China’s process of becoming a two-way bet

The People’s Bank of China (PBoC) on Saturday announced the widening of its allowable renminbi trading band to +/- 2% from its daily fixing rate (from +/- 1%), effective as at March 17. This is just the latest step on the part of Chinese policymakers to creating a more market-driven financial system, and curbing speculative capital flows based on potentially erroneous risk assumptions. 

Indeed, today’s decision comes after several weeks of heightened currency volatility that had led to widespread expectations that authorities would alter the trading regime. Moreover, the recent depreciation in the currency has also gone some way to negating the view that the yuan is a ‘one way bet’, with speculators engaging in a carry trade of borrowing cheaply offshore and investing at higher rates domestically (inflated export receipts and ample hot money flow data are often cited as evidence of this). Add in the recent default on a 1b CNY domestic bond by Shanghai Chaori Solar Energy Science and Technology, and heightened domestic conversations around the financial solvency of trust products, and the Chinese authorities appear to be guiding markets towards the message that they will no longer provide the same implicit backing to private market (and particularly speculative) activity, and that perceptions of risk must adjust accordingly.

These actions are all compatible with the gradual opening of the Chinese capital account, one of the key pillars of reform that is expected to occur over the coming 5 years (longer-dated hukou, SOE, and local government reforms will be potentially more difficult to achieve).  Yet the multi-billion dollar question will be what the net impact of Chinese capital account liberalisation will be?  The dominant view from economists within China is that opening will result in a large inflow of capital aimed at taking advantage of high interest rates.  Indeed, in one of the few quantitative studies to address this, IMF economists Bayoumi and Ohnsorge (2013), estimate net portfolio inflows of 2-10% of GDP.  And yet they simultaneously predict a net portfolio adjustment of between 15-25% of GDP in outflows as Chinese investors globally diversify their ample savings.  That is, a net outflow of 11-18% of GDP. 

Given the sheer magnitude of this process, and the potential ructions for the entire global financial system, getting the process ‘right’ (and managing market expectations) will be crucial.

Women in the workforce and the future of growth

March 8th was International Women’s Day, a day when much is said about the role of women in society, including female empowerment through, and in, the labour force. With this in mind we can step back and consider not just the personal and microeconomic implications, but also the macro consequences of varying female workforce participation in Asia.

Excluding, for a moment, the communist countries of China and Vietnam where government ideology and policies notably altered workforce dynamics, Thailand (and IndoChina broadly) actually ahs the highest rate of female participation in the region, and indeed one of the highest in the world given its level of economic development. In contrast, Malaysia has one of the lowest, even lower than neighbouring Indonesia. This has numerous implications.

First of all, Thailand’s demographic profile strongly resembles that of (better known) CHina. The working age population has started to shrink in response to a long-hence fall in the fertility rate (in part due to the pioneering familyb planning work of Mechai Viravaidya), the country is potentially reaching a point of social saturation with the level of immigration (not to mention improving economic prospects will likely see some emigration back to Myanmar), the number of women in the workforce is close to maxed out, and it is unclear if, as is the case in China (but interestingly not Japan) poor health outcomes in the older generation make extending the working lifespan an infeasible solution. In short, growth can no longer come from labour force expansion. Indeed, the Asian Development Bank estimates that the ‘demographic dividend’ enjoyed in much of Asia for the past 30 years will, for Thailand, shift to a demographic tax of 0.9ppt off trend GDP growth, which would leave Thailand growing old before it grows wealthy. Indeed, one way of viewing the growth slowdown in China since 2008 is not only the diminishing returns and productivity of infrastructure ivnestment, but also the peaking and subsequent diminishing of labour supply. But returning to Thailand, a quick glance at the indicators in Thailand defintely point to a tight labour market, with an unemployment rate consistently below 1%, and still solid private sector wage pressures despite extended sluggishness in the real economy.

