singapore focus i: singapore focus ii: china focus i ... · their fiscal balances. it also makes...

Singapore focus I:Recalibrating theUOB SGD NEER model

Singapore focus II:Normalisation in thenegative SOR-SIBOR basis

China focus I:Deposit insurancescheme on track

China focus II:Taking another look atChina’s trade data

Quarterly Global Outlook 1Q2015 • UOB Global Economics & Markets Research2

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EXECUTIVE SUMMARY

FX & INTEREST RATE OUTLOOK

SINGAPORE FOCUS I:RECALIBRATING THE UOB SGD NEER MODEL

SINGAPORE FOCUS II: NORMALISATION IN THE NEGATIVE SOR-SIBOR BASIS

CHINA FOCUS I:DEPOSIT INSURANCE SCHEME ON TRACK

CHINA FOCUS II: TAKING ANOTHER LOOK AT CHINA'S TRADE DATA

OIL & GAS: LOSING SHEEN

INDONESIA

MALAYSIA

SINGAPORE

THAILAND

INDIA

CHINA

HONG KONG

JAPAN

SOUTH KOREA

TAIWAN

EUROZONE

AUSTRALIA

UNITED KINGDOM

UNITED STATES OF AMERICA

FX TECHNICALS

Information as of 05 December 2014

CONTENT

Quarterly Global Outlook 1Q2015 • UOB Global Economics & Markets Research 3

EXECUTIVE SUMMARYGROWTH MUDDLES, MONETARY POLICY DIVERGES,

AND POLITICS RUFFLES

The lacklustre global growth story of 2014 looks set to continue in 2015. Japan and the Eurozone continue to struggle in both trying to revitalize their economies and ward off the deflation threat while China surprised the markets with an interest rate cut for the first time in more than 2 years to support growth. The latest OECD Economic Outlook re-duced their 2015 global GDP growth forecast from 3.9% to 3.7% with cuts to the growth outlook for most of the major economies (except UK). Falling oil prices – a reflection of both rich global supply and anemic demand for oil – has been immensely beneficial for oil-importing economies but a bane for oil producers, especially those struggling with their fiscal balances. It also makes the threat of (headline) CPI deflation more real, and with the Eu-rozone’s November inflation easing further to just +0.3%y/y, the common currency regions stands a high chance to see headline CPI y/y deflation in the coming months that pave the way for more aggres-sive ECB actions ahead.

In comparison, growth for the US economy has been most impressive among the major econo-mies so far in 2014. We remain positive for the US growth outlook in 2015 (notwithstanding a possible repeat of some nasty weather-related disruptions in the coming weeks).

While the threat of inflation in US has remained largely subdued and further moderated by falling commodity and oil prices, wage growth has re-turned. It may still seem to run below the pre-re-cession increment pace, but service sector inflation is now firmer and gathering pace (shown by core CPI services sub-component at 2.4%y/y in Octo-ber). Job creation is happening at an average of 200,000+ monthly pace for most of 2014.

Conditions are no longer justifiable for the Fed to maintain record low interest rates at 0-0.25%. After fully ending its quantitative easing (QE) program in its October 2014 FOMC as widely telegraphed, there is an intense attention on the Federal Reserve for their confirmation of the Fed rate normalization timeline. We believe that the Fed will give clearer guidance on its rate normalization timeline as soon as its 16/17 December 2014 FOMC meeting. We still think US interest rate hike/normalization will commence in mid-2015, with the Fed Funds Target Rate at 1.25% by end-2015.

The different circumstances facing the US as op-posed to other economies, especially Japan and the Eurozone continues to put their respective cen-tral bank’s monetary policy stuck firmly in opposite directions and the theme of monetary policy diver-gence among the major central banks will remain true in 2015.

The most interesting to watch will be the European Central Bank (ECB) where speculation is strife on whether the significant worsening of growth and inflation indicators in Europe may finally justify the ECB to launch its own outright sovereign bonds buying QE programme. We also expect more (tar-geted) interest rate/reserve requirement rate cuts from China in 2015 to keep growth steady.

With the continuation of the theme of diverging monetary policies, the broad strengthening of the US dollar remains intact especially in anticipation of the commencement of the Fed Reserve’s rate normalization process, though one should also be wary that market reaction could be unpredictable as the Fed commences its policy normalization.

So what could go wrong in 2015? In the previ-ous quarterly report, we highlighted the on-going Ukraine-Russia conflict, rise of the Islamic State in Iraq and Syria (ISIS) militants into rogue state, the Ebola outbreak. So far these issues are still unre-solved but fortunately none has proven to be fatal or disruptive to asset prices. That said, we note that the on-going sanctions and collapse in oil prices (down nearly 40% since the peak in June 2014) is putting a lot of strain on the Russian economy and its domestic financial market, and that is something we want to watch out for.

We think political risks also will be elevated in 2015 and could derail our best-thought out plans. The im-mediate political risk event will be the Japan 14 Dec 2014 Lower house snap elections. The base case scenario is a straight-forward victory for Abe be-cause of weak opposition and potentially low voter turnout. But if he unexpectedly loses the elections, then that will literally mean the end of “Abenomics” and the consequent risk-off trade could send the USD/JPY back below 110 in a blink.

Meanwhile, US politics may enter into a year of high-drama in 2015. Republicans are set to gain majority power in both House and Senate in the new Congress in 2015. Of particular immediate concern is whether the Republicans will respond to US President Obama’s recent executive action on immigration by holding up a spending bill which will force the US government to cease many of its operations by 12 Dec 2014, reliving the 2013 gov-ernment shutdown. The next issue that has global implications is the US debt ceiling limit which is sus-pended until 15 March 2015. As there are no elec-tion concerns in 2015, US political brinkmanship may once again push markets to the edge at some point. And lastly, the UK will be the next major econ-omy (after Japan) to go for general elections on 7 May 2015 which could see PM David Cameron & his coalition getting the boot, with the Labour party


EXECUTIVE SUMMARY

back in power (according to latest Yougov electoral calculus, 1 Dec 2014).

Happy holidays and have a good year in 2015!

SINGAPORE IN FOCUS I:Recalibrating the UOB SGD NEER model In the most recent MAS monetary statement (14 Oct 2014), the MAS reported that the SGD NEER had fluctuated within the upper half of the policy band over the past six months. However, our UOB SGD NEER model was showing that the SGD NEER had fluctuated within the lower half of the policy band. As such, our assumption that the SGD NEER is appre-ciating at a 2.5% pa rate is on the bullish end. With that, we updated our model with the assumption of a 2.0% pa appreciation, where the SGD NEER is currently trading around 0.15% below the midpoint, rather than the 1.9% below midpoint in the older model. We think that the 2.0% appreciation in the SGD NEER is justified by the lesser-than-expected core inflationary pressures domestically, as well as an expectation that there will be a broad-base ap-preciation of the USD against Asian currencies (in-cluding the SGD).

We also took the opportunity to re-adjust the UOB SGD NEER bilateral currency weights by incor-porating Singapore’s latest trade data while using econometric methods to reduce the tracking error with the MAS-released SGD NEER. Our view on the current trading bandwidth remains the same at 2%, both ways.

After the recalibration, our 2015 USD/SGD forecast is adjusted too. Now, we see the USD/SGD moving towards a high of 1.35/USD by 3Q 2015 (previous forecast: 1.33), before coming lower to 1.33/USD by 4Q 2015 (previous forecast: 1.31).

SINGAPORE IN FOCUS II:Normalisation in the negative SOR-SIBOR basisThe end of QE in October (2014) established USD strength as the new dominant narrative in minds of investors. SOR rates have re-priced aggressively higher due to the stronger USD and seasonal end of year funding pressures.The discount between SIBOR and SOR has normalized and we do not ex-pect to revisit the average levels seen in the past 4 years as long as the expectation for Fed hikes in 2015 persists.

As seasonal funding pressure ebbs, SOR & SIBOR should consolidate below end-2014 stressed highs.

CHINA IN FOCUS I:Deposit insurance scheme on trackLaying the ground for a big step towards further financial market reform, PBoC announced in late Nov 2014 the draft regulations for a deposit insur-ance scheme, which is likely to be implemented

in 2015 along with further interest rate cuts. This announcement suggests that the Chinese govern-ment is on track to accelerate financial market re-forms after it removed lending rate controls in July 2013. The deposit insurance system should result in better reflection of the “true” financing costs and lowering of systemic risks in the financial sector over the mid-to-long term, as it helps to level some the playing field for smaller banks and broaden the deposit base away from the largest banks. Overall, it is a positive development for China.

CHINA IN FOCUS II:Taking another look at China’s trade dataNotwithstanding the soft macro backdrop domesti-cally and diverging growth paths in developed econ-omies, China’s merchandise trade figures are again showing some signs of unusual activities, with trade balance hitting record highs in 3 months out of the 4 in the Jul to Oct period in 2014, underpinned by strong performance in exports. A closer look at the data show that exports “over-invoicing” appears to be a repeat of the similar anomaly seen during in 2012 to 2013, before authorities clamped down on such activities. Our calculations show that the ex-tent of “over invoicing” comes to US$107.6bn, or about 31% of China’s trade balance of US$335.5bn for the current period. In contrast, the previous episode of exports “over-invoicing” totaled 48% of China’s trade surplus during that period. As such, exports over-invoicing may be making a comeback, albeit in a smaller scale compared to the one prior to Jun 2013.

OIL IN FOCUS:Losing sheenOil prices have tumbled more than 30% to a multi-year low with Brent <US$70/barrel (as of 03 Dec 2014). This marks a dramatic turnaround from the spike earlier in the year to US$115/ barrel due to geopolitical concerns in the Middle East.

On the supply side, surging global oil production could outpace demand this year. Increased produc-tion from Libya and Angola alongside uninterrupted supply from Iraq despite the ongoing war with ISIS have pushed up OPEC’s total output to slightly un-der 31m barrels a day, 352,000 bpd higher com-pared to one year ago. Swelling US production on the back of its “Shale revolution” has also funda-mentally changed the global oil equation and re-sulted in more-than-ample global supply.

At the same time, demand has disappointed as global growth sputters. The International Energy Agency (IEA) estimated that the pace of expansion in oil demand for 2014 & 2015 would be weaker than expected. This year, it expects demand to rise by 0.7m bpd to 92.4m bpd, 0.2m barrels less than its previous forecast. Demand for next year is ex-pected to come in at 93.5 mbd.


EXECUTIVE SUMMARY

The Dollar bull looks set to charge into 2015In October [2014], the market witnessed some of the events that we have been calling for come to pass: The Fed Reserve fully ended its quantitative easing program in the October FOMC meeting while the Bank of Japan (BOJ) finally added more monetary stimulus on 31 October MPM policy meeting after staying on pause for one and a half years.

The divergence in policy directions was especially stark for these two central banks as the US recovery (in both economy and jobs market) continues unabated while Japan’s domestic economy suffered under the weight of the April 2014 sales tax hike and the BOJ grew increasingly concerned about achieving its inflation target. Governor Kuroda justified the latest QQE expansion to pre-empt such a risk of shifts of “deflation mindset” from manifesting. And the result of diverging policies is strength of the USD against the major and emerging markets FX.

2014 US Dollar Index: A story of 2 halvesIn 2014, the US dollar story is perhaps easiest characterized into 2 halves. Our expectation (made at the end-2013) for USD strength against major and Asian FX did not play out in 1H-14 as the market fully priced in the QE taper and eased back on Fed’s interest rate hike timeline. The US dollar index (DXY) – which indicates the general international value of the USD by averaging the exchange rates between the USD and 6 major currencies (EUR, CAD, CHF, GBP, SEK and JPY) – ended 2013 at 80.79 and by the time we reached end-2Q 14, the dollar actually fell with the DXY lower at 79.78.

But significant dollar strength started to materialize in 3Q (ending at 85.936, 6.4% higher YTD) and touched a high of 88.96 on 3 December as the US economy outperformed its peers in developed and emerging markets while there were increasing concerns about the Fed’s interest rate hike (“normalization”) timeline.

That said, the story between the Asian currencies against the US dollar is a bit more complex in part due to the resilience of some currencies like the INR (which has so far only depreciated slightly against the USD by 0.1% YTD) while the depreciation of IDR (-1.0% YTD) and THB (-0.7% YTD) & CNY (-1.6% YTD) has been relatively modest when compared to the declines suffered by SGD (-4.1% YTD) and MYR (-5.6% YTD). The Asia dollar index (ADXY) – which indicates the general international value of the USD by averaging the exchange rates between the USD and 10 major Asian currencies (CNY, HKD, INR, IDR, KRW, MYR, PHP, SGD, TWD and THB) – ended 2013 at 115.77 and by end-2Q 14, the ADXY was higher at 116.18, and has since tapered off and hovering at 113.42 (as of 3 December).

Outlook remains USD positive aheadLooking ahead into end-2014 and 2015, we believe more USD strength is likely when the Fed gives a concrete rate hike timeline. The latest US 3Q 14 GDP numbers (at 3.9% growth) further strengthened markets expectations for an earlier rate hike in spring 2015. There is potentially additional divergence from Europe as the ECB is mulling more stimulus in 2015, possibly sovereign bond purchases.

We remain positive on US outlook and we believe that an above 3% growth is achievable in 2H 2014, bringing 2014 GDP growth to 2.7%, and in 2015 at 3.2% with US housing market and US consumer providing the out-performance factors. We reiterate our view that the Fed rate normalization to take place in 2Q-2015 (possibly starting in 16-17 June 2015 FOMC), bringing the FFTR to 1.25% by end-2015, and to 3.25% by end-2016. We think the Fed may change its key phrases at the 16-17 Dec FOMC meeting for further clarity on rate lift-off guidance, and that could spark another bout of USD strength and volatility before the year is out.

Major and Asian Currencies against USD (3Q 2014)

-8.13-7.36-7.19

-6.27-6.05

-4.30-4.20

-3.32-3.23

-2.65-2.06-1.69-1.34

-0.33-0.16

1.111.26

1.75

-9.00 -7.00 -5.00 -3.00 -1.00 1.00NZDEURJPYCHFAUDINRIDR

KRWGBPPHPMYRSGDTWDVNDHKDCNHTHBCNY

Source: Bloomberg

Major and Asian Currencies against USD (1H 2014)

-2.48-2.46

-1.030.050.150.211.381.621.661.80

2.332.40

3.433.46

3.803.97

5.867.00

-3.00 -1.00 1.00 3.00 5.00 7.00CNHCNYVNDHKDEURTWDCHFTHBSGDPHPMYRIDRJPYINR

KRWGBPAUDNZD

Source: Bloomberg


EXECUTIVE SUMMARY

Global FXEUR/USD: Currently hovering around the 1.2370 region, the Euro continues to retreat as hopes are high that the ECB will unveil a QE package early next year. In fact, nothing has changed the underly-ing conditions that we expect will continue to put downward pressure on the EUR/USD currency pair. Factors include the weak growth/inflation backdrop in the Eurozone, further ECB easing eventually, as well as a constructive backdrop for the USD high-lighted by continued improvement in growth, the labor market and the gradual approach of the start of Fed rate hikes. We are thus looking for the EUR/USD pair to move towards 1.2100 by the end of this year and thereafter towards the 1.190 region by the end of 1Q15.

GBP/USD: GBP has seen a marked deprecia-tion against the USD, falling more than 5% year to date. Going forward, it looks like the weakness in GBP/USD is here to stay. The BoE is likely to raise rates later than the market currently anticipates, es-pecially now that low inflation will allow the BoE to “wait-and-see” longer. Besides, heightened political risk around the May general election could weigh on the currency. We have thus revised lower our forecasts for GBP/USD into 2015, now looking for an end-1Q target of around 1.550.

AUD/USD: Currently hovering below the 0.8400-figure, AUD/USD has spiked sharply down-wards. The fall in the Australian dollar is a very wel-come development for the RBA, giving the central bank more scope to hike rates down the road amid rising concerns about the elevated level of activity in the housing market. It will also aid the economy’s rebalancing, boosting growth and hiring in the non-mining sectors. We continue looking for a lower AUD/USD into 2015. A large part of the currency’s weakness is expected to be due to increasing US dollar strength, where the story of rising US interest rates is likely to dominate currency trade. We are penciling an end-1Q target of around 0.8100.

NZD/USD: TA pause in the RBNZ interest rate raising cycle in response to very low inflation is likely to see the NZD underperform. Although New Zealand’s interest rate is far more generous than any other major economy, with interest rates in the US and possibly the UK expected to rise in 2015, the yield advantage of New Zealand's financial as-sets diminishes. The RBNZ’s discontent with the high level of the NZD, alongside further declines in export commodity prices and continued slowing economic momentum should also continue to en-courage currency depreciation. With that, we see

the NZD/USD moving lower towards the 0.75 level by end-1Q15.

USD/JPY: We see a period of possible yen con-solidation amidst political uncertainty before 14 Dec election. If PM Abe re-captures the parliament with a stronger public vote, then that could send USD/JPY to fresh multi-year highs. Conversely, if he un-expectedly loses the popular vote, then that could see the yen weakness quickly unravel with the pair easily heading below 110. Political risk in Japan will be the dominant theme for now. Barring an unex-pected snap election outcome, we expect the USD/JPY pair to close 2014 at 120 and will head towards 125 by end-2Q 2015 as the Fed finally delivers the first rate action which we expect in June 2015 FOMC.

