- November 29, 2021
- Posted by: admin
- Category: Centennial Asia Insights
Highlights from the CAA Weekly Table:
COVID-19 and the omicron variant: don’t rush into pessimistic conclusions
- The omicron variant has shaken confidence in the economic recovery. But, note that medical experts have cautioned against drawing conclusions until more tests are done. Note, too, that while governments have imposed renewed border controls, they have been generally loath to tighten domestic restrictions. Moreover, medical progress continues to give hope that the dangers associated with the virus can be further contained with time.
Asian economic prospects:
- China’s industrial profits continue to grow, suggesting that the corporate sector stresses are probably contained and not likely to prompt policy makers into large-scale stimulus.
- South Korea’s economy is improving sufficiently to allow the central bank to mount further rate hikes but the timing may depend on other factors including the presidential election.
- The Philippines’ fiscal is likely to undershoot the target.
Asian currencies more resilient against Fed policy normalisation
- With inflationary pressures raising the risk of faster monetary policy normalisation in the US, concerns are rising about the impact on Asian currencies.
- We think that the worst is over for these currencies. The SGD, VND and TWD should continue to benefit from export strength, the alleviation of shortages and the reopening of borders.
Singapore: stars are aligned for new policies in 2022
- Three factors – brightening economic prospects, the political timetable and the need to respond to post-covid global trends – are set to prompt major policy moves in 2022. Sectors with a 17.5% weight in GDP are poised to rebound strongly while other sectors should benefit from secular trends. The political succession will be clarified by next year as well. Policy makers are keen to refocus their energies on preparing Singapore for the post-covid era.
- Look for more monetary tightening in April, an announcement of a GST rate hike in February and more signals on a wealth tax and carbon pricing. Some political reforms are also likely.
Key Drivers of Asian Economies
How worried should we be over omicron?
What does the omicron variant change in terms of economic outlook?
What has not changed is instructive
China: industrial profits continue to grow
South Korea: More rates hike to come in 2022
Assessment: The only way is up for rates, but how high will it go?
The Philippines: fiscal position in good shape
Assessment: Fiscal deficit likely to undershoot relative to target this year
The renomination of Federal Reserve Chairman Jerome Powell for a second term has fed into growing expectations that the Fed could expedite the normalisation of monetary policy, starting from an acceleration of the tapering of asset purchases, which was due to conclude by mid-2022 and may now be brought forward to end-1Q22. This became all the more salient after the PCE index, which is the Fed’s go-to measure to assess price pressures, rose 5% y/y in October.
Core PCE (i.e. PCE less food and energy) was also strong, rising 4.1%, adding to growing evidence that supposedly transitory inflation risks becoming more entrenched. Markets are now pricing the first rate hike by June 2022, well ahead of the Fed’s initial dot plot suggesting an fine split in the timing of normalisation between 2022 and 2023. The December FOMC meeting will shed more light on the Fed’s plans for tightening, though this has to be weighed against the emergence of the new Omicron variant, which cast a pall over the ongoing recovery, particularly if the variant, with its bevy of mutations, is able to evade the antibodies cultivated by vaccinations or natural infections.
Asian currencies have taken a beating
Covid-19 was the single-most important indicator in predicting the performance of Asian currencies in 2021. This stems from the fact that the output gap has closed in the US (though labour market slack is still a concern for the Fed), and the relative outperformance of developed markets have piled downward pressure on Asian currencies. Talk of the Fed normalising monetary policy has not helped things either, as it threatens to worsen yield differentials with Asian economies at best; at worst, central banks that refuse to move ahead of or in tandem with the Fed for purposes of keeping monetary conditions accommodative risks a run on the currency as yields creep up.
- Only the Chinese Yuan (+1.1% YTD) and the Taiwanese Dollar (+2.1%) have held up this year, thanks to the stellar management of Covid-19 by the respective authorities. China’s zero-Covid approach helped keep death rates low, but the medical naivety does raise concerns that Beijing is merely delaying the inevitable, and a gargantuan wave will eventually overwhelm dilapidated and under-funded hospitals.
