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Asia Economic and Stock Market Outlook Leading global growth, even as OECD momentum ebbs

Asia Economic and Stock Market Outlook Leading global growth, even as OECD momentum ebbs. August 2010 Prasenjit K. Basu, Chief Economist (Asia ex-Japan), Daiwa Capital Markets Tel: (65) 6321 3069 E-mail: p-k.basu@sg.daiwacm.com.

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Asia Economic and Stock Market Outlook Leading global growth, even as OECD momentum ebbs

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  1. Asia Economic and Stock Market Outlook Leading global growth, even as OECD momentum ebbs August 2010 Prasenjit K. Basu, Chief Economist (Asia ex-Japan), Daiwa Capital Markets Tel: (65) 6321 3069 E-mail: p-k.basu@sg.daiwacm.com

  2. ISM new orders and OECD CLI both suggest Asian exports in 2010 will expand at their fastest pace in 20 years • The OECD composite leading indicator has been rising at its fastest pace in 20 years. We expect intra-emerging-market (EM) demand to provide an additional fillip to demand for Asia’s exports, ensuring that they rise in 2010 at their fastest pace in two decades. • With ISM new orders expanding sharply in 1H10 (and US inventories low), we forecast Asian exports to the US to rise by 15-20% YoY through the rest of 2010, before decelerating at the beginning of 2011. We expect Asian imports to outpace exports this year, boosting intra-Asian exports and ensuring a powerful acceleration in Asian real GDP this year. Next year, growth will depend more on domestic demand, with exports propped up mainly by intra-EM demand. Source: CEIC, Thomson Reuters, Daiwa Source: CEIC, Daiwa Asia Master - charts.xls

  3. Aggregate private consumption expenditure Aggregate private consumption expenditure 100 12,000 25 (as a % of US PCE) 90 20 10,000 80 15 8,000 70 10 60 6,000 5 50 4,000 0 40 2,000 (5) 30 20 0 (10) 10 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 Asia-10+EM6: US$bn (LHS) US: US$bn (LHS) Asia-10+EM6: YoY% (RHS) US: YoY% (RHS) Asia-10+BRM Asia-10 Asia-11 Asia-10+EM6 Private consumption in EM (Asia10+EM6) is three quarters of that in the US, but increasing three times as fast • Non-Japan Asia-10 plus EM6 (Brazil, Russia, Mexico, South Africa, Argentina and Turkey) have seen private-consumption expenditure (PCE) increase at more than twice the pace of the US PCE since 2003 (and nearly three times that for 2008). We believe PCE growth in the Asia-10+EM6 should outpace that of the US considerably over the next five years. • Asia10+EM’s private consumption is about three quarters of that in the US. Even with our expectation of private consumption in the US remaining weak from 2011-14, we believe there will be ample consumption growth available in the emerging markets – not replacing the US completely, but becoming a substantial substitute for it. Source: CEIC, Thomson Reuters, Daiwa Source: CEIC, Thomson Reuters, Daiwa

  4. Asia’s exports less dependent on the OECD markets, and much more driven by intra-Asia demand • Asia is not immune to an OECD recession, but its dependence on OECD markets has declined, with an increasing share of exports going to emerging economies. • Medium-term weakness in OECD demand will probably hurt Asia, but barely 30% of Asia-9’s exports go to OECD markets, while 60.3% goes to Asia (including Japan), and nearly two-thirds goes to non-OECD emerging economies. China is more dependent on the OECD, but over half of its exports go to non-OECD economies too. • Given the large current-account surpluses, we think Asia has ample room to boost domestic demand in 2010 and in subsequent years. Source: CEIC, Daiwa; Asia-9 excludes China Note: EU = European Union, OPEC = Organization of Petroleum Exporting Countries, BRM = Brazil, Russia and Mexico

  5. Asia: not a consumer market, did you say? • In 2009, 13.6m automobiles were sold in China – almost a seven-fold increase on the 2m units sold in 2000. (Korea recorded a similar surge in sales from 1986-96, although Korea’s per capita GDP in 1986 was similar to China’s in 2007.) China’s savings rate is high – but declining slightly from its lofty levels – and consumption is thus rising faster than the rapid pace of nominal income growth. • India also has a high savings rate (35%), but consumption is rising rapidly there too: cellular-phone subscribers have increased 250-fold over the past decade. As China does not export cars (but imports components), and India produces few handsets, these countries’ strengthening demand for these products generates imports from the rest of Asia. Source: CEIC, Daiwa Source: CEIC, Daiwa

