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Economics
Markets
Strategy
2Q 2013
DBS Group Research
14 March 2013

Economics – Markets – Strategy March 14, 2013
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Economics–Markets–Strategy
March 14, 2013
Contents
Introduction 4
Economics A global RMB: inventing the necessary 6
Currencies Enter the dragon 20
Yield Time for caution 34
Offshore CNH Regionalizing the RMB franchise 50
Asia Equity Sanguine 54
Greater China, Korea
China Rising risk of overheating 68
Hong Kong Better times 72
Taiwan JPY risks vs. RMB opportunities 78
Korea Recovery on track, despite JPY concerns 84
Southeast Asia, India
India Challenges remain 90
Indonesia Adjustments 94
Malaysia Strong fundamentals 98
Thailand Momentum 104
Singapore Cyclical improvement, structural drag 108
Philippines Sweet spot 114
Vietnam Sustainable growth 118
G3
United States Progress under the hood 122
Japan Short-term outlook upgraded 126
Eurozone Far from over 132
1

March 14, 2013
Economics–Markets–Strategy
Economic forecasts
GDP growth, % YoY
CPI inflation, % YoY
2010 2011 2012 2013f 2014f 2010 2011 2012 2013f 2014f
US 3.0 1.8 2.3 1.7 2.5 1.6 3.1 2.1 1.9 2.0
Japan 4.5 -0.6 2.0 1.8 0.6 -0.7 -0.3 0.0 0.0 2.0
Eurozone 1.9 1.6 -0.5 -0.3 0.1 1.6 2.7 2.5 1.9 1.9
Indonesia 6.1 6.5 6.2 6.3 6.5 5.1 5.4 4.3 5.3 5.4
Malaysia 7.2 5.1 5.6 5.5 5.5 1.7 3.2 1.7 2.8 3.2
Philippines 7.3 3.9 6.6 6.0 6.0 3.8 4.8 3.1 3.8 4.2
Singapore 14.8 5.2 1.3 3.2 4.0 2.8 5.2 4.6 4.0 4.2
Thailand 7.8 0.1 6.4 5.0 5.0 3.3 3.8 3.0 3.6 3.7
Vietnam 6.8 5.9 5.0 5.6 6.0 9.2 18.6 9.3 7.5 6.8
China 10.3 9.3 7.8 9.0 8.5 3.3 5.4 2.6 3.5 3.5
Hong Kong 7.0 4.9 1.5 5.0 4.0 2.4 5.3 4.0 3.5 3.5
Taiwan 10.7 4.1 1.3 4.2 4.0 1.0 1.4 1.9 1.3 1.3
Korea 6.2 3.6 2.0 3.5 3.9 2.9 4.0 2.2 2.3 2.9
India* 8.4 6.5 5.1 6.0 6.7 9.6 8.9 7.4 7.0 6.8
* India data & forecasts refer to fiscal years beginning April; inflation is WPI
Source: CEIC and DBS Research
Policy and exchange rate forecasts
Policy interest rates, eop
Exchange rates, eop
current 2Q13 3Q13 4Q13 1Q14 current 2Q13 3Q13 4Q13 1Q14
US 0.25 0.25 0.25 0.25 0.25 … … … … …
Japan 0.10 0.10 0.10 0.10 0.10 96.0 98 100 102 104
Eurozone 0.75 0.75 0.75 0.75 0.75 1.296 1.33 1.35 1.36 1.37
Indonesia 5.75 5.75 5.75 5.75 5.75 9,711 9,600 9,550 9,500 9,450
Malaysia 3.00 3.00 3.25 3.50 3.50 3.11 3.08 3.04 3.00 2.96
Philippines 3.50 3.50 3.50 3.75 4.00 40.6 40.1 39.7 39.3 39.0
Singapore n.a. n.a. n.a. n.a. n.a. 1.25 1.21 1.20 1.19 1.18
Thailand 2.75 2.75 2.75 3.00 3.25 29.6 29.6 29.5 29.4 29.3
Vietnam^ 9.00 9.00 9.00 8.00 8.00 20,950 20,750 20,750 20,750 20,750
China* 6.00 6.00 6.00 6.25 6.50 6.22 6.15 6.11 6.07 6.05
Hong Kong n.a. n.a. n.a. n.a. n.a. 7.76 7.78 7.79 7.80 7.80
Taiwan 1.88 1.88 1.88 2.00 2.13 29.7 29.1 28.8 28.6 28.4
Korea 2.75 2.75 2.75 2.75 3.00 1109 1050 1040 1030 1020
India 7.75 7.25 7.00 7.00 7.00 54.4 54.0 53.5 53.0 52.5
^ prime rate; * 1-yr lending rate
Source: Bloomberg and DBS Group Research
2

Economics–Markets–Strategy
March 14, 2013
Interest Rate Forecasts
%, eop, govt bond yield for 2Y and 10Y, spread in bps
13-Mar-13 2Q13 3Q13 4Q13 1Q14
US 3m Libor 0.28 0.30 0.30 0.30 0.30
2Y 0.26 0.39 0.78 0.78 1.17
10Y 2.02 2.50 2.75 3.00 3.25
10Y-2Y 176 211 197 222 208
Japan 3m Tibor 0.25 0.25 0.25 0.25 0.25
Eurozone 3m Euribor 0.20 0.19 0.19 0.19 0.19
Indonesia 3m Jibor 4.90 5.50 5.75 5.75 5.75
2Y 4.32 4.50 5.00 5.50 6.00
10Y 5.40 6.00 6.00 6.50 7.00
10Y-2Y 108 150 100 100 100
Malaysia 3m Klibor 3.21 3.25 3.50 3.75 3.75
3Y 3.06 3.20 3.50 3.75 3.75
10Y 3.45 3.60 3.90 4.25 4.25
10Y-3Y 39 40 40 50 50
Philippines 3m Phibor 0.50 1.00 1.50 2.00 2.50
2Y 2.28 2.50 2.75 3.00 3.25
10Y 3.52 4.00 4.25 4.50 4.75
10Y-2Y 124 150 150 150 150
Singapore 3m Sibor 0.38 0.35 0.35 0.35 0.35
2Y 0.19 0.30 0.40 0.40 0.46
10Y 1.56 1.90 2.10 2.25 2.35
10Y-2Y 137 160 170 185 189
Thailand 3m Bibor 2.86 2.90 2.90 3.15 3.40
2Y 2.86 3.40 3.50 3.75 3.75
10Y 3.64 4.25 4.25 4.50 4.50
10Y-2Y 78 85 75 75 75
China 1 yr Lending rate 6.00 6.00 6.00 6.25 6.50
2Y 3.09 3.25 3.25 3.50 3.75
10Y 3.60 3.75 3.75 4.00 4.25
10Y-2Y 51 50 50 50 50
Hong Kong 3m Hibor 0.38 0.40 0.40 0.40 0.40
2Y 0.21 0.44 0.83 0.93 1.32
10Y 1.14 1.60 2.10 2.60 2.85
10Y-2Y 93 116 127 167 153
Taiwan 3M CP 0.84 0.80 0.80 0.90 1.00
2Y 0.74 0.80 0.80 0.90 0.90
10Y 1.37 1.40 1.40 1.50 1.50
10Y-2Y 62 60 60 60 60
Korea 3m CD 2.81 2.95 3.00 3.05 3.30
3Y 2.61 2.90 3.30 3.50 3.50
10Y 2.96 3.20 3.60 3.80 3.80
10Y-3Y 35 30 30 30 30
India 3m Mibor 9.56 8.25 8.00 8.00 8.00
2Y 7.74 7.50 7.00 7.00 7.00
10Y 7.87 7.75 7.50 7.50 7.50
10Y-2Y 13 25 50 50 50
Source: Bloomberg and DBS Group Research
3

Introduction
Economics–Markets–Strategy
KBO
Keep buggering on, Churchill used to say. There’s no wind at your back. There’s
no steak on your plate. There’s no hope for next week and you ain’t making hay.
What do you do? Keep buggering on. Keep your nose to the grindstone and keep
your legs moving. Eventually things will turn.
That’s what the first quarter has felt like this year. The US continues to grind at a
2% growth pace. No acceleration, no deceleration. Same pace whether you average
it over the past three quarters, 6 quarters or 9 quarters. Fiscal policy is in tatters
thanks to a dysfunctional Congress. Monetary policy is at the end of its rope. And
more than a few Fed officials are publicly pondering whether QE3 is a good idea or
not. What do you? KBO. Household leverge is falling and excess labor is getting
mopped up. So there is some progress, even it its slow. Things could be worse.
Like in Europe. Little change on the margin there either. The trouble is, ‘steady’
over there means steady contraction. Output has fallen for five straight quarters
and trouble in the periphery has spread to the core. Germany’s economy shrank by
2% (QoQ, saar) in the fourth quarter; France’s fell by 1.1%. The Eurozone might get
away with a smaller contraction this year than last year’s 0.5% but it won’t be easy.
In the meantime, the pain intensifies. EU unemployment rose to an all-time high
of 11.9% in January. In France, it hit 10.6%; in Italy it jumped three ticks to 11.7%.
It’s over 26% and climbing In Spain and Greece. What do you do? KBO. And hope
that markets continue to fear the ECB and its promise to protect the euro.
It’s KBO in Asia too, though things out here are on a whole other plane. Growth is
faster than in the G3, of course, and it increasingly appears to have bottomed too.
We continue to look for mild acceleration in 2013 – to 7.3% this year from 6.2%
last year. That’s just about par for Asia – 100 – compared to last year’s 85. To do
that while the US continues to run at 64 or 65 of par and the Eurozone continues to
contract is remarkable, even if it’s no longer surprising for those who have watched
Asia over the past 4-5 years while the G3 did nothing.
China, we think, will drive much of Asia’s faster growth this year and, as explained
several times in recent months, we think the pickup will come mostly from invest-
Eurozone – unemployment rate
%, sa
12.0
11.9
11.5
11.0
10.5
Economic
pain runs one-way
INTRODUCTION
10.0
9.5
Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13
David Carbon • (65) 6878-9548 • davidcarbon@dbs.com
4

Economics–Markets–Strategy
Introduction
ment. There were a lot of distractions in China last year – the leadership transition,
high profile criminal trials, international disputes over island territories – and
investment growth was slower in 2012 than it was fast in 2009. We think that will
turn partially around once the new leadership takes over.
Interest rates in Asia are lower than they were a year ago and that too should help
stir the pot. Rates were cut 18 times over the past 18 months and they never got
back to normal heights following the global financial crisis to begin with. They are
well below normal today, much to the chagrin of officials in Singapore and Hong
Kong who are having difficulty controlling property prices.
Finally, capital inflows have made a modest comeback over the past 6-8 months.
Foreign investors remain cautious compared to 2010-2011, but who wouldn’t be
given the ongoing contraction in Europe and weak growth in the US. That’s fine
though: Asia doesn’t need or want a return to that sort of inflow. Growth is only a
tad below average currently and the combined push of these three factors – investment
in China, low interest rates and returning capital flows – should be more than
enough to lift Asia back to 100 this year.
Keep buggering on. The markets seem happy enough to do that. Equities – US and
Asian – are up 24% since the start of 2012 and 4%-8% since the start of 2013. Yes,
Europe remains a big risk and will for as long as the unemployment rate continues
to rise. But the economy isn’t falling off a cliff there and it’s growing at a 2% pace
in the US. In Asia we should move back towards par and Japan is readying itself for
another big push to end deflation.
The war’s not over but it’s starting to feel like it could be in another year or so.
KBO.
David Carbon, for
DBS Group Research
March 14, 2013
5

Economics
Economics–Markets–Strategy
A global RMB: inventing the
necessary
• China presses forward with the internationalization of the RMB. More
and more trade is being denominated in RMB. New offshore clearing
banks are being established in Taipei and Singapore
• But internationalizing the RMB carries a lot of risk, so why does China
really want to globalize the RMB?
• Because the structure of the global economy has changed radically
since 1978 while the financial architecture has changed barely at all
• Between now and 2020, China’s two-way trade will grow by $4 trn.
That’s nearly the size of the entire of offshore eurodollar market
• China doesn’t just want a globalized RMB, it needs one
Most are aware that China’s economy has grown really fast for a really long time.
Readers wouldn’t be too surprised to learn that, officially, it works out to 10% per
year since 1978, when Deng Xiaoping began replacing central planning with market-based
economic reforms. They might be a little more surprised to learn that,
at that rate, GDP (or anything) doubles in size every 7 years. But they’d probably
be quite surprised to learn the equivalent fact: China’s economy is 28 times bigger
today than it was back in 1978.
Twenty eight times. No fooling, no magic. Except perhaps the magic of compound
growth that you teach your kids about in high school – put a dollar in the bank
today and 35 years later it’s worth a lot more than you’d think.
Thirty five years of compound growth have made China the second largest economy
in the world (after the US). Even more remarkably, China is now the largest
Total trade – China and US
US$ bn / yr, X+M, goods
4,000
US $3867
3,500
3,000
2,500
China
2,000
1,500
ECONOMICS
1,000
500
0
91 93 95 97 99 01 03 05 07 09 11 13
David Carbon • (65) 6878-9548 • davidcarbon@dbs.com
6

Economics–Markets–Strategy
Economics:
trading nation in the world. Last year, its total trade (exports plus imports) came to
$3867bn, one billion dollars more than the total trade of the US (chart on p6).
Real economy vs financial economy
At DBS, we have been talking about the
shift in economic gravity from West to
East for the past 8 years. It is, without
doubt, the biggest structural change underway
in the global economy today.
Ironically though, these tectonic shifts in
the world’s real economy have not been
accompanied by similar changes on the
financial side. China may now be the
biggest trading nation in the world but
nobody uses its currency, the renminbi
(RMB), to do the deals. In mid-2011, less
than 1% of the world’s trade was conducted
in RMB terms. By contrast, some
46% of the world’s trade was still conducted
in US dollars (USD). The next 35%
of the world’s trade was done with euros
(EUR), yen (JPY), pounds (GBP) and Aussie
dollars (AUD).
A global RMB
Currencies used in global trade
share in world trade, June 2011
share cum share
Rank Currency % %
1 USD 45.9 45.9
2 EUR 16.9 62.8
3 JPY 6.8 69.6
4 GBP 5.8 75.4
5 AUD 3.7 79.1
6 CHF 2.9 82.0
7 CAD 2.4 84.4
8 SGD 1.6 86.0
9 HKD 1.2 87.2
10 KRW 1.0 88.2
14 CNY 0.9 --
27 THB 0.2 --
Subtotal 89.3
Source: SWIFT
China aims to change this lopsided situation. In the past 2-3 years, it has embarked
on a path to make the RMB an ‘internationalized’ global currency – one as important
to the world’s financial markets as China’s production, demand and trade have
become to the world’s real economy.
Like any globalized currency – of which the dollar and the euro are really the only
two examples – an internationalized RMB would be used:
1) to denominate and settle international trade, whether conducted with
China or between countries external to China;
2) to borrow and lend in on- and off-shore markets, with free and transparent
access to domestic and foreign parties alike;
3) as a benchmark for other currencies to be tracked / valued against; and,
relatedly,
3) as a foreign reserve currency held by central banks outside China.
That’s a short and simple list but it implies huge changes for China’s economy and
the way it does business today. For starters, if the RMB is to be held and traded and
do everything the dollar or the euro do in international markets, China’s markets
would have to be open to foreigners no less than America’s and Europe’s are today.
It’s interest rates would have to go up and down according to market forces, instead
of government command. And China would have to create the rules and institutions
to govern these markets before investors would feel comfortable holding RMB
the same way they hold the USD, EUR or GBP.
None of this would come easily. Take just the first point, for instance: opening
China’s financial markets to foreign participation. Economists call this “opening
the capital account” and it opens a whole can of worms for managing – or not –
the macro economy. Anyone in Asia during the financial crisis of 1996-98 might be
forgiven for asking why on earth any country would want to do something so silly
The shift in
economic gravity
from West to
East is the biggest
structural change
underway in the
global economy
today
China trades more
than any country
in the world. But
nobody uses its
currency to do the
deals
7

Economics
Economics–Markets–Strategy
Transaction costs
in currency markets
are miniscule
as open its capital account? Foreign money comes rushing in. The currency loses
competitiveness. Exporters fail. A bubble grows in this sector or that. It pops.
The foreign capital rushes out. The currency collapses. Interest rates shoot to the
moon. The economy collapses.
And that’s just in the first year.
China has experienced 35 years of relatively stable 10% GDP growth. It’s 28 times
bigger today than it was in 1978. Why risk this kind of success for a globalized RMB
and an open capital account?
The non-reasons for internationalizing the RMB
There are 2-3 reasons why it makes sense for China to take the plunge and we’ll
come to them in a minute. The first task, though, is to dismiss the 6-7 reasons one
usually hears for internationalizing the RMB because they are mostly nonsense.
Non-reason 1: To save on FX transactions costs
The first reason one hears is that if China denominated its foreign trade in RMB
instead of, say, USD, it would save a lot of money on foreign exchange costs. Poppycock.
These days, thanks in large part to computerized trading, the bid-offer
spread on foreign exchange transactions is miniscule. For the RMB, the spread
has averaged 1.3 basis points since 2008 (chart below). That’s nothing. Currency
markets are extremely efficient / cheap to operate in and the RMB market is no
exception.
But take it a step further. Suppose, for the sake of argument, that the bid-ask
spread was actually 100 times wider than this 1.3 basis points. And suppose further
that trade is now denominated in RMB terms. Would that mean the US side pays
100% of this cost and the Chinese side gets off scott free? Of course not. The US
importer, say, would demand that the Chinese exporter pay half. If the Chinese exporter
has a lot of market power, he may say no. But if the Chinese exporter has a
lot of market power, he is surely passing that cost off to the US side already. Doing
the deal in RMB terms is superfluous.
In either case, FX costs can’t factor highly, if at all, in any serious decision to internationalize
the RMB.
CNY – bid-offer spread
percent
0.40
0.35
0.30
0.25
0.20
0.15
0.10
0.05
0.00
Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13
8

Economics–Markets–Strategy
Economics:
Non-reason 2: To save on hedging costs
The second reason most often heard to internationalize the RMB is to save on hedging
costs. Exchange rates bounce around and a Chinese importer who accepts a dollar
price today may find the RMB he pays three months hence is quite different than
what he’d planned on. These risks, of course, can be completely hedged by buying
or selling dollars in the forward currency market – but this ‘insurance’ costs money.
How much? Not very much. The cost of locking in an exchange rate in the forward
market is simply the difference between local and foreign interest rates. For
example, if the local (RMB) interest rate is 3% and the foreign (US) interest rate is
2% then a Chinese importer would need to pay his bank 1% to guarantee the price
of dollars one year hence [1]. More likely, the importer will take delivery in two
months (not one year), so the cost of insurance would be 2/12ths of 1%, or 17 basis
points.
Seventeen basis points isn’t very expensive as insurance goes. In fact it’s downright
cheap.
But here’s the thing: it’s even cheaper from a macro / national perspective. For every
Chinese importer paying 17 basis points to guarantee the RMB price of a dollar
doesn’t go up, there is a Chinese exporter getting paid – yes paid – 17 basis points
to guarantee the number of RMB he receives for a dollar doesn’t go down. From a
national point of view, the cost of hedging is zero [2].
Plainly, hedging costs can’t be driving the internationalization of the RMB either.
Hedging costs are
zero when looked
at from a national
point of view
Non-reason 3: To borrow at a cheaper rate
This non-reason to internationalize the RMB is heard almost as often as NR1 and
NR2. If China had a currency that everyone wanted to hold, the idea goes, it could
borrow more cheaply in international markets. More cheaply than what exactly?
And more to the point, China doesn’t borrow in international markets. It lends, big
time! Over the past 15 years, China has run trade and current account surpluses
equivalent to 6% of GDP on average – big enough to have most of the world’s developed
nations hopping mad about it. Added up, China’s surpluses – its lending,
that is – comes to some 2.3 trillion dollars since 1997.
GDP per capita, 2012
Thousand USD per capita
60
58
50
50
47
40
39
36
30
20
23
21
10
0
10.4
6.0 5.5
3.5
2.4 1.6
SG USA JP EZ3 HK KR TW MY China TH ID PH IN
9

Economics
Economics–Markets–Strategy
Seigniorage lets a
country pay for a
deficit simply by
printing currency.
But China doesn’t
run deficits and
most people fear it
never will
China has lent so much money that its central bank now owns $3.3 trillion worth of
foreign exchange reserves. And China purportedly wants to internationalize the
RMB so it can ... turn around and borrow?
Nice try, no cigar.
In theory of course, if everyone wants to hold your currency that should make it
easier to borrow – your currency – if the need ever arose. Still, one needs to be
careful to compare apples to apples, and oranges to oranges.
If China issued a globalized RMB that everyone wanted to hold, it would make it
cheaper for China to borrow RMB than would be the case if people did not want
to hold the RMB. That doesn’t mean it would be cheaper to borrow RMB than, say,
dollars or euros. And that’s what matters when it comes to profits and losses and
real economic growth and real incomes.
China is a rapidly developing economy but it’s still a poor country compared to most
(chart bottom of previous page). China’s per-capita income in 2012 was $6000,
about one-tenth of Singapore’s $58,000 and one-eighth of the US’s $50,000. Capital
is relatively scarce in China and returns – interest rates – should be considerably
higher than in the US [3]. For as long as this remains the case, there is a powerful
incentive for China to borrow – should it ever wish or need to do so – in dollars,
not RMB.
The fact that China has already built up large claims on foreigners, many of which
are denominated in dollars, makes it all the more likely that China would wish to
borrow – again, hypothetically speaking – in dollars rather than in RMB. Doing so
would reduce its considerable dollar exposure on the margin, rather than raise it.
NR4: The free lunch of seigniorage
More generally, an internationalized RMB is supposed to confer upon China all the
privileges and entitlements of ‘seigniorage’, of which lower interest rates are but
one example. What is seigniorage? In layman’s terms, it’s the free lunch a country
enjoys when other countries ‘have to’ buy and hold its currency.
To exaggerate for the sake of example, seigniorage would, in the extreme, allow
China to run large current account deficits and pay for them simply by printing
RMB.
That would be nice, surely. But the thing is, for the past fifteen years China has not
been trying to get something on the cheap from its trading partners. The problem,
according to most, is precisely the opposite: China has been giving things away –
running large current account surpluses by keeping its currency undervalued. If
you’re like many in the West, your biggest fear is that China will still be trying to
give things away for free when your kids have kids. In any event, it’s hard to argue
that any country running a current account surplus – sending abroad more than it
takes in – is scouting around for a free lunch.
This non-reason for internationalizing the RMB can be crossed off the list too.
NR5: Protecting the value of its international assets
Since 1997, China has run current account surpluses amounting to some 2.3 trillion
US dollars. It holds 3.3 trillion dollars worth of foreign exchange reserves. Its
international balance sheet (top of next page) isn’t quite that lopsided in net asset
terms but, at $1.8 trillion, foreigners still owe China a lot of money. The argument
goes, that if China’s trade and net international assets were denominated in RMB
instead of, say, US dollars, then it would be protected from a hypothetical crash in
the value of the dollar.
10

Economics–Markets–Strategy
Economics:
China -- international balance sheet
USD bn, September 2012
Net assets 1,820
Assets 5,040 Liabilities 3,220
Foreign reserves 3,360
Currency 3,285
Gold 60
SDRs 11
FDI (outward) 420 FDI (inward) 1,954
Securities 250 Securities 315
Equities 100 Equities 255
Bonds 150 Bonds 60
Loans 280 Loans 370
Other 640 Other 581
Trade credit 320
Deposits 350
Note: China's current account surpluses from 1997-2012 sum to approx US$2300 bn.
But would it really? The landscape is littered with examples of lending to foreigners
in one’s own currency that haven’t lowered the risk to the lender much, if at all. The
reason is currency crises and credit crises tend to go together. You may lend money
to a foreigner in your own currency thinking you’re protected from a crash in his.
But if his currency hits the floor, his ability to pay you back in your currency does too.
A bigger question, perhaps, is, could China ‘renminbize’ its international assets even
if it wanted to [4]? The answer is, less than one might think. Not surprisingly, most
of China’s foreign assets are its 3.3 trillion dollars of foreign exchange reserves. By
definition, forex reserves cannot be ‘renminbized’ – they are what they are – dollars,
euros yen. Internationalizing the RMB wouldn’t alter this fact one iota.
The good news is, protecting one’s reserves from a drop in the dollar is easy. Hold
euros instead. Or yen, or sterling. Or a basket of all four. It’s Finance 101. And
if China is worried that all four currencies will lose their value (inflation will rise
sharply), Finance 102 says buy physical assets like gold, or oil or mineral reserves, all
of which China is already doing.
The bottom line is two-fold: first, whatever China’s worry is regarding its foreign
exchange reserves, there is a simple solution for it – much simpler than internationalizing
the RMB. Second, globalizing the RMB and denominating its trade in RMB
would not eliminate the forex risk of its forex reserves anyway.
This non-reason for internationalizing the RMB can be crossed off the list too.
There are many
ways to protect
one’s forex reserves
from a drop
in the dollar – and
all are easier than
internationalizing
one’s currency
NR6: China’s trade surpluses depend on the US (and other countries) running
deficits and those countries don’t have enough dollars to pay for them
There’s a lot of truth here but most of it is tautological. China’s surpluses are indeed
the flip side of other countries’ deficits – international trade is a zero sum game.
And we certainly agree that China can’t continue to run surpluses of 5.2% of GDP as
it has, on average, for the past decade.
Why? Mainly because China today is an $8.2trn economy; a decade ago it was a $1.3
trillion economy. In dollar (or euro or yuan) terms, China’s imports are multiplying
11

Economics
Economics–Markets–Strategy
Asia’s trade collapsed
in late-
2008 not because
demand from the
West fell but because
dollar lending
froze solid
much faster than other countries’ are. This puts downward pressure on China’s
surpluses. Moreover, the implied debt burden of any country that runs the counterpart
of a Chinese surplus of 5% of GDP eventually becomes unmanageable. For
both reasons, we have long argued that Asia’s trade and current account surpluses
are likely to move towards balance – and probably into deficit – over the coming
decade [5].
But none of this has much to do with what currency the trade flows may or may not
be denominated in. A huge deficit (eventually) implies a huge debt burden and
denominating it in RMB instead of USD doesn’t make it any smaller or any easier
to finance.
Cross this non-reason off the list for internationalizing the RMB too.
NR7: to allow Chinese corporates to lend abroad in local currency terms
In this scenario, a Chinese corporate, an insurance company perhaps, wishes to hold
RMB assets to match its local liabilities but prefers to lend to, say, a US company
instead of a domestic one.
Now this reason – diversifying credit risk – is actually a good one for internationalizing
the RMB. But it flips all the earlier ones on their heads. In the earlier scenarios,
China feared a falling dollar and the ability of foreigners to pay their debts. In this
scenario, foreigners are preferred to locals. Is anyone getting dizzy?
We’ll give this reason half-credit. It’s a good one. But it is inconsistent with the
others and the benefits wouldn’t seem to be anywhere near great enough to justify
something so momentous and risky as internationalizing one’s currency.
Internationalizing the RMB: the real reasons
That’s a lot of dubious territory. Are there any good reasons to internationalize the
RMB? Yes, two or three in fact.
The first reason is to avoid a credit crunch like that which followed the collapse of
Lehman Brothers in September 2008. The collapse was the catalyst that triggered
the biggest global recession in 80 years, which many countries are still recovering
from today. Asia, of course, recovered way back in mid-2009. But the downturn
here was still sharp and deep and most of it probably could have been avoided had
an alternative to the US dollar existed for financing Asia’s trade.
A shock, not a daisy-chained downturn
To see this, one must understand that Asia’s downturn wasn’t imported from the US
or Europe in the normal textbook manner. In the textbooks, one economy, say the
US, runs into trouble and stops importing from its neighbors. A couple of months
later, the neighbors stop importing from their neighbors. A couple months after
that ... and so on. The global economy slows in a daisy-chained way, owing to real
economy linkages.
When the global economy went down in 4Q08, it didn’t take a few months for
the neighbors to feel unwell, and a few more months for their neighbors to feel
unwell. When Lehman Brothers collapsed in Sep08, the whole world dropped at
once – instantly and simultaneously. Asia fell just as fast if not faster than the US,
not from a lack of real economy demand but from the financial sector shock – the
‘credit crunch’ – the freeze in dollar funding that is so absolutely crucial to Asia’s
international trade. No credit, no trade, no activity. End of story.
The collapse in Asia’s trade is illustrated well in the chart at the top of the next
page. Asia-8 exports to China fell immediately and severely. Exports to the US fell
too but the drop was shallower and slower. By the time exports to the US had hit
bottom, those to China were halfway back to normal.
12

Economics–Markets–Strategy
Economics:
Asia 8 – exports to China & USA
US$ terms, Jan02=100, seas adj, DX for HK, SG
650
550
450
New drivers ...
... new risks
350
250
Asia X
to China
150
50
01 02 03 04 05 06 07 08 09 10 11
Asia X
to the US
The shock drop can also be seen in the chart below. Compared to other global recessions,
the drop in Asia’s trade this time was twice as fast and twice as deep. Trade
hit bottom in Jan09, only four months after it began to fall. In the dotcom crash of
2000/01 – a good example of the daisy-chained, textbook model – trade didn’t hit
bottom for 14 months. In the 2008/09 downturn, trade had 50% recovered at the
14-month mark.
Of course there were real economy impacts being thrown at Asia too that kept
growth slower than it otherwise would have been. But we’ve shown many times
how relatively unimportant weak demand from the G3 was to Asia throughout the
crisis, and we may as well state it again.
Between mid-2008 and mid-2012 – the four year period that ‘bookends’ the global
financial crisis – Asia grew by 32 percentage points (chart at top of next page).
That’s almost average growth from the front to the back of what most regard as the
biggest financial crisis in 100 years. And Asia did this without the help of the US, the
EU or Japan, which grew not at all (or barely at all in the case of the US) between
Jun08-Jun12.
Lehman Brothers
was shuttered
over a weekend.
On Monday
morning, dollar
financing froze.
By Monday noon,
Asia’s trade froze
A recurrence is one
thing China hopes
to avoid with a
globalized RMB
Asia 9 – exports
USD terms, seas adj, 3mma, cyclical peak = 100
105
100
95
90
85
80
Nov97
Oct00
Sep08
May11
2011/12 EU
debt crisis
Dec08
2000/01
dotcom
crash
1997/98
financial
crisis
75
2007/08
Global Financial Crisis
70
t-4 t-2 t=0 t+2 t+4 t+6 t+8 t+10 t+12 t+14 t+16 t+18 t+20 t+22
13

Economics
Economics–Markets–Strategy
Real global GDP
2Q08=100, seas adj
132
128
124
120
116
112
The growth that came
108
"from nowhere"
104
100
96
92
Jun-08 Dec-08 Jun-09 Dec-09 Jun-10 Dec-10 Jun-11 Dec-11 Jun-12
Asia-10
US: 101.7
JP: 99.5
EU17: 98
The message here is not that Asia partied through the crisis. The message is that weak
demand from the West was never the key problem Asia faced during the crisis. Asia’s
downturn was sharp and severe but it was caused mainly by a credit crunch in the financial
sector – a lack of US dollars to fund regional and international trade.
Avoiding a recurrence of this situation is the first thing China hopes to gain by internationalizing
the RMB.
By 2014, the Asia-
10 will be every
bit as large as the
US
Real reason 2: rising trade volumes
Asia’s growth path in the picture above – we call it the ‘immaculate recovery’ –
would never have been possible 10 years ago, let alone 15 or 20 or 35 years ago.
This is a picture of solid growth in Asia juxtaposed against zero growth in the G3
and it is possible because Asia is no longer too small to matter – it can now drive
its own growth and help drive global growth like it never could before. This shift
in economic gravity from West to East has been underway for many years (chart
below) and it will continue for the next 2-3 decades, if not for longer.
Next year (2014), Asia-10 GDP will be every bit as large as the US’s; China alone will be
60% the size of the US. Even with slower growth in Asia and China in the years ahead,
China will be 83% as large as the US by 2020 and the Asia-10 will be 32% larger [7].
GDP – US and Asia10
USDbn, 2012 prices and FX rates, US=100
140
132
120
100
80
US=100
80
60
40
20
Asia10
40
0
1980 1984 1988 1992 1996 2000 2004 2008 2012 2016 2020
14

Economics–Markets–Strategy
Economics:
Asia – imports as a percent of GDP
Annual avg
40
Asia-10
35
30
Import volumes between 2012 and 2020
USDbn/year, constant 2012 US dollars, goods M
8,000
7,000
6,000
Asia10
$7200
25
20
15
China
10
5
0
87 89 91 93 95 97 99 01 03 05 07 09 11 13
5,000
4,000
3,000
2,000
1,000
0
12 13 14 15 16 17 18 19 20
China
$3800
US
$2700
What does this expansion path imply for imports going forward? Unless they fall
as a percentage of GDP, which doesn’t seem likely given the history (chart above
left) and increasingly inter-linked nature of the global economy, imports will grow
roughly in line with GDP. And even though that rate of growth will be slower than
in the past, in absolute dollar (or yuan or euro) terms, the expansion in Asia’s imports
will be stunning.
We reckon China’s imports will grow to 3.8 trillion dollars by 2020 in today’s prices
and exchange rates (chart above right). That would be an increase of nearly two trillion
dollars over 2012 levels (chart below). For the Asia-10 overall, import demand
will likely expand by 3 trillion dollars, 7 times more than US imports will expand by.
It’s harder to say how Asia’s exports might expand but if they move roughly in line
with imports then China’s total two-way trade would grow by some 4 trillion dollars
by 2020 (again, at today’s prices and exchange rates).
Between now
and 2020, China’s
imports will expand
by nearly $2
trillion
Four trillion dollars is a lot money. But the only way to really appreciate the fact is
to compare it to something. Here’s one comparison: four trillion dollars could buy
all of Germany’s GDP this year, with change left to spare. Here’s another: four trillion
dollars is two trillion more than the Fed’s balance sheet expansion over the past
Import demand growth – 2012-2020
USD bn, constant 2012 US dollars
3,500
3,000
3,056
2,500
2,000
1,500
1,000
500
426
4.5x
1,923
65% of
Asia's
import
growth
will come
from
China
0
USA China Asia10
15

Economics
Economics–Markets–Strategy
couple of years. All that QE that many fear will ignite global inflation? It would
cover but half the growth in China’s trade between now and 2020.
Four trillion dollars
is about the size of
the entire offshore
eurodollar market
The size of the eurodollar market
Here’s another comparison, one that speaks more directly to internationalizing the
RMB. The BIS estimates that in mid-2010 the size of the offshore dollar market was
some $4.5 trn (table below).
The eurodollar market – born in the 1960s, fed by US current account deficits, the
market that grew and grew and that many feared would balloon to infinity because
it was beyond the Fed’s jurisdiction to require a reserve ratio, the market that
finances anything and everything but most of all international trade – could barely
cover just the growth in China’s trade between now and 2020 [8, 9].
Now it becomes clearer still why China wants to internationalize the RMB. Indeed
at this level it’s more about needs than wants. China is 28 times larger than it was
back in 1978. The structure of the global economy has changed dramatically since
then. The world’s financial architecture has not. The entire eurodollar market
would barely cover just the growth in China’s trade over the coming 7 years.
A globalized RMB doesn’t exist. And it has become necessary to invent one.
Real reason 3: prestige and politics
Economics is key but there’s no denying that prestige and politics play a third role
in the push to internationalize the RMB. How could they not? China is now the
largest trading nation in the world. By 2020 the gap will widen dramatically.
Against this backdrop, it would be surreal were China to still be denominating its
trade in US dollars in 2020. It would be like having the biggest house on the street
– a mansion – and calling a taxi for a ride to the ball. Mansion owners don’t take
taxis to the ball.
Global consolidated US dollar balance sheet
USD bil, June 2010
Onshore banks (excl interbank)
Assets
Liabilities
Cash at Fed 956 Cash
Loans 6,837 Deposits 8,274
Of which: to r.o.w. 101 Of which: from r.o.w. 590
Securities 2,576 Credit market instr 1,923
Misc assets 4,117 Misc liabilities 2,549
Total claims onshore 14,486 Total liab onshore 12,746
Offshore banks (excl interbank)
Assets
Liabilities
Loans 2,246 Deposits 2,588
Of which: to US resid 1,086 Of which: from US resid 1,465
Other claims 2,621 Other liabilities 1,519
Total claims offshore 4,867 Total liabilities offshore 4,107
Of which: on US resid 2,143 Of which: to US resid 1,491
Total onshore + offshore 19,353 Total onshore + offshore 16,853
Offshore as % of total 25.1 Offshore as % of total 24.4
Source: BIS Quarterly Review, June 2012
16

Economics–Markets–Strategy
Economics:
It doesn’t just look funny. What if there are no taxis available? What if one day
China calls its foreign bank to arrange for some dollar trade credit and the bank says
‘sorry, you recently took control of a disputed offshore territory and we’re no longer
at liberty to facilitate this transaction’. What then?
If China wishes to assume the role in Asia and in the world that it seems destined to
do, a globalized currency is necessary and desirable for both economic and political
reasons.
No free lunch
Nothing worth having comes free. An internationalized RMB means the capital account
has to be opened up and that can spell all kinds of trouble.
Why does the capital account have to opened? And what sort of trouble are we
talking about? The easiest way to see that the capital account has to be opened is
to consider the following. Suppose China denominates its trade in RMB and, for one
reason or another, continues to run a trade surplus. Since foreigners hold almost
no RMB today, (China has run surpluses for 15 years) they have no RMB to pay for
China’s exports. They need to borrow them, which is practically the definition of an
open capital account. More generally, if foreigners are to be willing to hold RMB for
whatever reason, they will want to earn a return; they will want to own securities
that pays interest or dividends. The ability of foreigners to buy and sell domestic
assets is the very essence of an open capital account.
Now why is this a problem? Two reasons. First, capital flows can be volatile and difficult
to control. Indeed, if the capital account is truly open, direct controls on flows
are ruled out as a matter of course.
More generally, capital flows complicate the task of macro economic management.
Central bankers and economists, especially those from Asia, are well acquainted
with the ‘trilemma’ – a problem identified by Nobel prize winner Robert Mundell
in the early-1960s. The trilemma says that a country can’t have an open capital account,
control over interest rates and control over the currency all at the same time.
Officials may choose only two. Any two. But only two.
Going with an open the capital account means you surrender control of either interest
rates or the currency. If you’re a country like China, where control has been the
name of the game for 60 years, that may not come so easily. If the economy is weak
and the currency is falling, do you raise interest rates or lower them? There’s no
easy answer. Conversely, if the economy is running too fast and you’d like to cool
things down, raising interest rates may simply bring capital inflow, which pushes
rates back down and the economy back up. Back to Square-One.
And in the end
At the end of the day, there are three good reasons for China to internationalize the
RMB: to avoid short-term dollar-based liquidity shortages like that which followed
the collapse of Lehman Brothers; to finance its long-term structural growth in trade
volumes (where it’s not clear that the dollar is up to the task); and to ensure that
its trade and investment flows continue uninterrupted should Western banks for
whatever reason ever curtail access to dollar funding.
China’s leaders understand that these needs dominate the old fashioned wish to
control every aspect of the macro economy. After all, the government has been relinquishing
control of the economy ever since 1978 when Deng’s black and white cats
confronted central planning with the truth about catching mice. Internationalizing
the RMB is merely the next step along the road to becoming a modern developed
economy. If Asia’s smaller economies can live with the inconvenience of a trilemma,
the vastly larger China can too.
A globalized RMB
does not exist.
And it has become
necessary to invent
one
Politics are important
too. What if
China called for
a taxi and none
were available?
17

