A number of emerging Southeast Asian (EM) economies are enjoying some of the strongest rates of economic growth in the world. Malaysia’s economy grew 8.9% year-on-year in the second quarter, while the Philippines’ economy grew 7.4% over the same period.
The Association of Southeast Asian Nations (ASEAN) EM of Indonesia, Malaysia, the Philippines and Thailand are a contrasting group with different growth drivers. What they all have in common this year has been the benefit of post-pandemic economic reopening, which has come later than other global economies.
From an equity market perspective, all ASEAN markets have been more resilient than the broader emerging markets, which are down -18.6% year-to-date in dollar terms as measured by the MSCI Emerging Markets Index as of 13th September. However, the result for ASEAN was very mixed, from Indonesia returning +12% to the Philippines falling -13.5% YTD. This despite currency weakness in all four markets.
All of this begs the question, are there opportunities within the ASEAN region?
Where does economic growth go from here?
Economic growth in ASEAN economies is recovering as restrictions on activity introduced during the Covid-19 crisis are gradually lifted. Strong commodity prices earlier this year also benefited Indonesia and Malaysia. Thailand was more of a laggard on this front, with Q2 GDP growth picking up a very modest 2.5% yoy.
However, with the easing of entry requirements, tourism is picking up again and arrivals surpassed one million in July for the first time since the pandemic began. Tourism accounted for more than 20% of GDP before the pandemic and the rise in visitor numbers is affecting consumer confidence.
The growth outlook is more complex and is increasingly being overshadowed by rising inflation, which is now prompting central banks to raise interest rates. Higher energy and food prices are also having an impact on fiscal policy. For example, Indonesia recently announced a compensatory cash bonus for low-income families and workers ahead of a 30 percent fuel price hike. While Malaysia has no energy subsidies in its budget, these are likely to be higher given the rise in oil prices.
Commodity prices, especially base metals, are falling now. This could affect balance of payments balances in Indonesia and Malaysia. Meanwhile, prospects for exports of manufactured goods are clouded by expectations of a slowdown in global trade.
In Indonesia, long-term reforms under the Omnibus Law, a package of amendments to tax and labor legislation, are important support and should help improve productivity and output. There are already signs that this is having an effect as foreign direct investment (FDI) increases. The surge in foreign direct investment is also associated with some offshoring of manufacturing out of China as companies diversify their supply chains. Malaysia is also benefiting from this trend.
Another factor to consider is politics.
The Philippines elected a new leader in May, Ferdinand “Bongbong” Marcos, who came to power. Despite some populist political rhetoric during the campaign, policy priorities appear to be pro-market so far. However, close monitoring is required.
In Malaysia, with parliamentary elections due in July 2023, there could be more uncertainty about the political outlook and there is speculation that it could be imminent. Former Prime Minister Najib Razak lost his last appeal in August and began serving a 12-year sentence on criminal breach of trust, money laundering and abuse of power. He has applied for a royal pardon and remains a Member of Parliament pending a decision.
The political landscape is increasingly fragmented and there are concerns that without sufficient political consensus, progress on much-needed structural reforms could be limited. Although there are prospects of some improvement in the political outlook, this is not yet clear.
Thailand is scheduled to hold general elections by March 2023. After a coup in 2014, Thailand held elections in 2019, albeit with a junta-appointed Senate. Before the Covid-19 pandemic, Thailand had been experiencing anti-government protests and recent opinion polls show the opposition Pheu Thai Party has a wide lead, with Paethongtarn Shinawatra the lead candidate for prime minister.
Paethongtarn is the daughter of former Prime Minister Thaksin Shinawatra, who was deposed in a military coup in 2006, and the niece of former Prime Minister Yingluck Shinawatra, who was ousted by the Constitutional Court in 2013. The Constitutional Court recently suspended current Prime Minister Minister Prayut Chan-o-cha on the grounds that he had exceeded the eight-year constitutional term. Until a final decision is made, this could lead to an early election.
As in most global economies, ASEAN inflation has been rising, albeit from lower levels. This is most evident in Thailand, where headline inflation hit 7.9% yoy in August, well above the 2% target. Inflation is also above target in the Philippines and at the high end of the target range in Indonesia. The Malaysian central bank does not name an explicit inflation target.
ASEAN central banks have started taking measures to control inflation this year. The Philippine central bank has hiked interest rates by a total of 175 basis points (bps) to 3.75%, while the Malaysian central bank has hiked interest rates by 75 bps to 2.5% this year. The central banks of Thailand and Indonesia reacted more slowly and only started raising interest rates in August. These were the first rate hikes since 2018.
However, it is worth noting that despite these moves, real interest rates in Malaysia and Thailand remain firmly in negative territory.
Aggregated scores for each ASEAN index market vary, reflecting in part some nuances in each market’s outlook and available sector and stock opportunities.
On a combined basis (price-to-earnings, price-to-book and dividend yield), valuations in Thailand, the Philippines and Indonesia are slightly below their historical median but do not compare favorably to other emerging markets. Profitability in Malaysia and Thailand is also the lowest in emerging markets, while Malaysia has barely improved since 2019, with Thailand’s return on equity deteriorating somewhat.
Malaysia is a market that looks cheap, especially with a windfall tax on banks ending in 2023. However, the macroeconomic outlook faces several long-term challenges that are at least partly responsible for some of the cheapness.
A similar picture emerges for ASEAN currencies. All four currencies are cheap but less attractive compared to other emerging markets.
A mixed picture for the emerging economies of Southeast Asia
The good news for emerging Southeast Asia is that these economies are recovering as they begin to benefit from the broader economic reopening. This is very welcome after a difficult time during the pandemic.
The bad news is that much of this reopening was expected by markets and reflected in valuations. In addition, there are various challenges that could weigh on the outlook. At market level, we do not favor ASEAN EM. However, there are some interesting opportunities for stocks within the region and a more specific, holistic assessment of each ASEAN EM is warranted.
While reforms in Indonesia are supportive over the long term, overall valuations are not that attractive. In Malaysia, valuations are reasonable but political uncertainty continues to cloud the outlook. Thailand’s tourism reopening is positive, but the domestic economy remains sluggish. The political risk also increases in the run-up to the parliamentary elections. At the same time, there are some attractive companies in all three markets.
The Philippines is perhaps our least favorite emerging Southeast Asian country. The service-based economy is recovering, but valuations are not attractive and opportunities for bottom-up stocks are limited.