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The ASEAN Economic Community: A Long Road Ahead

An Institutional Investor Sponsored Report

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The formation of the $2.3 trillion ASEAN Economic Community by year-end promises to accelerate trade and development and lay the foundations for a vibrant new single market in the heart of the Asia Pacific. But delays in implementing the master plan mean that real integration is still a long way down the road.

It’s been almost a decade in the making. But the launch of the 10-member ASEAN Economic Community (AEC) by the end of this year marks the biggest step yet in a process that will eventually remove all barriers to the movement of people, goods and services in the region and usher in a vibrant new single market.

By almost any measure, the new economic trade bloc comprising Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, the Philippines, Singapore, Thailand and Vietnam, looks compelling. Located in the heart of the Asia Pacific and situated across major trade routes, the AEC has a population of more than 600 million, larger than the European Union or North America, but with considerably younger demographics. Better still, according to J.P Morgan, at current growth rates, ASEAN should become the fourth-largest market in the world after the EU, U.S. and China by 2030, supported by an increasingly well-educated workforce and plentiful natural resources.

At the same time, free trade agreements already signed with China, Japan, India, Korea, Australia and New Zealand will in theory give the AEC access to an even bigger market with a population estimated as high as 3 billion.

“We envisage ASEAN as an integrated region where there are abundant and varying opportunities for business, greater community interactions and personal growth, a region that is fully connected to the rest of the world, able to turn diversity into opportunities so that ASEAN can be proudly called a Community of Opportunities,” according to H.E. Le Luong Minh, secretary general of ASEAN, in a keynote address.

But while most bankers agree on the region’s long-term potential, they point to plenty of shortcomings that must be addressed before real integration can take place. Among the biggest stumbling blocks are the enormous political, cultural and economic disparities between ASEAN countries. Per-capita GDP ranges from more than $40,000 in Singapore and Brunei to less than $1,000 in the emerging economies of Myanmar, Laos and Cambodia. Added to that are regulatory obstacles such as currency regulations, labor laws and protectionist tariffs, which have yet to be fully removed. And while ASEAN leaders claim that 88 percent of the reforms set out in the blueprint have been implemented, others are less certain.

“I think the AEC is over-hyped,” says Dr. Thitinan Pongsudhirak, a director of the Institute of Security and International Studies at Bangkok’s Chulalongkorn University. “It talks a lot more than it delivers, although over time it does deliver.”

Nonetheless, some impressive reforms have taken place. Among the biggest achievements, the Asian Development Bank (ADB) lists the reduction of tariffs, with more than 70 percent of intra-regional trade in ASEAN enjoying zero tariffs and less than 5 percent of goods being subjected to tariffs of more than 10 percent. The ADB also believes that reasonable progress has taken place on liberalizing investment and capital flows and negotiating free-trade agreements.

Conversely, much remains to be done. Among the most urgent tasks are removing barriers to trade in sensitive areas such as agriculture, steel and services, eliminating non-tariff barriers, adopting harmonized standards on competition policy and promoting greater labor mobility to include unskilled as well as skilled labor.

Jayant Menon, an economist at the ADB, sums up the ASEAN Economic Community as “a work in progress.” He notes that the real results of the formation of the AEC and its ability to compete with neighboring China and India as well as the US and EU could take years if not decades to achieve. That does not mean, however, that integration into one market is not a worthy goal. “As an investor you need to have consistency and transparency,” says Boonchai Opas-iam-likit, chairman and managing director of BASF Group Thailand. “As long as there is consistency, there will be support.”

Connectivity
The good news is that many initiatives are under way that will boost connectivity among ASEAN members and pave the way for closer physical integration.

In late 2014, the Thai government signed an initial agreement with the Chinese government to build a Bt350 billion ($10.6 billion) railway connecting Bangkok to the city of Nong Khai on the border with Laos. If all goes to plan, work on the 600 km track could begin early next year.

Pridiyathorn Devakula, former Deputy Prime Minister of Thailand, expects plenty more of the so-called “mega projects” to follow. “Given its central geographical location among the ASEAN 6, Thailand is now actively undertaking several megaprojects to improve seamless connectivity in ASEAN and in particular in the Greater Mekong Subregion,” he said at a regional conference in late May.

Thailand is far from being the only country pushing for better infrastructure. The Lao government is also expected to sign a contract with the Chinese government for a $7.2 billion high-speed railway. Eventually a standard gauge double-track will link China’s Yunnan province to Laos, Thailand, Malaysia and Singapore.

Nor is it only railways that are high up on the priority list. As part of the ASEAN Vision 2020, governments also are pushing the ASEAN highway network, which will consist of 23 routes covering 38,400 kilometres to connect all 10 member states.

