ASEAN Economics: What Does A Cross-Current of DM Recovery, Rising Real Rates & China Slowdown Mean For ASEAN?

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STANLEY
RESEARCH
ASIA/PACIFIC
Morgan Stanley Asia (Singapore) Pte.
Deyi Tan
[email protected] +65 6834 6703
September 3, 2013
ASEAN Economics
What Does A Cross-Current of DM Recovery, Rising Real Rates & China Slowdown Mean for ASEAN?
Whats new? We are downgrading our 2013/2014 ASEAN4 GDP growth numbers from 4.8%/5.3% to 4.5%/4.6%. Our first stab at 2015 looks for a growth pickup to 5%. The downgrade reflects a weaker-thanexpected 1H13, and a more clouded outlook. Indeed, apart from idiosyncratic country factors, ASEAN now faces a more disparate cross-current of macro forces from: (a) a DM recovery which would help buoy exports; (b) exogenous tightening from a less easy Fed policy; and (c) further China slowdown which would have collateral impact on commodity prices. Country outlines below: Indonesia: Still in Disequilibrium; Too Early to Turn Constructive We believe real exchange rates need to be 10% weaker from current levels and real interest rates need to rise to 2%. This would drive a growth slowdown, needed for a more sustainable equilibrium. Malaysia: Not Quite In The Same Boat As Indonesia Malaysia does not face the same funding squeeze as Indonesia. The bigger similarity lies in what lower commodity prices would mean for medium-term growth. Singapore: Lower Trend Growth, Higher Trend Inflation & A Less Easy Fed Policy The economy continues to see a new normal of lower growth and somewhat higher inflation though the worst of stag-flation is behind us. A less easy Fed policy would likely take some wind out of the credit cycle. Thailand: Next At Risk After Indonesia To Rising Real Rate Trend Weak current account, previously strong credit cycle and elevated LDR increase the vulnerability to the exogenous tightening from less easy Fed policy. The latter could also constrain how aggressive fiscal policy in Thailand can be.
For important disclosures, refer to the Disclosures Section, located at the end of this report.
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September 3, 2013 ASEAN Economics
What Does A Cross-Current of DM Recovery, Rising Real Rates & China Slowdown Mean for ASEAN?
Whats new? We are revising our ASEAN4 GDP growth numbers down from 4.8% to 4.5% for 2013, and from 5.3% to 4.6% for 2014. Meanwhile, our first stab at 2015 looks for a mild growth recovery to 5.0% (Exhibit 1). The mostly downward revisions incorporate weaker-than-expected datapoints for 1H13 and a more clouded outlook going forward. Indeed, apart from idiosyncratic domestic developments (which we will elaborate in the country pages), ASEAN economies now also face a more disparate cross-current of global macro forces, namely: (1) a DM recovery i.e healthy rebound in US and a less bad Europe (as expected); (2) exogenous tightening effects from expected QE taper and rising US real rates on the back of the US growth rebound; (3) a further China GDP growth downgrade which would have implications not only on end-demand but also on commodity prices. These factors make us less optimistic about ASEANs 2014 growth prospects compared to before. We discuss in further detail as follow: (1) Twilight to Daylight in DM Should Buoy Export Growth The twilight-to-daylight call for DM economies remains according to script (Exhibit 2), and our US and Europe teams have left their 2014 GDP growth forecasts unchanged (Exhibit 1). In the Back-to-School Global Macro Outlook piece which the Global Economics Team published today (see Back-to-School Global Macro Outlook: Acceleration, Stabilisation and Accommodation by Joachim Fels & team), our Global Chief Economist highlighted that the global narrative for the next 6-12 months is likely to be based on three pillars (Acceleration, Stabilisation and Accomodation). One of these pillars Acceleration, alludes to the fact that DM growth looks set to accelerate, with the US, UK and Japan all expected to show solid growth in the next few quarters and the Euro area, having just escaped recession. ASEAN economies (e.g. Singapore, Malaysia and Thailand are some of the most export-oriented economies) in AXJ (Exhibit 3) and ASEAN export growth has been on a downtrend (Exhibit 4) since the 2010 peak, posing a drag on overall momentum. A rising DM tide should help to lift the ASEAN exporters boat and
Exhibit 1
GDP Growth Revisions

Real GDP %YoY
2004-2007 average 2012 2013O 2014O 2013E 2014E 2015E
Global US Euro China Indonesia Malaysia Singapore Thailand ASEAN4
5.0 2.8 2.5 12.1 5.6 6.0 8.5 5.3 6.0
3.2 2.8 -0.5 7.8 6.2 5.6 1.3 6.5 5.6
3.1 1.9 -0.7 7.6 5.6 4.8 2.3 4.7 4.8
3.9 2.7 0.9 7.6 5.9 4.8 4.0 5.3 5.3
2.9 1.6 -0.5 7.6 5.6 4.1 2.9 3.7 4.5
3.5 2.7 0.9 7.1 5.1 4.3 3.6 4.4 4.6
3.7 2.6 1.2 6.9 5.5 4.8 4.0 4.8 5.0
Source: CEIC & Morgan Stanley Research O=Original estimates; E=Current estimates
Exhibit 2
DM Economies: From Twilight to Daylight

