Deloitte's Asia Pacific outlook august 2011

IN THIS ISSUE:

China JapanMalaysiaTaiwanVietnam

August 2011

Asia Pacific Economic Outlook

Asia Pacific Economic Outlook — August 2011 2

China

China’s role in the worldIn the United States and Europe, the sizable deficits of governments have been partly funded externally; to a large extent using funds provided by both the Chinese private sector and the Chinese central bank. The United States and Europe now plan to substantially de-leverage. That is, they intend to reduce their deficits. For this to take place smoothly, reductions would be needed to China’s surplus. That, in turn, would need to be driven by China’s private sector saving less and spending more – especially its consumer sector. To create an conducive environment for this happen China’s central bank would need to reconsider its practice of accumulating foreign assets and allow the Chinese currency to rise in value. If China fails to do this, then the de-leveraging undertaken by U.S. and European governments could lead to financial market volatility.

Chinese growth continuesWhile future challenges will likely arise, the economy continues to hum. Growth in the second quarter was a pleasant 9.5 percent. Inflation, while now above 6percent, is believed to be at a peak and many analysts expect that the rate of inflation will soon abate. This will likely be the lagged result of tightening of monetary policy during the past year. In addition, the government has allowed the currency to strengthen at a faster speed. This suggests that it is more concerned about inflation than about the competitiveness of exports.

Going forward, it is likely that growth in 2011 will come in at a healthy pace, but slower than in 2010. For 2012, expect continued growth at a moderate pace. What, then, are the risks facing the Chinese economy in the medium term?

First, the slowdown in the global economy will have an impact on China given its continued reliance on exports – especially to Europe and the United States. While China continues to shift away from export driven growth, a large part of the economy (and employment) remains dependent on exports. This is especially true in the Pearl River and Yangtze River deltas.

Second, the continuing sovereign debt crisis in Europe, and the possibility of further crises in the United States in 2013, poses challenges for China. Financial market turmoil in

Europe and the United States, and especially higher interest rates in those markets, could lead to large capital losses for China’s central bank as well as other Chinese financial institutions.

On the other hand, higher interest rates in the West would take away some of the upward pressure on China’s currency. Furthermore, slower global growth is likely to dampen energy and other commodity prices that are of critical importance to China. And indeed, this is already happening.



The Japanese economy is showing signs of recovery. Industrial production is trending upward. Auto-sector output is also on the mend. Several automakers have restarted production lines, with operations at near normal levels. Furthermore, exports are beginning to pick up but an appreciating yen is a potential dampener for the export sector. While the worst seems to be over, the government’s policy response will likely determine the speed of Japan’s recovery. If electricity generation returns to normal, supply-chain issues are overcome and government spending on reconstruction is fast-tracked, Japan’s economy could stage a comeback during the second half of 2011.

For some industries, the recovery has been faster than expected. Month-on-month, industrial production rose 6.2 percent in May and 3.9 percent in June 2011 marking three straight months of growth post the earthquake. The Shoko Chukin small business manufacturing survey index rose sharply in June, to 45.4 from 36.9 in May and 36 in April. A further gain is projected for July. Furthermore, the earnings of major electronics companies for the quarter ending June were favorable. The recovery has also spurred growth in the steel manufacturing industry. On the downside, the production of cars, buses and trucks was down nearly 14 percent compared to June last year. But

the post-quake recovery in the auto industry is better thanexpected and automobile production grew at a staggering rate in May.

So far, government allocations of nearly 6 trillion yen were largely spent on immediate relief efforts. A majority of the spending on reconstruction is expected to happen over the second half of 2011 and well into 2012. Local governments will likely present their reconstruction requirements by August. Thereafter, the government will allocate a 13 trillion yen spending package toward rebuilding.

The other important question revolves around the financing of reconstruction. Earlier, the government had indicated that it would like to increase the consumption tax from 5 to 8 percent. However, the parliament is yet to reach a consensus. Besides, the government could issue bonds to finance reconstruction expenses. Ultimately, revenues from subsequent tax hikes will likely be used to redeem these bonds. Japan’s debt to GDP ratio is the highest among developed countries. However, over 95 percent of Japan’s outstanding public debt is held by domestic residents. So far, Japan has no visible problems in financing its debt and Japan’s high debt levels do not pose an immediate risk.