The enhanced transport links are all the more remarkable given the region’s turbulent history. “Little more than two decades ago, cross-border trade was negligible,” says Stephen Groff, vice president for Southeast Asia at the ADB. “Today trade is booming.”

Besides the obvious benefits of increased trade and tourism, an improved network of roads and railway links will lower costs for companies in ASEAN, making it cheaper and more profitable for them to ship goods around the region.

One infrastructure project that has encountered more than its fair share of problems is the Dawei deep-sea port and special economic zone. Situated in southeast Myanmar, a short distance from the Thai border, it was originally slated to include an industrial estate spanning 132 sq. kilometres and a deep-sea port capable of handling 250 million tons of cargo a year, as well as power plants and four-lane highways.

However the ambitious project foundered after the Japanese decided to back their own competing industrial zone. Now a slimmed-down version of the Dawei project may once again be inching forward with support from governments in Thailand, Myanmar and Japan. Construction company Italian-Thai Development and its consortium partners Rojana Industrial Park and LNG Plus International recently signed a concession agreement with the Myanmar government. The first phase of the project is expected to include a small port, a two-lane road to Thailand, an industrial estate, power plants and a liquefied natural gas terminal.

Corporate M & A
Infrastructure is not the only sector that is attracting the attention of investors. From manufacturing to energy exploration and property development, the AEC is helping to redraw the lines of business, throwing up opportunities for companies who are in a position to capitalize on them.

Some of the biggest corporate names have already stolen a march on the AEC. Thailand’s Siam Cement Group has set the pace in recent years, opening up sales and manufacturing operations in almost every country around the region. In one of its most recent acquisitions, Siam Cement paid Bt1.5 billion for an 80 percent stake in Vietnam’s Tin Thanh Packing Joint Stock Company near Ho Chi Minh City. The acquisition will transform the Thai conglomerate into a major packaging producer in ASEAN.

For his part, veteran Siam Cement president and CEO Kan Trakulhoon is upbeat about prospects for the AEC. “SCG continues to operate its businesses with an aim to become a sustainable leader in the ASEAN region,” he says. “Our investment expansion plan is still on track and we continue to export our products within the regional markets as we anticipate growth within the ASEAN region.”

Siam Cement is far from being the only company to expand its footprint in ASEAN. CapitaLand is one of Asia’s largest real estate companies headquartered and listed in Singapore. Its core markets are Singapore and China, but the group also has identified Vietnam, Indonesia and Malaysia as growth markets. Meanwhile, Thailand’s giant energy group PTT and its subsidiaries also have invested heavily in the region.

Not all countries appear to relish the idea of foreign companies muscling in on their home turf. Malaysia repeatedly dragged its feet over the implementation of the preferential tariff system in a bid to protect its home-grown automobile industry from outside competition. Some bankers worry about the reluctance of Indonesia’s President Joko Widodo to actively embrace the concept of the AEC. Given that Indonesia is widely viewed as the economic powerhouse of the region, any refusal to open up its markets to foreign competition would mark a serious setback for the regional bloc.

Financial Services
Of all the business sectors in ASEAN where barriers abound, the financial services sector is close to the top of the list. This is hardly surprising. Many governments are understandably reluctant to open up their financial markets to foreign entrants for fear that their own banks will be unable to compete.

One of the most glaring examples of protectionism came in 2013, when Indonesia’s central bank turned down an attempt by Singaporean lender DBS to assume a majority share of Bank Danamon Indonesia, the country’s sixth largest bank by assets. Some observers claim the case may set a dangerous precedent. “The creation of the AEC will have a much more limited impact on the financial services sector than in many other areas of the regional economy,” notes a March 30 report by BMI Research. “We expect full liberalization to only realistically take place long after Vision 2020.”

This has not stopped some of the big Thai and Singaporean banks from opening branches and representative offices around ASEAN. In June, Bangkok Bank, which has the largest foreign branch network of any Thai bank, officially re-opened its branch in the Cambodian capital Phnom Penh after a 14-year absence. Bangkok Bank now has a presence in every ASEAN country with the exception of Brunei.

Kobsak Pootrakool, executive vice president of international banking at Bangkok Bank, sees regional expansion as a logical step for many local businesses. “My clients are starting to realize that they cannot stay in Thailand alone,” he says. “They have to go out and capture the opportunities within the region.”

One of the latest countries to open up its doors to foreign banks is Myanmar. Late last year, Bangkok Bank, Malayan Banking, United Overseas Bank and Oversea-Chinese Banking Corp won coveted licences to this formerly closed country. Many businessmen have hailed Myanmar as one of the most exciting long-term prospects in ASEAN. Indeed it was little more than three years ago that the first ATMs were rolled out in the capital Yangon.

