- We present our key macro themes for 2014 for the region and the main economies. In aggregate, growth in 2014 portends to be slightly stronger than in 2013 owing to stronger external demand growth and its attendant impact on exports and investment. Country divergence is, however, likely to remain wide.
- Prospects of QE tapering by the Fed will remain a disruptive force, in our view, with variations in impact across countries. The intensity of this force is, however, likely to be less aggressive than in 2013. External imbalances in the region have receded considerably, and the more recent proclamations by the Fed suggest that any changes in the policy stance will be gradual.
- Inflation should remain below or within the official forecast ranges for much of the region. In countries where inflation is likely to remain a problem, it will be driven either by supply-side deficiencies or government policies such as a reduction in subsidies.
- Diminished external imbalances and manageable inflation suggest only modest monetary tightening for most countries. Short-end rates are likely to remain well anchored. Long-end rates are, however, likely to rise, in line with US yields. Again, expect significant divergence across individual markets.
- Exchange rate performance was mixed in 2013 and the outcomes at least in H1 2014 are unlikely to be much different. We continue to favor currencies whose underlying macro fundamentals are characterized by improving growth momentum and limited imbalances, although intervention could be part of the picture.
- A key focus area for asset markets will be whether, and the degree to which, policymakers are willing to embrace productivity and efficiency-enhancing reforms. China’s leadership has outlined its plans; implementation will be the key. Prospects for significant reforms are, however, weaker in South East Asia and India.
Higher but uneven growth
We forecast non-Japan Asia (NJA) to grow by 6.5% in 2014, moderately up from 6% in 2013. The principal reasons for the modest acceleration are firmer growth in external demand from the US and EU and the ongoing pick-up in China’s growth.
The region’s business cycle has become closely intertwined with China’s, predominantly due to the latter’s rise as a key export market. However, support from China’s growth is least apparent in India, Indonesia and Malaysia, as they are least linked up to China via exports. Our forecasts for the region as well as for developed economies are tabulated later in this report.
Two features are, however, important to note. The first is that the upturn is likely to become more pronounced in the second half of 2014 as a material improvement in external demand is likely to materialize only when the recovery in developed economies becomes more mature.
Compared with previous business cycles, global trade has recovered at a slower pace in this episode. Higher import demand that is generally typical of recoveries in developed economies has been slow to come about, constrained by deleveraging and fiscal austerity. Growth will need to become sufficiently deeper for the trade channel to become more solid.
Divergent country prospects
Intra-regional divergences are likely to be another feature, with South East Asia and India lagging the upturn in other economies. Unlike their North Asian counterparts and China, domestic demand in India, Indonesia and Malaysia is likely to be constrained by the necessary emphasis on fiscal austerity.
In both Indonesia and Malaysia, budget plans for 2014 entail significantly slower growth in government spending and in subsidies in particular. Reductions in subsidies tend to adversely impact consumption, at least initially.
In India, a key imponderable would be the outcome of the national parliamentary elections, ie. will the incoming government have sufficient majority to undertake politically sensitive but growth-enabling reforms?
The maturing credit cycle will pose yet another challenge for Indonesia, Malaysia and Thailand. Each of these economies has in recent years seen a remarkable increase in credit intensity, a development with a finite lifespan. China’s government is also moving towards reining in the rise in leverage.
Inflation on the backburner
Considering prospects of stable commodity prices and only gradually closing output gaps, inflation is likely to remain within the comfort zone of central banks. Our estimates of trend growth and 2014 forecasts suggest that output gaps will generally be neutral to inflation.
Further, as mentioned above, the primary driver of growth in 2014 will be external and not domestic demand. Historically, overheating in domestic demand has had a greater bearing on inflation owing to greater pricing power and more limited scope for productivity increases.
On commodity prices, we note that most international agencies have forecast moderate declines in commodity prices, including for crude oil.
Inflation in India, Indonesia, Singapore and Malaysia is, however, likely to be elevated – but this will be due to policy developments. For example, in India, government-mandated increases in food procurement costs and rural wages have and should continue to be the basis for inflation spikes.
Reductions in energy subsidies have in recent months imparted an upward bias to inflation in Indonesia – this bias is likely to persist at least in the early part of 2014. A similar pattern is likely to emerge in Malaysia if the government makes a serious effort to mitigate fiscal imbalances.
Finally, in Singapore, the inflationary impact of restrictive foreign labor policies looks set to continue through 2014.
