2013 outlook - Asia’s overheating risks

7/30/2019 2013 outlook - Asias overheating risks

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Nomura

N O M U R A I N T E R N A T I O N A L ( H K ) L I M I T E D

Asia Special ReportNOMURA GLOBAL ECONOMICS

November 28, 2012

Principal authors

Economics, Asia ex-Japan

Rob SubbaramanChief Economist, AEJ+852 2252 1370

[email protected]

FX strategy, Asia ex-Japan

Craig ChanHead of FX strategy, AEJ+65 6433 6106

[email protected]

Credit desk analyst

Pradeep Mohinani, CFAHead of EM credit desk analysts+852 2536 7030

[email protected]

2013 outlook: Asias overheating risks Buoyed initially by China, plus very loose policies and robust

capital inflows, we expect Asias economies to remain resilientto a continued weak outlook in the advanced economies.

The biggest risk is that Asia overheats and central banks findthemselves behind the curve in tackling credit booms, assetprice bubbles and inflation. Watch for policy rate hikes in H2 inChina, Taiwan, Malaysia, Indonesia and the Philippines.

In China we highlight three out-of-consensus calls for next year:CPI inflation rising to over 5% by Q4, interest rates being hikedtwice, and GDP growth slowing from over 8% in H2 to 7% by Q4.

In Asia FX, we are long but expect more differentiation in H2.The outperformers are likely to be PHP and MYR; the mid-performers KRW, CNY, SGD and THB; and the underperformersINR, IDR and TWD. We offer seven trade recommendations.

In Asia rates, we are bullish on India bonds and positioned forfurther bear steepening in China. We remain received inSingapore and will position for paying Korea and Taiwan 5yr.

In Asia credit, we expect a bumpy road to tighter spreads, withhigh yield outperforming. Of Asian sovereigns, the Philippinesis most likely to see a rating upgrade, whereas India, Sri Lanka

and Vietnam are potential downgrade candidates.Any portion of this report that has been prepared by a trading desk analyst is NOT a product of the Fixed IncomeResearch Department and is NOT covered by the Research Analyst certification provided in Appendix A-1. For additionalinformation concerning the role of Trading Desk Analysts, please see the important conflicts disclosures beginning atpage 59 of this report. See Appendix A-1 for analyst certification, important disclosures and the status of non-US

analysts.
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Table of contents

Overview ....................................................................................................................... 3Three growth engines ................................................................................................ 4Four risks .................................................................................................................... 5

Zooming in on the key themes and risks .................................................................. 8China: Expect surprises on inflation, interest rates and growth ................................. 8South Korea: Rates on hold through 2013 ............................................................... 10Hong Kong and Taiwan: property markets pose two-way risk ................................. 10India: No more short-cuts ......................................................................................... 12ASEAN: Spot the difference ..................................................................................... 15

Forecast summary ..................................................................................................... 18Economic outlook...................................................................................................... 19

China: Up in H1, down in H2 .................................................................................... 19Hong Kong: Looming fiscal stimulus ........................................................................ 20India: A year of consolidation ................................................................................... 21Indonesia: Watch policies and politics ..................................................................... 22Malaysia: Time for fiscal tightening .......................................................................... 23Philippines: Still likely to shine ................................................................................. 24Singapore: The (long) road to restructuring ............................................................. 25South Korea: Growth to rebound from a very low base ........................................... 26Taiwan: External demand holds the key .................................................................. 27Thailand: New growth engines ................................................................................. 28

FX outlook: a story of two halves ............................................................................ 29First half appreciation ............................................................................................ 29Second half differentiation ..................................................................................... 30Seven trade recommendations ................................................................................ 30Six themes driving Asia FX in 2013 ......................................................................... 37

Rates outlook: Global factors to dominate early, local drivers emerge in H2 .... 41Key recommendations for 2013: SGD, INR and CNY rates .................................... 42Rates views across the region ................................................................................. 46

Credit outlook in the EM context.............................................................................. 53Key macro drivers for EM credit in 2013 .................................................................. 53Asia themes .............................................................................................................. 55Asia trade ideas ....................................................................................................... 56

Recent Asia Special Reports .................................................................................... 58

This study was a collaborative effort by Nomuras Asia economists and fixed income strategists. Individualauthors names and contact details are shown at the top of the sections to which they contributed. Theauthors would like to thank David Vincent and Kenneth Persing for editorial and Candy Cheung for researchassistance.


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Rob Subbaraman+852 2536 [email protected]

Overview

Since the global financial crisis, Asia ex-Japan has been instrumental in helping to rebalance

the global economy. The regions total current account surplus has shrunk to 2% of GDP, a

level not seen since the Asian financial crisis 15 years ago (Figure 1). The shrinkage is not just

due to weak exports but also resilient Asian domestic demand (Figure 2). Unlike in 2008-09,

Asian exports have cooled but not collapsed, so the multiplier effects on domestic demand, via

job losses, have not been as significant, while Asias already-lax policies have become looser.

Fig. 1: Asia ex-Japans total current account surplus

-2

-1

01

2

3

4

5

6

7

8

Jun-96 Jun-00 Jun-04 Jun-08 Jun-12

% of GDP

Source: CEIC and Nomura Global Economics.

Fig. 2: Contribution to GDP growth (y-o-y), Q1-Q3 2012

Note: All data are Q1-Q3 2012 average except India (H1). Source:CEIC and Nomura Global Economics.

To be sure, the ongoing healing process from balance-sheet recessions will keep the big,

advanced economies fragile in 2013, especially the euro area where we expect more bouts of

financial market turmoil and a slight GDP contraction in every quarter next year. In 2013, we

expect GDP to grow by 1.5% in the US, 0.5% in Japan, and to fall by 0.8% in the euro area

(Figure 3; seeGlobal Annual Economic Outlookfor more details of our global forecasts). While

cognizant of the downside risks to global growth, our base case is for the global economy to not

suffer another major heart attack, as it did in late 2008. This distinction is important, for without a

collapse in Asian exports or a mass exodus of foreign capital, non-linear multiplier effects on

domestic demand are unlikely to kick in.

Fig. 3: Nomuras GDP growth forecasts

3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 2012 2013

US 2.0 1.4 0.7 1.2 2.3 2.7 2.1 1.5

Euro area -0.6 -1.6 -0.8 -0.6 -0.2 -0.1 -0.5 -0.8

Japan -3.5 -1.5 2.0 1.9 1.8 2.0 1.6 0.5

Asia ex Japan 5.9 6.9 6.7 6.6 6.3 6.1 6.3 6.4

China 7.4 8.4 8.4 8.0 7.4 7.0 7.9 7.7

Hong Kong 1.3 1.7 2.0 2.5 2.8 2.5 1.2 2.5

India 5.4 5.3 5.9 6.0 6.1 6.4 5.3 6.1Indonesia 6.2 5.7 6.1 6.2 6.0 6.0 6.1 6.1

Malaysia 5.2 5.1 4.9 4.6 4.0 3.9 5.3 4.3

Philippines 7.1 6.9 6.7 6.4 6.2 6.2 6.6 6.4

Singapore 0.3 2.7 2.5 2.2 2.3 2.7 1.8 2.4

South Korea 1.6 1.8 1.6 2.3 2.9 3.3 2.3 2.5

Taiwan 1.0 2.7 3.1 3.2 3.6 2.2 1.0 3.0

Thailand 3.0 15.2 4.0 4.1 4.8 4.9 5.5 4.5

Note: numbers in bold are actual data. For the US, euro area and Japan the growth rates areseasonally adjusted quarter-on-quarter annualised rates; For Asia ex-Japan the growth rates areyear-on-year. Source: CEIC and Nomura Global Economics.

Hence, our core view is for emerging Asia to display resilience and for the rebalancing to

continue, with Asian domestic demand further increasing its contribution to GDP growth.Despite slowing growth in the big advanced economies, we expect aggregate GDP growth in

Asia ex-Japan to rise from 6.3% in 2012 to 6.4% in 2013 (see the country outlook chapter for

details). Our over-arching theme for Asia next year is increasing symptoms of overheating, like

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p.p.Net exports

Investment

Consumption
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debt build-up, frothy property markets and rising CPI inflation. The biggest risk, in our view, is

that Asian policymakers fall behind the curve in normalising very accommodative macro

policies. This is the crux of our China story of two halves: 8.2% y-o-y GDP growth in H1 2013,

followed by 7.2% in H2.