“The single more important change in the Greater Mekong Subregion is the opening up of Myanmar,” says Kamalkant Agarwal, head of international banking business at Siam Commercial Bank (SCB), Thailand’s third biggest lender. SCB already has a representative office in Myanmar. Last year, it applied for a banking licence, but failed to gain approval. The bank has since made it clear that it will consider re-applying if and when Myanmar decides to issue new foreign bank licences. “We still see great potential for the Myanmar market,” says Kamalkant.

Foreign Investors Seek Value in ASEAN Stocks
Until recently, one of the most difficult questions facing global fund managers wanting ASEAN exposure was how to buy a broad spread of regional equities with the maximum ease. And until recently the answer has been that it was not possible.

For one thing, ASEAN’s seven stock exchanges lacked any mechanism that would allow investors to trade in different markets using one platform. For another, stocks had to be settled in local currencies with varying settlement dates.

Fortunately, some links have now been put in place to remove the biggest obstacles. In 2012, stock exchanges and regulators in Thailand, Malaysia and Singapore launched the ASEAN Trading Link, which provides investors with a single point of entry into three of the largest ASEAN equity markets. Today, investors in principle can trade more than 2,200 companies listed on these three exchanges. The authorities have taken other steps to boost the visibility of equity products in the region and create a larger universe of investible stocks. One of the most important is the launch of three new tradable indices covering the ASEAN market: the FTSE ASEAN All-Share Index, the FTSE ASEAN Stars Index and the FTSE ASEAN All Share Ex-Developed Index. The next step, fund managers hope, will be to expand the ASEAN Trading Link to other exchanges in the region and harmonize processes for seamless end trades.

Dato’ Tajuddin Atan, CEO of Bursa Malaysia, remains optimistic about the outlook. “The emergence of ASEAN as an integrated capital market is already happening,” he says. “ASEAN Exchanges will continue to support this development and partnership in the spirit of competitive collaboration.”

An equally welcome development has been the launch of growing numbers of dedicated ASEAN funds seeking to cash in on burgeoning demand for ASEAN equities. In September 2014, One Asset Management, a Bangkok-based fund management company, launched the $4.2 million One ASEAN Stars Fund with exposure to the region’s largest markets. This year, it went a step further by introducing Thailand’s first ASEAN index fund, the One Stoxx ASEAN Select Dividend 30 Index. With a size of $15.8 million, the fund’s objective is to replicate the underlying index.

Some investment bankers are also waking up to the new opportunities offered by greater ASEAN integration. Adisorn Singhsacha, managing director of Twin Pine Consulting, advised EDL-Generation Public Company—Laos’ biggest power producer—on a Bt6.5 billion bond issue in the Thai capital market. Adisorn believes it is a logical step for companies in less-developed countries such as Cambodia, Laos and Myanmar to raise funds in more developed capital markets such as Thailand or Singapore. “We already have a couple of deals in the pipeline,” he says.

Big Potential in E-commerce
Another sector that is beginning to attract the attention of foreign investors is E-commerce. At present, online broadband users account for just 29 percent of the adult population in ASEAN’s six largest economies. That compares with 46 percent in China and more than 90 per cent in Japan. Indeed the only country to have higher levels of broadband access is Singapore, which is on par with other developed economies.

But according to global management consulting firm A.T. Kearney, the situation may be about to change. As the cost of broadband access falls across the region and consumers become more comfortable with the new technology, the number of users is likely to soar. And that in turn is likely to boost the E-commerce business, which accounts for less than 1 percent of total retail sales in ASEAN, compared to rates of 6-8 percent in Europe, China and the US.

“Retail E-commerce offers a unique opportunity to connect millions of merchants and consumers across the region,” says A.T. Kearney’s report “Lifting the Barriers to E-commerce in ASEAN.” The report forecasts that the ASEAN E-commerce markets could grow as much as 25 percent annually. That’s a rate which can probably only be matched by China.

There are other enthusiasts of E-commerce in the region. The Lazada group, which operates one of Southeast Asia’s leading online shopping stores, has so far raised €520 million in investment for expansion around ASEAN.

Investors include Temasek Holdings, J.P. Morgan Asset Management, Verlinvest, Summit Partners, Tesco, Investment AB Kinnevik and Rocket Internet. The Lazada group now boasts around 4,000 employees across the region and an online footprint of more than 4.5 million daily visitors. “The E-commerce market in Southeast Asia is still in its early days,” says Maximilian Bittner, CEO of Lazada. “We will continue to invest in our operations to enhance our customer experience.”

Before online sales can really take off in Asia, governments must still address a number of significant barriers. High on the list is state aid to improve broadband access and cross-border connectivity. Other areas of concern include the need to improve online security and e-payments, boost logistics and trade efficiency and support the emergence of local players in the industry.

