The most volatile segment of an economy is investment spending, so any surprise to expectations of economic growth would tend to come from how investment behaves. We believe that there is a good chance that a new investment cycle in the Asian region could emerge, which would produce better economic prospects than currently expected.
This is not to discount the downside risks that clearly do exist. But remember how there had been concerns last year that higher interest rates, geopolitical frictions or other risks would hammer 2023’s prospects — and how these were then offset by positive drivers which had been underestimated. Similarly, we think that the region will again show resilience, this time as a result of a pick-up in investment. If this investment rebound can last for a few years, as we believe possible, the result will be a higher investment share of economic output that produces an acceleration in economic growth over the next few years.
Investment dynamics are critical to economic growth prospects
If a higher share of total output is devoted to investment, the productive capacity of the economy will expand and that will help speed up its growth rate. Of course, this is so long as the investment is not wasteful (for example, pouring money into constructing condos which no one wants to buy). Unfortunately, except for China and India, this investment share of output has not regained the high levels that prevailed before the 1997 Asian financial crisis. That is a major reason why Southeast Asian economies have failed to replicate the booming growth rates that they enjoyed before 1997.
There are many reasons why the region’s investment share of GDP remained depressed but ultimately it was all about “animal spirits”. Animal spirits arise from a burning sense of confidence among entrepreneurs who sense great opportunities for profit and believe that the risks are manageable. The Asian financial crisis dealt a massive blow to the confidence of local businessmen who also had to deal with weak balance sheets and unexciting prospects for sales, while the banks they relied on had become wary of lending.
The region also had to confront difficult political adjustments which further depressed confidence. These factors also scared away foreign investors from Southeast Asia. That worsened when global investors also saw the immense opportunities in China as its reforms and entry into the World Trade Organization in 2001 triggered the most impressive acceleration of economic growth in economic history. In India, the past few years saw companies with swollen debt levels and banks and non-bank financial institutions that had balance-sheet difficulties. All of that depressed investment spending.
More recently, companies were wary of making big investment commitments because of an unnerving series of global shocks in the past few years. The Covid pandemic caused unprecedented declines in economic activity, which left companies utterly uncertain about the future. In addition, the perception that globalisation offered exciting opportunities has given way to worries about de-globalisation or “slowbalisation” as the US and China, the world’s largest economies, engaged in bitter feuds over global influence, trade, technology and investment. Rising protectionism and the proliferation of inward-looking policies added to these concerns. If all that were not enough, we also saw how the sharpest pace of monetary tightening in four decades triggered anxiety over a possible recession. Finally, China’s unexpected downturn also led to considerable apprehension as one of the world’s most dynamic engines of growth seemed to stall.
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Now a new investment cycle is taking shape
In short, the past few years saw virtually everything that could impair animal spirits. Our view is that this downbeat era is ending and a new, more bullish one is emerging. This will be particularly evident in India and in Southeast Asia.
First, as the global economy settles down after an unusually rough patch, economic conditions are normalising, encouraging firms to dust off old capital spending plans.
The major central banks have stopped raising rates and some may even cut their policy rates this year. The lagged effects of higher rates will of course produce some stresses in some areas such as commercial real estate in the US or among highly indebted emerging economies. But there is greater confidence now that these stresses will be episodic rather than prolonged after policymakers successfully dealt with shocks such as the collapse of some regional banks in the US earlier last year and the near-meltdown in the UK bond market in October 2022.
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Moreover, while US-China relations remain bad, the two powers are building guard rails around their contestation so as to limit the risks that small incidents could escalate into a crisis that no one wants. Recent high-level meetings, including between the military officials of both sides, suggest that this effort is being sustained. This gives us confidence that while there may well be continued frictions over Taiwan and the South China Sea, for instance, Chinese and American leaders will ensure that these are contained. The Middle East remains a dangerous place but unless there is a huge disruption of oil supplies to the rest of the world, it is unlikely that the tragic developments there will cause economic dislocation elsewhere.
In addition, there are clear signs that the authorities in China are stepping up their support for the economy. The Chinese economy will probably continue to endure strains, given the troubles in the property sector and among highly leveraged entities such as local governments. But targeted government measures will help ensure that the economy maintains growth at a pace similar to this year’s.
Second, even though the cost of capital may have risen, improving economic conditions and prospects for stronger returns on investment should boost investment spending.
There are a whole host of factors that will help promote investment in India and Southeast Asia.