  6. Risks from the EU-periphery contained until end-2011; moral hazard reduced through IMF conditionality • We believe there is little scope for contagion to Asia from the EU periphery via the external debt route, as seven Asian economies – China, India, Malaysia, Singapore, Hong Kong, Taiwan, Thailand – are net creditors to the world. Foreign reserves exceed short-term external debt in the rest of Asia. • ECB purchases of government bonds (QE) should not be inflationary, in our view, given that M3 growth is negative in the Eurozone: money multipliers have collapsed in both the EU and US, and core CPI inflation is below 1% YoY, so central banks have ample room to boost base money. Moral hazard from the massive EU rescue package is reduced via the involvement of the IMF, and the necessity to meet IMF/EU surveillance targets before withdrawing ‘rescue’ funds from the pool. Source: CEIC, Daiwa Source: CEIC, Daiwa

  7. The crucial IT sector looks set for a powerful rebound in 2010 after nine sluggish years • US new orders for IT products (computers and electronic items) are a good leading indicator of US imports from the six Asia economies that depend on IT exports (Singapore, Taiwan, Malaysia, the Philippines, Thailand and Korea –the last is the most diversified out of IT). US IT new orders have bottomed out – the actual level of orders is still 30% lower than that for 2000 – and we expect the strength of new orders to be aided by low inventories. Increased demand from the US has sparked a recovery in Asian electronics exports in the past two quarters. • Last year,there was a major IT-inventory adjustment, which appears to have been prolonged by the credit crisis. However, we think the long-awaited turnaround has now begun, and looks likely to be reinforced by a long-delayed replacement cycle in IT hardware. Source: CEIC, Daiwa Source: US Census Bureau, CEIC, Daiwa Asia Master - charts.xls

  8. Food-driven inflation a near-term threat; risk of higher asset and goods inflation from excessive capital inflows in 2010 • China and (especially) India switched quickly from deflation to inflation in 4Q09. The major culprit (as in 2007) was food inflation (6.1% YoY in China for May 2010, 16.5% YoY in India). Smaller Asia economies (Singapore, Taiwan, Thailand, Malaysia) made the same switch to positive inflation in 1Q10. Korea and Indonesia avoided deflation altogether, but inflation remains tame except in Chindia. • Rapid monetary growth in China has contributed to the rise in inflation, but monetary aggregates have been muted elsewhere in Asia. Given its already-high inflation rate, we expect India to raise policy rates 50bp by end-July. In China, we forecast another 50-basis-point hike in the reserve requirement and a 54-basis-point rise in the policy rate. We expect other central banks in Asia to tighten in 2H10. Source: CEIC, Daiwa Source: CEIC, Daiwa

  9. Gross fixed-capital formation: 1996-2008 (% change) China (+305.3%) India (+222.8%) US (+49.9%) Singapore (+48.1%) Eurozone (+41.4%) OECD (+41.2%) Indonesia (+24.2%) Taiwan (+23.9%) Philippines (+19.9%) Korea (+13.2%) HK (+9.6%) Malaysia (-4.3%) Japan (-18.0%) Thailand (-27.4%) -150 -100 -50 0 50 100 150 200 250 300 350 Global imbalances: Asia is helping to redress them (a little) • Asia’s large current-account surplus was arguably a major contributor to the excess-liquidity that led to the global crisis. The US deficit has shrunk over the past year, as has China’s current-account surplus (which contracted to 6% of GDP for 2009, from 9.8% for 2008). • The rest of Asia’s surplus widened in 2009, so the region as a whole recorded scant reduction in its surplus. As domestic demand rebounds in 2010, we expect Asia’s surplus to shrink further, to a still-healthy 4.5% of GDP. • Structural surpluses in Southeast Asia are partly a consequence of an investment drought. China’s low cost of capital (and under-valued Renminbi) has resulted in an investment boom there, and an excessively capital-intensive pattern of economic growth. To address such internal imbalances, we expect China to allow the Renminbi to appreciate to US$:Rmb6.45 by the end of 2010. Source: CEIC, Daiwa Source: CEIC, Daiwa

  10. Asian REERs broadly stable over time; the argument for Renminbi appreciation rests mainly on addressing internal imbalances • The currencies in Asia are all stronger against the US dollar than at their trough in 1997-98. However, only the Singapore dollar is stronger now than in 1993 (and even it has appreciated by less than 1% a year against the US dollar); the Rupiah, Rupee and Won are the weakest relative to their 1993 levels. • The real effective exchange rates (REERs) of all the currencies in Asia have been broadly stable since 1998; China and India’s REERs are close to 1993 levels (although they have recorded more real effective appreciation since 1996 than the other currencies). • The argument for China to appreciate the Renminbi is not that its REER has weakened. However, rapid productivity growth (relative to the rest of the world), driven by much higher investment spending in China, requires China’s real exchange rate to appreciate. In our view, the more compelling argument for Renminbi appreciation is the need to address internal imbalances (over-investment, export-reliance, under-consumption). Source: CEIC, Thomson Reuters, Daiwa Source: CEIC, Thomson Reuters, Daiwa

