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Credit Conditions: Largely Stable InAsia-Pacific, With A Dash Of NegativeAnd A Focus On China's FinancialSector Risks

Primary Credit Analyst:

Andrew D Palmer, Melbourne (61) 3-9631-2052; [email protected]

Secondary Contact:

Fabienne Michaux, Melbourne (61) 3-9631-2050; [email protected]

Table Of Contents

The Macroeconomic Environment: Steady Growth Is Expected Across

Asia-Pacific

Financing Conditions

Risks And Imbalances

Sector Trends: Largely Stable With A Dash Of Negative

Credit Trends: Outlook Remains Cautious

Related Research

Appendices

WWW.STANDARDANDPOORS.COM/RATINGSDIRECT MARCH 26, 2014 1

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Credit Conditions: Largely Stable In Asia-Pacific,With A Dash Of Negative And A Focus On China'sFinancial Sector Risks

(Editor's Note: Standard & Poor's Credit Conditions Committees meet quarterly to review the macroeconomic

environment in each of four regions (Asia/Pacific, Europe/Middle East/Africa, Latin America, and North America).

Discussions center on identifying credit risks in various sectors and outlining the potential impact these risks might have

on ratings. The committees also evaluate how economic conditions will influence borrowing and lending activity for

businesses and consumers within those regions in the following few months. This article reflects the view developed

during the Asia-Pacific Credit Conditions Committee discussion of March 14, 2014.)

While risks have generally subsided for the time being, flatter economic growth and potential financial markets

volatility resulting from any quantitative easing tapering make for some potential credit headwinds for Asia-Pacific

issuers.

Standard & Poor's outlook for real GDP growth for Asia-Pacific as a whole remains broadly unchanged from

December. We expect China, which accounts for just under half of the region's GDP, to continue to see a gradual

moderation in growth in line with that country's policymakers' desire for rebalancing China's economy and reining in

financial excesses. Japan's growth should moderate as well, as the initial boost from Abenomics subsides. In contrast,

we expect a pick-up in 2014 growth for the more trade-dependent economies of Asia-Pacific, given the expected

improvements in the U.S. and European economies and the resultant rise in global trade. Although emerging Asia is

likely to experience periodic episodes of capital outflows as U.S. monetary policy normalizes, we believe that much of

the market adjustment has already taken place, leaving less pricing space for the markets if further weakness occurs.

These assumptions have underpinned our baseline scenario for 2014 and 2015 since the December Credit Conditions

Committee meeting, and as such there are only minor changes to our baseline forecasts in the current round.

However, in this forecast we have revised our downside scenarios to incorporate rising near-term risks in China's

financial sector.

OVERVIEW

Overall growth in Asia-Pacific in 2014 will be broadly unchanged from 2013. However, there are some

divergences across sub-regions.

The largest economies will see moderating growth. China's authorities are steering the economy onto a more

sustainable growth path, while Japan's initial boost from Abenomics is fading.

Improvements in the U.S. economic outlook, as well as global trade, will result in slightly better growth profiles

in South Korea, Hong Kong, Taiwan, and Singapore. Indian growth should pick up as well, due in part to a low

base.

The more domestically-oriented ASEAN economies are likely to see slower growth, for various reasons.

Moral hazard concerns continue to mount in China's financial sector in light of widespread perceptions of

government guarantees. This takes place amidst moderating growth, creating rising near term risks. If

unchecked, these could pose significant downside growth risks to China, the rest of the region and beyond.

Sector credit trends are largely stable with a dash of negative--about 20% of issuer credit ratings in Asia-Pacific

were on negative outlook or CreditWatch with negative implications as of February 2014.


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The Macroeconomic Environment: Steady Growth Is Expected AcrossAsia-Pacific

Our baseline macroeconomic views for Asia-Pacific as a whole in the near term have not changed materially since

December 2013. We continue to see GDP growth as being broadly unchanged from 2013--below trend but reasonably

solid (see table 1). The steady overall pace masks a divergence between the growth paths of China and Japan

(together, 60% of regional GDP) from that of the rest of the region.

Table 1

GDP Proposed Scenarios, March 2014

Baseline Downside Upside

(%)2014f 2015f 2016f 2014f 2015f 2016f 2014f 2015f 2016f

Australia 2.6 3.0 3.1 1.8 1.7 2.6 2.9 3.4 3.4

China 7.4 7.2 7.0 6.1 6.0 6.6 7.9 7.6 7.2

India* 6.0 6.3 6.5 4.7 5.0 5.2 6.2 6.7 7.0

Japan 1.3 1.2 1.2 0.5 0.4 0.9 1.6 1.6 1.7

South Korea 3.5 3.8 3.8 1.5 1.7 3.3 4.6 4.8 4.2

Hong Kong 3.6 4.1 3.6 0.3 0.4 3.5 5.5 5.5 4.9

Indonesia 5.6 5.8 6.0 4.6 4.7 5.8 6.0 6.2 6.1

Malaysia 5.2 5.6 5.7 3.9 3.4 5.0 6.2 5.7 5.6

Philippines 6.6 6.0 6.1 5.3 4.8 5.7 7.0 6.7 6.6

Singapore 3.7 3.9 3.5 0.5 0.7 2.7 4.9 5.1 4.4

Taiwan 3.7 3.9 3.8 0.8 0.7 3.3 4.9 5.2 4.0

Thailand 2.7 5.1 4.4 1.6 3.5 3.8 3.5 4.7 4.8

Vietnam 5.5 6.0 6.3 4.5 4.5 4.7 6.3 6.5 6.9

New Zealand 3.1 2.5 2.5 1.9 2.0 2.1 3.5 3.3 3.0

Asia Pacific 5.4 5.4 5.4 4.1 4.1 4.8 5.9 5.9 5.7

EM Asia 6.3 6.4 6.3 4.9 4.9 5.7 6.9 6.8 6.6

NIE 3.6 3.9 3.7 1.1 1.2 3.3 4.8 5.0 4.2

ASEAN 5.1 5.7 5.7 3.9 4.2 5.1 5.7 5.9 5.9

*Fiscal year ending March. Regional aggregates are calculated as a weighted average using 2012 GDP measured in PPP terms. f--Forecast.