5 4 3 2 1 0 -1 -2 -3 -4 -5 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 US Real GDP growth (%YoY) Euro Area Real GDP growth (%YoY)
Source: CEIC & Morgan Stanley Research
Exhibit 3
Export Orientation Across AXJ

200 180 160 140 120 100 80 60 40 20 0
As at 2012
Exports (% of GDP) (LS) Current account balance (% of GDP) (RS)
25 20 15 10 5 0 -5 -10
M alaysia
Singapore
Taiw an
H ong Kong
Korea
C hina
Indonesia
Philippines
Thailand
India
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lend some beta to the export growth cycle as we head into 2014. Indeed, the US ISM new orders index has already shown a strong rebound and our US economist, Ted Wieseman, highlights that this is consistent with a robust manufacturing growth showing a pace of improvement typically seen when the economy is accelerating out of recession, supporting expectations for an inflection higher in 2H13 (See US Economics: ISM, August 1 by Ted Wieseman). Meanwhile, Europe PMIs have also shown an uptick (Exhibit 5). That said, whilst the export trajectory is up, we believe this export growth recovery is likely to be more subdued than previous ones due to two factors. First, global growth is likely to be lower than before as Europe continues to navigate what our chief European Economist Elga Bartsch believes is still a frustratingly slow and fragile recovery and as EM economies such as China see dimmer growth prospects. MS estimates 2014/2015 Global GDP growth at 3.5% and 3.7% (vs 5% CAGR in 2004-2007) (Exhibit 1). Second, our US economics team points out that the uptick in US growth is primarily driven by a significant pickup in business investment and residential investment, quite unlike the consumption boom which had driven ASEAN export cycle before. One could argue that ASEAN export segments e.g. electronics PC & PC parts, office equipment and telcom products could still very well cater to the investment pickup to meet office demand. However, the same could not be said for segments such as electrical appliances, consumer electronics and autos. Moreover, Malaysia and Indonesia, the two largest net commodity exporters (as % of GDP) in AXJ, would also suffer from slower commodity exports amid the collateral impact from China slowdown as we discuss in (3) below. (2) ASEAN domestic demand Face Exogenous Tightening Effects From Less Easy Fed Policy The overeasy monetary policy in DM since the 2008/2009 GFC has been exported to ASEAN as capital flows moved from DM to EM in search of yields. Such easy money has been funding domestic demand in current account deficit economies such as Indonesia. Meanwhile, real interest rates were also depressed, leading ASEAN economies to leverage up to varying degrees in the past 5 years. Indeed, bank credit (% of GDP) in Singapore and Thailand has increased by ~40% of GDP in the 2007-2012 period (Exhibits 7-8). Expectations of a start to QE taper and a rise in real rates in US (See Asia Economics: Rise in Real rates Why It Feels like the 1990s, August 22 by Chetan Ahya) have unwound the carry
Exhibit 4
ASEAN Export Growth Momentum Has Trended Down

60%
%YoY, 3MMA (US$ terms)

50% 40% 30% 20% 10% 0% -10% -20% -30% -40% Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jul-03 Jul-04 Jul-05 Jul-06 Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13
Indonesia exports Malaysia exports Singapore exports Singapore non-oil domestic exports Thailand exports
Exhibit 5
US ISM & Euro PMI: On an Improving Trend

75 70 65 60 55 50 45 40 35 30 25 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jul-03 Jul-04 Jul-05 Jul-06 Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13
US ISM: New Orders Index (3MMA) Euro PMI (3MMA)
Exhibit 6
Real Policy Rate Trend

