Economics Markets Strategy - DBS Bank

Loading...
Economics Markets Strategy 3Q 2017

DBS Group Research 8 June 2017

Economics–Markets–Strategy

June 8, 2017

Singapore Treasury & Markets - Wealth Management Solution: Donne Lee Boon Hua Treasury & Markets - International Sales (Corporate/Institution): Thio Tse Chong Yip Peck Kwan Treasury & Markets - Corporate Advisory: Teo Kang Heng Rebekah Chay Wan Han Catherine Ng Pui Ming Wesley Foo Shing Meng James Tan Kia Huat Regional Equities (DBS Vickers Securities (SGP) Pte Ltd) Kenneth Tang (Institutional Business) Chew Chong Shoon (Retail Business)

China

Treasury & Markets - Management Jacky Man Fung Tai Treasury & Markets - Advisory Sales Wayne Hua Ying (Shanghai) Ray Sheng Lei (Shanghai) Yao Gang (Shanghai) Tristan Jiang Ming Zhe (Beijing)

Hong Kong

Treasury & Markets - Management Leung Tak Lap Treasury & Markets - Advisory Sales Anthony Lau Kam Hing Treasury & Markets - Large & Medium Corporates Angia Chan Shiu Man Treasury & Markets - Sales Derek Mo

India

(65) 6682 7030 (65) 6682 8288 (65) 6878 1818 (65) 6682 7121 (65) 6682 7131 (65) 6682 7102 (65) 6682 7126 (65) 668 27144 (65) 6398 6951 (65) 6682 3660

(86 21) 3896 8607 (86 21) 3896 8609 (86 21) 3896 8608 (86 21) 3896 8602 (86 10) 5752 9176

(852) 3668 5668 (852) 3668 5670 (852) 3668 5682 (852) 3668 5777

Treasury Vijayan Subramani Arvind Narayanan

(91 22) 6638 8831 (91 22) 6638 8830

Treasury & Markets Wiwig Santoso

(62 21) 2988 4001

Jakarta

Taiwan

Treasury & Markets - Sales Teresa Chen Treasury & Markets - Trade Lina Lin

(886 2) 6612 8909 (886 2) 6612 8988

Disclaimer: The information herein is published by DBS Bank Ltd (the “Company”). It is based on information obtained from sources believed to be reliable, but the Company does not make any representation or warranty, express or implied, as to its accuracy, completeness, timeliness or correctness for any particular purpose. Opinions expressed are subject to change without notice. Any recommendation contained herein does not have regard to the specific investment objectives, financial situation and the particular needs of any specific addressee. The information herein is published for the information of addressees only and is not to be taken in substitution for the exercise of judgement by addressees, who should obtain separate legal or financial advice. The Company, or any of its related companies or any individuals connected with the group accepts no liability for any direct, special, indirect, consequential, incidental damages or any other loss or damages of any kind arising from any use of the information herein (including any error, omission or misstatement herein, negligent or otherwise) or further communication thereof, even if the Company or any other person has been advised of the possibility thereof. The information herein is not to be construed as an offer or a solicitation of an offer to buy or sell any securities, futures, options or other financial instruments or to provide any investment advice or services. The Company and its associates, their directors, officers and/or employees may have positions or other interests in, and may effect transactions in securities mentioned herein and may also perform or seek to perform broking, investment banking and other banking or financial services for these companies. The information herein is not intended for distribution to, or use by, any person or entity in any jurisdiction or country where such distribution or use would be contrary to law or regulation. Sources for all charts and tables are CEIC and Bloomberg unless otherwise specified. DBS Bank Ltd., 12 Marina Blvd, Marina Bay Financial Center Tower 3, Singapore 018982. Tel: 65-6878-8888. Company Registration No. 196800306E.

Economics–Markets–Strategy

June 8, 2017

Contents Introduction

4

Economics

On sentiment vs reality, cycles vs structures and

6



60-year track records

Currencies

Volatility falls

18

Yield

Carry on

32

Offshore CNH

Tightening the grip

42

Asia Equity

Calculating the risks

46

China

The Beijing put

62

Hong Kong

A sea of madness

68

Taiwan

Betting on the second half

72

Korea

Out of the tunnel

76

Unbalanced recovery

80

Greater China, Korea

Southeast Asia, India India

Indonesia Crawling

86

Malaysia

In a sweet spot

90

Thailand

Domestic struggles

94

Singapore Peaking

98

Philippines Moderation

104

Vietnam

Cautiously optimistic

108

United States

A series of hikes

112

Japan

No success yet

116

G3

Eurozone Encouraging

120

Refer to important disclosures at the end of this report.

1

June 8, 2017

Economics–Markets–Strategy

Economic forecasts GDP growth, % YoY

CPI inflation, % YoY

2014

2015

2016

2017f

2018f

2014

2015

2016

2017f 2018f

US Japan Eurozone

2.4 0.2 1.1

2.6 1.1 1.9

1.6 1.0 1.7

2.2 1.3 1.7

2.5 1.0 1.8

1.6 2.7 0.6

0.1 0.8 0.0

1.5 -0.1 0.2

2.5 0.5 1.6

2.3 0.6 1.6

Indonesia Malaysia Philippines Singapore Thailand Vietnam

5.0 6.0 6.2 2.9 0.9 6.0

4.9 5.0 5.9 2.0 2.9 6.7

5.0 4.2 6.9 2.0 3.2 6.2

5.1 5.0 6.4 2.8 3.4 6.3

5.4 4.6 6.7 2.5 3.5 6.4

6.4 3.1 4.2 1.0 1.9 4.1

6.4 2.1 1.4 -0.5 -0.9 0.6

3.5 2.1 1.8 -0.5 0.2 2.7

4.5 3.7 3.2 1.2 0.9 3.7

5.0 2.5 3.2 1.8 1.7 3.2

China Hong Kong Taiwan Korea

7.3 2.5 4.0 3.3

6.9 2.4 0.7 2.8

6.7 1.0 1.5 2.8

6.5 2.5 2.5 2.7

6.3 2.1 2.3 2.8

2.0 4.4 1.2 1.3

1.4 3.0 -0.3 0.7

2.0 2.6 1.4 1.0

2.0 2.0 1.2 1.8

2.1 2.5 1.0 1.6

India*

7.5

8.0

7.1

7.3

7.6

6.0

4.9

4.5

4.5

5.0

Source: CEIC and DBS Research * fiscal year ending Mar

Policy and exchange rate forecasts Policy interest rates, eop

Exchange rates, eop

current

3Q17

4Q17

1Q18

2Q18

current

3Q17

4Q17

1Q18

2Q18

1.00 -0.10 0.00

1.50 -0.10 0.00

1.75 -0.10 0.00

2.00 -0.10 0.00

2.25 -0.10 0.00

… 109.9 1.126

… 114 1.11

… 116 1.11

… 117 1.11

… 119 1.10

Indonesia Malaysia Philippines Singapore Thailand Vietnam^

4.75 3.00 3.00 n.a. 1.50 6.50

4.75 3.00 3.50 n.a. 1.50 6.50

5.00 3.00 3.50 n.a. 1.50 6.50

5.00 3.00 3.50 n.a. 1.50 6.50

5.00 3.00 3.50 n.a. 1.50 6.50

China* Hong Kong Taiwan Korea

4.35 n.a. 1.38 1.25

4.35 n.a. 1.38 1.25

4.35 n.a. 1.38 1.25

4.35 n.a. 1.38 1.25

4.35 n.a. 1.38 1.50

6.80 7.79 30.1 1,125

6.88 7.78 31.2 1,150

6.94 7.78 31.2 1,150

7.01 7.78 31.3 1,150

7.08 7.78 31.4 1,150

India

6.25

6.25

6.25

6.25

6.25

64.4

64.8

64.8

64.9

65.0

US Japan Eurozone

^ prime rate; * 1-yr lending rate Source: Bloomberg and DBS Group Research

2

13,306 13,393 13,411 13,429 13,447 4.26 4.22 4.22 4.23 4.24 49.6 50.2 50.4 50.7 50.9 1.38 1.39 1.39 1.40 1.40 34.1 34.4 34.5 34.7 34.9 22,695 22,722 22,771 22,820 22,869

Economics–Markets–Strategy

June 8, 2017

Interest rate forecasts %, eop, govt bond yield for 2Y and 10Y, spread in bps

US

3m Libor 2Y 10Y 10Y-2Y

8-Jun-17 1.22 1.31 2.18 87

3Q17 1.75 1.90 2.40 50

4Q17 2.00 2.10 2.60 50

1Q18 2.25 2.30 2.80 50

2Q18 2.50 2.50 3.00 50

Japan

3m Tibor

0.06

0.05

0.05

0.05

0.05

Eurozone

3m Euribor

-0.33

-0.30

-0.30

-0.30

-0.30

Indonesia

3m Jibor 2Y 10Y 10Y-2Y

6.86 6.52 6.95 43

7.00 6.60 7.00 40

7.20 6.80 7.20 40

7.20 6.80 7.40 60

7.20 6.80 7.50 70

Malaysia

3m Klibor 3Y 10Y 10Y-3Y

3.43 3.28 3.87 59

3.40 3.40 3.90 50

3.40 3.40 4.00 60

3.40 3.40 4.10 70

3.40 3.40 4.20 80

Philippines

3m PHP ref rate 2Y 10Y 10Y-2Y

2.77 3.66 4.63 97

3.00 3.50 5.00 150

3.25 3.75 5.20 145

3.50 4.00 5.40 140

3.50 4.25 5.50 125

Singapore

3m Sibor 2Y 10Y 10Y-2Y

1.00 1.22 2.06 84

1.50 1.65 2.20 55

1.75 1.85 2.40 55

1.95 2.05 2.60 55

2.15 2.25 2.70 45

Thailand

3m Bibor 2Y 10Y 10Y-2Y

1.59 1.49 2.49 100

1.60 1.60 2.70 110

1.60 1.60 2.80 120

1.60 1.60 2.90 130

1.60 1.60 3.00 140

China

1 yr Lending rate 2Y 10Y 10Y-2Y

4.35 3.50 3.65 15

4.35 3.60 3.75 15

4.35 3.50 3.75 25

4.35 3.40 3.75 35

4.35 3.30 3.75 45

Hong Kong

3m Hibor 2Y 10Y 10Y-2Y

0.75 0.65 1.21 56

1.25 1.30 1.70 40

1.50 1.50 1.90 40

1.75 1.70 2.10 40

2.00 1.90 2.30 40

Taiwan

3m Taibor 2Y 10Y 10Y-2Y

0.66 0.49 1.01 52

0.66 0.60 1.05 45

0.66 0.60 1.10 50

0.66 0.60 1.15 55

0.66 0.60 1.20 60

Korea

3m CD 3Y 10Y 10Y-3Y

1.38 1.62 2.16 54

1.40 1.75 2.30 55

1.40 1.75 2.40 65

1.40 1.75 2.50 75

1.65 1.85 2.60 75

India

3m Mibor 2Y 10Y 10Y-2Y

6.58 6.43 6.57 13

6.50 6.75 6.80 5

6.50 6.75 6.90 15

6.50 6.75 7.00 25

6.50 6.75 7.00 25

Source: Bloomberg and DBS Group Research

3

Introduction

Economics–Markets–Strategy

Forging ahead The global economy continues to strengthen. If the numbers aren’t wildly better than last year then it’s because last year wasn’t bad to begin with. Think about it: Europe grew by 1.7%; unemployment fell by another full point to 9.5%. Japan grew by 1% – more than twice its potential rate given a working age population that is shrinking by 1% every year. And that followed 1.2% growth in 2015. Per person of working age, Japan grew by 2.1% per year for two years. That’s huge. The US continued to grow at the 2% pace that has been its norm for the past 6 years. Does that mean things aren’t improving? Not at all. Job growth continues to run at 165k/175k per month – three times faster than the 55k/month growth in working age population – and unemployment has fallen to 4.3% – among the lowest levels in post-WWII history. Asia? It grew by 5.75% in 2016 and the improvement in imports and exports makes us think it will be a half a point higher in most countries this year. And while it‘s nice to hear people finally talking about ‘today’s’ better numbers, it’s not a recent development – the turn came more than a year ago (chart opposite). Most of us simply refused to recognize it. But it’s not just in Asia where perception seems to lag reality, it’s everywhere. The US has been getting stronger; Europe has been getting stronger; Japan and the rest of Asia have been getting stronger. Yet many are still asking whether sentiment might have gotten ahead of the data? Not so much, really. Our sense is it couldn’t be further behind. What’s it mean for monetary policy? Let’s put it this way. Poor sentiment probably kept the Fed from hiking 4 times last year when it had expected to and probably should have. A stock market crash in Jan/Feb nixed a hike in March. A sharp drop in nonfarm payrolls in May scuppered June. Brexit came in August; September was out. ‘Don’t mess with investor sentiment’, was the mantra – and it left the Fed a bit behind the curve.

Eurozone – unemployment rate %, sa 12.1%

12.0 11.5

11.4%

11.0 10.5

10.5%

INTRODUCTION

10.0 Steady progress for 3 years

9.5 9.0 Jan-11

Jan-12

Jan-13

David Carbon • (65) 6878-9548 • [email protected]

4

Jan-14

Jan-15

Jan-16

9.5%

Jan-17

Economics–Markets–Strategy

Introduction

Asia 10 – exports US$bn/mth, seas adj, Dom X for SG, HK, 3mma 440 15 months of rising exports

420

400

380

360

340 11

12

13

14

15

16

17

We’ve now had two hikes in two quarters and markets think a June hike will make it three-for-three. Our guess is the Fed won’t stop there. Why would it? Everything in the economy is back to normal, unemployment has fallen to 4.3% and inflation has been trending north for more than a year. And, as San Francisco Fed President Williams puts it, “the Fed still has the pedal to the metal”. That doesn’t make sense. Policy rates need to rise to 2.75%-3% to be considered ‘normal’. At one hike per quarter, it would take two years to get there. That’s a long time. We don’t expect the Fed to waste any of it. Best plan on one hike per quarter through mid-2019, with the risk that the Fed has to up the pace before then. David Carbon DBS Group Research June 8, 2017

5

Economics

Economics–Markets–Strategy

On sentiment vs reality, cycles vs structures and 60-year track records • The global economy continues to strengthen. 2017 will look considerably better than 2016, which was already better than 2015 • But growth will continue to moderate over the medium-term as population growth continues to fall and, in Asia, as incomes continue to rise • To the extent slower GDP growth owes to falling population growth, it’s a non-issue. Only per-capita growth matters. To the extent growth slows due to rising incomes, it’s a good thing, not a bad thing • Despite slowing growth, the shift in economic gravity from West to East is accelerating. Asia is dangling a pool of fresh demand in America’s nose the likes of which it has never seen before • If Trump is smart, he will grab onto it with all his might. If he doesn’t, America will be the main and perhaps only loser

On sentiment vs reality

Nomenclature Economic areas cited in this report adhere to the following conventions: Asia-10: CH, HK, TW, KR, SG, MY, TH, ID, PH, IN

The global economy continues to strengthen. In Asia, the US, Europe and Japan, virtually all the cyclical data – trade, industrial production, consumption and, less fortuitously, inflation – is picking up. Yet a feeling persists among many that ‘sentiment’ may have gotten ahead of itself – that the hard data don’t portray the recovery that others are feeling on the ground. Our sense is the opposite is true – that sentiment, as usual, is lagging the hard data. And pretty much for the usual reason: When economies are booming, people think

Asia-9: A10 less CH

Eurozone – unemployment rate

Asia-8: A10 less CH, IN

%, sa

Asia-3: CH, IN, ID

12.1%

Asean-5: TH, MY, ID, PH, SG

12.0

EU-10: UK, GE, FR, IT, SP, NL, SP, PT, BG, DK, GR

11.5

EU-3: GE, FR, IT G4: US, EU10, JP, A10 G3: US, EU10. JP

11.4%

11.0 10.5

10.5%

ECONOMICS

10.0 Steady progress for 3 years

9.5 9.0 Jan-11

Jan-12

Jan-13

David Carbon • (65) 6878-9548 • [email protected]

6

Jan-14

Jan-15

Jan-16

9.5%

Jan-17

Economics–Markets–Strategy

Economics

US – unemployment rate %, sa 12 10 8

US unemployment is among the lowest levels in postWWII history

6 4 Dotcom boom

Vietnam War

2

Yellen boom?

Subprime boom

0 60

64

68

72

76

80

84

88

92

96

00

04

08

12

16

nothing can go wrong. Why look at data? Once bitten, they become twice shy. No interest in the data now either. Blind faith / disinterest is part and parcel of what makes a cycle a cycle. Does this mean the numbers are going to look a lot better in 2017 than last year? Probably not, or not much. But that’s because last year wasn’t bad to begin with. Sentiment was. Think about it. The Eurozone grew by 1.7% in 2016; the unemployment rate fell by a full point to 9.5% (chart p1). Both were continued improvements over 2015. Japan grew by 1% in 2016 and by 1.2% in 2015. In percapita terms, output there rose by 2.1% per year for two years. That’s huge. [1] The US? Growth there hasn’t changed in 7 years. It continues to run at the 2% pace that it has since late-2010. Does that mean things aren’t improving? Not at all. Job growth continues to run at 165k/175k / month and the unemployment rate continues to fall. It is now down to 4.3%, among the lowest levels in post-WWII history (chart above). Asia? Industrial production and trade growth didn’t start improving a couple of months ago when the year-over-year growth numbers turned positive. If you look at the activity levels themselves – what any analyst should always do – the pivot came in late-2015, some 15-16 months ago! And yet everyone seems surprised by ‘today’s’

Asia 10 – exports

Asia’s exports turned north 1516 months ago

US$bn/mth, seas adj, Dom X for SG, HK, 3mma 440 15 months of rising exports

420

400

380

360

340 11

12

13

14

15

16

17

7

Economics

Economics–Markets–Strategy

Asia 9 – exports to China & USA US$ terms, Jan02=100, seas adj, DX for HK, SG

Asia X to China

850 750 650

In per-capita terms, Japan grew by 2.1% per year in 2015 and 2016. That’s huge

550

Back on the upswing

New drivers ...

450

... new risks

350 250 Asia X to the US

150 50 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17

better numbers. These aren’t ‘today’s’ numbers, these aren’t green shoots. The turn came a long time ago (chart below). Ditto for China. As in the rest of Asia, China’s imports and exports have been running north for 14 months (imports from Asia are shown above); PMIs have been headed north for 18 (chart below). Debt, both total and that generated by ‘shadow banks’, began to stabilize more than a year ago (chart top of next page). As a percentage of GDP, total social financing barely budged in 2016. Shadow bank financing fell. Bottom line? Simple: if the hard data anywhere in the world don’t look a lot better this year than last year it’s only because last year was already experiencing a very significant improvement that most simply refused to recognize. Sentiment was as sour as it comes. The Fed should have hiked rates 4 times in 2016 but fear got in the way. Global stock markets dropped by 10% in Jan/Feb. That scuppered a March hike. Nonfarm payrolls dropped to zero in May, putting paid to a June hike. Brexit came in August; September was a non-starter. ‘Don’t mess with investor sentiment’, was the mantra – at the Fed and everywhere else. And all the while, the hard data continued to improve. That trend continues today and it’s left the Fed with a bit of catch-up to do. We don’t put much stock in sentiment. It is what it is. But we do know this: sentiment is not leading the hard data. As usual, it couldn’t be further behind. Sentiment isn’t leading the hard data. As usual, it couldn’t be further behind

China – PMIs index, sa, 50 = "neutral", avg of private and national surveys 58 56 Services

54 52 50 Mnfg

48 46 11

8

12

13

14

15

16

17

Economics–Markets–Strategy

Economics

China -- national debt % of GDP, qtr

236%

National debt

240

238%

200

200% 199%

Govt debt (Central + local)

160

Total social financing

120 80

"Shadow banking" 1. Entrusted loans 2. Trust Co. loans 3. Bankers' acceptances

40

33% 30%

0 05

06

07

08

09

10

11

12

13

14

15

16

17

On cycles vs structure Stronger cyclical growth is great. But by definition, it’s the wiggle around the trend, not the trend itself (chart below). Is growth headed back to 3% in the US and Europe? 2% in Japan? 8%-9% in China? No. The structural trend everywhere in the world is downward. If you think growth in recent years was slow, get used to it. It’s likely to be slower five years from now and slower yet five years after that. What’s driving this? Two things. Demographics – slower, and in some cases negative, population growth – and rising incomes, especially in Asia [2]. In the G3 – the US, Europe and Japan – slower GDP growth is mainly about falling population growth, especially working-age population growth. Societies are growing older at the same time that population growth is slowing. The result is that the growth in working-age populations – what matters to GDP – is falling much more rapidly than populations overall. Take Japan for example – the population there is shrinking at a rate of 0.2% per year. But working-age population is falling five times faster, or by 1% per year. In the US, post-WWII baby boomers are retiring in droves. Working age population growth has fallen to 0.4% per year from 0.8% five years ago and 1.2%

Growth will continue to moderate over the mediumterm as population growth continues to slow and, in Asia, as incomes continue to rise

Stylized cycle and structure growth rate

structrural trend

cyclical swing

time

9

Economics

Economics–Markets–Strategy

Japan – population growth

US – population growth

% per year

% per year

1.20

1.80 Working age

0.80

Working age

1.60

Total

Total

1.40

0.40

1.20 1.00

0.00

0.80 -0.40

0.60 0.40

-0.80

0.20 -1.20 75

80

85

90

95

00

05

10

15

20

25

30

0.00 75

80

85

90

95

00

05

10

15

20

25

30

five years before that. Europe falls in between Japan and the US – the working-age population is shrinking at a rate of 0.1% or 0.2% per year. Five years ago, it was 5-6 ticks higher, or about 0.4%-0.5% per year. Falling population growth is a big deal when it comes to GDP growth. Since potential / structural GDP growth is simply the sum of productivity and worker growth, a 1% drop in the latter brings an identical 1% drop in the former. The only way to make up for fewer workers is to make everyone more productive. Greater investment in infrastructure, education and research & development would help but only after a long gestation period and, in spite of widespread claims to the contrary, output per working age person in the US, Europe and Japan does not appear to have slowed since 1980 anyway [3]. Raising productivity growth above its average (1.5%-1.6%) pace since 1980 is a laudable goal but 45 years of history suggest the bridge too far. Meanwhile, the UN projects working age population growth will continue to fall throughout much of the world [4]. Over the next five years, WAPG in the US is projected to drop by another three ticks to 0.1% per year. WAPG in Europe is expected to drop by another two ticks to -0.3% per year. Other things equal, then,

EU4 – population growth

China – population growth

% per year, EU4 is GE, FR, IT, UK

% per year

1.25

3.50 Working age

1.00

Total

0.75

Total

2.50 2.00

0.50

1.50

0.25

1.00

0.00

0.50

-0.25

0.00

-0.50

-0.50 -1.00

-0.75 75

10

Working age

3.00

80

85

90

95

00

05

10

15

20

25

30

75

80

85

90

95

00

05

10

15

20

25

30

Economics–Markets–Strategy

Economics

potential growth in the US will be 3 ticks slower in 2022 than it is today and in Europe it will be 2 ticks slower than at present. If one assumes generous productivity growth of 1.5% per year, that would put potential growth in the US at 1.6% per year by 2022, down from 1.9% today. In Europe, it would fall to 1.2% from 1.4%1.5% today. The UN estimates that Japan’s WAPG has already hit bottom (at minus 1% per year) but a slow rebound means that potential GDP growth would rise beyond 0.7%-0.8% per year by 2022 (again assuming productivity growth of 1.5% per year).

The situation in Asia Falling WAPG will put a brake on Asia’s economies too. But slower GDP growth here will owe mainly to continued rises in per-capita incomes, not demographics. Higher incomes have always come hand-in-hand with slower GDP growth. Japan, for example, grew rapidly in the 1950s and 60s. But when incomes went up, the fast growth moved to Hong Kong and Singapore. When incomes there rose, the fast growth moved to Korea and Taiwan. From there to Malaysia and Thailand. And on to China and now, India and Vietnam.

In Asia, slower growth will owe mainly to rising incomes. In this sense, slower growth is a good thing, not a bad thing

The logic of this migration is straightforward. At low income levels, it is relatively easy to import old machinery and technologies from abroad and put them to work locally. Productivity jumps, seemingly overnight. And with low wages / incomes, it’s easy to sell the output in global markets, undercutting neighbors whose wages are higher. Output, wages and incomes grow rapidly and countries naturally attempt to repeat the process with more advanced / newer technology. On the second goround, however, the imported machinery costs more – more of what is produced has to be given up to the foreign exporter. Moreover, local wages have gone up, making it harder to steal market share from one’s neighbors. For both reasons, the second boost to growth isn’t as large as the first; the third is less than the second, and so on. Bottom line: when incomes and technological levels go up, growth rates go down. As wages and technological levels in emerging economies converge on those of Japan, the US and so on, so too do their growth rates. Hence higher incomes in Singapore have left it with advanced country growth rates of 2%-3%. Hong Kong, Taiwan and Korea aren’t far behind. But now it should be plain that slower GDP growth isn’t necessarily a bad thing. If growth is slower in the US, Japan and Europe because population growth is slower, the response should be: Who cares? It’s growth per-person that matters, not growth in the aggregate. And in Asia, if growth is falling because incomes are rising, that’s a good thing, not a bad thing. Which would you rather have – a high income with a raise once per year? Or a low income with two raises per year? We know which one we’d choose.

Cyclical vs structural risks Cyclically, economies are picking up and if they’re slowing structurally it either doesn’t matter (G3) or it’s a good thing not a bad thing (Asia). This all sounds very benign, hunky-dory almost. Are there no risks out there? Of course there are. But just as it is important to distinguish between cyclical and structural growth, it’s important to distinguish between cyclical and structural risks too.

A debt problem is just another name for a cycle

Take China, for example. It has a debt problem, which all too often one hears described as – distant rolling thunder sound effects please – a ‘structural’ problem, as if that adds gravitas to the discussion. But China’s debt problem isn’t structural. It’s cyclical, practically by definition, just like it is almost everywhere else in the world. In most instances, a debt problem isn’t so much a problem per se as it is simply another name for a cycle in the first place. Think about it: An economy booms, too much gets invested in X, Y or Z (usually property is the main culprit), investors figure out that someone isn’t going to get repaid, they stop lending until they can figure out who that’s going to be, and the economy dips or crashes depending on how excessive / exuberant the initial boom was. Where in all this is the difference between a ‘cycle’ and ‘debt problem’? From a macro perspective, there isn’t one.

11

Economics

The empty building on the corner is the real economy counterpart to the bad debt that most think about only from the financial side of the economy. Building it was a mistake. But it’s water under the bridge. It doesn’t prevent tomorrow’s growth from being whatever it would otherwise would have been

Economics–Markets–Strategy

Three points. First, no matter what you call them, cycles / debt problems have been with us for 400 years. They come and they go – in capitalist and command economies alike. Government officials from the latter have proven no better or worse at misallocating scarce resources than capitalist entrepreneurs from the former. Second, unless and until flurries of divine stardust start to fall on government officials and private investors, cycles / debt problems will be with us for the next 300 years too. They’re as common as the common cold and every bit as unlikely to ever disappear. Finally, and this is key: neither cycles nor the common cold change the structure of our environment; they don’t alter the growth outlook for the future. That empty building on the corner? It’s the real economy counterpart to the bad debt that most think about only from the financial side of the economy. The fact that it’s sitting there idle is unfortunate. Building it was a mistake, But it’s water under the bridge. Unless the same mistake is repeated tomorrow, it doesn’t prevent tomorrow’s growth from being whatever it otherwise would have been. The Asian financial crisis of 1997/98 offers a good illustration (chart below). Without a doubt, the crisis was Asia’s biggest economic event since WWII. But it was a cyclical event. It didn’t alter the underlying path in output and income growth. Indeed, some of the reforms it wrought have undoubtedly enhanced the stability of Asia’s growth path in the 20 years since the crisis.

Asia 8 – industrial production 1997=100, sa, simple avg for Asia, ex-pharma for SG 200 175

China "slowdown"

150 125

Subprime crash

100 AFC

75

Dotcom crash

50 90

92

94

96

98

00

02

04

06

08

10

12

14

16

The bigger risk

Structural risks are the big risks

12

Cycles are temporary. The bigger challenges to China and the global economy are structural in nature – freeing up labor markets, changing tax and incentive regimes, dumping laws that restrain investment and risk taking, tilting national budgets towards education and infrastructure and away from defence, and so on. A lack of progress here doesn’t bring a temporary dip in output, it brings a permanent drop in growth from what it otherwise would or might have been. In the chart above, the upward sloping red line of output and income takes a sharp turn to the right. The structural risks are the big risks. As a developing economy with a still-low per-capita income of US$7,800 per year, China’s To-Do list of structural reforms is much broader and deeper than those mentioned above. They run the gamut from macro to micro economy, real to financial sector and everything from the state to the individual (table top of next page). Investors can and do argue over the amount of progress that has been

Economics–Markets–Strategy

Economics

China – structural changes ahead Macro changes

Micro / efficiency changes

Real economy

Financial economy

1. Raise consumption as a driver of GDP 2. Lower exports as a driver of GDP 3. Lower investment as a driver of GDP

1. Clean up bad debts 2. Globalize the RMB 3. Open capital account (implied by 2) 4. FX liberalization 5. Interest rate liberalization 6. Reform / reregulate shadow banks 7. Tax reform

1. Lessen role of state-owned enterprises (SOEs) in the economy 2. Pension / social security reform 3. Healthcare reform 4. Urbanization / Hukou reform 5. Inland development vs coastal areas 6. Lower production capacity of steel, alumunum, other metals, concrete, paper 7. More private investment in airports, urban transit, energy, shipping. 8. Allow more private capital in banking

made so far but no one argues about the underlying risk: failure to get on with the reforms outlined above will lower future growth by far more than it must inevitably slow by anyway [5]. Complaining about the pace of reform and structural change in China is de rigueur among investors but our sense is that progress has perhaps been faster than it seems. The main focus of the past five years has been on the financial sector – globalizing the RMB, liberalizing interest rate markets, opening the capital account and so on. And while there has been some ebb-and-flow, particularly on the capital account, almost everyone would admit that far more progress has been made over the past five years than they expected five years ago. Most foreign investors and analysts, including ourselves, would like to see the focus shift more decisively toward shuttering plants with excess capacity and reducing the role of state-owned enterprises (SOEs) in the economy more broadly. But here too, progress has probably been faster than most appreciate. Last year, for example, employment in the private sector passed the 50% mark, up from 15% just 15 years ago (chart below left). Mirroring the move in reverse, employment in the state sector has fallen to a mere 15% from 50% back in 1997. Meanwhile, the share of profit in the economy contributed by the state sector has fallen to 20% from 60% 15 years ago (chart below right). From yet another angle, the share of services in GDP has risen to 52% from 44% just 5 years ago while manufacturing’s share has fallen to 40% from 47% on China – SOE/private employment transformation

China – state sector share of industrial economy

percent share in urban employment

SOE plus state-holding companies, as % industrial sector

80

100 90

70

Private & self employed

60

51

50

80 70

state share of industrial assets

60

40

50

30

40

45

30

20

15

10

State owned enterprises

0 76

80

84

88

92

96

00

04

08

12

16

20 10

state share of industrial profit

20

0 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16

13

Economics

Economics–Markets–Strategy

the same time frame. It’s natural to wish for faster progress but the structural transformation of the economy over the past 10-15 years has by no means been insignificant. Indeed it may well be unmatched by any developing economy in the post-war period. Asia now adds a Germany to the world’s economic map every 3 years

Nor is China the only country in the world in need of some structural reform. Nearly everyone agrees that it is desperately needed in Japan, Europe and the US too. Just as many agree that structural reforms are not being undertaken in Japan, nor in the US, and only slowly in Europe. Indeed, one can probably point to only three places in the world today where reform and structural change programs are being undertaken in earnest and at great pain: China, Singapore and India, probably in that order. What does that tell you about where these economies will be on a 5-year time frame? What does that tell you about where the US, Japan and Europe will be at the end of the same 5 years?

Sixty-year track records We often talk about Asia ‘creating’ Germanys and adding them to the world’s economic map every 3.2 years. Actually, it now takes even less time than that. Last year, for example, Asia’s 5.75% growth on a GDP base of $19,000bn meant that it generated some $1100 of new demand. Since Germany’s GDP is about $3300bn, Asia puts a Germany on the map every 3 years instead of the 3.2 just noted. No need to split hairs though when you’re talking about elephants this big. One can, and we often do, express Asia’s growth relative to the US too. Last year, US GDP was almost exactly the same size as the Asia10 ($19trn) and its 1.7% growth meant it generated $325 of new demand. Compare that to Asia’s $1100bn of new demand and you see that for every dollar of growth the US put on the global table, Asia put out $3.40. In short, Asia is now 3.4 times the driver of global growth that the US is.

That capability didn’t appear overnight. The shift in economic gravity from West to East has been underway for 60 years

There’s something so ‘surreal’ about these numbers, so different from the past, that many still have a hard time accepting them. Something must be wrong, they surmise – the growth isn’t real, or it can’t last. For years we thought “when the US sneezes, Asia catches cold”. How could this have been turned on its head? And how so suddenly? There’s no magic here. And nothing has happened all-of-a-sudden. The shift in economic gravity from the West to the East has been underway for 60 years. Yearby-year, grain by grain, sand has been added to the Asia side of the see-saw. If something feels ‘all-of-a-sudden’, it just that the see-saw has passed the halfway point and one kid is getting flung off the lighter end. If there’s any magic here at all, it’s simply the magic of compound growth – what your parents taught you in high school. Put a dollar in the bank today and next year it’s worth more. Leave it there: five years, ten years – sooner than you think you’ve got some serious money. In 1967, Asia was one-tenth as big as the US. As we all know, it grew rapidly. But Asia never ‘drove’ global growth because it was too small to matter. Fast growth on a tiny base just doesn’t get you anything. But year by year, grain by grain, Asia’s rapid growth added up. And compounded. And compounded some more. By 1980, Asia was two-tenths as big as the US, twice as big as in 1967. By 1992, Asia was one-third the size of the US and by the Dotcom bubble of 2000 it was half as large. When Lehman went over the cliff in 2008, Asia was 70% as big as the US and today – nine years later – the US and Asia both have GDPs of $19trn. First point: to repeat, there’s nothing all-of-a-sudden about this. Asia has been converging on the US for 60 years. Second point: there’s no reason to expect it to stop now. A 60-year track record is pretty good as track records go. And Asia continues to grow three times faster than the US. Bottom line? The shift in economic gravity from West to East is a structural one and it’s not going away anytime soon.

14

Economics–Markets–Strategy

Economics

Asia10 – GDP growth as % of US GDP growth dollars of growth in Asia per dollar of US growth 4.25

4.50 4.00

3.40

3.50 3.00 2.50

2.12

2.00

1.50

1.50 1.00 0.50

1.00 .50

0.00 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12 14 16 18 20 22

In fact – and this is key – the shift in gravity is accelerating. Today, Asia generates $3.40 of new final demand for every dollar generated by the US. Asia’s growth will slow, we know, as incomes rise. But the base – Asia’s size – is now so large that even slower growth rates still generate lots of dollars of new demand. Five years from now, Asia will generate $4.25 for every dollar put out by the US. Five years after that, the gap will be to $5-to-1. US President Trump talks about ‘getting a better deal’ for Americans in their dealings with Asia. But the best deal he could ever hope for is already staring him in the face – to engage in a market that provides 5 dollars of growth for every dollar the US does. Never in history has the US had such a pool of demand dangled in front of it. It wasn’t created overnight. It wasn’t created at US expense. Best to get on with business than to complain. Asia is conducting a growth seminar that Trump is welcome to attend, or not, as he sees fit. If he stays home, America will be the loser. Probably the only loser.

