spex issue 34

IN

COLLABORATION WITH

PROUDLY SUPPORTED BY

ISSUE 34

4 MARCH 2013 - Indonesia’s Growth Story - The Property Market Crisis in Vietnam - ASEAN’s Economic Integration: Looking at the EU, Should the ASEAN Region Integrate Faster and Further? (Part 1) The Fortnight In Brief (18th February to 3rd March) US: Sequestration

On March 1, President Obama signed into effect $85 billion in across-the-board cuts as congress failed to reach any last-minute agreements on an alternative proposal to deficit reduction. The IMF has cautioned against sequestration which is expected to slow the global economy, and is likely to cut U.S growth forecast by 0.5%. However, financial markets shrugged off concern over federal spending cuts with both the S&P and Dow seeing gains on the back of better than expected economic data. The ISM factory index rose to its highest since June 2011 at 54.2. Fed Chairman Ben Bernanke once again warned against a premature rate increase which may snuff out the delicate economic recovery. Asia Pacific: Less Scope for Indonesia to Cut Interest Rates

Indonesia’s inflation accelerated to a 20-month high of 5.31% in February, driven by higher food prices and power tariffs. This compares unfavourably to a survey of 18 economists’ estimates which placed expected inflation at 4.81%. Indonesia’s central bank has maintained record low borrowing costs at 5.75% for the past year in an attempt to bolster exports. The higher inflation reduces scope for central bankers to reduce interest rates.

EU: Review of Greece’s Performance

On March 2, officials from the EU and the IMF reviewed Greece’s performance as the government played down the prospect of public sector job cuts. Unemployment is at a record 27%. The government must transfer 25,000 employees to a mobility scheme by the end of the year if vacant spots are not found in the public sector. Finance Minister Stournaras commented that the public sector had already shrunk by 75,000 in the last 1.5 years, and there would be no further layoffs. Bankers have also asked for an extension to an end-April deadline to wrap up a scheme to restore the solvency of the country's four biggest lenders

SMU Political-Economic

Exchange

AN SMU ECONOMICS INTELLIGENCE CLUB PRODUCTION

280

282

284

286

288

290

292

2/1

8/1

3

2/1

9/1

3

2/2

0/1

3

2/2

1/1

3

2/2

2/1

3

2/2

3/1

3

2/2

4/1

3

2/2

5/1

3

2/2

6/1

3

2/2

7/1

3

2/2

8/1

3

3/1

/13

STOXX…

146014701480149015001510152015301540

2/1

9/1

3

2/2

0/1

3

2/2

1/1

3

2/2

2/1

3

2/2

3/1

3

2/2

4/1

3

2/2

5/1

3

2/2

6/1

3

2/2

7/1

3

2/2

8/1

3

3/1

/13

S&P 500

544546548550552554556558560562

2/1

7/1

3

2/1

8/1

3

2/1

9/1

3

2/2

0/1

3

2/2

1/1

3

2/2

2/1

3

2/2

3/1

3

2/2

4/1

3

2/2

5/1

3

2/2

6/1

3

2/2

7/1

3

2/2

8/1

3

MSCI AC…

© Copyright 2012 SMU Economics Intelligence Club

2

Indonesia’s Growth Story

By Anirudh Maru, Singapore Management University

The statues of Krishna and Arjuna, central characters in the Indian epic, Mahabharata, stand

in the center of Indonesia’s capital city, Jakarta. The iconic landmark depicts the legendary

characters in a chariot being pulled by eleven horses in full gallop. It is an apt metaphor for

the Indonesian economy, which has surged in recent years. In 2012, the economy grew by

approximately 6.2% while estimates for 2013 remain optimistic at 6.5%.

The Indonesian economy is on track to hit the $1 trillion GDP mark by 2014. If it does so, it

will enter the league of 15 countries that have been able to achieve such a feat. Indonesia is

also part of MIST1 - a term coined by Jim O’Neill, chairman of Goldman Sachs Asset

Management, to describe next decade’s growth engines.

