clsa eye on asian economics

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March 2012

Eye on Asian Economies • 2Q2012

Contents

Viewpoint: Myanmar-Thai nexus - Blazing the Asean trail .................................................... 1

World view ......................................................................................................................... 27

Australia: Carry-commodity combo .................................................................................... 31

China: Property policy driven ............................................................................................. 35

Hong Kong: Inflation extreme ............................................................................................ 39

India: RBI cannot be the saviour ........................................................................................ 43

Indonesia: Indonesian star wanes ..................................................................................... 47

Korea: Official nerves ......................................................................................................... 51

Malaysia: Hey, big spender ................................................................................................. 55

Philippines: Investment boom is back ................................................................................ 59

Singapore: Down but not out .............................................................................................. 63

Taiwan: Better but still not good ........................................................................................ 67

Thailand: Regaining FDI appeal .......................................................................................... 71

Viewpoint written by Anthony Nafte

Forecasts written and prepared by Eric Fishwick, Mark Walton, Rajeev Malik and Anthony Nafte

Editing: Ines Lam and Krishna Goradia

12 March 2012


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Myanmar-Thai nexus Blazing the Asean trail

Myanmar is back on direct investors’ radar screens, portfolio investors will have to wait a few years for a viable stock exchange. A radical transition is underway both politically, from a military to civilian led government, and economically from an isolated to an open trading economy. Our recent trip to Yangon reinforced the perception that change is irreversible in Myanmar. We are under no illusion that Myanmar will transform into an Asian Tiger overnight. However, Myanmar’s political and economic liberalisation will have profound implications for Asean and the rest of Asia from the outset. Myanmar is the keystone (Figure 1) for expanding trade and investment in Asean. Thailand will be central to this momentous economic shake up in South East Asia.

Figure 1 THE KEYSTONE OF ASEAN Myanmar’s strategic geographical location

Source: MapZones.com

Myanmar’s impact on the region will be along three main lines:

Development into a regional transport hub providing an alternative shipping route from Asia to the Middle East, India and Europe, by-passing the Malacca Strait.

Development of Myanmar’s rich resources will provide a new energy and food source for Asia.

Rising incomes in Myanmar and expansion of the transportation network from Bangkok (east-west and north-south) will become a magnet for foreign direct investment (FDI) inflows to the region.

MYANMAR IS BACK WITH BIG IMPLICATIONS FOR ASIA; THAILAND WILL BE CENTRAL TO THE ASEAN SHAKE-UP


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Political reform in Myanmar will be reasonably well established once Ms Aung San Suu Kyi is given a role in government. She is expected to lead her National League for Democracy (NLD) party to a resounding win in the April 2012 by-election. This will be a watershed for Myanmar with reduced risk of a political reversal and the trigger for lifting EU and, more gradually, US sanctions. Economic growth will initially be led by increasing output in the agricultural sector, leveraging off Myanmar’s comparative advantage in arable land and agricultural resources. Gaining competitiveness in the manufacturing sector will take more time but will be facilitated by Myanmar’s low labour costs. Services targeting the untapped consumer market, notably telecommunications, financial and retail, also have potential for accelerating growth.

It will take time for Myanmar to build up the fundamental institutions for economic development. Myanmar is effectively starting from scratch, underlined by a GDP per capita (best estimates, no official data) which may be less than 10% of Thailand and less than 40% of Vietnam (Figure 2). Monetary reform and rationalisation of the exchange rate are priorities which, from our discussions with the Central Bank of Myanmar (CBM), are being urgently addressed under the guidance of the IMF.

Figure 2 LOW GDP PER CAPITA Selected indicators (2010 estimates)

GDP (USD bn) GDP per capita (USD) Arable land (hectares mn) Cambodia 11.2 795 3.9 Lao PDR 7.3 1,177 1.4 Myanmar 24.0 350 - 550 11.0 Thailand 318.8 4,728 15.3 Vietnam 103.2 1,187 6.3 Note: No official data for Myanmar GDP, numbers are best estimates. Source: World Bank, CLSA Asia-Pacific Markets

Thailand and Myanmar will benefit from a complementary relationship in trade, investment and labour flows.

There is scope for a significant expansion of bilateral trade given Thailand’s increasing demand for energy (specifically natural gas) and Myanmar’s increasing demand for manufactured goods.

Thailand already has a strong reliance on migrant labour from Myanmar. In turn, Myanmar will have increasing demand for engineers and other skilled workers from Thailand as its economy develops.

Thailand will have a key role in developing Asean’s expanding transportation network. The west-east connection will run from the planned Dawei port and industrial park in Myanmar to Bangkok and eventually to Cambodia and Vietnam. The planned north-south high speed rail connection will stretch from Yunnan province in China through Laos to Bangkok, and eventually to Malaysia and Singapore.

These mega-projects look great on paper but one needs to stop and consider: how will these projects be financed? Thailand will be spending a lot more on infrastructure development over the next few years. Realistically though, this will fall short of the funding required for the mega-projects. The key sources of financing will be China and Japan.

APRIL 2012 WILL BE A WATERSHED FOR MYANMAR

CHINA AND JAPAN WILL BE THE MAIN SOURCE FOR MEGA-PROJECT FINANCING

COMPLEMENTARY RELATIONSHIP BETWEEN MYANMAR AND THAILAND


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China has strong incentive to provide funding. It uses FDI as a way of expanding its political influence. But there are also viable economic motives. Improved connectivity between China and Asean will ensure a more secure supply of food and energy resources. The planned Dawei port will provide an alternative route for China’s oil imports from the Middle East, which strategically, will leave China less exposed to blocked passage through the Malacca Strait.

Japan’s incentive also extends beyond maintaining political influence in the region. Myanmar is seen as a new production base with the Japanese keen to diversify their supply chains following the recent natural disasters in Japan and Thailand. Japan also has a strategic interest in the planned Dawei port, which will provide a gateway to India.

Myanmar’s political transition and economic development prospects are discussed in Section 1, pp 4-9. Our conclusion is that Myanmar has the potential to become a major trade and transportation hub in South East Asia. Restructuring will take time, though. The priorities are monetary reform and establishing a credible exchange rate.

The regional implications of Myanmar’s economic restructuring are discussed in Section 2, pp 9-21. An alternative shipping route to Asia by-passing the Malacca Strait has important strategic implications for both China and Japan. Prospects for expanded Asean connectivity will attract increased FDI inflows to the region and reinforce Asean’s progress to an Asean Economic Community. Our assessment of the AEC is on p18.

Section 3 (pp 21-25) discusses how Thailand will benefit from its complementary relationship with Myanmar. Our conclusion is that Thailand will rely increasingly on Myanmar for its energy supply (natural gas) while both countries will benefit from expanding trade and an exchange of labour (with low cost Myanmar workers going to Thailand and Thai engineers going to Myanmar). The investment upswing driving Thailand’s economic rebound will be reinforced by rising FDI inflows from China and Japan.

The Myanmar-Thai nexus, strengthened by the Dawei port construction and connecting road and rail transportation network, will attract rising foreign investment flows into the region. There will be tough challenges though, for both governments. The Myanmar economy needs a complete overhaul with monetary and banking sector reform and institution building. Thailand will need to implement its own infrastructure projects efficiently (also courting Chinese and Japanese financing) if it is to get private investors on board.

In both Myanmar and Thailand, the military has been sidelined and democratic rule has taken root. There are strong domestic incentives for the Myanmar and Thai governments to succeed. These will be reinforced by external pressure. Myanmar’s government will need to make reasonable progress on economic restructuring for the economy to absorb the anticipated surge in investment capital. Thailand’s infrastructure projects will rely on financing from China and Japan, for which they

MYANMAR: POTENTIAL TRADE AND TRANSPORTATION HUB IN SOUTH EAST ASIA

JAPAN’S INCENTIVE: NEW PRODUCTION BASE AND A GATEWAY TO INDIA

BENEFITS FOR THAILAND: EXPANDING TRADE AND CHEAP LABOUR


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will demand efficient implementation by the Thai government. If both governments do deliver, along with the rewards to their own economies, it will put Asean on course for a major investment boom.

MYANMAR REFORM: NO GOING BACK Myanmar’s liberalisation effectively began with Mr. Thein Sein taking over as president in March 2011. The November 2010 ‘election’, boycotted by Ms Suu Kyi’s National League for Democracy (NLD) party, was heralded as a transition from military rule to a civilian government. Ms Suu Kyi subsequently met with Mr Thein Sein in August 2011 as the government pushed out its reform agenda with peace overtures to the separatist movements, reduced curbs on the media and the release of political prisoners.

Ms Suu Kyi, demonstrating her willingness to cooperate if the government was sincere about political and economic reform, agreed to contest the 1 April, 2012 by-election with her NLD party. This was a bold decision, having seen the landslide victory for the NLD overturned by the military in 1990 and spending 15 of the last 21 years under house arrest. Along with assurances of a free and fair election, Mr Thein Sein has released more political prisoners and brokered peace agreements with the rebel groups (the Kachins being a notable exception), in an effort to convince Western governments to lift sanctions.

We travelled to Myanmar in late February to witness the historic change embracing the country. We were not the only ones, our trip had to be pushed forward a week because all the hotels in Yangon were full and, with our Myanmar contacts in heavy demand, meetings were difficult to set up. The political and economic reform process is irreversible, this was the overriding impression from our trip. Disgruntled factions in the military, were they to challenge Mr Thein Sein’s government, would find themselves isolated.

For Myanmar to turn back from its liberalisation path would be highly improbable. To understand why, consider the factors that motivated the military-led government to change course.

Economic growth has slowed due to low investment, deficient infrastructure, undeveloped human capital (low education and skills levels) and limited technology, the result of Myanmar’s isolation.

Development programmes have been constrained by a lack of foreign capital.

China has provided capital and technical expertise for the development of Myanmar’s resources but at a cost, namely increasing dependence on China. Cancellation of the Myitsone dam project in September 2011 reflected a policy shift by Myanmar’s’ leaders to a less dependent relationship with China.

Myanmar takes over the rotational chairmanship of Asean in 2014. This would be jeopardised by a reversal of political and economic reform.

FROM A MILITARY TO CIVILIAN LED GOVERNMENT

GOVERNMENT EFFORTS TO GET SANCTIONS LIFTED

STRONG INCENTIVES FOR MYANMAR AND THAILAND TO SUCCEED

WHAT MOTIVATED THE GOVERNMENT TO CHANGE COURSE?


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Myanmar’s political transition to a full democracy will be gradual so that the military establishment is not unduly threatened. The next general election will be in 2015. Ms Suu Kyi has called for changes in the constitution which will reduce the military’s political influence (currently it has 25% guaranteed seats in parliament) and its extensive business interests. Tactful diplomacy and compromise on all sides will be required for a satisfactory outcome.

Myanmar’s economic potential will be unleashed by strong structural forces, in particular positive demographics and resources development (energy and agricultural). Its positive demographics are illustrated in Figure 3, with 65% of the population below 35 years of age and a dependency ratio below 50%.

Figure 3 MYANMAR DEMOGRAPHICS: IN THE SWEET SPOT Myanmar population 2010 Dependency ratio¹

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Note: ¹ Dependency ratio is the ratio of the dependent population (aged below 15 or above 64) to the productive population (aged from 15 to 64). Source: US Census, CLSA Asia-Pacific Markets

An abundance of young workers will not translate into rapid economic growth without rising investment to provide more jobs and on-the-job training to raise skill levels. That said, a youthful population does adapt more easily to political and economic change. Moreover, the government can redress the balance of defence spending at 21% of public expenditure and health and education spending at only 13%. (These are official figures, defence spending is believed to have been much higher). We expect Myanmar to take significant strides towards narrowing its competitiveness gap with its emerging Asean peers over the next five years.

Myanmar’s extensive energy and agricultural resources will be a magnet for foreign investment in Asia. Its energy resources, largely untapped, have been hungrily eyed by Thailand, China, India, Japan and Korea. Natural gas accounted for 38% of Myanmar’s total exports in 2011, followed by agricultural and seafood exports with an 18% share (Figure 4, left chart). Imports are dominated by machinery, electronics and transport equipment (Figure 4, right chart) which will increase as its economy expands.

GROWTH POTENTIAL UNDERLINED BY POSITIVE DEMOGRAPHICS

NATURAL GAS RESOURCES: A MAGNET FOR FOREIGN INVESTMENT


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Figure 4 MYANMAR: OPENING UP TO GLOBAL TRADE Myanmar export product breakdown Myanmar import product breakdown

Rice & maize4%

Pulses, beans & seeds12%

Rubber1%

Seafood3%

Gas38%

Wood7%

Garments5%

Others30%

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base metals 11%

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Fabrics3%

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Source: CEIC, CLSA Asia-Pacific Markets

Regional trade hub aspirations Because of US and EU imposed sanctions, Myanmar’s export revenues have been largely derived from cross-border trade (defined as the buying and selling of goods between businesses in neighbouring countries). Estimates of the shared border area between Myanmar and its five neighbouring countries, China, India, Bangladesh, Thailand and Lao PRD, are shown in Figure 5. The map on the right highlights Myanmar’s geographical advantage with the potential to develop into one of Asia’s major trading countries, strategically connected with China, India and Asean.

Figure 5 MYANMAR AND ITS NEIGHBOURS Shared border area (km) The 5 countries bordering Myanmar

China 2,227

India 1,453

Bangladesh 272

Thailand 2,099

Lao PDR 235

Source: Agribusiness and Rural Development Consultants, Myanmar

However, there is more restraining Myanmar’s trade than US and EU sanctions. Myanmar’s trade flows are miniscule in comparison to other Asian economies. Its export revenues have been estimated at an average USD7.3bn per annum over the last five years which compares with USD67.5bn for Vietnam and USD179bn for Thailand (Figure 6). Myanmar’s route to becoming a regional trade hub will be through development of its resources, the improvement in its infrastructure (construction of ports and connecting transport links) and the expansion of its consumer market as GDP per capita increases.

STRATEGICALLY BORDERING CHINA, INDIA AND ASEAN


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Figure 6 HUGE SCOPE FOR TRADE EXPANSION Annual export revenues (USD bn) in Myanmar, Thailand and Vietnam

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Source: Burma Economic Watch, CEIC, CLSA Asia-Pacific Markets

That said, US and EU sanctions have contributed to Myanmar’s stunted economic development and their removal will spur recovery efforts. It is important therefore that the US restored full diplomatic relations with Myanmar in January 2012 and announced a waiver on assessment missions and technical assistance from the multilateral institutions (IMF, World Bank and ADB). Conditions for fully lifting US sanctions include:

Release of all political prisoners and establishment of the rule of law.

Cessation of hostilities in ethnic areas with international monitoring.

Efforts towards a true political settlement with the opposition and ethnic groups; free and fair parliamentary by-elections.

Legislation protecting the universal freedoms of assembly, speech, and association; creation of a broader space for political and civic activities.

Severance of military ties with North Korea.

Top priority: monetary reform We would expect the economic transition to be relatively arduous with many obstacles to overcome. The current reality is an undeveloped agricultural and resources sector, a poorly competitive manufacturing sector, a dysfunctional financial sector and an infant services sector.

Financial sector reform is a priority. These are the key problems that need to be addressed:

The official rate of Kyat6-6.5/USD is universally ignored with the currency valued in the black market at around Kyat800/USD (Figure 7, left chart).

Monetisation of the fiscal deficit has undermined the exchange rate.

There is no monetary framework for inflation control.

DYSFUNCTIONAL FINANCIAL SECTOR

THESE ARE THE PROBLEMS


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Shortcomings in the banking sector are evident from the low share of domestic credit going to the private sector at less than 20% (Figure 7, right chart).

The agricultural sector has been starved of credit, at less than 1% of domestic credit.

Figure 7 DYSFUNCTIONAL FINANCIAL SECTOR Unofficial exchange rate (kyat/USD) Domestic credit allocation (FY 2004-08)

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Our discussions with the Central Bank of Myanmar (CBM) threw some light on the steps being taken towards monetary reform.

These are the planned solutions:

Myanmar will move to a managed float exchange rate system on 1 April 2012 with a starting exchange rate at Kyat800/USD. The IMF will provide technical assistance.

A formal interbank foreign exchange market will be established.

The CBM will adopt a ‘reserve money targeting’ monetary policy framework.

It has not been officially stated, but our impression is that the central bank will be given relative independence for monetary and inflation control preventing monetisation of the fiscal deficit.

Restrictions on current account transactions are currently being lifted and will be followed by gradual liberalisation of the capital account.

Development of the capital markets includes plans for the entry of foreign banks (which currently are only allowed representative offices). The banking sector comprises 4 state-owned banks, 19 private banks, 1 finance company and 16 foreign bank representative offices. Authorised dealer licenses were granted to 11 private banks in late 2011. The CBM is confident that, with an upgrading of management resources and information systems, the local banks will be sufficiently competitive, downplaying the need for mergers between the domestic and foreign banks. We think this is unrealistic. Greater foreign bank participation will be needed to lift performance in the financial sector if it is to keep pace with economic restructuring.

THESE ARE THE SOLUTIONS


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It will take time to re-build the institutions (legal, education etc.) which withered during the 50 years of military rule. That said, the overwhelming impression from our country visit is that economic change in Myanmar is genuine. The government intends to ease FDI regulations on private land use and repatriation of profits which will reassure potential investors. We are confident about Myanmar maturing from a stagnant to an economically viable economy which will have beneficial implications for the rest of Asia.

MYANMAR: KEYSTONE TO INVESTMENT Myanmar’s economic restructuring will have a significant impact on the region. We would stress the following major effects:

Myanmar will provide an alternative shipping route which will by-pass the Malacca Strait, thereby reducing shipping time and lowering transportation costs. This will boost regional trade and investment flows and provide added impetus to the ratification of the Asean Economic Community (see pp 18 for our assessment of the AEC).

Myanmar will be an increasingly important source of energy for the region, and for Thailand in particular. The development of Myanmar’s energy resources, along with the connecting Asean transportation network, will boost foreign investment flows into the region.

Myanmar’s attraction of FDI inflows will extend beyond the energy sector. Agriculture has strong growth prospects given Myanmar’s endowment of arable land and agricultural resources. The manufacturing sector will bring in foreign companies attracted by the low cost of labour. In the services sector, tourism has huge scope for development while telecommunications, financial and retail firms will be setting their sights on Myanmar’s untapped consumer market.

The four key projects or roles that will enhance Myanmar’s importance in the region are assessed below:

1. Dawei: Regional transport hub ‘An Industrial Project That Could Change Myanmar’

The New York Times, November 2010

Myanmar’s southern city of Dawei was designated a special economic zone in November 2010 with a 60-year concession granted to Italian-Thai Development (ITD) PCL for development of the 250 square km industrial estate. The focal point will be a deep-sea port, along with other projects including an integrated steel mill, oil and gas project, petrochemical complex and fertilizer plant. There have been environmental objections to the planned coal fired power plant but, we expect, this issue will be resolved. Financing will be the more important constraining factor.

WHAT ARE THE REGIONAL IMPLICATIONS OF MYANMAR’S ECONOMIC RESTRUCTURING?

FINANCIAL SECTOR NEEDS TO KEEP PACE WITH ECONOMIC RESTRUCTURING

DAWEI PORT: HUGELY AMBITIOUS, HUGELY IMPORTANT


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The Dawei mega-project, with cost estimates running as high as USD50bn, is a hugely ambitious undertaking. It will also be hugely important for Asean’s development. The scope of the project is immense. A 160km eight-lane highway and rail link will be constructed to connect Dawei port with the Thai border, with oil and gas pipelines laid in parallel. The road connection will be extended a further 110 km to Bangkok and will eventually connect via Sisaphon in Cambodia to Quy Nhon and Vung Tau in Vietnam. Dawei port, once fully constructed, will rival the capacity of Singapore. Its major strategic advantage though, will be the significant reduction in shipping time and costs compared to the traditional sea route through the Malacca Strait (Figure 8).

Figure 8 BY-PASSING THE MALACCA STRAIT Traditional sea routes and the Dawei alternative with proposed rail and road connections

Source: Italian-Thai Development

We have compared the travelling times to Bangkok for ships passing through the Malacca Strait and ships docking at Dawei with the cargo continuing overland to Bangkok. We estimate a reduced shipping distance of 950 nautical miles and reduced shipping time of 2.8 days (Figure 9, left chart). On this basis, we estimate the cost savings per ship at USD80,000 for ships from India, Middle East and Europe (Figure 9, right chart). Adding on trucking costs for the overland route and assuming 16,000 freight vessel visits per year (equivalent to Port Klang port in Malaysia), the annual cost savings would be over USD1bn. For 102,000 freight vessel visits per year (equivalent to Singapore port), the annual cost savings would be over USD8bn.

REDUCED SHIPPING TIME AND COST FOR SHIPS BY-PASSING THE MALACCA STRAIT


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Figure 9 DAWEI BY-PASS: SAVING TIME AND MONEY Savings in nautical miles and days Savings per ship in USD¹

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The cost savings rise substantially with rising bunker oil costs. Our sensitivity analysis is shown in Figure 10. Cost considerations in the shipping industry will be reinforced by the rising global oil price, with our forecast for Brent crude at USD140/bbl by end-2012 and at USD160/bbl at end-2013. There is no direct link between crude oil prices and bunker oil prices but industry sources estimated average bunker oil prices at around 6.3 times the Brent crude price in 2011. On our USD140/bbl oil price forecast, our base case estimate of USD80,000 savings per ship (which assumed USD705/tonne bunker oil price) would rise to USD97,500 savings per ship (assuming USD882/tonne bunker oil price).

Figure 10 GREATER COST SAVINGS AS FUEL PRICES RISE Cost savings sensitivity to varying bunker oil price (Dawei by-pass)

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Source: CLSA Asia-Pacific Markets

Along with the Dawei port connection to Bangkok, there are plans for an extended road and rail line to Cambodia and Vietnam which will form the east-west link. There is also the planned north-south high speed rail link from China, through Laos and Thailand and eventually connecting with Malaysia and Singapore. Improved connectivity will spur Asean trade, reinforced by reduced shipping costs to the Middle East and Europe. Rising intra-Asean trade will enhance its progress to an Asean Economic Community.



Given the huge potential benefits, why has the Dawei project been so slow to get off the ground? In early January, Myanmar’s government blocked construction of the planned 4,000 megawatt coal-fired power plant citing environmental concerns. This was in response to domestic lobbying against the power plant, an unanticipated consequence of Myanmar’s democratisation. This issue will likely be resolved, the latest report is that Myanmar’s government will allow coal-based power for domestic use but not for export to Thailand. There is a much broader constraint though, which is the limited capacity of Thailand and Myanmar to implement a project of such a massive scale.

Moreover, there will be financing constraints. Thailand does not have the financial means to finance this ambitious project. The swing factor will be strong financial backing from China which will be determined to establish the east-west connection to Dawei port, gateway to the Middle East and Europe, and the connecting north-south railway from Yunnan to Bangkok. China has a dual motivation, to ensure a secure supply of energy and food resources and to strengthen its political influence in the region.

Realistically, from both a financing and an implementation perspective, the Dawei project will not fly without the committed support of China and Japan. They provide financing, technical expertise and a proven capacity for implementing large projects. China has expressed strong support for the project. The construction of Dawei port will establish an alternative supply route for China’s oil imports from the Middle East and open a new and cheaper route for trade with Europe. Japan is keen on the Dawei industrial park as a possible location for a new production base and a gateway to India. On this basis Italian Thai Development PCL has expressed confidence in securing financing from the Japan Bank for International Cooperation (JBIC) and from Chinese lenders for the Dawei port, road and rail projects.

The involvement of China and Japan will make private companies more confident about investing in the project, allaying concerns about the dependability of the government guarantees provided by Dawei’s special economic zone (SEZ) status. Companies across Asia have expressed interest in investing in the Dawei project. Aside from Thailand’s Rathchaburi which has a 30% stake in the power project, China’s Guangdong Zhenrong Energy has plans to build a 100,000 bbl/day oil refinery (estimated cost USD2.5bn) and Japan’s Toyo-Engineering Toyo-Thai hopes to build a petroleum complex in Dawei.

