ASEAN: Building in Weaker External Demand in 2008

How Will ASEAN Be Affected by Slowdown in US and Europe?

Although ASEAN is not plagued by the same funding difficulties in the developed world, it will be impacted as trade growth slows amidst weaker external demand. Direct US and EU15 trade makes up about 24% of ASEAN exports. Though intra-Asia trade is holding up relatively well for now, there are likely to be some ripple effects from the West. From a trade perspective, export-oriented economies such as Singapore and Malaysia would be more impacted than other countries in the region.

In addition, one of the risks we have been highlighting is potential turbulence in financial markets if the growth deceleration in developed economies proves more severe than expected. With lower corporate earnings now forecast in the US and Europe, equity markets are likely to be affected, and with it the availability of risk capital to ASEAN through capital inflows. Previously, loose liquidity conditions coupled with risk appetite have led to a build-up of liquidity. This has reduced the cost of capital in Indonesia and Philippines, where credit growth have picked up. It has also led to strong related business activities for financial hubs such as Singapore. In the reversal, risk reduction would be most negative for these three economies.

Better Placed to Weather External Weakening
ASEAN growth will undoubtedly see a deceleration in 2008. To reflect the downward adjustments in US and Europe, we are cutting our ASEAN growth forecasts by 0.3 ppt to 5.3% for 2008 and by 0.1 ppt to 5.9% for 2009. For reasons discussed above, Indonesia and Singapore are likely to be most exposed, and we have cut 2008 growth there by 0.4 ppt and 0.3 ppt respectively. However, we still believe the negative impact from developed economies this time round will be less than proportional (i.e., soft decoupling) and prospects remain relatively reasonable for the following reasons.

First, ASEAN is heading into the slowdown from a position of relative strength. 3Q07 growth for ASEAN economies has mostly been stronger than expected based on domestic demand, and we have revised upwards our 2007 forecast from 6.1% to 6.2% as a result. Arguably, 3Q07 performance is a reflection of past strength and the brunt of Western slowdown would only be felt in 2008. Still, the starting point for growth matters, and ASEAN now has more room to cushion against the slowdown expected in US and Europe.

Second, macro fundamentals of the region are very different in the current cycle. Macro balance sheet is now healthy. Specifically, amid the foreign reserve build-up to about 40% of GDP, external debt has now declined to about 31% of GDP. Public debt in relatively higher-indebted countries such as Indonesia and Philippines (national government debt) has also declined to 33% and 68% of GDP in 2Q07 from previous highs of around 100%. In addition, the region has not had any excesses in terms of overall leveraging post the Asian crisis, and the credit-to-deposit ratio has declined to about 70%.

Improvement in the macro balance sheet matters in terms of the reduction in risk premium and vulnerability associated with external shocks. A structural improvement in the balance sheet gives policy makers more room to use monetary as well fiscal policy to support growth trend.

Third, ASEAN domestic demand has typically been correlated with foreign trade, as business investments are made with an eye on potential future global demand. But in the current cycle, both capex cycle and private consumption trends are already witnessing soft decoupling from the foreign trade cycle amid construction upswing, acceleration in wage growth, and higher commodity prices supporting rural incomes.

Some of the factors supporting domestic demand strength such as higher commodity prices could reverse as global slowdown proves disinflationary. However, the construction capex cycle currently underway, such as in Singapore, is a result of a decade-long construction recession where residential and commercial space excesses had been worked off. Current low vacancy rates amid a demand and supply mismatch should put a floor under construction activities and lend a degree of resilience. Lastly, with ASEAN 5 budget balances having improved from -3.2% in 2001 to -1.2% in 2006, governments have the fiscal wherewithal to lift expenditure, and election spending amid the election season in ASEAN should also help.

What’s The Pecking Order Within ASEAN?
Within our coverage, we are positive on Thailand and Malaysia in the short-term and positive on Indonesia and Singapore in the medium to long term. Philippines remains in the middle of the pack. Indonesia and Singapore are likely to be more affected by the global slowdown due to availability of risk capital and trade linkages respectively. However, over the medium term we are constructive on Indonesia due to its healthy demographic trends, relatively stable democratic politics, and ongoing reform efforts, which are slowly building towards a critical mass. Despite the high beta nature of the economy, we are also constructive on Singapore principally due to the government’s diversifying the economy and its immigration policy.

In the next 3-6 months, we are relatively more positive on Thailand and Malaysia. In Thailand, we expect the country to move forward with formation of a coalition government, albeit a weak one, in the December elections. This will support a continued soft recovery in domestic demand amid negative external conditions. For Malaysia, there could be short-term support from relatively strong domestic demand with increased government spending prior to early elections in 1H2008.

By Chetan Ahya Singapore
Morgan Stanley
December 17, 2007