Efforts by the Aquino government in the Philippines, together with improving economic indicators in Indonesia, have made the two countries prime hunting grounds for foreign direct investment (FDI) recently in Southeast Asia.
However, capital inflows, particularly to the more leveraged economies such as Malaysia and Thailand, may ease, leaving the region’s major economies more exposed to reversals, warns HSBC.
“We expect that capital inflow coming into the region to be more selective, favouring countries with stronger fundamentals and stable political conditions, leaving the Philippines least vulnerable and Thailand most vulnerable. This is likely to pose headwinds for credit growth in coming years,”
wrote Leif Eskesen, chief economist for India and Asean with HSBC, in a recent report.
However, Mr Eskesen does not expect capital reversals for sustained periods given that the Asean-5 economies (Singapore, Malaysia, Indonesia, the Philippines and Thailand) still have favourable growth and interest rate differentials. Even so, inflows are likely to be smaller than in recent years and more volatile.
He said policymakers in the five countries would have to walk the straight and narrow on monetary and fiscal policies to keep inflation, leverage and external imbalances in check. They should not just focus on policies that fuel growth in the short term, but on structural reforms that can help raise productivity growth.
Recent figures from Bank of America Merrill Lynch showed that FDI inflows to the Asean-5 economies in 2013 stood at US$128.4 billion, which was higher than the total to China of $128.4 billion. The figure represented a 7% year-on-year increase for the five Asean countries, while China faced a 3% drop.
Capital inflows are generally positive for an economy as they help support consumption and investment, and bring spillover benefits in terms of know-how and competition.
Among the big supporting drivers for the repositioning of FDI in Asia are regional demographic change and the China-Asean Free Trade Agreement (Cafta).
According to the Bank of America Merrill Lynch report, Cafta has reduced tariffs to practically zero on 90% of all goods traded between Asean member countries and China over the past five years or so.
These changes have significantly helped countries such as Indonesia, the Philippines, Malaysia and Thailand to become manufacturing destinations for the giant Chinese market.
Moreover, Vietnam recently stated that it would reduce corporate income tax to 20% by 2016, leading to a new expected boom in FDI into an economy that has been struggling, just as the Asean Economic Community (AEC) starts to become a reality.
On the demographic front, meanwhile, China is getting older; it has reached the stage of “age-dependency optimum” and has already started losing workers. Last year, 2.4 million workers retired from China’s labour force and were not replaced.
The number of elderly Chinese is expected to reach 30% of the population by 2030. However, the Philippines has a strong advantage in terms of a demographic dividend, with a median age at only 23 years in 2010.
On the other hand, with the US Federal Reserve scaling back its stimulus and emerging markets losing some of their shine as a result, if an extended period of capital inflows is followed by abrupt capital flow reversals, it could be a bumpy ride.
“If policymakers do not adequately disperse countermeasures by tightening domestic policies, FDI can also cause loose domestic financial conditions which can result in excessive credit expansion and asset price bubbles,”
said Mr Eskesen.
The HSBC report also indicated that after the global financial crisis of 2008, which followed a buoyant credit cycle, it is important to look at the extent to which capital flows helped drive credit growth. It is important to determine whether the credit cycle is vulnerable to capital outflows, or more likely to a decline in net inflows.
The report said monetary policy should focus on gradually moving from its current accommodative stance back to neutral to contain inflation and external imbalances, and ensure the credit cycle does not get over-extended.
“Among the five countries, the Philippines is in a relatively favourable situation, given the lower degree of leverage and its current account surplus which make its less vulnerable to a tightening in global financial conditions,” the report said.
“Whereas, Thailand’s case, much depends on how the political situation pans out. If a resolution is found in coming months and growth resumes in the second half, confidence can be restored.”
Malaysia and Vietnam, HSBC added, are better placed in terms of their external positions, but they have higher leverage ratios.
“If capital inflows, however, in a pessimistic scenario turn into significant outflows, there could potentially be a need to ease monetary policy, introduce emergency liquidity measures, and loosen the fiscal purse strings, if the knock-on effect on the economies is large enough. However, that is not the scenario that we see at this moment,” Mr Eskesen concluded.
Assessing the economic impacts of COVID-19 on ASEAN countries
All ASEAN countries are dependent on tourism flows but Thailand is probably the most dependent.
