Strengthening ties: The ASEAN Economic Community aims to boost regional integration

The year 2014 marks a major milestone in Myanmar’s efforts to position itself internationally and amongst its regional peers, as the country assumes the rotating chair of ASEAN for the first time since it joined the regional economic club 17 years ago. Its chosen slogan, “Moving Forward in Unity to a Peaceful and Prosperous Community,” underscores its strategic intent to focus on economic development priorities whilst defusing tensions at home and in the region. Moving forward with the ASEAN Community 2015 agenda is perhaps the biggest challenge anticipated by ASEAN watchers, as this will require further liberalisation of the services sector to allow for the free flow of capital.

Regional Integration

ASEAN is set to declare itself a common market at the end of 2015 in a move that will create new opportunities for investors in a region that boasts not only some of the world’s fastest growing economies, but also a rapidly expanding middle class. “ASEAN and South-east Asia are one of the few really bright spots in the world economy,” said Teoh Kok Lin, founder of Singular Asset Management in Kuala Lumpur. “We still have a young population so the demographics are positive. We also have a huge emerging middle class; people are buying their first television, their first mode of transport. It’s a sweet spot.” In the past decade, the economies of emerging Asia have expanded by more than 7.5% a year, according to the IMF. ASEAN’s combined GDP is already valued at $2.3trn and is expected to reach $10trn by 2030. The group, now home to an estimated 609m people, was formed in 1967 as a bulwark to the communism that had begun to spread through South-east Asia. The original members – Malaysia, Indonesia, Singapore, Thailand and the Philippines – made economic growth a priority from the very start. Historically, countries have tended to compete in the same industries, focusing on the potential outside ASEAN rather than within the region itself. Even today, intra-ASEAN trade is just 25% of the region’s total trade. Thailand, for example, has become known as the “Detroit of the East” and acts as a hub for global carmakers. However, those same vehicle manufacturers also have bases in Indonesia, South-east Asia’s biggest car market, and the Philippines. ASEAN’s 10 members also compete in other areas such as food processing, telecommunications, tourism and business services, while those with better standards of English – the Philippines, Singapore and Malaysia – have tended to have an advantage in the global economy.

Diversity

The original five members are now at the core of what has grown into a highly diverse organisation. As well as differing political systems – from the vibrant democracies of the Philippines and Indonesia to the communist regimes of Laos and Vietnam and the sultanate of Brunei Darussalam – there are also vast disparities in economic management, culture and wealth. Singapore is the richest but also the smallest. The city-state’s per capita income is estimated to be more than 40 times that of Myanmar, but the island nation has less than a 10th of the population.

Background

The ASEAN Economic Community (AEC) was launched in 2003 as the region emerged from the Asian financial crisis. Five years earlier, the collapse of the Thai baht ricocheted across the region, triggering deep recession in many countries and bringing an end to the authoritarian rule of Indonesia’s President Suharto. In the aftermath, leaders sought a way to rebuild their economies on a more secure foundation.

“Asians did not draw the wrong lesson from the Asian crisis; they did not hunker down, pull up draw bridges or withdraw from the world,” Christine Lagarde, the IMF’s managing director, said in a speech in Kuala Lumpur in November 2012. “Asia’s economic foundations became safer, sounder and more resilient, but still open to the world and open for business.”

The AEC is designed to transform ASEAN’s 10 member countries into a single production base allowing for the free movement of goods, services, investment, skilled labour and capital. Initially set to take effect in 2020, the AEC is now expected to come into force on December 31, 2015. ASEAN has also championed closer economic integration as a way to bridge developmental differences within and among member nations, deepen the region’s economic ties with the rest of the world and compete more effectively with China.

Key Challenges

The group has set itself key targets and deadlines in a binding “blueprint” that tracks each of the AEC’s four pillars and was agreed in 2007. An “AEC scorecard” keeps track of each country’s compliance. Lim Hong Lin, the deputy secretary-general with responsibility for the AEC, notes that as of August 2012, 72% of measures for 2008-11 had been implemented. Still, other than peer pressure, there are no penalties for countries missing their targets and no way to ensure measures take effect at the national level. With the AEC built on the foundation of the existing ASEAN Free Trade Agreement, it is perhaps not surprising that most progress has been made in trade liberalisation. But efforts to integrate Customs procedures to create an ASEAN “single window”, liberalise services and harmonise crucial regulations and standards have been slower to materialise. Indonesia’s trade minister, Gita Wirjawan, acknowledged in November 2012 that his country was finding it difficult to deal with the cross-border measures. Thailand and the Philippines have also struggled. Local companies, fearful of competition in their home markets and often politically well connected, have made it difficult for governments to effect the policy changes that the AEC demands. Indeed, a Global Trade Alert report noted that in 2011 Indonesia adopted more potentially restrictive trade measures than any other country in South-east Asia, ranking it among the world’s top 10 protectionist nations.

