Singapore Focus I

3Q 2015

Singapore focus I: Can Singapore government securities outperform during a global bond sell off? Singapore focus II: Housing: Volume down, prices holding up so far China focus I: A brief on the "silk road economic belt and 21st century maritime silk road" China focus II: Aiming for the SDR basket CONTENT

EXECUTIVE SUMMARY 3 THE WAITING GAME IN 2H 2015 FX & INTEREST RATE OUTLOOK 10 SINGAPORE FOCUS I 11 CAN SINGAPORE GOVERNMENT SECURITIES OUTPERFORM DURING A GLOBAL BOND SELL OFF? SINGAPORE FOCUS II 14 HOUSING: VOLUME DOWN, PRICES HOLDING UP SO FAR CHINA FOCUS I 19 A BRIEF ON THE "SILK ROAD ECONOMIC BELT AND 21ST CENTURY MARITIME SILK ROAD" CHINA FOCUS II 22 AIMING FOR THE SDR BASKET CHINA FOCUS III 27 MARKET LIBERALIZATION MEASURES UPDATE CHINA FOCUS IV 29 RMB INTERNATIONALIZATION UPDATE

INDONESIA 32 MALAYSIA 33 SINGAPORE 34 THAILAND 35 INDIA 36 CHINA 37 HONG KONG 38 JAPAN 39 SOUTH KOREA 40 TAIWAN 41 EUROZONE 42 AUSTRALIA 44 NEW ZEALAND 45 UNITED KINGDOM 46 UNITED STATES OF AMERICA 47 FX TECHNICALS 48

Information as of 19 June 2015 EXECUTIVE SUMMARY THE WAITING GAME IN 2H 2015

As we enter into the second half of 2015, we con- two 25 bps hike this year and then possibly four tinue to be troubled by unresolved issues of the re- 25bps hikes in 2016. But when exactly? While we cent past and waiting for the outcomes which hope- missed the mark in our expectation that the US fully will be positive or at least palatable, and let the Fed liftoff would begin in June, we still expect the global economy continue on its recovery road. Fed rate normalization to take place in 2015. Fol- lowing the dot plot chart guidance, we now look for Indeed, the state of the global economy remains a the first hike to take place at the 16-17 Sep 2015 concern: Chinese data continued to show econom- FOMC, followed by the second move at the 15-16 ic growth momentum stuck at a tepid pace of “new Dec FOMC. We have further lowered our rate hike normal” and the Chinese central bank responded trajectory, bringing the FFTR to 0.75% by end-2015 with another rate cut in May, its third in six months (from 1.0% previously), and to 1.75% by end-2016 and more easing measures are expected to be un- (from 2.0% previously). Our September FOMC lift- veiled in 3Q. The growth bright spots are surprising- off view is still premised on three factors: ly found in the Eurozone and Japan where the data point to better prospects ahead but Greece could 1. An expected growth rebound in 2Q & 3Q-2015 potentially trip up not just Europe but also the glob- in the US (similar to what we experienced in al economy. Global oil prices which plunged in late 2014); 2014, has stabilized in recent months and provided 2. Tighter labor market conditions and Increasing some comfort to oil producers as well as allaying US domestic wage pressure; and most impor- concerns that price weakness will be further aggra- tantly, vated in 2H. Additionally, the prospects of a return 3. The Fed Reserve’s desire to get away from of El Nino weather phenomenon in 2015 could re- the prolonged state of zero-interest rate policy verse the recent commodity price weakness (such (ZIRP) environment. as rice) and set a return path for inflation not only in Asia but also globally. That said, as the Fed emphasized their monetary policy formulation is data-dependent, there unfor- One key concern for the markets will still be about tunately remains significant risk to both our project- the US Federal Reserve’s timeline for its interest ed timeline and rate trajectory. In addition, we are rate normalization. At the conclusion of the June worried that US politics could re-emerge as a risk 2015 FOMC meeting, US Federal Reserve Chair factor for Fed policy making in 4Q 2015 (just like Janet Yellen reiterated that rate liftoff remains on in late 2013 during Bernanke’s Fed Chairmanship course in 2015 but continued to emphasize on when the US debt ceiling crisis erupted) could pos- data-dependent guidance and that exact timing of sibly delay the rate hike schedule in the September liftoff matters less than the path of rate hike, which meeting. Specifically, we fear there may be a re-run is likely to be gradual. The 2015 and 2016 “dot plot” of the US debt ceiling limit drama come late 2015 chart projections released at the June FOMC imply (when US$18.113trn US debt ceiling limit must be

Central Banks’ Policy Decisions on Rates in So Far In 2015 – Will US Finally Tighten Instead?

Contractionary Expansionary

Source: Bloomberg, Various news wires

4 Quarterly Global Outlook 3Q2015 • UOB Global Economics & Markets Research EXECUTIVE SUMMARY

raised in 4Q 2015 for the US government to stay ther 5-10% price decline. Mortgagee sales have under the limit). Some believe that it will be different spiked as more buyers default. this time as we will have the 2016 US Presidential primary campaigns and both Republicans & Demo- And while the high-end segment remains under crats lawmakers will avoid political brinkmanship pressure from supply overhang, mass market is in 2015. But nothing should be taken for granted also feeling the pinch as supply builds; shoebox these days, especially regarding US politics. units are particularly vulnerable. At the same time, vacancy rate could return to peak levels (~9%) on As the US Federal Reserve prepares the markets the back of a supply glut, especially as immigration for a “liftoff” this year, there is the other closely-fol- policies remain tight. lowed issue that is a “wilder” card within the deck of past unresolved problems – Greece. The debt prob- The Singapore Government is still unlikely to re- lems of Greece first surfaced in 2010. After simmer- verse policy measures unless prices decline more ing quietly in the background for a few years, the significantly. Soft landing could nonetheless be at issue has re-surfaced even more prominently this hand with generally strong balance sheets and ta- time when a anti-austerity government was voted pering land supply. into power in January 2015. Though our base case assumption remains to be that a last-minute deal CHINA IN FOCUS: will be reached (similar to past episodes) to resolve I. Silk Road Economic Belt and 21st Cen- its debt repayment to IMF, one cannot help but be tury Maritime Silk Road: China is embarking increasingly concerned that a man-made accident on an ambitious project by connecting to Asia, Af- can happen and send things spiraling out of control rica, and Europe through its land-based silk road towards default and “Grexit”. The matter was seri- and maritime silkroad. It is motivated by long-term ous enough for the US to warn against such sce- strategic needs as well as near term economic rea- nario at the G7 meeting on 29 May 2015. sons. The initiative is already in motion, with political support in China and financing falling in place A quote from Robert H. Schuller reads, “Again and through the establishment of the Silk Road Fund, again, the impossible problem is solved when we Asian Infrastructure Investment Bank, and the see that the problem is only a tough decision waiting BRICS Bank. In addition, various infrastructure pro- to be made.” The Fed is finding it tough to make the jects are already kicking off in countries along the decision when to start normalizing because it has “Belt and Road”. too many considerations. But the longer the Fed waits, the more difficult it gets and clearly markets II. Aiming for the SDR Basket: One key agen- are pricing that “difficulty” in now. In comparison, the da for China this year is being admitted to IMF’s tough decision that Greece has to make is too diffi- Special Drawing Rights (SDR) basket, as the once- cult to stomach. And without compromise from both in-5-years (“quinquennal”) review due by end-2015. sides, it looks increasingly likely for Greece take the A score with SDR could further accelerate the RMB other extreme “tough decision”, potentially leading internationalization efforts and adoption. However, to disastrous and unintended consequences. a positive decision remains uncertain at this year’s review, as it can be argued that China has yet to satisfy all the four requirements set out by IMF in SINGAPORE IN FOCUS I: 2011, and we peg the probability of RMB’s admis- Can Singapore Government Securities sion into SDR in 2015 at 60%. As China keeps its Outperform During A Global Bond Sell Off? eyes on the SDR basket, the risks of a sharp depre- SGS performance during previous periods of Bund ciation for the RMB would be low, and our projec- selling has been inconsistent; having outperformed tions for USD/RMB exchange rate still stand at 6.20 in April but underperformed in June. We view June for end-2015. We also expect a further widening of underperformance as driven by idiosyncratic fac- the RMB trading band to 3% from 2% sometime this tors which will diminish in significance going for- year. ward and together with light domestic supply, the prospects of SGS outperforming during future Bund III. Market Liberalization Measures: China liquidations is much improved. announced a slew of financial market liberalization in recent months, as it looks to strengthen its finan- SINGAPORE FOCUS II: cial markets and moves towards further opening of Housing: Volume Down, its capital accounts. Among the measures are the Prices Holding Up So Far Pledged Supplementary Lending (PSL), which co- Private residential property sales have plunged incides with the initiation of local government debt >50% to crisis lows but average prices were only swap program, large denomination certificates of 6% off the recent peak. However, rising interest deposit program which is now open to non-bank rates & a sharper fall in rentals could trigger a fur- corporates and individuals, and the approval for

Quarterly Global Outlook 3Q2015 • UOB Global Economics & Markets Research 5 EXECUTIVE SUMMARY

offshore RMB clearing and settlement banks to to move rates lower, and stay low for longer than participate in the onshore interbank bond market’s widely expected, this should see the NZD weaken. repurchase facilities. USD/JPY: Even without any new easing this year, IV. RMB Internationalization Update: PBoC the yen is about 2.7% weaker against the US dol- released on 11 Jun 2015 its first report on the RMB lar so far this year (as of 18 Jun). The USD/JPY internationalization efforts since 2009. Aside being pair was initially pushing to multi-year high of 125 in a treasure trove of data and information, it also pro- early June but BOJ Kuroda called for currency sta- vides an authoritative assessment of the progress bility on 10 June, saying that it was “hard to see [the so far and the road ahead. The report coincides JPY] real effective rate falling further,” which sent with the IMF’s SDR decision later this year (please the JPY strengthening towards 122 (from above see Focus II. Aiming for the SDR Basket, for more 125) against the US dollar. We keep our view for details). The gist is that RMB internationalization is USD/JPY to push fresh multi-year highs although gaining ground either through trade, investment, or the pair may be stuck in 120-124 range in early 3Q even cash notes, and is here to stay. The usage barring any unexpected global event. We expect and acceptance of RMB globally will be accelerated the USD/JPY pair to break conclusively above 125 if admission to SDR is a success. However, even when the Fed finally delivers the first rate action without SDR, PBoC is likely to continue to pursue (now expected in Sep 2015). the same path. Asian FX Global FX USD/CNY: The focus this year is the IMF review of EUR/USD: Despite the ongoing saga in Greece, its Special Drawing Rights (SDR) by end-2015 and the Euro has been able to find plenty of support. In China is keen to have the RMB as part of the SDR the last three months, the currency has been follow- basket of currencies. This means that the the risks ing Bunds slavishly, with the recurrent selling wave of a sharp depreciation for the RMB are relatively in Bunds being a constant source of EUR strength. low as it would jeopardize the chance We continue We continue to look for a lower EUR/USD in the to maintain our forecast of USD/RMB at 6.23 for coming quarter, reflecting the concerns we have on end-3Q15, and at 6.20 for end-2015. A band widen- Greece and the Eurozone. That said, we have con- ing is still likely before year end, possibly around sistently been of the view that the ramifications of a the annual IMF/World Bank annual meetings in Oct. default by Greece would be severe. And because of political reasons, it would be in Europe’s interest USD/SGD: More than anytime during the past to keep Greece firmly in the EU, including providing 8 years of low interest rate environment, the US it with further financial assistance. Hence, similar Federal Reserve will likely start their interest rate to previous episodes, we believe a last-minute deal normalization cycle this year, although the 18 June will be reached. We thus see limited downside for FOMC statement signaled a downward adjustment the EUR further out. in the pace of rate hike. With that and our view that the Monetary Authority of Singapore will keep the GBP/USD: Previously, we cited political uncer- SGD NEER appreciation slope unchanged at our tainty and slowing of economic data as the two ma- estimated 1% pa rate as core inflation environ- jor factors explaining our bearish view on the GBP. ment remains within their forecast, we lowered the However, heading into the second half of the year, USDSGD appreciation trajectory and forecast the we think we are past that short-term uncertainty. In USD/SGD to reach 1.38 by end of 2015, from 1.40 fact, another reason why we see the GBP perform- as expected earlier. ing is our belief that the BoE will be the next major central bank after the US Fed to raise rates. USD/IDR: USD/IDR surged to a fresh 17-year high in June on the back of rate normalization expecta- AUD/USD: We continue to look for a lower AUD/ tion in the US which was compounded by domestic USD, largely due to the combination of a slowing growth concerns and seasonal USD demand for China, weak domestic economy, a stalling domes- debt payments. Since the start of the year, IDR has tic economic transition and an RBA with an easing/ depreciated by around 7.0% against USD, mak- cautious bias. In addition, we believe that Aussie ing it the worst-performing currency in Asia. The dollar weakness will come through in the next few eventual rate liftoff in the US supports higher USD/ months because the US is going to be raising inter- IDR but a more gradual pace will likely reduce the est rates. upward trajectory in the pair. We expect USD/IDR at 13,500 and 13,600 at end-3Q15 and end-4Q15 NZD/USD: Further declines in commodity prices respectively. However, a soft commodity outlook coupled with continued slowing economic mo- could further weigh on the currency. mentum is likely to see the NZD underperforming. Besides, the yield advantage of New Zealand is USD/KRW: Weaker sentiment towards South Ko- clearly diminishing. With the central bank expected rea contributed to USD/KRW rebound from its clos-

6 Quarterly Global Outlook 3Q2015 • UOB Global Economics & Markets Research EXECUTIVE SUMMARY

ing low of 1,068.60 in April. We have reduced our of 2015 from the 63.84 level at the time of writing. expectation of the USD/KRW upward trajectory in line with a gradual pace of US Fed interest rate nor- Global Interest Rates malization. South Korea's strong current account Federal Reserve: The Fed kept its ultra-low surplus (1Q15: 7.0% of GDP) will also moderate rates policy unchanged in June, even as Yellen the up-move in the pair. Our end-3Q15 and end- said rate liftoff remains on course in 2015 but con- 4Q15 targets for USD/KRW are at 1,130 and 1,140 tinued to emphasize on data-dependent guidance respectively. and that exact timing of liftoff matters less than the path of rate hike which is likely to be gradual. The USD/MYR: Despite expectation of a more gradual dovish sentiment was further reinforced by margin- pace of rate normalization in the US, uncertainties ally more dovish June dot-plot chart forecasts from in Malaysia will continue to underpin USD/MYR March. upside. USD/MYR surged to fresh highs since the July 2005 de-peg on the back of USD strength and We now expect the first Fed rate hike to take place more downbeat domestic sentiment. While the Fi- in the 16-17 September 2015 FOMC but we re- nance Ministry has said that there are no plans to vised lower the rate trajectory, expecting the FFTR reintroduce a currency peg, the weakening MYR is to reach 0.75% by end 2015, and 1.75% by end likely to keep the concerns alive. Before the end 2016. That said, we fear that re-emergence of US of June, Fitch is expected to announce its review political brinkmanship in late 2015 could complicate of Malaysia’s credit rating. The rating agency has Fed monetary policy decision making during Sep- put the chance of a downgrade at more than 50%. tember. Although market has priced it in, there could still be knee-jerk reaction and pressure on MYR should European Central Bank: There were no sur- the risk materializes. Political risk is another area of prises at the June ECB meeting and press confer- concern given the fallout from state investment firm ence. In line with our expectations, ECB President 1Malaysia Development Bhd.’s RM42 bn debt, of Mario Draghi reiterated the ECB Governing Coun- which slightly more than half is US dollar-denomi- cil’s strong commitment to fully implementing its nated. While we are maintaining our end-3Q15 and quantitative easing (QE) plans. All policy rates were end-4Q15 USD/MYR forecast at 3.78 and 3.80 re- kept unchanged; and no new policy initiatives or spectively, the uncertainties in the domestic econo- changes to the current asset purchase programme my and the start of the Fed’s interest rate normali- were announced. There was no reconsideration of zation may cause the pair to overshoot our targets. its policy plans, no discussion of exit. The ECB’s new mantra is the intention to maintain a “steady USD/THB: The USD/THB moved up in a big way course” on monetary policy. Market speculation in 2Q 2015 and had gained 3.4% to date as the cur- about possible QE tapering may well continue dur- rency market reacted negatively to the 25bps rate ing the coming months/quarters, but we remain of cut by BoT on 11 March and then another 25bps cut the view that this will be met with little support from on 29 Apr. We think that the moves seemed overly the ECB, and that purchases will continue up to aggressive, and some profit-taking may pare off September 2016. the gains in the near term ahead. Going forward, we are not anticipating any more rate cuts by the Bank of England: Minutes of the latest BoE’s BoT and this should act as an anchor to support the meeting saw all nine panel members voting to keep THB. However, the anticipation of the US Fed rate the benchmark interest rate at 0.5% in June and hike will see a stronger greenback against the THB voting unanimously to leave the size of the central and we expect the USDTHB pair at 34.30 by end bank’s bond portfolio at GBP375bn. Although gen- of 2015. erally, the MPC members’ view on the economic outlook, and the appropriate stance of monetary USD/INR: The USD/INR gained 2.2% in the 2Q to policy that it implies, had not changed materially; date as the Reserve Bank of India proceeded with the overall stance appears slightly more hawk- the third cut in the key interest rate to 7.25% on 2 ish than previously. Given the latest set of labour June, on the back of lower inflation and other weak- market statistics, it could be a matter of time be- er economic indicators such as auto sales, core fore both Weale and McCafferty break ranks with industrial growth, and credit growth. However, we the majority and start agitating for monetary policy believe that further rate cuts will not be in the cards tightening. This could happen as soon as August, because the possible shortfall in the Southwest the same month as when the next Inflation Report monsoon may drive inflation higher in the coming is due (6 August). months. Not only that, further monetary easing may see another round of capital outflow from India and Reserve Bank of Australia: The RBA chose to will be detrimental to the INR. Even without any keep interest rates unchanged at a record low of easing, we keep to our long-held view that the USD/ 2.0% during the June meeting. Whilst there is room INR will likely trend higher towards 66.0 by the end for further easing amid continuing sluggishness

Quarterly Global Outlook 3Q2015 • UOB Global Economics & Markets Research 7 EXECUTIVE SUMMARY

in business investment and consumer spending, low of 5.31% in December 2008, while the 1Y de- we believe the central bank would prefer to moni- posit rate matches the low seen in December 2008, tor the impact of the 50bps cuts already delivered and not much further from the record low of 1.98% this year. Furthermore, the RBA has its hands tied in February 2002. For now, we see just one more because further lowering rates risks inflating the round of interest rate cuts, which are likely to take nation’s housing bubble. Watching the effects of place in 3Q 2015 as well, as we expect signs of APRA’s tightening measures, incoming economic stabilization in broad Chinese data by second half data as well as the Australian currency would be of 2015. The move would also likely come with the what the RBA would do, although we believe the announcement of a removal of the deposit interest current rate of 2.0% should mark the low point for rate ceiling (last raised to 1.5x on 10 May) as China the cash rate in this easing cycle. liberalizes the interest rate market.

