ASEAN economies have seen a shift of emphasis in recent years. The role of exports as a growth driver has somewhat diminished, to be superseded by domestic growth factors such as internal consumption and investment. This shift has important implications for the economic outlook over the next three to five years for two main reasons:
- The move towards domestic demand has been supported by generally low interest rates, whi ch has made borrowing inexpensive.
- This, in turn, has allowed many households in ASEAN to take on a significant amount of debt, which has been used to fund domestic consumption. For instance, in Malaysia and Thailand, household debt-to-GDP ratios are high, in the case of Malaysia approaching 90%.
Therefore, as global liquidity and interest rates gradually normalise over the next few years, a key factor to watch will be how the highly indebted ASEAN economies adjust at the household level, as this can affect overall consumption and GDP growth.
During this period of adjustment, it is also important to consider the structural reforms that some ASEAN countries have (or have not) implemented recently. Has their growth been purely credit and debt driven, or have they put in place measures to rebalance the way their growth is formed? Have they undertaken fiscal reforms, targeted better allocation of public finances, or invested in infrastructure? Their activity in any or all of these areas will help determine their economic performance over the next few years.
The consequences of interest rate rises are particularly pertinent in ASEAN, as such policy moves either are already in progress or appear imminent. ASEAN central banks in general appear likely to implement interest rate hikes even before the US Federal Reserve. This is because persistently above-trend growth has led to inflationary pressure or generally low interest rates have led to economic or financial imbalances, or both. Indonesia already raised rates in 2H 2013, while Malaysia and the Philippines began tightening in recent months.
A tale of three economies
Given its large geographical spread, diverse political systems, different working-population dynamics, and varying infrastructure quality, it is perhaps hardly surprising that ASEAN can produce three countries with such differing economic prospects as Indonesia, Malaysia, and Thailand.
Indonesia has come a long way in the last 10 years under the Yudhoyono administration, and trend growth is now at about 6% per annum. But there is potential for acceleration given that the raw ingredients for good economic growth, such as favourable demographics and significant natural resources, are already present. The big question is whether future administrations can combine these ingredients to best effect and move the country up the next rung on the economic development ladder so it advances beyond low-income developing economy status.
In this regard, for the next five years at least, there appears to be cause for optimism. Jakarta Governor Joko Widodo (‘Jokowi’) is slated to take over as Indonesia’s seventh President on 20 October 2014, assuming legal challenges do not result in the Constitutional Court overturning his official victory at the 9 July presidential election. As he did in Solo, and more recently in Jakarta, Jokowi is likely to make efforts to reduce red tape and corruption, improve infrastructure and allocate public expenditure more efficiently in the coming years. He is also likely to bring in a smaller government and increase regional autonomy under an economic model that will emphasise decentralisation. Jokowi has estimated that under such conditions economic growth can eventually exceed 7%.
Structural change cannot occur overnight, particularly with reform on the scale that is planned. In the near term, the incoming administration will have its work cut out, with the country’s current account and budget deficits needing urgent attention. Owing to significant government subsidies on fuel and a large dependence on imported oil, demand for oil imports has escalated well beyond oil exports, resulting in a structural and large oil deficit and, in turn, a widening current account deficit. Likewise, the rising domestic consumption of oil, together with weakness in the rupiah and higher global oil prices, have brought the budget deficit close to around 2.5% of GDP, not far from the legal cap of 3.0%.
The gradual fuel price hikes that Jokowi is advocating for the next four to five years will help greatly. His running mate, Jusuf Kalla, has indicated that fuel prices may be hiked even within Jokowi’s first 100 days in office. There are plans to reduce the country’s reliance on imports of food and other goods and, importantly, to reform the oil and gas sector to increase domestic energy supplies.
But it will take months or, more likely, years before these changes can materially reduce the country’s twin deficits. In the meantime, there are hints that domestic activity may be accelerating again after having moderated in early 2014. This is in spite of tightening measures by the authorities last year, including a 44% fuel price hike in June 2013, depreciation of the rupiah, and increases in the reference and deposit facility rates since May 2013, to 7.50% and 5.75%, respectively. In short, it could still be challenging for authorities to rein in the current account and budget deficits in the months ahead.