2. New energy source for Asia Development of Myanmar’s energy resources, natural gas in particular, will provide a new source of energy for the region. The BP Statistical Review estimate for natural gas reserves at 0.3tn cubic metres is one eighth of Malaysia’s gas reserves (Figure 11). Arguably though, Myanmar’s gas reserves are much higher given the unexplored areas of its extensive coast line. The government’s estimate for natural gas reserves is 0.64tn cubic metres which would put it on a par with Vietnam.

LIMITED PROGRESS DESPITE HUGE POTENTIAL BENEFITS

PRIVATE COMPANIES WILL BE REASSURED BY CHINESE AND JAPANESE INVOLVEMENT

DAWEI WILL NOT FLY WITHOUT THE SUPPORT OF CHINA AND JAPAN

THAILAND HAS NEITHER THE FINANCING NOR THE CAPACITY TO IMPLEMENT

MYANMAR’S NATURAL GAS RESERVES ARE ONE EIGHTH OF MALAYSIA



Figure 11 MYANMAR: NATURAL GAS CONTENDER Natural gas: Proven reserves

Cubic metres tn Share of total (%) Reserves/production ratio ² Australia 2.9 1.6 58.0 Bangladesh 0.4 0.2 18.3 Brunei 0.3 0.2 24.7 China 2.8 1.5 29.0 India 1.5 0.8 28.5 Indonesia 3.1 1.6 37.4 Malaysia 2.4 1.3 36.1 Myanmar¹ 0.3 0.2 27.5 Pakistan 0.8 0.4 20.9 Thailand 0.3 0.2 8.6 Vietnam 0.6 0.3 66.0 Total Asia Pacific 16.2 8.7 32.8 Australia 2.9 1.6 58.0 Note: ¹ Myanmar claims gas reserves are almost double BP estimate at 0.6tn cubic metres. ² R/P ratio: Number of years reserves will last. Source: BP Statistical Review

Myanmar has been fast to attract overseas expertise and capital to exploit the resource. Early this year, Myanmar awarded 10 of the 18 onshore oil and gas blocks that had been offered at the August 2011 tender. Malaysia’s Petronas and Thailand’s PTT were awarded two blocks each; China’s Tianjin New Highland, Hong Kong listed EPI holding and India’s Jubilant Energy were awarded one block each; the remaining blocks were awarded to an Indonesian firm, a Swiss based firm and a Russian linked firm. Myanmar is now offering 9 offshore blocks, with the Japanese expressing strong interest in the deepwater blocks.

Figure 12 PIPELINES TO CHINA AND THAILAND Myanmar’s natural gas and oil pipelines

Source: Stratfor Global Intelligence



China has focused its efforts on Kyaukphyu port, another designated special economic zone on Myanmar’s west coast. China National Petroleum Corporation (CNPC) is laying two 800km pipelines from Kyaukphyu to Ruili in Yunnan Province (Figure 12) with construction already underway since mid-2010. There are official plans too, for a railway line to follow the pipelines. One pipeline will carry oil from the Middle East with a capacity of 440,000 bbl/day and the other pipeline will carry natural gas with a capacity of 12bn cubic metres per annum. CNPC is also building a crude receiving terminal at Kyaukphyu port.

3. Facelift for Myanmar’s ports Myanmar’s current port capacity pales in comparison with the major ports in Asia. Yangon port handles over 80% of Myanmar’s trade flows. Its capacity is 5% of Laem Chabang port in Thailand and only 4% of Tanjung Pelepas port in Malaysia (Figure 13). Aside from capacity, Myanmar would score poorly on a comparison of port efficiency in Asia.

Figure 13 MYANMAR PORTS ARE LOW CAPACITY Port container capacity in Asia’s major ports (TEU)

Ranking Port Total TEU Ranking Port Total TEU 1 Shanghai, China 31,700,000 12 Kaohsiung, Taiwan 9,636,289 2 Singapore 29,937,700 15 Tanjung Pelepas, Malaysia 7,500,000 3 Hong Kong 24,404,000 20 Laem Chabang, Thailand 5,731,063 4 Shenzhen, China 22,569,800 23 Jawaharlal Nehru, India 4,617,000 5 Busan, Korea 16,184,706 24 Tokyo, Japan 4,554,000 6 Ningbo, China 14,686,200 27 Jeddah, Saudi Arabia 4,010,448 7 Guangzhou, China 14,400,000 29 Yokohama, Japan 3,080,000 8 Qingdao, China 13,020,000 33 Tanjung Perak, Indonesia 2,643,518 9 Dubai 13,000,000 52 Bangkok, Thailand 1,305,429 11 Tianjin, China 11,500,000 na Yangon, Myanmar 302,000

Source: Containerisation Online, Myanmar Port Authority, CLSA Asia-Pacific Markets

Myanmar will look a lot different in five years’ time though, comparing more favourably with the other Asian countries. The capacity of Dawei port, once completed, will rival the capacity of Singapore. Moreover, Dawei port is not the only port undergoing development. China’s expansion of Kyaukphyu port is well underway. Sittwe port is being developed by India’s Tata Group. Currently, transportation of goods from Kolkata to Aizawl (in the northeastern state of Mizoram) follows a 2,000 km route through Bangladesh. In the future, shipping the goods from Kolkata to Sittwe port and then up the Kaldan river to Aizawl will shorten the route by 700km. Development of Sittwe will also boost exports from Myanmar (primarily agricultural goods) to Kolkata and Aizawl.

Thilawa, south of Yangon, is another port which could see rapid development over the coming years. The Japanese have expressed interest in developing Thilawa, which has also been designated a special economic zone. Considering all these port developments (Figure 14), Myanmar has the potential to emerge as a major shipping hub in Asia.

DAWEI PORT WILL RIVAL THE CAPACITY OF SINGAPORE

YANGON PORT’S CAPACITY IS ONLY 4% OF MALAYSIA

GAS PIPELINE FROM WESTERN COAST OF MYANMAR TO SOUTHERN CHINA



Figure 14 MYANMAR: ASIA’S FUTURE SHIPPING HUB? Ports of Myanmar

Source: Myanmar Port Authority, CLSA Asia-Pacific Markets

4. Magnet for foreign investment

‘As Myanmar reforms its foreign investment laws, there’ll be a wave of foreign direct investment into major sectors like banking, electricity, telecoms, internet services and hotels.’

Douglas Clayton, CEO Leopard Capital

FDI in Myanmar has been concentrated in the energy sector. However, there has been increasing interest in other sectors by foreign investors. If the April by-election is deemed to be free and fair, bringing Ms Suu Kyi and her NLD party into parliament, the expectation is that European sanctions will largely be lifted. The US will also start to lift sanctions although the process will be more drawn out due to legislative procedures. Policy reform in Myanmar will also be crucial for facilitating foreign investment and will influence how FDI is distributed among the various sectors. The experience of Vietnam and Indonesia provide some insight.

The US trade embargo on Vietnam was lifted in February 1994. Average real GDP growth rose to 8.3% between 1994 and 1998, from 6.5% in the previous 5-year period. Acceleration was fastest in manufacturing with average growth rising from 1.9% to 11.9% over the corresponding periods. There was also a spurt in construction growth from 8.1% to 11.6%. Services growth was buoyant at an average 8.1% between 1994 and 1998 while agriculture was (and has remained) the laggard with only 4.1% average growth.

LIFTING SANCTIONS IS IMPORTANT, BUT GOOD POLICY EVEN MORE SO

THE MAIN LESSON FROM VIETNAM…



Myanmar will hope to emulate Vietnam’s six-fold increase in manufacturing growth (Figure 15). It has a similar low labour cost advantage but will also require the Vietnamese work ethic and an open-door policy towards foreign manufacturing firms. A rapidly expanding manufacturing sector would provide the necessary jobs for the increasing number of young workers entering the labour force. That said, Myanmar also needs to raise productivity in agriculture as this employs 60 - 70% of the labour force. Land reform will be a challenge, complicated by forced land repossessions following cyclone Nargis in 2008.

Figure 15 MANUFACTURING LEADS IN VIETNAM Vietnam GDP: sector trends 1999 - 2011

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There are lessons too, both positive and negative, from Indonesia’s economic development. The benefit of an open-door policy that facilitates foreign investment was demonstrated by telecommunications which has been the fastest growing sector in Indonesia (Figure 16). In contrast, manufacturing growth has lagged, the result of restrictive employment policies that have deterred foreign investment. Indonesia’s labour cost advantage has been offset by restrictive labour policy, specifically the high cost of firing and arbitrary wage setting arrangements. Myanmar should follow Indonesia’s example on opening telecommunications to foreign competition and extend this to other services. On the other hand, Myanmar should avoid Indonesia’s protectionist instincts and maximise the advantage of its low labour costs in order to spur manufacturing growth.

Figure 16 TCM AND CONSTRUCTION LEAD IN INDONESIA Indonesia GDP: sector trends 2000 - 2011

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…IS THE 6 TIMES INCREASE IN MANUFACTURING GROWTH

COPY INDONESIA’S POLICY ON TCM BUT NOT ON MANUFACTURING



Myanmar’s low technological capacity and low internet penetration (Figure 17) reinforce the argument for opening its telecommunications (TCM) to foreign competition. There will be expanding demand for telecommunications services from a number of sources which include a young labour force with rising income, new business start-ups and restructuring of the financial sector. If government policy is responsive to this anticipated rise in demand, Myanmar’s TCM sector should be among the fastest growing sectors over the next few years.

Figure 17 MYANMAR NEEDS TO GET WIRED Internet and mobile cellular penetration (2010)

Per 100 people Internet users Mobile cellular subscriptions Singapore 70 144 Thailand 21 101 Malaysia 55 121 Indonesia 9 92 Vietnam 28 177 Lao PDR 7 65 Myanmar 0.2 1.2 Cambodia 1 58 Source: World Bank

‘There's the old Shway Dagon, said my companion. Confound it! But it was not a thing to be sworn at. It explained in the first place why we took Rangoon and in the second why we pushed on to see what more of rich or rare the land held. Up till that sight my uninstructed eyes could not see that the land differed much in appearance from the Sunderbuns, but the golden dome said: This is Burma, and it will be quite unlike any land you know about.’

Rudyard Kipling

Along with the financial sector and telecommunications, tourism will be another rapidly growing services sector. Myanmar is an attractive tourist destination with tremendous scope for development once the US and EU sanctions are lifted. There were only 456,000 tourist arrivals in 2011 compared to 18.8mn in Thailand and 24.7mn in Malaysia (Figure 18). Myanmar is already experiencing a surge in tourist arrivals which was evident during our recent visit. However, the supportive infrastructure is lacking. As an illustration, Malaysia has 2,515 hotels and over 174,000 hotel rooms. Myanmar has 570 hotels and fewer than 25,000 rooms. The anticipated construction boom in Myanmar has sparked the interest of Thailand’s Siam Cement Group which plans to open a USD300mn cement plant in 2013.

Figure 18 MYANMAR TOURISM SET TO TAKE OFF Tourist arrivals in Asean (2011)

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MYANMAR NEEDS TO GET WIRED

TREMENDOUS SCOPE FOR DEVELOPING THE TOURISM SECTOR



The Asean Economic Community: Herding Tigers The Asean Economic Community (AEC) was conceived at the 2003 Asean Bali Summit with clear targets and timelines adopted at the 2007 Asean Singapore Summit. Originally the AEC was to be implemented by 2020, but this was brought forward 5 years to 2015. The 2007 blueprint for the AEC comprises four key elements:

A single market and production base with a free flow of goods, services, investment and skilled labour, as well as a freer flow of capital.

Development of Asean into a competitive entity.

Equitable economic development including SME promotion and initiatives geared to help the least-developed ASEAN member states.

Global integration, with Asean participation in global supply networks.

and specific actions to achieve these goals:

Elimination of trade barriers

Creation of a single window for customs clearance

Deregulation of services trade and liberalisation of capital markets

Competition policy, consumer protection and intellectual property rights

Coordinated infrastructure development and technical co-operation

Rationalised taxation and e-commerce.

Asean’s biggest achievement has been on trade liberalisation. But while trade tariffs have been significantly reduced or eliminated, non-trade barriers still remain. The Asean-6 is meant to remove non-trade barriers this year but this looks doubtful. Disappointingly, intra-Asean trade flows have lagged Asean trade with Asia and Asean trade with the rest of the world (Figure A).

The Asean Comprehensive Investment Agreement (ACIA) concluded in 2008 grants benefits to Asean investors and Asean-based foreign investors. However the ACIA has not been implemented. Varying restrictions on market access, lack of transparency and complicated procedures are persistent factors constraining investment in the region. The more contentious issues relate to the ratification and implementation of legal treaties, where domestic legislation holds sway. FDI inflows to Asean accounted for around 10% of total FDI inflows to developing countries in 2010. The key sources of Asean FDI are shown in Figure B.

Labour issues remain problematic. Most countries have yet to adopt domestic legislation to implement the Mutual Recognition Arrangements for skilled labour. The issue of migrant labourers appears to have been shelved. Considering the extent of migrant labour inflows in Asean, neglect of this issue is a major failing of the EAC. Closer integration of migrant labourers would boost consumption and overall GDP growth in the region.

There has been progress on integration of capital markets with the creation of the ASEAN Exchanges Initiative in May 2011 for the electronic connection of regional exchange markets. There have been multiple inter-regional trade agreements including ASEAN FTAs with China, India, Japan, Korea, Australia and New Zealand.

The members have implemented 84% of the AEC measures for 2008-09 and 64% for 2010-11. Objectives for 2012-13 include extending tariff reduction to sensitive listed products and the removal of restrictions on logistical services trade. The customs ‘single window’ will be imposed across ASEAN. There will be further obligations for investment restriction reduction.

It is unlikely that the Asean Economic Community will be fully ratified by 2015. Moreover, Asean integration will be far looser than in the EU, which given the current crisis in Europe, may be a strength rather than a weakness of the AEC plan.

Figures A and B INTRA-ASEAN TRADE AND INTRA-ASEAN FDI Intra-Asean trade vs Asean trade with Asia and the ROW Source of FDI in ASEAN (2008 – 2010)

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Source: DataStream, CLSA Asia-Pacific Markets



Labour costs Myanmar’s manufacturing prospects, following in Vietnam’s footsteps, are underlined by its low cost of labour. Jetro’s survey of Japanese companies operating in Asia in 2011 showed that the lowest wages were in Myanmar. The monthly manufacturing wage was 55% of wages paid in Vietnam, 24% of Thailand and 22% of China (Figure 19). The pattern for non-manufacturing wages was similar, 50% of the wage in Vietnam, 28% of the wage in Thailand and 25% of the wage in China. However, Myanmar’s low wages are offset by limited skills. Moreover, businesses face cost pressures from power shortages and infrastructure deficiencies, while there is no clustering of supply industries to provide support. However Vietnam, facing similar circumstances, has proved that these difficulties can be overcome.

Figure 19 ASIA’S CHEAPEST SOURCE OF LABOUR Monthly wage comparison in Asia (Manufacturing and non-manufacturing)

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It could take years for Myanmar to gain export competitiveness in electronics and other manufactured goods industries. Myanmar’s comparative advantage, as well as cheap labour, stems from its generous endowment of arable land and agricultural resources. Arguably, it should focus on developing its agri-industry sector (primarily food processing). Thai President Foods, encouraged by the government’s initiative on allowing companies to rent business properties for 60 years (which can be extended), intends to open a second instant noodle factory in Myanmar this year. It has also considered setting up a biomass power plant.

Sources of FDI China and Thailand will remain the dominant sources of FDI inflows into Myanmar (Figure 20) as long as US and European companies harbour concerns over sanctions and restrictions on foreign capital flows. Sanctions have also been the reason for Japan’s limited investment but this will soon change. The Japanese have stated their keen interest to engage with Myanmar.

FOLLOWING IN VIETNAM’S FOOTSTEPS

AGRI-INDUSTRY HAS POTENTIAL AS A RAPID GROWTH SECTOR



Figure 20 MAJOR INVESTORS IN MYANMAR Source of Myanmar FDI by country (2005-2011)

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Over one third of Japan’s outbound investment in 2011 was in Asia, of which half was in Asean (Figure 21). One can reasonably expect that Japanese FDI into Myanmar will be substantial over the coming years, with the following key incentives.

Japan is interested in Myanmar as a low cost production base, reinforced by moves to establish an alternative supply base following the earthquake and tsunami in Japan and the flood in Thailand.

Myanmar will provide a gateway to India’s consumer market.

Myanmar’s power supply barely satisfies existing demand. Economic expansion will exacerbate the supply shortfall providing investment opportunities for Japanese firms.

Figure 21 JAPAN SETS ITS SIGHTS ON MYANMAR Share of Japanese outward direct investment

China33%

Hong Kong4%

Taiwan2%Korea

6%Singapore

11%

Thailand18%

Indonesia9%

Malaysia4%

Philippines3%

India5%

Vietnam5% Asia: 34% share

Asean: 17% share


The large Japanese delegation to Myanmar in early January pledged powerful public and private sector support. This included help with overhauling the power sector and providing trade insurance in order to expand trade and investment flows.

BY THE WAY, YOU OWE US USD6.4BN

INCENTIVES FOR RISING JAPANSE FDI IN MYANMAR



There is one issue that needs to be resolved though, namely Myanmar’s unpaid foreign debt. The official estimate for foreign debt is USD11bn of which USD6.4bn is owed to Japan. If Myanmar shows good faith by agreeing to resume debt repayment, it should not be an obstacle to broadening economic ties between Myanmar and Japan.

THAI-MYANMAR COMPLEMENTARITY ‘Burma is arguably the single most important country to Thailand in terms of national interest.’

Thitinan Pongsudhirak, Director of the Institute of Security and International Studies (ISIS), Chulalongkorn University

Thailand’s political relations with Myanmar have fluctuated over the years from close and friendly to distant and hostile. Thailand’s policy on Myanmar has been inconsistent, reflecting the balancing act of complying with sanctions on the one hand and pursuing trade and investment interests on the other hand. Policy has ultimately been driven by the fundamental notion which Chulalonghorn University’s ISIS has referred to as ‘not making enemies out of next-door neighbours’. Political reform in Myanmar and its closer integration with Asean will reduce the complexity of Thailand-Myanmar relations. Specifically, economics rather than politics will dominate the agenda.

Bilateral trade: scope for expansion This is good news since their economic relationship will be complementary. Thailand’s increasing demand for energy will largely be supplied by natural gas from Myanmar. In order to secure this energy supply, Thailand will make substantial investments in developing Myanmar’s energy sector. With rising income in Myanmar, there will be increasing demand for Thai exports, notably autos and other manufactured goods. The defining point of this evolving complementary relationship will be the development of a transport hub in Asean centred on Dawei Port and the connecting road and rail links through Bangkok (as discussed in Section 2, pp 9-12).

Thailand relies on natural gas for 70% of its energy demand. Myanmar supplies 25% of Thailand’s natural gas with official projections that gas imports from Myanmar will almost double over the next twenty years (from 31.1m to 56.6m cubic metre/day). Thailand’s demand for Myanmar’s gas will increase with its own declining gas reserves in the Gulf of Thailand. Myanmar has cautioned that it will curb its natural gas exports as its own demand for energy expands. Even so, Thailand is confident of a secure supply based on the estimate of 26.8 years of proven natural gas reserves in Myanmar.

Thailand has an extensive border with Myanmar estimated at 2099km. Estimates of the value of border trade between Thailand and Myanmar should be viewed with caution. Official estimates are understated due to smuggling and illegal

DON’T MAKE ENEMIES OUT OF NEXT DOOR NEIGHBOURS

THAILAND’S GAS IMPORTS FROM MYANMAR WILL ALMOST DOUBLE

MYANMAR’S EXPORTS ARE UNDERSTATED DUE TO ILLEGAL (DRUGS) TRADE



trade, notably the opium trade. Myanmar is the second biggest opium supplier after Afghanistan, producing 610 tonnes in 2011 with 256,000 households involved in poppy growing (UN estimates). Because the drugs trade is illegal, the trade that it finances is also illicit and therefore hidden from the official statistics. If households could be induced to shift from poppy growing to alternative crops, it would legalise more transactions and therefore enhance cross-border trade. Thailand’s experience is instructive. Its official ban on opium cultivation began in 1959. The initial phase was unsuccessful but improved market access, viable alternative crops, and harsh penalties resulted in an effective substitution program.

Cross-border trade between Thailand and Myanmar was estimated at USD7.3bn in 2011 (combined exports and imports). In perspective, this was 16% of Thailand’s total border trade. The bulk of Thailand’s border trade (65%) has been with Malaysia. Thailand’s trade with Malaysia at USD29.4bn was four times higher than with Myanmar. This gives an indication of the potential expansion in Thai-Myanmar trade flows with the development of Myanmar’s economy. The breakdown for Thailand’s cross-border trade is summarised in Figure 22. Thai exports to Myanmar, Cambodia and Laos were roughly the same at around USD3.4bn in 2011. However, Thailand’s trade deficit with Myanmar contrasts with its trade surplus with Cambodia and Laos, a reflection of Thailand’s large natural gas imports from Myanmar.

Figure 22 CROSS-BORDER TRADE Thailand's trade with its neighbouring countries (2011)

Thai exports to: Thai imports from:

USD bn % share of total exports

% share of border exports

USD bn % share of total exports

% share of border exports

Cambodia 3.4 1.3 13.9 0.2 0.1 1.0 Laos 3.3 1.2 13.3 1.4 0.5 6.7 Malaysia 14.7 5.4 59.2 14.8 5.4 72.9

Myanmar 3.4 1.2 13.6 3.9 1.4 19.3 Source: CEIC, CLSA Asia-Pacific Markets

Thailand’s energy imports comprised over 90% of its total imports from Myanmar, towering over the other key imports: food, wood and copper (Figure 23). Thailand’s major exports to Myanmar were machinery, refined oil, steel and autos. Myanmar’s government has been keen to boost cross-border trade, opening the Myewaddy checkpoint opposite Mae Sot district, Tak province in late 2011. There are plans to open more border checkpoints in Kanchanaburi province. Myanmar has also lifted its ban on a number of Thai food imports.

HUGE SCOPE FOR EXPANDING THAI-MYANMAR TRADE

MYANMAR IS KEEN TO BOOST CROSS-BORDER TRADE



Figure 23 NATURAL GAS DOMINATES THAI IMPORTS Thailand's key imports from Myanmar

Food2.9%

Mineral fuels94.1%

Wood1.7%

Copper0.7%

Other0.6%


Labour mobility, mutual benefits Thailand has a high reliance on migrant labourers, mostly supplied by Myanmar. There are an estimated 2 – 2.5 million Myanmar labourers working in Thailand, equivalent to 5 – 6% of the labour force. Most of them are not legally registered. Around 900,000 applied for registration in 2011 of which over 40% had not been processed by year-end. Most of the workers are from the Karen and Shan states with the delay in processing due primarily to citizen verification on the Myanmar side.

Myanmar accounted for over 60% of total migrant labourers in Thailand in 2010. Figure 24 shows the breakdown for Cambodia, Laos and Myanmar (CLM) of which Myanmar labourers comprised 87%, largely employed in the agricultural and construction sectors. Moreover, Myanmar migrants are valued most highly in Thailand, evident from an International Labour Organisation (ILO) study. Among Thailand’s migrant workers, Myanmar workers have the highest median income and highest median remittances to their home country.

Figure 24 MIGRANT WORKERS MOSTLY FROM MYANMAR Migrant workers registered in Thailand 2010

Total CLM Myanmar Lao PDR Cambodia Total 932,255 812,984 62,792 56,479 Agricultural & fisheries 367,505 329,006 14,671 23,828 Construction 163,570 142,344 7,020 14,206 Food & beverage sales 49,472 39,863 7,269 2,340 Garment manuf'g/sales 66,870 61,211 4,520 1,139 Retail & other services 128,104 110,052 11,565 6,487 Domestic workers 87,926 71,771 12,502 3,653 Other 68,808 58,737 5,245 4,826 % of CLM migrant workers 100 87 7 6 % of total migrant workers 72 63 5 4 Source: Office of Migrant Workers Administration, Thai Ministry of Labour

THAILAND’S HIGH RELIANCE ON MIGRANT LABOUR



Stepped up infastructure spending in Thailand will sustain its high demand for labour with Myanmar providing a cheap labour source. In turn, Myanmar will look to Thailand as economic development generates demand for engineers and other skilled workers. This underlines the complementary relationship between these two countries. There is good communication too, since many people in Myanmar speak and understand Thai. From a broader Asean perspective, closer integration of migrant labourers into the economy would lead to stronger consumption and overall GDP growth.

