- We are moderately constructive on growth prospects for 2013. ASEAN economies will continue to outperform on the growth metric. The fiscal stance is likely to remain relatively more expansionary in this sub-region.
- The inflation picture is neutral, moderately rising or modestly declining in most countries. Only in India do we anticipate a markedly lower inflation trajectory.
- Accordingly, we are not anticipating any material change in the region’s fiscal or monetary policies. Apart from growth and inflation dynamics, we believe that surprisingly benign levels of unemployment have increased the propensity to maintain status quo on policy.
- Several rate curves, however, continue to price in rate cuts. We believe this anomaly will be corrected over the course of the year and curve steepening is likely in several countries. The correction process will, however, be slow, frustrated by foreign purchases of local bonds.
- The primary trend for most regional currencies is higher but country-specific developments will also be a key influence.
We believe that regional growth successfully transited from its point of maximum weakness in third quarter 2012. This was evident either in third-quarter GDP data or high-frequency indicators such as Purchasing Managers’ Index (PMI) reports and exports.
Of particular importance was that GDP growth in the third quarter declined sequentially only in Singapore and Thailand, and in the latter only because of a very high base. China saw a mild acceleration in activity with growth improving to 7.4% (seasonally adjusted annual rate) from 6.3% previously.
Both Hong Kong and Taiwan captured some tailwinds from China’s recovery, with growth similarly inflecting higher. Activity in Korea did not accelerate but exports have been expanding since September, a critically positive development considering that domestic demand has been constrained by a high level of consumer indebtedness.
At a broader regional level, leading indicators such as PMIs have shown a trend improvement even though absolute levels remain weak.
The outlook for 2013 is moderately more constructive. We forecast growth in non-Japan Asia (NJA) to accelerate from 5.9% in 2012 to 6.6%. Underlying this improvement is acceleration in China’s growth to 8% from 7.6% in 2012. A modest recovery in exports as well as the on-going improvement in infrastructure and property-related investment will likely provide the basis for this acceleration.
It is, however, important to bear in mind that infrastructure investment can neither be aggressive nor expand linearly. Financing constraints of local governments given caution in Beijing on lending to local governments imply a restrained increase in such spending. What we are saying is that the country’s cyclical deceleration has ended and a modest upturn is unfolding.
Other countries should see single-digit growth in exports; not outstanding but nonetheless an improvement from 2012. A modest improvement in China’s demand as well as a slowdown in the pace of deceleration in exports to Europe should help.
Furthermore, assuming that the full impact of the fiscal cliff is avoided, demand from the US should continue to improve. Recent data from the US have been encouraging on several fronts, including housing and employment. Typically, an improvement in these components is indicative of a durable recovery.
Southeast Asia is likely to continue deliver strong growth founded on relatively more expansionary fiscal and wage policies. In Indonesia, a 40% increase in the minimum wage is likely, with further support coming from potentially higher absorption of developmental spending ahead of the 2014 elections.
In Thailand also, minimum wage increases in some provinces this year are likely to be extended on a national basis in 2013. Furthermore, growth should benefit from the implementation of a seven-year infrastructure programme that has cumulatively been estimated at 20% of GDP.
In the Philippines, better compliance with budgeted spending is likely, considering that several of the technical constraints on spending have been resolved and the overall fiscal constraint is no longer as tight as in 2010 and 2011.
Public spending in Malaysia is a more contentious issue. With public debt now running close to the government’s self-imposed limit of 55% of GDP, fiscal flexibility is limited and it is possible that the authorities will be forced to scale back spending after the conclusion of parliamentary elections (due by April 2013). Still, wage increases are planned, which are estimated to impact almost a quarter of the country’s workforce.
We also expect India’s growth to accelerate to 6.7% from 5.4% next year supported by a slightly better investment climate and monetary easing.
