentals. Large official reserves will also create a strong buffer against capital outflows. Meanwhile, a relatively stable RMB should also help anchor the performance of Asian currencies. As such, we do not envisage major moves in Asian currencies, and we expect economies with strong fundamentals to see their currencies appreciate modestly against the US dollar by end-2018.
The Indonesia rupiah and Philippines peso are the two exceptions. Bank Indonesia has proactively raised its policy rate three times since mid-May and stands ready to take necessary policy actions to defend the rupiah. In Philippines, the central bank has also raised interest rates a cumulative 100bp this year. Higher interest rates should provide some support for the rupiah and peso. Nonetheless, compared to their SEA peers, these two currencies will probably remain more vulnerable during any potential upcoming bouts of EM stress
Real GDP picked up in Q2 rising 5.3% year-on-year, from 5.1% the previous quarter driven by an acceleration in private consumption. Government consumption also gathered momentum. However, after accelerating for four consecutive quarters, investment growth eased back, although growth was still healthy. Despite improved export growth, net exports subtracted 1.2ppts from GDP growth and has weighed on growth since Q4 2017.
Despite the slowdown in Q2, we expect investment to regain some momentum over H2. And given higher commodity prices, the commodity sector could stage an investment rebound in 2018 after the weakness of 2015-16. We think the government will follow through on its commitment to raise public infrastructure investment, despite aiming to lower the fiscal deficit (to 2.2% of GDP in 2018 from 2.6% for 2017). That said, the government is concerned about the downward pressure accelerating imports is having on the currency. Importantly, measures being considered by the government include policies to slow raw materials and capital imports – particularly related to government and SOE investment projects – posing a downside risk for investment.
Overall, August’s Asia Games and increased fiscal spending ahead of the April 2019 general election could provide short-term tailwinds to domestic demand. But tighter financial conditions – from a weaker rupiah and higher interest rates – will likely more than offset any boost over the next few quarters. At the same time, as easing Chinese demand and global trade growth coincide with rising China-US trade tensions, export growth is likely to decelerate over H2. As such, we think growth on an annual basis will slow slightly during H2 and continue to expect GDP growth to stay at 5.1% in both 2018 and 2019.
The robust momentum in the economy in Q2 has likely strengthened the central bank’s commitment to prioritising currency stability in the short term. Indeed, the 8% depreciation in the Indonesia rupiah this year versus the US$ has already led Bank Indonesia (BI) to raise interest rates a total of 125 basis points since May, bringing the policy rate to 5.5% at end-August. We expect BI to raise the policy rate a further 25bp in the coming months to provide further support to the currency. Indeed, we believe the currency will remain under depreciation pressure as the widening current account deficit (no longer fully covered by net FDI inflows like in 2017), means Indonesia is increasingly reliant on capital inflows. This and the high non-resident ownership of local bonds (close to 40%) also means the currency is vulnerable to swings in investor sentiment. This is especially worrisome as US Fed rate rises and global trade tensions are weighing on EM currencies in general. Although we expect only one more rate hike this year, we acknowledge that risks remain tilted towards additional near-term BI rate rises.
GDP surprised on the downside in Q2 slowing to 4.5% year-on-year, down from 5.4% in the previous quarter. Imports grew at a much faster pace than anticipated, rising 2.1% year-on-year and outpacing exports of 2%. Underpinning the strong growth in imports was a pick-up in domestic demand, which rose 4.7% year-on-year from 0.4% in Q1. In particular, household spending surged to a multi-year high of 8% year-on-year reflecting a boost to consumer sentiment after the new government abolished the Good and Services Tax and the re-introduced fuel subsidies.
We expect household spending will remain the key driver of GDP growth through to 2019. However, most other domestic demand components are forecast to cool. We look for public spending to moderate as the new government reviews major infrastructure projects and undertakes plans to prune government expenditure. That said, there exists a number of uncertainties surrounding the government’s fiscal decisions.
The government is committed to improving the fiscal deficit, however, the reinstated Sales and Service tax (from September) will only apply to ‘selected services at 6%’ and will cover a smaller range of goods and services compared to GST. As such we do not think it will be sufficient to fill the revenue gap caused by the removal of the GST (which accounted for around 18% of revenues in 2018).
In the short term the new government does have some fiscal space as oil tax revenues are likely to be higher than previously projected. We forecast oil prices of around US$75pb on average in 2018, compared with the previous government’s expectation of US$52pb. The announcement of the disbandment of several ‘politically-linked’ departments will also help ease some of the fiscal pressures.
However, if the government remains committed to lowering the fiscal deficit beyond this year, further expenditure cuts and/or a new source of revenue generation will be needed. Our base case is that government will tolerate some fiscal slippage to support domestic demand amid moderating export growth. Overall given the weaker than expected Q2 GDP outcome we have downgraded our 2018 GDP growth forecast to 4.9% previously with GDP expected to grow by 4.7% in 2019.
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