North-south rail: The China factor ‘The development of China-Thailand ties has brought pragmatic benefits to the two peoples and made important contributions to regional peace and development.’

Xi Jinping, Chinese Vice President

Mr Xi Jinping’s visit to Thailand in December 2011, the first official bilateral Chinese visit in eleven years, was significant in recognising Thailand’s central role in broadening Asean’s connectivity. The two countries signed a memorandum of understanding on promoting infrastructure and transportation projects. The high speed rail project is especially important to the Chinese for securing resources from and expanding their influence in the region. China would like to see Thailand pushing ahead with the Bangkok to Chiang Mai section of the high speed rail line for its eventual extension through Laos to Yunnan province in China. For the same reason, China has been firmly behind the Dawei deep-sea project in Myanmar.

The Chinese will support Thailand’s high speed rail development through co-investment and technology. For any mega-project, financing is a major constraint which should be facilitated by Chinese funding. During Mr Xi’s visit, an agreement was signed on a RMB70bn (USD11.1bn) swap agreement, along with a USD0.4bn special loan for flood defence initiatives. Chinese funding of the high speed rail will undoubtedly come with strings attached, the most controversial of which is China’s insistence on using Chinese workers and engineers. This is an issue which will be strongly resisted by the Thais and will need to be resolved.

The Thai government has expressed its determination to implement the high speed rail projects but has not released a definite schedule. Four specific routes have been proposed (Figure 25) at an estimated cost of THB480bn (USD15.8bn):

Bangkok to Nakhon Ratchasima (Korat) (256km).

Bangkok to Chiang Mai (745km), which the Chinese are pushing for.

Bangkok to Rayong (221km).

Bangkok to Hua Hin (225km).

FINANCING OF THE MEGA-PROJECTS REQUIRES CHINESE FUNDING

GEOPOLITICAL MOTIVATION FOR STRENGTHEING CHINESE-THAI RELATIONS

THAILAND’S HIGH SPEED RAIL PROJECTS: THE 4 ROUTES

MYANMAR WILL NEED THAI ENGINEERS AND OTHER SKILLED WORKERS



Figure 25 WELL CONNECTED, BUT WILL IT HAPPEN? Planned routes for Thailand’s high speed rail project

Source: Office of Transport and Traffic Policy and Planning

Will the Yingluck administration have the political skill to implement the high speed rail project? Not right away. The belief of Thai political commentators is that the current cabinet is too weak. However, their expectation is that the cabinet will be strengthened by the inclusion of former Thai Rak Thai politicians (from former prime minister Thaksin’s disbanded party) whose five year ban from politics will end in June 2012. The high speed rail projects will spur development in the provinces outside of Bangkok from which the government draws most of its voter support. The government will therefore be keen to push ahead with the projects with the ‘re-armed cabinet’ providing renewed impetus.

PARTNERSHIP FOR PROGRESS The Myanmar-Thai nexus, strengthened by the Dawei port construction and connecting road and rail transportation network, will attract rising foreign investment flows into the region. There will be tough challenges though, for both governments. The Myanmar economy needs a complete overhaul with monetary and banking sector reform and institution building. The government will need to make reasonable progress on economic restructuring for the economy to absorb the anticipated surge in investment capital.

The Central Bank of Myanmar recognises the scale of the problem, including the farcical exchange rate system, and is serious about finding solutions. Reassuringly, there is a sense of urgency with the CBM striving to initiate a workable exchange rate system on 1 April 2012.

THAI CABINET WILL BE STRENGTHENED IN JUNE 2012



Thailand will be at the centre of the planned Asean transportation network and is well placed to benefit from the trade expansion that this will potentially generate. The infrastructure projects, notwithstanding stepped up public spending by Thailand this year, will rely on financing from China and Japan. They will demand efficient implementation by the Thai government, which will also be necessary to get private investors on board. We have discussed the prospect of increasing Chinese investment in the Thai projects. Presently though, Japan accounts for the bulk, over 40%, of Thailand’s FDI. The intention of Japanese companies operating in Thailand is paramount to sustained FDI inflows to Thailand which have picked up over the last two years (Figure 26)

Figure 26 FDI HAS NOT ABANDONED THAILAND Thailand FDI inflows and outflows

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The feedback from Japanese investors has been positive, but conditional on greater assurance that operations will not be disrupted in future natural disasters. The result of the recent Japanese Chamber of Commerce - Jetro survey was that over 90% of Japanese investors would remain in Thailand. However, planned flood defence measures are not seen as sufficient underlining the importance of effective policy by the Thai government for a sustained uptrend in FDI.

In both Myanmar and Thailand, the military has been sidelined allowing democratic rule to take root. There are strong domestic incentives for the Myanmar and Thai governments to succeed, not least to ensure their own political survival. If both governments do deliver, along with the rewards to their own economies, it will put Asean on course for a major investment boom.

HIGH INCENTIVE FOR MYANMAR AND THAILAND TO DELIVER

JAPANESE INTENTIONS ARE PARAMOUNT FOR SUSTAINED THAI FDI

Eye on Asian Economies • 2Q2012 W O R L D V I E W


WORLD VIEW USA CLSA FORECAST CONSENSUS

2009 2010 2011 2012¹ 2013¹ 2012¹ 2013¹ Real GDP growth (3.5) 3.0 1.7 2.0 3.0 2.2 2.5

Consumer prices (average) (0.4) 1.6 3.1 2.5 3.2 2.0 2.0

Federal funds rate (% y/e) 0 - 0.25 0 - 0.25 0 - 0.25 0 - 0.25 0 - 0.25 0 - 0.25 0 - 0.25

3-month LIBOR (% y/e) 0.25 0.30 0.58 0.30 0.40 0.52 0.71

10-year Treasury Note (% y/e) 3.80 3.29 1.88 2.20 2.75 2.15 2.38

¹ CLSA forecasts, consensus forecasts and market futures implied/forward rates as at 7 March 2012. Source: IMF World Economic Outlook, DataStream, CLSA Asia-Pacific Markets

GDP growth 2011 ended strongly but we expect a 1H12 pause as equipment and software spending (accelerated to exploit last

year’s depreciation allowances) pauses and inventories (which added 1.9ppts to 4Q growth) decline. By mid year these temporary negatives will have passed. We remain optimistic that 2012 will end strongly with non-residential construction and apartment building forming a new investment cycle in 2H12 and into 2013.

Inflation We have pushed up our inflation forecast for the US in line with the stronger commodity prices that we describe on

p29. However, as during the “QE” periods there will be minimal pass through from commodity prices to wages. Core inflation measures will therefore remain subdued.

Interest rates Bernanke gave no hint that QE3 was likely in his Semi-annual Monetary Policy Report to Congress. QE3 may still be

on the table as a sterilised bond buying program however and policy remains loose in absolute terms, the January FOMC confirmed that the first Fed funds rate increase will be in 2014. This obviously provides an anchor to bond yields. Even so we would expect the curve to steepen through 2013.

EURO ZONE CLSA FORECAST CONSENSUS

2009 2010 2011 2012¹ 2013¹ 2012¹ 2013¹ Real GDP growth (3.6) 1.7 1.6 0.0 0.8 (0.3) 0.9

Consumer prices (average) 0.3 1.6 2.7 1.5 1.5 2.0 1.7

7-day repo rate (% y/e) 1.00 1.00 1.00 0.50 0.50 0.50 n.a.

3-month EURIBOR (% y/e) 0.66 0.94 1.35 0.55 0.60 0.68 0.88

10-year Bund (% y/e) 3.39 2.96 1.83 1.80 2.00 2.02 2.32


GDP growth The LTRO will, in our view, usher in a period of asset price inflation but its initial benefits to Eurozone growth

will be minimal. Banks will continue to tighten lending attitudes to the non-bank private sector (this was the last thing to improve following US QE) and austerity measures will continue to squeeze growth. We have retained a zero 2012 growth forecast. Our 2013 forecast is for growth of less than 1%.

Inflation Monetary aggregates and GDP growth will both be weak arguing for minimal inflationary pressures beyond the direct

terms of trade loss from commodity prices rising.

Interest rates The LTROs have changed the global liquidity environment dramatically and we expect risk measures in the EUR and

USD money markets to continue to decline. This is more important than policy rates, however we see no reason (other than, perhaps, the desire to keep the Bundesbank onside) why policy rates should not be reduced. We have 50bp as our forecast. The Eurozone growth outlook is weak, the yield curve can stay flat. The forecast is for German Bunds. As important we expect sovereign spreads to be significantly reduced by the LTROs.



JAPAN CLSA FORECAST CONSENSUS

2009 2010 2011 2012¹ 2013¹ 2012¹ 2013¹ Real GDP growth (5.2) 3.9 (0.5) 1.7 1.2 1.8 1.4

Core CPI (average) (1.0) (0.7) (0.3) 0.3 0.3 (0.3) 0.0

Overnight call rate (% y/e) 0.10 0.10 0.10 0.10 0.10 0.10 0.10

3-month LIBOR (% y/e) 0.28 0.19 0.33 0.30 0.20 0.33 0.35

10-year government bond (% y/e) 1.29 1.13 1.00 1.20 1.10 1.15 1.34


GDP growth Consensus growth forecasts for Japan have been coming down as end-2011 data have been disappointing. We agree

with this; though some of the drag on 4Q11 manufacturing data has eased this year (thanks to the ECB) we are wary about extrapolating the 1Q12 improvement forward. We continue to believe that 2012 will be a slow world trade growth year and that this will weigh on manufacturing exporters, Japan included.

Inflation Inflation fell deep into negative territory in 2009 and has been steadily returning to zero since then. 2012 should

see it consistently positive if our commodity price forecasts are correct. Consensus inflation forecasts for both 2012 and 2013 look too low. We expect core (ex fresh food) inflation of 0.3% in 2012 and 2013.

Interest rates Albeit due to pressure from a stronger yen, the Bank of Japan has become more aggressive in the scale of its outright

purchases of JGBs. We remain unconvinced that Shirakawa believes wholeheartedly in the policy, but clearly there is no room for rate increases given Fed policy. 10 year yields have been in a declining channel for six years. Despite the BoJ, we expect them to move to the top of this channel (around 1.2%) in 2012 on firmer growth.

CHINA CLSA FORECAST CONSENSUS

2009 2010 2011 2012¹ 2013¹ 2012¹ 2013¹ Real GDP growth 9.2 10.4 9.2 7.8 9.0 8.4 8.6

Consumer prices (average) (0.7) 3.3 5.4 3.1 4.9 3.3 3.7

1-year savings rate (% y/e) 2.25 2.75 3.50 3.50 3.50 flat flat

1-year lending rate (% y/e) 5.31 5.81 6.56 6.56 6.56 flat flat

CNY/USD (y/e) 6.83 6.61 6.32 6.31 6.10 6.31 6.34


GDP growth Trade data will improve a little (on a MoM) basis in coming months. However, the most important growth driver

is resi and infrastructure FAI and these will continue to slow. We expect YoY growth of 7.5% in 2Q12. At this point we expect government attitudes to residential property to soften and our forecast has stronger construction in the second half. Full year growth will be around 7.8%, a little down from what we thought three months ago.

Inflation With a high correlation between local and international prices the increase in our commodity price assumptions

(see below) implies higher Chinese inflation. Year on year trends will be benign until August/September but inflation will accelerate in 4Q to end the year at 4.3% YoY. Expect inflation a little over 5% in 1H13.

Currency and rates The higher inflation discussed above limits the opportunity for rate reductions, reference lending and deposit rates

will be unchanged this year. Higher rates are possible in 2013 but we prefer to think that anti-inflation policy will be restricted to slower credit and money supply growth. The yuan is now moving sideways versus the USD. This will continue this year but China is not quite at an equilibrium exchange rate, we expect small gains in 2013.



TRADE AND COMMODITIES CLSA FORECAST CONSENSUS

2009 2010 2011 2012¹ 2013¹ 2012¹ 2013¹ Oil price (Brent crude average) 62.7 80.3 111.0 124.0 150.0 118.6 113.2

Oil price (Brent crude y/e) 77.9 93.5 108.0 140.0 160.0 117.4 109.5

CRB index (y/e) 283.4 332.8 310.0 345.0 380.0 314.4 n.a.

Gold (y/e) 1,097 1,421 1,550 2,050 2,500 1,682 1,700

Global trade volume (11.0) 10.0 6.0 1.0 6.0 n.a. n.a.

¹ CLSA forecasts, consensus forecasts and market futures implied/forward rates as at 7 March 2012. Source: OECD World Economic Outlook, DataStream, CLSA Asia-Pacific Markets

Oil prices We revised our commodity price forecasts in Triple-A on 22 February to reflect the speed with which the ECB is

normalising money market conditions. In our view this is inherently inflationary of asset prices, commodities included. We expect a near term pause in oil prices as US data fall short of expectations, but the second half should see commodity price inflation resume. We expect Brent crude at USD140/bbl at end-2012.

Industrials There is little chance that China repeats the extreme investment-led and commodity-intensive policies that it

conducted in 2009. Thus, although we expect the acceleration in Chinese growth we forecast for the second half (combined with super-abundant funding liquidity) to cause industrial commodities to rise in price they will lag the increase we expect for oils and soft commodities.

Global trade World trade was contracting in 4Q11 as risk spiked in the Euro banking system. This is dissipating and trade

figures (and manufacturing PMIs) have improved. We do not expect much more of a sequential improvement. Europe is weak as is the EUR currency and this combination has resulted in weak world trade growth in the past.

EXCHANGE RATES CLSA FORECAST FORWARDS

2009 2010 2011 2012¹ 2013¹ 2012¹ 2013¹ USD/EUR (y/e) 1.44 1.34 1.29 1.10 1.10 1.32 1.32

JPY/USD (y/e) 92.0 81.1 77.0 85.0 85.0 80.5 79.6

USD/GBP (y/e) 1.62 1.56 1.55 1.30 1.30 1.57 1.56

JPY/EUR (y/e) 132.1 108.7 99.3 93.5 93.5 105.9 105.2

GBP/EUR (y/e) 0.89 0.86 0.83 0.85 0.85 0.84 0.84

¹ CLSA forecasts, consensus forecasts and market futures implied/forward rates as at 7 March 2012. Source: Bloomberg, DataStream, CLSA Asia-Pacific Markets

Euro The success of ECB policy has implications for the EUR. In the company of super-loose monetary policy in the

US, UK and Japan the EUR is not the guaranteed funding currency that the USD was. However, it is the most likely one given that the economic growth environment facing the Eurozone is more challenging than elsewhere and it is in the EUR money markets where the fall in risk resulting from the LTROs is most marked. We have reduced our end-2012 forecast to USD1.10/EUR1.

Yen The perception of a more aggressive Bank of Japan has weakened the yen. We expect this to continue but we

would caution that the moves will be gradual rather than dramatic. We expect the yen to finish the year around JPY85/USD1. This means that it will appreciate against the EUR, something to bear in mind when assessing Japanese exporters.

Sterling The Eurozone crisis suggest that sterling can outperform the EUR but not to the same extent as the US dollar.

Cable will therefore weaken. We expect USD1.30/GBP1 by year end.



ASIAN FORECAST SUMMARY REAL GDP GROWTH (%YOY) INFLATION (%YOY) (average) 2010 2011 2012 2013 (average) 2010 2011 2012 2013 Australia 2.5 2.0 3.5 4.0 Australia 2.8 3.4 2.4 3.5 China 10.4 9.2 7.8 9.0 China 3.3 5.4 3.1 4.9 Hong Kong 7.0 5.0 2.0 5.9 Hong Kong 1.9 5.7 5.3 5.9 India 8.4 6.7 6.3 7.2 India 9.6 8.7 7.8 7.0 Indonesia 6.2 6.5 6.0 7.0 Indonesia 5.1 5.3 5.3 7.4 Korea 6.2 3.6 2.8 4.2 Korea 2.9 4.0 3.1 4.2 Malaysia 7.2 5.1 4.2 4.5 Malaysia 1.7 3.2 3.4 5.4 Philippines 7.6 3.7 4.2 4.7 Philippines 3.8 4.8 3.8 5.6 Singapore 14.8 4.9 1.5 5.0 Singapore 2.8 5.3 5.5 8.0 Taiwan 10.7 4.0 2.0 4.4 Taiwan 1.0 1.4 2.3 4.5 Thailand 7.8 0.1 4.8 5.8 Thailand 3.3 3.8 3.3 4.8

CURRENT ACCOUNT BALANCE (USD BN) CURRENT ACCOUNT BALANCE (% GDP) (total) 2010 2011 2012 2013 (average) 2010 2011 2012 2013 Australia (35.3) (29.2) (10.4) 12.0 Australia (2.9) (2.0) (0.6) 0.6 China 305.4 201.1 104.1 70.8 China 5.1 2.8 1.2 0.7 Hong Kong 11.6 6.6 (2.5) (4.0) Hong Kong 5.2 2.7 (1.0) (1.4) India (45.9) (66.6) (73.1) (88.5) India (2.7) (3.7) (3.9) (4.1) Indonesia 5.1 2.1 (7.2) (11.4) Indonesia 0.7 0.2 (0.8) (1.0) Korea 29.4 26.5 23.7 8.4 Korea 2.9 2.4 2.1 0.6 Malaysia 27.3 32.0 31.6 32.3 Malaysia 11.5 11.5 10.5 9.0 Philippines 8.9 4.7 3.8 4.1 Philippines 4.5 2.1 1.6 1.5 Singapore 55.5 57.0 43.3 46.7 Singapore 24.4 21.9 16.2 15.5 Taiwan 39.9 41.3 37.1 32.7 Taiwan 8.9 8.6 7.4 5.9 Thailand 13.2 11.9 (4.5) (13.0) Thailand 4.1 3.4 (1.2) (3.1)

EXCHANGE RATES (VS USD) POLICY RATES (%) (y/e) 2010 2011 2012 2013 (y/e) 2010 2011 2012 2013 Australia1 0.99 1.01 1.10 1.15 Australia 4.75 4.25 4.25 5.00 China 6.61 6.32 6.31 6.10 China 2.75 3.50 3.50 3.50 Hong Kong 7.77 7.77 7.75 7.75 Hong Kong 0.33 0.33 0.30 0.30 India 44.65 50.00 55.00 52.00 India 6.75 8.50 8.50 8.00 Indonesia 8,991 9,068 8,900 8,650 Indonesia 6.50 6.00 6.00 6.50 Korea 1,133 1,145 1,120 1,090 Korea 2.50 3.25 3.25 3.75 Malaysia 3.08 3.18 3.07 2.96 Malaysia 2.75 3.00 3.00 3.50 Philippines 43.89 43.93 42.30 40.50 Philippines 4.00 4.50 4.00 4.00 Singapore 1.29 1.30 1.23 1.17 Singapore 0.44 0.38 0.40 0.60 Taiwan 30.37 30.29 28.50 28.00 Taiwan 1.63 1.88 1.88 2.38 Thailand 30.12 31.21 30.50 29.50 Thailand 2.00 3.25 3.00 3.50 Note: 1Rates are quoted in USD/AUD.

EoAE Forecasts 2Q12


Mark Walton [email protected]

(852) 26008739

LONG-RUN HISTORY AND FORECAST SUMMARY 2005 2006 2007 2008 2009 2010 2011 2012clsa 2013clsa

Real GDP growth 3.1 2.7 4.7 2.5 1.4 2.5 2.0 3.5 4.0 Domestic demand (contr. to growth) 4.1 3.0 6.9 3.6 (1.0) 4.0 4.5 3.8 3.8 Nominal GDP growth 7.8 7.7 9.2 9.3 1.7 8.0 6.5 7.2 8.5 Consumer prices (y/e) 2.8 3.3 3.0 3.7 2.1 2.7 3.1 2.9 3.4 Cash target rate (% y/e) 5.50 6.25 6.75 4.25 3.75 4.75 4.25 4.25 5.00 USD/AUD (y/e) 0.74 0.79 0.87 0.67 0.90 0.99 1.01 1.10 1.15 Money supply M1 (y/e) 7.1 12.6 12.9 3.8 2.7 5.9 7.0 7.7 6.1 Current account balance (USD bn) (41.6) (41.4) (59.1) (46.9) (43.7) (35.3) (29.2) (10.4) 12.0 - as a % of nominal GDP (5.7) (5.3) (6.2) (4.5) (4.4) (2.9) (2.0) (0.6) 0.6 General government deficit (% GDP) (1.3) (1.7) (1.6) (1.8) 2.3 4.2 3.1 1.6 0.8

Note: % YoY rates unless otherwise stated.

Source: ABS, RBA, OECD, DataStream

.

Carry-commodity combo Carry trade and mining boom a powerful currency combo.

AUD to USD1.15 in 2013.

Commodity price inflation and sustained strength in export volumes will see the current account reach balance.

We have removed all rate cuts from our forecasts. Higher inflation will prompt 75bp of rate increases in 2013.

Carry trade darling The ‘lucky country’ is the standout amongst its Western peers; growth is stable and close to trend, inflation is benign and interest rates are near long-term averages. The terms of trade are easing but remain close to peak levels and income growth, both national and household, is very good. Balance sheets are in generally good health and the fiscal position is relatively sound.

This laundry list of macro-economic positives is well-understood. But these points of differentiation are key drivers of investor flows, and their impact is amplified during periods of heightened global liquidity. Growth differentials between Australia and the US will narrow late in 2012 given a forecast rapid expansion in the US economy (see the World View section on pp27-30) but the macro advantage will remain firmly in Australia’s favour.

Most importantly, interest rate differentials will be consistently AUD-supportive. We discuss the outlook below but in summary we expect the RBA to keep rates unchanged during 2012, before tightening in 2013. Throughout this entire period, the US Fed has committed to holding its policy rate at effectively zero. The ECB and BoJ are less explicit but there is also no reason to believe that policy rates in either Europe or Japan will be increased anytime over our forecast horizon. And all three of the major central banks are engaged in quantitative easing. This has all the hallmarks of the mother of all currency carry trades. Crucially, the strong Australian macro picture painted above suggests that the risk on such a trade is very low.

Eye on Asian Economies • 2Q2012 A U S T R A L I A


GDP GROWTH FORECASTS

Government (FY) Updated: Feb 2012: 3.5

Consensus Updated: Mar 2012: 3.3

CLSA 2012: 3.5

THE CLSA DIFFERENCE

GDP growth Mining will dominate growth but a strong currency

should see non-tradable services pick up.

Inflation Will trough at mid-2012 before heading through the

RBA’s 3% upper target near year end.

Interest rates & exchange rate Meaning the RBA will be in tightening mode again in

2013. All signals point to a stronger AUD.

Plus the commodity effect The desire to hold AUD to gain significant carry is in addition to the strong ‘real’ demand arising from a ramp up in export receipts. The benefits of the mining boom, which we first laid out in the 1Q11 Eye on Asian Economies: Sharing the lode, are being realised. Mining export volumes are expanding rapidly, partly as coal production rebuilds after flooding in 2011, but more fundamentally as increases in mineral capacity come on line. The sector continues to grow at a rapid pace; mining capex in the first half of the year ending June 2012 was already above 80% of 2010/11 capex (which in turn was up 34% on 2009/10). Surveyed intentions are for capex to double in 2011/12 over 2010/11.

This implies mineral output (and exports) will continue to grow rapidly, provided the demand is there. We think it will be. Chinese growth will slow in 2012 (see p37) and become less commodity-intensive but incremental commodity demand will still lift.

Our bullish view on commodity prices also has clear implications for Australian export prices. As a broad gauge, we expect the CRB commodity index to lift by over 10% YoY in each of 2012 and 2013. This compares to our previous forecast in which we expected no commodity price inflation, at least in 2012.

This means that growth in nominal Australian exports will be very strong over the next two years. We expect around 24% in 2012 and 17% in 2013 (2011 growth was 28%), with roughly equal contributions coming from volumes and prices. The trade balance will balloon and the current account will move into surplus in 2013.

