Market Insights June 2015 240615 - FINAL

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M A L A Y S I ACIMB Bank Berhad

June 2015


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Contents

CIMB Bank Berhad Page 2May 2015

EDITORIAL

Effendy Shahul Hamid

Head, Group Marketing and Communications

CIMB Group

EDITORIAL COMMITTEE

Ken Kamal, Nurlia Binti Ismail, Lee Sui Sheng

PUBLISHED BY

Group Marketing and Communications

CIMB Investment Bank Berhad (18417-M)

Level 6 Menara SBB, 83 Jalan Medan Setia 1,

Plaza Damansara, Bukit Damansara,

50490 Kuala Lumpur, Malaysia

CONTENTS

3 Economic Outlook

China is fighting disinflation, something it willneed to eliminate to deal with excess capacityand debt. However, the stimulus required to do

so may need to be much larger than whatconsensus believes. In the event, the slowdownmay not follow a linear path and growth, in

particular, investment, may rebound for a fewquarters. That, in turn, will affect commodity

prices and could have significant implicationsfor the region. Malaysia and Indonesia are likelybeneficiaries.

7 Central Bank Watch

A round-up of key developments and newsarising from central banks around the world.

10 Fixed Income

There are several positives for the Indonesianbond market, with stable politics, a looser policystance and prudent fiscal spending. Indonesiamay be on the verge of returning to theinvestment-grade world. The IDR 10Y bondenjoys a near-600bp spread over the US 10Yand we think that is an attractive option.

13 Latest Highlights

The spectre of a Greek default continues toconcern investors, but how much would a Greekdefault really disrupt markets?

By Schroder Investment Management Limited


3/16

Economic Outlook


China: Deviating from the script?

The received wisdom on the Chinese economyis that it is rebalancing - moving away frominvestment-led growth to being consumption-led. And, while it does this rebalancing, it isalso moving from a near-10% growth rate forseveral decades to a more sustainable rate ofsomewhere between 5% and 6%. Implicit inthis story is that the path from 10% to 5% willbe a linear one, with the economy growing just

a tad slower each year, for example, 7% thisyear, down from 7.4% last year and, then,perhaps 6.5% next year and so on.

That is the new normal and policy is workingtowards it. The investment boom, where theinvestment ratio reached an unprecedented50% of GDP, was driven by several policymeasures, such as keeping an undervaluedexchange rate and a real interest rate below itsmarket-clearing level. Furthermore, from thestart of reforms to around the late-1990s, in realterms, wages grew at well below GDP growth.

As such, household income growth also did notkeep pace with GDP growth and consumptionas a percentage of GDP declined from about50% of GDP to about 35% of GDP in the mid-2000s. Moreover, with the lack of social safetynets, the savings rate rose from 35% in 1980 toabout 50% by the mid-2000s.

In short, we had a high-savings and low-consumption economy, thereby supplying fundsor the ability to invest. The incentive to investwas created via low real rates and anundervalued currency. In short, China did 10%growth while increasing its investment ratio. All

that is now changing. In real terms, wagegrowth has been outstripping the growth rate ofGDP and social safety nets have also beenimproving, giving support to a possible declinein the national savings rate. In addition, in itslatest Article IV consultation, the IMF concludedthat the exchange rate was no longerundervalued. Progress is also being made oninterest rate liberalisation.

So far, so good or so it seems. The 10% growthrate came at a price. In particular, in the latteryears, especially after the 2008 global financialcrisis, there was a credit-fuelled investmentsurge that left the economy saddled with threemain problems: debt, bad loans and excess

capacity. Moreover, adding to these problems,the economy is facing disinflationary pressures.None of these problems is easy to resolve insuch an environment.

The real hurdle to reforms: Disinflation

In a situation where inflation is either very lowor falling, real wages tend to rise, thusdampening employment and, in turn, keeping

capacity utilisation rates low. Furthermore, withdisinflation, real debt levels rise or stayelevated and asset quality suffers. For theseproblems to be addressed, it is imperative thatChina gets rid of disinflation.

