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					EYE ON ASIAN ECONOMIES
ECONOMICS RESEARCH

ASIAN

December 2009

Eye on Asian Economies • 1Q2010

Contents
Viewpoint: Ten in ’ten .......................................................................................................... 1 World view ......................................................................................................................... 27 Australia: Up, up and away................................................................................................. 31 China: Enter the Chinese consumer .................................................................................... 35 Hong Kong: Boom in 2010, boom in 2011........................................................................... 39 India: Gets to the next upturn ............................................................................................ 43 Indonesia: Reaching out for 6% GDP ................................................................................. 47 Korea: Domestic resilience ................................................................................................. 51 Malaysia: Not Asia’s favourite market ................................................................................ 55 Philippines: A disappointing year, but a better 2010 .......................................................... 59 Singapore: Bust to boom .................................................................................................... 63 Taiwan: Domestic economy stabilising ............................................................................... 67 Thailand: Exports to the rescue .......................................................................................... 71

Viewpoint written by Eric Fishwick Forecasts written and prepared by Eric Fishwick, Tony Nafte and Sharmila Whelan Editing: Antonia da Cruz and Susanna Tsoi 17 December 2009

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Ten in ’ten
Economic themes for the New Year
WE IDENTIFY THE TOP TEN
THEMES FOR 2010

The first Eye on Asian Economies of each New Year is an opportunity to outline our global forecast for the next two years. Ten in ’ten does this in the form of the ten dominant themes that will drive Asian markets and economies in 2010. The country forecast tables that follow take these and extend them into 2011. Three or four years ago most of our “themes” would concern economies outside the region. Now it is different. Of the ten themes four are directly concerned with China. Three more have China and Chinese policy at their core. It is not just that China is large (though it is). Its growth is becoming increasingly complementary to production around the Pacific Rim. It is this complementarity that makes this note and Asia itself so China-centric. Only one “theme”, our expectations for US growth, can really be considered external. And even here China’s absence as the financier of the last resort (see the 4Q09 Eye on Asian Economies) is an important factor in our analysis. 2010 will be the first year that Asian demand can really be said to be the driver of Asian economies. This is not because countries have suddenly become less export dependent. On the contrary most Asian economies are just as reliant on exports as ever. But for the first time the countries that provide the exception to this rule will be large enough buyers of consumer goods to compensate for any weakness in demand from the US. The Chinese consumer is central here. More than any other economic agent he (and she) will shape the world economy for the coming decade. Chinese consumption of durable goods is growing out of all proportion to its historical levels. A combination of rapid real income growth combined with still low penetration rates of consumer durables has massively boosted the rate of growth of Chinese demand. It is on its way to reflating China’s own light industrial sector and is doing the same, through rapid import growth, for the rest of the region. Chinese consumption is a subject that we will return to repeatedly in months to come. In the meanwhile it is the first and most important of our themes for 2010. 1. Chinese consumer spending At first glance this seems a tall order. US consumer spending, even after a lacklustre start to 2009, is US$10tn. We estimate Chinese consumer spending in 2009 to be around US$1¾tn. Add in the US$8tn from consumers in the Eurozone (with an additional US$1.7tn in the UK) and Chinese consumption seems tiny. Can it really compensate for lacklustre spending patterns in the west?

CHINA IS CENTRAL

2010 WILL BE THE YEAR
THAT ASIAN DEMAND DRIVES

ASIAN PRODUCTION

THE CHINESE CONSUMER
WILL SHAPE THE NEXT DECADE

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LACKLUSTRE EU
CONSUMPTION IS OFFSET BY CURRENCY EFFECTS

The first thing to note is that it doesn’t have to. European consumer spending in euro terms will be weak but as we argue in Theme #5 the native growth of the Eurozone is unimportant to Asia when the euro currency is appreciating. It is really only the US consumer that China has to compensate for. And he is already proving up to the task. Recalculate the historical comparison in growth terms and China’s contribution already looks much more impressive. Figure 1 shows the dollar growth in private consumer spending in the US and China. 2009 is clearly exceptional but even during the late cycle period, when US consumer spending was growing rapidly, the Chinese consumer was catching up fast.

CHINESE CONSUMPTION HAS OVERTAKEN THE US AS A
SOURCE OF WORLD GROWTH

Figure 1

CONSUMPTION DELTA IS MOVING EAST
US$ change in annual household consumption
China USA (US$bn increase)

600 500 400 300 200 100 0 (100)

98

99

00

01

02

03

04

05

06

07

08

09

Source: CEIC, CLSA Asia-Pacific Markets

Even Figure 1 understates the true importance that Chinese consumer spending will play to Asian trade. In 2009 China overtook the US as the world’s largest car market: Figure 2.
AND IN CONSUMER DURABLES CHINA RIVALS THE US IN LEVEL TERMS
Figure 2
(mn units saar)

OVERTAKING ON THE INSIDE
Light vehicle sales (mn units)
China US

25 20 15 10 5 0

2005

2006

2007

2008

2009

Source: CEIC, CLSA Asia-Pacific Markets

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Of course there are problems with the Chinese data. Many cars are purchased by companies and should not be considered “consumer spending”. Figure 3 is probably more trustworthy. It shows quarterly shipments of LCD TVs compiled by CLSA from DisplaySearch data. China, at 8.2mn is catching up fast with the US (and is already ahead of Western Europe).
CATCHING UP IN LCD TV
SHIPMENTS

Figure 3
(mn units) North America Western Europe Eastern Europe Japan China Asia Pacific Latin America Middle East/Africa Total Source: DisplaySearch

Global LCD shipments by region (mn units)
3Q08 8.0 6.4 2.5 2.1 3.7 1.9 1.6 0.8 27.1 4Q08 8.7 10.1 3.2 2.8 4.5 2.0 1.8 0.8 33.9 1Q09 7.3 6.8 2.0 2.3 5.0 1.8 1.2 0.7 27.1

A DISCONTINUITY IN THE DATA
2Q09 9.1 6.6 1.6 2.5 5.5 2.3 1.7 1.0 30.3 3Q09 9.6 7.8 2.3 3.1 8.2 3.0 2.1 1.5 37.5

A DISCONTINUITY BUT NOT A
ONE OFF

Figure 3 reveals a second critical point. It would have been a brave economist that forecast 3Q09 Chinese sales increasing on the quarter by the 48% that DisplaySearch shows. For those schooled in the analysis of time series data this appears an impossible-to-forecast discontinuity in the data series. Our optimism that China can more than compensate for weak US consumption is based on the expectation that this discontinuity will not be a one off. It will be repeated in different products and different points in the Chinese income distribution supercharging demand growth for consumer durables (and income elastic services) through 2010 and 2011. Price is critical here. Demand for most products increases when their price falls relative to the price of alternatives. Economists call this the substitution effect. However in situations where households are strongly aspirational and constrained by income the effect of a price fall in increasing affordability is also important: the income effect. And the income elasticity of demand can be huge. This is why China’s policy of subsidising consumer durables purchase was inspired. By increasing affordability it boosted ownership rates. But more than subsidies are at work; Moore’s law is pushing in the same direction. LCD TVs were discounted aggressively during the Chinese Golden Week holiday. But equally important is the tendency of these products to decline systematically in price over time. This is extreme in the case of LCD TVs, whose unit price has fallen by around 15% in the last twelve months, but the same trends are visible in all consumer electronics and appliances. The subsidy program required the economy to have first been stabilised through aggressive infrastructure and SOE investment. The success of this policy has been seen in the speed with which consumer confidence has rebounded: Figure 4.

MAKE THINGS CHEAPER AND
PEOPLE WILL BUY THEM

MAKING SUBSIDISED
PURCHASE AN INSPIRED POLICY

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CONSUMER CONFIDENCE IS
RISING

Figure 4

INCREASINGLY CONFIDENT CONSUMERS
CRR Consumer Sentiment Index
Overall Present Future (index)

70 60 50 40 30 20 10 0

Sep 08

Nov 08

Jan 09

Mar 09

May 09

Jul 09

Sep 09

Nov 09

Source: China Reality Research: Consumer Monthly, December 2009

AND WE EXPECT WAGE
GROWTH NEXT YEAR TO BE GOOD

The CRR data show substantial improvements in current and expected business conditions, income and employment expectations. The assessment of current job market conditions has begun to improve and (from CRR’s SME Quarterly) hiring in the private sector has started to return. The first anecdotal evidence of skills shortages and problems hiring suitable staff in coastal regions has started to emerge. These are more properly described as “frictions” than shortages and will be solved by increases in wage rates; we would expect wage growth to accelerate over 2010 and into 2011. The aggregate impact of this in retail sales is shown in our China By Numbers section on page 37. We expect nominal retail sales growth of 24% YoY in 2010 and 22% in 2011. The Central Economic Working Meeting has indicated that the government remains committed to rebalancing the economy towards consumption. Hu and Wen’s closing speeches said that the efforts to encourage rural appliance and auto ownership would be increased and urban schemes maintained. Retail sales growth will therefore continue to be skewed towards consumer durables spending, just as it was in 2009. The spending is boosting production. The product breakdown of industrial production does not allow “consumer durables” to be easily broken out as an aggregate category. Figure 5 is the result of picking from the detailed (400+) product breakdown of industrial output everything that might sensibly be considered a consumer durable. It shows the year on year growth in the volume of production in the three months to October 2009. The simple average of the 31 products shown is +24.2% YoY. Industrial production growth as a whole was, in the same period, 11.7% YoY and export values were down 17.5% YoY. There is no evidence to suggest that, outside of heavy industries, there is a problem of production outstripping demand resulting in inventory accumulation. On the contrary purchasing managers’ indices show that Chinese inventory control has been tight. Output growth in this case reflects demand growth as China’s maturing consumer goods markets absorb cheaper products.

MEANS STRONG RETAIL
SALES AND SUPER-STRONG DURABLES DEMAND

AND DURABLE GOODS
PRODUCTION

WHICH IS NOT BEING
EXPORTED

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CONSUMER GOODS OUTPUT
IS INCREASING RAPIDLY

Figure 5

CONSUMER DURABLES PRODUCTION LEADING
Growth in output of durable goods (3mths to Oct % YoY)
% YoY 146.0 104.4 100.4 89.0 81.0 70.5 39.1 32.9 31.2 27.5 22.0 20.8 19.9 19.7 16.6 9.5 Metal furniture Soft furniture Automobile: Sedan: <2.5L to <=3.0L Motorcycles Microwave ovens Digital cameras Mobile handsets Digital CD & VCD players TV set-top boxes Bicycles Watches Hi Fi Clocks Plasma TV sets CRT TV sets Average of 31 durable gds categories % YoY 7.1 6.9 6.8 4.5 2.7 2.6 1.3 0.3 (5.4) (6.6) (7.7) (10.5) (13.4) (30.6) (37.7) 24.2

Automobile: MPV LCD TV sets Automobile: Sedan: <1L to <=1.6L Automobile: SUV Automobile: Sedan: <=1L Automobile: Sedan: <1.6L to <=2.0L Airconditioners Personal computers Freezers Household refrigerators Household washing machines Household gas water heaters Computer monitors Indoor fitness equipments Electric cookers Electric bicycles Source: CEIC, CLSA Asia-Pacific Markets

THE REST OF ASIA IS
SUPPLYING THE PARTS

The durable goods production shown in Figure 5 will primarily benefit the rest of Asia in the form of increased shipments of parts and materials. As Figure 6 shows, even for Korea (the Asian economy with the broadest export composition and the strongest export brands) the export rebound has been most conspicuous in a narrow trade segment: SITC 776 - electronic parts and components. From January to September Korean exports had increased by 61%, nearly 20ppt (or one third) of this came from SITC 776. This is something that we examine in more detail below as Theme #2.
Figure 6

SITC 776

ELECTRONIC COMPONENTS LEAD THE REBOUND
Korean exports by SITC
(US$bn) Electronic parts and components Total exports (RHS) (US$bn) 40 35 30 25 20 15 10 5 0

8 7 6 5 4 3 2 1 0 00

01

02

03

04

05

06

07

08

09

Source: CEIC, CLSA Asia-Pacific Markets

ASIA’S EXPORT DRIVEN GROWTH MODEL ISN’T BROKEN, SO WHY FIX IT?

2. Chinese brands but what about the rest? China’s economy has moved towards being domestically driven as a result of government policies put in place in 2009. However the growth rebound in the rest of the region as exports (to China) have increased means that mercantilism will

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remain alive and well in the Pacific Rim in 2010 and 2011. The post-Asian crisis growth model is still working because, in China, other Asian countries have a new “importer of the last resort”. The extent to which the Asian growth rebound is a reflection of export trends is exemplified by Figure 7. Figure 7 shows Korea’s exports (% YoY in US$ terms) alongside real GDP growth. Korea’s government aggressively stimulated its economy in 2009, but the strong and continuing correlation between the lines shows that it was the rebound in exports that was responsible for the bulk of the recovery.
EXPORTS ARE ENOUGH TO
EXPLAIN KOREAN GROWTH

Figure 7

Year on year growth in nominal exports and real GDP
10 8 6 4 2 0 (2) (4) (6) 01 02 03 04 05 06 07 08 09 Real GDP growth Export growth (RHS) (%YoY) (%YoY) 50 40 30 20 10 0 (10) (20) (30) (40)

EXPORT DRIVEN KOREA

Source: CEIC, CLSA Asia-Pacific Markets

We could have drawn a virtually identical chart for nearly all Emerging Asian economies. Only India and Indonesia (and now China itself) are exceptions. And, as Figure 8 shows, the export recovery is most concentrated in increased shipments to China.
EXPORT GROWTH IS BEING
LED BY EXPORTS TO CHINA Total exports Trough Rise from trough (%)

Figure 8

A CHINA-CENTRIC EXPORT REBOUND
Change in exports (US$ %)
Exports to China Trough Rise from trough (%) Seasonally adj annl rates from trough Total exports (%) Exports to China (%)

India Nov 08 21.6 Indonesia Jan 09 49.7 Korea Jan 09 41.8 Malaysia Jan 09 12.8 Philippines Jan 09 26.2 Singapore Jan 09 32.5 Taiwan Jan 09 40.9 Thailand Mar 09 20.9 Source: CEIC, CLSA Asia-Pacific Markets

Nov 08 Feb 09 Dec 08 Jan 09 Sep 09 Jan 09 Jan 09 Dec 08

121.0 82.8 59.7 89.8 5.1 71.9 127.4 70.7

23.8 71.2 52.0 48.3 38.0 45.5 66.2 38.4

228.5 181.3 75.3 135.0 81.9 105.9 168.0 90.0

A LARGE DOMESTIC MARKET
MAKES BUILDING BRANDS RATIONAL

The rebound in Asian exports into China has been led by electronic parts and components because of the strength of Chinese brands in China. Figure 9 is again taken from CLSA’s report on LCD televisions. International brands lead in virtually all markets but China, where domestic names dominate.

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THE BRANDS THAT LEAD
EVERYWHERE ELSE ARE NOWHERE IN CHINA

Figure 9
Rank North America 1 2 3 4 5 6 7 Samsung Funai Vizio Sony LGE Toshiba Others

CHINESE BRANDS IN CHINA
Top LCD TV brands by geography
Japan Sharp Toshiba Panasonic Sony Funai Sanyo Others Asia-Pacific Samsung LGE Sony Panasonic Sharp Toshiba Others Europe Samsung LGE Philips Sony Toshiba Panasonic Others LatAm & ROW Samsung LGE Sony Panasonic Philips TCL Others China Skyworth TCL Hisense Konka Changhong Haier Others

Source: DisplaySearch

CLSA CHINA BRANDS INDEX

LCD televisions perhaps form an extreme example but the presence of Chinese companies with significant brand equity primarily reflects the fact that the Chinese consumer market has the scale to make brand investment an efficient business practice. CLSA’s special report, The China Brands Index (September 2009), identified China’s top 100 brands. A portfolio of 30 stocks drawn from this has significantly outperformed the MSCI China index: Figure 10.
Figure 10

BRANDS GET ACCESS TO
CHEAPER CAPITAL

BRANDS REWARDED WITH CHEAPER CAPITAL
CLSA China Brands Index relative to MSCI China
CLSA brand portfolio (2005=100) MSCI China

800 700 600 500 400 300 200 100 0

Jan 05

Jul 05

Jan 06

Jul 06

Jan 07

Jul 07

Jan 08

Jul 08

Jan 09

Jul 09

Source: Bloomberg, CLSA Asia-Pacific Markets

AND COMPANIES WITH
CHEAPER CAPITAL WILL GROW MORE RAPIDLY

Figure 10 implies that brand presence in China results in a lower cost of capital. Over time these companies should grow faster than average increasing their brand strength further. There is frequent concern that the Pacific Rim, increasingly dependent on China as a source of demand for its OEM manufacturing exports will wake up one day to find that China has replaced imports with domestic production. The outperformance of the China brands index challenges this view. It confirms that ownership of the brand, not the manufacturing capability, is where the value added resides and that stock markets recognise this fact. The risk is not that China develops a domestic parts and materials industry to replace imports. Rather the risk is that China will, alone in emerging Asia, invest significantly in consumer brands. Without them the Pacific Rim will remain relegated to OEM manufacturing.

THE REST OF THE REGION
RELEGATED TO BEING A PARTS MAKER FOR CHINA’S BRANDS

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3. The changing nature of China’s capex China’s SME manufacturers were hit hard by the export slump at the end of 2008. Capacity utilisation rates fell, jobs were lost and wages contracted. Investment plans were shelved. This persisted through the first quarter. However conditions in the second quarter improved as domestic orders growth returned positive. In the third quarter China Reality Research’s SME Quarterly showed that this recovery continued with overall sales growth turning positive on a year on year basis for the first time since 3Q08: Figure 11.
LIGHT INDUSTRIAL SMES
ARE SEEING THEIR ORDERS RETURN

Figure 11

LIGHT INDUSTRIAL GROWTH IS BACK
CRR SME Quarterly – Average YoY growth of orders
Domestic orders Overseas orders (%YoY)

20 10 0 (10) (20) (30) 2007

1Q08

2Q08

3Q08

4Q08

1Q09

2Q09

3Q09

Source: China Reality Research: SME Quarterly 3Q09

On the back of this utilisation rates increased. Figure 12 shows the average capacity utilisation rate across the SME panel. Though still down on the cycle peak levels it is rising rapidly. In 3Q09 it exceeded its year-ago level for the first time, with an average operating rate of 84.5%.
UTILISATION RATES ARE
RISING

Figure 12

CAPACITY UTILISATION RATES ARE RISING
CRR SME Quarterly – Average capacity utilisation rate
(%)

95 90 85 80 75 70

2Q07

3Q07

4Q07

1Q08

2Q08

3Q08

4Q08

1Q09

2Q09

3Q09

Source: China Reality Research: SME Quarterly 3Q09

THIS WILL SUPPORT WAGE
GROWTH AND CAUSE A SECOND ROUND OF DEMAND EXPANSION

Manufacturing wage and capacity utilisation trends move together because of the importance of overtime. The SME Quarterly confirms the continued recovery of wages with the first YoY increase for unskilled workers. This implies further increases in household consumption again disproportionately boosting spending on durable goods. This in turn will feed into more demand for light industrial products. The beauty of boosting Chinese consumption is that this is a much closer substitute for exports than is

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infrastructure or heavy industry. Promoting consumption is enabling China’s economic structure to be realigned faster than we thought possible at the start of 2009. Figure 13 shows SME capex plans. As with capacity utilisation investment growth is not back at cycle-peak levels, but investment plans in China’s private sector manufacturers are being normalised rapidly.
PLANNED INVESTMENT
COMPARED WITH LAST YEAR

Figure 13

CRR SME Quarterly – Planned investment compared with a year ago
Plans for 2008 capex (vs'07) 100 80 60 40 20 0 4Q07 1Q08 Increase 2Q08 3Q08 Stay the same 100 80 60 40 20 0 4Q08 1Q09 Decrease 2Q09 3Q09 No reply Plans for 2009 capex (vs'08)

INVESTMENT PLANS ARE NORMALISING

Source: China Reality Research: SME Quarterly 3Q09

One common misconception is that full capacity utilisation is needed for investment to restart. This is wrong. Private sector investment cycles invariably start when capacity utilisation is below average levels. Figure 14 shows the US as example.
INVESTMENT STARTS WHEN
CAPACITY UTILISATION IS LOW NOT HIGH

Figure 14

US capacity utilisation and % QoQ in equipment and software investment
90 85 80 75 70 65 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 Capacity utilisation (LHS) %QoQ equipment and software (constant prices) (%)

CAPEX DOESN'T WAIT FOR FULL CAPACITY USE
(3mma %QoQ) 7 5 3 1 (1) (3) (5) (7)

Source: CEIC, CLSA Asia-Pacific Markets

SME INVESTMENT IS A
NORMAL CAPITALIST INVESTMENT CYCLE

In this respect the upgrades to investment plans shown in Figure 13 are normal. We expect continued orders growth to accelerate capital spending further through 2010 so that light industry takes over from heavy industries and infrastructure. In this respect we expect China’s investment cycle in 2010 and 2011 to revert to what was normal in 2006 and 2007. Then private sector light manufacturing firms and private sector builders drove fixed asset investment.

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One of the most frequently voiced concerns about China is that the investment surge will result in over capacity that will destroy profitability. As capital spending growth shifts towards the SME/light industrial sector these concerns become less justified.
PRIVATE SECTOR CAPEX HAS
NOT BEEN USED TO SUPPORT THE ECONOMY

China’s low cost of capital means that overinvestment cannot be dismissed as a risk even among private business. However they are private sector companies run in the interests of their proprietors rather than the government. SMEs are the least favoured sector by China’s banks and investment typically is funded from undistributed profits not credit. The SME sector has not built capacity into the cyclical downturn and obviously has not been used as an agent of government policy. Accepting that these are market driven businesses implies that we should trust the market in deciding when investment is justified. The market is already saying that the supply-demand balance in China’s light industries has tightened by enough to warrant investment restarting.

FALLING PRICES MEAN “PRODUCE LESS”, BUT…

Markets signal that capacity is excessive and supply needs to be reduced by the price of products falling. The rapid contractions in demand in 4Q08 and 1Q09 instigated a period of rapidly falling manufactured goods prices. This is clearly visible in data from China Reality Research’ SME Quarterly: Figure 15.
Figure 15

FACTORY GATE PRICES HAVE
STABILISED

ORDERS CRASH GENERATED DEFLATION
SME factory gate and prices % QoQ and %YoY
(%) Average YoY growth Average QoQ growth

10 8 6 4 2 0 (2) (4) (6) 2Q07

3Q07

4Q07

1Q08

2Q08

3Q08

4Q08

1Q09

2Q09

3Q09

Source: China Reality Research: SME Quarterly 3Q09

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And in the prices of Chinese exports to the US:
AND SO HAVE EXPORT
PRICES

Figure 16

EXPORT PRICES FELL, BUT ARE STABILISING
US import prices from China
(sa, Dec 03=100)

104 103 102 101 100 99 98 97 96

2004

2005

2006

2007

2008

2009

Source: CEIC, CLSA Asia-Pacific Markets

INVESTMENT IN RESPONSE
TO RISING PRICES IS NOT OVERINVESTMENT

Figures 15 and 16 show that manufactured goods prices have stabilised and are beginning to rise. We expect modest manufactured goods price inflation in 2010 as the market signals that SME manufacturers need to expand capacity again. Investment that occurs in response to product prices rising is not value destructive. Concerns about Chinese overcapacity are valid in some sectors, but not the ones that will be driving investment in 2010. 4. China moving towards current account deficit We introduced the idea that China was moving towards a current account deficit in the 4Q09 Eye on Asian Economies: Buddy, can you spare a dime? and we have retained it in our 2010 and 2011 forecast. The deficit is generated by the rapid growth of Chinese domestic demand at a time when there is spare manufacturing capacity elsewhere. An extraordinary rate of growth in domestic demand is already apparent in 2009 statistics. China does not produce a constant price expenditure breakdown of GDP so it is presently hidden from view but a few “back of the envelope” calculations are enough to show what is going on.

BUDDY, CAN YOU SPARE A DIME?

FIXED INVESTMENT IN 1Q-3Q09 ADDED 16PPT TO GDP

In the first nine months of 2009 urban fixed asset investment was Rmb13,317bn. The same period in 2008 saw FAI of Rmb9,987bn. The increase on the year (of Rmb3,330bn) arithmetically adds 16ppt to 1Q-3Q09 year on year GDP growth. Urban fixed asset investment is not quite fixed capital formation as measured in the national accounts but it is close enough for the boost to growth from increased investment to be a very large number. A similar analysis can be done for retail sales with the conclusion that it added around 6ppt to nominal GDP growth. We have no monthly visibility on government consumption but with C+I alone adding more than 20 points to C+I+G+X-M it is clear that it is only destocking and imports rising ahead of exports that are holding GDP growth to single digits.

ANOTHER 6PPT CAME FROM
RETAIL SALES

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WE EXPECT A REPEAT IN 2010 – VERY STRONG
DOMESTIC DEMAND

Broadly speaking this is what we expect for 2010. Investment growth will slow but consumer spending growth will accelerate (and its import content will rise). In aggregate our 10% GDP forecast assumes that domestic demand expands (in real terms assuming reasonable deflators) by roughly 16%. Again it is a deteriorating net trade position that keeps growth down. As we argued in Buddy, can you spare a dime? a diminished surplus has little significance for China. On the contrary it is the consequence of moving towards a more desirable, domestic demand driven, growth model. However it amounts to a tightening in the supply and demand balance for savings that is visible on a global scale. In 2008 and 2007 China generated around one third of the world’s current account surplus. It therefore funded around one third of the world’s current account deficits (Figure 17). It will not be funding them in 2010 and 2011.

