Economics Markets Strategy
4Q 2016 DBS Group Research 15 September 2016 Economics–Markets–Strategy September 15, 2016
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The information herein is published by DBS Bank Ltd (the “Company”). It is based on information obtained from sources believed to be reliable, but the Company does not make any representation or warranty, express or implied, as to its accuracy, completeness, timeliness or correctness for any particular purpose. Opinions expressed are subject to change without notice. Any recommendation contained herein does not have regard to the specific investment objectives, financial situation and the particular needs of any specific addressee. The information herein is published for the information of addressees only and is not to be taken in substitution for the exercise of judgement by addressees, who should obtain separate legal or financial advice. The Company, or any of its related companies or any individuals connected with the group accepts no liability for any direct, special, indirect, consequential, incidental damages or any other loss or damages of any kind arising from any use of the information herein (including any error, omission or misstatement herein, negligent or otherwise) or further communication thereof, even if the Company or any other person has been advised of the possibility thereof. The infor- mation herein is not to be construed as an offer or a solicitation of an offer to buy or sell any securities, futures, options or other financial instruments or to provide any investment advice or services. The Company and its associates, their directors, officers and/or employees may have positions or other interests in, and may effect transactions in securities mentioned herein and may also perform or seek to perform broking, investment banking and other banking or financial services for these companies. The information herein is not intended for distribution to, or use by, any person or entity in any jurisdiction or country where such distribution or use would be contrary to law or regulation. Economics–Markets–Strategy September 15, 2016
Contents
Introduction 4 Economics Global growth: redefining strength 6 Currencies Defying pessimism 16 Yield Limits to policy 30 Offshore CNH Ready to go 40 Asia Equity Pain, but no collapse 44
Greater China, Korea China False alarms continue 58 Hong Kong Disheartening abnormalities 64 Taiwan Counting on electronics 70 Korea Relying on stimulus 74
Southeast Asia, India India Encouraging signs 78 Indonesia Fiscal pains 84 Malaysia Close call 88 Thailand Three percent 92 Singapore On thin ice 96 Philippines Staying strong 102 Vietnam Grinding 106
G3 United States Recovery proceeds 110 Japan Abenomics 3.0 114 Eurozone Treading water 118
1 September 15, 2016 Economics–Markets–Strategy
Economic forecasts
GDP growth, % YoY CPI inflation, % YoY 2013 2014 2015 2016f 2017f 2013 2014 2015 2016f 2017f
US 1.5 2.4 2.6 1.7 3.0 1.5 1.6 0.1 1.3 2.2 Japan 1.4 -0.1 0.5 0.6 0.6 0.4 2.7 0.8 -0.2 0.5 Eurozone -0.3 0.9 1.9 1.6 1.6 1.5 0.6 0.0 0.1 0.6
Indonesia 5.6 5.0 4.8 5.1 5.3 6.4 6.4 6.4 3.7 4.6 Malaysia 4.7 6.0 5.0 4.2 4.5 2.1 3.1 2.1 2.0 2.2 Philippines 7.1 6.1 5.9 6.6 6.3 2.9 4.2 1.4 1.6 2.6 Singapore 4.4 2.9 2.0 1.5 1.9 2.4 1.0 -0.5 -0.5 0.9 Thailand 2.9 0.9 2.8 3.3 3.5 2.2 1.9 -0.9 0.3 1.9 Vietnam 5.4 6.0 6.7 6.0 6.4 6.6 4.1 0.6 2.4 3.4
China 7.7 7.3 6.9 6.5 6.5 2.6 2.0 1.4 2.0 1.8 Hong Kong 3.1 2.5 2.4 1.0 2.0 4.3 4.4 3.0 2.6 1.5 Taiwan 2.2 3.9 0.7 0.9 1.8 0.8 1.2 -0.3 1.2 0.9 Korea 2.9 3.3 2.6 2.8 2.7 1.3 1.3 0.7 0.8 1.4
India* 6.7 7.3 7.6 7.8 7.9 9.5 6.0 4.9 5.2 5.4 Source: CEIC and DBS Research
Policy and exchange rate forecasts
Policy interest rates, eop Exchange rates, eop
current 4Q16 1Q17 2Q17 3Q17 current 4Q16 1Q17 2Q17 3Q17
US 0.50 1.00 1.25 1.50 1.75 …………… Japan 0.10 0.10 0.10 0.10 0.10 102.3 101 101 101 101 Eurozone 0.00 0.00 0.00 0.00 0.00 1.124 1.10 1.10 1.10 1.10
Indonesia 5.25 5.00 5.00 5.00 5.00 13,208 13,160 13,339 13,518 13,697 Malaysia 3.00 2.75 2.75 2.75 2.75 4.15 4.13 4.17 4.20 4.24 Philippines 3.00 3.00 3.25 3.50 3.50 47.8 47.8 48.1 48.4 48.7 Singapore n.a. n.a. n.a. n.a. n.a. 1.37 1.37 1.37 1.37 1.38 Thailand 1.50 1.50 1.50 1.50 1.50 35.0 35.1 35.2 35.4 35.5 Vietnam^ 6.50 6.50 6.50 6.50 6.50 22,310 22,243 22,243 22,243 22,243
China* 4.35 4.35 4.35 4.35 4.35 6.67 6.72 6.77 6.82 6.87 Hong Kong n.a. n.a. n.a. n.a. n.a. 7.76 7.78 7.78 7.78 7.78 Taiwan 1.38 1.25 1.25 1.25 1.25 31.8 31.4 31.5 31.5 31.6 Korea 1.25 1.25 1.25 1.25 1.25 1,127 1,088 1,090 1,093 1,095
India 6.50 6.25 6.25 6.25 6.25 67.0 67.4 67.5 67.6 67.7
^ prime rate; * 1-yr lending rate Source: Bloomberg and DBS Group Research
2 Economics–Markets–Strategy September 15, 2016
Interest rate forecasts %, eop, govt bond yield for 2Y and 10Y, spread in bps
15-Sep-16 4Q16 1Q17 2Q17 3Q17 US 3m Libor 0.85 1.30 1.55 1.80 2.05 2Y 0.76 1.25 1.50 1.70 1.90 10Y 1.69 1.70 1.85 2.05 2.25 10Y-2Y 94 45 35 35 35 Japan 3m Tibor 0.06 0.01 0.01 0.01 0.01 Eurozone 3m Euribor -0.30 -0.30 -0.30 -0.30 -0.30
Indonesia 3m Jibor 7.17 7.00 7.00 7.00 7.00 2Y 6.54 6.70 6.70 6.70 6.70 10Y 7.09 7.00 7.15 7.30 7.50 10Y-2Y 55 30 45 60 80 Malaysia 3m Klibor 3.40 3.10 3.10 3.10 3.10 3Y 2.88 2.75 2.90 3.00 3.00 10Y 3.56 3.40 3.50 3.60 3.70 10Y-3Y 69 65 60 60 70 Philippines 3m PHP ref rate 2.15 2.50 2.75 3.00 3.25 2Y 2.35 2.30 2.40 2.50 2.60 10Y 3.58 3.50 3.60 3.80 4.00 10Y-2Y 123 120 120 130 140 Singapore 3m Sibor 0.87 1.30 1.45 1.65 1.85 2Y 0.85 1.25 1.50 1.65 1.85 10Y 1.86 1.80 1.85 2.05 2.20 10Y-2Y 101 55 35 40 35 Thailand 3m Bibor 1.60 1.60 1.60 1.60 1.60 2Y 1.54 1.55 1.55 1.55 1.55 10Y 2.17 2.30 2.40 2.45 2.50 10Y-2Y 63 75 85 90 95
China 1 yr Lending rate 4.35 4.35 4.35 4.35 4.35 2Y 2.37 2.50 2.50 2.50 2.50 10Y 2.77 2.80 2.90 2.95 3.00 10Y-2Y 40 30 40 45 50 Hong Kong 3m Hibor 0.59 1.00 1.25 1.50 1.75 2Y 0.55 0.90 1.15 1.30 1.50 10Y 0.99 1.25 1.40 1.60 1.80 10Y-2Y 45 35 25 30 30 Taiwan 3m Taibor 0.66 0.56 0.56 0.56 0.56 2Y 0.32 0.30 0.35 0.40 0.45 10Y 0.69 0.70 0.75 0.80 0.85 10Y-2Y 37 40 40 40 40 Korea 3m CD 1.34 1.35 1.35 1.35 1.35 3Y 1.35 1.40 1.45 1.50 1.55 10Y 1.57 1.50 1.60 1.70 1.80 10Y-3Y 22 10 15 20 25 India 3m Mibor 6.92 6.75 6.75 6.75 6.75 2Y 6.79 6.80 6.80 6.80 6.80 10Y 6.87 7.20 7.25 7.30 7.35 10Y-2Y 8 40 45 50 55
Source: Bloomberg and DBS Group Research
3 Introduction Economics–Markets–Strategy
Redefining strength
Consensus is clear about growth: there isn’t enough. The G20 finance ministers recently implored their governments to use “all available measures” – fiscal policies, monetary policies and structural change / reform policies – to get things going again. The IMF has been even more strident – “forceful policies are needed”, it said on 1 September, “to avoid a trap of low growth” [*]. But consensus is also realizing that demographics are largely responsible for the slowdown in GDP growth. Population growth – and especially working-age population growth – has slowed sharply over the past decade in the US, Japan, Europe and Asia. One has to expect that GDP growth will fall just as sharply. The only way to compare growth today with, say, ten or twenty years ago is to look at it in per-person terms. Better yet, in per-working-age person terms. When you do that, a number of interesting things stand out. First, it’s no longer ‘obvious’ that growth is slow, or slower than is should be. Take Japan, for example. Its working age population is shrinking by 1% every year. If one starts with the rather generous assumption that productivity continues to grow at 1.5% per year, then one should expect GDP growth of only 0.5% per year (1.5% minus 1% working age population growth. This (0.5%) is precisely what Japan did grow by last year, what most expect it to grow by this year and what most expect it will grow by in 2017. Japan isn’t growing any more slowly than one would expect given the demographics. Ditto for the US and Europe. In Europe, WAPG has fallen to zero or slightly below. Add 1.5% productivity growth to that and Europe’s potential GDP growth comes to 1.5% per year. In the US, retiring baby-boomers have lowered WAPG to 0.4% per year. Potential GDP growth of 1.9% is implied (1.5% plus 0.4%). Just like in Japan, growth in Europe and the US is no slower than what demographics would dictate. The second thing that stands out when you look at growth in per-working-age- person terms is that Japan is no longer the world’s growth laggard. And the US is no longer the world’s leader. The math is again straightforward. Most expect the US will grow by 1.9% this year. But WAPG is 0.4%, so growth per person (of working age) comes to 1.5%. Japan? Aggregate GDP growth 0.5% is expected
Global – real GDP per person of working age 2007=100, age20-64 Japan 110 Germany
108 Japan 106 US France 104 Germany 102
100
98
96
94 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 INTRODUCTION David Carbon • (65) 6878-9548 • [email protected]
4 Economics–Markets–Strategy Introduction
Global – real GDP per person of working age 2000=100, age 20-64 128 Germany 124
120 Japan
116 US France 112
108
104
100
96 00 02 04 06 08 10 12 14 16 but WAPG is -1%, so growth per working age person comes to 1.5% in Japan too, identical to the US. That’s only one year. Look back a few more years and the picture may be even more surprising. Since the collapse of Lehman Brothers in 2008, Japan’s GDP growth in per-capita terms (of working age) has run neck and neck with Germany (chart at bottom of previous page). Both countries have far outperformed the US. Start back in 2000 (chart above) and nothing changes – Japan and Germany still lead global growth, the US still lags. Finally, and here’s the good news, when you look back over the past 30-40 years, it’s by no means clear that growth in per-capita terms has slowed, as many fear it has (see “Global growth: redefining strength“ below). One should always aspire to greater income / productivity growth but rates today do not appear any slower than they were 30-50 years ago. Two questions, or sets of questions, immediately arise. First, which is more important – growth in the aggregate or growth redefined in per-person terms? That’s easy: it’s growth per person that matters – your income, my wage. Small families can be just as rich, or richer, than big ones. Growth in the aggregate is only important for what it tells you about growth per person. If it doesn’t do that, it’s irrelevant. Second, if aggregate growth is running at potential in the US, Europe and Japan, why are central banks doing their darndest to raise it further? Will negative interest rates, QE and other ‘forceful policies” make any difference? Probably not. One could turn the question around too: doesn’t the fact that economies are already running at potential perhaps explain why such policies have failed to raise growth in the first place? Rapidly falling working-age population growth is distorting our perception of performance. It’s time to express it in per-capita terms.
David Carbon, for DBS Group Research September 15, 2016
* https://blog-imfdirect.imf.org/2016/09/01/we-need-forceful-policies-to-avoid-the- low-growth-trap/
5 Economics Economics–Markets–Strategy
Global growth: redefining strength
• Working age population growth has fallen far more rapidly than most seem to realize. This is distorting our perception of which economies are doing well and which are not • On a per-capita basis, the US is not leading the global recovery; Japan is not lagging it. Their positions are reversed • There has been no change in trend growth in output per working age person in the G3 since 1980. The recent slowdown in GDP growth ap- pears to be due entirely to demographics • Japan and Europe have been growing at-or-above their potential rates for the past two years. The US has been doing so for the past five • With G3 growth already at-or-above potential, there is nothing to be gained from further QE, ZIRP and NIRP. Indeed, this partly explains why monetary policies have failed to lift growth in the first place
Former Minneapolis Fed president Kocherlakota recently argued that “The US recovery is not what it seems” [1]. Specifically, the Princeton mathematician and Chicago PhD noted that differences in population growth among countries are distorting our perception of which countries are doing well and which are not. “What really matters,” he said, “is how much output-per-person has changed”, not how much output in the aggregate has. We couldn’t agree more [2]. In fact we’d take it a few steps further. Population growth – especially working-age population growth – has fallen far more rapidly than most seem to realize and this is distorting not just our perception of which countries are doing well, but how well they are doing compared to the past, how
Nomenclature Global – real GDP Economic regions in this report adhere to the 2007=100 following conventions: 116 Asia-10: CH, HK, TW, 114 KR, SG, MY, TH, ID, US PH, IN 112 110 Asia-9: A10 less CH Germany Asia-8: A10 less IN, CH 108 Asean-5: TH, MY, ID, 106 France PH, SG 104 Asean-4: TH, MY, ID, PH 102 Japan Asia Big3: CH, IN, ID 100 G4: US, EU4, JP, A10 98 G3: US, EU4. JP 96 EU4: GE, FR, IT, UK 94 EU3: GE, FR, IT 92 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 ECONOMICS
David Carbon • (65) 6878-9548 • [email protected]
6 Economics–Markets–Strategy Economics
Global – real GDP per person of working age 2007=100, age20-64 Japan 110 Germany
108 On a per-capita Japan basis, the US is 106 US not leading the France 104 global recov- Germany ery. Japan is not 102 lagging it. The reverse is true 100
98
96
94 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
fast they could / should be growing today, whether growth is likely to go back up soon, whether current policies – especially monetary policies – aimed at achieving faster growth are futile and, indeed, the very question of whether today’s slower growth is a good thing or a bad thing. There’s a lot of fundamental issues here so let’s start right at the top: which countries are doing well and which ones aren’t?
The conventional wisdom The picture on page 1 sums up the conventional wisdom. Since the Lehman Brothers collapse of September 2008, the US recovery has been the strongest in the G3. Germany has recovered solidly. France, not so much. And poor Japan, even after three years of Abenomics, has barely grown at all. But as Kocherlakota says, “US population is growing much faster than those of either Europe or Japan, so its economy should almost automatically grow faster as well.” Any meaningful comparison would ask how these countries have fared on a per-person basis. In fact, if you’re comparing performance, you need to ask how well they have grown per working-age person (WAP), because babies and grandparents don’t bring home the bacon. When you do that, the picture changes radically (chart above). Germany still does well. But now Japan does just as well. Reprobate Japan – with all the QE and negative interest rates and ‘why can’t they ever do things right?’ sentiment – has performed just as well as world-beater Germany. The US, it turns out, has grown only half as well as Germany and Japan. And France, with all it’s bureaucratic / socialistic tendencies, has grown about the same as the US. Importantly, the picture does not change if one looks at the past sixteen years instead of just the past eight (charts top of next page). In aggregate terms, the US economy has again grown by the most – by nearly a factor of two over Germany and France. But in working-age per-capita terms, Germany and Japan again take first place – still by a wide margin and still on an equal footing. Look back 8 years, look back 16 – the German hare and the Japanese tortoise are one and the same. And both countries beat the pants off the US and France. What’s going on?
7 Economics Economics–Markets–Strategy
Global – real GDP Global – real GDP per working age person 2000=100 2000=100, age 20-64 136 128 US Germany 132 124 128 120 Japan 124 FR 116 US 120 GE France 116 112
112 JP 108 108 104 104 100 100 96 96 00 02 04 06 08 10 12 14 16 00 02 04 06 08 10 12 14 16
Working-age population growth The answer is populations aren’t growing like they used to. In the US, Japan, Europe and most countries in Asia [3], population growth has fallen sharply over the past decade and, according to the UN’s World Population Prospects, it will continue to fall for the next 2-3 decades [4]. In Japan, population growth has fallen from 1% back in 1980 to negative 0.2% at present (chart below). In China, it has fallen by three-quarters – to 0.5% from 2% on the same time frame. US population growth has fallen to 0.7% from 1.2% twenty years ago and Germany’s population has been shrinking for the past fifteen years. Falling population growth isn’t the half of it. Societies are aging too. Put these two facts together and it means that working-age population growth is falling much faster than population growth overall. This is important because it’s the working age guys and gals who, well, go to work everyday. The difference between total and working age population is large. In Japan, total population growth has fallen to negative 0.2% per year but the working age
Global population growth % per year China 2.00 Germany 1.75 US 1.50 Japan 1.25 1.00 0.75 0.50 0.25 0.00 -0.25 -0.50 75 80 85 90 95 00 05 10 15 20 25
8 Economics–Markets–Strategy Economics population is shrinking five times faster – by 1% per year (chart below left). The difference between total and working age population growth is just as stark in the US (chart below right). After WWII, the country experienced the ‘baby boom’ that brought so much growth in the 1980s and 1990s. But the baby boomers began retiring five years ago and working age population growth is falling like a rock. US Working age pop- WAPG is now 0.4% per year. Eight years ago, on the eve of the Lehman Brothers ulation growth is collapse, it was double that, or 0.8%. Five years before that, WAPG was 1.2%. In a falling much more dozen years, US WAPG has fallen by two-thirds. rapidly than most In Europe, steady total population growth disguises the drop in WAPG more than seem to realize anywhere else in the world. Total population growth has run at 0.1%-0.2% since 1975 (chart bottom left). But WAPG, has dropped in straight-line fashion from 1% in 1985 to zero by 2015 and is now minus 0.1% per year. In China, the one- child policy is working through the system and working age population growth has fallen to 0.25% from 1.5% just 8 years ago. In 1985, it grew by 3% per year (chart bottom right).
Japan – population growth US – population growth % per year % per year 1.20 1.80 Working age 1.60 Working age 0.80 Total Total 1.40
0.40 1.20
1.00 0.00 0.80
-0.40 0.60
0.40 -0.80 0.20
-1.20 0.00 75 80 85 90 95 00 05 10 15 20 25 30 75 80 85 90 95 00 05 10 15 20 25 30
EU4 – population growth China – population growth % per year, EU4 is GE, FR, IT, UK % per year 1.25 3.50 Working age Working age 1.00 3.00 Total Total 2.50 0.75 2.00 0.50 1.50 0.25 1.00 0.00 0.50 -0.25 0.00
-0.50 -0.50
-0.75 -1.00 75 80 85 90 95 00 05 10 15 20 25 30 75 80 85 90 95 00 05 10 15 20 25 30
9 Economics Economics–Markets–Strategy
Growth implications The implications for GDP growth are straightforward. Since GDP is output-per- worker times the number of workers, GDP growth is the sum of output-per-worker growth and labor force growth, or in simple terms, WAP growth. Thus the sharp fall in WAP growth in the US, Japan Europe and Asia over the past decade has brought equally sharp falls in potential GDP growth, the rate than can be expected Growth in the G3 to prevail through the cycle. has been run- ning at-or-above What is potential today? potential for two Now go back to those fundamental questions posed earlier on. First, what sort of years. Why all the GDP growth should investors be expecting today? That depends on productivity despair over ‘slow’ growth. In the developed world, most consider 1.5% annual productivity growth growth? pretty impressive, partly because it hasn’t been that high for 10-15 years. But take that generous assumption and add today’s WAP growth rates to it. What do you get? In Japan, potential GDP growth comes to 0.5% per year (1.5% productivity growth minus 1% WAPG). In Europe, potential growth comes to 1.4% (1.5% minus 0.1%). And in the US, potential growth comes to a lowly 1.9% per year (1.5% plus 0.4%). This is a pretty relevant observation given the despair in global markets over weak global growth. In all cases, GDP growth is currently running at or above potential. In Japan, where potential growth is 0.5% per year, GDP grew by 0.5% in 2015 and is expected to grow by another 0.5% this year and by 0.6% in 2017. In Europe, where potential is 1.4%, GDP grew by 1.6% in 2015 and is expected to grow by 1.5% this year and next. In the US, growth has run at a 2.1% pace for the past five years – two ticks above its 1.9% potential rate. But if GDP is running at potential, why are markets so worried? Why are the IMF and G20 finance ministers urging governments to take ‘urgent’ action to lift growth by ‘all available means’. Why are the BoJ and ECB pursuing QE and negative interest rate policies? And why is the Fed still effectively at zero?
Will growth be faster tomorrow? No doubt because the multi-laterals and central banks hope growth can be raised higher than it currently is. Can it be? Not for long if we’re already at potential. If you’re wor- Moreover, if the UN’s population projections are anything to go by – they can’t be ried about slow far off because tomorrow’s working age population already lives in today’s 1-19 growth today, age group – GDP growth isn’t going to go back up. It’s going to drop further. get used to it. It’s What sort of magnitudes Working age population growth projections likely to be slower are likely? Based on % per year five years from demographics alone, US now and slower US JP EU4 G3 Asia-10 potential GDP growth yet five years after 2016 0.40 -0.97 -0.11 -0.02 0.99 will fall to 1.6% by 2021 that 2021 0.12 -0.71 -0.28 -0.16 0.57 and to 1.5% by 2026. 2026 0.08 -0.69 -0.50 -0.25 0.36 Europe’s potential growth, Change (pct pts) currently 1.4%, will fall to 2016-21 -0.27 0.26 -0.17 -0.14 -0.42 1.2% by 2021 and to 1% by 2021-26 -0.04 0.03 -0.22 -0.09 -0.21 2026. The UN reckons that Japan’s WAPG is already at bottom and therefore potential growth should rise by 2-3 tenths over the coming decade. That would raise Japan’s potential growth to 0.8% in 2026 from 0.5% at present. (Assuming in all cases productivity growth of 1.5% per year). The message is clear: if you’re worried about slow growth today, get used to it. Growth is likely to be even slower five years from now and slower yet five years after that.
10 Economics–Markets–Strategy Economics
Is slower growth ‘bad’? The obvious premise is that slow growth is bad. Is it really? Not necessarily, and we don’t mean this from a ‘green’ / save the planet perspective. We mean it from an old-fashioned, hardball capitalism perspective. To the extent that slower GDP growth results from slower population growth, the response should be: who cares? It’s a false concern. It’s GDP per person that matters – your income, my wage – not GDP in the aggregate. Small families can be just as rich or richer than big ones. The question then becomes: how much of the slowdown in GDP growth is due to To the extent slowing / negative population growth and how much of it is due to slower growth slower growth in output-per-person – a true concern? owes to slower population Productivity growth growth, it’s a false concern. Small Judging by the growth in output per working-age person, the slowdown in GDP families can be growth in the G3 appears to be due entirely to demographic changes. None of just as rich, or it appears due to slower productivity growth. The quickest way to gain a feel for richer, than big this is to look again at the chart of GDP per working-age person shown at the ones top righthand side of page 3. While sharp drops in GDP/WAP were experienced during the global financial crisis of 2007/08, it’s hard to see any structural shift in the upward-sloping trend of GDP/WAP since 2000 anywhere in the G3. Nor does there appear to be any structural shift in productivity growth if one looks at longer periods of time. Take Japan, for starters (chart below). Growth in output per working age person was high during the late-1980s thanks to the cyclical boom underway at the time. As most are aware, boom ended in bust in 1990 and productivity growth then fell below trend accordingly. It dipped again following the Asian financial crisis of 1997/98 and again during the global financial crisis of 2008/09. For all Japan’s recent woes, however, productivity growth has averaged 1.6% per year since 2011. That’s not far off the 1.8% growth averaged since 1980 and considerably better than the 1.2% growth averaged since 1990. The bottom line is there doesn’t appear to be any structural shift in Japan’s output per working age person for the past 35 years. Indeed, given the very respectable performance since 2011, one wonders once again why the BoJ continues its strenuous pursuit of QE and negative interest rates [5]. Plainly, the chart below shows how tricky measuring productivity growth is because it bounces around so much. You need a lot of years of data before you can draw conclusions. How many years are enough? Not even 24 in the case of Japan, as
Japan – real GDP per working age person % YoY, age 20-64 8
6 late-80s bubble 4
2
0
-2 Global 1990 Asian Fin -4 bubble Crisis burst Fin Crisis -6 80 85 90 95 00 05 10 15
11 Economics Economics–Markets–Strategy
Japan – real GDP per working age person % YoY, age 20-64 6 Twenty-four years is not enough 4 time to accurately measure Japan’s 2 productivity growth. It may 0 not be sufficient in other countries -2 either Global -4 Asian Fin Fin Crisis Crisis -6 92 94 96 98 00 02 04 06 08 10 12 14 16
the chart above shows. If one looks at the period since 1992, productivity growth appears to be improving instead of running sideways or getting worse, as many fear it is today. Of course we know the improvement is illusory because the late- 1980s and early-90s are missing from the picture. Twenty four years is not sufficient time to gauge changes in productivity growth in Japan and it may not be sufficient in other countries either. Against that backdrop, consider the US experience shown below. Many worry that productivity growth there has fallen too but, once again, output per working-age person doesn’t show much change. Importantly, for the past three years, output per working age person has grown by 1.8% per year. That’s three ticks higher than the 1.5% growth averaged since 1980. It’s four ticks higher than the 1.4% averaged since 1990. The bottom line again is that there doesn’t appear to be any shift in trend productivity growth whatsoever for the past 36 years. The corollary follows There has been no immediately: slower US GDP growth in recent years is due entirely to demographics, slowdown in the i.e., slower WAP growth. None of it is due to slower productivity growth. growth in output per working age person in the US for 36 years. In US – real GDP per working age person short, slower GDP % YoY, age 20-64 growth of late 8 owes entirely to slower population 6 growth 4 avg 1.5% 2
0
-2
-4
-6 80 84 88 92 96 00 04 08 12 16
12 Economics–Markets–Strategy Economics
Germany – real GDP per working age person France – real GDP per working age person % YoY, age 20-64 % YoY, age 20-64 14 8 12 10 6 8 avg 4 avg 6 1.7% 1.3% 4 2 2 0 0 -2 -4 -2 -6 -8 -4 80 84 88 92 96 00 04 08 12 16 80 84 88 92 96 00 04 08 12 16
The same is true in Germany and France (charts above). Do you see a change in trend output per-WAP growth? We don’t either. Germany’s average productivity growth has been higher than France’s – by 4 tenths of a point per year – but neither country shows any change in trend. As in the US and Japan, the recent slowdown in aggregate GDP growth in Germany and France owes to falling population growth and not falling output per person.
Asia Asia’s growth is slowing too of course but here the reasons are reversed from the G3. In Asia, the main driver of slower GDP growth is not demographics – though slower WAP growth is a factor – the main driver is falling productivity growth. This shouldn’t come as a surprise because productivity growth accounts for the lion’s share of GDP growth in Asia. Nor should it be a cause for alarm because productivity The slowdown growth falls when incomes go up. And Asia’s incomes continue to rise rapidly. in Asia is due to slower productiv- Take these thoughts in order. In Asia, a ‘young’ developing economy might ity growth. This grow by 9% and its population by 2%, implying productivity growth of 7%. If should neither so, productivity would have accounted for 7/9ths of GDP growth. That wouldn’t surprise nor be untypical. Historically, productivity growth has accounted for 80%-85% of all alarm. Higher economic growth in the Asia-10 since the end of WWII (chart below). Population incomes are driv- growth has accounted for a far lower 15%-20%. ing slower growth and it’s higher incomes that are Asia-10 – share of GDP growth due to productivity growth the ultimate goal, per cap GDP growth as % of total GDP growth not growth per se 100 90 80 70 60 50 40 30 20 10 0 64 69 74 79 84 89 94 99 04 09 14
13 Economics Economics–Markets–Strategy
The bigger point to grasp, however, is that when incomes go up, productivity growth goes down. The way to see this is to think about where productivity growth When incomes go comes from. It comes from roads and bridges and electricity grids and other kinds up, growth rates of hard infrastructure. But it comes from software too – transparent legal systems, go down. ‘Twas effective reward and incentive systems, better management practices and so on. ever thus Many believe (and we would agree) that, at the end of the day, the three most important drivers of productivity growth are education, education and education. But all these things come slowly to low income countries starting out on the development path. It takes decades, for example, to raise education levels. For low income countries, the fastest way to lift productivity is to import technology and machinery from countries that developed it 10, 20 and 30 years earlier. Why re-invent the wheel when you can buy an old one cheaply? Foreign techniques and equipment allow a developing economy to raise output almost immediately and low wages mean the output can be readily sold into global markets. Output and incomes jump sharply. But to keep incomes growing, a developing economy has to raise the technology bar again. Techniques, machinery and ideas developed 20 years ago are not as cheap as those developed 30 years ago. You get less bang for the buck. Local wages are now higher too so it’s tougher to break new ground (steal market share) in global markets. For both reasons, the second jump in productivity and wages is smaller than the first. The third less than the second, and so on. Productivity and wage growth continue to slow as local incomes and education / technological levels get closer and closer to those of the globally most advanced countries. Ultimately, productivity growth can’t be taken “off the shelf anymore” – it has to come from raw research and development, and these gains come grudgingly and sporadically. Productivity growth of 1.5% per year is typical in the US, Japan and Europe. It will become the norm in Asia too as incomes continue to rise. This progression is nothing new. Japan grew fast in the 1950s and 60s. But when wages and incomes and technological capabilities rose, the fast growth passed to Growth slows Singapore and Hong Kong. From there it went to Korea and Taiwan and later when things go to Malaysia, Thailand, China and so on. Rising incomes were the biggest reason right, not just behind this migration and the inexorable slowdown in GDP growth. No one wants when things go slower growth but it’s important to remember that rising incomes are the cause wrong of it and higher incomes are the goal, not growth per se. To the extent higher incomes are driving the slowdown in growth – as is the case in Asia – slower growth is unequivocally a good thing, not a bad thing.
Fundamental issues It’s time to summarize. Population growth has fallen much more rapidly than most realize. Working age population has fallen even more rapidly. This has distorted our perception of what economic performance across the globe is and what it should be. The implications are numerous and fundamental: 1) On a per-capita basis, growth in Japan and Germany has far surpassed that of the US and France since 2007. The US is not leading the global recovery, Japan is not lagging it. The reverse is true. The same is true if one looks 10, 20 or 30 years further into the rear-view mirror; 2) Given the sharp drops in working age population growth, the US, Japan and Europe have all been growing at-or-above their potential rates for the past three years; 3) Further expected drops in working age population growth mean that GDP growth in the G3 is likely to be slower in five years than it is today, not faster. If you’re worried about slow growth, get used to it; 4) To the extent slower growth derives from slower population growth, this is a false concern. We concur with Kocherlakota: what matters is income per
14 Economics–Markets–Strategy Economics
person, not income in the aggregate. Small families can be just as rich, or richer, than big families; 5) There does not appear to have been any slowdown in trend growth in output per working age person in the G3 since 1980. The slowdown in GDP growth owes entirely to slower population growth; 6) In Asia, the drivers of slower GDP are reversed from the G3. In Asia, most of today’s slower GDP growth owes to slower productivity growth, in turn the result of rapid increases in per capita income. Growth slows when things go With growth al- right, not just when they go wrong. ready at-or-above potential, QE, ZIRP Central bank policy and NIRP won’t lift it any fur- The implications for global central banks are clear. First, with growth currently ther. It’s time to running at-or-above potential, there is little need for further QE or negative normalize global interest rates in Japan and Europe and no need for near-zero interest rates in the monetary policies US. Second, at-or-above potential growth means continued QE, ZIRP and NIRP policies are unlikely to lift growth. Indeed, thirdly, the fact that economies are already running at potential partly explains why QE, ZIRP and NIRP policies have failed to lift growth in the first place. Finally, slower growth does not imply that inflation will remain low. Inflation rises or falls depending on whether actual growth rises above / falls below its potential rate, not on the absolute rate of growth. Lower potential growth implies inflation would rise sooner rather than later other things equal. Core (ex-food and energy) inflation is rising rapidly in the US and it has risen considerably in Europe and Japan over the past year. Continued GDP growth at-or-above potential will further this trend.
Notes: [1] https://www.bloomberg.com/view/articles/2016-08-18/the-u-s-recovery-is-not-what- it-seems. Kocherlakota served as Minneapolis Fed president from 2009 until Janu- ary 2016. [2] “Global growth: what is potential and where is it going?”, DBS Group Research, 25Feb16. [3] Only India, Indonesia and the Philippines continue to experience steady-to-rising population growth. [4] http://esa.un.org/unpd/wpp/ [5] The usual answer one gets is that the BoJ wants higher inflation. But the BoJ doesn’t want higher inflation for its own sake, it wants higher inflation because it thinks that would raise GDP growth. If GDP growth is already at potential, infla- tion is moot.
Sources: Population data are from the United Nations. Other data are from CEIC Data, Bloomberg and DBS Group Research (forecasts and transformations).
