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Global Economic Outlook
Other Southeast Asia: Q3 2010 Outlook
By Michael Sieburg and Arpitha Bykere
- In Cambodia, a fragile recovery in garment exports is leading the economic rebound. Despite improved prospects for foreign investment in commodities and real estate, growth will remain below pre-crisis rates.
- In Laos, new hydropower operations and improved production and Asian investment in the mining sector will boost growth in H2 2010 and 2011.
- In Myanmar, scheduled elections will be the key story in H2 2010. While the outcome of the polls is predictable, the real question is whether civil unrest will result.
Outlook Update: Foreign Investors Eye Natural Resources
After contracting in 2009, Cambodia's economy is on pace for positive GDP growth in 2010. A low base and upturns in key trading and investment partners (the U.S., EU, China, South Korea, Japan and ASEAN) will lead to a rebound in the country's key drivers of growth: garment exports, tourism services, FDI and commodity exports. RGE forecasts growth of 4.2% for Cambodia this year, falling short of the rates in the pre-crisis boom years. After a period of deflation in 2009, inflation will pick up in H2 2010, but price pressures should be sustainable given stable fuel prices.
Big investment projects will drive growth in H2 2010 in Laos, with hydropower and mining leading the way. With Nam Theun II coming online in March, more hydropower projects underway and a number of mining projects restarted, RGE expects Lao growth to pick up from its estimated 6.7% pace in 2009 to reach 7.5% in 2010. Laos is tentatively planning to tap international debt markets in H2 2010 with its first foreign currency (Thai baht) bond sale, but, as with stock market development plans, further delays are possible. The uptick in economic growth will drive inflationary pressures in H2 2010, but these should not present a serious risk to stability.
RGE foresees Myanmar's economy growing 3.5% in 2010, still driven by investment in natural resources by Asian neighbors, especially China and Thailand, and trade with regional partners like India, China and ASEAN. Agricultural output is likely to be significantly constrained in H2 2010 by an ongoing severe drought, exacerbated by the lingering impact of Cyclone Nargis and a persistent lack of access to inputs like seeds, fuel and fertilizers. Elections will be the most notable event in H2 2010 but promise few surprises, especially with the National League for Democracy (NLD) party boycotting the contest. Risks to political stability are clear, especially if dwindling agricultural output causes food shortages and price rises. The possibility of election-related civil unrest should not be discounted.
Growth Dynamics: Exports and Commodities Fuel Expansion
Cambodia’s exports finally showed signs of life in 2010, expanding 13.82% y/y in the first five months of the year as demand from major trading partners revived. Exports in the all-important garment category grew 11% y/y, with U.S. purchases rising 8% y/y. Cambodia also had good news on the foreign investment front, with FDI pledges growing 53% y/y in March following a rough start to 2010 and a dismal 2009, when FDI pledges dropped 46.18% y/y and disbursements dropped more than one-third. FDI in the garment industry is a potential bright spot this year, with investment approvals up more than 60% y/y through May. Beyond 2010, the garment industry should draw increased interest as a result of labor disputes in China. Authorities hope the recent liberalization of property ownership laws for foreigners will boost the real estate sector in H2 2010. Despite potential global slowdown in H2 2010, Cambodia's commodity sector will attract Asian investors, especially those from China and Vietnam, who have been active in the exploitation of rubber and agricultural commodities as well as the development of road infrastructure and hydropower. Oil and gas finds remain untapped and are not expected to produce in 2010, but they have the potential to boost Cambodia's growth and attract FDI in supporting industries and real estate. Improving global conditions and a recovery across Asia, Cambodia's key tourism source, boosted tourist arrivals by 11.5% y/y in 2010 through May, and the easing of Thai unrest should provide further support in H2 2010.
