GDP Growth Alert: India, Indonesia and Japan

At the time of writing, five countries – China, Korea, Indonesia, Singapore and Taiwan – had reported first-quarter GDP numbers. Activity either slowed or remained anaemic in all of them. In fact, the data reminded us yet again that the recovery process is likely to be slow and halting and, more importantly, contingent upon an improvement in the global environment.
We analyse the economies of India, Indonesia and Japan in this article. We will look at Korea, Malaysia, Philippines, Singapore, Taiwan and Thailand in subsequent articles. 
India: Lacklustre activity
We are still waiting for signs of revival in economic activity. Barring exports which picked up modestly in March, all indicators continue to point to lacklustre economic activity.
New investment announcements in Q4 FY13 (fiscal year ending March 2013) were estimated at 657 billion rupees, the lowest quarterly number during the fiscal year. For the full year FY13, new investment announcements were 4.33 trillion, the same level as in FY06.
Equally, the number of stalled projects has continued to rise. It is difficult to envisage a major improvement in the situation with the reforms process having stalled again. The critical land acquisition and mining bills were not approved in the last parliamentary session, which was disrupted by charges of corruption.
Consumption data tells a similar story. Be it car sales or currency in circulation, there has been a significant decline. Car sales have now been declining since December and averaged (minus) 11% in the three months to March.
Similarly, real currency in circulation, a good indicator of volume transactions in a cash-based economy, has grown by less than 5% in the last six months. It is now clear that the long stretch of weak income growth and persistently high retail inflation is biting into purchasing power.
The decline in WPI (wholesale price index) inflation has been slow to filter through to retail prices until now. WPI inflation, which has a greater weighting for manufactured products, has predictably reacted faster to the softening in commodity prices.
Retail inflation, or CPI (consumer price index), is more sensitive to food and labour costs, which have yet to ease. Rural wages increased 17% year-on-year in January, well ahead of productivity.
Policy outlook. The Reserve Bank of India, while delivering a 25-basis- point rate cut in its last review, continued to emphasise that the uncertain inflation outlook, and the fiscal and current account deficits still limit the space for monetary easing.
For FY14, the RBI is targeting average WPI at 5.5% year-on-year and a terminal rate (March 2014) of 5%. There is no target for CPI, but we suspect the central bank will place considerable emphasis on it, considering its linkage with the current account deficit and deposit growth.
The RBI has acknowledged the possibility of windfall gains from the recent decline in oil and gold prices but has also stressed the difficulties in quantifying the impact. This is primarily because of the uncertain price sensitivity of gold demand (discussed below).
The RBI is also seeking a current-account funding mix that can be sustained in the event of higher global interest rates or a drop in risk appetite.
There has been a marked deterioration in the funding mix. Portfolio flows and borrowings account for close to half the available funding, whilst the share of FDI is only 8%. This is a marked departure from the pre-global financial crisis period when FDI flows could finance as much as 70% of the deficit.
On the fiscal situation, the RBI has acknowledged improvement, but has still characterised it as insufficient. We believe these constraints will probably allow for only one more rate cut of 25 basis points in FY14.
FX outlook. Theoretically, oil at US$100 a barrel and gold at US$1,400 per ounce could narrow the current account deficit to 3.1% of GDP. But the response of the household sector is unknown. Our understanding is that physical purchases of gold have increased sharply in response to lower prices – this implies that the actual correction will be more moderate.
It is also likely that, against the backdrop of moderating inflation, the RBI will opt to step up intervention in the FX markets and accumulate reserves. This would be a beneficial approach, considering that the import cover has dropped from 11 months to around six.
We are also of the view that portfolio flows could easily reverse in the face of weak GDP and earnings growth. Therefore, even though we recognise that the Indian rupee is very competitively valued on a real basis, the case for significant strengthening is weak. We continue to believe that USD/INR will trade in a 53-55 range.