Reserve Bank of New Zealand: The RBNZ Monetary Authority of Singapore: Singa- slashed its cash rate by 25bps in June to 3.25%. pore’s headline inflation had contracted for the sixth This was the first rate cut since January 2011 and consecutive month in April while core inflation also reverses a period of rate hikes that the central bank edged lower to an average of 0.95% in the first four engaged in 2014. More importantly, the central months of 2015. With that, there had been talks bank also provided a very strong hint that the latest that the MAS may ease further in their upcoming rate cut will not be a one-off. Indeed, slowing growth October 2015 policy meeting. We are of a differ- not only underscores the RBNZ's latest decision but ent view. The on-going period of lower core inflation also for further reductions ahead. We are now ex- (which matters for policy decision, and not headline pecting another 25bps cut in the coming quarter, inflation) was due to lower healthcare costs from bringing the cash rate to 3.00%. Further out, much the Pioneer Generation scheme, as well as low fuel will depend on economic data, and all eyes will be prices compared to a year ago. Global oil price has on the quarterly CPI print due on 16 July. been on the rise and towards the end of this year, the low base effects from 2014 will wear off. We Bank of Japan: We believe the BOJ is unlikely still think that core inflation will fall nicely within the to do more easing & probably maintain the status central bank’s forecast of 0.5% to 1.5% and that quo position at least in 3Q 2015 after its last stimu- there should likely be policy inaction in October. lus addition in October 2014. The 1Q GDP upward With that, we maintain our view of the SGD NEER revision certainly helps our view and is an affirma- appreciation of 1% pa unchanged, together with tion of the BOJ’s optimism that Japan “continued its no changes to the bandwidth and midpoint. The 18 moderate recovery trend” and meant little impetus June FOMC statement had signaled a downward to add more easing into the system. We reiterate adjustment in the pace of rate hike in the US and our belief that the BOJ policy makers viewed further we have lowered the USD/SGD appreciation tra- monetary easing to shore up inflation as a counter- jectory. As such, our forecast for the SGD 3-month productive step in the foreseeable future and that SIBOR had been adjusted lower to 1.15% by end additional stimulus could trigger significant declines 2015, from the 1.30% expected earlier. in the yen which in turn would damage confidence while giving little mileage to generate inflation. Bank Indonesia: Despite the slowdown in growth, Market views about more BOJ stimulus were also we believe that Bank Indonesia (BI) has little room dialed back more easing expectations after BOJ to cut its interest rates further in the short-term after Governor commented (10 June) that further yen the surprise 25 bps rate reduction in February. The weakness is “unlikely” which may imply BOJ has no headline inflation rate edged higher to 7.15% y/y in plans for more easing.. May from 6.79% y/y in April and is likely to remain at around 7.0% in the next few months. We may Asian Interest Rates see some upward price pressure through Ramadan People’s Bank of China: China delivered its but inflation will drop in 4Q15 due to a high base third interest rate cut in 6 months on 10 May 2015. effect. Against the backdrop of rate normalization There is certainly room for further policy flexibility expectation in the US this year and the depreciation ahead. In particular, there is a long way to go for the pressure on the IDR, we expect BI to maintain its RRR at current level of 18.5%, which is higher than policy rate unchanged at 7.50% for the upcoming the previous low of 15.5% (2009) and record low meetings. of 6% (1999-2003). We see risks of another round of RRR cut at 50bps, most likely in 3Q 2015. For Bank of Korea: Near-term growth concerns over- interest rates, it is more challenging for PBoC with shadowed that of the high household debt, leading the 1Y benchmark interest rates at or near historic to two interest rate cuts so far this year. The 25 lows. To reap, China’s 1Y lending rate is already bps cut in June to bring the base rate to fresh re- at the lowest level since 1991 and surpassing the cord low at 1.50% was clearly driven by the MERS

8 Quarterly Global Outlook 3Q2015 • UOB Global Economics & Markets Research EXECUTIVE SUMMARY

outbreak. Going forward, the rate decisions will be rate was at 1.25%. Although there remains room for highly data-dependent. Due to expectation of US another 25bps to the ‘crisis level’, we think that the rate normalization in the second half of the year BoT will stand pat, as yet lower interest rates may and concerns over the household debt, more rate aggravate the already-high household debt prob- cuts in Korea will have to be driven by further sharp lem in Thailand and the recent dynamics in interna- deterioration in growth outlook. As such, we expect tional oil prices may point to upside risks to future the base rate to be kept at 1.50% for the rest of this inflation. The current policy rate will likely remain as year. such for the rest of 2015, and then coming in with a 25bps rate hike in 1Q 2016 to match the start of the Bank Negara Malaysia: Pressure on the MYR rates normalization cycle in the US. and higher inflation post-GST implementation has limited the options for Bank Negara. Reflecting the Reserve Bank of India: The Reserve Bank of impact of the 6% GST, headline inflation surged to India proceeded with the third cut in the key interest 1.8% y/y in April from 0.7% in 1Q15 and is likely rate to 7.25% on 2 June, on the back of lower in- to rise quickly to an average of 2.5-3.0% y/y in the flation and other weaker economic indicators such second half of the year. We are maintaining our call as auto sales, core industrial growth, and credit for Bank Negara to be on hold at 3.25% for the rest growth. However, w e believe that further of this year. rate cuts will not be in the cards for the rest of this year because the possible shortfall in the Southwest Bank of Thailand: In the benign environment of monsoon may drive inflation higher in the coming lower prices as well as slower economic growth, the months. Not only that, further monetary easing may Bank of Thailand cut its policy rate to 1.5%, the low- see another round of capital outflow from India and est since the 2008/09 financial crisis, where policy will be detrimental to the INR.

Growth Trajectory y/y % change 2012 2013 2014 2015F 2016F 1Q15 2Q15F 3Q15F 4Q15F China 7.7 7.7 7.4 6.8 6.8 7.0 6.8 6.7 6.9 Eurozone -0.9 -0.4 0.8 1.5 1.7 1.0 1.4 1.6 1.7 Hong Kong 1.7 3.1 2.5 2.6 2.8 2.1 2.2 2.3 3.5 Indonesia 6.0 5.6 5.0 5.0 5.5 4.7 4.9 5.1 5.1 Japan 1.5 1.6 -0.1 1.0 1.5 -0.9 1.5 1.5 2.0 Malaysia 5.5 4.7 6.0 5.0 5.3 5.6 4.9 4.8 4.7 Philippines 6.8 7.2 6.1 6.2 6.3 5.2 6.0 7.3 6.2 India 4.8 4.7 6.9 7.4 7.7 7.3 7.5 7.5 7.3 Singapore 3.4 4.4 2.9 2.9 3.4 2.6 2.8 2.8 3.6 South Korea 2.3 2.9 3.3 2.9 3.5 2.5 2.5 2.9 3.5 Taiwan 2.1 2.2 3.8 3.0 3.5 3.3 3.0 2.8 2.7 Thailand 7.6 2.9 0.9 2.7 4.9 3.7 3.1 2.2 2.0 US (q/q SAAR) 2.3 2.2 2.4 2.5 2.5 -0.5 3.2 3.8 3.2 Source: CEIC, UOB Global Economics & Markets Research Estimates

Quarterly Global Outlook 3Q2015 • UOB Global Economics & Markets Research 9 FX & INTEREST RATE OUTLOOK

FX OUTLOOK As at 19 Jun End 3Q15F End 4Q15F End 1Q16F End 2Q16F

USD/JPY 123 126 127 129 130 EUR/USD 1.14 1.09 1.10 1.12 1.12 GBP/USD 1.59 1.60 1.62 1.64 1.67 AUD/USD 0.78 0.75 0.74 0.74 0.73 NZD/USD 0.69 0.66 0.64 0.63 0.62 USD/SGD 1.33 1.36 1.38 1.40 1.39 USD/MYR 3.72 3.78 3.80 3.80 3.77 USD/IDR 13314 13500 13600 13700 13500 USD/THB 33.7 33.5 34.3 34.6 34.3 USD/PHP 45.0 43.0 42.0 42.0 41.0 USD/INR 63.7 64.8 66.0 65.0 64.0 USD/TWD 31.1 31.4 31.8 32.0 31.7 USD/KRW 1103 1130 1140 1150 1130 USD/HKD 7.75 7.75 7.75 7.80 7.80 USD/CNY 6.21 6.23 6.20 6.19 6.17

Source: Reuters, UOB Global Economics & Markets Research

INTEREST RATE TRENDS As at 19 Jun End 3Q15F End 4Q15F End 1Q16F End 2Q16F

US (Fed Funds Rate) 0.25 0.50 0.75 1.00 1.25 EUR (Refinancing Rate) 0.05 0.05 0.05 0.05 0.05 GBP (Repo Rate) 0.50 0.50 0.50 0.50 0.75 AUD (Official Cash Rate) 2.00 2.00 2.00 2.00 2.00 NZD (OCR) 3.25 3.00 3.00 3.00 3.00 JPY (OCR) 0.10 0.10 0.10 0.10 0.10 SGD (3-Mth SIBOR) 0.82 1.05 1.15 1.22 1.27 IDR (BI Rate) 7.50 7.50 7.50 7.50 7.50 MYR (Overnight Policy Rate) 3.25 3.25 3.25 3.25 3.25 THB (1-Day Repo) 1.50 1.50 1.50 1.75 2.00 PHP (Overnight Reverse Repo) 4.00 4.00 4.00 4.00 4.00 INR (Repo Rate) 7.25 7.25 7.25 7.25 7.25 TWD (Official Discount Rate) 1.88 1.88 1.88 1.88 1.88 KRW (Base Rate) 1.50 1.50 1.50 1.50 1.50 HKD (Base Rate) 0.50 0.75 1.00 1.25 1.50 CNY (1-Yr Working Capital) 5.10 4.85 4.85 4.85 4.85

Source: Reuters, UOB Global Economics & Markets Research

10 Quarterly Global Outlook 3Q2015 • UOB Global Economics & Markets Research SINGAPORE FOCUS I CAN SINGAPORE GOVERNMENT SECURITIES OUTPERFORM DURING A GLOBAL BOND SELL OFF?

The highlight in Q2 2015 has been the unexpected only circuit breakers were the day’s closing bell or ferocity of a Bund led global bond sell off. Crowded zero net exposures. investor positioning, recovery in commodity prices, and the increase in inflation expectations were Since April, global yields have shot higher and yield some of the reasons put forward to explain the bond curves have steepened due to the Bund led selloff. shedding that manifested in April and then again in While SG rates markets have not been able to resist June. Singapore’s rates markets were not immune the directional pull of risk re-pricing, SGS did suffer from external volatility and performance of Singapore relatively less price damage/yield increase in phase Government Securities (SGS) has been inconsistent 1. However, SGS outperformance in phase 1 could relative to US treasuries (UST) and Bunds. not be sustained and in the days leading up to the phase 2 sell off, SGS significantly underperformed The global bond sell off coincided with recoveries in with yield and curvature increases that exceeded both the EU and US inflation expectations. It is not a even those experienced by Bunds. surprise to find that the Bund curve has experienced the largest steepening in phase 1 of liquidations since The shifting relative performance characteristic in the uptick in EU inflation expectations has been more SGS between phase 1 and phase 2 can be mainly pronounced than their US equivalents. Furthermore, attributed to the 10Y SGS auction on 27th May. investors’ positioning in Bunds was more extreme Concession building ahead of auction supply caused due to the dominance of ECB QE theme. Crowded SGS to underperform even while the UST and Bund positions resulted in a cascade of selling where the curves were undergoing consolidation after phase

Phase 1: April Yield Changes Phase 2: June Yield Changes

70 70

60 60

50 50

40 40 bps 30 bps 30

20 20

10 10

0 0 Bund UST SGS Bund UST SGS 2Yx10Y curve 10Y 2Yx10Y curve 10Y

Source: Bloomberg Source: Bloomberg

EU Leads In Reflation Expectations Steeper Curves As A Result Of Bond Selloff

3.05 2.20 1.90 1.20 2.10 1.80 1.10 2.85 1.70 1.00 2.00 1.60 0.90 2.65 1.90 1.50 0.80 % % % 1.80 % 1.40 0.70 2.45 1.70 1.30 0.60 1.20 0.50 1.60 2.25 1.10 0.40 1.50 1.00 0.30 2.05 1.40 0.90 0.20 Jun 14 Aug 14 Oct 14 Dec 14 Feb 15 Apr 15 Jan 15 Feb 15 Mar 15 Apr 15 May 15 Jun 15 USD Inf Swap Fwd 5Y5Y EUR Inf Swap Fwd 5Y5Y (rhs) US 2Yx10Y (lhs) SG 2Yx10Y (lhs) EU 2Yx10Y

Source: Bloomberg Source: Bloomberg

Quarterly Global Outlook 3Q2015 • UOB Global Economics & Markets Research 11 SINGAPORE FOCUS I

1; this can be seen through the abrupt widening in the SG vs. UST and Bunds interest rate differentials SGS Cross Market Performance Has Been Checkered in the middle of May (illustrated by the “V” shape curve). Before the ink could dry on the 10Y SGS 0.60 2.40 auction, phase 2 of Bund selling took place and this complicated the market’s digestion of a relatively 0.50 2.20 large auction supply. SGS performance in phase 0.40 2 has consequently been unable to revert back to 2.00 outperformance because of forced adjustments in 0.30 misaligned hedges. % 1.80 % 0.20 1.60 Therefore, SGS underperformance in phase 2 has 0.10 mainly been driven by idiosyncratic factors, and 1.40 these factors are likely to play a diminished role 0.00 going forward. In addition to waning post auction -0.10 1.20 drag, there are other reasons to expect better relative Mar 15 Mar 15 Apr 15 May 15 May 15 Jun 15 performance from SGS should there be another bout SGS - UST 10Y SGS - Bund 10Y (rhs) of Bund led liquidations;

Source: Bloomberg The auction calendar favours demand for SGS into the early parts of the 3rd quarter; auction at the end of June is for a new 5 year Benchmark bond and will be against SGD 6.3 bio of maturing proceeds, furthermore SGS auctions will also be taking a break in July.

2 rounds of Bund selling have elevated SGS yields to their highest levels this year which increases the possibility that sentiments towards SGS could receive an unexpected boost from a successful launch of the Singapore Savings Bonds (see side box) in the 3rd quarter.

The Bund led rise in SGS yields has largely been missing the currency multiplier effect. Underperformance or widening in interest rate differentials has not matched the extremes seen in Q1 primarily due to a lack of follow through in FX swaps. Without this multiplier, the potential for significant SGS underperformance is more limited.

12 Quarterly Global Outlook 3Q2015 • UOB Global Economics & Markets Research SINGAPORE FOCUS I

Side Box: Singapore Savings Bonds Inauguration of the Singapore Savings Bonds (SSBs) will take place in the 3rd quarter of 2015. The start date, which has not been announced, could be as early as July since savers would have had almost 2 months to complete the preparatory tasks of setting up CDP accounts and earmarking of funds.

Based on the MAS information available, SSBs will be issued monthly and the yield to maturity will be based on the average yield of the previous month’s 10Y Singapore Government Securities (SGS). Note that on pricing, it has not been made explicit if the SSB pricing will reference the benchmark SGS curve or an interpolated constant maturity SGS curve, we suspect it will be the latter to adjust for seasoning effect.

SSBs subscription amount can vary between SGD 500 to SGD 50,000, while the maximum holding is limited to SGD 100,000. There is a cash flow timing mismatch between application and redemption of SSBs, therefore this will limit the ability of savers to actively take advantage of higher yields through a redeem and reinvest strategy. Savers should also be prudent in exercising the early redemption option; frequent and small quantum redemptions will significantly erode the after transaction costs return of SSBs.

A key benefit of SSBs is that it addresses the dearth of alternatives in long term savings by introducing a risk free asset to a choice which has traditionally been either equity or property. Perhaps future innovations could see the introduction of inflation linked bonds to target saver’s concerns on preserving purchasing powers.

For further details and FAQ regarding the Singapore Savings Bonds (SSBs) please refer to MAS's website link http://www.mas.gov.sg/news-and-publications/media-releases/2015/applying-for-singapore-savings-bonds.aspx

Quarterly Global Outlook 3Q2015 • UOB Global Economics & Markets Research 13 SINGAPORE FOCUS II HOUSING: VOLUME DOWN, PRICES HOLDING UP SO FAR

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

2014 new home sales volume has been dismal, The public housing segment has not been spared falling 51% YoY to 7,316 units, levels last seen during with 1Q15 HDB resale prices down 5.5% YoY the GFC. 1Q15 sales have also been lackluster, (-1% QoQ), marking the 7th consecutive quarter of down 25% YoY (-5% QoQ). Developers’ reluctance declines. The 9.2% fall in HDB prices from the recent to launch new projects in a softening market coupled peak has surpassed that of the private segment. with financing constraints and prohibitive transaction This could consequently dampen demand for private costs (eg. TDSR, ABSD, SSD) are key contributors. properties by HDB upgraders as sizeable Cash-

Fig 1: Primary & Secondary Sales Have Plunged Fig 2: Singapore PPI vs HDB Resale Price Index

30,000 180

25,000 160 140 20,000 120 15,000 100 80 10,000 60 5,000 40 20 0 0 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 1Q90 1Q94 1Q98 1Q02 1Q06 1Q10 1Q14 Primary sales Secondary sales 10-yr avg primary sales 10-yr avg secondary sales PPI HDB Resale Price Index

Source: UOB, Bloomberg Source: UOB, URA, HDB

Resale transactions have also contracted as sellers Over-Valuation (COV) premiums over the past few have been unwilling to significantly lower their years have helped facilitate down payments. price expectations while prospective buyers take a wait-and-see approach. The result of this ongoing Deeper Price Correction On The Cards stalemate is sharply reduced sales volume but milder As Interest Rates Rise And Rents Slip price declines. Some resolution to the stalemate could emerge this year as developers and sellers capitulate in the face The slew of tightening measures has resulted in of rising interest rates and weakening rentals. The increased interest in foreign property investments in 3-month SIBOR and 3-month SOR have surged markets such as Malaysia, UK, Australia and Japan. around 40bps and 70bps respectively, representing Developers have also stepped up their offshore more than a doubling YoY. As the majority of diversification in response to shrinking development mortgages in Singapore are floating, home owners margin domestically and in acknowledgement that will need to brace themselves for higher mortgage the challenging conditions could prolong. As such, payments. Nonetheless, with interest rates still local developers’ participation in government land low by historical standards, the impact should be sales has been lukewarm and land prices have manageable although overleveraged buyers will slid. In contrast, foreign developers (particularly the feel more pain. Chinese players) continue to be relatively upbeat. Rents have fallen for 5 quarters as the massive Uneven Price Declines supply pipeline starts to progressively hit the market. Based on the government’s official Private Property While the decline has been mild thus far (-5% from Price Index (PPI), average prices have fallen by 5.9% peak), the pace could accelerate as bargaining since peaking in 3Q13. Price declines accelerated power shifts to tenants amid a sharp surge in supply. across all segments in 1Q15, with prices of non- CBRE data showed that 1Q15 prime rental yields landed properties falling the most in the Rest of the dipped from 2.8% to 2.7% YoY. While this still implies Central Region (RCR) or city fringe areas (-1.7% positive carry with mortgage rates <2%, the buffer QoQ). The overheated suburban segment, captured could be rapidly eroded given the expected interest under Outside Central Region (OCR) has also started rate trajectory. to cool (-1.1% QoQ) after rising 75% from 2Q09 to 3Q13. Meanwhile, price declines in the Core Central Competition for tenants looks set to intensify further Region appear to have leveled off (-0.4% QoQ). on the back of the government’s tighter immigration

14 Quarterly Global Outlook 3Q2015 • UOB Global Economics & Markets Research SINGAPORE FOCUS II

policy. In the face of oversupply, tenants’ flight to 2,050psf. quality suggests that suburban landlords could be vulnerable as tenants opt to move closer to the CBD As only foreign developers are subject to QC rules, for similar rental budget. more developers are seeking privatization to escape

Fig 3: Private Residential Rents By Segment: Fig 4: Price Gap Between Properties In The Central Re- Luxury Rents Have Been Under The Most Pressure gion vs. Suburban Areas Have Narrowed To All-Time Low

S$psf x 7.00 1.9 6.00 1.7 5.00 1.5 4.00

3.00 1.3

2.00 1.1 1.00 0.9 0.00 1Q90 1Q94 1Q98 1Q02 1Q06 1Q10 1Q14 1Q97 2Q01 3Q05 4Q09 1Q14 Central/ East Central/ NE Luxury Prime Islandwide Central/ West LT average premium

Source: CBRE, UOB Source: CEIC, UOB Global Economics & Markets Research

HDB sub-letting rents have also started to slide and these hefty charges. Popular Holdings recently we anticipate further weakness as HDB upgraders emerged as the latest to go private, following in the move out to private properties upon completion. With footsteps of SC Global and HPL. demand for resale HDB flats constrained by the 30% mortgage service ratio, more owners could elect to Nonetheless, further price falls in the high-end put their units up for rent instead. 4Q14 subletting segment could slow after the >15% drop last year, approvals surged 43% YoY to 10,365 and continued narrowing the gap to mass market properties to to tick up in 1Q15 to a high of 10,385. The total an all-time low. Supply will fall sharply from next number of HDB flats being sublet rose by 3.6% YoY year, which could support prices. Moreover, the to 48,338 units in Dec 2014 (c.5% of stock). bulk of unsold stock resides in the hands of major developers with greater holding power. A Forced Handshake? Distress sales have increased particularly in the Despite having written down the value of their non-landed prime segment which is currently facing residential land banks, developer balance sheets the most pressure due to oversupply and smaller remain generally healthy with net gearing significantly accommodation budgets for expatriates. below 2008 peak. This should help prevent disorderly price cuts that could destabilize the market. Based on data from Colliers, mortgagee sales spiked Household balance sheets also remain firm and the fivefold last year as over-committed borrowers pace of growth in household debt has decelerated defaulted on their loans. There were 159 forced sales on the back of MAS’ macroprudential measures. listings, up from just 32 in 2013. The bulk (78%) was residential non-landed units in prime districts 9 and Increased willingness by developers/ sellers to cut 10. Luxury apartments from newer prime districts 1 prices could help spur inventory clearance as more and 4 (Sentosa and the City Centre) and shoebox price-sensitive demand returns. In addition, investors units also featured. caught by the 4-year Seller’s Stamp Duty imposed in Jan 2011 could start to exit from this year onwards In the high-end segment, property funds approaching and may be more amenable to lower asking prices. the end of their fund life as well as developers facing This could in consequently set the stage for the potential Qualifying Certification (QC) penalties market to trough. We expect a further 5-10% fall in have offered units in bulk. Through its wholly-owned private home prices this year. company, Hiap Hoe acquired 55 units in bulk for S$227m across three of its own projects in order to Start Of Supply Avalanche; minimize extension charges. Heeton is once again Mass Market Completions Accelerating looking for a bulk buyer for 30-unit iLiv@Grange 2014 private completions surged 52% YoY to a 20- after cutting asking prices by 10-15% to S$1,879- year high of 19.9k units, significantly higher than

Quarterly Global Outlook 3Q2015 • UOB Global Economics & Markets Research 15 SINGAPORE FOCUS II

URA’s projections at the start of the year. We expect 21.2k units to complete this year and a further 19.6k Fig 5: Long Term Trend Of Overall Supply vs Population Growth units in 2016 before easing materially from 2017. Including HDB supply, around 183k housing units will 60,000 2015-2018 supply: 3.4% pa 6.0% come on stream over the next 4 years which will bring 2015-2018 population : 1.5% pa the overall stock of housing from the current 1.28m 50,000 5.0% to 1.47m, representing a 14.5% increase or 4-year 40,000 4.0% CAGR of 3.4%. With population growth forecasted at 3.0% 30,000 only 1.5% pa over the same time period, oversupply 2.0% pressures will persist. 20,000 1.0% 10,000 Supply composition will start to shift this year. While 0.0% supply over the past few years was dominated by the 0 -1.0% HDB under-building, private en-bloc boom caused severe shortage high-end segment, the number of homes in the fringe -10,000 -2.0% and suburban areas will account for >80% share of 1996 1999 2002 2005 2008 2011 2014 2017E overall supply. Supply will pick up most prominently Net change EC Net change private in the North-East (Sengkang, Punggol) with close Net change HDB LT avg dd to 14k new private and ECs slated for completion Population growth (RHS) in the next 3 years, excluding the bumper crop of Source: UOB, URA, HDB new HDBs. This may result in near term indigestion.

