ASIAN INTELLIGENCE An Independent Fortnightly Report on Asian Business and Politics No. 818
Wednesday January 12, 2011
Prospects and Warnings for 2011
REGIONAL OVERVIEW .................... 2
PHILIPPINES ................................... 10
CHINA .................................................. 4
SINGAPORE ..................................... 11
HONG KONG ....................................... 4
SOUTH KOREA ............................... 12
INDIA ................................................... 7
TAIWAN ........................................... 13
INDONESIA ......................................... 7
THAILAND ....................................... 13
JAPAN .................................................. 8
VIETNAM ......................................... 15
MALAYSIA .......................................... 9
EXCHANGE RATE TABLE ............. 16
POLITICAL & ECONOMIC RISK CONSULTANCY LTD.
Political & Economic Risk Consultancy, Ltd.
Issue #818
REGIONAL OVERVIEW Economic prospects and warnings for 2011 Although individual Asian governments like to take credit for the success of their economies, the way most economies move in step on real economic growth, inflation, and export expansion rates indicates that the major forces at play are outside the scope of individual governments to influence greatly – at least on the upside. Clearly, government policies can be so bad that their economies grossly underperform their neighbors by almost all measures. Just look at Myanmar and North Korea. And governments can take steps that change the long-term rates of development in their own countries. China and Vietnam have both done so by switching from central command systems to more market-oriented systems of development. Similarly, over time the best managed economies experience a magnitude and quality of development that is noticeably superior to economies that were less well managed. Compare, for example, the development of Korea, Taiwan, Hong Kong and Singapore since the 1950s with that of the Philippines, Indonesia and Malaysia. All started out at roughly the same level of poverty, but one group today has reached developed status, the Philippines and Indonesia are still developing, and Malaysia is stuck somewhere in the middle. In most individual years, better managed economies outperform poorer managed ones by a small magnitude. Over time these incremental gains make a big difference and, in the case of Asia’s wealthiest economies, have enabled them to progress from developing to developed status. In the short term, however, the differences in the performances of individual economies are relatively small, giving the impression that Asian economies move largely in step with each other. Economic prospects for 2011 are relatively good. The consensus view, as represented by organizations like the World Bank and the Asian Development Bank and echoed by most bank economists, is that Asia, excluding Japan, will grow between 7% and 8% in real terms this year, once
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again outpacing the rest of the world. The growth rates of most individual Asian economies will be within one percentage point above or below this range. Japan will be out of step with the rest of Asia in that its economy is likely to grow by only about 1.5% in real terms. What Japan has in common with the rest of Asia is that the direction trend of its macro numbers will be moving the same way as in the rest of Asia. Inflation in Asia might average around 4%, with a range of two percentage points plus or minus depending on the country. The fiscal situations of most Asian governments are relatively strong, and non-performing loans are less of an issue in Asia than in Europe or the US. Export trends are broadly similar, with differences in growth rates accounted for more by whether the country in question relies on commodities or manufactured products for its exports. Moreover, turning points in trade trends also tend to be experienced simultaneously throughout the region, indicating how interconnected trade is becoming. Last year export growth rates were exceptionally high for almost every country since they were compared against the depressed conditions that prevailed in 2009. In most countries the trend in exports was decelerating as 2010 drew to a close, and prospects are for a much slower overall rate of export growth in 2011 than in 2010 – but there will still be growth (probably around 12% in real terms), and in many ways the rate will be closer to the region’s long-term average. Asia’s current account surplus as a proportion of the region’s GDP should continue to narrow in the near term. The surplus is expected to decline from about 3½% in 2010 to about 3% in 2011, reflecting contributions from most major economies in the region. Monetary policy has turned more cautious across the region. Because interest rates in Asia are expected to rise faster than interest rates in the US and Europe, there is likely to be more private capital attracted to Asia. This inflow, combined with the current account surpluses most Asian countries are likely to register, will cause most Asian currencies to stay under appreciation pressure, although central banks in the region will intervene to reduce exchange rate volatility and limit the appreciations of their currencies so Asian units move roughly in step with
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each other (the Hong Kong dollar and Vietnam dong are the two obvious exceptions, since the former will stay linked to the US dollar, while the dong will undergo a controlled devaluation). One of the main concerns of many governments will be to prevent bubbles from developing in their stock and property markets, as the capital inflow combined with domestic liquidity will inflate these kinds of assets. A number of governments are already adopting controls such as raising down-payment requirements on real estate purchases and imposing special taxes on property that is resold within a specified period. However, as in the case with exchange rate policies, the emphasis will be more to reduce volatility and capital flows that can reverse direction on very short order. Most countries still want to attract as much foreign direct investment as they can and also to get more foreign investment in their stock markets – but on a committed bases. The biggest risk that could upset this relatively sanguine forecast for 2011 is inflation. As 2010 drew to a close, consumer price inflation was already exceeding the upper limit of many Asian governments’ inflation target bands, including Indonesia and China. The main reason inflation could be much higher than most economists are currently forecasting is because of the risk that adverse weather conditions in Australia and the US could push up sharply food, coal and many other commodity prices. The Australian floods will clearly have a negative impact on coal, sugar and wheat output, while the harsh winter in the US Midwest could hurt wheat and corn output there. Higher commodity prices will feed into higher meat, steel and other prices. The biggest wild card is oil. The International Energy Agency recently revised its forecast and said that global oil demand will grow more this year than previously expected. Oil prices have already been moving slightly higher, having recently touched US$90 per barrel, a level that most economists were using as the basis of their macroeconomic forecasts for 2011. If they are wrong and oil prices climb to US$100 or more at a time when other commodity prices are also surging, cost pressures could be much higher around the world.