China is likely to continue its gradual moderation in the pace of activity as policymakers attempt to steer the economy

onto a more sustainable growth path. In Japan, the effects of the increase in consumption tax continue to pose the

largest risk to growth and especially the fight against deflation, as the initial boost from Abenomics begins to fade.

Australia has passed the peak of its investment boom, but exports should be able to provide decent growth in the short

term as previous years' mining investments come online. India is in the midst of a period of sub-par growth, challenged

by structural rigidities and also by tighter policies implemented to combat inflation and capital outflows stemming

from the market turbulence of mid-2013. The more export-dependent Tiger economies (the highly

developed economies of Hong Kong, Singapore, South Korea, and Taiwan) will likely see a pick-up in growth this year

given the improvements in the U.S. economy and global trade, as well as a modest improvement in Europe. Finally,


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Credit Conditions: Largely Stable In Asia-Pacific, With A Dash Of Negative And A Focus On China's FinancialSector Risks

the southeast Asian economies' growth outlooks are increasingly driven by country-specific factors.

Thailand is the one exception, where we significantly revised our baseline forecasts downward. The domestic political

turmoil has gone on longer than expected, and there is little indication of what the end game might be. As such, we

have lowered our growth forecast by 1.7 percentage points for 2014 to 2.7%, given the disruptions that the political

situation is causing within the economy and the negative effect it will have on confidence.

Another key macroeconomic view that we believe remains valid is the ongoing emerging market sell-off. In the

previous Credit Conditions Committee we noted that there was less downside risk for Asia-Pacific's markets should

financial turbulence resume. Moreover, policymakers in the most vulnerable economies (India and Indonesia) have

taken steps to address their structural weaknesses, including easing restrictions on foreign investment and tightening

monetary policies to cool domestic demand, reining in current account deficits, and increasing the attractiveness of

their economies for global investors. In the current "risk off" environment, this so far appears to be largely correct.

Relative to the previous bouts of stress between May and September last year, exchange rate depreciation in

Asia-Pacific has been quite modest. Also, in contrast to the outsized impact on the twin deficit economies of India and

Indonesia during the last round, the outflows appear more evenly distributed this time around. As such, we continue to

expect the region's financial markets to exit this phase of emerging market stress relatively unscathed.

We continue to expect inflation to remain under control across most of the region. Although improving external

growth prospects will likely cause a narrowing of output gaps and an uptick in inflation--especially in the Tiger

economies--the sub-par growth performance of the past few years suggests that most economies are still operating

below capacity. The Philippines may be the exception, having experienced rapid growth driven by the

business-process-outsourcing sector and the significant spillovers it has had on the rest of the economy. Japan and

Malaysia will likely see higher inflation from consumption taxes. In India and Indonesia, tighter monetary policy

enacted during the previous round of financial market stress will cause inflation to moderate. (Note that in this Credit

Conditions Committee we have shifted from forecasting the Wholesale Price Index to the Consumer Price Index for

India.)

Monetary Policy

On the monetary policy front, we see very little impulse for policy makers to move interest rates in either direction

over the year. Policy rates are still either very accommodative, growth steady, or improving, and inflation is largely

benign. The key exception remains the Reserve Bank of New Zealand (RBNZ), which is likely to tighten settings

steadily on concerns about the possible overheating of the housing and construction market; indeed, the RBNZ raised

its policy rate in March 2014. The Philippine central bank may also need to cool its economy after consecutive years of

above-trend growth, but the bank's view remains that potential growth has increased. Meanwhile, Bank of Thailand

will likely prefer to ease monetary conditions to provide support to an economy that is being hindered by political

gridlock, as seen by its recent rate cut. In the rest of the region, India and Indonesia have tightened ahead of their

neighbors, reducing the need to raise policy rates much further. The People's Bank of China will likely hold its main

policy rate steady while increasing the relative importance of its open market operations within its policy toolkit.

Already, it has extended its liquidity facilities to include small and medium banks. Finally, we would not rule out the

Bank of Japan increasing its rate of asset purchases to try to counter the effects of the consumption tax hike on


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disposable incomes and confidence should growth slow and prices start to fall again.

We continue to attach a 60%-70% probability for our baseline scenario. Below, we give further details:

China's growth remains strong by emerging market standards, despite slowing to around 7.5% from 8%-10% over

the past two decades. We expect the authorities to continue steering the economy onto a more sustainable growth

path as financial-sector risks, stemming from fast credit growth, remain elevated, and are rising. As such, we see

China gradually moderating from its current pace of growth to around 7% by 2016. Nonetheless, structural risks

remain, particularly in the financial sector, where banking regulations and perceived state guarantees have led to 1)

high credit growth in the shadow banking sector, and 2) a generalized mispricing of risk in the system. Though

disorderly fallout from this situation is not our baseline scenario, this poses the most significant risk to growth in

China and the region in the next few years, in our view.

Japan's economy received a confidence and growth boost last year from Abenomics. The domestic economy

strengthened and inflation has turned positive by most metrics. However, the consumption tax that is scheduled to

rise by 3 percentage points in April could significantly dampen that momentum. Crucially, the decreased spending

power of households poses a key difficulty for undoing long-standing deflation expectations. The Bank of Japan

might try to increase the pace of its asset-purchase program should growth slow significantly and prices start to fall

again.