Fig 7: Inflows Of Foreigners, PRs And Fig 6: LT Composition Of Private Supply Singapore Citizens Still Constrained

100% 200,000 90% 180,000 80% 160,000 39% 40% 46% 52% 70% 53% 140,000 60% 60% 60% 66% 120,000 78% 83% 50% 84% 100,000 80,000 40% 60,000 30% 31% 28%

19% 40,000 30% 20% 31%

6% 20,000 22% 26%

10% 23%

8% 0 12% 0% 2007 2008 2009 2010 2011 2012 2013 2014 2007 2009 2011 2013 2015 2017 PRs granted # citizens granted Others 15 9,10,11 1,2,4 Chg in # of foreigners

Source: UOB, URA Source: UOB, Singstat

Floodgates Still Shut With Singapore’s anemic rate of natural increase in Private vacancy rates have risen from a low of 4.6% population, the government’s immigration policy is in 2010 to 7.2% in 1Q15 (24k vacant units). We a major driver of demand. It is however showing no expect it to increase further to a high of c.9%, before signs of loosening its tight stance on immigration. dipping from 2017 onwards as supply tapers off. By location, the high-end oversupply is reflected in The increase in the number of foreigners has above average vacancy rates for the Central Region dwindled to 44,600 last year, representing around a (8.6% in 1Q15). Vacancy rates in other areas have quarter of peak levels of ~163k pa from 2005-2008. also picked up, e.g. in the North, up from 2.6% in Similarly, the number of Permanent Residencies 1Q13 to 11.5% in 1Q15. In the North East (Punggol, (PRs) granted has more than halved from the peak Sengkang), vacancy rates have doubled in two years of 79,167 to slightly under 30,000 from 2010-2012. and could continue to trend up amid record supply.

As a result, Singapore’s longer term population Light At The End Of The Tunnel trajectory is unlikely to revert to the rapid increase As Future Supply Moderates seen last decade. In the 2013 Population White While pockets of distress could emerge, a soft Paper, growth rates are projected to decelerate to landing scenario could be at hand with affordability 1.3-1.6% this decade and slow further to 1.1-1.4% restored by rising income levels and supply starts to from 2020-2030. This will weigh heavily on rents, taper off from 2017. The government continues to particularly as supply surges in the coming years. hold back on land sales, with confirmed supply on

16 Quarterly Global Outlook 3Q2015 • UOB Global Economics & Markets Research SINGAPORE FOCUS II

Fig 8: Private Housing Demand, Supply & Vacancy Rates Fig 9: Total Inventory As At 1Q15

25,000 10 60,000 9 20,000 8 50,000 7 40,000 15,000 6 5 30,000 10,000 4 3 20,000 5,000 2 10,000 1 0 0 0 1989 1993 1997 2001 2005 2009 2013 2017E 2Q98 3Q01 4Q04 1Q08 2Q11 3Q14 Demand Supply Without prerequisites for sale With pre-requisites for sale 10-yr avg demand Vacancy rate (%) RHS

Source: UOB, URA Source: UOB, URA

the 1H15 GLS Programme cut by 23% to 3,000 units may make sense to tweak some of the stamp duty representing more than half of peak levels in 2012. measures such as the ABSD and SSD as market speculation has fallen significantly and the TDSR On the public housing front, after ramping up the BTO framework and LTV limits essentially ensure financial building programme for 3 years, the government has prudence. Nonetheless, the government is unlikely tapered the BTO flat supply as the backlog has been to act in the absence of a larger price decline as the cleared. This year, HDB will offer 16,900 Build-To- sharp rise in property prices was a key flash point Order flats, down by 1/3 compared to the past 4-year during the last “watershed” General Elections. average of approximately 25,100 units. In late Oct 14, Deputy PM and Finance Minister Consequently, total inventory has fallen steadily to a Tharman commented that there is “some distance historical low of 33.5k units in 1Q15 as the number of to go in achieving a meaningful correction”, without units without approvals fall sharply. This represents which property prices will run ahead of the growth a manageable 2.6 years of supply based on the past in household incomes. This view was echoed by 10-year average take-up. National Development Minister Khaw who said that it was still not the right time to wind down the cooling Tightening Measures To Go? measures with further room for prices to moderate. Prospective homebuyers continue to harbour hope that the government will start to remove some of While there is no guidance on what constitutes a the tightening measures this year. In our view, it “meaningful” correction, we think anything short of a

Fig 10: The Curious Case Of Fig 11: Affordability Ratio Singapore’s Ever-Shrinking Homes

1,600 1,400,000 1400 120% 1,400 1,200,000 1200 100% 1,200 1,000,000 1000 1,000 80% 800,000 800 800 60% 600,000 600 600 400,000 40% 400 400 200,000 200 200 20% 0 0 2009 2010 2011 2012 2013 2014 0 0% 1Q90 1Q93 1Q96 1Q99 1Q02 1Q05 1Q08 1Q11 1Q14 Median price/ unit (S$) RHS Median size (sf) Median price of condo (S$psf) LHS Median price (S$psf) Affordability ratio (RHS)

Source: UOB, URA Source: UOB, URA, Singstat

Quarterly Global Outlook 3Q2015 • UOB Global Economics & Markets Research 17 SINGAPORE FOCUS II

10% fall may not suffice. Historically, the government Home sizes have also continued to shrink with the only reacted when faced with major external shocks average size of a 3-bedroom unit now less than such as the Asian Crisis, Dot Com crisis) which led 800sf (smaller than a 4 room HDB flat). As shown to significant price declines (45% peak-to-trough in in Fig 10, the median size of new homes has fallen the former and 20% in the latter). ~40% over the past 6 years. Notably, despite the sharp 45% increase in psf prices, overall price tag Given our expectation of a 5-10% correction this only increased by 7.5% with ~S$1m the sweet spot. year, the government could potentially review the measures at year-end. Relaxation in SSD and As a result, our estimated affordability improved selected reductions in ABSD rates particularly for slightly from 33% as at end-2013 to around 31% Singaporeans may be likely. currently. Assuming the 3-month Sibor trends up further to 1.0%, affordability ratio will increase slightly Rising Incomes And Falling Prices Dampen to 32% which is still below the long term average. Impact Of Rising Rates On Housing Affordability First time home buyers have been spared by the consecutive rounds of tightening measures. While the sharp spike in interest rates has adversely affected affordability, this has been offset by income growth and falling prices. Median household income from work by residents increased by a 3-year CAGR of 5.6% to S$7,400 last year.

18 Quarterly Global Outlook 3Q2015 • UOB Global Economics & Markets Research CHINA FOCUS I A BRIEF ON THE “SILK ROAD ECONOMIC BELT AND 21ST CENTURY MARITIME SILK ROAD"

Embarking On An Ambitious Project: and efficient transport routes connecting major sea Connectivity, Integration, And Cooperation ports along the route, and will involve the China- China President Xi Jinping first mooted the “Belt Pakistan Economic Corridor and the Bangladesh- and Road" initiative in Sep/Oct 2013. This ambitious China-India-Myanmar Economic Corridor. strategy, based on the two ancient trade routes, aims to develop a land-based Silk Road Economic Motivation For “Belt And Road” Belt through western China starting from Xian, and Why would China commit the resources for such a the 21st Century Maritime Silk Road, which begins bold project? We believe that there are three main from Fuzhou via the maritime route. In addition to considerations: historical context, this project should be seen as an extension of China’s plans to develop the western, Long term strategic requirements: As the world's land-locked part of the country, which is lagging far top trading nation, China needs to ensure that it has behind the coastal provinces. timely, efficient, and secure access to markets and resources, and therefore facilitation of trade and As can been in the map below, the “Belt and Road” investment is one key focus. In addition, it should project envisages a seamless connectivity between not be surprising that securing conventional and China and Asia, Africa, and Europe, via land-based renewal energy and resources is another focus for or maritime routes, with increased integration and China. Once completed, “Belt and Road” will provide cooperation with the Asian, African and European land-based and sea-based alternatives not just for continents. The plan fits with China’s economic, China accessing to the continents, but also access security, military, and diplomatic strategy. The Silk for other countries to China. Transport link is a critical Road Economic Belt focuses on bringing together consideration for China, as it is vulnerable to choke China, Central Asia, Russia and Europe (the points along its sea route. Such threats would be Baltic); linking China with the Persian Gulf and the mitigated once land based alternatives including Mediterranean Sea through Central Asia and West railroads, highways, and communication links are Asia; and connecting China with Southeast Asia, in place. South Asia and the Indian Ocean. The 21st-Century Maritime Silk Road goes from China's coastal region Near term economic reasons: More immediately, to Europe through the South China Sea and the “Belt and Road” also provides new markets and Indian Ocean in one route, and from China's coast business opportunities for the country to deal with through the South China Sea to the South Pacific its excess industrial capacity especially for its in the other. debt-laden state-owned companies. In addition, after three decades of breakneck economic Specifically for the maritime segment, “Belt and development, Chinese companies are now more Road” will focus on jointly building smooth, secure capable of competing for businesses with its

Source: Wall St Journal http://www.wsj.com/articles/chinas-new-trade-routes-center-it-on-geopolitical-map-1415559290

Quarterly Global Outlook 3Q2015 • UOB Global Economics & Markets Research 19 CHINA FOCUS I

overseas competitors, given the rise in technological more than 25% in terms of voting rights. In contrast sophistication and maturity. Note that countries in Asian Development Bank (ADB) holds USD5.9bn of the "Belt and Road" initiative account for 63% of the capital and a loan portfolio of USD75bn. This means world's population and 29% of global GDP. Trade that once AIIB’s capital is fully subscribed, it could between these countries and China reached more potentially lend up to USD1.27tn, which is in a relative than US$1tn in 2014, or 26% of China's total trade stronger position than ADB as China’s Ministry of value. Finance estimated earlier that, over the next 10 years, financing needs for infrastructure development Financial capability: China’s financial capability has in Asia amounted to US$700 billion per year. also increased significantly to fund such a venture, given that its stock of foreign exchange reserves Another less prominent financing vehicle is the at USD3.73tn (~32% share of world’s total) is the New Development Bank, commonly known as the largest in the world, and its four largest domestic BRICS bank, which was established in July 2014 with Chinese banks (ICBC, CCB, ABC, and BOC) are authorized capital of USD100bn and to be based in also the world’s top four largest in 2015, according to Shanghai. The institution is to be headed for the first a Forbes review in Jun 2015 based on a composite 5 years by non-executive chairman of ICICI Bank, KV score of revenues, profits, assets and market value. Kamath, which will then be succeeded by a Brazilian and then a Russian. The BRICS bank will be used for “Belt And Road” Is Already In Motion infrastructure financing and sustainable development Political support: How sustainable is the “Belt project funding within the BRICS nations, though and Road” initiative? Political support in China other low- and middle-income countries will be able appears to be firm, as the Third Plenary Session of to access loans as well. the 18th Central Committee in Nov 2013 called for accelerating infrastructure links among neighboring Note that financial integration is among the key countries and facilitating the “Belt and Road” planks in the “Belt and Road” Initiative and we initiative. None other than China President Xi Jinping anticipate RMB to play a significant role, helping is the chief advocator himself. NDRC, Ministries of to push RMB internationalization further. As China Foreign Affairs and Commerce are the ministries opens up its capital account, there will be more responsible, led by senior, heavyweight political opportunities for companies and FIs along the route leaders including Vice Premier Zhang Gaoli, Vice to raise funds by issuing RMB bonds in China, while Premier Wang Yang, State Councilor Wang Jiechi, Chinese FIs and companies are also expected to among others. increase its bond issuance in both RMB and foreign currencies outside China, and use the funds in To underscore its seriousness, the Chinese countries along the “Belt and Road”. government in Mar 2015 released a “vision and actions plan” for the project (Vision and Actions Projects underway: Looking at some of the on Jointly Building Silk Road Economic Belt and examples below, the “Belt and Road” project 21st-Century Maritime Silk Road, the National is already taking shape quickly, at least at this Development and Reform Commission, Ministry of early phase, as a number of projects is being Foreign Affairs, and Ministry of Commerce, Mar 2015 operationalized or undergoing studies. It should be http://news.xinhuanet.com/english/china/2015-03/28/c_134105858.htm). noted that most of these projects are infrastructure in nature, which is the nature at this early stage. Financing channels: Secondly, the main financing platforms are falling in place, starting with the Silk Some recent examples: Road Fund in Feb 2015 with US$40bn, of which 65% The building of a China-Pakistan Economic was from China’s foreign exchange reserves, 15% Corridor (CPEC) - a network of roads, railway from sovereign wealth fund China Investment Corp, and pipelines between the two countries, and remaining 20% from state-owned Export-Import announced in Apr 2015. A superhighway is Bank of China and China Development Bank. planned to run some 3,000km from Gwadar in Pakistan to China's western Xinjiang region. This is followed by the establishment of Asian China is expected to inject a total of US$46bn Infrastructure Investment Bank (AIIB), with 57 for the CPEC project, just a little less than countries as its founding members, including 16 of three times the entire foreign direct investment the world’s 20 largest economies on board, after Pakistan has received since 2008. the 30 Mar 2015 deadline. The United States, Japan, Mexico and Canada remain absentees A bridge over the Danube to be financed and citing concerns of lack of transparency, lending built by the Chinese in Belgrade and environmental safeguards, governance, and China’s influence. AIIB members voted at a meeting Two nuclear power plants will be built in in Singapore on 22 May 2015 to double the capital to Romania, under a "binding and exclusive" USD100bn, with China expected to hold a stake of agreement with China

20 Quarterly Global Outlook 3Q2015 • UOB Global Economics & Markets Research CHINA FOCUS I

China is building a high speed rail connecting The probability of success for this initiative looks to southeastern tip of Europe with the central part be high as long as China’s political support continues. of the continent Financing is falling in place with the establishment of Silk Road Fund and the AIIB which saw 16 of the Hungary in early June signed an MOU with world’s 20 largest economies as founding members, China to promote the One Belt, One Road and backed by China’s foreign exchange reserves. proposals, the first European country to do so However the Initiative will be subject to challenges While these infrastructure projects are designed along the way including domestic factors, to be joint venture with local host countries, one opposition/resistance from countries along the observation is that often the bulk of the materials routes, geopolitical developments, technological and labour force come from China, and financed by advancements, among others. China banks.

Conclusion China has embarked on an ambitious undertaking in a bid to integrate further with the global economy, and to secure access to markets and resources. This connectivity is reflective of its rising role as a political and economic power in the next decades. Cooperation is needed, and not guaranteed, from countries along the “Belt and Road”, though investment in infrastructure is likely to bring benefits to those involved. Business opportunities are also likely to arise, as incomes and livelihood improve. ASEAN economy and businesses should benefit directly, being part of the maritime silk road, which will accelerate the already close trade and investment linkages between the two sides.

Quarterly Global Outlook 3Q2015 • UOB Global Economics & Markets Research 21 CHINA FOCUS II AIMING FOR THE SDR BASKET

With its rising economic size and position as a of the RMB’s inclusion into SDR in 2015 at 60%, top trading nation, China is aiming for the RMB with the remaining 40% hinging on factors such to be included into the SDR basket of currencies as evaluation by IMF executive board, which is at the 2015 IMF review, which could further dominated by advanced economies and has yet to accelerate the RMB internationalization efforts implement the quota reform agreed to in 2010. and adoption. As China keeps its eyes on the SDR, the risks of However, a positive decision remains uncertain a sharp depreciation for the RMB are relatively at this year’s review, as it can be argued that low as it would jeopardize the chance of becoming China has yet to satisfy all the four requirements a reserve currency. Concerns for depreciation were set out by IMF in 2011, and we estimate the heightened in early 2015 when the RMB fell to nearly probability of RMB’s admission into SDR in 3 year low of 6.274/USD. Furthermore, there are no 2015 at 60%. fundamental reasons to support a sharp depreciation or devaluation of the currency, given the size of As China keeps its eyes on the SDR basket, its foreign reserves at USD3.7tn. We continue to the risks of a sharp depreciation for the RMB expect USD/RMB exchange rate at 6.20 for end- would be low, and our projections for USD/RMB 2015, vs. current 6.20 level. However, the RMB exchange rate still stand at 6.20 for end-2015, is likely to move in volatile fashion on a day to day vs. current 6.20 level. We also expect a further basis as it responds to both domestic and global widening of the RMB trading band to 3% from market conditions, and we are still expecting a further 2% sometime this year. widening of the RMB trading band to 3% from 2% sometime this year.

Summary: China Seeking How Has China Progressed So Far? To Score The SDR Basket China’s rise as a major economy and trading nation Among the key initiatives for China this year is to has been progressing at an astonishing speed over have the RMB admitted into International Monetary the past three decades. Based on IMF’s purchasing Fund (IMF) Special Drawing Rights (SDR) basket of power parity (PPP) measure, China’s economic currencies, which currently consists of four members: size rose from less than 5% share of the global US dollar, the euro, British pound, and Japanese yen. economy in early 1990s, to 16.3% share in 2014, SDR is a reserve asset created by IMF in 1969 to and is projected to account for nearly 20% of the supplement its members’ international reserves. The global economy by 2020. Meanwhile, the share SDR is reviewed every five years (“quinquennial”), of the US economy is expected to decline steadily and a decision is due by end of 2015 for the latest from nearly 20% in early 1990s and 2000s, to 15% review. share of the world by 2020. As shown in the chart, it is remarkable that both China and India started at As China presses ahead with capital account opening about the same size, though India’s economy has and RMB internationalization, an endorsement from expanded much slower and is projected to be less the IMF and international community via admission than half of China by 2020. into the SDR basket would accelerate this process further, and widen the acceptance of RMB in the As a trading nation, China’s combined value of global financial system. From China’s point of view, exports and imports is the largest in the world at a positive decision from IMF would affirm its efforts US$4.3tn in 2014, given its position as the world’s of more than 2 decades to integrate with the global largest exporter. However, in terms of imports, China financial system and allow China a greater say in trails the US, but still imported about the same international financial affairs. amount in 2014 as the next two large importers, Germany and Japan, combined. To be sure, China’s rising stature in the global economy and as a top trading nation means that its At the same time, this economic strength and trading currency should be a candidate as a reserve currency. strength have also spilled into the financial arena, with On its part, China has also gradually liberalized its the most visible impact being the internationalization capital account for fund inflows and outflows and of the RMB, as well as the opening of the capital strengthened the resilience of its domestic financial account in recent years as China stepped up financial markets, though much more work needs to be done. connectivity with the rest of the world.