In short, what this means for Thailand (and China) is the need for a substantial lift in productivity growth. A shift (in Thailand) away from subsistence farming in what is still a heavily agricultural country (66% rural population), a shift up the value chain away from textiles and lower value-add manufactured goods, heavier investment in secondary and tertiary education and training as has been advocated by the World Bank, put simply, Thailand needs to redefine its competitive advantages over the next decade to meet the demographic challenges.

Doom and gloom, however, is not the only consequence of these demographic dynamics. Rather, the propensity in Thailand towards high workforce participation and few children (factors that, from an economic development standpoint tend to be causally related) – Thailand has a below-replacement fertility rate of 1.4 children per woman – creates an interesting consumption pattern as well, from a larger pool of double-income families with few dependents. Or in other words, a mass of Thai households are now reaching the age and income maturity where financial services, property, and discretionary consumer goods will become increasingly important, fuelling stronger growth rates than, say, children’s products or non-discretionary items. The Thai consumer story has been well recognised by the market (and by industry, with a supply response already well advanced), the demographic impact on the financial services and property sector, however, has not. The consequences are not just for sectoral growth rates, however, but also for the sustainability of debt, where the systemic vulnerability of higher household debt levels (over which much concerned ink has been spilled) is lessened (improved) in an environment of two wage earners in secure employment.

Which provides us with a neat contrast point back to Malaysia, where debt servicing ratios are higher (~45% of income, vs ~32% in Thailand), the ratio of women in the workforce is much lower, and fertility rate higher. That is, Malaysians are supporting a similar household debt to GDP ratio, but in an environment of many more single income multiple dependent households, making the sustainability of debt growth lower, along with discretionary purchasing power weaker. That is, the same underlying consumption support and shift in consumer behaviours are unlikely to occur in the same manner in Malaysia owing to differing demographic, particular gender-related, dynamics.

The positive story for Malaysia (and notably India) however, comes from any ability of the respective governments to push pro women in the workforce policies, something which Malaysia noted in its 2014 Budget but is yet to bare fruit on implementation. This dynamic could provide a substantial uptick to long-term growth rates.

In short, there is a lot more than empowerment at stake in female workforce participation.

Indonesia on hold, but cutting growth to market

The Bank of Indonesia (BI) today held its key policy rate at 7.50%, as was widely anticipated by the market. Indeed, with the currency easing to 11,387 USD/IDR and 10 year government bond yields down 100bps to 8.05%, it is clear that capital flows have again turned in Indonesia’s favour, placing no pressure on monetary authorities. Indeed, perhaps indicative of a changing attitude within the BI, the accompanying policy statement even included the phrase that the BI may ‘stimulate the economy in a more balanced direction’.

And these cheers of joy are largely coming on two fronts. First, inflationary pressures appear to be easing (albeit I would still highlight that it is unlikely that the 4.5% +/- 1% infation target for 2014 will be met), for now at least. Second, the CAD has improved, reducing fears of Indonesia as one of the ‘fragile five’ in emerging markets. What is interesting, however, is that the BI expects the CAD ‘will be managed at a level below 3% of GDP’, that is, implying very little further improvement from here.

I have of course, written on these dynamics previously. But what is more interesting news from today’s announcement is the BI’s lowering of its 2014 growth forecast to 5.5-5.9% (from 5.8-6.2%). This owed to softer consumer spending on earlier tightening measures, and less pre-election fiscal largesse, as well as softer than expected export growth (a topic we will examine in more detail at a later point).

Overall, with growth still disappointing, and external risks still notable, I remain near-term cautious on Indonesia.

The conundrum of Philippine bonds

Philippine inflation has been the source of some concern over the past few months as headline inflation exceeded 4% YoY. That said, with today’s inflation data stabilising, investors should again start to focus on the strong fundamental growth and liquidity story in the economy, further easing the jitters that had hit the local bond, equity, and currency markets.

Headline inflation eased slightly to 4.1% YoY in February (from 4.2% YoY in January), below market expectations, with most of the easing occurring as base effects from the 2013 introduction of the sin tax rolled off. Inflation rates across regulated utilities (namely, electricity), for some imported goods (given the weakness in the Peso), and a number of agricultural products (given last year’s natural disasters) remain elevated. However, importantly, core inflation eased back to 3.0% YoY (from 3.2% YoY in January), and the seasonally adjusted monthly trend in inflation is clearly softening.