In the recent financial downturn of 2008, the Indonesian economy survived relatively

unscathed, gaining 3.2% while most of the markets failed and struggled to recover. Credit

rating agencies, Fitch and Moody, have upgraded Indonesia’s rating to investment grade2 after

14 years. All these changes point toward the possibility of Indonesia being the next growth

story and an unstoppable Asian powerhouse.

Strong Financial Health

Indonesia’s current debt to GDP ratio stands at 23%, far below the average rate for other

emerging markets. As evidenced from the graph, the declining trend is expected to continue in

the near future. The budget deficit has also been maintained at single digits with economists

predicting a real possibility of a net credit by the end of 2013 or early 2014.

Figure 1: Debt to GDP Ratio Comparison

Robust Internal Market

Indonesia’s large domestic market is the backbone of the economy and has shielded the

country from the global financial crisis. Two-thirds of its consumption is internal which keeps

the economy resilient despite global adversity.


3

Economic growth has expanded far beyond Java into rural provinces. According to a study in

2012, 46% of total capital formation occurred outside Java. This spread of wealth into rural

provinces has created a burgeoning middle class, which facilitates stronger domestic

consumption. Today, Indonesia’s middle class group stands at around 50 million people, and

is expected to grow to 155 million by 2030.

Foreign Direct Investment

Largely due to the rating agencies’ upgrade of the country’s credit status, the inflows of FDI in

Indonesia have rapidly picked up pace as foreign investors look to capitalize on Indonesia’s

growth potential while the government facilitates infrastructure upgrades.

The silver lining here is the fact that FDI is opening up in new regions and new sectors apart

from traditional areas such as mining. Investments have strengthened in the automobile

industry and some other manufacturing sectors. Toyota, among other auto-manufacturers,

invested huge sums in its production facilities in Indonesia while L’Oreal opened up their

biggest factory globally in Indonesia this year.

Youthful Population

Indonesia is the world’s third largest democracy and is currently is in a position to benefit

from an enormous demographic dividend3. Approximately 50% of its population is under the

age of 30 and more than 30% is between the ages of 19 and 24. This makes it one of the

youngest productive nations in the world. Indonesian minister Gita Wirjawan has realized the

importance of investing in human capital development to reap its full benefit.

Today, Indonesia has the capital, it just needs to be smart about it and allocate sufficient funds

to educate its people. It is an opportune time for the country to start shifting its focus to the

development of human capital and lower its dependencies on its natural resources.

Challenges

Indonesia has proved its economic potential by being the second fastest growing nation in the

G20. However, much remains to be done to unlock the full potential of this economy.

Youth employment levels fair poorly compared to the global average while education

standards are still poor and the lack of English proficiency continues to limit the nation’s

ability to achieve higher levels of globalization.

Infrastructure within the country remains insufficient and inefficient. Water transport

systems between the archipelago’s 17,000 islands remain underdeveloped. Regular traffic

jams plague major cities like Jakarta and Surabaya. But while this may be a nuisance to

visitors, they are a testimony of the rapid growth the nation has experienced.

Current Account Deficit

In the last quarter of 2012, exports of natural resources fell, causing the country to face its

first ever trade deficit since the 1960s. The current account also turned red, ending a 14 year


4

run of surpluses. The so-called ‘immune’ economy of Indonesia has finally started to show

signs of weakness owing to the global financial crisis. These factors have mounted pressures

on the rupiah, which has been one of Asia’s worst performing currencies in recent times.

In the short term, the government is faced with the problem of maintaining an imported

inflation threatened by the weak currency and high demand for crude oil imports. The

country has to balance these priorities with the need to reverse export trends in a grim global

market. Slashing fuel subsidies might tip inflation levels and further pressurize the currency

and as a result, worsen the terms of trade. The challenge is to find the right balance to ensure

that the economy pulls out of deficit and returns back to its previous levels.

In the long term, the government has to develop strategic policies to remain competitive in

the region against other emerging neighbors such as Vietnam and Philippines, which boast

better infrastructure and education levels. It needs to focus on developing a sustainable

growth strategy that will be viable for the long run. And most importantly, it needs to invest in

its people, so prevent its population of millions from becoming a liability.