Asian FXUSD/CNY: Our views remain intact with the unit firming marginally to 6.03/USD by end-2015. Even if it hit our target of 6.10/USD for end-2014 (spot: 6.1501 on 4 Dec), that would still be a full year de-cline of 0.8%, which would be the first annual de-cline since 2009. What is more important than the currency level is that as RMB internationalization accelerates, 2-way moves for the currency would also be the “new normal” as it behaves more like a global currency that is subject to both external and domestic factors. This means that there could be repeat of the bouts of depreciation, as seen during the Jan-Apr period 2014. For 2015, our expecta-tions for Fed interest rate “normalization” could see USD strength pressuring the RMB as well. Having said that, the risks of prolonged depreciation are low, as the currency may need to maintain a largely stable value at this early stage of internationaliza-tion.

USD/SGD: We continue to believe that the MAS will maintain the current stance of a “modest and gradual” appreciation of the SGD NEER as the still-tight labour market may see higher wage costs fil-tering into higher core inflation. However, we expect the interest rate normalization in the US to start in June next year and would see a downward pres-sures in Asian currencies. This will see the USD/SGD moving towards a higher of 1.35/USD by end 3Q 2015, before moving to 1.33/USD by end 4Q 2015.

USD/IDR: The budget for 2015 will be reviewed following the fuel price hike. Fiscal improvement and the orientation of the new government towards higher spending on infrastructure, healthcare and education are positive for the IDR. Nonetheless,


EXECUTIVE SUMMARY

we still see upside risk to USD/IDR in line with broad USD strength. We expect USD/IDR to rise to 12,400 in 1Q15.

USD/KRW: JPY factors are expected to continue to dominate and if the expectation of BoK easing leads to a sharper upward momentum in USD/KRW, this may reduce the risk of further rate cut by the BoK. Other than the BoJ, the expectation of US Fed’s monetary normalisation will also contribute to higher USD/KRW. As such, we expect USD/KRW to head up to 1,140 by end-1Q15.

USD/MYR: Sharp fall in global oil prices has un-settled markets. The government’s heavy reliance on oil-related revenue (around 30% of total reve-nue) and the country’s position as a net oil-exporter have weighed heavily on MYR, particularly com-pared against the regional countries which are net oil importers. Concern of narrowing current account surplus in the fourth quarter has led to the rapid as-cent in USD/MYR above 3.45 in early December. Expectation of Fed interest rate normalization and soft commodity prices are expected to keep USD/MYR biased towards 3.50 in the first half of 2015.

USD/THB: The next Bank of Thailand monetary meeting will be on 17 December and we still ex-pect the BoT to maintain the current policy rate of 2.0%, supported by the lower inflationary trajectory. With Thai interest rates expected to remain low go-ing into 2015, and the expected normalization of the US interest rates starting in 2H 2015, we maintain our view that there would be downward pressure on the THB going forward. We expect the THB to move lower against the USD towards 33.50/USD by end 2014 from around the 32.90 level currently.

USD/INR: The Reserve Bank of India will be watching closely on the impact of the expected in-terest rate normalization in the US on the INR in 2015. We recall the period of capital outflow after the “taper talk” in May 2013 and the quick 22% de-preciation of the INR from 53.9/USD towards 68.8/USD. Thus, we keep our view that the RBI will keep their current repo rate of 8% unchanged in 2015, especially since recent months of trade deficits have widened again. We predict that rates normali-zation in the US and continued trade deficits will see a weaker INR towards 64.90 by middle of 2015.

Global Interest RatesFed Reserve: We believe the 16-17 December FOMC meeting could move the USD materially as there is a strong possibility the Fed adjusts its key phrases during that meeting to provide clarity on

Fed’s lift-off timetable and that could spark another bout of USD strength and volatility before the year is out. We reiterate our view that we are still ex-pecting the Fed rate normalization to take place in 2Q-2015 (possibly starting in the 16-17 June 2015 FOMC) bringing the FFTR to 1.25% by end-2015, and to 3.25% by end-2016. Two issues will compli-cate the FOMC decision in 2015, data and US poli-tics. An early assessment of the 2015 FOMC voters suggests a more dovish group.

ECB: Although there wasn’t any concrete action from the ECB at the final Governing Council meet-ing of 2014, President Mario Draghi in his clearest language yet, offered assurances that more ag-gressive stimulus was just around the corner, un-derlining the central bank’s commitment to support the ailing economy of the 18-country bloc. It is clear that the ECB wants to wait out a little longer to see the current policy mix, including the take-up of the upcoming TLTRO on 11 December. Besides, plung-ing oil prices is seen blurring the ECB outlook and they will require more clarity before acting. But our call for the ECB to implement a broad-based asset purchasing plan including sovereign QE in the first half of next year remains valid. Although there is some resistance, it is obvious that Draghi is commit-ted to using additional unconventional instruments, at the same time, willing to live with some dissent in a QE vote in order to ease the policy stance further and deliver on the ECB’s primary legal mandate.

BOE: Since August 2014, Martin Weale and Ian McCafferty have continued to push for higher rates but given the deterioration seen in economic con-ditions of late, the majority of the MPC remained against raising interest rates. Some MPC mem-bers have noted concern over diminishing slack in the economy and said low productivity could be a source for potential wage pressures, which might see inflation overshoot the 2% target. Besides, in the current environment where weakness in the Eurozone prevails and factoring in lower commod-ity prices, the risk for inflation overshooting the 2% target would seem less pronounced than that of an overshoot. We believe that the BoE will hold fire on rates and have thus pushed back our rate hike ex-pectations to 4Q15.

RBA: We think that the decline in the exchange rate is not yet enough to offset the negative impact on the economy and labour market, as well as the ongoing weakness in commodity prices and slowing Chinese growth. In fact, these factors have prompt-ed some discussion that the RBA’s next move could be to cut rates. That said, the biggest sector holding


EXECUTIVE SUMMARY

the RBA from cutting interest rates is the property market. The bank cannot ignore the risks associat-ed with an overheated property market, yet we may see the introduction of macro-prudential measures aimed at preventing buyers from overleveraging, similar to what the RBNZ did. We still see the next RBA move as up, as growth continues to rebalance. However, we have pushed back the hike towards the end of 2015, with the risk for that rates could stay unchanged for longer.

RBNZ: The October meeting culminated with the RBNZ leaving the OCR unchanged at 3.50%. Un-like in September where the RBNZ had said it was on pause, but explicitly referred to future policy tight-ening; the October’s statement was vague and non-committal. It highlighted that growth was expected to moderate; the exchange rate was expected to depreciate; inflation was expected to increase; and the OCR was expected to remain unchanged for a while. Although the central bank removal of any explicit reference to future hikes was indeed a sig-nificant change, the RBNZ does expect that the next OCR change will be up. This is in line with our expectations. We believe that the OCR will remain on hold for some time, especially given the sub-dued inflation backdrop, but will eventually move up some time in the second half of 2015.

BOJ: After expanding its quantitative and qualita-tive easing (QQE) program in October 2014, the Bank of Japan (BOJ) kept its monetary stance un-changed in Nov and we believe the BOJ is unlikely to do more in December or in 2015. We initially factored another round of stimulus ahead of the Oct 2015 sales tax hike, but the stimulus is now off the table since the hike has been delayed till 2017. However, the pace of CPI inflation has been eas-ing since August with the continued decline in oil prices, that will surely add more downside pressure on inflation & puts BOJ in a tight spot in 2015 to consider more monetary easing (to achieve its 2% inflation target) but without the government’s com-mitment to fiscal discipline.

Asian Interest RatesPBoC: PBoC’s surprise interest rate cuts an-nounced on 21 Nov was the first reductions since July 2012. On the surface it looks to be a shift to-wards “easing” policy. However after factoring in the increase in deposit rate ceiling, there is virtually no change to the deposit rates post-announcement, whereas there is an outright reduction in borrowing costs. In other words, the announcement is yet an-other “targeted” move like others that took place for most this year. In case the message is lost, PBoC

followed up with the release of the draft regulations for deposit insurance scheme one week later, on 30 Nov, for public consultation (please see our focus piece on deposit insurance for more details). Once the deposit insurance scheme is implemented, pos-sibly by mid-2015, it is conceivable that the ceiling on deposit rate will be removed as well. Meanwhile, we expect PBoC to continue to lower lending rates into the first half of 2015, as well as deposit rates (raising ceiling limit at the same time), and reserve requirement ratios (RRR) to ensure sufficient credit in the system.

MAS: Singapore’s labour market continues to re-main tight (3Q unemployment at a low of 1.9%) and the risks of higher wage costs filtering into higher core inflation remains a concern. Also, our view that the US interest rate normalization starting in June next year will see downward pressures on the SGD. With that, we believe that the MAS will continue to keep the current stance of a “modest and gradual” appreciation of the SGD NEER unchanged. With the SGD SIBOR positively correlated with the USD LIBOR, our expectations that the US interest rate normalization in June 2015 will see the SIBOR moving on a higher trajectory in 2015. We expect the 3M SGD SIBOR to move to 1.00% by end 2015.

BI: BI raised its policy rate by 25 bps to 7.75% at an unscheduled monetary policy meeting on 18 No-vember, a day after the government delivered on its fuel subsidy cut, announcing Rp2,000 per litre or 31% hike in the fuel price. This was the first interest rate increase in a year after the previous fuel price hike in June 2013.

As a result of higher fuel prices, headline inflation jumped to 6.2% y/y in November from 4.8% in Octo-ber but core inflation only edged up slightly to 4.2% y/y from 4.0% in October. We expect the headline CPI to hit 8.0% in the middle of 2015 before easing off by year-end to the top of BI’s 3-5% target due to base effect. As this will be close to the inflation peak that we have seen in the previous fuel price hike, it is unlikely to trigger an aggressive reaction from the central bank, particularly as the positive sentiment from the subsidy reform has driven Indo-nesian yields lower.

Monetary normalisation in the US could pressure on the IDR in the coming months and with Indone-sia expected to continue registering a current ac-count deficit, we still see a possibility of another 25 bps hike in the BI rate in the short-term to prevent a situation of negative real interest rates and to con-tain the capital outflow risks. The overnight deposit


facility rate (FASBI) which was left unchanged at 5.75% in November could also be raised to effec-tively contain the inflationary pressure.

BOK: Easing monetary policy in Japan will pres-sure the BoK to cut its base rate further especially if the incoming economic data do not improve. Cen-tral to the worry was the decline in JPY/KRW rate which poses challenges to South Korean exporters especially those in the local car and steel industries even as the diversification of the production bases out of South Korea has helped to alleviate some of the competitiveness concerns.

After a combined 50 bps interest rate cut in August and October, the base rate is now at a record low of 2.00%, similar to its lowest during the Global Finan-cial Crisis. The low domestic inflation suggests that the base rate could go below 2.00% in the short-term but a sustained period of extremely low inter-est rate runs the risk of fanning more debt build-up which is an increasing concern for the households. Our baseline expectation is for the base rate to re-main at 2.00% in the first half of 2015.

BNM: Other than slower domestic growth, easy monetary policies in Japan and Europe have re-duced the probability of a 25 bps rate hike in Ma-laysia next year. The key risk is the MYR as further depreciation in the currency could pose greater in-flation risk and would probably increase the chance of a rate increase. All in all, we still see some chance of a 25 bps hike in the Overnight Policy Rate (OPR) to 3.50% in 1Q15 before the GST implementation. The next meeting has been scheduled on 27-28 January 2015. Bank Negara has kept to a slightly

hawkish bias in its November monetary policy state-ment, maintaining its view that inflation “will contin-ue to be above its long-term average next year due to domestic cost factors” but expects some mitigat-ing effect from the lack of external price pressures and more moderate demand conditions.

BOT: The next Bank of Thailand monetary meet-ing will be held on 17 December and at this junc-ture, we still expect the BoT to maintain the current policy rate of 2.0%, supported by the lower inflation-ary trajectory. Although we will likely see stronger economic growth (our forecast: 4.0%) in 2015, that would mainly be due to the low base this year. With that, we think that a stronger confirmation of strong-er consumption and investment demand needed to be observed before any possibility of the BOT hik-ing the current policy rate in 2015.

RBI: The current favourable inflationary environ-ment in India due to lower energy prices, stable INR, and a lower trend in core inflation points to some leeway for the Reserve Bank of India (RBI) to pursue lower interest rates in 2015. Consumer pric-es certainly have more room to move lower and the RBI governor, on 2 Dec, said there is possibility to cut rates should inflation move lower. However, we think that the RBI should also be wary that the US will start their interest rate normalization and capital outflow worries should be on their dashboard. We recall the period of capital outflow and the quick de-preciation of the INR during May 2013 when the US Fed started the ‘taper talk’. As such, we maintain our view that the RBI will keep their current repo rate of 8% unchanged in 2015, especially since re-cent months of trade deficits have widened again.

EXECUTIVE SUMMARY

Growth Trajectory

y/y % change 2012 2013 2014F 2015F 3Q14 4Q14F 1Q15F 2Q15F 3Q15F 4Q15F

China 7.7 7.7 7.4 7.2 7.3 7.5 7.1 7.2 7.3 7.3

Eurozone -0.7 -0.4 0.8 1.1 0.8 0.6 0.7 0.9 1.2 1.4

Hong Kong 1.5 2.9 3.5 3.7 2.7 1.3 2.0 2.1 2.7 3.6

Indonesia 6.3 5.8 5.1 5.5 5.0 5.0 5.3 5.4 5.7 5.7

Japan 1.5 1.5 0.7 1.0 -1.2 1.4 -0.9 1.0 1.0 2.8

Malaysia 5.6 4.7 5.9 5.2 5.6 5.4 5.4 5.0 5.2 5.2

Philippines 6.8 7.2 6.0 6.5 5.3 6.2 6.8 6.5 6.4 6.3

India 4.8 4.7 5.4 5.8 5.3 5.8 5.7 5.9 6.2 5.3

Singapore 2.5 3.9 3.2 3.3 2.8 2.7 3.0 3.3 3.3 3.5

South Korea 2.3 3.0 3.4 3.9 3.2 3.2 3.3 3.8 4.0 4.2

Taiwan 2.1 2.2 3.6 3.5 3.6 3.0 3.3 3.0 3.3 3.2

Thailand 6.5 2.9 0.7 4.0 0.6 2.3 4.9 4.4 3.6 3.1

US (q/q SAAR) 2.3 2.2 2.7 3.2 3.9 3.2 2.7 4.2 3.2 -0.4

Source: CEIC, UOB Global Economics & Markets Research Estimates


FX & INTEREST RATE OUTLOOK

FX OUTLOOK As of 05 Dec 14 End 1Q15F End 2Q15F End 3Q15F End 4Q15F

USD/JPY 119.9 121.0 125.0 126.0 127.0

EUR/USD 1.24 1.19 1.17 1.17 1.16

GBP/USD 1.57 1.55 1.53 1.54 1.55

AUD/USD 0.84 0.81 0.80 0.78 0.78

NZD/USD 0.78 0.75 0.74 0.74 0.72

USD/SGD 1.31 1.33 1.34 1.35 1.33

USD/MYR 3.46 3.49 3.50 3.50 3.45

USD/IDR 12,300 12,400 12,500 12,500 12,400

USD/THB 32.86 34.1 33.7 33.5 33.4

USD/PHP 44.51 45.0 44.0 43.0 42.0

USD/INR 61.78 63.7 64.9 66.3 67.8

USD/TWD 31.07 31.6 31.8 31.9 31.8

USD/KRW 1,112 1,140 1,150 1,150 1,130

USD/HKD 7.75 7.75 7.75 7.75 7.75

USD/CNY 6.15 6.08 6.06 6.05 6.03

Source: Reuters, UOB Global Economics & Markets Research

INTEREST RATE TRENDS As of 05 Dec 14 End 1Q15F End 2Q15F End 3Q15F End 4Q15F

US (Fed Funds Rate) 0-0.25 0-0.25 0.50 1.00 1.25

EUR (Refinancing Rate) 0.05 0.05 0.05 0.05 0.05

GBP (Repo Rate) 0.50 0.50 0.50 0.50 0.75

AUD (Official Cash Rate) 2.50 2.50 2.50 2.50 2.50

NZD (OCR) 3.50 3.50 3.50 3.75 4.00

JPY (OCR) 0-0.10 0-0.10 0-0.10 0-0.10 0-0.10

SGD (3-Mth SIBOR) 0.43 0.39 0.40 0.60 1.00

IDR (BI Rate) 7.75 8.00 8.00 8.00 8.00

MYR (Overnight Policy Rate) 3.25 3.50 3.50 3.50 3.50

THB (1-Day Repo) 2.00 2.00 2.00 2.00 2.00

PHP (Overnight Reverse Repo) 4.00 4.00 4.00 4.00 4.00

INR (Repo Rate) 8.00 8.00 8.00 8.00 8.00

TWD (Official Discount Rate) 1.88 1.88 1.88 1.88 1.88

KRW (Base Rate) 2.00 2.00 2.00 2.00 2.25

HKD (Base Rate) 0.50 0.50 1.00 1.50 1.75

CNY (1-Yr Working Capital) 5.60 5.35 5.10 5.10 5.10

Source: Reuters, UOB Global Economics & Markets Research


SINGAPORE FOCUS IRECALIBRATING THE UOB SGD NEER MODEL

Current SGD NEER is probablyon a 2.0% pa appreciating trendIn the most recent MAS monetary statement (14 Oct 2014), the MAS reported that the SGD NEER had fluctuated within the upper half of the policy band over the past six months. However, the UOB SGD NEER model was showing that the SGD NEER had fluctuated within the lower half of the policy band in the same period. As such, we concluded that our assumption of the SGD NEER appreciating at a 2.5% pa rate is on the bullish end.

