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Economics
Markets
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1Q 2016
DBS Group Research
10 December 2015
Economics–Markets–Strategy
December 10, 2015
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Economics–Markets–Strategy
December 10, 2015
Contents
Introduction
4
Economics
Holiday heresies 2016: China scraps 6
consumption-driven growth, and other tales
Currencies
More volatility 24
YieldFed-up
38
Offshore CNH
After the SDR 48
Asia Equity
Inflexion point
52
China
Next phase of transition
68
Hong Kong
Chugging along
74
Taiwan
Multiple challenges
80
Korea
A short-term recovery
84
India
Uneven 88
Indonesia
Grinding higher
94
Malaysia
Calm returns
98
Thailand
Private sector drag
102
Singapore
Winter before spring
106
Philippines
A transition year
112
Vietnam
Exception to the rule
116
United States
Ready or not …
120
Japan
Still disappointing
124
Eurozone
Slow but steady
128
Greater China, Korea
Southeast Asia, India
G3
1
December 10, 2015
Economics–Markets–Strategy
Economic forecasts
GDP growth, % YoY
CPI inflation, % YoY
2012
2013
2014
2015f
2016f
2012
2013
2014
2015f 2016f
US
Japan
Eurozone
2.2
1.7
-0.7
1.5
1.4
-0.4
2.4
0.0
0.9
2.5
0.6
1.4
2.2
0.9
1.4
2.1
0.0
2.5
1.5
0.4
1.3
1.6
2.7
0.4
0.2
0.8
0.0
1.3
0.6
0.8
Indonesia
Malaysia
Philippines
Singapore
Thailand
Vietnam
6.0
5.6
6.7
3.4
7.3
5.0
5.6
4.7
7.1
4.4
2.8
5.4
5.0
6.0
6.1
2.9
0.9
6.0
4.7
4.8
5.7
1.8
2.7
6.6
5.2
4.5
6.1
2.1
3.4
6.7
4.0
1.7
3.2
4.6
3.0
9.3
6.4
2.1
2.9
2.4
2.2
6.6
6.4
3.1
4.2
1.0
1.9
4.1
6.4
2.1
1.4
-0.4
-0.9
0.7
5.7
2.8
2.5
0.5
1.5
1.8
China
Hong Kong
Taiwan
Korea
7.7
1.7
2.1
2.3
7.7
2.9
2.2
2.9
7.4
2.3
3.9
3.3
6.8
2.4
0.9
2.6
6.5
2.4
2.4
3.3
2.6
4.1
1.9
2.2
2.6
4.3
0.8
1.3
2.0
4.4
1.2
1.3
1.5
3.7
-0.3
0.7
1.5
3.5
1.2
1.8
India*
5.1
6.9
7.3
7.4
7.8
7.4
9.5
6.0
5.0
5.4
* India data & forecasts refer to fiscal years beginning April; prior to 2013.
Source: CEIC and DBS Research
Policy and exchange rate forecasts
Policy interest rates, eop
Exchange rates, eop
current
1Q16
2Q16
3Q16
4Q16
current
1Q16
2Q16
3Q16
4Q16
US
Japan
Eurozone
0.25
0.10
0.05
0.75
0.10
0.05
1.00
0.10
0.05
1.25
0.10
0.05
1.50
0.10
0.05
…
121.7
1.099
…
123
1.07
…
124
1.05
…
126
1.03
…
125
1.04
Indonesia
Malaysia
Philippines
Singapore
Thailand
Vietnam^
7.50
3.25
4.00
n.a.
1.50
6.50
7.50
3.25
4.00
n.a.
1.50
6.50
7.50
3.25
4.00
n.a.
1.50
6.50
7.50
3.25
4.25
n.a.
1.50
6.50
7.50
3.25
4.25
n.a.
1.50
6.50
China*
Hong Kong
Taiwan
Korea
4.35
n.a.
1.75
1.50
3.85
n.a.
1.63
1.50
3.85
n.a.
1.63
1.50
3.85
n.a.
1.63
1.50
3.85
n.a.
1.63
1.50
6.44
7.75
32.9
1,182
6.45
7.76
33.0
1,193
6.49
7.76
33.4
1,212
6.52
7.76
33.8
1,232
6.50
7.76
33.6
1,222
India
6.75
6.75
6.50
6.25
6.25
66.8
67.5
68.6
69.6
69.1
^ prime rate; * 1-yr lending rate
Source: Bloomberg and DBS Group Research
2
13,957 14,450 14,830 15,200 15,000
4.27
4.37
4.50
4.64
4.57
47.2
47.5
48.0
48.4
48.2
1.40
1.43
1.45
1.47
1.46
36.0
36.5
36.9
37.4
37.2
22,489 22,620 22,725 22,840 22,960
Economics–Markets–Strategy
December 10, 2015
Interest rate forecasts
%, eop, govt bond yield for 2Y and 10Y, spread in bps
US
3m Libor
2Y
10Y
10Y-2Y
10-Dec-15
0.49
0.92
2.22
129
1Q16
0.90
1.30
2.50
120
2Q16
1.15
1.50
2.60
110
3Q16
1.40
1.70
2.70
100
4Q16
1.65
1.90
2.80
90
Japan
3m Tibor
0.17
0.20
0.20
0.20
0.20
Eurozone
3m Euribor
-0.12
-0.20
-0.20
-0.20
-0.20
Indonesia
3m Jibor
2Y
10Y
10Y-2Y
8.67
8.28
8.53
25
8.50
8.20
8.60
40
8.30
8.27
8.70
43
8.10
8.34
8.80
46
7.90
8.40
9.00
60
Malaysia
3m Klibor
3Y
10Y
10Y-3Y
3.80
3.42
4.23
80
3.75
3.60
4.30
70
3.75
3.60
4.30
70
3.75
3.60
4.30
70
3.75
3.60
4.30
70
Philippines
3m PHP ref rate
2Y
10Y
10Y-2Y
2.71
3.96
4.11
15
2.75
3.90
4.90
100
2.75
4.10
5.10
100
3.00
4.30
5.30
100
3.00
4.50
5.50
100
Singapore
3m Sibor
2Y
10Y
10Y-2Y
1.08
1.07
2.46
139
1.40
1.45
2.70
125
1.60
1.65
2.80
115
1.80
1.85
2.85
100
1.95
2.00
2.90
90
Thailand
3m Bibor
2Y
10Y
10Y-2Y
1.63
1.52
2.65
113
1.70
1.60
2.70
110
1.70
1.65
2.80
115
1.70
1.70
2.90
120
1.70
1.75
3.00
125
China
1 yr Lending rate
2Y
10Y
10Y-2Y
4.35
2.72
3.06
34
3.85
2.70
3.10
40
3.85
2.70
3.20
50
3.85
2.70
3.30
60
3.85
2.70
3.40
70
Hong Kong
3m Hibor
2Y
10Y
10Y-2Y
0.39
0.52
1.56
104
0.75
0.90
1.95
105
1.00
1.10
2.05
95
1.25
1.30
2.15
85
1.50
1.50
2.25
75
Taiwan
3m Taibor
2Y
10Y
10Y-2Y
0.80
0.49
1.19
70
0.73
0.55
1.20
65
0.73
0.55
1.25
70
0.73
0.55
1.30
75
0.73
0.55
1.35
80
Korea
3m CD
3Y
10Y
10Y-3Y
1.67
1.76
2.21
45
1.60
1.75
2.35
60
1.60
1.80
2.40
60
1.60
1.85
2.45
60
1.60
1.90
2.50
60
India
3m Mibor
2Y
10Y
10Y-2Y
7.39
7.39
7.78
39
7.25
7.40
7.70
30
7.00
7.30
7.60
30
6.75
7.20
7.50
30
6.75
7.10
7.50
40
Source: Bloomberg and DBS Group Research
3
Introduction
Economics–Markets–Strategy
Tiptoeing unto the breach
For the first time in five years, the year ahead doesn’t look so dubious. Yes, the
Fed is preparing to hike rates for the first time in 11 years. But markets seem more
relieved than worried. They’ve waited and waited (and waited) and if anyone
is caught by surprise now, well, wouldn’t that be the surprise? The economy
continues to grow at a 2.1% pace – a notably pedestrian pace that could probably
be sustained forever – and the only reason the Fed wants to get going now is so it
can move at a snail’s pace. Unless the economy takes off, a highly unlikely event,
policy will remain loose for another 2-3 years. How benign is all that?
But it’s not just the US where things are normalizing. Since the European debt crisis
/ recession of 2011-12, growth there has returned to 0.9% in 2014 and to 1.4% this
year. We expect another 1.4% growth, perhaps a tick more, in 2016. Draghi may
have disappointed markets recently by not expanding QE but with the economy
growing at 1.4% and core inflation having nearly doubled over the past 6 months,
they’ll get over it soon enough. Things look better, not worse, in Europe.
Even Japan’s numbers look a bit better, no thanks to Abenomics, where the third
arrow remains firmly stuck in the quiver. Flat growth in 2014 has turned to 0.6%
this year and we expect a 0.9% rise in 2016 mainly on the back of a stabilization
in global trade flows. Sub-1% GDP growth may sound low but it’s actually pretty
close to potential for Japan, where the population continues to shrink at a rate of
about a quarter of one percent per year.
China, alas, will continue to slow in 2016. But the 6.5% growth expected is only a
trickle slower than the 6.8% registered in 2015 and shouldn’t prevent Asian growth,
nor global growth more broadly, from stabilizing in 2016 after slipping in 2014/15.
Our 2016 forecasts put Asia-10 GDP growth at 5.9%, unchanged from 2015. In the
G4 – the US, EU19, Japan and Asia-10 – we think growth will rise by a tick to 3.1%.
Plainly, this isn’t gangbusters growth. But that’s surely a good thing, not a bad
thing. After 8 years of QE/ZIRP, the last thing anyone wants is for central banks to
get nervous. From a market perspective, a small improvement in global growth – or
even just a stabilization in it – is better than a sharp turn north. It keeps everyone’s
Asia10 – GDP
G4 – GDP growth
% YoY, wtd avg
% YoY, wtd avg (US, EU19, JP, Asia-10)
6.8
3.5
6.6
6.6
3.0
6.4
6.4
5.9
6.0
5.9
5.8
INTRODUCTION
3.0
2014
2015f
3.1
2.6
2.5
6.2
2.0
1.5
5.6
1.0
5.4
0.5
5.2
5.0
2013
2014
2015f
2016f
David Carbon • (65) 6878-9548 • [email protected]
4
3.1
0.0
2013
2016f
Economics–Markets–Strategy
Introduction
hands where you can see them. Historically, markets do very well indeed when the
compass turns slowly north but much slack remains. 2016 could be a great year.
Nothing’s guaranteed. In the US, the Fed wants to normalize slowly – great. But
that means it has to start before it’s sure it’s time – not so great. There’s no way
around this. All the Fed can do is tiptoe out into the waters. Put a hike out there,
see what happens. Put another one out there, check again. If things go well, as
we reckon is likely, the Fed will have hiked 5 times by the end of 2016. If things go
less well, the tiptoeing stops, presumably before any real damage is done. Housing,
capex and exports – the most interest rate / FX-sensitive sectors of the economy –
will be the things to watch.
In Europe, Draghi talks a lot about getting inflation back to 2%. But he can’t
control headline inflation because Europeans don’t drive global oil prices. If he
tries anyway with more QE, that could put the euro below par, the Fed on hold and
markets into a tizzy. The euro is cheap enough, please.
In Asia, markets continue to fret over the risk of a hard landing in China, as they
have for the past four years. There’s no small irony here: 4-year landings are soft by
definition. The real risks are related to long-run structural change and reform, not
to where the PMI went last month. In adding the RMB to the SDR currency basket
two weeks ago, the IMF said things are moving in the right direction. They are. But
not rapidly and there’s lots more to do. Rationalizing state-owned enterprises is
next on everyone’s wish-list and progress to date has not been encouraging.
Enough of the Bah, humbug! If risks didn’t exist we’d have to invent them. The
central scenario for 2016 looks good: The growth compass is stabilizing and
perhaps tilting north. Much slack remains. And monetary policy will remain highly
accommodative for years to come. Can a softball get lobbed any more softly than
that?
We’ll find out soon enough. Best of luck in 2016.
David Carbon, for
DBS Group Research
December 10, 2015
5
Economics
Economics–Markets–Strategy
Holiday heresies 2016:
China scraps consumption-driven growth
• Why will China scrap consumption-driven growth? Because consumption-led growth is the quickest way imaginable to fall into the middleincome trap that China hopes to avoid
• When will China scrap consumption-driven growth? When it discovers
that the One Road One Belt strategy is more important than sports cars
and jewelry and dining out. Not even command-driven China can have
both
• China can pursue investment-led growth for another 50 years, and it
would be a good thing, not a bad thing
• These and other heresies for 2016 are explored below
For the first time since 2008, the year ahead doesn’t look so dubious. The US
continues to grind ahead at the same 2% growth pace that has prevailed since
2010. The Fed is preparing to hike rates but markets seem more relieved than
worried. Europe’s growth is back above 1% and, rhetoric notwithstanding,
the ECB is shying away from the idea of more QE. There’s no need. And China
increasingly appears to have bottomed. After four years of worrying about a hard
landing, investors have finally realized that any landing that takes 4 years is soft
by definition. Increasingly, they are focussing on what they should have all along:
long-term structural change and reform. The capital account is increasingly open,
interest rate liberalization is largely complete and the IMF has stamped its approval
on the process by adding the yuan to the SDR basket. There’s boatloads more to do,
goodness knows, but things are moving in the right direction. With the US, Europe
and China all plunking along perfectly pedestrian-like, 2016 could be a great year.
US – saving / GDP and income (1929-2014)
Japan – saving / GDP and per-capita income
Saving / GDP (%)
Saving / GDP (%)
25
35
30
20
25
15
20
15
ECONOMICS
10
Subprime
crisis 2008-10
WWII
5
10
5
0
0
20,000
40,000
60,000
per-capita income in 2014 USD
David Carbon • (65) 6878-9548 • [email protected]
6
0
0
20,000
40,000
per-capita income in constant 2014 USD
60,000
Economics–Markets–Strategy
Economics
Holiday Heresies 2016
2016 almost looks too smooth. Thank goodness it’s December – when analysts are
encouraged to speculate a bit. To push a little, challenge some assumptions and
generally color outside the lines. Eleven months of the year we comb our hair. In
December, not so much. Thus the Holiday Heresies for 2016: twelve disheveled, if
not all that far-fetched, hypotheses for the year ahead.
With so much of this year’s focus centered on China, we begin there too.
Holiday Heresy 1: China will scrap consumption-led growth
Consumption-led growth. Consumption-led growth. Consumption-led growth.
For the past three years, C-led growth has been the mantra of officials, analysts and
investors alike. China needs more C and less I. So why would China scrap the idea
of consumption-led growth?
The year ahead
may not be a
cakewalk. But it
sure looks to be
smoother than the
past five
Because it’s a lot of silly nonsense. Since when did consumption ever drive growth?
When the industrial revolution took off in the 18th century? When the US laid its
railroads and interstate highways in the 19th and 20th? When the Asian Tigers
roared in the 20th and 21st? No. All these hyperbolic growth phases were and
continue to be driven by massive amounts of saving and investment, not new
dresses and bicycles and nights on the town.
So why does China and everyone else think shifting from investment to consumption
is a good idea? Because that’s what other, ‘more developed’, economies have done.
And China wants to be ‘developed’ like everyone else.
Take a look at the experiences the US and Japan (on the first page) and Hong Kong
and Malaysia (below). As income goes up, saving (eventually) goes down. This
happens for both supply- and demand-side reasons. From a technical, supply side
perspective, productivity growth and the returns from investment fall as incomes go
up (the low-hanging fruit disappears). On the softer, demand side of the equation,
people themselves change. As incomes rise, most want to enjoy the fruits of their
labor. A dollar in the bank becomes less attractive than a night on the town or a trip
to Spain. Supply and demand jointly push savings lower as economies develop [1].
But that doesn’t mean less saving / more consumption is a good thing – or that costs
aren’t involved. What these charts don’t show – but which everyone knows to be
true – is that growth slows when incomes go up and savings goes down. There’s
Nomenclature
References to economic
regions in this
report follow these
conventions:
Asia-10: CH, HK, TW,
KR, SG, MY, TH, ID,
PH, IN
Asia-9: A10 less CH
Asia-8: A10 less CH, IN
Asean-5: SG, MY, TH,
ID, PH
Asia Big3: CH, IN, ID
G4: US, EU, JP, A10
G3: US, EU, JP
EU: EA19
Hong Kong – saving / GDP and per-capita income
Malaysia – saving / GDP and per-capita income
Saving / GDP (%)
Saving / GDP (%)
40
50
45
35
40
30
35
25
30
20
25
15
20
15
10
10
5
5
0
0
0
10,000
20,000
30,000
40,000
per-capita income in constant 2014 USD
50,000
0
3,000
6,000
9,000
12,000
per-capita income in constant 2014 USD
7
Economics
Economics–Markets–Strategy
no way around it. The only way to keep growth as fast as it can be is to save and
invest as much as you can.
How could this not be true? Has any parent ever told their 20-year old son or
daughter to stop saving and investing in their future? To stop putting money in
the bank or to quit school and buy a sports car instead? Fancy clothes? Jewelry?
Parents in Hong Kong don’t tell their kids that. Nor in Singapore. Nor the US or
Japan or Malaysia. They all tell their kids to save and invest every penny they can
because that’s the best way to ensure a bright future. If it’s true for one person, it’s
true for 100. Or a 100 million. What’s good for Xiaolong is good for China.
Why would China
scrap consumption-led growth?
Because C-led
growth is the
quickest way we
know of to fall
into the middleincome trap that
China hopes to
avoid
China recently held its 13th Plenum where delegates approved the next 5-year
economic plan. The specifics of “13-5” won’t be revealed until March but what
the government did say loud and clear was that the main goal is to continue lifting
incomes and living standards – to prevent China from falling into a “middle-income
trap” like so many countries do after an initial period of successful development.
So why will China scrap consumption-driven growth? Because officials will soon
discover what most already know: consuming rather than saving and investing is
the quickest way imaginable to fall smack into the middle-income trap that China
hopes to avoid.
Holiday Heresy 2: Saving and investing 50% of GDP is just fine
China has saved and invested nearly 50% of its income for the past ten years. That’s
too much. Or at least that’s what everyone says. Why else would China be in such
a mess today? No one saves or invests that much.
Actually, they do. Singapore has saved and invested 50% of it’s GDP for the past 40
years – and has nothing to show for it but one of the highest income levels in the
world. At US$62,500 in 2014, Singapore’s average income per person is higher than
the US’s and Germany’s and almost as high as Switzerland’s.
Whoa, hold on. Singapore is a tiny country. China is huge. It’s not a fair comparison.
At least that’s what some say when we point this out.
And they’re right. It’s not a fair comparison. It’s much harder for Singapore to
maintain a 50% investment ratio than it is for China. Singapore is a small land scarce
island – it can’t keep building roads and houses and subway lines like China can,
where land stretches farther than the eye can see. And Singapore is an advanced
country – you can’t keep investing in education where 90% of the kids have tertiary
degrees like you can where most have only primary or secondary degrees. And
Singapore is a high wage country – it’s far harder to invest in industries that would
China and Singapore – saving / GDP and per-capita income
Saving / GDP (%)
55
50
45
40
35
30
25
20
15
10
5
0
China
Singapore
0
10,000
20,000
30,000
40,000
Per-capita GDP in constant 2014 USD
8
50,000
60,000
Economics–Markets–Strategy
Economics
Asia – per capita GDP timeline
USD per person in 2014 and number of years required to reach Singapore pci (assuming 6% pci growth rate)
70,000
SG
63,486
60,000
HK
50,000
40,895
40,000
KR
TW
30,000
28,758
22,702
20,000
IN
PH
ID
1,677
2,643
3,501
10,000
TH
CH
5,977 7,649
MY
11,244
0
-64
-60
-56
-52
-48
-44
-40
-36
-32
-28
-24
-20
-16
-12
-8
-4
t=0
be undercut by low-wage neighbors than it is to be that low-wage neighbor in the
first place (chart above).
If Singapore can save and invest 50% of its GDP for 50 years, then China – with
its vast undeveloped regions and comparatively low education, wage and income
levels – can too. Growth slows as incomes rise – there’s no stopping that. But even
at a heady 6% growth rate in per-capita income, China is 36 years behind where
Singapore is today (chart above). It can grow rapidly for many years to come. But
if China wants to prevent growth from slowing more than it has to, and to lift
incomes as high as they can be, it will save and invest every penny it can. There’s
nothing wrong with 50% of GDP. Nor, for that matter, 60%.
Holiday Heresy 3: There’s no such thing as over-investment
Plainly, Heresies 1 and 2 lead to Heresy 3: there’s no such thing as ‘over investment’
when you’re talking about the economy as a whole. You can have too much
steel (for a while), or too much concrete (for a while), or too many apartments
(again, for a while). But these are short-run cyclical problems best described as
poor investment, not over investment. Even China’s infamous ‘ghost towns’ – built
but not yet occupied cities – are examples of poor investment rather than over
investment. Any technocrat could have used the money spent on the ghost town
to build something more immediately beneficial to society, if that’s the criteria by
which investment is to be judged.
All countries invest poorly from time to time. It’s the essence of an economic cycle.
You run too fast in one direction (boom) and then you have to sit and wait while the
rest of the economy catches up (recession). It takes a while because you’ve invested
too much over there and not enough over here.
Singapore has invested 50% of its
GDP for the past
50 years and has
nothing but the
highest income in
Asia to show for it
Two summary points: First, cycles are as common as the common cold. Everyone
gets them and there’s no cure – you just gotta wait it out. Second, the problem isn’t
one of over-doing it, it’s one of balance – too much X, not enough Y. If there’s one
iron law of economics, it’s that you can’t have too much of everything, otherwise
we’d all be at the beach. Alas, most of us are not.
HH 4: Debt crises are easy to fix
If cycles are as common as colds, debt crises have become nearly as ubiquitous. The
good news is while there is no cure for a cold, fixing a debt problem, at least from a
clinical perspective, is easy: You carve out the bad debt, you make someone pay for
it and you fire the management.
9
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But if debt problems are so easy to fix, why do they seem to run on forever? In
capitalist countries, that’s easy to answer. First, no one wants to carve out the bad
debt. The owners (shareholders) of a troubled company don’t want to carve it out
because they’re first in line to pay for it. Managers don’t want to carve it out either
because they are soon fired. Both stall for as long as possible. Both would prefer to
grow their way out of the problem. Or at least try.
That’s not impossible. It can be done, if interest rates are low enough. But it takes
forever. And economic growth suffers in the meantime because resources don’t get
put to their best use. In sum then, owners, managers and in some cases central banks
of market economies all join hands to make debt crises long, drawn out affairs.
From a clinical
perspective, debt
crises are easy to
fix. You cut out
the bad debt, you
make someone
pay for it and you
fire the management
Command economies fail in most regards but at least you don’t have to wait for
markets to get the job done. Neither time, nor energy nor real income is wasted
attempting to grow an economy out of a debt problem. Directives are issued;
results follow.
This is important in the case of China. As most know, China has a local government
debt problem. A rather large one at that. But the central government has already
carved out CNY3.2 trillion of bad debt equivalent to 5% of GDP. And the central
bank will likely pay for most of it. Firing the management is all that’s left to do
– and Xi Jinping’s anti-corruption campaign has already proved so vigorous that
many worry he has over-stepped his bounds. Time will tell. What is abundantly
clear is that China has no intention of allowing a simple debt problem hold back
growth for 25 years like it has in Japan. Not when cleaning it up is as easy as 1-2-3.
Of course fixing a debt problem doesn’t guarantee another won’t arise. But firing
the management helps, as does interest rate reform, which is nearly complete. A
final measure in China’s case will be to let a good many companies go under. If the
restructuring exercise of 2000-2004 is any guide, a good many will.
HH 5: One-Belt-One-Road? Or consumption-driven growth? Pick one. Only one
Economics truly is the dismal science. The first thing they pound into you – if you
didn’t already know it – is you can’t have everything. Want more ice cream? Give
up more french fries. At the national level, the textbook choice is guns or butter;
textiles or aircraft. More of this means less of that. Life’s tough. Get over it.
Unfortunately, a command economy won’t get you out of this one, as China is
about to discover with its One Belt, One Road (OBOR) initiative. What’s the OBOR?
Perhaps the biggest infrastructure / investment project ever conceived and certainly
the biggest since the Marshall Plan for European reconstruction and development
that followed WWII.
In capitalist
countries, you fire
the manager. In
China, you run an
anti-corruption
campaign
The OBOR is China’s vision for a 21st century Silk Road, the trade route that ran
from Beijing to Xian to Istanbul and on into Europe. But the OBOR isn’t camels
and dust and a straight line from here to there. It’s a vast network of land, sea
and air links that would connect north and south, east and west and most of the
angles in-between. Imagine a Charlotte’s web of infrastructure laid over North and
Southeast Asia, the Near East, Russia, Africa and Europe – linking trade, finance,
transportation, tourism, student exchanges and whatever else might lie in its way.
That’s the OBOR.
Plainly, this inter-continental web of infrastructure investment isn’t going to be
built over night. But it’s Xi’s grand vision of the future. We think it’s a fabulous
vision indeed – the nuts and bolts for an Asian renaissance of sorts. The trouble is, it
runs smack up against another Chinese vision – that of consumption-driven growth.
The dismal science is pretty clear about this: you can’t have both.
So what will China choose? Decades of infrastructure investment driving Asian
growth and development? Or decades of clubbing and jewelry and dinner banquets
in Guangzhou, Shanghai and Beijing? Not even command-driven China can have it
both ways. OBOR or consumption-driven growth? Pick one, only one.
10
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HH 6: Asia needs to invest more, not less. And it needs to invest at home,
not abroad
At the end of the day, most people know deep down that ‘over-investment’ is a dubious concept and that Asia needs boatloads of investment if middle-income traps
are to be avoided and growth and living standards are to continue rising.
The question is, how is the OBOR, or any other large-scale infrastructure initiative,
to be financed? Who is going to pay for it? America? Not likely. Europe? Not a
chance.
The answer can only be Asia itself. But does Asia have the resources for this – to
fund an OBOR? Yes, it most certainly does. Every year, the Asia-10 invests 6% of its
GDP in US Treasuries or real estate or stocks and bonds of corporations somewhere
outside of Asia. It’s been doing this for the past 18 years. That’s a huge amount
of money that it could be investing at home – that it should be investing at home.
China will have to
choose between
the OBOR and
consumptionled growth. The
OBOR is far more
important
How is Asia investing so much in Treasuries and other foreign assets? By running
current account surpluses. Surpluses – exporting more than you import – mean
you’re lending the difference to the foreigner (or paying down old debt). And
Asia’s been doing that to the tune of 6% of GDP ever since 1997 (chart below).
It’s a lot of money. Asia-10 GDP is now US$17trn and 6% of that amounts to more
than a trillion dollars every year that Asia could be investing at home instead of
lending it to foreigners.
Asia 10 – current account surplus
% of GDP, simple average
10
8.6
9
7.7
8
7
6.8
5.6
5.6
6
7.4
6.7
6.1
6.0
5.6
5.3
4.8
5
3.8
4
4.7
4.1
3.6
4.0
3
2
1
98
99
00
01
02
03
04
05
06
07
08
09
10
11
12
13
14
Compare that sum to the $100bn that the Asian Infrastructure Investment Bank
(AIIB) – China’s alternative World Bank – hopes to raise for regional investment
projects. Even if you leveraged up the latter four times and lent out every penny,
you’d still be talking about a total AIIB loan book of $500bn. That is but half the
amount that could be lent out every year ad-infinitum if Asia’s current account
surpluses were wound down to zero.
Asia needs more
investment, not
less. The best
way to finance
it is to chop its
current account
surpluses to the
bone. Better still
would be to run
modest deficits
Asia has the resources to finance an OBOR. All it has to do is start investing at
home, where it’s needed, instead of abroad, where returns are embarrassingly low.
The time has come to scrap the surpluses and bring investment home.
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HH 7: Asia should scrap its current account surpluses and run (modest) deficits instead
Scrap the current account surpluses? Run ‘em down to zero? Into deficit? Now that
really is blasphemy. Foreign investors would holler. Rating agencies would holler.
Local officials would holler. Everyone thinks deficits are bad – it’s unanimous.
Deficits aren’t
heretical. They are
Finance -101
And unanimously wrong. Running deficits isn’t heresy – it’s Finance 101. It’s the
way things are supposed to be in a place like Asia. Higher income / capital abundant
countries are supposed to lend to lower income / capital scarce countries. Not viceversa. The foreign lender earns a higher return than he can at home; the local
borrower can invest more than his own savings will allow. Everyone’s incomes go
up more than they otherwise would. It’s a handshaking deal that benefits both
sides of the borrower/lender equation.
Why do rating agencies, local officials and foreign fund managers all believe
deficits are bad? Because 20-25 years ago Asia borrowed too much and it led to
the financial crisis of 1997. The thing is, the current account surpluses that Asia
has run ever since have cut external debt loads to a tiny fraction of what they once
were. Six of the Asia-10 countries are now net creditors in global markets when all
assets and liabilities – not just debt – are taken into account [2]. 1997 was a long
time ago. It’s time to move on. For the sake of much needed investment in Asia
and higher incomes for borrower and lender alike, mind sets need to change. Asia
needs to scrap the surpluses and bring investment home.
Asia – net foreign debt as % of GDP
ext debt (public + priv)less FX reserves as % of GDP
60
50
40
30
IN, PH
20
Crisis 4:
TH: MY, ID, KR
10
0
90
The big risks are
structural, not
cyclical. Where
the PMI goes this
month or next is
utterly unimportant
92
94
96
98
00
02
04
06
08
10
12
14
HH 8: Forget about China’s PMI, it’s not the real risk
Markets and media are obsessed with China’s manufacturing sector PMI. That’s
strange because not only did 95% of the PMI’s drop come 4 years ago, but the drop
was intentional. The plan all along was to cut state investment and the industrial
production that is mostly just the supply-side measure of it. Foreign investors
approved; there was ‘too much’ investment. Now that it’s being cut, they don’t like
what they see. “The sky is falling” seems to be the new mantra.
The sky isn’t falling. For the most part, things are running according to script.
China is in the midst of a slowdown that is part structural and part cyclical. Neither
are great but the cyclical risk – that things slow more than you want in the shortrun – is almost trivial compared to the structural risk – that things slow more than
they must in the longer-term. Cycles are cycles. Structure is what matters.
12
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Economics
The easiest way to see this is to consider the Asian financial crisis of 1997. When
you’re sitting in the middle of it, it feels like the sky is falling (chart below left).
Every tick of the PMI feels like a 2-story plunge in a broken elevator. Every slip in
exports feels like 2 stories more. You think you’re going over the cliff and never
coming back.
But you’re not. Growth resumes and before you know it, you’re standing in the
middle of the Dotcom crash of 2000/2001 (chart below right). It’s no fun but now
you have some perspective. You’ve been here before. Everything seems smaller,
less dramatic.
Asia 8 – industrial production
Asia 8 – industrial production
1997=100, sa, simple avg for Asia
1997=100, sa, simple avg for Asia
106
124
Dotcom
crash
120
104
116
!!!!!
Asia
Financial
Crisis
!!!!!
102
100
112
108
AFC
104
98
100
96
96
94
Mar-97
Sep-97
Mar-98
Sep-98
Mar-99
Sep-99
92
Mar-97
Mar-98
Mar-99
Mar-00
Mar-01
Mar-02
Pretty soon, you’re smack in the middle of the Subprime crisis and Lehman Brothers
and QE and the Great Recession – the Big One. But as quickly as Asia falls, it rises
again – the V-shaped recovery is almost old hat by now. 1997 and the Dotcom crisis
seem even smaller than before.
And now? Now we’re looking at a slowdown in China and the tick-by-tick blow of
the PMI. Every newspaper headline makes it sound like 1997 all over again. But
is it really? We pull out the charts to check and it’s not even close. But that’s not
what strikes us the most. What strikes us the most is how small and insignificant
Asia 8 – industrial production
1997=100, sa, simple avg for Asia, ex-pharma for SG
225
200
175
China
"slowdown"
150
125
100
Dotcom
crash
AFC
75
Lehman
Bros
50
25
88
90
92
94
96
98
00
02
04
06
08
10
12
14
16
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the Asian financial crisis now looks today, and how much growth has occurred since
then. Today, the 97 crisis, and the Dotcom crisis, and even the Lehman Brothers
crisis, all look like little blips on an upward sloping red line of structural growth.
Which of course is the point – they are little blips on an upward sloping red line of
structural growth.
Which brings us back to the original point. Which is the bigger risk? That the cycle
– those blips – wiggle a little more or a little less than the one before? Or that the
big red line of structural growth takes a turn to the right?
It’s chalk and cheese – there’s no comparison. Cycles aren’t the real risk. What
matters is the structural rise in Asia and whether it continues. For most of Asia,
that depends first and foremost on whether China’s efforts at reform and structural
change succeed or fail.
China – structural changes ahead
Macro changes
Real economy
Financial economy
1. Raise consumption
as a driver of GDP
2. Lower exports
as a driver of GDP
3. Lower investment
as a driver of GDP
1. Clean up bad debts
2. Globalize the RMB
3. Open capital account
(implied by 2)
4. FX liberalization
5. Interest rate liberalization
6. Reform / reregulate
shadow banks
7. Tax reform
Micro / efficiency changes
1. Lessen role of state-owned enterprises
in the economy
2. Pension / social security reform
3. Healthcare reform
4. Urbanization / Hukou reform
5. Inland development vs coastal areas
6. Lower production capacity of steel,
alumunum, other metals, concrete, paper
7. More private investment in airports, urban transit,
energy, shipping.
8. Allow more private capital in banking
China’s to-do list is long and wide. It encompasses macro reforms, micro reforms,
the real sector, the financial sector, labor markets, insurance markets -- you name
it, it’s on the list (table above). The last time China attempted a reform program
of this scale was in 1978, when Deng Xiaoping moved to free agriculture, and
later industry, from state control. But China today is 30 times larger than it was in
1978 and in a very real sense that makes reform and structural 30 times harder to
implement. Lots could go wrong.
Whether China succeeds in this effort remains unclear. What is certain, however, is
that this is where the real risks and benefits lie – for global investors as much as for
Asian income growth. The PMI and the so-called debt ‘crisis’ are short-term cyclical
issues – the blips in the charts above. Reform and structural change are orders of
magnitude more important. This is where China makes or breaks the world. This is
where investors should be focussing their attention.
HH 9: Asia’s currencies aren’t in crisis; 1997 this isn’t
Swimming down
the middle is good
policy
14
In the middle of 2014, the ‘divergence story’ took hold – the dollar went north, the
euro and the yen went south. What did Asia’s currencies do? For the most part,
just what you would want them to do: they ran down the middle – they fell against
the dollar but rose against the euro and the yen. And in so doing, Asia’s currencies
maintained a modicum of stability amidst the tidal waves thrown up by the majors.
This was good policy. But it didn’t stop the newspapers from shouting “Currency X
drops to it’s lowest in 20 years” on an almost weekly basis. Against the dollar, yes.
Against what matters – a simple basket of the 3 majors – no.
Economics–Markets–Strategy
Economics
To see this, take the ‘Crisis-4’ countries (TH, ID, MY and KR) – the ones whose
currencies fell the most in 1997 and have been among the most vulnerable to dollar
moves over the past 16 months too. How bad is the carnage? Not very. Back in
1997, these currencies lost more than 50% of their value against the dollar (chart
below). Over the past year, their purported ‘thrashing’ has put them down by 15%.
Is that a lot? Not when the dollar has risen by 20% against both the euro and yen
on the same time frame.
Asia currency values versus US dollar – 1997 crisis and today
increase = appreciation, Crisis-4 countries (TH, MY, KR, ID)
110
100
90
85
80
Jul14-present
70
Mar97-Mar99
60
50
47
40
t=0
t=3
t=6
t=9
t=12
t=15
t=18
t=21
t=24
Now look at the Crisis-4 currencies in tri-currency basket terms – the way any
currency should be measured (chart below). In 1997, they lost 53% of their value
against the tri-currency, identical to what they lost against the dollar alone (in the
picture above). The Crisis-4 currencies really did take a thrashing back then.
But where have they gone over the past year? Instead of plunging like the papers
would have you believe, they’ve run a little north and a little south. Today, they’re
almost smack where they were 16 months ago. Asia’s Crisis-4 currencies aren’t in
the slightest bit of crisis. The others even less so.
Asia’s Crisis-4
curencies aren’t in
the slightest bit of
crisis. The others
even less so
Asia currency values vs tri-currency – 1997 crisis and today
increase = appreciation, Crisis-4 countries (TH, MY, KR, ID), tri-ccy (USD, EUR, JPY)
110
100
98
90
Jul14-present
80
70
Mar97-Mar99
60
50
47
40
t=0
t=3
t=6
t=9
t=12
t=15
t=18
t=21
t=24
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Economics–Markets–Strategy
HH 10: Capital outflows from Asia are in fact mostly inflows
Except for China,
Asia has seen
more inflow than
outflow
But everyone’s talking about capital outflow from Asia. How have Asia’s currencies
remained stable if capital is fleeing the region? The main reason is that all Asian
countries, save for Indonesia and India, are running current account surpluses
(instead of deficits like they did back in 1988-1997). Those surpluses have offset
most of the capital outflow and foreign reserves have fallen by far less than the
capital outflow per se.
With a touch of irony in fact, most of the outflows from Asia are nothing but the
inflows earned from C/A surpluses in the first place. How is this? You export more
than you import: that’s an inflow of, say, $10 on the current account. But instead of
putting the $10 under your pillow, you buy a Treasury bond with it: that’s a capital
outflow. Thus most outflows are nothing but the flip-side of Asia’s current account
surpluses. Net flows – changes in forex reserves – have been square (or positive)
for most Asian countries since the middle of last year when all the hoopla started
(chart below left).
Not everywhere of course. China has spent 10% of its reserves over the past
year defending a currency that is too strong (chart below right). The RMB has
strengthened by 12% against the tri-currency over the past 16 months – something
the authorities should never have allowed. Yet rather than letting it fall back into
line today, the central bank continues to prop it up in the name of stability and
‘being a good soldier’ now that it has been included in the IMF’s SDR basket. It’s a
high price to pay and would not have been necessary had China simply followed a
basket policy for the RMB over the past year like most other countries did.