- All other Asian economies are laggards but there is clearly some differentiation in terms of the relative risk profile. Singapore (-4.1%), Malaysia (-6.2%), Indonesia (-3.0%) and the Philippines (-5.1%) have only seen moderate outflows. Rising commodity prices and solid export strength help explain why the currency has held up. The other piece of the puzzle lies with collapsing caseloads in once-hard-hit economies such as India (-1.5%), which more than offset the negative sentiment stretching from hefty energy prices. Vietnam’s manufacturing prowess (-1.7%) was a formidable offset for a time, before buckling under the pressure of the relentless rise of caseloads amid medium-concerns that labour shortages are holding back the manufacturing sector.
- Thailand (-12.1%) and Korea (-10.3%) have stood out, albeit for the wrong reason. With tourism in the doldrums, the recovery in the Thai economy has lagged the region, which also shows up in external accounts, as we elaborate below. As for Korea, a perfect storm arising from rising caseloads, the prospect of hitting “peak growth”, and shortages that have hit prominent tech champions such as Samsung and SK Hynix meant that the Won has been particularly vulnerable to capital outflows this year as investors took stock of Korea’s growth outlook moving forward.
- Besides currency weakness, the uncertainty over the interaction between growth and stability (from stirring prices) plays out in currency volatility. This also implies central banks have turned to currencies as a shock-absorber, as opposed to smoothing out the shocks through reserves which is not case, given the bountiful reserve accumulation since the outbreak of the pandemic, as we elaborate later. On this metric, the Won (1.6), Rupiah (1.6) and the Thai Baht (1.5) have been most volatile; the Rupiah’s inclusion may come as a surprise, given its modest depreciation this year. But it also points to the constantly shifting expectations among investors of Indonesia’s growth prospects with the rise and fall of Covid-19 caseloads, as well as hefty commodity prices that are now under threat with a slowdown in the Middle Kingdom.
That said, we should point out that currencies that have lost significant ground should start to witness a recovery in 1H22 on the back of several common denominators that will lift all boats.
- Commodity prices should remain elevated through 1H22, which should undergird the Rupiah and the Ringgit. Solid demand for manufactured exports will also buoy other Asian currencies such as the Baht and the SGD.
- The reopening trade, on the back of the reopening of borders, albeit in a measured manner, will be a positive for economies reliant on tourist footfall. Singapore and Thailand should be main beneficiaries, assuming the new variant does not put paid to hopes for a further reopening of borders.
- The alleviation of shortages, especially in the electronics and tech sector, should lift the currencies of exporters with a footprint in tech. In this vein, the Korean Won, Singapore Dollar and even the Taiwanese Dollar could come under appreciation pressure as well.
What could jeopardise our hitherto optimistic scenario lies in 1) an aggressive tightening effort by the Fed that entails gyration in financial markets as debt servicing costs soar and 2) the new variant turns out to be more transmissible (which appears likely) and is able to evade the antibodies induced by the vaccines (which is unclear at the moment). Note that both are tail events, for now, but the risk calculus is very fluid and in flux as new information comes in.
Look past the recent currency weakness: fundamentals are sound, alongside strong buffers
Besides the headline currency weakness, the reserve accumulation by central banks and the external imbalances point to the solid fundamentals that underpin Asian economies and their respective currencies. As such, there is less room for concern over the uncertainty from the Fed’s plans for tightening vis-à-vis 2013’s taper tantrum, which threw many EM currencies into a tailspin.
- In terms of reserve accumulation, the MAS (61.3%), Vietnam (28.1%) and the RBI (40.1%) leads the pack. MAS’ seemingly aggressive reserve accumulation comes as no surprise, given the managed float framework, as is the case for the interventionist State Bank of Vietnam (SBV). As for India, it is likely the RBI was sterilising inflows of portfolio investments that propelled the BSE to stratospheric levels stemming from optimism over India’s upbeat near-term growth prospects.
- Other East Asian economies have also seen a moderate uptick in reserves under the central bank’s belt, which includes the likes of Taiwan (14.1%), Korea (10.8%), the Philippines (21.9%), Malaysia (8.9%), Indonesia (7.7%) and China (3.3%). Given the stellar and resurgent export receipts, central banks were turning to currencies as a shock absorber, as opposed to running down reserves to prop up the domestic currency, which explains the seemingly disjointed picture involving reserves and currency weakness. Only the Bank of Thailand (-5.7%) has expended some of its reserves, and even so, the weakness in the Baht indicates that the currency would have been much lower if not for the BoT’s intervention.