15 Currencies Economics–Markets–Strategy FX: defying pessimism
Asia EM outperformed DM during the post-Brexit rally Currency war fears subsided; G3 economies disappointed More Asian economies reported faster than slower growth One final test remains – Fed normalization CNY Exporting capital HKD Stable TWD Growth is back KRW Less tolerant of appreciation SGD No further easing MYR Cutting rates THB Moving with Asia IDR More resilient PHP Guarding against complacency VND Remarkably stable INR From depreciation to consolidation USD Underestimating the Fed JPY Unwanted appreciation EUR QE doubts GBP Awaiting Article 50 AUD Watch Fed, not RBA
Currencies mixed about Fed hike prospects after Jackson Hole NZD MAJOR CURRENCIES B R I C S EMERGING ASIAN CURRENCIES 2 GBP CHF 1.2 1.2 EUR 1.0 0.8 1 0.6 USD 0.4 0.4 0.3 AUD 0.0 0.0 0 CAD 0.0 0.0 JPY -0.2 -0.2 -0.3 -0.3 -0.2 -0.2 INR -1 -0.6 -0.8 RUB CNY % change vs USD, -1.3 ZAR -2 9 Sep 2016 vs 26 Aug 2016 BRL * USD is performance of DXY index -2.3 KRW -3 IDR TWD IDR INR JPY BRL CHF PHP ZAR THB GBP EUR SGD USD RUB CNY NZD CAD VND HKD AUD MYR KRW TWD VND CURRENCIES
Philip Wee • (65) 6878 4033 • [email protected]
16 Economics–Markets–Strategy Currencies
Currency forecasts
9-Sep 4Q16 1Q17 2Q17 3Q17
EUR /usd 1.1229 1.10 1.10 1.10 1.10 Consensus 1.09 1.08 1.08 1.09 Forwards 1.13 1.13 1.14 1.14
usd/ JPY 102.68 101 101 101 101 Consensus 105 106 107 109 Forwards 102 102 101 101
usd/ CNY 6.6378 6.72 6.77 6.82 6.87 Consensus 6.75 6.77 6.82 6.81 NDF 6.76 6.81 6.85 6.89
usd/ HKD 7.7565 7.78 7.78 7.78 7.78 Consensus 7.76 7.76 7.76 7.76 Forwards 7.75 7.74 7.74 7.74
usd/ TWD 31.624 31.4 31.5 31.5 31.6 Consensus 32.4 32.5 32.6 32.7 NDF 31.4 31.3 31.3 31.2
usd/ KRW 1108 1088 1090 1093 1095 Consensus 1165 1174 1180 1170 NDF 1109 1109 1108 1107
usd/ SGD 1.3587 1.37 1.37 1.37 1.38 Consensus 1.38 1.39 1.39 1.39 Forwards 1.33 1.35 1.35 1.35
usd/ MYR 4.0675 4.13 4.17 4.20 4.24 Consensus 4.15 4.10 4.10 4.13 NDF 4.11 4.12 4.13 4.14
usd/ THB 34.763 35.1 35.2 35.4 35.5 Consensus 35.4 35.4 35.5 35.6 Off fwd 34.9 34.9 34.9 34.9
usd/ IDR 13097 13160 13339 13518 13697 Consensus 13400 13467 13500 13500 NDF 13324 13507 13709 13891
usd/ PHP 47.435 47.8 48.1 48.4 48.7 Consensus 47.3 47.2 47.5 47.6 NDF 47.8 47.9 48.1 48.2
usd/ INR 66.675 67.4 67.5 67.6 67.7 Consensus 68.5 68.8 69.0 68.8 NDF 67.9 68.8 69.7 70.6
usd/ VND 22277 22243 22243 22243 22243 Consensus 22750 23000 23000 23200 Forwards 22470 22612 22754 --
AUD /usd 0.7538 0.72 0.72 0.72 0.72 Consensus 0.74 0.73 0.73 0.73 Forwards 0.75 0.75 0.75 0.75
GBP /usd 1.3262 1.25 1.23 1.20 1.17 Consensus 1.27 1.27 1.28 1.29 Forwards 1.33 1.33 1.33 1.34 DBS forecasts in red. Consensus and forwards from Bloomberg as at 9 Sep 2016
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FX in 2016 without monetary policy divergences Stock markets have recovered from global risks 16-Dec-15 % YTD change vs USD as at 9 Sep 2016 Indexed:JPY16 Dec 2015=100 (1st Fed hike) EUR Fed 25 Majors Big ANIEs SE Asia 120 AUD hike 1-Jul-15 Asia DXY talks 2-Jul-15 20 GBP 3-Jul-15 115 MSCI Emerging CNY Fed 6-Jul-15 15 Market Index INR hike 7-Jul-15 110 talks MSCI 10 KRW World 8-Jul-15 Fed's Index 105 SGD first 9-Jul-15 5 TWD hike 10-Jul-15 HKD 13-Jul-15 100 0 MYR 14-Jul-15 IDR Cautious 15-Jul-15 -5 95 Fed THB CNY 16-Jul-15 -10 VND deval Brexit 17-Jul-15 90 PHP volatility Cautious shock 20-Jul-15 & patient -15 Fed 21-Jul-15 85 22-Jul-15 JPY INR IDR PHP EUR GBP THB SGD CNY DXY HKD VND AUD
MYR Oct-15 Dec-15 Feb-16 Apr-16 Jun-16 Aug-16 KRW TWD 23-Jul-15
EM outperformed DM on cautious and patient Fed hike stance Emerging Markets (EM) were the main beneficiaries of the post-Brexit recovery, just as they were after the CNY-led volatility at the start of the year. Markets have come to bank on the Fed to turn cautious and patient on rate hikes to support and shore up investor confidence during periods of global market volatility. The factors that triggered EM volatility in 2013-15 reversed in 2016. G3 economies slowed while many Asia ex Japan (AXJ) economies surprised on the upside. Currency war fears led the G7/G20 to discourage countries such as Japan and the Eurozone from heavily relying on ultra-loose monetary policies, especially negative interest rates, to support growth. USD/JPY subsequently plunged from 120 to 100, and paved the way for the recovery in Asia ex Japan (AXJ) currencies. The IDR shone as a high yield currency whenever the Fed held back its hike ambitions. The THB was bolstered by good progress on Thailand’s growth and outlook. Externally-dependent currencies such as the KRW, SGD and TWD benefitted from signs that exports worldwide may be bottoming out. Unlike the past few years, the countries have now become more concerned about appreciation in their currencies.
Real GDP growth, % YoY World exports – a bottom may be in sight Nov-91 % YoY, 3mth mov ave USD bn, 3MMA Dec-91 Country 2015 2016f 2017f 1Q16 2Q16 Jan-92 US 2.6 1.5 2.2 1.6 1.2 40 Export value 1800 Feb-92 EU 2.0 1.5 1.2 1.7 1.6 (right) Mar-92 30 1600 UK 2.2 1.6 0.6 2.0 2.2 Apr-92 JP 0.6 0.5 0.7 2.1 0.7 May-92 20 1400 CN 6.9 6.5 6.3 6.7 6.7 Jun-92 Jul-92 IN* 7.6 7.7 7.8 7.9 7.1 10 1200 HK 2.4 1.2 1.8 0.8 1.7 Aug-92 Sep-92 TW 0.6 0.9 1.8 -0.3 0.7 0 1000 KR 2.6 2.6 2.7 2.8 3.3 Oct-92 SG 2.0 1.8 2.1 2.1 2.1 -10 800 Nov-92 MY 5.0 4.1 4.4 4.2 4.0 Dec-92 TH 2.8 3.1 3.3 3.2 3.5 -20 600 Jan-93 ID 4.8 5.0 5.4 4.9 5.2 Export growth Feb-93 PH 6.3 6.4 6.2 6.8 7.0 -30 (left) 400 Mar-93 VN 6.7 6.3 6.5 5.5 5.5 Apr-93 -40 200 * FY is Apr-Mar; Forecast is consensus as at 9 Sep 2016 May-93 Slower growth in red; Faster growth in blue 99 01 03 05 07 09 11 13 15 Jun-93
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Market is too bearish vs the Fed on inflation From NIRP by ECB/BOJ to Fed's push for hike(s) % YoY, 12M mov ave % pa 10Y governmentJan-06 bond yields, % pa Feb-06 5 5 US CPI inflation (left) 2.50 Mar-06 Apr-06 Fed's projection May-06 4 Fed's 2-2.5% 4 2.00 inflation target keeps real rates Jun-06 US negative to support growth Jul-06 3 3 1.50 Aug-06 Sep-06 Fed hike Oct-06 rhetoric 2 2 1.00 Nov-06 Dec-06 Eurozone 1 1 0.50 Positive again on Jan-07 BOJ/ECB doubts Fed Funds Rate (right) Feb-07 over NIRP Mar-07 0 0 0.00 Apr-07 Market's projection May-07 Japan considered too dovish -1 -1 -0.50 Jun-07 08 09 10 11 12 13 14 15 16 17 18 Oct-15Jul-07Dec-15 Feb-16 Apr-16 Jun-16 Aug-16
USD to surprise on the upside if Fed wins gradual hike case We remain guarded against extrapolating USD weakness for the rest of 2016. Unlike summer, conditions are in place for a Fed hike at the FOMC meetings on 21 Sep. Beyond that, markets are also underestimating the Fed’s resolve to return to a gradual path of rate increases. The upcoming FOMC meeting is likely to shed some light that this does not imply a Fed Funds Rate of less than 1% in 2018, with emphasis that the US economy ran the risk of overheating if rates were kept too low for too long. The latest US nonfarm payrolls did not fall off the cliff in Aug16 like they did in May16. Average hourly earnings have, on a 3mth moving average (MA) basis, risen above the Fed’s 2-2.5% inflation target. As for the real economy, personal consumption expenditure rebounded in spite of the low headline GDP growth in 2Q16. The Fed believes that the low 10Y US bond yield did not reflect US fundamentals but external pressures. Looking at CPI on a 12mth MA basis, the Fed’s case for inflation to return to 2% by late 2017 may not be unfounded. Even if the Fed hikes every quarter from September into 2017, Fed Funds Rate will still be below inflation, keeping real interest rates negative and supportive of growth.
Fed sees labor market fuelling modest wage growth Consumer spending is leading US recovery US real GDP thousands of persons % YoY, 3M mov ave % QoQ saarJan-11 Mar-08 Feb-11 Jun-08 6 500 US ave hourly 2.75 Mar-11 Sep-08 Apr-11 Dec-08 450 earnings (right) US nonfarm 4 May-11 Mar-09 payrolls 400 Fed's 75-150K range to 2.50 Jun-11 Jun-09 (left) 2 keep jobless rate stable Jul-11 Sep-09 350 Aug-11 Dec-09 0 300 2.25 Sep-11 Mar-10 250 -2 Oct-11 Jun-10 Nov-11 Sep-10 200 2.00 -4 Dec-11 Dec-10 150 Jan-12 US real GDP Mar-11 -6 Feb-12 Jun-11 100 1.75 Mar-12 US personal consumption Sep-11 50 -8 Apr-12 Dec-11 May-12 Mar-12 0 1.50 -10 Jun-12 Jun-12 11 12 13 14 15 16 08Jul-12 09 10 11 12 13 14 15 16 Sep-12
19 Currencies Economics–Markets–Strategy
FX reserves increased most in Thailand this year 3M SGD SOR below 3M USD Libor again Net increase in FX reserves, USD bn, Aug16 vs Dec15 % pa
25 1.50 2.00 1.80 1.45 20 1.60 1.40 1.40 15 1.20 1.35 1.00
10 USD/SGD 0.80 1.30 0.60 5 3M SGD SOR 0.40 1.25 0.20 3M USD Libor (left) 0 1.20 0.00 TH IN TW ID KR PH SG HK MY Jan-14 Jan-15 Jan-16
Some notable developments in Asia ex China currencies Unlike the start of the year, Asia ex China (AXC) currencies did not panic when the CNY resumed and extended its depreciation from Apr. The petering out of currency war fears was best reflected by the fall in Singapore’s money market rates below their US counterparts again. AXC currencies were, instead, pre-occupied with currency appreciation as evidenced by the increase in their foreign reserves. Investor confidence was highest in Thailand, where its stock market and accumulation of foreign reserves topped the region. Renewed confidence in India’s reform agenda have also led us to flatten the INR’s depreciating price channel into a stable range. Despite the optimism, we noted that challenges lie ahead for some currencies. The PHP is vulnerable to a significant widening in its trade deficit. If sustained, a further deterioration could offset the overseas foreign worker remittances keeping the current account in surplus. We have also put the MYR back on a depreciating price channel. Having delivered its first rate cut since 2009, Malaysia is likely to ease again at a time when the Fed is about to resume rate hikes.
Philippine trade deficit wider than crisis levels Malaysia – room for a second rate cut USD billion, 12mth rolling sum % pa Jan-93 Feb-93 35 80 5.00 Mar-93 BNM policy rate 5.00 Imports Apr-932Y MGS 30 70 4.50 4.50 (left) 10Y MGS 25 May-93 60 4.00 Jun-93 4.00 20 Jul-93 50 3.50 3.50 15 Exports Aug-93 10 (left) 40 3.00 Sep-93 3.00 Oct-93 5 30 2.50 2.50 Nov-93Official 2-3% 0 inflation target 20 2.00 Dec-93 2.00 -5 10 1.50 Jan-94 1.50 -10 Trade balance (right) Feb-94 0 1.00 Mar-94 1.00 -15 Asian Lehman CPI inflation Apr-94 crisis crisis -10 0.50 (% YoY) 0.50 -20 May-94 -25 -20 0.00 Jun-94 0.00 95 97 99 01 03 05 07 09 11 13 15 Jan-13Jul-94 Jan-14 Jan-15 Jan-16
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Weights of currencies in IMF SDR Breakdown of world's FX reserves into currencies % of total % share of allocated reserves as at 1Q16 8.1
8.3 11.3
9.4 Inner ring: 41.7 10.9 Current weights 41.9 USD: 63.6% Un- Allocated: Outer ring: allocated 65.7% New weights 34.3% w.e.f. 1 Oct 2016 EUR: 20.4$
37.4 Majors*: 13%
Others: 3% 30.9
USD EUR CNY JPY GBP * Majors: GBP (4.8%); JPY (4.1%), CAD (2%); AUD (1.9%)
CNY becomes part of SDR The International Monetary Fund (IMF) will officially include the CNY into its Special Drawing Rights (SDR) with effect from 1 Oct. The CNY will account for 10.9% of the weights at the expense of the EUR, GBP and the JPY. While central banks around the world have started or intend to add the CNY to their reserves, there is no rush for the CNY. Each currency’s weight in the SDR does not automatically dictate its share of the world’s allocated foreign reserves (see charts above). The decision lies more with the currency’s outlook and fundamentals. For example, CNY deposits have fallen in Hong Kong and Singapore, and flattened in Taiwan after the one-off CNY devaluation in Aug 2015. The CNY’s depreciation trend that started last year is synonomous with China’s shift towards becoming a major net exporter of capital in the world. China’s companies have been encouraged to regionalize, or seek trade and investment opportunities outside the country along the “One Belt, One Road”. This was accompanied by the fall in foreign reserves, and the multiple cuts in the banks’ lending rates and reserve requirement ratios in 2014-15.
China – a net exporter of capital in 2016 CNY deposits in offshore centres USD billion, 12mth rolling sum CNY billions
120 6.00 1100 Hong Kong 100 6.20 1000 900 80 6.40 USD/CNY 800 60 (inverted, right) 6.60 ↓ weaker CNY 700 40 6.80 600 20 7.00 500 400 0 7.20 Taiwan 300 -20 Net foreign direct 7.40 investment (left) 200 -40 7.60 100 Singapore -60 7.80 0 07 08 09 10 11 12 13 14 15 16 10 11 12 13 14 15 16
21 Currencies Economics–Markets–Strategy
US dollar The DXY (USD) index has risen from the floor of DXY (USD) Index – moving off from the low of a range its 93-100 range 105 ECB CNY Fed 105 The lowest daily close for the DXY (USD) Index QE deval hike DBSf Consensus this year was 92.626 on 2 May. Since then, the 100 100 USD has been struggling to move higher on Projected trading range the Fed seeking to resume rate hikes. The Fed’s 95 95 first attempt at preparing markets for a summer hike was hijacked by a weak US jobs report for Brexit 90 90 May16, and volatility in global financial markets BOJ from UK’s unexpected vote on 23 Jun to leave the BOJ 85 QQE2 85 European Union. Unlike the CNY-led volatility QQE1 at the start of the year, the fallout from Brexit 80 80 on investor confidence and data was brief and Fed limited. This time around, the Fed was quicker taper at ending its cautious and patient hike stance. 75 75 A few weeks into the Jackson Hole Symposium US loses AAA on 26-27 Aug, Fed officials came out, one after 70 70 another, to outline a compelling case for gradual 11 12 13 14 15 16 17 rate increases. The Fed is likely to look past the 9-Sep 4Q16 1Q17 2Q17 3Q17 lower-than-expected nonfarm payrolls and DBS 95.3360 96.7 96.7 96.7 96.7 GDP data and hike at the next FOMC meeting Consensus 97.2 97.9 98.4 97.2 on 21 Sep. Even so, the DXY’s ability to keep Projected trading band rising towards the ceiling of its 93-100 range Ceiling 100.33 100.3 100.3 100.3 100.3 will depend on improving US data eclipsing Floor 93.135 93.1 93.1 93.1 93.1 any unforeseen surprises at the US presidential Slope 0.0% depreciation a year for USD election scheduled on 8 Nov. Width 3.9% around mid
Japanese yen USD/JPY is hoping for the Fed and the BOJ to help USD/JPY – from fall to consolidation lift it off its psychological 100 level 130 130 USD/JPY hit a low of 102.19 after the Brexit CNY deval Projected ECB QE referendum on 23 Jun. Since then, the currency trading range Fed hike pair has range-bound between 99.50 and 107.50. 120 120 USD/JPY fell from above 120 since late Jan on two BOJ QQE2 factors – the Fed’s cautious and patient rate hike 110 Brexit 110 stance and uncertainties over where Abenomics Fed taper is headed. As of 9 Sep, the JPY has appreciated 100 100 17.2% YTD to become the strongest major and BOJ QQE1 Asian currency this year. Looking ahead, the DBSf coming weeks will be critical in deciding if USD/JPY 90 Consensus 90 finds a floor at 100. First, the Fed will be deciding on 21 Sep whether to resume rate hikes. At 80 80 around the same period, the Bank of Japan (BOJ) will, at its next meeting on 20-21 Sep, conduct a US loses AAA comprehensive assessment on the effectiveness 70 70 of its policies taken since 2013. There are doubts 11 12 13 14 15 16 17 that the BOJ would move towards “helicopter 9-Sep 4Q16 1Q17 2Q17 3Q17 money” or buy foreign bonds, steps that would DBS 102.68 101 101 101 101 weaken the JPY. This was best reflected by the Consensus 105 106 107 109 rise of the 10Y JGB yield to -0.015% on 9 Sep from Projected trading band its all-time low of -0.287% on 27 Jul. Keeping an Ceiling 106.46 107 107 107 107 open mind, a surprise combination of a Fed hike Floor 95.02 95 95 95 95 and more BOJ monetary stimulus could lead the Slope 0.3% depreciation a year for JPY JPY to return some of this year’s unwanted gains. Width 6.0% around mid
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Euro Post-Brexit EUR/USD remains stable in its post-QE EUR/USD – range-cound for more than a year range between 1.05 and 1.15 1.55 1.55 Contrary to popular belief, the Brexit referendum 1.50 US loses 1.50 on 23 Jun did not hurt the Eurozone more than AAA 1.45 BOJ 1.45 Britain. In contrast, EUR appreciated 13.5% QQE1 against GBP to 0.8682 from 0.7651 between 23 1.40 1.40 Jun and 15 Aug. EUR/USD was resilient and did 1.35 1.35 not break out of its post-QE range between 1.05 BOJ DBSf and 1.15. 1.30 Consensus 1.30 1.25 1.25 In fact, EUR/USD spent 82% of this year (as of 9 Fed Sep) in the stronger half of this range. This was 1.20 taper Brexit 1.20 attributed to global risks keeping the USD weak 1.15 1.15 via the Fed dampening rate hike expectations. 1.10 Projected 1.10 This could change if we are correct about markets trading range ECB QE 1.05 1.05 underestimating the Fed’s intention to resume CNY Fed rate hikes in Sep and Dec. More so if the positive 1.00 hike 1.00 EU-US growth differential, in YoY terms, start to 11 12 13 14 15 16 17 reverse in America’s favour. 9-Sep 4Q16 1Q17 2Q17 3Q17 With its quantitative easing program (QEP) DBS 1.1229 1.10 1.10 1.10 1.10 scheduled to end in Mar 2017, the European Consensus 1.09 1.08 1.08 1.09 Central Bank (ECB) is expected to make a decision Projected trading band to extend/expand this program at its remaining Ceiling 1.1500 1.15 1.15 1.15 1.15 two governing council meetings (on 20 Oct and 8 Floor 1.0500 1.05 1.05 1.05 1.05 Dec) this year. Slope 0.0% depreciation a year for EUR Width 4.8% around mid
British pound GBP/USD can keep consolidating until Brexit GBP/USD – consolidating after a plunge negotiations start and resume depreciation push 1.80 1.80 When UK voted to leave the European Union (EU) US loses AAA on 23 Jun, GBP/USD plunged 14.8% to a low of 1.70 BOJ 1.70 QQE1 CNY 1.2796 on 6 Jul. Since then, GBP/USD has stabilized Fed between 1.2850 and 1.3480. Earlier fears of a 1.60 BOJ hike 1.60 fallout from Brexit were mitigated by better- 1.50 Brexit 1.50 than-expected UK data. UK stocks recovered to Fed their strongest levels since Jun 2015. taper ECB QE 1.40 1.40 With UK yet to invoke Article 50 of the Lisbon Treaty, it is premature to declare that the worst is 1.30 1.30 over for Brexit. PM Theresa May remains elusive Projected over when this would take place. Her preference 1.20 trading range 1.20 is to start formal negotiations with the EU in early 1.10 DBSf 1.10 2017. This will provide the time to come up with Consensus a plan for the best possible exit deal for Britain. 1.00 1.00 If so, GBP/USD could keep consolidating for the 11 12 13 14 15 16 17 rest of the year. Even so, we have not narrowed 9-Sep 4Q16 1Q17 2Q17 3Q17 our projected trading range for GBP/USD. Once DBS 1.3262 1.25 1.23 1.20 1.17 the exit negotiations start, GBP is expected to Consensus 1.27 1.27 1.28 1.29 come under renewed depreciation pressures. Projected trading band With uncertainties weighing on the economy, Ceiling 1.3764 1.34 1.31 1.28 1.25 fiscal and monetary policies must support growth Floor 1.2034 1.17 1.14 1.11 1.08 amidst constraints from UK’s wide twin budget Slope -8.8% depreciation a year for GBP and current account deficits. Width 7.7% around mid
23 Currencies Economics–Markets–Strategy
Chinese yuan USD/CNY continued to rise in the upper half of an USD/CNY – upper half of price channel ascending price channel Projected 7.00 trading range 7.00 USD/CNY, as of 9 Sep, traded into a higher trading range between 6.6190 and 6.7030 in 3Q16. The 6.90 6.90 width of this range was 1.3%, narrower than 6.80 6.80 the 3.2% band in 2Q16. This was in line with our expectations for a more stable CNY running into 6.70 Brexit 6.70 6.60 6.60 the G20 Summit hosted by China on 4-5 Sep. As Fed hike of 9 Sep, the CNY fell 2.8% YTD against the USD 6.50 6.50 this year vs 4.5% in 2015. US loses AAA CNY deval 6.40 ECB QE 6.40 The CNY will officially become part of the DBSf International Monetary Fund’s (IMF) Special 6.30 Consensus 6.30 Drawing Rights (SDR) from 1 Oct. The IMF 6.20 6.20 announced last Nov that the CNY would account BOJ QQE1 for 10.92% of the weights in the SDR. 6.10 6.10 Fed taper BOJ QQE2 While more central banks are expected to include 6.00 6.00 the CNY into their foreign reserves, this does not 11 12 13 14 15 16 17 imply a reversal in the CNY’s depreciation trend. 9-Sep 4Q16 1Q17 2Q17 3Q17 China has become a net exporter of capital DBS 6.6830 6.72 6.77 6.82 6.87 this year. In the first seven months of this year, Consensus 6.75 6.77 6.82 6.81 outbound direct investment increased 61.8% YoY Projected trading band to $102.75bn, well above the $77.1bn in foreign Ceiling 6.7315 6.79 6.84 6.89 6.94 direct investments. Foreign reserves fell to a new Floor 6.5789 6.64 6.69 6.74 6.79 year’s low of $3.185trn in Aug16 vs $3.33trn at Slope 2.9% depreciation a year for CNY end-2015. Width 1.1% around mid
Hong Kong dollar USD/HKD was more stable in 3Q16 but will firm USD/HKD – lower half of convertibility band up if Fed hikes materialize 7.90 7.90 Projected USD/HKD was more stable in 3Q16. The trading trading range range was, as of 9 Sep, narrower at 7.7521-7.7614 vs 7.7528-7.7718 in 2Q16. The high for the range was lower this time around. 7.85 7.85
Although the central parity for USD/CNY rose to its US loses AAA DBSf highest level since Oct 2010, the spread between Consensus the CNH and the mainland’s CNY remained 7.80 7.80 ECB CNY narrow. The Hang Seng Index rose to 24099.7 on QE deval 9 Sep, which was not only its highest close this year, but also at levels when China devalued its CNY in Aug 2015. More importantly, HK stocks 7.75 7.75 BOJ Fed BOJ Fed outperformed their US counterparts during the QQE1 taper QQE2 hike Brexit post-Brexit rally. In year-to-date terms, HK stocks overtook US equities in early Sep. 7.70 7.70 When 3M USD Libor increased 22.9bps to 0.8522% 11 12 13 14 15 16 17 between 24 Jun and 9 Sep, 3M HKD Hibor rose 9-Sep 4Q16 1Q17 2Q17 3Q17 only 6.9bps to 0.5804%. The rise in US rates was DBS 7.7565 7.78 7.78 7.78 7.78 attributed to upcoming US money market reforms Consensus 7.76 7.76 7.76 7.76 in Oct. The market remained skeptical over the Projected trading band Fed’s plan to resume rate hikes. We, however, Ceiling 7.8000 7.80 7.80 7.80 7.80 believe that the markets may be too complacent. Floor 7.7500 7.75 7.75 7.75 7.75 If we are correct about Fed hikes this year, USD/ Slope 0.0% depreciation a year for HKD HKD should eventually move higher to 7.78. Width 0.3% around mid
24 Economics–Markets–Strategy Currencies
Taiwan dollar USD/TWD returned into the lower half of its USD/TWD – falling into lower half of channel ascending price channel 34 34 With growth rates (YoY) in real GDP and exports Projected exiting negative territory, USD/TWD abandoned trading range Fed hike the upper half of its broad ascending price 33 Brexit 33 channel. Taiwan’s recovery hopes were also CNY deval reflected by the 15% rise in the TAIEX between 13 32 ECB QE 32 May and 8 Sep. US BOJ While encouraging, the nascent recovery needs 31 loses QQE1 31 AAA to be more sustainable. We see the economy DBSf Consensus expanding 0.9% in 2016, below the 1.22% official 30 30 growth forecast. Export growth has turned BOJ QQE2 positive for only two months and they remained low 1-1.2% in Jul-Aug16. Export orders growth, 29 Fed taper 29 meanwhile, have yet to turn positive. Hence, we see scope for another rate cut in 4Q16. 28 28 Against this background, USD/TWD should not 10 11 12 13 14 15 16 17 deviate too far below the mid-point of its price 9-Sep 4Q16 1Q17 2Q17 3Q17 channel. Our new projected trading range sees DBS 31.624 31.4 31.5 31.5 31.6 USD/TWD in a lower 31-32 range vs the 32-33 Consensus 32.4 32.5 32.6 32.7 consensus over the next 6-12 months. Note also Projected trading band that the TWD has been highly correlated, on an Ceiling 31.830 31.9 32.0 32.0 32.1 indexed basis, with the Asian NIE currencies (KRW, Floor 30.811 30.9 30.9 31.0 31.1 SGD, HKD). The rising price channel reflects our Slope 0.8% depreciation a year for TWD belief that the Fed would hike rates gradually and Width 1.6% around mid support the USD.