Economics
Economics–Markets–Strategy
Notes:
[1] Why does the cost of insuring in the forward market equal the interest rate
differential? Consider the example: a Chinese importer goes to his bank
and says he needs $1 in one year’s time. The only way the bank knows what
that dollar will cost in one year’s time, hence what to charge the customer,
is to buy the dollar today and keep it for one year. The bank earns the USD
interest rate and loses the RMB interest it would otherwise have earned. The
cost is the difference between the two rates, which the bank passes on to the
customer, plus a small fee.
[2] Assuming balanced trade. Some hedging costs would still exist for surplus or
deficit countries.
[3] In fact, China keeps interest rates artificially low to promote investment
and raise profits at the expense of savers / consumers. This is sometimes
called ‘financial repression’.
[4] The term ‘renminbize’ comes from Cheung, Ma and McCauley, “Why is China
attempting to internationalize the renminbi?”, East Asia Forum, December
2011, http://www.eastasiaforum.org/2011/12/02/why-does-china-attempt-tointernationalise-the-renminbi/.
[5] See “Asia-vu”, Economics-Markets-Strategy, 15Jun07; “Asia-vu (2): back to
the 90s”, Economics-Markets-Strategy, 17Sep09; “Oil prices: dog or tail?”,
Economics-Markets-Strategy, 11Mar11; “Where have all the surpluses gone?”,
Economics-Markets-Strategy, 14Jun12.
[6] Asia-10 growth is assumed to grow at a modest 7.2% per year between 2012
and 2020. Between 1990 and 2012 it averaged 7.7%.
[7] These ratios will arrive much sooner and grow much higher if Asia’s currencies
continue to appreciate against the dollar as we expect. In our
charts and estimates, however, we assume no currency appreciation to
keep things simple and to be conservative.
[8] Thirty years ago, graduate students fretted over the offshore eurodollar market
in much the same way students today wonder about QE3. The worry then
was that, with no required reserve ratio, the offshore dollar creation multiplier
was infinite. The fear was that the dollar would ultimately collapse and
inflation would soar. Leakages from the system (back onshore) and voluntary
/ prudential reserves kept the size of the eurodollar market from expanding
infinitely. Today it is about 25% as large as the onshore dollar market.
Among other things, an infinite offshore money multiplier means that China
would not have to run a current account deficit for an offshore market in
RMB to grow, as is sometimes claimed. As Friedman explained in 1969 (“The
Eurodollar market: some first principles”, Milton Friedman, University of
Chicago Graduate School of Business, Selected Papers #34) an infinite money
multiplier is more than up to the task all by itself.
[9] One needs to be mindful that the offshore dollar market size is a stock and
that imports and exports are flows. Theoretically, the eurodollar market
could expand / contract to facilitate almost any flow. In practice, as noted in
[8] above, it has grown to a size roughly one-quarter that of the onshore dollar
market.
Sources:
Except where noted, data for all charts and tables are from CEIC Data, Bloomberg
and DBS Group Research (forecasts and transformations).
18

Economics–Markets–Strategy
Economics:
This page is intentionally left blank.
19

CURRENCIES
Currencies
Economics – Markets – Strategy
FX: Enter the dragon
Asia:
CNY:
HKD:
TWD:
KRW:
SGD:
MYR:
THB:
IDR:
PHP:
INR:
VND:
USD:
JPY:
EUR:
AUD:
NZD:
Volatility in 1Q13 was about policy confusion in the G3, not the
return of a strong USD
In any recovery, the strong currency belongs to the growth pole
of the world. That is China
Appreciation pressure on higher inflation/trade surpluses
Peg speculation abated; back to business as usual with CNH
The government is upgrading the outlook
Focus on the yen/won cross rate
No change in ‘modest and gradual’ appreciation policy
Still sound in spite of election jitters
Resilient to weak yen
Stabilizing but no appreciation yet
Bullishness reflected in stocks, not the currency
Some fiscal progress, the current account comes next
Devaluation is more speculation than an expectation
Twin deficits prevent a strong USD
Depreciation to be more orderly
In a range
Turning from dove to hawk
Faring better than Oz due to rate hike expectations
USD firmer in 1Q13 – currency volatility on policy confusion in the G3
6
MAJOR CURRENCIES
B R I C S
3.9
3.9
4
3.3
EMERGING ASIAN CURRENCIES
2
0
-2
-4
-6
-0.9 -1.2
-1.8
-3.4
-3.8
1.3
0.3
-0.8
1.1
-0.1
-0.5 -0.6
-1.6
-2.2 -2.2
-3.2
-8
-10
-12
-8.2
-9.7
-8.2
% change vs USD, 13 Mar 2013 vs 31 Dec 2012
* USD is performance of DXY index
DXY
AUD
NZD
EUR
CAD
CHF
GBP
JPY
BRL
INR
CNY
RUB
ZAR
THB
PHP
HKD
VND
IDR
MYR
TWD
SGD
KRW
Philip Wee • (65) 6878 4033 • philipwee@dbs.com
20

Economics – Markets – Strategy
Currencies
Currency forecasts
13-Mar 2Q13 3Q13 4Q13 1Q14
EUR/usd 1.2960 1.33 1.35 1.36 1.37
Previous 1.33 1.35 1.36 1.37
Consensus 1.32 1.31 1.30 1.26
usd/JPY 96.09 98 100 102 104
Previous 85 86 87 88
Consensus 95 96 96 95
usd/CNY 6.2138 6.15 6.11 6.07 6.05
Previous 6.15 6.11 6.07 6.05
Consensus 6.18 6.15 6.10 6.09
usd/HKD 7.7585 7.78 7.79 7.80 7.80
Previous 7.78 7.79 7.80 7.80
Consensus 7.75 7.76 7.76 7.76
usd/KRW 1098 1050 1040 1030 1020
Previous 1030 1010 990 980
Consensus 1060 1050 1040 1045
usd/TWD 29.694 29.1 28.8 28.6 28.4
Previous 28.5 28.2 28.0 27.8
Consensus 29.0 28.9 28.6 28.7
usd/SGD 1.2491 1.21 1.20 1.19 1.18
Previous 1.19 1.18 1.17 1.16
Consensus 1.23 1.22 1.21 1.21
usd/MYR 3.1075 3.08 3.04 3.00 2.96
Previous 3.00 2.98 2.96 2.94
Consensus 3.05 3.02 3.00 3.01
usd/THB 29.600 29.6 29.5 29.4 29.3
Previous 30.0 29.8 29.5 29.3
Consensus 29.8 29.6 29.4 29.7
usd/IDR 9688 9600 9550 9500 9450
Previous 9300 9200 9100 9050
Consensus 9767 9725 9625 9760
usd/PHP 40.570 40.1 39.7 39.3 39.0
Previous 40.1 39.7 39.3 39.0
Consensus 40.4 40.1 39.9 39.8
usd/INR 54.300 54.0 53.5 53.0 52.5
Previous 54.0 53.5 53.0 52.5
Consensus 54.0 53.5 53.0 53.0
usd/VND 20920 20750 20750 20750 20750
Previous 20750 20750 20750 20750
Consensus 21000 21000 21000 21000
AUD/usd 1.0296 1.04 1.06 1.08 1.10
Previous 1.08 1.09 1.10 1.11
Consensus 1.03 1.03 1.02 1.02
NZD/usd 0.8183 0.84 0.85 0.86 0.87
Previous 0.86 0.87 0.88 0.89
Consensus 0.84 0.84 0.84 0.80
DBS forecasts in red. Consensus are median forecasts collated by Bloomberg as at Mar 13, 2013
21

Currencies
Economics – Markets – Strategy
1Q13 volatility is about short-covering, not a trend reversal for strong AXJ
We have not changed our currency view for 2013. Despite the volatility in 1Q13,
we believe that by December 31, most Asia ex Japan (AXJ) currencies will be
stronger than current levels.
Much of the currency volatility in 1Q13 could be attributed to market confusion
over G3 policies that came together to bolster the USD. First, Japan’s anti-deflation
policies triggered “currency war” worries via a very weak yen. Second, many
betted the European Central Bank (ECB) may cut rates to weaken the euro when
it appreciated to a 15-month high. Third, the bear steepening in the US bond
curve increased doubts over QE3, namely, its path and form.
Of the three reasons above, we subscribe only to the weak yen, but do not see
this overturning AXJ currency appreciation longer term. The region’s growth
story has always been about China, and not Japan. Today, China’s slowdown has
turned into growth reacceleration story amidst solid trade surpluses, and a central
bank now vigilant against inflation. Conversely, Japan needs to end deflation
and to reverse its trade deficits back into surpluses. Hence, it is the appreciating
yuan and not the depreciating yen that should matter more to AXJ. That said,
some export- and surplus-led countries (especially Korea) would use the weak
yen as an excuse to resist appreciation in their currencies.
We are also convinced that markets misread the monetary policies of the Fed
and the ECB. During his semiannual congressional testimonies in February, Fed
Chairman Ben Bernanke affirmed that the Fed would continue asset purchases
at a monthly rate of USD85 bn till end-2013. On the other hand, ECB President
Mario Draghi exhibited no urgency to cut rates. First, Draghi emphasized that
euro was near its long-term average, and needed to be markedly higher on a
sustained basis to warrant any rate action. Second, real deposit rates are already
in negative territory with no inflation expectations.
Overall, we view the volatility in 1Q13 as a short-covering in the recovery of AXJ
currencies from the Eurozone crisis. While the odds of more volatility spilling
over into 2Q13 cannot be totally discounted, our view is based on a global
recovery story that is likely to see the green shoots getting greener in 2H13,
including the Eurozone. With its fiscal consolidation starting only this year, we
don’t believe that the US is ready to return to a strong USD policy anytime soon.
Instead, the US is probably more anxious for China to signal its willingness to
step up its role to support world growth by moving towards a more marketdetermined
exchange rate reflecting its relatively favorable fundamentals.
AXJ FX – 1Q13 rise in USD more likely a squeeze
106
Indexed: 1 Sep 2011 = 100
ANIE FX fall more in crisis, rise more in recovery
108
Indexed: 1 Sep 2011 = 100
105
104
106
USD vs SE Asia
(MYR,THB, IDR, PHP, VND)
103
Trading range
during EU crisis
104
102
102
101
USD vs Asian currencies index
100
USD
comprising CNY, HKD, TWD, KRW,
weaker
SGD, MYR, THB, IDR, PHP & VND
99
Jan-11 Jul-11 Jan-12 Jul-12 Jan-13
100
USD vs ANIE
USD
(HKD, TWD, KRW, SGD)
weaker
98
Jan-11 Jul-11 Jan-12 Jul-12 Jan-13
22

Economics – Markets – Strategy
Currencies
Premature to think about a strong USD
Unless the US is ready to become the growth pole, the global recovery story
should not be about the return of a strong USD, but about the Chinese yuan
resuming its appreciation.
US President Barack Obama is starting a second four-year term which will be
preoccupied with returning the US to a sustainable fiscal path. In Bernanke’s
view, the US recovery, while encouraging, has yet to gain traction either. Hence,
Bernanke believed that a premature QE3 exit would add more pain to an economy
already facing fiscal headwinds. In the Fed’s latest Beige Book report, America
Inc was only confident that the US economy was strong enough to absorb the
end of payroll tax holiday on January 1, but not the automatic budget spending
cuts that kicked in from March 1. Note that while there was a last minute bipartisan
tax deal, no compromise was reached on the sequestration. Until corporate America
shows more confidence, Bernanke remains guarded about the US jobs recovery,
a key factor determining consumer confidence. Here, the US Treasury Department
warned that the US sequester would cause real pain on the middle class.
Given the uncertainties surrounding domestic demand, US policymakers have
started to look to external demand for support. Bernanke told US lawmakers
during his congressional testimonies on February 27, that he would like the
yuan to appreciate further. A week later, on March 5, US Treasury Undersecretary
of International Affairs Lael Brainard confirmed that China was a top priority
for the US this year. As a systematically significant emerging economy, Brainard
urged China to “reinvigorate the move to market determination of the exchange
rate and interest rates”.
With their leadership in place this year, America and China will be returning to
the negotiating table to address global imbalances. This issue is likely to gain
momentum at future G7/G20 meetings, especially now that China’s inflation
and trade surpluses have both started to increase again. Neither did it help that
the bilateral US-China trade deficit hit another record in 2012, and accounted
for a whopping 43% of the total US trade gap.
From the perspective of the US, its twin (fiscal and current account) deficits are
too wide to return to a strong USD policy. When America first started to push
China to appreciate the yuan in 2003, it was mostly about the record current
account deficit. Today, the push is aimed at the record fiscal deficit, just like the
mid-1980s. Back then, former President Ronald Reagan was also under political
pressure to tackle fiscal woes during his second presidential term.
US twin deficits too wide to return to Strong USD
4
2
0
-2
-4
-6
-8
-10
% of GDP
Current
account
Strong
JPY push
Strong
USD policy
Strong
CNY push
Budget
-12
81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 11
US-China trade tensions are returning
700
600
500
400
300
200
100
USD billion
12mth rolling sum
Bilateral
US-China
trade deficit
(lhs)
USD/CNY
(rhs)
China's
trade surplus
(lhs)
0
04 05 06 07 08 09 10 11 12 13
9
8
7
6
5
4
3
23

Currencies
Economics – Markets – Strategy
A stronger yuan is in China’s interest
China may be ready to let its yuan appreciate again. In its latest quarterly report,
the central bank (PBOC) focus shifted to monitoring inflation. Since its depeg in
2005, the yuan’s annual appreciation has consistently tracked inflation. The pace
tends to be stronger than inflation when the current account surplus exceeded
4% of GDP, and vice versa. Hence, we should not ignore the fact that the rising
trade surplus is converging on its pre-crisis high in 2008. Xi Jinping and Li Keqiang
are scheduled to take over as China’s new leaders on March 14. Over the next
ten years, they will seek to boost household consumption as a share of GDP. This
will be important in affirming China’s commitment to play a more meaningful
contributory role to support world growth. This commitment is evident on
several fronts. Li is championing urbanization as a huge engine of growth.
Household consumption rises at a geometrically faster pace in the urban sector
compared to the rural sector. Apart from pledges to steadily reform the ‘hukou’
system, there are also plans to relax the 75% ceiling for the loan-to-deposit
ratio in the banking sector. Advancing the yuan internationalisation process to
the next crucial stage of increasing capital account convertibility would help
attract funding. Moving to a more market-determined exchange rate would
allow the yuan to reflect its favorable fundamentals.
Trade surplus is widening again in China
Inflation is turning up again in China
700
9
20
9
600
8
15
8
500
400
300
USD/CNY
(rhs)
7
6
10
5
CPI inflation
(% YoY, lhs)
USD/CNY
(rhs)
7
6
200
100
Trade balance
(USD bn, 12mth rolling sum, lhs)
5
0
5
0
04 05 06 07 08 09 10 11 12 13
4
-5
04 05 06 07 08 09 10 11 12 13
4
China to lift the contribution of consumer spending
48
46
44
42
40
38
36
34
Loan-to-deposit
ratio (rhs)
Household
consumption
(% of GDP, lhs)
90
85
80
75
70
China urbanization program to boost consumption
14
12
10
8
6
4
2
Household consumption
CNY trillion
Urban
Rural
32
99 00 01 02 03 04 05 06 07 08 09 10 11
65
0
91 93 95 97 99 01 03 05 07 09 11
24

Economics – Markets – Strategy
Currencies
Weak Japanese yen – from currency war worries to carry trade opportunities
We believe that the Japanese yen will depreciate to 102 vs the US dollar by the
end of 2013. This, however, does not imply weaker Asia ex Japan (AXJ) currencies
in a global recovery environment longer term. We remain mindful that today’s
growth story in emerging Asia has always been about the appreciating Chinese
yuan, and not the depreciating yen.
Nonetheless, we acknowledge that the weak yen can temper (but not reverse)
the appreciation pace of the region’s more export- and surplus-led currencies.
They include the Korean won, the Taiwan dollar, the Singapore dollar and the
Malaysian ringgit.
Amongst these currencies, the won will be most concerned about maintaining
its competitiveness against the yen. The battlefield will be the JPY/KRW cross
rate with the line drawn at the psychological 10 level. In other words, USD/KRW
is unlikely to fall below 1000 with USD/JPY seen heading up to 100.
Taiwan and Singapore, on the other hand, will be busy establishing themselves
as new offshore yuan hubs. They will be more sensitive to their CNY/TWD and
CNY/SGD cross exchange rates. Like Hong Kong back in 2010, these new offshore
yuan centres should underpin prospects for more yuan appreciation going forward.
Singapore will play a pivotal role in helping China to internationalize the yuan
in Southeast Asia. This will reinforce the importance of the yuan to the region.
There is scope for the weak yen story to evolve from “currency war” worries to
yen carry trades. Conditions are falling into place, like in 2005, when China
freed its yuan peg and led the global growth story. Against this constructive
macro backdrop, and convinced that the government had steered the yen towards
weakness, Japan’s pension funds and institutions, together with Mrs Watanabe,
should start to look for higher yielding investments outside of Japan. Note that
Japan’s new financial year is around the corner, starting on April 1.
Hence, the monetary policy outlook will be important. Due to deleveraging, the
advanced economies – the US, Eurozone, UK and Japan – will not be hiking
rates before emerging economies. China is already vigilantly monitor inflation
expectations; other Asian economies have started doing the same. As rate hike
expectations firm with recovery prospects in AXJ, this should start to trickle
down into Australia. So, pay close attention to the 2-year treasury bond yield in
Australia. When this yield moves above the Reserve Bank of Australia’s policy
rate, doves will turn to hawks and take the Oz higher.
JPY carry trades vs commodity currencies
2.20 Indexed: Jan 2002
2.00
Stronger AUD
1.80
Weaker JPY
1.60
1.40
1.20
AUD
JPY
Australian stocks vs China stocks
8000
7000
6000
5000
4000
3000
2000
Benchmark stock indices
Australia
All Ordinaries
Shanghai
Composite
1.00
Weak JPY
Weak JPY
USD
carry USD
carry
0.80
00 02 04 06 08 10 12 14
1000
Weak JPY
Weak JPY
USD carry USD carry
0
00 02 04 06 08 10 12 14
25

Currencies
Economics – Markets – Strategy
US dollar
With the fiscal consolidation process just starting,
America is not thinking about a strong USD
The US is not ready to return to a Strong USD
policy. Neither will the Fed end QE3 earlier-thanexpected
or reduce asset purchases. The Fed is
not taking any chances with the fiscal consolidation
process that started this year. According to the
Fed’s latest Beige Book Report, businesses were
only confident that the economy was strong enough
to absorb the end of payroll tax holiday on January
1, but not the automatic budget spending cuts
that kicked in from March 1. While there was a
last minute bipartisan tax deal, no compromise
was reached on the sequestration. Hence, there
is a risk that the better data in 1Q13 may have
been misread as optimism instead of relief. The
real test of the economy’s resilience lies in the
data after March. Businesses are also wary of more
fiscal battles ahead. The immediate task is to
pass the “continuing resolution” by March 27
and keep government offices running till end-
September. This will be followed by a tough summer
to negotiate the budget for FY2014, which will
be key to raising the already-busted federal debt
ceiling. Hence, America is probably more concerned
about maintaining confidence in the USD.
DXY index – weak yen distorts USD picture
90
88
86
84
82
80
78
76
74
72
QE1
QE2
QE3
70
2008 2009 2010 2011 2012 2013 2014
DXY 13-Mar 1Q13 2Q13 3Q13 4Q13
Revised 82.889 81.5 80.9 80.7 80.6
Previous 80.4 80.0 79.6 79.2
Consensus 81.4 81.9 83.3 85.6
Policy, % 13-Mar 1Q13 2Q13 3Q13 4Q13
Revised 0.25 0.25 0.25 0.25 0.25
Previous 0.25 0.25 0.25 0.25
Consensus 0.25 0.25 0.25 0.25
90
88
86
84
82
80
78
76
74
72
70
Euro
There are enough positive and negative factors
to keep EUR/USD in a broad 1.30-1.40 range
Between last July and early February, EUR/USD
rallied 13.9% to 1.3711 from 1.2040. Since then,
the euro started to return its gains on the weak
yen-led currency war worries. By March 1, EUR/
USD fell to 1.3020, and returned 41% of its gains.
We believe that losses will be limited to around
1.29, the lows seen during the early periods of
QE1 and QE2. While the Eurozone economy remains
weak from the sovereign debt crisis, fragmentation
risks have subsided. Moody’s reckoned that Ireland
was on course to exit its bailout program this
year. Eurozone governments are working on ways
for Ireland and Portugal to return to the capital
markets. Fundamentally, the euro is also supported
by the reversal of current account deficits into
surpluses and a stronger German outlook this
year. Conversely, the euro’s upside is also likely
to be limited by EU officials’ worry about
competitiveness. Then again, none would want
a weaker euro triggering another break-up panic
either. With the real exchange rate around average,
and monetary conditions still ultra-loose, it will
take a higher EUR/USD above 1.40 to prompt
the ECB to consider another rate cut.
EUR/USD – more neutral than weak
1.60
1.55
1.50
1.45
1.40
1.35
1.30
1.25
1.20
QE1
QE2
QE3
1.15
2008 2009 2010 2011 2012 2013 2014
1.60
1.55
1.50
1.45
1.40
1.35
1.30
1.25
1.20
1.15
EUR /usd 13-Mar 2Q13 3Q13 4Q13 1Q14
Revised 1.2960 1.33 1.35 1.36 1.37
Previous 1.33 1.35 1.36 1.37
Consensus 1.32 1.31 1.30 1.26
Policy, % 13-Mar 2Q13 3Q13 4Q13 1Q14
Revised 0.75 0.75 0.75 0.75 0.75
Previous 0.50 0.50 0.50 0.50
Consensus 0.75 0.75 0.75 0.63
26

Economics – Markets – Strategy
Currencies
Japanese yen
Yen depreciation pace to slow after sharp falls
in the past few months
The yen depreciated sharply from mid-November
to mid-February. The last time the yen fell by
this magnitude over a three-month period was
in 1995. Back then, the depreciation pace of the
yen slowed for the rest of 1995 into 1996 after
the initial burst. We reckoned that it will be the
same for 2013. Even so, USD/JPY is likely to eventually
hit triple-digit levels over the next year or two.
The focus of Abenomics has, so far, been on boosting
the anti-deflation credentials of the Bank of Japan
(BOJ). The government hopes that, by bringing
back inflation and a weaker yen via a larger central
bank balance sheet, Japan Inc could be persuaded
to start raising wages again and to reverse their
hollowing out plans. Looking ahead, more attention
needs to be paid to the pension funds in the
new financial year starting April 1. The Government
Pension Investment Fund (GPIF) has been urged
to increase investments in foreign assets and local
equities. As at end-September 2012, domestic assets
accounted for 75% of GPIF investments, with
domestic debt taking up the lion’s share at 64.35%.
The GPIF is the world’s largest pension fund managing
some JPY100 trillion in assets.
USD/JPY – yen depreciation pace to moderate
115
110
105
100
95
90
85
80
QE1
QE2
QE3
75
2008 2009 2010 2011 2012 2013 2014
115
110
105
100
usd/ JPY 13-Mar 2Q13 3Q13 4Q13 1Q14
Revised 96.09 98 100 102 104
Previous – 85 86 87 88
Consensus – 95 96 96 95
Policy, % 13-Mar 2Q13 3Q13 4Q13 1Q14
Revised 0.10 0.10 0.10 0.10 0.10
Previous – 0.10 0.10 0.10 0.10
Consensus – 0.10 0.10 0.10 0.10
95
90
85
80
75
Chinese yuan
Yuan appreciation pace to quicken with better
growth and higher inflation this year
We maintain our view for the yuan to appreciate
by a faster 2.6% this year compared to only 1.0%
in 2012. This is in line with official expectations
for inflation to pick up to 3.0% from 2.6% for
the same period. In line with past trends, keeping
the appreciation pace below the inflation rate
is also consistent with a current account surplus
less than 4% of GDP. The yuan will, however,
not appreciate in a straight line, but fluctuate
more within its official trading band. Under its
new leaders over the next ten years, the yuan
internationalization process will not only focus
on making the yuan more flexible and marketdetermined,
but also more convertible on the
capital account. Accessibility to the yuan was
also increased geographically recently. Taiwan
and Singapore have joined Hong Kong as new
offshore yuan centres, with London likely to be
next. They serve as important bridges between
foreign investors keen on yuan investments and
the onshore participants requiring funding in
China’s massive urbanization program. In this
regard, it is too early to write the obituary on
the yuan’s appreciation prospects.
USD/CNY – yuan keeps a steady appreciation path
7.40
7.20
7.00
6.80
6.60
6.40
6.20
6.00
QE1
QE2
QE3
5.80
2008 2009 2010 2011 2012 2013 2014
7.40
7.20
7.00
6.80
6.60
6.40
6.20
6.00
5.80
usd/ CNY 13-Mar 2Q13 3Q13 4Q13 1Q14
Revised 6.2138 6.15 6.11 6.07 6.05
Previous 6.15 6.11 6.07 6.05
Consensus 6.18 6.15 6.10 6.09
Policy, % 13-Mar 2Q13 3Q13 4Q13 1Q14
Revised 6.00 6.00 6.00 6.25 6.50
Previous 6.00 6.25 6.25 6.25
Consensus 6.00 6.13 6.13 6.25
27

Currencies
Economics – Markets – Strategy
Hong Kong dollar
Speculation against the HKD peg has abated; it
is back to business as usual with the CNH
The Hong Kong Monetary Authority (HKMA) is
no longer intervening to support the floor of
the 7.75-7.85 convertibility band for USD/HKD.
Contrary to the final quarter of 2012, the US dollar
was firmer in the first quarter of 2013, no thanks
to yen-led currency war worries and doubts over
QE3. We expect these concerns to be transient.
The recovery of CNH deposits in HK since September
implies that the global growth story will eventually
shift back to China from the US. With China’s
new leaders in place, the territory will start to
play an active role in helping the mainland to
increase the yuan’s convertibility on the capital
account over the next ten years. The China Securities
Regulatory Commission expanded the Renminbi
Qualified Foreign Institutional Investors (RQFII)
program in March. Effectively, the HK units of
Chinese banks and insurers can now join the HK
units of Chinese fund management and securities
companies to invest in China’s capital markets
with the yuan that they raised offshore. As the
gateway for foreign investors into China’s capital
markets, Hong Kong will remain vigilant against
a property bubble.
USD/HKD – peg to hold & eventually higher to 7.80
7.86
7.86
7.85
7.85
7.84
7.84
7.83
7.83
7.82
7.82
7.81
7.81
7.80
7.80
7.79
7.79
7.78
7.78
7.77
7.77
7.76
QE1
QE2
QE3
7.76
7.75
7.75
7.74
7.74
2008 2009 2010 2011 2012 2013 2014
usd/ HKD 13-Mar 2Q13 3Q13 4Q13 1Q14
Revised 7.7585 7.78 7.79 7.80 7.80
Previous 7.78 7.79 7.80 7.80
Consensus 7.75 7.76 7.76 7.76
Policy, % 13-Mar 2Q13 3Q13 4Q13 1Q14
Revised 0.38 0.40 0.40 0.40 0.40
Previous 0.40 0.40 0.40 0.40
Consensus 0.41 0.43 0.45 0.48
Taiwan dollar
Things are looking up for the Taiwan economy
and the TWD
For the second time this year, Taiwan upgraded
its official growth and inflation outlook for 2013.
The growth forecast was lifted to 3.59% on February
22; it was previously raised to 3.53% from 3.15%
on January 31. The inflation outlook was increased
to 1.37% after it was lifted to 1.31% from 1.27%
for the comparable periods. This was a refreshing
change from the consistent growth downgrades
throughout last year. We expect the central bank
to hike rates later this year after the green shoots
become greener. Apart from the constructive outlook,
the TWD is also supported by its positive external
balances. Foreign reserves exceeded USD400 bn
again in November, and have posted new record
highs since then. Taiwan was also the only Asian
country apart from Singapore to post a current
account surplus of more than 10% of GDP in
2012. Hence, it was probably no coincidence why
the TWD is closely correlated with the Singapore
dollar. This relationship should continue to be
tight now that Taiwan and Singapore have been
endorsed by China as new offshore yuan centres.
Lastly, Singapore is also the third largest export
market for Taiwan after China and Hong Kong.
USD/TWD – latest bounce a detour in LT downtrend
36
35
34
33
32
31
30
29
28
QE1
QE2
QE3
27
2008 2009 2010 2011 2012 2013 2014
usd/ TWD 13-Mar 2Q13 3Q13 4Q13 1Q14
Revised 29.694 29.1 28.8 28.6 28.4
Previous 28.5 28.2 28.0 27.8
Consensus 29.0 28.9 28.6 28.7
Policy, % 13-Mar 2Q13 3Q13 4Q13 1Q14
Revised 1.88 1.88 1.88 2.00 2.13
Previous 1.88 1.88 2.00 2.13
Consensus 2.00 2.00 2.00 2.13
36
35
34
33
32
31
30
29
28
27
28

Economics – Markets – Strategy
Currencies
Korean won
Korea is unlikely to let USD/KRW fall below 1000
if USD/JPY is set to rise above 100
South Korea is visibly the Asian country most
upset with Japan’s policy push to weaken the
yen. President Park Geun-hye vowed to take preemptive
steps if the won appreciates sharply on
capital inflows. The Ministry of Finance is closely
monitoring the yen-won exchange rate. The Bank
of Korea (BOK) warned that yen volatility may
hurt exports and recovery prospects. Currency
woes surfaced for the first time, ranking second
after household debt and ahead of corporate
credit risks, as the top core systemic risks in the
BOK’s latest survey on financial stability. Against
this background, we removed our expectation
for USD/KRW to fall below 1000 this year when
we downgraded the end-year target for the yen
to 102. Even so, we maintained an appreciation
bias for the won this year. The currency is supported
by solid current account surpluses and record
high foreign reserves widening its gap with shortterm
external debt. Export competitiveness worries
should ease over the year as export/manufacturing
data improves with the world economy. Unless
these key sectors surprise strongly, the won is
still likely to be more stable than strong.
USD/KRW – to stay above 1000 during weak JPY
1600
1500
1400
1300
1200
1100
1000
QE1
QE2
QE3
900
2008 2009 2010 2011 2012 2013 2014
1600
1500
1400
1300
1200
1100
1000
900
usd/ KRW 13-Mar 2Q13 3Q13 4Q13 1Q14
Revised 1098.4 1050 1040 1030 1020
Previous 1030 1010 990 980
Consensus 1060 1050 1040 1045
Policy, % 13-Mar 2Q13 3Q13 4Q13 1Q14
Revised 2.75 2.75 2.75 2.75 3.00
Previous 2.75 2.75 3.00 3.00
Consensus 2.61 2.61 2.69 2.86
Singapore dollar
SGD appreciation policy stance intact and likely
unchanged at the April policy review
From mid-January into February, the SGD, like
many of its Asian peers, fell victim to currency
war fears triggered by the yen’s fast depreciation.
To counter such speculation, the Monetary Authority
of Singapore (MAS) reaffirmed, on February 22,
its current policy of appreciating the SGD nominal
effective exchange rate (NEER) policy band at a
modest and gradual pace. This policy stance is
likely to be reaffirmed at the upcoming policy
review around mid-April. According to our model,
the policy band is appreciating by 3% a year
within a +/-2% band. There should be no change
to the slope as long as the official outlook remains
for inflation to average 3.5-4.5% in 2013. Owing
to the weak yen slowing the appreciation in the
Sing’s basket of currencies, we have lifted our
end-2013 forecast for USD/SGD to 1.19 from 1.17
previously. The full-year appreciation of the SGD
is now lower at 2.6% vs 4.5% previously, the
ceiling of the official inflation forecast. Apart
from the yen, the new forecasts also took into
account the latest measures to slow loan growth
in the property and transport sectors, the two
largest components in the CPI basket.
USD/SGD – a volatile and tempered downtrend
1.60
1.55
1.50
1.45
1.40
1.35
1.30
1.25
1.20
1.15
1.10
QE1
QE2
QE3
1.05
2008 2009 2010 2011 2012 2013 2014
1.60
1.55
1.50
1.45
1.40
1.35
1.30
1.25
1.20
1.15
1.10
1.05
usd/ SGD 13-Mar 2Q13 3Q13 4Q13 1Q14
Revised 1.2491 1.21 1.20 1.19 1.18
Previous 1.19 1.18 1.17 1.16
Consensus 1.23 1.22 1.21 1.21
Policy, % 13-Mar 2Q13 3Q13 4Q13 1Q14
Revised 0.38 0.35 0.35 0.35 0.35
Previous 0.35 0.35 0.35 0.35
Consensus 0.38 0.39 0.42 0.44
29

Currencies
Economics – Markets – Strategy
Malaysian ringgit
USD/MYR to trade in lower half of descending
price channel
Despite the volatility in Asian currency markets
since mid-January, the ringgit is still considered
a fundamentally sound currency. Like its Southeast
Asian counterparts, the Malaysian economy was
resilient during the Eurozone crisis, thanks to
strong domestic demand. Interestingly, this did
not result in higher inflation or external deficits,
as witnessed in some of its peers. On the contrary,
inflation slowed to 1.7% in 2012 from 3.2% in
the previous year even whilst real GDP growth
accelerated to 5.6% from 5.1%. The “added”
resilience of Malaysia was probably attributed
to its large current account surplus, which until
last year, exceeded 10% of GDP. Although the
current account surplus narrowed to 6.4% of
GDP last year, this ratio was still high by global
standards. Turning to politics, the general election
is likely to be held in the second quarter. The
Barisan Nasional (BN) coalition led by PM Najib
Razak is expected to win. Najib’s mandate to
rule will, however, depend largely on BN improving
on its disastrous performance at the 2008 polls.
Needless to say, his position will strengthen if
BN wins back the parliamentary majority.
USD/MYR – election uncertainties in 2Q13
3.80
3.70
3.60
3.50
3.40
3.30
3.20
3.10
3.00
2.90
2.80
QE1
QE2
QE3
2.70
2008 2009 2010 2011 2012 2013 2014
3.80
3.70
3.60
3.50
3.40
3.30
3.20
3.10
3.00
2.90
2.80
2.70
usd/ MYR 13-Mar 2Q13 3Q13 4Q13 1Q14
Revised 3.1075 3.08 3.04 3.00 2.96
Previous 3.00 2.98 2.96 2.94
Consensus 3.05 3.02 3.00 3.01
Policy, % 13-Mar 2Q13 3Q13 4Q13 1Q14
Revised 3.00 3.00 3.25 3.50 3.50
Previous 3.00 3.00 3.00 3.00
Consensus 3.13 3.13 3.25 3.25
Thai baht
THB had been resilient to recent Asian currency
volatility but there is little room for complacency
Compared to its Asia ex Japan peers, the baht
was more resilient to the weak yen. This was
attributed to the Thai stock market rising with
USD/JPY to highs not seen since 1994. Even so,
the yen’s negative spillover into the other Asean
currencies prevented the baht from extending
its appreciation beyond 29.70 vs the US dollar.
After the 2008 global crisis, more Thai exports
headed to China and Asean at the expense of
the G3 economies. Unfortunately, this did not
translate into stronger external balances. On a
custom basis, the merchandise trade deficit more
than doubled to 5.7% of GDP in 2012 from 2.6%
in the previous year. For now, this is not a problem
because the current account did not reverse into
a deficit. Even so, there is little room for complacency.
With a surplus of only 0.8% of GDP, the current
account is at risk of returning into a deficit position.
Curiously, the stronger Thai stock market did
not translate into higher foreign reserves which
retreated, as at February, to its lowest levels since
August. Given the circumstances, it should not
come as a surprise why the central bank thinks
that interest rates may be too low.
USD/THB – pace of fall to moderate
37
36
35
34
33
32
31
30
29
28
QE1
QE2
QE3
27
2008 2009 2010 2011 2012 2013 2014
usd/ THB 13-Mar 2Q13 3Q13 4Q13 1Q14
Revised 29.600 29.6 29.5 29.4 29.3
Previous 30.0 29.8 29.5 29.3
Consensus 29.8 29.6 29.4 29.7
Policy, % 13-Mar 2Q13 3Q13 4Q13 1Q14
Revised 2.75 2.75 2.75 3.00 3.25
Previous 3.00 3.00 3.00 3.00
Consensus 2.75 2.88 3.00 3.13
37
36
35
34
33
32
31
30
29
28
27
30