- Insofar as fundamentals are concerned, the conducive external environment has been a blessing for this part of the world. Rising commodity prices have translated into a positive terms-of-trade shock for net energy exporters, such as Malaysia (+3.8%) and Indonesia (+0.2%). Depressed investments help explain why the same phenomenon has not led to a widening current account deficit in the case of India (+0.5%). Moving forward, still-stirring export strength and the revival of tourism will provide another layer of insulation for Asian economies, particularly in the case of Singapore (19.4%) and Thailand (-2.3%) where the sizeable leisure and hospitality sector has been in deep-freeze for close to 2 years after the border closures. Vietnam (-2.2%) booked a rare current account deficit, as Covid-19 has hit the goods trade, which is the key plank of Vietnam’s external accounts. That should normalise once Covid-19 comes under control in 1H22.
In terms of the output gap, the recovery across East Asia continues to lag the developed markets. Singapore’s stellar management of Covid-19 meant that output has finally converged with pre-pandemic levels, though the labour market recovery has been largely uneven. The rest of Southeast Asia is still plotting a recovery underpinned by widespread vaccination rates and the continuing imposition of social distancing measures that will keep the retail sector under a cloud.
- The Indonesian Rupiah, where inflation has been persistently lower than target, could be an outperformer in 1H22, particularly if commodity prices remain elevated. BI’s insistence on tightening ahead of the Fed should preserve yield differentials vis-à-vis the US.
- The Thai Baht should start making up for lost ground as borders are opened to facilitate regional travel. As the laggard in the region, the recovery momentum should perk up in the coming quarters, and the revival of tourism will nudge the current account back toward the black.
- Political uncertainty in 1H22 meant that the Indian Rupee, Korean Won, the Philippine Peso and the Malaysia Ringgit may still trade sideways and remain range-bound, despite the fact that all three have come under depreciation pressure over the course of the year. Even this will pass however, once the respective national elections (Uttar Pradesh state for India) conclude in earnest by 2Q21.
- Putting it altogether, the SGD, VND and TWD have been the outperformers in the region as Covid-19 comes under control, and export strength feeds into the currency. The alleviation of shortages should help the VND find its footing in the near-term, as is the reopening of borders and tourism for the SGD.
- The Ringgit, Thai Baht, Korean Won and the Chinese Yuan have been middling through, according to our Z-scores. Given the backdrop of China’s draconian zero-Covid measures and financial explosions in the property sector, sustaining the CNY strength will hinge on the opening of the monetary spigot by the PBoC with more rate cuts. A robust external sector, particularly in commodities (for MYR) and tourism (for THB), should undergird the respective currencies.
- As we have noted in previous weeklies, the Rupiah, Rupee and the Philippine Peso are notable laggards when it comes to external imbalances. But here, we should see a divergence, between the IDR and both the INR and PHP. An improving external position and a hawkish BI should lend support to the Rupiah. As for India and the Philippines, political temperatures are set to rise sharply ahead of the looming Uttar Pradesh and Presidential elections, respectively. Investors will parse the results with an eye on any possible loosening of fiscal purse-strings, which cannot be ruled out if the incumbent BJP loses momentum in UP, or Bongbong Marcos, who favours fiscal injections, sweeps the presidential polls.
Singapore: stars are aligned for new policies in 2022
Unless the omicron variant proves to be far more horrible than we expect, three factors are shaping up to produce a series of important policy changes in 2022: (a) The economy is not just steadying but is poised for a strong recovery in 2022, making the coming year a propitious time to make big changes; (b) from the perspective of the political timetable, it also seems to us that 2022 might be the right time for important policy initiatives; and (c) Singapore’s economic restructuring in response to trends in the global economy, delayed for two years by the pandemic needs to be stepped up. In other words, 2022 could be a year when there could be greater policy clarity on some issues that have hung over the economy for some time such as the timing of the GST hike and there could also be more substantive measures to ready the economy for the post-covid future.
