Asia Pacific Economic Outlook May 2013 China India Malaysia Thailand The growth picture China’s government reported that, in the first quarter of 2013, real GDP was up 7.7 percent from a year earlier. This was slower than expected and slower than the 7.9 percent growth recorded in the fourth quarter of 2012. This is the first time in 20 years that growth has been less than 8.0 percent for four consecutive quarters. Growth of fixed- asset investment, while strong at 20.6 percent, was worse than the market expected. China is clearly becoming a more mature economy with growth that is more consistent with middle-income affluence. So while many people will long for the blistering 10–12 percent growth of the past, it is entirely normal that China would shift to a lower rate of growth, especially as labor force growth has basically ceased. Thus the rapid growth that was needed to absorb new entrants into the labor force is no longer an issue. The government is projecting growth of 7.5 percent going forward. The real question is whether even this level can be sustained given the severe imbalances in the Chinese economy. In addition, there is the question as to whether the growth will continue to come from govern- ment-financed investments in infrastructure, or from domestic demand—principally consumer demand—that is needed for a sustainable growth path. It is not clear at this point if China is going to make that transition anytime soon. In any event, financial markets were disappointed with the Chinese figures, especially as growth came in lower than the market had predicted. Indeed the market was hoping for acceleration in growth. Equity markets across Asia declined on this news. Going into the second quarter, there are signs of weakness: • In April, industrial production was up 9.3 per- cent from a year earlier, and retail sales were China By Dr. Ira Kalish Asia Pacific Economic Outlook—May 2013 1 up 12.8 percent over a year ago—both figures represent a slowdown in growth. • The government reported that its purchasing manager’s index (PMI) for services fell from 55.6 in March to 54.5 in April. This indicates continued moderate growth of services, but at a slower pace. • The government reported that the PMI for manufacturing dropped from 50.9 in March to 50.6 in April—just barely above the criti- cal 50.0 level, below which output declines. In addition, an index of new orders in China’s manufacturing sector fell from 52.3 in March to 51.7 in April. These reports mean that the manufacturing sector is barely growing. • The government reports that, in April, con- sumer prices were up 2.4 percent over a year ago. This is well below the government’s target of 3.5 percent inflation. In addition, wholesale prices fell 2.6 percent in April versus a year ago. This is likely due to declining commodity prices as well as excess capacity at factories. The divergence of wholesale and retail prices will boost the profit margins of retailers. Declining wholesale prices are likely to lead to lower consumer-price inflation in the coming months. Lower inflation will give the govern- ment leeway in deregulating the prices of resources and utilities. Such price controls lead to inefficient use of resources, which in turn restrain productivity growth and contribute to pollution. The slowdown in economic activity, of course, is partly due to policies implemented by the new regime. The effort to scale back borrowing by local governments is having a dampening impact on fixed-asset investment—much of which is financed by local governments. The anti-cor- ruption campaign, including discouraging the entertaining of government officials, appears to be suppressing retail sales. The question now is what the government does next. Although inflation is modest, the central bank may not want to ease policy further lest it encourage excessive borrowing or more property price increases. There is concern that, given the excessive growth of credit and a property price bubble, the government may not have the flexibil- ity necessary to stimulate the economy. An easing of monetary policy and the opening of new sources of credit would only exacerbate the credit market problems. More fiscal stimulus would boost the parts of the economy that are already growing rapidly, such as investment in infrastructure, but it would do little to assist the economy in shifting toward more sustainable forms of growth, such as consumer spending. Yet the government may decide to engage in more investment-driven stimulus. In other words, China appears constrained in its ability to under- take reforms that are necessary for long-term structural adjustments and sustainability. China is clearly becoming a more mature economy with growth that is more consistent with middle-income affluence. Asia Pacific Economic Outlook—May 2013 2 On the reform front China’s government announced that