PROVIDING 1/3 OF THE
GLOBAL SURPLUS MAKES

Figure 17

China current account surplus as a % of global current account surplus
40 30 20 10 0 2000 2001 2002 2003 2004 2005 2006 2007 (%)

FINANCING ONE THIRD OF THE WORLD’S DEFICIT

CHINA THE FINANCIER OF 1/3
OF THE WORLD DEFICIT

2008

Source: IMF, CLSA Asia-Pacific Markets

CHINA IS TIGHTENING THE GLOBAL SUPPLY-DEMAND
BALANCE FOR SAVINGS

A tightening of the savings supply-demand balance on this scale implies that the cost of capital (or real interest rates) will rise. This will advantage creditor countries relative to debtor countries. The most obviously disadvantaged will be the US. Figure 18 shows the financial balances of the US public and private sectors. It has taken a huge swing in the private sector towards surplus to contain the exploding government deficit on the current account. (The US government would argue that it has taken a huge increase in government net spending to limit the deflationary implications of a collapse in private sector net spending).
Figure 18
1,000 500 0 (500) (1,000) (1,500) (2,000) Government Private sector Aggregate 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09

THE US ECONOMY IS
SAVINGS CONSTRAINED

PRIVATE PARSIMONY, PUBLIC PROFLIGACY
US public and private financial balances
(US$bn saar)

Source: DataStream, CLSA Asia-Pacific Markets

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5% TREASURY YIELDS BY END-2010

Irrespective of what spin is put on Figure 18 recovery in the US will initially be savings constrained. The more limited the availability of surpluses in creditor countries the more exposed this domestic savings shortfall becomes. Higher interest rates in the US will be the most visible implication of the end of the Chinese surplus. We have retained our expectation that 10 year yields will hit 5% by end2010 despite the best efforts of the US central bank in keeping short rates unchanged. As we discuss in Theme #10 high risk free rates are a reason that US recovery will be later than the market hopes. (Even though, when the recovery finally starts, they will not be a problem). 5. US dollar weakness (and euro strength) The financing requirement of the US also drives our currency forecasts. The reality of attracting capital from the rest of the world as the savings-constrained US economy starts to recover requires its assets to be cheaper. This is achieved via a depreciated US dollar. We expect 2010 to be a year of persistent dollar weakness. More pragmatically the need to keep bank funding costs as low as possible, to better enable banks to buy Treasuries and recapitalise themselves, means that the Fed will keep interest rates low for as long as possible. We expect the Fed funds target rate to be increased only at end-10/start-11. Rate increases in 2011 will be rapid, but by that time inflationary pressures will have built. A central bank keeping rates low for longer than is necessary is never currency positive. It raises inflation risks requiring currencies to depreciate to maintain export competitiveness. Abundant liquidity will give ample opportunity to sell the dollar short. Whether one regards currencies to be driven by the need to attract foreign savings, long term relative price movements or money market rates 1H10 conditions suggest further dollar depreciation. Our expected profile is shown in Figure 19.
Figure 19
2009clsa 1.48 95.0 1.64

US ASSETS NEED TO BE
CHEAPER TO ATTRACT FOREIGN CAPITAL

THE FED WILL KEEP RATES
LOW

THERE ARE MULTIPLE
ROUTES TO THE SAME CONCLUSION – A WEAKER DOLLAR

WE EXPECT US$1.60/EUR BY MID-2010

A WEAK US DOLLAR IN 1H10
Key currency forecasts
2010clsa 1.60 105.0 1.65 0.98 6.57 43.00 8,960 950 31.25 2011clsa 1Q10clsa 2Q10clsa 3Q10clsa 4Q10clsa 1.55 1.55 1.60 1.60 1.60 110.0 100.0 100.0 102.5 105.0 1.65 1.65 1.65 1.65 1.65 0.94 6.20 39.00 8,700 925 30.25 0.97 6.83 46.00 9,300 1,050 32.00 1.00 6.74 45.00 9,150 1,000 31.75 0.99 6.66 44.00 9,050 970 31.50 0.98 6.57 43.00 8,960 950 31.25

US$/Euro ¥/US$ US$/£

A$/US$ 0.93 Rmb/US$ 6.83 IRs/US$ 47.00 Rp/US$ 9,500 W/US$ 1,150 NT$/US$ 32.20 Source: CLSA Asia-Pacific Markets

AN APPRECIATING EURO
WILL BOOST ASIA’S EXPORTS TO THE EU

Our expectation of continued euro gains is critical for Asian exporters. The strong euro is contributing to weak Eurozone growth by squeezing exporters (see page 27). But for as long as the euro currency is appreciating native Eurozone growth doesn’t really matter. Currency effects are much more important.

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THE DOLLAR GROWTH OF THE EU IS MORE IMPORTANT
THAN THE EURO GROWTH

Figure 20 shows, by way of illustration, the relationship between China’s exports to Europe and the dollar growth in Eurozone GDP growth to explicitly include currency effects. Eurozone growth in dollar terms leads Chinese export growth to the EU by around 4 months. In practice this means that even if the currency stabilises from here 1H10 should see decent export growth to the EU. Our expectation of first half euro gains extends this period to the end of 2010. We find similar relationships for the rest of Asia, with a similar conclusion: good Asian export growth to the EU even though the European economy is weak.
Figure 20

THE WORST IS OVER FOR EXPORTS TO EUROPE

EURO GAINS MAKE FOR ASIAN EXPORT GAINS
EU growth in US$ terms and China’s exports to Europe
(%YoY) (%YoY) 70 60 50 40 30 20 10 0 EU13 growth in US$ terms (lagged 4mths) China exports to EU 3mma (RHS) (10) (20) (30) 07 08 09 10

40 30 20 10 0 (10) (20) (30) (40) 99

00

01

02

03

04

05

06

Source: CEIC, CLSA Asia-Pacific Markets

Figure 20 looks how it does because Asia has operated an informal dollar peg. Our central case is that this peg will (in practical terms) continue through 2010.
THE RENMINBI WILL
APPRECIATE VERSUS THE DOLLAR WHEN SME CAPEX RESTARTS

This is primarily a function of our expectation for the renminbi. China continues to send signals that it is committed to increasing the flexibility with which it manages its currency. However we expect a move only when it is clear that firmer exports and increased domestic demand for durable goods have restarted the light industrial sector’s investment cycle. As we discuss above this is happening faster than we expected and we have advanced the point at which the renminbi starts to appreciate versus the dollar to 2Q10. However progress after this will be moderate. First, the scope for further straight line depreciation in the US dollar will be limited by the squeeze that it applies to the Eurozone economy. Our end-2010 forecast for euro-dollar is only 7% stronger than the spot rate (compared with an 18% appreciation from March to December 2009) because by the second half of 2010 the underperformance of the Eurozone economy will be too conspicuous. Because renminbi appreciation has to be considered as a trade weighted exchange rate as well as the renminbi-dollar rate a more slowly appreciating euro limits the speed with which China will allow the renminbi to rise. Second, is our forecast of a current account deficit. This does not preclude an appreciating renminbi, capital inflows can keep its overall balance of payments in surplus. But it does suggest that the balance of payments surplus will be smaller than in 2009 and consequently that the effort of monetising it more manageable.

WE EXPECT THE RENMINBI
TO BE 4% ABOVE THE CURRENT SPOT RATE AT END-10

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We would see the renminbi 4% stronger versus the dollar at the end of 2010 than it is now at Rmb6.57/US$1 (an annualised rate of appreciation from 2Q10 of 5%).
IN ECONOMIC TERMS THIS IS STILL PEGGED TO THE US$

In economic terms this is a gradual move, hence our remark that practically Asia will continue to operate on an informal dollar peg. In one respect the incentive to manage currencies will be even stronger. China, driven by increased affordability of manufactures and supplied by OEM manufacturers, is a more price sensitive market for Pacific Rim exporters than even the US. Governments have already shown that they regard currency appreciation as undesirable. We expect this to continue through 2010 (see Theme #6). From the perspective of Asian exports to the EU it means that the historical trade relationship shown in Figure 20 will continue. 6. Asian liquidity vs affordable housing A soft US dollar combined with strong Chinese demand is positive for Pacific Rim liquidity. China will see its overall balance of payments surplus fall but in the Pacific Rim, for whom China is a rapidly growing market, current account surpluses in 2010 will be larger than 2009. This will require increased efforts to restrain currencies even before capital inflows are considered. Historically Asia has sterilised the intervention used to keep currencies cheap with some success. CPI inflation has been contained. But sterilisation can only ever be incomplete, particularly in containing the effects of reserve growth on asset prices. This includes residential property whose prices are likely to be under persistent upward pressure in 2010. However while property prices are likely to rise in absolute terms there are other assets that we prefer. This opinion is mainly a function of government policy. Governments are already intervening verbally to try and restrain residential property prices. Many are going further. Korea has reintroduced loan to value caps withdrawn during the credit crisis. China has quickly moved to restrain property markets in localities where price rises have been seen as excessive. Commercial banks are being dissuaded from riskier borrowers and encouraged to be conservative in loan to value ratios. Mass market supply is being increased in China and Singapore and Taiwan are dropping hints that it will start building public housing for the first time in a decade. No Asian central banker wishes to preside over a property market bubble so recently after the US bubble blew up; over-geared purchases are being discouraged. However liquidity is a powerful force. It is proving difficult to dissuade Hong Kong banks from pricing mortgages aggressively as their balance sheets are underutilised. This problem is typical across Asia: Figure 21.

POSITIVE PRESSURES ON PAC-RIM LIQUIDITY

PROPERTY PRICES WILL RISE
BUT THERE ARE OTHER ASSETS WE PREFER

GOVERNMENTS ARE TRYING
TO KEEP PROPERTY AFFORDABLE

HOWEVER LIQUIDITY IS A
POWERFUL FORCE

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PERSUADING BANKS NOT TO
LEND WILL BE TOUGH

Figure 21

FUNDS AVAILABLE TO LEND
Bank loan to deposit ratios

Korea Australia India Thai Japan Malay Sing Indo Taiwan Phils China HK 0 20 40 60 80 100 120 140 (%)

Note: Thai number adjusted to exclude loans to the central bank Source: CLSA Asia-Pacific Markets

HOWEVER GOVERNMENTS
HAVE MANY TOOLS AT THEIR DISPOSAL

However governments’ ability to influence property markets should not be underestimated. They have legislation at their disposal. Property markets are already extensively administered with foreign ownership often restricted. It is much more socially and politically acceptable for governments to try to limit the effect of liquidity on residential property prices than it is on financial assets. We normally refrain from commenting on equity prices. However from economic principles we would expect the stock prices of export-related companies to be among the strongest performers. As this is largely a “China” story we can be more specific – choose companies that have China as a market, make products (or parts of products) that are income elastic and are operationally geared so that profit gets the maximum boost from increasing demand. In a more “macro” framework we would expect assets closer to the source of the liquidity to perform most strongly. In this case “liquidity” is the product of current and capital account inflows being monetised. In this situation the cash flows of exporting companies will be most directly inflated. Our preference for financial assets over property is reinforced by consideration of interest rates. Compared with one quarter ago we have increased our forecasts for Asian inflation as the manufactured goods deflation we expected to persist through 1H10 is already dissipating (as we discussed in Theme #3). Asian unemployment rates have started to fall suggesting that output gaps are now closing. It is too soon to be talking about demand pull inflation, but it will not be in six months time. In the meanwhile commodity prices are rising as the dollar weakens. Higher interest rates will be needed to contain the effects of the cheap currency policy on the real economy (see Theme #9). Following the 1997 Crisis, Asian corporates have been wary of debt. Gearing levels are low and most investment has been financed from undistributed profits. Interest rate increases therefore have little impact

FROM FIRST PRINCIPLES
GROWTH CYCLICAL STOCKS WILL BE BETTER

THEY ARE CLOSER TO THE
LIQUIDITY

AND WILL BE LESS
IMPACTED BY HIGHER RATES

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on firms’ cost of capital. However while property purchase in Asia is undergeared relative to that in the west it still involves a mortgage. Residential property is leveraged by Asian standards. It will suffer more than manufacturing when interest rates rise. 7. Government intervention and controls Faith in the free market is in retreat. Economic management has been a success. Governments have a stronger mandate to meddle in economies than at any point in the last decade. From an Asian investor’s perspective two areas are most important. Capital controls and trade protectionism. In October Perng Fai-nan, governor of Taiwan’s central bank, said that foreign investors have five times more in NT$ deposit accounts than he considered acceptable. In November the financial regulator banned foreign investors from placing funds in time deposits to prevent currency speculation. India, Indonesia and Korea have voiced concern over the impact of speculative money inflows.
MERCANTILIST
GOVERNMENTS DON'T WANT CURRENCY APPRECIATION

FAITH IN THE FREE MARKET
IS IN RETREAT

The fact that inflows are seen as an unwelcome factor appreciating currencies highlights the point we made in Theme #5: most Asian governments are still mercantilist. Allowing currencies to rise would make Asian assets more expensive without inflating their local currency price. Initially, currency appreciation would encourage capital inflows but this would be only temporary. Stronger currencies would eventually move the balance of payments closer to equilibrium. However if currency appreciation is ruled out two options are available. The first is simply to continue as normal. Since 1998 Asian central banks have monetised balance of payments inflows systematically to keep currencies cheap. Figure 22 shows the cumulative current account surplus, and change in reserves since 1998 in Korea with the same for Taiwan as Figure 23.

KOREA HAS BEEN
MONETISING AND STERILISING SINCE THE

Figure 22

Reserve change vs cumulative current account surplus (from January 1998)
300 250 200 150 100 50 0 98 99 00 01 02 03 04 05 06 07 08 09 (US$bn) Forex reserves Change in forex reserves Cumulative current a/c surplus (US$bn) 300 250 200 150 100 50 0

KOREAN MERCANTILISM

ASIAN CRISIS

Source: CEIC, CLSA Asia-Pacific Markets

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AND SO HAS TAIWAN

Figure 23

Reserve change vs cumulative current account surplus (from January 1998)
290 240 190 140 90 40 (10) 98 99 00 01 02 03 04 05 06 07 08 09 (US$bn) Forex reserves Change in forex reserves Cumulative current a/c surplus 190 140 90 40 (10) (US$bn) 290 240

TAIWANESE MERCANTILISM

Source: CEIC, CLSA Asia-Pacific Markets

IN MANY COUNTRIES CURRENT BOP INFLOWS ARE
UNREMARKABLE GIVEN WHAT HAS HAPPENED IN THE PAST

Figure 23 reveals the present pace of reserve growth in Taiwan to be unremarkable in the post-Asian-crisis context. Looking across Asia on this basis (the full chart set is available in the ChartRoom of the Economics pages of www.clsa.com) shows the current pace of reserve growth and, more particularly capital inflows, to be unexceptional everywhere but Hong Kong (whose currency board precludes a response), India, Korea and Thailand. All other countries, including Taiwan, are presently expending less effort in holding their currencies down than has been typical. In nearly all Asian countries reserve growth has been sterilised as matter of course. And judged according to CPI inflation rates sterilisation has worked most of the time. Most Asian countries have had acceptable consumer price inflation rates since 1998: Figure 24.

STERILISATION OF RESERVE
GROWTH HAS WORKED PRETTY WELL

Figure 24

ON AVERAGE INFLATION NOT PROBLEMATIC
CPI inflation GDP weighted
All Excluding Indonesia (%YoY)

9 8 7 6 5 4 3 2 1 0 (1) 98

99

00

01

02

03

04

05

06

07

08

09

Source: CEIC, CLSA Asia-Pacific Markets

TAIWAN IS STILL OPEN TO
EQUITY INFLOWS

The fact that Taiwan has already acted to restrict capital mobility emphasises that these “historical norms” do not mean that capital controls are impossible in 2010 but it does provide a context. There is also the question of exactly how opposed to

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capital inflows Taiwan is. It has restricted foreign money inflows into its banking system. But George Chou, the deputy governor of central bank, explained the move in terms of: “The original intention for foreign investors was to put their money in the capital market, and this ban will make sure they return to this purpose” suggesting that the country remains open to foreign inflows into equities.
AND LIQUIDITY INFLOWS
INTO KOREA ARE LIKELY TO WEAKEN

Korea is an example of a country where reserve growth does imply significant monetisation of capital inflows on top of current account receipts. It is also example of the fact that while correcting an undervalued exchange rate will in the end reduce both current and capital account surpluses, the process of appreciating the currency towards this level increases money inflows. The won is still undervalued relative to historical norms but it is getting closer to fair value. Looking into 2010 Korea is likely to have to work less hard to hold its currency down than it has in 2009. Our expectation is that sterilised intervention will remain the preferred course of action for 2010 and that restrictions on equity inflows will not be introduced. The inflation pressures that result will be dealt with conventionally, through interest rate increases (Themes #8 and #9). The second issue, protectionist policies in the west, are a more immediate problem. Unemployment in 2010 will be an acute political problem for governments that have already used fiscal policy as aggressively as is practicable. “Protecting jobs” has never lost a politician a vote and we fear that increased trade tensions are inevitable as western politicians struggle to increase popularity against weak economies. No economist or investor should like restrictions on trade any more than restrictions on capital. However, restrictions on international trade should be less damaging to Asian growth than they might have been in the past. Asian trade is becoming more Asia centric. Access to western markets is starting to matter less. China’s scale means that it is the inevitable “target” of most international trade disputes so it is important that this statement applies to China itself. China’s light industry is being reflated by Chinese consumers not a rebound in exports. Government meddling in economies is undesirable at all times, but Asian growth in 2010 will be rapid regardless. 8. Inflation and deflation, both at the same time It has taken only twelve months for capacity utilisation rates in Chinese light industry to be restored to the point where finished goods and export prices have stabilised (Figures 15, 16). The rest of the region is behind but in general manufactured goods prices have stabilised quickly And commodity prices have been rising since the start of the year. Figure 25 shows The Economist all industrial commodities price index over the last 12 months in both euro and dollar terms. Though emerging market demand has been a consistent driver of commodity prices the differential behaviour of commodity prices in euro and dollar terms shows that a currency effect is present also; first the markets and now the Fed have created too many US dollars. Commodities have been bought as a hedge against dollar inflation.

TRADE DISPUTES LOOK TO
BE AN UNFORTUNATE INEVITABILITY

BUT WE DO NOT THINK THAT
THEY WILL BE ENOUGH TO DERAIL GROWTH

MANUFACTURED GOODS
PRICES ARE RISING

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AND COMMODITY PRICES
ARE RISING

Figure 25

Economist Industrials commodity price indices – dollar and euro
300 250 200 150 100 50 00 01 02 03 04 05 06 07 08 09 (index) Dollar price Euro price

COMMODITIES MORE EXPENSIVE

Source: DataStream, CLSA Asia-Pacific Markets

BUT THESE ALONE ARE NOT
ENOUGH FOR INFLATION

It takes more than commodity and even manufactured goods price rises to generate inflation. Wages are critical – we would expect to see wage inflation returning in Asia as utilisation rates (and therefore productivity) rise and output gaps disappear. Already price trends have started to deteriorate though this is concealed by year on year statistics that are still flattered by being based in 4Q08 when commodity prices were still falling. Figure 26 shows China’s year on year CPI growth and the change on a rolling three month basis that avoids this historical distortion. In the three months to November the CPI rose at a seasonally adjusted annualised rate of 3.8%.
Figure 26

WHERE THE 3MTH CHANGE LEADS THE YOY WILL
FOLLOW

China CPI %YoY and % chg on 3 months saar
15 12 9 6 3 0 (3) (6) (9) Jan 07 May 07 Sep 07 Jan 08 May 08 Sep 08 %YoY %QoQ saar

PRICE PICKUP

Jan 09

May 09

Sep 09

Source: CEIC, CLSA Asia-Pacific Markets

The combination of accelerating growth, rising primary product prices and ultraloose monetary policy make it unsurprising that inflation has been quick to return. China’s domestic monetary stance has been ultra loose but also its currency has been pegged against a weak US dollar. However, while China is the extreme case these three conditions, of rising costs (translated through to local currency prices by quasi-pegged exchange rates), rapid rebounds in growth and loose monetary policy are present across the region. In consequence the price trends shown in Figure 26 are similarly common. Figure 27 shows the year on year change in CPIs in each Asian country alongside the annualised change in the last three months. This points to accelerating CPI headlines everywhere but Indonesia, Korea (which allowed their currencies to rise) and Taiwan (where domestic demand has been soft).

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CURRENT TRENDS ARE
BENIGN IN ONLY KOREA,

Figure 27

Change in CPI %YoY and % chg on 3 months saar
China HK India (WPI) Indonesia Korea Malaysia Philippines Singapore Taiwan Thailand China HK India Indonesia Source: CEIC, CLSA Asia-Pacific Markets %YoY 0.6 2.2 1.3 2.4 2.4 (1.5) 2.8 (0.8) (1.6) 1.9 0.6 2.2 11.5 2.4 %QoQ saar 3.8 4.9 7.9 4.1 2.7 3.1 10.3 1.9 (4.8) 7.0 3.8 4.9 10.8 4.1 Last reading Nov 09 Oct 09 Oct 09 Nov 09 Nov 09 Oct 09 Nov 09 Oct 09 Nov 09 Oct 09 Nov 09 Oct 09 Oct 09 Nov 09

A COMMON PROBLEM

INDONESIA AND TAIWAN

FOOD AND FUEL PRICES ARE
A SQUEEZE ON WESTERN INCOME

Figure 27 shows that if Asia wishes to keep its currencies cheap it will have to remain vigilant and raise rates sooner rather than later. And rate hikes feature in most of our Asian forecasts (Theme #9). However the risk posed by inflation in the west is very different. In the west the present state of labour markets is weak and wage inflation will be absent for most of 2010. In this environment commodity and fuel price inflation is an unwelcome squeeze on income and discretionary spending. It will have a numerical impact on CPI because these products form part of the index but it will not be truly inflationary unless wage earners can boost wages to protect their real income. In most circumstances we would argue that inflation which reflects a terms of trade loss should not provoke a policy response from the central bank. However this argument applies only if commodity prices are exogenous. The differential dollar and euro prices shown in Figure 25 shows that this is not the case in the US. Commodity price inflation could be moderated by earlier tightening by the Fed. This however is unlikely to happen (see Theme #9) and commodity and fuel prices will continue to rise in 2010. Deducting expenditure on price inelastic necessities (food, fuel, shelter, medical and education expenses etc) from US household income shows zero growth in the “discretionary income” that is left to buy luxuries (or repay debt) in the last six months. It will remain under pressure in 1H10 and is a reason to be wary of US consumer demand. 9. Exit strategies Fiscal and (especially) monetary policy was an outstanding success in 2009. By putting ultra loose policies in place governments prevented an economic meltdown. But the policies now have to be removed. 2010 will be dominated by government and central bank exit strategies. Exit has already started in Australia; the RBA raised rates in October, November and December. Asian central banks have been more reticent. However with growth good, price inflation coming back and strong liquidity inflows as currencies are held cheap, they will have to raise rates quickly in 2010. Figure 28 summaries our monetary policy forecasts for the coming twelve months.

THE FED SHOULD TIGHTEN

BUT WON’T SO
DISCRETIONARY INCOME WILL BE SQUEEZED

THE PROBLEM WITH AN
EFFECTIVE STIMULUS…

…IS THAT YOU HAVE TO
WITHDRAW IT

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RATES WILL RISE ACROSS ASIA

Figure 28
% p.a. Australia China HK India Indonesia Korea Malaysia Philippines Singapore Taiwan Thailand

ASIAN INTEREST RATE FORECASTS
Policy/benchmark rate Cash target rate 1-year lending rate 3-month HIBOR Reverse repo rate BI policy rate Call rate Overnight policy rate Overnight repo rate 3-month SIBOR Rediscount rate 1-day repo rate 4Q09 3.75 5.31 0.10 3.25 6.50 2.00 2.00 4.00 0.68 1.25 1.25 1Q10 4.00 5.31 0.10 3.50 6.50 2.00 2.00 4.25 0.70 1.25 1.25 2Q10 4.50 5.85 0.20 3.75 6.75 2.25 2.00 4.50 0.70 1.25 2.00 3Q10 4.75 6.12 0.30 4.25 7.00 2.50 2.25 4.75 0.75 1.25 2.50 4Q10 5.00 6.39 0.70 4.75 7.25 3.00 2.75 5.25 0.80 1.50 2.75 ... 4Q11 5.50 6.93 2.50 6.00 8.00 4.75 4.25 6.75 2.50 2.50 4.25

Source: CLSA Asia-Pacific Markets

CHINA’S INVESTMENT
GROWTH IS ALREADY BEING REINED IN

Fiscal policy will be tightened also in Asia. But it is China that obviously matters most. We expect and hope that China’s directed investment stimulus will continue to be reduced as, if our expectations of accelerating investment in the SME sector are realised, failure to do so will result in an overheated economy. It is encouraging that this is already apparent in current data: Figure 29 shows China’s urban FAI as a proportion of GDP. It is already declining, especially the state directed part. Monthly data show that this continues in 4Q. We would not expect overall fixed asset investment to continue to fall relative to GDP as private sector capex (residential construction first, light industrial later) accelerates. But overall FAI growth in 2010 will be much slower than 2009. We have assumed 16% real FAI growth as part of our 10% GDP growth forecast.