  11. US and Japan had prolonged bear markets after a five-fold surge in market cap • US equity-market capitalisation increased more than five-fold in the decade ended August 2000, but only surpassed those levels again briefly (June-October 2007) before falling back. In effect, the US has been in an eight-year bear market since August 2000 – a lot like Japan, which recorded a similar five-fold surge in the 1979-89 period followed by a decade-long bear market until the end of 1999. • The key difference between the two economies lies in their approach to monetary policy – the Bank of Japan (BoJ) tightened policy to deflate the asset bubble entirely, while the Federal Reserve has kept real interest rates low. • Market capitalisation-to-GDP ratios are similar across developed and developing countries, with the ratios for most countries converging toward one, although there is no reason for this to be true always. Emerging markets see manifold increases in market cap typically (as Japan did from 1951-80, before the 1980s increase). Source: CEIC, Thomson Reuters, Daiwa Source: CEIC, Thomson Reuters, Daiwa Copy of Global Mkts - Mkt Cap -Oct-08.xls

  12. Non-Japan Asia should narrow its market-capitalisation gap with the US/Japan over the medium term • High savings rates (over 50% for China, 35% for India, and 34% on average for the other economies in Asia) and stable banking systems with robust domestic deposit bases should provide the platform for strong economic growth over the medium term for Asia’s 10 big economies. • Superior medium-term growth prospects for emerging economies should ensure faster increases in their market capitalisations, as compared with those of developed economies. The market capitalisations of the BRIC economies look set to narrow the gap with the US’s market cap over the medium term – and in fact did so quite sharply in 2009. Source: CEIC, Thomson Reuters, Daiwa Source: CEIC, Thomson Reuters, Daiwa Copy of Global Mkts - Mkt Cap -Oct-08.xls

  13. The rest of Asia has lost US market share to China, but less so over the past two years • China gained market share in the US at the expense of all of Asia (except India, which had a tiny share) from 1997-05. Since 2006 (and in 2009 in particular), China’s market-share gains have been at the expense of non-Asia economies, while the rest of Asia held its US market share stable. • China lost market share in 2008 as the Renminbi appreciated, but has resumed gaining market share with the Renminbi stable since August 2008. • All of Asia (with the exception of India) has large bilateral trade surpluses with China (including Hong Kong), and we think that mitigated the impact of the loss of market share in the US. Source: CEIC, Daiwa Source: CEIC, Daiwa Asia Master - charts.xls

  14. ‘Stable disequilibrium’: China’s large surplus with the US and deficits with Asia (ex-India) both declined in 2009, but are set to widen anew • We believe China’s large deficit with Asia will increase anew now that China’s loan and investment growth is rebounding after the inventory correction in 4Q08-1Q09. Note, however, that Taiwan, Korea and Japan are the main net suppliers of capital and intermediate goods to China – and have large bilateral trade surpluses with China. ASEAN’s surplus reversed in 2009, but is rising slowly once again, while India has a deficit. • China’s large bilateral surplus with the US shrank in 2009, but looks likely to shrink less in 2010. However, China’s strong domestic demand should increase its bilateral deficits with Taiwan, Korea and Japan in 2010. Source: CEIC, Daiwa Source: CEIC, Daiwa Asia Master - charts.xls

  15. China: global price environment turns unfavourable Import prices rise much faster than export prices Net exports are shrinking H:\Kevin\CEIC\China\China Tradet\Prod2 H:\Kevin\CEIC\China\China Trade\Prod2 • The terms of trade have turned negative again – for March, import prices rose by 17.6% YoY while export prices increased by just 1.4% YoY. • Gross exports rose by 29% YoY for January-April, but net exports declined by 79% YoY. • Half of the surplus decline was due to the price effect (import price inflation and export price deflation), and the other half was due to the volume effect (domestic-demand surge driven by the stimulus). Source: CEIC, Daiwa

  16. China: industrial margins are under pressure CPI-PPI Industrial production H:\Kevin\CEIC\China\China Inflation\Prod H:\Kevin\CEIC\China\China Invt&IP\Sheet5 • The PPI is rising more rapidly than the CPI. It is difficult to pass on price pressure fully to consumers when supply capacity remains excessive. • Heavy industries react to the PPI, while light industries are sensitive to the CPI-PPI differentials. Source: CEIC, Daiwa

  17. Investment demand overshoots Central vs. local government projects Growth contribution from FAI H:\Kevin\CEIC\China\China Invt\Projects H:\Kevin\CEIC\China\China GDP\Contribution • FAI still rose by a sharp 25.6% YoY for 1Q10 (from a high base for 1Q09). • Its contribution to GDP growth still reached 6.9 percentage points. • Urban projects by local governments still increased by 27.6% YoY for January-April, while those by the central government slowed to 10.6% YoY. • Real-estate FAI accelerated to 37.6% YoY for January-April, from 19.9% YoY for 2009. Source: CEIC, Daiwa

