ASEAN
Preferring Domestic Demand Plays in a Slow and Steady World
September 14, 2009

By Deyi Tan, Chetan Ahya & Shweta Singh | Singapore

Setting the Global Context

‘Up' without ‘swing' typifies our global outlook for 2010 and 2011 (see Joachim Fels and the global economics team's "‘Up' Without ‘Swing'", Global Forecast Snapshots, September 10, 2009). Our global economists highlight that there has been more bang for the buck in the near term as super-easy policy finds more traction than expected and our full-year 2010 global GDP forecast has moved up by almost 1% to 3.7% from a quarter ago. However, most of this reflects stronger momentum in 2H09, and we believe that the recovery path in 2010 will still be bumpy, sustaining double-dip fears. Boomerang effects from this year's fiscal incentives, rising unemployment and capital-constrained lenders will be a drag, but accommodative policies will still prop up growth and likely remain in place for much of 2010. Our first cut at 2011 global GDP growth of 3.7% sounds like more of the same kind of dull expansion in terms of headline growth, but the story differs in terms of the details. Growth could be expected to become more self-sustained as consumers' angst about subsides and entrepreneurs' animal spirits revive. The global economy should also become more balanced as external imbalances shrink. Amid the recovery, we expect global inflation to edge up from 1.9%Y in 2009 but to still-benign levels of 2.9%Y and 3.3%Y in 2010 and 2011.

Highlighting ASEAN Macro Themes

For ASEAN, macro investment ideas are likely to center on three key issues: 1) the nature of the global recovery in 2010-11; 2) the tilt in price pressures; and 3) the potential phasing out of policy stimulus and what this would mean. Given the global context outlined above, we highlight the three macro themes that we see for the ASEAN economies: 

1) We Prefer Domestic Demand Secular Stories to External Demand Cyclical Stories

With global growth likely to stay modest as rebalancing adjustment gets underway, we would favor domestic demand secular stories over external demand cyclical stories. Within ASEAN, Indonesia is the least export-oriented economy, with export share standing at 27% of GDP, followed by Thailand (64%), Malaysia (90%) then Singapore (185%).

From this perspective, the low export share in Indonesia would serve as a buffer against lower global growth trends in 2010-11 compared to 2004-07. In addition, on the domestic front, a confluence of growth-conducive factors such as demographic dividend/natural resources, a structural decline in the cost of capital and strengthened political mandate should also help to push Indonesia towards its potential growth of 6-7% from 2011 onwards. At the other extreme, Singapore remains the most exposed to the global cycle with the high export-orientation.

This exposure is further aggravated by policy-makers seeming to have added more beta into the macro portfolio with the inclusion of highly cyclical industries such as financials and tourism. Moreover, the growth strategy of catering to global demand means that domestic demand has become less domestic in nature and is inevitably a function of the former. As a result, we have a conservative outlook on Singapore.

2) We Prefer Net Commodity Exporters to Net Commodity Importers

In our view, near-term inflation could remain subdued. However, unlike the last cycle, inflation pressures could come back sooner over the medium term as the one-off structural factors underpinning the goldilocks nature of 2004-07, such as the entrance of large excess capacity into the trading system (e.g., China), are no longer present. On near-term inflation, we would also draw the distinction between our views on core inflation versus headline inflation. Core inflation is a lagging indicator and is likely to remain relatively low, given the buffer from excess slack, which would limit pass-through. However, headline inflation could see a step-up from a reversal in base effects from commodity prices amid the tight supply-side dynamics. Based on oil futures, oil prices could be expected to average US$75/bbl in 2010 and US$79/bbl in 2011, up from US$60/bbl in 2009. In this regard, we would prefer net commodity exporters over net commodity importers as a ‘hedge'. Malaysia and Indonesia are the top two net commodity exporters within Asia. Singapore and, to a lesser extent, Thailand are net commodity importers. Coincidently, net commodity exporters in ASEAN also tend to have a retail fuel subsidy system. Putting aside the issue that price distortion could lead to inefficient resource allocation - potentially affecting growth prospects in the long run - in the short term not only will there be a net transfer of commodity dollars from elsewhere to these economies, but the internal transfer of income from consumers to producers is also mitigated, allowing the positive spillover from the commodity prices to be more widespread.

3) We Think That Economies Where Policy-Makers Operate Aggressive Policies Could Offer More Domestic Demand Alpha than Others

Markets have shifted their focus from the end of the easing to the beginning of policy normalization and tightening. As our global macro colleagues pointed out in their recent research (see The End of Easing: What to Expect as Policymakers Reverse, September 1, 2009), markets have hawkish expectations with regard to the pace of monetary tightening over the next two to three quarters. However, our macro team believes that a return to restrictive policy is still some time away. Similarly in ASEAN, we think that 2010-11 would entail a phasing out of policy stimulus at a gradual pace. However, in the case of Thailand, the flow of events and the implementation timing of the second stimulus package mean that fiscal policy (including extra budgetary spending) is likely to get more expansionary in 2010 (versus 2009) while others are winding down their fiscal policies. To be sure, the phasing out of policy stimulus is endogenous to the growth cycle. ASEAN economies that ran the risks of earlier tightening (such as Indonesia's monetary policy) are also the economies that have a better ability to withstand it, in our view. Similarly, Thailand is running an aggressive policy response because macro conditions were dampened by the political climate. Yet, we think that the size of the stimulus package, the improvement in government execution and the potential crowding-in from the private sector as improved execution is perceived as a pick-up in political conditions will mean that policy response could offer most alpha to domestic demand for Thailand. Separately, we would prefer Malaysia and Singapore over Indonesia in this aspect. The former is typically more fiscally accommodative while the latter has the strongest government balance sheet in ASEAN.