Korean won USD/KRW returned into lower half of its broad USD/KRW – into the lower half of its price channel ascending price channel 1250 Projected 1250 USD/KRW did not hold up in the upper half of its trading range ascending price channel as we expected. Instead, Fed hike the KRW started to overtake its peers in August to 1200 1200 CNY deval become the best performing Asia ex Japan (AXJ) BOJ currency this year. The KRW appreciated 7.5% QQE1 ECB QE YTD to 1093 vs USD on 8 Sep, its strongest level 1150 1150 since May 2015. This contrasted sharply with the 7% depreciation posted by the KRW in 2015. Brexit 1100 1100 On a relative basis, between 2Q16 and 1Q16, Korea’s economic growth improved to 3.3% YoY US loses DBSf from 2.8% while the US economy slowed to 1.2% AAA BOJ Consensus 1050 QQE2 1050 from 1.6%. The post-Brexit recovery favoured Fed emerging markets over developed markets. The taper USD was weak globally, especially vs the JPY, from 1000 1000 market skepticism over Fed hikes later this year. 11 12 13 14 15 16 17 From the policymakers’ perspective, monetary 9-Sep 4Q16 1Q17 2Q17 3Q17 and fiscal policies are facing constraints (e.g. high DBS 1108 1088 1090 1093 1095 household and national debt levels) to address Consensus 1165 1174 1180 1170 slow growth and low inflation. With exports still Projected trading band weak, Korean officials have little tolerance for Ceiling 1139 1142 1145 1147 1149 more trade-weighted appreciation in the KRW. Floor 1031 1034 1036 1039 1041 The best relief here will be the Fed delivering on Slope 0.9% depreciation a year for KRW its rate hike promise. Width 5.2% around mid
25 Currencies Economics–Markets–Strategy
Singapore dollar USD/SGD trading band flattened and narrowed USD/SGD – trading range between 1.34 and 1.40 to 1.34 and 1.40 for the rest of 2016 1.50 1.50 Projected The Monetary Authority of Singapore (MAS) is trading range likely to maintain the status quo at the upcoming 1.45 Fed 1.45 SGD policy review around mid-Oct. Singapore hike ended its modest and gradual SGD appreciation CNY deval 1.40 1.40 policy at its last policy review in Apr. Since then, ECB QE the SGD nominal effective exchange rate (NEER) 1.35 1.35 policy band has been tracking a zero appreciation slope. The central bank indicated that another Brexit easing would only be considered in the event 1.30 1.30 BOJ DBSf that global economic conditions and Singapore’s QQE2 Consensus 1.25 1.25 inflation outlook deteriorate significantly. Fed taper BOJ We have narrowed our projected trading range 1.20 QQE1 1.20 for USD/SGD to 1.34-1.40 for the rest of 2016 US loses AAA vs 1.35-1.45 in our previous quarterly. First, the 1.15 1.15 post-Brexit trading range for USD/SGD has been 11 12 13 14 15 16 17 stable and narrow between 1.3343 and 1.3660 9-Sep 4Q16 1Q17 2Q17 3Q17 compared to 1.3315-1.3840 in 2Q16 and 1.3409- 1.4442 in 1Q16. More importantly, 3M SOR fell DBS 1.3587 1.37 1.37 1.37 1.38 below 3M Libor from 10 Aug, for the first time Consensus 1.38 1.39 1.39 1.39 since Sep 2014. As of 9 Sep, 3M SOR fell to Projected trading band 0.6262%, 22.6 bps below 3M Libor at 0.8522%. Ceiling 1.3920 1.40 1.40 1.40 1.40 This was an important signal that currency war Floor 1.3335 1.34 1.34 1.34 1.35 pressures via monetary policy divergences has Slope 0.9% depreciation a year for SGD subsided substantially this year. Width 2.2% around mid
Malaysian ringgit USD/MYR is no longer seen flat around 4.10 but USD/MYR – BN rate cut vs Fed hike rising towards 4.24 in the next 12 months 4.60 4.60 We no longer expect USD/MYR to consolidate Fed hike in a narrowing trading range, and sees the 4.40 Brexit 4.40 currency pair returning into an ascending rising Projected 4.20 trading range 4.20 price channel. Malaysia has started to cut rates CNY deval on lower growth and falling inflation, at a time 4.00 ECB QE 4.00 when America is set to resume its rate hike cycle. 3.80 DBSf 3.80 Consensus On 13 Jul, Bank Negara Malaysia (BNM) lowered US loses its overnight policy rate by 25bps to 3%, its first 3.60 AAA 3.60 rate cut since 2009. Last at 1.1% YoY in Jul16, CPI 3.40 3.40 inflation has been below its official 2-3% target range since Jun16. After slipping below 5% YoY 3.20 BOJ QQE2 3.20 in 2Q15, real GDP growth retreated to 4% in 2Q16, the floor of the official 4-4.5% growth 3.00 Fed taper 3.00 BOJ QQE1 target for 2016. If these numbers do not stabilize 2.80 2.80 as the central expects, another rate cut at the 23 11 12 13 14 15 16 17 Nov meeting should not be discounted. 9-Sep 4Q16 1Q17 2Q17 3Q17 Against this background, it should not come as a DBS 4.0675 4.13 4.17 4.20 4.24 surprise why Malaysian stocks were flat this year, Consensus 4.15 4.10 4.10 4.13 in contrast to the rally in global and regional Projected trading band equities. Investor sentiment was hurt by the civil Ceiling 4.2549 4.30 4.33 4.37 4.41 lawsuit filed in July by the US Justice Department Floor 3.9178 3.96 4.00 4.03 4.07 to seize assets from scandal-tainted 1Malaysia Slope 3.4% depreciation a year for MYR Development Bhd or 1MDB. Width 4.2% around mid
26 Economics–Markets–Strategy Currencies
Thai baht USD/THB may be bottoming out and looking to USD/THB – lower on investor optimism trade higher again 37 Fed hike 37 The THB is a fundamentally strong currency. The Brexit 36 36 current account surplus widened to 10.8% of GDP Projected CNY deval in 2Q16 from 10.3% in the previous quarter. It was trading range 35 35 not too long ago in 2013 that Thailand reported a current account deficit. Foreign reserves increased 34 34 the most in the region this year, to $182.2bn in 33 DBSf 33 Aug16 from $156.5bn at end-2015. Consensus In contrast to its Asian peers, the Bank of Thailand 32 ECB QE 32 (BOT) did not cut rates to support the economy. BOJ QQE2 31 31 The benchmark interest rate has been unchanged Fed taper at 1.50% since Apr15. CPI inflation bottomed in 30 30
May15, turned positive in Apr16 and ended 17 US loses consecutive months of deflation. Real GDP growth 29 AAA BOJ 29 QQE1 bottomed at -0.6% YoY in 1Q14 and recovered to 28 28 3.5% in 2Q16. 10 11 12 13 14 15 16 17 Despite its favorable fundamentals, the THB has 9-Sep 4Q16 1Q17 2Q17 3Q17 been more than 90% correlated with Asian ex DBS 34.763 35.1 35.2 35.4 35.5 Japan currencies on an indexed basis, after the Consensus 35.4 35.4 35.5 35.6 CNY-led global market volatility in Jan-Feb. Ever Projected trading band since the THB appreciated about 4% YTD against Ceiling 35.966 36.2 36.3 36.5 36.6 the USD in August, the BOT has been warning Floor 33.786 34.0 34.1 34.3 34.4 that a rapid rise in the THB could hurt businesses Slope 1.8% depreciation a year for THB and the economy. Width 3.2% around mid
Indonesian rupiah USD/IDR returned into the lower half of its USD/IDR – resilience of IDR noted ascending price channel 15000 15000 The IDR has recovered nicely from its bottom in Fed hike Sep 2015. Investor confidence returned on the 14000 14000 back of economic growth rising back to 5%, Projected CNY deval trading range inflation falling back into its 3-5% target range, 13000 ECB QE 13000 Brexit and a stable current account deficit around 2% BOJ QQE1 of GDP. 12000 BOJ QQE2 12000 Hence, we have lowered our projected trading DBSf range for USD/IDR into the lower half of its 11000 Consensus 11000 ascending price channel. This implies that USD/ IDR is unlikely to rise above 14,000 this year. Our 10000 10000 31-Aug point forecasts, which reflect the middle of our Fed taper 30-Sep projected trading band, is consistent with the 9000 9000 average 13300-13500 rates assumed by the State US loses AAA Budget for the next two years. 8000 8000 Longer term, it is too early to conclude that the 11 12 13 14 15 16 17 IDR has reversed its downtrend. USD/IDR remains 9-Sep 4Q16 1Q17 2Q17 3Q17 aligned to global USD trends that fall on global DBS 13097 13160 13339 13518 13697 risks and rise with Fed hike expectations. Its Consensus 13400 13467 13500 13500 Indonesia’s international liquidity position is not Projected trading band strong enough to ignore rising US rates. The IDR’s Ceiling 13752 13973 14152 14331 14510 resilience depends on the success of the new Floor 12127 12347 12526 12705 12884 policies (stimulus packages and the tax amnesty Slope 5.3% depreciation a year for IDR plan) to attract fresh capital inflows. Width 6.4% around mid
27 Currencies Economics–Markets–Strategy
Philippine peso USD/PHP has been consolidating between 45.85 USD/PHP – a rising price channel takes shape and 47.37 since Mar 2016 51 51 The PHP was the second worst performing DBSf 50 Consensus 50 currency in Asia ex Japan (AXJ) so far this year. In spite of achieving the best growth rate (2Q16: 49 49 7% YoY) in East Asia, the PHP depreciated 1.1% 48 Fed hike 48 YTD as of 9 Sep. Investor optimism was better CNY deval 47 47 reflected in the Philippine stock market which was one of the four AXJ markets that achieved 46 Projected 46 trading range BOJ QQE2 double-digit gains in 2016. Foreign reserves rose 45 Brexit 45 to a new record high of $85.5bn in Jul16. 44 44 ECB QE To be fair, USD/PHP had been stable in a 45.85- 43 43 47.37 range after the CNY-led volatility in Jan- Fed taper 42 42 Feb. Achieving high growth in a weak external US loses AAA environment has hurt the country’s balances. The 41 BOJ QQE1 41 trade deficit widened to $11.9bn in 1H16, close to 40 40 the $12.2bn deficit for the whole of 2015. Exports 10 11 12 13 14 15 16 17 contracted 7.5% YTD in 1H16 while imports 9-Sep 4Q16 1Q17 2Q17 3Q17 expanded 17.7%. Similarly, the budget deficit reached to PHP 120bn in 1H16 vs PHP 122bn in DBS 47.435 47.8 48.1 48.4 48.7 2015. The current account narrowed to 2.28% of Consensus 47.3 47.2 47.5 47.6 GDP in 1Q16, its smallest since 2Q12. The reliance Projected trading band on domestic demand to support growth has also Ceiling 48.792 49.2 49.5 49.8 50.1 led inflation to rise to 1.9% YoY in Jul16 from its Floor 45.939 46.3 46.7 47.0 47.3 low of 0.4% in Sep15. If these trends continue, it Slope 2.7% depreciation a year for PHP could hurt the PHP down the road. Width 3.0% around mid
Vietnam dong USD/VND – remarkably stable despite global risks
USD/VND has been stable around 22300 since the 23500 23500 middle of the year
Following the CNY-led global market volatility at 23000 23000 the start of the year, USD/VND has been stable Fed between 22219 and 22415 since Feb 2016. The hike range is narrower than the 22171-22546 band 22500 22500 Projected after the CNY devaluation in Aug 2015. trading range Brexit 22000 22000 Despite economic growth decelerating to 5.52% DBSf CNY YoY in 1H16 from 6.68% in 2015, investors kept Consensus deval faith in Vietnam’s long term growth potential. 21500 ECB 21500 QE The Vietnam Ho Chi Minh Stock Index broke, in BOJ BOJ QQE2 3Q16, above its 2.5-year trading range between 21000 QQE1 21000 508 and 645. This year’s slowdown was blamed Fed taper on the worst drought in 30 years, and hence, considered as temporary. 20500 20500 12 13 14 15 16 17 There were also no signs of the macro imbalances 9-Sep 4Q16 1Q17 2Q17 3Q17 that led to multiple devaluations in 2008-10. Initial fears that inflation will break above the DBS 22277 22243 22243 22243 22243 5% cap have subsided. After quickening to 2.28% Consensus 22750 23000 23000 23200 YoY in May16 from 0.8% in Jan16, CPI inflation Projected trading band slowed its rise to 2.57% in Aug16. The trade Ceiling 22571 22571 22571 22571 22571 surplus totaled $2.5bn in Jan-Aug16 vs a deficit Floor 21914 21914 21914 21914 21914 of $3.7bn in the same period last year. Slope 0.0% depreciation a year for VND Width 1.5% around mid
28 Economics–Markets–Strategy Currencies
Indian rupee USD/INR has stopped rising in a price channel in USD/INR – flattening out favour of a stable 65-70 range 75 75 Earlier fears over the exit of Raghuram Rajan as the Reserve Bank of India (RBI) Governor on 4 Sep 70 70 Brexit has subsided. On 9 Aug, the Modi government Fed hike pushed through legislation to establish a Projected 65 trading range 65 nationwide goods and services tax (GST). This CNY deval unprecedented feat was considered an important ECB QE 60 Fed 60 milestone to push through more reforms. taper DBSf Consensus Since end-Feb, the stock market has been one of 55 BOJ 55 QQE2 the top performers in emerging markets. Having BOJ QQE1 rallied some 29% from its low of 22495 on 29 50 50 Feb, the Sensex is converging on its all-time high of 30025 seen in Mar 2015. The capital inflows 45 45 during this period was best represented by the US loses AAA $20bn increase in foreign reserves to $367bn in 40 40 the Feb-Aug16. 10 11 12 13 14 15 16 17 Against this background, there are less concerns 9-Sep 4Q16 1Q17 2Q17 3Q17 over the $26bn worth of Foreign Currency Non- DBS 66.675 67.4 67.5 67.6 67.7 Resident (Bank) or FCNR(B) deposits due to Consensus 68.5 68.8 69.0 68.8 mature in Sep-Nov. RBI indicated on 9 Aug that it has already covered 80% of these needs in Projected trading band Ceiling 69.865 70.0 70.1 70.1 70.2 the forward markets. Hence, renewed investor Floor 64.702 64.8 64.9 65.0 65.1 confidence in India should help the INR to be Slope 0.5% depreciation a year for INR more resilient to future US rate hikes. Width 4.0% around mid
Australian dollar AUD/USD could correct down if the Fed hikes AUD/USD – fall flattens into a gentle slope return to support the USD 1.20 1.20 AUD/USD appreciated 7.3% to 0.7702 from 0.7179 between end-May and Aug in spite of several 1.10 Fed 1.10 domestic headwinds. Standard & Poor’s put, on 7 taper Jul, Australia’s triple-A sovereign debt rating on negative watch. The Reserve Bank of Australia 1.00 1.00 (RBA) lowered, on 2 Aug, its cash rate to a record US loses BOJ low of 1.50%. CPI inflation fell to 1.0% YoY in AAA DBSf 0.90 Consensus 0.90 2Q16, well below the RBA’s 2-3% target range. BOJ QQE1 The economy, however, surprised on the upside. Brexit 0.80 0.80 Growth returned to 3% in 1Q16 for the first time Projected since 1Q14 and accelerated to 3.3% in 2Q16. trading range Conversely, US growth, slowed for the fifth 0.70 0.70 quarter to 1.2% YoY in 2Q16 from 3.3% in 1Q15. ECB CNY Fed hike In reality, the above factors did not influence the 0.60 0.60 AUD as much as Fed hike expectations this year. 11 12 13 14 15 16 17 The AUD rallied whenever global risks, such as 9-Sep 4Q16 1Q17 2Q17 3Q17 the CNY-led volatility in Jan-Feb and Brexit in DBS 0.7538 0.72 0.72 0.72 0.72 Jun, pushed the Fed to be cautious and patient in Consensus 0.74 0.73 0.73 0.73 hiking rates. The lesson from May, when the Fed Projected trading band signaled its desire to resume rate hikes in summer, Ceiling 0.7767 0.77 0.77 0.77 0.76 was the AUD returning 70% of its gains achieved Floor 0.6790 0.68 0.67 0.67 0.67 in Jan-Apr. Slope -1.5% depreciation a year for AUD Width 7.3% around mid
29 Yield Economics–Markets–Strategy Yield: limits to policy
US Short-term USD rates are rising on the back of money market re- forms, not the Fed The front of the UST curve is not priced for the Fed The back of the UST curve is vulnerable to any pullback in stimuli from the ECB or the BOJ Steepening in developed market yield curves is already occurring Asia The post-Brexit yield-grab benefitted Asia government bonds However, most of the gains are over if Fed normalization is intact Higher USD rates and a stronger USD are the key risks SG SGD / SOR correlation breaks HK Tight CNH liquidity KR Mixed outlook TW Easing almost done TH Swap spread normalized MY Easing ahead ID Neutral PH Expensive IN Too flat CN Stable policy
Change in 10Y Government Bond Yields since 30 June bps Developed Economies Emerging Asia 30 20 10 0 -10 -20 -30 -40 -50 -60 -70 US GE UK AU SG HK MY TH ID PH IN KR TW CN YIELD
Eugene Leow • (65) 6878-2842 • [email protected]
30 Economics–Markets–Strategy Yield
US – policy limits The past few months were eventful. Brexit was unexpected, triggering very fleeting risk aversion. Markets quickly got round to the fact that major central banks will be even more dovish, bringing government bond yields sharply lower. This played out as the Bank of England (BOE) cut its policy rate by 25bps to a record low 0.25% and re-introduced quantitative easing (QE). The Fed also deferred from hiking rates. Lower interest rates without any financial or economic shock proved a boon for risky assets.
Monetary policy at the limit However, monetary policy easing is nearing limits. Policy rates in the US and the UK are close to zero while those in the Eurozone and Japan are negative. QE is ongoing in the UK, Eurozone and Japan while the balance sheet of the Fed has not shrunk. Collectively, USD 12.5trn (two-thirds the size of the US economy) worth of government bonds are no longer available to the private sector. With a shortage of government bonds looming, it is unclear if the Bank of Japan (BOJ) and the European Central Bank (ECB) will be able to keep up the pace of bond buying for an extended period. In any case, with the German Bund and JGB curves already negative out to the 9Y and 10Y tenor respectively, incremental benefits to the real economy from even lower rates appear negligible. The market has also responded unfavorably to negative rates in Japan and the Eurozone. As such, further monetary easing (if implemented) by the ECB and BOJ are likely to involve a greater mix of assets to purchase (equities, corporate bonds, municipal bonds). With deeper rate cuts and an expansion of government bond buying looking improbable, downside to JGB and German Bund yields are limited. This also implies that the external drag on USD interest rates has largely dissipated. Notably, when the ECB refrained from adding stimuli in September, developed market yield curves bear steepened accordingly.
Money market reforms kicking in Short-term USD swap rates have started rising, even as longer-term rates have stayed low post-Brexit. Most of this came on the back of money market reforms (not Fed hike expectations) that will be in place on 14 Oct. By stipulating stricter rules on money market funds, rates on short-term commercial papers have risen, dragging Libors along. This is a one-off re-pricing in Libors equivalent to a Fed hike. As the regulations do not apply to government bills, TED spreads (Libors less US T-bill rates) have also permanently widened.
US Fed Funds Rate Ceiling & 3M Libor USD Swap Curve %pa % pa 1.50 1.75
1.25 1.50 23-Jun-2016 3M Libor 1.00 1.25 Fed Funds Target Rate Ceiling 1.00 0.75 Spot 0.75 0.50 0.50 0.25 0.25
0.00 0.00 Jan-09 Jan-11 Jan-13 Jan-15 3M 1Y 2Y 3Y 4Y 5Y 6Y 7Y 8Y 9Y 10Y
31 Yield Economics–Markets–Strategy
Fed Funds Rate: Implied & Fed Projections USD Swap Spreads % pa bps 30 2.50 25 2.25 Median Fed 2Y 20 2.00 projections (Jun-16), 1.75 interpolated 15 1.50 10 5 1.25 5Y 1.00 0 0.75 -5 0.50 -10 10Y 0.25 Implied Fed Funds rate -15 0.00 -20 Sep-16 Sep-17 Sep-18 Jan-15 Jul-15 Jan-16 Jul-16
However, wider TED spreads did not translate into wider swap spreads (USD swap less UST yields) in the longer tenors. Swap spreads are negative in the 10Y sector and barely above zero in the 5Y sector. The market is likely too complacent on this. We expect longer-term swap spreads to widen over the coming quarters.
The Fed is still a factor for short-term rates Meanwhile, market expectations of Fed hikes have been volatile. The probability of a Fed move in September ranged from 22-42% over the past two months, oscillating between hawkish Fed rhetoric and lackluster US data. The market is more convinced of a Fed move in December (60% priced in). Over the next three years, the market sees just 1.5 hikes from the Fed, reflecting a case of secular stagnation. This appears too pessimistic. 1Y-5Y USD interest rates are vulnerable to a selloff if the US economy holds up. Longer-term USD rates are likely to be sticky to the upside for now. 10Y UST yields broke above 1.62% when the ECB refrained from adding stimuli. A Fed move in
Fed, ECB, BOJ Balance Sheet Sizes UST, JGB & German Bund Curves USD bn % pa 5000 2.00 Fed 4500 1.50 4000 UST 3500 1.00 3000 2500 0.50 JGB 2000 ECB 0.00 1500 1000 -0.50 BOJ 500 German Bund 0 -1.00 Sep-96 Sep-01 Sep-06 Sep-11 Sep-16 3M 1Y 2Y 3Y 4Y 5Y 6Y 7Y 8Y 9Y 10Y
32 Economics–Markets–Strategy Yield
Selected Yielding Assets 10Y Government Bond Yields % pa % pa 2.50 10.00 Range for past 6 mths 9.00 Range for past 6 mths 2.00 Spot 8.00 Spot 7.00 1.50 6.00 5.00 1.00 4.00 3.00 0.50 less 2.00 4%-pts 1.00 0.00 0.00 2/10 spd TED spd IG OAS HY OAS SPX yld US SG HK MY TH ID PH IN KR TW CN
September would probably push 10Y yields towards 1.7%, but we suspect that upside may be limited in the near term. To be sure, 10Y UST yields are very low relative to growth / inflation dynamics. However, fundamentals have taken a backseat over the past few quarters. Without a meaningful uptick in German Bund or JGB yields, 10Y UST yields appear anchored. It might be several months before 10Y UST yields can normalize into the 2.0-2.5% range. In general, USD yielding assets (corporate bonds, stocks) all appear expensive as the hunt for yield persists. Aside from Fed policy, taper risks from the ECB and the BOJ in the coming quarters bear close watching.
Less supportive conditions for Asia government bonds The global hunt for yield has benefitted Asia government bonds. With USD 12.6trn worth of negative yielding bonds in the market, the relatively high yields of Asian sovereigns become very attractive. A weaker USD that came on the back of receding Fed hike expectations also helped. Further large gains to Asia government bonds appear unlikely unless Fed normalization gets aborted. External conditions are likely to turn less supportive. Fed hikes would put upward pressure on Asia yields, stalling the rally. However, we think this adjustment is likely to be benign as USD strength is unlikely to revisit the highs seen late last year. Against this backdrop, we think that shorter-term Asia government bonds are likely to hold up relatively well in the coming months. Fundamentally, many economies (excluding China) are also showing strong or improving external accounts balances. Aside from bolstering their currencies, this also provides room for Asian central banks to cut rates further if needed. We have pencilled in rate cuts for India, Indonesia, Malaysia and Taiwan while seeing risks that Korea and Thailand could ease further. Longer-term Asia government bonds benefit from these factors. However, given the flatness of the yield curves, we think shorter-term bonds provide better risk-to- reward. We expect yields on US Treasuries to rise. By mid-2017, 2Y yields should reach 1.70%; 10Y yields should reach 2.05%.
33 Yield Economics–Markets–Strategy
Singapore – SGD / SOR correlation breaks USD/SGD & 3M SOR The relationship between the SGD and SORs has SGD per 1 unit of USD % pa broken down in recent weeks. Under normal 1.50 2.00 circumstances, SGD weakness would prompt a 1.75 concomitant rise in forward points and put upward 1.45 USD/SGD pressure on the FX-implied SORs. This was the 1.50 case for the most part of 2015. In the first half 1.40 of 2016, when the SGD was strengthening, SORs 1.25 fell accordingly. Therefore, it was surprising that forward points remain anchored during the recent 1.35 1.00 bout of SGD weakness (sparked by renewed worries 0.75 of Fed hikes). 1.30 0.50 The market is showing a higher USD/SGD (people 1.25 3M SOR (rhs) are converting SGD to USD at spot) but are also 0.25 buying SGD forward (accounting for the decline in SGD forward points). We suspect this may be 1.20 0.00 a reflection of increased demand for USD in the Jul-14 Jan-15 Jul-15 Jan-16 Jul-16 immediate term. This development indirectly translates into lower SORs even as the SGD has been weakening and that Libors have been rising. • SORs will come under upward pressure once the The 3M SOR is already 13bps lower than the 3M SGD forward points normalize from overly low Libor. This appears excessive. We think it is just a levels matter of time before the traditional relationship • We expect 2Y and 10Y SGD yields to reach 1.65% between the SGD and SOR is re-established. and 2.05% respectively by mid-2017
Hong Kong – tight CNH liquidity 6M Onshore & Offshore Rates The rally in CNH interest rates that started in the % pa beginning of the year has ended. After hovering 8.00 below the 6M Shibor (2.88%) in the four months 7.00 ending August, the 6M CNH implied rate has now Implied 6M CNH Hibor touched 3.57%. Similarly, spread widening has 6.00 been taking place between the 5Y CNH CCS rate and the 5Y onshore swap rate over the past two 5.00 weeks. 4.00 The underperformance in CNH rates can be 3.00 attributed to two factors. Firstly, there has been increasing speculation that the authorities may be 2.00 more tolerant of RMB weakness after the inclusion 6M Shibor of the currency into the SDR basket. Secondly, the 1.00 authorities may be deliberately keeping offshore 0.00 liquidity tight (keeping interest rates high) to deter Jul-14 Jan-15 Jul-15 Jan-16 Jul-16 speculators. Against this backdrop, we suspect that CNH interest rates are likely to stay elevated relative to CNY yields in the immediate few months. • CNH interest rates are likely to come under Moreover, we continue to think that the market is upward pressure as the market comes to terms underestimating Fed hike risks. Higher USD interest with Fed normalization rates and a stronger USD would likely place more upward pressure on CNH interest rates relative to • We expect CNH rates to hover above onshore CNY interest rates. rates of similar tenor in the short term
34 Economics–Markets–Strategy Yield
Korea – mixed outlook 1Y, 2Y & 3Y KRW Swap Rates vs 3M CD Rate Bets on further rate cuts by the Bank of Korea (BoK) %pa have receded somewhat over the past few weeks. 2.00 This has largely been reflected in the sharp rise in short-term KRW swaps (1Y, 2Y and 3Y) even as the 3M CD Rate 3M CD rate stayed steady. 1.75 On balance, KRW swaps are still pricing in further easing, but are no longer as convicted as before. Judging from the price action since Brexit, KRW 1.50 swaps appear to be largely driven by external factors, rather than domestic considerations. 3Y KRW Swap KRW swap rates plunged in the immediate 1.25 2Y KRW Swap aftermath of Brexit, fully pricing in a rate cut within the coming six months. However, with the Fed 1Y KRW Swap sounding hawkish in late August, the KRW swap 1.00 rates have erased half of their decline. Notably, Jul-15 Jan-16 Jul-16 KRW swap rates remain at elevated levels despite the downside surprise in headline CPI (CPI dipped to 0.4% YoY in August against consensus expectations of a 0.7% rise). • The market is no longer as convicted that the BoK The outlook for KRW rates is mixed. While there is would cut rates further scope for the BoK to cut rates, concerns on domestic • We expect 3Y and 10Y Korean Treasury Bond household debt and Fed normalization are likely to yields to reach 1.50% and 1.70% respectively by prompt caution. mid-2017
Taiwan – easing almost done 2Y TWD Swap Rate & 2Y TWgov Yield TWD swaps and TWgov bonds are sending a %pa conflicting picture on TWD interest rates. Over the 1.00 0.75 past few months, TWgov yields have been grinding lower even as TWD swap rates were modestly rising. With a liquidity squeeze or credit event 0.90 2Y TWD Swap 0.65 looking unlikely, swap spreads (TWD swap rates less TWgov yields of similar tenor) appear too wide. On 0.80 0.55 balance, we think that TWgov bonds may be too pessimistic on the economic outlook and are likely to play catch up to swap rates. 0.70 0.45 Notably, YoY economic growth finally turned positive in 2Q16 (after staying in negative territory 0.60 0.35 for three consecutive quarters). With export 2Y TWgov numbers surprising on the upside in August (actual: 1.0% YoY, consensus: 0.3% YoY) and August 0.50 0.25 manufacturing PMI numbers showing signs of Jul-15 Jan-16 Jul-16 improvement, we think that the central bank’s monetary loosening cycle is likely coming to an end.
Externally, developed market yields have hit a • Another 25bps rate cut has been pencilled into short-term floor post-Brexit and have rebounded in our forecast recent weeks. If Fed normalization is intact, upward pressure on USD and TWD interest rates is likely to • We expect the 2Y and 10Y government bond materialize. However, the increase in TWD rates yields to rise to 0.40% and 0.80% respectively by should be more muted. mid-2017
35 Yield Economics–Markets–Strategy
Thailand – swap spreads normalized 2Y, 5Y & 10Y Swap Spread THB swap spreads (swap rates less THgov yields bps of comparable tenor) have normalized. Sharply 75 declining THB forward points and an appreciating 2Y Swap Spread THB have put down pressure on the FX-implied 5Y Swap Spread 6M THB FIX (floating leg of THB swaps). This FX 50 distortion has benefitted THB swaps more than THgov bonds, eroding the sizable swap spread 25 built up in 2015. Coupled with the selloff in THgov bonds since July, THB swap spreads have turned modestly negative across the 2Y, 5Y and 10Y tenors, 0 a development not been seen since early 2015.
As such, we think that THgov yields and THB swaps -25 are likely to track closely going forward. With yields 10Y Swap Spread close to levels seen at the start of the year, THgov bonds do not appear as expensive as their Asian -50 counterparts do. Moreover, THgov bonds now offer Jan-15 Jul-15 Jan-16 Jul-16 a decent pickup over USTs (50bps in the 10Y sector). With the policy rate likely to stay stable over the coming quarters (with risks of further easing), • After the recent selloff, 10Y THgov yields are short-term THgov bonds are likely to hold up well now at a premium over 10Y UST yields even if the Fed resumes its normalization cycle. Meanwhile, the sizable and growing current • We expect 2Y and 10Y Thailand government account surplus should provide support for longer- bond yields to reach 1.55% and 2.45% respectively term THgov bonds. by mid-2017
Malaysia – easing ahead MYR Swap Curve - 1Y/3Y Segment bps Speculation of rate cuts by Bank Negara Malaysia (BNM) has been intensifying with the market pricing 40 in a rate cut within the next six months. Notably, 35 1Y/3Y Spread MYR swap rates have been declining since late 2015 30 with the 3Y-10Y segment of the swap curve level shifting lower by around 100bps. 25 Swap rates are now relatively low, comparable to 20 levels seen in 2013, before the taper tantrums. A 15 combination of easing emerging market stress, 10 a rebound in oil prices, the cut in the reserve requirement ratio and receding political noise 5 helped drive MYR interest rates lower. 0 Fundamentally, the decline in headline inflation to -5 1.1% (YoY) in July (from as high as 4,2% in February) -10 has provided BNM with some room to maneuver. Jan-13 Jan-14 Jan-15 Jan-16 To be sure, base effects play a large role towards explaining the low inflation prints. However, with the policy rate (3%) still near the all-time high, real interest rates appear too high. • The bounce in oil prices is providing support for There is a bias towards further rate cuts and we Malaysian government securities expect one to be delivered in 4Q16. Keeping in mind Fed risks and BNM easing, we suspect that the • We expect 3Y and 10Y Malaysian government MYR 1Y/3Y segment of the swap curve is poised to securities yields to reach 3.00% and 3.60% steepen in the coming months. respectively by mid-2017
36 Economics–Markets–Strategy Yield
Indonesia – neutral 10Y IDgov Yield Spread Over 10Y UST bps Depending on the timeframe considered, IDgov bonds can be considered cheap or fairly priced. We 1200 are leaning towards the latter. A lot hinges on the global growth / inflation outlook relative to Asia 1000 as well as the pace of Fed normalization. 10Y UST Spread is about average yields at 1.65% are similar to what was seen in 2012 800 when the Fed was running quantitative easing (QE). Back then, term premia across emerging markets 600 was compressed and 10Y IDgov yields were just above 5%. The additional premium of 10Y IDgov bonds over 10Y USTs (10Y IDgov/UST) was as low as 400 Post-GFC average 322bps. 200 Comparatively, the 10Y IDgov/UST spread is now at 535bps, slightly higher than the post-Global Financial Crisis average. Further spread compression 0 via lower IDgov bonds can take place, but that Feb-09 Feb-12 Feb-15 would require the market to be even more dovish on the Fed than current pricing (a Fed hike over the coming one year). This would stoke more funds to seek higher yields in Asia. • Commodity prices are supportive of IDgov bonds even as Fed normalization has begun However, if the Fed normalizes policy as we expect, upward pressure on USD interest rates should stall • We expect 2Y and 10Y Indonesian government the rally in IDgov bonds. Spread compression would bond yields to reach 6.70% and 7.30% respectively then take place on the back of high UST yields. by mid-2017
Philippines –expensive 10Y PHgov & 10Y UST Yield
The global hunt for yield has spilt over unto PHgov %pa bonds. This is most apparent in the 10Y sector 5.00 10Y PHgov Yield 3.50 where yields have fallen by 110bps since the begin- 4.50 ning of July (when negative spillover from Brexit 3.00 faded) to 3.31% currently. 2Y yields also exhibited 4.00 similar decline but are considerably more volatile. 3.50 2.50 The Philippines’ 5Y USD credit default swap (CDS) spread also collapsed over the same period, track- 3.00 ing similar moves in the region. PHgov bonds have 2.50 2.00 benefitted not due to a lower risk profile, but to 2.00 very low rates globally. Ironically, low CDS spreads 1.50 and low PHgov yields actually point to high dura- 1.50 tion risks and increasing susceptibility to changes in 10Y UST Yield (rhs) global sentiment. 1.00 1.00 Domestically, the economy is growing just shy of Apr-13 Apr-14 Apr-15 Apr-16 7% while inflation is still at a relatively muted 1.9% YoY July. From a longer term, fundamental perspective, 10Y PHgov yields appear too low relative to the economy’s trend growth / inflation • Modest tightening has already taken place. profile. With yields low by historical standards, More is likely to come in 1Q17 as strong economic (not particularly attractive compared to regional momentum is maintained peers) and no signs that rate cuts are imminent, • We expect 2Y and 10Y Philippine government 10Y PHgov bonds are likely to underperform in the bond yields to reach 2.50% and 3.80% respectively coming months. by mid-2017
37 Yield Economics–Markets–Strategy
India – too flat INgov Curve - 2Y/10Y Segment 10Y INgov bonds look relatively expensive after bps the recent sharp rally. Since early July, 10Y yields 75 are down by 60bps, outpacing that of 2Y yields (down by 20bps). The performance is even more 50 remarkable considering that 10Y UST yields rose by 2Y/10Y Spread 20bps over the same time period. Externally, the delay in Fed hikes had sparked a 25 hunt for yield that benefitted Asia government bonds. Domestically, India was enjoying a period of 0 low inflation, allowing the Reserve Bank of India (RBI) to keep monetary policy loose. Conditions are likely to become less favorable for -25 INgov bonds. To be sure, the RBI is likely to deliver one more rate cut and are likely to stay committed -50 to the neutral liquidity framework. However, rising Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 Jul-16 WPI inflation and Fed hike risks are likely to prompt a more cautious RBI going forward. On balance, this suggests that there will be some support for short-term INgov bonds, but longer-term INgov • Close attention will be paid to new RBI governor bonds may be prone to a selloff. Urjit Patel’s monetary policy stance After flattening by 20bps (to just 4bps) since early • We expect 2Y and 10Y Indian government bond July, we think that the 2Y/10Y segment of the INgov yields to reach 7.0% and 7.6% respectively by mid- curve is poised to steepen in the coming quarters. 2017
China – stable policy CNgov Curve - 5Y/10Y Segment bps Short-term CNY interest rates (the 7D repo and 40 the 3M Shibor) have been going nowhere since 5Y/10Y Spread Oct15 as the People’s Bank of China (PBoC) kept liquidity conditions ample. Injection of liquidity 30 through the different facilities were more than sufficient to offset the fall in base money brought about by outflows earlier this year. Notably, policy- 20 making appears to be more targeted as the PBoC has avoided tweaking the 1Y lending rate or the reserve requirement ratio (RRR) since 1Q16. With 10 no signs that there would be a policy change, short- term CNY rates are likely to be range-bound for the 0 foreseeable future. Meanwhile, longer-term CNgov bonds outperformed over the past three months. 10Y -10 CNgov yields pushed to a new low for the year Jan-14 Jan-15 Jan-16 and are now trading at 2.80%. Comparatively 2Y yields also dipped over the same time period, but did not quite retest the low of 2.21% set in • Monetary policy is likely to be kept accommodative March. On balance, short-term yields are likely for the foreseeable future to be anchored even if further downside seems constrained. Comparatively, longer-term yields may • We expect 2Y and 10Y Chinese government bond be susceptible to a re-alignment higher in global yields to rise to 2.50% and 2.95% respectively by yields. We see scope for the 5Y/10Y segment of the mid-2017 curve to steepen in the coming months.
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39 CNH Economics–Markets–Strategy CNH: ready to go
• The yuan will be included in the IMF’s SDR basket on 1 Oct • It has become a more mature currency a year after FX reforms • Reserve managers and institutional investors are accumulating yuan assets • China’s sovereign debt presents yield enhancement opportunity • It also offers diversification benefits
Two weeks from today, the Chinese yuan (CNY) will be included in the IMF’s SDR basket. Across a range of indicators, the CNY is now perceived by investors as a more mature currency. After the PBoC devalued the yuan and reformed the daily fixing mechanism on Aug15, the daily fixing rates have been tracking spot more closely. The CNH-CNY spread has in turn narrowed despite occasional divergences due to remaining capital restrictions (Chart 1). Narrowing the spread is crucial be- cause deviations between the two rates imply that CNH cannot be a perfect hedge for SDR users’ CNY-based exposures. That also explains why the authority has earlier approved foreign banks / domestic banks to trade directly in the onshore / offshore forex market. FX aside, substantial efforts have been made to improve the transparency and ac- cessibility of the China interbank bond market (CIBM). For instance, foreign inves- tors, both central banks and institutional investors, have gained greater access to the CIBM recently. Meanwhile, restrictions are reduced on investments by foreign commercial banks, insurance companies, securities companies, and investment funds. Regulators have also allowed cross-border remittances in onshore yuan as well as foreign currencies. The broader access and simplified process make it easier for overseas investors to tap into the growth of the CIBM, which is already the 3rd largest fixed income market in the world.
Increasing allocation Chart 1: CNY-CNH spread pips Indeed, data suggest that 900 central banks around the USD/CNY-USD/CNH world might have already 700 started to re-allocate re- 500 serves. Cumulative foreign 300 institutional flows into yu- 100 an-denominated treasury -100 bonds reached an all-time -300 high of RMB345 bn in Au- -500 gust, up by 38% from Janu- -700 ary (Chart 2). The Monetary -900 Authority of Singapore (MAS) recently announced -1100 that yuan assets have been -1300 included as part of its offi- -1500 cial reserves since June. Jul-15 Oct-15 Jan-16 Apr-16 Jul-16 OFFSHORE CNH Nathan Chow • (852) 3668 5693 • [email protected]
40 Economics–Markets–Strategy CNH
We expect the CNY will com- Chart 2: Chinese sovereign bonds held prise 4% of global reserves, by foreign institutions similar to that of Japanese RMB bn Yen in three years’ time. That 350 implies US$440 bn out of the 330 US$11 trn global reserves 310 could be allocated to yuan as- sets. This is based on the on- 290 going development of yuan 270 CNY will comprise internationalization. 4% of global re- 250 serves within the As of July, the CNY ranked 230 next three years fifth in global payment value, 210 trailing the JPY by a mere 1.5 190 percent. The yuan is currently the 2nd most active used cur- 170 rency in the Asia Pacific for 150 payments with China/HK; Aug-2014 Aug-2015 Aug-2016 trailing the JPY with a mini- mal gap. In 2015, some 30% of mainland trade was settled in the CNY. This is very close to the JPY’s usage.
Yields are attractive On top of central bank reserve allocation, we expect increased allocation by global bond investors into the Chinese bond markets. The appeal is apparent given low yields for most global bonds. The value of negative yielding debt – primarily gov- ernment bonds in Europe and Japan but also a mounting number of highly-rated corporate bonds – swelled to US$13.4 trn in August. While US Treasury yields are still positive, strong appetite for dollar assets has low- ered its return. For non-US based asset managers, 10-year Treasuries yield little after factoring in hedging costs. This highlights the relative attractiveness of the China’s sovereign debt. The yield advantage of China’s 10-year debt over 10Y USTs rose to 149 basis points in July, the widest since Aug15 (Chart 3).