Three growth engines

We see three main factors supporting Asias rapid economic rebalancing:

China. Contrary to consensus, we have long held the view that China can experience a

policy-led cyclical economic recovery despite its deep structural problems. Fiscal policy

easing really only started in earnest in July after the announcement that Q2 GDP growth had

fallen below 8%; there was no single large-scale stimulus announcement as in late 2008, but

add up all the measures and it is significant. We expect GDP growth to rebound from 7.4%

y-o-y in Q3 to 8.4% in Q4, and to stay above 8% in H1 2013. However, we expect a positive

output gap and accelerating food prices to stoke inflation. We forecast CPI inflation to rise

sharply, to average 5.1% y-o-y in H2 2013, triggering policy tightening. A renewed debt

buildup outside the regulated banking sector the sum of new trust loans, entrusted loans

and net issuance of bills and bonds has surged in recent months, eclipsing new bank RMB

loans and slow progress in rebalancing from investment- to consumption-led growth,

urgently require accelerated structural reforms (that can be painful in the short run), or

investor concerns over Chinas sustainable growth are likely to intensify. Either way, we

expect GDP growth to slow to 7% y-o-y by Q4 2013.

GDP growth of 7% may seem weak by Chinas standards, but it is worth remembering that

the size of Chinas economy (at market exchange rates) has almost doubled from USD4.5trn

in 2008 to an estimated USD8.2trn in 2012. The growth of Chinas consumption has not been

weak; in fact, it has been very strong by global standards, it is just that investment growth has

been even stronger. On our estimates, 2012 is set to be the crossover year when the annual

increase in nominal personal consumption in China (USD478bn) permanently surpasses the

US (USD403bn). What is more, two-thirds of US consumption is on services, which are less

internationally tradable than goods. Narrowing the consumption comparison to nominal retail

sales shows that it will not be long before China is the worlds biggest consumer of goods

(Figure 4). Chinas much larger economy growing at a moderately slower pace is still a very

powerful growth pole for the rest of Asia, so much so that the rest of Asias aggregate exportsto China (and its entrept, Hong Kong) are now bigger than to the US and EU combined

(Figure 5).

Fig. 4: Nominal retail sales in China and the US

0

50

100

150

200

250

300

350

400

Oct-92 Oct-96 Oct-00 Oct-04 Oct-08 Oct-12

US

China

USD bn


Fig. 5: Asia ex-Chinas exports to China+HK, US and EU

10

20

30

40

50

60

70

Aug-03 Aug-05 Aug-07 Aug-09 Aug-11

China+HK

EU

US

USDbn

Note: Asia ex-China includes India, Indonesia, Japan, Korea,Malaysia, Philippines, Singapore, Taiwan and Thailand.Source: CEIC and Nomura Global Economics.

Loose policies. The central banks in China, India, Indonesia, Korea, Thailand and the

Philippines have all cut policy rates this year and, adjusted for inflation, real policy rates are

historically low across Asia. But what is less appreciated is the extent of easing on the fiscal

side: many other Asian governments are mimicking China, taking advantage of their low debt

this year public debt is below 50% of GDP in all emerging Asian countries except Malaysia

(53%) and India (68%), compared to an average of 118% of GDP for the G20 advanced

economies and shifting to more expansionary fiscal policies. Hong Kong, Malaysia, Thailand

and the Philippines release timely monthly fiscal data, which show that their combined budget


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deficit in the 12 months to September is almost as large as it was after the global financial crisis

(Figure 6). In the advanced world, loose monetary policies are being offset by fiscal austerity; in

emerging Asia, both policies work together and are more effective. Low unemployment, solid

credit growth and positive wealth effects from buoyant property markets are conspiring with

these loose macro policies to bolster domestic demand. There are, however, some exceptions:

India has limited room to use countercyclical policies due to high inflation and poor fiscal

finances; Koreas loose policies are being dampened by a household sector overburdened with

debt; and Singapore has refrained from fiscal easing as it focuses on raising productivity.

Capital inflows. Net foreign capital inflows to Asia have significant scope to intensify in 2013.The most comprehensive gauge, which captures FDI, portfolio debt and equity flows, as well as

cross-border foreign bank claims, is the financial account of the balance of payments. Using this

measure (Figure 7), we see that, in the space of just two and a half years since the crisis (Q1

2009 to Q2 2011), net capital inflows to Asia ex-Japan totalled a massive USD783bn, more than

the USD573bn in the five years prior, pulled by Asias relatively higher growth prospects and

pushed by central bank quantitative easing in advanced economies (which, through portfolio

rebalancing, has spill-over effects on emerging markets by pushing investors into riskier assets).

While volatile in recent quarters, we expect another large bout of net inflows, buoyed by Chinas

economic recovery, the fading of US fiscal cliff fears, QE3 and the increasing search for yield.

There certainly seems to be room for more inflows. A glaring example is the widening gap

between the shares of emerging Asia in world GDP and in the MSCI world equity index, despite

Asias superior economic fundamentals relative to the advanced world (Figure 8). Another largebout of net capital inflows would accelerate Asias rebalancing via: 1) currency appreciation,

which crimps exports; or 2) likely FX intervention and central banks keeping interest rates lower

than they would otherwise, thereby easing liquidity conditions and buoying asset markets.

Fig. 6: Government budget positions

-40

-30

-20

-10

0

10

20

-250

-200

-150

-100

-50

0

50

100

Sep -03 Mar-05 Sep -06 Mar-08 Sep -09 Mar-11 Sep -12

China, LHS

Rest of Asia, RHS

USD bn, 12-month roll ing sum USD bn, 12-month roll ing sum

Note: Rest of Asia is the aggregate fiscal balances of HongKong, Malaysia, Thailand and the Philippines. Source: CEIC.

Fig. 7: Asia ex-Japans net capital inflows

-90

-60

-30

0

30

60

90

120

Jun-03 Dec-04 Jun-06 Dec-07 Jun-09 Dec-10 Jun-12

US$bn

QE2announced

QE1announced

USD573bn

USD783bn

Note: Countries are China, HK, India, Indonesia, Korea, Taiwan,Malaysia, Philippines, Singapore and Thailand. Source: CEIC.

Four risks

The risk we are most concerned with is that some Asian economies may overheat.

Overheating. In our view, there is too much reliance on countercyclical policies to counter weak

exports and not enough focus on structural reforms to boost the supply-side of economies. In

October, the real interest rate on 1yr bank deposits in China was 1.3%, while in the rest of Asia

the average real policy rate, weighted by GDP, was just 0.3% and this is during a period of

low inflation in the region (Figure 9). Central banks justify erring on the side of laxity as

insurance against the downside risks to global growth, to promote domestic demand given the

weakness of exports and to avoid provoking too-strong capital inflows. From 1999 to 2005, we

estimate that the real interest rate was negative 19% of the time in China and 10% of the time

elsewhere in Asia, while from 2006 to 2012, this grew to 57% and 43%, respectively. But

persistently negative real rates sow the seeds of overheating, and Asias real policy rate is likely

to turn negative again as inflation rises.


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Fig. 8: Asia emerging market share in world GDP and MSCI

1

5

9

13

17

21

25

1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016

Asia EM share in world MSCIequity index

Asia EM share in world GDP(at market exchange rates)

% shareIMF forecasts

Note: Asia EM is China, India, Indonesia, Malaysia, Korea,Philippines, Taiwan and Thailand. Source: MSCI and IMF.

Fig. 9: Real policy interest rates (deflated by headline CPI)

-5-4-3-2-1

01234567

Oct-00 Oct-02 Oct-04 Oct-06 Oct-08 Oct-10 Oct-12

Chin a's real bank deposit rate

Rest of Asia's real policy rate

% p.a.

Note: For the rest of Asia, the real policy rate is GDP weighted ofHong Kong, India, Indonesia, Korea, Malaysia, Philippines,Singapore, Taiwan and Thailand. Source: Bloomberg and CEIC.

Negative side effects are already emerging: credit has been growing faster than nominal GDP

across the region, and property markets are frothy in many capital cities. If we overlay

residential property prices in the US (indexed to 100 in January 2000) on residential property

prices in several Asian countries or major cities (indexed to 100 in December 2008), it is strikingthat prices in Hong Kong, India, China and Taipei are tracking above the US price bubble

(Figure 10). We see a danger in the likely increased use of macroprudential measures in an

attempt to cool property markets and credit growth; these measures may work for a while but

over time, as loopholes are found, they turn out to be a poor substitute for higher interest rates.