Asia is dangling a pool of demand in America’s nose the likes of which it has never seen before. Best if Trump gets on with business than complain about it

In sum That’s the state of play in June 2017. Cyclically, this year will be better than last year, which was already significantly better than 2015. But growth will continue to moderate over the medium-term, as working age population growth continues to fall and, in Asia, as incomes continue to rise. Even with slower growth, however, Asia is going to dangle a pool of demand in America’s nose, the like of which it has never seen before. If Trump is smart, he will grab onto it with all his might. If he snubs his nose at it instead, America will be the main and perhaps only loser.

Notes: [1] Japan’s working age population (age 20-64) is shrinking by 1% per year. [2] See “Global growth: where is potential and where is it going?”, 28 Feb 16. [3] See “Global: revenge of the demographic dividend”, 14 Nov 16. [4] “World Population Prospects (2015)”, http://esa.un.org/unpd/wpp/. [5] Even if China does everything ‘right’ on the reform front, growth will slow as incomes rise. The task is to prevent growth from slowing more than it has to.

15

Economics

Economics–Markets–Strategy

Sources: All data are from CEIC, Bloomberg and DBS Group Research (forecasts and transformations).

16

Economics–Markets–Strategy

Economics

This page is intentionally left blank

17

Currencies

Economics–Markets–Strategy

FX: volatility falls Asia

Fed is normalizing monetary policy sooner and faster than ECB



Without Trump’s stimulus plans, USD’s recovery will be muted



Currency volatility has fallen across-the-board in Asia



Exchange rate stability is becoming a policy preference

CNY

Discouraging one-way bets

HKD

Wary of Fed hikes

TWD

Turning sluggish

KRW

External risks

SGD

Neutral

MYR

Realigning

THB

Vigilant against volatility

IDR

Balanced

PHP

A stable range

VND

Muted depreciation

INR

Tempering optimism

USD

Too pessimistic on Fed

JPY

Fed is key

EUR

Too optimistic on ECB

GBP

Tracking EUR more than Brexit

AUD

Domestic risks

USD has been struggling since the start of 2017 % YTD vs USD as of 2 Jun 2017 14

MAJOR CURRENCIES

BRICS

EMERGING ASIAN CURRENCIES

12 10 8 6

CURRENCIES

4 2 0 -2 -4 -6

DXY is the benchmark USD Index

EUR JPY GBP AUD NZD CAD DXY RUB ZAR INR CNY BRL KRW TWD THB MYR SGD IDR VND PHP HKD

Philip Wee • (65) 6878 4033 • [email protected]

18

Economics–Markets–Strategy

Currencies

Currency forecasts

DXY index

usd/ JPY

EUR /usd

GBP /usd

usd/ CNY

usd/ HKD

usd/ TWD

usd/ KRW

usd/ SGD

usd/ MYR

usd/ THB

usd/ IDR

usd/ PHP

usd/ VND

usd/ INR

AUD /usd

2-Jun

3Q17

4Q17

1Q18

2Q18

96.715

97.4

97.8

98.2

98.6

Consensus

98.7

98.2

97.6

97.1

110.40

114

116

117

119

Consensus

113

114

115

115

1.1279

1.11

1.11

1.11

1.10

Consensus

1.10

1.11

1.12

1.13

1.2888

1.27

1.26

1.25

1.24

Consensus

1.27

1.27

1.28

1.28

6.8100

6.88

6.94

7.01

7.08

Consensus

6.96

7.00

7.05

7.00

7.7890

7.78

7.78

7.78

7.78

Consensus

7.78

7.78

7.77

7.77

30.120

31.2

31.2

31.3

31.4

Consensus

30.8

31.0

31.2

31.0

1122

1150

1150

1150

1150

Consensus

1150

1160

1170

1164

1.3807

1.39

1.39

1.40

1.40

Consensus

1.42

1.42

1.42

1.41

4.2802

4.22

4.22

4.23

4.24

Consensus

4.35

4.35

4.35

4.30

34.050

34.4

34.5

34.7

34.9

Consensus

34.9

35.2

35.2

35.0

13315

13393

13411

13429

13447

Consensus

13450

13500

13500

13450

49.511

50.2

50.4

50.7

50.9

Consensus

50.5

50.9

50.8

50.5

22707

22722

22771

22820

22869

Consensus

22867

23000

23000

22500

64.441

64.8

64.8

64.9

65.0

Consensus

65.5

66.1

66.0

65.8

0.7443

0.74

0.74

0.74

0.74

Consensus

0.74

0.74

0.74

0.76

DBS forecasts in red. Consensus from Bloomberg as of 2 Jun 2017

19

Economics–Markets–Strategy

Currencies

Is EUR/USD running ahead of itself?

ECB is not concerned about underlying inflation

bond spread, % -1.40

Spot rate 1.14

-1.50 -1.60

Post-US

1.13

3.0

presidential election

1.12

2.5

1.11

2.0

-1.70

EUR/USD

-1.80

↓ weaker EUR (rhs)

1.10

-2.10

Core inflation 2% target

Intercept Slope

0.5

1.07

(lhs)

CPI inflation

Start Latest

1.0

1.08

EU-US 10Y bond spread

Start Latest

1.5

1.09

-1.90 -2.00

% YoY 3.5

Int

0.0

1.06

-2.20

1.05

-0.5

-2.30

1.04

-1.0

-2.40 Jul-16 Sep-16 Nov-16 Jan-17 Mar-17 May-17

1.03

-1.5

1Q17

09

10

11

12

13

14

15

16

17

Sources: DBS Research, Bloomberg data

Sources: DBS Research, Bloomberg data

From politics in 1H to monetary policy divergences in 2H The first five months of 2017 turned out to be opposite of what everyone expected for the USD and the EUR. First, the benchmark DXY (USD) index did not extend its rally and returned, around mid-May, all of its post-US presidential election gains. After Trump’s stimulus plans went off track from March, the US 10Y bond yield retreated from the upper into the lower half of the Fed’s 2-2.5% inflation target range. Second, European Union (EU) break-up fears did not materialize after elections in the Netherlands and France rejected far right populism. This coupled with speculation over European Central Bank’s (ECB) exit strategy from its loose monetary policy led EUR/USD back above 1.10 from mid-May from the year’s low of 1.0341. Speculation that this may be the start of a USD downtrend is likely to be premature. Tearing away from its EU-US 10Y bond differential, EUR/USD may have run ahead of itself. Barring surprises at its governing council meeting on 8 Jun, ECB President Mario Draghi had already told the EU Parliament in late March that any rate hike will only come well after its scheduled asset purchase program ends in December.

ECB is likely to be patient and cautious in withdrawing stimulus 2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

2020

2021

2022

Jan Feb Mar Apr May Jun

QE

Jul

Extend QE

Aug Sep Oct Nov

Extend QE

Dec Source: DBS Research

20

Economics–Markets–Strategy

Currencies

Fed's monetary policy and exit strategy 2009

2010

2011

2012

2013

2014

Jan

2015

2016

2017

2018

2019

2020

2021

2022

Fed is here

Feb

1.00% 2.00% 3.00%

Mar Apr May

1.25% 2.25%

Jun Jul Aug

QE1 1.50% 2.50%

Sep Oct

QE ∞

Nov

QE 2

Dec

Fed hike Taper

0.50% 0.75% 1.75% 2.75%

Unwinding Fed's balance sheet (USD trillion)

Source: DBS Research

4.5

Markets, meanwhile, are complacent over the Fed’s plans to normalize monetary policy. On the Fed’s gradual and steady hike stance, San Francisco Fed President John Williams sees three hikes this year and four next year. In its economic projections on 15 Mar, the Fed pinned its median forecast for the Fed Funds Rate at 3% in 2019 and later. After the last Fed hike in March, Fed officials have been paving the ground to start unwinding its balance sheet later this year. The Fed is looking past the recent soft US data. Consensus agrees with the New York and Atlanta Fed that real GDP growth will pick up again in 2Q17 after a disappointing first quarter. Advance estimate will be released on 29 Jul. With US capacity utilisation starting to rise meaningfully from its floor, the implied yield for Fed Funds Futures expiring in Dec 2018 look too low at 1.485%. Unless the US economy really disappoints, the Fed is moving to withdraw stimulus sooner and faster than the ECB. The Fed sees gradual rate hikes prolonging and not curtailing the US economic expansion. Despite recent optimism in the Eurozone recovery, the ECB finds it premature to withdraw stimulus and prudent to keep monetary policy looser for longer. Hence, the USD may yet surprise on the upside again in the second half of the year, just as it had in the past three years.

Fed wants gradual and steady rate hikes

USD struggled in 1H, recovered in 2H in past 3 years

% pa 10

% 86

8

84 82

US capacity utilisation

6

80

(rhs)

4

78

2

76

Fed Funds Rate (lhs)

74

0

72

-2

70

-4

68

-6

66 90

95

00

05

Sources: DBS Research, Bloomberg data

10

15

20

Jan-90 DXY index Feb-90 105 Mar-90 Apr-90 May-90 100 Jun-90 Jul-90 95 Aug-90 Sep-90 90 Oct-90 Nov-90 Dec-90 85 Jan-91 Feb-91 80 Mar-91 75 Jan-14

Jan-15

Jan-16

Jan-17

Sources: DBS Research, Bloomberg data

21

Currencies

Economics–Markets–Strategy

Asia ex Japan currencies – 2Q17 vs 1Q17

Asia ex Japan equities – 2Q17 vs 1Q17

Y-axis: % ch vs USD in 2Q17 (2 Jun vs 31 Mar) 4

MYR

3 2

PHP

CNY

THB

SGD

1 0

TWD

IDR

VND HKD

INR KRW

-1

X-axis: % ch vs USD in 1Q17

-2 -2

0

2

4

6

8

Sources: DBS Research, Bloomberg data

CNY Y-axis: % ch in stock indices, 2Q17 (2 Jun vs 31 Mar) HKD 12 TWD KRW 10 KR SGD PH 8 MYR THB HK 6 IDR PHP TW IN 4 VND ID INR 2 VN MY SG 0 JPY TH -2 CN X-axis: % ch in 1Q17 -4 0 2 4 6 8 10 12

CNY HKD TWD KRW SGD MYR THB IDR PHP VND INR

Sources: DBS Research, Bloomberg data

Exchange rate stability returning to Asia ex Japan There was no strong spill-over from the USD’s weakness against the major currencies into Asia ex Japan (AXJ). With the exception of the MYR, AXJ currencies were notably stable in Apr-May compared to 1Q17. Most stock markets did not repeat their strong performances in 1Q17; two actually fell in Apr-May vs none in JanMar. This was in line with export growth, in the past 12 months, coming off their high double-digit levels in many countries. Five AXJ currencies, especially the more export-dependent ones, recovered their Trump-led depreciation and more. Unlike the past few years, currency volatility fell consistently across AXJ currencies this year. With the USD dampened by Trump’s stimulus plans going off track, and complacency over the Fed’s exit strategy, USD/AXJ currency pairs are no longer seen breaking out of their ranges established since 2015. With many currency pairs back in the lower half of their ascending price channels, some AXJ countries (e.g. Thailand, India and Taiwan) have started to warn against excessive currency strength hurting their economies while others (e.g. Indonesia) cited preferences for exchange rate stability.

Export growth off their high double-digit levels

Currency volatility down across AXJ in 2017

% YoY in the past 12 months

12M ATM volatility, 2 Jan to 2 Jun 2017

30

As of Apr17 Mar17: PH; May17: KR, VN

12

25

11

20

10

15

9

10

8

5

7

0

6

-5 -10

5

-15

4

-20

3 PH MY IN

VN CN KR

Sources: DBS Research, Bloomberg data

22

ID TW HK TH

SG

KRW MYR IDR

INR TWD PHP THB SGD CNY

Sources: DBS Research, Reuters data

KRW MY ID IN TWD PH TH SGD CNY HKD

Economics–Markets–Strategy

Currencies

CNY has realigned with Asia ex Japan currencies

USD/MYR is realigning to "tantrum buddies"

Indexed: 1 Jul 2014=100 (Start of USD rise)

Indexed: 1 May 2013=100 (Fed taper tantrum)

130

160

USD vs Major currencies

USD/IDR

125

150

120

140

115

130

USD vs Asia ex Japan currencies

110

120

105

110 USD CNY

100 95 2014

2015

2016

100

2017

Sources: DBS Research, Bloomberg data

USD/MYR

1-Jan-13 2-Jan-13 3-Jan-13 4-Jan-13 7-Jan-13 8-Jan-13 9-Jan-13 10-Jan-13 11-Jan-13 14-Jan-13

90 2013

1234789101114-

USD/INR

2014

2015

2016

2017

Sources: DBS Research, Bloomberg data

The two major surprises this year were the CNY and MYR. The latest CNY appreciation should not be viewed as the start of a new appreciation trend. Rather, China has been seeking to discourage one-way bets (up or down) in its exchange rate after spending the past 2-3 year realigning USD/CNY to the USD’s strength, in particular, against the AXJ currencies. Similarly, USD/MYR is now playing catch up to the weaker USD this year, especially after 1Malaysia Development Berhad (1MDB) reached a settlement with Abu Dhabi International Petroleum. Understandably, the other two exchange rates – USD/INR and USD/IDR – hit hard during the Fed taper tantrums in 2013 are not underestimating the Fed’s intentions to normalize monetary policy. Despite their record high stock markets, India and Indonesia are guarding against complacency in favour exchange rate stability for now. Looking ahead, we do not discount a USD recovery in 2H17 on renewed US economic optimism fuelling Fed hike bets. AXJ currencies at risk to giving back this year’s gains are likely to be those that are high correlated with the DXY, and those that have appreciated past levels seen at last November’s US presidential election.

How much Trump losses did AXJ FX recover? % ch vs USD, 2 Jun2017 vs 8 Nov 2016 6 4

Have recovered Trump depreciation and more

2 0 -2 -4 Still posting Trump depreciation

-6 -8

TWD INR THB KRW SGD CNY HKD VND PHP IDR MYR Sources: DBS Research, Reuters data

Who will be most sensitive to a USD recovery? TWD Y-axis: % ch in FX vs 1 % ch in DXY INR 1.2 THB KRW 1.0 SGD CNY 0.8 HKD VND 0.6 PHP 0.4 IDR MYR 0.2 PHP

-0.2 -0.4 -100

HKD

-50

MYR INR

TWD

KRW THB SGD

CNY IDR

VND

0.0

Period: 2 Jan to 2 Jun

0

X-axis: correlation with DXY 50 100

Sources: DBS Research, Bloomberg data

23

Currencies

Economics–Markets–Strategy

US dollar DXY index weak in the first half of the year, with scope to recover in the second half For the third year running, the DXY Index returned into the lower half of its ascending price channel in the first half of the year. While the DXY could still head lower, we are unconvinced that this is the start of a major USD downtrend. Unlike 1H16, the USD’s weakness in 1H17 was not due to global risks pushing the Fed to turn dovish and patient on rate hikes. This year, the DXY fell in spite of two Fed hikes in Dec and Mar. Rather, USD bulls were disappointed that US President Trump’s stimulus plans went off track. This coupled with mixed US data dampened the US growth/inflation outlook and returned the US 10Y bond yield into the lower half of the Fed’s 2-2.5% inflation target range. For a third time, markets are complacent over the Fed’s policy intentions. The Fed plans to keep to a steady and gradual hike cycle (of possibly one hike per quarter) while moving to unwind its balance sheet later this year. Unlike the DXY, US stocks did not give back their post-election gains and rallied to new record highs instead.

DXY index outlook 105

105 Consensus

Projected trading range

100

100 95

95 DBSf

90

90

85

85 80

80 Shaded area: Ascending price channel Upper half in pink; lower half in gray

75 14 DBSf Consensus

15

16

2-Jun 96.715

3Q17 97.4 98.7

17

75

18

4Q17 97.8 98.2

1Q18 98.2 97.6

2Q18 98.6 97.1

Projected trading range Ceiling 99.2 99.8 100.2 100.6 101.0 Floor 94.4 95.0 95.4 95.8 96.2 Slope 1.7% appreciation a year in DXY vs USD Width ±5.0% around mid Sources: DBS Research, Bloomberg data & consensus

Japanese yen Our projected trading range for USD/JPY remains the lower half of its ascending price channel USD/JPY continues to be highly correlated with the US-JP 10Y bond yield differential. With the Bank of Japan’s (BOJ) yield curve control scheme anchoring the 10Y JGB yield near 0% since last September, USD/JPY has been moving up and down with the 10Y US treasury yield. The “higher Nikkei, weak JPY” relationship under Abenomics continued to weaken this year. The correlation was 43.6% in Jan-May this year, less than half the 94% seen at the start of Abenomics in 2013. For a second straight year, the JPY has risen alongside the Nikkei index in 2017. Last year was the first year since 2005 that Japan reported uninterrupted (QoQ saar) economic growth. Not surprisingly, BOJ Governor Haruhiko Kuroda felt compelled, for the first time on 10 May, to inform parliament that the bank would start to consider an exit strategy from its ultra-loose monetary policy. With BOJ far from achieving its inflation goal, this does not mean that the BOJ will abandon its stimulus. Nonetheless, it opens the door for more volatility should BOJ officials fall short in communicating its policy intentions. 24

USD/JPY outlook 130

130 DBSf Projected trading range

120

120

110

110 Consensus

100

100 90

90

80

80 Shaded area: Ascending price channel Upper half in pink; lower half in gray

70 12 DBSf Consensus

13

14 2-Jun 110.40

15 3Q17 114 113

16

17

4Q17 116 114

70

18 1Q18 117 115

2Q18 119 115

Projected trading range Ceiling 121 123 124 125 127 Floor 104 106 108 109 111 Slope 4.7% depreciation a year in JPY vs USD Width ±15.0% around mid Sources: DBS Research, Bloomberg data & consensus

Economics–Markets–Strategy

Currencies

Euro EUR/USD returned into the upper half of its descending price channel The first half of 2017 turned out better-thanexpected for the EUR. USD bulls were disappointed that US President Trump’s stimulus plans went off track. EUR bears were upset that Eurozone breakup fears abated after far right opposition parties lost key elections in the Netherlands and France. EUR bulls are now banking on the European Central Bank (ECB) to map out an exit strategy from its ultra-loose monetary policy. These players may be running ahead of themselves. The ECB is expected to upgrade, at its governing council meeting on 8 Jun, its economic risk assessment to balanced from downside. While the improving economy does not need extra measures, it is still not strong enough for the ECB to withdraw stimulus. ECB officials affirmed that any rate hike will only come well after asset purchases end in December. Given its desire to avoid a taper tantrum, the current pace of asset purchases will remain intact. ECB probably needs the stronger surplus-led EU nations to increase fiscal stimulus before withdrawing its support for the economy. This won’t be visible until after the German election in August.

EUR/USD outlook Projected trading range

1.20

1.20

1.18

1.18

1.16

Consensus

1.16

1.14

1.14

1.12

1.12

1.10

1.10

1.08

1.08

1.06

DBSf

1.04

1.06 1.04

1.02

1.02

Shaded area: Descending price channel Upper half in pink; lower half in gray

1.00 15

DBSf Consensus

16 2-Jun 1.1279

1.00

17 3Q17 1.11 1.10

18 4Q17 1.11 1.11

1Q18 1.11 1.12

2Q18 1.10 1.13

Projected trading range Ceiling 1.14 1.14 1.13 1.13 1.13 Floor 1.09 1.09 1.08 1.08 1.08 Slope 1% depreciation a year in EUR vs USD Width ±4.6% around mid Sources: DBS Research, Bloomberg data & consensus

British pound GBP/USD returned to its path seen after the Brexit referendum and before the flash crash After two rounds of Brexit-related sell-off in Jun-Oct last year, GBP has caught up with the weaknesses of the EUR and other major currencies seen since 2014. In turn, GBP/USD had become more correlated with EUR/USD this year. This probably explained why GBP/USD did not panic and was stable around 1.25 when British PM Theresa May triggered Article 50 on 29 Mar. The USD had already started to return its post-US election gains on Trump’s stimulus plans going off track. EUR was also underpinned by elections in the Netherlands and France rejecting far right populism that threatened the unity of the EU. Not surprisingly, GBP/USD broke above its sixmonth 1.21-1.27 range on 18 Apr, the day PM May called for snap election on 8 Jun. GBP/USD’s upside was, however, limited to an uninspiring range between 1.2750 and 1.3050. Initial optimism for a landslide victory for May’s Conservative Party evaporated after polls showed the opposition Labour Party closing its gap. If the polls prove unreliable again, GBP/USD should return to tracking the EUR/USD after a relief rally.

GBP/USD outlook 1.50

1.50 Projected trading range

1.45

1.45

1.40

1.40 Consensus

1.35

1.35

1.30

1.30

1.25

1.25

1.20 1.15 1.10

1.20 DBSf Shaded area: Descending price channel Upper half in pink; lower half in gray

16 DBSf Consensus

1.10

17 2-Jun 1.2888

3Q17 1.27 1.27

1.15

18 4Q17 1.26 1.27

1Q18 1.25 1.28

2Q18 1.24 1.28

Projected trading range Ceiling 1.31 1.30 1.29 1.28 1.27 Floor 1.25 1.24 1.23 1.22 1.21 Slope 3.4% depreciation a year in GBP vs USD Width ±4.9% around mid Sources: DBS Research, Bloomberg data & consensus

25

Currencies

Economics–Markets–Strategy

Chinese yuan USD/CNY is still stabilizing within its ascending price channel Moody’s decision on 24 May to downgrade China’s sovereign debt rating to A1 from Aa3 did not hurt the CNY. Quite the contrary, USD/CNY fell to 6.8100 from 6.8901 between 24 May and 2 Jun. The latest CNY appreciation that started in late May should not be viewed as the start of a new appreciation trend. USD/CNY spent the last 2-3 years realigning to the USD’s strength, especially against Asia ex Japan currencies. Hence, it is timely for the central bank to discourage oneway bets in the exchange rate, up or down. That was why the central bank announced on 26 May that a counter-cyclical factor would be added into the calculation of the daily reference rate to discourage herd effects in the market. China is likely to continue favouring CNY stability this year. On the external front, the US government is investigating into the trade practices of its major trading partners in 2Q17. More importantly, China has started financial deleveraging in April ahead of its crucial leadership reshuffle in the final quarter of the year.

USD/CNY outlook 7.40

7.40 Consensus

7.20 7.00

7.20 7.00

Projected trading range

6.80

6.80 DBSf

6.60

6.60 6.40

6.40

6.20

6.20 Shaded area: Ascending price channel Upper half in pink; lower half in gray

6.00 14 DBSf Consensus

15

16

17

2-Jun 6.8100

3Q17 6.88 6.96

6.00

18

4Q17 6.94 7.00

1Q18 7.01 7.05

2Q18 7.08 7.00

Projected trading range Ceiling 6.89 6.98 7.04 7.11 7.18 Floor 6.69 6.78 6.85 6.91 6.98 Slope 3.7% depreciation a year in CNY vs USD Width ±2.8% around mid Sources: DBS Research, Bloomberg data & consensus

Hong Kong dollar USD/HKD has moved off the lowest quartile of its convertibility band Since the beginning of 2017, USD/HKD has been rising from the floor towards the middle of its 7.75-7.85 convertibility band. With the HKD pegged to the USD, the Hong Kong Monetary Authority (HKMA) has matched the Fed hikes since December with corresponding increases in the base rate. Still, this did not prevent HK money market rates from diverging with its US counterparts. In Jan-May 2017, the 3M HKD Hibor eased to 0.7738% from 1.0239% even as the 3M USD Libor firmed to 1.21% from 0.9979%. HK rates ignored the Fed hikes because capital flows returned to Asia ex Japan (AXJ). As of 2 Jun, HK stocks rallied 17.3% YTD to become the best stock market in the region. HK’s economic recovery exceeded expectations with 4.3% YoY growth in 1Q17, above 4% for the first time since 2Q11. Foreign reserves increased to a record high of $400bn in Apr17, up from $386bn at end-2016. With the liquidity also finding its way into the property sector, the HKMA introduced more cooling measures in May. The HKMA is not taking lightly the prospect for 8-9 Fed hikes into 2019. 26

USD/HKD outlook 7.90

7.90 Projected trading range

7.85

7.85 DBSf

7.80

7.80

7.75

7.75 Consensus

7.70

Shaded area: Convertibility band Upper half in pink; lower half in gray

11 DBSf Consensus

12

13 2-Jun 7.7890

14

15

3Q17 7.78 7.78

7.70 16

17

4Q17 7.78 7.78

18

1Q18 7.78 7.77

2Q18 7.78 7.77

Projected trading range Ceiling 7.80 7.80 7.80 7.80 7.80 Floor 7.75 7.75 7.75 7.75 7.75 Slope 0% appreciation a year in HKD vs USD Width ±0.6% around mid Sources: DBS Research, Bloomberg data & consensus

Economics–Markets–Strategy

Currencies

Taiwan dollar USD/TWD may be finding support around its psychological level at 30 USD/TWD fell from 32.326 to 30.208 in the first five months of 2017. In YTD terms, the TWD appreciated 7.3% by end-May, its fastest level since 2010. The TWD was the second best performing Asian currency so far this year. The TWD has a close correlation with the TAIEX index, which for the first time since Apr 2015, hit its psychological 10,000 level on 11 May. Unlike two years ago, the index did not reverse trend but extended its rally to 10,102 by end-May. The positive markets were in line with Taiwan’s improved outlook. The Directorate General of Budget, Accounting and Statistics (DGBAS), on 26 May, lifted its 2017 growth forecast to 2.05%. The outlook was first revised up to 1.92% in Feb from 1.87% last Nov. On the other hand, the National Development Council (NDC) overall monitoring index flashed “yellow blue” in Apr17, and suggested that the economy may be turning sluggish after 9 straight months of stable growth. The NDC also warned that the strong TWD may have hurt manufacturing and business revenues. The prospect for USD/TWD to be supported at its psychological 30 level cannot be discounted.

USD/TWD outlook 34

34 33

DBSf Projected trading range

32

33 32

31

31

30

30 Consensus

29

29 Shaded area: Ascending price channel Upper half in pink; lower half in gray

28 11

12

DBSf Consensus

13

14

2-Jun 30.120

15 3Q17 31.2 30.8

16

17

4Q17 31.2 31.0

18

1Q18 31.3 31.2

28 2Q18 31.4 31.0

Projected trading range Ceiling 32.1 32.2 32.3 32.3 32.4 Floor 30.1 30.2 30.2 30.3 30.4 Slope 0.8% depreciation a year in TWD vs USD Width ±6.7% around mid Sources: DBS Research, Bloomberg data & consensus

Korean won USD/KRW is still stable within our projected trading channel between 1100 and 1200 Korea’s improved economic outlook and more stable domestic political environment were better reflected by its record high stock market than its exchange rate. As of 30 May, the KOSPI had rallied 15.6% YTD vs a 7.2% appreciation in the KRW vs the USD. The KOSPI had been posting record highs since 4 May while USD/KRW consolidated between 1110 and 1150 since mid-March. The Bank of Korea (BOK) intends to upgrade its 2017 growth outlook in July; the outlook was last lifted in April to 2.6% from 2.5%. The BOK supported the newly-elected Moon government’s plans to address high household debt while providing more fiscal stimulus to create jobs and support growth. In turn, this will pave the ground for a BOK rate hike in 2018. The KRW was probably underpinned in Jan-May by a rise in the KR 10Y bond yield to 2.23% from 2.09%, as opposed to a fall in its US counterpart to 2.24% from 2.44%. That said, the KRW is still vulnerable to an escalation in geopolitical tensions over North Korea as well as to a more hawkish Fed policy.

USD/KRW outlook 1250

1250

Projected trading range

Consensus

1200

1200

1150

1150

1100

1100 DBSf

1050

1050 Shaded area: Ascending price channel Upper half in pink; lower half in gray

1000 13 DBSf Consensus

14

15 2-Jun 1122

16 3Q17 1150 1150

17 4Q17 1150 1160

1000

18 1Q18 1150 1170

2Q18 1150 1164

Projected trading range Ceiling 1200 1200 1200 1200 1200 Floor 1100 1100 1100 1100 1100 Slope 0% appreciation a year in KRW vs USD Width ±9.1% around mid Sources: DBS Research, Bloomberg data & consensus

27

Currencies

Economics–Markets–Strategy

Singapore dollar USD/SGD returned into the lower half of its ascending price channel The Monetary Authority of Singapore (MAS) shifted to a neutral policy stance in Apr 2016. At the next two policy meetings in Oct 2016 and Apr 2017, the MAS believed that this zero appreciation stance was appropriate for an extended period of time to ensure medium-term price stability. This stance was important in keeping USD/SGD’s decline in the first half of this year (5.1% over 5 months) muted compared to last year (7.6% over 3 months). First, a stable SGD nominal effective exchange rate (NEER) “anchored” around the mid-point of its policy band minimized spot exchange rate fluctuations. Second, the tradeweighted basket of currencies, especially the JPY and MYR, were less volatile this year. We expect the neutral stance to stay at the next policy review in October. We also expect the USD to be underpinned by renewed optimism in the US economy and more Fed hikes this year. Unless Trump’s stimulus plans get back on track, we expect USD/SGD’s recovery to be muted, in line with stable exchange rate biases in the region.

USD/SGD outlook 1.48 1.46 1.44 1.42 1.40 1.38 1.36 1.34 1.32 1.30 1.28 1.26 1.24 1.22

Consensus

Projected trading range

DBSf

Shaded area: Ascending price channel Upper half in pink; lower half in gray

14 DBSf Consensus

15

16

2-Jun 1.3807

3Q17 1.39 1.42

17 4Q17 1.39 1.42

1.48 1.46 1.44 1.42 1.40 1.38 1.36 1.34 1.32 1.30 1.28 1.26 1.24 1.22

18 1Q18 1.40 1.42

2Q18 1.40 1.41

Projected trading range Ceiling 1.41 1.41 1.41 1.42 1.42 Floor 1.36 1.36 1.37 1.37 1.38 Slope 1.1% depreciation a year in SGD vs USD Width ±3.4% around mid Sources: DBS Research, Bloomberg data & consensus

Malaysian ringgit USD/MYR has been retreating from the ceiling to the mid-point of our ascending price channel USD/MYR fell from a high of 4.5002 on 4 Jan to a low of 4.2675 on 29 May. At its peak, the MYR appreciated 5.1% against the USD. Most of the gains were achieved in the first two months of 2Q17 when the MYR bested all its peers in Asia ex Japan.

USD/MYR outlook 4.80

Consensus

4.60

4.60

Projected trading range

4.40

4.80

4.40

4.20

4.20

4.00

4.00

The MYR started appreciating meaningfully after 24 Apr, the day when 1Malaysia Development Berhad (1MDB) reached a settlement with Abu Dhabi International Petroleum. The next rally began on 19 May when real GDP growth came in at 5.6% YoY in 1Q17, above 5% for the first time since 1Q15. Apart from double-digit export growth, domestic demand also improved. With CPI inflation above its official 3-4% range since Feb17, Bank Negara does not appear overly concerned about MYR strength.

3.80

We have, in our mid-FX quarterly on 3 May, already flattened the slope of our ascending price channel for USD/MYR. Our new projected trading range sees the possibility for the currency pair to fall into the lower half of its ascending price channel.

Projected trading range Ceiling 4.36 4.37 4.38 4.38 4.39 Floor 4.05 4.06 4.07 4.08 4.09 Slope 0.7% depreciation a year in MYR vs USD Width ±7.5% around mid

28

DBSf

3.80

3.60

3.60

3.40

3.40

3.20

Shaded area: Ascending price channel Upper half in pink; lower half in gray

3.00 14 DBSf Consensus

15

16

2-Jun 4.2802

3Q17 4.22 4.35

17 4Q17 4.22 4.35

Sources: DBS Research, Bloomberg data & consensus

3.20 3.00

18 1Q18 4.23 4.35

2Q18 4.24 4.30

Economics–Markets–Strategy

Currencies

Thai baht Downside in USD/THB limited as it approaches the floor of our projected trading channel The THB was, as of 30 May, the best performing Southeast Asian currency this year. USD/THB fell to the year’s low 34.052 on 26 May, its lowest level since mid-Jul 2016. This represented a 5.2% YTD appreciation in the THB vs USD on this day. Apart from 2010, the THB had never been able to sustain YTD gains in excess of 5% after the 2008/09 global financial crisis. In fact, the THB has been known to return gains after achieving this milestone. The Bank of Thailand (BOT) signaled, in the next trading session (29 May), its discomfort with the currency’s strength and capital inflows into short-term bonds. The central bank also warned of actions, without advance notice, to curb any excessive strength in the THB. This should not come as a surprise. Despite a better growth outlook this year, the Thai stock market was the second worst performer in Asia ex Japan. More importantly, CPI inflation peaked at 1.55% YoY in Jan17 and retreated to 0.38% in Apr17, below the BOT’s 1-4% target for 2017 for a second straight month.

USD/THB outlook 38

38 Consensus

37 36

37 36

Projected trading range

35

35

34

34

33

DBSf

32

33 32

31

31

30

30

29

Shaded area: Ascending price channel Upper half in pink; lower half in gray

28 11

12

DBSf Consensus

13 2-Jun 34.050

14

15 3Q17 34.4 34.9

16

17

4Q17 34.5 35.2

29 28

18

1Q18 34.7 35.2

2Q18 34.9 35.0

Projected trading range Ceiling 35.2 35.4 35.5 35.7 35.8 Floor 33.2 33.4 33.6 33.7 33.9 Slope 1.7% depreciation a year in THB vs USD Width ±5.8% around mid Sources: DBS Research, Bloomberg data & consensus

Indonesian rupiah USD/IDR has been stable in a 13237-13422 range since mid-January Exchange rate stability remains a priority with Bank Indonesia (BI) this year. Despite strong foreign inflows into Indonesian stocks and bonds, USD/IDR has been remarkably stable within a 1.4%-wide band between 13237 and 13422 since mid-January. Foreign reserves increased $6.9bn to $123.2bn in Jan-Apr17 vs the $10.4bn rise for the whole of 2016. Jakarta stocks have been posting new lifetime highs since March. ID 10Y government bond yield fell to 6.69% in May after it peaked at 8.32% last November. On 19 May, Standard & Poor’s finally joined Moody’s and Fitch in awarding an investment grade to Indonesia’s sovereign debt rating. Despite the optimistic environment, BI has not lost sight of controlling inflation and maintaining macroeconomic stability. CPI inflation rose from 3.02% YoY to 4.17% in Dec16-Apr17, above the mid-point of its official 3-5% target band. BI has called for more structural reforms from the government to achieve its medium-term 7% growth target.

USD/IDR outlook 15000

15000 Projected trading range

14500

Consensus

14500

14000

14000

13500

13500

13000

13000 DBSf

12500

12500 12000

12000 11500

Shaded area: Ascending price channel Upper half in pink; lower half in gray

11000 14 DBSf Consensus

15 2-Jun 13315

16 3Q17 13393 13450

17

18

4Q17 13411 13500

1Q18 13429 13500

11500 11000 2Q18 13447 13450

Projected trading range Ceiling 13734 13757 13775 13793 13811 Floor 13004 13028 13046 13064 13082 Slope 0.5% depreciation a year in IDR vs USD Width ±5.6% around mid Sources: DBS Research, Bloomberg data & consensus

29

Currencies

Economics–Markets–Strategy

Philippine peso USD/PHP has been consolidating between 49.3 and 50.4 since last December We have decided to flatten the slope of our projected trading channel for USD/PHP. Previously, we projected the currency pair to track the upper half of its ascending price channel. Investor confidence returned to the Philippines. From early April, the stock market overtook its peers to become the best performer in Southeast Asia, in line with expectations for its economy to remain the fastest growing in the region. By end-May, the PSEi Index rallied 14.6% YTD vs an average 7.9% in the region. Ironically, the PHP was the only Southeast Asian currency that depreciated this year. As of 31 May, the PHP fell 0.4% YTD against the USD. This, however, did not imply that the PHP was a weak currency. In reality, USD/PHP had been stable since last December, consolidating between 49.264 and 50.467, and staying mostly below its psychological 50 level. All said, there is little room for complacency. The Philippines is set to enter into a twin (current account and budget) deficit position this year at a time when the Fed is set on a gradual and steady hike path.