FIXED ASSET INVESTMENT FELL RELATIVE TO GDP IN 3Q09

Figure 29

INVESTMENT PULLBACK ALREADY STARTED
China urban FAI as % GDP
Private sector¹ Govt influenced (% GDP sa)

70 60 50 40 30 20 10 0

Mar 04
1

Mar 05

Mar 06

Mar 07

Mar 08

Mar 09

Note: Private enterprises, HK/Macao/Taiwan & other foreign funded enterprises and individual businesses. Source: CEIC, CLSA Asia-Pacific Markets

WE HAVE INCREASED OUR
INFLATION FORECAST FOR

CHINA TO 3-4%

Even on this “lower investment growth” forecast China’s GDP growth of 10% includes a substantial drag from net trade. And, as in 2009, rapid import growth not only holds real GDP growth down but suppresses inflation by limiting price rises in manufactures. Inflation in non-traded sectors continues to build. CRR’s Wet Market Report reveals rising prices for basic foods, and its December Consumer Monthly shows a sharp increase in household inflation expectations. While traded goods

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prices were falling we expected this “goods arbitrage” to keep Chinese inflation in 2010 below 2%. With manufactured goods prices having stabilised (Figures 15 and 16) this forecast has increased to 3-4%.
THIS IS ENOUGH TO
WARRANT RAISING RATES

This number includes the effects of an appropriate monetary tightening. As always the real meat of tightening in China will be quantitative. We expect a loan quota of Rmb6-8tn for 2010 equivalent to around 15-19% YoY growth. But rates will also be increased. We expect 108bp increase in lending rates over 2010 and 54bp on deposit rates. In absolute terms this is not “tight” monetary policy in an economy whose nominal GDP growth is 11% but the question is whether the markets will perceive it to be. This is the problem with the ultra-accommodative policies of 2009, any shift is a tightening in comparison. The gap between market perception and reality will be more relevant in the US where initially weak growth and deleveraging means that we expect a “phony war” with the markets worrying about the Fed tightening policy long before the Fed actually acts. As we argue above our forecast is that the Fed only raises rates over the turn of the year. But ahead of this the Fed will shrink its balance sheet. At heart the Fed remains an interest rate targeting central bank. It does not regard the size of its balance sheet (or excess reserves) as a target variable in its own right. Accordingly it is planning to start to reduce banks excess reserve balances through tightening (short end) money market operations while maintaining its holdings of long-dated bonds. Whether the market will remain as relaxed about this is another matter. The majority of market participants regard the size of the Fed’s balance sheet as the key variable in “quantitative easing”. 10. US recovery – later, but faster than you think We are cautious on US growth in 2010. The immediate future is one of continued deleveraging, weak income growth and lacklustre personal consumer spending. As Figure 30 shows virtually all national income growth in 3Q accrued to the corporate sector. This is a necessary process of generating the profit growth needed to fund the next investment upswing but it obviously makes for weak consumer spending.

A PHONY WAR IN THE US

THE FEDS BALANCE SHEET
WILL SHRINK, BUT IS THIS TIGHTENING?

WE ARE BEARISH ON US GROWTH IN 2010.

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ONLY FINANCIAL
CORPORATES ARE SEEING INCOME GROWTH

Figure 30

GROWTH ACCRUING TO (FINANCIAL) CORPORATES
US national income and contribution to change
Seasonally adjusted at annual rate 4Q08 14,347 714 607 14,454 1,881 139 12,434 8,030 1,084 237 1,127 122 669 855 982 132 (8.9) 1Q09 14,178 580 480 14,278 1,884 185 12,209 7,826 1,038 246 1,183 238 629 826 963 138 (10.7) 2Q09 14,151 571 479 14,244 1,864 162 12,218 7,816 1,028 262 1,227 266 659 784 965 145 (8.8) 3Q09 14,266 581 454 14,394 1,852 191 12,352 7,838 1,039 279 1,357 363 672 764 957 125 (6.3) 4Q08 na na na na na na (2.7) (0.3) (0.2) 0.1 (2.6) (1.3) (0.8) 0.4 (0.2) 0.1 0.0 Contribution to QoQ national income growth (%) 1Q09 na na na na na na (1.8) (1.6) (0.4) 0.1 0.5 0.9 (0.3) (0.2) (0.2) 0.0 0.0 2Q09 na na na na na na 0.1 (0.1) (0.1) 0.1 0.4 0.2 0.2 (0.3) 0.0 0.1 0.0 3Q09 na na na na na na 1.1 0.2 0.1 0.1 1.1 0.8 0.1 (0.2) (0.1) (0.2) 0.0

(US$bn) Gross domestic product Plus: Income receipts from ROW Less: Income Payment to ROW Equals: Gross national product Less: Consumption of fixed capital Less: Stats discrepancy Equals: National income Compensation of employees Proprietors' income w/ IVA & CCAdj Rental income of person w/ CCAdj Corp profits with IVA & CCAdj Domestic financial Domestic non-financial Net interest & misc payments Taxes on prodn & imports less subs Busn current transfer payment (net) Current surplus of govt enterprises

Source: www.bea.gov, CLSA Asia-Pacific Markets

WE WANT TO SEE A
RECOVERY IN NONFINANCIAL PROFITS, EVEN THEN INVESTMENT WILL LAG

The profits growth implied in Figure 30 is encouraging but its distribution isn’t. More than three quarters of the improvement in corporate profits occurred in the financial sector. The monetary transmission mechanism is broken. Interest rate reductions are benefitting banks but little else. We will be more confident of an investment recovery when non-financial profits start to increase more significantly. Figure 31 shows non-financial corporate profits (% GDP) and real investment growth. The correlation is self evident, but it takes time for investment growth, having bottomed, to turn positive on a sustained basis.
Figure 31

THERE IS TYPICALLY 3-5
QTRS BETWEEN THE PROFITS CYCLE AND THE INVESTMENT CYCLE

US non-financial profits (%GDP) and %QoQ real private investment
9 8 7 6 5 4 3 2 1 0 69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 Non-financial profits %GDP Private investment %QoQ (RHS) (15) 5 0 (5) (10) (%GDP) (%QoQ) 10

PROFITS LEAD, CAPEX FOLLOWS

Source: DataStream, CLSA Asia-Pacific Markets

CONFIDENCE AND INTEREST
RATES ARE CRITICAL

How long it takes for a profits recovery to generate the investment recovery depends on business confidence and interest rates. Confidence has rebounded for large firms, however as Figure 32 shows, the unlisted sector is much weaker. Small firms also appear to have been an increasing source of job losses signalled by a growing disconnect between the job market as described by the establishment survey (that provides non-farm payrolls) and the household survey (that provides the civilian employment data). Unincorporated businesses continued to reduce gearing in the Fed’s latest flow of funds accounts where incorporated businesses did not.

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SMALL US FIRMS ARE STILL
VERY DEPRESSED

Figure 32

SMALL & LARGE BUSINESSES MOVING APART
US NFIB small firm confidence vs Conference Board CEO survey
(index) (index) 110 105 100 95

80 70 60 50 40 30 20 10

90 Conference Board CEO Confidence NFIB small business optimism (RHS) 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 85 80

Source: DataStream, CLSA Asia-Pacific Markets

WE EXPECT 1H10 TO BE
DISAPPOINTING

Business confidence will at some point recover even for small firms. Interest rates will be a more intractable problem. As we showed in Figure 18 the US recovery will take place in a savings constrained economy. Any reduction in US private sector net savings will be met by rising interest rates. This will act to postpone recovery. Our central case is that US growth disappoint in the first half with robust numbers only emerging in the second half of 2010. However, when recovery does arrive it will be vigorous. Figure 33 shows the ratio of private sector investment to GDP. In 3Q09 it had fallen to 12.6%. As the US investment ratio starts to revert to “normal” levels growth will expand rapidly and as this investment will be funded from undistributed profits it can do so even with an absence of credit growth. At this point the savings shortfall in the US also becomes less of a problem – portfolio inflows into US equities will be enough to bridge any gap.
Figure 33

HOWEVER WHEN THE
RECOVERY DOES ARRIVE IT WILL BE VIGOROUS

MEAN REVERSION MEANS
RAPID CAPEX GROWTH

INVESTMENT RATIOS ARE ULTRA DEPRESSED . . .
US private fixed investment %GDP
(% GDP)

19 18 17 16 15 14 13 12 11 60

Trend line is estimated using slow moving HP filter

64

68

72

76

80

84

88

92

96

00

04

08

Source: DataStream, CLSA Asia-Pacific Markets

A similar argument applies to consumer durables. Figure 34 shows personal consumer spending on durable goods both as a percentage of GDP and personal disposable income. Though less extreme than with investment here too mean reversion suggests very rapid growth rates once the business cycle bottoms and household income growth has started to improve.

eric.fishwick@clsa.com

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Eye on Asian Economies • 1Q2010
V I E W P O I N T

AND DURABLE GOODS
DEMAND WILL ALSO REBOUND

Figure 34

. . . DURABLE GOODS CONSUMPTION TOO
US PCE on durable goods %GDP and %disposable income
(% disp income) (% GDP) 10.5 10.0 9.5 9.0 8.5 8.0 7.5 7.0 6.5 6.0 95 00 05

15 14 13 12 11 10 9 8 60

PCE on durable goods % disposable income PCE on durable goods % GDP (RHS) 65 70 75 80 85 90

Source: DataStream, CLSA Asia-Pacific Markets

WE EXPECT 4.1% GDP GROWTH FOR 2011

Practically this means that while our full year 2010 forecast is a rather unexciting 1.8% we are bullish about 2011. The IMF has yet to roll its forecasts out to 2011 but the OECD’s November forecast saw US growth at 2.8% in 2011 after 2010 growth of 2.5%. The 2011 number is likely to prove much too conservative. Our 2011 forecast is for US GDP growth of 4.1%.

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Eye on Asian Economies • 1Q2010
W O R L D
V I E W

WORLD VIEW
USA 2007
Real GDP growth Consumer prices (average) Federal funds rate (y/e) 3-month LIBOR (y/e) 10-year Treasury Note (y/e) 2.0 2.8 4.25 5.00 3.50

CLSA FORECAST 2008
1.1 3.8 0 - 0.25 1.42 2.21

CONSENSUS 2010¹
2.7 2.3 0.50 1.36 3.85

2009¹
(2.5) (0.4) 0 - 0.25 0.30 3.75

2010¹
1.8 1.6 0.25 0.70 5.00

2011¹
4.1 3.8 2.00 2.50 5.50

2011¹
2.8 1.3 1.75 2.66 4.12

¹ CLSA forecasts, consensus forecasts and market futures implied/forward rates as at 7 December 2009. Source: OECD World Economic Outlook, Datastream, CLSA Asia-Pacific Markets

GDP growth

The November payrolls numbers have lifted our near-term forecast for consumer spending however we continue to expect that it will be mid-year before the US sees QoQ growth consistently exceed trend. When recovery kicks in fully it will be extremely vigorous. As we discuss on pp23-26 investment and consumer durable spending is very suppressed, mean reversion implies a strong rebound. We expect 2011 growth of 4.1%.
Inflation

We have increased our inflation forecast as manufactured goods prices have stabilised earlier than we expected. However wage inflation is minimal and it is this that is required (even with an extremely loose monetary policy) for price rises to become ingrained. CPI inflation will be suppressed in 2010 but much faster in 2011.
Interest rates

The markets are now speculating on a US rate increase in 2H10 and though we see higher rates only from the turn of the year the shrinkage of the Fed’s balance sheet will keep “exit strategies” in focus (see pp21-23). Rate increases in 2011 will be rapid as the Fed attempts to get back ahead of the curve. Higher funding costs and a large Federal deficit mean higher bond yields. By end-2010 we see 10 year notes at 5%, with yields rising further in 2011.
EURO ZONE 2007
Real GDP growth Consumer prices (average) 7-day repo rate (y/e) 3-month EURIBOR (y/e) 10-year euro bond (y/e) 2.6 2.1 4.00 5.00 4.20

CLSA FORECAST 2008
0.6 3.3 2.50 2.89 2.95

CONSENSUS 2010¹
1.2 1.1 1.75 1.88 3.62

2009¹
(4.1) (0.2) 1.00 0.75 3.25

2010¹
0.5 1.0 1.75 2.00 4.00

2011¹
2.5 2.8 2.50 2.90 4.25

2011¹
1.7 0.7 2.50 2.73 3.92

¹ CLSA forecasts, consensus forecasts and market futures implied/forward rates as at 7 December 2009. Source: OECD World Economic Outlook, Datastream, CLSA Asia-Pacific Markets

GDP growth

We have upgraded our forecast for 2010 Eurozone growth from 0% to 0.5% but this will remain a laggard economy. This becomes much more apparent in 2011 when the speed of the US upswing will leave the Eurozone standing. We have pencilled in growth of 2.5% for 2011. Unemployment will be sticky through to end-2011.
Inflation

For a country whose currency has risen by 18% versus the dollar the inflation performance of the Eurozone is unremarkable. The harmonised CPI stabilised in 3Q09 after small QoQ declines in 1H09. The lagged effect of euro gains, not to mention a large Eurozone output gap, will suppress inflation for much of 2010: our CY2010 forecast is for inflation of 1%. But this effect will wear off quite quickly in 2011. We see inflation then of 2.8%.
Interest rates

The ECB is giving more and more details about its exit strategy. This is, first, the removal of the exceptional facilities (long duration repos) that the ECB introduced when the markets needed liquidity. These will be gone by the end of 1Q allowing the ECB to take the next step, raising rates, early in the second half. We see 75bp of tightening before end-10. There will be further rate increases in 2011. eric.fishwick@clsa.com

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V I E W

JAPAN 2007
Real GDP growth Core CPI (average) Overnight call rate (y/e) 3-month LIBOR (y/e) 10-year government bond (y/e) 2.3 0.1 0.50 0.90 1.60

CLSA FORECAST 2008
(0.7) 1.5 0.10 0.83 1.20

CONSENSUS 2010¹
1.4 (0.9) 0.10 0.36 1.51

2009¹
(5.2) (1.2) 0.10 0.48 1.30

2010¹
1.8 (0.9) 0.10 0.60 1.60

2011¹
1.5 (0.2) 0.50 0.80 2.00

2011¹
2.0 (0.4) 0.10 0.47 1.75

¹ CLSA forecasts, consensus forecasts and market futures implied/forward rates as at 7 December 2009. Source OECD World Economic Outlook, Datastream, CLSA Asia-Pacific Markets

GDP growth

Current indicators have been good and we have increased our 2010 growth forecast slightly. We see GDP growth at 1.8% YoY. Consumption (due to the DPJ’s consumer friendly policies) and exports (in large part a function of strong Chinese demand for parts, materials and investment goods) lead. For 2011 we see growth slower at 1.5%, this leaves Japan an underperformer relative to the US and (even) the Eurozone.
Inflation

The above forecasts imply that Japan will be growing above trend. However we would not expect the output gap to be closed until early 2011. Deflation therefore will persist. We expect the core CPI to fall 0.9% in 2010 and a further 0.2% in 2011.
Interest rates

Japan seems intent in disproving the truism that when rates have been cut to zero the only possible policy move is a tightening; the BoJ is discussing how to ease further. We expect policy rates to be kept at the current level of 0.1% until well into 2011. Bond yields in 2010 will initially fall but, thereafter, the poor Japanese fiscal position suggests a steeper curve. We expect 10-year JGB yields of 1.6% for end-2010, higher in 2011.
CHINA 2007
Real GDP growth Consumer prices (average) 1-year savings rate (y/e) 1-year lending rate (y/e) Rmb/US$ (y/e) 13.0 4.8 4.1 7.5 7.32

CLSA FORECAST 2008
9.0 5.9 2.3 5.3 6.83

CONSENSUS 2010¹
9.6 2.6 higher higher 6.63

2009¹
9.0 (0.8) 2.3 5.3 6.83

2010¹
10.0 3.5 2.8 6.4 6.57

2011¹
10.0 4.0 3.3 6.9 6.20

2011¹
9.3 n.a. n.a. n.a. 6.33

¹ CLSA forecasts, consensus forecasts and market futures implied/forward rates as at 7 December 2009. Source: OECD World Economic Outlook, Datastream, CLSA Asia-Pacific Markets

GDP growth

China continues to grow very rapidly with consumption and investment expanding well ahead of GDP. This underlines the “drag” on growth represented by net trade, the fact that is enabling China to pull the rest of the region in its wake. We have retained a 10% GDP growth forecast for 2010 with domestic expenditure up 16%. We expect similar GDP growth in 2011 but this conceals slower domestic growth and stronger exports.
Inflation

Manufactured goods prices have stabilised faster than we expected and with factor and food markets either already tight or expected to tighten quickly in 2010 this has increased our inflation forecast. We now see CPI inflation of 3-4% in 2010. It will be hard to slow inflation in 2011.
Currency and rates

We have changed our currency forecast. The speed with which China is reflating its light industrial sector implies a drop in export dependence. This in turn allows a stronger renminbi to be used as both a political tool (to defuse US trade pressure) and economic tool (to start to squeeze inflation). We expect the currency to be appreciated from 2Q10. Rate increases are also likely. We have 108bp on lending rates and 54bp on deposit rates in 2010.

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Eye on Asian Economies • 1Q2010
W O R L D
V I E W

TRADE AND COMMODITIES 2007
Oil price (Brent crude average) Oil price (Brent crude y/e) CRB index (y/e) Gold (y/e) Global trade volume 72.6 93.8 358.7 836.7 7.3

CLSA FORECAST 2008
98.5 45.6 229.5 882.1 3.0

CONSENSUS 2010¹
82.4 85.2 280.0 1,177 n.a.

2009¹
60.1 78.0 290.0 1,100 (11.9)

2010¹
75.0 80.0 310.0 1,350 2.0

2011¹
80.0 80.0 330.0 1,500 10.0

2011¹
87.8 88.9 n.a. 1,233 n.a.

¹ CLSA forecasts, consensus forecasts and market futures implied/forward rates as at 7 December 2009. Source: OECD World Economic Outlook, Datastream, CLSA Asia-Pacific Markets

Oil prices

From February oil prices have doubled in euro terms and increased by 130% in dollar terms. Looking forward we would anticipate demand growth being good – China and emerging Asian growth will lead in 2010 and be joined by the rapid growth we see for the US in 2011. However prices have already discounted much of this and there is a near term risk of retracement. We expect Brent to average US$75/bbl in 2010 increasing modestly in 2011.
Industrials

We expect similar trends in industrial commodities. Strong Asian growth in 2010 followed by the rapid recovery we see in the US in 2011 make for a bullish physical market. But dollar weakness has front loaded a lot of the gains into 2009. In the near term we would expect a pull back before rising prices (both dollar and euro terms) reassert themselves.
Global trade

The recovery in Asian trade has been extremely rapid as Chinese demand has pulled the region higher. This will continue into 2010 with Asian trade becoming more and more Asia centric as Chinese consumer durable demand increases. 2011 will see another acceleration; there is no reason to expect Chinese demand for durable goods to slow but the US consumer will finally return in force.
EXCHANGE RATES 2007
US$/Euro (y/e) Yen/US$ (y/e) US$/GBP (y/e) Yen/Euro (y/e) GBP/Euro (y/e) 1.50 110.0 2.00 165.0 0.75

CLSA FORECAST 2008
1.39 90.6 1.45 125.9 0.95

FORWARDS 2010¹
1.49 89.4 1.64 133.2 0.91

2009¹
1.48 95.0 1.64 140.6 0.90

2010¹
1.60 105.0 1.65 168.0 0.97

2011¹
1.55 110.0 1.65 170.5 0.94

2011¹
1.48 87.8 1.64 129.9 0.90

¹ CLSA forecasts, consensus forecasts and market futures implied/forward rates as at 7 December 2009. Source: OECD World Economic Outlook, Datastream, CLSA Asia-Pacific Markets

Euro

The US$ has strengthened and will end 2009 quite close to our previous forecast (of US$1.45/€1). Although the November payrolls figures have made US tightening credible our view remains that rates will increase first in Europe. And there are reasons beyond short spreads to sell US$ – the economy is savings deficient and needs to attract capital from overseas. We would be long euro to US$1.60/€1 around mid year. Euro gains past this point should not be expected: the US economy will be much more vigorous than the Eurozone in 2011.
Yen

The yen is looking acutely exposed; it is the only major currency where a short position does not carry any policy risk. The BoJ’s immediate concern is with how much to ease policy when both the Fed (quite distantly) and the ECB (more imminently) are planning their exit strategies. Short yen vs US$ and euro.
Sterling

Sterling has been trading pretty consistently around US$1.65/£1 and we expect this to continue implying that in 1H10 it will underperform the euro. eric.fishwick@clsa.com

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W O R L D
V I E W

Notes

30

eric.fishwick@clsa.com

EoAE Forecasts
1Q10
Anthony Nafte
tony.nafte@clsa.com (852) 26008320

Up, up and away
Investment in resource development projects will increase future export earnings and boost employment. Unemployment has peaked, rising employment growth and wage income will spur consumption in 2010 and 2011. Rising capital inflows will offset the deficit on the current account lifting the A$ to parity with the US$ by mid-2010. Rate hikes have not dented sentiment

The export recovery in late 2009 has positioned Australia for buoyant real GDP growth in 2010 and 2011. The rebound in exports has been driven primarily by demand from China but will be reinforced by rising demand from the rest of Asia including Japan and India. We forecast 3.4% real GDP growth in 2010 (unchanged from the 4Q09 EoAE forecast). With global demand further reinforced by recovery in the US, this rapid growth pace can be sustained. We expect real GDP growth to remain robust at 3.4% in 2011. There has been a concern that aggressive monetary tightening will stifle the recovery in private investment and consumption. However, the late 2009 surveys showed business confidence spiking to a record high fuelled by a surge in forward orders. Encouragingly, there was also a suggestion of a pick up in investment from the uptrend in capital goods imports. Investment growth was still contracting in 3Q09 so indications of a rebound have provided reassurance for the employment and consumption outlook. The resources sector dominates focus in Australia. The mining sector employs less than 2% of the workforce but does generate large taxation revenues. Moreover, resource development projects boost employment indirectly by creating jobs in allied sectors. Major LNG gas project developments (Gorgon, Wheatstone, Browse) will be getting underway in Western Australia and Queensland. While the potentially huge export revenues may not come on stream within the next two years, there will be a substantial boost to construction and engineering jobs and other contract labour.
LONG-RUN HISTORY AND FORECAST SUMMARY

2003
Real GDP growth Domestic final sales growth Nominal GDP growth Consumer prices (y/e) Cash target rate (% y/e) A$/US$ (y/e) Money supply M1 (y/e) Current account balance (US$bn) - as a % of nominal GDP Public sector deficit (% of GDP) Note: % YoY rates unless otherwise stated. Source: ABS, RBA, OECD, DataStream 3.0 4.9 6.6 2.4 5.3 0.74 8.2 (28.6) (5.4) (1.0)

2004
3.8 6.0 7.4 2.6 5.3 0.77 5.6 (39.7) (6.2) (1.2)

2005
2.8 4.3 7.4 2.8 5.5 0.74 7.1 (41.4) (5.8) (1.6)

2006
2.8 3.7 7.4 3.3 6.3 0.79 12.6 (41.0) (5.4) (2.1)

2007
4.0 5.4 8.3 3.0 6.8 0.87 12.8 (58.2) (6.4) (1.6)

2008 2009clsa 2010clsa 2011clsa
2.4 4.8 9.2 3.7 4.3 0.67 6.7 (47.7) (4.7) (1.3) 1.1 0.7 3.6 2.1 3.8 0.93 4.7 (36.4) (3.8) 2.3 3.4 4.5 6.1 3.3 5.0 0.98 10.2 (53.1) (4.2) 4.2 3.4 4.6 6.2 3.7 5.5 0.94 9.8 (68.5) (5.2) 1.0

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Eye on Asian Economies • 1Q2010
A U S T R A L I A

Unemployment has peaked

It is the services sector though, where most of the workforce (two thirds) is employed. The performance of services index (PSI) has signalled that Australia is in the early stage of a cyclical upswing in services. The PSI breached the 50 breakeven level in October 2009 which indicates expansion in the services sector. This reinforces our bullish prediction that real GDP growth will top 3% in both 2010 and 2011. More specifically on job prospects, November saw the PSI employment index rising above the 50 level for the first time in eighteen months and the unemployment rate dropping to 5.7%. It is likely that the unemployment cycle peaked in the previous month at 5.8%. There was a 71k increase in full time jobs over the three months to November along with a sharp rise in working hours. We expect a continued rise in employment growth through 2010 which should bolster consumer spending in the face of rising interest rates. There were mixed signals on consumption in late 2009. Retail sales remained stalled going into 4Q09 but consumer goods imports were trending up. Consumer confidence, despite slipping in November, remained at a relatively buoyant level. Will household spending prove resilient though, to further interest rate hikes? The negative view is that increasing debt servicing charges will reduce consumption given already high household interest payments at over 10% of disposable income. We have a more sanguine view. At the same time that interest payments will be increasing, higher wage income (longer working hours and a shift from part time to full time hiring) will increase the denominator. So the interest payments to disposable income ratio will not rise to the point of constraining discretionary spending. Given the strengthening economic outlook and improving job prospects, rising consumer confidence will translate into increased spending. Personal credit (excluding mortgages) was contracting YoY in late 2009 but had turned (marginally) positive on a QoQ annualised basis. We anticipate accelerating credit growth as a spur to household spending in 2010 and 2011.
GDP GROWTH FORECASTS THE CLSA DIFFERENCE

Government

GDP growth

Updated: 2010:
Consensus

Nov 1.5 Dec 2.7 3.4

Government will likely revise up its forecast given the strong signals from exports, investment and consumption.
Inflation

Updated: 2010:
CLSA

Housing bubble has been more of a concern to the RBA but CPI inflation is now also trending up.
Interest rates & exchange rate

2010:

Our forecasts are in line with the perceived neutral cash rate range between 5 and 5.5%.