A more technical way to see this is to recognisethat there is now a negative output gap inChina, meaning that actual output is less thanpotential output. And this is despite a decline inthe potential growth rate as the economy triesto move to a more sustainable growth path.Thus, for inflation to return, China needs toclose the gap between potential and actualoutput and that essentially means an increasein demand.

The increase in demand could come via twosources: external or domestic. China could getlucky and global growth could pick up, therebyboosting its exports. Unfortunately, globalgrowth is currently showing a fair amount oflethargy and forecasts are being downgraded.The IMF has recently lowered its 2015 forecastfor the US economy to 2.5% from 3.1% and its2016 forecast to 3% from 3.1%. The OECD iseven more cautious, lowering its US growth

forecast from 3.1% to 2.1% for this year andfrom 3% to 2.8% for 2016. The OECD is fairlyunenthusiastic in its outlook, recognising thateven if the negative first quarter growth numberin the US is a blip, the outlook for investmentdemand and, hence, overall demand, is stillunsatisfactory.

The poor outlook for investments bringsanother problem because it is the import-intensive part of domestic demand. Forecaststhat expect the US economy to rebound largelyrest on rising income growth fuelling

consumption demand. For China and Asia, thatis not much consolation as their exports catermore to business investment. If the likes of


4/16

Economic Outlook


OECD and IMF are correct, it looks unlikely thatChinas exports are going to show muchstrength anytime soon. That then leavesdomestic demand to close the output gap andbring back inflation so reforms can continue. Arise in domestic demand, in turn, depends onhow policy monetary and fiscal isconducted.

Using monetary policy

The authorities have been reasonably clear in

their response. Small doses of fiscal stimulus -measures dealing with the environment,shantytowns, etc. - have been ongoing for awhile but disinflation has persisted. In addition,the drop in oil prices exacerbated matters and,with producer prices headed for nearly threeyears of decline, the authorities concluded thatmonetary stimulus was needed - an economy-wide measure to deal with the economy-wideproblem of disinflation. Since then, reserverequirements have been cut two times by atotal of 150bp and interest rates three times bya total of 90bp.

The extent of stimulus needed will depend onhow effective these measures are in endingdisinflation. Our belief is that monetary policy isnot a particularly sharp instrument right nowand, therefore, to have any effect, the extent ofstimulus needs to be big, much more than thepiecemeal effort that consensus anticipatesfrom the PBOC.

A discussion of Chinese monetary policy istricky, especially as not only policy but also theentire policy framework is in flux. Until 1997,the PBOC largely used a quota system to

manage the size of credit and cash. Since then,it has moved toward controlling the growth ofmonetary aggregates using a variety ofinstruments. The monetary base is controlledthrough open market operations, the reserverequirement ratio, central bank lending andrediscounting. Credit is, then, managed throughboth price-related measures, such as interestrates, and administrative controls such as astipulated loan-deposit ratio and quotas. Macro-prudential measures are also used.

Furthermore, with China trying to increasingly

integrate with the global economy and, hence,being subject to changes in global liquidity, thePBOC has introduced liquidity management

tools, such as the standing lending facility(SLF) and short-term liquidity operations (SLO).

The longer-term goal is of course liberalisationand the increasing use of a price-basedmechanism, such as interest rates, and itappears that deposit rate liberalisation is highon the reform agenda. However, the monetarysystem is getting increasingly complex, withboth increased global integration and thedevelopment of shadow-banking institutions.The role of the bank and, hence, instrumentsthat motivate banks behaviour have limits totheir effectiveness. For our purposes in thisreport, we will discuss two of the instrumentsused thus far: the reserve requirement ratio(RRR) and the benchmark interest rate. Cuts inthe reserve requirement add to the monetarybase by boosting its net domestic assetcomponent. How much that increase translatesinto broad money then depends on whether alack of deposits (excess of reserves) was thebinding constraint on credit growth. With asystem loan-deposit ratio of 72.62% (versus theceiling of 75%), one could argue that RRR cutswill ease the growth of credit.