  18. China: we think money and loans are still rising too rapidly Inflation is a monetary phenomenon Loan growth is still too high H:\Kevin\CEIC\China\China Inflation\Prod H:\Kevin\CEIC\China\China Monet\Prod • Money/credit growth tends to overshoot real GDP growth in a reflation cycle, because China’s monetary policy’s transmission mechanism is relatively weak –a large increase in money/credit can only have a minor impact on real economic variables. • The need for massive monetary stimulus is now over, as real GDP has picked up significantly. Source: CEIC, Daiwa

  19. China: the labour market is tighter than in 2007-08 Labour shortages are serious … … especially in the coastal provinces H:\Kevin\CEIC\China\China Wage\Demand & Supply Source: 103-City Labour Market Survey, CEIC, Daiwa H:\Kevin\CEIC\China\China Wage\Labour • In our view, the output gap has been completely closed. Exports have risen by more than 50% from the trough in 1Q09. The Rmb4tn stimulus has created millions of extra jobs, competing directly with the manufacturing sector. • More permanently, the demographic dividend is now dwindling. The surplus of young, rural labour is no longer in rich supply.

  20. Current-account surplus and net capital inflows contribute to the emergence of a property bubble • In our view, money supply growth has been too high for too long. • Capital is trapped domestically because of the closed capital account. Mainland citizens have limited access to foreign investments, artificially increasing the appeal of domestic investments such as property. • Very low or negative real interest rates. The People’s Bank of China (PBOC) has been holding down interest rates for too long, in our view. • Local governments’ reliance on land sales for income (typically accounting for up to 50% of revenue). • Infrastructure programmes make it easier for the local governments to develop properties. • Cultural pressures encourage home ownership, particularly for men seeking a wife.

  21. China: we expect steady Rmb appreciation vs the US dollar; the stock-market appears inexpensive Wild swings in terms of trade H:\Kevin\CEIC\China\China Trade\Prod2 H:\Kevin\CEIC\China\China FX\FX • Pegging the Renminbi to the US dollar was problematic for China. • The 2Q10 US-dollar bounce was mostly against the EUR, CHF and GBP. Oil and commodity prices remain stubbornly high. To mitigate the impact, we believe China will have to allow the Renminbi to rise against the US dollar to US$:Rmb6.45 by end-2010, a 5% rise from the current level. • The trailing PE-ratio for the stock-market is still close to a decade-low, suggesting that the under-valued market has room to move higher by end-2010. Source: CEIC, Daiwa Source: CEIC, Daiwa

  22. China outlook – post-stimulus slowdown from 2Q10 • Inflation pressure should continue to build for the rest of the year, unless substantial tightening can be frontloaded. • We forecast the RRR to rise by 50 basis points and interest rates to increase by 54 basis points (compared with a 216-basis-point reduction in 2H08). • The benchmark real deposit rate would still be negative. • We believe real GDP growth peaked in 1Q10, and will begin to slow on the back of more tightening, waning stimulus support, and cooling external demand. • Gross exports should do well this year, but net exports should contribute less to GDP growth. We forecast the current-account surplus to shrink from 6.1% to 2.5% of GDP this year. • Our GDP forecasts: 9.8% YoY for 2010 and 8.6% YoY for 2011. • Our inflation forecasts: 3.5% YoY for 2010 and 2.5% YoY for 2011.

  23. The 9.7% YoY real GDP growth for FY06-07 was India’s strongest ever (apart from one monsoon-induced year two decades ago), and the previous year’s 9.2% YoY was the next-fastest for 50 years. After 9% YoY real GDP growth for FY07-08, the economy slowed sharply to 6.7% for FY08-09, but rebounded to rise 7.4% YoY in FY09-10. We forecast 9.3% YoY real GDP growth in FY10-11. We think the five-year moving average of real GDP growth (8.5%) is the new potential growth rate – and will rise as the gross domestic investment rate has risen to 36% at present (from 25% seven years ago), with the recent rebound in investment reflected in the continued strength of capital-goods output and imports over the past five years (the gross domestic savings rate is at 35%). India: real GDP growth, five- and 10-year moving averages India: GDI moderated in the last two years but is rebounding India: the global downturn slowed the economy to below-potential growth, but a strong recovery now is under way Source: CEIC, Daiwa Source: CEIC, Daiwa \\dwfilesvr1\DIR-Production\Prod\PowerPoint\2009\0902_Asia Economic Outlook\Asia Master - charts (HK)1.xls[IN charts]