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Eye on Asian Economies • 1Q2010
A U S T R A L I A

AUSTRALIA BY NUMBERS

2007
Breakdown of real GDP Private consumption Public consumption GFCF Domestic final sales Exports, goods & services Imports, goods & services Real GDP growth Prices Consumer prices (y/e) Consumer prices (average) Producer prices (y/e) Currency & interest rates A$/US$ (y/e) A$/US$ (average) Cash target rate (% y/e) Lending rate - big corporates (% y/e) External sector Exports (US$, % YoY) Imports (US$, % YoY) Trade balance (US$bn) Current account balance (US$bn) - as a % of nominal GDP FDI (US$bn) Adjusted resource gap (% of GDP) External debt (total, US$bn) Debt service ratio (% exports) International reserves (US$bn, y/e) Money supply Money supply M1 (y/e) Money supply M3 (y/e) Private sector credit (y/e) Private sector credit (% of GDP) Government sector General gov’t deficit (% of GDP) General gov’t debt (% of GDP, y/e) Nominal GDP Nominal GDP (US$bn) Nominal GDP per capita (US$) Nominal GDP (A$bn) Nominal GDP (A$, % YoY) Other data Industrial production Retail sales Unemployment (% y/e) 3.2 7.7 4.4 910.4 43,319 1085.6 8.3 (1.6) 15.4 12.8 22.2 16.7 160.8 14.3 19.4 (17.8) (58.2) (6.4) 29.1 (3.2) 513.9 4.2 26.9 0.87 0.84 6.8 7.5 3.0 2.3 2.8 4.4 2.4 9.5 5.4 3.3 11.8 4.0

2008
2.6 4.1 9.6 4.8 3.8 11.3 2.4 3.7 4.4 6.4 0.67 0.85 4.3 6.3 32.3 20.5 (4.7) (47.7) (4.7) 11.3 (3.6) 466.9 2.6 32.9 6.7 16.1 9.2 160.8 (1.3) 14.2 1,010.0 47,126 1185.0 9.2 2.8 4.4 4.5

2009clsa
1.3 2.4 (1.9) 0.5 1.4 (9.0) 1.0 2.1 1.8 0.8 0.93 0.79 3.8 6.1 (17.8) (17.8) (3.8) (36.4) (3.8) 2.5 (3.5) 520.0 4.4 50.0 4.7 7.2 1.4 157.4 2.3 16.0 967.0 44,452 1227.1 3.6 (2.5) 5.3 5.7

2010clsa
3.4 2.1 8.0 4.5 8.4 13.1 3.4 3.3 3.0 4.6 0.98 0.98 5.0 7.3 15.0 19.2 (11.1) (53.1) (4.2) 14.0 (3.1) 560.0 4.4 60.0 10.2 8.4 8.1 160.4 4.2 19.0 1,274.6 57,728 1302.3 6.1 4.3 6.1 5.1

2011clsa
3.2 1.3 9.0 4.6 10.8 15.2 3.4 3.7 3.5 5.2 0.94 0.96 5.5 7.5 18.5 23.5 (22.5) (68.5) (5.2) 24.0 (3.4) 600.0 4.1 66.0 9.8 9.3 9.0 164.6 1.0 18.8 1,327.6 59,240 1382.9 6.2 4.8 8.7 4.3 22.4

Investment will drive employment and wage growth.

Exports will be a key growth driver in the next two years. Rising interest rates will cap inflation at 3.7%. We predict the A$ will reach parity with the US$ by mid-2010 before easing in 2H10. 125bp rate hike in 2010, 50bp hike in 2011. Soaring exports with China demand reinforced by rising US demand in 2011. Widening current account deficit due to import surge on rising investment. Increasing FDI inflows.

Fiscal deficit will decline in 2011 as tax revenues rebound.

Unemployment will decline over the next two years.

Population (millions) 21.0 21.4 21.8 22.1 Note: % YoY rates unless otherwise stated. Fiscal deficit estimates are for the fiscal year ending in June eg, 2007/08 is under 2008. Source: ABS, RBA, OECD, Datastream

tony.nafte@clsa.com

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Eye on Asian Economies • 1Q2010
A U S T R A L I A

EXPORTS & IMPORTS

Pre-emptive tightening will cap inflation rise

20 18 16 14 12 10 8 6 4 02

(US$bn)

Exports Imports

smoothed data are HP filters 03 04 05 06 07 08 09

In a pre-emptive strike, the RBA has already increased interest rates by 75bp since October 2009. We expect another 125bp rise lifting the cash rate to 5% by end-2010 and a further 50bp hike to 5.5% by end-2011. The 5 to 5.5% range corresponds to the perceived neutral monetary policy setting desired by the RBA. Firming domestic demand will drive inflation up 1.2ppt to 3.3% in 2010. But in response to monetary tightening, through combined interest rate hikes and exchange rate appreciation, there will be a slower inflation increase to 3.7% in 2011. As private sector demand gains traction, there will be pressure to withdraw public spending initiatives. Politically though, this may prove difficult. Even so, rising commodity tax revenues will keep the fiscal deficit below the official 4.6% of GDP target for the current fiscal year ending June 2010 and drive the deficit down further to 1% in FY 2011.
A$/US$ parity by mid-2010

AUD NEER & REER

160 150 140 130 120 110 100 90 80 95

(Jan 00 = 100)

NEER REER

97

99

01

03

05

07

09

MONEY SUPPLY AND CREDIT

The current account deficit, which had been narrowing since 2007, started to widen again in 2H09. As investment rebounds, insufficient household savings means that a widening current account deficit will be inevitable. From our 3.8% of GDP estimate for the 2009 current account deficit, we expect the deficit to top 5% in 2011. The widening trade and current account deficits could unsettle the Australian dollar but we would downplay these fears. Export growth will be robust while surging imports, the proximate cause of the widening deficit, will be a reflection of firming domestic demand. Rising interest rates have been largely discounted, as indicated by interest rate forwards, which leaves the A$ vulnerable to a correction. We remain positive though. With rising export revenues and a positive growth differential relative to other industrialised countries, Australia should continue to attract foreign capital which will offset the deficit on the current account. We expect the A$ to reach parity with the US$ by mid2010. We expect a softer A$ in 2H10 though, on renewed US$ strength, with our forecast at 98 US cents by end-2010. We forecast further modest depreciation to 94 US cents by end-2011 as the market starts to speculate on the end of the monetary tightening cycle.
CURRENCY FORECAST

30 25 20 15 10 5 0 -5

(sa 3mma, %QoQ annualised)

-10 Jun-07 M1

Dec-07

Jun-08 Broad money

Dec-08

Jun-09 Total credit

Period-end 2008
A$/US$ A$/Yen 100 A$/GBP A$/Euro Memo: US$/Euro Memo: Yen/US$ 0.67 60.8 0.46 0.48 1.39 90.6

Annual 2009clsa
0.93 88.4 0.57 0.63 1.48 95.0

Coming 12 months by quarter 2011clsa
0.94 103.4 0.57 0.61 1.55 110.0

2010clsa
0.98 102.9 0.59 0.61 1.60 105.0

1Q10clsa
0.97 97.0 0.59 0.63 1.55 100.0

2Q10clsa
1.00 100.0 0.61 0.63 1.60 100.0

3Q10clsa
0.99 101.5 0.60 0.62 1.60 102.5

4Q10clsa
0.98 102.9 0.59 0.61 1.60 105.0

34

tony.nafte@clsa.com

EoAE Forecasts
1Q10
Eric Fishwick
eric.fishwick@clsa.com (852) 26008033

Enter the Chinese consumer
Beijing is already slowing investment. Good. If it didn't China would overheat in 2010. Subsidising appliance purchases was inspired, it has allowed China to reflate the rest of the region. Tightening will occur throughout 2010. But slowing growth will be difficult in 2011 given a US recovery. Domestically driven

China’s 3Q GDP growth was a little below our expectation hence the cut in our 2009 estimate to 9%. However this shouldn’t obscure an economy whose rebound from the weakness of 4Q08 has been remarkable. First, the acceleration is still ongoing. Both manufacturing PMIs suggest that the pace of MoM growth in 4Q will be faster than it was in 3Q. Second, the headline GDP numbers understate the pace of the domestic economy because of the swing in the real trade surplus towards deficit. The monthly urban FAI and retail sales data suggest that in 1Q-3Q09 consumption and investment grew by enough to add more than 20ppt to 1Q-3Q09 GDP growth(!). This is an extraordinary expansion. It is already dragging inflation higher.
Being slowed down and changing character

Those that argued that Beijing was not interested in growth for growth’s sake are being proven right. The 8.9% YoY growth headline in 3Q represents a slowdown when growth is calculated on a QoQ basis (from 3.9% QoQ in 2Q to 2.5% QoQ in 3Q). Some of this was inevitable as 1Q was an easy comparison. However Beijing has been quick to reduce stimulus as the economy has accelerated. As we noted on page 22 the huge investment surge of 1H09 started to be withdrawn in 3Q. Credit growth decelerated from summer.
Enter the Chinese consumer

The investment super-surge was critical in supporting economic activity and confidence. Without it the other policies would not have worked. But having
LONG-RUN HISTORY AND FORECAST SUMMARY

2003
Real GDP growth Domestic demand growth Nominal GDP growth Consumer prices (y/e) 1-year savings rate (% y/e) Rmb/US$ (y/e) Money supply M1 (y/e) Current account balance (US$bn) - as a % of nominal GDP 10.0 9.4 12.9 3.2 2.0 8.28 18.7 45.9 2.8

2004
10.1 6.5 17.7 2.4 2.3 8.28 13.6 68.7 3.6 1.3

2005
10.4 4.9 14.6 1.6 2.3 8.08 11.8 160.8 7.2 1.2

2006
11.6 6.4 15.7 2.8 2.5 7.82 17.5 253.2 9.5 0.8

2007
13.0 7.4 21.4 6.5 4.1 7.32 21.0 371.8 11.0 (0.6)

2008 2009clsa 2010clsa 2011clsa
9.0 4.3 16.9 1.2 2.3 6.83 9.1 426.1 9.8 0.4 9.0 15.4 7.8 0.6 2.3 6.83 35.0 256.4 5.4 5.0 10.0 15.9 11.1 4.0 2.8 6.57 25.0 (16.9) (0.3) 7.0 10.0 11.5 14.4 4.0 3.3 6.20 22.0 (138.8) (2.2) 3.0

Public sector deficit (% of GDP) 2.2 Note: % YoY rates unless otherwise stated. Source: IMF, World Bank, China Economic News, CEIC

eric.fishwick@clsa.com

35

Eye on Asian Economies • 1Q2010
C H I N A

done its job, and stabilised the economy, the main driver of growth has already moved past infrastructure and SOE investment. The prime mover is now the Chinese consumer. We write about this in detail as the first (and most important) Theme in our Ten in ’ten Viewpoint article. In brief China is displaying an extraordinary income and price elasticity of demand for consumer durables. This is apparent as a leap in sales of household appliances, consumer electronics, autos and the like. In six months this demand has stabilised factory gate prices in China’s own light industrial sector (see CRR’s SME Quarterly). Demand for products (and parts & materials) from the rest of the region is spreading the benefit internationally. This was accelerated by Beijing’s decision to subsidise appliance and auto purchase. This was an inspired policy which exploited the fact that China is in the income sweet spot: households have free income to spend but ownership rates of products in many areas are still low. While in this sweet spot a combination of stabilising income, massively boosting confidence and dropping price has caused durable goods demand to surge. For Asia as a whole this was the most important policy from Beijing for the simple reason that this is the “stuff” that the rest of Asia makes.
Less investment, more consumption

We expect state directed investment to continue to be reined in so that, while 2010 will have stronger private construction and SME capex growth than 2009, overall FAI growth will slow to a more normal 16% (in real terms on our estimate) from 33% in 2009. Consumption will accelerate. The Central Economic Working Meeting has indicated that the government remains committed to rebalancing the economy towards consumption. Hu and Wen’s closing speeches said that the efforts to encourage rural appliance and auto ownership would be increased and urban schemes maintained. The longer these programs are continued the less necessary they will become. Hiring in China’s SMEs has restarted and already there is
GDP GROWTH FORECASTS THE CLSA DIFFERENCE

Government

GDP growth

Updated: 2010:
Consensus

Dec 8.0 Dec 9.6 10.0

We’re slightly above consensus but there is a bigger difference concerning domestic demand.
Inflation

Updated: 2010:
CLSA

We see inflation higher than the majority as a result.
Interest rates & exchange rate

2010:

Following the Nov non-farm payrolls our projected Rmb appreciation is more than implied by the NDFs.

36

eric.fishwick@clsa.com

Eye on Asian Economies • 1Q2010
C H I N A

CHINA BY NUMBERS

Consumer spending driving 2010 growth. 2009clsa
17.0 n.a. 33.0 15.4 (9.9) 1.9 9.0 0.6 (0.8) (5.5) 6.83 6.83 2.3 5.3 (17.5) (10.0) 217.0 256.4 5.4 29.2 6.0 n.a. n.a. 2,400.0 35.0 30.0 35.0 129.5 5.0 4,744.4 3,555 32,404 7.8 12.0 16.0 n.a.

2007
Breakdown of real GDP Private consumption Public consumption GFCF
2 1

2008
9.9 n.a. 12.1 4.3 14.4 8.2 9.0 1.2 5.9 (1.1) 6.83 6.95 2.3 5.3 17.6 18.7 360.7 426.1 9.8 94.3 12.0 374.7 1.8 1,946.0 9.1 17.8 18.8 103.4 0.4 4,326.2 3,258 30,067 16.9 12.9 21.6 4.2

2010clsa
20.5 n.a. 15.9 15.9 9.4 29.0 10.0 4.0 3.5 2.5 6.57 6.70 2.8 6.4 10.0 35.0 (2.9) (16.9) (0.3) 36.5 0.4 n.a. n.a. 2,569.6 25.0 20.0 19.2 138.9 7.0 5,373.3 4,006 36,001 11.1 16.0 24.0 n.a.

2011clsa
18.0 n.a. 10.6 11.5 22.8 29.2 10.0 4.0 4.0 3.5 6.20 6.39 3.3 6.9 25.0 28.0 (42.8) (138.8) (2.2) 47.5 (1.4) n.a. n.a. 2,628.3 22.0 15.0 16.0 140.8 3.0 6,450.3 4,785 41,185 14.4 20.0 22.0 n.a. 1,348

11.5 n.a. 11.3 7.4
3

FAI bears main brunt of efforts to slow economy.

Domestic demand Exports, goods & services Imports, goods & services Real GDP growth Prices Consumer prices (y/e) Consumer prices (average) Producer prices (y/e) Currency & interest rates Rmb/US$ (y/e) Rmb/US$ (average) 1-year savings rate (% y/e) 1-year lending rate (% y/e) External sector Exports (US$, %YoY) Imports (US$, %YoY) Trade balance (US$bn) Current account balance (US$bn) - as a % of nominal GDP FDI (US$bn) Adjusted resource gap (% of GDP) External debt (total, US$bn) Debt service ratio (% exports) International reserves (US$bn, y/e) Money supply Money supply M1 (y/e) Money supply M2 (y/e) Financial institutions loans (y/e) Financial institutions loans (% of GDP) Government sector General government deficit (% of GDP) Nominal GDP Nominal GDP (US$bn) Nominal GDP per capita (US$) Nominal GDP (Rmbbn) Nominal GDP (Rmb, %YoY) Other data Industrial production Retail sales Unemployment (% y/e)
4 3

23.1 15.9 13.0 6.5 4.8 5.4 7.32 7.60 4.1 7.5 25.8 20.3 315.4 371.8 11.0 121.4 14.6 373.6 2.0 1,528.2 21.0 16.7 16.1 101.7 (0.6) 3,385.5 2,562 25,730 21.4 18.5 16.8 4.0

Exports accelerate and moderate drag on growth from net exports. Still a drag though as China’s output gap is fully closed by this point.

China will prove hard to slow down in 2011, apparent in persistence of inflation … … despite higher rates and currency.

A deficit is still in our forecast. Increasing deficit in 2011 is the mirror of net trade being a drag on growth in real terms.

Slow appreciation supports capital inflows. Even so, forex reserve growth much slower than when current account was in surplus. Lending rates will rise ahead of deposit rates.

Fiscal tightening ASAP.

Exports augment domestic demand in 2011.

Population (millions) 1,321 1,328 1,335 1,341 1 2 3 Note: % YoY rates unless otherwise stated. Deflated by CPI; Deflated by GDP deflator; Deflated by estimated G&S 4 deflators; PBoC foreign exchange balances. Source: IMF, World Bank, China Economic News, CEIC

eric.fishwick@clsa.com

37

Eye on Asian Economies • 1Q2010
C H I N A

EXPORTS & IMPORTS

140 120 100 80 60 40 20 0 02

(US$bn)

Exports Imports

anecdotal evidence of skills shortages. This is labour friction rather than shortage but we expect wage growth to be robust in 2010 as firming labour demand combines with households that expect prices to rise. The final part of the equation is rising SME capacity utilisation. As in 2006 and 2007 increases in output per person employed will make wage growth possible.
Rates and currency both higher

smoothed data are HP filters

03

04

05

06

07

08

09

RMB NEER & REER

Productivity gains mean that wage rises will not be a source of cost inflation but they will tighten the supply-demand environment. This will keep import growth rapid but in areas where international trade is low inflationary pressures will increase. Even with the “safety valve” of increased imports we have raised our inflation forecast for 2010 to 3-4% as manufactures prices have stabilised earlier than we thought. This is enough to justify higher interest rates. We expect policy rates to be increased from 2Q with a cumulative tightening of 108bp in lending rates by end-2010. 2009 saw rapid deposit growth and we expect deposit rates to increase by less. We have assumed 54bp to end-2010.

130 120

(Jan 00 = 100)

110 100

90 80 95 97 99 01 03 05

NEER REER 07 09

MONETARY CONDITIONS INDEX

8.0 6.0 4.0 2.0 0.0 -2.0 -4.0 04

(chg from 05/2004)

Additionally we have changed our view concerning the currency from the last EoAE. The last period of renminbi appreciation combined three factors, a weak US$, a need to slow the Chinese economy and inflation. We see similar forces in 2010. From 2Q10 we expect the renminbi to be appreciated versus the US$. The pace will be quite moderate. By end2010 we see the Rmb/US$ 4% stronger than the current spot rate (this is an annualised pace of appreciation of just over 5%). Critically the renminbi will still depreciate versus the euro (see pp13-15).
2011 similar but different

05

06

07 from NEER

08

09 MCI

from short rates

These policies will progressively slow the domestic economy. However our expectation that US growth will exceed 4% in 2011 will boost Chinese growth through international trade. With no output gap net trade will still be a drag on Chinese growth in 2011 but a much smaller one than in 2010 or 2009. We expect growth in 2011 to stay around 10% as the improved performance by exports offsets a further slowdown in FAI. Inflation will stay around 4% in 2011.
CURRENCY FORECAST

Period-end 2008
Rmb/US$ Rmb/Yen 100 Rmb/GBP Rmb/Euro Memo: US$/Euro Memo: Yen/US$ 6.83 7.54 9.97 9.49 1.39 90.6

Annual 2009clsa
6.83 7.19 11.20 10.11 1.48 95.0

Coming 12 months by quarter 2011clsa
6.20 5.64 10.23 9.61 1.55 110.0

2010clsa
6.57 6.26 10.84 10.51 1.60 105.0

1Q10clsa
6.83 6.83 11.27 10.59 1.55 100.0

2Q10clsa
6.74 6.74 11.12 10.78 1.60 100.0

3Q10clsa
6.66 6.50 10.99 10.66 1.60 102.5

4Q10clsa
6.57 6.26 10.84 10.51 1.60 105.0

38

eric.fishwick@clsa.com

EoAE Forecasts
1Q10
Anthony Nafte
tony.nafte@clsa.com (852) 26008320

Boom in 2010, boom in 2011
Rising services revenues will spur investment growth, the strengthening labour market will boost consumption. Rapidly expanding liquidity has not been transmitted into the real economy because of weak demand for credit. Credit growth will rebound as domestic demand firms but will be accompanied by accelerating inflation. Bright capex and consumption prospects

Retail sales, trade flows and services revenues were all trending up in late 2009. This will lift the platform for growth in 2010. Sustained trade, investment and tourism flows from China will boost investment and consumption growth in Hong Kong lifting our 2010 real GDP forecast to 5.2% (2ppt higher than our forecast in the 4Q09 EoAE and 1ppt above the current market consensus). In 2011, we expect the US recovery to be in full swing which will mean sustained buoyant trade and investment flows in Hong Kong. We forecast another year of robust real GDP growth at 5.4% in 2011. The rebound in services revenues has lifted business confidence and will spur new investment growth. After two years of contraction, we forecast 9% real investment growth in 2010 and 9.4% in 2011. Business receipts collapsed in 1Q09, rebounded over the next two quarters but were still down YoY in September 2009. There have been indications though, of a further steep increase in business receipts in 4Q09. The Hong Kong PMI index, which first rose above the 50 breakeven level signalling expansion in the services sector in August, continued to increase hitting a two year high in November. Firming private consumption growth was evident from the convincing uptrend in retail sales in late 2009. Consumer confidence has perked up. While estimates of the wealth effect may vary, one cannot dismiss the feel good factor of rising asset prices which has spurred household consumption. The stock market was up over 50% since the end of March and, by late 2009, residential property prices had surged to 45% over the ten year average.
LONG-RUN HISTORY AND FORECAST SUMMARY

2003
Real GDP growth Domestic final sales growth Nominal GDP growth Consumer prices (y/e) 3-month HIBOR (% y/e) HK$/US$ (y/e) Money supply M1 (y/e) Current account balance (US$bn) - as a % of nominal GDP 3.0 (0.5) (3.3) (1.2) 0.1 7.74 39.8 16.5 10.4

2004
8.5 5.2 4.6 0.6 0.3 7.77 17.2 15.7 9.5

2005
7.0 2.6 7.0 1.3 4.2 7.77 (10.3) 20.2 11.4 (1.1)

2006
7.0 5.6 6.7 1.9 3.8 7.77 13.1 22.9 12.1 (3.9)

2007
6.3 6.8 9.5 3.4 3.3 7.80 25.4 25.5 12.3 (7.5)

2008 2009clsa 2010clsa 2011clsa
2.4 1.1 3.8 4.7 0.9 7.75 4.7 30.7 14.2 (0.1) (3.0) (0.7) (2.3) 0.9 0.1 7.75 50.0 21.8 10.3 2.8 5.2 5.8 9.8 5.9 0.4 7.75 37.0 24.2 10.4 2.1 5.4 5.7 13.0 5.5 1.2 7.75 27.0 27.7 10.5 0.7

Public sector deficit (% of GDP)¹ 3.2 (1.6) Note: % YoY rates unless otherwise stated. ¹ Fiscal year starting April. Source: CEIC, CLSA estimates, HK government

tony.nafte@clsa.com

39

Eye on Asian Economies • 1Q2010
H O N G K O N G

The more fundamental argument for firming consumption prospects has been the strengthening labour market. The unemployment rate peaked at 5.4% in 3Q09 with indications of improved hiring sentiment. The December 2009 survey from Manpower Professional showed 17% of firms planned new hirings in 1Q09 (up from 11% in the September survey). A large proportion of these are new hirings, not replacements. The rebound in global trade saw Hong Kong re-export growth accelerating to a 26% QoQ annualised pace in late 2009. We expect that trade flows will moderate in 1H10 as the global inventory cycle fades and weak US consumer demand persists. Sustained demand from China though, will support regional trade flows including Hong Kong reexports. China’s influence on Hong Kong moreover, stretches well beyond trade with tourism and investment providing a significant boost. The share of direct investment in Hong Kong from China has increased to around 40%. The more immediate impact though, will continue to be felt through the ‘hot money’ inflows from China.
Expanding liquidity but contracting credit

There has been a huge expansion of the monetary base since October 2008, intermittently, but only temporarily, halted by HKMA intervention. Between 25 November and 8 December 2009 there was another HK$4.1bn increase in the aggregate balance, which measures the amount outstanding in the HK$ interbank market (i.e. the cash component of the monetary base). This was an indication of the continuing large liquidity inflows to Hong Kong in late 2009. This has raised fears of soaring inflation and asset bubbles in Hong Kong. The risk has so far been mitigated by weak transmission of reserve money growth into the real economy. This has been evident from depressed credit growth (aside from mortgages) and the falling money multiplier. Bank credit was contracting at an 8% QoQ annualised pace in October 2009 dragging the HK$ loan to deposit ratio below 70%, from an 84% peak in August 2008. The money multiplier (ratio of M3 money supply to the monetary base) has sunk to 7.5 from over 18 in mid-2008.
GDP GROWTH FORECASTS THE CLSA DIFFERENCE

Government

GDP growth

Updated: 2010:
Consensus

n.a. Dec 4.2 5.2

We are above consensus with expectations for a strong rebound in investment and consumption growth.
Inflation

Updated: 2010:
CLSA

Our robust domestic demand forecast also means we expect a sharper rise in inflation.
Interest rates & exchange rate

2010:

Hong Kong HIBOR rates will follow the monetary path set by the US Federal Reserve.

40

tony.nafte@clsa.com

Eye on Asian Economies • 1Q2010
H O N G K O N G

HONG KONG BY NUMBERS

2007
Breakdown of real GDP Private consumption Public consumption GFCF Domestic final sales Exports, goods & services Imports, goods & services Real GDP growth Prices Consumer prices (y/e) Consumer prices (average) Currency & interest rates HK$/US$ (y/e) HK$/US$ (average) 3-month HIBOR (% y/e) Prime rate (% y/e) External sector Domestic exports (US$, % YoY) Re-exports (US$, % YoY) Exports (US$, % YoY) Imports (US$, % YoY) Trade balance (US$bn) Current account balance (US$bn) - as a % of nominal GDP FDI (US$bn) Adjusted resource gap (% of GDP) International reserves (US$bn, y/e) Money supply Money supply M1 (y/e) Money supply M2 (y/e) HK$ bank lending (y/e) HK$ bank lending (% of GDP) Government sector Public sector deficit (% of GDP)¹ Fiscal reserves (HK$bn)¹ Min permitted reserves (HK$bn)¹² Nominal GDP Nominal GDP (US$bn) Nominal GDP per capita (US$) Nominal GDP (HK$bn) Nominal GDP (HK$, % YoY) Other data Industrial production Retail sales Unemployment (% y/e) Population (millions) (1.5) 13.1 3.4 6.9 207.2 29,854 1,615 9.5 (7.5) 492.9 229.4 25.4 20.8 13.9 135.2 (15.5) 10.9 9.4 10.7 (19.7) 25.5 12.3 (6.7) 9.1 152.7 7.80 7.80 3.3 6.8 3.4 1.3 8.5 3.0 3.4 6.8 8.3 9.2 6.3

2008
1.5 1.7 (0.5) 1.1 2.7 2.0 2.4 4.7 5.6 7.75 7.78 0.9 5.0 (13.2) 6.2 5.4 6.0 (23.2) 30.7 14.2 3.1 15.6 182.5 4.7 2.7 7.8 140.4 (0.1) 494.4 234.8 215.7 30,883 1,677 3.8 (6.7) 10.4 4.1 7.0

2009clsa
(0.6) 2.8 (2.6) (0.7) (10.5) (9.6) (3.0) 0.9 1.1 7.75 7.75 0.1 5.0 (26.8) (11.9) (12.5) (11.2) (25.3) 21.8 10.3 0.9 10.8 258.0 50.0 12.0 (1.1) 142.2 2.8 445.5 315.1 211.3 30,046 1,638 (2.3) n.a. (0.8) 5.1 7.0

2010clsa
5.0 3.6 9.0 5.8 14.7 13.9 5.2 5.9 4.0 7.75 7.75 0.7 5.3 4.1 16.5 16.1 15.6 (27.8) 24.2 10.4 (0.8) 10.1 318.0 37.0 13.0 10.4 143.0 2.1 403.3 325.6 232.0 32,528 1,798 9.8 n.a. 11.8 4.4 7.1

2011clsa
5.2 1.0 9.4 5.7 21.8 20.5 5.4 5.5 5.8 7.75 7.75 2.5 6.8 17.0 21.9 21.8 20.6 (29.1) 27.7 10.5 (0.9) 10.2 363.0 27.0 15.7 15.0 145.5 0.7 387.1 336.2 262.2 36,254 2,032 13.0 n.a. 15.3 3.8 7.2

Consumption will rebound with the strengthening labour market. Rising services revenues will boost investment.