Australia still faces the difficult task of rebalancing its investment away from the mining sector as China reins in its

investment binge. This will remain a key drag on growth in 2014, despite some offset from a stronger housing

market. We expect growth to remain at close to 2.5% this year before rising to about 3% in 2015. The labor market

will probably remain weak in the near term. In New Zealand, there have been significant improvements in

confidence and the labor market, while concerns about an overheating property market increase. This sets the stage

for rate increases--perhaps significant ones--by the RBNZ.

India and Indonesia used the time between the mid-2013 emerging market sell-off and the start of U.S. Federal

Reserve ("Fed") tapering in December to address their respective vulnerability issues. The authorities in both

economies have undertaken measures to restore confidence and reduce external deficits, as GDP growth and

exchange rates weakened sharply. As such, investors have so far given both economies the benefit of the doubt in

the latest round of emerging market volatility. Political uncertainty in both countries, owing to elections in

mid-2014, remains a near-term issue.

The trade-driven Tiger economies are likely to see stronger growth this year than last, as the outlook for U.S.

growth and global trade flows improves. However, our baseline forecasts for 2014 and 2015 are only modestly up

from the December Credit Conditions Committee round despite the upward revision of our U.S. forecast. This is

because our previous baseline already incorporated the strength of the U.S. private sector, while the latest U.S.

revisions were largely driven by the removal of the fiscal drag.

The relatively more domestically-oriented southeast Asian economies may face slower growth this year. The factors

leading to easing growth are country-specific. In Malaysia and Thailand, rising household debt would weigh down

on consumption. In Indonesia, growth will be hurt by the much tighter monetary policy stance that the central bank

enacted to rein in both inflation and the current account deficit. In the Philippines, growth could normalize from its

rapid pace in 2013, although post-disaster rebuilding efforts could provide an offset in the short term. In Thailand,

political turmoil has pulled down the growth outlook significantly for this year.

In contrast to our broadly unchanged baseline views, recent developments have led us to reconsider our alternative

scenarios, particularly the downside. Previously, the key drivers of our near-term downside scenarios were growth

risks in the advanced economies. Meanwhile, we had long recognized that fast growth in China's opaque non-bank

financial system, taken together with slower economic growth and perceived widespread government guarantees and


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moral hazard, posed a key medium-term growth risk (but only a tail risk in the very near term).

We now see an increased likelihood of the Chinese authorities addressing its country's financial sector risks sooner

than thought, possibly as early as this year. Under our base case scenario, spillover effects on investment and growth

from such an event can largely be contained, especially given the authorities' track record in dealing with external and

internal shocks over the past decades, as well as the existing policy space and macroeconomic buffers. But the

downside risks cannot be ignored.

Our increasing concern lies with a fast-growing class of credits outside of the banking sector, most notably,

wealth-management products (WMPs) issued by non-bank entities such as local government financing vehicles,

property developers, and trust companies. The underlying assets can essentially be anything. These products are sold

through the state-guaranteed banks and promise returns that are much higher than WMPs issued by the banks

themselves, making them very attractive to investors. Crucially, there is widespread belief in China that the state

guarantee of the banks that distribute WMPs extends to these non-bank initiated products as well. This leads to moral

hazard in the form of risks not being correctly monitored and priced. That results in oversupply and underpricing of

such risky products.

The Chinese authorities are well aware of these risks, and in our view they will, at some point, address the moral

hazard problem by allowing selective failure of some non-bank WMPs. However, determining the gravity and timing of

the fallout from such an event is fraught with uncertainty, given the opaque nature of the financial system. For our

downside scenario, we attempt to lay out what could go wrong in China if the fallout from such an event is less than

smooth.

Under the downside scenario, a credit event in the non-bank portion of the financial sector leads to market instability

as perceptions of state guarantees unravel. This would initiate a turbulent period in which funding could dry up as the

domestic market struggles to re-price risk across a broad spectrum of credit products. Even viable investments could

struggle to be financed. As a result, China's growth could fall sharply for at least a few quarters, led by investment. We

note, however, that a) China's fiscal and monetary authorities will almost certainly step in strongly to try to mitigate

the fallout from such an event, and b) the self-financed nature of the system rules out a full-blown external or fiscal

crisis. The effectiveness of the policy response would be crucial in determining the length and severity of such a credit

event.

This scenario would have significant spillover effects into the rest of the region as well. Economies that are highly

exposed to China's investment demand stand to see the largest slowdowns. Specifically, in Hong Kong, Australia, and

most likely Taiwan (where data are not available), capital and/or raw materials exports to China account for large

percentages of total exports--close to 40% for Hong Kong and around 25% for Australia. Korea, Japan, and the

Philippines form the next tier, with China-bound capital and/or raw materials shipments making up 10% or more of

total exports for each. India is the least vulnerable, at 2.5% (see chart 1).


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Chart 1

We note that because we now regard China's financial sector risk as being in the near term, the balance of risks around

our baseline view now tilts to the downside. We have raised the probability of our downside scenario by 5% to

20%-25%.

We are keeping our upside scenarios largely unchanged from the last Credit Conditions Committee. However, we have

reduced the probability we attach to this scenario by 5%, to 10%-15%. This scenario involves faster-than-expected

recoveries in the U.S. and, to a lesser extent, Europe. Global trade picks up as well. Once again, the Tiger economies

are the main beneficiaries in Asia-Pacific. Stronger-than-expected growth would also see output gaps beginning to

close across the region. Interest rate normalization could happen faster, but central banks in economies with rising

household debt (South Korea, Thailand, Malaysia) will find space to tighten has been limited. In the more detailed

discussion of growth numbers that follows, we will focus on the likely growth impact of our new downside scenario.