The last time the MAS had ‘tweaked’ the SGD NEER was during the April 2012 monetary policy meeting where the “slope will be increased slightly, and there will be no change to the level at which the band is centered…(while) restoring a narrower policy band”. Since our assumption that the policy slope was 2.0% just before that announcement, we assumed that the “slight increase” will bring the appreciation of the SGD NEER to 2.5% pa.

With the MAS publishing the actual SGD NEER at a higher frequency (weekly average at the start of each month, rather than twice a year) since Oct 2012, we have been able to track and compare the MAS SGD NEER and the UOB SGD NEER. Both had trended quite well together until this year when the assumption of a steeper 2.5% pa slope started to break down. Looking back at the various statements by the MAS on the movements and directions of the MAS SGD NEER, we determine that a slope assumption of 2.0% pa will best fit the statements.

As such, we performed a retrospective adjustment to our assumptions of the policy slope until the monetary policy meeting of April 2011, where the assumption of the policy slope was at 3.0% pa. Our assumption of the current bandwidth at 2.0% (since April 2012) remains unchanged. The chart below shows the UOB SGD NEER and the assumptions of both 2% and 2.5% slopes, while the chart above

� In the most recent MAS monetary statement (14 Oct 2014), the MAS reported that the SGD NEER had fluctuated within the upper half of the policy band over the past six months. However, the UOB SGD NEER model was showing that the SGD NEER had fluctuated within the lower half of the policy band. As such, our assumption that the SGD NEER is appreciating at a 2.5% pa rate is on the bullish end.

� We also took the opportunity to re-adjust the UOB SGD NEER bilateral currency weights by incorporating Singapore’s latest trade data while using econometric methods to reduce the tracking error with the MAS-released SGD NEER. Our view on the current trading bandwidth remains the same at +/-2%.

� Our updated model now assumes the SGD NEER’s appreciation path at 2.0% pa, where the SGD NEER is currently trading around 0.15% below the midpoint, rather than the 1.9% below midpoint in the older model. We think that the 2.0% appreciation in the SGD NEER is justified by the lesser-than-expected core inflationary pressures domestically, as well as the broad-base appreciation of the USD against Asian currencies (including the SGD). With that, we see the USD/SGD moving towards a high of 1.35/USD by 3Q 2015, before coming lower to 1.33/USD by 4Q 2015.

UOB SGD NEER with 2.5% and 2.0% slope assumptions since April 2012

116

118

120

122

124

126

Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Jul-14 Oct-14

UOB SGD NEEROld MidpointNew Midpoint

2.0% slope

2.5% slope

Source: CEIC


SINGAPORE FOCUS I

shows the UOB SGD NEER with the midpoints and the 2% bands.

Adjusting the UOB SGD NEERcurrency pair components & weightsWe also took the opportunity in the review of the UOB SGD NEER to re-adjust the bilateral currency weights by incorporating Singapore’s latest trade data.

There are basically two main steps involved in the derivation of the new UOB SGD NEER. First, we conducted a review of the most recent trade data of Singapore’s trading partners. The member countries in the list did not change much, and mostly were just a shift in the positioning. However, we realized that India had been moving up into the list over the years and is currently Singapore’s top 12th trading partner in 2013.

Latest 2013 trade data showed the importance of India as a direct trading partner with Singapore. During that year, India’s total trade with Singapore hit US$16.1 billion, from US$3.4 billion just 10 years ago (an annual compounded growth rate of nearly 19%). With the optimism surrounding the recent election win by Modi and the positive impact on economic growth through a series of pro-business reforms centering around foreign direct investments, land acquisition, and labour market, we believe that there will be a lot more bilateral trade between Singapore and India. In fact, growing by the same annual rate will see total trade with India growing to US$31 billion a year in 2030 (roughly Singapore’s total trade with Japan currently). As the old version of the UOB SGD NEER did not capture movements of the SGDINR, we have decided to include this currency pair.

Second, although we could have used the trade weights of each country to compute the UOB SGD NEER, it may not be an ideal method, because

it ignores other important variables such as the trading of services (which had been getting traction in recent years) and bilateral investment flows. Both are important determinants of the demand for each currency pair, but will not be captured in a simple trade-weighted SGD NEER model. As such, we turned to econometric modeling to derive the optimal bilateral currency weights that will determine each day’s UOB SGD NEER, using the information from day-to-day movements of all the specified currencies.

Performance evaluationIn any index derivation exercise, we need to ensure that the newer index follows more closely to the actual index (ie: reduce tracking error). Using a commonly used performance evaluation methodology, we used the Mean Average Percentage Error1 (MAPE) to evaluate the deviation of our new model to the actual MAS SGD NEER vs the older model’s deviation. The larger the MAPE, the higher the tracking error.In the sample testing period from Jan 2011 to Oct 2014 (using weekly data), we found that the new UOB SGD NEER model performs better as it had a much lower MAPE compared to the older model. The table below shows the evaluation results:

We provide a visual representation of both New and Old models together with the actual MAS SGD NEER data. Although we see all three moving in the same,

1 where At is the actual value and Ft is the forecast value

UOB SGD NEER with 2.0% slope and 2.0% bandwidth

100

105

110

115

120

125

130

2009 2010 2011 2012 2013 2014

UOB New SNEERMid-Point of Estimated Policy BandUpper-end: 2%Lower-end: 2%

Source: CEIC

Mean average percentage errors of both SGD NEER models

UOB SGD NEER Mean average percentage error

New UOB SGD NEER 19.03 bps

Old UOB SGD NEER 26.12 bps

Source: UOB Global Economics & Markets Research

M = ― ∑ � �1nt=1

n At - Ft

At


SINGAPORE FOCUS I

general direction, we can see that the Old UOB SGD NEER experienced a few periods of ‘deviation’ from the MAS SGD NEER, while the New UOB SGD NEER model tracked it more tightly (Chart above).

Implications for the USD/SGDOur latest exercise in re-weighting the UOB SGD NEER and the modified assumptions on the rate of appreciation (to 2.0% pa) shows that the New UOB SGD NEER is currently trading around 0.15% below the midpoint (as of 26 Nov 2014), while the Old UOB SGD NEER is trading at 1.9% below the midpoint. We think that the 2.0% pa SGD NEER appreciation assumption is justified as recent trends in Singapore’s core inflation point to a weaker-than-expected trajectory. With that, current levels of the USD/SGD

are trading tightly around the implied USGSGD from our new SGD NEER model (Chart below).

USD/SGD in 2015Going forward, we continue to expect a broad-base appreciation in the USD against Asian currencies due to the expected interest rate normalization in the US in June 2015. As such, this will result in a weaker-than-previously-forecasted SGD against the USD. Moreover, our revised UOB SGD NEER model has us moving our forecast of the USD/SGD higher to reach 1.35/USD by the 3rd quarter of 2015, rather than the 1.33/USD we had penciled before this exercise. The USD/SGD will likely ease after the start of the rate normalization and move lower to 1.33/USD by 4Q 2015 (from our forecast of 1.31/USD earlier).

New and old UOB SGD NEER and MAS SGD NEER

110

112

114

116

118

120

122

124

126

Jan-11 Jun-11 Nov-11 Apr-12 Sep-12 Feb-13 Jul-13 Dec-13 May-14 Oct-14

New UOB SGD NEERMAS Actual SNEEROld UOB SGD NEER

Source: CEIC

Implied USD/SGD from new SGD NEER model

1.15

1.20

1.25

1.30

1.35

Jan-12 Sep-12 May-13 Jan-14 Sep-14

USD/SGD (Actual)Lower-EndUpper-EndMid-Point (Implied)

Source: CEIC


SINGAPORE FOCUS IINORMALISATION IN THE NEGATIVE SOR-SIBOR BASIS

When we look at the long term relationship between SGD SOR and SIBOR, the relationship can be divided into 3 distinct phases, delineated by the 2008 global financial crisis. Pre crisis, SOR–SIBOR basis has been generally positive and tightly distributed around 0. Crisis period, risk aversion and liquidity/credit concerns caused volatility in the basis to spike. Post crisis, as market volatility dampened SOR–SIBOR basis settled in negative territory after FED funds reached the zero bound. With FED rates at zero, SIBOR also found a floor and lost impetus to the downside, whilst SOR got dragged lower by declining USD LIBORs and a weaker USD due to the enactment of QE.

Since the QE ended in October, SOR-SIBOR basis have started widening (getting less negative) led by the shorter tenors. At the end of November, the cumulative change in 1M SOR-SIBOR basis sums to around +24bp, with 3M and 6M basis also registering

positive gains of +16bp and +8bp respectively.

Volatility has been most pronounced in the 1M SOR due seasonal end of year funding stress, and this has pushed 1M SOR to a high of 0.53% in November and inverting the SOR yield curve. We do not foresee an inverted SOR curve to persist much beyond the first few weeks of December because end of year funding pressures would have moved down the curve into the shorter tenors relieving the stress seen in 1M SOR.

The catalyst for the uptick in SOR-SIBOR basis in November has been the strengthening USD driven by the end of QE. Further support for USD strength was also provided by the BOJ and ECB who have stepped in with their own monetary accommodation. When USD/SGD broke higher in October, through the 1.2800 shackles that contained it for much of 2014, this triggered better bidders in the USD/SGD forwards looking to capitalize/hedge further upside

Cummulative daily change in SOR-SIBORbasis since Oct FOMC

-10

0

10

20

30

40

Nov 14Nov 14Nov 14Oct 14

SORF1M Index - SIBF1M IndexSORF3M Index - SIBF3M IndexSORF6M Index - SIBF6M Index

Source: Bloomberg

SORF1M Index - SIBF1M Index

-120

-80

-40

0

40

80

120

Nov 99 Nov 02 Nov 05 Nov 08 Nov 11 Nov 14

Source: Bloomberg

1M SOR pulled higher by USD/SGD

0.15

0.25

0.35

0.45

0.55

0.65

1.265

1.275

1.285

1.295

1.305

1.315

Oct 14 Oct 14 Nov 14 Nov 14 Nov 14

SGD Curncy (LHS)SDO1M Curncy (RHS)

Source: Bloomberg

SOR curves

0.1

0.2

0.3

0.4

0.5

0.6

Oct 14 Nov 14 Nov 14 Nov 14

SORF1M IndexSORF3M IndexSORF6M Index

Source: Bloomberg

SOR curve inversion


SINGAPORE FOCUS II

in the USD/SGD.

SOR fixings have consequentially shifted higher and look to remain so. After a prolonged period of QE, positions and mindsets will need time to grapple with the transition towards higher USD/SGD and USD yields. This transition expected to keep SOR supported on dips into 2015. We expected the negative SOR-SIBOR basis to be whittled away gradually by the combination of hedging requirements and currency positioning with the latter gaining dominance as the days roll on, when clarity on the FED hike cycle improves. SOR repriced aggressively higher in the last week of November, realizing our call for normalization of the basis early.

Despite the early normalization, we do not expect to revisit the discount seen in the last 4 years. We continue to expect that the SOR-SIBOR basis up to 6 months will fluctuate around 0 without any systematic discount. Funding that has relied on the

relative stability of the “discount” in SOR rates for the past few years are facing a limited shelf life. The main risk to this view will be from a re-emergence of credit fears, which could drive a disorderly surge in demand for USD relative to SGD. However, the severity of potential funding crunch is unlikely to be as pronounced as in the past since current bank balance sheets are in better shape. Looking ahead, we expect the Fed to begin rate normalization cycle during the June 2015 FOMC and for SGD rates to move in tandem with US rates. The current level in the USD LIBOR is near the zero-bound, any movement higher will see both SOR and SIBOR moving up accordingly at a measured pace. However, as we continue to expect the SGD NEER to remain on a “modest and gradual” appreciation trend, the SOR and SIBOR rates will not match the moves in the USD LIBOR one for one due to “uncovered interest parity” and the gap that has already opened between SIBOR/SOR and LIBOR.


CHINA FOCUS IDEPOSIT INSURANCE SCHEME ON TRACK

Draft deposit insurance regulations announced China’s central bank PBoC had on 30 Nov released draft regulations on deposit insurance, requesting for public consultation within 30 days, as the country takes its final steps towards implementing a scheme that has been in discussion since 1993. The latest announcement shows that the government’s market reform plan remains on track and is taking yet another step towards the opening of its capital account as well as improving the transparency and stability of the financial system, as smaller financial institutions will have a better chance in competing for customers’ deposits.

PBoC’s surprise interest rate cuts announcement recently on 21 Nov already hinted at more reform measures ahead, as at that time it also lifted deposit interest rate ceiling at that time to 1.2x of benchmark rate, from 1.1x previously.

Once deposit insurance is in place, which is likely to be around the first half of 2015 given the 30-day feedback window, the ceiling on deposit interest rate will also go the way of the lending interest rate floor, which itself was abolished on 20 July 2013, or nearly one and half year ago.

After the surprise move on 21 Nov from PBoC, we expect another round of interest rate cuts along with the implementation of deposit insurance scheme in 2015, with cuts to both deposit and lending rates, as well as possible reductions in reserve requirement ratios (RRR) in the first half of next year.

Market reform pace accelerating As we mentioned back in April (please see our report “China: Pushing Ahead Financial Sector Reforms” dated 30 April 2014), the pace of financial market reform in China has taken on greater urgency under the administration of Xi Jinping/Li Keqiang.

After allowing the establishment of privately owned banks with private capital to promote the opening of the sector since the 18th session of the Third Plenum, PBoC was already working on an accelerated schedule to set up a deposit insurance scheme.

A deposit insurance scheme is a key component in China’s ongoing financial sector reform as it will form a bedrock of consumer confidence once the financial

system is open to freer capital flows.

Such a scheme should also enhance transparency and strengthen the stability of the financial system, making it more resilient to shocks. This is because smaller institutions will have a better chance in competing for deposits and will also allow for the spreading out of the deposit base, which would otherwise bias towards the largest institutions that are perceived to be “safe”.

Without a deposit insurance scheme, one potential risk is that smaller financial institutions are more exposed to deposit runs given that there is generally less confidence due to their size. But at the same time a high concentration of deposits in the largest institutions could also raise the risks of the entire system (i.e. “systemic risk”) should these financial institutions fail for some reason. Thus a healthy development of smaller financial institutions will actually help to lower overall systemic risks as well as funding and credit costs, and to extend the reach to small and medium enterprise (SME) and agricultural sectors, which are generally not as well served by larger institutions.

According to the Q&A accompanying PBoC’s announcement, the proposed deposit insurance scheme will insure deposits of up to RMB500,000 (approx. US$81,400) for both individual and corporate depositors, an amount equivalent to 12x China’s per capita GDP in 2013. This ratio is relatively high compared to the typical insured range of 2-5x of per capita GDP, e.g. the ratio of 5.3x for the US, 3x for the UK, 2x for South Korea, and 1.3x for India, with the rationale being that China is a high savings country, PBoC said. Based on its calculations, it is expected the insured amount of RMB500,000 would cover 100% of deposits for more than 99.5% of all depositors, including corporate depositors.

As a comparison, the table below shows various deposit insurance schemes in the Asia Pacific region, with India’s being the oldest in Asia and the insured amount the smallest in absolute amount, consistent with the per capita measure as pointed out by PBoC in its Q&A.

ImplicationsAfter percolating for more than 20 years, the

� PBoC announced the draft regulations for a deposit insurance scheme, which is likely to be implemented in 2015 along with further interest rate cuts

� This announcement suggests that the government is on track to accelerate financial market reforms after it removed lending rate controls in July 2013

� The deposit insurance system should result in better reflection of the “true” financing costs and lowering of systemic risks in the financial sector over the mid-to-long term.


CHINA FOCUS I

imminent implementation of a deposit insurance scheme is a right direction for China’s financial sector in the mid to long term towards a healthier and more resilient system, and the draft regulation suggests that PBoC remains on track. As we expect the ceiling for deposit interest rate to be removed at about the same time of the implementation of the deposit insurance, banks’ margins will be compressed further as interest rates are fully liberalized and subject to fiercer competition. This should help to reflect the “true” funding costs for the system, thus allowing for a more proper allocation of credit.

In the near term however, such a scheme is not expected to have any significant effect on the broader economy. We continue to maintain our projections of 7.4% for 2014 (with 7.4% expansion already achieved in the first three quarters of 2014) and slowing slightly to 7.2% for 2015 as China continues with its rebalancing and restructuring efforts. While

the slightly more accommodative monetary policy would keep China’s economic growth on track, downside risks to our growth projections for 2015 remain significant.

As mentioned earlier, we also anticipate interest rate and RRR cuts to be announced along with the expected implementation of deposit insurance in the first half of 2015, bringing the 1Y lending rate to 5.10% by end-2015 from 5.60% currently.

Our expectations remain that there is little room for appreciation for the RMB going into 2015, and instead more two-way volatility should be expected for the currency with the US Federal Reserve poised to “normalize” interest rates. We maintain our end-2014 USD/CNY forecast at 6.10, and at 6.03 for end-2015, keeping in mind the possibility of bouts of depreciation for the currency as PBoC accelerates financial market reform and RMB internationalization.