1 A term used to describe Mexico, Indonesia, South Korea, and Turkey as the growth engines for the next decades.

2 Credit ratings are assigned letter designations (such as AAA, B, CC, etc.). Typically, ratings BBB-/Baa and above are considered investment grade and safe for investors to invest in. 3 The demographic dividend is a window of opportunity in the development of a society or nation that opens up as fertility rates decline when faster rates of economic growth and human development are possible when combined with effective policies and markets.


5

The Property Market Crisis in Vietnam

By Hang Dieu Quang, Singapore Management University and Luu Nguyen Trieu Duong, National University of Singapore

The Crisis

The current property market crisis, especially in the residential apartments for sale segment in Vietnam is caused by many factors including: skewed market structure, high inflation rate, speculative demand and oversupply.

Skewed Market Structure

Fuelled by the belief that the Vietnamese economy would continue to grow at double digit rates, the apartments for sale segments were often aimed at the growing middle and high income class. These apartments were priced at very high margins and developers were used to earning abnormally high returns. However, that was during 2006-2007, when the economy was still booming. When the global economic crisis hit in 2008 and Vietnam’s inflation rate skyrocketed to 23%, the demand for high and mid end apartments suddenly disappeared as companies struggled to survive and state-owned firms1 grappled with debts. In addition, foreign direct investments also dried up.

In Vietnam, where the working class makes up a large portion of the population, the housing market is clearly not catered for the majority of the population. With prices for even the low end apartments ranging from 625 USD to 1000 USD per square meter in late 2012, which is equivalent to around 13 million VND to 21 million VND per square meter, the majority of Vietnam’s population are unable to afford housing. This is because prices are about more than 13 times the average annual income of an office worker for a mere 50 square meter apartment. Clearly, majority of the population, even in the big cities, cannot afford that price, even after the crisis, which has led to prices dropping in most segments.

Figure 1: Prices in Primary and Secondary Markets

Source: Vietnam Research Forecast Report 3Q-2012 – Colliers International


6

High Inflation & Speculative Demand

The high inflation rate of over 20% in 2008 and the subsequent years forced the government to implement a string of cooling measures including a hike in interest rates for loans. All of a sudden, many developers and speculative buyers found themselves in trouble as they had to repay loans at high interest rates, which were as high as 15% in 2008. In addition, stricter lending policies were implemented as banks were increasingly concerned over their bad debts.

Figure 2: Monthly Prime Lending Rate

Source: State Bank of Vietnam

When the economy was booming and peaked during 2006-2007, many firms and investors viewed the property market in Vietnam as the prime area for quick returns. This led to the practice of borrowing heavily to finance new projects and the purchasing of houses with the hope of reselling at a much higher price. This was particularly attractive when property prices were increasing at a fast pace and bank interest rates were affordable. Furthermore, lending policies were very loose as banks competed for clients and loans.

However, when the demand declined sharply in 2008, many developers and investors found themselves unable to offload properties on hand as buyers could no longer afford the prices. The bubble burst when many developers could no longer sustain the high prices they demanded, as banks pressed for repayment of loans. As a result, prices declined sharply. According to Colliers International, apartments in high-end, mid-end and low-end segments have dropped 40%, 30% and 27% respectively. Yet, many buyers are waiting and delaying their purchases. As such, the current price trend will persist for some time.

Oversupply

During the economic boom, many firms rushed to the property market with the hope of earning staggering high returns, as prices increased steadily. Many state-owned firms with access to cheap loans and easy credit jumped on the bandwagon, which contributed to the property bubble.