Another attractive feature is its low correlation to global bonds. Just days after For non-US inves- the UK referendum, when risk appetite soured, the Ministry of Finance auctioned tors, 10-year Trea- dim sum bonds in Hong Kong with attractive yields. The 3.25% offered in the five- suries yield little year maturity, for instance, was high compared to that of developed-markets such after factoring in hedging costs
Chart 3: China’s 10Y sovereign debt over UST bp 160
140
120
100
80
60
40 Aug-2015 Oct-2015 Dec-2015 Feb-2016 Apr-2016 Jun-2016 Aug-2016
41 CNH Economics–Markets–Strategy
as JGBs or Bunds. In an in- Chart 4: China’s sovereign curve dication of robust demand, 2.9 China’s sovereign curve is little changed from 1Q16 2.8 31-Aug even with increased issu- 31-Mar ance (Chart 4). 2.7 2.6 Shy away from corporate debt 2.5
In fact, interest is likely go- 2.4 ing to revolve around gov- ernment bonds and quasi- 2.3 sovereign credits. Investors 2.2 will shy away from corpo- China’s corporate rate debts in the near term 2.1 bond default rate due to rising credit risks is still a fraction of 2 after a number of onshore the global average 6M 1Y 3Y 5Y 7Y 10Y bond failures occurred. Sev- enteen publicly-traded bonds have defaulted in 1H16, almost triple that of FY15. Flight-to-quality has led to wider spreads. Credit premiums of five-year A- rated corporate debt over top-rated bonds climbed to 840 basis points in June. Despite recent retrenchment, poor earnings and tight cash-flows have prevented credit spreads from narrowing significantly. Spreads for industries with overcapacity are under pressure to widen further. Non-financial companies listed onshore have only generated operating earnings 1.97x their interest payment, down from 5.2x five years ago. Looking forward, credit in the corporate sector could deteriorate further. That said, China’s corporate bond default rate is still a fraction of the global aver- age. Allowing for more defaults is a necessary part of financial market reform that would help curb overcapacity. Previously, bond defaults were virtually non-existent because the majority of bonds were issued by large state-owned enterprises. As a result, yield spreads in the corporate bond market provide investors scant informa- tion on true risks. A large and open bond market that accurately prices risk helps the Chinese financial system to become less bank-dependent / more efficient.
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43 Asian Equity Strategy Economics–Markets–Strategy
Asia equity: pain, but no collapse
• Stay cautious in 4Q as market volatility tends to rise. Valuations, the US presidential election, Fed policy and flow reversal are key issues • Cheaper valuations could provide better entry points later on, especially for ASEAN markets • Indonesia, and Hong Kong/China are our top markets for prospects of stronger earnings growth and equity flows next year • Taiwan, Korea and Malaysia remain as Underweight as we find very few reasons to like these markets • Thailand is downgraded to Neutral, Philippines remains an Underweight. Watch for growth surprise and cheaper valuations which could lead us to upgrade these markets
The last quarter has brought us closer to the first rate hike for the year which the strategy team believes to be likely in December. In line with a better-than-expected and improving macro conditions (stable oil price - up from lows in February with a WTI price per barrel of US$42; easing monetary conditions – world of zero-to- negative interest rates and low bond yields; moderate economic recovery – global economies averting a recession), Asia markets have generally performed well year- to-date. However, a lack of earnings growth has given rise to rich valuations, and forward PE valuations are now above their long-term averages, which make these markets vulnerable to negative news, in our view. Thus, we believe it pays to be cautious in 4Q in view of a few unsettled issues on the horizon, as history suggests that September and October are the most volatile months of the year. Nonetheless, fundamentals in Asia markets are improving, which could give rise to better earnings outlook next year. Any weakness should be deemed as a buying opportunity, in our view. Our top pick markets are Indonesia, China (H-shares and MSCI China), and Hong Kong (HSI, MSCI Hong Kong). Taiwan, Korea and Malaysia are Underweight as we do not see the markets trading out of their respective ranges. Philippines is an Underweight as we see more downside to the index levels in the near term but will be interested to pick up on lower valuations. Singapore, Thailand and India are Neutral. While pain is expected in the current quarter, we do not expect a repeat of a market collapse as in 2015. We recommend investors to buy on weakness. The key issues that markets have to grapple with but will soon blow over in the fourth quarter are: 1. Asia’s high valuations; 2. Uncertainty over US presidential election; 3. Tightening tantrums; 4. Weak earnings outlook; 5. Reminiscence of 2015 correction; 6. Fear of flow reversal. ASIA EQUITY Joanne Goh • (65) 6878 5233 • [email protected]
44 Economics–Markets–Strategy Asian Equity Strategy
Asia valuations close to previous highs Clearly, Asia valuations have risen above their long-term averages, as a lack of earnings growth and rising stock prices have re-rated stocks instead. On a PE basis, levels are close to post-GFC crisis high, and near levels where some form of consolidation is quite likely, as in the two past incidents in the 2015 market selloff, and 2010/11 US debt ceiling crisis. (Fig. 1) On a PB basis, Asia markets are still about 8% away from the top of the recent range. Our sense is that consolidation is not going to be deep, as there is very little evidence these incidents are likely to repeat. The uncertainty of a Fed US rate hike leading to higher interest rates and stronger USD and inducing capital outflows, and a non- consensus US presidential election win could eventually create some sort of political instability in the financial markets, are tail risk assumptions which need to be blown over. As long as these two events remain an overhang, Asia markets are likely to be trapped within their trading ranges. Current valuations are on the top side of the trading range, underscoring the downside risks markets are facing. Among Asia markets, four trade above +1SD over their 10-year averages, while only two trade below their 10-year averages. (Fig. 2) We recommend investors to pay close attention to valuations, and look for drivers such as yield, earnings visibility, and specific domestic factors for good support in these markets and sectors. US presidential election US financial market volatility is expected to be quite high as the country prepares for its next presidential election. Various studies have concluded that financial market volatility is usually high in September – October, and even more so and in an election year. Monthly price declines and frequencies of negative returns were even greater during presidential election years without an incumbent candidate. However should an incumbent party win by a landslide victory, a year-end rally should follow. Consensus views that the incumbent party should win, but remains uncertain how close the race is going to be, which suggests that the current market has probably priced in what is expected, and a low chance of an opposition party win that could upset the market. In view of the high correlation of the global market with the US, it remains prudent to watch for the election results.
Fig. 1: MSCI Asia ex-Japan — 12-month forward PE Fig. 2: Asia regional markets: 12-month forward PE valuations
(x) 10-yr P/E (x) 12-m 17 Avg +1SD 2015 2016F 2017F fwd Hong Kong 16 HSI 11.8 14.3 12.4 12.7 11.6 11.8 MSCI China 11.4 14.5 13.2 13.1 11.4 11.8 15 MSCI HK 15.3 17.1 16.7 16.7 15.5 15.7 14 China 'A' 14.7 16.2 18.9 17.7 15.4 16.0 Singapore 13.5 14.7 12.0 12.8 12.3 12.4 13 Korea 9.9 13.2 11.7 10.9 10.0 10.2 Taiwan 14.1 16.6 13.9 14.6 13.1 13.5 12 India 15.5 16.7 22.3 19.6 16.5 17.9 11 Malaysia 14.6 16.2 16.5 17.0 15.9 16.1 Thailand 11.3 13.1 18.0 16.2 14.4 14.8 10 Indonesia 13.3 15.9 19.5 18.3 15.9 16.4 Philippines 15.9 17.3 21.7 20.1 18.5 18.8 9 Asia ex-Japan 12.2 13.7 14.2 13.9 12.5 12.9 Sep-06 May-08 Jan-10 Sep-11 May-13 Jan-15 Sep-16 Source: Datastream, IBES, DBS. Horizontal lines are aver- Source: Datastream, IBES, DBS. Numbers shaded in pink age and +/- one standard deviation bands trade below average, those in grey trade above +1SD.
45 Asian Equity Strategy Economics–Markets–Strategy
We believe investors are likely to remain on the sidelines running up to the elections, with muted market activities. The US market is unlikely to provide much upside for global markets prior to the elections. Hence for Asia, unless there are specific market news, we believe the current consolidation could last. “Tightening” tantrums Growing expectations of the Fed's rate hike in coming months should put a dampener on markets in the near term. We are assuming a base case of a Fed rate hike in December, and the USD and LIBOR should rise as expectations of a December rate hike gathers. The market estimates the probability of an increase in December this year at 57.8% While US non-farm payroll data is as volatile as ever, the latest ISM manufacturing survey data shows that the US economy has returned to contraction mode, and that the services data have declined. Inflation remains low, and that includes the PCE inflation data. Wage inflation, core inflation, and household income, however, have risen. There will be concerns over if Fed is making a policy mistake if it raises rates in such a scenario when growth is lacking. Confidence in growth, and the rise in longer term bond yields may not follow suit. There are a few implications for fund outflows in the region should there be a rate hike, especially the CNY. An increase in USD fed fund rates will drive an increase in short-term interest rates and bring on short covering of local currency liabilities (vs the USD). Short rates could also spike up, especially in Singapore and Hong Kong. USD versus many Asia countries will have upward pressure. With Japan and Europe still on negative interest rates, we believe that the search for yield is still on. Our fixed income strategist expects the long end of global bond yields to see little impact from Fed hikes as they continue to be pressured by deflationary concerns, and negative interest rates outside the US. 10-year US bond yield is thus expected to stay around current levels by year-end. We continue to like the Singapore REITs, following its own sector classification which helps with its identification as an important sector. However ECB’s inaction in its last policy meeting has capped further downside on global bond yields, in our view.
Fig. 3: Correlation with the US is rising Fig. 4: Asia markets — sensitivity to weakening domestic currencies ( correlation coefficient) r 0.53 0.6 most affected least affected 0.5 with China 0.4 0.48
0.3
0.2 0.43 with US 0.1
0.0 0.38 Oct-14 Mar-15 Aug-15 Jan-16 Jun-16 Nov-16
Source: Datastream, DBS. Calcualted based on two-year rolling data of daily returns. US lagged by one day Source: DBS
46 Economics–Markets–Strategy Asian Equity Strategy
We revisit our sensitivity analysis of Asian markets to the various factors that could potentially result from a potential US rate hike in the charts in Fig. 4-6. In general ASEAN markets are more sensitive to currency weakness resulting from rate hikes (USD strengthening), rising US fed hikes, and rising US bond yields. However we would like to emphasise that circumstances are different now. Asia markets would prefer a weak currency; their short rates are under no pressure to rise with the US except in Singapore and Hong Kong, and bond yields are likely to stay low on global deflationary threat. Unless these changes are abrupt, we believe that impact on Asian markets should be short-lived. Earnings outlook remains weak with hopes pinned on next year Asia markets continue to be affected by a weak global growth outlook. Earnings growth for the region remains weak with much hope pinned on a recovery from next year onwards. Earnings results for the first half of this year were generally in line with expectations which had already been lowered against an uncertain macro backdrop. Growth in top line was generally weak and focus was placed on those driven by government spending (Construction, Building Materials), and resilient sectors such as Healthcare, Telcos and Consumer Staples. Margin pressure remains in general with the lack of pricing power, while a lower oil price helps relieve some cost pressure. “New economy” sectors such as gaming and software IT and e-commerce are the only bright spots. Pockets of growth are found in mid- to small-cap stocks which are leaders in their respective space and are able to control costs appropriately. A realisation reached at the recent G20 meeting in China Hangzhou is the limitation of the effectiveness of the use of monetary policies in stimulating economies, and encouragement for countries with the capacity to use fiscal stimulus programmes to do so. Looking forward, as global uncertainties abate somewhat, investors will be able to focus more on the prospects of an economic recovery even as the global central banks turn off the tap. 2015 correction – US and China Asia markets have just recovered in August from their one-year negative performance after two extended corrections during the one-year period. Both were indeed due to increasing Fed rate hike expectations and the CNY devaluation. Concerns that
Fig. 5: Asia markets — sensitivity to Fed funds rate Fig. 6: Asia markets — sensitivity rising US bond hikes yields ( correlation coefficient) ( correlation coefficient) 0.2 0.45 0.1 0.40 least affected 0.0 0.35 most affected - 0.1 0.30 - 0.2 0.25 - 0.3 0.20 - 0.4 0.15 - 0.5 0.10 - 0.6 0.05 most affected - 0.7 least affected 0.00 - 0.8 - 0.05
Source: DBS Source: DBS
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history will repeat itself are spooking investors. Last year the CNY was devalued by 3% once in August from 6.21 to 6.41, and again depreciated from 6.32 to 6.6 from early November last year to the middle of January this year. The Fed finally hiked rates once in December after hawkish rhetoric set the tone as early as middle of 2015. In recent weeks, the CNY has been steadily climbing towards 6.7 from 6.5, translating to a depreciation of about 3% since May. Fed rate hike expectation has also been building up in recent weeks on Fed officials’ rhetoric, with rate hike expected to be as soon as 21 September. Last year’s US rate hike was the first in 10 years, and with the Fed officials then sounding hawkish in general, a “moderate” rate hike schedule was thought to be once every quarter with a target of 3% by 2018. During the year, perception and the Fed’s “dot” plots have been scaled down to two hikes for this year. Currently, the Fed funds futures is only pricing in a 27% chance of another rate hike throughout 2017. Hence, unlike last year, a December rate hike would not necessarily lead to the belief that there will be more increases in 2017, now that the terms “normalisation” and “moderation” are more understood. The CNY depreciation last year was mainly due to speculative positions on the offshore CNH which trades at a big discount to the CNY, a build-up of offshore short-term USD liability against the CNY, and a less transparent currency policy by the PBOC. During the year, the CNH-CNY premium has closed up, external debt has declined, and with the introduction of the RMB basket index and its trading band, currency policy has been clearer as well. The CNY is also on schedule to join the IMF’s Special Drawing Rights (SDR) basket effective 1 October, which should also increase the demand for CNY and hence limit outflows. PBOC is also more prepared to handle speculation and outflows on the CNY by being quick to inject liquidity and increase costs of borrowing. (see “CNH: ready to go”, below, Nathan Chow) As such, we tend to think that this time round, market reactions to financial markets should not be as volatile as last year.
Fig. 7: Asia markets — Consensus earnings growth Fig. 8: CNY spot vs RMB index — moving more in line forecasts with each other
Earnings growth (%) (index) RMB/USD 103 6.4 2015 2016F 2017F 2018F LT gro 102 Hong Kong 6.45 HSI -9.3 -2.6 9.7 10.7 8.7 101 MSCI China -3.4 0.6 14.3 13.7 13.3 100 6.5 MSCI HK -13.5 0.3 7.4 7.9 5.5 99 RMB/USD China 'A' -0.9 9.6 14.7 14.6 12.7 98 6.55 Singapore -4.4 -5.8 4.2 5.4 2.9 Korea 16.4 7.4 8.8 8.1 16.4 97 (index) 6.6 Taiwan -0.1 -5.0 11.4 9.1 6.6 96 India 3.5 12.7 18.3 14.1 17.1 95 6.65 Malaysia -1.4 -2.8 6.8 7.2 5.8 94 Thailand -1.4 11.1 12.4 11.3 19.1 93 6.7 Indonesia -8.2 6.7 15.3 11.8 13.1 Philippines 5.8 7.8 9.0 12.2 13.0 Jul-16
Asia ex-Japan 0.3 2.0 11.5 10.7 11.9 Jan-16 Jun-16 Feb-16 Sep-16 Dec-15 Apr-16 Mar-16 Aug-16 May-16
Source: Datastream, IBES, DBS Source: Datastream, Bloomberg, DBS
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Flow reversal Asia have been the prime beneficiary of the low interest rate environment and is back in vogue once again in a major way, as evidenced by the strong inflows in the past two months. Year-to-date, foreign flows to Asia (excluding Singapore and Hong Kong) added up to US$36.7bn, which is almost equivalent to the inflow in 2014. In July and August alone, total flows were US$21bn. From the perspective of a half-full glass, one could argue that focus on emerging markets has just returned again, and with a more dovish Fed, serious investors will make use of a correction to add to positions. However, in the event of a massive exodus, correction will be quick and sharp, while sentiments will again turn and find it difficult to return another round. The imminent Fed rate hikes could play a role in what happens next.
Strategy and asset allocation The strategy team’s base-case scenario of one rate hike in December and a moderate rate hike schedule for next year, which is in line with consensus, should see risk appetite for Asia markets returning after the September Fed meeting. Fed chatters and CNY risks are causing volatility which should present opportunity to accumulate quality stocks for longer-term investments and the prospects of economic recovery next year. Our high-conviction picks are in Indonesia, and Hong Kong (both Hong Kong and Chinese shares). In Indonesia, we believe the new finance minister and economic minister can work hand in hand with President Jokowi to achieve the latter’s reform ambitions. China’s continuous capital market reform should attract flows to the Hong Kong market which has been undervalued for some time. We are Underweight in Philippines for valuation reasons, and the reactions to the spate of negative news recently reflect the markets’ vulnerability. We continue to see Korea and Taiwan trading in a tight range in this environment. We stay Underweight in Korea as we are concerned on the downsides risks from the failure of Hanjin Shipping group on the broader economy and other sectors. Taiwan could start to see growth disappointments in the second half. We are downgrading Thailand to Neutral on a tactical view after a very strong performance and significant inflows.
Fig. 9: Net foreign flows to Asia equity markets
Hong Total ex-SG, US$mil Indonesia Thailand Philippines Malaysia India Korea Taiwan S'pore ** Kong ** HK 2005 (1,737) 2,947 354 10,901 (3,549) 23,990 1,202 2,633 32,906 2006 1,996 2,135 720 8,338 (12,659) 16,962 2,146 4,582 17,492 2007 3,141 1,853 1,354 18,518 (29,095) 477 3,477 6,892 (3,752) 2008 1,801 (4,942) (1,135) (12,918) (36,742) (16,364) (3,295) (7,578) (70,300) 2009 1,384 1,137 420 17,639 24,446 15,617 997 3,166 60,643 2010 2,345 2,684 1,232 5,300 29,321 19,657 6,577 693 3,501 67,116 2011 2,853 (167) 1,329 686 (396) (8,584) (9,076) (2,133) (2,375) (13,355) 2012 1,703 2,504 2,548 4,538 24,548 15,069 4,907 (224) 1,308 55,817 2013 (1,804) (6,211) 678 1,229 19,986 4,855 9,178 1,026 763 27,911 2014 3,766 (974) 1,287 (1,936) 16,162 5,967 13,551 708 1,391 37,823 2015 (1,580) (4,372) (1,194) (4,990) 3,274 (3,626) 3,322 785 (472) (9,166) 2016TD 2,999 3,202 1,125 707 5,752 8,942 14,015 (6) (2,255) 36,742 Q116 316 543 76 1,412 1,213 758 4,982 138 (1,230) 9,300 Q216 669 494 564 128 1,742 2,591 1,264 35 (32) 7,452 Jul-16 905 1,268 418 249 1,658 4,677 5,384 41 14 14,559 Aug-16 1,109 897 66 422 1,139 916 2,386 NA NA 6,935 Sep-TD (181) 364 (267) (40) 200 909 (722) NA NA 263
Source: Bloomberg, EPFR, FirstMetro Securities, Bursa, DBS. ** Numbers from EPFR fund survey
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Fig. 10: Summary of market recommendations
Targeted Current Year end 12M Upside Downside Market return to index view target yearend risks to market return risks to market return
Bottoming outlook on earnings Singapore 2809 2950 5.0% N and economic growth; effective Growth continues to disappoint market and fiscal stimulus Recovery in oil prices, early snap Withdrawal of local funds Malaysia 1661 1700 2.3% UW elections chatter, aggressive support, political upheaval interest rate cuts Government spending gathers pace, further stimulus, growth Thailand 1458 1480 1.5% N Domestic sentiments deteriorate surprise in 3Q, better managed political risks US rate hike delayed, rate cuts, tax amnesty repatriation gains US bond yield spike up, bond Indonesia 5146 5500 6.9% OW traction, growth surprise, fiscal market foreign fund exodus stimulus Philippines 7546 7300 -3.3% UW Extended elections honeymoon Toppish valuations Domestic investors having short Regulatory tightening; China ‘A’ memory; MSCI inclusion; 3239 3600 11.2% N withdrawal of government CSI300 continuous tighening in property market support measures market Growth surprise, MSCI 'A' share Rapid CNY depreciation; 'A' share H-shares 9543 10600 11.1% OW inclusion, SZ-HK Connect, interest tumbles; Trump election win in BRIC returns
Growth surprise, MSCI 'A' share China angst persists, Trump MSCI China 63 69 10.0% OW inclusion, improving global risk election win appetite, interest in BRIC returns
China policies to support growth, resilient housing market, More aggressive US rate hikes; MSCI Hong 14227 15540 9.2% OW southbound flows to benefit HKD de-peg talks return; Trump Kong Hong Kong blue chips, Fed hikes wins in US elections benefiting Hk Banks
Growth surprise, MSCI 'A' share Speculative shorts return, Trump HSI 23191 24900 7.4% OW inclusion, improving global risk election wins appetite for China stocks,
Domestic demand wanes; lack of Saumsung's S7 surprise, China's stimulus support; exports Korea 1999 2050 2.5% UW growth surprise slowdown aggravates; overhang from Hanjin Shipping bankruptsy Stronger global recovery, Global growth slowdown persists; effective new government Taiwan 8902 8800 -1.1% UW China policies turn antagonistic; policies, yield surprise, stable disappointing iphone 7 sales NTD, new gadget Risk appetite for EM returning, Reform hiccups, earnings growth India 28372 30000 5.7% N reform gathering pace downgrades, BRICS theme return
Asia ex- Risk appetite for EM returning; Global growth concerns persist; 663 689 3.9% N Japan dovish Fed, stable oil price China angst persist Source: DBS
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China / Hong Kong (Overweight H-shares, MSCI China, MSCI Hong Kong, HSI; Neutral ‘A’ shares) We had raised China/Hong Kong to Overweight in the last quarter and indeed HSI and H-shares were the among best performing markets in 3Q. Going forward, we believe that the outperformance can continue, due to positive sentiments from better-than-expected earnings announcements and potential opening of the SZ-HK connect, and as the CNY joins the SDR basket effective 1 October. Earnings have also been supportive of the rally. Although there are concerns that the market is still very policy driven, we believe regulatory policies should be moderate to ensure a low-volatility environment. Note that the performance in the A-share market has been more muted compared to the boom bust in 2015, and de-regulations have been met with more sobered reactions by the market. We should see more market-friendly measures to manoeuvre a positive trading environment in China. With the H-shares trading at cheap valuations, there is still plenty of room for re-rating, in our view. There are many possibilities for more upside surprise in the market. The inclusion of ‘A’ shares in MSCI international benchmark is a matter of time, and that could happen before the next MSCI annual review next June. CNY inclusion in the SDR basket will take effect on 1 October, thus moving towards a more market oriented mechanism in time to come. So far the CNY depreciation has been orderly and in line with the RMB basket index. The fear of a sharp CNY devaluation, such as last year’s should fade. Growth in China has been more stable in the second half and sentiments should improve if the trend continues. The risk appetite for emerging markets could return after the current volatility episode. In particular the BRICs investment theme could return after Russia and Brazil show signs of economic recovery. China will benefit from this broader investment theme. We like the H-shares due to their cheaper valuations, MSCI China as a proxy for the overall Chinese economy with the inclusion of the “new economy” stocks, HSI and MSCI Hong Kong as a prime beneficiary of sound-bound flows. We rate the ‘A’ shares as Neutral. Investment options by Chinese investors have yet to include the ‘A’ shares due to its high volatility, in our view. We believe government controls are still present to prevent a boom-bust cycle like last year’s. Singapore (Neutral) Singapore market has been the worst performing market in Asia this year. The market has been plagued by poor economic growth, weak oil & gas industry imposing on employment and the services sector, cautious financial sector, and weak property market. Consensus earnings growth for MSCI Singapore stands at -5.9% this year, after falling 4.4% last year, and only 4.3% for next year. Earnings recession is likely to be prolonged with GDP growth for next year at 1.9%, only a tad higher than this year’s 1.5%. There are two ways that Singapore tries to differentiate itself: 1) growth through regional exposure especially in the high-growth areas such as in ASEAN, China and India; and 2) serving as a yields haven in this yield grab environment. These two themes have been working well this year as the regional currencies and economies have been more stable this year. We believe investors can outperform the market with portfolio populated with stocks based on these two themes. DBS economist Irvin Seah continues to warn that risks lie ahead for the Singapore economy as the services sector, which constitutes about two-thirds of the Singapore economy, is already in “technical“ recession, after having already contracted two quarters in a row. Hence, unless the manufacturing sector surprises in a big way, we are unlikely to see the economy recovering this year.
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Moving on, the strategy team believes big infrastructure projects like the Singapore – KL high speed rail (HSR) may be needed to give a structural lift to growth prospects in the longer term. On this end, there are tentative signs that the project is likely to be a reality after more than 20 years of delay, when the Land Transport Authority of Singapore (LTA) called for tender to be closed in October for a Joint Development Partner for the project. The Singapore government has already started planning works in the Jurong West area, which is designated for the terminus station for the HSR. Other ongoing infrastructure projects include the SmartNation, and the extension of Mass Railway Transport (MRT) lines. Progress on a fourth Telco player and Public Transportation reform have already been made. The government has also announced it will be reviewing the “CPFIS”, an investment option in the Central Provident Fund scheme. This could hopefully unleash more liquidity into the Singapore stock market. Near term, DBS Singapore strategist Janice Chua is cautious on the Singapore market and believes that the Singapore Straits Index (STI) could test the post-Brexit low of 2714 in the next 1-2 months. Two binary events that could induce a major correction includes a possible rate hike in the September Fed meeting (September 22 Asia time), and an informal oil producers meeting at end of September to discuss production freeze, should the outcomes turn against expectations. (See “Shadow of September - October Volatility”, Janice Chua et. al., 29 August). From a regional perspective, Singapore corporates have the worst earnings profile. We like the market for its high yields, and its undemanding valuations which leave room for re-rating should global risk appetite return, and should there more be evidence that the economy has passed its worst. Indonesia (Overweight) The Indonesia market soared in July-August as risk appetite for emerging markets improve amidst low global bond yields and a dovish Fed stance. The domestic investment climate is also clearing on the back of a stable and strong rupiah, Jokowi’s economic stimulus package (especially the tax amnesty bill, and interest rate cuts), and lately a better-than-expected 2Q16 GDP growth which hinted at growth bottoming. We have upgraded Indonesia to Overweight with a 12-month target of 5900. The investment climate could continue to improve as policies are being rolled out. Bank Indonesia (BI) expects the new tax amnesty plan to draw in some IDR560tn of inflows between July 2016 and March 2017. The Jokowi government is also mulling corporate tax cuts, while there is still room for BI to cut rates further. There is still room for market valuations to trade higher given the positive investment climate. The Indonesia market had re-rated in the early 2000s, driven by improving risk appetite in emerging markets and as the country entered a higher-growth era. Subsequently, the re-rating has paused in the last five years post the GFC amid the commodity cycle bust. With Jokowi’s reform agenda, we believe the re-rating could continue and the market could potentially trade up to 17x PE, translating to 5900 by year-end based on 10% earnings growth (the blended average earnings growth in 2016 and 2017). Our base case is for earnings to grow at 7% and 14% in 2016 and 2017 respectively. With the strong liquidity expected, the Indonesia market could sustain its surge. We outline below the blue sky scenario that could keep the party going: 1) Bottoming economic outlook if economic stimuli work themselves into the economy; 2) Private sector growth boosting earnings outlook;
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3) Further rate cuts if inflation stays below 4%; 4) Low global bond yields induced by global central banks supporting the domestic bond market and attracting flows; 5) Rupiah stable at current levels. Market volatility and stretched valuations are our two major concerns. Worries remain from global political and economic uncertainty which could easily reverse risk appetite. The bigger macro picture of potential US interest rate normalisation (and hence stronger dollar and higher bond yields), slowing China demand (hence lower commodity prices), and above-average valuations are biased against Indonesia in the longer run. Hence, until earnings return in a big way, Indonesia will still be subject to the tides of emerging market risks. Near-term risks on a September Fed hike, the first for this year should present a good opportunity to accumulate Indonesia on weakness, in our view. (See “ Indonesia Overweight, Index target 5900”, 25 August, Joanne Goh et. al.). Malaysia (Underweight) In view of the rise in risk appetite for emerging markets, we have removed one of our defensive trades by downgrading Malaysia to Underweight. Recent headwinds from 1MDB, lower oil price and weak earnings should keep the market in check. Still maintaining our year-end target at 1700, there is very little room for us to raise the index target further given: 1. PE valuations are already above +1SD high at 16.1x. Valuations have risen as the earnings downgrade trend continues despite a flattish market; 2. Consensus earnings growth for this and next year stays at -2.8% and 6.8% respectively. We are skeptical on the earnings recovery into next year. Coming from a low base, while we do not think that an 6.8% growth is unlikely, but further upgrades to earnings can be quite limited, in view of the weak economic momentum. 3. 2Q GDP growth has weakened to 4.0% from 4.2% in 1Q. In acknowledging the economic weakness, the central bank, Bank Negara (BN) has reduced the policy rate for the first time after holding on to the rate since 2014. Inflation came in at 1.1% in July, down sharply from 1.6% in June, affirming the demand weakness despite ongoing cost rationalisation in many of the subsidised sectors. DBS economist is forecasting that BN may cut rate again in November in view of the downside risk to growth. 4. Our base-case assumptions include: 1) stable oil price at current levels; 2) MYR relative to SGD at around 3; and 3) absence of a sovereign crisis, fallout in bond yields. These are the factors supporting the Malaysia market in recent months. The risks to our negative view on Malaysia is if there will be a snap election in early 2017. Street expectation has been rising on a snap general election in early 2017 although the incumbent federal government’s current mandate does not end until early 2018. This has led to a rally in politically-linked counters recently. Expectation for government to pump-prime before the elections could also lead to better domestic sentiments. A people- and market-friendly Budget 2017 is expected in October.
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Thailand (Downgrade to Neutral) After a very strong YTD and quarterly performance, valuations in Thailand have shot up to above +2SD over its historical average. We believe Thailand could be vulnerable to profit taking ahead of the Fed rate hikes, US elections, and informal meeting among the major oil producers on production cuts. Indeed the market has corrected sharply in the first two weeks of September, reflecting its vulnerability to change in sentiments. We are downgrading the market to Neutral as near term headwinds could stop the strong foreign inflows. Headwinds in the near term During the quarter, the SET index did indeed try to test our 12-month target of 1570 but was found to be unsustainable. We highlight a few issues that Thailand has to deal with in the near term:- 1. The heavyweight Energy sector which has been resilient despite lower oil prices is not in line with past correlation; 2. The construction of the MRT line will be delayed by about two years, which give rise to doubts about the accelerated bidding process in the last few months if the projects can smoothly follow through, and the high expectations of the bidding schedule for 2H16. Cost overruns are one of the main concerns for the Contractors 3. Recent bombing incidents across Thailand post the referendum on the constitution change suggests that political stability still fall short of expectations Consumption remains the main drag The 2Q GDP is better than expected and there are signs that private consumption is picking up. However, our economist is doubtful that given the recent inflation data which has been coming in persistently below target, it seems rather unlikely that private consumption can continue to grow in excess of 3.5% YoY, like it did in 2Q16. Downside risks are present in his full-year GDP forecast. Domestic consumer and property stocks are indeed laggards in the markets but domestic consumption is unlikely to pick up in a big way unless political stability can be truly found. Together with the delay in some of the construction projects, loan growth could again fall behind expectations. We believe that without the push from these laggard stocks, the index could remain stuck, with downside bias as global macro uncertainty again rises in anticipation of rate hikes and a US election awaiting. Investors should avoid the domestic sentiment related stocks. In light of the recent security issues we are also avoiding the Tourism-related stocks. Inflows have hit a record high Foreign fund flows into Thailand has hit a record high compared to the past 10 years since 2005. Although it can be viewed positively in the context of negative flows in the last three years, the huge flows in the past two months should take a breather for the time being. Month-to-date flows to Thailand has slowed down to US$92m compared to US$2,255 for July-August. Foreign investors have just started returning to Thailand in a big way. We are concerned that a change of sentiments could dampen foreign investment inflows once again, and may take longer to return the second time around. Neutral for strong yields and earnings growth We like the market for its high yields, strong earnings growth, key sector niches, and a vibrant domestic investment environment. After all, Thailand is not the most expensive market among ASEAN on a absolute basis. Its earnings growth profile is also one of the better ones, with growth engine from a very diversified sectors. Our marketing feedback suggests that investors were generally underweight in Thailand
54 Economics–Markets–Strategy Asian Equity Strategy and the short term rally in the past two months have caught most by surprise. We will be prepared to upgrade the market as soon as the headwinds blow over, and if growth momentum shows no sign of fading. Philippines (Underweight) We are maintaining the Philippines market at Underweight. The Philippines market has enjoyed a post-election rally amid optimism on the new president. The two concerns we have on the Philippines are its rich valuations and unexciting corporate earnings growth. Despite strong economic growth, corporate earnings growth continued to hover at the 5-10% range while the PE continue to re-rate on economic optimism. Near term, we believe that the re-rating should take a pause as investors take profit ahead of the Fed meeting, and as well as with the increasing negative International media reports on the new president on his handling of sensitive issues such as the South China Sea disputes, and his controversial human rights record. These concerns should limit how far valuations can go, and if foreign investors will look for better opportunities elsewhere such as Indonesia. Undoubtedly Philippines has stood out in Asia as one of the fastest growing economy with a strong fiscal position. To be sure, DBS economist noted that the impact from the May elections turned out to be way more significant than what we had thought initially. 2Q16 GDP growth came in robust at 7.0% (YoY), well above our expectations. The economy has grown 6.9% in 1H16 alone, driven by a strong expansion across all the domestic components of the GDP. Private consumption grew a record-high 7.3% (YoY), government consumption expanded 13.5% while investment growth came in at 27.2%, bringing domestic demand growth in excess of 10% in 1H16. The sense of optimism has continued to linger in the private sector and investing domestically is still the priority for now. Besides, the new government is ready to step up its spending on infrastructure projects. The strategy team however believes that all these optimism has already been priced into the market, if one looks at the rich valuations in the equity, bond and exchange rates. We will review the market, should there be more evidence that the 3Q GDP can continue to excel after the elections, and should valuations fall to more reasonable levels. Taiwan (Underweight) DBS economist is maintaining her GDP growth forecasts below the government’s, at 0.9% for 2016 and 1.8% for 2017. For the full-year GDP growth to match the government’s forecast, it requires the QoQ (saar) growth to reach 3% per quarter in 2H16, a notable rise compared to 1.8% in 1H16. In our view, although there are some signals that the short-term growth cycle is bottoming out, a sustainable recovery is yet to be confirmed. Even in the electronics sector where peak season demand is widely expected, the signs of recovery are not very apparent. July’s trade and production data had came in below expectations. Export orders shrank -3.4% YoY, worse than the -2.4% in June, albeit still better than the 2Q average of -6.4%. Likewise, industrial production slipped 0.3% in July, also down from the 1.1% growth in the prior month. It was the first contraction for industrial output after posting two consecutive months of positive growth in May-June. The market had performed better than expected in 3Q, thanks to the improvement in global risk appetite, GDP growth turning positive in 2Q, a bottoming signal in the Taiwan economy, and a crowded ex-dividends calendar. Moving forward, a weaker- than-expected recovery could dampen risk sentiment in the financial markets. Note that foreign equity inflows have started to retreat since last week after a strong rise in the first half of August and in July. Meanwhile, the USD/TWD has reverted to the range of 31.5-32.0 since 19 August, after dipping below 31.5 temporarily earlier this month. Current market valuation is hovering around the average 14x, leaving very limited room for re-rating. Consensus earnings growth for this year and next are -4.9% and
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11.1% respectively, and are unlikely to provide much upside market surprise, given the weak economic growth. We are maintaining our Underweight stance on the market. (see “Taiwan: counting on electronics”, below, Tieying Ma) Korea (Underweight) We are maintaining Korea as Underweight. Undoubtedly, on the data front, the economy is showing some signs of a modest recovery. However there are still headwinds facing the 2H outlook, given the government’s push for corporate restructuring in certain industries, implementation of an anti-corruption law in September and the persistence of external uncertainties. The progress of corporate restructuring is picking up, which should have negative spillover effects on the broad economy. For instance, Hanjin Shipping, the nation’s largest shipping company, has applied for court receivership this week after failing to reschedule debt with its major lenders. Consensus is expecting 7.3% and 8.4% earnings growth in 2016 and 2017 respectively. There should however be downside risks given that 1) interest rate cuts are negative for the Banks; 2) the Korean won, which is expected to weaken, has been strengthening instead and that should be negative for exporters; 3) corporate restructuring and reform which could hurt domestic sentiments; and 4) rising tension with China (Korea’s largest trading partner) has affected exports to China amid a general slowdown in the latter’s growth. Standard & Poor’s (S&P) has recently raised Korea’s long-term sovereign credit rating to AA from AA-, citing the country’s steady economic performance, sound fiscal position, and flexible fiscal and monetary policies as the key reasons for the upgrade. Despite the upgrade, we do not see Korea assets been particularly attractive in this yield grab environment given that 10Y KTB yield is below the US’s and BoK is likely to cut rates next as opposed to US Fed hiking rates. We continue to expect the KOSPI to trade within the 1950-2050 range and the valuation discount to the region to persist. Geopolitical risks, corporate governance, cross-holding accounting are some of the reasons for the valuation discount. For the KOSPI to stay sustainably above 2000 we need to see better confidence in China’s economic growth. (see “Korea: relying on stimulus”, below, Tieying Ma) India (Neutral) The biggest reform story in India was the GST bill reform, which has been approved and targeted for implementation starting April 1, 2017. While there will be growth, inflation and fiscal implications, and some likely delays in its implementation, the passing is a big step in registering that reforms in India has not stalled and positive sentiments in the market are likely to be sustainable. We are maintaining our view on the India market at Neutral, rather than upgrading to Overweight. While the top-down story in India is strong, it is not supported by valuations, earnings or index composition. India’s PE valuation is at 18x which is +1SD above its 10-year average. We believe there is very little room for re-rating. Headlines on major reforms, such as the GST bill, improving foreign investments and fuel subsidy reform, have already been issued and right now they are mostly on the implementation stage. While GDP growth has been strong, corporate earnings growth have been lagging and companies are not benefitting from these reforms as yet. Consensus earnings growth for 2016 and 2017 are 12.9% and 18.2% respectively. There should be more evidence that earnings growth can substantially improve. We believe that credit expansion holds the key for private sector growth.
