Asia Economic and Bond Outlook – Q4 2009

By: Kheng Siang Ng, CFA, CAIA, Head of Asian Fixed Income
Nigel Foo, CFA, Investment manger
September 30, 2009

Main Themes of Current Market Expectations

! Asian growth is expected to continue to improve on the back of better global sentiment as well
as fiscal stimulus plans by the Asian governments.
! However, waning impact of the fiscal stimulus and any slowdown in global growth may reduce
optimism to our growth forecasts.
! Low inflation trend is expected to end soon. Higher economic growth and base effects would
result in higher inflation going forward, but not to levels that are of concern.
! Asian central banks would likely keep monetary policy rates unchanged for the rest of this
year, but some are expected to gradually hike interest rates in 2010 to normalize rates as
inflation picks up.
! Bond yields are expected to head higher in general as the market is looking beyond a no rate
change policy currently into one of higher rates next year.
! Near term Asian currency strength could persist given the rebound in Asian economies and
improved investors risk appetite, but we expect central bank interventions to prevent any
volatile swings in the currencies.

Summary of Asian Bond and Currency Outlook

Duration Curve Vs. US Asian

Treasuries currency vs.
USD
China Short Flatten Underperform Appreciate
HK Short Steepen Underperform Neutral
Indonesia Neutral/short Flatten Outperform Appreciate
Korea Short Flatten Underperform Appreciate
Malaysia Neutral Flatten Outperform Appreciate
Philippines Short Flatten Underperform Appreciate
Singapore Short Steepen Outperform Appreciate
Thailand Short Steepen Underperform Appreciate

* The information above does not constitute investment advice and it should not be relied on as such.

Outlook by Country

CHINA
Even with one more quarter to go, we believe China will deliver the 8% growth promise it made at the
start of the year. We grossly underestimated the authority’s resolution to deliver its promise though we
remained dubious on the quality of growth. Against the backdrop of a more favorable global economic
landscape, we expect even stronger growth for 2010, at around 9%. Growth in the next few quarters
will likely stay strong, but we expect monetary policy to remain accommodative. We are likely to see
more administrative measures such as window guidance for slower lending growth, stricter home
mortgage policies and tighter project approval for sectors facing overcapacity.

Headline inflation has been negative for most of this year and we expect it to remain low. Inflation is
likely to remain benign till mid 2010 when it should hit above 2.5% partly due to the low base effect.
Relatively low oil prices and stability in food prices have been the main reasons behind the low
inflation and thus they pose the main risks for any potential spike up in prices.

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We see no hikes in interest rate by the People’s Bank of China at least until mid 2010 though bond
yields are likely to trend higher on increasing inflationary expectations. We also expect to see little
change in the Chinese yuan over the next six months with the currency likely trading closer to the 6.8
level by Q1 2010.

HONG KONG
Economic data coming out on Hong Kong over the past few quarters provided strong evidence that
the country’s open economy is still very much dependent on G3 growth. Following the stabilization in
the developed economies, we saw strong revival in Hong Kong exports gaining 8.8% 1 quarter-over-
quatrer in Q2. Domestic consumption also got a boost from rising stock and property prices. Against a
more favourable backdrop, GDP growth will likely come in at around -3% for 2009 and range between
3%-4% for 2010.

Just like many of its counterparts, Hong Kong slipped into a deflationary environment, but we believe
CPI is set to rise but not to worrying levels at least until mid 2010. For 2009, we expect to see CPI
inflation ranging between 1%-2%. For 2010, we expect it to trend higher towards 3%-4%.

Liquidity remained in abundance and the IPO pipeline still looks heavy in the near term. As such, we
expect short end rates to stay compressed and the HKD to remain on the strong side of the 7.75-7.85
band. We maintain no change to the currency peg for the foreseeable future. Hong Kong yields have
fallen largely in line with US treasuries, but with the UST 10 year at 3.2%, we are of the opinion that
the only way for yields to go is up. Thus, we expect to see higher yields at the longer end of the Hong
Kong yield curve moving into 2010.

MALAYSIA
We are likely to witness an export-led recovery well into mid 2010 with the improved outlook for G3
economies. However, risks remain if the government decides to end the stimulus too quickly amid
widening budget deficits and if the global recovery turns out to be short-lived. We are maintaining our
view that 2009 full year growth will come in between -2% to -3%, and are cautiously optimistic about
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seeing 3%-4% growth in 2010. The budget, to be announced on 23 October, is key for Malaysia’s
growth outlook for the 2nd half of 2010.

Inflation is currently negative because of the impact of last year’s fuel price adjustment, but we expect
that to reverse in the remaining part of the year. We are revising downwards our CPI inflation
expectation for 2009 to 0.5%- 1% from the previous 3%-4%. We expect inflation will rise, moving
towards 2.5% around mid-2010. This is based on the assumption that there will not be any changes in
subsidized food and fuel prices. Against a benign inflationary backdrop and uncertainty over the
sustainability of the global recovery, we expect Bank Negara Malaysia to keep policy rates unchanged
at least until Q4 2010. As such, the bond market is likely to stay well supported. On the currency front,
we expect further near term strength in the Malaysian ringgit on the improving economic outlook and
we are looking for the ringgit to end the year at around 3.4200.

