Credit Conditions: Asia-Pacific Growth Is Mostly Stable, But Some Lagging Credit Risks Remain For 2014

Primary Credit Analyst: Andrew D Palmer, Melbourne (61) 3-9631-2052; andrew.palmer@standardandpoors.com Secondary Contact: Fabienne Michaux, Melbourne (61) 3-9631-2050; fabienne.michaux@standardandpoors.com

Table Of Contents
The Macroeconomic Environment: Asia-Pacific Growth To Be Largely Flat Financing Conditions: Tight Yields Unlikely To Last Risks And Imbalances Sector Trends: Largely Stable With A Dash Of Negative Outlook: Cautious Going Into 2014 Related Research Appendix

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Credit Conditions: Asia-Pacific Growth Is Mostly Stable, But Some Lagging Credit Risks Remain For 2014
(Editor's Note: Standard & Poor's Credit Conditions Committees meet quarterly to review the macroeconomic environment in each of four regions (Asia/Pacific, Europe/Middle East/Africa, Latin America, and North America). Discussions center on identifying credit risks in various sectors and outlining the potential impact these risks might have on ratings. The committees also evaluate how economic conditions will influence borrowing and lending activity for businesses and consumers within those regions in the following few months. This article reflects the view developed during the Asia-Pacific Credit Conditions Committee discussion of Dec. 3, 2013.) Credit conditions for Asia-Pacific issuers have improved in the fourth quarter of 2013, owing to better-than-expected Chinese GDP growth and deferment of the U.S. Federal Reserve's tapering of its quantitative easing (QE). However, looking ahead into 2014, we anticipate credit conditions could tighten again and become more volatile as QE tapering impacts market interest rates (although we believe some of the expected market adjustments have taken place if the Fed does start to taper). Our outlook for real GDP growth for Asia-Pacific as a whole remains largely unchanged from the previous quarter. However, there have been changes in the distribution of growth risks across key economies within the region. In particular, China now seems broadly on track to hit its government's growth target over the next two years. With China's growth more stable and European growth appearing to have bottomed out, the main risk to Asia-Pacific growth has shifted, in our view, from a sharp slowdown in China to a possibly weaker U.S. recovery. Against this backdrop, improvements in the more export-dependent Tiger economies of Hong Kong, Taiwan, South Korea, and Singapore will likely be less impressive than we had initially expected. Meanwhile, Japan's government has confirmed that the consumption tax hike will push through in April 2014, creating a potential drag on consumption and growth. With China's growth stabilizing and broadly on track with government targets over the next two years, issuers appear to be breathing a sigh of relief across the region. Despite this, it looks like it is still going to be a rough ride for some issuer credit ratings, countries and industry sectors as we move into 2014. We believe the economies of Indonesia, Philippines, Thailand, and Vietnam have high country risks. In addition, the sovereign ratings on India and Japan are on negative outlooks, which have a knock-on effect on the ratings on public finance entities in those countries. Sectors facing the most stress, as indicated by the net negative ratings bias of issuers we rate, are building materials, chemicals, metals and mining, and financial institutions. (See "Asia-Pacific Credit Outlook 2014: A Sigh Of Relief As Growth And Market Risks Subside").

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Credit Conditions: Asia-Pacific Growth Is Mostly Stable, But Some Lagging Credit Risks Remain For 2014

Overview Growth in Asia-Pacific remains below trend, despite the stabilization of activity in China. External factors continue to threaten the outlook, but the composition of these risks has changed. A major risk comes from the resilience (or lack thereof) of the U.S. economic recovery. The fortunes of the Tiger economies of South Korea, Hong Kong, Taiwan, and Singapore continue to be more dependent on global economic conditions than other economies in the region. In Japan, the initial effects of "Abenomics" appear to be positive. However, the negative effects of the consumption tax hike on consumption and inflation expectations need to be monitored closely. While risks have subsided, softer economic prospects--partly China-driven--and skittish financial markets make for a difficult environment for Asia-Pacific issuers going into 2014. About 14% of issuer ratings as at November 2013 are on net negative outlook or CreditWatch with negative implications. Sectors such as building materials, chemicals, metals and mining, public finance, and financial institutions continue to be affected by lower economic growth and in some cases cyclical downturns.

Other sectors facing strain include utilities, capital goods, retail, project finance, and transportationcyclical. Somewhat better placed are the insurance, oil and gas, consumer products, and transportation infrastructure. Best positioned, although some still with some slight negative bias, are issuers in real estate development, diversified, automobile original equipment manufacturers and suppliers, gaming and entertainment, high technology, real estate investment trusts (REIT), and telecommunications.