However, even as the RRR has been cut, creditgrowth by banks and aggregate financing havebeen decelerating, suggesting that the bindingconstraint may not be the supply of credit.Instead, most likely, it is credit risk, withconcerns over credit quality, that is holdingbanks back.

Rate cuts should, however, help boost creditgrowth. If the binding constraint on creditgrowth is indeed credit risk, then lower rates, byreducing debt service payments, should help.

However, the story does not end here. Insimple terms, the mechanism by which aneasing by the central bank affects the realeconomy has two components to it. After all,the central bank only controls base moneygrowth or its financial position with the bankingsystem. The first part of the transmissionmechanism is the extent to which the increasein base money makes it into the real economy.In other words, how much base money growthtranslates into broad money growth or, to keepit simpler, lets say, credit growth. This is the

money multiplier.


5/16

Economic Outlook


The second part of the transmissionmechanism is how fast the money in the realeconomy turns around. In other words, what isthe velocity of money. The greater it is, themore transactions are conducted for a givenamount of money in the system.

If either the money multiplier or the velocity ofmoney is impaired, then so is the effectivenessof monetary policy. In Chinas case, as one cansee from the chart above, credit growth hasbeen decelerating, and as one can see fromthe chart below, the velocity of money has beensteadily declining. In short, monetary policy is arather blunt instrument. To be effective, theextent of stimulus needs to be large. At aminimum, policy stimulus is likely to be muchlarger than the piecemeal effort that consensusexpects it to be.

We think another 100bp to 150bp of rates cutscannot be ruled out and even that may not bethe end of the story. Fiscal policy may alsoneed to be used. Recall that the goal of policyis much larger than merely cushioning a

downturn. It needs to get actual output abovepotential output so that inflationary pressuresbuild up and headway can be made in dealingwith excess capacity and debt.

The cuts in reserve requirements are unlikely tosimulate the economy directly. We think theyare largely being undertaken to maintain thegrowth rate of base money to compensate forcapital outflows, a simple substitution of onecomponent of base money (net foreign assets)by another (net domestic assets). It is more ofa compensatory measure rather than astimulatory one. However, with the change inthe composition of base money towards morenet domestic assets, it is likely that theexchange rate will be weaker and that couldindirectly help growth.

The full picture

We anticipate much greater monetary stimulusthan consensus; we expect rates to be lower byat least another 100bp and for the exchangerate to be weaker. Now, these are pretty muchthe same policy settings when China wasrunning its investment-led growth story. As

such, the path to the new normal for Chinamay not be a linear one. For a few quarters,until inflation appears again, China may go

back to the model of rising investment demandand, hence, rising commodity prices. Theconsequences for the region could beprofound.

If investment rises, the capital good exporters -Japan and Korea - will benefit. Chineseinvestment has the strongest backward linkagethrough the construction industry to the mining,metals and minerals sectors. Within the region,Japan and Korea are exposed as capital goodsexporters, Malaysia exports commodities,Indonesia sends coal and India exportscommodities and metals.

Besides all this, most countries are part of asupply chain in which China plays an importantrole. China accounts for close to 50% of intra-regional imports, most of it related tomanufacturing. Intermediate goods accountedfor 70% of regional export growth over the pastdecade. The IMF has calculated elasticitiesand the countries most affected by the supply-chain effectare the Philippines, Singapore andThailand. The effect on Japan and Korea is

lower, albeit not negligible. The commodityexportersIndia, Indonesia and Malaysia donot have much supply-chain considerations butare likely to be affected as China increases itscommodity imports with rising investmentgrowth.

