July 27, 2016 7:00 pm JST

Forecasts show Brexit weighing on Asia -- Malaysia in particular

MASASHI UEHARA, principal economist, and KENGO TAHARA, senior economist, Japan Center for Economic Research

TOKYO -- The U.K.'s decision to leave the European Union has cast uncertainty over key Asian economies, new Japan Center for Economic Research forecasts show.

The center on Wednesday published its fourth short-term outlook for five Asian markets: China, Indonesia, Thailand, Malaysia and the Philippines. Though the Brexit vote has had little immediate impact on these countries' stock prices and exchange rates, the decision is expected to depress growth through trade and the financial markets as the withdrawal approaches.

This year, China's economy is expected to continue decelerating, following the slowdown in 2015. The four major Association of Southeast Asian Nations economies are projected to tread water around their 2015 gross domestic product growth rates, with China holding them back.

Malaysia looks likely to feel the biggest effects from Brexit and the Chinese slowdown, with its real GDP growth rate falling to 4.1%.

Under the circumstances, Asian countries are expected to step up monetary easing, including interest rate cuts.

China's waning momentum

JCER projects China's real GDP growth rate in 2016 will slow to 6.5%, down 0.4 of a point from last year's 6.9%. The country is coming off its worst economic performance since 1990, in the wake of the Tiananmen Square crackdown the previous year. Real estate investment has underpinned growth in the first half of 2016, but sluggish capital investment -- long a main engine for China -- will hinder the economy. Last year's boost of the financial sector are bound to wear off this year.

In 2017, China's growth rate is projected to slow to 6.0%, with the European economy also taking a hit from Brexit.

In June 2016, Chinese private-sector investment lost momentum and its year-on-year growth fell to nearly zero. Meanwhile, investment by state-owned enterprises increased rapidly, sustaining overall investment growth. Investment in the real estate sector expanded in large coastal cities, and housing prices appreciated strongly. Corporate debt is swelling, mainly in the steel, shipbuilding and property sectors.

Since the global financial crisis hit in 2008, China has accumulated a great deal of corporate debt, with the ratio reaching 170% of GDP in the fourth quarter of 2015. That is above the level of Japan during the economic bubble years.

Looking ahead, China is facing reduced investment, an increase in defaults and depreciation of the yuan. The ratio of nonperforming loans is officially less than 2%, but the ratio of debts bearing interest greater than companies' profits is over 15%, according to the International Monetary Fund. The central government still has deep pockets, but it is important to monitor the risk of defaults fueling credit anxiety.

Malaysian risks

The 2016 growth rate for the four ASEAN countries remains at 4.6%, on a par with the 2015 figure. Weaker growth in Malaysia, compared with 2015, and a sluggish Thai economy should be offset by strong growth in Indonesia and the Philippines. Indonesia is seeing healthy domestic consumption, and expectations for the Philippines are rising now that this year's presidential election has come and gone.

Flat aggregate growth is expected in 2017, at 4.6%, due to China's slowdown and Brexit.

Malaysia is in for a pinch: The 4.1% annual growth projected for 2016 and 2017 is down from a relatively high 5.0% last year. The projected rate would be the lowest since 2009, when the global crisis sent the figure plunging to minus 1.5%.

Malaysia heavily depends on exports, which account for about 70% of its GDP. The ratio of exports to the U.K. and other EU countries as a percentage of GDP is just below 7% -- the highest among the four major ASEAN countries surveyed. Out of the four, Malaysia also has the most credit from British banks and makes the most direct investment in the U.K. This is why it is the most exposed to Brexit.

The Southeast Asian country's dependence on exports to China is also relatively high.

Since the introduction of a goods and services tax in April 2015, Malaysia's consumption has turned sluggish as well. The large household debt load means a quick consumption recovery is unlikely. Budget austerity will also weigh on investment.

Delayed U.S. rate hikes and the rise in crude oil prices will help to stem the ringgit's depreciation -- making a generally positive impact on Malaysia's fiscal balance and corporate earnings. But if the ringgit were to rapidly strengthen against the dollar, it would hamper already slowing exports.

Political risk must also be taken into account. Prime Minister Najib Razak remains shrouded in suspicion over a graft scandal dogging state-owned investment company 1MDB. 

Turning to Thailand, exports under the military regime are slumping amid China's slowdown. The consumption recovery appears shaky. And private-sector investment is stagnating.

In 2015, Thailand mustered 2.8% growth, and the figure is expected to increase only slightly, to 3.0%, in 2016. The projection factors in a net export increase, since imports are shrinking more than exports. The Thai economy relies heavily on exports, with China accounting for a significant portion. Tourism is another key contributor, and a recent decrease in Chinese arrivals bodes ill for service exports. Chinese travelers make up just under 30% of total visitors to Thailand. 

In Thailand, too, political risk is increasing ahead of a national referendum in August on a new draft constitution. The growth rate for 2017, when a general election is expected, is projected at 2.9%.

Relatively high growth can be expected in Indonesia and the Philippines, which are less dependent on external demand. Both countries are less susceptible to the influence of China and Brexit. In Indonesia, domestic demand, such as private consumption, is expanding steadily. As President Joko Widodo's government has become more stable, there is hope that deregulation will proceed smoothly, boosting growth.

Indonesia's growth forecast for 2016 is 4.9%, up 0.1 of a point from 2015, with another uptick to 5.0% expected in 2017. The actual rate of 4.8% in 2015 was the first below 5% since the collapse of Lehman Brothers in 2008.

The Philippine economy is expected to expand under the new administration of President Rodrigo Duterte, who took office at the end of June. Robust domestic demand is seen supporting consumption growth. This year, the economy is projected to grow 6.4%, up 0.5 of a point from 2015.

The government intends to accelerate infrastructure investment, and Duterte's other economic plans -- such as measures to attract foreign investment -- are worth watching. Growth is projected to remain brisk, at 6.4%, in 2017.

Stimulus ahead

In these uncertain times, many Asian countries have already executed monetary stimulus measures, such as interest rate cuts, and they are likely to strengthen those measures in the near future. Malaysia cut its policy interest rate by 0.25 of a point, to 3%, for the first time in about seven years on July 13 -- a few weeks after the Brexit referendum. Malaysia is expected to trim the rate further in the second quarter of 2017, but there is a chance it will do so again within 2016.

Indonesia reduced interest rates four times in 2015, and a further cut to 5% is expected in the fourth quarter of 2016. Thailand is seen making a cut to 1.25% in the fourth quarter of 2016, after reductions in both March and April last year. China is also expected to carry out a cut of 0.25 of a point, to 4.1%, in the fourth quarter of 2016. China lowered its key rate five times in 2015.

Last year, Asian countries faced currency depreciation in anticipation of higher interest rates in the U.S. That is not the case in 2016. In addition to currency stability, inflation rates are within the scope of official expectations. As a result, central banks are now well-positioned to cut rates.

Only the Philippines is expected to carry out a rate hike in the fourth quarter of 2016, to ward off higher inflation and prevent the economy from overheating.

Tsuyoshi Minami, Hiroyuki Motegi and Yukiko Nakajima contributed to this article. 

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