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Although governments of commodity consuming economies would not have many options to deal with this situation, China would be in a better position than the US. Oil, coal, wheat and other commodity prices are priced in terms of US dollars on the world market. Therefore, China has the option of allowing its exchange rate to appreciate in order to hold down the renminbi cost of commodities that it imports. Beijing’s top priority in 2011 – a year leading up to the next generational change in leadership – will be to maintain social stability. This will mean keeping economic growth in the high single digits and limiting consumer price inflation – especially food, housing and other products that average households are extremely sensitive to – to the low single digits. One policy that would be consistent with both goals would be to allow the renminbi to appreciate against the US dollar. Recent forecasts have spoken of a 5% rate of appreciation being likely in 2011, but it could be larger if oil and other commodity prices increase sharply. There are more negative implications in this scenario. Because China is holding down the local currency cost of imported commodities and the import purchasing power of average Chinese would be augmented by the currency appreciation, demand in China would remain strong – further feeding the upward pressure on oil, coal and other commodity prices. The US is stuck with a low-interest rate policy and would have little room in which to maneuver. It would not only have to bear the full burden of the increased oil and other commodity prices but also would have to pay higher prices for imports of manufactured products from China. Of course US importers could switch to other supply sources. But as we saw last year, when the Chinese authorities allowed the yuan to appreciate more against the US dollar, most other Asian currencies also followed the yuan. Either way, therefore, the dollar prices of imports to the US would rise, aggravating inflation there. Capital flows are another wild card – not just the direction of flows but the entire system in which the flows are taking place. The current pattern is not really ideal or sustainable in the long term. Asian savings are high and governments like those of China, Japan, Taiwan, Korea, Hong Kong and Singapore have been investing their reserves mainly in US Treasury
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bills and similar US dollar assets despite the low level of US interest rates and the falling value of the US dollar. Presumably the Asian governments do not have the capacity to invest these surplus funds at home and do not feel their indigenous institutions are capable do doing so either. Private US and European financial institutions have been able to raise funds in the West in the low-interest rate environment (sustained by capital inflows from Asia) and have been seeking out higher returns – focusing in many cases on some Asian currencies and stock markets. Something is clearly amiss with a system in which Asia is the source of the capital surplus and also where much of the capital is ultimately invested but only after going through channels that distort interest rates, divert the flow of funds through the US, and, in the process, diminish asset values. There have to be more efficient ways of putting Asia’s savings to productive use. Similarly, while one could argue that China’s huge investments in US Treasuries make the two economies so dependent on each other that it promotes cooperation and coordination rather than confrontation, the downside risks are also huge. There are bound to be differences between the world’s two largest economic and political powers –
and if those in charge of either country ever become so focused on political and national security that they are able to justify accepting the high economic costs – they could turn the capital flows into a weapon every bit as powerful as a nuclear bomb. Meanwhile, Europe is already getting chewed up by the global bond market, as stronger countries wrestle with how to bail out weaker ones in a system where countries might share the same currency but are perceived by the private capital market to have different sovereign risks. It remains to be seen if the euro zone will survive as we now know it. Asia’s economic performance in 2011 is unlikely to be affected directly since its exposure to the worst affected European countries is limited. However, to the extent that what is happening in Europe causes governments everywhere to review how global capital markets work (and how risks are shared by the public and private sectors), it is possible that current developments in Europe could be a catalyst resulting in reforms that have important global implications that influence how Asian governments use their reserves and how private financial institutions are able to capitalize on systemic differences to their profit while passing on downside risks to others.
CHINA Comments One of the peculiarities of China’s system is that the country’s leaders expect that their saying something is true should be taken as gospel by the public. Unfortunately, their credibility even with the Chinese public is not this good. Premier Wen Jiabao might have tried to sooth concerns about the accelerating rate of inflation when he said “…we are completely able to control the overall level of prices,” but the facts do not support this expression of confidence. When monthly income levels are increasingly squeezed by cost increases of basic necessities, people notice and tempers flare. Consumer price inflation hit a 28-month high of 5.1% in November-over-November, and the system has yet to absorb a 4% hike in state-controlled petrol and diesel prices announced in December. The inflation problem for China is all the worse since it is being driven by an 11.7% increase in food prices in November-overNovember, which affects poorer households most directly and is an especially sensitive political issue in a year when the government is getting ready to transfer power to the next generation of leadership. Although food represents only about one-third of the CPI it accounts for about 75% of the index’s recent rise. The government has directly stepped in to cool rising food prices by both increasing the supply of food staples and cracking down on people believed to be manipulating prices. In November, the government ordered the largest producers of edible oils to cap their retail prices through March, and it quintupled the fine for conspiring to raise prices to 5 million yuan.