Will China be able to score the SDR basket this The use of RMB as a payments and trade settlement year? A positive decision remains uncertain, as it currency has also increased significantly. For can be argued that China has yet to satisfy all the instance, the amount of cross border goods and four requirements set out by IMF in 2011, especially services trade settled in RMB has risen from virtually the condition that the currency to be widely held as zero prior to 2009, to RMB6.5tn in 2014, or about a reserve currency. We estimate the probability 25% of China’s total trade. Similarly for foreign

22 Quarterly Global Outlook 3Q2015 • UOB Global Economics & Markets Research CHINA FOCUS II

Size of GDP (PPP) World Top Five Trading Nations (2014)

% share of Global GDP (PPP) USD trillion 25.0 5.0 4.30

20.0 18.5 4.0 3.91 15.3 15.0 3.0 2.67 2.34 11.4 2.33 1.96

10.0 2.0 1.58 1.62 8.2 1.45 1.26

5.6 1.22 3.8 0.80

5.0 1.0 0.82 0.68 2.2 0.58

0.0 0.0 US China EZ Japan India ASEAN5 UK US China Germany Japan France 1992 2001 2007 2014 2019F Imports Exports Total Trade

Source: IMF, Bloomberg, UOB Global Economics & Markets Research Est Source: UOB, URA

direct investment and outward direct investment, the payments, as well as closer integration and relations amount settled in RMB has also picked up sharply, with these economies, and will benefit corporates (see chart below). and financial markets along the way. China has so far established offshore RMB centers in 14 countries/ Based on SWIFT (Society for Worldwide Interbank regions, covering trading time zones from East Asia Financial Telecommunication) payments data, RMB to North American west coast when Vancouver is now the world’s 7th largest currency as a payments joined the rank with Toronto in March 2015. In currency, with 1.8% share. While this value looks addition, China has signed bilateral currency swaps small or insignificant, the difference with Japanese agreements with foreign central banks to the tune yen at number 4 is only 1% point. With the ongoing of RMB3.15tn as of April 2015, from just RMB180bn internationalization and widening acceptance, the when the process started in late 2008. RMB could soon catch up with the Japanese yen or even the British pound. However, it will take a long More important however, is for the Chinese time for China to challenge the position of the euro government to strengthen the domestic financial or the US dollar, the top two payments currencies sector, particularly its banks, so that it is sufficiently in the world. resilient to cope with the new pressures that financial liberalisation inevitably brings. The integration of a The setting up of RMB clearing arrangements will new major currency in the global financial system play an important role in facilitating cross-border means that financial shocks would transmit more

RMB Settlement Of Cross Border Trade & Investment SWIFT: Payments Currency

RMB, billions % share 8,000 862.0 USD 43.09 186.60 EUR 28.95 6,000 GBP 8.57 JPY 2.75 CHF 1.85 4,000 1.82 656.5 CAD CNY 1.81 5,900.0 2,000 AUD 1.80 HKD 1.08 THB 1.08 0 2009 2010 2011 2012 2013 2014 0 10 20 30 40 50 FDI ODI Services Goods trade Feb 2015 Jan 2014

Source: CEIC, UOB Global Economics & Markets Research Est Source: SWIFT, UOB Global Economics & Markets Research Est

Quarterly Global Outlook 3Q2015 • UOB Global Economics & Markets Research 23 CHINA FOCUS II

easily across borders in either direction. On this front, it should be noted that the Chinese authorities Bilateral Currency Swap Agreements are embarking on the implementation of banks’ deposit insurance scheme (effective 1 May 2015), RMB trillion and restructuring of local government debt, among 3.50 other things, to improve resilience of the domestic financial system. 3.00

Thousands 2.50 What Is IMF’s Special Drawing Rights (SDR)? The SDR (which is also known as “paper gold”) is 2.00 an international reserve asset, created by the IMF in 1969 to supplement its member countries’ official 1.50 reserves. Its value is based on a basket of four key 1.00 international currencies (as of April 2015), and SDRs can be exchanged for freely usable currencies. As 0.50 of 17 March 2015, 204bn SDRs were created and allocated to members (equivalent to about 0.00 US$280bn). Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15

Source: Bloomberg UOB Global Economics & Markets Research Est The SDR is neither a currency, nor a claim on the IMF. Rather, it is a potential claim on the freely usable currencies of IMF members. Holders of SDRs can changed circumstances warrant, to ensure that it obtain these currencies in exchange for their SDRs in reflects the relative importance of currencies in the two ways: first, through the arrangement of voluntary world’s trading and financial systems. This happened exchanges between members; and second, by the in 1998 when the euro was incorporated into the SDR IMF designating members with strong external basket, replacing Deutsche mark and French franc. positions to purchase SDRs from members with weak external positions. In addition to its role as a In 2011, the IMF Executive Board set down the supplementary reserve asset, the SDR serves criteria that a country should meet in order for its as the unit of account of the IMF and some other currency to be included in the SDR basket. First, international organizations. As such it should be clear the currency should be actively traded on foreign that the SDR by itself does not function as “money”, exchange markets. Second, there should be active as it is only able to fulfill the role of “unit of account” markets in exchange-based and over-the-counter and “store of value”, and not the role “medium of foreign exchange derivatives. Third, the country exchange” for payments for goods and services and should have market-based interest rate instruments. repayment of debts. And, fourth, the currency should be widely held as foreign exchange reserves. (Please refer to : “IMF The SDR basket today consists of the euro, Japanese Executive Board Discusses Criteria for Broadening yen, pound sterling, and US dollar. The value of the the SDR Currency Basket,”, IMF Public Information SDR in terms of the US dollar is determined daily, Notice (PIN) No. 11/137, 11 November 2011, calculated as the sum of specific amounts of the https://www.imf.org/external/np/sec/pn/2011/pn11137.htm) four basket currencies valued in US dollars, on the basis of exchange rates quoted at noon each day in China is likely to be able to meet the first three criteria e London market. The weights of these currencies of active trading and availability of FX derivatives are shown in the table below. Valuation of SDR is given the ongoing RMB internationalization efforts, posted on IMF website. while the onshore interest rate market will be (https://www.imf.org/external/np/fin/data/rms_sdrv.aspx) liberalized before end of 2015 following the implementation of deposit insurance system on 1 The basket composition of SDR is reviewed every May 2015. The last criterion on foreign exchange five years (“quinquennial”), or earlier if the IMF finds reserves will be problematic, as it is really a chicken-

SDR Basket Weightage (% share) Effective IMF/WB Annual Decision USD EUR GBP JPY Sum Period Meetings Announced 2011-2015 8-10 Oct 2010 15 Nov 2010 41.9% 37.4% 11.3% 9.4% 100.0% 2006-2010 24–25 Sep 2005 28 Oct 2005 44.0% 34.0% 11.0% 11.0% 100.0% 2001-2005 19–28 Sep 2000 12 Oct 2000 45.0% 29.0% 11.0% 15.0% 100.0% 1999-2000* 29 Sep – 8 Oct 1998 31 Dec 1998 39.0% 32.0% 11.0% 18.0% 100.0% * Euro was introduced in the SDR basket from 1999, with the weight consisting of DEM (21%) and FFR (11%) upon inception. Source: IMF, UOB Global Economics & Markets Research Est

24 Quarterly Global Outlook 3Q2015 • UOB Global Economics & Markets Research CHINA FOCUS II

and-egg problem: the currency needs to be widely RMB a more freely usable currency, according to held as a foreign reserves asset to be included in China’s plans. SDR, however foreign central banks would only increase holding of that currency if it is in the SDR The steps to be taken include: basket. As such, it could be a contentious issue 1. For individuals: channels for cross-border leading up to the decision at the end of this year. investments include the pilot Qualified Domestic Individual Investor (QDII2) program; For the 2015 edition, Annual Meetings of the World 2. For the upcoming Shenzhen-Hong Kong Stock Bank Group and the International Monetary Fund are Connect program, nonresidents will be allowed slated to take place in Lima, Peru, from 9 to 11 Oct to issue financial products on the domestic 2015. As shown in the table, a decision is likely to be markets with the exception of derivatives; returned approximately one month after the end of 3. Foreign exchange regulations will be revised to the Annual Meetings, though it could be as late as the remove requirements for ex ante approvals in end of the year in certain circumstances, as in the most cases, and a system for ex post monitoring; case for the euro’s inclusion into SDR basket in 1999. 4. For foreign institutional investors, further access to the Chinese capital markets; China’s March Towards 5. Further facilitate the international use of the Capital Account Convertibility RMB by removing unnecessary policy barriers China began its pursuit of capital account convertibility and providing the necessary infrastructure. more than 2 decades ago, when the Third Plenum of 14th CPC Central Committee in 1993 set the goal of Implications Of Inclusion Into SDR “gradually making the RMB a convertible currency.” RMB’s admission into the SDR basket will be a significant step forward for the internationalization After achieving current account convertibility in 1996, efforts, and likely to boost further usage and China set its target on capital account convertibility. acceptance as a currency for international trade The quest was twice interrupted: first by the 1997 and investment. It will also allow the RMB to be a Asian Financial Crisis, and then the 2008/09 Global contender as a reserve currency, in addition to the Financial Crisis. US dollar, euro, British pound, and Japanese yen, given that SDR itself is counted as part of a country’s Nevertheless, the progress has largely remained foreign exchange reserves. on track with gradual liberalization, with the RMB becoming convertible for foreign direct Beside counted as a reserve currency, this will investment (FDI) and outward direct investment allow the RMB to contest in the space of pricing (ODI); registration-based management has been commodities with China being a large consumer. In adopted for trade credit and trade-related claims on addition, the more widely used and internationalized nonresidents, and only external debt remains subject RMB is, the easier and less costly for China-based to quota management; Qualified Foreign Institutional businesses to venture abroad through trade or Investors (QFII) and Qualified Domestic Institutional investment. Investors (QDII) programs have been introduced and improved. In addition, China also expanded the In terms of weightage in the SDR basket, it is worth usage of RMB in cross border trade and investment, noting from the table earlier that GBP’s share has establishing offshore RMB centers in 14 countries/ stayed quite constant throughout the period while regions, as well as the signing of bilateral currency JPY’s share has fallen steadily, consistent with swaps with foreign central banks, establishing free Japan’s waning economic influence. As such, it is trade zones (Shanghai Pilot Free Trade Zone was very likely that inclusion of RMB would be at the established in 2013) cross-border stock connect expense of JPY and GBP, and to a lesser extent (Shanghai-HK Stock Connect scheme commenced from EUR and USD, depending on what is the entry in late 2014), among others. weight for the new constituent. A 10% to 15% weight for the RMB at the outset would be a good starting Obviously, the aim is to achieve some form of point for the new SDR basket. full capital account convertibility and PBoC noted that currently more than 85% of China’s capital What are the chances for RMB’s scoring the SDR account (35 out of 40 items) are either fully or partly basket in 2015? At this stage, it remains uncertain as convertible under IMF classification. The remaining it can be argued that China has yet to satisfy all the 15% (5 out of 40 items) that are still nonconvertible requirements set by IMF in 2011, especially the part include individual cross-border investment and the on foreign central banks and governments holding a issuance of shares and other financial instruments by significant share of their foreign exchange reserves nonresidents on domestic markets. In PBoC’s view, in the RMB. On this criterion, it is really a chicken- it is getting close to full capital account convertibility. and-egg problem, i.e. the currency needs to be widely The five broad items that are currently nonconvertible held as a foreign reserves asset to be included in will be gradually liberalized in 2015, making the SDR, however foreign central banks would be more

Quarterly Global Outlook 3Q2015 • UOB Global Economics & Markets Research 25 CHINA FOCUS II

inclined to increase holding of that currency if it is in the SDR basket.

We estimate the probability of the RMB’s inclusion into SDR in 2015 at 60%, with the remaining 40% hinging on factors such as evaluation by IMF executive board, which is dominated by advanced economies and has yet to implement the quota reform agreed to in 2010.

For the RMB exchange rate itself, the risks of a sharp depreciation or devaluation have certainly diminished significantly as China aims for the SDR basket. A sharp weakening of the currency would certainly jeopardize the chance of becoming a reserve currency. Furthermore, there are no fundamental reasons to support such weakening, given the size of its foreign reserves at USD3.7tn. We continue to expect USD/RMB exchange rate at 6.20 for end-2015, vs. current 6.20 level. However, the RMB is likely to move in volatile fashion on a day to day basis as it responds to both domestic and global market conditions, and we are still expecting a further widening of the RMB trading band to 3% from 2% sometime this year.

26 Quarterly Global Outlook 3Q2015 • UOB Global Economics & Markets Research CHINA FOCUS III MARKET LIBERALIZATION MEASURES UPDATE

China’s financial market and capital account Unlike other instruments, which are short term tools liberalization continues to quicken, with a slew to manage liquidity conditions ranging from short of news and data releases in recent days. On 2 term operations of 1 day to 3 months (for SLO and Jun, PBoC released details on its PSL (Pledged SLF/MLF), PSL is of medium term duration of 3 to Supplementary Lending) program, as well as 5 years. This means that PBoC can now employ a announced the launch of large-denomination, range of tools to influence short term to medium term floating-rate tradable certificates of deposit (CD) liquidity conditions and interest rates. to individuals and companies, as it moves towards full interest rate liberalization. On 3 Jun, PBoC also PSL And Local Government Debt Swap announced further opening of the capital account The release of details on PSL also coincided with and RMB internationalization, by allowing offshore the recent developments on the local government RMB-clearing and -settlement banks to participate debt swap program, with the total amount doubled to in China’s interbank bond market’s repurchase RMB2tn from the original RMB1tn. This increase no facilities, and the funds raised can be used outside doubt was encouraged by the successful placement of mainland China. of Jiangsu province’s RMB10.9bn worth of bonds on 1 Jun, as part of the debt swap program. All these developments are aimed at strengthening the financial sector: the PSL as one of the tools to The swap program is one of the key planks in manage financial sector’s liquidity condition, CDs resolving China’s local government debt burden, to improve the banks’ funding needs and liability which the National Audit office estimated to stand at management, and participation of offshore institutions RMB17.9tn at end-Jun 2013 (some recent analyses in domestic bond markets to see increased inflows suggested the outstanding balance may have risen and outflows of funds, and ultimately full RMB to more than RMB20tn since then), with an estimated internationalization. RMB1.86tn coming due in 2015, in addition to contingent liabilities of RMB919.3bn, data from the More Details On PSL same 2013 audit report show. Based on the 2013 China’s central bank PBoC on 2 Jun released more audit report, more than 56% of the local government information on its PSL (Pledged Supplementary debt was in the form of bank loans. As such, banks Lending; 抵押补充贷款) program. PSL was first play a crucial role in this restructuring exercise to mooted in Apr 2014, and was reported in July 2014 rehabilitate local governments’ finances. that PBoC has extended RMB1tn at low interest rates for 3 years, to China Development Bank (CDB) to As these loans owed by local governments are facilitate rebuilding of slum areas (棚户区改造). The swapped and restructured into bonds with longer aim of PSL is to provide stable, longer term funding duration and lower interest rates, the upside is that at reasonable costs to financial institutions for long banks will be able to free up capital/boost capital term development projects, backed by high quality ratios, reduce the loan-to-deposit (LD) ratios, slow collaterals. down the formation of non-performing loans (NPLs) and provisions, and otherwise improve the overall Based on data released on 2 Jun by PBoC, the funds asset and credit quality of the banking sector as a released under PSL amounted to RMB383.1bn in whole. It is therefore no surprise that the restructuring 2014, and RMB262.8bn so far in 2015, thus the size expanded from the current RMB1tn. outstanding amount under the PSL program is RMB645.9bn at end-May 2015. Equally important, However, up to this point, a necessary condition interest rate on the PSL was lowered from 4.5% in is being created for banks to improve their asset 2014 to 3.1% so far in 2015, reflecting PBoC’s three quality and capacity to lend. This condition is not consecutive interest rate cuts over the past 6 months. sufficient to spur local banks to increase their lending The data confirmed that CDB is the only borrower activities. This is where the PSL could potentially under this program so far. From June onwards, PBoC play a role, even though it is not explicitly stated as will be releasing data on PSL on a monthly basis. such. As these privately placed, restructured local government bonds are not tradable in the open The latest statement further reaffirmed the role market, the only way to obtain stable and low cost of PSL, which is one of the instruments among funding is to pledge them to the central bank, via PBoC’s monetary policy “toolbox”. These include programs such as the PSL. This will be in line with an alphabet soup of acronyms such as MLF Premier Li Keqiang’s earlier exhortation of targeted (Medium-term Lending Facility, 中期借贷便利), SLO use of increased quantity and existing resources (“ (Short-term Liquidity Operations,公开市场短期流用好增量盘活存量”). 动性调节工具), SLF (Standing Lending Facility, 常备借贷便利) created only in recent years as PBoC This may sound like a China version of “Quantitative refined its liquidity and interest rates management Easing” or QE. However, it is only true to the extent just as financial markets are further liberalized that PSL, MLF, QE, and others are “quantitative” in and increasingly becoming more complex and nature, i.e. the creation of new money. But the QE of sophisticated. the US Fed, European Central Bank (ECB), and Bank

Quarterly Global Outlook 3Q2015 • UOB Global Economics & Markets Research 27 CHINA FOCUS III

of Japan comes with a prescribed size of large scale With the recent increased deposit rate ceiling to asset purchase (LSAP) program over a set calendar 1.5x of benchmark rates and the introduction of period to expand the central bank’s balance sheet. deposit insurance from 1 May, commercial banks In this this instance, PSL and the likes are closer have increased flexibility to price their deposits, to refinancing programs such as ECB’s Long Term especially with larger denominations being involved. Refinancing Operations (LTRO), than to QE. This will certainly make CDs an attractive alternative to wealth management products (WMPs), after taking Large Denomination Certificates Of Deposit into account features such as deposit insurance, (CDs) tradability, ability to pledge, early withdrawal, among On 2 Jun, PBoC also announced the launch of others. Large Denomination Certificates of Deposit to both individuals and institutional investors, which Capital Account Opening Measures will help banks to improve funding and liability On 3 Jun, China announced further opening of the management, and to reduce the attractiveness capital account, by allowing offshore RMB-clearing of wealth management products. Previously, only and -settlement banks to participate in China’s depositary financial institutions were allowed to issue interbank bond market’s repurchase facilities, and the and trade in CDs. funds raised can be used outside of mainland China.

The minimum amounts for large denomination CDs This latest move is to address the last few remaining are set at RMB300,000 for individuals and RMB10mn major restrictions of China’s capital account, i.e. for institutional investors, and will be sold among the inability of foreign institutions to raise funds in core members in a self-regulated system as a trial China’s bond and equity markets, and individuals at initial stage. More importantly, CD interest rates from China to move funds offshore. The further are to be decided by market with the floating-rate opening of China’s capital account will help to lower CD using Shibor as a benchmark, as China moves offshore RMB funding costs and improve offshore towards full liberalization of interest rate, which is liquidity conditions, as China keep its eye on the likely before end-2015. Making CDs attractive to prize of being included in IMF’s Special Drawing investors are that they can be transferred, pledged, Rights (for further details on SDR, please refer to redeemed and withdrawn early, and will be included Focus II: “China: Aiming for the SDR Basket, dated in deposit insurance system. 30 Apr 2015).