Japan


However, unless the government takes significant steps to address the imbalance, Japan’s fiscal deficit could become unsustainable. Furthermore, Japan’s aging population will add further strain on the country’s debt situation through lower private savings and higher government expenditures on social security.

Meanwhile, the rise in the value of the yen has had mixed consequences. The yen has appreciated from over ¥85/US$ in April to under ¥77/US$ in July. The Japanese economy depends heavily on exports and the yen’s sharp appreciation has thrown up a few challenges. While exporters were already grappling with infrastructure bottlenecks and manufacturing disruptions following the earthquake, the appreciating currency has dealt a further blow to the export industry. As a result, the government intervened in the foreign exchange market to stem the rise of the yen and thereby protect Japanese exports. On the other hand, some multinational companies are

ramping up investments in emerging markets. By setting up manufacturing units overseas, several Japanese companies have tried to safeguard their competitiveness. As a result, there has also been a spurt in overseas M&A activity. Furthermore, terms of trade for imports of oil, natural gas and metals have become favorable. That is, a rising yen has reduced the domestic price of imported commodities.

The second half of 2011 will probably see accelerated growth, yet for 2011 as a whole, GDP will likely contract between 0.5 and 0.7 percent. Reconstruction and investment in the housing sector will likely boost GDP growth. However, a return to normal electricity generation appears to be an uphill task. Finally, how Japan’s industry copes with a rising currency could have significant implications on Japan’s exports and, therefore, the country’s growth prospects.


MMalaysia’s private sector was the star performer recently.The sector demonstrated bullish growth, expanding at a pace of 6.6 percent during the quarter. Albeit exports were lower than last year, they continued to providesupport to the domestic economy. Furthermore strong economic fundamentals and favorable rates of return encouraged a surge of foreign direct investment (FDI) and provided an additional boost to the economy. Similar to the woes of its Asian peers, rising inflation remains a key concern for Malaysia’s policymakers. However in light of weak international demand conditions, the central bank refrained from tightening rates in the latest monetary policy meeting in July. Supply disruptions in Japan and a slower Chinese economy have dampened regional demand for Malaysia’s exports. Nonetheless, ifinternational conditions improve in the second half of the year, policymakers will have more room to tighten rates in order to maintain price stability.

Despite wavering international demand, domestic demand in Malaysia has shown resilience. Favorable labor market conditions and accompanying income growth percolated down to robust consumer spending during the first quarter. According to official statistics, private consumption grew 6.7 percent during the first three months of 2011,

up from 6.4 percent recorded during the previous quarter. Public consumption also expanded at a robust pace of 6.1 percent during the first quarter. Moreover, implementation of planned investment projects kept gross fixed formation elevated, providing the necessary stimulus for the Malaysian economy during the first quarter.

Malaysia’s local industries were hit due to supply disruptions in Japan but are now showing signs of revival. Japan is amongst Malaysia’s top five export destinations and accounted for almost a third of Malaysia’s mineral fuel and petroleum exports last year. Given Japan’s reconstruction demands, total exports to the country grew by 9.5 percent in July. Overall, total outbound shipments from Malaysia grew by 8.7 percent in July after a brief slowdown in May. Asia’s robust commodity demand continued to boost Malaysia’s palm oil, petroleum and LNG exports which accounted for 88 percent of revenue growth during the month.

Malaysia’s domestic industries also stand to benefit from the surge of FDI seen of late. According to a UNCTAD report, Malaysia received the third highest level of FDI amongst its South East Asian peers at the start of the year. Within the first quarter alone, FDI inflows reached $3.7

Malaysia


billion, equivalent to 40 percent of the total FDI received during 2010. Manufacturing has traditionally attracted the largest share of FDI, receiving 54.9 percent in 2010, while services attracted 34.1 percent of the total FDI received during the year. Given the surge of inflows during the initial months of the year, the government is estimating a total inflow of $10 billion this year. This will likely provide an additional boost to the country’s manufacturing sector which has seen sluggish growth in recent months.