8
Indonesia
6 4 2 0 -2 -4 -6 -8
Malaysia Singapore
Thailand
Real policy rates %
Jan-03
Jul-03
Jan-04
Jul-04
Jan-05
Jul-05
Jan-06
Jul-06
Jan-07
Jul-07
Jan-08
Jul-08
Jan-09
Jul-09
Jan-10
Jul-10
Jan-11
Jul-11
Jan-12
Jul-12
Jan-13
Jul-13
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trade which has been in favour of EM, exerting a tightening effects on these economies from without. To be sure, we do not hold the view that the current reversal in capital flows would lead to a situation akin to 1998 because of the following reasons: (a) The run-up to 1998 had seen a large degree of asset misallocation and domestic demand excesses. This has taken place amid financial liberalization, run-away credit growth and moral hazard within the banking sector given inadequate macroprudential and supervisory standards. Much of such lending turned out to be unviable when growth slowed. Now, with the exception of Singapore, the pick up in leverage in the last five years (% of GDP) and the level of bank credit penetration (as % of GDP) is less than the 5 years running up to 1998 (Exhibit 8). (b) Before the AFC, the pegged currency regimes (e.g. Baht and Ringgit) and the very steady Rupiah depreciation engineered by the Suharto regime had meant an increase in unhedged foreign currency debt as the private sector tried to take advantage of low foreign interest rates and high visibility with regards to their currency. Now, however, external debt (as % of GDP) has been brought down (Exhibit 9) and total external debt to FX reserve ratio, short-term external debt to FX reserve ratio and foreign reserve import cover ratio (except for Indonesias import cover) have mostly improved. (c) Current accounts were in deficit positions for Malaysia (-4.2% of GDP in 1996), Indonesia (-3.4% of GDP in 1996) and Thailand (-7.9% of GDP in 1996) in the run up to 1998. Now, Indonesias current account deficit has gone back to 1996 levels. However for Malaysia and Thailand, current account balances have weakened but are still less stretched compared to the run-up to 1998 (Exhibit10). This is a reflection that we have not seen domestic demand excesses of the sort seen in the run up to 1998. (d) Loan-to-deposit ratios were 100% and above before 1998 but are mostly less stretched now. However, that said, ASEAN will not be immune to this rise in US real rates and a reversal of the carry trade. Pressures will be felt in ASEAN economies which have weak current account balances (Indonesia) and which have seen strong credit growth cycle/rising LDR amid depressed real interest rates before (Thailand/Singapore). Indeed as we saw in recent months, expectations of a less easy Fed policy is already causing cashflow problems in Indonesia, leading to currency depreciation and forcing policymakers hand in undertaking
Exhibit 7
Bank Credit Has Picked Up In Past Years

200% 180% 160% 140% 120% 100% 80% 60% 40% 20% 0% 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
2013
Bank credit penetration (% of GDP) Indonesia Singapore Malaysia Thailand
Exhibit 8
Leverage cycle: 1998 vs Now

200% 180% 160% 140% 120% 100% 80% 60% 40% 20% 0% Indonesia Malaysia Singapore Thailand
% of GDP
Increase in bank credit: 1992-1997 Increase in bank credit: 2007-2012 Bank credit penetration: 1997 Bank credit penetration: 2012
Source: CEIC & Morgan Stanley Research; Singapore data for 2007-2012 refers to resident lending by DBU & ACU; For 1992-1997, it refers to lending by DBU.
Exhibit 9
External Debt Ratios

160% 140% 120% 100% 80% 60% 40% 20% 0% 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
External debt, % of GDP
Indonesia Malaysia Thailand
2013
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rate hikes. We think Thailand looks next most at risk within ASEAN to such tightening effects given its weak current account balances and previously strong credit growth cycle and rising LDR. Meanwhile, although the Fed will likely not start hiking rates until mid-2015, an end to the zero-interest rate policy which is now closer than it had been before is already causing Singapore banks to start re-pricing longer tenure loans such as mortgages. (3) A Further China Slowdown Would Also Have Collateral Impact on Commodity Prices Our regional AXJ economist Chetan Ahya has been bearish on China (See The China Deleveraging Series Part 1 A Bumpy Ride Ahead, by Chetan Ahya, 23rd July) and our China economist Helen Qiao further downgraded her 2014 GDP growth numbers from 7.6%YoY to 7.1%YoY and her first stab at 2015 GDP growth stands at 6.9%YoY. North Asia economies tend to have the largest trade links and the largest trade surplus with China (Exhibit 11) and would be more directly impacted from a China slowdown. However, for ASEAN, there would also be the indirect impact via the collateral impact that a China slowdown would have on commodity prices. China is either the worlds largest or a key, consumer for several commodities such as iron ore, steel, aluminium, copper, oil, coal and CPO (Exhibit 12). It also accounted for more than 50% of the increase for many of these commodities in 2012. To that point, we note that Malaysia and Indonesia are the two largest net commodity exporters (as % of GDP) in AXJ (Exhibit 13). The reversal in the commodity supercycle has already led Indonesia to see its most persistent stretch of CAD since 1998 and Malaysias current account surplus to fall from double-digit territory in 2011 to 1.1% of GDP (quarterly annualized) in 2Q13. Continually soft or falling commodity prices would mean poor or poorer terms-of-trade for the commodity exporters. What Are The Risks and Where We Could Go Wrong? As our chief global economist Joachim Fels pointed out in MSs Back-to-School publication, our global base case assumes that DM bond market stabilizes and China slows down in a controlled fashion. However, the bear case scenario could emerge if US bond yields surge to 4% in the next few months on fears of earlier Fed rate hikes and if China undergoes a U-shaped slowdown in 2H13 and 1H14 with growth rolling over to 5%-6%
Exhibit 10
Current account balance trends

20% Current account balance (4Q trailing sum, % of GDP) 30% 15%
25%
10% 20% 5% 15% 0% 10% -5%
-10%
Indonesia Malaysia Thailand Singapore (RS)

Mar-94 Mar-95 Mar-96 Mar-97 Mar-98 Mar-99 Mar-00 Mar-01 Mar-02 Mar-03 Mar-04 Mar-05 Mar-06 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 Mar-12 Mar-13
5%
-15%
0%
Exhibit 11
Who Has Bigger Trade Linkages With China?