Author: Jayant Menon, ISEAS–Yusof Ishak Institute
The COVID-19 pandemic is first and foremost a human tragedy. Measures introduced to deal with the pandemic could save lives but are having wide-ranging economic effects and inducing economic contagion.
There are already studies estimating the economic impact of the virus. But greater focus is needed on the transmission mechanisms of the economic contagion and in critiquing how assessments of the economic impacts are made, concentrating on the ASEAN region.
The effects of COVID-19 are hitting ASEAN economies at a time when other risk factors, such as a global growth slowdown, were already rising.
COVID-19 is disrupting tourism and travel, supply chains and labour supply
Uncertainty is driving negative sentiment. This all affects trade, investment and output, which in turn affects growth. Tourism and business travel, as well as related industries, especially airlines and hotels, were the first to be affected. And the conditions are worsening as more countries go into shutdown.
The supply disruptions emanating mostly from China will reverberate throughout the value chain and disrupt production. Since China is the regional hub and accounts for 12 per cent of global trade in parts and components, the cost of the disruption in the short run will be high.
The negative effects of quarantine arrangements on labour supply could also be high depending on duration and sector. Manufacturing has been hit harder than service industries, where telecommuting and other technological aids limit the fall in productivity.
All these disruptions will lead to sharp declines in domestic demand. And their impact on economic growth will further propagate these disruptions. This compounding effect can magnify and extend short-run effects into the long run.
The highest economic cost could come from the intangibles
The effects of negative sentiment about growth and general uncertainty — which is already affecting financial markets — will feed into reduced investment, consumption and growth in the long run.
Rolling recessions around the world now appear inevitable, despite the stimulus measures being contemplated. If so, there will be sharp increases in unemployment and poverty. Some degree of decoupling from China, or de-globalisation in general, may also be a permanent reminder of this pandemic.
Among ASEAN countries, Singapore, Malaysia and Thailand are heavily integrated in regional supply chains and will be the most affected by a reduction in demand for the goods produced within them. Indonesia and the Philippines have been increasing supply chain engagement and will also not be immune.
Vietnam is the only new ASEAN member integrated into supply chains with China and is already suffering severe supply disruptions.
Given time, supply-side adjustments will alter trade and investment patterns. The main adjustment will involve relocating certain activities along the supply chain from China to ASEAN countries. Although the pandemic will disrupt the relocation phase, ASEAN countries can benefit from the new investments, mitigating overall negative impacts.
Thailand is probably the most tourism dependent Asean country
All ASEAN countries are dependent on tourism flows but Thailand is probably the most dependent. Cambodia and Laos receive most of their investment and aid from China, and a marked growth slowdown in China will affect them the most.
The Philippines and Mekong countries have large overseas foreign worker populations and restrictions on their movement or employment prospects as COVID-19 spreads will affect sending and receiving countries. Brunei and Malaysia are net oil exporters and the price war indirectly induced by the pandemic will hit them hard. Others will benefit from lower oil prices, as will the struggling transport sector.
In measuring the impacts of COVID-19, it is important to separate its marginal impact from observed outcomes. This is important because the remedy may vary depending on the cause of the disruption. This requires an analytical framework that can measure deviations from a baseline scenario that incorporates pre-existing trends. A model-based analysis, rather than casual empiricism, is required to reduce the problem.
Even before the outbreak, risks of a global growth slowdown were rising
The restructuring of regional supply chains had started, driven initially by rising wages in China and accelerated by the US–China trade war. While COVID-19 may further hasten the pace and extent of the restructuring, it is only partly responsible for what may happen. It would be misleading to attribute all of the current disruption to COVID-19. Had the trade war not preceded it, COVID-19 may have resulted in greater disruption to supply chains.
Any assessment of impacts must recognise that the spread of COVID-19 is unpredictable, and so too the response by governments. It is difficult to estimate the impacts of a shock that is uncertain in itself. This reiterates the need for rigorous modelling and scenario analyses. The current trend points to risks rising, often accelerating, as with previous epidemics. This uncertainty underscores the need for caution in assessing, and regular recalibration in producing assessments.
Jayant Menon is a Visiting Senior Fellow in the Regional Economic Studies Programme at the ISEAS–Yusof Ishak Institute, Singapore.
A version of this article first appeared in ISEAS Commentary.
This article is part of an EAF special feature series on the novel coronavirus crisis and its impact.
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