Asia – change in FX reserves, past 16 months
Asia – change in FX reserves, past 16 months
USDbn, Jun14-Oct15, spot plus forward holdings
% change, Jun14-Oct15, spot plus fwd holdings
34
50
0
0
-50
-38
-100
-19
-3
36
3
15
10
-3
4
5
0
-150
-200
-5
-250
-10
-300
-15
-350
-11
-11
TH
CH
0
0
KR
ID
0
0
PH
TW
-20
-400
-25
-450
-500
12
-30
-468
CH
MY
TH
KR
ID
PH
TW
IN
HK
-28
MY
HK
IN
If they had, reserves would have remained stable – and might have even risen like
they did elsewhere in Asia. The latter fact is an important one that the media
never mentions: excluding China, net capital flows have been positive over the past
16 months, not negative. Modest net outflows from Malaysia and Thailand have
been offset by modest net inflows in India and Hong Kong. Net flows in Korea, the
Philippines, Taiwan and, importantly, Indonesia were square.
Capital inflow may not sell as many papers as fear and loathing do. But it’s still
good to know that Asia enjoys it.
16
Economics–Markets–Strategy
Economics
HH 11: Global trade isn’t going great guns, but much of the slowdown is dollar illusion
Global trade has slowed in 2015. Part of this owes to slower GDP growth of course,
particularly in Asia. Another factor is the ‘double-counting’ of imports and exports
that amplifies swings in the trade statistics. Globalization means an export might
pass through 5 countries, with value being added in each of them before it reaches
its final destination. But while GDP is a ‘final goods’ or ‘value added’ concept,
imports and exports are counted in gross terms. A small swing in global GDP can
bring a big swing in imports and exports because they get counted – and counted
in full – so many more times.
Trade swings are
always twice as
large as economic
swings
But the biggest reason trade looks weak is surely because we measure it in dollars.
Why does this mislead? Because the dollar has soared by 20% over the euro and
yen since mid-2014. That makes any trade denominated in euros or yen (or most
anything else) look 20% smaller than it really is. Central banks run into the same
problem when they count their foreign reserves – in dollar terms, reserves have
shrunk by a lot; in euro or yen terms they’ve risen by a lot.
What to do? Count your reserves or trade (or anything you want) in basket terms
rather than in terms of any single currency. In HH9 and HH10 above, we use the
‘tri-currency’ basket – a simple average of dollars, euros and yen – and find it useful
here too.
G4 – exports in USD and tri-ccy terms
Jan11=100, sa, 3mma
135
5.6%
growth path
130
Tri-ccy
terms
125
120
115
110
105
100
Jan-11
USD terms
Jan-12
Jan-13
Jan-14
Jan-15
Jan-16
When you measure trade in tri-currency terms (red line in chart above) you discover
that global trade (G4 trade, to be precise: exports and imports of the US, EU, JP and
Asia-10) hasn’t really plunged by 12% since mid-2014 like the dollar measure says it
has. Trade continues to grow at the same 5%-6% pace that is has for the past five
years. It’s not gangbusters but it is steady. And positive.
The biggest reason trade looks
weak is because
we measure it in
dollars
The same applies to individual countries like China as it does in the aggregate.
In dollar terms, China’s exports plod along at a 2% growth pace. In tri-currency
terms, growth is a much better 9%-10% (chart in endnote [3]). By both measures,
trade continues to grow. Records aren’t being broken, to be sure, but most of the
weakness people talk about isn’t weakness per se – it’s dollar illusion.
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HH 12: ‘Liquidity’ is one of those technical terms best left to the experts
Markets can’t seem to make up their minds. When they’re going up, it’s because
central banks “have injected large amounts of liquidity” through their QE programs.
When they’re going down, it’s because “there’s no liquidity out there – regulators
have raised capital requirements on banks and restricted their trading activities”.
So which is it? Is there too much liquidity or too little? Or is the term itself just one
of those technical ‘explanations’ as to why markets are going up or down?
Can anyone out
there explain what
‘liquidity’ is?
Mostly the latter. Start with the ‘too much liquidity’ idea. When people think of QE,
they think of the Fed dumping wheelbarrows of cash into the streets of Chicago.
That’s not what’s going on. Or at least that’s not what happened. Most of the
$3200 bn that the Fed supposedly ‘injected’ into the economy never hit the streets
of Chicago, it never found its way into the stock market or fled the US for foreign
shores – it went into straight into the Fed’s basement in the form of excess reserves
held by the banks that the Fed bought its $3200bn of bonds from.
The technical way to see this is to look at the Fed’s balance sheet (chart below).
Ninety percent of all the QE injected into the economy is still sitting in the Fed’s
basement in the form of excess reserves. Rather than lend the money into a weak
and risky economy, banks chose to leave it in the Fed’s basement, safe and sound,
earning 25 basis points per year. Which of course is why growth never took off and
inflation continued to fall and fall and fall instead of go up like so many claimed
it would.
An easier and perhaps more poignant way of seeing this is to look at the M3 money
supply (chart at top of next page). M3 is the biggest, boldest measure of ‘liquidity’
there is. Yet it didn’t grow by a single dollar in the past 4.5 years. Too much
liquidity? Really? M3 today is 30% lower than on the day QE1 was launched.
So maybe there’s isn’t too much liquidity after all. Maybe there is too little, like
everyone said in October when equity markets fell by 10%. It’s those darn regulators
– they’re restricting the trading activities that financial institutions can engage in
and the drop in liquidity is forcing prices down.
It’s an interesting thought. But it’s tough to square with the 14% average rise
in the S&P 500 for the past five years. Did the number of traders suddenly fall in
October? Did they suddenly get re-hired in November when markets recouped
their losses? Not that we’re aware of.
US Fed – balance sheet (liability side)
QE3
Sep12 - Jun14
US$bn
4,500
4,000
QE1
Dec08-Mar10
3,500
QE2
Nov10-Jun11
Op Twist
Sep11-Dec12
3,000
2,500
Excess bank reserves
at the Fed
2,000
1,500
Other liabilities
1,000
Currency in circulation
500
0
Mar-06
18
Mar-07
Mar-08
Mar-09
Mar-10
Mar-11
Mar-12
Mar-13
Mar-14
Mar-15
Economics–Markets–Strategy
Economics
US - M3 money stock
US$bn, seas adj
2,800
2,600
2,400
2,200
QE didn't lift M3 by a
single dollar.
2,000
1,800
1,600
Where is all the money
the Fed "pumped" into
the economy? Sitting in
the Fed's basement.
1,400
1,200
1,000
Jan-07
Jan-08
Jan-09
Jan-10
Jan-11
Jan-12
Jan-13
Jan-14
Jan-15
Still, the argument persists – regulators have cut the number of middle-men in the
market equation. These middle men provide, or at least used to provide, a pool of
liquidity that acts as a ‘shock absorber’ for market prices. Fewer middle-men means
the shock absorber is gone.
Another interesting idea. Still no cigar. The shock-absorber idea implies that, when
prices are falling, middle men take a loss so Mary doesn’t have to. That’s nice of
them. And when prices are rising, they let Bob buy at a lower one than what’s on
the screen. Jeepers, these guys really are swell.
And broke in very short order. Buying high and selling low has never been the key
to success. Eventually, all price stabilization schemes cost money because they lose
money by design. Traders aren’t in business to lose money. No one is.
When prices are
going up, it’s
because there’s
too much liquidity. When they’re
going down, it’s
because there’s
not enough. So
which is it?
Bottom line? Prices don’t fall because there are fewer middle men in the equation.
Prices fall because there are more sellers than buyers.
Which leaves us back where we started. When prices are going up, it’s because
we’re flush with liquidity. Hurray for QE. When prices are going down, it’s because
liquidity has evaporated. Darn those regulators. But both can’t be right. You can’t
have too much and too little liquidity all at the same time. Unless of course liquidity
doesn’t mean anything to begin with. Or, equivalently, whatever we want it to
mean.
HH 13: Outright deflation in the US will wreak havoc in 2016
US retail sales grew solidly in October but not solidly enough to prevent on-year
growth from slipping further than it already had in recent months. Control group
sales, which exclude gasoline (and other currently less relevant items) dropped to
2.7% YoY. If you knock of a point-and-a-half for (core) inflation, you’re looking at
real growth of 1.2% over the past twelve months – pretty paltry.
So how do you get 1.2% real growth in retail sales when you’re getting almost 3.5%
real growth in consumption in the GDP accounts? That’s what Yellen is pointing to
when she talks about an economy “performing well”. What gives?
The difference is not due to services, which don’t factor into retail sales – even
goods consumption in the GDP accounts is running stronger than retail sales. Nor is
it due to low oil prices which boosts growth in real terms – take energy out of the
GDP consumption measure and it still outperforms ‘control group’ retail sales by a
wide margin.
19
Economics
Economics–Markets–Strategy
US - control group retail sales
%YoY
6
5
A big step down
from 2014
4
3
2
Oct15 (c) :
2.7%
1
10
11
12
13
14
15
The reason why goods consumption looks so much better in the GDP accounts is
because goods prices – even core goods prices, which exclude food and energy – are
falling and have been for the past 2.5 years. Instead of deflating nominal growth
rates by inflation to get to real growth, you need to inflate them by the amount the
of deflation. Confusing? Not really.
17% of the US
economy is experiencing outright
deflation. Has
been for 2.5 years.
The Fed hasn’t
mentioned this
once. This is disconcerting
The point is, the Fed’s favorite inflation gauge – core PCE – has been falling for 3.5
years and is now down to a 1.25% YoY pace. The Fed says this is due to the strong
dollar and oil prices. But it doesn’t square. Oil prices don’t enter into the core
calculations and the dollar has been strong for 16 months, not 3.5 years.
The real reason core PCE inflation has been falling for 3.5 years is that the goods
portion of it – which accounts for 17% of GDP – has been in negative territory for
the past 2.5 years (chart below). The economy may be ‘performing well’, as Yellen
claims. But a significant portion of it owes to outright deflation that for some
inexplicable reason the Fed has never mentioned.
This is disconcerting. When real growth is being driven by falling prices, you’re
never sure if the ice you’re skating on is thick or thin. One might have more
confidence in the outlook – and the need for higher interest rates – if the Fed told
us whether they thought the deflation shown below is the good kind or the bad
kind. Rather than ignore it altogether.
US – core PCE deflator inflation
%YoY, 3mma
Core PCE:
falling inflation for
3.5 years
2.5
2.0
1.5
1.0
0.5
0.0
-0.5
Goods portion of core:
outright deflation
for 2.5 years
-1.0
-1.5
-2.0
Jan-10
20
Jan-11
Jan-12
Jan-13
Jan-14
Jan-15
Economics–Markets–Strategy
Economics
Holiday Heresy 14: Asia’s growth may be slowing. But the number of Germanys that Asia is ‘putting on the map’ every year is accelerating. The shift
in economic gravity from West to East is picking up, not slowing down
In very important ways, Asia is speeding up, not slowing down. To be sure, Asia’s
growth rate has slowed. But that’s normal – it’s what happens when incomes go
up, like Asia’s have at a remarkable pace for decades. With luck, Asia’s growth will
be even slower five years from now and slower yet five years after that. It sounds
ironic but when things go right, growth slows down. The best you can do is to
prevent it from slowing more than it must.
Does slower growth mean Asia will lose its attractiveness as a place to invest? Not
in the slightest. Asia is where the world’s growth is being generated today and it
will contribute an even bigger proportion tomorrow. Even with slower growth, the
shift in economic gravity – who is generating the dollars of growth each year – is
accelerating in favor of Asia, not decelerating.
A few numbers may help. Between mid-2008 and mid-2012, Asia did what, back in
2006/07, everyone said would be impossible: it grew, and rapidly, with no help from
the US, Japan or Europe (chart below). Over those four years – in some sense the
front and back of the global financial crisis – Asia grew by 32 percentage points, or
at about a 7.25% annualized rate.
In 25 years, Asia
will be creating an
entire Germany
every 18 months.
Still think slower
growth means
you should invest
elsewhere?
Think again
Real global GDP
2Q08=100, seas adj
132
Asia-10
128
124
120
116
The growth that came
"from nowhere"
112
108
104
US
JP
EU17
100
96
92
Jun-08
Dec-08
Jun-09
Dec-09
Jun-10
Dec-10
Jun-11
Dec-11
Jun-12
If you add up the dollars of growth in that triangle between Asia and the other G3
countries in the chart above, it amounts to the entire GDP of Germany. In short, in
the middle of the biggest financial crisis in 100 years, and with no help from the US,
Japan or Europe, Asia put a Germany on the map, right here in Asia.
Yes, yes – Asia has slowed, as everyone will tell you. But here’s the thing: even with
that slower growth, it doesn’t take Asia 4 years to put a Germany on the map any
more. Today it only takes 3.5 years. Five years from now, it will take only 3 years
and five years after that it will take even less time. Why? Because Asia’s base will
have grown that much bigger.
Think about it: in the 7 years since the collapse of Lehman Brothers, Germany has
grown by about 4% – it has added about 4/100ths of one Germany to the world’s
economic map. Asia has put two entire Germanys on the map in the same amount
21
Economics
Economics–Markets–Strategy
of time. And, as mentioned, the time it takes to do this grows shorter every year.
Twenty five years from now, in 2039, Asia will be producing a Germany every 18
months.
Still think slower growth means you ought to invest elsewhere? Think again. The
simplest rule for any business is: go where the growth is. That’s Asia today. ‘Twill be
Asia all the more so tomorrow.
Forward to 2016
As often happens with the Heresies, we run a bit overboard. But it was a big year
and next year could be even bigger.
Best of luck in 2016.
Notes:
[1]For more detail, see “Asia: arresting the Great Investment Slowdown”, DBS Group
Research, June 5, 2014.
[2]Asia – net external debt and net International invst position ("net wealth")
percent of GDP
Net external debt*
(neg sign indicates debt)
% of GDP
Korea
Thailand
Malaysia
Indonesia
Philippines
India
China
HK
Taiwan
Spore
Crisis-4**
1997
2001
2014
2001
2014
-29
-67
-27
-57
-45
-18
-3
-32
-19
-66
-56
-14
-3
8
-32
-23
-6
-7
-11
-44
-38
-71
-49
-14
6
-25
-1
-49
-14
-17
-3
#N/A
#N/A
#N/A
3
#N/A
#N/A
#N/A
28
#N/A
#N/A
#N/A
4
155
67
72
20
283
178
174
-45
-30
-12
-41
-17
* Debt less foreign reserve holdings
** TH, MY, KR, ID
22
Net Intl Invst Position
("Net wealth")
% of GDP
Economics–Markets–Strategy
Economics
Notes (con’t):
[3] China – exports in USD and Tri-currency terms
Jan11=100, sa, 3mma, (tri-ccy is a simple USD, EUR, JPY basket)
170
Tri-ccy terms
10% growth path
160
150
140
130
120
110
USD terms
2% growth path
100
90
11
12
13
14
15
16
Sources:
Except where noted, data for all charts and tables are from CEIC Data, Bloomberg,
and DBS Group Research (forecasts and transformations).
23
Currencies
Economics–Markets–Strategy
FX: more volatility
Asia
Expect more volatility when US rates rise
Stability will return later in the year as the global economic recovery becomes more balanced and synchronized
Calling a top in the USD remains premature
CNY
Capital outflow persists
HKD
Not ready to peg to the CNY
TWD
Still competitive
KRW
Aligned with peers
SGD
Always a price-taker
MYR
Less volatile but still weak
THB
Moving in line with Asia
IDR
Better. But still vulnerable
PHP
Depreciating reluctantly
VND
Another 2% devaluation possible
INR
Bracing for US-led volatility
USD
Stronger still
EUR
Targeting a weaker REER
JPY
Banking on a higher USD
AUD
Drifting lower with ASEAN+3
NZD
Targeting a weaker TWI
Performance in 2015 – USD strong across-the-board
20
10
MAJOR CURRENCIES
EMERGING ASIAN CURRENCIES
9.1
0.2
0
0.1
-2.6
-10
-3.3
-3.6
-10.0
-11.7
-20
-4.0
-5.7
-14.5 -14.8
-4.9
-5.0
-5.9
-7.3
-8.6
-10.7
-16.4
-17.9
-20.7
% change vs USD,
31 Dec 14 to 8 Dec 2015
-30
-30.0
* USD is performance of DXY index
Philip Wee • (65) 6878 4033 • [email protected]
24
MYR
IDR
THB
KRW
SGD
PHP
VND
TWD
HKD
BRL
ZAR
RUB
INR
CNY
NZD
CAD
AUD
EUR
GBP
JPY
CHF
-40
USD
CURRENCIES
BRICS
USD
CHF
JPY
GBP
EUR
AUD
CAD
NZD
CNY
INR
RUB
ZAR
BRL
HKD
TWD
VND
PHP
Economics–Markets–Strategy
Currencies
Currency forecasts
EUR /usd
usd/ JPY
usd/ CNY
usd/ HKD
usd/ TWD
usd/ KRW
8-Dec
1Q16
2Q16
3Q16
4Q16
1.0893
1.07
1.05
1.03
1.04
Previous
Consensus
1.08
1.05
1.06
1.04
1.04
1.05
1.04
1.05
122.90
123
124
126
125
Previous
Consensus
120
124
121
124
122
125
122
125
6.4172
Previous
Consensus
6.45
6.45
6.48
6.49
6.49
6.50
6.52
6.52
6.55
6.50
6.50
6.60
7.7497
7.76
7.76
7.76
7.76
Previous
Consensus
7.76
7.76
7.76
7.76
7.76
7.76
7.76
7.76
32.924
Previous
Consensus
33.0
33.0
33.5
33.4
33.4
33.6
33.8
33.8
33.8
33.6
33.7
33.8
1,179.5
1,193
1,223
1,212
1,242
1,232
1,262
1,222
1,257
1,200
1,210
1,210
1,216
Previous
Consensus
usd/ SGD
usd/ MYR
usd/ THB
usd/ IDR
usd/ PHP
usd/ INR
usd/ VND
AUD /usd
NZD /usd
1.4083
1.43
1.45
1.47
1.46
Previous
Consensus
1.43
1.44
1.45
1.45
1.47
1.46
1.46
1.47
4.2550
4.37
4.50
4.64
4.57
Previous
Consensus
4.35
4.38
4.36
4.36
4.37
4.38
4.37
4.40
35.960
36.5
36.9
37.4
37.2
Previous
Consensus
36.5
36.8
36.9
37.0
37.4
37.2
37.3
37.1
13,870
14,450
14,830
15,200
15,000
Previous
Consensus
14,450
14,250
14,830
14,475
15,200
14,613
14,640
14,700
47.120
47.5
48.0
48.4
48.2
Previous
Consensus
48.4
47.5
48.8
47.8
49.3
47.9
49.1
48.2
66.835
67.5
68.6
69.6
69.1
Previous
Consensus
67.5
66.9
68.6
67.0
69.6
67.1
69.4
67.1
22,460
22,620
22,725
22,840
22,960
Previous
Consensus
22,500
22,569
22,500
22,750
22,500
22,813
22,500
22,875
0.7214
0.69
0.67
0.65
0.66
Previous
Consensus
0.69
0.69
0.68
0.69
0.67
0.69
0.67
0.69
0.6642
0.64
0.61
0.58
0.60
Previous
Consensus
0.60
0.63
0.59
0.62
0.58
0.62
0.62
0.62
DBS forecasts in red. Consensus are median forecasts by Bloomberg as at 8 Dec vs previous as at 9 Sep
25
Currencies
Economics–Markets–Strategy
DXY (USD) index during Fed hike cycles
180
45
DXY (USD) index
160
140
(left)
40
Red segments denote Fed hike periods
35
120
30
100
25
80
20
60
15
Fed Funds Rate
40
10
(% pa, right)
20
5
0
0
70
75
80
85
90
95
00
05
10
15
20
Making sense of the USD and Fed rate hike cycles
The Federal Reserve is widely expected to lift interests on 16 Dec for the first time
since Jun 2006. It remains unclear whether this will be positive or negative for the
US dollar, as measured by the DXY (USD) index.
• After the end of Bretton Woods in 1971, there were four cycles where the DXY
appreciated, and five where it fell.
• During the most aggressive hike cycle in 1976-79, the DXY fell by as much as 20%.
Back then, the Fed was struggling to regain its inflation-fighting credentials.
• Conversely, the DXY appreciated steadily during the brief US hike cycles in 1980
and 1984. The Fed Funds Rate was high at double-digit levels then. The USD was
so strong that the G7 nations needed policy coordination (Plaza Accord in 1985)
to bring it down.
• There were also mixed cycles (1999-00 and 2004-06) where the DXY depreciated
first before appreciating.
US hike cycles where DXY Appreciated
US hike cycles where DXY Depreciated
% change in DXY
% change in DXY
14
5
Mar88Feb89
12
0
10
8
6
Jun99May00
Aug80Dec80
4
2
Jun04Jun06
-5
Mar84Aug84
-10
Dec86Sep87
-15
0
-2
Feb94Feb95
Mar72Aug73
-20
-4
-25
-6
0
26
Dec76Oct79
3M
6M
9M
1Y
0
1Y
2Y
3Y
4-J
5-J
6-J
7-J
8-J
11-J
12-J
13-J
14-J
15-J
18-J
19-J
20-J
21-J
22-J
25-J
26-J
27-J
28-J
Economics–Markets–Strategy
Currencies
DXY (USD) index, Fed hikes and the Gold cycle
180
1800
DXY (USD) index
160
(left)
1600
140
Red segments denote Fed hike periods
1400
120
1200
100
1000
80
800
Gold prices
60
600
40
400
20
200
0
0
70
75
80
85
90
95
00
05
10
15
20
The strong USD environment today resembles the early 1980s and the late 1990s.
Similar to those periods, today’s monetary policy is more hawkish compared to the
other large economies. Today, this is known as monetary policy divergences. Both
Japan and the Eurozone launched quantitative easing programs (that weakened
their currencies) in Apr 2013 and Mar 2015 respectively, which were subsequently
expanded in Oct 2014 and Dec 2015. Since Nov 2014, China has cut interest rates,
lowered its reserve requirement ratio, and delivered in Aug 2015, a one-off
devaluation in the CNY.
Against this background, the USD appreciated on a real effective exchange rate
(REER) basis, initially against the major currencies. This spilled over negatively
into the currencies of its other important trading partners, creating stress in the
commodity and emerging markets. Like the early 1980s, gold prices fell as the USD
regained its credibility as a global reserve currency. Like the late 1990s, oil prices are
low today due to weak demand led by Asia. Hence, it is may be premature to try
to predict a top for the USD. Even so, there is scope for the USD to give back some
gains if the global growth outlook becomes more balanced and synchronized in 2H
2016.
ECB's monetary conditions index (MCI)
USD REER – major currencies a drag on others
Mar73=100
2
140
Other important
trading partners
MCI – real
interest rates
MCI – real
exchange rate
1
130
0
Major
currencies
120
-1
110
QE
-2
100
90
-3
80
-4
Monetary
Conditions
Index (MCI)
G7 asked to help
support euro
QE
-5
70
70
75
80
85
90
95
00
05
10
15
20
99
01
03
05
07
09
11
13
15
27
Currencies
Economics–Markets–Strategy
Most AXJ currencies returned their post-GFC gains
Most AXJ equities retained their post-GFC gains
% change vs USD
% change from crisis low in local currency terms
70
60
Gains returned
450
Gains retained
400
50
as at 4 Dec 2015
40
Gains returned
Gains retained
350
as at 4 Dec 2015
300
30
250
20
200
10
150
0
-10
100
-20
50
-30
0
KR
ID
IN
MY
SG
TH
TW
PH
CN
ID
HK
PH
TH
IN
CN
HK TW
KR
SG
MY
Asia ex-Japan FX – buckle up
2016 will be another challenging year for Asia ex Japan (AXJ) currencies.
Over the past three years, emerging market volatility has been reflected mostly in
the exchange rates and not equities. Most AXJ currencies have returned more than
half of their post-2008 crisis gains by early Dec 2015. The worst currencies (INR, IDR
and MYR) returned all gains and depreciated to new lows. These currencies were
highly indebted and vulnerable to higher US borrowing costs i.e., a stronger USD
and rising US rates.
Don’t expect the first Fed hike to be a “buy the rumor, sell the fact” outcome like
the relief rally after the first Fed taper in Dec 2013. Short-term US interest rates (3M
Libor) will not fall and stay low like they did during the taper in 2014. They have
been rising ahead of the Fed rate lift-off expected on 16 Dec, and are likely to keep
increasing into next year. Our baseline scenario sees the Fed normalizing monetary
policy with one hike per quarter in 2016, which has yet to be discounted by interest
rate futures.
Will emerging markets underestimate Fed?
% pa
1.50
Fed's baseline
for FFR
1.25
Malaysia & Indonesia sovereign spreads
% pa
1.50
0.50
1.25
0.45
3M futures
1.00
1.00
0.40
0.75
0.75
0.35
0.50
0.30
FFR
futures 0.25
0.25
0.00
0.20
3M USD Libor
0.50
0.25
Fed Funds Rate
0.00
09
28
10
11
12
EM
vol
EM
vol
13
14
15
16
17
5Y credit default swap, bps
300
2-Jan-09
5-Jan-09
6-Jan-09
7-Jan-09
8-Jan-09
9-Jan-09 MY CDS
12-Jan-09 (right)
13-Jan-09
14-Jan-09
15-Jan-09
16-Jan-09
19-Jan-09
20-Jan-09
Taper tantrums
21-Jan-09
1322-Jan-09
14
250
ID CDS
(right)
200
150
100
3M Libor
(left)
MP divergences
15
50
0
IN
CN
HK
TW
Economics–Markets–Strategy
Currencies
AXJ – negative exports, low inflation
BIS REER as at Oct 2015
% YTD in 2015; X-axis: CPI inflation; Y-axis: Exports
Standard deviation above average
10
3
+ve inflation
-ve inflation
+ve
exports
5
MYR
0
THB
SGD
TWD
-10
2.2
1.8
2
1.8
overvalued
1.3
1
0.2
HKD
CNY
-5
2.5
0.1
0.1
0
PHP
-ve
exports
KRW
-1
-0.8
-2
IDR
-15
INR
-20
undervalued
-3
-4
-4
-2
0
2
4
6
8
-3.6
CN
IN
TH
PH
SG
KR
HK
ID
TW MY
There is one critical difference between this Fed hike cycle and those in the past.
Higher US rates are coming at a time when emerging Asian economies are struggling
with weak exports and low inflation. The world economy has consistently fallen short
of the IMF’s forecasts after the V-shaped recovery in 2010. In USD terms, Eurozone
and Japan did not contribute to the world economy because of significantly weaker
exchange rates from quantitative easing policies. Neither does it help that China
will be guiding economic growth to a slower 6.5% pace, accompanied by more CNY
depreciation, during its 13th Five Year Plan (2016-2020).
Against their dampened fundamentals, the real effective exchange rates (REER)
of CNY, INR, THB, PHP and SGD are considered overvalued with room for more
downside correction. While its REER is considered undervalued relative to its
better exports and inflation, we remain cautious on the MYR. In Fitch’s assessment,
Malaysia and Indonesia stood out from their peers as most vulnerable to external
risks. After the 2008 crisis, both countries accummulated external debt at a pace that
was equivalent or exceeded their present levels of foreign reserves. Hence, it should
not come as a surprise why sovereign credit default swaps in Indonesia and Malaysia
have been rising with the 3M Libor this year.
Asia's highly indebted economies
Global economy disappointing since 2011
USD billion
Latest FX reserves
World real GDP, % YoY
Malaysia
5.5 Indonesia
Actual growth
India
5.0
5.1
Latest external debt
4.5
500
400
Post-crisis rise in ext debt
IMF forecast
4.2
4.0
300
3.8
4.0
3.5
200
3.9
3.1
3.4
3.0
100
3.6
3.3
3.6
3.6
3.4
3.1
2.5
2.0
0
Malaysia
Indonesia
India
2010
2011
2012
2013
2014
2015
2016
29
Currencies
Economics–Markets–Strategy
US dollar
DXY is looking to break above 100 on monetary
policy divergences
At the time of writing, the Fed signalled its
intention to start, on 16 Dec, lifting the Fed Funds
Rate (FFR) from 0-0.25%. Once this happens, we
believe that another four hikes will follow in
2016, at a gradual pace of one hike per quarter.
The Fed’s baseline scenario is for FFR to rise to
3.25-4% by 2018. Measured against its 2-2.5%
inflation outlook target, this implies a preference
for the real FFR to be at least 75 bps. Historically,
Fed hikes often turned out as “buy the rumor, sell
the fact” plays for the USD. The greenback would
appreciate into the first hike and depreciate once
it materialized. Except that the circumstances today
are different in several regards. First, the global
recovery is uneven and unsynchronized. China is
slowing, Japan’s economy has been struggling
after the sales tax hike in Apr 2014, and Europe is
fighting deflation. All three have dovish monetary
policies that kept their exchange rates weak. In the
emerging economies, there are some misgivings
that Fed hikes are coming at a time when trade/
manufacturing activities are weak. Rating agencies
are concerned that the more indebted ones will
struggle with rising US rates and a higher USD.
DXY index – higher first before stabilizing
110
110
DBSf
Consensus
105
105
100
100
95
95
90
90
85
85
80
80
75
75
70
70
08
09
10
11
12
13
14
15
16
DXY
DBS
Previous
Consensus
8-Dec
98.474
1Q16
102.5
98.2
100.9
2Q16
104.0
99.5
101.6
3Q16
105.5
98.8
101.2
4Q16
105.1
98.5
100.9
Policy, %
8-Dec
0.25
1Q16
0.75
0.75
0.50
2Q16
1.00
1.00
0.70
3Q16
1.25
1.25
0.85
4Q16
1.50
1.50
1.05
DBS
Previous
Consensus
Euro
EUR/USD to remain soft in the lowest quartile of
its descending price channel
The weakness of the EUR is policy-driven. The
objective of the central bank’s (ECB) quantitative
easing (QE) program launched on 5 Mar is to ease
monetary conditions via a weaker real exchange
rate. On 3 Dec, the duration of the QE program was
extended to Apr 2017 from Sep 2016. Maintaining
asset purchases at a monthly pace of EUR 60bn,
this would, by default, expand the program by
37% to EUR 1.56trn from EUR 1.14trn. The deposit
rate was further lowered by another 10 bps to
-0.30%, while asset purchases were broadened
to include local and regional debt. With the Fed
set to start lifting US rates on 16 Dec into 2016,
this policy divergence should keep EUR/USD on its
downward trajectory into a lower 1.00-1.05 range
next year. Unlike 2015, the key political risk to watch
for in 2016 is not Grexit but UK’s referendum on
Brexit. This could hurt both the GBP and EUR next
year, especially if the British government decides
to hold it in mid-2016 instead of 2017. If so, the
market’s hope for a UK rate hike in 1H 2016 may
evaporate. Speculation should also return for the
ECB to consider fresh stimulus by increasing the
monthly pace of its asset purchases.
30
EUR/USD – policy bias remains weakness
1.60
1.60
1.50
1.50
DBSf
Consensus
1.40
1.40
1.30
1.30
1.20
1.20
1.10
1.10
1.00
1.00
0.90
0.90
08
09
EUR /usd
DBS
Previous
Consensus
Policy, %
DBS
Previous
Consensus
10
11
12
13
14
15
16
8-Dec
1.0893
1Q16
1.07
1.08
1.05
2Q16
1.05
1.06
1.04
3Q16
1.03
1.04
1.05
4Q16
1.04
1.04
1.05
8-Dec
0.05
1Q16
0.05
0.05
0.05
2Q16
0.05
0.05
0.05
3Q16
0.05
0.05
0.05
4Q16
0.05
0.05
0.05
Economics–Markets–Strategy
Currencies
Japanese yen
Lacking direction and conviction, USD/JPY is likely
to keep to 116-125 range
If USD/JPY ends 2015 above 120, the JPY would
have depreciated for four straight years. Even
so, the 2.6% YTD depreciation as at 8 Dec was
paltry compared to the average annual 11.9% fall
in 2012-14. Unlike 2014, the central bank (BOJ)
did not expand its quantitative and qualitative
easing (QQE) program after the economy entered
temporarily into a technical recession in 2015. The
preliminary -0.8% QoQ saar growth in 3Q15 was
revised up to +1.0%. Hence, the Abe government
is under pressure to push structural reforms rather
than rely continuously on QQE and a weak JPY to
support growth and lift inflation. With the real
effective exchange rate (REER) very weak, Japan
can no longer justify correcting the JPY’s excessive
strength. Instead, the Abe cabinet is planning another
supplementary budget. The key policy focus for 2016
will be to encourage corporates to lift investment
and hike wages. To achieve this, Japan plans to
lower the corporate tax rate to below 30% w.e.f.
Apr 2016. The tax rate was lowered in the current
fiscal year to 32.1% from 34.6%. Unless emerging
economies falter and trigger more QQE, USD/JPY is
likely to be stably underpinned by rising US rates.
USD/JPY – flat without QQE3
140
140
EM
volatility
130
130
120
120
110
DBSf
Consensus
QQE1
QQE2
100
100
EM
volatility
90
110
90
80
80
70
70
12
13
usd/ JPY
DBS
Previous
Consensus
Policy, %
DBS
Previous
Consensus
14
15
16
8-Dec
122.90
1Q16
123
119
124
2Q16
124
120
124
3Q16
126
121
125
4Q16
125
122
125
8-Dec
0.10
1Q16
0.10
0.10
0.10
2Q16
0.10
0.10
0.10
3Q16
0.10
0.10
0.10
4Q16
0.10
0.10
0.10
Chinese yuan
USD/CNY to keep rising in the upper half of its
ascending price channel
The CNY is expected to depreciate against the USD
for a third straight year in 2016. Capital outflows
were more important than current account surpluses
in driving the CNY weaker in 2014 and 2015. It was
no coincidence that the one-way appreciation bet in
the CNY ended in 2014, the year China first became
a net exporter of capital. The one-off devaluation in
the CNY on 11 Aug probably affirmed that overseas
direct investments are likely to keep surpassing
foreign direct investment over the next five years.
China has ambitions to promote the use of the CNY
for trade and investment purposes in its “One Belt,
One Road”, a key initiative of its 13th Five-Year
Plan (2016-2020). To this end, the International
Monetary Fund’s (IMF) decision on 30 Nov to include
the CNY into its Special Drawing Rights (SDR) was
an important first step to lift the CNY’s status as
a global reserve currency. Joining the SDR also
meant that China is now committed to foster an
increasingly market-determined CNY. On balance,
USD/CNY is likely to align itself to the globally strong
USD trend, while reflecting its relative strength on
a trade-weighted basis. Put simply, USD/CNY’s rise
is likely to be muted than aggressive.
USD/CNY – resuming uptrend
6.90
6.90
6.80
6.80
6.70
DBSf
Consensus
6.60
6.70
6.60
6.50
6.50
6.40
6.40
6.30
6.30
6.20
6.20
6.10
6.10
6.00
6.00
10
usd/ CNY
DBS
Previous
Consensus
Policy, %
DBS
Previous
Consensus
11
12
13
14
15
16
8-Dec
6.4172
1Q16
6.45
6.45
6.48
2Q16
6.49
6.49
6.50
3Q16
6.52
6.52
6.55
4Q16
6.50
6.50
6.60
8-Dec
4.35
1Q16
3.85
4.10
4.20
2Q16
3.85
3.85
4.05
3Q16
3.85
3.85
4.05
4Q16
3.85
3.85
4.05
31
Currencies
Economics–Markets–Strategy
Hong Kong dollar
USD/HKD stays near the floor of its 7.75-7.85
convertibility band
Speculation about the HKD peg to the USD is unlikely
to subside in 2016. The central bank (HKMA) has
intervened in 2015 to support USD/HKD at the floor
of its 7.75-7.85 convertibility band. Although the
CNY is now included in the International Monetary
Fund’s (IMF) Special Drawing Rights (SDR), the HKD
is not ready to shift its peg from the USD to the CNY.
In reality, increasing the capital account convertibility
of the CNY is a necessary but insufficient condition
for the HKD to abandon the USD. More importantly,
the CNY needs to integrate with the global financial
system first. This is a process that China is showing
no signs of rushing at the expense of financial
stability. It will take time to create offshore CNY
financial markets with sufficient depth, breadth
and liquidity to provide the territory with the CNY
assets need to back a HKD peg to the CNY. After
the unanticipated CNY devaluation on 11 Aug, CNY
deposits in Hong Kong has fallen to CNY 845bn from
CNY 994bn between Jul15 and Oct15. Instead of the
HKD peg, the HKMA is probably more concerned
about the risks to the property sector from rising
US interest rates, a slowing China economy, and
more residential homes coming on stream.
USD/HKD – comfortable in lowest quartile of band
7.90
7.90
7.85
7.85
7.80
7.80
7.75
7.75
DBSf
Consensus
7.70
7.70
10
11
usd/ HKD
DBS
Previous
Consensus
Policy, %
DBS
Previous
Consensus
12
13
14
15
16
8-Dec
7.7497
1Q16
7.76
7.76
7.76
2Q16
7.76
7.76
7.76
3Q16
7.76
7.76
7.76
4Q16
7.76
7.76
7.76
8-Dec
0.39
1Q16
0.75
0.95
0.79
2Q16
1.00
1.20
0.96
3Q16
1.25
1.35
1.11
4Q16
1.50
1.50
1.31
Taiwan dollar
USD/TWD to keep moving up in an ascending
price channel
USD/TWD – uptrend holding up
The TWD is expected to keep depreciating in 2016. Taiwan’s record trade and current account surpluses
did not reflect reflect strength but weakness. Due to
low oil prices and weak external demand, especially
from China, imports fell faster than exports. The
contraction in total trade, the first since the 2009
global crisis, was sufficient to push real GDP growth
into the negative territory (-0.6% YoY) in 3Q15. CPI
inflation was also negative for the third straight
quarter in 3Q15. Against this difficult background,
the central bank (CBC) lowered on 24 Sep, for the
first time since Jun 2009, its policy rate by 12.5 bps
to 1.75%. Looking ahead, cross-straits relations,
while unlikely to roll back, are not expected to
improve after the elections on 16 Jan. According
to the latest polls, Tsai Ing-wen of the opposition
pro-independent Democratic Progress Party (DPP)
is expected to become Taiwan’s first democratically
elected female president. Given China’s global clout,
diplomatic isolation has already led Taiwan to fall
behind its competitors in establishing free trade
agreements. Hence, Taiwan is expected to keep
USD/TWD tightly aligned to the globally strong
USD trend, especially against Asian currencies.