USD/PHP outlook 54

54 Consensus

52 50

50

48

48 DBSf

46

46

44

44

42

Shaded area: Ascending price channel Upper half in pink; lower half in gray

40 13

14

DBSf Consensus

15 2-Jun 49.511

VND has been more stable than weak in the first 5 months of this year

23500

Although the official mid-rate for USD/VND was lifted by 1% to 22384 in Jan-May, the spot rate was only higher by a paltry 0.1% YTD at 22732. In fact, spot USD/VND drifted lower after it peaked at 22843 on 3 Mar, in line with the global retreat in the USD after Trump’s stimulus plans went off track. We, however, remained mindful that USD/ VND had been close to the ceiling of its official trading band in the past three Fed hikes.

30

17

3Q17 50.2 50.5

40

18

4Q17 50.4 50.9

1Q18 50.7 50.8

2Q18 50.9 50.5

Sources: DBS Research, Bloomberg data & consensus

USD/VND outlook

Despite the growth disappointment in 1Q17 (5.1% actual vs 6.3% consensus), Fitch joined Moody’s in giving a positive outlook to Vietnam’s sovereign debt ratings. Investor confidence in the country’s macroeconomic and political stability and pro-investment policies were best reflected by the double-digit gains in the stock market.

16

42

Projected trading range Ceiling 50.6 50.9 51.1 51.3 51.6 Floor 49.3 49.6 49.8 50.0 50.2 Slope 1.7% depreciation a year in PHP vs USD Width ±2.7% around mid

Vietnam dong

We flattened the slope of our projected trading channel for USD/VND in our Mid-Quarterly report published on 3 May. The annual depreciation pace for the VND implied by our new channel is now just below 1% instead of 3% previously.

52

Projected trading range

23500 Projected trading range

Consensus

23000

23000

22500

22500 DBSf

22000

22000

21500

21500 Pink/gray shaded areas are upper/lower halves of official trading band

21000 15 DBSf Consensus

16 2-Jun 22707

17 3Q17 22722 22867

21000

18 4Q17 22771 23000

1Q18 22820 23000

2Q18 22869 22500

Projected trading range Ceiling 22892 22956 23005 23053 23102 Floor 22424 22488 22537 22586 22635 Slope 0.9% depreciation a year in VND vs USD Width ±2.1% around mid Sources: DBS Research, Bloomberg data & consensus

Economics–Markets–Strategy

Currencies

Indian rupee USD/INR stopped falling since late Apr in favour of a stable 64-45 range USD/INR fell from a high of 68.388 to a low of 63.931 between 11 Jan and 26 Apr. At its best level this year, the INR appreciated 6.2% YTD against the USD. Historically, whenever INR rose more than 5% YTD in the first half of the year, the Indian stock market achieved record highs. Indeed, the Bombay Sensex pushed new lifetime highs above its psychological 30,000 level in May. Despite this, USD/INR kept to a tight 64-65 range around the centre of its narrowing price channel in Apr-May. Chief Economic Adviser Arvind Subramanian warned on 28 Apr, two days after the INR peaked this year, that excessive INR strength could hurt exports and the economy. The improved landscape that fuelled INR optimism appeared to have reversed. After the Reserve Bank of India (RBI) upgraded its stance to neutral from accommodative on 8 Feb, real GDP growth came in at 7% YoY in 4Q16, well above the 6.1% consensus. Conversely, the RBI is now seen softening its stance at its upcoming June review, especially after growth came in at 6.1% in 1Q17, and fell short of the 7.1% consensus.

USD/INR outlook 72

72

Projected trading range

70

Consensus

70

68

68

66

66

64

64

62

62

60

60 DBSf

58

58

56

56

54

54

52

52

50

Shaded area: Narrowing price channel Upper half in pink; lower half in gray

48 12

13

DBSf Consensus

14 2-Jun 64.441

15

16

3Q17 64.8 65.5

17

4Q17 64.8 66.1

50 48

18 1Q18 64.9 66.0

2Q18 65.0 65.8

Projected trading range Ceiling 66.7 66.8 66.8 66.8 66.9 Floor 62.6 62.8 62.9 63.0 63.1 Slope 0.5% depreciation a year in INR vs USD Width ±6.2% around mid Sources: DBS Research, Bloomberg data & consensus

Australian dollar AUD/USD to keep retreating from the ceiling to the floor of our projected trading range AUD/USD peaked at 0.7750 on 21 Mar and retreated to 0.7440 on 29 May. The scope for AUD/USD to extend its fall to 0.72, the floor of our projected trading channel, cannot be discounted. In May alone, Australia equities gave back most of the year’s gains. Banks and property-related stocks were hurt by increased worries over a correction in home prices. The country’s largest banks were also hit by a $6.2bn bank levy over 4 years announced in the May Budget. Subsequently, Standard & Poor’s, on 22 May, downgraded 23 financial institutions.

AUD/USD outlook 0.84

Projected trading range

0.82

Shaded area: Descending price channel Upper half in pink; lower half in gray

0.80

0.84 0.82 0.80

Consensus

0.78

0.78

0.76

0.76

0.74

0.74

0.72

0.72 DBSf

0.70 0.68

0.70 0.68

AUD was also bruised by a downgrade in China’s sovereign debt rating by Moody’s. The struggle in commodity markets and the peak in the Australian property market had been attributed to slower demand from China.

0.66

Against the above outlook, the Reserve Bank of Australia will not join the Fed in hiking interest rates. With the AU-US 10Y bond yield spread at 15bps by end-May, its narrowest since 2001, the AUD is no longer an attractive carry trade.

Projected trading range Ceiling 0.77 0.77 0.77 0.76 0.76 Floor 0.72 0.72 0.72 0.72 0.72 Slope 0.7% depreciation a year in AUD vs USD Width ±6.8% around mid

0.66 15

DBSf Consensus

16 2-Jun 0.7443

17 3Q17 0.74 0.74

18 4Q17 0.74 0.74

1Q18 0.74 0.74

2Q18 0.74 0.76

Sources: DBS Research, Bloomberg data & consensus

31

Yield

Economics–Markets–Strategy

Yield: carry on US

Sentiment is supported as the synchronized cyclical recovery continues



While US growth is resilient, the market has brought down the probability of Trump being able to deliver on his pro-growth policies



UST curve flattening remains the most likely scenario as the Fed continues to normalize monetary policy



Asian government bonds should still outperform their developed market counterparts in the ongoing carry environment

SG

Watch the SGD

HK

Elevated

KR

Swap spreads widening

TW

Neutral

TH

Steep

MY

Outperforming

ID

Moderating returns

PH

External support

IN

Flat

CN

Liquidity squeeze

Change in 10Y Government Bond Yields over the past three months bps 60

G10

Other EMs

Asia

40 20 0 -20 -40 -60 -80 -100

Eugene Leow • (65) 6878-2842 • [email protected]

32

IDR

HKD

THB

SGD

INR

MYR

KRW

COP

CNY

TRY

RUB

MXN

BRL

ZAR

NZD

AUD

USD

CAD

NOK

SEK

GBP

CHF

GER

YIELD

JPY

-120

Economics–Markets–Strategy

Yield

US – tempered expectations The carry environment is set to continue for the next few months. The synchronized global economic recovery is still very much in play with economic data out of Europe and Japan displaying clear signs of improvement. This has kept sentiment buoyant even as the market is increasingly discounting what stimulus Trump will be able to deliver by the end of the year. The USD has given up all its post-Trump gains while the 10Y UST yield has retraced about 50% from its peak in March. Fundamentally, the US economy did not change sufficiently over the past six months to justify the gyrations in longer-term UST yields. Notably, 10Y UST yields were around 1.80% in early November (before Trump’s election), rose to a peak of 2.63% in March before drifting towards 2.16% (currently). Over the same period, US nonfarm payrolls have been stable while the unemployment rate drifted below 4.5%. With US economic growth largely intact, the fall 10Y UST yields appears to be a function of Trump expectations. As the probability of fiscal stimulus and tax cuts fade, inflation expectations fell accordingly. US medium-term inflation expectations (5Y5Y inflation swap) have fallen to the 2.22%, levels last seen in early November. With commodity and oil prices no longer pushing up headline inflation, the market is unconvinced that inflation will push sharply higher in the next few quarters. Moreover, the Fed has already reassured the market that the impending balance sheet shrinkage will be gradual, minimizing the risks of another tantrum. It has been communicated that the Fed intends to increase the balance sheet run off cap every three months (until a fully phased-in level is hit). In any case, shrinking the balance sheet should not have much impact on USD interest rates for quite some time. US banks have USD 2trn of excess reserves. Assuming that the balance sheet run off cap stays relatively small, there is little reason to see why liquidity is going to tighten meaningfully (and push up rates) for the foreseeable future. Speculative positioning has also swung from one extreme to another. The market is now net long 258k 10Y UST futures contracts (levels last seen in 2007), from a record net short 410k 10Y UST futures contracts in February. Conversely, the market is still net short in the 2Y and 5Y tenors. Given the shape of the curve, we broadly agree that shorter-term USD rates are underestimating the Fed. The market is barely pricing in 3-4 hikes over three years while we think this could be delivered within a year. The outlook for longer-term USD rates is less clear. In the short-term, we suspect that 10Y UST yields will be confined to the 2.16-2.40% trading range. While taking duration risk makes sense if the inflation outlook has become more muted, 10Y Commodity prices & inflation expectations %

325

3.00

300

US 5Y inflation swap, 5Y forward (rhs)

275

2.75 2.50 2.25

225 2.00

200

150 Jan-14

contracts, thousands 400 300 200 100 0

250

175

Thousands

10Y UST Net non-comm futures position

Index

-200 -300

CRB index (lhs)

1.75 1.50

Jan-15

-100

Jan-16

Jan-17

-400 -500 Jan-13

Jan-14

Jan-15

Jan-16

Jan-17

33

Yield

Economics–Markets–Strategy

Excess Reserves

Fed holdings of USTs by maturity Thousands

USD bn 3000 2500 2000

USD bn 450 400 350 300 250

1500

200 1000

150 100

500

50

0 Aug-07

0 Aug-10

Aug-13

2017

Aug-16

2022

2027

2032

2040

2045

yields are close to the bottom of the current trading range. Moreover, we are wary of the large net long positions in the sector that has been suddenly built up. 10Y USTs are thus vulnerable to a sharp sell-off if an inflation shock hits.

Watching the ECB and the BOJ This range is likely to nudge higher towards the end of the year. With higher inflation expectations lacking domestically, events unfolding in Europe and Japan will be key. The European Central Bank’s (ECB) asset purchase program runs out by the end of the year. As such, the market is speculating that the ECB may taper the current program for 2018, keeping 10Y German yields buoyant in the 0.2-0.4% range. The market is likely to look for greater clarity in the next few ECB policy meetings. Any change in outlook or hint of a reduction in asset purchases would likely push 10Y German yields above 0.5%, nudging up 10Y UST yields in the process. The 6M daily correlation between the two instruments stands at around 0.5, suggesting that half of the yield move in 10Y German Bunds would filter into 10Y USTs. In Japan, GDP growth has held above 1.5% (YoY) for the past two quarters. High frequency data (employment data and industrial production) have also been very encouraging of late, pointing to firm 2Q growth. JGB yields have adjusted

German Bund Curve

JGB Curve

% pa

% pa 0.25

1.00

JGB Curve. spot

0.75 0.50 0.25

German Bund Curve. spot

0.00

0.00 German Bund Curve, 1 Jan 17

-0.25 -0.50

-0.25

JGB Curve, 1 Jan 17

-0.75 -1.00

-0.50 1Y2Y3Y4Y5Y6Y7Y8Y9Y10Y

34

15Y

20Y

3M 6M 1Y 2Y 3Y 4Y 5Y 6Y 7Y 8Y 9Y 10Y

Economics–Markets–Strategy

Yield

3M Total Return Indices & FX Returns (vs USD) For Sovereigns % chg 8 7

FX return in USD

6

Bonds total return (lcy)

5 4 3 2 1 0 -1 -2

Dated: 7 June 2017 INR

GER MYR THB

IDR

JPY

KRW SGD AUD HKD

PHP USD

CNY

accordingly. Most of this adjustment higher in yields took place in the shorter tenors. This is perhaps unsurprising as the market no longer sees further rate cuts from the Bank of Japan (BOJ) while 10Y JGB yields are still anchored by the 10Y yield target of 0%. There is an increasing chance that this yield target will be tweaked higher (albeit slowly). Similarly, there should be some pass-through unto 10Y UST yields.

Environment conducive for Asian bonds Against a backdrop of improving economic growth but muted inflation, we argue that conditions are still good for risk taking. With USD strength faded and global inflation not running away, there is little reason to expect a sharp spike up in longer-term USD rates. Asian government bonds should still outperform developed market bonds as they have been in the past three months. Looking across the total returns (in USD terms) for the various government bond indices, traditional high-yielding government bonds (Indonesia and India) fared very well with returns in excess of 5%. Malaysia, which we flagged as a catch up play, is close behind. Interestingly, total returns for German Bunds were stellar on account of the surge in the EUR. In local currency terms, German Bunds fared poorly. Lastly, PHgov bonds underperformed peers, in line with what we expected. Going forward, we suspect that capital gains in Asian government bonds may be limited. Considerable spread compressions vis-à-vis comparable USTs have already taken place. Total returns are thus likely to be smaller than that seen over the past three months. High-yield government bonds still appear to be the most attractive. Lastly, CNgov bonds were one of the worst performers, but we suspect that the worst of the selloff may be over. CNgov yields appear to be stabilizing at higher levels and should perform better in the coming months. We expect yields on US Treasuries to rise. By mid-2018, 2Y yields should reach 2.50%; 10Y yields should reach 3.00%.

35

Yield

Singapore – watch the SGD The 3M SOR has diverged from the 3M Sibor and the 3M Libor. Notably, the spread of the 3M Sibor over 3M SOR (25bps) looks wide by historical standards. Similarly, the spread of 3M Libor over the 3M SOR is at 40 bps, levels not seen since 2011. The relatively low SOR can largely be attributed to the market becoming increasingly bullish on the SGD over the coming months. This also happened in the 2004-2006 Fed hike cycle. However, there are limits to how low the 3M SOR can go if Fed normalization continues as we expect. Interestingly, the market is expressing the strong SGD view differently in the SGD swap curve and the SGS curve. The front of the SGD swap curve is low compared to the USD swap curve while the back of the SGS curve is low compared to the UST curve. Comparing relative values, we think that the 5Y10Y segment of the SGS curve has the most room to outperform if USD weakness continues. This segment of the curve is also appealing as it sidesteps the Fed normalization cycle (still not adequately reflected in shorter-term USD and SGD rates).

Hong Kong – elevated Another liquidity squeeze is underway in the offshore RMB market. This spike in CNH rates is unlikely to persist beyond the short term. Notably, CNH rates had been coming off since early 2017 (when the last liquidity squeeze took place) and converged with rising CNY interest rates in early May. Worries about RMB devaluation have eased with the USD/CNH once again below the USD/CNY (market speculating on further RMB strength). With the current carry environment persisting and the authorities adding a counter cyclical factor to the USD/CNY fixing, the market arguably has little reason to keep CNH interest rates up. Secondly, short-term onshore interest rates have risen in response to the liquidity tightness engineered by the authorities in an attempt to maintain macro stability. Consequently, the market has priced in significant term premia across the entire onshore swap curve. We suspect that upside to onshore interest rates at current levels may be limited as Chinese data moderates. As onshore interest rates fall, this would provide more room for offshore rates to follow suit (once the engineered liquidity squeeze ends) in the coming few months.

36

Economics–Markets–Strategy

10Y SGS Yield & 10Y UST Yield %pa 3.00

10Y UST Yield

2.75 2.50 2.25 2.00 1.75

10Y SGS Yield

1.50 1.25 Jan-15

Jul-15

Jan-16

Jul-16

Jan-17

Jul-17

• Sibors / SORs will come under further upward pressure through 2017 amid Fed hikes. However, pressure arising from a strong USD has faded • We expect 2Y and 10Y SGS yields to reach 2.25% and 2.70% respectively by mid-2018

5Y CNY Swap & 5Y CNH CCS % pa

5.50 5.00

5Y CNH CCS rate

4.50 4.00 3.50 3.00 2.50 2.00 Dec-14

5Y CNY swap rate

Dec-15

Dec-16

• Ample liquidity conditions are going to keep HKD interest rates low relative to USD interest rates through the Fed hike cycle • We expect 2Y and 10Y HK government bond yields to reach 1.90% and 2.30% respectively by mid-2018

Economics–Markets–Strategy

Korea – swap spreads widening KRW swaps tend to be more sensitive to changes in market conditions compared to KTB yields. Directionally, KRW swaps appear to be following USD swaps. Longer-term KRW swaps have outperformed longer-term KTBs, resulting in widening swap spreads (KRW swaps less KTB yields of similar tenor). 10Y swap spreads are now close to -40bps, levels not seen since 2012. In relative terms, long KTB positions are now a lot more attractive than comparative receiving swap positions. Meanwhile, improved liquidity conditions in Korea have resulted in a divergence between short-term KRW swaps and USD swaps. This is reflected by the steepness in the front of the KRW curve (3M/3Y) despite significant flattening in the front of the USD swap curve. Notably, the 3M CD rate (which serves as the floating leg fixing of KRW swaps) has been declining over the past few months despite the steady policy rate. Inflows (as represented by KRW strength) into Korea nudged down the 3M CD rate while the passthrough to KRW swaps was more muted, resulting in a relatively steep KRW swap curve. If the KRW stays strong, this divergence is likely to persist.

Yield

KRW Swap Spreads bps 40

10Y Swap Spread

30

5Y Swap Spread 3Y Swap Spread

20 10 0 -10 -20 -30 -40 Jan-11

Jan-13

Jan-15

• The market no longer thinks that the BoK would cut rates further • We expect 3Y and 10Y Korean Treasury Bond yields to reach 1.85% and 2.60% respectively by end-2018

Taiwan – neutral

1Y, 2Y & 3Y TWD Swap Rates vs 3M Rate

TWD interest rates have rallied significantly over the past five months. Short-term TWD swaps (1Y3Y) have almost completely erased the Trump-led selloff in November. The market no longer sees any rate hikes over the coming one year, which is in line with our view. Further out, the market expects just one hike from the central bank (CBC) over the next three years, compared to 3-4 hikes from the Fed. Notably, the adjustment lower in the implied short-term TWD rate has been larger than its US counterpart.

%pa

Conditions are still supportive of TWD rates even as very low absolute levels of yields render TWgov bonds to be relatively unattractive. Taiwan enjoys a sizable current account surplus of 12.7% of GDP in 1Q17. This number has come off slightly and may be due to the surge in the TWD over the past few quarters. Domestically, there appears to be limited impetus for the CBC to tighten policy. While external demand has picked up somewhat, the 12M smoothed inflation profile is still below 1% YoY in April. Against the backdrop of a strong TWD, low inflation and strong external funding dynamics, we are neutral on TWD rates.

Jan-17

3Y TWD Swap

1.25

2Y TWD Swap 1Y TWD Swap 1.00

0.75

3M Rate 0.50 Jan-15

Jul-15

Jan-16

Jul-16

Jan-17

• Taiwan does not need to maintain interest rates differentials with the US • We expect the 2Y and 10Y government bond yields to rise to 0.60% and 1.20% respectively by mid-2018

37

Yield

Thailand – steep Longer-term THgov bonds look more attractive compared to shorter term ones. The 2Y/10Y segment of the THgov curve has been relatively steep (>100bps) since last November despite 10Y UST yields drifting lower by some 30-40bps (flattening the UST curve in the process) over the course of the year. Such steepness in the THgov curve does not appear warranted. Without any imminent overheating risks in growth, inflation and external funding, the jump in term premium for the longer tenors (>2Y) appears inordinately large. THgov bonds are also attractive to USD, EUR and JPY-based investors. From an after-swap (FXhedged) perspective, there is a still sizable yield pick up from THgov bonds compared to their respective government bonds. The pickup appears to be more significant for longer-tenor THgov yields (>5Y). Unsurprisingly, foreign ownership in THgov bonds has climbed 10% since the start of the year. With foreign investors likely to provide a tailwind to longer-term THgov bonds, upward pressure on THgov yields will likely to be muted in the coming months.

Malaysia – outperforming MYR market interest rates have played catch up to peers over the past few months. There is still modest scope for outperformance (versus peers) if the current carry environment continues as we expect. MYR interest rates reacted similarly to other emerging market interest rates in the aftermath of Trump’s victory last November. While other EM government bonds have retraced a large chunk of the sell-off, MGSs are still lagging. Moreover, MYR swaps are still pricing in rate hikes by Bank Negara Malaysia (BNM). Prior to the US elections, the market was pricing in cuts. Current levels of MYR interest rates are probably not justified. While headline inflation has pushed above 5% (YoY) in March, the spike was largely driven by administered oil prices. Headline CPI has since eased. Core inflation is still very low at 2.5% (YoY) in Apr17. Externally, there is little urgency for the BNM to hike rates especially if the headwinds from a stronger USD have faded and risk appetite has improved. Through the ongoing Fed hike cycle, we suspect that MGS yields will rise by a smaller magnitude than UST yields.

38

Economics–Markets–Strategy

THgov Curve - 2Y/10Y Segment bps 150 125 100 75 50 25

2Y/10Y Spread

0 Jul-15

Jan-16

Jul-16

Jan-17

• 10Y THgov yields are now at a modest premium over 10Y UST yields • We expect 2Y and 10Y Thailand government bond yields to reach 1.60% and 3.00% respectively by mid-2018

3Y, 5Y & 10Y MYgov Yield %pa 4.50 4.25 4.00 3.75 3.50 3.25 3.00 2.75

10Y MYgov Yield 5Y MYgov Yield 3Y MYgov Yield

2.50 Jan-15

Jul-15

Jan-16

Jul-16

Jan-17

• There is still room for MYR interest rates to outperform their peers • We expect 3Y and 10Y Malaysian government securities yields to reach 3.40% and 4.20% respectively by mid-2018

Economics–Markets–Strategy

Indonesia – moderating returns IDgov yields have been grinding lower, but the downside from current levels may be limited. Over the past few weeks, 2Y IDgov yields could not break below 6.5% convincingly. Similarly, 10Y IDgov yields have gone sideways after they dipped below 7.0%. Notably, IDgov yields reacted little to the S&P rating upgrade. We continue to argue that the yield spreads of IDgov bonds over comparable USTs are already tight by historical standards. This is more apparent in USD-denominated 10Y IDgov bonds where the yield spread over 10Y UST has compressed by about 150bps since early 2016. With yield spreads already tight, the pass-through from UST yields to IDgov yields becomes significant. In the near term, the outlook is balanced. The market has pared down US inflation expectations, drove the USD down and kept UST yields low. Against this carry backdrop, IDgov bonds should still perform well from a total return perspective. While further yield decreases in IDgov bonds appear constrained, returns from the carry component (higher IDgov yields compared to UST yields) is still fairly attractive. Going forward, total returns are likely to be moderate compared to the first five months of the year.

Philippines – external support The Philippine economy is displaying early signs of overheating. GDP growth has been running at close 7% YoY for the past year. Headline CPI inflation has been above 3% YoY since Feb17, up from sub-2% levels a year ago. Investment growth is very strong; gross fixed capital formation expanded more than 20% YoY in 2016. Hence, there is a case for the central bank (BSP) to tighten monetary policy in the coming months. The BSP has, however, refrained from lifting the policy rate. PHP market interest rates have responded by drifting higher over the past year, in contrast to flat to lower rates in many other Asian economies. The 3M PHP interbank rate has, from its low in October, risen 155bps to 2.75%, broadly tracking the higher 1M term deposit rate. Clearly, PHgov bonds have underperformed their Asian peers over the past few months. The carry environment has, so far, helped to contain the upside in PHgov yields. Even so, there is a need to guard against complacency. PHgov yields can become more volatile when monetary policy starts to address overheating risks.

Yield

10Y IDgov Yield spread over 10Y UST Yield bps 800 700

10Y average 600 500 400 300 200 Aug-10

Aug-12

Aug-14

Aug-16

• IDgov bonds is attractive from a total return perspective in this carry environment • We expect 2Y and 10Y Indonesian government bond yields to reach 6.80% and 7.50% respectively by mid-2018

Short-term PHP Rates %pa 5.00

1M Term Deposit

4.50 4.00

2Y PHgov

3.50 3.00 2.50 2.00 1.50

3M Interbank Ref

1.00 Jun-16

Sep-16

Dec-16

Mar-17

• The prospect of monetary tightening and a weakening current account balance point to higher PHP interest rates • We expect 2Y and 10Y Philippine government bond yields to reach 4.25% and 5.50% respectively by mid-2018

39

Yield

India – flat The 2Y/10Y segment of the INgov curve is now flattish at 15bps. The room for further outperformance in longer-term bonds is now limited. This flattening can be attributed to two key reasons. Firstly, the significant fall in long-term UST yields since the start of the year has dragged down Asia government bond yields (including INgov bonds) accordingly. Secondly, the market is reassessing India’s growth/inflation outlook. 1Q GDP growth was 6.1% (YoY), well below the 7% consensus. Headline inflation is back below 3% (YoY) in April, and this has nudged down inflation expectations. By contrast, shorter-term yields are likely to be stable with limited downside. After the Reserve Bank of India (RBI) hiked the reverse repo rate by 25bps to 6% at its meeting in April, expectations for more hikes were dampened by the recent disappointing data.

Economics–Markets–Strategy

INgov Curve - 2Y/10Y Segment bps 300

2Y/10Y Spread

250 200 150 100 50 0 -50 -100 Jan-05

Jan-10

Jan-15

Comparatively, longer-term INgov yields may be more susceptible to changes in the global inflation outlook and rising USD interest rates. From a riskto-reward perspective, the additional yield pick up for longer-tenor INgov bonds is unattractive.

• The demonetization spillover unto INgov bonds has run its course

China – liquidity squeeze

3M Shibor & 7D Repo Rate

There are significant distortions across the different CNY curves. This was brought about as the authorities tolerated a liquidity squeeze that pushed the 7D repo and the 3M Shibor sharply higher over the past few months. In turn, this had a significant spillover unto the front of the CNY swap curve (1Y5Y). Longer-term CNY swap rates and CNgov yields also rose over the same period. With headline CPI inflation still very low (1.2% YoY in April) and PPI numbers starting to moderate, we suspect that upside to CNY interest rates from current levels may be limited. Tight liquidity conditions have led to an inversion in the 5Y/10Y segment of the CNgov curve. This is unlikely to be sustained. The 7D repo is already drifting lower and this should be positive for shortterm CNgov bonds. A normalization in the CNgov curve is likely in the coming weeks. In relative value terms, we think 10Y CNY swaps are very attractive compared to 10Y CNgov bonds. The 10Y swap spread close to 75bps, very wide by historical standards. We see scope for the spread to narrow significantly in the coming months.

40

• We expect 2Y and 10Y Indian government bond yields to reach 6.75% and 7.00% respectively by mid-2018

%pa 5.50

7D Repo Rate

5.00 4.50 4.00 3.50

3M Shibor

3.00 2.50 2.00 Jan-16

Apr-16

Jul-16

Oct-16

Jan-17

Apr-17

• With signs of the economy stabilizing, the authorities are tolerating slightly higher shortterm rates • We expect 2Y and 10Y Chinese government bond yields to touch 3.30% and 3.75% respectively by mid-2018

Economics–Markets–Strategy

Yield

Sources All data are sourced from Bloomberg and CEIC. Transformations and forecasts from DBS Group Research.

41

CNH

Economics–Markets–Strategy

CNH: tightening the grip • New fixing mechanism institutes more control over the exchange rate • Capital outflows are better deterred when exogenous shocks hit • Prolonging capital controls is not without costs

China taught yuan bears a tough lesson, again Offshore yuan strengthened to a seven-month high of 6.73 on 1 Jun, breaking months of calm against the US dollar. There were early signals. Chinese banks were seen selling dollars in the offshore and onshore markets since the last week of May. The People’s Bank of China (PBoC) consistently set stronger reference rates (or known as fixing rate/central parity rate) during the period. Adding to the momentum is the jump in yuan funding cost offshore. For example, overnight CNH HIBOR spiked to 43% (vs normal 1-2% levels; Chart 1) on 1 Jun. The high interbank rates squeezed speculators by driving up the cost of short positions. PBoC’s intervention resembled to moves taken in Jan 17 and Jan 16 to fend off speculators in one-way bearish bets. The strength in yuan was also supported by China’s rule-change proposals around the yuan’s daily fixing rate. The China Foreign Exchange Trade System (CFETS) announced the inclusion of a “counter-cyclical adjustment factor” to the closing rate and to the basket of currencies for forming the yuan’s daily reference rate. The aim was to reorientate speculative herding behavior in the forex market to follow longer term economic fundamentals. Indeed, the daily fixing rate failed to strengthen in spite of the US dollar’s weakness and a resurgent domestic economic activities in Jan-Apr. This was exactly the lingering yuan depreciation expectation that the new model was designed to tackle.

Limited room for further monetary tightening Many argued the latest move was a swift response to deter the potential negative impact on the CNY due to Moody’s sovereign downgrade. We, however, believed that the rationale was more far-reaching. The new component weakens the signifiChart 1: Overnight CNH HIBOR %

70 60 50 40

OFFSHORE CNH

30 20 10 0 Jan-16

May-16

Sep-16

Nathan Chow • (852) 3668 5693 • [email protected]

42

Jan-17

May-17

Economics–Markets–Strategy

CNH

Chart 2: PBoC interest rate corridor % 3.8 3.6

Standing lending facility, 7D

5Y government bond yield

7D repo rate (20D mov. Avg.)

PBoC 7D reverse repo

Jun-16

Dec-16

3.4 3.2 3.0 2.8 2.6 2.4 2.2 Apr-16

Aug-16

Oct-16

Feb-17

Apr-17

Jun-17

cance of the daily closing price against the dollar in the central parity calculation. It can therefore be seen as a preemptive step to ward off potential capital outflows resulting from the Fed’s impending rate hikes. The yuan’s 6.5% slide in 16 created a vicious circle of capital exodus and bets on further currency weakness. That prompted forex reserves to fall by USD 320bn alongside tighter capital controls. The new fixing mechanism is a cheaper way to stabilize the yuan. The ambiguous nature of the design makes it resilient against speculative attacks.

New fixing mechanism is a cheaper way to stabilize the yuan

As far as timing is concerned, tweaking the formula now signifies limited room for further monetary tightening. In a bid to ease the yuan depreciation pressure, PBoC has been guiding market rates higher over the past few months via targeted instruments such as standing lending facility (SLF) and medium-term lending facility (MLF) (Chart 2). China’s banking, insurance, and securities regulators have also made collective efforts to rein in financial speculation and leverage. The combination of these actions erased more than USD 300bn off the value of the stock market and sent bond yields to their highest levels in nearly two years. Meanwhile, signs are emerging that the tightening moves are starting to impact the real economy. The growth of industrial output, fixed asset investment (FAI), and retail sales all retreated in April. The Caixin manufacturing PMI for May contracted for the first time in 11 months. The slowdown indicated that the window for tightening may be narrowing. Diminished scope for higher interest rates will subsequently add pressure for yuan weakness and capital outflows.

There is a cost to prolonged capital controls Although capital controls are effective in stemming outflows, they damage crossborder activities. Payments for goods and services in yuan have already suffered. Yuan trade settlement in Apr17 accounted for only 15.2% of China’s total goods traded, down from 30% in early 2016 (Chart 3). The yuan’s share of global payments have also dropped to 1.6%, compared to a high of 2.79% in Aug15.

Capital controls damaged crossborder activities

Furthermore, tight restrictions on forex conversion and repatriation put the regulators in an awkward position ahead of key events. These include the upcoming launch of the Bond Connect Scheme and a possible A-share inclusion in the MSCI global benchmark. Strict capital controls are also delaying One Belt and One Road (OBOR) project approvals. It is reported that mainland private companies currently need at least 3-6 months to acquire approval for outward direct investments. More documentations are required for proof. Such phenomenon contradicts with China’s ambitious OBOR initiative. The existing capital controls have to be loosened somewhat over time.

43

CNH

Economics–Markets–Strategy

Maintaining stability has gained prominence Interventions spook overseas investors

The Chinese government has repeatedly emphasized the wide availability of policy options to defend the currency. Yet it always comes at a price. In particular, liquidity squeezes deter overseas investors from using derivatives in offshore markets as hedging tools for their RMB-denominated bond investments. That largely explains the 65% YoY drop in dim sum bond issuance YTD, after a 68% fall in 16. Meanwhile, the introduction of the new “counter-cyclical factor” undermines Beijing’s efforts to achieve a genuine free floating forex regime. In the lead up to the nation’s once-every-five-years leadership reshuffle, the pursuit of stability prioritizes over everything.

Chart 3: Yuan cross-border trade settlement RMB bn

%

900

Trade volume

40

800

% of China's total trade (rhs)

35

700 600 500 400 300

30 25 20 15

200

10

100

5

0 0 Apr-12 Oct-12 Apr-13 Oct-13 Apr-14 Oct-14 Apr-15 Oct-15 Apr-16 Oct-16 Apr-17

Sources All data are sourced from CEIC Data, Bloomberg, Indian government agencies, RBI and press reports. Transformations and forecasts are DBS Group Research.

44

Economics–Markets–Strategy

CNH

This page is intentionally left blank

45

Asian Equity Strategy

Economics–Markets–Strategy

Asia equity: calculating the risks • Growth moderation in process but end of cycle not in sight; Investors should stay invested and rotate to potential growth pockets and bright spots • Selective in ASEAN markets — Overweight Philippines, downgrade Singapore to Neutral and Thailand to Underweight • Earnings recovery bodes well for Korea but it is in the price for Taiwan; raise Korea to Neutral • More upside potential for China / Hong Kong stocks driven by the new millenials — reiterate Overweight

There is no doubt that the global economy continues to strengthen. In Asia, the US, Europe and Japan, and virtually all the cyclical data – trade, industrial production, consumption – are showing a pick up. Sentiment, however, is poor as these are lagging data, and given that we had just recovered from one of the worst financial years in 2016. Valuations, like sentiments, have yet to be exuberant, and investors are still anticipating more good news down the road. We reckon that growth is likely to have peaked in Q1, and on year-on-year terms, growth would probably start to fall sharply in fourth quarter 2017. We believe valuations still have some room to rise, but investors will have to be selective, taking into account varying growth prospects. We are maintaining our Overweight calls on China / Hong Kong, Philippines, and upgrading Korea to Neutral. The downgrades this quarter include Thailand (Neutral to Underweight), and Singapore (Overweight to Neutral). Taiwan, India and Malaysia are maintained at Underweight. Indonesia is a Neutral. IMF World GDP growth forecasts vs MSCI AC World Index performance % 7

% GDP growth (L)

MSCI AC World avg perf (R)

6

30 20

5 10

4 3

0

2

-10

ASIA EQUITY

1 -20

0 -1

90

92

94

96

98

00

02

04

06

08

10

12

Source: IMF, Bloomberg, Datastream, DBS

Joanne Goh • (65) 6878 5233 • [email protected]

46

14

16

18

20

-30

Economics–Markets–Strategy

Asian Equity Strategy

Concurrents Year to date (YTD) to June 6th, the MSCI Asia ex-Japan had gained 18%, recording one of the best performances over a six-month period since 2011. Seven of the 10 MSCI Asia ex-Japan markets achieved new all-time closing highs in May. The market uptrend has been fairly smooth despite global macro headwinds. Significant rotational shifts among markets were seen, with Korea’s performance catching up after the presidential elections, and Singapore turned out to be one of the worst performers in Q2TD after a stellar performance in Q1. ASEAN markets, including Indonesia, Malaysia and Thailand, were laggards, but the former two still managed to chalk up gains of 8%. Thailand has deeply underperformed YTD, but is not too far away from its all-time high. In assessing these concurrents, we take a step back and revisit our assumptions made earlier in the year. Global recovery has been on track, and many exporters in the region had in fact surprised on the upside. DBS’ chief economist believes the trend remains intact, but growth is likely to moderate going forward for both structural and cyclical reasons.