18% 16% 14% 12% 10% 8% 6% 0% 4% 2% 0% -2% -4% 4% 2% Exports to China (% of GDP) Trade balance with China (% of GDP) 6% 2012 10% 8%
Taiwan
Singapore
Korea
Malaysia
Thailand
Philippines Indonesia
Exhibit 12
China: % Share of World Commodity Demand

80 70 60
50 64 53
China's % Share of World Commodity Demand (2012)
76
50 40 30 20 10 0 Iron Ore China

9 2 25
46 35
45 40 36 29 15 11 15 9 8 30 21 15
12
12
11
12 11 2
Steel Aluminum Copper Coal ROW Europe
Oil
US
CPO
Source: World Bureau of Metals statistics, International Copper Study Group, BP Stats, Wood Mackenzie Brook Hunt, Morgan Stanley Research
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quickly. The likely result from this given the still fragile state of EM and Euro would be the next global recession. We believe Indonesia would be worst impacted in the bear case (and also in the base case). In the bull case scenario, incoming US datapoints remain in a sweet-spot of continued expansion and the Fed successfully communicates the separation principle of keeping rates low for longer. Meanwhile, China sees a soft take-off in growth amid stimulus measures and structural reforms. Overall, the team still sees growth risks as skewed to the downside (Exhibit 14).
Exhibit 13
Exhibit 15
GDP: Bull Bear Base

Real GDP (%YoY) Global Bull Base Bear Indonesia Bull Base Bear Malaysia Bull Base Bear Singapore Bull Base Bear Thailand Bull Base Bear 2012 2013E 3.2 2.9 2.6 2014E 4.1 3.5 2.4 2015E 4.4 3.7 2.7
3.2
6.2
5.7 5.6 5.5
5.5 5.1 4.3
5.8 5.5 5
AXJ: Whos the Largest Net Commodity Exporter

15% 10% 5% 0% -5% -10% -15% -20% Hong Kong Singapore Philippines Indonesia Malaysia Taiwan Korea China India Thailand
2012 Trade Balance (% of GDP)
5.6
4.3 4.1 3.9
5.2 4.3 2.5
5.4 4.8 3.9
1.3
3.1 2.9 2.7
5.1 3.6 1.1
5.2 4 2.6
6.5
3.9 3.7 3.5
5.4 4.4 2.7
5.5 4.8 3.9
Food and live animals Crude materials Animal and vegetable oils and fats
Beverages and tobacco Mineral fuels and lubricants All Commodities
Source: CEIC & Morgan Stanley Research E=MS estimates
Exhibit 16
Policy Rates: Bull Bear Base

Policy Rates Indonesia Bull Base Bear Malaysia Bull Base Bear Singapore Bull Base Bear Thailand Bull Base Bear 2012 2013E 7.25 7.75 9.00 2014E 7.25 7.75 9.00 2015E 7.25 7.75 9.00
Exhibit 14
Inflation: Bull Bear Base

Inflation (%YoY) Global Bull Base Bear Indonesia Bull Base Bear Malaysia Bull Base Bear Singapore Bull Base Bear Thailand Bull Base Bear 2012 2013E 3.4 3.3 2.9 2014E 3.6 3.0 2.0 2015E 3.9 3.1 2.1
5.75
3.3
3.00
4.3
7.5 7.3 7.1
7.3 7.6 8.6
6.2 6.5 7.1
3.00 3.00 3.00
3.00 3.00 2.50
3.50 3.00 2.50
0.38
1.7
2.0 1.9 1.8
2.8 2.4 2.0
2.8 2.4 2.0
0.40 0.40 0.40
0.40 0.40 0.40
1.25 1.00 0.40
2.75
4.6
2.6 2.4 2.2
3.2 2.5 1.8
3.3 2.6 1.9
2.50 2.50 2.50
4.00 3.50 2.50
4.00 4.50 2.50
Source: CEIC & Morgan Stanley Research; E=MS estimates
3.0
2.5 2.3 2.1
3.2 2.6 2.0
3.1 2.5 1.9
Source: CEIC & Morgan Stanley Research; E= MS estimates
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Indonesia: Still in Disequilibrium; Too Early to Turn Constructive

