Asia Pacific Economic Outlook March 2013

China India

MyanmarPhilippines

Asia Pacific Economic Outlook—March 2013 2

The pace of recoveryThere are indications that China’s recovery from the slow growth of 2012 is weaker than anticipated. Data for January and February— the two months are combined due to the Chinese New Year—showed that industrial production and retail sales increased more slowly than expected. Industrial production in the first two months of the year rose 9.9 percent from a year earlier, the slowest start to the year since 2009. Retail sales for the first two months of the year were up merely 12.3 percent. The slowdown in retail spending was partly due to an official effort to curtail spending on entertaining officials.

At the same time, exports and fixed asset investment are growing strongly, suggesting that China’s expansion is reverting to the old pattern of exports and investment rather than consumer spending. In the long term, this is not a sustainable pattern for China. Fixed asset investment was up 21.2 percent in the first two months of the year. In addition, exports in February were up 21.8 percent from a year earlier, even though there were four fewer working days in February this year

than last. Imports actually declined in February, raising concerns that domestic demand is lagging. Particularly noteworthy was a 16.5 percent increase in exports to the EU. This was the third consecutive monthly increase in exports to the EU, the first time this has happened since 2011. Exports to the United States were up 15.7 percent, and exports to Japan were down 6.5 percent.

Recent pessimism about the weak numbers for China’s manufacturing sector was offset, however, by more positive news. It was a relief to learn that a preliminary purchasing manager’s index for manufacturing was up. The index, published in March by Markit and HSBC, increased from 50.4 in February to 51.7, suggesting accelerating growth in the manufacturing sector. In addition, inbound foreign direct investment into China rose in February for the first time in nine months with a 6.8 percent increase from a year earlier. Outbound FDI was up as well and exceeded inbound FDI. The increase in inbound FDI signals a possible revival of foreign business confidence in China’s outlook.

China

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The future of government policyChina’s new premier, Li Keqiang, made a surprisingly candid speech about what is needed for China to move forward. He said that he wants to reduce the power of the Chinese government and increase the role of the private sector in the economy. According to Li, “it is about cutting power, it is a self-imposed revolution. It will be very painful and even feel like cutting one’s wrist.” He backed up his statements by appointing an economic policy team composed of respected and experienced reformers. Li also made a strong statement about dealing with pollution: “we shouldn’t pursue economic growth at the expense of the environment—such growth won’t satisfy the people.” At a time when smog in Beijing and elsewhere is seen as a significant threat to public health, Li’s statement was welcome.

In addition, head of China’s central bank indicated that he is worried about rising inflation, which reached 3.2 percent in February. He says that the bank’s policy is “no longer relaxed” and “relatively neutral.” Zhou Xiaochuan said that “we will use monetary policy and other measures to hopefully stabilize prices and inflation expectations.” This statement comes at a time when China’s economy is showing signs of sputtering, with industrial production rising more slowly than had been anticipated. However, the central bank is concerned about consumer prices in addition to a possible housing bubble and the rise of non-bank sources of credit. Zhou also expressed

concern that some loans to regional governments are not backed by revenue-generating projects and are, therefore, at risk. The central bank set its money supply growth target at 13 percent, which would be the slowest rate of money supply growth since 2000. Zhou is the longest serving head of China’s central bank and, despite reaching the age of 65, is widely expected to be retained after the mandatory retirement age. He has been instrumental in pushing the liberalization of credit markets. His comments suggest that he wants to stabilize prices and the financial system before he departs. For the government, the challenge will be to keep growth going in the midst of a tighter monetary policy.

Meanwhile, Moody’s chimed in with a warning that China’s local government debt is at risk of default. This follows the central bank’s assessment that there might be trouble. According to Bloomberg, local government debt issuance increased by 179 percent from 2011 to 2012 and accounted for 50 percent of corporate bond issuance in China in 2012. It is estimated that local government debt amounts to between 18 and 30 percent of China’s GDP. As local governments cut back on borrowing, this could have a negative impact on economic growth.

Another issue in China concerning credit growth has been the very rapid expansion of the so-called shadow banking system. This has involved the creation of credit outside the formal banking system, often using off-balance

China’s new premier, Li Keqiang, made a surprisingly candid speech about what is needed for China to move forward. He said that he wants to reduce the power of the Chinese government and increase the role of the private sector in the economy.