Comparison of Deposit Insurance System Across Asia Pacific

Jurisdiction Established /Operationalized Type of system Insured amount

(local currency)USD equivalent

(current exchange rate)

Australia 1998 Government legislated and administered AUD $250,000 231,850

Brunei 2011 Government legislated and privately administered B$50k per depositor per institution 39,825

Chinese Taipei 1985 Government legislated and administered NTD3 million 99,438

HK 2006 Government legislated and privately administered

HK$500,000 per depositor (individual or business entity) per bank 64,488

India 1962 Government legislated and privately administered

INR100,000 per depositor in same capac-ity and same right. 1,655

Indonesia 2004 Government legislated and privately administered IDR 2 billion 174,000

Japan 1971 Other Government legislated. Single Accounts=JPY 10 million 97,440

Korea 1996 Government legislated and administered

KRW 50,000,000 per depositor, per institution 48,500

Malaysia 2005 Government legislated and administered RM250,000 per depositor per institution 76,717

Philippines 1963 Government legislated and administered PHP 500,000 per depositor per institution 11,245

Singapore 2006 Government legislated and privately administered S$50,000 (per depositor per institution) 39,824

Thailand 2008 Government legislated and administered

Baht 50,000,000 per depositor per institu-tion* 1,550,550

Vietnam 1999 Government legislated and administered 50 million VND 2,350

* The 50 million baht coverage will be implemented until 10 Aug 2015 before lowering to 25 million baht during 11 Aug 2015 to 10 Aug 2016. The 1 million baht coverage as stipulated by the Act, will be implemented from 11 Aug 2016 onwards.Source: International Association of Deposit Insurers (http://www.iadi.org/di.aspx?id=168), UOB Global Economics & Markets Research Estimates

For further details:Deposit Insurance Regulation (Draft) 存款保险条例（征求意见稿）http://www.pbc.gov.cn/publish/main/527/2014/20141130165955327719569/20141130165955327719569_.html

Rationale For Deposit Insurance (Draft) 中国人民银行关于《存款保险条例（征求意见稿）》的说明http://www.pbc.gov.cn/publish/main/527/2014/20141130170627847426506/20141130170627847426506_.html

PBoC’s Q&A on Deposit Insurance Scheme 存款保险知识专家问答http://www.pbc.gov.cn/publish/main/527/2014/20141130171434519357762/20141130171434519357762_.html


CHINA FOCUS IITAKING ANOTHER LOOK AT CHINA’S TRADE DATA

Exports “over-invoicing”making another comeback? Notwithstanding the soft macro backdrop domestically and diverging growth paths in developed economies, China’s merchandise trade figures are again showing some signs of unusual activities.

Trade balance hit record highs in 3 months out of the 4 in the Jul to Oct period in 2014. A new record for China’s trade balance was set in Aug 2014 at US$49.8bn, surpassing the previous high of US$40.1bn in Nov 2008.Underpinning this was the strong performance in exports, which rose 11.6%y/y in Oct 2014, extending the 15.1% jump in Sep 2014.

As shown in the chart on the right, it is clear that, on a 3-month moving average basis, exports have accelerated strongly in the second half of 2014, while accompanied by lackluster performance in imports. This pattern is similar to that in 2012 and early 2013, when exports “over-invoicing” was widespread until SAFE and other authorities began cracking down on such practice starting from 1 Jun 2013.

If the period immediately after 1 Jun 2013 to late 2013 – with close scrutiny from the authorities – is considered to be “normal”, then the two periods straddling this “normal” period look very unusual indeed, with high exports growth coupled with low imports momentum. In fact, after authorities came in starting from 1 Jun 2013, imports growth was briefly outperforming exports growth, suggesting that some unwinding of the previous exports “over-invoicing” may have taken place.

Drilling deeper into trade data between China and its trade partners as well as exports trade originating from various trade zones in China, there are signs that export “over-invoicing” may be rearing its head again. For this exports “over-invoicing” to be cost effective, it typically involves goods that are small

and of high value, and the nearest exports destination to minimize transportation costs and time. As such, Hong Kong was the favourite destination in the previous round. It appears that external trade data over the one year show the same pattern is emerging yet again.

As shown in the charts below, reported figures by both China and Hong Kong authorities have diverged widely in 2012-mid 2013, and again in 2014 after easing off from mid-2013 as a result of official scrutiny.

To get a sense of the magnitude, the mathematical differences between “exports to Hong Kong” (reported by China) and “Imports from China” (reported by Hong Kong) began to turn more pronounced in the past six months, although the extent of which was below the period seen at the peak in Mar 2013 before the authorities stepped in. The discrepancy between

China and Hong Kong trade data

.0

10.0

20.0

30.0

40.0

50.0

Jan-93 Jan-00 Jan-07 Jan-14

USD bn

China: "Exports to HK"HK: "Imports: from China""Exports to HK" Trendline

Source: CEIC, UOB Global Economics & Markets Research

External trade (3-month moving average)

-10

10

20

30

40

50

-10.0

-5.0

0.0

5.0

10.0

15.0

20.0

25.0

Jan 12 Sep 12 May 13 Jan 14 Sep 14

Exports %y/y change (LHS)Imports %y/y change (LHS)Trade Balance USDbn (RHS)


Difference between China's "Exports to HK"and HK's "Imports from China"

1 Std Dev2 Std Dev

3 Std Dev

-20-15-10-5

51015202530

Jan-93 Jan-00 Jan-07 Jan-14

USD bn China's "Exports to HK" Less HK's "Imports from China" (Monthly)



CHINA FOCUS II

the two reported figures peaked at US$13.5bn in Sep 2014, about 3 standard deviations away, while the Oct 2014 reading of US$9bn is at the 2 standard deviations mark. These suggest that there is sign of some kind of export over-invoicing taking place between the China-HK route, although the extent has been less aggressive than during peak in 2013.

Looking at exports figures from exports processing zones (EPZ) and bonded areas in China, it is clear that Shenzhen, which is the nearest to HK in terms of distance among these various zones, has been the main driver behind the volume in these areas. For example, in bonded areas, Shenzhen accounted for 51% of the volume in 2014, as shown in the charts above.

Taking all these together, the differences reported by the two statistical agencies remain significant, as shown in the table below. Total difference for Nov 2013 to Oct 2014 comes to US$107.6bn (average of US$8.7bn per month). Total trade surplus reported by China for the same period is US$335.5bn. This means that the difference of China’s exports to HK and HK’s imports from China accounts for 31% of China’s trade balance. In contrast, during the Mar 2012 to Jun 2013 period when exports over-invoicing was at its peak, the discrepancy amounted to a total of US$166.0bn (average of US$10.4bn per month), accounting for 48% of total trade surplus

of US$346.2bn for the period. As such, the current round of trade discrepancy remains significant, though at a slower run rate.

As a comparison, differences of China’s exports figures with other trade partners such as the US and Taiwan appear to be more consistent based on historic trend. Even if there are differences, the amounts involved tend to much smaller, presenting less of a puzzle to observers, as shown in the two charts on next page.

It should be noted that prior to the RMB exchange rate reform in 2005, differences of reported merchandise trade figures between China and HK were mostly against China, implying there was some extent of under reporting of China’s exports or overstating of imports to facilitate movements of funds to overseas given concerns of RMB depreciation (even devaluation) risks and capital control concerns. However, the trend then reversed since China’s exchange rate reform of 2005, as prospects of RMB appreciation became more apparent.

Nevertheless, the differences looked largely “normal” and tolerable as they were mostly confined within +/- 1 SD. That is until March 2012 when differences started to rise sharply just as the RMB trading band was widened in mid-April 2012 with expectations of more RMB liberalization measures ahead. After

Exports from bonded area

0

5000

10000

15000

20000

25000

30000

Jan 98 Apr 01 Jul 04 Oct 07 Jan 11 Apr 14

Total Exports from Bonded AreaShanghai Waigaoqiao Bonded AreaGuangzhou Bonded AreaShenzhen Futian & Shatoujiao Bonded Area

US$ mn, monthly


Exports from exports processing zone

0500

10001500200025003000350040004500

Jan 08 Apr 09 Jul 10 Oct 11 Jan 13 Apr 14

Shanghai CaohetingShanghai SongjiangGuangzhouShenzhen

US$ mn, monthly


Table of comparisons of exports "Over-Invoicing"

Period Months Exports discrepancy*

(US$ mn)Average per month

(US$ mn)

Trade balance for the period

(US$ mn)

As % of trade

balance

Mar 2012 to Jun 2013 16 166,038.0 10,377.4 346,230.3 48.0%

Nov 2013 to Oct 2014 12 104,575.5 8,714.6 335,470.6 31.2%

* China's exports to HK (reported by China) less China's imports to HK (reported by HK)



the authorities’ scrutiny from Jun 2013, it appears that funds are beginning to flow into China as the government clamps down on shadow banking activities and the bouts of depreciation in Jan-Apr 2014 period ended.

Exports over-invoicingremains but at smaller scale With differences in recent trade figures too big to be ignored, there are signs that exports over-invoicing in China may be making a comeback, albeit in a smaller scale compared to the one prior to Jun 2013. With the reporting gap between China and HK accounting for 31% of China’s trade balance between Nov 2013 and Oct 2014 or US$104bn for the period, this is too significant an amount to be brushed off as “statistical errors”.

Despite the bouts of RMB depreciation experienced in earlier part of 2014, capital is still attracted to China due to the relatively high yield onshore. Even after PBoC’s 40bps cut to the lending rate in Nov 2014, it is still at a relatively attractive 5.6% onshore for the 1Y rate, compared to the nearly 0% for USD (and HKD by implication). While the US Fed’s interest rate normalization is looming by mid-2015, this is still a window of opportunity given expectations that the

rate hikes would be gentle.

Perhaps more important is that high interest rate onshore in China reflects the difficulty borrowers getting access to credit, especially with the clampdown in shadow banking activities. These over-invoicing activities are one of channels to meet the demand for credit.

As such, it is important for the Chinese government to continue to push through reforms in financial market to address the imbalance in demand and supply of credit. It is indeed taking such a step with the release of the draft deposit insurance scheme for public consultation on 30 Nov 2014.

We expect the deposit insurance scheme to be implemented by mid-2015 and would go toward addressing at least some of the credit demand issues as leveling the playing field for smaller banks (More details on China’s deposit insurance scheme are discussed elsewhere in this issue of the Quarterly report).

CHINA FOCUS II

Difference between China's "Exports to US"and US' "Imports from China"

1 Std Dev

2 Std Dev

3 Std Dev

-15

-10

-5

5

10

Jan 93 Jan 00 Jan 07 Jan 14

USD bn

China's "Exports to US" less US' "Imports from China" (Monthly)


Difference between China's "Exports to Taiwan"and Taiwan's "Imports from China"

1 Std Dev

2 Std Dev

3 Std Dev

-1,200

-800

-400

0

400

800

1,200

Jan 98 Jan 02 Jan 06 Jan 10 Jan 14

USD mn

China's "Exports to Taiwan" less Taiwan's "Imports from China" (Monthly)



OIL & GASLOSING SHEEN

By Elaine Khoo & Wesley Chong From UOB Country & Credit Risk Management

Losing its sheen;uneven impact on economies and industries Oil prices have tumbled more than 30% to a multi-year low with Brent <US$70/barrel (as of 03 Dec 2014). This marks a dramatic turnaround from the spike earlier in the year to US$115/ barrel due to geopolitical concerns in the Middle East. Brent has averaged ~US$110/barrel over the past three years following the large GFC-induced slump. This sharp about-turn can be explained by both supply and demand side factors, as well as the strength in USD.

On the supply side, surging global oil production could outpace demand this year. Increased production from Libya and Angola alongside uninterrupted supply from Iraq despite the ongoing war with ISIS have pushed up OPEC’s total output to slightly under 31m barrels a day, the highest this year and 352,000 bpd higher YoY. Swelling US production on the back of its “Shale revolution” has also fundamentally changed the global oil equation and resulted in more-than-ample global supply.

At the same time, demand has disappointed as global growth sputters. The International Energy Agency (IEA) estimated that the pace of expansion in oil demand for 2014 & 2015 would be weaker than expected. This year, it expects demand to rise by 0.7m bpd to 92.4m bpd, 0.2m barrels less than its previous forecast. Demand for next year is expected to come in at 93.5 mbd.

How will OPEC play its hand?Holding cards close to its chest for nowDespite the sharp fall in prices, OPEC (which controls c. 40% of global production) appears reluctant to cut back production. Saudi Arabia, the largest OPEC producer has traditionally been the swing producer due to its large spare capacity and is thus seen as a wild card that could influence the direction of oil prices. It could choose to cut production to

increase prices or tolerate lower prices, which could disproportionally impact Russia, Iran and ISIS financially.

Latest comments seem to suggest that Saudi Arabia is inclined to maintain its market share and may be willing to tolerate lower prices to force Western oil companies to cut back on less profitable production and slow down US shale investments.

This could set the stage for deepening internal rifts within OPEC as certain members, such as Venezuela and Angola, are dependent on high oil prices to balance their fiscal budgets (reportedly US$120/barrel and US$98/barrel respectively vs. US$85/ barrel for Saudi Arabia). Although sustained lower prices could tilt Saudi’s budget into deficit, its sizeable foreign exchange reserves could enable it to withstand a period of reduced revenue.

Beginning of a “new normal”;uneven impact on global economyMarket price expectations have fallen to US$80-90/barrel next year and while prices are not expected to collapse, the world is now entering into a lower oil price environment over the next few years, in contrast to oil prices of >US$100/barrel which the market has grown accustomed to.

The economic and political consequences of the fall in oil prices vary around the world. While the drop in oil prices is negative for oil producing countries, it would benefit consumers and oil importing nations with the price reduction akin to a tax cut which could help boost purchasing power. Overall, the impact on the global economy should be a net positive, given that net oil importers have the propensity to spend more of their incomes than oil producing nations, and this would have a knock-on impact on global consumption.

Global crude oil producers

Saudi Arabia11% Iraq

4%

Iran4%

Kuwait3%UAE

3%

Rest of OPEC12%

US13%Russia

12%

China5%

Canada5%

Mexico3%

Brazil3%

Rest of Non-OPEC22%

Source: OPEC Monthly Oil Market Report, UOB

Brent and WTI price trend

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40

60

80

100

120

140

160

Jul 05 Jan 07 Jul 08 Jan 10 Jul 11 Jan 13 Jul 14

BrentWTI

Source: Bloomberg, UOB

US$/bbl


OIL & GAS

IMF in its recent World Economic Outlook report estimated that the net effect of a US$20 decline in oil prices would increase world GDP 0.5% alone, and this figure could rise to about 1.2% if economic confidence were improved as a result.

Falling oil prices could lead to significant revenue shortfalls for some oil exporters, with the cash-strapped governments of Venezuela, Russia and Iraq the most vulnerable. Although production costs are low in these countries, government budgets are based on oil prices of US$100 or more.

Venezuela for one depends on oil for 95% of its export revenues, and lower oil prices are threatening to choke off export dollars the country needs to pay off its foreign debt. The fall in crude oil prices could force the government to adjust spending to avoid default, or print more money, but that would only serve to fuel rampant hyper-inflation of >60%. This has led to mounting expectations that Venezuela could default on its foreign debt.

The plunge in global oil prices is also straining Russia’s economy, which is heavily dependent on oil exports. Oil revenues account for roughly 45% of Russia’s budget. Russia is already teetering on brink of recession due to the ongoing Ukrainian crisis and Western sanctions. The government had been setting its 3-year budget with expectations of oil prices >US$100/bbl, and a continued fall in prices could mean having to dig into its foreign exchange reserves or cutting spending. The rouble has already declined sharply this year and could be further undermined by falling oil prices.

Sustained lower oil prices are also likely to push Saudi Arabia’s budget into deficit, which faces a break-even point of ~US$90/bbl. Nonetheless, Saudi Arabia would be able to, and perhaps willing to, ride-out a period of lower oil prices. Other gulf producers such as United Arab Emirates and Kuwait have also built up sizable foreign exchange reserves, which mean that they would be able to run deficits for a number of years if needed.

Other OPEC members e.g. Iran, Iraq, Nigeria could however face more pressure, with greater budgetary demands vis-à-vis their oil revenues. As at the beginning of 2014, oil prices had already been below break-even for these countries, and combined foreign reserves of <US$200bn suggest relatively limited headroom for manoeuvre.

US shale industry under threatbut average consumers should benefitIn the U.S., a drop in oil prices could crimp U.S. shale oil producers’ profits, which would in turn lead to cut back in capital spending and a slowdown in U.S. oil production as drillers become more hesitant to take on new development prospects. The cost of

extracting oil from U.S. shale formations is relatively more expensive than conventional oil supplies, with average breakeven costs of about US$75-85/bbl. This could have knock-on effects on supporting industries, including everything from pipeline builders to cement makers.

Nonetheless, it could take some time before we see a significant pullback in rig count and overall US oil production, with most shale producers hedged against lower prices in the short term. This could be further delayed as oil companies move down the experience curve in better-exploited shale formations such as the Eagle Ford and Bakken, along with the large sunk costs already poured into some at some of the more pricey shale projects. Other high-cost oil projects could be put on hold, including those in deepwater, Arctic, international shale and Canadian oil sands.

While cheaper oil is a bane for U.S. shale oil producers across states like Texas and North Dakota, it could well be a boon for the average American consumer. Cheaper pump prices mean higher disposable incomes, which in turn could encourage spending and stimulate the economy. The fall in oil prices could also be a welcome development for beleaguered governments in Europe’s flagging economies, which have been besieged with weak growth (although deflationary pressures also mean a tougher job for ECB as it attempts to raise consumer prices).