The credit event described above could reduce China's growth to around 6% over the next two years, staying below

7% into 2016; on a quarterly basis the effects of the shock would be more pronounced. The significant slowdown in

growth might turn even more financial system credit, including bank loans, sour, leading to further reluctance by

banks to finance growth. In this scenario, the policy response will be key in mitigating the length and depth of the

slowdown. We would expect both the central government and the People's Bank of China (PBOC) to put their full

weight behind the economy in such a scenario. The public balance sheet might be used to absorb impaired assets,


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while the central bank might infuse liquidity to keep solvent but temporarily illiquid banks afloat. Crucially, bank

reserves locked up at the PBOC could be released while authorities urge banks to lend to targeted key development

projects.

In Japan, 10% of total exports consist of capital goods shipments to China. The investment slowdown in China

would compound the previously held downside scenario, wherein we envisioned slower growth in U.S. and Europe

as well as a larger-than-expected slowdown in consumption following the consumption tax increase. Growth would

slow to significantly below 1%, and crucially, so would inflation.

Australia is the second most exposed economy to an investment slowdown in China. Almost a quarter of its exports

are raw materials shipped to China. In our downside scenario, Australia's growth falls to less than 2% over the next

two years. In contrast, New Zealand's exposure to China's investment story is much smaller.

As mentioned above, India is the least exposed to China's investment growth in Asia. As such, we are keeping our

downside scenario unchanged from December, in which India's growth falls to 4.2% in fiscal 2013-2014 and 4.7%

the following year. This is predicated on a fractured government mandate after the elections, monsoons turning

unfavorable and industrial production losing the little momentum it currently has.

The credit-led slowdown in China heavily affects the Tiger economies of Hong Kong, Taiwan, South Korea, and

Singapore. The first three are heavily exposed to China's investment through their capital goods exports, particularly

Hong Kong. Growth in the Tigers could slow by as much as 1 percentage point relative to the baseline. Within this

group, Singapore's exports are the least exposed to China's investment story; however, Singapore would still see

significantly lower growth in the downside because of the slowdowns in key neighboring trading partners.

In the ASEAN group, capital and raw materials exports to China typically account for less than 10% of total

shipments. We still reduced growth in our downside scenarios relative to December because of the significance of

China to their key trading partners, but by less than in the other sub-regions. Within this group, the Philippines is the

most exposed to China overall, and therefore saw the biggest downward revisions in the scenario.

Financing Conditions

We expect that the majority of central banks in the Asia-Pacific will hold policy interest rates (see the Monetary Policy

section) relatively steady in 2014 as to varying degrees they shadow the Fed in anchoring the short end of yield curves.

However, we think that market interest rates of longer tenors are likely to creep up in 2014-2015, as the U.S. economy

recovers and the Fed tapers its asset purchases. A critical part of this process will be the strategies of central banks in

managing interest rate rises as they change the relative funding costs of issuers in the region.

While investment strategies vary across the region, we expect some large funds to continue to favor a carry-and-credit

strategy while keeping durations low until yields rise toward the levels seen at the end of August. Consequently, some

funds will emphasize the intermediate part of the yield curve while remaining defensive in longer maturity bonds and

buying selectively, in our view.

Although we continue to see ongoing volatility in emerging market bonds, we believe that some dollar-denominated

emerging-market bonds will benefit from any rise in the U.S. currency, as the Fed moves closer to raising interest rates

from their record low.


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Risks And Imbalances

The risks emanating from advanced economies--namely, the U.S. fiscal policy and contagion from eurozone

problems--have receded, in our view. Therefore, we have removed them from the global top risks that we are most

actively monitoring. The current top global risks are summarized in table 2.

Table 2

Top Global Risks Q1 2014

Risk Level* Trend

Geopolitical risk that leads to financial turmoil or economic shock (escalation of Ukraine crisis, China-Japan

conflict, Middle East turmoil, North Korea threats)

Moderate Increasing

Unexpected disruption in Chinas gradual rebalancing efforts, stemming from rising financial sector risks Moderate Increasing

Disorderly exit from quantitative easing and impact of Fed normalization of interest rates, particularly on

emerging markets

Moderate Stable

*Risk levels may be classified as very low, low, moderate, elevated, high, or very high. Trends may be classified as stable, decreasing,

or increasing.

As outlined in table 2, we point to increasing geopolitical risks around the globe. Tensions between China and Japan

remain, as do issues in Syria, Iran, and North Korea. Most recently there has been the escalation of the Ukraine crisis,

and the tensions that has created between Western governments and Russia. These may have significant economic

effects around the globe should any of them materialize. However, the fallout would be hard to quantify ex ante.

In our view the global economic recovery is on track. The key driver for the global economy is that the U.S. continues

to recover as fiscal headwinds abate. Global economic risks have generally receded. In the base case scenario we do

not anticipate the Fed tapering/normalizing interest rates, nor greater market volatility derailing the global economy,

although emerging markets will likely remain under pressure from it.

Relative to the previous round, U.S. fiscal risks have abated significantly, particularly for this year, as key agreements

between the Democrats and Republicans were struck. This largely reduces the fiscal drag on the U.S. economy that

has been present in the past few years. Meanwhile, the private sector remains resilient, notwithstanding the headwinds

from abnormally cold weather in recent months. This momentum has led to continued recovery in the housing and

labor markets, as well as positive knock-on effects on consumer spending. The U.S. energy boom is also providing

positive support.

One main global risk coming from the U.S. remains that of an adverse market reaction to the Fed's process of

monetary policy normalization. This will likely affect emerging markets more negatively than the U.S. itself, as the Fed

generally sets policy with specific domestically-oriented goals. For now, as we mention above, Asia-Pacific's markets

are being spared from market turbulence. However, further normalization over the medium term, particularly on

interest rates, and large unforeseen short-term fluctuations still hold the potential to destabilize Asian markets or

expose various weaknesses.