This created a steady supply of apartments for sale over the years, which continued well into the current crisis. According to Colliers International’s report for the year ending in Q1 2012,

0

2

4

6

8

10

12

14

16

Jan

-05

May

-05

Sep

-05

Jan

-06

May

-06

Sep

-06

Jan

-07

May

-07

Sep

-07

Jan

-08

May

-08

Sep

-08

Jan

-09

May

-09

Sep

-09

Jan

-10

May

-10

Sep

-10

Jan

-11

May

-11

Sep

-11

Jan

-12

May

-12

Sep

-12

Jan

-13


7

the supply of apartments rose by 37% with new supply increasing by 32% and existing apartments adding 44% y-o-y. This increase in supply together with continued weak demand would sustain the current declining price trend.

The Significance of the Property Crisis

A prolonged property crisis will create serious repercussions for the real economy. Should property developers continue to fail to sell off their apartments, they may find their ability to meet financial obligations seriously hampered. Loans on finished and semi-finished projects may therefore turn sour, leading to an increase in property-related bad debts.

This prospect of ballooning bad debts from the property market puts an already-battered banking system further at risk. Major Vietnamese banks are already saddled with a large amount of nonperforming loans incurred from past reckless lending to inefficient state-owned enterprises. With the banks’ exposure to the property market taken into account, the total ratio of banks’ bad debt could be as high as 8.8% according to the State Bank of Vietnam’s (the central bank) estimate, the highest in South East Asia.

With the banking system struggling with such a high level of bad debt, of which the property crisis is a major contributor, there is sufficient reason to believe that a credit squeeze2 might occur. In such a scenario, operation slowdowns and business failures will occur, leading to a slowdown in growth and high unemployment. The spectre of credit squeeze will be especially detrimental for the Vietnamese economy given that bank loans are still the predominant channel through which firms in Vietnam finance their operations. As such, there is an urgent need to address the property crisis as part of a larger effort to stabilize the banking system.

Policy Responses

On 7th January 2013, the Vietnamese government issued Resolution 02 (02/NQ-CP) aimed at tackling the property crisis and economic slowdown in general. Regarding the property crisis, the government adopted a two-fold approach.

On one hand, the government provides support for property developers in the form of tax breaks and value-added tax3 (VAT) reduction. On the other hand, the government also tries to shore up demand. The state’s commercial banks are directed to provide low interest loans for public servants and the lower income groups to buy or rent properties under 70m2 selling at 15 million dong per square meter. New financing facilities for real estate purchases such as the Home Saving Fund, the Real Estate Investment Fund and the Mortgage Refinance Fund were also set up. Perhaps most significantly, the government directed provincial authorities to use funds earmarked for new public housing development to buy up commercial residential properties and convert them to public housing instead.

This policy package may succeed in preventing the property crisis from deteriorating. Two welcoming initiatives in the package are the extensive tax breaks and the plan for local governments to buy property inventory. Tax breaks and reductions for property developers ease their cost pressure, thus reducing their risk of default. Meanwhile, the government’s active purchases of existing housing stock provide an emergency relief to property developers who cannot rid themselves of their inventory, preventing these developers from going under.

Nevertheless, as we have argued throughout this paper, the root cause of the persisting supply-demand gap lies in an excessive abundance of middle and upper-end housing units. With these units not meeting the means and the needs of the general populace, while their


8

intended targets, the upper middle class, are still reeling from the 2012 economic slowdown, private demand seems set to remain low for the foreseeable future. The government’s measures of making credit cheaper and more accessible make property purchases more attractive for potential homeowners (and speculators). However, it remains to be seen whether this factor is large enough to induce market participants to overcome the current mismatch between existing supply stock and buyer’s profile.

Sources:

1. CEIC database

2. Colliers International – Vietnam Research Forecast Report Q1, Q2 & Q3 2012

3. State Bank of Vietnam

1 A legal entity that is created by the government in order to partake in commercial activities on the government's behalf.

2 A reduction in the general availability of loans (or credit) or a sudden tightening of the conditions required to obtain a loan from the banks. 2 A type of consumption tax that is placed on a product whenever value is added at a stage of production and at final sale.