Economics – Markets – Strategy
Currencies
Indonesian rupiah
Rupiah depreciation pace slows; no imminent
signs of USD/IDR returning to 9000-9500 range
Owing to new developments in the first quarter,
USD/IDR is no longer expected to fall back into
its 9000-9500 range. Instead, the currency pair
is expected to keep to its 9500-10000 range for
the rest of this year. The rupiah remains pressured
by its current account deficit which policymakers
expect to narrow only to 2.5-2.6% of GDP in
2013 from 2.7% in the previous year. Given the
circumstances, the well-being of the rupiah will
continue to hinge on surpluses in the capital
and financial account to ensure a stable balance
of payments. Unfortunately, with his Democrat
Party hit by corruption scandals, President Susilo
Bambang Yudhoyono appears to be prioritizing
political stability over economic reforms ahead
of the general elections in 2014. The president
has nominated pro-reform Finance Minister Agus
Martowardojo as the next Bank Indonesia (BI)
governor. The post is currently held by Darmin
Nasution whose term ends in May. Vice President
Boediono indicated that the plan to raise the
prices of subsidized fuel is unlikely to materialize
this year. In turn, this may require the government
to relax its budget assumptions for 2013.
USD/IDR – to take time to fall below 9500 again
12500
12000
11500
11000
10500
10000
9500
9000
8500
QE1
QE2
QE3
8000
2008 2009 2010 2011 2012 2013 2014
12500
12000
11500
11000
10500
10000
9500
9000
8500
8000
usd/ IDR 13-Mar 2Q13 3Q13 4Q13 1Q14
Revised 9688 9600 9550 9500 9450
Previous – 9300 9200 9100 9050
Consensus – 9767 9725 9625 9760
Policy, % 13-Mar 2Q13 3Q13 4Q13 1Q14
Revised 5.75 5.75 5.75 5.75 5.75
Previous – 5.75 5.75 5.75 5.75
Consensus – 5.88 6.00 6.00 6.13
Philippine peso
The peso is more stable than the strong currency
its stock market makes it out to be
The Philippines is still favorite destination for
investors in Asia ex Japan (AXJ) where the stock
market dominated the exchange rate. Since the
2008 global crisis, Philippine equities consistently
outperformed the MSCI AXJ index by a wide
margin. The all-time high achieved by the PHISIX
in March was more than 70% above its pre-global
crisis peak in 2007. It, however, remains to be
seen if the stock market can sustain last year’s
impressive performance into this year. 2012 was
a rare year when real GDP growth reaccelerated
against falling consumer inflation, amidst stronger
current account surpluses and record high foreign
reserves. Even so, the peso is well underpinned
by the country’s strong international liquidity
position. With the foreign reserves exceeding
external debt, the Philippines is no longer the
“sick man of Asia”. Against this favorable landscape,
the three major rating agencies have upgraded
the country’s long-term foreign currency debt
rating to one notch below investment grade.
To move out of junk bond status, the government
will need to, going forward, reduce its public
debt/GDP ratio.
USD/PHP – slow & steady move lower
52
50
48
46
44
42
40
QE1
QE2
QE3
38
2008 2009 2010 2011 2012 2013 2014
usd/ PHP 13-Mar 2Q13 3Q13 4Q13 1Q14
Revised 40.570 40.1 39.7 39.3 39.0
Previous 40.1 39.7 39.3 39.0
Consensus 40.4 40.1 39.9 39.8
Policy, % 13-Mar 2Q13 3Q13 4Q13 1Q14
Revised 3.50 3.50 3.50 3.75 4.00
Previous 3.50 3.75 3.75 3.75
Consensus 3.50 3.63 3.75 3.88
52
50
48
46
44
42
40
38
31

Currencies
Economics – Markets – Strategy
Indian rupee
INR helped by progress on fiscal slippage but
remains vulnerable on current account deficit
USD/INR has not been able to deviate too far or
too long from the psychological 55 level. This
represented the enormous challenges faced by
the Indian government to restore macroeconomic
stability. Nonetheless, the rupee did become less
volatile each quarter after hitting a record low
in June 2012, especially after the appointment
of Mr P Chidambaram as finance minister last
July. Under him, India met its budget deficit target
of 5.2% of GDP for FY2012/13 via spending cuts
and avoided a debt rating downgrade to junk
status. To persuade Fitch and Standard & Poor’s
to restore its debt rating outlook to stable from
negative, India needs to further lower its budget
deficit to 4.8% of GDP in FY2013/14. Understandably,
the finance ministry wants the Reserve Bank of
India (RBI) to lower interest rates to help achieve
its 6.5% growth target in the current fiscal year.
The central bank did cut rates in January after
the finance ministry met its condition to contain
the fiscal deficit. To persuade it to cut again,
the RBI needs to see more progress to rein in
the record current account deficit, last at 5.4%
of GDP in the September quarter.
USD/INR – stabilizing in upper half of price channel
60
58
56
54
52
50
48
46
44
42
40
QE1
QE2
QE3
38
2008 2009 2010 2011 2012 2013 2014
usd/ INR 13-Mar 2Q13 3Q13 4Q13 1Q14
Revised 54.300 54.0 53.5 53.0 52.5
Previous 54.0 53.5 53.0 52.5
Consensus 54.0 53.5 53.0 53.0
Policy, % 13-Mar 2Q13 3Q13 4Q13 1Q14
Revised 7.75 7.25 7.00 7.00 7.00
Previous 7.50 7.25 7.00 7.00
Consensus 7.38 7.25 7.25 7.38
60
58
56
54
52
50
48
46
44
42
40
38
Vietnam dong
Dong devaluation is more speculation than expectation
The unofficial USD/VND rate rose, for the first
time since late January 2012, above the official
trading band in February. While this was attributed
to the weak yen, speculation also emerged that
the government may devalue the dong by 2-4%
to boost exports. Some believe that a weaker
dong would aid the government’s goal to revive
real GDP growth to 5.5% in 2013 from a 13-year
low of 5.0% last year. This view was not shared
by all. In particular, the State Bank of Vietnam
(SBV) played down the devaluation rumors. The
spot USD/VND rate was more stable and stayed
near to the official mid-point. This exchange rate
stability, together with trade deficits reversing
into surpluses and inflation returning to singledigit
territory, reflected some of Vietnam’s recent
successes restoring macroeconomic stability. The
cooling process, unfortunately, also increased
nonperforming loans and weakened the banks.
For now, there is enough scope for the SBV to
focus on rate cuts and work on regulations to
attract more foreign investment in local banks.
Weakening the dong now would only risk another
depreciation/inflation spiral.
USD/VND – maintaining a stable profile
21500
21000
20500
20000
19500
19000
18500
18000
17500
17000
16500
16000
QE1
QE2
QE3
15500
2008 2009 2010 2011 2012 2013 2014
21500
21000
20500
20000
19500
19000
18500
18000
17500
17000
16500
16000
15500
usd/ VND 13-Mar 2Q13 3Q13 4Q13 1Q14
Revised 20920 20750 20750 20750 20750
Previous 20750 20750 20750 20750
Consensus 21000 21000 21000 21000
Policy, % 12-Dec 2Q13 3Q13 4Q13 1Q14
Revised 9.00 9.00 9.00 8.00 8.00
Previous 10.00 9.00 9.00 9.00
32

Economics – Markets – Strategy
Currencies
Australian dollar
If you are bullish on emerging Asia, you cannot
be bearish on the AUD
We remain committed, in spite of the currency
volatility in the first quarter, in our view that
2013 will be a stronger year for the AUD. Despite
its domestic structural challenges, the health of
the Australian economy is improving from better
growth prospects in China as well as a more stable
Eurozone. As long as these two factors remain
friendly, the Reserve Bank of Australia (RBA) is
not going to cut its cash target rate from the
record low level that it considers sufficient to
support the economy. Neither do we subscribe
to a strong USD view nor see the Fed diluting
QE3 this year. What we have noted instead is a
10-year AUD government bond yield above the
RBA policy rate. Past recovery cycles warned that
once the 2-year bond yield does the same, the
AUD would rally strongly as rate cut fears give
way to rate hike hopes. Although its officials
consider the AUD overvalued, the odds for actual
interventions remain minimal or nonexistent. Doing
so would sorely undermine the AUD as an increasingly
important world reserve currency. The IMF has
signalled its intention to add the AUD into its
foreign reserve report this year.
AUD/USD – trapped b/w RBA doves & improving Asia
1.30
1.20
1.10
1.00
0.90
0.80
0.70
0.60
QE1
QE2
QE3
0.50
2008 2009 2010 2011 2012 2013 2014
1.30
1.20
1.10
1.00
0.90
0.80
0.70
0.60
0.50
AUD /usd 13-Mar 2Q13 3Q13 4Q13 1Q14
Revised 1.0296 1.04 1.06 1.08 1.10
Previous 1.08 1.09 1.10 1.11
Consensus 1.03 1.03 1.02 1.02
Policy, % 13-Mar 2Q13 3Q13 4Q13 1Q14
Revised 3.00 3.00 3.00 3.00 3.00
Previous 3.00 3.00 3.00 3.00
Consensus 2.88 2.75 2.75 2.88
New Zealand dollar
The NZD has fared better than the AUD due to
its rate hike expectations
Compared to the AUD, the NZD was more resilient
to currency volatility in the first quarter. First,
the market sees the next policy rate move as a
hike in New Zealand and a cut in Australia. The
finance ministry and the Reserve Bank of New
Zealand (RBNZ) are also examining using macroprudential
measures to control credit growth and
the overheating in the housing market. Second,
the RBNZ wants to government to move towards
a budget surplus. The finance ministry is expected
to present on May 16, a budget aimed at delivering
a more competitive economy with more jobs in
order to achieve a budget surplus by FY2014/15.
Australia aborted in December its long-held pledge
to return to a fiscal surplus in the current fiscal
year. Like Australia, New Zealand is unhappy about
its “significantly overvalued” exchange rate. Unlike
the RBA, the RBNZ warned of interventions, but
this is likely to be more bark than bite. The finance
ministry acknowledged that the country does not
have the funds to intervene. Foreign currency
assets amounted to a paltry NZD17.7 bn at end-
2012, of which only NZD9.1 bn was available for
intervention.
NZD/USD – resilient on rate hike expectations
0.95
0.90
0.85
0.80
0.75
0.70
0.65
0.60
0.55
0.50
QE1
QE2
QE3
0.45
2008 2009 2010 2011 2012 2013 2014
0.95
0.90
0.85
0.80
0.75
0.70
0.65
0.60
0.55
0.50
0.45
NZD /usd 13-Mar 2Q13 3Q13 4Q13 1Q14
Revised 0.8183 0.84 0.85 0.86 0.87
Previous 0.86 0.87 0.88 0.89
Consensus 0.84 0.84 0.84 0.80
Policy, % 13-Mar 2Q13 3Q13 4Q13 1Q14
Revised 2.50 2.50 2.50 2.75 2.75
Previous 2.50 2.50 2.50 2.50
Consensus 2.63 2.63 2.75 3.13
33

YIELD
Yield
Economics – Markets – Strategy
Yield: Time for caution
• US: Increasingly, the improvement in the US economy means interest rate
risk has to be priced into the front-end of the curve
• SG: If the USD curve steepens in the coming quarters, the SGD curve will
too. Some spread widening between longer-term SGD and USD rates is
expected
• HK: The EFN curve steepened more than the US Treasury curve and the
HKD swap curve in 1Q13. This underperformance will not continue
• KR: The improvement in global financial market conditions over the past
three months has led to greater downward pressure on KTB yields than
onshore swap rates. As a result, the KTB curve slipped below the onshore
swap curve. The conditions that prevailed in 1Q13 will persist
• TW: The TWD swap curve should continue to exhibit a steepening bias as
interest rate risk is increasing
• TH: Trends in domestic demand and credit suggest that the cost of credit
should go up. The yield curve will remain under steepening pressure
• MY: Swap rates remain in familiar ranges, with the 1Y, 3Y and 5Y rates
close to 3M Klibor and the 3Y/10Y curve spread around 50bps. We think
that intermediate-maturity swap rates should trade in the upper half of
their respective ranges and see any move below 3M Klibor as and
opportunity to enter pay fixed positions
• ID: Strong foreign sentiment has lowered yields and flattened the
government bond curve. We doubt yields can go any lower
• PH: With liquidity conditions favourable, the benchmark 2Y/10Y
government yield curve remains low and flat. We expect it to stay around
current levels in 2Q13
• IN: Interest rates must remain high until macroeconomic and exchange
rate stability improve. The policy repo rate and reverse repo rate are likely
to fall by only 25bps in 2Q13
• CH: With the economic outlook improving, the balance of risks is shifting
to inflation from growth. The probability of a rise in interest rates and
currency appreciation is increasing
Jens Lauschke • (65) 6682 8760 • jensjoerg@dbs.com
34

Economics – Markets – Strategy Yield
Markets cannot have recovery and low rates forever
Global crisis risks have receded and financial market conditions are improving.
If this continues, global growth will gradually strengthen this year, led by developing
market economies. However, for that to play out, continued improvement in
the advanced market economies is crucial.
The world’s biggest economies, the US, China, Japan and Germany need to provide
a positive backdrop. In USD nominal terms, the US and China alone account for
more than 30% of global GDP and Japan and Germany for another 15%. With
that size, even small changes in the pace of economic expansion matter.
The good news is that the big economies will likely do pretty well this year.
With housing having turned in the US and private sector activity improving,
aggregate demand in the world’s biggest economy is likely to strengthen despite
fiscal consolidation. China too is rebounding after a two-year slowdown and
Japan is trying to revitalize its economy by kick-starting it through expansionary
fiscal and monetary policy.
Global growth will not rebound to the high rates achieved during the v-shaped
recovery in 2010–11, but it will improve and with that improvement comes an
increase in interest rate risk, which has to be factored into yield curves.
The probability of rate hikes is generally increasing in the region as the balance
of risks is shifting from growth to inflation, current account balances are deteriorating
and credit growth remains strong. Concerns that rapid credit growth is giving
rise to risks to financial stability suggest that debt levels – in addition to inflation
developments – are starting to have the potential to oblige some central banks
to raise borrowing costs.
In addition to interest rate risk stemming from domestic demand and credit
conditions, there is interest rate risk stemming from a steeper USD yield curve.
As the USD yield curve is the global benchmark yield curve for the pricing of
capital and risk, its behavior has major implications for savers and borrowers
globally. A higher cost of capital in the USD space should generally be expected
to lead to a higher cost of capital around the world. Needless to say, this has
major implications for policymakers, corporates and investors.
To be clear, short-term USD interest rates are still expected to remain low for
some time, but there are more and more factors that suggest the risk of them
rising soon is increasing. If the deleveraging of private sector balance sheets in
the US is over and private sector activity has regained enough strength to drive
aggregate demand, then the US economy has regained it resilience and the US
government can move to stabilize its balance sheet. In other words, the public
sector can move from expansionary fiscal policy to fiscal consolidation. If this is
indeed the point we are at, then, the behaviour of the USD yield curve during
the second term of the Obama administration will be opposite to that during
the first. It bull-flattened during fiscal expansion. Now, it should bear-steepen
during fiscal consolidation.
More intuitively, Fed rate hike risk is increasing with an improving investment
climate in the US. After all, the key to stimulating growth and successful fiscal
consolidation is a sustained revival of investment. If that materializes, aggregate
demand will strengthen, the economy will add more jobs, and the yield curve
will steepen to price in the risk of rising short-term rates. Especially a strengthening
recovery in the housing sector could lead to improving sentiment, investment
and consumer spending and as such has the potential to cause the overall economic
expansion to be much stronger than expected. House prices, according to the
S&P/Case-Shiller index increased 6.8% last year, the biggest annual gain since
July 2006, suggesting that housing has turned. If the US continues to improve,
the flat front end of the USD curve is not sustainable.
35

Yield
Economics – Markets – Strategy
Federal Debt held by the Public & Fed Funds
% of GDP %pa
80%
25
70%
60%
50%
40%
30%
20%
Debt/GDP
(lhs)
Rate
Hikes
?
10%
Fed Funds Target Rate (rhs)
0%
Dec-71 Dec-76 Dec-81 Dec-86 Dec-91 Dec-96 Dec-01 Dec-06 Dec-11 Dec-16
20
15
10
5
0
If the USD curve continues to steepen, we either get steeper Asian curves or a
compression in interest rate differentials in the intermediate and long maturity
sectors. We think the former is a lot more likely than the latter in most cases,
which suggests it is time for caution in the government bonds markets. Investors
will become more fearful of a strong dollar and a rise in short-term interest
rates in Asia. This is because they will expect Asian central banks to match higher
USD rates with higher local rates to maintain interest rate differentials in support
of their currencies.
As we already pointed out in the 1Q13 outlook, with Asian central banks managing
their exchange rates, flat yield curves in the region are only sustainable as long
as the U.S. Treasury yield curve remains anchored at extremely low levels and
flat. While the former condition is likely to remain in place for some time, the
latter is not. Especially in markets where domestic demand growth is strong
and/or external balances weak, is sustained steepening pressure likely. In fact, a
steeper dollar curve, not inflation or credit growth, is the major risk factor for
yield curve steepening in Asia this year.
Bottom line, markets cannot have recovery and low rates forever. The prospect
of improving US private sector activity puts the spot light firmly on the front
end of the US yield curve this year. If data flow over the coming months confirms
that fiscal consolidation is not premature and aggregate demand can strengthen
in spite of it, the yield curve cannot ignore the implications. If the private sector
is back on its feet, it wont be long before short-term interest rates will be back
above inflation.
36

Economics – Markets – Strategy Yield
US: Shifting gear
On 12 December, 2012 the Fed abandoned its calendar date guidance for economic
targets. This marked a significant change in the Fed’s use of communication
strategy to affect the yield curve. The calendar date guidance was introduced 9
August, 2011 and had effectively prevented rate hike speculation from steepening
the front end of the yield curve. Now, the Fed is using a more flexible policy,
which suggests that the FOMC is seeing the risk of a stronger-than-expected
economic cycle. With rate policy now linked to economic targets, there is going
to be more volatility in the front-end of the USD yield curve.
Interest rate risk in the US is increasing with an improving investment climate
and the front end of the yield curve should remain under steepening pressure.
Especially a strengthening recovery in the housing sector could lead to improving
sentiment, investment and consumer spending and as such has the potential to
cause the overall economic expansion this year to be stronger than what market
consensus is expecting. House prices, according to the S&P/Case-Shiller index
increased 6.8% last year, the biggest annual gain since July 2006, suggesting
that housing has turned.
Increasingly, then, the improvement in the US economy means interest rate risk
in the form of rising short-term rates, which has to be priced into the front-end
of the yield curve. So far, the front-end of the USD yield curve remains flat, but
that is not sustainable, if the US economy shows more signs of broad based
improvement.
Longer-term rates are already on an upward trend. Since July last year, the yield
on benchmark 10Y U.S. Treasuries has risen more than 50bps to around 2%. The
yield curve is steepening despite the Fed's open-ended Treasury purchase programme
(through which the Fed takes $45bn worth of Treasury securities onto its balance
sheet every month). That is not surprising. While monetary policy accommodation
in the form of Treasury purchases puts downward pressure on interest rates,
overall economic conditions have improved and with them interest rate risk.
Bottom line, barring any shock to consumer and business sentiment, the frontend
of the yield curve will have to price in Fed rate hike risk for 2015 (maybe
even some 2014) more aggressively. If it does, it will continue to exhibit a steepening
bias and 10Y Treasury yields will be lifted further towards 3%, our end-2013
forecast.
We expect US Treasury yields to rise to 0.39% in the 2Y sector and to 2.5% in the
10Y in 2Q13. The USD yield curve should continue to steepen.
Interest rate risk in
the US is increasing
with an improving
investment climate
and the yield curve
should remain
under steepening
pressure
Chart 1: 10Y US Treasury Yield
%pa
6.00
5.00
4.00
3.00
2%-3%
2.00
1%-2%
1.00
0.00
1-Jan-07 1-Jan-09 1-Jan-11 1-Jan-13 1-Jan-15
Chart 2: Unemployment Rate & Fed Funds Rate
%pa %
25
20
15
10
5
Unemployment
Rate (RHS)
Fed Funds Rate (LHS)
0
Jan-85 Jan-90 Jan-95 Jan-00 Jan-05 Jan-10
10
9
8
7
6
5
4
3
2
1
0
37

Yield
Economics – Markets – Strategy
With signs that USD
short-term interest
rates might rise
soon, all eyes are
now on the slope of
the yield curve
Singapore: Yield curve normalization underway
Much suggests the Federal Funds Rate and USD Libors will remain low this year
(see preceding pages). If so, 3M Sibor and 3M SOR will remain low too.
With both USD Libors and SGD SORs expected to remain low, the SGD swap
curve should remain close to the USD swap curve. With both curves well-anchored
in the 3-6M sector, longer-term SGD swap rates should track movements in longerterm
USD rates. Some spread widening between longer-term SGD and USD rates
is expected, but not to the extent that could keep the SGD curve flat.
Plainly, focus this year is on the slope of the yield curve not the short-rate level
at which it is anchored. With the Fed having abandoned calendar date guidance,
upward pressure on yields is likely this year, if US investment activity increases
and brings about further improvement in the labor market.
So, watch the 2Y sector and the steepness of the USD 2Y/5Y curve. That’s where
the anomalies are. First, USD interest rates in the 2Y sector are too low, not
pricing interest rate risk appropriately. We think that could change this year.
Note that the 2Y sector at the end of the year will have to reflect rate expectations
for 2014 and 2015. Some rate hike risk for 2015 will have to be priced in, if the
labor market continues to improve. Second, the USD 2Y/5Y curve is still flatter
than the USD 5Y/10Y curve (Chart 3 shows that this is also the case for the SGS
curve), which is unusual for the current stage in the economic cycle. It should be
steeper, as for example during the period from 2001 to 2005. This sector too
does not price interest rate risk appropriately. In fact, it is quite rare for the 2Y/
5Y curve to be flatter than the 5Y/10Y curve. That only tends to happen when
short rates are high. Once rate hike risk is priced more aggressively into the
front end of the USD yield curve, both spreads will be in 100-150bps range, with
the 2Y/5Y curve likely to be steeper than the 5Y/10Y curve.
These anomalies are testimony of how successful the Fed interventions have
been, especially the verbal interventions targeted at the front end of the yield
curve. So, for the USD rates market, it is not the unwinding of the asset purchases
that matters most, but the unwinding of the rate guidance. The yield curve is
extraordinarily flat because of the rate guidance and not because of the Fed’s
Treasury purchases.
We expect the SGS curve to bear-steepen in 2Q13. Yields are likely to rise to
around 0.3% in the 2Y sector and to around 1.9% in the 10Y sector.
Chart 3: 2Y/5Y& 5Y/10Y SGS Curve Segments
bps
200
5Y/10Y Curve Segment
150
100
Chart 4: SGS 2/10 Spread vs UST 2/10 Spread
bps
350
2Y/10Y UST Curve
300
250
50
200
0
2Y/5Y Curve Segment
150
2Y/10Y SGS Curve
-50
Jan-00 Jan-03 Jan-06 Jan-09 Jan-12
100
Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13
38

Economics – Markets – Strategy Yield
Hong Kong: Steepening
USD/HKD interbank interest rate differentials moved further in favour of the
HKD in 1Q13. In the 3M sector, Libors have been below Hibors since 11 September
and 3M Libor fell to 0.29% in February while 3M Hibor fell to 0.38%. Even in
the 12M sector, Libors are now significantly lower than Hibors. Libors have
been below Hibors since 6 December and 12M Libor fell to 0.75% in February
while 12M Hibor fell to 0.85%. Put differently, the 3M/12M Libor curve is flattening
and as a result it has been below the Hibor curve since 6 December.
A flattening Libor curve is good news. It suggests that the risk premium in
longer-term USD interbank lending transactions is coming down. In fact, the
3M/12M curve spread is back below 46bps; levels last seen in 2008. Admittedly,
that was not a period of calm and the spread was low because Libors were high,
but still, that's a long time ago.
Other measures of the risk premium in Libors, like the spread between Libors
and OIS rates, too suggest that risk premia in the interbank market are falling.
If this continues, we might soon have normal spread conditions in the USD
Libors market.
What does that mean for HKD rates? It should mean that HKD liquidity will
continue to expand and that Hibors should be under downward pressure. They
might not fall, but they should certainly not rise. The HKD swap curve, which
uses 3M Hibor as its fixing index, should remain firmly anchored around current
levels (there wont be upward pressure on swaps from the fixing index) and
trace movements in the USD swap curve closely. Therefore, as the USD curve is
expected to steepen, the HKD curve should steepen too.
The EFN curve has steepened considerably since November. The 2Y/10Y curve
spread doubled from around 40bps in November to about 100bps in February.
As such, the EFN curve steepened by more than the US Treasury curve and the
HKD swap curve. This underperformance will not continue. Essentially, the 10Y
EFN yield has realigned with its fair value range and the swap spread in the 10Y
sector, which widened to 80bps in December, is back below 50bps.
We expect the EFN curve to steepen alongside the US Treasury curve. Yields on
government bonds in the 2Y sector are likely to rise to 0.44% and those in the
10Y sector are likely to rise to 1.6% in 2Q13.
The HKD yield
curve will continue
to steepen this
year, tracing
movements in the
USD yield curve
Chart 5: EFN 10Y Yield
%pa
5.0
4.5
+50bps
4.0
3.5
3.0
2.5
2.0
1.5 -50bps
1.0
10Y EFN Yield
0.5
Fair Value (10Y UST - 3M Libor/Hibor spread)
0.0
Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13
Chart 6: 2/10 EFN Curve vs 2/10 Swap Curve
bps
300
250
200
150
100
2Y/10Y Swap Curve
50 2Y/10Y EFN Curve
0
Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13
39

Yield
Economics – Markets – Strategy
The steepening
potential of the
Korean curves is
limited. Even if the
USD curve steepens
considerably in the
coming months, the
Korean curve wont
Korea: The KTB curve has slipped below its onshore swap counterpart
As we had predicted in the 1Q13 outlook, the improvements in global financial
market conditions over the past three months led to downward pressure on
KTB yields relative to onshore swap rates. As a result, the KTB curve slipped
below the onshore swap curve.
We think that the conditions that prevailed over the past three months will
persist and keep it there. The bond curve is likely to remain under downward
and flattening pressure relative to the onshore swap curve, as banking system
liquidity is expected to continue to improve on capital inflows through the
current account and portfolio flows.
This keeps the outlook for KTBs positive as major rate hike expectations that
exert significant upward pressure on the front end of the yield curve are unlikely.
Domestic demand conditions and credit flow to the private sector are still weak
and both the real GDP growth rate and CPI inflation rate are below their respective
10Y averages. The annual growth rate in real GDP, which stood at 1.5% in
December, remains below the 10Y average of 3.7%. And the annual headline
CPI inflation rate, which stood at 1.4% in February, remains below the BOK’s
2.5%-3.5% target zone. Some improvement is expected this year, but the Bank
of Korea should keep the 7-day repo rate at 2.75%. We forecast average real
GDP growth of 3.5% and an average annual inflation rate of 2.3%
More importantly, market expectations for the forward path of the repo rate will
change only slowly. While we see interest rate risk increasing due to an improved
economic outlook, we don't expect a substantial repricing of the BoK.
As a result, the potential for curve steepening is limited, even if the USD curve
were to steepen considerably. A sharp rise in benchmark 3Y and 10Y USD rates
would likely not lead to a correspondingly strong rise in 3Y and 10Y benchmark
KRW rates, but a compression of interest rate differentials is possible.
Bottom line, the prospect of good demand for KTBs out of the banking system
together with a weak economic outlook suggest that the outlook for KTBs remains
positive. The yield curve should remain flat, with term premia staying compressed.
We expect 3Y KTB yields to trade around 2.9% and 10Y KTB yields around 3.2%
in 2Q13. The 3Y/10Y curve is likely to remain around 30bps.
Chart 7: O/N Call Rate, KTB 3Y & KTB 10Y Yield
%pa
7
Chart 8: 3Y vs 10Y Bond-Swap Spreads (Onshore)
bond yield - swap rate, bps
200
6
5
10Y KTB Yield
150
100
10Y sector
3Y sector
4
3
3Y KTB Yield
50
2
Policy Rate
1
Jan-05 Jan-07 Jan-09 Jan-11 Jan-13
0
-50
Jan-07 Jan-09 Jan-11 Jan-13
40

Economics – Markets – Strategy Yield
Taiwan: Improving
Marco economic conditions in Taiwan are improving. The annual growth rate
in real GDP rebounded to 3.7% in 4Q12 and we think full year average growth
should be above 4% this year. The annual headline CPI inflation rate stood at
3% in February, but the full year average should not be higher than last year’s
1.9%. In fact, we think it could be as low as 1.3%.
If so, the Central Bank of China should keep its main policy rate, the discount
rate, unchanged at the 1.875% level it has been at since June 2011. While private
sector activity should pick up, we don’t think it will be strong enough to oblige
policymakers to raise borrowing costs in the next six months.
That said, barring any shock to confidence, interest rate risk is increasing with
private sector activity. Private sector loans growth likely bottomed around 2.5%
in 3Q12. It stood at 2.8% in January and is likely to increase this year amid
improvements in global growth and the outlook for China. If investment activity
increases, the flow of credit to the private sector will increase too. Growth in
real fixed investment has already rebounded to 5.6% in 4Q12 from -12.5% in
4Q11, but as a percentage of GDP, real fixed investment is at about the same
10% level as during the crisis months of 1H09 and 2H11.
Barring any shock
to confidence,
interest rate risk is
increasing with
private sector
activity and the
yield curve should
continue to exhibit
a steepening bias
With these dynamics, the TWD swap curve should continue to exhibit a steepening
bias. The 5Y swap rate could easily rise to 1.4% in the coming months from
1.08% on 28 February and a low of 0.89% in June last year. The 1.4% level was
last seen in May 2011, before the acute phase of the European debt crisis.
Bottom line, we think the TWD yield curves will continue to steepen in 2Q13 to
price the risk of rising short rates more appropriately. In addition to stronger
domestic demand and faster credit growth, movements in the USD curve have
the potential to lead to significant steepening pressure in Taiwan. Given the
extremely low levels of short-term rates in both countries, a scenario in which
only the dollar curve steepens and interest rate differentials widen sharply is
very unlikely.
We expect the yield on the 2Y government bond to end 2Q13 near 0.80% and
that on the 10Y government bond to rise to 1.40%.
Chart 9: Disc. Rate, TWD CP 3M & Onshore Swaps
%pa
2.5
2.0
5Y Swap
2.5Y flattening
trend
Discount Rate
Chart 10: TWD Swap Curve
%pa
1.50
1.40
1.30
1.5
1.0
0.5
1Y Swap
3M CP
1.20
1.10
1.00
0.90
0.80
3M CP
Swaps
Quarterly fixed rate
vs 3m CP
0.0
Jan-09 Jan-10 Jan-11 Jan-12 Jan-13
0.70
3M 1Y 2Y 3Y 4Y 5Y 6Y 7Y 8Y 9Y 10Y
41

Yield
Economics – Markets – Strategy
Strong investment
and consumption
growth together
with rapidly
expanding credit
suggest that the
next rate action
from the bank of
Thailand will be a
hike
Thailand: Credit too cheap
The onshore THB yield curves have steepened considerably over the past three
quarters. Given strong domestic demand conditions, strengthening global growth,
improving financial market conditions and a steepening USD dollar yield curve,
that is not surprising.
Domestically, strong investment, consumption and loan growth suggest the
next rate action from the Bank of Thailand will be a hike. Externally, stronger
demand and risk-taking activity should strengthen the balance of payments
and expand primary liquidity in the banking system.
Moreover, the THB curves are highly correlated with the USD curves as the Bank
of Thailand tends to move THB short rates with USD short rates to keep interest
rate differentials favourable. Therefore, if the USD curves steepen to price in
interest rate risk, the THB curve will do the same. This is a clear and present
danger. Interest rate risk in the US is increasing with an improving investment
climate and the front end of the yield curve should remain under steepening
pressure. Especially a strengthening recovery in the housing sector could lead
to improving sentiment, investment and consumer spending and a strongerthan-expected
overall economic expansion this year.
If these conditions remain, domestic inflation is likely to pick up, the THB is
likely to be strong and the Bank of Thailand should and likely will increase
borrowing costs to respond to strong credit growth, which is giving rise to
financial stability risks.
Admittedly, higher interest rates risk attracting undesirable speculative inflows
as a side effect. But this should not discourage monetary policy from responding
to domestic financial imbalances. In fact, for any country with an open capital
account, this tradeoff, in the extreme, is nothing else than the classic choice
between independent domestic monetary policy and a fixed exchange rate.
The freedom of independently conducting domestic monetary policy comes at
the cost of letting the currency float.
In short, we think that the cost of domestic credit should and will go up and
thatr the THB yield curve will remain under steepening pressure because of it.
We expect yields on 2Y Thai government bonds to trade between 3% and 3.4%
and yields on 10Y bonds to trade between 3.75% and 4.25% in 2Q13.
Chart 11: Depository Institutions Deposits & Loans
THB bn
15000
14000
13000
12000
11000
10000
9000
8000
7000
Deposits
Private
Credit
6000
Jan-04 Jan-06 Jan-08 Jan-10 Jan-12
Chart 12: 2Y THgov Yield & Policy Rate
%pa
6.0 Policy Rate + 52bps
5.0
2Y THgov Yield
4.0
3.0
2.0
Policy Rate
1.0
Policy Rate - 25bps
0.0
Jan-06 Jan-08 Jan-10 Jan-12
42

Economics – Markets – Strategy Yield
Malaysia: Range-bound behaviour continues
As intermediate maturity swap rates rose above 3M Klibor (their floating leg
fixing index) in 2H12, the 3Y/10Y swap curve steepened noticeably and swap
spreads generally widened. However, steepening pressure gave way to flattening
pressure in February. The swap curve flattened and swap spreads came under
downward pressure. As a result, swap spreads in the 10Y sector remain in the 0-
50bps range, which has been in place since mid-2008.
Overall, then, not much has changed in the Malaysian rates market and swap
rates remain in familiar ranges, with the 1Y, 3Y and 5Y swap rates close to 3M
Klibor and the 3Y/10Y curve spread around 50bps.
We think that intermediate-maturity swap rates should trade in the upper half
of their respective ranges and see any move below 3M Klibor as attractive opportunities
to enter pay fixed positions. Rate action from Bank Negara seems unlikely in
2Q13 and the Overnight Policy Rate should remain at 3% and 3M Klibor around
3.2%. In fact, the next move in policy rates is likely to be up, not down.
Credit growth slowed to about 10% in year-on-year terms in December, the
annual growth rate in M3 fell to 8.6% in January and the annual CPI inflation
rate is running at 1.3%. The latter is way below its 5Y average of 2.5%, but that
does not mean that Bank Negara should cut rates.
In fact, strong imports relative to exports and a trade suplus which has fallen to
levels last seen in 2001 suggest that domestic demand conditions are fairly strong.
If external demand conditions don’t improve this year, domestic demand might
need to be cooled. The risk therefore is for policy interest rates to be hiked not
cut. However, with the prospect of improving external demand conditions, we
think that the current policy stance is appropriate and will be maintained in
2Q13.
With policy rates expected to be steady, 3M Klibor is expected to be stable and
swap rates below 3M Klibor – be it because of rate cut expectations or merely
weak paying interest – would imply a very unlikely forward path for their fixing
index. Essentially, we think that recent trends have short legs. Swap rates should
remain above 3M Klibor.
We expect 3Y MGS yields to trade between 3% and 3.2% in 2Q13 and 10Y MGS
yields to trade between 3.5% and 3.7%.
We continue to
think that frontend
swap rates will
remain in familiar
ranges, anchored
by steady rate
policy of Bank
Negara
Chart 13: O/N Policy Rate, 3M Klibor & 3Y MGS Yield
%pa
5.0
4.5
4.0
3Y MGS Yield
3.5
3.0
2.5
3M Klibor
2.0
O/N Policy Rate
1.5
May-04 May-06 May-08 May-10 May-12
Chart 14: Policy Rate, 3M Klibor & MYR IRS
%pa
5.0
4.5
4.0
MYR IRS 3Y
O/N Policy Rate Klibor 3M
MYR IRS 1Y
MYR IRS 2Y
3.5
3.0
2.5
2.0
1.5
May-08 May-09 May-10 May-11 May-12
43

Yield
Economics – Markets – Strategy
The IDR
government bond
yield curve is likely
to remain under
steepening pressure
Indonesia: New dynamics
Since the global financial crisis of 2008/09, improvements in the conditions for
risk taking have meant increasing foreign interest in Indonesia’s domestic government
bonds and bullish curve flattening pressure. This dynamic is likely to change as
policy rates in Indonesia have bottomed and improvements in the US economy
increasingly have the potential to cause the US Treasury curve to steepen on
perceptions of interest rate risk.
With private sector credit growth running at 20% and the CPI inflation having
risen to 5.3% in February, rate hike pressures are increasing, especially in light
of rupiah weakness last year. Current inflation is still much lower than the 10Y
average of 7.2%, but we expect it to rise moderately in the coming months
amid strong domestic demand, strengthening global growth and improving
global financial market conditions. Together this means that IDR short rates
should come under some upward pressure and that the IDR yield curve should
remain under moderate steepening pressure, especially if the USD dollar yield
curve continues to steepen.
So far, the 2Y/10Y curve spread has increased to above 100bps from 50bps in
November, as 10Y yields moved higher while 2Y yields moved lower. The curve
has steepened despite foreign participation in the domestic government bond
market increasing. Foreign holdings of domestic government bonds stood at
IDR 281.63 trillion on 28 February, 33% of the total market.
The 2Y/10Y curve spread is likely to increase further within its longer-term 75-
175bps range. The 10Y yield has potential to rise to 6% in an environment
characterized by concerns about rate tightening and a steepening USD yield
curve. Even if foreign holdings continue to increase, putting downward pressure
on yields, that pressure is unlikely to be strong enough to keep the yield curve
flat. With 10Y yields below 6% and short-term rates not expected to fall, there
is essentially no more scope for capital gains in the government bond market
and foreign interest should concentrate in shorter tenors.
With the balance of payments positions improving this year on better external
demand conditions and the prospect of portfolio inflows, the 4-6% yield range
should more than compensate for currency risk. In fact, we expect the current
account to improve from -2.7% of GDP in 2012 to -1.5% of GDP this year, which
should allow the rupiah to be range-bound.
We expect yields on 2Y Indonesian government bonds to rise to 4.5% and yields
on 10Y government bonds to rise to 6% in 2Q13.
Chart 15: FASBI, BI Rate, O/N Jibor & 3M Jibor
%pa
10
Chart 16: 2Y & 10Y IDgov Yield
%pa
10
9
8
7
6
O/N Jibor
BI Rate
9
8
7
10Y IDgov Yield
5
FASBI Deposit Rate
6
4
3
Jan-09 Jan-10 Jan-11 Jan-12 Jan-13
5
2Y IDgov Yield
4
Jan-10 Jan-11 Jan-12 Jan-13
44