USD/AUD: next stop 1.10, then 1.15 The perhaps obvious conclusion is that we have revised our currency expectations higher. After a pull-back in USD/AUD to around parity in 2Q12 (in line with a patch of soft US growth and a hiatus in commodity price gains), we target USD1.10/AUD by end 2012 and USD1.15/AUD by mid-2013.



AUSTRALIA BY NUMBERS

2009 2010 2011 2012clsa 2013clsa Breakdown of real GDP

Private consumption 1.0 2.9 3.4 2.6 3.2 Public consumption 0.7 3.4 1.8 1.5 2.7 GFCF (3.1) 5.0 6.9 7.4 4.8 Domestic demand (contr. to growth) (1.0) 4.0 4.5 3.8 3.8 Exports, goods & services 2.1 5.8 (1.6) 8.6 9.4 Imports, goods & services (8.6) 14.1 11.6 7.8 7.2 Real GDP growth 1.4 2.5 2.0 3.5 4.0 Prices Consumer prices (y/e) 2.1 2.7 3.1 2.9 3.4 Consumer prices (average) 1.8 2.8 3.4 2.4 3.5 Producer prices (y/e) (1.5) 2.7 2.9 3.5 3.9 Currency & interest rates USD/AUD (y/e) 0.90 0.99 1.01 1.10 1.15 USD/AUD (average) 0.78 0.91 1.02 1.04 1.14 Cash target rate (% y/e) 3.75 4.75 4.25 4.25 5.00 Lending rate - big corporates (% y/e) 6.00 6.70 6.50 6.70 7.65 External sector Exports (USD, % YoY) (18.5) 38.1 27.5 21.5 19.9 Imports (USD, % YoY) (18.0) 23.2 24.2 15.5 15.4 Trade balance (USD bn) (4.4) 17.6 28.8 49.6 72.0 Current account balance (USD bn) (43.7) (35.3) (29.2) (10.4) 12.0 - as a % of nominal GDP (4.4) (2.9) (2.0) (0.6) 0.6 FDI (USD bn) 11.4 6.2 36.0 13.0 10.0 CA + net FDI (% GDP) (3.3) (2.4) 0.5 0.2 1.2 External debt (total, USD bn) 594.7 643.8 744.1 850.0 900.0 Debt service ratio (% exports) 6.4 12.3 9.3 9.5 8.8 International reserves (USD bn, y/e) 33.2 32.0 35.9 38.0 42.0 Money supply Money supply M1 (y/e) 2.7 5.9 7.0 7.7 6.1 Money supply M3 (y/e) 5.3 9.0 8.3 8.2 7.2 Private sector credit (y/e) 0.9 3.0 3.6 7.0 8.2 Private sector credit (% GDP) 153.2 146.0 142.0 141.7 141.3 Government sector General gov’t deficit (% GDP) 2.3 4.2 3.1 1.6 0.8 General gov’t debt (% GDP, y/e) 19.4 23.6 26.8 27.9 27.9 Nominal GDP Nominal GDP (USD bn) 983.4 1,236.2 1,477.1 1,610.3 1,906.1 Nominal GDP per capita (USD) 44,799 55,435 64,940 69,406 80,547 Nominal GDP (AUD bn) 1,253.4 1,354.3 1,442.3 1,546.2 1,677.6 Nominal GDP (AUD, % YoY) 1.7 8.0 6.5 7.2 8.5 Other data Industrial production (1.7) 4.6 (0.1) 2.7 1.8 Retail sales 5.9 2.5 2.4 2.4 3.2 Unemployment (% y/e) 5.6 5.1 5.2 5.5 5.1 Population (millions) 22.0 22.3 22.7 23.2 23.7

Note: % YoY rates unless otherwise stated. Fiscal deficit estimates are for the fiscal year ending in June eg, 2010/11 is under 2011. Source: ABS, RBA, OECD, DataStream

There are signs the housing market is stabilising and private sector borrowing is trending higher, albeit modestly.

Tracking around trend. Overseas travel likely to remain a growth industry with AUD high.

The surge in actual mining capex is only being eclipsed by the lift in investment expectations.

Inflation will be firmly on the RBA’s radar by the end of this year.

Weak employment growth means unemployment rate will end 2012 higher. But leading indices for a 2013 improvement are appearing.

Sustained volume and price growth will eliminate the current account deficit.

The RBA will be sounding more hawkish at end-12 with higher rates to come in 2013.

Local spending growth still below trend but should pick up in 2013 as income growth re-accelerates.

Excess global liquidity, positive carry and robust export receipts all point to a stronger Aussie.



CURRENCY FORECAST

Period-end Annual Coming 12 months by quarter 2009 2010 2011 2012clsa 2013clsa 2Q12clsa 3Q12clsa 4Q12clsa 1Q13clsa USD/AUD 0.90 0.99 1.01 1.10 1.15 1.00 1.05 1.10 1.12

JPY 100/AUD 82.8 80.3 77.8 93.5 97.8 82.0 88.2 93.5 95.2

GBP/AUD 0.56 0.63 0.65 0.85 0.88 0.67 0.75 0.85 0.86

EUR/AUD 0.63 0.74 0.78 1.00 1.05 0.80 0.90 1.00 1.02 Memo: USD/EUR 1.44 1.34 1.29 1.10 1.10 1.25 1.17 1.10 1.10

Memo: JPY/USD 92.0 81.1 77.0 85.0 85.0 82.0 84.0 85.0 85.0

EXPORTS & IMPORTS

6

8

10

12

14

16

18

20

22

24

26

05 06 07 08 09 10 11 12

(US$bn)

Exports

Imports

smoothed data are HP filters

AUD NEER & REER

70

75

80

85

90

95

100

105

110

115

05 06 07 08 09 10 11 12

(2010 = 100)NEERREER

MONEY SUPPLY AND CREDIT

-15

-10

-5

0

5

10

15

20

25

30

07 08 09 10 11M1 Broad money Total credit

(sa 3mma, %QoQ annualised)

RBA to return to tightening mode The other implication of rising international commodity prices is that domestic inflation will once again be an issue for the RBA to contend with. We expect inflation to be close to the top of its 2-3% YoY target band by end-2012. This is in line with the RBA’s forecast. Thereafter our views diverge; the central bank expects inflation to move back to the mid-point of the target band by end-2013, we think it will remain well above 3% YoY.

That will prompt a reaction from the central bank. We expect 75bp of rate increases in 2013 (after zero change in the policy rate in 2012), but the tone will shift earlier; the RBA will be raising the prospect of higher rates before the end of this year. Given our carry trade argument above any signal from the RBA that it may be contemplating increasing interest rates should be interpreted as AUD-positive.

But downside risks in the short-term We continue to harbour reservations about the strength of the domestic economy over coming quarters. Growth outside of primary production is well below trend and, as a consequence, the labour market has stagnated; employment growth in the year to February was around zero. Despite this, the unemployment rate has held steady at around 5.2%, thanks to declining participation. But with the participation rate now at its lowest since mid-2007, we suspect this downtrend is near its end.

On balance this means we still expect unemployment to lift but we have scaled back our end-12 forecast to 5.5% from the 6% we forecast previously, with a recent upturn in job advertisements suggesting that employment growth could improve in coming months. The labour market will be closely eyed by the RBA but, given our modest forecast increase in the unemployment rate, we think the risk of a rate cut is low. Certainly, the window of opportunity if the RBA is to ease is brief. As we note above, by 2H12 domestic inflation will be increasing (the RBA expects as much) and international commodity prices will be considerably higher. Practically, the RBA has only a 3-4 month period in which it might realistically be expected to cut rates.

EoAE Forecasts 2Q12


Eric Fishwick [email protected]

(852) 26008033


Real GDP growth 11.3 12.7 14.2 9.6 9.2 10.4 9.2 7.8 9.0 Domestic demand (contr. to growth) 8.7 10.7 11.7 8.8 12.8 9.5 9.8 8.6 9.6 Nominal GDP growth 15.7 17.0 22.9 18.1 8.6 17.8 17.4 12.8 17.4 Consumer prices (y/e) 1.6 2.8 6.5 1.2 1.9 4.6 4.1 4.3 4.3 1-year savings rate (% y/e) 2.25 2.52 4.14 2.25 2.25 2.75 3.50 3.50 3.50 CNY/USD (y/e) 8.08 7.82 7.37 6.83 6.83 6.61 6.32 6.31 6.10 Money supply M1 (y/e) 11.8 17.5 21.0 9.1 32.4 21.2 7.9 12.9 17.4 Current account balance (USD bn) 134.1 232.7 354.0 412.4 261.1 305.4 201.1 104.1 70.8 - as a % of nominal GDP 5.9 8.6 10.1 9.1 5.2 5.1 2.8 1.2 0.7 Public sector deficit (% GDP) 1.2 1.0 (0.2) 0.8 2.8 1.6 1.1 2.0 1.6


Source: IMF, World Bank, China Economic News, CEIC

Property policy driven FAI is slowing due to construction spending slowing.

Policy will be reversed gradually.

Inflation will be back before year end. Markets will worry. Stronger exports, but… In common with most Asian economies China’s exports weakened in 4Q11. As is usual in periods of trade stress China outperformed, export growth slowed but did not turn negative. Manufacturing PMI data (one of the few Chinese statistics that “out the box” measures MoM change) fell, but only to just below 50. Monthly trade and manufacturing trends began to improve in December and the manufacturing PMI moved back above 50. But, just as the 4Q dip was modest so the rebound has been anaemic. The NBS manufacturing PMI in February was up 0.5pts from January, poor given the early Chinese New Year holiday. Chinese New Year makes interpretation of early 2012 statistics difficult but anecdotal evidence suggests that activity remains soft and that sequential growth is still slowing.

Investment more than exports This represents the balance between domestic and international pressures. In 2010 26% of China’s GDP was exported. This number had been 35% three years earlier. In contrast, gross fixed capital formation (GFCF) in 2010 was 46% of GDP (39% in 2007). And China’s investment cycle is slowing.

Intra-year data for GFCF, the national accounts measure of investment, are not available. In aggregate capital formation provided 5ppts of the 9.2% 2011 GDP growth but monthly fixed asset investment growth suggests that this conceals a first half-second half split with the second significantly slower. In the three months to December nominal FAI growth was 21.3% compared with average FAI growth of 25.5% in the first half.

Policy influenced, with no rush for reversal With GFCF nearly half of GDP this deceleration represents a substantial drag. It is ongoing. Positively, the composition of FAI reveals that it is government influenced sectors that are responsible for the majority of the

Eye on Asian Economies • 2Q2012 C H I N A



Government Updated: Mar 2012: 7.5


CLSA 2012: 7.8

THE CLSA DIFFERENCE

GDP growth The government is prepared to accept slower growth than

the market presently gives it credit for.

Inflation Back before the end of this year.

Interest rates & exchange rate NDFs are flat for the next 12 months; we agree.

slowdown. Negatively (at least as far as GDP growth), there is little indication that government policy in respect of key sectors is about to reverse.

The first key sector is infrastructure. China has been very explicit about the undesirability of overinvestment in infrastructure. We see no chance of a repeat of the local authority implemented surge in infrastructure spending that formed the core of the 2009 stimulus. On the contrary, current policy appears focussed on minimising local authority related risk.

The second key sector is residential real estate. This is now the single biggest drag on FAI/GFCF growth. Weak resi construction is the consequence of the government’s aggressive controls on property speculation, aimed at making property more affordable, combined with monetary tightening that has become more effective as it has targeted off quota as well as on quota lending. We calculate that the deceleration in resi construction in 4Q11 slowed YoY GDP growth by a little less than 1ppt compared with 3Q.

This is a harder brake on growth than the “hard landing” in Chinese property in 2008. Continued (plus the lacklustre export growth that is our central case), it implies YoY GDP growth of 8.3% in 1Q and 7.5% in 2Q. Without an acceleration in growth on a QoQ basis 3Q growth would drop below 7% YoY. Wen has indicated that he expects GDP growth of 7.5%. This suggests increased tolerance of volatility. However, we do not believe that a protracted period of sub-7% growth is compatible with it. Our forecast assumes that resi construction slows during 1H12 but that a 2Q12 a shift in government attitudes towards property purchase combined with increased social housing starts (7mn targeted 2012) allow FAI growth to accelerate again in 2H12. Our full year growth forecast is 7.8%. We expect 9% growth for 2013.

Inflation and credit The main “easing” in this forecast is a shift in central government attitudes towards price increases in residential property. It will have to



CHINA BY NUMBERS


Private consumption 8.9 5.9 8.8 8.5 8.8

Public consumption 8.8 12.9 13.0 13.0 13.0

GFCF 23.2 11.9 10.0 8.5 10.0

Domestic demand (contr. to growth) 12.8 9.5 9.8 8.6 9.6

Exports, goods & services (10.3) 29.5 9.7 4.0 10.0

Imports, goods & services 3.3 24.4 10.0 6.0 11.0

Real GDP growth 9.2 10.4 9.2 7.8 9.0 Prices Consumer prices (y/e) 1.9 4.6 4.1 4.3 4.3

Consumer prices (average) (0.7) 3.3 5.4 3.1 4.9

Producer prices (y/e) 1.7 5.9 1.7 6.0 4.0

Currency & interest rates CNY/USD (y/e) 6.83 6.61 6.32 6.31 6.10

CNY/USD (average) 6.83 6.77 6.46 6.31 6.21

1-year savings rate (% y/e) 2.25 2.75 3.50 3.50 3.50

1-year lending rate (% y/e) 5.31 5.81 6.56 6.56 6.56

External sector Exports (USD, %YoY) (16.1) 31.4 20.4 5.0 15.5

Imports (USD, %YoY) (11.1) 39.1 25.1 11.4 16.6

Trade balance (USD bn) 249.5 254.2 243.8 150.2 154.1

Current account balance (USD bn) 261.1 305.4 201.1 104.1 70.8

- as a % of nominal GDP 5.2 5.1 2.8 1.2 0.7

FDI (USD bn) 70.3 124.9 95.0 90.0 90.0

CA + net FDI (% GDP) 6.6 7.3 4.1 2.3 1.6

External debt (total, USD bn) 428.6 548.9 n.a. n.a. n.a.

Debt service ratio (% exports) 2.9 n.a. n.a. n.a. n.a.

International reserves (USD bn, y/e)1 2,399.2 2,847.3 3,181.1 3,395.2 3,556.1

Money supply Money supply M1 (y/e) 32.4 21.2 7.9 12.9 17.4

Money supply M2 (y/e) 27.7 19.7 12.4 13.1 16.7

Financial institutions loans (y/e) 31.7 19.9 15.0 14.6 15.4

Financial institutions loans (% GDP) 117.2 119.3 116.2 118.0 116.0

Government sector General government deficit (% GDP) 2.8 1.6 1.1 2.0 1.6

Nominal GDP Nominal GDP (USD bn) 4,990.7 5,931.7 7,296.4 8,433.1 10,064.9

Nominal GDP per capita (USD) 3,739 4,424 5,415 6,229 7,399

Nominal GDP (CNY bn) 34,090 40,151 47,156 53,213 62,453

Nominal GDP (CNY, %YoY) 8.6 17.8 17.4 12.8 17.4

Other data

Industrial production 11.0 15.7 13.9 12.3 14.0

Retail sales 15.5 18.4 17.1 15.6 16.7

Unemployment (% y/e) 4.3 4.1 4.1 n.a. n.a.

Population (millions) 1,335 1,341 1,347 1,354 1,360

Note: % YoY rates unless otherwise stated. 1PBoC foreign exchange balances. Source: IMF, World Bank, China Economic News, CEIC

In consequence we no longer expect rates to be cut.

FAI profile sets direction of growth in our forecast. FAI ended 2011 weak, will slow further in 1H and pick up in 2H12.

PCE volume growth to be a little slower in 2012 than 2013; pickup in nominal retail sales growth in 2013 is an inflation effect.

Terms of trade losses accelerate demise of current a/c surplus.

Export environment better than we thought 3 months ago but this is still a soft trade profile.

Shadows commodity price profile, so CPI rises in 4Q12 and peaks (YoY) in 2Q13.

We’ve cut the amount of monetary growth partially in response to higher inflation. Note that assessed relative to nominal GDP growth 2013 will be a tighter year than 2012.

We have 3 quarters in which growth is below 8%. Reflects increased acceptance of economic volatility by government.

But FDI is large and rising risk appetite in 2012 will support FX reserve growth.



CURRENCY FORECAST

Period-end Annual Coming 12 months by quarter 2009 2010 2011 2012clsa 2013clsa 2Q12clsa 3Q12clsa 4Q12clsa 1Q13clsa CNY/USD 6.83 6.61 6.32 6.31 6.10 6.31 6.31 6.31 6.28

CNY/JPY 100 7.42 8.15 8.21 7.42 7.18 7.70 7.51 7.42 7.39

CNY/GBP 11.06 10.31 9.80 8.20 7.93 9.47 8.83 8.20 8.16

CNY/EUR 9.81 8.86 8.15 6.94 6.71 7.89 7.38 6.94 6.91 Memo: USD/EUR 1.44 1.34 1.29 1.10 1.10 1.25 1.17 1.10 1.10

Memo: JPY/USD 92.0 81.1 77.0 85.0 85.0 82.0 84.0 85.0 85.0

EXPORTS & IMPORTS

40

60

80

100

120

140

160

180

05 06 07 08 09 10 11 12

(US$bn)

Exports

Imports


RMB NEER & REER

80

85

90

95

100

105

110

05 06 07 08 09 10 11 12

(2010 = 100)

NEER

REER

MONETARY CONDITIONS INDEX

-6

-4

-2

0

2

4

6

05 06 07 08 09 10 11 12

(ppts YoY)

Interest rates TWI MCI

be backed up with a loosening of lending guidelines. However, the aggressive CNY10tn increase in loan quota that we forecast one quarter ago will not happen. We now pencil in CNY8.5tn for this year.

Two things have changed. First, corporate bond issuance is likely to increase. Bonds count in total social financing but not yuan lending. However, they both finance investment and fund deposit growth.

Second, the inflationary environment has become more complicated than we assumed in the 1Q12 Eye on Asian Economies. As we argued in Triple-A on 22 February (…Draghi’s boot), the LTROs raise the likelihood of commodity price inflation. Our Asian forecasts now assume Brent crude at USD140/bbl by end-2012 and parallel (if slightly slower) rises in industrial commodities and foods (see p29).

Near-term trends are good. Inflation is falling and will do so for another six months. It might get as low as 2% in summer. However, the commodity price profile we discuss above means that this will be the low point of the inflation cycle. Inflation will rise in the final quarter of this year before stabilising in a 5-5½% range in spring 2013.

For a rapid growth country this is still a decent performance. However, it will be enough to worry financial markets that, as soon as GDP growth has been stabilised, Beijing’s attention will turn back towards inflation control. Our forecast mirrors these concerns. We do not expect rates to be cut at all in the coming 18 months and our money supply and credit forecasts for 2013 are less generous than for this year when nominal GDP growth is taken into account.

BoP back to surplus and monetised China releases FX reserve data quarterly. However, partial information and comments from the central bank leave no doubt that the balance of payments has returned to surplus. The surplus is being monetised: the CNY is moving sideways versus the USD. We expect this to continue albeit with more volatility than during 2009 and 1H10. USD strength versus the EUR means the trade-weighted CNY will appreciate but the depreciation of the CNY versus the USD needed to negate this is not realistic given the politicised nature of the CNY-USD exchange rate.

EoAE Forecasts 2Q12



(852) 26008739


Real GDP growth 7.1 7.0 6.4 2.3 (2.6) 7.0 5.0 2.0 5.9 Domestic demand (contr. to growth) 1.4 5.3 7.1 1.4 0.7 6.9 5.7 3.7 4.2 Nominal GDP growth 7.0 6.7 9.5 3.8 (3.2) 7.3 8.7 5.3 11.1 Consumer prices (y/e) 1.3 2.3 3.8 4.6 0.3 2.7 6.4 5.2 5.8 3-month HIBOR (% y/e) 4.16 3.84 3.31 0.89 0.13 0.33 0.33 0.30 0.30 HKD/USD (y/e) 7.75 7.77 7.80 7.75 7.76 7.77 7.77 7.75 7.75 Money supply M1 (y/e) (10.3) 13.1 25.4 4.7 39.6 12.8 10.8 9.8 15.3 Current account balance (USD bn) 6.0 7.3 9.8 10.6 11.4 11.6 6.6 (2.5) (4.0) - as a % of nominal GDP 3.4 3.9 4.7 4.9 5.4 5.2 2.7 (1.0) (1.4) Public sector deficit (% GDP)¹ (1.1) (3.9) (7.5) (0.1) (1.6) (4.2) 0.5 (0.8) (0.7)

Note: % YoY rates unless otherwise stated. ¹ Fiscal year starting April.

Source: CEIC, CLSA estimates, HK government

Inflation extreme Hong Kong has weathered the trade slowdown relatively

well. 2012 growth is upgraded though still modest.

Discretionary retail is slowing faster than many appreciate but, as a liquidity trade, will rebound in coming months.

Already very high, inflation will be a major problem in 2013. The government will implement relief measures.

Surprisingly resilient Hong Kong’s economic performance was better than might have been expected at the end of last year, given its entrepot role and the sharp slowing in broader Asian trade volumes. 4Q GDP increased 0.3% QoQ seasonally adjusted, with real exports increasing 1.3% QoQ. These figures are far from stellar but they represent an improvement from 3Q11 when GDP growth was just 0.1% QoQ (and exports up 0.5% QoQ).

Domestic demand trends are weakening but remain relatively robust. Private consumption increased 1.1% QoQ, just below its long-run average growth rate. Capital formation also expanded to be up 8.8% YoY, somewhat surprising given a generally soft export backdrop.

In last quarter’s Eye on Asian Economies we predicted that the Hong Kong economy would weaken over the next two quarters. We still hold that view, expecting slower US growth in 1H12 to act as a drag on Asian trade, but have moderated it slightly. Industrial activity and exports across Asia have rebounded healthily from the end of 2011, more quickly than we thought, thanks to steps to soothe European financial markets by the ECB. Accordingly, we have lifted our 2012 growth forecast to 2.0% (from 1.3% previously), consistent with our upgrades made in this publication for Asian economies overall.

Retail softening temporary Chinese New Year usually provides a boost to Hong Kong retail sales; specifically, spending in the week prior to the holiday surges. Only twice in

Eye on Asian Economies • 2Q2012 H O N G K O N G



Government

Updated: Mar 2012: 1-3


CLSA 2012: 2.0

THE CLSA DIFFERENCE

GDP growth

The rebound in Asian trade year-to-date is a plus but a US softening will be a drag in 1H. 2012 growth will be weak.

Inflation Commodities and housing will ensure inflation remains

elevated in 2012 and reaches 6% in 2013.

Interest rates & exchange rate Market rates have already eased. A super-liquid monetary

environment points to aggressive lending.

the past twelve years have sales fallen in a CNY month, and then only because the holiday occurred right at the beginning of the month (so the spending spree occurred in the month prior).

January’s retail sales should thus have been strong. They were not; the value of sales declined 0.9% MoM seasonally adjusted (from +2.0% MoM sa in December) and volumes were down 1.5% MoM sa (from +1.7% MoM sa in December). Discretionary components were amongst the weakest, with durables, department stores and jewellery/watches registering month-on-month declines.