The Macroeconomic Environment: Asia-Pacific Growth To Be Largely Flat

Growth in Asia-Pacific remains slightly below trend, despite the stabilization of activity in China. External factors continue to threaten the outlook, but the composition of these risks has changed. Earlier in the year, the biggest risk to regional growth was a sharper-than-expected slowdown in China. At that time, the authorities were providing what appeared to be minimal monetary and fiscal support even as the investment-led growth model appeared to be losing some traction. Many analysts and market participants feared a "hard landing," the effects of which were supposed to spill over from China into the global economy. China's growth has stabilized at close to the official target of 7.5%, and the authorities have demonstrated that, although they are intent on engineering a slower but more sustainable growth rate, they are not going to allow a sharp downturn (widely understood to be growth of below 7%) to threaten China's development or social stability. The second major risk to Asia-Pacific was the market turbulence that resulted from fears related to the tapering of asset purchases by the U.S. Federal Reserve. As this episode played out, the market reaction was largely as expected. Asset prices and funding costs were most affected in economies that have external financing deficits--India and Indonesia. Exchange rates depreciated sharply, interest rates rose, and eventually, growth deteriorated. The surprise decision by the Fed not to taper in September bought some time for these economies to recover and adjust their policy mix. Nonetheless, we see this as a temporary reprieve. But there are a few reasons why we think

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that the next round of market volatility will be less painful for Asia-Pacific's external deficit economies. First, markets have already forced a substantial correction in Asian growth and currency values in the previous round of turbulence. In the quiet period after September, Asian markets did not see stellar rebounds, suggesting that there is now less downside risk should the turbulence resume. Second, policymakers in the most vulnerable economies have taken steps to address their structural weaknesses, including easing restrictions on foreign investment and tightening monetary policies to cool domestic demand, reining in current account deficits, and increasing the attractiveness of their economies for global investors. A risk that Asia-Pacific continues to face comes from the resilience (or lack thereof) of the U.S. economic recovery. Recurring and escalating fiscal shocks may undermine the economic momentum that the private sector has built up. Although we still expect growth to improve in 2014, there are increased risks of government inaction and infighting that could destabilize not only the U.S. economy but also the world's.
Table 1

Standard & Poors Real GDP Scenarios

Baseline (%) Australia China India* Japan South Korea Hong Kong Indonesia Malaysia Philippines Singapore Taiwan Thailand Vietnam New Zealand Asia-Pacific Emerging Asia Newly industralised economies ASEAN 2013f 2.5 7.6 4.8 1.8 2.7 2.8 5.7 4.7 7.0 3.9 2.0 2.9 5.2 2.5 5.3 6.0 2.6 5.1 2014f 2.6 7.4 6.0 1.4 3.5 3.4 5.6 5.2 6.4 3.4 3.5 4.4 5.5 3.1 5.4 6.3 3.5 5.4 2015f 3.0 7.2 6.3 1.2 3.8 4.1 5.8 5.4 6.0 3.7 3.8 4.8 6.0 2.2 5.4 6.4 3.8 5.6 2013e 2.5 7.6 4.2 1.8 2.7 2.8 5.7 4.7 7.0 3.9 2.0 2.9 4.5 2.5 5.1 5.9 2.6 5.0 Downside 2014e 2.2 6.9 4.7 1.1 1.7 0.8 4.7 4.0 5.7 0.9 1.0 3.6 4.6 2.0 4.6 5.4 1.3 4.5 2015e 2.4 6.6 5.0 0.8 2.6 1.4 5.1 3.7 5.4 1.3 1.9 4.1 4.8 2.1 4.6 5.4 2.1 4.7 2013e 2.5 7.6 5.3 1.8 2.7 2.8 5.7 4.7 7.0 3.9 2.0 2.9 6.3 2.5 5.3 6.2 2.6 5.2 Upside 2014e 2.9 7.8 6.2 1.6 4.6 5.3 6.0 6.2 7.0 5.0 4.9 5.2 6.5 3.5 5.9 6.8 4.8 6.1 2015e 3.3 7.4 6.8 1.5 4.8 5.6 6.2 5.6 6.8 5.0 5.1 5.5 6.9 3.3 5.8 6.8 5.0 6.1

*Fiscal Year ending March. RBI exploring a new monetary policy framework. Regional aggregates are calculated as a weighted average using 2012 GDP measured in PPP terms. Source: Standard & Poors.

Against this new backdrop, Standard & Poor's maintains its base-case growth outlook for Asia-Pacific overall, although the composition of growth has changed. Our confidence in the overall economic picture has improved, however: we are now attaching a probability of 60%-70% to our baseline forecasts. Regional growth has largely disappointed in the third quarter of 2013, although China surprisingly rebounded. We continue to forecast an improvement in 2014, driven by slight pickups in U.S. and European growth, but the extent of the rebound is now less than we initially thought given