There are many moving parts in the globaleconomy given uncertainty over growth, policyrates, currencies and even the future of theEurozone. It is a time to move with care but, inthese trying times, it looks possible that Chinamay just be getting ready to throw one moreold-fashioned party, one with stimulus andrising investment and commodity prices.


6/16

Economic Outlook


Sourced fromArup RAHA

CIMB Econ om ics Research Team

Figure 1: China GDP, investment and consumption growth

SOURCES: NBS, IMF, CEIC, CIMB RESEARCH

Figure 2: China CPI, PPI

SOURCES: CEIC, CIMB RESEARCH

Figure 3: Export growth of China and ASEAN (3mma)

SOURCES: CEIC, CIMB RESEARCH


7/16

Central Bank Watch


Highlights

United States

The US Federal Reserve kept the Fed funds

rate unchanged when it last met on 29 Apr. In

a statement released at the conclusion of its

meeting, the Fed said: "Although growth in

output and employment slowed during the first

quarter, the Committee continues to expect

that, with appropriate policy accommodation,

economic activity will expand at a moderate

pace." The Fed also decided to remove any

specific references to calendar dates when

discussing the timing of a rate rise, which

could further confuse markets that have often

reacted badly to any hint of the end of cheap

money in the US economy. Minutes released

on 20 May indicated that members were

looking at a rate hike sometime after June

given economic weakness in the early months

of the year. The minutes also suggested,

however, that policymakers were ready to

move as soon as that evidence was

accumulated.

European Union

The European Central Bank (ECB) on 3 Jun

kept its interest rate and asset purchase policy

unchanged. ECB President Mario Draghi said

the bank's 1.1tr euro (US$1.2tr) stimulus

programme is supporting the eurozone's

modest recovery as the money works its way

through the financial system to the real world

of businesses and consumers. The ECB'sefforts have "contributed to a broad-based

easing of financial conditions," Draghi said.

"The effects of these measures are working

their way through to the economy. We expect

the economic recovery to broaden," he added.

Draghi cautioned, however, that Greece

remained a concern and that governments'

slow progress in reducing debt and making

their economies more business-friendly was

still acting as a weight on growth.

Japan

Bank of Japan (BOJ) governor Haruhiko

Kuroda on 22 May kept the asset purchase

target unchanged at 80tr. The central bank

also revised up its assessment of private

consumption and housing investment,

underscoring its confidence that the world's

third-largest economy has emerged from the

hit levelled by last year's sales tax hike.

However, there is some admission that there

may be somewhat of a delay in hitting the

ambitious inflation target. Deputy Governor

Kikuo Iwata said that, with the underlying trend

of inflation improving steadily and wages on

the rise, Japan is likely to hit the 2% inflation

mark around the first half of the next fiscal

year, beginning in April, while BOJ policy

board member Sayuri Shirai, said that

consumer price inflation is likely to approach

the Bank of Japan's target of 2% "toward the

end of fiscal 2016."

China

The Peoples Bank of China (PBOC) on 10May cut interest rates for the third time in six

months, reducing the one-year lending rate by

0.25% pt to 5.1% and cutting the one-year

deposit rate by the same amount to 2.25%. In

another step to free up interest rates, the

central bank will also raise the limit on what

banks can pay savers. Inflation remained

subdued and exports and imports both slid inApril, underscoring the economys struggle to

match Premier Li Keqiangs 2015 growthtarget of about 7%. With capital flowing abroad

and local governments embroiled in a complex

debt clean-up, economists anticipate further

easing.


8/16

Central Bank Watch


South Korea

The Bank of Korea's (BOK) policy board on 11

Jun cut the policy interest rate to a record low

of 1.5%. This was mainly a pre-emptive move

to minimise the adverse impact of an outbreak

of Middle East respiratory syndrome (MERS),

with the economy already grappling with

slowing exports and sluggish domestic

consumption. Governor Lee Ju-yeol saidMERS was having a "significant" impact on

consumption as consumers preferred to stay

home while foreign tourists cancelled trips to

South Korea. "A rate cut was needed to ease

the impact of MERS, which has increased

downside risks to our growth trajectory amid

slowing exports," he said.