(For details, see DBS Economics—Markets—Strategy 3Q17: “On sentiment vs reality, cycles vs structures and 60-year track records”, David Carbon, 8Jun).

Calculating the risks Recovery could have peaked DBS’ economists have cautioned that the recovery could be as good as it can get for countries such as Taiwan and Singapore. Uncertainties lie ahead with the reception towards the launch of the new iPhone in Taiwan, and in Singapore, base effects should see growth declining by 4Q. Since these two countries have performed well YTD, we are keeping Taiwan as Underweight, and reduce Singapore to Neutral. Slower rise in USD and bond yields Currencies had interesting moves in the first half. US dollar index (DXY) sank to their lowest level in seven months to 96.715, a far cry from the consensus bullish view on the USD earlier in the year. The euro benefitted from the dollar weakness, climbing 7% to $1.125, after gaining assurance upon the French elections that the new president would be helpful in strengthening the EU bond. The Japanese yen swayed between 108 and 118 at the mercy of changing risk appetite. The US treasuries 10-year yield has declined by 27 basis points from the beginning of the year to 2.18%, and forecast are now less hawkish than earlier in the year. DBS’ economist is now forecasting 10-year yields at 2.6% against an earlier forecast of 3.25%. Despite the global recovery, and US Fed hikes, inflationary expectations remain low as consumer demand has lagged. ASEAN markets, as well as the REITS sector managed to hold on to gains and still have some upside due to the weaker than expected USD and bond yields. However, they still underperformed the exporting countries and cyclical sectors. We believe they can still hold on to their gains with the current USD and yield outlook. Markets and stocks (in the case of REITS) which have specific catalysts should outperform. The Philippines is our Overweight market among ASEAN countries while we downgraded Thailand to Underweight. We continue be be selective on REITS. Bellwether US stock index recorded 18 new all time highs this year One of the main themes we have for this year is that we believe the US market is likely to continue to do well while Asia markets, which have a high correlation with the US, will be lifted by the rising tide. Indeed, YTD-June 2, the S&P500 has recorded 18 new all-time closing highs.

47

Asian Equity Strategy

Economics–Markets–Strategy

We are sticking with this assumption, as growth expectations, valuations and risk appetite for the US market have yet to become excessively optimistic to design a market crash. Fearing the unknown, potential black swans such as Trump’s impeachment, escalating Middle-East crisis, rising terrorism threats, faster than anticipated Fed hikes, sharper China slowdown, China political upheaval — just to name a few — could reduce risk appetite in the near term. With most technical indicators showing an overbought situation, and the frequent market sell-offs in the past two years. We believe it pays to be cautious and investors should take calculated risks in their investments. Watch out for earnings risk in the US In the very near term, we cannot ignore earnings risks for US Banks and Energy sectors in the coming quarter result season. Wall street Banks had warned of sluggish second quarter trading revenue. Flattening yield curves have also pressured banks on concerns of less profitable lending. Energy stocks could struggle as oil prices remain volatile, and the outlook is not bright. We believe the Tech sector should post good results but this could already be in the price after the strong YTD performance. Consolidation risk in Asia markets are thus high from this perspective as re-rating comes to a halt.

More important to watch China China is now at the peak of the fifth cycle from 2001 and there is still downward pressure on the economy for the rest of 2017 with an estimated GDP growth of 6.5% in 2017 and 6.3% in 2018 (DBS forecasts). Recent data shows manufacturing PMI falling unexpectedly to 49.6, a seven-month low in May, while the services PMI rose to 52.8. Growth in investment rose in April at 8.9% while retail sales grew at 10.7% y-o-y. Infrastructure investment is the solid support for the economy in 2017. It needs bank credit to grow however. Of late, PBOC, CBRC and CSRC (People’s Bank of China, China Banking Regulatory Commission, China Securities Regulatory Commission) have been strengthening controls over its RMB 49.4 trillion shadow banking. The central bank has also tightened liquidity in the financial system, sparking angst earlier this year. Moody‘s Investor’s Service downgraded China’s sovereign debt rating by one notch in May, but raised the future outlook to stable. Financial reform is a highlight of the government’s structural reform program. Its transition to a consumer and services based economy is well underway. The challenge of completing this transition will result in gradually slower growth rates and increased volatility but the risks of a hard landing or outbreak of systemic financial risk is low, in our view.

Buy on weakness The general global macro trends of weak USD and low bond yields have worked well for Asia markets so far. We reckon that if nothing specifically goes wrong on the domestic side in the Asia markets, and the US market doesn’t encounter any major shocks, Asia’s outperformance should continue. As the end of the economic cycle is also not in sight, we would recommend buying on market corrections.

48

Economics–Markets–Strategy

Asian Equity Strategy

Asset allocation Asia markets led the US market again in 2Q17-to date, led by Korea, the Philippines, China / Hong Kong and India. We believe short covering on investors’ Underweight positions was at work in driving Korea and China. Both are also the two cheapest markets in Asia. Investor positions are now Neutral in both markets. Investors chasing for growth would have turned their attention to both the Philippines and India, which are the strongest economic growth markets. Valuations do not matter in this case. According to EPFR data as of end-April, Asia ex-Japan funds remain significantly Overweight in Philippines, and Underweight in Malaysia. Looking at sectors, they are also Overweight in Consumer and Healthcare and Underweight Utilities. We expect to see modest improvements in global economic growth providing good backdrop for pockets of growth opportunities. Judging from investors’ positioning, valuations do not matter. We look at some key downside risks for markets in view of high valuations in some markets, and overbought technical signals displayed in some key markets. 1. Indices and valuations Most markets have hit new highs which begs the question what lies next? The JCI, KOSPI, TWI, and Sensex had hit new highs in May and other emerging ASEAN markets are trading at less than 10% away from their all-time highs in terms of valuations. Using data from 2010, which is after the global financial crisis, there still remains 1-15% upside for Asia markets if 12-month forward PE valuations were to hit their recent highs. We believe China ‘H’ share is an outlier, in predicting up to 60% potential return. 2. Risk in Underweight Malaysia Thoughts on Malaysia surround the elections and potentially how much further flows it can bring on, and if it can truly outperform the region. Empirical evidence from the past nine elections suggests that the market does not necessarily outperform in an elections year. In the past 9 elections, the market outperformed the Asia region meaningfully 6 months before the elections only once, and outperformed the Asia region six months after the elections only 3 times. These episodes also occurred only when Asia had negative years correspondingly, which is reflective of Malaysia’s defensive attributes. We hence are not too concerned on the risk to our Underweight Malaysia recommendation because of the election effect. With foreign ownership already high for some of the favourite foreign names, such as construction stocks, we remain skeptical that foreign investors would chase the election rally. Meanwhile, domestic investors’ appetite is low, as suggested by the participation level of locals in the market. Investors which are positive on Malaysia’s elections should just load up on Malaysian Banks. 3. Are Thai valuations expensive or cheap? Thai market’s valuations are polarized by sectors which make it look inexpensive on an absolute basis. Banks and Energy sectors, both account for a combined 45% of MSCI Thailand, trade at under 11x, thus making the overall market look cheap. On a historical basis, Thailand trade at more than one SD from the mean valuation. Hence, we take a stock specific strategy on mid- small caps for Thailand. We like the Banks for its cheaper valuations but investors may have to wait for signs that nonperforming loans (NPLs) have peaked before a re-rating can occur. The volatility on oil price makes investing in the Energy sector a challenging task. Other sectors are expensive from both absolute and historical basis.

49

Asian Equity Strategy

Economics–Markets–Strategy

We are reducing Thailand to Underweight as we believe stock picking opportunities are abundant in the small and mid-caps space but the key index is unlikely to move significantly higher due to the weak outlook for the Banks and upside on oil price being capped. 4. What’s next for Indonesia after S&P upgrade? Investors looking for an S&P upgrade in Indonesia got what they wanted in May. As expected, the market has priced in the S&P upgrade — bond yields hardly moved and that the stock market took a breather after the upgrade. We believe the market has to deliver growth before a re-rating can occur. The Indonesian government has set a GDP growth target of 5.3% for this year and 5.4%6.1% next year. Looking at the details on the underlying assumptions especially on tax collection, DBS economist believes they seem overly optimistic. The strategist holds the view that based on political considerations, the incumbent president will have to boost growth in order to stay competitive in the next election. A stronger fiscal and external balance sheet as well as an investment grade rating should entice foreign investors to re-look at the market. Meanwhile consensus earnings growth will drop to 13% next year from 18% this year. Without the base effect, 13% seems like a decent growth number. We are keeping Indonesia as Neutral. 5. Where is the global recovery? There is no doubt that the global economy continues to strengthen. In Asia, the US, Europe and Japan, virtually all the cyclical data – trade, industrial production, consumption – show a pick up. Yet a feeling persists among many that ‘sentiment’ may have gotten ahead of itself – that the hard data does not portray the recovery that others are feeling on the ground. Meanwhile in Asia, especially in ASEAN countries, as there wasn’t a “bad” year like the more cyclical markets, things suddenly look a lot worse for them as “growth has stalled”. The survey on sentiment in Asia is also mixed and does not gel with growth numbers. Our sense is that people do not look at hard data anymore and refuse to believe in them, due to the poor sentiment as we had just come off from a very turbulent financial world in 2016. According to IMF data, 2016 was the worst year in terms of global growth since 2010. And sentiment, as usual, is lagging the hard data. On balance we are maintaining our Overweight calls on China / Hong Kong, Philippines, and upgrading Korea to Neutral. The downgrades this quarter include Thailand (Neutral to Underweight), and Singapore (Overweight to Neutral). Taiwan, India and Malaysia are maintained at Underweight.

China/Hong Kong — Strong drivers intact (Overweight) We reiterate Hong Kong / China as our key overweight market this year. While the market is showing a technical overbought signal, the market should resume on its uptrend after some consolidation. We raise our year-end Hang Seng Index (HSI) target to 27,380, while maintaining the H-shares Index (HSCEI) target at 11,600. China should be able to achieve a more balanced economic model in 2017 with its GDP growth target of 6.5%, driven by sustained domestic spending and the rising services sector. Following 1Q17’s strong growth dynamics, growth momentum had softened at the outset of 2Q17, with weaker internal demand and manufacturing activity but with infrastructure, housing and real estate sectors remaining resilient. The recently launched “One Belt One Road” initiative to build a new Silk Road under President Xi Jinping’s vision is the cornerstone of China’s international strategy of making US$1 trillion worth of infrastructure projects available to 60 countries.

50

Economics–Markets–Strategy

Asian Equity Strategy

Potential risks come from the North Korean threat and a more protectionist America. Drivers in place for Hong Kong listed Chinese stocks We believe the following drivers are still strongly in place for stocks listed in Hong Kong, noting that growth and financial stability will be the government’s top priority before the Communist Party Congress is held at the end of the year:1. The outlook for the equity market versus the other asset classes in China has improved by default. Real interest rates are currently close to zero, while there are still regulatory tightening measures imposed on property investments, wealth management products, and capital outflows. 2. Capital control measures should see Chinese domestic liquidity diverted to assessable offshore markets, such as Hong Kong. The potential inclusion of ETFs in the stock connect list makes MSCI China funds especially attractive as it includes US ADR stocks. 3. Confidence in the market should be better as regulators tread carefully to avoid creating too much of a shock to liquidity and credit creation which could present risks for the domestic stock and bond markets. A better way to participate in the equities market would be through stocks listed in Hong Kong which are deemed to be better managed companies with greater transparency as these stocks are also being sought after by international investors. 4. The financial balance sheet rebalancing, and de-regulation in domestic pension funds and insurance funds, should also see these funds preferring to invest in fundamentally strong stocks. 5. Recent macro data continues to point to stability in the economy which should lead to foreign investors having more confidence in its policies. Data from EPFR and MSCI that were compiled by FirstMetro Securities (our JV partner in the Philippines) points to Asia ex-Japan funds being Neutral in China and Underweight in Hong Kong on average as of April. The allure of cheaper valuations versus the rest of the region should continue to attract fund flows to Hong Kong Chinese stocks. 6. The outlook for China’s debt problems is now more stable, thanks to Moody’s. The on-going financial de-leveraging should not be seen as a process to eliminate debt but to grow debt at a slower pace and to rebalance the balance sheet, where there will be losers and winners in the process. More importantly, its debt burden should not be viewed as a financial crisis in the making. Technically overbought; short selling and hedging activities kicking in With the HSI trading close to its two-year high and levels reached in 2015 before the stock market crash, speculative and hedging activities have started to kick in. We argue that it is different this time round as 1) absence of Chinese margin traders; 2) risk appetite for emerging markets is still strong, driven by favourable global macro trends; 3) there are more quality growth, and new economy stocks represented in MSCI China; and 5) the underlying assumption is that the US market remains resilient. Still, it pays to be cautious and we expect profit taking to kick in. Key risks to watch in the near term are US Fed rate hikes, terrorism threats, escalating crisis in the Middle-East, and uncertainties on Trump policies. Furthermore, North Korea could weigh on investor sentiment which could create reasons to take profit. The MSCI review for ‘A’ share inclusion could be another “sell on news” event. Our recommendation is to accumulate MSCI China and HSI stocks on weakness. We recommend buying into new economy stocks with exposure to consumption and spending behaviour of the new tech-savvy millennials as China’s transition to a consumer and services based economy is well underway.

51

Asian Equity Strategy

Economics–Markets–Strategy

Singapore — Rebound to continue, but slower (Downgrade to Neutral) The market has been in a consolidation mode with only 2% gain since April, against 5% for the region. Nevertheless, the benchmark Straits Times Index (STI) breached its 20-month high in May at 3271. We believe there is still room for the index to rise further in the second half of the year. A synchronized global recovery that is currently underway, and a buoyant M&A corporate sector scene in Singapore, coupled with inexpensive valuation versus the region, provides an impetus for re-rating. We see the STI ending the year higher at 3400, which is 0.5SD above the average 12-month forward PE multiple. Strong inflows registered Portfolio flows have been strong in the first two quarters of this year. Net portfolio flows was at its strongest in 1Q17, and other commercial sources (EPFR and ETFs) registered further inflows in April and May. We believe Singapore’s attractiveness as a regional cyclical play should continue to attract investors’ interests following a dip in the business cycle during the last two years. Economy peaking but growth can be sustained DBS economist Irvin Seah notes that the Singapore economy could have peaked in 1Q17, but there are signs that the electronic cluster may get a second wind in 2H17 should business investment spending in the US start to pick up. Considering that Singapore is still heavily dependent on electronics exports, growth could be sustained till the third quarter. Moreover, the services sector should rebound as leading indicators such as bank loans are showing good momentum. DBS’ economist is maintaining his GDP growth forecast of 2.8% and 2.7% for 2017 and 2018 respectively. Downward revision in earnings Unfortunately, the 1Q17 results season saw a resumption of the downward earnings revision trend for stocks under our coverage. FY17F earnings were revised down 2.9% while FY18F earnings were cut by 1.5%. However, this was driven by companies in the commodity and oil related sectors, and airlines. Earnings uplifts were seen accordingly in the Technology and the REITS sectors, in line with the recovery. Broad macro trends positive for the market The index could be stuck in a tight range but specific sector catalysts should support an overall buoyant market sentiment. Visible broad macro trends specific to Singapore of strong SGD and low bond yields should sustain risk appetite. DBS sees USD/SGD ending the year at 1.39 (from 1.38 currently), and Singapore 10-year bond yields at 2.4% (from 2.1% currently). Technically overbought positions in the major markets like Hong Kong, Korea and India could see fund flows rotating to other markets, such as Singapore. Improving property sector sentiments Sentiment continues to be positive for property developers since the government relaxed part of the property regulations. Land-deprived Singapore developers have started land banking bid aggressively, having closed three en-bloc sales over the past month. Our property analyst thinks the Singapore government will respond by (i) raising the number of available land sites in the 2H17 government public land tender programme and/or (ii) raising the number of confirmed sites in the pipeline. We also expect office blocks to change hands potentially in the second half. With property companies pricing in a recovery in 2018, we believe these transactions are likely to fetch higher prices.

52

Economics–Markets–Strategy

Asian Equity Strategy

Regional growth plays Singapore, a gateway to ASEAN and regional exposure, houses many companies which are growing outside the region. These include regional Telco, Plantation, and Food & Beverage companies, which are likely to register stronger growth than the overall market. Tech recovery plays Ahead of a thriving semiconductor, smartphone and Internet of Things (IoT) endmarkets, we believe that the Information Technology sector still has room to run. We prefer tech companies with (1) strong earnings momentum, (2) turnaround plays with lower execution risk, or (3) potential M&A targets.

Indonesia — Complimented by S&P upgrade (Neutral) The Indonesia market, in-line with other emerging markets, is enjoying strong foreign inflows during this quarter-to-date. We believe that the market will continue to attract strong investor interest as the volatility in the market over the course of the past one year has fallen, despite two US Fed hikes in the past six months. This has been brought about by a stable rupiah and strong reserves accumulation which has helped to strengthen the external balance sheet and thus reduce the risks of capital outflow. Events such as the S&P upgrade and closure of ex-Jakarta governor Ahok’s blasphemy court case should shift investors’ attention back to growth. The ongoing economic reform should attract longer-term investors to this market, especially supported by S&P’s sovereign rating upgrade to investment grade. GDP growth around 5% is still good GDP growth slowed to around 5% in 1Q17, in view of the on-going economic reform. The government is hoping to achieve 5.3% this year and in the 5.4-6.1% range for 2018. While it seems optimistic to us (DBSf: 5.1% and 5.4% respectively), the presidential elections in 2019 could deliver stronger growth by way of pre-elections stimulus spending. Meanwhile, progress of investment projects especially those targeted for completion by the 2018 Asian Games should also start to accelerate. Still twin deficits but manageable One key positive so far this year is the current account (C/A) deficit at 1% of GDP in 1Q17. This is set to widen to 1.9% by year end as it was driven by the higher value of coal and crude palm oil (CPO) exports in 1Q17. Moderating commodity prices, and stronger growth in imports are the two suspects for a widening deficit. However, given that Indonesia’s investment-grade status is likely to spur FDI flows, external financing risks should remain manageable despite the widening C/A deficit. Tax revenue collection is crucial in supporting the government’s spending plan, given the strict adherence to the maximum 3% fiscal deficit rule, and higher GDP growth target. We suspect that tax collection may have been below target as capital expenditure only hit 80% of target. More efforts to boost tax revenues may be announced later this year, including possible changes to the current value-added tax (VAT) system. This could possibly hurt private consumption further, on top of the new regulation for the tax office being given access to account information from banks and other financial institutions. DBS economist sees inflation rising to 5% by 4Q17 as food inflation should have already bottomed this year. Any marked uptick in food inflation would easily push CPI inflation higher going forward. Investors looking for rate cuts could be disappointed.

53

Asian Equity Strategy

Economics–Markets–Strategy

Earnings growth of 17% strongest among ASEAN Earnings for 2017 is forecast to grow by 17% after two years of flat CAGR earnings growth. Indonesia offers the highest corporate earnings growth outlook among ASEAN countries, primarily driven by the Banking and Commodities sectors. Earnings growth in 2018 is expected to slow down to 13%, but this is still good considering the absence of this year’s base effect, in our view. Macro profile has improved Improvement in macro profile has provided room for the index to trade higher. However, the challenge is on the main index and the individual top weighted stocks having hit new highs. We believe both earnings growth and re-rating could sustain the rally. Based on current PE valuations of 16x (+0.5SD), JCI could rise to 6700 by the end of 2018. Our year end forecast for JCI remains at 6000. Our focus is thus on the big caps which include Consumer stocks, and consumer demand proxies such as Banks and Telcos. The Commodity Sector should still continue to deliver strong earnings growth, driven by higher coal prices.

Malaysia — Potential upgrade, but upside still lags the region (Underweight) The Kuala Lumpur Composite Index (KLCI) was in a consolidation mode in 2Q17 with a rather flat performance despite continued net buying by foreign institutional investors (+USD1.17bn in 2Q-to date). Compared with regional markets, the KLCI has lagged the MSCI South East Asia Index which posted a gain of 3.0%, and primarily against Philippines Composite Index which gained 8.8% in 2Q so far. While gains in banking stocks helped to keep the market buoyant, losses in Telco and Healthcare stocks dragged the overall market performance. Potential upgrade by consensus An above expectation 1Q17 GDP growth of 5.6% was a pleasant surprise. This was driven by gross exports, private consumption and private investment, which support our view of improving earnings momentum going forward. AllianceDBS (DBS research JV partner in Malaysia) witnessed earnings upgrades over the course of the 1Q17 earnings season, and are projecting KLCI earnings growth of 9.1% in FY17 (vs 7.8% a month ago). This was largely driven by lower credit costs for banks while revenue drivers are also showing nascent signs of recovery. Consensus is projecting 4.4% GDP growth (by Consensus Economics Inc.) and 2.3% KLCI earnings growth (by IBES) vs our expectations of 5% and 9.1% respectively. Uncertainties still lie with weak consumer sentiment and rising inflation, which could be holding back the upgrades, especially for domestic-demand driven industries. The MIER Consumer Sentiment Index remains in contractionary territory for over two years. Corporates in the consumer, media, automotive, and telco sectors continue to face uncertain growth prospects as a result of weak consumption. Given the removal of fuel subsidy and rebound in crude oil price, headline inflation has risen in recent months. This will negatively impact consumer sentiment and consumption as well. Foreign sentiment has improved Foreign institutional investors continued to be net buyers, but this was met with selling by local institutions — a reflection of the weak domestic sentiment index. DBS economists note that the current interest rates in Malaysia are high relative to the outlook for its own inflation and US rate hikes, and hence should rise by a smaller magnitude than the US yields upong US Fed rate hikes. Bonds are thus attractive from this perspective if the yield carry environment continues.

54

Economics–Markets–Strategy

Asian Equity Strategy

KLCI target at 1800 provides little upside We maintain our end-2017 KLCI target at 1,800 which is derived using a bottom-up valuation approach. This implies a CY17 PE target of 16.7x. We are positive on the Banks which generally posted a better set of 1Q17 results. We believe that positive net interest margin (NIM) trends are sustainable, while capital markets momentum should also add to stronger fee income in the quarters ahead. Corporate actions in the banking space is also picking up.

Thailand — A small-mid caps play (Downgrade to Underweight) Broad macro trends still weak GDP growth came in at 3.3% (y-o-y) in 1Q17, in line with our forecast. We are on track to see full-year GDP growth at 3.4% but find it hard to get any more optimistic on the economy despite strong exports growth. This is due to the weak private sector demand growth and the lower contribution to growth from the manufacturing sector. Latest headline CPI inflation came in at -0.04% (YoY) which is back in the negative for the first time since Mar 2016. Core inflation has also slipped below 0.5%. The soft inflation figures suggest that there is hardly any improvement in underlying demand. 1Q17 earnings better than expected 1Q17 results generally beat market expectation. The companies under our coverage reported an aggregate net profit of Bt224m in 1Q17, beating market expectation by about 16%. 2017 earnings should thus continue to grow. Our current forecast of 5% is a tad conservative compared with consensus earnings growth of 9% for 2017. We believe the key difference lies mainly in the Banking and Energy sectors, due to differences in provisioning and oil price assumptions. Consensus growth estimates for MSCI Thailand is also around 6%, dragged down mainly by Banks. Opportunity to accumulate small- and mid-cap stocks The weak macro outlook versus the region has deterred foreign inflows, with Thailand seeing only 10% of 2016 inflows, vs for example, Indonesia, which attracted double the flows in 2016. The SET index has underperformed the region greatly. With strong earnings growth among the small-mid caps stocks, we see this as an opportunity to accumulate stocks with strong fundamentals and good prospects. Five key themes could continue to support the market:- (i) Undervalued plays; ii) Strong export recovery; (iii) Strong cash flow generation; (iv) Strong growth outlook; and (v) High-yield plays. According to the statistics from the Ministry of commerce, total exports increased 8.5% y-o-y to US$16.9bn in April 2017. Growth came from both agricultural products (+11.9% y-o-y) and industrial products (+7.9% y-o-y), suggesting that exports have become more broad-based, thanks to the global recovery which is underway. Technicals are weak — downgrading the market to Underweight We believe the market has potential for more upside as it is a laggard in terms of performance, flows as well as valuation. Foreign flows could rotate to Thailand as long as the risk appetite for emerging markets remains. However, index technicals are weak according to RSI and momentum. We thus downgrade the market to Underweight until there are better signals.

55

Asian Equity Strategy

Economics–Markets–Strategy

Key indicators to watch are:1. Technical indicators such as MACD show that the trend is still down as the shorter term moving averages are still diverging away from the longer term moving averages, and there is no sign of it reversing with the RSI indicator. 2. Leading indicators to track on the macro front are capacity utilisation ratio and foreign direct investments (FDI). Capacity utilisation ratio remains very subdued. While FDI applications have shot up, actual utilisation remains slow. 3. Trading turnover has been very subdued and local investors have been selling. We need local investors to be more positive on the market. Our 12-month SET target index remains at 1650. This is based on an estimated 5% market EPS growth in 2017 and 15.7x 2017 PE (based on +0.5SD of its historical average).

Philippines — 2017 GDP growth still strong at 6.4% (Overweight) Although 1Q GDP growth was slightly disappointing at 6.4% (YoY) in 1Q17, it was the 8th consecutive quarter in which growth has exceeded 6%. Post elections’ normalisation has started to kick in and we expect growth in 2017 to be around 6.4%, after a strong 6.9% in 2016. While growth is unlikely to surprise on the upside, progress from tax reform, infrastructure spending, and a potential delay in interest rate hikes should keep sentiment positive in the market. We expect the country’s economic fundamentals to remain strong, with infrastructure at the forefront of growth. With all eyes now set on the Philippines and how it is progressing under the Duterte’s administration, it is timely to look at potential growth pockets and bright spots that investors can delve into given the country’s infra-driven economy. Investments make up about 28-30% of GDP currently, up from about 20-22% average in the preceding 5-year period. Outperformance should continue We have upgraded Philippines to Overweight in the middle of the quarter in our ASEAN strategy (see “Better prospects ahead”, 9 May, Joanne Goh). Flows into Philippines were negative in 1Q, but have started to pick up in 2Q, in line with the rest of the emerging markets. We believe Philippines should outperform the rest of the emerging markets as the following strong drivers remain intact:1. Save for some delays, infrastructure spending should lift the economic growth in Philippines in the longer run. Conglomerates generally remain bullish on the Philippine infra story despite setbacks on the government’s pace of public– private partnership (PPP) project roll-outs 2. With GDP growth running at 6.4%, it is one of the highest in the region and among emerging markets, and will likely remain the fastest growing ASEAN economy over the next few years 3. Political risks should be less of a focus now as economic reforms have been rolled out. All eyes are on the new Duterte’s administration, which has received lesser negative bad press after Trump becomes US president for obvious reasons 4. External balance risk is generally reflected in the currency which has depreciated against the region YTD. But there are no reasons to be worried about with the peso’s weakness as investors come to realise the strength in imports growth, especially capital goods for investment needs; still strong overseas workers’ remittances; and strong forex reserves should bode well for growth later on. The peso is deemed attractive at current levels. DBS forecasts USD/PHP at 50.4 (from 49.4 currently) by year end.

56

Economics–Markets–Strategy

Asian Equity Strategy

Demographic dividends strongest in Philippines Among Asian countries, together with India and Indonesia, Philippines will continue to experience steady-to-rising population growth for the next 25 years. This means Philippines should still be able to reap the benefits of favourable demographics in the next 25 years. Investments facilitated by a strong workforce, and better education levels in the case of Philippines, and strong consumption potential will naturally attract investments into Philippines. Philippines has now overtaken India as the largest business processing outsourcing (BPO) centre. From this point of view, Philippines should continue to be attractive to Emerging Market funds looking for superior growth and to participate in the demographics story from a top down macro perspective. Valuations are stretched but they have yet to reach an all-time high before a re-assessment of re-rating potential is needed. Therefore, foreign fund flows should continue to pick up, given that they had ignored the market since the middle of 2016. Infrastructure plays in focus We look into the direct infra players as well as the indirect recipients. We like Banks, which could take advantage of the infra-driven loan growth, and Retail and Property developers, which we see benefiting from increased economic activity, and rise in property values. Key infra players in the private sector have opted to be more proactive by submitting their own project proposals. The new administration is still unfamiliar with the PPP and approval procedures, and it will take time to process all the infrastructure funds from different governments, multilateral funding sources, and even the private sector. We also see upside for Banks should the infra story materialise. We see loan growth in the mid to high teens with incremental gains from infra-related credit demand should the government’s infrastructure development plans materialise. Infra-related loans should be positive for banks given their size and possibly high yield due to the long-term maturity profiles. Big, well-capitalised banks are primary beneficiaries of the country’s infra push. Cebu-based property and retail operators in Cebu City well poised to benefit. Cebu City is one of the key growth centers in the Vis-Min region as it continues to attract more investments from both the public and private sectors. The strong tourism and thriving BPO leasing sector is driving economic activity, and this should improve incomes of the local community, which translates into higher demand both for residential and office space take-ups, and consumer spending.

Korea — Earnings growth too high to ignore (Upgrade to Neutral) Optimism has reigned under the newly elected President in South Korea with the KOSPI setting an all-time high after a 6.4% rise in May. May alone has brought in close to US$2bil of foreign inflows against an inflow of US$5,678 in the first 4 months of this year. The optimism is also complemented by a better than expected 1Q GDP growth which rose to 4.3% (QoQ saar), up from 2.0% in 4Q16 and the highest over the past six quarters. The near term prospects are now looking better with the pick-up in exports which we believe is sustainable, recovery in sentiment which hopefully can translate to better private consumption and investment growth, as well as a proposed government supplementary budget which could boost GDP growth by 0.2ppt per annum in 2017 and 2018. DBS economist has raised GDP forecasts to 2.7% for 2017 and 2.8% for 2018, compared to the previous forecast of 2.5% in both years.

57

Asian Equity Strategy

Economics–Markets–Strategy

Exports on the recovery path In line with the rest of the region, external demand, led by the electronics sector had recovered strongly in Q1. This was also accompanied by a strong surge in gross fixed capital formation. Despite some signs of moderation in exports and investment in early-2Q, we believe the externally-driven recovery is sustainable as Korean companies are important suppliers of OLEDs, an important component which proliferates across the consumer electronics landscape. Meanwhile, the risk of trade protectionism from the US is easing. While Trump has requested to review the US-Korea free trade agreement, the focus seems to be to urge Korea to further open its domestic market to American goods/services, instead of restricting its exports to the US. This could however pose a risk to the domestic economy which is already weak fundamentally. Domestic economy hopeful but challenging It is hopeful that as political uncertainties fade and confidence recovers, together with the wealth effect from stock market rise, and the supplementary budget, could bring about a recovery in domestic demand. Our economist, however believes it remains challenging. The labour market has remained sluggish amid the on-going corporate restructuring; and the property market has begun to lose momentum as support from last year’s monetary easing starts to fade.

(For details, see DBS Economics—Markets—Strategy 3Q17: “KR: out of the tunnel”, Tieying Ma, 8Jun). Earnings growth strong at 45% The contribution of the Electronics sector to overall GDP and KOSPI cannot be ignored. The company Samsung Electronics alone, already makes up about 20% of GDP and 20% of KOSPI’s market cap. Earnings growth for the Industrial and IT sectors are forecast to grow in excess of 50% this year. We believe these are too big to ignore. KTB Investment & Securities’ analyst (DBS Research partner for Korea) has a price target of KRW2,700,000 for Samsung, representing another 17% upside. We calculate this to translate to about 5% potential upside to the KOSPI at 2500 by year end. Market re-rating may not happen MSCI Korea is trading at 9.3x PE which is below its historical average. We believe the optimism led by the new President may not lead to a market re-rating. Unsettling issues on the domestic and external fronts have been inherited by the new President which we believe bear impossible solutions. The P/E discount due to chaebols’ influence, North Korea, corporate governance and the lack of accounting transparency are all likely to stay. On the economy front, overhanging issues with China on THAAD, review of trade pact with US, and the on-going corporate restructuring will need immediate attention but these are unlikely to be resolved soon. Upgrading Korea to Neutral We believe Korea deserves a Neutral weighting despite the uncertainties ahead and growth pockets in the IT sector is attractive with >50% earnings growth. Investors should just Overweight this sector for outperformance.

Taiwan — 2H outlook still uncertain, but hopeful (Underweight) The economy has performed as expected at the start of this year, in line with the synchronized recovery seen in other parts of the region. In YoY terms, GDP growth slipped to 2.6% in 1Q17, down from the peak of 2.8% in 4Q16. On a QoQ (saar) basis, growth actually rose to 3.8% in 1Q17, notably higher than the 1.4% in 4Q16.

58

Economics–Markets–Strategy

Asian Equity Strategy

But some key indicators have surprised on the downside since the release of 1Q GDP. Export orders slowed more than expected in April and industrial production contracted. Risks have surfaced for 2Q GDP to miss the 2% (YoY) mark. Therefore, a resilient 2H rebound will be required to keep full year GDP above 2%. Exports should bounce back It remains possible that exports will bounce back. The slowdown in early-2Q came after two consecutive quarters of a strong surge, which could be seen as a temporary correction instead of the beginning of a downturn. Although exports growth dropped to 8.9% (YoY) in Apr-May from 15.9% in 1Q17 and 11.8% in 4Q16, it remained pretty much in line with the long-term trend. Hopeful for the second half Externally, the global economy remains on course for recovery, while the protectionism risks in US and political risks in Europe have abated. The electronics sector remains on a cyclical upturn. Industry news still suggest that Apple will release the much-awaited iPhone 8 this autumn. Its innovation elements should create new demand for electronics components, which bodes well for the Taiwanese firms highly involved in the iPhone supply chain. On the domestic front, if exports rebound, private machinery investment could also pick up on the back of a higher capacity utilisation ratio. Capital goods imports, a key indicator for machinery investment, continued to grow 7.6% in Apr-May, compared to 22.6% in 1Q. In addition, public investment may pick up towards the end of this year. The government unveiled a long-term infrastructure plan in March, proposing to spend TWD 890bn over the next eight years to promote transportation, water environment, green energy, digital infrastructures and urban-rural construction. This bill has been submitted to parliament for approval and is targeted to be implemented within this year. Assuming one half is fresh spending and the execution rate is 80%, this program will boost GDP growth by 0.2ppt per year in 2017-2024. Headwinds are likely to come from a renewed China slowdown and a strong TWD.