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the strength of headwinds in the U.S. economy. This affects the outlook in the more trade-dependent Tiger economies of South Korea, Taiwan, Hong Kong, and Singapore, although a more stable outlook in China helps to partially offset the slower-than-expected U.S. recovery. Structural rigidities and low investor confidence will likely hold India to a sub-par growth rate this fiscal year, but we expect the recent reform momentum to enable a return to around 6% moving forward. Japan has been the major upside surprise this year, but we expect the consumption tax hike to shave off some of this momentum. Finally, the Southeast Asian economies continue to have resilient domestic demand, but recent market stress caused growth to ease by raising costs of borrowing for consumption and investment. Inflation will remain well under control across most of the region, in our view, as slower growth and existing output gaps result in little demand-side price pressure. The notable exceptions are India and Indonesia, which have not only seen fuel subsidy cuts, but have also experienced extremely sharp depreciation of their currencies. On the monetary policy front, we see very little impulse to move interest rates in either direction over the next year, with rates already very accommodative and inflation largely benign. The exception would be the Reserve Bank of New Zealand, which is likely to tighten settings steadily due to concerns about the possible overheating of the housing and construction market. India and Indonesia have tightened ahead of the rest of the region, reducing the need to raise policy rates further. The People's Bank of China will likely hold its main policy rate steady while increasing the relative importance of its open market operations within its policy toolkit. Finally, we would not rule out the Bank of Japan increasing its rate of asset purchases to try to counter the effects of the consumption tax hike on disposable income and confidence. China's economy is now on track to grow by 7.6% in 2013 after its unexpectedly strong performance in the third quarter, and by 7.4% in 2014. With renewed economic stability, policymakers now appear increasingly determined to reform China's dependence on lending and investment for growth. And the recently completed Plenum has generated some positive surprises on the increased role of markets in the economy. However, the reform process will be gradual, and will not be without difficult tradeoffs (see "The Unpleasant Math Of Raising China's Consumption-To-GDP Ratio"). Japan's economy received a jump start this year from the thrust of "Abenomics." Crucially, the Bank of Japan has shown a willingness for and dedication to ending deflation, which appears to have given businesses and consumers a confidence boost. The economy is likely to achieve a growth rate of just under 2% this year. However, the other two "arrows of Abenomics" seem to be less convincing from a growth perspective. The second arrow targets fiscal flexibility in balancing growth and debt concerns. The consumption tax hikes are now set to push through in April 2014 and October 2015. Although good for fiscal consolidation, we are wary of the negative effects this will have on consumption, overall growth, and crucially, defeating entrenched deflation expectations. There has also been some progress with the third arrow of structural reform, but some key measures on easing the declining labor force are lacking, in our opinion (see "The Bull's-Eye Of The Third Arrow Of Abenomics"). Australia continues to face a slightly bumpy path on the way to a needed rebalancing of growth drivers. We maintain our 2.5% forecast for 2013, rising to just 2.6% in 2014, as the economy continues to struggle to rotate investment and growth away from the mining sector. Previous investments are coming online, but mining investment has peaked faster than expected. The exchange rate will play a key role in spurring the needed rotation. India's growth forecast has been cut further to 4.8% in fiscal 2013-2014 in view of the weak investment outlook. However, the reform momentum generated by recent market pressures as well as the reinvigorated efforts of the Reserve Bank of India may allow the economy to return to around 6% growth. The Tiger economies have seen a slower export recovery this year than we initially expected. We forecast real GDP

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for this group--which is led by South Korea, with a 50% weight--to grow by 2.6% in 2013 and 3.5% in 2014, down fractionally from our previous forecasts. These economies, while not experiencing consumer price inflation, continue to see asset price rises from capital inflows as well as importing record low U.S. interest rates. Countries in the Association of Southeast Asian Nations (ASEAN) continue to grow at a steady pace, owing to the larger contribution of domestic demand to growth in these economies. However, momentum has eased for various reasons. Rising household indebtedness has weighed on consumption in Thailand and Malaysia, while Indonesia is facing tighter monetary settings that were put in place to rein in the current account deficit. Of this group, only the Philippines looks like growth will continue at a high pace, particularly as rebuilding efforts begin after the disastrous typhoon that hit the country. Standard & Poor's risk scenarios for Asia-Pacific are now more symmetric, reflecting the alternative scenarios we have regarding growth in the advanced economies. In our downside scenario (15%-20% probability), the U.S. sees recessionary conditions and grows at only 0.6% next year, possibly driven by a policy mistake. Europe's recovery also reverses, most likely caused by tight monetary and credit conditions. Under this alternative, Asia-Pacific's external demand and investment take large hits, particularly the Tiger economies. Central banks will try to counteract these developments somewhat, but are limited by the fact that rates are already at or close to historic lows. The upside scenario (15%-20% probability) would include faster than expected recoveries in Europe and the U.S. Once again, the Tiger economies are the main beneficiaries. Stronger-than-expected growth would also see output gaps beginning to close across the region. Interest rate normalization could happen faster, but central banks in economies with rising household debt (South Korea, Thailand, and Malaysia) will find their space to tighten limited. We see China's growth falling to 6.9% and 6.6% over the next two years under our downside scenario. This would be caused not only by external factors, but more so by tighter policies than initially anticipated. Crucially, we are not anticipating a credit crunch or massive deleveraging in the short run. In the upside scenario, China reforms much more slowly, bringing its growth rate at the pace of the past two years (7.5%-8%). Japan's risk scenarios center on the success or failure of Abenomics. In the downside, the policy momentum wanes, the consumption tax hike hits confidence hard, growth slips back below 1% again in 2015, and inflation remains at or below 1% after the initial spike from the tax. In the upside, growth stabilizes at around 1.5% over the next two years; importantly, inflation reaches the Bank of Japan's 2% target in 2015. In Australia, the downside scenario largely tracks China, given the strong dependence of mining production and exports on Chinese investment growth. Real GDP growth in the downside is now forecast at 2.2% in 2014 and 2.4% in 2015. Our upside scenario has Australian growth at around 2.9% in 2014 and 3.3% in 2015. India's growth could fall to 4.2% in 2013-2014 and 4.7% the following year under our downside scenario, predicated on a fractured government mandate after the elections, monsoons turning unfavorable and industrial production losing the little momentum it currently has. Unlike the rest of the region, risks are more on the downside than upside. The scenarios in the Tiger economies mirror the scenarios for the U.S. and Europe closely, given their dependence on trade. Growth for this group falls to 1.3% in 2014 in the downside, with Hong Kong leading the slowdown at 0.8%. Symmetrically, stronger growth in the advanced economies could push the growth rate for this group to around 5% in the next two years. The ASEAN group, led by the Philippines, continues to outperform the Tigers, given the former's more domestically led growth. Nonetheless, overall ASEAN growth slows 0.5 percentage point to around 4.5% in 2014 and 2015 under the downside scenario. In the upside scenario, growth could exceed 6%.