Whats new? How are we different from consensus? We have been bearish on Indonesia and are now downgrading our 2014 GDP growth numbers from 5.9%YoY to 5.1%YoY (Exhibit 17) but leaving our 2013 GDP growth number (+5.6%YoY), which already pencils in a 2H13 slowdown, unchanged. Our first stab at 2015 looks for a mild uptick to 5.5%YoY. Consensus has been downgrading and 2013/2014 now stands at 5.8%/6.0%. We think more downgrades from the street are likely but suspect that we would still be below consensus for 2014. Key points: - Why are we downgrading? We have highlighted for a while that Indonesias uncomfortable current account deficit (CAD) and still healthy domestic demand do not go hand-in-hand with a stable IDR we called this the Impossible Trio. Macro stability is not in the hands of policymakers given the uncomfortable external imbalances and dependence on external funding, and further policy tightening and currency depreciation are required to bring Indonesia to a more sustainable near-term equilibrium of lower cyclical growth, narrower CAD and a less overvalued currency. Indeed, expectations of QE taper and rising real rates in the US since late May have exposed this macro vulnerability and forced policymakers hand in undertaking a cumulative 125bps policy rate hike. The reversal in carry trade has led IDR/USD to depreciate by 18% ytd, even after policymakers spent US$20bn in foreign reserves this year, of which US$12.5bn happened since May (Exhibit 18). Despite the policy response, we believe the macro adjustment is not over yet and it is still too early to turn constructive on the economy. The confluence of: (a) the longest stretch of CAD since 1998, courtesy of the commodity supercycle reversal (Exhibit 19); and (b) market adjustments to a less easy Fed policy have now increased the risk of a sharper tightening process and more currency depreciation within a compressed time span. This will drive a bigger growth deceleration in domestic demand than we had previously anticipated, forcing current account deficit down from -3.7% of GDP in 2013 to a narrower -2.5% of GDP in 2014. Growth risks are still skewed to the downside. - Currency adjustment process far from over Indeed, the still incomplete currency adjustment process is why we believe it is still too early to turn constructive on Indonesia. Although the IDR/USD has depreciated by 7% in the
Exhibit 17
Indonesia: Forecast Revisions

%YoY Real GDP growth - Private consumption %YoY - Public consumption %YoY - Gross capital formation %YoY -- Gross fixed capex %YoY - Exports %YoY - Imports %YoY - Domestic demand %YoY - Domestic demand (ex inventor%YoY %YoY, period CPI average %, period Policy rate end % of Current account balance GDP 2012 6.2 5.3 1.2 16.9 9.8 2.0 6.6 8.2 6.2 2013O 5.6 4.6 6.7 11.3 6.4 1.2 3.0 6.8 5.3 2014O 5.9 5.0 6.3 10.5 8.5 7.0 9.5 6.9 6.1 2013E 5.6 4.9 2.9 3.3 4.5 4.8 0.7 4.2 4.6 2014E 5.1 4.2 4.0 2.2 3.4 6.3 2.8 3.6 3.9 2015E 5.5 4.6 4.0 7.5 6.3 6.5 6.5 5.4 5.0
4.3
6.7
6.6
7.3
7.6
6.5
5.8 -2.8
7.0 -2.6
7.0 -2.6
7.75 -3.7
7.75 -2.5
7.75 -2.5
Source: CEIC & Morgan Stanley Research; O=Original estimates; E= Current estimates
Exhibit 18
Foreign Reserve Trend

250
Foreign reserves, US$bn
Malaysia
Indonesia Thailand
200
Singapore Philippines
150
100
50
0 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12
Dec-10 Dec-11
Exhibit 19
Current Account: Going Back to 1996 Levels

8% 6% 4% 2% 0% -2% -4%
Current account balance (Quarterly annualised, % of GDP)

-6%
Dec-93 Dec-94 Dec-95 Dec-96 Dec-97 Dec-98
Current account balance (4Q trailing sum, % of GDP)

Dec-99 Dec-00 Dec-01 Dec-02 Dec-03 Dec-04 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Dec-12
Jan-13
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Dec12-Jul-13 period and by 18% from the strength in Aug-11 vs Jul-13, the real effective exchange rate (REER) (trade weighted basket adjusted for inflation differentials), which we believe is the more relevant matrix to watch, has appreciated by 6% between end Dec-12 and Jul-13. Meanwhile, it has only marginally depreciated by 0.5% since Aug-11 (Exhibit 20). This is because Indonesias inflation is typically higher compared to its trading partners. In our view, there needs to be two phase of currency adjustments. The first phase of currency adjustment is to correct for what looks like an overvalued currency amid the persistent CAD and a lower new normal in commodity prices. Indeed, the IDR has behaved like a commodity currency (Exhibit 21). The REER has appreciated amid the commodity supercycle in past years (Exhibit 22) and the non-commodity current account balance has deteriorated as a result. Hence, to account for the lower new normal in commodity prices and to restore competitiveness in the non-commodity segments and get CAD to a more comfortable level, we believe that REER still needs to depreciate by ~10% from current levels after what the IDR has done recently. Once this overvaluation is corrected, we believe the second phase of currency adjustment would involve keeping the real exchange rate stable so as not to again weaken competitiveness in non-commodity segments. This can be achieved either by raising productivity and hence lowering inflation, or by engineering a steady rate of nominal exchange rate depreciation. Policymakers may have concerns regarding the potential destabilizing effects of weaker currency, given memories of 1998. However, we believe a weaker currency will not have the same destabilizing effect this time, to the extent that the currency depreciation should be significantly lower than during 1998 when NEER and REER depreciated by 60-80% between mid-97 and mid-98. Moreover, external debt (% of GDP) has come down from 48.2% of GDP in 1996 to 29.1% of GDP in 2Q13. Meanwhile, concerns on how currency depreciation could increase the oil import bill are also likely less valid given the hedge in the form of USD commodity export revenue. - Real interest rates still need to go up more The gap between Indonesias real interest rate and US real rates both at the short end and the long end of the curve has been falling as carry trade depressed EM yields. This fall in Indonesia real rates has also coincided with worsening CAD trends in Indonesia (Exhibit 23) as capital inflows/ low real rates fund domestic demand. Now, the rise in US real rates, the
Exhibit 20
IDR Currency Trends