(For details, see DBS Economics—Markets—Strategy 3Q17: “TW: betting on the second half”, Tieying Ma, 8Jun). Valuations have room to trade up to average levels Meanwhile, the Taiwanese stock market gained 4.2% in Q2-to-date, after gaining 6% in Q1. The Taiwan market currently trades below its historical average. With the electronics sector set to register strong earnings growth of 55% in 2017, we believe there is still room for the Index to move higher. Prefer Korea to Taiwan Korea and Taiwan are both cyclically driven by the electronics recovery which is underway. We believe Korea could outperform Taiwan in the coming quarter due to the following reasons: 1. With optimism starting to kick in post elections in Korea, stock market activity could pick up with both increased local and foreign participation 2. Earnings growth is stronger in Korea 3. Taiwan holds more uncertainty as it is more deeply involved in the iPhone supply chain while Korea’s components are more prolific among consumer electronics products 4. Domestic demand in both countries are weak but winds of change favours Korea in the near term

59

Asian Equity Strategy

Economics–Markets–Strategy

India — risk reward unfavourable (Underweight) Growth momentum has lost steam in 1Q17 (final quarter of fiscal year 2016/17), pointing to a spillover impact from the December quarter’s banknote ban, when growth had proved surprisingly resilient. Real GDP eased to 6.1% YoY in 1Q17 from 7.0% a quarter before. Looking forward, the momentum is likely to be more positive in 2Q17, with on-track re-monetisation, normal monsoon, better wage growth, lower financing costs and fresh action to address the challenges in the banking sector. Growth may soften temporarily in 3Q17 yet again in the wake of GST implementation, but should return to trend growth late-year. Exuberance in the equity markets might be under check after weak investment growth trends. Market however remained supported as policy tightening expectations have been pared down after the weak April inflation reading. A rate cut would be positive for the market. Foreign inflows accelerated again in May Foreigners turned positive again in May after selling in April. This comes after the sweeping wins by Modi’s Bharatiya Janata Party (BJP), reaffirming that his coalition is likely to win again in the 2019 general elections to continue with its reform process with a strong mandate. From a fragile state in 2013, the coalition government led by Prime Minister Narendra Modi and his BJP party had reached its three-year milestone in May where it will achieve an estimated growth rate of 7.5% in 2017, which outstrips China for the second year running. Tough structural reforms like de-monetisation, the nationwide Goods and Services Tax, liberalisation of foreign direct investments, boost from a number of its large infrastructure projects and easing price pressures demonstrated strong will by the government for economic transformation and progress. India maintain at Underweight We believe consensus is too optimistic on earnings growth for the next two years. Earnings growth was downgraded from 19.0% to the current 15%, but still bears downside risk in our view. We maintain our index target range of 29000-32750, based on 12% earnings growth (equivalent to nominal GDP growth) for the next two years. The index should hover around 16x-18x with a valuation breakout unlikely in the near term. It is now trading at +1SD valuation band.

60

Economics–Markets–Strategy

Asian Equity Strategy

This page is intentionally left blank

61

China

Economics–Markets–Strategy

CN: the Beijing put • Real economy all set to slow further in 2H17 • Tightening of liquidity cannot last too long • OBOR influences orientation of domestic reforms

Equity markets worldwide disregarded Moody’s downgrade on China’s long-term local currency and foreign currency issuer ratings. The economic arguments behind the move are solid but repeated alerts have yet to consequentially translate into a financial crisis. Businesses have to move on. Market fears are short-lived. China is still very far from the Minsky moment because enterprises and banks are concurrently owned by the state. The phenomenon of ghost towns, proliferation of wealth management products, property market bubble, industrial overcapacity, and substantial loss of foreign reserves e.t.c. are direct results of contradictory economic goals levered by a constant flip flopping of macroeconomic policies. To the irony of this unbreakable vicious cycle, it has become easier to predict policy inflection points. Tightening domestic liquidity, as evidenced by rising credit costs, has been biting the real economy for a long while. As a result, it was unsurprising that the PMI fell to 49.6 in May17, below the 50 threshold for the first time since 3Q16. The decline was due to a faster deceleration of industrial output and new export orders. Under such circumstances, cash flow is negatively affected. This, in turn, will trigger price cutting. A new deflationary spiral at the producer level may have already begun. Net export started contributing to headline growth in 1Q17 after 6 quarters of declines. The RMB’s depreciation since Aug 2015 restored export competitiveness. Authorities, however, had halted weakening the RMB by tightening capital control measures since early 2017. The boost factor to exports is gone. Investment does not fare well either. State driven investment decelerated notably since Jul16. The marginal improvement of private investment is not potent enough to arrest the declining trend (Chart 2). Chart 1: Contribution to GDP growth (ppt, YTD) 10

Consumption

Gross Capital Formation

Net Export

8 6 4 2

CHINA

0 -2 Mar-13

Mar-14

Mar-15

Chris Leung • (852) 3668 5694 • [email protected]

62

Mar-16

Mar-17

Economics–Markets–Strategy

China

Chart 2: Fixed Assets Investment YTD YoY% 30

Private investment

State investment

25 20 15 10 5 0 Apr-12

Apr-13

Apr-14

Apr-15

Apr-16

Apr-17

The real economy is set to slow in 2H17 unless the course of tightening is reversed. China prioritizes economic growth over reform due to the enormous amount of leverage in the system. Executing supply side structural reforms will be slow given the complicated politics. When growth decelerates, the debt bomb starts ticking again. This structure perpetuates without extreme shocks hitherto.

Real economy is set to slow down further in 2H17

Keeping the “status quo” would decelerate per capita “disposable income” which already grew slower than headline GDP for the first time in 1Q17 (See Chart 3). The authorities’ reliance on ramping up property/land prices to buttress confidence has led to frantic property purchases and banks aggressively pushing for more mortgage loan businesses. As the mortgage burden on household increases, disposable income falls. It does not help that health/education costs have also been surging in recent years. Also, a braking in the growth momentum is usually followed by a relaxation of austerity measures in the property market. Price ascents often resume shortly. Obviously, the policy reverse when the opposite happens. Hence, the property bubble deflates when it is looks like it is about to explode. This pattern is deeply ingrained in households and investors as an invisible “Beijing put” that underpins long-term optimism in the property sector.

Property bubble always deflates when it is about to explode

As a result, many simply take comfort from the stability of headline GDP figure within a range, say, between 6% to 6.5%. After all, China is too gigantic a market to be ignored despite all the known risks. To all, what matters the most is Beijing’s strong commitment to bail out, regardless of all present economic ills, should that happen one day. Constant reminders of crisis only heighten the risk alertness but that neither changes the mindset nor the behavior, which are endogenously determined by the political institutions. In China, economic means are often used to justify political ends.

One Belt One Road History shows that China would only opt for external forces to advance domestic reforms if the deal favors Beijing. China’s accession to the World Trade Organisation (WTO) in 2001 was one prime example, as evidenced by the sharp rise of foreign reserves from only USD 166bn in 2000 to USD 1946bn in 2008. Authorities just needed to understand the rule-based trade system. The next step was to reap its economic benefits. Unlike the WTO deal, the financial payback from the One Belt One Road (OBOR) initiative may, based on optimistic project assumptions, take decades. Also, it is a

Financial rewards of OBOR may take decades to be paid off

63

China

Economics–Markets–Strategy

Chart 3: GDP vs disposable income growth % YoY 15

GDP

14

Disposable income per capita

13 12 11 10 9 8 7 6 Mar-14

Sep-14

Mar-15

Sep-15

Mar-16

Sep-16

Mar-17

novel concept integrating the goals of foreign policies with economic policies. The program drives state-owned enterprises (SOEs) to go global backed by state credit to advance foreign policy objectives by investing in infrastructure along the ancient silk road. If successful, this program concurrently exports Chinese-made goods (overcapacity), promotes RMB settlements, and proliferates Chinese engineering standards. This a model that involves a long term commitment to export capital (credit), labor and know-how of Chinese standard to rest of the world assuming participants are willing to accept them. It is also a complicated system involving the facilitation of long term investment in numerous countries with vast cultural and economic differences, notwithstanding pragmatic political aspirations. At present, the OBOR initiative is being driven by very strong political impetus to move forward. Indeed, the program has even hastened authorities to reform key SOEs by merging them to become industrial mammoths. More than USD 1trn in state-directed mergers have taken place since 2014 in OBOR related sectors such as railway, metals, mining and shipping. The next merging target is energy related sector, including nuclear energy.

Economic means are often used to justify political ends

Meanwhile, China is increasing the control of these newly merged SOEs by including Communist Party Committee members in the board of directors. They are encouraged to seek direction from the Party Committee Member before making major decisions. Many SOEs are also combining the role of company chairman and party secretary. These policies reflect a consolidation of political control over core industries. It is a key departure from the past emphasis over the separation of political control from the enterprise management. After all, the business calculus of justifying infrastructure investment in some poor countries along the silk road does not make economic sense. In this light, the foreign policies of China have already started influencing the orientation of domestic economic reforms. The implications are profound here.

Conclusions The rapid advance of the OBOR initiative observed recently represents another leapfrog in projecting political influences via economic means. The orientation of domestic SOE reform also changes in accord with the new paradigm – centralization of control. China is developing her own growth model premises on the axis of “statecraft”. As a result, behavior of economic parameters is difficult to be predicted based on conventional macroeconomic analytics. What is clearer is the strong political element in the decision making process; this was best reflected in the latest apprecia-

64

Economics–Markets–Strategy

China

tion of the RMB in response to the Moody’s downgrade. Capital controls cannot last forever given the rapid progression of the OBOR initiative. Likewise, domestic liquidity cannot be tightened further given the amount of leverage in the system. And the exchange rate cannot appreciate too long on the back of a weakening real economy. For the time being, it is difficult to beat the “impossible trinity”. The only way to rationalize all these contradictions is the invisible faith in the “Beijing Put”.

65

China

Economics–Markets–Strategy

China Economic Indicators 2016

2017f

2018f

1Q17

2Q17f

3Q17f

4Q17f

1Q18f

2Q18f

Real GDP growth GDP by expenditure: current price Private consumption Government consumption Urban FAI growth (ytd) Retail sales - consumer goods

6.7

6.5

6.3

6.9

6.6

6.4

6.3

6.3

6.3

8.8 10.0 8.1 10.4

8.6 10.0 8.5 10.4

8.4 10.0 7.9 10.0

8.7 10.0 9.2 10.9

8.6 10.0 8.5 10.5

8.5 10.0 8.3 10.2

8.4 10.0 8.0 10.0

8.3 10.0 7.9 10.0

8.3 10.0 7.9 10.0

External Exports (USD bn) - % YoY Imports (USD bn) - % YoY

2,098 -8 1,587 -6

2,152 3 1,674 5

2,200 2 1,700 2

483 8 417 24

540 4 402 3

564 2 420 1

565 -3 435 -3

490 2 420 1

550 2 415 3

511 210 1.9

478 230 2.0

500 235 2.0

66 n.a. n.a.

138 n.a. n.a.

144 n.a. n.a.

130 n.a. n.a.

70 n.a. n.a.

135 n.a. n.a.

3,010 126

3,000 136

2,800 140

3,009 34

3,020 33

3,010 34

3,000 35

3,000 36

2,950 34

2.0 0.8

2.0 1.4

2.1 1.0

1.4 1.1

2.0 1.3

2.3 1.5

2.3 1.5

2.1 1.2

2.2 1.2

22.7 12.0

15.1 10.4

12.0 12.0

18.2 11.0

16.0 10.5

14.0 10.0

12.0 10.0

12.0 10.0

12.0 10.0

n.a. n.a.

n.a. n.a.

n.a. n.a.

n.a. n.a.

n.a. n.a.

n.a. n.a.

Trade balance (USD bn) Current account balance (USD bn) % of GDP Foreign reserves (USD bn, eop) FDI inflow (USD bn) Inflation & money CPI inflation RPI inflation M1 growth M2 growth Other Nominal GDP (USD bn) Fiscal balance (% of GDP)

11,100 11,580 12,000 -3.0 -3.5 -3.5

* % change, year-on-year, unless otherwise specified

CN - nominal exchange rate

CN – policy rate

CNY per USD 7.2

%, 1-year lending rate 7.0

7.0

6.5

6.8

6.0

6.6

5.5

6.4

5.0

6.2 6.0 Jan-12

4.5

May-13

Sep-14

Jan-16

May-17

4.0 Jan-12

May-13

Sep-14

Jan-16

May-17

Sources for charts and tables are CEIC Data, Bloomberg and DBS Group Research (forecasts are transformations). 66

Economics–Markets–Strategy

China

This page is intentionally left blank

67

Hong Kong

Economics–Markets–Strategy

HK: a sea of madness • The economy surprised on the upside • Inbound tourism from China rebounded • Property price rises remained relentless

Annual GDP growth revised upward to 2.5% in 2017 Real GDP expanded 4.3% (YoY) in 1Q17 and beat the 3% consensus by a wide margin (Chart 1). The upside surprise was primarily driven by a 3.7% jump in private consumption, thanks to a strong stock market and elevated property prices. The 6.4% jump in gross domestic capital formation (investment) was spearheaded by a 9.6% jump in “expenditure on building and construction”. Investment expenditure on “machinery, equipment and intellectual property”, however, declined by 8.9%, worsening from a fall of 4.2% in 4Q16. External trade was also encouraging. Total exports and imports jumped 9.2% and 9.9% respectively in 1Q17, up significantly from 5.1% and 5.6% in 4Q16. CPI inflation remained broadly stable, advancing 0.5%, alongside a record-low unemployment rate of 3.3% (sa) in 1Q17. Even after assuming some moderation in 2H17, we have revised up our full-year GDP growth forecast to 2.5% from 2.0% previously.

Tourism turned around Tourist arrivals probably bottomed in 2016; the 4.5% decline was the worst since SARS in 2003. Visitor arrivals increased 8.8% YoY in Mar17. Arrivals from mainland China were higher at 10.4%, not far behind the 11.5% jump in the rest of Asia, namely from Japan and South Korea. Geopolitical and domestic political factors were partly behind the rebound. On the former, Sino-Korean relations deteriorated after Seoul agreed to host the THADD missile system. This led Chinese tourists to replace Korea with alternative destinations such as Hong Kong. On the latter, “anti-China” sentiment in HK has diminChart 1: HK GDP growth % YoY 6 5

4.3

4 3.1

3.4

3.1 3.1

3

HONG KONG

1

2.6

2.2

1.8

2

3.2

2.9 3.0

3.2

3.1 2.4

2.3

1.8 2.0

1.9 1.0

0.8 1.0

Chris Leung • (852) 3668 5694 • [email protected]

68

1Q17

4Q16

3Q16

2Q16

1Q16

4Q15

3Q15

2Q15

1Q15

4Q14

3Q14

2Q14

1Q14

4Q13

3Q13

2Q13

1Q13

4Q12

3Q12

2Q12

1Q12

0

Economics–Markets–Strategy

Hong Kong

ished two full years after the “Occupy Central Movement” in 2014. Furthermore, Chinese tourists enjoyed higher purchasing power in Hong Kong this year due to a stronger CNY and a weaker HKD this year. With these constructive factors intact, tourism is likely to remain healthy into 2H 2017.

Structural decline of the retail sector The recovery in tourism will help to cushion the struggling retail sector. While the sector continued to contract this year, the 1% decline was better than the 8.1% fall for the whole of 2016 but still below the peak seen in Aug 2014 (Chart 2). Having learnt the lesson of being too overly reliant on tourists, retailers have come to appreciate spending from locals. Except that locals are increasingly travelling overseas during their holidays. Chart 2: Retail sales

Tourism industry tremendously impacted local retail sectors

Retail sales value

% YoY, 3mma 25 20

Retail sales value

15 10 5 0 -5 -10 -15 Apr-12 Oct-12 Apr-13 Oct-13 Apr-14 Oct-14 Apr-15 Oct-15 Apr-16 Oct-16 Apr-17

Expect the number of departures (HK residents) to rise by 5% this year, at a similar pace seen in the past 5 years. Several factors are at play here. According to research done by MasterCard, Hong Kong has the second highest propensity to travel in the Asia Pacific. This did not come as a surprise. HK’s GDP per capita is 3rd highest in Asia. The ratio of outbound travel trips to the total number of households is at a staggering 222.3 in 2016 and is projected to exceed 270 in five years’ time.

Hardships to stay

One socioeconomic factor driving outbound traffic higher is high property prices. As properties becomes less affordable, local residents (mainly the young) prefer to spend during their travels abroad.

Extreme irrational exuberance While the shopping malls struggled to attract crowds, the property market periststently drew long queues. The property market frenzy is now driven entirely by locals who have lost confidence in the administrative measures to restore housing affordability. Having risen 2.1% MoM to 327.4 in Apr17, the monthly home price index has surpassed the two peaks in 2015 and 1997. Average property prices jumped for the 13th straight month and registered a record-high 20% YoY jump in Apr17 (Chart 3).

The property market frenzy is now driven by locals

Property developers face a similar madness. Aggressive bids at land auctions have led to new record prices. Mainland Chinese consortiums joined the party last year and ramped up valuation. In 2017, HK property developers returned to front row seats. For instance, the Lands Department awarded the office-retail-hotel site, named Area 1F Site 2 in the Kai Tak area, to a local property developer for HKD 24.6bn or almost USD 3.2bn. This price translates to HKD 12,863 per square foot, which is 7% higher than the top end of market expectations.

69

Hong Kong

Economics–Markets–Strategy

The property market is under the simultaneous pressure of “demand-pull” and “cost-push” inflation sustained by an extended period of low interest rate. This in turn substantiates the social psychology to chase properties even at high prices regardless of affordability. Property developers then jump on the bandwagon by providing mortgage financing to buyers, bypassing the governance of HKMA. This cycle is self-perpetuating for as long as pace of US rate hikes is measured. The situation prompted HKMA to introduce more measures to cool down the market. From 1 June, the caps for construction loans will be lowered to 40% of site value and 80% of construction cost, with the overall limit reduced to 50% of the expected value of completed properties. Such measures aim to constrain aggressive bidding for land. But most property developers are cash rich. As a result, only small property developers may be impacted by these regulations. The measures had not had much impact on the market. It is unclear how will the looming new supply of 96,000 units of residential flats (with a 4-year lag) would change the dynamics of demand and supply. Property developers are unlikely to bid aggressively now if they expect future supply to lower prices substantially. In retrospect, HK property prices were almost completely insulated from the subprime crisis in 2008, European sovereign debt crisis in 2012, various alerts of Fed tapering on QEs between 2012-14, the unexpected devaluation of the CNY in Aug 2015, and the start of US rate hikes from Dec 2015. The sea of madness observed from those long queues of property buyers may well be the new normal. We may not have a financial crisis in the near term but the next generation is likely to pay the price of this irrational exuberance.

Chart 3: Residential property prices (Rating and Valuation Dept) 1999=100 350

Policy measures have not made an impact in the market as yet

300 250 200

Class A (smallest size) Class B Class C Class D Class E (largest size)

150 100 50 Apr-99

70

Apr-01

Apr-03

Apr-05

Apr-07

Apr-09

Apr-11

Apr-13

Apr-15

Apr-17

Economics–Markets–Strategy

Hong Kong

Hong Kong Economic Indicators 2016

2017f

2018f

1Q17

Real output and demand GDP growth (14P) Private consumption Government consumption Investment (GDFCF) Exports of goods and services Imports of goods and services Net exports (HKD bn)

2Q17f 3Q17f 4Q17f 1Q18f 2Q18f

1.9 1.8 3.4 -0.3 0.9 1.2 44

2.5 2.4 3.3 3.9 5.1 5.4 39

2.1 1.9 3.1 1.0 1.5 1.6 25

4.3 3.7 3.7 6.4 8.0 8.7 6

2.1 2.0 3.2 4.0 5.0 5.2 7

1.9 1.8 3.2 3.0 4.2 4.5 10

1.8 1.9 3.2 2.0 3.0 3.2 16

2.1 2.0 3.1 1.0 3.0 3.0 4

2.0 1.9 3.1 1.5 3.0 3.2 4

External (nominal) Merch exports (USD bn) - % YoY Merch imports (USD bn) - % YoY Trade balance^ (USD bn)

460 -1 514 -1 -54

466 1 521 1 -55

475 2 520 0 -45

110 10 124 11 -14

116 4 132 6 -16

120 -1 130 -3 -10

120 -6 135 -6 -15

118 7 122 -2 -4

126 8 135 2 -9

Current acct balance (USD bn) % of GDP

14.8 4.4

10.8 3.1

11.0 3.1

-

-

-

-

-

-

Foreign reserves (USD bn, eop)

386

410

440

-

-

-

-

-

-

Inflation CPI inflation

2.4

2.0

2.5

0.6

2.3

2.5

2.6

2.0

2.0

Other Nominal GDP (USD bn) Unemployment rate (%, sa, eop)

339 3.4

349 3.3

360 3.6

3.1

3.3

3.4

3.5

3.6

3.6

* % change, year-on-year, unless otherwise specified ^ Balance on goods

HK - nominal exchange rate

HK – policy rate

HKD per USD

%, base rate

7.84

2.0

7.82

1.5

7.80 1.0 7.78 0.5

7.76

7.74 Jan-12

May-13

Sep-14

Jan-16

May-17

0.0 Jan-12

May-13

Sep-14

Jan-16

May-17

Sources for charts and tables are CEIC Data, Bloomberg and DBS Group Research (forecasts are transformations).

71

Taiwan

Economics–Markets–Strategy

TW: betting on the second half • 1Q growth matched expectations, but 2Q might be weaker than predicted • A 2H rebound is required to keep full-year GDP growth above 2% • It is possible that exports and investment will regain momentum in 2H • But consumption will continue to lag and inflation will remain subdued • High chances that the CBC will stay on hold in the rest of this year

The economy performed well as expected at the start of this year, in line with the synchronized recovery seen in other parts of the region. In YoY terms, GDP growth slipped to 2.6% in 1Q17, down from the peak of 2.8% in 4Q16. On the QoQ (saar) basis, growth actually rose to 3.8%, notably higher than the 1.4% in 4Q16. But some key indicators have surprised on the downside since the release of 1Q GDP. Export orders slowed more than expected in April and industrial production contracted. Risks have surfaced that the 2Q GDP will miss the 2% (YoY) mark. As such, a resilient 2H rebound is required to keep the full-year GDP above 2%.

Exports outlook not a big worry The 2H outlook for exports may not be a big worry. The slowdown in early-2Q came after two consecutive quarters of strong surge, which could be seen as a temporary correction instead of the beginning of a downturn. Although exports growth dropped to 8.9% (YoY) in Apr-May from 15.9% in 1Q17 and 11.8% in 4Q16, it remained pretty much in line with the long-term trend (Chart 1). Externally, the global economy remains on course for recovery, while the protectionism risks in US and political risks in Europe have both abated. The US Treasury didn’t label China or Taiwan a currency manipulator during the evaluation in April. Washington and Beijing have reached a tentative agreement to address

Chart 1: Exports growth slowed, but still on trend

Chart 2: Is the TWD too strong?

% YoY

BIS index, 2010=100

Trade balance (RHS) Exports Imports

100 80

USD bn 6

135 5

60 4

40 20

3

TAIWAN

130 125 120 115 110

0

2

-20 1

-40 -60 Jan-08

TWD REER

140

+5%

105 100

36mma

95 0 Jan-10

Jan-12

Jan-14

Jan-16

90 Jan-01

-5% Jan-04

Ma Tieying • (65) 6878 2408 • [email protected]

72

Jan-07

Jan-10

Jan-13

Jan-16

Economics–Markets–Strategy

Taiwan

trade imbalance, through boosting American exports to China instead of restricting Chinese exports to the US. This should provide some relief for Taiwanese exporters, many of which have production bases in China and export from there. Meanwhile, the electronics sector remains on a cyclical upturn. Industry news still suggest that Apple will release the much-awaited iPhone 8 this autumn. Its innovation elements should create new demand for electronics components, which bodes well for the Taiwanese firms highly involved in the iPhone supply chain. A key source of headwinds, on the other hand, comes from the slowdown in the Chinese economy. Along with the softer China manufacturing indicators, Taiwan’s exports to the mainland have fallen to 12.1% (YoY) in Apr-May from 29.1% in 1Q. Our sense is that the Chinese authorities will manage policies in a flexible manner and ensure economic stability ahead of the 19th National Congress this autumn. A drastic decline in Chinese demand should be unlikely.

Tailwinds outweigh headwinds for the exports outlook

Currency appreciation is another headwind. The TWD has gained some 7% versus the USD so far this year, the second best performer in emerging Asia. A strong currency directly weighs on exporters’ revenues and profits. Thankfully, the real effective exchange rate of the TWD is not too strong from the long-term perspective, which suggests that trade competitiveness is not a big problem for the time being (Chart 2). Despite the nominal appreciation of the TWD, its impact on export prices could be offset by Taiwan’s relatively low inflation and low wage costs to some extent.

Investment still has room to grow On the domestic front, investment still has room to grow. If exports bounce back, private machinery investment should also pick up on the back of a higher capacity utilization rate. Capital goods imports, a key indicator for machinery investment, slowed to 7.6% (YoY) in Apr-May from 22.6% in 1Q. But it was largely due to the high base effects – the level of capital goods imports still held up well as of May. Meanwhile, private construction investment is likely to bottom out. There are already signs of stabilization in the residential property market, thanks to the fading impact of tax reforms and the persistence of an easy financing environment. Housing prices have stopped falling and showed a tentative rebound in 1Q (Chart 3). Building permits granted for construction have also come out of contraction territory, registering a positive 20.4% (YoY) during the first four months this year. In addition, public investment may pick up towards the end of this year. The government has unveiled a long-term infrastructure plan in March, proposing to spend TWD 890bn over the next eight years to promote transportation, water environment, green energy, digital infrastructures and urban-rural construction. This bill has been submitted to the parliament for approval and is targeted to Chart 3: Property prices bottoming

Chart 4: The labor market improving slowly

Mar05=100

% YoY

250

% sa Unemployment rate (RHS) Regular wages

4.0

Sinyi index

3.0

230

2.0

5.5

1.0

210

0.0 190

5.0

-1.0 -2.0

170

4.5

-3.0 -4.0

150 130 Mar-10

6.0

4.0

-5.0 Mar-12

Mar-14

Mar-16

-6.0 Jan-08

3.5 Jan-10

Jan-12

Jan-14

Jan-16

73

Taiwan

Economics–Markets–Strategy

Chart 5: Consumer confidence sluggish

Chart 6: Inflation remains subdued

points

% YoY 3.5

110

Headline CPI Core CPI

105 2.5

100 95

1.5

90 85

0.5

80 75

Overall

70 60 Jan-10

-0.5

Consumption on durable goods

65 Jan-12

Jan-14

Jan-16

-1.5 Jan-10

Jan-12

Jan-14

Jan-16

be implemented within this year. Assuming one half is fresh spending and the execution rate is 80%, this program is expected to boost GDP growth by about 0.2ppt per year in 2017-2024.

Consumption will remain a laggard Consumption will likely remain a laggard. Companies are cautious in hiring and raising wages, in light of the lingering uncertainties surrounding the long-term business prospects. The labor market is improving at a slow pace. The unemployment rate dropped slightly to 3.78% (sa) in April from 3.84% in January. Regular wages grew only modestly by 1.6% (YoY) in 1Q (Chart 4, previous page). Consumer confidence is also weak (Chart 5). The pension reforms pushed by the government, which is set to cut the payments for retired teachers, soldiers and civil servants, have weakened the income prospects for the elderly people. The young people, on the other hand, want bigger reforms and still worry about the sustainability of the pension system. The shrinking of pension benefits, against the backdrop of a rapidly aging population, helps to explain why consumer confidence is sluggish despite the wealth effects from a strong TWD and a higher stock market.

The CBC will stay on hold

Inflation could be lower than 1%if oil and food prices remain stable

Taiwan’s central bank (CBC) held rates steady at the latest meeting in March, citing the negative output gap, moderate inflation and the tightening of financial conditions caused by TWD appreciation. The output gap has remained negative, inflation has slowed and the TWD has remained firm since then. All these point to a high chance that the CBC will continue to stand pat in the near term. We expect the benchmark discount rate to remain flat at 1.375% in 2H17. A positive output gap should be an important precondition for the CBC to begin to normalize rates. The Directorate General of Budget, Accounting and Statistics (DGBAS) forecasts 2.1% growth in 2017. This is not enough to bring the economy back to potential growth by the end of this year, or to eliminate the negative output gap. From the perspective of inflation, there is also little pressure on the CBC to hike rates. The DGBAS projects 1.0% inflation this year. But the actual CPI rose merely 0.6% (YoY) in Jan-May (Chart 6). Food prices have receded as effects from weather disruptions faded. The stabilization in oil prices and the TWD’s appreciation have also mitigated the risk of energy inflation. If oil prices continue to stay below US$ 55/barrel and food prices stay below last year’s average levels, the 2017 CPI could turn out to be lower than 1%. This would, in turn, strengthen the case for the CBC to keep rates unchanged throughout this year.

74

Economics–Markets–Strategy

Taiwan

Taiwan Economic Indicators 2016

2017f

2018f

1Q17

1.5 2.2 3.1 2.5

2.5 2.0 -0.2 2.5

2.3 2.2 2.0 2.0

2.6 2.0 -4.8 4.1

2.0 1.9 0.5 3.2

2.7 2.2 1.0 1.1

2.5 2.1 2.0 1.8

2.0 2.2 3.4 3.3

2.6 2.2 2.2 3.4

Net exports (TWDbn, 11P) Exports (% YoY) Imports (% YoY)

1045 2.1 3.4

1166 4.7 4.0

1223 2.5 2.3

230 7.4 7.7

260 5.2 5.1

278 4.4 3.5

398 2.3 0.4

232 3.1 3.3

279 3.8 3.5

External (nominal) Merch exports (USDbn) - % chg Merch imports (USDbn) - % chg

280 -1.8 231 -2.8

308 9.7 260 12.7

319 3.6 272 4.6

72 15.1 61 21.6

75 9.1 65 14.8

78 9.5 65 10.2

83 6.2 68 6.3

76 5.0 65 5.6

80 6.6 69 5.8

Trade balance (USD bn) Current account balance (USD bn) % of GDP

50 72 13.6

48 69 12.3

47 67 12.0

11 -

10 -

13 -

14 -

11 -

11 -

Foreign reserves (USD bn, eop)

434

445

455

-

-

-

-

-

-

Inflation CPI inflation

1.4

1.2

1.0

0.8

0.6

1.7

1.5

1.5

1.4

Other Nominal GDP (USDbn) Unemployment rate (eop %, sa) Fiscal balance (% of GDP)

531 3.8 -0.3

563 3.8 -0.6

568 3.7 -0.5

3.8 -

3.8 -

3.8 -

3.8 -

3.8 -

3.8 -

Real output and demand GDP growth Private consumption Government consumption Gross fixed capital formation

2Q17f 3Q17f 4Q17f 1Q18f 2Q18f

* % growth, year-on-year, unless otherwise specified

TW - nominal exchange rate

TW – policy rate

TWD per USD

%, rediscount rate 2.0

35.00 34.00

1.8

33.00 32.00

1.6 31.00 30.00

1.4

29.00 28.00 Jan-12

May-13

Sep-14

Jan-16

May-17

1.2 Jan-12

May-13

Sep-14

Jan-16

May-17

Sources for charts and tables are CEIC Data, Bloomberg and DBS Group Research (forecasts are transformations).

75

Korea

Economics–Markets–Strategy

KR: out of the tunnel • Growth prospects are looking better as exports pick up, political drags fade, and sentiment recovers • We raised our GDP forecasts to 2.7% for 2017 and 2.8% for 2018 • Risks include a slowdown in exports to China and a weaker-than-expected implementation of government policies • Inflation is not a problem; the BOK will stand pat for the rest of this year

Following the months-long political turmoil, the economy finally made a rebound at the beginning of this year. GDP growth rose to 4.3% (QoQ saar) in 1Q, up from 2.0% in 4Q16 and the highest over six quarters. As exports pick up, political drags fade and sentiment recovers, short-term growth prospects are now looking better. We have revised up GDP forecasts to 2.7% for 2017 and 2.8% for 2018, compared to the previous estimate of a flat 2.5%.

Exports on the recovery path External demand was a major driver in 1Q17. Exports of goods and services grew 8.6% (QoQ saar), the strongest over five quarters. Gross fixed capital formation also surged by 21.0%. Despite some signs of moderation in exports and investment in early-2Q, we think the externally-driven recovery will be sustained. The electronics sector remains on a cyclical upswing. Electronics exports have started to rise since end-2016 and maintained double-digit growth for five consecutive months (Chart 1). Samsung is still struggling to recover from the reputation damage caused by last year’s smartphone explosion controversy. But Korean companies could also benefit from Apple’s new product release later this year, as they are important suppliers of iPhone’s components. For instance, Samsung is reportedly a key supplier of the curved OLED screens for the upcoming iPhone 8. Demand for electronics components is likely to remain buoyant in 2H17.

Chart 1: Electronics exports on a strong upturn

Chart 2: Exports to China started to slow

% YoY

% YoY

25

50

China

US

20

40

EU

Japan

15

30

10

20

5

10

0

0

KOREA

-5

-10

-10

-20

-15 -20 Jan-12

Jan-13

Jan-14

Jan-15

Jan-16

Jan-17

-30 Jan-14

Jan-15

Ma Tieying • (65) 6878 2408 • [email protected]

76

Jan-16

Jan-17

Economics–Markets–Strategy

Korea

Meanwhile, the risk of trade protectionism from the US has eased. The US Treasury didn’t label Korea a currency manipulator during the evaluation report in April. While Trump has requested to review the US-Korea free trade agreement, the focus seems to be urging Korea to open its domestic market further to American goods and services, instead of restricting its exports to the US. The risk of US-Korea trade tensions appears low, at least for now. Admittedly, deteriorating demand from China remains a risk. The renewed slowdown in the Chinese economy, which emerged since early-2Q, bodes ill for Korea’s exports of manufacturing goods. Exports to China have decelerated to 10.2% (YoY) in April, down from 18.0% in 1Q (Chart 2). Moreover, the political tension with China, as a result of the THAAD disputes, also acts as a drag on Korea’s services exports. The number of Chinese tourists visiting Korea has plunged, by 53% in Mar-Apr. It is unclear how long it will take for the Korea-China ties to normalize.

It is unclear when the Korea-China ties will normalize

Political uncertainties fade, confidence recovers Domestic demand has remained weak as of 1Q. Private consumption grew just 1.6% (QoQ saar), significantly lower than the five-year average of 2.2%. That said, things may have started to improve in 2Q. Thanks to the May election that cleared political uncertainties, consumer confidence has rebounded strongly and the KOSPI has rallied to a record high of 2300 (Chart 3). Better confidence and positive wealth effects should encourage consumers to spend more in the near-term. Nonetheless, a strong and sustainable recovery in consumption is difficult as fundamentals remain weak. The labor market is still sluggish, given spare capacity and an ongoing corporate restructuring. The seasonally-adjusted jobless rate has risen to 4.0% in April, up from 3.6% in January (Chart 4). Meanwhile, the property market has begun to lose momentum, due to fading support from last year’s monetary easing. Housing prices gained 1.2% (YoY) in Apr-May, barely changed from in 1Q (Chart 5, next page). Growth in mortgage-based household loans has slowed to 10.3% in April, down from 11.2% at the beginning of this year. Eyes are now on the new government’s push for fiscal stimulus. President Moon has pledged to create 810k jobs in the public sector over the next five years. In order to achieve this goal, the finance ministry has compiled a KRW 11.2trn supplementary budget and submitted it to the parliament in early-June. But the passage of this budget is not guaranteed, given that the ongoing economic improvement has reduced the need for extra fiscal spending. Legal constraints are in place, and importantly, the state of the parliament is divided. Whether the implementation of fiscal policy can match expectations remains to be seen.