Asian countries benefit the most;Malaysia the exceptionAsia is a net beneficiary as most countries are major importers and the cost of fuel is heavily subsidised. IEA estimates that the cost of government subsidies for fossil fuels globally rose from US$311bn in 2009 to US$544bn in 2012. Indonesia spent around 3% of GDP in 2012 on fuel subsidies, whereas in Thailand, and Vietnam the bill came to >2%. Falling prices have provided an opportunity to wean off costly subsidies, which India, Indonesia and Malaysia have recently done.

While Malaysia also subsidizes fuel prices, its position as a net exporter amid a sea of importers means that it losses on oil-related revenues could more than offset lowered subsidy spending. Oil-related revenues from national oil company Petronas accounted for about a third of total federal government revenue, and dividends to the government could be impacted by falling oil prices.

China, the world’s largest net importer of oil, should benefit which will keep manufacturing and transportation costs down. Every US$1 drop in oil prices saves it US$2.1bn per annum, which means the recent fall could lower its import bill by US$60bn or 3% if sustained.


Lower oil prices also augurs well for India, which imports 75% of its oil, and would result in lower inflation, improvements in the fiscal and current account balances, and higher growth. Lower inflation would raise disposable incomes for households and encourage discretionary spending, while falling input costs would improve corporate margins and spur investment. Meanwhile, an improvement in the balance of trade could provide more latitude for accommodative growth policies.

For Japan, the fall in crude oil prices is both a blessing and a curse. The country paid around US$160bn to import petroleum in the 12 months to August, and the decline, while dampened somewhat by a weakened Yen, would bring about a much-welcomed improvement in the terms of trade. Japan has seen more than three years of trade deficit as energy imports surged to cover for the loss of nuclear power following the Fukushima disaster. Lower oil prices however are also throwing a spanner in Prime Minister Shinzo Abe’s bid to rid the Japanese economy of deflation that has paralyzed the country for more than 20 years.

As a net oil importer, Singapore directly benefits from lower prices but by a smaller extent v.s. its neighbours. This is because its oil dependence in production (amount of oil used as intermediate inputs into production) has fallen >10% over the past decade. In addition, Singapore’s overall oil dependence (amount of oil used to produce US$1 of real GDP) is one of the lowest regionally. Furthermore, the share of oil-related consumption in total household spending has risen only very slightly over the past two decades.

In the nearer term, Singapore’s petroleum and petrochemicals industry (top 3 globally and a backbone of its economy) could however be affected

by softening demand. Singapore imports oil from other countries before refining them for further use and re-exporting to other countries. 1H14 oil exports amounted to S$66bn, accounting for 25% of Singapore’s total exports and the oil industry accounts for ~5% of GDP.

Identifying the winners and losersSimplistically, falling crude oil prices would benefit industries in which oil is a key input (eg. transportation, fertilizer) while negatively affecting companies involved in oil and alternative energy production where profitability is directly correlated with oil prices.

The upstream oil and gas industry, specifically companies involved in E&P (exploration and production) are likely to be most directly impacted as falling prices erode margins and spur capex cuts. The higher production costs (US$70-90 per barrel) associated with unconventional resources such as oil sands and shale make them most susceptible. According to BG Group, 40% of oil from US shale wells has a breakeven point between US$80-90/bbl.

Production costs of oil have generally seen a substantial increase over the past decade. According to Infield Systems, the breakeven cost for oilfield developments range from US$20/bbl to US$80/bbl. Shallow-medium water projects have the lowest breakeven costs of US$20-30/bbl in the Caspian Sea and US$30-40/bbl in Southeast Asia. In contrast, deepwater developments are most costly with ultra-deepwater breakeven at US$40-50/bbl for Brazil Pre-Salt, US$50-60/bbl for US Gulf and US$60-70/bbl for West Africa. The highest cost structures are those in the Arctic region, with breakeven cost of US$70-80/bbl. Therefore, the top-end of ultra-deepwater capex would be most at risk.

Apart from the oil producers, the drilling rig market could also be similarly affected if capex slows. There has historically been a correlation between oil prices and rig demand, and lower oil prices could dampen orders to yard and add further pressure on rig utilization. Rig orders have already decelerated this year after bumper orders in 2011-13, with total orders for 27 drilling rigs YTD vs. 104 orders last year. Nonetheless, sizable orderbooks for local rig builders should help mitigate the lull in rig orders.

Dayrates and utilization of semi-submersible rigs and drillships could be particularly vulnerable as ultra-deepwater developments are more sensitive to oil prices. Meanwhile, jack-ups could fare better given lower break-even costs in shallow waters, though the wave of newbuilds entering the market over the next 2 years could weigh on rates. Retirements of older jackups could nevertheless help balance the market, and utilization and day-rates of premium rigs have remained strong, especially in the South-east Asia region.

OIL & GAS

Offshore oilfield breakeven Brent prices

Source: Various sources, UOB

20

30

40

50

60

70

80Arctic Region

Shallow-Medium Water (Caspian Sea)

Shallow-Medium Water (SE Asia)

Ultra-Deepwater (Brazil Pre-Salt)

Ultra-Deepwater (US Gulf) Medium (N.Sea)

Ultra-Deepwater


The offshore support vessel (OSV) market would also be impacted if O&G capex slows. Nonetheless, the global OSV orderbook has normalized to 12% of the existing fleet, vs. c.25% during the GFC peak. This should help avoid a repeat of the 2008-10 charter rates crash where oil prices fell to as low as US$40. We note however that the PSV market is likely to face more pressure than AHTS vessels, given a relatively larger order backlog.

OSV players in the region should show resilience due to their exposure to Asian National Oil Companies (NOCs), whose capex are more stable vs. international oil companies during periods of oil price weakness as energy independence remains high on their agenda. Moreover, the region’s E&P activities are predominantly in shallow waters, which are less impacted by weaker oil prices.

Even for newer initiatives such as marginal field development and enhanced oil recovery, NOCs like Petronas face a breakeven point of around US$60/bbl, which could mean little impetus to cut back on spending at current oil price levels. OSV owners who have access to cabotage markets such as Indonesia and Malaysia should be able to weather the soft patch better. Those that serve mainly deepwater oilfield activities such as those in the North Sea however could be affected more adversely by capex budget cuts.

Bio-fuels and other alternativesources of energy could be hitFalling oil prices could slow the drive towards renewable technologies (eg. solar, wind) and petroleum substitutes. The LNG industry, for example, could be hit as LNG prices are linked to oil which would affect Australia the most. Within this region, crude palm oil (CPO) is particularly vulnerable as its viability as a competitive source of fuel is reduced. Our estimates show that biodiesel conversion at current crude oil prices is not economically viable in the absence of government subsidies. In fact, at today’s POGO (palm oil, gas oil) spreads, the refining margin is negative. Biodiesel take-up in both Indonesia and Malaysia had fallen short of expectations and could continue to disappoint into next year. With insufficient support from biodiesel demand, palm oil prices could remain under pressure.

Refiners could benefit ST althoughample capacity and sluggish demandcould weigh on marginsDownstream operations which refine crude oil into gasoline and other petroleum products should generally be more profitable when the feedstock is cheaper as prices of refined products e.g. gasoline typically do not fall as quickly as crude’s. This could in turn provide some buffer for integrated oil companies from falling upstream profits.

Nonetheless, this could only be a short-term boost as chemical prices are correlated with crude oil and volumes in petrochemical value chains could be challenged by a sluggish demand backdrop. Furthermore, refiners could suffer inventory losses from the value of their stockpiles accumulated when prices were higher.

Gross refining margin for Asia refiners have been weak and is expected to remain largely flat against 2013 levels of around US$6 per barrel as capacity additions outstrip demand growth. The Singapore complex gross refining margin weakened to US$4.8 in 2Q compared to US$6.2 in 1Q.

Total refining capacity in Asia may increase to as much as 36m bpd by 2018, driven predominantly by China and India. Pakistan and Vietnam are also planning new additions over the next few years. These new refineries are reportedly configured to produce around 30-50% of middle distillates which consist mainly of diesel and diesel margins could thus be most affected.

Overcapacity could result in delays in refinery projects and force plants to run at low rates as companies try to calibrate demand/ supply. Refiners could also close older, inefficient facilities as the case in Japan and Australia.

On the other hand, lower oil prices will bring much needed relief to the grossly oversupplied shipping industry, with bunker prices falling in tandem with Brent crude. Lower bunker costs for ship owners translates to a boost to time charter earnings in the short term, though the longer term outcome of weak oil prices could be more difficult to gauge.

Cheap oil prices also mean a reduction in the fuel bill and better margins for airlines, where jet fuel costs could burn through 30-40% of revenue. However if that spurs airlines to adding more routes and scheduling more flights to gain market share however, that could well plunge the industry back into overcapacity.

OIL & GAS


INDONESIA

No aggressive monetary tighteningbut room for further interest rate hikeBank Indonesia (BI) raised its policy rate by 25 bps to 7.75% at an unscheduled monetary policy meeting on 18 November, a day after the govern-ment delivered on its fuel subsidy cut, announcing Rp2,000 per litre or 31% hike in the fuel price. This was the first interest rate increase in a year after the previous fuel price hike in June 2013.

As a result of higher fuel prices, headline inflation jumped to 6.2% y/y in November from 4.8% in Octo-ber but core inflation only edged up slightly to 4.2% y/y from 4.0% in October. We expect the headline CPI to hit 8.0% in the middle of 2015 before easing off by year-end to the top of BI’s 3-5% target due to base effect. As this will be close to the inflation peak that we have seen in the previous fuel price hike, it is unlikely to trigger an aggressive reaction from the central bank, particularly as the positive sentiment from the subsidy reform has driven Indo-nesian yields lower.

Monetary normalization in the US could pressure on the IDR in the coming months and with Indone-sia expected to continue registering a current ac-count deficit, we still see a possibility of another 25 bps hike in the BI rate in the short-term to prevent a situation of negative real interest rates and to con-tain the capital outflow risks. The overnight deposit facility rate (FASBI) which was left unchanged at 5.75% in November could also be raised to effec-tively contain the inflationary pressure.

Indonesia Finance Minister Bambang Brodjone-goro expects the current account deficit to remain within 2.5-3.0% of GDP in 2015, suggesting only a minimal improvement resulting from the fuel price adjustment. Although the rout in global oil prices is exerting a positive impact as Indonesia turned net oil importer, weaker commodity prices will continue

to weigh on export.

The budget for 2015 will be reviewed following the fuel price hike. Fiscal improvement and the orientation of the new government towards higher spending on infrastructure, healthcare and educa-tion are positive for the IDR. Nonetheless, we still see upside risk to USD/IDR in line with broad USD strength. We expect USD/IDR to rise to 12,400 in 1Q15.

Downside risks to growth Indonesia’s GDP grew at its slowest pace since 3Q09, moderating to 5.01% y/y in 3Q14 from 5.12% in 2Q14. Exports continued to weigh on the econo-my as it contracted for the third consecutive quarter in 3Q14. Fixed investment growth remained weak but outlook is likely to improve in subsequent quar-ters as the new government pushes ahead with its plans for more infrastructure spending. The bright spot in 3Q14 was the private consumption.

Consumer confidence has continued improving since the middle of the year after the presidential election. However, the increase in the domestic fuel prices and higher interest rates could dampen busi-ness and private consumption ahead. Weakness in global commodity prices will diminish the prospect of an export-led recovery in Indonesia as primary exports account for more than half of the country’s exports. We forecast 2015 GDP growth at 5.5%, up from an expected 5.1% in 2014.

UOB Economic Projections 2012 2013 2014F 2015F

GDP 6.3 5.8 5.1 5.5

CPI (average, y/y %) 4.0 6.4 6.3 7.4

Unemployment rate (%) 6.1 6.3 6.2 6.1

Current account (% of GDP) -2.8 -3.4 -3.0 -2.4

Fiscal balance (FY, % of GDP) -1.9 -2.3 -2.4 -2.1

Consumer confidence and FDI continued to improve

90

95

100

105

110

115

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125

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1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

Jan 10 Dec 10 Nov 11 Oct 12 Sep 13 Aug 14

FDI (US$bn)Consumer Confidence Index

US$bn


Headline inflation to peak at around 8.0% in 2015

3.0

4.0

5.0

6.0

7.0

8.0

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Jan 10 Dec 10 Nov 11 Oct 12 Sep 13 Aug 14

BI Rate (%)FASBI Rate (%)Headline CPI (y/y %)



MALAYSIA

Oil price plunge weighs on MYRThe government’s removal of its subsidies on RON95 petrol and diesel (effective December 1) is expected to save MYR10-20 bn annually (1-2% of GDP) and net revenue collection from GST in 2015 after accounting for the removal of Sales and Ser-vices Tax and assistance programmes is estimated to bring in MYR0.7 bn. The positive impact on the fiscal position will be offset partially but not totally by an expected reduction in government’s revenue if the slump in global oil prices is prolonged. Petro-nas which contributes MYR10 bn annually to the budget has warned that dividend payments to the government may be cut. At this point, we are not too worried about the government missing its fiscal deficit target in 2015.

Nonetheless, the government’s heavy reliance on oil-related revenue (around 30% of total revenue) and the country’s position as a net oil-exporter have weighed heavily on MYR, particularly compared against the regional countries which are net oil importers. Concern of narrowing current account surplus in the fourth quarter has led to the rapid as-cent in USD/MYR above 3.45 in early December. Expectation of Fed interest rate normalization and soft commodity prices are expected to keep USD/MYR biased towards 3.50 in 1H15.

Growth moderation aheadMalaysia’s GDP growth moderated to 5.6% y/y in 3Q14 from 6.5% in 2Q14 partly due to a high base effect. The key driver in the quarter was private consumption while private investment and export growth moderated. Nonetheless, net export was supported by slower import growth.

Going forward, we expect 4Q14 GDP growth to moderate further. For 2015, we expect a slower growth at 5.2%, due to GST, higher interest rate environment and soft commodity prices. Domestic

demand including private investment arising from ETP projects are expected to continue driving the growth next year.

Weaker growth reduces rate hike prospect In the short-term, we expect little impact on inflation resulting from the removal of subsidies on RON95 petrol and diesel in December as the price hike in October had already brought it close to the unsub-sidised rate. The impact on CPI would show up as global oil prices rise.

The fuel hike in October has not had significant impact on inflation which only edged up slightly to 2.8% y/y from 2.6% in September. We expect infla-tion of 3.3% and 4.3% in 2014 and 2015 respec-tively. The key upside risk is from weak MYR.

As for the monetary policy, we still see some chance of a 25bps hike in the Overnight Policy Rate (OPR) to 3.50% in 1Q15 before GST. Bank Negara has kept to a slightly hawkish bias in its November monetary policy statement, maintaining its view that inflation “will continue to be above its long-term av-erage next year due to domestic cost factors” but expects some mitigating effect from the lack of ex-ternal price pressures and more moderate demand conditions. Further rise in USD/MYR could increase rate hike prospects. Overall, the probability of a rate hike has eased due to weaker growth outlook while BoJ’s and ECB's actions also require some consid-eration.


GDP 5.6 4.7 5.9 5.2

CPI (average, y/y %) 1.7 2.1 3.3 4.3


Current account (% of GDP) 5.8 4.0 4.6 3.6


Weak CPO and rubber prices further weigh on growth

400

600

800

1000

1200

1400

1500

2000

2500

3000

3500

4000


Palm oil price (lhs, RM/metric tonne)Rubber price (sen/kg)

Source: Bloomberg; UOB Global Economics & Markets Research

Decline in global oil and commodity pricespressure on current account position

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5

10

15

20

25

Mar 05 Jul 07 Nov 09 Mar 12 Jul 14

Current Account (% of GDP)

Source: CEIC; UOB Global Economics & Markets Research


SINGAPORE

2015 GDP growth to be steady,despite global growth concernsWe forecast Singapore’s GDP to remain on a steady growth path in 2015 to register a 3.3% growth rate, slightly higher than the 3.2% estimated rate in 2014. Latest 3Q 2014 GDP report showed that on a year-to-date basis, growth was still seen across all sectors in the economy, with the manu-facturing, business services, and accommodation & food services picking up pace. Although the con-struction sector grew 4.2% y/y, it experienced the 2nd consecutive quarter of q/q SAAR contraction and we think that weaker private sector construc-tion activities will continue into 2015.

Weakness in global economic indicators recently affected confidence of Singapore’s 2015 growth potential. We believe such concerns may be over-played. In 2012, the simultaneous threat of a Eu-rozone breakup (and the “Greek Crisis”), a China hard-landing, and the US and Japan economic slowdown caused many to lose confidence in Sin-gapore’s economic growth as well. This was be-cause these countries are Singapore’s largest trading partners and trade is still very much an im-portant portion of our economy (being three times the size of GDP). Nevertheless, Singapore’s GDP still grew 2.5% that year. Going forward in 2015, with uplift in the US economy, expectations for more easy money policies from the ECB and BOJ to prop up their economies, and China maintaining a steady course even as the economy continues to restructure, we believe that the external risks from these countries will be manageable and Singapore is poised to maintain another year of steady GDP growth path.