1. The economy is gathering strong momentum
The estimate for 3Q21 GDP growth was revised up to +7.1% y/y from the advance estimate of +6.5% y/y given in October, signalling the upbeat trajectory in the economy. Sequentially, the economy expanded at a relatively robust clip (+1.3% q/q), which is a reversal from the contraction of 1.4% q/q in the previous quarter. A number of features of the economy are worth emphasising:
Good chance of sharp spurt of activity in some sectors: Barring unexpected shocks, prospects for 2022 are good as the global economy recovers and domestic activity revives as covid-19 related restrictions are eased. We estimate that 17.% of GDP is in sectors where output is substantially below pre-pandemic levels and which can snap back sharply if cross-border travel revives and domestic consumer spending returns to normal.
Current indicators show strong growth: Industrial production surged 16.9% y/y in October, rebounding from a contraction of 2.2% y/y in September. The expansion was led by growth in the biomedical manufacturing sector (+56.1%), while growth in the electronics sector (+6.5%) and precision engineering sector (+9.1%) eased slightly. When biomedical manufacturing is excluded, overall IIP grew by 9.7% y/y. The chemicals sector (+15.3%) and transport engineering sector (+35.3%) displayed marked improvement as well.
Leading indicators are mostly positive: The composite lead indicator fell by 0.1% q/q in 3Q21, after rising 0.9% in 2Q21. This suggests some moderation in growth in the next two quarters. Similarly, the Economic Development Board’s survey of manufacturers showed a net weighted balance of 16% of manufacturers expect conditions to improve between October and March next year, a little below the 20% net weighted balance in 2Q21. However, the mood in services is brightening with the Department of Statistic survey of service sector businesses showing that net weighted balance of services firms expecting a more favourable business outlook rose to 19% from 11% in mid-year.
The net effect of the above factors is that the economy has a very good chance of a rapid return to trend levels, such that the output gap could turn positive sooner than expected, by the middle of the year.
Stability indicators also point to policy change
A positive output gap would raise inflation risks: Indeed inflation is already rising, coming in at +3.2% y/y in October, up further from +2.5% y/y in September. Core inflation continued on its ascent (+1.5%), rising to its highest in 3 years. The surge in prices was mainly driven by private transport (+1.6%) and housing (+2.7%). Recreation (+2.1%) and education (+1.6%) also saw a notable uptick, while food prices (+1.7%) increased marginally. In addition, as the economy reopens, higher airfares and holiday expenses have driven up the price of services too (+1.6%). The persistence of global inflationary pressures and the rising likelihood of the
The largest current account surplus in five years could suggest that the exchange rate needs to appreciate: The current account surplus soared to 21.6% in 3Q21 (2Q21: 20.8%). The increase was driven by an overwhelming surge in the goods balance, which more than offset the moderation in the services account as remittances and repatriation of profits.
2. The political calendar also suggests that 2022 could be the time for policy moves
Over the weekend, Prime Minister Lee Hsien Loong indicated that the next generation of leaders will need more time before they settle on a successor to him. Although this has increased uncertainty about the succession process, our take is that the succession will be decided sooner rather than later, given the political timetable:
- The ruling People’s Action Party (PAP) holds its leadership elections for its Central Executive Committee (CEC) every two years. That means that the next opportunity to restructure the party’s leadership will be some time around November 2022. It would make sense to have a new leader announced by then so that the new CEC composition reflects the new leadership team.
- The next presidential election is slated for around August or September 2023. Although the office of the president does not carry much political power, the president does have significant powers over key appointments in the civil service and judiciary as well as a say over how the country’s gargantuan financial reserves are deployed. It would be neater for a new prime minister to be in place before there is a change in the presidency.
- The term of the current parliament ends around October 2023 by when a general election has to be held.
Given this time table, our guess is that the PAP would want a successor to Prime Minister Lee announced before the end of 2022 and in place soon after.
Why do we think this is important for policy making? One reason is that Lee had indicated in the past that he saw it as his duty to bring in difficult policy changes before he left office, rather than burden his successor with such decisions. Given our guess as to the succession timing, then it follows that Lee would want to clear the decks by introducing big changes before he leaves office. Moreover, Lee may want to cement his legacy by introducing necessary changes as well.
All in all, the political dynamics point to 2022 being a consequential year for policy changes.