35
32
36
DBSf
Consensus
36
35
34
34
33
33
32
32
31
31
30
30
29
29
28
28
27
27
26
26
09
10
usd/ TWD
DBS
Previous
Consensus
Policy, %
DBS
Previous
Consensus
11
12
13
14
15
16
8-Dec
32.924
1Q16
33.0
32.6
33.5
2Q16
33.4
33.0
33.6
3Q16
33.8
33.4
33.8
4Q16
33.6
33.8
33.8
8-Dec
1.75
1Q16
1.63
1.75
1.65
2Q16
1.63
1.75
1.65
3Q16
1.63
1.75
1.65
4Q16
1.63
1.75
1.70
Economics–Markets–Strategy
Currencies
Korean won
USD/KRW to rise along and around the middle of
its ascending price channel
Expect the KRW to stay competitive in 2016. Policies
are aligning to support growth and improve the
competitiveness of the Korean economy. To achieve
its 3% growth target for 2016, the government
is once again relying on domestic demand and
supplementary fiscal stimulus. To support consumer
spending, the central bank (BOK) signalled that it
would not follow the US in hiking rates. Barring
a shock in the emerging economies, the BOK is
unlikely to lower rates again due to the high level of
household debt. The BOK noted that the looming US
hikes are coming at a time when trade/manufacturing
activities are weak in emerging economies. On the
broader economy, policymakers are less concerned
about the slowdown in China than they are about
Chinese companies closing their technological gap
with their Korean counterparts. Hence, they are
promoting deregulation to encourage industries
to develop futuristic technologies as new growth
engines. Some examples include self-driving cars,
the Internet of Things, 3D printing and smart home
solutions. Even so, these are longer term strategies.
In the immediate term, the KRW will stay aligned
with the currencies of its major trading partners.
USD/KRW – uptrend is volatile
1350
DBSf
Consensus
1300
1350
1300
1250
1250
1200
1200
1150
1150
1100
1100
1050
1050
1000
1000
10
11
usd/ KRW
DBS
Previous
Consensus
Policy, %
DBS
Previous
Consensus
12
13
14
15
16
8-Dec
1,179
1Q16
1,193
1,223
1,200
2Q16
1,212
1,242
1,210
3Q16
1,232
1,262
1,210
4Q16
1,222
1,257
1,216
8-Dec
1.50
1Q16
1.50
1.75
1.40
2Q16
1.50
1.75
1.40
3Q16
1.50
1.75
1.40
4Q16
1.50
1.75
1.40
Singapore dollar
USD/SGD to rise in the upper half of an ascending
price channel
As a price-taker in global markets, the SGD should
remain weak in 2016. Monetary policy divergences,
namely US rate hikes vs more quantitative easing
in the Eurozone, are expected to support the USD
against the currencies of Singapore’s major trading
partners. The market’s expectation for USD/SGD to
head higher is reflected by higher SG interest rates
over their US counterparts. Barring unforeseen shocks,
especially in emerging economies such as China,
Indonesia and Malaysia, the central bank (MAS) is
likely to maintain the status quo on its exchange
rate policy. The slope of the SGD nominal effective
exchange rate (NEER) policy band was flattened
twice (on 28 Jan and 15 Oct) in 2015. According to
our model, the policy band is now appreciating at
a near-neutral pace of 0.5% a year compared to 2%
at the start of 2015. Keeping the band unchanged is
consistent with the official forecast for 2016 growth/
inflation to move at roughly the same pace as 2015.
The Ministry of Trade and Industry forecast growth
of 1-3% in 2016 vs a projected 2% for 2015. The
MAS sees CPI inflation falling between -0.5% and
+0.5% in 2016 vs -0.5% in 2015, and core inflation
at 0.5-1.5% from 0.5% for the comparable periods.
USD/SGD – uptrend intact
1.60
1.60
1.55
DBSf
Consensus
1.50
1.55
1.50
1.45
1.45
1.40
1.40
1.35
1.35
1.30
1.30
1.25
1.25
1.20
1.20
1.15
1.15
09
usd/ SGD
DBS
Previous
Consensus
Policy, %
DBS
Previous
Consensus
10
11
12
13
14
15
16
8-Dec
1.4083
1Q16
1.43
1.43
1.44
2Q16
1.45
1.45
1.45
3Q16
1.47
1.47
1.46
4Q16
1.46
1.46
1.47
8-Dec
1.08
1Q16
1.40
1.15
1.32
2Q16
1.60
1.25
1.40
3Q16
1.80
1.40
1.37
4Q16
1.95
1.50
1.38
33
Currencies
Economics–Markets–Strategy
Malaysian ringgit
USD/MYR to move up in the upper half of its
ascending price channel
The multiple factors that led the MYR to become
the worst performing Asian currency in 2016 have
not gone away. The sale of 1Malaysia Development
Bhd’s (1MDB) energy arm to a China company for
MYR 9.83bn will not end the leadership challenges
confronting PM Najib Razak. The budget deficit is
still vulnerable to another fall in oil prices hurting
government revenue. More importantly, USD/MYR
has not decoupled from the higher USD trend in
the region. While short-term external debt fell to
$85bn in 3Q15 from its peak of $112bn a year ago,
it is still high compared to foreign reserves (Oct15:
$94bn). Not good when the USD starts rising with
US rates. Hence, the risk for USD/MYR to test the
4.6805 high hit during the 1997/98 Asian crisis
cannot be totally dismissed. In fact, the real effective
exchange rate (REER) has already fallen to 84.25
in Sep15, worse than the 84.93 low seen during
the Asian crisis in Jan98. In this regard, the MYR is
considered undervalued. Unfortunately, the MYR
is still beset by a confidence crisis. Overall, USD/
MYR is unlikely to repeat the sharp surge seen in
Aug-Sep 2015, and move up in the upper half of
its ascending price channel.
USD/MYR – premature to call an end to uptrend
4.80
4.80
4.60
4.60
4.40
4.40
4.20
4.20
4.00
4.00
3.80
3.80
DBSf
Consensus
3.60
3.60
3.40
3.40
3.20
3.20
3.00
3.00
2.80
2.80
11
12
usd/ MYR
DBS
Previous
Consensus
Policy, %
DBS
Previous
Consensus
13
14
15
16
8-Dec
4.2550
1Q16
4.37
4.35
4.38
2Q16
4.50
4.36
4.36
3Q16
4.64
4.37
4.38
4Q16
4.57
4.37
4.40
8-Dec
3.25
1Q16
3.25
3.25
3.20
2Q16
3.25
3.25
3.20
3Q16
3.25
3.25
3.20
4Q16
3.25
3.25
3.25
Thai baht
USD/THB to keep rising in the upper half of its
ascending price channel
USD/THB – rise to slow after sharp move up
USD/THB has been rising in an ascending price channel
after it bottomed in Apr 2013. The two periods that
propelled USD/THB from the floor to the ceiling
of this channel were blamed on emerging market
(EM) volatility rather than Thailand’s lacklustre
fundamentals. EMs were nervous ahead of the Fed
taper that started in Dec 2013, and ahead of the US
rate lift-off expected in Dec 2015. Unlike 2014-15,
USD/THB may not consolidate into the lower half
of the channel this time around. US interest rates
will not stay low like it did after the EM volatility
in 2013, and keep rising into 2016. The Eurozone
is keeping EUR weak with its quantitative easing
program. With monetary policy divergences keeping
the USD globally strong, the market-determined
CNY is likely to weaken against the USD. Against
this background, the central bank (BOT) is no longer
looking to lower rates again. Instead, the BOT is
banking on public infrastructure construction to
underpin the economic recovery in the next couple
of years, and open the door to normalize monetary
policy. Put simply, the BOT will probably be preoccupied with stability too when it keeps the THB
aligned with its weaker Asian peers.
39
34
40
40
DBSf
Consensus
39
38
38
37
37
36
36
35
35
34
34
33
33
32
Monetary
policy
divergences
31
30
29
10
usd/ THB
DBS
Previous
Consensus
Policy, %
DBS
Previous
Consensus
11
12
13
14
31
30
29
Taper
tantrums
28
32
28
15
16
8-Dec
35.960
1Q16
36.5
36.5
36.8
2Q16
36.9
36.9
37.0
3Q16
37.4
37.4
37.2
4Q16
37.2
37.3
37.1
8-Dec
1.50
1Q16
1.50
1.50
1.45
2Q16
1.50
1.50
1.40
3Q16
1.50
1.50
1.40
4Q16
1.50
1.75
1.45
Economics–Markets–Strategy
Currencies
Indonesian rupiah
USD/IDR to grind higher in the lower half of its
ascending price channel
2016 is likely to remain challenging for the IDR.
Its recovery in Oct 2015 should not be viewed
as a reversal of its downtrend. Instead, the IDR’s
appreciation was part of a relief rally in emerging
markets from receding Fed hike expectations.
Unfortunately, this turned out to be short-lived.
The Fed is now widely expected to start its longawaited rate lift-off on 16 Dec, which is likely to be
followed by a gradual US rate hike cycle of 25 bps
per quarter. This has prompted the central bank (BI)
to consider rescheduling, in 2016, its monetary policy
meetings after the FOMC meetings. Clearly, BI will
continue to prioritize stability over growth in setting
monetary policy, by cooling inflation and keeping
the current account deficit narrow. Instead of cutting
rates, BI sought to encourage more bank lending
by lowering banks’ statutory reserve requirements
to 7.50% from 8.00%, and the interest it pays their
reserve requirement deposits to 2.50% from 3.00%,
both with effect from 1 Dec. Politicians pushing
for rate cuts to boost growth should realise that
the 3M Jibor has already breached BI’s reference
rate at 7.50% on 26 Aug, and extended its rise to
8.67% on 8 Dec.
USD/IDR – back in lower half of price channel
16000
16000
15000
15000
14000
14000
DBSf
Consensus
13000
12000
12000
Monetary
policy
divergences
11000
10000
11000
10000
Taper
tantrums
9000
13
14
usd/ IDR
DBS
Previous
Consensus
Policy, %
DBS
Previous
Consensus
13000
9000
15
16
8-Dec
13,870
1Q16
14,450
14,450
14,250
2Q16
14,830
14,830
14,475
3Q16
15,200
15,200
14,613
4Q16
15,000
14,640
14,700
8-Dec
7.50
1Q16
7.50
7.50
7.30
2Q16
7.50
7.50
7.20
3Q16
7.50
7.50
7.10
4Q16
7.50
7.50
7.05
Philippine peso
USD/PHP to rise in the upper half of its ascending
price channel
While the PHP did not buck the depreciation in
emerging market currencies, it held up better than
many of its peers in 2015 due to positive investor
sentiment. Fitch upgraded, on 24 Sep, the country’s
sovereign debt rating outlook to “positive” from
“stable”. The central bank (BSP) did not join its peers
in lowering its 4% policy rate when CPI inflation fell
below its 2-4% inflation target from May15. Real
GDP growth did not slip below 5% YoY in any of
the quarters in 2015. Domestic demand helped to
offset the weakness in exports, but this led to higher
imports and a wider trade deficit. This was not a
concern as long as overseas foreign worker (OFW)
remittances kept the current account in surplus. In
fact, the Philippines was one of the few countries
where the current account surplus covered shortterm external debt. Hence, the country is considered
resilient to a higher USD from rising US rates.
Looking ahead, the presidential election on 9 May
2016 will be closely watched. While not expected
to repeat the stellar economic performance under
the current leadership, the next presidency is still
expected to keep the country on its growth path.
USD/PHP – rising reluctantly
50
50
DBSf
Consensus
49
49
48
48
47
47
46
46
45
45
44
44
43
43
42
42
41
41
40
40
09
10
usd/ PHP
DBS
Previous
Consensus
Policy, %
DBS
Previous
Consensus
11
12
13
14
15
16
8-Dec
47.120
1Q16
47.5
48.4
47.5
2Q16
48.0
48.8
47.8
3Q16
48.4
49.3
47.9
4Q16
48.2
49.1
48.2
8-Dec
4.00
1Q16
4.00
4.00
4.00
2Q16
4.00
4.00
4.00
3Q16
4.25
4.25
4.05
4Q16
4.25
4.25
4.15
35
Currencies
Economics–Markets–Strategy
Indian rupee
USD/INR is expected to keep rising in the lowest
quartile of its ascending price channel
India’s economic growth is expected to beat China
in 2016. Unfortunately, this may not be enough to
prevent the INR from depreciating against the USD.
Indian equities have not been impressed either
and remained weak. Externally, US rates are set
to rise from Dec 2015 into 2016. The central bank
(RBI) sees volatility in the emerging markets at the
initial phase of the US hike cycle. Rating agencies
are vigilant about risks from high corporate
indebtedness here. Domestically, there are currently
two concerns over the proposed 23.6% increase in
the salaries and pensions of government employees.
If passed, India’s fiscal consolidation efforts may
disappoint rating agencies while higher inflation
prevent the RBI from easing monetary policy again.
Following the defeat of the Modi government at
the Bihar state elections, doubts have increased
over the momentum of reforms, already hurt by
the failure to implement the Goods and Services
Tax and the land acquisition laws. Hence, investors
will be closely watching the five state elections
scheduled for 2016 – Tamil Nadu (22 May), West
Bengal (29 May), Kerala (31 May), Puducherry (2
Jun) and Assam (5 Jun).
USD/INR – rising steadily in lowest quartile
75
75
70
70
65
65
DBSf
60
60
55
55
50
50
13
14
usd/ INR
DBS
Previous
Consensus
Policy, %
DBS
Previous
Consensus
15
16
8-Dec
66.835
1Q16
67.5
67.5
66.9
2Q16
68.6
68.6
67.0
3Q16
69.6
69.6
67.1
4Q16
69.1
69.4
67.1
8-Dec
6.75
1Q16
6.75
7.25
6.70
2Q16
6.50
7.25
6.60
3Q16
6.25
7.25
6.55
4Q16
6.25
7.25
6.50
Vietnam dong
VND may depreciate again in 2016, albeit by a
smaller 3% against the USD
VND depreciated 5.0% YTD as at end-Nov15, its
worst performance since 2011. The mid-point of
the official trading band for USD/VND was lifted
thrice this year, by 1% each time, on 7 Jan, 7 May
and 19 Aug. The same band was widened twice,
initially from ±1% to ±2% on 12 Aug, and finally to
±3% on 19 Aug. That said, the devaluations were
more about policy keeping the VND competitive
by aligning it to the weaker Asian currencies. With
rising US interest rates expected to buoy the USD
against Asian currencies in 2016, the central bank
(SBV) will probably devalue the VND again. Despite
this, foreign investors are expected to view Vietnam
favorably. Actual foreign direct investment (FDI)
totaled $13.2bn in Jan-Nov15, a new record high.
In turn, the reversal of the $803mn trade surplus
in 2014 into a $3.78bn deficit in Jan-Nov15 was
considered a positive sign that the economy was
ready to grow again. Vietnam is targeting an average
growth rate of 6.5-7% during 2016-2020, up from
an average 5.9% in the previous five years. With
monthly CPI inflation mostly below 1% YoY this
year, and well below the official 5% target, the SBV
has scope to lower rates, if it wants to, this year.
36
USD/VND – more upside possible
23000
DBSf
Consensus
22500
23000
22500
Official
trading band
22000
22000
21500
21500
21000
SBV fixing
20500
21000
20500
13
usd/ VND
DBS
Previous
Consensus
Policy, %
DBS
Previous
Consensus
14
15
16
8-Dec
22,460
1Q16
22,620
22,500
22,569
2Q16
22,725
22,500
22,750
3Q16
22,840
22,500
22,813
4Q16
22,960
22,500
22,875
8-Dec
6.50
6.50
1Q16
6.50
6.00
n.a.
2Q16
6.50
6.00
n.a.
3Q16
6.50
6.00
n.a.
4Q16
6.50
6.00
n.a.
Economics–Markets–Strategy
Currencies
Australian dollar
It is too early to call a bottom in the AUD/USD which
could still fall below 0.70
The prospect for the AUD to depreciate a fourth
year in 2016 cannot be dismissed. Commodities
remain weak from China’s ongoing shift from an
investment-led to a consumption-led economy
over the next five years. AUD/USD remains highly
correlated with the currencies of ASEAN+3 (China,
Japan and Korea), the region that absorbed almost
two-thirds of Australia’s exports in Jan-Sep15.
Australia’s budget and current account deficits
look set to widen again. AUD/USD is also likely
to be underpinned by a narrowing AU-US rate
differential. The Fed is expected to hike rates to
1.50% in 2016 from 0.25% while the central bank
(RBA) keeps its cash rate stable at 2%. Based on its
latest forecasts made in Nov, the RBA only expects
its growth outlook to improve from 2H16, around
the same period it sees CPI inflation returning to its
2-3% inflation target. Inasmuch as this supports a
weak AUD view in 1H16, it also implies scope for the
AUD to start stabilizing in 2H16. It was encouraging
that the unemployment rate fell encouragingly to
5.9% in Oct15, below 6% for a second time this year.
Barring shocks to emerging Asia, AUD is unlikely to
repeat the sharp depreciation seen in 2016.
AUD/USD – falling to floor of price channels
1.20
1.20
1.10
1.10
DBSf
Consensus
1.00
1.00
0.90
0.90
0.80
0.80
0.70
0.70
0.60
0.60
09
10
AUD /usd
DBS
Previous
Consensus
Policy, %
DBS
Previous
Consensus
11
12
13
14
15
16
8-Dec
0.7214
1Q16
0.69
0.69
0.69
2Q16
0.67
0.68
0.69
3Q16
0.65
0.67
0.69
4Q16
0.66
0.67
0.69
8-Dec
2.00
1Q16
2.00
2.00
1.85
2Q16
2.00
2.00
1.80
3Q16
2.00
2.00
1.80
4Q16
2.00
2.00
1.80
New Zealand dollar
NZD/USD has yet to complete its downtrend; a
bottom is likely to be found only below 0.60
NZD/USD is likely to depreciate again in 2016 despite
its hefty 16% YTD loss in as at end-Nov. This was
consisent with past trends seen after Bretton Woods
ended in 1971. The only exception was 2009 when
the NZD appreciated after incurring a double-digit
loss during the 2008 global financial crisis. Back then,
the Fed started its quantitative easing program
which brought the USD down globally. Today, the
Fed is set to normalize US monetary policy with
rate hikes in 2016. In contrast, the central bank
(RBNZ ) is still seen lowering its official cash rate
by another 25 bps to 2.50%. CPI inflation was 0.30.4% YoY in 1Q-3Q15, well below the mid-point
of the official 1-3% inflation target. This would fit
in with the RBNZ’s stated desire to lower the NZD
trade-weighted index (TWI) to 65 from 71 as at 30
Nov. If so, NZD/USD has scope to fall below 0.60.
The monetary policy divergence between the Fed
and RBNZ effectively eclipsed the government’s
milestone achievement to return the budget to a
NZD 414mn surplus in FY14/15. This small budget
surplus paled in comparison to the wider trade
deficit of NZD 2.8bn in Jan-Oct15, which more-thandoubled the full-year deficit of NZD 1.2bn in 2014.
NZD/USD – targeting sub-60 levels
0.90
0.90
0.85
0.85
0.80
0.80
0.75
0.75
0.70
0.70
0.65
0.65
0.60
0.60
0.55
0.55
DBSf
Consensus
0.50
0.50
0.45
0.45
09
NZD /usd
DBS
Previous
Consensus
Policy, %
DBS
Previous
Consensus
10
11
12
13
14
15
16
8-Dec
0.6642
1Q16
0.64
0.60
0.63
2Q16
0.61
0.59
0.62
3Q16
0.58
0.58
0.62
4Q16
0.60
0.62
0.62
8-Dec
2.75
1Q16
2.50
3.00
2.45
2Q16
2.50
3.00
2.45
3Q16
2.50
3.00
2.45
4Q16
2.50
3.50
2.50
37
Yield
Economics–Markets–Strategy
Yield: Fed-up
US
The Fed is about to raise rates for the first time in a decade. Some
volatility is to be expected
The pace of normalization is underestimated. A re-pricing higher in
1Y-5Y UST yields is likely
A return of price pressures should bring 10Y UST yields into the 2.53.0% range
Asia Asian rates reflect interest rate risks from Fed hikes over the
medium-term
There is scope for spread compression between Asia rates and US
rates as Fed normalization proceeds
SG
Ahead of the Fed
HK
Weaker RMB, higher CNH rates
KR
No further easing
TW
Decoupling from the US
TH
Front-end rates to stay low
MY
Releasing stress
ID
Watching the rise in Jibor
PH
Front-end steepening
IN
Further cuts ahead
CN Liberalization complete
Change in 10Y Government Bond Yields since 30 September
bps
50
Developed Economies
+ HK & SG
Asia
25
0
-25
-50
-75
-100
YIELD
-125
US
GE
UK
AU
SG
HK
Eugene Leow • (65) 6878-2842 • [email protected]
38
MY
TH
ID
PH
IN
KR
TW
CN
Economics–Markets–Strategy
Yield
US: Fed-up
Hiccups, scares and all, 2015 is still ending on a strong enough footing for the US
economy to pave the way for Fed hikes through 2016. Divergence in short-term
USD and EUR rates is about to begin in earnest. Fed lift-off has been telegraphed
by officials with a rate hike at the upcoming FOMC meeting on 15/16 Dec largely
anticipated by the market (Fed funds futures put the probability of lift-off in excess
of 70%). Notably, the reactions in the different markets have largely been benign in
recent weeks. Increased expectations of Fed hikes did not result in further stress in
the emerging markets. China hardlanding fears have receded somewhat and global
equity markets appeared to have stabilized.
That said, some volatility in 2016 cannot be ruled out especially since the Fed is the
only developed economy on the verge of tighter monetary policy. The European
Central Bank (ECB) and the Bank of Japan (BOJ) are on an easing bias, with the
monetary policy divergence likely to become more stark.
With excess reserves abundant, the Fed funds rate has become irrelevant from a
policy pass-through perspective. New policy tools such as the interest on excess
reserves (IOER) and the Fed’s reverse repo rate will be in focus and it remains to be
seen how effective they will be in putting a floor on short-term USD rates.
The technical aspects aside, the market continues to underestimate the pace of Fed
hikes. We think that the Fed is likely to raise rates at a pace of 25bps/quarter (half
of the 2004/06 cycle) while the market is pricing in roughly half that. This leaves the
front-to-intermediate sector of the UST curve vulnerable to an upward adjustment
in the coming months. Spillover into emerging market assets cannot be discounted
under such a scenario with the taper tantrums of mid-2013 coming to mind.
Meanwhile, longer-term USD rates are projected to grind moderately higher. Much
of this is contingent on a rebound in inflationary pressures. As downward distortions from depressed commodity prices fade, investors are likely to demand higher
compensation for holding USTs. This should be manifested clearly with 10Y yields
likely to break into the 2.5-3.0% range. More, importantly, the uptick in hourly
wages, if sustained, point to greater domestic price pressures down the line as the
labor market slack diminishes.
On balance, rate adjustments should prove greater in the front of the UST curve,
leading to bear flattening over the course of 2016.
Fed Funds Rate: Implied & Fed projections
Commodity Prices & 10Y UST Yields
% pa
Index
3.0
335
2.5
2.0
1.5
Median Fed
projections (Sep-15),
interpolated
3.1
310
Implied Fed
Funds rate, 9Dec-2015
CRB Index (lhs)
2.9
285
2.7
260
2.5
2.3
235
2.1
1.0
210
0.5
0.0
Dec-15
%
Dotted line,14Oct-2015
Dec-16
Dec-17
185
1.9
10Y UST Yield
160
Jan-14
1.7
1.5
Jul-14
Jan-15
Jul-15
39
Yield
Economics–Markets–Strategy
Implied chg in policy/ST rates over next 1 year
bps
75
50
25
0
-25
US
HK
SG
EZ
CN
TW
KR
MY
PH
TH
IN
Source: Bloomberg, 9 Dec 2015
Asia bracing for Fed normalization
Bracing for Fed normalization, selected Asia markets are reflecting interest rate
risks over the coming year. Modest upward pressure on short-term rates is seen
for Thailand and the Philippines. Singapore and Hong Kong are expected to see
relatively large increases in short-term rates (tracking USD rates higher), which is
to be expected given their respective currency systems. For China, Korea, Taiwan,
Malaysia and India, the market is pointing to stable rates.
Our view is broadly similar to the market. Short-term Asia rates have adjusted
higher since the taper tantrums of mid-2013. Economies which are more
vulnerable (India, Indonesia and Malaysia) already have relatively high short-term
interest rates. Barring another bout of sharp outflows, there could be scope for
selected Asian rates to fall. In particular, an easing bias may emerge for India and
to a lesser extent, Indonesia, over the coming months if volatility proves to be
short-lived through Fed normalization.
The biggest risk to our Asian rates outlook is a souring of emerging market
sentiment. This could happen in a number of ways including a more hawkish Fed
than the market expects and/or a divergence in the growth outlook between Asia
and the US. Outflows from Asia could trigger upward pressure on selected Asian
rates. To this end, the market is likely to be closely scrutinizing the “dot plot”
for insights into the pace of Fed hikes. In Asia, close attention should be paid to
China’s economic indicators to confirm that a cyclical bottoming out is at hand.
We expect yields on US Treasuries to rise. By end-2016, 2Y yields are likely to reach
1.90% while 10Y yields should reach 2.80%.
40
Economics–Markets–Strategy
Yield
Singapore: ahead of the Fed
Within Asia, SGD rates are one of the most sensitive
to changes in USD rates. Implied rates point to a
44bps increase in short-term SGD rates (3M SOR
and 3M Sibor) over the next four quarters. This
figure is only dwarfed by an implied 70bps increase
in the 3M Hibor over the same time period. This
is unsurprising given Singapore and Hong Kong’s
exchange rate system. With Fed normalization
likely to take place through 2016, short-term SGD
rates are likely track the 3M Libor higher. However,
with SGD rates already elevated ahead of Fed liftoff, the magnitude of increase in SGD rates is likely
to be more muted.
3M SGD SOR & 3M Sibor vs 3M USD Libor
The premium in SGD rates over USD rates of similar
tenors is likely to shrink. While SGD rates are likely
to be buoyed by a weakening bias in the CNY and
continued USD strength, we are cognizant that a
recovering global economy should draw flows back
into Asia. As speculative depreciative pressure on
Asia currencies gives way to stability, there is scope
for SGD rates to fall relative to USD rates. Some of
this erosion in premium has already taken place in
longer-term SGD rates. We expect this development
to play out in shorter-term rates once the cyclical
recovery become more apparent.
0.25
%pa
1.75
1.50
3M SOR
1.25
1.00
0.75
3M Sibor
0.50
0.00
Jul-14
3M Libor
Jan-15
Jul-15
Jan-16
• The premium of short-term SGD rates over USD
rates has kept the SGD swap rates elevated. This
premium is likely to fade in the coming quarters
• We expect 2Y and 10Y SGD yields to reach 2.00%
and 2.90% respectively by end-2016
Hong Kong: weaker RMB, higher CNH rates
Speculative pressures on the CNH have emerged
again in recent weeks, pushing forward points (and
implied Hibors) higher. This ended a period of calm
that came after the knee-jerk reaction to the CNY
devaluation in late-August. Markets can be fickle
as attention shifts from China hardlanding fears in
late August to anticipating the inclusion of the CNY
as part of the Special Drawing Rights (SDR) to the
current sentiment that the People’s Bank of China
(PBoC) would tolerate a weaker CNY since the status has been granted.
CNH HIbor & Forward Points
Much of these short-term fluctuations overshadow
the fact that CNH rates are likely to stay higher
than CNY rates (Shibors and CNY swaps) for the
foreseeable future. Economic fundamentals have
not changed. Growth is generally accepted to stay
slow even with further monetary easing. The CNY is
not likely to behave any differently than currencies
of other countries where monetary policy outlooks
diverge from the Fed. CNY weakness relative to the
USD is to be expected even if rebalancing flows
from central banks provide some fringe benefit. As
speculative weakness on the CNY manifests in the
CNH market, CNH interest rates are likely to stay
elevated relative to CNY rates.
% pa
pts
7
1400
6
1200
5
3M CNH Hibor
1000
4
800
3
600
2
400
1
0
Jan-14
3M CNH Fwd Pts
200
0
Jul-14
Jan-15
Jul-15
• Market speculation of RMB weakness over the
medium term should persist. This will keep CNH
forward points high
• CNH rates are likely to stay elevated relative to
CNY rates in the coming months
41
Yield
Economics–Markets–Strategy
Korea: no further easing
Front-end KRW swap rates are now trading above
the 3M CD rate (which serves as the floating leg
fixing for KRW swaps). This marks a change from
3Q when the market was speculating on further
easing by the Bank of Korea (BoK). We broadly
agree with the market that rate cuts are done.
However, increases in KRW market rates are likely
to be modest in the coming quarters. The pace of
Fed hikes and the state of the Korean economy are
critical to gauge the trajectory of KRW rates.
1Y, 2Y & 3Y KRW Swap Rates vs 3M CD Rate
While KRW swap rates appear to have decoupled
from USD swap rates (on the back of a slowing
domestic economy and improving external
balances) in the recent two years, price action in
the past few weeks point to some wariness as the
Fed prepares to normalize policy. Notably, the
spike in KRW swap rates occurred only after the
Fed reaffirmed rate hike intentions in late October.
Meanwhile, the Korean economy is running on
two speeds. Domestically, there have been clear
signs of revival even as external demand remains
lackluster. Against the backdrop, the KRW swap
curve is likely to stay flattish before steepening
when price pressures become more apparent.
2.00
%pa
2.75
3Y KRW Swap
2Y KRW Swap
2.50
1Y KRW Swap
2.25
1.75
3M CD Rate
1.50
Jul-14 Oct-14 Jan-15 Apr-15 Jul-15 Oct-15
• Monetary policy easing is likely over. KRW
swap rates are biased modestly higher as the Fed
normalization begins
• We expect 3Y and 10Y Korean Treasury Bond
yields to rise to 1.90% and 2.50% respectively by
end-2016
Taiwan: decoupling from the US
TWD market rates have become increasingly decoupled from USD rates. Previously, spikes in USD
rates nudged 2Y and 3Y TWD swap rates higher.
However, the correlation broke down in recent
weeks even as the market starts to price in Fed normalization more aggressively. Much of this has got
to do with significant pessimism on the Taiwanese
economy over the medium term. Real GDP growth
dipped into negative territory in 3Q (-0.63% YoY),
with the economy still facing considerable cyclical
and structural headwinds. Both external and domestic demand growth have been anemic.
Against this backdrop, the economic outlook divergence between Taiwan and the US is likely to
translate into monetary policy divergence. From
2004-2006, the Central Bank of the Republic of
China (CBC) paced the Fed in the rate hike cycle,
albeit at a more moderate pace. For the coming
few quarters, the CBC is likely to keep an easing
bias even as Fed normalization begins. In contrast
to previous cycles, rising USD rates are not likely
to place much upward pressure on TWD rates. We
expect TWD market rates to remain broadly stable
over the coming four quarters.
42
3Y TWD & 3Y USD Swap Rates
% pa
% pa
1.25
1.50
1.25
1.13
1.00
1.00
0.75
3Y TWD Swap
0.50
3Y USD Swap (rhs)
0.88
0.25
0.75
Jul-14
0.00
Jan-15
Jul-15
• With risks to the economy building, further rate
cuts appear likely
• We expect the 2Y and 10Y government bond
yields to rise to 0.55% and 1.35% respectively by
end-2016
Economics–Markets–Strategy
Yield
Thailand: front-end rates to stay low
The movements in the USD/THB have dictated the
trajectory of THB market rates over the past few
months. The Bank of Thailand (BoT) held the policy
rate steady since May. As USD strength pulled back
in the early part of October, this has allowed the
FX-implied 6M THB FIX and THB swap rates to fall.
In any case, Thailand still faces a challenging export
environment even as current low rates did little to
stoke a revival in domestic demand. This economic
pessimism is firmly reflected in the flatness in 3M/2Y
segment of the THB swap curve.
Going forward, several moving parts need to be
taken into account. Firstly, speculation of further
BoT easing is likely to build as growth/inflation
dynamics stagnate. Secondly, the prospect of impending Fed hikes could trigger another bout of
USD strength while pushing up 2Y-5Y UST yields.
As such, the intermediate segment of the THB swap
curve may be vulnerable to upward pressures, but
the very front of the curve should be anchored as
BoT keeps monetary policy easy. Steepening in the
3M/2Y sector of the THB swap curve is likely once
there are clearer signs that Fed normalization
would get underway.
2Y THB Swap Rate vs 6M THB FIX
%pa
bps
4.00
6M THB FIX (lhs)
3.50
2Y THB Swap - 6M THB
FIX (rhs)
200
3.00
2.50
150
100
2.00
50
1.50
1.00
0
0.50
0.00
Jan-10
-50
Jan-12
Jan-14
• Economic pessimissm is likely to keep the front of
the THB swap curve anchored
• We expect 2Y and 10Y Thailand government
bond yields to rise to 1.75% and 3.00% respectively
by end-2016
Malaysia: releasing stress
Stress in the front of the MYR swap curve has
dissipated over the two months with 1Y and 2Y
rates retracing about half of the upmove that
occurred since mid-2015. An improvement in
global risk sentiment has a significant part to play
as the market shrugs off China slowdown and
Fed normalization worries. Domestically, several
factors have also buoyed sentiment. Firstly, the
2016 budget signaled that fiscal consolidation is
expected to continue despite an extended period of
depressed oil prices. Under relatively conservative
assumptions on as assumptions on oil prices (USD
48/bbl) and GDP growth (4-5% for 2016), the fiscal
deficit is projected to shrink marginally to 3.1% in
2016 from 3.2% in 2015.
Secondly, announced asset sales (amounting to
MYR 9.83bn) by 1Malaysia Development Bhd
(1MDB) have eased concerns about the company’s
heavy debt load. Notably, Malaysia’s 5Y credit
default swap spread has also narrowed sharply,
indirectly providing scope for MYR rates to fall.
Barring a sharp negative emerging market reaction
to the impending Fed hike or another collapse in oil
prices, we think that MYR rates are likely to head
modestly higher as the Fed normalizes policy.
1Y, 2Y & 3Y MYR Swap Rates vs 3M Klibor
%pa
4.25
3Y MYR Swap
2Y MYR Swap
1Y MYR Swap
4.00
3.75
3M Klibor
3.50
Jul-14
Oct-14
Jan-15
Apr-15
Jul-15
Oct-15
• Continued fiscal consolidation and the divestment
of 1MDB assets have provided room for MYR rates
to fall
• We expect 3Y and 10Y Malaysian government
securities yields to rise to 3.60% and 4.30%
respectively by end-2016
43
Yield
Economics–Markets–Strategy
Indonesia: watch the rise in Jibor
IDgov bonds have proven to be surprisingly resilient, outperforming its Asian counterparts over
the past few weeks. Notably, most Asian government bond yields headed higher, in tandem with
rising UST yields after the October FOMC meeting
prompted the market to start pricing in Fed hikes
more aggressively. 10Y IDgov bonds bucked the
trend, staying broadly unchanged over the same
time period. While the market may be focusing on
some positives in the short term, it is unclear that
IDgov bonds can sustain their outperformance over
a longer period.
One of the key factors behind IDgov yields stability
is the relatively outperformance of the rupiah in
recent weeks. While commodity prices continue to
hold back exports, the slowdown in domestic demand (especially investment) had been more than
sufficient to keep the trade balance in surplus.
However, with the 3M Jibor pushing to levels not
seen since 2009, we should be cognizant that currency stability may have come on the back of intervention by the central bank. From a longer term
perspective, the spread of 10Y IDgov yields over
10Y UST yields is marginally above the 10Y average. While further spread compression is possible,
IDgov bonds are not attractive with yields at current levels.
ID: BI Policy Rates & Jibor Interbank Rates
%pa
3M Jibor
9
BI Reference
Rate
8
7
6
5
4
O/N Jibor
FASBI Deposit Rate
3
2
Jan-10
Jan-11
Jan-12
Jan-13
Jan-14
Jan-15
• Indonesian government bonds are unattractive
after the recent rally
• We expect 2Y and 10Y Indonesian government
bond yields to reach 8.40% and 9.00% respectively
by end-2016
Philippines: front-end steepening
The convergence in short-term PHP swap rates has
likely come to an end. This trend had been apparent
since mid-2013 when Fed taper tantrums brought
about the early stages of USD strength. Since then,
the FX-implied 3M PHP reference rate (which serves
as the floating leg fixing for PHP swaps) has been
grinding steadily higher, dragging 1Y and 2Y PHP
swap rates towards the 3Y PHP swap rate. We think
that the 3M/3Y segment of the PHP swap curve is
likely to steepen in the coming months.
Two opposing factors are at play currently. With
inflation missing the target range of 2-4% this year,
there would likely be some speculation that rate
cuts by Bangko Sentral ng Pilipinas (BSP) may be at
hand. While not our core view, any rate cuts now
should have more impact on the very front of the
PHP swap curve (3M, 1Y). On the other hand, the
market is likely to be wary of rising USD rates with
Fed normalization looking to take place as soon as
December. Notably, 5Y PHP swap rates have been
under slight upward pressure over the past week.
As the market continues to price in Fed hikes more
aggressively, we think 3Y-5Y PHP swap rates are
likely to head higher.
44
1Y, 2Y & 3Y PHP Swap Rates vs 3M Interbank Ref Rate
%pa
3Y PHP Swap
4.0
2Y PHP Swap
3.5
1Y PHP Swap
3.0
2.5
2.0
1.5
1.0
0.5
0.0
3M Interbank Ref
-0.5
-1.0
Jan-13
Jan-14
Jan-15
Jan-16
• The front-end of the PHP swap curve is likely to
steepen as the market takes into account higher
USD rates
• We expect 2Y and 10Y Philippine government
bond yields to reach 4.50% and 5.50% respectively
by end-2016
Economics–Markets–Strategy
Yield
India: further cuts ahead
Optimism on INR assets have faded somewhat over
the past few weeks as the market comes to terms
with the setback at the recent state elections and
the prospect of slow passage of key bills at the
winter parliamentary session. In contrast to other
Asian currencies which have been largely stable, the
INR has been weakening versus the USD since late
October. In the rates space, 10Y INgov yields drifted
to 7.79%, from a low of 7.51% in early October.
Similarly, there has also been upward pressure in
the overnight Financial Benchmarks interbank rate.
Previously, this rate had been hugging the repo
rate (6.75%) closely.
