Asian growth slowed somewhat in the first quarter of 2014. Reforms were introduced in many of the region’s countries in the past year and this is weighing on growth in the leading economies, including China, India and Indonesia. However, there are no signs that the situation is fundamentally deteriorating. Meanwhile, Asia’s two largest democracies, India and Indonesia, will be holding elections. There is optimism surrounding the leading candidates, which bodes well for the reform momentum. Risks to the outlook have shifted from the US Fed’s tapering to a slowdown in China. Although our base scenario is for stable growth in China, a change in sentiment could affect China’s major trading partners in the region. Our GDP forecast remains steady compared to 2013 at around 6% in both 2014 and 2015.
From “fragile five” to “fragile three”
India and Indonesia, the two Asian countries most affected by last summer’s turmoil, seem to be steadily heading towards a recovery and are better off than Brazil, Turkey and South Africa − the other members of the so-called fragile five. India has managed the largest turn in investor sentiment. The fight against inflation seems to be making progress, while the PMI surveys measuring manufacturing sentiment indicate that India is among the strongest in the region (51.3) Expectations that the incoming government will be more decisive and reform-minded, and thus able to unlock the economy’s potential, suggest that this could be India’s moment. Meanwhile, Indonesia has also been making progress. Its economy has been improving on the back of a number of measures recently taken to diminish its imbalances, including reducing oil subsidies and hiking interest rates. Although the current account deficit has come down, this could be temporary given the recently adopted mineral ore ban.
As for the other countries in the region, Taiwan, South Korea and the Philippines have been reporting some strong indicators, particularly trade data, which is gradually improving.
Policy priorities vary across the region
Despite the slowdown, most countries have kept interest rates on hold in the past months. Those where inflation is lower have had more room to manoeuvre. But considerations of the impact on capital flows have also played a role. China, for instance, began to signal restrained monetary conditions as a means of communicating discipline to the financial system. However, as stress increased in the interbank market, authorities reverted to an easing mode. But this was done with some caution as there have been moments when the central bank has withdrawn liquidity, but interbank rates remain below the level of end-2013. As for the FX policy, we think that introducing two-way volatility to the CNY in February was initially intended to reduce inflows of speculative capital, but now a weaker currency seems to be a tool to support the economy, particularly export growth which has been disappointing. Still, a more meaningful measure for stabilising growth was the announcement of a “mini stimulus” via investments in railways and tax breaks. We think that authorities will be reluctant to use conventional instruments, including reserve requirements, because of the impact they could have on credit growth.
Meanwhile, the slowdown in India and Indonesia is partly a result of policy measures to reduce fiscal and external imbalances, which were a source of instability and capital outflows in the summer. These economies are adjusting, but at the cost of growth. Indeed, India has made inflation more of a priority than growth, and it increased rates in January despite signs of a slowdown. Since then, however, the central bank of India has been on hold and has signalled that interest rates need time to filter through the economy. We think that putting interest rates on hold, despite that inflation (5.7% yoy in March) is still above-the target inflation, takes some account of the economic slowdown. Meanwhile, GDP growth in Thailand slowed to 0.6% yoy in the last quarter of 2013 due to the political instability, which is already in its seven month, and a lack of decision-making. Interest rates were cut in March in an effort to support the economy, but we are sceptical about the impact of these measures in a context of political volatility.
We expect that the overall picture in Asia will be skewed by adjustment policies in the coming months, which will continue to impact short-term growth, along with high volatility. However, these polices are aimed at strengthening the fundamentals of the region and this is a positive for investor sentiment. Our steady growth forecasts for the region are based on the following developments:
Asia’s synchronisation with the US and the eurozone. The Asian economy will be supported mainly by the recovery in the US and eurozone as we expect export growth in the region to pick up. In 2013, global demand was highly uncertain for Asia and monthly export growth to the US was around 2.5% yoy during the year, compared to an average of 8% yoy in 2012.
We think that the US recovery is now much more firm and the eurozone’s modest improvement in economic activity is on track. A steady growth in China going forward should alos support exports in the region. The two countries which we see leading the export cycle, Taiwan and Korea, have shown a gradual improvement in export growth in the first quarter. This trend should continue over the coming months. Meanwhile, Indonesia’s export prospects are perhaps the most uncertain, since the impact from the export ban on certain commodities is unclear. As for Thailand, exports continue to fare well despite the political instability.
Election optimism surrounds the leading candidates. India and Indonesia − two of the world’s largest democracies – are set to elect their next leaders. In India, the total electorate is estimated at 814 million, while Indonesia has around 190 million voters. The candidates leading the polls, Narendra Modi in India and Joko Widodo in Indonesia, have been positively embraced by markets thanks to their track records in their current functions. Mr. Modi has strong political capital, which he can use to make difficult decisions in the coming months, while it seems that Mr. Widodo failed to garner enough votes to form a single-party government during the recent parliamentary elections, which could make it more difficult to push through reforms.
In contrast, the election in Thailand held on 2 February was declared invalid and there is no political solution in sight. The Election Commission has indicated that it is prepared to hold another election but the opposition Democrat Party has said it will not participate in any election that is not “free and fair”, according to Bloomberg. At the same time, the risks of another election being disrupted by protests cannot be discounted. As a result, and given the duration of the crisis, we are tuning negative on the outlook for Thailand.
Risks to the outlook
The biggest risk for Asia is a hard landing in China, but we see this as a low probability risk, since we expect deleveraging to be orderly. However, the recent slowdown in China may have an impact on Asia, unless it is reversed in the coming months. China is the largest trading partner for many countries, particularly Korea, Malaysia, Indonesia and the Philippines.
The economic slowdown can lead to a deterioration in sentiment and can be accompanied by volatility in, for instance, exchange rates to which exports, too, are sensitive. Finally, geopolitical risks in Asia remain an ongoing concern. There are continually events that remind us that tensions could resurface at any moment. In March, students protested in Taiwan against an agreement to increase ties with China, which would allow freer trade in cross-strait trade in services such as banking and health care. These protests could make Taiwan vulnerable to political pressure from Beijing. Other territorial spats in the South China Seas continue, with no immediate solution likely. All these factors have an impact on investor sentiment.