Despite month-on-month declines in January, discretionary spending trends are generally still holding up well. The notable exception is spending on jewellery/watches which slowed sharply during 2H11 and is now little better than flat. We think this slowdown is likely to be temporary. Hong Kong’s retail sector – and its luxury component in particular – thrives on liquidity. Pressure on the HKD to appreciate will be countered by the HKMA via expansion of the aggregate balance, increasing the quantum of loanable funds. Hong Kong retail interest rates will be pushed lower. And while monetary easing in China is likely to be modest relative to that seen in during the previous cycle, it will nonetheless be a positive influence. Notably there has been very little slowdown in the number of tourist arrivals from mainland China, accelerating in recent months to an annualised pace of around 15%. The return of problematic inflation In our view Hong Kong’s biggest challenge over the next year or so will be inflation. Our bullish commodity price view (summarised in the World View section on pp27-30) translates as higher inflation for Hong Kong as it does for the rest of Asia. An additional complication in Hong Kong’s case is that the domestic inflationary starting point for a bout of global commodity price inflation is very high. Unlike the experience of



HONG KONG BY NUMBERS




GFCF (3.9) 7.7 7.2 4.7 5.4



Imports, goods & services (9.0) 17.3 4.7 2.5 9.4

Real GDP growth (2.6) 7.0 5.0 2.0 5.9

Prices Consumer prices (y/e) 0.3 2.7 6.4 5.2 5.8

Consumer prices (average) 1.0 1.9 5.7 5.3 5.9

Currency & interest rates

HKD/USD (y/e) 7.76 7.77 7.77 7.75 7.75 HKD/USD (average) 7.75 7.77 7.78 7.78 7.75

3-month HIBOR (% y/e) 0.13 0.33 0.33 0.30 0.30

Prime rate (% y/e) 5.00 5.00 5.00 5.00 5.00

External sector

Domestic exports (USD, % YoY) (24.9) 7.6 5.7 0.4 5.5 Re-exports (USD, % YoY) (11.8) 23.2 11.5 7.1 15.9

Exports (USD, % YoY) (12.3) 22.7 11.4 7.0 15.6

Imports (USD, % YoY) (10.6) 25.6 13.3 8.6 15.0

Trade balance (USD bn) (26.9) (43.0) (56.1) (68.3) (75.8)

Current account balance (USD bn) 11.4 11.6 6.6 (2.5) (4.0)

- as a % of nominal GDP 5.4 5.2 2.7 (1.0) (1.4)

FDI (USD bn) 3.6 (2.1) 3.6 2.0 1.7

CA + net FDI (% GDP) 7.2 4.3 4.2 (0.2) (0.8)

International reserves (USD bn, y/e) 255.8 268.7 285.4 315.4 345.4

Money supply

Money supply M1 (y/e) 39.6 12.8 10.8 9.8 15.3 Money supply M2 (y/e) 5.3 8.1 12.9 9.8 12.6

HKD bank lending (y/e) 2.0 17.6 11.9 6.1 12.6

HKD bank lending (% GDP) 148.0 162.2 166.9 168.2 170.4

Government sector

Public sector deficit (% GDP)¹ (1.6) (4.2) 0.5 (0.8) (0.7) Fiscal reserves (HKD bn)¹ 520.3 595.4 585.4 615.4 660.4

Min permitted reserves (HKD bn)² 315.1 292.5 301.4 370.0 350.0 Nominal GDP

Nominal GDP (USD bn) 209.4 224.1 243.4 256.4 285.8


Nominal GDP (HKD bn) 1,623 1,742 1,894 1,993 2,215

Nominal GDP (HKD, % YoY) (3.2) 7.3 8.7 5.3 11.1

Other data

Industrial production (8.3) 3.5 n.a. n.a. n.a.

Retail sales 0.4 18.5 24.9 14.3 15.8

Unemployment (% y/e) 5.0 3.9 3.3 4.5 4.2

Population (millions) 7.0 7.1 7.1 7.2 7.3

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

…but surging interbank funding will see aggressive lending from Hong Kong banks.

Interest rate tied to the Fed funds target…

Retail spending was weak in early 2012 but will pick up in 2H12 given abundant liquidity.

Labour conditions will weaken but the wealth affect from rising house prices will dominate.

Weak growth in the West will limit trade in 2012 but stronger US and Chinese economies will see a bounce in 2013.

The inflationary starting point is already high and cheap money will see inflation peak at 6% in mid-13.

The HKMA will be forced to defend the peg, meaning expansion of the aggregate balance.

Government expects a big improvement in its fiscal position, allowing for inflation relief policies.



CURRENCY FORECAST

Period-end Annual Coming 12 months by quarter 2009 2010 2011 2012clsa 2013clsa 2Q12clsa 3Q12clsa 4Q12clsa 1Q13clsa

HKD/USD 7.76 7.77 7.77 7.75 7.75 7.80 7.80 7.75 7.75

HKD/JPY 100 8.43 9.58 10.09 9.12 9.12 9.51 9.29 9.12 9.12

HKD/GBP 12.57 12.12 12.04 10.08 10.08 11.70 10.92 10.08 10.08

HKD/EUR 11.14 10.41 10.02 8.53 8.53 9.75 9.13 8.53 8.53 Memo: USD/EUR 1.44 1.34 1.29 1.10 1.10 1.25 1.17 1.10 1.10

Memo: JPY/USD 92.0 81.1 77.0 85.0 85.0 82.0 84.0 85.0 85.0

EXPORTS & IMPORTS

2

4

6

8

10

12

20

25

30

35

40

05 06 07 08 09 10 11 12

(US$bn)

Re-exportsRetained imports (RHS)


HKD NEER & REER

90

95

100

105

110

115

120

05 06 07 08 09 10 11 12

(2010 = 100)

NEER

REER


-7

-5

-3

-1

1

3

5

7

05 06 07 08 09 10 11 12

(ppts YoY)


other Asian economies, inflation in Hong Kong was still increasing at the end of 2011; the composite index measure reached 6.1% YoY in January, compared to 3.5% YoY a year earlier.

In addition to its exposure to internal commodity prices, Hong Kong has the additional element of very sticky housing-related costs; the housing component of the CPI (which comprises around 32% of the consumption basket) is running at around 8.5% YoY, mostly due to pressure from rising rent. Consistently high increases in rents are a function of the tight property market, which squeezes out prospective home buyers.

Government intentions to increase the supply of public housing from this year onwards will probably help lower rents for cheaper homes but a more generalised easing is only likely if there is broader correction in house prices. We think this is unlikely. Recent history shows Hong Kong property to be a favoured investment during periods of excess global liquidity, and while mainland China’s monetary easing will be modest compared to that seen during the GFC, it will nonetheless be a marginal positive influence on local property prices.

In coming months inflation should drift lower, helped by base effects and the unwind of food price increases during Chinese New Year, troughing in 3Q12 at around 5% YoY. Thereafter, however, we expect the inflation rate to increase, hovering around 6% YoY throughout 2013.

Government to the rescue? With no independent monetary policy (and super-low interest rates thanks to Fed policy) any official response to high rates of inflation has to come from the government. Real wage growth is still in positive territory at present but this situation will weaken if the labour market deteriorates as we expect over the coming year. The government has (or at least expects to have) the means to be able to provide some relief via utility and rent subsidies; it projects an increase in its fiscal reserves to HKD660bn in 2013, around 30% of GDP. Even so, past experience suggests that the benefits of such measures are fleeting.

EoAE Forecasts 2Q12


Rajeev Malik [email protected]

(65) 64167890

LONG-RUN HISTORY AND FORECAST SUMMARY

2005/06 2006/07 2007/08 2008/09 2009/10 2010/11 11/12clsa 12/13clsa 13/14clsa Real GDP growth 9.5 9.6 9.3 6.7 8.4 8.4 6.7 6.3 7.2 Domestic demand (contr. to growth) 11.0 10.2 11.1 6.7 8.6 9.2 9.1 7.1 8.4 Nominal GDP growth 13.9 16.3 16.1 12.9 14.7 18.8 16.1 14.4 14.7 Wholesale prices (y/e) 4.2 6.7 7.7 1.6 10.4 9.7 6.5 10.0 8.3 Repo rate (% y/e) 6.50 7.50 7.75 5.00 5.00 6.75 8.50 8.50 8.00 INR/USD (y/e) 44.61 43.60 39.99 50.95 45.14 44.65 50.00 55.00 52.00 Money supply M1 (y/e) 27.2 17.1 19.4 9.0 18.2 9.8 8.0 10.0 10.0 Current account balance (USD bn) (9.9) (9.6) (15.7) (27.9) (38.2) (45.9) (66.6) (73.1) (88.5) - as a % of nominal GDP (1.2) (1.0) (1.3) (2.3) (2.8) (2.7) (3.7) (3.9) (4.1) Central gov’t deficit (% GDP) 4.0 3.3 2.6 6.0 6.4 4.7 5.5 5.0 4.7

Note: All figures % YoY growth rates, unless otherwise stated. All data refer to fiscal years starting April.

Source: CMIE, Reserve Bank of India, IMF, ADB, World Bank, IIF, CEIC

RBI cannot be the saviour Below-trend GDP growth forecast maintained; key risk

remains uncertainty over policy action to boost investment.

Decline in inflation will be temporary, and it will rise again due to higher crude oil price.

RBI’s easing will be much less than market expectations; BoP pressure and USD strength will weaken INR.

Still more negatives than positives No other Asian economy has suffered more than India from the policy myopia of its politicians. This political short-sightedness contributed to the sharp deceleration in growth, skewed dependence on consumption at the expense of investment, populist policies made inflation stickier than it otherwise would have been, and unwarranted fiscal laxity prompted the RBI to tighten more than was needed. Adding insult to injury is the drubbing given to the Congress party in the recent state legislative elections. The embarrassing election outcome is likely to make the Congress party more cautious and it will be less open to taking risks with strong and unpopular measures/reforms even if it does not become more populist.

The global risk-on liquidity rally since mid-December has prompted scenarios that are more optimistic than the on-the-ground reality suggests. Policy-inaction-for-ever has never been our mantra but it remains to be seen if the government will follow through the recent improvement in decision-making. Policy coordination could suffer if the government is distracted by the poor election results and coalition compulsions even though better policy coordination does not require political signoff. In any case, a sustained investment-led recovery will need much greater favourable policy activism.

India’s 4Q11 GDP grew an uninspiring 6.1% YoY, well below the 6.9% in the prior quarter. It is also the lowest growth in almost three years and not far from 4Q08’s 5.8% that was due to the fallout from the Global Financial Crisis. That hit was because of external factors but was cushioned by aggressive fiscal and monetary easing. But the current deceleration is largely

Eye on Asian Economies • 2Q2012 I N D I A



Government

Updated: Feb 2011/12: 7.5-8.0

Consensus Updated: Mar 2011/12: 7.0

CLSA 2011/12: 6.7

THE CLSA DIFFERENCE

GDP growth

We remain below consensus on GDP growth for both FY12 and FY13.

Inflation Fall in inflation will be temporary; it will move up again

due to higher prices of commodities, including crude oil.

Interest rates & exchange rate CRR cuts will ease the excessive liquidity tightness, but

50bp of cumulative rate cuts will be reversed in 4Q12.

self-inflicted with limited monetary-fiscal flexibility. India’s GDP-expenditure details are unreliable as they are often substantially revised. Still, data show that private consumption appeared to recover to 6.2% YoY in 4Q11 after a large and questionable downward revision to 2.9% (from 5.9%) in 3Q11. GFCF fell 1.2% YoY, the second quarter of decline, and remains a key concern as an investment upturn is crucial for a sustained recovery in economic growth. While it is fashionable to blame monetary tightening for the investment slump, the main reason lies with government policy inaction and the fallout from the corruption scandals that hurt business confidence.

We expect FY12 GDP growth at 6.7% versus the official estimate of 6.9% as growth in 1Q12 – the closing quarter of India’s fiscal year – will be around 6.2%, similar to the outcome for 4Q11. We maintain our FY13 GDP growth forecast of 6.3%, with a weak 1H yielding to a better 2H, depending on policy measures that boost investment. Growth and inflation will also be adversely affected by the impact of the much-needed fiscal correction and by the limited monetary easing by the RBI.

Inflation will re-emerge as a problem WPI inflation eased to a 2-year low of 6.6% YoY in January due to a combination of the lagged effect of monetary tightening, a seasonal fall in food prices and the favourable effect of last year’s high base. However, higher oil prices are set to create more challenges for policy makers. Our revised forecast envisages Brent crude at USD140/bbl by end-2012. Such an outcome will make the current optimism over inflation and the quantum of rate cuts by the RBI short-lived.

The price of crude oil in INR terms is already nearing an all-time high, and greater pass through to local retail prices will be inevitable. Additionally, the upcoming Budget will likely raise excise duty and service tax rates to reverse fiscal laxity. This in turn will add to core inflationary pressures. Consequently, inflation will re-emerge as a worry in India and could even jump to 8-10% YoY.



INDIA BY NUMBERS

2009/10 2010/11 11/12clsa 12/13clsa 13/14clsa Breakdown of real GDP


Public consumption 14.3 7.8 3.5 3.0 3.0 GFCF 6.8 7.5 5.6 8.0 10.0


Exports, goods & services (4.1) 22.7 14.3 5.0 10.0 Imports, goods & services (2.0) 15.6 17.0 6.0 10.0

Real GDP1 8.4 8.4 6.7 6.3 7.2

Prices Wholesale prices (y/e) 10.4 9.7 6.5 10.0 8.3 Wholesale prices (average) 3.8 9.6 8.7 7.8 7.0


INR/USD (y/e) 45.14 44.65 50.00 55.00 52.00 INR/USD (average) 47.44 45.56 49.23 53.75 53.50

Repo rate (% y/e) 5.00 6.75 8.50 8.50 8.00

Reverse repo rate (% y/e) 3.50 5.75 7.50 7.50 7.00

External sector

Exports (USD, %YoY) (3.5) 37.3 22.0 9.0 17.0 Imports (USD, %YoY) (2.6) 26.7 26.0 10.0 18.0

Trade balance (USD bn) (118.2) (130.6) (174.6) (195.1) (233.5) Current account balance (USD bn) (38.2) (45.9) (66.6) (73.1) (88.5)

- as a % of nominal GDP (2.8) (2.7) (3.7) (3.9) (4.1)

FDI (USD bn) 18.0 9.4 20.0 15.0 15.0 CA + net FDI (% GDP) (1.5) (2.2) (2.6) (3.1) (3.4)

External debt (total, USD bn) 261.0 306.4 340.0 370.0 400.0

Debt service ratio (% exports) 6.8 5.6 5.2 5.4 5.1 International reserves (USD bn, y/e) 279.1 304.8 297.0 285.0 280.0

Money supply

Money supply M1 (y/e) 18.2 9.8 8.0 10.0 10.0 Money supply M3 (y/e) 16.8 16.0 16.0 15.0 15.0 Private sector credit (y/e) 16.9 21.5 16.0 16.0 17.0

Private sector credit (% GDP) 50.2 51.4 51.3 52.0 53.1

Government sector

Central gov’t deficit (% GDP) 6.4 4.7 5.5 5.0 4.7 General gov’t deficit (% GDP) 9.3 7.3 8.0 7.7 7.2

Central gov’t debt (% GDP, y/e) 48.9 46.0 44.5 43.5 42.0 General gov’t debt (% GDP, y/e) 70.6 64.3 56.6 55.0 53.0

Nominal GDP

Nominal GDP (USD bn) 1,361.1 1,684.3 1,810.3 1,896.1 2,184.3

Nominal GDP per capita (USD) 1,163.3 1,420.2 1,506.1 1,556.7 1,770.2

Nominal GDP (INR bn) 64,574 76,741 89,118 101,914 116,862 Nominal GDP (INR, %YoY) 14.7 18.8 16.1 14.4 14.7 Other data


Population (millions) 1,170 1,186 1,202 1,218 1,234

Note: All figures % YoY growth rates, unless otherwise stated. All data refer to fiscal years starting April. ¹ At factor cost. Source: CMIE, Reserve Bank of India, IMF, ADB, World Bank, IIF, CEIC

Capital inflows won’t be sufficient to finance the wider CA deficit.

Private consumption growth will cool.

RBI will start cutting policy rates in April but will be forced to reverse the cuts in 4Q12 on higher inflation.

Our revised outlook for commodity prices indicates that inflation will come back to haunt policy makers.

Recent drubbing received by the Congress party suggests that bold fiscal correction in FY13 Budget unlikely.

Industrial activity continues to be hurt by both cyclical factors and the ongoing policy inaction.

India remains highly vulnerable to global risk-off due to a large CA deficit and dependence on volatile capital inflows.

Global risk-on will be positive for INR but higher crude oil price will more than offset that impact.

However some improvement is likely in investment if the government comes through with positive policy action.



CURRENCY FORECAST

Period-end Annual (Fiscal years) Coming 12 months by quarter 2009/10 2010/11 2011/12clsa 2012/13clsa 2013/14clsa 2Q12clsa 3Q12clsa 4Q12clsa 1Q13clsa INR/USD 45.14 44.70 50.00 55.00 52.00 51.00 52.00 55.00 55.00

INR/JPY 100 48.33 53.86 60.61 64.71 61.18 62.20 61.90 64.71 64.71

INR/GBP 68.52 71.61 78.35 71.50 67.60 76.50 72.80 71.50 71.50

INR/EUR 60.98 63.25 66.00 60.50 57.20 63.75 60.84 60.50 60.50

Memo: USD/EUR 1.35 1.42 1.32 1.10 1.10 1.25 1.17 1.10 1.10

Memo: JPY/USD 93.4 83.0 82.5 85.0 85.0 82.0 84.0 85.0 85.0

EXPORTS & IMPORTS

0

5

10

15

20

25

30

35

02 03 04 05 06 07 08 09 10 11

(US$bn)

Exports Imports


INR NEER & REER

80

85

90

95

100

105

110

115

120

05 06 07 08 09 10 11 12

(2010 = 100)

NEERREER


-8

-6

-4

-2

0

2

4

6

05 06 07 08 09 10 11 12

(ppts YoY)


The cut in the cash reserve ratio (CRR) by 75bp to 4.75% is slightly earlier and bigger than the widely anticipated reduction (50bp at the 15 March policy meeting). The move is meant to ease excessive money market tightness that is beyond the comfort level of the Reserve Bank. The reason for the earlier move is technical: Indian banks follow a fortnightly reporting cycle and a CRR cut on 15 March would have been effective only from 24 March. This would have been too late to meet effectively the temporary drain caused by quarterly advance tax payments.

There is no change to our view of a repo rate cut on 17 April but we now expect the cumulative easing to be only 50bp compared to consensus expectations of 100-150bp. And, given the renewed inflation threat posed by our oil price forecast, RBI will be forced to raise rates again in 4Q12. We expect two increases, restoring the repo rate back to its current level of 8.5% by March 2013. Lower GDP growth will limit the pricing power of the corporate sector but the RBI will be more focussed on “squeezing” out inflationary pressures despite weaker economic growth. The bottom line is that the RBI cannot be the saviour of the economy this year; India will have to live with sub-trend GDP growth and still-high inflation (see Triple-A India-Epidural unavailable, 15 February).

INR remains vulnerable INR has had an exceptionally volatile ride in the past few months. Since mid-December, a combination of an unexpectedly strong jump in capital inflows due to global risk-on and the RBI’s desperate measures to bring stability to the exchange rate has facilitated some recovery. While global risk-on will be positive for INR, the recent election outcome is negative as it lowers the chances of reforms. Also, the upcoming Budget is unlikely to be bold. Higher crude oil prices will widen the current account (CA) deficit. Admittedly, global risk-on will boost volatile capital inflows but it is unlikely that these will fully finance the wider CA deficit that is already beyond the comfort level. This along with our forecast of a stronger USD sets the stage for INR to weaken to INR55/USD by end-2012.

EoAE Forecasts 2Q12


Anthony Nafte [email protected]

(852) 26008320


Real GDP growth 5.7 5.5 6.3 6.0 4.6 6.2 6.5 6.0 7.0 Domestic demand (contr. to growth) 5.7 3.0 3.7 6.7 4.6 5.3 5.5 6.9 8.2 Nominal GDP growth 20.8 20.4 18.3 25.3 13.3 14.8 15.4 14.3 16.8 Consumer prices (y/e) 17.1 6.6 5.7 11.1 2.8 7.0 3.8 6.8 7.8 BI policy rate (% y/e) 12.75 9.75 8.00 9.25 6.50 6.50 6.00 6.00 6.50 IDR/USD (y/e) 9,830 9,020 9,419 10,950 9,400 8,991 9,068 8,900 8,650 Money supply M1 (y/e) 10.2 28.0 29.7 1.5 12.9 17.4 19.4 16.6 21.0 Current account balance (USD bn) 0.3 10.9 10.5 0.1 10.6 5.1 2.1 (7.8) (12.1) - as a % of nominal GDP 0.1 3.0 2.4 0.0 2.0 0.7 0.2 (0.8) (1.1) Public sector deficit (% GDP) 0.5 0.9 1.3 0.1 1.6 0.6 1.3 2.3 2.3


Source: IMF, IFS, CEIC, CLSA estimates, Bank Indonesia

Indonesian star wanes Monetary policy was (mis)used to support domestic

demand, now Indonesia faces a heightened inflation risk.

Resources development will be set back by the 49% cap on foreign ownership of mining assets.

A current account deficit will add to currency volatility but rising FDI will support the balance of payments.

Inflation is the main risk Monetary policy has been relied on to keep domestic demand strong, ensuring that Indonesia’s real GDP growth remains above 6% despite the global headwinds. With fiscal policy sidelined by poor policy implementation, Bank Indonesia (BI) assumed the role of supporting growth. BI was sufficiently reassured by falling inflation, down 340bp from end-2010 to 3.6% in February 2012, to pursue aggressive monetary easing. However, the economy did not need the added monetary stimulus given already accommodative conditions, robust domestic demand and buoyant credit growth. As a result, Indonesia now faces a heightened inflation risk facing the rise in global oil and commodity prices.

Infrastructure development would have been the more appropriate policy for sustaining high GDP growth but policy implementation in SBY’s second term has remained poor. As investors lose their appetite for Indonesian assets, the government has offered the reassurance of stepped up infrastructure projects. Specifically, it claims that the land acquisition law will facilitate infrastructure development valued at USD4.9bn this year including the long-delayed Tanjung Priok port expansion. We would be (pleasantly) surprised if it achieved even one quarter of this. It took forever for parliament to pass the land bill, while the government has still not issued the regulation for land acquisition to be put into practice.

There has been the added complication of rising fuel subsidies. Inevitably, when subsidies rise, budgeted capital expenditure on infrastructure has been the casualty. After months of procrastination, the government submitted a

Eye on Asian Economies • 2Q2012 I N D O N E S I A



Government Updated: Mar 2012: 6.3 – 6.5


CLSA 2012: 6.0

THE CLSA DIFFERENCE

GDP growth In agreement with government and consensus that

domestic demand will support 6% growth or higher. Inflation BI has recognised that a fuel price increase will push

inflation above its 3.5-5.5% inflation target. Interest rates & exchange rate BI has not talked about raising rates. We forecast a 25bp

rise in 2H12 and 50bp rise in 1H13.

revised budget to parliament in March, with a planned 33% increase in the domestic fuel price. The official inflation target has been raised to 7% for end-2012. (We have been warning about 6.8% inflation for some time). The official GDP forecast for 2012 has been marginally reduced to 6.5%, from 6.7% previously. We have maintained our GDP forecast at 6% for this year and 7% for 2013.

Resources development has been jeopardised Our 6% GDP forecast will be achieved in spite of poor policy implementation. Strong structural forces, specifically urbanisation and middle class expansion, have continued to drive growth. This has forced the government to make infrastructure improvements, barely scraping the surface, but contributing to growth. The private sector has been the key driver though, with private consumption growing at 5% and investment at 20% QoQ annualised in 4Q11.

We expect domestic demand trends to remain strong this year. Indonesia will be insulated against weakening global demand by its low export to GDP ratio and high commodity share of exports. Residential construction will remain the key investment driver. High commodity prices, while pressuring the fiscal deficit, will lift rural income and consumption. Higher fuel prices will reduce real incomes but lower income households will be compensated with a cash handout.

While we remain positive on Indonesia’s growth prospects, downside risk has been introduced. Our assumption had been that government policy would do little to promote growth, but neither would it obstruct growth. This is now in doubt.

