ASEAN Cracks Break Presumed Protective Spell

MSCI’s EM ASEAN index is down 4.1% through end-May, dragged down by Indonesia, Malaysia, and the Philippines, while the broad EM Index has gained 6.5%. Another wave of Covid-19 lockdowns and elevated debt and deficit levels hurt equity market performance, while in the region China, Korea, Taiwan and Thailand are in positive territory.  In the currency market, the PHP is flat against the USD this year, while the THB (-4.1%), MYR (-2.8%) and IDR (-1.7%)  lag due in part to the exit of some foreign investors from local stock and bond markets, reversing the massive inflows late last year.

As Malaysia enters another strict lockdown to stem soaring Covid cases, the government and analysts revised growth and deficit forecasts. After the economy contracted 5.6% last year, the central bank was forecasting expansion of 6-7.5%. While the total lockdown allows manufacturing at reduced levels, growth is now likely to be less than 4% after a 0.5% contraction in the first quarter.  The fiscal deficit will now top the earlier planned 6% of GDP level after the government announced a new USD 9.7 billion stimulus and aid package which includes cash handouts to the poorest households. The current program brings total spending since the start of the pandemic to more than USD 82 billion, according to the Prime Minister. The central bank has only bought USD 2 billion, 0.6% of GDP, of local government bonds since the start of the pandemic but larger than expected issuance caught commercial holders off guard and may spur further buying.  On the stock market, retail investors have been the swing buyers this year, investing net USD 1.5 billion through end-May. In contrast, domestic institutional and foreign investors have sold net USD 824 million and USD 741 million, respectively, sending the market down 6.5% in USD terms. After FTSE Russell decided to keep Malaysian bonds in its World Government Bond Index at end March, overseas buyers upped purchases the next month.  As of end-April, foreign investors held 15% of outstanding debt securities and 40% of government bonds.

Indonesia’s stock exchange is down 7.5% despite record low interest rates, with inflation comfortably below 2% even with the currency’s depreciation.  Foreign investors have withdrawn more than USD 8 billion from the local bond market this year, reducing their holdings to just over 20% from nearly 40% last year. The central bank stepped in to stabilize the market, buying bonds in the primary market, and now holds more than non-residents at USD 44 billion, 3.8% of GDP. After the government suspended the budget deficit ceiling of 3% of GDP last year, it soared to over 6%, almost three-times the 2019 level. USD 50 billion went to the National Economic Recovery program and limited GDP contraction to 2%. Now a tax package is being debated to close the budget gap, with the business community opposing a hike in the value-added tax, arguing that after 4 quarters of GDP declines higher levies would hurt recovery prospects. The government is targeting GDP growth of 4.5-5.3% this year, widely seen as optimistic as the country continues to battle an increase in Covid-19 cases.  Indonesia has for a decade recorded current account deficits, but in 2020 it narrowed to 0.4% of GDP from 2.7% a year earlier. Widening again is in the cards as consumption picks up later in the year and will reintroduce rupiah pressure.

The Philippine Stock Exchange fell nearly 6.5%, but the PHP is up 0.5% against the dollar through end-May. The bourse opened June with a record-breaking USD 1 billion-plus IPO by Monde Nissin, the country’s best-selling instant noodle maker. It was 4-times oversubscribed, with foreign institutional participation, and came as a proposed Capital Market Development Act works its way through congress, along with proposed tax code simplification for passive income and financial intermediaries.  Strict lockdowns on Covid waves have resulted in five straight quarterly economic contractions.  GDP plummeted by a record 9.6% last year and a further 4.2% on an annual basis in Q1. While the government targets growth of 6-7% this year, a slow vaccine rollout combined with a strict 2-month lockdown in Manila and surrounding provinces from March-May will at best halve the forecast.

The central bank has been the most active government debt buyer in the emerging markets universe. Since March 2020 it has purchased more than USD 35 billion, 8.7% of GDP. The QE, lower bank reserve requirements, and bottom interest rates have not spurred bank lending, down 5% on an annual basis in April, the fifth consecutive monthly contraction. The drop is due to lack of demand and bank reluctance as non-performing loans grow. Despite a spike in public debt from 35% to almost 50% of GDP, Standard and Poor’s affirmed the sovereign’s BBB+ rating with a stable outlook on “ good economic recovery prospects once the Covid-19 pandemic is contained.” External accounts are healthy with a record high 2020 current account surplus of 3.6% of GDP on a lower trade deficit and healthy remittances. FX reserves at over UISD 100 billion cover more than 10 months imports.

The latest Covid-19 mobility restrictions and erratic vaccine rollout across these Asian markets will continue to hit domestic demand, although strong growth in the US and China will boost exports. They take 30% of commodity and merchandise shipments from Indonesia, Malaysia, and the Philippines, as labor and transport issues cramp supply chains.  Stock markets are hostage to economic recovery behind Asian neighbors, as foreign investor bond market scrutiny latches on to elevated debt and deficit levels. The sub-region’s safe haven asset allocation preference is in doubt this year, and geopolitical/refugee spillover from a Myanmar civil war could relegate it to the sidelines indefinitely.

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