it will take action aimed at reducing capital controls. Specifically, it will allow freer movement of cur- rency in and out of the country. In addition, it will create a mechanism to allow the Chinese to invest money outside of China. These initial steps could later be followed by measures to remove obstacles to foreign portfolio investment in China’s equity and bond markets, as well as measures to allow the Chinese to borrow money overseas. The reduction in capital controls is ultimately aimed at allowing free movement of the exchange rate and making the renminbi a fully convertible currency. This would help to boost the use of the renminbi in trade and reserve accumulation. It is likely that if the renminbi were to become convertible, then more trade and investment would take place in renminbi, thus removing some of the currency risk that Chinese businesses face. In addition, allowing the Chinese to invest overseas could remove some of the upward pressure on the value of the currency. The deregulation of capital flows is highly relevant. It has been reported that capital flow into China accelerated sharply—likely due to two factors. First, quantitative easing in the United States, Japan, and United Kingdom has led to very low interest rates in those countries. This in turn has led investors to seek higher returns elsewhere, including in China. Moreover, Chinese enterprises are increasingly borrowing abroad and bringing hard currency back through vari- ous channels, including export invoicing. Second, some investors now expect an increase in the value of the renminbi. Consequently, they are putting money into China in anticipation of a currency appreciation. The irony is that the inflow of capital is putting upward pressure on the cur- rency. The government must decide to either allow the currency to rise or purchase foreign currency reserves in order to prevent appreciation. The latter would entail increasing the money supply when the leadership is concerned about inflation. It is reported that, in the first three months of the year, the government purchased $157 billion in foreign reserves, thereby preventing apprecia- tion. However, in April the government allowed some appreciation. Finally, the Chinese government announced that other reform efforts will be speeded up, including new controls over local government debt. The government said that the national government agency responsible for approval of local government debt issuance will more closely scrutinize debt issuance. Specifically, it is expected to pay more attention to debt issuance when the vehicles used by local governments have a low bond rating and when debt levels are already high. The government is keen to limit local government debt, which has already grown explosively and poses a risk to the financial system. Actually, local governments are forbidden by law from issuing debt or borrowing from banks; however, they have established an estimated 10,000 special-purpose vehicles to issue bonds to pay for infrastructure development. For projects that fail to generate a positive return, local governments service these debts through the sale of land use rights. Asia Pacific Economic Outlook—May 2013 3 India By Dr. Rumki Majumdar ThE Indian economy is caught between low growth and stubbornly high inflation. Last month, the International Monetary Fund (IMF) revised the year-over-year GDP growth forecast of India to 5.7 percent for 2013, down from its January estimate of 5.9 percent. The IMF attrib- uted structural factors as the primary reasons for the poor performance, rather than the cycli- cal factors cited by the government last month. Additionally, the IMF expects consumer-price inflation to remain at around 10 percent in 2013 due to a rise in food and fuel prices. Lately, there have been signs of easing inflationary pres- sures. The wholesale-price inflation has steadily decreased since late 2012, while consumer-price inflation went below 10 percent this May, as the economy operates below capacity. However, the government’s attempt to reduce the fuel subsidy bill by raising administered fuel prices will likely reverse the fall in inflation in the remaining part of the year. The policy dilemma The situation for India is unique because both fiscal and monetary policies have had limited flexibility to bail out the economy. High fiscal and current-account deficits restrict the government’s ability to undertake proactive stimulus programs to boost the economy. The level of domestic infla- tion remains higher than the Reserve Bank of India’s (RBI’s) comfort level, which limits the RBI’s ability to ease monetary policy further. Despite such pressures, the RBI is expected to reduce the policy rates, though marginally, in order to boost economic activity in the country. Asia Pacific Economic Outlook—May 2013 4 Last month, the International Monetary Fund