Against this backdrop, we continue to expect only a gradual narrowing in the current account deficit, from -3.4% of GDP in 2013, to -2.8% this year and -2.5% in 2015. The budget deficit, too, may not narrow that quickly, staying sticky at -2.5% of GDP this year before going to -2.2% next year.
Nevertheless the government’s willingness to pursue reforms is encouraging. In particular, subsidy reform will unlock significant funds for more productive expenditure in the coming years that will, in turn, boost Indonesia’s economic development. Jokowi intends to spend these funds on more roads, ports and other infrastructure, which Indonesia badly needs. He also intends to spend more on education.
This is important, as Indonesia’s large and youthful labour pool is a huge resource that would benefit from further development. Unlike countries such as Singapore and Thailand, Indonesia’s working-age population will continue to increase for some years. With better education and training, the workforce and economy can become wealthier over time because the jobs they obtain will be more highly skilled and of better quality.
As an aside, it is perhaps worth noting in passing that the Philippines is undergoing economic and political transitions similar to those of Indonesia. The country is due to go to the polls in 2016, with current President Benigno Aquino not allowed to stand for re-election after his six-year term ends. Like Indonesia, the Philippines enjoys favourable demographics and, while its government does not subsidise basic items to the same extent as Indonesia, the budget faces significant leakages in terms of revenue collection. Again, like Indonesia, it is aware of the reforms needed, and has already taken some steps to pursue them, such as reducing corruption. The momentum of these efforts in the coming years will hinge on the resolve of the next government.
In terms of economic prospects, Malaysia represents the middle ground in ASEAN. The country’s high level of household debt suggests that consumer spending – and, in turn, growth – may weaken in the medium term, should the central bank continue to tighten monetary policy further in response to growing financial imbalances and rising inflation. But structural reforms implemented by the government in the past few years should help bring growth back to decent levels following the household-sector adjustment.
A key plank of change in Malaysia has been the Economic Transformation Programme (ETP). Launched in late 2010, the ETP aims to elevate the country to developed-nation status by 2020 by attracting USD444 billion in investments in 12 National Key Economic Areas including oil, gas and energy, palm oil and rubber, financial services, tourism and the Greater Kuala Lumpur/Klang Valley region. The ETP also aims to create 3 million jobs by 2020. There has been strong progress towards these aims so far: at end-2013, committed investments since the implementation of the ETP totalled nearly MYR220 billion, while new employment stood at 1.3 million.
Reforms are also being made on the fiscal front. Sugar, fuel and electricity subsidies have been cut recently, and there are plans to broaden the revenue base through a 6% Goods and Services Tax in April 2015. These fiscal reforms improve Malaysia’s longer-term economic prospects, as they free up vital public resources for more productive expenditure in areas such as infrastructure, education and healthcare. They also help to reassure ratings agencies – in 2013 the government reported a lower-than-expected budget deficit of 3.9%, down from 4.5% in 2012, and with additional fiscal consolidation this year the deficit should further narrow to 3.6% of GDP.
In the nearer term, GDP growth figures for 2014 and 2015 are expected to be 5.2% and 5.0%, respectively, modestly above the 4.7% of 2013.
Much of the growth improvement annually is likely to come from a positive export balance, with higher shipments of both manufactured products and commodities providing support. Even though export growth is likely to be modest, in view of the similarly modest economic prospects for markets such as the US and Europe plus steady growth in China, it will still probably outstrip import growth. This can be attributed to weaker domestic demand, reflecting the effect that government fiscal consolidation efforts are starting to have on both public and consumer expenditure.
While Malaysia’s central bank, Bank Negara Malaysia (BNM), has seemed cautious in its response to what it terms “domestic cost push factors”, headline inflation is already above the central bank’s 2-3% comfort zone and hit a 30-month high of 3.5% year on year in February 2014. Further subsidy rationalisation is likely – which, given the government’s fiscal consolidation objectives, would easily push this figure above 4.0%.