Australia

The Reserve Bank of Australia (RBA) on 2 Jun

kept its benchmark interest rate unchanged at

a record low of 2.0%. RBA Governor GlennStevens said, having eased monetary policy

last month, the board judged that leaving the

cash rate unchanged today was appropriate.

However, Mr Stevens held the door open for a

further cut, saying economic data would

indicate whether the current policy stance

would foster sustainable growth and inflation

consistent with the RBAs 2% to 3% target

band.

India

The Reserve Bank of India (RBI) cut interest

rates for the third time this year on 2 Jun,

reducing the policy repo rate by 25bp to

7.25%. RBI Governor Raghuram Rajan said

that monetary policy would continue to be

data-contingent, warning that a below-normal

monsoon, global crude prices and external

sector risks pose a threat to inflation. The

central bank projects inflation of around 6% by

January 2016. Rajan reiterated that the

government should avoid putting the burden

on the central bank to revive the economy,

which he believes is in a "slow recovery".

Thailand

The Bank of Thailand (BOT) met on 10 Jun,

where it unanimously decided to keep its

policy rate at 1.5%, after two consecutive cuts

in Mar and Apr. The Thai economy grew at a

sluggish pace in the first quarter as exports

contracted amid weak spending, forcing the

government to cut its 2015 growth outlook.

Looking ahead, the economy is projected toimprove gradually but subject to downside

risks from a slower-than-expected recovery of

the global economy, especially China and

other Asian economies, the bank said.

Malaysia

Bank Negara Malaysia (BNM) on 7 May left

the overnight policy rate (OPR) unchanged at

3.25%. BNMs view seems to not havechanged much from its Mar meeting. It expects

global growth, on balance, to improve at a

moderate pace, although downside risks stillpersist. On the domestic front, Malaysias

growth is expected to remain on a steady path,

supported by investment activities in the

export-oriented industries, the services sector

and infrastructure projects. This will help buffer

the lower investments expected in the oil &

gas-related sector as well as the moderation in

private consumption due to the GST. Exports

will continue to be supported by manufactured

products, benefiting from the improvements in

several advanced economies and sustained

growth in Asia.

Indonesia

Bank Indonesia (BI) on 17 Feb cut its

benchmark BI rate by 25bp to 7.50% as it

expects inflation to continue easing. The cut

effectively cancelled out the quarter-point rate

increase in late-Nov. BI also cut its overnight

deposit facility, known as Fasbi, by 25bp to

5.50% but it maintained the lending facility rate

at 8%. BI Governor Agus Martowardojo said

the central bank expects inflation to continue

to move towards the lower end of its 3-5%

year-end target.


9/16

Central Bank Watch


Philippines

The Bangko Sentral ng Pilipinas (BSP) on 12

Feb kept its key policy rates steady at 4% for

the reverse repurchase facility and 6% for the

repurchase facility. The central bank is not

inclined to tweak its monetary policy stance for

now given subdued inflation and continued

robust domestic growth, BSP Deputy Governor

Diwa Guinigundo said. Ample liquidity andstrong domestic activity provide ample fiscal

headroom for the central bank to retain the

current benchmark interest rates despite a

steep drop in the price of oil and Chinasslowing economy.

Singapore

The Monetary Authority of Singapore (MAS)

said on 28 Jan that it will adjust its monetary

policy and let the Singapore Dollar Nominal

Effective Exchange Rate (NEER) appreciate at

a slower pace. The revision in monetary policy

came as a surprise as MAS was only

scheduled to release its next monetary policy

statement in Apr. MAS will continue with the

policy of a modest and gradual appreciation of

the Singapore Dollar NEER policy band.However, the slope of the policy band will be

reduced, with no change to its width and the

level at which it is centred, the central bank

said. "This measured adjustment to the policy

stance is consistent with the more benign

inflation outlook in 2015 and appropriate for

ensuring medium-term price stability in the

economy," it added.