Asia Pacific Economic Outlook—March 2013 4

sheet vehicles operated by traditional banks. The huge growth of this system played an important role in the country’s economic recovery after the global crisis of 2008–2009, but its large size and lack of supervision worries many observers. They are concerned that the system poses a risk to the economy. Consequently, the Chinese government recently announced that it will require fuller disclosure about off-balance sheet vehicles operated by banks. It will also consider rules that would cap the size of such vehicles. Such rules could curtail credit growth.

Dealing with income distributionFinally, an important policy issue concerns the rising inequality of income in China. The country currently has a system of residence permits known as the “hukou” system. The permits indicate where a person resides and whether they are urban or rural.

Many rural migrants live in big cities, but they are not entitled to many of the services enjoyed by local residents because they are classified as rural. These can include education and healthcare. As such, China has developed a two-tiered system that is a source of considerable tension and potential unrest. Now there is word that the new leadership intends to do away with the hukou system and replace it with a system of national residence permits. The idea is to end the two-tier system and to encourage more rural people to permanently settle in urban areas. Outgoing Premier Wen Jiabao says that promoting urbanization will assist with continued strong economic growth. The transition to a more consumer-led economy will require more urban dwellers with greater purchasing power. The challenge, of course, will be to fund the added government services that will become available to migrants.

Asia Pacific Economic Outlook—March 2013 5

The Indian economy is experiencing one of its slowest periods of growth in nearly a decade. India’s GDP grew just 5.5 and 5.3 percent in the first two quarters of the 2012–2013 fiscal year, prompting the Central Statistical Organization to lower its growth estimate to a meager 5.0 percent for the year as a whole. Slower GDP growth is primarily attributable to a weakness in the industrial sector. The Index of Industrial Production (IIP) grew a mere 0.7 percent between April and December 2012, down from 3.7 percent for the corresponding period in 2011–2012. Meanwhile, growth in the agriculture sector has been slow after an erratic start to the monsoon season, which likely caused lower growth in allied sectors as well. Furthermore, cautious monetary policy and tight credit conditions put a lid on the possibility of an investment-led growth revival.

On February 28, 2013, the finance minister presented the Union Budget 2013–14. He highlighted that persistent and large deficits on the current account coupled with a substantial fiscal deficit pose significant challenges to the economy. Furthermore, inflation and low investments have dampened India’s growth prospects. India ran the risk of

its sovereign rating being downgraded to junk status in the absence of a clear fiscal consolidation plan. In his budget speech, the finance minister reaffirmed a commitment to continue on the fiscal roadmap laid out during the last year that would limit India’s fiscal deficit to 4.8 percent of GDP in the 2013–2014 fiscal through measures that rely largely on expenditure cuts and disinvestment proceeds. However, the success of the fiscal consolidation plan is largely dependent on the underlying assumptions, and the threat of a sovereign downgrade has not been entirely averted.

Meanwhile, India’s current account deficit rose to 5.4 percent of GDP in the second quarter of the 2012–2013 fiscal year, taking the deficit for the first half of 2012–2013 to 4.6 percent. Export growth fell faster than imports during the second quarter. So far, the current account deficit has been financed without drawing down reserves. While foreign direct investments (FDI) have declined in the first three quarters of 2012–2013 compared to the previous year, foreign portfolio investments have registered a healthy increase. A global recovery and an uptick in external demand will likely support a revival in the export sector, which augurs well for

India

Asia Pacific Economic Outlook—March 2013 6

the economy. However, India’s import basket, which consists largely of petroleum imports, will likely continue to exert pressure on the country’s current account.In its third-quarter monetary policy meeting held on January 29, the Reserve Bank of India (RBI) cut its policy rate by 25 basis points, the first instance where the central bank tinkered with policy rate since April 2012. Meanwhile, wholesale price index (WPI) based inflation fell to 6.62 percent in January 2013, its lowest level since December 2009. The declining trend in the WPI is certainly a positive sign for the economy, but a majority of the decline is due to a moderation in non-food manufacturing inflation.

