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CIMB Research ReportREGIONAL ECONOMIC COMPASS

December 2009

KKDN PP 14048/11/2010 (025968)

20102010Malaysia • Singapore • Indonesia • Thailand • ChinaMalaysia • Singapore • Indonesia • Thailand • China

REGIONAL ECONOMIC COMPASS

CIMB Investment Bank Bhd

CIMB-GK Research Pte. Ltd.

PT CIMB Securities Indonesia

CIMB Securities (HK) Limited.

CIMB Securities (Thailand) Co. Ltd.

CIMB Securities (UK) Ltd.

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Regional Economic Compass December 2009 [2]

CIMB INVESTMENT BANK

CIMB-GK RESEARCH PTE LTD

Malaysia and Thailand

Priscilla Peggy TongAssistant Manager+60 (3) [email protected]

Kenneth WongAssistant Manager+60 (3) [email protected]

Lee Heng GuieHead of Economics+60 (3) [email protected]

Julia Goh Senior Manager+60 (3) [email protected]

Song Seng WunRegional Economist+65 [email protected]

Singapore and Hong Kong/China

Contents

SuMMaRy .....................................................................................................................................................3

Review of 2009 .......................................................................................................................................4

Key drivers for 2010 ................................................................................................................................8

Outlook of major economies ...................................................................................................................9

Regional economic outlook ..................................................................................................................16

Interest rate outlook .............................................................................................................................20

Currency outlook ..................................................................................................................................21

Key risks for 2010 ................................................................................................................................23

MaLaySIa - How strong is the recovery?....................................................................................................27

SINGaPORE - Bracing for bumpy recovery ................................................................................................43

INDONESIa - Higher growth ........................................................................................................................51

THaILaND - Coming out of the tunnel .........................................................................................................59

CHINa - Defying expectations .....................................................................................................................71

aPPENDIX TaBLES ....................................................................................................................................78


Regional Economic CompassDecember 2009

Please read carefully the important disclosures at the end of this publication.

Summary

• What kind of recovery is in store? Investors and policymakers are in general agreement that the world economy has entered a recovery phase. The question now is what kind of recovery can we expect? In our view, this will be an uneven recovery, with the US and Europe, in particular, trudging slowly along the recovery path given their impaired financial systems and continued deleveraging, especially by households which are rebuilding their tattered finances.

• Asia: from rebound to recovery. Asia is leading the charge in the global recovery as both domestic demand and exports are gathering momentum. Financial markets have rebounded and private capital has begun to flow back as investors are regaining an appetite for risk. But there are still doubts about whether Asia has built up sufficient momentum for a self-sustaining recovery if the G-3 economies recover at a snail-like pace.

• Central banks to signal end to policy largesse? As there are clearer signs of global economic recovery, financial conditions have stabilised amid improved credit markets. Major central banks are starting to prepare their exit strategies or are even gradually unwinding the unconventional liquidity measures they introduced early this year to stave off a second global depression. Although the Fed, Bank of Japan, European Central Bank and Bank of England have all signalled that quantitative easing will be gradually unwound by next year, it may be some time before interest rates are increased. Mounting concerns over new asset bubbles in Asia have prompted some central banks to tighten regulations and rein in the excessive run-up in asset prices. Some central banks have implemented capital controls to thwart the speculative inflows. In our opinion, most central banks will start to signal a shift to monetary tightening no earlier than 2H 2010.

• Asian currencies at turning points. Bolstered by strengthening economic growth prospects and a growth differential which is in Asia’s favour, regional currencies will climb back on an appreciation path for the greater part of 2010. That said, regional central banks’ fear of the impact of stronger currencies on export competitiveness is likely to limit the magnitude of the appreciation.

• Major risks to the outlook include (i) a weaker-than-expected recovery in the developed countries, (ii) new asset bubbles, (iii) mistiming of economic stimulus withdrawal or premature monetary tightening, and (iv) a slower-than-expected pick-up in private sector demand.


Review of 2009The global recovery has started. Global Depression Version 2 has been averted, thanks to synchronised global fiscal and monetary actions. Clearer signs of recovery have emerged for major developed economies. However, the road to recovery is likely to be uneven. Emerging economies will generally be the first to rebound, led by Asia which is seeing a resurgence of selected economies. Thanks to unprecedented fiscal boosts, historically low interest rates, a rebound of industrial output and a turning global inventory cycle, the G-3 and Asian economies have stabilised and are now in recovery mode. The pace of economic contraction has come off substantially and some large domestic-demand driven economies are even racking up growth.

Figure 1: Major developed economies are pulling out of a recession in 3Q09

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% qoq 1Q09 2Q09 3Q09

Source: US Bureau of Economic Analysis (BEA), Bloomberg

Figure 2: Regional economies are generally further ahead on the road to recovery

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% yoy 1Q09 2Q09 3Q09

Source: Bloomberg, CEIC, Department of Statistics (DOS)

Global indicators point to a synchronised recovery. Timely government intervention, very loose monetary policies and expectations of a global recovery have triggered rallies in the global financial and commodity markets. We are seeing more signs of stabilisation and recovery of industrial production, world trade and retail sales. According to the data released by the CPB Netherlands Bureau of Economic Policy Analysis, trade volumes rose by 5.3% mom in September – the largest ever monthly increase since 1991. Consumer confidence has turned the corner, helped by the prospect of economic recovery and stabilised financial markets. The OECD Composite Leading Indicators (CLI) have been on the rise for seven consecutive months since Mar 09, pointing to a stronger recovery ahead.

The road to recovery will be a bumpy one

Forward indicators point to recovery on the horizon


Figure 3: The OECD CLI continues to point to synchronised recovery

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Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09

Index OECD - Total United States Euro area Japan

Source: Organisation for Economic Cooperation and Development (OECD)

Figure 4: Global trade contraction has bottomed while industrial activity picked up

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IndexGlobal merchandise trade OECD industrial output Global PMI (RHS)

Source: Bloomberg, OECD, Netherlands Bureau for Economic Policy Analysis (CPB)

Figure 5: Consumer sentiments in the G-3 are slowly on the mend

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% ptsUS Japan Euro area (RHS)

Source: Bloomberg

Financial market conditions have improved, with interbank spreads returning to pre-crisis levels and upswings in equity markets across the globe even though they remain well below previous peaks. Private capital flows have returned as investors’ risk appetite has improved and emerging market risks have lessened. Despite the improved financial conditions, banks in the US and Europe continue to deleverage, especially those with high exposure to commercial real estates. Still-tight lending standards have resulted in the contraction of loans even though there is more liquidity in the banking system.

Banks still deleveraging amid improved financial conditions


Figure 6: Interbank spreads have returned to pre-crisis levels…

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Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09

% US$ 3M LIBOR-3M OIS EUR 3M LIBOR-3M OIS

Source: Bloomberg, CIMB/CIMB-GK Research

Figure 7: … as risk aversion eases and market volatility subsides

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Figure 8: Emerging Asia is the unambiguous leader of the private capital flow cycle

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2007 2008 2009E 2010F

US$ bn Latin America Emerging EuropeAfrica/Middle East Emerging Asia

18.3%

35.6%

12.4%

33.7%

20.4%

41.6%11.6%26.4%

28.6% 5.9%10.7%54.8%

40.6%

22.5%26.7%

10.2%

Source: International Institute of Finance (IIF)

Figure 9: Bank credit in the US and Europe has been contracting

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1012


% yoy US EU

Source: CEIC


Deflation risks ebbing. Major developed economies and most Asian economies are either in deflationary mode or witnessing a decelerating pace of inflation. Inflation is on the decline across the globe due to the slowdown in growth and lower oil & food prices. However, the normalisation of base effects, recovery of domestic demand and higher food and commodity prices are likely to drive headline inflation into positive territory in late 09 and 2010. That said, demand-pull inflation pressures are likely to be contained given the ongoing slack in both the labour and products markets. Concerns over new asset bubbles are starting to mount, prompting some central banks to implement administrative measures to cool property prices and rein in bank lending for property purchases.

Figure 10: G-3 inflation temporarily dipped into negative territory…

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Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09

% yoy US Euro area Japan

Source: Bloomberg, CEIC

Figure 11: … while inflation in China and India are inching up

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% yoy China India


Figure 12: Most regional economies also slipped into a brief period of deflation

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% yoy

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% yoyMalaysia Singapore Thailand Indonesia (RHS)


Global headline inflation set to increase, albeit moderately in 2010


Commodity prices are making a strong comeback as a result of the improved prospects for the global economy. Crude oil price averaged US$60.61/bbl in Jan-Nov 09, reflecting the underlying demand support amid some inventory adjustment. Crude palm oil prices (CPO) also held up well with an average of RM2,238.32/tonnes in Jan-Nov 09, underpinned by solid demand from China, India and other developing economies. Given the supply of cheap money around the globe, speculative buying also played a part in keeping prices firm. Another contributing factor was the weak US dollar. We project crude oil price to rise to US$75/bbl in 2010 and US$80/bbl in 2011. Our CPO price forecasts are RM2,380/tonne in 2010 and RM2,450/tonne in 2011.

Figure 13: Crude oil and palm oil prices have firmed up

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Figure 14: Firmer crude oil price supported by global recovery prospect and speculative demand

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Key drivers for 2010What to expect from the recovery? Investors and policymakers are in general agreement that the world economy has entered a recovery phase. The question now is what kind of recovery can we expect? The danger is that a premature withdrawal of support could spark swings in global financial markets and spoil the recovery before it has taken root.

In our view, this will be an uneven recovery, with the US and Europe in particular trudging slowly along the recovery path given their impaired financial systems and continued deleveraging, especially by households which are rebuilding their tattered finances. The recovery path remains a bumpy one unless private sector demand can sustain the growth traction and take over the driving seat as fiscal support is pulled back. Until we see greater clarity of the Dubai debt restructuring process, Dubai debt crisis with an estimated US$80bn debt is a set-back to the nascent global recovery. It highlights that while the financial conditions are stabilising, global deleveraging process is still working through the system and this raises questions about the vigor and sustainability of economic recovery.

Recovery will be uneven due to impaired financial systems and continued deleveraging process


Figure 15: Recovery will most likely be slow and uneven

'W'-shaped cycle (30% probability) V-shaped recovery (20% probability) ••

•••

Growth boosted by restoking and trade recoveryFinal demand remains weak as banks and households keep deleveragingMisjudged exit from stimulusOil and commodity prices spike and asset bubblesGrowth turns sluggish again in 2H 2010

•

•

•

•

Sharp recoveries boost business and consumer confidenceContinuous government stimulus to sustain a strong recoveryExtremely loose monetary policy drive strong rally in financial and commodity marketsEmerging markets boosted, adding to global growth

Square Root (50% probability) CIMB outlook•

••

•

•

Initial V-shaped recovery owing to inventory rebuilding and fiscal boostDe-stocking ends, but fiscal spending continuesFiscal boost fades and ongoing deleveraging weigh down private demandStaggered monetary tightening to keep a lid on inflation risk and asset price inflationEconomy flat lines from 2H 2010 and beyond

•

•

•

•

The recovery path for G-3 economies is expected to be slow and unevenThe outlook for Asia's recovery is positive but will only regain a high-growth trajectory if the G-3 recovers stronglyChina, India and Indonesia will grow solidly due to large domestic demand. Malaysia and Thailand growth below potential on internal constraints. Singapore will be lifted by buoyant services sectorAsset bubble concerns in China, Singapore, Korea and Hong Kong

Source: CIMB/CIMB-GK Research

Figure 16: Global economic outlook

Real GDP growth (%)2008 1Q09 2Q09 3Q09 2009E 2010F 2011F

US 0.4 -6.4 -0.7 2.8 -2.3 1.0 - 2.0 2.0 - 3.0EU 0.6 -5.0 -4.8 -4.1 -4.3 0.6 1.5Japan -0.7 -8.9 -5.8 -5.1 -5.6 1.5 1.8UK 0.7 -5.0 -5.5 -5.1 -4.4 0.9 2.5China 9.0 6.1 7.9 8.9 8.2 10.0 10.0India 7.3 5.8 6.1 7.9 6.0 7.0 7.3

Source: International Monetary Fund (IMF), BEA, Bloomberg, CEIC Note: US quarterly GDP growth is on annualised qoq basis. Quarterly GDP growth for all other economies above is on yoy basis.

Over the next 6-12 months, investor sentiment will be dictated by (i) the sustainability of the economic rebound, particularly in 2H 2010, (ii) the strength of the signs of recovery in many economies which could lead to different expectations over monetary policy, and (iii) the timing of exit strategies. In a normal recovery phase, especially after a deep recession preceded by a deep financial crisis, the incoming data will tend to bounce along at an uneven pace.

Outlook of major economiesUS - How strong is the recovery?Real GDP rebounded 2.8% in 3Q09. The US economy pulled out from an 18-month long recession to expand at an annualised rate of 2.8% in 3Q09 (-0.7% in 2Q). The growth reflects continuing fiscal boost, inventory restocking and pent-up investment demand. Net external demand subtracted 0.83% pts from 3Q GDP growth as imports grew at a faster pace of 20.8% compared to export growth of 17%. The weakening dollar should help to improve the trade balance and enhance net external demand’s contribution to GDP growth.

Recession has ended but the recovery will be slow


Figure 17: The US economy has pulled out from a deep recession in 3Q09

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% QoQ YoY

Source: BEA

Consumer spending turned around, gaining 2.9% in 3Q (-0.9% in 2Q), thanks to the unprecedented government stimulus. Spending on consumer durables jumped 20.1%, boosted by the “cash-for-clunkers” scheme. But the spending splurge is one-off and is likely to taper off in 4Q09. Falling wage growth, ongoing job losses and tight lending requirements continue to restrain consumer spending. The household savings rate eased to 4.4% in October from 6.4% in May.

Figure 18: Job losses have eased amid rising unemployment rate

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Persons th

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12%Non-farm payroll Unemployment rate (RHS)

Source: Bloomberg

Figure 19: Consumer confidence is gradually recovering

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Index Conference Board

Source: Bloomberg


Figure 20: Households are still mending their balance sheets

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% of disposable

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Personal saving

Source: Bloomberg

Figure 21: Credit lending remains tight despite monetary easing

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% yoy M2 growth Loan growth

Source: Bloomberg

The fall-off in business investment improved markedly to -4.1% on 3Q (-9.6% in 2Q and -39.2% in 1Q). Residential investments rebounded strongly with a 19.5% upsurge in 3Q (-23.3% in 2Q), boosted by the temporary tax credit for first-time buyers capitalising on a stabilising housing market. However, investment in commercial real estate remained a big drag on total investment as it fell 15.1% in 3Q (-17.3% in 2Q). Spending on equipment and software eked out a modest gain of 2.3% in 3Q (-4.9% in 2Q).

Figure 22: Contractions in private investment eased in 3Q09

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% yoy Business Residential Total

Source: BEA


Figure 23: Inventory levels have started to normalise…

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Inventory-sales ratio

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Source: CEIC

Figure 24: Capital investments still cautious

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% mom Capital goods (non-defence) Durable goods

Source: CEIC

Figure 25: Home prices have stopped sliding

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% yoy S&P/Case Shiller FHFA /OFHEO

Source: Bloomberg

Figure 26: The housing market slump has bottomed out

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Source: Bloomberg


How strong is the recovery? In our view, the recovery path will be a bumpy one as it will take some time for the economy to regain strong momentum. The financial system remains impaired, credit lending standards are still tight and households whose assets are in tatters will continue to rebuild their savings. We need to see a sustained rebound in private consumption if the recovery is to stay on course. Continued deleveraging and a jobless recovery will weigh on consumer spending, especially as the effect of fiscal stimulus starts tapering off in 2H 2010. Nov’s unemployment rate eased slightly to 10% after hitting a 26-yr high of 10.2% in Oct 09, with cumulative job losses amounting to 7.2m since Jan 08. The unexpectedly small 11,000 decline in non-farm payrolls in Nov 09 is a sign that the job market is stabilising. If this trend continues, we should start to see net job gains by 1Q 2010.We continue to estimate a GDP contraction of 2.3% for 2009, followed by growth of 1.0-2.0% in 2010.

Highly accommodative monetary policy is warranted. We continue to expect the Fed to keep interest rates low for an extended period to ensure a firmer recovery in 2010. The Fed will gradually slow the pace of mortgage-backed securities purchases in order to ensure a smooth transition for financial markets. It expects to end the purchases by end-1Q10.

Euro area - Patchy recoveryRecession has ended. The Euro area pulled out of its worst post-war recession, with real GDP growth posting a small positive growth of 0.4 % in 3Q09 (-0.2% in 2Q) following five consecutive quarters of qoq declines. On an annual basis, the pace of contraction eased significantly to 4.1% in 3Q (-4.8% in 2Q). The improvement was attributed to the sharp rebound in Germany and France, the two largest economies in the euro area. In tandem with turns in global inventory cycle, industrial activity grew by 0.2% mom in September (1.2% in Aug) for the fifth consecutive month. The regional purchasing managers’ indices (PMI) continue to show solid performance, rising to a 18-month high of 51.2 in November (50.7 in Oct), boosted by a surge in overseas orders for Germany’s capital goods.

Figure 27: Recession in the Euro area ended in 3Q09…

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%

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104IndexGDP growth %yoy GDP growth %qoq Euro area CLI (RHS)

Source: Bloomberg, OECD

Figure 28: …thanks to the improvement in Germany, France and Italy

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%qoq 4Q08 1Q09 2Q09 3Q09

Source: Eurostat

The US economy is expected to post a modest growth of 1.0-2.0% in 2010

The Fed will likely keep interest rates low for an extended period of time

Likely to hit a soft patch in 1H2010 before gaining a firmer footing in 2H2010


Figure 30: Japan’s economy continued to improve in 3Q09

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Source: Bloomberg

Can recovery be sustained when stimulus measures wane? Domestic demand indicators have shown signs of improvement. Retail sales declined at a slower pace as consumer confidence climbed to a 24-month high, bolstered by the Democratic Party of Japan’s (DPJ) promises of cash handouts such as childcare allowances and abolishing highway tolls, and a slight improvement in the labour market. Signs of a revival in capital spending seem to be emerging as machinery orders climbed by 6% mom in September (-1.9% in Aug), the fourth month in five months of sequential gains. Corporate earnings are encouraging companies in Japan to spend more on tools and factory equipments. Manufacturing output gained for the eighth consecutive month, albeit at a slower pace of 0.5% mom in October (2.2% in Sep and 1.6% in Aug). Exports also contracted at a slower pace of 23.2% yoy in Oct, the smallest decline in 12 months. The recovery is being led by exports to Asia, while sales to the US and Europe are also picking up. Yet, skeptics argue that much of Japan’s recovery was fuelled by large fiscal pump priming of the previous government. Domestic spending, which accounts for half of the economy is still under threat as the deteriorating labour market conditions along with low wages will weigh on household spending. It remains to be seen whether the new political leadership can sustain the nascent recovery as there is uncertainty about their policy intentions over the medium-term. On 8 Dec 09, Japan announced US$80bn in new spending as part of a US$274bn stimulus package to boost the fledgling recovery. The extra budget will require approval by the Diet legislature, due to convene in Jan 2010. We expect the economy to record a full-year contraction of 5.6% in 2009 and to clamber back to a moderate growth of 1.5% in 2010.

Figure 31: Japan’s exports and industrial activity have picked up

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Source: Bloomberg

Liquidity operations to unwind but interest rates remain at near zero. In our opinion, the Bank of Japan (BoJ) will keep its policy rate close to zero for an extended period. The policy focus is on supporting growth and stopping deflation. Japan’s core CPI fell further by 1.1% in Oct 09 (-1% in Sep), the tenth month of decline since Jan 09, raising concerns that the economy may slip back into a deflationary spiral. BoJ has decided to end corporate debt buying programme by end-09 as it became easier for companies to raise funds needed for its business. It would also

Unveiled a surprise monetary easing programme…


Deflation risks ebbing. Major developed economies and most Asian economies are either in deflationary mode or witnessing a decelerating pace of inflation. Inflation is on the decline across the globe due to the slowdown in growth and lower oil & food prices. However, the normalisation of base effects, recovery of domestic demand and higher food and commodity prices are likely to drive headline inflation into positive territory in late 09 and 2010. That said, demand-pull inflation pressures are likely to be contained given the ongoing slack in both the labour and products markets. Concerns over new asset bubbles are starting to mount, prompting some central banks to implement administrative measures to cool property prices and rein in bank lending for property purchases.

Figure 10: G-3 inflation temporarily dipped into negative territory…

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% yoy US Euro area Japan


Figure 11: … while inflation in China and India are inching up

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Figure 12: Most regional economies also slipped into a brief period of deflation

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% yoyMalaysia Singapore Thailand Indonesia (RHS)


Global headline inflation set to increase, albeit moderately in 2010


stop all key funding support programmes by Mar 2010. Nevertheless, the BoJ has assured that it will continue to provide ample liquidity through its regular market operations once these emergency measures expire. On 30 Nov 09, BoJ unveiled a surprise monetary easing effort that it could inject up to JPY10tr (US$115bn) into an economy facing deflation and a soaring yen. The new lending programme carries a low interest rate of 0.1% for three-month loans.

Regional economic outlookCan the recovery be sustained?From rebound to recovery. Asia is leading the charge in the global recovery as both domestic demand and exports are gathering momentum. The timely fiscal injection and aggressive monetary easing helped to ease the devastating impact of global financial crisis on the real economy. The easing pace of retrenchments, falling consumer prices and favourable farm incomes has helped to keep consumer spending afloat. Consumer confidence has strengthened and business sentiment has revived. Financial markets have rebounded and private capital has begun to flow back as investors are regaining an appetite for risk.