Resolving these issues, in many cases, is likely to be simply a matter of time. And as the region’s burgeoning middle class continues to expand, investors in E-commerce could find themselves among the biggest winners of ASEAN integration.

Slowing Economies
How ASEAN will weather the challenging global environment is one of the most difficult questions to answer. Until earlier this year, ASEAN looked to be a relatively bright spot in an otherwise unimpressive environment. The 2014 GDP growth came in at a healthy 4.4 percent, well above the 0.9 percent reported by the EU and the 2.4 percent registered by the US.

Some countries did especially well. The Philippines expanded at an impressive 6.1 percent rate, making it one of the world’s fastest-growing nations after China and India. Meanwhile Indonesia, ASEAN’s largest economy, managed to notch up a respectable 5 percent, despite holding general elections and suffering weak prices for its main commodity and energy exports.

This year, however, the slowdown in China together with the prospect of higher US interest rates, have already put a damper on the region’s economies. And while the ADB forecasts that ASEAN economies will expand by 4.9 percent in 2015, many economists expect a downward revision on the back of slowing global trade volumes.

According to Deutsche Bank, global trade expanded at just 1.8 percent year on year in the first few months of 2015, compared with annual growth of 6.8 percent during the period from 2000-2007. “Trade malaise is hugely problematic for the export-oriented economies of Asia, casting substantial downside risk to their outlook,” notes a report by Deutsche Bank published on July 31. The report highlights other structural weakness like lower investment around the region, rising trade restrictions and changing patterns of production.

Compounding the situation is the recent move by the People’s Bank of China to lower the value of the renminbi in a bid to revive the Chinese economy. On the one hand, the weaker renminbi could kick start the Chinese economy, which in turn could stimulate ASEAN exports. But on the other hand, it risks igniting a currency war around the region as countries seek to maintain their own competitiveness by lowering interest rates and letting their own currencies weaken.

One of the hardest hit economies has been Thailand, which suffered a military coup in May last year. After experiencing a short-term bounce thanks to more stable government and the promise of widespread structural reform, business confidence has once again plunged in recent months on the back of slowing exports, weak farm prices and poor economic prospects. The Ministry of Finance lowered its 2015 growth forecast in July to 3 percent from 4 percent earlier in the year. Credit Suisse believes the real figure may be 2.5 percent. Meanwhile the Thai baht has weakened to a six-year low of Bt35 to the US dollar, making it one of the worst performers in Southeast Asia since the start of the year.

Singapore is also facing another lackluster year largely due to the sluggish global recovery. GDP shrank to? 4.6 percent in the second quarter, driven by a sharp fall in manufacturing amid reduced demand from China. Analysts are already downgrading their full-year forecasts.

Despite the tougher economic conditions, debt levels in the region remain for the most part manageable. This was spelled out in the latest assessment on ASEAN banks by global credit ratings agency Standard & Poor’s issued in early August. While the asset quality of ASEAN banks could weaken over the next 12-18 months as a result of rising household indebtedness and tight liquidity, the report concludes that “the accumulation of capital and provisioning buffers should be sufficient to offset these headwinds and continue to underpin the ratings on the banks.”

The good news is that the challenging global outlook has done little to slow down growth in Cambodia, Laos, Myanmar and Vietnam, highlighting the wide economic disparities within the region. Investors have coined a new term for these four countries. They are known as the CLMV and they are attracting growing attention from investors who see them as immune to many of the economic forces that are shaping markets in the developed world.

“The whole world is talking about the CLMV region,” says Kamalkant at Siam Commercial Bank. “Three of the four countries are growing at 7 percent. And these kind of growth rates are only going to get better given the high level of FDI we are seeing, together with abundant labor and natural resources.”

Many economists expect rapid development of the CLMV countries to continue at least for the next few years as they play catch-up with their neighbors. But some worry that unless these countries put in place the physical, legal and regulatory infrastructure now, they will begin to hit bottlenecks.

“How do you keep the good times going?” asks Kobsak at Bangkok Bank. “It is easy to see that Myanmar can grow by 10 percent for the next five years, but the key question is what happens after that? You have to keep reforming yourself to make sure that the good times last.”

In the future, local issues may also cloud the outlook for some ASEAN countries. Next year sees general elections in the Philippines and possibly in Thailand, although it remains unclear if and how general elections will proceed. In addition, both the Philippines and Vietnam are entagled in disputes with China.

Nonetheless the broad consensus is that prospects for next year will improve with economic growth across ASEAN expected to reach 5.3 percent, according to the ADB. That would be welcome news for the region’s leaders celebrating the inaugural year of the ASEAN Economic Community.
by Ben Davies

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