Economics – Markets – Strategy Yield
Philippines: Macro and liquidity environment remaining bond-friendly
The yield on benchmark 10Y Philippine government bonds fell to fresh record
lows around 4% in 1Q13. As such, it has now fallen below the 5Y average of the
annual headline CPI inflation rate, which stood at 4.7% in February. Downward
pressure on USD/PHP and Phibor interbank rates suggest that primary liquidity
in the banking system continues to expand. With liquidity conditions favourable,
it is not surprising that the benchmark 2Y/10Y government yield curve in the
Philippines remained flat despite the steepening in the US Treasury curve and
many regional curves.
Can this continue? From a liquidity point of view, it almost certainly can, as
both PHP and USD liquidity in the banking system should continue to expand
through surpluses on both the current account and the capital account. As a
result, there is likely to continue to be a primary liquidity surplus. Banks will
remain in a very strong position to extend credit to the private sector and the
annual growth rate in loans outstanding should remain above 10%. It stood at
15.44% in December. This compares with the recent high of 25% in August 2011
and the recent low of 12.2% in June 2012.
At this point, there is nothing that suggests that Bangko Sentral ng Pilipinas
(BSP) would be uncomfortable with the annual growth rate in loans rising. The
annual CPI inflation rate stood at 3.4% in February and until it is rising into the
upper half of the central bank’s 3-5% target range for 2013, rate hikes are unlikely.
So, even from an inflation point of view, it can continue for some time.
To be clear, we think the inflation rate will rise significantly this year to above
4%, but at the moment we see inflation dynamics intensifying only in 2H13.
Therefore, perceptions of rate hike risk and the BSP’s monetary policy bias should
change only later in the year.
Bottom line, we stick with the call made in the 1Q13 outlook. The most likely
scenario until at least middle of 2013 is one where 3M Phibor stays low, before
starting to slowly drifting higher towards the 4% top of the 0-4% range. As
long as inflation remains manageable, when and how fast interbank rates rise
will depend on the evolution of liquidity conditions. As it is likely that liquidity
conditions remain good, the process is likely to be slow and we expect both 2Y
and 10Y yields on government bonds to remain low at least through mid-2013.
We expect yields on Philippine government bonds to stay around 2.5% in the
2Y sector and around 4% in the 10Y sector in 2Q13.
Liquidity trends
remain favourable
and that should
allow yields on
government bonds
to remain record
lows
Chart 17: Foreign Reserves & 3M Phibor
USD bn
90
80
70
60
50
40
30
20
10
Foreign
Reserves
(lhs)
3M Phibor
(rhs)
%pa
0
0
Dec-08 Dec-09 Dec-10 Dec-11 Dec-12
10
9
8
7
6
5
4
3
2
1
Chart 18: 2Y PHgov Yield vs 10Y PHgov Yield
%pa
11
10
9
8
10Y Phgov Yield
7
6
5
4
2Y Phgov Yield
3 Spread (RHS)
2
Jan-10 Jan-11 Jan-12
bps
350
300
250
200
150
100
50
0
45

Yield
Economics – Markets – Strategy
Room for rate cuts
is emerging, but
policy easing will
be slow
India: Improving but still vulnerable
After hitting a low of 5.3% in the second quarter of F12/13, growth is now likely
to stabilize. However, a substantial pick-up in the growth pace is unlikely for
some time, as is more stimulative interest rate policy from the RBI.
The key to stimulating growth is a revival in investment, but we are unlikely to
see conducive conditions anytime soon. First, the outlook for new investment
demand remains weak as risks to macroeconomic and exchange rate stability
stemming from the twin deficit limit scope for rate cuts. For now, RBI policy will
remain focused on improving the Indian economy’s macroeconomic and exchange
rate stability. The wide current account deficit, which needs to be financed with
volatile capital account flows (inflows from direct and institutional investors,
corporate borrowing and remittances), makes the Indian economy vulnerable to
adverse shifts in risk appetite, which have the potential to result in capital outflows
and pressures on banking system liquidity. In the event of another crisis, equity
market outflows and a shift from offshore to onshore borrowing would significantly
reduce net capital account flows and tighten dollar and rupee liquidity. With the
wide current account deficit making systemic liquidity and exchange rate stability
dependent on capital account surpluses, India’s current macroeconomic situation
is too fragile for policy interest rates to be lowered significantly.
Second, credit flow to productive sectors of the economy is at risk of being constrained
by growing non-performing assets of banks and tight liquidity. Banks have turned
more cautious as slower growth is putting pressure on their asset quality and the
weak balance of payments position is putting pressure on systemic liquidity. As
the balance of payments has not been generating substantial net foreign exchange
earnings, there has been a structural liquidity deficit in the banking system and
the RBI has been relying on cash reserve ratio cuts to inject permanent primary
liquidity into the banking system.
With these dynamics, slower inflation does not mean that the RBI will lower
policy rates significantly. It will not. Interest rates have to remain fairly high
until macroeconomic and exchange rate stability have improved with the current
account. The policy repo rate and reverse repo rate are likely to fall by only 25bps
in 2Q13 and 3Q13. Still, falling policy rates are good news for the bond market
and we expect yields on government bonds to continue to fall.
The 2Y and 10Y Indian Gilt yields are likely to fall somewhat in 2Q13, as liquidity
conditions improve and the probability of further rate cuts increases. However, a
sharp move lower is unlikely. Yields around the 2Y and 10Y sectors are likely to
end 2Q13 at around 7.5% and 7.75% respectively.
Chart 19: RBI Repo & Reverse Repo Rate & CRR
% pa
10.0
9.0
8.0
7.0
6.0
5.0
4.0
1-day Repo
3.0
Reverse Repo
2.0
RBI Cash Reserve Ratio
1.0
Jan-03 Jan-05 Jan-07 Jan-09 Jan-11 Jan-13
Chart 20: Repo, Rev. Repo & 10Y Gilt Yields
%pa
10
10Y INgov Yield
9
8
7
Repo
6
Reverse Repo
5
4
3
2
Jul-05 Jul-08 Jul-11
46

Economics – Markets – Strategy Yield
China: Growth picking up
After China’s economy grew 7.8% last year – the least since 1999 – a pick-up in
the pace of growth is likely this year. Signs of that already emerged, with the
economy expanding 7.9% in year-on-year terms in the final quarter of 2012, the
first pick-up in the annual growth rate in two years.
Faster growth is likely despite the State Council’s determination to cool the
property market. It stepped up efforts to stabilize prices on March 1 through
higher down payments and a 20% tax on the profit from the sale of investment
properties. There should be no doubt that China will continue to address domestic
risks to financial stability and imbalances after a strong investment and credit
boom that helped it become the world’s second largest economy. Rapid wealth
creation widened wealth and income gaps, which makes it imperative that economic
policy now targets sustainability through rebalancing.
What does that mean? At is core it means three things: First, it means slower
investment activity to prevent excesses from getting bigger, which will give
consumption a bigger role in aggregate demand. Second, as consumption comes
out of income, it means that a better distribution of wealth and income and an
increase in personal interest income are desirable. And lastly, it means that if
China wants to solidify its position as the world’s second largest economy and
play a more important role in the global financial system, it must stop managing
the yuan, open up capital markets and overhaul its financial market infrastructure.
The latter centers on moving to fully market-determined interest rates to improve
monetary policy transmission, financial intermediation and the pricing of capital
and risk. Liberalization is also widely expected to benefit households and SMEs.
The fomer should benefit from an increase in financial income as a share of total
income. The latter should benefit from better access to credit. These benefits
and more effective monetary policy transmission (interest rates assume the function
of pacing credit growth) are expected to come at the expense of a higher cost of
capital and a lower volume of lending.
The latest cooling measures should take some pressure of monetary policy to be
tightened. However, we think that with interest rate liberalization on the agenda
and the economic outlook improving, the probability of a rise in policy interest
rates and curreny appreciation is increasing with the outlook. That said, for now
we don’t expect any rate action in 2Q13 and yields on 2Y and 10Y government
bonds should remain stable around current levels in the next three months.
Yields on 2Y Chinese government bonds are likely to trade around 3.25% in
2Q13, while yields on 10Y government bonds are likely to trade around 3.75%
With the PBOC
expected to be on
hold into the
second half of this
year, yields on
government bonds
should remain
stable
Chart 21: China's Policy Rates & Reserve Ratio
%pa
25
Chart 22: 2Y & 10Y CHgov Yield
%pa
6.0
bps
250
20
15
10
5
Reserve
Requirement
Ratio
1Y Best Lending Rate
0
1Y Deposit Rate
Feb-02 Feb-05 Feb-08 Feb-11
5.0
10Y CHgov Yield
200
4.0
150
3.0
100
2.0
2Y CHgov Yield
1.0
50
Spread
0.0
0
Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13
47

Yield
Economics – Markets – Strategy
Interest rate forecasts
%, eop, govt bond yield for 2Y and 10Y, spread bps
48
13-Mar-13 2Q13 3Q13 4Q13 1Q14
US Fed Funds 0.25 0.25 0.25 0.25 0.25
3m Libor 0.28 0.30 0.30 0.30 0.30
2Y 0.26 0.39 0.78 0.78 1.17
10Y 2.02 2.50 2.75 3.00 3.25
10Y-2Y 176 211 197 222 208
Japan O/N Call Rate 0.10 0.10 0.10 0.10 0.10
3m Tibor 0.25 0.25 0.25 0.25 0.25
Eurozone Refi Rate 0.75 0.75 0.75 0.75 0.75
3m Euribor 0.20 0.19 0.19 0.19 0.19
Indonesia BI Reference Rate 5.75 5.75 5.75 5.75 5.75
3m Jibor 4.90 5.50 5.75 5.75 5.75
2Y 4.32 4.50 5.00 5.50 6.00
10Y 5.40 6.00 6.00 6.50 7.00
10Y-2Y 108 150 100 100 100
Malaysia O/N Policy Rate 3.00 3.00 3.25 3.50 3.50
3m Klibor 3.21 3.25 3.50 3.75 3.75
3Y 3.06 3.20 3.50 3.75 3.75
10Y 3.45 3.60 3.90 4.25 4.25
10Y-3Y 39 40 40 50 50
Philippines O/N Reverse Repo Rate 3.50 3.50 3.50 3.75 4.00
3m Phibor 0.50 1.00 1.50 2.00 2.50
2Y 2.28 2.50 2.75 3.00 3.25
10Y 3.52 4.00 4.25 4.50 4.75
10Y-2Y 124 150 150 150 150
Singapore .. .. .. .. .. ..
3m Sibor 0.38 0.35 0.35 0.35 0.35
2Y 0.19 0.30 0.40 0.40 0.46
10Y 1.56 1.90 2.10 2.25 2.35
10Y-2Y 137 160 170 185 189
Thailand O/N Repo 2.75 2.75 2.75 3.00 3.25
3m Bibor 2.86 2.90 2.90 3.15 3.40
2Y 2.86 3.40 3.50 3.75 3.75
10Y 3.64 4.25 4.25 4.50 4.50
10Y-2Y 78 85 75 75 75
China 1 yr Lending rate 6.00 6.00 6.00 6.25 6.50
1yr deposit rate 3.00 3.00 3.00 3.25 3.50
2Y 3.09 3.25 3.25 3.50 3.75
10Y 3.60 3.75 3.75 4.00 4.25
10Y-2Y 51 50 50 50 50
Hong Kong .. .. .. .. .. ..
3m Hibor 0.38 0.40 0.40 0.40 0.40
2Y 0.21 0.44 0.83 0.93 1.32
10Y 1.14 1.60 2.10 2.60 2.85
10Y-2Y 93 116 127 167 153
Taiwan Discount Rate 1.88 1.88 1.88 2.00 2.13
3M CP 0.84 0.80 0.80 0.90 1.00
2Y 0.74 0.80 0.80 0.90 0.90
10Y 1.37 1.40 1.40 1.50 1.50
10Y-2Y 62 60 60 60 60
Korea 7d Repo 2.75 2.75 2.75 2.75 3.00
3m CD 2.81 2.95 3.00 3.05 3.30
3Y 2.61 2.90 3.30 3.50 3.50
10Y 2.96 3.20 3.60 3.80 3.80
10Y-2Y 35 30 30 30 30
India 1d Repo 7.75 7.25 7.00 7.00 7.00
3m Mibor 9.56 8.25 8.00 8.00 8.00
2Y 7.74 7.50 7.00 7.00 7.00
10Y 7.87 7.75 7.50 7.50 7.50
10Y-2Y 13 25 50 50 50

Economics – Markets – Strategy Yield
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49

CNH
Economics–Markets–Strategy
CNH: Regionalizing the RMB
franchise
• The PBoC recently designated a Chinese bank in Singapore to undertake
RMB clearing trades
• The city-state can facilitate RMB use in China-ASEAN trade
• Singapore can also support “third party” RMB trade in Southeast Asia
• The regionalization of the RMB has started to form
After eight years of development, the offshore RMB market in Hong Kong has
become more mature. Currently, banks in Hong Kong offer wide range of RMB-denominated
financial products both at the corporate and retail levels. The continued
expansion of repatriation channels also allows easier two-way RMB flow between
the onshore and offshore markets. With the ongoing success in Hong Kong’s RMB
story, Beijing recently turned to other regional partners to promote wider use of
its currency.
With its advanced
financial infrastructure,
Singapore
has much
to offer as a hub
for offshore RMB
trading
Growing penetration in other parts of Asia
In February, the People’s Bank of China (PBoC) designated a Chinese bank in Singapore
to undertake RMB clearing trade. With its advanced financial infrastructure
and cosmopolitan orientation, Singapore has much to offer as an offshore hub for
RMB activities. As Asia’s second largest FX trading center, Singapore houses many
multi-national corporations’ treasury centers as well as offshore trading operations.
Once the clearing mechanism is set up, there will be greater transparency in the
movement of RMB funds. Market confidence in accepting RMB for trade settlement
will increase. In turn, this will encourage more participation from corporations and
banks, potentially increasing the range of RMB investment products.
Chart 1: ASEAN surpassed Japan as China’s No.2 import source
USD mn
250,000
China's imports from ASEAN
200,000
China's imports from EU
China's imports from Japan
150,000
100,000
OFFSHORE CNH
50,000
0
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
Nathan Chow • (852) 3668 5693 • nathanchow@dbs.com
50

Economics–Markets–Strategy
CNH
Singapore, as a gateway to the Southeast Asia and a commodities hub, also provides
a platform for Beijing to facilitate wider use of the RMB in China-ASEAN trade. In
2012, ASEAN exports to China grew to USD195.8 billion from USD22.2 billion in
2000; surpassing Japan to become China’s second largest importing region (Chart
1). Much of ASEAN’s exports to China are key resources such as petrol and timber.
China’s demand for commodities will likely remain strong going forward. Beijing is
delighted to see more trades to be settled in RMB. More importantly, China’s trade
deficit against ASEAN means that outflows of RMB to the region will be faster than
RMB inflows from the region.
China’s intention to accelerate the use of RMB in the region did not come overnight.
Since 2008, the PBoC has signed a total sum of RMB1.8 trillion swap lines with
19 foreign central banks (Chart 2). Of that amount, nearly three quarters went to
Singapore, Indonesia, Thailand, and Malaysia. These swap lines promote the use of
RMB for bilateral economic activities between China and these countries. They also
support Beijing’s reserves diversification objective by swapping the RMB into foreign
currencies, which could then be invested in foreign sovereign bonds. The outstanding
swap lines last accounted for merely 9% of China’s USD3.3 trillion foreign
reserves. This suggests plenty of scope for further expansion.
Chart 2: Three quarter of PBoC's swap lines went to Asian monetary authorities
Hong Kong
Korea
Australia
Brazil
Malaysia
Singapore
Indonesia
Thailand
Argentina
UAE
New Zealand
Belarus
Ukraine
Mongolia
Turkey
Pakistan
Kazakhstan
Iceland
Uzbekistan
PBoC's RMB swap lines (RMB, bn)
0 50 100 150 200 250 300 350 400 450
Activating the “third party” function
As the presence of the RMB in the region grows, the RMB clearing line created in the
city-state will be utilized by not just Singapore but by its trade partners as well. This
is a great opportunity for Beijing to promote the “third party” usage of the RMB.
This refers to RMB-denominated transactions between parties not involving China.
This will help the RMB to move up the ranks as a global payments currency. Here, the
RMB is currently ranked No. 13 with a tiny share of 0.6% (Chart 3). This contrasted
sharply with the 40.2% and 33.5% share of the euro and USD respectively, the two
most-used currencies for global transactions. Looking forward, with Beijing’s pledge
to liberalize its capital account, the growth of RMB use in international payments
will only accelerate further. By developing the necessary infrastructure and services,
Singapore can capitalize on its potential as a key conduit to encourage “third party”
RMB trade in Southeast Asia.
Singapore can
capitalize on its
potential as a key
conduit to support
“third party” RMB
trade in Southeast
Asia
51

CNH
Economics–Markets–Strategy
Chart 3: RMB ranks 13th as world payments currency
%
45
40
Market share of world payments currency
35
30
25
20
15
10
0.63%
5
0
EUR
USD
GBP
JPY
AUD
CHF
CAD
SGD
HKD
THB
SEK
NOK
CNY
DKK
RUB
ZAR
NZD
MXN
TRY
HUF
Regionalization, then internationalization
With the growing penetration in Asia, the regime of RMB regionalization is gradually
taking shape. Due to geographical proximity, Asia is a natural starting point for
China to promote the RMB use in international trade and investments. The need
for greater foreign reserve diversification by Asian countries after the 2008 global
crisis could also lead to the formation of a RMB bloc. Although the RMB has not
achieved basic convertibility status, many central banks in the region have already
started to add it to their official foreign currency funds. This, coupled with the yuan
internationalization process moving towards increasing capital account convertibility,
will improve the odds for the RMB to be included in the IMF’s Special Drawing
Rights (SDR) basket at its next review in 2015. This is necessary for the RMB to be
recognized as a truly international currency.
52

Economics–Markets–Strategy
CNH
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53

ASIA EQUITY
Asian Equity Strategy
Economics – Markets – Strategy
Asia equity: Sanguine
• Near term outlook clouded by uncertainty on US spending cuts; continuous
bond buying by the Fed offsets negatives
• Markets in a holding pattern while awaiting recovery signals; equity
markets have not priced in any outcome
• Worse has to come before a bigger correction; we remain sanguine
The near-term outlook for Asian equities is clouded by the impact of US automatic
spending cuts. IMF estimates the damage to the US economy at around -0.6% of
GDP. Assuming consensus is looking at 1.8% growth this year, downgrades will
bring this down to around 1.3%.
In our view, this should not be a big concern as both Fed Chairman and Vice-
Chairwoman have affirmed that the Fed will continue buying assets at USD85bn
a month till the end of 2013, while also hinting that rate hikes will be later
rather than sooner.
The US market reaching new highs after a lagged six years is not a surprise,
considering the financial market reform, low interest rates, abundant QE, housing
recovery and strong earnings. Asian markets should ride on this positive momentum
and the euphoria could extent to the second quarter.
While correction risk is high when markets move too much and too fast in such
a short time, any pull back will be shallow in our view. Markets have not priced
in any recovery outcome where positive surprise elements in China’s and US
growth are still possible. Recent China’s exports growth and US job adds numbers
both substantiate our recovery scenario.
With a strong US, stabilising Eurozone, recovering China and a rising Japan, we
are sanguine on the year ahead. Second quarter could be another good quarter
for domestic demand sectors before more evidence of the global recovery drive
the cyclical sectors in the second half.
Fig. 1: Regional indices — 2007 till current
(index)
150
130
110
90
70
50
30
07 08 09 10 11 12 13
MSCI AXJ S&P Euro St oxx Topix
Source: Datastream, DBS
Joanne Goh • (65) 6878 5233 • joannegohsc@dbs.com
54

Economics – Markets – Strategy
Asian Equity Strategy
China
China’s latest PMI dropped from previous months. Coming in below expectations
and marginally above 50, this has led to concerns on whether China’s recovery is
sustainable. Data has been more mixed but mostly exhibiting signs of moderation
after the initial spurt. However latest data on exports growth (+20% YoY vs
estimates +8.6%) and CPI data (+3.2% vs last month’s 2.2%) show signs of strong
growth and even suggested signs of overheating — monetary tightening may
be necessary by year end if growth continues at this rate. All things considered,
the post-2008 crisis global economy is really about China leading Asia as the
growth pole of the world. A strong China is not a bad thing even if interest
rates must rise.
The National People’s Congress kicked in on 5 March with the government announcing
targets of 7.5% growth and 3.5% inflation rate. While it will be icing on the
cake if the target growth is raised, the underlying message should be that inflationary
pressure still exists and that monetary policies will not be eased to promote
growth. Money supply will be kept at 13%. We expect moderation in China’s
growth forecasts among consensus.
Instead fiscal stimulus will be selectively targeted to reach the growth target.
The budget deficit will be widened by CNY1.2t or CNY400bn more than last
year’s. This is equivalent to 2% of GDP compared to last year’s 1.5%.
Our view remains that China is on course to achieve >8% GDP growth on the
back of higher government spending. Upside surprise could come from improved
consumer confidence and more effective implementation of policies.
Europe
We continue to expect another full year contraction at 0.4% in 2013, largely
unchanged from the 0.5% contraction estimated for 2012.
The Italian political impasse after the elections caused Italian bond yields to
spike up briefly, an aide memoire that the Eurozone crisis is far from over.
While the ECB has dealt with external threats using OMT, the deteriorating real
economy, high unemployment rates, and social instability are real domestic
threats that need to be addressed.
Investors will be watching the commitment by Eurozone leaders and steps taken
to keep the Euro as one, as well as ECB’s further action to help save the economies
via monetary support. Risks stemming from Germany’s elections in September,
the details of the Single Supervisor Mechanism to be worked on, how banks are
vulnerable to capital and profitability risks, are some of the reasons that could
take away some heat away from the markets.
Japan
Prime Minister Abe has made it very clear that he wants more easing measures
by the central bank and most likely he will get it. The JPY has depreciated 8%
YTD and the trend is likely to continue. DBS is forecasting 102 JPY to the US
dollar by year end.
There are more policy actions to look forward to in Japan. In April, the new BOJ
governor will come on board. Prime Minister Abe is likely to nominate ADB
president Haruhiko Kuroda as the central bank’s new governor, who has said
the bank should do more. There are expectations that the QE, designated to
start next year, could be moved forward or expanded.
In June, the new government will issue a medium term fiscal plan whereby
more spending can be expected. This could lead to ratings agency downgrade
which is generally bad for the Yen. However, the outlook for the economy
could be lifted as a result of additional fiscal spending.
55

Asian Equity Strategy
Economics – Markets – Strategy
DBS has lifted Japan’s growth for this year to 1.8% from 1.0%. This is on account
of stronger exports growth due to the weaker yen, stronger consumption growth
as a result of stock market wealth and sentiments effect, as well as government’s
fiscal stimulus spending. Consensus forward earnings had undergone a major
re-rating in the past two months. A few of the large Japanese corporates such as
Sony and Toyota have upgraded their earnings outlook, initially through translation
gains from stronger international currencies. Exports sensitivity has also shown
that every 10% USD/ JPY depreciation would enhance exports competitiveness
by 5ppt, which will in turn lift GDP growth by 0.4ppt.
We believe that a better outlook for Japan will help affirm global sentiment
and outlook. Asia ex-Japan equities will benefit from stronger growth and Yen
carry trade liquidity.
Valuation
Asia markets have broken out of their derating trend to reach +1SD of mean
price to book (P/B) multiples. We believe Asia ex-Japan P/B could test 2010 high.
Recall that in 2010, initial fears over PIG (Portugal, Ireland, Greece) countries
defaulting had eased after bailout funds were set up and handed over to Greece
and Ireland. China’s GDP growth for that year was 10.3%, and it had been growing
at near 10% every quarter in that year. The US Fed also announced QE2 in that
year, committing US$600 billion to buy more government bonds/treasuries to
stimulate the weak US economy. Currently, with a strong US market, easing
eurozone crisis, recovering China economy, and Japan picking up, valuations
could re-rate on positive sentiment.
We expect Asia ex-Japan to return 8.7% from current levels premised on valuations
reaching 2x P/B (post-GFC crisis high) by year end. The individual markets may
offer sufficient drivers to continue their re-rating, such as in China/Hong Kong,
Taiwan, and Thailand. These are our overweight markets.
Fig. 2: Japan TOPIX 12-month forward eps
(index)
74
72
70
68
66
64
62
60
Jan-12 Apr-12 Jul-12 Oct-12 Jan-13
Source: Datastream, IBES
Fig. 3: Japan GDP growth forecast trend
(% )
2
1.8
DBS forecast
1.6
1.4
1.2
1
0.8
0.6
0.4
Jan-12 Apr-12 Jul-12 Oct-12 Jan-13
Source: Consensus Economics Inc., DBS
56

Economics – Markets – Strategy
Asian Equity Strategy
Earnings growth
Asia ex-Japan earnings growth is projected to be in the low teens this year. The
markets had continued to downgrade earnings this quarter as results in key
countries such as Singapore and Hong Kong were generally weak. However, we
believe we are near the end of earnings downgrades after this results season,
and expect earnings to recover strongly in line with a stronger GDP growth
forecast for this year.
Fig. 4: Asia ex-Japan price to book valuations
(x)
2.1
2
1.9
1.8
1.7
1.6
1.5
1.4
Jan-10 Jan-11 Jan-12 Jan-13
Fig. 5: MSCI Asia ex-Japan 12-month forward PE
(x)
15
14
13
12
11
10
9
8
Jan-10 Jan-11 Jan-12 Jan-13
Source: Datastream, IBES
Source: Datastream, IBES
Fig. 6: Asia ex-Japan net % no. of companies with
downward revisions in 12m forward earnings
(%)
40
20
0
-20
-40
-60
-80
00 01 02 03 04 05 06 07 08 09 10 11 12 13
Source: Datastream, IBES
Fig. 7: MSCI Asia ex-Japan earnings yield minus US
10-year treasury bond yield
10
9
8
7
6
5
4
3
2
1
0
(% )
Equity is
cheap
Equity is
expensive
02 03 04 05 06 07 08 09 10 11 12 13
Source: Datastream, IBES
57

Asian Equity Strategy
Economics – Markets – Strategy
Asset allocation
We are biased towards a scenario where the global recovery is intact. However
correction risk is high when markets move too much too fast in such a short
time. That said it has to take a lot worst for a major pull back to occur. We
recommend staying in yield plays and domestic names where earnings risk are
lower.
The valuation normalisation in cyclicals have occurred in tandem with growth
bouncing off from lows. Upside in growth forecasts are limited after the initial
spurt, especially when US sequestration has taken effect and China’s growth
target stays at 7.5%. We are reducing overweight in cyclicals before more signs
of global recovery are present.
We focus on policy risks, growth surprise and value as the main drivers for asset
allocation in the second quarter. This leaves us with the following market preference:
overweight China/ Hong Kong, Taiwan, Thailand, and Indonesia; underweight
India, Malaysia and Korea; and neutral in Singapore, Philippines.
As the China’s NPC meeting comes to a close on the 17th, we expect policy
details to be released over the course of the quarter. So far, headline growth of
7.5% is maintained, slightly disappointing but not unexpected. Fiscal stimulus
will be selectively targeted to reach the growth target. The budget deficit is
widened to 2% of GDP compared to last year’s 1.5%. The revamp made to several
ministries should help in instilling confidence in the new leadership in carrying
out urbanisation promises. We are hopeful that with exports recovering from a
low base last year, GDP growth could surprise on the upside with an expanded
budget spending. We look for 8.3% YoY GDP growth in Q1.
We like Taiwan for the greater China story where Taiwan will benefit from
improved policy visibility. The progress of cross-straits negotiation is expected
to re-accelerate and it remains sufficient scope for China to relax policies in
many areas , such as tourism, investments, trade restrictions with other countries,
and financials.
We are upgrading Indonesia to overweight. Concerns on rupiah weakening has
eased in our view and BI has taken bold steps to assure investor confidence.
Going forward we can expect some of sort of stabilisation in the external balance
as the global economy and China show signs of recovery, boosting exports and
commodity prices. We do not expect fuel price hike as the budget deficit is
narrow enough to handle moderate shocks. BI has also made it clear that policy
rates need not follow FASBI increases in the defence of currency.
Thailand is maintained at overweight. We are positive on the Thai market in the
mid to long term as we see potential of multi-year re-rating of the Thai market.
Confidence relating to political stability has only just started to build up. The
Thai market has lagged behind Philippines and Indonesia in terms of performance
and valuations over a 10-year period. The strong performance in the last two
years has been consistent with newly favoured emerging markets where outperformance
can typically last a few years. Mid and small caps are still trading on low multiples
despite strong growth. This should continue to attract rotational buying, providing
room for re-rating.
Korea is downgraded to underweight as it stands to lose out in price competitiveness
when Yen depreciates. We expect KOSPI to trade range bound on 12-month
forward PE of 8-9x, translating to 2080 – 2340 for the index. Amid growing
global currency volatility, we believe that it may be challenging for KOSPI to rerate
beyond that.
58

Economics – Markets – Strategy
Asian Equity Strategy
Malaysia is an underweight as uncertainty to the elections escalates. However
wind directions could change after the elections - headwinds into tailwinds and
vice versa. We remain watchful of buying opportunities while staying underweight.
Our suspicion is that correction may be shallow as domestic liquidity is strong.
We see downside to 1500 on the KLCI at most.
India has also a heavy election calendar in the next 12 months which could
undermine policy making. Short term worries on ratings downgrades may be
discarded with the budget cuts. Growth could however be stifled and in return
makes revenue collection unrealistic. We believe inflation is structural and only
came down recently because of the sharp slowdown in growth. If the slow
growth is not handled properly, growth could be gone forever. We remain skeptical.
Philippines is neutral on grounds of relative valuations where one need not be
invested there as it is expensive. The top down picture looks strong as it is in a
strong growth / low inflation sweet spot. Policy risk is low. We will be buyers of
the consumer sector which still has strong growth to support the high valuations.
The outlook for the Singapore economy looks cloudy as the government retains
its low growth forecast of 1-3%. Domestic indicators such as retail sales, tourist
arrivals and bank loans are showing signs of fatigue. We believe the Singapore
market has shifted into a more gradual ascend compared to the fast paced climb
that lifted the STI by 13% in mid Nov to reach 3320 in early February. We are
maintaining our Neutral stance on the Singapore market. As a yields haven,
Singapore tend to give out most dividends in the second quarter.
Asia aggregate P/E is trading at below the long term average, implying there is
room for P/E expansion before markets are deemed expensive.
Fig. 8: Asia ex-Japan country recommendations, P/E valuations and earnings growth
P/E
Earnings Growth
10-yr Avg -1SD 2012E 2013F 2014F 2012E 2013F 2014F Recommendation
Hong Kong
HSI 13.1 10.8 11.9 11.1 10.2 -1.9 7.4 9.3 Overweight
MSCI China 12.1 9.2 11.2 10.1 9.1 0.6 10.2 11.6 Overweight
MSCI HK 15.6 13.7 17.6 15.9 14.4 -12.1 10.6 10.2 Overweight
China 'A' 15.0 10.7 13.5 11.6 9.9 6.2 16.3 15.8 Overweight
Singapore 13.9 12.3 14.9 14.5 13.3 5.9 2.4 8.9 Neutral
Korea 9.4 7.9 10.3 8.9 7.8 29.7 15.9 12.7 Underweight
Taiwan 13.8 10.4 19.3 15.2 13.4 3.6 27.1 13.0 Overweight
India 14.7 11.9 16.0 13.9 12.1 9.7 15.1 15.0 Underweight
Malaysia 13.9 12.8 15.1 14.2 12.9 11.9 6.6 9.6 Underweight
Thailand 10.3 9.1 15.1 12.8 11.4 12.6 18.5 11.8 Overweight
Indonesia 13.5* 11.0 16.9 14.9 12.8 5.4 14.1 15.8 Overweight
Philippines 13.7 11.8 21.5 19.4 18.2 14.4 11.2 10.7 Neutral
Asia ex-Japan 12.1 10.5 13.5 11.9 10.6 7.9 13.5 12.1
Source: Datastream, IBES, DBS. Shaded cells are more than one SD cheap.
59

Asian Equity Strategy
Economics – Markets – Strategy
Thailand – New emerging market darling
The Thai market extended its strong momentum in 4Q12 to 1Q13 QTD supported
by strong earnings and GDP reports. We believe the momentum will moderate
in 2Q13 as the economy has likely passed the strong growth/low inflation sweet
spot. Going forward we expect the market to be sensitive to macro variables as
excesses are slowly building up. The market ascend is likely to be met with
volatility. However, we maintain overweight in Thailand as we see upside for
growth in 2H this year amid a multi-year PE re-rating trend.
Bangkok just witnessed a smooth election for governor where the opposition
party retained control. The controversial amnesty bill is unlikely to be passed
into law, according to views from academics.
Political risks have been easing in Thailand in our view, and this is also reflected
in the rise in the consumer confidence index. The index last month reached its
highest level in 19 months, driven mainly by economic expansion, fiscal stimulus
and higher purchasing power. It was the fifth consecutive rise, though still below
the 100 benchmark for positive confidence.
4Q12 GDP data had surprised on the upside with full year at 6.4% vs forecast of
5.5%, boosted by broad-based aspects - investments, consumption and exports.
The subsidies for auto and housing purchases has ended which could erode
pent-up demand. But accordingly the backlog for auto deliveries still run to
about 12-18 months, which should continue to support economic growth.
We are positive on the Thai market in the mid to long term as we see potential
of multi-year re-rating of the Thai market. Confidence relating to political stability
has only just started to build up. The Thai market has lagged behind Philippines
and Indonesia in terms of performance and valuations over a 10-year period.
The strong performance in the last two years has been consistent with newly
favoured emerging markets where outperformance can typically last a few years.
Mid and small caps are still trading on low multiples despite strong growth.
This should continue to attract rotational buying, providing room for re-rating.
We prefer domestic sectors including property, tourism and consumer, which
still offer strong growth.
Fig. 9: Thailand , Indonesia, Philippines - 12-month
forward PE
20
18
16
14
12
10
8
6
4
(x)
03 04 05 06 07 08 09 10 11 12 13
Source: Datastream, IBES
Thailand Indonesia Philippines
Fig. 10: Thailand , Indonesia, Philippines market
indices
(index)
1400
1200
1000
800
600
400
200
0
03 04 05 06 07 08 09 10 11 12 13
Thailand Indonesia Philippines
Source: Consensus Economics Inc., DBS
60

Economics – Markets – Strategy
Asian Equity Strategy
Indonesia
JCI returned 13% YTD, one of the best quarters in the last two years. The strong
performance was driven by strong earnings reports from the Banks as well as
dissipating rate hike concerns.
BI had kept the policy rate on hold in two meetings this year. Currency weakness
had been a main concern for Indonesia during the initial part of 1Q13, leading
to fears that BI may hike rates to defend the rupiah. But as soon as the currency
stabilised with administrative measures relating to USD holdings imposed on
the Banks, Indonesia staged a strong rebound. The performance was driven
both by foreign flows as well as domestic liquidity.
The regional strategy team believes that the FASBI rate (overnight bank deposit
rate) if raised will be for defending the rupiah, and policy rate need not follow.
At this point BI probably doesn’t see the need to raise policy rate although
there is no room for easing as inflationary pressure exists. Inflation has climbed
up to a 20-month high cut core inflation stayed roughly flat. The tone was less
hawkish than what the market was expecting, in our view. We see the rupiah
stabilised at current levels.
Confidence in BI picked up after all these concern are ease. Economic growth
was maintained at 6.2% for 2012 despite external weakness and the drag from
strong imports growth. Indonesia’s growth is driven by domestic demand with
consumption and investments powering ahead.
Going forward we can expect some of sort of stabilisation in the external balance
as the global economy and China show signs of recovery, boosting exports and
commodity prices. Growth is expected to remain at around 6.5% during these
two years.
Valuation in Indonesia is not demanding. The market has re-rated in the last 10
years and stabilised at current levels supported by strong earnings growth. Banks,
autos, building materials are the main earnings contributors. Our JCI index target
is raised to 4972, pegging P/E target at 13.5x and 15% earnings growth. We are
maintaining the market at Neutral as the upward move in the index may slow
down in the second quarter after a very strong start.
Fig. 11: JCI 12-month forward P/E
(x)
18
16
Fig. 12: Indonesia stock market — local participation
in trading turnover
75%
Domestic / Total (L) JCI R)
5000
14
12
10
8
6
4
2
0
01 02 03 04 05 06 07 08 09 10 11 12 13
Source: IBES, Datastream, IBES
70%
65%
60%
55%
50%
Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13
Source: Bloomberg, DBS
4500
4000
3500
3000
2500
61

Asian Equity Strategy
Economics – Markets – Strategy
Singapore
The outlook for the Singapore economy looks cloudy as the government retains
its low growth forecast of 1-3%. The domestic challenge to search for Singapore’s
new growth engine is still at the experimental stage, and policy direction may
be blurred. Faced with a resilient domestic economy and a global recovery scenario,
the central bank is biased toward tightening in our view.
Domestic indicators such as retail sales, tourist arrivals and bank loans are showing
signs of fatigue. We believe the sectors that are likely to outperform will be the
cyclicals, and companies which are benefiting from growth outside Singapore.
We believe the Singapore market has shifted into a more gradual ascend compared
to the fast paced climb that lifted the STI by 13% in mid Nov to reach 3320 in
early February. Liquidity has pushed STI’s forward PE up to its average of 14.1x,
and has the potential to lift the index closer to 3600 by year-end based on FY14F
earnings. While temporary choppiness is expected in the near term, we maintain
our view that equities will rise further in 2013, with momentum picking up in
2H when there are further signs of global recovery. We are hence maintaining
our Neutral stance on the Singapore market.
Earnings have stabilized in 4Q12, pointing to potential for earnings upgrade,
ending a two-year downgrade trend. FY13F earnings growth of 4.9% for STI
stocks and 8.9% for stocks under DBS coverage indicate a low base for big caps.
Pending earnings upgrades which favour cyclicals in 2H, we are selective on big
caps, preferring stocks which offer earnings stability, visibility or backed by
attractive yields. We expect interest in small mid caps to continue, lifted by
stronger earnings growth. Post the reporting season, we raised FY13F earnings
growth for small mid caps from 12% to 14.3%, widening the gap with big caps’
growth at 7.8%.
Fig. 13: MSCI Singapore 2012 - 2014 earnings
integer forecast trend
Fig. 14: Singapore retail sales growth, tourist
arrivals and consumer loan growth
(index)
33
1600
pers, thousand
%YoY
25
32
31
2014 eps
30
29
28
27
2013 eps
26
2012 eps
25
24
Jan-11 Jul-11 Jan-12 Jul-12 Jan-13
Source: IBES, Datastream, IBES
1400
20
1200
1000
15
800
10
600
5
400
200
0
0
-5
Jan-11 Jul-11 Jan-12 Jul-12
tourist arrivals (L)
retail sales ex-autos (R)
consumer loan (R)
Source: Bloomberg, DBS
62

