Economic Update: South East Asia
The ICAEW Economic Update: South East Asia, is a quarterly forecast for the region prepared directly for the finance profession.
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Q3 2019 Summary
Policy settings to ease as export outlook deteriorates
- Economic prospects, particularly among the more trade dependent economies such as Singapore, have deteriorated after another round of tariffs and trade restrictions by the US and China. We expect GDP in the South East Asia (SEA) region to slow from 5.1% in 2018 to 4.5% this year and next.
- Amid challenging global conditions, and lower US interest rates, we expect central banks across the region to further reduce policy rates to support domestic demand. Fiscal policy should also become more supportive amid higher infrastructure investment.
- Vietnam is set to outperform the rest of the region with GDP growth expected to moderate to 6.7% this year and 6.3% in 2020. However, the risk that the US will impose higher import tariffs on Vietnam has risen in recent months. This would cut GDP growth to an average of 5.9% in 2020−21 compared to our baseline of 6.2%
Policy to step up amid ongoing global headwinds
Central banks across South East Asia have started to ease monetary policy as spillovers from the US-China trade war, slower Chinese domestic demand and a downturn in the global electronics cycle have put mounting pressure on manufacturing activity, exports and growth. Indeed, average regional economic growth in the first half of 2019 slowed to .% on the year compared to 4.5% in the previous six months.
As a small open economy heavily dependent on exports, Singapore has experienced the sharpest slowdown in growth, with GDP contracting 3.3% quarter on quarter (seasonally adjusted) in Q2. Slower export momentum in Thailand and the Philippines also weighed heavily on growth, although temporary delays in budgetary spending were also a drag on the Philippine economy. Meanwhile, Vietnam and Malaysia have outperformed, reflecting a more modest deceleration in export growth and resilient domestic demand.
However, global trade conditions have deteriorated further after another round of tariffs and trade restrictions by the US and China from September. This will weigh on regional trade flows and we also expect lower corporate profits and uncertainties about trade to weigh on business investment, notably for machinery and equipment. This will only be partly offset by an increase in infrastructure spending.
Against a more challenging external backdrop, lower US interest rates and subdued inflationary pressures we expect most central banks to reduce policy rates to support domestic demand. After lowering interest rates by 50 basis points (bp) a piece this year, we expect Bank Indonesia and Bangko Sentral ng Pilipinas to lower rates once more in Q4 by 25bp. Meanwhile, despite the outperformance of the Malaysian economy to date, we expect Bank Negara to follow its May rate cut with another 25bp reduction in December and a further 25bp cut in Q1 2020. This assumes that the government remains focused on fiscal consolidation in its upcoming budget due in October. Thailand is also forecast to reduce rates a further 25bp in early 2020, complementing the recently announced fiscal stimulus package.
Meanwhile, we expect the Monetary Authority of Singapore (MAS) to ease policy in October, shifting to a zero appreciation bias in its key policy tool the SG$NEER, a trade weighted baskets of currencies agains the SGD.
Although we expect domestic-driven activities to cushion the weaker trade outlook, aided by more accommodative macro policies, we now expect regional South East Asia GDP growth to moderate to 4.5% this year, from 5.1% in 2018, with growth to remain stable at 4.5% in 2020. Against a challenging external backdrop, we forecast Singapore to dip into a manufacturing-led technical recession (two consecutive quarters of negative growth) in Q3 2019. Growth is also set to remain below potential in Indonesia, the Philippines and Thailand. Meanwhile, although growth is set to ease in Vietnam, at 6.7% this would place it as the fastest growing SEA economy.
Asia: GDP Growth
Outperforming amid some trade diversion
As the escalation in US-China trade tensions and slower Chinese domestic demand weigh on exports and growth across the region, Vietnam appears to be one of the few beneficiaries. Indeed, exports to the US rose 33% year-on-year in H1 2019, helping to offset slower trade with China and other countries in the region. Industrial production has also been boosted by new production coming online in export-oriented manufacturing and processing industries. Supported by solid exports and industrial production, the economy rose 6.7% in Q2 2019, only slightly lower than the 6.8% growth recorded in Q1.
Although we expect Vietnam to continue to benefit from positive trade diversion effects, we think that momentum will continue to trend lower given weaker Chinese import demand and increased trade protectionism generally. The recent re-escalation in US-China trade tensions will add further downward pressure on external demand.
Domestically, we expect demand to remain healthy in 2019−20. Household spending will remain solid amid stable inflation and rising incomes, while sustained tourism should support the service sector. Meanwhile, although new registered foreign direct investment (FDI) dipped slightly last year, disbursed FDI rose 6.3% in the first eight months of 2019, with the manufacturing and processing sector garnering the most interest from foreign investors. Solid FDI inflows will continue to support investment. Against this backdrop we expect the State Bank of Vietnam (SBV) to keep its refinancing rate unchanged at 6.25% over the next year. Overall, we maintain our forecast that GDP will grow by 6.7% this year, with a modest deceleration to 6.3% in 2020 and then about 6% a year in 2021−22.
Readying for a trade flare up
The acceleration in exports to the US has helped cushion the impact of slower Chinese import demand, but it has also led to a widening in the US goods trade deficit, which has caught the US administration’s attention. Indeed, President Trump recently called Vietnam ‘almost the single worst abuser’.