China will support export growth until the US consumer recovers.

Accelerating inflation in 2010 when domestic demand firms.

HIBOR rates will follow the path set by the US Federal Reserve.

US recovery will revive global grade flows in 2011.

Credit growth has been demand restrained so credit will rebound when domestic demand firms. Fiscal stimulus will be reined in, but only in FY10/11.

Unemployment rate peaked at 5.4% in 3Q09 and will trend lower over the next two years.

Note: % YoY rates unless otherwise stated. ¹ Fiscal year starting April. ² Equals 12 months government expenditure. Source: CEIC, CLSA estimates, HK government

tony.nafte@clsa.com

41

Eye on Asian Economies • 1Q2010
H O N G K O N G

EXPORTS & IMPORTS

35

(US$bn) Re-exports Retained imports (RHS)

12

30

10

25

8

20

6

15 smoothed data are HP filters 10 02 03 04 05 06 07 08 09

4

2

How does one explain the apparent disconnect between expanding liquidity and depressed credit growth? The answer is that bank lending has not been constrained by the availability of reserve money. The constraint has been the lack of willing or suitable borrowers. However, with improving business and household sentiment and firming income and employment prospects the demand for credit will increase through 2010 and 2011. This reinforces our strong investment and consumption forecasts but also sounds a warning on accelerating inflation over the next two years.
Inflation subdued, but not for long

HKD NEER & REER

120 110 100 90 80

(Jan 00 = 100)

Annual inflation (CPI A excluding distortions) was negative in October 2009. However, the same series showed the inflation trend had already turned up with the ex distortions index rising at a 4% saar in the three months to October. As domestic demand firms and the output gap starts to close in Hong Kong, inflation will continue to accelerate. We forecast a 5ppt rise lifting inflation to 5.9% by end-2010 followed by a gradual easing to 5.5% by end-2011. Our sharply rising inflation forecast is in line with our robust capex and consumption forecasts. There are two main reasons for expecting inflation to peak in 2010 rather than to continue rising in 2011. First, we expect a relative tightening of monetary policy in China which should curb money flows from the mainland into Hong Kong assets. Second, we expect the US Federal Reserve to start hiking rates in late 2010 which will lead to rising HIBOR rates through 2011.
Renminbi business matters more than re-pegging

NEER 70 60 95 97 99 01 03 05 07 09 REER

MONETARY CONDITIONS INDEX

6.0 4.0 2.0 0.0 -2.0 -4.0 -6.0 -8.0 04

(chg from 05/2004)

05

06

07

08

09 MCI

from short rates

from NEER

Monetary tightening in China will include renminbi appreciation. Arguments for a Hong Kong re-pegging are not soundly based however. The restraining factor remains the lack of renminbi convertibility. Renminbi appreciation moreover, will be gradual (we forecast 4% in 2010 and 6% in 2011). The more important focus for Hong Kong will be the expansion of renminbi business, in particular the use of renminbi for cross border trade and project financing and hopes by the Hong Kong banks to gain Beijing’s approval for renminbi capital raising in China.
CURRENCY FORECAST

Period-end 2008
HK$/US$ HK$/Yen 100 HK$/GBP HK$/Euro Memo: US$/Euro Memo: Yen/US$ 7.75 8.55 11.32 10.77 1.39 90.6

Annual 2009clsa
7.75 8.16 12.71 11.47 1.48 95.0

Coming 12 months by quarter 2011clsa
7.75 7.05 12.79 12.01 1.55 110.0

2010clsa
7.75 7.38 12.79 12.40 1.60 105.0

1Q10clsa
7.75 7.75 12.79 12.01 1.55 100.0

2Q10clsa
7.75 7.75 12.79 12.40 1.60 100.0

3Q10clsa
7.75 7.56 12.79 12.40 1.60 102.5

4Q10clsa
7.75 7.38 12.79 12.40 1.60 105.0

42

tony.nafte@clsa.com

EoAE Forecasts
1Q10
Sharmila Whelan
sharmila.whelan@clsa.com (852) 26008352

India gets to the next upturn
We expect India to grow by 7.8% in FY10/11 and 8.4% in FY11/12. The investment led recovery is on track while consumption is holding up better than expected. We expect the RBI to raise CRR in early 2010 followed by interest rates. India story unchanged and on track

Our India story remains unchanged. Back in 2008 we argued that India was facing a sharp cyclical slowdown but that she would arrive at the next business cycle upswing by the end of 2009. This was because India is predominantly a domestic demand driven economy. Initial recovery from trough would start as profit margins improved and companies started to invest to upgrade and modernise existing capacity. The investment cycle would broaden mid-2010 onwards as companies borrowed to invest in new capacity and the government’s infrastructure program gained traction. Consumption would improve during the course of FY10/11 as companies stepped up hiring and compensation and as households started to borrow. With the twin engines of investment and consumption driving the economy, growth would accelerate further in FY11/12. This forecast is on track despite the weak monsoons. Indian GDP growth accelerated in 3Q09 to 7.9% YoY from 6% YoY and to 3.5% QoQ from 1.7% QoQ in 2Q09. Growth was led by manufacturing and by services as had been indicated by monthly industrial production data. In line with the weak monsoons, agriculture and related industries grew by a weak 0.9% YoY and contributed 0.2ppt to YoY GDP growth. On the expenditure side consumption grew by a robust 5.6% YoY and investment by 7.3% YoY, testifying to the resilience of the domestic economy. We are currently forecasting that growth will pick up from 6.3% in the current fiscal year to 7.8% in FY10/11 and 8.4% in FY11/12.
LONG-RUN HISTORY AND FORECAST SUMMARY

2003/04
Real GDP growth Domestic demand growth Nominal GDP growth Wholesale prices (y/e) Reverse repo rate (% y/e) IRs/US$ (y/e) Money supply M1 (y/e) Current account balance (US$bn) - as a % of nominal GDP 8.5 7.2 12.2 4.6 4.5 43.4 22.2 14.1 2.3

2004/05
7.5 9.4 14.3 5.1 4.8 43.8 11.9 (2.5) (0.4)

2005/06
9.5 10.8 13.9 4.1 5.5 44.6 27.6 (9.9) (1.2)

2006/07
9.7 8.6 15.1 6.7 6.0 43.6 16.9 (9.6) (1.0)

2007/08
9.0 10.7 14.4 7.7 6.0 40.0 18.8 (17.0) (1.4) 5.0

2008/09 09/10clsa 10/11clsa 11/12clsa
6.7 6.2 12.7 0.8 3.5 51.0 9.2 (29.8) (2.6) 8.3 6.3 4.5 8.5 9.5 3.5 46.0 12.8 (38.7) (3.2) 10.3 7.8 7.0 13.0 4.5 5.3 42.0 18.0 (52.0) (3.5) 7.1 8.4 8.2 15.5 5.0 6.0 38.0 22.4 (76.9) (4.1) 5.3

Public sector deficit (% of GDP) 8.9 7.4 6.6 5.3 Note: All figures % YoY growth rates, unless otherwise stated. All data refer to fiscal years starting April. Source: CMIE, Reserve Bank of India, IMF, ADB, World Bank, IIF, CEIC

sharmila.whelan@clsa.com

43

Eye on Asian Economies • 1Q2010
I N D I A

We expect some moderation in growth in 4Q09 as the weak monsoon impact feeds through more fully. Industrial production has softened as well. However this does not detract from the message that manufacturing, a reliable indicator of overall economic activity, is in recovery mode. Importantly the upturn is being led by capital, basic and intermediary goods sectors. Further CLSA’s 2QFY10 SME Pulse report showed that domestic orders had improved for 79%, up from 67%, of respondents on a QoQ basis. Companies are still cautious and major capacity expansion plans are still on hold for the next six months. This was one of the key takeaways from our country visit in November. This is normal at this stage of the recovery cycle and is in line with our timeline. Companies, however, are starting to spend on replacing/modernising existing facilities as capacity utilisation levels and cashflows improve. Business sentiment is improving quickly. Led by greater optimism about sales volumes, net profits and new orders, the Dun & Bradstreet business sentiment jumped from 132 in September to 143 in December. We expect rural incomes and spending to be hit in the current fiscal year. Encouragingly for the Indian consumer the labour market is past the worst point and companies are starting to increase hiring plans. The Manpower net employment diffusion index, rising for the second quarter, increased from 28 in 4Q09 to 39 in 1Q10. We expect consumption to strengthen over the forecast period, to grow by 5.2% in FY10/11 and 7.1% in FY11/12 even as inflation picks up and interest rates rise (more about that in the next section). Finally like elsewhere the export outlook for India has improved. We expect the competitive advantage bestowed by a strong euro to buoy Indian exports to Europe, its largest destination market, next year and for the global recovery to lift exports further in FY11/12. This, however, will be hard to spot in a conventional ‘net exports’ framework as the negative contribution from net trade to GDP growth will widen
GDP GROWTH FORECASTS THE CLSA DIFFERENCE

Government

GDP growth

Updated: 2010/11:
Consensus

n.a. Dec 7.6 7.8

Like us the consensus view is also for growth above 7%; is good news in the price?
Inflation

Updated: 2010/11:
CLSA

Inflation is and will continue to pick up very steadily from here onwards.
Interest rates & exchange rate

2010/11:

We expect CRR to rise in early 2010 and rates by end 1Q10.

44

sharmila.whelan@clsa.com

Eye on Asian Economies • 1Q2010
I N D I A

INDIA BY NUMBERS

2007/08
Breakdown of real GDP Private consumption Public consumption GFCF Domestic demand Exports, goods & services Imports, goods & services Real GDP Prices Wholesale prices (y/e) Wholesale prices (average) Currency & interest rates IRs/US$ (y/e) IRs/US$ (average) Reverse repo rate (% y/e) Prime lending rate (% y/e) External sector Exports (US$, %YoY) Imports (US$, %YoY) Trade balance (US$bn) Current account balance (US$bn) - as a % of nominal GDP FDI (US$bn) Adjusted resource gap (% of GDP) External debt (total, US$bn) Debt service ratio (% exports) International reserves (US$bn, y/e) Money supply Money supply M1 (y/e) Money supply M3 (y/e) Private sector credit (y/e) Private sector credit (% of GDP) Government sector Public sector deficit (% of GDP) Public sector debt (% of GDP, y/e) Nominal GDP Nominal GDP (US$bn) Nominal GDP per capita (US$) Nominal GDP (IRsbn) Nominal GDP (IRs, %YoY) Other data Primary industries Tertiary industries
3 3 2 1

2008/09
2.9 20.2 8.2 6.2 12.8 17.9 6.7 0.8 8.5 50.95 46.46 3.5 12.0 5.4 14.3 (119.4) (29.8) (2.6) 17.5 (1.1) 224.0 5.6 241.4 9.2 18.8 17.8 51.3 8.3 80.6 1,145.6 992.7 53,218 12.7 1.6 3.9 9.7

09/10clsa
3.6 13.9 6.4 4.5 (11.4) (23.4) 6.3 9.5 2.9 46.00 47.71 3.5 11.0 (15.9) (21.6) (83.5) (38.7) (3.2) 18.5 (1.7) 250.0 8.2 290.4 12.8 16.7 13.0 53.4 10.3 81.8 1,210.2 1,034.2 57,741 8.5 (2.0) 7.2 8.0

10/11clsa
5.2 3.1 9.7 7.0 6.1 7.3 7.8 4.5 6.2 42.00 44.00 5.3 12.3 7.8 8.9 (92.6) (52.0) (3.5) 24.0 (1.9) 275.0 11.4 339.4 18.0 19.8 23.9 58.6 7.1 78.4 1,482.9 1,249.6 65,247 13.0 2.0 8.1 9.2

11/12clsa
7.1 (3.7) 13.4 8.2 17.2 19.0 8.4 5.0 4.4 38.00 40.00 6.0 13.8 23.7 28.0 (125.4) (76.9) (4.1) 27.0 (2.6) 300.0 13.4 389.4 22.4 23.8 21.6 61.6 5.3 73.0 1,884.0 1,565.7 75,361 15.5 2.2 8.5 10.0 1,203

With the labour market improving we expect consumption to pick up. Capex and infrastructure will drive investment from mid2010 onwards.

8.5 7.4 12.9 10.7 2.1 6.9 9.0 7.7 4.6 39.97 40.13 6.0 12.5 28.9 35.2 (91.6) (17.0) (1.4) 15.4 (0.1) 223.3 5.8 299.2 18.8 20.9 23.0 49.1 5.0 80.6 1,177.0 1,034.2 47,234 14.4 4.9 8.1 10.9

Our India recovery story is a domestic led one. Inflation starts to come down in FY10/11 and FY11/12 due to base year effects and rising interest rates. Rising interest rates, strong growth and capital inflows will support a strong rupee. We expect the RBI to raise rates in the first half of 2010. We expect the current account to start widening again as import demand and commodity prices pick up.

We expect the budget deficit to narrow as the economy recovers and growth in expenditure moderates.

Secondary industries
3

Population (millions) 1,138 1,154 1,170 1,187 Note: All figures % YoY growth rates, unless otherwise stated. All data refer to fiscal years starting April. ¹ At factor cost. ² Excluding gold and SDRs. ³ Value added at constant prices. Source: CMIE, Reserve Bank of India, IMF, ADB, World Bank, IIF, CEIC

The manufacturing sector is in recovery.

sharmila.whelan@clsa.com

45

Eye on Asian Economies • 1Q2010
I N D I A

EXPORTS & IMPORTS

over the next two years as India’s domestic economy rebounds and sucks in imports faster than exports.
Inflation, interest rates and the rupee

35 30 25 20 15 10 5

(US$bn)

Exports Imports

smoothed data are HP filters 0 02 03 04 05 06 07 08 09

Inflation has picked up on the back of food prices. Monthly YoY inflation turned positive in September and on a quarterly annualised basis WPI was already running at 8.1% in October. YoY inflation is expected to accelerate from here as the high base effect falls out. November WPI was up already 4.8% on a YoY basis. We expect WPI inflation to be 9.5% at the end of March 2010. Clearly the RBI needs to address inflation sooner rather than later by reversing its super accommodative monetary policy stance. Once the domestic recovery gets underway and producer pricing power returns manufactured goods prices will start to rise faster. There is also the issue of liquidity, particularly now with capital inflows returning. Our expectation is that the RBI will raise CRR in early 2010 to take liquidity directly out of the system and will be raising rates by end 1Q10. We expect the reverse repo rate to reach 5.25% by March 2011. Finally we expect the rupee, barring some interim volatility, to strengthen from here. We are forecasting a IRs/US$ FY09/10-end rate of 46 and 42 for the end of FY10/11. The arguments supporting our strong rupee call are first, India’s improving growth fundamentals, second, our weak US$ forecast and third a widening interest rate differential between India and the US. From this it follows that we expect capital inflows to stay firm over the forecast period. Depending on how quickly inflation does or does not respond to rising interest rates, the RBI will have to continue to use sterilisation in conjunction with the CRR to manage capital inflows.

INR NEER & REER

125 120 115 110 105 100 95 90 85 80 95

(Jan 00 = 100) NEER REER

97

99

01

03

05

07

09

MONETARY CONDITIONS INDEX

6.0 5.0 4.0 3.0 2.0 1.0 0.0 -1.0 -2.0 -3.0 -4.0 04

(chg from 05/2004)

05 from short rates

06

07

08

09 MCI

from NEER

CURRENCY FORECAST

Period-end
IRs$/US$ IRs/Yen 100 IRs/GBP IRs/Euro Memo: US$/Euro Memo: Yen/US$ 50.95 51.99 71.33 66.74 1.31 98.0

Annual (Fiscal years) 2008/09 2009/10clsa 2010/11clsa 2011/12clsa
46.00 46.00 75.90 71.30 1.55 100.0 42.00 39.25 69.30 66.36 1.58 107.0 38.00 34.55 62.70 58.90 1.55 110.0

Coming 12 months by quarter 1Q10clsa
46.00 46.00 75.90 71.30 1.55 100.0

2Q10clsa
45.00 45.00 74.25 72.00 1.60 100.0

3Q10clsa
44.00 42.93 72.60 70.40 1.60 102.5

4Q10clsa
43.00 40.95 70.95 68.80 1.60 105.0

46

sharmila.whelan@clsa.com

EoAE Forecasts
1Q10
Anthony Nafte
tony.nafte@clsa.com (852) 26008320

Reaching out for 6% GDP
There are more convincing indications that infrastructure projects will be rolled out, especially in the power sector. Combined exchange rate and interest rate strategy to control inflation will limit the rise in interest rates. Large current account surplus and rising FDI inflows will drive our 6% Rp/US$ appreciation forecast for 2010. Infrastructure projects starting to move

The gradual economic upswing in 2H09, which has lifted our 2009 real GDP estimate to 4.4%, will accelerate over the next two years. Under the SBYBoediono administration, there has been a more determined effort to tackle regulatory issues aimed at facilitating infrastructure development. If the government is seen to be successful at implementing public projects, it will provide the spur for stepped up investment spending in the private sector. The boost to employment and wages will lift consumption growth. Confidence levels were up in late 2009 with indications of increased consumer spending. With both consumption and investment firing, real GDP growth will accelerate to 5.4% in 2010 and further to 6.2% in 2011. Given Indonesia’s dismal record on infrastructure implementation, cynicism is justified. Why should this time be any different? Toll road construction has advanced at a glacial rate in Indonesia, especially if compared to the frenzied pace in China. However, CLSA Jakarta’s research analyst Sarina Lesmina has delivered a favourable progress update (December 2009) on toll-roads and power plants. Specifically, the government has started to tackle regulatory issues necessary to speed up road construction. Most important will be the revision to the land acquisition law slated for 1Q10. Planned projects will more than double the total length of toll road in Indonesia although realistically, these will not be fully operational until 2012/13. Expansion of Indonesia’s power supply will progress more rapidly, the motivation being the country’s chronic power shortage. Our Jakarta team
LONG-RUN HISTORY AND FORECAST SUMMARY

2003
Real GDP growth Domestic final sales growth Nominal GDP growth Consumer prices (y/e) BI policy rate (% y/e) Rp/US$ (y/e) Money supply M1 (y/e) Current account balance (US$bn) - as a % of nominal GDP 4.8 3.6 10.5 5.6 8.3 8,465 16.6 8.1 3.5

2004
5.0 7.0 14.0 6.3 7.4 9,290 9.9 1.6 0.6 1.0

2005
5.7 5.8 20.8 17.8 12.8 9,830 10.2 0.3 0.1 0.5

2006
5.5 3.6 20.4 6.1 9.8 9,020 28.0 10.8 3.0 0.9

2007
6.3 6.0 18.3 5.5 8.0 9,419 29.7 10.5 2.4 1.3

2008 2009clsa 2010clsa 2011clsa
6.1 7.4 25.4 11.5 9.3 10,950 1.5 0.1 0.0 0.1 4.4 5.6 12.4 2.9 6.5 9,500 9.0 8.8 1.6 1.4 5.4 6.3 11.4 5.6 7.3 8,960 10.1 13.6 2.0 2.6 6.2 6.6 14.9 6.7 8.0 8,700 10.5 11.4 1.4 2.7

Public sector deficit (% of GDP) 1.7 Note: % YoY rates unless otherwise stated. Source: IMF, IFS, CEIC, CLSA estimates, Bank Indonesia

tony.nafte@clsa.com

47

Eye on Asian Economies • 1Q2010
I N D O N E S I A

estimates a required US$84bn investment in the power sector over the next nine years in order to support real GDP growth rates above 6%. For the next two years, this implies annual investment around 1.3% of GDP. Indonesia is not fiscally constrained having kept its fiscal deficit below 1.5% of GDP for the last six years. The perennial problem has been inability to implement spending, rather than excessive spending.
Link between exports and rural income

There is a temptation to downplay exports given their relatively low 30% share of GDP. However, this understates the importance of exports for overall GDP prospects. Excluding oil and gas, commodities comprise over 20% of total exports. The steep uptrend in exports in late 2009 was encouraging because of the implied boost to rural income. Rural consumption was a key contributor to the 6% plus real GDP growth rates in 2007 and 2008. After an initial bout of profit taking we expect commodity prices to strengthen gradually over the next two years providing firm support for rural income and consumption growth. Robust demand from China will keep commodity prices buoyant. China has become a key market for Indonesia, as it has for most economies in the region. The share of Indonesia’s total exports going to China in 2009 was 10%, which placed it in joint third position with the US, behind Japan (16%) and Europe (12%). China’s importance to Indonesia moreover has extended beyond being an export market to a growing source of investment capital (notably in the power sector).
Stronger rupiah implies smaller rate hike

Annual inflation was still falling in late 2009, to 2.4% in November, but has likely bottomed. There is a major inflation risk brewing in Asia as discussed in Triple-A #40, Asian inflation – stealthy approach. The risks for Indonesia are smaller because of Bank Indonesia’s prescience in allowing the rupiah to appreciate through 2009. Between March and end2009, the rupiah will have appreciated by over 20%. Even so, inflation risks cannot be shrugged off in Indonesia where price
GDP GROWTH FORECASTS THE CLSA DIFFERENCE

Government

GDP growth

Updated: 2010:
Consensus

Nov 5 – 5.5 Dec 5.4 5.4

With exports and domestic demand firming, the forecasts from government, consensus and ourselves are all in line.
Inflation

Updated: 2010:
CLSA

Like us, the government predicts inflation between 5 and 6% in 2010.
Interest rates & exchange rate

2010:

Exchange rate appreciation will limit the extent to which Bank Indonesia needs to hike rates.

48

tony.nafte@clsa.com

Eye on Asian Economies • 1Q2010
I N D O N E S I A

INDONESIA BY NUMBERS

2007
Breakdown of real GDP Private consumption Public consumption GFCF Domestic final sales Exports, goods & services Imports, goods & services Real GDP growth Prices Consumer prices (y/e) Consumer prices (average) Wholesale prices (y/e) Currency & interest rates Rp/US$ (y/e) Rp/US$ (average) BI policy rate (% y/e) Lending rate: working cap (% y/e) External sector Exports (US$, % YoY) Imports (US$, % YoY) Trade balance (US$bn) Current account balance (US$bn) - as a % of nominal GDP FDI (US$bn) Adjusted resource gap (% of GDP) External debt (total, US$bn) Debt service ratio (% exports) International reserves (US$bn, y/e) Money supply Money supply M1 (y/e) Money supply M2 (y/e) Private sector credit (y/e) Private sector credit (% of GDP) Government sector Public sector deficit (% of GDP) Public sector debt (% of GDP, y/e) Nominal GDP Nominal GDP (US$bn) Nominal GDP per capita (US$) Nominal GDP (Rptn) Nominal GDP (Rp, % YoY) Other data Industrial production Unemployment (% y/e) Population (millions) Note: % YoY rates unless otherwise stated. Source: IMF, IFS, CEIC, CLSA estimates, Bank Indonesia 4.7 9.1 225.6 430.9 1,909 3,949 18.3 1.3 35.2 29.7 19.3 27.6 25.0 14.0 15.4 32.8 10.5 2.4 2.3 3.0 136.6 19.2 56.9 9,419 9,164 8.0 13.1 5.5 5.8 21.9 5.0 3.9 9.4 6.0 8.5 9.0 6.3

2008
5.3 10.4 11.7 7.4 9.5 10.0 6.1 11.5 9.5 9.7 10,950 9,757 9.3 14.3 18.3 36.9 22.9 0.1 0.0 2.8 0.6 149.1 13.5 51.6 1.5 14.9 30.8 26.0 0.1 32.8 451.8 1,977 4,954 25.4

2009clsa
5.1 14.2 3.6 5.6 (11.3) (18.0) 4.4 2.9 4.9 3.7 9,500 10,385 6.5 12.8 (18.0) (27.0) 29.3 8.8 1.6 1.3 1.9 165.4 17.3 67.0 9.0 12.4 9.5 25.4 1.4 33.4 536.4 2,317 5,571 12.4

2010clsa
5.5 10.0 6.8 6.3 9.1 13.0 5.4 5.6 4.6 6.9 8,960 9,183 7.3 13.3 11.5 15.5 29.3 13.6 2.0 3.0 2.5 173.8 16.9 88.0 10.1 13.5 13.9 25.9 2.6 35.0 675.7 2,882 6,205 11.4

2011clsa
5.7 5.0 9.2 6.6 15.8 19.8 6.2 6.7 6.3 10.4 8,700 8,851 8.0 13.8 19.6 23.0 31.6 11.4 1.4 4.0 1.9 180.8 14.7 102.0 10.5 14.2 17.3 26.5 2.7 35.0 805.7 3,392 7,132 14.9

High commodity export revenues will boost rural income.

