Left Brain Right B - the DBS Vickers Securities Equities Research

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Regional Equity Strategy 4Q 2009 Strategy Overview: Asia Equity Indonesia: Upside risks (Lim Su Sian, limsusian@dbs.com, extracted from “Economics – Markets – Strategy, 4Q09” dated 17 September 2009) • Indonesia remains on track for 4.3% growth this year, and 5.5% in 2010. The economy has not suffered a major fall-out from the global financial crisis, thanks to prompt policy response and strong domestic demand • Risks to now lie to the upside in 2010. Although BI has concluded its rate cut cycle, lending rates should fall 200bps in the coming months. This easing in credit conditions will be bolstered by ongoing fiscal stimulus • Domestic and foreign investor sentiment should continue to improve. President Yudhoyono and his new cabinet are set to unveil more details about longer-term plans for infrastructure spending in October Bank Indonesia caps deposit rates On August 21, Bank Indonesia (BI) announced that fourteen major banks had agreed to slash their deposit rates. Banks can now at most pay 8% on deposits; in December this ceiling will fall to 7%, or just 50bps above the policy rate. The agreement significantly lowers the cost of funds for banks, and ultimately aims to lower lending rates for borrowers. Although BI had cut its policy rate by 300bps since Dec08, lending rates had fallen by less than half that. This inefficiency was a result of the liquidity crisis. Banks were also unable to lower lending rates because their funding costs – or deposit rates – were elevated, a legacy of those few months when scarce rupiah liquidity resulted in intense competition for deposits. With a coordinated drop in deposit rates now in place, there should be no major disruptions to flows within the banking system. BI has also attained the support of state-owned enterprise not to withdraw funds, and in any case stands ready to provide liquidity to banks via a 3-mth repo facility. Lending rates should fall We believe BI’s decision should pay off soon enough in the form of lower lending rates. Typically, lending rates have closely tracked deposit rates, with very little lag. Assuming that banks maintain the spread between deposit and lending rates, lending rates could fall by some 200bps in the coming months, from 13% to around 11%. Implications for the real economy An additional 200bp fall in lending rates will have stimulative effects on the economy, even as we look to BI holding its policy rate steady at 6.50% until end-2Q09. Even under a constrained post-crisis credit environment, economic momentum has managed to accelerate. This acceleration is not apparent when looking at YoY GDP growth, but according to our estimates, QoQ sa growth has in fact gained every quarter post-crisis. Growth paused at nearly 0% QoQ sa in 4Q08, but by 2Q09 had reached 1.3% QoQ sa 4.3% growth this year, 5.5% next year with upside risks Our base case continues to be for the economy to achieve growth of 4.3% this year, and 5.5% in 2010. Sequentially, this reflects an acceleration in growth to a near-potential 1.5% QoQ sa by 4Q09, as budget spending accelerates. In 2010, this momentum then normalizes, slowing a touch to 1.3%-1.4% QoQ sa each quarter. As is clear from the discussion above, these assumptions may well prove overly conservative, particularly for 2010. If lending rates do fall as materially at the tail-end of this year, it would pave the way for significant multiplier effects on the economy in 2010. This could potentially see growth accelerating to over 6% next year. This upside risk as yet appears to be under-appreciated by the markets, representing an opportunity for investors. Consensus polls show that the majority of banks made steep and unwarranted cuts to their growth forecasts between March and May, and have begun to lift them back up only in recent months, and modestly at that. We will consider upgrading our forecasts once the data confirms a sustained acceleration in credit growth. A mitigating concern, however, is the rise in inflation expectations. While not yet at elevated levels, expectations have risen steadily since Feb09, fuelled in part by buoyant economic conditions. This could pose a risk to actual inflation. Based on our growth forecasts it seems reasonable to project inflation of 5% this year, and 5.4% in 2010. Any higher than that, and BI may have to hike interest rates earlier than 3Q10. This may shorten the recovery in the credit cycle. Page 35 “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 India: Risks remain (Ramya Suryanarayanan, ramya@dbs.com, extracted from “Economics – Markets – Strategy, 4Q09” dated 17 September 2009) • The economy is rebounding faster than expected, led by manufacturing • But drought like conditions lead us to trim FY09 GDP growth expectations to 5.7%. We have raised FY10 growth to 7.5% from 6.9% • At projected sub-8% growth rates, we do not expect price pressures to intensify for a while. But expectations of higher prices will form and we expect 200bps of rate hikes in 2010. • Wider deficits raise risks to economic and financial stability. Higher than expected inflation could also arise from these imbalances • We maintain the view that a ratings downgrade is possible. The longer term consequence of the higher deficit could be higher inflation followed by monetary tightening. Higher rates could “crowd out” private sector investment and is a negative for the long-term growth outlook GDP review and outlook The non-agricultural economy is rebounding faster than expected, led by the manufacturing sector. At the same time, the agriculture sector is facing a setback from the drought-like conditions in nearly half of the country. While it is clear that the spectre facing the agriculture sector is temporary, the bigger question is if the recovery in manufacturing is durable. Our take is that pent up demand is in part driving the rise in consumer demand, and consumption is otherwise not on a solid footing. At the same time, supply side constraints - partly temporary and partly structural (such as infrastructure) - appear to be pushing prices higher in the interim. We believe this would have to be dealt with by the removal of policy accommodation to prevent inflation expectations from hardening. All told, while we pencil in faster non-agricultural GDP growth than a quarter ago, a sustainable return to 8-9% growth rates is not envisaged in the near-term. At the same time, the wider fiscal deficit announced in the July budget has further worsened the risk profile of the economy. Assuming a 2% drop in agriculture GDP as a result of the circa 20% deficiency in the monsoon, the direct hit on GDP from the drought works to a 0.4%-pt reduction in overall GDP growth. We do not expect any material indirect effect on consumer demand from the drought. What about prices ? Constraints on the supply side and pressures from high food prices have led to 5-7% (MoM, saar) rise in prices since Mar09. While we expect the price increase to moderate to circa 5% (MoM, saar) in the months ahead, the pace of rise in prices clearly is at odds with the apparently sub-potential rate of economic growth. At these growth rates, we do not expect price pressures to intensify like they did in 2007 or first half of 2008. However, a removal of policy accommodation is warranted to prevent inflation expectations from hardening. This is especially so after the 5% rise in dearness allowance sanctioned last week to central government employees. Consequently, we expect 150bps of repo and reverse repo rate hikes from Jan-June 2010 and another 50bps of rate hikes in July-Dec 2010. This should take the repo rate to 6.75% and reverse repo rate to 5.25% by Dec10. In addition, cash reserve ratio (CRR) hikes would likely kick in simultaneously or ahead of rate hikes to assist in withdrawal of liquidity and clamp credit growth directly. Risks assessment We believe risks to economic and financial stability remain significant especially after the July budget has revealed a greater than expected fiscal deficit projection (6.8% of GDP), and that even after optimistic revenue assumptions. We expect the national fiscal balance to register a deficit of close to 10% of GDP in FY09, over 1%-pt wider than the government’s estimates, as commodity prices rise. Ratings agencies are waiting at present for the 13th Finance Commission report out late October for the government’s long-term strategy for fiscal consolidation. We maintain the view that a ratings downgrade is a real risk. The longer term consequence of the higher deficit - in a benign scenario, as is our core scenario - might manifest in higher inflation followed by higher rates. This, of course, would point to a crowding out of private sector as a result of the government’s fiscal profligacy. This is the ultimate risk lying ahead for the economy. Page 36 “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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Left Brain Right B - the DBS Vickers Securities Equities Research

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