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Officials might like to think that this will solve the problem, but their interference with market forces is more likely to change the nature of problems rather than solve them. The price caps will discourage production and cause producers to withhold product from the market. There will probably be a further up-spurt in prices in December and January as the system absorbs the fuel price hike and the Lunar New Year spike in consumer demand. This might be followed by a stabilization in prices or even a slight fallback toward the 4% p.a. level in following months. But then the risk is growing that global food prices might be moving higher as a result of recent disruptions to production in Australia and the US. The Chinese government does not seem to be factoring this risk into its calculations at all, which is why Mr. Wen’s confident prediction looks shaky and why the government might resort to increasingly drastic measures to control prices as 2011 progresses. The government is clearly worried about the disproportionate burden of rising food costs on lowincome households, which spend a larger share of their income on basic necessities. It also fears that persistent price rises could stoke social unrest. With this in mind, cities have been raising minimum wages. The increases in 2010 ranged from 12% to 41% (in Beijing). The State Council also ordered that pensions of retired employees be increased by 10% from this year and that state allowances for poor college students be raised to 3,000 yuan per student per year from 2,000 yuan in order to ease the impact of inflation on these categories of citizens. Even so, labor unrest intensified in many parts of the country, and in view of the continuing acceleration in prices, more unrest is likely in 2011. Property is another sore point. The government’s efforts to curb speculation in the real estate market so far have not worked very well. The latest measure to stabilize prices is to build 10 million more units of affordable housing next year, up from last year’s target of 5.8 million. China does not have inflation under nearly as much control as it would like the public to believe. There is a problem of coordination, and the more that inflation accelerates, the more the issue could turn into a political hot potato that pits different government departments against each other. Different government bodies have control over different aspects of the price equation. Moreover, the priorities of many local governments are not necessarily in line with the central government’s. Many local governments still place more priority on growth than controlling inflation. As for the selection of weapons used to fight inflation, the emphasis is more on such sector-specific administrative measures as price controls and raising bank reserve requirements rather than on broader tools like raising interest rates or allowing the exchange rate to appreciate. However, the more inflation accelerates, the more the authorities seem to be relying on these other weapons too. As we have already seen, on Christmas Day, the Central Bank announced its second interest rate increase in 10 weeks, while the past month has also seen an acceleration in the renminbi’s rate of appreciation. Still, the dominant voice in the fight against inflation is by those who favor more targeted approaches in order to avoid hurting exports and jeopardizing GDP growth, since that could be just as dangerous politically and socially as an acceleration in inflation.
HONG KONG Comments Hong Kong is in the midst of a structural change – its third since World War II. The first phase lasted through the 1970s, when growth was driven by export-oriented manufacturing. The second phase lasted through the 1990s, when the economy was driven mainly by local real estate. The third phase is seeing the economy driven by the financial sector, particularly China-related business built upon helping Chinese companies arrange IPOs and spearheading the development of the Asian yuan market. To be sure, the financial sector has long been important for Hong Kong, and Hong Kong has benefited a lot more from China than just as a sophisticated service support base. It has been an entrepot for imports to
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China and exports from there; it has drawn increasing numbers of Chinese tourists; and the Hong Kong property sector is a magnate for new wealthy investors from China. But the financial and service support Hong Kong is giving to China is driving the growth of high value-added jobs that are defining Hong Kong’s global competitive position. The significant phrase here is “high value-added”. By this we mean not just lawyers, accountants, bankers and consultants but the upper-end of these professions who previously congregated in New York and London. The markets are not moving to these people; they – or rather the companies they represent – are having to move to the places where the most dynamic market in the world, China, is favoring for certain types of business. That place happens to be Hong Kong when it comes to such business as offshore IPOs and experimentation with the internationalization of the yuan. This new engine for Hong Kong’s economy is enough to keep driving real growth by more than 5% a year – possibly several percentage points more during good years, which is why we think the consensus view of economists that Hong Kong’s real GDP will expand by 5% in 2011 after having expanded an estimated 6.4% last year is conservative. Indeed, even the 6.4% estimate for last year might be revised upwards once the final figures are in. One of two things would have to happen to spoil the optimistic picture we have painted. One would be if China’s economy were to stumble badly and its potential to keep growing as the world’s most dynamic market stops. We are willing to give strong odds against that happening in the next couple years. China’s leaders have already shown that they can sustain the economy’s strong forward momentum through one of the most difficult global environments since the Great Depression. They should be able to keep doing so now that the global economy is recovering, however tentative that recovery might be. The other spoiler for Hong Kong would be if it were to lose favor with Beijing and China’s leaders decided it is in China’s best interests not to favor Hong Kong but to choose another location. This scenario warrants more discussion than we are giving it here. It is unlikely to happen but the different possibilities of why it could are interesting and worthy of analysis. However, China’s leadership is, if anything, extremely cautious and makes radical changes only after a great deal of deliberation. Hong Kong seems to be working very well from China’s perspective, and if something isn’t broken, why try to fix it? This is why we would rate very high the chances of Hong Kong continuing to get China’s full backing for the next five years as the main site for listing its international IPOs and developing the offshore yuan market. So what is the biggest risk or problem going forward that is not simply possible but highly likely? In many ways it is the same shortcoming that has dogged Hong Kong for years, namely, the parasitic approach to profits by rent-seekers. In particular, local property developers are so powerful that they can not only influence government policy but also can pursue policies of their own – through the cartels that they control – that create social problems and detract from Hong Kong’s attractions as China’s hand-picked international financial center of choice. The types of companies that will be driving Hong Kong’s economy in the foreseeable future will be much less labor intensive than were the companies that drove its development until the 1990s. There will be more highly-paid labor that can afford luxury housing, but the job opportunities outside these very specialized industries will not be able to pay these kind of wages. The unaffordability of housing for even middle-class residents is likely to become a much more contentious issue in the future if the prices and rents for real estate catering to this part of the market are dragged higher by the demands of the upper end of the market. Moreover, as unique as Hong Kong’s qualifications are to serve as a special services base for China, there could come a financial point where companies inside and outside of China decide that operating costs in Hong Kong are too high and that profits are not going to the professional firms and banks actually doing the work but to the landlords who own the office space and residential buildings. A key question for Hong Kong going forward, therefore, is how it can contain its rental costs so it does not price itself out of business niches that it
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otherwise could dominate. This issue of costs, especially relating to property rents and prices, is likely to turn increasingly contentious as 2011 progresses and has the potential to turn into a big political issue.