Economics – Markets – Strategy
Asian Equity Strategy
Hong Kong / China
Hong Kong’s HSI returns are flat YTD but that was preceded by 2 quarters of
strong gains. Valuation for the HSI has broken out from its trading range. We
believe valuations will stay at around for the next 12 months — post GFC normalised
range which was derated by the Eurozone crisis in the last two years.
2Q13 will be an important quarter to assess if the recovery is going to be sustainable.
The improvement in China’s data has so far gathered pace but has been due to
a rebound off lows in the last 3 months. The acceleration is likely to moderate in
the coming months; Taiwan exports orders are moderating after the initial surge.
The NPC economic meeting will be the highlight over the coming quarter, with
market sentiment likely to stay buoyant running up to the meeting, and after
the meeting when policy details are released. So far, headline growth of 7.5%
is maintained, slightly disappointing but not unexpected. Fiscal stimulus will be
selectively targeted to reach the growth target. The budget deficit will be widened
by CNY1.2t or CNY400bn more than last year’s. This is equivalent to 2% of GDP
compared to last year’s 1.5%.
Several restructurings also took place involving some ministries where past policies
are in question, such as Railway Ministry, Food Safety Agency, Family Planning
Commissions, and revamping agencies in focus such as Energy and Maritime. All
considered we believe these measures should boost confidence in the new leadership.
Results season is in full swing now. 2012 results have been poor, leading to
downgrades on the street. We believe earnings downgrades are now nearing an
end.
Economically, private consumption was the growth driver in 4Q. It sped up to
4.1% in real terms in 4Q from 2.8% in 3Q, on improved retail sales. For 2012 as
a whole, consumption rose by 4.0%. Retail sales values and volumes rose by
7.5% and 6.6% in 4Q respectively versus 5.9% and 4.2% respectively in 3Q. In
particular, retail sales values quickened considerably in November and December
(9.5% and 8.8% respectively). This is primarily due to stronger tourist arrivals.
Fig. 15: Hang Seng Index P/E Bands (8, 11, 13, 16,
18x)
(index)
36000
Fig. 16: China’s GDP growth, actual, forecast vs
target
(% )
11
31500
27000
10.5
10
9.5
Actual
DBS
forecast
22500
9
18000
13500
9000
07 08 09 10 11 12 13
8.5
8
7.5
7
govt. target
2008 2009 2010 2011 2012 2013F
Source: IBES, Datastream, IBES
Source: IBES, Datastream, IBES
63

Asian Equity Strategy
Economics – Markets – Strategy
Malaysia
Outlook for the Malaysian stock market appears challenging, given high valuations,
weak earnings growth and political uncertainty with the impending general
election. Although Malaysia’s PE premium to regional markets has narrowed to
20%, it remains above the 10-year average of 17%. Earnings had been under
pressure over the last two quarters, and our universe is expected to register only
6.9% growth in 2013 and 8.6% in 2014. Compared to ten other countries in the
region, Malaysia’s earnings growth is the second lowest in 2013 and lowest in
2014. The PE/G ratio for Malaysia in 2013 is the second highest in the region at
2.1x. Coupled with uncertainty over the general election outcome that is weighing
on sentiment, we expect continued weakness in the KLCI in the near term before
a rebound in 2H13.
Looking at Malaysia’s last six GE years, the KLCI’s historical out- or underperformance
ahead of the dissolution of Parliament had been erratic; there is no clear trend,
and the circumstances had been different each year. Much will depend on issues
arising, how major players respond and ground sentiment in the coming weeks,
leading to the dissolution of Parliament and polling day. With another few
weeks to go before the eventual deadline when an election has to be called, we
recommend investors to stay cautious. The current standoff between the Philippines
gunmen and the federal army in Sabah adds to the uncertainty.
Philippines
Philippine recorded a stellar year in 2012 and the momentum is expected to
continue into 2013. Both manufacturing and services sector had held up well
despite the global slowdown. Lagging behind are government spending and
investment growth which have shown signs of acceleration this year.
DBS economist Eugene Leow notes that the Philippine economy is currently
going through an extended high growth and low inflation period, lasting through
3Q13. This is important in its ability to maintain low interest rates, and allowing
Peso to appreciate to accumulate reserves.
(For details please see “Economics-Markets-Strategy, PH: Sweet spot”, Eugene
Leow, 13 March 2013).
We are maintaining our Neutral weighting on the Philippine market. Our concern
is on valuations. The stronger economic growth is not translating to strong
earnings growth to support the valuations. We believe this is due to the lack of
breadth in the market which is not represented in the economy. We like the
consumer sector as a proxy to the strong economy.
India
We maintain our underweight recommendation on India. We believe that high
expectations on budget and interest rate cuts are being priced into the market.
If both these events do materialise, it implies that growth is likely to have slowed
and will continue to slow. By then growth may not recover as there is limited
scope for further stimulus.
Against a backdrop of slowing domestic growth and run-up to next year’s elections,
the Budget did not propose any meaningful expenditure restraint, which is
worrisome when revenue collection is thought to be overly ambitious. Budget
deficit is targeted to consolidate from the current 5.2% to 4.8%, leaving high
hopes that the RBI will hasten the pace of monetary stimulus. Meanwhile the
current account deficit is expected to stay wide and inflation rate high, leaving
very little room for interest rate cuts.
64

Economics – Markets – Strategy
Asian Equity Strategy
Korea
Although the latest economic data posted mixed results, DBS economist is maintaining
the view that a cyclical growth recovery remains on track. Latest manufacturing
PMI rose above the neutral level to register 50.9 driven by the rise in new orders.
This is also in line with a pick-up in exports growth, confirming a recovery in
final demand.
We expect KOSPI to trade range bound on 12-month forward PE of 8-9x, translating
to 2080 – 2340 for the index. Amid growing global macro volatility, we believe
that it may be challenging for KOSPI to re-rate beyond that.
1) Korea’s corporate competitiveness will be mostly affected by a weakening
JPY. As shown in Fig. 17, Korea’s export structure bears the most similarity with
Japan’s among Asian countries. The competition between Korea and Japan in
the export market ranges from crude materials, chemicals, metals to electronics
and automobiles. A weaker JPY would allow Japanese exporters to cut their
export prices in the international market, squeezing market share of their Korean
counterparts.
2) Interest rate cuts unlikely. Although Inflation has stayed low and stable, the
downside risk to BOK’s growth forecast of 2.8% is very low (DBSf: 3.5%), thus
providing less scope for monetary stimulus. This is also taking into context that
rates were cut twice last year, and inflation numbers probably have bottomed.
3) The tension in the Korean Peninsular will continue to compress risk premiums.
Fig. 17: KOSPI 12-month forward PE Band (8, 9, 10,
12 13x)
(index)
2600
2400
2200
2000
1800
1600
1400
1200
1000
09 10 11 12 13
Source: IBES, Datastream, IBES
Fig. 18: Overall Export Similarity Index vs Japan,
2008
Germany 0.544
Korea 0.510
United States 0.487
United Kingdom 0.430
France 0.421
Austria 0.401
Italy 0.400
Czech Republic 0.392
Spain 0.381
Thailand 0.368
China 0.356
Singapore 0.351
Hong Kong 0.327
Malaysia 0.294
Philippines 0.276
Source: IMF
65

Asian Equity Strategy
Economics – Markets – Strategy
Taiwan
DBS economist is maintaining the view that Taiwan’s economy stays on the path
of a modest recovery, while inflation remains tame at this early stage of recovery,
although the data has been more mixed. Demand from China has maintained a
steady uptrend ever since 3Q12. Demand from Europe also appeared to have
bottomed out in 4Q12. More recently, downside risks facing the US economy
have surfaced due to budget spending cuts. But Japan’s growth data has turned
positive thanks to the government’s aggressive push for the twin easing of fiscal
and monetary policies.
There are also some signs that business sentiment is turning better and investment
spending has started to recover – capital goods imports have showed MoM increases
for two consecutive months since Dec12.
Consensus view on the Taiwan market has been less enthusiastic with the index
target not exceeding 8000 on average. On a bottom up calculation, apart from
the heavily weighted TSMC, the Taiex is well diversified with over 700 stocks
each not exceeding 5% in weight. Combined Tech weighting is 70%. Without
a major sector leader, it will be challenging for the Taiex to break out of its
range. The outlook for the Tech sector has been modest.
We expect Taiwan to benefit from improved cross straits developments to lift
overall sentiment in Taiwan. Recovery in exports, tourism, capital flows and
deregulation can continue to support domestic demand growth amid a modest
global outlook. Our target remains at 8500 for the TWI by year end.
66

Economics – Markets – Strategy
Asian Equity Strategy
This page is intentionally left blank
67

CHINA
Economics: China
Economics – Markets – Strategy
CN: Rising risk of overheating
• Economic growth will accelerate notably under the "urbanization"
campaign. Recent loans and FAI data are clearly indicative of such
forthcoming trend. 1Q13 GDP may surprise on the upside and advance
no less than 8.5%
• Risk of inflation will escalate. PBoC will adopt a holistic approach to
the formulation of monetary policy by monitoring capital inflows, wage
pressure and asset prices on top of the CPI
• External trade is also improving steadily contributing to a larger trade
surplus. As such, both the currency and interest rates will face upward
pressure over the medium term
Near-term growth outlook
China's economic structure facilitates forthcoming risks of overheating. Let's be
realistic. It will be years before China can successfully make the transition to a
consumption-led economy. Private consumption is now only around 35% of
GDP, even less then the levels prior to the global financial crisis. The reliance on
investment to propel growth remains in the medium term. Investment-led
growth championed by the concept of urbanization has already spurred the
rebound of FAI growth from 20.4% (YoY, YTD) in mid-2012 to 21.2% in the first
two months of 2013. The uptick is consistent with strong M2 figures during the
same period that rose from 13.6% YoY in Jun12 to 15.2% in Feb13. Merchandise
exports growth have also rebounded from its trough of 1.0% in Jul12 to 25.0%
and 21.8% respectively in the first two months of this year (Trade balance YTD:
USD 44.4bn). Other readings such as the manufacturing PMI suggest growth
momentum has sustained. As a result, GDP growth in 1Q13 will likely grow no
less than 8.5%.
No room for monetary complacency
We have long argued there is no room for complacency in monetary management
in spite of moderating economic growth for six straight quarters. Despite the
economic downtrend, asset prices have managed to defy gravity. The macroeconomic
tightening program was somewhat successful in restraining investment-led growth
and the ascent of asset prices. However, economic forces are back at work again
ramping up inflation risks over the medium-term. This is in spite of the lower
annual CPI target of 3.5% set at the National People's Congress. A holistic approach
to the formulation of monetary policy will be beneficial to the long run betterment
of the economy. As such, interest rates must rise in China.
It is now clear that administrative controls on property transactions cannot hold
the floodgates shut forever. On March 1st, ahead of the National People's Congress,
authorities had imposed a 20% capital gains tax for existing home sales in order
to cool down the market. The ever-growing demand for property precipitated
the surge of property prices, which in turn contributed to elevated inflation
expectations.
Chris Leung • (852) 3668 5694 • chrisleung@dbs.com
68

Economics – Markets – Strategy
Economics: China
Chart 1: Differences between conventional and alternative measures of real deposit
rates
% pa, 3mma
15
10
5
0
-5
-10
-15
-20
-25
Jan-05
May-05
Sep-05
Jan-06
May-06
Sep-06
Jan-07
May-07
Sep-07
Jan-08
May-08
Sep-08
Jan-09
May-09
Sep-09
Jan-10
May-10
Sep-10
Jan-11
May-11
Sep-11
Jan-12
% pa, 3mma
May-12
Sep-12
5
4
3
2
1
0
-1
-2
-3
-4
-5
Alternative measure of real deposit rates
Real deposit rates (RHS)
If "real interest rates" are calculated alternatively as nominal deposit rates minus
inflation of property prices (that is, deflating by housing prices instead of the
CPI), it is easy to explain the solid demand for properties - real rates have been
in negative territory for many years. From this perspective, monetary policy
should be tighter than otherwise. As shown in Chart 1, the differences between
conventional and alternative measures of real deposit rates are significant, which
may lead to the central bank to draw different conclusions on how monetary
policy should be conducted. At present, the PBoC bias leans towards tightening.
Wages are escalating nationwide (Chart 2). Although wage data are not published
frequently, they influence inflation expectations just the same. In fact, expectations
of future wage hikes amongst manufacturers remain high in spite of moderating
growth. The persistent surge of wages is not only a reflection of declining
surplus young labor but is also a direct result of the state's regulatory mandate
to improve labor's income prospects over the medium term.
Price reforms in necessities such as water/electricity/fuel will also exert upward
pressure on end consumer prices. For construction spending was listed as one of
the six major missions for 2013. The plan, involving around 20 city groups, aims
to attract investment of CNY 40 trillion (US$6.42 trillion).
Chart 2: Wages have quadrupled in the past decade
Index: 2000=100
500
450
400
Average annual wage
350
300
250
200
150
100
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
69

Economics: China
Economics – Markets – Strategy
Two approaches
Against this backdrop, interest rates in China must rise over the medium term.
Of course, China can lift rates the conventional way - by altering benchmark
rates. But the same outcome could be achieved via interest rate liberalization,
which the central bank had restarted last year by raising the ceiling on the
benchmark deposit rate and lowering the floor on the benchmark lending rate
simultaneously. The experimentation last year confirmed that: (1) all banks raised
deposit rates for fear of losing deposits to each other; (2) lending rates did not
go down because of higher risk premium amid more stringent risk controls.
Finally, quantitative easing programs conducted by other central banks around
the world increases the risk of capital inflows and a resultant boost in money
supply. Funds outstanding for foreign exchange at financial institutions increased
by CNY 683.7 billion in January, even more than the whole of last year's 494.6
billion, threatening to drive up inflationary risks. More importantly, this is the
part of money supply that the PBoC has little control over. Even the domestic
portion of money supply is increasingly difficult to be controlled as the growth
of total social financing [1] has quickened over the past year. Financial instruments
such as trust loans and corporate bond financing saw much faster rates of growth
than conventional RMB bank loans. That explains the constant worry over the
proliferations of China's wealth management products. Real rates are too low
forcing liquidity everywhere for yields regardless of risks.
It is heartening to see that authorities have accounted for these inflation forces
when formulating monetary policy. First, the PBoC neither cut the reserve requirement
ratio nor interest rates even at a time when the CPI was decelerating. Second,
the PBoC has increasingly used repo operations to control liquidity in the banking
system. Third, the government has reiterated that administrative controls on
the property market will remain. Authorities know well the considerable impact
on property prices if the reins are cut loose. That explains why administrative
controls on the property market will likely remain in place in spite of completion
of leadership transition. Finally, PBoC has acknowledged in its 4Q12 Monetary
Policy Report that "due to different factors, demand and supply curves will
probably become steeper, making prices more sensitive to demand expansion",
reflecting its vigilance against inflation over the longer run.
Interest rates must rise over the medium term
The medium-term outlook on China's interest rate trend is clear. The central
bank can either choose to raise benchmark rates or achieve the same result by
deepening interest rate liberalization. Pursuing the latter route would be more
consistent with China's desires to internationalize the renminbi, which implies
fewer controls over the capital account and the need for interest rates to be
market determined.
Notes:
[1] Total social financing is equal to the sum of RMB loans, foreign exchange
loans, entrusted loans, trust loans, bankers’ acceptances, corporate Bonds, nonfinancial
corporate stocks, insurance benefits, insurance company’s investment
property etc.
70

Economics – Markets – Strategy
Economics: China
China Economic Indicators
2012 2013f 2014f 4Q12 1Q13f 2Q13f 3Q13f 4Q13f 1Q14f
Real GDP growth 7.8 9.0 8.5 7.9 9.0 9.0 9.0 9.0 8.5
GDP by expenditure: current price
Private consumption 12.8 15.5 15.0 12.8 15.5 15.5 15.5 15.5 15.0
Government consumption 13.8 16.3 16.0 13.8 16.3 16.3 16.3 16.3 16.0
Urban FAI growth (ytd) 20.6 22.0 21.0 21.0 21.0 21.5 21.8 22.0 21.0
Retail sales - consumer goods 14.3 16.5 16.0 15.5 16.5 16.5 16.5 16.5 16.0
External
Exports (USD bn) 2,049 2,379 2,736 554 517 603 622 637 595
- % YoY 8 16 15 9 20 15 15 15 15
Imports (USD bn) 1,818 2,055 2,364 470 459 524 530 541 527
- % YoY 4 13 15 3 7 15 15 15 15
Trade balance (USD bn) 231 324 372 84 59 79 92 97 67
Current account balance (USD bn) 214 539 620 n.a. n.a. n.a. n.a. n.a. n.a.
% of GDP 2.6 5.5 5.5 n.a. n.a. n.a. n.a. n.a. n.a.
Foreign reserves (USD bn, eop) 3,375 4,037 4,793 n.a. n.a. n.a. n.a. n.a. n.a.
FDI inflow (USD bn, YTD) 112 123 135 93 31 61 92 123 34
Inflation & money
CPI inflation 2.7 3.5 3.5 2.1 2.5 3.1 3.8 4.5 3.5
RPI inflation 2.2 2.9 2.9 1.6 1.9 2.4 2.9 3.4 0.0
M1 growth 6.5 6.6 6.6 4.0 8.0 8.0 8.0 8.0 8.0
M2 growth 13.8 14.0 14.0 14.0 14.0 14.0 14.0 14.0 14.0
Other
Nominal GDP (USD bn) 8,376 9,756 11,205 n.a. n.a. n.a. n.a. n.a. n.a.
Fiscal balance (% of GDP) -1.8 -1.5 -2.0 n.a. n.a. n.a. n.a. n.a. n.a.
* % change, year-on-year, unless otherwise specified
CN- nominal exchange rate
CNY per USD
7.20
CN- policy rate
%, 1-yr lending rate
7.5
7.00
7.0
6.80
6.5
6.60
6.0
6.40
5.5
6.20
Mar-08 Mar-09 Mar-10 Mar-11 Mar-12 Mar-13
5.0
Mar-02 Mar-04 Mar-06 Mar-08 Mar-10 Mar-12
Sources for charts and tables are from CEIC, Bloomberg and DBS Research (forecasts and data transformations)
71

HONG KONG
Economics: Hong Kong
Economics – Markets – Strategy
HK: Better times
• By now, the appeal of property as an investment has diminished. However,
demand-supply imbalances remain, keeping property prices elevated
• The coincidence of rate hikes and a surge in housing supply could be lethal
• We anticipate more government intervention down the road, with 5%
additional property price inflation as a trigger point
• Demand-pull inflation will make a comeback this year as Hong Kong
piggybacks on China's economic recovery
Since last quarter, the government and HKMA have introduced a raft of measures
to further cool down the property market. After climbing 20% in 2012, private
residential property prices went up by a further 5% (6% for mass estates) by the
third week of February before the government intervened. In fact, this is the
seventh time authorities have intervened in an attempt to stem the rise of property
prices (Chart 1).
By now, the appeal of property as an investment has diminished. The government’s
measures have greatly increased the transaction costs of short term (

Economics – Markets – Strategy
Economics: Hong Kong
Chart 1: Intervention in the property market
23/10/2009
LTV
24/02/2010
Increase
stamp duties
13/08/2010
LTV
(2nd time)
20/11/2010
LTV
(3rd time)
SSD
10/06/2011
LTV
(4th time)
27/10/2012
BSD
SSD2
23/02/2013
Increase
stamp duties
Source: HKSAR government, HKMA
LTV: Loan-to-value ratio tightening
SSD: Special stamp duty
BSD: Buyer's stamp duty
The government has reiterated from time to time how the affordability ratio
(mortgage payments-to-income) will surge when interest rates turn the tide.
Specifically, the Financial Secretary said the ratio would jump to 68% assuming
300bps jump in interest rates from existing levels. In light of the risks, HKMA
has recently required banks to assume a mortgage rate increase of 300bps instead
of the existing 200bps for all types of property when conducting stress tests,
thereby driving out marginal buyers. This makes a lot of sense because in the
last Fed rate hike cycle, interest rates climbed 440 bps in two years and nine
months. In the first year alone, rates went up by more than 100bps. While the
affordability ratio is such a commonly used (and arguably the easiest to understand)
tool to gauge property market risks, it does not fully reflect mortgage repayment
burden. Some people opt to take out “second mortgages” from property developers
or finance companies to circumvent loan-to-value regulations. The interest rates
for these mortgages are often higher than rates offered by large banks, which
are used in official affordability rate calculations.
Property prices will
remain sticky
For now, prices will stay high
Yet, between now and the day of reckoning, property prices will remain sticky.
The most fundamental reason is the nagging demand-supply imbalance. Government
actions have arguably deterred most investment demand. But one can infer
from the quick price ascent in recent years that the imbalance was quite huge.
Even discounting investment demand, pent-up demand from end-users is enormous.
Demographically, higher birth and marriage rates in recent years increase the
demand for space. Furthermore, existing home-owners’ holding power is strong
amid ultra-low interest rates. Owner-occupiers, in particular, are unlikely to sell
their properties in response to recent government clampdowns because it is
costly to rent or to purchase an alternative property due to increased stamp
duties. As such, an unintended consequence of government intervention is that
the supply of secondary market properties will be squeezed.
Residential property transaction volumes are already down significantly since
the government introduced the Special Stamp Duty for the first time in November
2010. Transaction volumes averaged 11,315 per month back in 2010 and are
progressively down to just 6,778 last year. For the first two months of 2013,
volumes averaged only 5,869. Shrinking transaction volumes will negatively
impact real estate employment, which accounts for around 4% of total employment.
As Chart 2 shows, residential property transactions per thousand real estate employees
are currently at the doldrums, signaling imminent employee cutbacks.
73

Economics: Hong Kong
Economics – Markets – Strategy
Chart 2: Residential property transactions per thousand real estate employees
units
120
100
80
60
40
20
0
Chart 3: Rental inflation could beat property price inflation this year
% YoY
Units
40%
16,000
30%
14,000
20%
10%
0%
-10%
-20%
12,000
10,000
8,000
6,000
4,000
2,000
-30%
0
Jan-08
May-08
Sep-08
Jan-09
May-09
Sep-09
Jan-10
May-10
Sep-10
Jan-11
May-11
Sep-11
Jan-12
May-12
Sep-12
Jan-13
May-13
Sep-13
Jan-08
Jul-08
Jan-09
Jul-09
Jan-10
Jul-10
Jan-11
Jul-11
Jan-12
Jul-12
Transaction volumes (RHS) Property price inflation Rental inflation
Inflation expectations still elevated
While the pace of climb in property prices will most likely decelerate to about
5%-10% in 2013 due to intervention risks and dampening investor interest, residential
rental price could charge ahead. Historically, rental growth has tracked property
price very closely. It often rises (or falls) at a milder rate than property prices
(Chart 3). However, it may turn out to be different this time. After tightening
measures were announced in late February, rents at some residential estates hit
historical highs. The more that people get into wait-and-see mode, the more
boost it gives to rental markets. As housing rents are factored into the CPI, the
upside risk to our CPI forecast of 3.5% this year has increased.
To help people better cope with inflation, the Financial Secretary has once again
unveiled one-off measures in the 2013/2014 Budget. Measures that directly impact
the CPI include electricity subsidy of $1,800 per residential electricity account
and two months rent waiver for public housing tenants. Rent subsidies, despite
its “one-off” nature, have been in place for the past five years. As these measures
are already expected by the public, they will not lower inflation expectations.
74

Economics – Markets – Strategy
Economics: Hong Kong
Economic recovery has started
While the focus has largely been on cost-push inflation last year, demand-pull
inflation will make a comeback this year. The growth picture is getting rosier as
Hong Kong piggybacks on China’s economic recovery.
Private consumption growth (of residents) has recovered to 4.1% in 4Q12 after
dropping to 2.8% in the second and third quarters of 2012. As private consumption
accounts for about 65% of GDP, its deceleration can explain sub-par GDP growth
(1.4%) last year. Thankfully, China’s economic recovery in 2013 will exert positive
impact on locals’ consumption via better equity market performance and generally,
upbeat consumer sentiment. A sustained rebound in China will also support
Hong Kong’s retail sales as tourists loosen their purse strings, and bolster services
exports.
Nevertheless, weakness in merchandise trade is expected to continue. Europe
continues to be a source of exasperation. Meanwhile, US economic growth will
likely be subpar. As roughly 20% of Hong Kong’s exports go to the EU and the
US, it is hard to argue for considerable recovery in merchandise trade. That said,
the pickup in Asian demand (accounts for over 70% of exports) is expected to
cushion the sluggish growth of Western economies.
Property price
inflation will be
more aligned with
economic
fundamentals
More sanguine
Hong Kong started the year on a solid footing, riding on China’s recovery. We
anticipate further trend improvement in retail sales, consumption and even
trade in 2Q13. Meanwhile, property price inflation will finally become more
aligned with economic fundamentals as the government douses the flames of
the red hot market.
75

Economics: Hong Kong
Economics – Markets – Strategy
Hong Kong Economic Indicators
2012 2013f 2014f 4Q12 1Q13f 2Q13f 3Q13f 4Q13f 1Q14f
Real output and demand
GDP growth (10P) 1.4 5.0 4.5 2.5 5.3 6.4 4.4 4.1 4.8
Private consumption 4.0 7.2 4.6 4.1 6.2 7.0 8.4 7.1 4.6
Government consumption 3.7 3.5 3.5 3.5 3.5 3.5 3.5 3.5 3.5
Investment (GDFCF) 9.1 5.6 4.4 10.5 6.0 4.5 6.0 6.0 4.4
Exports of goods and services 1.3 8.1 7.1 5.0 10.9 7.6 6.6 7.8 7.1
Imports of goods and services 2.5 9.0 6.9 6.4 11.1 7.4 8.7 9.0 6.9
Net exports (HKD bn) 21 -14 -7 9 3 -13 0 -4 -1
External (nominal)
Merch exports (USD bn) 443 475 516 116 118 115 124 126 118
- % YoY 3 7 9 7 11 7 7 7 7
Merch imports (USD bn) 531 577 636 132 136 133 142 146 138
- % YoY 4 9 10 8 13 8 8 8 8
Trade balance^ (USD bn) -88 -102 -120 -16 -17 -18 -18 -20 -19
Current acct balance (USD bn) 0.2 -6.2 -12.2 - - - - - -
% of GDP 0.1 -2.2 -4.1 - - - - - -
Foreign reserves (USD bn, eop) 317 349 381 - - - - - -
Inflation
CPI inflation 4.1 3.5 3.3 3.8 3.0 3.0 4.4 3.4 3.5
Other
Nominal GDP (USD bn) 263 282 301 - - - - - -
Unemployment rate (%, sa, eop) 3.3 3.3 3.3 3.3 3.5 3.5 3.3 3.3 3.5
* % change, year-on-year, unless otherwise specified
^ Balance on goods
HK - nominal exchange rate
HKD per USD
7.84
7.82
7.80
7.78
7.76
7.74
Mar-08 Mar-09 Mar-10 Mar-11 Mar-12 Mar-13
HK - policy rate
%, base rate
8.0
7.0
6.0
5.0
4.0
3.0
2.0
1.0
0.0
Mar-03 Mar-05 Mar-07 Mar-09 Mar-11 Mar-13
Sources for all charts and tables are from CEIC. Forecasts are by DBS Group Research
76

Economics – Markets – Strategy
Economics: Hong Kong
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77

Taiwan
Economics–Markets–Strategy
TW: JPY risks vs. RMB
opportunities
• We maintain our above-consensus growth forecast of 4.2% for 2013
• Market worries about JPY depreciation derailing Taiwan’s export recovery
are overstated
• Banks’ start of RMB business has raised the longer-term prospects of establishing
an offshore RMB market in Taiwan
• On monetary policy, the central bank is expected to hold rates steady in
the next couple of quarters. The impact on TWD liquidity as a result of
TWD-RMB conversion is likely to be mild
Investors’ anxiety increased significantly at the start of 2013, as large depreciation
of the Japanese yen posed risks to the outlook for Taiwan’s exports and general
economic recovery. Nonetheless, confidence remained supported by the new signs
of progress in cross-strait economic cooperation – the kick start of offshore RMB
business in Taiwan’s banking sector in February. In the first two months of 2013, the
Taiwan dollar fell 2% versus the greenback, while the TAIEX still rose a modest 3%.
No need to overreact to JPY depreciation
The worries about JPY depreciation derailing Taiwan’s export recovery are overstated,
in our view. Foremost, the TWD exchange rates remain competitive. The
TWD was still undervalued against the JPY by 27% as of end-February (Big Mac
index). It was also significantly undervalued against the USD, by 42%. Compared
to a basket of trade partners’ currencies and adjusted by the inflation differences
abroad and at home, the real effective exchange rate of TWD remained lower than
the long term equilibrium levels (Chart 1).
TAIWAN
Chart 1: The TWD remains undervalued
2010=100
135
130
125
TWD NEER
TWD REER
120
115
110
105
100
95
Mar-00 Mar-03 Mar-06 Mar-09 Mar-12
Chart 2: Japan is Taiwan's major import market
% of total imports
Central &
South
America
Europe
US
Middle
East
Oceania
Others
Asia
Japan
China
ASEAN6
Others
Ma Tieying • (65) 6878 2408 • matieying@dbs.com
78

Economics–Markets–Strategy
Taiwan
While the attention focuses on the adverse impact of JPY depreciation on Taiwan’s
exports, we also note that a weak JPY can benefit Taiwanese importers and consumers
via disinflation effects. Japan is Taiwan’s largest import market, accounting for
almost 20% of its total imports (Chart 2). Taiwan’s import dependence on Japan is
high, not only in the segments of raw materials and capital goods (chemicals, machinery
and etc.), but also consumer goods including electronics and automobiles. A
significant portion of Taiwan’s food imports (8%) also come from Japan.
Positive economic data will help to alleviate the JPY-related worries. Real GDP
growth already reported a stronger-than-expected rise of 3.7% YoY in 4Q12, or
7.3% QoQ saar. This was the second consecutive quarter of growth acceleration,
supporting our assessment that the economy has bottomed out in 3Q12 and entered
into the expansion phase from 4Q12.
More recently, manufacturing PMI rose to 50.9 on average in Jan-Feb13, up from
48.6 in 4Q12. Despite the monthly volatility in trade data caused by the Lunar New
Year, the underlying trend in export orders and exports remained up (Chart 3).
Meanwhile, the leading indicators for domestic demand – consumer confidence and
capital goods imports – also turned north (Chart 4-5).
Compared to one quarter ago, the official forecast of 2013 GDP growth has been
upgraded by 0.4ppt to 3.59%. The market consensus forecast has also risen 0.2ppt
to 3.6%. We are comfortable to maintain our above-consensus forecast of 4.2%.
The consensus
forecast of 2013
growth is rising
An objective look at the RMB opportunities
Despite the external JPY risks, there is optimism among local investors about the
offshore RMB opportunities in Taiwan and the outlook of Taiwan’s financial sector
development. From February, Taiwanese banks have started the offshore RMB
businesses including deposits, remittances and loans. Banks and nonbank financial
institutions have also launched the RMB-denominated investment products including
bonds, ETFs and insurance policies (invested in the CNH market for now). Meanwhile,
Chinatrust Commercial Bank – one of Taiwan’s leading lenders – sold Taiwan’s
first offshore RMB bond in February (CNY 1bn, 3-year, yield: 2.9%).
Going forward, a substantial development of RMB wealth management products
and the RMB bond market will require local liquidity pool to reach a certain size.
Trade settlement by Taiwanese corporates is expected to be the key driver for ac-
Chart 3: Exports and production trending up
Jan08=100, sa
130
120
110
100
90
80
70
Export orders
Real exports
Industrial production
60
Mar-08 Mar-09 Mar-10 Mar-11 Mar-12
Chart 4: Consumer confidence started to improve
Points
90
85
80
75
70
65
60
55
50
45
Mar-07 Sep-08 Mar-10 Sep-11
79

Taiwan
Economics–Markets–Strategy
Taiwan’s trade
surplus with the
Mainland provides
a lot of RMB
liquidity
cumulation of RMB liquidity in Taiwan. A conservative estimate is that the RMB net
inflows stemming from cross-strait trade settlement will grow to CNY 100bn by
2015 (Table 1). The 100bn threshold could be reached earlier in 2014, if considering
the possibility of Taiwan-Hong Kong trade to be settled in RMB, as well as the
inflows stemming from cross-strait tourism and remittances (also Table 1). In a more
bullish scenario, if the current growth pace of RMB deposits in Taiwan’s domestic
banking units (DBUs) is sustained, RMB deposits will reach the 100bn mark by the
end of this year (in the first month after DBUs started RMB business, they received
deposits of CNY 10bn).
Developing the offshore RMB market also requires establishing a mechanism to increase
the circulation of funds between Taiwan and China. Participating in China’s
RQFII program will provide a channel for Taiwanese institutional investors to access
China’s onshore financial markets using the RMB funds they accumulate. The
chairman of China Securities Regulatory Commission said in January that China is
considering granting Taiwan a RQFII quota of CNY 100bn. The relevant details will
likely be announced within this year.
Still, Taiwan needs to relax its own restrictions on cross-strait capital flows. Chinese
enterprises and financial institutions – the major RMB bond issuers in Hong Kong
– currently are prohibited from selling bonds in Taiwan. Taiwan also doesn’t allow
Chinese companies to be listed and traded in its stock market.
Meanwhile, Taipei is not a global financial hub. If Taiwan wants to attract the participation
of Chinese and foreign investors in its offshore RMB market (rather than
only serving the RMB financing needs of Taiwanese companies with operations on
the mainland), great effort also need to be made to promote its capital market internationalization
and liberalization and improve financial infrastructures.
Central bank to stay on hold
On monetary policy, Taiwan’s central bank (CBC) has maintained a neutral stance.
The benchmark discount rate was left unchanged at 1.875% at the latest CBC meeting
in Dec12. The overnight interbank rate, which in part reflects the results of the
CBC’s liquidity management via open market operations, stayed stable at 0.39%
in Jan-Feb13 (Chart 6). As economic growth has started to recover and underlying
inflation remains a non-issue at the early stage of recovery, the CBC is expected to
hold rates steady in the near term at least till 3Q.
Chart 5: Investment indicators also picked up
Jan07=100
180
160
140
120
100
80
60
40
Capital goods imports
20 Machinery, Electrical equipment
imports (real, sa)
0
Mar-07 Sep-08 Mar-10 Sep-11
Chart 6: Interest rates remained stable
% pa
4.00
3.50
3.00
2.50
Policy rate
Interbank rate: Overnight
Time deposit rate: 1 year
New loans rate
2.00
1.50
1.00
0.50
0.00
Mar-08 Mar-09 Mar-10 Mar-11 Mar-12
80

Economics–Markets–Strategy
Taiwan
Table 1: Projections of RMB deposit growth in Taiwan
Exports to
China
Imports from
China
Trade surplus
with China
RMB trade
settlement ratio
RMB inflows from
trade settlement
Share of RMB deposits
in total deposits
USD bn USD bn USD bn % RMB bn %
2013f 90.4 46.6 43.8 10 26.7 0.5
2014f 101.3 53.2 48.1 20 58.7 1.0
2015f 113.4 60.6 52.8 30 96.6 1.6
*Assumptions: export growth=12% (2005=2012 avg), import growth=14%
Exports to
China & HK
Imports from
China & HK
Trade surplus
with China & HK
RMB trade
settlement ratio
RMB inflows from
trade settlement
Share of RMB deposits
in total deposits
USD bn USD bn USD bn % RMB bn %
2013f 128.2 48.8 79.4 10 48.4 0.9
2014f 138.4 54.7 83.8 20 102.2 1.8
2015f 149.5 61.2 88.3 30 161.5 2.9
*Assumptions: export growth=8%, import growth=12%
Other assumptions: USD/RMB=6.1, USD/TWD=29.0, TWD deposit growth=5%
Notes: Tourism receipts from China amounted to RMB 30bn in 2012. Taiwan's OBU RMB deposits stood at RMB 24bn in end-2012
One interesting development to watch is the possible tightening of TWD liquidity
as a result of the conversion of TWD deposits to RMB deposits. Banks are currently
offering high yields and competing for RMB deposits. The 1-year RMB time deposit
rate was set at 1.1%-2.38% among the five leading banks in February, higher than
the comparable TWD deposit rate of 1.36%. The favorable rate differentials would
provide incentives for Taiwanese depositors to get exposure to RMB assets.
That said, the attraction of the RMB appreciation story to Taiwanese individuals
would be relatively limited – the TWD is also undervalued and has the bias to appreciate.
Meanwhile, the conversion from TWD deposits to RMB deposits is subject to a
limit of CNY 20k per person per day. The near-term impact of TWD-RMB conversion
on TWD liquidity is likely to be mild, in our view.
Policy rate to stay
at 1.875% in 2Q-
3Q
81

Taiwan
Economics–Markets–Strategy
Taiwan Economic Indicators
2012 2013f 2014f 4Q12 1Q13f 2Q13f 3Q13f 4Q13f 1Q14f
Real output and demand
GDP growth 1.3 4.2 4.0 3.7 3.9 4.0 4.4 4.4 3.7
Private consumption 1.5 1.9 2.4 1.6 1.5 1.6 2.3 2.3 2.4
Government consumption 0.4 0.3 0.8 -1.7 -0.8 -0.4 1.1 1.0 0.9
Gross fixed capital formation -4.4 4.5 3.4 1.3 2.2 3.9 4.7 6.8 5.1
Net exports (TWDbn, 06P) 2896 3275 3640 859 717 779 828 951 805
Exports (% YoY) 0.1 6.4 6.7 4.0 5.9 6.9 6.0 6.8 7.0
Imports (% YoY) -1.9 4.0 5.0 2.2 3.9 3.8 3.3 5.1 5.1
External (nominal)
Merch exports (USDbn) 301 321 347 78 73 82 82 85 81
- % chg -2.3 6.8 7.9 2.5 2.5 7.6 7.3 9.3 10.9
Merch imports (USDbn) 271 295 319 67 69 76 75 75 74
- % chg -3.8 8.9 8.2 -0.1 6.1 7.6 9.1 12.9 6.3
Trade balance (USD bn) 30 27 28 11 3 6 8 9 7
Current account balance (USD bn) 50 45 48 - - - - - -
% of GDP 10.4 9.1 9.3 - - - - - -
Foreign reserves (USD bn, eop) 403 429 456 - - - - - -
Inflation
CPI inflation 1.9 1.3 1.3 1.8 1.9 1.4 0.6 1.2 1.2
Other
Nominal GDP (USDbn) 475 498 513 - - - - - -
Unemployment rate (eop %, sa) 4.2 4.2 4.1 4.2 4.3 4.3 4.2 4.2 4.1
Fiscal balance (% of GDP) -1.8 -1.1 -0.7 - - - - - -
* % growth, year-on-year, unless otherwise specified
TW - nominal exchange rate
TWD per USD
36.00
35.00
34.00
33.00
32.00
31.00
30.00
29.00
28.00
Jan-07 Mar-08 Jun-09 Sep-10 Dec -11 Mar-13
TW – policy rate
%, rediscount rate
5.0
4.5
4.0
3.5
3.0
2.5
2.0
1.5
1.0
Jan-01 Jan-03 Jan-05 Jan-07 Jan-09 Jan-11 Jan-13
82

Economics–Markets–Strategy
Taiwan
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83