10Y INgov yield spread over 10Y UST
We remain constructive on INgov bonds from a
total return perspective. The yield cushion over
USTs is still sizable (555bps in the 10Y sector) and
is probably unwarranted given the improvement
in external balances. Moreover, a cyclical recovery
appears to be underway. Meanwhile, the upcoming
Fed meeting on 15-16 Dec is a source of uncertainty.
Although Fed liftoff is largely anticipated, a possible
adverse reaction in emerging market assets is likely
prompting some wariness from the Reserve Bank of
India (RBI). Moving past the immediate few months,
an expected resumption of RBI easing should buoy
INgov bonds.
100
bps
700
600
500
400
300
200
0
Jan-02
Jan-05
Jan-08
Jan-11
Jan-14
Jan-17
• Downward impetus on Indian government
bond yields is likely with further rate cuts over our
forecast horizon
• We expect both the 2Y and 10Y Indian government
bond yield to rise to 7.4% and 7.6% respectively by
end-2016
China: liberalization complete
Interest rate liberalization in China is essentially
complete with the scrapping of the deposit rate
ceiling announced on 23 Oct. The IMF has also approved the RMB’s inclusion into the SDR basket on
30 Nov. The year 2015 shaped up to be a milestone
for financial liberalization in spite of the slowing
Chinese economy.
7D Repo Rate & 3M Shibor
In the context of policy tools available to the People’s Bank of China (PBoC) and the state of economy, interest rate liberalization need not necessarily
lead to higher CNY interest rates in the short term
(as was widely thought). As China’s growth concerns
mount, liquidity injection and weaker growth/inflation expectations have generally brought CNY rates
(money market and CNgov yields) lower in recent
months. These dynamics are likely to offset upward
pressure on rates from the deposit rate liberalization in the short term.
4
Notably, the PBoC has already cut the reserve requirement ratio to 17.5% and reduced the 1Y
lending rate to 4.35%. With further easing on the
horizon, short-term CNY rates are likely to remain
broadly stable with a bias to the downside.
%pa
7
6
5
3M Shibor
3
2
1
0
Jan-14
7D Repo Rate
Jul-14
Jan-15
Jul-15
• The PBoC is likely to keep the easing bias in 2016.
Longer-term CNY rates are likely to rise once the
economy stabilizes
• We expect 2Y and 10Y Chinese government bond
yields to rise to 2.70% and 3.40% respectively by
end-2016
45
Yield
Economics–Markets–Strategy
Interest rate forecasts
%, eop, govt bond yield for 2Y and 10Y, spread bps
US
3m Libor
2Y
10Y
10Y-2Y
10-Dec-15
0.49
0.92
2.22
129
Japan
3m Tibor
0.17
0.20
0.20
0.20
0.20
Eurozone
3m Euribor
-0.12
-0.20
-0.20
-0.20
-0.20
Indonesia
3m Jibor
2Y
10Y
10Y-2Y
8.67
8.28
8.53
25
8.50
8.20
8.60
40
8.30
8.27
8.70
43
8.10
8.34
8.80
46
7.90
8.40
9.00
60
Malaysia
3m Klibor
3Y
10Y
10Y-3Y
3.80
3.42
4.23
80
3.75
3.60
4.30
70
3.75
3.60
4.30
70
3.75
3.60
4.30
70
3.75
3.60
4.30
70
Philippines
3m PHP ref rate
2Y
10Y
10Y-2Y
2.71
3.96
4.11
15
2.75
3.90
4.90
100
2.75
4.10
5.10
100
3.00
4.30
5.30
100
3.00
4.50
5.50
100
Singapore
3m Sibor
2Y
10Y
10Y-2Y
1.08
1.07
2.46
139
1.40
1.45
2.70
125
1.60
1.65
2.80
115
1.80
1.85
2.85
100
1.95
2.00
2.90
90
Thailand
3m Bibor
2Y
10Y
10Y-2Y
1.63
1.52
2.65
113
1.70
1.60
2.70
110
1.70
1.65
2.80
115
1.70
1.70
2.90
120
1.70
1.75
3.00
125
China
1 yr Lending rate
2Y
10Y
10Y-2Y
4.35
2.72
3.06
34
3.85
2.70
3.10
40
3.85
2.70
3.20
50
3.85
2.70
3.30
60
3.85
2.70
3.40
70
Hong Kong
3m Hibor
2Y
10Y
10Y-2Y
0.39
0.52
1.56
104
0.75
0.90
1.95
105
1.00
1.10
2.05
95
1.25
1.30
2.15
85
1.50
1.50
2.25
75
Taiwan
3m Taibor
2Y
10Y
10Y-2Y
0.80
0.49
1.19
70
0.73
0.55
1.20
65
0.73
0.55
1.25
70
0.73
0.55
1.30
75
0.73
0.55
1.35
80
Korea
3m CD
3Y
10Y
10Y-3Y
1.67
1.76
2.21
45
1.60
1.75
2.35
60
1.60
1.80
2.40
60
1.60
1.85
2.45
60
1.60
1.90
2.50
60
India
3m Mibor
2Y
10Y
10Y-2Y
7.39
7.39
7.78
39
7.25
7.40
7.70
30
7.00
7.30
7.60
30
6.75
7.20
7.50
30
6.75
7.10
7.50
40
46
1Q16
0.90
1.30
2.50
120
2Q16
1.15
1.50
2.60
110
3Q16
1.40
1.70
2.70
100
4Q16
1.65
1.90
2.80
90
Economics–Markets–Strategy
Yield
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47
CNH
Economics–Markets–Strategy
CNH: after the SDR
• Beijing knows that SDR membership is neither necessary nor sufficient
to ensure the yuan becomes a global reserve asset
• More financial reforms and liberalisation are needed
• The investing landscape is changing for the yuan after its surprise devaluation in August
Earlier this month, the Executive Board of the International Monetary Fund (IMF)
completed the regular five-yearly review of the basket of currencies that make up
the Special Drawing Right (SDR). The Board decided that the Chinese yuan has met
all existing criteria. The yuan will be included, with effect from 1 Oct 2016, in the
SDR basket as a fifth currency, along with the US dollar, the euro, the Japanese yen
and the British pound.
In terms of China’s transition from a centrally planned economy to a globally integrated market-based model, the CNY’s entry into the SDR is the biggest milestone
since China joined the World Trade Organisation (WTO) in 2001. The SDR membership, however, is neither a necessary nor sufficient condition to boost the CNY’s
stature as a global reserve asset. For example, when EUR was launched in 1999,
many believed that the single currency would rival the USD as a global reserve asset. EUR’s share of reported global reserves rose to around 25%, but then stalled
and fell back to below 20% (Chart 1). When investors lost confidence in the EUR
during the Eurozone crisis, liquidity fled EU countries that badly managed the sovereign debt crisis to better-managed assets that are liquid and safe such as Bunds.
More financial reforms
Clearly, deep and liquid markets matter to reserves managers. After all, reserve assets are held for liquidity management purposes. In light of this, Beijing will speed
up the pace of market reforms and liberalisation, in particular, the onshore bond
market. Notwithstanding its hefty size, China’s bond market is only about 50%
Chart 1: Currency composition of official foreign exchange reserves
80%
US dollar
70%
Euro
60%
Pound sterling
50%
Japanese yen
40%
Canadian
dollar
Austrlian
dollar
Swiss franc
OFFSHORE CNH
30%
20%
10%
Other
0%
2000
2003
2006
2009
2012
Nathan Chow • (852) 3668 5693 • [email protected]
48
2015Q2
Economics–Markets–Strategy
CNH
of the country’s GDP. This is low Chart 2: Government bonds turnover ratio
compared to the average 200% 1.4
for key developed markets.
1.2
Liquidity is another issue that
must be addressed. The an1.0
nual turnover rate for China’s
government bond (CGB) is only
0.8
avg. 0.67
0.54x; below the regional average of 0.67x (Chart 2). It is also
0.6
impractical for the yuan to become a reserve currency if for0.4
eigners’ holdings accounted for
only ~2% of outstanding do- 0.2
mestic bonds. This is low compared to ratios in other markets 0.0
such as Australia (65%) and the
CN
HK
ID
JP
KR
MY
SG
TH
US (50%) (Chart 3). Hence, the
yuan’s growth as a reserve currency will require China to further increase access to
its domestic markets.
Encouragingly, the mainland authorities have, over the past year, been loosening
restrictions on bond market access for both overseas official and private institutions. Equally impressive was the growing issuance of financial/corporate/municipal
bonds, which offer more diversity to the usual staple of government and policy bank
bonds.
Major strides were also made
on exchange rate liberalisation. The introduction of a new
and more market-determined
exchange rate regime should
allow the central bank (PBoC)
to step back further from dayto-day intervention over time.
More importantly, it helped to
close the spread between the
central parity and the spot exchange rate, an important criterion for the yuan to stay in
the SDR.
Chart 3: Foreign holdings of domestic government
bonds
%
80
70
60
50
40
30
20
10
As per the official report re- 0
leased after the 5th Plenum,
China will opt for a “negative
list” foreign-exchange system
during the 13th Five Year Plan
(2016-2020) with a target to achieve full convertibility of the yuan by 2020. This will
greatly enhance the hedging ability for reserve managers.
Changing investment landscape
China’s reduction in currency interventions has, nevertheless, increased concerns
over the yuan's depreciation outlook. Despite Beijing’s reassurances that China will
not engage in competitive devaluation, markets expects the offshore exchange rate
to fall by about 2.9% over the next 12 months. Apart from dampening the incentive of investors to hold yuan deposits, corporates have also started to unwind their
long-yuan positions.
As a result, yuan deposits in Hong Kong contracted for the third consecutive month
in Oct15 to RMB 854.3bn, the lowest level since Nov13 (Chart 4). Hong Kong is not
the only offshore center going through the impact of yuan weakness, especially
49
CNH
Economics–Markets–Strategy
after Beijing's surprise devaluation of its currency on 11 Aug.
Yuan deposits in South Korea
declined for the fifth consecutive month in Sep, and Taiwan,
for the third straight month.
Fears of yuan liquidity shortages once pushed the 3M CNH
HIBOR to 6% in Aug. The rate
was still elevated at 5% in
early Dec. This added pressure
on the offshore dim sum bond
markets which are already facing competition from their better performing onshore counterparts supported by dovish
monetary policies (Chart 5).
Chart 4: HK's RMB deposits has shrunk 14% since
July
RMB bn
1,000
900
800
Latest: Oct 15
700
600
500
400
300
200
100
0
Jul-10
Jul-11
Jul-12
Jul-13
Jul-14
Jul-15
For example, the Ministry of Finance (MoF) recently issued RMB 14bn worth of dim sum bonds in Hong Kong. The
coupon rate of 3.45% on 2Y bonds for retail investors reached an all-time high. By
comparison, the MoF auctioned RMB 28bn of 3Y bonds in the mainland interbank
market at just 2.7961% in Nov. Financing costs for Chinese developers, who used
to be key issuers of high-yield dim sum bonds, have dropped more significantly on
the mainland. Shimao Property Holdings Limited, for example, issued a 5Y bond at
3.9% onshore via its subsidiary.
Demand for dim sum is also being affected by the revived panda bond market
(foreign issues in China's domestic bond market). The first public offerings of Panda
bonds from foreign commercial banks were launched in Sep. In addition to banks,
foreign governments are also keen to tap the onshore market due to pricing advantages. Canada’s British Columbia is registered to sell RMB 6bn of debt in the
onshore market. Meanwhile, South Korea is reportedly in talks with China’s regulatory body to become the first sovereign to issue panda bonds. Indonesia and Russia
may follow in 2016. While this was only a fraction of the ~RMB 800bn dim sum
bond market, the panda bond market has a tremendous potential given the very
deep pool of liquidity onshore.
Chart 5: Sovereign dim sum yield is now higher
%
5.0
Onshore 2Y
Offshore 2Y
4.5
4.0
3.5
3.0
2.5
2.0
Latest: 7 Dec
1.5
Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Apr-15 Jul-15 Oct-15
50
Economics–Markets–Strategy
CNH
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51
Asian Equity Strategy
Economics–Markets–Strategy
Asia equity 2016 outlook:
inflexion point
• Uncertainty over the pace of interest rate normalization and economic recovery will keep volatility high in Q1
• A bottoming points to upside risk in Asia markets as major turning points
could turn favourable
• Our near-term outlook favours Korea and Malaysia on a best-hedged basis.
Risks and opportunities in China’s macro and micro reforms present more
upside than downside risks on a 12M view
• A top in the US dollar could drive strong returns in ASEAN markets
• Expect 9% return for Asia markets on average with a chance of more
Monetary policy normalization in the US is coming, and along with it, new risks and
challenges for Asia’s markets in 2016. The heartening thing is that Asia equities have
been adjusting to the “tightening tantrums” for most part of 2015, and valuations
are near bottom. We believe lift-off has been priced in, and should not cause major
capital outflows in Asia markets. According to our yield gap model, Asia equities are
adequately priced for now with a 175-bp cushion before the markets are deemed
expensive
Fig. 1: Asia earnings yield minus 10-year US bond yields
10
(%)
9
8
7
6
5
4
3
2
1
ASIA EQUITY
0
03
04
05
06
07
08
US 10-year bond yields
09
10
11
12
13
14
15
16
Asia ex-Japan earnings yield gap
Source: Datastream, DBS. Shaded area with forecasts of US bond yields rising to 2.8% and
earnings growth of 11% combined for next two years
Joanne Goh • (65) 6878 5233 • [email protected]
52
Economics–Markets–Strategy
Asian Equity Strategy
With US 10-year bond yields poised to rise in tandem with the Fed funds next
year, we are concerned that markets will still be subject to the whims of pace of
interest rate normalization and hence volatility will reign. However we believe odds
are against the shorts as major turning points could be anticipated in 2016. The
potential topping of the USD, bottoming oil price, and the current cycle could see
prices skewed to the upside. Asia markets have generally performed well in past rate
hike cycles and by comparison, the current forecast pace of normalization will be
slower than previous rate hike cycles.
Importantly, in many Asia countries, macro-economic policy mix is carefully calibrated
to adjust for the new normal. We believe Asia equities should end 2016 9% higher
than current. Markets poised to outperform in the first half of the year are Korea,
Malaysia and Hong Kong / China. ASEAN’s underperformance could reverse in 2H if
USD tops.
China’s slowdown largely priced in
Asia equities have been impacted by China’s slowdown mainly through the export
cycle and lower commodity prices. Economies which are more leveraged to China,
such as Singapore and Taiwan, and commodity-driven countries such as Indonesia
and Malaysia, are among the worst performers in Asia this year. Thailand stock
market has the highest commodity content which also explained its relative
underperformance. Singapore and Taiwan’s GDP growth forecasts have also been
cut the most this year. All these suggest to us that China’s GDP slowdown has been
adequately priced in.
US rate hikes
With a 3: 1 chance being priced into the Fed fund futures, we believe a December
lift-off is now a base case for markets. The pace of Fed hikes, however as priced by
the market remains on the low side (slightly over two hikes per year) and we suspect
that another round of adjustment is likely once lift-off occurs. DBS is forecasting four
hikes for next year, which by comparison, is still modest when compared to past rate
hike cycles. But importantly the deviation from what the market is expecting and
the Fed officials’ expectations remains sizeable, which means that risks is still skewed
to the upside as far as expectations are concerned. Volatility deriving from pace of
rate hike expectations will be the main focus in 2016.
Fig. 2: Asia countries exports and exports breakdown
to China and US, as % of GDP
Fig. 3: Fed fund rates hikes, history and expectations
cumulative chg in Fed funds rate in bps
Exports
Exports as % of GDP
as % of total exports Total
China
US
Exports
Exports to
China
US
350
1994/95
1999/00
2004/06
DBS forecasts
Market implied
Fed projections
300
250
Korea
25.7%
13.1%
39%
10%
5%
Taiwan
25.5%
12.0%
54%
14%
7%
India
3.8%
14.4%
16%
6%
22%
Malaysia
12.6%
9.0%
63%
8%
6%
Indonesia
10.0%
10.3%
19%
2%
2%
Thailand
10.9%
11.0%
54%
6%
6%
Philippines
11.6%
14.7%
21%
2%
3%
Singapore
13.3%
6.4%
124%
17%
8%
Hong Kong
53.6%
9.5%
16%
87%
16%
Source: Datastream, IFS, DBS
200
150
100
50
0
1Q
2Q
3Q
4Q
5Q
Source: Bloomberg, DBS. 1Q from December 15 in the
current cycle
53
Asian Equity Strategy
Economics–Markets–Strategy
We believe the bar for the Fed to hike rates has been set very low, at most 2.5%
GDP growth, when past five year’s average is around 2%. The risks to our view are
exports, housing, and capex expenditure which are all interest rate sensitive and
could give in once interest rates start to rise. That said, we are wary of any signs of
inflationary pressure that may appear in the coming months. As base effects wane
and commodity prices stabilise, price pressures could materialise. The market would
also be closely scrutinising signs of labour market tightness that could spark wage
inflation.
We looked at past equity market performances when US started to hike rates. Asia
performance was negative in two out of three past rate hike cycles, while S&P
performance was positive in two out of three. This leads us to believe that developed
markets are likely to outperform emerging markets again going into next year. The
transmission impact is mainly through higher bond yields and weaker currencies.
However, we caution that the circumstances surrounding each Fed rate cycle are
all different, and next year could see some major turning points in these variables.
Valuations are cheaper now than then
In 1994, Asia valuations were excessively high following the strong rally in 1993 as
foreign investors poured liquidity into Asia. When expectations on the sustainability
of Asia’s strong growth were not met, and coupled with the Fed pushing the strings
on interest rates, Asia markets corrected in a big way. While current expectations for
growth, albeit low, still remain tested, the major difference between now and then
is that valuations are lower now.
Indeed Asia ex-Japan valuations one standard deviation below trend, which should
provide support for bargain hunters with a longer-term view. Base is low after three
years of sub-par performance, and when major turning points could happen next
year.
Bond yields may not rise as much
In 2004, the normalization of Fed rates did not cause a spike in US bond yields as
US growth rate was declining. Asia, on the other hand, was recovering from the
2001 tech bubble recession and 2003 SARS-led recession. Fiscal stimulus, especially in
Fig. 4: Asia markets price to book
2.8
(x)
Fig. 5: Asia markets 12-month forward P/E
18
2.6
17
2.4
16
2.2
15
2.0
1.8
1.6
1.4
(x)
14
13
12
11
10
1.2
9
1.0
Dec-05 Jun-07 Dec-08 Jun-10 Dec-11 Jun-13 Dec-14
8
Dec-05 Jun-07 Dec-08 Jun-10 Dec-11 Jun-13 Dec-14
Source: Datastream, IDBS. Bands are average and +/- one
SD bands
Source: Datastream, IBES, DBS. Bands are -1.5SD, -1 SD,
average and +1 SD bands
54
Economics–Markets–Strategy
Asian Equity Strategy
China was aggressive following the recession, and monetary policies were also very
accommodative. Asia markets had a strong run despite US interest rate hikes from
1% to 5.25%.
We see the bond market as the key source of risk for Asia markets from a Fed rate
hike as risk trades (including Asia equities) are generally benchmarked against
US bond yields. Our fixed income strategist sees bond yields rising lesser than
the targeted Fed hikes this time round, if Fed normalization takes place in a low
inflationary environment. Should price pressure start to appear, we would expect an
adjustment in interest rates expectations, both in the short end as well as the long
end. The distortion in global bond yields due to safe haven flows, and abundant
global liquidity could also see bond yields spiking up if these trends reverse.
That said, credit spreads have already widened, and that VIX has had some sharp
moves this year due to changes in interest rate expectations. Asia economies are
on the mend and are experiencing a cyclical bottom. A US rate hike, coupled with
a corresponding spike in US bond yields, should signal a potential recovery, which
would be constructive for Asian equities. The relationship between US bond yields
and Asia markets is generally positive, except in the past one year.
Asia earnings gap over US bond yields still have about a 175-bp cushion, sufficiently
providing for the rising US bond yields outlook over the next two years, before
markets are deemed excessively expensive. As such, we believe tail risks from broad
market sell-off can be avoided, but markets will still be jittery. Among Asia markets,
Korea and Singapore are the most positively correlated to rising US bond yields. A
rise in bond yields generally signifies economic growth.
Asia short rates
In Asia, adjustments in short-term interest rate expectations have been very gradual,
owing more to domestic factors such as inflation and growth rates. We believe this
will change once Fed lifts off, and pace of normalization will be more important to
watch. Other than Hong Kong and Singapore, which will move closely in tandem
with the US, given their respective currency systems, India, Korea, Malaysia, Thailand
and the Philippines will see upward pressure on short-term interest rates. China and
Taiwan still have easing bias lingering.
Fig. 6: US bond yields vs MSCI Asia ex-Japan, yearon-year changes
(%)
80
2
( correlation coefficient)
0.45
1.5
0.40
(%)
100
US Bond
1
60
40
-20
0
0.20
-0.5
0.15
-40
-1.5
MSCI Asia ex-J (L)
-60
-2
least positive
most positive
0.30
0.25
-1
(R2 = 20%,
correlation =
0.45)
0.35
0.5
20
0
Fig. 7: Asia stock market correlation with rising US
bond yields
0.10
0.05
0.00
-0.05
-2.5
04 05 06 07 08 09 10 11 12 13 14 15
Source: Datastream, DBS
Source: Datastream, DBS
55
Asian Equity Strategy
Economics–Markets–Strategy
DBS economist forecast short-term interests to stay flat in 2016, except Philippines
(+0.25%), Taiwan (-0.125%) and China (-0.5%).
The regional strategy team sees risk of interest rate expectations in Asia rising next
year as inflation rises.
USD trend another major turning point to look for
Outflows from emerging markets to developed markets are also exacerbated by the
USD strength this year. With the DXY index testing the critical 100 level, and studies
from previous rate hike cycles have shown that USD may not strengthen upon the
beginning of the rate hikes, Asian currencies may not weaken as much next year
compared to last year.
Our currency strategist continues to see DXY staying above 100 next year and rising
moderately by 3Q16, at the back of a broad picture pointing to a Fed marching policy
rates slowly-but-steadily towards 1.375% by end-2016 and continuing onward into
2017 at that every-other-meeting pace. Markets may also want to be reminded of
the great monetary policy divergence which is still around and not present in past
rate hikes cycle.
At this juncture, the BoJ seems increasingly less inclined to push for greater QE.
In Europe, QE policy will still be around until March 2017, and deposit rates are
negative, juxtaposed against the 100-bp rise most see for the US over the coming
year. The USD is likely to strengthen against EUR and could weaken against JPY. The
risk on DXY in Q1 is the short covering on EUR, and could be a “buy on the rumor
sell on the hike” on the USD, considering the overcrowded long USD/EUR position.
Note that this view represents that of the regional strategy team and may not be
the view from our currency team, essentially pointing out the volatility in risk assets
due to mixed but important over arching view on the USD. If one takes a strong
view on the USD direction, the scenario for this year is likely to be repeated, i.e.
Asean countries will still have to be avoided altogether as fund flows are unlikely to
be attracted into this region.
Asia currencies, generally USD price takers, will weaken on the currency pair against
USD in our base case scenario. This year the strength in CNY has been keeping Asia
Fig. 8: DXY and Fed fund rates
Fig. 9: DBS currency forecasts , end of period
(index)
130
120
(%
dollar index (L)
8
7
6
fed funds (R)
110
5
4
100
3
90
2
80
1
70
0
91 93 95 97 99 01 03 05 07 09 11 13 15
Source: Bloomberg, Datastream, DBS
56
US
Japan
Eurozone
current
1Q16
2Q16
3Q16
4Q16
98.5
123.0
1.089
102.5
123
1.07
104.0
124
1.05
105.5
126
1.03
105.1
125
1.04
Indonesia 13,893 14,450 14,830 15,200 15,000
Malaysia
4.27
4.37
4.50
4.64
4.57
Philippines
47.1
47.5
48.0
48.4
48.2
Singapore
1.41
1.43
1.45
1.47
1.46
Thailand
36.0
36.5
36.9
37.4
37.2
China
Hong Kong
Taiwan
Korea
India
6.42
7.75
32.8
1,178
6.45
7.76
33.0
1,193
6.49
7.76
33.4
1,212
6.52
7.76
33.8
1,232
6.50
7.76
33.6
1,222
66.8
67.5
68.6
69.6
69.1
Source: Bloomberg, Datastream. Current as of 9 Dec.
DXY index for the US
Economics–Markets–Strategy
Asian Equity Strategy
currency strong against EUR and JPY. After CNY’s inclusion in SDR, and the CNY
fixing mechanism changing to more market oriented, the PBoC may have shifted
its focus from solely targeting the USD to a currency basket approach. We expect
CNY to depreciate to 6.50 by end of next year. Meanwhile China’s growth worries
have not gone away, and further monetary easing is still expected. Measured against
China’s “new normal” economy, the CNY is considered overvalued in REER terms.
Among Asian currencies, the strength of external balance sheet, and economic
fundamentals will determine the relative strength of these currencies. The countries
with the least depreciation expected to 3Q16 are China and Philippines , and the
worst are Indonesia and Malaysia.
A weak currency doesn’t bode well for Asia markets as an asset class. Capital
outflows are unlikely to reverse next year as long as the broad dollar strength in
intact. Investors should watch out for this major trend to turn. A recovery in growth
could also see flows returning to Asia.
The regional strategy team believes there is a case for USD not to strengthen as
much in 2016 as this year, if the past 3 months is for anything to come by. Investors
could best hedge against the currency risk by avoiding stocks exposed to currency,
while riding on the cyclical upside on growth, likely to come in the second half this
year.
Oil prices
IMF is forecasting the global economy to pick up to 3.8% in 2016 from 3.3% next
year. The cyclical backdrop for oil price should hence be moderately better next year.
We target for oil price to range between US$50-60. We believe that oil price will
find difficulty crossing beyond US$60 on a sustainable basis. Firstly, despite a boost
to growth from the decline in oil prices, global growth did not pick up materially
this year, suggesting that underlying demand remains too weak to benefit from the
growth dividend.
Secondly, studies have shown that shale gas production becomes viable once oil
price crosses US$60, hence pressuring oil price on the supply side. Thirdly, our base
case for a strong DXY suggests a weaker oil price based on historical relationship.
Our regression analysis for oil price and dollar index (basket of currencies against
Fig. 10: DXY and oil price
130
(index)
Global
Interest
Defensive Cyclical
Price
rate
sectors
exposure exposure exposure
140
120
110
(USD pbl)
160
Fig. 11: Asia market cap breakdown by exposure to
economic sensitive sectors
oil price
(R)
dollar
index (L)
100
120
80
70
Source: Datastream, DBS. Regression stats: r=-0.41
23%
0%
65%
China
18%
28%
9%
42%
Singapore
19%
20%
5%
56%
80
Malaysia
35%
23%
8%
30%
Thailand
24%
13%
30%
28%
Indonesia
32%
20%
6%
39%
40
Korea
12%
63%
10%
13%
20
Taiwan
8%
65%
10%
17%
India
31%
36%
16%
17%
Philippines
24%
28%
0%
47%
0
91 93 95 97 99 01 03 05 07 09 11 13 15
12%
100
60
90
Hong Kong
Asia ex-J
19%
39%
9%
33%
Source: Datastream, IBES, DBS. Oil rig support services
sector classified as global price exposure in Singapore.
57
Asian Equity Strategy
Economics–Markets–Strategy
USD) shows oil price sensitivity of +2% for every -1% move in the dollar index. Based
on our DXY forecast, the low side for oil price is not far from now. The risk to the
view is thus a major turn on the DXY which will cause oil price to overshoot on the
upside, or a lack of production discipline by OPEC countries could overshoot oil on
the downside.
The best-case scenario for commodity prices is thus maintaining at the current levels.
Without a meaningful rise in oil price, financing stress, production cuts and order
cancellation will continue to haunt the energy sector. We will continue to avoid the
energy-related sectors. Thailand has the highest exposure by market capitalization
to this sector.
Asset allocation
We are positive on Asia equities and look for a return of about 9% on average in
the region. As we look for major turning points in 2016, asset allocation has become
a challenge. For 1Q16, we take the base case of 1) four US rate hikes next year; 2)
US growth and 3) oil price to stay relatively stable; 4) USD strengthening and CNY
weakening, and 4) spiking bond yields on the onset of the first Fed rate hike in our
3M view.
Investors should brace for volatility but keep a lookout for major turning points
which could be positive to Asia markets which have been brutally beaten by macro
uncertainties this year.
We tally and summarize in Fig. 12, how the few variables discussed in the previous
sections have an impact on Asia markets. Korea and Malaysia are our best pick
markets in Q1. As uncertainties scooped up in Q1 for China/Hong Kong, Taiwan
and Singapore, investors should make use of weakness to accumulate these markets
during market corrections. There are our Neutral markets on a 3M view. Indonesia,
Thailand, Philippines and India are Underweights.
Fig. 12: Assessment of impact from Fed funds rate hikes
USD strength
Korea
Malaysia
Taiwan
58
Short rates
Less affected by
Rate view
USD strength
compared to ASEAN independent of US
countries
MYR affected by
domestic
sentiments in 2015;
could be less
Interest rates need
affected by USD
not follow;
trend this year;
upside high from
total return
perspective
Taiwan strongest
Room for rate cuts
among Asian
and more tolerant
currencies, aligning
of currency
more towards
weakness
Chinese policies
US Growth
Leveraged to US
growth outlook
Leveraged to US
growth, but still
domestic reigns;
market will like a
growth
confirmation from
the US
Leveraged to US
growth outlook
Oil price
1Q uncertainty
Markets likely to
range trade;
Seen as a
overcrowded
beneficiary of low
overweight
oil prices; may be
position; domestic
viewed negatively if
investors not as
oil price rises
positive as foreign
investors;
Investors need to
take a view on
Outlook should be
politics for
positive with a
confidence to pick
stable oil price;
up; forex and equity
teams differ
Elections on
January 16; policy
Least affected by oil
changes and crossprice
straits relation post
elections
Economics–Markets–Strategy
Asian Equity Strategy
Fig. 12 cont’d: Assessment of impact from Fed funds rate hikes
USD strength
China
Least affected by
Hong Kong USD due to pegged
currency
Singapore
Short rates
Least affected by
USD; CNY policy
uncertainty —
Expectations for
weakening could be
rate cuts,
more realigned to
independent of US
USD strength on
policy divergence
and SDR inclusion
High uncertainty if
SGD will follow suit
in 2016 after the
sharp depreciation
this year; market
has strong upside if
USD trend changes
US Growth
Oil price
1Q uncertainty
Firmer US growth
could provide
upside on exports
Least concerned
with oil price
Growth outlook still
a debate among
investors
Certain for short
Less leveraged to US Least concerned
China’s growth
rate to move in
growth, but China
with oil price
outlook
tandem
Short rates to move
Leveraged to the
in tandem, but
uncertain if it will US; growth outlook
Interest rates and
Market sector
can be more
keep pace with the
forex uncertainty
affected by outlook
positively
US’s as rates have
on the onset of US
for oil price
ascertained if US
already overshot
rate hikes
this year. Singapore rate hikes gather
pace
rates also depends
on forex outlook
Unexpectedly weak
this year although
Need not follow US;
Least affected by oil
balance is strong;
rates biased to the
price, but inflation
Philippines
Leveraged to the US
domestic issues
upside as inflation
has been lower as a
more leading to
bottoms;
result
outflows are more
of a concern;
Indonesia
Markets are
Domestic-demand
IDR has been more uncertain on policy oriented economy,
volatile than USD;
direction, US rate
except for
equal risks on the
hikes a
commodity exports
upside and
consideration for
which could be
downside
funds flow and
stronger if global
currency weakness growth is affirmed
Thailand
THB depreciation
least of a concern
Rates likely
unchanged due to
pro-growth
government; views
independent of US
India
Inflows affecting
currency outlook,
not USD direction
US rate hikes to
dampen high rate
cut expectations
Outlook is mixed
with a stable oil
price
Elections in May a
concern if the last
four years of strong
growth could be
repeated; market is
priced for policy
continuation
Economy unlikely to
pick up in the near
term. Although
there are
bottoming signals;
the sector outlook
guided by
corporates are still
weak
Private
consumption still
weak; prospects of
Market sector
stronger
affected by outlook
infrastructure
for oil price
spending could
have been overly
priced and very few
sectors to benefit
Leveraged to US
growth on export
outlook
Seen as a
Market is priced for
beneficiary of low
More leveraged to
reform success and
oil prices; may be
US than China
driven by rate cut
viewed negatively if
expectations
oil price rises
Source: DBS
59
Asian Equity Strategy
Economics–Markets–Strategy
Our 12m view on markets are affected by the longer term fundamental views on
the various markets. We are turning more positive on Indonesia, and Philippines
(Neutral) , and less on Thailand (Underweight).
1. Korea (3M /12M Overweight) Korea may not be best placed for impact of rate
hikes and growth confirmation, but near-term domestic risks are less compared
to other markets. The government is pro-growth, and domestic demand has been
resilient. 2015 earnings are less likely to face disappointment in the upcoming
reporting season. A more positive US outlook, brought about by accelerated rate
hike expectations, should bode well for its export outlook. We are concerned
that domestic growth may lose momentum at some point next year as the effects
of policy stimuli will eventually wane. But that should be offset by a stronger
export outlook if pro-growth policy measures were to be removed.
2.Malaysia (3M Overweight / 12M Neutral) The Malaysia market will be less affected
by the US rate hikes as the outlook is overshadowed by domestic concerns on
politics and oil prices which saw the ringgit tank 22% this year. With the view that
crisis of confidence has dissipated somewhat, we believe the Malaysia market can
display its defensive capabilities in times of uncertainty around US rate hikes. The
RM20bil Valuecap fund is expected to be deployed into the market in January
which will provide support for the market. Longer term, low oil price and weak
external balance will still be an overhang for the market to outperform.
3.Taiwan (3M Neutral, 12M Underweight) Taiwan should be least affected by
Fed rate hikes as it is also facing uncertainty on elections in early January. We
prefer to wait for the elections overhang to be removed, while downside risk to
growth is still high in the near term. Taiwan is least concerned on USD strength
as its external balance sheet is strong, and has room to cut rates. Taiwan has
now faced two quarters of negative growth. While it is not difficult to argue
for economic bottoming in Taiwan, it still faces multiple challenges ahead for a
cyclical recovery.
4. China (3M Neutral, 12M Overweight) China is least concerned about US rate
hikes, but we believe the direction of the USD trend will underpin the outlook
on the CNY, and hence sentiments for the stock market. We expect a modest CNY
depreciation, supported by rate cut expectations, which on balance should be
market negative, in our view. However, a turn in USD could see the CNY being
more stable. In view of the uncertainty, we stay Neutral in the Chinese market in
the near term. The outlook for the CNY will be clearer after the US rate hike. We
are positive in China on a 12-month view as financial and capital markets reform
gather pace.
5. Hong Kong (3M Neutral, 12M Overweight) While Hong Kong will be least
affected by the USD outlook, interest rate hikes in the US will raise short-term
rates in Hong Kong. We believe liquidity in Hong Kong is sufficiently abundant
for the banks to price up loans. Consumption is already too weak to be affected
by interest rate hikes, while stock market multiplier on wealth effects is more
important to watch. The tipping point on the residential property markets when
interest rates start to rise should not be too much of a concern as interest rates
are still low when compared to the past.
6. Singapore (3M /12M Neutral) Interest rates in Singapore are expected to rise
in tandem with the US. With this in mind, the SGD may not weaken as much
next year when compared to 2015 and could beat expectations. Recall that in
2015, the market lived with a sharp depreciation in the SGD, fund outflows, and
growth disappointment. A relief from the currency outlook could see the market
getting a temporary reprieve.
60
Economics–Markets–Strategy
Asian Equity Strategy
7. Indonesia (3M Underweight, 12M Neutral) The upside risk on a USD reversal is
high for Indonesia — currency appreciation, oil price rebound, and increased
chance of interest rate cuts. While downside risks are widely known, heavy
capital outflow like this year is less likely. We stay cautious in the market in the
near term as earnings growth is likely to be disappointing and the rupiah has
already recovered somewhat from its low. We believe government investment
spending should pick up in the second half, and the economic packages delivered
so far should have some impact on the real economy.
8. Thailand (3M /12M Underweight) In contrast with historical analysis, the Thai
market should be least affected by US Fed rate hikes as it now maintains a flexible
currency policy system. The market should also favour a weak THB as it helps
with exports and tourism sector. All eyes are on government spending to drive
growth this year, regardless of US rate hikes. However near term headwinds from
lower oil price will weigh on the heavy weight energy sector.
9. Philippines (3M Underweight, 12M Neutral) Philippines will be challenged by US
and domestic concerns in the 1H of this year, as the presidential elections become
hotly contested. Although not directly connected to US rate hikes, we expect
Philippines to be the first country to raise rates in Asia.
10.India (3M Underweight, 12M Neutral) The rupee will have the tendency to
depreciate in a US rate hike scenario regardless of the USD direction. Meanwhile,
domestic concerns on GST bill and civil servants’ pay rise should put pressure
on some of the nervous issues on Modi’s reform, budget deficits, and growth
outlook.
A summary of our 3M and 12M index targets and recommendations are presented
in Fig. 13.
Following are our fundamental views on the various markets which determine our
12m expectations:-
Market views
China / Hong Kong (3M Neutral, 12M Overweight)
China has increasingly appeared to us that it has bottomed. After four years of China
is increasingly appearing to us that it has bottomed. After four years of worrying
about a hard landing, investors have finally realized that any landing that takes four
years is soft by definition. Increasingly they are focusing on what they should have
all along: long-term structural change and reform. The capital account is increasingly
open, interest rate liberalization is largely complete and the IMF has stamped its
approval on the process by adding the yuan to the SDR basket. Things are moving
in the right direction.
As most know, China has a large local debt problem. But the central government has
already carved out RMB3.2tn of bad debt equivalent to 5% of GDP, and likely to be
paid by the central government. What is clear to us is that China has no intention of
allowing a simple debt problem hold back growth for 25 years like it has in Japan,
when cleaning it up is as easy as 1-2-3.
China recently held its 13th Plenum where delegates approved the next –year
economic plan. The specifics of “13-5” will not be revealed until March but what
the government did say loud and clear was that the main goal is to continue lifting
incomes and living standards – to prevent China from falling into a “middle-income
trap” like so many countries do after an initial period of successful development.