INDIA Comments When India entered 2010, the main pressure on the government was to do a better job of building the country’s infrastructure. Now that the country has entered 2011, it is still under pressure to invest more in infrastructure, which is a bottleneck that will prevent the country from keeping economic growth in the high single-digit range unless it is addressed, but it is also faced with a growing need to improve food security, which is driving inflation into the double-digit range and making life particularly difficult for poorer Indians. The yearon-year inflation rate for food is now running at a rate of 18.32% and accelerating. Food inflation will have much more immediate political repercussions than infrastructure bottlenecks, so it is the issue on which government leaders are likely to focus in the near term. Unfortunately, some of the measures being adopted – like increasing subsidies on vegetable oil -- will aggravate other problems, like adding to the budget deficit. The economy is likely to grow by 8%-9% in real terms this year. In the quarter ending September 2010 the annual expansion rate was 8.9%. The IMF predicts the GDP will grow 8.75% in the year ending March 31 and 8% in the following 12 months, driven by high consumer demand and strong industrial growth. But with ports, power supplies, road and rail systems far too inadequate to support the country’s current rate of industrial development, the resulting bottlenecks could be a bigger drag on growth than government forecasts are calculating and also could put local prices under more upward pressure. The infrastructure problems carry over into the agricultural sector as well. There is a dramatic need for better irrigation facilities, storage facilities, and logistical systems to transport the food to markets. Yet the Ministry of Agriculture’s total annual budget, including spending on the development of such infrastructure, stands at just US$4.6 billion, or 2% of India’s annual budget. In addition to infrastructure bottlenecks, economic growth in 2011 could also be adversely affected by the move toward higher interest rates and a shortage of liquidity in the banking system that could reduce lending and force companies to hold back on investments that they otherwise would like to make. Some economists are warning that these factors could limit growth to between 7% and 8% in the coming year. The big risk for 2011 has less to do directly with the economy than with the possibility that corruption scandals could derail the government’s agenda and cause the public to lose confidence, focusing more on the negatives than the positives and even forcing the government to call for new elections. If there are elections, the big issue will probably be the quality of growth rather than the rate of growth, and with inflation hurting poorer Indians hard, they will be looking for relief – and changes in political leadership. It is possible that corruption controversies could slow down rather than speed up implementation of infrastructure projects, first, by putting the spotlight more on bidding procedures and making compliance requirements so onerous that projects are stalled and, second, by making it increasingly difficult to acquire land for large projects because of opposition from local groups who are threatened with displacement.
INDONESIA Comments
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By and large, the Indonesian government has been playing its economic cards right and can look forward to GDP growth in 2011 at least as rapid as last year’s 6.2% estimated rate of real increase. Private consumption will again be the main driver of the economy, but private investment should also contribute, including foreign direct investment, which started to turn much stronger in 2010 after several weak years. Foreign portfolio investment will also increase into the country’s stock market and bonds. If the authorities have made any mistakes, it is in holding interest rates too low for too long – for 17 consecutive months through December. Inflation is still not a big problem, but it is accelerating and consumer prices are now running almost 7% higher than their level of a year ago. Real interest rates are negative, and liquidity is quite high. Certain sectors could overheat in the coming year and too much money might be channelled into relatively unproductive investments instead of into projects that the country really needs. The Central Bank says it would like to limit inflation to around 5%, but politicians are placing a higher priority on keeping GDP growth rapid, and as foreign companies join in the enthusiasm with local business people about Indonesia’s economic prospects as the third sprinting giant of Asia, along with China and India, it could be difficult controlling the money supply and the exchange rate in the face of heavy capital inflows. It is important not to get so caught up in the euphoria that one forgets Indonesia’s problems with corporate governance and corruption. Major enterprises like Pertamina and Garuda are trying to take advantage of the improved environment to raise funds through IPOs. Their stories are likely to make headlines in ways that are flattering for the companies and Indonesia, but raising funds and investing them prudently are two different matters. The big risk for Indonesia going into 2011 is that it will repeat its mistakes of the past and that abuses by a few well-placed individuals could spoil the party.
JAPAN Comments Japan’s export-led economy will continue to struggle in 2011. The coming year for Japan is likely to be very much like so many previous ones: low growth (1%-1.5%), low inflation (0%), low interest rates, an appreciating yen, decent but slowing export growth, and a push by companies to invest more in other Asian countries, including Indonesia, China and India, while turning more cautious about their investments in Japan. Consumer spending is expected to slow this year to 0.6% from 1.5% last year. Politics will be the same too in 2011. The ruling Democratic Party is increasingly unpopular and the opposition, sensing a chance to bring down the government, has grown increasingly uncooperative, especially as it faces regional elections in the Spring. It takes far too long to debate and pass key legislation like budgets, and the final product usually pleases no one since it tries to appease everyone. The policy paralysis is compounded by continuing arguments within the ruling party. Like global warming, the day of reckoning for the really big issues in Japan lies so far down the road that no one considers the need to address them as a matter of great urgency. Japan’s gross government debt will reach the equivalent of 204% of the GDP in 2011, up from 198% last year. This is by far the highest level of any major economy. Prime Minister Naoto Kan has said he wants to begin talks with the country’s opposition parties on raising the nation’s consumption tax as a first step in addressing the debt issue. Assuming Mr. Kan is able to stay in office throughout the year – which is a big assumption – this will dominate the debate in the government. If Mr. Kan has his way, he will get parliament to agree to a cut in the corporate tax rate in exchange for a hike in the consumption tax. Yet even if he fails, the government is unlikely to have any trouble funding its immediate deficit, with demand for government bonds remaining robust.