These risks fall under two general categories. The first is short-term funding stress due to capital outflows, which will

tend to affect economies that have large external and fiscal deficits. The second is the possibility of asset-price

corrections if global interests rise more rapidly than borrowers had expected, leading to difficulties in financing debt


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burdens. Economies that have increased leverage significantly over the past few years (Korea, Singapore, Malaysia,

Thailand -) maybe the potential candidates. However, this latter risk is likely a medium-term one, outside of the

current forecast horizon.

We continue to view a disruption in China's rebalancing as a risk. Chinese financial sector risk is rising as banking

regulations and perceived state guarantees have led to high growth in the shadow banking sector and a potential

mispricing of risk in the system. Although not our baseline assumption, this poses a significant risk if not managed to

the growth in China and the Asia-Pacific region.

Standard & Poor's also forecasts a slight economic recovery in Western Europe, albeit an uneven one. Still, some

uncertainties remain, including tight monetary policy conditions as the credit channel remains dysfunctional. This also

leads to risks to corporate investment. Further, the risk of deflation is present, particularly if the euro remains strong

and commodity prices ease further, while the European Central Bank (ECB) faces some institutional challenges in

enacting unconventional measures. As Europe remains one of Asia-Pacific's largest trading partners, these risks still

pose a potential crucial headwind.

Sector Trends: Largely Stable With A Dash Of Negative

Sovereigns: Risk of Inadequate Policy Response To QE Tapering

Disorderly market responses or inappropriate policy responses to the withdrawal of quantitative easing are still a risk

to sovereign creditworthiness. The long-awaited start of Fed tapering has had modest impact on the Asia-Pacific so far.

India and Indonesia, despite being grouped in the so-called "fragile five", have seen their currencies recover part of

their losses in 2013.

Nevertheless, with important national elections due this year in both, political events that hurt confidence and cause

renewed capital outflows are still possible. In the scenario of wider risk averseness toward emerging markets, other

sovereigns whose economies depend much on external financing could also be affected.

Relatively high levels of domestic credit in important economies--including China, Korea, and Australia--constrain

monetary policy as a countercyclical tool in another economic slowdown (see "An Asia-Pacific Credit Crisis Remains

UnlikelyBut The Signs Are There," published Feb. 17, 2013). Stimulating credit growth further with monetary easing

could increase financial risks even if it lifts short-term growth. This is likely why China's finance minister said that he

would consider China's target growth rate achieved even if it comes in as low as 7.2%.

Officially, China still targets annual real GDP growth of 7.5%. However, the risk that growth decelerates more sharply

than policymakers expect--at least temporary--cannot be ruled out. In this scenario, the financial risks in China could

grow further. This would have longer term impact on financial and economic stability in the country. Pressures on

economic growth could also spread across the Asia-Pacific. This could have implications for the ratings of some

sovereigns if the policy responses are insufficient to limit the impact on credit fundamentals.

Geopolitical risks in the Asia-Pacific seem unlikely to die down anytime soon. Frictions between China and Japan

continue while Korea-Japan relations remain cool. We believe that common interest in maintaining economic stability


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will continue to prevent a serious escalation of tensions. Still, risks of miscalculations or accidental military contact

have risen with the increased (see "Shared Economic Interests In A Stable Asia-Pacific Should Help Contain

Geopolitical Risks")

Finally, a renewed global slowdown triggered by events in the U.S. or Europe could still hurt sovereign

creditworthiness in this region. However, latest indicators continue to show continued recovery in the major

developed markets. The likelihood of this has eased compared with the previous Credit Conditions Committee.

As of early March 2014 three Asia-Pacific long-term sovereign ratings have negative outlooks and none have positive

outlook. The remaining 19 carry stable outlooks.

Public Finance: Tax-Collection Key To Stability

The outlook for public finance is mainly stable (see table 3). The primary macroeconomic risk to several of

Asia-Pacific's local and regional governments (LRGs) relates to their ability to collect corporate, mining, employment,

housing, and consumption taxes. LRGs reliant on property rates, such as those in New Zealand, Australia, and Japan,

are not as vulnerable to national GDP conditions as many other LRGs tend to be.

Table 3

Asia Pacific Public Finance Trends, Next 12 Months

Sector Current Business Conditions Business Outlook Finance Trends Sector Outlook

Australian states Satisfactory No Change Same Stable

Local governments Satisfactory No Change Same Stable

Higher education Satisfactory No Change Same Stable

In Australia, the main risks to LRGs relate to consumption, specifically for the state governments that rely on the goods

and services tax to fund services; and transaction taxes associated with houses being bought and sold rather than sat

upon. Mining royalties are particularly important to the states of Western Australia and Queensland, and the soft

commodity prices are impacting both of these state's operating performance. These risks have begun to stabilize, with

revenue write-downs notably smaller in fiscal 2014. Over the medium term, the horizontal fiscal equalization system in

Australia will compensate these states for any reduction in own-source revenues.

In response to this slower revenue growth, the Australian states have undertaken structural rebalancing to varying

degrees, and we expect that the cost savings will start flowing through to the states' operating performances. Over the

medium term, this will support credit quality.

In Japan, we expect the increase of the national sales tax will ease the credit risks of rated prefectures and cities. The

national sales tax rate will be increased to 8% in April 2014 and to 10% in October 2015 from its current level of 5%.

Both prefectures and cities will have a share of the revenues from the tax increase. In 2014, we also anticipate the

recovery of corporate profit tax that will further support the prefectures' tax collections, while the urban cities will

enjoy the pick-up of the property rates as the real estate market begins to show signs of recovery.

Financial Institutions: Negative Economic Trends For Australia, India, Malaysia and New Zealand

Financial institutions will continue to be challenged with downward pressure because softer economic growth and

wary financial markets will likely weigh on their asset quality. Although we see GDP growth in Asia-Pacific improving,


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slower growth and tightening monetary conditions in China could have spillover effects on markets, including

Indonesia, Australia, Taiwan, Korea, and Hong Kong. In addition, the Fed will likely continue tapering its quantitative

easing program, and this could lead to more volatile foreign exchange and interest rates.