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The India market has also been riding on the rate cut cycle in the past one year. DBS economist forecasts one more rate cut for the rest of the year and may not come by if inflation starts to pick up. However, rate cut has not materially led to lower lending rates in India due to higher provisioning requirements by the Banks. Composition of India’s stock market lacks the new “new”. While the top-down story in India is strong, growth dynamics for the key sectors are not strong. For instance, Financials, IT and Healthcare, and Staples sectors are already 52% of the MSCI India Index and have their own set of issues to deal with. Financials are affected by slow credit growth and NPL provisioning, and both Technology and Healthcare sectors are affected by weak pricing power due to weak global growth, and the latter on global regulatory concerns. We like India on a top-down view, where we see reforms coming through and sound monetary and fiscal policies compared to previous years. Valuations can be supported at current levels as long as the global risk appetite for emerging markets stay. Foreign buying has been a key support for the market but domestic participation has slowed. Near-term risks on Fed rate hikes cannot be ignored considering the sizeable foreign flows in the past two months.
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CN: false alarms continue
• Growth remains sluggish • Exchange rate to weaken gradually • Mild retreat in property prices • Debt/equity swap program faces resistance
Headline indicators suggest that fundamentals have improved on the margin. PPI contracted 0.8% YoY in Aug16, its smallest decline since Apr 12. On the trade front, in RMB terms, export growth accelerated to 5.9% YoY in Aug16 from 2.9% in Jul16 while import growth reversed to +10.8% from -5.7%. The official PMI, which tracks primarily large state-owned enterprises (SOEs), improved to 50.4 in Aug16 from 49.9 in Jul16. These improvements are encouraging and probably reflected (1) the positive spillover effects from reducing overcapacity on producer prices; (2) fiscal stimulus lifting manufacturing activities; and (3) a boost to export competitiveness via a weaker exchange rate. It will be difficult to sustain these improvements due to a number of structural constraints. First, cutting overcapacity is difficult for local governments because the SOEs concerned employ many people. It is also tremendously difficult to redeploy retrenched workers during such difficult times. As a result, China has achieved only 47% of its target cuts on crude steel capacity that amounted to 5 million tons in the first seven months of 2016. If the government speeds things up, the PPI will turn positive sooner, but this will risk increasing unemployment as well as lead to other adverse effects on the broader economy. The strategy to call on SOEs to ramp up spending is a double-edged sword. Mak- ing up some of the slack on headline GDP number with more spending risks ag- gravating their already high debt-to-GDP ratios and burdening banks with more
Chart 1: RMB exchange rates 104 6.30 103 6.35 102 CFETS RMB Index 101 6.40 100 6.45 99 6.50 98 97 6.55
96 6.60 CNYUSD (rhs) 95 6.65 94 93 6.70 Sep-15 Nov-15 Jan-16 Mar-16 May-16 Jul-16 Sep-16 CHINA
Chris Leung • (852) 3668 5694 • [email protected]
58 Economics–Markets–Strategy China non-performing loans. The retreat in aggregate demand in the past few years has not been entirely unhealthy because it mitigate project redundancies. The worry is the persistent slump in private investment which accounts for 60% total investment, which in turn, accounts for the lion’s share of GDP. In spite of state-driven fiscal expansion, fixed asset investment slowed further to 8.1% YOY YTD in Aug16, down from 10.2% in 1Q16. Hence, there is a natural clamour for more stimulus. But the ongoing intensity of the anti-corruption pro- gram also hampers the progress of fiscal projects relative to the past. Furthermore, state-driven investment projects often lack long term planning in order to synergize with existing infrastructure to generate sustainable growth. (Industrial SOEs gen- erated merely a return on assets of 2.9% in 15 compared with 10.3% for private A weaker ex- industrial enterprises.) When funding for such project dries up, everything grinds change rate is the into a halt. way to go The easiest solution is to jumpstart the export engine to generate income via a weaker exchange rate. This is because the underlying infrastructure and economies of scale are already in place. Moreover, some studies concluded that the substitu- tion of domestic for imported materials by exporters substantially increases domes- tic content in exports to 70% during the period 2000-2007 (compared with around 50% in the mid 90s), particularly in relatively more labor intensive industries. It is reasonable to allow the exchange rate to better reflect weakening economic fun- damentals so long as it synergizes with institutional reforms. The sharp fall in the pound sterling after Brexit did not wreck the global financial system. In another ex- ample, Vietnam - which is now dubbed the next Asian tiger - achieved initial success of economic reform by allowing the currency to depreciate alongside institutional reforms focusing on generating income since 2009/2010. Market reaction to a weakening RMB has been much calmer after the volatility at the beginning of the year. Should the Fed eventually hike rates, it is not unwise to let the currency weaken more (Chart 1). Something has to give in sometimes down the pipeline should the authority is determined to bring the country to the next stage of development. Certainly, the authority has all the muscle to keep the “sta- tus quo” for an extended period of time. But that makes sense only with the right set of policies are target specifically to generate some income as soon as possible.
Mild correction of property prices ahead The property market has, over the past 18 months, cushioned the domestic economy from an overall shrinkage in investment. Residential sales increased by 37% MoM and 15% YoY respectively in Jun16. Property sales in 1H16 were higher by 44% YoY. Monthly average gross floor area (GFA) sold in 1H16 rose 29%, while newly started GFA jumped 14%. Unsold inventory of completed residential flats in the key 11 cit- ies fell further to 6.5 months in Jul16 from 6.7 months in Jun16. This allowed major listed developers to lock in, on average, 60% of their full-year sales targets in 1H16, more than the 45% and 39% seen in 1H15 and 1H14 respectively. Sales growth is Demand and sup- likely to slow down in 4Q16 due to rising risks of policy tightening. Developers who ply imbalances have already locked in a high proportion of sales are likely to delay new project remain launches and save bullets for land investment. Property prices have been going up too fast (Chart 2). The People’s Bank of China (PBOC) recently warned that more measures may be needed to prevent excessive capital flows into the real estate market from fuelling a housing bubble. The central bank will probably not cut interest rates or lower the reserve requirement ratio. The National Development Reform and Commission’s (NDRC) stance is to lower inven- tory in order to keep average selling prices (ASPs) in Tier 1 & 2 cities under control. This implies tightening risks, particularly for Tier 1 & 2 cities, if ASPs continue to increase for the rest of the year.
59 China Economics–Markets–Strategy
Chart 2: Property prices RMB/sqm 70,000 Beijing 60,000 Shanghai 50,000 Shenzhen 40,000 Nanjing 30,000 Wuhan 20,000 Suzhou 10,000 Xiamen
0 Hefei Jul/2013 Jul/2014 Jul/2015 Jul/2016 Jan/2013 Jan/2014 Jan/2015 Jan/2016 Oct/2013 Oct/2014 Oct/2015 Apr/2013 Apr/2014 Apr/2015 Apr/2016
Absent price adjustments, demand and supply imbalances remain huge. In 2015, 61% of new residential building starts were concentrated in third and fourth-tier cities, while only 5% were in first-tier hubs. This sector has simply become another “too big to fail” story. Authorities are unlikely to pursue policies that risk a sharp fall of property prices. Speculators understand this. The strategy of “managed as- cendance of property prices” via administrative measures will continue.
Daunting challenges facing the Debt-Equity swap program Conventional fiscal and monetary policies are only meant for smoothing out volatil- ity in an economic cycle. Sustainable growth cannot be achieved if structural prob- lems are not rectified. High debt levels undermine the effectiveness of macroeco- nomic policies. At last count, corporate debt stood around 160% of GDP and is still rising quickly. According to the IMF’s latest Global Financial Stability Report, around 15.5% of total loans to corporate are potentially at risk. The total is around $1.3trn, compares with about $1.7trn in bank tier-one capital. Banks vocal in The situation has prompted the Chinese government to execute a debt-to-equity opposing large swap program to remove non-performing loans (NPLs) from banks’ balance sheets. haircuts According to China’s local press, Sino-steel Corporation and Bohai Steel Group had reached debt-for-equity swap agreements with creditors. However, the criteria for eligibility for the debt-equity programs are not clear. The authority has only high- lighted that it is applicable to enterprises facing short term financial difficulties. The absence of a clear definition is bound to create “moral hazard”. Local govern- ments may use this platform to keep problematic debt-ridden enterprises afloat. To compare, the last major debt cleanup was in 1999. Four asset management com- panies were set up to acquire CNY 1.4trn of NPLs from state banks at face value. Creditors’ interests were protected as the government directed around 30% of the bad loans to be swapped into equity. This time round, the asset management com- panies were not involved because the gigantic debt loads. Instead, creditors, enter- prises and the local government are forced to enter into very complicated negotia- tions. With banks vociferously opposing large haircuts, such processes will be slow and painful for all parties.
Too many false alarms China will not collapse in spite of its many challenging structural problems. For ev- ery pessimist on China, there is also an optimist. Entrepreneurs starting businesses in Chongqing (real GDP advancing 10.6% in 1H16) see only sunshine compared to the darkness engulfing blue-collar workers in the Northeastern provinces. By the
60 Economics–Markets–Strategy China same token, homeowners who reaped so much from high property prices in Shen- zhen and Shanghai would not feel the ordeal of the manufacturing sector in the Pearl River Delta. Such polarizing economic trends will likely continue for a long while. In turn, it is difficult to zero in on the “crisis” points of the economy in spite of all the known risks such as rising domestic debts, the property market bubble, dwindling export competitiveness, ongoing malaise of overcapacity, and heighten- ing income inequity. Policymakers understand all the problems at hand. There have been successful eco- nomic experimentations in the right direction. For example, interest rate/exchange rate reforms and gradual capital account liberalization have internationalized the RMB. Reforming enterprises in China is fundamentally different from western economic theories that emphasized free market competition and hard budget constraints. Advancing SOE reforms have not been easy due to the reluctance of allowing bank- ruptcies. Instead, SOEs have been pushed towards mega mergers to achieve econo- mies of scale. More private sector participation to foster competition is also unlikely. Create behemoths is aimed more at lessening unemployment rather than reaping productivity gains. Elsewhere, experimentations with mixed ownership enterprise reform have not yielded any substantial results yet. China has ammunition to maintain the “status quo” for a long time given the strong government. China bears have been accused of ringing false alarms too often. On the other hand, China bulls may get a few calls right because of market momentum. The truth is that China is at the very beginning of a major transition characterized by contradictory developments on many fronts.
61 China Economics–Markets–Strategy
China Economic Indicators
2015 2016f 2017f 2Q16 3Q16f 4Q16f 1Q17f 2Q17f 3Q17f
Real GDP growth 6.9 6.5 6.5 6.7 6.5 6.4 6.4 6.4 6.5 GDP by expenditure: current price Private consumption 9.2 8.8 9.6 9.0 8.5 8.5 8.5 9.5 9.5 Government consumption 10.5 10.0 10.0 10.0 10.0 10.0 10.0 10.0 10.0 Urban FAI growth (ytd) 10.0 9.0 7.5 9.0 8.0 8.0 7.5 7.5 7.5 Retail sales - consumer goods 10.7 10.0 11.0 10.2 10.0 9.5 10.0 11.0 11.0
External Exports (USD bn) 2,273 2,140 2,169 527 564 594 453 540 576 - % YoY -3 -6 1 -5 -5 -3 0 2 2 Imports (USD bn) 1,680 1,563 1,569 390 409 426 330 390 414 - % YoY -14 -7 0 -7 -5 -3 -2 0 1
Trade balance (USD bn) 593 577 600 137 155 168 123 150 162 Current account balance (USD bn) 331 300 250 n.a. n.a. n.a. n.a. n.a. n.a. % of GDP 3.1 2.7 2.2 n.a. n.a. n.a. n.a. n.a. n.a.
Foreign reserves (USD bn, eop) 3,330 3,000 3,000 n.a. n.a. n.a. n.a. n.a. n.a. FDI inflow (USD bn) 126 127 127 34 26 31 35 35 35
Inflation & money CPI inflation 1.4 2.0 1.8 2.1 1.8 1.8 1.8 1.8 1.8 RPI inflation 0.1 0.5 0.4 0.4 0.4 0.4 0.4 0.4 0.4
M1 growth 15.2 23.0 10.0 24.6 25.0 23.0 15.0 10.0 10.0 M2 growth 13.3 12.0 12.0 11.8 10.0 10.0 11.0 11.0 12.0
Other Nominal GDP (USD bn) 10,770 10,914 11,580 n.a. n.a. n.a. n.a. n.a. n.a. Fiscal balance (% of GDP) -3.4 -3.0 -3.0 n.a. n.a. n.a. n.a. n.a. n.a.
* % change, year-on-year, unless otherwise specified
CN - nominal exchange rate CN – policy rate CNY per USD %, 1-year lending rate 8.0 7.5 7.8 7.0 7.6
7.4 6.5 7.2 6.0 7.0 6.8 5.5 6.6 5.0 6.4 4.5 6.2
6.0 4.0 Jan-07 Jun-09 Nov-11 Apr-1 4 Sep-16 Jan-07 Dec -0 8 Nov-10 Oct-12 Sep-14 Aug-16
62 Economics–Markets–Strategy China
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63 Hong Kong Economics–Markets–Strategy
HK: disheartening abnormalities
• Key economic pillars are flagging • Competitiveness is weakening • Against the odds, property prices remain firm
Hong Kong’s GDP growth rebounded by 1.6% (QoQ, sa) in 2Q16 from a decline of 0.5% in 1Q due primarily to an improvement in goods exports. Property prices have started going up again in recent months (Chart 1). The unemployment rate is hovering at record lows, averaging only 3.4% for the three months ending Jul16. Hong Kong’s current economic situation is abnormal. These numbers do not con- form to the city’s weak outlook. Tourism/retail, logistics/trade, financial services and property related businesses are all being hit by the cyclical downturn with no medium-term recovery in sight.
Logistics and trade The upgrading and expansion of China’s port facilities have already fundamentally eroded Hong Kong’s prime role as a “transshipment hub” - where a container is first discharged in Hong Kong before goods are loaded onto another ship. Trans- shipment cargo accounted for 72% of total traffic compared to less than 25% in early 2000’s. In 2015, Shanghai was the world’s top port, followed by Singapore, Shenzhen, and Ningbo. The last time that Hong Kong topped the list was in 2004. This is a structural issue because the dwindling competitiveness in terms of cost and physical space began more than a decade ago, before the onset of recent economic malaise. The logistics and trade sector, which represents 23.4% of Hong Kong’s GDP, is aggra- vated further by the downturn in international trade. Overall container through- put in Hong Kong Port fell by 11% (YoY) in July, which is the twenty-fifth straight
Chart 1: Residential property prices (Rating and Valuation Dept) 1999=100
400 Class A (smallest size) 350 Class B 300 Class C Class D 250 Class E (largest size) 200
150
100 Latest: Apr 16 50
0 Jul-98 Jul-00 Jul-02 Jul-04 Jul-06 Jul-08 Jul-10 Jul-12 Jul-14 Jul-16 HONG KONG
Chris Leung • (852) 3668 5694 • [email protected]
64 Economics–Markets–Strategy Hong Kong month of on-year decline. Consolidated figures for the first seven months of the year fell 10.7% to 10.79mn teu (twenty-foot equivalent units). Rising competitive pressure from nearby ports in China suggests more pressure ahead. Even when global trade subsequently recovers, it is not easy for Hong Kong to regain business volume achieved during the heydays.
Retail and tourism The outlook for the retail sector remains bleak. Retail sales fell 8.5% (YoY) in July, following a 9.6% decline Jun (Chart 2). Everything ranging from consumer durable goods, watches/jewelry, goods sold in department stores to food/alcohol/tobacco registered persistent drops. The exceptions are clothing/footwear and fuel. The persistent slump is attributed to the sharp fall in the number of mainland tourists and a drop in their purchasing power. Of course, the most fundamental reason is the continual deceleration of the mainland economy alongside the ongoing anti- corruption program. But structural factors are also at play - the restrictions of visi- tors with multiple-entry visa and once-a-week-entry (probably enacted in response to social resentment in Hong Kong against mainland parallel traders) directly led to a 10.6% decrease in mainland tourists, after a 3% fall in 2015. Notably, these visa issuances have dropped by 36.7%.
Chart 2: Retail sales % YoY, 3mma Survival of busi- 30 Retail sales value Retail sales volume nesses depends 25 heavily on factor 20 cost adjustments and change of busi- 15 ness strategies 10 5 0 -5 -10 -15 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 Jul-16
Although mainland tourist arrivals increased by 2.2%YoY in Jul, the first increase in 13 months, their spending continued to plummet. Average spending per Chinese tourist is around HK$7,100, down 20% from HK$9,000 two years ago. The rebound in July was probably attributed to a number of temporary factors such as: (1) the strengthening of the Japanese yen, (2) the increasing frequency of terrorism activi- ties in Europe, and (3) the deteriorating relationship between Taiwan and China thereby diverting some mainland tourists to HK. Looking ahead, the cyclical downturn is likely to deepen further. The survival of businesses depends heavily on factor cost adjustments and changes of business strategies. According to the Savills retail rental index, rents of prime street shops in tourist hotspots fell by 5% in 1Q16 after sinking by 30% in 2015. That in turn has driven food &beverage, sportswear, and some medium-priced fashion brands tak- ing up the rental space previously occupied by jewelry/high-end watch shops. The emerging pattern echoes the closures of up to 7-8 jewelry shops by Hong Kong’s biggest jewelry chain. This is a natural business response to changing economic realities. Many people perceive such change as likely to be permanent. As far as wages and salaries are concerned, widespread pay cuts are yet to be re- ported. Official statistics show that median wages decreased slightly to HK$15,055
65 Hong Kong Economics–Markets–Strategy
(US$1,942) in 1Q16 from an all-time high of HK$15,126 in 4Q15. Significant down- ward adjustment of wages/salaries is unlikely due to: (1) the aging population, (2) scarcity of specialized labor in many industries, and (3) difficulty of talent reten- tion. The viability of the retail sector thus is unlikely to be sustained by labor cost adjustment. While downward pressure on rents is inevitable in the near term, retail companies’ survival must hinge on adapting their businesses.
Banking and finance The banking/finance sector is also facing immense challenges as the mainland economy continues to flag. Exposure of the local banking sector to the mainland increased by 29% in 2015, accounting for 20% of total banking assets. Ongoing de- terioration of China’s economy has resulted in rising credit costs and default risks. Banks in Hong Kong thus will have to reduce exposure to China substantially. As a result, loan growth has been anemic at 2.2% in Aug YTD in 2016, compared with annual growth of 3.5% in 2015 and 12.7% in 2014. Shrinking balance sheets will likely go on for a while longer due to: (1) rising regu- latory costs, (2) intensifying competition from FINTECH, and (3) rising uncertainty Ongoing deterio- over the progress and results of economic reform in China. Banks in Hong Kong ration of China’s will remain highly cautious in extending loans to the mainland even assuming eco- economy has nomic growth will likely stabilize somewhat for the remainder of the year. There resulted in rising is not much banks can do under the prevailing economic landscape given a poor credit costs and prospect of revenue growth and rising loan impairments. default risks Despite all these, the property market stands firm Property prices and the state of the real economy seem to be out of sync. Integra- tion with China in the past two decades has make Hong Kong economically heavily dependent on China. But what went off axis is the resilience of the local property market in spite of many administrative measures, Occupy Central 2014, sudden de- valuation of the RMB in 2015 and Brexit in 2016. All these negative economic and political factors merely caused a temporary dip in prices. In fact, prices started surg- ing again lately, particularly after Brexit. This suggests that only US interest rate hikes would do the trick. Given the abun- dance of liquidity in the monetary system, Hong Kong rates need not follow US, assuming if the Fed only hikes once or twice by 25bps each. However, the probabil- ity of a rapid US rate hike scenario is extremely low. This situation reinforces the established investment psychology to concentrate their savings in physical proper- ties. The fact that Hong Kong went through almost a decade of de-leveraging after the Asian financial crisis has buttressed households’ buying appetite in properties post 2008/09.
Chart 3: Unemployment rate vs. property prices %, 3mma, sa 1999=100 10.0 350 Unemployment rate (LHS) Property price index (RHS) 300 8.0 250
6.0 200
150 4.0 100
2.0 50 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 ------Jul Jul Jul Jul Jul Jul Jul Jul Jul Jul Jul Jul Jul Jul Jul Jul Jul Jul Jul Jul Jul
66 Economics–Markets–Strategy Hong Kong
For as long as the property market is resilient, conditions in the labor market shall remain fairly stable (the sharp rise of unemployment in HK only happened after the property market crashed in 97/98, Chart 3). This in turn has created an atypi- cal phenomenon of ongoing job security despite a bleak economic outlook. Such contradictory development breeds social resentment.
Conclusion Absent exchange rate flexibility and monetary policy independence, a small and open city economy like Hong Kong is always reactive to exogenous shocks. Nor- mally, the subsequent adjustment will have to be borne by deflating domestic prices. Indeed, Hong Kong had once experienced almost seven long years of defla- Absent exchange tion from 1997-2003, with consumer prices and asset prices falling simultaneously. rate flexibility and But similar adjustments are absent this round after 2007/08 due to the Fed’s QE monetary policy in- program and China’s gigantic fiscal stimuli in-between. Until now, the decline of dependence, Hong property prices is very mild compared to two decades ago. Given the moderate US Kong will always interest rate outlook, property prices will likely remain elevated. reactive to exog- enous shocks There is not so much Hong Kong can do to weather the current economic malaises. All key economic pillars are facing a prolonged cyclical downturn imported from China and the rest of the world. Rather than waiting for an upturn, it is wise to speed up the constructions of long overdue mega transportation projects now. The goal is to facilitate better and more efficient economic integration with China in the future. This should eventually pay off handsomely once China recovers.
67 Hong Kong Economics–Markets–Strategy
Hong Kong Economic Indicators
2015 2016f 2017f 2Q16 3Q16f 4Q16f 1Q17f 2Q17f 3Q17f Real output and demand GDP growth (14P) 2.4 1.0 2.0 1.7 1.1 1.5 1.8 2.1 2.1 Private consumption 4.7 1.1 2.9 0.6 1.4 1.5 1.5 3.0 3.0 Government consumption 3.4 3.1 3.2 3.4 3.0 3.0 3.2 3.2 3.2 Investment (GDFCF) -2.0 -4.9 4.9 -4.9 1.0 -4.0 4.8 4.4 4.4 Exports of goods and services -1.5 -3.8 -2.8 0.6 -2.6 -4.3 -5.0 -2.5 -2.2 Imports of goods and services -1.9 -4.1 -2.1 0.3 -2.1 -5.1 -4.9 -1.6 -1.5 Net exports (HKD bn) 21 32 31 -24 29 23 3 -33 20
External (nominal) Merch exports (USD bn) 465 442 434 113 114 117 97 108 115 - % YoY -2 -5 -2 -1 -6 -3 -3 -2 -1 Merch imports (USD bn) 523 503 499 126 129 133 111 127 130 - % YoY -4 -3 -1 -3 -3 -1 -1 -1 0 Trade balance^ (USD bn) -57 -61 -65 -13 -15 -16 -14 -19 -15
Current acct balance (USD bn) 11.0 -0.9 -10.6 ------% of GDP 3.6 -0.3 -3.3 ------
Foreign reserves (USD bn, eop) 359 354 349 ------
Inflation CPI inflation 3.0 2.6 1.5 2.7 3.5 1.2 1.5 1.5 1.5
Other Nominal GDP (USD bn) 310 318 326 ------Unemployment rate (%, sa, eop) 3.3 3.5 3.8 3.4 3.5 3.5 3.6 3.6 3.6
* % change, year-on-year, unless otherwise specified ^ Balance on goods
HK - nominal exchange rate HK – policy rate HKD per USD %, base rate 7.84 7.0
6.0 7.82 5.0
7.80 4.0
3.0 7.78
2.0 7.76 1.0
7.74 0.0 Jan-07 Jun-09 Nov-11 Apr-1 4 Sep-16 Jan-07 Dec -0 8 Nov-10 Oct-12 Sep-14 Aug-16
68 Economics–Markets–Strategy Hong Kong
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69 Taiwan Economics–Markets–Strategy
TW: counting on electronics
• Recession is over. But the recovery is weak and uneven • Electronics exports remain key for the short-term growth outlook; domes- tic demand is unlikely to lead the recovery • The central bank is likely to keep monetary policy loose for as long as needed, amid the concerns about “L-shaped” growth • GDP forecasts are unchanged at 0.9% for 2016 and 1.8% for 2017. The benchmark discount rate is projected to fall to 1.25% in end-Sep16 and remain flat thereafter
The good news is recession is over. After three quarters of contraction, growth finally returned to the positive territory in 2Q16, registering a rise of 0.7% YoY (Chart 1). Yet there are few reasons to be optimistic. The recovery is uneven. Exports were the only area of improvement. Domestic demand remains weak. Companies are reluctant to expand capex amid a high degree of business uncertainty, while consumers have tightened their purse strings as the labor market continued to deteriorate. Gross fixed capital formation contracted by 0.1% (YoY) in 2Q16. Private consumption grew just 1.2%, a notable slowdown compared to the 2.5% in 1Q16. Moreover, the momentum of recovery remains very weak. On the QoQ (saar) basis, GDP growth rose only 1.8% on average in the past two quarters in 1H16. Looking at a longer period, the average growth over the past five years was not very different, at 2.5%. Going forward, if GDP growth continues to run at the current pace (on the QoQ basis), annual growth will reach about 1% in 2016 and 2% in 2017. This will be well below the 4% growth rate witnessed in the 2000s (also Chart 1).
Chart 1: GDP growth: actual and forecast % YoY 15
10
5
0
-5
-10 1Q01 1Q04 1Q07 1Q10 1Q13 1Q16 TAIWAN
Ma Tieying • (65) 6878 2408 • [email protected]
70 Economics–Markets–Strategy Taiwan
Electronics exports are crucial Electronics exports remain a crucial factor dictating the short-term growth outlook. Taiwan’s electronics exports normally enter an upcyle in the second half of the year, thanks to the release of new mobile products by global leading companies. Typically, there is also an increase in consumers’ electronics demand during the year-end festive season. This year, new products including iPhone 7, smart watches and VR/AR equipment may help to lift the demand for Taiwan-made semiconductors and other electronics components in 2H16. Nonetheless, the strength and the duration of this cycle remain questionable. From the macro perspective, global demand remains on a soft patch amid sluggish growth in the developed markets while the Chinese economy is undergoing structural transition. As of Aug16, Taiwan’s export orders and exports have only showed some signs of a bottoming out, but not a strong rebound (Chart 2). Don’t expect domestic demand to lead the recovery. The boost from monetary easing on credit growth and asset prices is likely to be limited. Liquidity has been abundant in the financial system for a long time and interest rates have been very low even prior to the recent round of easing. Taiwan’s central bank (CBC) has cut the benchmark discount rate by a total of 50bps since Sep15, which led to 20-30bps decline in the short-term money market rates. Bank loans growth picked up only slightly to 3.4% (YoY) in Jun16 from 2.9% in Sep15. Residential property prices have Fiscal policy will stopped falling, but showing no clear signs of a rebound (Chart 3). be neutral in 2017 Don’t expect fiscal policy to drive growth as well. The new government under President Tsai Ing-wen maintains a prudent fiscal policy stance, balancing the goals of supporting growth and that of improving public finances. In the FY2017 budget unveiled in Aug16, the government planned to increase public expenditures by just 1.1% next year, and keep the fiscal deficit to GDP ratio roughly unchanged at 0.9%. The impact of fiscal policy on GDP growth will be neutral. In addition, it is worth noting that the tourism sector is losing steam. The number of total visitor arrivals grew 2.2% in 2Q16, a sharp slowdown versus 15.9% in 1Q16. This was mainly due to the fall in Chinese tourists amid the deterioration in cross-strait relations (Chart 4). As a response, the Taiwanese government has adopted measures to attract visitors from other countries in the region, for instance, waiving visa for tourists from Thailand and Brunei. But this may not be enough to pick up the slack, given that Chinese visitors account for a dominant share of 40% in tourist arrivals.
Monetary policy will remain loose The CBC expressed concern about “L-shaped” growth at the last policy meeting in Jun16. Amid such concerns, the CBC is likely to keep monetary policy loose for
Chart 2: Export orders & exports Chart 3: Property price indices % YoY Mar00=100 280 30 Export orders Sinyi 25 260 Exports Cathay 20 240 15 220
10 200 5 180 0 160 -5 140 -10 -15 120 -20 100 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Mar-08 Mar-10 Mar-12 Mar-14 Mar-16
71 Taiwan Economics–Markets–Strategy
Chart 4: Number of visitor arrivals Chart 5: Inflation vs. interest rates % YoY % YoY, % pa 80 Total China 4.0 Headline CPI 70 Core CPI Policy discount rate 60 3.0 50 40 2.0 30 20 1.0 10 0 0.0 -10 -20 -1.0 Jan-11 Jan-13 Jan-15 Jan-10 Jan-12 Jan-14 Jan-16
as long as needed. At the upcoming Sep16 meeting, expect the CBC to cut the discount rate by 12.5bps, bringing it to the historical low of 1.25% seen during the 2008-09 global financial crisis.
Short-term rates We expect rates to remain flat at 1.25% in 4Q16 and thereafter. This is based on the could revisit the assumption that GDP growth will improve modestly and gradually and the output 2008-09 lows gap will narrow. If growth figures were to remain sluggish, additional rate cuts towards 1.00% are possible. Given current inflation, there is arguably some room for the central bank to ease further. Headline and core CPI were 0.6% (YoY) and 0.8% respectively in Aug16, both below the 1-year deposit rate of 1.04% (Chart 5). Assuming inflation stays at the current levels, real deposit rates are set to remain positive until the benchmark discount rate is cut below 1.00%. On the FX front, we see modest upside pressure on the USD/TWD, due to lower TWD rates and a stronger dollar in the global environment. Against the other emerging Asian currencies, however, the TWD is expected to remain relatively stable, thanks to Taiwan’s strong external position and low vulnerability to Fed rate hikes.
Government policies focus on the long-term To take the economy back onto a sustainable growth path, what’s needed the most is to implement reforms to upgrade industries, restore trade competitiveness and address other structural issues like population aging. Long-term economic restructuring is a primary focus of President Tsai’s government. So far, policies have been moving in the right direction, albeit slowly. On a positive note, public spending under the FY2017 budget is well allocated. The budget includes a notable 7.1% increase in central government expenditures on education, science and culture, which is consistent with the long-term goals of promoting industrial innovation and fostering human capital development. Meanwhile, the National Development Council (NDC) has established a new TWD 100bn public fund, to inject capital into companies seeking to invest in innovative industries. The NDC is also mulling plans to set up a national trade and investment company, which will help Taiwanese companies to expand business in the emerging markets in South/Southeast Asia. More initiatives surrounding the Five Innovative Industries Plan and the New Southbound Policy could be expected next year, such as deregulating rules to encourage business start-ups in the new industries and providing more information/ financial support for companies investing in South/Southeast Asia.