140 130
Appreciation
IDR NEER IDR REER IDR/USD
120 110 100 90
Depreciation
80 70 60
Indexed Jan-2000=100
50 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12
105
Appreciation Depreciation
Depreciation Appreciation
Exhibit 21
IDR Had Behaved Like Commodity Currency

600 550 500 450 400
100 95 90 85
350
80
300 250 200 150 100 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13
75
CRB Commodity Index (LS) Indonesia REER (2010=100) (RS)
70 65 60
Source: CEIC, Bloomberg & Morgan Stanley Research
Exhibit 22
Non-Commodity Current Account Balance Deteriorated Amid REER Appreciation

-2% 40 50
-3%
60 -4% 70 -5% 80 -6% 90 -7% 100 CAB less commodities trade balance (4Q trailing sum, % of GDP) -8% REER (2010=100) 110
-9% Dec-93 Dec-94 Dec-95 Dec-96 Dec-97 Dec-98 Dec-99 Dec-00 Dec-01 Dec-02 Dec-03 Dec-04 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Dec-12
120
Jan-13
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reversal in capital flows from EM to DM, the lack of excess domestic savings in Indonesia, as seen in its CAD, the rising LDR and the need to anchor inflation expectations amid currency depreciation all point to this Indonesias real interest rate not only has to keep in tandem, but in fact rise faster than the global trend in order to maintain macro stability and to keep a rein on external imbalances. In our view, Indonesias inflation is likely to normalize at 6.5%YoY in 2015 after the impact from the retail fuel price hike wears out. We think policymakers need to bring short-term real rates up to 2%, i.e., 8.5% based on a normalized inflation rate of 6.5%. To be sure, we expect BI to only raise the policy rate by another 75bps to 7.75% as they tend to have a dovish bias. However regardless of policy action, we think market conditions will force short-term real interest rates up to where they need to be. This is because as the currency continues to depreciate, the process of FX intervention (selling USD and buying IDR) would withdraw liquidity from the system, leading market-oriented interest rates to move up. To this point, we note that although the benchmark policy rate has been hiked by 125bps from May levels, 1M and 3M JIBOR have already moved up by 193bps and 182bps from May-Aug (Exhibit 24). - Increased Urgency for Structural Reform 2.0 For the medium-term, we believe Indonesia still has one of the more attractive structural stories in ASEAN. However, external dampeners in the form of a structural China slowdown and its collateral impact on commodity prices also now means that the structural growth story in Indonesia cannot be seen in the same light. Put differently, if the same structural growth drivers could deliver 6.5% or even higher GDP growth before, the changed global environment now means that there is an increased urgency to undertake structural reform 2.0 to enhance growth negatives inflicted by exogenous factors. Otherwise, Indonesia could face lower growth and macro stability risks (See Asia Insight: Why the Next Election is More Important Than the Last, July 30). Indeed, structural reform 1.0 post AFC has run its course and served its purpose and structural reform 2.0 now needs to be kick-started and should involve policy measures to improve competitiveness of non-commodity segments by ensuring that resources are spent on productive areas such as infrastructure and education. Labour market regulations to ensure that wage growth is consistent with productivity increases would also help ensure cost competitiveness. Meanwhile, improving the investment landscape to attract more FDI would help ensure a bigger share of stable flows relative to short-term portfolio flows and would mitigate funding volatility.
Where are the risks? Upside/downside risks would stem from: (a) movements in US long yields; (b) Chinas growth and commodity prices movements; and (c) policy response/ policy mistakes.
Exhibit 23
Indonesia Real Interest Rate Cannot Just Move In Tandem, But Needs To Rise Faster
5%
6 4 2
4% 3% 2% 1% 0%
0
-1%
-2
-2% -3%
-4
-4%
-6
Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jul-03 Jul-04 Jul-05 Jul-06 Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13
-5%
Indo 10Y real rates less US 10Y real rates (3MMA) Indo - CAB (Quarterly annualised, % of GDP) (RS)
Source: Bloomberg, CEIC & Morgan Stanley Research
Exhibit 24
JIBOR Has Moved Up Faster Than Policy Rates

16
BI Policy Rate Deposit Facility Rate 1M JIBOR
16
Lending Facility Rate 3M JIBOR
14 12 10 8 6 4 2 Jan-06 Jan-07 Jan-08
14 12 10 8 6 4 2
Jan-09
Jan-10
Jan-11
Jan-12
Jan-13
Jul-06
Jul-07
Jul-08
Jul-09
Jul-10
Jul-11
Jul-12
Source: Bloomberg & Morgan Stanley Research
Jul-13
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Malaysia: Not Quite In The Same Boat As Indonesia

