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 Korea, Malaysia and Philippines in this article. We will look at Singapore, Taiwan and Thailand in a subsequent article.
Korea: Mending slowly
The economy is slowly improving, even if the data is mixed and, at times, contradictory. For example, the reasonably strong export data in volume terms (up 7.7% year-on-year in Q1) is at odds with weak industrial production (down 1.6% year-on-year in Q1) and historically high inventories.
Based on monthly indicators most observers also expect a downward revision in Q1 GDP growth, from 0.9% quarter-on-quarter, seasonally adjusted, to 0.7%. But even after the revision, quarter-on-quarter growth would show an upward trend from 0% in Q3 2012 to 0.3% in Q4 2012 to 0.7% plus in Q1 2013.
Private consumption is weak, which can be blamed on household debt and the wealth effect of falling property prices – property constitutes three-quarters of Korean households’ wealth.
Investment rebounded on a quarter-on-quarter basis in Q1 2013, but is still down 4.5% year-on-year. However, we forecast domestic demand to strengthen. The housing market seems to have bottomed, aided by the housing measures announced in early April. And 20 chaebols, after consultations with the government, have promised 20 trillion won in new investment in 2013, equivalent to 10% of the 2012 level.
GDP 2013 forecast. We maintain our growth projection of 2.6% for 2013. In line with the negative output gap, we expect average inflation to remain well below 2% this year. The baby-care subsidies that reduced inflation by 0.5 of a percentage point expired in early 2013, but were replaced by similar subsidies that are scheduled to expire in February 2014.
Policy outlook. On 16 April, the government unveiled a supplemental budget of 17.3 trillion won, equivalent to 1.3% of GDP. As expected, the actual fiscal stimulus is much smaller, amounting to 5.3 trillion won, or 0.4% of GDP. The remainder was to cover revenue shortfalls in the face of slower-than-expected GDP growth.
Another 2 trillion won of spending is supposed to occur outside the budget, supposedly through funds that support exporters or SMEs, but this spending is usually conditional and cannot be taken for granted. The government reckons that the fiscal stimulus will add 0.3 of a percentage point to growth, implying a realistic fiscal multiplier of 0.6-0.8 (depending on whether you count the extra-budgetary outlays).
On 9 May, the Bank of Korea finally cut its policy rate by 25 basis points to 2.5%. Out of the four holdouts, three board members switched side and voted for a rate cut, including the governor himself. Most likely, Lim Seungtae was the one Monetary Policy Committee (MPC) member who voted against a cut – as he did on previous occasions – on concerns about high and rising household debt.
Why did it take the governor, deputy governor and central-bank-recommended MPC member Moon Woo Sik so long to make up their mind? High and rising household debt was one good reason. But other reasons given hold much less water, like a supposedly accommodative monetary policy stance and rising inflation pressures in H2 2013.
Therefore, to many in Korea, it seems the true reason for not cutting earlier was to reassert the central bank’s independence. The governor is seen as having more leeway under the new administration, since he was put into the job by the previous administration.
What do we expect going forward? Since this cut came with some delay and given that monetary policy operates with a lag of about six months, we believe it is too late for more rate cuts. Barring any deterioration in the global outlook, the Korean economy should be well on the way to recovery in H2 2013, weakening the case for another cut
FX outlook. We have said repeatedly that a yen around 100 is not a major challenge for Korean exports. This view was mirrored by our discussions with Korean officials in the second week of May.
According to one observer, the exchange rate has little impact on export performance (which is confirmed by the relatively firm performance of export volumes) and only a temporary impact on exporters’ profitability.
Profitability usually returns to normal once business processes are adjusted to the new exchange rate level. This explains why government officials are primarily concerned about the speed of exchange rate appreciation.
Malaysia: Fiscal tightening
First-quarter growth probably remained steady in the 5-6% range. (Ed. note: Malaysia announced GDP growth of 4.1% year-on-year on 16 May). Underlying this growth is a likely deterioration in its composition, i.e., the contribution of exports has started to decline again.
Exports fell 2.9% year-on-year in Q1 2013. The decline was even sharper in electronics exports, reflecting a product mix that does not cater to high-growth areas of end-user demand.
This weakness has also been reflected in manufacturing activity, which has now contracted for three consecutive months through February. The evolving trend of intermediate imports does not reflect an improvement anytime soon.
Countervailing this trend is robust domestic demand. Various consumption indicators, including consumer credit, auto sales and narrow money, are all suggesting that consumption is holding up well. It is also possible that the recent government decision to convert the one-off low income wage supplement into a permanent programme has helped.
Investment activity, as evident from capital goods imports, also appears to be holding up well. However, considering that business sentiment has been softening, it appears that fiscal pump priming ahead of the elections has been the main driver of investment. Spending increased by 9% in Q1 2013 – the official 2013 target is to reduce spending by around 0.5%.
Policy outlook. The main issue for growth in the remainder of the year is whether it can hold up in the face of fiscal tightening.