Figure 32: Regional economies are leading the global economic recovery

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Figure 33: Private consumption has recovered…

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Asian economies are generally further ahead on the road to recovery


Figure 34: Regional exports are gradually recovering as global demand picks up…

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Figure 35: … as well as gradually recovering industrial production

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There are still doubts about whether Asia has built up sufficient momentum for a self-sustaining recovery if the G-3 economies recover at a snail-like pace. The pace of recovery will diverge between the large domestic-demand driven and export-driven economies. China, India and Indonesia will continue to register stronger economic expansion. In the case of Singapore, Malaysia and Thailand, although these economies will recover, just how strong the rebound will be depends on (i) the strength of export recovery, and (ii) whether private sector demand can be sustained. We do not doubt that exports, which have shown an easing pace of declines so far in 2H09, will recover in 2010 due to the extremely low base. But Asian economies are still not decoupled from G-3 economies. If the pick-up in growth of the industrialised economies remains moderate and uneven, it will continue to weigh on Asian exports as some 60% of Asia’s direct and indirect exports still goes to G-3 economies.

Figure 36: Regional exports to G-3 nations have stabilised…

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… but there are doubts as to whether the recovery is self-sustaining


Figure 37: Export demand from China has helped to take up the slack

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Figure 38: Regional GDP growth


Hong Kong 2.4 -7.8 -3.6 -2.4 -2.0 6.0 6.0Indonesia 6.1 4.4 4.0 4.2 4.4 5.8 6.0Malaysia 4.6 -6.2 -3.9 -1.2 -2.3 3.5 5.5Singapore 1.2 -9.5 -3.3 0.6 -2.0 6.5 6.0Thailand 2.5 -7.1 -4.9 -2.8 -2.8 3.5 5.0China 9.0 6.1 7.9 8.9 8.2 10.0 10.0India 9.0 5.8 6.1 7.9 6.0 7.0 7.3

Source: IMF, Bloomberg, CEIC

China: The clear and modest improvement in global demand has brought jobs back to coastal manufacturing regions. Together with improving consumer and business confidence, there is a gradual broadening of China’s growth. Investments will continue to fuel growth in 2010 as the large stimulus measures continue to foster credit and investment growth. Domestic demand (investment and consumption) is expected to contribute in the coming two years as demand in advanced economies may remain subdued. We see a reversal in net exports from a 17% decline this year to 10-15% growth next year. We expect economic growth of 10% in 2010 (8.2% in 2009). With its growth target of more than 8% met in 2009, the government will be looking to “manage inflation expectations” and “adjusting the economic structure” to ensure balanced growth in 2010 and beyond. In the coming months, setting credit-growth targets and pushing out structural reforms will be the areas to watch. We expect the Chinese central bank to bring broad money supply (M2) growth to about 16-20% next year, sharply down from this year’s 30% pace.

India: The combination of countercyclical fiscal policies, appropriate monetary adjustments as well as renewed investor confidence has provided a lift to the domestic economic environment. India’s real GDP growth surged 7.9% yoy in 3Q09 (6.1% in 2Q), marking the fastest growth since 1Q08. Benefiting from the global recovery and improved trade activity, India is expected to ratchet up higher real GDP growth of 7.0% in 2010 from an estimated 6.0% in 2009. This is premised on firmer domestic demand, improved agriculture production as well as recovering exports. The government has alluded to the winding down of emergency fiscal measures in 2010 in an attempt to reduce the budget deficit from the estimated 6.8% of GDP this year. In fact, India has already taken its first steps in tightening monetary policy by ordering lenders to invest a greater proportion of their deposits in government bonds, on concern inflation may accelerate. Inflation is estimated to soar to 6.5% by 1Q 2010 from 1.5% currently. As such, the Reserve Bank of India (RBI) is likely to begin rate hikes as early as in 1Q 2010 to contain inflation expectations. We expect the policy rate will rise to 5.75% by end-2010 from 4.75% in 2009.


Malaysia: The recovery has started, evident from the clearer signs of improvement in both external and domestic demand conditions. The rebound in growth is supported by continuing fiscal support, pick-up in manufacturing and the turning inventory cycle. We expect the Malaysian economy to recover by 3.5% in 2010 and 5.5% in 2011 after shrinking by an estimated 2.3% in 2009. The economic expansion is expected to be broad-based, with private sector demand leading the charge as the public sector gradually unwinds its fiscal support. Private sector demand is estimated to rise 4.3% in 2010 while public sector expenditure is set to pull back 3.6%. Exports should rebound 8-10% after the collapse of global trade last year. The policymakers remain committed to a market-oriented economy and will continue to tackle any regulations or structural gaps that stifle private sector initiative. Since Apr 09, notable liberalisation steps were rolled out in the services, banking, insurance and fund management industries. The one with the most impact is the Foreign Investment Committee (FIC) deregulation on M&A, foreign equity ownership, IPO and property acquisitions.

Indonesia: Resilient domestic demand has kept the Indonesian economy growing positively and putting Indonesia in the league of positive-growth countries in Asia. We expect the economy to expand faster to 5.8% in 2010 from an estimated 4.4% in 2009. Stronger consumption and the resumption of investment along side with positive growth on exports would underpin overall GDP growth in 2010. The manufacturing sector will expand faster on higher external demand and steady purchasing power. Government’s infrastructure programs will benefit the electricity and construction sectors. While agriculture sector will be negatively affected by El Nino and grow lower in 2010. Bank Indonesia has been conducting accommodative monetary policy by cutting the BI rate by 300bp on the back of fast-receding inflation. However, inflation will crawl up considerably on some administered price increases next year. We expect BI to continue rate-pause until mid 2010 and starts tightening afterwards until 7.5% at end 2010.

Singapore: Being a small open economy largely dependent on external demand for growth, the key growth driver in 2010 will be net exports. With the export of goods and services expected to rebound by 10-12% in 2010 against a 12% fall in 2009, net exports should once again contribute to headline GDP growth. The clear and modest global recovery currently underway suggests Singapore may enjoy 2-3 quarters of strong growth in the coming year. The government’s expansionary bias in 2009 and 1H10 will continue to support private consumption growth of 2-4% in 2010 after a 1.2-1.5% decline in 2009 (vs. a pre-crisis average of 5%). The completion of Singapore’s two integrated resorts in 2010 will create several thousand new jobs and new sources of income for Singapore. The number of visitors, for leisure or business, will depend on the state of regional economies and the global economy. Our baseline estimate is 6-7% growth for 2010 with possible growth of 6-10% in 1H10.

Thailand: Thailand’s economy is gradually stabilising with the help of fiscal stimulus and monetary easing. We expect GDP to rebound by 3.5% in 2010, after shrinking 2.8% in 2009, and grow further by 5.0% in 2011. The anticipated improvement of global trade activity next year should provide some impetus to Thailand’s growth. We estimate that exports in US$ terms will bounce back 10-15% in 2010 (-13.5% in 2009). Domestic demand is on the mend, thanks to continued government largesse, lower unemployment, supportive interest rates, benign inflation and a gradual recovery of the tourism sector. The private sector is projected to grow 3.3% in 2010 while the public sector is set to rise 5.5%. The step-up of fiscal spending (18.5% of GDP) and more aggressive fiscal expansion plans have the potential to lend further upside to overall growth over the next two years. We believe that the central bank will refrain from tightening rates too soon given that the recovery is still slow and fragile. As inflationary pressures are still benign, ensuring a sustained recovery takes precedence over inflation. Should there be rate hikes, it is more likely to be in 2H 2010 and will be in the magnitude of 25-50bp.


Interest rate outlook Normalisation of monetary policyCentral banks to signal end to policy largesse? Now that the global recession has ended, policymakers are turning their attention to the planning of exit strategies from the current easing cycle. The challenge is to get the timing right for the withdrawal of the massive fiscal and monetary stimulus. The Reserve Bank of Australia became the first G20 central bank to hike interest rates on 6 Oct as the country’s growth outlook improved.

It is likely that major central banks will keep interest rates at these unprecedented low levels for an extended period until they see more convincing signs of economic stabilisation and recovery. Major central banks are starting to prepare their exit strategies or are even gradually unwinding the unconventional liquidity measures they introduced early this year to stave off a second global depression. But the Fed, Bank of Japan, European Central Bank and Bank of England have all signaled that quantitative easing will be gradually unwound by next year. In our opinion, most central banks will start to signal a shift to monetary tightening no earlier than 2H 2010. If there is any rate action, it will be in baby steps.

Asia’s policy rates to start normalise in 2H 2010. As economies gradually pick up in 2010, inflation should remain under control considering the substantial resource slack as growth remains below potential. We remain convinced that most regional central banks will keep their policy rates low for some time, at least in 1H 2010 until they see an entrenched recovery or substantial inflationary pressures re-emerge. Rising food and commodity prices, however, may be inflationary and hurt the nascent recovery. The central banks of both China and India have raised their inflation forecasts, which is a sign that the monetary tightening measures are on the cards. The flooding of liquidity that propped up the economy has pushed asset prices beyond economic fundamentals. Concerns over new asset bubbles are starting to mount even before the economic recovery has taken root. South Korea, Indonesia and India are likely to be the first few countries in the region to hike rates, probably as soon as 2Q-3Q 2010.

Figure 39: Regional inflation rates

Inflation (% yoy)2008 1Q09 2Q09 3Q09 2009E 2010F 2011F

Hong Kong 4.3 1.7 -0.1 -0.9 0.0 1.5 - 2.0 1.5 - 2.0Indonesia 10.3 8.6 5.6 2.8 3.5 6.3 7.0Malaysia 5.4 3.7 1.3 -2.3 0.7 1.5 2.0Singapore 6.5 2.1 -0.5 -0.4 0.0 3.0 - 3.5 1.5 - 2.0Thailand 5.5 -0.2 -2.8 -2.2 -0.8 3.0 3.2China 5.9 -0.6 -1.5 -1.3 -0.5 1.5 - 2.0 1.5 - 2.0India 9.1 3.2 0.5 -0.1 1.6 5.0 5.7

Source: Bloomberg, CEIC, IMF, CIMB/CIMB-GK Research

Figure 40: Interest rate forecasts

Major central banksEnd-07 End-08 As at

3 Dec 092009E 2010F 2011F

% p.a. % p.a. % p.a. % p.a. % p.a. % p.a.US Fed funds rate 4.25 0.00-0.25 0.00-0.25 0.00-0.25 0.50 1.25Bank of Canada 4.25 1.50 0.25 0.25 1.00 1.75ECB Benchmark rate 4.00 2.50 1.00 1.00 1.00 1.50Bank of England bank rate 5.50 2.00 0.50 0.50 1.00 2.00Japan target rate 0.50 0.10 0.10 0.10 0.10 0.10Australia cash target rate 6.75 4.25 3.75 3.75 3.75 4.50New Zealand official cash rate 8.25 5.00 2.50 2.50 3.00 3.75Asian central banksMalaysia overnight policy rate 3.50 3.25 2.00 2.00 2.00 3.00Thailand 1D repo 3.25 2.75 1.25 1.25 1.75 3.00Singapore 3M SIBOR 2.38 0.96 0.69 0.70 0.70 1.00 - 2.00Indonesia 1M SBI 8.00 9.25 6.50 6.50 7.50 8.00Hong Kong base rate 5.75 0.50 0.50 0.50 1.00 1.75People's Bank of China 7.47 5.31 5.31 5.31 5.85 6.66South Korea base rate 5.00 3.00 2.00 2.00 3.00 3.75Taiwan discount rate 3.38 2.00 1.25 1.25 1.50 2.00India repo rate 7.75 6.50 4.75 4.75 5.75 6.50

Source: Bloomberg, CEIC, IMF, CIMB/CIMB-GK Research

Major central banks are edging towards the normalisation of interest rates…

… while some will likely start raising rates as soon as 2Q 2010


Currency outlook Asian currencies at turning pointDollar weakness. The US dollar has lost 9.9% on a trade-weighted basis since Mar 09. The yen has firmed 10.1% against the greenback while the euro has also strengthened 6.3%. For the rest of the year and in 2010, four main factors will determine the direction of the dollar (i) US economic growth and global recovery prospects, (ii) worries over incipient inflation resulting from looser monetary policies, (iii) the timing of the reversal of the Fed’s quantitative easing, and (iv) investors’ reservations about the dollar’s status as a global reserve currency in the face of the US’s unresolved twin deficits. The net effect of these factors is probably a weaker dollar assuming that the market does not expect interest rates to rise before 2H 2010.

Figure 41: The US dollar has been sliding

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Figure 42: Against yen and Euro, the dollar has fared poorly

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Dollar’s long-term weakness remains. We continue to expect the dollar to be weak over the long term unless there is a significant correction of the global imbalances. As the global economy shows stronger signs of recovery, the limelight will be on the dollar weakness. The greenback did not strengthen during the recoveries that followed the last two recessions because the initial sluggish nature of those upturns prevented the Fed from tightening monetary policy aggressively.

Implications for Asian currencies. Bolstered by strengthening economic growth prospects and a growth differential which is in Asia’s favour, regional currencies will climb back on an appreciation path for the greater part of 2010. That said, regional central banks’ fear of the impact of stronger currencies on export competitiveness is likely to limit the magnitude of the appreciation. We see potential upside for the Singapore dollar and Indonesian rupiah as we think that the ongoing equity market rebalancing and emphasis on cyclical plays continue to favour these two markets, supported by their projected stronger economic recoveries. Another key determinant of exchange rate movements is the market perception of future monetary policy moves. This year’s cooling inflationary pressure is likely to reverse and gain intensity in 2010, adding complication to the currency policy.

The US dollar has been sliding and is expected to keep weakening

Regional currencies are projected to appreciate


Figure 43: Regional currencies have gained against the USD

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1. Favour S$ and rupiah. Given our expectations of ongoing equity market rebalancing and emphasis on cyclical plays as well as our current preference for the Singapore and Indonesia stockmarkets, we think there could be upside to the Singapore dollar and Indonesian rupiah as long as these economies continues to outperform the rest of the region growth-wise. Among the Asean-4 economies, Singapore and Indonesia head the pack with the highest 2010 growth projections of 6.5% and 5.8%, respectively, followed by Malaysia and Thailand with 3.5% growth. For Indonesia, the stable political climate under President Susilo, coupled with the much-anticipated policy reform, should continue to attract investments and support growth.

2. Small downside for ringgit and Thai baht. Fiscal deficit for the 13th year running will continue to overhang the Malaysian ringgit. The baht has firmed against the US dollar, partly due to its cumulative current account surpluses. The Thai stockmarket has been playing catch-up with the rest of the region after being heavily sold down over the past two years. We expect the economy to turn around from a contraction of 2.8% this year to 3.5% expansion next year. However, given the lingering political concerns and the recent Map Ta Phut issue, the economic recovery pace is likely to be moderate in 2010.

3. Renminbi flattish. The renminbi has charted a stable path, barely moving against the US dollar in comparison to its regional peers. This is clear evidence of central bank intervention to suppress appreciation of the yuan given the continued rise in China’s foreign reserves by US$326.6bn since end-2008 to US$2.3tr as at end-Sep 09. China is set to return to strong growth of 10% next year as a result of sustained domestic spending and export recovery. We expect the renminbi to stay within a tight range over the next 12 months amid mounting pressure from major developed economies for stronger appreciation of the Chinese currency. This will help to boost domestic demand and correct global imbalances.

Figure 44: Regional currencies forecast (end-period)

Exchange rate vs US$ 2005 2006 2007 2008 2009E 2010FJapanese yen (JPY) 117.75 119.05 111.75 90.64 92.00 102.00Euro dollar (EUR) 1.18 1.32 1.46 1.40 1.55 1.48Hong Kong dollar (HKD) 7.75 7.78 7.80 7.75 7.75 7.80Korean won (KRW) 1,010 930 935 1,260 1,150 1,250Chinese renminbi (CNY) 8.07 7.80 7.30 6.83 6.81 6.75Singapore dollar (SGD) 1.66 1.54 1.44 1.43 1.37 1.42Malaysian ringgit (MYR) 3.78 3.53 3.31 3.47 3.35 3.45Indonesian rupiah (IDR) 9,830 8,995 9,393 11,120 9,200 9,500Philippines peso (PHP) 53.09 49.03 41.25 47.52 47.00 47.50Thai baht (THB) 41.03 35.45 33.71 34.74 33.30 34.50Taiwan dollar (TWD) 32.83 32.59 32.43 32.79 32.40 33.00

Source: Bloomberg, CIMB Group Treasury


Key risks for 2010Major risks to the outlook include (i) a weaker-than-expected recovery in the developed countries, (ii) new asset bubbles, (iii) mistiming of economic stimulus withdrawal or premature monetary tightening, and (iv) a slower-than-expected pick-up in private sector demand.

What could trigger a double-dip recession? We see a 30% probability of a double-dip recession in the US. Is the recovery in global asset prices and commodity prices driven by economic fundamentals? Is it sustainable? The following risks of a downward market and economic correction remain. 1. Confidence and risk aversion are fickle. Bouts of renewed volatility may occur

if macroeconomic and financial data surprise on the downside or if the global recovery does not materialise or turns out to be weaker than expected.

2. The sharp rise in some asset prices threatens the recovery of the global economy.

3. Extremely loose monetary stimulus (near-zero interest rates, quantitative easing, the purchase of riskier private assets) may cause a liquidity-driven asset bubble in financial and commodity markets.

4. A premature “exit” strategy could undermine the tentative stabilisation of the global economy.

Concern over new asset bubbles. The arsenal of extremely loose monetary and liquidity measures that the authorities have used to prop up the economy and markets has caused a surge in the prices of assets from stocks to commodities and gold as well as currencies, especially in Asia. The weak US dollar is also partly responsible for the rally of global assets.

Figure 45: Stock markets rallied across the globe, fuelled by abundant liquidity

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Figure 46: Commodity prices have also surged

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Downside risks to global growth

Extremely loose monetary policy may have caused new asset bubbles


Figure 47: Currencies in the region have gained against the US dollar…

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Figure 48: … while commodity currencies spiked

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The run-up in asset prices beyond the levels supported by economic fundamentals has stirred worries of a new asset bubble risk among the policymakers, especially in Asia. The flood of billions of dollars in investment capital is raising concerns over asset bubbles in equity markets across Asia and in real estate in China, Hong Kong, Singapore and Vietnam.

Figure 49: Abundant liquidity flooding the system has caused a spike in asset prices in China and Korea…

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Figure 50: And pushed up property prices in Singapore & Hong Kong

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Dollar carry trade may destabilise financial markets. The near-zero Fed funds rate and weak US dollar have made the US dollar the currency du jour for carry trades. As long as the Fed continues to keep the rate low, the bigger the carry trades, which mirror the yen carry trades. If the carry trade starts to unwind or if exit strategies are set in motion, it could destabilise the global financial and commodity markets.

Figure 51: Persistently low Japan interest rates made the yen the traditional source of carry trades

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Figure 52: The US dollar is now also funding the carry trade due to historically low interest rates

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Pre-emptive measures taken. To prevent bubbles from developing, policymakers have resorted to administrative measures to cool property prices. Singapore’s authorities have suspended the interest absorption scheme, ended real-estate stimulus policies and also made more land available for development. The Hong Kong regulator has increased the downpayment on luxury homes from 30% to 40% for properties valued at HK$20m or more. South Korea has tightened real estate lending requirements for seven districts around Seoul where prices have jumped. China has also implemented measures to curb excessive credit expansion, including tightening banks’ capital requirements and raising the reserves provision for non-performing loans.

Global central banks are shifting course. As concerns over developing asset bubbles are stirring even as the signs of economic recovery emerge, the policymakers are facing the policy dilemma of when to start reining in the recovery and what the exit strategy should be. Global central banks are starting to unwind emergency measures introduced earlier this year to stave off a second Great Depression. The danger is that a mistimed withdrawal of support could spark swings in the financial markets worldwide and derail the recovery before it has taken a firm hold.

Capital controls on speculative inflows. Some form of capital controls in emerging Asia is inevitable if the speculative “hot money” continues to pour in and threatens to destabilise the real economy and financial markets. Brazil and Taiwan have acted to stem the short-term capital inflows while India, Indonesia and Korea are mulling over the policy options. Among emerging Asia, Indonesia is a wild card. Thailand is not likely to impose control on capital inflows given its bad experience in 2006. Malaysia is a remote case as there was no large influx of private capital. Countries’ experiences showed that at least in the short run, capital controls were effective if the capital inflows are perceived as being temporary. However, capital controls are never effective in the long run and may in fact make things even worse. Further, from the viewpoint of an international investor, one can always redirect investments where there are fewer impediments.

Lee Heng Guie +60(3) 2084 9667 – [email protected] Tong +60(3) 2084 9867 – [email protected]

Pre-emptive measures were taken to contain asset price inflation

Timing of exit strategy is critical

Mulling plans over capital controls


December 2009


MalaysiaHow strong is the recovery?

Lee Heng Guie +603 2084 9667 – [email protected]

• What to expect. The recovery has started, evident from the clearer signs of improvement in both external and domestic demand conditions. The rebound in growth is supported by continuing fiscal support, pick-up in manufacturing and the turning inventory cycle. We expect the Malaysian economy to recover by 3.5% in 2010 and 5.5% in 2011 after shrinking by an estimated 2.3% in 2009. Potential upside to growth could come from stronger exports and domestic demand, especially private investment.

• Continuation of broad-based growth. The recovery is expected to be broad-based, with private sector demand leading the charge as the public sector gradually unwinds its fiscal support. Private sector demand is estimated to rise 4.3% in 2010 while public sector expenditure is set to pull back 3.6%. Exports should rebound 8-10% after the collapse of global trade last year.