THAILAND
2
Thailand’s economy rebounded strongly in the second quarter and at a respectable 2.3% quarter-
over-quarter in tandem with regional economies. More encouraging is that despite exports remaining
anemic, private consumption and investment rose strongly. Recently approved FY10 budget is still
accommodative at THB 1.7 trillion, although lower than last year’s THB 1.95 trillion. 3 We maintained
our 2009 GDP forecast at -3% to -4% while we expect 2010 GDP to be around 4%. The main risk is
an eruption in the political landscape which could derail the nation’s nascent recovery.

Barring a nasty turn for the worse on the political front, we expect Bank of Thailand to start hiking
rates should signs of inflation emerge by mid 2010. CPI has been negative since the start of the year
and should average around -1.5% for 2009 before normalizing to around 2% - 3% in 2010. Thai baht
has been fairly stable as of late, and we expect it to stay range-bound with a slight bias towards
appreciation in tandem with Asian currencies. We see the THB ending the year at around 33.10.

1
HSBC Research, 6 October 2009
2
Ibid.
3
Nomura Research, 2 October 2009

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INDONESIA
The Indonesia economy has stood up well so far this year compared to other regional Asian
economies as it is less reliant on exports and resilient domestic demand helped to keep growth at 4%
year-over-year in Q2 2009. 4 We expect that the better domestic economic sentiment with past rate
cuts from Bank Indonesia and the smooth outcome of the Presidential election to continue to improve
as the Consumer Confidence Index for August reached 114.3, 5 , which was not far from the previous
peak in 2004. We expect GDP for 2009 to reach 4.3%, and 5% to 5.5% in 2010. The recent
Presidential election results and developments showed that the electorates have started to elect
leaders with strong credentials who are committed to economic reform, not just based on popularity of
politicians given their links to past dominant political groups. This would bode well for the future
prospects of Indonesia to further improve its economic growth. The positive development may lead to
further sovereign credit rating improvement. The recent earthquakes in Sumatra island may lead to
further government spending in infrastructure reconstructions. This would have limited impact on the
fiscal deficit for this year. Next year it is expected to be at 1.5% and 2%, respectively. Inflation is
expected to stay low at around 5% in 2009, but may gradually rise to 6% in 2010 with a change in
base effect for oil prices and plans to adjust electricity tariffs by 20% for households in 2010. 6

We expect Bank Indonesia (BI) to keep policy rates unchanged at the current level of 6.50% for at
least the next 6 months. There is no immediate concern for inflationary pressures and the central
bank is keen to let the low rates stimulate further economic growth. Hence, BI is monitoring the
implementation of its agreement with local banks to reduce their deposits rates so that banks will step
up loan growth. We expect the rupiah bond market to stay well supported near term with still positive
sentiments towards the currency and BI keeping rates on hold leading to investors having a slight bias
to buy bonds for the carry. However, current yield levels are not far from historic lows and hence we
may start to see yields head higher medium- to long-term. The IDR is expected to trade towards 9300
by the end of the year.

SOUTH KOREA
The South Korean economy continued to show positive growth and the government’s fiscal stimulus
played vital role in encouraging consumption. This resulted in positive GDP growth of 2.6% quarter-
7
over-quarter in Q2 2009. We expect a stabilizing global growth outlook will lead to further recovery in
Korean exports as we have witnessed the industrial production starting to turn positive on a year-on-
year basis from July 2009 onwards. 8 This upward growth trend is expected to continue leading to
better than expected 2009 GDP growth at -1.8% and 3% in 2010. The better economic growth has
kept the inflation at level of 2.2% year-over-year in September 9 just a tad below the Bank of Korea
policy inflation range of 2.5% to 3.5%. We expect inflation in 2009 to average at around 2.8% and
gradually edged up to 3.3% in 2010.

The Bank of Korea (BoK) is concerned about the growth of mortgage loans and the home prices that
may lead to further inflationary pressures. The Korean financial regulators have imposed more limits
on mortgages for people buying homes in Seoul and the surrounding areas to slowdown the
mortgage loan growth. 10 It is widely expected that the BoK may hike interest rates should the housing
market show no signs of moderation. We do not expect the BoK to hike in Q4 this year, but it is
increasingly likely that rate hikes of 50 basis points may be delivered in Q1 next year from the current
level of 2.00%. As such, we expect the bond market to remain under pressures with yields rising and
the curve flattening. With the improved economy, expectations of rate increases and general
improvement in investors risk appetites, the KRW may appreciate further from the current level even
though the authorities have voiced concerns about the pace of appreciation. The KRW is expected to
reach 1150 by the end of the year.

