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Regional Equity Strategy 4Q 2009 Strategy Overview: Asia Equity Taiwan: Ideals vs reality (Ma Tie Ying, matieying@dbs.com, extracted from “Economics – Markets – Strategy, 4Q09” dated 17 September 2009) • Taiwan’s recession was driven by exports. They are now driving recovery. We expect the upturn in global demand to continue and for this to translate into further growth in production and employment • There are high expectations about Taiwan’s longterm economic prospects as a result of cross-strait liberalization, which have triggered inflows and revived asset markets. But achieving an ideal structural recovery will take time • The central bank will focus on the near-term economic reality, i.e., the fact that recovery has been export-driven and domestic demand remains weak. We forecast no rate change in the rest of this year, and only modest rate hikes in 1H10 Export driven recovery The economy expanded 20.7% (QoQ, saar) in 2Q09, ending four quarters of contraction with the second strongest growth quarter on record. Exports drove the recession and they are now driving recovery. As of July, the volume of export orders has fully returned to its peak level before global financial crisis broke out. Real exports and industrial production have also each recouped one half of their respective losses during the crisis. We expect the upturn to be sustained. Chinese demand should continue to grow steadily in 2H09, so long as China maintains an accommodative fiscal and monetary policy stance. US demand is improving and we expect above-potential growth in Q3 and Q4. The recovery in exports should lead to investment, especially for manufacturers in the export-oriented tech industry. Already, imports of machinery and electrical equipments have made a decisive turn in 2Q09 and continued to edge up in July. Gross fixed capital formation fell by 40% in the three quarters ending 1Q09, even more than the 30% drop in exports. This inspite of the fact there was little overcapacity to begin with. Corporates have been unenthusiastic about capital spending ever since 2001, preferring to invest in the mainland instead following China’s accession to WTO. Political chaos at home didn’t help either. Gross fixed capital formation grew by a mere 0.9% per year between 2001-2007, far below GDP growth of 3.8%. After the drastic capacity reduction during the global crisis last year, the ratio of GFCF to GDP slipped further 16.7%, a 20-year low. In short, we think the cut in private sector investment had been excessive and look for a significant rebound going forward. A structural recovery still takes time Uncertainties remain, such as the sustainability of policy stimulus in the US and other advanced economies, and inflation risk and earlier-than-expected tightening in the emerging markets, most importantly in China. Meanwhile, Taiwan’s structural problem of hollowing-out still exists. The gap between export orders and exports is large and widening, due to the high ratio of overseas production, especially in China. To reduce its vulnerability to global shocks, Taiwan will need to restructure its economy and nurture domestic growth drivers. The liberalization of cross-strait relations is widely viewed as a possible solution. Since last year, cross-strait negotiations have made good strides in the areas of transportation, tourism, investment and financial sector cooperation. The two sides are currently mulling further steps toward a formal Economic Cooperation Framework Agreement that would allow free trade in many goods and services and investment flows across the strait. The effects from these policy initiatives so far are mainly seen in fund flows and the asset markets. In the BoP accounts, for example, local residents’ “currency & deposits” have been the recipient of inflows for six quarters, with the cumulative value reaching USD 31bn. Foreign portfolio inflows have also increased since 2Q09, offsetting the rebound in outward portfolio investment. The TAIEX is up 60% year-todate. The volume of residential property transaction has also risen since 1Q09, and home prices (as proxied by the Sinyi index) have rebounded in 2Q09. Still, the ideal scenario would be an expansion in real investment. Moreover, one that would not be limited to the export-oriented tech industry, but occur in a large number of sectors linked to cross-strait liberalization such as transportation, retail trade, tourism, finance and construction. To encourage longer-term investment, ensuring the continuity and timeliness of liberalization policies will be essential. In this regard, it remains to be seen how well the new cabinet executes a number of tasks including post-typhoon reconstruction, H1N1 pandemic prevention, fiscal policy exit strategy and the cross-strait negotiations related to a free trade pact with China. Page 31 “This report has been re-printed with permission from DBS Group Research (Regional Equity Strategy) of DBS Bank Limited” disclosures on page 37 of this report