• Fiscal consolidation remains a medium-term priority, going by the smaller budget deficit of 5.6% of GDP proposed for 2010, a reduction from 7.4% of GDP in 2009. This will be achieved through a drastic 13.7% cut in operating expenses (mainly on subsidies, supplies & services and grants & transfers). We take a positive view of the gradual rollback of fiscal support as it provides space for the private sector to take over the driving seat.

• Bold liberalisation move. The policymakers remain committed to a market-oriented economy and will continue to tackle any regulations or structural gaps that stifle private sector initiative. Since Apr 09, notable liberalisation steps were rolled out in the services, banking, insurance and fund management industries. The one with the most impact is the Foreign Investment Committee (FIC) deregulation on M&A, equity ownership, IPO and property acquisitions.

• Potential downside risks to growth could come from several external sources (i) slow and uneven growth in the G-3 economies, which would lead to an anaemic recovery for exports, (ii) premature exit strategies which could cause a double-dip recession, especially in the US, and (iii) renewed asset bubbles, especially in Asia. The main domestic risk would be the failure of private sector demand to pick up the baton as government largesse is gradually withdrawn.

Review of 2009Coming back to life. In 1H09, the Malaysian economy was mired in a recession for the first time since 1998 as real GDP growth retreated 5.1% yoy on an export slump, slowing consumption and falling investment.

However, global economic conditions showed clearer signs of stabilisation and recovery in 2H as coordinated fiscal stimulus packages and monetary easing around the globe took hold. With the easing of global trade contractions and a turnaround in manufacturing activity and inventory cycles, Malaysia’s export contraction also improved from -26.3% yoy in 2Q to -22.3% yoy in 3Q. Surprisingly, exports turned around sooner than expected to rise by 1.6% yoy in Oct 09. Domestic demand also turned the corner after getting a fillip from the RM67bn stimulus packages and the frontloading of interest rate cuts by 175bps to 2.00% currently. The pace of layoffs eased substantially in recent months, providing a boost to consumer sentiments. The 3Q09 GDP data were more upbeat than expected with a smaller contraction of 1.2% (-3.9% in 2Q and -6.2% in 1Q). We estimate the economy will rebound

Countercyclical policy measures helped to lift the economy out of a deep recession


to positive growth in 4Q09, taking the full-year GDP estimate to a contraction of 2.3% (4.6% in 2008).

Figure 1: Real GDP contracted at a slower pace of 1.2% yoy in 3Q09

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Countercyclical and stabilisation measures. To mitigate the adverse impact of the global financial crisis on the domestic economy, two fiscal stimulus packages totalling RM67bn or 9.3% of GDP were rolled out. The first package of RM7bn was announced on 4 Nov 08, followed by a RM60bn package on 10 Mar 09. The key measures included the quick implementation of smaller projects with high multiplier effect in four major areas, namely housing, public transport, infrastructure and maintenance work, and the provision of guaranteed funds for working capital as well as the voluntary reduction of employees’ provident fund contribution by 3% pts to 8% for 2009-10.

Bold liberalisation move. We are encouraged by Prime Minister Dato’ Seri Najib Razak’s sweeping policy reforms that strive to address structural gaps and make Malaysia more relevant and competitive after the global financial crisis blows over. These include the scrapping of 30% bumiputera equity ownership in 27 services sub-sectors, financial liberalisation and FIC deregulation. We expect the policymakers to continue undoing regulations and procedures that stifle the growth of the private sector and a market-oriented economy. In a move to restore the country’s fiscal position back on the sustainable path, the Prime Minister announced that the Bill on Goods and Services Tax (GST) will be tabled in Parliament for the first reading this year and second reading in Mar 2010, paving the way for the implementation of GST in 18 months after the second reading. This move is expected to widen the country’s narrow tax base and reduce its dependence on oil revenue (39.9% of total revenue).

Bold policy reforms to address structural issues in the economy


Figure 2: Liberalization measures for 27 services subsectors were announced on 23 Apr 09

Computer and related services1. Consultancy services related to the installation of computer hardware2. Software implementation services – systems and software consulting services; systems analysis services; systems designing services; programming services and

systems maintenance services3. Data processing services – input preparation services; data processing and tabulation services; time sharing services and other data processing4. Data base services5. Maintenance and repair services of computers6. Other services – data preparation services; training services; data recovery services and development of creative content

Health and Social services7. All veterinary services8. Welfare services delivered through residential institutions to old person and the handicapped9. Welfare services delivered through residential institutions to children10. Child day-care services including day-care services for the handicapped11. Vocational rehabilitation services for handicapped

Tourism services12. Theme park13. Convention and exhibition centre (seating capacity above 5,000)14. Travel agencies and tour operators services (for inbound travel only)15. Hotel and restaurant services (for 4 and 5 star hotels only)16. Food serving services (for services provided in 4 and 5 star hotels only)17. Beverage serving services for consumption on the premises (for services provided in 4 and 5 star hotels only)

Transport services18. Class C Freight Transportation (private carrier license – to transport own goods)

Sporting and other recreational services 19. Sporting services (sports event promotion and organization services)

Business services20. Regional distribution centre21. International procurement centre22. Technical testing and analysis services23. Management consulting services – general, financial (excluding business tax), marketing, human resources, production and public relations services

Rental/leasing services without operators24. Rental/leasing services of ships that excludes cabotage and offshore traders25. Rental of cargo vessels without crew (bareboat charter) for international shipping

Supporting and auxiliary transport services26. Maritime agency services27. Vessel salvage and refloating services

Source: Ministry of Finance (MoF), CIMB/CIMB-GK Research

Figure 3: Followed by some financial liberalisation measures announced on 27 Apr 09

Issuance of New Licences1. Up to two new Islamic banking licences will be offered in 2009 to foreign players to establish new Islamic banks with paid-up capital of at least USD1bn;2. Up to two new commercial banking licences will be offered in 2009 to foreign players that will bring in specialised expertise; 3. Up to three new commercial banking licences will be offered in 2011 to world-class banks; 4. Up to two new family takaful licences will be granted in 2009.

Increase in Foreign Equity Limits1. With immediate effect, existing domestic Islamic banks are given greater flexibility to enter into strategic partnerships with foreign players through an increased

foreign equity limit of up to 70%. These banks will be required to maintain a paid-up capital of at least USD1bn;2. With immediate effect, the foreign equity participation in investment banks will be increased to a limit of up to 70% (the foreign equity limit for domestic commercial

banks will remain at the current 30%);3. With immediate effect, the foreign equity participation in insurance companies and takaful operators will be increased to a limit of up to 70%;4. A higher foreign equity limit beyond 70% for insurance companies will be considered on a case-by-case basis.

Operational Flexibilities1. With immediate effect, locally-incorporated foreign commercial banks can establish up to ten microfinance branches. Further branches will be considered based

on the effectiveness of these branches in serving microenterprises; 2. Locally-incorporated foreign commercial banks in Malaysia will be allowed to establish up to four new branches in 2010 based on a distribution ratio of

1(market centre): 2(semi-urban): 1(non-urban); 3. Locally-incorporated foreign insurance companies and takaful operators are allowed to establish branches nationwide without restriction;4. With immediate effect, no restrictions for locally-incorporated foreign insurance companies and takaful operators to enter into bancassurance / banctakaful

arrangements with banking institutions; 5. With immediate effect, banking institutions, insurance companies and takaful operators will be accorded greater flexibility to employ specialist expatriates;6. Offshore banking institutions and offshore insurance companies licensed by the Labuan Offshore Financial Services Authority that meet the predetermined criteria

will be accorded flexibility to have a physical presence onshore from 2010 and 2011 respectively

Source: BNM, CIMB/CIMB-GK Research


Figure 4: Deregulation of the Foreign Investment Committee announced on 30 Jun 09

FIC Deregulation1. Reduction of FIC's roles

• FIC guidelines on the acquisition of equity stakes, mergers and takeovers is repealed.• FIC will no longer process share transaction nor impose equity conditions on such transaction.• Equity conditions for investments, if any, will be imposed by relevant sector regulators.

2. Equity ownership requirements• FIC's 30% bumiputera equity requirement for companies going for IPO is removed.• Securities Commission (SC), as sector regulator, will continue to impose public spread requirement of 25% of total shares issued.• SC will now impose a bumiputera equity spread requirement of 50% of the 25% public spread.• Listed companies are no longer subject to equity conditions post-IPO except in the case of RTO and backdoor listing.

3. Acquisition of properties• FIC will only process transactions involving the dilution of Bumiputera and government interests (i.e. sale of property by Bumiputera to non-Bumiputera) and

government interests in property. In such cases, FIC approval is only required for properties above RM20m, whether bought directly or indirectly.• All other transactions (i.e. sale of property among Bumiputera and sale of property between non-Bumiputera and foreigners) will no longer require FIC approval

subject to a minimum property value of RM500K for commercial and industrial property.• Threshold price of residential property sold to foreigners will be doubled to RM500K from RM250K w.e.f. 1 Jan 2010.• State governments maintain the right to impose additional conditions.

Fund Management Liberalisation1. Ownership in wholesale fund management industry is fully liberalised to allow 100% ownership for qualified and leading fund management companies.2. Foreign ownership in retail fund management industry raised to 70% from 49%.

Stock Broking Liberalisation1. Foreign ownership shareholding limits in existing stock broking companies be increased to 70% from the current 49%.

VISA Application1. Bank Negara Malaysia and Securities Commission to review all visa applications for international talent for the financial services industry and capital market

industries.

Establishing Ekuinas1. Ekuiti Nasional Berhad (Ekuinas) is etablished with initial capital of RM500m, eventually to be enlarged to RM10bn fund.2. Ekuinas will focus on investments in high growth sectors.

Source: Economic Planning Unit (EPU), CIMB/CIMB-GK Research

Monetary easing continues. Bank Negara Malaysia (BNM) has frontloaded its interest rate cuts, having lopped 175bp off the overnight policy rate (OPR) in three separate meetings between Nov 08 and Feb 09. The OPR now stands at a historical low of 2.00%. BNM policy is also directed towards enhancing credit accessibility to support the economic recovery. Fortunately, deflation rather than inflation is the order of the day in 2H09, allowing BNM to keep interest rates low for an extended period until it sees a strong economic revival.

Key drivers for 2010Economy in recovery mode. The Malaysian economy is gradually coming out of a deep recession as clearer signs of a recovery started emerging in 2H09. Several factors were behind the revival of the economy – a gradual turn of exports, uptick in manufacturing output and the government’s fiscal boost. Both consumer and business sentiments have turned the corner, which bodes well for private sector demand. This, along with the projected recovery in exports, will lift real GDP growth higher to 3.5% in 2010 and 5.5% in 2011, after an estimated contraction of 2.3% in 2009. The index of leading indicators, which is the best indicator of turning points, bottomed out in Feb 09 and has since racked up seven straight months of monthly gains.

Clearer signs of recovery have started emerging in 2H09


Figure 5: Leading index points to better GDP prospects

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0

5

10

15

20

25


Annualised 6mth % chg

Leading Index Trendline

Source: DOS

The growth catalysts for 2010-11 will be (i) a firmer recovery of domestic demand as fiscal spending is stepped up as well as the completion of 9MP projects, and (ii) a turnaround of exports as the global economy recovers. The recovery is expected to be broad-based, with private sector demand leading the charge as the public sector gradually unwinds its fiscal support. Private sector demand is estimated to rise 4.3% in 2010 while public sector expenditure is set to pull back 3.6%. Exports should rebound 8-10% after the collapse of global trade last year.

Figure 6: Real GDP growth forecast

Demand side% yoy % share %pt cont.

2008 Jan-Sep 09 2009E 2010F 2011F 2009E 2010F 2011F 2009E 2010F 2011FReal GDP 4.6 -3.8 -2.3 3.5 5.5 100.0 100.0 100.0 -2.3 3.5 5.5Private Consumption 8.4 0.5 1.5 4.1 5.6 54.4 54.7 54.7 0.8 2.2 3.0Public Consumption 10.9 4.9 0.6 -4.3 -4.3 14.1 13.0 11.8 0.1 -0.6 -0.6Private Investment 0.8 -9.4 -30.0 5.8 8.7 8.5 8.7 8.9 -3.5 0.5 0.8Public Investment 0.7 24.5 -2.9 1.0 13.3 12.5 12.0 2.6 -0.4 0.1Exports 1.3 -15.3 -11.8 5.8 6.8 106.9 109.3 110.6 -13.9 6.2 7.4Imports 1.9 -18.5 -14.1 6.9 8.8 92.6 95.5 98.5 -14.9 6.4 8.4

Supply side% yoy % share %pt cont.

2008 Jan-Sep 09 2009E 2010F 2011F 2009E 2010F 2011F 2009E 2010F 2011FReal GDP 4.6 -3.8 -2.3 3.5 5.5 100.0 100.0 100.0 -2.3 3.5 5.5Agriculture 4.0 -1.4 -1.3 2.0 2.5 7.6 7.5 7.3 -0.1 0.2 0.2Mining -0.8 -4.1 -4.0 1.2 2.0 7.9 7.7 7.5 -0.3 0.1 0.2Construction 2.1 4.5 5.4 4.2 5.6 3.2 3.2 3.2 0.2 0.1 0.2Manufacturing 1.3 -13.6 -10.1 4.5 5.5 26.8 27.0 27.0 -2.9 1.2 1.5Services 7.2 1.7 2.2 4.2 6.4 57.5 57.9 58.4 1.2 2.4 3.7

Source: DOS, BNM, CIMB/CIMB-GK Research

External drivers – Global recovery has startedGlobal recession has ended. The global economy has clambered onto a moderate recovery track, thanks to synchronised fiscal stimulus around the world, aggressive monetary easing and financial stabilisation measures. The growth impetus is also supported by substantial inventory restocking and easing global trade contraction. The OECD leading indicators point to stronger signs of improvement while global manufacturing production and trade have rebounded in recent months. But the million-dollar question now is whether the recovery can be sustained when the fiscal stimulus is phased out and governments around the globe apply their exit strategies.

Coordinated global policy actions have averted global depression version II…


Figure 7: Global leading indicators signal improvements ahead

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3MMA %yoy

90

92

94

96

98

100

102

104

IndexGlobal PMI OECD CLIs (RHS)

Source: Bloomberg, OECD

Figure 8: Industrial activity rebounded as external trade improved

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Jan-06 Jun-06 Nov-06 Apr-07 Sep-07 Feb-08 Jul-08 Dec-08 May-09 Oct-09

% yoy Global merchandise trade OECD industrial output

Source: Netherlands Bureau for Economic Policy Analysis (CPB), OECD

The International Monetary Fund expects the global economy to expand 3.1% in 2010 after shrinking an estimated 1.1% in 2009. Nonetheless, we foresee a slow and uneven recovery, especially in the major crisis-stricken economies. Financial systems remain impaired while households need to repair their balance sheets and rebuild savings. Meanwhile, continued job losses will constrain consumption.

The US economy is estimated to grow by 1-2% in 2010 (estimated -2.3% in 2009) on continued fiscal support, a return to growth for the manufacturing and services sector and an improvement in the housing market. But continued deleveraging and slow job growth will continue to weigh on consumer spending. The eurozone economy has broadly stabilised and may expand modestly in 2H09, driven mainly by rising exports, a turning inventory cycle and continued government largesse. But the recovery will be gradual, with real GDP expected to inch up just 0.6% in 2010 following an estimated 4.3% pullback in 2009. After an estimated 5.6% downturn in 2009, the Japanese economy is projected to rack up growth of 1.5% in 2010, thanks to higher government investment, fiscal support and export resurgence. In Asia, China’s, India’s and Indonesia’s economies are expected to grow robustly as a result of continued gains in fixed investment, consumption and a turnaround in exports. The risks to our China’s GDP growth estimate of 10% for 2010 are asset bubbles and higher inflation.


Figure 9: Global economic growth forecast


US 0.4 -6.4 -0.7 2.8 -2.3 1.0 - 2.0 2.0 - 3.0EU 0.6 -5.0 -4.8 -4.1 -4.3 0.6 1.5Japan -0.7 -8.9 -5.8 -5.1 -5.6 1.5 1.8UK 0.7 -5.0 -5.5 -5.1 -4.4 0.9 2.5China 9.0 6.1 7.9 8.9 8.2 10.0 10.0India 7.3 5.8 6.1 7.9 6.0 7.0 7.3

Source: International Monetary Fund (IMF), Bloomberg, CIMB/CIMB-GK ResearchNote: US quarterly GDP growth is on annualised qoq basis. Quarterly GDP growth for all other economies above is on yoy basis.

Exports are on the mend. We have reason to believe that Malaysia’s exports have hit bottom and should stabilise and recover in the months ahead. The pace of contraction eased from -26.3% yoy in 2Q09 to -22.3% yoy in 3Q09 and rebounded by 1.6% in Oct 09 on a pick-up in electronics exports, in tandem with eight consecutive monthly gains in global chip sales. Positive leads underpinning the export recovery are: (i) the easing contraction of global trade, (ii) a moderate recovery for the major developed economies, (iii) improved demand for consumer electronic goods. According to semiconductor research firm Gartner, global semiconductor revenue is estimated to grow about 10% in 2010 after two years of declines (-5.4% in 2008 and estimated -22.4% in 2009) as new computers and feature-jammed smart phones help boost chip demand; and (iv) still-firm commodity prices as well as the waning of high-base effects. We are keeping our average crude oil projections of US$75/bbl for 2010 and US$80/bbl for 2011. Our CPO price forecasts are RM2,380/tonne for 2010 and RM2,450 for 2011. We estimate export growth of 8-10% for Malaysia in 2010 after an estimated contraction of 16.8% in 2009. Benefiting from the recovery of exports, we estimate the current account surplus will remain substantial at RM109.4bn or 15.0% of GDP in 2010 (an estimated surplus of RM111.0bn or 16.0% of GDP in 2009). This will continue to fuel domestic liquidity while providing the underlying support to the ringgit. Our ringgit/US$ estimate is RM3.45 by end-2010 compared to an estimated RM3.35 by end-2009.

Figure 10: Both E&E and non-E&E exports have stabilised

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010203040


3MMA % yoy

Exports of E&E Exports of non-E&E Total exports

Source: DOS, CIMB/CIMB-GK Research

Figure 11: Exports are on the mend as the global economy gradually recovers…

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Jan-04 Sep-04 May-05 Jan-06 Sep-06 May-07 Jan-08 Sep-08 May-09

3MMA %yoy

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110Index

Malaysia exports OECD CLIs (RHS)

Source: DOS, OECD, CIMB/CIMB-GK Research

… and this should benefit Malaysia’s external sector


Figure 12: The improving US ISM new orders also presage a gradual recovery in exports

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3MMA %mom

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Malaysia's E&E exportsUS ISM Manufacturing new orders (RHS)

Source: DOS, Bloomberg, CIMB/CIMB-GK Research

Figure 13: Exports expected to post a decent growth of 8-10% growth in 2010

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growth % % mom % yoy


Domestic demand driver – On the path to recoveryReviving domestic demand. Recent data suggest that domestic demand has entered into a recovery phase, lifted by strengthening consumer confidence and business sentiment due to more optimism over the recovery of the domestic economy and exports. Aggregate domestic demand recovered to grow marginally by 0.4% yoy in 3Q09 (-2.6% in 1H) on continued improvement in private consumption (+1.5% in 3Q and 0.5% in 2Q09) while total investments declined at a slower pace of 7.9% in 3Q09 (-9.5% in 2Q and -10.8% in 1Q). As such, we estimate aggregate domestic demand to strengthen by 1.9% yoy in 2010 from an estimated marginal decline of 0.2% in 2009.

Figure 14: Domestic demand will continue to support the economy

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% yoy; % contr

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% share of GDPReal GDP Domestic demand contributionDomestic demand share (RHS)


Domestic demand to strengthen on improved labour market conditions and income


Pent-up consumer demand. We expect consumer spending to grow at a faster pace of 4.1% in 2010 from an estimated 1.5% in 2009, raising its share of GDP to 54.7% in 2010 from 52.3% in 2008. The main drivers of consumption growth are: (i) more stable labour market conditions. The pace of layoffs has come off significantly from 3,343 persons/month in 1H09 to 1,006 persons/month in Jul-Oct 09. About 55% of the local retrenched workers were rehired in Oct 08-Aug 09, (ii) improved disposable incomes, steady commodity prices and low inflation; and (iii) historically low interest rates and accommodative financing.

Figure 15: Private consumption is expected to grow faster as labour market conditions improve

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2001 2002 2003 2004 2005 2006 2007 2008 2009E 2010F 2011F

% yoy; % contr

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% shareGrowth % contribution % share of GDP (RHS)


Figure 16: Consumer sentiment has turned the corner

0

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IndexRetrenchments MIER Consumer Sentiment Index (RHS)

Source: CEIC

Figure 17: Household loan demand remains steady

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Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09

RM bn Loans approved Loans disbursed Loan applications

Source: BNM


Figure 18: Private consumption indicators are holding up

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Jan-01 Nov-01 Sep-02 Jul-03 May-04 Mar-05 Jan-06 Nov-06 Sep-07 Jul-08 May-09

% yoy Consumption credit Imports of consumption goods Passenger car sales

Source: DOS, BNM

Turnaround in investment prospects. Following a strong 24.5% rise in 2009, public investment is expected to decline 2.9% in 2010 as capital spending tapers off with the completion of 9MP projects. As such, 2010’s capital spending is budgeted at RM51.2bn or 7.1% of GDP, which is 4.4% lower from 2009’s RM53.6bn. The two stimulus packages totalling RM67bn amount to 9.3% of GDP for 2009-10. As at 6 Nov 09, RM5.7bn worth of projects are in various stages of implementation while RM9.3bn has been completed and paid out to contractors. The completed projects under the stimulus packages include low-cost houses, infrastructure, schools, police stations and army quarters.