Hong Kong is a case in point. The Hong Kong Monetary Authority has progressively imposed

higher stamp duties on property transactions and tighter restrictions on mortgage lending on six

occasions since late 2009, but the property market has yet to cool (Figure 11). Central banks

ultimately find themselves behind the curve in tackling credit booms, asset price bubbles and

inflation. Hong Kong seems most at risk, but we cannot rule out overheating in other countries,

including China, India, Indonesia, Singapore and Taiwan.

Fig. 10: Residential property prices in Asia and the US

70

90

110

130

150

170

190

210

t t+1 t+2 t+3 t+4 t+5 t+6 t+7

Index

Chin a, Dec-08HK, Dec-08Ind ia, Dec-08Kuala Lumpur , Dec-08Singapore, Dec-08US, Jan-00Taipei, Dec-08

Note: Wherever possible official property price measures havebeen used. Data are either monthly or quarterly, while t=numberof years from the starting date (Jan 2000 for the US and Dec2008 for Asia). Chinas index is the average of Shanghai,Beijing, Shenzhen, Guangzhou and Tianjin; Indias is theaverage of all major cities; the US index covers 898 counties.Source: CEIC, Centa Property; US CoreLogic and NomuraGlobal Economics.

Fig. 11: Hong Kong polices to cool residential property price

Note: 1) Oct 09, cut loan-to-value (LTV) ratio; 2) Feb 10, stampduty hike; 3) Aug 10, cut LTV ratio; 4) Nov 10, seller stamp dutyhike to as high as 15% and cut LTV ratio; 5) Jun 11, cut LTV ratio;6) Oct 12, stamp duty hike to as high as 20% plus new buyer stampduty of 15% for non-permanent residents.Source: CEIC, HKMA and Nomura Global Economics.

Commodity price surge. Despite lacklustre growth in the advanced economies, the global

search for yield and strengthening demand in emerging economies (especially Asia), could fuel

another surge in global commodity prices, particularly food prices. The global supply-demandequation for food remains tight. The supply side of the food equation is being constrained by: 1)

insufficient new investments for large agricultural productivity gains; 2) competing use of

available land due to biofuels, urbanisation and industrialisation; and 3) increasing uncertainty

50

100

150

200

250

Jan-93 Jan-96 Jan-99 Jan-02 Jan-05 Jan-08 Jan-11

Index, 1999=100

1234

5

6


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due potential for QE-driven commodity price speculation and more volatile weather due to

global warming. On the demand side, the relevance of the worlds most populous countries

being in the sweet spot of rapid economic development should not be underestimated. The size

of the annual increase in Chinas personal consumption is about to overtake that of the US, to

become the worlds largest. This is important. For unlike other commodities, the sensitivity of the

demand for food to an increase in personal income is much greater for lower-income countries,

as is the changing of diets toward a higher calorie intake. A surge in the global price of food

items, which on average accounts for 31% of Asias CPI basket versus 14% in the US, could lift

Asias CPI inflation sharply and hurt growth, notably in India, Indonesia, and the Philippines.

Recoupling. Trend GDP growth in Asia ex-Japan is around 7%, a full 5 percentage points (pp)

higher than in advanced economies. Or put more starkly, real GDP is above its pre-global

financial crisis peak by 41% in China, 31% in India, 25% in Indonesia and 11% in Korea

compared with 2.3% in the US and still 2.4% belowin the euro area. From this vantage point, in

long-run trend terms there is a widening divergence between emerging Asia and the advanced

world (Figure 12). However, in terms of short-run dynamics, the global financial crisis has

debunked any notion that Asia can decouple from advanced economies at times of extreme

dislocation. During 2008-09, the peak-to-trough decline in year-on-year real GDP growth was

between 10pp and 17pp in Hong Kong, Korea, Malaysia, Singapore, Taiwan and Thailand all

larger than the declines in the US (-6.2pp) or euro area (-7.3pp). While relatively strong

economic and policy fundamentals have helped buffer Asian economies against sub-par growth

in the US and euro area, another deep recession in the advanced world would be a completelydifferent story; one in which Asia hits a tipping point where non-linear effects kick in from a

collapse in exports and foreign capital flight. Those economies that are very open to trade

(Hong Kong, Singapore, Malaysia), have sizable current account deficits (India and Indonesia)

or are structurally weak domestic economies (Korea) are most vulnerable.

Fig. 12: Long-run trends in real GDP growth of Asia ex-Japan vs advanced economies

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-2

0

2

4

6

8

10

1980 1985 1990 1995 2000 2005 2010 2015

%

Major advanced economies (G7) As ia ex-Japan

IMFforecasts

Lon g-run trends

Source: IMF, CEIC and Nomura Global Economics.

China hard landing. In November 2011, we published an Anchor Report,China risks, in which

we analyzed Chinas structural challenges ranging from overinvestment and increasing

shadow banking activities to over-privileged state-owned enterprises and concluded that theyhad become too big to ignore. While our base case is forChinas GDP growth to average 7.7%

in 2012-14, we concluded that the macro risks were sufficiently large to assign a one-in-three

likelihood of China experiencing a hard economic landing before the end of 2014, which we

defined as real GDP growth averaging 5% y-o-y or less over four consecutive quarters. To help

quantify the macro risks on an ongoing basis we developed theNomura China Stress Index

(CSI), which is a composite of 18 vulnerability indicators. The CSI indicates that hard-landing

risks have been on the rise since 2003, a trend that steepened after the global financial crisis.

The CSI remains near an all-time high and we therefore maintain our view of a one-in-three

likelihood of a hard landing. A China hard landing would have a significant impact on the global

economy, but especially Asia. A recent IMF study estimated that each percentage point decline

of investment growth in China would lower GDP growth by more than 0.5pp in Korea, Taiwan

and Malaysia.
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Zhiwei Zhang+852 2536 [email protected]

Wendy Chen+86 21 6193 [email protected]

Zooming in on the key themes and risks

When one looks more specifically at the individual economies in the region, it quickly becomes

apparent that Asia should not be treated as one homogeneous region. Several countries are

likely to raise interest rates next year (China, Malaysia, Indonesia, the Philippines and Taiwan)

but not all face overheating risks (Korea). Some are more vulnerable to a sudden stop in capital

inflows (India and Indonesia), while China looks set to experience the sharpest slowdown in

GDP growth in H2 2013.

China: Expect surprises on inflation, interest rates and growth

We highlight three out-of-consensus calls: inflation rises to higher than consensus, two

rate hikes in 2013 and a growth slowdown in H2 2013.

Inflation will rise to higher than the consensus forecast

We believe inflation will rise to 4.2% in 2013, higher than the consensus forecast of 3.2%. There

are both structural and cyclical reasons behind higher inflation. We presented seven structural

reasons in our thematic report,The case for structurally higher inflation in China, 21 September

2011. These structural reasons remain valid for Chinas inflation outlook in 2013.

We are also concerned about inflation from a cyclical perspective. While GDP growth hasslowed to 7.4% in Q3, we believe the economy is running close to its (slowing) potential growth

rate for two reasons. First, the labour market remains tight as the ratio of job openings to job

seekers has stayed above 1 (Figure 13). With low quality unemployment data, this ratio has

been useful in gauging labour market tightness it dropped sharply in Q4 2008 after the global

financial crisis affected Chinas exporters, and recovered quickly after the government released

its 2009 stimulus package. Despite GDP growth decelerating from 12.1% in Q1 2010 to 7.4% in

Q3, this ratio has consistently remained above 1, which suggests that the excess labour supply

in China has been depleted and potential growth may have slowed to around 7.0-7.5%.

Second, non-food inflation month-on-month has, in recent months, been running higher than its

historical average (Figure 14). While there is more focus on headline year-on-year CPI inflation,

we do not believe it fully reflects the underlying inflationary pressures as it is dominated by

volatile food prices and base effects. We think month-on-month non-food inflation is a better

indicator for determining the cyclical position of the economy. The fact that it is still running at a

3.6% annualised rate in October suggests that the economy is running close to its potential.