This once again supports the view that the recent inflation spike has been largely a result of transitory factors – higher electricity tariffs, and the earlier impact of natural disasters in late 2013 – rather than the overheating concerns that markets have been waiting for. Indeed, the Philippine economy, almost uniquely across the emerging markets space, is still undertaking ample productivity improvements, investment and general capacity building to absorb demand-driven inflation pressures for now.

This should provide some reassurance to the recent volatility across Philippine markets. Government bond yields in the secondary market have already eased back, and the Treasury auction on Monday went much smoother than last month (when all bids for 182-day and 364-day bills were rejected, and 91-day bill yields jumped 80bps). Whilst yields are still uniformly higher than at the end of 2013, 91-day bill yields reduced to 1% (from 1.49% in February), and the 91-day and 182-day bill auctions were fully subscribed, although only 44% of the total available 364-day bills were awarded as the yield remained elevated at 1.86%. The currency has likewise retreated from its peaks.

Overall, I remain confident in the Philippine economy and markets. Whilst bond markets in particular reflect an exceptionally difficult valuation for offshore investors, the large amount of captive domestic liquidity should keep yield spreads (relative to US Treasuries) exceptionally narrow. Moreover the country, with strong internal fundamentals and external stability metrics, should remain fairly well insulated from emerging market turmoils.

Indonesian trade data puts a pause on the external rejoicing

After a strong run in bond and currency markets over the past couple of weeks, a proverbial spanner was thrown into the works for Indonesia today as trade data disappointed. And whilst it wasn’t all bad news, with headline inflation easing, some recalibration is still likely as markets again question just how significant external risks are for the country.

In the good news, headline inflation eased to 7.8% YoY in February, down from 8.2% in January, a fall that was largely attributable to better base effects and softer food prices. Core inflation, however, remained elevated at 4.6% YoY. It also appears that the full pass through from higher administered utility prices is yet to occur, and hence inflation is still a metric to keep an eye on over coming months.

The big news, however was the trade deficit again slipping into deficit at –US$440m in January after three consecutive months of trade surpluses (including a US$1.5b surplus in December). And the reasons were varied:

• First and foremost was a -34.9% YoY decline in the export of ‘ores, slag, and ash’ as the mineral export ban finally came into effect in January. Indeed the deterioration of the trade balance back into deficit largely reflected an unwinding of the prior build up in November and December’s surplus of mineral exports ahead of the impending ban. That said, this effect was substantially larger than the market had been anticipating.
• Moreover, strong domestic palm oil demand, coupled with ongoing soft soybean prices also played a role. with exports in the ‘animal or vegetable fats and oils’ category (Indonesia’s second largest export sector) down -26.0% YoY. This will be redressed somewhat, over February as prices have lifted on recent turmoil in the Ukraine.
• Finally, a number of other categories, such as ‘rubber and articles thereof’ and also ‘electronic, electrical and machinery goods’ exports were also softer, making this by no means a solely mineral export ban phenomenon. Overall, manufactured exports were down -2.3% YoY.

Indeed, the pattern of trade also strongly resembled the Thai data released last week, with exports to other ASEAN economies down significantly -20.6% YoY, whilst exports to developed economies such as the US and Europe were up modestly (1.4% YoY and 1.9% YoY respectively). The deterioration in the export sector, however, was partially offset by a -10.6% YoY decline in imports focused on iron and steel, autos, and some food categories. Indeed, raw and intermediate goods have seen the most substantial slowdown, reflecting the soft domestic demand environment.