Regional Equity Strategy 4Q 2009 Strategy Overview: Asia Equity Korea: Growth vs quality (Ma Tie Ying, matieying@dbs.com, extracted from “Economics – Markets – Strategy, 4Q09” dated 17 September 2009) • Korea’s growth numbers are undoubtedly strong, thanks to the currency depreciation, fiscal expansion and monetary easing • But the quality of growth is a concern. Currency depreciation helped exporters, but also eroded businesses and consumers’ international purchasing power. Moreover, there are doubts about whether the recovery will be sustainined once fiscal and monetary stimulus fades • House prices, bank loans and household debt all experienced fast growth over the past several years, and are rising again. The authorities are worried about a possible bubble in the property market and problems in the banking and household sectors. The central bank could raise rates as early as 1Q10 The Korean economy grew 11% QoQ saar in 2Q09 after a 0.5% gain in 1Q09. Compared to the -18.8% drop in GDP during the outbreak of global financial crisis in 4Q08, the recovery so far has amounted to about one half of the original drop in output. One key growth engine is exports. As of July, custom exports have increased a cumulative 40% (sa) from the bottom in January, and in real terms, exports have already approached their peak levels seen in Sep08 (producers’ shipment index for exports: 135.0 sa in Jul09, versus 137.1 in Sep08). Going forward, we expect exports will continue to closely follow the upturn in global demand. Korea has a high exposure to the emerging markets which are leading the current global recovery. As high as 44% of Korea’s exports head to ex-Japan Asia (including 22% to China), and an additional 15% of shipments are sold to Latin America and the Middle East. More importantly, the price competitiveness of Korean exporters remains intact as a result of currency weakness. Although the Korean won has strengthened in the past several months in tandem with a globally weaker US dollar, the USD/KRW rate remains 20% away from the pre-crisis level of 1000. And we forecast only a gradual recovery in the won going forward, similar to the trajectory witnessed after the 1997/98 Asian financial crisis (DBSf of USD/KRW: 1190 in end- 09 and 1120 in end-10. The dollar-denominated export prices currently remain low relative to those of the major trade rivals such as Japan and Taiwan, and such a price advantage is unlikely to be eliminated soon. Public investment is another source of growth. Public construction orders have jumped since 1Q09, thanks to the government’s decisive and aggressive fiscal actions to counteract recession. The government has engaged in largescale spending on civil engineering projects such as roads, bridges and railways. Machinery orders in the public sector have also soared, boosted by spending in transport and electric power areas. As the newly started infrastructure projects require certain amount of time to be completed, the growth in public investment would remain robust and underpin growth in the next several months. Quality is not enough Korea’s growth figures are undoubtedly strong. But we would caution that the underlying quality of growth is still not great. The strength in exports is partly due to currency weakness, which also simultaneously erodes businesses and consumers’ international purchasing power and thus hurts domestic demand. This is especially true if we consider Korea’s high reliance on fuel imports and large external debt levels. The negative effects of KRW weakness are currently masked, as the plunge in global fuel prices has significantly lowered production/living costs for manufacturers and consumers. The drop in crude oil prices from USD 90/bbl in 2008 to USD 50/bbl in 1H09 is estimated to help the economy to save an amount equivalent to 4% of GDP on an annual basis. More recently, the stabilization of international financial markets has allowed Korean banks to roll over or refinance a large portion of their external debt. The nation’s short-term external debt has stopped falling in 2Q09 (USD 147.2bn in June, versus USD 146.1bn in March), and gross external debt has started to increase once again due to higher long-term borrowings (USD 380.1bn in June, up from USD 369.1bn in March). The potential negative effects from KRW depreciation should not be completely dismissed, however, as global commodities prices have bottomed out, and the repayment of external obligations will still have to be done some day. Moreover, the ongoing recovery largely relies on government policy support. It remains to be seen if the recovery in the private sector will be self-sustaining, once the government exits. The rebound in private consumption in 1H09 was primarily due to a surge in automobile sales, following the government’s tax reduction on new car purchases. Retail sales Page 32 “This report has been re-printed with permission from DBS Group Research (Regional Equity Strategy) of DBS Bank Limited” disclosures on page 37 of this report
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