Korea
Economics–Markets–Strategy
KR: Recovery on track, despite
JPY concerns
• GDP growth is projected to rise to 3.5% in 2013 (vs. 3.7% in the previous
forecast), a moderate rebound from 2.0% last year
• Export recovery should remain on track despite JPY depreciation, because
1) the KRW/JPY is just normalizing from the excessive lows during
the 2008 crisis, 2) the export demand outlook is positive
• The major concern about JPY depreciation, from the policymakers’ perspective,
would be a rise in short term capital flows and FX volatility.
Macroprudential measures could be strengthened, if needed
The KOSPI was nearly flat in the first two months of this year, underperforming
the regional stock markets. The KRW dropped against the USD by about 2%. The
stock market sluggishness and currency weakness in large reflected the deterioration
in investor sentiment, on worries that the sharp depreciation of the Japanese
yen since end-2012 will seriously hurt Korea’s exports and derail Korea’s economic
recovery.
Positive economic data are needed to assuage the JPY-related concerns. Real GDP
growth rose slightly to 1.5% QoQ saar in 4Q12 from the bottom of 0.2% in 3Q12.
We expect the quarterly growth profile to continue to improve over the next four
quarters, in both QoQ and YoY terms. Annual GDP growth is projected to rise to
3.5% in 2013, a moderate rebound from 2.0% last year.
Chart 1: Is the KRW overvalued?
2010=100
140
Chart 2: Export growth vs. KRW
% YOY % YOY
40
Correlation: +0.50
30
KOREA
130
120
110
100
KRW NEER
90
KRW REER
80
Mar-00 Mar-03 Mar-06 Mar-09 Mar-12
30
20
10
0
-10
-20
Export volume
-30 KRW REER (RHS)
-40
Mar-00 Mar-03 Mar-06 Mar-09 Mar-12
20
10
0
-10
-20
-30
-40
Ma Tieying • (65) 6878 2408 • matieying@dbs.com
84

Economics–Markets–Strategy
Korea
The outlook of export recovery remains unchanged
The negative impact of JPY depreciation on Korea’s exports may be less than feared.
The KRW’s appreciation against the JPY since late-2012 (and appreciation against
the USD since 2009) came after its massive declines during the 2008 global financial
crisis. In other words, the KRW is just normalizing and correcting its excessive weakness
during the crisis. As of end-February this year, the KRW remained slightly undervalued
versus the JPY, by 1.2%; and significantly undervalued versus the USD, by
22% (Big Mac index). The effective exchange rates of KRW have stayed lower than
the long term averages (Chart 1).
Admittedly, the JPY is widely expected to weaken further in the coming months, on
the back of more aggressive monetary easing to be taken by the Bank of Japan. This
will likely bring the KRW/JPY rate higher, soon above the fairly valued levels. Note
that, however, the JPY’s weakness is versus Asia ex-Japan currencies ranging from
RMB, TWD to SGD, rather than the KRW alone. As the appreciation against the JPY
will be an Asia-wide phenomenon, in the trade-weighted terms, the KRW effective
rates should rise only modestly.
More importantly, the demand for exports is turning up from the cyclical perspective.
Our 2013 GDP growth forecast for the G3 and China is 0.2ppt higher than 2012
actual growth (simple average, Table 1). Compared to one quarter ago, we have
lowered the US growth forecast by 0.3ppt to reflect the kick-start of automatic budget
spending cuts. This is however, offset by the 0.8ppt upgrade for Japan’s 2013
growth forecast, based on its twin easing of fiscal and monetary policies (US and
Japan account for 10% and 7% respectively in Korea’s total exports).
The trajectory for export growth is determined by multiple factors including global
demand, exchange rates and other elements impacting competitiveness such as
wage costs and productivity. The single role of exchange rates shouldn’t be overemphasized.
The correlations between KRW and Korea’s export growth were in fact
positive in recent years – a stronger KRW, higher export growth (Chart 2-4). This
was probably explained by the pro-cyclical nature of the KRW, as well as the strong
competitiveness of Korean exporters backed by persistent productivity gains and
technology advancement.
Export growth is
determined by
multiple factors
Chart 3: Electronics exports vs. KRW/JPY
% YOY % YOY
80
Correlation: +0.29 30
60
20
40
10
0
20
-10
0
-20
-20
-30
Electronics exports
-40
KRW/JPY (RHS)
-40
-60
-50
Mar-00 Mar-03 Mar-06 Mar-09 Mar-12
Chart 4: Automobile exports vs. KRW/JPY
% YOY % YOY
100
80
60
40
20
0
-20
-40
-60
Auto exports
KRW/JPY (RHS)
Correlation: +0.33
-80
Mar-00 Mar-03 Mar-06 Mar-09 Mar-12
30
20
10
0
-10
-20
-30
-40
-50
85

Korea
Economics–Markets–Strategy
Table 1: Global GDP forecasts
2012 2013F
(old)
2013F
(new)
2013F vs.
2012
2013F
revisions
(A) (B) (C) (C-A) (C-B)
US 2.3 2.0 1.7 -0.6 -0.3
Europe -0.5 -0.3 -0.3 0.2 0.0
Japan 2.0 1.0 1.8 -0.2 0.8
China 7.8 9.0 9.0 1.2 0.0
Simple avg 2.9 2.9 3.1 0.2 0.1
Weighted avg* 4.3 4.7 4.8 0.5 0.1
*Adjusted by weights in Korea's exports
Sources: DBS
Chart 5: Exports still trending up
Jan08=100, sa
150
140
130
120
110
100
90
80
70
Exports
Producers' shipments
for exports
60
Mar-08 Mar-09 Mar-10 Mar-11 Mar-12
Overall, we think the outlook for export recovery remains unchanged. The latest
data support this view. Despite the distortions due to the Lunar New Year, the average
monthly levels of exports rose about 2% between Oct-Dec12 and Jan-Feb13
(seasonally adjusted, Chart 5). Manufacturing PMI also picked up to 50.4 in Jan-
Feb13 from 48.6 in 4Q12, largely driven by the increase in new export orders. This
was in spite of industrial production remaining soft, due to excessive inventory and
temporary supply-side constraints arising from cold weather.
Macroprudential
measures are more
likely than rate
cuts
Domestic demand bottoming out
In the domestic economy, there are also signs that demand has bottomed out. Private
consumption growth in the GDP accounts accelerated to 3.2% QoQ saar in
4Q12, the fastest pace over three quarters (Chart 6). We expect a rise in private
consumption growth to 2.8% on average in 2013, up from 1.8% in 2012, albeit still
lower than the long term average of near 4%. This thanks to the boosting effects
of monetary and fiscal stimulus measures rolled out in 2H12. The new government’s
pledge to narrow the income gap and address the social inequality problem should
also lend support to confidence. The consumer sentiment index has stayed above
the neutral level of 100 for two consecutive months in Jan-Feb13. The subcomponents
of general economic conditions, employment opportunities and household
debt burdens have improved notably.
Keeping an eye on capital flows
On the policy front, there has been market talk about capital controls and rate cuts
in Korea. The JPY depreciation has caused concerns amongst policymakers that the
yen-funded carry trades will resume, which will boost short term capital inflows
into Korea and elevate the risks of FX volatility and financial instability. There is
insufficient evidence so far to support such concerns. Banks’ short term foreign currency
borrowings and short term external debt among all sectors both continued
to fall as of 4Q12 (Chart 7).
But monetary easing is not over in Japan and the JPY is expected to depreciate
further. Policymakers in Korea would keep a close watch on international capital
movements and, if needed, curb inflows via macroprudential measures. Cutting interest
rates to discourage inflows should be less likely, in our view. A more notable
recovery in economic growth and a rebound in inflation numbers in the next few
86

Economics–Markets–Strategy
Korea
Chart 6: Consumption growth bottoming out
Points
% YoY
120
8
115
110
105
100
95
90
85
80
75
Consumer confidence
Private consumption
(RHS)
70
Jul-08 Jul-09 Jul-10 Jul-11 Jul-12
6
4
2
0
-2
-4
-6
Chart 7: Short-term external debt continued to fall
USD bn
200
175
150
125
100
75
50
25
ST external debt
Domestic banks
Foreign banks' branches
0
Jun-07 Jun-08 Jun-09 Jun-10 Jun-11 Jun-12
quarters won’t justify a rate cut. Meanwhile, as the economic recovery boosts the
return of KRW assets, it is also doubtful whether cutting rates can have effective and
lasting impact on capital inflows and the KRW exchange rates.
Among the macroprudential measures to manage inflows, the authorities are most
likely to tighten the existing regulations on banks’ FX forward trading and short
term FX borrowings, specifically targeting at dampening the incentives of carry
trades. Punitive, across-the-board regulation measures such as imposing a financial
transaction tax are less likely. In order to avoid the side effects of damaging investor
confidence and causing excessive capital outflows, the government will have to
carefully consider the feasibility of implementing such a tax, including the appropriate
timing, optimal tax rate and targets of taxation.
87

Korea
Economics–Markets–Strategy
Korea Economic Indicators
2012 2013f 2014f 4Q12 1Q13f 2Q13f 3Q13f 4Q13f 1Q14f
Real output and demand
GDP (05P) 2.2 3.5 3.9 1.5 2.1 3.0 4.1 4.4 4.0
Private consumption 1.8 2.8 3.0 2.8 2.6 2.9 2.9 2.9 3.0
Government consumption 3.6 3.8 4.0 3.1 3.2 3.5 3.8 4.6 4.0
Gross fixed capital formation -1.3 1.5 2.7 -4.1 -5.0 -0.6 2.5 8.1 5.7
Net exports (KRW trn) 102 117 136 29 23 30 30 34 27
Exports 3.7 5.7 8.5 4.0 3.0 5.7 5.0 8.7 8.7
Imports 2.3 3.7 6.8 3.1 0.4 3.8 3.7 6.8 6.9
External (nominal)
Merch exports (USD bn) 548 598 663 140 138 153 150 157 150
- % YoY -1.3 9.1 10.8 -0.4 2.0 9.5 12.9 12.1 9.1
Merch imports (USD bn) 520 567 637 130 132 142 144 148 150
- % YoY -0.9 9.1 12.4 -1.1 -0.9 9.0 14.7 13.9 13.5
Trade balance (USD bn) 28 31 26 10 5 11 6 9 0
Current account balance (USD bn) 43 35 29 - - - - - -
% of GDP 3.8 2.7 2.1 - - - - - -
Foreign reserves (USD bn, eop) 327 347 366 - - - - - -
Inflation
CPI inflation 2.2 2.3 2.9 1.7 1.6 2.1 2.6 2.8 3.1
Other
Nominal GDP (USD bn) 1,141 1,292 1,380 - - - - - -
Unemployment rate (eop %, sa) 3.0 3.0 3.0 3.0 3.2 3.2 3.0 3.0 3.0
Fiscal balance (% of GDP) -1.5 -1.2 -0.6 - - - - - -
* % change, year-on-year, unless otherwise specified
KR - nominal exchange rate
KWR per USD
1590
1490
1390
1290
1190
1090
990
890
Jan-07 Mar-08 Jun-09 Sep-10 Dec -11 Mar-13
KR – policy rate
%, target rate
6.0
5.5
5.0
4.5
4.0
3.5
3.0
2.5
2.0
1.5
Jan-01 Jan-03 Jan-05 Jan-07 Jan-09 Jan-11 Jan-13
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Economics–Markets–Strategy
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89

India
Economics–Markets–Strategy
IN: Challenges remain
• Unmet infrastructure needs, high input costs and a sluggish external
environment have made the downturn more structural in nature
• Looking ahead, a normal monsoon, increase in fiscal spending (as outlined
in the recent budget) and stabilization in consumption spending
should see GDP growth improve to 6.0% in FY13/14
• Focus will also be on adequate external financing to bridge the current
account shortfall and ideally, through non-debt creating flows
• Easing WPI inflation fulfil one of RBI’s main pre-requisites, though current
account and rupee worries limit room for aggressive rate cuts
Third quarter (Oct-Dec) GDP growth undershot expectations with a 4.5% (YoY) rise
(3.1%, QoQ, saar), marking the weakest growth since December 2009. On the year,
growth in the first three quarters of FY12/13 stood at 5.1% and we expect full-year
growth to also average 5.1%. This will be the slowest growth in ten years. Activity
has been sluggish across the board. While insufficient rains halved growth in agricultural
output, weakness in the industrial sector extended for a second consecutive
year, at 3.5% YoY (1Q-3Q), far below the FY 2005-2011 average of 7.4%. While
piecemeal measures were initiated in September last year, the impact is only likely
to be reflected in the medium-term.
Unmet infrastructure needs and high input costs have made the downturn more
structural in nature. With both industry and agricultural slowing, weakness has
percolated to the key services sector. As part of the fiscal stimulus was rolled back,
final consumption expenditure slowed in the first three quarters of FY12/13, to
3.3% (YoY). Sticky inflation and high borrowing costs, meanwhile, eroded purchasing
power. Looking ahead, a normal monsoon, a 16% increase in fiscal spending
(outlined at the recent budget) and stabilization in consumption spending should
put GDP growth at 6.0% in FY13/14.
India: GDP growth - signs of broad-based slowdown
Percentage points
10
8
6
4
2
INDIA
0
Mar-11 Jun-11 Sep-11 Dec -11 Mar-12 Jun-12 Sep-12 Dec -12
Agriculture Construction Industry (ex Constrn) Services
Radhika Rao • (65) 6878 5282 • radhikarao@dbs.com
90

Economics–Markets–Strategy
India
Correction in the current account gulf to be a drawn-out affair
Even as consumption and investment spending moderated in the past year, the current
account deficit (CAD) remains high, touching a record high 5.4% of GDP in
2Q (Jul-Sep). This suggests the deficit is structural and reflects a savings/investment
mismatch. Matters are unlikely to have improved much in 3Q as well (data due end-
Mar), on further deterioration in the merchandise trade deficit and invisibles balance.
The FY12/13 CAD is expected to average 5.0% of GDP, well above the previous
year’s 4.2%, before improving marginally to 4.0% thereafter.
Little can be done in the short-term to address the deficit, with moves such as an
increase in import duties on gold failing to achieve the desired result, amidst struggling
exports. Indeed, any revival in consumption or capex would only raise the
imbalance and pique rating agencies’ attention. With limited scope to restrain the
imports bill, the focus is on external financing and, ideally, through non-debt creating
flows. At present, however, the reliance on portfolio capital inflows is high, thus
increasing the economy’s vulnerability to the external environment. Admittedly, the
economy’s debt indicators are not at worrisome levels, with its external debt to GDP
ratio low. However, the source of concern is the rising proportion of short-term debt
(23% of total external debt) and Non Resident Indian deposits (18%) in the mix. The
foreign reserve holdings have also been on a gradual decline, with the position as
a percentage of GDP slipping below 100% last year. An unexpected bout of riskaversion,
thereby, would renew financing fears.
Further out, the deterioration in external balances needs to be dealt on multiple
fronts. For one, export growth has to return to pre-crisis growth rates. In this regard,
there has been little support to the exports sector as end-demand remains sub-par.
Secondly, to correct the savings/investment mismatch, the gradual downdraft in
the savings rate has to be reversed. This will require inflation to trend back to the
authorities’ comfort levels of around 5.0%-5.5%. The increase in real rates could
encourage households to channel savings back to bank deposits and limit demand
for gold. In 13/14 there is limited room for corrective action and the CAD is likely to
move closer to 4% of GDP.
India’s external
debt is low
Reinvigorating investments a priority
A turnaround in investment and capex spending remains key. This is however unlikely
to materialize this fiscal year or next. An increase in investment allowance and
plans to improve inter-state transport connectivity were initiated at the recent bud-
India: External debt on the rise
USD bn
400
350
External debt
300
250
FX reserves
200
150
Latest: Sep12
100
50
Jun-02 Jun-04 Jun-06 Jun-08 Jun-10 Jun-12
91

India
Economics–Markets–Strategy
get but these steps are insufficient. The root of the problem lies with infrastructure
bottlenecks, problems with land acquisition, lack of legal/governance clarity,
high borrowing rates and a sluggish global growth. While one of these issues
– borrowing costs – can be tackled by adjustments in the monetary policy, others
need undivided attention with a view on the medium-term.
Limited adjustment
in subsidies
and an approaching
election means
spending will
remain high
Room for monetary easing is limited
After holding off for nine months, the RBI stood by the guidance provided in the
October/ December 2012 policy reviews and eased the repurchase rate by 25bps in
January. The softening of WPI inflation fulfilled one of their main pre-requisites,
alongside moves by the government to partly deregulate fuel prices. Room for further
rate cuts is limited given the current account deficit and risks of rupee depreciation.
We expect the central bank to deliver a 25bps cut at the mid-March rate
review, though beyond that, there is room only for 50bps more cuts until the end
of the year.
Expenditure restraint in 2H FY12/13 and divestment helped the government meet
its fiscal deficit target. It may not, however, be two-time lucky. The budget for 13/14
carries plans to boost spending by 16% while revenue targets assume firm growth.
Given little adjustment in subsidies and an approaching election, willingness to
scale back spending will be limited. The fiscal deficit could well exceed the 4.8% of
GDP target by about half a percentage point or more.
India: Current account vs trade deficit
as % of GDP
4
2
0
-2
-4
-6
-8
Latest: Sep12
-10
-12
2000-01 2003-04 2006-07 2009-10 2012-13
CAD Net merchandise trade
India: Policy rates vs WPI
YoY, %
12
10
Latest: Jan12
8
6
4
2
0
-2
-4
Apr-07 Apr-08 Apr-09 Apr-10 Apr-11 Apr-12
Non-food mfg WPI Repo rate WPI
92

Economics–Markets–Strategy
India
India Economic Indicators
12/13f 13/14f 14/15f 4Q12 1Q13f 2Q13f 3Q13f 4Q13f 1Q14f
Real output (04/05P)
GDP 5.1 6.0 6.7 4.5 5.0 5.5 5.8 6.2 6.3
Agriculture 0.1 3.0 4.0 1.1 1.0 2.0 2.2 3.0 3.0
Industry (ex constrn) 0.3 5.0 6.5 1.9 2.9 3.6 4.5 5.1 5.1
Services 4.3 7.0 7.5 6.2 6.9 7.0 7.2 7.2 7.5
Construction 5.9 7.0 8.0 5.8 6.5 6.8 7.3 7.5 7.5
External (nominal)
Merch exports (USD bn) 285 307 360 70.1 73.1 76.8 74.4 76.4 79.7
- % YoY -6.6 8.0 17.5 -3.0 -6.5 5.0 8.0 9.0 9.0
Merch imports (USD bn) 490 515 586 129.0 127.6 116.5 124.4 138.0 136.5
- % YoY 0.2 5.4 12.7 7.2 1.7 2.0 4.0 7.0 7.0
Trade balance (USD bn) -205 -208 -226 -58.9 -54.5 -39.7 -50.0 -61.6 -56.8
Current a/c balance (USD bn) -87 -110 -125 n.a. n.a. n.a. n.a. n.a. n.a.
% of GDP -5.2 -4.0 -3.5 n.a. n.a. n.a. n.a. n.a. n.a.
Foreign reserves(USD bn, eop) 297 320 351 n.a. n.a. n.a. n.a. n.a. n.a.
Inflation
WPI inflation (% YoY) 7.3 7.0 6.8 7.3 6.5 6.8 7.0 7.1 7.2
Other
Nominal GDP (USD tn) 1.9 1.8 1.8 n.a. n.a. n.a. n.a. n.a. n.a.
Fiscal balance (% of GDP) -5.2 -5.4 -5.2 n.a. n.a. n.a. n.a. n.a. n.a.
* % change year-on-year, unless otherwise specified
** Annual data refers to fiscal years beginning April of calendar year.
***Quarterly data is with reference to calendar year for ease of comparison with other economies
IN - nominal exchange rate
INR per USD
58
56
54
52
50
48
46
44
42
40
38
Jan-07 Mar-08 Jun-09 Sep-10 Dec -11 Mar-13
IN – policy rate
% repo rate
16.0
14.0
12.0
10.0
8.0
6.0
4.0
Jun-00 Aug-03 Oct-06 Dec -09 Feb-13
93

Indonesia
Economics–Markets–Strategy
ID: Adjustments
• The domestic demand story is still intact. GDP growth is expected to
reach 6.3% and 6.5% in 2013 and 2014 respectively
• The current account deficit should narrow this year on the back on an
improvement in exports and modest credit tightening
• BI is unlikely to favor further rupiah weakness to facilitate the current
account deficit adjustment, especially with inflationary pressures rising
• A subsidized fuel price hike is not our core scenario. The budget can handle
moderate shocks to the assumptions before a price hike is required
4Q GDP growth reached 6.1% YoY, taking full-year 2012 growth to 6.2%. Although
headline growth is slightly slower compared to the 6.5% registered in 2011, the
overall GDP growth number does point to resilience in the domestic economy despite
significant external headwinds. In fact, domestic private sector performance
was stronger in 2012 compared to 2011. Notably, private consumption growth and
investment growth reached 5.3% and 9.8% respectively in 2012, compared to 4.8%
and 8.8% respectively in 2011. The overall economic slowdown was due in large
part to net exports, which took away 1.3pct-pts from headline growth.
Going forward, external headwinds should become tailwinds amid stabilization in
the major economies and a turnaround in China. Aside from an expected increase in
external demand, commodity prices should become more favorable, reducing concerns
on external funding. Domestically, growth momentum remains strong even if
there have been some signs of softening on the investment front. Inflation is going
to be a concern down the line and the central bank (BI) may embark on modest
tightening to reduce price pressures and further reassure on external imbalances.
GDP growth is expected to reach 6.3% and 6.5% in 2013 and 2014 respectively.
Chart 1: Consumption demand got stronger in 2012
INDONESIA
% YoY
8.0
7.0
6.0
5.0
4.0
3.0
2.0
GDP
PCE
1.0
Latest: 4Q12
Net Exp (RHS)
0.0
Q107 Q407 Q308 Q209 Q110 Q410 Q311 Q212
Eugene Leow • (65) 6878 2842 • eugeneleow@dbs.com
% YoY
40
30
20
10
0
-10
-20
-30
-40
94

Economics–Markets–Strategy
Indonesia
Chart 2: Current account balance
USD bn
6
4
2
0
-2
-4
-6 latest: 4Q12
-8
-10
Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 Mar-12
Chart 3: CPI & food prices
% YoY
18
16
14
Headline
Food
12
10
Latest: Feb 13
8
6
4
2
0
Jan-11 Jun-11 Nov-11 Apr-12 Sep-12 Feb-13
The current account has not improved yet
The strength of the domestic economy relative to the rest of the world has placed
some stress on the external accounts. Last year, the current account deficit widened
to USD 7.7bn in 4Q from USD 3.1bn in 1Q. The economy also registered the first
full-year current account deficit since the Asian financial crisis, amounting to 2.7%
of GDP. Cyclical factors have contributed to depressed commodity prices while continued
investment-led growth resulted in an increase in capital goods imports. Accordingly,
almost the entire shift in the current account surplus in 2011 to a deficit
in 2012 was due to the deterioration in the trade balance.
Bank Indonesia (BI) has taken incremental steps to address this external imbalance
over the past several quarters. These include more stringent rules on home and
vehicle loans and a 25bps increase in the FASBI deposit rate. The rupiah was also allowed
to weaken by 6.7% through 2012. The higher loan-to-value (LTV) ratios are
aimed at moderating household credit growth and reducing financial stress when
the cycle turns. Similarly, higher FASBI deposit rates will have a direct impact on
interbank rates and should translate into higher borrowing costs and a reduction
in loan demand. There has been some effect. Loan growth eased to 22.7% YoY in
December (from 26.3% in May) as credit growth for consumption stabilized.
BI has also opted to facilitate the adjustment in the current account by allowing
a weaker rupiah as opposed to more aggressive hikes in the FASBI deposit rate.
Via a weaker exchange rate, exports should receive a boost while import demand
should be curtailed. However, there is a limit to how much rupiah weakness BI is
willing to tolerate. In January this year, BI intervention was clearly reflected in the
USD 4bn drop in foreign reserves. This was in contrast to 2H12 where BI was slowly
accumulating reserves. BI has also stepped up rhetoric on controlling speculation
on the rupiah, told local lenders to set up an onshore reference rate to settle rupiah
forward transactions and started clamping down on companies which are not
channeling earnings through local banks.
All these measures have helped to stabilize the rupiah and this is reflected by the
narrower spread between the 1-month forward rate and spot rate for the currency.
However, these measures also imply that BI is cognizant that excessive rupiah
weakness could undermine investor confidence in the country. Domestically,
a further adjustment in the current account is likely to take place through higher
interest rates and/or further macro-prudential measures aimed at tightening loan
growth. Externally, a moderate bounce in commodity prices will help lift exports.
We expect an uneven return to surplus in the trade balance in the coming months,
thereby cutting down the current account deficit to 1.5% of GDP in 2013.
The current account
deficit
remains a worry
95

Indonesia
Economics–Markets–Strategy
Price pressures rising
Price pressures are building amid a robust domestic economy and are starting to
be reflected in the inflation numbers. Inflation came in at 5.3% YoY in February,
the highest level in 20 months, as food prices stayed elevated due to floods that
took place in January. Higher electricity tariffs also contribute to the higher inflation
rate. Moreover, rupiah weakness is likely to lead to higher imported inflation,
highlighting BI’s dilemma as it grapples with the widening current account deficit.
Notably, the January inflation figure is already at the higher end of BI’s inflation
target range of 3.5-5.5%. Increased vigilance towards price pressures are likely this
year and we expect a modest increase in the FASBI deposit rate in the coming quarters.
We have recently revised up our inflation forecast for 2013 to 5.3% (from
4.9% previously). This projection is contingent on the government staying pat on
subsidized fuel prices.
Unlikely to be a
fuel price hike this
year
Fuel price adjustment not our core scenario
Budget assumptions for 2013 are optimistic, but it will still take significant negative
deviations before an adjustment in subsidized fuel prices is needed. To be sure, the
assumptions for subsidized fuel consumption and oil price are on the low side. Subsidized
fuel consumption reached 46mn kiloliters in 2012 but the budget assumes
that this figure stays unchanged this year. If, however, fuel usage follows real GDP
growth, one would expect subsidized fuel demand to grow by around 6% a year,
implying subsidized fuel usage of 48-49mn kiloliters for 2013.
Meanwhile, the average Indonesian crude price (ICP) is set at USD 100/bbl in the
budget. This is about 10% lower than the average ICP of USD 112/bbl last year.
With signs of stabilization in the major economies and a turnaround in China, oil
demand may increase. Add a weak rupiah into the mix, and it is clear that the oil
subsidy bill is going to be much higher than the allocated IDR 194trn.
The overall impact on the budget deficit will depend on the deviation from budget
assumptions. Here we employ the simplifying assumption that the revenue numbers
are likely to be met especially if commodity prices bounce. Under a mild stress
scenario, fuel subsidy may be underestimated by around IDR 52trn, which amounts
to about 0.6% of GDP. In this case, the budget deficit would reach 2.2% of GDP,
higher than the government’s base case of 1.65%. It would require larger deviations
from the assumptions (especially the price of crude oil) to put the budget
position at risk. With elections coming up in 2014 and the threat of social unrest (as
shown in early 2012 when fuel prices were supposed to be increased), it is unlikely
that fuel reforms will take place this year unless oil prices stayed high (above USD
120/bbl) for an extended period.
Fuel price stress test Budget Mild stress Bad scenario
IDR/USD 9,300 9,500 10,000
Fuel quota 46 mn kiloliters 48 mn kiloliters 50 mn kiloliters
Crude oil price USD 100/bbl USD 110/bbl USD 120/bbl
Estimated extra costs n.a IDR 52.4trn IDR 110.8trn
Budget deficit (% of GDP) 1.65% 2.21% 2.84%
Using budget assumptions:
Per IDR 100/USD deviation in FX will increase fuel subsidies by IDR 2trn*
Per 1 mn kiloliter deviation in fuel quota will increase fuel subsidies by IDR 4.2trn*
Per USD 10/bbl increase in crude oil price will increase fuel subsidies by IDR 40trn*
*everything else held constant
96

Economics–Markets–Strategy
Indonesia
Indonesia Economic Indicators
2012 2013f 2014f 4Q12 1Q13f 2Q13f 3Q13f 4Q13f 1Q14f
Output and Demand
Real GDP growth 6.2 6.3 6.5 6.1 6.1 6.4 6.3 6.4 6.7
Private consumption 5.3 5.5 5.7 5.4 5.5 5.3 5.4 5.9 5.7
Government consumption 1.2 3.7 5.2 -3.3 2.7 3.6 3.0 4.8 5.5
Gross fixed capital formation 9.8 8.9 9.6 7.3 7.8 8.2 9.7 9.7 10.9
Net exports (IDRtrn, 00P) 240.8 263.3 279.8 56.1 65.8 61.7 75.3 60.5 69.2
Exports 6.6 7.5 7.0 0.5 5.9 7.9 8.4 7.5 9.7
Imports 6.2 7.0 9.3 6.8 7.8 4.6 8.4 7.4 10.9
External
Merch exports (USDbn) 190 204 229 47 48 50 52 54 55
- % chg -6.7 7.1 12.3 -8.2 -2.0 2.6 12.9 15.5 16.5
Merch imports (USDbn)** 192 201 226 50 47 51 51 54 54
- % chg 8.1 4.9 12.6 4.9 3.0 -3.3 12.6 7.8 16.0
Merch trade balance (USD bn)** -2 3 2 -3 0 -2 1 1 0
Current account bal (USD bn) -24 -16 -14 n.a. n.a. n.a. n.a. n.a. n.a.
% of GDP -2.8 -1.5 -1.1 n.a. n.a. n.a. n.a. n.a. n.a.
Foreign reserves (USD bn, eop) 113 115 119 n.a. n.a. n.a. n.a. n.a. n.a.
Inflation
CPI inflation 4.3 5.3 5.4 4.4 5.0 5.1 5.4 5.8 5.1
Other
Nominal GDP (USDbn) 871 1,053 1,233 n.a. n.a. n.a. n.a. n.a. n.a.
Fiscal balance (% of GDP) -1.8 -2.4 -2.1 n.a. n.a. n.a. n.a. n.a. n.a.
* % change, year-on-year, unless otherwise specified
ID – policy rate
BI rate
13.5
12.5
11.5
10.5
9.5
8.5
7.5
6.5
5.5
Nov-05 Apr-08 Sep-10 Feb-13
ID – policy rate
BI rate
13.5
12.5
11.5
10.5
9.5
8.5
7.5
6.5
5.5
Nov-05 Apr-08 Sep-10 Feb-13
97

Malaysia
Economics–Markets–Strategy
MY: Strong fundamentals
• Growth has surprised on the upside in 4Q12 and should remain healthy
• Domestic growth should remain resilient; improvement can be expected
from the external front
• Expect healthy GDP growth of 5.5% for 2013 and 2014
• But inflationary pressure is picking up. We expect inflation to average
2.8% this year and 3.2% in 2014
• There is room for tightening in monetary policy. Look for 50bps of hikes
in 2H13
GDP growth for 4Q12 surprised on the upside. The headline number showed that
the economy has expanded by 6.4% YoY in the quarter, lifting the full year average
growth to 5.6% (Chart 1). This is way higher than the consensus forecast. Sequentially,
growth momentum picked up to 8.5% QoQ saar, from 5.2% in 3Q12 on the
back of the ramp-up in investment ahead of the election. Overall, this is the strongest
quarterly GDP growth since 2Q10 and much has to do with a resilient domestic
growth and significant improvement on the external front.
Improvement on the external front
Most will point to the strong domestic demand as the driver behind growth but
in effect, the improvement on the external front is the key reason for the upside
surprise in our opinion (Chart 2). Apart from the seasonal drop in December, export
and industrial output are still rising (Chart 3). Such upward trends came on the
back of a better global outlook. As it is, the risk from Europe has stabilised. The US
recovery, albeit proceeding slowly, remains on track. Growth momentum in Northeast
Asia has been healthy in 4Q12. The PMIs of key export markets have been improving
since then (Chart 4). That has been manifested in the improvement in net
exports, thereby providing a strong boost to overall GDP growth.
Chart 1: Steady growth
% YoY, % QoQ saar
15
%QoQ saar
10
5
0
8.5%
4.3%
Chart 2: Sharp improvement on the external front
YoY %-pt contribution
20
15
10
5
Net exports
Investment
Govt expenditure
Pvt consumption
GDP growth
MALAYSIA
-5
%YoY
-10
Latest: 4Q12
-15
Mar-09 Mar-10 Mar-11 Mar-12
0
-5
Latest: 4Q12
-10
Mar-10 Sep-10 Mar-11 Sep-11 Mar-12 Sep-12
Irvin Seah • (65) 6878 6727 • irvinseah@dbs.com
98

Economics–Markets–Strategy
Malaysia
Chart 3: Exports and mfg generally heading north
2005=100, 3mma
MYR bn, 3mma
135
Mfg IPI
68,000
130 Exports
66,000
64,000
125
62,000
120
60,000
Chart 4: Global PMIs recovering
Index
65
Singapore
China
60
55
EZ
US
115
110
105
Latest: Dec12
100
Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12
58,000
56,000
54,000
52,000
50,000
50
45
Latest: Feb13
40
Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13
The export decline moderated to just 1.5%YoY against a 3.0% drop in the previous
quarter. But it was the fall in import growth that provided the twist to the story.
Imports contracted for the first time since 3Q09, resulting in a sharp improvement
to the net exports as well as the overall GDP growth (Chart 5). The drag from net
export on GDP growth has thus eased sharply from -6.8%-pts to a mere -0.6%-pt.
This is the main reason GDP surprised on the upside.
Domestic demand still the key driver of growth
Domestic demand is still in the driving seat but it is slowing down. That’s probably
why import growth has fallen. The contribution from domestic demand to GDP
growth shrunk from 12.1%-pts to 7.1%-pts (Chart 2).
The slowdown in domestic growth is much in line with expectation and leading
indicators are also pointing to a gradual cooling off in the domestic sectors in the
coming quarters (Chart 6). As a matter of fact, domestic growth cannot continue
to grow at the previously rapid pace without stoking inflation. Such gradual slowdown
in the domestic engines will ensure that the current pace of growth can be
sustained into the longer term.
Chart 5 : Imports fell sharply
%-pt contribution
40000
Net exports
35000
Export growth
30000
Import growth
25000
20000
15000
10000
5000
Latest: 4Q12
0
Mar-10 Sep-10 Mar-11 Sep-11 Mar-12 Sep-12
35
30
25
20
15
10
5
0
-5
Chart 6: Domestic growth cooling
index
130
120
110
100
90
80
Consumer sentiment index
Biz condition
Latest: 4Q12
70
Mar-09 Mar-10 Mar-11 Mar-12
index
130
120
110
100
90
80
70
60
50
40
99

Malaysia
Economics–Markets–Strategy
Chart 7: Healthy growth ahead
MYR mn
240000
230000
220000
210000
200000
190000
180000
170000
160000
150000
GDP
GDP growth
DBSf
140000
Mar-11 Mar-12 Mar-13 Mar-14
% YoY
7.0
6.5
6.0
5.5
5.0
4.5
4.0
3.5
3.0
Chart 8: Inflation & monetary policy outlook
% YoY
4.0
Overnight Policy Rate
CPI inflation
DBSf
3.5
3.0
2.5
2.0
1.5
1.0
Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13
Growth forecasts raised
With such an upside surprise in the final quarter of the previous year, it raises the
growth trajectory for this year. We now expect full year GDP growth to register
5.5%, up from our previous forecast of 5.0%. Such healthy growth momentum is
also expected to persist into 2014, barring any significant downside risk from the
external environment. The economy will likely continue to cruise at a pace of 5.5%
in 2014 (Chart 7).
Upside risk to inflation; policy to stay vigilant
Latest January inflation posted a benign 1.3% YoY rise (Chart 8). In fact, average
inflation last year at 1.7% was the lowest amongst the Asia ex-Japan economies
(Chart 9). On the other hand, growth has been healthy and is expected to remain so
in the coming quarters. Indeed, Bank Negara kept the Overnight Policy Rate (OPR)
unchanged at 3.00% at the recent meeting on account of the favorable growth and
inflation outlook.
Chart 9: One of the best inflation profiles in 2012
% YoY
11.0
9.0
7.0
5.0
3.0
1.0
-1.0
100

Economics–Markets–Strategy
Malaysia
However, January inflation should mark the bottom of this current declining trend.
Beyond that, headline inflation is expected to trend steadily upwards. Persistently
strong domestic demand, coupled with the wage hikes and rapid increase in property
prices are stoking inflationary pressures. These factors will likely drive inflation
towards the 3% mark in the coming months (Chart 8).
Though market is not expecting any rate hike in the near term, risk of a monetary
action by the central bank in the second half of the year is rising if the authority
hope to anchor inflation expectations. Full year inflation is likely to average 2.8%
this year and probably 3.2% in 2014. This calls for policy vigilance and possibly upward
adjustment in the policy rate to pre-empt against rising inflationary pressures
and anchor inflation expectations. We expect the central bank to hike the OPR by
50bps in the second half of the year to take the policy rate to 3.50%.
Strong political will
required to push
through reform
Economic transformation must persist despite political noises
Economic transformation should persist with or without election. As it is, Malaysia
will have its election soon. In the previous election in 2008, the incumbent Barisan
Nasional coalition suffered a shocking setback. Apart from losing key states such
as Penang, Selangor, Perak, Kedah and Kelantan to opposition parties, it was also
denied a two-third majority in the parliamentary seats. Its vote share was also drastically
eroded to 63%, down from the record-high 91% achieved in its 2004 victory.
Beyond politics, Malaysia is in the midst of transforming its economy. The New Economic
Model (NEM) that was announced in conjuncture with the Tenth Malaysia
Plan (10MP) in 2010 seeks to achieve an average GDP growth of 6.5% per annum
over 2011-2020 and double per-capita income to USD 15,000, up from USD 7,500
back in 2010.
Declining competitiveness, falling productivity, cumbersome bureaucratic procedures,
a poorly skilled workforce and outflow of talents are the key underlying
problems facing the economy. As a result, Malaysia has found itself sandwiched between
lower cost producers such as China, India and Vietnam and more developed
Asian economies such as Singapore, Taiwan and Korea over the last two decades.
As it is, Malaysia is now back on the radar screen of foreign investors. FDI and private
investment in the last 2-3 years have been rising. GDP growth has been healthy,
averaging 5.9% over the last three years while inflation has been manageable at
just 2.2% in the same period. The labour market has remained buoyant and asset
prices have risen steadily in recent years on the back of this domestic optimism. Indeed,
Malaysia seems to have struck the right note in its economic policies for now.
Nonetheless, risks remain in the form of high government debt and household
leverage while fiscal deficit needs to be trimmed further. To mitigate against such
risks and ultimately achieve the longer term economic objectives, much will depend
on the political will to push through tough reform measures. So regardless of the
outcome of the election result, continuity in policies to persevere with the current
transformation process will be crucial in the longer-term economic success of the
country.
101