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Much of the dissatisfaction with the government centers on its handling of foreign-policy issues. The feeling is that it has been too soft in the face of aggressive action by China. The debate over weak leadership in Japan could therefore concentrate in 2011 more on foreign policy issues than on domestic economic policies. The government would probably prefer that this is the case since in many ways it should be easier to make headway on foreign policy changes than on economic ones, which are too complicated and involve too many painful choices to resolve when the political equation is as finely balanced as it is.
MALAYSIA Comments Malaysia is on a sustainable growth path of 5%-6% GDP growth per annum, but that is not what the government wants. It wants to push growth back up to 8%-9% and, more importantly, to push Malaysia over the hump from developing to developed status. However, the obstacles to this transformation are as formidable as ever. Malay groups do not want to give up their entitlements. Old guard elements in the government continue to defend strongly the concept of national champion companies even though some of those companies have never really made the competitive grade and have turned more into obstacles to development than catalysts for it (the national car company Proton is the best example). Foreign investors are proving difficult to woo back to the country when there are so many other opportunities elsewhere in the region. Most importantly, the government is finding it difficult to develop new engines for development to replace those like export-oriented laborintensive electronics manufacturing that served the country well in the 1980s and first part of the 1990s but have lost their competitive edge to lower cost countries like China, Thailand and Vietnam. The good news is that the government headed by Prime Minister Najib Razak has a good understanding of the problems. The bad news is that most of the steps he has so far taken to address them are inappropriate. For example, his stated policy is to transform Malaysia’s economy from one that is based on natural resources and labor-intensive exports to one that is based more on higher-skilled services. But his first showcase project to achieve this aim is to promote the construction of a new 100 story skyscraper. In the end, the capital might have a tall new building that it can boast about, but the country will not be any further down the road of transforming its economy away from exports to financial and other services. The main reason for building the new skyscraper at this time is to create a buzz ahead of elections that Mr. Najib can use to show he is doing something to promote growth at a time when exports and industrial production are starting to slow. However, the building project does not address any of the underlying issues that are holding the economy back. Another example of how what is actually taking place differs from what the government says it wants to do is Volkswagen’s announcement that it has signed a pact with DRB-Hicom Bhd. to assemble up to 50,000 vehicles a year in Malaysia. To be sure, the government can boast that this deal shows a major foreign company is making a major investment in Malaysia in an industry that the government considers to be a high priority. On the other hand, Volkswagen’s decision to team with DRB-Hicom Bhd. and not the government’s favorite child, Proton, is a reflection of the failure to undertake the reforms required to turn ailing enterprises like Proton into more competitive entities. In other words, this is an indication of the difficulties Prime Minister Najib is having in rectifying mistakes of the past that have hurt the evolution of the economy and its ability to develop new industries that can compete regionally and globally. Implementation of PM Najib’s Economic Transformation Program (ETP) will still be in the early stages by the time the next general elections are called. Therefore, from the government’s perspective, the real significance of the ETP in the near term has more to do with its political than its economic impact. Will the promise of economic reform be enough to win back support for the government, especially among ethnic Indians and Chinese? Momentum had been going the opposition’s way, but recent developments, including the PR
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impact of the ETP, could have worked in the government’s favor. The test will be not simply whether or not the coalition headed by UMNO can win the next elections but whether they can win back their two-thirds majority in parliament and reduce the number of states under the control of the opposition. If that happens, Mr. Najib will have the mandate he needs to push his own agenda over elements of his own party who are more averse to reform. On the other hand, if it doesn’t happen, the gap between the level of Malaysia’s economic development and Asia’s developed economies, especially Singapore, is likely to widen, while the gap between Malaysia and poorer developing economies like Thailand will narrow.
PHILIPPINES Comments As in the case of Indonesia, the Philippines is another Asian country where a sense of optimism seems to be increasing. It remains to be seen how much this improvement is due to substantive changes for the better and how much is really unjustified because of continuing systemic idiosyncracies like corruption. Real GDP growth is very much in line with what is taking place in Asia’s other developing economies, no better and no worse. Inflation is low, and the government is not having much difficulty borrowing the funds needed to finance the budget deficit. Its latest US$1.25-billion global peso bond was priced quite finely and found a healthy appetite among investors. International ratings agencies have raised their assessment of the country’s sovereign rating, which should make future borrowings even easier and less expensive, especially if remittances from foreign workers continue to hold up well, the government’s foreign exchange reserves keep rising, the government demonstrates a commitment to fiscal consolidation, and President Aquino is able to put into action his “publicprivate partnership program” for infrastructure development. There is a good chance that the government will find foreign investors for some of the big infrastructure projects it is expected to announce in the coming months. One reason for this interest is because the government has gone out of its way to court China, and it will want something in return for this “good neighborliness.” Unlike many governments, the Philippines did not send a representative to attend the Nobel Prize ceremony presenting the award for peace to a prominent Chinese dissident. Manila has also been quiet about China’s position regarding North Korea’s recent hostile actions, and it has also refrained from commenting on China’s sovereignty claims on islands in the South China Sea, even though some of these disputed islands are also claimed by the Philippines. In return for this friendly posturing toward China, Beijing has been extending more military support to the Philippine army. However, what the government could really use is a major Chinese commitment to support infrastructure projects in the Philippines, much as it is doing in Cambodia and several other Asian countries. It is still very doubtful that the Philippines will be able to move fast enough on infrastructure development to stop power shortages, public transport inadequacies, and waste and water deficiencies. The government also has been unable to reduce the level of violence in the south of the country, where troops have been clashing with armed militias and Islamic extremists. The country’s reputation for personal security risks is also keeping it out of step with other Asian countries in terms of attracting significant numbers of new foreign tourists. The main reason we have doubts about the extent that the Philippines is changing substantively for the better has to do with continuing problems in fighting corruption and with systemic shortcomings that are interfering with President Aquino’s ability to implement some of his key policies. His predecessor, Gloria Arroyo, succeeded in appointing people to so many key positions, particularly in the Supreme Court, that Mr. Aquino is having difficulty pushing any policies that threaten the position of Mrs. Arroyo, her friends and family. The Supreme Court froze Mr. Aquino’s executive order that removed many of the people Mrs. Arroyo appointed