Eyes on the new government’s fiscal stimulus

Chart 3: Consumer confidence rebounded strongly

Chart 4: Unemployment rate remained elevated

Index, 100=neutral

%, sa

110

5.0 4.5

105

4.0 100 3.5 95

90 Jan-12

3.0

Jan-13

Jan-14

Jan-15

Jan-16

Jan-17

2.5 Jan-08

Jan-10

Jan-12

Jan-14

Jan-16

77

Korea

Economics–Markets–Strategy

Chart 5: Housing prices growth stabilizing

Chart 6: CPI inflation off the peak

% YoY

% YoY

10

National Seoul

8

Headline CPI

3.5

Core CPI

3.0

6

BOK's 2% target

2.5

4

2.0

2

1.5

0

1.0

-2 -4 Jan-08

4.0

0.5 Jan-10

Jan-12

Jan-14

Jan-16

0.0 Jan-12

Jan-13

Jan-14

Jan-15

Jan-16

Jan-17

BOK may only hike rates next year

Inflation to stay at 2% in 2Q-3Q and dip to 1.5% in 4Q

The Bank of Korea (BOK) kept rates unchanged at 1.25% in May. It expressed greater confidence about the economic outlook, signaling a possible upward revision to its GDP growth forecast in July. Despite the upbeat rhetoric, the BOK may stand pat for the rest of this year, and begin to normalize rates only from 2Q18 onwards. Inflation is not a big problem this year. Headline CPI has eased slightly to 1.9% (YoY) in Apr-May, down from the peak of 2.2% in March (Chart 6). Food prices retreated, thanks to fewer supply-side disruptions (such as bad weather, bird flu and foot-and-mouth disease). Energy inflation has also stabilized, as oil prices lost upward momentum and the KRW appreciated. Barring unexpected shocks on food and energy, CPI is likely to stay around 2% in 2Q-3Q and then dip to 1.5% in 4Q. The underlying inflation risks may only emerge next year. The negative output gap will be almost gone next year, as GDP growth returns to potential. Fiscal stimulus from the new government, if implemented, will provide further support to the 2018 growth and inflation outlook. All things considered, our judgement is that conditions will be ripe for the BOK to normalize rates around mid-2018.

Other things to watch Several things to watch under the new government in the medium-term. President Moon has called for reforms to reduce income disparity and protect small enterprises against the large ones. Tax reforms could be on the cards, such as phasing out tax exemptions / benefits for large companies and raising income / inheritance taxes for high-income earners. Chaebol reforms can also be expected, such as strengthening the oversight on chaebols’ business transactions / investments, and improving their corporate governance. It remains to be seen how the government will deal with the other structural issues that weigh on the economy’s long-run prospects. In terms of promoting industrial upgrade and addressing deteriorating demographics, a concrete reform plan is still lacking for the time being. Geopolitical developments also need to be watched closely. Tensions on the Korean peninsula have increased due to Pyongyang’s persistent military provocations and the US’s tough reactions. Moon favors a soft line towards North Korea, such as resuming the six-party talks and increasing the bilateral economic cooperation. But the Sunshine Policy adopted by the former governments before 2008 didn’t lead to a settlement of peace between the two Koreas. Whether Moon’s policies will be effective this time remains a big question mark.

78

Economics–Markets–Strategy

Korea

Korea Economic Indicators 2016

2017f

2018f

1Q17

Real output and demand GDP (2010P) Private consumption Government consumption Gross fixed capital formation

2.8 2.5 4.3 5.2

2.7 2.1 3.2 6.3

2.8 2.3 3.7 3.1

2.9 2.0 2.7 10.4

2.5 1.9 3.5 6.1

2.7 2.0 3.1 4.9

2.9 2.3 3.6 4.8

2.7 2.5 3.8 1.7

2.8 2.3 3.6 3.4

Net exports (KRW trn) Exports Imports

67 2.1 4.5

60 4.0 5.3

74 3.5 2.0

-2 3.9 9.9

21 3.7 4.9

18 3.7 2.8

23 4.7 3.6

6 3.5 -0.5

23 3.4 2.8

External (nominal) Merch exports (USD bn) - % YoY Merch imports (USD bn) - % YoY

495 -5.9 406 -6.9

565 14.0 480 18.1

577 2.1 493 2.7

132 14.7 116 23.9

144 14.5 117 17.6

140 15.3 121 18.4

148 11.9 125 13.5

137 3.4 119 2.1

145 0.4 121 4.0

Trade balance (USD bn) Current account balance (USD bn) % of GDP

89 99 7.0

85 93 6.2

84 93 6.0

16 -

27 -

19 -

23 -

18 -

23 -

Foreign reserves (USD bn, eop)

371

379

386

-

-

-

-

-

-

Inflation CPI inflation

1.0

1.8

1.6

2.1

1.9

1.9

1.4

1.2

1.5

1413 3.4 -1.4

1493 3.5 -1.6

1553 3.4 -1.7

3.7 -

3.6 -

3.5 -

3.5 -

3.7 -

3.6 -

Other Nominal GDP (USD bn) Unemployment rate (eop %, sa) Fiscal balance (% of GDP)

2Q17f 3Q17f 4Q17f 1Q18f 2Q18f

* % change, year-on-year, unless otherwise specified

KR - nominal exchange rate

KR – policy rate

KWR per USD

%, target rate

1290

3.5

1240

3.0

1190

2.5

1140 2.0 1090 1.5

1040 990 Jan-12

May-13

Sep-14

Jan-16

May-17

1.0 Jan-12

May-13

Sep-14

Jan-16

May-17

Sources for charts and tables are CEIC Data, Bloomberg and DBS Group Research (forecasts are transformations). 79

India

Economics–Markets–Strategy

IN: unbalanced recovery • FY18 is likely to be another year of unbalanced recovery • Investment spending is likely to remain soft, putting the onus yet again on consumption and government support to lift growth • Pipeline growth triggers and likelihood of a transient post-GST softpatch is likely to see FY18 GDP at 7.3% YoY from FY17’s 7.1% • RBI remained on hold in June but odds of a rate cut in Aug are rising • Inflation is expected to remain steady this year • The rollout of the Goods and Services Tax in July will be a litmus test for the ongoing reform agenda

The economic impact of demonetisation was more apparent in 1Q17, after 4Q16 numbers downplayed the fallout. Real GDP eased to 6.1% YoY in 1Q, down from 4Q16’s 7.0%. Private consumption softened to 7.3% while government consumption surged by 32%. Lower private sector participation weighed on investment growth. Net trade was also a drag as import growth outpaced the 10% jump in exports. 1Q Gross-value added (GVA) growth also slowed, with sharp upward revisions to 1Q16’s GDP aggravating the pace of slowdown. Besides mining and public administration services, all other components slowed, particularly construction (-3.7%), manufacturing and financial services. With this, FY17 full-year growth slowed to 7.1% from 8.0% in FY16 (Chart 1). On a GVA basis, growth slowed to 6.6% from FY16’s 7.9%. Clearly all the blame for the slowdown cannot be laid on the doors of demonetisation. Non-farm growth was drifting south even before the banknote ban, with the backdated revisions making the pace of correction even starker (Chart 2).

Chart 1: Recovery from the demonetisation slump

Chart 2: GVA growth - sectors

YoY % 12.0

pts contribution 7

10.0

6 DeMon

8.0

Agri FF Industry Services

5 4

6.0

3 4.0

2 1

GDP growth before FY12 are DBS calculations

FY18f

FY17

FY16

FY15

FY14

FY13

FY12

FY11

FY10

FY09

FY08

0.0 FY07

INDIA

2.0

0 -1 Jun-12

Jun-13

Radhika Rao • (65) 6878 5282 • [email protected]

80

Jun-14

Jun-15

Jun-16

Economics–Markets–Strategy

India

Gradual recovery on the cards Looking ahead, FY18 (Apr17-Mar18) is likely to be another year of unbalanced growth. Consumption should fare well on improving rural wages (up 6.5% in 1Q17 vs 5% in 2016), normal monsoon, public sector wage increases and lower financing costs. Next, public sector spending is expected to, yet again, pick up the slack from sub-par private sector interests. There are a few encouraging signs of corporate activity, but a sharp rebound seems unlikely. Aggregate net sales of the listed non-finance companies rose by 12% in the Mar17 quarter, a second quarter of double-digit rise. Sales revenue growth was, however, concentrated in the larger companies, according to the Centre for Monitoring India Economy (CMIE). This implies that the impact on the note ban was more acute on the smaller and informal sector players. Easing cash shortage and better demand conditions should help, but a fifth of the major industry sub-sectors fall under the banks’ stressed advances category. These factors will limit the scope of a swift revival in the private sector.

RBI was on hold in June but odds of a Aug cut are rising

In the interim, foreign direct investment (FDI) inflows (record high in FY17) are likely to provide support to the capex cycle, alongside higher centre and states’ spending. Fiscal trends are under watch as the ruling government enters the last two years of its 5 year term. Factoring in these offsetting forces, we moderate our FY18 GDP estimate to 7.3% (vs prev 7.6%). Under the sectoral breakdown, forecasts for a normal monsoon and better service sector (esp. public administration) will be supportive, while industry revival lags. The latter will also be influenced by the implementation of the Goods and Services Tax (GST) in 3Q17, ahead of which inventories will be drawn down but restocking demand will return in 2H17. This is likely to shore full-year growth to 7.0% from FY16’s 6.6%.

RBI to closely watch evolving inflation trends The Reserve Bank of India kept benchmark rates on hold in June but slashed inflation forecasts. 1H FY18 inflation (Apr-Sep17) is now seen in the range of 2.0-3.5% range and 3.5-4.5% in 2H. This compares to 4.5% and 5.0% earlier. RBI’s guidance has softened vs April but there was little to suggest that it has turned outright dovish. Emphasis was on gaining more clarity towards a) whether Apr’s

Dec -16

Dec -15

Dec -14

1995 1998 2001 2004 2007 2010 2013 2016 Source: IMD, DBS Group research

Dec -13

-25

Dec -12

-20

Dec -11

-15

Dec -10

IMD est. 2017

-10

Government Private sector

Dec -09

-5

20 18 16 14 12 10 8 6 4 2 0

Dec -08

0

INR trn

Dec -07

5

Chart 4: Stalled investment projects (by value)

Dec -06

Chart 3: Rainfall deficiency/excess- Jun-Sep vs LPA % 10

Source: CMIE, press reports

81

India

Economics–Markets–Strategy

weak momentum can sustain, b) softer core inflation might prove short-lived in midst of better rural wages and firm consumption, c) impact of the seventh pay commission needs to be worked into the calculations, and d) flagged fiscal risks for states from loan waivers. For now, the RBI is still vigilant against inflation and less inclined to cut rates to buoy investment. At this juncture, inflationary risks are subdued. Imported pressures are benign, given a strong rupee and stable oil prices. The bulk of the inflation basket has been exempted from GST, with tax incidence likely to rise on service sector components. The seasonal spurt in food prices, that usually plays out mid-year, looks subdued this year thanks to a combination of ample supplies, a good harvest and support from administrative measures. Monsoon progress is also encouraging, with actual rainfall trending at 5% above normal by 5 Jun. Growth is still below trend, pointing to a negative output gap.

Inflation base effects to turn adverse at end-2017

Looking forward, inflation is likely to drift up in the second half, as growth stabilises from its 1Q17 trough and disinflationary forces subside. CPI inflation is expected to rise b yan average of 4.5% YoY this year, with downside risks. In all, the above factors are likely to keep inflation close to the RBI’s revised path. By Aug’s review, the committee will be armed with May and June inflation numbers. Given the RBI’s balanced tone at its policy meeting on 7 Jun, and its reluctance to ease rates, we maintain our call for policy to remain on hold. We, however, acknowledge that the odds of a rate cut in August has risen. In our view, this will need i) inflation to slip below 2.5% in May17, and/ ii) inflation to break, in Jun17, below its projected path and test the lower bound of its targeted 2-6% range.

GST and other reforms strength structural story Apart from cyclical trends, India’s structural story is also strengthening. Benefits here will, however, accrue more in the medium-term rather than in the short-run [1]. These changes will help improve the economy’s potential growth over time. A crucial domestic reform in this regard is the GST, due to be rolled out on 1 Jul. This measure, conceptualised about a decade back, is poised to subsume several state and central government taxes. In practical terms, setting the GST wheels into motion will be no easy feat, given the complex structure of multiple-tiered rates, demarcation by way of state & centre / integrated GSTs and extensive network / architectural requirements. Besides teething problems, the economic impact might be modestly negative in the shortterm, but positive longer-out. Chart 5: Main CPI sub-heads

Chart 6: Inflation before and after GST

Contribution. ppt

% YoY 25

4.0 3.5

20

3.0 2.5

4Q16

2.0

1Q17

1.5

Apr-17

t

15

t+1 t+2

10

t+3

1.0

5

0.5

Services

Fuel& lgt

Housing

Clthg/Fwr

Tob, pan

Food,Bevs

CPI

0.0

82

t-1

t+4

0 United Canada Kingdom

New Australia Malaysia Zealand

Source: RBI, DBS Group Research

Economics–Markets–Strategy

On inflation, the bulk of the essential goods (food grains etc.) and services (education, medical) have been kept in the exempt category, with services for which tax incidence will increase making up less than a fifth of the CPI basket. The government’s estimate of a 2% fall in inflation due to GST is optimistic given the asymmetry in price changes. Cross-country inferences reinforce this view (Chart 6). We estimate that a 10% change in select service categories might lift headline CPI by 20bps at best. If producers pass on partial / full benefits on reduced tax rates, headline inflation might soften by 20-40bps. Growth implications might be modestly negative in the near-term. Temporary disruption is likely on front-loaded spending, inventories drawdown and business uncertainty etc. An estimated 20-30bps fall in 3Q17 growth is likely, but expected it reverse out by end-year. The impact on the fiscal math might be neutral, with significant savings unlikely in the short-term. States will receive compensation for the first five years if revenue growth is sub-14%.

India

Teething issues and short-term disruption to economic activity likely in wake of GST

Efficiency gains might be limited given the complexity of the new system, but longerout, benefits will include formalisation of the economy, simplified tax structure, better compliance and lower inefficiencies due to cascading taxes. Apart from the GST, other key changes include boosting FDI interests, improve the ease of doing business, financial inclusion, push for affordable housing, infra spending (particularly roads and railways), plans to increase use of technology and digitalization across sectors, expanding the manufacturing base under the Make in India umbrella, which will be positive for job creation given its better absorption levels, amongst others.

In sum India’s growth is likely to improve this year, but recovery will remain unbalanced in the midst of the stressed books’ of corporates and the banking sector. Nonetheless, the structural story is being strengthened at a time when inflation is benign, current account deficit is narrow, foreign reserves are rising, fiscal consolidation efforts are credible and domestic markets are bullish. Beyond the near-term trough in growth conditions, we expect the economy to improve at a gradual pace, which backs our benign view on the rates and currency (see Yields and Currencies section for details).

Notes: [1] DBS Group Research; “India structural tailwinds to add to cyclical upswing”; 31Mar17

Sources All data are sourced from CEIC Data, Bloomberg, Indian government agencies, RBI and press reports. Transformations and forecasts are DBS Group Research.

83

India

Economics–Markets–Strategy

India Economic Indicators 16/17f 17/18f 18/19f

4Q17

1Q18f 2Q18f 2Q18f 3Q18f 4Q18f

Real output (11/12P) GDP growth** Agriculture Industry (incl constrn) Services Construction

7.1 4.7 5.6 7.7 1.8

7.3 5.4 5.1 8.2 1.9

7.6 4.5 6.0 9.2 2.5

6.1 5.2 3.1 7.2 -3.7

6.7 6.0 4.7 7.7 1.0

6.3 5.5 4.4 7.2 1.0

7.9 5.0 5.2 8.7 2.0

8.2 5.0 6.1 9.0 3.5

8.2 4.0 5.8 8.0 3.0

External (nominal) Merch exports (USD bn) - % YoY Merch imports (USD bn) - % YoY

275 5.0 383 2.0

324 18.0 452 19.0

350 8.0 485 7.3

76 16.9 105 25.4

80 21.9 110 29.6

80 20.9 112 22.6

82 21.7 115 13.0

82 8.0 115 9.7

85 6.3 120 9.1

-108 -15 -0.6 370

-128 -27 -1.2 390

-135 -30 -1.3 400

-28.9 na na na

-30.0 na na na

-32.0 na na na

-33.0 na na na

-33.0 na na na

-35.0 na na na

Inflation CPI inflation (% YoY)

4.5

4.5

5.0

3.6

2.6

4.1

5.4

5.5

5.6

Other Nominal GDP (USD tn) Fiscal balance (% of GDP)

2.3 -3.5

2.5 -3.2

2.8 -3.0

na na

na na

na na

na na

na na

na na

Trade balance (USD bn) Current a/c balance (USD bn) % of GDP Foreign reserves(USD bn, eop)

% change year-on-year, unless otherwise specified Annual and quarterly data refers to fiscal years beginning April of calendar year. ** GDP growth stands for Real GDP; breakdown is under GVA (Gross Valued Added) series

IN – policy rate

IN - nominal exchange rate

% repo rate

INR per USD

9.0

71 68

8.5

65 8.0 62 7.5

59 56

7.0

53 6.5

50 47 Jan-12

May-13

Sep-14

Jan-16

May-17

6.0 Jan-12

May-13

Sep-14

Jan-16

May-17

Sources for charts and tables are CEIC Data, Bloomberg and DBS Group Research (forecasts are transformations).

84

Economics–Markets–Strategy

India

This page is intentionally left blank

85

Indonesia

Economics–Markets–Strategy

ID: crawling • GDP growth is likely to come in at 5.1% and 5.4% in 2017 and 2018 respectively • Higher export earnings are yet to boost consumption growth • Imports of capital goods have bottomed out, which is an encouraging sign for investment growth outlook • CPI inflation may top 5% by the year-end • Bank Indonesia prefers a relatively stable rupiah. Raising the key policy rate still looks likely later in the year

We have lowered our 2017 GDP growth forecast to 5.1%, down from the previous estimate of 5.3% (2018 forecast remains at 5.4%). 1Q17 GDP growth disappointed but recent data still points towards GDP growth gaining momentum in 2H17. Consumption picked up pace after a slow start to 2017. After contracting 12% (YoY) in Jan and Feb17, imports of consumer goods were up an average 32% in Mar and Apr17 (Chart 1). A turnaround is also seen in the monthly retail sales index, growth of which is back at around 5-6%, after hitting a 3-year low of 3.7% in Feb17. Auto vehicle sales continue to grow at a decent annual pace of 6%, a tick higher than actual 4.9% in 2016. Exports have grown by 18.9% (YoY) in the year up to Apr17, with most of it coming from the commodity sector. This is the fastest pace of export growth since mid-2011. Higher export earnings are, however, yet to make a marked impact on household spending. Consumption of discretionary goods remain at sub-5%, far below the 6.5% average in mid-2011. Discretionary consumption growth continues to lag non-discretionary trends.

Chart 1: Imports of consumer goods % YoY 60 50 40 30 20 10

INDONESIA

0 temporary slump

-10 -20 Jan-16

Apr-16

Jul-16

Oct-16

Gundy Cahyadi • (65) 6682 8760 • [email protected]

86

Jan-17

Apr-17

Economics–Markets–Strategy

Indonesia

Chart 3: Investment by type

Chart 2: Tax revenue growth % YoY

10 8.2

10

(DBSf)

8

7.0

6 4

3.6

5 0

% YoY, quarterly data

14.8

15

2

0.1

0 -2 -4

-5 -10

-6

Up to Apr Full-year

-8

-9.6

-15 2015

2016

Buildings and structures

-10 2017

Machinery and equipment

-12 1Q15

1Q16

1Q17

Unless commodity prices go up further, the only boost for the economy would be either an acceleration in government spending or stronger private investment growth. The government remains committed to deliver its budget spending, but is also mandated to keep budget deficit below 3% of GDP. Higher tax revenues are crucial to allow a more aggressive fiscal spending. Tax revenues were up a strong 14.8% (YoY) this year, up to Apr (Chart 2). Total tax revenues may exceed 90% of this year’s target, an improvement when compared to actual 85.5% last year. Yet, even at this improved pace, the tax-to-GDP ratio is likely to remain sub-11%, well below the 14% average amongst the rest of ASEAN-5 countries. To deter tax evasion, the government has issued a new regulation in early-May17 that grants the tax office full access to account information across banks and other financial institutions. More efforts to boost tax revenues may be announced later this year, including possible changes to the current value-added tax (VAT) system. Any impact on tax revenues is likely to come in 2018, at the earliest. Meanwhile, investment growth came in at 4.8% in 1Q17, unchanged from 4Q16. But it was also the first time since mid-2015 that saw positive growth in both construction-related and machinery investments (Chart 3). The recovery in the imports of capital goods suggests that investment on machinery may no longer be a drag this year.

Tax revenues are up a strong 14.8% (YoY) in the yearto-date

After a cumulative fall of 50% since 2013, imports of capital goods have now bottomed out. Up to Apr17, year-to-date growth is at a decent 6% pace. If this pace were to be sustained, it is a clear indication of a recovery in investment growth this year. At this juncture, we look for investment growth at circa 5.2% in 2017, fastest since 2012.

Back to investment grade S&P upgraded Indonesia’s sovereign credit rating to BBB- in mid-May. For the first time since 1997, Indonesia is rated in the investment grade by the three major credit rating agencies. As the upgrade had been mostly priced-in, the financial markets only saw a knee-jerk impact. Nonetheless, the upgrade may help to attract more foreign direct investment (FDI) flows in the coming years, assuming the macro risk profile remains favourable. On the risk profile, expect fiscal assessment to remain neutral. The budget deficit is set to remain circa 2.5% of GDP in the coming years. This keeps the overall government debt stable, below 30% of GDP in the medium-term. A gradual and sustained increase in tax revenue collection will only be a plus for rating outlook.

87

Indonesia

Economics–Markets–Strategy

Chart 4: Inflation trajectory

Chart 5: Foreign reserves and portfolio flows % YoY

% YoY 8

6 DBS forecast

7 6

8 6

5

5

4 2 0

4

4

-2 -4

3 2 Jan-15

USD bn, quarterly

3 Jan-16 CPI inflation

Jan-17

Latest: Mar17

-6 -8

Core inflation (RHS)

Change in FX reserves Mar15

Mar-16

Net portfolio flows Jan-17

Meanwhile, external financing risks remain manageable. Stronger investment growth is likely to translate to a widening of the C/A deficit from the low 1% of GDP seen in 1Q17, Nonetheless, expect the C/A deficit to remain modest circa 2.0% of GDP in 2017 and 2018. Coupled with the anticipated increase in net FDI flows, the C/A deficit is no longer seen as a major risk right now.

Inflation may exceed 5% by year-end We maintain our 2017 CPI inflation forecast at 4.5%. The upward trend in inflation persists, and there is a good chance of CPI inflation topping the 5% mark later this year (Chart 4). Food inflation has managed to keep headline prints in check. Making up 35% of the CPI basket, food inflation (including processed food) came in at 3.7% (YoY) in Apr17, lowest in 5 years. Contribution from food inflation to overall CPI inflation was also a multi-year low at 1.4%-pt for the month. But food prices remain volatile on monthly basis. And as Ramadhan came earlier this year, we reckon that food inflation might have seen a bottom. Any uptick in food inflation from now on is set to push CPI inflation closer to 5%. After all, transport and housing / utilities (the other 2 main components) inflation already sit comfortably above 5% (YoY). Look for CPI inflation at 5.2% in 4Q17.

25bps rate hike still a possibility

Bank Indonesia has been tolerant of a gradual tradeweighted currency appreciation

Expect Bank Indonesia (BI) to raise its key policy rate by 25bps towards the yearend. As both inflation and GDP growth pick pace, there is less pressure for BI to trim its interest rate further. In fact, the central bank’s priority has shifted towards ensuring rupiah stability. BI has been building up reserves as it allows the central bank to dampen the impact of fund flows (Chart 5). Reserves rose USD 6.6bn in the first four months of this year, just as a total of USD 7.7bn worth of foreign inflows were seen in equities and IDgov bond markets. This follows from last year, when BI added some USD 10bn to its coffers, roughly equivalent to the total foreign portfolio inflows recorded for the year. The central bank is tolerant of gradual trade-weighted currency appreciation, even if the rupiah is relatively stable against the USD. As of Apr17, the rupiah nominal effective exchange rate (NEER) is up by 3.5% since end-2015, making it one of the top performers in the region. Raising the key 7D reverse repo rate later this year may be necessary if the Fed sticks with its plan to normalize interest rates in 2017 and 2018.

88

Economics–Markets–Strategy

Indonesia

Indonesia Economic Indicators

2016

2017f

2018f

1Q17

Real output and demand Real GDP growth (10P) Private consumption Government consumption Gross fixed capital formation

5.0 5.0 -0.1 4.5

5.1 5.0 3.9 5.2

5.4 5.1 5.0 5.5

5.0 4.9 2.7 4.8

5.1 5.0 2.5 5.2

5.3 5.0 4.6 5.2

5.3 5.0 5.0 5.3

5.4 5.1 6.0 5.6

5.4 5.1 4.5 5.6

Net exports (IDRtrn, 10P) Exports Imports

152 -1.7 -2.3

192 7.6 6.0

176 3.3 4.4

56 8.0 5.0

42 7.0 6.7

48 9.0 8.8

45 6.5 4.0

47 2.0 2.3

55 3.0 4.4

External Merch exports (USDbn) - % chg Merch imports (USDbn) - % chg Merch trade balance (USD bn)

145 -3.8 136 -4.9 9

164 13.5 148 9.4 16

175 7.1 164 10.8 11

41 22.0 37 15.6 4

40 12.4 37 8.8 3

40 14.3 36 9.1 4

43 7.5 39 5.4 4

42 4.0 38 2.7 4

43 7.5 41 10.8 2

Current account bal (USD bn) % of GDP Foreign reserves (USD bn, eop)

-17 -1.8 116

-18 -1.9 120

-21 -2.1 123

n.a. n.a. n.a.

n.a. n.a. n.a.

n.a. n.a. n.a.

n.a. n.a. n.a.

n.a. n.a. n.a.

n.a. n.a. n.a.

Inflation CPI inflation (average)

3.5

4.5

5.0

3.7

4.2

4.7

5.2

5.1

4.9

Other Nominal GDP (USDbn) ** Fiscal balance (% of GDP)

933 -2.6

970 -2.5

1,010 -2.5

n.a. n.a.

n.a. n.a.

n.a. n.a.

n.a. n.a.

n.a. n.a.

n.a. n.a.

2Q17f 3Q17f 4Q17f 1Q18f 2Q18f

* % change, year-on-year, unless otherwise specified

ID - nominal exchange rate

ID – policy rate

IDR per USD

BI 7D reverse repo rate 7.0

15600 14700

6.5

13800 6.0

12900 12000

5.5

11100

5.0

10200 4.5

9300 8400 Jan-12

May-13

Sep-14

Jan-16

May-17

4.0 Aug-12

Oct-13

Dec -14

Feb-16

Apr-17

Sources for charts and tables are CEIC Data, Bloomberg and DBS Group Research (forecasts are transformations).

89

Malaysia

Economics–Markets–Strategy

MY: in a sweet spot • GDP growth surprised on the upside in 1Q17, driven by robust consumption and investment growth • Growth is expected to be faster at 5.0% in 2017, from 4.5% previously • Inflation has peaked and is expected to average 3.7% in 2017 before easing to 2.5% in 2018 • Bank Negara will continue to stand pat on policy as inflation is recedes

First quarter GDP growth was stronger than expected. A conducive external environment and possibly stronger domestic growth imply that there could be upside risks to overall GDP growth this year. Meanwhile, inflation has peaked and will likely ease steadily for the rest of the year. The central bank is now in a sweet spot to persist with the current accommodative monetary policy.

Upside surprise in 1Q17 GDP growth GDP growth in the first quarter registered 5.6% (YoY), significantly stronger than expected. Domestic growth was the main driver and accounted for 6.8%-pts to overall GDP growth. Net export turned negative as a surge in imports (12.9%) offset a good showing in exports (9.8%). On the margin, growth momentum accelerated by 7.5% (QoQ saar). This is the strongest sequential growth since 4Q12.

Domestic engines roaring Private consumption (6.6% YoY) remained an important engine of growth. Earlier on, there was concern that a soft labour market could weigh down on consumer spending. But latest labour market statistics suggest that employment prospects are brightening up. Unemployment rate (sa) has been trending lower while job vacancies has increased in Feb17 (Chart 2). Juxtaposed with a slew of people-centric stimulus measures rolled out by the government over the past two budgets, private consumption will continue to remain resilient at about 6.5-7.0% in the coming quarters.

Chart 1: Domestic growth remains the key driver %YoY, %-pt contribution Net exports 8 Govt spending

Investment

Pvt consumption

GDP growth

6

4

MALAYSIA

2

0 Latest: 1Q17

-2 Mar-15

Sep-15

Mar-16

Irvin Seah • (65) 6878 6727 • [email protected]

90

Sep-16

Mar-17

Economics–Markets–Strategy

Malaysia

Chart 2: Employment prospects brightening up %, sa 3.7

Job vacancies (RHS) Unemployment rate

Chart 3: Business sentiments improving

unit x 1000 140

3.6

120

3.5

100

3.4

80

3.3

60

3.2

40

3.1

20

Latest: Feb/Mar17

3.0

0 Jan-16

May-16

Sep-16

index, 3qma 110

Biz condition

index, 3qma 82 81

Capacity utilisation

105

80 100

79 78

95

77 90

76

Latest: 1Q17 85

Jan-17

75 Mar-14

Mar-15

Mar-16

Nonetheless, the main upside surprise came from the investment component. Gross Fixed Capital Formation (GFCF) surged by 10% (YoY) in the quarter, up from a mere 2.2% average over the past two quarters. Business sentiment has improved and capacity utilisation rate is up (Chart 3). There is also a healthy pipeline of development infrastructure projects and industrial plans that support private capital investment. Turnaround in oil prices has also prompted more aggressive developmental expenditure, particularly given that oil prices are now higher than the budget assumption of USD 45/bbl. With that, we expect continued strong investment growth in the coming quarters.

Mar-17

Investment growth expected to remain strong

Drag from net exports Exports rose by a solid 9.8% (YoY) in 1Q17. Upswing in global electronics cycle has boosted the tech sector while the turnaround in the commodity and energy sectors also helped. However, this was superceded by an even stronger increase in imports (+12.9%). This has resulted in net exports becoming a drag on overall GDP growth (Chart 1). The surge in imports was largely driven by the demand for intermediate and capital goods (Chart 4). For example, a high percentage of electronics components is imported and demand for raw materials arising from ongoing multiple infrastructure projects also raised imports significantly. Due to the high import content for Malaysia’s Chart 4: Imports rose sharply

Chart 5: PMIs have peaked

% YoY 90

59

Index

Gross imports Capital gds Intermediate gds

60

57

Consumer gds 55

30

Singapore EZ China US

53 51

0 49 Latest: Mar17 -30 Jan-16

Apr-16

Jul-16

Oct-16

Jan-17

Latest: Apr17 47 Jan-15 Jul-15

Jan-16

Jul-16

Jan-17

91

Malaysia

Economics–Markets–Strategy

Chart 6: Transport costs driving up inflation

Chart 7: Inflation and monetary policy outlook

% YoY 25

6.0

20

% YoY, % p.a. CPI inflation

DBSf CPI Inflation

Transport CPI inflation

5.0

OPR

15 4.0

10 5

3.0

0

2.0 2017f: 3.8% 2018f: 2.5%

-5 1.0

-10 Latest: Apr17

-15 Jan-16

Jul-16

Jan-17

0.0 Jan-16

Jul-16

Jan-17

Jul-17

manufactured products and investment activity, any acceleration in export or investment growth will be matched by a corresponding increase in imports. Besides, export demand may also taper off in the coming months. PMI readings for some of the key export markets have peaked (Chart 5). With export demand expected to ease and domestic investment activity likely to remain strong, net exports will continue to weigh down on GDP growth in the coming quarters.

Growth forecast upgraded Despite the drag from net exports, overall GDP growth for the year will still turn out stronger than previously anticipated. Not only has the entire growth trajectory been lifted by the significantly stronger than expected 1Q GDP, underlying domestic fundamentals are expected to remain resilient. Growth forecast for 2017 raised to 5.0%

This is despite the risk that headwinds may pick up towards the latter part of the year. Plainly, private consumption and investment will remain the key drivers of Malaysia’s domestic growth story. The factors supporting these two engines are internal by nature and remain highly conducive. Overall GDP growth is now expected to register 5.0% in 2017, up from our previous forecast of 4.5% (Chart 6). But growth momentum may slow going into next year. This will be consistent with our GDP growth projection of 4.6% in 2018.

Easing inflation makes for a stable monetary policy Thus far, inflation has surprised on the upside on account of upward adjustments in pump prices (Chart 6). Specifically, transport inflation averaged 16.5% over the past four months. However, inflation has peaked and is expected to ease steadily over the course of the year (Chart 7). Factoring in the recent upside surprises in inflation, we have revised up our full year inflation forecast to 3.7% in 2017 but maintain our projection of 2.5% in 2018. While the higher inflation has pushed real policy rates to negative, Bank Negara has maintained the Overnight Policy Rate at 3.00% in recent meetings. Of note, core inflation has remained below policy rate at about 2.4% year-to-date and headline inflation is also expected to ease. Growth has been buoyant and will be within the official forecast range of 4-5%. Although there could be pressure on the local currency amid a tightening bias in US Fed policy, the depreciation risk of the ringgit versus the greenback is expected to be modest given an improving domestic economic fundamentals. So, with inflation risk easing and growth outlook likely to remain sanguine, Bank Negara is in a sweet spot to keep the OPR at 3.00% for the rest of the year.

92

Economics–Markets–Strategy

Malaysia

Malaysia Economic Indicators 2016

2017f

2018f

1Q17

Real output and demand GDP growth Private consumption Government consumption Gross fixed capital formation Exports Imports

4.2 1.6 6.1 2.6 0.1 0.4

5.0 4.7 6.6 7.9 8.2 10.9

4.6 3.6 6.6 4.9 3.4 4.5

5.6 7.5 6.6 10.0 9.8 12.9

5.4 3.0 6.8 8.7 8.5 12.2

4.7 4.2 6.4 6.3 8.0 11.4

4.4 4.0 6.5 6.5 6.4 7.1

3.8 7.0 6.6 7.0 2.3 5.5

4.3 3.0 6.5 3.8 3.7 5.0

External (nominal) Exports (USD bn) Imports (USD bn) Trade balance (USD bn)

184 163 20

217 200 17

209 191 18

52 48 4

53 49 3

53 50 4

59 54 5

58 53 5

56 51 5

6 2

6 2

8 2

n.a. n.a.

n.a. n.a.

n.a. n.a.

n.a. n.a.

n.a. n.a.

n.a. n.a.

95

100

107

n.a.

n.a.

n.a.

n.a.

n.a.

n.a.

Inflation CPI inflation

2.0

3.7

2.5

4.3

4.3

3.6

1.2

1.8

2.3

Other Nominal GDP (USDbn) Fiscal balance (% of GDP)

297 -3.1

324 -3.0

347 -2.8

n.a. n.a.

n.a. n.a.

n.a. n.a.

n.a. n.a.

n.a. n.a.

n.a. n.a.

Current account bal (USD bn) % of GDP Foreign reserves (USD bn, yr-end)

2Q17f 3Q17f 4Q17f 1Q18f 2Q18f

- % growth, year-on-year, unless otherwise specified

MY - nominal exchange rate

MY – policy rate

MYR per USD

%, OPR 3.4

4.50 4.30 4.10

3.2

3.90 3.70 3.50

3.0

3.30 3.10 2.90 Jan-12

May-13

Sep-14

Jan-16

May-17

2.8 Jan-12

May-13

Sep-14

Jan-16

May-17

Sources: CEIC, Bloomberg and DBS Group Research (forecasts are transformations).

93

Thailand

Economics–Markets–Strategy

TH: domestic struggles • GDP growth still likely to come in at 3.4% and 3.5% for 2017 and 2018 respectively • Negative wage growth will be a drag on private consumption • Private investment growth numbers may appear better ahead, mainly due to the low base effects • We lowered our CPI inflation forecasts to 0.9% and 1.7% for 2017 and 2018 respectively • Bank of Thailand set to keep rates steady

Most of the external data have outperformed our expectations so far this year. On the domestic front, however, private sector growth continues to struggle at 2% pace (Chart 1). Unless we start seeing significant improvement from the domestic data, we see no reasons to change our GDP growth forecasts of 3.4% and 3.5% for 2017 and 2018 respectively.

