Renewable energy is key to economic growth in emerging Asia market

Emerging Asia expected to grow 6.2%.

Despite the market turmoil surrounding Brexit, the attraction of growth prospects of Emerging Asia (Southeast Asia, China and India) should continue to expand, spurred on by an emphasis on renewable energy projects.

A new report, Economic Outlook for Southeast Asia, China and India, by the OECD Development Centre in Paris, found that real GDP growth in Emerging Asia is expected to remain robust at 6.5% in 2016, and grow at an average of 6.2% over the period of 2017-2021.

The reason: continued domestic consumption, spurred on by developing alternative energy sources. Of the nations covered in this report, India is expected to be near the top of the list in terms of rapid growth, while China will see a slowdown. Overall, growth in the Association of Southeast Asian Nations (ASEAN) is projected to average 4.8% in 2016 and 5.1% over the period of 2017-2021. Growth will be strongest in the Philippines, Vietnam and the CLM (Cambodia, Lao PDR and Myanmar) countries, according to the report.

Accompanying this growth will be a push for renewable energy sources, such as wind, solar and hydroelectric. India and China are making the largest investments in renewables, while Vietnam, Thailand, Malaysia and Lao PDR are promoting renewables, with large investments in hydropower, the report said.

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India, China and Indonesia have received the largest inflows of money (about 60%) from greenfield Foreign Direct Investment (FDI.) The FDIs allow investments, technology and expertise in renewables that are creating a demand for new green jobs. Considering all renewable energy technologies, the leading employers in 2015 were China, Brazil, the United States and India, according to the Renewables 2016 Global Status Report .

The Economic Outlook for Southeast Asia, China and India report said the area’s main challenge is to “set the right conditions for the development of renewable energy in Emerging Asia and requires addressing the challenges of grid access, administrative barriers and energy pricing mechanisms.”

“Harnessing Emerging Asia’s enormous potential for renewable energy is vital to mitigate climate change and facilitate the transition to a low-carbon economy. It also provides opportunities for enhanced energy security, job creation and reduced air pollution,” said Mario Pezzini, Director of OECD Development Centre and Special Advisor to the OECD Secretary-General on Development.

But all is not entirely positive. China has suffered an economic slowdown, and exports over the past five years also have slowed, the OECD said. Low interest rates have also factored into slower economic growth and this has strained the region’s banking system. Productivity levels also have stagnated and this can be improved if companies use more technology and adopt more productivity improvements from companies outside of the region. The report also said “achieving sustained growth will require Emerging Asian policymakers to manage slowing export growth, the impacts of persistent low interest rates in the advanced economies, as well as plateauing productivity growth in the region.”

Investments in renewable energy have increased and hit a milestone in 2015. “For the first time in history, total investment in renewable power and fuels in developing countries in 2015 exceeded that in developed economies. The developing world, including China, India and Brazil, committed a total of USD $156 billion (up 19% compared to 2014). China played a dominant role, increasing its investment by 17% to USD $102.9 billion, accounting for 36% of the global total. Renewable energy investment also increased significantly in India, South Africa, Mexico and Chile,” according to REN, a global renewable energy policy multi-stakeholder network.

For example, in India, solar energy is now cheaper than coal, so many utility companies there are pushing for renewables over conventional power projects. The second-largest private sector power-generating company in India, Tata Power, wants to expand its renewable energy portfolio by acquiring 300 megawatts(MW) of wind projects in northwest India, according to Cleantechnica.

Vietnam is another emerging nation that has found renewables as a major force to expand its power grid into the countryside, while also creating jobs. Vietnam’s GDP grew at an annual rate of 6.8% between 1990 and 2013, and is projected to approach 7% annually from 2016 to 2030. What’s driving the country’s effort is increased industrialization, combined with a growing population, and demand for more energy, especially electricity. This has resulted in an increase of energy consumption at an average annual rate of 5.7% between 1990 and 2012, and a rise in electricity use of 14% annually during the same period, according to the East Asia Forum.

These projects are so important that the Asian Development Bank (ADB) has named renewable energy, environmental sustainability and responses to climate change as one of the country’s top three priorities, along with ADB’s country partnership strategy for Vietnam of promoting job creation and competitiveness, increasing the inclusiveness of infrastructure and service delivery, according to a December 2016 report.

By Chuck Epstein

What explains the disconnect between improved business growth and lower CAPEX?

Business spending remains stagnant for new equipment.

According to two national surveys of business financial executives, businesses are optimistic on most fronts, except when it comes to expanding capital expenditures.

One possible explanation for this divergence is executives’ beliefs that when shareholder expectations about returns on projects are reduced, investor expectations decline, according to Gene Balas, portfolio manager at United Capital Financial Life Management, Newport Beach, Calif. And when the hurdle is lower, more projects clear it, so companies then invest more in their businesses, rather than return cash to shareholders. That is how lowered return expectations can improve economic growth.