Fig. 13: Labour demand/supply ratio and real GDP growth

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8

10

12

14

16

0.6

0.7

0.8

0.9

1.0

1.1

Sep-03 Sep-06 Sep-09 Sep-12

% y-o-yRatio Labour demand/supp ly ratio

Real GDP growth, rhs


Fig. 14: Non-food CPI inflation

0.0

0.1

0.2

0.3

0.4

July Aug Sept Oct

% m-o-m

2012

Historical average


If growth is currently running near its potential, policy easing will likely push growth to above itspotential in Q4 and H1 2013, which would drive up inflation. The central government approved

an estimated RMB1trn with of infrastructure projects last summer, with implementation

beginning in Q4. Total social financing rose to RMB 1.6trn in September and RMB 1.3trn in
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October. The planned railway infrastructure investments will also likely pick up to RMB530bn in

2013 from RMB516 in 2012, according to the 21st Century Business Herald. There have been

positive leading indicators in the housing sector as well. We expect overall investment growth in

China to accelerate, at least in H1 2013, which should drive GDP growth above 8%.

Two interest rate hikes in H2 2013

Unlike consensus, which expects inflation to be mild and interest rates to remain unchanged

throughout 2013, we believe there will be two rate hikes in H2 2013, as inflation should rise to

above 4% by mid-year. The inflation target for 2013 has not yet been set, but we believe it willremain unchanged at 4% at the Central Economic Working Conference in December. The most

recent rate hike cycle began in October 2010 when CPI inflation rose above 4%. Moreover we

believe the government has recently become more tolerant of slower growth and less tolerant of

inflation. This was reflected in the Q3 monetary policy report, which added this new statement:

The economy has become less sensitive to the constraint imposed by employment, and more

sensitive to constraint imposed by inflation.

Moreover the government may tighten policy if there are other signs of risk in the economy,

such as sharp rebound of housing prices and over-leverage in the financial system. Housing

prices in October already rose month-on-month in 35 out of the 70 major cities surveyed by the

government, up from 31 in September. The sharp rise in total social financing suggests that

leverage is building in the corporate sector which will likely be a concern of regulators in 2013.

GDP growth slows down in H2 2013

We believe GDP growth in 2013 will be a story of two halves: averaging 8.2% in H1 2013, but

then slowing noticeably to 7.2% in H2 2013. This differs from the consensus which expects

growth to rise through most of 2013 (Figure 15). Our cautious view is premised upon our above-

consensus inflation forecast and consequent policy tightening. We also believe that the current

round of policy easing will lead to rising risks in the financial system, and the government will

probably have to rein in the rapid credit increases from trust loans at some point in H1 2013.

New trust loans rose to RMB202.4bn in September and RMB144.5bn in October (Figure 16).

According to China Real Estate Journal, about 40% of these loans went to infrastructural

projects with an average guaranteed interest rate of 7-8%. We believe such a rapid expansion

of credit to the infrastructure sector at such a high average interest rate is indicative of a

potential bubble and increased default risks. The government is well aware of these risks, as it

tightened regulations on trust loans in the summer of 2011 to control the financial risks, but then

had to loosen regulations in 2012 to prevent the economy from slowing further. We believe the

current boom in trust loans is not sustainable, and expect the government to tighten regulations

on trust loans again in H1 after the leadership transition is completed and growth recovers.

Once the pace of credit supply growth normalises, GDP growth will likely slow toward its

potential of about 7.0-7.5%.

Fig. 15: Consensus versus Nomura forecasts for 2013 realGDP growth in China

6.5

7.0

7.5

8.0

8.5

9.0

1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13

% y-o-y Consensus fo recast

Nomura


Fig. 16: New trust loans since January 2011

-30

0

30

60

90

120

150

180

210

240

Jan-11 Jun-11 Nov-11 Apr-12 Sep-12

RMB bn



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Young Sun Kwon+852 2536 [email protected]


Aman Mohunta+91 22 6617 [email protected]

South Korea: Rates on hold through 2013

We expect the Bank of Korea to keep rates unchanged at 2.75% through 2013 as

GDP growth and CPI inflation should rise modestly from a very low base.

The KRW swap curve is pricing in -15bp of cuts in 12 months as of 27 November (seeAsia

Local Market Rate Expectations, 28 November 2012). Based on a Taylor Rule-type monetary

policy reaction function which we estimate from the policy responses to the output gap and

inflation gap since 2000 our 2013 GDP growth (2.5%) and CPI inflation (2.7%) forecasts

suggest a 25bp cut in 2013, yet the Bank of Koreas (BOK) official GDP growth (3.2%) and CPI

inflation (2.7%) forecasts suggest no cut in 2013 (Figure 17).

Despite the Taylor Rule indicating a 25bp cut based on our GDP and CPI forecasts, we firmly

believe that the BOK will keep rates on hold at 2.75% through 2013. GDP growth and CPI

inflation should rise modestly, but only from a very low base, supported by inventory restocking

in Q4 and a modest recovery of foreign demand in 2013. Although our 2013 GDP growth

forecast is a below-consensus 2.5%, it is not as weak as it may first appear once allowance is

made for a very powerful base effect. Our quarter-on-quarter GDP growth forecast on a

seasonally adjusted annualised rate (saar) averages 3.3% in 2013. The discrepancy between

having an annual GDP growth forecast that is lower than average quarterly growth (saar)

forecast is explained by 2013 GDP starting from a very low base in H2 2012 (Figure 18).

We expect the BOK to focus on quarter-on-quarter growth and therefore to see little need to cut

rates further. We would only expect the BOK to cut rates should quarterly GDP growth fall far

below Q3 2012s 0.156% (sa, q-o-q), but this is not our base case. Between Q1 2000 and Q3

2012 (47 quarters) the historical probability of quarterly growth coming in below 0.156% is 11%.

In other words, over that period only five quarters have seen growth that low and these were

associated with the dotcom bubble bursting in 2001, the credit card crisis in 2003 and the global

financial crisis in 2008. We do not expect growth to slump that badly, unless one of the major

downside risks to global growth (the US fiscal cliff; a renewed eurozone sovereign crisis; a

China hard landing) actually materialises, but none of these are held in Nomura Global

Economics base case.

Fig. 17: Nomuras Taylor Rule-type estimates for policy rate

1

2

3

4

5

6

Mar-00 Mar-04 Mar-08 Mar-12

Actual BOK po licy rates

Fitted based on BOK forecasts

Fitted based o n Nomura forecastsF

%

Note: Policy rate = neutral rate + a [output gap] + b [inflation gap]+ policy rate (-1). Source: Nomura Global Economics estimates.

Fig. 18: Nomuras Korea GDP, CPI and BOK policy forecast

0

1

2

3

4

5

6

Mar-11 Mar-12 Mar-13

GDP growth (seasonally adjusted annualized rate)

CPI inflation (y-o-y)

BOK poli cy rates

%

Forecast

Source: CEIC and Nomura Global Economics estimates.

Hong Kong and Taiwan: property markets pose two-way risk

We see the risk that property prices rise further due to very low interest rates and

ample liquidity.Aside from the main external risks (the US fiscal cliff; a renewed eurozone sovereign crisis; a

China hard landing), property markets in Korea, Taiwan and Hong Kong may all turn out to be

sources of up- or downside risks to our growth outlook. Since 2009, house prices have surged
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in Hong Kong and Taipei, while Seoul has seen house prices fall (Figure 19). As a result, Hong

Kong and Taiwan have tightened while Korea has eased property market regulations:

Hong Kong: The Hong Kong Monetary Authority (HKMA) introduced in September

2012 a new round of measures to strengthen risk-management in mortgage-lending.

For borrowers with multiple properties under mortgage, the debt servicing ratio (DSR)

limit was lowered from 50% to 40% and the maximum loan-to-value (LTV) ratio was

reduced from 40% to 30%. The financial secretary also announced a 15% buyer stamp

duty charged on all residential properties acquired by non-permanent residents,

including corporate owners. Taiwan: In 2011, the Central Bank of China (CBC) tightened prudential measures to

stabilise the property market, including the introduction of a 60% LTV cap on second or

more housing loans for home purchases in specific areas (Taipei and some districts in

New Taipei City). Also, the ministry of finance imposed a Specifically Selected Goods

and Services Tax: a 10-15% levy on the sale price of non-self-use residences and city

land with building permits that were bought less than two years ago.

South Korea: In September 2012 the Financial Services Commission raised the debt-

to-income (DTI) ratio from 40% to 50% in the three Gangnam districts (known as

speculative zones). The government also cut the acquisition tax by 50% on all home

purchases and the transfer tax on unsold apartments purchased before end-2012.

Between June 2010 and July 2011, the BOK and the CBC hiked policy rates by 125bp and62.5bp, respectively. Although Taiwans GDP growth should slow from 4.0% in 2011 to 1.0% in

2012 much sharper than that of Korea, from 3.6% to 2.3% the CBC has kept rates

unchanged while the BOK has cut rates by 50bp. We believe that this is partly due to different

housing market conditions. Due to the USD/HKD peg, Hong Kong has had to keep short-term

rates extremely low, in line with the US Fed, despite surging property prices (Figure 20).