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Credit Conditions: Asia-Pacific Growth Is Mostly Stable, But Some Lagging Credit Risks Remain For 2014

Financing Conditions: Tight Yields Unlikely To Last

The trending pullback for various bond segments reversed somewhat on Sept. 19, 2013, upon the Fed's decision to not taper. Yields had declined across the board subsequent to the Fed's announcement, and particularly for the riskier bond segments like emerging markets and Asia. The depreciation of Malaysia's ringgit against foreign currencies translated into currency gain for investors, further enhancing the quarterly returns of foreign bond funds. The U.S. dollar and the Singapore dollar strengthened 3.1% and 3.8%, respectively, against the Malaysian ringgit in the third quarter. Emerging market bonds and Asian bonds advanced 3.4% (JP Morgan EMBI Global Total Return Index) and 3.9% (JP Morgan Asia Credit Index Total Return Composite), respectively, in the third quarter, registering the year-to-date returns at minus 1.2% and 3.6%. Malaysian bonds reported a quarterly loss of minus 0.2%, reducing its year-to-date gains to 1.2%. While investment strategies vary across the region, some large funds appear to favor a carry-and-credit strategy while keeping durations low until yields rise toward the levels seen at the end of August. Consequently, some funds will emphasize the intermediate part of the yield curve while remaining defensive in longer maturity bonds and buying selectively, in our view. We anticipate that the majority of central banks in the Asia-Pacific will hold policy interest rates steady in 2014 as they, to varying degrees, shadow the US Fed, anchoring the short end of yield curves. However, we anticipate that market interest rates of longer tenors are likely to creep up in 2014-2015 as the US economy recovers and the Fed tapers its asset purchases. A critical part of this process will be the strategies of central banks in managing interest rate rises as they change the relative funding costs of issuers in the region.

Risks And Imbalances

Table 2

Top Global Risks Third-Quarter 2013

Risk Level* Shock/uncertainty from U.S. fiscal negotiations Contagion from eurozone problems Unexpected disruption emerging from long-term rebalancing of Chinas economy toward consumption from investment Disorderly exit from quantitative easing High High Moderate Moderate Trend Decreasing Stable Stable Stable

*Risk levels may be classified as very low, low, moderate, elevated, high, or very high. Trends may be classified as stable, decreasing, or increasing.

We consider a disorderly market response from the end of quantitative easing remains an important risk globally. The process of the Fed's return to more normal monetary policy could lead to unexpected and disruptive effects. Adverse market reaction to shifting policy expectations could lead to increased financial volatility across markets. In addition, the continuation of extraordinary easy money policy and investor search of yield has reinvigorated many asset

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markets, renewing concerns of a potential buildup in bubbles or imbalances. In Europe we view the risks emanating from the eurozone to have stabilized with the Outright Monetary Transactions program going a long way in diminishing tail risk in the eurozone region. Our baseline assumptions for the European economy are that it will remain in recession this year, but that it has bottomed out. In Asia-Pacific the two main macro risks to the region's economic growth over the past year have narrowed. First, China's growth appears to have stabilized at around the authorities' 7.5% target, and the risk of a hard landing in the near term appears increasingly unlikely. Second, financial market stress stemming from speculation about the U.S. Federal Reserve's QE tapering have eased for now. Although capital outflows from Asia could return once the Fed does start to taper. In terms of global developments, weaker growth in the U.S. on one hand will be partially offset by stable growth in China and slight improvements in Europe, resulting in a largely steady pace of external demand facing Asia economies for this year and next. Nonetheless, structural risks remain in China, particularly in the financial sector. These appear manageable in the near term, but we believe policymakers are serious about gradually shifting out of the investment/credit-led growth model to a more sustainable consumption-led growth path. As such, we believe that China's overall growth rate will continue to ease from this year to next. Japan is still on track to grow at or close to 2% this year and next, but the annual figures mask the easing trend of growth momentum over the next few quarters. Abenomics and the confidence it inspired were able to jump-start the economy, but the consumption tax that is scheduled to increase in April could significantly dampen that momentum. Crucially, the decreased spending power of households would make undoing entrenched deflation expectations much more difficult. The Bank of Japan could try to counter this by increasing the pace of their asset-purchase program. The Tiger economies in Asia might face a significant headwind from any weaker U.S. outlook, although they have the strongest upside should global growth and trade perform better than expected. Nonetheless, offsets from stable growth in China and slightly better economic growth in the E.U. might help to balance this out, resulting in only small changes in our baseline growth forecasts. In contrast, Australia is more exposed to China, and the stable growth outlook there will be one less headwind as the economy struggles to rebalance its economy away from mining investment. Southeast Asian economies may face slower growth next year. Markets there will be hit harder by QE tapering fears (although possibly not as hard as in the past few months), and the resulting negative risk sentiment will affect funding and investment. Slower U.S. growth will also weigh on growth prospects, while the tailwinds from a stronger Japanese economy may lose some momentum, especially after the tax hike there. Concerns about fiscal deficits (outside of the Philippines) and excess liquidity provide very little space for policy support. Overall, we continue to monitor market developments, particular with regard to volatility related to Fed tapering. While the destabilizing risks from an adverse market reaction remain, we believe that the risks to asset prices and funding costs are now less than they were midway through the year. There have also been significant economic adjustments in the most vulnerable economies, which address their structural weaknesses somewhat.

