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2004 positive for SEA but risks remain

THE year 2003 has been a tough, but productive, one for Asia. The SARS and the Iraq war kept us on the defensive in the first half of the year. It was really not until the fourth quarter when the optimism we had been heralding finally appeared. 

One is naturally tempted to extrapolate this buoyant optimism into 2004. The US economy is finding a new lease of life with investment demand – crucial to the recovery's sustainability – increasing significantly, Japan is doing very well. And it is difficult to find anybody saying anything negative about China's rise at the moment – unless you happen to walk in the corridors of the US Senate where “stolen” jobs top the agenda. Only Europe seems to disappoint repeatedly. The good news is that none of this looks likely to change in 2004. 

But as investors, both individual and corporate, we should recognise that the world economy is walking several tightropes. In the United States, there is a trade-off between strong growth, which puts increasing pressure on the current account deficit and thus the country's funding requirements, and the dollar's decline, which mitigates these pressures but increases the burden of adjustment on those countries whose currencies are appreciating. 

Steve Brice

This brings into question the burden that the three major economic zones are willing to bear. So far, Japan and Europe have allowed most of the foreign exchange adjustment while Asia has remained firm in its desire for currencies to remain relatively weak. Forex tensions, and with them trade tensions, are likely to only increase going forward with Asia's role in the debate increasing. 

The best way out for the world economy is a continued gradual reduction in external balances via a shared dollar decline. The worst solution is for this to be effected by a sharp slump in US imports via a recession. Unfortunately, we feel no more confident now that this can be averted than a year ago with the loose fiscal and monetary policy settings countering the effects of a weak US dollar by spurring domestic spending. 

Meanwhile, the reliance on Chinese investment is increasing. This is evident from the strong export growth to China from all countries in South-East Asia over the past two years. With China's investment approaching a similar percentage of gross domestic product (GDP) as Thailand's in the pre-crisis period, this reliance must be a concern. 

Of course, if the Chinese authorities were able to increase the economy's dependence on consumer spending, then this would become less of an issue. And time is still on the authorities' side with no signs that the investment bubble is bursting yet. However, this is a risk we should remain alert to. 

Enough bad news. After all, the New Year is meant to bring with it hope, not fear. This year promises to build on 2003's successes as the recovery becomes broad-based. Cyclically, Thailand will continue to show the rest of the region the way, with growth accelerating from 2003's impressive 6.3% to a whopping 7% in 2004, second only in Asia to China's forecast 7.7%. Vietnam comes in at a close second at 6.8%, followed by Malaysia (5.5%), the Philippines (4.8%), Singapore (4.5%), and Indonesia (4.3%). 

The first thing that is clear is that all the South-East Asian growth numbers (apart from Vietnam's) are an improvement on those posted in 2003. Also expect growth to be more balanced within the economies with exports and investments (both domestic and foreign) firming while governments start withdrawing the fiscal stimulus that has characterised the post-IT bubble era in the region. 

Central banks are also likely to become less accommodative; a direction reinforced by the outlook for US interest rates to rise from the first quarter. However, in most countries, inflation will remain relatively benign and interest rate rises will be moderate. 

In this environment, economics is likely to be supplanted by politics as the major concern. Malaysia, Indonesia, Thailand, and the Philippines all face elections in the next 12–18 months. Of these, a change in power is possible in only two countries. 

Domestically, the elections will really give us an idea of how secure the new Prime Minister is. His initial performance suggests that a two-thirds majority is the most likely outcome and will keep infighting at bay for now. In Thailand also, only the size of Thaksin Shinawatra's victory is in doubt given the domestic economic boom and his strong management of the political situation.  

This leaves Indonesia and the Philippines. In Indonesia, President Megawati Sukarnoputri is seen likely to be returned by the vast majority of political analysts. While we concur with this opinion, a lot can happen before the second presidential vote likely in September. In the Philippines, it is still anybody's guess as to who will win. At the moment, both the ruling president's and the opposition's votes are being split (by Raul Roco and Panfilo Lacson respectively). Anything that changes this equation, together with the naming of running mates (watch Noli de Castro's moves in particular), will be crucial. 

In summary, the outlook for 2004 is promising. But it is important that we do not get lulled into a false sense of security. Outside of the economic and political risks highlighted above, terrorism and the threat of conflict are never far away. 

While the world has proven remarkably resilient to these events in recent months, this is never something to be taken for granted, especially when global growth is still relatively imbalanced.