Source: PBoC’s PSL Operations Details 人民银行开展抵押补充贷款操作 2 Jun 2015 http://m.weibo.cn/3921015143/Ckicit8gm

PBoC’s Guidelines for Large Scale Certificates of Deposit 大额存单管理暂行办法 2 Jun 2015 http://www.pbc.gov.cn/publish/goutongjiaoliu/524/2015/20150602161842756366076/20150602161842756366076_.html

28 Quarterly Global Outlook 3Q2015 • UOB Global Economics & Markets Research CHINA FOCUS IV RMB INTERNATIONALIZATION UPDATE

China’s central bank PBoC on 11 Jun 2015 released in cross border RMB settlement with China its first report on RMB internationalization. Other than in 2014. Within China and under the current a treasure trove of information and data, this report account items, Guangdong province led in terms provides a comprehensive assessment of the RMB of cross border settlement with 26.7% share of internationalization development so far, as well as the total amount of RMB6.55tn, reflecting the a look to the future, from an official point of view. province’s role as a powerhouse in goods trade and manufacturing center. The report is also timely – ahead of the once-every- five-year review before end-2015 by IMF on the Rise in usage of RMB in direct investment in Special Drawing Rights (SDR) basket of currencies both directions, i.e. foreign direct investment – providing a definitive perspective of various, and (FDI) into China and outward direct investment sometimes confusing, analyses of the entire RMB (ODI) to overseas as Chinese enterprises internationalization process that began in 2009. look beyond China’s borders for business and investment opportunities. The combined amount While China has largely met three out of the four SDR of cross border RMB settled FDI and ODI rose criteria, the FX reserve requirement may be the only from RMB106.6bn in 2011 to RMB1.05tn in weakness, as data from PBoC’s report shows that 2014, a nearly 10 times increase in just three the currency accounted for just 1.4% share of global years. (ex-China) foreign reserves of USD7,840.9bn. This is lower than JPY's 4% share held in advance countries' Use of RMB as a reserve currency has forex reserves. As such, we are still pegging China’s also expanded since the currency’s success in the SDR admission at 60% probability. internationalization began in 2009. Aside from the bilateral currency swap agreements With or without SDR, we expect financial market signed with 32 central banks worldwide worth liberalization efforts in China to continue to accelerate RMB3.2tn, the more interesting piece of data ahead. This means that there will be further two way is how much of the RMB is being held by moves for the RMB exchange rate and no more central banks. PBoC disclosed that, based on one-way appreciation/depreciation trend, and also estimates, RMB-denominated bonds, stocks, the possibility of widening of RMB trading band to and deposits held by central banks worldwide 3% from 2% before end-2015. amounted to RMB666.7bn as of end-Apr 2015. Assuming that there was minimal amount In terms of interest rates, full removal of the deposit held prior to 2009, the growth rate would rate ceiling (at 1.5x currently) is very likely in 3Q certainly be impressive. However, the amount 2015, along with one more round of interest rate is approximately USD107.5bn or just around cuts and reserve requirement ratio (RRR) cuts to 1.4% share of global foreign reserves (ex- lend support to economic growth. China) of USD7,840.9bn. This is lower than JPY's 4% share held in advance countries' forex Some of the highlights from the report: reserves. This means that it is still long way for Rise in usage of cross border RMB under current China to catch up with other reserve currencies, account: the amount of goods and services trade especially the USD. settled in RMB rose from RMB3.60bn in 2009 to RMB6.55tn in 2014. Nonresidents’ (including institutions and individuals) holdings of RMB assets in China There were 189 countries (excluding HK, have also risen, though it appears that the Macao, Taiwan, and other areas) involved pace is more measured. Total assets rose from

Cross Border RMB Settlement of Current Account Items Global Trade Global Trade Services and Total Current Ac- In RMB billions % share (Exports) (Imports) other trade count items Guangdong 736.8 870.4 144.9 1,752.1 26.7% Shanghai 320.2 506.5 188.2 1,014.9 15.5% Zhejiang 379.5 345.3 19.0 743.9 11.3% Beijing 88.6 453.5 131.4 673.5 10.3% Shangdong 157.8 390.5 18.9 567.1 8.7% Jiangsu 187.1 181.8 45.2 414.1 6.3% Tianjin 66.5 89.9 23.1 179.5 2.7% Guangxi 89.0 53.1 1.4 143.5 2.2% Fujian 61.5 61.7 7.7 130.9 2.0% Others 430.1 427.5 76.8 934.3 14.3% Total 2,517.0 3,380.3 656.5 6,553.9 100.0% Source: RMB Internationalization Report (2015), p 6; UOB Global Economics & Markets Research Est

Quarterly Global Outlook 3Q2015 • UOB Global Economics & Markets Research 29 CHINA FOCUS IV

Nonresidents’ (including institutions and individuals) Holdings of RMB Assets in China In RMB billions Dec-13 Mar-14 Jun-14 Sep-14 Dec-14 Mar-15 Apr-15 Equity 344.8 319.3 364.2 462.5 555.5 601.1 644.4 Bonds 399.0 512.3 559.3 634.1 671.6 712.8 735.2 Loans 531.0 746.8 893.8 860.5 819.0 876.9 873.9 Deposits 1,604.9 1,984.0 2,045.1 2,237.2 2,372.2 2,024.8 2,153.0 Total 2,879.7 3,562.4 3,862.4 4,194.3 4,418.3 4,215.6 4,406.5 Source: RMB Internationalization Report (2015), p 11; UOB Global Economics & Markets Research Est

RMB2,879.7bn at end-2013 to RMB4,406.5bn restrictions against foreign central banks’ at end-Apr 2015, as shown in the table above. participation in mainland markets. It should be noted that deposits account for the bulk of the assets given restrictions on Implications bonds and equity markets, the target for further As we noted in our earlier reports (for further reductions in restrictions in the capital account. details please refer to: Focus III: “China: Market Liberalization Measures Update” and Focus II: RMB FX trading in China (including interbank “China: Aiming for the SDR Basket”), China’s and on behalf of customers) averaged about financial market liberalization remains on track and, USD55.0bn per day in 2014, and a total of the pace has been accelerating. USD4.12tn of spot trading was conducted that year, a 1.2% growth from 2013. FX derivatives PBoC’s main aim this year is obviously the admission saw much stronger growth in 2014, with total to the SDR basket by end of 2015. To ensure amount of OTC FX swap expanding 32.1% from success, China needs to show progress in the four 2013 to USD4.49tn in 2014, while FX forwards main areas considered by IMF. First, the currency value rose 63.5% to USD52.9bn in 2014. should be actively traded on foreign exchange Based on its estimates, the combined trading of markets. Second, there should be active markets RMB in offshore markets such as Hong Kong, in exchange-based and over-the-counter foreign Singapore London, and others averaged more exchange derivatives. Third, the country should than USD230bn per day in 2014, which is more have market-based interest rate instruments. And, than 4 times the onshore volume. This also fourth, the currency should be widely held as foreign suggests the importance of offshore market in exchange reserves. (Please refer to: “IMF Executive driving the RMB FX value. Board Discusses Criteria for Broadening the SDR Currency Basket,”, IMF Public Information Notice In the next steps, PBoC is focusing on driving the (PIN) No. 11/137, 11 November 2011, 1) convertibility of the capital account, a process https://www.imf.org/external/np/sec/pn/2011/pn11137.htm). that started after current account convertibility in 1996; 2) interest rate liberalization, including As described earlier, data provided in the RMB the announcement of the large-denomination, internationalization report suggest that China is floating-rate tradable certificates of deposit (CD) likely to have met three out of the four criteria set to individuals and companies; and 3) market- in the IMF report, except the one on the usage as a determined pricing of the RMB exchange rate, reserve currency. We note that RMB accounted for including the widening of trading bands to 2% in just around 1.4% share of global foreign reserves March 2014, as well as the increased two-way (ex-China) at end-Apr 2015, which could be a deal trading and flexibility of the exchange rate. breaker in the SDR admission process.

Further steps to internationalize the RMB The key reason for such low usage in FX reserve is remain in place, and PBoC is looking to 1) mainly due to the non-convertibility of China’s capital implement cross border payment system (China account, which actually has very few restrictions left. International Payment System, or CIPS) before As mentioned in our report on SDR, China’s capital end-2015; 2) expand mainland entities’ usage account is basically convertible for 85% of the items, of RMB under current account; 3) broaden and PBoC is now working on the remaining 15% the usage of RMB in cross border financing, (or 5 out of the 40 items) which include individuals’ e.g. offshore entities’ issuing of RMB bond in cross-border investment and the issuance of shares China, Chinese entities raising RMB funding and other financial instruments by nonresidents in in offshore market, pricing of commodities in domestic markets. China’s capital account is in fact RMB; 4) enlarge the scope and amount of closer to full convertibility than many people think. bilateral currency swap agreements; and 5) accelerate the admission of RMB into the SDR As such, we are still holding to our view that RMB basket and to support the adoption of RMB as success probability at SDR admission this year foreign reserve currency by removing certain at 60%, with the remaining 40% hinging on factors

30 Quarterly Global Outlook 3Q2015 • UOB Global Economics & Markets Research CHINA FOCUS IV

such as evaluation by IMF executive board, which In terms of interest rates, full removal of the deposit is dominated by advanced economies and has yet rate ceiling (at 1.5x currently) is very likely in 3Q to implement the quota reform agreed to in 2010. 2015, along with one more round of interest rate cuts and reserve requirement ratio (RRR) cuts to However, we believe that financial market liberalization lend support to economic growth. We look for one efforts in China will continue to accelerate ahead with more round of 25bps cut in interest rates, to 2.00% or without SDR. This means there will be further two for benchmark deposit rate and 4.85% for lending way moves for the RMB exchange rate and no more rate, and a 50bps cut to bring RRR to 18%. one-way appreciation/depreciation trend, and also the possibility of widening of RMB trading band to 3% from 2% before end-2015. The risks of a sharp Source: depreciation or devaluation have certainly diminished significantly as China aims for the SDR basket. A 人民币国际化报告 (2015) sharp weakening of the currency would certainly RMB Internationalization Report (2015), 11 Jun 2015 jeopardize the chance of becoming a reserve http://bit.ly/pbc-rmbint2015 currency. Furthermore, there are no fundamental reasons to support such weakening, given the size of its foreign reserves at USD3.7tn. We continue to expect RMB exchange rate at 6.23/USD at end-3Q15 and 6.20 for end-2015, vs. current 6.2080/USD level.

Quarterly Global Outlook 3Q2015 • UOB Global Economics & Markets Research 31 INDONESIA

Despite The Sharp IDR Depreciation vs. USD, Inflation To Hover At Around 7.0% y/y In The Coming The Currency Has Appreciated In REER Terms Months Before Moving Lower In 4Q15 Due To Base Effect

8,000 105 9.0 100 UOB's Estimate 9,000 8.0 95 10,000 7.0 90 11,000 85 6.0 12,000 80 5.0 13,000 75 4.0 14,000 70 Dec 11 Oct 12 Aug 13 Jun 14 Apr 15 3.0 Jan-10 Mar-11 May-12 Jul-13 Sep-14 Nov-15 USD/IDR (LHS) NEER (2010=100) REER (2010=100) FASBI Rate BI Rate CPI (y/y %)

Source: CEIC, UOB Global Economics & Markets Research Source: CEIC, UOB Global Economics & Markets Research

USD/IDR At Highest Level Since 1998 in February. The headline inflation rate edged high- USD/IDR surged to a fresh 17-year high in June er to 7.15% y/y in May from 6.79% y/y in April and on the back of rate normalization expectation in the is likely to remain at around 7.0% in the next few US which was compounded by domestic growth months. We may see some upward price pressure concerns and seasonal USD demand for debt pay- through Ramadan but inflation will drop in 4Q15 due ments. Since the start of the year, IDR has depreci- to a high base effect. Against the backdrop of rate ated by around 7.0% against USD, making it the normalization expectation in the US this year and worst-performing currency in Asia. The eventual the depreciation pressure on the IDR, we expect BI rate lift-off in the US supports higher USD/IDR but to maintain its policy rate unchanged at 7.50% for a more gradual pace will likely reduce the upward the upcoming meetings. However, in order to lower trajectory in the pair. We expect USD/IDR at 13,500 lending rates for small businesses, the government and 13,600 at end-3Q15 and end-4Q15 respec- said it will subsidize interest payments and provide tively. cheap funding to the government and state-owned banks. While this might provide some support to The current account deficit remains a major con- credit growth, a weak overall sentiment could still cern for Indonesia. Indonesia’s 1Q15 current ac- hinder the growth recovery. count deficit narrowed slightly to 1.8% of GDP from 2.6% in 4Q14 and was smaller than 1.9% in 1Q14. Second Quarter Growth To Remain Sub-Par The deficit is expected to widen in 2Q15 before Domestically, growth outlook remains downbeat narrowing again in 2H15. Overall, the current ac- after Indonesia turned in its slowest growth pace count is expected to remain in a deficit of around since 2009 at 4.71% y/y in 1Q15 (4Q14: 5.01%). 2.5-3.0% of GDP this year (2014: 2.9%). 2Q15 growth is likely to remain below 5.0%.With soft commodity outlook, private consumption which While BI has already mandated the use of IDR in accounts for around 56% of GDP will be the key Indonesia since 2011, further restrictions on the use growth driver ahead but slowing car sales point- of foreign currencies for non-cash transactions will ing to weak domestic demand are disconcerting. be implemented starting July 1, but may not have a The government has only disbursed about 31% significant impact on the USD/IDR. of its spending target through end-May and is expected to accelerate spending in the second half of Despite the IDR depreciation against USD, relative- the year in order to push up the growth rate. This ly higher inflation in Indonesia compared to its trad- should improve outlook in 2H15 and bring the full- ing partners has led to firmer IDR on a real effective year growth to around 5.0%. exchange rate basis which has compromised the country’s competitiveness. Containing the high in- UOB Economic Projections 2013 2014 2015F 2016F flation rate will be of immediate concern to BI. GDP 5.6 5.0 5.0 5.5

CPI (average, y/y %) 6.4 6.4 6.5 4.8 Relatively High Inflation And IDR Slump Limiting Monetary Policy Options Unemployment rate (%) 6.3 5.9 5.7 5.3 Despite the slowdown in growth, we believe that BI Current account (% of GDP) -3.2 -2.9 -2.9 -2.3 has little room to cut its interest rates further in the short-term after the surprise 25 bps rate reduction Fiscal balance (FY, % of GDP) -2.2 -2.3 -1.9 -1.7

32 Quarterly Global Outlook 3Q2015 • UOB Global Economics & Markets Research MALAYSIA

Sharp Depreciation In MYR Inflation Heading Higher Ahead

110 2.5 6.0 5.0 105 2.7 4.0 2.9 100 3.0 3.1 95 2.0 3.3 1.0 90 3.5 0.0 85 3.7 -1.0

80 3.9 -2.0 Dec 04 Jun 07 Dec 09 Jun 12 Dec 14 Jan-11 Nov-11 Sep-12 Jul-13 May-14 Mar-15 Headline CPI (y/y %) CPI: Non Food NEER 2010=100 REER 2010=100 USD/MYR CPI: Food OPR (%)

Source: CEIC, BIS Source: CEIC, UOB Global Economics & Markets Research Est

Domestic Factors Underpin MYR Weakness Capital spending in both manufacturing and servic- USD/MYR surged to fresh highs since the July es sectors were firm in 1Q15, but investments could 2005 de-peg on the back of USD strength and weaken with the deterioration in sentiment and a more downbeat domestic sentiment. While the Fi- soft commodity sector. Indeed, exports went on to nance Ministry has said that there are no plans to contract by a sharper 8.8% y/y in April compared to reintroduce a currency peg, the weakening MYR is the 2.5% drop in 1Q15, led by the slump in crude, likely to keep the concerns alive. Before the end palm oil and natural gas shipments as well as re- of June, Fitch is expected to announce its review cent weakness in electrical and electronics (E&E) of Malaysia’s credit rating. The rating agency has orders. Industrial production grew at a slower pace put the chance of a downgrade at more than 50%. of 4.0% y/y in April compared to 6.5% in 1Q15. The Although market has priced it in, there could still be data suggests that growth will moderate further in knee-jerk reaction and pressure on MYR should the the second quarter, especially as private consump- risk materializes. Politics is another area of concern tion is also likely to ease after the GST roll-out. given the fallout from state investment firm 1Malay- sia Development Bhd.’s RM42 bn debt, of which Slowing export will narrow the current account sur- slightly more than half is USD-denominated. While plus to 2.4% of GDP this year which is another neg- we are maintaining our end-3Q15 and end-4Q15 ative factor for the MYR. Malaysia’s current account USD/MYR forecast at 3.78 and 3.80 respectively, surplus fell to 3.6% of GDP in 1Q15 compared to the domestic uncertainties and the start of Fed’s 7.3% in 1Q14. Some pick up in tourism activities rate normalization may cause the pair to overshoot. with MYR weakness may alleviate the impact.

Interest Rate Expected To Be On Hold On the fiscal front, we think the government’s deficit Pressure on the MYR and higher inflation post-GST target of -3.2% of GDP in 2015 is achievable and is implementation has limited the options for Bank Ne- likely to narrow to -2.7% in 2016. The government gara. Reflecting the impact of the 6% GST, headline expects to collect additional revenue of RM31.4bn inflation surged to 1.8% y/y in April from 0.7% in per annum and possibly more depending on the ef- 1Q15 and is likely to rise quickly to an average of fectiveness of GST implementation. We anticipate 2.5-3.0% y/y in 2H15. We are maintaining our call lower contributions from Petronas but would be off- for Bank Negara to be on hold at 3.25% this year. set by additional dividends from other government linked entities. That should help ensure fiscal con- GDP Growth Slowing Further Ahead solidation plans remain on track. Malaysia’s GDP grew a better-than-expected 5.6% y/y in 1Q15 (4Q14: 5.7%). Private demand growth UOB Economic Projections 2013 2014 2015F 2016F strengthened, offsetting the drag from the export GDP 4.7 6.0 5.0 5.3 contraction. A stable labour market and wage CPI (average, y/y %) 2.1 3.1 2.1 2.7 growth continued to drive private demand while the front-loading of spending ahead of the GST imple- Unemployment rate s/adj (%) 3.3 2.8 2.9 2.7 mentation in April also provided a boost. That said, Current account (% of GDP) 3.5 4.3 2.4 3.4 we would expect a pullback in private consumption Fiscal balance (FY, % of GDP) -3.9 -3.5 -3.2 -2.7 in 2Q15.

Quarterly Global Outlook 3Q2015 • UOB Global Economics & Markets Research 33 SINGAPORE

Services Sectors Grew At A Faster Pace Of 3.8% In 1Q 2015, While Goods Sectors Fell 1.4%

% y/y Better Performing Services Sectors in 1Q2015 10 7.9 7.7 8 6 4.6 4.1 3.6 3.1 4 3.0 2.8 2.9 2.6 1.7 1.5 1.7 2 1.1 0 -2 -0.4 -4 -2.7 Finance & Infocomms Wholesale & Construction Business Transport & Accomodation Manufacturing Insurance Retail Trade Services Storage & Food Services 2014 Share 12% 4% 18% 5% 14% 8% 2% 19% of GDP 1Q 2015 2014

Source: CEIC

Robust Services Sectors Will Support 2015 saw the fastest on-year pace in four quar- Economic Growth In 2H 2015 ters to reach 3.8% y/y. The key push came from Singapore’s 2nd reading of 1Q GDP (+2.6% y/y), the wholesale & retail trade sector, and finance came in higher than the 2.1% y/y estimated during & insurance sector. We remain optimistic on the the 1st reading. The two key reasons for the better- economic recovery in the US and anticipate some than-expected GDP performance was the smaller positive spillovers to the non-oil tradeables sector in on-year contraction in the manufacturing sector, as Singapore. However, the external economic condi- well as, the stronger growth from the services sec- tions remain fluid, with recent concerns re-center- tor. ing on “Grexit” and the resurgence of political-economic uncertainties in the Eurozone. Deflationary Although the manufacturing sector fell 2.7% y/y in pressures, slower growth and high unemployment 1Q, the second consecutive quarter of on-year con- rates amongst Singapore’s top exporting countries traction, we think that the worst is over and manu- continue to pose risks on the trade front. facturing activities will likely pick up from 2Q-4Q this year due to low base effects. However, this does The government maintained their 2015 GDP not mean that manufacturing growth will be strong growth forecast of 2-4% while we maintain our this year. We are projecting a full year manu- forecast of 2.9%. More than anytime during the facturing sector growth rate of 1.3%, and this past 8 years of low interest rate environment, the is only half the 2.6% growth rate in 2014. Year- US Federal Reserve will likely start their interest to-date, the chemicals clusters was the only bright rate normalization cycle this year, although the 18 spot as it was the only cluster with a positive on- June FOMC statement signaled a downward ad- year growth. Even so, the chemicals cluster grew justment in the pace of rate hike. With that and our only 3.1% y/y and since it comprised only 11% of view that the Monetary Authority of Singapore will total manufacturing activity, it is likely not able to keep the SGD NEER appreciation slope unchanged pull up overall growth. Moreover, the offshore & ma- at our estimated 1% pa rate as core inflation envi- rine engineering and petrochemicals clusters may ronment remains within their forecast, we lowered see slower growth as uncertainty in future oil prices the USDSGD appreciation trajectory and forecast continues to question capex in this sector. Addition- the USD/SGD to reach 1.38 by end of 2015, from ally, growth in the electronics cluster (the largest 1.40 as expected earlier. We also adjust our fore- cluster in the manufacturing sector) could be ham- cast for the SGD 3-month SIBOR to reach 1.15% pered as suppliers in the personal computer value by end of 2015, from 1.30% expected earlier. chain continue to face lower external demand for their products, while they manage the rising costs UOB Economic Projections 2013 2014 2015F 2016F amid a contraction in labour productivity growth. GDP 4.4 2.9 2.9 3.4 Manufacturing sector’s labour productivity fell 1.4% CPI (average, y/y %) 2.4 1.0 0.3 0.8 y/y in 1Q 2015, registering the second consecutive quarter of contraction. Unemployment rate (%) 1.9 1.9 2.1 2.1 Current account (% of GDP) 17.9 19.1 21.6 19.4 Nevertheless, economic growth should be well Fiscal balance (FY, % of GDP) 1.3 1.3 -1.7 1.0 supported by the robust services sector, where 1Q

34 Quarterly Global Outlook 3Q2015 • UOB Global Economics & Markets Research THAILAND

Although the lowered economic growth forecasts Private Consumption At One-Year Low and the ‘deflationary’ environment may provide dovish policy impetus for the BoT, we do not think that % y/y the BoT will move to cut policy rates lower for the 35 rest of this year. The current ‘deflation’ in Thailand 30 is due to the transmission of lower oil and commod- 25 ity prices into several segments of the consumption basket (chiefly in the transportation segment). 20 Weakness in This is not the same as the deflation seen during 15 Private the 2008/09 global financial crisis where there was 10 Consumption slack in the labour market, wage growth was nega- 5 tive, and prices across most segments in the con- 0 sumption basket contracted. -5 Moreover, lower interest rates may aggravate the -10 already-high household debt problem in Thailand, 2011 2012 2013 2014 2015 while the recent dynamics in oil prices may point to Pte Consumption Index Pte Investment Index upside surprise. As such, we believe that the BoT may stand pat at the current policy rate for the Source: CEIC rest of 2015, and then coming in with a 25bps hike in 1Q 2016 to match the start of the US interest rate 1Q Growth Missed Forecasts; normalization cycle. More Headwinds For Rest Of 2015 Thailand’s 1Q 2015 GDP grew 3.0%, although at Going ahead, more work needs to be done to im- the fastest pace in 8 quarters, it was lower than mar- prove business sentiments and getting the invest- ket forecast of a 3.4% growth rate. Caution should ment engine roaring once more. Fiscal stimulus will be exercised regarding the data as it reflected a low also be another key area to boost economic growth, base in the same quarter a year ago. In fact, it could especially in times of sluggish consumer and busi- probably be the strongest on-year growth rate seen ness confidence. With new information on 1Q GDP in 2015 as headwinds from slower global growth will growth and our assessment of the economic envi- likely hamper export demand, while weak domestic ronment for the rest of 2015, we had revised Thai- consumption may fail to lift up aggregate demand. land’s 2015 GDP growth forecast to 2.7%, from 4.0% earlier. Recent data showed that Thailand’s exports fell for the 4th month in April and the private consumption Recent moves in the USDTHB seemed to be index was seen dropping to a one-year low in April. overly aggressive, and some profit-taking may The Thai government (NESDB) had also reduced pare off the gains in the near term ahead. However, its 2015 export growth forecast to 0.2%, from 3.5% the anticipation of the US Fed rate hike will see a earlier. stronger greenback against the THB and we expect the USDTHB pair at 34.30 by end of 2015. Although the 29 Apr Bank of Thailand policy decision of a 25bps cut to the policy rate to 1.50% had surprised markets then, but on hindsight, that rate UOB Economic Projections 2013 2014 2015F 2016F cut was probably meant to provide the much need- GDP 2.9 0.9 2.7 4.9 ed monetary boost to economic growth, as the infla- CPI (average, y/y %) 2.2 1.9 -0.5 2.5 tion environment remained benign. In fact, Thailand had reported its fifth month of ‘deflation’ (the longest Unemployment rate (%) 0.7 0.8 0.8 0.8 run since the global financial crisis) in May, and reg- Current account (% of GDP) -0.8 3.3 3.5 3.2 istered a rate that was worse than any other major Fiscal balance (FY, % of GDP) -2.3 -2.7 -3.0 -3.0 emerging market economy.