Some highlights from the 2016-2020 work plan includes: 1) GDP growth targeted
at 6.5%; 2) relaxation of one-child population policy; 3) environmental protection
and renewable energy targets; 4) innovation on major sectors, including the use of
61
Asian Equity Strategy
Economics–Markets–Strategy
Fig. 13: Summary of market recommendations
Market
3M
Index
Current
3M view
index
target
12M
view
12M
Index
Upside
Downside
target
risks to market return
risks to market return
Singapore
2861
N
27503050
N
3200
SGD, interest rates
more stable than
expected
Growth continues to
disappoint
Malaysia
1659
OW
1700
N
1750
Support from
ValueCap fund
Political concerns resurface
Thailand
1298
UW
12001300
UW
1302
Government spending
gathers pace
Low oil price, political
concerns emerged
Indonesia
4464
UW
4200
N
4700
USD tops
Rupiah weakens in line
with our forecasts
Philippines
6848
UW
7000
N
7300
Next president
GDP growth below 6%
Regulatory tightening;
withdrawal of
government market
support measures
China ‘A’
3636
N
3800
OW
4000
Domestic investors
having short memory
H-shares
9559
N
10333
OW
11495
Growth surprise, MSCI
'A' share inclusion
More CNY depreciation
HSI
21804
N
22615
OW
25039
Growth surprise, MSCI
'A' share inclusion
More aggressive US rate
hikes
Korea
1948
OW
2000
OW
2200
Stronger US recovery
Domestic demand wanes
Taiwan
8230
N
8400
UW
8600
Stronger China
recovery
Growth disappoints
India
25036
UW
25000
N
27000
Risk appetite for EM
returning, GST bill
passed
Reform hiccups
Source: DBS
62
Economics–Markets–Strategy
Asian Equity Strategy
big data and internet to enhance efficiency; 5) carrying out <China manufacturing
2025> initiative to promote strategic high-end manufacturing sectors; and 6) focus
on One Belt One Road strategy.
Worrying about China is not worrying about the PMI, we reckon. China is in the
midst of a slowdown that is part structural and part cyclical. Neither is great but
the cyclical risk is almost trivial compared to the structural risk. Cycles are cycles.
Structure is what matters.
China’s to-do list is wide and long. It encompasses macro reforms, micro reforms, the
real sector, the financial sector, labor markets, insurance markets etc. This is where
the real risks and opportunities lie for investors.
As China enters the next phase of transition, continuous adjustment and
rationalization of policies are expected. On the back of this volatility we prefer to
stay Neutral on the market.
(see DBS Quarterly Economics-Markets-Strategy, “Holiday Heresies 2016”, “CN: Next
phase of transition begins)
Indonesia (3M Underweight, 12M Neutral)
Indonesian assets are the major beneficiaries of the changes in rate hike expectations
in Sep-Oct. 10-year government bond yield spread over US Treasuries has pulled
back, the IDR appreciated 9.7% against the USD, and the JCI gained 11% from the
low.
GDP growth came in at 4.7% (YoY) in 3Q15, just slightly below our expectations. This
is the third consecutive 4.7% showing for the year. Encouraging takeaway from the
GDP report is the jump in government consumption and investment growth. If the
trend persists, our GDP growth forecast of 5.2% can be maintained. It seems likely
that GDP growth might have just bottomed out.
The government has also announced several economic packages to boost growth to
attract investments and stabilise the rupiah. More essence is in the latest package
where energy prices are cut, and deregulation in the land policy and financial sector.
However, we believe Indonesia is not out of the woods yet. 3Q earnings season is
expected to be weak. Indonesia equities are still at risk from very weak exports. With
Fig. 14: CNY forecasts
Fig. 15: IDR forecasts
16000
7.4
CNY/USD daily
fixing
NDFs, as of 8 Dec
7.2
7
15000
IDR/USD daily
spot
NDFs, as of 8
Dec
14000
13000
6.8
12000
6.6
11000
6.4
10000
6.2
6
Jan-08
9000
Sep-10
Source: Datastream, DBS
Jun-13
Mar-16
8000
Jan-08
Sep-10
Jun-13
Mar-16
Source: Datastream, DBS
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Asian Equity Strategy
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external debt at 2.8x foreign reserves, the IDR is still vulnerable to a higher USD and
higher US rates.
The recovering IDR and lower inflation provide some room for rate cuts but lower
rates may not necessarily boost growth.
We continue to be defensive in our Indonesia strategy and prefer the Telcos and
Consumer Staples where earnings are defensive; while avoiding the importers and
companies with USD debt exposure. Longer term, we are positive on demographic
structural winners such as property and infrastructure-related sectors including
building materials. Banks, being heavy index weights, are index proxies which we
prefer to have a neutral exposure, in line with our market expectations that the
Asia markets should return positively this year. We devise our strategy through
underweight the consumer discretionary sectors which are likely to see slowing
growth.
Singapore (3M Neutral, 12M Neutral)
The Singapore economy surprised on the upside with a +1.9% (QoQ, saar) expansion
in 3Q during vs earlier expectation of a technical recession. This is mainly driven
by the positive surprise in the services sector, which accounts for two-thirds of the
economy. The manufacturing sector, which accounts for the other third, continue
to be in a recessionary mode and has been registering negative growth for the past
four quarters.
The headline numbers such as exports and IP numbers aren’t going to look pretty
going forward. The Singapore market is likely to be affected by the global macro
and the SGD outlook, affecting fund inflows. Themes should revolve around the
sustainability of the growth in the services sector, especially in the e-commerce and
Telco space.
DBS currency strategist continues to look for a weakening in the SGD towards
1.47 by 3Q16 before finding some reprieve in 4Q. This is driven by the strong USD
outlook as a result of the policy divergence between US and Europe, and a gradual
depreciation in the CNY. Markets are currently pricing in two hikes next year. The
pace of rate hikes will likely be revisited after the December lift-off, leading to more
volatility in the SGD.
We reiterate that Singapore market is not cheap, hence the upside possibility of a
sustainable re-rating is significantly reduced. More than half of Singapore STI stocks
are trading above 16.4x, which is near historical high. The drivers for the markets
will have to be mainly earnings growth or thematic themes such as value unlocking
among the GLCs, and re-rating in the new industries.
In the latest business outlook survey for the services sector in the next six months,
general business expectations are only up for the Accommodation & Food Services,
Information & Communication, Recreation, Community & Personal services (RCP).
In this regard, we believe the REITs, Telcos and some niche stocks in the Personal
Services space such as education and healthcare can still sustain their growth rates
next year. In our DBS coverage list, Consumer Services, Healthcare, Industrials,
and Oil & Gas sectors will record double-digit growth rates next year. Other than
Healthcare, growth from the rest of the other sectors is derived from low base
of negative earnings growth this year. Conviction in their recovery remains low,
considering the weak global growth and low oil price. We recommend 1) staying
selectively opportunistic with GLC names for M&A possibility; 2) riding on the
SmartNation theme in the Info & Coms space, while staying away from interest ratesensitive sectors such as Property and REITs.
64
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Asian Equity Strategy
Malaysia (3M Overweight, 12M Neutral)
The Malaysia market is the worst performing market in USD terms. At the heart of
the problem is currency weakness and crisis of confidence / trust. For the next three
months, we believe price risk will gradually skew to the upside as the overhanging
issues get resolved.
In the past one year, the economy was struggling with weakness on the external
front, given the slump in commodity and energy prices. It runs a high fiscal deficit
and external debt, and coupled with uncertainties over domestic politics, have led
to capital outflows and weakness in its currency.
After the outflows this year, we believe foreign ownership has dropped to 20% for
equities. The equity market is generally under-owned in our view.
The Malaysia economy is expected to grow at 4.8% this year and 4.5% next, both
relatively strong when compared to its ASEAN neighbors. This comes about despite
weak exports, subsidy cuts and GST hikes. In the last budget announcement, the
government re-affirmed its budget and fiscal spending targets, which can be met as
a result of the restructuring efforts in the last two years.
The cost of doing business in Malaysia has come down significantly with the cheaper
MYR and commodity prices. The ASEAN Economic Community will be formally
established at the end of this year. Investors could re-look at Malaysia as a favorite
FDI destination.
FDI into Malaysia has stagnated in the last few years. Chinese investors have recently
bought into power assets in Malaysia, and the upcoming Kuala Lumpur – Singapore
high-speed rail has attracted a lot of investors’ interest. We expect investments into
Malaysia to pick up if the government continues to step up its efforts to attract FDI.
Market valuation in Malaysia is not cheap however. This is due largely to domestic
liquidity supporting the stock market. Sectors which are still attractive in terms of
valuations and growth among their ASEAN counterparts are plantation and gaming
stocks.
We are upgrading Malaysia to Neutral. Confidence is at rock bottom right now
which could turn for the better upon the easing of political tensions and if the
economy proves to be resilient. The ValueCap fund will start buying in January, thus
rendering support for the market, especially for the government-linked stocks. The
debt-ridden 1MDB has begun with its asset sale programme, thus easing concerns on
the associated political crisis faced by the current government.
Risks to the market are 1) political volatility, which is hard to predict, could
resurface. This is indeed reflected in DBS currency forecasts; 2) more aggressive
USD strengthening than our current forecast. This could be brought about by more
aggressive Fed tightening than our forecast of four times a year.
Thailand (3M Underweight, 12M Underweight)
The SET index returned -9% YTD, much worse than MSCI Asia ex-Japan’s -6.6%
return. Three main sectors have brought the index down, namely Banks, Oil & Gas, as
well as the Telcos, due to a weak domestic economy, low oil prices and the negative
outlook for the Telco sector after the 4G auction. Top performers are stocks in the
Healthcare, Tourism and Infrastructure-related sectors.
We believe the economic growth in Thailand should pick up next year as interest rates
stay low and the government pushes through pro-growth stimulus programmes. 3Q
GDP growth has accelerated towards 4% versus an average of 1.5% in the first half.
If the momentum continues, our target of 3.7% for full-year 2016 should be within
reach.
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Economics–Markets–Strategy
As global macro uncertainty is likely to prevail in the first half, we prefer to stick
with sectors with strong earnings momentum. From a bottoms-up view, the strong
earnings visibility in the healthcare and tourism sectors should safeguard the index
from downside, while the infrastructure and manufacturing sectors could provide
some upside surprises. The heavyweight energy sector is still a wild card, in our view.
The key drivers for the Thailand market going into next year largely depends on the
pace of infrastructure spending and private investments.
Taiwan (3M Neutral, 12M Underweight)
We maintain the forecast that the economy will grow only modestly by 2.4% next
year, significantly below the long-term trend rate of 4%. The growth should however
have bottomed in 3Q this year and picked up moderately from here.
The presidential elections in early January should not change the macro outlook
where sustainability of recovery still remains a question in view of the uncertainty
poses by China slowdown and US Fed rate hikes. Implementing pro-growth
policies, such as joining the TPP and building economic ties, should not be affected
by politically developments now. We believe throughout the years, Taiwanese
corporates have adjusted to the volatility in cross-straits relationship by looking
beyond China, such as in ASEAN countries as alternative investment regions. That
said, hollowing out is still a structural issue for Taiwan to deal with in the longer
term. Otherwise, domestic demand growth will continue to be sub-par and Taiwan
remains largely cyclical.
Among Asian economies, the Taiwanese economy is the most leveraged to the US
economy. The growth confirmation from a US rate lift-off in December should drive
the bottoming cyclical outlook for Taiwanese companies. Consensus looking for
4.4% earnings growth for Taiwan bear upside risks, in our view.
The Taiwan market has de-rated in line with its weak economic and corporate
earnings growth this year. With the expectations that they have both bottomed, we
believe the de-rating trend has halted. We look for the market to trade towards its
5-year average PE by the end of the year.
Korea (3M Overweight, 12M Overweight)
The short-term outlook for Korea has improved as the domestic economy recovers
with the stimulus effects from pre-emptive policy easing earlier in the year. While
exports continue to pose risks for the economy the structural transformation from
“old” to “new” economy should support the PE re-rating of the broad market,
especially with the new economy stocks. These would include healthcare, tourism,
content, education, finance, logistics and software sectors. Korea has traded out of
its 5-year PE range as a result, but still remains one of the cheapest in the region.
The growth confirmation from a US lift-off should pose upside risks for the global
cyclical stocks in Korea, such as Technology and Auto sectors.
Volatility for Korea will mainly emerge from its competitive outlook from currency
cross rates with JPY and CNY. China is now an important trading partner for Korea,
and provides a main support for its tourism industry. A weak CNY outlook will add
on to the volatility for the stock market.
Going into next year, whether there will be more stimulus measures to sustain its
domestic growth could also add to concerns. We believe there is less room to cut
rates, and the pick-up in housing prices could induce BoK to tighten some of its
property credit measures.
That said, with growth remaining sub-par, macro uncertainty still at large, and
elections in 2016 and 2017, we believe the government should still be biased towards
supporting the nascent recovery.
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Asian Equity Strategy
Philippines (3M Underweight / 12M Neutral)
DBS economist remains positive on the Philippine economy to return to above 6%
next year, driven by strong domestic demand. So far, foreign remittance flows have
been robust. While investment growth could moderate going into the elections as
business decisions get delayed, private consumption is likely to be able to offset the
drag. Philippines will still be one of the few countries to register more than 6% GDP
growth and with a strong external balance. The Philippines market should benefit
if risk appetite returns for emerging markets.
Near term, the uncertainty brought about by potential US rate hikes and the
presidential elections in May should give rise to market resistance. The market
PE has dropped from a high of 20.5x to 17.6x currently. Although it has become
interesting again for the Philippines, GDP falling below expectations and earnings
disappointment could be near-term risks for the market. We would be more positive
on the market if it becomes clearer that the forerunner in the presidential race turns
out to be a person who can continue with Aquino’s economic policies, and thus the
market could re-rate.
India (3M Underweight / 12M Neutral)
Although the Indian market has traded off its recent high valuations of 18x, the
market has re-rated from 13x to the current 16.9x in a mere two years, driven by
reform promises by the new government. The phenomenal growth in the stock
market has also been partly driven by cyclical factors, such as lower oil prices, interest
rates, and portfolio flows which work in its favour, especially in the first half of this
year.
The strategy team believes that reform is still an ongoing process that takes time
and many issues still remain unresolved. Meanwhile, the twin deficits of fiscal and
budget imbalances still remain. Near-term risks stemming from US Fed rate hikes
and uneasiness with emerging market currencies are not going to drive flows in
India’s way. We believe the current PE valuation is unsustainable without the cyclical
uplift.
India’s GDP growth expectation has been tempered down from 8+% growth to
7-ish growth, the main reason for the market to have underperformed in the last
quarter. Growth in the first half of FY16 averaged 7.2%, with an uneven recovery
in the key growth engines. Much of the cyclical upturn was led by higher urban
consumption and accelerated government-led investments, while sluggish rural
demand and subdued private sector activity has lagged. Going forward, unless
private investments start to pick up, there are downside risks to growth.
We are staying cautious on the market in the near term on US rate hikes, and on
a 12M view, stay cautiously optimistic that risk appetite should return to emerging
markets in the second half.
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CN: next phase of transition
• Economic transition is usually characterized by slower growth, disinflation and adjustments in asset prices. Restoration of balance is necessary
before proceeding to the next stage • Demand side stimulus is limited. Supply side polices are all-important
but much higher precision in execution is needed to achieve policy goals
• Rationalization of exchange rate behavior to align with domestic economic fundamentals will help facilitate the economic transition
Economic growth will continue to decelerate in 2016. Achieving 6.5% real GDP
growth target is still a tall order against the backdrop of the fragile global economy
alongside tremendous structural challenges domestically (Table 1). Monetary and
fiscal policies had limited effectiveness in 2015 for two reasons: (1) Execution of
fiscal projects is compromised by the ongoing anti-corruption program (a lack of
coordination between central and local governments); (2) Borrowing costs remain
high due to rising credit risk. The situation will likely remain the same in spite of
further cuts in interest rates and reserve requirement ratios.
Supply side policies and structural reforms are needed to harness sustainable
growth. They require much more precision in planning and execution, compared to
demand-side policies. Such policies include interest rate liberalization, SOE reform,
de-regulation of utility prices, and capital account liberalization. The common goal
is to improve allocation of resources through accurate signaling of prices. Economic malaise such as over-capacity and all types of rent-seeking behaviors can then
be avoided more easily.
Beyond the financial sector, structural reforms include urbanization, environmental
conservation, medical/pension/education system reforms, population planning and
the legalization of property rights, to name a few. These require a holistic mindset
in policy design. For instance, the recent adoption of the Two Child Policy is meant
Table 1: Key macroeconomic targets announced at the NPC
Actual
2015
2014
1Q-3Q
7.0%
around 7%
around 7.5%
Oct YTD
1.4%
around 3%
around 3.5%
M2 growth
Oct YTD
13.5%
around 12%
around 13%
Total exports and imports growth
Nov YTD
-8.5%
around 6%
around 7.5%
Real GDP growth
CHINA
CPI
Fixed assets investment
Oct YTD
10.2%
15%
17.5%
Retail sales
Oct YTD
10.6%
13%
14.5%
Registered urban unemployment
rate
Sep YTD
4.0%
2014
2.1%
Budget deficit to GDP
Chris Leung • (852) 3668 5694 • [email protected]
68
not exceed 4.5% not exceed 4.6%
2.3%
2.1%
Economics–Markets–Strategy
China
to tackle the issue of long-run labor supply. But might having more children reduce
womens’ participation in the labor force? Empirical studies of other countries show
women with two or more children are more likely to stay at home. In another
example, the reform of the “Hukou” system is not only a function of the recipient
cities granting migrant workers the permit to work locally but it would also involve
pension system reform. It is because migrant workers’ pensions are tied to their
original hometown that they are reluctant to move. Rationalizing such structural
issues is not only complicated but often faces tremendous political resistance.
Unlike demand side stimulus, supply-side policies do not normally raise growth very
quickly. This is the biggest problem now – fiscal/monetary policy is not as effective
as before, and yet structural reforms may take years to yield results. Meanwhile, the
old export-led growth model is faltering but a new model isn’t in place yet. The
consequential transition to a consumption-driven economy first requires sustainable
income growth. Experiences of other Asian economies showed that income have to
increase first before consumption share of GDP can rise. China is still very far away
from achieving this.
In retrospect, China might have chosen to downplay manufacturing prematurely.
Labor-intensive industries at the lower end of the value-added spectrum had already migrated to countries like Vietnam, Bangladesh and Cambodia. While China
has succeeded in moving up the value-added chain, the margins of such businesses
are not as high as they may appear on the surface. Most Chinese enterprises import
parts of export items classified as “high tech”, then they assemble them in labor
intensive plants, before ultimately exporting them as a final “high tech” product.
This is vastly different from truly higher-end manufacturing achieved in technologically more advanced nations like Germany and Japan.
China might have
chosen to undermine the importance of manufacturing prematurely
Meanwhile, the old export model continues to be challenged by rising labor costs
(Chart 1) and persistent strengthening of the real effective exchange rate (REER)
(Chart 2). As a result, the manufacturing sector is hampered by deflation and, therefore, high real interest rates. They cannot reduce labor costs easily either because of
regulatory constraints or labor shortages.
Conventional macroeconomic reasoning would conclude monetary policy is still too
conservative when comparing the nominal interest rate against either the CPI or the
PPI. Many argued for more aggressive rate cuts given where rates currently stand.
But China should not follow this strategy like Japan did in the 90s. (Japan cut interest rates to zero but permitted the persistent appreciation of the JPY, which contributed to deflation.) China’s high debt-to-GDP ratio and overcapacity are preventing
rate cuts from stimulating growth.
Chart 1: Average real wage
% YoY
20
15
10
5
0
2012-2014 average: 8.1 %YoY
-5
-10
1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014
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China
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Chart 2: REER versus PPI
% YoY
% YoY
20
10
15
6
10
2
5
0
-2
-5
-6
PPI (LHS)
-10
Sep-06
Sep-07
Sep-08
Sep-09
Sep-10
Sep-11
Sep-12
REER (RHS)
Sep-13
Sep-14
-10
-15
Sep-15
The exchange rate matters
In the short term, a weaker REER would help improve competitiveness. The current
fragile state of the global economy renders consumers to be much more pricesensitive when making purchasing decisions. Monetary authorities should make
good use of the timing of US rate hike to guide the currency weaker. The issue at
stake here is to ensure exporters’ survivability first. After all, the manufacturing
sector still accounts for 31% of GDP by value-added and 29% of total employment.
A sustainable
export rebound is
a function of many
parameters
A sustainable export rebound is a function of many things including economic
health of importing countries, product innovation, branding and pricing strategies.
As a result, a longer-term strategy is to begin fostering enterprises’ technological
innovation urgently. The consequential goal is to climb up the value-added chain
by producing unique products that could command a price premium in global markets. Achieving such a tall order requires carefully structured industrial policies
alongside sweeping institutional reforms to incentivize innovation particularly in
SOEs.
The importance of innovation is heavily emphasized by the 13th five-year plan,
which fits well with Premier Li’s “Made in China 2025” initiative. The plan involves
policies to encourage the adoption of robotics, 3D printing and other advanced
techniques to leapfrog China’s manufacturing capability to the leading edge. While
the intentions are good, the state must avoid repeating the failures of past industrial policies. The dominant strategy should be to support those industries that
already possess a comparative advantage in their respected fields (See “China: The
importance of industrial policy in the rebalancing process”, Oct 2012).
Services and manufacturing must develop together
Services sector optimism offsets manufacturing pessimism for obvious reasons.
By comparison, the services sector is debt free and not plagued by over capacity.
Capital intensity is also lower than in manufacturing. But in the absence of high
frequency data to gauge service sector performance, it is hard to make concrete
judgments about it. So far, optimism comes primarily from spurious reports by the
media citing the spending spree over the internet on just one day surpassing the
US’ similar festival.
Without an adequately understanding of what drives services sector growth, optimism may be misplaced. The primary growth determinants of the services sector
other than income levels are: urbanization (demand for services naturally increases
when more people move into urban areas from rural areas), deregulation (empiri-
70
Economics–Markets–Strategy
China
cal evidence shows deregulation of services industries such as telecommunications,
health, insurance and banking spurs their growth), and even participation of women in the work force (demand for babysitting services to beauty treatment increases
as more women enters the labor force) .
Finally, the push of manufacturing into higher value-added segments adds to demand for services as well. As such, the market should not view manufacturing and
services sector as a zero-sum game. One does not really growing at the expense of
the other. They must develop together.
Conclusion
We need to understand the growth
determinants of
the services sector
China’s current economic transition is unprecedented in history, scale, and complexity. Standing at a juncture where the 13th five-year plan is forthcoming, it is of utmost important to set the strategy right now.
Exchange rate policy matters tremendously at the outset of this phase. The experiences of post-bubble Japan in the 90s serve as a good example of what ought not
to be pursued. For China, a weaker exchange rate helps to facilitate the transition
process smoothly. It should not be narrowly viewed as a tool to stimulate short-term
export growth nor should any judgement of success be based on short-term trade
figures. When the exchange rate is allowed to freely respond to market forces, the
benefits will flow through to aid microeconomic efficiency. Manufacturing companies in particular will adjust their business strategy so as to ensure their survival. This
in turn would drive an array of new reform imperatives spurring productivity and
ultimately benefiting the services sector as well.
As far as demand-side stimulus is concerned, monetary policy under the prevailing
background of overcapacity and high domestic debt should remain conservatively
accommodative. Fiscal policy is more complicated because the linkages between
central and local governments are hampered by the ongoing anti-corruption campaign. This will take time to resolve. Nevertheless, an expansionary fiscal policy
with clearly defined goals would help growth greatly.
Once the policy mix is executed effectively, structural reforms on all fronts must
simultaneously proceed swiftly. The road to reform is always rocky. New lessons
will be learnt. But if policy is set right at the beginning, the probability of success
increases.
Exchange rate
policy matters
tremendously at
the outset of this
phase
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China
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China Economic Indicators
2014
2015f
2016f
3Q15
4Q15f 1Q16f 2Q16f 3Q16f 4Q16f
Real GDP growth
GDP by expenditure: current price
Private consumption
Government consumption
Urban FAI growth (ytd)
Retail sales - consumer goods
7.3
6.8
6.5
6.9
6.5
6.4
6.5
6.6
6.7
9.9
6.8
15.7
12.0
12.3
10.0
10.2
10.8
12.2
10.0
11.5
11.2
12.3
10.0
10.3
10.7
12.3
10.0
10.2
10.8
12.3
10.0
10.5
10.9
12.2
10.0
10.8
11.0
12.2
10.0
11.2
11.2
12.2
10.0
11.2
11.2
External
Exports (USD bn)
- % YoY
Imports (USD bn)
- % YoY
2,342
6
1,959
0
2,259
-4
1,671
-15
2,344
4
1,699
2
595
0
433
-10
597
-8
431
-13
529
3
381
-2
574
4
417
0
618
4
450
4
622
4
450
4
383
220
2.1
589
337
3.2
645
369
3.3
162
n.a.
n.a.
165
n.a.
n.a.
148
n.a.
n.a.
157
n.a.
n.a.
168
n.a.
n.a.
172
n.a.
n.a.
3,843
120
3,500
128
3,000
130
n.a.
26
n.a.
33
n.a.
36
n.a.
34
n.a.
27
n.a.
34
2.0
1.0
1.5
0.2
1.5
0.5
1.7
0.5
1.7
0.5
1.5
0.5
1.5
0.5
1.5
0.5
1.6
0.5
3.2
12.2
6.5
13.0
6.8
13.5
11.4
13.1
6.5
13.0
6.5
13.0
6.6
13.1
6.7
13.3
6.8
13.5
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
Trade balance (USD bn)
Current account balance (USD bn)
% of GDP
Foreign reserves (USD bn, eop)
FDI inflow (USD bn, YTD)
Inflation & money
CPI inflation
RPI inflation
M1 growth
M2 growth
Other
Nominal GDP (USD bn)
Fiscal balance (% of GDP)
10,326 10,685 11,177
-2.1
-2.0
-2.0
* % change, year-on-year, unless otherwise specified
CN - nominal exchange rate
CN – policy rate
CNY per USD
%, 1-yr lending rate
8.0
7.5
7.8
7.0
7.6
6.5
7.4
7.2
6.0
7.0
5.5
6.8
5.0
6.6
4.5
6.4
6.2
6.0
Jan-07
72
4.0
Jan-07
Oct-08
Jul-10
Apr-12
Jan-14
Oct-15
Oct-08
Jul-10
Apr-12
Jan-14
Oct-15
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Hong Kong
Economics–Markets–Strategy
HK: chugging along
• Private residential property prices and rents have both come down in recent months. DBS projects private residential property prices will decline
by 5%-10% in 2016
• The retail sector continues to face multi-year challenges, namely a strong
HKD and China’s economic slowdown. However, retailers may find relief
from lower rents. Large-scale layoffs are unlikely
• Disinflation has likely been driven by rental disinflation – and deflation
in some cases – in both the retail and residential segments
• Positive wealth effects are diminishing, no longer supporting private
consumption. We forecast 2.4% GDP growth in 2016
Residential property prices climbed rapidly in the first nine months of 2015 (Chart
1). Prices increased by 10.9% from January to mid-September, before retreating
4.5% from the peak by late November. Transactions also dropped sharply in recent
months, contracting by 46.7% (YoY) and 41.7% in October and November respectively. In October, residential rents dipped by 1.8% MoM to $33.4/sq feet, marking
the biggest monthly decline in four years.
Going into 2016, property risks will continue to rise. Crucial factors supporting the
many-year price rally – ultra low interest rates and demand-supply imbalance – are
fading. The US is preparing to hike interest rates and housing completions have
increased notably since early 2014 (Chart 2).
However, we do not foresee a collapse in property prices (>20% within a year)
for four key reasons. First, the US rate hike is largely anticipated, ruling out any
fear-selling in response. Second, the 3M Hibor is extremely low at 0.4%, and it will
take many rounds of rate hikes (at least 200 bps) to significantly erode housing
affordability. Currently, the mortgage-income ratio of small-medium sized flats is
54%. This compares to 114% in Jun 1997 (3M HIBOR: 6.5%). Third, HIBOR may not
Chart 1: Residential property prices (Rating and Valuation Dept)
1999=100
400
Class A (smallest size)
Class C
Class E (largest size)
350
Class B
Class D
300
250
200
HONG KONG
150
100
Latest: Oct 15
50
0
Jul-97
Jul-99
Jul-01
Jul-03
Jul-05
Jul-07
Chris Leung • (852) 3668 5694 • [email protected]
74
Jul-09
Jul-11
Jul-13
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Hong Kong
Chart 2: Private residential unit completions
35,000
30,000
25,000
Average: 15,140
20,000
15,000
Average: 9,284
10,000
5,000
0
2002
2004
2006
2008
2010
2012
2014
2016F
immediately track US interest rates if liquidity in Hong Kong is plentiful. Fourth,
end-user demand is strong and supply is still relatively constrained. An estimated
15,300 units to be completed in 2016 still falls short of an estimated 18,000 units
of annual demand.
An orderly correction will happen
over several years
The most likely scenario is for interest rates to gradually increase through the Fed
rate hike cycle, eroding local housing affordability, leading to an orderly property
price correction over several years. In 1Q16, negative sentiment surrounding the
first US rate hike – despite full anticipation – and further yuan depreciation will
weigh on property prices. DBS projects private residential property prices to decline
by 5%-10% in 2016.
The retail outlook remains bleak
The retail sector continues to be afflicted by multi-year challenges. Ongoing currency depreciation in Europe, Japan, the mainland and a handful of Asian economies are dampening tourists’ spending in Hong Kong and encouraging locals to
spend overseas. In addition, popular tourist destinations have relaxed visa requirements recently, and this would divert mainland shoppers away from Hong Kong.
Chinese tourists travelling under the Individual Visitors Scheme fell 7.5%YoY and
16.6% in 2Q and 3Q respectively.
So far, the luxury retail sector has been hardest hit as there is no apparent end to
China’s economic slowdown and the anti-corruption campaign. Sales of jewellery
and watches have been contracting year-on-year for 19 consecutive months. Several international luxury labels are renegotiating rents and some companies have
chosen to consolidate two or more stores into one.
Even mass-market retailers are facing an increasingly challenging environment. In
April, the Chinese government has ceased issuing multiple (unlimited) entry permits into Hong Kong for Shenzhen residents. In June, China has slashed import
tariffs on a range of consumer goods. The most important game changer is the
slowing of locals’ spending (accounts for >60% of retail sales) on the back of weaker equity and property markets. We project total retail sales values to contract by
3.0% in 2015 (-2.7% YTD), and contract by another 2.0% in 2016. The five-year
trend growth is 12.7%.
No apparent end to
China’s economic
slowdown and the
anti-corruption
campaign
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Economics–Markets–Strategy
Retailers may find relief from lower rents
Retail rents have
come down by
5.8% on average
from May to Sep
A prolonged slowdown has resulted in rental adjustments, bringing much needed
relief to retailers. According to government data, retail rents have come down by
5.8% on average from May to Sep. Prime street level stores, e.g., those on Russell
Street, have seen rents slashed by as much as 40%. More widespread rental cuts
are expected in 2016, which gives retailers room to cut product prices. In particular,
fashion retailers are likely to offer generous discounts to quicken inventory destocking, in light of the unexpected hot weather. Of course, staying competitive would
require other adaptive business strategies. For example, stores targeting mainland
customers have been attempting to refocus on local customers. Others are cutting
costs by relocating to suburban locations, moving upstairs or even online. As a result of these dynamics, we envision visible changes to the retailer mix – especially in
prime shopping areas. The presence of luxury retailers will gradually diminish, and
mid-tier brands targeting local consumers will take their place. For example, an
international sports apparel retailer will take the place of a US luxury leather goods
retailer in a multi-storey building in the heart of Central.
The retail sector’s unemployment rate should remain steady in the near term
(Sep15: 4.5%; GFC peak: 6.8%), because labor mobility within the retail industry is
quite high. But risks are increasing at the margin. The government’s 4Q15 Quarterly
Business Tendency Survey indicated that 9% (vs. 2% in the 3Q survey) of respondents in the retail sector expect their employment to decrease. It remains to be
seen if rental adjustments could delay or prevent layoffs. For the time being, the
sector’s slowdown may increase the incidence of job hopping and lower employee’s
sense of job security.
Disinflation intensifies
Disinflation has likely been triggered by rental disinflation – and deflation in some
cases – in both the retail and residential segments.
The clothing and
footwear component of the CPI has
been deflating
As discussed, lower retail rents will give retailers room to lower prices, resulting in
product disinflation/deflation. In fact, the clothing and footwear component of the
CPI has been deflating by an average of 1.7%YoY for every month since October
2014. The deflationary trend is set to continue.
In the residential space, rental adjustments tend to lag property prices. Rental
growth impacts the CPI with a least a six-months time lag. As property prices began declining in September, it is likely that rental disinflation will impact the CPI in
2H16.
Chart 3: Underlying CPI
% YoY
4.5
4.0
3.5
Latest: Oct 15
3.0
2.5
2.0
Jan-14
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Apr-15
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Hong Kong
We project the CPI will increase by 3.0% in 2016, unchanged from 2015. Intuitively,
the CPI in 2016 should be lower than that in 2015 because of deepening rental
disinflation and deflation of selected items (e.g., clothing and footwear). However,
arithmetically, the CPI in 2H15 (est. 2.3% vs. 3.7% in 1H15) was skewed downwards
by the timing and amount of government measures, such as rates waivers and
electricity subsidies. In any case, the underlying CPI, which excludes the effects of
government measures, is likely to continue disinflating in 2016 (Chart 3).
An additional factor that will cloud the CPI outlook for 2016 is the government’s
CPI weighting and basket adjustment, which is updated once every five years “to
ensure that up-to-date expenditure patterns of households in different expenditure ranges can be accurately reflected in the compilation of the CPI”. Full details
of the adjustment for the 2014/15-based CPI will be released around mid-2016. The
new basket weightings and the inclusion of new items of consumer goods and services will affect CPI values in 2016 and beyond.
The government
will adjust CPI
weightings and
baskets in 2016
No growth catalyst
Positive wealth effects from stellar equity and property markets had supported
private consumption in 1H15. Private consumption grew 5.3% and 6.0% in 1Q and
2Q respectively. As equity indices point south and risks to the property market escalate, positive wealth effects are diminishing. Private consumption growth is likely
to retreat to about 3.6% in 2H15, and further to 3.2% in 2016.
Meanwhile, the outlook for private investment and external trade remains dire.
Hong Kong’s private investment is positively correlated with China’s economic performance. China’s slowdown has been protracted (annual real GDP growth dipped
below 8.0% since 2012), and economic growth is set to slow further to about 6.8%
this year and 6.5% next year. As profits are being squeezed, Hong Kong enterprises’ business expansion and capital expenditures should slow. Indeed, private
investment growth contracted 6.1% in 3Q, compared to expanding 6.3% in 1H15
(10-year trend: 4.9%).
Net exports will likely chip off some headline growth. Nominal net exports have
fallen by 17.1% YTD. Export growth to major markets was negative across-theboard. Exports growth rates to Japan and the EU have been consistently negative since 3Q14. Growth rates averaged -5.1% and -3.6% respectively over the past
three months (Aug-Oct). Exports to China fell 4.9% over the same period. While export growth rates to ASEAN and USA were positive up to July, they abruptly dived
to -3.0% and -4.9% over the past three months (Aug-Oct). We anticipate exports
to the US would recover in 1Q16 on the back of a firmer economic recovery, while
those to emerging markets in Asia would remain negative.
A deepening economic slowdown on the mainland, a tough external environment,
and uncertainty in financial markets would likely drag down GDP growth to 2.4%
in both 2015 and 2016.
77
Hong Kong
Economics–Markets–Strategy
Hong Kong Economic Indicators
4Q15f 1Q16f 2Q16f 3Q16f 4Q16f
2014
2015f
2016f
3Q15
Real output and demand
GDP growth (13P)
Private consumption
Government consumption
Investment (GDFCF)
Exports of goods and services
Imports of goods and services
Net exports (HKD bn)
2.5
3.2
3.0
-0.2
0.8
1.0
6
2.4
4.6
3.2
2.3
-0.5
-0.5
6
2.4
3.1
3.5
4.0
3.9
4.4
-18
2.3
4.3
2.6
-6.5
-2.8
-3.3
34
2.0
2.8
3.5
3.5
3.1
3.1
0
2.1
3.5
3.5
4.0
2.2
2.9
-11
2.6
3.2
3.5
4.0
4.1
4.7
-33
2.3
3.0
3.5
4.0
4.3
4.8
29
2.6
2.9
3.5
4.0
4.7
4.9
-3
External (nominal)
Merch exports (USD bn)
- % YoY
Merch imports (USD bn)
- % YoY
Trade balance^ (USD bn)
474
3
544
4
-70
472
1
537
1
-65
498
5
577
6
-79
122
1
133
1
-12
128
3
151
4
-22
111
4
128
4
-17
118
4
136
5
-18
133
5
152
6
-19
136
6
162
7
-26
Current acct balance (USD bn)
% of GDP
0.2
0.1
-7.3
-2.4
-16.1
-5.1
-
-
-
-
-
-
Foreign reserves (USD bn, eop)
329
332
341
-
-
-
-
-
-
Inflation
CPI inflation
4.4
3.0
3.0
2.3
2.4
2.6
3.0
3.1
3.1
Other
Nominal GDP (USD bn)
Unemployment rate (%, sa, eop)
291
3.3
302
3.3
314
3.4
3.3
3.3
3.4
3.4
3.4
3.4
Apr-12
Jan-14
* % change, year-on-year, unless otherwise specified
^ Balance on goods
HK - nominal exchange rate
HK – policy rate
HKD per USD
%, base rate
7.84
7.0
6.0
7.82
5.0
7.80
4.0
3.0
7.78
2.0
7.76
7.74
Jan-07
78
1.0
Oct-08
Jul-10
Apr-12
Jan-14
Oct-15
0.0
Jan-07
Oct-08
Jul-10
Oct-15
Economics–Markets–Strategy
Hong Kong
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79
Taiwan
Economics–Markets–Strategy
TW: multiple challenges
• Hit by China’s slowdown, the economy fell into a technical recession this
year
• The outlook for 2016 remains challenging, given weak exports, excess inventories and a softening labor market
• On the back of a low base, GDP growth is projected to rise to 2.4% in 2016
and inflation may rise to 1.2%
• The central bank is expected to cut rates by a further 12.5bps to 1.625%
• Multiple challenges need to be addressed to reinvigorate the economy.