4
Bloomberg Data, 10 August 2009.
5
Bloomberg Data, 3 September 2009.
6
Citigroup Research, 25 September 2009.
7
Bloomberg Data, 3 September 2009.
8
At 0.9% year-over-year in July 2009, Bloomberg Data, 31 August 2009.
9
Bloomberg Data, 1 October 2009.
10
Banks can extend up to 50% of a borrower’s annual income for buying homes in Seoul and 60% in Incheon
and Gyeonggi Province. Bloomberg News, 4 September 2009.

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SINGAPORE
The quick turnaround in global sentiment, from global recession to stabilization and early recovery,
has led to a revival of economic confidence for the Singapore economy. While the government
continues to remain cautious with warning of a potential double dip, the underlying data seems to
indicate pockets of strength and overheating perhaps in the residential housing market. The truth may
lie somewhere in between. Global inventory rebuilding has given the industrial production (+12.3%
year-over-year in August 11 ) and non-oil domestic exports (from a double digit percentage decline to
single digit at -7.1% year-over-year in August 12 ) some encouraging rebounds. This may go on further
even though the pace may slow somewhat into year-end. The government’s fiscal measures have
helped to prevent a broad based increase in unemployment and has kept consumer sentiment
relatively positive. The sharp rebound in the equities market and signs of global recovery have led to
a sharp run up in residential property transactions and prices. We are raising our 2009 GDP forecast
slightly to a range of -2.8% to -3.8% from the previous forecast of -3.5% to -5%. The economy is
expected to do even better next year at an expected growth rate of 4.5% as the global economic
recovery gains better traction. We expect inflation to stay low for the time being, but the disinflation
trend is already turning with CPI in August at -0.3% year-over-year 13 , after moving sideways around
this level for 4 months and having shown two consecutive quarters of month-on-month increase. We
maintain our average CPI for 2009 at 0.5%, but expect this to pick up to 1.2% in 2010.

The Monetary Authority of Singapore (MAS) is expected to maintain its present policy stance of zero
appreciation of nominal effective exchange rates in its October policy statement, even though there
are tentative signs of inflation picking up in the housing sector. A global economy that is only
gradually coming out of a recession may yet offer another reason for the status quo exchange rate
stance now. However, this may tilt towards an appreciating bias in April 2010 as the inflation uptrend
becomes clearer. We expect long end bond yields to rise going forward as the economy recovers and
inflation bottoms out. The SGD may stay well bid with inflows into Asia. Thus, we expect the SGD to
push towards the 1.3900 level by year-end.

PHILIPPINES
The Philippines economy fared better than expected with Q2 GDP growth of 1.5% year-over-year as
private consumption (2.2% year-over-year) and government consumption (9.1% year-over-year) held
14
up well. .With the government committed to maintaining its spending plans to lift economic growth
amid a nascent global recovery, and overseas workers remittance flows that are resilient, we believe
GDP growth for 2009 will be at the higher end of our forecast range of 1.5% to 2%. Improved
economic sentiment and overseas workers remittance that accelerated to 9.3% year-over-year in
July 15 will underpin consumption. The economy will also received a boost from consumption as it
heads towards the Presidential election in May 2010. Budget deficits are expected to rise above the
government deficit forecast of PHP250 billion in 2009 as the government steps up spending in
response to lackluster economic growth and repair infrastructures damaged by typhoons. The
government will thus likely raise additional finance from USD and Samurai bond issuance over the
next 6 months. A sustained high budget deficit may undo the positive fiscal momentum the
government has been trying to maintain over the last few years. On the inflation front, we expect the
recent disinflationary trend to start to reverse as the base effect fades as seen by the latest rise of CPI
for September at 0.7% year-over-year from 0.1% year-over-year previously. 16 We expect CPI to
average around 3.3% for 2009 and edge up towards 4.5% for 2010.

Bangko Sentral ng Pilipinas (BSP) is seen as generally dovish with regard to monetary policy as it
sees inflation well contained and wants to keep rates low to stimulate economic activities. Hence, we
expect the BSP to keep rates on hold at 4% for the coming months. However, we do not believe
either the low inflation or interest rates are the norms for the economy. As inflation gradually creeps
higher and economic activities pick up, we expect present ultra accommodative policy to be removed
in mid 2010. We expect bond yields to eventually rise from the current low levels as the budget deficit
rises and inflationary pressures increase. Positive current account dynamics with overseas workers

11
Bloomberg Data, 25 September 2009
12
Bloomberg Data, 17 September 2009
13
Bloomberg Data, 23 September 2009
14
Bloomberg Data, 27 August 2009
15
Bloomberg Data, 15 September 2009
16
Bloomberg Data, 6 October 2009

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remittance and the regional currency appreciation trend would see the PHP approach 46.00 by year-
end.

This material is for your private information.

The views expressed in this material are the views of Kheng Siang Ng and Nigel Foo through the period ended
September 30, 2009, and are subject to change based on market and other conditions. The information provided
does not constitute investment advice and it should not be relied on as such. All material has been obtained from
sources believed to be reliable, but its accuracy is not guaranteed. This content contains certain statements that
may be deemed forward-looking statements. Please note that any such statements are not guarantees of any
future performance and actual results or developments may differ materially from those projected.

Past performance is no guarantee of future results

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