The country is also bracing for higher inflation this year. In order to reduce its burgeoning subsidy bill, the government increased electricity tariffs and gas prices, effective June. Electricity prices were raised by an average of 7 percent and gas prices were revised up by around 28 percent. This will likely result in cost-push inflation, which combined with robust domestic demand, is expected to induce inflationary

pressures in the months to come. In June, consumer price inflation accelerated to 3.5 percent up from 3.3 percent in May. This spike in prices was mainly attributed to a rise in global food costs, with local food prices up 4.7 percent in June from a year ago. The central bank kept its benchmark policy rate unchanged in July, choosing to remain supportive of growth. However, going forward it will likely keep a close watch on international prices as well as domestic indictors as it normalizes its loose monetary policy stance this year.

Overall, the Malaysian economy will likely see a moderate expansion of 5 to 5.5 percent during 2011. Most of this growth will probably be seen in the second half of the year. While the outlook remains positive, rising inflation and uncertainties around global developments pose downside risks to the Malaysian economy.


Taiwan’s strong growth seen during the last few quarters is

now showing signs of slowing down. Weak demand from China, coupled with supply disruptions in Japan, is putting downward pressure on Taiwan’s export-dependent economy. Following 6.6 percent expansion during the first three months of the year, the country’s annual GDP growth rate decelerated to under 5 percent by mid-year. Going forward, the outlook for Taiwan is expected to improve as private consumption and investment continues to prop up the economy. The government expects the economy to grow at 5 percent this year. However, the actual pace of growth is dependent on the global recovery and the performance of Taiwan’s external sector.

The month of June saw subdued export orders which grew 9.2 percent year-over-year, compared to 11.5 percent growth logged during the previous month. With monetary policy tightening taking effect in China, orders from Taiwan’s neighbor grew at a modest pace of 4.8 percent. Demand from Japan compounded matters, as orders contracted by 15.6 percent from a year ago. Despite the slowdown, demand for Taiwan’s hi-tech exports remained strong and is likely to strengthen further as the high season approaches. Moreover as the Japanese pipeline opens up and global economic conditions improve, Taiwan’s export sector is expected to rebound in the latter half of the year.

A sluggish export sector had a negative impact on local industries in recent months. The industrial production index expanded by 3.6 percent year-over-year in June, compared to 7.6 percent growth logged in May. This was the slowest expansion in nearly two years. Manufacturing output, which accounts for almost 90 percent of Taiwan’s factory output, increased by 3.5 percent, down from 7.5 percent recorded during the previous month.

On the bright side, domestic consumption continues to be a major driver of the Taiwanese economy. During the second quarter, private consumption expanded by 3.2 percent. Registrations of new cars, a strong indicator of domestic consumption, nearly tripled during the first half of the year. Improvements in labor market conditions are likely to further bolster private consumption this year. The unemployment rate fell marginally in recent months. An upcoming government wage hike will likely encourage consumption spending further. Consumer sentiment already touched record levels in July reaching 86.84 in July, its highest level since 2001. Thus, consumer sentiment will likely power domestic demand, which is expected to play a crucial role in propelling the economy during the latter half of the year.

A downside risk to consumer confidence arises from the growinginflation in the Taiwanese economy. Inflation rose to 1.9 percentin June, up from 1.6 percent in the previous month.

Taiwan


Prices of fuel and food items rose 10.8 percent and 3.3 percent respectively. Core inflation rose to 1.2 percent in June. Rising inflation and surging property prices prompted the central bank to raise interest rates in its policy meeting in June. It raised its benchmark policy rate by 12.5 basis points to 1.875 percent this June. However, given the elevated prices of international raw materials and the potential risk of imported inflation, the central bank is expected to continue tightening policy rates through 2011. The government estimates inflation to climb to 2.8 percent during the second half of the year and settle with an average of 2.1 for the entire year.

Overall, weak external demand put a damper on Taiwan’s otherwise bright outlook. With global conditions expected to improve along with resilient demand for the country’s hi-tech electronics exports, Taiwan’s export performance will likely improve during the second half of the year. Nonetheless, the economic recovery will also depend on the extent of monetary policy tightening by the central bank as it keeps a close eye on inflation. Consistently rising interest rates could encourage strong capital inflows thereby strengthening the local currency and hurting exports. Hence, the next two quarters are crucial for the Taiwanese economy this year both from a monetary policy

standpoint as well as from the external sector perspective.