Malaysia
Economics–Markets–Strategy
Malaysia Economic Indicators
2012 2013f 2014f 4Q12 1Q13f 2Q13f 3Q13f 4Q13f 1Q14f
Real output and demand
GDP growth 5.6 5.5 5.5 6.4 6.0 5.8 5.6 4.7 5.1
Private consumption 7.7 7.1 7.4 6.1 7.0 7.2 7.3 6.8 7.0
Government consumption 5.0 5.6 6.0 1.1 11.0 5.4 4.0 3.5 6.2
Gross fixed capital formation 19.9 9.7 7.2 14.9 11.8 10.0 9.2 8.0 7.4
Exports 0.1 2.6 6.1 -1.5 1.1 1.4 3.9 4.0 6.4
Imports 4.5 4.0 7.9 -0.9 0.2 3.3 4.4 7.8 8.5
External (nominal)
Exports (USD bn) 231 245 254 58 60 62 62 61 60
Imports (USD bn) 199 223 233 50 55 56 56 56 55
Trade balance (USD bn) 31 22 21 9 5 6 6 6 5
Current account bal (USD bn) 19 12 8 n.a. n.a. n.a. n.a. n.a. n.a.
% of GDP 6 4 2 n.a. n.a. n.a. n.a. n.a. n.a.
Foreign reserves
(USD bn, yr-end) 149 157 165 n.a. n.a. n.a. n.a. n.a. n.a.
Inflation
CPI inflation 1.7 2.8 3.2 1.3 1.7 2.7 3.2 3.5 3.5
Other
Nominal GDP (USDbn) 304 328 346 n.a. n.a. n.a. n.a. n.a. n.a.
Fiscal balance (% of GDP) -4.5 -4.0 -3.6 n.a. n.a. n.a. n.a. n.a. n.a.
- % growth, year-on-year, unless otherwise specified
MY - nominal exchange rate
MYR per USD
3.80
3.70
3.60
3.50
3.40
3.30
3.20
3.10
3.00
2.90
Jan-07 Apr-08 Jun-09 Sep-10 Dec -11 Mar-13
MY – policy rate
%, OPR
3.7
3.4
3.1
2.8
2.5
2.2
1.9
Apr-04 Feb-06 Nov-07 Aug-09 May-11 Mar-13
102

Economics–Markets–Strategy
Malaysia
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103

Thailand
Economics–Markets–Strategy
TH: Momentum
• Growth will remain above average at 5% for 2013 and 2014. Momentum
from 4Q will spillover as many of the drivers of robust domestic
demand remain
• Low real rates for an extended period has resulted in sharp increases
in asset prices. With a positive output gap and higher inflationary risks
down the line, slower credit growth will be better for financial stability
• Low interest rates have not deterred inflows and baht strength is becoming
a source of concern for exporters
4Q GDP growth reached 3.6% QoQ sa (18.9% YoY), significantly above consensus
expectations. Taking into account revisions in the preceding quarter, full-year
2012 growth hit 6.4%, making the Thai economy the 2nd fastest in Southeast Asia
(behind the Philippines and just ahead of Indonesia). Base effects from the floods
in 4Q11 played a role towards these numbers, but the acceleration in sequential
growth in 4Q should not be understated. Favorable conditions including low interest
rates, low inflation and a hike in minimum wages have encouraged consumer
spending, especially in durable goods. Meanwhile, investment levels stayed elevated
as shown by the construction and machinery investment numbers. External
demand is something of a mixed bag with services exports and autos clearly outperforming.
2013 is going to be another strong year and growth of 5% has been penciled in.
Notably, the drivers for domestic demand – a substantial hike in minimum wages in
January, low interest rates and the rice pledging scheme – are still largely in place.
To be sure, there have been reports of operational issues with regards to the rice
pledging scheme. Stockpiles of rice have hit 17 mn tons and only a small portion of
the funds has been paid by the government to the state bank funding the scheme.
Chart 1: Domestic demand momentum remains strong
pct-pt contri
15
10
Latest: 4Q12
5
0
-5
THAILAND
-10
-15
Net Exports Inventories GFCF GCE PCE GDP
1Q07 1Q08 1Q09 1Q10 1Q11 1Q12
Eugene Leow • (65) 6878 2842 • eugeneleow@dbs.com
104

Economics–Markets–Strategy
Thailand
Chart 2: SET index
Index
1800
1600
Latest: Feb 13
1400
1200
1000
800
600
doubled and
doubled again
400
200
0
Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13
Chart 3: Property price indices
Jan-2009 = 100
150
140
Latest: Dec 12
130
120
110
100
Land
90
Condominium
80
Jan-09 Jan-10 Jan-11 Jan-12
The government has also proposed lowering the pledged rice price, but the proposal
has since been withdrawn. For this year, the impact of the rice-pledging scheme
is likely to be less as the government may cut the budget for the scheme from THB
405bn to THB 300bn in anticipation of a drought-related fall in harvest. However,
this is still considerable stimulus to the economy.
Meanwhile, the first car buyer rebate scheme has expired in end-2012. However,
only about 20% of the total 1.2mn applications have been delivered. Some 0.7-
0.8mn units are expected to be delivered this year implying that production numbers
are going to get a boost for 2-3 quarters this year.
For investment, a lot depends on the pace of implementation of the government’s
infrastructure plans. There has been progress on the new private-public partnership
law (expected to come into effect within the coming months), which should pave
the way for transport infrastructure bidding. Moreover, the external sector can be
a big swing factor this year. Aside from stabilization in the global economy, yen
weakness may prove to be a boon for car manufacturers.
With momentum in the domestic economy still strong, inflation levels are going to
creep up from current low levels. Moreover, the buildup of asset prices also bears
watching and the central bank is likely to be more vigilant about the pace of credit
growth going forward.
Watch out for excesses in asset prices
Conditions have been favorable for the buildup of asset prices over the last few
years. In 2009, the policy rate was lowered to 1.25% in response to the GFC, but
some normalization took place and the policy rate was raised to 3.5% by 3Q11.
The floods that hit in 4Q11 gave the BoT another reason to lower the policy rate to
the current level of 2.75%. As a result, the real policy rate (policy rate less headline
inflation) has been negative for the most part of the last three years. Currently, the
real policy rate stands at -0.5% in February. Thailand’s real policy rate is also one of
the lowest in the region.
Coupled with capital inflows, asset prices have risen. The SET index doubled between1Q09
(the GFC trough) and mid-2011. Since the floods of 4Q11, the index
has doubled again to 1530. Real estate prices have also risen, led by a 36% increase
in condominium prices over the past 4 years. Judging from the land price index
(viewed as a leading indicator), it is conceivable that property prices may be pushed
higher still. The rise in asset prices has outstripped that of the CPI index, which has
Asset prices have
greatly outstripped
consumer prices
105

Thailand
Economics–Markets–Strategy
Chart 4: Loan growth
% chg YoY
25
Individuals (LHS)
% chg YoY
30
Businesses
25
20
Latest: Dec 12
20
15
15
10
10
5
5
0
-5
0
-10
Jan-05 Jan-07 Jan-09 Jan-11 Jan-13
Chart 5: Output gap
THB mn, 1988 prices
60000
40000
20000
0
-20000
-40000
-60000
-80000
-100000
-120000
Latest: 4Q12
*derived from HP filter after
seasonal adjustment
-140000
1Q00 1Q02 1Q04 1Q06 1Q08 1Q10 1Q12
risen by a cumulative 15% over the same period. The question facing the BoT is
whether the policy rate is too low and is encouraging excessive speculation in the
property and equity markets, especially in view of the massive ramp up in asset
prices already.
BoT has to balance
inflation
risks against baht
strength
Positive output gap and inflationary pressures looming
Lower rates will add to inflationary pressures. To be sure, core inflation has been
muted thus far, coming in at 1.6% YoY (headline inflation stood at 3.2%) in January.
An adjustment in electricity prices and elevated food prices are the main reasons
behind the difference in headline CPI and core inflation over the past several
months. However, the low core inflation rate cannot be sustained in light of the
strengthening economy. The output gap, which has been positive over the last
three quarters, rose to its highest level since early-2008, suggesting that demandpull
inflation is likely in coming quarters.
Loan growth has also been robust in recent months, mirroring strong GDP growth.
With credit growth (especially consumer credit) already above trend, there is little
need for BoT to further stimulate the economy as this would only add to price pressures.
Notably, while rates need to stay relatively low to support the government’s
infrastructure projects, the divergence in consumer and business credit growth
bears watching. The fast pace of consumer debt accumulation could lead to an
increase in non-performing loans (NPLs) when the cycle turns. The BoT has already
sounded warnings on this and is likely to pursue a more moderate pace of consumer
loan growth. All these points suggest that the policy rate is not going lower.
Striking the balance with baht strength
Despite relatively low interest rates, there have still been sizable inflows over the
past several quarters. This has helped the baht to appreciate against the greenback
and concerns are mounting about excessive baht strength eroding export competitiveness.
There have been calls for BoT to lower the policy rate to discourage inflows.
However, the interest rate differential is not the only factor affecting portfolio
flows. A lower policy rate would not necessarily bring about a weaker baht.
Rather, the BoT would run the risk of a further buildup in asset prices and inflation.
106

Economics–Markets–Strategy
Thailand
Thailand Economic Indicators
2012 2013f 2014f 4Q12 1Q13f 2Q13f 3Q13f 4Q13f 1Q14f
Real output and demand
GDP growth (88P) 6.4 5.0 5.0 18.9 5.3 5.0 5.6 4.2 4.2
Private consumption 6.6 4.4 4.1 12.2 7.1 3.9 4.0 2.7 4.1
Government consumption 7.4 5.5 4.6 12.1 9.3 5.1 3.7 4.8 6.0
Gross fixed capital formation 13.3 5.8 6 23.5 9.8 5.4 3.5 4.8 6.7
Net exports (THBbn) 657 742 817 173 214 178 142 208 240
Exports 3 9 6 19 9 11 8 9 6
Imports 6 8 5 15 7 7 12 6 4
External
Merch exports (USDbn) 226 237 260 56 55 57 61 65 66
- % YoY 3 5 10 18 2 0 3 15 6
Merch imports (USDbn) 219 229 254 56 57 55 57 60 61
- % YoY 8 5 11 16 8 -1 5 6 7
Trade balance (USD bn) 7 8 6 0 -2 2 4 5 5
Current account balance (USD bn) 1 1 2 1 -3 -2 2 7 6
% of GDP 0.6 1.2 2 n.a. n.a. n.a. n.a. n.a. n.a.
Inflation
CPI inflation 3.0 3.6 3.7 3.2 3.4 3.7 3.6 3.6 3.6
Other
Nominal GDP (USDbn) 366 415 468 n.a. n.a. n.a. n.a. n.a. n.a.
Unemployment rate, % 0.5 0.6 0.6 n.a. n.a. n.a. n.a. n.a. n.a.
Fiscal balance (% of GDP)** -2.9 -2.7 -2.2 n.a. n.a. n.a. n.a. n.a. n.a.
* % change, year-on-year, unless otherwise specified
** Central govt cash balance for fiscal year ending September of the calendar year
TH - nominal exchange rate
THB per USD
37
36
35
34
33
32
31
30
29
Jan-07 Mar-08 Jun-09 Sep-10 Dec -11 Mar-13
TH – policy rate
%, 1-day RRP
5.0
4.5
4.0
3.5
3.0
2.5
2.0
1.5
1.0
107

Singapore
Economics–Markets–Strategy
SG: Cyclical improvement,
structural drag
• Near term cyclical dynamics for the key manufacturing and services
sectors are improving given the better global economic conditions
• GDP growth forcast for 2013 is maintained at 3.2% and it should average
4.0% in 2014
• Inflation is still a problem and it is structural in nature. That makes for
higher than normal inflation of 4.0% in 2013 and 4.2% in 2014
• The Monetary Authority of Singapore (MAS) is expected to maintain
the appreciation of the Sing NEER in the upcoming April review
The economy expanded 3.3% QoQ saar (1.5% YoY) in the final quarter of 2012
(Chart 1). This was an upward revision from the advance estimate of 1.8% QoQ
saar (1.1% YoY). It also marked a turnaround in the growth trajectory from the
4.6% decline in the previous quarter. This brought full-year GDP growth to 1.3%,
the slowest full year growth since 2009 as well as the weakest in East Asia in 2012.
Manufacturing turning around
The main drag came from the manufacturing sector although the other sectors
performed poorly as well. Weak demand from the developed economies was a key
factor. But we reckon there are structural constraints as well.
The drastic decline in Singapore’s export competitiveness was certainly one key
factor behind the poor outcome. The export sector, which is still an important engine
for the economy, is facing a double whammy from higher-than-average inflation
and a stronger Sing dollar. Together, these two factors exerted tremendous
pressure on margins. This mainly explains the decline in the manufacturing sector,
and probably also the pressure faced by other sectors too.
Chart 1: Growth bottomed in 3Q12 and recovered in 4Q12
% YoY, % QoQ saar
40
30
20
% MoM saar
10
% YoY
3.3%
SINGAPORE
0
-10
-20
GDP bottomed in 3Q12
Latest: 4Q12
Mar-10 Sep-10 Mar-11 Sep-11 Mar-12 Sep-12
1.5%
Irvin Seah • (65) 6878 6727 • irvinseah@dbs.com
108

Economics–Markets–Strategy
Singapore
Chart 2: Global PMIs recovering
Index
65
Singapore EZ
China
US
60
55
50
45
Latest: Feb13
40
Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13
Chart 3: NODX and IPI bottoming
2011=100, sa
104
SGD mn, sa
17,000
102
IPI , ex-biomedical (LHS)
16,500
16,000
100
15,500
98
15,000
96
14,500
94 NODX, ex pharma
14,000
13,500
92
13,000
90
12,500
Jan-12 Apr-12 Jul-12 Oct-12 Jan-13
In fact, the compounded effects of the tightening in the exchange rate policy as well
as the foreign labour policy imply that Singapore will continue to underperform in
terms of growth and inflation profiles within the region. The phenomenon of slow
growth, high inflation will persist in the coming quarters. Structural factors are at
play, resulting in such poor performance.
On a cyclical basis, we expect a gradual improvement in the higher frequency data in
the coming months, led by a possible recovery in China investment growth. Though
uncertainties remain, the PMIs for key export markets have been rising (Chart 2).
Stripping out the volatility from the biomedical cluster, exports and industrial production
also appeared to be bottoming-out (Chart 3). All in all, a steady improvement
for the manufacturing sector can be expected from the second quarter onwards.
Global demand for electronics is also improving (Chart 4). The SEMI book-to-bill ratio
is back to above parity level while global semiconductor sales growth has turned
positive. But Singapore’s electronics cluster has been a laggard to the global electronics
cycle due to its high cost, the strong Sing dollar and the fact that local manufacturers
are not that well plugged into the smartphone supply chain. A uptick in
the Feb13 electronics PMI may provide a glimmer of hope but it remains to be seen
whether this will be sustainable.
Services sector growth is key
More importantly, the services
sector improved in
4Q12. Year-on-year growth
in this sector has been declining
steadily over the last
two years. But it grew 1.7%
YoY in 4Q12, up from the
flat growth in the previous
quarter. Sequentially, it expanded
2.5% MoM saar in
4Q12 against a sluggish 0.4%
rise in the third quarter. Now
this sector accounts for about
68% of overall GDP. If this
sector turns, the entire economy
will move along with
it. This has been evident on
several occasions in previous
years (Chart 5).
Chart 4: Electronics turning north
Index
1.60
Growth in semicon sales
1.50
1.40
1.30
1.20
1.10
1.00
0.90
0.80
SEMI book-to-bill ratio (LHS)
% YoY
60
-10
-20
0.70
Latest: Jan13
-30
0.60
-40
Jan-11 Jul-11 Jan-12 Jul-12 Jan-13
50
40
30
20
10
0
109

Singapore
Economics–Markets–Strategy
Chart 5: GDP and services sector growth
% YoY
25
20
15
GDP growth
Services growth
10
5
0
-5
-10
-15
Mar-76 Mar-82 Mar-88 Mar-94 Mar-00 Mar-06 Mar-12
Growth to register
3.2% in 2013
While the further tightening by the government on foreign labour inflow may impede
the growth performance for this sector, the return in investor confidence as
well as stronger intra-regional trade will provide the necessary impetus for services
growth in the coming quarters.
Overall, the global economic outlook appeared to have stabilised. The US economy
has weathered the fiscal cliff well so far, but growth will remain below potential.
Barring a relapse in the Eurozone crisis, Asia’s growth is gaining momentum,
spearheaded by an improvement in China. Against such a backdrop, we continue
to maintain our full year GDP growth forecast of 3.2% for the year. Growth momentum
in the near term will remain flattish but it should pick up from the second
quarter onwards (Chart 6). Beyond 2013, we expect growth to return back to the
potential growth level of 4%.
Structural inflation
Headline CPI inflation for Jan13 registered 3.6% YoY, down from 4.3% in the previous
month. Frankly, there’s nothing to cheer about as this is still significantly higher
than the 30 years historical average of 2.0%, and came largely against the backdrop
Chart 6: Growth to improve
% YoY, %-pt contribution
25
20
15
10
Services Producing Industries
Goods Producing Industries
GDP growth
DBSf
2012: 1.3%
2013f: 3.2%
5
0
-5
Mar-10 Sep-10 Mar-11 Sep-11 Mar-12 Sep-12 Mar-13 Sep-13
110

Economics–Markets–Strategy
Singapore
Chart 7: Inflation will remain higher than normal
% YoY
9
8
DBSf
7
6
5
4
3
Historical avg.
2
1
0
-1
-2
Jan-10Jul-10Jan-11Jul-11Jan-12Jul-12Jan-13Jul-13
Chart 8: COE prices & transport CPI rising
SGD Index, 2009=100
120,000
100,000
80,000
60,000
40,000
20,000
Avg mthly COE prices
(open cat.)
Transport CPI (RHS)
Latest: Jan13
145
140
135
130
125
120
115
110
105
0
100
Jan-10 Jan-11 Jan-12 Jan-13
of the high base in Jan12. Inflation will remain sticky and is expected to average
4.0% throughout the year (Chart 7). In 2014, inflation will remain high and could
possibility rise to 4.2% against the backdrop of further curbs on foreign labour.
Plainly, Singapore’s inflation is structural in nature and largely driven by policy
changes in recent years. Curbs on the foreign labour and the tightening in COE
quota have driven up business costs, which are consequently passed on to consumers.
These measures are unlikely to be unwound in the near term and that makes for
continued upward pressure on prices.
In addition, the recent tightening on vehicle financing and the hikes in vehicle taxes
may have some impact on inflation. The Monetary Authority of Singapore (MAS)
has recently re-introduced financing curbs on vehicle loans. Cars with an Open Market
Value (OMV) that does not exceed SGD 20,000 will now face a maximum loan
to value (LTV) of 60%. For a motor vehicle with OMV of more than SGD 20,000, the
maximum LTV is now 50%. This is down from a maximum LTV of 100% previously. In
addition, the tenure for vehicle loan has also been capped at 5 years.
These changes essentially require consumers to put up substantially more cash upfront,
which in effect, has already slammed the brake on car demand. COE premiums
have already plunged sharply, which will have knock-on effect on CPI inflation.
The only factor that is keeping the situation afloat for now is that the financing
companies not registered with the central bank will still be able to offer car loan at
previous levels of LTV. But this gap is expected to be closed in the coming months
by policymakers determined to clamp down on the excessive household leverage.
Separately a tiered structure for vehicle taxes (i.e. Additional Registration Fee, ARF),
where more expensive cars pay higher tax rates, have also been introduced in the recent
budget. This will essentially raise the underlying cost of a motor vehicle. These
higher tax rates, which will eventually be passed on to consumers, may offset the
downside impact of the LTV tightening on CPI inflation.
That is, the effects on the headline CPI inflation from both policy changes will be
opposing in nature. The hikes in taxes will drive private transportation cost higher
whereas the fall in COE premiums will bring it down. Private transport cost accounts
for 11.66% of the entire CPI basket and it has been rising steadily in recent years
(Chart 8). Our assessment is that there could be slight downside surprise on the CPI
inflation in the coming months as the effects of the loan curbs will likely override
that of the tax hikes.
Higher than normal
inflation will
persist
111

Singapore
Economics–Markets–Strategy
No change in April
meeting
Nonetheless, along with the rapid rise in property prices/rental and the factors mentioned
above, domestic inflationary pressure will continue to remain high. Even if
inflation is set to ease and may surprise slightly on the downside, it’ll remain higher
than usual in the coming years due to the structural shift in the economy.
MAS to stand pat on policy in April
Inflation will likely ease and possibly even surprise on the downside in the coming
months. Growth, on the other hand, will remain subdued but will probably be
faster than the sluggish pace of 1.3% last year. Indeed, both inflation and growth
outlook will likely remain stable in the coming 12 months. That essentially makes
for a stable monetary policy come April when the central bank meets again to decide
on the exchange rate stance going forward.
We expect the Monetary Authority of Singapore to maintain its current Sing dollar
Nominal Effective Exchange Rate (NEER) appreciation in the coming review. The authority
is also likely to keep the slope and the width of the policy band unchanged.
112

Economics–Markets–Strategy
Singapore
Singapore Economic Indicators
2012 2013f 2014f 4Q12 1Q13f 2Q13f 3Q13f 4Q13f 1Q14f
Real output and demand
Real GDP (00P) 1.6 3.2 4.0 1.5 0.7 1.9 4.7 5.3 5.2
Private consumption 2.2 1.8 3.0 2.0 1.0 1.6 2.1 2.5 2.7
Government consumption -3.3 4.1 2.7 -4.6 2.0 3.4 3.7 7.4 1.3
Gross fixed investment 7.4 6.2 4.2 5.8 2.0 6.7 8.2 8.0 4.3
Exports 0.3 3.6 4.1 -1.9 1.1 1.9 4.4 7.0 5.3
Imports 3.2 2.2 4.3 3.5 1.2 2.3 2.5 2.9 4.9
Real supply
Manufacturing 0.1 3.3 3.3 -1.1 -3.7 -0.2 8.3 9.0 7.4
Construction 8.2 6.5 4.1 5.8 8.6 9.4 4.3 4.1 4.1
Services 1.2 2.8 4.3 1.7 1.7 2.4 3.2 4.0 4.5
External (nominal)
Non-oil domestic exports 0.5 3.2 5.0 -4.2 -1.0 1.2 4.9 8.0 2.7
Current account balance (USD bn) 51 54 57 n.a. n.a. n.a. n.a. n.a. n.a.
% of GDP 18 18 19 n.a. n.a. n.a. n.a. n.a. n.a.
Foreign reserves (USD bn) 259 272 281 n.a. n.a. n.a. n.a. n.a. n.a.
Inflation
CPI inflation 4.6 4.0 4.2 4.0 3.8 3.9 4.0 4.3 4.5
Other
Nominal GDP (USDbn) 277 296 308 n.a. n.a. n.a. n.a. n.a. n.a.
Unemployment rate (%, sa, eop) 2.0 2.2 2.5 1.8 1.9 2.0 2.1 2.2 2.3
- % change, year-on-year, unless otherwise specified
SG - nominal exchange rate
SGD per USD
1.60
1.55
1.50
1.45
1.40
1.35
1.30
1.25
1.20
1.15
Jan-07 Mar-08 Jun-09 Sep-10 Dec -11 Mar-13
SG – 3mth SIBOR
% pa
4.0
3.5
3.0
2.5
2.0
1.5
1.0
0.5
0.0
Jan-01 Jan-03 Jan-05 Jan-07 Jan-09 Jan-11 Jan-13
113

Philippines
Economics–Markets–Strategy
PH: Sweet spot
• Momentum remains strong in the domestic economy. GDP growth is
expected to reach 6% in 2013 and 2014
• Despite strong growth, inflation dynamics remain favorable. Inflation is
projected to average 3.8% and 4.2% in 2013 and 2014 respectively.
• Low inflation and moderate credit growth provide leeway for the central
bank to manage portfolio inflows by keeping the policy rate low
• Price pressures will become apparent in 4Q. One 25bps rate hike has
been penciled in by the end of 2013
2012 was a stellar year. 4Q GDP growth reached 6.8% YoY, significantly outperforming
consensus expectations (6.3%) and taking full-year growth to an impressive
6.6% (the fastest in Southeast Asia). Sequentially, growth accelerated to 1.8%
QoQ sa, from 1.3% in the preceding quarter, shrugging off any impact from a lackluster
global economy. This comes in stark contrast to 2009 when the Philippine
economy was dragged down by weak global growth. There are three key reasons
for the economic resilience this time round.
Firstly, non-electronics manufacturing was able to offset the slump in electronics.
Overall, although manufacturing output numbers underperformed the broader
economy, things are nowhere as bad as in 2009. Secondly, the services sector have
held up very well, with the financial intermediation and the real estate, rent & business
activities components registering growth of 7.2% YoY and 7.7% YoY respectively.
Despite increased government spending, growth in public service remains a
laggard at 6.1%. Thirdly, a construction revival is currently underway and growth
in this sector hit 19.5% YoY in 2H. On the demand side, annual gross fixed capital
formation and government consumption numbers for 2012 were both markedly
Chart 1: Southeast Asia
Real GDP, % chg YoY
15.0
Latest: 4Q12
10.0
5.0
0.0
PHILIPPINES
-5.0
ID MY PH TH
-10.0
Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 Mar-12
Eugene Leow • (65) 6878 2842 • eugeneleow@dbs.com
114

Economics–Markets–Strategy
Philippines
stronger compared to 2011. Positive momentum is expected to spill over into 2013
and we have revised up our GDP growth forecast from 5.3% to 6.0%. For 2014,
growth is expected to be maintained at 6%.
Favorable growth/inflation dynamics
The economy is currently going through an extended period of high growth and
low inflation that stretched from 1Q12. This sweet spot is expected to last through
to 3Q13 before price pressures become uncomfortable. In 2012, while GDP growth
reached 6.6%, inflation stood at just 3.1%. This year, GDP growth is projected to
reach 6% and inflation is expected to average 3.8%. To put things in perspective,
the central bank (BSP) is targeting an inflation band of between 3-5% for 2013
and 2014. Notably, momentum in the domestic economy remains strong with sequential
private consumption growth averaging 1.7% QoQ sa over the last three
quarters of 2012. Consumer confidence rose to a two-year high in 4Q12 and car
sales rose sharply over the last few months.
Meanwhile, investment growth will become increasingly important over the medium
term. Currently, gross fixed capital formation (GFCF) makes up around 20%
of GDP, but this figure is set to increase in the coming years. As a reference, Indonesia’s
GFCF made up 25% of GDP in 2012. The current administration has helped
to transform the country’s image as an investment destination through fiscal reforms,
clampdowns on corruption and the introduction of multiple private-publicpartnership
(PPP) projects. Over the last few quarters, there has been significant
progress on the PPP projects with two projects already awarded and six others in
the live bidding phase. Construction on these infrastructure projects will help propel
GFCF growth.
Moreover, congressional elections are due in mid-2013. Government spending is
likely to stay elevated through 1H before tapering off slightly in the second half
of this year. On the external front, exports should get a lift from stabilization in
the major economies and acceleration in the Chinese economy. However, a turn
in electronics exports will be more difficult to call, given a high concentration in
semiconductors. There has not been much positive impact from increased demand
for smartphones and mobile devices. Non-electronics manufactured goods such as
machinery & transport equipment should continue to perform.
Growth is going
to be higher while
inflation stays low
BSP has flexibility to deal with inflows.
The central bank (BSP) has relatively more flexibility to deal with inflows than
many of its Asian counterparts. Over the past several quarters, price pressures were
well-contained as food prices generally remained stable. Moreover, credit growth
has not been excessive despite the upswing in 2H last year. In fact, the breakdown
Projects Value (PHP bn) Situation
Automatic Fare Collection System 1.80 Live bidding phase
LRT Line 1 (Cavite Extension and O & M) 59.20 Live bidding phase
Mactan-Cebu International Airport
Passenger Terminal
10.15 Live bidding phase
Modernization of the Philippine
Orthopedic Center
5.00 Live bidding phase
NAIA Expressway Project (Phase II) 15.77 Live bidding phase
Angat Hydro Elec. Power Plant (O & M) 1.60 Live bidding phase
PPP for School Infrastructure Project 10.04 Awarded (phase1)
DaangHari – SLEX Link Road 1.96 Awarded
Source: PPP Center
115

Philippines
Economics–Markets–Strategy
Chart 2: Rate response needed by end-2013
% YoY
6.0
5.5
DBSf
5.0
4.5
4.0
3.5
3.0
2.5
2.0
CPI
OBR (%)
Latest: Feb 13
1.5
1.0
Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13
Chart 3: Balance of payments
USD bn
10
Capital & financial acct
8
Current acct
6
4
2
0
-2
-4 Latest: 3Q12
-6
Mar-02 Mar-04 Mar-06 Mar-08 Mar-10 Mar-12
BSP has leeway to
manage inflows
of loan growth indicates that business loans have been accelerating while that of
consumption loans has not (despite the pickup in private consumption). Going forward,
although accelerating credit growth and the robust domestic economy imply
rising price pressures, headline inflation is unlikely to breach 4% decisively until
close to the end of the year. This provides BSP the leeway to deal with the problem
of strong portfolio inflows.
The current account has been in a surplus position averaging over 3.7% of GDP
over the last five years. This is due in large part to the surplus in transfer payment
(remittance) balance and services balance (driven by increasing success in the business
process outsourcing sector) that was more than able to offset the merchandise
trade deficit. Regarding the financial account, improving foreign investor perception
about the viability the Philippines as an investment destination has also led to
substantial portfolio inflows. Coupled with accommodative monetary policy and
quantitative easing in the developed markets, the financial account was also in
surplus for the most part of the last three years. As such, it is not surprising that the
Philippine stock exchange index and the peso have been pushing higher.
Excess liquidity in the system can be a threat to financial stability when the cycle
turns and inflows become outflows. In response to inflows, BSP has been taking
measured steps including letting the peso strengthen against the greenback and
accumulating foreign reserves. Since mid-2012, foreign reserves have risen by USD
9bn and stood at USD 85bn in January. With the peso’s nominal effective exchange
rate is already pushing to multi-year highs, export competitiveness is becoming
more of a worry. With moderate credit growth, no external funding concerns and
still-low inflation, BSP will be able to keep rates low to limit excessive speculative
inflows. Several macro-prudential measures have also been introduced including
the increasing of capital charges for on-deliverable forwards (NDFs), limiting foreign
banks’ exposure to NDFs, tightening of rules for access to the BSP’s special
deposit accounts (SDAs) and a reduction in rates for SDAs.
It is unlikely that BSP will further cut the benchmark overnight borrowing rate
(OBR) to reduce portfolio inflows. Moreover, price pressures are likely to become a
problem by the end of the year and we think that a rate hike cycle will be in place
by 4Q. In the near term, however, further macro-prudential measures are likely
forthcoming. Possible measures include a further reduction in SDA rates and setting
a minimum holding period requirement for the holding of securities. If needed,
hikes in the reserve requirement ratio would probably be utilized to moderate the
pace of loan growth.
116

Economics–Markets–Strategy
Philippines
Philippines Economic Indicators
2012 2013f 2014f 4Q12 1Q13f 2Q13f 3Q13f 4Q13f 1Q14f
Real output and demand
Real GDP growth 6.6 6.0 6.0 6.8 6.0 5.8 5.6 6.3 6.2
Private consumption 6.1 5.6 5.8 6.9 6.2 5.7 5.2 5.2 5.9
Government consumption 11.8 4.4 2.4 9.1 7.0 4.5 3.0 3.0 2.0
Gross fixed capital formation 8.7 6.7 6.7 10.6 7.3 6.4 6.4 6.9 7.6
Net exports (PHP bn, 00P) -6.3 -66.5 -49.4 -112.1 -4.6 13.4 32.7 -108.0 -1.6
Exports 8.7 3.3 5.2 9.1 -3.1 3.8 6.7 6.5 4.3
Imports 4.2 5.3 4.5 4.6 6.5 4.5 5.6 4.9 3.9
External (nominal)
Merch exports (USD bn) 52.0 54.1 58.5 11.9 12.7 13.3 13.9 14.2 14.4
- % YoY 7.6 4.0 8.1 9.1 -1.4 -4.2 4.4 19.0 13.4
Merch imports (USD bn) 61.6 64.8 68.9 15.5 15.6 16.0 16.4 16.8 17.1
- % YoY 1.8 5.3 6.3 5.8 0.6 4.9 7.3 8.2 9.6
Merch trade balance (USD bn) -9.6 -10.7 -10.4 -3.6 -2.9 -2.7 -2.5 -2.6 -2.7
Current account balance (USD bn) 8 7 7 n.a n.a n.a n.a n.a n.a
% of GDP 3.1 2.5 2.3 n.a n.a n.a n.a n.a n.a
Foreign reserves, USD bn 84 93 100 n.a n.a n.a n.a n.a n.a
Inflation
CPI inflation 3.1 3.8 4.2 3.0 3.3 3.7 3.9 4.4 4.5
Other
Nominal GDP (USD bn) 250 289 321 n.a n.a n.a n.a n.a n.a
Budget deficit (% of GDP) -2.5 -2.2 -1.9 n.a n.a n.a n.a n.a n.a
Govt external debt (USD bn) 48 48 48 n.a n.a n.a n.a n.a n.a
% of GDP 19 17 16 n.a n.a n.a n.a n.a n.a
* % change, year-on-year, unless otherwise specified
PH - nominal exchange rate
PHP per USD
52
50
48
46
44
42
40
Jan-07 Mar-08 Jun-09 Sep-10 Dec -11 Mar-13
PH – policy rate
%, o/n rev repo
11.5
10.5
9.5
8.5
7.5
6.5
5.5
4.5
3.5
Feb-01 Jul-03 Dec -05 May-08 Oct-10 Mar-13
117

Vietnam
Economics–Markets–Strategy
VN: Sustainable growth
• Inflation is rising but we think the pick up will be transient
• Full-year inflation will likely moderate to 7.5% in 2013 and 6.8% in
2014, down from 9.3% in 2012
• Still, the central bank is expected to hold rates steady through the
end of the year
• Growth has eased to 5.0% last year but should improve gradually to
5.6% this year and 6.0% in 2014
• The government is embarking on a reform path to ensure longer-term
sustainable growth
The State Bank of Vietnam (SBV) cut policy rates by 100bps at the end of last year
(Chart 1). This brought the refinance rate to 9.00% and the discount rate to 7.00%.
While this is consistent with our view that there is room for monetary easing given
the moderation in inflationary pressure in 2012, the rate cuts came earlier than expected,
thereby raising fears that the central bank could be heading for the same
mistake it made years ago. And this fear is further compounded by the fact that
inflation has once again picked up after the rate cuts.
Vigilance on inflation is crucial to economic stability
Having a tight rein on inflation is crucial in maintaining longer-term economic stability.
The central bank has adopted a calibrated approach in the current easing cycle.
Although it has delivered a total of 600bps cuts since early 2012, it has ensured
that the pace of easing has been conditional on the decline in inflation (Chart 1).
This is very unlike the episode in 2008/09 when the monetary easing was premature
and too aggressive. This cautious pace of easing has ensured that real policy rates
remain in positive territory in the current cycle.
Chart 1: SBV expected to stand pat for now
%, % YoY
Discount rate
30
Refinance rate
25
CPI inflation
Prime rate
20
15
10
VIETNAM
5
Latest: Feb13
0
Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13
Irvin Seah • (65) 6878 6727 • irvinseah@dbs.com
118

Economics–Markets–Strategy
Vietnam
Chart 2: Inflationary pressure slightly higher
% MoM sa
CPI inflation, %
5.0
MoM
4.0
3.0
2.0
1.0
0.0
Food inflation, %
MoM
CPI inflation, %
YoY
-1.0
Latest: Feb13
Jan-11 Jul-11 Jan-12 Jul-12 Jan-13
% YoY
25
20
15
10
5
0
Chart 3: GDP growth by key sectors
% YoY
14
10
6
2
Latest: 4Q12
-2
Real GDP growth
-6 Construction
Agri, forestry & fishery
-10 Industry
Services
-14
Mar-10 Sep-10 Mar-11 Sep-11 Mar-12 Sep-12
Indeed, apart from the calibrated approach taken in the current round of monetary
easing, it is worth noting that SBV has been more responsive during the hiking
phase compared to 2008/09. The central bank was more reluctant in hiking interest
rates in the previous round but has been more decisive this time round.
For now, the central bank still has the upper hand on inflation. Any further cut in
the policy rates in the near term before a more significant decline in inflation would
risk losing this hard-earned advantage. So despite the rhetoric from top political
leaders for lower rates to accommodate growth, we expect the SBV to keep a tight
rein on inflation for now by keeping the policy rates steady
Moreover, inflation has picked up in recent months (Chart 2). The most recent Feb13
inflation registered 7.0% YoY, up from 6.8% in Dec12. The pick-up in inflationary
pressure on the margin is even more pronounced. The CPI index rose by 1.3% MoM
sa in February against a benign 0.3% in December.
That said, we do not think that inflation risk is at a threatening level as long as the
authority is able to hold rates steady for now. The recent pick up in price pressure is
probably just a result of the Tet festive season and it should be transient in nature.
As it is, it is led by food inflation, which typically will rise during any festive season.
The only concern is that food items accounts for about 40% of the total CPI basket
and is often the key driver of inflation in Vietnam.
If food inflation picks up rapidly, it would surely lift overall CPI inflation. Because
the current rise in food inflation appears to be demand-driven, there is a need for
the central bank to anchor inflation expectations to prevent second round effects.
With that, we expect the central bank to hold rates steady for now before resuming
its easing cycle towards the end of the year. That’s when inflation is expected to dip
more significantly. We expect another 100bps cut in the fourth quarter of this year.
Inflation on the other hand, should average 7.5% this year and 6.8% in 2014. This
is down from 9.3% in 2012.
Easing cycle nearing
the end
Towards more sustainable growth
Against the backdrop of tight monetary policy, GDP growth in 2012 slowed to 5.0%,
down from 6.0% in 2011. Although a marked improvement was made in the construction
sector, it is largely due to the low base in Dec11 when the government
tightened its belt on many developmental projects to rein in the widening fiscal
deficit. Generally, the growth pace across the board has moderated, particularly for
the key manufacturing and the services sectors.
119