revised the year-over-year GDP growth forecast of India to 5.7 percent for 2013, down from its January estimate of 5.9 percent. High twin deficits may limit government actions Fiscal deficit is expected to be 5.3 percent of GDP in 2012–2013, while the current account recorded the largest-ever deficit of 6.7 percent of GDP in the third quarter of 2012–2013. The government’s strategy of fiscal consolidation has repeatedly gone off course since 2008 due to a series of unfavorable developments. Since last September, the government has taken bold mea- sures to cut down fuel subsidies to prop up public finance, helping the government to restrict the fis- cal deficit within the revised target of 5.1 percent of GDP. However, with general elections being just a year away, progress in this direction will be limited and even likely reverse. On the other hand, the fall in external demand for exports and the rise in import bills due to an increase in fuel prices and gold resulted in a record-high current-account deficit. The March data shows some improvement in the current- account balance due to a rise in merchandise exports and recent moderation in commodity prices, especially in international oil and gold prices. However, it is the capital-account growth that can play an important role in swinging the balance of payments to a surplus. Recent govern- ment reforms in the retail and aviation sectors and the establishment of a ministerial panel to fast- track industrial projects may improve investment sentiments and capital inflows. However, more than 40 percent of the capital flow in 2012–2013 has been institutional in nature, and the risk of a reversal of capital flows is very high. Easy monetary policies may not help after all The combination of low growth, high inflation, and high current-account deficit has induced the RBI to manage liquidity through the calibrated use of various monetary policy instruments. The government’s recent fiscal consolidation has provided some space to the RBI to ease monetary policy in order to support growth. The RBI has cut interest rates thrice this calendar year and undertaken durable liquidity injections through outright purchases of government securities as a part of open-market operations. However, despite policy easing, interbank liquidity conditions tight- ened, especially since November 2012, mainly due to large and persistent buildups in govern- ment cash balances and strong currency demand. Credit demand has remained low due to sluggish domestic demand as well deterioration of bank- ing asset quality. In addition, poor investment growth and an expected low rate of returns from investment are likely to limit the impact of easing monetary policy. Asia Pacific Economic Outlook—May 2013 5 The problem lies elsewhere The issues in India are structural, with sup- ply factors (such as labor-market bottlenecks and poor infrastructure) and domestic policy fac- tors (such as policy uncertainty and regulatory obstacles) contributing to the fall in investments. The pace of reforms is slow as governance con- cerns and delay in approvals continue to weigh on business confidence. It will be difficult to sustain growth without a revival of investment growth in the economy. As long as inflation, especially consumer-price inflation, remains high, growth in consumption demand will be gradual, in turn keeping invest- ments low. On the brighter side, growth in the Indian economy is expected to bottom out as the IMF expects that the government’s recent reform measures, improving external demand, and a better monsoon season will likely boost economic activity. However, the pace will likely remain gradual until the next elections as uncertain poli- cies fail to address the core structural problems. Asia Pacific Economic Outlook—May 2013 6 Malaysia By Navya Kumar MAlAysiA maintained status quo in Q1 2013. Not only was the country’s 56-year- old government re-elected for another five-year term, signaling policy stability, the economy also expanded in the 5–6 percent range, as it has on an average since 2011. However, amid the several positives for Malaysia, there are a few pockets of concern. On the political front, the opposition is calling for nationwide protests against alleged election irregularities, even as the Malaysian economy faces struggling exports and a potential credit bubble. Real GDP grew 5.6 percent year over year in Q1 2013, boosted by higher domestic demand, even as real exports declined an estimated 1 percent. In fact, private consumption, which accounts for nearly 50 percent of the GDP, has been a major driver of the Malaysian economy for the past eight quarters, with growth signifi- cantly exceeding exports. Exports in Q1 2013 were limited by falling sales of vegetable oils and manufactured goods, which together constitute more than 60 percent of Malaysia’s total exports. Sales of