In 2013, our property analyst expects Hong Kong property prices to stall as home prices

become less affordable as household income growth slows (seeHong Kong property outlook

2013: Walking a tightrope, 21 November 2012). Taipei property prices should be stable too, but

Seoul house prices should continue to fall modestly.

However, the risk we see is that property prices rise further in Hong Kong and Taiwan due to

very low interest rates and ample liquidity. If this happens, both governments would likelyimpose more administrative tightening measures and curb credit growth, as the ratio of

mortgage loans-to-GDP is high in Hong Kong (41% in 2011) and Taiwan (40%), compared with

Koreas 25%. An eventual policy-induced property market correction would have a large

negative impact on Hong Kong and Taiwan. Meanwhile, Koreas property market points to

potential upside risks to our growth outlook if the new government eases mortgage financing

regulations aggressively (but this is not our base case).

Fig. 19: House price index in Seoul, Taipei and Hong Kong

40

60

80

100

120

140

160

180

Sep-94 Sep-00 Sep-06 Sep-12

Hong Kong

Seoul

Taipei

2008=100


Fig. 20: Policy rates in Korea, Taiwan and Hong Kong

0

1

2

3

4

5

6

7

8

9

Oct-00 Oct-03 Oct-06 Oct-09 Oct-12

Hong Kong

South Korea

Taiwan

%

Note: Discount rate is for HK and Taiwan. 7day repo rate is forSouth Korea. Source: CEIC and Nomura Global Economics.
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Sonal Varma+91 22 403 [email protected]


India: No more short-cuts

Correcting fiscal finances will lead to medium-term gains; not doing so, will lead to

more pain. Either way, the economy will experience high inflation and slow growth.

Indias GDP growth plummeted to a 10-year low of 5.3% y-o-y in 2012, due to weak global

demand, domestic policy paralysis and high interest rates. Recent reform announcements are

positive for market sentiment, but have yet to be implemented (see:India reforms (Part I): A

long way to go, 25 October 2012) and a lot hinges on whether the government corrects its fiscalfinances for real and not just on paper. Due to the close proximity to elections, we fear only the

latter, and so we expect a shallow recovery in 2013 (6.1%), below consensus, as supply-side

constraints, sticky inflation and weak exports combine to depreciate the rupee, which in turn

feeds into inflation and limits the extent of rate cuts. We set out five themes to watch in 2013.

A year of productivity growth

Lack of investment is one of the fundamental reasons behind Indias slowing potential growth,

but falling productivity is also responsible (seeIndia: Make or break,2 May 2012). Indias

incremental capital output ratio (ICOR), a measure of capital productivity, has risen from 3.6 in

2007 to above 5 in 2012, suggesting falling capital productivity (Figure 21). Slow

land/environment clearances are responsible for project delays and rising costs. In 2013, we

expect productivity to improve as the setting up of the National Investment Board and faster

approvals free many existing projects from bottlenecks that have thus far stymied progress.

However, we do not expect fresh investments to revive in 2013 as the conditions for an

investment take-off (as seen in 1994 and 2004) are not yet in place: low and stable inflation, a

sustained rise in profitability, low cost of capital, fiscal consolidation and higher global growth.

We believe that it will take time to raise potential growth again it took the accumulation of over

a decade of reforms to lift potential growth in the mid-2000s. The governments diktat to public

sector undertakings (PSUs) to use or lose cash may not be able to offset the drag from weak

private investment as the private sector (corporates plus households) account for the bulk (70%)

of total investments and private sector corporate savings far exceed PSU savings (Figure 22).

Fig. 21: Incremental capital output ratio

3.0

3.5

4.0

4.5

5.0

5.5

6.0

6.5

7.0

7.5

1993 1999 2005 2011

Incremental Capital Output Ratio (ICOR)

ICOR (5-year moving average)

Unit

Falling cap italproductivity

Note: ICOR (t+1) = Investment-to-GDP (t)/Real GDP growth(t+1). Source: CEIC and Nomura Global Economics estimates.

Fig. 22: Corporate savings: private versus government

0

2

4

6

8

10

1971 1976 1981 1986 1991 1996 2001 2006 2011

Private Corporate (non-financial)

Government companies & statutory corporations

% of GDP


The consumption binge is behind us

Despite a sharp investment slump since 2007, real private consumption remained resilient

during 2006-11, growing at an annual average of 8.0-8.5%, aided by expansionary fiscal policy

and rising wages. Some of the drivers are still in place (such as the 15-20% rise in rural wages

this year), but we do not see this consumption binge continuing for long as the government is

running out of fiscal bullets and persistently high inflation is squeezing purchasing power. We

expect consumption demand to remain in low-gear, growing at a more muted 4-5% y-o-y in

2013 (Figure 23).
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The extent of future weakness in consumer demand depends on fiscal policy. If the government

substantially consolidates its fiscal finances through a cut in outlay on inclusive growth schemes

and a steep hike in fuel prices, then we would expect consumption growth to dive sharply.

However, even if it does not which is our base case the outlay on flagship programmes

should plateau due to tight fiscal constraints, and government spending would cease to be an

incremental driver of consumer demand. Moreover, the non-farm sector, which now constitutes

close to 70% of rural GDP, slowed sharply in 2011-12 and will have a lagged dampening effect

on rural demand. With urban demand already subdued due to high interest rates, high inflation

and weak job market prospects, we expect overall consumption growth to remain weak.

A year of currency weakness

For a fourth consecutive year, we expect Indias current account deficit to remain above

sustainable levels at 3.8% of GDP in 2013. High inflation and domestic supply-side bottlenecks

are leading to import substitution in sectors such as rubber products, toys, electronics, electrical

equipment, capital goods, textiles and consumer goods. Energy demand remains largely

inelastic, despite recent fuel price hikes, due to a large arbitrage between petrol and diesel

prices and unavailability of gas. With global demand still weak, we expect Indias trade deficit to

remain elevated. Moreover, invisibles no longer provide an offset to a worsening trade deficit as

services exports are growing at a slower pace and investment income outflows are on the rise.

India needs consistent capital inflows just to finance the deficit and to avoid digging into its FX

reserves. Already, import cover of foreign currency reserves has fallen below six months for the

first time since 1997, highlighting the growing external vulnerability (Figure 24). Global push

factors can lead to a sudden surge in capital inflows, but with domestic inflation still high, the

resultant real effective exchange rate appreciation will only eat into export competitiveness (see

India's chronic balance of payments, 3 September 2012). India needs aggressive reforms to de-

bottleneck investments plus tighter fiscal policy and/or higher interest rates. In their absence, we

expect the burden of adjustment to fall on the currency, with INR/USD depreciating to 60 in H2

2013, a new record high.

Fig. 23: Real private consumption growth

0

1

2

3

4

5

6

7

8

910

1988 1993 1998 2003 2008 2013

Private

% y-o-y


Fig. 24: Import cover of FX reserves

2

4

6

8

10

12

14

16

18

Oct-92 Oct-96 Oct-00 Oct-04 Oct-08 Oct-12

Impor t cover of FX reserves

Months


Politics to drive fiscal policy in H2 2013

The threat of a credit rating downgrade suggests that the government will present a balanced

FY14 budget in February 2013. We expect the government to target a fiscal deficit of 4.8% of

GDP in FY14, in line with the Kelkar Committee recommendations (seeIndia: New fiscal

consolidation roadmap lacks details, 29 October 2012). However, we expect this consolidation

to appear only on paper and not in practice we forecast fiscal deficits of 5.8% and 5.2% of

GDP for FY13 and FY14 as the political calendar gets busier, raising the risk of politics

dominating economics. After the Gujarat state elections in December, 10 other autonomous

states are due to hold assembly elections in 2013, two more in H1 2014 and then the generalelection must be held by May 2014 (Figure 25). In the 2009 election, the government leveraged

the rural employment guarantee (MG-NREGA) and farm-debt waiver schemes to woo voters.

While the fiscal position is worse now, populist acts such as delaying tough decisions (like
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raising fuel and fertilizer prices) or announcing new schemes (the Food Security Act) cannot be

ruled out, especially if state elections show the ruling UPA government losing its grip on power.

