In 2012, Southeast Asia faces the prospect of increased economic uncertainty generated by the macroeconomic difficulties of advanced countries (particularly Europe, but also the United States and Japan) as well as the likelihood of a further slowdown in China. Not only are the Southeast Asian economies among the most open to trade and financial flows in the world, they are also tightly integrated through production networks with China, and via China with US and European markets. Openness to trade and finance has brought immeasurable benefits to Southeast Asian economies — but that openness now makes them vulnerable to the actions of others.
Southeast Asian leaders should be worried. There is a significant probability that Europe, Southeast Asia’s largest trading partner, will go into recession in 2012 — and that is if things go relatively well. The trade implications are well known, but may be underestimated — especially if a European recession snuffs out a tentative recovery in the US. Financial repercussions are more difficult to anticipate. Global financial markets have become so tightly integrated that a sudden increase in demand for liquidity following any unpleasant shock or surprise in Europe could easily translate into a capital reversal on the other side of the world.
Over the course of the last two years, the liquidity injected into the global financial system by the European Central Bank and the US Federal Reserve quickly found its way to the shores of Southeast Asia in search of higher returns. These flows could just as easily reverse direction. This is a phenomenon Southeast Asia has seen three times in recent memory — prior to the Asian financial crisis, then following the collapse of Lehman Brothers in 2008 and (to a lesser extent) toward the end of last year. If it were to happen again, the shock to liquidity, interest rates and exchange rates — and ultimately investment and growth — could prove difficult to manage. Indonesia has always been the most vulnerable in this regard, given the large share of short-term financial assets owned by non-residents, although this time around Thailand and Malaysia are also exposed.
China’s slowdown and rebalancing toward domestic sources of growth add another layer of uncertainty for Southeast Asia. China’s GDP is two-and-a-half times that of Southeast Asia and it is now the world’s second-largest importer. A misstep by Chinese policy makers as they seek to engineer a soft landing, or unanticipated consequences as the gradual real appreciation of the renminbi works its way through relative prices into the balance sheets of enterprises and banks, will have consequences that could easily spill over into Southeast Asia.
Most Southeast Asian economies are less well positioned to handle the economic uncertainties and surprises of 2012 than they were when the global financial crisis hit in 2008. True, inflation is on the wane, external reserves are plentiful and growth is resilient. But most Southeast Asian countries are running out of fiscal space, and this will limit public policy options to boost domestic demand in the event of yet another global slowdown. Moreover, there are serious doubts that China will once again come to the rescue with an outsized stimulus package, given that the government there is still cleaning up the mess left behind from the last one. Finally, with the exception of Singapore, Southeast Asian economies are dependent to varying degrees on commodity and natural resource exports, and commodity prices are likely to be particularly volatile this coming year.
Of course, each country in Southeast Asia is positioned differently. At one extreme is Indonesia, which has the most policy options available, given strong growth (6.4 per cent in 2011), low government and external debt burdens and a small fiscal deficit. At the other extreme is Vietnam, which suffers from periodic bouts of macroeconomic instability (inflation exceeded 18 per cent in 2011), continues to run high external current account and fiscal deficits, has a large state enterprise sector in desperate need of reform, and is now suffering from a rising number of unofficial labour strikes.
In between are the remaining economies of Southeast Asia, each with its own strengths and vulnerabilities: Thailand, where growth is going to climb from its nadir in 2011 as the economy rebuilds after last year’s devastating floods; Malaysia, where an expansionary budget in anticipation of an election year is expected to maintain growth at close to last year’s rate; Cambodia and Laos, which continue to be propelled by their abundance of natural resources (including hydro-power) and rapidly growing markets in their neighbourhood, notably China and Vietnam; and finally, Singapore and Brunei, Southeast Asia’s small but wealthy states, the former driven by the power of trade, innovation and high-end services, the latter by the power of oil.
Differently positioned though they may be, the Southeast Asian economies will certainly face shared challenges as 2012 unfolds. They will be keeping an anxious eye on Europe and the US as the year brings either a tentative and sputtering recovery or yet another recession. Either way, Southeast Asian policymakers should be prepared for a testing time ahead. .
Vikram Nehru is Senior Associate in the Asia Program and Bakrie Chair in Southeast Asian Studies at the Carnegie Endowment for International Peace.
An earlier version of this article was first published here by the Carnegie Endowment for International Peace.