The ICAEW Economic Insight: South East Asia, is a quarterly forecast for the region prepared directly for the finance profession.
The H1 growth scorecard confirms our view that domestic demand remains the primary driver of GDP growth in the region. Though export growth accelerated across the board at the beginning of the year (with USD exports rising at the fastest pace in the first quarter since the last quarter of 2011), the contribution of net external trade to headline GDP growth was negative in many countries, outpaced by import growth.
This is not a surprise. Asia’s supply chain mechanisms and resilient domestic demand mean that imports are likely to benefit as exports and overall growth improve. In fact, domestic demand has now been the sole driver of Asian growth for five years. But that does not mean exports no longer matter.
In part, the rise in importance of internal factors in supporting the region’s growth is the result of a long period of subdued global demand and limited opportunities for export gains. With an important growth driver weakening, domestic macro policies have turned more expansionary, bolstering consumption and investment. This strategy has been broadly successful, as Asia has continued to outperform other regions, in spite of the sluggish external environment. And we expect policy makers to retain an accommodative stance, both in terms of fiscal and monetary policy, in the foreseeable future.
Structurally, we do not think that the fortunes of Asian, particularly east Asian, economies have in any way decoupled from the global trade cycle. Gross exports have important spillover effects on the domestic economy that shouldn’t be ignored. We find that the pick-up in private domestic demand momentum has been particularly strong in some of the economies where export growth has accelerated notably, such as Singapore and Malaysia.
This is primarily because manufacturing, which is the dominant sector in these economies, is largely export oriented - improved external demand facilitates production, leading to higher investment, rising incomes and increased consumer spending. These, in turn, support job creation, improved productivity and overall economic prosperity.
While we expect domestic demand to continue playing an important role in determining Asia’s growth trajectory, the anticipated weakness in exports in the second half of the year (on the back of cooling Chinese demand and a global trade slowdown), is likely to lead to deceleration in most Asian economies, if not all.
The GDP growth outturn for Q2 2017 surprised on the upside, with seasonally adjusted GDP increasing by 1.33% q/q . On an annual basis, the economy expanded 3.7% vs 3.3% in the first quarter. Growth picked up on the back of stronger consumption and a slower rundown of inventories. However, net exports and investment weighed on growth, with imports outpacing solid export growth (1.2% q/q) and public investment falling significantly. Notwithstanding the latter, we have edged up our 2017 GDP growth forecast to 3.5%, marginally higher than our previous forecast and the expansion achieved in 2016.
Monthly data suggested that the domestic economy is maintaining respectable growth. The consumer spending indicator increased for a third month in a row in July, while the stronger performance of merchandise exports this year may now be starting to lift business investment and manufacturing output. In addition, tourism has rebounded this year, with the year-on-year growth in international tourist arrivals improving from -0.9% in Q4 2016 (when the tourism sector was hit by the death of King Bhumibol) to plus 1.7% in Q1 2017 and plus 7.6% in Q2. And in recent months the pickup has been broad, with visitors from China increasing again after six months of weakness. We expect the tourism sector to continue its robust expansion.
Though public investment dropped by about 1% of GDP in Q2, it is still significantly higher than 2014 (when the military took control). With the government keen to bolster an economy that has been growing only modestly for some years now, increasing public investment will remain a key focus, in part for political reasons. At the same time, monetary policy is expected to remain very accommodative for some time longer, to facilitate a more broad based expansion of the domestic economy. The Bank of Thailand (BOT) has maintained near record-low interest rates of 1.50% since April 2015. At its latest monetary policy meeting in August, the bank expressed concerns about the impact of a prolonged period of low interest rates for excessive risk-taking and future financial stability. So it is unlikely to cut rates any further, but we do not expect the first interest rate hike until late 2018.
The chances of a more pronounced economic acceleration still seem low and credit conditions remain relatively tight. While loans to businesses are driving the increase in commercial bank loans, these are being used to bolster working capital and financial restructuring rather than providing funds for new investment. Private investment remains subdued.
The political landscape is also a source of concern. The Thai authorities showed determination to maintain continuity and stability in the country (and the economy), when they ensured the smooth transition of power to the new King Maha Vajiralongkorn, following the death of King Bhumibol last year. However, the next general election, previously scheduled for 2017, has now been postponed to 2018. It remains the case that the political situation could quickly become much more strained as Thai society is still deeply divided. For now, the military government has a firm grip on the political system, but the underlying political tensions may resurface at some point, which could test the new monarch’s power to keep the country as united as King Bhumibol during times of political turmoil.
There are also downside risks to our forecast from bureaucratic delays hampering public spending, and the anticipated weakening of external demand in H2. After stagnating in 2014 and 2015, Thailand’s export volumes (including those of goods) rose in 2016, and will be followed by further reasonable expansion in 2017 (from 1.1% in 2016 to 6.2% this year). The Bank of Thailand expects the recovery in merchandise exports to broaden out, helped by increased demand for electronic goods and the relocation of some products to sites in Thailand. We remain relatively cautious in our expectations.
Bank Indonesia (BI) surprised markets with back-to-back rate cuts, lowering the seven day reverse repo rate from 4.75% in July to 4.25% in September. According to the bank, low inflation, a reasonable current account deficit and reduced external risks created room for further monetary easing. Furthermore, BI has not ruled out the possibility of further easing, but added that it would be monitoring external risks and the stability of the currency.
We do not expect any more rate cuts. The external backdrop may turn less favourable as Fed begins to normalise its balance sheet from October and cautiousness is warranted. However, a lacklustre domestic economy poses risks to this view.
Real GDP grew 5% y/y in Q2 2017, the same pace as in the previous quarter and broadly in line with our expectations. Private consumption remained the primary driver, contributing 2.75 percentage points to headline growth. But consumer spending showed few signs of gathering momentum, with private consumption growth steady at 5% y/y and government consumption contracting -1.9% y/y. On the positive side, investment growth jumped up to 5.4% y/y from 4.8% in Q1 (rising back above 5% for the first time in six quarters). And net exports contributed 0.6 percentage points to overall growth, in spite of a deceleration in export performance.
Looking ahead, the mixed economic trends mean that we remain cautious, keeping our forecast of 5.1% GDP growth in 2017. Consumption is expected to benefit from muted inflationary pressures and low borrowing costs gradually feeding through the economy. 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 and forecast private spending growth to tick up marginally to 5.1% in 2017, after 5% growth in 2016.
Another silver lining is the positive outlook for FDI. In February, 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. At first glance, the trade data appears reassuring, with both exports and imports growing strongly. But a closer look reveals slower momentum. This is broadly in line with our expectations of global trade beginning to cool down and imports resetting to a more sustainable pace post Ramadan festivities. That said, the turnaround in import growth momentum does raise some concern about the GDP growth outlook, especially since the nominal breakdown shows a more marked deceleration in consumption and capital goods imports than in raw material imports.
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%.
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