FISCAL CHALLENGES CAST SHADOW ON POLITICS
Much of Asia is vulnerable to an intensification and broadening of tensions between the US and China, a source of geopolitical risk. For some APAC sovereigns, domestic politics, including potential changes in policy priorities, are an additional source of uncertainty that could weigh on government credit quality.
Vote-driven changes to fiscal plans, including previous budgetary consolidation objectives and/or measures aimed at broadening the tax base, could call into question the capacity and willingness to reform, especially as the growth and financing environment becomes more challenging.
Political and policy priorities will also determine the effectiveness of measures to address banking sector – and in the case of India, non-bank financial sector – vulnerabilities. In some advanced economies, untested policies focusing on income equality, while beneficial to social stability longer term, could be a drag on near-term economic activity.
Elections this year could result in leadership changes but are unlikely to cause significant policy shifts. Assuming regular election cycles, parliamentary elections will be held in Australia, India, Indonesia, the Solomon Islands and Thailand, involving the potential for leadership changes. Local elections are due in Hong Kong, while the Philippines will hold mid-term elections, with the entire lower house of Congress and half the Senate up for reelection, but there will be no leadership change.
Consistent with Moody’s domestic political risk scores for these countries, the elections are not expected to result in significant shifts in policies that would slow near-term economic activity, or alter sovereign credit quality. In Thailand, where elections are scheduled to take place for the first time since the military took power in 2014, related risks are limited, particularly in light of the constitution passed in 2017 that ties the new administration to the current military government's development strategy, including implementation of the Eastern Economic Corridor.
Fiscal challenges have increased most notably in Malaysia and Sri Lanka. In Malaysia, the abolishment of the goods and services tax in favour of a narrower sales and services tax will shrink the government's tax base. In general, the government's focus on supporting growth and incomes of poorer households is a factor behind a slower fiscal consolidation path than previously projected.
The administration is expected to pursue fiscal consolidation from wider deficit levels. But should the government prioritise growth and provisions to low-income households further, Malaysia's fiscal strength would weaken. In Sri Lanka, there will be continued political tension and disruption to fiscal and economic policymaking to slow budgetary consolidation efforts and keep the government debt burden higher for longer.
Upcoming elections could also weigh on fiscal consolidation in India and hinder the Indonesian government's plan to widen the tax base. The impact of policy choices on fiscal outcomes would be more limited in Australia, where we expect budget deficits to continue to narrow despite a fractious political environment that has persisted for some time, and in the Philippines.
Banking and financial sector challenges remain in Bangladesh, India and Vietnam. Lending by state-owned banks to state-owned enterprises and/or to finance public projects with low returns has long weighed on profitability and asset quality in all three of these economies. Non performing loans are high across state-owned banks in Bangladesh and India, while a number of these institutions are undercapitalised.
For Vietnam, profitability and asset quality in state-owned banks have increased from low levels, but still-high credit growth raises the risk of boom-bust cycles. Stateowned banks account for more than 50 per cent of banking system assets in India and Vietnam, and around 30 per cent in Bangladesh, posing economic and contingent liability risks to the sovereigns.
In India, challenges now extend to non-bank financial institutions (NBFIs), which are largely funded by wholesale deposits and accounted for 30 per cent of new credit over the past five years. A sharp slowdown in credit availability, should NBFIs experience a liquidity squeeze, would raise domestic interest rates and weigh on growth.
Quality of life
Social policy tilt in Japan and Korea, while fostering more inclusive growth, could weigh on near-term economic activity. These two advanced economies have started to place more emphasis on social welfare and quality of life. Workstyle reforms in Japan limit overtime to 100 hours a month for non-white-collar workers, and raise compensation for part-time and temporary work to ensure “equal work for equal pay” with full-time employees. Korea raised the minimum wage by 16% in 2018 and reduced the cap on the number of hours worked per week to 52 from 68 previously. Korea's minimum wage will increase by a further 11 per cent in 2019.
While improvements to social welfare would reduce political risk stemming from socioeconomic challenges such as income inequality over the longer term, these policy measures could weigh on near-term investment and domestic demand, should higher labour costs lower business sentiment, reduce profit margins, and weaken job growth and business spending. Companies and labour unions alike have opposed the new labor policies and job growth has fallen sharply in Korea. New Zealand is also focusing on the quality of growth through its Living Standards Framework, which incorporates human, natural and social capital considerations in policymaking. While the country has a longer track record in implementing social welfare policies, business confidence has fallen following the 5 per cent increase in the minimum wage in 2018, with a further 21 per cent increase by 2021 planned.
Lambadi tribeswomen pose with their ink-marked fingers after casting their votes in the Telangana state legislative assembly election, on the outskirts of Hyderabad last month.