Tough tasks await the new government after the Jan16 elections
It was a disappointing year for Taiwan. Economic growth deteriorated sharply due
to China’s slowdown and falling demand from emerging markets. Full-year GDP is
estimated to rise marginally by 0.9%, the lowest growth rate over six years and the
worst amongst the four Asian dragons. Thanks to the plunge in global commodity
prices, inflation pressures also evaporated. CPI growth is projected to be -0.3% in
the full year, the first negative reading since 2009.
Reflecting the sluggish macro performance, the TAIEX dropped 10% in Jan-Nov15,
one of the worst performing equity markets in Asia. Interest rates declined across
the curve as the central bank shifted towards monetary easing. Nonetheless, the
TWD remained stable compared to most of its Asian peers, thanks to Taiwan’s
strong external position and low vulnerability to Fed tightening.
The 2016 outlook remains challenging
On the quarter-on-quarter (saar) basis, GDP growth contracted consecutively
in 2Q15 and 3Q15 (-4.5% and -1.2% respectively), matching the definition of a
technical recession. In YoY terms, growth has also fallen into the negative territory
in 3Q15 (-0.6%, Chart 1). While a real recession appears unlikely, we believe that
Chart 1: Taiwan fell into a technical recession in 2015
% YoY, % QoQ saar
30
GDP growth: YoY
25
QoQ
20
15
10
5
0
TAIWAN
-5
-10
-15
Tech
bubble
burst
-20
1Q01
1Q03
European
debt crisis
Global
financial
crisis
SARS
1Q05
1Q07
1Q09
Ma Tieying • (65) 6878 2408 • [email protected]
80
1Q11
1Q13
China's
slowdown
1Q15
Economics–Markets–Strategy
Taiwan
Chart 2: Export orders vs. industrial production
Chart 3: Inventory-to-shipment ratio
2011=100, sa
X times
135
1.4
Export orders
Industrial production
Overall manufacturing
Electronics
1.3
125
1.2
115
1.1
105
1.0
95
85
Jan-11
0.9
Jan-12
Jan-13
Jan-14
Jan-15
0.8
Jan-12
Jan-13
Jan-14
Jan-15
the short-term outlook remains challenging. Our forecast is for GDP growth to rise
to just 2.4% next year, far below the long-term average of 4%.
The external sector remains weak. It was true that export orders have rebounded
lately thanks to the arrival of festive season and the launch of new smartphone
products. But industrial production and actual exports failed to rise proportionately
(Chart 2). We suspect that the mismatch phenomenon will remain in place for a long
time. First, the inventory level in the electronics sector is excessively high at present,
which means manufacturers will ramp up production only after eliminating the
existing inventories (Chart 3). Second, a rising portion of export orders received by
Taiwanese manufacturers is processed offshore nowadays (overseas production ratio
has risen to an all-time high of 54.4% in Jan-Oct15, vs. 52.6% in 2014). This naturally
widens the gap between export orders and domestic production. Last but not the
least, the offshore-based Taiwanese firms are now able to source components from
Chinese suppliers, thanks to the maturation of supply chains on the mainland (the
ratio between China’s imports and exports of electronics products has dropped to
72% this year, down from 75% in 2014 and more than 100% a decade ago). This in
turn, reduces the need for importing from Taiwan.
Weak exports are unlikely to be offset by a rise in domestic demand. Labor market
conditions have begun to soften, with wage growth losing steam rapidly and the
number of workers on unpaid leave rising to a three year high. Policy stimulus is not
enough to turn things around. The central bank has cut rates by only 12.5bps so far
this year and the government announced a fiscal stimulus package worth just TWD
5bn (0.03% of GDP). Despite the relaxation of home-mortgage rules, the positive
impact on the housing market could be offset by an implementation of property
capital gains tax that starts at the beginning of next year.
Policy stimulus
not enough to lift
domestic demand
For now, there is little evidence that policy stimulus has yielded notable effects in
the domestic economy. The key indicators including bank loans, retail sales and
consumer confidence have continued to languish (Chart 4-5, next page).
Deflation risks outweigh inflation risks
Technical recession this year was also accompanied by “technical deflation”. Headline
CPI has stayed in negative territory for eight consecutive months, averaging -0.4% in
Jan-Nov15. We expect it to turn slightly positive next year on the back of a low base
(forecast: 1.2%). But this doesn’t mean a rise in underlying inflation.
In light of a softening labor market and lackluster consumer demand, downstream
producers and retailers would lean towards cutting prices to boost sales volumes.
Upstream price pressures should also be muted as global commodity prices remain
low. The risk of deflation would continue to outweigh that of inflation.
81
Taiwan
Economics–Markets–Strategy
Chart 4: Bank loans growth
Chart 5: Retail sales & consumer confidence
% YoY
2011=100, sa
10
8
points
Total loans
108
Retail sales
95
Consumer loans:
housing
106
Consumer confidence
(RHS)
90
6
104
4
102
85
80
2
0
Jan-11
75
100
Jan-12
Jan-13
Jan-14
Jan-15
98
Jan-12
70
65
Jan-13
Jan-14
Jan-15
One more rate cut is likely
Disappointing data obliged the central bank (CBC) to cut rates by 12.5bps on Sep15,
the first such move in six years. Absence an improvement in exports and production,
the CBC should ease monetary policy in the near term. We expect the benchmark
discount rate to be lowered by another 12.5bps to 1.625% in Dec15.
Rate hikes by the US Fed – if conducted in a calibrated and gradual manner –
shouldn’t undermine Taiwan’s monetary policy independence. Higher USD rates will
likely result in more capital outflows and further depreciation in the TWD (versus
the USD). But current account surpluses could provide a cushion, mitigating the
risks of large external deficits and excessive currency depreciation. Furthermore,
moderate weakness in the TWD can be tolerated because of Taiwan’s modest
external debt exposure and non-existent inflationary pressures. A weak currency
may help exports, an important driver for Taiwan’s GDP growth.
In all, we think that the CBC could afford to go its own way on monetary policy.
Decoupling from the Fed is not impossible, especially as other major central banks
(e.g., ECB, BOJ and PBOC) are also biased towards easing.
Elections under spotlight
Tasks facing the
next government:
upgrading industries, increasing
economic openness, and improving wealth distribution
A special focus in the Taiwanese markets is the upcoming presidential and legislative
elections (16th Jan, 2016). The opposition DPP party currently leads the ruling KMT
by a wide margin in the public opinion polls, suggesting that a transition of political
power is likely. A DPP victory will cast some uncertainties on the outlook for crossstrait relations, because it doesn’t accept the “one China” concept defined by the
“1992 consensus”. But the DPP may not refuse to collaborate with China on all the
fronts. Cross-strait economic ties are unlikely to suffer major setbacks.
On the domestic side, multiple challenges need to be addressed and tough tasks
will face the new government after elections. Economic growth is deteriorating
due to both cyclical and structural headwinds. Wealth gap has widened, along
with the surge in property prices, stagnancy in wage growth and rise in youth
unemployment. In addition, external competition is increasing as China moves up
the value chain and other Asian countries actively push for free trade.
There is urgent need for Taiwan to foster new growth sectors, upgrade industrial
structure, increase trade/investment openness, and improve wealth distribution.
The DPP’s presidential candidate Tsai Ing-wen has proposed to join the Trans-Pacific
Partnership and promote a new industrial revolution with information technology.
Whether these promises are delivered and how well concrete measures are
implemented remains to be seen.
82
Taiwan
Economics–Markets–Strategy
Taiwan Economic Indicators
4Q15f 1Q16f 2Q16f 3Q16f 4Q16f
2014
2015f
2016f
3Q15
3.9
3.3
3.6
1.8
0.9
2.6
-0.6
1.2
2.4
2.6
1.6
1.7
-0.6
0.5
-0.4
3.1
-0.1
2.8
-0.1
1.4
0.1
2.0
2.1
4.1
2.2
2.5
1.4
2.5
3.4
3.3
1.4
-0.7
3.6
2.5
1.4
1.2
Net exports (TWDbn, 11P)
Exports (% YoY)
Imports (% YoY)
1320
5.9
5.7
1222
-0.1
0.8
1299
3.2
2.8
306
-3.0
-2.2
389
-2.1
-0.5
220
-1.2
1.8
276
4.1
2.7
357
4.9
3.4
445
4.9
3.4
External (nominal)
Merch exports (USDbn)
- % chg
Merch imports (USDbn)
- % chg
314
2.7
274
1.5
282
-10.2
230
-16.0
299
6.2
252
9.4
70
-13.9
57
-19.4
69
-12.5
56
-14.6
68
-2.5
56
-1.1
76
5.0
65
9.1
76
8.9
65
13.3
79
13.5
66
16.4
Trade balance (USD bn)
Current account balance (USD bn)
% of GDP
40
65
12.3
51
75
14.2
47
70
13.5
13
-
13
-
12
-
11
-
11
-
13
-
Foreign reserves (USD bn, eop)
419
426
433
-
-
-
-
-
-
Inflation
CPI inflation
1.2
-0.3
1.2
-0.3
0.4
1.2
1.1
1.2
1.1
Other
Nominal GDP (USDbn)
Unemployment rate (eop %, sa)
Fiscal balance (% of GDP)
531
3.8
-0.8
529
3.8
-0.7
515
3.8
-0.7
3.8
-
3.8
-
3.8
-
3.8
-
3.8
-
3.8
-
Apr-12
Jan-14
Real output and demand
GDP growth
Private consumption
Government consumption
Gross fixed capital formation
* % growth, year-on-year, unless otherwise specified
TW - nominal exchange rate
TW – policy rate
TWD per USD
%, rediscount rate
36.00
4.0
35.00
3.5
34.00
3.0
33.00
2.5
32.00
31.00
2.0
30.00
1.5
29.00
28.00
Jan-07
83
Oct-08
Jul-10
Apr-12 Jan-14
Oct-15
1.0
Jan-07
Oct-08
Jul-10
Oct-15
Korea
Economics–Markets–Strategy
KR: a short-term recovery
• The cycle has bottomed as the impact of MERS has faded and the effects of
policy easing have kicked in
• We expect GDP growth to rise to 3.3% in 2016, and inflation to rise to 1.8%.
Domestic demand will remain the key driver
• The Bank of Korea is expected to stand pat in the next 4 quarters, holding
rates steady at 1.50%
• The longer term outlook remains challenging because of supply-side constraints and rising foreign competitions. The pace of reform may slow as
elections loom
The economy deteriorated this year, with the external slowdown hitting its exports
and the MERS outbreak disrupting domestic demand. Thanks to the decisive and
timely policy actions, growth recovered resiliently in the second half of the year.
The KOSPI registered a cumulative gain of 4% in Jan-Nov15, bucking the declines
across the equity markets in the region.
Inflation eased rapidly this year, reflecting the slump in global commodity prices.
CPI numbers revisited the historical lows seen in 1999. Interest rates also fell to
record lows as the slowdown in inflation provided more leeway for the Bank of
Korea to loosen monetary policy.
Capital outflows increased notably as the concerns about Fed lift-off prevailed. The
KRW depreciated 5% against the USD between Jan15 and Nov15, underperforming
most of the North Asian currencies but outperforming the Southeast Asian ones.
Against a basket of trade partners’ currencies, the won has remained largely stable.
Growth bottoms out
We believe that the short-term growth cycle has bottomed out. GDP growth has
rebounded to 5.3% (QoQ saar) in 3Q15, significantly up from 1.3% in 2Q15 and
Chart 1: GDP growth rebounded on domestic demand
% QoQ saar, % ppt
18
Net exports
Domestic demand
13
GDP growth
8
3
KOREA
-2
-7
-12
1Q10
1Q11
1Q12
1Q13
Ma Tieying • (65) 6878 2408 • [email protected]
84
1Q14
1Q15
Economics–Markets–Strategy
Korea
Chart 2: Consumption growth picked up
points
110
Consumer confidence
Chart 3: Construction sector started to recover
2010=100, sa
Retail sales (RHS)
120
118
105
Jan-13
Jan-14
Jan-15
Construction orders
120
Construction works
completed
100
80
114
60
112
40
108
95
Jan-12
140
116
110
100
% YoY
20
0
-20
106
-40
104
-60
Jan-12
Jan-13
Jan-14
Jan-15
3.3% in 1Q15 (Chart 1). On the year-on-year basis, growth has also risen to 2.7% in
the third quarter from 2.2-2.5% in the first half. We expect GDP growth to rise to
3.3% on average in 2016. Domestic demand is foreseen to be the key driver, while a
modest recovery in exports is also a core assumption behind our forecast.
Admittedly, private consumption is unlikely to repeat the strong growth witnessed
in the second half of this year. Thanks to the end of MERS, consumer confidence
has recovered to the neutral level of 100. Retail sales have surged strongly, not
only due to the release of pent-up demand, but also the stimulus effects from a
temporary cut in consumption tax by the government (Chart 2). A stronger recovery
in consumption will require improvements in real fundamentals going forward,
such as faster wage growth and more job creations. This will take time as the labor
market slack will remain in place for a while due to a negative output gap.
By contrast, potential remains for investment and public spending growth to pick up
and drive domestic demand. Monetary easing has successfully boosted household
loans, property sales and housing prices ever since late-2014. The positive impact is
now spreading to the construction sector, as evidenced by the rise in construction
orders and output since mid-2015 (Chart 3).
The effects of
monetary and fiscal easing would
remain in 1H16
Fiscal stimulus should also continue to work through the economy in the near term,
given that a KRW 11.5trn supplementary budget has just received parliamentary
approval in 3Q15 and a full implementation will follow.
Inflation also bottoms out
As the economy passed the trough during the short-term cycle, inflation has also
showed some signs of bottoming. Headline CPI rose to 1.0% (YoY) in Nov15, up
from the April low of 0.4% (Chart 4, next page). Core CPI has risen to 2.4% from
2.0% in the meantime. We expect headline inflation to inch up further to 1.8% in
2016, driven by gains in both commodity and service prices.
The service items, such as housing, transportation, and eating out & accommodation,
have seen modest price hikes in recent months (Chart 5, next page). The pricing
power of retailers and services providers should prevail next year, thanks to a further
recovery in domestic demand.
Commodity prices under the CPI have showed a slower rate of decline on a year-onyear basis in 4Q15 because the low base effect for oil prices has kicked in (also Chart
5). Barring new shocks in global commodity market, the deflation phenomenon in
this segment should gradually disappear next year.
85
Korea
Economics–Markets–Strategy
Chart 4: Inflation bottomed out
Chart 5: Price gains driven by services items
% YoY
% YoY
4.0
6
3.5
5
3.0
BOK's target band
3
2.0
2
1.5
1
1.0
0.0
Jan-12
CPI: services
4
2.5
0.5
CPI: commodities
0
Headline CPI
Core CPI
Jan-13
-1
Jan-14
Jan-15
-2
Jan-12
Jan-13
Jan-14
Jan-15
Rates to stay low and stable
We believe the Bank of Korea (BOK) has completed its short-term easing cycle after
cutting rates to a record low of 1.50% this year. A recovery in domestic demand and
easing deflation risks should provide a source of comfort for the BOK.
In the other direction, there is little reason for the BOK to hike rates anytime soon.
Despite expected Fed tightening, capital outflow does not appear to be a large
risk. Thanks to the improvement in external debt repayment capabilities and the
upgrade of sovereign credit ratings in the last several years, foreign investors’
confidence on the stability of the KRW assets has improved. A crisis-style capital
flight triggered by rising US rates and higher USD financing costs is unlikely.
In fact, the BOK would like to deliberately keep domestic rates low, allow the USDKRW yield spreads to widen, and accept more weakness in the won against the
dollar. While the Fed is set to tighten, the European Central Bank has just announced
to extend QE and the Bank of Japan also kept the door open for additional easing.
Policy divergence amongst the G3 central banks could mean a broadly strong
greenback and further weakness in emerging Asian currencies. Against such a
backdrop, the BOK would find it necessary to keep the KRW effective exchange
rates stable in order to maintain trade competitiveness.
A challenging outlook beyond the short term
Slower growth
and lower inflation have become
a “new normal”?
The outlook beyond the short term remains challenging. GDP growth has stayed
below the trend rate of 4% for five consecutive years; and inflation has remained
below the BOK’s target (2.5-3.5%) for four years. Concerns are mounting that
slower growth and lower inflation have become a so-called “new normal”.
Like its peers in other parts of North Asia, Korea faces the supply-side growth
bottlenecks due to an aging population and slipping productivity. From the demand
perspective, exports are losing ground as China’s technology upgrade enables it
to reduce the imports of intermediate goods from Korea and to compete with
Korean exporters actively in the global markets. Domestic consumption growth is
also constrained, due to the heavy debt load in the household sector.
Exploring new growth drivers and preserving competitiveness are urgently needed.
The government’s efforts of promoting free trade and deregulating FDI rules
in service sector have been the steps in the right direction. But the momentum
of reform may slow temporarily next year as political issues could dominate the
government’s agenda till the Apr16 legislative elections.
86
Korea
Economics–Markets–Strategy
Korea Economic Indicators
4Q15f 1Q16f 2Q16f 3Q16f 4Q16f
2014
2015f
2016f
3Q15
Real output and demand
GDP (2010P)
Private consumption
Government consumption
Gross fixed capital formation
3.3
1.8
2.8
3.1
2.6
2.0
3.3
4.8
3.3
2.7
3.8
4.0
2.7
2.1
3.0
5.1
3.2
2.6
3.7
8.9
3.2
2.6
4.3
5.4
3.7
3.4
4.4
5.2
3.1
2.7
3.4
2.8
3.1
2.2
3.2
2.8
Net exports (KRW trn)
Exports
Imports
99
2.8
2.1
83
0.2
2.5
91
3.8
3.1
20
0.3
3.2
26
1.0
3.3
10
2.1
3.4
25
3.1
3.2
25
4.9
2.8
31
4.9
2.8
External (nominal)
Merch exports (USD bn)
- % YoY
Merch imports (USD bn)
- % YoY
573
2.3
526
1.9
530
-7.5
438
-16.7
574
8.3
492
12.4
128
-9.5
108
-18.5
133
-10.0
107
-17.0
129
-3.0
115
3.2
146
8.3
123
11.1
144
12.6
124
14.6
154
15.5
130
21.1
Trade balance (USD bn)
Current account balance (USD bn)
% of GDP
47
89
6.0
92
108
7.9
82
98
7.1
20
-
26
-
14
-
24
-
20
-
24
-
Foreign reserves (USD bn, eop)
364
372
380
-
-
-
-
-
-
Inflation
CPI inflation
1.3
0.7
1.8
0.7
1.0
1.7
1.7
1.8
1.9
1,410
3.5
-2.0
1,380
3.4
-2.8
1344
3.3
-2.0
3.5
-
3.4
-
3.6
-
3.5
-
3.4
-
3.3
-
Jan-14
Oct-15
Other
Nominal GDP (USD bn)
Unemployment rate (eop %, sa)
Fiscal balance (% of GDP)
* % change, year-on-year, unless otherwise specified
KR - nominal exchange rate
KR – policy rate
KWR per USD
%, target rate
1590
5.5
5.0
1490
4.5
1390
4.0
1290
3.5
1190
3.0
2.5
1090
2.0
990
890
Jan-07
87
1.5
Oct-08
Jul-10
Apr-12
Jan-14
Oct-15
1.0
Jan-07
Oct-08
Jul-10
Apr-12
India
Economics–Markets–Strategy
IN: uneven
• 7.4% growth is expected in FY16. Amid rising fiscal commitments and
slow private sector participation, we lower our FY17 forecast to 7.8%
• Progress of the winter parliamentary session is in focus, with passage of
the GST amendments likely to be seen as a litmus test
• Impending price risks and February’s Budget will see policy rates on hold
in February 2016. Room for further easing to open in FY17
• Improvement in external balances and macro stability will help the Indian markets better tackle global risk events
India’s growth is amongst the fastest in the region, even surpassing China’s in 3Q15.
Beyond the headline narrative of a reform-oriented government, macro-stability
and easing inflation, however, markets are turning to on-the-ground realities. For
reasons explained below, we lower our FY17 growth forecast to 7.8%.
Uneven revival in growth
In contrast to earlier expectations of a sharp return to 8%+ growth, market
estimates have drifted towards our sub-consensus call for FY16 growth of 7.4%.
Growth in first half of FY16 averaged 7.2%, with an uneven recovery in the key
growth engines (Chart 1).
Much of the cyclical upturn is led by higher urban consumption and governmentled investments, while sluggish rural demand and subdued private sector activity
lag. On trade, weak exports weighed on the contribution of net exports.
Heading into FY17 (Apr-16-Mar17), the next leg higher will be hamstrung by a
slower pick-up in private sector capex interests, the need to meet stringent fiscal
targets and weak corporate earnings. While investment as a % of GDP has bottomed
out, clearance of stalled projects slowed in the Sep15 quarter. At the same time,
overcapacity across sectors has lowered appetite for greenfield investments. The
Chart 1: Real GDP growth grinds up, private sector participation lags
% YoY
9
8
6
5
3
INDIA
2
0
Jun-12
Dec-12
Jun-13
GDP
Dec-13
Jun-14
Dec-14
Jun-15
Domestic demand
Radhika Rao • (65) 6878 5282 • [email protected]
88
Economics–Markets–Strategy
India
Chart 2: Capital formation as % of GDP
Chart 3: RBI industrial indicators
as % of GDP
36
%, 2Q moving avg
75
34
74
33
73
17.5
71
30
70
28
Sep-12
20.0
72
31
ratio
22.5
Sep-13
Sep-14
Sep-15
15.0
Jun-14 Sep-14 Dec-14 Mar-15 Jun-15
Cap utilisation LHS
Finished gds/sales ratio
finished goods to sales ratio also ticked up in the Jun15 quarter according to the
central bank’s survey (Chart 2,3), while credit growth stagnates.
With banks still struggling with the burden of stressed assets, private sector expansion
is likely to be led by a pick-up in existing capacity and a revival in stalled projects
rather than fresh investments. At the same time, while imports slow, simultaneous
weakness in exports proved to be an additional headwind for the domestic industrial
cycle.
On the fiscal end, the government is likely to face additional funding commitments
next fiscal year. An increase in public-sector wages (0.5% of GDP), banks’ capital
infusion needs and pension scheme will compete with the need to step up capital
spending. If FY17 fiscal targets are maintained, the space to boost capex will narrow
significantly.
FY17 GDP growth
is likely to average
7.8%
Against this background, we revise FY17’s growth estimate to 7.8% from 8% earlier,
with consumption likely to pull the cart in the first phase of the cyclical recovery.
Executive reforms have been easier to push through than legislative decisions.
Progress on structural impediments are being watched closely, with several piecemeal
initiatives like diesel deregulation, easing FDI regulations, support for distressed
power distributors etc., to be growth positive in the medium-term.
Doubts emerge on the nominal GDP trends
A debate, meanwhile, arose from the Jul-Sep15 GDP numbers. Two points were of
concern. Firstly, nominal GDP growth slipped below real GDP. Slowing nominal GDP
growth is worrisome as this puts pressure on the government’s fiscal metrics and
external balances while hurting corporate performance at home. The FY16 fiscal
assumptions were based on 12.5% nominal growth, while the actual pace lags at
7.4% in 1H.
Sectoral deflators
mirror WPI trends
rather than CPI
Secondly, there are doubts on the veracity of the sectoral deflators. Industry and
service sector deflators extended their decline to -2.3% (vs Jun quarter’s -1.1%) and
-2.7% (vs Jun quarter’s -0.5%) respectively - Chart 4. This sharp fall signals that the
deflators mirror WPI trends rather than the crucial CPI gauge.
This is further compounded by the fact that the WPI inflation basket does even not
include services. Hence, deflating services GDP by the WPI inflation gauge is erroneous
and technically understating the nominal GDP growth pace. This discrepancy is likely
to spur calls to use retail inflation as a preferred gauge to deflate growth rather
than the wholesale price indices.
89
India
Economics–Markets–Strategy
Chart 4: Sectoral deflators vs CPI and WPI
% YoY
12
10
8
6
4
2
0
-2
-4
-6
Sep-12
Sep-13
Industry (incl constrn)
Sep-14
Services
Sep-15
WPI
CPI
Focus on easing legislative hurdles
Lack of a majority in the upper house of parliament has posed legislative hurdles
to the reform process. Having faced two unproductive sessions in the past and a
setback at a recent state elections prompted the government to reach out to the
opposition parties to arrive at a consensus on the agenda.
Key legislations that will be in focus are the nationwide goods and services tax
(GST), the bankruptcy code, labour reforms and amendments to the Reserve Bank
of India act (monetary policy committee formation). Land acquisition reforms are
likely to gain more traction at the states’ level.
Amongst these, priority is being given to the GST constitutional amendments. The
GST panel tabled its proposals recently, where it recommended a revenue neutral
rate of 15.0-15.5% (excluding petroleum, real estate, alcohol and electricity). While
a single unified rate was preferred, it also laid out a rate structure to provide
flexibility.
Pending the nod
in the parliament,
GST is unlikely to
be implemented
by Apr16
The committee estimated minimal inflationary and fiscal implications from this
shift. But intermittent price pressures are likely as services taxes are raised from
the current 14.5% to 17-18%, while product taxes are fine-tuned (few lowered). To
compensate for any fiscal pressure on states, a revenue compensation period of five
years is under consideration.
Passage of the GST bill will boost the “Make in India” policy and improve the ease
of doing business by subsuming the plethora of taxes / exemptions. On growth, the
Thirteenth Finance Commission taskforce estimated that the boost to growth could
be in the range of 0.9-1.7% of GDP.
Prima facie, these proposals fulfil key objections raised by the opposition parties,
increasing the odds of its passage in the ongoing parliament session. Factoring
in logistical and technological architecture that is needed for this unified rate to
become operational, the Apr16 implementation deadline will, however, stand
delayed to 2H 2016 or early-2017.
Small window to ease rates contingent on inflationary trend
Against the backdrop of rising fiscal commitments and a go-slow on the reform
agenda, the central bank adopted a cautious tone in December. Apr-Nov15 inflation
averaged a tepid 4.6% and with base effects kicking in over the remaining months
of the fiscal year, we expect full-year to average 5%.
90
Economics–Markets–Strategy
India
Chart 5: Basic balance of payments improve
USD bn
10
% of GDP
3
2
0
0
-10
-2
-20
-3
-5
-30
-40
Jun-09
-6
Jun-11
Basic BOP (CAD+FDI)
Jun-13
% of GDP (RHS)
-8
Jun-15
Into FY17, there are impending price risks on the back of a pick-up in aggregate
demand and seventh pay commission proposals. On the latter, the nearly 140%
jump in the housing allowance will filter through the headline. But the quantum
of the jump will depend on the extent of adjustment and time of implementation.
The US Fed rate trajectory will also be another crucial input. Sum of these factors
suggests that the RBI will extend its on-hold stance to the Feb16 rate meeting. The
Union budget later that month will highlight how public sector wage increases will
be factored into the fiscal books, with implications on fiscal deficits and inflation.
A window to lower rates might re-emerge when base effects suppress readings
around mid-2016. This is however contingent on monsoon progress, aggregate
demand conditions and subdued inflationary expectations. The pending formation
of the RBI monetary policy committee will also influence policy direction.
A repeat of the
2013 episode is
not on the cards
Macro balances return to view ahead of US Fed hikes
Markets now price in an 80% chance of Fed hikes in December. With the US dollar
gaining on these expectations and rates headed higher, local markets are unlikely
to be immune to the accompanying volatility. But a repeat of the 2013 shake-out is
not on the cards.
The economy has made considerable progress in narrowing the twin deficits,
increasing the FX reserves buffer and improving macro fundamentals. We expect
the current account deficit to narrow to -1.4% of GDP this year and the fiscal deficit
target of -3.9% of GDP to be met. The basic balance of payments (current account
balance plus FDI) also returned to a surplus (Chart 5).
More recently, the reserves stock is off record highs but the coverage of reserves
over short-term external debt is comfortable. Some soft-spots remain. Rising
non-government external debt, particularly external commercial borrowings is
worrisome. The reserves coverage of total external debt is modest at 70%, weaker
than most regional peers. To mitigate these risks, the authorities have exercised
heightened vigilance and encouraged FX exposures to be hedged.
In the meantime, the rupee has been largely stable as the authorities tap opportune
times to build reserves, only to utilise them to address volatility in the currency
markets (see FX section for INR view). Overall, the economy is likely to feel the
heat from any broad sell-down in EM assets in wake of the US rate move, but the
reaction will be not as severe as in 2013.
91
India
Economics–Markets–Strategy
India Economic Indicators
14/15f 15/16f 16/17f
2Q16
3Q16f 4Q16f 1Q17f 2Q17f 3Q17f
Real output (11/12P)
GDP growth**
Agriculture
Industry (incl constrn)
Services
Construction
7.3
0.2
6.1
10.2
4.8
7.4
2.0
6.7
9.5
4.0
7.8
2.1
7.0
10.1
4.0
7.4
2.2
6.8
8.8
2.6
7.9
2.2
6.5
9.0
3.0
7.1
1.8
7.0
10.1
4.0
7.9
1.8
6.9
9.4
3.5
7.5
2.0
7.0
10.6
3.5
8.3
2.2
7.2
10.2
4.0
External (nominal)
Merch exports (USD bn)
- % YoY
Merch imports (USD bn)
- % YoY
310
-0.9
448
0.1
273
-12.0
421
-6.0
300
9.9
460
9.3
66
-18.7
102
-15.6
68
-13.4
110
-6.3
72
2.7
110
14.5
75
12.6
115
16.4
75
13.2
115
12.7
75
10.3
115
4.5
-138
-28
-1.3
340
-148
-32
-1.4
350
-160
-38
-1.5
365
42
na
na
na
34
na
na
na
22
na
na
na
25
na
na
na
23
na
na
na
21
na
na
na
Inflation
CPI inflation (% YoY)
6.0
5.0
5.4
3.9
5.3
6.0
5.4
4.6
5.4
Other
Nominal GDP (USD tn)
Fiscal balance (% of GDP)
2.1
-4.0
2.2
-3.9
2.5
-3.5
na
na
na
na
na
na
na
na
na
na
na
na
Trade balance (USD bn)
Current a/c balance (USD bn)
% of GDP
Foreign reserves(USD bn, eop)
% change year-on-year, unless otherwise specified
Annual and quarterly data refers to fiscal years beginning April of calendar year.
** GDP growth stands for Real GDP; breakdown is under GVA (Gross Valued Added) series
IN - nominal exchange rate
IN – policy rate
INR per USD
% repo rate
71
9.0
68
8.5
65
8.0
62
7.5
59
56
7.0
53
6.5
50
6.0
47
5.5
44
5.0
41
38
Jan-07
92
Oct-08
Jul-10
Apr-12
Jan-14
Oct-15
4.5
Jan-07
Oct-08
Jul-10
Apr-12
Jan-14
Oct-15
Economics–Markets–Strategy
India
This page is intentionally left blank
93
Indonesia
Economics–Markets–Strategy
ID: grinding higher
• Expect GDP growth to rise to 5.2% in 2016, on the back of a mild rise in
investment
• Fiscal spending is crucial to our forecast
• The current account deficit is likely to widen to about 2.5% of GDP
• Despite falling inflation, Bank Indonesia will likely hold rates steady to
safeguard the rupiah
Quicker fiscal spending and a mild recovery in investment are expected to boost
momentum heading into 2016. Consumption growth stays resilient at 5%. We
expect GDP growth to tick up to 5.2% in 2016 from 4.7% this year.
The economy is far from roaring again, with downside risks to our forecast arising
from weak sentiment on the rupiah. While Bank Indonesia (BI) loosened its policy
stance to help boost GDP growth earlier this year, the key BI rate will be held steady
at 7.5% next year. This is despite a lower CPI inflation at 5.7% in 2016, down from
6.4% this year.
GDP growth may have bottomed out
Slow investment growth has been a key drag for the economy. But investment
gained momentum in 2H15 and may recover further going forward (Chart 1). Recent
indicators are encouraging for the 2016 outlook. Cement consumption rose 5.1%
(YoY) in 2H15, compared to the -2.9% seen in 1H15. Loan growth has also made a
turnaround in mid-2015, led by loans for new investments. Meanwhile, construction
is among the fastest growing sectors of the economy in 2H15, suggesting a pick-up
in infrastructure projects (Chart 2, next page).
Indeed, the government has stepped up efforts to increase spending. By the yearend, budget disbursement may reach 85% of the 2015 budget, compared to a runChart 1: Gradual recovery in investment growth is likely
YoY, 10p
DBS forecast
12
11
10
9
10Y average
8
7
6
5
INDONESIA
4
3
2
1
0
Dec-10
Dec-11
Dec-12
Dec-13
Dec-14
Gundy Cahyadi • (65) 6682 8760 • [email protected]
94
Dec-15
Dec-16
Economics–Markets–Strategy
Indonesia
Chart 3: Consumption increasingly important
Chart 2: A pick-up in infrastructure works
% YoY
16
14
% YoY
20
construction sector growth (RHS)
10
4Q15 as of DBS
forecast
8
6
6.0
Latest: 3Q15
2
55
5.5
50
5.0
16
14
4
12
0
45
-2
-6
Dec-12
60
YoY
18
12
-4
% share of GDP growth
10
cement consumption
Dec-13
Dec-14
8
Dec-15
4.5
contribution to GDP growth
consumption growth (RHS)
40
Sep-11
Sep-12
Sep-13
Sep-14
4.0
Sep-15
rate of below 40% in 1H15. The pace of fiscal spending remains crucial for GDP
growth outlook in 2016. For now, we expect government consumption growth to
tick up higher to 6.5% in 2016, from a projected 5.0% this year.
Fiscal deficit is likely to come in at 2.5% of GDP in 2016. As long as fiscal deficit
remains below the 3% legal limit, we see no reason to be concerned. At circa 25%,
Indonesia’s public debt-to-GDP ratio is relatively low among its credit peers.
It remains to be seen, however, if fiscal policy implementation can be further
improved. Central government expenditure continues to spike only towards the
year-end, making it less effective in supporting GDP growth momentum throughout
the year. Note also that the pace of capital expenditure (capex) continues to lag that
of operating expenditure. In 2015, projected capex is less than 50% of the year’s
target and some 40% lower than actual capex spending in 2014.
The government also needs to work on the structural impediments facing the
economy. Improved production efficiency is crucial to revitalize the manufacturing
sector. Note that manufacturing GDP growth has actually moderated to 4% from an
average of 6% in 2011-12. It is hardly surprising that the economy is struggling to
diversify away from commodities [1].
Government can
afford to be more
aggressive in its
spending
Resilient consumption not to be taken for granted
Meanwhile, private consumption continues to grow at a modest 5% pace, slightly
above its long-term average. That private consumption growth will remain strong
is not to be taken for granted. Consumption growth has eased in recent years but it
is contributing increasingly more to overall GDP growth (Chart 3). This is unlikely to
be sustainable in the longer-term.
For now, we still expect 5% private consumption growth to persist in 2016. Consumer
confidence sentiment has risen again in 4Q15 after the sharp fall at the start of the
year. Expect retail sales to grind higher in 2016, following the moderation in 2H15.
External financing risks prevail
External balances have improved markedly in 2015. Merchandise goods trade
surplus is projected at USD 10bn this year. This compares to a total of USD 8bn deficit
in 2012-14. The current account (C/A) deficit is also set to narrow to 2% of GDP, a
sustainable level in the medium-term.
Yet, the improvement is driven by a slump in import demand rather than a rebound
in export growth (Chart 4, next page). Monthly imports have fallen by some 30%
95
Indonesia
Economics–Markets–Strategy
Chart 4: Sharp fall in imports
Chart 5: Foreign ownership IDgov bonds
index, sa, Jan10 = 100
% of total outstanding bonds
180
Latest: Oct15
170
USD bn
45
Latest: Nov15
3
40
160
2
150
140
130
120
90
Oct-10
35
1
30
0
-1
110
100
4
25
imports
Oct-11
exports
Oct-12
Oct-13
Oct-14
Oct-15
20
Nov-12
net monthly flows (RHS)
foreign ownership
Nov-13
Nov-14
-2
-3
Nov-15
since Jan-14, dragged by a weak rupiah. On both value and volume terms, exports
have continued to fall this year. Manufactured goods exports are growing at a mere
2% per annum, not enough to offset the decline in commodity exports.
We expect the C/A deficit to widen again to 2.5% of GDP in 2016 driven by a mild
recovery in the economy. At an estimated 60-70% across industries, import content
of production remains relatively high. Imports of capital goods are likely to rise
alongside a revival in investments next year. As import substitution remains poor, a
wider C/A deficit cannot be avoided.
Rupiah stability remains a priority
Net foreign flows into IDgov bonds reached USD 5bn in 2015, offsetting USD 1.5bn
outflows from equities. This is a signal that long-term investors remain invested for
now. But markets continue to regard the 37% foreign ownership of IDgov bonds as
a potential risk (Chart 5). Additionally, foreign reserves coverage of total short-term
external debt is still hovering circa 220%, among the lowest in the region.
Expect BI to keep
its policy rate
steady to maintain
rupiah stability
Despite CPI inflation likely to ease to 5.7% in 2016, BI may not trim the policy rate
just yet despite mounting pressure to support growth. BI signaled its easy policy
stance with a 50bps cut in the reserve requirement rate (RRR) in November in a bid
to inject more liquidity in the banking system. Further policy loosening through
more cuts in the RRR or lowering of the deposit facility rate (FASBI) are not ruled
out.
BI remains focused on managing volatility of the rupiah. Indeed, we reckon that
rupiah stability is more crucial in supporting GDP growth as compared to marginal
cuts in the BI rate. Persistent weakness of the rupiah will only weigh on domestic
confidence, further delaying the recovery in investment growth.
BI is no longer tolerant of a weak rupiah. The central bank has been actively
intervening in the FX and IDgov bond markets to prevent excessive rupiah weakness.
New measures were also introduced in September to encourage foreign flows into
short-term monetary instruments. Given the current conditions, we expect the BI
rate to remain steady at 7.50%.