First, supply chains are undergoing a reconfiguration as a result of the US-China tussle. Companies are “de-risking” by shifting production out of China. Company announcements and foreign investment approvals data in the region suggest that this reconfiguration is picking up pace and broadening out to benefit Southeast Asia and India. The UN reports that the Asia Pacific region attracted US$302 billion ($401 billion) worth of greenfield projects in January to September 2023, up 35% over the same period in 2022. It noted that the Asean region had emerged as the top region for greenfield investments, while India was cementing its position as a major destination for foreign investment given its rapid growth, large pool of labour and the size of its domestic market. As foreign investors expand factories, local suppliers and providers of support services will see opportunities and also raise investment in areas such as industrial estates, component production and logistics services.
Second, infrastructure spending is likely to be stepped up after a setback during the pandemic. In Thailand, the new government is keen to demonstrate its capacity to boost the economy through initiatives such as the Eastern Economic Corridor (EEC). To enhance the attractiveness of the EEC, 77 infrastructure projects in transportation, totalling THB337.8 billion (around $13 billion) are planned. Similarly, in the Philippines, the Marcos Administration is keen to improve infrastructure — state infrastructure expenditure and other capital outlays surged by 19% in the first nine months of last year, substantially exceeding the budgeted amounts. This surge in infrastructure spending will have two implications. One is to directly increase investment in construction and works. The other is to crowd in more investment as private firms see opportunities that will be created in future as the infrastructure improvements reduce logistics costs by improving connectivity.
Third, advances in technology will spur more investment as well. Take airlines, for example, which have little choice but to invest in new aircraft. Failure to take advantage of advances in jet engine technology which improves range and fuel efficiency and in composite materials — which make aircraft much lighter — would mean that their competitors would crush them. That should boost investment in transportation equipment. Note that Air India and IndiGo, India’s two biggest airlines, are buying close to 1,000 aircraft worth around US$150 billion. In Thailand, eight new airlines will begin operations this year which will lead to more investment in new planes, just as Thai Airways International is reported to be firming up an order for around 80 airliners from Boeing.
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Fourth, the latest trade data around the region, particularly from South Korea and Taiwan, indicate that a turnaround in export demand is underway which will boost the manufacturing sector, partly as a result of the upturn in the electronics cycle. Over time, there has been a correlation between manufacturing sector growth and investment in machinery and plant.
Fifth, there are some emerging synergies from regional integration. An example is the Rapid Transit System link between Singapore and Johor which will improve connectivity between the two regions. This should create new opportunities as more Singaporeans shop and spend in southern Johor, encouraging Johor companies to invest to take advantage. More Malaysians will be able to work at higher salaries in Singapore as well. If a Malaysia-Singapore special economic zone is announced, this benefit will be further reinforced.
Finally, the region is just beginning its decarbonisation efforts. This should also spur some new investments as companies seek to green themselves and as countries pursue adaptation and mitigation strategies.
So, what can go wrong?
Much as we believe that there are compelling reasons to expect stronger investment in the region, it is also true that there are many potential pitfalls.
The major concern has to be the global environment. A good part of our case for a new investment cycle rests on foreign investment. But any major blow to confidence could put planned foreign investment on hold. This could result from a geopolitical shock of some kind or some kind of financial dislocation, perhaps because the higher level of interest rates exposes imbalances that regulators had not expected.
Another area to watch will be the elections around the world and in the region. India’s general election is likely to be in April or May, while the Indonesia presidential elections are almost certain to go into a second round in June. So, businesses could remain uncertain about policies and the prospects for good governance for close to half the year. Taiwan’s elections in mid-January are too close to call, with a chance that a victory for the incumbent party could precipitate an angry reaction from Beijing. The American elections will be in November — the chances of former president Donald Trump being re-elected on a platform of more tariffs and toughness towards China adds to the sense of unpredictability in global politics that could deter investment spending.
Finally, the lagged effects of the sharp monetary tightening of the past year could produce more dire impacts on global demand than many of us anticipate. Or the Chinese economy might be more precarious than policymakers and economists appreciate. We are in uncharted territory insofar as the post-pandemic global economy is concerned, so there could be unexpected downside risks.
Conclusion: Overall, a more promising year beckons
As we discussed in the beginning, in the end it is all about animal spirits. Our judgement is that even if some of the risks above materialise, the effects will be episodic and unlikely to last a prolonged period. Given the pent-up demand for investment and the many factors that could energise entrepreneurs, we think that animal spirits will triumph in the end. If all goes well, a new investment cycle will raise the share of investment in the economy and usher in a period of higher economic growth in India and Southeast Asia.
Manu Bhaskaran is CEO at Centennial Asia Advisors