On the other hand, food prices remain elevated and are an area of concern. Unlike the previous year, when food inflation was mainly driven by higher prices of protein

foods, the price of cereals has exerted upward pressure this year. Rising food inflation has widened the gap between inflation measured using the WPI index and the consumer price index (CPI) to over 4 percent in January 2013, primarily on account of higher weightage given to food items in CPI. India continues to witness double digit CPI inflation, which stood at 10.79 percent in January following a reading of 10.56 in December2012.

India’s growth rate appears to have bottomed-out, and the tide is likely to turn in India’s favor. The government hopes that its recent push for reforms will help trigger investments and jumpstart the economy. Based on current forecasts, the economy is expected to achieve a growth rate of 6.1–6.7 percent in the fiscal year beginning in April 2013.

India’s growth rate appears to have bottomed-out, and the tide is likely to turn in India’s favor. The government hopes that its recent push for reforms will help trigger investments and jumpstart the economy.

Asia Pacific Economic Outlook—March 2013 7

Myanmar’s GDP is expected to continue growing at a steady pace, and international sanctions against the country have eased following recent economic and political reforms. The economy is estimated to expand 6–6.5 percent in the fiscal years 2012–13 and 2013–14. A potential rise in foreign investments and spending by locals and tourists are Myanmar’s primary drivers of growth. The resumption of international lending will also help the economy develop in the long term. However, the country’s infrastructure and transparency challenges may adversely affect investment decisions. In addition, a likely slowdown in exports coupled with high rates of inflation could limit growth.

Myanmar’s steps toward democracy and economic reforms have resulted in the lifting of several sanctions, and they may contribute to increased foreign investments. For instance, while investments in dollar terms declined from $4.6 billion in FY11 to $800 million in the first nine months of FY12, the number of projects surged from 13 to 62. The latest investments encompass agriculture, fisheries, mining, oil and gas, manufacturing, and hotels and tourism, in contrast to previous years’ predominant focus on multibillion dollar oil and gas or power projects. Moreover, the government is taking several measures to improve the investment climate in Myanmar. Regulations

are being changed to allow foreign banks to form joint ventures with local lenders, hold up to 80 percent stake, and potentially apply for wholly owned subsidiaries and full branches at a later stage. The telecommunications sector is also opening up; the government is inviting foreign investors to bid for two of the country’s four national licenses in January. The oil and gas rich country will also allow full foreign control of 25 offshore blocks; the bidding is scheduled for April. In March, the country also agreed to sign the Convention on the Recognition and Enforcement of Foreign Arbitral Awards 1958 (New York Convention) to encourage investment. However, limitations in transport, electricity, telecommunication, and capital market infrastructure may hinder progress in Myanmar. Corruption, significant skill gaps in the workforce, and ongoing interethnic and interreligious conflicts may also hamper investment in the country.

As a market of 60 million consumers opens up, companies from sectors ranging from food and beverage to automotive and electronics are boosting their presence in Myanmar and likely driving growth. A 57 percent rise in tourism during the first nine months of FY12 is also a significant boost to the economy, and an if the country relaxes its visa requirements, the tourism industry could enjoy additional improvement. An international hotel

Myanmar

Asia Pacific Economic Outlook—March 2013 8

chain entered Myanmar in March to capitalize on the trend. However, continuing infrastructure issues could limit the growth in tourism, especially outside the commercial capital, Yangon. In addition, steep price increases can hinder consumer spending. Inflation is projected at 6.4 percent in FY2012 and 6.6 percent in FY2013 because the prices of food, fuel, electricity, and housing are rising.

While foreign investment, tourism, and domestic consumption appear positive for Myanmar, exports could become a challenge. The country’s major exports include natural gas, agricultural products, timber and timber

products, garments, and fish and other marine products. Although the easing of sanctions will likely boost exports going forward, a slowdown in global demand can limit trade. Exports for April–December 2012 are 4 percent lower compared to the same period in 2011; natural gas sales stagnated, and agricultural products fell by double digits. There are, however, a few pockets of growth in areas such as fish, timber, and garments. In order to enhance the country’s export competitiveness, the government is looking to stabilize exchange rates for the local currency to approximately 848 kyat per US dollar.