Risks to this forecast are, however, firmly to the downside. The investment climate has improved only moderately, whereas the persistence of high twin deficits or a sovereign rating downgrade could easily delay rate cuts. The objective of the Reserve Bank of India (RBI) in such a situation would be to maintain macroeconomic stability as opposed to promoting growth. We have discussed this issue in detail in the relevant country section.
We expect inflation to remain in recent ranges, rising moderately in some countries and declining moderately in others. In general, inflation in Asia is predominantly influenced by commodity prices, which we expect to remain stable.
Furthermore, with output gaps unlikely to be significantly positive, the pass-through from any unforeseen increases in commodity prices should be contained. India is likely to be an outlier – persistently sub- potential growth (despite the modest improvement discussed above) should allow for a relatively larger correction in inflation. Core inflation is already starting to soften.
Another economy that deserves mention is Singapore. Though inflation is likely to subside from 4.7% in 2012 to slightly below 4% in 2013, it will remain high by historical standards owing to a tight labour market and elevated accommodation costs.
These growth-inflation dynamics do not call for any material changes in policy dynamics. We forecast rate cuts only in India and Korea over the next six months and that too by only 25 basis points in Korea.
The case for maintaining the status quo on policy is further strengthened by the on-going strength of regional labour markets. By and large, unemployment rates in the region have remained low relative to both history and the strength of the business cycle. This is likely to have raised policymakers’ tolerance for lower growth.
Add that real rates remain supportive to growth and further reductions are unlikely to have much impact on growth. India should be an exception, where we see potential for a 100-125 basis-point cut in the policy rate, subject to a moderation in the twin deficits.
Based against this macro and policy backdrop, the primary trend for regional risk assets appears positive, albeit volatile. Owing to the volatility element, we favour currencies/markets where country-specific overlays complement this primary trend.
Our top currency picks are the Philippine peso (PHP), Singapore dollar (SGD) and Korean won (KRW). The fundamental issue facing the Philippines is the inability of the economy to absorb the structurally high current-account surpluses amid rising sterilisation costs. Most of the policy options to slow down inflows have focussed on managing capital flows and have, therefore, proven inadequate.
In Singapore, inflation is likely to remain high in the transition to productivity-led growth – this will likely ensure the authorities persist with the policy of gradual appreciation of the SGD nominal effective exchange rate (NEER).
On the KRW, we believe the currency should benefit from renewed macro stability arising from lower external indebtedness, currency and maturity mismatches and declining loan-deposit ratios. In short, the KRW no longer qualifies as a high beta currency influenced primarily by global risk appetite.
The rates space is more complicated, rhough several curves continue to price in rate cuts and, therefore, should correct as the above-discussed economic scenario evolves.
The problem, however, lies with the likelihood of yield-seeking flows from both developed markets and regional central banks/sovereign wealth funds. Given that both considerations need to be balanced, our recommendations are of a shorter duration.
We like receiving Indian rates, considering that aggressive rate cuts are feasible should the current and fiscal accounts deficits materialise. Conversely, we believe that front-end rates in Indonesia will need to rise if the Indonesian rupiah (IDR) is to be stabilised – this is likely to be achieved via an increase in the deposit or the central bank rate.
We also recommend lightening up on Malaysia bonds – the fiscal deficit has deteriorated whereas the surplus on the current account has diminished in measurable manner. Excess liquidity in the banking system, though still adequate, has moderated. Finally, we believe that Thai rates also could head higher, reflecting a combination of a tighter labour market, minimum wage increases and a diminished current account surplus.
We like credit and equities. The marginal macro momentum and relatively undemanding earnings multiples provide a favourable backdrop for strong equity performance. Asian credit already had a very good run in 2012, but low global interest rates and improving growth should to provide a favourable backdrop, particularly for corporate credit. We do, however, recommend caution on sovereign credit given the tightness in spreads.
About the Author
This article is excerpted from “The Year Ahead Asia: A More Constructive 2013," a report by Royal Bank of Scotland and affiliated companies that was published on 18 December 2012. It has been re-edited for conciseness and clarity.