Manu Bhaskaran: Watch the politics in Asia next year

AFTER A YEAR full of major elections and leadership changes in leading countries around the world, investors need a break from politics. But, the next 12 months in Asia will see important political developments, some of which could be game changers. We could well see fundamental changes in policy direction as a result of general elections or through post election political realignments. Investors will need to watch carefully how politics impinge on the investment environment in Asia.

More reforms likely in China
There appears to be an emerging consensus that the new leadership line-up announced at the conclusion of the Chinese Communist Party (CCP)��s 18th Congress signalled a weak likelihood of political or economic reforms. Analysts were disappointed by the failure of wellknown reformists such as Wang Yang and Li Yuanchao to make it to the seven-member Politburo Standing Committee, the apex of the Chinese political system. Several also interpreted former CCP leader Hu Jintao��s policy speech as indicating a firm rejection of political reforms. Others argued that the personalities and experiences of the top leaders suggest that they will be risk averse and avoid anything but incremental changes.

These views are probably overly pessimistic. Our sense is that we are likely to see important economic reforms as well as some moves to create a better political atmosphere in coming years. Note that:

• Xi Jinping is probably more of a reformer than he has been credited with. Xi is the son of Xi Zhongxun, one of the giants of the CCP, the man who led the economic reform drive in Guangdong after 1978 and who was known as a relative liberal on political issues, including Tibet. Xi Jinping was reported to have met leading reform advocate, Hu Deping, just prior to the party congress and promised more reforms. Such a meeting and the way it leaked out is significant and telling, given the highly controlled political setting in the run-up to the congress. Hu Deping is the son of the late Hu Yaobang who was deposed as CCP leader in 1987 for pushing political and economic liberalisation too aggressively. More importantly, Xi Zhongxun had supported Hu Yaobang��s liberal policies.
• One should not assume that the absence of some well-known reformists in the apex leadership means a weak commitment to economic reforms. The makeup of the new Politburo Standing Committee primarily reflects the balancing of different factional interests, not an ideological balance. Several of the new leaders are close to former leader Jiang Zemin, under whom China experienced some of its most thoroughgoing reforms including the politically gutsy policy to lay off tens of millions of state enterprise workers in the late 1990s.
• There is a clear signal that decisive actions to attack corruption are likely. Hu Jintao warned starkly that the failure to root out corruption could spell the end of the CCP��s rule while his successor Xi Jinping��s first important speech following his anointment was to repeat the call for firm action against corruption. The appointment of Wang Qishan as head of CCP party discipline was significant �� he has a no-nonsense reputation for ruthlessly and effectively getting things done.
• At the end of the day, Xi Jinping is the front man for a collective leadership which will push policies reflecting the collective views and political interests of the top leadership. It is clear from the speeches and discussions in the run-up to the congress that the CCP collectively accepts the need for a step up in economic reforms as well as sufficient political reforms to accommodate the emerging social forces in the country.

What does this mean in practical terms? Investors should expect a decisive shift in favour of reforms in China in areas as diverse as taxation, treatment of rural migrants and the role of the private sector vis-à-vis the state sector.

Of course, the reform process will not be the big bang type that we saw in 1978. China��s leaders will test out economic reforms in some localities first and implement them in phases so that weaknesses can be ironed out before the reforms go nationwide. On the political front, we will not see any move towards democracy but we are likely to see some gestures to address issues such as corruption, cronyism and nepotism. Such a reform process will be significantly positive for the Chinese economy.

Japan��s December elections will crystallise a realignment of politics
Japan��s general election on Dec 16 will probably produce a weak coalition government led by the Liberal Democratic Party (LDP). But the really important story is one which will unfold after the elections. Neither the LDP, nor the ruling Democratic Party of Japan (DPJ), is popular �� it will be third parties that are likely to gain the most seats as the DPJ crumbles. Over time, we are likely to see the LDP and DPJ weaken with the eventual formation of ideologically more coherent parties.

In the meantime, some things will change in Japan. One thing is becoming clear �� the government elected in December will be able to change the composition of the Bank of Japan (BOJ) board by April as a large number of board members and the governor end their terms. If the LDP does lead the new government, it will nominate a board that is prepared to undertake a decisive change in BOJ policy towards a more aggressive monetary easing. This will lead to further yen weakness.

Do we need to worry about territorial disputes in 2013?
Rising tensions in the East China Sea between China and Japan and in the South China Sea involving mainly China, Vietnam and the Philippines have worried observers. Although the islands in dispute are tiny, they sit astride strategically important sea lanes as well as potential deposits of oil and natural gas. Tensions have gone up recently because rising energy prices and increased nationalism in the countries involved make it harder for their leaders to make the compromises necessary to resolve these disputes. China��s increased economic and military needs as a rising power also mean that it has a greater, and legitimate, strategic interest in these sea lanes. However, the manner in which China has sought to assert its presence in these waters has caused tensions to rise.

It remains unlikely that these tensions will expand into outright conflict. There is no desire on any country��s part for conflict �� China��s focus is overwhelmingly on economic development and it knows that any conflict will give the US greater scope to engage in the region to its detriment. Similarly, Japan is pre-occupied with its internal challenges as are Vietnam and the Philippines. The risk of an accidental clash is there but even this risk is reduced by the care each country takes to avoid deploying fully-armed naval vessels in the vicinity of the disputed waters.

Nevertheless, there are some negative effects.

• Japan��s confidence in good relations with China has been dented, giving the nationalist right wing in Japan the opening to raise their profile. A few Japanese businesses are considering reducing their dependence on China by moving some operations out of China.
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• Moreover, the recent tensions have crystallised a changed view of China among several Asian countries. This has led them to boost defence spending, especially on naval assets. A few countries have decided to strengthen their military ties with the US as a result.

Elections in Asean will have important consequences
There are two sets of elections approaching in Southeast Asia:

• Malaysia will hold its 13th general election in 1H2013. Most analysts believe that the ruling Barisan Nasional (BN) coalition led by Prime Minister Najib Razak will return to power with a narrow but comfortable majority. But most also expect �� as do senior ruling party officials �� that it will be the most competitive elections in Malaysia��s history. Once the elections are over, investors will want to be assured of two things in particular. First, will Najib��s position be secure after the elections? If BN wins comfortably and the leading party in it, Najib��s United Malays National Organisation (UMNO), performs well, then he will continue in power. But if UMNO performs poorly, we may see increased uncertainty as he comes under pressure from rivals in the party. Second, will the re-elected BN government feel confident enough to pursue necessary but unpopular reforms such as the rationalisation of subsidies and the implementation of the goods and services tax?
• The Philippines will hold mid-term elections for senators and representatives in its congress. Although President Benigno S Aquino III is not up for re-election, the results of these mid-term elections could determine the future course of his administration. If his allies do well, he will have the legislative numbers to continue his reforms which have put the Philippines back on the map of attractive investment destinations for the first time in decades. If his allies lose, then the risk is that he becomes a lame duck president and the reform momentum falters. Given his popularity and the rising mood of confidence in the country, we expect President Aquino to come out of the elections in a reasonably firm position.

The coming year will see political events frequently intrude into the investment environment. But overall, there is reason to expect outcomes to be largely positive for markets, particularly in China.