ASEAN: Region faces growing external headwinds from Brexit
July 19, 2016
The surprising result of United Kingdom’s referendum on 23 June sent shockwaves across the globe, rattling financial markets and casting a shadow on the outlook for the global economy. Reverberations from the historic vote were felt in the economies in the Association of Southeast Asian Nations (ASEAN) as a knee jerk reaction by financial markets caused stock markets to plummet and investors to flock into risk-averse assets. While it is difficult to anticipate the full effects that Brexit will have on the ASEAN region—the outcome of negotiations between the EU and the UK are critical—waves of contagion from Brexit decision are expected to hit the region through trade, financial and investment channels. In addition, an increase in external headwinds to the region’s growth outlook will increase pressure on policy makers to mitigate the adverse effects and could pave the way for additional fiscal or monetary stimulus. Malaysia’s Central Bank was the first in the region to react following the Brexit vote when it delivered a surprise cut to the policy rate on 13 July.
The ASEAN region is heavily reliant on the external sector as a growth driver and reduced demand from important trading partners as a result of Brexit is a key risk to the region’s outlook. That said, direct trade linkages between the region and the United Kingdom are small, with just over 1.0% of the region’s exports destined for the UK. The region is more vulnerable to reduced demand from the European Union, which is the destination of nearly 10% of ASEAN exports and is expected to be hard hit by Brexit. In addition, any further slowdown in global trade due to heightened global uncertainty could have a further impact on the region’s external sector. On a positive note, some countries could benefit from better trade deals with the UK as the British government seeks to diversify markets.
On top of trade, spillover effects from heightened volatility in global financial markets will likely impact the region. Investors flocking to safe-haven assets following the vote has increased demand for the United States dollar and put a number of the region’s currencies under pressure. In addition, high global uncertainty could damper on confidence levels and investment in the region. However, the ASEAN economy has become more resilient to macroeconomic shocks in recent years thanks to larger foreign exchange reserves and stronger financial systems. On the upside, the uncertain economic outlook will likely force the United States’ Federal Reserve to postpone its tightening cycle, thereby taking some pressure off the ASEAN’s financial markets and allowing central banks in the region to adopt a more accommodative monetary policy.
Looking at the countries within the region, Singapore and Malaysia are likely to be most affected by Brexit given the open nature of their economies and financial linkages to the UK. Brexit will add to the economic challenges Singapore is already facing, as the UK is one of the main sources of FDI into the country. However, the effects of Brexit on Indonesia, the region’s largest economy, are expected to be contained, as growth is largely driven by domestic demand. Our panel sees the ASEAN region growing by 4.5% this year, which is down 0.1 percentage points, and analysts foresee 4.8% growth in 2017.
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Growth wanes slightly in Q2
A preliminary set of data suggest that growth in the Association of Southeast Asian Nations (ASEAN) inched down in the second quarter of 2016. GDP expanded 4.5% annually in Q2, which was just below Q1’s 4.6% expansion. While GDP data are not yet available for all economies, external headwinds—largely due to tepid global demand—likely continued to weigh on growth in many of the region’s largest economies. In addition, a significant drought hit some countries in the region, including Vietnam. Although economic activity in Vietnam inched up slightly in the second quarter, falling agricultural output hampered growth in the first half of the year.
Meanwhile, Singapore’s GDP growth picked up slightly in the second quarter, although the economy’s momentum remained weak. The reading was due to a rebound in the services sector, while momentum continued to fade in the manufacturing sector.
On a positive note, Indonesia’s government approved a much-delayed tax amnesty bill on 28 June, offering a nine-month window for citizens to declare previously unreported assets. The bill should provide a boost to government revenues, which have been shrinking amidst slow growth and low commodities prices. In addition, the bill could bring added gains from repatriated assets, as repatriated funds pay a reduced penalty rate, although the take-up rate remains highly uncertain.
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ASEAN’s prospects deteriorate
The outlook for ASEAN worsened this month following a stable forecast in the previous two months. Analysts polled by FocusEconomics see the region growing 4.5% in 2016, which is down 0.1 percentage points from last month’s forecast. This month’s forecast reflected downward revisions for half of the 10 countries surveyed, including major players Indonesia, Malaysia, Singapore and Thailand. The more uncertain global backdrop following the United Kingdom’s Brexit vote will likely ripple through investment, exports and exchange rates throughout the region and has increased downside risks to our forecasts. Meanwhile, forecasts for five countries were left unchanged this month, including the Philippines. Next year, our panel of analysts expects the ASEAN economy to expand 4.8%.