Indonesia has seen a substantial increase in net FDI, USD11.1bn in 2010 and USD10.4bn in 2011. It was only in these last two years moreover, that there has been significant investment in resources. Specifically, the share of resources investment increased to 16% of total FDI in the last two years, from only 1.4% in the previous thirteen years. Development of the resources sector was one of the structural forces that would lift



INDONESIA BY NUMBERS




GFCF 3.3 8.5 8.8 14.0 17.4




Real GDP growth 4.6 6.2 6.5 6.0 7.0

Prices

Consumer prices (y/e) 2.8 7.0 3.8 6.8 7.8


Wholesale prices (y/e) 4.6 6.2 6.4 7.2 8.0


IDR/USD (y/e) 9,400 8,991 9,068 8,900 8,650

IDR/USD (average) 10,408 9,087 8,787 9,096 8,746

BI policy rate (% y/e) 6.50 6.50 6.00 6.00 6.50

Base lending rate (% y/e) 12.83 11.98 11.84 11.75 12.25

External sector

Exports (USD, % YoY) (14.3) 32.1 27.5 9.3 11.4

Imports (USD, % YoY) (24.0) 43.7 30.3 14.4 16.8




FDI (USD bn) 2.6 11.1 10.4 12.6 14.5

CA + net FDI (% GDP) 2.4 2.3 1.5 0.6 0.3


Debt service ratio (% exports) 16.9 10.2 15.4 10.6 9.2


Money supply

Money supply M1 (y/e) 12.9 17.4 19.4 16.6 21.0

Money supply M2 (y/e) 13.0 15.4 16.4 16.0 22.0

Private sector credit (y/e) 10.1 23.3 24.7 17.5 30.0


Government sector

Public sector deficit (% GDP) 1.6 0.6 1.3 2.3 2.3

Public sector debt (% GDP, y/e) 28.6 27.4 25.0 24.2 23.0

Nominal GDP



Nominal GDP (IDR tn) 5,606 6,436 7,427 8,489 9,912

Nominal GDP (IDR, % YoY) 13.3 14.8 15.4 14.3 16.8

Other data


Unemployment (% y/e) 7.9 7.3 6.8 6.5 6.1


Note: % YoY rates unless otherwise stated. Source: IMF, IFS, CEIC, CLSA estimates, Bank Indonesia

Residential construction remains the key investment driver.

We had warned of inflation risk, official forecast is now 7% for end-2012.

High commodity prices will lift rural income and consumption.

Credit growth will not be derailed by rising interest rates.

FDI will be relied upon to support the balance of payments.

Easing cycle has ended, first rate hike in 2H12.

Rupiah will be volatile but end 2012 with a small appreciation.

Good fiscal deficit control, but not that good if it is achieved by sacrificing capital expenditure.

Current account will shift into deficit in 2012 as rising investment sustains import demand.

Urbanisation and middle class expansion are driving domestic demand.



CURRENCY FORECAST

Period-end Annual Coming 12 months by quarter 2009 2010 2011 2012clsa 2013clsa 2Q12clsa 3Q12clsa 4Q12clsa 1Q13clsa IDR/USD 9,400 8,991 9,068 8,900 8,650 9,200 9,050 8,900 8,810

IDR/JPY 100 10,217 11,086 11,777 10,471 10,176 11,220 10,774 10,471 10,365

IDR/GBP 15,228 14,026 14,055 11,570 11,245 13,800 12,670 11,570 11,453

IDR/EUR 13,498 12,048 11,698 9,790 9,515 11,500 10,589 9,790 9,691 Memo: USD/EUR 1.44 1.34 1.29 1.10 1.10 1.25 1.17 1.10 1.10

Memo: JPY/USD 92.0 81.1 77.0 85.0 85.0 82.0 84.0 85.0 85.0

EXPORTS & IMPORTS

2

4

6

8

10

12

14

16

18

20

05 06 07 08 09 10 11 12

(US$bn)

Exports

Imports


IDR NEER & REER

75

80

85

90

95

100

105

110

115

120

05 06 07 08 09 10 11 12

(2010 = 100)

NEER

REER


-30

-20

-10

0

10

20

30

40

05 06 07 08 09 10 11 12

(ppts YoY)


Indonesia’s trend growth rate to 7% (see 4Q11 EoAE, Arise Indonesia). However, this prospect has been jeopardised by the short sighted presidential decree issued in March 2012.

Foreign mining companies will be required to reduce their ownership of mining assets to 49%, in stages, within the next ten years. Indonesia’s own demand for resources has outstripped the available supply (oil and gas trade is now in marginal deficit). We are sceptical that the necessary supply expansion can be achieved without the financing and technical-managerial expertise of the foreign mining companies. Our overall assessment of government policy is an unequivocal fail. Bluntly put, the SBY administration’s ‘use by date’ has expired more than a year before the next presidential election.

Easing cycle is over, rising rates in 2013 Bank Indonesia was overly aggressive in cutting interest rates and is now on the back foot facing a higher inflation risk. BI cut its policy rate by 100bp to 5.75% over the five months to February 2012. However, monetary easing was actually twice as aggressive. This is because the interbank rate has been tracking the overnight deposit facility (Fasbi rate) with a matching 200bp decline, rather than the historical policy rate.

BI only recently acknowledged that a domestic fuel price rise would push inflation above its 3.5 – 5.5% target, which likely marks the end of the easing cycle. On our forecast for an inflation rise to 6.8% by end-12 and 7.8% by end-13, we forecast a 25bp policy rate increase to 6% in 2H11 and a further 50bp increase to 6.5% in 1H13.

The exchange rate will be volatile over the coming months as the market assesses the inflation impact from the planned fuel and electricity price increases. Currency vulnerability will be reinforced moreover, by a current account shift to deficit (with import demand sustained by rising investment). However, high and rising FDI will underpin the balance of payments for a modest rupiah appreciation over the full year, barring any further ‘misguided’ policy initiatives which deter foreign investment.

EoAE Forecasts 2Q12



(852) 26008739


Real GDP growth 4.0 5.2 5.1 2.3 0.3 6.2 3.6 2.8 4.2 Domestic demand (contr. to growth) 3.8 4.8 4.4 1.4 (2.6) 5.5 1.9 1.9 3.5 Nominal GDP growth 4.6 5.0 7.3 5.3 3.8 10.1 6.1 5.0 7.0 Consumer prices (y/e) 2.6 2.1 3.6 4.1 2.8 3.0 4.2 3.5 4.8 Call rate (% y/e) 3.75 4.50 5.00 3.00 2.00 2.50 3.25 3.25 3.75 KRW/USD (y/e) 1,037 938 921 1,363 1,169 1,133 1,145 1,120 1,090 Money supply M1 (y/e) 2.5 11.0 (13.9) 4.8 18.2 10.3 3.0 5.1 7.7 Current account balance (USD bn) 18.6 14.1 21.8 3.2 32.8 29.4 26.5 23.7 8.4 - as a % of nominal GDP 2.2 1.5 2.1 0.3 3.9 2.9 2.4 2.1 0.6 Federal deficit (% GDP) (0.4) (0.4) (3.5) (1.2) 1.7 (1.4) 0.1 1.7 0.1


Source: IMF, World Bank, Bank of Korea, CEIC

Official nerves A weaker external backdrop is flowing through to softer

domestic demand.

Recent indicators point to an improvement in export conditions but developed economy headwinds remain.

Government and monetary authorities are worrying about oil already. No chance to ease in 2012, hikes in 2013.

Soft domestics Korean 4Q GDP was slightly below our expectations, lifting 0.4% QoQ, from 0.8% QoQ in 3Q, taking full-year 2011 growth to 3.6% (we expected 3.7%). Exports were unsurprisingly soft, down 1.5% QoQ, in line with the sharp deterioration in end-year merchandise trade.

The bigger disappointment was in domestic demand. Private consumption contracted in quarter-on-quarter terms for the first time in nearly three years, surprising given the labour market continued to tighten in 4Q. Gross fixed capital formation also contracted, down 2.1% QoQ, led by business investment. This was consistent with the drop-off in exports but nonetheless was a large drag on growth.

Poor domestic demand growth in 4Q translated into weak imports, also down heavily (-3.1% QoQ), lessening the impact on headline GDP. Nonetheless, a poorer than expected performance from the domestic economy has necessitated slight downgrades in our 2012 forecasts for both household consumption and capital formation.

Export turnaround but headwinds remain The external picture has improved significantly thus far in 2012. February’s advance trade figures were very strong, with exports jumping around 15% MoM sa. History suggests the boost from a Lunar New Year-affected January will be significant (and not adequately accounted for by seasonal

Eye on Asian Economies • 2Q2012 K O R E A





CLSA 2012: 2.8

THE CLSA DIFFERENCE

GDP growth On average, exports will be softer in 2012 than 2011, so

GDP growth will slow. We are below consensus.

Inflation Higher oil prices feed quickly into domestic inflation

which will be close to the BoK’s upper limit this year.

Interest rates & exchange rate Thus the BoK has no capacity to ease to protect growth.

Liquidity-fuelled risk appetite sees KRW strengthen.

adjustment) but smoothing through both months still shows good underlying growth; on a rolling three-month basis, exports were up 3.9% QoQ sa in February (and imports up 4.2% QoQ sa). A similar improvement from the late-2011 trough in activity is evident in industrial production which jumped in January.

Moreover, this improvement is not unique to Korea. Trends in industrial activity and exports have also greatly improved in Taiwan and Singapore since the end of 2011. This suggests a common cause; we believe a thawing in trade credit conditions following the ECB’s first phase of LTRO in December is the likely catalyst. The injection of additional liquidity into the European banking system via LTRO phase 2, at the end of February, means that constrained trade finance will not be a recurring problem for Asian exporters.

But solving the issue of trade credit still leaves the problem of weak underlying demand in key trading partners and this prevents us from being bullish on Korean (and Asian) growth in 2012. Recent data from both the EU and the US point to a slowing in demand. From Europe, Germany’s latest factory goods orders and manufacturing PMI were weak (and below expectations). And in the US, capital goods orders excluding defense and aircraft - the key indicator on business equipment and software investment - are slowing rapidly.

Both are consistent with our view that the next six months will be difficult for Asian economies that rely significantly on demand in the West. The turning point will be around mid-2012 when US growth starts to lift (see pp27-30) but in annual average terms 2012 will look soft compared to 2011. We expect Korean export volume growth to slow to 3.8% in 2012, from 10.1% in 2011.

Official nerves Korean officials are already sounding nervous about oil prices. Such nerves are understandable, given the last time oil pushed above USD130/bbl (mid-2008), headline inflation nearly reached 6% YoY.



KOREA BY NUMBERS

2009 2010 2011 2012clsa 2013clsa Breakdown of real GDP Private consumption (0.0) 4.1 2.3 1.8 3.4


GFCF (1.0) 7.0 (2.4) 1.8 4.0

Domestic demand (contr. to growth) (2.6) 5.5 1.9 1.9 3.5



Real GDP growth 0.3 6.2 3.6 2.8 4.2 Prices





KRW/USD (y/e) 1,169 1,133 1,145 1,120 1,090

KRW/USD (average) 1,278 1,156 1,108 1,133 1,073

Call rate (% y/e) 2.00 2.50 3.25 3.25 3.75

Average lending rate (% y/e) 5.8 5.4 5.7 5.8 6.3

External sector

Exports (USD, % YoY) (17.8) 28.9 19.8 6.5 11.2

Imports (USD, % YoY) (25.5) 31.5 23.8 7.9 14.2




FDI (USD bn) (14.9) (22.2) (15.7) (18.0) (18.0)

CA + net FDI (% GDP) 2.1 0.7 1.0 0.5 (0.7)

External debt (total, USD bn) 345.4 n.a. n.a. n.a. n.a.

Debt service ratio (% exports) n.a. n.a. n.a. n.a. n.a.


Money supply

Money supply M1 (y/e) 18.2 10.3 3.0 5.1 7.7

Money supply M2 (y/e) 9.8 5.9 5.3 6.1 8.2



Government sector

Federal deficit (% GDP) 1.7 (1.4) 0.1 1.7 0.1

Federal debt (% GDP, y/e) 32.5 31.9 30.5 31.2 31.1

Nominal GDP

Nominal GDP (USD bn) 841.0 1,014.4 1,123.8 1,154.4 1,307.7


Nominal GDP (KRW tn) 1,065.0 1,172.8 1,244.9 1,307.2 1,399.8

Nominal GDP (KRW, % YoY) 3.8 10.1 6.1 5.0 7.0

Other data

Industrial production (0.7) 16.6 6.9 2.4 7.6

Retail sales 4.0 9.6 8.4 4.6 6.7

Unemployment (% y/e) 3.5 3.5 3.1 3.8 3.9


Note: % YoY rates unless otherwise stated. Source: IMF, World Bank, Bank of Korea, CEIC

Consumption was softer than we expected in 4Q11, meaning a downgrade in expectations.

A difficult export environment in 1H12 means employment growth will slow.

Credit uptake has proven more resilient than we expected but soft domestic demand suggests further expansion will be modest.

No room for rate cuts in 2012. 50bp of tightening in 2013, consistent with the pace of rate increases seen previously.

We’ve revised our inflation outlook higher to reflect a bullish commodity view.

Export demand has picked up in recent months but weakening in core-EU and the US poses a challenge.

The same applies to investment. 2013 will be better given stronger export prospects.

Abundant global liquidity will lead to gentle KRW/USD appreciation.



CURRENCY FORECAST Period-end Annual Coming 12 months by quarter 2009 2010 2011 2012clsa 2013clsa 2Q12clsa 3Q12clsa 4Q12clsa 1Q13clsa KRW/USD 1,169 1,133 1,145 1,120 1,090 1,150 1,140 1,120 1,110

KRW/JPY 100 1,271 1,397 1,487 1,318 1,282 1,402 1,357 1,318 1,306

KRW/GBP 1,894 1,767 1,775 1,456 1,417 1,725 1,596 1,456 1,443

KRW/EUR 1,679 1,518 1,477 1,232 1,199 1,438 1,334 1,232 1,221

Memo: USD/EUR 1.44 1.34 1.29 1.10 1.10 1.25 1.17 1.10 1.10

Memo: JPY/USD 92.0 81.1 77.0 85.0 85.0 82.0 84.0 85.0 85.0

EXPORTS & IMPORTS

15

20

25

30

35

40

45

50

05 06 07 08 09 10 11 12

(US$bn)

Exports

Imports


KRW NEER & REER

80

90

100

110

120

130

140

05 06 07 08 09 10 11 12

(2010 = 100)

NEERREER


-15

-10

-5

0

5

10

05 06 07 08 09 10 11 12

(ppts YoY)


Inflation down, but only temporarily Inflation has trended back into the Bank of Korea’s policy band of 2-4% YoY in recent months, falling to 3.1% YoY in February. This is largely the effect of lower international commodity price inflation but the softening in domestic demand in 2H11 suggests that local price pressures are also dissipating. The only obvious sign of residual inflation in the Korean economy is in the labour market, where private sector employment growth has been good enough to hold the unemployment rate at a cyclical low of just above 3%. Even so, unit labour costs are falling. Moreover, a generally soft export backdrop points to a weaker labour market in coming months; we expect the unemployment rate to lift to be close to 4% by the end of 2012.

But this downtrend in annual inflation is close to running its course. The benefit of a high year-ago base will shrink in coming months and, more pertinently, there is very little lag (about one month) between international oil price moves and domestic headline inflation in Korea. We do not expect the current commodity price rally to be sustained – it should falter as US growth slows – but our forecast of bullish commodity markets in 2H12 means that inflation will re-emerge as a policy concern by the end of the year. Overall we expect inflation to track between 3.5-4% YoY for most of 2012 (thus close to the Bank of Korea’s 4% YoY target limit), before climbing to 4.8% YoY by end-2013.

The BoK displayed no inclination to cut rates at its policy meeting in March and the accompanying statement made reference to “potentially destabilising factors such as high inflation expectations and the geopolitical risks in the Middle East”. The BoK clearly recognises the importance of future rather than current inflation in setting monetary policy and a cut in rates, even if warranted to stabilise growth, is highly unlikely while oil prices remain high. Indeed, our inflation forecast means there will be no room for the BoK to ease this year with rising inflation prompting 50bp of tightening in 2013.

EoAE Forecasts 2Q12



(852) 26008320


2005 2006 2007 2008 2009 2010 2011 2012clsa 2013clsa Real GDP growth 5.3 5.8 6.5 4.8 (1.6) 7.2 5.1 4.2 4.5 Domestic demand (contr. to growth) 4.5 6.3 7.9 5.0 (2.0) 10.7 6.5 6.8 4.9 Nominal GDP growth 10.2 10.0 11.8 15.6 (8.4) 12.7 11.3 10.5 13.0 Consumer prices (y/e) 3.4 3.1 2.3 4.5 1.0 2.1 3.0 5.0 5.8 Overnight policy rate (% y/e) 3.00 3.50 3.50 3.25 2.00 2.75 3.00 3.00 3.50 MYR/USD (y/e) 3.78 3.53 3.31 3.46 3.42 3.08 3.18 3.07 2.96 Money supply M1 (y/e) 8.5 13.7 19.6 8.3 9.8 11.7 15.1 9.5 13.9 Current account balance (USD bn) 20.6 26.1 29.8 39.6 31.9 27.3 32.0 31.6 32.3 - as a % of nominal GDP 15.0 16.7 15.9 17.8 16.5 11.5 11.5 10.5 9.0 General gov’t deficit (% GDP) 3.6 3.3 3.2 4.8 7.0 5.6 5.0 6.2 5.7


Source: CEIC, Bank Negara Malaysia, IMF, DataStream, Bloomberg, CLSA estimates

Hey, big spender Public spending has been ramped up ahead of the expected

election, while restructuring has been put on hold.

The public sector will drive investment, major projects include the Klang Valley MRT and oil exploration.

Renewed inflation uptrend in 2012 but no interest rate increase until 2013.

Spending big ahead of the election We have revised up our 2012 real GDP forecast to 4.2%, from 2.8% in the 1Q12 EoAE. We had expected exports to be hit by a double whammy, with weakening global demand reducing manufactured exports by volume and easing commodity prices reducing commodity exports by value. However, with oil and commodity prices on the rise, prospects are for a terms of trade gain this year, not the loss we had previously predicted. This means that the GDP drag from slowing electronics export growth will be partly offset by resilient oil and commodity exports.

The offset will only be partial, a reflection of the high electronics share of total exports at close to 40%. We still expect slowing growth in nominal exports (USD terms) to 4.8% this year from 14.5% in 2011. Our 4.2% real GDP forecast therefore requires that domestic demand remains strong.

Question: what will drive domestic demand in 2012? Answer: the public sector. An early election is widely expected with speculation that it will be called around mid-year. This is a crucial election for Mr Najib who needs to regain a two thirds majority for his Barisan coalition party which would give him the required mandate for structural reform. The outcome of this election is difficult to predict but one thing we can say with relative certainty is that the government will spend big in the run up to the poll.

It has already started. Civil servants will be given a 7 – 13% salary increase in May, although this will be withheld from the top officials after protests from the public sector unions. Mr Najib is also set to introduce a monthly

Eye on Asian Economies • 2Q2012 M A L A Y S I A



Government Updated: Mar 2012: 5 - 6


CLSA 2012: 4.2

THE CLSA DIFFERENCE

GDP growth Hints have been dropped that the official GDP forecast

will be revised down to 4 – 5%. Inflation BNM has remained cautious ahead of anticipated fuel and

electricity price increases this year (post-election). Interest rates & exchange rate BNM’s conservative stance means there is no urgency to

raise rates in 2012.

minimum wage of between MYR800 – 1,000 (around USD300). By official estimates, one quarter of Malaysia’s 12.8bn workforce will benefit from the minimum wage increase which would suggest a significant burden on business profits. However, the impact will be diluted since it excludes migrant labour.

Public sector will drive investment Public infrastructure spending will continue to drive investment growth. Our CLSA Kuala Lumpur research team has focused on the huge Klang Valley Mass Rapid Transport project (see Malaysian infrastructure: Moving along, March 2012). The project value has been estimated at around USD6.9bn, of which 45% will be awarded by April and 85% awarded by October 2012.

Exploration and development in the oil sector will be another major driver of investment growth. This was highlighted in another report by our CLSA KL Research team, Oilfield services: Wakeriders. The need for stepped up investment in this sector has been underlined by the 3% contraction in oil production in each of the last 6 years. The state oil company, Petronas, has USD100bn capital spending plans over the next 5 years, along with the need for increased foreign investment.

Net FDI in Malaysia has been negative in each of the last 5 years, the result of crowding out of the private sector which has sought more profitable investment opportunities offshore. Private sector investment has dropped to less than 10% of GDP. However, obscured by negative net figure, FDI inflows have picked up in the last two years to an average USD10bn per annum. The bulk of foreign investment (almost 60%) has been in manufacturing. This component of FDI inflows could fall sharply this year given the expected downturn in the electronics sector. The rest of the higher FDI inflows was in services (30%) and mining (10%).



MALAYSIA BY NUMBERS

2009 2010 2011 2012clsa 2013clsa

Breakdown of real GDP



GFCF (5.6) 9.8 6.0 8.0 6.6




Real GDP growth (1.6) 7.2 5.1 4.2 4.5

Prices





MYR/USD (y/e) 3.42 3.08 3.18 3.07 2.96

MYR/USD (average) 3.52 3.23 3.06 3.12 2.97

Overnight policy rate (% y/e) 2.00 2.75 3.00 3.00 3.50


External sector

Exports (USD, % YoY) (20.9) 25.8 14.5 4.8 9.5

Imports (USD, % YoY) (20.5) 33.5 13.8 7.0 10.2




FDI (USD bn) (6.7) (4.3) (4.0) (2.8) (2.0)

CA + net FDI (% GDP) 13.0 9.7 10.1 9.5 8.4




Money supply

Money supply M1 (y/e) 9.8 11.7 15.1 9.5 13.9

Money supply M3 (y/e) 9.2 6.8 14.3 8.7 13.0



Government sector

General gov’t deficit (% GDP) 7.0 5.6 5.0 6.2 5.7

General gov’t debt (% GDP, y/e) 53.3 53.1 55.2 58.2 59.0

Nominal GDP



Nominal GDP (MYR bn) 679.9 766.0 852.7 942.5 1,064.8

Nominal GDP (MYR, % YoY) (8.4) 12.7 11.3 10.5 13.0

Other data


Unemployment (% y/e) 3.5 3.2 3.0 3.4 3.2


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

Rising rural income will underpin private consumption growth.

Renewed inflation uptrend in 2013.

Election casualty: the fiscal deficit will rise to 6.2% of GDP lifting public debt closer to the 60% of GDP threshold.

Foreign reserves build up on renewed foreign capital inflows.

Current account surplus wil remain huge.

No interest rate increase until 2013.

Large current account surplus favours ringgit appreciation.

Public sector will be the key driver of investment growth.

Sustained rise in the credit to GDP ratio.

Declining electronic exports will overwhelm commodity price boost for overall slowing exports in 2012.



CURRENCY FORECAST Period-end Annual Coming 12 months by quarter 2009 2010 2011 2012clsa 2013clsa 2Q12clsa 3Q12clsa 4Q12clsa 1Q13clsa MYR/USD 3.42 3.08 3.18 3.07 2.96 3.12 3.09 3.07 3.04

MYR/JPY 100 3.72 3.80 4.13 3.61 3.48 3.80 3.68 3.61 3.58

MYR/GBP 5.55 4.81 4.92 3.99 3.85 4.68 4.33 3.99 3.95

MYR/EUR 4.92 4.13 4.10 3.38 3.26 3.90 3.62 3.38 3.34 Memo: USD/EUR 1.44 1.34 1.29 1.10 1.10 1.25 1.17 1.10 1.10

Memo: JPY/USD 92.0 81.1 77.0 85.0 85.0 82.0 84.0 85.0 85.0

EXPORTS & IMPORTS

6

8

10

12

14

16

18

20

05 06 07 08 09 10 11 12

(US$bn)

Exports

Imports


MYR NEER & REER

90

92

94

96

98

100

102

104

05 06 07 08 09 10 11 12

(2010 = 100)

NEERREER


-6

-4

-2

0

2

4

6

8

05 06 07 08 09 10 11 12

(ppts YoY)


Rural underpinning for consumption There will be opposing pressures on wages. The introduction of a minimum wage and the civil sector salary increase will exert upward pressure on wages generally while slowing growth in the electronics sector will exert downward pressure on manufacturing wages. Private consumption prospects overall though, should be reasonably underpinned by rising rural income from high commodity prices. This though, will also have consequences for inflation. We expect a renewed inflation uptrend this year.