Indonesia: Waiting on fuel hikes
The economy seems to be entering a slowdown phase. The first-quarter growth figure attested to this with headline real GDP slowing further to 6%, the lowest rate since recovery from the global credit crisis of late 2010, when growth was close to 7%.
In particular, private consumption slowed to 5.2% year-on-year in Q1 2013 from 5.4% in Q4 2012 (55% of GDP is driven by domestic private consumption alone). What is more worrying for us is that the investment growth momentum is tapering off from 12.5% year-on-year growth in Q2 2012 to just below 6% in Q1 2013.
This is happening at a time when the current-account deficit has started to widen once again, raising further concerns that most imports are not investment-related. A tepid recovery in the exports market from a contraction of 1% year-on-year in H2 2012 to muted growth of 0.3% year-on-year in Q1 2013 has not been able to cushion the growth slowdown, let alone help to reduce the current account deficit.
As a result, we believe that without a significant improvement in the country’s terms of trade or bigger government spending, the economy is bound to slow down from here.
We acknowledge that pre-election spending may add to the consumption momentum and lend some support to the overall growth. However, the impact of this, which we had estimated at around 0.3 of a percentage point in overall growth, could easily be countered by monetary tightening arising from a possible fuel price hike.
Although raising the price of fuel would be a politically risky and unpopular move, we have argued earlier that the increasing subsidy bill, owing to rising consumption, and higher interest burden due to a weakening rupiah, necessitate a fuel price hike.
Inflation has averaged 5.3% year-on-year year-to-date with the April figure easing slightly amidst the lifting of the import ban imposed in February. Inflation may average as high as 8-8.5% year-on-year in the latter half of 2013, depending on the extent of the hike and our estimated second-round effect.
We think that a precondition to a fuel price hike (a single price hike with withdrawal of the dual pricing scheme) would be approval of direct cash transfer for the needy by the Indonesian parliament. We think this may happen by the end of this month, thus paving the way for a fuel price hike.
This time round, the hike could be somewhere between 30% and 40% of the current heavily subsidized price of 4,500 rupiah per litre. Based on the growth-inflation outlook, it seems stagflation risks have started to build up.
Policy outlook. As the risk of stagflation becomes more imminent, monetary policy becomes more relevant to ensure macroeconomic stability of Indonesia. Given that interest rates were hiked around the time of fuel price adjustments in 2005 and 2008, Bank Indonesia (BI) may hike its policy rate by 50 basis points in July-August.
This is based on our expectation of a fuel price hike as early as next month. The repercussion of this could be a slowing of the economy, but it could also anchor inflation expectations.
However, we think that hikes in FASBI (the deposit rate the central bank pays on overnight deposits) should precede policy rate hikes in order to tighten domestic monetary conditions. This is especially so given that the slowdown in credit growth has not been enough to allay overheating concerns of investors.
Credit growth of 26% in Q2 2012 was close to its historical peak, but only marginally slowed to 23.3% in February this year. When fuel prices were increased in 2005, credit growth halved after a 425 basis-point hike in the policy rate. In 2008, it took a 125 basis-point policy rate hike to cut credit growth by around 6 percentage points.
FX outlook. Monetary tightening typically results in a stronger local currency. The cumulative hike of 50 basis points that we project in H2 2013 may render some appreciation bias for the rupiah.
Most importantly, as monetary tightening may also bring about slower import growth, the current-account deficit should diminish, even without a recovery in the exports market. This would further support the Indonesian currency.
Also, in the very short term, the capital equivalent maintained assets (CEMA) would ensure that interest in domestic bond buying remains, thus keeping the rupiah well supported. Foreign exchange reserves also improved to US$107.3 billion in April, from US$104.8 billion in March.
However, beyond June, we may see inflation risks rising, and this time round higher bond yields, due to a likely sell-off, may put the rupiah at risk of weakening again. We are keeping a relatively neutral view on the currency until there is more clarity on policies surrounding fuel price hikes and their ramifications.
