Wednesday, December 23, 2009

Politics Set to Spoil Southeast Asia's Recovery

After suffering contractions not felt since the 1997-98 Asian financial crisis, Southeast Asian economies are poised to bounce back strongly in 2010. As the region whipsaws between bust and boom, governments will be torn between policies that support recovery and contain emerging asset price bubbles, which are already percolating in areas of Northeast and South Asia.

Conjecture that Southeast Asia's export-oriented economies might, through increasingly diversified trade flows, including with China and the Middle East, decouple from the US-led downturn foundered as economic growth collapsed across the region in late 2008 and early 2009. While the region's banks and debt profiles are comparatively sound, the collapse of first US, and then European, export markets were more than intra-regional trade flows could support.

Economists now predict strong gross domestic product (GDP) growth in 2010 across Southeast Asia, buoyed by rising global growth and fast recovering exports. Credit Suisse, for one, predicts growth of 5.7% in Indonesia, 5.5% in Malaysia, 4.3% in the Philippines, 4.7% in Thailand, and 6% in Singapore, the region's most open economies. Those fast clips compare with projected year-on-year sharp declines in 2009 for the same sequence of countries of 4.4%, minus 2.3%, 1.6%, minus 3.3%, and minus 1.8%. Other big banks, including HSBC and JP Morgan, are similarly bullish on the region's growth prospects for 2010.

Nearly all regional governments ramped up spending and eased monetary policies in response to the crisis. Tentative signs of stabilization became apparent in the first quarter, recovery in production by the second, and to varying degrees expanding rather than contracting economic growth rates by the second half of 2009. A recent HSBC research report estimates that "even if we assume that the various governments only deliver half of what they have promised, the addition to GDP will be no less than two percentage points next year according to our growth model."
With exports also expected to recover, many private economists believe that the region's central banks will need to move swiftly to rein in stimulus measures, especially low interest rates, to avoid inflating asset price bubbles that could short-circuit recovery and if left unchanged lead to more damaging domestic-driven imbalances, particularly in property and other asset price speculation.

While Southeast Asia's economies wholly failed to decouple from the US's and Europe's collapse, economists believe the region's central banks must soon move to unpeg their interest rate policies from the United States' Federal Reserve. Policymakers in Southeast Asia have long shadowed US rate cycles to maintain currency competitiveness, but are now badly mismatched in light of the US's extraordinary financial troubles and the region's comparatively sound finances and liquidity rich banks.

None of the region's central banks, however, has indicated a move in that tighter direction and continue to intervene in foreign exchange markets to tamp down any significant appreciation of their currencies. They are partially constrained by China's fixed rate regime and the threat an appreciation vis-a-vis the yuan would have on export recovery. At the same time, HSBC predicts the US will not start raising rates until at least 2011.

Meanwhile, there are nascent signs of equity and property price bubbles. Despite overall negative economic performances, Southeast Asia's stock markets zoomed across the board in 2009; by mid-December, gains in local-currency terms were as high as 83% in Indonesia, 43% in Malaysia, 59% in Singapore, and 54% in Thailand. Another sign of froth: Singapore's property prices recently zipped past their 2007 record levels, which at a time of breakneck economic growth many analysts considered to have entered bubble territory.

Rising political risks, including in Indonesia, Malaysia and Thailand, and to a lesser degree Vietnam, threaten to muddle timely policy responses as embattled governments are expected to shy from rolling back politically popular stimulus measures. They are arguably the countries that will need to move the quickest in re-calibrating their policy mixes to avoid medium term asset price bubbles and a jarring repeat of an accelerated boom and bust cycle.

Nowhere are those risks higher than in Thailand, which looks to enter a fourth year of destabilizing political turmoil that has been a drag on growth and recovery. Protesters loyal to criminally convicted former premier, Thaksin Shinawatra, threatened to stage a "million-man" march on Bangkok in late November, but reversed their plans at the eleventh hour. They are expected to ramp up their activities dramatically by February if a Thai court rules to seize over US$2 billion worth of Thaksin's assets frozen in Thai banks.