3. The need to respond to global trends
Even before the pandemic, it was clear that Singapore needed to adjust its growth model in view of geo-political and technological shifts in its environment and to address domestic weaknesses such as weak productivity growth and rising inequality. There had been attempts such as the Emerging Stronger Task Force and the Committee for the Future Economy to address these issues but these left many observers dissatisfied. Now that the pandemic has accelerated some of the trends in the global economy, the need for more thorough-going strategic responses has become clearer. Our impression is that the Singapore leaders appreciate this and are keen to re-focus their attention on these structural issues and not be distracted by the management of the pandemic.
So, what should we expect?
Further monetary tightening in 2022
The latest figures for Singapore came in stronger than expected, where growth was not only led by a strong performance in the manufacturing sector but was also supported by construction and services. In addition, overall exports remained buoyant as growth came in at 22.7% y/y in October, up further from +18.6% in September. As such, we expect recovery to continue through to 2022 on the back of resilient exports and manufacturing. Furthermore, as the country approaches an endemic equilibrium, domestic demand is expected to catch up, further boosting growth in the process.
With recovery well underway, we reiterate our expectation that the Monetary Authority of Singapore (MAS) is likely to tighten monetary policy again in April next year by allowing the Singapore Dollar Nominal Effective Exchange Rate (SGDNEER) to appreciate at a faster pace as inflationary pressures mount in both external and domestic settings.
Fiscal policy changes
The Finance Minister will deliver his Budget 2022 in February. We expect a number of important changes to be set out:
- First, the increase in the goods and services tax (GST) rate from 7% to 9%, which the government has been signalling for a long time. In a speech in October, the Finance Minister noted that the rate increase would be made sooner or later but more likely sooner. We think that was a hint that the GST rate hike will be announced this coming February, for implementation in January 2023. Aware of rising prices eating into the spending power of Singaporeans, particularly, lower income ones, the government will combine the GST adjustment with substantial measures to alleviate the impact on the lower income groups. This will take the form of GST vouchers and other transfers.
- Second, the government is conscious of the need for more measures to tackle inequality and to assist the disadvantaged segments of society. Both the Prime Minister and the Finance Minister have flagged the need for some kind of wealth tax. But both leaders have also acknowledged the difficulty of designing a wealth tax that achieves its purpose without damaging Singapore’s position as a wealth management hub. We suspect that no hard decision will be made but that a number of ideas will be floated – such as an enhanced property tax – for further study.
- Third, the government probably recognises that Singapore is not where it should be in terms of carbon pricing. More fiscal measures to further the process of decarbonisation are likely.
- Fourth, the government is likely to set out how it proposes to respond to global efforts at a minimum corporate tax. Singapore has long used tax incentives to attract multinational enterprises to locate in Singapore – as such tax incentives come under greater scrutiny, other measures might be needed to maintain Singapore’s attractiveness to global corporations.
Growth model: expect tweaks, no fundamental overhaul
Government efforts to promote Singapore’s continued development have had their share of success. Despite the pandemic, Singapore has become a centre for start-ups with many young companies which started in regional countries finding Singapore a good base to relocate to, to raise capital and find talent as well as to leverage off its extensive free trade agreements to expand into other markets. There has been particular success in the fin tech space, where the Monetary Authority of Singapore’s carefully balanced strategies have succeeded in an eco-system that has spawned a number of potential unicorns.
Singapore has also benefited from more business and financial operations being relocated to Singapore. Some of this has come from Hong Kong but Singapore’s success goes beyond just Hong Kong’s political misfortunes. Singapore has built a critical mass of interlocking activities in its global hub which makes it highly competitive.
However, we believe that the growth model is not up to the task of addressing significant weaknesses in the domestic economy – weak productivity growth, insufficient entrepreneurship including an indigenous corporate sector that appears to have lost its dynamism and an inadequate capacity to turn largescale mobilisation of inputs for innovation into actual innovation outcomes. So far, we have seen little hint in ministerial pronouncements of an appetite for fundamental changes to address these flaws.
Political reforms likely
The Prime Minister’s speech over the weekend repeated themes that many senior leaders have been raising over the past year, reflecting a concern over social harmony. There has been much focus on racial discrimination and the role of the minorities, for example. We believe that new legislation will be brought in to update existing laws to preserve ethnic harmony. The Prime Minister also mentioned the need for more efforts at women’s empowerment.
In short, we expect 2022 to be a year when important policy changes will be introduced as a prelude to the political succession.