BNM’s recent move to tighten monetary policy is therefore encouraging. In addition to upside inflationary risks, financial imbalances are building. Malaysia now has the highest household debt to GDP ratio in Asia at 86.8%. This has been driven by property and vehicle loans and, although overall bank lending activity has declined, residential property loan momentum unfortunately remains high.
Following the military coup on 22 May 2014, an economic management team was established to prioritise growth. Although we estimate the political uncertainty of the first half of 2014 will pull full-year growth down to 1.4% this year from 2.9% in 2013, the immediate effect of the various economic measures has been to boost private sector and consumer sentiment. This should prepare the way for a gradual normalisation of consumer and investment spending in the second half of 2014, and we forecast full-year growth of 5.0% in 2015, assuming political stability can be maintained.
However, Thailand faces a number of challenges over the long term. Surveys such as the World Economic Forum’s Global Competitiveness Survey suggest that the country’s competitiveness has been steadily declining from as far back as 2006. By contrast, the Philippines and Indonesia have been making progress on this front, with the latter’s Global Competitiveness Index now on the brink of overtaking Thailand’s.
The stimulus measures introduced in 2012 in response to the major flooding of late 2011 masked the situation for a while. However, once the measures ended, the domestic economy started to struggle as underlying growth was already in decline.
This is in sharp contrast to the ‘miracle years’ of the late 1980s and early 1990s, but our estimates show that much of Thailand’s growth over that period was driven by an accumulation of capital in the form of plant, infrastructure and machinery. Labour has not contributed much as a growth input, and technology even less so.
Looking ahead, contributions from labour and technology look set to diminish further. United Nations' projections show Thailand’s working age population starting to shrink as soon as from 2017. To compensate for this decline, the country could either open the migration door or achieve significant growth in productivity. But progress on the former has been slow. Migration policies are hardly ever discussed and, given historic border tensions, this seems unlikely to be addressed soon. This is in stark contrast to its ASEAN neighbour Singapore, which has a similar ageing population issue, but has been making preparations and implementing various population management policies for the past few decades.
The alternative possibility of a major advance in productivity also looks improbable. The Global Competitiveness Survey suggests that Thailand’s weak international competitiveness can be partly attributed to a labour force lacking the skills to innovate and deal with technological advancements. While Thailand has done well in providing the basics that foreign investors have traditionally sought, such as infrastructure and strength of institutions, it has not progressed to the next stage of providing 'efficiency enhancers', such as technological readiness and labour market efficiency, and offers even less in the way of business sophistication and innovation.
Furthermore, in terms of capital inputs, investment flows into Thailand have been relatively weak, due to a combination of political and policy uncertainty since the 2006 coup. The THB2 trillion seven-year infrastructure plan proposed by the previous Pheu Thai government represented a significant opportunity to boost capital and, in turn, economic growth, but recent political uncertainty has resulted in those plans being largely put on hold. Most of the spending would have been allocated to a major high-speed rail link, placing Thailand at the geographic heart of the ASEAN Economic Community, between Southeast Asia to the south and China to the north. Meanwhile, with the Thai government having run persistent budget deficits, the ability to ramp up public investment is constrained. Given the above factors, if no meaningful structural reforms are made in the next few years, long-term GDP growth could sink below the 4.0-4.5% trend recorded over the past decade.
The significance of the AEC
The inception of the AEC in 2015 is a major undertaking for ASEAN in terms of lowering barriers. We expect it, in time, to benefit the region as a whole in terms of reducing production costs and facilitating the free flow of labour and capital, as well as assisting trade and investment flows.
Nevertheless, different member countries are moving at different speeds and have highly divergent perspectives. Countries such as Thailand are focused on what the AEC can bring and the concept is constantly in the public space, but in Malaysia or Indonesia it has a much lower profile.