Vietnam

The Vietnamese economy is growing, but soThe Vietnamese economy is growing, but so is inflation. Inflation has accelerated for 11 straight months and is among the highest in Asia. As a result, the government’s focus has shifted from being predominantly pro-growth to ensuring macroeconomic stability and countering inflation. Amid tighter credit conditions, both consumer and investor confidence has declined. Overall, the economy will likely grow at a still-healthy pace of over 6 percent in 2011.

Vietnam’s struggle against rising inflation continues. The central bank imposed a slew of rate hikes through the first half of the year to counter inflation. However, on July 5, the central bank lowered its reverse repo rate by 100 basis points to 14 percent. This move was surprising against the backdrop of rising inflation. Meanwhile, in July, CPI rose 1.2 percent month-on-month, and nearly 22 percent compared to July last year. The reason for the increase in inflation was a 3.2 percent surge in the prices of food. Furthermore, demand-supply mismatches in several food categories have caused a steep hike in prices. The central bank revised its inflation target to a range between 15 and 17 percent. However, keeping inflation within that target range is likely to be quite a challenge, unless the central bank tightens policy further.

During second quarter, Vietnam’s GDP expanded by nearly5.7 percent, faster than growth achieved at the start of the year. Industrial output rose 9.6 percent in July from a year earlier, while the month-on-month increase registered at 6.1 percent. Mining and quarrying, manufacturing, power, and water and gas all contributed to industrial growth in Vietnam. Despite concerns of slowing global demand, manufacturing growth is expected to hold up in the second half of 2011. A spike in manufacturing activity may boost employment and private consumption. Furthermore, higher remittances and rising wages may help in alleviating concerns stemming from rising food prices and tighter credit market conditions. However, recent monetary tightening will likely dampen GDP growth to some extent during the latter half of 2011.

Meanwhile, agriculture continues to play an important role in Vietnam. The share of agriculture in the economy has been rising since 2005 and now stands at over 20 percent of GDP. During the first seven months of 2011, exports of agricultural products were estimated at $8.1 billion, up 45 percent over last year. Furthermore, agricultural exports are likely to grow steadily over the remainder of the year. Given the rising prices of Vietnam’s agricultural exports


such as cashew nuts, coffee, pepper and rice, the sector has the potential to grow further.

Despite strong exports from the agriculture sector, Vietnam’s trade deficit will likely widen in 2011. During the first seven months, Vietnam’s trade deficit stood at US$6.64 billion. Moreover, imports, supported by rising domestic consumption, are expected to outweigh exports in the coming months. In addition, the services sector will likely also record a net deficit. Vietnam now imports all kinds of goods, including vegetables and seafood to equipment and hi-tech devices. The country’s dependence on imported crude oil could worsen the deficit further. Furthermore, manufacturers have stepped up imports of materials and machinery, even if domestic and external demand is unable to keep pace, perhaps, anticipating import prices to go up in the future.

Meanwhile, after a slow start, foreign direct investment (FDI) bounced back in July, reaching approximately $1 billion. Vietnam’s northern province of Hai Duong took the

lead in attracting FDI after Malaysia’s Jaks Resource Berhad agreed to develop a $2.26 billion coal-fired power plant in the province. With this project, Hai Duong has attracted nearly $2.5 billion in foreign investment in the first seven months of this year. Furthermore, the government is also offering incentives to boost investments in the automotive sector. Companies from South Korea and Thailand made investments in the auto, electronics components and animal feed processing sectors. Vietnam has set a target of achieving $20 billion in FDI this year, up from $18.6 billion last year.

Inflation is the country’s immediate challenge and the government is prioritizing its policies accordingly. How well the government manages rising inflation will shapemacroeconomic stability in Vietnam. A rising trade deficit and reduced confidence in the local currency could potentially increase the country’s vulnerability to external shocks. Yet, Vietnam is expected to enjoy steady growth in 2011.


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Dr. Ira KalishDeloitte Research Deloitte Services LP Tel: +1 213 688 4765 E-mail: [email protected]

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Deloitte's Asia Pacific outlook august 2011

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