9

ASEAN’s Economic Integration: Looking at the EU, Should the ASEAN Region Integrate Faster and Further? (Part 1)

By Ng Yongxiang, Singapore Management University

The Benefits of Regional Integration

Regional integration is an approach to trade liberalization and an alternative to a global trade

agreement, an idea put forth by the World Trade Organization (WTO). It is broadly defined as

a staged process through which a group of countries coordinate and merge their economic

policies over time. The prospects of enhanced economic growth are reaped through fostering

specialization, economies of large-scale production and attracting foreign direct investment.

There are also non-economic benefits such as ease of managing immigration flows and

promoting regional security. These benefits, together, serve as an impetus for countries to

pursue regional integration. In this article, I use the European Union (EU) as an elaborate

example to compare the pace and stage of ASEAN’s integration.

The Different Levels of Integration

There are four levels of integration, with the free trade area being the most basic form of

integration. This is followed by the customs union, the common market and finally the

economic union. In this article, I shall first observe the implementation of ASEAN’s strategy in

its objective as a flourishing and prosperous economic entity.

The establishment of the ASEAN Free Trade Agreement (AFTA) and signing of the Common

Effective Preferential Tariff Scheme (CEPT) in 1992 resulted in the proliferation of intra-

regional trade flows in the past two decades. Unlike the EU, ASEAN does not apply an external

tariff on imported goods into the region but imposes tariffs based on its national schedules.

The initiative for ASEAN Economic Community (AEC) was first introduced in 2002. The

blueprint for the AEC outlines the goals in four key areas, of which the goal of a single market

and production base would be discussed more extensively.

Trade Creation1 and Diversion2

Parallels can be drawn with the current stage of ASEAN integration and EU’s integration. In

particular, the static and dynamic effects delineated from EU’s integration as a regional

trading arrangement. Trade creation was pronounced in transportation equipment,

petroleum and machinery while trade diversion was apparent in agriculture commodities and

raw materials. Trade creation exceeded trade diversion by a wide margin, estimated at 2 to 15

percent. The realized dynamic effect was in the form of economies of scale through the

production for both domestic market and for exports.

A Comparison of the Regions’ Integration Histories

The details for the creation of a common market in EU were announced in 1985. This came


10

after the establishment of the free-trade area in 1968 and its subsequent formation of the

customs union in 1970. The common market eliminated the remaining non-tariff trade

barriers to intra-EU transactions. It also further liberalized trade and permitted the mobility

for factors of production across national borders within the EU. The European Monetary

Union (EMU) emerged in 2002, with a common currency known as the euro, and this would

be further elucidated upon in the later paragraphs.

After the CEPT-AFTA, the integration of the ASEAN countries has progressed on many fronts.

These areas include investments, services and intellectual property protection amongst

others. The AEC initiative evokes memories of the EU’s integration. However, there is a stark

difference. ASEAN lacks a customs union, a critical aspect of the AEC.

The challenges faced by ASEAN nations are the inherent development gap and the divergent

commercial policies that range from relatively free-trade zones to more protected economies

if ASEAN attempts to impose a common external tariff (CET). Admittedly, the process of

establishing a customs union and common market is fraught with difficulties. Therefore, an

analysis of the post-integration benefits is imperative in answering the question of whether

ASEAN should integrate faster and further.

Characteristics of the ASEAN nations

The economies of the ASEAN nations are heterogeneous and with wide economic

development disparities. These disparities became more distinct with the admission of

Cambodia, Laos, Myanmar and Vietnam (CLMV) as opposed to the ASEAN-6 countries.

Figure 1: Gross Domestic Product Purchasing Power Parity per capita

The economic powerhouses in ASEAN are Singapore and Brunei. Malaysia, Thailand,

Indonesia and Philippines are the emerging markets. CLMV are transitional economies, which

are undergoing a shift from centrally-planned to market-oriented economies. Economic

integration at the CEPT-AFTA level was a platform for ASEAN nations to harvest mutually

beneficial gains as observed by the increased trade flows. However, the ASEAN nations failed

to converge in terms of income and development gap. While this gap was not an impediment

for the initial stages, the persistent wide gap generates differences in ability to integrate

further and reflects imbalances in integration capacity.