Jayant Menon, lead economist for trade and regional cooperation at the Asian Development Bank (ADB), has been tracking the implementation of the AEC. He doubts the core countries will meet their 2015 target for implementation – though they will declare the AEC in existence anyway – and admits that the poorer nations of Cambodia, Laos, Myanmar and Vietnam are even further behind, perhaps by as much as a decade. But he stresses that the 2015 target should be seen more as a “milestone” than a hard target. “One should not expect in 2015 to see ASEAN suddenly transformed, its nature and processes abruptly changed and its members’ interests substantially altered,” he said. “2015 should be viewed more as a milestone year – a measure of a work in progress. The journey remains relevant even if the destination takes longer to arrive at.” Menon estimates the region’s core members will achieve AEC implementation by 2020, their original target.

Gradual Progress

ASEAN officials are also mindful of the region’s vulnerability to the economic uncertainty in the rest of the world. “The intensification of global risks puts into question the credibility of globalisation and casts some doubts on the region’s ability to manage its own integration,” Lim told delegates at a forum on the AEC in September 2012. “Of particular concern are the potential pullbacks in trade and capital flows into the region and global conditions deteriorate, and the possibility that some ASEAN countries may revert to protectionist measures and inward-looking policies to protect their own domestic economies.”

The poorer nations, Cambodia, Laos, Vietnam and Myanmar – the latter only just opening up to the world after decades under military rule – have, officially, until 2018 to reach their targets, but even richer countries have been able to negotiate exclusions for what they deem to be “sensitive” industries such as automotive manufacturing and agriculture. Malaysia, for instance, has long sought to protect its “national carmaker” Proton from outside competition. Furthermore, Indonesia and the Philippines are seen as among the world’s most restrictive countries, concerned about opening their vast domestic markets even to regional rivals.

Rising Trade

Still, while data suggests policy implementation has been slower in some areas than it should be, trade between ASEAN and the rest of Asia, as well as within ASEAN itself, has risen sharply in the past decade. Most recent data shows trade within the 10-member grouping rose to $601bn in 2012, compared with $121m in 1998. There are signs that ASEAN nations appreciate the benefits of cooperation.

Increasingly, electronics factories in ASEAN are making components that are then shipped to production centres in China for assembly and export to the wider world. Japanese carmakers have taken advantage of the ASEAN Industrial Cooperation Scheme to set up an integrated region-wide production system. The importance of trade to the region is reflected in the proliferation of free trade agreements either on a bilateral basis or between ASEAN and its major trading partners such as China, Japan and Korea. The bloc is now trying to streamline these group level agreements under the Regional Comprehensive Economic Partnership (RCEP).

The RCEP is designed to put ASEAN back at the heart of this trade machinery. Among other things, it is an effort to harmonise the widely differing rules of origin and investment protections among the 10 members and with their trading partners. The group agreed to start negotiations in November 2012, although it is not clear when any final agreement will be made.

Shifting Activities

In the past few decades, the region’s impressive growth rates have helped millions out of poverty and transformed what were once largely agrarian economies, such as Malaysia and Thailand, into centres for manufacturing and industry. The richer nations are now looking to develop more advanced service industries and move up the manufacturing value chain. As a result, ASEAN’s poorer members have moved into low-level manufacturing: factories on the outskirts of the Cambodian capital, Phnom Penh, now produce clothing for some of the world’s most high profile brands including H&M and Gap, and Cambodia’s garment industry is one of the region’s biggest.

All this is putting more money into the hands of ordinary people, growing the middle class. In Indonesia, for example, ASEAN’s biggest economy and the source of around one-third of the group’s GDP, some 163m people are expected to enter the middle class by 2020, equivalent to the combined population of Britain and Germany. As incomes grow, discretionary spending becomes more common, and demand for motorbikes and cars, electrical appliances and gadgetry, as well as banking and financial services, increases.

New Opportunities

 Companies within ASEAN have begun to see the potential. AirAsia, a low-cost carrier that started flying in Malaysia a decade ago, now has operations in three more ASEAN countries. In 2013, AirAsia’s Indonesian rival, Lion Air, established its own service in Malaysia, Malindo Air, as a joint venture with Malaysia’s National Aerospace and Defence Industries. ASEAN leaders have named “open skies” a priority for the AEC, recognising air transport as a crucial element of the modern infrastructure necessary to support its economic development plans.