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Credit Conditions: Asia-Pacific Growth Is Mostly Stable, But Some Lagging Credit Risks Remain For 2014

Sector Trends: Largely Stable With A Dash Of Negative

Sovereigns: Risk of Inadequate Policy Response To QE Tapering
Disorderly market responses or inappropriate policy responses to the withdrawal of quantitative easing remains a key risk to sovereign creditworthiness. The delay to the Fed tapering brought relief for some Asia-Pacific emerging market economies that had experienced capital outflows, exchange rate depreciation, and foreign exchange losses since May. However, the U.S. central bank is unlikely to maintain its current policy stance for very long. And even before it changes, investor sentiments could turn even more negative on emerging markets. Without addressing the causes behind the capital outflows, the capital accounts of affected countries could weaken further. Relatively high levels of domestic credit in important economies--including China, Korea, and Australia--constrain monetary policy as a countercyclical tool in another economic slowdown (see "An Asia-Pacific Credit Crisis Remains UnlikelyBut The Signs Are There," published Feb. 17, 2013). Stimulating credit growth further with monetary easing could increase financial risks even if it lifts short-term growth. This is a likely reason for China's greater willingness to see lower economic growth. And while China appears intent to keep annual real GDP growth above 7%, the risk that growth decelerates more sharply than policymakers expect--at least temporary--cannot be ruled out. In this scenario, pressures on economic growth could spread across the Asia-Pacific. This could have implications for the ratings of some sovereigns if the policy responses are insufficient to limit the impact on credit fundamentals. Even though attention on North Korea has dissipated for the time being, geopolitical risk in Northeast Asia remains prominent late in 2013. China's decision to set up an Air Defence Identification Zone that covered territory claimed by its neighbors has raised tensions. The move evoked responses from the U.S., Japan, and Korea, that raised the specter of a possible military conflict in the region. While this scenario remains very unlikely in our view, it carries significant negative potential impact on regional sovereign ratings if it becomes a reality. Missteps by the key countries involved could lead to a minor military engagement followed by a major disruption in trade or economic flows in the region. Finally, a renewed global slowdown triggered by a deepening of Eurozone banking sector problems or further U.S. fiscal policy uncertainties could bring downward pressures on sovereign ratings in this region. The impact would be magnified if global financial market instability develops at the same time. As of end-November 2013, there are three long-term sovereign ratings with negative outlook and none with positive outlook in the Asia-Pacific. All of the remaining 19 long-term sovereign ratings in the region carry stable outlooks (see "Report Card: Gravity Tugs At Asia-Pacific Sovereign Ratings As Global Risks Persist And Domestic Challenges Grow", published Oct 1, 2013.)

Public Finance: Tax-Collection Key To Stability

The outlook for public finance is mainly stable (see table 3). The primary macroeconomic risk to several of Asia-Pacific's local and regional governments (LRGs) relates to their ability to collect corporate, mining, employment, housing, and consumption taxes. LRGs reliant on property rates, such as those in New Zealand, Australia and Japanese cities, are not as vulnerable to national GDP conditions as many other LRGs tend to be.

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Table 3

Asia-Pacific Public Finance Trends

Next 12 months Sector Australian states Current business conditions Business outlook Satisfactory Somewhat stronger No change No change Financial trends Sector outlook Same Same Same Stable Stable Stable

Local governments Satisfactory Higher education Satisfactory

Source: Standard & Poors.

In Australia, the main risks to LRGs relate to consumption, specifically for the state governments that rely on the goods and services tax (GST) to fund services; and transaction taxes associated with houses being bought and sold rather than sat upon. Mining royalties are particularly important to the states of Western Australia and Queensland and the soft commodity prices are impacting both of these state's operating performance. Over the medium term, the horizontal fiscal equalization system in Australia will compensate these states for any reduction in own-source revenues. In response to this slower revenue growth, the Australian states have undertaken structural rebalancing to varying degrees and we expect that the cost savings will start flowing through to the states operating performances. Over the medium term, this will support credit quality. In Japan, we expect the increase of the national sales tax which was recently approved will ease the credit risks of rated prefectures and cities. The national sales tax rate will be increased to 8% in April 2014 and to 10% in October 2015 from its current level of 5%. Both prefectures and cities will have a share of the revenues from the tax increase. In 2014, we also anticipate the recovery of corporate profit tax which will further support the prefectures' tax collections, while the urban cities will enjoy the pick-up of the property rates as the real estate market begins to show signs of recovery.