In my view, a more sustainable monthly trade balance for 2014 will be between US$100-500m, equating to an improvement in the current account to between 2½-3% of GDP over the full year. The key question, however, is if this is in line with market expectations? Certainly it is a more stable deficit than appeared likely at the peak of Indonesia’s CAD fears in mid-2013, and owes in part to the policy action and adjustments undertaken over the past 9 months. But I also believe the market has gotten ahead of itself over the past couple of weeks, with much of the improvement in the Rupiah (and Rupiah bond markets) attributable to the better than expected improvement in the CAD over 4Q13 to 2.0% of GDP (down from a quarterly peak of 4.4% in 2Q13). This had been enough to put paid to investor concerns of Indonesia as a ‘fragile 5’ economy.

And yet, if today’s data is any indication, these fears are not yet (in indeed should not be) over.

Thai data in the doldrums

The Bank of Thailand’s (BOT) monthly Economic Conditions report continued to reflect a very weak economy buffeted by ongoing political turmoil. Indeed, consumption, investment, agricultural exports, tourism, and intra-Asia demand all appear to be turning down simultaneously, boding poorly for the Thai economy. However, despite the aggressive cyclical slowdown, Thailand should still avoid the worst of the capital outflow pressures and stability fears that have been felt across emerging markets, owing to strong fundamentals from the lessons learnt of the Asian Financial Crisis.

Private investment remains a key concern for the Thai economy, falling a further -0.3% MoM in January.  Moreover, business sentiment remains soft, and import growth has slowed sharply -12.9% YoY including a -16.9% YoY decline in capital goods. Loans growth, meanwhile, has fallen to single digits at just 9.2% YoY owing to a precipitous further fall in consumer lending activity, and still only 8.4% YoY business lending growth. FDI indicators, likewise, remain weak and worryingly, construction indicators are also starting to roll over with construction area permitted and cement sales both recording negative growth. Indeed, the BOT has noted that Thai businesses are not only suffering from lacklustre demand, but are deferring expenditures as a result of political turmoil. Also notable is weak consumer sentiment, including a significant deterioration in consumer expectations for their own incomes – usually a reliable predictor of household spending behaviour. In short, political turmoil is having a real and detrimental impact on Thai domestic activity, and I estimate a total GDP drag of ~-1ppt off growth over 2014.

That said, it is also worrisome that, unlike during prior periods (2006/07), exports do not look set to provide a safety net. Exports remain subdued at -1.5% YoY, as whilst the improved global demand environment is benefiting some product classes (electrical appliances, and machinery and equipment) and this is apparent in stronger exports to developed markets of US, EU and Japan; this has been insufficient to offset lacklustre demand from the rest of ASEAN, and also a roll-over in high Chinese export demand. In essence, soft EM demand is starting to hit the Thai export sector, at the same time as agricultural exports are also being hit at numerous sides, from weak global pricing through to shrimp disease, and may be so further impacted by drought conditions. Indeed, as a comparator the historical impact of the 2004/05 drought on Thai GDP is estimated at ~0.5ppt off growth. (Additionally, in solving what had been a mystery, the BOT noted that the recent fall in steel and metal exports reflected a “high base effect thanks to the repeal of anti-dumping measures by trading partners”).

That said, services exports and related spending comprise a significant chunk of the Thai economy (tourism is approximately 9% of GDP) and had, through 2013, provided a cushion to external accounts not experienced elsewhere in ASEAN. Yet on this front as well, ongoing political turmoil has resulted in a significant softening, with tourist numbers flat 0.1%YoY in what ought be a high season and the occupancy rate subdued. That the balance of payments remains in surplus largely owes to good timing, with 4Q and 1Q stronger seasonal quarters in (non-seasonally-adjusted) current account data.

That said, even with a modest current account deficit, as is likely to reoccur in 2Q14, I still have no major external stability concerns for Thailand. External debt levels remain manageable, reserves remain incredibly healthy, the Bank of Thailand has been an exceptionally strong macroprudential regulator and I have no concerns on the stability of Thai household balance sheets, and capital inflows under quantitative easing were mainly reflected in an appreciation of the Baht. As such, I expect further weakness in the currency without posing the kind of external risks as have been faced in Indonesia, and coupled with a likely further cut in the policy rate by the BOT.