Whats new? How are we different from consensus? We are downgrading our 2013/2014 GDP growth numbers from 4.8%YoY/4.8%YoY to 4.1%YoY/4.3%YoY respectively (Exhibit 25). Our first stab at 2015 looks for a growth pick up to 4.8%YoY. Our numbers are below consensus, which stands at 4.8%YoY/5.3%YoY for 2013/2014 respectively. Key Points: - Why are we downgrading? Our previous growth forecasts had been premised on a cross-current of macro trends, namely: (a) a pickup in manufactured exports but with commodity exports still likely to see subdued trend amid soft prices; (b) a moderation in domestic demand as the pre-election boost tapers off and policymakers embark on a fiscal consolidation stance post elections. The storyline behind our revised numbers is the same. A still intact growth recovery in DM points to an export lift heading towards 2014. On the other hand however, domestic demand momentum could be somewhat hampered by the following: Fitchs recent downgrade to Malaysias outlook and recent rhetoric by policymakers suggest that fiscal consolidation is underway. Meanwhile, with elections done and dusted, capex momentum had decelerated significantly from a peak of +29.3%YoY in 3Q12 to +8.9%YoY in 2Q13 (Exhibit 26). The market had previously been sanguine regarding the continued capex strength on the back of ETP (Economic Transformation Projects) but we had been sceptical. Outside of the strategic push to ETP in the run-up to elections, a sustained inflexion point for investment depends critically on an improvement to the competitiveness of the workforce, which is still not evident yet, in our view. That said, a growth revision was necessary given: (a) a further China downgrade/EM growth downgrade and the collateral impact on commodity prices which would be negative for the largest net commodity exporter in AXJ; (b) a weaker level of incoming growth trajectory heading into 2H13. - Malaysia Does Not Face the Same Funding Squeeze As Indonesia With the developments in ASEAN, markets have tried to decipher which economy could be next in terms of bearing the brunt of the contagion effect. Some have highlighted the
Exhibit 25
Forecast Revisions
Real GDP growth - Private consumption - Public consumption - Gross capital formation -- Gross fixed capex - Exports - Imports - Domestic demand - Domestic demand (ex inventories) %YoY %YoY %YoY %YoY %YoY %YoY %YoY %YoY %YoY %YoY, period average %, period end % of GDP 2012 5.6 7.7 5.1 22.3 19.9 -0.1 4.7 11.3 10.6 2013O 4.8 7.4 5.9 9.6 10.4 0.0 2.7 7.8 8.1 2014O 4.8 7.4 3.0 5.2 6.2 5.0 6.5 6.1 6.4 2013E 4.1 6.8 4.8 7.3 6.9 -2.2 -0.1 6.7 6.6 2014E 4.3 6.8 4.0 1.1 4.9 4.5 5.0 4.7 5.8 2015E 4.8 7.5 4.0 2.8 5.5 6.0 7.0 5.6 6.4
CPI
1.7
2.3
2.5
1.9
2.4
2.4
Policy rate Current account balance
3.0 6.4
3.0 5.4
3.0 5.7
3.00 2.8
3.00 2.5
3.00 1.1
Source: CEIC & Morgan Stanley Research; O=Original estimates; E=Current estimates
Exhibit 26
Pre-election boost to Domestic Demand Fading?

30 25 20 15 10 5 0 -5 -10 -15
Mar-06 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 Mar-12 Nov-06 Nov-07 Nov-08 Nov-09 Nov-10 Nov-11 Nov-12 Mar-13 Jul-06 Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Jul-12
Domestic demand (%YoY) Gross Fixed Capex (%YoY)
Exhibit 27
Current Account Balance Trend

