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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.

Q1 2019 Summary

External headwinds but slowdown in trade not as bad as 2015/16

  • We forecast GDP in the South East Asia (SEA) region to slow to 4.8% this year from 5.1% in 2018, as export growth moderates amid increased trade protectionism and slower Chinese import demand. 
  • But with China’s growth to find a floor by Q2 and domestic demand to remain resilient aided by accommodative macro policies, we do not expect the slowdown in growth to become as worrisome as 2015/16.
  • We expect fiscal spending to be strong in Indonesia, Thailand and the Philippines ahead of upcoming elections in H1 2019. We see little political risks for Indonesia with Jokowi expected to remain in power. However, there is a risk that the absence of a clear majority by the pro-junta Palang Phracharat party leads to protests in Thailand, disrupting economic activity.
  • The risks to the SEA economic outlook are primarily to the downside. A sharper slowdown in Chinese economic growth triggered by worsening confidence or a renewed escalation in US-China trade tensions would all weigh on global trade and growth across the region.

Downside pressures to abate going forward

The year has undeniably started on a soft note, in and outside of Asia. Bottom-up data indicate that the late 2018 weakness in global economic activity has spilled over into 2019. And with China slowing below trend, the rest of Asia has expectedly not fared well. 

Indeed, regional merchandise exports growth in US$ terms tumbled in December, contracting 2.3% on the year, following a weak outcome (2.2%) in November. The deterioration in export momentum was broad-based, with only Malaysia recording positive annual growth, although this follows some normalisation in mining production following earlier supply disruptions. And while Singapore and China data showed some improvement in exports in January, the data is likely to be volatile in Q1 given the shifting timing of Chinese New Year.

Asia Nominal USD Exports

High frequency data also points to further weakness ahead in the manufacturing and export sectors. In January, our aggregate measure of the Asia PMI slipped into contractionary territory (below the no-change in activity level of 50) for the first time since May 2016. While South East Asia countries fared better than their North Asia counterparts, Indonesia and Malaysia both reported readings below 50.

Looking ahead, we expect exports to remain under pressure. Although recent US-China trade negotiations suggest that a deal leading to a more lasting suspension of new tariffs is more likely than before, the outlook for Asia trade continues to face headwinds from weaker Chinese import demand. We also do not expect the increase in trade protectionism over the past year to be removed anytime soon.

That said, we do not expect the external environment to be as worrisome as in 2015/16. With China’s growth expected to stabilise in Q2, we still forecast Chinese import growth for 2019 to be notably stronger than in 2015/16. And any trade agreement resulting in prolonged tariff suspension from the US would be a plus. 

Domestic demand to act as a buffer against challenging external backdrop

We expect domestic demand to cushion the region from trade headwinds aided by accommodative macro policies. The recent change in the Fed’s rhetoric and lower external financing concerns (due to oil prices declining and currencies stabilising) have meaningfully eased the pressure on Asian central banks to tighten monetary policy aggressively. We expect most central banks to keep policy rates unchanged well into the second half of 2019 amid muted inflationary pressures. Fiscal policies are also likely to be supportive of growth in the region, particularly in Indonesia, the Philippines and Thailand ahead of upcoming elections in H1 2019. 

That said, there are pockets of concern. Private capex, especially in machinery and equipment (M&E) investment, has been on a downtrend in some of the places where export growth has notably decelerated – such as in Singapore and Malaysia. Residential investment will also be held back by demand and supply imbalances in both these economies. However, we expect construction, particularly infrastructure investment, to limit the downside to overall investment. Meanwhile, we expect benign inflation conditions and rising real income growth to continue to support household spending. 

Overall, against a more challenging export environment we expect regional South East Asia GDP growth to moderate to 4.8% this year from 5.1% in 2018 before easing to 4.7% in 2020.

Asia GDP Growth

Indonesia GDP growth to slow to 5% in 2019 despite pre-election spending

Real GDP growth rose 5.2% on the year in Q4, unchanged from the previous quarter bringing full year growth to 5.2%, up slightly from 5.1% in 2017. As we anticipated, domestic demand remained the key engine of growth in the quarter although the data was mixed. Consumer spending picked-up slightly, growing 5.1% year-on-year, aided by mild inflation and a healthy labour market. However, growth in government spending and investment decelerated amid efforts to lower fiscal expenditure and a paring down in the pace of infrastructure investment. Part of the slowdown in infrastructure project development has been a concerted effort by the government to cool imports and reduce the downward pressure strong import growth places on the IDR. 

The government’s efforts to stem import growth appears to have had some success with import growth falling from 14% in Q3 to 7.1% in Q4. However, as export momentum also softened in Q4, the external sector remained a drag on annual growth.