Domestic growth still weak Private consumption growth came in at 3.2% (YoY) in 1Q17, a modest pick-up from an average of 2.8% in 2H16. Bulk of the boost came from strong agriculture earnings. The agriculture sector rose 7.7% in the period, a multi-year high. Sales data have also improved in 1Q17, although the surge was also likely to be a normalization after a weak end of 2016. For example, consumption of motor vehicles rose a significant 15.9% in 1Q17, just about reversing the 13.6% fall in the previous quarter (Chart 2). Retail sales are currently growing at an annual pace of around 3.5%, just about the trend growth before numbers plunged in 4Q16. Note that up until Sep16, the 1-year average for retail sales growth was at 3.9%.

Chart 1: Private sector growth sum of private consumption and investment, % YoY, 02P 20 15 10 5

THAILAND

0 -5 -10 Mar-09

2011 floods Financial crisis Mar-11

2013-14 political crisis Mar-13

Mar-15

Gundy Cahyadi • (65) 6682 8760 • [email protected]

94

Mar-17

Economics–Markets–Strategy

Thailand

Chart 3: Average wage growth

Chart 2: Encouraging sales data in 1Q17 % YoY 25 20

%YoY

Latest: Apr17

15 10 5

12

8

10

6

8

4

6

2

4

0

2

-2

0

0 -5 -10 -15 -20

motor vehicle sales retail sales index (RHS)

-25 Jan-16

Jul-16

Jan-17

% YoY

10

-4

-2 Mar-13

Mar-14

Mar-15

Mar-16

Mar-17

Any further acceleration in private consumption growth appears unlikely for now. The monthly consumption index continues to indicate stable private consumption growth in the 3-4% range. In fact, we continue to see some downside risks on the outlook for private consumption growth. Lower food prices are set to be a drag on the agriculture sector going forward. The manufacturing sector continues to grow at a mere 1% pace. And making things worse, nominal wage growth has actually turned negative again in 1Q17 (Chart 3). Meanwhile, investment growth was a poor 1.7% (YoY) in 1Q17, dragged by the 1.1% contraction in private investments. While public investment growth stays robust due to the government’s aggressive spending, private investment has continued its gradual slide. As indicated by the monthly index, private investments have pretty much given back all the gains seen from 2H16. Private investment growth numbers may appear better ahead, but this is mainly due to the low base effects. The high frequency data remain mixed otherwise. Imports of capital goods were up an encouraging 7.2% in 1Q17. But outstanding loan growth has actually slipped to an average of 2.8% in 1Q17, as compared to 4.5% last year. Approved foreign direct investments (FDI) are down 27% (YoY) for the first two months of the year. In the medium-term, we remain watchful that outward investments may continue to rise, limiting the extent of recovery in domestic investment growth. Competitiveness issues aside, the delayed elections could also be factor. It is now widely expected that elections will be delayed again from the 2018 date.

Strong export growth but manufacturing still sideways Export growth is currently the brightest spark in the economy. Goods exports are up by 5.7% for the year up to Apr17. Exports of electronics and electrical product (E&E) were up 10% (YoY) in 1Q17, on the back of a stronger global demand. While this double-digit growth in E&E exports is unlikely be sustained in 2H17, total goods exports are still set to grow by about 6.6% this year. Imports data still paint a relatively positive outlook of export growth (Chart 4). Imports are up by 14.5% (YoY) in the year-to-date. Bulk of this was due to the surge in imports of intermediate goods, a sign that demand for exports will remain supportive of the economy going forward. As domestic private investment growth recovers, expect even stronger import growth going forward. Total net exports of goods and services are set to top THB 1tn for the first time ever this year. The tourism sector remains supportive of the flows perspective, even if growth in the sector may continue to moderate this year. Visitor arrivals are up 3% (YoY) in the year up to Apr17, as compared to 14.1% in the same period last year. 95

Thailand

Economics–Markets–Strategy

Chart 4: Strong import of intermediate goods

Chart 5: CPI inflation

% YoY

% YoY

% YoY

20

5.0

30

15

4.0

20

10

10

5

0

0

40

Latest: Apr17

-10

-5

-20

-10

-30 -40 Apr-15

Imports of intermediate goods export growth (RHS) Apr-16

-15

-20 Apr-17

Latest: May17

3.0 2.0 1.0 0.0 -1.0 -2.0 May-14

CPI inflation May-15

food May-16

May-17

Meanwhile, despite the recovery in exports of manufactured goods this year, the manufacturing sector has continued to move sideways. Manufacturing GDP was up 1.2% (YoY) in 1Q17, pretty much the average pace seen in the last 3 years. Even with stronger export growth of manufactured goods in 1Q17, the sector continues to contribute a mere 10% of GDP growth, well below its near-30% weight in the GDP.

Softer inflation We lowered our CPI inflation forecasts to 0.9% and 1.7% for 2017 and 2018 respectively. While inflation appeared to be heading up at the start of the year, it has softened again in 2Q17. A sharp decline in food prices drove CPI inflation down to 0.0% (YoY) in May17, its lowest since Mar16 (Chart 5). Food inflation has plunged to -1.38% in May17, a 17-year low. Volatility in oil price will mean potential swings in headline CPI going forward. But demand-pull inflationary pressures remain weak, and thus, keep inflation below target. Core inflation has been practically flat at circa 0.6% so far this year. If core inflation continues at this current pace, 2017 will mark the third consecutive year of falling core inflation print. This is also the longest stretch in history that core inflation remains below 1%.

Keeping a close watch on the baht With inflation set to remain sub-2% until at least mid-2018, expect the Bank of Thailand (BOT) to keep rates steady at 1.5%. In fact, the central bank is likely to stay dovish in the near-term amid a flat trajectory in core inflation. Further rate cuts are unlikely but not to be ruled out completely. Rate cuts may be the last option for the BOT as it continues to prevent excessive baht gains. The BOT has been wary of a stronger baht. Reserves rose USD 10bn in the first four months of this year, already 2/3 of the entire amount last year. The central bank has also curbed the supply of short-term bonds in a bid to limit further foreign inflows. At the same time, verbal intervention remains prevalent, with the BOT consistently indicating its preference for a weaker baht in its policy statements. The problem is flows remain supportive of the baht. The current account (C/A) surplus is likely to shrink this year, on the back of the recovery in domestic demand. Still, at an estimated 9% of GDP, the C/A surplus is still among the highest in the region.

96

Economics–Markets–Strategy

Thailand

Thailand Economic Indicators 2016

2017f

2018f

1Q17

3.2 3.1 1.6 2.8

3.4 3.3 4.3 4.9

3.5 3.3 3.6 4.5

3.3 3.2 0.2 1.7

3.4 3.2 4.9 5.4

3.4 3.3 9.3 9.1

3.5 3.3 3.0 3.6

3.5 3.3 4.0 5.3

3.6 3.3 3.1 3.8

977 2.1 -1.4

1050 5.3 4.9

930 4.5 7.1

323 2.7 6.0

206 5.2 5.5

240 5.6 5.9

280 7.6 2.5

350 3.7 2.3

170 4.8 7.7

External Merch exports (USDbn) - % YoY Merch imports (USDbn) - % YoY Trade balance (USD bn) Current account balance (USD bn) % of GDP

215 0.5 195 -3.9 21 47 11.5

227 6.6 218 9.7 9 38 9.0

230 2.5 221 3.4 9 32 7.3

57 4.6 52 13.9 4 13 n.a.

55 7.8 53 11.9 2 10 n.a.

58 5.8 57 14.6 1 8 n.a.

58 4.7 56 7.5 2 7 n.a.

56 -0.5 53 0.8 3 7 n.a.

56 1.3 54 2.5 2 7 n.a.

Inflation CPI inflation

0.2

0.9

1.7

1.3

0.2

0.9

1.2

1.4

2.1

Other Nominal GDP (USDbn) Unemployment rate, % Fiscal balance (% of GDP)**

407 0.8 -1.0

420 1.1 -2.4

440 1.0 -2.2

n.a. n.a. n.a.

n.a. n.a. n.a.

n.a. n.a. n.a.

n.a. n.a. n.a.

n.a. n.a. n.a.

n.a. n.a. n.a.

Real output and demand GDP growth (02P) Private consumption Government consumption Gross fixed capital formation Net exports (THBbn) Exports Imports

2Q17f 3Q17f 4Q17f 1Q18f 2Q18f

* % change, year-on-year, unless otherwise specified ** central government net lending/borrowing for fiscal year ending September of the calendar year

TH - nominal exchange rate

TH – policy rate

THB per USD

%, 1-day RRP

37

4.0

36 3.5

35 34

3.0

33

2.5

32

2.0

31 30

1.5

29 28 Jan-12

1.0 May-13

Sep-14

Jan-16

May-17

Sources for charts and tables are CEIC Data, Bloomberg and DBS Group Research (forecasts are transformations).

97

Singapore

Economics–Markets–Strategy

SG: peaking • GDP growth in 1Q17 came in marginally short of expectation • The manufacturing rally is coming to an end while outlook for the services sector remains mixed • GDP growth remains on track to meet our forecast of 2.8% in 2017 and 2.5% in 2018 • Inflation will continue to rise, averaging 1.2% and 1.8% in 2017 and 2018 respectively • The central bank is in no hurry to return to an appreciation stance given a weak labour market and potentially slower growth going forward

After a strong surge in 4Q16, economic growth cycle may be nearing its peak. Manufacturing growth is likely to run sideways in the coming months. Although growth in the externally-oriented services sectors may continue to show some upside, the domestic services segment will remain a drag.

1Q17 growth in line with expectation The economy expanded by 2.7% (YoY) in 1Q17, up from 2.5% in the advance estimate previously (Table 1). On a sequential basis, the economy contracted by a smaller margin of 1.3% (QoQ saar), from 1.9%. Table 1: GDP growth by sectors 1Q16 2Q16 3Q16 4Q16 2016 Percentage change year-on-year Overall GDP 1.9 1.9 1.2 2.9 2.0 Manufacturing -0.4 1.5 1.8 11.5 3.6 Construction 3.1 2.7 -2.2 -2.8 0.2 Services producing 1.5 1.1 0.4 1.0 1.0 Quarter-on-quarter annualised growth rate, seasonally adjusted Overall GDP -0.5 0.8 -0.4 12.3 2.0 Manufacturing 12.9 3.6 -5.0 39.8 3.6 Construction -1.6 3.1 -12.6 0.8 0.2 Services producing -4.2 -0.7 1.1 8.4 1.0

1Q17 2.7 8.0 -1.4 1.6 -1.3 -1.5 4.3 -2.1

Two-speed recovery in the services sector The disappointment came from a less than expected upward adjustment in overall services growth. Although the sector posted an expansion of 1.6% (YoY), it contracted by 2.1% QoQ saar when compared to the previous quarter. The drag came from the wholesale retail trade (-2.1%), accommodation and food services (-5.2%) and financial services (-17.8%).

SINGAPORE

The domestic services clusters are mostly weighed down by structural challenges (Chart 1). The emergence of e-commerce has impacted the retail sector while the soft labour outlook remains a drag on the F&B industry. Meanwhile, the decline in financial services was mainly a technical payback, especially after a 36.5% surge in the previous quarter. With loan growth and market turnovers rising, the sector will likely flip back to expansion mode in 2Q17. Moreover, trade-related services should continue to improve. Growth of re-exports and container throughput have remained buoyant (Chart 2). Irvin Seah • (65) 6878 6727 • [email protected]

98

Economics–Markets–Strategy

Singapore

Chart 1: Domestic services sector still struggling

Chart 2: Improvement in external services segment

2014=100, constant px, sa

% YoY

105

Re-exports

14

Container throughput

10

Loan growth (RHS)

Retail sales ex motor vehicles F&B

100

% YoY 7 5

6

3

2 95

1

-2 -1

-6 90

-3

-10 Latest: Mar17

85 Jan-15

Jul-15

-14 Jan-16

Jul-16

Jan-17

Latest: Apr17

-18 Jan-15

-5 -7

Jul-15

Jan-16

Jul-16

Jan-17

Manufacturing rally could be coming to an end The manufacturing sector expanded by 8.0% (YoY) in 1Q17 but a pullback of -1.5% QoQ saar was registered. Although this was to be expected after a surge of 39.8% in the previous quarter, there are also growing signs that the manufacturing rally could be coming to an end. Latest April industrial output has moderated. The headline IP figure registered an expansion of 6.7% (YoY), down from 11% previously (Chart 3). While the slowdown could be partly attributed to the volatile biomedical cluster (-23.3%), there are signs to suggest that manufacturing may run sideways going forward. For example, PMIs in US, China and Singapore and recent NODX figures have all fallen in the latest April data set, suggesting that the run-up in global consumer demand could be waning (Chart 4 and 5). The electronics cluster, the key driver of this rally, has remained fairly resilient (+48% YoY in April). But there are lingering concerns about the sustainability of global demand for electronics towards the latter part of the year (see next section).

PMIs and NODX have all moderated

As the manufacturing sector approaches the peak, data will be increasingly mixed. This is particularly the case, given the ongoing rally has been mainly driven by only one industry. Chart 3: Manufacturing starting to run sideways YoY% 50

Latest: Apr17

30

10

-10 Electronics

Biomedical

Overall manufacturing

Manufacturing ex biomedical

-30 Jan-16

Apr-16

Jul-16

Oct-16

Jan-17

99

Singapore

Economics–Markets–Strategy

Chart 4: NODX is peaking

Chart 5: PMIs have peaked

% YoY 25

59

Index

20

EZ

57

NODX

15

Singapore

10

China US

55

5

53

0 -5

NODX 3mma

-10

51 49

-15

Latest: Apr17

-20 Jan-16

Apr-16

Jul-16

Oct-16

Jan-17

Apr-17

Latest: Apr/May17 47 Jan-15

Jul-15

Jan-16

Jul-16

Jan-17

Growth outlook to remain sanguine We continue to see full-year GDP growth at 2.8%. This is on the premise that global economic conditions continue to improve. Hope is now pinned on companies’ capex spending to increase and for consumer demand in the US to be sustained. These will definitely lend some support to the manufacturing sector in the coming months. There are also signs showing that the strong performance in the manufacturing sector is spilling over to the externally-oriented services sector. Risks remain. Tighter credit conditions and stiffer property market regulations in China could weigh down on its consumer sentiment and, indirectly, on Singapore’s export growth. Besides, the transport engineering cluster is not entirely out of the woods given that oil prices have ran sideways. Tighter monetary policy in the US and a difficult Brexit process could also weigh down on global outlook.

Growth momentum expected to slow

As such, expect growth momentum to moderate in the coming quarters. Headline growth will still inch modestly higher due to the low base effect (Chart 6). But a high base in 4Q16 means headline growth will dip towards the tail end of the year. The slower growth momentum is also expected to persist into 2018, with GDP growth projected to register 2.5% for the full year.

Chart 6: Growth outlook for 2017

Chart 7: Inflation rising

% YoY, %-pt contribution

% YoY 2.0

4.0

DBSf

Services Producing Industries

3.5

1.5

Goods Producing Industries

3.0 2.5

Latest: Apr17 Core inflation

1.0

2.0

0.5

1.5 0.0

1.0 0.5

-0.5

0.0 2016: 2.0% 2017f: 2.8%

-0.5 -1.0 Mar-15

100

Sep-15

Mar-16

Sep-16

-1.0 -1.5 Jan-16

CPI inflation

Jul-16

Jan-17

DBSf 2017f: 1.2% 2018f: 1.8%

Jul-17

Economics–Markets–Strategy

Singapore

'000 pax 5.0

Retrenchments

70

Job vacancies

4.5

65

4.0

Thousands

Chart 8: Retrenchments have risen while job vacancies have fallen

60

3.5 55 3.0 50

2.5 2.0 1.5 Mar-14

45

Latest: 4Q16/1Q17 Sep-14

Mar-15

Sep-15

Mar-16

Sep-16

40 Mar-17

Inflation still on an upward trend CPI inflation surprised on the downside, with a reading of 0.4% (YoY) in April, compared with 0.7% in March (Chart 7). This was partly due to the base effects associated with the disbursement of service and conservancy charges (S&CC) rebates. Besides that, cost of accommodation fell by 6.7%, which was offset by a 7% rise in private transport costs owing to the faster pace of increase in car and petrol prices.

Inflationary pressure is building up

Importantly, core inflation has spiked up to 1.7% (YoY) in April, up from 1.2% in the previous two months. Cost pressure is indeed building up and this could accelerate when the water price hike (15%) kicks in in July. Although the weightage of water prices in the overall CPI basket is not significant, the second-order impact of the price hike, particularly the pricing behaviour from retailers could be a risk factor. Though policy measures to soften the net impact on consumers and businesses have been introduced, the impact on prices will be direct. Inflation is likely to register 1.2% this year, before rising further to 1.8% in 2018.

MAS to remain on hold Despite the upward trend in inflation, the Monetary Authority of Singapore (MAS) is in no hurry to return to a SGD NEER appreciation stance. Apart from the fact that the upcoming bout of inflationary pressure will be largely policy-driven, the main concern is that the growth turnaround has been restricted to just a few externally-driven clusters. More importantly, the labour market has been very weak. Retrenchments have remained persistently high while job vacancies have been falling (Chart 8). Plainly, there are structural challenges weighing down on the domestic sectors and the doldrums are unlikely to dissipate in the near-term.

MAS to remain on hold despite higher inflation

An accommodative stance is likely to persist. The MAS will continue to maintain a zero rate appreciation of the SGD NEER in the near term. There are enough reasons for the authority to maintain status quo on monetary policy given the uneven pace of the recovery at present.

101

Economics–Markets–Strategy

Singapore

Singapore Economic Indicators 2016

2017f

2018f

1Q17

Real output and demand Real GDP (00P) Private consumption Government consumption Gross fixed investment Exports Imports

2Q17f 3Q17f 4Q17f 1Q18f 2Q18f

2.0 0.6 6.3 -2.5 1.6 0.3

2.8 1.4 5.7 2.9 3.0 3.6

2.5 2.8 5.1 4.4 2.3 2.2

2.7 -0.4 5.5 -0.3 5.1 5.0

3.1 0.3 3.2 1.3 2.1 3.7

3.4 2.5 6.0 5.0 1.8 3.1

1.9 3.0 8.0 5.8 2.8 2.6

2.3 2.5 3.0 4.2 2.7 2.2

2.4 2.6 5.0 4.1 2.1 1.9

Real supply Manufacturing Construction Services

3.6 0.2 1.0

8.4 0.8 1.6

2.3 0.0 2.8

8.0 -1.4 1.6

7.9 2.1 2.2

11.8 1.6 1.7

6.0 0.8 1.0

3.9 -0.1 2.3

3.2 -1.3 2.5

External (nominal) Non-oil domestic exports Current account balance (USD bn) % of GDP Foreign reserves (USD bn)

-2.8 57 20 247

2.4 58 19 267

2.3 60 19 279

15.2 n.a. n.a. n.a.

-1.2 n.a. n.a. n.a.

0.7 n.a. n.a. n.a.

-3.7 n.a. n.a. n.a.

-3.1 n.a. n.a. n.a.

1.4 n.a. n.a. n.a.

Inflation CPI inflation

-0.5

1.2

1.8

0.6

0.8

1.6

1.7

1.6

2.0

Other Nominal GDP (USDbn) Unemployment rate (%, sa, eop)

292 2.2

304 2.4

317 2.4

n.a. 2.3

n.a. 2.3

n.a. 2.3

n.a. 2.4

n.a. 2.4

n.a. 2.4

- % change, year-on-year, unless otherwise specified

SG - nominal exchange rate

SG – policy rate

SGD per USD

% pa

1.50

1.4

1.45

1.2

1.40

1.0

1.35

0.8

1.30

0.6

1.25

0.4

1.20 Jan-12

May-13

Sep-14

Jan-16

May-17

0.2 Jan-12

May-13

Sep-14

Jan-16

May-17

Sources: CEIC, Bloomberg and DBS Group Research (forecasts are transformations).

102

Economics–Markets–Strategy

Singapore

This page is intentionally left blank

103

Philippines

Economics–Markets–Strategy

PH: moderation • GDP growth is still likely to come in at 6.4% and 6.7% for 2017 and 2018 respectively • While staying supportive of the GDP growth outlook, export growth may moderate in 2H17 • Government expenditure to pick up in the coming quarters. But inventory drawdown may still mean total investment growth to ease • The passage of the government’s tax reform bill will have a bearing on both consumption and investment outlook in the medium-term • Expect a total of 50bps rate hikes in 3Q17

Normalization has kicked in. GDP growth eased to 6.4% (YoY) in 1Q17, down from 6.6% in 4Q16, which was already slower than 7.1% in 2Q and 3Q16. The numbers are likely to get softer in 2Q and 3Q17. It is partly due to the base effects however, as the underlying growth drivers remain firm. We maintain our GDP growth forecasts at 6.4% and 6.7% for 2017 and 2018 respectively. Private consumption growth came in a slightly disappointing 5.7% in 1Q17, partly distorted by last year’s election effects (Chart 1). The high frequency data continue to be supportive of the outlook ahead. Retail sales averaged a robust 19.3% (YoY) in 1Q17. Motor vehicles sales have eased but remain strong at the current 18% pace. Foreign remittances hit a record-high of USD 2.6bn in Mar17 and set to continue to bolster consumption growth. Expect government expenditure to pick up pace in the coming quarters. Up to Apr17, fiscal spending rose by a mere 2% (YoY), way below the 14.6% jump in 2H16. The pace of spending is also slower than the 5.9% growth in fiscal revenues in the year-to-date. If revenue growth is sustained at the current pace, government

Chart 1: Consumption growth hovering around its 5-year average % YoY

DBSf

8.0 7.5 7.0 6.5

2012-16 average: 6.2%

6.0 5.5

PHILIPPINES

5.0 4.5 4.0 Sep-12

Sep-13

Sep-14

Sep-15

Gundy Cahyadi • (65) 6682 8760 • [email protected]

104

Sep-16

Sep-17

Economics–Markets–Strategy

Philippines

Chart 2: Contribution to GDP growth

Chart 3: Inventory build-up slowing down

YoY, %-pt contribution

PHP bn, 00P, 4q-rolling sum

15

100 80

Private consumption + GFCF 10

60 40

5

20 0

0

-20 -40

-5 -10 Mar-14

Mar-15

Mar-16

Latest: Mar17

-60

Net exports Mar-17

-80 Mar-13

Mar-14

Mar-15

Mar-16

Mar-17

spending growth needs to hit about 9% (YoY) in 2H17, for the budget deficit to come in within the 3% of GDP target. Exports of goods and services rose 20.3% (YoY) in 1Q17, highest since mid-2010. The strong performance was led by exports of merchandise goods, benefitting from stronger global demand for electronics. Exports of electronic products were up a solid 15% in the period, the key reason that spurred the manufacturing sector to accelerate to 7.5% (YoY) in the period, from 7.0% in 4Q16. While staying supportive of the GDP growth outlook, expect export growth to moderate in 2H17. In fact, exports data from elsewhere in the region suggest that this moderation might have even started in 2Q17. Not that the moderation in export growth will matter so much for the GDP growth outlook though. Given that import growth has been just as strong, contribution from net exports to GDP growth has actually been negative for 9 consecutive quarters since 1Q15 (Chart 2).

Investment growth to ease but still lead the way Moderation is also underway in investments. Change in inventories slipped back into the negative in 1Q17, after the unexpected surge in 4Q16. Inventories are now practically flat on a 4-quarter rolling sum basis (Chart 3). Expect to see inventory drawdown picking up pace going forward, keeping overall investment growth in check. Nonetheless, data still suggest investment growth staying close to the double-digits this year. Loan growth has ticked up to 18% (YoY) in 1Q17, from 16.9% at the end of last year. Imports of capital goods are also up a healthy 9.3% in the year up to Mar17. Overall investment growth may come in at 9.8% this year, still pretty strong considering the high base effects from 2016. Meanwhile, the government’s infrastructure overhaul has continued to draw interest from foreign investors. Actual foreign direct investment (FDI) jumped 40% to a record-high USD 7.9bn in 2016 (Chart 4). As a percentage of GDP, it was also at a record-high of 2.6% last year, up markedly from an average of 1.8% in the previous 3 years.

Investment growth likely to come in at 9.8% this year

Watching progress of the tax reform bill More reforms are necessary for FDI growth to be sustained going forward. Other than further liberalization in the economy, it is also important for the government to push forward the proposed changes to corporate taxes. The second package of the Comprehensive Tax Reform Package (CTRP) is expected to be tabled in the par-

105

Philippines

Economics–Markets–Strategy

Chart 4: Foreign direct investment

Chart 5: Inflation trend

BOP basis, % of GDP

% YoY

3.0

5 4

2.5

Latest: May17

3

2.0

2 1.5

1

1.0

0

0.5

-1

0.0

-2 May-15

Food 07

08

09

10

11

12

13

14

15

16

Nov-15

Transport May-16

Core CPI Nov-16

May-17

liament later this year. The government aims to lower corporate taxes to 25% from 30% currently, making the Philippines more competitive regionally. The lower house has actually passed the first package of the CTRP at the end of May. Among the changes under the bill, income tax rates will be lowered, with the maximum set at 30% by 2020, except for the highest income bracket. To offset the fall in tax revenues, new excise taxes will be introduced for non-alcoholic sweetened beverages, diesel and liquefied petroleum gas. Higher duties will also be imposed on gasoline, kerosene, as well as automobiles. The tax reform bill will still need to be approved by the Senate before the government can sign it into law. The earliest this is likely to be done is in July before the changes are to be effective in Jan 2018. The impact on public investment growth is clearly a positive. An additional PHP 82bn worth of revenues is expected for the government, about 3% of a typical annual expenditure budget. But expect the impact on private consumption growth to be only a slight positive, given some modest impact on inflation.

Rate hikes are imminent

The BSP seems to be slightly behind the curve in policy tightening

We revised our CPI forecasts higher to 3.2% for both 2017 and 2018, up from 2.8% and 3.0% previously. Inflation has been inching higher since the start of the year, driven by food and transport prices (Chart 5). Transport inflation is set to rise further towards the year-end, particularly given the low base effects from 2016. Furthermore, expect second-round impact from the increased levies under the tax reform bill, even if the direct impact is likely to be modest. While our current inflation forecasts still fall within the Bangko Sentral ng Pilipinas’ (BSP) official target of 2-4%, we reckon that rate hikes are imminent. Coupled with upside risks to inflation, growth remains fairly robust. Indeed, given the aggressive infrastructure overhaul, there is need to manage overheating risks in the economy. Investment growth has now averaged 20% since 2015, well above the average of 6.2% in the 10-year period before that. At 18% (YoY) in 1Q17, loan growth has also approached its record-high of 20% seen in 2014. The BSP may be even slightly behind the curve in normalizing its monetary policy. We reckon that rate hikes might have been delayed due to the imminent change in the BSP leadership. The new governor will take over on July 3. Given that he is a career central banker, expect a smooth transition. Among others, long-term growth sustainability remains as a key priority. Against this backdrop, look for a total 50bps rate hikes in 3Q17.

106

Economics–Markets–Strategy

Philippines

Philippines Economic Indicators 2016

2017f

2018f

1Q17

6.9 7.0 8.4 25.2

6.4 5.9 2.4 9.8

6.7 6.6 9.8 12.7

6.4 5.7 0.2 11.8

6.2 5.4 1.5 10.7

6.3 5.8 4.1 8.0

6.6 6.5 4.1 8.9

6.7 6.7 11.1 11.7

6.8 6.7 9.1 11.9

-631 10.7 18.5

-675 7.3 8.4

-632 7.0 9.2

-184 20.3 17.5

-40 20.5 13

-171 14.8 19

-278 12.5 13

-170 8.5 6.2

-37 8.3 7.8

57 -3 84 18 -27

65 13 94 12 -30

67 4 98 5 -31

16 19 22 16 -7

16 16 23 14 -7

17 13 25 20 -8

16 13 24 14 -8

16 5 23 5 -7

17 1 23 1 -7

1 0.2 82

-1 -0.3 82

-3 -1.0 80

n.a n.a n.a

n.a n.a n.a

n.a n.a n.a

n.a n.a n.a

n.a n.a n.a

n.a n.a n.a

Inflation CPI inflation

1.8

3.2

3.2

3.2

3.3

3.4

3.1

3.2

3.3

Other Nominal GDP (USD bn) Budget deficit (% of GDP)

304 -2.4

308 -2.6

315 -2.7

n.a n.a

n.a n.a

n.a n.a

n.a n.a

n.a n.a

n.a n.a

Real output and demand Real GDP growth Private consumption Government consumption Gross fixed capital formation Net exports (PHP bn, 00P) Exports Imports External (nominal) Merch exports (USD bn) - % YoY Merch imports (USD bn) - % YoY Merch trade balance (USD bn) Current account balance (USD bn) % of GDP Foreign reserves, USD bn

2Q17f 3Q17f 4Q17f 1Q18f 2Q18f

* % change, year-on-year, unless otherwise specified

PH - nominal exchange rate

PH – policy rate

PHP per USD 52

%, o/n rev repo 4.5

50 4.0 48 3.5

46 44

3.0 42 40 Jan-12

May-13

Sep-14

Jan-16

May-17

2.5 Jan-12

May-13

Sep-14

Jan-16

May-17

Sources for charts and tables are CEIC Data, Bloomberg and DBS Group Research (forecasts are transformations).

107

Vietnam

Economics–Markets–Strategy

VN: cautiously optimistic • Despite the disappointment in first quarter GDP growth, outlook remains fairly sanguine • GDP growth forecasts have been lowered to take into account the growth hiccups in 1Q17 and a slower growth momentum ahead • Inflation will continue to ease, which will provide room for the central bank to maintain the current accommodative monetary policy stance

Growth outlook remained sanguine despite a disappointing first quarter GDP growth of 5.1% (YoY). Higher frequency data are suggesting that growth momentum is picking up. On the other hand, inflation is easing. As a result, the central bank will likely keep rates steady and maintain an accommodative monetary policy stance for the rest of the year.

First quarter growth “hiccups” GDP growth surprised on the downside in 1Q17 (Chart 1). The headline growth figure reported an expansion of 5.1% (YoY), significantly lower than expected. Growth in the agriculture sector doubled to 1.4% (YoY) but all the remaining key sectors reported slower growth. The manufacturing sector moderated to 8.3% (YoY), from 11.9% previously. Essentially, Samsung’s decision to stop production of the Galaxy Note 7 has caused a 10.7% drop in exports related to the production of mobile phones. This was notable as Samsung is Vietnam’s largest exporter. Additionally, the mining industry contracted 11.4% (YoY) during the first quarter, shaving a whopping 2.5%-pts off GDP growth. A combination of industry specific factors and higher tax on natural resources are weighing down on the sector. Likewise, the construction and the services sectors also reported slower growth of 6.5% and 6.1%, possibly due to some negative spillover effects from the other sectors. Chart 1: Disappointment in 1Q17 GDP growth % YoY 18 16 14 12

Real GDP growth Construction Agri, forestry & fishery Industry Services

10 8 6

VIETNAM

4 Drought

2 0 -2 Mar-14

Latest: 1Q17 Sep-14

Mar-15

Sep-15

Irvin Seah • (65) 6878 6727 • [email protected]

108

Mar-16

Sep-16

Mar-17

Economics–Markets–Strategy

Vietnam

Chart 2: Export growth marching steadily north % YoY 40

Chart 3: Upswing in global electronics cycle % YoY 80

Latest: May17

% YoY 20

Semicon billing, 3mma

70

Semicon shipments, 3mm a (RHS)

15

60

30 Exports growth

50

10

40

20

5

30 20 10

0

10 Tet New Year

0 Jan-16

Apr-16

Jul-16

Oct-16

Jan-17

-5

0 Apr-17

Latest: Mar/Apr17

-10 Jan-15

Jul-15

Jan-16

Jul-16

-10

Jan-17

Growth forecast lowered Despite the disappointment, one has to realise that data reliability in emerging economies is often an issue. For example, the economy somehow has a tendency to start the year on a slow note. GDP growth for the first quarter has been the slowest over the past four years. Whether this is really the case or is merely a statistical reporting problem is anyone’s guess. Nevertheless, our previous GDP growth forecast of 6.6% appears stretched after taking into account the disappointment in 1Q17 GDP. Assuming external demand to strengthen and domestic conditions to steadily improve (see below section), GDP growth is expected to register 6.3% in 2017, before inching marginally higher to 6.4% in 2018.

GDP growth to register 6.3% in 2017

Optimism remains intact Indeed, outlook on the external front has been buoyant with recent export numbers being exceptionally strong. Latest May exports surged by 19.9% (YoY) against the backdrop of a global electronics upswing and improving commodity prices (Chart 2 & 3). In fact, export growth after the Tet New Year dull (Feb-May) has averaged a solid 21.5% (YoY), significantly stronger than the full-year average of 8.9% in 2016. Going forward, export growth is expected to remain strong, particularly with the launch of the new Samsung Galaxy S8 phone. Chart 4: Retail sales growth above historical average

Chart 5: Dip in trade balance drove dong weaker

% YoY

USD mn 1000

16 14

Weaker VND

22800

500

22600

Retail sales

12

0

10

22400 22200

-500

8 6

22000

-1000

4 2 Apr-16

Jul-16

Oct-16

Jan-17

21800

USD-VND (RHS)

21600 21400

Latest: May17

0 Jan-16

Trade balance

-1500

Latest: May17 Apr-17

USD/VND 23000

-2000 Jan-16

21200 Jul-16

Jan-17

109

Vietnam

Economics–Markets–Strategy

Chart 6: Both core and headline inflation have eased

Chart 7: Key drivers of inflation

% YoY

% YoY

6.0 5.0

Core inflation Overall CPI inflation

70

Healthcare

60

Transport

50

4.0

Education

40 30

3.0

20 10

2.0

0

1.0 Latest: May17

-10

Latest: May17

-20

0.0 Jan-16 Apr-16

Jul-16

Oct-16

Jan-17 Apr-17

Jan-16 Apr-16

Jul-16

Oct-16

Jan-17 Apr-17

Effects of the strong export performance has also spilled over to the domestic sector. Private consumption has strengthened, with retail sales growth averaging 11.7% (YoY) for the first five months of the year (Chart 4). This is up from 8.4% in 2016. Higher income growth in the export sector and positive wealth effect from a booming property market probably have provided impetus to domestic consumption.

Risks on trade balance

Trade deficit put pressure on the dong

However, the surge in domestic consumption and exports have also brought about an increase in demand for imports. For example, a significant portion of the parts and components used in electronics manufacturing are imported. The local valueadded in the manufacturing process is not significant. Coupled with the domestic spending in imported consumer goods, there has been a deterioration in the trade balance. Trade balance registered a massive deficit of USD 2.6bn in the first five months of the year (Chart 5). While expectation is that this will improve towards the latter part of the year, the point is that this is a 290% decline compared to the same period last year. The dong has depreciated since 2H16 partly due to the falling trade balance and will likely remain under pressure in the coming months.

Inflation easing On a separate note, inflationary pressure has remained benign. In fact, headline inflation has peaked and is still trending downward on account of the high base last year (Chart 6). Latest May CPI inflation registered 3.2% (YoY), down sharply from 4.3% in the previous month. Barring any adverse weather-related factors, inflation is set to moderate throughout the course of the year even with some anticipated fiscal rationalisation.

SBV to maintain accommodative stance

Indeed, fiscal consolidation resulting in spikes for healthcare and education costs has been the main reason for the most recent bout of inflation (Chart 7). But there hasn’t been any further hike in education costs. And despite a recent fee increase for healthcare in April, the high base last year has helped to keep healthcare inflation in check. These essentially imply that headline inflation will continue to moderate in the coming months. We now expect inflation to average 3.7% in 2017 before easing to 3.2% in 2018. Easing inflation and the growth disappointment in 1Q17 mean that the State Bank of Vietnam (SBV) would have to keep monetary policy accommodative in the shortto medium-term. We continue to expect the SBV to maintain the policy rate at 6.50% in the months ahead.