A cynic might argue that this difference in attitude could be explained by Thailand’s relative economic weakness and its hope that the AEC will provide stimulus. However, a paper released by the Asian Development Bank Institute2 (ADBI) last year estimated that the country expected to achieve the greatest welfare gains3 from the AEC was Singapore, with Thailand ranking only fifth.
At a more granular level, which countries in ASEAN will derive which benefits from the AEC is actually quite a complex question. For instance, a manufacturing hub such as Malaysia wholeheartedly adopting the AEC concept could tap a cheaper pool of labour.
A further complication is that some poorer ASEAN economies with paper-driven bureaucracies administering their existing barriers and regulations derive significant employment from the status quo. Many of these jobs will effectively cease to exist post-AEC. This prompts the question of how they will be replaced if the local labour market can offer only a relatively limited set of alternative skills. At a high level, a country might eventually enjoy more foreign direct investment flows and trade volumes, but in the shorter term those who were earning a low wage in stable employment may see greater labour mobility as small recompense. The individual benefits of labour mobility are closely linked with labour skill and opportunities, which are by no means universal across ASEAN, and the achievable benefits apply only in a specific fashion. For example, under the general umbrella of manufacturing, the distinction between a worker capable of making semiconductors and one capable of making shoes is substantial in terms of the opportunity and value of labour mobility.
This is not to denigrate the AEC’s potential benefits, which at a high level should be significant. The ADBI paper cited earlier suggests that ASEAN could see a 5% reduction in trade costs and that ASEAN economic welfare under the AEC should rise by 5.3% relative to the baseline. In monetary terms, this translates into USD69.4 billion – nearly seven times the dollar benefit of the ASEAN Free Trade Area. Projections mentioned in the ADBI paper also suggest that competition policy alone could raise per capita GDP by 26-38% in the region encompassing ASEAN-54 and Brunei Darussalam. Furthermore, the net benefits of the AEC may be larger than the estimated 5.3% economic welfare increase mentioned earlier. Other possible gains include lower cost of capital due to its freer movement, improved financial systems, and greater macroeconomic stability resulting from the more conservative policies required to support the AEC.
Impressive as these figures are, a glance at the implementation rates for the AEC to date suggests that the transformation will not happen overnight. The AEC scorecard for implementation covers four principal areas:
- Integration into the global economy
- Equitable economic development
- The formation of a competitive economic region
- The formation of a single market and production base
With some six months to the launch date, the first point scores the highest, with nearly 86% of the necessary measures already implemented. But the other three are all still between 66% and 68% in terms of implementation rate.
Despite (or perhaps because of) its diversity, ASEAN’s economic potential is exceptional. Its population exceeds that of both the EU and Latin America. While it remains relatively small economically, it has demonstrated an ability to grow rapidly. This will continue to be the case in 2014 and 2015. Although like most emerging market regions HSBC expects GDP growth in ASEAN-5 and Vietnam to moderate cyclically this year before accelerating in 2015, the speed of its expansion should remain above that of Latin America or Europe, Middle East and Africa (EMEA). We expect growth in ASEAN-5 and Vietnam to average 4.6% this year and 5.5% in 2015, from 5.2% in 2013. By contrast, stable growth is projected for EMEA this year at 2.4% before a pick-up to 2.7% in 2015. Meanwhile Latin America is expected to slow from 2.0% to 1.6% this year, before accelerating to 2.4% in 2015. In the longer term, the effects of the introduction of the AEC may see ASEAN’s acceleration extend even further into the future.
1 The Association of Southeast Asian Nations. Current membership comprises Brunei Darussalam, Cambodia, Indonesia, Laos, Malaysia, Myanmar, the Philippines, Singapore, Thailand, and Vietnam
2 "The ASEAN Economic Community: Progress, Challenges, and Prospects", Author: Siow Yue Chia, ADBI Institute, October 2013
3 As a percentage of baseline GDP
4 Indonesia, Malaysia, the Philippines, Singapore, and Thailand