Figure 19: Status of fiscal packages as at 6 Nov 09

First fiscal package

RM4.7bRM0.5b

RM1.7b

RM0.0b

Various stages of implementation To be awarded Payment made Undisbursed

Second fiscal package

RM4.0b

RM6bn RM4.6b

RM0.4b

Source: Ministry of Finance (MoF)

Fiscal consolidation to start in 2010 Fiscal consolidation is not a choice but a must. We are encouraged by the 2010 Budget which signals the gradual consolidation of the budget deficit, going by the smaller budget deficit of RM40.5bn or 5.6% of GDP proposed for 2010 (-RM51.1bn or 7.4% of GDP in 2009). The government is shooting for an unprecedented 13.7% cut in operating expenses, the first cut in 11 years. The axe will fall on subsidies, asset acquisitions as well as transfers and grants to government agencies. The Budget promises to restructure the fuel subsidy scheme, which will not be across the board and will target the needy groups. This will help minimise the misallocation of limited public resources. On the revenue side, the government has explored the broadening of the non-oil revenue base such as the disposal of government assets. The Bill on Goods and Service Tax (GST) will be tabled in Parliament for first reading in Dec 09 and for second reading in Mar 2010 and will be implemented in 18 months time after the second reading. The country’s high dependence on oil revenue (39.9% of total federal revenue in 2009) and low indirect taxes on consumption (17.1% of total revenue) makes a strong case for the broadening of the present narrow tax base. The proposed GST rate of 4%, which is lower than the current services and sales tax of between 5-10%, is deemed appropriate to avoid dampening consumer spending and its impact on inflation.

Fiscal consolidation remains a medium-term policy


Figure 20: Malaysia enters its 13th year of fiscal deficit in 2010

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Figure 21: Development expenditure lower during the 10MP

35.8 40.6 42.853.6 51.2

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Figure 22: High dependency on oil-related revenue (39.9% of total revenue)

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100% of total revenueOil revenue Non-oil revenue

Oil revenue (RHS) Non-oil revenue (RHS)

Source: MoF, BNM, CIMB/CIMB-GK Research

The success of the fiscal consolidation package hinges on the trust of the public in the solvency of government finances. The policymakers need to commit a credible plan to reverse the deterioration of the fiscal position in the medium term and build a broad public consensus around a concrete consolidation plan when the economic recovery has taken hold. Should fiscal sustainability come into question, interest rates would rise despite monetary easing efforts. This would severely curtail the government’s ability to support the financial sector and pressures on the currency could emerge.

The trust of the public in the solvency of government finances is essential to ensure the success of fiscal consolidation


What to expect from the 10MP? The Tenth Malaysia Plan (10MP) which covers 2011-15 is scheduled to be tabled in Parliament in June 2010. The six strategic directions of 10MP are: (i) build a competitive private sector as an engine of growth; (ii) drive productivity and innovation through K-economy; (iii) nurture as well as develop creative and innovative human capital; (iv) inclusiveness in bridging development gap; (v) improve the standard and quality of life; and (vi) to strengthen institutional and implementation capacity with the government as an effective facilitator. Faced with its highest budget deficit of 7.4% of GDP in 2009 since 1987, Malaysia is proposing to cut development expenditure by 21.7% to RM180bn for 2011-2015 from RM230bn in the Ninth Malaysia Plan (2006-2010). The total amount of public investment comprises (i) direct federal capital spending of RM165bn and RM15 facilitation fund to promote private finance initiatives (PFI). Total amount of private investments required in 10MP are RM510bn, which will translate into real private investment growth of 10.5% pa in 2011-15. It is hopeful that the proposed cut in both the development and operating expenditures as well as enhanced revenue base will lower the budget deficit to 3% of GDP in 2015. The plan also targets an average real GDP growth of 5.5% p.a. in 2011-15. Projects under 10MP will be announced on a yearly basis to ensure smooth implementation and allow for financial adjustments. For instance, projects that are slated for implementation in 2011-12 will be announced in 2010.

Pinning hopes on private investment. Private investment, which is estimated to collapse 30.0% in 2009, is projected to recover by 5.8% in 2010 as business sentiment turn positive given the improved prospects for the global and domestic economies. Enhanced access to credit also helps to support businesses and SMEs. According to Syarikat Jaminan Pembiayaan Perniagaan Bhd, the RM7bn total allocation for the Working Capital Guarantee Scheme (WCGS) was fully utilised as at 23 Oct 09 while RM541.2m of the RM3bn Industry Restructuring Financing Guarantee Scheme (IRFGS) was taken up.

Figure 23: Private investment to recover modestly after the sharp contraction in 2009

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% yoy; % contr

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% shareGrowth % contribution % share of GDP (RHS)


In the wake of the Asian financial crisis, private investment has underperformed since 1997 due to (i) the prevalence of excess capacity or overinvestment, especially in the property sector, in the years leading up to the Asian crisis, (ii) intense competition from China and India as well as other new economies that are fast catching up, (iii) uncompetitive investment policies, and (iv) structural impediments such as cumbersome rules, shortage of skilled workers and security concerns. The policymakers are fully aware of the constraints and promised in the 2010 Budget to dismantle any barriers to re-energising private investment including policies, rules, regulations and procedures.

Since Apr 09, Prime Minister Datuk Seri Najib Razak has rolled out a number of bold initiatives to stimulate the economy and investments. These include (i) the scrapping of bumiputra equity ownership requirements for 27 services subsectors; (ii) Foreign Investment Committee (FIC) deregulation in M&A, equity listings and property acquisition; and (iii) new licences for the banking and insurance sectors, which is a big step in financial liberalisation.

10MP policy thrusts are to steer private sector initiatives

Private sector needs to be re-energised as the driver of economic growth


The PM has taken these bold steps as time is not on Malaysia’s side. It faces a dilemma in its quest for a quantum leap in economic expansion. In his 2010 Budget speech, the PM said, “We are now at a critical juncture, either to remain trapped in a middle-income group or advance to a high-income economy. As such, we must be the agent of change and seek solution in addressing global economic challenges.” …“We now have to shift to a new economic model based on innovation, creativity and high-value added activities. Only then, we will be able to remain relevant in a competitive global economy.”

Malaysia is trailing behind in FDIs. Foreign direct investments (FDI) have increased from a mere RM2.1bn in 2001 to RM29.1bn in 2007 and RM24.1bn in 2008. In Jan-Sep 09, FDI inflows amounted to RM7.2bn. In our view, the projected moderate as well as uneven global recovery, especially in major developed economies will dampen the inflows of long-term capital into Asia. Malaysia, too, will likely experience a setback in FDI inflows in the near-term. We estimate FDI to shrink to RM9.0-11.0bn in 2009 and RM10.0-12.0bn in 2010 from RM24.1bn in 2008 due to the shrinking FDI flows following the continued global financial deleveraging process. The pattern of FDI has changed from predominantly manufacturing to services in recent years as investors actively participated in a cross-section of services, including financial, hotels, wholesale and retail trade and insurance. The recent liberalisation moves are expected to help boost foreign interest in the services sector. However, Malaysia still lags behind its regional peers in wooing FDI, not only because of the perception of policy risks but also because other economies are fast catching up.

Figure 24: FDIs into Malaysia moderated sharply on global economic downturn

05

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1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Jan-Sep 09

RM bn

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%Net FDI flow % of GDP (RHS)


Figure 25: Yet Malaysia lags behind in terms of the amount of FDI inflows

FDI Inflows, US$ m % of GDP1990-1997 1998-2006 2007 2008 1990-1997 1998-2006 2007 2008

China 204,646 485,372 83,521 108,312 4.1 3.3 2.5 2.5Hong Kong 50,983 261,053 54,365 63,003 5.1 17.2 26.3 29.2India 10,365 57,521 25,127 41,554 2.0 6.5 15.1 22.8Singapore 60,873 136,300 31,550 22,725 1.9 2.6 3.0 2.4Thailand 18,241 53,933 11,238 10,091 1.7 4.2 4.6 3.7Malaysia 41,549 31,279 8,401 8,053 7.1 3.4 4.5 3.6Indonesia 23,960 5,406 6,928 7,919 0.9 0.1 0.6 0.7South Korea 9,725 56,761 2,628 7,603 7.7 16.0 3.7 8.5

Source: UNCTAD, CIMB/CIMB-GK Research

FDI inflows into Malaysia have been lagging behind its peers.


Malaysian companies’ outward investments outpaced FDI from 2007 to Jan-Sep 09 due to the rapid pace of overseas investment by Malaysian companies. In the review period, Malaysian companies’ invested RM100.2bn outside Malaysia, which is 1.7x higher than that of foreign direct investment in Malaysia. Outward investments increased 28.1% p.a. in 2000-08, with their share of total GDP rising from 1.7% in 1999 to 6.8% in 2008. The increased flow of overseas investments by Malaysian companies reflected (i) the saturation of the domestic market, (ii) the regionalisation of business operations, especially for the banking sector, and (iii) the search for business and investment opportunities as well as synergistic ventures abroad. Among the sectors involved are construction and property, financial services, power generation, water supply, plantation as well as gaming and leisure.

Figure 26: Investments by Malaysian companies abroad has been rising rapidly

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1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Jan-Sep

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012345678

Overseas investment % of GDP (RHS)


Figure 27: Overseas investment has exceeded FDIs for the last three years

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1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Jan-Sep

09

RM bn Overseas investment FDIs

Source: DOS

Broad-based expansionReal GDP growth in 2010 is expected to be broad-based, with all sectors contributing positively to the overall economic expansion.

Figure 28: A broad-based expansion is expected in 2010

Supply side% yoy % share %pt cont.

2008 Jan-Sep 09 2009E 2010F 2011F 2009E 2010F 2011F 2009E 2010F 2011FReal GDP 4.6 -3.8 -2.3 3.5 5.5 100.0 100.0 100.0 -2.3 3.5 5.5Agriculture 4.0 -1.4 -1.3 2.0 2.5 7.6 7.5 7.3 -0.1 0.2 0.2Mining -0.8 -4.1 -4.0 1.2 2.0 7.9 7.7 7.5 -0.3 0.1 0.2Construction 2.1 4.5 5.4 4.2 5.6 3.2 3.2 3.2 0.2 0.1 0.2Manufacturing 1.3 -13.6 -10.1 4.5 5.5 26.8 27.0 27.0 -2.9 1.2 1.5Services 7.2 1.7 2.2 4.2 6.4 57.5 57.9 58.4 1.2 2.4 3.7


Positive contributions from all sectors

Malaysian companies’ outward investments have exceeded FDIs in the last three years


All sectors to register positive growth in 2010. The services sector is envisaged to expand 4.2% in 2010 (2.2% in 2009), supported by a recovery of domestic consumption and trade-related activities. The services sector is expected to be a bigger contributor to GDP growth, supported by the liberalisation measures and policy measures to enhance competitiveness. The manufacturing sector is set to turn around with 4.5% growth in 2010 after an estimated decline of 10.1% in 2009. This reflects the rebound in demand for electronics and electrical products as well as improved output growth for domestic-oriented industries. The construction sector is estimated to sustain a growth rate of 4.2% in 2010 (5.4% in 2009), reflecting ongoing implementation of projects under the two stimulus packages. Major projects include the Light Rail Transit (LRT) extension of the Kelana Jaya and Ampang Lines, Pahang Selangor Raw Water Transfer, new LCCT at KLIA, expansion of the Penang International Airport and the electrified double track between Ipoh-Padang Besar. From a 4.0% pullback in 2009, the mining sector is projected to turn around to growth of 1.2% in 2010 due to higher output of crude oil and natural gas. Growth of the agriculture sector is envisaged to rebound to 2.0% in 2010 (-1.3% in 2009), largely because of the recovery of palm oil production (+4.9% to 17.8m tonnes vs. 17m tonnes in 2009). Rubber output is expected to increase due to better demand and prices while other agriculture produce such as livestock and fishery will also expand.

Accommodative monetary policy to remain Interest rates to stay low in 1H 2010. In our view, Bank Negara Malaysia is not in a hurry to shift its monetary stance towards a tightening bias given the projected subdued inflation outlook. The central bank views the current monetary easing as appropriate to support the recovery given the improved signs of domestic demand and stabilised external economies. We project inflation to rise to 1.5% in 2010 from an estimated 0.7% in 2009 due to (i) the normalisation of statistical base effects due to the oil price shock, (ii) higher global commodity prices, and (iii) the recovery of domestic demand. Upside risk to inflation could come from the restructuring of the fuel subsidy scheme in 1H 2010 as well as the removal of subsidy on sugar.

Rates to move in 2H 2010? Even if rates were to normalise in 2H 2010, it would probably be in small steps of 25-50bp, depending on the nature of the global and domestic recoveries as well as how fast inflation accelerates, especially demand-pull inflation. As such, we believe BNM will keep the overnight policy rate at 2.00% for the greater part of 2010.

Figure 29: Inflation is expected to remain subdued in 2010

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Monetary policy will remain accommodative for greater part of 2010


Figure 30: Interest rates to remain accommodative

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Figure 31: Liquidity is still ample

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Figure 32: Monetary conditions are still healthy

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Key risks for 2010Potential downside risks to growth could come from several external sources (i) slow and uneven growth in G-3 economies, which would lead to an anaemic recovery for exports, (b) premature exit strategies which could cause a double-dip recession, especially in the US, and (iii) renewed asset bubbles. The main domestic risk would be the failure of private sector demand to pick up strongly and assume the mantle of engine of growth as the government gradually withdraws its fiscal support.

Failure of private sector to pick up could be a set-back to economic recovery


December 2009


SingaporeBracing for bumpy recovery

Song Seng Wun +65 6210-8602 - [email protected]

• 2009 turned out stronger than expected. At the start of the year, the Ministry of Trade and Industry (MTI) announced that the Singapore economy was expected to shrink by 6-9%. There was reason for pessimism because the economy had contracted for the fourth straight quarter with a decline of 12.2% annualised and quarter-on-quarter (SAAR) in 1Q09. Yoy, 1Q09 GDP contracted a record 10%. However, the economy rebounded sharply in 2Q09, expanding by a seasonally adjusted 22% qoq SAAR. Strong gains in the manufacturing sector underpinned the improvement. The MTI narrowed its growth forecast for 2009 to -6% to -4%. This was narrowed further to -2.5% to -2.0% after the economy expanded 0.6% yoy or 14% qoq SAAR in 3Q09, with the help of all major sectors. Supported by government measures, the seasonally adjusted unemployment rate only climbed to 3.4% in Sep 09 from 3.3% in Jan 09 and 2.3% in Sep 08.

• Bracing for a bumpy 2010. Being a trade-dependent economy with the highest trade to GDP ratio in the world, Singapore is very vulnerable to any moderation in the external trade cycle. On the upside, any upturn in global demand will have a positive impact on Singapore. The clear and modest global recovery currently underway suggests Singapore may enjoy 2-3 quarters of strong growth in the coming year. In Nov 09, the MTI announced that it expected the Singapore economy to grow by 3-5% in 2010. Our baseline estimate is 6-7% growth for 2010 with possible growth of 6-10% in 1H10! However, economic activities, especially in developed economies, may remain below pre-crisis levels because of weak labour market conditions and stagnant income.

• Risks to forecasts. There is great uncertainty as to how strong this recovery will be. While Asia, especially China, is likely to post strong growth rates, driven by improved consumer confidence lifting domestic consumption and intra-regional trade flows, the recovery in developed economies remains fragile. Weak household balance sheets and persistently high unemployment, especially in the US, will continue to weigh on private consumption and investment. In addition, uncertainties over the withdrawal of monetary and fiscal measures are a risk. Finally, inflationary pressures in 2010 and beyond may be stronger than expected. The MTI has revised its 2010 CPI forecast from 1-2% to 2.5-3.5% and from nearly zero in 2009.

Review of 2009 The Singapore economy contracted almost 15% qoq SAAR in 1Q09, the fourth consecutive quarter of decline. Yoy, real GDP shrank by a record 10% in 1Q09. Except for construction and financial services, all major sectors were down yoy and sequentially. Weighed down by continued weakness in electronics, biomedical manufacturing, precision engineering and chemicals, manufacturing contracted 18.9%, just slightly less than the previous quarter’s -21.3%. Service-producing industries contracted 9.7%, less than the 15.0% decline in the previous quarter. Financial services provided a small boost for the service sector in the first quarter, but the other segments of the sector were down, mainly because of a collapse in global trade in early 2009. Tourist arrivals also slumped, affecting tourism-related segments of the service sector. The MTI was expecting the Singapore economy to contract by a record 6-9% in 2009.

Poor start to 2009 as global demand imploded


The government brought forward its annual budget presentation by a month, from end-February to end-January. Budget 2009’s deficit was to be the largest on record. At 6% or S$20.5bn, the operating or primary deficit (i.e. deducting TOTAL spending, or capital and operating expenditure, from tax receipts only) was the biggest on record. The budget firmly put in place measures to reduce wage and other business costs, providing a buffer to the economic fallout.

On the back of a sharp rebound in global consumer confidence thanks to aggressive monetary and fiscal measures by governments across the world, economic activities recovered after plunging sharply in 4Q08 and 1Q09. Singapore’s 2Q09 GDP expanded by nearly 22% qoq SAAR, a significant improvement from the 12.2% decline in 1Q09. Strong gains in the manufacturing sector, especially pharmaceuticals, underpinned the improvement. Financial services also improved in 2Q09, growing nearly 23% sequentially. This performance provided a lift to service-producing industries, which grew 8% compared with the nearly 10% decline in 1Q09. Except for hotels and restaurants, service industries booked modest gains, unlike the previous quarter. Yoy, 2Q09 GDP contracted by 3.3%. The MTI revised its 2009 GDP growth forecast to -6% to -4%.

The MTI raised its 2009 GDP growth forecast again, to -2.5% to -2.0% in October after the economy expanded 0.6% yoy or 14% qoq SAAR in 3Q09 with all major sectors registering positive growth. The expansion was led by the manufacturing sector, which grew 27% qoq SAAR. Once again, it was stronger production of higher-value pharmaceutical ingredients that lifted biomedical manufacturing output. Growth in the service-producing sector accelerated to 11% from 2Q09’s 8%. Trade-related and tourism sectors (via wholesale & retail trade, transport & storage, and hotels & restaurants) posted double-digit sequential growth, as global trade flows improved and international travel picked up. And supported by government measures, the seasonally adjusted overall unemployment rate only rose to 3.4% in Sep 09 from 3.3% in Jan 09 and 2.3% in Sep 08.

The collapse in global demand caused commodity and energy prices to fall off the cliff, especially in 1Q09. But headline CPI started to climb in line with the global recovery in commodity prices. By October, headline CPI had risen in eight out of 10 months. But due to the “base effect”, headline inflation moderated from 2.1% yoy in 1Q09 to -0.4% yoy in 3Q09. CPI had spiked in 2008, averaging 6.5% vs. 2007’s 2.1% due to a 2%-pt hike in the Goods and Services Tax, higher energy and commodity prices.

In November, the government raised its 2010 CPI forecast from 1.0-2.0% to 2.5-3.5%, on account of higher annual values used for computing public-housing property taxes. On the back of higher crude-oil, food and car prices, we now expect headline inflation of 1-3% yoy in 1H10 and 3-5% in 2H10, a reflection of the “base effect”, pushing headline inflation to 3-4% from nearly zero in 2009. Although headline inflation could be V-shaped rather than the protracted U-shape seen in the aftermath of the Asian financial crisis, dotcom crash as well as SARS outbreak, the V-shape would probably be exaggerated by a low base in 2009, higher valuations for public flats, a more restrictive auto policy and a sharper recovery in global resource prices. The Monetary Authority of Singapore’s underlying inflation forecast, which excludes costs of accommodation and private road transport, remains a relatively low 1-2%.

The government brought forward its Budget presentation and proposed a hugely expansionary budget

Sharp rebound in the second quarter as global consumer confidence returned

The recovery continued into the third quarter

Deflation in 2009

V-shape headline inflation likely in 2010, but core inflation expected to be stable


Figure 1: V-shape recovery in 2009

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Figure 2: Smaller drag from domestic demand and net exports in 2H09

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Figure 3: Public-sector spending led private consumption in 2009…

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Figure 4: …as weaker labour market conditions capped private spending

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Figure 5: Record-low interest rates...

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Figure 6: ...and accommodative exchange-rate policy supported the economic recovery

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Figure 7: …and lifted the local property market as well

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Global recovery underway, but… Clear and modest recovery in external demand for next 2-3 quarters. In its October World Economic Outlook, the International Monetary Fund noted that strong policy actions by governments have stabilised the global economy and are supporting a tentative recovery, but warns of major ongoing risks and advises against any premature withdrawal of economic stimulus. Pulled up by the strong performances of Asian economies and modest recoveries elsewhere, the IMF expects the global economy to contract 1.1% in 2009, revised up from 1.4%. It expects the global economy to grow 3.1% in 2010, revised up from 2.5%. However, the IMF also cautioned that the global recovery is likely to be slow and unemployment may rise further for some time. During 2010-14, global growth is forecast to average just above 4%, appreciably less than the 5% in the years before the Lehman crisis.

The IMF expects world output to expand an estimated 3.1% in 2010 from a 1.1% contraction in 2009


Being a trade-dependent economy with the highest trade to GDP ratio in the world, Singapore is very vulnerable to any moderation in the external trade cycle. On the upside, any upturn in global demand will have a positive impact on Singapore. The clear and modest global recovery currently underway suggests that Singapore may enjoy at least 2-3 quarters of strong growth in the coming year. In Nov 09, the MTI announced that it expected the Singapore economy to grow by 3-5% in 2010. Our baseline estimate is for growth of 5-7% for 2010 with possible growth of 6-10% in 1H10! However, economic activities, especially in developed economies may remain below pre-crisis levels because of weak labour market conditions and stagnant income. A sluggish recovery in final demand in the advanced economies will moderate Singapore’s growth prospects in 2010.