Notes:
[1] See “Indonesia - manufacturing still a drag”, 3 December 2015
96
Economics–Markets–Strategy
Indonesia
Indonesia Economic Indicators
2014
2015f
2016f
3Q15
Real output and demand
Real GDP growth (10P)
Private consumption
Government consumption
Gross fixed capital formation
5.0
5.1
2.0
4.1
4.7
5.0
5.0
4.3
5.2
5.1
6.5
5.4
4.7
5.0
6.6
4.6
4.8
5.0
7.1
4.4
5.1
5.0
7.3
5.4
5.2
5.0
7.3
5.4
5.3
5.1
6.0
5.5
5.3
5.2
6
5.4
Net exports (IDRtrn, 10P)
Exports
Imports
58
1.0
2.2
163
-0.2
-5.4
117
2.0
4.6
53
-0.7
-6.1
48
1.1
-6.1
38
0.6
-1.4
11
0.7
5.5
30
1.9
7.3
38
4.7
7.2
External
Merch exports (USDbn)
- % chg
Merch imports (USDbn)
- % chg
Merch trade balance (USD bn)
176
-3.4
178
-4.5
-2
152
-13.8
142
-20.2
10
154
1.5
155
8.8
-1
37
-15.9
34
-22.7
3
37
-15.9
34
-22.7
3
37
-5.1
35
-5.4
2
40
2.6
39
5.4
1
37
0.0
38
11.8
-1
41
10.8
42
23.5
-1
Current account bal (USD bn)
% of GDP
Foreign reserves (USD bn, eop)
-26
-2.9
112
-17
-2.0
100
-22
-2.5
104
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
Inflation
CPI inflation (average)
6.4
6.4
5.7
7.1
4.8
4.9
4.9
5.6
6.2
Other
Nominal GDP (USDbn) **
Fiscal balance (% of GDP)
888
-2.0
870
-2.7
890
-2.5
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
Apr-12
Jan-14
4Q15f 1Q16f 2Q16f 3Q16f 4Q16f
* % change, year-on-year, unless otherwise specified
ID - nominal exchange rate
ID – policy rate
IDR per USD
BI rate
10.0
14800
9.5
14000
9.0
13200
8.5
12400
8.0
11600
7.5
10800
7.0
10000
6.5
9200
6.0
8400
Jan-07
Oct-08
Jul-10
Apr-12 Jan-14
Oct-15
5.5
Jan-07
Oct-08
Jul-10
Oct-15
Sources for charts and tables are CEIC Data, Bloomberg and DBS Group Research (forecasts are transformations).
97
Malaysia
Economics–Markets–Strategy
MY: calm returns
• Economic fundamentals are improving along with the trade balance.
This has enabled the ringgit to recover some lost ground
• Growth will remain at sub-five percent levels. We expect 4.5% in 2016,
down from 4.8% in 2015
• Inflation will average 2.8% in 2016, up from a revised 2.1% this year
• With growth expected to be marginally slower and inflation higher,
Bank Negara will keep monetary policy stable in 2016
It has been a difficult year. What started with emerging market jitters that hit the
MYR more than other Asian currencies soon devolved into concerns over domestic
political stability and corporate governance. Investors were spooked and the ringgit
was hit all the harder. In all, the currency has depreciated by some 17% against
the USD year-to-date, making it the worst performing currency in Asia by a wide
margin (Chart 1).
While political concerns remain, light is emerging at the end of the tunnel. In
November, the ringgit was the best performing currency in Asia despite the risk of
an upcoming Fed hike (Chart 2). The emerging stability was further supported by
an improvement on the external front. The trade surplus, a pain-point for Malaysia
since the slump in oil prices is rising again (Chart 2). It ballooned by 33% (YoY) in
3Q15 and by 11% in 2Q15 after shrinking by 19% in 1Q15.
Economic fundamentals improving
Such improvement in the trade balance has helped to cushion the external balance
against persistent capital outflows. Though the foreign reserves position remains
below the USD 100bn threshold, the latest October data shows an increase of USD
678mn over the previous month to about USD 94bn (Chart 3).
Chart 1: Performance of Asian currencies
% appreciation vs USD,
4
+0.8
0.1
-1
-3.4
-6
-6.3
MALAYSIA
-5.2
-2.5
-5.1
-10.5
YTD
-16
November
Latest: 30 Nov15
-18.0
MYR
IDR
THB
SGD
INR
PHP
KRW CNH
Irvin Seah • (65) 6878 6727 • [email protected]
98
-2.9
-8.4
-11
-21
-5.2
-3.0
CNY
TWD
JPY
HKD
Economics–Markets–Strategy
Malaysia
Thousands
Chart 2: Trade surplus rising
MYR bn
12
Chart 3: Fall in reserves stabilising
Trade balance (LHS)
Exports
Imports
10
8
% YoY
15
USD bn
140
10
130
5
120
Official reserves (LHS)
Reserves to imports ratio
Mth
10
9
8
6
0
110
4
-5
100
2
-10
90
-15
80
Jan-14
7
6
Latest: Sep/Oct15
Latest: Sep15
0
Oct-14
Jan-15
Apr-15
Jul-15
5
Jul-14
Jan-15
Jul-15
In fact, the earlier concern regarding Malaysia’s falling reserves position could be
overplayed. The rule of thumb for an optimal level of reserves is to cover at least five
months of import payments. Malaysia’s foreign reserves to imports ratio currently
stands at 6 months given an average monthly import payments of USD 15.5bn over
the past twelve months.
Another commonly used measure is the reserves-to-GDP ratio. The reserves position
as of October is about 30% of total nominal GDP over the past four quarters. This
compares favorably to the average reserves-to-GDP ratio of 9% observed in 34
middle-income countries between 1975-2003.
In addition, fiscal consolidation is progressing, albeit gradually. There has been an
increase in reliance on the GST receipts over oil-related income to drive revenue
growth. This will help to enhance the sustainability of the fiscal position in the longer
term. The government expects the fiscal deficit in 2016 to register 3.1% of nominal
GDP, down from 3.2% in FY2015.
Trade balance
improving
The downside risk to Malaysia’s economic conditions has moderated. Though the
ringgit may continue to depreciate gradually against the USD in the coming months,
it is more a case of dollar strength rather than ringgit weakness per se. Economic
fundamentals are gradually strengthening but political stability remains the key risk.
Slower growth
Growth momentum has slowed. GDP growth in 3Q15 registered 4.7% (YoY), down
from 4.9% previously (Chart 4). Sequentially, GDP growth moderated to 2.6% (QoQ
saar), from 4.5% in 2Q15. Despite slower domestic consumption, the drag from net
exports has dissipated while investment growth has picked up marginally (Chart 5).
The GST impact has taken a toll on consumption growth. Private consumption
growth in particular has eased to just 3.5% (YoY) in 3Q15, from 6.8% previously.
Beyond the head-on GST effect on consumer spending, sentiment is also cooling
amid increasingly uncertain employment prospects.
Nonetheless, the moderation in domestic consumption was partially offset by
improvements in investment and net exports. Capital spending in the services sector
and infrastructure development projects has risen by 4.3%, from a mere 0.5% in
2Q15. In addition, net export is no longer a drag. A weaker ringgit has crimped
import demand and boosted export performance. Despite the uncertainties in the
external environment and softer domestic demand, full year GDP growth is still on
track to meet our forecast of 4.8% for the year.
99
Malaysia
Economics–Markets–Strategy
Chart 4: Modest slowdown in 3Q15
Chart 5: Slower growth
% YoY, % QoQ saar
8
%YoY, %-pt contribution
8
%QoQ saar
7
Latest: 3Q15
6
6
4.7%
5
4
%YoY
4
2.6%
3
2
2
0
1
Latest: 3Q15
0
-1
Net exports
Govt expenditure
GDP growth
-2
-4
Mar-13
Sep-13
Mar-14
Sep-14
Mar-15
Sep-15
Mar-14
Sep-14
Investment
Pvt consumption
Mar-15
Sep-15
That said, an uncertain global environment will continue to weigh down on growth
outlook. Higher interest rates arising from US Fed’s monetary normalisation process
will temper global growth prospects and potentially stoke volatility in the financial
markets. Slowdown in China will definitely undermine export performance.
Moreover, fiscal consolidation and political tension could weigh down on domestic
growth. These factors will make for a lower growth trajectory in the coming
quarters. Overall GDP growth in 2016 is expected to register 4.5%.
Stable monetary policy
Growth expected
to be slower
Inflation has been lower
than expected. The latest
October
CPI
inflation
reported a 2.5% (YoY) rise.
The combined impact of the
GST and the weaker currency
has been less than expected.
This
probably
can
be
attributed to the persistently
low energy prices. With oil
prices expected to remain
low in the near future given
the lack of demand, full year
inflation will likely average
just 2.1%, lower than our
previous forecast of 2.4%.
Chart 6: Inflation and monetary policy outlook
% YoY, % p.a.
DBSf
5.0
4.5
CPI Inflation
4.0
OPR
3.5
3.0
2.5
2.0
1.5
1.0
0.5
Slump in
oil prices
GST
hike
0.0
However, a low base will
Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 Jul-16
set in over the first six
months of 2016. This should
see headline inflation rising above the 3% level. But this is purely technical and
transient in nature. Inflation will ease going into 2H16, which will deliver a full year
average inflation of 2.8%.
With growth momentum easing and inflation set to be higher, monetary policy will
have to track the middle ground. That is, Bank Negara will continue to maintain a
stable monetary policy stance. The central bank is expected to keep the Overnight
Policy Rate (OPR) at 3.25% for the whole of 2016.
100
Economics–Markets–Strategy
Malaysia
Malaysia Economic Indicators
2014
2015f
2016f
3Q15
Real output and demand
GDP growth
Private consumption
Government consumption
Gross fixed capital formation
Exports
Imports
6.0
4.9
7.0
4.8
5.2
4.2
4.8
4.3
5.7
4.2
0.2
0.8
4.5
4.3
4.8
4.1
2.6
2.7
4.7
3.5
4.1
4.3
3.2
3.2
3.8
3.2
4.0
4.5
2.0
1.9
3.9
3.0
4.2
3.5
1.4
3.0
4.0
4.0
4.8
3.6
2.7
2.5
4.7
4.6
5.0
4.1
2.5
2.5
5.4
5.0
5.1
5.0
3.7
2.7
External (nominal)
Exports (USD bn)
Imports (USD bn)
Trade balance (USD bn)
237
211
26
200
176
25
182
151
31
48
42
5
53
45
8
46
38
8
45
38
8
45
37
8
46
38
8
15
5
7
3
9
3
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
117
95
99
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
Inflation
CPI inflation
3.1
2.1
2.8
3.0
2.5
4.1
2.8
2.2
2.2
Other
Nominal GDP (USDbn)
Fiscal balance (% of GDP)
327
-3.5
297
-3.2
318
-3.1
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
Jan-14
Oct-15
Current account bal (USD bn)
% of GDP
Foreign reserves
(USD bn, yr-end)
4Q15f 1Q16f 2Q16f 3Q16f 4Q16f
- % growth, year-on-year, unless otherwise specified
MY - nominal exchange rate
MY – policy rate
MYR per USD
%, OPR
4.50
3.6
4.30
3.4
4.10
3.2
3.0
3.90
2.8
3.70
2.6
3.50
2.4
3.30
2.2
3.10
2.90
Jan-07
2.0
Oct-08
Jul-10
Apr-12
Jan-14
Oct-15
1.8
Jan-07
Oct-08
Jul-10
Apr-12
101
Thailand
Economics–Markets–Strategy
TH: private sector drag
• Private sector demand remains sluggish. We downgrade our 2016 GDP
growth forecast to 3.4%, from 3.7% previously
• As the government rolls out its stimulus measures, look for strong contribution from the public sector to be sustained
• CPI inflation will remain subdued, circa 1.5% next year
• Expect Bank of Thailand to maintain an accommodative policy stance,
reflecting its tolerance for a softer currency
The government is holding up the economy as private sector demand remains
sluggish. The government has rolled out a series of stimulus measures, the impact
of which is likely to be more pronounced in 2H16. External demand provides little
help. Export growth will tick higher to 3% next year, which is not much considering
the projected 5% drop in 2015. We now expect GDP growth to tick down to 3.4%
in 2016, compared to our previous forecast of 3.7%.
CPI inflation is likely to recover but remain subdued at 1.5% in 2016. The Bank of
Thailand (BOT) may continue to keep rates steady, maintaining an accommodative
policy stance. This is partly due to its tolerance for a weak baht, in a bid to boost
export growth.
Government upping the ante
The government has introduced a string of measures to boost GDP growth. Look
for strong contribution from the public sector to be sustained. Government
consumption and public investment growth contributed more than 50% of the
GDP growth created in 2015 (Chart 1). This may be the case once again in 2016.
Government consumption growth is likely to inch higher to 4.6% in 2016, twice as
fast as the projected pace this year.
Chart 1: Strong contribution from public sector to overall GDP
%-pt contribution to GDP growth
3.5
5y average GDP growth = 3%
3.0
DBS forecast
2.5
2.0
1.5
1.0
0.5
THAILAND
0.0
-0.5
-1.0
-1.5
Mar-11
public investment
government spending
Mar-12
Mar-13
Mar-14
Mar-15
Gundy Cahyadi • (65) 6682 8760 • [email protected]
102
Mar-16
Economics–Markets–Strategy
Thailand
Chart 2: GFCF growth
Chart 3: Consumption still struggling
index, sa, Jan09=100
index, sa, Jan00=100
180
120
Latest: Sep15
point, 100 = neutral
100
Latest: Oct15
160
110
90
100
80
90
70
140
120
30% higher
than 1Q14
100
80
60
Mar-12
private investment
public investment
Mar-13
Mar-14
Mar-15
80
Oct-11
BOT private consumption index
consumer confidence index (RHS)
Oct-12
Oct-13
Oct-14
60
Oct-15
Among others, the government’s measures include extra spending of up to USD
3.8bn in rural area development. There is also a new subsidy program for rubber
farmers. Meanwhile, a new housing loan program and generous tax deductions
have been introduced for low-income earners who can’t get housing mortgages
from commercial banks.
Additionally, the first phase of the government’s USD 50bn worth of public
infrastructure projects is to be kicked off in 2016. There are also plans to establish
special economic zones, as the government aims to revitalize the manufacturing
sector.
Delivery is important. The experience from 2015 is somewhat encouraging on this
front, given the sharp spike in public investment (Chart 2). Expect public investment
growth to remain robust, in excess of 10% next year. This will propel overall gross
fixed capital formation (GFCF) growth to inch higher to 5.6% in 2016, even if private investment remains sluggish.
Private sector demand remains a drag
The monthly consumption index has ticked up higher in 4Q15. Still, it is barely higher
than where it was 3 years ago. Retail sales index also continues to run sideways,
and that of durable goods lagging behind. These suggest underlying demand has
remained weak at this juncture. Even if consumer confidence has ticked up towards
end-2015, consumers are ending the year more pessimistic than at the start of the
year (Chart 3).
Expect just a slight improvement in private consumption growth to 2.3% in 2016,
up from a projected 2.1% this year. There is a debt overhang among households.
Household loan growth has eased to trend circa 5% currently, slowest in more than
a decade. Consumers are cutting back on their leveraging, evidenced in the fall of
outstanding credit card loans as well as new mortgages. Household debt remains
high, however, in excess of 80% of GDP. Stronger income growth would help but
nominal wage growth is practically zero in 2015.
Private consumption growth to tick
up slightly higher
to 2.3% next year
Private investment growth is not faring any better. While we have also seen some
upticks in 4Q15, the private investment index has generally been running sideways.
There is still plenty of excess capacity in the economy and we don’t anticipate a
strong surge in demand going forward.
Infrastructure-related works will pick up as the government rolls out its stimulus.
Even then, bulk of the impact on private sector investment is likely to be witnessed
only in 2H16. Expect private investment to grow 2% in 2016, reversing from this
year’s -1.8% projected fall.
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Thailand
Economics–Markets–Strategy
Chart 5: Accommodative monetary policy
Chart 4: Manufacturing still struggling
index, sa, Jan00=100
% YoY
4
190
Latest: 3Q15
2
Index, 2010=100
%
115
4
Latest: Oct15
180
110
170
105
160
100
0
-2
-4
3
2
-6
-8
-10
Mar-13
150
manufacturing GDP
industrial production (RHS)
Mar-14
140
Mar-15
95
90
Oct-11
THB REER
BOT Rate (RHS)
Oct-12
Oct-13
Oct-14
1
Oct-15
Strong external balance amid weak domestic demand
Contribution from net exports to overall GDP growth is a full percentage point.
But this is due to weak import demand and not strong export growth. Merchandise
goods exports are down by 5% this year and we expect only a mild 3% rise next
year. Even after adding services, total exports are likely to be flat for 2015.
Without stronger export growth, expect utilization rate to remain low, around
60%. It is hardly surprising then to see the manufacturing sector continuing to
struggle, as production continues to fall (Chart 4). The manufacturing sector has
seen no growth for 3 years running. Manufacturing makes up almost 1/3 of overall
GDP and it is important to see a recovery in this sector.
BOT tolerant of a weak baht
Keeping rates
low is a way to
facilitate a softer
currency
CPI inflation is likely to remain subdued in 2016. Barring any further collapse in
global oil prices, transport inflation will normalize after averaging -6.7% in 2015.
This will push headline inflation higher, given a sizeable 25% weighting of transport
in the CPI basket. Some upside risks also stem from food prices. With core inflation
staying soft below 1%, however, expect only a gradual lift to headline inflation
next year. We forecast CPI inflation to average 1.5% in 2016.
The BOT is likely to continue holding its interest rates steady. The current policy
stance remains highly accommodative (Chart 5). Further rate cuts are unlikely to
alter domestic demand by much, given that the current policy rate is just 25bps
higher than its record-low. More importantly, fiscal policy has taken over the driver’s
seat to boost GDP growth.
Keeping interest rates low is also a way to facilitate a softer currency. The BOT is
tolerant of a weaker baht, in an effort to boost export growth. We reckon that the
BOT will start tightening its policy stance once GDP growth can be sustained in the
3.5-4.0% range. As it is, household debt remains a policy concern for the longerterm. Despite the deleveraging in the past two years, household debt remains
above 80% of GDP, relatively high compared to elsewhere in the region.
Politics
Continue to monitor development on the political front. Elections have been
postponed to 2017, at the earliest. Prior to that, a new constitution charter needs
to be completed and put in a referendum by mid-2016. Any delay will only push
back the date for the next elections.
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Economics–Markets–Strategy
Thailand
Thailand Economic Indicators
2014
2015f
2016f
3Q15
0.9
0.6
1.8
-2.6
2.7
2.1
2.3
3.5
3.4
2.3
4.6
5.6
2.9
1.7
1.0
-1.2
2.4
2.4
1.4
3.4
2.8
2.0
2.0
3.1
3.3
2.2
3.3
6.0
3.5
2.3
6.3
6.6
3.6
2.6
6.3
6.6
670
0.0
-5.1
700
0.1
-0.3
697
2.6
2.9
171
1.8
-2.4
214
-3.0
-0.7
172
-0.7
-0.2
117
3.0
4.2
181
4.1
4.0
228
4.0
3.7
External
Merch exports (USDbn)
- % YoY
Merch imports (USDbn)
- % YoY
Trade balance (USD bn)
Current account balance (USD bn)
% of GDP
228
0
228
-9
0
15
3.7
215
-5
205
-10
10
30
7.6
221
3
213
7
8
20
4.9
55
-6
50
-10
4
6
n.a.
54
-5
51
-9
3
9
n.a.
52
-2
50
-4
2
6
n.a.
54
1
53
3
1
5
n.a.
58
6
55
9
3
5
n.a.
57
6
55
8
2
4
n.a.
Inflation
CPI inflation
1.9
-0.9
1.5
-1.1
-0.8
0.2
1.2
2.4
2.6
Other
Nominal GDP (USDbn)
Unemployment rate, %
Fiscal balance (% of GDP)**
405
0.9
-2.3
395
1.0
-2.0
405
0.9
-3.0
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
Real output and demand
GDP growth (02P)
Private consumption
Government consumption
Gross fixed capital formation
Net exports (THBbn)
Exports
Imports
4Q15f 1Q16f 2Q16f 3Q16f 4Q16f
* % change, year-on-year, unless otherwise specified
** central government net lending/borrowing for fiscal year ending September of the calendar year
TH - nominal exchange rate
TH – policy rate
THB per USD
%, 1-day RRP
38
5.0
37
4.5
36
4.0
35
3.5
34
33
3.0
32
2.5
31
2.0
30
1.5
29
28
Jan-07
1.0
Oct-08
Jul-10
May-12
Feb-14
Dec-15
Sources for charts and tables are CEIC Data, Bloomberg and DBS Group Research (forecasts are transformations).
105
Singapore
Economics–Markets–Strategy
SG: winter before spring
• The economy averted a technical recession in 3Q15, thanks to a resilient services sector
• GDP growth is expected to rise to 2.1% in 2016 from 1.8% in 2015
• Inflation will turn positive from 2Q16 onwards and average 0.5% for
the year overall
• With growth and inflation inching higher, the exchange rate policy
stance will remain one of modest and gradual appreciation
It has been a tough year for the economy. Being a small and open economy, negative
shocks in the external environment sent ripples across the domestic economy.
But despite contracting by 2.6% (QoQ, saar) in the second quarter, the economy
managed to avert a technical recession with 1.9% (QoQ, saar) growth in the third
quarter (Chart 1). This translated to a 1.9% (YoY) growth.
Services the key driver
The service sector drove growth in the third quarter. Growth came in at 3.6% (YoY),
stronger than the 3.0% projected in the advance GDP estimates (Chart 2). Notably
this sector accounts for about two-thirds of the economy. A good showing from this
sector lifted the boat, but growth here has plateaued. Drag from the manufacturing
sector, a domestic manpower crunch and uncertainties in the global environment
will continue to cast a shadow on the performance of the sector going forward.
Manufacturing stuck in recession
Unsurprisingly, the main drag came from the manufacturing sector. A contraction
of 6.2% (YoY) was reported, compared to the advance projection of -6.0%. A worse
than expected outcome in September industrial production was the main reason.
Industrial output has declined in ten out of the past twelve months (Chart 3). In
fact, production contracted by an average of 3.7% YoY over the past four quarters
Chart 1: A close brush with technical recession in 3Q15
% YoY, % QoQ saar
10
8
6
% QoQ saar
% YoY
4
1.9%
SINGAPORE
2
0
-2
Latest: 3Q15
-4
Mar-13
Sep-13
Mar-14
Sep-14
Irvin Seah • (65) 6878 6727 • [email protected]
106
-2.6%
Mar-15
Sep-15
Economics–Markets–Strategy
Singapore
Chart 2: Services sector holding up
YoY %-pt contribution
8
Biz services
Financial services
7
Tpt & storage
Wholesale & retail
6
Others
Services growth
5
4
3
2
1
-1
Latest: 3Q15
Mar-12 Jun-12 Sep-12 Dec-12 Mar-13 Jun-13 Sep-13 Dec-13 Mar-14 Jun-14 Sep-14
and the near-term outlook doesn’t seem to be improving given weak external
demand. PMIs of key export markets may have bottomed but broadly still hint of
weak demand ahead (Chart 4)
Plainly, the manufacturing sector is in a structural decline. It has been stuck in the
doldrums for the past three years and its GDP share has fallen from 26% in 20042006 to just 17% in 2013-2014. External competition, continued increases in business
costs and manpower shortage are eroding the long term prospects of the sector.
Manufacturing
is in a structural
decline
It’s time for policymakers to intensify their efforts to keep the sector afloat.
Manufacturing has always been an important engine for the economy and the
nation wouldn’t have achieved today’s success if not for the tremendous progress
made in this sector. However, at the current pace of decline, Singapore could soon
follow the path of Hong Kong where manufacturing has become irrelevant.
Winter before spring
The Ministry of Trade and Industry (MTI) now expects GDP growth of “close to 2.0%”
for the full year, close to our 1.8% forecast. This would be the slowest growth in six
years and risks remain.
Chart 3: Exports and manufacturing in doldrums
Chart 4: PMIs still down
% YoY
35
Index
60
Three years of doldrums
25
Singapore
EZ
China
US
58
15
56
5
54
-5
52
-15
NODX
IPI
-25
50
Latest: Oct15
-35
Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15
Latest: Oct15
48
Jan-14
Jul-14
Jan-15
Jul-15
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Singapore
Economics–Markets–Strategy
Chart 5: Growth outlook for 2015-16
% YoY, %-pt contribution
10
Services Producing Industries
Goods Producing Industries
8
GDP growth
DBSf
6
2015f: 1.8%
2016f: 2.1%
4
2
0
-2
Mar-14
Sep-14
Mar-15
Sep-15
Mar-16
Sep-16
The growth outlook in the next 6-9 months will remain challenging and with
significant risks to global growth and trade flows. The US Fed is rushing to hike rates
when recovery is still shaky. Higher interest rates amid fragile economic conditions
will surely hinder the prospects of the global economy.
Growth to be tad
higher in 2016
Moreover, the extent of China’s slowdown remains a concern and Eurozone will
probably be weighed down by the refugee crisis and terror threats. Coupled with
that is potential capital flight that could result from higher US interest rates and /
or fears of further yuan devaluation. These risk factors will hurt the growth outlook
for Singapore, as well as for Asia.
Signs of stabilisation will probably emerge only in the latter part of next year
when the impact of Fed’s monetary normalisation is fully digested by the markets
and uncertainties revolving around China’s deceleration are addressed. Domestic
restructuring measures may also turn more accommodative with new emphasis on
helping companies boost revenues and internationalise.
This should bring overall GDP growth for 2016 to 2.1%, a tad higher than the
growth pace in 2015 (Chart 5). Simply put, winter comes before spring. Just hope
that it won’t be a long winter.
Chart 6: Benign inflation
% YoY
5
4
3
2
Core inflation
DBSf
2015f: -0.4%
2016f: 0.5%
1
CPI inflation
0
-1
Jan-14
108
Latest: Sep15
Jul-14
Jan-15
Jul-15
Jan-16
Jul-16
Economics–Markets–Strategy
Singapore
Benign inflation, not deflation
Inflation has remained stuck in negative territory. October CPI inflation slipped to
-0.8% (YoY) on the back of lower costs of housing & utilities and transport (Chart
6). The high base effect from energy prices is still being manifested in the headline
number given the continued slump in oil prices. Macro-prudential measures of the
past are also depressing rentals and home prices. In addition, slowdown in growth
momentum is taking a toll on costs of domestic services (i.e. communication).
Though outright deflation risk is still low, much depends on the growth outlook and
inflation expectations. While the former will remain subdued, the latter is unlikely
to turn sharply negative for the near future. Moreover, the labour market is still
holding up with low unemployment rate of 2.0% sa. Although core inflation has
eased to 0.3% (YoY) in Oct15, down from 0.6% previously, it will likely continue to
stay above water. In fact, the negative all-item CPI inflation will only last till 2Q16
before the base effects lapse. Even though full year inflation for 2015 will likely
register -0.4%, inflation will rise to 0.5% in 2016 (Chart 6).
MAS to maintain the modest appreciation stance
The Monetary Authority of Singapore (MAS) eased monetary policy marginally in the
last meeting in October (Chart 7). While it continues to pursue the policy of a modest
and gradual appreciation of the SGD NEER policy band, the rate of appreciation was
reduced slightly. With subdued economic growth and full-year inflation expected to
be negative, the easing was in line with underlying fundamentals.
Although the global environment remains challenging with potential risks in the
horizon, growth and inflation are expected to pick up marginally in 2016. Plainly,
global business cycle may be bottoming-out. Though a pick-up in growth momentum
could be lacking in the near future, the need for further monetary accommodation
is diminishing. This backs a stable monetary policy stance.
The SGD may continue to depreciate against the USD but that’s mainly due to the
dollar strength, riding on Fed’s interest rate normalisation. Against a basket of
currencies, the MAS is expected to maintain the present modest appreciation of the
SGD NEER policy stance in the upcoming meeting in April.
No change in the
monetary policy
stance
Chart 7: DBS SGD NEER and policy band
110
Indexed: 2-5 Apr 2012 = 100
108
106
104
102
100
98
SGD NEER
96
Lower
94
Mid
92
90
88
2010
Upper
Latest: 7 Dec15
2011
2012
2013
2014
2015
109
Economics–Markets–Strategy
Singapore
Singapore Economic Indicators
2014
2015f
2016f
3Q15
Real output and demand
Real GDP (00P)
Private consumption
Government consumption
Gross fixed investment
Exports
Imports
4Q15f 1Q16f 2Q16f 3Q16f 4Q16f
2.9
2.5
1.7
-1.9
2.2
1.5
1.9
3.8
6.1
0.9
2.5
1.8
2.1
2.9
5.2
2.7
1.9
2.8
1.9
5.2
12.5
0.2
3.2
6.0
0.9
3.0
5.5
1.6
1.1
1.9
0.7
2.8
4.0
0.8
0.6
4.1
2.1
2.8
5.0
2.8
0.9
2.5
2.5
2.9
5.9
3.0
3.3
2.4
3.0
3.0
6.0
4.0
2.6
2.2
Real supply
Manufacturing
Construction
Services
2.6
3.0
3.2
-5.3
0.6
3.6
-1.8
1.2
3.4
-6.2
1.6
3.6
-7.4
0.1
2.8
-7.1
2.0
2.6
-3.0
1.9
3.7
0.1
-0.1
3.8
2.9
0.9
3.5
External (nominal)
Non-oil domestic exports
Current account balance (USD bn)
% of GDP
Foreign reserves (USD bn)
-0.7
59
19
257
1.2
69
24
246
1.8
71
24
250
-3.0
n.a.
n.a.
n.a.
1.1
n.a.
n.a.
n.a.
-4.2
n.a.
n.a.
n.a.
4.8
n.a.
n.a.
n.a.
5.0
n.a.
n.a.
n.a.
1.8
n.a.
n.a.
n.a.
Inflation
CPI inflation
1.0
-0.4
0.5
-0.6
-0.3
0.3
0.5
0.8
0.4
Other
Nominal GDP (USDbn)
Unemployment rate (%, sa, eop)
308
2.0
289
2.1
296
2.3
n.a.
2.0
n.a.
2.1
n.a.
2.2
n.a.
2.2
n.a.
2.3
n.a.
2.3
Jan-14
Oct-15
- % change, year-on-year, unless otherwise specified
SG - nominal exchange rate
SG – 3mth SIBOR
SGD per USD
% pa
3.5
1.60
1.55
3.0
1.50
2.5
1.45
2.0
1.40
1.5
1.35
1.30
1.0
1.25
0.5
1.20
1.15
Jan-07
Oct-08
Jul-10
Apr-12
Jan-14
Oct-15
0.0
Jan-07
Oct-08
Jul-10
Apr-12
110
Economics–Markets–Strategy
Singapore
This page is intentionally left blank
111
Philippines
Economics–Markets–Strategy
PH: a transition year
• GDP growth is likely to tick higher to 6.1% in 2016, driven by domestic
demand
• Foreign remittances will stay robust and keep the current account balance in surplus
• The central bank is likely to resume tightening and raise its overnight
borrowing rate to 4.25% in 2H16
• The elections in May are eagerly awaited. Risks seem limited
The economy continues to sit in a sweet spot. Growth is likely to tick higher to 6.1%
in 2016 while CPI inflation will remain low at 2.5%. Robust remittances keep the
external accounts strong. The Bangko Sentral ng Pilipinas (BSP) is likely to resume
tightening and raise its overnight borrowing rate to 4.25% in 2H16.
The elections in May are eagerly awaited. Investment growth, including in the
private sector, may moderate as businesses adopt a wait-and-see approach. But
consumption growth is strong and likely to offset any temporary drag.
Back to 6% GDP growth
Domestic demand continues to spur overall GDP growth. Taken together,
contributions from private consumption and investment growth have averaged
6%-pts to overall GDP growth in the past year. Expect no less in 2016.
Strong underlying demand will keep private consumption growth robust at 6.1% in
2016. Recent data is encouraging. Non-food consumption continues to lead overall
consumption growth (Chart 1). It is hardly surprising that motor vehicle sales are
still growing at a strong 20% annual pace. The anticipated fall in crops production
may weigh on spending in the rural areas in early-2016. But this is likely to be
Chart 1: Non-food leading overall consumption
% YoY
Latest: 3Q15
8.5
8.0
7.5
7.0
6.5
6.0
PHILIPPINES
5.5
5.0
4.5
4.0
Sep-12
Personal consumption
Sep-13
Non-food consumption
Sep-14
Gundy Cahyadi • (65) 6682 8760 • [email protected]
112
Sep-15
Economics–Markets–Strategy
Philippines
Chart 2: Investment growth remains strong
Chart 3: Upward trend in cap goods imports
% QoQ, saar, 00P
index, sa, Jan10=100
25
140
120
20
130
118
10
10y average
0
114
110
112
100
110
90
108
106
80
-5
-10
Sep-11
116
120
15
5
index, Jan10=100
70
Sep-12
Sep-13
Sep-14
Sep-15
60
Jan-14
104
capital goods
PHP REER (RHS)
102
100
Jul-14
Jan-15
Jul-15
more than offset by robust foreign remittance flows. Note also the positive spillover
impact from the political campaigns ahead of the elections in May.
Some moderation in public investment growth may be in the offing ahead of
the elections. We are not particularly concerned though. On a sequential basis,
investment is growing twice as fast as the average pace seen in the last 10 years
(Chart 2). Even after penciling some easing in early-2016, we reckon that full-year
investment growth would still come in a strong 8.8%.
The string of recent data is supportive of our view. Growth in private sector
construction remains modest, circa 8% in 2015. Investment in durable equipment,
including industrial machinery, stayed strong at circa 8%. Imports of capital goods
jumped more than 20% (YoY) in 3Q15, despite a weaker peso in the period (Chart 3).
Fiscal revenues continue to grow in excess of 10% every year in the past 5 years and
provide room for the government to spend more aggressively if there is a need to.
While there could be some moderation in early-2016, expect the pace of government
consumption to pick up again towards the year-end.
External balances still healthy
Strong domestic
demand will lift
GDP growth back
above 6% in 2016
Exports should grow by 7% next year. This is not as good as it sounds, however,
considering they fell by some 6% this year. One consolation is that exports of
electronics have continued to grow at 8% annual pace, despite the fall in overall
exports in 2015 (Chart 4, next page). This is important given the increasing stature
of the manufacturing industry in the economy.
Meanwhile, import demand is set to remain strong, on the back of the still rapid
investment growth. On balance then, the trade deficit is likely to widen to about
USD 12bn in 2016. But foreign remittance flows are still robust and we expect total
inflows to remain circa USD 25bn. Overall, the current account (C/A) is still likely to
record a surplus, in excess of 3 % of GDP.
External financing risks are limited. Foreign reserves still provide 6x coverage of
short-term external debt. The Philippines will continue to stand out on this front,
amid concerns over capital outflows from the region due to higher US rates.
Inflation not a threat
The impact from El Nino turns out to be more modest than earlier expected. The
government has also pledged to increase food import to calm supply fears. While we
still expect food prices to climb higher in 2016, we revise down our 2016 CPI forecast
to 2.5% from 3.0% initially.
113
Philippines
Economics–Markets–Strategy
Chart 5: Inflation trajectory
Chart 4: Sustained growth in electronics exports
index, sa, 1Q10 = 100
% YoY
150
6
140
120
4
110
3
100
2
90
80
70
60
Mar-11
DBS
forecast
5
130
1
electronic products
Mar-12
CPI inflation to
trend higher in
2016
Mar-13
total exports
Mar-14
Mar-15
0
Mar-12
CPI inflation
core inflation
Mar-13
Mar-14
Mar-15
Mar-16
Food inflation has gained momentum towards end-2015. A weaker peso has also
added some inflationary pressures amid the increase in food imports. Despite global
commodity prices staying benign, both headline and core inflation might have bottomed out in 3Q15 (Chart 5). Not that the BSP is worried though. If anything, the
central bank may be encouraged that CPI inflation returns to the 2-4% target.
BSP to tighten policy further
The BSP plans to introduce a new interest rate corridor and hold weekly auctions
for term deposits in 2Q16. The rate corridor mechanism is expected to improve
monetary policy transmission while the term deposit facility is another tool to
manage short-term liquidity in the banking system.
No policy rate move is likely to happen before the shift to the new rate corridor.
Given that CPI inflation is on course to meet target and GDP growth remains strong,
expect a 25bps hike in the overnight borrowing rate in 2H16.
Expect a 25bps
rate hike in 2H16
The BSP remains focused on long-term GDP growth sustainability. On this front,
managing excess liquidity continues to be a policy priority. This is especially
important considering the rapid investment growth that is likely to persist. Loan
growth has eased to around 12% currently, down sharply from over 20% a year
ago. We reckon that the BSP is more comfortable with loan growth circa 10%, if
not slightly lower.
Compared to early-2015, the BSP is more tolerant of a weaker currency now. But
there is also the need to prevent excessive volatility of the peso. Note that bulk of
the peso’s 5% depreciation against the US dollar in 2015 has occurred in the second
half of the year.
Eyes on the presidential elections
Some political risks have resurfaced ahead of the 2016 presidential elections.
Incumbent Vice President Jejomar Binay’s campaign has been tainted by corruption
allegations. Meanwhile, the popular Senator Grace Poe’s bid has been disqualified
by the elections committee. This makes former Interior Minister Manuel Roxas as
the clear frontrunner.
Roxas has outgoing president Aquino’s endorsement, and promises to continue
with Aquino’s economic platform. This means a sustained focus on infrastructure
development through public-private partnerships as well as further diversification
of the economy.
114
Economics–Markets–Strategy
Philippines
Philippines Economic Indicators
2014
2015f
2016f
3Q15
6.1
5.4
1.7
6.8
5.7
6.1
7.2
9.3
6.1
6.1
5.2
8.8
6.0
6.3
17.4
9.3
5.7
6.2
7.4
9.2
6.8
6.2
7.6
10.1
5.7
6.1
3.5
9.0
6.1
6.0
3.5
7.5
5.9
6.0
6.9
8.5
-69
11.3
8.7
-259
5.5
10.9
-251
6.8
6.2
-59
6.4
13.5
-159
7.7
10.9
-64
6.8
6.6
22
9.7
9.6
-48
5.4
4.1
-162
5.5
4.9
62
9
65
2
-3
58
-6
68
4
-10
63
7
75
10
-12
15
-12
19
12
-4
14
-8
18
15
-4
14
0
18
8
-4
16
7
17
15
-1
17
13
21
8
-4
16
14
20
11
-4
13
4.5
80
11
3.9
81
10
3.3
82
n.a
n.a
n.a
n.a
n.a
n.a
n.a
n.a
n.a
n.a
n.a
n.a
n.a
n.a
n.a
n.a
n.a
n.a
Inflation
CPI inflation
4.2
1.4
2.5
0.6
0.9
1.6
2.1
3.0
3.3
Other
Nominal GDP (USD bn)
Budget deficit (% of GDP)
285
-0.9
285
-0.5
300
-1.2
n.a
n.a
n.a
n.a
n.a
n.a
n.a
n.a
n.a
n.a
n.a
n.a
Jan-14
Oct-15
Real output and demand
Real GDP growth
Private consumption
Government consumption
Gross fixed capital formation
Net exports (PHP bn, 00P)
Exports
Imports
External (nominal)
Merch exports (USD bn)
- % YoY
Merch imports (USD bn)
- % YoY
Merch trade balance (USD bn)
Current account balance (USD bn)
% of GDP
Foreign reserves, USD bn
4Q15f 1Q16f 2Q16f 3Q16f 4Q16f
* % change, year-on-year, unless otherwise specified
PH - nominal exchange rate
PH – policy rate
PHP per USD
%, o/n rev repo
8.0
51
7.5
50
49
7.0
48
6.5
47
6.0
46
5.5
45
5.0
44
4.5
43
42
4.0
41
3.5
40
Jan-07
Oct-08
Jul-10
Apr-12
Jan-14
Oct-15
3.0
Jan-07
Oct-08
Jul-10
Apr-12
Sources for charts and tables are CEIC Data, Bloomberg and DBS Group Research (forecasts are transformations).