Financial Institutions: Negative Economic Trends For Australia, India, Malaysia and New Zealand
Financial institutions will continue to be challenged with downward pressure on asset quality. In 2014, Standard & Poor's expect gradual recovery of GDP growth in Asia-Pacific region. However, the growth prospects in emerging countries such as China and India are softer than the past trend and will be exposed to several risks such as Eurozone problem, disorderly market response from tapering off of US quantitative easing and ineffective outcome of region's economic policy. China's slower growth could have spill-over effects on other countries such as Australia, Indonesia, Taiwan, Korea and Hong Kong. Sluggish economic conditions combined with high level of corporate and household debt in some major economies will impose stress on banks' asset quality. We expect credit costs would surge but not increase sharply and harm banks' capitalization assuming the base case scenario of gradual recovery of economy. Compared with other regions, Asia-Pacific's banking sector shows resilient credit standings, demonstrated by no changes to the any of the region's respective economic and industry assessments under our Banking Industry Country Assessment (BICRA) in 2013. We use our BICRA methodology to identify and incorporate rising and receding risks for banks consistently and globally. BICRA determines the anchor rating for all banks in the system which is the starting point in assigning an issuer credit rating. In Asia-Pacific, our BICRA scores range from '2', which we consider as having

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low risk, to '9', which we consider as having high risk (see table 4).
Table 4

Banking Industry Trends

Economic risk factors Industry risk factors

BICRA group Australia China India 2 5 5

Credit risk in Economic Economic the Economic Economic Institutional Competitive resilience imbalances economy risk score risk trend framework dynamics Very Low Intermediate Low High High 2 6 5 Negative Stable Negative Stable Stable Stable Very Low High High Very High Intermediate Intermediate Very Low High High High Intermediate Intermediate

Systemwide funding Intermediate Very Low Low Intermediate Very Low Low

Industry Industry risk risk score trend 2 5 5 7 3 3 Stable Stable Stable Positive Stable Stable

Intermediate High High Very High Low Low

Indonesia 7 Japan Korea 2 3

Intermediate Very High 7 Low Low High 2 4

Intermediate Low

Note: BICRA Group '1' to '10', from lowest to highest risk. Economic and Industry risk classified as "very low", "low", "intermediate", "high", "very high", or "extremely high". For information about other Asia Pacific nations please see Banking Industry Country Risk Assessment Update: November 2013, Nov 6, 2013.

Except for Australia, New Zealand, India, and Malaysia, we assign stable economic trends for all countries, while many eurozone countries have negative economic trends. Of the industry risk trends we see Indonesia trending positively on the back of improved bank regulations and supervision, and stable trends for all other countries. We began to assign 'positive', 'stable', and 'negative' trends in our view of economic and industry risk in the first quarter, to better capture emerging risks (see "S&P to Publish Economic and Industry Risk Trends for Banks").

Insurance: Insurers Show Business and Financial Resilience

The outlook for life insurance, property & casualty, and reinsurance is stable (see table 5), with a relatively benign net negative ratings outlook bias of 9% at November, 2013. This regional outlook bias is slightly weaker than 7% for insurance globally, in part from the negative outlook on the Japan sovereign rather than industry stand-alone issues.
Table 5

Asia-Pacific Insurance Industry Trends

Next 12 months Sector Life insurance Current business conditions Business outlook Financial trends Sector outlook Satisfactory No change No change No change Same Same Same Stable Stable Stable

Property & casualty insurers Satisfactory Reinsurers Source: Standard & Poors. Satisfactory

The economic slowdown in China and its impact on the wider region, as well as ongoing low interest rates in many markets are likely to continue to constrain insurers' premium growth and earnings in the near term. Despite this slowdown, the growth is still a high level relative to the developed markets, and we believe that insurers have the business and financial resilience to withstand adverse conditions (see table 6 and "Asia-Pacific Insurers Are On Firm Footing As Economic Conditions Shift," Sep.3, 2013). This resilience was demonstrated as insurers maintained their favorable operating performance despite ongoing low interest rates and volatile investment markets. Meanwhile,

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insurers' capital positions either recovered or stabilized post the 2011 natural catastrophe events in New Zealand, Thailand, and Japan.
Table 6

Asia-Pacific Insurance Country And Industry Risks

Property and casualty IICRA score Australia China Hong Kong Japan Korea Singapore Low Intermediate Low Intermediate Low Low Country risk Very low Moderate Very low Low Intermediate Very low Industry risk Low Low Intermediate Moderate Low Intermediate IICRA score Very low Intermediate Low Intermediate Low Life Country risk Very low Moderate Very low Low Very low Industry risk Low Intermediate Low Intermediate Low

Note: Insurance Industry and Country Risk Assessment (IICRA), country risk and industry risk are classified as very low, low, intermediate, moderate, high or very high. For information about other Asia-Pacific systems, please see Asia-Pacific Insurers Are On Firm Footing As Economic Conditions Shift, Sep.3, 2013. Source: Standard & Poors.

For the property and casualty (non-life) sector, we expect only modest movement in premium rates after solid rate increases in 2012 in markets such as Thailand, New Zealand, Australia, and Japan, and more recent increases in Taiwan's property catastrophe and commercial fire lines. Although catastrophe claims have been low throughout 2013, with limited insurance losses to Typhoon Haiyan in the Philippines, we still believe the potential for extraordinary natural catastrophe losses is a heightened concern. We have already seen the sign of reinsurance price softening on catastrophe risks following the spike in premium rates in 2012. Largely unmodeled risks such as flood risk remain an industry issue in terms of pricing for risk, so we expect pricing for flood-prone properties to be variable as ongoing research and market feedback emerges. Motor pricing should be less affected. We maintain a negative outlook on the Thailand non-life sector as there is still scope for reserve strengthening associated with the 2011 floods. Although growth moderated for life insurers because of the region's slowing economy, they still enjoy stronger prospects than insurers operating in the U.S. and Europe. We see underlying strength in the Australian life market despite recent increased lapse rates and more disability claims under subdued economic conditions and greater pursuit and acceptability of stress and mental illness claims. Australia's growing population, underinsurance, high debt to income levels, and cross-sell opportunities from the mandatory pension scheme should support life insurers' underlying growth and future profitability in the country. Nevertheless, investment volatility, asset-liability mismatches, and low interest rate returns continue to constrain our ratings on many life insurers (such as those in China, Japan, and Taiwan), but we see ongoing improvement in managing these risks structurally. We see Japan life insurers leveraging from higher interest rates and the economic stimulus measures in the near term. Taiwan's life insurers should continue their 2013 trend of slower new business momentum under softer economic conditions and some capital constraint, with underlying profitability still constrained by low interest rate pressures. We maintain our negative outlook on the China life market amid moderating profitability, in part from bancassurance branch sales restrictions, and modest capitalization in the sector.