Another reason many banking systems in Asia-Pacific are more susceptible to external shocks is that both household

and corporate debt have risen to unprecedentedly high levels. Substantial inflows of capital and low interest rates amid

global monetary easing have supported high credit growth in the region, but we expect such conditions to hit a turning

point in 2014. Generally, we expect credit costs to rise, particularly in sectors that have excessive indebtedness.

Nevertheless, we believe a sharp increase in credit costs is unlikely because the region will benefit from a gradual

recovery in the global economy. Regulators in many countries have also taken preemptive measures over the past few

years to cool the expansion of property-related loans and asset inflation.

Compared with other regions, Asia-Pacific's banking sector has been characterized by resilience. Except for Thailand,

we did not change any of the region's respective economic and industry assessments under our Banking Industry

Country Assessment (BICRA) in 2013. However, we expect downward pressure to weigh on many countries' BICRA

scores. We have seen an increasing number of negative economic trends and negative changes in the BICRA

sub-scores. We lowered our BICRA on Thailand to group 6 from group 5, due to a rise in the country's private sector

and household debt, which could worsen economic imbalances. (For more details, see Credit FAQ What Revising Our

BICRA Score for Thailand Means for Its Banks," Dec. 6, 2013). We use our BICRA methodology to identify and

incorporate rising and receding risks for banks consistently and globally. BICRA determines the anchor rating for all

banks in the system, which is the starting point in assigning an issuer credit rating.

Table 4

Asia Pacific Banking Industry Trends

Economic risk factors Industry risk factors

BICRA

Group

Economic

resilience

Economic

imbalances

Credit

risk in

the

economy

Economic

risk score

Economic

risk trend

Institutional

framework

Competitive

dynamics

Systemwide

funding

Industry

risk

score

Industry

risk

trend

Australia 2 Very Low Intermediate Low 2 Negative Very Low Very Low Intermediate 2 Stable

China 5 Intermediate High High 6 Stable High High Very Low 5 Stable

India 5 High Low High 5 Negative High High Low 5 Stable

Indonesia 7 Very High Intermediate Very High 7 Stable Very High High Intermediate 7 Positive

Japan 2 Low Low Low 2 Stable Intermediate Intermediate Very Low 3 Stable

Korea 3 Intermediate Low High 4 Stable Intermediate Intermediate Low 3 Stable

Note: BICRA Group '1' to '10', from lowest to highest risk. Economic and Industry risk classified as "very low", "low", "intermediate", "high", "very high", or

"extremely high". For information about other Asia Pacific nations please see Banking Industry Country Risk Assessment Update: November 2013, Nov 6,

2013.

For the banking systems in Australia, New Zealand, India, and Malaysia, we assign negative economic trends. Of the

industry risk trends we see Indonesia trending positively on the back of improved bank regulations and supervision,

and stable trends for all other countries. We began to assign positive, stable, and negative trends scores in our view of

economic and industry risk in the first quarter, to better capture emerging risks (see "S&P to Publish Economic and

Industry Risk Trends for Banks").


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In China, we expect the banking sector's loan quality and profitability to slip further in 2014. Banks remain heavily

exposed to debt-laden local government financial platforms, and many manufactures saddled with oversupply. In

addition, distorted growth in China's shadow banking system could lead to an unintended build-up of credit risks. If

authorities' efforts to rein in growing shadow banking without causing disruption in the market are unsuccessful, the

sector's risk could spread to other parts of the economy. Nevertheless, our views about banking industry risks in China,

whose BICRA is group 5, incorporate a high degree of risk and volatility.

Insurance: Insurers Show Business and Financial Resilience

The sector outlook for life insurance, property & casualty, and reinsurance in Asia-Pacific is stable (see table 5), with a

benign net negative ratings outlook bias at February 2014. Two groups in Taiwan and Australia/New Zealand were

assigned positive CreditWatch on merger and acquisition activity, which was offset to a degree by some negative

outlook rating action on release of our Ratings Above the Sovereign Criteria (Nov. 19, 2013).

While the sector outlook for reinsurance remains stable, we acknowledge the business outlook is somewhat weaker,

with increased competition from global players and premium rate declines from the January 2014 renewal season

placing pressure on the sector. Still-good market growth in APAC versus markets like U.S. and in Europe protects

against a more negative assessment.

Table 5

Asia Pacific Insurance Trends, Next 12 Months

Current Business Conditions Business Outlook Finance Trends Sector Outlook

Life insurance Satisfactory No Change Same Stable

Property & casualty insurers Satisfactory No Change Same Stable

Reinsurers Satisfactory Somewhat weaker Same Stable

The economic slowdown in China and its impact on the wider region, as well as ongoing low interest rates in many

markets are likely to continue to constrain insurers' premium growth and earnings in the near term. Despite this

slowdown, the growth is still high relative to the developed markets outside Asia-Pacific. At the same time, the sector

in the region is also facing tightening and uncertainty in regulatory development, which could result in increase of cost

of capital and behavior of insurers in managing risks.

The key risks and trends for life insurers are slower economic growth in a number of Asian countries, capital pressure

due to asset risks, and potential earning volatilities due to volatile investment markets. Also, investment volatility,

asset-liability mismatches, and low interest rate returns continue to constrain our ratings on many life insurers (such as

those in China, Japan, and Taiwan), even though we see ongoing improvement in the structural management of these

risks.