  24. Services account for half of GDP, and have expanded at an average pace of 9.5% annually for the past 10 years (10.2% for the past five years). The wider cross-border tradability of services bolsters their growth, as India is still a price-taker in internationally traded services. After decelerating substantially over the past 15 months, we expect Services to return to the previous decade’s trend pace. Near-5% average annual growth in agriculture over the six years before last year’s drought bolstered private consumption, as did higher civil-servant salaries. NREGA, and the shift in internal terms of trade in favour of agriculture, gave a big boost to rural consumption. The moderation in manufacturing last year would have reduced the current-account deficit – but rising oil prices caused the deficit to widen instead (to 2.5% of GDP for the 12 months to March 2009, and high defence imports partly offset the impact of lower oil prices in FY09/10 – with the stronger-than-expected manufacturing rebound led by capital goods boosting imports too). India: services are structurally strong, imports decelerated with industry, but oil worsened the current account Source: CEIC, Daiwa Source: CEIC, Daiwa \\dwfilesvr1\DIR-Production\Prod\PowerPoint\2009\0902_Asia Economic Outlook\Asia Master - charts (HK)1.xls[IN charts]

  25. Rising oil imports were the key factor causing the trade deficit to balloon in 2008. With oil-import values declining, and sluggish investment spending reining in other imports, the trade deficit has contracted to a two-year low. Services exports have low import content, so they help bolster the current account directly. Exports of goods and services (‘invisibles’) have increased 12-fold over 16 years. While the trade deficit was nearly 8% of GDP, the current-account deficit was likely to have narrowed to 0.1% of GDP for FY09-10. With the KG-6 gas and Rajasthan oil fields coming on stream, we expect India’s net oil-import bill to decline by nearly 20% for FY10-11, reducing the current-account deficit to 2.2% of GDP even as fixed-investment spending rebounds this year. India: rising net exports of services boost the current account, which should also benefit from the rising substitution of net oil imports Source: CEIC, Daiwa Source: CEIC, Daiwa \\dwfilesvr1\DIR-Production\Prod\PowerPoint\2009\0902_Asia Economic Outlook\Asia Master - charts (HK)1.xls[IN charts]

  26. Strong FDI inflows (over 3% of GDP for FY07-08 and FY08-09) are bolstering the overall balance of payments (BoP). FDI is likely to stay strong, but portfolio flows are likely to be volatile. Foreign M&As by India corporates have been funded offshore – and remain in some difficulty amid global de-leveraging. Inflation was negative until September 2009, but surging food prices pushed headline WPI inflation to 10.2% YoY by May 2010. However, rising food prices (up more 16.5% YoY) have mitigated the impact on rural incomes from last year’s bad monsoon. Real PLRs were at a 15-year high in September 2009, but they have declined in response to banks’ excess liquidity, especially with WPI inflation rising to 10% YoY by March 2010. Lower real PLRs are helping to ignite a strong investment-led rebound in manufacturing, which we expect to push real GDP growth to 9.3% for FY10-11 (aided also by a likely improvement in agriculture). India: rising FDI inflows bolster the BoP; lower real lending rates should ignite an investment-led acceleration in GDP Source: CEIC, Daiwa Source: CEIC, Daiwa

  27. The equity market’s trailing PER is slightly above its 10-year average – despite last year’s rally – as corporate earnings held up reasonably well during the global downturn and have now begun to rebound sharply. We think the pipeline of disinvestment proceeds will restrain the upside for equity prices. However, once the 3G-spectrum auction and disinvestment pipeline is completed, the government’s borrowing requirement for the year ahead will be met comfortably without pushing 10-year bond yields much above 8%. We expect WPI inflation to moderate by June, as grain reserves (and the strong rabi harvest) are deployed to dampen food inflation. We also expect the Rupee to rebound modestly against the US dollar by March 2011, as the current account swings back to surplus with lower oil prices. However, the recent spurt in inflation has caused the REER to rise to the top of its 15-year trading range, so near-term Rupee depreciation is likely; the Rupee rally must wait for a clear moderation in inflation to below 8% YoY. India: overvalued equities slumped in 2008, but last year’s rally made them rich again; near-term rupee weakness to end when inflation recedes Source: CEIC, Daiwa Source: CEIC, Daiwa \\dwfilesvr1\DIR-Production\Prod\PowerPoint\2009\0902_Asia Economic Outlook\Asia Master - charts (HK)1.xls[IN charts]