India cannot afford populist measures. Fiscal consolidation has historically been achieved via

higher revenues rather than less expenditure. Expenditure compression is difficult since

consumption (wages, salaries, services) and transfer payments (interest payments, grants,

subsidies, pensions) together account for 75% of total expenditure, and tends to rise in line with

inflation. In addition, we expect INR depreciation to raise the cost of imported oil, keeping the

subsidy bill elevated. Revenue gains due to the implementation of the goods & services tax and

cost savings by the direct cash transfer scheme are unlikely in 2013, in our view. With theeconomic recovery set to be shallow, we expect only a slight uptick in tax buoyancy. As such,

the structural fiscal deficit will remain large and, more likely, the government will rely on asset

sales (disinvestment, land monetisation, telecom spectrum auctions) to plug the revenue hole.

Window for rate cuts closes in H2 2013

The Reserve Bank of India (RBI) has guided for a rate cut in Q1 2013, saying at its October

policy meeting that the baseline scenario suggests a reasonable likelihood of further policy

easing in the fourth quarter of this fiscal year [Jan-Mar]. We concur. INR appreciation in

September due to the governments reform announcements and global liquidity easing, along

with a slight moderation in commodity prices, led to a surprise moderation in WPI inflation to

under 7.5% y-o-y in October, pushing core WPI inflation to a five-month low of 5.2%. We expect

a favourable mix of supply (lagged effect of INR appreciation, lower commodity prices, good

winter crop prospects), demand (negative output gap) and technical (base effects) factors to

moderate core inflation further in Q1 2013, paving the way for a 50bp repo rate cut in H1 2013.

However, we expect this window of easing to close in H2. By Q3 2013, upside pressures on

inflation are likely to build again. First, Indias potential growth has fallen to under 7% and so it

does not take much of a GDP recovery for the output gap to quickly close and start exerting

upward pressure on inflation (Figure 26). Second, imported inflation is likely to build due to INR

depreciation in H2 2013, raising input costs and translating into higher output prices due to a

narrower output gap. Third, with an eye on the upcoming elections, we expect the government

to raise minimum support prices for food grains and enact the Food Security Act, adding to food

price inflation pressures. As a result, we expect inflation momentum to start to inch higher, core

inflation to inch back towards 5.5-6.0% by Q4 2013 and the RBI to stay on hold in 2H 2013.

We maintain our view that space for rate cuts remains very limited because of the persistence of

large twin deficits (fiscal and current account) and sticky inflation. Rate cuts in H1 should not be

interpreted as the start of an aggressive rate easing cycle. This time is, indeed, different.

Fig. 25: Election schedule

State/HouseEnd of

term

Rulling

party

Seats in Lok

Sabha

Gujarat Jan-13 NDA/BJP 25

Meghalaya Mar-13 UPA/INC 2

Tripura Mar-13 CPI (M) 2

Nagaland Mar-13 NPF 1

Karnataka Jun-13 NDA/BJP 28

Madhya Pradesh Dec-13 NDA/BJP 29

Mizoram Dec-13 UPA/INC 1

Delhi Dec-13 UPA/INC 7

Rajasthan Dec-13 UPA/INC 25

Chhatisgarh Jan-14 NDA/BJP 11

Sikkim May-14 SDF 1

Lok Sabha May-14 UPA/INC 545

Notes: UPA- United Progressive Alliance; INC- Indian NationalCongress; NDA- National Democratic Alliance; BJP- BhartiyaJanata Party; CPI (M) Communist Party of India (Marxist);

SDF- Sikkim Democratic Front. Source: Election Commissionand Nomura Global Economics.

Fig. 26: Output Gap and WPI inflation

-2

0

2

4

6

8

-6

-5

-4

-3

-2

-1

01

2

3

4

Q405 Q407 Q409 Q411 Q413

Output Gap, lhs Core-WPI, rhspp % y-o-y

F



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Euben Paracuelles+65 6433 [email protected]

Lavanya Venkateswaran+91 22 3053 [email protected]

Nuchjarin Panarode,CNS Thailand+662 638 [email protected]

ASEAN: Spot the difference

ASEAN has been resilient, but it is a diverse grouping of Southeast Asian countries,

with growth prospects and policy considerations that may diverge even more in 2013.

We expect ASEANs growth to slow only moderately in 2013 afterdisplaying notable resilience

this year to the volatile external environment.1

We forecast GDP growth for the region at 5.4% in

2012, before slowing only modestly to 5.1% in 2013. The resilience in 2012 was across the

board, and manifest itself even in the relatively open economies (Figure 27). However, we seegreater differentiation in 2013, and in some cases, the contrasts will be increasingly stark.

Indonesia and the Philippines: diverging momentum on reforms

We believe the domestically oriented economies of Indonesia and the Philippines will still lead

the pack and forecast 2013 GDP growth for both at 6% or more. However, this belies a key

distinction between the two: the Philippines is on a path toward a higher growth potential while

Indonesia is likely to underperform its medium-term growth target of 7% by 2014. The reason:

the momentum of structural reforms will likely remain strong in the Philippines but we judge it to

be waning in Indonesia. We expect the Philippines to progress into the next phase of fiscal

reforms, starting with the passage of the all important sin tax bill. The Aquino administration

has shown a strong commitment to pursue these reforms and, importantly, continues to have

the political capital to succeed (seeStill strong approval ratings, 12 November 2012).

Business sentiment has been buoyant, and as a result, we expect a virtuous investment cycle,

where reforms, investment, growth and confidence interact positively with each other.

In Indonesia, the political environment will likely heat up next year, ahead of the 2014 elections,

and we see the rising risk of a policy impasse, or worse, more nationalist/populist regulations

that could further restrict investment (seeAsia Special Report: Indonesia: Policy swings, 2

August 2012). This is likely to add pressure to Indonesias already weakening external position

and hence a headwind to Indonesias quest for an investment grade rating at all three agencies

(S&P is still one notch below despite having a positive outlook since April 2011). Indonesias

current account has turned to a deficit, causing a noticeable decline in its basic balance, which

could deteriorate further if FDI inflows start to slow (Figure 28). In the Philippines, by contrast,

given the durable current account surplus and the prospect of solid FDI inflows, we believemarket expectations of a sovereign credit rating upgrade to investment grade are likely to rise

sharply in 2013. Our credit research team believes an upgrade could come through as early as

H2 2013.

Fig. 27: Investment spending in ASEAN economies

-15

-10

-5

0

5

10

15

20

Jun-05 Jun-06 Jun-07 Jun-08 Jun-09 Jun-10 Jun-11 Jun-12

Less export oriented

Export oriented% y-o-y

Source: CEIC, Nomura Global Economics.

Fig. 28: Basic balance (current account balance + net FDI)

-6

-4

-2

0

2

4

6

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Sep-05 Sep-06 Sep-07 Sep-08 Sep-09 Sep-10 Sep-11 Sep-12

Indonesia

Philippines

USDbn


Singapore, Thailand, Malaysia: varying degrees of cyclical policy support

Among the more open ASEAN economies, the external environment will obviously remain a keydrag, but the economies that have the ability to maintain policy support to shore up domestic

demand will likely outperform, which we have already started to see in H2 2012.

1 ASEAN refers to the five countries in our coverage: Indonesia, Malaysia, Philippines, Singapore and Thailand.
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Thailand stands out as having both the space and the sense of urgency to maintain very loose

monetary and fiscal policies following the 2011 floods. The Bank of Thailand has already cut its

policy rate by a total 75bp to 2.75%, but there is still room to reduce it further particularly i f

exports remain depressed. More importantly, public debt, at 44.2% of GDP, is well below the

governments 60% ceiling. There is scope for the government to ramp up spending, particularly

infrastructure, and in the process crowd in more private investment that already benefits from

highly accommodative monetary policy and the post-flood recovery (seeAsia Anchor Report:

Thailand: new growth engines, 24 September 2012). We forecast Thailands GDP growth at a

solid 4.5% in 2013 from an average of 2.8% in 2011-12.

In contrast, Singapore is more constrained, and as long as our baseline no heart attack

scenario for the global economy holds, we see few reasons to expect countercyclical policies.

The Monetary Authority of Singapore (MAS) is likely to remain focused on inflation, which is still

at historically high levels driven not only by accommodation costs and car prices but also by

wage pressures as a result of government policies. The government remains steadfast in its

resolve to restructure the economy toward one that is more productivity-driven and less reliant

on foreign labor. Two years into this restructuring agenda, productivity growth continues to

decline but policies that tighten the supply of workers are well underway. So the transition will

clearly take time and the economy will have to endure a low growth, high-inflation environment

in the short term until productivity increases are achieved to offset the decline in labor supply.