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The key risks and trends for life insurers are the slowing economic growth in a number of Asian countries, capital pressure due to asset risks, and potential earning volatilities due to volatile investment markets. Capital pressure exists from rapid growth markets such as China, Malaysia, and Thailand. Prolonged low interest rates, asset-liability mismatch, and investment market volatility continue to affect markets such as Taiwan and Japan, although profitability continues to improve under these conditions. For Australia, the industry is seeing increased lapse rates and disability claims patterns. For property and casualty insurers, the key risks include the slower economic growth, competitive pricing, and unmodeled natural catastrophe risks exposure. At the same time, the risk management control for a number of local players is still relatively less sophisticated compared to life insurers. We believe regulators' push for risk management is likely to improve awareness of its importance, in light of rising risk complexity in the region for some players. The sector is also facing uncertainty in regulatory standards, similar to the life sector. For reinsurers, a softening rate environment and ongoing competition in a non-catastrophe reinsurance market are threatening the sustainability of profits.

Corporates: Metals And Mining Still Negative But Moderating

About 18% (11% on net basis) of the corporate issuer ratings pool is on negative outlook or on CreditWatch with negative implications. Geographically, Japanese issuers contribute nearly a fifth of this (in turn, about a quarter are government-related); India and Australia, a sixth each, China-related, a seventh; and Hong Kong a ninth. Among the 17 industries covered, we view the 12-month outlook for metals and mining as negative, and for building materials, capital goods, chemicals, consumer products, retail and utilities as stable-to-negative (see table 7). The outlook on the other sectors (auto, diversified, gaming, oil & gas, real estate development, real estate investment trusts, technology, telecommunications, transportation-cyclical, and transportation infrastructure) is stable. (Healthcare is not displayed in table 7 because the sector comprises just four rated entities). As expected, there is some correlation between the sector outlook discussed here and the net negative ratings bias discussed previously. However the primary focus of the former is on economic and industry risk for the sector, while the latter, by definition, includes issuer-specific rating risks.
Table 7

Asia-Pacific Credit Trends By Sector Corporate

Next 12 months Current business conditions Satisfactory Satisfactory Satisfactory Satisfactory Satisfactory Satisfactory

Sector Auto original equipment manufacturer and suppliers Building materials Capital goods Chemicals Consumer products Diversified

Business outlook No change Somewhat weaker No change No change No change Somewhat weaker

Financial trends Same Same Same Same Same Same

Sector outlook Stable Stable to Negative Stable to Negative Stable to Negative Stable to Negative Stable

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Table 7

Asia-Pacific Credit Trends By Sector Corporate (cont.)

Gaming Metals and mining Oil and gas Real estate development Real estate investment trusts Retail Technology, high Telecom Transportation-cyclical Satisfactory Weak Satisfactory Satisfactory Satisfactory Satisfactory Satisfactory Satisfactory Weak Somewhat stronger No change No change Somewhat weaker No change No change No change No change No change shipping Somewhat stronger airline Transportation infrastructure Utilities Source: Standard & Poors. Satisfactory Satisfactory No change No change Same Lower Stable Stable to Negative Same Same Same Lower Higher Lower Same Same Same Stable Negative Stable Stable Stable Stable to Negative Stable Stable Stable

For further details on each of the sectors listed in Table 7 please refer to "Asia-Pacific 2014: Risks Narrow As Growth Grinds Higher"

Structured Finance: Trends Stable Across Asset Classes.

Structured finance credit conditions are satisfactory and the trends are stable (see table 8). Economic conditions are supportive for unemployment to remain low in countries such as Australia and Japan, where most structured finance ratings are outstanding. The low unemployment rates have underpinned the strong performance to date of residential mortgage-backed securities (RMBS) and asset-backed securities (ABS). Household debt serviceability remained resilient through periods of slowdown in Japan and certain industry sectors in Australia after the global financial crisis and natural disasters.
Table 8

Asia-Pacific Structured Finance Trends

Next 12 months Sector RMBS ABS CMBS Current business conditions Business outlook Financial trends Sector outlook Satisfactory Satisfactory Satisfactory No change No change No change No change Same Same Same Same Stable Stable Stable Stable

Structured Credit Satisfactory Source: Standard & Poors.

There are some bright spots in Japan's economy, such as export-oriented corporates, but it may take more time for consumers to enjoy the benefit and secure better financial positions. For seasoned transactions, credit-enhancement percentages for senior-ranking notes have continued to strengthen while the quality of underlying collateral has improved over time.