No rate change in 2012 Bank Negara Malaysia (BNM) has maintained a conservative policy stance. It hiked by 75bp in 2010 and by a further 25bp in May 2011. Since then it has held its overnight policy rate steady at 3%. Annual inflation dropped to 2.7% in January from a tight range of 3 – 3.5% in the previous 10 months, turning real interest rates positive. BNM held rates steady at its March policy meeting notwithstanding the weak export performance in early 2012 and the January inflation dip.

CPI data do not give an accurate picture of inflation in Malaysia due to the many subsidies on food and fuel. There are likely to be sharp inflation spikes this year due to rising fuel and electricity prices, although these may be delayed until after the anticipated election. The domestic fuel price hike in 2008 lifted inflation by 6.5ppt to 8.5%. We forecast a smaller rise in inflation, to 5% this year. Because BNM declined to cut interest rates in this cycle there is no urgency to raise rates this year. However, a continued rise in inflation, to 5.8% by end-13 on our forecast, will trigger a 50bp rise in the policy rate to 3.5%.

With import demand sustained by rising public investment, we expect narrowing surpluses on the trade and current accounts. However, the current account surplus will still be huge at our forecast USD31.6bn (10.5% of GDP) in 2012, favouring a 3.5% ringgit appreciation to MYR3.07/USD by end-12.

EoAE Forecasts 2Q12



(852) 26008320


Real GDP growth 5.0 5.3 7.1 4.6 1.1 7.6 3.7 4.2 4.7 Domestic demand (contr. to growth) 3.6 5.2 6.3 3.4 1.1 8.2 6.5 6.1 6.1 Nominal GDP growth 11.8 10.8 10.2 12.3 4.0 12.2 8.1 7.5 9.8 Consumer prices (y/e) 6.7 4.3 3.8 7.7 4.5 3.6 4.2 4.8 6.2 O’night reverse repo rate (% y/e) 7.50 7.50 5.25 5.50 4.00 4.00 4.50 4.00 4.50 PHP/USD (y/e) 53.07 49.13 41.40 47.49 46.36 43.89 43.93 42.30 40.50 Money supply M1 (y/e) 8.8 24.4 17.7 20.9 13.6 10.6 10.9 11.5 13.0 Current account balance (USD bn) 2.0 5.3 7.1 3.6 9.4 8.9 4.7 3.8 4.1 - as a % of nominal GDP 1.9 4.4 4.8 2.1 5.6 4.5 2.1 1.6 1.5 Public sector deficit (% GDP) 2.6 1.0 0.2 0.9 3.7 3.5 2.0 3.0 2.4


Source: IMF, IFS, CEIC, CLSA estimates, National Statistical Coordination Board, Philippines

Investment boom is back We have revised up our GDP forecasts for 2012 and 2013

on the improving investment outlook.

The private investment upswing is taking off again, public infrastructure projects will be the cherry on top.

A renewed inflation uptrend will trigger interest rate increases, but not until 2013.

GDP revised up on improved outlook 2011 was a disappointing year for the Philippines with real GDP growth slowing to 3.7% YoY. Philippines exports underperformed in the region, a reflection of the country’s low manufacturing competitiveness and the high concentration of electronics in total exports (close to 60%). That said, expectations for the export sector had not been very high anyway. It was domestic demand that disappointed, specifically slowing real investment growth to only 2.7% YoY in 2011.

Given the weak global environment, we were previously sceptical of a convincing rebound in 2012, reflected in our soft 2.9% real GDP forecast in the 1Q12 EoAE. However, recent signals from government and the private sector have been more reassuring. Backed up by anecdotal reports, the investment upswing appears to be regaining pace, the basis for an upward revision to our 2012 real GDP forecast to 4.2%.

The ‘construction boom theme’ which described the investment surge in 2010 is set to recur in 2012. The specific investment drivers are (1) overseas remittances for residential construction; (2) the expanding BPO sector for commercial construction and (3) the expanding tourism sector for hotel and resorts construction. In addition, investment growth will be reinforced by public and private public partnership (PPP) infrastructure projects.

Investment cycle is turning again Overseas remittances growth slowed to 7.2% YoY in 2011, from 8.2% in 2010. Remittances prospects for 2012 will be influenced by global conditions but, more so in the Middle East and Asia than in Europe, based on deployment

Eye on Asian Economies • 2Q2012 P H I L I P P I N E S



Government Updated: Mar 2012: 5 – 6


CLSA 2012: 4.2

THE CLSA DIFFERENCE

GDP growth Our upward GDP revision is below the government’s

target but will be a good result in this global environment.

Inflation We expect inflation to remain within the BSP’s 3- 5%

target range this year, but to breach the target in 2013.

Interest rates & exchange rate BSP won’t have the option for further rate cuts, we think.

patterns. We expect remittances growth of 6.5% or higher this year. Remittances appear to have been strong in the first two months of the year as suggested by the USD2.5bn increase in foreign reserves. The government moreover, has started to lift deployment bans to the Middle East, notably an imminent lifting of the 6-year ban on overseas Filipino workers to Lebanon and a partial lifting of the ban on OFW to Yemen. In addition, the ban on au pairs to European countries has been lifted. The positive development in the Business Process Outsourcing sector has been the gradual transition from an exclusively call-centre operation to higher value non-voice operations. Positive prospects have been underlined with the official statement that three foreign banks are considering non-voice BPO investments in the Philippines this year. The tourism sector has performed well with double digit growth in tourist arrivals in each of the last two years. There could be an added boost to investment from the tourism sector with Universal Entertainment breaking ground on its planned USD2bn casino in Manila Bay. There are other projects which could lift investment this year. Development of Manila North Harbour Port has been given the go-ahead with an estimated project cost at USD350mn. Efforts have also been made to promote the manufacturing sector, with the government considering an industrial zone exclusively for Taiwanese investors. There has been increased interest from Japanese firms too, which have been experiencing wage pressures in their Chinese operations. Roll out the projects but keep the deficit down The improved fiscal accounts and declining public debt have contributed to positive foreign investor sentiment in the Philippines market. Public debt declined to 51% of GDP in 2011, from over 70% five years ago. The fiscal deficit in 2011 was contained at 2% of GDP, from 3.5% in 2010. However, this largely reflected failed implementation of budgeted infrastructure spending. Early indications are that infrastructure spending will be more efficiently implemented this year with the funds already



PHILIPPINES BY NUMBERS

2009 2010 2011 2012clsa 2013clsa

Breakdown of real GDP

Private consumption 2.3 3.4 6.1 5.0 5.5 Public consumption 10.9 4.0 (0.7) 9.5 2.5

GFCF (1.7) 19.1 2.7 8.0 9.0

Domestic demand (contr. to growth) 1.1 8.2 6.5 6.1 6.1 Exports, goods & services (7.8) 21.0 (3.8) 2.4 7.6


Real GDP growth 1.1 7.6 3.7 4.2 4.7 Prices



Producer prices (y/e) (2.2) (5.8) 1.6 5.2 6.6


PHP/USD (y/e) 46.36 43.89 43.93 42.30 40.50

PHP/USD (average) 47.64 45.11 43.31 42.63 41.35

O’night reverse repo rate (% y/e) 4.00 4.00 4.50 4.00 4.50 Prime lending rate (%y/e) 8.19 7.22 6.21 5.70 6.20

External sector

Exports (USD, % YoY) (22.1) 34.9 (6.7) 2.2 8.2

Imports (USD, % YoY) (24.0) 32.9 2.5 5.8 10.2 Trade balance (USD bn) (8.8) (11.0) (15.9) (18.5) (21.4)


- as a % of nominal GDP 5.6 4.5 2.1 1.6 1.5 FDI (USD bn) 1.6 1.2 1.1 1.8 2.4

CA + net FDI (% GDP) 6.5 5.1 2.6 2.3 2.3

External debt (total, USD bn) 64.9 73.7 82.0 88.5 93.0 Debt service ratio (% exports) 12.5 9.2 9.6 12.0 11.9


Money supply

Money supply M1 (y/e) 13.6 10.6 10.9 11.5 13.0 Money supply M3 (y/e) 8.3 10.6 6.3 10.0 13.5



Government sector


Public debt (% GDP, y/e) 65.7 61.7 50.9 52.8 52.5

Nominal GDP

Nominal GDP (USD bn) 168.5 199.6 224.8 245.5 277.8 Nominal GDP per capita (USD) 1,827 2,123 2,345 2,513 2,789

Nominal GDP (PHP bn) 8,026 9,003 9,735 10,466 11,488

Nominal GDP (PHP, % YoY) 4.0 12.2 8.1 7.5 9.8 Other data


Unemployment (% y/e) 7.3 7.4 6.7 6.6 6.4 Population (millions) 92.2 94.0 95.9 97.7 99.6

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

Remittances expected to be resilient; Asia and Middle East matter more than Europe.

Poor implementation behind the low 2011 deficit; rebound in public spending will lift the deficit in 2012.

Current account surplus and rising FDI favour peso appreciation.

Inflation will breach the BSP’s 3 – 5% inflation target in 2013.

Renewed construction investment upswing.

Widening trade deficit but remittances will keep the current account in surplus.

Confirmation of public debt to GDP ratio at 51% in 2011 will clinch this year’s expected sovereign debt rating upgrade for the Philippines.

Rising credit to GDP ratio in 2012 and 2013.

Export weakness will persist in 2012 with the global electronics downturn.

Scope for a 50bp rate cut in 1H12.



EXPORTS & IMPORTS

2

3

4

5

6

05 06 07 08 09 10 11 12

(US$bn) Exports

Imports


PHP NEER & REER

70

75

80

85

90

95

100

105

110

115

05 06 07 08 09 10 11 12

(2010 = 100)

NEERREER


-6

-4

-2

0

2

4

6

8

05 06 07 08 09 10 11 12

(ppts YoY)


CURRENCY FORECAST

Period-end Annual Coming 12 months by quarter 2009 2010 2011 2012clsa 2013clsa 2Q12clsa 3Q12clsa 4Q12clsa 1Q13clsa PHP/USD 46.36 43.89 43.93 42.30 40.50 42.50 42.40 42.30 41.80

PHP/JPY 100 50.39 54.11 57.05 49.76 47.65 51.83 50.48 49.76 49.18

PHP/GBP 75.10 68.46 68.09 54.99 52.65 63.75 59.36 54.99 54.34

PHP/EUR 66.57 58.81 56.67 46.53 44.55 53.13 49.61 46.53 45.98

Memo: USD/EUR 1.44 1.34 1.29 1.10 1.10 1.25 1.17 1.10 1.10

Memo: JPY/USD 92.0 81.1 77.0 85.0 85.0 82.0 84.0 85.0 85.0

assigned to the relevant ministries. As public spending increases though, the deficit will need to be contained. The difficulty arises because the Philippines has among the lowest tax revenues to GDP ratio in the region, at just over 12%. The government aims to boost tax revenues this year by increasing alcohol and tobacco revenues and by withdrawing unnecessary tax breaks.

The government has targeted a 2.6% of GDP deficit in 2012. We think the deficit will be higher at 3.1% of GDP. Last year, only 1 of the 10 planned PPP projects was successfully tendered. The underlying assumption for our deficit forecast is that 60% of the PPP projects will be rolled out this year (which we would consider a good result).

No more cuts in 2012, tightening in 2013 The sharp dip in inflation to 2.7% in February from 4% in January was exaggerated by a large base year effect. Still, it vindicated Bangko Sentral’s 50bp reduction in the reverse repo policy rate to 4% in 1Q12. While BSP may be inclined to cut rates further, it will be constrained by rising oil and commodity prices. The February inflation dip has turned real interest rates positive but this will prove temporary as inflation starts to trend up again.

The Philippines is an inflation prone economy, as an importer of both food and oil. In 2008, inflation rose by 7ppt to 10% over the space of eight months. The anticipated inflation rise may not be as steep as in 2008 but we still expect a rise to 4.8% by end-12 and to 6.2% by end-13. With an inflation target range of 3 – 5%, BSP will likely hold rates steady in 2012, but hike rates by 50bp in 2013, lifting the policy rate up to 4.5% again.

Overseas remittances, which are classified as transfer payment credits, keep the Philippines current account in surplus. Along with rising net FDI, there will be strong support for the balance of payments. We forecast a 3.8% peso appreciation to PHP42.3/USD by end-12.

EoAE Forecasts 2Q12


Rajeev Malik [email protected]

(65) 64167890


Real GDP growth 7.4 8.8 8.9 1.7 (1.0) 14.8 4.9 1.5 5.0 Domestic demand (contr. to growth) 1.9 6.0 6.4 8.2 (5.4) 5.0 3.7 0.0 3.3 Nominal GDP growth 9.6 10.9 15.6 0.4 0.5 14.8 5.4 3.5 7.1 Consumer prices (y/e) 1.3 0.8 3.7 5.5 (0.5) 4.6 5.6 7.0 6.7 3-month interbank rate (% y/e) 3.25 3.44 2.38 1.00 0.69 0.44 0.38 0.40 0.60 SGD/USD (y/e) 1.66 1.53 1.44 1.44 1.40 1.29 1.30 1.23 1.17 Money supply M1 (y/e) 4.4 13.4 22.4 18.4 23.5 20.3 14.8 10.0 13.0 Current account balance (USD bn) 26.9 35.7 45.9 26.3 30.1 55.5 57.0 43.3 46.7 - as a % of nominal GDP 21.4 24.5 25.8 13.9 16.2 24.4 21.9 16.2 15.5 Government fiscal deficit (% GDP)1 (0.7) 0.0 (2.8) (0.3) (0.3) (0.1) (0.7) (0.5) (1.0)

Note: % YoY rates unless otherwise stated. 1Fiscal years beginning 1 April.

Source: CEIC, MAS, MTI, Datastream, Bloomberg, CLSA estimates

Down but not out GDP growth forecast for 2012 raised to 1.5% from 0%;

2013 forecast remains unchanged at 5%.

Despite slower growth, inflation will rise because of higher global commodity and food prices.

MAS will maintain its policy of slight appreciation of SGD NEER band in April but increase the slope in October.

Slight improvement in 2012 growth outlook After contracting 2.5% QoQ (saar) in 4Q11, the Singapore economy is likely to expand again in 1Q12. This is a better-than-expected outcome than we expected three months ago, due mainly to the slight improvement in the global backdrop. Consequently, we have raised our full year GDP growth forecast to 1.5% (official forecast: 1-3%) from 0%.

Still, GDP growth of 1.5% - the lowest in Asia - is hardly anything to crow about. However, it should be seen in the context of the above-trend growth in the last couple of years of a highly cyclical economy that is heavily geared to global trade. In 2009, the economy contracted 1% before posting sizzling GDP growth of 14.8% in 2010 which then moderated to 4.9% in 2011. Thus, in the last three years the economy averaged annual GDP growth of 6.2% - above its medium-term potential growth rate of 3-5%.

Details of GDP-expenditure growth of 3.6% YoY in 4Q11 show that total demand grew 1.8% YoY (3Q11: 2.5%) with total domestic demand (including change in inventories at 1ppt) contributing 1.1ppt and external demand contributing 0.7ppt. Growth rates of private consumption (+1.9% YoY) and GFCF (-0.2%) eased in 4Q11, and are likely to soften further due to the impact of slower income growth and still-weak export performance in 2012.

1Q12 has got off to a good start with industrial production (IP) jumping 3.3% MoM (sa) in January (December: 8.9%) and IP excluding biomedical rising 2.8% MoM (sa) on top of the 7.2% surge in December. In YoY terms IP declined 8.8% but due mainly to the shifting Chinese New Year, which fell in

Eye on Asian Economies • 2Q2012 S I N G A P O R E



Government Updated: Feb 2012: 1 - 3


CLSA 2012: 1.5

THE CLSA DIFFERENCE

GDP growth Our upwardly revised GDP growth forecast of 1.5%

remains below consensus. Inflation CPI inflation will be sharply higher later in the year

because of higher food and commodity prices. Interest rates & exchange rate The MAS will keep its policy unchanged at the April

review but shift to a tightening bias in October.

January this year but in February in 2011. We will get a more reliable sense of the underlying trend in activity after the February data are announced but the improvement in industrial activity despite the adverse impact of the Chinese New Year can’t be ignored. However, higher crude oil price and EUR weakness (see Triple-A: The consequences of Draghi’s boot, 22 February) will be significant headwinds.

Sensible budget but inflation risk re-emerges The FY12 Budget focused on strengthening the foundation of longer-term growth by boosting productivity, lowering reliance on foreign workers and encouraging firms to hire older Singaporeans. The government expects a budget surplus of around SGD1.3bn (0.4% of GDP) versus last year’s SGD2.3bn (0.7% of GDP). The most significant move was reducing the dependency ratio ceilings (DRC), which specify the maximum proportion of foreign workers to Singapore workers that a company can hire. DRC for manufacturing firms has been reduced to 60% from 65% earlier and to 45% from 50% for services. The move to reduce the dependency ratio will exacerbate wage pressure in the near term but will also prompt businesses to improve productivity.

Singapore’s CPI inflation in January came in at 4.8% YoY, the first sub-5% reading in eight months. However, the MAS’ core inflation measure (excluding accommodation and private transport) jumped to 3.5% YoY in January (December: 2.6%). This is the highest reading since December 2008. The MAS expects YoY CPI inflation to remain elevated and volatile over the next few months due to a combination of continued increases in housing rentals, tight COE supply, and cost increases in the labour market. The official 2012 forecast for CPI inflation and MAS’ core inflation remain at 2.5-3.5% and 1.5-2%, respectively, but are predicated on some moderation in domestic and external cost pressures in the second half of the year.

However, based on our revised crude oil forecast of USD140/bbl and higher food prices by end-2012, the MAS will have to reassess its inflation outlook. We now expect CPI inflation to end 2012 at 7% YoY (old forecast: 2.5%) and average 5.5% (old forecast 3.5%) for 2012.



SINGAPORE BY NUMBERS


Private consumption 0.1 6.5 4.1 2.5 4.5 Public consumption 3.6 11.0 0.9 2.0 2.0

GFCF (2.9) 7.0 3.3 (4.3) 5.5

Domestic demand (contr. to growth) (5.4) 5.0 3.7 0.0 3.3 Exports, goods & services (7.8) 19.1 2.6 (2.0) 7.0

Imports, good & services (11.1) 16.2 2.4 (2.2) 7.5

Real GDP growth (1.0) 14.8 4.9 1.5 5.0 Prices Consumer prices (y/e) (0.5) 4.6 5.6 7.0 6.7

Consumer prices (average) 0.6 2.8 5.3 5.5 8.0 Domestic supply prices (y/e) 12.4 2.7 7.9 10.0 8.3

Currency & interest rates SGD/USD (y/e) 1.40 1.29 1.30 1.23 1.17 SGD/USD (average) 1.45 1.36 1.26 1.27 1.20 3-month interbank rate (% y/e) 0.69 0.44 0.38 0.40 0.60 External sector NODX (USD, % YoY) (13.0) 31.1 10.8 (3.6) 12.8

Retained imports (USD, % YoY) (27.5) 24.7 27.1 10.2 17.3

Trade balance (USD bn) 47.3 63.1 67.5 54.3 58.7 Current account balance (USD bn) 30.1 55.5 57.0 43.3 46.7


FDI (USD bn) 6.7 27.4 38.8 15.8 12.5 CA + net FDI (% GDP) 19.9 36.5 36.9 22.1 19.6


Debt service ratio (% exports) 0.0 0.0 0.0 0.0 0.0 International reserves (USD bn, y/e) 187.8 225.8 237.7 252.7 267.7

Money supply Money supply M1 (y/e) 23.5 20.3 14.8 10.0 13.0 Money supply M2 (y/e) 11.3 8.6 10.0 6.0 10.0


Private sector credit (% GDP) 104.2 104.1 128.6 136.7 137.9 Government sector Government fiscal deficit1(% GDP) (0.3) (0.1) (0.7) (0.5) (1.0)

Nominal GDP Nominal GDP (USD bn) 185.7 227.5 260.0 267.4 301.9


Nominal GDP (SGD bn) 270.0 310.0 326.8 338.4 362.3 Nominal GDP (SGD, % YoY) 0.5 14.8 5.4 3.5 7.1

Other data

Industrial production (4.2) 29.7 7.8 2.0 7.0 Retail sales (7.8) (1.0) 4.6 3.0 6.0

Unemployment (% y/e) 2.3 2.2 2.0 2.3 2.0


Note: % YoY rates unless otherwise stated. 1Fiscal years beginning 1 April. Source: CEIC, MAS, MTI, DataStream, Bloomberg, CLSA estimates

MAS will tighten its exchange-rate centered monetary policy in October 2012.

Slight improvement in the global backdrop has prompted us to revise the 2012 GDP forecast to 1.5% from 0% earlier.

Unemployment rate will inch upwards mainly because of frictional mismatches.

Fiscal policy remains responsible and offers room for counter-cyclical measures if desired.

Inflation will accelerate because of higher global commodity and food prices.

Loan growth should moderate after being unexpectedly strong.

External sector’s performance will remain unispiring this year but should recover in 2013.

Investment spending will suffer due to the weaker outlook for export and construction sectors.

Biomedical production will again offset weakness in electronic production.



CURRENCY FORECAST

Period-end Annual Coming 12 months by quarter 2009 2010 2011 2012clsa 2013clsa 2Q12clsa 3Q12clsa 4Q12clsa 1Q13clsa SGD/USD 1.40 1.29 1.30 1.23 1.17 1.26 1.25 1.23 1.23

SGD/JPY 100 1.52 1.59 1.69 1.45 1.38 1.54 1.49 1.45 1.45

SGD/GBP 2.27 2.01 2.02 1.60 1.52 1.89 1.75 1.60 1.60

SGD/EUR 2.01 1.73 1.68 1.35 1.29 1.58 1.46 1.35 1.35 Memo: USD/EUR 1.44 1.34 1.29 1.10 1.10 1.25 1.17 1.10 1.10

Memo: JPY/USD 92.0 81.1 77.0 85.0 85.0 82.0 84.0 85.0 85.0

EXPORTS & IMPORTS

6

8

10

12

14

16

18

20

22

05 06 07 08 09 10 11 12

(US$bn)

Domestic exports

Retained imports


SGD NEER & REER

85

90

95

100

105

110

05 06 07 08 09 10 11 12

(2010 = 100)

NEER

REER


-4

-2

0

2

4

6

8

05 06 07 08 09 10 11 12

(ppts YoY)


Some unique inflation drivers It is important not to lose sight of the key drivers of inflation as some are unique to Singapore. Thus, accommodation cost rose by 10% YoY in January. It is the single largest contributor to CPI inflation. The owner-occupied accommodation sub-group, with a 15.6% weight in the CPI basket, contributed 1.8ppt to CPI inflation. This reflects the rise in market rents which are used to calculate the imputed rent for owner occupied properties. However imputed rents have no direct impact on cash expenditures for most households as Singaporeans typically own their own homes. Inflation less imputed rentals on owner occupied property is significantly lower than the headline at 3.5%.

And most of the increase in core inflation in January was due to seasonal and base effects. Thus, of the 0.9ppt increase in core inflation, the MAS and the MTI estimate that 0.2ppt can be attributed to the seasonal uptick in food prices during the Chinese New Year. Another 0.5ppt comes from the removal of radio and TV license fees in January 2011. The remaining 0.2ppt of the increase in core inflation was due to the pass-through of higher labour costs to consumer prices, especially related to healthcare and education.

MAS to tighten later this year Some of the reasons for historical inflation are therefore temporary or not representative of out of pocket expenses. However, inflation is forecast to rise on account of higher global commodity and food prices and this will impact MAS’ monetary policy. Last October, the MAS eased its exchange rate-centred monetary policy by reducing the slope of the undisclosed SGD NEER policy band. We expect the MAS to keep its policy unchanged in April, but tighten by increasing the slope of the band at the October policy review in line with the higher inflation risk and improving economic growth outlook. We expect SGD/USD to appreciate slightly to SGD1.23/USD by end-2012. The quantum of appreciation would have been bigger if not for the anticipated strengthening of the USD against EUR.