Japan: Abenomics’ early fruits
Japan’s economic momentum continues to improve, in contrast to a broad downturn in overseas recovery trends. But while this trend in Japan goes beyond just growth momentum and is showing up in production, consumption, and other hard data, there could be downside risks to the sustainability of the outlook even with a structural decline in the country’s export presence.
In fact, industrial production index data released in the second week of May suggested lacklustre manufacturing recovery prospects, with corporate estimates at +0.8% month-on-month for April and -0.3% month-on-month for May.
However, the Japanese economy is now clearly more resilient to overseas economic slumps given healthier non-manufacturing conditions. We expect sustained stimulus for domestic final demand through a broad asset effect as long as the Abe administration and Kuroda-led Bank of Japan (BoJ) go ahead with efforts to eliminate asset deflation.
We anticipate positive market assessments of the efficacy of Abenomics and the BoJ’s new-dimension monetary easing to raise the growth rate, given that the Japanese economy delivered just over 3% annualized growth in Q1, led by stronger personal consumption.
Wages remain an issue. The market consensus appears to be that the 2% inflation target is not achievable without a reversal in the wage decline trend because of its central role in causing deflation.
The BoJ presented an outlook for a moderate upward trend in the hourly wage with tightening labour market conditions in the Outlook Report it released on 10 May. However, we do not expect tightening to automatically raise wages because of the large number of companies covering their labour requirements by recruiting non-regular employees at relatively low unit labour costs.
Additionally, the Abenomics policy of raising the participation rate of women in the labour force might curtail any wage upswing and thereby work against achievement of the inflation target.
A recent Nikkei Newspaper survey reviewing wage negotiations for 2013 found that a large majority of companies did not increase base wages and responded to the Abe administration’s request to raise wages by increasing one-time payments.
We do not expect a change in this corporate stance toward wage hikes without the Abe administration applying significant pressure, and thus anticipate a substantial time lag between the Japanese economy’s contrarian growth improvement and inflation rate advances driven by higher wages.
Policies. Given that BoJ Governor Haruhiko Kuroda said at the policy meeting on 4 April that the central bank has done whatever it could, we think the BoJ will maintain its stance of assessing the spill-over effects on the economy and the markets for the time being.
Improved economic conditions and a continuing rise in stock prices will support this wait-and-see stance. We think additional easing measures will be announced in October, when the BoJ releases its bi-annual Outlook report.
It is becoming clear that the BoJ’s bold actions have been considerably effective in raising asset prices, bringing about positive wealth effects in the economy. But we believe achievement of the 2% inflation target on a two-year horizon is another matter.
Compared to the BoJ’s economic forecast, the price forecast appears to be optimistic. Even if the business economy continues to expand in line with BoJ’s base-line scenario, we think the BoJ may have to lower its price forecast in the October Outlook report.
An additional tool available to the Bank is the purchase of risk assets such as ETFs and J-REITs. The BoJ’s intervention in the Japanese Government Bond (JGB) markets is already to the extent that it now dominates 70% of annual JGB issuance (deficit-financing JGBs). Coupled with the fact that the economy has experienced the positive wealth effect of stock price increases, we think the BoJ is likely to commit to stimulating riskier asset prices.
In fact, at the 4 April policy meeting, board members expressed the view that it was not necessary to take into account the constraint in terms of the market size of ETFs as new arrangements for these assets could be made.
On the fiscal policy front, the event worth noting for the time being would be the release of a growth strategy (the ‘third arrow’ of Abenomics). The revision of the fiscal reform policy is due in early June.
While the global trend of fiscal reconstruction has been recently receding, whether or not the Abe administration will be able to unveil a renewed fiscal reform strategy could serve as a test of sustainability of Japan’s sovereign conditions.
If the government panders to public opinion by scaling back its reform stance, particularly ahead of the Upper House elections scheduled for July this year, this could cool down the market’s positive expectations for Japan.
About the Author
This article is excerpted from “Asia Navigator,” a report by Royal Bank of Scotland and affiliated companies that was published in May 2013. It has been re-edited for conciseness and clarity.  
Photo credit: Manamana/



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