Sourced from

Jarratt MaCIMB Econ om ics Research Team

Figure 4: Major central bank policy rates

SOURCES: BLOOMBERG, CIMB RESEARCH

Figure 5: Scheduled monetary policy meeting dates in 2015

SOURCES: CENTRAL BANK WEBSITES, BLOOMBERG, CIMB RESEARCH


10/16

Fixed Income


Indonesian spreads attractive

The case for Indonesia

In our opinion, there are a couple of major

positives for Indonesias bond market: 1) on

the back of a stable political environment,

authorities are looking to boost growth via a

loose monetary stance (good for bonds) and/or

prudent fiscal spending (good for credit

ratings), and 2) indeed, Indonesia is on the

cusp of fully returning to the investment-grade

world.

Bank Indonesia (BI) cut its policy rate by 25bp

to 7.50% at its policy meeting in February. BI

also cut its overnight deposit facility rate (Fasbi

rate), which is considered the floor price in the

money market, to 5.5% at the same meeting.

CIMB economists felt that the February

loosening was more a reversal of the hike BI

introduced in November 2014. BI had raised

rates in November in anticipation of higher

prices as oil subsidies were reduced. True toexpectations, BI held the BI rate at 7.50% at its

17 Mar meeting (and the Fasbi at 5.50% and

lending facility rate at 8%) and again at its 14

Apr meeting. As BI kept policy on hold, we

were reminded of high inflation in Mar-May.

Also, Indonesias current account deficit was a

concern and a constraint on further loosening.

Indonesias inflation was high at +7.15% yoy in

May, following +6.79% yoy in Apr and +6.38%

in March. However, we also note that the May

number was boosted by the stocking up offood items ahead of the fasting month and the

numbers in Mar and April came after the

government increased fuel prices twice in

March. The first increase was relatively small

(3%) while the second was bigger (7%). The

consensus estimate for the 2015 full-year CPI

is 6.50% against +6.42% in 2014. Meanwhile,

the consensus for economic growth for 2015 is

still a relatively small 5.10% against 5.03% in

2014 and 5.58% in 2013. The view of our

economists is that the case for more rate cuts

in Indonesia this year is clear and BI may justdo it, with 2015 possibly ending with a BI rate

of 7.00%. On top of the moderate economic

growth, the decline in oil prices will help

reduce the current account deficit (and bring

down inflation). Elsewhere, capital inflows

have been strong, resulting in an accumulation

of reserves.

On 22 May, Standard & Poors upgraded

Indonesias BB+ sovereign rating outlook to

Positive from Stable. This signalled the

possibility of an upgrade to investment grade

(BBB-) within a year, bringing it on par with

Moodys (Baa3) and Fitchs (BBB-) ratings on

Indonesia. S&P cited greater policy

effectiveness and predictability have resulted

in expanded fiscal and reserve buffers and

improved Indonesias external resilience as

reasoning for the upgrade. We believe this

was brought on by fiscal reform moves by the

new government, including the fuel subsidy

cuts, and expectations of more potent fiscal

spending and budgetary discipline. Earlier this

year, Moodys also said Indonesias narrowercurrent account deficit and balance of

payments surplus are credit positives and

these will lower external financing costs for the

government. We think that when or if

Indonesia is upgraded is secondary. What is

important is that the Positive outlook should

maintain inflows to the country, with the hope

that the higher rating will dampen the risk

premium on Indonesia going forward.

Furthermore, an investment-grade rating

solidifies Indonesias inclusion in global or

Asia-centric fixed income indices, such as

Citis Asia Pacific Government Bond Index,

which relies heavily on S&Ps ratings. Data

dated 30 April by Citi showed that Indonesia

has a 7.0% weightage in this index.