Infrastructure is being rolled out along with increased construction projects in the private sector. Inflation will rise rapidly as infrastructure bottlenecks raise distribution costs. Current account surplus combined with rising FDI favour rupiah appreciation.

Rate hikes would have been steeper if not for currency appreciation.

Foreign reserves will top US$100bn in 2011.

There will be pressure on the banks to reduce interest margins and expand credit.

Indonesia is not fiscally constrained, poor implementation usually keeps spending below target.

3.7 8.4 228.5

1.8 10.4 231.5

4.2 9.6 234.5

7.8 8.8 237.6

tony.nafte@clsa.com

49

Eye on Asian Economies • 1Q2010
I N D O N E S I A

EXPORTS & IMPORTS

14 12 10 8 6 4 2

(US$bn)

Exports Imports

smoothed data are HP filters 0 02 03 04 05 06 07 08 09

increases will be exacerbated by rising distribution costs due to deficient infrastructure. We expect inflation to rise 2.7ppt to 5.6% by end-2010. Bank Indonesia has employed a combined exchange rate and interest rate strategy in order to cap inflation rises. We forecast a 6% appreciation of the rupiah which implies a decisive break through the Rp9,000/US$ level. This will allow Bank Indonesia to limit interest rate hikes to 75bp in 2010, lifting the policy rate to 7.25%, with the first hike coming in 2Q10. A continued inflation rise to 6.7% by end-2011 will trigger a further 75bp hike in interest rates lifting the policy rate to 8%. A challenge for Bank Indonesia is to persuade the commercial banks to keep their lending rates down. When Bank Indonesia was cutting interest rates between November 2008 and August 2009, the banks took advantage, increasing their interest margins by 2 percentage points. There is ample room therefore, for the banks to hike by less than BI.
Policy commitment required for FDI rebound

RMB NEER & REER

350 300 250 200 150 100 50 0 95

(Jan 00 = 100)

NEER REER

97

99

01

03

05

07

09

Robust export growth and improving tourism revenues will lead to a rising current account surplus in 2010. On the capital account we expect an increase in net FDI after disappointing inflows, a little over US$1bn, in 2009. The rise in FDI will be linked to public infrastructure projects and expanding construction projects in the private sector. Combined inflows on the current and capital accounts will drive our 6% Rp/US$ appreciation forecast for 2010. In order to attract higher FDI inflows however, there will need to be an easing of regulations which presently deter foreign investment, including harmonisation of central and regional taxes on resources development. There is the risk of political interference. Political stability, contrasting with the other emerging Asean economies, has been a key strength for Indonesia. However, the opposition party showed from its actions in late 2009 that it intends to disrupt the government’s policy programme. President SBY has considerable popular support to withstand the challenge but it will require astute political and economic management in order to ensure timely implementation of policy initiatives.

MONETARY CONDITIONS INDEX

20 10 0 -10 -20 -30 -40 -50 04

(chg from 05/2004)

05 from short rates

06

07

08

09 MCI

from NEER

CURRENCY FORECAST

Period-end 2008
Rp/US$ Rp/Yen 100 Rp/GBP Rp/Euro Memo: US$/Euro Memo: Yen/US$ 10,950 12,086 15,987 15,221 1.39 90.6

Annual 2009clsa
9,500 10,000 15,580 14,060 1.48 95.0

Coming 12 months by quarter 2011clsa
8,700 7,909 14,355 13,485 1.55 110.0

2010clsa
8,960 8,533 14,784 14,336 1.60 105.0

1Q10clsa
9,300 9,300 15,345 14,415 1.55 100.0

2Q10clsa
9,150 9,150 15,098 14,640 1.60 100.0

3Q10clsa
9,050 8,829 14,933 14,480 1.60 102.5

4Q10clsa
8,960 8,533 14,784 14,336 1.60 105.0

50

tony.nafte@clsa.com

EoAE Forecasts
1Q10
Sharmila Whelan
sharmila.whelan@clsa.com (852) 26008352

Domestic resilience
We are forecasting that Korea will grow by 6.7% in 2010 and 7.2% in 2011. Exports are growing but more pertinently the private sector is recovering nicely. Inflation remains weak meaning the earliest BoK will raise rates is end 1Q/2Q10. 3Q09 GDP indicates domestic resilience

In line with our expectations Korea posted another strong quarter of growth in 3Q09, expanding by 2.9% QoQ, slightly ahead of our forecast of 2.6% QoQ. The upside surprises to growth came from consumption spending and investment in facilities. Real consumption grew by 1.4% QoQ in 3Q09 after 3.7% QoQ. This was a good number as we were expecting spending to slump in the quarter following the expiry of the first car incentive scheme in June. Meanwhile capex, rising for the second quarter, grew by a robust 8.9% QoQ after 10% QoQ in 2Q09. The key message from 3Q09 GDP was that the private domestic economy is exhibiting more resilience than previously thought. This is important because exports have slowed in recent months and government spending is running out of steam. Export volumes rose by 4.4% QoQ in 3Q09 after rising at a breakneck pace of 11% QoQ in 2Q09. Government consumption, following the front loading of its fiscal stimulus spending program in 1H09, fell 0.8% QoQ in 3Q09. We do expect GDP growth to slow in the final quarter of the year; high frequency monthly retail volume sales numbers were already weakening towards the end of 3Q09. As for exports they are rising but growth has moderated. So for instance exports in 4Q09 to November have risen on average by 4% QoQ, compared with 6% in 3Q09 and 10% in 2Q09. Despite this we now expect the Korean economy to grow slightly, by 0.2% in 2009 against our previous forecast of a 0.3% QoQ contraction.
LONG-RUN HISTORY AND FORECAST SUMMARY

2003
Real GDP growth Domestic final sales growth Nominal GDP growth Consumer prices (y/e) Call rate (% y/e) W/US$ (y/e) Money supply M1 (y/e) Current account balance (US$bn) - as a % of nominal GDP Federal deficit (% of GDP) Note: % YoY rates unless otherwise stated. Source: IMF, World Bank, Bank of Korea, CEIC 2.8 1.8 6.5 3.4 3.8 1,181 5.3 11.9 1.9 (1.0)

2004
4.6 1.3 7.8 3.0 3.3 1,095 7.1 28.2 3.9 (0.6)

2005
4.0 3.7 4.6 2.6 3.8 1,037 2.4 15.0 1.8 (0.4)

2006
5.2 4.6 5.0 2.1 4.5 939 10.7 5.4 0.6 (0.4)

2007
5.1 4.9 7.3 3.6 5.0 921 (14.1) 5.9 0.6 (3.5)

2008 2009clsa 2010clsa 2011clsa
2.2 0.6 5.0 4.1 3.0 1,364 4.4 (6.4) (0.7) (1.2) 0.2 0.5 2.6 2.3 2.0 1,150 20.0 39.9 4.8 0.8 6.7 3.2 8.7 3.4 3.0 950 22.7 58.0 5.0 (1.2) 7.2 4.3 10.9 4.5 4.8 925 25.6 52.6 3.9 (3.7)

sharmila.whelan@clsa.com

51

Eye on Asian Economies • 1Q2010
K O R E A

Twin engines to lead in 2010 and 2011

Turning to 2010 and 2011 the prognosis is positive. We expect Korea to grow by 6.7% in 2010 (an upgrade in our forecast from one quarter ago), and 7.2% in 2011. We expect growth in 2010 and in 2011 to be domestic demand led but for the contribution of net trade to increase in 2011 as the global economy recovers boosting Korean exports. But turning to the domestic economy, the resilience of which is behind our above consensus GDP growth forecasts. We expect Korean consumption to grow by 3.9% in 2010, even after incorporating some weakening of household spending in 1Q10 following the expiry of the second car incentive scheme in December. Not only is the household sector benefiting from the rise in overtime and take home pay as manufacturing revives but now companies are re-hiring. Since June almost 300k new jobs have been created. Consequently unemployment fell from 3.9% to 3.4% in October. We expect improving labour market conditions to combine with rising consumer sentiment to support a steady acceleration in consumption spending. Export growth after driving the rebound in economic activity since 2Q09 has softened of late. This is likely to prove temporary for a couple of reasons. First, as we note in the Viewpoint section, we expect Chinese consumption and private investment spending to strengthen. This will drive demand for Asian exports, particularly those of consumer goods oriented NE Asian countries like Korea and Taiwan. Second, even though we are bearish about Euroland growth next year, the competitive boost of a strong euro will continue to support Asian exports to the region. Third, we expect that Asian exports will accelerate further in 2011 as the world economy, led by the US, recovers. The outlook for investment spending is also positive. With the domestic economy gaining traction and exports growing, we expect investment spending to strengthen over the forecast period. It is worth noting that industrial production growth has moderated, in line with exports, from
GDP GROWTH FORECASTS THE CLSA DIFFERENCE

Government

GDP growth

Updated: 2010:
Consensus

Nov 5.0 Dec 4.5 6.7

We are above consensus and government forecasts for GDP growth in 2010 and are bullish about 2011.
Inflation

Updated: 2010:
CLSA

Inflation is picking up from low levels but expect it to accelerate in 2010.
Interest rates & exchange rate

2010:

Despite being a hawk the BoK is likely to raise rates in 1Q10 at the earliest, more likely 2Q10.

52

sharmila.whelan@clsa.com

Eye on Asian Economies • 1Q2010
K O R E A

KOREA BY NUMBERS

2007
Breakdown of real GDP Private consumption Public consumption GFCF Domestic final sales Exports, goods & services Imports, goods & services Real GDP growth Prices Consumer prices (y/e) Consumer prices (average) Producer prices (y/e) Currency & interest rates W/US$ (y/e) W/US$ (average) Call rate (% y/e) Average lending rate (% y/e) External sector Exports (US$, % YoY) Imports (US$, % YoY) Trade balance (US$bn) Current account balance (US$bn) - as a % of nominal GDP FDI (US$bn) Adjusted resource gap (% of GDP) External debt (total, US$bn) Debt service ratio (% exports) International reserves (US$bn, y/e) Money supply Money supply M1 (y/e) Money supply M2 (y/e) Private sector credit (y/e) Private sector credit (% of GDP) Government sector Federal deficit (% of GDP) Federal debt (% of GDP, y/e) Nominal GDP Nominal GDP (US$bn) Nominal GDP per capita (US$) Nominal GDP (Wtn) Nominal GDP (W, % YoY) Other data Industrial production Retail sales Unemployment (% y/e) Population (millions) Note: % YoY rates unless otherwise stated. Source: IMF, World Bank, Bank of Korea, CEIC 7.0 5.1 3.1 48.5 1050.6 21,681 975.0 7.3 (3.5) 29.7 (14.1) 11.3 14.3 119.2 14.2 15.4 28.2 5.9 0.6 (13.8) (0.8) 383.2 n.a. 262.2 921 928 5.0 7.1 3.6 2.5 3.6 5.1 5.4 4.3 4.9 12.6 11.7 5.1

2008
0.9 4.2 (1.6) 0.6 5.7 3.7 2.2 4.1 4.7 5.6 1,364 1,107 3.0 6.9 14.3 21.8 6.0 (6.4) (0.7) (10.6) (1.8) 380.5 n.a. 201.2 4.4 11.9 15.8 131.4 (1.2) 27.1 925.2 19,034 1023.9 5.0

2009clsa
0.4 5.5 (2.1) 0.5 0.1 (7.6) 0.2 2.3 2.6 (2.3) 1,150 1,273 2.0 5.8 (17.3) (25.8) 41.3 39.9 4.8 (3.3) 4.4 n.a. n.a. 275.2 20.0 10.6 4.9 134.4 0.8 29.3 825.6 16,931 1,050.6 2.6

2010clsa
3.9 0.2 3.4 3.2 18.1 17.6 6.7 3.4 2.0 1.3 950 993 3.0 6.3 20.9 19.7 54.0 58.0 5.0 0.8 5.1 n.a. n.a. 342.2 22.7 12.5 9.8 135.7 (1.2) 29.8 1,150.8 23,530 1,142.2 8.7

2011clsa
4.8 (0.6) 6.0 4.3 23.0 21.5 7.2 4.5 3.7 3.0 925 929 4.8 7.5 30.6 36.1 49.9 52.6 3.9 0.4 3.9 n.a. n.a. 397.2 25.6 16.4 14.7 140.5 (3.7) 28.4 1,363.3 27,792 1,266.2 10.9

Consumption will be underpinned by improving labour market conditions.

2010 and 2011 will be years of fiscal consolidation. We expect exports to strengthen as China grows and the global economy recovers. We are forecasting a strong rebound. We expect inflation to rise but from low levels.

We expect the won to appreciate further underpinned by rising interest rates, healthy growth fundamentals and capital inflows.

We expect the government to start reining back spending next year.

3.0 0.8 3.3 48.6

(1.0) 1.8 3.2 48.8

11.1 6.0 3.0 48.9

13.5 8.5 2.8 49.1

Unemployment is already declining.

sharmila.whelan@clsa.com

53

Eye on Asian Economies • 1Q2010
K O R E A

EXPORTS & IMPORTS

45 40 35 30 25 20 15 10 02

(US$bn)

Exports Imports

the unsustainably high rates of 2Q09 and was in October was growing by 17.5% QoQ and 4.2% YoY. However the manufacturing operating rate has risen steadily from 77 in January to reach 97 in October, business sentiment remains high and the inventory to shipments ratio continues to fall.
Inflation, interest rates and the won

smoothed data are HP filters 03 04 05 06 07 08 09

KRW NEER & REER

140 130 120 110 100 90 80 70 60 95

(Jan 00 = 100)

We see no near term respite for the won despite on-going intervention. The current account has accounted for the bulk of reserve accumulation this year but capital inflows are increasingly the driver as foreign monies flow into undervalued Korean assets, mainly equities. While Korean won assets remain cheap we see capital inflows persisting and the won continuing to strengthen. Capital inflows will begin to slow as the won moves through W1,000/US$1 as, at these exchange rates, the competitive advantage of Korean exporters will no longer be as compelling. However Korea’s large current account surplus will maintain upward pressure on the currency. We are forecasting year-end rates of W950/US$1 for 2010 and W925/US$1 in 2011. As for interest rates they will rise but it is difficult to see rates rising before 2Q10. Not only does the strength of the won argue against an early hike but inflation remains low. Headline inflation is running at 2% YoY and core at 2.7% YoY. We do expect inflation to pick up; it is already doing so on a quarterly annualised rate. However inflation is rising from low levels; we are forecasting inflation will be running at 3.4% at the end of next year. Given this we expect the Bank of Korea to raise rates only gradually, despite its habitual hawkishness. We are forecasting rates will increase by 75bp in 2010, in increments of 25bp but more aggressively in 2011, by 175bp in total, as growth strengthens, inflation concerns grow and the pace of won appreciation decelerates.

NEER REER 97 99 01 03 05 07 09

MONETARY CONDITIONS INDEX

15 10 5 0 -5 -10 -15 04

(chg from 05/2004)

05 06 from short rates

07 08 from NEER

09 MCI

CURRENCY FORECAST

Period-end 2008
W/US$ W/Yen 100 W/GBP W/Euro Memo: US$/Euro Memo: Yen/US$ 1,364 1,506 1,991 1,896 1.39 90.6

Annual 2009clsa
1,150 1,211 1,886 1,702 1.48 95.0

Coming 12 months by quarter 2011clsa
925 841 1,526 1,434 1.55 110.0

2010clsa
950 905 1,568 1,520 1.60 105.0

1Q10clsa
1,050 1,050 1,733 1,628 1.55 100.0

2Q10clsa
1,000 1,000 1,650 1,600 1.60 100.0

3Q10clsa
970 946 1,601 1,552 1.60 102.5

4Q10clsa
950 905 1,568 1,520 1.60 105.0

54

sharmila.whelan@clsa.com

EoAE Forecasts
1Q10
Anthony Nafte
tony.nafte@clsa.com (852) 26008320

Not Asia’s favourite market
Export rebound and public investment spending will lift real GDP growth to 5.3% in 2010 and 4.9% in 2011. Export manufacturing rebound will boost employment and wage growth, commodities will boost rural income. Negative net FDI: Low foreign investment and preference of private sector companies to invest outside Malaysia. Manufacturing spur for jobs and wages

The recovery momentum has been sustained with accelerating exports and industrial production growth going into 4Q09. With an export to GDP ratio of over 100%, export manufacturing is a major driver of economic growth in Malaysia. Electronics have a dominant 40% share of total exports. Thus, the rebound in electronics output will have positive spill over for the rest of the economy through increased employment and rising wage income in the manufacturing sector. The outlook is not entirely blue skies though. The electronics sector faces uncertain demand in 1H10 with US consumer demand unlikely to strengthen convincingly before late 2010. That said, Asian exporters will continue to be shielded by robust demand from China. This is as true for Malaysia as for the rest of the region. China has expanded to become Malaysia’s second biggest export market with a 12% share, behind Singapore with a 14% share, but ahead of the US and EU with an 11% share each and Japan with a 10% share. Malaysian export growth to China turned positive YoY in September which spurred the overall export acceleration going into 4Q09. Oil and commodities have also been prominent in the export surge to China. With oil and gas, palm oil and rubber comprising 23% of total exports, rising oil and commodity prices will lead to substantial gains on Malaysia’s terms of trade. Buoyant commodity export revenues will lift rural income providing an added spur to consumption prospects. We have factored in a 25% increase in the average global oil price for 2010 and a further 7% increase in 2011.
LONG-RUN HISTORY AND FORECAST SUMMARY

2003
Real GDP growth Domestic final sales growth Nominal GDP growth Consumer prices (y/e) Overnight policy rate (% y/e) RM/US$ (y/e) Money supply M1 (y/e) Current account balance (US$bn) - as a % of nominal GDP 5.8 6.6 9.3 1.2 n.a. 3.80 14.4 13.3 12.1

2004
6.8 7.7 13.2 2.2 2.7 3.80 11.8 15.1 12.1

2005
5.3 7.6 10.2 3.3 3.0 3.78 8.5 20.7 15.0

2006
5.8 6.7 10.0 3.1 3.5 3.55 13.7 26.2 16.7 3.5

2007
6.2 9.6 11.4 2.4 3.5 3.33 19.6 29.2 15.7 3.7

2008 2009clsa 2010clsa 2011clsa
4.6 6.8 15.5 4.4 3.3 3.55 8.3 38.9 17.6 4.9 (2.3) (0.2) (11.3) 0.7 2.0 3.40 10.8 33.0 17.8 7.6 5.3 4.8 9.3 4.2 2.8 3.30 11.5 40.7 19.0 5.0 4.9 4.8 9.9 5.2 4.3 3.22 12.0 39.8 16.5 4.2

General gov’t deficit (% of GDP) 5.2 4.4 4.2 Note: % YoY rates unless otherwise stated. Source: CEIC, Bank Negara Malaysia, IMF, Datastream, Bloomberg, CLSA estimates

tony.nafte@clsa.com

55

Eye on Asian Economies • 1Q2010
M A L A Y S I A

Public infrastructure and development will provide the major impetus for investment growth. Along with robust export growth, this will lift 2010 real GDP growth to 5.3%, on our forecast. Strong GDP growth will mean keeping the fiscal deficit above 5% of GDP despite rising tax revenues. Generous tax and other incentives in the Iskandar Development zone could spur private investment growth in 2011. In perspective though, the share of private investment is unlikely to rise substantially above the latest 12% of GDP estimate. Exports will remain the key driver with the assumption of a strong rebound in US electronics demand behind our 4.9% real GDP forecast for 2011.
Rising interest rates, more rapid in 2011

Employment in the manufacturing sector has been rising gradually but was still 5% below year ago levels in October 2009. Encouragingly though, manufacturing wage growth turned positive rising by 2% YoY in October. We expect a stronger pick up in employment and wage growth in 2010 although this may only come through convincingly in the second half of the year. This will be favourable in terms of firming household demand but will also have the negative effect of reinforcing inflation. Like elsewhere in Asia, mercantilist policy bias towards maintaining export competitiveness by keeping the currency cheap has fueled inflation risks. Price increases are being accommodated by expansionary monetary conditions. As firming domestic demand removes the slack from the economy, inflation will accelerate. But with loose monetary conditions persisting too long, we forecast a 3.5ppt increase in inflation to 4.2% by end-2010 and a further 1ppt increase to 5.2% by end-2011. Bank Negara may be slow to react to inflation while doubts on global demand persist. We expect the first hike to be delayed until July and forecast only a 75bp hike in rates in 2010. In 2011, as the pace of inflation quickens we forecast a more aggressive 150bp tightening lifting the policy rate to 4.25% by year-end. With the commercial banks’ base lending rate rising to 7.75%, the rising cost of capital will be a partial constraint on private sector demand, capping 2011 real GDP growth below 5%.
GDP GROWTH FORECASTS THE CLSA DIFFERENCE

Government

GDP growth

Updated: 2010:
Consensus

Nov 2.0-3.0 Dec 4.4 5.3

Prime Minister Najib has been talking about 4.5-5.0% GDP prospects for 2010, higher than the official forecast.
Inflation

Updated: 2010:
CLSA

Bank Negara has started to fall behind the curve with inflation pressures building rapidly.
Interest rates & exchange rate

2010:

Rapidly rising inflation will force Bank Negara to tighten more aggressively in 2011.

56

tony.nafte@clsa.com

Eye on Asian Economies • 1Q2010
M A L A Y S I A

MALAYSIA BY NUMBERS

2007 Breakdown of real GDP
Private consumption Public consumption GFCF Domestic final sales Exports, goods & services Imports, goods & services Real GDP growth 10.4 6.5 9.6 9.6 4.5 6.0 6.2 2.4 2.0 10.8 3.33 3.44 3.5 6.7 9.6 12.8 37.2 29.2 15.7 (2.7) 14.3 56.2 4.4 101.3 19.6 9.5 8.6 100.8 3.7 41.7 186.3 6,857 639.8 11.4

2008
8.5 10.9 0.8 6.8 1.3 1.9 4.6 4.4 5.4 (3.4) 3.55 3.33 3.3 6.5 13.3 6.7 51.3 38.9 17.6 (7.8) 14.0 66.5 3.1 91.5 8.3 11.9 12.8 98.4 4.9 41.5 222.1 8,008 738.7 15.5

2009clsa
1.5 4.6 (6.9) (0.2) (12.1) (14.1) (2.3) 0.7 0.6 (2.5) 3.40 3.54 2.0 5.5 (21.6) (21.6) 40.3 33.0 17.8 (5.2) 15.0 72.0 5.3 99.0 10.8 9.1 7.6 119.4 7.6 54.8 185.3 6,544 655.5 (11.3)

2010clsa
4.2 6.9 5.0 4.8 9.2 9.5 5.3 4.2 3.2 3.8 3.30 3.35 2.8 6.3 13.2 11.9 47.1 40.7 19.0 (3.0) 17.6 78.0 5.2 118.0 11.5 9.7 9.2 119.2 5.0 55.6 214.1 7,407 716.5 9.3

2011clsa
4.0 2.0 8.7 4.8 16.3 18.1 4.9 5.2 4.7 7.6 3.22 3.26 4.3 7.8 18.3 21.8 51.3 39.8 16.5 (3.5) 15.0 80.0 4.8 133.0 12.0 12.4 10.9 120.3 4.2 55.2 241.5 8,182 787.5 9.9

Manufacturing wages rising while commodities boost rural income. Public sector will be the key investment driver, private capex up gradually in 2011.

Prices
Consumer prices (y/e) Consumer prices (average) Producer prices (y/e)

Exports will be the growth driver from mid-2010.

Currency & interest rates
RM/US$ (y/e) RM/US$ (average) Overnight policy rate (% y/e) Base lending rate (% y/e)

Rapidly rising inflation as Bank Negara falls behind the curve.

External sector
Exports (US$, % YoY) Imports (US$, % YoY) Trade balance (US$bn) Current account balance (US$bn) - as a % of nominal GDP FDI (US$bn) Adjusted resource gap (% of GDP) External debt (total, US$bn) Debt service ratio (% exports) International reserves (US$bn, y/e)

More aggressive tightening in 2011.

US recovery will spur electronics exports in 2011.

Current account will support the ringgit.

Money supply
Money supply M1 (y/e) Money supply M3 (y/e) Private sector credit (y/e) Private sector credit (% of GDP)

Negative FDI highlights policy failures.

Government sector
General gov’t deficit (% of GDP) General gov’t debt (% of GDP, y/e)

Rising interest rates will cap credit growth in 2011.

Nominal GDP
Nominal GDP (US$bn) Nominal GDP per capita (US$) Nominal GDP (RMbn) Nominal GDP (RM, % YoY)

Public debt will be approaching the 60% of GDP danger level.