The US has also brought into question what portion of the growth in Vietnam’s exports to the US reflects countries, including China, routing products to Vietnam for minor adjustments to avoid higher US duties.
Indeed, there is evidence that some Chinese goods have been diverted to Vietnam and labelled as Made in Vietnam to avoid higher US duties. Vietnamese officials have cited an increase in fraudulent labelling on products ranging from agriculture to textiles and steel.
We believe that, on top of the higher duties on several steel and aluminium products already in place, three product groups are at risk of higher tariffs, covering around US$18.4bn or nearly 39% of Vietnam’s exports to the US in 2018. These include computers and parts, textiles and fisheries.
It is estimated that if the Trump administration were to raise tariffs by 10% on US$18.4bn of Vietnam exports to the US, GDP growth would slow to around 5.9% pa in 2020−21 compared to 6.2% pa in our baseline. The loss in investor confidence could also see equity prices 5%−10% lower than our baseline in 2020.
Impact of 10% tariffs on GDP growth
Medium-term prospects still bright
The impact would possibly be larger if it damaged FDI inflows. However, we see Vietnam as one of the most attractive destinations for FDI across the region over the medium term. Not only does it benefit from its close proximity to China, but labour dynamics are also positive. Its participation in trade agreements, notably as part of ASEAN, and policies to attract investment are also favourable. Still, Vietnam needs structural reforms to improve firms’ ability to do business in the country, and to ensure adequate education to enhance the scalability of production.
Economic prospects improve as Myanmar opens up to foreign investment
After recording 6.8% in 2017 we estimate that economic growth moderated to 6.3% in the Transition Period (April 2018 to September2018). However, despite rising global trade headwinds, prospects are improving. We forecast the economy to expand 6.4% in 2018/19, before picking up to 6.8% in 2019/20, due to higher infrastructure investment, and increased manufacturing and wholesale & retail services activity on the back of the government opening up these sectors to foreign investment.
Indeed, after a 14% drop in FDI to $5.7bn in 2017/18, FDI inflows are improving. In large part this follows the launch of the Myanmar Sustainable Development Plan (MSDP) in August 2018 and the opening of the retail and wholesale trade, education, finance companies, and the insurance sector to full foreign ownership. According to the Myanmar Investment Commission, FDI inflows rose to over US$3.5bn over the 10 months to August 2019, with a sharp rise in investment channelled into the transportation & communication sector and manufacturing sector. This should lead to a rise in manufacturing activity and, as production comes online, support exports over 2019/20 despite the backdrop of weaker Chinese import demand.
Indeed, total goods exports rose nearly 40% in the first 11 months of 2018 from 14.4% in 2017 as weaker demand from China partly offset a surge in exports to the US, Japan and EU countries. We expect momentum to trend lower over the next 18 months amid weaker Chinese import demand and increased trade protectionism. But, as signalled by the latest Purchasing Managers’ index, external demand is unlikely to fall off a cliff. Although the manufacturing PMI eased to a seven-month low in August, the sub-indices for production and new orders increased sharply in the month and remain well above their respective long-run averages.
Domestically, infrastructure investment is expected to accelerate over the coming 18 months boosted by big infrastructure projects including those under the China-Myanmar Economic Corridor (CMEC) such as New Yangon City, Kyaukphyu Deep Sea Port and Kyaukphyu-Kunming Railway. We also look for growth in household spending to be supported by healthy labour market conditions and a moderation in inflation.
Ongoing Rakhine crisis a key downside risk
In spite of the relatively positive outlook for the Myanmar economy, the risks are tilted to the downside. Beyond the global risk to trade from escalating US-China trade tensions, the ongoing humanitarian crisis in the Rakhine state and slow progress in the repatriation of refugees is a key risk. Some of the economic impacts of the conflict are already being felt in tourism, with the number of international visitors down some 25% from their 2015 peak. Further impacts could include the loss of some special trade preferences from the EU, which would greatly impact textile exports. Over half of Myanmar’s textile exports are to the EU. The situation could also lead to a further reduction in concessional donor financing and weaker FDI commitments over the medium term due to increased uncertainty surrounding the investment climate.
Meanwhile, on the domestic front we expect the current governing party, the National League for Democracy (NLD) to retain its majority at the next general election due to be held in late 2020. This would see continued progress in pro-market and anti-corruption reforms. However, if the NLD only manages to form a coalition with regional and ethnic-based parties, we expect the NLD’s ability to resolve the Rohingya crisis will be constrained, and reforms could take a back seat. This could also see foreign investment lower than our current expectations.
Further reforms need to reap full benefits of labour advantage
Looking further ahead, given its relatively low wage workforce we expect Myanmar to benefit from strengthening FDI inflows as global supply chains adjust to higher costs in China. But structural reforms are needed to improve firms’ ability to do business in the country. According to the World Bank’s Doing Business Report 2019 Myanmar ranked 171 out of 190 countries, comparing unfavourably to the rest of the region. Moreover, the business environment is even worse when looking at the complexity of the tax system, enforcement of contracts and trading across borders. Power outages and the prospect of higher demand for electricity also highlight the ongoing need to fill the large power gap. We believe these drawbacks will hinder Myanmar’s ability to fully reap the benefits of its low-wage advantage.
Asia: Ease of doing business, 2018
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