The economy is estimated to expand 6–6.5 percent in the fiscal years 2012–13 and 2013–14. A potential rise in foreign investments and spending by locals and tourists are Myanmar’s primary drivers of growth.

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The Philippines economy will likely continue expanding at a moderate pace this year, achieving the government’s growth target of 6–7 percent. The country ended 2012 on a positive note, registering a growth rate of 6.6 percent—the fastest in Asia after China. Favorable domestic consumption, government spending, and business investments in the Philippines will remain the country’s primary drivers of growth as exports stay subdued with only a marginal improvement in the global economy.

Domestic consumption in 2013 will likely be driven by expectations of better employment prospects, salary increases, and stable prices. According to the central bank’s consumer sentiment survey, demand for big-ticket items such as consumer durables, automobiles, and real estate is expected to remain steady for the next 12 months. Remittances from overseas Filipino workers, which account for nearly 8.5 percent of the GDP and are vital to household spending, are also projected to rise by 6.3 percent in 2013. Meanwhile, spending related to the midterm elections in May will likely be another significant economic driver this year.

In addition, rising government expenditure on infrastructure, health care, education, and other social welfare initiatives is expected to enhance economic activity in 2013. The government is planning to increase its spending by 10 percent in 2013 to $47 billion, and it will direct nearly $7.7 billion toward infrastructure development, including highways, railways, and natural gas pipelines. However, similar to previous years, the government may underspend its infrastructure budget because the public-private partnership (PPP) scheme to execute these projects is progressing slowly; delays in infrastructure improvement could adversely affect growth prospects in the long run.

Philippines’ economy might also benefit from positive business sentiment across most sectors, including manufacturing, construction, trade, and services. Anticipated election-related spending, higher consumer demand, rising tourism, stable prices, and foreign exchange rates are driving business confidence. As such, 30 percent of the 1,247 respondents of the central bank’s sentiment survey are planning expansions, new projects and product lines, and hiring in the second quarter of 2013. Expansion plans are the strongest in the electricity,

Philippines

Asia Pacific Economic Outlook—March 2013 10

gas, water, mining, agriculture, and manufacturing sectors. To support local businesses’ growth aspirations, the central bank intends to keep interest rates low this year. Inflation is also expected to remain at the lower end of the targeted 3–5 percent range this year.

Furthermore, the country may achieve an investment grade rating in 2013, which could expand foreign investments and boost growth. In addition, increasing production costs in China and disputes in the South China Sea are prompting many Japanese and South Korean businesses to shift their operations to the Philippines. Meanwhile, the government plans to revisit policies that restrict foreign ownership in order to attract overseas investments. However, bureaucratic hurdles and challenges related to infrastructure and labor laws have traditionally limited investments in the country.

Amid the many positives for the Philippines economy, exports could be a dampener. In 2012, exports grew 7.6 percent, falling short of the government’s target of 8 percent. This year could prove more challenging; the

United Nations Economic and Social Commission for Asia and the Pacific (UNESCAP) expects weak export growth of 4.3 percent for Philippines due to lukewarm global demand. However, the Philippines government remains hopeful and has again set an annual target of 10 percent export growth. According to the Department of Trade and Industry (DTI), there will be rebound demand for goods such as electronics, garments, and wood products as well as services such as business process outsourcing. Last year, electronics exports, which account for 38 percent of total exports, shrank 5.5 percent.

The central bank plans to ease rules on foreign exchange transactions to prevent an appreciation of the local currency in order to improve export performance. In addition, the DTI is encouraging local businesses to boost their global competitiveness on non-price aspects such as innovation and superior after-sales service. Local businesses are also being asked to explore new markets in emerging economies worldwide while continuing to concentrate on the traditional markets of China, Japan, Korea, and the United States.

In addition, rising government expenditure on infrastructure, health care, education, and other social welfare initiatives is expected to enhance economic activity in 2013.

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Additional resources

Global Economic Outlook Q1 2013

Eurozone, United States, China, Japan, India

Deloitte Review Issue 12

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About the economistsEditorDr. Ira KalishDeloitte Research Deloitte Services LP Tel: +1 213 688 4765 E-mail: ikalish@deloitte.com

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Navya KumarDeloitte Research Deloitte Services LP India Tel: +1 678 299 7123knavya@deloitte.com

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