Singapore should continue its own economic re-structuring to improve the quality and value-add of our goods/services, while tackling the labour crunch issue. The restructuring of the manufacturing sec-

tor is on-going and we will see more manufacturing firms specializing in even higher value added and highly specialised products while moving into the manufacturing-related services space. Firms which are producing lower value added products will find it increasingly unprofitable in such high business cost environment. As such, they may continue their shift out of Singapore and we may see a further shrink-ing of manufacturing’s share of GDP (from 20% to-day to around 15% in the medium term).

USD/SGD to reach the highest 1.35 mark by 3Q2015 before easing to 1.33 by end 2015We believe that the MAS may continue to keep to its current stance of a “modest and gradual” SGD NEER appreciation during the upcoming April 2015 policy meeting. Singapore’s labour market contin-ues to remain tight (3Q unemployment at a low of 1.9%) and the risks of higher wage costs filtering into higher core inflation remains a concern. Addi-tionally, our view that the start of the US interest rate normalization in June next year will see fur-ther downward pressures on the SGD in 2015. Our forecast for the USD/SGD remains at 1.34/USD as of end 2Q 2015, from the 1.31 level currently. With the SGD SIBOR positively correlated with the USD LIBOR, our expectations that the US interest rate normalization in June 2015 will see the SIBOR moving on a higher trajectory in 2015. We expect the 3M SGD SIBOR to move towards 1.00% by end 2015.


GDP 2.5 3.9 3.2 3.3

CPI (average, y/y %) 4.6 2.4 0.9 0.9



Fiscal balance (FY, % of GDP) 2.0 1.3 1.3 1.4

Manufacturing is the only sector with faster year-to-date growth compared to 2013 growth

7.2

4.2 4.13.0 2.5 2.5 2.4

1.1

10.8

1.7

6.14.3

6.1

3.24.3 4.5

0

2

4

6

8

10

12

Finance &Insurance

Manufacturing Construction BusinessServices

Wholesale &Retail Trade

Transport &Storage

Infocomms Accomodation& Food

Services

% y/y

2014 YTD2013

2013 Share 11% 20% 5% 13% 18% 8% 4% 2%of GDP

Source: CEIC


THAILAND

Poorer growth prospects as exports slumpedThailand’s 3Q GDP grew 0.6% y/y, slightly higher than the 0.4% y/y growth in 2Q, but still lower than consensus estimates of a 1.0% y/y growth rate. On a q/q SA basis, GDP growth gained 1.1%, a similar rate to that in 2Q.

On a positive note, 3Q GDP saw stronger growth in private consumption (+2.24% y/y) demand, as it clocked the best growth rate since 2Q 2013. Ad-ditionally, investment demand also picked up in the same quarter and grew 2.86% y/y, reversing four quarters of consecutive contraction. The pickup in consumption and investment demand showed that the bid to kick-start Thailand’s economy since the military coup on 22nd May had provided some form of confidence and certainty to consumers and the investment community. In fact, after reaching a re-cent low of 67.8 in April this year, Thai consumer confidence had risen steadily to 80.1 in October. However, weakness in Thailand’s 3Q GDP growth this time came from the export sector, where net exports fell 15.5% y/y.

Although Thailand’s manufacturing sector remained weak and continued the 6th quarter of consecutive contraction (-0.67% y/y) in 3Q, the sector is seeing some signs of improvement. Year-to-date indus-trial production still contracted by 5.3% y/y, but the slowly improving capacity utilization rate (61.1 in September 2014 vs the year’s low of 56.41 in April) is signaling some cautious optimism amongst man-ufacturers. However, the tourism sector remains weak and the hotels & restaurants sector continued the third quarter of consecutive contraction and reg-istered a 4.6% y/y decline in 3Q, from the 4.7% y/y decline a quarter ago.

The National Economic & Social Development Board (NESDB) trimmed its 2014 GDP growth forecast to 1.0% from the 1.5-2.0% forecast made

in August. Export growth projection is also cut to 0%, from 2.0% earlier. 2015 GDP growth forecast is maintained at 3.5-4.5%. Meanwhile, the Bank of Thailand predicted GDP growth of 1.5% in 2014 and 4.8% in 2015, although we think there could be a downward revision.

We had earlier revised our 2014 Thailand GDP growth forecast to 0.7% from 1.5% on 17 No-vember, as we believe the economic growth in 2H would not come in strong enough to reduce the drag from 1H. Although there are some signs of op-timism from the capacity utilization index, we do not think that there will be a material improvement in the manufacturing sector to boost 4Q GDP growth. Domestic sectors will likely be held up by local con-sumption demand, as tourism demand continued to remain weak. Year-to-date tourist arrivals are still 10.3% below 2013. Our forecast for GDP growth in 2015 is currently at 4.0%.

The next Bank of Thailand monetary meeting will be held on 17 December and at this juncture, we still expect the BoT to maintain the current policy rate of 2.0%, supported by the lower inflationary trajectory. With Thai interest rates expected to remain low go-ing into 2015, and the expected normalization of the US interest rates starting in 2H 2015, we maintain our view that there would be downward pressure on the THB going forward. We expect the THB to move lower against the USD towards 34.10/USD by 1Q2015 from around the 32.80 level currently.


GDP 6.5 2.9 0.7 4.0

CPI (average, y/y %) 3.0 2.2 2.0 2.1


Current account (% of GDP) -0.4 -0.5 1.8 1.4


3Q2014 Report card: Weak domestic sectors year to date

5.83.9 2.4 1.9

0.1

-0.7 -1.7-4.1

-5.8

10.18.0

1.4 0.93.2 4.5

0.1

12.2

1.0

-10

-6

-2

2

6

10

14

Finance Tpt, Storage,Comms

Agriculture Utilities Wholesale &Retail

Real Estate Manufacturing Hotels &Restaurants

Construction

2014 YTD2013

Share of 5% 10% 8% 4% 13% 4% 38% 5% 2%2013 GDP

Source: CEIC


INDIA

Weak manufacturing sectordampened GDP growth potentialIndia’s GDP grew at a slower pace of 5.3% y/y (pre-vious: 5.7% y/y) in the three months ended Sep-tember 2014, as the manufacturing sector saw al-most no growth (+0.1% y/y), compared to a 3.5% y/y growth in 2Q. Nevertheless, both 2Q and 3Q GDP averaged 5.5% growth that bucked the trend that saw eight consecutive quarters of sub-5% growth before this.

Although there was a pick-up in project clearances over the past six months, the corporate sector did not manage to pull up GDP growth as investment’s contribution to GDP growth was flat (compared to 2.3% pts in previous quarter). There was also plenty of spare capacity in the manufacturing sector as capacity utilization fell to around 70% in 2Q this year, compared with almost 85% just three years ago.

Weaker-than-expected manufacturing growth caused doubts to plans by the Modi-led government to boost the output of millions of factories and rais-ing the share of manufacturing to GDP from 15% to 25%. Although the government had gone all out to attract foreign investors with a list of initiatives such as “Make in India” to turn India into a manufacturing powerhouse, bureaucratic issues were still a com-mon hindrance to investment confidence. Another hindrance to investment demand is the high bor-rowing costs facing firms. This had led to slower credit growth registering a 13-year low in Sep 2014.

RBI pressure to cut rates, but concerns ofcapital outflow in 2015 counter such pressuresTThe current favourable inflationary environment due to lower energy prices, stable INR, and a lower trend in core inflation points to some leeway for the Reserve Bank of India (RBI) to pursue lower inter-est rates in 2015. For example, India's retail infla-

tion fell to a three-year low of 5.52% y/y in October, while wholesale inflation rate plunged to five year low of 1.77% y/y, aided by a sharp drop in vegeta-ble and petrol prices. However, we think that the RBI should also be wary that the US will start their interest rate normalization and capital outflow wor-ries should be on their dashboard. We recall the pe-riod of capital outflow and the quick depreciation of the INR during May 2013 when the US Fed started the ‘taper talk’. As such, we maintain our view that the RBI will keep their current repo rate of 8% un-changed in 2015, especially since recent months of trade deficits have widened again. We predict that rates normalization in the US and continued trade deficits will see a weaker INR towards 64.90 by middle of 2015.

2015 & Beyond:Reforms, reforms, and more reformsAfter the election win by Modi, Indian firms are pressing for a series of reforms on rules such as the Land Acquisition Act, labour reforms, foreign di-rect investment in the insurance sector, as well as the introduction of GSTs. It is estimated that India will see around 100 million young Indians entering the workforce over the next decade and many will look to Modi fulfilling his promise during the elec-tions to lift the lowest living standards in the country by creating jobs for them. Reforms will not be over-night, but we remain optimistic that it will help India achieve the next economic leap.


GDP 4.8 4.7 5.4 5.8

CPI (average, y/y %) 9.3 10.9 7.5 6.8




Trade deficit widened in recent months

-24,000

-20,000

-16,000

-12,000

-8,000

-4,000

0

-40

-20

0

20

40

60

80

1991 2002 2013

Trade Balance (USD million) - RHSExports 3mma %y/yImports 3mma %y/y

Source: CEIC

Slow manufacturing growth in quarter endingSeptember puts drag on GDP

0.5%-2.6%

2.1%3.3%3.5%5.4%4.4%

12.6%

0.6%1.1%

3.3%3.5%4.6%

7.2%8.7%

10.8%

-10% 0% 10% 20%

MfgMining

ConstructionTrade/Hotels/Tpt/Comms

AgriCommunity/Social

UtilitiesFinance/Real Est/Biz Svcs % y/y

India GDP at Factor Cost2014 YTD2013

20%

GDP share (2013)

2%

13%14%26%8%

2%15%

Source: CEIC


Entering the “New Normal” environment Despite China's better than expected 3Q14 head-line GDP growth of 7.3%y/y (data released in Oct), there is a discernible slowdown from the 7.4-7.5% pace seen in 1H14. Of note also is that on a q/q ba-sis, activities expanded by 1.9%q/q seasonally ad-justed in 3Q14, vs. average pace of 1.97% during 2011-2013. While this difference looks negligible, it is magnified once the figures are annualized. This is translated to an annualized pace of 7.8% for 3Q14, compared to the annualized rate of 8.1% based the average in 2011-2013.

By mid-December, there will be further confirmation that China is shifting into a “new normal” growth en-vironment when the annual Economic Work Confer-ence gets underway to set the economic policy tone for 2015 (reportedly to begin on 9 Dec). It is widely expected to lower the country’s growth target to 7% for 2015 from 7.5% currently.

The speed of recent measures such as RMB inter-nationalization (for instance, the number of offshore RMB centers appointed this year has far exceed-ed the number between 2010 to 2013) and finan-cial market reforms (impending implementation of deposit insurance, Shanghai-HK Stock Connect scheme, among others) suggest that the current government is committed and determined to the re-balancing and restructuring of the Chinese econo-my. Keeping these factors in mind, we are trimming slightly our 2015 GDP forecast to 7.2% (from 7.5% previously), while maintaining our projection for 2014 at 7.4%, implying a 4Q14 growth of 7.5%y/y, which is still achievable with PBoC taking increas-ingly proactive approach in its interest rate policy.

Interest rate cuts in Nov not a policy shiftThe surprise interest rate cuts announced on 21 Nov, with lowering of 25bps in deposit rate and 40bps on lending rate and the lifting of deposit rate ceiling to 1.2x of benchmark from 1.1x previously, was the first reductions since July 2012. On the sur-face this looks to be a shift towards “easing” policy. However after factoring in the increase in deposit rate ceiling, there is virtually no change to the de-posit rates post-announcement, whereas there is an outright reduction in borrowing costs. In other words, the announcement is yet another “targeted” move like others that took place for most 2014. In case the message is lost, PBoC followed up with the release of the draft regulations for deposit insur-ance scheme one week later, on 30 Nov, for public consultation (please see our Focus piece on de-posit insurance for more details). Once the deposit insurance scheme is implemented, possibly by mid-2015, it is conceivable that the ceiling on deposit rate will be removed as well. Meanwhile, we expect PBoC to continue to lower lending rates into the first half of 2015, as well as deposit rates (raising ceiling limit at the same time), and reserve requirement ra-

tios (RRR) to ensure sufficient credit in the system (see table below for our forecasts).

As for the RMB, our views remain intact with the unit firming marginally to 6.03/USD by end-2015. Even if it hit our target of 6.10/USD for end-2014 (spot: 6.1501 on 4 Dec), that would still be a full year de-cline of 0.8%, which would be the first annual de-cline since 2009. What is more important than the currency level is that as RMB internationalization accelerates, 2-way moves for the currency would also be the “new normal” as it behaves more like a global currency that is subject to both external and domestic factors. This means that there could be repeat of the bouts of depreciation seen during the Jan-Apr period 2014. For 2015, our expectations for Fed interest rate “normalization” could see USD strength pressuring the RMB as well. Having said that, the risks of prolonged depreciation are low, as the currency may need to maintain a largely stable value at this early stage of internationalization.


GDP 7.7 7.7 7.4 7.2

CPI (average, y/y %) 2.7 2.6 2.0 2.1




Real GDP growth

7.30

%7.

50%

7.10

%7.

20%

7.30

%

0%

2%

4%

6%

8%

10%

12%

1Q10 1Q11 1Q12 1Q13 1Q14 1Q15

%y/y Forecast

Source: CEIC, UOB Global Economics & Markets Research Estimates

CHINA

Interest rate and RRR forecasts (%)

Indicator 4Q14 1Q15 2Q15 3Q15 4Q15

1-year Best Lending Rate 5.60 5.35 5.10 5.10 5.10

1-year Deposit Rate 2.75 2.50 2.25 2.25 2.25

Reserve Requirement Ratio 20.00 19.50 19.00 19.00 19.00

Source: UOB Global Economics & Markets Research


HONG KONG

Strong rebound in 3Q14 but outlook clouded Hong Kong’s 3Q14 GDP growth came in much stronger than expected, at 2.7%y/y gain vs. ex-pectation of 2.0% and 1.8% pace in 2Q14. Overall momentum has also picked up sharply, at 1.7%q/q SA, on the back of the negative 0.1% seen in 2Q14 and ahead of expectation of 0.9%. The strong per-formance in 3Q14 was boosted by both external and domestic demand, with private spending rising a sharp 3.2%y/y in 3Q14, more than doubling the average 1.35%y/y pace in first half of the year.

However, outlook for the 4Q14 is clouded by the “Occupy Central” protest movement that took place all of October and November and still continuing in sporadic manner, as businesses in the affected ar-eas of Central attempting to regain some normalcy as public support for the protests dwindles.

It is obvious that both tourist arrivals, retail sales, F&B, hotel, transport, and related activities were severely affected during the occupy period. Servic-es accounted for 93% of HK’s GDP in 2013, which is nearly 10% point higher from 84% share in 2000, while manufacturing sector accounted for only 1% share in 2013, down from 5% share in 2000.

Within services sector, wholesale & retail, accom-modation, financial, transport, and other profes-sional services in all accounted for 61% of GDP in 2013. In addition, retail sales accounted for 23.3% of GDP in 2013 vs. 14% in 2000. For the labour force, more than 75% are employed with services sector (including public administration), or 2.96 mil-lion workers out of a total workforce of 3.91 million.

All these figures mean that business activities HK was severely impacted by the Occupy movement, and finance chief John Tsang has just warned eco-nomic growth this year could come in below an ear-lier forecast of 2.2%. We expect the services sector

continue to be dragged down into early 2015 by the uncertainty created by the “Occupy” movement. We look for HK’s economic growth at 2.1% for 2014, slightly below official forecast of 2.2%, with an im-plied 1.3%y/y expansion in 4Q14, to account for the disruption. For 2015, we expect activities picking up in the second half along with improvements in senti-ment for China, for a full year growth of 2.6%.

Interest rate outlook hinging onFed’s normalizationAgainst the backdrop of US Fed’s tapering and ex-pectation for US rate hike cycle ahead, the HKD interbank rates continue to be steady at the 0.36-0.38% level for 3-month. We do not expect domes-tic interest rates to move higher until early 2015 when the US rate hike cycle becomes more visible. We look for the 3-month HIBOR to edge up mar-ginally to 0.4% by end-2014, vs. 0.375% currently, and to 0.65% by end-2015, assuming the US Fed begins to tighten by mid-2015.

As for the HKD, we do not anticipate any change to the peg to USD any time soon. The commencement of the much-delayed “Shanghai-HK Stock Connect” or “Through Train” on 17 Nov ushered in another new step for China to continue on its market re-forms/RMB internationalization path, which should help enhance competitiveness for HK financial mar-kets, as the RMB20,000 daily currency-conversion cap for Hong Kong’s permanent residents was also abolished along with “Through Train”.


