The ICAEW Economic Insight: South East Asia, is a quarterly forecast for the region prepared directly for the finance profession.
2017 has been a great year for South east Asia. The region is on track to clock 5% growth for the first time in 4 years, with almost all countries expected to grow at a much faster pace compared to 2016. Several factors have contributed to this year’s strong performance. Since the beginning of the year, the region has benefited from the improving outlook for world growth. The initial concerns stemming from a Trump presidency have dissipated, and fewer concerns about rising trade protectionism, has boosted the outlook. This has been complemented by continued resilience in domestic demand, in part supported by accommodative macro policies. But what does 2018 hold?
The external backdrop continues to be highly supportive, as indicated by the exports data from large Asian manufacturing countries and robust PMI readings across the world (particularly in Europe). And we expect world trade to continue to grow comfortably over its average pace in recent years in 2018 as well. However, the strength witnessed in 2017 is unlikely to sustain, as China’s economy continues to cool down on the back of tightening monetary conditions. We forecast world trade growth to slow to 4.2% from 6% this year.
On the domestic front, monetary policy is expected to turn less accommodative. Low inflation has not only pushed up real wages and given consumers added purchasing power in recent years, but has also given many Asian central banks the leeway to pursue monetary policy independently of the Fed. But this is unlikely to remain the case going forward.
Inflationary pressures in some south east Asian countries, particularly Malaysia and Philippines, have risen, in line with the benign global reflation that is taking place as a result of improving growth and world trade and higher commodity prices. In other countries, high leverage and financial stability risks have raised the need for policy normalisation, as growth has picked up.
That said, the policy backdrop is unlikely to turn highly restrictive for growth, with fiscal policy partly picking up the slack. Also, we think that normalisation of monetary policy, both by domestic central banks and the US Fed, will proceed in a gradual and well communicated manner. Most south east Asian central banks are expected to tighten at the mild pace of 25bp each year.
In all, this doesn’t paint a very worrisome picture for the region next year. We forecast a modest deceleration to 4.7%. The slowdown is expected to be broad-based, with only Indonesia growing faster than 2017.
Real GDP growth edged up marginally to 5.1% y/y in Q3 2017 from 5.0% in the previous quarter, supported by stronger investment and external demand. Higher private sector investment spending and a likely pick-up in fiscal spending on public infrastructure projects, pushed fixed investment growth to a four year high of 7%. Government consumption reversed the weakness seen in Q2 and grew 3.5% in Q3. However, private consumption growth failed to gather pace, remaining steady at 5%. Meanwhile, net exports contributed 0.7 percentage points to headline growth, with export volumes growing 17.3% y/y, the fastest pace since 2011, while imports increased by 15.1%.
Looking ahead, we expect a modest improvement in Q4 GDP growth, on the back of robust government spending and investment. We maintain our view that GDP will grow 5.1% in 2017; albeit with the risks to the forecast tilted to the downside due to the relative sluggishness of private consumption growth. We continue to forecast slightly faster growth of 5.3% in 2018.
While consumer spending has been lacklustre so far this year, consumers should begin to benefit from lower borrowing costs gradually feeding through into the economy in the quarters ahead. And with inflationary pressures contained – CPI inflation is likely to stay within the central bank’s target range of 2.5-4.5% in 2018; we do not perceive any imminent risk of monetary tightening.
Moreover, a partial recovery in commodity prices is positive for a country such as Indonesia that is highly dependent on commodity exports. We expect that the firmer terms of trade will bolster household incomes and support private consumption. We forecast private spending to grow by 5% in 2017, followed by a small pick-up to 5.1% in 2018.
Another silver lining is the positive outlook for foreign direct investment (FDI). In February 2017, Moody’s upgraded its credit outlook on Indonesia to ‘positive’ from ‘stable’, suggesting that if the measures designed to contain the current account deficit and slow the growth in private sector external debt stay on track, then Indonesia may be upgraded from its current Baa3 rating. And in May, reassured by the steps taken to stabilise the fiscal position, S&P upgraded Indonesia’s rating to BBB- from BB+, meaning that the country now has an investment-grade rating from all three major agencies.
These developments should spur investment inflows. Meanwhile, the outlook for direct investment should also be supported by the various policy packages announced by the government last year. These packages should restore investor confidence in Indonesia and help lift FDI – which weakened noticeably in 2015.