That aside, we note that net foreign inflows to

the IDR govvies market continued to rise,

recording a pace of IDR6.3tr in May 2015, with

the foreigners share of outstanding IDRgovernment bonds maintained at 38.4% vs

38.5% in April. A continued delay in the

expected Fed rate hike to end-2015 and thesustained injection of liquidity by global central


11/16

Fixed Income


banks contributed to the foreigners current

high shareholding.

IDR spreads are attractive

IDR government bond yields have surged in

the past couple of months. The 5-year

indicative yield is now hovering around 8.10%

versus 7.35% at the start of April, a climb of

75bp. The sell-off coincided with higher

inflationary expectations as the fuel subsidy

was cut, liquidity was tight whilst BI held itspolicy rates and the IDR was weak against the

surging USD, surpassing the 13,000 level. On

top of increased EM fears during the period,

Indonesia was also held back as the Jokowi

government still had not detailed its spending

plans (especially infrastructure and other

growth-boosting spending out of the savings

from the fuel subsidy cuts).

However, we expect to see a rebound in

demand for IDR bonds in the short- to

medium-term horizon. Expected policy ratecuts later this year look likely to happen and

will ease liquidity concerns. Meantime, inflation

should be able to trend downwards. Also, the

government will have the next budget

(announcement slated for 2H2015) to outline a

more prudent plan and identify spending

targets to boost the economy. Indonesia will

ride on the S&Ps positive outlook, especially if

fiscal reforms continue.

After the recent surge in bond yields, we think

spreads are now attractive. We note the 3-year

IDR govvies is now at about 7.90% versus

levels of 6.75% at the start of Mar 2015. That

is a jump of 115bp, bringing it to above the BI

rate of 7.50%. Yield pick-up is also attractive

vis--vis regional markets. Indonesian 10-year

govvies (Baa3/BB+) versus Malaysias (A3/A-)

10-year is currently near a spread of 440bp.

This is its widest since Sep 2014. Meanwhile,

the spread between Indonesias 10-year bond

and Thailands (Baa1/BBB+) is more than

540bp and up from 440bp in Feb this year.

Indonesias 10-year spread over 10-year US is

near 600bp. This is a jump of about 100bp

since Feb 2015 and the widest since Dec

2014. In addition, we take note of the razor-

thin spreads along the IDR govvies yield

curve. The spread between the 3-year and 10-

year government bonds has tightened to under

30bp against a range of 60-130bp over a year

ago. This signifies pent-up demand for longer-

term govvies and players preference for IDR

duration.

Risks

Risks to our expectations include IDR

remaining on a weak trajectory and sustaining

its risk premium, a faster rise in UST yields as

global investors price in a quicker Fed hike

and foreign shareholding looking a tad high

whilst a decline in short-term yields will need a

surer signal that BI is closer to slashing rates.

On the other hand, our prior concerns over a

surge in short-term fresh issuances of IDR

government bonds have now diminished,

following the recent heavy activity in thissegment.

Supply less of a worry

Financing requirements may be more

comfortable in 2H2015. So far this year, the

government has issued approximately 55% of

its 2015 gross debt issuance target. This is in

line with its frontloading strategy where 60% of

its targeted offerings are to be issued in

1H2015 and 40% in 2H2015. The expectation

is that the government will issue IDR26tr of

securities in Jun 2015 (from five regular bond

auctions). However, the government is also

likely to issue less than the targeted in Jun to

Jul due to the high-yield environment but we

think it will still meet its target relatively easier

thereafter, judging by the expected smaller

size. In 2H2015, the government may issue

IDR1.0tr of retail bonds and one global bond,

amounting to IDR35tr in total.


12/16

Fixed Income


Sourced from

Nik A. Mukharr iz

CIMB Group Treasury Fixed Incom e Research Team

CIMB Investment Bank B hd

Figure 6: 10-year government bond yield movement (%)

SOURCES: BLOOMBERG, CIMB ESTIMATES

Figure 7: 3-year and 10-year IDR government bonds yields and spread

SOURCES: BLOOMBERG, CIMB ESTIMATES


13/16

Latest Highlights


How much should markets fear a Greek default?