Figure 8: Leading indicator points to stronger export growth in 1H10…

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Figure 9: …and GDP growth

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Key drivers for 2010On the back of massive global stimulus packages, global GDP growth in 2009 had surpassed even the most optimistic forecasts made a year ago. Given that governments around the world are not yet ready to withdraw monetary and fiscal stimulus, growth, especially in Asia, may again surprise on the upside, especially in 1H10.

Being a small open economy largely dependent on external demand for growth, the key growth driver in 2010 will be net exports. Net exports were a drag on headline GDP in 2008 and 2009. With the export of goods and services expected to rebound by 10-12% in 2010 vs. a 12% fall in 2009, net exports should once again contribute to headline GDP growth.

Recovery may be uneven because of drag on demand in OECD economies

Global recovery should provide a lift to Asia

Net exports should contribute positively to GDP growth


The Singapore government’s expansionary bias in 2009 and 1H10 will continue to support private consumption growth of 2-4% in 2010 after a 1.2-1.5% decline in 2009 (vs. a pre-crisis average of 5%). However, a sustained recovery in private consumption and investment in OECD economies would be needed to support the growth momentum going into 2H10 and beyond.

The completion of Singapore’s two integrated resorts in 2010 will create several thousand new jobs and new sources of income for Singapore. The number of visitors, for leisure or business, will depend on the state of regional economies and the global economy. The two most important markets for the resorts will be Indonesia and Malaysia. Together, these two countries account for a quarter of total visitor arrivals in Singapore. The IMF expects the ASEAN-5 economy to expand 4% in 2010 vs. 0.7% in 2009 and developing Asia to grow 7.3% from 6.2% in 2009. If these forecasts materialise, Singapore should be able to welcome a record number of visitors in 2010. Arrivals fell to an estimated 9.5m in 2009, a drop of almost 6% (-2% in 2008).

Figure 10: Government likely to maintain expansionary bias in 2010 to sustain the recovery

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Figure 11: Hospitality sector could be lifted by the completion of integrated resorts

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Key risks for 2010The risk of a double-dip recession exists but the risk is low. It could occur in 2H10 if the developed world sinks back into recession, dragged down by stubbornly high unemployment rates and a fall in demand, especially in developed economies. A big positive is that Asian economies are likely to push ahead with growth, driven by domestic demand and improved intra-regional trade flows.

The recovery in advanced economies remains fragile. A return to pre-crisis levels of output is likely to be gradual. The growth momentum over the past 2-3 quarters has been spurred by loose monetary and targeted fiscal measures. The return of consumer and business confidence has led to one-off restocking. These factors are likely to taper off in 2H10. A sustained recovery in global demand, especially in OECD countries, is needed to support the growth momentum into the second half of 2010. Weak household balance sheets and persistently high unemployment, especially in the US, will continue to weigh on consumer demand. Uncertainties over the withdrawal of monetary and fiscal stimulus pose an additional risk. A sluggish recovery in final demand in the advanced economies will moderate Singapore’s growth prospects in 2010.

Asset bubble concern. One consequence of this year’s exceptionally loose monetary policies around the world is excess liquidity. Being a small open economy with no capital controls, Singapore has benefited from this rush of liquidity. The abundant liquidity has already led to a spike in asset prices causing public housing prices to hit a roof in 2009. Although the government may intervene to stabilise the local property market, a stronger-than-expected recovery coupled with abundant liquidity may still cause asset prices to spike further.

Another possible source of inflation is food inflation due to supply disruptions from adverse weather conditions. Weather forecasters are predicting an El Niño event over the coming months leading to drought conditions in parts of Asia. Further US$ depreciation could push up dollar-denominated commodity prices further. Even if the dollar rebounds in the future, this would likely be supported by strong US economic fundamentals, which in turn could mean stronger global demand for commodities and price inflation.

Slower global growth

Sluggish growth in developed economies offsets stronger growth in Asia

Asset bubble forming from excess liquidity

Figure 12: Highlights of Singapore’s GDP (% yoy and % qoq seasonally adjusted and annualised)

Singapore GDP (%yoy) 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 2007 2008 2009f 2010fOverall GDP 2.5 0.0 -4.2 -9.5 -3.3 0.6 7.8 1.1 -2.0 6.5- Goods Sector -2.0 -6.2 -6.5 -17.4 1.6 7.1 7.2 -1.0 -0.3 8.5 Manufacturing -5.6 -11.0 -10.7 -24.2 -1.1 6.6 5.9 -4.1 -3.2 8.5 Construction 23.7 26.0 18.5 24.4 18.6 12.8 18.2 20.3 16.7 12.0- Services Sector 7.5 5.5 -1.3 -5.1 -4.9 -2.2 8.1 4.7 -2.4 5.5 Commerce 6.0 4.2 -4.3 -13.0 -12.7 -8.3 6.6 2.8 -8.3 11.0 Transp. & Comm. 5.8 3.8 -2.4 -9.7 -10.7 -7.5 5.0 3.1 -7.6 7.6 Financial services 11.2 5.6 -8.1 -7.6 -4.5 -0.2 15.7 5.5 -2.1 2.0 Business services 7.7 8.2 5.2 3.8 2.8 2.6 9.1 7.4 3.0 2.5- Domestic demand 12.0 7.7 -4.0 -8.7 -4.1 0.9 9.2 7.1 -1.4 1.0 Private consumption 4.4 2.7 -1.2 -4.2 -3.4 -0.9 5.2 2.4 -1.4 2.0Real GDP (%qoq, saar) -7.7 -2.1 -16.4 -12.2 21.7 14.2 - Goods producing -35.9 -0.8 -16.2 -14.5 50.5 21.4 - Services producing 7.6 -1.7 -15.0 -9.7 7.9 10.8


Commodity price inflation


Figure 13: Singapore’s inflation in post-recession periods

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Source: MAS, CEIC, CIMB/CIMB-GK Research


December 2009


IndonesiaHigher growth

Winang Budoyo +62 21 5460555 ext. 70021 - [email protected]

• Indonesia escapes recession. Resilient domestic demand has placed Indonesia in the league of positive-growth countries in Asia. We expect the Indonesian economy to expand by a faster 5.8% in 2010 from an estimated 4.4% in 2009.

• Growth in investment and exports resumes. Stronger consumption and the resumption of investment alongside export growth should underpin GDP growth in 2010.

• Broad-based expansion. The manufacturing sector is expected to expand faster on higher external demand and steady purchasing power. Government infrastructure programmes should benefit the electricity and construction sectors, while the agriculture sector could be hurt by El Nino and post lower growth in 2010.

• BI to change monetary stance next year. Bank Indonesia cut the BI rate by 300bp in 9 months since Dec 09 on the back of fast-receding inflation. However, inflation should creep up on some administered price increases next year. We expect BI to maintain its policy rate until mid-2010 and start tightening until 7.5% at end-2010.

• Risks to growth outlook. Risks could still arise from a weak global economic rebound and the possibility of short-term capital outflows, if the BI decides to impose controls on foreign ownership of BI certificates.

Review of 2009During the global economic turmoil of 2009, the Indonesian economy kept growing and was the only ASEAN country to fend off recession. Resilient domestic demand, made possible by easing commodity prices, lower fuel prices, easing interest rates and “handouts” during election campaigning mitigated an export slack. After slowing down in five quarters and bottoming at 4.0% in 2Q09, the economy grew faster at 4.2% in 3Q09 on the back of better investment and exports. Investment growth resumed to +4.0% in 3Q09 (+2.6% in 2Q09) as private-sector investors placed their money back in Indonesia after elections. The contraction in exports also eased from -15.5% in 2Q09 to -8.2% in 3Q09, on better external demand.

A combination of better purchasing power (as low interest rates continue) and full disbursement of fiscal spending should prop up growth in the last quarter, taking this year’s growth to 4.4% and placing Indonesia in the league of positive-growth countries that include China and India. Coupled with signs of better global economic conditions, we believe the Indonesian economy could expand 5.8% in 2010

Growth rebounded in 3Q09 on the back of better investment and exports


Figure 1: Real GDP & GDP per capita forecasts

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Macroeconomic conditions in 2009During the year, fast-receding inflation gave BI reasons to cut the BI rate to its lowest level ever. After the government lowered fuel prices in Dec 08, inflation cascaded from 9.2% in Jan 09 to only 2.6% in Oct 09. To boost domestic spending in the wake of the global recession, BI cut its rate by 300bp to its lowest level of 6.5%.

A massive reversal of capital flows from Indonesia and other emerging markets weakened exchange rates in the year. After stabilising at Rp9,000 per US$, the rupiah plunged to more than Rp12,000 per US$ in 4Q08. But as one of the few countries with strong fundamentals and high-yielding assets, private capital soon flowed back to Indonesia and has strengthened the rupiah by 16% YTD.

Figure 2: During the global turmoil, the rupiah fluctuated on the back of short-term inflows

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BI’s aggressive monetary easing has not been followed by the banking sector. In 1Q09, domestic banks faced “uneven” access to interbank liquidity in which only the big banks could access interbank liquidity given their size and reputations. The smaller banks had to resort to jacking up their deposit rates to solicit third-party funds. This prompted the bigger banks to respond, although they were not short of funds. Furthermore, as interbank transactions are not guaranteed by the government, banks with excess liquidity chose to place their funds with BI rather than lend out to the other banks.

The “uneven” liquidity problem was more or less resolved in 2Q09, but even then, only short-term interest rates had followed the aggressive monetary easing. Banks seemed hesitant to cut deposit rates aggressively as almost half of their total deposits are non-guaranteed deposits. Most depositors in this bracket comprise institutions with strong bargaining power for special rates above the maximum guaranteed rates.

Aggressive rate cuts on the back of fast-receding inflation

Strong rupiah on the back of short-term capital inflows

Banking sector cannot keep up with BI’s aggressive monetary easing


Facing this situation, BI compelled 14 major banks on 20 Aug 09 to limit rates for time deposits for all tenures to 150bp above the BI rate or 8% starting 1 Sep 09. And starting 20 Nov 09, the cap was reduced to 50bp above the BI rate or 7%. There have been no formal regulations to enforce this “agreement”, but BI is monitoring progress closely.

Figure 3: Loan growth has been declining while deposit growth has been rather stable

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Even though this tacit “agreement” has been fruitful in lowering lending rates, it fails to increase loan growth. After peaking at 38% yoy in Oct 08, loan growth dipped as low as 9.6% yoy in Sep 09. This proves that banks remain cautious in their lending and prefer placing their money in SBI. As at mid-Nov 09, SBI had reached Rp240tr and may increase further to Rp300tr in 2010, as predicted by BI.

On the other hand, deposits have grown by an average of 20% this year, reflecting higher placements by 86m depositors (of which 99.9% are guaranteed deposits). Over Jan-Sep 09, third-party funds increased 6%.

Figure 4: Key economic, banking and monetary indicators

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009GDP growth (%yoy) 4.9 3.8 4.4 4.9 4.9 5.7 5.5 6.3 6.1 4.4 (E)GDP per capita (US$) 720 684 820 1,116 1,182 1,318 1,663 1,942 2,271 2,170 (E)Inflation (%yoy) 9.4 12.6 10.0 5.2 6.4 17.1 6.6 6.6 11.1 2.6 (Oct)Policy rate (%) 14.5 17.6 12.9 8.3 7.4 12.8 9.8 8.0 9.3 6.5 (Nov)Deposit growth (%yoy) 15.1 12.3 4.4 6.8 7.0 17.5 14.5 17.7 14.7 15.8 (Sep) Loan growth (%yoy) 19.5 14.3 18.8 19.8 26.4 24.6 14.1 26.4 31.4 9.6 (Sep) Loan to deposit ratio (%) 37.3 38.0 43.2 48.5 50.0 59.7 61.6 66.3 74.6 73.6 (Sep)NPL ratio (%) 18.8 12.1 8.1 8.2 4.5 7.6 6.1 4.1 3.2 3.8 (Sep)International reserves (US$bn) 29.4 28.0 32.0 36.3 36.3 34.7 42.6 56.9 51.6 64.5 (Oct)Fiscal balance (% GDP) -1.2 -2.4 -1.3 -1.7 -1.1 -0.5 -0.9 -1.3 -0.1 -2.4 (E)Current account balance (% GDP) 4.8 4.2 4.0 3.5 0.6 0.1 2.7 2.4 0.1 1.2 (3Q)

Source: BI, CBS, CIMB Niaga

Key drivers for 2010Indonesia has been less affected by the global recession because of a low export share to GDP (lower than 30% in 2008, the lowest in ASEAN). Nevertheless, weaker external demand and depressed commodity prices caused its exports to slack. Even though Indonesia has diversified its trading to Asian countries, it is still dependent on three major trading partners: the US, Japan, and China. Together, they contribute 30% to its total non-oil & gas exports. As such, when demand from these countries plummets, exports deteriorate. Indonesia’s annual export growth has been in contraction since 4Q08. The contraction has been easing from 2Q09 and probably hit a bottom in 3Q09. We expect smaller export contractions in the last three months of 2009. And on signs of more stable demand from major trading partners (especially developed countries), we project an export contraction of 12.2% for this year, before a rebound to 3.0% growth in 2010.

Stabilising external demand has eased export contraction


Figure 5: Exports and imports are on their way up again

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468

10

1214

Feb-00 Feb-01 Feb-02 Feb-03 Feb-04 Feb-05 Feb-06 Feb-07 Feb-08 Feb-09

Trade Balance Exports ImportsUS$bn

Source: CBS

After facing deficits in the last three quarters in 2008, Indonesia’s current account reversed to surpluses in the first three quarters of 2009. The surplus peaked in 2Q09, underpinned by a stronger trade balance and current transfers, which mitigated deficits in the capital account. The current account surplus was a smaller US$1.7bn or 1.2% of GDP in 3Q09 due to a smaller trade balance. The capital account reverted to a surplus in 3Q09 on the back of inflows of portfolio investment (+US$3.4bn) seeking higher yields, mitigating a drop in direct investment.

Figure 6: Both the current and capital accounts are in surplus again

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0

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4

Mar-05 Sep-05 Mar-06 Sep-06 Mar-07 Sep-07 Mar-08 Sep-08 Mar-09 Sep-09

Current Account Capital AccountUS$bn

Source: BI

Smaller trade balance to continue in 4Q09. The current account surplus should widen to 2% of GDP in 2010 as more stable demand from developed countries would increase the surplus in the trade balance and accompanied by a surplus in the capital account from more inflows of direct and portfolio investments.

The bigger trade surplus has benefited foreign-exchange reserves, which increased from US$50.9bn in Jan 09 to US$64.5bn in Oct 09. The accumulation of more than US$13bn in the first 10 months strengthened the rupiah from Rp11,375 per US$ in Jan 09 to Rp9,565 in Oct 09. BI’s international reserves are expected to increase further to US$66bn by end-2009 and US$74bn by end-2010.

Current account surplus to widen in 2010


Figure 7: Capital inflows have lifted foreign reserves to the highest level

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Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09

6,000

7,000

8,000

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11,000

12,000

13,000

FX Reserves US$/IDR (RHS)US$bn US$/IDR

Source: BI

Internal drivers. Domestic demand would remain the backbone of the Indonesian economy. However, in line with better external demand, export contributions should be back to 30% of total GDP in 2010. All this is expected to support GDP growth in 2010.

Figure 8: Demand-side components

2004 2005 2006 2007 2008 2009E 2010F 2011FReal GDP 5.0 5.7 5.5 6.3 6.1 4.4 5.8 6.0

Private consumption 5.0 4.0 3.2 5.0 5.3 5.6 6.0 6.2Public consumption 4.0 6.6 9.6 3.9 10.4 10.0 8.7 6.1Investment 14.7 10.9 2.6 9.4 11.7 4.7 10.8 10.9Exports 13.5 16.6 9.4 8.5 9.5 -12.2 3.0 8.4Imports 26.7 17.8 8.6 9.0 10.0 -19.6 8.4 8.1

Source: CBS, CIMB Niaga

In 2009, consumer spending held up pretty well, thanks to fast-receding inflation and low interest rates. Furthermore, cash “handouts” during election campaigning and from government stimulus programmes encouraged the population to keep spending. Fast-receding inflation has also improved consumer confidence and this is expected to continue in 2010. Backed by higher consumer confidence, private consumption growth (60% of total GDP) should strengthen to 6.0% in 2010 from an estimated 5.6% in 2009. In a more expansive business environment, higher inflation is not expected to hurt consumer purchasing power in 2010.

Figure 9: Leading indicators show better consumer confidence

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120

160

200

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Jan-02 Oct-02 Jul-03 Apr-04 Jan-05 Oct-05 Jul-06 Apr-07 Jan-08 Oct-08 Jul-09

Consumer Confidence Index Retail Sales IndexIndex

Source: CEIC

Private-sector investors generally adopted a “wait and see” approach during the last elections, but had put their money back in Indonesia after the elections. The trend is expected to continue in 2010 as the government intends to remove “bottlenecks” in infrastructure projects to lift investment growth. Of the total infrastructure needs of Rp1,429tr over 2010-14, the government can only provide 31%. With the improvement of the Public-Private Partnership (PPP) scheme, we believe private-sector investors could increase their contributions and fill the gap.

Higher consumer confidence to continue in 2010 and provide support to private consumption

Better political and economic conditions to improve investment


Figure 10: Direct & portfolio investments

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0

2

4

6

Mar-05 Sep-05 Mar-06 Sep-06 Mar-07 Sep-07 Mar-08 Sep-08 Mar-09 Sep-09

Direct Investment Portfolio InvestmentUS$bn

Source: BI

Inflows of foreign investors were reflected by a US$2bn qoq increase in portfolio investments to US$3.3bn in 3Q09. A safe and successful election has restored investors’ confidence in investing in Indonesia again. Investors have been accumulating government bonds (SUN) and BI certificates (SBI) since Apr 09 after disposing of them during the global economic turmoil in 3Q08-1Q09. From Jan to 13 Nov 09, they added Rp63tr of Indonesian assets, equal to US$6.6bn, comprising Rp16tr of SUN, Rp39tr of SBI, and Rp8tr of investment in the stock market.

The huge inflows had strengthened the rupiah from Rp11,375 per US$ in Jan 09 to Rp9,375 in mid-Nov 09. Of course, portfolio investment is short-term and can move easily in and out. But with a better investment climate and better government regulations, we believe higher portfolio investments would induce foreign direct investments, which are longer term. On the expectation of renewed strength in the US dollar in 2H 2010, we estimate the rupiah to weaken moderately to Rp9,500 per US$ at end-2010 from Rp9,200 per US$ at end-2009.

Figure 11: Foreign ownership of government bonds (SUN) & BI certificates (SBI)

0

40

80

120

160


8,700

9,700

10,700

11,700

12,700

SUN SBI IDR/USD (RHS)IDR tr USD/IDR

Source: BI

BI’s approach to reducing lending costs should bear fruit in 2010. And with better confidence, lending should increase faster next year than this year’s growth of less than 10% yoy. BI predicts that lending can expand 15% yoy in 2010. Combining with foreign direct investment, growth in total investment (31% of GDP) is expected to increase to 10.8% in 2010 from an estimated 4.7% in 2009.

To accommodate its fiscal stimulus, the government had widened the budget deficit in 2009 from 1% of GDP to 2.5% of GDP. For 2010, it has tabled another expansionary budget, with a narrower budget deficit of 1.6% of GDP. We see limited room for fiscal expansion as total expenditure has only increased by Rp4tr for the 2009 budget and subsidies are still a big portion of expenditure. However, the government has committed to more spending on infrastructure, education, and civil-service reforms. Debt financing is still the main source of funds. And as the government relies on domestic debt, the outstanding domestic debt has leapt from Rp23tr (net) in 2005 to Rp104tr (net) in 2010. The government is expected

Incoming portfolio investment will be followed by direct investment

Limited room for budget expansion in 2010


to issue Rp180tr (gross) of government bonds in 2010. With higher interest rates expected in 2H10 and Rp10tr of government bonds that require re-profiling in early of 2010, there is a possibility that the government will front-load the issue of government bonds.

Figure 12: Government budget still depends on debt financing

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2000 2001 2002 2003 2004 2005 2006 2007 2008 2009F 2010F

-3%

-2%

-1%

0%

Budget Deficit Debt-nettNon Debt-nett Budget Deficit-% GDP (RHS)

IDR tr % of GDP

Source: Ministry of Finance

Lack of disbursement the main culprit. Up until Sep 09, the government could only realise 35% of its Rp12.2tr infrastructure stimulus. The government may expand the budget deficit to 2% of GDP to get a more expansionary budget. But we believe it can only tap funds from the domestic debt market to finance the deficit. With an abundant supply of bonds foreseen in 2010, and another Rp29tr from the private sector, it would be hard to bring down bond yields.

All sectors are expected to grow higher and only the agriculture, transport and communication sectors should expand at a slower pace in 2010.• The manufacturing sector is expected to grow by a higher 4.9% in 2010

(from an estimated 1.7% in 2009) on higher external demand. With its biggest contribution to total GDP, higher growth from this sector can lift GDP growth.

• Higher external demand would lift growth in the trade sector to 7.6% in 2010, after a big drop to only 1.4% (estimated) this year.

• In line with the government’s 10k MW mega-projects, the electricity sector is expected to expand by 10.8% in 2010 (estimated 10.0% in 2009). This sector has been growing by more than 10% since 2007.

• Government infrastructure projects should benefit the construction sector, which is expected to grow by 6.1% in 2009 and 7.2% in 2010.

• Higher consumer confidence should have a positive impact on the services sector. This sector is expected to grow by 8.1% in 2010 from an estimated 7.0% in 2009. A 0.2% yoy increase in tourist arrivals over Jan-Sep 09 would be an important contributor.