Quarterly Global Outlook 3Q2015 • UOB Global Economics & Markets Research 35 INDIA

Treading With Caution India’s Inflation Slowed Considerably And Is Below RBI’s On India’s New GDP Numbers 8% Target; But Risks Of Prices Climbing Back Up India’s Jan-Mar 2015 GDP delivered a solid growth of 7.5%, beating the downward revised % y/y 6.6% growth in the previous quarter, and outshining 18 most economies in the world. Growth was driven 16 mainly by the services sector, with the trade, hotels, 14 transport sector (+14.1% y/y) and the financial, real 12 estate & professional service sector (+10.2% y/y) gaining strongly. In line with recent industrial pro- 10 duction numbers, the Indian manufacturing sector 8 also gained at a stronger pace of 8.4% y/y. 6 4 With such ‘rosy’, world-beating numbers, it 2 seemed paradoxical that the Reserve Bank of 0 India (RBI) cut its key interest rate for the third 2004 2006 2008 2010 2012 2014 time this year in less than a week after the Jan- CPI CPI Target Mar 2015 GDP numbers were released. Our 2Q 2015 quarterly report discussed India’s new method Source: CEIC in their GDP computation that followed the interna- tionally-recognised “market prices”, rather than the The annual rain is the only source of irri- “factor cost” approach. Although the new approach higher. gation for much of India’s farmland and is a vital had ‘boosted’ GDP growth rates by at least one driver for producing a plentiful harvest. Since food more percentage point, the real economy remained is the largest component (40%) in the average In- weak still. Several recent higher frequency indian consumption basket, should lower crop yields dicators such as auto sales, core industrial drive up food prices, overall consumer prices will growth, and credit growth all pointed to a softer surprise on the upside. economy.

As such, it was of no surprise that the RBI cut the Second, our view that the US could start their key interest rate by 25bps to 7.25% in their latest 2 interest rate normalization in this year may We June move, as both lower inflation and other weak- point to further capital outflow from India. recall the period of capital outflow and the quick de- er economic indicators point to further monetary preciation of the INR during May 2013 when the US easing. Inflation had been tame over the last few Fed started the ‘taper talk’. months. The latest consumer inflation of 4.9% y/y was well within RBI’s target of 6% until Jan 2016. Additionally, wholesale price inflation was also in Any further RBI rate cuts will only worsen the A quicker deprecation of the the negative on-year zone, weakening any price outflow of capital. INR will ensue, further eroding the purchasing pow- pass-through to consumer prices going forward. In- er of the INR and higher imported inflation will add dia’s cargo traffic remained weak, while two-wheel- on inflationary risks. Even without any further rate er sales were decelerating. Exports fell for the fifth cuts in our forecasts, our expectations of a stronger consecutive month in April. Moreover, the RBI had USD from the US interest rates normalization will also cited low domestic capacity utilization, weak likely see the corporate results, and subdued investment and USD/INR trending higher towards credit growth as reasons for the need to lower the 66.0 by end of this year. policy rate.

More Rate Cuts? It Depends UOB Economic Projections 2013 2014 2015F 2016F It seemed that there could be more room for further rate cuts in 2H 2015 should the various eco- GDP 4.7 6.9 7.4 7.7 nomic indicators continues to worsen, and inflation CPI (average, y/y %) 10.9 6.4 5.9 6.2 remains benign. However, it would have to depend Unemployment rate (%) 9.1 8.6 8.4 8.4 on two key events. Current account (% of GDP) -2.6 -1.4 -1.5 -1.8

First, concerns on a possible shortfall in the Fiscal balance (FY, % of GDP) -5.9 -4.8 -4.3 -4.5 Southwest monsoon may drive food prices

36 Quarterly Global Outlook 3Q2015 • UOB Global Economics & Markets Research CHINA

“new normal”. Note that South Korea exports were China: Real GDP Growth negative y/y for four straight months, and imports in negative for 8 straight months, while Taiwan report- %y/y ed negative exports for 4 months, negative imports 12% for 5 months, for the first five months of 2015.

Forecast 10% Given these data, we expect 2Q15 GDP growth rate to run at the 6.8%y/y pace, below that of 7% 8% 7.0% in 1Q15. 6.9% 6.8% 6.7%

6% Financial Market Reform In Progress The key agenda for China this year will be accelera- 4% tion of financial market reform, with IMF’s Special Drawing Rights (SDR) once-every-5-year review 2% by end-2015 the main highlight. As mentioned in our Focus article on SDR, the admission is not a 0% sure thing and we assign a probability of success 1Q10 1Q11 1Q12 1Q13 1Q14 1Q15 at 60%, with the remaining 40% at the disposal of IMF’s executive board which US has the largest vot- Source: CEIC, UOB Global Economics & Markets Research Estimates ing block. While China is able to deliver most of the criteria, including market-determined interest rates, 2Q15 Growth Outlook Remains Downbeat the requirement that the currency be a “reserve cur- China’s recent data releases continue to reflect the rency” could be problematic. This is because the gripping impact of the downdraft from “new normal” RMB comprises of just about 1.4% of the world’s environment. Data for manufacturing, external trade foreign exchange reserves, well below that of even and investment in Apr-May largely point to a sub- the JPY which has a 4% share in advance countries’ 7%y/y GDP growth rate for 2Q15, despite the fact reserves. that 1Q15 managed to turn in a surprisingly strong 7%y/y reading. With or without SDR, we expect China to continue to pursue its market reform measures, including Since the beginning of 2Q15, data releases have further opening of the capital account, interest rate not shown much improvement. For the manufac- liberalization, RMB internationalization. Meanwhile, turing sector, both the official and HSBC/Markit monetary policy is expected to remain neutral and manufacturing purchasing managers’ index (PMI) we do not anticipate excessive easing bias for the headlines are below historic average. From 2005 to remainder of the year. 2013, the average headline official PMI is 52.6, and for the HSBC PMI index is 51.4. Since 2014 how- We continue to maintain our forecast of USD/RMB ever, both versions of PMI figures have averaged at 6.23 for end-3Q15, and at 6.20 for end-2015. A just 50.5 for the official PMI and 49.7 for the HSBC band widening is still likely before year end, possi- PMI, 2.1 points and 1.7 points below the long term bly around the annual IMF/World Bank annual meet- averages, respectively. ings in Oct. For rates, one more round of interest rate cuts and also RRR cut are likely (please see Inflationary pressure in China is expected to remain table below) to keep headline growth at even keel, subdue, with CPI at 1.2%y/y from 1.5% in Apr, vs. along with the removal of deposit interest rate ceil- average of 1.2% in 1Q15. While producer prices re- ing sometime in the second half of 2015. main in y/y declines for the 39th consecutive month since Mar 2012, at -4.6%y/y vs. -4.6% in Apr. The downward pressures on goods prices echo the tepid performance for manufacturing sector, which has Interest Rate & RRR Forecasts 3Q15 4Q15 1Q16 2Q16 seen the monthly industrial growth staying well be- 1-year Best Lending Rate % 4.85 4.85 4.85 4.85 low the long run average of 13%y/y (Jan 1995 - Dec 2013) for the second consecutive year. 1-year Deposit Rate % 2.00 2.00 2.00 2.00 Reserve Requirement Ratio % 18.00 18.00 18.00 18.00 While exports surprised on the upside in May at -2.5%y/y from -6.4% in Apr, it was nonetheless the UOB Economic Projections 2013 2014 2015F 2016F third straight y/y declines despite low base in 2014. GDP 7.7 7.4 6.8 6.8 What is more worrying is the further sharp drop in imports, the 7th straight month of imports decline CPI (average, y/y %) 2.6 2.0 1.5 2.0 since Nov 2014, and at an increasing magnitude: Unemployment rate (%) 4.1 4.1 4.1 4.1 double digits drops (-13% to -21% range) in the first 5 months of 2015. These are largely attributed to Current account (% of GDP) 1.9 2.0 1.6 1.3 both weak external demand, and domestic factors of Fiscal balance (% of GDP) -1.9 -2.0 -2.2 -2.2

Quarterly Global Outlook 3Q2015 • UOB Global Economics & Markets Research 37 HONG KONG

Growth Momentum Likely to Stay Subdue Hong Kong’s 1Q15 GDP expanded 2.1%y/y, mar- Hong Kong: Labour Market ginally slower than the upwardly revised 2.4% pace in 4Q14. While it appears that economic growth % million persons seems to be off to a good start, the latest figure is 9.5 4.0 3.8 well below that of the average of 4.5% for the 1Q in 8.5 the past 5 years. Nevertheless, both private spend- 3.6 ing and investment helped support 1Q15 growth 7.5 3.4 but with domestic retail sales likely to remain sub- 6.5 3.2 due for this year and China is shifting to the “new 3.0 5.5 normal”, headline growth momentum is likely to re- 2.8 main under pressure. 4.5 2.6 2.4 3.5 Similar to a number of exports powerhouses in the 2.2 region, Hong Kong’s external environment remains 2.5 2.0 clouded in the near term. For the first four months of Jan-03 Jun-05 Nov-07 Apr-10 Sep-12 Feb-15 2015, Hong Kong’s total exports rose only 2.2%y/y, Employed Workers (3MMA, mn persons, RHS) slower than the 3.2% pace in 2014 and just about Unemployment Rate (%) - LHS one quarter of the average exports growth of 8.5% Source: CEIC, UOB Global Economics & Markets Research in the past 5 years. HKD Peg To Stay On the domestic front, situation is equally downbeat. As for the HKD, we do not anticipate any change to HK visitor arrivals edged up an average 3.9%y/y in the peg to USD any time soon, given the dominance the first four months 2015, a significant slowdown of the latter as a global reserve currency and that from the double-digit growth of the past 5 years, as the RMB is still a non-convertible currency for now. mainland tourist arrivals, which account for nearly The commencement of the “Shanghai-HK Stock 80% share of total visitors and from just about 54% Connect” last year ushered in another new step for share in 2006, slumped to just single digit growth China to continue on its market reforms/RMB inter- so far in 2015 vs. 16% in all of 2014. The number of nationalization path, and the pace of RMB interna- mainland visitors to HK has been rising at double- tionalization continues rapidly. As of end-Apr 2015, digit pace every year since 2010, with 47 million vis- the RMB only accounted for 1.4% share of global its recorded in 2014. The slowdown is on the back (ex-China) forex reserves, well below that of JPY’s of China’s “new normal”, restrictions on daily trips 4% share held in advance countries’ forex reserves. by mainland authorities, as well as anti-mainland Nevertheless, the situation is likely to change in the sentiment in HK. This has led to retail sales rising years ahead especially if the RMB is able to gain just 0.6% in 2014. For the first four months of 2015, entry to IMF’s Special Drawing Rights at the review retail sales managed to expand just 0.5%y/y. With this year’s end. dark clouds continue to overhang HK retail sales sector, outlook for this year remains downbeat. With the US Fed’s rate normalization likely to start However, domestic factors are still supportive of the only in Sep 2015 (instead of our earlier contention sector, including low unemployment rate of 3.3%, of Jun 2015), the HKD interbank rates continue to as well as wealth effect from the recent run up of stay steady, with the 3-month HIBOR at around the the equity market. 0.36-0.38% level since beginning of 2015. We do not expect domestic interest rates to move higher With the electoral reform plan failed to pass in HK until 3Q 2015 when the US rate hike cycle be- legislature on 18 Jun, one immediate impact is that comes more visible. We look for the 3-month HI- it reduces risks of a repeat of the “Occupy Central” BOR to edge up marginally to 0.5% by end-2015, protest movement that lasted nearly three months in response to higher USD Libor and based on our late year which interrupted daily lives and business- end-2015 Fed funds rate forecast of 0.75%. es. However, it also means that Hong Kong will not hold the first-ever election of its political leader in 2017. The chief executive will continue to be cho- sen by a 1,200-member selection committee of the city’s elites that has picked all three leaders since UOB Economic Projections 2013 2014F 2015F 2016F control of the city was returned to China in 1997. GDP 3.1 2.5 2.6 2.8 CPI (average, y/y %) 4.3 4.4 3.0 3.6 We continue to maintain our GDP trajectory for the coming quarters, but with the 1Q GDP print, our Unemployment rate (%) 3.2 3.3 3.3 3.3 forecast for headline GDP growth now stands at Current account (% of GDP) 1.5 1.9 2.5 3.0 2.6% for full year 2015, with low base to help pro- Fiscal balance (% of GDP) 2.6 1.1 0.7 0.7 vide some lift in the second half of 2015.

38 Quarterly Global Outlook 3Q2015 • UOB Global Economics & Markets Research JAPAN

Japan’s CPI inflation is markedly lower with head- Hopeful For A Trade Surplus In 2H 2015 line at 0.6%y/y in Apr from 2.3%y/y in Mar 2015 (versus high of 3.7% in April 2014) while core eased 10,000 60 to 0.4%y/y from 2.1%y/y in Mar. The BOJ-calculat- 8,000 ed inflation (which excludes the April sales tax hike 40 effect) was lowered to 0% in April & May (from 0.2% 6,000 20 in Jan) although the danger of slipping into deflation 4,000 eased as energy prices stabilised. 0 2,000 More Easing Unlikely For Rest Of 2015 -20 0 We believe the BOJ is unlikely to do more easing & probably maintain the status quo position in -2,000 -40 2H 2015 after its last stimulus addition in October -4,000 -60 2014. The 1Q GDP upward revision certainly helps Jan-08 Jun-09 Nov-10 Apr-12 Sep-13 Feb-15 our view and is an affirmation of the BOJ’s optimism Trade Balance (JPY bn) Exports (JPY bn) that Japan “continued its moderate recovery trend” Imports (JPY bn) Exports (%y/y - RHS) and meant little impetus to add more easing into the Imports (%y/y - RHS) system. We reiterate our belief that the BOJ policy

Source: CEIC, UOB Global Economics & Markets Research Est makers viewed further monetary easing to shore up inflation as a counterproductive step in the foreseeable future and that additional stimulus could trigger Sustaining The Good [GDP] Start significant declines in the yen which in turn would Japan's 1Q-2015 GDP growth was revised to a damage confidence while giving little mileage to higher pace of 1%q/q, 3.9%q/q SAAR (better than generate inflation. Market views about more BOJ the 1st estimate of 0.6%q/q, 2.4%q/q SAAR), while stimulus were also dialed back more easing expec- the 4Q-2014 GDP rebound was revised to higher to tations after BOJ Governor commented (10 June) 0.3%q/q, 1.2%. Stronger 1Q reflected improvement that further yen weakness is “unlikely” which may in private demand due to a jump in private non-resi- imply BOJ has no plans for more easing. dential investments to 2.7%q/q (from 0.4%) even as private consumption was unchanged (at +0.4%q/q) June's BOJ decision did provide some buzz with while private residential investments came in lower a new monetary policy meeting framework start- at 1.7%q/q (from 1.8%). 1Q was also helped by ing 2016 which will reduce the number of meetings further inventories increase (to 0.6ppt from 0.5ppt). to 8 (from 14 presently) and introducing quarterly External demand remains an uncertainty for the outlook report & doing away with the monthly eco- export-oriented Japan as decline in net exports was nomic report (much like the FOMC framework). unchanged at -0.2ppt of 1Q growth despite Japan recording a trade surplus in March 2015, its first JPY Kept In Range Until Fed Hikes surplus since June 2012. Even without any new easing, the yen is about 2.7% weaker against the US dollar so far this year (as of While 1Q GDP’s upward revision was expected, 18 Jun). The USD/JPY pair was initially pushing to we were hopeful that the final number may be multi-year high of 125 in early June but BOJ Kuro- slightly improved due to upward revision in trade da called for currency stability on 10 June, saying numbers late in 1Q but that was not to be. After the that it was “hard to see [the JPY] real effective rate brief turnaround in March, Japan returned back into falling further,” which sent the JPY strengthening trade deficit in April & May, denting hopes of more towards 122 (from above 125) against the US dol- sustained trade improvement after 3 years in dollar. We keep our view for USD/JPY to push fresh drums. That said, we still believe a turnaround in multi-year highs although the pair may be stuck in Japan’s trade prospects is still in sight on the back 120-124 range in early 3Q barring any unexpected of a weaker yen. We also expect delay in the 2015 global event. We expect the USD/JPY pair to break sales tax hike and base effect (from last year’s conclusively above 125 when the Fed finally deliv- sales tax hike) to be helpful for domestic demand ers the first rate action (now expected in Sep 2015). recovery in 2015. Japanese companies are also showing willingness to increase wages and unlock- ing more of their cash holdings via raising dividends UOB Economic Projections 2013 2014F 2015F 2016F to shareholders & increasing capital investments. GDP 1.5 -0.1 1.0 1.5 But we are still concerned about persistent domestic consumer weakness and the other risk for weak- CPI (average, y/y %) 0.4 2.7 1.0 1.8 er growth is the external outlook which will erode Unemployment rate (%) 4.0 3.6 3.3 3.3 Japan’s external demand contribution to GDP. We Current account (% of GDP) 0.8 0.5 2.0 2.5 continue to expect Japan’s GDP to grow by 1% in 2015 after its minute -0.1% contraction last year. Fiscal balance (% of GDP) -9.1 -8.3 -7.5 -6.5

Quarterly Global Outlook 3Q2015 • UOB Global Economics & Markets Research 39 SOUTH KOREA

MERS Clouding Outlook Comparison Of MERS And SARS Outbreak In Asia Sentiment has deteriorated with the outbreak of Severe Acute Respiratory Syndrome Middle East Respiratory Syndrome Pandemic Middle East Respiratory Syndrome (MERS) cases (SARS) (MERS) in South Korea, the largest outside of Saudi Arabia. September 2012 – ? GDP growth which has moderated to 2.5% y/y in Period November 2002 – July 2003 First confirmed case in South Korea 1Q15 (4Q14: 2.7%) is likely to remain under 3.0% on 20 May 2015 in the second half of the year if the outbreak is pro- China (349 deaths, 5,328 infected) South Korea (23 deaths, 164 infected) longed as this will delay the recovery that we have Hong Kong (299 deaths, 1,755 infected) China (1 infected) Asian Taiwan (37 deaths, 346 infected) Thailand (1 infected) expected. Household private consumption (48% of Countries Singapore (33 deaths, 238 infected) the GDP) will be most affected as South Koreans Affected Vietnam (5 deaths, 63 infected) stay indoors while tourism revenue (1.3% of GDP) Philippines (2 deaths, 14 infected) is still relatively small. Short of announcing a sup- South Korea (0 death, 4 infected) Global Total plementary budget, the government has pledged 8,273 1,321 to maintain an expansionary fiscal policy until the Infected Global Total economy is firmly on recovery. Looking at the SARS 775 466 Deaths crisis which hit Asia in November 2002-July 2003, Fatality rate the impact from MERS could be significant if the Around 10% 30-40% (%) outbreak continues for another six months. Note: Information as of 18 June 2015. Source: WHO, various newswires At the same time, external demand from either de- veloped economies or China had been lacklustre. South Korea’s export contracted for the 5th straight Despite Higher USD/KRW Since September 2014, month in May. Exports slumped by 9.4% y/y in April- KRW Has Appreciated In NEER And REER Terms May, sharper-than -2.9% y/y in 1Q15. In April, Bank of Korea (BoK) has downgraded its 2015 GDP 800 130 growth forecast to 3.1% from 3.4% previously. We 900 120 expect further downgrade in the growth forecast 1000 ahead. For now, we expect 2015 growth at 2.9%. 110 1100 100 BoK Brings Interest Rate To Fresh Record Low 1200 Near-term growth concerns overshadowed that of 90 1300 the high household debt, leading to two interest 80 rate cuts so far this year. The 25 bps cut in June 1400 to bring the base rate to fresh record low of 1.50% 1500 70 was clearly driven by the MERS outbreak. Weak domestic inflation provided room for the monetary 1600 60 easing as headline CPI stayed at near 16-year low Jan-08 Nov-09 Sep-11 Jul-13 May-15 of 0.5% y/y in May. With low oil prices, we expect USD/KRW NEER 2010=100 REER 2010=100 the inflation rate to remain below 1.0% y/y in 3Q15 before picking up in 4Q15 due to a low base effect. Source: CEIC, BIS

Going forward, the rate decisions will be highly data- KRW NEER has appreciated by 4.5% in the first dependent. Due to expectation of US rate normali- 4 months of the year which reflected the relative zation in the second half of the year and concerns strength in the currency compared to its trading over the household debt, more rate cuts in Korea partners. One of the most important to watch is still will have to be driven by further sharp deterioration the JPY/KRW which touched a 7-year low of 8.8458 in growth outlook. As such, we expect the base rate during 2Q15. There will be further downward pres- to be kept at 1.50% for the rest of this year. sure on the KRW as JPY weakens further.