Other data
Industrial production Unemployment (% y/e) Population (millions) 2.3 3.0 27.2 0.7 3.1 27.7 (7.4) 3.7 28.3 10.6 3.2 28.9 13.0 2.7 29.5

Note: % YoY rates unless otherwise stated. Source: CEIC, Bank Negara Malaysia, IMF, Datastream, Bloomberg, CLSA estimates

tony.nafte@clsa.com

57

Eye on Asian Economies • 1Q2010
M A L A Y S I A

EXPORTS & IMPORTS

Current account support for the ringgit

20 18 16 14 12 10 8 6 4 02

(US$bn)

Exports Imports

smoothed data are HP filters 03 04 05 06 07 08 09

The ringgit will be underpinned by the huge current account surplus which we forecast at 19% of GDP in 2010. Buoyant export growth and the rebound in tourism revenues (equivalent to a substantial 7% of GDP) will contribute to the large current account surplus. Even with offsetting outflows such as outward FDI and worker remittances, there will be overall balance of payments support for a gradually appreciating ringgit. We forecast a 3% appreciation to RM3.3/US$ by end-2010 and a further 2.5% to RM3.22/US$ by end-2011. In the first three quarters of 2009, cumulative FDI inflows of only US$2bn were overwhelmed by FDI outflows of US$6.2bn. This highlights a dual policy failure, inability to attract foreign investment and the preference of Malaysian private sector companies to invest outside of Malaysia. The government’s initiatives, including reduced restrictions on foreign investment in the services sector and dilution of the Bumiputera requirement, have not gone far enough. The priority remains to substantially increase the share of private investment but this will require a major policy readjustment.
Another corruption scandal

MYR NEER & REER

150 140 130 120 110 100 90 80 95

(Jan 00 = 100) NEER REER

97

99

01

03

05

07

09

MONETARY CONDITIONS INDEX

5.0 4.0 3.0 2.0 1.0 0.0 -1.0 -2.0 -3.0 -4.0 04

(chg from 05/2004)

As an open economy, volatile capital flows are a constant concern for Bank Negara. It is notable that while the monthly trade surplus has recently expanded above US$3bn, foreign reserves increased by a marginal US$0.2bn over the two months to November. Government efforts to boost foreign investment were set back by the latest corruption scandal which revealed conflicting political and business interests in the Port Klang Free Trade Zone. A cost overrun of near seven times initial estimate to US$3.7bn and the government having to honour bonds sold with a fake government guarantee is the latest fiasco resulting from excessive public sector involvement in the Malaysian economy. Strong GDP prospects are reassuring but extensive policy reform will be needed to entice investors back into the Malaysian market.

05 06 from short rates

07 08 from NEER

09 MCI

CURRENCY FORECAST

Period-end 2008
RM/US$ RM/Yen 100 RM/GBP RM/Euro Memo: US$/Euro Memo: Yen/US$ 3.55 3.92 5.19 4.94 1.39 90.6

Annual 2009clsa
3.40 3.58 5.58 5.03 1.48 95.0

Coming 12 months by quarter 2011clsa
3.22 2.93 5.31 4.99 1.55 110.0

2010clsa
3.30 3.14 5.45 5.28 1.60 105.0

1Q10clsa
3.37 3.37 5.56 5.22 1.55 100.0

2Q10clsa
3.34 3.34 5.51 5.34 1.60 100.0

3Q10clsa
3.32 3.24 5.48 5.31 1.60 102.5

4Q10clsa
3.30 3.14 5.45 5.28 1.60 105.0

58

tony.nafte@clsa.com

EoAE Forecasts
1Q10
Sharmila Whelan
sharmila.whelan@clsa.com (852) 26008352

A disappointing year, but a better 2010
3Q09 GDP missed our forecast by a wide margin and takes our 2009 GDP estimate down to 0.8% from 1.7%. However we expect 5.3% growth in 2010 and 6.7% in 2011 on the back of an improved outlook for exports and resilient remittance inflows. The budget deficit and inflation bear close watch though. 3Q09 GDP falls short

While for most of our Asian countries 3Q09 GDP has either been in line with or surpassed our bullish forecasts, growth in the Philippines fell short. Not only did third quarter GDP growth come in at a relatively muted 1% QoQ but 2Q09 was revised down from 2.4% QoQ to 1.7% QoQ. Incorporating these revisions and even allowing for a boost from re-construction in 4Q09 following the tropical storms at the end of September, this leaves our estimate for 2009 growth at 0.8% compared with 1.7% three months previously. However while 3Q09 GDP was disappointing all is not lost as the quality of growth was a bit better than the headline would suggest. Consumption growth after being revised up to 4.9% QoQ in 2Q09, the fastest on record, slowed to 0.2% QoQ but did not contract. Investment spending grew by a robust 2.9% QoQ after 4.8% QoQ in 2Q09. Exports slowed in the quarter as was expected after the pace of expansion seen in 2Q09 which was boosted by the global inventory restocking cycle. However the slowdown in exports from 5.2% QoQ to 1.2% QoQ in 3Q09 was more modest than seen in for instance either Korea or Taiwan the other two electronics exporters. Having said that Philippine exports were slowing from a lower base compared with both Korea and Taiwan where exports have recovered much faster by virtue of them being more closely geared into the China market. Increased spending due to reconstruction and replacement following the September floods should combine with accelerated disbursement of the government’s stimulus package to lift growth in the final quarter of the year.
LONG-RUN HISTORY AND FORECAST SUMMARY

2003
Real GDP growth Domestic final sales growth Nominal GDP growth Consumer prices (y/e) 91-day T-bill rate (% y/e) P/US$ (y/e) Money supply M1 (y/e) Current account balance (US$bn) - as a % of nominal GDP 4.9 4.8 8.9 3.2 6.8 55.53 8.6 0.3 0.4

2004
6.4 4.7 12.9 8.6 6.8 56.28 9.9 1.6 1.9

2005
5.0 2.5 11.8 6.7 7.5 54.04 11.4 2.0 2.0

2006
5.3 5.5 10.8 4.3 7.5 49.57 18.7 5.3 4.5 1.1

2007
7.1 6.7 10.2 3.9 5.5 42.72 18.3 7.1 4.8 0.2

2008 2009clsa 2010clsa 2011clsa
3.8 4.3 11.7 8.0 5.9 48.37 20.1 3.9 2.4 0.9 0.8 2.9 2.5 3.0 4.0 47.00 20.0 8.5 5.3 4.5 5.3 4.3 8.2 6.7 5.3 46.00 23.3 9.0 5.1 5.4 6.7 4.9 10.0 7.4 6.8 45.00 27.4 7.6 3.8 5.2

Public sector deficit (% of GDP) 4.9 4.0 2.7 Note: % YoY rates unless otherwise stated. Source: IMF, IFS, CEIC, CLSA estimates, National Statistical Coordination Board, Philippines

sharmila.whelan@clsa.com

59

Eye on Asian Economies • 1Q2010
P H I L I P P I N E S

A better 2010 and a much better 2011

In line with the rest of the region we expect the Philippines to have a much better 2010 and stronger still 2011 as the global economy recovers boosting further both exports and remittance inflows. In 2010 we expect the Philippines to grow by 5.3% and by 6.7% the year after. In the Philippines favour is the continued resilience of remittance inflows. As we have noted before in this down cycle remittance inflows have held up remarkably well. Remittances in October were growing by 11% QoQ and were up 4.5% YoY in the first nine months of the year, despite the tremendous squeeze in OECD household discretionary spending this year. By comparison during the dotcom bust Philippine remittance inflows fell 0.5% in 2001. There is some concern about what Dubai’s fallout means for remittances; an estimated 25% of 600k Filipino workers deployed in the ME are employed in the UAE. We are not unduly concerned. Filipino workers have already shifted increasingly away from the construction industry towards service sectors like healthcare, hotels and professions such as accountancy and finance. Further we expect the contagion from Dubai to the rest of the region to be limited. Meanwhile back at home consumer expectations for the next 12 months continue to improve rapidly in line with the revival in manufacturing activity. This combined with high levels of government spending next year, an election year, bodes well for consumption spending overall. Like elsewhere in Asia, Philippines industrial production has rebounded but it is worth noting that, in line with the regional trend, output growth is moderating from the exceptional pace of 2Q09. Nonetheless capacity utilisation rates continue to improve as exports grow and domestic consumption spending firms. Given this we expect investment spending, with an additional kick from government infrastructure spending, to accelerate next year and the year after. A final word on exports; 2010 will be a better year for Philippine exporters, however given that performance to date has lagged the region and by virtue of
GDP GROWTH FORECASTS THE CLSA DIFFERENCE

Government

Updated: 2010:
Consensus

Sep 4.0 Dec 3.7 5.3

GDP growth

We are above consensus for 2010 growth and expect a further acceleration in 2011.
Inflation

Updated: 2010:
CLSA

Inflation is rising and will pick up sharply in 2010.
Interest rates & exchange rate

2010:

We expect the Bangko Sentral to raise rates by 125bp in 2010 and a further 150bp in 2011.

60

sharmila.whelan@clsa.com

Eye on Asian Economies • 1Q2010
P H I L I P P I N E S

PHILIPPINES BY NUMBERS

2007
Breakdown of real GDP Private consumption Public consumption GFCF Domestic final sales Exports, goods & services Imports, goods & services Real GDP growth Prices Consumer prices (y/e) Consumer prices (average) Producer prices (y/e) Currency & interest rates P/US$ (y/e) P/US$ (average) Overnight repo rate (% y/e) Prime lending rate (%y/e) External sector Exports (US$, % YoY) Imports (US$, % YoY) Trade balance (US$bn) Current account balance (US$bn) - as a % of nominal GDP FDI (US$bn) Adjusted resource gap (% of GDP) External debt (total, US$bn) Debt service ratio (% exports) International reserves (US$bn, y/e) Money supply Money supply M1 (y/e) Money supply M3 (y/e) Private sector credit (y/e) Private sector credit (% of GDP) Government sector Public sector deficit (% of GDP) Public debt (% of GDP, y/e) Nominal GDP Nominal GDP (US$bn) Nominal GDP per capita (US$) Nominal GDP (Pbn) Nominal GDP (P, % YoY) Other data Industrial production Unemployment (% y/e) Population (millions) 6.8 7.4 88.7 146.9 1,655 6,647 10.2 0.2 71.8 18.3 10.4 3.3 31.5 6.4 8.7 (8.4) 7.1 4.8 (0.6) 4.4 54.9 15.2 33.8 42.72 45.26 5.5 9.1 3.9 2.8 (3.0) 5.8 6.6 10.9 6.7 5.4 (4.1) 7.1

2008
4.7 3.2 2.9 4.3 (1.9) 2.4 3.8 8.0 9.3 7.3 48.37 45.26 5.9 9.3 (2.5) 5.6 (12.9) 3.9 2.4 1.3 3.2 53.9 15.0 37.6 20.1 14.8 16.6 32.9 0.9 63.7 164.0 1,813 7,423 11.7 5.0 7.7 90.5

2009clsa
3.5 8.2 (1.5) 2.9 (12.7) (5.9) 0.8 3.0 3.0 (3.4) 47.00 47.98 4.0 8.5 (24.2) (31.0) (5.6) 8.5 5.3 0.3 5.5 51.0 15.5 46.0 20.0 13.1 3.0 33.1 4.5 66.6 158.6 1,717 7,609 2.5 (2.9) 7.8 92.4

2010clsa
3.9 8.1 4.3 4.3 10.1 9.3 5.3 6.7 4.7 3.8 46.00 46.50 5.3 9.0 12.7 14.2 (7.0) 9.0 5.1 0.7 5.4 52.0 16.0 57.0 23.3 16.9 6.6 32.6 5.4 66.9 177.0 1,879 8,233 8.2 7.0 7.5 94.2

2011clsa
5.6 (5.2) 5.7 4.9 20.7 19.1 6.7 7.4 7.0 5.1 45.00 45.50 6.8 9.8 23.1 25.5 (9.8) 7.6 3.8 0.7 4.2 53.0 16.5 66.0 27.4 22.6 14.0 33.8 5.2 66.0 199.0 2,071 9,056 10.0 10.3 6.8 96.1

Robust remittances and improving sentiment will support spending.

Philippines exports will lag the region.

Inflation is set to pick up sharply.

We expect interest rates to rise by 125bp in 2010 and by 150bp in 2011.

We expect the current account surplus to narrow again in 2011 as import demand picks up and terms of trade deteriorate.

Rising government spending will be accompanied by a widening budget deficit.

Note: % YoY rates unless otherwise stated. Source: IMF, IFS, CEIC, CLSA estimates, National Statistical Coordination Board, Philippines

sharmila.whelan@clsa.com

61

Eye on Asian Economies • 1Q2010
P H I L I P P I N E S

EXPORTS & IMPORTS

6

(US$bn) Exports

the fact that the Philippines is more geared into the US than China, the rebound we are forecasting is more gradual compared with regional peers and in particular NE Asia.
Fiscal concerns, inflation and interest rates

5

Imports

4

3 smoothed data are HP filters 2 02 03 04 05 06 07 08 09

PHP NEER & REER

160

(Jan 00 = 100) NEER REER

Government finances are deteriorating fast; in October the budget deficit breached our previous target by jumping to Peso 266bn. With revenues down 7% YoY in October and spending up 13% YoY, the outlook is not good. Thanks to individual tax exemptions, lower corporate taxes and slower economic growth, the Philippines Bureau of Internal Revenue, expects revenue targets to be missed again in the last two months of the year. We now expect the 2009 budget deficit to be 4.5% of GDP, against previous forecast of 3.4%. In 2010 cyclical tax revenues should recover as the economy grows but it is difficult to see much reining in of spending particularly as the Arroyo government faces re-election. The upshot is that we expect the budget deficit to widen to 5.4%. On the back of food prices headline inflation jumped in November to 2.9% YoY from 1.7% YoY. While the pick up in food prices is largely attributable to temporary supply side disruptions following the tropical storms at the end of September, price pressures are growing. Core inflation for instance has been rising for the last two months and was running at 3.9% QoQ in November. Our expectation is that with global commodity prices picking up and domestic demand recovering inflation will continue to increase: we are forecasting 6.7% for end2010 and 7.4% end-2011. This will force the central bank to start normalising interest rates sooner rather than later. Thus we expect the Bangko Sentral to raise rates by 125bp next year and by a further 150bp in 2011. With interest rates rising and economic fundamentals strengthening this point to a stronger peso and this is what we have in our forecasts. However, we also believe that the Philippines’ deteriorating fiscal position will temper gains. This leaves us forecasting a 2010 year-end P/US$ rate of 46 and 45 for end-2011.

140

120

100

80

60 95 97 99 01 03 05 07 09

MONETARY CONDITIONS INDEX

20 15 10 5 0 -5 -10 04

(chg from 05/2004)

05 06 from short rates

07 08 from NEER

09 MCI

CURRENCY FORECAST

Period-end 2008
P/US$ P/Yen 100 P/GBP P/Euro Memo: US$/Euro Memo: Yen/US$ 48.37 53.39 70.62 67.23 1.39 90.6

Annual 2009clsa
47.00 49.47 77.08 69.56 1.48 95.0

Coming 12 months by quarter 2011clsa
45.00 40.91 74.25 69.75 1.55 110.0

2010clsa
46.00 43.81 75.90 73.60 1.60 105.0

1Q10clsa
46.75 46.75 77.14 72.46 1.55 100.0

2Q10clsa
46.50 46.50 76.73 74.40 1.60 100.0

3Q10clsa
46.25 45.12 76.31 74.00 1.60 102.5

4Q10clsa
46.00 43.81 75.90 73.60 1.60 105.0

62

sharmila.whelan@clsa.com

EoAE Forecasts
1Q10
Eric Fishwick
eric.fishwick@clsa.com (852) 26008033

Bust to boom
3Q09 growth was impressive. Like elsewhere Singapore is benefiting from the trade rebound. This provides a bullish baseline forecast for 2010, to it we have added the gains from the opening of the IRs. More of the same in 2011 though import growth will constrain growth. Fast on the way down, fast on the way up

As the most cyclical economy in Asia (capital intensive manufacturing is combined with financial services) Singapore’s rebound as international trade has recovered has been impressive. The “rebound quarter”, 2Q09, saw 21.7% QoQ saar growth. More impressively the third quarter grew 14.2% QoQ saar without the advantage of an ultra-weak base. Of course in 4Q08 and 1Q09 this same cyclicality was working against Singapore. GDP in 3Q09 was only 0.6% higher than it was a year previously and though year on year growth will jump to 5.8% in 4Q09, 2009 as a whole will still be a contraction of 1.7%. Still this is a better economic performance than Singapore achieved during the dot.com bust. This is testament to how successful economic and monetary stimulus has been in the last 12 months.
Straight to boom

Conditions on the ground certainly bear this out. In many respects Singapore has gone from bust to boom without any period of moderation in-between. The boom will persist as it is much more than a simple rebound effect. We expect GDP growth around 9% in 2010 as the established rebounds in trade, manufacturing and financial services are joined by the “opening party” effect from Singapore’s two Integrated Resorts. We should admit at this stage that our estimates for the boost given by the IRs are approximate. We have no precedent to work with and the base of the comparison, 2009, could hardly be called a normal year. In our forecast we have modelled the IRs rather simplistically as a boost to net services income (offset partially by stronger
LONG-RUN HISTORY AND FORECAST SUMMARY

2003
Real GDP growth Domestic final sales growth Nominal GDP growth Consumer prices (y/e) 3-month interbank rate (% y/e) S$/US$ (y/e) Money supply M1 (y/e) Current account balance (US$bn) - as a % of nominal GDP
1

2004
9.3 5.7 14.2 1.3 1.4 1.63 14.0 19.9 18.1

2005
7.3 3.0 8.6 1.3 3.3 1.66 4.4 27.4 22.7 (0.6)

2006
8.4 7.1 9.9 0.8 3.4 1.53 13.4 35.4 25.4 (0.2)

2007
7.8 9.2 13.8 4.4 2.4 1.44 22.4 39.1 23.5 (3.0)

2008 2009clsa 2010clsa 2011clsa
1.1 7.1 2.3 4.3 1.0 1.43 18.4 27.2 14.8 0.8 (1.7) (1.4) (2.6) (0.2) 0.7 1.39 27.9 24.3 13.9 3.5 8.9 6.1 12.4 3.7 0.8 1.32 34.8 49.6 23.8 0.1 6.3 7.1 10.5 3.5 2.5 1.30 17.0 66.9 28.1 (0.3)

3.8 (0.6) 2.7 0.7 0.8 1.70 8.1 22.1 23.7

Public sector deficit (% of GDP) 0.8 0.4 1 Note: % YoY rates unless otherwise stated. Fiscal years beginning 1 April. Source: CEIC, MAS, MTI, Datastream, Bloomberg, CLSA estimates

eric.fishwick@clsa.com

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S I N G A P O R E

imports of goods) and have assumed that the overall full year impact will be sufficient to add around 3ppt to 2010 GDP growth. We will almost certainly have to refine this forecast as the year progresses but it is worth noting that even without the IRs visible trade and financial services growth would be sufficient to generate more-than-satisfactory growth of around 6%. Compared with three months ago this forecast is an increase of 3ppt, reflecting upgrades to our expectations for goods trade and financial services.
Hitting the speed limit

As small open economies close their output gaps they start to hit a constraint on growth. Further domestic demand or export growth results in disproportionate increases in imports. Singapore will be approaching this in 2011. This, combined with the likelihood that the growth in service revenues from the casinos will normalise after the initial spurt, suggests slower growth in 2011 even though we anticipate that goods trade and manufacturing output growth will be faster. Our 2011 forecast is for GDP to grow by 6.3%.
Inflation and reaction

In common with most other countries Singapore’s inflation statistics are benign in year on year terms but this conceals quite large price increases on a month on month basis. And, in common with other Asian countries, this means that inflation headlines increase quite rapidly in 2010 as the elevated commodity prices in 2008, which are keeping current year on year figures low, drop out. We expect inflation to increase steadily over the year. Our average CY2010 CPI forecast is 2.7% but the inflation rate will end the year at 3.7%. By Singapore standards these are relatively high numbers. Inflation in the last ten years has rarely been above 2%. We expect the Monetary Authority of Singapore to start appreciating the Singapore dollar from its April monetary policy meeting. This policy is framed against a nominal trade weighted exchange rate basket.
GDP GROWTH FORECASTS THE CLSA DIFFERENCE

Government

Updated: 2010:
Consensus

Nov 3 to 5 Dec 5.5 8.9

GDP growth

Consensus is too conservative given the immense cyclicality of Singapore growth.
Inflation

Updated: 2010:
CLSA

Inflation will rise quicker than people think.
Interest rates & exchange rate

2010:

Readoption of appreciation bias for S$ at April meeting is majority view and with good reason.

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Eye on Asian Economies • 1Q2010
S I N G A P O R E

SINGAPORE BY NUMBERS

2007
Breakdown of real GDP Private consumption Public consumption GFCF Domestic final sales Exports, goods & services Imports, good & services Real GDP growth Prices Consumer prices (y/e) Consumer prices (average) Domestic supply prices (y/e) Currency & interest rates S$/US$ (y/e) S$/US$ (average) 3-month interbank rate (% y/e) Prime rate (% y/e) External sector NODX (US$, % YoY) Retained imports (US$, % YoY) Trade balance (US$bn) Current account balance (US$bn) - as a % of nominal GDP FDI (US$bn) Adjusted resource gap (% of GDP) External debt (total, US$bn) Debt service ratio (% exports) International reserves (US$bn, y/e) 8.1 7.0 47.1 39.1 23.5 7.0 27.7 0.0 0.0 163.0 22.4 13.4 16.9 88.4 (3.0) 99.3 167.6 36,289 251.6 13.8 6.4 4.1 1.7 1.44 1.50 2.4 5.3 4.4 2.1 10.4 5.2 2.2 19.2 9.2 8.7 8.3 7.8

2008
2.4 8.1 13.7 7.1 1.3 6.1 1.1 4.3 6.5 (18.9) 1.43 1.41 1.0 5.3 (1.5) 25.2 31.1 27.2 14.8 13.7 22.4 0.0 0.0 174.2 18.4 12.0 15.2 107.8 0.8 103.2 182.9 38,458 257.4 2.3 (4.2) 3.0 2.5

2009clsa
(1.6) 4.4 (3.1) (1.4) (12.3) (12.9) (1.7) (0.2) 0.1 11.3 1.39 1.45 0.7 5.4 (14.3) (22.7) 32.8 24.3 13.9 12.7 19.3 0.0 0.0 194.1 27.9 10.7 3.2 105.6 3.5 109.5 173.7 35,444 250.8 (2.6) (1.3) (8.0) 4.0

2010clsa
4.8 5.0 8.4 6.1 15.3 15.0 8.9 3.7 2.7 9.3 1.32 1.36 0.8 5.3 19.1 22.6 37.7 49.6 23.8 16.9 21.4 0.0 0.0 261.9 34.8 12.5 13.6 107.6 0.1 103.8 207.6 41,138 281.8 12.4 11.5 11.0 3.0

2011clsa
5.8 0.9 11.3 7.1 20.2 22.0 6.3 3.5 3.8 10.4 1.30 1.31 2.5 5.3 23.1 31.9 31.7 66.9 28.1 18.5 32.7 0.0 0.0 338.1 17.0 14.8 14.8 106.8 (0.3) 100.0 238.2 45,834 311.4 10.5 14.5 13.0 2.6 5.2

2009 number conceals good consumption growth from 2Q09. Confidence is high. IRs will add a further boost in 2010. Tourist spending is measured in service exports. Also we have revised up our expectations for goods exports. As GDP rises relative to trend import growth accelerates limiting GDP growth. Inflation steps up rapidly at the start of 2010; monetary tightening starts to slow inflation from 2Q11. Trade weighted appreciation of around 2% annl is typical.

Current account surplus is structural – a reflection of forced savings via the CPF.

Money supply
Money supply M1 (y/e) Money supply M2 (y/e) Private sector credit (y/e) Private sector credit (% of GDP) Government sector Public sector deficit (% of GDP) Public sector debt (% of GDP) Nominal GDP Nominal GDP (US$bn) Nominal GDP per capita (US$) Nominal GDP (S$bn) Nominal GDP (S$, % YoY) Other data Industrial production Retail sales Unemployment (overall % y/e)
2 1

Govt balances the budget over the cycle, will use strong growth as an opportunity to reduce borrowing ASAP.

Tourism spending appears in retail sales but not personal consumption, this number will run ahead.