  28. The fiscal balance deteriorated sharply over the year to November 2009 (the ‘kitchen sink strategy’), but began moderating in December 2009 as tax revenue began to benefit from the industrial recovery. The 2010 Budget contained a credible strategy to boost revenue (2p.p. rise in excise duties, MAT raised to 18% from 15%, higher customs duties on oil/gold/silver) without sacrificing the momentum of consumption spending (by lowering effective income tax rates across the board). There were also elements of reform, with a GST now genuinely likely by April 2011, oil and fertilizer subsidies to be paid in cash, and oil-product prices up. With credible disinvestment proceeds, and stronger revenue from the industrial acceleration (and wider service tax base) we expect the actual fiscal deficit in FY10-11 to be about 5% of GDP. By the second half of the fiscal year, the moderating borrowing requirement of the government will help crowd in more private investment (even as real PLRs stabilize) and we forecast real GDP to rise by 9.3% YoY for FY10-11, albeit with higher average WPI inflation of 7.3%. India: higher interest rates rein in industrial growth; some ‘crowding-in’ of investment as rates fall Source: CEIC, Daiwa Source: Ministry of Finance (India), Daiwa \\dwfilesvr1\DIR-Production\Prod\PowerPoint\2009\0902_Asia Economic Outlook\Asia Master - charts (HK)1.xls[IN charts]

  29. Korea: GDP looks set to stay strong, with inflation still tame • The leading indicators (both the Leading Composite Index and the shipment-to-inventory ratio) suggest to us that economic activity is likely to rebound strongly in 2010. We forecast real GDP growth of 7% YoY for 2010. • CPI inflation has been tame (at 2.7% YoY for May 2010, versus the Bank of Korea’s [BOK] official target of 2-4%), with core CPI inflation barely edging up to 1.6% YoY. We expect Won appreciation to bear some of the burden of tightening, but we also expect the policy rate to be raised by 25 basis points in 3Q10 (with more aggressive action if Won-weakness persists). Source: CEIC, Daiwa Source: CEIC, Daiwa Asia Master - charts.xls[KR]

  30. Korea: fiscal stimulus on the wane, offsetting improved liquidity from the rebounding trade surplus • The strong fiscal position in 1H08 allowed President Lee Myung-bak to provide a massive stimulus through lower corporate, income, inheritance, and property tax rates. Fiscal policy likely to be less accommodative this year. • Improving terms of trade and a highly competitive Won are boosting the trade balance(to a record surplus of US$41bn for 2009). After a current-account surplus of 5.6% of GDPfor 2009, there is ample room for a domestic demand-led rebound – and we forecast real GDP to expand by 7% as the current-account surplus moderates to 3.8% of GDP in 2010. We think exports will recover strongly as emerging economies crank up their fiscal engines: Russia/India/Latin America now take more of Korea’s exports than the US, while China (27%) and ASEAN+Japan (20%) are the biggest markets. Source: CEIC, Daiwa Source: CEIC, Daiwa Asia Master - charts.xls[KR]

  31. Korea: consumption looks set to recover strongly, as do facility investment and exports • Facility investment was weak for 2008, affected by the policy uncertainty that usually accompanies a new president. However, President Lee’s shift of policy focus to deregulation and economic growth (from ‘distribution’) should result in an investment-led rebound in domestic demand by 2010, aided by a stable Won and robust export prospects. • Consumer confidence is near a 10-year high. After five years of subdued private-consumption spending, we expect a powerful rebound in 2010. Source: CEIC, Daiwa Source: CEIC, Daiwa Asia Master - charts.xls[KR]

  32. Indonesia: we look for real GDP growth to rebound, aided by exports, domestic consumption and FDI • Private consumption (4.9%) propped up GDP growth in 2009, aided by a 15.7% YoY increase in government consumption, while fixed investment rose by a more moderate 3.3%. We expect rebounding fixed investment to boost growth in 2010. • Banks are highly liquid (with a loan-to-deposit ratio of 75.6% at the end of 2009), so there is ample scope to sustain loan growth. The fiscal deficit remains among the lowest in Asia, so we see little need for any ‘exit strategy’. Source: CEIC, Daiwa Source: CEIC, Daiwa Asia Master - charts.xls[TH&ID]

  33. Indonesia: robust, diversified exports should ensure the trade surplus, and FDI rebound from a mild setback in 2009 • Although its net exports of oil and gas are shrinking, Indonesia’s diversified export basket enables it to run a modest monthly trade surplus, which has widened sharply in recent months. Asian demand should ensure continued strength in non-oil exports this year. • FDI has staged a strong recovery in recent years, climbing to an all-time high in 2008, and boosting fixed-investment spending. Last year, FDI moderated amid the global downturn, but should rebound strongly this year and fixed-investment should remain a medium-term spur to real GDP, which we forecast to expand by 6.5% YoY for 2010 and 6.1% YoY for 2011. Source: CEIC, Daiwa Source: CEIC, Daiwa Asia Master - charts.xls[TH&ID]