Current Account Surplus Continues To Buoy KRW NEER Weaker sentiment towards South Korea contributed to USD/KRW rebound from its closing low of 1,068.60 in April. We have reduced our expecta- UOB Economic Projections 2013 2014 2015F 2016F tion of the USD/KRW upward trajectory in line with GDP 2.9 3.3 2.9 3.5 a gradual pace of US Fed interest rate normaliza- CPI (average, y/y %) 1.3 1.3 0.9 2.0 tion. South Korea's strong current account surplus (1Q15: 7.0% of GDP) will also moderate the Unemployment rate (%) 3.0 3.5 3.5 3.2 up-move in the pair. Our end-3Q15 and end-4Q15 Current account (% of GDP) 6.2 6.3 6.7 5.8 targets for USD/KRW are at 1,130 and 1,140 re- Fiscal balance (FY, % of GDP) -1.8 -1.7 -2.1 -2.0 spectively.

40 Quarterly Global Outlook 3Q2015 • UOB Global Economics & Markets Research TAIWAN

Average Monthly Earnings USD/TWD vs. USD/JPY Trend

%y/y 12-month MA 32.0 130 15.0 31.5 120 10.0 31.0 110 30.5 5.0 30.0 100 29.5 0.0 90 29.0 80 -5.0 28.5 28.0 70 -10.0 Sep 12 Mar 13 Sep 13 Mar 14 Sep 14 Mar 15 Jan-04 Nov-05 Sep-07 Jul-09 May-11 Mar-13 Jan-15 USD/TWD (LHS) USD/JPY (RHS)

Source: CEIC, UOB Global Economics & Markets Research Est Source: Bloomberg, UOB Global Economics & Markets Research Est

Weak Domestic Growth Ahead cline 8.75%, vs. original forecast of -2.07%. Taiwan’s 1Q15 GDP growth rose a downwardly revised 3.37%y/y (from a prelim 3.46%y/y), vs. 3.35% CBC To Stay Put pace in 4Q14. The headline figure is on par with Taiwan’s headline CPI fell 0.73%y/y in May, extend- the average of 3.25% seen in 1Q for 2011-2014. ing its negative inflation trend since early 2015, due Nevertheless, the performance was still ahead that to weak commodity prices since mid-2014. We do of Hong Kong, Singapore and South Korea in the not expect CPI to rise sharply for the rest of 2015, first quarter. Growth momentum was maintained at as long as commodity prices stay subdue. Taiwan 0.7%q/q SA in 1Q15, from 0.5% in 4Q14. government has in May slashed full-year inflation target to 0.13% from 0.26% earlier, nearing a defla- In other data, Taiwan’s manufacturing PMI index tionary environment. went below 50 for the second straight month in May and averaged just 49.3 for April and May, vs. 51.6 in With the US Fed poised for its “liftoff” this year, 1Q15, and the first sub-50 readings since Jul 2013. we expect CBC to hold its policy rate unchanged This is a reflection of manufacturing output which through 2015. The next policy meeting is scheduled fell 1.1%y/y in Apr. on 25 June 2015. Of more interesting note is that TWD has gained 3% vs. USD. There were reports One bright spot amidst dim data elsewhere is the earlier that CBC has asked major custodian banks labour market. Taiwan's jobless rate held steady at to look into foreign customers' transactions, amid to 3.75% seasonally adjusted in Apr, similar to Mar, worries that inflows could over-inflate TWD. More and at the lowest level in more than 14 years. Low critically, since mid-2011, the TWD has gained jobless rate together with stable job gains, should 60%+ from 0.40 TWD per yen to 0.25 TWD per yen support steady domestic demand growth. in Jun 2015, while the KRW rose from 15.5 per JPY to 8.99, an appreciation of 72% against the JPY. As The sharp downward revision in 1Q15 GDP figures all these three economies rely on external demand was inline with the rest of the global economy, es- as a key driver, and with BoJ’s holding to its weak pecially with the developments in China. Taking into JPY policy, CBC is expected to keep a wary eye account of the data so far, we are scaling back our on TWD strength. As such, we expect upward pres- view for 2015 GDP to 3.0% (from previous forecast sure in USD/TWD, targeting at 31.40 for end-3Q15 of 3.4%) but keeping our call for 3.5% for 2016. (previous: 32.6) and 31.80 by end-4Q15 (previous forecast: 32.40), from current level of 31.05. For comparison, Taiwan’s official forecast for 2015 was cut by 0.5% point in May to 3.28%, having UOB Economic Projections 2013 2014 2015F 2016F

raised it to 3.78% in Feb (2014: 3.77%), on uncer- GDP 2.2 3.8 3.0 3.5 tainty in global outlook, sluggish external demand, and competition from mainland especially in IT CPI (average, y/y %) 0.8 1.2 0.3 1.2 products. Taiwan government also expects exports Unemployment rate (%) 4.1 3.8 3.9 3.9 in USD value to contract 2.62% in 2015 vs. original Current account (% of GDP) 10.8 12.5 15.0 12.6 forecast of +1.02%, its first annual exports decline since 2009. For 2015 imports are projected to de- Fiscal balance (FY, % of GDP) -1.2 -1.4 -1.1 -1.0

Quarterly Global Outlook 3Q2015 • UOB Global Economics & Markets Research 41 EUROZONE

Higher Inflation Expectations EUR In Thrall To Rising Bund Yields

1.6 2.8 1.6 1.42

1.5 2.6 1.4 1.37

1.4 2.4 1.2 1.32 1.0 1.27 1.3 2.2 0.8 1.22 1.2 2.0 0.6 1.17 1.1 1.8 0.4 1.12 1.0 1.6 0.2 1.07

0.9 1.4 0.0 1.02 Jun-10 Aug-11 Oct-12 Dec-13 Feb-15 Jun-14 Sep-14 Dec-14 Mar-15 Jun-15 EUR Currency 5y5yswap 10-Year Bund Yields EUR Currency

Source: CEIC, UOB Global Economics & Markets Research Source: CEIC, UOB Global Economics & Markets Research

ECB Sticks With Bond-Buying Plan its asset purchase programme until at least Sep- As Eurozone Economy Improves tember 2016. The ECB projected annual inflation There were no surprises at the June ECB meeting at 0.3% in the Euro area in 2015, 1.5% in 2016 and and press conference. In line with our expectations, 1.8% in 2017. In comparison with the March 2015 ECB President Mario Draghi reiterated the ECB ECB staff macroeconomic projections, the inflation Governing Council’s strong commitment to fully projections have been revised upwards for 2015 implementing its quantitative easing (QE) plans. All and remain unchanged for 2016 and 2017. The policy rates were kept unchanged; and no new pol- way Draghi put it was that the recent rise in inflation icy initiatives or changes to the current asset pur- – above consensus but in line with the ECB’s own chase programme were announced. There was no expectations – strengthens the Council’s conviction reconsideration of its policy plans, no discussion of that the QE policy is appropriate. exit. The ECB’s new mantra is the intention to maintain a “steady course” on monetary policy. Market Euro – Can It Go Lower? speculation about possible QE tapering may well Despite the ongoing saga in Greece, the Euro has continue during the coming months/quarters, but been able to find plenty of support. In the last three we remain of the view that this will be met with little months, the currency has been following Bunds support from the ECB, and that purchases will con- slavishly, with the recurrent selling wave in Bunds tinue up to September 2016. being a constant source of EUR strength. The spike in bund yields was triggered in part by improving The June press statement also noted that the Gov- growth and inflation data, as well as a reflection of erning Council expects the economic recovery to overcrowded positioning and very illiquid market broaden. The word “strengthen” included in the conditions. April statement was omitted this time around because the ECB had expected to see stronger fig- We continue to look for a lower EUR/USD in the ures. However, compared with the March 2015 ECB coming quarter, reflecting the concerns we have on staff macroeconomic projections, the projections for Greece and the Eurozone. Indeed, fears over a pos- real GDP growth over the projection horizon remain sible Greek exit from the Eurozone are growing as virtually unchanged. Thus the June 2015 ECB staff relations between the creditors and Greek negotia- macroeconomic projections foresee annual real tors over reforms grow increasingly tense. We are GDP increasing by 1.5% (1.5% in March) in 2015, heading into the 18 June Eurogroup meeting as we 1.9% (1.5%) in 2016 and 2.0% (2.1%) in 2017. write, and President of the Eurogroup Jeroen Dijs- Draghi noted that the loss of growth momentum has selbloem had previously identified this date as the been due to the weakening of economies outside deadline for reaching an agreement. This should the Euro area. give enough time for those countries, including Germany, that have to pass the agreement through QE Working Better Than Hoped parliaments to do so, and the Greek parliament to Meanwhile, the 2015 inflation forecasts were re- pass all the required laws in time to complete the vised up for the first time ever although the 2016- programme review and allow the creditors to dis- 17 inflation forecasts were unchanged, helping to burse at least part of the EUR7.2bn on hold since reinforce the expectation that the ECB will complete December in time to avoid missing the EUR1.55bn

42 Quarterly Global Outlook 3Q2015 • UOB Global Economics & Markets Research EUROZONE

Greece's Debt Obligations Greek Debt By Holder (EURbn)

EUR bn IMF T-Bills 4 24 15 ECB 27 3

Private Debt 2 55

EFSF Loans 1 142

0 Jun-15 Jul-15 Aug-15 Sep-15 Oct-15 Nov-15 Dec-15 GLF Loans ECB IMF Treasury Bill Holders 53

Source: CEIC, BIS Source: CEIC, UOB Global Economics & Markets Research Est

payment to the IMF at the end of June. to the ECB. Assuming that the Greek government remains solvent up until that point, the repayment Still, we think the chances of reaching agreement to the ECB is critical due to the Greek central bank with Greece by 18 June are slim. Besides, even if and Greek banking sector’s heavily reliance on the a disbursement by the EU creditors allows Greece ECB’s Emergency Loan Assistance (ELA) program. to meet the IMF payments, the situation beyond The ELA has effectively kept the Greek financial June remains very challenging. Greece faces a system intact as these funds protect against large mountain of around EUR6.7bn of debt repayments outflows of capital from private banks. If the Greek (and EUR1bn in interests) to the ECB in July and government is unable to repay the ECB, we can be August, as well as another EUR3.4bn by the end of almost certain it would be cut off from much-needed the year. There is only about EUR3.7bn left in the ELA funds and many Greek banks would become current EU programme, including some EUR1.5bn insolvent. of ECB profits on Greek bond holdings for 2015. So whilst default does not necessarily mean Grexit, As such, we think that a third EU programme is very default would certainly unleash new uncertainties much needed and has to be in place before 20 July, and, in our view, putting all these elements togeth- date of the first ECB repayment, to avoid a default er, we think the uncertainty ahead could bring about more volatility and downside for the EUR/USD. Key Dates 5 Greece will have to make a payment of about EUR305mn That said, we have consistently been of the view SDRs to the IMF that the ramifications of a default by Greece would Greece will have to make a payment of about EUR344mn be severe. And because of political reasons, it 12 SDRs to the IMF would be in Europe’s interest to keep Greece firmly 12 Greece must roll over EUR3.6bn of Treasury bills in the EU, including providing it with further financial Greece will have to make a payment of about EUR573mn assistance. Hence, similar to previous episodes, 16 SDRs to the IMF we believe a last-minute deal will be reached. After June Greece will have to make a payment of about EUR344mn all, a recent poll continues to suggest that the over- 19 SDRs to the IMF whelming majority of the Greek population, includ- 19 Greece must roll over EUR1.6bn of Treasury bills ing Syriza voters, wants to stay in the Euro. We thus 25-26 EU leaders hold summit in Brussels see limited downside for the EUR further out. Expiry of extended bailout agreement between the Eurozone 30 and Greece, which means the end of access to the funds left over from the Eurozone bailout. UOB Economic Projections 2013 2014 2015F 2016F 10 Greece must roll over EUR2bn of Treasury bills GDP -0.5 0.9 1.5 1.7 Greece will have to make a payment of about EUR458mn July 13 CPI (average, y/y %) 1.3 0.4 0.2 1.2 SDRs to the IMF Unemployment rate (%) 12.0 11.6 11.1 10.6 20 Greece’s EUR3.5bn bond held by the ECB matures 8 Greece must roll over EUR1bn of Treasury bills Current account (% of GDP) 1.9 2.1 2.6 2.5 August 20 Greece’s EUR3.2bn bond held by the ECB matures Fiscal balance (FY, % of GDP) -2.9 -2.4 -2.2 -1.8 Source: Bloomberg, ECB, IMF

Quarterly Global Outlook 3Q2015 • UOB Global Economics & Markets Research 43 AUSTRALIA

Australian GDP Beats But Concerns Persist tial Regulation Authority (APRA) has been turning The Australian economy grew at a seemingly up the dial on lending standards, especially when healthy pace for the first quarter. The seasonally- growth in lending to housing investors has been adjusted 0.9% q/q expansion was a touch above running ahead of the 10% target pace. Hence, we expectations and an acceleration from 0.5% in Q4. think the RBA would also want to watch the effects In y/y terms, growth slowed to 2.3% from 2.4%. The of APRA’s tightening measures first. Meanwhile, it breakdown showed that consumer spending rose will continue to keep a close eye on incoming eco- by a solid 0.5% q/q, contributing 0.3pp to headline nomic data and the Australian currency. In all, our growth. Net exports contributed another 0.5pp to own view remains unchanged. We continue to think growth. The main weak point was investment, with that the current rate of 2.0% should mark the low private gross investment falling by 1.0% q/q, de- point for the cash rate in this easing cycle. spite a 4.7% rise in dwelling investment. Although the headline figures may suggest that the economy Lower Aussie Preferred has weathered last year's fall in commodity prices, The RBA has flagged out that a further fall in the we think it could get worse from here. The end of AUD is both likely and necessary, especially given the mining investment boom and the lagged effects lower commodity prices. Hence, it is clear that the of lower commodity prices will continue to drag on Australian central bank continues to prefer a lower the economy. Australia’s employment data has also currency, hopefully able to let a lower currency do been very volatile and just as April’s downwardly the work in terms of further supporting the rebal- revised 13.7k drop in employment overstated the ancing of growth. In fact, because wage growth is weakness in the labour market, the most recent 42k so benign, the RBA would not have a problem if gain last month overstates its strength. We remain the currency overshoots on the way down, even if cautious and have even downgraded our full year consumer prices got a bit of a boost. We thus con- GDP growth to 2.3% for 2015. tinue to look for a lower AUD/USD, largely due to the combination of a slowing China, weak domestic RBA To Hold Fire economy, a stalling domestic economic transition The RBA chose to keep interest rates unchanged and an RBA with an easing/cautious bias. In ad- at a record low of 2.0% during the June meeting. dition, we believe that Aussie dollar weakness will Whilst there is room for further easing amid con- come through in the next few months because the tinuing sluggishness in business investment and US is going to be raising interest rates. consumer spending, we believe the central bank would prefer to monitor the impact of the 50bps cuts UOB Economic Projections 2013 2014 2015F 2016F already delivered this year. Besides, it continues to be in a difficult position. Although low interest rates GDP 2.1 2.7 2.3 3.0 are required to support the rebalancing of growth CPI (average, y/y %) 2.5 2.5 1.8 2.7 towards the non-mining sectors of the economy; the RBA is reluctant to cut rates further, doubting Unemployment rate (%) 5.7 6.1 6.4 6.1 the efficacy of further reductions on anything other Current account (% of GDP) -3.3 -2.8 -2.9 -2.4 than the Sydney, and to a lesser extent, Melbourne Fiscal balance (FY, % of GDP) -1.4 -2.2 -2.8 -2.4 property markets. As it is, the Australian Pruden-

44 Quarterly Global Outlook 3Q2015 • UOB Global Economics & Markets Research NEW ZEALAND

Economy Poised To Struggle decision but also for further reductions ahead. With New Zealand’s first quarter GDP fell below expecta- slower growth suppressing inflation, the economy tions, increasing 0.2% from the fourth quarter, when needs lower interest rates and a weaker currency it rose a revised 0.7%, way below the 0.6% forecast to get prices gauge back up to the 2% target. We by the RBNZ, which was also market consensus. are now expecting another 25bps cut in the com- This was the slowest pace since 0.1% in the first ing quarter, bringing the cash rate to 3.00%. Further quarter of 2013. On a yearly basis, the economy out, much will depend on economic data, and all grew 2.6% versus 3.1% expected and 3.5% prior. eyes will be on the quarterly CPI print due on 16 Growth was weighed by a fall in agriculture, forestry July. The RBNZ would also want to be careful about and mining as a summer drought curbed agricul- stoking an already overheated property market in tural output and falling global dairy prices damped Auckland, the country's biggest city. farm incomes. That said, consumer spending was underpinned by record immigration and a surge Kiwi Vulnerable To RBNZ’s Moves in tourist arrivals as New Zealand co-hosted the The yield advantage of New Zealand is clearly di- cricket World Cup, whilst rebuilding in earthquake- minishing. With the central bank expected to move damaged Christchurch boosted construction. Since rates lower, and stay low for longer than widely ex- New Zealand’s prospects depend significantly on pected, this should see the NZD weaken. Further- the evolution of global dairy prices, we think the more, the RBNZ continues to reiterate that the New agriculture-focused economy will continue to strug- Zealand currency remains overvalued, despite the gle, especially given that global dairy prices are fall in commodity prices and the expected weak- down more than 50% since early 2014 and New ening in demand, adding that a further significant Zealand's biggest trading partners, Australia and downward adjustment is justified. Another weighing China, are experiencing slower growth. factor is the weakness in the country's dairy indus- try, the world's top milk exporter. Further declines Further Easing On The Horizon in prices coupled with continued slowing economic The RBNZ slashed its cash rate by 25bps in June momentum is likely to see the NZD underperform- to 3.25%. This was the first rate cut since January ing. As such, we look for a lower NZD from here. 2011 and reverses a period of rate hikes that the central bank engaged in 2014. Whilst the timing of the rate cut may have come earlier than expected, UOB Economic Projections 2013 2014 2015F 2016F the RBNZ justified the cut by saying that the unexpected worsening in the terms of trade largely GDP 2.5 3.0 3.0 2.5 triggered by the decline in dairy prices means that CPI (average, y/y %) 1.2 1.2 0.6 2.0 “monetary policy needs to be more stimulatory to encourage the pickup in inflation”. More importantly, Unemployment rate (%) 6.3 5.8 -4.9 5.1 the central bank also provided a very strong hint that Current account (% of GDP) -3.4 -3.3 -5.3 -5.1 the latest rate cut will not be a one-off. Indeed, slow- Fiscal balance (FY, % of GDP) 0.3 1.4 -0.1 0.2 ing growth not only underscores the RBNZ's latest

Quarterly Global Outlook 3Q2015 • UOB Global Economics & Markets Research 45 UNITED KINGDOM