However, other factors are less supportive. On the trade front, there are early signs of slowdown in momentum, in line with our view that global trade growth is likely to ease heading into 2018 due to cooling import demand from China. Although, the geographically broad-based nature of the trade pick-up over the past year is likely to prevent a strong deceleration. As such, exports volume growth eased to 5.9% on the year in October, from an average of 9.6% in Q3. And although imports volume growth picked up implying stronger domestic demand, we remain cautious, given the volatile nature of the monthly trade data.
We are hopeful of a pick-up in infrastructure spending leading to some pick-up in growth in the second half of 2017. But the outlook for 2018 is dampened by the recently released budget plans. The government aims to lower the fiscal deficit to 2.2% of GDP next year from a revised target of 2.9% for this year. Also, the infrastructure share of expenditure is projected to be at broadly similar levels to this year – a clear departure from the trend witnessed since Widodo’s election in 2014. While we think that the fiscal deficit target is ambitious, it does pose some downside risks to our 2018 growth forecast.
Eventually, a better political backdrop and a stronger pick-up in domestic demand are required for growth to push back towards 6%.
GDP growth defied expectations in Q3, accelerating to 6.2% y/y, up from 5.8% in Q2. This marked the strongest rise in annual growth since 2014. Sequentially, headline GDP growth also rose to 1.8% q/q, compared to 1.3% in Q2. Aside from government consumption, all other GDP components increased. Total investment rebounded by 3.4% q/q after contracting in Q2. Exports also picked-up as expected by 3.9% in the quarter, outpacing import growth and underpinning another positive contribution from net exports. And while private consumption moderated for the second consecutive quarter, growth was still solid at 0.7% q/q.
The synchronised recovery in global growth will continue to be supportive of exports next year. But global trade growth is projected to slowdown, following the sharp acceleration in 2017. This is in part because of less buoyant import growth in China. Indeed, China accounted for more than a quarter of the 8.2% surge in nominal good exports so far this year. As such, the moderation in import demand from Malaysia’s trading partners will lead to a smaller contribution from the external sector next year.
Domestically, we expect solid labour market conditions and infrastructure spending, funded both domestically and via foreign direct investment flows, to continue to support solid household spending and investment. Indeed, Phase 1 of the construction on the East Coast rail link has commenced and construction for the KL-Singapore High Speed Rail line is slated to begin in 2018. The latest 2018 Budget also ear marked MYR6.5bn as part of the government’s rural infrastructure fund. But with US and domestic policy interest rates set to rise next year, overall investment growth may lose some momentum during 2018 and 2019.
The 2018 Budget also included personal income tax cuts for a number of income brackets and one-off cash aid to civil servants, retirees and the rural sector to alleviate the rising inflation. These will provide ongoing support for consumer spending even with statutory EPF contributions set to normalize at the start of next year. Notwithstanding these measures household spending is expected to moderate from the exceptional growth this year as household debt servicing costs are expected to increase in line with the rise in domestic borrowing rates.
Overall, given less favourable base effects and a moderation in export growth, and somewhat tighter credit conditions we expect GDP growth to ease back to 4.8% next year from an estimated 5.9% in 2017.
Notwithstanding the positive outlook for economic growth for the remainder of this year and next inflation expected to moderate in 2018. Headline inflation has accelerated in recent months, rising 4.3% y/y in September, largely due to higher oil prices. However, core inflation has been stable. Whilst we think core inflation will edge higher next year amid robust domestic demand overall inflationary pressures are still expected to be contained. We expect headline inflation to moderate to 2.9% next year from an estimated 3.8%.
Against such a backdrop, we still expect Bank Negara to start normalising rates with a 25bps hike in Q1 2018 with an increase in the Statutory Reserve Ratio (SRR) also expected. Indeed, they adopted a more hawkish tilt at the last monetary policy meeting, signalling a desire to initiate rate lift-off soon. That said, with inflationary pressures to remain contained next year we expect the pace of normalising rates to be gradual.
Economic Insight reports are produced with ICAEW's partner Oxford Economics, one of the world’s foremost advisory firms. Their analytical tools provide unparalleled ability to forecast economic trends.