• As El Nino could hurt crop cultivation in 2010, growth in the agriculture sector is expected to slow down to 3.1% in 2010 from an estimated 3.8% in 2009.

Figure 13: Supply-side components

2004 2005 2006 2007 2008 2009E 2010F 2011FReal GDP 5.0 5.7 5.5 6.3 6.1 4.4 5.8 6.0

Agriculture 1.7 2.7 3.4 3.4 4.8 3.8 3.1 3.8Mining -4.9 3.1 1.8 2.0 0.5 1.2 1.2 1.2Manufacturing 6.4 4.6 4.6 4.7 3.7 1.7 4.9 6.5Electricity 4.3 6.3 5.8 10.3 10.9 10.0 10.8 10.3Construction 6.9 7.4 8.5 8.6 7.3 6.1 7.2 7.4Trade 5.8 8.4 6.3 8.4 7.2 1.4 7.6 5.1Transport & Communication 14.0 13.0 14.0 14.0 16.7 16.8 15.4 14.1Financial 7.9 6.8 5.4 8.0 8.2 6.1 9.3 4.3Services 5.9 5.0 6.3 6.6 6.4 7.0 8.1 4.9

Source: CBS, CIMB Niaga

Growth accelerating across the board


Indonesia faced abnormal inflation rates this year due to slow global inflation. Its inflation dropped from 9.2% in Jan 09 to as low as 2.6% in Oct 09, even after the government increased toll tariffs and LPG prices in Oct 09. Inflation is not likely to amount to more than 1% in the last two months of the year, even with year-end festivities, we believe. However, alongside higher global commodity prices and the impact of El Nino, pressures on inflation would come from a normalising base and government plans to increase electricity tariffs and LPG prices next year. As such, we believe inflation will creep up to 6.3% at the end of 2010. We believe BI will not tighten monetary policy prematurely and will wait until inflation pressure builds up in mid-2010. Then, it is expected to start monetary tightening, possibly raising the BI rate to 7.5% by end-2010. However, as bond yields will not drop significantly, it will be hard to see a drop in lending rates.

Figure 14: Greater possibility of higher BI rates as pressures on inflation increase

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Inflation BI Rate (RHS)% yoy %

Source: BI, CBS, CIMB Niaga

Key risks for 2010Global economic conditions would still be a big risk in 2010. A wobbly rebound in the US and other developed economies may pull down our growth forecasts. A sudden reversal of capital inflows could weaken the rupiah as the rupiah is still predominantly affected by portfolio investments. Rupiah weakness will increase country risks and tighten access to foreign credit, while increased debt repayments could worsen the government’s debt burden and limit room for fiscal expansion. Rising unemployment and lower purchasing power will depress consumer spending. In order to control short-term capital inflows, BI could impose controls on foreign ownership of BI certificates (SBI). Such a policy would be positive in the long run as the economy will not depend on hot money, but would have a negative impact in the short run. The rupiah would be the first victim.

Inflation to increase in 2010 and BI to change monetary stance in mid-2010

Global economic conditions still a big risk


December 2009


ThailandComing out of the tunnel

Lee Heng Guie +603 2084 9667 – [email protected] Julia Goh +603 2084 9698 – [email protected]

• Recovery on the horizon. In tandem with clearer signs of recovery in both developed and regional economies, Thailand’s economy is gradually stabilising with the help of fiscal stimulus and monetary easing. We expect GDP to shrink 2.8% this year before rebounding 3.5% in 2010 and 5.0% in 2011.

• External drivers reverse from negative to positive. The anticipated improvement of global trade activity next year should provide some impetus to Thailand’s growth. Much of the recovery in the manufacturing sector over the past two quarters stems from increased export demand for high-tech products. We estimate that exports in US$ terms will sag 13% this year before bouncing back 10-15% next year.

• Domestic demand is ratcheting up. Domestic demand is on the mend, thanks to continued government largesse, lower unemployment, supportive interest rates, benign inflation and a gradual recovery of the tourism sector. Both consumer confidence and business sentiment are strengthening. The private sector is projected to grow 3.3% in 2010 while the public sector is set to rise 5.5%.

• Flexing its fiscal muscle. The step-up of fiscal spending and more aggressive fiscal expansion plans have the potential to lend further upside to overall growth over the next two years. The government’s monetary and fiscal response to the global downturn has been strong. In fact, Thailand’s fiscal package of 18.5% of GDP is the largest in the Asean region.

• Potential downside risks. Thailand’s domestic risks are ranked the highest among the regional economies given its vulnerability to political developments. More recent domestic risks that could upset government efforts to spur domestic investments include the Map Ta Phut dispute and the actions of environmental groups. Risks from external sources include a weaker external recovery which would derail the export recovery, a sharp spike in commodity prices, a potential double dip in the US and renewed asset bubbles, especially in Asia.

Review of 2009Coming out of a recession. The Thai economy has progressed steadily from a 7.1% slump in 1Q09, the worst contraction since the 1997/8 Asian financial crisis, to less worrying declines of 4.9% in 2Q09 and 2.8% in 3Q09. The bulk of the growth in the first three quarters this year came mainly from gains in net exports which contributed 6.7% pts to overall GDP growth. Overall domestic demand subtracted 8.6% pts from GDP growth as private spending knocked 10.8% pts off, which more than offset the 2.3% pts chipped in by gains in public spending. Total fixed capital formation was one of the biggest losers, subtracting 7.2% pts from growth. Inventory reduction also took 12.5% pts off amid the slump in global demand and domestic production. The large export declines were matched by a bigger contraction of imports arising from depressed demand and lower oil imports. We are confident that growth will flip to the positive territory by 4Q09, aided by 4Q08’s low base, fiscal stimulus and a modest global recovery. In 4Q09, we expect turnarounds for the manufacturing and services sectors.

Gradual recovery underway


Figure 1: Real GDP (% yoy, % qoq s.a.)

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Q1-00 Q3-01 Q1-03 Q3-04 Q1-06 Q3-07 Q1-09

% % qoq % yoy

Source: CEIC, NESDB

Figure 2: Demand- side components (% pt contribution)

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Q1-00 Q1-01 Q1-02 Q1-03 Q1-04 Q1-05 Q1-06 Q1-07 Q1-08 Q1-09

% pt Net exports Domestic demand


Domestic economy vulnerable to politics. Thailand’s growth composition is more skewed towards the local economy as domestic demand’s share of GDP is 85% compared to 64% for exports. However, domestic growth in 1H09 was slammed hard by political tension as anti-government protests in April after an extended period of rising political tension led to a temporary state of emergency in the Bangkok capital. In the presence of uncertainty in the political climate where investors fret about the stability of the ruling government, private investment remains in a funk. Meanwhile, private spending has been undermined by weakness of the tourism sector and feeble consumer confidence. Private fixed capital investment fell 15.4% in Jan-Sep (+5.6% in Jan-Sep 08), reflecting weak demand, political uncertainty and cautious bank lending activity. Due to the political unrest, S&P lowered Thailand’s long-term currency debt rating to A- from A in Apr 09. Fitch also downgraded the long-term foreign currency rating to BBB from BBB+ on the basis that political strife will undercut the ability of the government to implement policies. Despite the appearance of a more stable political landscape recently, Moody’s kept its negative credit ratings, citing political instability.

Figure 3: Private investment undermined by politics, restrained credit and weak sentiment

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Q1-00 Q1-01 Q1-02 Q1-03 Q1-04 Q1-05 Q1-06 Q1-07 Q1-08 Q1-09

% yoy Construction Equipment Overall private investment

Source: NESDB

Domestic growth dampened by political risks


Other domestic risks. Foreign direct investments sank 42% to US$2.7bn in 1H09 relative to US$4.6bn in the same period last year. Investment applications in Jan-Oct fell 9.3% yoy from THB367.5bn to THB333.2bn. Investor confidence has been sapped by the Central Administrative Court’s injunction against 76 industrial projects in Map Ta Phut. Further delays in resolution of the dispute would deal another blow to investment prospects. If prolonged, the injunction could shave about 1% pt off GDP growth in 2010 and 2011 via a reduction in investments.

Figure 4: Declining FDI inflows

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Q1-00 Q1-01 Q1-02 Q1-03 Q1-04 Q1-05 Q1-06 Q1-07 Q1-08 Q1-09

US$bnForeign direct investments

Source: Bank of Thailand (BoT)

Figure 5: Investment applications and approvals

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THB bnApplications Approv als

Source: CEIC

Key drivers for 2010The growth catalysts for next year will stem from: (i) a turnaround of exports as the global economy, particularly the G-3 economies, recover; (ii) stepped-up fiscal spending and more aggressive fiscal expansion plans that have the potential to boost overall growth over the next two years; and (iii) a firmer domestic recovery amid improvements in farm income, employment and the tourism sector.

Riding on external recovery. The anticipated improvement of global trade activity next year should provide some impetus to Thailand’s growth. But the path to recovery will be bumpy as there are still question marks over the strength of the global recovery. As much as China has contributed to the region’s initial rebound in economic activity, ultimately the G-3 is still the largest final consumer of Asia’s goods. G-3 is the final destination for 47% of China’s exports and nearly two-thirds of east Asia’s shipments abroad. The recent financial crisis and its spillover effects for the region far from demonstrated decoupling. In fact, it underscored the hard reality that Asia remains closely linked to the global economy.

Map Ta Phut dispute delays major investments

Uneven path to recovery


Figure 6: Thailand’s exports to G-3, Asean and China

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% shareG3 Asean China

Source: BoT

Exports lifted from the trough. Since 4Q08, exports contracted at an increasing pace until 2Q09 due to the global recession. Manufacturing production also plunged 9.8% yoy in Jan-Oct 09, bringing capacity utilisation levels to 66%. Utilisation went as low as 55% in Feb 09. But from May 09 onwards, export growth levels started to improve with positive month-on-month increases seen in five consecutive months. The year-on-year export contractions abated from double-digit rates to 2.6% in Oct 09 as the high base effect gradually normalised. Global chip sales have been rising on a month-on-month basis, helping to lift the electronic and electrical export sectors. The improvement is also in tandem with global manufacturing activity as several industries enjoyed a return of orders following heavy destocking activity in 1Q09. The expected boost from inventory restocking and the impact from fiscal spending by governments around the world have the potential to lift investments further over the coming quarters. This would be driven by a release of pent-up demand as consumer confidence recovers and businesses regain their appetite for risk. That said, there is also a chance that the boost to demand will be short-lived, as was the case with the US “cash for clunkers” scheme and Germany’s “auto trade-in” subsidy which temporarily lifted motor vehicle sales. We estimate that exports in US$ terms will sag 13% this year before rebounding 10-15% next year.

Figure 7: Exports rising in line with global manufacturing indices

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Index

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3MMA % momUS ISM index China PMI indexSpore PMI index Thailand exports

Source: BoT, Bloomberg

This is not to say that external factors are the only driver of Thailand’s recovery next year. Increased fiscal spending and aggressive implementation of the fiscal plans, particularly for the second stimulus package (SP2), have the potential to lend further upside to overall growth next year. The government’s monetary and fiscal response to the global downturn has been strong. Thailand’s fiscal package is the largest in the Asean region in value terms.

Exports have improved

Strong monetary and fiscal policy support


Figure 8: Size of fiscal packages in the region (US$ bn)

0 100 200 300 400 500 600

China

South Korea

Thailand

Malaysia

Singapore

Indonesia

Vietnam

Philippines

ASEAN

Source: IMF

The size of the government’s response has been dictated by challenges which are twofold, i.e. on the external front as well as on the domestic front where political conflict has sapped domestic growth for over three years. Other unexpected noises that could be damaging to the investment outlook include the Central Administrative Court’s decision to suspend 76 industrial projects in Map Ta Phut due to environmental concerns. Though a mammoth task given the circumstances, if Prime Minister Abhisit’s administration is able to pull the economy out of its slump next year, it will have a higher chance of garnering more political support and stay in government, marking a major turning point for Thailand’s economic future. The continuing ebbing of global risks and a steady recovery for the international economy next year will help Thailand’s exports, manufacturing sector and ailing tourism industry.

Although fiscal spending has potential to help resurrect domestic investments, we have accounted for minimal investment multiplier effects from the fiscal injection given the uncertainties over the strength of global recovery, lingering concerns over political stability and the recent Map Ta Phut issue. Already, the global crisis and political vagaries have thrown a damper over foreign investments. We are, therefore, projecting a modest real GDP growth of 3.5% in 2010.

Figure 9: Demand-side components

% yoy % contribution% share Comments2008 2009E 2010F 2011F 2008 2009E 2010F 2011F

Real GDP* 2.5 -2.8 3.5 5.0Consumption 3.0 -0.5 3.1 4.3 1.8 -0.3 1.9 2.7 62.9Private Consumption

2.7 -1.6 2.8 4.5 1.4 -0.8 1.5 2.4 52.8 Lifted by favorable farm income, low unemployment, rehiring as economic prospects improve, consumer confidence strengthens, tourism sector recovers.

Public Consumption

4.6 5.5 4.8 3.0 0.4 0.5 0.5 0.3 10.1 Gradual easing as subsidy measures from 1st fiscal package expire; slower net purchases from abroad.

Investment 1.2 -9.2 5.4 5.1 0.3 -2.0 1.1 1.0 20.6Private investment

3.2 -13.6 4.8 5.5 0.5 -2.3 0.7 0.8 14.9 Improved business outlook, spending to boost capacity expansions, stable political scenario.

Public investment

-4.6 4.4 7.1 4.0 -0.3 0.2 0.4 0.2 5.7 Higher disbursements of 2nd stimulus package.

Exports 5.1 -15.1 6.0 8.0 3.6 -10.9 3.8 5.2 63.3 Global trade activity strengthens as key trading partners see firmer signs of recovery.

Imports 8.5 -23.2 12.5 8.2 4.6 -13.4 5.7 4.1 45.7 Increased imports of materials and equipment amid higher consumer spending and domestic investments.

Source: NESDB, CIMB/CIMB-GK ResearchNotes: * Includes change in inventories and statistical discrepancy

Many challenges ahead

Guarded optimism


Figure 10: Supply-side components

% yoy % contribution% share Comments2008 2009E 2010F 2011F 2008 2009E 2010F 2011F

Real GDP 2.5 -2.8 3.5 5.0Agriculture 3.5 -0.5 1.8 2.0 0.3 0.0 0.2 0.2 9.0 Recovery of crop prices and production

as global demand rebounds.Mining and quarrying

0.6 -3.0 0.9 2.3 0.0 -0.1 0.0 0.0 2.2 Higher production expansions of natural gas and LNG, increased demand for construction materials.

Manufacturing 3.9 -5.9 5.4 6.2 1.6 -2.4 2.1 2.5 38.9 Recovery in global trade activity will fuel export-related manufacturing; domestic production lifted by higher investment activity.

Construction -5.3 -0.6 2.5 3.0 -0.1 0.0 0.1 0.1 2.2 Bulk of government investment projects to be implemented in 2010; business sentiment improves as outlook turns more visible; more public-private partnership projects.

Services* 1.5 -0.7 2.3 4.6 0.7 -0.3 1.1 2.2 47.6 Recovery of consumer demand, tourism sector, retail and trade-related activities.

Source: NESDB, CIMB/CIMB-GK ResearchNote: * Includes utilities, wholesale and retail trade, hotels and restaurants, transport, storage and communication, financial intermediation, real estate, renting and business activities, public administration and defence, compulsory social security, education, health and social work, other community, social and personal service activities and private household with employed persons.

Flexing its fiscal muscleEngineering a recovery. Like other governments which were busy putting out fires during the global economic turmoil, Thailand responded with expansionary fiscal measures and aggressive monetary policy actions. In early 2009, shortly after the government came into office, it passed a bill for a special mid-year budget (SP1) of THB116.7bn. There were two cash transfer programmes amounting to around THB28bn, comprising THB18.9bn for living cost subsidies for low-income households and THB9bn as supplementary income for the elderly. As the living cost subsidies tended to benefit urban low-income workers, it should have a bigger stimulating effect given this group’s higher marginal propensity to spend.

Figure 11: Mid-year supplementary budget (THB m)

Projects / Expenditure items AmountTotal mid-year supplementary budget 116,700.0Economy recovery and confidence restoration 1.1 Living cost subsidy for low-income earners and government officials 1.2 Extension of five measures to reduce living costs 1.3 Water resouces for farmers and agriculture 1.4 Road construction in villages and rural area 1.5 Commercial funds for low income earners 1.6 Tourism promotion 1.7 Small water resource and water management projects 1.8 Small-and-medium-size enterprise promotion 1.9 Economic confidence restoration and national image promotion

37,464.718,970.411,409.22,000.01,500.01,000.01,000.0760.0500.0325.0

Revenue creation, Quality of life enhancement and social security 2.1 Free education program for the first 15 years 2.2 Social development fund 2.3 Monthly allowance for senior citizens 2.4 Unemployment reduction and labor potential promotion 2.5 Health care promotion 2.6 Civil servant and police officers housing scheme 2.7 Clinic and health station development

56,004.819,001.015,200.09,000.06,900.03,000.01,808.01,095.8

Expenditure under emergency circumstances 4,090.4Treasury cash repayment 19,139.5

Source: Ministry of Finance, Fiscal Policy Office

Subsequently, the government announced the second fiscal stimulus package (SP2) valued at THB1.43tr, which averages to be about 5% of GDP in each of the years between 2010 and 2012. SP2 focuses on key sectors such as mass transit and transportation, irrigation, education, public health and energy. The government estimates that the projects under SP2 will create 1.5m jobs. It has identified THB1.1tr worth of “Tier-1” projects that are ready to be implemented with minimal lags or delays. Total investment expenditure of THB200bn has been planned for the next

1st stimulus package (SP1)

2nd stimulus package (SP2) to be implemented from 4Q09 until 2012


two years, of which 75% will be implemented in 2010. However, there have been some recent hiccups for the suspended projects in Rayong’s Map Ta Phut and surrounding areas. The total value of projects suspended is THB400bn or about 4% of GDP. Of this, it is roughly estimated that state-owned enterprise investments totalling THB240bn in 2010 and 2011 under SP2 are related to the 76 projects halted by the court. The Ministry of Finance estimates that the best-case scenario of 100% disbursement of SP2 will propel growth to 4.1% in 2010, 5.2% in 2011 and 5.5% in 2012. We think that more realistic growth targets would be 3.5% for 2010 and 5.0% for 2011 and 2012 given the upcoming challenges.

Figure 12: Fiscal stimulus programmes

2009 2010 2011 2012 2013

4. Expedite disbursement of budget

5. Push forward investment projects

1. Supplementary budget B 116.7 bn

2. Tax measures

3. Utilise Special Financial Institutions (SFI) to increase credit in the system by B 300

6. External Borrowings to broaden financing flexibility

State budgetB 1.84 trn

S.O.E. investment budget

Municipal investmentBudget B 356 bn

2009 multi-year commitment budget extending to 2010, 2011, 2012 and 2013 are B 120 bn, B 50 bn, B 10 bn and B 2 bn, respectively

Mega Projects plan THB 1.7 trn(Mass Transit B 440 bn, Transportation and communication B 440 bn, Energy B 370bn)


Figure 13: Stimulus package two (SP2) budget framework by sector

Investment Programs Total investment: THB 1,431bn1,064

229 139

Tier-1 Tier-2 Tier-3

Key Projects

Water management (17%) 222.5 7.2 8.8 Rehabilitation of reservoirs / Irrigation projects

Transportation (40%) 335.9 164.3 71.3 Improve motorway / Rural roads / MRTEnergy / Alternative energy (14%) 156.6 0 49.2 Transmission lines and gas pipelinesTelecommunication (2%) 24.8 0 0 3G networkTourism infrastructure (1%) 5.6 0 4.4 Waterworks / Submarine cables to islandsEducation facilities (10%) 128.6 9.3 0 Increase education support / Training

programs for teachersPublic health facilities (7%) 98.2 0.5 0.6 Upgrade local healthcare service / Build

Excellence CentersSocial well-being (1%) 8.5 0 0 Police housingScience and technology (1%) 11.2 0.9 0 Develop new production technologiesNatural resources / Environment (0.3%) 4.2 0.7 0 Promote forest conservation and replantingTourism development (1%) 3.9 0.6 3.9 Develop nature reserves as new tourist

attractionsCreative economy (1%) 3.8 13.8 0 Encourage creativity / Entertainment

industryCommunity investment (6%) 59.8 31.6 0.3 Increase income level and improve rural

quality of life



Figure 14: Impact of SP2 on economy

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% yoy

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Spending progress. As at Sep 09, 91.8% or THB1.79tr of the total budgeted spending of THB1.95tr for 2009 has been disbursed. This includes spending under SP1, of which 81.3% or THB94.8bn has been dished out. For selected SP1 measures such as living cost subsidies, utility and transportation extensions, free education, healthcare subsidies and village infrastructure, the disbursement rate is close to 100%. The estimated contribution of SP1 to overall growth is +0.7% in 2009. Private spending inched up 0.8% qoq in 2Q09 while public consumption grew 1.0% qoq, thanks to SP1.