A Surprise Election Result in which the policy decision is released separately It has been more than a month now after the in- from the minutes. From August, the Bank will pub- cumbent Conservative Party returned to power in lish the two documents simultaneously in an effort the UK – following an election result that surprised to boost the transparency of its decisions to finan- and reassured markets – as the Conservatives won cial markets and the public. an outright majority (331 of the 650 parliamentary seats). Looking past the 7 May election, we can say Pound Hinges On Race that political risks have been pushed under the ta- To Normalize Monetary Policy ble for the timebeing, although the Chancellor of the Previously, we cited political uncertainty and slow- Exchequer, George Osborne, could make reference ing of economic data as the two major factors ex- to the EU referendum, which is slated to be held by plaining our bearish view on the GBP. However, the end of 2017, when he gives his first post-elec- heading into the second half of the year, we think tion economic budget on 8 July. In the meantime, we are past that short-term uncertainty. In fact, an- the broader UK economy has been positive. The other reason why we see the GBP performing is latest labour market report revealed a rise in aver- our belief that the BoE will be the next major cen- age weekly earnings growth (ex-bonus) to 2.7% y/y tral bank after the US Fed to raise rates. This cre- in the three months to April – the most since early ates a yield advantage, given that a good portion 2009 – even as employment gains slowed and the of advanced economies are looking to cut rates. unemployment rate remained stable for a second Although we had previously flagged out falling infla- month. tion as a big risk for the GBP, the latest BoE minutes show that officials expect annual inflation to accel- Faster Wage Growth Could Force BoE erate “notably” later this year even after recent data To Raise Interest Rates showed consumer prices in Britain rose on the year Minutes of the latest BoE’s meeting saw all nine in May by just 0.1%, and recording the first annual panel members voting to keep the benchmark inter- fall in April for more than 50 years. One of the fac- est rate at 0.5% in June and voting unanimously to tors expected to push inflation higher is faster wage leave the size of the central bank’s bond portfolio at growth, which rate-setters in the UK said may be GBP375bn. For two officials, probably Martin Weale running at a speedier clip than official data suggest. and Ian McCafferty, who voted for higher borrowing On a whole, the economic data prints coming out of costs as recently as December, the decision not to the UK should continue to drive the GBP ahead as raise rates was “finely balanced”. Although gener- market participants weigh the outlook for monetary ally, the MPC members’ view on the economic out- policy. look, and the appropriate stance of monetary policy that it implies, had not changed materially; the overall stance appears slightly more hawkish than previously. Given the latest set of labour market statis- UOB Economic Projections 2013 2014 2015F 2016F tics, it could be a matter of time before both Weale GDP 1.7 2.6 2.5 2.5 and McCafferty break ranks with the majority and CPI (average, y/y %) 2.6 1.5 0.4 1.6 start agitating for monetary policy tightening. This could happen as soon as August, the same month Unemployment rate (%) 7.6 6.3 5.4 5.2 as when the next Inflation Report is due (6 August). Current account (% of GDP) -4.5 -5.5 -4.7 -4.2 On a side note, it is worth noting that the June MPC meeting is the penultimate under the current regime Fiscal balance (FY, % of GDP) -5.9 -5.4 -4.4 -3.3

46 Quarterly Global Outlook 3Q2015 • UOB Global Economics & Markets Research UNITED STATES OF AMERICA

Rebound Likely In 2Q But How Strong? FOMC – Tentative September Lift-Off This year’s first quarter began like 1Q 2014 when The Fed kept its ultra-low rates policy unchanged extreme weather & West Coast port disruptions in June, even as Yellen said rate liftoff remains sent 1Q 2015 GDP tumbling from a prelim +0.2%q/q on course in 2015 but continued to emphasize on SAAR increase to a revised -0.7% contraction. data-dependent guidance and that exact timing of While personal consumption was revised lower to lift-off matters less than the path of rate hike which 1.8% (from 2.0%), the biggest drags were the sharp is likely to be gradual. The dovish sentiment was correction in net exports, shaving 1.9ppt off head- further reinforced by marginally more dovish June line growth as exports in 1Q contracted by -7.6% dot-plot chart forecasts as compared to March. (from -7.2%) while private domestic investments growth was revised lower to +0.7% (from +2.0%) as We now expect the first Fed rate hike to take place growth in the intellectual property products compo- in the 16-17 September 2015 FOMC but we revised nent was severely revised to +3.6% (from +7.8%) lower the rate trajectory, expecting the FFTR to even as rest of investment components experi- reach 0.75% by end 2015, and 1.75% by end 2016. enced upward revisions. That said, we fear that re-emergence of US political brinkmanship in late 2015 could complicate Fed Despite the 1Q setback, we expect growth to re- monetary policy decision making. bound in 2Q & 3Q (similar to 2014 when 2Q & 3Q together recorded strongest US growth in a dec- UST – Waiting For Higher, Flatter Yield Curve ade). US retail sales grew 1.2%m/m in May while After falling below 2% after the March FOMC, the April was also revised higher. The US economy 10-year UST yield has since returned above the continue to add jobs above 250,000 monthly pace 2.3% range (as of 17 Jun 2015) boosted by the with wages increasing at 2.3%y/y in May, and re- Fed’s eventual normalization of interest rate policy cent US indicators continue to show improvement & the recent global bond sell off led by German in the housing sector, adding to optimism that GDP bunds. While 10-year UST yields are likely to go may be boosted by higher personal consumption higher (to 2.7% by end-2015), we still expect long- & domestic housing investment. The trade situa- end yields to be well anchored due to: 1) Fed will tion improved as the April trade deficit narrowed to not be UST seller to reduce its balance sheet any- US$40.9bn after it initially widened to US$50.6bn time soon, 2) UST supply is lower due to improv- in March, right after the West Coast port disrup- ing US fiscal position, 3) QE from BOJ & ECB will tion was resolved. We now expect US 2015 GDP re-direct buyers to UST, and 4) geo-political risk to growth lower at 2.5% (from 2.9% estimated pre- boost safe haven demand for UST. The UST yield viously) bolstered by the US consumer and hous- curve will revert to flattening in 2015 as US rate hike ing market with downside risks of weak external gets underway. environment & strong USD. The Fed revised 2015 growth lower to 1.8-2.0% (from 2.3-2.7%) while USD – Dollar Supported Amid Volatility World Bank lowered it 0.5ppt to 2.7% and IMF cut For 2H 2015, we still believe the US dollar will be it 0.6ppt to 2.5%. supported when the Fed gives a concrete rate hike timeline. The divergence in policy directions will be US politics is a domestic risk factor in 2015 when especially stark between US and BOJ-ECB, add- there are no US elections. The defeat of Obama’s ing to USD strength against majors and emerging Trade Adjustment Assistance bill by his own Dem- markets currencies. ocrats highlights the difficulty of getting politics to support the economy. We reiterate our fear of a repeat of the US debt ceiling limit drama in late 2015. UOB Economic Projections 2013 2014 2015F 2016F The US debt ceiling limit was reset to US$18.113trn GDP 2.2 2.4 2.5 2.5 and must be raised in 4Q 2015 after the US Treas- CPI (average, y/y %) 1.5 1.6 0.5 2.5 ury exhausted all "extraordinary'' accounting measures to stay under the limit, according to CBO. Po- Unemployment rate (%) 6.7 5.6 5.0 4.7 litical brinkmanship may be avoided in 2015 amid Current account (% of GDP) -2.4 -2.4 -2.0 -1.7

2016 Presidential primary campaigns but nothing Fiscal balance (FY, % of GDP) -4.1 -2.8 -1.8 -1.5 should be taken for granted.

Quarterly Global Outlook 3Q2015 • UOB Global Economics & Markets Research 47 FX TECHNICALS

EUR/USD: 1.1250 EUR bottomed out at 1.0456 in the middle of March, roughly one week after ECB announced its QE program. The rebound from the low failed to move above the strong resistance at 1.1530 with a high of 1.1465. However, the up-move from 1.0456 to 1.1465 is likely just the first leg of a corrective recovery which is expected to move above 1.1530 towards 1.1805/10 in the next couple of months. From current level, EUR could trade sideways for several weeks but a clear break above 1.1530 could lead to a quick move to 1.1805/10 (38.2% retracement of the drop from 1.3995 to 1.0456). The less likely scenario is for a break below 1.0750 which would signal a retest of the year’s low at 1.0456.

USD/SGD: 1.3330 While USD/SGD has likely made a major bottom at 1.3150 in late April, the up- move from the low is viewed as part of a broad sideway consolidation range and not the start of a sustained up-move. The drop from the early June high of 1.3635/40 high may extend lower to 1.3200 but a move below 1.3150 appears unlikely in the next few months. Overall, we expect this pair to trade between 1.3200 and 1.3640 and only a clear break above 1.3640 would indicate the start a sustained rally to 1.3750/1.3800.

AUD/USD: 0.7720 AUD made a low of 0.7535 in late March before rebounding to touch a high of 0.8165. The messy price action suggests that the movement is likely part of a corrective recovery phase. In view of the sharp decline since the middle of last year, the recovery appears incomplete and could extend higher to the major 0.8295/00 resistance. In other words, while the longer term outlook for AUD still appears to be bearish, further AUD weakness is likely only after the correction phase is over.

48 Quarterly Global Outlook 3Q2015 • UOB Global Economics & Markets Research FX TECHNICALS

GBP/USD: 1.5840 The failure to break above the major 1.5815/20 resistance in May resulted in sharp pull-back to a low of 1.5170. How- ever, the subsequent sharp rise from the low is accompanied by impulsive upward momentum and the clear break above 1.5820 suggests further upward pressure in the next couple of months. The next key level is at 1.6188 which is the 61.8% retracement of the drop from 1.7192 to 1.4565. From current level, any pull-back is expected to hold above 1.5490 and the 1.5170 low is unlikely to come under threat in the next few months.

USD/JPY: 123.10 USD dropped sharply after making a high of 125.85 in early June. Not only is the upward momentum waning, the strongly rally from Aug 2014 is clearly over-extended. From the current level of 123.10, a move lower to test the 118.10 support will not be surprising but any weakness is viewed as corrective pull-back and not the start of a major reversal. Overall, we expect 125.85 to cap for the early part of Q3 but at this stage, a sustained move below 118.10 appears unlikely.

EUR/SGD: 1.5200 The rebound from the low of 1.4350 in April is likely part of a corrective rebound that is expected to extend higher to the strong resistance zone at 1.5540/1.5618 (minor peak in February as well as 38.2% retracement of the drop from 1.7670 to 1.4350). In view of the patchy upward momentum, a clear break above this resistance zone is not expected, at least not in Q3. On the downside, an unexpected break below 1.5000 would indicate a retest of 1.4640 low before a stronger recovery can be expected.

Quarterly Global Outlook 3Q2015 • UOB Global Economics & Markets Research 49 FX TECHNICALS

GBP/SGD: 2.1100 After making a low of 1.9900 in early April, GBP staged a remarkable rally that took out the major mid-term resistance at 2.1065. Strong and impulsive upward momentum suggests further GBP strength in the coming quarter. The obvi- ous target is at the 2014 peak of 2.1425. In order to maintain the current momentum, any pull-back should hold above the 2.0840 support.

AUD/SGD: 1.0330 AUD traded in a choppy manner in Q2 by swinging from a high of 1.0805 to 1.0240 before retesting the 1.0800 level. The subsequent drop from the high is approaching 1.0240 one more time. While a break below 1.0240 will not be surprising, this is likely only at a later stage. From the current level of 1.0320, we prefer to see another attempt to 1.0800/05 before a deeper down-move to 1.0020 can be expected.

JPY/SGD: 1.0840 While the sharp drop in JPY from the 1.1540 high in early April is oversold, it is too early to expect a significant rebound. However, waning downward momentum suggests that any further down-move is likely limited to 1.0650 where the risk of a stronger rebound will increase. On the upside, 1.1000 is a strong resistance ahead of the key level of 1.1155.

50 Quarterly Global Outlook 3Q2015 • UOB Global Economics & Markets Research OUR INTERNATIONAL NETWORK

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PT Bank UOB Indonesia has 209 branches in Indonesia.

Quarterly Global Outlook 3Q2015 • UOB Global Economics & Markets Research 51 OUR INTERNATIONAL NETWORK

Taiwan UOBBF Clearing Limited UOB Asset Management Ltd UOB Taipei Branch (a subsidiary) (a subsidiary) 16th Floor, Union Enterprise Plaza 80 Raffles Place, 5th Floor 80 Raffles Place, 3rd Floor 109 Minsheng East Road, Section 3 UOB Plaza 1 UOB Plaza 2 Taipei 10544 Singapore 048624 Singapore 048624 Phone: (886)(2) 2715 0125 Phone: (65) 6539 4362 Phone: (65) 6532 7988 Fax: (886)(2) 2713 7456 Email: [email protected] Fax: (65) 6535 5882 Email: [email protected] Email: [email protected] Taiwan Website: www.UOBAM.com.sg Thailand UOB Bullion & Futures Limited, United Overseas Bank (Thai) Taiwan Branch UOB-SM Asset Management Pte Ltd Public Company Limited 16th Floor, Union Enterprise Plaza, (a subsidiary) (a subsidiary) 109 Minsheng East Road, Section 3 80 Raffles Place, #15-22 191 South Sathon Road Taipei 10544 UOB Plaza 2 Sathon, Bangkok 10120 Phone: (886)(2) 2545 6163 Singapore 048624 Phone: (66)(2) 343 3000 Fax: (886)(2) 2719 9434 Phone: (65) 6589 3850 Fax: (66)(2) 287 2973/287 2974 Email: [email protected] Fax: (65) 6589 3849 SWIFT: UOVBTHBK Website: www.UOB.co.th Thailand UOB Venture Management Private United Bullion & Futures (Thai) Limited United Overseas Bank (Thai) Public Company Limited (a subsidiary) Company Limited has 154 branches in (a subsidiary) 80 Raffles Place, #30-20 Thailand. 7th Floor, 191 South Sathon Road UOB Plaza 2 Sathon, Bangkok 10120 Singapore 048624 United Kingdom Phone: (66)(0) 2343 3903/3906 Phone: (65) 6539 3044 UOB London Branch Fax: (66)(0) 2213 2614 Fax: (65) 6538 2569 19 Great Winchester Street Email: [email protected] Email: [email protected] London EC2N 2BH Website: www.UOBFT.co.th Phone: (44)(20) 7448 5800 Brunei Fax: (44)(20) 7628 3433 INSURANCE UOB Asset Management (B) Sdn Bhd SWIFT: UOVBGB2L (a subsidiary) Email: [email protected] Singapore Unit FF03-FF05, 1st Floor United Overseas Insurance Limited The Centrepoint Hotel United States of America (a subsidiary) Jalan Gadong UOB New York Agency 3 Anson Road, #28-01 Bandar Seri Begawan BE3519 UOB Building Springleaf Tower Phone: (673) 242 4806 592 Fifth Avenue Singapore 079909 Fax: (673) 242 4805 10th Floor, 48th Street Phone: (65) 6222 7733 New York, NY 10036 Fax: (65) 6327 3869/6327 3870 China Phone: (1)(212) 382 0088 Email: [email protected] UOB Investment (China) Limited Fax: (1)(212) 382 1881 Website: www.UOI.com.sg (an associate) SWIFT: UOVBUS33 8/F Taiji Building Email: [email protected] Myanmar No. 211, Bei Si Huan Middle Road United Overseas Insurance Myanmar Haidian District UOB Los Angeles Agency Representative Office Beijing 100083 Suite 518 Room No. 1401, 14th Floor Phone: (86)(10) 8905 6671 777 South Figueroa Street Olympic Tower Fax: (86)(10) 8905 6700 Los Angeles, California 90017 Corner of Mahar Bandoola Street and Email: [email protected] Phone: (1)(213) 623 8042 Bo Aung Kyaw Street Fax: (1)(213) 623 3412 Kyauktada Township UOB Venture Management (Shanghai) Email: [email protected] Yangon, Myanmar Limited Telephone: (95)(1) 392 917 (a subsidiary) Vietnam Fax: (95)(1) 392 916 Room 3307, United Plaza UOB Ho Chi Minh City Branch 1468 Nanjing Road West 1st Floor, Central Plaza Office Building INVESTMENT MANAGEMENT Shanghai 200040 17 Le Duan Boulevard Phone: (86)(21) 6247 6228 District 1, Ho Chi Minh City Singapore Fax: (86)(21) 6289 8817 Phone: (84)(8) 3825 1424 UOB Orient Capital Pte. Ltd. Email: [email protected] Fax: (84)(8) 3825 1423 (a joint venture) SWIFT: UOVBVNVX c/o Augentius (Singapore) Pte. Ltd. SZVC-UOB Venture Management Co. Ltd Email: [email protected] 112 Robinson Road, #04-02 (an associate) Singapore 068902 FL. 11 Investment Building Correspondents Phone: (65) 6420 6990 No. 4009 Shennan Road In all principal cities of the world Fax: (65) 6420 6999 Futian Centre District Email: [email protected] Shenzhen 518048 RELATED FINANCIAL SERVICES Website: www.UnitedOrientCapital.com Phone: (86)(755) 8291 2888 Fax: (86)(755) 8291 2880 Bullion, Brokerage and Clearing UOB Asia Investment Partners Pte Ltd Email: [email protected] (a subsidiary) Singapore 80 Raffles Place, #10-21 Ping An UOB Fund Management UOB Bullion and Futures Limited UOB Plaza 2 Company Ltd (a subsidiary) Singapore 048624 (an associate) 80 Raffles Place, 5th Floor Phone: (65) 6539 2492 5F Galaxy Center UOB Plaza 1 Fax: (65) 6532 7558 Fuhua Road, Futian District Singapore 048624 Email: [email protected] Shenzhen 518048 Phone: (65) 6751 5791 / 5792 / 5793 Website: www.UOBAIP.com Phone: (86)(755) 2262 2289 Fax: (65) 6534 1984 / 6535 6312 Fax: (86)(775) 2399 7878 Email: [email protected] Website: www.UOBFutures.com

52 Quarterly Global Outlook 3Q2015 • UOB Global Economics & Markets Research OUR INTERNATIONAL NETWORK

France Taiwan United States of America UOB Global Capital SARL UOB Investment Advisor (Taiwan) Ltd UOB Global Capital LLC (a subsidiary) (a subsidiary) (a subsidiary) 40 rue La Perouse Union Enterprise Plaza, 16th Floor UOB Building 75116 Paris 109 Minsheng East Road, Section 3 592 Fifth Avenue Phone: (33)(1) 5364 8400 Taipei 10544 Suite 602 Fax: (33)(1) 5364 8409 Phone: (886)(2) 2719 7005 New York, NY 10036 Fax: (886)(2) 2545 6591 Phone: (1)(212) 398 6633 Indonesia Email: [email protected] Fax: (1)(212) 398 4030 UOB Venture Management Email: [email protected] Private Limited Thailand Representative Office UOB Asset Management (Thailand) MONEY MARKET UOB Plaza, 22nd Floor Co. Ltd. Jalan M.H. Thamrin No. 10 (a subsidiary) Australia Jakarta Pusat 10230 Asia Centre Building, 23A, 25th Floor UOB Australia Limited Phone: (62)(21) 2938 8441 173/27-30, 32-33 South Sathon Road (a subsidiary) Email: [email protected] Thungmahamek United Overseas Bank Building Sathon, Bangkok 10120 Level 9, 32 Martin Place Japan Phone: (66)(2) 786 2000 Sydney, NSW 2000 UOB Asset Management (Japan) Ltd Fax: (66)(2) 786 2377 Phone: (61)(2) 9221 1924 (a subsidiary) Website: www.UOBAM.co.th Fax: (61)(2) 9221 1541 13F, Sanno Park Tower SWIFT: UOVBAU2S 2-11-1 Nagatacho, Chiyoda-ku Email: [email protected] Tokyo 100-6113, Japan Phone: (81)(3) 3500 5981 STOCKBROKING Fax: (81)(3) 3500 5985 Singapore Malaysia UOB-Kay Hian Holdings Limited UOB Asset Management (Malaysia) (an associate) Berhad 8 Anthony Road, #01-01 (a subsidiary) Singapore 229957 Level 22, Vista Tower, The Intermark Phone: (65) 6535 6868 348 Jalan Tun Razak Fax: (65) 6532 6919 50400 Kuala Lumpur, Malaysia Website: www.uobkayhian.com Phone: (60)(3) 2732 1181 Fax: (60)(3) 2732 1100 Email: [email protected] Website: www.UOBAM.com.my

Disclaimer

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

Quarterly Global Outlook 3Q2015 • UOB Global Economics & Markets Research 53 GLOBAL ECONOMICS & MARKETS RESEARCH

Jimmy Koh Head of Research (65) 6598 1798 [email protected]

Suan Teck Kin, CFA Senior Economist (65) 6598 1796 [email protected]

Alvin Liew Senior Economist (65) 6598 1797 [email protected]

Julia Goh Senior Economist (60)3 2776 9233 [email protected]

Lee Sue Ann Economist (65) 6598 1792 [email protected]

Ho Woei Chen Economist (65) 6598 1793 [email protected]

Manop Udomkerdmongkol Economist (66)0 2343 4330 [email protected]

Francis Tan Economist (65) 6598 1791 [email protected]

Quek Ser Leang Market Strategist (65) 6598 1795 [email protected]

Victor Yong Tze Chow Interest Rate Strategist (65) 6598 1799 [email protected]

More reports available on: URL: www.uob.com.sg/research Email: [email protected] Bloomberg: UOBR

MCI (P) 166/04/2015

54 Quarterly Global Outlook 3Q2015 • UOB Global Economics & Markets Research United Overseas Bank Limited Head Office 80 Raffles Place UOB Plaza Singapore 048624 Company Registration No.: 193500026Z Telephone: (65) 6533 9898 Facsimile: (65) 6534 2334 Website: www.uob.com.sg Quarterly Global Outlook 3Q2015 • UOB Global Economics & Markets Research 55