QE tapering – disruptive but less so
The possibility of QE tapering by the Fed will remain a potentially disruptive risk for many of the region’s financial markets, in our view. Its impact on financial markets, however, will likely be less aggressive than during May-September 2013, when talks of tapering had initially surfaced.
External imbalances have since receded, most notably in India, Malaysia and Thailand. In India and Thailand, the current account deficit has narrowed sharply, whereas Malaysia’s current account surplus, which had been receding through 2012 and 2013, has started to widen again, primarily in response to a restrictive fiscal policy.
In Indonesia, the latest available (July-September 2013) current account deficit reading of 3.8% of GDP remains discomforting, but more recent trade data suggests a gradual course correction is falling in place.
A second development is that even if QE tapering does commence in 2014, the impact may be more moderate than in the past. The ongoing saga of low inflation, weak wage growth and a possible US Fed preference for an unemployment rate target of less than 6.5% help the argument for dovish forward guidance.
In other words, the impact of QE tapering may well be offset by an overall dovish stance.
Interest rates – modest tightening
What does this mean for monetary policy? The combination of a gradual closing of output gaps, manageable inflation and a dovish Fed suggests only modest tightening. We are expecting modest rate hikes of 25-50 basis points in Korea, Malaysia, Taiwan and Thailand. In our view, this stance reflects the need to normalize policy conditions as opposed to squarely combating inflation and overheating.
Only in the Philippines do we forecast a tightening of 75 basis points, aimed directly at curbing inflation pressures. This is the only economy that has been and is expected to continue to grow significantly above trend in 2014.
In China, we expect benchmark rates to remain steady through 2014 even with a firmer monetary stance reflected in higher interbank rates than in the past.
What of India and Indonesia? The situation in India is somewhat unclear because the Reserve Bank of India is in the midst of shifting its policy target from WPI to CPI. Still, considering that CPI will likely begin to recede around Q2 2014, albeit to still elevated levels, we believe that the tightening cycle is already in its conclusive stage. In fact, the central bank is likely to gradually commence easing in H2 2014.
In Indonesia, we believe that additional tightening of 50 basis points is still necessary to sufficiently rein in inflation and the current account deficit. But once again, Bank Indonesia should regain flexibility to ease in H2 2014. Overall, we believe that monetary policy will remain growth supportive and will be easily digested in financial markets.
Exchange rates – divergent trends
The combination of improving growth, reduction in imbalances and a supportive Fed policy suggests a better environment for Asian currencies in general. At the same time, this favorable trend should be mitigated by the fact that growth in many countries will not exceed trend growth by much, ie. central bank intervention could be substantial and appreciation modest.
On individual currencies, trend-wise, we forecast the renminbi to continue to appreciate by around 2.5%, reflecting productivity gains that are relatively stronger than at its trading partners. The prevalence of a structural surplus should also be supportive to the currency.
We also expect a turnaround in the Indian rupee and Indonesian rupiah against the backdrop of receding external imbalances. The likely timeline for a meaningful turnaround is H2 2014, when elections in both countries have concluded.
Our outlook for the Malaysian ringgit and Thai baht is less clear. In Malaysia, whereas improvement in the fiscal/current accounts augurs for a stronger currency, the absence of growth drivers and structurally declining competitiveness suggest that the proclivity for a weaker currency may rise.
In Thailand, the principal risk is a faltering of growth should infrastructure development fail to take off. Given the uncertainty surrounding this issue, we have opted for a relatively flat USD/THB forecast with the risk firmly to the upside.
We have long argued that any structural re-rating of Asian markets will be contingent upon the ability of policymakers to deliver productivity and efficiency-enhancing reforms. The reform agenda varies across countries, ranging from greater market orientation, a reduction in subsidies, improving governance, opening new sectors to foreign direct investment, and investing in human capital.
Unfortunately, given political imperatives in many countries, significant changes are unlikely. Even if the political environment turns out to be more favorable than they are now, it is unlikely that reforms will be implemented in a hurry.
We are positive on the implementation of reforms only in China and Malaysia. In China, the new leadership appears determined to increase the role of markets and recalibrate the role of the state with the objective of attaining more sustained and better balanced growth. We are also hopeful of a meaningful reduction in subsidies in Malaysia and further progress towards the implementation of a goods and services tax.
About the Author
This article is excerpted from “Asia: Themes and Issues for 2014,” a report by Royal Bank of Scotland and affiliated companies that was published on 12 December 2013. It has been re-edited for conciseness and clarity. ©Copyright 2013 The Royal Bank of Scotland plc and affiliated companies (RBS). All rights reserved.
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