electronics and electrical goods were par- ticularly hit. Geographically, while the country’s exports to the slowdown-affected markets of the European Union and United States suffered, sales to the ASEAN Free Trade Area (AFTA) increased in double digits. The AFTA now accounts for nearly 30 percent of Malaysia’s exports, up from 27 percent in 2012. For Q2 2013, GDP will likely continue expanding in the 5–6 percent range, sup- ported by robust domestic demand. The industrial production index for Malaysia registered a 0.2 percent year-over-year decline in Q1 2013, due to lackluster performance by the manufacturing and mining sectors. While business closure for the Lunar New Year celebra- tions suppresses output in the first quarter of each year, this year was particularly impacted by Asia Pacific Economic Outlook—May 2013 7 In fact, private consumption, which accounts for nearly 50 percent of the GDP, has been a major driver of the Malaysian economy for the past eight quarters, with growth significantly exceeding exports. export challenges. However, the outlook for the rest of 2013 appears encouraging, with positive consumer and business sentiment. Even as local consumption will likely remain upbeat, exports could demonstrate a slight uptick in the second half. In addition, the growing economy is forecast to attract higher foreign direct investment (FDI) this year in various sectors, including electri- cal and electronics, real estate, aerospace, solar energy, and medical services. Low rates of infla- tion (below 2 percent) also ensure lower risk to investment returns. The government expects FDI of $12 billion in 2013, compared to nearly $10 bil- lion in the last year. However, a lingering concern in the Malaysian economy is the level of debt fueling domestic demand. Household loans and liabilities rose 13 percent year over year in Q1 2013 and are estimated at more than 150 percent of the per- sonal disposable income. Loans and liabilities are expected to continue their double-digit rise in Q2 2013, with no increase likely in the benchmark interest rate, which has remained at 3 percent since Q3 2011. With nearly half the household debt incurred to buy houses, the economy is vulnerable to any sudden slump in home prices, which have risen an average 9.5 percent year over year for the past eight quarters. Government debt is also at the highest level in 19 years, at 54 percent of the GDP, with the increase likely to fund the government’s expen- diture on infrastructure projects and subsidies. Higher expenses resulted in a fiscal deficit of 3.9 percent in Q1 2013. In order to improve its budget balance, the government plans to introduce new goods and service tax this year, as well as rational- ize subsidies. In addition, the government plans to divest nearly 30 state-owned enterprises. Overall, the first quarter has been fairly posi- tive for the Malaysian economy, registering steady growth despite external headwinds. The com- ing quarter will likely be similar, with domestic demand driving the economy but exports remain- ing a challenge and high levels of household debt posing a persistent risk. Asia Pacific Economic Outlook—May 2013 8 Thailand By Dr. Rumki Majumdar RObust growth, low unemployment, stable inflation, strong currency, and a growing equity market—the year 2012 was marked by sig- nificant improvements in Thailand with respect to all economic parameters. The economy bounced back with a strong growth of 6.4 percent year over year after a dismal growth of 0.1 percent year over year in 2011 because of the devastating flood. Q4 2012 saw the biggest-ever jump (19 percent) in year-over-year performance of real GDP due to very strong growth in private investment, change in inventories, and services export. The growth in consumption demand was also robust during the quarter. The spending power of the grow- ing middle class, augmented by income tax cuts and rise in general wages in 2012, along with the government’s intense efforts to build infrastruc- ture, helped overall spending growth. Recently, the World Bank revised its forecast for Thailand’s GDP to 5.3 percent in 2013, up from its earlier prediction of 5 percent, citing the resilience of the economy. The factors that helped The consumer confidence index has been rising for six consecutive months and, this April, reached its highest level since 2006. It played an important role in boosting private consumption demand in 2012, which grew at 6.6 percent year over year, the highest rate since 2008. Accounting for more than half of the GDP, consumption demand is expected to remain strong this year and will be an important factor driving growth. The business confidence index too has been improving on the back of rising domestic demand, better export performance, and a stable political environment. Growth in industrial production Asia Pacific Economic Outlook—May 2013 9