72 Economics–Markets–Strategy Taiwan
Taiwan Economic Indicators
2015 2016f 2017f 2Q16 3Q16f 4Q16f 1Q17f 2Q17f 3Q17f Real output and demand GDP growth 0.7 0.9 1.8 0.7 1.5 1.8 1.4 1.9 1.9 Private consumption 2.3 1.8 2.0 1.2 2.2 1.4 1.6 2.1 2.2 Government consumption -0.3 2.4 1.0 2.0 1.2 1.3 0.4 1.2 1.2 Gross fixed capital formation 1.2 -0.3 1.0 -0.1 -1.2 0.4 2.0 1.1 0.5
Net exports (TWDbn, 11P) 1208 1169 1194 243 297 407 207 255 310 Exports (% YoY) -0.2 0.1 2.0 0.6 1.9 1.5 2.5 1.8 1.8 Imports (% YoY) 0.9 0.4 1.9 0.2 1.9 1.1 3.3 1.5 1.5
External (nominal) Merch exports (USDbn) 285 275 287 69 72 72 67 72 73 - % chg -10.9 -3.9 4.3 -6.2 0.4 3.4 6.1 5.1 2.1 Merch imports (USDbn) 237 229 242 57 61 61 57 61 62 - % chg -15.8 -3.3 5.7 -7.6 2.9 5.7 13.7 6.6 1.5
Trade balance (USD bn) 48 46 44 12 12 10 11 9 12 Current account balance (USD bn) 74 72 70 ------% of GDP 14.1 13.8 13.4 ------
Foreign reserves (USD bn, eop) 426 438 447 ------
Inflation CPI inflation -0.3 1.2 0.9 1.3 0.9 0.8 1.0 0.7 0.9
Other Nominal GDP (USDbn) 526 528 554 ------Unemployment rate (eop %, sa) 3.9 4.1 4.0 4.0 4.1 4.1 4.0 4.0 4.0 Fiscal balance (% of GDP) -0.7 -0.9 -0.8 ------
* % growth, year-on-year, unless otherwise specified
TW - nominal exchange rate TW – policy rate TWD per USD %, rediscount rate 36.00 4.0
35.00 3.5 34.00 3.0 33.00
32.00 2.5
31.00 2.0 30.00 1.5 29.00
28.00 1.0 Jan-07 Jun-09 Nov-11 Apr-1 4 Sep-16 Jan-07 Dec -0 8 Nov-10 Oct-12 Sep-14 Aug-16
73 Korea Economics–Markets–Strategy KR: relying on stimulus
• The economy remains on a bumpy road to recovery • Fiscal support is important. Thanks to a supplementary budget, stimulus will be extended into early-2017 • Monetary easing has limited effects. Corporate restructuring is ongoing and credit risk is perceived to be high. Banks have been expanding house- hold loans, but the rapid rise is unsustainable • Authorities will rely on fiscal/monetary policy to support demand in the near-term. Tackling structural issues via reform won’t be easy, given the standoff between key political parties
The economy remains on a bumpy road to recovery. Recent experience shows that growth could slow when the effects of fiscal/monetary stimulus dissipate. But it also regains momentum when new measures are introduced. This year, for instance, GDP growth dropped to 2.1% (QoQ saar) in 1Q16 as a temporary sales tax cut on automobiles expired and private consumption contracted. After the tax cut was restored, GDP growth rebounded to 3.2% in 2Q16 (Chart 1). The stimulus-driven nature of growth is not sustainable. But the authorities will continue to rely on fiscal/monetary policy in the near term. Tackling the structural issues via reform will not be easy, given the political standoff between the ruling and opposition parties in parliament and the upcoming 2017 presidential election.
Fiscal stimulus remains important The finance ministry announced a stimulus package totaling KRW 20trn in Jun16, which included a supplementary budget worth KRW 11trn. The supplementary budget was approved by the parliament at the beginning of Sep16 after a weeks- long delay caused by political deadlocks.
Chart 1: GDP vs. consumption growth % QoQ saar 6 Private consumption GDP growth
4
2
0
-2 KOREA 1Q11 1Q12 1Q13 1Q14 1Q15 1Q16
Ma Tieying • (65) 6878 2408 • [email protected]
74 Economics–Markets–Strategy Korea
The passage of the supplementary budget is important. The main budget for FY2016 has been front loaded to first half of the year. The sales tax cut on automobiles, albeit extended, expired again in Jun16. Retail sales have fallen back as a result (Chart 2). The supplementary budget will offer new tax incentives/rebates for consumer purchases of eco-friendly cars and appliances. This is expected to lend renewed support to consumption growth in the coming months. The supplementary budget will also be used to provide unemployment benefits for the industries hurt by corporate restructuring. Progress of corporate debt restructuring is picking up. For instance, Hanjin Shipping, the nation’s largest shipping company, has applied for court receivership in Aug16 after failing to reschedule debt with the major lenders. The fallout on unemployment, particularly, needs to be contained in order to mitigate pain on the broad economy. The govern- ment has drafted The government plans to withdraw fiscal stimulus in the medium-term. During the supplementary FY2017 main budget proposed in Aug16, total government spending will be lifted budget in 3 of the by 3.7% to KRW 400.7trn next year. Compared to the final budget in FY2016, which past 4 years includes the supplementary budget, expenditure will increase by only 0.8% next year, and fiscal deficit will be lowered to 1.7% of GDP from 2.4%. That said, it is possible that the government adds to spending through another extra budget next year. It has actually drafted supplementary budget in 3 out of the past 4 years in 2013-16. Political motivation will remain strong next year as the country’s next presidential election is scheduled for the end of 2017.
Monetary easing has limited effects On the monetary policy front, the latest move from the Bank of Korea (BOK) was a 25bps cut in Jun16, which pushed down the benchmark repo rate to a new record low of 1.25%. Meanwhile, the BOK and the government announced in Jun16 to jointly establish a KRW 11trn bank recapitalization fund. This will be used to purchase the hybrid bonds issued by the state-run policy banks, which are exposed to the bad debt risks as a result of corporate restructuring. The benefits of monetary easing are likely to be limited. Lower interest rates may not help much to boost new loans growth in the corporate sector, given that the restructuring program is ongoing and credit risk is perceived to be high during this process. Lower rates will only alleviate the financial burden for the indebted companies and therefore, reduce the risk of aggressive deleveraging. Likewise, the establishment of the bank recapitalization fund will only mitigate the risk of a credit crunch triggered by stress in the banking sector. A gradual and moderate slowdown in corporate loans would remain inevitable in the coming quarters. Thus far, banks’
Chart 2: Retail sales Chart 3: Banks' non-performing loans ratio 2010=100, sa 2010=100, sa % 125 Total 200 2.0 NPL SBL Automobiles (RHS) 180 120 1.5 160 115 140 1.0 110 120 0.5 105 100
100 80 0.0 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Mar-12 Mar-13 Mar-14 Mar-15 Mar-16
75 Korea Economics–Markets–Strategy
corporate loan growth has decelerated to 5.1% (YoY) in Jul16, down from 6.9% in Jan16. The ratio of nonperforming loans and that of substandard and below loans have gone up, but are still at manageable levels of 1-2% (Chart 3). Monetary easing might instead have undesirable side-effects on household loans and the property market. Household debt levels are already high in Korea. A recovery in the property market, if driven by higher household leverage, is unsustainable. Following the BOK’s rate cut in Jun16, housing prices have showed a moderate rebound in the Seoul area. This was accompanied by the double-digit growth in banks’ household loans (Chart 4). Should the situation persist, it won’t be surprising to see the central bank and the financial regulator re-introduce macroprudential measures to contain associated risks.
Rates on hold for now The BOK will likely hold rates steady in the coming months after the latest round of easing in 2Q16. The central bank currently projects GDP growth to rise 2.7% in 2016. This forecast appears attainable as it requires just about 2% (QoQ saar) Expect policy growth per quarter in 3Q16 and 4Q16. As such, there is no urgency to further cut rate to remain at rates to boost GDP growth in the near term. 1.25% in the rest of this year There is also no pressure for the BOK to cut rates to combat deflation. It is true that CPI growth has fallen to merely 0.4% (YoY) in Aug16 (Chart 5). But this was mainly caused by a temporary discount program offered by the government on electricity bills. It is also true that inflation has stayed persistently below the official target of 2% so far this year. But the BOK has highlighted during a statement in Jul16 that the 2% inflation target is set for the medium-term instead of the short-term. Policymakers don’t need to respond whenever CPI figures undershoot the target. Admittedly, the room for monetary easing remains. Based on the assumption that CPI inflation will return to 0.8% in 4Q16 after the temporary dip in Aug16, there is space for the BOK to cut the benchmark rate by another 25bps to 1.00% before the year-end – if additional support to GDP growth is required. USD/KRW is expected to be largely dictated by the dollar’s movement and Fed rate hike expectations in the near term. Fundamentals of the won remain solid, given Korea’s steady current account surplus, strong foreign reserves and falling exposure to external debt. The nation received an upgrade in its sovereign credit rating to AA from AA- by S&P in Aug16, and by Moody’s in Dec15. This should help to improve the prospect for the KRW bonds to become a safe-haven asset, attract long-term foreign capital inflows, and hence, reduce volatility in the won exchange rates.
Chart 5: Policy rate vs. CPI inflation Chart 4: Bank loans growth % pa, % YoY % YoY 4.0 7-day repo rate 15 Headline CPI Core CPI
12 3.0
9 2.0
6
1.0 3 Household loans Corporate loans 0 0.0 Jan-15 Jul-15 Jan-16 Jul-16 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16
76 Economics–Markets–Strategy Korea
Korea Economic Indicators
2015 2016f 2017f 2Q16f 3Q16f 4Q16f 1Q17f 2Q17f 3Q17f Real output and demand GDP (2010P) 2.6 2.8 2.7 3.3 2.6 2.6 2.8 2.6 2.6 Private consumption 2.2 2.4 2.3 3.3 2.5 1.7 2.5 2.1 2.3 Government consumption 3.4 3.5 3.3 3.6 3.2 2.9 2.6 3.4 3.4 Gross fixed capital formation 3.8 4.4 3.4 5.3 3.7 5.4 5.4 2.9 2.8
Net exports (KRW trn) 81 81 87 24 21 26 10 25 23 Exports 0.8 1.8 3.3 1.9 2.9 1.6 3.6 3.2 3.2 Imports 3.2 2.0 2.8 3.3 2.7 0.1 3.9 2.6 2.4
External (nominal) Merch exports (USD bn) 527 492 522 126 122 128 121 134 130 - % YoY -8.0 -6.6 6.2 -6.7 -4.9 -1.3 4.8 6.7 6.9 Merch imports (USD bn) 436 399 433 99 102 105 105 109 108 - % YoY -16.9 -8.5 8.4 -10.5 -5.5 -1.6 12.2 9.8 5.8
Trade balance (USD bn) 90 93 89 27 20 24 16 26 22 Current account balance (USD bn) 106 102 94 ------% of GDP 7.7 7.5 6.7 ------
Foreign reserves (USD bn, eop) 368 378 385 ------
Inflation CPI inflation 0.7 0.8 1.4 0.9 0.7 0.7 1.3 1.3 1.5
Other Nominal GDP (USD bn) 1,379 1421 1546 ------Unemployment rate (eop %, sa) 3.5 3.6 3.5 3.6 3.7 3.6 3.8 3.6 3.6 Fiscal balance (% of GDP) -2.4 -2.5 -1.8 ------
* % change, year-on-year, unless otherwise specified
KR - nominal exchange rate KR – policy rate KWR per USD %, target rate 1590 5.5
5.0 1490 4.5 1390 4.0
1290 3.5
1190 3.0
2.5 1090 2.0 990 1.5
890 1.0 Jan-07 Jun-09 Nov-11 Apr-1 4 Sep-16 Jan-07 Dec -0 8 Nov-10 Oct-12 Sep-14 Aug-16
77 India Economics–Markets–Strategy IN: encouraging signs
• Consumption and public spending will support recovery in FY16/17, as the private sector deleverages • CPI inflation remains subdued on cyclical factors, providing room for mon- etary easing • Stealth easing through liquidity support is likely to continue • External vulnerabilities remain under check. Current account dynamics are positive
India continues to clock the fastest regional growth with a pace of 7% for five consecutive quarters. Growth eased to 7.1% in 2Q16 (first quarter of FY16/17) from 7.9% in 1Q. On a gross valued added (GVA) basis, growth slowed to 7.3% YoY from 7.4% the quarter before. Most sectors barring government spending lost momentum. Under GVA, services remained on the driver’s seat while weak agriculture and mining activity hurt headline growth. Notably, real GDP is below GVA growth for a first since late-2014, much due to higher subsidy payouts. Looking ahead, growth is likely to accelerate but the sectoral composition will stay uneven. Consumption and public capex spending are likely to play a more dominant role in lifting growth while private investment lags (Chart 1). Private consumption is expected to improve driven by two catalysts – good monsoon and public sector wage hikes. Financing costs have also softened on improved liquidity provision. High frequency fiscal numbers point to frontloaded capex spending, along with off-budget financing. Improving net trade should also be a
Chart 1: Real GDP growth - drivers % YoY 12 GDP Fixed capital formation Private consumption
9
6
3
0
-3 Jun-13 Dec-13 Jun-14 Dec-14 Jun-15 Dec-15 INDIA
Radhika Rao • (65) 6878 5282 • [email protected]
78 Economics–Markets–Strategy India boost to growth. Pulling these together, GDP growth is likely to average 7.8% YoY in FY16/17. For GVA, our annual estimate stands at 7.6%, from 7.2% year before. On the supply-end, agricultural output is expected to improve on the back of a normal monsoon. Higher public sector participation and firmer domestic demand should lift services output, while manufacturing GDP finds strength in better- faring listed companies, in addition to a moderate 2.5-3.0% estimate for industrial production. Nominal GDP growth is off last year’s trough of 8.7% and expected to stabilise at 10-11% as GDP deflators harden, mirroring a sharp upswing in WPI/ CPI inflation prints. CPI inflation is Inflation path to remain in focus likely to slip below As growth stabilizes, focus is on the inflationary path. From a subdued 4.9% YoY in 5% between Sep- FY15/16 CPI inflation firmed up to 5.7% YoY between Apr-Jul16 on higher food costs Dec16 and upturn in service sector inflation. This upswing lost steam as inflation eased to 5.1% YoY in August on passage of seasonal factors and better supplies. Headline inflation is likely to slip below 5.0% until December, before firming up on base effects and stronger demand dynamics. Higher public sector wages and a pick-up in rural demand on the back of a good summer crop are likely to lift demand, but will be more apparent next year. That said, this is unlikely to develop into a wage-price spiral given existing slack, global disinflationary impulses and limited wage-related pressures. Core inflation (ex-food and fuel) is likely to settle in 4.5-5.0% for the second consecutive year. We look for FY16/17 CPI inflation to average 5.2% (previous 5.4%) and quicken to 5.4% (previous 5.6%) next year (Chart 2). This implies near-target inflation this year but above-goal next year (assuming 4% target). While cyclical tailwinds have helped contain inflation, more structural support by way of soft and physical infrastructure are needed to break the sharp swings due to monsoon vagaries and intermittent supply shocks. WPI Inflation is meanwhile in a midst of an upturn on fading base effects from low commodity prices and improving pricing power. With CPI inflation off the boil but WPI turning up, the two gauges are converging, providing an ideal backdrop for an inflation-focused central bank (Chart 3).
Prioritizing liquidity infusion, RBI to stay accommodative With one eye on inflation, the RBI is focused on policy transmission through the liquidity route. Since initiating a key change in its liquidity framework in April, borrowing costs are down even as policy rates remain unchanged.
Chart 2: CPI inflation vs targets Chart 3: WPI vs CPI inflation % YoY %, YoY 13 15 Headline CPI 11 Core CPI 11
9 DBSf 7
7 3
CPI target range 2-6% 5 -1
3 -5
1 Oct-10 Oct-11 Oct-12 Oct-13 Oct-14 Oct-15 Oct-16 12 13 14 15 16 17 Apr-10 Apr-11 Apr-12 Apr-13 Apr-14 Apr-15 Apr-16 CPI infln WPI infln
79 India Economics–Markets–Strategy
Chart 4: Liquidity injection: absorption (-)/ injection (+) INR bn, 7 day mvg avg 550 400 250 injection 100 50 200 absorption 350 500 Jul-16 Jan-16 Jun-16 Feb-16 Apr-16 Mar-16 Aug-16 May-16
Source: RBI, DBS Group Research Liquidity injectn Mthly avg
While the fall in banks’ lending rates has been gradual, rates on short-term commercial papers and corporate bonds are down sharply. Bond yields have also tumbled, amidst softer global yields. Cumulative INR 1trn worth buybacks have been conducted since April 2016. Ten-year yields eased to a seven-year low this month, helped also by soft global rates. In the past, an inflation-wary RBI usually stepped up liquidity support during instances of a shortage. This time around bond buybacks have continued even when conditions are ample/ in surplus. This, we reckon, is to frontload support to ease any potential squeeze due to the FCNR maturities during Sep-Nov16. In addition, the present surplus liquidity is also likely being interpreted as seasonal and thus in need for more durable support. This was reflected in RBI’s remarks that by August, it had met only 40% of the liquidity needs. Thus more bond buybacks/ OMOs are likely forth coming, with consensus pointing to a cumulative INR 1.8- 2.0trn. Meanwhile, excess liquidity is being mopped up through reverse repos in recent months, in contrast to net injections previously (Chart 4). Looking ahead, we expect the central bank to approach further rate cuts with caution, instead tap stealth easing through liquidity boost and effective policy transmission. Absence of generalised inflationary pressures has also provided a conducive Stealth easing environment for this liquidity-focused policy support. Hence this approach might through liquidity continue till firmer demand dynamics, renewed uptick in inflationary expectations bound to continue and run-up in WPI inflation feed into broader price pressures, likely in FY17/18. Together with the 4% inflation target (+/-2% range), Governor Patel is expected to monitor the inflation path closely, much like his predecessor ex-Governor Rajan. The soft August inflation print and likelihood of sub-5% prints in Sep-Dec16, will keep the window open for a 25bps rate cut in 4Q16. External vulnerabilities under check Improvement in the economy’s growth, inflation profile, stable rupee and manageable twin deficits has lowered the economy’s vulnerability to external shocks (Chart 5, 6). The current account deficit narrowed to -1.1% of GDP in FY15/16, a third consecutive year of below 2% gap. Our estimates point to 0.9-1.0% of GDP this year, down from our previous estimate of 1.3%. This is on the back of a sharply narrower goods trade deficit. Even as
80 Economics–Markets–Strategy India
Chart 5: Twin deficits on the mend Chart 6: Gross financing requirements ease % of GDP $ bn $bn, CAD=4Q mvg sum 380 240 -0.5 FX reserves (lhs) 330 200 C/A deficit -2.5 280 S-T ext debt 160 -4.5 230 120 180 -6.5 80 130 -8.5 40 80
-10.5 30 0 06 07 08 09 10 11 12 13 14 15 16 17 Fiscal bal Current acct bal -20 -40 Sum of the two 01 03 05 07 09 11 13 15
exports decline, imports are down by a faster pace reflecting weak demand for gold and investment-related purchases. Fiscal consolidation meanwhile remains on track, even if the qualitative aspects are questionable given the smaller allocation to capital spending (on-the-books). Elsewhere, foreign reserves rose to a record high in August but are set to moderate in the September-November period as FCNR-related swaps mature. Given ample liquidity support by the central bank, record high reserves and smaller current account deficits, we do not expect the upcoming FCNR maturities to be disruptive. Total external debt continues to run in excess of the reserves build-up, but a smaller share of short-term debt and moderating external commercial borrowings will limit the fallout of an increase in US interest rates.
Risks Overall, the narrative on the economy remains positive spurred by positive growth prospects, moderating inflation, on-course reforms and improving macro-stability. Five states go to the polls in 2017. While the government hopes to expand its foothold in these states, we do not expect them to take their eyes off the reform agenda. Higher oil prices, US rate normalization and unfavourable external events are key risks to this view.
81 India Economics–Markets–Strategy
India Economic Indicators
15/16f 16/17f 17/18f 1Q17 2Q17f 3Q17f 4Q17f 1Q18f 2Q18f Real output (11/12P) GDP growth** 7.6 7.8 7.9 7.1 7.5 8.2 8.2 7.5 8.2 Agriculture 1.5 3.8 4.0 1.8 3.5 4.5 5.0 3.5 4.5 Industry (incl constrn) 7.4 6.8 7.0 6.0 6.8 6.1 6.7 6.4 6.5 Services 8.9 9.2 9.7 9.6 9.2 9.4 9.3 9.4 9.7 Construction 3.9 3.5 4.0 1.5 3.0 3.0 4.0 4.5 4.0
External (nominal) Merch exports (USD bn) 262 260 284 65 65 65 68 70 72 - % YoY -16.0 -0.5 7.5 -2.1 -2.4 2.3 5.1 6.9 10.8 Merch imports (USD bn) 380 377 400 84 90 98 105 105 110 - % YoY -15.0 -0.7 6.0 -15.3 -12.1 3.1 26.5 24.7 22.2
Trade balance (USD bn) -118 -117 -120 -18.7 -25.0 -33.0 -37.0 -35.0 -38.0 Current a/c balance (USD bn) -22 -20 18 na na na na na na % of GDP -1.1 -0.9 -0.8 na na na na na na Foreign reserves(USD bn, eop) 356 360 370 na na na na na na
Inflation CPI inflation (% YoY) 4.9 5.2 5.4 5.7 5.3 4.5 5.2 5.1 5.5
Other Nominal GDP (USD tn) 2.0 2.3 2.5 na na na na na na Fiscal balance (% of GDP) -3.9 -3.5 -3.0 na na na na na na
% change year-on-year, unless otherwise specified Annual and quarterly data refers to fiscal years beginning April of calendar year. ** GDP growth stands for Real GDP; breakdown is under GVA (Gross Valued Added) series
IN - nominal exchange rate IN – policy rate INR per USD % repo rate 71 9.0 68 8.5
65 8.0 62 7.5 59 56 7.0 53 6.5
50 6.0 47 5.5 44 41 5.0 38 4.5 Jan-07 Jun-09 Nov-11 Apr-1 4 Sep-16 Jan-07 Dec -0 8 Nov-10 Oct-12 Sep-14 Aug-16
82 Economics–Markets–Strategy India
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83 Indonesia Economics–Markets–Strategy ID: fiscal pains
• The pace of fiscal spending is set to ease going forward, as the govern- ment struggles to improve tax revenue collection • There is little reason to expect household consumption to deviate from its current 5% growth trend • CPI inflation should average 3.7% this year. This provides ample room for another 25bps cut in the policy rate • Bank Indonesia will continue building forex reserves
We maintain our 2016 GDP growth forecast at 5.1%, despite better-than-expected growth of 5.2% YoY in 2Q16. Growth could rise to 5.3% in 2017 but short-term risks stem from slower fiscal spending in 2H16. Government spending could fall as tax revenue collection remains below target.
Fiscal austerity in place Acceleration in the government’s capital expenditure (capex) has been a key driver for growth in 1H16. The government has spent about 22% of its annual capex budget in 1H16. This is high compared to 1H15, when disbursement was recorded at only 11%. The impact is clearly evident in the construction sector, which grew by 7% YoY in 1H16, compared to 5.6% in 1H15. Construction is also the fastest growing top-5 sector in the economy. However, the pace of fiscal spending is set to moderate. As of Jul16, fiscal deficit is running at about 2.3% of projected GDP. Raising revenues has been a challenge this year. By Jul16, tax revenue collection amounted to only 39.5% of its annual target (Chart 1). At the current pace, 2016 tax revenue is likely to reach only 80% of target. Accordingly, tax revenue / GDP ratio may fall to 10.1% this year, which would be the lowest since 2000.
Chart 1: Pace of tax revenue collection % of annual target 100 Dec14: 92% 90 80 70 60 Dec15: 83% 50 40 39.5% 30 20
10 2014 2015 2016 0 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec INDONESIA
Gundy Cahyadi • (65) 6682 8760 • [email protected]
84 Economics–Markets–Strategy Indonesia
Chart 2: motorcycle sales remain weak Chart 3: imports of capital goods still declining thousand units, 6mma thousand units, 6mma sa, 3mma, index, Jan10 = 100
750 120 Latest: Jul16 180 700 100
650 160 80
600 140 60 550 bottomed-out? 120 40 500 Latest: Jul16 20 100 450 motorcycles import of consumer goods vehicles - RHS import of capital goods 400 0 80 Jul-12 Jul-14 Jul-16 Jul-13 Jul-14 Jul-15 Jul-16
On current projections, the government will need additional revenues of IDR 65tn to keep its deficit below 3% of GDP this year. There are high hopes on the tax amnesty program, which runs until Mar17. The government expects up to IDR 165tn in additional tax revenues from the program. As of early-Sep16, however, only IDR 9.2tn had been raised from the program, 5.6% of the official target. Total revenues from the program should still rise towards the year-end but a below- target outcome remains likely. Given this, the government has implemented some austerity measures, by cutting this year’s budgeted spending by IDR 133tn (about 6.5% of the initial budget). The cuts are said to come mostly from operational expenses, but it remains to be seen how badly affected capex is. In any case, lower fiscal spending is likely to be a drag on growth momentum going into 2017.
Steady investment and household consumption growth There is no reason to expect any marked deviation in private consumption growth, which has been holding steady at 5% in the past couple of years. Going by the retail sales index, sales growth has been rising at a steady pace of 12%, just slightly above the pace of nominal GDP growth. As inflation stays generally low, consumer sentiment is set to remain supported. Any risks to the upside are limited though. Discretionary spending continues to lag behind non-discretionary spending. Lingering impact from the fallout in the commodity sectors continued to put pressure on underlying consumption. Evidently, sales of motorcycles remain weak despite stabilizing auto sales (Chart 2). The widely expected surge in consumption during the Ramadan and Eid festivities was never materialized. Imports of consumer goods have normalized since the 24% (YoY) jump in 1Q16. While price expectations are relatively steady and the rupiah As of early-Sep16, remains well supported in the markets, consumer confidence has barely moved up revenues from the in a steady manner this year. The recent moderation in core inflation also suggests tax amnesty pro- limited upside risks in household consumption growth ahead. gram amount to 5.6% of target Meanwhile, the recovery in investment growth is on-going at a gradual pace. Loans for new investments are growing at 12% annual pace, faster than overall loan growth at 8%. Coupled with the acceleration of fiscal spending so far this year, a resilient rupiah has also been a positive for the private sector. Without a stronger growth in the manufacturing sector, however, we reckon that investment growth will continue to remain well below the 8% historical average. Note that imports of capital goods are still falling, down by 15.2% (YoY) in 1H16. For now, expect investment growth to remain circa 5.5%.
85 Indonesia Economics–Markets–Strategy
Chart 4: inflation in top 3 CPI components Chart 5: foreign reserves and portfolio flows % YoY USD bn, quarterly 16 6 14 4 12 10 2 8 0 6 4 -2
2 -4 0 Food -6 Latest: Aug16 -2 Transport/Comm -4 Housing/Utilities -8 Change in FX reserves Net portfolio flows Aug-13 Aug-14 Aug-15 Aug-16 Jun-13 Jun-14 Jun-15 Jun-16
Monetary policy loosening as inflation eases We lower our CPI inflation forecasts to 3.7% and 4.6% in 2016 and 2017 respectively. CPI inflation eased to 2.8% (YoY) in Aug16, lowest since end-2009. The distortion from oil price remains prevalent, evidenced in the deflationary pressure in the transport / communications component of the CPI (Chart 4). Inflation in housing / utilities is benign, below 2%, even if there are some risks from possible electricity price revision. Meanwhile, food inflation is under control, currently at around 5%, amid generally stable rice prices. Core inflation is likely to average circa 3.5% this year, markedly lower than the 4.9% recorded last year. No material change in price expectations is likely going into 2017, barring any significant change in administered prices and / or a sharp weakening of the rupiah. Core inflation may still rise to circa 4 % next year amid the ongoing domestic recovery. We reckon that this is still within Bank Indonesia’s (BI) comfort zone. The current inflation trajectory provides some room for further policy easing. Expect BI to trim its policy rate by another 25bps before the year-end. The accommodative policy bias persists, particularly since the government’s hands are tied. BI’s focus is also on ensuring a more effective policy transmission going forward, and thus, the implementation of the 7-day reverse repo as the new BI rate. Note that despite BI having cut its policy rate by 100bps so far in the year, bank lending rates are down Bank Indonesia to by only about 50bps. deliver another 25bps rate cut by At this juncture, chances are slim that BI would go with more than 25bps cuts. Even the year-end if the rupiah has been resilient so far this year, the central bank remains cautious of potential volatility ahead. More importantly, sluggish momentum in loan growth may also limit the effectiveness of further rate cuts. In particular, commercial banks are still watching for any potential risk on asset quality, even if the non-performing loans ratio remains relatively low at circa 3% currently. Reserves accumulation signals a cautious approach BI is set to continue build up its foreign reserves going forward. Up until Aug16, foreign reserves rose by USD 7.5bn. This amounts to 75% of total foreign inflows recorded in equities and IDgov bond market during the same period (Chart 5). That BI has been building its foreign reserves is a step to improve the economy’s macro risk profile. Note that alongside the rise in foreign reserves, the growth in short- term external debt has also been under control. Currently, foreign reserves to short- term external debt ratio is circa 2.7x, compared to a mere 2x back in mid-2013.
86 Economics–Markets–Strategy Indonesia
Indonesia Economic Indicators
2015 2016f 2017f 2Q16 3Q16f 4Q16f 1Q17f 2Q17f 3Q17f Real output and demand Real GDP growth (10P) 4.8 5.1 5.3 5.2 5.1 5.1 5.2 5.2 5.3 Private consumption 5.0 5.0 5.1 5.0 5.0 5.0 5.0 5.1 5.2 Government consumption 5.4 5.0 6.0 6.3 5.0 5.0 6.5 6.2 6.2 Gross fixed capital formation 5.1 5.4 5.5 5.1 5.8 5.0 5.5 5.8 5.3
Net exports (IDRtrn, 10P) 136 156 124 34 47 44 47 26 35 Exports -2.0 -1.5 -0.4 -2.7 -3.4 4.0 0.8 -0.2 0.5 Imports -5.9 -2.8 1.4 -3.0 -2.6 -1.4 -2.7 1.6 3.4
External Merch exports (USDbn) 150 136 133 36 32 35 32 34 33 - % chg -14.6 -9.8 -2.1 -8.7 -13.5 0 -4.8 -4.5 3.1 Merch imports (USDbn) 143 130 136 34 30 35 33 34 33 - % chg -19.9 -8.8 4.7 -8.1 -11.8 0 3.1 0 10 Merch trade balance (USD bn) 8 6 -3 2 2 0 -1 0 0
Current account bal (USD bn) -17 -18 -21 n.a. n.a. n.a. n.a. n.a. n.a. % of GDP -2.0 -2.0 -2.2 n.a. n.a. n.a. n.a. n.a. n.a. Foreign reserves (USD bn, eop) 106 115 117 n.a. n.a. n.a. n.a. n.a. n.a.
Inflation CPI inflation (average) 6.4 3.7 4.6 3.5 3.1 4.0 4.0 4.2 4.4
Other Nominal GDP (USDbn) ** 862 922 968 n.a. n.a. n.a. n.a. n.a. n.a. Fiscal balance (% of GDP) -2.5 -2.8 -2.6 n.a. n.a. n.a. n.a. n.a. n.a.
* % change, year-on-year, unless otherwise specified
ID - nominal exchange rate ID – policy rate IDR per USD BI rate 14800 10.0
14000 9.5 9.0 13200 8.5 12400 8.0 11600 7.5 10800 7.0 10000 6.5
9200 6.0
8400 5.5 Jan-07 Jun-09 Nov-11 Apr-1 4 Sep-16 Jan-07 Aug-08 Mar-10 Oct-11 May-1 3 Dec -1 4 Jul-16
Sources for charts and tables are CEIC Data, Bloomberg and DBS Group Research (forecasts are transformations).
87 Malaysia Economics–Markets–Strategy
MY: close call
• Growth moderated to 4% YoY in 2Q16 owing to exports • Domestic demand may also cool given a soft labour market • Inflation should average 2.0% in 2016 and 2.2% in 2017, below our previous forecasts of 2.1% and 2.4% • Expect Bank Negara to cut the policy rate by another 25bps in Novem- ber
GDP growth and inflation have moderated. Economic activity appears to be playing out in slow motion. Bank Negara responded in July with a first easing since the global financial crisis. The Overnight Policy Rate (OPR) was lowered by 25bps to 3.00%, amid a downward shift in the official inflation forecast to 2.0-3.0%. We expect another cut in November.
Growth moderated GDP growth moderated marginally to 4.0% (YoY) in 2Q16, down from 4.2% previously (Chart 1). Sequentially, growth momentum has also eased with a quarter- on-quarter seasonally adjusted expansion of 0.7%, from 1.0% in the first quarter. Nonetheless, the domestic engines remain fairly resilient despite the challenging external environment. The main driver has been private consumption, which rose at a faster pace of 6.3% (YoY), up from 5.3% in 1Q16 (Chart 2). Consumers have obviously loosened their purse strings after the GST effect has dissipated. In addition, gross fixed capital formation (GFCF) has surprised on the upside with a surge of 6.1% (YoY), versus 0.1% in 1Q16. This strong showing was spurred by the growth of structures at 5.9% and the sharp rebound in machinery & equipment to 8.1%. Private sector investment (73.1% of total investments) posted a solid
Chart 1: Slower growth in 2Q16 Chart 2: Domestic growth still holding up % YoY, % QoQ saar %YoY, %-pt contribution 7 8 Latest: 2Q16 %YoY 6 6 5 4 4 4.0% %QoQ saar 2 3 2.7% 0 2 Latest: 2Q16 1 -2 Net exports Investment Pvt consumption Govt spending GDP growth 0 -4 Mar-14 Sep-14 Mar-15 Sep-15 Mar-16 Mar-14 Sep-14 Mar-15 Sep-15 Mar-16 MALAYSIA
Irvin Seah • (65) 6878 6727 • [email protected]
88 Economics–Markets–Strategy Malaysia
Chart 3: Business sentiments improving Chart 4: Labour market softening index Biz condition % Job vacancies (RHS) unit x 1000 120 81 3.5 400 Capacity utilisation Unemployment rate 3.4 115 350 80 3.3 300 110 3.2 Thousands 79 3.1 250 105 78 3.0 200 100 2.9 150 77 95 2.8 100 2.7 76 90 50 Latest: 2Q16 2.6 Latest: 2Q16 / 1Q16 85 75 2.5 0 Mar-12 Mar-13 Mar-14 Mar-15 Mar-13 Mar-14 Mar-15 Mar-16 expansion of 5.6%, and has been the main impetus behind the GFCF growth momentum. Evidently, investors remain sanguine on the economy’s longer-term prospects despite the negative limelight on politics and governance issues.