What's the Pecking Order?

Taking the above into consideration, we like Indonesia the most. Our rankings for Thailand, Malaysia and Singapore fall within a tight range. We see Thailand and Malaysia as offering similar growth prospects. However, we would rank Thailand ahead of Malaysia because of the positive expectation gap (relative to market's perception) that we expect on fiscal implementation. Last, we think that Singapore would find it hardest to extract growth in the global environment which we envisage.

What Are the Key Risks?

The risks around our global growth forecasts are evenly balanced. Similarly, risks are also somewhat evenly balanced around our base case of 0%Y for 2009, +4.8%Y for 2010 and +5.4%Y for 2011 for ASEAN4 GDP. We remain comfortable with Indonesia being our top preference in all scenarios. On the other hand, while we are comfortable with our baseline, Singapore is where we may run the highest possibility of being wrong, both in terms of the growth revisions and ranking preference, due to its high-beta nature.

As our global colleagues highlighted, upside risks to growth will stem from a blow-out scenario due to the combined impact of unprecedented stimulus and a sharp rally in risk assets. Indeed, a V-shaped rebound due to the inventory cycle and real estate transactions volume has prompted market watchers to extrapolate this as a sign of the strength of recovery to come. Yet, we still think that the global rebalancing process needs time to play out, which will have implications for the sustainability of a V-shaped trajectory beyond inventory adjustments. However, if we are wrong and upside risks do pan out, we expect Singapore to benefit most greatly, given its high-beta nature. Our preference rankings in this scenario are Indonesia, Singapore, Malaysia and then Thailand. Having said that, our global colleagues also note that even this blow-out scenario could be a short-lived growth spurt. Surging global growth could push up inflation and cause aggressive policy tightening in 2011. This could well push the global economy back into a more conventional, policy-induced recession in about two years' time. On the other hand, with the Great Recession having purged much of the imbalances, our global colleagues highlight that the main downside risk is now a premature policy reversal, with macro fundamentals failing to take over the growth baton when this happens. In this scenario, our preference rankings would stay the same as in our base case.

For further details, see the full report, ASEAN MacroScope: Preferring Domestic Demand Plays in a Slow & Steady World, September 11, 2009.

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Global
‘Up' Without ‘Swing'
September 14, 2009

By Joachim Fels | London

More bang for the buck, this year... In our previous Global Forecast Snapshots three months ago, we argued that the heavily stimulated global economy had returned to growth in 2Q09, led by a bounce in China and elsewhere in Asia, and that laggards such as the US and Europe would follow in the second half of this year.  Indeed, hard data received since then confirm that global growth resumed in 2Q09, with GDP surging by 4% annualised - twice the pace we estimated three months ago.  The bounce in Asia turned out to be even more pronounced than we thought (+19% saar in China!), and both US and euro area output contracted by less than expected, with Germany and France already clocking positive growth in 2Q. 

...so we lifted our 2H09 global GDP forecast to 4%+: Moreover, all available indicators at this stage suggest that both Europe and the US have emerged from the Great Recession in the current quarter, and thus even a tad earlier than previously expected. With super-easy monetary and fiscal policies finding even more traction than we thought, and with financial conditions easing further due to buoyant asset markets, we have boosted our 2H09 global GDP outlook from around 2.5% to a little more than 4% annualised over the last three months.  At this pace, global output would be back at its previous peak level reached in 2Q08 already in the final quarter of this year.  However, in the G10 advanced economies alone, which were hit harder by the crisis, the peak-to-trough output loss of 4.5% will only have been recouped by 2H11, on our current forecasts (see chart below)!

But 4%+ growth is unsustainable during 2010... However, we do not think that 4% global output growth is sustainable through 2010.  While our forecast for annual average 2010 GDP growth has moved up by almost a full percentage point to 3.7% compared to three months ago, most of this revision reflects the stronger assumed momentum in 2H09. During 2010, the path will still be bumpy and double-dip fears may well resurface. First, while the size will vary across countries, a boomerang effect for car sales and production is likely in the US and Europe already late this year and early next year now that the various car scrappage schemes have expired or are in the process of expiring.  Second, rising unemployment and a desire to lift saving will weigh down on consumer spending for some time to come.  Third, especially in Europe, we expect capital-constrained banks to restrict lending to consumers and companies. While this is not a binding constraint now while companies are cash-rich due to reduced inventories and capex, it could become a brake on growth as the recovery evolves.

