Left Brain Right B - the DBS Vickers Securities Equities Research

Regional Equity Strategy 4Q 2009
Strategy Overview: Asia Equity
excluding automobiles actually showed little sign of
improvement. Obviously, this support to private consumption
from government policy is one-off and not sustainable.
Also, the labor market is mainly aided by a temporary job
creation program adopted by the government. The jobless rate
has fallen slightly, but the details show that employment
growth concentrated in the areas of public administration and
social work. In spite of the recovery in exports, the impact on
jobs might be limited. Because of gains in productivity,
manufacturing now accounts for only 17% of Korea’s total
employment, much less than its 26% share in the GDP
accounts; and employment growth in the manufacturing sector
has been persistently negative in the past four years (an
average of -1.3% in 2005-2008). Another fact is that 80% of
the country’s employed persons work in small-and-medium
sized enterprises that are undergoing debt rescheduling and
corporate restructuring. With these uncertainties lingering over
the outlook for the labor market, it would be difficult to expect
private consumption to drive the economy, in our view.
Monetary policy: asset inflation and credit/debt growth
on watch
Like elsewhere in the region, asset prices in Korea have risen
due to domestic monetary easing and renewed foreign fund
inflows. House prices corrected downward only slightly during
the crisis, and began to pick up once again in 2Q09, especially
in the metropolitan areas such as Seoul. Note that house prices
had been rising fast ever since the bottom in 2000 (6.3% per
annum in 2001-2008), although the authorities adopted
various measures to cool the market. The nation-wide house
prices do not appear to be overvalued, as judged by the priceto-rent
ratio which has stayed near the long-term average. But
housing valuation in Seoul is clearly high, and continues to
appreciate.
Moreover, the rebound in house prices is accompanied by a
renewed expansion in mortgage lending and a continued
buildup of household debt. Note that bank loans growth ran at
15% YoY in 2001-2008, persistently and significantly
outpacing nominal GDP growth of 6.9%. The growth of
households’ financial debt reaccelerated to 10% YoY in 2005-
2008 following a slowdown during the 2004 credit card crisis,
also much faster than the 4.6% growth in household
disposable income over the past four years.
It is no surprise that the authorities are now concerned about
the risks of a bubble in the property market and debt/credit
problems in the household and banking sectors. The Financial
Supervisory Service called on banks to lower the loan-to-value
ratio for mortgage lending in Seoul and its vicinity (Jul 7th),
and took further steps to impose a debt-to-income ratio on
mortgage lending for a wider range of areas around Seoul (Sep
7th). The Bank of Korea has also begun to withdraw the
liquidity it had injected into the financial system during the
crisis period. The outstanding amount of monetary stabilization
bonds has increased KRW 38trn from Nov08 to Jul09, and base
money growth has fallen markedly on a sequential basis. It is
widely anticipated that the BOK will raise interest rates as the
next step. In our rate forecast, we have penciled in a total of
100bps of hikes for next year, starting from 1Q10 (25bps per
quarter).
That said, the odds of immediate and / or aggressive rate hikes
(such as in 4Q09 or in 50bps increment) should be low. This is
because the real economy has not fully recovered and the
ability of the private sector to sustain the recovery remains a
question. Administrative regulation may still be preferred over
monetary tightening to cool the property and credit markets, in
the near term.
Currency outlook (by Philip Wee)
We see Korean policymakers pursuing two goals in managing
the exchange rate. First, they would probably prefer keeping
the KRW aligned with the currencies of its major trading
partners. This was best reflected by the high correlation
between KRW and SGD, a popular proxy for Asian currencies.
Second, they would probably continue to reduce exchange rate
volatility in order to provide a more conducive environment to
revive business investment. Besides, a less volatile exchange
rate would also be consistent with a stable USD/CNY. The EUR
will also be important given the target to finalize a free trade
pact between Korea and its second largest export market, the
European Union, by the end of 2009.
Finally, the KRW should also draw support from expectations
for Korea to be amongst the first countries to hike interest
rates. The Bank of Korea (BOK) is uncomfortable with its
exceptionally low base rate, which has stayed below inflation in
12 out of the past 15 months ending Aug09. With CPI inflation
likely to have bottomed at 1.6% YoY in Jul09, and rebounding
strongly to 2.2% in Aug09, the central bank is increasingly
worried about asset price inflation, especially in the real estate
sector, as the recovery picks up momentum.
Currency and interest rate forecasts
eop Close 4Q09 1Q10 2Q10 3Q10 4Q10
USD/KRW 1217 1190 1175 1155 1140 1120
7D repo 2.00 2.00 2.25 2.5 2.75 3.00
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