Banking and financial services, including trade financing, insurance and microfinance, is another area where economists see much potential. The IMF estimates about 60% of people in the region are excluded from the financial system often because they don’t have enough money to open or maintain a bank account, don’t possess the proper documentation, or branches are too far away. In Cambodia, less than 5% of people have bank accounts, and Myanmar is estimated to have a similarly low banked population.

As part of the AEC, ASEAN officials have been working to develop and integrate the group’s diverse banking systems. While Singapore has turned itself into one of the world’s leading financial centres and Malaysia has carved a niche for itself in Islamic finance, other ASEAN jurisdictions are significantly less developed, partly because people in countries with lower GDP are poorer and have less interest in a formal banking system. Central bankers endorsed the ASEAN Financial Integration Framework in 2011, in an attempt to harmonise regulations across the region and identify the ASEAN banks most ready for regional expansion.

Regional Expansion

The small banked populations in some of ASEAN’s member countries have led institutions such as Singapore’s DBS Bank, Malaysia’s Maybank and CIMB, and Thailand’s Bangkok Bank to expand regionally. CIMB’s chief executive, Nazir Razak, has sought to develop the group as an “ASEAN” bank. With total assets of over $105bn at the end of 2012, CIMB employs more than 40,000 people across the region and provides financial services in nine of ASEAN’s 10 member states. Maybank operates in Indonesia, Singapore and Malaysia, and plans to open more than 100 branches across ASEAN in the run up to the AEC.

Still, as Maybank, CIMB and even international lenders such as HSBC, Citi and Standard Chartered have learned, financial services remains a highly protected industry across much of the region. Despite its enthusiasm for Islamic banking, for example, Malaysia places considerable restrictions on the operation of foreign banks in the conventional sector. Foreign banks can open only a limited number of branches and ownership of local lenders is restricted to 30%. Singapore also ensures that outsiders – including from ASEAN – have only limited access to its commercial banking sector although it is encouraging those with substantial local deposits to incorporate locally, a move that would give them the right to open more branches. Indonesia allows foreign institutions to acquire as much as 40% of domestic lenders, although this can be increased for publicly listed, financial strong banks.

Laying The Groundwork

Infrastructure is one area where there seems to be less resistance to outsiders. ASEAN governments are only too aware that creaky transportation networks – whether in the air, on land or at sea – threaten their ability to move goods and people smoothly around the region. The ADB estimates the cost of developing the infrastructure the region needs at about $60bn a year over the next 10 years. The ASEAN Infrastructure Fund, which is backed by the ADB, aims to leverage public-private partnerships to meet some of that demand.

Again, there are vast differences between members. In transport, while Singapore boasts one of the world’s most efficient public transportation systems and an airport that is voted frequently among the world’s best, Cambodia has next to no public transport, dangerous and pot-holed roads and limited air links. Its plans to rebuild a railway destroyed by years of conflict ran into trouble over the relocation of those living along the route. Despite this, the freight route linking the capital, Phnom Penh, to the modern port at Sihanoukville on the southern coast started operations in late 2012.

Utility Access

There are stark differences in power provision as well. In Cambodia, just over a quarter of the population has electricity – one of the lowest rates in the world – and many people do not have access to clean water either. It is a similar situation in Myanmar. The ASEAN Power Grid (APG), the Trans-ASEAN Gas Pipeline (TAGP) and other initiatives are designed to address these deficits. The APG involves the creation of 14 electricity interconnection projects and the TAGP will include seven gas connections.

When the AEC was conceived, few imagined that Myanmar would, less than a decade later, start political and economic reforms that would open the door once again to foreign investment. But even as business leaders beat a path to Yangon eager to secure “first mover” advantage in an economy long off-limits to outsiders, the challenges are undeniable. Myanmar’s per capita GDP is one of the lowest in South-east Asia, with 26% of its largely rural population living in poverty. Without access to basic services, many rely on wood and charcoal to light their homes and cook.

Reversing decades of isolation, the government is now welcoming foreign investors – its recently released legislation on foreign investment is among the most liberal in the region. With its vast, untapped resources of timber, gas, oil and hydropower most see the biggest opportunities in the energy sector. A recent ADB report notes that economic sanctions hindered the country’s development and ensured that the energy sector lagged well behind its potential. That is now changing. Offshore gas fields are the most important source of export revenue, with a pipeline to Thailand already in operation and a route to China under construction.

Myanmar is set to take the chairmanship of ASEAN in 2014 in what will be an historic moment for a country that has spent so long in isolation. As a frontier market with high growth potential, Myanmar provides a compelling reason why further integration should be pursued. ASEAN investors understand that Myanmar’s openness to foreign capital from the region will depend on the success of the regional integration efforts.