Figure 15: Progressive budgetary spending

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As at Sep 09, 91.8% disbursed


Figure 16: Supplementary budget disbursement (SP1)

Budget Items Framework Disbursement (Mar - Sep 09)

Disbursement rate (%)

1 Low income earner

Living cost subsidy for income earner of less than THB 15,000- Socially secured (8.1 million persons)- Public sector official (including pensioners civil servant) 1.3 million persons

18,970 17,918 97.0%

2 Household Extension of Utilities and transportation cost for another 6 months 11,297 11,295 100.0%3 Unemployed One month training program and living cost allowance for 3 months (Estimate of

240,000 persons)6,900 2,705 39.0%

4 Parents /Students

Free education for 15 years- (Estimate of 10 million students)

19,503 19,009 97.0%

5 Health Healthcare subsidy fund of THB600 per month- (Estimate of 830,000 persons)

3,000 3,000 100.0%

Health clinic improvement 1,096 776 71.0%6 Village Sufficiency economy philosophy enhancement on village

- Increase funding for 78,358 villages15,200 5,000 33.0%

7 Elder Elderly subsidy THB500 per month- (Estimate of 5 million persons)

9,000 8,997 100.0%

8 Utilities Agricultural water source 2,000 1,789 89.0%Small water source 760 420 55.0%Village infrastructure 1,500 1,446 96.0%

9 Policeman Police officer residents of 532 places 1,808 1,489 82.0%10 Tourism Tourism promotion 1,000 642 64.0%11 Others Consumer goods price subsidy 1,000 642 64.0%

Small and Medium Enterprises 500 445 89.0%Economic confidence restoration and national image promotion 325 64 20.0%

12 Contingency Contingency budget management 4,090 0 0.0%13 Treasury

repayment19,139 19,139 100.0%

Total 116,700 94,777 81.3%


SP1 contributed 0.7% to 2009 growth


Public debt and fiscal resources. Given the higher borrowings of THB800bn to part finance the budget deficit and stimulus measures, the public debt to GDP ratio is expected to reach 58% by 2012 compared with 45.7% as at Aug 09. The government expects public debt levels to fall steadily thereafter, thanks to sustained economic momentum, aided by stimulus measures and investment, on-schedule debt repayment and a balanced budget from 2015 onwards. To fund a projected fiscal deficit of around 4% of GDP next year, the government has to borrow close to THB468bn, which includes bond maturities totalling THB118bn next year. This excludes about THB252bn worth of stimulus spending outside the formal budget so that legal limits on the deficit are not breached. In our opinion, the increases in deficits and public debt are justified by the strong need for short-term countercyclical policy responses. The IMF supports the authorities’ intention to raise temporarily the mandatory government debt ceilings to finance the deficits under current circumstances. The temporary nature of the fiscal stimulus measures is an indication of the authorities’ continued fiscal discipline.

Figure 17: Fiscal sustainability to be maintained over the medium term

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Borrowing for Strong Thailand projects

(SP2)Rising debt from FIDF programmes


Inflation returns in 2010. Thailand was the first in the region to dip into deflation zone as inflation declined 1.2% yoy in the first eleven months of this year. The negative inflation trend started to abate from Aug 09 onwards and reverted to a gain of 0.4% in Oct 09. The temporary deflation trend was mainly the result of cyclical price effects of commodity-related factors. Other distorting elements included government subsidy measures (education, low-cost public transport, and electricity and water supply charges) aimed at lowering the cost of living. The demand fallout also exacerbated the price weakness. We project overall inflation to ease 0.8% this year before rising 3.0% in 2010. The higher inflation reflects overall economic recovery and higher costs of inputs and commodity prices. The projected pick-up in inflation is not a major concern, thanks to ample resource slack and low capacity utilisation. Besides that, the slow economic recovery is not likely to trigger strong demand-pull inflation.

Figure 18: Inflation moving up in tandem with crude oil price

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Source: Bloomberg

Temporary rise in budget deficits and public debts

Inflation makes a come back


No rush to hike rates. Similar to most other countries, Thailand also adopted aggressive monetary easing measures in response to the crisis. The Bank of Thailand lowered the policy interest rate on 3 December 2008 by 100bp. By end-May 2009, there were three other interest rate cuts amounting to an additional 150bp, bringing cumulative rate cuts to 250bp in six months. However, this has done very little to stimulate demand. Access to credit remains a problem as banks tightened their lending measures. Also, the policy rate cuts were not fully passed on to consumers, with lending rates cut by 136bp vs. deposit rate cuts of 192bp over a similar time period. Despite ample liquidity in the system and broad money expansion, private credit growth continues to weaken. We fear that the ineffective pass-through and weak credit expansion could hinder a broad-based recovery. We believe that the central bank will refrain from tightening rates too soon given that the recovery is still slow and fragile. As inflationary pressures are still benign, ensuring a sustained recovery takes precedence over inflation. Should there be rate hikes, it is more likely to be in 2H 2010 and will be in the magnitude of 25-50bp.

Figure 19: Aggressive rate cuts have been less effective in stimulating demand

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Source: Ministry of Finance

Figure 20: Banks need to step up lending as demand gradually recovers

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Source: BoT

The external position remains fairly strong on the back of sustained current account surpluses through the year and a reversion of outflows in the financial and capital account from Jul 09 onwards. Data from Emerging Portfolio Fund Research (EPFR) indicated that Thailand recorded a net inflow of foreign private capital of US$406m in Oct 09 (+US$66m in Sep), the seventh consecutive month of net inflows. Foreign reserves have increased by US$28.3bn to US$139.3bn as at 27 Nov 09, which is about 6.2 times the short-term external debt. This provides a large buffer against any external shocks. For 2010, we expect foreign reserves to rise at a slower pace as (i) oil prices are likely to rise in tandem with the economic recovery, which would weigh on imports; and (ii) Bank of Thailand is likely to intervene to stem a continued rise in the baht.

Sustained monetary policy support is required

Strong current account surplus and higher capital inflows


Figure 21: Sustained current account surplus and reversal of capital outflows

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Source: BoT

Figure 22: Net foreign inflows into Thai equities since Apr 09

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1012


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Foreign flows into equities (RHS)

Source: EmergingPortfolio.com Fund Research (EPFR), BoT

Liberalisation measures to encourage two-way flows. On 5 Aug 09, the Bank of Thailand relaxed several regulations to allow institutional investors and local residents to invest in securities abroad and undertake derivatives transactions. This relaxation which effectively lifts the permitted level of overseas investment will help to reduce the upward pressure on the baht. These measures were aimed at taking some pressure off the central bank in its management of foreign reserves which have been accumulating strongly. The relaxation will also provide greater flexibility for businesses and individuals to hedge committed and anticipated inflows and outflows of their trade and capital transactions, thereby helping to safeguard the value of overseas investments. This will reduce the cost of doing business and encourage better risk management.

Baht is 2nd best performing regional currency. After a dismal performance in 2008, the baht has regained its footing and is one of the better performing currencies in the region this year, gaining 4.6% YTD to THB33.22/US$. Based on the six-month forward spot rates, the market expects the baht to hold at 33.2 by the middle of 2010. The dollar’s weakness has propelled Asian currencies to new highs this year. The greenback is expected to remain weak until 2H 2010 when there should be more clarity on future monetary policy and the sustainability of a US recovery becomes more visible. We are projecting the baht to weaken again to 34.5 by end-2010.

Measures to stem appreciation of baht


Figure 23: Baht strengthens against US$ but is moving in tandem with other key trading currencies

6065707580859095

100

Jan-07 Jun-07 Nov-07 Apr-08 Sep-08 Feb-09 Jul-09

Index293031323334353637

Baht/USDNEER REER Baht

Source: BoT, Bloomberg

Key risks for 2010Potential downside risks to growth in 2010 could emanate from a weaker external recovery should (i) premature exit strategies lead to a double-dip recession, especially in the US, (ii) the global recovery stalls as fiscal stimulus measures abate, (iii) commodity prices spike up as the dollar plumbs new lows, and (iv) carry trade flows fuel asset bubbles anew.

Thailand’s domestic risks are probably the highest among the regional economies due to the events that have transpired over the past three years. The lingering domestic risks include (i) political uncertainty, (ii) concern over a possible sudden change in government, and (iii) the threat of a recurrence of violent street rallies and seizure of Bangkok’s international airport by protesters which would have severe implications for the economy. The Abhisit government has introduced aggressive stimulus measures that could put the economy on a stronger growth path provided the measures are implemented in an efficient and timely manner. However, more recent domestic risks that could upset the government’s efforts to spur domestic investments include the Map Ta Phut dispute and the actions of environmental groups. This would derail the government’s “Strong Thailand” four-year spending programme and could inflict long-lasting damage on private investment growth and the country’s long-term growth.


December 2009


ChinaDefying expectations

Song Seng Wun +65 6210-8602 - [email protected]

• 2009 turned out better than expected, despite a weak start to the year. In the aftermath of the collapse in global demand, 1Q09 GDP slowed to 6.1% yoy, the lowest in nearly a decade. There was deceleration across the board, in primary, secondary and tertiary sectors in 1Q09. However China’s economic growth improved to 7.9% in 2Q09. Despite weaker exports, the economy rebounded on the back of stronger domestic demand as massive stimulus measures worked their way through the economy. As the effects of the collapse in global trade tapered off, China’s 3Q09 GDP grew 8.9% yoy, the strongest in a year. And as massive government stimulus measures worked their way through the economy, average bank loans grew a record 34.1% yoy in 3Q09 (31.6% in 2Q09), driving investment growth of 33% yoy (36% in 2Q09) during the period. This contributed to a recovery in the other parts of the economy, especially relating to domestic demand.

• All set for a broader recovery in 2010. The clear and modest improvement in global demand has brought jobs back to coastal manufacturing regions. Together with improving consumer and business confidence, there is a gradual broadening of China’s growth, although still skewed towards credit-fuelled investment spending. Investments will continue to fuel growth in 2010 as the large stimulus measures continue to foster credit and investment growth. We expect economic growth of 10% in 2010 vs. 2009’s 8.2%.

• Risks to forecasts. A sustained recovery in private consumption and investment in developed economies will be needed to support the growth momentum in 2010 and beyond. But stubbornly high unemployment rates and weak income growth could weigh on final demand in OECD economies, especially the US. Within China, surging CPI or asset price bubbles could force the central bank to tighten monetary policy more than expected, forcing banks to pull back their lending sharply.

Review of 2009 1Q09 GDP slowed to 6.1% yoy, the lowest in nearly a decade. Deceleration was seen across the primary, secondary, and tertiary sectors in 1Q09. In terms of contributions to 1Q09 growth, net exports shaved off 0.2% pt on a slump in external demand (exports shrank nearly 20% yoy in 1Q09, the worst in a decade) while domestic demand accounted for 6.3% pts, in particular investment (2.0% pts), and consumption (4.3% pts), a reflection of the initial benefits of stimulus.

Despite weaker exports, the economy rebounded on the back of stronger domestic demand as massive stimulus measures worked their way through the economy. Chinese economic growth in 2Q09 improved to 7.9% yoy from its decade-low growth of 6.1% in 1Q09. In terms of contribution, net exports shaved off 0.2% pt on a slump in external demand while domestic demand accounted for 8.1% pts, in particular investment (3.4% pts) and consumption (4.7% pts), a reflection of the initial impact of stimulus working its way through the Chinese economy.

Bad news in 1Q09

Economy recovered in 2Q09 as stimulus kicks in


China’s 3Q09 GDP grew 8.9% yoy in 3Q09, the strongest in a year. Average bank loans grew a record 34.1% yoy in 3Q09 (31.6% in 2Q09), driving investment growth of 33% yoy (36% in 2Q09) during the period. According to the National Bureau of Statistics, investment and consumption contributed 7.7% and 4% pts respectively to China’s economic growth in the first three quarters this year while net exports dragged down GDP by about 3.6% pts. This contributed to the recovery in the other parts of the economy, especially relating to domestic demand. Retail sales expanded 15.4% over the same period, although it must be noted that retail sales are an imperfect barometer of private consumption because they include government purchases. Nevertheless, the headline figures generally corroborate with other data showing strong increases in automobile and housing sales. After removing the price effect, our calculations show that the growth in retail sales is almost back to last year’s rate, suggesting that underlying consumer spending has recovered, in line with consumer confidence.

In 3Q08, supply disruptions caused by preparations for and the hosting of the Summer Olympics and Paralympics pulled down secondary industry growth, to 9.0% yoy in 3Q08 from 11.1% in 2Q08. The secondary sector covers goods-producing industries except construction. This year, helped by a lower base and pump-priming, value-added industrial output, a key measure of activity in China’s manufacturing-dominated economy, expanded 13.9% yoy in September and 12.3% yoy in 3Q09 from 2Q09’s’s 9.0% gain, the strongest expansion since 3Q08. Heavy industry has been benefiting this year from a surge in automobile sales and new construction. The secondary sector expanded 10.6% yoy in 3Q09, its first double-digit growth since 2Q08’s +11.1%. And reflecting the recovery in consumer and business confidence, the service-producing sector expanded 10.7% yoy in 3Q09, the first double-digit growth and the strongest in six consecutive quarters. On another encouraging note, despite severe droughts in parts of the country, the primary sector (agriculture) managed to expand 4.7% yoy in 3Q09, up from 2Q09’s 4.1% and 1Q09’s 3.5%.

Although China’s exports declined 0.3% mom to US$110.8bn in October, the yoy contraction narrowed to -13.8%, the smallest this year. The export decline to the US narrowed to -9.9% yoy in October, the smallest since January to narrow the YTD decline to 21.3% (Jan-Oct 09: +22.4%). For the whole year, exports are expected to decline 17% yoy, a reversal from the 17% growth in 2008. Imports fell 1.4% mom NSA to US$86.8bn or -6.4% yoy (Sep 09: -6.4%) in October to narrow the yoy decline to 20.4% over the Jan-Oct 09 period (Jan-Oct 09: +29.0%). This pullback caused the trade surplus to swell to almost US$24bn from the 3MMA average of US$13bn. But YTD, the trade surplus fell 26% yoy to US$135.5bn. Imports of iron ore, aluminium, steel, copper, fertilisers all fell in October as traders went on a long holiday break after front-loading their imports in September. Copper imports for October slowed to a 14% yoy from September’s 87% jump. Iron ore imports, at 45.47m metric tonnes in October, were the lowest since January, though still up 49% yoy. China’s purchases of crude oil, however, were less affected by stockpiling, and might better reflect underlying demand in the economy. Crude oil imports rose 20% yoy in October, the most in three months. The surge in some commodity imports early this year also reflected the price competitiveness of imports relative to domestically produced products.

The consumer price index fell 1.3% in 3Q09, easing from 2Q09’s 1.5% decline. The producer price index slipped 5.8% yoy in October, the 11th monthly drop but smaller than September’s 7.0% decline. Both indices continued to climb in October from September levels, suggesting that price rises may be gathering steam. Like other Asian countries, food and energy prices have been responsible for the bulk of CPI fluctuations. The rise in headline CPI inflation between mid-2007 and mid-2008 was mainly caused by a surge in the prices of pork, poultry products, and vegetables, which subsequently led the fall. The recent rebound in food prices was partly due to the base effect and partly due to the government’s policy of raising agricultural product prices. PPI prices are also heavily influenced by the prices of energy and other commodities, apart from food.

Growth accelerated in 2H09

Recovery broadening out

Signs of stabilisation in trade sector

Deflationary pressures easing


Figure 1: Growth recovery in 2009...

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Figure 2: …driven by credit-led stimulus spending

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Figure 3: A recovery in consumer confidence…

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Figure 4: …leading to a rebound in the property market

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Uncertainties over strength of global recoveryClear and modest recovery in external demand for next 2-3 quarters. In its October World Economic Outlook, the International Monetary Fund noted that strong policy actions by governments have stabilised the global economy and are supporting a tentative recovery, but warns of major ongoing risks and advises against any premature withdrawal of economic stimulus. Pulled up by the strong performances of Asian economies and modest recoveries elsewhere, the IMF expects the global economy to contract 1.1% in 2009, revised up from 1.4%. It expects the global economy to grow 3.1% in 2010, revised up from 2.5%. However, the IMF also cautioned that the global recovery is likely to be slow and unemployment may rise further for some time. During 2010-14, global growth is forecast to average just above 4%, appreciably less than the 5% in the years before the Lehman crisis.

As there is still downside risk to global growth, we do not believe the Chinese government is ready to shift to a tighter monetary policy anytime soon despite the nearly 9% economic growth in 4Q09. However, the massive flow of liquidity we saw in 1H09 may not be sustainable. We do expect some withdrawal of liquidity, a stricter enforcement of regulations on lending, and more targeted measures to ensure that lending goes to productive rather than unproductive sectors, but we see no rate hikes or credit limits for the rest of 2009, since inflation is also not an immediate threat. A formal change in the policy statement from “appropriately loose” to “stable” may still be some months away. But policy planners are giving the banks a head start by telling banks to brace for a shift. The central bank governor has reminded banks to be more selective in their lending and has warned that the current easy monetary policy could not continue indefinitely. China’s Banking Regulatory Commission also issued a stern warning in late November to banks to comply with capital requirements or face sanctions. A gentle shift in the monetary policy is already under way, as indicated by a steady rise in the central bank’s bill issuance rate. Other possible measures include setting money supply (M2) and loan growth targets for 2010 to anchor market expectations of growth.

A formal policy shift (which may come with a hike in banks’ reserve requirements) will come when the authorities feel comfortable that the recovery has become entrenched and more broadly based. We project a moderate rise in the benchmark interest rate only from 2Q10, at the earliest, when CPI inflation is expected to be noticeably above zero. Benchmark rates are already high in real terms, and a hike is unlikely to be effective in curbing credit supply, but likely to add to capital inflow concerns.

Figure 5: Leading indicators point to improved export growth - at least for the next two quarters

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The IMF expects world output to expand an estimated 3.1% in 2010 from a 1.1% contraction in 2009

Despite improving fundamentals, we do not believe the Chinese government is ready to shift to a tighter monetary anytime soon


Figure 6: Current pace of monetary and loan growth is not sustainable…

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Figure 7: …but a return to normalcy for money multipliers will be some months away

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Key drivers for 2010On the back of massive stimulus, China’s GDP growth in 2009 surpassed even the most optimistic forecasts made a year ago. Indeed, China could again hit double-digit growth by 4Q09, the first time since 2Q08. The question in the coming months will be the sustainability and reach of the recovery. While the Chinese economy is expected to expand 9-10% in 2010 and beyond, external demand may not return to the levels seen in past years. Average monthly exports in 4Q09 may reach US$115bn vs. a peak of US$137bn in Sep 08, a 16% drop. China’s post-crisis growth would have to be different. Domestic demand (investment and consumption) is expected to contribute in the coming two years.

Demand in advanced economies may remain subdued over the next couple of years because of weak labour market conditions. This may hold back the recovery in emerging economies. Therefore, we do not expect the Chinese government to withdraw its stimulus, but expect the contribution of stimulus-related fixed investment to GDP growth to ease over the coming quarters as net exports add to rather than subtract from headline GDP growth. Net exports subtracted almost 4% pts from headline GDP growth in 2009. We see a reversal in net exports from a 17% decline this year to 10-15% growth next year. That will only return exports to 2007 levels.

With the record bank lending and money multipliers in 2009, the Chinese central bank may be more mindful of the possible impact of non-productive lending on the Chinese economy. Nonetheless, investment will likely remain the largest contributor to GDP growth. Infrastructure investment was one-third of fixed asset investment this year and will remain a major component as projects progress. With rising risks of asset inflation, the central bank may remove some of the conducive property-sector policies and tighten property lending, which could lead to softening demand. There may be no major new investment programmes, with any new spending likely to be modest and focused on promoting consumption.

Domestic demand is expected to play a bigger role

Net exports will be a positive contributor

Central bank to ensure bank lending goes to productive sectors


By early next year, the 12th five-year plan would be finalised and the plan is likely to focus on balanced and sustainable growth. While investment should stay as the key growth engine, private consumption is likely to improve in 2010 given improvements in the labour market. Improvements in global trade have brought jobs back to coastal manufacturing regions. This would be a boon to migrant and urban workers. Domestic demand, particularly in 2H10, may also be supported by measures designed to sustain or boost economic performances ahead of changes in the senior political leadership in 2012.

While China’s economic outlook for 2010 will still be linked to global conditions, risks to growth have been reduced by heavy government intervention. This helps support our call of 9 -10% growth for 2010-11. With its growth target of more than 8% met in 2009, the government will be looking to “manage inflation expectations” and “adjusting the economic structure” to ensure balanced growth in 2010 and beyond. In the coming months, setting credit-growth targets and pushing out structural reforms will be the areas to watch. We expect the Chinese central bank to bring broad money supply (M2) growth to about 16-20% next year, sharply down from this year’s 30% pace.

Figure 8: Massive stimulus spending did not blow a big hole in the central government’s budget

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Figure 9: The recovery in industrial activities has been led by SOEs

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12th five-year plan to focus on balanced and sustainable growth

Figure 10: Highlights of China’s GDP (% yoy)

China GDP (%yoy) 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 2007 2008 2009f 2010fOverall GDP 10.1 9.0 6.8 6.1 7.9 8.9 13.0 9.0 8.2 10.0- Primary sector 4.2 7.2 11.2 3.5 4.1 4.7 3.7 3.7 5.5 5.0- Industry 11.1 9.0 3.8 5.3 7.9 10.6 14.7 9.3 8.2 7.1- Services 10.5 9.9 5.9 7.4 9.2 10.7 13.8 9.5 9.3 9.1



Key risks for 2010The risk of a double dip (less than 8% growth) for China’s economy still exists but is a low risk. It could occur in 2H10 if the developed world falls back into recession, dragged down by stubbornly high unemployment rates and a fall in global demand.

One consequence of this year’s exceptionally loose monetary policies is the excess liquidity flooding the economy. If left unchecked, the abundant liquidity will lead to a spike in asset prices and wage and consumer price inflation. In its third quarter report, the Chinese central bank hinted that a shift in monetary policy is coming. A formal change in the policy statement from “appropriately loose” to “stable” may take place in 2Q10. We expect two rate hikes by the PBOC next year, starting possibly in mid- to late 2Q10, taking the benchmark interest rate to 5.85% by end-2010. But higher-than-expected CPI inflation or asset price bubbles could force the central bank and the government to shift to a tighter monetary and fiscal policy earlier than expected.