We therefore revised down our 2013 growth forecast to 2.4%, which is only a modest

improvement from growth of 1.8% in 2012, to reflect a slowdown in investment spending that isincreasingly dampened by external uncertainty and tight domestic policies.

Malaysia should fall somewhere in between Thailand and Singapore. Fiscal stimulus has been

the main lever through which domestic demand has been supported, while monetary policy has

remained on hold. Bank Negara (BNM) remains cautious, as lowering rates risks increasing

domestic financial imbalances and stoking already high debt levels. In our view, however, the

fiscal expansion is about to run its course after the elections, which we expect in March, the

government will have to return quickly to its medium-term fiscal consolidation target, adding to

the external drag in H2 that we see intensifying as China slows. That said, the f iscal belt-

tightening will not be accompanied by an unwinding of other government-led initiatives. Projects

under the Economic Transformation Program (ETP) are already underway and will likely

continue to be implemented in 2013. It is for this reason that we have modestly raised our 2013

forecast to 4.3% from 4.0%, despite fiscal and external headwinds.

In sum, our GDP growth forecasts are below consensus in Malaysia and Singapore but above

consensus in Thailand, where we think the powerful forces underpinning private consumption

and investment spending are still underappreciated (Figure 29).

Fig. 29: Consensus and Nomura GDP estimates of open economies in ASEAN

0

1

2

3

4

5

6

GDP (% y-o-y) PCE, ppt GFCF, ppt GDP (% y-o-y) PCE, ppt GFCF, ppt GDP (% y-o-y) PCE, ppt GFCF, ppt

Malaysia Singapore Thailand

Consensus Nomura

Source: Consensus Economics November 2012; Nomura Global Economics.

Upside inflation risks call for interest rate hikes in H2

Inflation is still relatively benign but we expect it to rise in 2013, in some cases to the top end ofofficial target ranges. Across the region, we see the balance of risks as tilted to the upside for

varying reasons, including positive output gaps (Philippines, Thailand), some food and energy

subsidy adjustments (Indonesia, Malaysia) and tight labor markets (Singapore). Minimum
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wages have been raised substantially in Indonesia (by 44% in Jakarta), Thailand and Malaysia,

which could stoke inflation expectations going into 2013. In response, monetary tightening will

likely begin next year. We see policy rate hikes starting in Q3 in Indonesia, Malaysia and the

Philippines. The pace and extent of the tightening should, however, be gradual, as central

banks continue to keep an eye on external risks.

In addition, the risk of excessive capital inflows could complicate monetary policy and limit the

scope for interest rate hikes. As we argued previously (seeThe case for capital controls in Asia,

1 November 2010), it is not only growth differentials which are clearly still wide in Asia relative

to developed markets that drive capital inflows, but also interest rate differentials. In thiscontext, we also expect the implementation of further macroprudential measures, which has

thus far been the preferred tool among ASEAN central banks to address asset price pressures

that could be exacerbated by large capital inflows. We do not see potential for any drastic

measures (i.e., broad-based capital controls), as central banks have already learned that these

tend to be counterproductive. In addition, although similar pressures occurred in 2010, the

circumstances are very different, especially among the vulnerable countries. Indonesia has

shifted from a current account surplus to a deficit and will therefore be careful not to drive away

foreign capital that help finance this deficit. In Thailand, we feel the authorities are more tolerant

of a stronger currency as it helps support the ongoing upgrade of productive capacity (which

entails higher importation requirements) following the devastating floods in 2011.

Fig. 30: CPI inflation in ASEAN

Source: CEIC: Nomura Global Economics estimates.

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Mar-08 Oct-08 May-09 Dec-09 Jul-10 Feb-11 Sep-11 Apr-12 Nov-12 Jun-13

Indonesia MalaysiaPhilippines SingaporeThailand

%y-o-yNomura forecasts
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Forecast summary


2012 2013 2014 2012 2013 2014

China 7.9 7.7 7.5 2.6 4.2 4.0

Hong Kong 1.2 2.5 3.5 4.0 4.3 4.3

India* 5.3 6.1 6.5 7.6 7.2 6.9

Indonesia 6.1 6.1 6.2 4.4 5.2 5.1

Malaysia 5.3 4.3 4.6 1.7 2.4 2.5

Philippines 6.6 6.4 5.8 3.2 4.6 4.5

Singapore 1.8 2.4 4.2 4.8 3.9 3.6

South Korea 2.3 2.5 3.5 2.2 2.7 3.0

Taiwan 1.0 3.0 3.5 2.0 2.3 2.3

Thailand 5.5 4.5 5.0 3.0 3.0 3.1

Asia ex-Japan 6.3 6.4 6.6 3.7 4.6 4.5

Note: * CPI refers to wholesale prices. Source: CEIC, Bloomberg, Nomura Global Economics.

2012 2013 2014 2012 2013 2014China 1.7 1.0 -0.4 -1.5 -1.5 -1.6

Hong Kong 1.9 -0.9 -2.5 -0.2 -0.5 -0.5

India -4.2 -3.8 -3.4 -5.8 -5.2 -5.0

Indonesia -2.2 -1.9 -1.6 -2.4 -2.0 -2.2

Malaysia 5.9 4.7 4.2 -4.9 -4.5 -4.2

Philippines 2.5 1.9 1.7 -2.2 -2.6 -2.2

Singapore 15.7 16.1 17.0 0.2 -0.2 0.4

South Korea 3.3 2.3 2.0 1.3 1.0 1.0

Taiwan 9.1 7.9 7.4 -1.8 -1.9 -2.0

Thailand 0.7 -0.7 -0.7 -2.5 -3.5 -3.7

Asia ex-Japan 0.9 0.4 -0.3 -2.3 -2.2 -2.3

2012 2013 2014 2012 2013 2014

China 6.00 6.50 6.50 6.26 6.15 6.14

Hong Kong 0.40 0.40 0.40 7.75 7.75 7.75

India 8.00 7.50 7.00 54.0 59.0 56.0

Indonesia 5.75 6.25 6.75 9620 9800 9600

Malaysia 3.00 3.50 4.00 3.02 2.92 2.84

Philippines 3.50 4.00 4.50 40.6 39.2 38.2

Singapore 0.38 0.48 0.50 1.22 1.19 1.17

South Korea 2.75 2.75 3.25 1080 1050 1040

Taiwan 1.88 2.13 2.13 29.0 28.7 28.2

Thailand 2.75 2.75 3.25 30.5 29.9 29.2

Note: All figures relate to the modal forecast, ie, the "most likely" outcome. Source: CEIC, Bloomberg, Nomura Global Economics.

The arrows signify changes from last week.

Real GDP Consumer Prices

Official Policy Rate Currency per US Dollar

Note: Fiscal balances are for fiscal years which differ from calendar years for Hong Kong (Apr-Mar), India (Apr-Mar), Singapore (Apr-Mar) andThailand (Oct-Sep). Fiscal data are for the central government and do not include off-budget. Source: CEIC, Bloomberg, Nomura Global

Economics.

Current Account (% of GDP) Fiscal Balance (% of GDP)


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Zhiwei Zhang+852 2536 [email protected]

Wendy Chen+86 21 6193 [email protected]

Economic outlook

China: Up in H1, down in H2

We expect economic growth to be driven by cyclical policies since progress on

structural reforms may be slow.

Activ i ty:We expect GDP growth to recover strongly to above 8% y-o-y in H1 2013, then slow inH2 toward 7% by Q4 2013. Fixed asset investment should be a main driver of the H1 recovery.

Infrastructure investment has already picked up strongly from policy easing, and its momentum

will very likely continue in H1 2013. Housing investment growth should pick up moderately in H1

2013 after falling over the first three quarters of 2012. Given that a recovery in H1 would be

driven by countercyclical policy easing and not an improvement in economic fundamentals,

GDP growth should return to its potential rate in H2 2013, when policy easing ends.

Inf lat ion:Inflation should rise to above 4% y-o-y by mid-2013 for two reasons: 1) Headline GDP

growth will be pushed above 8% y-o-y by policy easing in H1. This should result in the

emergence of a positive output gap and lead to inflationary pressures. 2) Global commodity

prices have rebounded recently and will likely push up production costs in 2013.