According to Business Roundtable’s CEO Economic Outlook Survey for the fourth quarter 2016, “CEO expectations for sales over the next six months increased by 4.5% points, and expectations for hiring increased by a more robust 14.8 points over last quarter. However, CEO plans for capital expenditures fell by 5.4 points relative to last quarter.” The lowest point in capex was in 2Q 2009, when the Business Roundtable’ scale of CAPEX and fixed investments fell to below 0.

Similarly, a monthly survey from the National Federation of Independent Businesses (NFIB) found that while smaller companies are more optimistic about the future, they are reporting less in-house investments. In a November 2016 trend survey of small companies, the group found “the percent of owners planning capital outlays in the next 3 to 6 months fell 3 points to 24 percent….Seasonally adjusted, the net percent expecting better business conditions rose 19 percentage points to a net 12 percent. Expectations for economic improvement and sales growth made significant gains, but plans for capital spending did not follow, declining after the election.”

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So while business are optimistic about increases in sales and hiring, why are they decreasing their capital spending on new plant and equipment?

According to Balas, this situation is a “puzzling issue” since “business investment [is] a direct engine of economic growth, [but] it also has downstream effects in the form of more efficient technologies and systems that could boost productivity. Yet, productivity is key to allowing corporate profits to grow simultaneously as wages might increase.”

Writing on his companys website, Balas hypothesized that investors and business executives may be expecting too much in terms of a return on their equity holdings. So while the real rate of interest is low, while inflation and the real rate of interest are increasing, “they are unlikely to return to previous levels seen in prior decades. Why this is so matters a great deal, as it influences investment returns across asset classes.” He also noted that “since the return on stocks depends on the risk-free interest rate plus a premium for the risks of investing in stocks, a lower real rate of interest means we might expect a lower return on stocks going forward.”

As to timing, Balas said “the timeframe for increasing capex depends on what is involved. A new facility will take considerable time to plan and then build, whereas equipment may be more readily purchased, and software is even more adaptable to a faster timeline. That said, in the November 2016 NFIB survey, there is a timeline: “The percent of owners planning capital outlays in the next three to six months jumped 5 points to 29%, the highest reading since December 2007, the peak of the last expansion, but well below the high readings in the mid-90s of 40%.”

What drives business to expand their capital expenditures is a stronger belief in long-term macroeconomic and company-specific trends. David Wessels, adjunct professor of finance at the Wharton School, University of Pennsylvania, said the long-term trends now are seeing movements away from capital-intense spending and more towards R&D, creating capital, intellectual property, and expanding sales and distribution. But right now, large capital expenditures are not happening.”

As a result, businesses are looking at short-term trends and are choosing to add capacity by adding people, rather than making large capital expenditures by purchasing equipment or building factories, for example. Adding staff gives financial managers more “optionality,” which Wessels defined as flexibility in terms of making major financial decisions.

For instance, in the United States, it is easier to hire and fire people than to make large capital expenditures to buy equipment that indicate a large commitment to increasing output. “Optionality gives a manager tremendous flexibility, so if a business is a risk taker, they would add more equipment. But if not, they would add people. In the short term, if a business is not a risk taker, adding staff is a better choice,” he said.

Wessels added that although the product and financial markets currently are doing well, there is uncertainty over how long that will last. “In this environment, managers are looking for more options that give them more flexibility to manage risk. Uncertainty breeds caution in the decision-making process, but with that said, we never have a crystal ball and there is always a lot of uncertainty when companies decide to spend money.”

Wessels noted that this uncertainty will not last, “but this uncertainty is different than the morefirm belief that the good times will not last. If this were the case, it would show more certainty and would result in a deleveraging and a market sell-off.”

When the economy is tightening, managers reduce their leverage and cut employees, but currently the market is seeing leverage ratios at an all-time high as measured by the non-financial S&P 500, which is at its highest level in 15 years due to a combination of low interest rates and excitement about economic growth.

“So as revenues rise, accompanied by declines in capital expenditures, it could signal that managers are choosing their most flexible short-term options over their long-term ones as their levels of confidence change,” Wessels said.

For large companies, the Business Roundtable reports in its 4th quarter CEO Economic Outlook that in the coming six months, 35% of the companies surveyed plan to increase investment in capital, whereas 21% forecast a decrease in such investment. This compares to the third quarter, where 38% planned an increase and 19% planned a decrease, he said. The silver lining here is that businesses may be ready to increase their capex because as shareholders expect a lower return on their equity holdings, “businesses may invest more rather than return that cash to shareholders. And that is how lowered return expectations can improve economic growth.”

But there are more uncertainties. According to Fidelity’s 2017 Economic Outlook (published December 2016) “late-cycle signs began to emerge as the year progressed, including pressure on corporate profit margins due to stalling productivity and rising wages. While corporate borrowing costs fell significantly, banks reported that they began tightening lending standards to businesses for the first time since the financial crisis.” This could also spell bad news for capex.

By Chuck Epstein

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