GDP 1.5 2.9 2.1 2.6

CPI (average, y/y %) 4.1 4.3 4.4 3.6



Fiscal balance (FY, % of GDP) 2.7 2.7 0.5 0.7

Retail sales

-15

-10

-5

0

5

10

15

20

25


%y/y change


3-month HIBOR vs. LIBOR

0

1

2

3

4

5

6

7

8

Jan 99 Jan 02 Jan 05 Jan 08 Jan 11 Jan 14

3M USD LIBOR3M HKD HIBOR

%



JAPAN

Little reprieve, if any, in 2015 Japan’s 3Q-14 GDP contracted 1.6%q/q SAAR (from 2Q’s -7.3%) and sent the economy into a technical recession as its domestic economy suf-fered a bigger & more sustained backlash from its April 2014 sales tax hike. We expect Japan’s full year growth to be a low 0.7% in 2014 even as we factor in some rebound in late 2014. We are con-cerned that 4Q may continue to disappoint espe-cially if the external environment weakens further and erodes Japan’s external demand contribution to growth. Japan’s latest set of monthly data con-tinued to point to weak bias. CPI inflation is tick-ing lower (headline at 2.9%y/y in Oct, from the high of 3.7% in April while core has been hovering at 2.3%y/y since April 2013) The BOJ-calculated in-flation (which excludes the April sales tax hike ef-fect) was lowered to 0.9%, (from 1.25% previously) and is in danger of slipping further below 1% on the back of declining energy prices. Industrial produc-tion provided a glimmer of hope as it grew for the 2nd straight month by 0.2%m/m (-1%y/y) in Octo-ber after 2.9%m/m (0.8%y/y) in September. Jobless rate edged lower to 3.5% but the domestic demand continued to be dismal with the continued collapse in household spending (-4% in Oct, -5.6% in Sep) and housing starts (-12.3% in Oct, -14.3% in Sep) while real wages continued to decline, underscores lingering domestic weakness following the sales tax hike and dampens hope of any imminent consump-tion recovery.

And while Japan remains mired in a trade deficit that has persisted since July 2012, October trade deficit eased to –JPY710bn from -JPY960.6bn in Sep, helped by cheaper oil. Despite the persistent trade deficit which is at a hefty JPY11.2trn for the first 10 months of 2014, the current account has fortunately turned around and it is in a JPY1.21trn surplus for first 9 months of 2014, as the deprecia-tion of the yen boosted yen-denominated returns on overseas assets. And so the yen weakness is a double-edged sword as it raises the cost of oil imports but it helps boost exports & the returns of overseas assets. It is still immensely difficult to reverse the trade deficit unless Japan restarts its nuclear power plants. That said, cheaper crude oil prices in coming months could lower the import bill and narrow the trade deficit.

The malaise in consumer weakness could persist into 2015 while external demand remains anemic. Political uncertainty adds to the downside risk. We consequently revised our 2015 GDP growth much lower to 1% (from 2%).

Monetary policy will have to waitAfter expanding its quantitative and qualitative eas-ing (QQE) program in October 2014, the Bank of Japan (BOJ) kept its monetary stance unchanged in Nov and we believe the BOJ is unlikely to do

more in Dec or in 2015. We initially factored another round of stimulus ahead of the Oct 2015 sales tax hike, but the stimulus is now off the table since the hike has been delayed till 2017. However, the pace of CPI inflation has been easing since August with the continued decline in oil prices, that will surely add more downside pressure on inflation & puts BOJ in a tight spot in 2015 to consider more mon-etary easing (to achieve its 2% inflation target) but without the government’s commitment to fiscal dis-cipline.

Politics may be key risk just before 2015Japan will go for snap election before the year runs out even though Prime Minister Shinzo Abe has 2 more years in office and majority in both upper and lower chambers of the Diet. Abe’s ruling party Liber-al Democratic Party (LDP) showed a strong lead in opinion polls on 24 Nov with 35% saying they would vote for Abe’s and its candidates in 14 December lower house election, while 9% supported main opposition Democratic Party of Japan (DPJ). 45% were undecided. But a majority of 51% of respond-ents disapproved of Abe’s economic policies with just 33% endorsing it. Early December polls all sug-gest the LDP is set to win around 300 seats in the next parliament's 475-seat lower house. A straight-forward victory for Abe is the base case scenario amidst weak opposition and potentially low voter turnout, but the concern is that if Abe chooses to campaign on contentious issues (restart of nuclear power plants & revision of the pacifist constitution) then the outcome is uncertain.

JPY in consolidation till the Fed hikesWe see a period of possible yen consolidation amidst political uncertainty before 14 Dec election. If PM Abe re-captures the parliament with a strong-er public vote, then that could send USD/JPY to fresh multi-year highs. Conversely, if he unexpect-edly loses the popular vote, then that could see the yen weakness quickly unravel with the pair easily heading below 110. Political risk in Japan will be the dominant theme for now. Barring an unexpect-ed snap election outcome, we expect the USD/JPY pair to close 2014 at 120 but will only break com-prehensively above 120 by end-2Q 2015 towards 125 when the Fed finally delivers the first rate ac-tion which we expect in June 2015 FOMC.


GDP 1.5 1.5 0.7 1.0

CPI (average, y/y %) 0.0 0.4 3.2 1.0





SOUTH KOREA

South Korea’s GDP growth momentum strength-ened to 0.9% q/q in 3Q14 from 0.5% in 2Q14, led by improvements in private consumption and construction fixed investment. However, down-ward pressure was seen coming from facilities in-vestments and exports which contracted from the second quarter. Weaker demand from China and strong KRW were the key factors behind the slow-down in exports during the quarter. China is South Korea’s largest export market accounting for 26% of its exports, which means that a structural slow-down in China could continue to weigh on South Korea’s outlook. On a y/y basis, growth has moder-ated to 3.2% y/y in 3Q14 from 3.5% in 2Q14. The economy grew 3.5% in the first three quarters of the year, on track for BoK’s revised growth forecast of 3.5% for this year. In October, the central bank also revised lower its 2015 growth to 3.9% from 4.0%.

Tame domestic inflation The prolonged weak inflationary environment has become a concern as headline CPI has been com-ing in below the BoK’s target range of 2.5-3.5% since mid-2012. This raises the prospect that the central bank may consider changing its inflation target.

The headline CPI was at 1.0% y/y in November (October: 1.2%) while core CPI moderated to 1.6% y/y from 2.2% y/y in 3Q14. Weak demand and de-cline in the global oil prices will continue to cap price gains but inflation is likely to rise gradually next year while the real estate market has shown improve-ments since bottoming out in late-2013. We expect the headline inflation to average 1.3% and 1.6% in 2014 and 2015 respectively.

Monetary policy remains in focusto revive growthDomestic demand is an important driver for growth next year given the lack of an external catalyst. The government is expected to continue to focus on the

recovery in consumer sentiment and the housing market. And taking into account of the easing mon-etary policy in Japan, there will certainly be pressure for the BoK to cut its base rate further especially if the incoming economic data do not improve. Cen-tral to the worry was the decline in JPY/KRW rate which poses challenges to South Korean exporters especially those in the local car and steel industries even as the diversification of the production bases out of South Korea has helped to alleviate some of the competitiveness concerns.

After a combined 50bps interest rate cut in August and October, the base rate is now at a record low of 2.00%, similar to its lowest during the Global Finan-cial Crisis. The low domestic inflation suggests that the base rate could go below 2.00% in the short-term but a sustained period of extremely low inter-est rate runs the risk of fanning more debt build-up which is an increasing concern for the households. Our baseline expectation is for the base rate to re-main at 2.00% in the first half of 2015.

More upside to USD/KRWJPY factors are expected to continue to dominate and if the expectation of BoK easing leads to a sharper upward momentum in USD/KRW, this may reduce the risk of further rate cut by the BoK. Other than the BoJ, the expectation of US Fed’s monetary normalization will also contribute to higher USD/KRW. As such, we expect USD/KRW to head up to 1,140 by end-1Q15.


GDP 2.3 3.0 3.4 3.9

CPI (average, y/y %) 2.2 1.3 1.3 1.6




JPY/KRW at more than 6-year low

1,0001,0201,0401,0601,0801,1001,1201,1401,1601,180

9.0

9.5

10.0

10.5

11.0

11.5

12.0

12.5

Jan 13 Jun 13 Nov 13 Apr 14 Sep 14

JPY/KRW (lhs)USD/KRW

Source: Bloomberg

Weak manufacturing outlook

-10-50510152025303540

45

47

49

51

53

55

57

59

Mar-10 Sep-11 Mar-13 Sep-14

HSBC PMI (LHS)Industrial Production (3mma, y/y %)Exports (3mma, y/y %)



TAIWAN

A minor set back by food scandals in 3Q14 Taiwan’s 3Q14 GDP growth final reading came in at 3.63%y/y, lower than advance estimate of 3.78%, and a revised 3.87% pace in 2Q14. On a season-ally adjusted basis, activities slowed somewhat to 2.65%q/q annualized rate in 3Q14, slower com-pared to the 3.47% pace in 2Q14 which is the sec-ond fastest in 8 quarters.

Looking at the details, the food scandal that en-gulfed the island during the quarter was the main culprit. This is reflected in the sharp deceleration in private spending to 1.2%q/q annualized, just about a quarter of the 4.85% annualized in 2Q14. How-ever other areas of spending were not as severely affected as government spending and private in-vestment stepped in to fill some of the gaps. This resulted in domestic demand expanding 5.08%q/q annualized, more than doubling the 2.54% pace in 2Q14. The other bright spot was the continued support from external demand, which saw exports rising 9.69%q/q annualized in 3Q14, from 7.15% in 2Q14 and the best performance in two years.

Going into 2015, we expect the US economic growth to remain intact, though the developments in Eurozone and Japan could offset the gains in the US. Nevertheless, the declines in commodities prices especially crude oil will be boon for Taiwan. In addition, latest exports orders data are encour-aging, with an increase of 13.4%y/y in Oct, from 12.7% rise in Sep, driven by strong orders from the US and Europe, as seasonal demand picked up.

As such, Taiwan’s economic growth prospects should remain positive in 2015, as we pen in a 3.2% forecast, vs. estimated 3.5% in 2014, with an im-plied 4Q14 growth of around 3% pace.

Monetary policy on watch for Fed’s move Despite a steady pick up in economic activities, inflationary pressure in Taiwan remains largely ab-sent, averaging just 1.3%y/y in the first 10 months of 2014, despite a low base of 0.8% rise in all of 2013. We expect Taiwan’s inflation rate at around 1.3% for the full year, and only marginally higher at 1.5% in 2015 as private spending recovers from the one-off food scandal and boosted by pre-election spending as the island heads to the 2016 legisla-tive (Jan) and presidential (Mar) elections. The recent “9-in-1” city, county, and local elections (29 Nov) saw the ruling KMT party losing its traditional strongholds of Taipei and Taichung, suggesting that it would be a major tussle in 2016 with the DPP.

The lack of price pressure is likely to persist in Tai-wan amidst the declines in commodities prices. In particular, the 40% plunge in crude oil price (WTI) since Jun which signals a major correction for the commodity. The recent news that OPEC insisting on keeping its output in the face of declining prices

is likely to see supply flowing to the market at a time when China is tilting towards a moderate growth mode and major oil users such as Japan and Eu-rozone are facing an uncertain economic outlook.

This means that for the CBC, status quo is expect-ed for the upcoming 4Q14 interest rate meeting on 18 Dec, with its policy rate unchanged at 1.875%. In fact, Taiwan’s real interest rate has stayed elevated for more than two years as inflationary pressure eased. This suggests that Taiwan’s central bank may not follow the Fed’s footstep when the latter is poised to “normalize” its interest rate into mid-2015.

One key consideration for CBC is that a domestic interest rate hike could have a strengthening effect on the TWD amidst a backdrop of weakening Japa-nese yen. Since mid-2011, the TWD has firmed from 0.40 TWD per yen to 0.26 TWD per yen, more than 40% gain, while the KRW rose from 15.6 per JPY to 9.39 currently, an appreciation of 66% against the JPY. As all these three economies rely on external demand as a key driver, the domestic currency is a key policy factor. This means that CBC is unlikely to make any change in its policy stance anytime soon. On our part, we look for the TWD to be kept at bay against the USD. Our forecast is for USD/TWD to grind gradually higher towards end-2015, to 31.80, from current level of 31.05 (1 Dec).


GDP 1.5 2.1 3.5 3.2

CPI (average, y/y %) 1.9 0.8 1.3 1.5




Taiwan: Real interest rate*

-2

-1

0

1

2

3

4

Jan 09 Jun 10 Nov 11 Apr 13 Sep 14


*Taiwan rediscount rate less headline inflation (%)


EUROZONE

Draghi lays the ground for QEAlthough there wasn’t any concrete action from the ECB at the final Governing Council meeting of 2014, President Mario Draghi in his clearest language yet, offered assurances that more aggressive stimulus was just around the corner, underlining the central bank’s commitment to support the ailing economy of the 18-country bloc. It is clear that the ECB wants to wait out a little longer to see the current policy mix, including the take-up of the upcoming TLTRO on 11 December. Besides, plunging oil prices is seen blurring the ECB outlook and they will require more clarity before acting. But our call for the ECB to implement a broad-based asset purchasing plan including sovereign QE in the first half of next year remains valid. Although there is some resistance, it is obvious that Draghi is committed to using ad-ditional unconventional instruments, at the same time, willing to live with some dissent in a QE vote in order to ease the policy stance further and deliver on the ECB’s primary legal mandate. This strongly indicates that Draghi would not allow opposition from Germany or anyone else to stop it.

Grim outlook for Eurozone economyAnd the reason for QE is simple. The threat of defla-tion and recession combined with stubbornly high unemployment across the 18-country Eurozone looms large. And consumer prices are expected to soften further after the sharp drop in oil prices. Responding to low inflation damped by oil prices is complicated for the ECB. Although the lower costs depress inflation further below the bank’s target, they may also help the economy by freeing up dis-posable income for households and businesses to spend and invest. However, the risk is that Europe-an households and businesses may not see falling energy prices as a temporary windfall but rather the continuation of an ultra-weak price trend that will persist far into the future. This could prompt com-

panies to put off investment and hiring. Indeed, new forecasts by the ECB predicted the bloc's economy would grow just 1.0% next year rather than the 1.6% predicted just three months ago. Inflation is seen at just 0.7% in 2015, down from a September forecast of 1.1% and way below the target of just under 2.0%.

Downside pressure in Euro mountsCurrently hovering around the 1.2370 region, the Euro continues to retreat as hopes are high that the ECB will unveil a QE package early next year. In fact, nothing has changed the underlying condi-tions that we expect will continue to put downward pressure on the EUR/USD currency pair. Factors include the weak growth/inflation backdrop in the Eurozone, further ECB easing eventually, as well as a constructive backdrop for the USD highlighted by continued improvement in growth, the labor market and the gradual approach of the start of Fed rate hikes. We are thus looking for the EUR/USD pair to move towards 1.2100 by the end of this year and thereafter towards the 1.190 region by the end of 1Q15.


GDP -0.7 -0.4 0.8 1.1

CPI (average, y/y %) 2.5 1.3 0.5 0.8




Why is the ECB so adamant about inflation?

-5

0

5

1998 2000 2002 2004 2006 2008 2010 2012

% Real Interest Rates - Eurozone

-5

0

5

10

1998 2000 2002 2004 2006 2008 2010 2012

%Inflation Rates - Western World

United States Eurozone United Kingdom

Source: Bloomberg, UOB Global Economics & Markets Research


AUSTRALIA

Economy faces challenges aheadAustralia’s 3Q GDP growth missed expectations, with output expanding by 0.3% for the quarter. The outcome was worse than the 0.7% increase expect-ed and lower than the 0.5% growth rate in the sec-ond quarter. Growth for the year held at 2.7%, well short of the 3.1% expected, and seemed certain to slow given the gloom hanging over commodity mar-kets, a rude awakening after years of plenty for the resource-rich nation. We continue to expect Aus-tralia’s economic momentum to remain dampened by declines in mining investment and renewed fis-cal tightening; although growth should continue to rebalance, with the low interest rate backdrop ex-pected to support rising household consumption and dwelling investment. We are looking for a GDP growth of 2.8% next year, down from an estimated 3.0% in 2014, as the economy continues to search for new growth drivers.

RBA’s next move is shifting to the downsideIt has been an uneventful year for the RBA. The final meeting of the year contained little surprises again, with the cash rate unchanged at a record low of 2.50%, and the central bank keeping to its stance that “the most prudent course is likely to be a period of stability in interest rates”. This observation has now been made in each of the past eleven post-meeting statements. We think that the decline in the exchange rate is not yet enough to offset the nega-tive impact on the economy and labour market, as well as the ongoing weakness in commodity prices and slowing Chinese growth. In fact, these factors have prompted some discussion that the RBA’s next move could be to cut rates. That said, the biggest sector holding the RBA from cutting interest rates is the property market. The bank cannot ignore the risks associated with an overheated property mar-ket, yet we may see the introduction of macro-pru-dential measures aimed at preventing buyers from overleveraging, similar to what the RBNZ did. We still see the next RBA move as up, as growth contin-ues to rebalance. However, we have pushed back the hike towards the end of 2015, with the risk for that rates could stay unchanged for longer.

Yet more disappointment for AUD/USDCurrently hovering below the 0.8400-figure, AUD/USD has spiked sharply downwards. Of late, tides have appeared to change as economic difficulties in China coupled with bear markets in metals and many commodities, have created a more opaque picture of the future of Australia's financial pros-pects. That said, the fall in the Australian dollar is a very welcome development for the RBA, giving the central bank more scope to hike rates down the road amid rising concerns about the elevated level of activity in the housing market. It will also aid the economy’s rebalancing, boosting growth and hir-ing in the non-mining sectors. We continue looking for a lower AUD/USD into 2015. A large part of the currency’s weakness is expected to be due to in-creasing US dollar strength, where the story of ris-ing US interest rates is likely to dominate currency trade. We are penciling an end-1Q target of around 0.8100.