Domestic growth may cool Indeed, business sentiment has improved and capacity utilisation rate appears to have bottomed and is recovering (Chart 3). There is still a healthy pipeline of development projects and industrial plans that will support private capital investment. In this regard, the continued implementation of the Economic Transformation Programme (ETP) and the Eleventh Malaysia Plan (11MP) will be crucial to buttress private investment growth. Lower cost of funding on the back of monetary policy easing by the central bank may help too. However, investment growth could be weighed down by possible moderation in private consumption demand going forward. The slower growth outlook is already exerting an impact on the labour market. The overall unemployment rate has inched up while job vacancies have visibly dipped (Chart 4). As there is always a lag effect from the growth cycle to the labour market, chances are high that consumers will Labour market start to rein in on their expenditure at some point in time. Risk is that a weaker has softened consumption growth may have a consequential second order impact on investment.
External headwinds remain strong The main drag continues to come from the external front. Net exports fell by 7.0% (YoY) amid the external headwinds and uncertainties in the global economy (Chart 2, previous page). Though exports did post an expansion of 1.0% in the quarter, imports rose by 2% and drag net exports down. While import demand is expected to soften as domestic growth cools, the risk is that the drag from export could potentially intensify. The PMIs across all key markets have turned southward again, reflecting sustained risks from the external environment (Chart 5). Export growth could ease further, implying further drag from net exports on overall GDP growth performance.
Downside risk on growth The economy grew 4.1% (YoY) in the first six months of 2016, compared with 5.3% in the same period last year. And despite the challenging economic environment, the central bank expects growth to average between 4.0-4.5% this year, driven by domestic demand. This is consistent with our view that sequential growth trajectory in the second half will remain fairly flat.
89 Malaysia Economics–Markets–Strategy
Chart 5: PMIs turning south again Chart 6: Inflation and monetary policy outlook Index % YoY, % p.a. Singapore EZ 60 4.5 DBSf China US CPI Inflation 58 4.0 OPR 3.5 56 3.0 54 2.5
52 2.0 1.5 50 1.0 Slump in 48 oil prices GST 0.5 hike Latest: Jul/Aug16 46 0.0 Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 Jul-16 Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 Jul-16
China’s structural slowdown will remain the key factor weighing on the growth prospects of the region. The sluggish growth in the US, risk of more Fed hikes and uncertainties surrounding Europe after Brexit are just exacerbating the slowdown in growth momentum. While we continue to maintain our full-year GDP growth forecast of 4.2%, risk is on the downside. Lower inflation and room for more easing Inflation eased to 1.1% in July (Chart 6). This is down from 1.6% in the previous month. A confluence of factors is weighing on the price barometer but transport costs have been the main drag, with effects of the cuts in pump prices in March still lingering. Moreover, imported inflationary pressure has been low too. Slow growth in the global economy and an existing disinflationary pressure amid persistently low Another 25bps energy prices will continue to suppress domestic price pressure. Inflation is now cut may be on the expected to average 2.0% in 2016 before inching marginally higher to 2.2% in cards 2017. Indeed, low inflation will continue to keep another rate cut in the radar screen. The central bank lowered the OPR by 25bps to 3.00% and lowered its inflation forecast in July. It highlighted that the adjustment to the OPR is intended “to ensure that the domestic economy continues on a steady growth path amid stable inflation”. It further added that it “will continue to monitor and assess the balance of risks surrounding the outlook for domestic growth and inflation”, which essentially is keeping the door open for more monetary accommodation if necessary. Bank Negara’s most recent rate cut is deemed to be an “insurance” cut against potential downside risk to growth and inflation in our opinion. In this regards, we expect growth to come within target but inflation will likely come in at the lower end of the official forecast range. Any downward shift in inflation in the coming months may prompt the central bank to act. We had earlier expected the central bank to remain on hold for the rest of the year, but the risk of another rate cut in November has risen. Although November will be a close call, another 25 bps cut has been penciled into our forecast.
90 Economics–Markets–Strategy Malaysia
Malaysia Economic Indicators
2015 2016f 2017f 2Q16 3Q16f 4Q16 1Q17f 2Q17f 3Q17f Real output and demand GDP growth 5.0 4.2 4.5 4.0 4.4 4.2 3.9 4.8 4.5 Private consumption 4.5 4.9 4.2 6.5 4.6 4.5 4.5 4.0 4.2 Government consumption 6.1 5.5 5.6 6.3 5.0 5.2 5.5 5.2 5.5 Gross fixed capital formation 3.8 3.8 4.9 6.1 4.1 5.0 5.0 5.0 5.2 Exports 0.6 1.1 2.7 1.0 1.9 2.2 2.5 2.3 3.0 Imports 1.2 1.9 3.5 2.0 2.2 2.1 3.0 3.2 3.6
External (nominal) Exports (USD bn) 200 186 185 44 46 51 44 45 46 Imports (USD bn) 176 168 167 40 42 46 40 41 41 Trade balance (USD bn) 24 18 18 4 4 4 4 5 5
Current account bal (USD bn) 9 5 8 n.a. n.a. n.a. n.a. n.a. n.a. % of GDP 3 1 2 n.a. n.a. n.a. n.a. n.a. n.a. Foreign reserves (USD bn, yr-end) 96 97 100 n.a. n.a. n.a. n.a. n.a. n.a.
Inflation CPI inflation 2.1 2.0 2.2 1.9 1.4 1.6 2.0 2.2 2.2
Other Nominal GDP (USDbn) 297 316 337 n.a. n.a. n.a. n.a. n.a. n.a. Fiscal balance (% of GDP) -3.2 -3.1 -3.0 n.a. n.a. n.a. n.a. n.a. n.a.
- % growth, year-on-year, unless otherwise specified
MY - nominal exchange rate MY – policy rate MYR per USD %, OPR 4.50 3.6 3.4 4.30 3.2 4.10 3.0 3.90 2.8 3.70 2.6 3.50 2.4
3.30 2.2
3.10 2.0
2.90 1.8 Jan-07 Jun-09 Nov-11 Apr-1 4 Sep-16 Jan-07 Dec -0 8 Nov-10 Oct-12 Sep-14 Aug-16
91 Thailand Economics–Markets–Strategy TH: three percent
• Downside risks remain for our revised 2016 and 2017 GDP growth fore- casts of 3.3% and 3.5% respectively • Private investment growth has been disappointing and we reckon there won’t be any significant improvement in the near-term • A resilient tourism sector is key to GDP growth momentum • CPI inflation is likely to rise to 1.9% next year from a projected 0.3% this year. Expect Bank of Thailand to keep rates steady
We have cut our GDP growth forecasts to 3.3% and 3.5% for 2016 and 2017 respectively from 3.4% and 3.6% previously. Downside risks remain. Despite stronger-than-expected consumption growth in 2Q16, investment remains weak. Overall, private demand is still growing at an annual pace of circa 2.5%, essentially unchanged since 2014. The rebound in 2Q16 private consumption growth surprised with a 3.8% (YoY) rise. On sequential terms, it amounted a sharper 8.0% (QoQ, saar) jump. Both figures are at their highs since 2013. Part of the boost stemmed from aggressive campaigning by auto retailers, which also led to the 9.2% jump in vehicle sales. This marked the strongest quarterly pace of vehicle sales since early-2013. The spike in 2Q16 is, however, more of a one-off. It is more likely that private consumption growth would ease back to circa 3% going forward (Chart 1). The monthly private consumption index has turned softer again in Jul16, suggesting that the recovery path is far from being smooth. Retail sales growth remains in positive, but is unlikely to improve from current 4% trend for now. Sales of durable goods have continued to underperform, growing at 2% trend currently.
Chart 1: projected GDP growth % YoY, 2002P
6.0 DBS forecast 5.0 2013-14 political crisis 3.8 4.0 3.0 2.0 1.0 0.0 -1.0 -2.0 -3.0 overall GDP private consumption -4.0 Mar-13 Mar-14 Mar-15 Mar-16 Mar-17 THAILAND
Gundy Cahyadi • (65) 6682 8760 • [email protected]
92 Economics–Markets–Strategy Thailand
Chart 2: sluggish private investment Chart 3: government spending index, 50 = neutral index, sa, Jan10=100 % YoY 54 128 12 127 52 10 126 Budget, current prices, fiscal year 50 125 8 Govt consumption, real prices 48 124 123 6 46 122 4 44 121 Latest: Jul16 120 42 2 business sentiment index 119 BOT private investment index (RHS) 40 118 0 Jul-14 Jul-15 Jul-16 12 13 14 15 16 17F
More importantly, structural limitations for consumption remain prevalent. Household debt-to-GDP ratio remains high, in excess of 80%. Deleveraging continues, with household loan growth currently at 5% pace, compared to an average of 15% in 2010-13. Given persistent weakness in the agriculture and manufacturing sectors, wage growth remained slow, around an annual pace of 2% in 1H16. These factors will keep private consumption growth stuck around 3% in the near-term.
Private investment growth stays weak Private investment grew by a mere 0.1% (YoY) in 2Q16 and a pick-up in the near-term looks unlikely. The monthly private investment index has shown little improvement this year (Chart 2). Business sentiment remains steady, hovering just below the neutral 50 level. Overall loan growth remains lacklustre at circa 5%. At the same time, weak export growth implies capacity utilization is low. Indeed, on seasonally-adjusted terms, the capacity utilization rate is at its lowest since Jan12, latter was due to the flood-related disaster. No turnaround is likely anytime soon, as exports of merchandise goods are set to contract again this year, with our current forecast for a 1.5% fall, marking a fourth consecutive year of decline. Lingering concerns on the political front might worsen the outlook for domestic investments. Anecdotally, more Thai companies have added or are looking to increase their investments overseas, given local uncertainties. The 2016 constitution was approved in the Aug 7 referendum, backed by popular support of 61% and with 59% voters turnout. With the new charter in place, the next election may now be held by late-2017, but no details have been announced as yet. In the meantime, even if fiscal policy remains highly accommodative, expect some Household debt moderation in the pace of government spending. Government consumption growth overhang and came in relatively weak at 2.2% (YoY) in 2Q16. Public sector investment growth low wage growth came in at 10.4% in 2Q16, slowest in the past 2 years. Note that the government remain a drag has budgeted only a 0.5% increase in expenditure in FY2017, down from 5.6% in on consumption FY2016 budget (Chart 3). growth Crucial for tourism to remain strong Any upside surprises on growth would probably come from the tourism sector. The contribution of tourism sector is significant, particularly in recent years. In 1H16, the fastest growing sector in the economy was the hotel / restaurants component, which rose a robust 14% (YoY). Excluding this component, GDP growth would have come in at 2.7% in 1H16, vs. actual growth of 3.4%.
93 Thailand Economics–Markets–Strategy
Chart 4: tourism sector remains a bright spot Chart 5: subdued inflation %, sa in millions, sa % YoY 70 3.0 DBSf 3.0 CPI inflation 2.8 2.5 Core inflation 65 2.6 2.0 2.4 60 1.5 2.2 1.0 55 2.0 0.5 1.8 50 1.6 0.0 Latest: Jul16 1.4 -0.5 45 hotel occupancy rate 1.2 -1.0 tourist arrival (RHS) 40 1.0 -1.5 Jul-13 Jul-14 Jul-15 Jul-16 Jun-14 Jun-15 Jun-16 Jun-17
Tourism is about the only sector that has returned to, in fact surpassed, the levels seen before the 2013/14 political crisis (Chart 4). Despite making up only about 5% of GDP, contribution from the hotel / restaurant component to 1H16 GDP growth was a high of 22%, second only to the more important wholesale / retail Tourism is the only component. This is well above the contribution from manufacturing, which at 28% sector that has re- is the biggest sector in the economy. turned to pre-2013 The recent string of bomb blasts in key tourism spots has once again triggered levels some concerns about the economy’s prospects. The tourism sector has proved to be resilient in previous instances of security or political threats, but it remains to be seen if this time would be of any difference. Apart from growth, tourism is also partly responsible for the economy’s record-high current account surplus. The current account (C/A) balance has been in surplus since end-2014. C/A surplus rose to 12.6% of GDP in 1H16, compared to 8% last year. While some moderation is set to follow in 2H16, the full-year total may still exceed 10% of GDP, which would be the highest since 1998.
Dovish monetary policy stance prevails Deflationary pressures persist in the housing and transport components of the CPI, amid the oil price distortion. Food inflation has moderated to 1.9% as of Aug16, as impact from the drought dissipated. Against this backdrop, inflation has once again fallen to 0.3% in Aug16, after hitting a 17month-high of 0.5% (YoY) in May16. Core inflation is inching higher, but very slowly. But at sub-1%, the gauge reflects Core inflation re- sluggish underlying demand. With inflation below target so far this year, we revise mains below 1% down our 2016 CPI inflation forecast to 0.3% from 0.7% previously. Expect some mild recovery in 2017, but at a projected 1.9%, CPI inflation is still below the Bank of Thailand’s (BOT) 2-3% target (Chart 5). Expect the BOT to keep rates unchanged at 1.50%, with smaller odds for a 25bps rate cut before the year-end. While the impact from another 25bps rate cut may be limited to loan growth, the central bank may continue to use it to facilitate a softer baht. For now, expect the central bank to maintain its verbal intervention in the market to keep the baht’s strength in check.
94 Economics–Markets–Strategy Thailand
Thailand Economic Indicators
2015 2016f 2017f 2Q16 3Q16f 4Q16f 1Q17f 2Q17f 3Q17f Real output and demand GDP growth (02P) 2.8 3.3 3.5 3.5 3.5 3.0 3.0 3.7 3.6 Private consumption 2.1 2.8 3.0 3.8 2.3 2.4 2.5 2.6 3.1 Government consumption 2.2 4.0 3.0 2.2 4.6 1.7 1.5 4.5 2.5 Gross fixed capital formation 4.7 3.2 5.3 2.7 6.6 -1.4 2.1 6.6 5.9
Net exports (THBbn) 709 1053 1300 184 237 283 370 263 299 Exports 0.2 2.2 4.4 0.6 1.5 1.7 -0.3 4.8 5.9 Imports -0.4 -1.5 3.2 -2.2 -2.7 -2.2 -1.6 0.3 2.9
External Merch exports (USDbn) 214 213 218 51 53 53 51 53 57 - % YoY -6 -2 3 -5 -4 0 -6 4 8 Merch imports (USDbn) 203 190 200 47 49 49 46 49 53 - % YoY -11 -6 1 -9 -3 0 0 4 8 Trade balance (USD bn) 12 22 17 4 4 4 5 5 4 Current account balance (USD bn) 32 37 24 8 7 6 6 6 6 % of GDP 8.0 9.3 5.8 n.a. n.a. n.a. n.a. n.a. n.a.
Inflation CPI inflation -0.9 0.3 1.9 0.3 0.3 1.0 1.6 2.0 2.5
Other Nominal GDP (USDbn) 396 398 413 n.a. n.a. n.a. n.a. n.a. n.a. Unemployment rate, % 0.8 1.1 1.0 n.a. n.a. n.a. n.a. n.a. n.a. Fiscal balance (% of GDP)** -1.9 -2.5 -2.5 n.a. n.a. n.a. n.a. n.a. n.a.
* % change, year-on-year, unless otherwise specified ** central government net lending/borrowing for fiscal year ending September of the calendar year
TH - nominal exchange rate TH – policy rate THB per USD %, 1-day RRP 38 5.0 37 4.5
36 4.0 35 3.5 34 3.0 33 32 2.5 31 2.0
30 1.5 29 1.0 28 Jan-07 Jun-09 Nov-11 Apr-1 4 Sep-16
Sources for charts and tables are CEIC Data, Bloomberg and DBS Group Research (forecasts are transformations).
95 Singapore Economics–Markets–Strategy
SG: on thin ice
• Headline growth has been weak. Things may be worse under the hood • Two consecutive quarters of contraction in the services sector means that two-thirds of the economy is in technical recession • But inflation has bottomed and core inflation should trend higher • While further monetary easing is unlikely, one should expect an expan- sionary budget in FY17
Second quarter growth was weaker than expected. A closer scrutiny of the most recent set of GDP figures revealed that there are more risks underneath. But inflation may have bottomed and core inflation should trend higher. The Monetary Authority of Singapore (MAS) is likely to stand pat at the upcoming policy review in October.
Poor outcome in 2Q16 GDP GDP growth in the second quarter was revised down to 0.3% (QoQ saar), from the advance estimates of 0.8% (Table 1). In addition, first quarter growth was lowered to 0.1%, from 0.2% previously. With just an average of 0.2% growth on a sequential basis in the first half of the year, the economy is weak (Chart 1). A negative shock from the external environment could tip the economy into recession.
The worst is yet to come Separately, although the headline year-on-year GDP figure has averaged 2.1% in 1H16, this came partly on the back of the low base in the same period last year (Chart 1). The opposite will occur in the coming two quarters since GDP accelerated in the second half of last year, particularly in the fourth quarter. Such high base effect essentially implies that the worst is yet to come in year-on-year terms. The headline figure will fall sharply in the next two quarters. In fact, that explains why the government lowered its official forecast range to 1-2%, which is below the average growth rate of 2.1% (YoY) thus far. We continue to expect 1.5% growth for the full year, the slowest in seven years before inching higher to 1.9% in 2017.
Table 1: GDP growth by sectors 2Q15 3Q15 4Q15 2015 1Q16 2Q16 (a) Percentage change year-on-year Overall GDP 1.7 1.8 1.8 2.0 2.1 2.2 Manufacturing -5.2 -6.0 -6.7 -5.2 -0.5 0.8 Construction 3.6 3.0 4.9 2.5 4.5 2.7 Services producing 3.2 3.4 2.8 3.4 1.7 1.7 Quarter-on-quarter annualised growth rate, seasonally adjusted Overall GDP -1.6 2.3 6.2 2.0 0.2 0.8 Manufacturing -13.8 -6.0 -4.9 -5.2 18.4 0.3 Construction 7.7 0.2 6.0 2.5 3.5 0.6 Services producing 0.4 3.8 7.7 3.4 -4.8 0.5 SINGAPORE
Irvin Seah • (65) 6878 6727 • [email protected]
96 Economics–Markets–Strategy Singapore
Chart 1: GDP slowed in 2Q16 % YoY, % QoQ saar 10 Latest: 2Q16 high base 8 %QoQ saar 6
4 DBSf %YoY 1.8% 2 0.3% 0
low base on thin ice -2 Mar-14 Sep-14 Mar-15 Sep-15 Mar-16 Sep-16
Technical recession The focus is on the decline in the services cluster. The sector has registered two consecutive quarters of contraction, which means that it is “technically” already in a recession (Table 1). Services sector accounts for slightly more than two-thirds of GDP and employment. So literally, two-thirds of the economy is already in a technical recession given the services’ slump. The bigger concern is that if the doldrums in the services sector persist, it could eventually drag down the entire economy. Note historically the sector has always been the key driver of growth in Singapore. When the services sector turns, the economy follows (Chart 2). Plainly, risk of a contraction in GDP has risen. Manufacturing is unlikely to pick up the slack from services. The former grew an Two-thirds of the average of just 0.3% (YoY) in 1H16. And that paltry pace of expansion was largely economy is in driven by the biomedical cluster (Chart 3). Without the “jab in the arm” from technical recession biomedical, overall manufacturing sector would have contracted by 2.7% (YoY) in the first half of the year instead. Given the volatile nature of the biomedical cluster, as well as the fact that it has little positive spin-offs to the rest of the economy, outlook for the overall manufacturing sector remains dicey amid the weak global demand.
Chart 2: Historical GDP and services sector growth % YoY 25 GDP growth Services growth 20
15
10
5
0
-5 AFC Mfg recession Dot.com -10 Latest: 2Q16 GFC -15 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12 14 16
97 Singapore Economics–Markets–Strategy
Chart 3: Manufacturing lifted by biomedical % YoY 25 Biomedical IP 20 Overall IP 15 Overall IP ex-biomed 10
5
0
-5
-10 Latest: 2Q16 -15 Mar-14 Sep-14 Mar-15 Sep-15 Mar-16
Inflation has bottomed Inflation remains stuck in the red. Latest Jul16 CPI inflation registered -0.7% (YoY) and this is the 21st consecutive month of decline (Chart 4). But interestingly, core inflation has remained in positive ground at 1.0% and is still pretty much on an upward trend. Housing and utilities has remained a key drag but transport inflation has become less negative on account of the higher COE premiums. The easing in car loan Core inflation will regulations announced by the MAS earlier on has brought about increase in car remain positive purchases and henceforth, upward adjustments in the COE premiums. That in turn has lifted the private transport CPI index given the strong influence of COE premiums on the index. Overall, inflation has bottomed and is expected to average -0.5% and 0.9% in 2016 and 2017 respectively. It will remain stuck in negative territory till the end of the year or the early part of next year. But core inflation will remain at positive level and is expected to creep higher.
Chart 4: Negative inflation % YoY 2.5
1.5 DBSf Core inflation 2016f: -0.5% 2017f: 0.9%
0.5 CPI inflation
-0.5 Latest: Jul16
21 months of -1.5 negative inflation Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 Jul-16
98 Economics–Markets–Strategy Singapore
Chart 5: DBS SGD NEER and policy band Zero 110 Indexed: 2-5 Apr 2012 = 100 appreciation 108 106 104 102 100 98 SGD NEER 96 Lower limit 94 Mid-pt 92 Upper limit
90 Latest: 16 Aug16 88 2010 2011 2012 2013 2014 2015 2016
Policy With growth outlook likely to remain dim, there will be expectation that policies may become more accommodative. However, the MAS had already eased the exchange rate policy to a zero appreciation of the Sing NEER in April, from a modest appreciation stance previously. And this was despite the fact that the headline GDP figures did not show a contraction in the economy yet. The point to note is that the shift in monetary policy stance was pre-emptive in nature and it was meant to guard against further downside risk to growth and No change to the that inflationary pressure had also been less than anticipated. In our opinion, the exchange rate current monetary policy stance already served as a “cushion” for the economy and policy is appropriate under the current economic conditions. From a technical perspective, the Sing NEER is still hovering nicely in the upper half of the policy band and is not under any downward pressure (Chart 5). Barring any unforeseen negative shock in the external environment, the MAS will most likely stick to status quo in the upcoming policy review in October. Furthermore, there were suggestions by some observers about a possible fiscal stimulus / off-budget measures to prop up the economy after the disappointing 2Q16 GDP figures were announced. It pays to note that there is only about five months left in the current fiscal year. And administratively, this is the first financial year for the new term of government and it is important for the fiscal department to keep their powder dry in case of rainy days ahead. As such, an expansionary fiscal policy is more likely in the upcoming Budget 2017. The extent of fiscal impetus will depend on how economic conditions pan out in the coming months as well as the medium-term outlook for the economy.
99 Economics–Markets–Strategy Singapore
Singapore Economic Indicators
2015 2016f 2017f 2Q16 3Q16f 4Q16f 1Q17f 2Q17f 3Q17f Real output and demand Real GDP (00P) 2.0 1.5 1.9 2.1 1.5 0.5 0.9 1.6 2.4 Private consumption 4.5 3.5 3.3 3.2 3.3 3.3 3.2 3.2 3.3 Government consumption 6.6 8.1 6.1 12.0 5.9 6.0 5.2 4.0 7.1 Gross fixed investment -1.0 1.0 3.3 1.1 2.7 2.8 3.0 2.2 3.4 Exports 2.5 1.7 1.8 4.1 2.2 1.6 1.9 0.4 2.3 Imports 2.1 1.9 3.0 1.7 0.8 3.9 2.9 2.9 3.0
Real supply Manufacturing -5.2 2.3 -0.4 1.1 3.8 4.8 -0.7 -0.6 -0.1 Construction 2.5 2.0 3.0 3.3 1.3 -0.6 0.8 5.4 2.9 Services 3.4 0.7 2.4 1.4 0.4 -0.7 1.2 2.0 3.1
External (nominal) Non-oil domestic exports -0.1 -3.4 -2.8 0.1 -3.0 -1.4 -4.5 -4.0 -0.3 Current account balance (USD bn) 58 57 61 n.a. n.a. n.a. n.a. n.a. n.a. % of GDP 20 19 20 n.a. n.a. n.a. n.a. n.a. n.a. Foreign reserves (USD bn) 248 256 263 n.a. n.a. n.a. n.a. n.a. n.a.
Inflation CPI inflation -0.5 -0.5 0.9 -0.9 -0.4 0.1 0.7 1.3 1.0
Other Nominal GDP (USDbn) 293 296 304 n.a. n.a. n.a. n.a. n.a. n.a. Unemployment rate (%, sa, eop) 1.9 2.2 2.4 2.1 2.1 2.2 2.2 2.3 2.3
- % change, year-on-year, unless otherwise specified
SG - nominal exchange rate SG – policy rate SGD per USD % pa 1.60 3.5
1.55 3.0 1.50 2.5 1.45
1.40 2.0
1.35 1.5 1.30 1.0 1.25 0.5 1.20
1.15 0.0 Jan-07 Jun-09 Nov-11 Apr-1 4 Sep-16 Jan-07 Dec -0 8 Nov-10 Oct-12 Sep-14 Aug-16
100 Economics–Markets–Strategy Singapore
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101 Philippines Economics–Markets–Strategy PH: staying strong
• Domestic demand remains strong and likely to continue driving GDP growth in excess of 6% going into 2017 • While investment growth may moderate going forward, overall liquid- ity conditions stay fairly supportive for the outlook • Government policies will have a bearing on how much longer invest- ment growth would remain in the double-digit territory. • Expect Bangko Sentral ng Pilipinas to raise its policy rates by a total of 50bps in 1H17 amid the robust GDP growth momentum
We have revised our 2016 GDP growth forecast to 6.6% from 6.3% previously. Growth may moderate going forward, as the May election effect fades. Nevertheless, domestic demand should continue drive 6-plus percent GDP growth into 2017. Over the past three quarters, investment has grown by 26% YoY, driven by frontloading ahead of the May election (Chart 1). Imports of capital goods rose 61% in 1H16, far outpacing the 24% and 7% recorded for consumer and intermediate goods respectively. Businesses sentiment remains firm, given government promises to be more aggressive in executing budget allocations. Overall liquidity conditions remain supportive. Loan growth inched higher to 16.2% YoY in 2Q16, the fastest since 4Q14. As business conditions start to normalize, expect some moderation in investment. Still, investment growth should average 10% over the next year, similar to the pace seen before the spike in 4Q16. Note also that inventory build-up has continued up to 2Q16 (Chart 2, next page). We have yet to see any material de-stocking activities since end-2013, making this
Chart 1: robust investment growth in the past year % QoQ, saar, 00P 45 40 35 30 25 20 15 10 10y average 5 0 -5 -10 Mar-12 Mar-13 Mar-14 Mar-15 Mar-16 PHILIPPINES
Gundy Cahyadi • (65) 6682 8760 • [email protected]
102 Economics–Markets–Strategy Philippines
Chart 2: change in inventories Chart 3: non-food consumption strong PHP bn, 00P, 4q-rolling sum % YoY 100 8.0
7.5 50 7.0
0 6.5 6.0 -50 5.5
5.0 Latest: Jun16 -100 Personal consumption Latest: Jun16 4.5 Non-food consumption -150 4.0 Jun-09 Jun-11 Jun-13 Jun-15 Jun-13 Jun-14 Jun-15 Jun-16
to be the longest stretch of inventory build-up in the past 10 years. As and when the de-stocking eventually starts, a moderation in investment growth follows. Household consumption growth has also been robust. Consumption grew a record- high 7.2% (YoY) in 1H16. Non-food consumption leads overall consumption growth, at 7.4% in the period (Chart 3). Demographic dividends remain highly supportive of consumption growth, also evidenced in motor vehicle sales, which continued to grow at circa 25% annual pace. Other high frequency data, including retail sales and imports of consumer goods suggest the outlook remains positive. We reckon household consumption growth may remain in excess of 6% for the coming years. Positive spillovers from robust foreign remittances persist. Additionally, President Duterte’s efforts to raise economic growth outside Metro Manila also deserve a closer watch. The government is currently mulling to set equal minimum wages for Metro Manila and the regional provinces. If successful, this may boost consumption growth in the rural areas.
Focus on government policies The implementation of the Duterte’s economic policies will also have a bearing on how much longer investment growth would remain in the double-digit territory. The new government aims to accelerate its public-private partnership projects, 12 of which with a total cost of more than USD 5bn are currently at different state of procurement. Meanwhile, the current 2017 budget proposal sets a 12% increase in expenditure, raising infrastructure budget to 7% of GDP. As promised, budget deficit target is Discretionary raised to 3% of GDP starting next year. This is well above the average of only 1.6% spending contin- of GDP in 2006-2015. ues to lead overall household con- It is also important to monitor the pace of fiscal expenditure going forward. Total sumption growth fiscal spending growth averaged 6.8% during Aquino’s terms, almost half the pace of revenue growth at 11.8% (Chart 4, next page). The Duterte’s administration is hopeful that its focus on regional development will help to speed up budget spending. Lastly, the government also aims to bring in more foreign direct investment. Among others, there are plans to adjust the cap on foreign ownership of local companies from 40% to 70%. Limits on property land-lease could also said be lifted to 40 years from 25 currently. The government is also mulling plans to lower the corporate tax rate from the current 30%. These are potentially significant. While foreign direct investment (FDI) increased several folds during Aquino’s term, it remains low compared to the rest of the region.
103 Philippines Economics–Markets–Strategy
Chart 4: spending vs revenue growth Chart 5: further moderation in export growth % YoY % YoY 16 50 Latest: Jul16 14 40
12 30
10 20
8 10 6 0 4 -10 2 -20 0 Electronic products Total 2011 2012 2013 2014 2015 1H16 -30 Govt revenue Govt spending Jul-13 Jul-14 Jul-15 Jul-16
Current account surplus to narrow Expect exports to fall by 5% this year. Weakness is prevalent across sectors. Exports of electronic products were down by 8% YoY in May-Jul16, a worrying sign given their importance to exports overall (Chart 5). After 3 years of strong growth, electronics exports could fall by 3% this year. Ironically, this has pulled overall GDP growth down. Growth averaged 6.4% over the past 3 years, even as net exports of goods and services have been persistently Exports are likely negative in the period. The more notable impact will be on the current account. to contract this Even if foreign worker remittances are likely to hit a record-high USD 26bn this year, year, but impact current account (C/A) surplus is set to narrow to about 1.3% of GDP this year. on GDP growth is As evidenced in the growth of imported capital goods, the narrowing of the C/A limited surplus merely reflects the increase in domestic investment. For now, we reckon there is still no reason to worry on the external liquidity front, especially considering the foreign reserves to short-term external debt ratio staying above 5.
Interest rate hikes likely in early-2017 Aug16 core inflation came in at 2.0% (YoY), the highest year-to-date. Core inflation seems to have bottomed out in 2Q16. Not only has underlying demand remained strong, but price expectations also seem to have inched up in recent months alongside the rise in food prices. Food inflation is currently trending around 3%, offsetting some of the drag prevalent in the housing / utilities and transport components of the CPI. Given that the distortion from low oil prices is likely to dissipate going into 2017, CPI inflation should average 2.6% next year, up from a projected 1.6% this year. Core inflation is also set to be steady within the 2.5-3% range by the mid-year. While Bangko Sentral ng Pilipinas (BSP) seems fairly comfortable with the current inflation trajectory (inflation target is 2-4%), expect the monetary policy bias to turn Inflation to aver- increasingly hawkish going into 2017. Look for the BSP to continue to drain excess age 2.6% in 2017, liquidity from the system. This is mainly done by gradually increasing the volume up from 1.6% this of its term deposit facility auction higher in the coming months, in an effort to pull year short-term rates closer to the current policy rate of 3%. An upward adjustment in the policy rates may then follow. At this juncture, expect the BSP to raise its policy rates to 3.5% by mid-2017.
104 Economics–Markets–Strategy Philippines
Philippines Economic Indicators
2015 2016f 2017f 2Q16 3Q16f 4Q16f 1Q17f 2Q17f 3Q17f Real output and demand Real GDP growth 5.9 6.6 6.3 7.0 6.8 5.4 6.7 5.4 6.9 Private consumption 6.3 6.5 6.0 7.3 6.8 5.5 6.0 6.0 6.0 Government consumption 7.8 10.6 11.0 13.5 10.2 6.4 12.9 11.0 8.8 Gross fixed capital formation 14.0 19.5 9.8 27.2 15.4 10.0 7.4 6.9 13.5
Net exports (PHP bn, 00P) -261 -672 -617 -95 -134 -261 -188 -47 -128 Exports 9.0 2.7 5.7 6.6 -0.2 -3.2 1.8 4.3 8.2 Imports 14.0 13.0 3.6 20.9 6.9 6.4 2.0 -0.5 6.7
External (nominal) Merch exports (USD bn) 59 56 59 14 15 14 14 15 16 - % YoY -5 -5 5 -7 0 0 8 7 7 Merch imports (USD bn) 71 80 81 20 22 19 19 19 22 - % YoY 2 13 1 25 16 0 0 -5 0 Merch trade balance (USD bn) -12 -24 -22 -6 -7 -5 -5 -4 -6
Current account balance (USD bn) 8 4 5 n.a n.a n.a n.a n.a n.a % of GDP 2.7 1.3 1.6 n.a n.a n.a n.a n.a n.a Foreign reserves, USD bn 81 87 89 n.a n.a n.a n.a n.a n.a
Inflation CPI inflation 1.4 1.6 2.6 1.5 1.9 1.9 2.2 2.5 2.7
Other Nominal GDP (USD bn) 293 302 315 n.a n.a n.a n.a n.a n.a Budget deficit (% of GDP) -0.9 -2.0 -2.3 n.a n.a n.a n.a n.a n.a
* % change, year-on-year, unless otherwise specified
PH - nominal exchange rate PH – policy rate PHP per USD %, o/n rev repo 51 8.0 50 7.5 49 7.0 48 6.5 47 6.0 46 5.5 45 5.0 44 4.5 43 4.0 42 3.5 41 40 3.0 Jan-07 Jun-09 Nov-11 Apr-1 4 Sep-16 Jan-07 Dec -0 8 Nov-10 Oct-12 Sep-14 Aug-16
Sources for charts and tables are CEIC Data, Bloomberg and DBS Group Research (forecasts are transformations).
105 Vietnam Economics–Markets–Strategy
VN: grinding
• Growth in the first half was slower than expected as drought contin- ued to weigh on agriculture • Full year GDP growth is expected to grow by 6.0%, down from 6.3% previously envisioned • Nevertheless, inflation is rising and will likely average 2.4% in 2016 and 3.4% in 2017 • With slower growth and rising inflation, the central bank is likely to keep rates steady in the coming quarters
It has been a tough year for the economy. Growth in the second quarter was weaker than expected. The country was hit by the worst drought in three decades, dragging down GDP growth in the first half of the year. Beneath the headline number and beyond weather related effects, underlying growth fundamentals are robust. Strong growth in the manufacturing and service sectors have picked up some of the slack in the agriculture sector. Inflation meanwhile is picking up. Slower growth and rising inflation mean that the central bank is caught between a rock and a hard place.
Drought effects The economy expanded 5.6% (YoY) in 2Q 2016, broadly unchanged from the previous quarter (Chart 1). Impact of drought on the agriculture sector continued to be the main factor weighing down on headline growth. The primary sector grew a modest 0.9% in the quarter, up from a decline of 1.2% previously.