EoAE Forecasts 2Q12



(852) 26008739


Real GDP growth 4.7 5.4 6.0 0.7 (1.8) 10.7 4.0 2.0 4.4 Domestic demand (contr. to growth) 1.8 0.9 1.3 (1.9) (2.9) 7.7 0.4 0.6 2.3 Nominal GDP growth 3.3 4.3 5.4 (2.2) (1.1) 9.1 1.0 3.2 5.8 Consumer prices (y/e) 2.2 0.7 3.3 1.3 (0.2) 1.2 2.0 2.8 5.5 Rediscount rate (% y/e) 2.25 2.75 3.38 2.00 1.25 1.63 1.88 1.88 2.38 TWD/USD (y/e) 32.85 32.60 32.44 32.86 32.03 30.37 30.29 28.50 28.00 Money supply M1b (y/e) 6.6 5.4 1.1 (2.2) 30.3 8.8 3.5 4.6 7.7 Current account balance (USD bn) 17.6 26.3 35.2 27.5 43.2 39.9 41.3 37.1 32.7 - as a % of nominal GDP 4.7 6.8 8.6 6.6 11.0 8.9 8.6 7.4 5.9 Public sector deficit (% GDP) 0.1 (0.1) (0.3) 0.5 3.5 2.3 2.4 2.7 2.1


Source: CEIC, CLSA estimates, Central Bank of China, DGBAS

Better but still not good Taiwan’s economy has turned the corner but external

challenges mean growth will be slow in 2012.

We are a long way below the consensus forecast, which implies a huge lift in the quarterly growth profile.

The CBC will be forced to hike next year and more flexible approach to currency control is also likely.

Leading indicators tick up Taiwan’s economic performance over recent months has largely mirrored that of the other Asian manufacturing economies. Activity has improved by a decent margin from the late-2011 trough, evident in a sizeable bounce in January’s industrial production data, despite being a truncated month due to the Chinese New Year. Taiwan also experienced a sharp correction in the number of workers placed on involuntary unpaid leave in February, a measure taken by manufacturers when orders fall unexpectedly quickly. And the annualised six-month growth in the leading economic indicator, a reasonable indicator of turning points in growth, has also lifted in recent months.

This all points to an improvement in economic conditions. Context, however, is important. The Taiwanese economy was extremely weak in 2011, with the economy no bigger in 4Q11 than it was in 1Q11. The hurdle for improvement is clearly very low.

4Q growth itself was a disappointment. GDP fell 0.1% QoQ sa, matching the 3Q11 contraction and putting Taiwan in technical recession – just. Private consumption contracted for the first time since early 2010 and capital formation fell 6.9% QoQ, following big falls in each of 2Q11 and 3Q11. Weak domestic demand was reflected in weak imports, helping buffer the impact of domestic weakness on aggregate GDP.

Historical drag, future positive This domestic demand profile is very similar to that of Korea (see pp51-54). A key difference, however, is that Taiwanese businesses heavily ran down inventories in 2H11; Korean inventories, on the other hand, have generally been

Eye on Asian Economies • 2Q2012 T A I W A N





CLSA 2012: 2.0

THE CLSA DIFFERENCE

GDP growth Industrial activity has rebounded but despite pulling up

growth we are still well below consensus.

Inflation 2012/13 will be a repeat of 2008, when government

policy was not enough to keep inflation below 5%YoY.

Interest rates & exchange rate The inflation threat will force the CBC to tighten in 2013.

Rates will lift and the TWD will strengthen.

rising. This drawdown of inventories is a growth drag; it effectively replaces current period production. But it also means that Taiwan is in a relatively strong position to face an expected slowdown in US growth over the next six months. By contrast, Korea’s inventory adjustment has yet to occur.

Consensus still too bullish Our poor US growth forecast in 1H12, combined with slower growth in mainland China and a flat EU economy mean that it is impossible to be outright bullish on Taiwan’s economic prospects in 2012. Annual export growth will be 2.4%, better than we expected a quarter ago thanks to the better data so far this year, but still down on 2011’s 4.5%. GDP growth will be 2.0% in 2012, compared to 4.0% in 2011.

This puts us more than 1ppt below consensus (see below) and nearly 2ppt below the government’s forecast. On the face of it, 2012 growth of 3-4% following 4% in 2011 seems reasonable. But the quarterly profile this implies is very strong. The consensus expectation of a 3.1% expansion in 2012 requires compound average quarterly growth of around 1.2% QoQ; the government’s forecast requires an even punchier 1.5% QoQ.

Given trend growth at present is, at best, flat, such rates represent a massive increase, and one that is unrealistic in our view. By contrast, we expect average growth of around 0.8% QoQ to get to our 2% full-year forecast. Given our expectation of weaker growth in both the US and China in 1H, even this will require a growth acceleration in 2H12 to be achieved.

CBC steady in 2012, tightening in 2013 In the 1Q12 Eye on Asian Economies we predicted that the CBC would cut its policy rate this year. We have now removed all monetary easing for two reasons. First, as we note above, we have upgraded our GDP expectations; albeit low by historical standards, 2% growth will be sufficient to discourage the CBC from easing.



TAIWAN BY NUMBERS




GFCF (11.2) 24.0 (7.6) (1.9) 5.2



Imports, goods & services (13.1) 28.2 (0.6) 0.7 7.7

Real GDP growth (1.8) 10.7 4.0 2.0 4.4 Prices

Consumer prices (y/e) (0.2) 1.2 2.0 2.8 5.5




TWD/USD (y/e) 32.03 30.37 30.29 28.50 28.00

TWD/USD (average) 32.74 31.45 29.75 29.38 28.06

Discount rate (% y/e) 1.25 1.63 1.88 1.88 2.38


External sector

Exports (USD, % YoY) (20.2) 34.6 12.1 3.1 13.8

Imports (USD, % YoY) (26.9) 43.1 13.0 5.0 16.5




FDI (USD bn) (3.1) (9.1) (14.8) (10.0) (8.5)

CA + net FDI (% GDP) 10.5 7.1 5.7 5.6 4.5




Money supply

Money supply M1b (y/e) 30.3 8.8 3.5 4.6 7.7

Money supply M2 (y/e) 6.0 5.1 5.0 3.6 5.0

Private sector credit (y/e) (0.2) 7.3 6.2 1.0 6.4

Private sector credit (% of GDP) 122.9 120.9 127.0 124.3 125.1

Government sector


Public debt (% GDP, y/e) 36.9 37.0 39.0 40.5 40.4

Nominal GDP



Nominal GDP (TWD bn) 12,481 13,614 13,757 14,197 15,021

Nominal GDP (TWD, % YoY) (1.1) 9.1 1.0 3.2 5.8

Other data


Retail sales 2.4 5.6 4.9 2.2 3.5

Unemployment (% y/e) 5.7 4.7 4.2 5.3 4.9


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

Falling consumer confidence was a poor omen but 4Q spending was weaker than we thought. We’ve downgraded 2012.

Government subsidisation only provides partial insulation against commodity inflation.

Business investment still very weak and likely to remain so near term since…

Industrial production bounced in January but will track soft exports in 1H12.

No change in view here. Continued declines in investment suggest demand for credit will be soft.

Liquidity-driven risk appetite will drive TWD appreciation.

No moves this year but rates will be increased in 2013 given inflation pressure.

…exports will struggle until US growth picks up in 2H12. 2013 will be good.

After many years of fiscal surplus, a deficit position is becoming entrenched. Public debt levels are already a favourite topic amongst media.



CURRENCY FORECAST

Period-end Annual Coming 12 months by quarter 2009 2010 2011 2012clsa 2013clsa 2Q12clsa 3Q12clsa 4Q12clsa 1Q13clsa

TWD/USD 32.03 30.37 30.29 28.50 28.00 30.00 29.50 28.50 28.25

TWD/JPY 100 34.82 37.45 39.34 33.53 32.94 36.59 35.12 33.53 33.24

TWD/GBP 51.89 47.38 46.95 37.05 36.40 45.00 41.30 37.05 36.73

TWD/EUR 46.00 40.70 39.07 31.35 30.80 37.50 34.52 31.35 31.08 Memo: USD/EUR 1.44 1.34 1.29 1.10 1.10 1.25 1.17 1.10 1.10

Memo: JPY/USD 92.0 81.1 77.0 85.0 85.0 82.0 84.0 85.0 85.0

EXPORTS & IMPORTS

8

12

16

20

24

28

05 06 07 08 09 10 11 12

(US$bn)

ExportsImports


TWD NEER & REER

95

100

105

110

115

120

05 06 07 08 09 10 11 12

(2010 = 100)

NEERREER


-5

-4

-3

-2

-1

0

1

2

3

4

05 06 07 08 09 10 11 12

(ppts YoY)


Second is the fact that we are now more bullish on global commodity prices (see World View section on pp27-30), with the CRB commodity basket about up around 10% per annum for the next two years. Typically modest CPI inflation gives the impression that Taiwan is insulated from the effects of rapidly rising international commodity prices. It isn’t; Taiwan is massively resource deficient, in particular relying entirely on imports for oil. Taiwanese import and producer price inflation has generally been on par with the rest of Asia during previous commodity bull markets.

Taiwan’s low CPI inflation is explained by government “price stabilisation” polices; effectively subsidisation via loss-making state-controlled enterprises. This provides a reasonable buffer between households and global commodity prices but is not 100% fool proof. The state-owned petroleum company, for instance, currently only absorbs half of all increases in international oil prices.

We expect the price of oil to reach USD140/bbl by end-2012, around a 30% YoY increase, followed by a further 15% YoY in 2013. Under current price stabilisation polices the implication is that domestic inflationary pressures will be acute. We see headline inflation reaching 5.5% YoY at end-2013. If anything this forecast has upside risk; the government has suggested it will review its price stabilisation policies with a view to limiting the losses incurred by state-owned enterprises.

The central bank will react by lifting interest rates. Again the pre-GFC experience provides a road-map and we expect the CBC to lift the discount rate by 12.5bp in each of its quarterly policy meetings in 2013. There is also a risk that the CBC allows the currency to strengthen to combat inflation, given the current belief amongst monetary policy makers that TWD appreciation between mid-2010 and mid-2011 was an effective antidote to imported inflation. Renewed risk appetite has already seen the currency appreciate 2.5% over the past three months. A pull-back is likely in the short-run but TWD/USD will strengthen steadily from mid-2012.

EoAE Forecasts 2Q12



(852) 26008320


2005 2006 2007 2008 2009 2010 2011 2012clsa 2013clsa Real GDP growth 4.6 5.1 5.0 2.5 (2.3) 7.8 0.1 4.8 5.8 Domestic demand (contr. to growth) 6.5 1.0 2.0 3.6 (5.9) 8.4 0.8 5.7 5.5 Nominal GDP growth 9.3 10.6 8.7 6.5 (0.4) 11.8 4.3 7.0 10.1 Consumer prices (y/e) 5.8 3.5 3.2 0.4 3.5 3.0 3.5 4.2 5.3 1-day repo rate (% y/e) 4.00 5.00 3.25 2.75 1.25 2.00 3.25 3.00 3.50 THB/USD (y/e) 41.03 35.78 33.66 34.98 33.18 30.12 31.21 30.50 29.50 Money supply – Narrow (y/e) 7.3 2.4 9.7 4.1 12.8 10.9 8.6 7.4 13.6 Current account balance (USD bn) (7.6) 2.3 15.7 2.2 21.9 13.2 11.9 (4.5) (13.0) - as a % of nominal GDP (4.3) 1.1 5.9 0.8 8.3 4.1 3.4 (1.2) (3.1) Public sector deficit (% GDP)¹ (1.1) 0.3 1.3 0.5 4.9 0.3 2.1 5.2 4.2

Note: % YoY rates unless otherwise stated; 1 Fiscal year ending September.

Source: IMF, IFS, CEIC, CLSA estimates, Bank of Thailand

Regaining FDI appeal We expect a convincing GDP rebound in 2012 led by

investment; prospects for rising FDI in 2012 and 2013.

This depends on efficient policy implementation to boost business sentiment for new investment spending.

The BOT’s policy bias will shift from growth to inflation concerns, for rising interest rates in 2013.

Renewed investment upswing post-flood Thailand’s economy will rebound convincingly in 2012 after the massive flood related contraction in 4Q11. From effectively zero growth in 2011, we forecast 4.8% real GDP growth in 2012 and 5.8% in 2013. This is a bullish forecast which projects a GDP rebound above pre-flood levels by mid-2012. While our 2012 forecast is below the official (NESDB) target at 5.5 – 6.5%, we are arguably more bullish on domestic demand which will be the growth driver, providing an effective offset to slowing exports.

Specifically, GDP growth will be led by a renewed investment upswing. The capital replacement cycle was already underway before the flood interruption in October 2011 and we expect it to resume this year, reinforced by the replacement of flood damaged machinery. Our positive investment outlook excludes the planned high speed rail and other mega-projects which are unlikely to be initiated before 2013. Other infrastructure projects will drive investment, notably flood defence and mass transit. From the current track length of only 50km (combined sky train and underground), there are plans to extend the Bangkok mass transit system by another 400km over the next three years at an estimated cost of THB800bn (USD26.2bn).

Low fiscal deficits in the last two years, highlighted by the declining public investment trend, underline the scope for a boost in public spending. In perspective though, the effect on GDP from a rise in public spending will be proportionately less than an equivalent rise in private investment given their

Eye on Asian Economies • 2Q2012 T H A I L A N D



Government Updated: Mar 2012: 5.5 – 6.5


CLSA 2012: 4.8

THE CLSA DIFFERENCE

GDP growth We are lower than the official forecast but arguably more

bullish on domestic demand.

Inflation The BOT will struggle to keep inflation within its target

ie, 0.5 – 3% for core and 2ppt higher for headline CPI.

Interest rates & exchange rate BOT’s concerns on the rising fiscal deficit reinforce our

view that the monetary easing cycle has ended.

relative shares of GDP at 6% for public sector and 21% for private sector investment (2011 estimates). However, while public spending will not be the major growth driver, it will be a vital catalyst for new investment by lifting business confidence in the private sector.

Dual deficit will invite government scrutiny Increased infrastructure spending on top of the government’s large fiscal stimulus will lead to a widening fiscal deficit. This will be obscured by the official estimate though, which excludes extra-budgetary spending. Including this lifts our fiscal deficit forecast to 5.2% of GDP in FY11-12 (ending September 2012) from 2.1% in FY10-11. We also forecast a current account shift to deficit (as the investment upswing sucks in imports).

If the government delivers (for Thailand, a 7 out of 10 performance would be deemed a success) it will spur confidence for increased private sector spending. Recent surveys have been encouraging. Business expectations rebounded to pre-flood levels in the 1Q11 survey.

The strongest reassurance on investment prospects has come from sustained foreign direct investment (FDI). Net FDI was actually negative in 2011 due to rising outbound FDI (as Thai companies pursued more profitable opportunities offshore). However, FDI inflows were strong at USD8.4bn in 2011, not far off the USD9.7bn in 2010 and an encouraging result in view of the flood. With Japan accounting for 43% of Thailand’s FDI in 2011, the intention of Japanese companies operating in Thailand is paramount for a sustained rise in FDI.

The result of the latest survey by the Japanese Chamber of Commerce (JCC) and Jetro was encouraging: more than 90% of Japanese investors will remain in Thailand. However, planned flood defence measures by the Thai government were not seen as sufficient and business sought greater assurance that operations will not be disrupted in future natural disasters. This underlines the importance of efficient implementation by the Thai government.



THAILAND BY NUMBERS


Private consumption (1.1) 4.8 1.3 4.0 4.2


GFCF (9.2) 9.4 3.3 11.2 13.0




Real GDP growth (2.3) 7.8 0.1 4.8 5.8

Prices





THB/USD (y/e) 33.18 30.12 31.21 30.50 29.50

THB/USD (average) 34.31 31.70 30.47 30.89 30.00

1-day repo rate (% y/e) 1.25 2.00 3.25 3.00 3.50

Minimum lending rate (% y/e) 5.85 6.12 7.25 7.00 7.50

External sector

Exports (USD, % YoY) (13.9) 28.4 16.4 4.0 12.0

Imports (USD, % YoY) (25.1) 37.0 24.7 10.2 16.0




FDI (USD bn) 0.7 4.2 (2.4) 3.2 4.4

CA + net FDI (% GDP) 8.6 5.4 2.8 (0.4) (2.1)




Money supply

Money supply - Narrow (y/e) 12.8 10.9 8.6 7.4 13.6

Money supply - Broad (y/e) 6.8 10.9 15.2 7.0 14.0



Government sector

Public sector deficit (% GDP)1 4.9 0.3 2.1 5.2 4.2

Public sector debt (% GDP, y/e) 43.9 42.4 40.8 43.8 44.4

Nominal GDP



Nominal GDP (THB bn) 9,042 10,105 10,539 11,282 12,425

Nominal GDP (THB, % YoY) (0.4) 11.8 4.3 7.0 10.1

Other data

Industrial production (6.1) 13.9 (4.3) 4.0 9.0


Note: % YoY rates unless otherwise stated; 1Fiscal year ending September. Source: IMF, IFS, CEIC, CLSA estimates, Bank of Thailand

Convincing GDP rebound in 2012 after 0.1% growth in 2011.

Mostly private sector investment; good policy implementation will boost confidence.

Our 5.2% of GDP fiscal deficit forecast for 2012 includes off budget expenditure.

Japanese vote of confidence signals sustained rise in FDI.

Easing cycle has ended, rising interest rates in 2013.

Renewed inflation pressures.

Current account will shift to deficit in 2012.

Investment upswing will sustain import demand.

Minimum wage rise, civil sector wage hike and pledging scheme for rice will lift consumer spending.

Credit to GDP ratio will continue to rise in 2012 and 2013.



CURRENCY FORECAST

Period-end Annual Coming 12 months by quarter 2009 2010 2011 2012clsa 2013clsa 2Q12clsa 3Q12clsa 4Q12clsa 1Q13clsa THB/USD 33.18 30.12 31.21 30.50 29.50 30.90 30.70 30.50 30.25

THB/JPY 100 36.07 37.14 40.53 35.88 34.71 37.68 36.55 35.88 35.59

THB/GBP 53.76 46.98 48.38 39.65 38.35 46.35 42.98 39.65 39.33

THB/EUR 47.65 40.36 40.26 33.55 32.45 38.63 35.92 33.55 33.28 Memo: USD/EUR 1.44 1.34 1.29 1.10 1.10 1.25 1.17 1.10 1.10

Memo: JPY/USD 92.0 81.1 77.0 85.0 85.0 82.0 84.0 85.0 85.0

EXPORTS & IMPORTS

8

10

12

14

16

18

20

22

24

05 06 07 08 09 10 11 12

(US$bn)

Exports

Imports


THB NEER & REER

80

85

90

95

100

105

110

05 06 07 08 09 10 11 12

(2010 = 100)

NEER

REER


-4

-3

-2

-1

0

1

2

3

4

5

6

05 06 07 08 09 10 11 12

(ppts YoY)


From growth to inflation risk Thailand’s overall economic prospects for 2012 and 2013 are favourable notwithstanding the terms of trade loss and inflation headwind from a continued rise in oil and commodity prices. The investment upswing will be reinforced by firming private consumption on the back of the minimum wage rise, civil sector salary hike, tax rebates for first home and first car buyers and the recovery in tourist arrivals. Thai tourist arrivals had already recovered to September 2011 pre-flood levels by January 2012. Rural income moreover, will benefit from rising commodity prices and the government’s pledging scheme for rice and cassava. Inflation, rather than growth, will determine BOT policy bias.

Rising interest rates in 2013 The sustained rise in oil and commodity prices will have closed the window for an interest rate cut by the time the Bank of Thailand meets on 21 March. This means that the monetary easing cycle, which lowered the 1-day repo policy rate by 50bp to 3% over the 3 months to January 2012, has ended. The BOT, cognizant of a sharply rising fiscal deficit from stepped up fiscal spending, will not sanction a further cut in interest rates, in our view. That said, the BOT will maintain an accommodative stance, allowing domestic demand to strengthen as an offset to slowing export growth. With annual inflation at 3.6% YoY in February, the policy rate was negative in real terms at -0.6%. Interest rates will get increasingly negative as inflation rises to our 4.2% inflation forecast by end-12. The BOT targets core inflation in a 0.5 – 3% range, with its (unofficial) headline target range 2ppt higher. A rise in inflation above BOT’s 5% inflation cap will trigger a 25bp hike in 3Q13 and another 25bp in 4Q13 lifting the policy rate to 3.5% by end-13. Thailand is well placed to benefit from renewed foreign capital inflows into the region this year, as discussed in the Viewpoint section. Rising FDI flows should provide strong underpinning for the balance of payments underlining our forecast for a 2.3% appreciation to THB30.5/USD in 2012 and a 3.4% appreciation to THB29.5/USD in 2013. We would stress though, that Thailand will be vulnerable during periods when global sentiment shifts to risk-off, on our prediction that its current account shifts to a 1.2% of GDP deficit in 2012, from a 3.4% surplus in 2011.



Notes


01/01/2012

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Taiwan CLSA Limited Taiwan Branch 27/F, 95 Dunhua South Road Section 2 Taipei Tel: (886) 2 2326 8188 Fax: (886) 2 2326 8166

USA - New York Credit Agricole Securities (USA) Inc 15/F, Credit Agricole Building 1301 Avenue of The Americas New York 10019 Tel: (1) 212 408 5888 Fax: (1) 212 261 2502

China - Shenzhen CLSA Limited - Shenzhen Rep Office Room 3111, Shun Hing Square Di Wang Commercial Centre 5002 Shennan Road East Shenzhen 518008 Tel: (86) 755 8246 1755 Fax: (86) 755 8246 1754

Korea CLSA Securities Korea Ltd 15/F, Sean Building 116, 1-Ka, Shinmun-Ro Chongro-Ku Seoul, 110-700 Tel: (82) 2 397 8400 Fax: (82) 2 771 8583

Thailand CLSA Securities (Thailand) Ltd 16/F, M Thai Tower All Seasons Place 87 Wireless Road, Lumpini Pathumwan, Bangkok 10330 Tel: (66) 2 257 4600 Fax: (66) 2 253 0532

USA - San Francisco Credit Agricole Securities (USA) Inc Suite 850 50 California Street San Francisco, CA 94111 Tel: (1) 415 544 6100 Fax: (1) 415 434 6140

Hong Kong CLSA Limited 18/F, One Pacific Place 88 Queensway Hong Kong Tel: (852) 2600 8888 Fax: (852) 2868 0189

Malaysia CLSA Securities Malaysia Sdn Bhd Suite 20-01, Level 20 Menara Dion 27 Jalan Sultan Ismail 50250 Kuala Lumpur Tel: (60) 3 2056 7888 Fax: (60) 3 2056 7988

United Kingdom CLSA (UK) 12/F, Moor House 120 London Wall London EC2Y 5ET Tel: (44) 207 614 7000 Fax: (44) 207 614 7070

CLSA Sales Trading Team Australia (61) 2 8571 4201 China (Shanghai) (86) 21 2020 5810 Hong Kong (852) 2600 7003 India (91) 22 6622 5000 Indonesia (62) 21 573 9460 Japan (81) 3 4580 5169 Korea (82) 2 397 8512

Malaysia (60) 3 2056 7852 Philippines (63) 2 860 4030 Singapore (65) 6416 7878 Taiwan (886) 2 2326 8124 Thailand (66) 2 257 4611 UK (44) 207 614 7260 US (1) 212 408 5800

© 2012 CLSA Asia-Pacific Markets ("CLSA").

Key to CLSA/Credit Agricole Securities investment rankings: BUY: Total return expected to exceed market return AND provide 20% or greater absolute return; O-PF: Total return expected to be greater than market return but less than 20% absolute return; U-PF: Total return expected to be less than market return but expected to provide a positive absolute return; SELL: Total return expected to be less than market return AND to provide a negative absolute return. For relative performance, we benchmark the 12-month total return (including dividends) for the stock against the 12-month forecast return (including dividends) for the local market where the stock is traded. CLSA/Credit Agricole Securities changed the methodology by which it derives its investment rankings on 1 January 2012. The stocks covered in this report are subject to the revised methodology. We have made no changes to the methodologies through which analysts derive price targets - our views on intrinsic values and appropriate price targets are unchanged by this revised methodology. For further details of our new investment ranking methodology, please refer to our website. 12/01/2012

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