Although growth moderated for life insurers because of the region's slower economy, those insurers still enjoy stronger

prospects than do the ones operating in the U.S. and Europe. Capital pressure exists from rapid growth markets such

as China, Malaysia, and Thailand. Prolonged low interest rates, asset-liability mismatch, and investment market

volatility continue to affect markets such as Taiwan and Japan, although profitability continues to improve under these

conditions. For Australia, the industry continues to be challenged by high lapse rates and disability claims patterns,

which, despite recent increases in pricing and tighter underwriting standards, is expected to continue over 2014.


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For property & casualty (non-life) insurers, the key risks include competitive pricing and natural catastrophe risks

exposure. At the same time, the risk-management control for a number of local players is still relatively less

sophisticated compared to life insurers. We expect the premium rates of the sector continue to be softened due to

combined effect of increasing competition and reinsurance capacity.

Although insurance losses from natural catastrophe claims have been low throughout 2013, we still believe the

potential for extraordinary natural catastrophe losses in some markets is a concern. We believe regulators' push for

risk management in the region is likely to improve awareness of its importance, in light of rising risk complexity in the

region for some players. An increase in the consumption tax in Japan in April 2014 is likely to affect the insurance

industry adversely, especially non-life profitability, but the adverse impact should be absorbed by revisions in premium

rates and cuts in operating expenses. Growth in the China non-life sector remains strong, with support from auto sales,

but the sector is subject to increasing catastrophe-risk exposure and capital shortfall pressures.

We have seen evidence of reinsurance price softening on recent catastrophe risk renewals, following the top of the

pricing cycle around 2012. Unmodeled risks due to climate change and urbanization will remain an industry issue.

For reinsurers, softening premium rates, higher retentions and ongoing competition in the non-catastrophe reinsurance

market are threatening the sustainability of profits.

Corporates: Metals And Mining Still Negative But Moderating

About 18% (15% on net basis) of the corporate issuer ratings pool is on negative outlook or on CreditWatch with

negative implications. Among the 17 industries covered, we view the 12-month outlook for metals and mining as

negative, and for building materials, capital goods, chemicals, consumer products, real estate development, and retail

as stable-to-negative (see table 6). The outlook on the other sectors (auto, diversified, gaming, oil & gas, real estate

investment trusts, technology, telecommunications, transportation-cyclical, transportation infrastructure and utilities)

is stable. (Healthcare is not displayed in table 6 because the sector comprises just three rated entities). As expected,

there is some correlation between the sector outlook discussed here and the net negative ratings bias discussed

previously. However the primary focus of the former is on economic and industry risk for the sector, while the latter,

by definition, includes issuer-specific rating risks.

Table 6

Asia Pacific Corporate Trends, Next 12 Months

Current Business Conditions Business Outlook Finance Trends Sector Outlook

Automakers and components Satisfactory Somewhat stronger Same Stable

Building materials, forest products and packaging Satisfactory Somewhat weaker Same Stable to negative

Capital goods, machinery Satisfactory No change Same Stable to negative

Chemicals Satisfactory No change Same Stable to negative

Consumer products, food Satisfactory No change Same Stable to negative

Diversified Stable Somewhat weaker Lower Stable

Gaming Satisfactory No Change Same Stable

Metals and minerals Weak No change Same Negative

Oil and gas Satisfactory No Change Same Stable

Real estate development Satisfactory Somewhat weaker Lower Stable to negative

Real estate investment trust Satisfactory No change Same Stable


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Table 6

Asia Pacific Corporate Trends, Next 12 Months (cont.)

Retailing Satisfactory Somewhat weaker Lower Stable to negative

High technology Satisfactory No change Same Stable

Telecommunications Satisfactory No Change Same Stable

Transportation cyclical Weak No change Same Stable

Transportation - infrastructure Satisfactory No change Same Stable

Utilities Satisfactory No change Same Stable

Automakers and components Satisfactory Somewhat stronger Same Stable

Structured Finance: Trends Stable Across Asset Classes

Structured finance credit conditions are satisfactory and the trends are stable (see table 7). Securities that have key

rating dependencies on transaction counterparties could continue to be affected the credit profiles of the

counterparties.

The economic outlook is mixed across countries in which outstanding Asia-Pacific structured finance securities are

predominantly domiciled. We expect economic growth to be relatively flat in Australia, to decline in Japan, and to

strengthen in Korea. However, we do not expect any material increase in the unemployment rate, which underpins the

resilience of household debt serviceability, and therefore the collateral performance of most residential-mortgage

backed securities (RMBS) and asset-backed securities (ABS). Additionally, for seasoned transactions,

credit-enhancement percentages for senior-ranking notes have continued to strengthen while the quality of underlying

collateral has improved over time. These improvements augur well for ratings to withstand a mild downturn.

Table 7

Asia Pacific Structured Finance Trends, Next

12 Months

Current Business

Conditions Business Outlook Finance Trends Sector Outlook

RMBS Satisfactory No Change Same Stable

ABS Satisfactory No Change Same Stable

CMBS Satisfactory No Change Same Negative

Structured credit Satisfactory No Change Same Stable

The Australian prime RMBS sector has significant exposure to lenders' mortgage insurance (LMI) cover, but most

senior-ranking note ratings could withstand lower ratings on LMI providers (currently in the 'AA' category) because of

additional credit enhancements that most transactions provide upfront. The ratings assigned to subordinated classes of

prime RMBS are more vulnerable to LMI providers' creditworthiness.

The number and volume of commercial mortgage-backed securities (CMBS) outstanding in the Asia-Pacific region

have continued to decrease due to a lack of new issuances and the ongoing repayment of existing transactions. We

expect a stable performance in the CMBS sector in 2014, except for some lower rated tranches of Japanese CMBS that

are currently vulnerable to nonpayment from realizing losses from commercial real-estate loans that have defaulted. In

Japan, the commercial property sector is recovering.

Most structured credit transactions coming out of the Asia-Pacific region are synthetic in nature and tend to follow


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global trends because the reference entities are companies and financial institutions around the globe, rather than

regional ones.