  34. Indonesia: overall BoP solidly in surplus, boosting liquidity; equity valuations still well below the pre-1997 ranges • After some severe capital flight in the early stages of the post-Lehman crisis, Indonesia’s overall BoP position had stabilised by March 2009, and has been robust ever since. With the rising current-account surplus, the overall BoP surplus should continue its trend improvement. • Despite the multi-year surge in equity prices since 2004 (and the setback during the global downturn), the trailing PER (about 15x) is well below its five-year peak, and far below the pre-1997 valuations. Consequently, portfolio inflows are likely to persist, given improved economic prospects. Source: CEIC, Daiwa Source: CEIC, Daiwa

  35. Indonesia: stable/stronger Rupiah helps restrain inflation • Foreign reserves resumed rising in April 2009, as the pressure of capital flight eased. • A stable/stronger Rupiah helps restrain inflation, and the latter allows interest rates to fall. With base money contracting, the Rupiah strengthened last year – allowing inflation to moderate as well. CPI inflation looks likely to begin rising in 1Q10, but we see little need for any monetary tightening before 2H10. Source: CEIC, Daiwa Source: CEIC, Daiwa

  36. Vietnam: A clear construction-led rebound in real GDP in 4Q09 (and 2Q10) came at the price of sharply wider twin deficits • Real GDP rebounded strongly to 7.7% YoY in 4Q09 (versus 3.1% YoY, 4.4% YoY and 5.2% YoY for the first three quarters of 2009). The strong performance in 4Q09 was aided by the 14% YoY surge in Construction (which accounts for a modest 9% of GDP, but benefitted from the fiscal focus on infrastructure spending). After 5.9% YoY growth in 1Q10, construction again led the acceleration to 6.3% growth in 2Q10. • The fiscal stimulus (passed piecemeal over the course of 2009) was targeted officially to total 8.7% of GDP, although some of it (particularly interest subsidies) have spilt over into 2010. We estimate a fiscal deficit of 9% of GDP for 2009 – still a very substantial stimulus, which has contributed clearly to the overheating. • The large trade deficit in 2H09 and 1H10, and elevated inflation, necessitated a pull-back from stimulative policy – which began with the Dong’s devaluation (5% in November 2009 and 3.5% in February 2010) and a hike in interest rates. Source: CEIC, Daiwa Source: CEIC, Daiwa, IMFNote: 2009 figures are Daiwa estimates

  37. Vietnam: Surging loan growth stretched the banking system, and the fiscal stimulus took the deficit to 9% of GDP • Overall credit is estimated to have increased by 38% YoY in 2009, much faster than the 27% YoY pace of deposit growth – thus stretching the banking system even more severely, pushing the loan-to-deposit ratio to about 150%. Credit decelerated to 10.3% YoY growth in June 2010, but the 2010 target of 25% is too high. • Fiscal austerity in 2H08 was crucial for reining in overheating pressure, but a renewed stimulus ensued in 2009 to counter the global downturn – including a 30% reduction in corporate tax for small-and-medium-sized enterprises (SMEs), a four percentage-point interest subsidy on some loans (part of which was disbursed in 2010), and increased infrastructure spending. We think the early-March 2010 removal of the interest subsidy was appropriate (but an outright rise in the policy rate would be more effective, in our view). Source: CEIC, Daiwa, IMF Source: CEIC, Daiwa, MoF. Note: 2009 figures are Daiwa estimates

  38. Vietnam: trade deficit soared for 1H08, improved in 2H08 and 1Q09, but has widened sharply in Apr09-Jun10 – limiting the improvement in the current account deficit • The 12-month rolling sum of the trade deficit burgeoned to US$23bn by May 2008 (equal to 32.5% of the previous year’s GDP), partly because of the strong Dong in the November 2007-February 2008 period. The June-July 2008 policy response (fiscal austerity and a sharp rise in interest rates) helped lower the full-year trade deficit to US$17.5bn for 2008. After being restrained in 1H09, the trade deficit deteriorated rapidly in 2H09 and 1Q10, as imports outpaced exports strongly, before stabilizing in 2Q10. • Vietnam’s services and transfers (tourism and remittances) surplus mitigates the trade deficit, but the 2008 current account deficit expanded to 11.9% of GDP (from 9.8% in 2007), partly because of higher net outflows of income (repatriation of profits by multinational corporations [MNCs]) but mainly on account of the larger trade deficit (especially in 1H08). We estimate the current account deficit moderated to 10.3% of GDP for 2009, but improved mainly in 1H09, while the May 2009-March 2010 trend is in our opinion unsustainable, and has necessitated two large Dong devaluations (November 2009 and February 2010). The Dong’s depreciation should lower the current-account deficit to 9.8% of GDP in 2010, in our view, but the unwillingness to raise interest rates faster will limit the degree of improvement in external balances. Source: CEIC, Daiwa Source: CEIC, Daiwa, IMF Note: 2009 CA figures are Daiwa estimates