110

Economics–Markets–Strategy

Vietnam

Vietnam Economic Indicators 2016

2017f

2018f

1Q17

Real output and demand GDP growth

6.2

6.3

6.4

5.1

6.4

6.5

7.0

6.3

6.1

Real supply Agriculture & forestry Industry Construction Services

1.4 7.1 10.0 7.0

2.3 7.6 8.0 6.7

2.6 8.2 7.6 6.6

2.0 3.9 6.1 6.5

2.2 9.2 7.9 6.7

2.4 8.0 8.5 6.9

2.6 9.4 9.5 6.7

2.3 8.0 8.0 6.4

2.5 9.0 7.0 6.6

External (nominal) Exports (USD bn) Imports (USD bn) Trade balance (USD bn)

176.7 174.2 2.5

207.1 209.3 -2.1

239.8 239.3 0.5

44.7 46.7 -2.0

52.1 52.8 -0.7

54.5 52.4 2.0

55.9 57.3 -1.5

54.9 54.3 0.6

59.2 60.0 -0.8

8.5 4.1

7.6 3.4

8.0 3.2

n.a. n.a.

n.a. n.a.

n.a. n.a.

n.a. n.a.

n.a. n.a.

n.a. n.a.

Inflation CPI inflation (% YoY)

2.6

3.7

3.2

5.0

3.5

3.6

2.7

3.1

3.7

Other Nominal GDP (USDbn) Unemployment rate (%, sa, eop)

205 2.4

226 2.3

248 2.2

n.a. n.a.

n.a. n.a.

n.a. n.a.

n.a. n.a.

n.a. n.a.

n.a. n.a.

Current account bal (USD bn) % of GDP

2Q17f 3Q17f 4Q17f 1Q18f 2Q18f

- % change, year-on-year unless otherwise specified

VN - nominal exchange rate

VN – policy rate

VND per USD

% pa

23000

16.0

22500

14.0

22000

12.0

21500

10.0

21000

8.0

20500 Jan-12

May-13

Sep-14

Jan-16

May-17

6.0 Jan-12

May-13

Sep-14

Jan-16

May-17

Sources: CEIC, Bloomberg and DBS Group Research (forecasts are transformations).

111

Economics: United States

Economics–Markets–Strategy

US: a series of hikes • The economy continues to grow at a 2% pace • Down to 4.3%, unemployment is among its lowest levels since WWII • Housing and consumption continue to grow significantly faster than GDP overall. And with the stabilization in crude prices, investment is now returning as a driver of GDP as well • Markets think a Fed hike in June is nearly a done deal. That would make three hikes in three quarters. That’s just the beginning, we think. Expect one hike per quarter through mid-2019

The economy continues to grow at the 2%-2.1% pace it has since late-2010. This has kept job growth running at 165k / month, whether measured over the past two or the past six months. It sounds as if nothing is changing but of course things are: the labor market is getting tighter and tighter and inflation has been on the rise for more than a year. The latter has eased back in the past two months, thanks to a temporary drop in oil prices. But crude has firmed again and the fig leaf offered to prices won’t last beyond May. Growth remains steady and inflation trends are unmistakably northward. The Fed is modestly behind the curve. It has hiked rates in each of the past two quarters and markets fully think there’s a 90% chance that June will make it threefor-three. That’s not the end of it, we think. Virtually everything is back to normal in the economy, save for the Fed, which, as San Francisco Fed President Williams puts it, “still has the pedal to the metal.” The Fed needs to hike 8-9 more times before policy rates can be considered normal and, at one hike per quarter, that would take a long time. We do not think the Fed will waste any more of it. Investors should expect one hike per quarter until mid-2019. That, in a nutshell, is the view. The somewhat longer version follows below.

US - private sector nonfarm payrolls private sector NFP x1000, sa 400

Apr11

Jan12 Nov14

Oct15 Jun16

300

May17

UNITED STATES

200

100

0 Jan-11

May16

Jan-12

Jan-13

Jan-14

Jan-15

David Carbon • (65) 6878-9548 • [email protected]

112

Jan-16

Jan-17

Economics–Markets–Strategy

Economics: United States

US – unemployment rate %, sa 12 10 8 6 4 Dotcom boom

Vietnam War

2

Yellen boom?

Subprime boom

0 60

64

68

72

76

80

84

88

92

96

00

04

08

12

16

GDP grew at a 1.2% (QoQ, saar) pace in the first quarter. That sounds low but first quarter growth has looked fishy for the past 5-6 years. Most suspect gremlins playing with the seasonal adjustment factors. We’re more inclined to simply chalk it up to volatility and point to the on-year growth figure, which, at 2%, remains identical to the average growth rate of the past 6 years. On the surface, consumption accounts for the soft GDP figure in Q1. The former advanced by a mere 0.6% (QoQ, saar), which, again, sounds awfully low for such an important base load driver of GDP. In fact it’s just ‘payback’ for the three quarters that preceded it when growth averaged a truly over-the-top 3.5%. In on-year terms, consumption growth continues to roll ahead at a 2.8% pace, almost a full one-third faster than GDP overall.

Unemployment has fallen to among its lowest levels since WWII

The main change we expect to see in GDP going forward is for consumption to cool to a more sustainable pace and for business investment to rise to a more normal pace. Growth in the latter averaged but 0.25% (QoQ, saar) over the 8 quarters of 2015/16, thanks to the collapse in crude prices and other oil-related activity. With the stabilization in oil prices over the past year, business investment has begun to regain consciousness. It grew by 11% (QoQ, saar) in the first and though we do US - job vacancy rate vacancies as % of unemployed 100

Yellen bubble?

Dotcom bubble

80 60 Subprime bubble

40 20 0 Jan-01

Jan-03

Jan-05

Jan-07

Jan-09

Jan-11

Jan-13

Jan-15

Jan-17

113

Economics: United States

Economics–Markets–Strategy

US – home prices Index, Case-Shiller, sa 180 170 160

Home prices are well and truly past their pre-crisis peaks

WestCoast

Apr06

Mar17

Nat avg

150 140 130 34% drop

120 Jan03

110 100 90 02

03

04

05

06

07

08

09

10

11

12

13

14

15

16

17

not expect it will remain that fast going forward, we do expect to see growth in the 3%-5% range. If so, and if consumption growth cools to the 2% pace we anticipate, then GDP growth overall should remain close to the 2% rate that has prevailed since late-2010. Fingers crossed. In the meantime, housing prices continue to grow rapidly and labor markets continue to tighten. Case-Shiller home prices rose by another 1% (MoM, sa) in March, taking them even further above the pre-crisis levels that they surpassed a couple of months ago (chart above). Prices rose at a 6% on-year pace and appear to be accelerating, thanks to mortgage rates that, at 3.10% for a 15Y fixed rate loan, are at post-WWII lows – barely 1% after adjusting for inflation. The unemployment rate has fallen to one of its lowest levels in the post-war period – 4.3% at last count – but that’s only half the story. Job vacancies continue to rise and, at nearly 6 million, are equivalent to 3.6% of the labor force. Put differently, 84% (3.6/4.3) of today’s unemployment would vanish overnight if we could match those looking for work with companies looking to hire. From this angle, unem-

US - headline inflation %YoY

Inflation trends are as logical as they are unmistakable

3.6 3.2 Latent trend

2.8 2.4

CPI

2.0 1.6 1.2

Oil price collapse

0.8

PCE

0.4 0.0 -0.4 Jan-11

114

Jan-12

Jan-13

Jan-14

Jan-15

Jan-16

Jan-17

Economics–Markets–Strategy

Economics: United States

US Economic Indicators 2016

2017(f) 2018(f)

2016 Q4

Q1

--- 2017 --Q2 (f) Q3 (f)

Q4 (f)

--- 2018 --Q1 (f) Q2 (f)

Output & Demand Real GDP* Private consumption Business investment Residential construction Government spending

1.6 2.7 -0.5 4.9 0.8

2.2 2.5 4.2 6.4 0.2

2.5 2.2 4.2 4.0 1.9

2.1 3.5 0.9 9.6 0.2

1.2 0.6 11.4 13.7 -1.1

2.7 3.0 1.0 7.0 1.0

2.7 2.5 4.0 6.0 1.5

2.8 2.3 6.0 5.0 2.0

2.4 2.1 4.0 4.0 2.0

2.3 2.0 4.0 3.0 2.0

0.4 1.1 -563 22

3.7 4.4 -602 8

4.4 3.7 -610 10

-4.5 8.9 -605 50

5.9 3.8 -600 4

5.1 4.0 -600 8

4.7 4.0 -602 10

4.5 4.0 -605 10

3.5 3.0 -607 10

4.7 4.0 -609 10

Contribution to GDP (pct pts) Domestic final sales (C+FI+G) Net exports Inventories

2.1 -0.1 -0.4

2.5 -0.2 -0.1

2.6 0.0 0.0

2.9 -2.0 1.0

2.2 0.1 -1.1

2.6 0.0 0.1

2.7 0.0 0.0

2.9 -0.1 0.0

2.5 0.0 0.0

2.4 0.0 0.0

Inflation GDP deflator (% YoY, pd avg) CPI (% YoY, pd avg) CPI core (% YoY, pd avg) PCE core (% YoY, pd avg)

1.3 1.5 2.2 1.7

1.8 2.5 2.3 1.9

2.1 2.3 2.3 2.2

1.8 2.2 1.7

2.6 2.2 1.7

2.5 2.2 1.7

2.4 2.4 1.9

2.3 2.4 2.1

2.3 2.3 2.2

2.3 2.3 2.2

External accounts Current acct balance ($bn) Current account (% of GDP)

-481 -2.6

-522 -2.7

-566 -2.8

18.6 -3.1

19.3 -3.3

20.2 -3.5 148 4.7

166 4.3

165 4.2

175 4.1

165 4.1

160 4.1

150 4.0

Exports (G&S) Imports (G&S) Net exports ($bn, 09P, ar) Stocks (chg, $bn, 09P, ar)

Other Nominal GDP (US$ trn) Federal budget bal (% of GDP) Nonfarm payrolls (000, pd avg) Unemployment rate (%, pd avg)

* % period on period at seas adj annualized rate, unless otherwise specified

ployment is at its lowest on record. Of course skill sets (and geographic location) of what’s on offer may not match up with what’s being demanded but to this extent, unemployment is no longer cyclical, it’s ‘structural, and monetary policy has done all it can do. As noted, inflation has been rising for more than a year (chart previous page). Continued growth and ever-tighter labor markets will extend that trend. The Fed has hiked twice in two quarters and markets think it will be three-for-three in another week’s time. Rates still have a long way to go before they can be considered normal. Assuming inflation of 2%, Fed funds need to rise to 2.75%-3%, or by another 8-9 hikes. At a pace of one hike quarter, that would take another 2 years – a long time, in other words. The Fed wants to move gradually but it may not have that luxury. One should expect one hike per quarter until mid-2019 with the risk that the Fed has to up the pace before then.

Expect one hike per quarter until mid-2019 with the risk that the Fed has to up the pace before then

Sources for charts and tables are CEIC Data, Bloomberg and DBS Group Research (forecasts are transformations).

115

Economics-Markets-Strategy

Japan

JP: no success yet • The short-term growth outlook is improving as exports pick up and consumption recovers • Growth forecast for 2017 has been lifted to 1.3% from 1.0% previously • But inflation is likely to stay below 1% for quite some time. Price expectations remain weak and the output gap is just slightly positive • It is too early for the BOJ to celebrate policy success and to exit QQE

Just like in other parts of the region, GDP growth in Japan picked up at the start of this year. At 2.2% (QoQ saar, preliminary), 1Q growth was the strongest in four quarters and well above consensus expectations. On account of the betterthan-expected 1Q outrun, we have revised up GDP growth forecast to 1.3% for 2017, compared to the 1.0% projected three months ago. The forecast for 2018 is trimmed to 1.0% from 1.1%, reflecting the high base effects.

Exports picking up The current round of recovery is largely driven by external demand. Custom exports, whether measured in nominal or real terms, have accelerated to 7-8% (YoY) in JanApr (Chart 1). Total exports of goods and services, as captured by the GDP statistics, also posted a strong rise of 8.9% (QoQ saar) in 1Q. Exports are expected to continue to lead recovery in the next few quarters. Global growth is on track to achieve 3.5% this year, the highest seen since 2012, according to IMF projections. Japan’s cyclically-sensitive exports like electronics and automobiles should well benefit from the increase in global demand. Meanwhile, the risk of US trade protectionism has abated. The US Treasury didn’t label Japan as a currency manipulator in the recent evaluation report. During US

Chart 1: Exports growth picked up since 1Q17

Chart 2: Consumption recovered from the tax hike

% YoY

2005p, JPY trn, sa

20

Nominal Real

JAPAN

15

310 305

10

300

5

295

0

290

-5

285

-10

280

-15 Jan-13

Jan-14

Jan-15

Jan-16

Jan-17

275 1Q08

2014 sales tax hike

1Q10

Ma Tieying • (65) 6878 2408 • [email protected]

116

1Q12

1Q14

1Q16

Economics-Markets-Strategy

Japan

Vice President Pence’s visit to Tokyo in April, the White House conveyed that it wants Japan to address trade imbalance with the US through further opening its markets to American companies. Restricting Japanese exports to the US doesn’t seem to be the preferred option.

Consumption also recovers Domestic demand is also recovering. Private consumption expenditure registered 1.4% (QoQ saar) rise in 1Q, notably higher than the 0.2% in 4Q16. Another quarter of solid growth appears underway in 2Q, which is evidenced by gains in April retail sales and household spending. Admittedly, from a longer-term perspective, consumption is still on a low-growth path. It has taken about three years for consumer spending to recover from the slump caused by the 2014 sales tax hike (Chart 2). During the post-tax hike period, PCE growth has been running at an average of just 0.8%. We expect consumption to grow about 1% this year. As the recovery in exports proceeds, the labor market will tighten and job opportunities will increase. This is already happening. The seasonally-adjusted unemployment rate has dropped to 2.8% in May, the lowest in over two decades. Job quality is also improving, as the government urges companies to reduce the number of working hours and to increase the hiring of regular workers. A better labor market outlook should help encourage Japanese consumers to spend.

What’s lacking in the current recovery is a rise in wage growth

What’s lacking, however, is a rise in wage growth. In theory, companies should hike wages when the labor market tightens. But Japan’s case is unique. Due to the deeprooted deflation mindset over the past two decades, companies tend to be cautious about raising wages and are reluctant to pass on higher costs to consumers through raising goods/services prices. Total and base wages grew only marginally as of April, by 0.5% (YoY) and 0.4% respectively (Chart 3). On the whole, large companies reported disappointing results during the labor negotiations this spring, which suggests that the near-term wages outlook will remain lackluster.

Inflation will stay below 1% In contrast to strong GDP figures, price indicators remain sluggish. Headline CPI stood at an average of 0.3% (YoY) in Jan-Apr. CPI less fresh food and energy was even lower, at 0.1% (Chart 4). Our inflation forecasts remain unchanged compared to three months ago, at 0.5% for 2017 and 0.6% for 2018. The economy’s output gap has turned positive, but not enough to push up inflation. As of 1Q17, the output gap remains small at 0.3% of GDP – long-term trend growth is now estimated at 1% based on the government’s new statistical methods. Such

Chart 3: Wage growth still weak

Chart 4: Inflation remains around 0%

% YoY

% YoY (VAT-adjusted)

2

2.0

Headline CPI Core CPI Core-Core CPI

1.5

1

1.0

0

0.5 -1 0.0 -2

Base wages

-0.5

Total wages -3 Jan-13

Jan-14

Jan-15

Jan-16

Jan-17

-1.0 Jan-13

Jan-14

Jan-15

Jan-16

Jan-17

117

Economics-Markets-Strategy

Japan

Chart 6: Base money growth slowed

Chart 5: Output gap vs. inflation 2q lag, % YoY

% of GDP 6

2.5

90

QQE2 (Oct14)

80

4

1.5

2 0.5 0 -0.5 -2

70 60 50 40 30

Output gap

-4 -6 1Q01

YoY, JPY trn

CPI (RHS) Core CPI (RHS) 1Q04

1Q07

1Q10

1Q13

-1.5

20

QQE1 (Apr13)

10 -2.5

1Q16

0 Jan-13

Jan-14

Jan-15

Jan-16

Jan-17

a small output gap will only take inflation to about 0.5% in 2H17, according to historical experience (Chart 5).

Expect inflation to rise only slightly to 0.5% in 2H17

It is also important to note that the Phillips curve remains flat. The BOJ has been aiming for a steeper Phillips curve in the past few years – boosting inflation expectations directly through quantitative and qualitative easing. But the impact of QQE was only one-off. Inflation expectations rose temporarily in 2013-14 and fell back thereafter. For now, the corporate sector expects inflation to rise just 0.7% in one year, according to the 1Q Tankan survey. As such, the shape of the Phillips curve hasn’t changed substantially compared to in the past.

The BOJ is not ready to exit The Bank of Japan kept the short-term policy rate and the long-term JGB yield target unchanged at the latest meeting in April, at -0.1% and “around 0%” respectively. In terms of the quantity of asset purchases, the BOJ has made a tweak. The pace of base money expansion has stayed below the official guideline of JPY 80trn so far this year, at an average of JPY 74trn (YoY) in Jan-May (Chart 6). We expect the BOJ to continue to keep rates unchanged in the rest of this year, and conduct asset purchases in a flexible manner in response to the change in market conditions. It remains too early to say that the BOJ has started the process of unwinding asset purchases. Thanks to the retreat in global yields early this year, the BOJ has quietly reduced bond purchases without putting upward pressure on the JGB yields. But market conditions can change. Global yields could rise again in 2H17 due to the Fed’s tightening and the ECB’s tapering, which would create spillover effects in the JGB market and require the BOJ to increase bond purchases to respond. This happened last year. The BOJ stepped up bond purchases to contain the rise in JGB yields in end-2016, as global yields rose synchronously after the US election. Base money growth, as a result, reaccelerated to JPY 79trn in Nov-Dec16 after a temporary slowdown to JPY 74trn in Sep-Oct16. A significant turn in monetary policy – rate hikes and a progressive unwinding of asset purchases – still appears unlikely for the next few quarters. A clear uptrend in consumer prices should be an important precondition for monetary policy to be normalized. While the 2% inflation goal is too ambitious and unrealistic, 1% should still be needed to assure the BOJ that the economy has come out of deflation and returned to a virtuous cycle of recovery. If without a notable improvement in inflation figures, it would be difficult for the BOJ to celebrate policy success and to formally exit QQE. In accordance with our forecast for weak inflation in 2H17, we think the BOJ will keep policy largely unchanged.

118

Economics-Markets-Strategy

Japan

Japan Economic Indicators 2016

2017f

2018f

1Q17

Real output and demand GDP growth Private consumption Government consumption Private & public investment

1.0 0.4 1.5 0.9

1.3 0.9 0.8 1.6

1.0 0.8 1.7 1.4

1.6 1.0 -0.6 2.0

1.5 1.0 0.8 1.2

1.2 0.8 1.2 1.7

1.1 1.0 1.7 1.3

0.9 0.8 1.9 1.5

0.8 0.8 1.9 1.4

Net exports (JPYtrn, 11P) Exports Imports

-4.0 1.2 -2.3

-1.5 6.2 2.8

-1.7 2.4 2.6

-0.5 6.1 1.3

-0.1 8.2 3.0

-0.3 6.7 3.9

-0.5 3.9 3.2

-0.6 2.3 2.5

-0.1 2.4 2.6

70 -7.4 66 -15.8 4

76 9.2 75 13.3 2

78 2.1 77 3.3 1

19 8.2 19 8.5 0

19 9.9 18 16.1 1

19 12.0 19 17.1 0

20 6.7 19 12.1 0

19 1.1 19 4.3 0

19 2.4 19 3.0 1

187 3.8

160 3.4

150 3.2

-

-

-

-

-

-

1,217

1,225

1232

-

-

-

-

-

-

Inflation CPI, % YoY

-0.1

0.5

0.6

0.3

0.5

0.7

0.3

0.5

0.6

Other Nominal GDP (USD bn) Unemployment rate (%, sa, eop) Fiscal balance (% of GDP)

4938 3.1 -6.0

4776 2.9 -5.9

4735 2.9 -5.6

2.8 -

2.9 -

2.9 -

2.9 -

2.9 -

2.9 -

External (nominal) Merch exports (JPY trn) - % YoY Merch imports (JPY trn) - % YoY Merch trade balance (JPY trn) Current acct balance (USD bn) % of GDP Foreign reserves (USD bn)

2Q17f 3Q17f 4Q17f 1Q18f 2Q18f

* % growth, year-on-year, unless otherwise specified

JP - nominal exchange rate

JP – policy rate

JPY per USD

%, call 0.3

135 125

0.2

115 0.1

105 95

0.0 85 75 Jan-12

May-13

Sep-14

Jan-16

May-17

-0.1 Jan-12

May-13

Sep-14

Jan-16

May-17

Sources for charts and tables are CEIC Data, Bloomberg and DBS Group Research (forecasts are transformations).

119

Eurozone

Economics–Markets–Strategy

EZ: encouraging • The Eurozone economy enters its fourth year of expansion, with growth likely to average a steady 1.7% this year • Household consumption will remain supportive, while investment spending turns a corner on improving capacity utilisation and favourable financing costs • Strong 1H17 inflation is likely to soften in 2H17, giving the ECB some breathing room • The ECB needs to draw a line between taper and hikes. We expect another round of rollback in QE purchases, effective next year • Brexit developments and next set of elections will draw attention in 2H17

The Eurozone economy has entered its fourth year of expansion (Chart 1). Improving sentiment, particularly confidence indices and PMIs, is translating into better hard data (Chart 2). Growth is likely to register a steady 1.7% YoY (revised from 1.6%). Private consumption will pull the growth cart, though its contribution might moderate as firm inflation and higher commodity prices erode real disposable incomes. Wage growth has also been subdued despite a falling unemployment rate. Investment growth is expected to pick part of the slack, while government expenditure moderates in the interest of fiscal consolidation. Some leeway is likely on a selective basis, with France a case in point where the incoming government will be required to keep the fiscal deficit within the Maastricht Treaty’s -3.0% of GDP threshold. Additional spending towards migration / asylum seekers and security threats will also need to be worked into the math. Higher export growth has been accompanied by firm imports, thereby narrowing the trade surplus in Jan-Apr17. As investment growth recovers and household

-1.0

80

-2.0

70

-3.0

60

Radhika Rao • (65) 6878 5282 • [email protected]

120

2017

2016

2015

2014

2013

2012

2011

2010

2009

2008

European Commission Economic sentiment indicator 2007

Mar-17

90

Sep-16

0.0

Mar-16

100

Sep-15

1.0

Mar-15

110

Sep-14

2.0

Mar-14

120

Sep-13

3.0

Mar-13

Chart 2: Economic sentiments continue to improve Index

Sep-12

% QoQ, saar

Mar-12

EUROZONE

Chart 1: Real GDP growth stabilises

Economics–Markets–Strategy

Eurozone

spending holds up, this trend is likely to persist, keeping the net trade contribution to growth at neutral this year, compared to -0.2ppt in 2016.

Investment growth turns a corner During the 2008-09 crisis, the decline in capital formation was starker than overall growth (Chart 3). Since then, headline growth is back to pre-crisis levels, but investments have been slow to catch up. More recently, the environment has become more conducive for a turnaround. An accommodative monetary policy has lowered financing costs, capacity utilisation rates are up, along with better demand conditions. This has led investment as percentage of GDP to inch up to 20.1% of GDP in 2016, the highest since the crisis years. In 4Q16, this ratio rose to 20.6%. Corporates also stepped up borrowings with loans up by 2.0% YoY in Feb17 from 1.7% in 2016. Capital formation growth accelerated 3.5% YoY last year, driven by higher equipment investments and construction activity. The latter is the fastest in seven years. Driven by low rates and better consumption demand, home prices have also been ramping up (heading to 2007 levels). A broader investment push is likely from the European Fund for Strategic Investments program, which has been extended by two years to 2020. The fund target will increase to EUR 500bn from the current EUR 316bn, as investments focus on infrastructure, supporting the private sector and SME financing, amongst others. Pressure has been building on Germany to step-up domestic investments to bring down its huge current account surplus. As investment growth regains strength, Eurozone recovery is likely to strengthen further. Given these dynamics, the central bank will keenly watch for pass-through to wage pressures and hiring trends.

Still in search of self-sustaining inflation Despite stable growth, inflation is still below target. Headline inflation averaged 1.8% YoY in Jan-Apr17 but eased to 1.4% in May17. Higher global energy prices lifted inflation strongly in the first four months, but with Brent prices (EUR terms) stabilising in recent months, base effects have narrowed from 67% YoY in Jan17 to 1.1% in May17 (Chart 4). These supply-side pressures will persist in 1H but fade into 2H, thereby dragging headline inflation towards 1.3-1.5% in 4Q17. Demand-pull forces, reflected in core inflation, remain non-threatening and below target. Core inflation has been steady between 0.8-0.9% YoY so far this year, barring the spurt in April on Easter-related spending. Despite a falling jobless rate

Chart 3: Gross capital formation trends still below pre-crisis levels

Chart 4: Oil prices - base effects narrow USD pb

Index; Mar09 = 100

120

115 Household expd 110

100

Gross fixed capital form 80

105 60

Jun16

QE: 1Q15

100

May17

40 95

14

15

16

Jan-17

13

Jul-16

12

Jan-16

11

Jul-15

10

Jan-15

09

Jul-14

90

Jan-14

20

121

Eurozone

Economics–Markets–Strategy

Chart 5: Labour participation rate

Chart 6: ECB estimates: inflation (as of Mar17)

% working age population 83 Italy Germany

78

% YoY 2.2 France Spain

Policy target

2.0 1.8

73

1.6

68

1.4

63

1.2 2015

2014

2013

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

58

2017

2018

2019

1.0 Jun-16

Sep-16

Dec -16

Mar-17

and better household spending, the impact on inflation has been subdued, as; a) the fall in unemployment has been slow; b) the employment rate is still below the 2008-09 crisis highs and; c) greater labour force participation has increased supply (Chart 5). German wage growth is showing signs of life. Minimum wages could be raised in few member countries this year and trade unions make a case in a few others. But the threat of any wage-price spiral is limited at present.

ECB guidance needs to draw the line between taper and hikes Even as growth has stabilised and political risks have receded, the European Central Bank is unlikely to tighten in a hurry. Policymakers are keen to see signs of inflation, particularly in core prices. This has yet to materialise, as we highlight above. There are other points to take note of. The ECB’s economic projections for 2017 – GDP at 1.8%, inflation 1.7% and core 1.1% – also argue against tightening. The official outlook in fact points to slight growth moderation over 2018-19, while headline and core inflation are seen below the 2% target until 2019 (Chart 6 - as on Mar17 review). Secondly, memories of a premature shift to a hawkish bias in 2008 and 2011 will weigh on the central bank. In Jul 2011, despite the Eurozone debt crisis, the ECB raised rates citing inflation. Officials had to reverse course in November over uncertainty in Greece and worries of recession in the bloc. This pushed the central bank to cut policy rates by a cumulative 125bps until Dec 2013. While the euro is not facing a crisis at this juncture, the need to normalise rates gradually is not lost on the central bank. Looking ahead, the ECB will need to tweak guidance to draw the line between rate hikes and tapering. Rather than a tighter policy, the latter signals a scaling back of stimulus. We expect QE to continue as scheduled until Dec 2017. Thereafter monthly QE purchases could be trimmed from the current monthly EUR 60bn. An announcement is due in September or 4Q17 and would take effect in early 2018. Apart from the data, concerns over a breach of the single security ceiling of 33% for individual member countries’ bond purchases under QE (especially Germany), also add to the case of a rollback in purchases. Presumably once tapering is complete, a gradual increase in the main repurchase rate (from 0%) would follow. This is not expected before 2019. A rise in the deposit facility rate (from -0.4%) could begin in second half of next year as a first step in policy normalisation.

122

Economics–Markets–Strategy

Eurozone

Political risks subside, but a few areas warrant attention Political risks facing the Eurozone economy have receded but it is premature to pop the champagne. There are a few areas that still warrant attention. Bailout negotiations with Greece hit a rocky stretch last month as discussions with key creditors, including other European governments, hit a wall. Lenders are scheduled to reconvene in mid-June, as Athens hopes to receive the next tranche of funds ahead of EUR 7.5bn worth repayments in July. In this midst, Greece is back in recession, contracting -1.2% (QoQ, sa) in 4Q16 and -0.1% (QoQ, sa) in 1Q17. Falling growth makes it more challenging to lower the debt overhang of nearly 180% of GDP. A decision to release these funds is likely this month, effectively kicking the resolution can down the road. Separately, former Italian PM Matteo Renzi suggested national elections be brought forward to 3Q17, around the same time as Germany. Polls are presently due in mid2018. This change will require amendments in the electoral rules, due to be visited in early July. Concerns over an early election and the subsequent risk of a hung parliament weigh on the domestic markets. Finally, UK election results (9 Jun) will determine the government’s strength in the parliament to push through tough post-Brexit negotiations.

In sum The Eurozone is in a stable position, back above the 2012-13 trough. Politics is also a less of a worry as euro-sceptic and far-right parties have lost ground at recent elections, particularly France and Netherlands. Amongst the other core economies, Germany polls in Sep 2017 and Italy in mid-2018 (if not rescheduled to this year). This stability has pushed markets to expect the ECB to scale back QE and gradually tighten policy. Though we reiterate that the ECB is unlikely to be in a hurry.

Sources All data are sourced from CEIC Data, Bloomberg, ECB and Eurostat. Transformations and forecasts are DBS Group Research.

123

Economics–Markets–Strategy

Eurozone

Eurozone Economic Indicators 2016

2017f

2018f

1Q17

1.7 1.9 1.9 3.5

1.7 1.3 0.9 3.6

1.8 1.1 1.7 1.9

1.7 1.2 1.0 4.6

1.7 1.3 0.9 3.9

1.7 1.3 0.9 4.4

1.5 1.4 0.7 1.5

1.9 1.5 1.5 2.3

2.0 1.5 2.3 2.3

Net exports (EUR bn) Exports (G&S) (% YoY) Imports (G&S) (% YoY)

372 2.8 4.0

385 1.4 1.3

430 1.4 0.5

96 2.7 3.1

100 1.5 1.7

105 1.5 1.8

110 -0.1 -1.6

108 1.5 0.8

111 1.7 0.6

Contribution to GDP (pct pts) Domestic demand Net Exports

2.1 -0.4

1.6 0.1

1.6 0.2

na na

na na

na na

na na

na na

na na

External accounts Current account (EUR bn) % of GDP

365 3.1

370 3.4

375 3.3

na na

na na

na na

na na

na na

na na

Inflation HICP (harmonized, % YoY)

0.2

1.6

1.6

1.8

1.7

1.8

1.3

1.3

1.0

Other Nominal GDP (EUR trn) Unemployment rate (%, sa, eop)

10.7 9.6

11.0 9.1

11.3 9.0

na na

na na

na na

na na

na na

na na

Real output and demand (% YoY) GDP growth (05P) Private consumption Government consumption Gross capital formation

2Q17f 3Q17f 4Q17f 1Q18f 2Q18f

EZ - nominal exchange rate

EZ – policy rate

USD per EUR

%, refi rate

1.5

2.0

1.4

1.5

1.3 1.0 1.2 0.5

1.1

1.0 Jan-12

May-13

Sep-14

Jan-16

May-17

0.0 Jan-12

May-13

Sep-14

Jan-16

May-17

124

Economics–Markets–Strategy

June 8, 2017

General Client Contacts Singapore DBS Bank Ltd

Japan (65) 6878 8888

DBS Vickers Securities

(65) 6327 2288

The Islamic Bank of Asia

(65) 6878 5522

Australia DBS Australia

DBS Tokyo

(81 3) 3213 4411

Korea DBS Seoul

(82 2) 6322 2660

Malaysia (612) 8823 9300

China DBS Shanghai

(86 21) 3896 8888

DBS Beijing

(86 10) 5752 9500

DBS Chongqing

(86 23) 6848 4688

DBS Dongguan

(86 769) 2723 6088

DBS Guangzhou

(86-20) 3818 0888

DBS Hangzhou

(86 571) 8113 3188

DBS Shenzhen

(86 755) 2223 3433

DBS Kuala Lumpur Rep

(603) 2116 3888

DBS Labuan

(6 087) 595 500

Hwang-DBS

(604) 263 6996

Myanmar DBS Yangon

(951) 255 299

Philippines DBS Manila Rep Office

(632) 869 3876

Taiwan DBS Taipei

Hong Kong

(886 2) 6612 9888

DBS Hsinchu

(886 3) 612 7500

DBS Kaohsiung

(886 7) 965 4888

DBS Asia Capital

(852) 3668 1148

DBS Hong Kong

(852) 3668 1900

DBS Taichung

DBS (SME & Corporates)

(852) 2290 8068

DBS Tainan

(886 6) 601 7200

DBS Taoyuan

(886 3) 264 7100

India DBS Mumbai DBS Bangalore

(91 22) 6638 8888

Thailand

(91 080) 6632 8888

DBS Chennai

(91 44) 6656 8888

DBS Kolkata

(91 33) 6621 8888

DBS Kolhapur

(91 023) 1305 0100

DBS New Delhi

(91 11) 3041 8888

Indonesia

(886 4) 3606 6000

DBS Bangkok Rep Office

(66 2) 658 1400

UAE DBS Dubai

(97 1) 4364 1800

United Kingdom DBS London

(44 207) 489 6550

USA

DBSI Jakarta

(62 21) 2988 5000

DBSI Medan

(62 61) 457 7336

DBSI Surabaya

(62 21) 531 9661

DBS Los Angeles

(1 213) 627 0222

Vietnam DBS Hanoi Rep Office

(844) 3946 1688

DBS Ho Chi Minh City

(84 8) 3914 7888

Disclaimer: The information herein is published by DBS Bank Ltd (the “Company”). It is based on information obtained from sources believed to be reliable, but the Company does not make any representation or warranty, express or implied, as to its accuracy, completeness, timeliness or correctness for any particular purpose. Opinions expressed are subject to change without notice. Any recommendation contained herein does not have regard to the specific investment objectives, financial situation and the particular needs of any specific addressee. The information herein is published for the information of addressees only and is not to be taken in substitution for the exercise of judgement by addressees, who should obtain separate legal or financial advice. The Company, or any of its related companies or any individuals connected with the group accepts no liability for any direct, special, indirect, consequential, incidental damages or any other loss or damages of any kind arising from any use of the information herein (including any error, omission or misstatement herein, negligent or otherwise) or further communication thereof, even if the Company or any other person has been advised of the possibility thereof. The information herein is not to be construed as an offer or a solicitation of an offer to buy or sell any securities, futures, options or other financial instruments or to provide any investment advice or services. The Company and its associates, their directors, officers and/or employees may have positions or other interests in, and may effect transactions in securities mentioned herein and may also perform or seek to perform broking, investment banking and other banking or financial services for these companies. The information herein is not intended for distribution to, or use by, any person or entity in any jurisdiction or country where such distribution or use would be contrary to law or regulation. Sources for all charts and tables are CEIC and Bloomberg unless otherwise specified. DBS Bank Ltd., 12 Marina Blvd, Marina Bay Financial Center Tower 3, Singapore 018982. Tel: 65-6878-8888. Company Registration No. 196800306E.

www.dbs.com.sg

Loading...

Economics Markets Strategy - DBS Bank

Economics Markets Strategy 3Q 2017 DBS Group Research 8 June 2017 Economics–Markets–Strategy June 8, 2017 Singapore Treasury & Markets - Wealth M...

2MB Sizes 41 Downloads 32 Views

Recommend Documents

No documents