Chart 1: Growth remains weak in 2Q16 Chart 2: exports and trade balance improving % YoY, USD bn Trade balance (LHS) USD bn Real GDP growth 14 Construction 1.0 Exports 16 Agri, forestry & fishery Imports 12 Industry 15 0.5 10 Services 14
8 0.0 13 6 12
4 -0.5 11
2 10 -1.0 0 9 Latest: Aug16 Latest: 2Q16 -2 -1.5 8 Mar-14 Sep-14 Mar-15 Sep-15 Mar-16 Jan-15 Jul-15 Jan-16 Jul-16 VIETNAM
Irvin Seah • (65) 6878 6727 • [email protected]
106 Economics–Markets–Strategy Vietnam
Chart 3: Electronics driving export growth Chart 4: PMIs remain lacklustre Index USD bn VN EZ 60 1.8 China US 1.6 58 1.4 56 1.2 54 1.0 0.8 52 Latest: Aug16 0.6 50 0.4 48 0.2 Latest: Aug16 0.0 46 Jan-01 Jan-04 Jan-07 Jan-10 Jan-13 Jan-16 Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 Jul-16
Nevertheless, poor weather conditions are expected to be transient. Encouraging signs from the manufacturing and service sectors imply that full year growth will surpass the 5.6% pace averaged thus far.
Manufacturing and services picking up the slack The main bright spark for the economy continues to be the manufacturing sector. Production accelerated by 7.4% (YoY) from 6.2% previously. What is remarkable is that while the rest of the region is struggling with weak global demand, manufacturers in Vietnam are still running at close to full capacity. Overall exports grew by a healthy clip of 5.4% YoY in the first eight months of the year (Chart 2). As export growth outpaced imports, overall trade balance has improved. The external balance reported a cumulative surplus of USD 382mn over the past two months after a deficit of USD 97mn in May-June. We expect trade balance for the year to return to a surplus after a disappointing deficit of USD 3.6bn in 2015. Electronics remain the key driver of total exports (Chart 3). Exports of electronics products continue to surge as MNC investments over the past years is bearing Electronics is still fruit. Essentially, the electronics cluster in Vietnam is capturing the market share of the key driver regional peers amid the geographical shift in Asia’s electronics supply chain. However, while Vietnam’s PMI is up, supported by a modest improvement in China’s manufacturing sector, the PMIs of its key trading partners, the US and Eurozone, have continued to languish (Chart 4). If over-arching global demand remains weak, growth prospects for the manufacturing sector are dim in the medium-term. This will consequently post downside risks to overall growth prospects.
Slower growth With an average growth of just 5.6% in the first half of the year, the official growth target of 6.7% is no longer achievable. In fact, there is even downside risk to our previous forecast of 6.3%. Even if we assume crops output will recover from the impact of the drought, weak external demand will keep a lid on manufacturing performance. Indeed, the external environment has been challenging and will remain so in the coming quarters. Slowdown in China is the main concern. It is structural in nature and the impact on the region will last for a while. In addition, sluggish growth
107 Vietnam Economics–Markets–Strategy
Chart 5: Growth and inflation outlook DBSf % YoY Real GDP growth % YoY 7.5 5.0 Inflation (RHS)
7.0 4.0
6.5 3.0
6.0 2.0
5.5 1.0
5.0 0.0 Mar-15 Sep-15 Mar-16 Sep-16 Mar-17 Sep-17
in the US, compounded by risks of Fed tightening and the US election will stoke uncertainties in the global economy in 2H16. And this will likely be exacerbated by concerns surrounding a post-Brexit Eurozone. Confluence of factors essentially means external headwinds will remain strong, which will weigh down on growth. As such, we have lowered our full year GDP growth forecast to 6.0%, down from the previous forecast of 6.3% (Chart 5). Assuming that global growth normalises after aforementioned risk factors come to pass, overall GDP growth is expected to return to our long held forecast of 6.4% in 2017.
Between a rock and a hard place Inflation has been rising steadily since the start of the year (Chart 5). High food prices from the drought and cuts in healthcare subsidies have fueled the increase despite low energy prices. In fact, inflation is set to rise in the coming months, on further increase in health-care and education costs in the coming quarters. With that, inflation is likely to rise above 4% towards the end of the year. Overall inflation will average 2.4% in 2016, up from our previous forecast of 2.0%. The main spike will occur in the months when there are subsidy cuts. Furthermore, credit growth is expected to surpass the targeted growth rate of 18- 20% on the back of healthy investment growth. With inflation and credit like to continue rising, the pressure is for the State Bank of Vietnam (SBV) to step on the brakes by tightening monetary policy. However, a large part of higher inflation stems from cuts in subsidies. This is aimed SBV will maintain at rationalising fiscal balances to ensure longer term sustainability. To the extent a steady policy inflation is policy-driven, the impact will be temporary and the need to tighten stance monetary policy will be less pressing. Indeed, we expect inflation to ease from 2H17. Moreover, growth is slowing. Though part of the slowdown is weather related and the effect is expected to be transient, external economic conditions remain challenging, which could impact growth outlook in the medium term. Considering downside risk to growth associated with the uncertainties in the global economy and the transient nature of the inflationary pressure, we believe the central bank will focus on macroeconomic stability by maintaining the refinance rate at 6.50% in the coming quarters.
108 Economics–Markets–Strategy Vietnam
Vietnam Economic Indicators
2015 2016f 2017f 2Q16 3Q16 4Q16 1Q17f 2Q17f 3Q17f Real output and demand GDP growth 6.7 6.0 6.4 5.6 5.9 6.9 6.1 6.6 6.7
Real supply Agriculture & forestry 2.4 1.2 2.3 0.9 1.9 3.3 1.8 2.4 2.4 Industry 9.4 7.6 8.7 7.4 7.4 9.4 8.0 9.0 9.7 Construction 10.8 9.4 7.6 7.7 10.0 10.0 8.0 8.0 6.8 Services 6.3 6.3 6.3 6.6 6.2 6.3 6.3 6.3 6.3
External (nominal) Exports (USD bn) 162.0 171.5 182.0 43.4 44.7 44.8 41.4 46.2 47.4 Imports (USD bn) 165.6 169.8 179.9 43.4 44.2 44.8 40.0 46.1 46.7 Trade balance (USD bn) -3.6 1.7 2.1 0.1 0.5 -0.1 1.4 0.1 0.7
Current account bal (USD bn) 0.6 1.2 1.5 n.a. n.a. n.a. n.a. n.a. n.a. % of GDP 0.3 0.6 0.7 n.a. n.a. n.a. n.a. n.a. n.a.
Inflation CPI inflation (% YoY) 0.6 2.4 3.4 2.2 2.5 3.5 4.6 3.8 3.2
Other Nominal GDP (USDbn) 193 209 216 n.a. n.a. n.a. n.a. n.a. n.a. Unemployment rate (%, sa, eop) 2.1 2.4 2.3 n.a. n.a. n.a. n.a. n.a. n.a.
- % change, year-on-year unless otherwise specified
VN - nominal exchange rate VN – policy rate VND per USD % pa 22900 14.0 22100 13.0
21300 12.0
20500 11.0 10.0 19700 9.0 18900 8.0 18100 7.0 17300 6.0 16500 5.0 15700 4.0 Jan-07 Jun-09 Nov-11 Apr-1 4 Sep-16 Jan-07 Dec -0 8 Nov-10 Oct-12 Sep-14 Aug-16
109 Economics: United States Economics–Markets–Strategy
US: recovery proceeds
• Labor markets are stronger than ever • Consumption remains robust • Housing is running off-the-charts (northward) • Wage growth and core inflation are headed north. At 2.3% YoY (3mma), core CPI inflation is already three ticks above the Fed’s target • The Fed is falling increasingly behind the curve
Nonfarm payrolls bounced back sharply in June and July from the plunge in May (to 24k) that scared the Fed away from hiking rates in June/July. Payrolls averaged 273k in those two months and even after the payback in August have averaged 232k for the past three. The bottom line is, volatility notwithstanding, payrolls continue to grow at the 210k trend pace that has prevailed for the past five years (chart below). With working age population growth now down to 0.4% per year, only 55k jobs need to be created every month to absorb the new entrants into the labor force. The rest of the 210k / month go to lowering the unemployment rate. Officially, that has remained unchanged at 4.9% for the past 8 months. But the steadiness owes to 1.6 million workers who have re-entered the labor force as demand for workers (and wages) continues to rise. Job growth could strengthen further given the recent JOLTs (job openings and la- bor turnover) data. Vacant positions jumped by 228k in July to 5.9 million. At this level, employers are actively seeking to fill 1.7 million more positions than they were two years ago. That’s after the 5.8 million workers they actually did hire over the period. In short, labor demand is outstripping supply and wage growth has finally begun to accelerate. After running sideways at 2% YoY between 2011-2015, wages turned north in early-2015 and are now rising at a 2.6% clip (3mma).
US - nonfarm payrolls NFP x1000, sa
400 Apr11 Jan12 Nov14 5-yr average: 210k Oct15 Jun/Jul16 300
200
Aug16 100
Mar15 Dec13 May16 0 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 UNITED STATES David Carbon • (65) 6878-9548 • [email protected]
110 Economics–Markets–Strategy Economics: United States
US - initial jobless claims thousand claims/week, seas adj, 4wma 650 Subprime crash 600
550 91 Dotcom recession crash 500 450 400 350 300 Subprime Yellen 250 Dotcom bubble bubble bubble? 200 90 92 94 96 98 00 02 04 06 08 10 12 14 16
Tight labor markets show up just as clearly on the firing side of the equation. Em- ployers are letting go of no one. Weekly jobless claims are, even in absolute num- bers, near their lowest in history (chart above). As a proportion of the labor force, they have never been lower (chart below). Jobless claims are at historical lows. Consumption and housing Wages are finally Real (inflation-adjusted) consumption growth accelerated sharply to a 4.4% (QoQ, rising saar) pace in the second quarter. Some of this was mere ‘payback’ for a weak first quarter but on-year growth is accelerating too. At 3.0% YoY in July, consumption growth is back near post-crisis peaks (chart at top of next page). Durables, non- durables and services are all driving the rise. New home sales have surged in recent months, reaching 654k (saar) in July, some 5 standard deviations above their (already strong) 12% growth trend (chart at bottom of next page). What are the odds of a 5-sigma surge occurring by chance? One in 3.5 million. Sales haven’t surged by chance. Strength owes to 7 years of recovery
US – jobless claims as % of labor force percent, 4wma 0.70
0.60
0.50
0.40
0.30
0.20
0.10 67 69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 11 13 15 17
111 Economics: United States Economics–Markets–Strategy
US - real personal consumption growth %YoY 5
4
3
Consumption is 2 acceleratiing 1
0
-1
-2
-3 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16
and interest rates at post-WWII lows. A 15-year fixed rate mortgage now costs 2.65% per year. As a result, mortgage applications (for purchase) have jumped by 75% over the past five quarters. National average home prices continue to rise at a 5.5% on-year pace. In many cities (Boston, Charlotte, Dallas, Denver, San Francisco, Portland, Seattle) prices have now surpassed their pre-crisis peaks. National aver- age prices will, on current trends, surpass their pre-crisis peak in early-2017. Higher wages and home prices are helping push inflation north. While headline in- flation remains low thanks to oil prices (a supply issue), core inflation took the same turn north in early-2015 that wages did (chart opposite). Core CPI inflation has ac- celerated to 2.3% YoY over the past three months, a post-crisis high and three ticks above the Fed’s medium-term target. Officials keep saying they want to see evidence that inflation is heading toward their 2% target before resuming rate hikes. Core CPI inflation passed the Fed’s tar- get six months ago (chart next page). The Fed is falling behind the curve.
US – new home sales
thous/mth, saar Jul16: 5 standard 650 deviations New home sales above trend are 5 sigmas above 600 trend. The odds of 550 that happening by chance are one in 500 3.5 million 12% growth 450 path
400
350 Jul13
300
250 10 11 12 13 14 15 16
112 Economics–Markets–Strategy Economics: United States
US Economic Indicators
--- 2016 ------2017 --- 2015 2016(f) 2017(f) Q1 Q2 (f) Q3 (f) Q4 (f) Q1 (f) Q2 (f) Q3 (f) Output & Demand Real GDP* 2.6 1.7 3.0 0.8 1.1 3.9 3.2 2.9 2.9 3.0 Private consumption 3.2 2.8 3.0 1.6 4.4 3.3 3.0 2.8 2.8 2.8 Business investment 2.1 -0.7 3.4 -3.4 -0.9 2.0 3.0 4.0 4.0 5.0 Residential construction 11.7 7.6 7.2 7.8 -7.7 16.0 12.0 6.0 6.0 5.0 Government spending 1.8 1.0 1.0 1.6 -1.5 1.5 1.5 1.0 1.0 1.0 Exports (G&S) 0.1 0.0 4.1 -0.7 1.2 3.2 4.2 3.8 5.1 5.0 Imports (G&S) 4.6 0.8 3.1 -0.6 0.3 2.5 3.0 3.0 4.0 4.0 Net exports ($bn, 09P, ar) -540 -563 -560 -566 -562 -562 -560 -560 -560 -560 Stocks (chg, $bn, 09P, ar) 84 12 10 41 -12 10 10 10 10 10 Contribution to GDP (pct pts) Domestic final sales (C+FI+G) 3.1 2.2 -103.4 1.2 2.3 3.4 3.2 2.9 2.9 3.0 Net exports -0.7 -0.1 0.0 0.0 0.1 0.0 0.0 0.0 0.0 0.0 Inventories 0.2 -0.4 0.0 -0.4 -1.3 0.5 0.0 0.0 0.0 0.0 Inflation GDP deflator (% YoY, pd avg) 1.0 1.7 2.1 CPI (% YoY, pd avg) 0.1 1.3 2.2 1.1 1.1 1.4 1.6 2.0 2.2 2.3 CPI core (% YoY, pd avg) 1.9 2.4 2.4 2.3 2.3 2.4 2.5 2.5 2.4 2.3 PCE core (% YoY, pd avg) 1.4 1.8 2.2 1.7 1.6 1.8 2.0 2.2 2.3 2.2 External accounts Current acct balance ($bn) -470 -519 -507 Current account (% of GDP) -2.6 -2.8 -2.6 Other Nominal GDP (US$ trn) 17.9 18.5 19.5 Federal budget bal (% of GDP) -2.7 -2.6 -2.5 Nonfarm payrolls (000, pd avg) 196 146 210 220 225 220 210 Unemployment rate (%, pd avg) 4.9 4.9 4.7 4.6 4.5 4.5 4.5
* % period on period at seas adj annualized rate, unless otherwise specified
US - wage growth and core CPI inflation %YoY 3.0
Avg hourly 2.5 earnings
2.0
1.5
1.0 core CPI
0.5 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16
Sources for charts and tables are CEIC Data, Bloomberg and DBS Group Research (forecasts are transformations).
113 Japan Economics-Markets-Strategy
JP: Abenomics 3.0
• It is the third time for Japan to pursue the twin easing of fiscal and mon- etary policies since Abenomics was introduced • The private sector remains cautious to spend, amid external and internal uncertainties (including a volatile yen, negative interest rates and weak global growth) • The current fiscal stimulus package may not help much. Extra spending for FY2016 is close to that in each of the previous three years • The BOJ is facing pressure to revamp its monetary policy, improving the flexibility and sustainability of the current framework. But radical easing, like “helicopter money”, is not on the table
Since Prime Minister Shinzo Abe took office and introduced Abenomics three years ago, it is now the third time for Japan to pursue the twin easing of fiscal and monetary policies. The government announced a JPY 28trn fiscal stimulus package in Jul16 and the Bank of Japan (BOJ) expanded its ETF purchases during the same month. This was right after the ruling LDP party won the upper house election in mid-Jul16 and pledged to step up efforts to support the economy. But the financial market reactions were different from that in 2013 and 2014 when Abenomics 1.0 and 2.0 were respectively introduced. The Nikkei rose only temporarily, the JPY appreciated versus the USD, and JGB yields inched up. By contrast, market reactions after the first two rounds of policy easing were broadly positive – rising equity prices, a weaker yen and lower bond yields.
The private sector remains cautious Essentially, the persistent weakness in economic data – notwithstanding two rounds of policy easing – has dampened investors’ confidence on Abenomics. Real GDP grew just 0.6% on average over the past three years. In the recent five quarters ending 2Q16, GDP growth averaged merely 0.3% (QoQ saar, Chart 1). Private consumption remained stubbornly weak after a sharp contraction triggered by the
Chart 1: GDP growth & contributions % QoQ saar, ppt 10
5
0
-5
-10 Net exports Investment -15 Private consumption GDP JAPAN -20 1Q12 3Q12 1Q13 3Q13 1Q14 3Q14 1Q15 3Q15 1Q16
Ma Tieying • (65) 6878 2408 • [email protected]
114 Economics-Markets-Strategy Japan sales tax hike in 2014. Meanwhile, exports and capital investment have started to deteriorate in recent months due to impact from a stronger yen. The near-term outlook remains lackluster. The corporate sector remains cautious to spend, amid a high degree of external uncertainties including the yen’s volatility and weak growth in the global economy. Reflecting the cautious attitude in the corporate sector, base wages for employees have remained nearly flat this year, despite the increase in the one-time bonuses (Chart 2). Without a rise in base wages, it would be difficult to expect a sustainable recovery in private consumption. Meanwhile, the negative interest rates adopted by the BOJ since the beginning of this year have created a complex and uncertain environment for financial institutions. Pension funds and insurance firms suffered from a decline in investment returns as long-term bond yields turned negative. Banks also came under stress as their interest rate margins narrowed. While banks’ mortgage loans growth has picked up slightly over the past half a year, overall loans growth continued to ease due to weak demand from the corporate sector (Chart 3). Without an expansion in total loans, the decline in interest rate margins will erode banks’ profits inevitably.
Fiscal stimulus may not help much The government’s new stimulus package may not help GDP growth by much. The cabinet has approved a JPY 28trn fiscal stimulus package in Aug16. It is seeking to pass the supplementary budget during the parliament session in Sep16 and implement it from 4Q16. More funds will be spent on upgrading public infrastructure in the Direct govern- run-up to the 2020 Tokyo Olympics, and promoting reconstruction works in the ment spending earthquake-hit areas earlier this year. will increase an But the overall impact on GDP growth should be small. The JPY 28trn stimulus extra JPY 4.5trn in package is largely comprised of low-interest loans, public-private partnerships and FY2016 other forms of indirect supports. Direct spending by the government amounts to only JPY 7.5trn. Moreover, the stimulus package will be implemented over several years. Outright spending allocated for FY2016 is only JPY 4.5trn, similar to the size of the supplementary budget in each of the previous three years (JPY 3-5trn). As such, the contribution to GDP growth, which is measured based on the year-on-year change in government expenditures, will be very marginal.
The BOJ likely to revamp monetary policy The BOJ is facing a tough situation. Its policy delivery has disappointed investors and triggered market swings several times this year. At the latest meeting in Jul16, the BOJ accelerated the pace of its ETF purchases from JPY 3.3trn annually to JPY 6trn. But it refrained from expanding the size of total asset purchases or further cutting the negative rate on excess reserves.
Chart 2: Wage growth Chart 3: Bank Loans growth % YoY % YoY 2.0 4.0
1.0 3.0
0.0 2.0 -1.0 Total 1.0 -2.0 Loans to corporates Base wages Loans to individuals Total wages -3.0 0.0 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-13 Jan-14 Jan-15 Jan-16
115 Japan Economics-Markets-Strategy
The board members will conduct “a comprehensive assessment” on economic/ financial conditions and the effectiveness of monetary policy at the next meeting on 20-21 Sep. This comprehensive assessment probably implies a policy revamp. Foremost, the BOJ may adopt a more flexible approach on its 2% inflation target, such as deleting the timeline imposed on it. The BOJ had promised to take inflation to 2% “in about two years” when introducing the QQE (Quantitative and Qualitative Easing) in Apr13. But this timeline has been pushed back several times due to the collapse in global oil prices and the slowdown in domestic GDP growth. Currently, the BOJ promises to take inflation to 2% in FY2017. This still appears very The focus is to difficult to achieve. The actual headline CPI has turned negative since Apr16 and improve the flex- remained at -0.5% as of Jul16. Core-core CPI (excluding fresh food and energy), ibility and sus- which is tracked closely by the BOJ as a measure of underlying inflation, has also tainability of the fallen to just 0.5% in Jul16 (Chart 4). The large gap between the actual and targeted current monetary inflation often fuels investors’ speculations about monetary easing. This results in policy framework market swings as the BOJ can’t ease policy every time to meet investor expectations. If the BOJ were to move to a flexible inflation target, it could trigger negative market reactions initially as investors may interpret it as a setback in the central bank’s reflation campaign. But the longer-term impact should be positive. A flexible inflation target will help to manage down the expectations for monetary easing and reduce the risk of market volatility in the longer-term. Meanwhile, in terms of the policy instruments, the BOJ may adjust the composition of QQE to improve its sustainability. There are growing concerns that the BOJ is facing technical limits to buy more government bonds, because it already owns one third of outstanding JGBs and importantly, the liquidity in the JGB market is falling (Chart 5). If the BOJ wants to maintain the current pace of QQE, it will need to broaden the category of asset purchases eventually. Alternatively, it could increase the flexibility in the targeted pace of asset purchases under QQE. As far as the negative rate policy is concerned, the BOJ is expected to handle it in a cautious manner. From the technical perspective, there is some room for the BOJ to trim rates further from the present level of -0.1%. In practice, however, the BOJ may find it necessary to tread it carefully, striking a balance between the benefits and risks. Any further rate cuts would be small and gradual. And it would be accompanied by complementary measures to offset the side effects. Regarding radical easing measures like “helicopter money” – directly financing government spending or monetizing fiscal deficit, chances remain low. There are legal hurdles that must be overcome. Meanwhile, the possible consequences of greater uncertainties / market volatilities should also dissuade the BOJ from pursuing such controversial measures.
Chart 4: CPI inflation Chart 5: The BOJ's holdings of JGBs % YoY (excl. consumption tax hike) % of the outstanding total JGBs 2.0 60 BOJ's 2% target 1.5 50
1.0 40
0.5 30
0.0 20
-0.5 Headline CPI 10 Core-core CPI -1.0 0 Jan-13 Jan-14 Jan-15 Jan-16 2010 2011 2012 2013 2014 2015 2016 2017 2018
116 Economics-Markets-Strategy Japan
Japan Economic Indicators
2015 2016f 2017f 2Q16 3Q16f 4Q16f 1Q17f 2Q17f 3Q17f Real output and demand GDP growth 0.5 0.6 0.6 0.8 0.5 1.1 0.7 0.7 0.6 Private consumption -1.2 0.4 0.5 0.4 0.2 1.2 0.6 0.5 0.5 Government consumption 1.2 2.0 1.2 2.0 2.1 1.6 1.0 1.2 1.2 Private & public investment 0.2 0.5 0.9 1.0 0.7 0.6 1.3 0.5 0.8
Net exports (JPYtrn, 05P) 11.9 11.5 11.0 3.1 2.9 2.7 2.5 3.1 2.8 Exports 2.8 -1.0 1.8 -0.1 -1.3 0.1 0.5 2.5 2.0 Imports 0.3 -0.7 2.6 -0.6 -0.9 0.8 2.1 2.8 2.8
External (nominal) Merch exports (JPY trn) 76 69 72 17 17 18 18 18 18 - % YoY 3.4 -8.1 3.3 -9.6 -10.0 -5.0 0.4 4.2 4.9 Merch imports (JPY trn) 78 66 70 16 16 18 17 17 17 - % YoY -8.7 -15.4 5.4 -18.6 -19.1 -7.6 0.8 8.1 8.3 Merch trade balance (JPY trn) -3 3 2 2 1 0 0 1 1
Current acct balance (USD bn) 136 175 161 ------% of GDP 3.3 3.9 3.6 ------
Foreign reserves (USD bn) 1,233 1,257 1,255 ------
Inflation CPI, % YoY 0.8 -0.2 0.5 -0.4 -0.4 -0.2 0.2 0.5 0.7
Other Nominal GDP (USD bn) 4126 4718 5059 ------Unemployment rate (%, sa, eop) 3.3 3.1 3.1 3.1 3.1 3.1 3.1 3.1 3.1 Fiscal balance (% of GDP) -6.5 -6.7 -6.3 ------
* % growth, year-on-year, unless otherwise specified
JP - nominal exchange rate JP – policy rate %, call JPY per USD 0.8 130 125 0.7
120 0.6 115 0.5 110 0.4 105 100 0.3
95 0.2 90 0.1 85 80 0.0 75 -0.1 Jan-07 Jun-09 Nov-11 Apr-1 4 Sep-16 Jan-07 Dec -0 8 Nov-10 Oct-12 Sep-14 Aug-16
117 Eurozone Economics–Markets–Strategy EZ: treading water
• Weak demand persists domestically and externally. We lower our 2016 growth forecast to 1.6% from 1.7% previously • Weak supply-side pressures and excess capacity will keep headline infla- tion below target at 0.1% in 2016 and 0.6% next year • More monetary policy easing is likely but not imminent • Pressure remains for less fiscal austerity / more stimulus
The economy expanded by 0.4% (QoQ, sa) in the first half of the year. In on-year terms, GDP grew by 1.7% (YoY) in 1H16, moderating from 2015’s 1.9%. While the momentum in domestic demand remains encouraging, support from external trade and other exogenous factors continue to recede. The fallout of the UK referendum has however been confined to confidence indices yet far. Household spending accounted for much of 1H16 growth, followed by government spending and fixed capital formation. Discretionary incomes got a hand from the slow but easing unemployment rate and low inflation. Jul unemployment rate steadied at 10.1%, a five year low. Wage pressures are beginning to stir, with hourly labor costs up 1.7% YoY in 1Q16 from 2015’s 1.5%. These have, however, been insufficient to spur price pressures (Chart 1). Signs are of a let-up in stringent fiscal austerity as 1Q16’s deficit widened modestly. Punitive action on Spain and Portugal was also deferred despite a breach of the zone’s budgetary rules. Meanwhile, private sector activity been treading water as reflected in Jul-Aug PMIs and production hit a soft patch, mainly due to capital and intermediate goods. The
Chart 1: GDP growth - breakdown Chart 2: GDP growth and inflation percentage pts % YoY 2.5 3.0
1.5 2.0
0.5 1.0 0.5 0.0 1.5
-1.0 2.5 GDP Inflation -2.0 Sep-12 Sep-13 Sep-14 Sep-15 Mar-12 Mar-13 Mar-14 Mar-15 Mar-16 10 11 13 14 16 Net exports Domestic dd GDP EUROZONE
Radhika Rao • (65) 6878 5282 • [email protected]
118 Economics–Markets–Strategy Eurozone business investment rate continues to stagnate, along with subdued pricing power despite better margins (due to low input prices). External factors are less favorable, as both exports and imports extended declines into the Jun quarter. The boost from supportive exogenous factors, i.e. low oil prices, weak euro and easy monetary policy have also waned. The euro has been range-bound, reacting little to the ECB’s policy overtures. Factoring in tailwinds from a stronger domestic sector, but partly offset by weak trade dynamics, we look for the Eurozone economy to expand by 1.6% YoY this year and hold steady at the same pace in 2017. This marks a modest downward revision from our estimate of 1.7% and 1.8% for 2016, 2017 respectively.
Muted impact from Brexit thus far, ears to the ground Shrugging the UK referendum results, risk assets recovered globally. Equities were up, currencies stabilized and bond yields were down on anticipation of further policy easing by the BOE/ BOJ/ECB. An end to the UK political impasse also calmed nerves. Skeptics came around the view that the economic fallout might be more localized to the UK than earlier feared. Eurozone data has been yet far, resilient to the Brexit vote. The European Commission economic sentiment indicators have recovered from July’s drop. Early 3Q PMIs are largely unaffected (Chart 3), setting the economy on course to expand by 0.3% QoQ, not far from the 1H average. Even as sentiments stabilize, one should be mindful that the UK government is yet One needs to be to trigger Article 50 of the EU treaties, to officially kickstart the exit process. Hence mindful that the there are risks in the horizon, especially to the external sector as GBP weakness Article 50 is still to outweighs the extent of adjustment in the euro. This could put trade relations be triggered under strain. There is also a high likelihood that investment decisions and capital spending plans will be put on hold until clarity on the exit process is available. More recently, signs of limited easing measures by BOJ/ECB have also seen bonds return part of the past gains.
ECB remains the only game in town While growth momentum is positive and fallout of the Brexit vote manageable thus far, these have been insufficient to spur inflation. Jan-Aug16 Eurozone inflation averaged 0.03% YoY, way below the 2% target. Weak supply-side factors have been the dominant factor in suppressing price pressures. Matters are exacerbated
Chart 3: Manufg PMIs steady despite Brexit vote Chart 3: Wage growth inches up qtrly avg, pts % YoY 55 2.6 2.4 53 50 - 2.2 neutral 51 2.0
49 1.8 1.6 47 1.4 45 Wages and salaries 1Q13 3Q13 1Q14 3Q14 1Q15 3Q15 1Q16 Jul-Aug 1.2 Negotiated wages 1.0 11 12 13 14 15 16
119 Eurozone Economics–Markets–Strategy
by excess capacity and subdued wage pressures (Chart 4). Energy price inflation declined by -7.2% (YoY) in first eight months of the year, weaker than 2015’s -6.8%. By contrast, core inflation has been firm at 0.8%-0.9%, though weighed by moderating inflationary expectations. We expect inflation to average 0.1% YoY this year, followed by 0.6% next year, still below official targets. Pressure for more action from the European Central Bank will persist. In September, the ECB flagged downside risks to growth from external uncertainties but played down the urgency for imminent action. Committees have been tasked to ensure that QE works smoothly. Official quarterly GDP and inflation projections were tweaked marginally. Expectations for a sharper pick-up in 2017-18 inflation was largely due to a rise in the ECB’s oil price assumptions and unfavorable base effects. Despite the pressure, we expect the ECB to preserve ammunition in light of concerns on the availability of eligible bonds (based on capital key, cut-off yields, issuers’ limits) to meet the monthly EUR 80bn target until and beyond March 2017. In particular, concerns surround the eligible pool of German assets (which account for the biggest chunk of bond purchases), if the current criteria are not tweaked. Germany’s plan to maintain a balanced budget balance profile also adds to the scarcity factor.
After a status quo Hence, while policy action is not imminent, the ECB will keep the door for further in Sept, attention policy action. December’s review will come under the scanner next when updated shifts to Dec’s quarterly numbers will be available. The next course of action could be a combination review of QE timeline extension beyond March 2017, ease restrictions surrounding these purchases, expand assets’ categories or consider further negative rates. Apart from the timeline extension, any decision on altering the eligibility criteria is unlikely to come easy.
Fiscal support and reforms As monetary policy space appears more constrained, there is likely to be a push for more accommodative fiscal policy. Encouragingly, the bloc-wide fiscal deficit met the Maastricht treaty last year, narrowing to -2.1% of GDP from its peak of -6% in 2009-10. At the start of this year however there are signs that the fiscal stranglehold is being loosened. 1Q16 deficit re-widened to -3.1% of GDP, accompanied by a slight deterioration in the primary deficit (excluding interest payments). Hence pressure
Chart 5: CPI headline and core inflation Chart 6: Eurozone fiscal balances YoY, % as % of GDP, 4Q mvg avg 5.0 5.0 ECB inflation target 4.0 3.0
3.0 1.0
2.0 -1.0
1.0 -3.0 0.0 -5.0 1.0 -7.0 Jan-03 Jul-05 Jan-08 Jul-10 Jan-13 Jul-15 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 CPI Core CPI Budget bal Primary bal
120 Economics–Markets–Strategy Eurozone will remain on economies with the available fiscal space, particularly Germany. With yields in negative territory out to the 10Y tenor, borrowing costs are also low, providing an ideal backdrop to loosen purse strings. The German government however remains reluctant and continues to run surplus balances. Slower growth might provide an impetus to reverse their fiscal stance, as would rising immigration- related expenditure. A handful of economies which are in breach of the legal thresholds are likely to be given more time to adjust their books. France recently announced tax cuts and tax credits this year, which will put pressure on its deficits. The absence of a government in Spain could lead to an overshoot in the public finances. But a looser fiscal stance will need to be balanced with containing the overall public debt levels which have routinely been a flash-point for the bloc. In all, the ECB is likely to push for more fiscal and reforms support to boost growth. Key event risks in the horizon include the late-Oct16 Italian referendum, Greek bailout negotiations, banking sector concerns, upcoming elections in Germany/ France and uncertainty over Spain’s political leadership. Any deterioration in the external environment will renew the push for the Eurozone to accelerate the move towards a common banking and fiscal union for long-term sustainability.
121 Eurozone Economics–Markets–Strategy
Eurozone Economic Indicators
2015 2016f 2017f 2Q16 3Q16f 4Q16f 1Q17f 2Q17f 3Q17f Real output and demand (% YoY) GDP growth (05P) 1.9 1.6 1.6 1.6 1.5 1.5 1.3 1.6 1.8 Private consumption 1.7 1.5 1.5 1.7 1.2 1.1 1.0 1.6 1.8 Government consumption 1.4 1.7 1.0 1.8 1.7 1.2 0.8 0.6 1.3 Gross capital formation 2.9 1.9 1.7 2.4 2.0 0.8 1.4 1.4 2.2
Net exports (EUR bn) 410 418 435 106 105 110 105 110 107 Exports (G&S) (% YoY) 6.1 2.3 1.7 2.2 2.2 2.4 2.4 1.7 1.7 Imports (G&S) (% YoY) 6.1 2.3 1.5 2.8 2.1 1.2 1.8 1.4 1.7
Contribution to GDP (pct pts) Domestic demand 1.7 1.7 1.4 na na na na na na Net Exports 0.2 -0.1 0.2 na na na na na na
External accounts Current account (EUR bn) 334 350 370 na na na na na na % of GDP 3.2 3.3 3.4 na na na na na na
Inflation HICP (harmonized, % YoY) 0.0 0.1 0.6 -0.1 0.2 0.4 0.5 0.4 0.6
Other Nominal GDP (EUR trn) 105 107 110 na na na na na na Unemployment rate (%, sa, eop) 10.5 10.0 9.8 na na na na na na
EZ - nominal exchange rate EZ – policy rate USD per EUR %, refi rate 1.7 5.0 4.5 1.6 4.0
1.5 3.5 3.0 1.4 2.5 1.3 2.0
1.2 1.5 1.0 1.1 0.5 1.0 0.0 Jan-07 Jun-09 Nov-11 Apr-1 4 Sep-16 Jan-07 Dec -0 8 Nov-10 Oct-12 Sep-14 Aug-16
122 Economics–Markets–Strategy September 15, 2016
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