Indonesia: Exports and Imports

Domestic demand to remain key engine of growth

Looking ahead, modestly higher inflation and lower planned uplifts to minimum wages in 2019 compared to last year are likely to weigh on real household income growth and consumption growth, offsetting the impact of pre-election fiscal giveaways contained in the 2018 Budget. 

Meanwhile, although we expect investment to remain supportive this year the risks have grown. In particular, we expect the pace of government infrastructure spending growth to slow. With the next general election scheduled for April 2019, the government is prioritising keeping fuel prices stable, raising public sector pay and boosting social assistance benefits over infrastructure. In addition, the potential for deteriorating SOE balance sheets (in the context of fuel price freezes) and uncertainties over the profitability of some infrastructure projects could challenge the medium-term outlook. And given the widening in the current account deficit during 2018, the government and BI are concerned about the financial stability risks linked to higher external financing needs, as well as the downward pressure strong import growth places on the IDR. Hence the government has announced measures which aim to cool imports, including delays to some projects and to capital imports (related to certain government and SOE investment plans) – posing downside risks for investment.

While the outlook for exports remains challenging amid cooling Chinese import demand, import growth is likely to continue to slow this year and we expect net exports to place less of a headwind on growth in 2019. Overall, we expect GDP growth to moderate to 5% this year from 5.2% in 2018.

Hawkish monetary policy stance

The IDR dropped by 10% against the USD between the end of Q1 2018 and late October 2018, amid broad dollar strength and pressure against many EM currencies. In the face of this pressure, and a wider current account deficit, Bank Indonesia (BI) attempted to support the currency and limit Indonesia’s external imbalances, with 175bp of cumulative rate hikes since May. Given our expectation that the Fed will resume US monetary policy tightening later in the year, the high foreign ownership of Indonesian bonds (close to 40%) could again leave the IDR vulnerable to swings in investor sentiment. As such we expect BI’s policy rate to rise over the course of this year, albeit at a slower pace than in 2018 given (i) BI’s action since May has increased the spread between Indonesian and US policy rates, supporting the IDR, and (ii) we forecast fewer US Fed rate hikes in 2019 compared to 2018. Overall, we look for BI to raise interest rates once this year by 25 basis points in Q3. 

Mildly expansionary Budget but external headwinds to weigh on Singapore growth

Against a backdrop of moderating economic growth and downside external risks the Singapore government announced a mildly expansionary Budget for 2019 with fiscal room to introduce counter-cyclical measures should economic conditions worsen sharply. The government continued to focus on policies to boost productivity as well as enhancing health care costs through the Merdeka Package and the Long-Term Care Support Fund. The government also announced a Bicentennial Bonus, which includes individual income tax rebates of up to $200 for low income individuals. Whilst a positive outcome we do not expect this to lead to any significant bounce in household spending in Singapore this year. 

While the mildly expansionary budget will support economic growth into the year to come, we maintain our cautious outlook for Singapore’s manufacturing and services sectors with the slowdown in global trade expected to impact both the manufacturing and external dependent service sectors this year. Indeed, Singapore is very exposed to China via supply chain linkages and directly through meeting China’s domestic demand.

Singapore: Contributions to GDP Growth

We still look for domestic demand momentum to ease this year. In particular, residential investment is expected to remain sluggish and the headwinds facing business investment in 2019 have risen. The recent fall in commodity prices is likely to weigh on investment in the oil & gas sector. Moreover, despite the recent truce in the US-China trade war we expect that trade protectionism will increasingly weigh on private sentiment and investment intentions, with momentum in corporate profits also forecast to soften. 

However, government measures to support businesses and encourage investment, particularly in adapting to Industry 4.0, should continue to support investment as well as boosting planned infrastructure investment, which should provide support for investment over the next 18 months.

Meanwhile, households have become more cautious about buying interest rate sensitive goods such as motor vehicles but spending in other goods and services suggests underlying momentum is moderate. Labour market conditions have recently shown some signs of improvement, with the job vacancy rate reaching a three-year high in Q3. We look for a moderate acceleration in employment growth in 2019, which should support wage growth of around 3.7%, similar to 2018 while lower oil prices will also see inflation remain contained. That said, momentum in household spending, is expected to moderate from the strong gains in most of 2018 as higher domestic interest rates and negative wealth effects (associated with the fall in equity prices in 2018) will dampen growth in households’ spending power. Overall, against a more challenging environment for exports and the manufacturing sector we forecast GDP to grow by 2.4% in 2019 from 3.2% in 2018.

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