Another possible source of inflation is food inflation due to supply disruptions from adverse weather conditions. Weather forecasters are predicting an El Niño event over the coming months leading to drought conditions in parts of Asia. Further US$ depreciation could push up dollar-denominated commodity prices further. Even if the dollar rebounds in the future, this would likely be supported by strong US economic fundamentals, which in turn could mean stronger global demand for commodities and price inflation.

The governments of developed economies have been pressing China to revalue the renminbi and China may be forced into a sharp one-off revaluation in 2010 in light of the weakening US$ and increased capital inflows. This is another low-probability but high-risk event. Our view is that as long as China’s exports remain below pre-crisis levels, the government will oppose any appreciation for fear of hurting China’s exports. Therefore, we believe the Rmb/US$ will remain roughly stable at Rmb6.80/US$ over the next 2-3 quarters. Even though China’s exports may expand by double digits by mid-2010, its exports would only be returning to 2H07 levels of US$111bn a month. However, if we see consistent double-digit export growth coupled with GDP growth at or above 10% yoy, a much surer global recovery as well as inflation, the Chinese government may be more willing to allow the Rmb to resume its appreciation against the US$.

Figure 11: A much stronger RMB in 2010 and beyond?

80

85

90

95

100

105

110

115


Broad US$ IndexUS$ Index - Against Major CurrenciesUS$ Index - Against Other Important Trading PartnersUS$ Index - Against the RMB

Strenghtening of the US$

Weakening of the US$

Nominal US$ Index (1 Jan 2007 = 100)


Double dip risk

Asset bubble concern

Food prices may jump on supply disruptions

A one-off revaluation of the Rmb?


Appendix Tables

Real GDP (% yoy)2001 2002 2003 2004 2005 2006 2007 2008 2009E 2010F 2011F

China 8.3 9.1 10.0 10.1 10.4 11.6 13.0 9.0 8.2 10.0 10.0Hong Kong 0.5 1.8 3.0 8.5 7.1 7.0 6.4 2.4 -2.0 6.0 6.0Indonesia 3.6 4.5 4.8 5.0 5.7 5.5 6.3 6.1 4.4 5.8 6.0Malaysia* 0.5 5.4 5.8 6.8 5.3 5.8 6.2 4.6 -2.3 3.5 5.5Singapore -2.4 4.1 3.8 9.3 7.3 8.4 7.7 1.2 -2.0 6.5 6.0Thailand 2.2 5.3 7.1 6.3 4.6 5.1 4.9 2.5 -2.8 3.5 5.0* Malaysia's GDP has been rebased from 1987 prices to 2000 prices

Private consumption (% yoy)2001 2002 2003 2004 2005 2006 2007 2008 2009E 2010F 2011F

China 6.6 7.6 6.9 8.4 9.8 11.7 12.5 12.3 9.0 10.0 12.0Hong Kong 1.8 -0.9 -1.3 7.0 3.0 5.9 8.5 1.5 -1.0 5.0 5.0Indonesia 3.5 3.8 3.9 5.0 4.0 3.2 5.0 5.3 5.6 6.0 6.2Malaysia 3.0 3.9 8.1 9.8 9.1 6.8 10.4 8.4 1.5 4.1 5.6Singapore 4.8 4.9 0.9 5.1 3.8 4.0 5.2 2.4 -1.4 2.0 3.0Thailand 4.1 5.4 6.5 6.2 4.6 3.2 1.7 2.7 -1.6 2.8 4.5

Fixed investment (% yoy)2001 2002 2003 2004 2005 2006 2007 2008 2009E 2010F 2011F

China 12.4 13.7 20.2 21.3 18.5 18.8 18.0 18.0 35.0 20.0 20.0Hong Kong 2.7 -4.7 0.9 2.5 4.1 7.1 3.4 -0.5 -4.0 5.0 5.0Indonesia 6.5 4.7 0.6 14.7 10.9 2.6 9.4 11.7 4.7 10.8 10.9Malaysia -2.1 0.6 2.8 3.6 5.0 7.5 9.6 0.8 -4.5 0.5 4.2Singapore -4.1 -11.7 -4.0 9.5 -0.2 13.3 19.2 13.7 -3.7 5.0 5.0Thailand 1.1 6.5 12.1 13.2 10.5 3.9 1.5 1.2 -9.2 5.4 5.1

Gross exports in NCU (% GDP) 2001 2002 2003 2004 2005 2006 2007 2008 2009E 2010F 2011F

China 22.2 24.6 30.2 36.2 39.2 42.2 44.1 44.0 41.0 43.0 44.0Hong Kong 114.1 122.4 141.4 156.4 162.9 166.8 166.5 167.0 151.0 160.0 167.0Indonesia 39.0 32.7 30.5 32.2 34.1 31.0 29.4 29.8 25.2 29.0 30.0Malaysia 94.8 93.3 95.0 101.5 102.6 102.5 94.6 89.8 79.5 83.3 85.2Singapore 142.1 141.6 171.6 181.1 190.0 195.1 179.1 185.2 160.0 170.0 180.0Thailand 54.6 52.1 54.6 58.9 62.1 61.6 60.6 64.3 57.5 61.1 68.2

Gross exports in NCU (% yoy)2001 2002 2003 2004 2005 2006 2007 2008 2009E 2010F 2011F

China 6.8 22.4 34.6 35.4 27.0 23.7 20.0 7.2 -18.5 15.0 15.0Hong Kong -5.9 5.4 11.6 15.8 11.4 9.3 9.3 5.1 -12.0 13.0 15.0Indonesia 10.8 -7.8 -1.7 22.0 30.1 11.1 12.9 27.4 -12.2 3.0 8.4Malaysia -10.4 6.9 11.3 21.0 11.4 9.8 2.7 9.6 -16.8 10.0 12.0Singapore -8.3 2.7 24.4 20.5 14.0 12.8 4.4 5.8 -18.0 13.0 15.0Thailand 2.6 1.3 13.9 18.2 15.3 9.8 7.7 11.9 -10.8 11.5 14.4

Tourist arrivals ('000 persons)2001 2002 2003 2004 2005 2006 2007 2008 2009E 2010F 2011F

China 11,209 13,824 11,394 16,932 20,248 22,192 26,110 24,325 24,000 25,000 26,000Hong Kong 13,725 16,566 15,537 21,811 23,359 25,251 28,169 29,507 29,300 31,500 33,000Indonesia 5,154 5,033 4,467 5,321 5,002 4,871 5,506 6,429 6,500 7,000 8,000Malaysia 12,775 13,292 10,577 15,703 16,431 17,547 20,973 22,052 23,360 24,530 25,800Singapore 7,522 7,567 6,127 8,329 8,943 9,751 10,285 10,115 9,600 10,500 12,000Thailand 10,062 10,799 10,004 11,651 11,517 13,822 14,371 14,594 12,500 13,000 13,500


Appendix Tables

Tourism earnings (% GDP)2001 2002 2003 2004 2005 2006 2007 2008

China 1.3 1.4 1.1 1.3 1.3 1.3 1.4 1.4 Hong Kong 4.8 6.0 5.7 7.2 7.7 8.2 8.2 8.4 Indonesia 3.4 2.2 1.7 1.9 1.6 1.2 1.2 2.5 Malaysia 6.9 6.7 5.1 6.3 6.1 6.3 7.2 6.7 Singapore 6.5 5.6 4.3 5.3 5.5 5.7 5.7 5.8 Thailand 5.8 5.9 5.2 5.9 5.2 6.2 6.4 5.0

Consumer prices (% yoy)2001 2002 2003 2004 2005 2006 2007 2008 2009E 2010F 2011F

China 0.7 -0.8 1.2 3.9 1.8 1.5 4.7 5.9 -0.5 1.5 - 2.0 1.5 - 2.0Hong Kong -1.6 -3.0 -2.6 -0.4 0.9 2.0 2.0 4.3 0.0 1.5 - 2.0 1.5 - 2.0Indonesia 11.5 11.8 6.8 6.1 10.5 13.1 6.4 10.3 3.5 6.3 7.0Malaysia 1.4 1.8 1.1 1.4 3.0 3.6 2.0 5.4 0.7 1.5 2.0Singapore 1.0 -0.4 0.5 1.7 0.5 1.0 2.1 6.5 0.0 3.0 - 3.5 1.5 - 2.0Thailand 1.6 0.6 1.8 2.8 4.5 4.6 2.2 5.5 -0.8 3.0 3.2

Fiscal balance (% GDP)2001 2002 2003 2004 2005 2006 2007 2008 2009E 2010F 2011F

China -2.3 -2.6 -2.2 -1.3 -1.2 -0.8 0.6 -0.4 -3.1 -2.0 to -4.0 -2.0 to -4.0Hong Kong -4.9 -4.8 -3.2 1.6 1.0 3.9 7.7 -0.8 -3.7 -1.0 to -2.0 -1.0 to 0Indonesia -2.5 -1.3 -1.7 -1.0 -0.5 -0.9 -1.3 -0.1 -2.5 -1.6 -2.0Malaysia -5.2 -5.3 -5.0 -4.1 -3.6 -3.3 -3.2 -4.8 -7.4 -5.6 -3.8Singapore -0.3 -1.2 6.4 5.5 6.7 9.7 12.2 7.2 -3.0 -2.0 to 0.0 -1.0 to 0.0Thailand -2.1 -2.2 0.6 0.3 0.2 0.1 -1.1 -0.3 -4.1 -4.2 -1.6

Balance of payments current account (% GDP)2001 2002 2003 2004 2005 2006 2007 2008 2009E 2010F 2011F

China 1.7 3.4 3.5 3.9 10.2 10.4 11.7 8.8 5.0 6.0 6.0Hong Kong 5.9 7.6 10.4 9.5 11.4 12.1 12.3 13.0 14.0 12.0 11.0Indonesia 4.2 4.0 3.5 0.6 0.1 2.7 2.4 0.1 1.5 2.0 3.0Malaysia 7.9 8.0 12.1 12.1 15.0 16.7 15.7 17.5 16.0 15.0 15.8Singapore 14.0 13.7 24.0 19.6 23.7 26.1 23.5 15.8 14.0 15.0 17.5Thailand 4.4 3.7 3.3 1.7 -4.3 1.1 5.7 0.3 7.6 3.3 3.8

Unemployment rate (%)2001 2002 2003 2004 2005 2006 2007 2008 2009E 2010F 2011F

China 3.6 4.0 4.3 4.2 4.2 4.1 4.1 4.5 4.5 4.2 4.2Hong Kong 6.3 7.4 7.5 6.6 5.2 4.4 3.4 4.1 5.1 4.3 4.0Indonesia 8.1 9.1 9.6 9.5 10.6 9.6 9.1 9.2 9.5 9.0 8.8Malaysia 3.7 3.2 3.2 3.3 3.8 3.0 3.0 3.7 3.7 3.5 3.0Singapore 3.6 3.6 3.8 3.0 2.6 2.6 1.7 2.5 3.3 2.6 1.8Thailand 1.8 1.4 1.5 1.5 1.4 1.0 0.8 1.4 1.1 1.0 1.0

Policy interest rate (% p.a.)2001 2002 2003 2004 2005 2006 2007 2008 2009E 2010F 2011F

US Fed funds 1.75 1.25 1.00 2.25 4.25 5.25 4.25 0.0 - 0.25 0.0 - 0.25 0.50 1.25ECB Refinancing Rate 3.25 2.75 2.00 2.00 2.25 3.50 4.00 2.50 1.00 1.00 1.50Japan Overnight call 0.00 0.00 0.00 0.00 0.00 0.25 0.50 0.10 0.10 0.10 0.10China 1Y lending 5.85 5.31 5.31 5.58 5.58 6.12 7.47 5.31 5.31 5.85 6.66Hong Kong Base rate 3.25 2.75 2.50 3.75 5.75 6.75 5.75 0.50 0.50 1.00 1.75Indonesia 1M SBI 17.62 12.99 8.31 12.75 12.75 9.75 8.00 9.25 6.50 7.50 8.00Malaysia Overnight policy* 5.00 5.00 2.71 2.70 3.00 3.50 3.50 3.25 2.00 2.00 3.00Singapore 3M S$ SIBOR 1.25 0.83 0.75 1.50 3.25 3.44 2.38 0.96 0.70 0.70 1.0 - 2.0Thailand 1-day repo1 2.25 1.75 1.25 2.00 4.00 5.00 3.25 2.75 1.25 1.75 3.00* Overnight KLIBOR, prior 2003, intervention rate1 1-day REPO rate from January 07 onwards


Appendix Tables

End of period spot rates vs US dollar*2001 2002 2003 2004 2005 2006 2007 2008 2009E 2010F

Euro dollar 0.89 1.05 1.26 1.36 1.18 1.32 1.46 1.39 1.55 1.48Japanese yen 131.66 118.79 107.22 102.63 117.75 119.05 111.75 90.64 92.00 102.00Chinese renminbi 8.28 8.28 8.28 8.28 8.07 7.81 7.30 6.83 6.81 6.75Hong Kong dollar 7.80 7.80 7.76 7.77 7.75 7.78 7.80 7.51 7.75 7.80Indonesian rupiah 10,400 8,950 8,420 9,270 9,830 8,995 9,393 11,120 9,200 9,500Malaysian ringgit 3.80 3.80 3.80 3.80 3.78 3.53 3.31 3.47 3.35 3.45Philippines peso 51.60 53.60 55.54 56.23 53.09 49.03 41.25 47.52 47.00 47.50South Korean won 1,314 1,186 1,192 1,035 1,010 930 935 1,260 1,150 1,250Singapore dollar 1.85 1.73 1.70 1.63 1.66 1.53 1.44 1.43 1.37 1.42Thai baht 44.21 43.11 39.62 38.92 41.03 35.45 33.71 34.74 33.30 34.50* All currencies are quoted in NCU/US$ except for Euro dollar which is quoted in US$/NCU

External debt (% GDP)2001 2002 2003 2004 2005 2006 2007 2008 2009E 2010F 2011F

China 14.0 12.8 12.7 12.8 12.6 12.2 10.5 9.3 8.1 7.5 7.5Hong Kong 30.5 30.7 39.6 41.2 41.0 39.0 36.1 36.0 31.5 30.0 29.6Indonesia* 84.1 64.5 56.9 55.4 46.3 34.8 32.6 30.0 31.0 29.0 27.0Malaysia 49.2 48.4 44.6 42.3 37.8 32.1 29.3 32.0 34.7 32.2 29.2Singapore 21.5 23.4 23.8 21.7 19.9 17.7 15.8 14.0 11.5 10.4 9.9Thailand 58.1 47.0 34.7 30.8 30.1 26.9 24.4 24.9 23.2 24.0 22.0

Short term external debt (% GDP)2001 2002 2003 2004 2005 2006 2007 2008 2009E 2010F 2011F

China 3.8 4.0 4.8 5.4 6.2 6.3 5.4 4.7 4.3 4.0 4.0Hong Kong 11.0 11.2 12.5 13.4 13.8 14.1 14.5 14.3 11.0 10.5 10.1Malaysia 6.8 8.5 8.0 9.2 9.0 7.5 8.5 10.8 11.7 10.7 9.9Singapore 9.9 8.9 9.1 8.3 7.6 6.8 6.0 5.5 4.0 4.3 4.5Thailand 11.5 9.4 7.3 7.3 9.5 8.4 8.6 9.3 8.0 7.5 6.5

Foreign reserves (US$bn)2001 2002 2003 2004 2005 2006 2007 2008 2009E 2010F 2011F

China 212.2 286.4 403.3 609.9 818.9 1,066.3 1,528.2 1,946.0 2,300.0 2,550.0 2,950.0Hong Kong 111.2 111.9 118.4 123.6 124.3 133.2 152.7 182.5 240.0 275.0 320.0Indonesia 28.0 32.0 36.3 36.3 34.7 42.6 56.9 51.6 66.0 74.0 80.0Malaysia 29.9 33.7 44.2 66.2 70.2 82.5 101.3 91.4 96.6 108.6 120.6Singapore 75.7 82.2 96.2 112.6 116.2 136.3 163.0 174.2 184.0 195.0 210.0Thailand 33.0 38.9 42.1 49.8 52.1 67.0 87.6 111.0 140.0 155.0 160.0


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Persons who do not have professional experience relating to investments should not rely on this document.United States: This research report is distributed in the United States of America by CIMB Securities (USA) Inc, a U.S.-registered broker-dealer and a related company of CIMB-GK Research Pte Ltd solely to persons who qualify as "Major U.S. Institutional Investors" as defined in Rule 15a-6 under the Securities and Exchange Act of 1934. This communication is only for Institutional Investors and investment professionals whose ordinary business activities involve investing in shares, bonds and associated securities and/or derivative securities and who have professional experience in such investments. Any person who is not an Institutional Investor must not rely on this communication. 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STOCK RECOMMENDATIONS SECTOR RECOMMENDATIONS

OUTPERFORM: The stock’s total return is expected to exceed a relevant benchmark’s total return by 5% or more over the next 12 months.

OVERWEIGHT: The industry, as defined by the analyst’s coverage universe, is expected to outperform the relevant primary market index over the next 12 months.

NEUTRAL: The stock’s total return is expected to be within +/-5% of a relevant benchmark’s total return.

NEUTRAL: The industry, as defined by the analyst’s coverage universe, is expected to perform in line with the relevant primary market index over the next 12 months.

UNDERPERFORM: The stock’s total return is expected to be below a relevant benchmark’s total return by 5% or more over the next 12 months.

UNDERWEIGHT: The industry, as defined by the analyst’s coverage universe, is expected to underperform the relevant primary market index over the next 12 months.

TRADING BUY: The stock’s total return is expected to exceed a relevant benchmark’s total return by 5% or more over the next 3 months.

TRADING BUY: The industry, as defined by the analyst’s coverage universe, is expected to outperform the relevant primary market index over the next 3 months.

TRADING SELL: The stock’s total return is expected to be below a relevant benchmark’s total return by 5% or more over the next 3 months.

TRADING SELL: The industry, as defined by the analyst’s coverage universe, is expected to underperform the relevant primary market index over the next 3 months.

* This framework only applies to stocks listed on the Singapore Stock Exchange, Bursa Malaysia, Stock Exchange of Thailand and Jakarta Stock Exchange. Occasionally, it is permitted for the total expected returns to be temporarily outside the prescribed ranges due to extreme market volatility or other justifiable company or industry-specific reasons.

CIMB-GK Research Pte Ltd (Co. Reg. No. 198701620M)

RECOMMENDATION FRAMEWORK #1*


STOCK RECOMMENDATIONS SECTOR RECOMMENDATIONS

OUTPERFORM: Expected positive total returns of 15% or more over the next 12 months.

OVERWEIGHT: The industry, as defined by the analyst's coverage universe, has a high number of stocks that are expected to have total returns of +15% or better over the next 12 months.

NEUTRAL: Expected total returns of between -15% and +15% over the next 12 months.

NEUTRAL: The industry, as defined by the analyst's coverage universe, has either (i) an equal number of stocks that are expected to have total returns of +15% (or better) or -15% (or worse), or (ii) stocks that are predominantly expected to have total returns that will range from +15% to -15%; both over the next 12 months.

UNDERPERFORM: Expected negative total returns of 15% or more over the next 12 months.

UNDERWEIGHT: The industry, as defined by the analyst's coverage universe, has a high number of stocks that are expected to have total returns of -15% or worse over the next 12 months.

TRADING BUY: Expected positive total returns of 15% or more over the next 3 months.

TRADING BUY: The industry, as defined by the analyst's coverage universe, has a high number of stocks that are expected to have total returns of +15% or better over the next 3 months.

TRADING SELL: Expected negative total returns of 15% or more over the next 3 months.

TRADING SELL: The industry, as defined by the analyst's coverage universe, has a high number of stocks that are expected to have total returns of -15% or worse over the next 3 months.

** This framework only applies to stocks listed on the Hong Kong Stock Exchange and China listings on the Singapore Stock Exchange. Occasionally, it is permitted for the total expected returns to be temporarily outside the prescribed ranges due to extreme market volatility or other justifiable company or industry-specific reasons.

RECOMMENDATION FRAMEWORK #2 **


CIMB INVESTMENT BANK

CIMB-GK RESEARCH PTE LTD

Malaysia and Thailand

Priscilla Peggy TongAssistant Manager+60 (3) [email protected]

Kenneth WongAssistant Manager+60 (3) [email protected]

Lee Heng GuieHead of Economics+60 (3) [email protected]

Julia Goh Senior Manager+60 (3) [email protected]

Song Seng WunRegional Economist+65 [email protected]

Singapore and Hong Kong/China

Contents

SuMMaRy .....................................................................................................................................................3

Review of 2009 .......................................................................................................................................4

Key drivers for 2010 ................................................................................................................................8

Outlook of major economies ...................................................................................................................9

Regional economic outlook ..................................................................................................................16

Interest rate outlook .............................................................................................................................20

Currency outlook ..................................................................................................................................21

Key risks for 2010 ................................................................................................................................23

MaLaySIa - How strong is the recovery?....................................................................................................27

SINGaPORE - Bracing for bumpy recovery ................................................................................................43

INDONESIa - Higher growth ........................................................................................................................51

THaILaND - Coming out of the tunnel .........................................................................................................59

CHINa - Defying expectations .....................................................................................................................71

aPPENDIX TaBLES ....................................................................................................................................78

CIMB OFFICES

CIMB Research ReportREGIONAL ECONOMIC COMPASS

December 2009

KKDN PP 14048/11/2010 (025968)

20102010Malaysia • Singapore • Indonesia • Thailand • ChinaMalaysia • Singapore • Indonesia • Thailand • China


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