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during her final days in office, and more recently it declared as unlawful Mr. Aquino’s “truth commission, ” which he set up to probe suspected cases of corruption and other abuses during Mrs. Arroyo’s term of office. Other important government bodies that were staffed by people appointed by Mrs. Arroyo are similarly protecting her position now that she is out of the presidency and in Congress. These problems of “loyalty” go deeper than just the way Mrs. Arroyo has buffered herself against attacks and, in the process, has interfered with Mr. Aquino’s ability to govern effectively and to follow through on major campaign promises – like fighting corruption. They describe a systemic feature of the Philippines that weakens key institutions and encourages abuses by limiting penalties. For example, one of the biggest corruption cases that emerged during Mrs. Arroyo’s term of office was the case against Major General Carlos Garcia, who amassed a personal fortune while he worked as armed forces comptroller. First of all, the case might never have surfaced had not the US forced the issue when in 2003 US Customs informed the Philippines that Gen. Garcia’s sons had been caught trying to enter the United States with US$100,000 in undeclared funds. Now, seven years later, the Philippine judicial system has still not worked its way through the case and the Office of the Ombudsman has approved a deal that would allow Gen. Garcia to post bail for a lesser offense than “plunder” and leave jail. The government’s chief lawyer has filed a motion asking the anti-graft court to reverse its approval, but the whole case is a reminder of just how deeply entrenched the problem of corruption is in the Philippines and how difficult it is to punish offenders in even obvious cases. If this is still the prevailing atmosphere, the growth of optimism might not only be misplaced but also, if it enables corrupt officials to obtain money more easily under the excuse of financing major infrastructure projects, ultimately be self-defeating.
SINGAPORE Comments Singapore’s real GDP grew 14.7% in 2010, the fastest rate of growth in the island’s 45-year history since independence. Last year’s expansion was exaggerated because it was compared against a particularly poor year in 2009, when the GDP contracted 1.3%, but it was still impressive by any measure. Growth is clearly going to slow in 2011, but a rate of expansion even half the 2010 rate would still be the envy of most economies in the world that have reached Singapore level of development. The government is forecasting a GDP growth rate of 4%-6% for this year, but it tends to be conservative in its predictions. As rapid as Singapore’s growth is, the Republic faces less of a risk than Hong Kong of bubbles developing, particularly in the property sector. The Singapore government is more proactive than the Hong Kong government when it comes to intervening in the property market to stabilize prices. Singapore does not have China on its doorstep and there is less hot money flowing into the island’s system from the Mainland than there is in Hong Kong. Still, inflation will be a challenge for Singapore’s economic authorities in 2011. Although consumer price inflation is currently running at a level of only 3.8% p.a., this is the fastest rate in two years and is still accelerating. The implication is that the Singapore dollar will appreciate more in 2011 after having risen 9.5% against the US dollar in 2010. The MAS said in October that it would steepen and widen the Singapore dollar’s trading band while continuing to seek a “modest and gradual appreciation.” With the economy growing as strongly as it is, the issue of imported labor could grow in significance, especially if the government decides to hold early elections. The government has tightened procedures for granting permanent residency and is taking a more cautious approach to importing labor, but this policy could have inflationary consequences as well and also ultimately affect Singapore’s competitiveness. Like Hong Kong,
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its economy is shifting to a new phase that will be much more dependent on new financial and other services. It will be very difficult moving fast into these new, profitable niches if Singapore avoids using imported talent.
SOUTH KOREA Comments Korea’s GDP last year expanded by at least 6% in real terms and prospects for 2011 are for only a slight slowdown. However, the domestic economy is much weaker than the external sector. Consumer demand weakened throughout 2010 and, unlike most other Asian countries, Korea is suffering from a depressed housing sector, which is having negative fallout on other sectors as well. Domestic construction contracted on an annual basis in both the second and third quarters of the year and probably in the fourth quarter as well (preliminary statistics for last year are not yet out). Non-performing property loans rose sharply, and the country’s financial sector is vulnerable because of this. One of the features of the system in 2011 will be major banks taking over debt-strapped savings banks as the government seeks to avert a shock to the broader financial system. Inflationary pressures are building. The official consumer price rose 3.5% in December-over-December, up from 3.3% in the year through November. However, the food and non-alcoholic beverage component of the index rose 10.6% in December-over-December, indicating that Korea is being hit by the same forces that are pushing up food prices in China and most other Asian countries. Part of the problem is seasonal, and it is probable that the increase in food prices will decelerate in the months ahead, but higher food prices could still cause the government some political headaches and is one of the big wild cards to watch for in the coming year. The biggest wild card, of course, is North Korea. However, we are not even going into those risks here. All our predictions for 2011 assume that North Korea does not do anything that so shocks South Korea that its economy is seriously disrupted. This assumption could be wrong. In fact, the odds of its being so are higher than in most previous years given the recent mercurial behavior by the regime in the North (see Asian Intelligence Issue No. 817). On the other hand, the good news that could cause current favorable trends to turn even better would be if Seoul and Washington can finally conclude and implement their Free Trade Agreement. Korean exports were strong throughout 2010 and even finished the year on an uptick rather than decelerating like most other developed Asian economies. Moreover, although domestic consumer demand is too weak to get Korean companies to step up their investments, foreign demand is driving new investment in Korea and causing the total level of investment to grow strongly. Major Korean companies also stand to be big beneficiaries from the upturn in big-ticket infrastructure investments in Asia, North Africa and the Middle East. In view of the lack of business at home, they have the capacity and motivation to be especially aggressive bidders not only against US and European firms but also against Mainland Chinese companies. Korea’s economic managers are feeling vulnerable to global exchange rate developments and the fickleness of short-term capital flows. The government has reimposed a 14% withholding tax on interest income on bonds that foreigners buy, as well as a 20% capital-gains tax. It also plans to lower the ceiling on banks’ foreign exchange forward positions. The authorities have indicated that the ceiling for domestic banks will be cut to 40% of their capital from 50% currently and the limit for local branches of foreign banks in Korea will be lowered to 200% of their capital from 250% currently. The intention of the controls is to cool surging capital flows and reduce the risk that the current heavy inflows could be followed by equally disruptive sudden outflows. The authorities also want to correct a possible a mismatch between banks’ assets and liabilities that might exist at present.