The spectre of a Greek default continues toconcern investors, but how much would aGreek default really disrupt markets?

Greeces Prime Minister, Alexis Tsipras, isfacing an unwinnable game. Having ordered a

750 million loan payment to the IMF in May,just hours ahead of crunch talks with Greecescreditors, the country remains far from out of

the woods. The next IMF deadline is thisFriday (5th June), when a 300 million loanrepayment is due. In May, some members ofMr Tsipras governing Syriza party had lobbiedfor defiance of the payment. What remainsclear is that Mr Tsipras can either appease thecountrys creditors or his electorate. Not both.

Without further assistance, Greece coulddefault on its debt repayments as soon as thisweek. But how significant an event would adefault be for investors?

Systemic links reduced

It is important to note that it is far from certainthat a default on its IMF payment would lead toGreeces exit from the eurozone andconsequently a default on its Europeanlenders.

Greeces links with the eurozone financialsystem have significantly declined in the wakeof 2012, when one of the largest debtrestructuring deals in history wiped 100 billionfrom Greeces liabilities. The risks associatedwith Greek sovereign debt also largely passedfrom the eurozones banking sector to the

eurozones public sector.Who holds Greek debt?

The bulk of Greek debt is held by theEuropean Financial Stability Facility (EFSF),the European Central Bank (ECB), and theEuropean Investment Bank (EIB) as well assome in bilateral loans. The bilateral loans,according to S&P, amount to 53 billion, sotheir importance should not be downplayed.However, in October 2014, the degree of directexposure to Greek debt by eurozonegovernments stood at 302 billion. This

amounts to around 3% of eurozone GDP(excluding Greece), and we believe that the

direct impact of a Greek default should belimited.

Impact of a default

From the EFSF perspective, the net balancesheet exposure to Greek bonds is around

166 billion, but this will be absorbed by theeurozone member states over a number ofdecades. The restructuring process also

extended the repayment schedules for theGreek bonds in question. The first repaymentto the EFSF is due in only 2023. It is alsoimportant to note that the central banks ofmost eurozone member states would not needto cover capital short falls as a commercialbank would.

The ECBs exposure is predominantly via theEmergency Liquidity Assistance (ELA)scheme, which allows Greek banks access tothe additional liquidity so long as they canprovide enough eligible collateral. Were

Greece to default on a bond payment, the ECBwould be able to withdraw this support, andany shortfall, as detailed above, would notnecessarily need to be covered.

The EIB exposure amounts to around 7billion. In relative terms, this is a small sum forthe EIB and we envisage no risk of the bankbecoming insolvent. On its own, it would notdestabilise the bank.

Contagion risk

Finally, the contagion risk for Greek debt hasalso been theoretically muted by the

establishment of the European StabilityMechanism. This pot of capital, of around 500billion, should maintain the flow of cash foraffected states should there be any threat tovital payments brought on by a Greek default.

Of course, the possibility of hidden financialties, as well as indirect and politicalimplications, must not be ruled out. If Greeceoutright and unilaterally defaults, it is likely tohave significant market implications at least inthe short run. However, we believe thatstructurally, global financial markets look well

shielded from the fallout of such an event.


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Latest Highlights


Sourced from

Alan Cauberghs

Senior Investm ent Director, Fixed incom e

Schroder Investment Management Limited

Important Information

The material above is provided for informational purposes only. Reliance should not be placed on the

views and information expressed when making individual investment and/or strategic decisions.Please note that the views expressed in these articles are those of the authors and do not necessarilyrepresent Schroders' views.

Issued by Schroder Investment Management Limited, 31 Gresham Street, London EC2V 7QA.Registered No: 1893220 England. Copyright 2015 Schroders plc


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