Vietnam
Economics–Markets–Strategy
Towards sustainable
growth and
economic stability
While current growth profile pales in comparison to Vietnam’s historical track record,
the moderation is positive. The country has pursued a “growth at all cost”
strategy for years that had led to the roller-coaster inflation and instability.
In fact, policymakers are trying hard to institutionalize the focus on economic stability
rather than outright growth. Recently, Prime Minister Nguyen Tan Dung has
approved a scheme on the country’s overall economic restructuring from 2013 till
2020. The scheme aims to switch the country’s growth model towards improved
quality, efficiency and competitiveness.
Specifically, the scheme will focus on restructuring public investment, state-owned
enterprises (SOEs) and credit institutions to lay foundations for sustainable growth.
Under the scheme, the government aims to maintain a stable macroeconomic environment,
with monetary policies to be implemented cautiously together with fiscal
policies to curb inflation, secure macro stability and sustain a sound growth rate.
So gone are the days when GDP growth always came in above 7%. A more sustainable
pace of growth would probably prove to be about 6.0%. Barring any significant
downside to the global economy, we expect full-year GDP growth of 5.6% in
2013. If inflation remains manageable and reforms are introduced, growth could
rise to 6.0% in 2014. We maintain our view that Vietnam remains on track to
achieve longer-term stability.
Improvement on external balance supports stable currency
The improving external balances are strong testaments that economic stability is
finally taking hold in Vietnam. Export growth has continued to outstrip import
growth despite the challenging external environment. The investment in high
value-added manufacturing in previous years is paying off. Moreover, the government’s
effort to cool the economy and to slow imports is also taking effect.
Vietnam recorded its first annual trade surplus for the first time since 1992. Overall
trade surplus registered USD 780mn (0.6% of nominal GDP) in 2012, up from a
deficit of USD 9.8bn in 2011 (Chart 4 & 5). This has lifted the current account to a
surplus position. As long as the central bank and political leaders remain focused on
stability, such healthy improvement on the external balances should persist.
Indeed, given the improving external balances, the Vietnamese dong will remain
stable. Our forecast is for the VND to hover at 20750 throughout 2013 given the
current economic stability.
Chart 4: External surplus to persist
% of nom. GDP DBSf
5
0
-5
-10
-15
-20
-25
-11.8
-19.8
-6.3
-13.2
-4.0
-11.8
-0.6
-8.0
2.5
3.8
0.6 1.9
Current account
balance
Trade balance
2008 2009 2010 2011 2012 2013
Chart 5: Stable dong amid trade surplus
USD mn
1000
500
0
-500
USD/VND
21500
21000
20500
20000
19500
19000
-1000
Trade balance
18500
18000
-1500
USD-VND (RHS)
17500
-2000
Latest: Mar13
17000
Jan-11 Jul-11 Jan-12 Jul-12 Jan-13
120

Economics–Markets–Strategy
Vietnam
Vietnam Economic Indicators
2012 2013f 2014f 4Q12 1Q13f 2Q13f 3Q13f 4Q13f 1Q14f
Real output and demand
GDP growth 5.0 5.6 6.0 5.5 5.3 5.3 5.8 5.9 5.7
Real supply
Agriculture & forestry 2.7 3.6 3.6 -0.5 4.0 3.4 3.0 4.1 3.8
Industry 5.2 6.4 6.4 4.8 5.8 6.1 6.7 6.8 6.1
Construction 2.1 3.0 7.0 12.2 0.0 3.1 4.2 3.0 4.0
Services 6.4 6.3 6.3 6.9 5.8 6.1 6.4 6.7 6.1
External (nominal)
Exports (USD bn) 114.4 129.8 143.4 31.0 28.9 30.9 34.1 36.0 33.3
Imports (USD bn) 112.4 127.1 140.9 30.0 27.2 31.9 33.3 34.8 31.4
Trade balance (USD bn) 2.0 2.8 2.5 1.0 1.8 -1.0 0.8 1.2 1.9
Current account bal (USD bn) 3.5 6.0 8.2 n.a. n.a. n.a. n.a. n.a. n.a.
% of GDP 2.5 3.8 4.7 n.a. n.a. n.a. n.a. n.a. n.a.
Inflation
CPI inflation 9.3 7.5 6.8 7.0 7.2 8.2 8.2 6.3 6.6
Other
Nominal GDP (USDbn) 142 158 174 n.a. n.a. n.a. n.a. n.a. n.a.
Unemployment rate (%, sa, eop) 4.8 4.6 4.3 n.a. n.a. n.a. n.a. n.a. n.a.
- % change, year-on-year, unless otherwise specified
- Figures may differ from official sources due to difference in reporting format
VN - nominal exchange rate
VND per USD
21300
20500
19700
18900
18100
17300
16500
15700
Jan-07 Mar-08 Jun-09 Sep-10 Dec -11 Mar-13
VN – prime interest rate
% pa
14.0
13.0
12.0
11.0
10.0
9.0
8.0
7.0
6.0
Jan-01 Jun-03 Nov-05 Apr-08 Sep-10 Feb-13
121

Economics: United States
Economics–Markets–Strategy
US: Progress under the hood
• The economy continues to grumble along at a 2% rate
• Consumption and investment remain notably subpar
• But things are happening under the hood
• Household leverage has fallen significantly. This is the most important
factor behind sustaining recovery in the days ahead
• Unemployment has fallen only a little (to 7.7%). But here too, progress
is being made under the hood. Unemployed workers are rejoining the
labor force
• Excess labor is being mopped up, even if it’s never fast enough
The economy continues to grumble along at about a 2% (saar) pace, just where
it’s been, on average, for the past 3, 6, 8 and 10 quarters. There’s nothing much
in the way of acceleration nor, thankfully, deceleration and it may look as though
nothing’s changing. In fact, important things are changing under the hood, even if
more slowly than one would like.
Consumption and investment
Retail sales took a sharp turn to the right about a year ago and they are now
running considerably more slowly than in 2010 and 2011 (chart below). So far,
consumption overall continues to grind ahead at about a 2% (saar) pace and this
continues to lay the bedrock for slow but steady GDP growth overall.
Investment demand derives from consumption growth, so it’s no surprise that capex
has been unimpressive for the past two years. On the margin, growth here has
averaged less than 4% (QoQ, saar) over the past 2 quarters and it seems unlikely
UNITED STATES
US - retail sales
US$bn/month, seas adj
420
410
400
390
380
370
360
350
340
330
Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13
David Carbon • (65) 6878-9548 • davidcarbon@dbs.com
7.5% saar
growth
trajectory
Mar12
3.5% saar
growth
trajectory
122

Economics–Markets–Strategy
Economics: United States
US – new home sales and housing starts
Jan11=100
200
180
160
140
starts:
25% trend
Jan13
120
100
sales:
8% trend
80
08 09 10 11 12 13
to rise to a more normal 8%-9% pace until consumption has more fully recovered.
That could take 2-3 more years, as explained below.
The housing sector remains the one and only bright spot of the economy. Starts are
running at a 25% growth pace and this is adding about three tenths of a percentage
point to headline GDP growth each quarter. It’s not a huge amount but housing is
punching above its weight and, symbolically, it’s at least reassuring to have the sector
at the heart of the downturn growing once again. Sales are running at a much
slower 8% growth pace and while this mismatch can’t last forever, unsold inventories
are at a very low 4 months’ worth of sales so for now it’s not an issue.
Household leverage
has fallen significantly
over the
past four years
Deleveraging progress
But three years of consumption and GDP growth, however slow, brings changes.
From a longer-term perspective, the most important one is that household leverage
has been lowered considerably. Household debt as a percentage of GDP has fallen
to an eight year low of 81%. Other things equal, this should allow for stronger
US – non-financial sector leverage
household and public debt as % of GDP
100
97%
98%
90
80
70
60
50
Mar08
57%
90%
81%
Govt
Household
40
00 02 04 06 08 10 12 14
123

Economics: United States
Economics–Markets–Strategy
private consumption growth going forward and a return to more normal (3%) GDP
growth as well.
The problem is that while private sector deleveraging has been substantial in recent
years, public sector deleveraging has barely begun. Public sector debt has climbed
to 90% of GDP and the only progress made on this front has been accidental /
dysfunctional. Congress allowed the “sequester” to take effect two weeks ago
and some $87bn of automatic spending cuts will occur over the next nine months
absent a rethink in Washington.
That seems unlikely. Many Republicans seem more than willing to accept the cuts,
even if they aren’t the precise ones they would have chosen. Many Democrats,
meanwhile, have tried for years to cut the defense budget and regard the sequester
as a means, imperfect though it is, to a long sought-after end. Call it progress
if you will but in the short-term it means slower growth. We have cut our forecast
for 2013 GDP growth to 1.7% from 2.0% last quarter.
Workers are reentering
the labor
force. That’s great
news. The true
unemployment
rate is falling
Unemployment, inflation and the Fed
The other key change is that labor markets are gradually improving. Nonfarm payrolls
growth is averaging 190k per month (3mma) and the February reading of 236k
was especially encouraging. The 3-month average reading is nearly double where
it was in mid-2012.
The unemployment rate has fallen to a new low of 7.7% and, more importantly, the
labor force is growing again – unemployed workers are becoming less discouraged
about the prospects of finding a job and are re-entering the labor force. While
this means the unemployment rate will not fall as much it otherwise would, the far
more important fact is that, under the hood, excess labor is getting mopped up.
With the improvement in labor markets, several Fed officials have begun pondering
publicly how long QE3 can and should continue. Chairman Bernanke has taken
up the debate and continues to press the case that QE3 ($85bn of new bond purchases
per month) must remain in force for now. At the short end, the Fed says that
the policy rate (Fed funds) will remain near zero at least until the unemployment
rate falls below 6.5%, so long as inflation remains contained. That target looks
unlikely to be reached until late-2015 or 2016, given the encouraging fact that the
labor force is growing again at a 1% rate if not a bit more.
Core PCE inflation – the Fed’s favored gauge – has fallen to a very low 1.2% YoY as
of January (1.4%, 3mma) and there seems little risk that it would force the Fed’s
US Fed – balance sheet (liability side)
US$bn
3,000
2,500
QE1
Dec08-Mar10
QE2
Nov10-Jun11
Op Twist
Sep11-
Dec12
QE3
Sep12 - open
2,000
1,500
1,000
500
Excess bank reserves at
the Fed
Other liabilities
Currency in circulation
0
Mar-06 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 Mar-12 Mar-13
124

Economics–Markets–Strategy
Economics: United States
US Economic Indicators
--- 2012 --- --- 2013 --- 2014
2012 2013(f) 2014(f) Q3 Q4 Q1 (f) Q2 (f) Q3 (f) Q4 (f) Q1 (f)
Output & Demand
Real GDP* 2.2 1.7 2.5 3.1 0.1 2.2 1.7 2.0 2.1 2.8
Private consumption 1.9 2.0 2.2 1.6 2.1 2.4 2.0 2.0 2.2 2.2
Business investment 7.7 5.1 7.1 -1.8 9.7 4.0 6.0 6.0 7.0 7.5
Residential construction 12.1 13.0 12.0 13.6 17.4 12.0 12.0 12.0 12.0 12.0
Government spending -1.7 -2.2 -0.9 3.9 -6.9 -1.5 -2.5 -2.5 -2.5 0.0
Exports (G&S) 3.3 2.3 6.3 1.9 -3.9 3.3 2.7 6.2 6.2 6.7
Imports (G&S) 2.4 2.3 5.9 -0.6 -4.5 4.0 5.0 6.0 6.0 6.0
Net exports ($bn, 05P, ar) -402 -410 -428 -395 -388 -395 -410 -415 -420 -423
Stocks (chg, $bn, 05P, ar) 43 26 38 60.3 12.0 20.0 25.0 30.0 30.0 35.0
Contribution to GDP (pct pts)
Domestic final sales (C+FI+G) 2.1 1.9 2.6 2.0 1.6 2.2 2.0 2.0 2.2 2.8
Net exports 0.0 -0.1 -0.1 0.4 0.2 -0.2 -0.4 -0.1 -0.1 -0.1
Inventories 0.1 -0.1 0.1 0.6 -1.4 0.2 0.1 0.1 0.0 0.1
Inflation
GDP deflator (% YoY, pd avg) 1.8 1.9 1.9
CPI (% YoY, pd avg) 2.1 1.8 2.0 1.7 1.9 1.4 1.6 1.9 2.1 2.0
CPI core (% YoY, pd avg) 2.1 1.8 2.0 2.0 1.9 1.9 1.7 1.8 1.9 2.0
PCE core (% YoY, pd avg) 1.7 1.6 1.9 1.6 1.5 1.3 1.5 1.7 1.9 1.9
External accounts
Current acct balance ($bn) -468 -505 -509
Current account (% of GDP) -3.0 -3.1 -3.0
Other
Nominal GDP (US$ trn) 15.7 16.3 17.0
Federal budget bal (% of GDP) -6.9 -6.4 -5.9
Nonfarm payrolls (000, pd avg) 152 209 191 195 200 205 210
Unemployment rate (%, pd avg) 8.0 7.8 7.8 7.8 7.7 7.6 7.5
* % period on period at seas adj annualized rate, unless otherwise specified
hand on either QE or Fed funds policy anytime soon. Most believe an unemployment
rate of 5.5% is where inflation starts to pick up, so a 6.5% target for when the
Fed starts to move seems more than prudent. When the time comes to raise rates,
the Fed will be moving on its own initiative.
Sources for charts and tables are CEIC Data, Bloomberg and DBS Group Research (forecasts are transformations).
125

Japan
Economics–Markets–Strategy
JP: Short-term outlook upgraded
• Our 2013 growth forecast is raised to 1.8% from 1.0%
• Revisions are based on yen depreciation, a higher stock market and an
increase in government spending
• The longer term outlook remains challenging
• Reflecting a planned 3ppt consumption tax hike next year, we forecast
0.6% growth and 2.0% inflation in 2014
GDP growth forecast
is raised to
1.8% from 1.0%
for 2013
There are nascent signs that the short-term growth outlook is improving in Japan.
The supply and demand-side macro indicators have both started to improve since
end-2012, including industrial production, exports and retail sales (Chart 1-2). We
had projected GDP growth of 1.0% in 2013 (in line with the growth average witnessed
in the 2000s), based on the assumptions of a cyclical recovery in global economy
and normalisation of Japan-China trade relations. On account of the Japanese
government’s aggressive push for domestic policy easing to bolster growth and end
deflation, we have raised the 2013 growth forecast by 0.8ppt to 1.8%.
Monetary easing and the financial market effects
The Bank of Japan (BOJ) in January introduced the open-ended asset buying approach,
and lifted the official inflation target to 2% from 1%. The open-ended QE
will start from January 2014, which involves monthly asset purchases of JPY 2trn
short-dated JGBs and JPY 10trn T-bills. Ahead, another round of substantial easing
is likely to come in 2Q, after the new BOJ governor takes office. Haruhiko Kuroda,
who has been nominated by Prime Minister Abe to become the new BOJ chief,
supports more radical monetary easing including purchases of long term JGBs and
Chart 1: The supply-side indicators turning positive
2005=100, sa
110
Chart 2: The demand-side also improving
2005=100, sa
140
JAPAN
105
100
95
90
85
80
Industrial production
75
All-industry output
70
Mar-08 Mar-09 Mar-10 Mar-11 Mar-12
130
120
110
100
90
80
Real exports
Retail trade
70
Mar-08 Mar-09 Mar-10 Mar-11 Mar-12
Ma Tieying • (65) 6878 2408 • matieying@dbs.com
126

Economics–Markets–Strategy
japan
risk assets in the private sector. Other options may also include bringing forward the
start of the open-ended QE to 2013 and accelerating the pace of asset purchases.
As a byproduct of monetary easing, the JPY weakened sharply by over 10% against
the USD in the three months between Nov12 and Feb13. The JPY REER also fell 7%
(Chart 3-4). DBS has revised the USD/JPY forecast to 98 for mid-2013 and 102 for
end-2013, which equates to 20% depreciation on the annual average basis. A weaker
JPY should help boost exports. Based on a simple regression model between real
exports and JPY, global GDP (weighted average of US, Eurozone and China GDP),
our estimates show that a 10% drop in JPY/USD leads to 5ppt rise in export growth
(adjusted R 2 =0.77). This will in turn, lift real GDP growth by 0.4ppt.
Admittedly, the negative relationship between JPY and Japan’s exports could have
been exaggerated, as the JPY tends to depreciate during a global economic upcycle
and appreciate during a global downturn – due to its nature as a safe haven currency.
As such, we only added 0.4ppt into our growth forecast to reflect the impact
of 20% JPY deprecation on exports.
The positive effects of monetary easing have also been seen in the stock market. The
Nikkei surged strongly by 20% over the past three months. Given that equity assets
account for 6% of Japanese households’ total financial assets, household wealth
should appreciate by 1% due to the 20% rise in equity prices (Chart 5-6). Holding
other factors constant, private consumption growth is expected to rise 0.5ppt and
GDP growth will rise 0.3ppt. Considering the volatile nature of equity prices, we
lifted our growth forecast by a modest 0.1ppt to capture the wealth effect.
The core aim of monetary easing is to create inflation expectations, encourage consumers
and businesses to spend and borrow, in order to pull the economy out of
deflation and get it back on a growth track. The bond market investors are already
expecting an end of deflation. The 5-year breakeven inflation rate (the yield difference
between inflation-linked bonds and conventional bonds) rose 50bps between
Nov12 and Feb13 to reach +1.3%. However, it remains too early to conclude that the
inflation expectations currently built in the financial markets will last and spread to
the broad economy. The credit market and real estate market indicators, which better
reflect the long-term inflation expectations among consumers and businesses,
will be interesting to observe in the coming quarters.
The 0.8ppt upgrade
reflects both
exports (0.4ppt)
and domestic demand
(0.4ppt)
Chart 3: JPY fell sharply since end-2012
2010=100
110
105
100
95
90
85
80
JPY REER
USD/JPY (RHS)
75
Mar-07 Sep-08 Mar-10 Sep-11
70
80
90
100
110
120
130
Chart 4: Export growth vs. JPY
% YoY % YoY
50
Correlation: -0.53
30
40
30
20
20
10
10
0
0
-10
-20
-10
-30
-40
Real exports
JPY REER (RHS)
-20
-50
-30
Mar-02 Mar-05 Mar-08 Mar-11
127

Japan
Economics–Markets–Strategy
Fiscal stimulus effects
Apart from monetary easing, the government will also increase fiscal expenditures
this year to support economic growth. A supplementary budget worth JPY10.3trn
was announced in January. In the general budget for FY2013, the government plans
to spend JPY 92.6trn (70.4trn excluding debt services) this year, also more than the
JPY 90.3trn (68.4trn) in 2012’s initial budget. Combining the general budget and
supplementary budget, total government expenditures will increase JPY 12.3trn in
FY2013 (2.5% of GDP, Table 1).
Adding the entire 2.5% into the 2013 growth forecast will be exaggerating. It is
opaque how much of the money allocated in the supplementary budget is fresh
spending. Meanwhile, on the calendar year basis, budget disbursement will occur
in 2013 and also early-2014. For prudent reasons, our 2013 growth forecast only
penciled in a 0.3ppt boost from fiscal stimulus.
The 2014 growth
and inflation forecasts
reflect the
potential impacts
of a consumption
tax hike
The longer term growth outlook remains challenging
A recovery in Japan’s growth, especially domestic demand growth, should alleviate
concerns about the repercussions of Japan’s policy shift on the Asia region – the
weak yen policy boosting Japan’s exports at the expense of squeezing other countries.
The question is, whether Japan’s growth will be sustainable.
Looking ahead, the 2014 outlook will largely hinge on the fate of the consumption
tax bill. Without a consumption tax hike, an above-trend growth of 1.0-1.5%
could continue in 2014, considering the time lag for monetary and fiscal easing to
boost the economy. Real GDP growth will be cut by up to 1ppt, if the 3ppt tax hike
kicks in April 2014 as currently scheduled. Our 2014 growth forecast of 0.6% has
factored in the potential drag from the consumption tax increase.
The longer-term outlook beyond 2014 remains challenging. Fiscal tightening will
be on the cards, whether the consumption tax plan is postponed/canceled or not.
The consumption tax hike is the first commitment made by the previous administration
towards fiscal consolidation, in the face of the mounting burden of public
debt and downgrades of sovereign ratings. Despite the ambiguous stance on the
consumption tax, the new Abe government still pledges to stick to the target of
balancing the budget by FY2020, which implies spending cuts or other forms of tax
hikes – positive for fiscal conditions but negative for economic growth.
In fact, the economy faces longstanding structural problems including the rapidly
aging population, insufficient productivity growth and deteriorating trade com-
Chart 5: The breakdown of household assets
Shares &
Other
equities
Pension
reserves
Others
Currency
&
Deposits
Chart 6: Consumption growth vs. Nikkei
% YoY % YoY
5
4
3
2
1
0
-1
-2
-3
Private Consumption
Nikkei (RHS)
Securities excl shares -4
-60
Mar-04 Mar-06 Mar-08 Mar-10 Mar-12
60
40
20
0
-20
-40
128

Economics–Markets–Strategy
japan
Table 1: Government spending plans
(JPY trn)
General Budget
FY 2012 FY 2013 Changes
Total spending 90.3 92.6 2.3
- Excl debt repayment 68.4 70.4 2.0
- Public works 4.6 5.3 0.7
- Education & Science 5.4 5.4 0
- Economic assistance 0.5 0.5 0
- SMEs 0.2 0.2 0
- Social security 26.4 29.1 2.7
Structural reforms
are essential
Supplementary Budget
Total spending 10.3
- Post-quake reconstruction & disaster prevention
3.8
- Wealth creation through growth (stimulating private investment,
3.1
SME assistance, human capital development)
- Security of life & Regional activation
3.1
petitiveness. It is doubtful whether a single use of the Keynesian economic policies
can successfully tackle Japan’s malaise. To reinvigorate growth, boosting the supplyside
potential is essential for Japan. In a joint statement announced with the BOJ
in January, the government pledged to formulate measures to strengthen competitiveness
and growth potential, mainly through promoting innovation and R&D. The
supplementary budget unveiled in January also emphasized R&D, innovation and
human capital development. It remains unclear whether and how the government
will tap other aspects of reforms – trade openness, investment deregulations and
measures to boost population growth and labour participation. Abe’s long term
economic and fiscal plan to be presented in June will be widely watched.
129

Japan
Economics–Markets–Strategy
Japan Economic Indicators
2012 2013f 2014f 4Q12 1Q13f 2Q13f 3Q13f 4Q13f 1Q14f
Real output and demand
GDP growth 2.0 1.8 0.6 0.5 0.4 1.4 2.6 2.6 1.4
Private consumption 2.4 0.9 -0.1 1.1 0.3 0.6 1.4 1.2 1.2
Government consumption 2.7 3.2 1.4 3.0 2.4 3.0 3.6 3.9 2.9
Private & public investment 4.1 0.5 0.5 -0.3 0.3 -0.8 1.0 1.4 1.1
Net exports (JPYtrn, 05P) 9.0 9.6 12.6 1.5 1.6 2.2 2.7 3.1 2.8
Exports -0.3 3.6 7.7 -5.7 -5.3 -1.9 7.1 15.2 12.2
Imports 5.3 3.2 4.6 0.7 0.7 0.9 3.3 7.8 6.5
External (nominal)
Merch exports (JPY trn) 64 71 78 15 17 17 18 19 19.0
- % YoY -2.8 11.6 9.1 -5.5 3.3 6.0 15.0 22.9 16.3
Merch imports (JPY trn) 71 77 81 18 19 19 19 20 20.0
- % YoY 3.8 8.8 5.1 0.4 5.3 7.6 10.1 12.5 8.5
Merch trade balance (JPY trn) -7 -6 -3 -2 -2 -2 -1 -1 -1
Current acct balance (USD bn) 59 71 97 - - - - - -
% of GDP 1.0 1.4 1.9 - - - - - -
Foreign reserves (USD bn) 1,268 1,229 1,226 - - - - - -
Inflation
CPI, % YoY 0 0 2.0 -0.2 -0.4 -0.2 0.3 0.3 0.2
Other
Nominal GDP (USD bn) 5,975 5,068 5,154 - - - - - -
Unemployment rate (%, sa, eop) 4.3 4.3 4.2 4.3 4.4 4.4 4.3 4.3 4.3
Fiscal balance (% of GDP) -10.8 -8.8 -7.4 - - - - - -
* % change, period-on-period, seas adj, unless otherwise specified
JP - nominal exchange rate
JPY per USD
125
120
115
110
105
100
95
90
85
80
75
Jan-07 Mar-08 Jun-09 Sep-10 Dec -11 Mar-13
JP – policy rate
%, call rate
0.8
0.7
0.6
0.5
0.4
0.3
0.2
0.1
0.0
Jan-01 Jan-03 Jan-05 Jan-07 Jan-09 Jan-11 Jan-13
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131

Eurozone
Economics–Markets–Strategy
EZ: Far from over
• Improvements in financial markets stand in stark contrast to real economy
deterioration
• Protracted fiscal belt-tightening and deleveraging at the national level
have depressed government spending, with all growth engines losing
steam simultaneously
• A lower main refi rate will pull down interbank rates and by extension,
borrowing rates. But liquidity is not the problem here, lack of confidence
is
• Decisions on the banking/ fiscal union are unlikely to be easy given the
large economic diversity between member states
Developments on the ground continue to point towards a disconnect between the
relative improvement in the financial markets’ conditions and weak real economies,
in the Eurozone. Last year, the ECB introduced the Outright Monetary Transactions
(OMTs) to dilute the negative feedback loop between banks and sovereign risks.
Even without any of the member countries’ actually tapping the facility as yet, the
mere provision of such a ‘backstop’ pulled the brakes on the bonds sell-off. Longterm
yields eased significantly across the board (close to 200bps in some cases).
While the modalities of the facility remain untested, attached conditionalities are
likely to ensure that the participating countries stick to pre-determined economic
and debt goalposts, or risk falling off the program. The risk of an imminent breakup
of the union and exit of certain vulnerable member countries have also receded.
However it is clear that the sense of calm in the financial market conditions did not
percolate to the real economies. Eurozone 4Q GDP growth numbers contracted
across the board, including Germany’s. Unemployment rates, meanwhile, touched
another record high, though the headline masks the divergence in rates across the
continent.
EZ: Growth continues to decelerate..
% QoQ sa
1.8
1.2
0.6
Latest: 4Q 12
0.0
-0.6
IEUROZONE
-1.2
3/1/2011 6/1/2011 9/1/2011 12/1/2011 3/1/2012 6/1/2012 9/1/2012 12/1/2012
Eurozone Germany Spain
Radhika Rao • (65) 6878 5282 • radhikarao@dbs.com
132

Economics–Markets–Strategy
Eurozone
Real economy unable to break the shackles
In the quarter gone by, more signs have emerged that the improvement in the financial
market sentiments had limited bearing on the real economy. In fact GDP
growth fared worse than expected, as lacklustre external trade failed to pick the
slack from a downcast domestic sector. In the EU-17, advance 4Q12 GDP registered
-0.6% (QoQ, sa), weakest in over three years. On seasonally adjusted annualised
basis, GDP growth declined 2.3%. Much of the drag stemmed from sharper than
anticipated decline in output in Germany (-0.6% QoQ, sa), France (-0.3%), Spain
(-0.7%) and Italy (-0.9%), with the peripheral countries in far worse state. Greece,
in particular, contracted by a stark 6.0% (YoY) extending the free fall in the past
fifteen consecutive quarters as high unemployment and weak consumption spending
impinged on economic activity. For 2012, GDP growth in the euro area fell -0.5%
(YoY), down from 1.5% in 2011.
Which brings us to the question – after a downcast 2012, are we on course for a full
recovery this year? Unlikely, in our view. Depressed labour market conditions and
squeeze on welfare programs will keep a lid on consumption spending, just as capital
formation is expected to remain depressed from weak demand, tighter credit
availability and resultant low profits. Protracted fiscal belt-tightening and deleveraging
at the national level have depressed government spending, with all growth
engines losing steam simultaneously.
While the nascent signs of stabilisation in data out of China and US provide some
comfort, a sharp recovery for the external sector remains a challenge. Against this
backdrop and in absence of structural reforms, the member economies will be unable
to claw themselves out of weak growth this year. While a bottom is in sight, the
Eurozone is set for slow return back to health, a process that could only kick start in
earnest in late-2013 on cyclical revival. We expect growth on the aggregate level to
contract 0.3% this year, way below the 2000-2007 GDP average rate of 2.2%.
Much of the burden to support Eurozone growth rests on the shoulders of Germany.
After an unexpected contraction of -0.6% (QoQ sa) in 4Q12, consumption and business
surveys signalled a bottom early this year. This has increased the scope of a
slight improvement in 1Q13 GDP growth numbers, though a sharp revival in the
external sector will prove elusive as the key inter-regional trade remains downcast.
On-going deleveraging amongst households and businesses will keep a lid on purchases,
thus weighing on Germany’s trade sector.
After a downcast
2012, are we on
course for a full
recovery this year?
Unlikely, in our
view
EZ: Money supply growth remains lacklustre
% QoQ sa
4.0
3.0
2.0
1.0
0.0
-1.0
-2.0
-3.0
-4.0
Mar-00 Mar-03 Mar-06 Mar-09 Mar-12
M1 3Q lead GDP
EZ: Subued inflation; sub- 2.0% in '13
% YoY
7.5
6
4.5
3
1.5
0
-1.5
Mar-07 Sep-08 Mar-10 Sep-11 Mar-13
HICP HICP (c ore) Unit labour costs
133

Eurozone
Economics–Markets–Strategy
Sombre growth
outlook and
subdued inflation
make a case
for further easing.
However the
policy direction is
not so clear cut
Course of monetary policy action not clear cut despite subdued inflation
Depressed households’ balance sheets, weak demand and moderating commodity
prices suggest that inflation will remain subdued this year. The HICP inflation
averaged 2.5% in 2012 and a sub-2.0% print has been pencilled in for 2013. High
unemployment rates and downcast business conditions limit the case of nominal
wage increases this year, thus likely to keep a lid on demand-side price pressures as
well. Given the sombre growth outlook for the Eurozone and subdued inflation ,
there is a strong case for further monetary easing. However the policy direction is
not so clear cut.
Firstly, sharp euro appreciation and resultant deflationary impact captured some attention
after the ECB unexpectedly highlighted the strong currency as a concern at
the January 2013 policy meeting. The currency, however, has since erased this year’s
gains, pressured also by greenback recovery on Fed’s dovish bent. Also, on nominal
effective exchange rate basis, the EUR was at 106.0 by February 2013, higher than
2012 average of 100.8 though still way below 118.8 witnessed in mid-2008. This
limits the justification to lower rates from the point of view of taming the common
currency. In addition, while concerns about the impact of prolonged currency appreciation
on prices are justified, the euro is still below the NEER threshold which
necessitates action, based on ECB studies.
Secondly, even as the main refinance (refi) rate is at 0.75%, the deposit facility rate
is already at 0%. Effectively even a 25bps cut in the refi rate at this juncture will
push the deposit rate to negative territory, a first for the region. This move carries
benefits and disadvantages. Though given the current economic backdrop, we are
not convinced that a modest cut will channelize funds to the real sector. Admittedly
a lower main refi rate will pull down interbank rates and by extension, borrowing
rates for the households and businesses. But liquidity is not the problem here. Over
the course of last year, the ECB has gradually lowered rates along with conducting
liquidity injections. This has seen the overnight EONIA rate edge towards the
deposit rate and hover with 0.06%-0.13% since July last year. In addition, banks
have also been slow to repay the Long Term Refinancing Operations (LTROs), implying
there is sufficient liquidity in the financial system. The lack of confidence
seems to be a bigger problem here. The weak macroeconomic backdrop has made
banks vulnerable to capital and profitability risks, with their credit exposure also
coming under increasing scrutiny. Thus cautious banks and lacklustre demand for
EZ: Loan growth weak, confidence a problem
% YoY
20
15
10
5
0
-5
Jan-01 Jan-04 Jan-07 Jan-10 Jan-13
EZ: Flush liquidity with o/n rate close to 0%
%
6
5
4
3
2
1
0
Jan-01 Jan-04 Jan-07 Jan-10 Jan-13
Loans-households
Loans-ex households
Refi rate EONIA Depo
134

Economics–Markets–Strategy
Eurozone
credit from households and businesses have led to the deceleration in bank lending
growth in recent quarters.
In light of these factors, the ECB might show a preference to conduct liquidity injections
and other non-standard measures to buoy the real economy, rather than
cutting rates. The central bank might give higher weightage to the need to lower
interbank rates, under the belief that negative deposit rates will prod the banks
(possibly in the core) to withdraw funds from the ECB’s facility and direct it towards
the economy. However as was clear from the reaction to the Italian elections, episodes
of market stress might lead the banks to give priority to safety over returns.
The trajectory for rates thereby is likely to remain flat this year, unless recession lasts
longer or renewed euro appreciation threatens the ECB’s price stability mandate.
Snail-paced progress towards banking/ fiscal union expected
With immediate risks to the longevity of the Eurozone pushed to the backburner,
focus is back on the need and willingness to commit for a banking union, which ultimately
might take the shape of a fiscal union. After protracted discussions, member
states agreed late in December 2012 to place ECB as the supervisory authority over
financial institutions in the Eurozone, even as some core economies remain wary of
‘mutualisation’ of risks concerning weak banks in the region.
Such decisions are unlikely to be easy given the large economic diversity between
member states which need to be brought under the purview of the regulator. Thus
as it can be expected, the decision to create the Single Supervisor Mechanism (SSM)
has been agreed upon, but the critical nitty-gritties are still to be worked out. Certain
contentious issues, like the coverage and scope of such a regulator, are also
likely to be negotiated in the months ahead. As things stand, the SSM is unlikely to
receive legal support and brought into existence before mid-next year.
Once the SSM has been agreed upon, the next two areas of the banking union –
bank resolution and deposit guarantee schemes need to be pondered upon. Relative
to the SSM, these two decisions could face heightened resistances from the
core economies in the group. Much of this stems from discomfort amongst the core/
financially-stronger economies in the group that the burden of recapitalising the
weaker banks (especially from the peripheral countries) will indiscriminately fall
upon them. Most policy and regulation related decisions are likely to be kept on ice
ahead of the German elections in September this year.
Most policy and
regulation related
decisions are likely
to be kept on ice
ahead of the German
elections in
September
Conclusion
While the monetary and financial systems are well-integrated, the national governments
are still left to their own devices to follow through with tough austerity
measures. It does not help that the steps to cut back on public spending and welfare
schemes prove recessionary in the short-term, inherently carrying political risks. The
recent impasse after the Italian elections is a case in point. This serves as a poignant
reminder that measures to un-freeze the domestic financial system and provide a
‘backstop’ to contain the sovereign debt crisis cannot be banked upon to fuel economic
activity in the member countries. What is required then is for the member
states to introduce structural reforms, to ensure that the return to growth is more
sustainable.
Sources for charts and tables are CEIC Data, Bloomberg and DBS Group Research (forecasts are transformations).
135

Eurozone
Economics–Markets–Strategy
Eurozone Economic Indicators
2012f 2013f 2014f 4Q12 1Q13f 2Q13f 3Q13f 4Q13f 1Q14f
Real output and demand
GDP growth (05P) -0.5 -0.3 0.1 -0.9 -0.3 -0.4 -0.3 -0.3 -0.2
Private consumption -1.2 -0.3 -0.1 -1.2 -0.5 -0.4 -0.3 -0.2 0.0
Government consumption -0.1 -0.1 -0.2 -0.1 -0.1 0.0 -0.1 -0.1 -0.1
Gross capital formation -3.5 -2.2 -1.0 -3.5 -2.3 -2.2 -2.1 -2.0 -1.8
Net exports (EURbn) 315 330 362 79 80 85 85 88 95
Exports (G&S) 2.7 2.3 2.6 2.0 2.1 2.1 2.2 2.3 2.4
Imports (G&S) -0.8 2.0 2.0 -0.8 0.9 1.2 1.6 2.2 2.0
Contribution to GDP (pct pts)
Domestic final sales (C+FI+G) -2.0 -0.6 -0.3 -2.0 -1.5 -0.6 -0.4 -0.4 -0.4
Net exports 1.4 0.2 0.4 1.8 0.8 0.3 0.1 0.1 0.2
External accounts
Current account (EUR bn) 59.4 0.9 13.0 na na na na na na
% of GDP 1.0 0.7 0.7 na na na na na na
Inflation
HICP (harmonized, % YoY) 2.5 1.9 1.9 2.3 2.0 1.9 1.8 1.8 1.7
Other
Nominal GDP (EUR trn) 9.5 9.3 9.1 2.3 2.3 2.3 2.3 2.4 2.5
Unemployment rate (%, sa, eop) 11.4 12.0 12.4 11.7 11.8 12.0 12.0 12.0 12.1
* % change, period-on-period, seas adj, annualised unless otherwise specified
EZ - nominal exchange rate
USD per EUR
1.70
EZ – policy rate
%, refi rate
4.8
1.60
1.50
1.40
3.8
2.8
1.30
1.20
1.10
Jan-07 Mar-08 Jun-09 Sep-10 Dec -11 Mar-13
1.8
0.8
Jan-01 Jun-03 Nov-05 Apr-08 Sep-10 Feb-13
136

Economics–Markets–Strategy
March 14, 2013
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DBS Labuan (6 087) 595 500
Hwang-DBS Penang (6 04) 263 6996
Philippines
DBS Manila Rep Office (63 2) 845 5112
Taiwan
DBS Taipei (886 2) 6612 9888
DBS Hsinchu (886 3) 612 7500
DBS Kaohsiung (886 7) 965 4888
DBS Taichung (886 4) 3606 6000
DBS Tainan (886 6) 601 7200
DBS Taoyuan (886 3) 264 7100
DBS Tainan (886 6) 601 7200
Thailand
DBS Bangkok Rep Office (66 2) 660 3781
United Kingdom
DBS London (44 207) 489 6550
UAE
DBS Dubai (97 1) 4364 1800
USA
DBS Los Angeles (1 213) 627 0222
Vietnam
DBS Hanoi Rep Office (844) 3946 1688
Ho Chi Minh City (84 8) 3914 7888
Disclaimer:
The information herein is published by DBS Bank Ltd (the “Company”). It is based on information obtained from sources believed to be reliable, but the
Company does not make any representation or warranty, express or implied, as to its accuracy, completeness, timeliness or correctness for any particular
purpose. Opinions expressed are subject to change without notice. Any recommendation contained herein does not have regard to the specific investment
objectives, financial situation and the particular needs of any specific addressee. The information herein is published for the information of addressees
only and is not to be taken in substitution for the exercise of judgement by addressees, who should obtain separate legal or financial advice. The Company,
or any of its related companies or any individuals connected with the group accepts no liability for any direct, special, indirect, consequential, incidental
damages or any other loss or damages of any kind arising from any use of the information herein (including any error, omission or misstatement herein,
negligent or otherwise) or further communication thereof, even if the Company or any other person has been advised of the possibility thereof. The information
herein is not to be construed as an offer or a solicitation of an offer to buy or sell any securities, futures, options or other financial instruments or to
provide any investment advice or services. The Company and its associates, their directors, officers and/or employees may have positions or other interests
in, and may effect transactions in securities mentioned herein and may also perform or seek to perform broking, investment banking and other banking or
financial services for these companies. The information herein is not intended for distribution to, or use by, any person or entity in any jurisdiction or country
where such distribution or use would be contrary to law or regulation.