... and expansionary policy will still be required to keep things going:  The main counterforce against these growth-retarding factors will be a continued expansionary stance of monetary and fiscal policies in most countries during 2010.  Policy-makers are likely to keep accommodation in place until they can be reasonably sure that the recovery can stand on its own feet.  We think that the latter will only become apparent from about the middle of next year, and in many cases only in 2011.  On balance, we think that 2010 will rather bring a slight deceleration than acceleration from the current 4%+ growth rate of global output, with growth not being self-sustained yet. Note that in Japan, where a major tightening is expected to kick in next fiscal year, we even forecast a renewed (technical) recession in the two middle quarters of next year.

More of the same in 2011? Not really: At first glance, our 2011 global outlook, which we roll out here today, may seem to suggest that the story continues as in 2010.  After all, our first cut at 2011 global GDP growth of 3.7% is smack in line with our 2010 forecast.  However, the details reveal a much more interesting story than meets the eye when looking at the global GDP aggregate only, in three respects.

Accelerators versus decelerators: In some countries - most notably the US, China, India and Korea - we expect the expansion to slow somewhat in 2011 on a 4Q/4Q basis compared to 2010.  This largely reflects a less stimulative monetary policy, higher rates along the curve, and the start of fiscal drag in the US with the sunset of the Bush tax cuts in 2011 (unless policy changes).  In other countries - most notably Japan, Australia, UK, Sweden, Russia and Brazil, our economists expect the expansion to gain some speed during 2011 from, in most cases, fairly subdued rates in 2010.

More self-sustained, more balanced: Importantly, we expect the expansion to become increasingly self-sustained in 2011, allowing policy-makers to gradually withdraw monetary and fiscal stimulus.  With unemployment peaking during 2010 in most countries and receding (though slowly), consumer spending in the Western countries will likely pick up somewhat.  Also, companies will likely lift capital spending, which has fallen precipitously during the Great Recession. Moreover, it should become more apparent over the next couple of years that the global economy achieves more balance. Most notably, our China team expects the current account surplus to halve from close to 10% of GDP last year to around 5% by 2011, and our US team expects the current account deficit (as percent of GDP) to stay below the heady pre-crisis levels. 

Inflation subdued, but upside risks in 2011: While global inflation is expected to remain well below the 5%+ peak of 2008 in the previous cycle in 2011 (3.3%), the upside risks are likely to rise during 2010/11 as economies continue to recover, unemployment peaks and monetary policy (despite some gradual tightening) will still be very expansionary.  On our forecasts, inflation will likely rise slightly above central banks' respective targets during 2011 in the US and euro area.  Still, official policy rates in the US and the euro area are expected to rise to only 2.75% by the end of 2011, which may not be enough to keep inflation pressures at bay in the following years.  

Main downside risks now emanate from premature tightening: As we see it, the main downside risk to our base scenario for global growth would now be major policy mistakes, such as a premature monetary or fiscal tightening.  This is because several imbalances that were previously the main sources of downside risks - excessive house prices, ultra-low household savings rates in the US, and an inventory overhang in the corporate sector - have been either corrected or become less severe.  However, policy-makers are very well aware of the risk of tightening prematurely and are thus more likely to keep accommodation in place for too long.  Other downside risks emanate from a (potential) surge in oil prices, which would hit consumer spending and could push up inflation expectations, and from a surge in bond yields if investors lose confidence in the ability of governments to rein in budget deficits and the ability of central banks to keep inflation under control.

A blow-out scenario? On the other side, an important risk to consider is that global growth keeps surprising on the upside as it has over the last several months, as we may well be underestimating the impact of the unique combination of massive monetary and fiscal stimulus, coupled with a sharp rally in risk markets.  Our bull case scenario envisages average GDP growth in 2010/11 in excess of 5% in the US, 11% in China, and more than 3% in the euro area, with global output growth averaging 5.7%. Inflation would move well above targets in most countries over 2010/11, sparking aggressive monetary tightening especially during 2011.  While we haven't spelled out scenarios beyond 2011 in detail, such a blow-out (again, not our base case) could push the global economy into another recession in about two years' time.   

Bottom line: Upside and downside risks to our base scenario still abound, mainly because of the uncertainty about the true impact of unprecedented policy stimulus and the uncertain timing and amount of the inevitable policy reversal.  Policy-makers thus face a complicated balancing act.  Yet, our base scenario is still a not-so-great recovery overall, but is somewhat brighter than it was three months ago: beyond a 4%+ spurt in global output in 2H09, we expect a fairly dull expansion over the next two years, which will only become more self-sustained as we move into 2011.  Policy accommodation is thus likely to remain in place well into 2010 and will likely be removed only gradually thereafter.  Note, however, that a dull expansion isn't necessarily bad, especially as we believe that the global economy will become more balanced over time.  Yes, global growth will be at least a percentage point lower in this expansion than in the previous one.  But this implies a better chance that it will not lead to another bust of historic proportions.  Fingers crossed...

For full details of our forecasts, please see Global Forecast Snapshots, September 10, 2009.

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