Pol icy:2013 is the first year of new leadership in China. We think that progress on reforms willlikely be slow in 2013, as the new leaders will need time to build the political capital required to

push through tough reforms. On monetary policy, the Peoples Bank of China stated that, The

economy has changed to be less sensitive to the constraint imposed by employment, but more

sensitive to constraint imposed by inflation in its Q3 monetary policy statement, which suggests

that it is more concerned with inflation than growth. We expect two rate hikes in H2 when

inflation rises above 4%.

Risks:We see three key risks to our forecast. The first and most important is policy uncertainty,

as there could be political pressures to maintain the loose policy stance longer than we expect.

The second risk is inflation, which may return at a slower pace and delay policy easing. The

third risk is the global economy, as there is still uncertainty over economic conditions in Europe.

Details of the forecast

% y-o-y growth unless otherwise stated 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 2012 2013 2014

Real GDP 8.1 7.6 7.4 8.4 8.4 8.0 7.4 7.0 7.9 7.7 7.5

Consumer prices 3.8 2.9 1.9 2.0 2.8 3.7 4.6 5.6 2.6 4.2 4.0

Core CPI 1.5 1.3 1.5 1.8 2.0 2.1 2.4 2.1 1.5 2.2 2.0

Retail sales (nominal) 14.9 13.9 13.5 15.0 16.2 15.9 15.5 15.6 14.3 15.8 16.0

Fixed-asset investment (nominal, ytd) 20.9 20.4 20.5 21.0 20.8 21.2 21.3 22.0 21.0 22.0 20.0

Industrial production (real) 11.6 9.5 9.1 12.0 10.9 10.7 10.5 10.3 10.6 10.6 10.5

Exports (value) 7.6 10.5 4.5 5.0 3.0 4.0 6.0 6.0 6.8 4.8 6.0Imports (value) 6.9 6.5 1.4 9.0 7.0 8.0 9.0 9.0 6.0 8.3 10.0

Trade surplus (US$bn) 1.1 68.8 79.5 32.1 -16.0 53.4 70.4 19.1 181.5 126.9 54.5

Current account (% of GDP) 1.7 1.0 -0.4

Fiscal balance (% of GDP) -1.5 -1.5 -1.6

New increased RMB loans (CNYtrn) 8.0 9.0 9.0

1-yr bank lending rate (%) 6.56 6.31 6.00 6.00 6.00 6.00 6.25 6.50 6.00 6.50 6.50

1-yr bank deposit rate (%) 3.50 3.25 3.00 3.00 3.00 3.00 3.25 3.50 3.00 3.50 3.50

Reserve requirement ratio (%) 20.5 20.0 20.0 19.5 19.5 19.5 19.5 19.5 19.5 19.5 18.5

Exchange rate (CNY/USD) 6.29 6.35 6.28 6.26 6.22 6.18 6.16 6.15 6.26 6.15 6.14

Notes: Numbers in bold are actual values; others forecast. Interest rate and currency forecasts are end of period; other measures are

period average. The CNY/USD forecast is for the fixing rate, not the spot rate. All forecasts are modal forecasts (i.e., the single mostlikely outcome). Table reflects data available as of 28 November 2012.Source: CEIC and Nomura Global Economics
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Hong Kong: Looming fiscal stimulus

We expect an expansionary FY13 budget given weak external demand.

Activ i ty:Retail sales growth volume increased by 8.5% y-o-y in September from 3.2% in

August while the PMI rose to 50.5 from 49.6. We expect private consumption to remain robust,supported by a tight labour market, positive wealth effects from buoyant property prices and

increasing visitor numbers. Further, domestic fixed asset investment should remain strong

supported by infrastructure works. We expect fiscal stimulus and a moderate improvement in

external demand to lift real GDP growth from 1.2% in 2012 to 2.5% in 2013. A modest recovery

in the global economy should boost GDP growth further to 3.5% in 2014.

Inf lat ion:CPI inflation ticked up to 3.8% y-o-y in September from 3.7% in October on food

prices. Inflation should rise through 2013, driven by higher food, fuel and rent prices, only partly

offset by inflation-mitigating fiscal measures such as a temporary waiver of public housing rent

and electricity subsidies. We expect CPI inflation to rise from 4.0% in 2012 to 4.3% in 2013.

Pol icy:Hong Kong's fiscal policy is expansionary as the budget for FY12 (year starting April)

includes not only inflation-mitigating measures but also an income tax reduction for individualsof up to HKD12,000 per person and a 14.8% increase in capital expenditure. This should

continue to help stabilise inflation and support the job market. We expect the FY13 budget to

also be expansionary given that external demand remains weak. We would also expect the

government to continue implementing more macro-prudential property tightening measures,

such as hikes in stamp duty if house prices continue to rise, although so far these piecemeal

measures have had limited success in cooling the property market. Because of the USD/HKD

peg, Hong Kong is importing the super loose monetary policy of the US, and it remains unclear

whether tighter macro-prudential measures can provide a sufficient offset in the long run.

Risks:As a small, open economy and financial hub, Hong Kong is one of the most vulnerable

in Asia to weakness in the global economic outlook. An economic hard-landing in China would

be especially detrimental through both trade and financial channels.

Details of the forecast

% y-o-y growth unless otherwise stated 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 2012 2013 2014

Real GDP (sa, % q-o-q, annualised) 2.1 -0.2 2.5 2.7 3.1 1.3 4.0 1.7

Real GDP 0.7 1.2 1.3 1.7 2.0 2.5 2.8 2.5 1.2 2.5 3.5

Private consumption 6.4 3.1 2.8 4.5 3.2 3.4 3.6 4.5 4.2 3.7 4.4

Government consumption 2.5 3.5 3.7 3.2 3.5 3.7 3.8 4.2 3.2 3.8 4.4

Gross fixed capital formation 12.6 5.7 8.7 6.0 5.8 5.8 5.7 5.8 8.1 5.8 6.1

Exports (goods & services) 1.4 5.5 8.7 1.9 4.5 5.0 5.0 5.5 4.4 5.0 7.2

Imports (goods & services) 4.2 0.9 10.7 3.0 5.1 5.5 6.2 6.9 6.2 5.9 7.7

Contributions to GDP (% points)

Domestic final sales 7.4 3.7 4.3 4.7 3.8 4.0 4.2 4.8 5.0 4.2 4.8Inventories -1.8 -1.4 -1.1 -0.6 -0.7 -0.3 1.1 0.6 -1.2 0.2 -0.2

Net trade (goods & services) -5.4 -3.2 -3.3 -2.2 -1.0 -1.3 -2.3 -2.7 -3.5 -1.9 -1.1

Unemployment rate (sa, %) 3.4 3.3 3.5 3.4 3.4 3.4 3.4 3.4 3.4 3.4 3.2

Consumer prices 5.2 4.2 3.1 3.6 3.7 4.3 4.5 4.6 4.0 4.3 4.3

Exports -1.2 2.0 4.4 7.0 9.2 10.4 10.1 10.4 3.1 10.0 12.3

Imports 0.9 2.3 5.0 8.0 9.5 10.5 10.9 11.7 4.1 10.7 12.5

Trade balance (US$bn) -12.7 -15.9 -15.6 -17.2 -14.2 -17.6 -18.3 -20.8 -61.4 -71.0 -80.7

Current account balance (% of GDP) 1.9 -0.9 -2.5

Fiscal balance (% of GDP) -0.2 -0.5 -0.5

3-month Hibor (%) 0.40 0.40 0.40 0.40 0.40 0.40 0.40 0.40 0.40 0.40 0.40

Exchange rate (HKD/USD) 7.76 7.76 7.75 7.75 7.75 7.75 7.75 7.75 7.75 7.75 7.75

Source: Numbers in bold are actual values; others forecast. Interest rate and currency forecasts are end of period; other measures are

period average. All forecasts are modal forecasts (i.e., the single most likely outcome). Table reflects data available as of 28 November2012. Source: CEIC and Nomura Global Economics.
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Sonal Varma+91 22 403 [email protected]

Aman Mohunta+91 22 6617 5595

[email protected]

India: A year of consolidation

With macro imbalances slow to correct, binding supply-side constraints and weak

global demand, a quick rebound is unlikely. We expect a shallow growth recovery.

Activ i ty:Despite GDP growth falling to a 10-year low of 5.3% in 2012, we believe there will bea shallow recovery, with growth rising to 6.1% in 2013, for three reasons. First, we expect

growth in Western economies to remain weak in 2013. Second, as potential growth has fallen to

6.5-7.0%, the output gap will close quickly on any demand pic

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