Many factors will play into Asia’s economic performance this year. They include the movement of capital out of emerging markets, key elections and the pace of domestic macroeconomic reforms.
For example, China’s rapid credit expansion has created vulnerabilities in real estate, banking, and local government with fiscal stimulus supporting growth. Elsewhere elections in India and Indonesia should help to resolve policy uncertainties, but in Thailand, political violence has hurt economic performance and will diminish the country’s attractiveness as a manufacturing platform.
On the plus side, as the global economy improves, South Korea, Taiwan and Vietnam will see faster growth, supported by rising high-tech exports.
China’s GDP growth is slowing due to weakening real estate activity, tepid investment, and a sharp deceleration in output of state-owned enterprises. Construction starts (measured in floor space) contracted -25.4% in the first three months of 2014, compared with +13.5% growth in 2013 as a whole.
The construction weakness is widespread – of China’s 31 regions, 27 reported declines in starts. Profit growth has improved modestly in the economy, which should support spending, given that more than 60% of China’s investment is self-funded, and a significant portion of that is from retained earnings.
The government’s continued efforts to rein in the credit bubble, particularly shadow-banking, have skewed the housing market. The apparent housing weakness is partially a high base effect, as home buyers rushed into the market in early 2013 before the government implemented severe housing market restrictions.
Home sales soared +69% year-on-year in 2013, so the -7.7% decline in the first quarter of 2014 must be seen in context. Fiscal stimulus will be applied to keep GDP growth above 7%, including spending on railways, upgrades to low-income housing, and small-business tax cuts.
Meanwhile in Japan, the sales tax increase from 5% to 8% in April is creating economic volatility. Industrial production has been weak with many industries keeping production at conservative levels while reducing inventories.
The Bank of Japan has countered with aggressive monetary stimulus, but future growth will depend on how effectively the Abe administration implements stimulus programmes and reforms labour and product markets.
On the positive side, employment has increased at is fastest pace in more than seven years. The depreciation of the Yen and a recovery in exports will boost the profits and capital expenditures of multinational companies.
In India, growth in domestic demand remains sluggish and manufacturing is struggling as a result. Much of the weak investment climate was due to uncertainty ahead of the April-May elections, and the victory of the Bharatiya Janata Party (BJP), led by Narendra Modi, should allow for mild acceleration in the near term. A stable government and initiation of reforms, including a fast-track mechanism for project approvals, should gradually revive investment.
High inflation and a chronic fiscal deficit limit the scope for policy stimulus. Steps to liberalise foreign direct investment are positive, but more needs to be done.
Risk vs reward
The chart puts these major construction markets in the context of the region. The vertical axis represents the five year outlook for compound annual growth in the industry. The size of the bubble reflects the size of the construction market and the horizontal axis reflects the risk of construction investment.
This is a basket of risk assessment includes the ability to repatriate earnings, enforce a contract, protect a patent, deal with regulatory hurdles and obtain stable prices and labour relations.
The risk score extends to 100 and the cross-hairs represent global averages for construction market growth and risk.
Much of the region falls into the lower left quadrant which features slower growth, but also relatively low risk. India and Malaysia have the enviable position of offering above average growth with below average risk. Indonesia, Bangladesh, Vietnam and Pakistan join China offering above average growth, but with some higher risk exposure.
This forecast was completed before martial law in Thailand. It is likely that Thailand will move into the undesirable zone of below average growth and above average risk. Indeed, Pakistan routinely hovers in this zone as well, due to its political uncertainty.
There are issues affecting emerging markets around the world that have reduced construction growth projections in general. These include cyclical factors – withdrawal of policy stimulus, weak export markets, excess capacity after investment booms and capital rotation as money flows to the US thanks to better bond yields.
They also include structural forces, such as slower labour force growth, a slower pace of globalisation, the end of the commodities super-cycle and a lack of market reforms.
Indonesia is an example of the challenges to emerging markets. While it continues to offer above average growth on the strength of large infrastructure developments and a strong residential outlook, the outlook has softened. Weakness in commodities is compounded by a rigid regulatory framework that limits the potential for foreign investment.
However, Vietnam has managed to avoid some of these problems. This is partially due to its lower exposure to commodity prices.
But in addition, many companies set up operations in Vietnam as a hedge against problems in China, so uncertainty in the Chinese economy only makes these investments seem more prudent. And while tensions with China may limit Chinese investments in Vietnam, they may even encourage investment from other nations.
In general, the outlook for Asian construction has become a little more subdued.
Still, the region as a whole offers above average potential, and certain countries remain solid bets for the medium and long term.
If the new governments in India and Indonesia (and effectively in China) engage in serious structural reform, there could be positive change, and the outlook could improve this year.