115
Vietnam
Economics–Markets–Strategy
VN: exception to the rule
• GDP growth registered a solid 6.8% (YoY) in 3Q15 on the back of strong
domestic demand
• Full-year growth is now expected to average 6.6% in 2015 and 6.7% in
2016
• Inflation will pick up from 3Q16 onwards. Full-year inflation of 1.8% is
expected in 2016, up from 0.7% this year
• Expect a stable monetary policy stance in 2016 amid healthy domestic
growth
The wind is behind the sail in Vietnam. While global uncertainties dented many an
emerging market this year, Vietnam was a key exceptions. Growth accelerated.
GDP growth rose to 6.5% (YoY) in the first nine months of the year (Chart 1). On
a quarterly basis, the economy is estimated to have expanded by 6.8% in 3Q15,
compared to an average 6.3% in the preceding two quarters. Such strong growth
has kept the State Bank of Vietnam (SBV) from cutting interest rates despite inflation
dipping to zero in Sep-Oct15.
Moderate risk on the external front
The growth surge in the third quarter came as a surprise, especially given the
broad-based slowdown across Asia arising from strong external headwinds. Global
economic conditions have been challenging with the slow recovery in the US and
growth deceleration in China. Indeed, Vietnam’s export performance was struggling
just as much as with the regional peers.
The only bright spot is that overall trade balance has improved (Chart 2), largely on
the back of a weaker currency. The dong was devalued three times this year. That
has helped to keep exports competitive while putting the lid on import demand.
Chart 2: Trade bal. improved amid weaker dong
Chart 1: Growth accelerated in 3Q15
USD mn
500
% YoY, ytd
10
8
Real GDP growth
Construction
Agri, forestry & fishery
Industry
Services
USD/VND
22600
Trade balance
USD-VND (RHS)
22400
0
22200
6
22000
-500
21800
VIETNAM
4
2
0
Mar-13
21600
-1000
21400
Latest: 3Q15
Sep-13
Mar-14
Sep-14
Mar-15
Latest: Nov15
-1500
Sep-15
Jan-15
Irvin Seah • (65) 6878 6727 • [email protected]
116
Apr-15
Jul-15
Oct-15
21200
Economics–Markets–Strategy
Vietnam
However, the near-term outlook is not encouraging. Except for the Eurozone,
PMIs in the US and China, as well as Vietnam’s own PMI have all dipped into the
contraction territory (Chart 3). Export growth may continue to under-perform in
the coming months.
Strong domestic growth
The stunning GDP performance was backed by domestic growth, particularly that
of investment. This can be attributed to the healthy pipeline of infrastructure
development projects, as well as industrial and residential property construction
across the country. Evidently, there has been a spike in the construction sector
growth in 3Q15.
In addition, FDI flows are visibly stronger in 2H15 (Chart 4). And such phenomenon has
been gaining momentum in recent years. This is especially true in the manufacturing
sector where Vietnam is becoming an increasingly attractive destination for MNCs.
Vietnam’s pro-FDI policies, cost advantage, a weaker currency and competitive
labour force have all added to the development of the electronics sector in recent
years. Beyond that, Vietnam’s proximity to China makes it easier to integrate into
existing supply chains. A growing middle class supporting domestic demand has
further strengthened Vietnam’s overall attractiveness for global manufacturers (see
“VN: Asia’s latest electronics spark” dated 1 Jul15).
Investment to
remain key driver
of growth
Besides manufacturing, infrastructure development, liberalisation of the real estate
sector, gradual privatisation of the state-owned enterprises and reforms in the
banking sector should continue to spur investors’ interests.
Growth forecasts lifted
The robust domestic expansion has been clearly manifested in the surprise surge in
3Q15 GDP growth and such phenomenon will likely prevail in the coming quarters.
In addition, the strong GDP showing has also effectively lifted the growth trajectory
for the full year. This will put full-year GDP growth for 2015 on track to register
6.6%, up from our previous forecast of 6.2%.
However, 2016 could be tougher sailing given expected US rate hikes and ongoing
uncertainty in China. But domestic demand will continue to keep the economy in
good stead and allow overall growth of 6.7% in 2016 (Chart 5).
Chart 3: PMIs mostly down
Index
60
Chart 4: Rise in FDI flows
VN
EZ
China
US
USD bn
3.5
58
3.0
56
2.5
54
2.0
52
1.5
50
1.0
Foreign direct investment
Latest: Nov15
0.5
48
Latest: Nov15
46
Jan-14
0.0
Jul-14
Jan-15
Jul-15
Jan-15 Mar-15 May-15
Jul-15
Sep-15 Nov-15
117
Vietnam
Economics–Markets–Strategy
Chart 5: Growth and inflation outlook
% YoY, ytd
7.0
Inflation (RHS)
Real GDP growth
% YoY
6.0
DBSf
5.0
6.5
4.0
6.0
3.0
5.5
2.0
5.0
1.0
0.0
4.5
Mar-14
Sep-14
Mar-15
Sep-15
Mar-16
Sep-16
Reform is key
To sustain the sanguine economic outlook in the long-term, reforms will be
crucial. In this regard, a steady process is already underway. The government has
recently announced a decree to ban state-owned enterprises (SOEs) from non-core
investments. Such measure is expected to gradually dilute the state’s involvement
in businesses and is certainly a step in the right direction in the SOE reform process.
Promising signs in
domestic reform
Moreover, the restructuring efforts have also gained fresh urgency after the recent
agreement on the Trans-Pacific Partnership (TPP), which compel signatories to
remove preferential treatment for SOEs. Note only 94 SOEs were equitised in the first
nine months of 2015, which accounts for just about one-third of the government’s
target.
There are certainly bright sparks in the reform process. The residential property
market was opened for foreign investment in July. The 49% cap on the foreign
ownership of listed companies has also been lifted in most sectors. Furthermore, the
ratification of the TPP and the implementation of several free-trade agreements
(FTAs) will add extra impetus and bolster investors’ confidence in the liberalisation
process.
Monetary policy to be on hold
Inflation has remained benign on account of low energy prices. Latest Nov15
inflation registered just 0.3% (YoY) (Chart 5). In fact, the headline number was stuck
at zero percent over the past two months. However, the high base effect will lapse
going into 2016. CPI inflation is expected to climb gradually towards the 2% level by
3Q16. Full-year inflation for 2016 is likely to average 1.8%, up from 0.7% this year.
Robust domestic growth has kept the SBV from cutting interest rates despite the
benign inflation. In fact, currency depreciation has been the preferred option, so as
to align the dong with regional currencies and to maintain export competitiveness.
With inflation set to normalise and growth expected to remain healthy, monetary
policy direction will remain neutral. Barring any negative shock to growth arising
from the US Fed hike, the central bank will likely be on hold and will keep the
refinance rate at the current level of 6.50% in 2016.
118
Economics–Markets–Strategy
Vietnam
Vietnam Economic Indicators
2014
2015f
2016f
3Q15
Real output and demand
GDP growth
6.0
6.6
6.7
6.5
6.6
6.4
6.6
6.7
6.7
Real supply
Agriculture & forestry
Industry
Construction
Services
3.5
7.2
7.1
6.0
2.0
9.5
8.9
6.0
2.3
9.4
7.5
6.3
2.1
9.7
9.0
6.2
2.0
9.5
8.9
6.0
2.1
9.3
7.0
6.0
2.2
9.4
7.6
6.2
2.2
9.5
8.0
6.3
2.3
9.4
7.5
6.3
150.1
149.3
0.8
163.1
167.9
-4.8
176.7
179.7
-3.0
42.5
42.8
-0.4
43.0
43.5
-0.4
40.0
41.6
-1.6
44.5
45.2
-0.6
45.7
46.3
-0.5
46.5
46.7
-0.2
8.1
4.4
3.0
1.5
4.8
2.2
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
Inflation
CPI inflation (% YoY)
4.1
0.7
1.8
0.5
0.4
1.4
1.5
1.8
2.4
Other
Nominal GDP (USDbn)
Unemployment rate (%, sa, eop)
186
3.4
199
2.1
218
2.5
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
External (nominal)
Exports (USD bn)
Imports (USD bn)
Trade balance (USD bn)
Current account bal (USD bn)
% of GDP
4Q15f 1Q16f 2Q16f 3Q16f 4Q16f
- % change, year-on-year, year-to-date, unless otherwise specified
VN - nominal exchange rate
VN – prime interest rate
VND per USD
% pa
22900
14.0
22100
13.0
21300
12.0
20500
11.0
19700
10.0
18900
18100
9.0
17300
8.0
16500
15700
Jan-07
7.0
Oct-08
Jul-10
Apr-12
Jan-14
Oct-15
6.0
Jan-07
Oct-08
Jul-10
Apr-12
Jan-14
Oct-15
119
Economics: United States
Economics–Markets–Strategy
US: ready or not ...
• The economy is still sputtering at a 2% growth pace. Inflation continues
its 3.6 year decline. Why is the Fed so anxious to hike rates?
• Because it is terrified of falling behind the curve on inflation. That is the
cardinal sin for any central banker
• If the Fed dropped the ball with so many warning about inflation, it
would be the fumble of the century – something officials would never
live down
• But hiking too early is a risk too. What will the Fed do?
• Tiptoe out into the waters. We expect 5 hikes in total by end-2016, 2
more than markets currently price in
The economy has been sputtering along at a 2% growth pace for the past five years
and core PCE inflation – the Fed’s favoured gauge – has been drifting lower for the
past 3.6 of them. Why then is the Fed determined to hike rates in a few days’ time?
Because it’s terrified of falling behind the curve on inflation, mostly. That’s the cardinal sin for any central banker and the Yellen Fed would go down in history as the
one that blew the end game to eight years of QE and zero interest rates. Not only
would they have dropped the ball but they would have done so after everyone and
their brother told them that inflation was coming. Never mind that they said that
back in 2009. And 2010. And every year up until now. The writing was on the wall
and if the Fed somehow STILL managed to blow it, it would be the fumble of the
century – something officials would never live down.
Of course hiking too early is a risk too. If the economy responded negatively to
higher interest rates – and all the textbooks say it will – the Fed might have to stop
hiking or even pull a U-turn. That would be embarrassing and the cost to the economy and jobs of this event would be far higher than were inflation to overshoot for
US - core PCE inflation
% YoY, 3mma
2.6
QE1
Dec08-Mar10
2.4
QE2
Nov10-Jun11
Op Twist
Sep11-Dec12
QE3
Sep12 - Oct14
2.2
2.0
1.8
UNITED STATES
1.6
1.4
1.2
1.25%
1.0
0.8
Jan-07
Jan-08
Jan-09
Jan-10
Jan-11
Jan-12
Jan-13
David Carbon • (65) 6878-9548 • [email protected]
120
Jan-14
Jan-15
Economics–Markets–Strategy
Economics: United States
US - private sector nonfarm payrolls
private sector NFP x1000, sa
500
Nov14
Jan12
400
Apr11
5-yr average: 210k
Oct
300
200
Nov
100
Mar
0
Jan-11
Jan-12
Jan-13
Jan-14
Jan-15
Aug
Jan-16
a while. But the cost to Fed reputations of falling behind the inflation curve would
be orders of magnitude higher. What would you do in their shoes?
Probably tip-toe out into the waters, just like the Fed is preparing to do. Put a hike
out there, see what happens. Put another one out there, check again. Is there any
other way? Twenty-five or fifty basis points of hikes is unlikely to do much damage to the economy, especially when you consider that 500 basis points of cuts and
$3.5trn of QE didn’t do much good. If that many cuts don’t help, can a couple of
hikes hurt? No one knows for sure. All anyone knows is the US is in uncharted territory and tip-toe lightly is the name of the game.
Why is the Fed so
anxious to hike?
Because it’s terrified of falling
behind the curve
on inflation
If things go well, a couple of years from now (core PCE) inflation will have risen
to 2%, Fed funds will have risen to 2% and the economy will still be growing at a
2% pace. (Maybe higher, though that would be icing on the cake). The Fed would
have exited ZIRP with even less fanfare than it exited QE and Yellen could run for
president. If things go less well, the tip-toeing stops, presumably before any real
damage is done.
US – new home sales
thous/mth, saar
Feb15
550
500
Jan13
450
Nov14
Sep15
400
350
Jul14
Jul13
300
250
200
10
11
12
13
14
15
121
Economics: United States
Economics–Markets–Strategy
US – core capital goods orders
US$bn/mth, seas adj, non-def K goods, ex-aircraft
75
70
Core capex hasn’t
grown by a single
dollar in 3.5 years
Mar12
Jan 13
Jan14
Jan15
Jul08
Oct15
65
60
Zero growth for 3.5 years
Lehman
crash
55
50
45
Jan-08
Jan-09
Jan-10
Jan-11
Jan-12
Jan-13
Jan-14
Jan-15
Our best guess is that the economy will continue to run at about a 2% pace and, by
this time next year, the Fed will have hiked 5 times in total (once in 2015 and once
per quarter in 2016). Markets currently expect only 3 hikes by then but what’s the
risk that we’re both wrong? What are the things that might lead the Fed to stop
hiking mid-year?
Housing, business investment and exports, in that order. Housing is the most interest rate sensitive sector of the economy. When rates surged in mid-2013, the thentwo-year recovery stopped dead in its tracks (chart at bottom of previous page).
The subsequent drop in mortgage rates between mid-2013 and end-2014 pushed
housing back up again but both new and existing home sales have been falling
steadily since early-2015. Higher rates going forward won’t help. Housing is vulnerable.
Capital expenditures are another weak point. Whether you think the 2% GDP
growth of the past 5 years is strong or weak, the fact remains that core (non-defense, ex-aircraft) capital goods expenditures – the bedrock of US business investment – haven’t grown by a single dollar in 3.5 years (chart above). Higher interest
rates won’t help. Capex too is vulnerable.
US - exports of goods
The dollar has
taken a serious toll
on exports
US$bn/mth, sa, BoP basis
Oct14
140
138
136
134
132
130
128
126
Feb15
124
122
Jan-12
122
Oct15
Jan-13
Jan-14
Jan-15
Jan-16
Economics–Markets–Strategy
Economics: United States
US Economic Indicators
2014
Output & Demand
Real GDP*
Private consumption
Business investment
Residential construction
Government spending
Exports (G&S)
Imports (G&S)
Net exports ($bn, 09P, ar)
Stocks (chg, $bn, 09P, ar)
Contribution to GDP (pct pts)
Domestic final sales (C+FI+G)
Net exports
Inventories
Inflation
GDP deflator (% YoY, pd avg)
CPI (% YoY, pd avg)
CPI core (% YoY, pd avg)
PCE core (% YoY, pd avg)
External accounts
Current acct balance ($bn)
Current account (% of GDP)
Other
Nominal GDP (US$ trn)
Federal budget bal (% of GDP)
Nonfarm payrolls (000, pd avg)
Unemployment rate (%, pd avg)
2015(f) 2016(f)
Q2
--- 2015 --Q3
Q4 (f)
Q1 (f)
--- 2016 --Q2 (f) Q3 (f)
Q4 (f)
2.4
2.7
6.2
1.8
-0.6
2.5
3.1
3.1
8.4
0.7
2.2
2.3
3.5
4.9
1.1
3.9
3.6
4.1
9.4
2.6
2.1
3.0
2.4
7.3
1.7
1.7
1.9
3.0
5.0
0.7
1.9
2.0
3.5
4.0
1.0
2.3
2.1
4.0
4.0
1.0
2.4
2.2
4.0
4.0
1.0
2.4
2.2
4.0
4.0
1.0
3.4
3.8
-443
68
1.5
5.1
-541
99
3.6
3.0
-545
70
5.1
3.0
-535
114
0.9
2.1
-544
90
2.5
2.0
-544
80
3.8
3.0
-544
70
4.2
3.5
-545
70
5.0
4.0
-545
70
5.6
4.5
-545
70
2.6
-0.2
0.0
2.9
-0.6
0.2
2.4
0.0
-0.2
3.8
0.2
0.0
2.9
-0.2
-0.6
2.0
0.0
-0.2
2.2
0.0
-0.2
2.3
0.0
0.0
2.4
0.0
0.0
2.4
0.0
0.0
1.4
1.6
1.7
1.5
1.2
0.2
1.8
1.3
1.3
1.1
1.9
1.4
0.0
1.7
1.3
0.1
1.8
1.3
0.6
1.9
1.3
0.7
1.9
1.3
0.9
1.9
1.4
1.1
1.9
1.5
1.6
1.9
1.5
-390
-2.2
-454
-2.5
-484
-2.6
17.3
-2.8
18.0
-2.4
18.6
-2.5
231
5.4
174
5.2
236
5.0
210
5.0
210
4.9
215
4.8
215
4.8
* % period on period at seas adj annualized rate, unless otherwise specified
Finally, exports have fallen by 10% since October of 2014 (chart opposite). Yes,
the US is a large economy but goods exports alone account for 10% of GDP so a 10
percent drop cuts GDP by a full point. It’s not chump change. Exports matter, even
to the US.
Exports and the dollar aren’t just a function of the Fed, of course. Japan and Europe
have pushed their currencies down by some 20% against the dollar since the middle
of 2014. Further weakness in either of those two economies could lead to more QE
there and further dollar strength. Beggar-the US policies in Europe and Japan may
have already had the equivalent effect of two rate hikes from the Fed. In the event,
it’s not just US weakness that could cause the Fed to stop hiking rates in mid-year.
Weakness in either Europe or Japan could lead to the same outcome.
Sources for charts and tables are CEIC Data, Bloomberg and DBS Group Research (forecasts are transformations).
123
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Japan
JP: still disappointing
• The economy barely avoided a technical recession this year. Growth remains weak
• The outlook for 2016 is only a little better, as external demand remains
subdued and fiscal policy has turned prudent
• Monetary policy is a wild card. Another round of easing could boost
sentiment and spur growth. But the impact wouldn’t last long if history
is any guide
• We expect 0.9% GDP growth in 2016, inflation at 0.6%; both below official expectations
• Policies may focus on social security and regional gap issues ahead of
upper house election next summer
Abenomics disappointed again this year. GDP contracted in 2Q before rebounding
mildly in the second half. Consumer prices stayed nearly flat through the year. For
the whole of 2015, GDP growth is estimated to be only 0.6%. Inflation is likely to
be slightly positive, at 0.3% (adjusted by the consumption tax).
In the financial markets, the yen moved sideways against the dollar, hovering in a
narrow range of 120-125 in Jan-Nov15. Bond yields remained extremely low, thanks
to the aggressive asset purchases by the Bank of Japan.
Growth remains lackluster
The economy has suffered many shocks over the past several years, including the
2008 global financial crisis, the 2011 eastern Japan earthquake, the 2012 European
debt crisis, and the consumption tax hike last year (Chart 1). Solid growth has not
returned, despite the introduction of Abenomics since 2013. One reason is that
Chart 1: External and internal shocks in recent years
% QoQ saar, % ppt
16
12
Japan
earthquake
Global
financial crisis
European
debt crisis
Japan's
tax hike
8
4
0
JAPAN
-4
-8
Net exports
Domestic demand
GDP
-12
-16
1Q08
1Q09
1Q10
1Q11
1Q12
Ma Tieying • (65) 6878 2408 • [email protected]
124
1Q13
1Q14
1Q15
Economics-Markets-Strategy
Japan
Chart 3: The government's budget expenditures
Chart 2: Production forecast & PMI
% MoM sa
8.0
Production forecast
Index, 50=neutral
60
PMI (RHS)
6.0
55
4.0
JPY trn
100
Initial budget
90
Final budget
80
70
60
50
2.0
50
40
0.0
45
-2.0
30
20
10
-4.0
Jan-12
40
Jan-13
Jan-14
Jan-15
0
FY2004
FY2007
FY2010
FY2013
global economy has remained weak. China’s slowdown, for instance, hurt exports
this year, and depressed industrial production and business investment.
Given the US Fed is about to tighten policy and Chinese authorities focus on
structural, growth will likely remain subpar next year. External demand will remain
subdued as a result. In the export-driven manufacturing sector, data results were
mixed in recent months. The private sector PMI pointed to a consistent expansion in
manufacturing activities in 4Q. But an official survey suggested that production will
rebound only temporarily in early-4Q and lose steam subsequently (Chart 2).
On the domestic front, fiscal policy has turned prudent since the consumption tax
was raised last year. Despite the talk about a supplementary budget for FY2015, we
doubt that substantial stimulus is underway. In order to avoid adding public debt
burdens, the finance ministry insists to use the leftover funds from previous years
instead of issuing new bonds. As such, the size of the supplementary budget should
be small, just about JPY 3trn. This is identical to last year’s, meaning that the yearon-year increase in government expenditures will be negligible (note: Japan has a
supplementary budget almost every year after 2008, Chart 3).
Don’t expect fresh
fiscal stimulus
Monetary policy is a wild card. The impact from last year’s easing on the financial
markets has dissipated. Bank lending growth has picked up only modestly, despite
the rise in inflation expectations and the fall in long-term interest rates (Chart 4,
next page). For the coming year, we see a 50% chance that the BOJ will ease further.
If it beats market expectations, quantitative easing could still provide short-term
impetus for the real economy through weakening the currency, lifting asset prices
and boosting sentiment. But the impact would last for just about two quarters, as
showed by the past experiences in both 2013 and 2014.
All in, we expect real GDP to grow 0.9% next year, significantly below the 2% level
that is required to meet the government’s target on nominal GDP. Downside risks
will stem from a weaker-than-expected global economy. Upside risks, on the other
hand, could come from monetary policy surprises. Risks are balanced, in our view.
Underlying inflation may come down rather than going up
Inflation may also undershoot the official target next year. It was true that the
core-core CPI (excluding fresh food and energy) has risen to about 1% in recent
months, in contrast to the fall in headline CPI dragged by energy prices (Chart 5,
next page). The BOJ argues that the rise in core-core inflation reflects a positive,
structural development – increases in long-term inflation expectations and changes
in companies’ behavior on wage/price settings.
125
Economics-Markets-Strategy
Japan
Chart 4: Bank lending growth
Chart 5: Price indicators
% YoY
% YoY (adjusted by consumption tax)
4
2.0
3
1.5
2
1.0
1
0.5
0
0.0
-1
-3
Jan-08
Headline CPI
Core CPI
Core-core CPI
-0.5
-2
Jan-10
Watch inflation
expectations, corecore CPI and wage
data
Jan-12
Jan-14
-1.0
Jan-13
Jul-13
Jan-14
Jul-14
Jan-15
Jul-15
It is unclear whether the rise in core-core CPI can really be attributed to structural
factors. The rise may simply be due to pass-through from yen depreciation, which
is temporary in nature.
If so, inflation expectations would soon fade and companies would lose the
incentives to raise wages and prices. The output gap has turned negative since
2Q15, which would be followed by a slowdown in inflation in two quarters’ time
based on historical experiences. Price expectations in the corporate sector have
begun to moderate, as revealed by the Tankan surveys. Wage growth has also
leveled off, down from the peak in mid-2015.
Further monetary easing is not off the table
Downplaying the worries about recession and deflation, the BOJ kept monetary
policy unchanged this year. But pressure will remain for the BOJ to ease in 2016,
considering the risks of a negative output gap, weakening inflation expectations,
and softness in core-core CPI and wage numbers.
To have a significant impact, the BOJ will need to surprise on the timing or the
form of any further policy easing. Given that its asset purchases are currently
concentrated on central government bonds, room will remain for the BOJ to buy
local government securities and risky assets like ETFs and REITs. In terms of the
timing of policy easing, April could be an option, as it allows the BOJ to evaluate
the results of spring wage negotiations and to pave the way for the government to
implement the second consumption tax hike.
“The third arrow”
The third arrow of Abenomics – structural reforms – remains key for Japan to end
the long economic malaise. During a recent review, the government has pledged to
speed up reforms to overcome the supply constraints, through increasing investment
on technology and human resources, boosting the birth rate and encouraging labor
participation of women and the elderly. Implementation of concrete measures
remains crucial. With the upper house election scheduled in the summer of 2016,
the short-term focus of government policies, in reality, will likely fall on improving
the social security system and reducing the regional gaps.
The conclusion of the Trans-Pacific Partnership (TPP) negotiations was a major
achievement this year. The TPP is expected to boost Japan’s exports in the longrun, and attract more FDI into its services sector. For now, it remains too early to
incorporate the TPP’s effects into our GDP growth projections, because revisions are
highly likely in the final deal and implementation could take a long time.
126
Economics-Markets-Strategy
Japan
Japan Economic Indicators
4Q15f 1Q16f 2Q16f 3Q16f 4Q16f
2014
2015f
2016f
3Q15
Real output and demand
GDP growth
Private consumption
Government consumption
Private & public investment
0
-0.9
0.1
1.4
0.6
-0.9
1.1
0.1
0.9
0.8
1.2
0.5
1.6
0.4
1.3
2.1
1.4
0.4
1.2
2.2
0.5
0.3
1.3
0.6
0.9
1.1
1.2
0.6
0.9
1.0
1.2
0.4
1.0
0.9
1.2
0.4
Net exports (JPYtrn, 05P)
Exports
Imports
9.6
8.3
7.2
12.0
3.2
0.7
13.2
3.5
2.5
3.0
3.0
1.4
2.9
1.2
1.5
3.0
0.2
0.4
3.5
5.8
3.9
3.4
4.1
2.8
3.3
4.1
2.8
External (nominal)
Merch exports (JPY trn)
- % YoY
Merch imports (JPY trn)
- % YoY
Merch trade balance (JPY trn)
73
4.8
86
5.7
-13
76
3.9
79
-7.6
-3
79
3.8
86
8.3
-7
19
3.8
20
-5.7
-1
19
-2.9
20
-9.9
-1
19
-1.1
21
0.8
-2
19
3.6
21
8.1
-1
20
5.3
22
9.9
-2
21
7.4
23
14.8
-2
Current acct balance (USD bn)
% of GDP
25
0.5
130
3.1
85
2.1
-
-
-
-
-
-
1,261
1,235
1,226
-
-
-
-
-
-
2.7
0.8
0.6
0.2
0.4
0.6
0.4
0.6
0.7
4,609
3.5
-6.9
4,135
3.3
-6.5
4,054
3.3
-6.2
3.4
-
3.3
-
3.4
-
3.3
-
3.3
-
3.3
-
Foreign reserves (USD bn)
Inflation
CPI, % YoY
Other
Nominal GDP (USD bn)
Unemployment rate (%, sa, eop)
Fiscal balance (% of GDP)
* % growth, year-on-year, unless otherwise specified
JP - nominal exchange rate
JP – policy rate
JPY per USD
%, call
0.8
130
125
0.7
120
0.6
115
0.5
110
105
0.4
100
0.3
95
0.2
90
85
0.1
80
75
Jan-07
Oct-08
Jul-10
Apr-12
Jan-14
Oct-15
0.0
Jan-07
Oct-08
Jul-10
Apr-12
Jan-14
Oct-15
127
Eurozone
Economics–Markets–Strategy
EZ: slow but steady
• Domestic demand is driving recovery in the Eurozone. GDP growth is
seen at 1.4% in 2015 and 2016
• Boost to the trade sector from a weak euro is likely to dissipate
• Base effects and a narrowing output gap will lift 2016 inflation. But it
will remain below the ECB’s 2% target
• Despite December’s measures, the ECB is not likely done easing monetary policy. The decision to keep some powder dry was prudent
The Eurozone economy is likely to head towards another year of slow but steady
growth. Domestic demand will play a bigger role in reviving growth, while external
sector faces headwinds from slowing global demand and limited euro weakness
here on.
1Q-3Q15 growth averaged 1.5% YoY, accelerating from 0.9% growth in 2014. Core
economies expanded 1.9% (QoQ, saar) in the first three quarters, with Spain as the
clear outperformer amongst the member countries (Chart 1).
We expect growth to average 1.4% this year and the next, even when the incremental
boost from low oil prices fade. Domestic demand conditions are gaining traction,
helped by the favourable tailwinds of low oil prices, easing inflation/ financial
conditions and a competitive currency (Chart 2). Household spending accounted
for two-thirds of the boost in 1Q-3Q15 as real disposable incomes got a boost from
easing inflation and wages grew modestly.
The unemployment rate meanwhile continues to drift south, but at a painstakingly
slow pace and with significant disparity between the member countries (Chart 3,
next page). Pick-up in growth has however been unable to lift job creation, thus
keeping the jobless rate in excess of 10% for nearly five years.
Chart 1: Growth momentum - core economies
Chart 2: Domestic demand pulls the recovery cart
%, qoq annualised, simple avg
5
percentage pts
2.0
3
1.0
1
-1
0.0
-3
-1.0
-5
EUROZONE
-7
GDP (GE,FR, IT,SP)
-9
-11
4 per. Mov. Avg.
(GDP (GE,FR, IT,SP))
-13
03
04
06
07
09
10
12
13
15
-2.0
-3.0
Mar-12
Mar-13
Net exports
Radhika Rao • (65) 6878 5282 • [email protected]
128
Mar-14
Domestic dd
Mar-15
GDP
Economics–Markets–Strategy
Eurozone
Chart 2: Unemployment rates differ widely amongst member countries
%, sa
28
EU
Germany
23
Italy
Greece
18
13
8
3
Jan-07
Jan-08
Jan-09
Jan-10
Jan-11
Jan-12
Jan-13
Jan-14
Jan-15
Investment demand is also expected to turn the corner though the pace of pick-up
will be lower than in previous cycles given the uncertain demand outlook, stressed
bank balance sheets and a still-weak global economy. PMI surveys also suggest that
manufacturers’ passed on lower costs with an eye on improving sales rather than
preserving margins. Encouragingly, capacity utilization continues to inch up, while
credit growth is off its trough on lower financing costs.
Fiscal adjustments are meanwhile ongoing, with the Eurozone’s general government
balances to fall within the desired -3% of GDP threshold, halving from -6.3%
average in 2009-10.
Trade sector strength to fade into next year
The external sector held its stead this year as exports benefited from resilient intraEU trade and a competitive currency. Exports grew 6.3% YoY in Jan-Aug, outpacing
imports at 2.5%. This will set the trade balance on course to register a strong EUR
250bn surplus this year, boosting the current account balance.
Boost from a cheap
currency is unlikely
to last
A repeat of this strong performance will however be a challenge. Moderation in
global trade cycles are bound to filter through to demand from the US, Asia and
intra-EU trends. Boost from a weak euro is also likely to dissipate. In Chart 3, we
compare Eurozone exports and euro’s nominal effective exchange rate trends.
Latter reflects euro’s moves vis-à-vis it trading partners.
Chart 3: Eurozone exports vs euro effective exchange rate movements
YoY
30
EUR NEER, YoY (reverse)
-15
25
-10
Weaker EUR
20
15
-5
10
0
5
5
0
-5
10
10
11
12
Exports (LHS)
13
14
EUR NEER YoY (BIS)
15
129
Eurozone
Economics–Markets–Strategy
Until 2014, export growth moved in lockstep of the currency movements. In the
past year, exports again turned north as the euro lost ground. However the scale
of turnaround this time around is restrained by weak global demand. Much has
already been discussed about slower growth in Asia particularly China, Japan and
other emerging market economies. This coupled with a gradual pick-up in growth
within the euro area, suggest that the economy’s exports are likely to improve this
year but not at the same pace as the past.
Inflation readings to rebound on base effects
With a still negative output gap and sustained disinflation in commodity prices,
the authorities rightfully remain concerned over price pressures. Headline inflation
slipped back towards the 0% mark in 4Q15 after a brief rebound in 3Q. The energy
price index has declined in past 26 out of 31 months, decelerating at a faster pace
this year. Jan-Nov energy price index declined 7.0% YoY compared to 2014’s -1.9%.
Inflation is poised
to rebound in 2016
but not deter the
ECB from sounding and acting
dovish
Impact of the collapse in commodity prices has however been partly offset by pickup in food, non-energy goods and service sector pressures. Into 2016, there will be
some reprieve on deflationary concerns.
Firstly, core inflation has stabilized around the 0.9%-1.0% mark in the December
quarter and is expected to inch higher as aggregate demand picks-up. There are
indeed signs that domestically-generated inflationary pressures are off the trough,
as seen by the GDP deflator rising in recent quarters (Chart 4).
In addition, base effects are also likely to perk next year’s inflation. From an
estimated 0% YoY this year, inflation is expected to tick up to 0.8% in 2016. 2H
inflation will hold above 1%, temporarily addressing deflation worries.
Despite the uptick, the ECB’s 2% target for inflation remains out of reach. This will
see the European Central Bank sound and act dovish in the year ahead.
It is far from (QE-) game over for the ECB …
The ECB undertook further easing measures this month. However, after weeks of
strong signals that more stimuli were in the pipeline, the actual decision fell short
of expectations. The ECB cut the deposit rate by -0.10bp to -0.30%. Existing QE
program was extended by six months to Mar17 and regional/local governments
bonds were added to the shopping list.
The biggest disappointment was over a small cut in the deposit facility rate and
no increase in the size of the QE purchases. A bigger cut in the deposit facility rate
Chart 4: Inflation and domestic price pressures
% YoY
Inflation
4.0
GDP deflator
3.5
3.0
2.5
2.0
1.5
1.0
0.5
0.0
-0.5
05
130
06
07
08
09
10
11
12
13
14
15
Economics–Markets–Strategy
Eurozone
Chart 5: US, Eurozone, Japan: central bank balance sheet
assets % of GDP
73.0
70
60
50
40
25.0
30
20
24.8
10
0
01
02
03
04 05
Japan BOJ
06
07
08
09
ECB
10
11
12
13 14
US Fed
15
would have made more bonds eligible for purchase, as yields are now bound by the
-0.3% threshold.
This measured action was likely a step to accommodate cautious members in the
Governing council and factor in stabilising growth indicators. The decision to
preserve part of the ammunition is also prudent in light of the uncertain global
developments and tepid recovery at home.
The ECB is far from
exiting QE
Looking ahead, the ECB is far from exiting QE. The need to arrest deflation from
pushing up real interest rates and to keep the euro at a competitive level remains
a priority. A deflationary environment will raise real interest rates, exacerbating
some member countries’ sizeable debt levels. Secondly, keeping the euro weak will
help to ease monetary conditions and provide a much needed boost to exports and
manufacturing activity. On nominal effective exchange rate basis, the euro is up 6%
since Mar15, when asset purchases were launched.
… but the impact will be muted
There are doubts on whether QE1 and an extension in Dec15 are sufficient to spur
growth and perk inflation [1]. Weak energy prices, subdued demand and economic
slack have kept inflation below the ECB’s 2% target for more than two years.
In addition, the limited impact of QE in the US and Japan does not set an encouraging
precedent. Since QQE2 was rolled out late last year, the Bank of Japan’s balance
sheet has ballooned beyond 70% of GDP (Chart 5). Three phases of asset purchases
took the US Fed’s balance sheet to 25% before the program ceased last year.
The ECB’s balance sheet will expand to 33% of GDP by Mar17, incorporating recent
changes. A combination of supply and demand factors has kept inflation targets out
of reach in Japan and the US, while a strong recovery proves elusive.
It is unlikely to prove any differently in the case of the Eurozone. In all, the ECB is
likely to consider further action and stay dovish despite the risk of a temporary and
shallower impact on economic conditions.
Notes
[1] DBS Group Research, Eurozone: will more QE help?, 4Nov15
131
Eurozone
Economics–Markets–Strategy
Eurozone Economic Indicators
2014
2015f
2016f
3Q15
0.9
1.0
0.6
1.2
1.4
1.5
1.1
1.5
1.4
1.0
1.1
1.3
1.6
1.4
1.1
1.5
1.4
0.9
0.9
0.9
1.3
0.4
0.4
0.2
1.5
0.5
1.1
1.1
1.4
0.9
1.0
2.1
1.6
1.3
1.9
2.1
Net exports (EUR bn)
Exports (G&S) (% YoY)
Imports (G&S) (% YoY)
402
3.9
4.2
414
4.0
4.2
430
1.1
0.3
103
3.3
3.4
108
2.9
2.5
115
2.2
0.7
115
0.6
-0.2
110
0.9
0.3
110
0.4
0.3
Contribution to GDP (pct pts)
Domestic demand
Net Exports
0.8
0.1
1.3
0.1
1.2
0.2
na
na
na
na
na
na
na
na
na
na
na
na
External accounts
Current account (EUR bn)
% of GDP
246
2.1
250
2.4
230
2.2
na
na
na
na
na
na
na
na
na
na
na
na
Inflation
HICP (harmonized, % YoY)
0.4
0.0
0.8
0.1
0.2
0.9
0.2
1.1
1.2
Other
Nominal GDP (EUR trn)
Unemployment rate (%, sa, eop)
101
11.4
104
10.8
105
10.2
na
na
na
na
na
na
na
na
na
na
na
na
Apr-12
Jan-14
Real output and demand (% YoY)
GDP growth (05P)
Private consumption
Government consumption
Gross capital formation
4Q15f 1Q16f 2Q16f 3Q16f 4Q16f
EZ - nominal exchange rate
EZ – policy rate
USD per EUR
%, refi rate
1.70
5.0
4.5
1.60
4.0
3.5
1.50
3.0
1.40
2.5
1.30
2.0
1.20
1.5
1.0
1.10
1.00
Jan-07
132
0.5
Oct-08
Jul-10
Apr-12
Jan-14
Oct-15
0.0
Jan-07
Oct-08
Jul-10
Oct-15
Economics–Markets–Strategy
December 10, 2015
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