Laos's presence on investors' radar screens is growing, with attractive opportunities in mining and hydropower drawing FDI from China, Vietnam, Thailand, Japan and Australia. H2 2010 will see the expansion of existing projects, including those at the country's largest gold and copper mines, and the start of operations at mines producing zinc, potash, bauxite, coal and natural gas. With relatively sustained emerging market commodity demand, especially from Asia, mining revenues will provide a boost to Lao growth in H2 2010 and 2011. Though an ongoing drought could dampen agricultural output in H2 2010, expect a rebound in 2011 on foreign investors' increasing commercialization of farms in Laos. Tourism, a growing segment of the Lao economy and its third-largest foreign currency earner (after hydropower and mining), should benefit from global recovery in H2 2010 and improved road links to Vietnam and China as well as expanded regional air links in 2011.
Risks: Weakening External Demand and Adverse Weather
The EU’s fiscal austerity poses risk to garment exports from Laos and Cambodia. Add a slowdown in the U.S., and Cambodia is particularly vulnerable, since an estimated 90% of its garment exports are destined for the U.S. and EU, according to the International Labour Organization. Though Laos depends less on the garment industry for growth than Cambodia, Laos relies on European consumers for more than three-quarters of its garment exports.
Meanwhile, poor weather and ongoing droughts could limit agricultural output in Cambodia, Laos and Myanmar in H2 2010. A serious drought bears an additional downside risk for Laos, which counts on hydroelectricity exports to Thailand, China and Vietnam to support growth. (Meanwhile, Laos's hydropower projects and large mining projects come with their own structural risks: adverse environmental impacts and limited employment generation.) In Cambodia, planned public investments in irrigation should gradually improve productivity, providing a boost to rice and other agricultural exports.
A potential slowdown in China is unlikely to seriously impact Chinese investment in the region, which is on the rise in a range of commodities and infrastructure sectors. With an aim of securing these countries as sources of agricultural products and other commodities, China has become the largest investor in Myanmar and Cambodia and the second-largest in Laos, after Thailand.
In Myanmar, risks in H2 2010 largely stem from elections and continued policy mismanagement, including corrupt privatizations of state assets.
Though not RGE’s baseline scenario, a global double dip and sharp correction in commodity prices would affect all three countries via trade, foreign investment and tourism channels, especially Laos, which is heavily reliant on commodity revenues to fuel growth. Additionally, any slowdown in emerging Asia’s growth could impact FDI flows, though this would likely be felt more strongly in the non-commodity sectors. Cambodia had a taste of this during the height of the financial crisis, when South Korean investors pulled out of its property sector.
Policy Implications: Reforms Key to Drawing More Investment
To increase their attractiveness to foreign investors, Cambodia and Laos will continue to pursue piecemeal reforms in H2 2010 and 2011. Cambodia liberalized property ownership for foreigners in H1 2010 and is considering expanding these measures in a bid to attract further investment. On the domestic political front, Hun Sen’s government is continuing to pursue measures that alarm the public, including plans to establish "freedom parks" that will serve as officially sanctioned protest zones. Meanwhile, land disputes and labor unrest over wages present risks to political stability in Cambodia moving forward. The goal of WTO accession will motivate Laos to undertake reforms.
As these economies recover, their governments will pull back fiscal stimulus measures, but stable global commodity prices should keep inflation subdued. Lao government finances will benefit from mining and hydropower revenues (especially now that the Nam Theun II dam is online), a new VAT and improved tax collections. In Cambodia, a series of new taxes and efforts to boost tax collection, along with bolstered exports, will improve government finances after a decline in customs revenues in 2009. Combined with a pullback of stimulus measures, this will help narrow the fiscal deficit. In Myanmar, election-year spending and a low revenue base will keep pressure on the fiscal deficit. Significant monetary tightening through raising reserve requirements or reining in lending should not be necessary in H2 2010 in Cambodia or Laos.
The Cambodian riel has been depreciating through H1 2010, and the central bank's U.S. dollar sales have had a limited impact on containing depreciation. The central bank hopes that a pickup in FDI disbursements, exports and tourist arrivals will boost FX reserves in H2 2010, reducing pressure on the riel. Until then, it will maintain its attempts to defend the currency.