  39. Vietnam: FDI inflows remain robust, and a crucial source of support to the external balances; portfolio inflows dried up in 2008-09 • Vietnam remains a darling of MNCs, especially Asian ones, and its attractiveness as a destination for foreign direct investment (FDI) remains undimmed by other macro-economic woes, in our opinion. FDI inflows rebounded in 2Q-3Q09 to over 10% of GDP, and we expect them to stabilise at a healthy 8-10% of GDP in the medium-term – an important source of support to the external balances. • Large net foreign portfolio inflows were a crucial factor in helping to buoy the stock-market index in 2006-2007. Net foreign portfolio inflows persisted throughout much of 2008, and continued for most of 2009 and 1H10. That left a large basic balance deficit for 2008-09, although tempered in 2009 by the rebound in FDI inflows. • Since FDI is bundled with technology and market-access, FDI inflows of 8-10% of GDP would boost productivity and restore annual real GDP growth to 7-8% over the medium term, in our view, once macro stability is restored. Although FDI is sufficient to finance most of the current account deficit, the latter still undermines confidence – resulting in capital outflows. Source: CEIC, Daiwa Source: CEIC, Daiwa

  40. Vietnam: foreign reserve position looks fragile to us; but the Dong’s depreciation and higher domestic interest rates should enable external balances to improve • After inflation rose rapidly to 28.3% YoY in August 2008, the State Bank of Vietnam’s (SBV) aggressive 525-bp hike in the base rate pushed the ceiling on lending rates to 21%. CPI inflation moderated to 19.9% YoY by December 2008, and sharply to 3.9% YoY for June 2009 (albeit still averaging over 10% YoY for 1H09). With month-on-month inflation moderating, the benchmark rate was cut by 700 bps to 7% in the October 2008-February 2009 period, helping to offset the impact of the global downturn. • However, inflation began rising sharply again between September 2009 and March 2010 (9.7% YoY), and the SBV raised the benchmark rate to 8% in December 2009. With CPI inflation at 8.7% YoY in June 2010, and looking likely to resume rising in the wake of the Dong’s depreciation, we expect the policy rate to rise by a further 100 bps this year (to 9%). • Foreign reserves declined to US$16.8bn in December 2009; we think the absence of timely, credible data prompts risks of speculation. The US$1bn sovereign bond issue in January 2010 bolstered reserves (but was expensive). Reserves are estimated (by the IMF) to provide only seven weeks’ import cover currently, but external debt is modest (US$24bn, with only about US$5bn short-term): fragile but not facing an imminent crisis, in our view. Source: CEIC, Daiwa, IMF Source: CEIC, Daiwa

  41. 950 China India 850 Indonesia Republic of Korea 750 650 550 450 350 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010E 2015E 2020E 2025E 2030E 2035E 2040E 2045E 2050E Dependency ratio (ratio of population aged 0-14 and 65+ per thousand population 15-64) Asia’s demographics: well-endowed until at least 2015 • We expect non-Japan Asia to continue to benefit from declining dependency ratios until 2020. Typically, savings rates rise during periods of declining dependency ratios (this began to happen in Asia from 1965 onwards; in India from 1980). Higher savings should be able to fund higher investment rates, enhancing the productivity of the increasing workforce. • Technology (embodied in FDI and through imports) should ensure strong total factor productivity (TFP) growth and a rapid economic catch-up for Asia. We think India has the demographic advantage for 2020-50. Source: CEIC, Daiwa

  42. China and Japan: mirror-image demographics • Japan has entered the most daunting phase of its demographic transition, in our opinion. Savings rates look likely to decline and the old-age dependency ratio looks set to surge between now and 2020. A surge in public debt compounds the problem, but that should improve as growth picks up and deflation (especially of assets) ends. • This decade, China’s demographics are probably at their most favourable for economic growth. By 2020, the population will have aged a bit more, and its dependency ratio should be past its trough. However, we think China’s demographics will still look a lot better than Japan’s. Source: UN, Daiwa Source: UN, Daiwa

  43. India: demography should support steadily stronger growth • The huge number of young people in the population today will reach working age over the next 15-20 years. By 2020, India is expected to have 270m people (more than today’s total US population) between the ages of 15 and 35. • Savings rates and productive potential should be at their highest. In our view, the challenge for India is to develop a more labour-intensive growth model to take full advantage of the productive potential of the masses. Source: UN, Daiwa Note: females on the left; males on the right Source: UN, Daiwa Note: females on the left; males on the right

  44. Asia: baseline forecasts Source: Daiwa forecasts Note: WPI for India Note: For India, 2010 = FY10E, April 2010 to March 2011 Asia Forecast Table - Sep09.xls

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