GDP 3.6 2.3 3.0 2.8

CPI (average, y/y %) 1.8 2.5 2.6 2.4




RBA’s forecasts (percentage change over year to quarter shown)

Indicator Dec-14 Jun-15 Dec-15 Jun-16 Dec-16

Forecasts as published by RBA in November 2014 SMP

GDP 2.50 2-3 2.5-3.5 2.75-3.75 2.75-3.75

Headline CPI 1.75 1.5-2.5 2.5-3.5 2.5-3.5 2.25-3.25

Underlying inflation 2.25 2-3 2.25-3.25 2.25-3.25 2.25-3.25

Forecasts as published by RBA in August 2014 SMP

GDP 2.50 2-3 2.5-3.5 2.75-3.75 2.75-3.75

Headline CPI 2.00 1.75-2.75 2.5-3.5 2.5-3.5 2.25-3.25

Underlying inflation 2.25 1.75-2.75 2.25-3.25 2-3 2-3

Source: RBA, UOB Global Economics & Markets Research


UNITED KINGDOM

Recovery unbalancedUK’s GDP grew 0.7% during the third quarter, un-changed from the preliminary estimate. That was down from 0.9% in the second quarter, the joint highest quarterly rate in four years. Year-on-year, GDP grew 3.0%, confirming Britain is one of the world's fastest-growing rich economies this year. That said, business investment fell by 0.7% for the quarter, its first drop in more than a year and a sharp slowdown from the second quarter's 3.3%. By contrast, consumer spending once again the key contributing factor to the UK’s steady growth rate, expanded by 0.8% on the quarter. Whilst growth generally remains on track, we remain cautious on the recovery. After all, trade is still proving to be a drag on the economy, especially with slowing global growth emanating from Japan and particularly the Eurozone.

Rate hike expectations pushed backThe BoE held its benchmark interest rate at 0.5% in December and kept its asset purchase programme target at GBP375bn. The minutes will be pub-lished on 17 December. Since August 2014, Martin Weale and Ian McCafferty have continued to push for higher rates but given the deterioration seen in economic conditions of late, the majority of the MPC remained against raising interest rates. Some

MPC members have noted concern over diminish-ing slack in the economy and said low productiv-ity could be a source for potential wage pressures, which might see inflation overshoot the 2% target. Besides, in the current environment where weak-ness in the Eurozone prevails and factoring in lower commodity prices, the risk for inflation overshooting the 2% target would seem less pronounced than that of an overshoot. We believe that the BoE will hold fire on rates and have thus pushed back our rate hike expectations to 4Q15.

Further weakness in GBP/USD likely to ensueGBP has seen a marked depreciation against the USD, falling more than 5% year to date. This oc-curred despite generally better than expected data throughout the month of November, largely driven by the BoE’s inflation report on 12 November, where growth forecasts were slashed and the central bank said inflation could fall below 1% within months as a renewed slump in the Euro area weighs. Going forward, it looks like the weakness in GBP/USD is here to stay. The currency is likely to move in line with interest rate expectations. In this regard, the BoE is likely to raise rates later than the market cur-rently anticipates, especially now that low inflation will allow the BoE to “wait-and-see” longer. Besides, heightened political risk around the May general election could weigh on the currency. The Scot-tish independence referendum in September 2014 clearly demonstrated the risk of politics, and the re-percussions for GBP for this could be far greater than the Scottish referendum, especially when the diminishing dominance of the main two political par-ties in the UK means another coalition government has become increasingly likely. We have thus re-vised lower our forecasts for GBP/USD into 2015, now looking for an end-1Q target of around 1.550.


GDP 0.7 1.7 3.0 2.6

CPI (average, y/y %) 2.8 2.6 1.5 1.6





UNITED STATES OF AMERICA

2015 Positive growth, painful politics US 3Q-2014 GDP growth was revised higher to 3.9%q/q SAAR (from first estimate of +3.5%) from 2Q’s 4.6%, boosted by higher personal consump-tion & gross private domestic investment and a smaller negative inventory contribution, even as the trade deficit have widened slightly with exports growing at a slower pace while the imports contrac-tion was reduced slightly. 2Q & 3Q together record-ed the strongest US growth in a decade.

And the latest October/November data still suggest continued US economic improvement albeit at a more subdued trajectory. Positive durable goods growth, strong services, healthy retail sales, lower but still-buoyant US consumer confidence, sus-tained improvement in US labor market conditions amidst mixed housing data, makes us still confident this US GDP growth streak could sustain into 2015. A net positive for the US is the structural change in its oil equation (turning from net importer to be-coming one of the biggest energy producers thanks to shale oil & gas). While the decline in oil prices is hurting the oil & gas sector, it significantly low-ers business operating cost in US (especially for energy-intensive industries) and it also puts more disposable income back to US consumers.

Two exogenous factors pose concern for US econ-omy: 1) weak external environment & a stronger US dollar hurting US exports and 2) the return of extreme weather disrupting US domestic economic activity (recall late 2013 and 1Q 2014). That said, exports make up just 13% of US GDP, the lowest among OECD countries while the stronger USD helps to mitigate the cost of imports. Oil imports are also markedly reduced given the rich US oil pro-duction. And while weather may cause a hiccup in growth, the effect is largely transient and we can expect a decent rebound after the storm passes. We continue to be positive on US growth outlook and keep our forecast for 2014 GDP growth at 2.7% but we are mindful that our 3.2% for 4Q assumes no weather-related shock in December. For 2015, we expect 3.2% growth with the US housing mar-ket, and the US consumer providing the out-perfor-mance factors.

A key domestic risk factor is US politics which may enter into a year of high-drama in 2015. US Presi-dent Obama issued executive orders on immigra-tion despite the strong protests from Republicans, and now we wait for the Republican response. Republicans are set to gain majority power in both House and Senate in the new Congress in 2015. Of particular immediate concern is that the Repub-licans will retaliate by holding up a spending bill which will force the US government to cease many of its operations by 12 Dec 2014, reliving the 2013 government shutdown. The next issue that has global implications is the US debt ceiling limit which

is suspended until 15 March 2015. As there are no election concerns in 2015, political brinkmanship may once again push markets to the edge at some point.

FOMC: June 2015 rates lift-off likely We believe the 16-17 December FOMC meeting could move the USD materially as there is a strong possibility the Fed adjusts its key phrases during that meeting to provide clarity on Fed’s lift-off time-table and that could spark another bout of USD strength and volatility before the year is out.

We reiterate our view that we are still expecting the Fed rate normalization to take place in 2Q-2015 (possibly starting in the 16-17 June 2015 FOMC) bringing the FFTR to 1.25% by end-2015, and to 3.25% by end-2016. Two issues will complicate the FOMC decision in 2015, data and US politics. An early assessment of the 2015 FOMC voters sug-gests a more dovish group.

A flatter UST yield curve view in 2015The 10-year UST yield is at 2.3% (03 Dec 14) well away from the 3% forecast we started 2014 with despite the tapering and eventual termination of QE in Oct 2014. In 2015, we expect several reasons to keep long-end yields well anchored: 1) Fed will not be UST seller to reduce its balance sheet, 2) UST supply is lower due to improving US fiscal position, 3) QE from BOJ & ECB will re-direct buyers into UST, and 4) geo-political risk to boost safe haven demand for UST. The UST yield curve may flatten further once rate hike expectations crystalized by late-2014, which will drive up short-end yields. 2Y UST at 0.55% (03 Dec 14) could be at 1.3% while 10Y at 2.8% by mid-2015.

USD on top of the currency pack Looking ahead into end-2014 and 2015, we believe significant dollar strength will materialize further when the Fed gives a concrete rate hike timeline before the year is up. The divergence in policy di-rections will be especially stark between US and BOJ-ECB, and the result of the diverging policies is the strength of the USD against the majors and emerging markets currencies.


GDP 2.3 2.2 2.7 3.2

CPI (average, y/y %) 2.1 1.5 1.7 2.3





FX TECHNICALS

EUR/USD: 1.2470EUR/USD is clearly oversold going into the end of 2014 and the movement sug-gests that this pair could be in the early stages of a bottoming process. The cur-rent price action is likely tracing out a falling wedge formation and another leg lower towards 1.2235 is likely before a sustained rebound can be expected. 1.2235 is the trend-line support connect-ing the 1.1876 low in June 2010 and the 1.2050 low in July 2012. Overall, we expect 1.2860 to act as a very strong resistant going into the next quarter but further EUR weakness is not expected move significantly below 1.2235. Even a move below this level is not expected to break below the major support at 1.2050.

GBP/USD: 1.5735Despite severely oversold conditions, it is premature to expect GBP to bottom just yet. Based on the momentum in-dicators, GBP weakness could extend towards 1.5430 but the next support at 1.5102 is likely out of reach during the first quarter of 2015. Major resistant is at 1.5945.

AUD/USD: 0.8400AUD/USD continues to make fresh lows going into end 2014 and the trend is ex-pected to persist in 1Q15. A move below the major support at 0.8310 will not be surprising but a break of the 2010 low of 0.8065 is not likely in view of the severely oversold conditions. Previous instances of extreme oversold conditions led to a rebound but only a break above 0.8800 would indicate the start of a recovery phase. Otherwise, AUD is expected to be on the defensive in the early part of 2015.


FX TECHNICALS

NZD/USD: 0.7780NZD traded in a well-defined range of 0.7660 and 0.8035 since early October 2014. The key level is obviously near 0.7660/70 as this level was tested sev-eral times in 2013 as well as in Novem-ber 2014. The sideway trading within the 0.7660/0.8035 range is expected to lead to an eventual move lower towards the 2012 low of 0.7450. That said, wan-ing downward momentum suggests any down-move to be slow and grinding. A sustained move above 0.8035 is not ex-pected in 1Q15.

USD/JPY: 118.80Strong momentum is expected to trump the current overbought conditions and lead to further USD gains in the first quar-ter of next year. A move above 119.85 will not be surprising but the 2007 peak of 124.14 is likely out of reach. Only a move back below 112.57 would indicate a mid to long-term top is in place.

USD/SGD: 1.3060USD continues to outperform and the strong monthly close in November broke above the falling trend-line resistant con-necting the peaks of 1.7065 and 1.5580. Upward momentum is still very strong and the obvious target is at the 2011 high of 1.3200. A move above this level will shift the focus towards the major resis-tant at 1.3453 (confluence of low in 2008 and trend-line from the 1.8557 high). Critical support is at the previous break-out point of 1.2860.


FX TECHNICALS

USD/MYR: 3.4150The explosive rally in the first of Decem-ber 2014 signals that this pair could be in the early stages of a trending phase which could last for several weeks. Un-less there is a move back below the previous break-out point at 3.3460, USD may extend towards the top of the rising channel near 3.5100 by end of 1Q2015.

EUR/SGD: 1.6250The major key support at 1.6000/05 was tested several times in October and No-vember but held. The break of the falling trend-line coupled with weekly MACD crossing into positive territory suggests that an interim low is in place. However, a sustained up-move is likely only upon a break above the major resistant at 1.6480. Otherwise, expect broad trading range between 1.6000 and 1.6480 in the early part of 1Q15 but this should even-tually lead to a move towards 1.6650.

GBP/SGD: 2.0505GBP traded in a well defined range against the SGD and the key levels at 2.0185 and 2.0955 will likely remain intact in 1Q15. Waning downward mo-mentum suggests limited downside risk for now but conversely, a move above 2.0955 is not expected. Overall, fur-ther range trading between 2.0185 and 2.0955 is likely in 1Q15.


FX TECHNICALS

AUD/SGD: 1.1010As of the time of writing, AUD/SGD is holding just above the 2014 low of 1.0995/00. The down-move is gain-ing momentum rapidly and further AUD weakness towards 1.0730 is likely by end of 1Q15. The minor peak of 1.1385 is a strong resistant but only an unlikely break above the key mid-term resistant at 1.1520 would indicate a sustained AUD recovery has started.

JPY/SGD: 1.1095Despite severely oversold conditions, there is no indication that JPY/SGD has found a low. That said, any further weak-ness will likely be at a slower pace and the major support at 1.0700 is not ex-pected to yield so easily. On the upside, the previous low at 1.1585 is acting as a very strong resistant and this level is expected to hold for 1Q15.


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UOB-SM Asset Management Pte Ltd(a subsidiary)80 Raffles Place, #15-22UOB Plaza 2Singapore 048624Phone: (65) 6589 3850Fax: (65) 6589 3849

UOB Venture Management Private Limited(a subsidiary)80 Raffles Place, #30-20UOB Plaza 2Singapore 048624Phone: (65) 6539 3044Fax: (65) 6538 2569Email: [email protected]

BruneiUOB Asset Management (B) Sdn Bhd(a subsidiary)1st Floor, Unit FF03-FF05The Centrepoint HotelJalan GadongBandar Seri Begawan BE3519Phone: (673) 242 4806Fax: (673) 242 4805

ChinaUOB Investment Consultancy (Beijing) Limited(an associate)8/F Taiji BuildingNo. 211, Bei Si Huan Middle RoadHaidian DistrictBeijing 100083Phone: (86)(10) 8905 6671Fax: (86)(10) 8905 6700Email: [email protected]

UOB Venture Management (Shanghai) Limited(a subsidiary)Room 3307, United Plaza1468 Nanjing Road WestShanghai 200040Phone: (86)(21) 6247 6228Fax: (86)(21) 6289 8817Email: [email protected]

SZVC-UOB Venture Management Co. Ltd(an associate)FL. 11 Investment BuildingNo. 4009 Shennan RoadFutian Centre DistrictShenzhen 518048Phone: (86)(755) 8291 2888Fax: (86)(755) 8291 2880Email: [email protected]

Ping An UOB Fund ManagementCompany Ltd(an associate)8/F Great China International Trading PlazaFuhua 1st Road, Futian DistrictShenzhen 518048Phone: (86)(755) 2262 2289Fax: (86)(775) 2399 7878



FranceUOB Global Capital SARL(a subsidiary)40 rue La Perouse75116 ParisPhone: (33)(1) 5364 8400Fax: (33)(1) 5364 8409

IndonesiaUOB Venture ManagementPrivate LimitedRepresentative OfficeUOB Plaza, 22nd FloorJalan M.H. Thamrin No. 10Jakarta Pusat 10230Phone: (62)(21) 2938 8442Email: [email protected]

JapanUOB Asset Management (Japan) Ltd(a subsidiary)Sanno Park Tower, 13F2-11-1 Nagatacho, Chiyoda-kuTokyo 100-6113, JapanPhone: (81)(3) 3500 5981Fax: (81)(3) 3500 5985

MalaysiaUOB Asset Management (Malaysia) Berhad(a subsidiary)Vista Tower, The Intermark, Level 22348 Jalan Tun Razak50400 Kuala Lumpur, MalaysiaPhone: (60)(3) 2732 1181Fax: (60)(3) 2732 1100Email: [email protected]

TaiwanUOB Investment Advisor (Taiwan) Ltd(a subsidiary)Union Enterprise Plaza, 16th Floor109 Minsheng East Road, Section 3Taipei 10544Phone: (886)(2) 2719 7005Fax: (886)(2) 2545 6591Email: [email protected]

ThailandUOB Asset Management (Thailand)Company Limited(a subsidiary)Asia Centre Building, 23A, 25th Floor173/27-30, 32-33 South Sathon RoadThungmahamekSathon, Bangkok 10120Phone: (66)(2) 786 2000Fax: (66)(2) 786 2370-74Website: www.UOBAM.co.th

United States of AmericaUOB Global Capital LLC(a subsidiary)UOB Building592 Fifth AvenueSuite 602New York, NY 10036Phone: (1)(212) 398 6633Fax: (1)(212) 398 4030Email: [email protected]

MONEY MARKET

AustraliaUOB Australia Limited(a subsidiary)United Overseas Bank BuildingLevel 9, 32 Martin PlaceSydney, NSW 2000Phone: (61)(2) 9221 1924Fax: (61)(2) 9221 1541SWIFT: UOVBAU2SEmail: [email protected]

STOCKBROKING

SingaporeUOB-Kay Hian Holdings Limited(an associate)8 Anthony Road, #01-01Singapore 229957Phone: (65) 6535 6868Fax: (65) 6532 6919Website: www.uobkayhian.com

Disclaimer

This analysis is based on information available to the public. Although the information contained herein is believed to be reliable, UOB Group makes no representation as to the accuracy or completeness. Also, opinions and predictions contained herein reflect our opinion as of date of the analysis and area subject to change without notice. UOB Group may have positions in, and may effect transactions in, currencies and financial products mentioned herein. Prior to entering into any proposed transaction, without reliance upon UOB Group or its affiliates, the reader should determine, the economic risks and merits, as well as the legal, tax and account-ing characterizations and consequences, of the transaction and that the reader is able to assume these risks. This document and its contents are proprietary information and products of UOB Group and may not be reproduced or otherwise.


GLOBAL ECONOMICS & MARKETS RESEARCH

Jimmy Koh Head of Research

(65) 6539 [email protected]

Alvin LiewSenior Global Economist


Lee Sue AnnTreasury Economist


Suan Teck Kin, CFASenior Asian Economist


Ho Woei ChenAsian Economist


Francis TanAsian Economist


Quek Ser LeangMarket Strategist


Victor Yong Tze ChowInterest Rate Strategist


More reports available on:URL: www.uob.com.sg/research

Email: [email protected]: UOBR

MCI (P) 006/01/2014


United Overseas Bank LimitedHead Office

80 Raffles Place UOB Plaza Singapore 048624Company Registration No.: 193500026Z

Telephone: (65) 6533 9898Facsimile: (65) 6534 2334Website: www.uob.com.sg

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