Population (millions) 4.6 4.8 4.9 5.0 1 Note: % YoY rates unless otherwise stated. Fiscal years beginning 1 April; 2 Government domestic debt (Singapore registered stocks, Treasury bills & deposits and advance deposits) Source: CEIC, MAS, MTI, Datastream, Bloomberg, CLSA estimates

Unemployment falling steadily through 2010 and 2011.

eric.fishwick@clsa.com

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S I N G A P O R E

EXPORTS & IMPORTS

18 16 14 12 10 8 6 4 02

(US$bn) Domestic exports Retained imports

Historically a 2% per annum appreciation rate in trade weighted terms has been typical. This implies that the S$ will reach around S$1.32/US$ by end-2010. Given that inflation will at this point still be accelerating there is upside risk (from the S$’s perspective) to this forecast should the MAS prove more aggressive than normal. Although we expect GDP growth to be slower in 2011 this should not be interpreted as any abatement of demand pull inflationary pressures. On the contrary these are better proxied by domestic final sales growth than GDP growth and this will be higher in 2011 than 2010. However the effect of the currency policy will start to moderate the pace of price rises (the mean lag between an exchange rate shift and the adjustment in CPI is 8 months in Singapore). By mid-2011 we see inflation falling again though, with commodity prices firm, the decline will be extremely small.
Rates and monetary aggregates

smoothed data are HP filters 03 04 05 06 07 08 09

SGD NEER & REER

115 110 105 100 95 90 85 95

(Jan 00 = 100) NEER REER

97

99

01

03

05

07

09

Singapore conducts monetary policy via the exchange rate (its structural current account surplus gives it a unique ability to manipulate the S$) and lets the market determine interbank rates. Typically these are influenced by interest rate parity. However with US rates ultra low, S$ interbank rates are above US$ rates when interest parity says they should be below. This will persist through 2010. Higher US$ rates should normalise the relationship in 2011. However while S$ rates are higher than they “should” be given the currency, they are low in absolute terms. Cash demand has expanded, rapidly inflating M1 growth. All these trends will persist in 2010. The integrated resorts are also likely to increase cash demand and M1 growth. Credit expansion has proven more elusive. Private sector credit growth was only 2% YoY in 2Q09. Quarterly trends are no more impressive. However we expect that, as growth accelerates and inflation becomes more visible, bank lending will start to increase. We expect lending growth of a little over 13% in 2010 enough to raise LDRs. With deposit rates remaining ultra-low 2010 should be a decent year for commercial banks.
CURRENCY FORECAST

MONETARY CONDITIONS INDEX

16 12 8 4 0 -4 04

(chg from 05/2004)

05 06 from short rates

07 08 from NEER

09 MCI

Period-end 2008
S$/US$ S$/Yen 100 S$/GBP S$/Euro Memo: US$/Euro Memo: Yen/US$ 1.43 1.58 2.09 1.99 1.39 90.6

Annual 2009clsa
1.39 1.46 2.28 2.06 1.48 95.0

Coming 12 months by quarter 2011clsa
1.30 1.18 2.15 2.02 1.55 110.0

2010clsa
1.32 1.26 2.18 2.11 1.60 105.0

1Q10clsa
1.38 1.38 2.28 2.14 1.55 100.0

2Q10clsa
1.36 1.36 2.24 2.18 1.60 100.0

3Q10clsa
1.34 1.31 2.21 2.14 1.60 102.5

4Q10clsa
1.32 1.26 2.18 2.11 1.60 105.0

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eric.fishwick@clsa.com

EoAE Forecasts
1Q10
Sharmila Whelan
sharmila.whelan@clsa.com (852) 26008352

Domestic economy stabilising
Robust exports and signs of domestic stabilisation mean an upgrade to our 2010 and 2011 forecasts. We expect Taiwan to grow by 6.8% in 2010 and 7.3% in 2011. Weak price pressures, however, argue that Taiwan will be among the last in Asia to start normalising interest rates. 3Q09 GDP not as good as Korea but a good turnout

Taiwanese GDP growth in 3Q09 fell short of the 2.9% QoQ increase recorded by Korea, but it was a good turnout. Beating our bullish forecast, actual GDP growth came in at 2% QoQ after 4.4% QoQ in 2Q09. There were two important new insights from 3Q09 GDP, which have been confirmed by high frequency monthly macroeconomic data since. First, exports are holding up better in Taiwan than in its competitor countries. 3Q09 GDP figures showed export volume growth slowing as expected, but exports were still up 7.7% QoQ after 12% QoQ in 2Q09. The parallel numbers for Korea 4.4% QoQ slowing from 11% QoQ. Monthly data since show Taiwanese nominal exports remain firmly on an upward trajectory. So in November for instance Taiwanese exports grew by a strong 8.4% MoM compared with Korea’s relatively tepid 0.8% MoM rise. The second takeaway is that the domestic economy is stabilising. Consumption growth accelerated to 0.9% QoQ from 0.7% QoQ in 2Q09. Investment spending, after rising by a massive 33% QoQ in 2Q09 on the back of investment by public sector companies and the government’s infrastructure spending, rose by 4.8% QoQ in 3Q09. Our fear had been that investment spending would pull back after the 2Q09 surge. Instead domestic demand drove GDP growth in 3Q09, contributing 1.3ppt to overall GDP growth of 2%. And this was despite continued inventory destocking (for the third straight quarter), shaving 1.4ppt off domestic demand.

LONG-RUN HISTORY AND FORECAST SUMMARY

2003
Real GDP growth Domestic final sales growth Nominal GDP growth Consumer prices (y/e) Rediscount rate (% y/e) NT$/US$ (y/e) Money supply M1b (y/e) Current account balance (US$bn) - as a % of nominal GDP 3.7 1.6 2.7 (0.1) 1.4 33.98 18.1 30.5 9.5

2004
6.2 6.5 6.3 1.6 1.8 31.92 14.4 19.7 5.6 2.8

2005
4.7 2.5 3.3 2.2 2.3 32.85 6.6 17.6 4.7 0.5

2006
5.4 0.9 4.3 0.7 2.8 32.60 5.4 26.3 6.8 0.6

2007
6.0 1.7 5.4 3.3 3.4 32.44 1.1 33.0 8.1 0.2

2008 2009clsa 2010clsa 2011clsa
0.7 (2.9) (1.6) 1.3 2.0 32.86 (2.2) 25.1 6.0 0.8 (3.1) (2.8) (4.5) (0.9) 1.3 32.20 26.1 38.7 10.1 5.9 6.8 2.6 4.0 1.8 1.5 31.25 28.5 42.1 10.2 4.5 7.3 3.6 8.0 3.0 2.5 30.25 27.1 44.5 9.7 2.2

Public sector deficit (% of GDP) 2.7 Note: % YoY rates unless otherwise stated. Source: CEIC, CLSA estimates, Central Bank of China, DGBAS

sharmila.whelan@clsa.com

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Eye on Asian Economies • 1Q2010
T A I W A N

Well positioned for next year and 2011

With the domestic economy recovering in its own right and the outlook for exports turning more positive Taiwan is well positioned for growth over the next two years. After contracting by 3.1% this year we expect the Taiwanese economy to expand by 6.8% in 2010 and 7.3% in 2011. The pace of industrial production and export orders growth has slowed from the unsustainably high rates of 2Q09. However the points to note are first, both are rising at a very healthy tick; industrial output was up 29% QoQ in October and export orders by 30% QoQ. Second, we expect both export orders and actual shipments to start to accelerate in early 2010 as Chinese consumption and private investment spending accelerate sucking in goods from the rest of Asia. We also expect Taiwan, like the rest of Asia, to continue to benefit from the strength of the euro, which will drive exports to the region despite Europe’s rather dismal growth outlook. In 2011 Taiwanese export growth is set to strengthen further as the global economy recovers. The upshot is we expect exports in volume terms to grow by 19% in 2010 and by close to 22% in 2011. Real net exports add 3.5ppt to our 2010 growth forecast. This number would be much larger but for our assumption that Taiwanese destocking will end in 2010 which supports import demand (the stabilisation of inventory levels adds 1.1ppt to our growth forecast in addition to the 2.2ppt from domestic final sales shown in the table opposite). The outlook for fixed investment spending is positive. Capacity utilisation rates continue to improve and inventory to shipments ratios are falling steadily. Investment spending is already recovering and we expect it to strengthen through 2010 and particularly in 2011 when we expect our ‘Capital Links’ story to start coming into full play and to boost investment in hotels, commercial & residential property. The weakness of Taiwanese consumption spending has been an area of concern which we have talked about on many occasions in the past. But changes are afoot. Importantly for consumption, the employment

GDP GROWTH FORECASTS

THE CLSA DIFFERENCE

Government

GDP growth

Updated: 2010:
Consensus

Nov 4.4 Dec 4.2 6.8

Domestic stabilisation and robust exports are driving our above consensus GDP growth forecast for 2010.
Inflation

Updated: 2010:
CLSA

Deflation persists and even next year inflation will be rising from very low levels.
Interest rates & exchange rate

2010:

We expect interest rates to rise only towards the end of 2010.

68

sharmila.whelan@clsa.com

Eye on Asian Economies • 1Q2010
T A I W A N

TAIWAN BY NUMBERS

2007
Breakdown of real GDP Private consumption Public consumption GFCF Domestic final sales Exports, goods & services Imports, goods & services Real GDP growth Prices Consumer prices (y/e) Consumer prices (average) Producer prices (y/e) Currency & interest rates NT$/US$ (y/e) NT$/US$ (average) Rediscount rate (% y/e) Base lending rate (% y/e) External sector Exports (US$, % YoY) Imports (US$, % YoY) Trade balance (US$bn) Current account balance (US$bn) - as a % of nominal GDP FDI (US$bn) Adjusted resource gap (% of GDP) External debt (total, US$bn) Debt service ratio (% exports) International reserves (US$bn, y/e) Money supply Money supply M1b (y/e) Money supply M2 (y/e) Private sector credit (y/e) Private sector credit (% of GDP) Government sector Public sector deficit (% of GDP) Public debt (% of GDP, y/e) Nominal GDP Nominal GDP (US$bn) Nominal GDP per capita (US$) Nominal GDP (NT$bn) Nominal GDP (NT$, % YoY) Other data Industrial production Retail sales Unemployment (% y/e) Population (millions) 7.8 1.9 3.8 22.9 394.7 17,260 12,911 5.4 0.2 33.3 1.1 1.4 4.2 116.1 10.1 8.2 30.4 33.0 8.1 (3.3) 7.5 94.5 2.7 270.3 32.44 32.71 3.4 4.3 3.3 1.8 8.6 2.1 2.1 0.6 1.7 9.6 3.0 6.0

2008
(0.6) 0.7 (11.2) (2.9) 0.6 (3.1) 0.7 1.3 3.5 (9.7) 32.86 31.44 2.0 4.2 3.4 9.4 18.5 25.1 6.0 (4.9) 5.0 90.4 4.0 291.7 (2.2) 6.4 2.5 121.0 0.8 34.5 403.9 17,606 12,699 (1.6) (1.8) (4.3) 5.0 22.9

2009clsa
0.6 3.5 (16.7) (2.8) (10.0) (14.9) (3.1) (0.9) (1.0) (9.2) 32.20 32.78 1.3 2.6 (22.7) (29.8) 31.2 38.7 10.1 (2.8) 9.7 75.0 3.8 350.0 26.1 7.9 (1.7) 124.6 5.9 42.0 369.9 16,070 12,127 (4.5) (12.2) (0.4) 6.0 23.0

2010clsa
2.7 1.1 3.5 2.6 19.1 17.7 6.8 1.8 0.2 0.0 31.25 31.63 1.5 2.9 23.0 25.5 34.1 42.1 10.2 (3.0) 9.8 70.0 4.0 400.0 28.5 9.8 3.0 123.4 4.5 44.9 398.8 17,268 12,612 4.0 10.4 2.5 5.5 23.1

2011clsa
4.1 (3.5) 6.9 3.6 21.8 20.8 7.3 3.0 2.6 1.9 30.25 30.63 2.5 3.9 30.3 34.6 35.5 44.5 9.7 (7.0) 8.4 70.0 4.5 454.0 27.1 13.1 6.1 121.3 2.2 43.7 444.8 19,197 13,621 8.0 12.2 7.0 4.8 23.2

Wages are rising again and so is sentiment underpinning an improved consumption outlook.

As exports and consumption strengthen, so will investment spending.

Exports and a recovery in the domestic economy are behind our bullish forecasts.

We expect the NT$ to strengthen over the forecast period as capital inflows continue.

We expect the Taiwanese to be among the last in Asia to raise rates.

The current account will stay in healthy surplus despite a terms of trade deterioration.

We expect fiscal consolidation to start next year.

We expect the manufacturing recovery to go from strength to strength.

Note: % YoY rates unless otherwise stated. Source: CEIC, CLSA estimates, Central Bank of China, DGBAS

sharmila.whelan@clsa.com

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T A I W A N

EXPORTS & IMPORTS

26

(US$bn) Exports Exports

22

18

14

10 smoothed data are HP filters 6 02 03 04 05 06 07 08 09

TWD NEER & REER

situation is slowly starting to improve and households in the last 3-4 months have started to borrow again. After hitting a record 6.1% in September, the unemployment rate has stabilised. 42k new jobs were created in the two months to October. Wages, after a period of extreme compression, are rising again. They were up 3.9% QoQ in September, as companies seeing topline revenues improve have eased cost controls. As a result consumer sentiment is improving rapidly; the six month forward expectations index stood at 62.5 in November compared with 53 in August. And households are spending; retail sales were rising by 13% QoQ October after 11% QoQ in September. We see improving labour market prospects and rising consumer sentiment combined with a continued low inflation - low interest rate environment to support a steady acceleration in consumption spending over the forecast period.
Inflation and interest rates

115 110 105 100 95 90 85 80 75 95

(Jan 00 = 100) NEER REER

97

99

01

03

05

07

09

Interest rates are not going to be rising anytime soon in Taiwan. Deflation remains very much the theme of the moment. Declining for the eighth straight month headline consumer prices were down 1.25% YoY in October. Core inflation came in at -0.41% YoY the same month. We do expect inflation to turn positive but the outlook is muted. We are forecasting headline consumer prices will be rising by 1.8% YoY by end-2010. Low inflation in the face of upward pressure on the NT$ is likely to stay the Taiwanese central bank’s hand longer than its Asian peers. Given this we are forecasting that interest rates will only rise towards the end of 2010, and there again incrementally, by 25bp in total. Interest rates will rise faster in 2011, by a cumulative 100bp, as economic activity picks up and both demand pull and cost push price pressures grow.

MONETARY CONDITIONS INDEX

4.0 3.0 2.0 1.0 0.0 -1.0 -2.0 -3.0 -4.0 -5.0 04

(chg from 05/2004)

05 06 from short rates

07 08 from NEER

09 MCI

CURRENCY FORECAST

Period-end 2008
NT$/US$ NT$/Yen 100 NT$/GBP NT$/Euro Memo: US$/Euro Memo: Yen/US$ 32.86 36.27 47.98 45.68 1.39 90.6

Annual 2009clsa
32.20 33.89 52.81 47.66 1.48 95.0

Coming 12 months by quarter 2011clsa
30.25 27.50 49.91 46.89 1.55 110.0

2010clsa
31.25 29.76 51.56 50.00 1.60 105.0

1Q10clsa
32.00 32.00 52.80 49.60 1.55 100.0

2Q10clsa
31.75 31.75 52.39 50.80 1.60 100.0

3Q10clsa
31.50 30.73 51.98 50.40 1.60 102.5

4Q10clsa
31.25 29.76 51.56 50.00 1.60 105.0

70

sharmila.whelan@clsa.com

EoAE Forecasts
1Q10
Anthony Nafte
tony.nafte@clsa.com (852) 26008320

Exports to the rescue
Rising export revenues will bolster business sentiment for an upturn in investment and employment growth. Inflation will rise sharply as the output gap starts to close triggering aggressive rate hikes when the BOT reacts. Current account surplus and FDI recovery will support the baht; politics is a risk, early election expected in 2H10. Sentiment spurred by export rebound

Political uncertainty has been an overhang on the Thai economy keeping private investment growth below potential. This has curbed employment and wage growth which has been a constraint on private consumption growth. Uncertainty will persist over the monarchy and succession issue. But as long as violence is averted with the coalition government holding until a new election is called, businesses will become more confident and more willing to invest. The rebound in sentiment will be facilitated by rising export revenues. Like the rest of Asia, Thailand has benefited from surging Chinese demand. The share of Thai exports going to China has risen above 10% this year putting China on a par with the US, EU and Japan. Domestic demand alone would not have been sufficient to support growth. The additional underpinning from China (with Thai exports to China turning positive YoY in August) has proven vital. Demand from China will be sustained over the next two years while recovery in the US will provide an added boost to exports in 2H10 and increasingly in 2011. The vulnerable period will be 1H10 when Thai GDP growth will be relatively weak. This has been reinforced by the Supreme Administrative Court decision to uphold the injunction declaring Map Ta Phut, the centre of Thailand’s petrochemical industry, a pollution control zone. The anticipated six month delay in industrial projects will cap the 2010 rebound in real investment growth below 5%. This leaves our 2010 real GDP
LONG-RUN HISTORY AND FORECAST SUMMARY

2003
Real GDP growth Domestic final sales growth Nominal GDP growth Consumer prices (y/e) 1-day repo rate (% y/e) Bt/US$ (y/e) Money supply - Narrow (y/e) Current account balance (US$bn) - as a % of nominal GDP
1

2004
6.3 7.9 9.7 3.0 1.9 39.18 10.6 2.8 1.7

2005
4.6 6.8 9.3 5.8 3.9 41.03 7.3 (7.6) (4.3) (1.1)

2006
5.1 3.3 10.7 3.5 5.0 35.78 2.4 2.3 1.1 0.3

2007
4.9 2.5 8.7 3.2 3.3 33.66 9.7 15.7 6.3 1.3

2008 2009clsa 2010clsa 2011clsa
2.5 2.5 6.4 0.4 2.9 34.98 4.1 1.6 0.6 0.5 (3.0) (2.8) (2.4) 2.8 1.3 33.30 10.5 17.5 6.8 4.9 4.1 3.5 8.3 6.2 2.8 32.50 11.0 15.9 5.5 4.3 5.1 4.7 10.6 5.6 4.3 31.50 12.2 11.9 3.6 3.6

7.1 7.4 8.6 1.7 1.3 39.67 14.3 4.8 3.4

Public sector deficit (% of GDP) (0.1) 0.4 1 Note: % YoY rates unless otherwise stated; Fiscal year ending September. Source: IMF, IFS, CEIC, CLSA estimates, Bank of Thailand

tony.nafte@clsa.com

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Eye on Asian Economies • 1Q2010
T H A I L A N D

forecast at 4.1%, the same as in the 4Q09 EoAE. We expect a stronger 9.2% surge in investment growth in 2011, both in the services sector as domestic sentiment firms and in the tradeable goods sector as US demand kicks in. This will lift real GDP growth to 5.1% in 2011, the fastest growth in five years, conditional on relative political stability.
Inflation genie is out the bottle

Our GDP forecast, bearing in mind Thailand’s 70% export to GDP ratio, will be at risk if external demand (specifically US and Chinese demand) proves to be weaker than our assumptions in the World View section (pp27-29). This is because Thailand’s fiscal and monetary options will be constrained. The fiscal deficit in FY2009 (October 2008 to September 2009) was close to 5% of GDP. Our projections of a gradually falling fiscal deficit over the next two years depend on rising tax revenues from a recovery in corporate profits and rising wage income. Monetary stimulus is no longer an option due to rapidly rising inflation. Oil and commodity price rises have been accommodated by monetary expansion with the exchange rate suppressed due to competitiveness concerns. Annual inflation spiked to 1.9% in November 2009 but the incremental rise was much steeper at an estimated 7% QoQ annualised. The BOT’s delayed response will allow inflation to soar by 3.4ppt to 6.2% by end-2010, subsiding only gradually to 5.6% by end-2011. Our inflation projection is way below the 9% peak in mid-2008, first because we do not expect oil prices to rise as steeply and second because we are factoring in aggressive tightening when the BOT does eventually react. Faced with economic and political uncertainty, the BOT had been reluctant to hike rates. However, it will be compelled to do so as inflation continues to pick up pace. We expect the first 25bp rate hike in 2Q10 and a further 125bp hike in 2H10 lifting the policy rate to 2.75% by end2010. Inflation will be relatively intractable though, as excess capacity is erased triggering a further 150bp rate increase in 2011. This will lift the policy rate to 4.25% by end-2011.

GDP GROWTH FORECASTS

THE CLSA DIFFERENCE

Government

GDP growth

Updated: 2010: Updated: 2010:
CLSA

Nov 3.3 to 5.3 Dec 4.0 4.1

Like us, government and consensus have raised their forecasts following the rebound in exports.
Inflation

Consensus

The BOT has not yet awoken to the serious inflation threat.
Interest rates & exchange rate

2010:

Our aggressive interest rate forecast reflects the view that, with the BOT behind the curve, inflation will rise sharply.

72

tony.nafte@clsa.com

Eye on Asian Economies • 1Q2010
T H A I L A N D

THAILAND BY NUMBERS

2007
Breakdown of real GDP Private consumption Public consumption GFCF Domestic final sales Exports, goods & services Imports, goods & services Real GDP growth Prices Consumer prices (y/e) Consumer prices (average) Producer prices (y/e) Currency & interest rates Bt/US$ (y/e) Bt/US$ (average) 1-day repo rate (% y/e) Minimum lending rate (% y/e) External sector Exports (US$, % YoY) Imports (US$, % YoY) Trade balance (US$bn) Current account balance (US$bn) - as a % of nominal GDP FDI (US$bn) Adjusted resource gap (% of GDP) External debt (total, US$bn) Debt service ratio (% exports) International reserves (US$bn, y/e) Money supply Money supply – Narrow (y/e) Money supply – Broad (y/e) Private sector credit (y/e) Private sector credit (% of GDP) Government sector Public sector deficit (% of GDP) Nominal GDP Nominal GDP (US$bn) Nominal GDP per capita (US$) Nominal GDP (Btbn) Nominal GDP (Bt, % YoY) Other data Industrial production Unemployment (% y/e) Population (millions)
1

2008
2.7 4.6 1.2 2.5 5.1 8.5 2.5 0.4 5.5 (1.7) 34.98 33.31 2.9 6.8 15.8 26.5 0.1 1.6 0.6 7.0 3.2 64.8 7.1 111.0 4.1 9.2 9.3 94.4 0.5 38.2 272.4 4,085 9,075 6.4

2009clsa
(1.7) 3.8 (8.4) (2.8) (14.2) (22.3) (3.0) 2.8 (1.0) 8.5 33.30 34.36 1.3 5.7 (17.0) (27.4) 18.3 17.5 6.8 1.8 7.5 79.0 13.3 138.0 10.5 6.8 0.4 97.1 4.9 44.0 257.8 3,841 8,857 (2.4)

2010clsa
2.6 5.8 4.6 3.5 10.2 11.4 4.1 6.2 4.3 9.2 32.50 32.90 2.8 7.0 13.8 16.9 16.9 15.9 5.5 2.9 6.4 87.4 13.7 165.0 11.0 7.3 8.7 97.5 4.3 44.9 291.5 4,316 9,590 8.3

2011clsa
3.2 3.0 9.2 4.7 15.5 18.7 5.1 5.6 5.9 10.5 31.50 31.95 4.3 8.0 19.3 24.1 13.1 11.9 3.6 3.8 4.7 91.5 12.8 188.0 12.2 9.0 10.4 97.2 3.6 44.2 332.1 4,887 10,610 10.6

1.7 9.7 1.5 2.5 7.8 4.4 4.9 3.2 2.2 8.7 33.66 34.52 3.3 6.9 18.2 9.1 12.8 15.7 6.3 9.4 10.1 61.7 11.8 87.5 9.7 6.3 4.9 91.9 1.3 38.5 247.1 3,729 8,530 8.7

Exports will lead growth in 2010 and 2011 with the boost to sentiment lifting investment.

Inflation will be relatively intractable when the output gap starts to close.

BOT will need to hike aggressively when it does finally react.

Chinese demand will drive exports in 2010, US recovery will reinforce export demand in 2011. Shrinking deficit (and rising inflation) highlights Thailand’s vulnerability to oil and commodity price pressures. FDI rebound, assuming the political situation remains relatively stable.

1

Public sector debt (% of GDP, y/e)

Foreign reserves increase with current account in surplus and rising FDI.

6.3 1.1 66.3

3.9 1.3 66.7

(6.7) 1.6 67.1

4.8 1.5 67.5

10.8 1.3 68.0

Rebound in credit growth as sentiment picks up and banks loosen their lending stance.

Note: % YoY rates unless otherwise stated; Fiscal year ending September. Source: IMF, IFS, CEIC, CLSA estimates, Bank of Thailand

tony.nafte@clsa.com

73

Eye on Asian Economies • 1Q2010
T H A I L A N D

EXPORTS & IMPORTS

Baht supported by current account and FDI

18 16 14 12 10 8 6 4 02

(US$bn) Exports Imports

smoothed data are HP filters 03 04 05 06 07 08 09

We expect gradually firming oil and commodity prices over the next two years rather than a massive surge. Thus, we anticipate only moderate terms of trade losses for Thailand which runs a deficit on oil and commodity trade. There will also be an offset from rising soft commodity prices, in particular rice and rubber, boosting rural income. Rising investment and import growth will lead to a narrowing current account surplus, but from an estimated high 6.8% of GDP in 2009. The surplus will remain relatively high at 5.5% of GDP in 2010 and 3.6% in 2011. Political risk remains high but if the situation stabilises, investor sentiment will pick up and FDI inflows will increase. With sustained inflows on the current account and rising FDI inflows on the capital account, we forecast an appreciating exchange rate in 2010 and 2011. Baht appreciation will be moderate at around 2.5 to 3% in both years, tempered by a firming US dollar and BOT resistance to further gains (which will be reflected by continued accumulation of foreign reserves).
Early election prospect for 2H10

THB NEER & REER

140 130 120 110 100 90 80 70 95

(Jan 00 = 100) NEER REER

97

99

01

03

05

07

09

The temptation for policy makers will be to sideline restructuring efforts and rely on the export engine to continue driving GDP growth. This would be a mistake relegating Thailand to low productivity growth and declining competitiveness. Policy needs to shift in favour of domestic demand driven growth, which is also the key to narrowing income disparities and bridging political divisions. Public sector initiatives, which have been rolled out to support the economy, need to be scaled back allowing the private sector to take the front seat on driving growth. Allowing the fiscal deficit to widen further from the near 5% of GDP in 2009 will increase Thailand’s vulnerability to any external shocks in the next two years. There is a compelling argument for re-initiating the privatisation programme. Realistically though, this would require a fresh election to provide a stronger mandate for economic restructuring. There are expectations from our research team in Bangkok that the government will call an early election in 2H10.

MONETARY CONDITIONS INDEX

8 7 6 5 4 3 2 1 0 -1 -2 04

(chg from 05/2004)

05 06 from short rates

07 08 from NEER

09 MCI

CURRENCY FORECAST

Period-end 2008
Bt/US$ Bt/Yen 100 Bt/GBP Bt/Euro Memo: US$/Euro Memo: Yen/US$ 34.98 38.61 51.07 48.62 1.39 90.6

Annual 2009clsa
33.30 35.05 54.61 49.28 1.48 95.0

Coming 12 months by quarter 2011clsa
31.50 28.64 51.98 48.83 1.55 110.0

2010clsa
32.50 30.95 53.63 52.00 1.60 105.0

1Q10clsa
33.10 33.10 54.62 51.31 1.55 100.0

2Q10clsa
32.90 32.90 54.29 52.64 1.60 100.0

3Q10clsa
32.70 31.90 53.96 52.32 1.60 102.5

4Q10clsa
32.50 30.95 53.63 52.00 1.60 105.0

74

tony.nafte@clsa.com

Eye on Asian Economies • 1Q2010

Notes

75

Eye on Asian Economies • 1Q2010

Notes

76

Eye on Asian Economies • 1Q2010

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© 2009 CLSA Asia-Pacific Markets ("CLSA"). Key to CLSA investment rankings: BUY = Expected to outperform the local market by >10%; O-PF = Expected to outperform the local market by 0-10%; U-PF = Expected to underperform the local market by 0-10%; SELL = Expected to underperform the local market by >10%. 26/10/2009 Performance is defined as 12-month total return (including dividends).


				
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