Myanmar, Laos and Cambodia, in that order, are expected to be the top performers in 2016, with expansion rates of 7.0% and higher. At the other end of the spectrum, Brunei and Singapore are likely to be the worst performers, followed by Thailand. Among the rest of the region’s major economies, Vietnam and the Philippines will grow the fastest, with projected expansions of 6.2%. Regarding regional giant Indonesia our panel of economists sees GDP expanding 5.0%.
INDONESIA | Tax amnesty bill approved in effort to boost government revenues
Indonesia’s economy lost some steam in the first quarter, however, recent high-frequency data suggest that economic activity picked-up towards the end of Q2. Retail sales growth accelerated in May and the manufacturing PMI rose in June. Moreover, the government took a step forward in halting its shrinking finances in June. On 28 June, Parliament approved the long-overdue tax amnesty bill, which provides citizens a nine-month window to declare previously unreported assets. While the revenue impact is highly uncertain and dependent on take-up rates, it should provide a temporary boost to government finances in the short-term and hopefully widen the tax base going forward. Alongside this, the government also approved a revised budget for 2016, which envisions a wider fiscal deficit of 2.35% of GDP.
Government spending on infrastructure and supportive conditions for household spending should fuel an acceleration in growth this year. However, the more uncertain global environment following the Brexit vote could impact Indonesia’s exports or investment flows. FocusEconomics panelists see GDP growth accelerating to a 5.0% expansion in 2016, which is down 0.1 percentage points from last month’s forecast, before speeding up slightly to 5.3% in 2017.
THAILAND | Baht hit by Brexit
Robust government spending and a rebound in exports were the main factors behind theacceleration of the Thai economy in the first quarter. More recent data show that the positive momentum was carried over into the second quarter. Growth in manufacturing accelerated in May and business confidence improved in June. The UK’s decision to leave the EU will likely have a limited effect on the Thai economy due their weak links in terms of trade and investment. However, Brexit’s short-term impact on financial volatility affected the baht negatively. The currency depreciated slightly in the wake of the vote, but has returned to stable levels since then. In other news, the country will hold a referendum to ratify the new constitution on 7 August, this will be the second time it has been ratified since the junta seized power two years ago. The possibility that the constitution is rejected again has increased the potential for sustained political unrest.
The fiscal stimulus that the military government is undertaking and an improvement in the tourism sector will be key drivers of growth this year. FocusEconomics panelists expect the economy to grow 3.0% in 2016, which is down 0.1 percentage points from last month’s estimate. For 2017, the panel projects the economy to expand 3.2%.
MALAYSIA | Economic data stabilizes as political uncertainties subside
Although Malaysia’s economy would appear to be one of the least impacted by Brexit, its high trade exposure to Europe and status as a financial hub make it more susceptible to Brexit headwinds than some other ASEAN countries. Concerns in this regard have been echoed by the Malaysia Central Bank, which cited the need to shield the country from external risks as motivation behind its July rate cut. The external challenges will not help Malaysia’s deteriorating export sector, which recorded its 19th consecutive contraction in May. In spite of external turmoil, Malaysia is enjoying domestic stability and growth rooted in solid consumer demand. Industrial production growth has been uncharacteristically low, yet steady around the 3.0% mark so far this year. Although allegations of graft are still unanswered, Prime Minister Najib Razak’s leadership tenure looks solid, this means that the government can continue to work towards its deficit reduction targets without political distractions.
Although external factors stemming from Brexit, China’s slowdown, the U.S. Fed’s monetary policy normalization and the still-weak commodity prices present downside risks, Malaysia’s domestic economy is functioning well and will be supported by solid domestic demand. FocusEconomics panelists expect GDP to expand 4.2% in 2016, which is down 0.1 percentage points from last month’s forecast. For 2017, the panel sees GDP growing 4.5%.
INFLATION | Inflation inches up in June
Preliminary data show that inflation in ASEAN rose slightly from 1.7% in May to 1.8% in June. June’s increase largely reflected slightly higher price pressures in Indonesia and the Philippines. Despite having increased, inflation remains historically low and this has given some central banks in the region room to ease monetary policies. On top of this, due to the UK’s Brexit vote and a rise in global uncertainty, analysts are now anticipating that the U.S. will delay interest rate hikes, which provides more room for easing for central banks in ASEAN. In addition, our panelists speculate that the rise in external headwinds following the vote will prompt more central banks to ease monetary conditions to support their economies.
Our panelists see inflation rising moderately in the coming months and averaging 2.5% in 2016, which is down 0.1 percentage points from last month’s forecast. This month’s ASEAN forecast reflects downward revisions to the inflation outlooks for four of the ten economies surveyed, including the region’s biggest player, Indonesia. The inflation outlook was left unchanged for five countries, while Thailand was the only economy for which the projection was raised. Next year, inflation is expected to pick up to 3.4%.
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Written by: Angela Bouzanis, Senior Economist