39%

32%

11%

6%

3%

3% 2% 2% 1% 1% Singapore

BruneiMalaysiaThailandIndonesiaPhilippinesVietnamLaosCambodiaMyanmar


11

In the next issue, Yongxiang will delve deeper to examine the EU region’s integration history to

draw conclusions for ASEAN…

Sources:

1. Bacha, O. I. (2008). A common currency area in ASEAN? Issues and feasibility. Applied Economics,

40, (515-529)

2. Bui, T. G. (Aug, 2008). Development Gaps in ASEAN as Crucial Nontraditional Security Issue: A 4-I

Approach. Consortium of Non-Traditional Security Studies in Asia.

3. Plummer, M. (Nov, 2006). An ASEAN custom union? Journal of Asian Economics, 17 (5), (923-938).

4. Thangavelu, S. M. and Chongvilavan, A. (Sep, 2009). Free Trade Agreements, Regional Integration

and Growth in ASEAN.

5. Tjhiong, R. (March, 2002). Forging an Economic Integration: The Case of ASEAN.

1 Trade creation occurs when there is an increase in trade among member nations in the good or service of each nation's comparative advantage due to the formation of a free trade area or a customs union.

2 Trade diversion occurs when trade is diverted from a more efficient exporter towards a less efficient one by the formation of a free trade agreement or a customs union.


12

The S&P 500 is a free-float capitalization-weighted index published since 1957 of the prices of 500 large- cap common stocks actively traded in the United States. It has been widely regarded as a gauge for the large cap US equities market The MSCI Asia ex Japan Index is a free float-adjusted market capitalization index consisting of 10 developed and emerging market country indices: China, Hong Kong, India, Indonesia, Korea, Malaysia, Philippines, Singapore, Taiwan, and Thailand. The STOXX Europe 600 Index is regarded as a benchmark for European equity markets. It represents large, mid and small capitalization companies across 18 countries of the European region: Austria, Belgium, Denmark, Finland, France, Germany, Greece, Iceland, Ireland, Italy, Luxembourg, the Netherlands, Norway, Portugal, Spain, Sweden, Switzerland and the United Kingdom.

Correspondents :

Vera Soh (Vice President, Publication) [email protected] Singapore Management University Singapore

Ng Jia Wei (Vice President, Operations) [email protected] Singapore Management University Singapore

Samuel Ong (Publications Director/ Editor) [email protected] Singapore Management University Singapore

Yingyu Zeng (Liaison Officer) [email protected] Singapore Management University Singapore

Ng Yongxiang (Marketing Deputy / Writer) [email protected] Singapore Management University Singapore

Darren Goh Xian Yong (Editor) [email protected] Singapore Management University Singapore

Hang Dieu Quang (Writer) Undergraduate School of Economics Singapore Management University [email protected]

Anirudh Ramavatar Maru (Writer) Undergraduate Lee Kong Chian School of Business Singapore Management University [email protected]

Luu Nguyen Trieu Duong (Writer) Undergraduate School of Arts (Economics) National University of Singapore [email protected]

Everything in this document and/or in this website is copyrighted by law and cannot be used without the written permission of its owner/publisher. It is forbidden to make digital copies or reproductions, however you may however use the information as reference material and it may be physically printed for personal use. You may also quote parts of the content of this publication, digitally or physically, if the source and author is clearly stated, together with the copyright information. All views expressed in this publication are the personal opinion of the researcher(s), do not constitute a buy or sell recommendation on any instruments, and in no way reflect the opinions, views, or thoughts of SMU and other abovementioned universities, and unless specified, of any other student clubs. All logos and/or images on these pages belong to SMU and the respective third party copyright and trademark owners. SPEX, affiliated clubs and the covering researcher accepts no liability whatsoever for any direct or consequential loss arising from any use of this document or further communication given in relation to this document. SPEX is the brainchild of current New York University undergraduate Mr. John Ang, further developed by SMU students for the benefit of both SMU and non-SMU students.

spex issue 34

Documents