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Credit Conditions: Asia-Pacific Growth Is Mostly Stable, But Some Lagging Credit Risks Remain For 2014

For new transactions in Australia, the underlying collateral has faced tighter underwriting standards, and the credit enhancement for senior-ranking notes are being set at a higher level at close than in the past to re-engage investor interest. Both bode well for the future performance of RMBS and ABS. The Australian prime RMBS sector has significant exposure to lenders' mortgage insurance (LMI) cover, but most senior-ranking note ratings could withstand lower ratings on LMI providers (currently in the 'AA' category). The ratings assigned to subordinated classes of prime RMBS are more vulnerable to LMI providers' creditworthiness. The commercial mortgage-backed securities (CMBS) sector has remained in run-off mode. The collateral liquidation for outstanding Japanese CMBS have mostly completed, while conditions of the commercial property sector appear to have bottomed out and are recovering. Most structured credit transactions out of the Asia Pacific region are synthetic in nature and tend to follow global trends because the reference entities are companies and financial institutions around the globe, rather than regional ones.

Outlook: Cautious Going Into 2014

Overall, while risks have subsided for the time being, flatter economic growth and potential financial markets volatility as a result of any QE tapering make for some potential headwinds for Asia Pacific issuers going into 2014. About 14% of issuer ratings are on net negative outlook or CreditWatch with negative implications at November 2013. Sectors that are most affected are those which are grappling with lower economic growth and, in some cases, cyclical downturns, include: chemicals, building materials, metals and mining, public finance, and financial institutions. Other sectors facing strain include utilities, capital goods, retail, project finance, and transportationcyclical. Somewhat better placed are the insurance, oil and gas, consumer products, and transportation infrastructure. Best positioned, although some still with some slight negative bias, are issuers in real estate development, diversified, automobile original equipment manufacturers and suppliers, gaming and entertainment, high technology, real estate investment trusts (REIT), and telecommunications. Among the major regional economies, the sovereign ratings on India and Japan are on negative outlook, which have a knock-on effect on public finance ratings.

Related Research
Credit Conditions: Europe Sees A Slight Improvement, But Structural Weaknesses Persist, Dec. 9, 2013 Credit Conditions: North America's Credit Conditions Remain Favorable Despite The U.S. Government Shutdown, Dec. 9, 2013 The Bull's-Eye Of The Third Arrow Of Abenomics, Nov. 8, 2013 S&P To Publish Economic and Industry Risk Trends For Banks, March 12, 2013 Report Card: Gravity Tugs At Asia-Pacific Sovereign Ratings As Global Risks Persist And Domestic Challenges Grow", published Oct. 1, 2013.) Asia-Pacific Insurers Are On Firm Footing As Economic Conditions Shift," Sept.3, 2013 The Unpleasant Math Of Raising China's Consumption-To-GDP Ratio, Nov. 21, 2013 "Asia-Pacific 2014: Risks Narrow As Growth Grinds Higher", Dec. 10, 2013

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Appendix
Table 9

CPI Inflation Forecasts

--Average year over year-(%) Australia China India* Japan South Korea Hong Kong Indonesia Malaysia Philippines Singapore Taiwan Thailand Vietnam New Zealand 2013f 2.4 2.7 6.2 0.4 1.2 4.1 7.0 2.0 3.0 2.5 0.9 2.2 6.7 1.1 2014f 2.5 3.3 6.0 2.2 2.1 3.9 6.3 2.8 3.8 2.9 1.5 2.6 7.8 2.0 2015f 2.2 2.9 6.0 1.4 3.0 4.3 5.4 3.0 3.4 3.0 1.6 2.8 6.7 2.0

*Wholesales price index for fiscal year ending March.

Table 10

Policy Rate Forecasts

(%) Australia China India Japan South Korea Indonesia Malaysia Philippines Taiwan Thailand Vietnam New Zealand f--Forecast. 2013f 2014f 2015f 2.50 6.00 8.00 0.10 2.50 7.50 3.00 3.00 1.875 2.50 7.00 2.50 2.50 6.00 8.00 0.10 2.50 7.75 3.50 3.50 2.000 2.50 7.00 3.50 3.00 6.00 8.00 0.10 3.00 7.75 3.75 3.75 2.500 3.00 7.00 4.00

Standard & Poor's (Australia) Pty. Ltd. holds Australian financial services licence number 337565 under the Corporations Act 2001. Standard & Poor's credit ratings and related research are not intended for and must not be distributed to any person in Australia other than a wholesale client (as defined in Chapter 7 of the Corporations Act).

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Additional Contacts: Terry E Chan, CFA, Melbourne (61) 3-9631-2174; terry.chan@standardandpoors.com Paul F Gruenwald, Singapore (65) 6216 1084; paul.gruenwald@standardandpoors.com Vincent R Conti, Singapore (65) 6216 1188; vincent.conti@standardandpoors.com Vera Chaplin, Melbourne (61) 3-9631-2058; vera.chaplin@standardandpoors.com KimEng Tan, Singapore (65) 6239-6350; kimeng.tan@standardandpoors.com Dominic Crawley, Singapore (44) 20-7176-3784; dominic.crawley@standardandpoors.com Ritesh Maheshwari, Singapore (65) 6239-6308; ritesh.maheshwari@standardandpoors.com Elena Okorochenko, Singapore (65) 6239-6375; elena.okorochenko@standardandpoors.com JaeMin Kwon, Hong Kong (852) 2533-3539; jaemin.kwon@standardandpoors.com Dharmakirti Joshi, Mumbai (91) 22-3342-8043; dharmakirti.joshi@crisil.com

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