Against that political backdrop, the Bank of Thailand has tracked closely the US's near zero percent interest rate policy and announced a second major fiscal stimulus package that promises to spend mostly off-budget 1.4 trillion baht (US$42 billion), or 16% of GDP, on investment between 2010 and 2012. HSBC believes that "given lingering political uncertainties, the Bank of Thailand may stay on hold a little longer than its neighbors ... and even then the path of tightening should prove gradual at best."

Credit Suisse warns that "rating agencies could downgrade Thailand's debt ratings in 2010, absent an improvement in the political situation". The bank noted in recent research that Fitch, Moody's, and Standard & Poor's all have negative outlooks on their Thai debt ratings and "could downgrade the sovereign within the BBB category unless prospects for sustained political stability improve substantially. They are likely to watch the next election closely to see whether it produces a more stable government that is accepted across society and is able to govern more effectively."

Faced with the prospect and ramped up street protests, Prime Minister Abhisit Vejjajiva's government is expected to maintain loose monetary and exchange rate policies, particularly with snap elections potentially on the horizon. A JP Morgan economist who requested anonymity noted that the government had failed to remove crisis-induced price-support subsidies for food and services even though the populist measures were due to expire in December.

Sudden new political risks could also weigh on Indonesia's policy response to the changing economic environment. With a strong electoral mandate, newly elected President Susilo Bambang Yudhoyono was until recently expected to push through structural and regulatory reforms that would lower the country's risk premium on its domestic and foreign debt. Indonesia performed comparatively well during the global economic downturn, but because of concerns over creditor rights and a weak legal system maintains the highest cost of credit in all of Asia.

Yudhoyono's ability to push through those reforms, some fear, will be significantly weakened by the recent scandals that have hit his government, one over alleged official attempts to undermine a quasi-independent and highly effective counter-corruption agency, and another surrounding alleged irregularities in his previous government's handling of a state bailout of a mid-sized bank. The scandals are expected to embolden conservative elements in parliament that had loosely aligned with Yudhoyono after his sweeping election win.

Recent HSBC research raises the question of how much of the Indonesian economy's resilience during the global downturn was related to one-off, election-related spending which has now faded away. "It is certainly hard to believe that the strong improvement in private consumption and confidence through the global crisis (Indonesia must have been one of the only countries to experience this) had nothing to do with the timing of the parliamentary and presidential elections."

At the same time, Bank Indonesia has maintained a strong pro-growth bias which even before Yudhoyono's political troubles was expected to move slowly if at all in tightening monetary policy. Credit Suisse notes that "inflation rates have recently surprised on the low side, but the trend is unlikely to last: we expect annual inflation to reach 6% in 2010." The risk is that the central bank maintains a monetary policy that inflates asset bubbles and renders ineffective later incremental rate hikes.

Malaysian Prime Minister Najib Razak pleased markets when he announced in October his government's fiscal consolidation plans in the 2010 budget, which provisionally will narrow the budget deficit to 5.6% of GDP in 2010 from 7.4% this year. That announcement came before a Malaysian court decided to follow through on hearing criminal sodomy charges against opposition leader Anwar Ibrahim, who was tried and jailed on similar charges in the late 1990s and has since emerged as a democratic icon in the country.

The trial threatens to ramp up political risks, including through street actions, and, if history is a guide, retaliatory government responses. Credit Suisse believes that "political pressures could delay or water down the planned [fiscal] reforms". Other big bank economists believe political instability will likely restrain Bank Negara, the country's central bank, from raising benchmark interest rates above their current level of 2% even as inflationary risks rise.

It's a policy decision - as will be weighed elsewhere in the region - where political considerations could trump technocratic sense and set in motion Southeast Asia's next bust to boom to bust cycle. By Shawn W Crispin is Asia Times Online's Southeast Asia Editor.

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