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TAIWAN Comments Taiwan’s economy did not do as well as Singapore’s in 2010, but it outperformed both Korea and Hong Kong. It will again be in the hunt for the best performing industrialized economy of Asia in 2011, since most of the factors that contributed to last year’s good performance are still in play. The ROC’s export-driven economy grew almost 10% in real terms in 2010. Growth was propelled by exports, which in turn stimulated private investment. Preliminary estimates are that exports of goods and services increased by 24% in real terms and that gross-fixed capital formation by private enterprises surged some 32%. In contrast, government consumption rose by less than 1% and government investment rose only 9%. Private consumption is not as weak as in Korea, but its growth of between 3% and 4% in real terms reflects a degree of caution by local consumers. The Taiwan authorities are even more conservative than the Korean authorities when it comes to their fear of short-term capital flows upsetting the exchange rate and destabilizing the economy. They do not shy away from capital controls, and their latest protective measure is to subject new currency deposits from foreign investors to a reserve requirement ratio of 90%. The Central Bank has also stopped paying lenders interest on reserves held for deposits from foreigners. Taiwan’s real estate market is not booming as much as Hong Kong’s or Singapore’s, but it is in much better shape than Korea’s. Speculators are betting that better relations with China will attract a lot more Mainland investors into Taiwan real estate. This is not something the government is sure it wants to see happen on a large scale – at least not now – and has tightened mortgage lending requirements on second homes. The appreciation of the New Taiwan dollar might be causing some concern for exporters, but the magnitude of the rise has not been as steep as in Korea or Japan. So far there is no indication that Taiwan’s exports have lost their competitiveness. The appreciation is also helping to hold down the rate of inflation. The official CPI fell 0.74% in December from the previous month to where it was only 1.25% higher than December 2009. On the other hand, just as in China, Korea and many other Asian countries, some critical food prices in Taiwan have been rising sharply, causing average households to feel like their costs are rising much more sharply than the overall official rate of consumer price inflation. The Taiwan government is likely to rely more on subsidies than the governments of the other industrialized economies of Asia to hold down food prices and keep the overall rate of inflation relatively low. This will come at a considerable financial cost to the government, but one thing the KMT does not want as Taiwan moves closer to elections is for average Taiwanese to turn against the government because of inflation.
THAILAND Comments Regardless of events on the political stage, Thailand is in for a harder year on the economics front. GDP growth is generally expected to slow to the 4%-5% range compared with about 7.5% last year. Of course a new eruption of political turmoil would make things worse. The main reason seen for the expected deceleration will be a significant slowdown in the growth of exports, which constitute more than 60% of GDP. However, the vital tourist industry, itself responsible for generating some 12% of GDP, is beginning to boom again. It has taken off rapidly since political calm was restored, the state of emergency terminated and the soldiers ordered off the streets. Final figures for 2010 are
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expected to show that tourist numbers in 2010 exceeded 15 million, more than 15% up on the previous year. The industry has forecast more than 17 million arrivals in 2011, up 8% on last year. Weaker demand for Thai products is predicted in the major markets: China, Japan, the US and Europe. However, these soothsayers may be underestimating the resilience of the export sector, which has often happened in the past. If exports do run into trouble, the government is relying on higher consumer and investment spending to provide some counter-balance. The Thais should have more money in their pockets as a result of increased salaries for civil servants and higher basic pay rates and easier credit. There will also be a range of government subsidies to lower the cost of essential items including auto fuel, domestic utilities, basic foods and public transport fares. Public spending on much needed transport and other infrastructure projects will depend on the government’s success in clearing away red tape and suspicions of corruption in tendering and other processes. Both those problems have been holding up projects for many years. The Central Bank will raise its benchmark interest rate during the year almost certainly more than once., There are conflicting indicators as to the timing. The CB appears to want an early rise but the government condemned the most recent lift to 2% in December and would prefer for the next one to be delayed until the second half of the year after the election, which is now expected sometime before mid-year. Further rate rises would also increase the high value of the baht against most other currencies. The CB has again been intervening in currency markets to moderate the appreciation of the currency as Malaysia, South Korea and others in the region have been doing with their currencies. At the same time, CB officials say that further printing of money by the US will now not have much impact on the baht. The CB’s growing anxiety about inflationary pressures may also hasten an earlier than expected lift in interest rates. Now running at an annual rate close to 3.5%, inflation will stay below 4% this year according to the CB, but higher prices, particularly for energy and food, and wage hikes may soon show that estimate to be altogether too sanguine. Food prices rose more than 5% in 2010. Labor shortages, which are a worsening problem for many businesses, will also add to inflationary pressures as companies struggle to find the workers they need and raise normal wages and salaries in order to obtain them. The scarcity is also causing some investors to think again about some of their planned projects, particularly in the petrochemical and steel industries. The Thai Board of Investment is expecting the amount of new investments in 2011 will be in the region of US$14 billion, about the same as last year. It will be vital in the year ahead for Thailand to stop delaying progress towards the formation of the ASEAN Economic Community scheduled to come into operation in 2015. Thailand is out of step with most of its ASEAN partners who have already ratified the agreements entered into for the creation of the new community that will be free of most traditional tariffs and other barriers to the flow of trade in goods and services and of investment and labor. Indonesia also has not yet ratified the agreements. Both countries are still considering which particular economic activities should be excluded from measures that are designed to enhance ASEAN as an investment destination. Pretty well everything is covered by the agreements -- manufacturing, agriculture, fishing, forestry, mining and services such as logistics, tourism, health care, information and communications technology. There are also measures to standardize customs procedures and transport systems.