Fiscal tightening is becoming imperative. In Q1, owing to a combination of higher spending and weaker revenues, the deficit amounted to 37% of the full-year projection. A continuation of this trend could result in negative ratings action.
Monetary policy is also likely to remain neutral, even though inflation has been remarkably well behaved and the pre-election pressure on the ringgit has receded substantially. We believe that Bank Negara would like to create space for easing in the event of a severe external shock.
What is likely, however, is that in an environment of loose global liquidity conditions, the impact of policy recalibration on bond yields will be limited. This is already evident from the compression in 3-month/10-year yields.
FX outlook. In a post-election relief rally, the ringgit has strengthened sharply. However, we believe a correction is likely. The electoral outcome and the support of the ruling administration by lower-income groups suggest a continuation of the subsidy regime at a time when there has already been a significant deterioration in the fiscal accounts.
Any rise in the fiscal risk premium would be difficult to manage and more so because the foreign ownership of local fixed income assets is already high at around 40%. We also note that commodity prices, including those of crude and palm oil, have fallen sharply, implying worsened terms of trade.
Furthermore, the recent rally has left the local currency in overvalued territory, a problem that Malaysia can ill afford in a period of weak exports.
Finally, the hangover from the elections is important. Although the ruling administration was voted back to power on 5 May, a change in party leadership cannot be ruled out considering that the margin of victory has narrowed even further. Overall, we expect USD/MYR to rise back to above 3 over the next three months.
Philippines: Strong momentum
Strong momentum in domestic demand has sustained through 2013. Consumption indicators, including currency in circulation and auto sales, have been very strong, with the latter rising an impressive 30.9% year-on-year in the first quarter.
Consumption. Consumer confidence on a forward looking basis continues to strengthen. Credit growth has remained steady in the 13-16% year-on-year range. Remittances, the key driver of consumption, continue to grow at a strong pace, with first two months of the year reporting a strong 7% year-on-year average growth.
Further temporary support to consumption, especially for Q2, should come from election-related spending – Congressional and local government elections were held on 13 May.
Government spending. We expect an even bigger impetus to growth from increased government spending. Early approval of the 2013 budget has allowed the government to increase expenditure in Q1 by 9.1% year-on-year. Realised spending may turn out to be even higher due to large disbursements in Q4 2012 (a 30% quarter-on-quarter increase).
As these disbursements are recorded on an accrual instead of cash basis, the money is likely to be spent only starting this year, which should provide an added push to project implementation, particularly public investment.
Industrial growth. On the supply side, strong rice and corn production in Q1 should provide a boost to agriculture growth, while the growing BPO sector is likely to keep services growth stable. Construction activity indicators for Q1 have shown improvement.
However, poor exports performance – a 6.2% year-on-year drop in Q1 – is weighing on industrial growth. Industrial production grew just 2.2% year-on-year in the first two months.
Going forward, though, we expect industrial production to improve given the significantly better business outlook for Q2 and the continued record high levels for capacity utilization. The central bank’s leading indicator for Q2 predicts a significant improvement.
Inflation. Despite strong domestic demand, inflation has dipped below the central bank’s 3-5% band in April, primarily because of low commodity prices. Considering the strong agriculture production and continuing low energy prices, we expect inflation to continue to test the lower band over the next few months. In light of this, we have revised our inflation forecast for 2013 from 3.3% to 3%.
Policy outlook. The central bank at its meeting in April again cut the Special Deposit Account (SDA) rate by 50 basis points to 2%. The intended aim is to reduce sterilization costs and push more of the funds into productive sectors of the economy. We, however, continue to worry that the absorptive capacity of the economy is limited.
Certain sectors of the real estate and equity markets are getting bubbly. Real estate loans have grown 25% year-on-year on average over the past 24 months while the trading PE ratio for the Philippine Stock Exchange’s PSEi Index has risen to 22.9 from the 13.7 average for 2009-11.
As portfolio inflows resume, especially post the second investment-grade sovereign rating from S&P, valuations are likely to rise further. In light of this we expect no further cuts for the policy and the SDA rates until Q4 this year. We also expect additional macro-prudential measures for the real estate sector.
The government is likely to support the central bank’s efforts to control foreign currency inflows by issuing only domestic debt this year. Falling domestic yields and the high cover ratio for the last onshore USD debt auction in November 2012 indicate there is ample domestic demand for the government to accomplish this. Under such a scenario, foreign debt would drop to 19% of GDP from 31% of GDP in 2009.
FX outlook. The appreciating pressure on the peso has been structural – generated by the current account surplus. Even though strong domestic demand is likely to ameliorate some of this surplus going forward, the main drivers – namely strong remittances and BPO revenues – are likely to sustain for several more years.
The central bank will have to continue sterilising these flows considering the growth in monetary aggregates. However, fast appreciation will likely push the central bank to introduce capital control measures.
For now, though, depreciation over the past month has given the central bank some breathing room. On the whole we expect a smaller drop in USD/PHP this year compared to 2012.
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.
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