Credit Trends: Outlook Remains Cautious

Overall, while risks have generally subsided for the time being, flatter economic growth, and potential financial

markets volatility as a result of any quantitative easing tapering make for some potential headwinds for Asia-Pacific

issuers in 2014. About 20% of issuer ratings were on negative outlook or CreditWatch with negative implications at

February 2014.

Among the major regional economies, the sovereign ratings on India and Japan are on negative outlook, which have a

knock-on effect on public finance ratings.

Related Research

Credit Conditions: Europe Is On A More Stable Path, Amid Turbulence In Emerging Markets, March 21, 2014

Credit Conditions: North America's Credit Conditions Remain Largely Favorable Despite Fed Tapering, March 21,

2014

Appendices

Table 8

CPI Forecasts

Base Downside Upside

(% average year-on-year) 2014f 2015f 2016f 2014f 2015f 2016f 2014f 2015f 2016f

Australia 2.7 2.7 2.8 2.5 2.0 2.1 2.9 3.0 3.2

China 3.0 3.0 2.7 2.6 2.2 2.0 3.2 3.3 2.8

India* 8.0 7.5 7.0 7.5 7.0 6.0 10.0 10.0 10.0

Japan 2.4 1.5 1.9 2.0 0.8 1.4 2.8 2.4 2.6

South Korea 2.2 3.0 2.9 1.6 2.0 2.3 2.4 3.4 3.2

Hong Kong 4.0 4.1 4.1 3.5 2.9 3.4 4.3 4.7 4.7

Indonesia 6.3 5.3 5.5 5.8 4.2 5.0 6.5 5.8 6.0

Malaysia 3.2 3.6 3.1 2.9 2.6 2.4 3.3 4.0 3.2

Philippines 4.1 3.5 3.7 3.9 2.9 3.3 4.4 3.9 3.9

Singapore 2.7 2.9 2.6 2.4 2.5 2.5 3.0 3.4 3.1

Taiwan 1.4 1.6 1.5 1.1 0.9 1.1 1.7 2.1 1.6

Thailand 2.4 2.7 2.7 2.0 1.9 2.3 2.4 2.9 3.0

Vietnam 6.9 6.5 6.1 6.6 5.8 5.4 7.0 6.9 6.5

New Zealand 2.0 2.1 2.1 1.3 1.5 1.7 2.7 2.5 2.2

f--Forecast.


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Table 9

Policy Rate Forecasts

Base Downside Upside

(%) 2014f 2015f 2016f 2014f 2015f 2016f 2014f 2015f 2016f

Australia 2.5 3.5 4.0 1.5 1.5 1.8 2.8 3.8 4.0

China 6.0 6.0 6.0 5.5 5.0 5.0 6.3 6.5 6.5

India* 8.0 8.0 8.0 7.8 7.5 7.0 8.0 8.5 9.0

Japan 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1

South Korea 2.5 2.5 3.0 2.0 2.0 2.3 2.8 3.3 3.5

Indonesia 7.8 7.5 7.5 7.0 7.0 7.0 8.0 8.0 8.0

Malaysia 3.5 4.0 4.0 2.5 2.5 2.8 3.8 4.3 4.3

Philippines 3.8 4.3 4.3 3.0 3.0 3.3 4.0 4.5 4.5

Taiwan 2.0 2.5 2.5 1.5 1.5 1.9 2.1 2.6 2.6

Thailand 1.8 2.3 2.3 1.5 1.5 1.8 2.5 3.3 3.3

Vietnam 6.5 6.5 6.5 6.5 5.0 5.0 6.5 7.0 7.0

New Zealand 3.5 4.5 5.0 2.5 2.8 2.8 4.0 4.3 4.3

f--Forecast.

Under Standard & Poor's policies, only a Rating Committee can determine a Credit Rating Action (including a Credit Rating change,

affirmation or withdrawal, Rating Outlook change, or CreditWatch action). This commentary and its subject matter have not been the subject

of Rating Committee action and should not be interpreted as a change to, or affirmation of, a Credit Rating or Rating Outlook.

Standard & Poor's (Australia) Pty. Ltd. holds Australian financial services licence number 337565 under the Corporations Act 2001. Standard &

Poor's credit ratings and related research are not intended for and must not be distributed to any person in Australia other than a wholesale

client (as defined in Chapter 7 of the Corporations Act).

Additional Contacts:

Paul F Gruenwald, Singapore (65) 6216 1084; [email protected]

Vincent R Conti, Singapore (65) 6216 1188; [email protected]

Terry E Chan, CFA, Melbourne (61) 3-9631-2174; [email protected]

Vera Chaplin, Melbourne (61) 3-9631-2058; [email protected]

KimEng Tan, Singapore (65) 6239-6350; [email protected]

Ritesh Maheshwari, Singapore (65) 6239-6308; [email protected]

Elena Okorochenko, Singapore (65) 6239-6375; [email protected]

JaeMin Kwon, Hong Kong (852) 2533-3539; [email protected]


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Research:The Macroeconomic Environment: Steady Growth Is Expected Across Asia-PacificMonetary Policy

Financing ConditionsRisks And ImbalancesSector Trends: Largely Stable With A Dash Of NegativeSovereigns: Risk of Inadequate Policy Response To QE TaperingPublic Finance: Tax-Collection Key To StabilityFinancial Institutions: Negative Economic Trends For Australia, India, Malaysia and New ZealandInsurance: Insurers Show Business and Financial ResilienceCorporates: Metals And Mining Still Negative But ModeratingStructured Finance: Trends Stable Across Asset Classes

Credit Trends: Outlook Remains CautiousRelated ResearchAppendices

untitled

Documents

credit risks

steady growth

moderating growth

potential credit headwinds

emerging asia

real gdp growth

flatter economic growth

overview overall growth