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Thais appear most concerned about stopping foreigners from obtaining any control of agriculture and land usage. Foreign interests in several parts of the world including the Middle East and China have been trying for years to secure a foothold in Thailand that they believe would help to give them food security in the future. The Thai approach on this issue, however, is seen by some of its ASEAN partners as an example of the xenophobia which from time to time has caused dissension within the grouping. Another is the current stand-off with Cambodia over the long-running border dispute, a confrontation that has been provoked and exacerbated for political gain by right-wing extremists in Thailand.
VIETNAM Comments Vietnam is out of step with the rest of the region, and it is likely to remain so in 2011. The only thing it really has in common with other Asian countries is a rapidly growing GDP – 6.78% in real terms last year, according to latest estimates, up from 5.32% in 2009. Growth of fixed capital formation and private consumption continue to be the dominant sources of overall growth. But Vietnam has the biggest problem with inflation of any country in Asia, its currency is alone in depreciating against the US dollar, and confidence in the country’s immediate prospects is weakening. Consumer price inflation jumped 11.75% in December-over-December, the trade deficit for the year hit US$13.2 billion, up from US$12.2 billion in 2009, and both state-owned and private companies are desperately squeezed for funds. The situation is so bad that one of the largest state-owned conglomerates, shipbuilder Vinashin, defaulted on a major foreign loan in December. In 2005 this company was the sole recipient of the proceeds from Vietnam’s maiden US$750-million sovereign-bond issue, and its financial troubles mean international credit rating agencies are downgrading the country’s overall sovereign credit rating. The fallout from this downgrading will mean that Vietnamese companies will have to pay even more for funding – provided they can find willing lenders. There is a rush into US dollars, and although the government has been accelerating the rate of the dong’s depreciation against the dollar, the greenback still commands a premium of around 11% in gold shops in Ho Chi Minh City. Average Vietnamese are questioning whether or not their government can manage rising costs in the months ahead. As in the case of Vinashin, the government is already distancing itself from the debts of stateowned enterprises, and with a major political reshuffle forthcoming, the economic problems are likely to influence who is and is not promoted, with the bias leaning toward hard-liners and more conservative elements in the Party, especially at a time when China is challenging Vietnam more openly for control over disputed islands in the South China Sea. Another problem with the government’s credibility is its lack of transparency. For example, of all the country’s covered by this report, it is the only one that keeps the precise level of its foreign exchange reserves secret. Largely for this reason and the problems of a strategic firm like Vinashin, there is speculation that the government has used up much of its reserves. The government increasingly is ignoring market forces and is resorting to price controls and other such interventionist measures that deal with problems cosmetically while creating other distortions in the process. For example, the authorities have ordered ministries to set prices on goods such as coal and petrol, and laws are in place so the government can impose price controls on goods and services produced by foreign and private companies in addition to those of SOEs. Economists are warning that Vietnam could face an even bigger crisis in 2011 if the government does not allow interest rates to rise further and fails to take strong measures to rein in SOE spending. The problem is
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that there are political threats no matter what the government does. Opponents of Prime Minister Nguyen Tan Dung might well find that his opponents take advantage of this month’s Party Congress to curb is power or even remove him from office.
EXCHANGE RATES Currency
12/31/09
12/31/10
1/07/11
Chinese renminbi
6.8270
6.5906
6.6282
Hong Kong dollar
7.7545
7.7725
7.7724
Indian rupee
46.620
44.703
45.352
9,425
9,009
9,025
Japanese yen
93.023
81.215
83.043
Malaysian ringgit
3.4235
3.0836
3.0694
Philippine peso
46.254
43.649
44.209
Singapore dollar
1.405
1.283
1.295
South Korean won
1,166
1,121
1,122
31.9898
29.1715
29.3600
Thai baht
33.356
30.066
30.349
Vietnamese dong
18,474
19,498
19,499
Indonesia rupiah
Taiwan dollar
Commercial middle rate expressed in terms of US$1.
Published by: Political & Economic Risk Consultancy, Ltd. 20th Floor, Central Tower 28 Queen’s Road, Central, Hong Kong Mailing address: G.P.O. Box 1342, Hong Kong
Tel: (852) 2541 4088 Fax: (852) 2815-5032 E-Mail:
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The material in this report may not be reproduced in whole or in part without permission in writing from the publisher. While every effort has been made to collate, check and present without ambiguity all data contained herein, the variety of sources from which they have been assembled and differing methods of reporting render verification oftentimes impossible. Thus, they are published without warranty.