25% 20% 15% 10% 5% 0% -5% -10% -15% -20% Mar-94 Mar-95 Mar-96 Mar-97 Mar-98 Mar-99 Mar-00 Mar-01 Mar-02 Mar-03 Mar-04 Mar-05 Mar-06 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 Mar-12 Mar-13 Current account balance (4Q trailing sum, % of GDP) Current account balance (Quarterly annualised, % of GDP)
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similarities between Indonesia and Malaysia. Both are large commodity exporters and have seen the reversal in terms-oftrade significantly weakening CAB (Exhibit 27). Foreign ownership of government bonds for both economies are high. Foreign ownership of Malaysia government securities stand at 42.7% of outstanding in Jul-13. Including treasury bills and investment issues, foreign ownership is 28.3% in Jul-13, very similar to the 30.6% in Indonesia in Aug-13 (Exhibit 28). However, we believe Malaysia does not face the same funding squeeze and cashflow problems in Indonesia for the following reasons: (a) Indonesias current account deficit has gone back to 1996 levels and we expect CAD of -3.7%/-2.5%/-2.5% of GDP in 2013/2014/2015. Malaysias current account surplus has also weakened significantly from 10.8% of GDP in 4Q11 (quarterly annualized) to 1.1% of GDP in 2Q13 from commodity price falls and the pre-election boost and we would not be surprised to see Malaysia running a persistent CAD in the medium-term if no reforms are taken up. However, we think it is still likely to run a mild current account surplus for our forecast horizon, at 2.8%/2.5%/1.1% of GDP for 2013/2014/2015. (b) Malaysia did not have as strong a credit cycle as Indonesia. Credit growth (12M trailing average) stood at 10.8% for Malaysia in Jul-13 vs Indonesias 22.7% in Jun-13 (Exhibit 29). Meanwhile, LDR ratios are more comfortable in Malaysia at 79% vs Indonesias 91% (Exhibit 30), suggesting that there is still an internal buffer of liquidity to fall back in the event of capital flight. (c) Real interest rates in Malaysia are highest in ASEAN at 1.0% vs Indonesias -1.8%. To the extent to which real rates were higher to begin with, it would be less vulnerable as the yield carry trade unwinds. - The Similarity With Indonesia Lies More In Terms of What Lower Commodity Prices Would Mean for Medium-term Growth We believe the similarity between Indonesia and Malaysia lies more in that both would have to contend with what lower commodity prices would mean for GDP growth going forward. We have highlighted for a long time that Malaysias structural story is not compelling as it suffers from a Dutch Disease of sorts. Benign demographic trends have provided the labour inputs for growth. Meanwhile, commodity-related government revenue has provided the capital inputs for growth via fiscal pump-priming. Together, these two factors have created a comfortable growth buffer, leading policymakers to neglect
Exhibit 28
Who Has High Foreign Ownership of Domestic Government Securities?

40%
Foreign Ownership of Domestic Government debt securities (% of total)

Indonesia Malaysia Thailand
35%
30%
25%
20%
15%
10%
5%
0% Jun-03 Jun-04 Jun-05 Jun-06 Jun-07 Jun-08 Jun-09 Jun-10 Jun-11 Jun-12 Dec-02 Dec-03 Dec-04 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Dec-12 Jun-13
Exhibit 29
Comparing Credit Cycles

45 40 35 30 25 20 15 10 5 0
Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Oct-07 Oct-08 Oct-09 Oct-10 Oct-11 Oct-12 Apr-07 Apr-08 Apr-09 Apr-10 Apr-11 Apr-12 Apr-13 Jul-13
Malaysia loan growth (%YoY) Indonesia loan growth (%YoY)
Exhibit 30
Who Has More Comfortable Loan-To-Deposit Ratio?

120% 110% 100% 90% 80% 70% 60% 50% 40% 30% Nov-96 Nov-97 Nov-98 Nov-99 Nov-00 Nov-01 Nov-02 Nov-03 Nov-04 Nov-05 Nov-06 Nov-07 Nov-08 Nov-09 Nov-10 Nov-11 Nov-12
Loan to Deposit Ratio (%)
Malaysia Thailand Singapore Indonesia
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whats needed on the competitiveness/ productivity. As a result, FDI trends have been on a secular downtrend (Exhibit 31). Its global share of manufactured exports has fallen. Non-commodity trade balance has been on a secular decline and is in deficit territory (Exhibit 32). Additionally, the tertiary-educated makes up an increasing share of the unemployed group, pointing to a degree of skills mismatch. In this context, a sustained reversal in commodity terms-of-trade, without a corresponding improvement in productivity in other non-commodity economic segments would constrain GDP growth prospects for Malaysia in the medium-term. - Global Developments Have Prompted Tentative Steps towards Macro-rebalancing The silver lining is that recent developments seem to have prompted more steps towards macro rebalancing. With commodity revenue standing at 30-40% of government revenue and public debt ratio pushing the 55% ceiling (Exhibit 33), policymakers have indicated plans to: (a) reduce fiscal deficit to 4% of GDP in 2014 Budget (to be announced on 25th October) and then to 3% in 2015, (b) widen revenue base via a Goods & Service Tax and; (c) reduce unproductive expenditure via subsidy rationalization. These measures should have the longer-term impact of helping the economy to deal with a new global environment of lower commodity prices. Apart from these measures, we reiterate our view that engineering a sustainable structural inflexion point in Malaysias growth story would require policymakers to address issues pertaining to the quality of human capital. Growth momentum in mega investment plans such as the ETP and Iskandar Development Region can only have longevity if policymakers implement a critical mass of reforms on the soft infrastructure front i.e human capital. Where are the risks and where we could go wrong? Upside/downside risks stem from: (a) pace of DM recovery; (b) movement in US long yields and the collateral impact that it would have on EM growth and hence commodity prices; (c) China growth story and implications for commodity prices; and (d) upcoming UMNO party elections and implications on leadership stability.
Exhibit 31
Malaysia: Secular Decline in FDI

27 Malaysia 22 17 12 7 2 -3
Net FDI, US$bn
Singapore Indonesia
Thailand Philippines
-8 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010
Jan-12
0% 45% 40% 35% 30% 25% Dec-91 Dec-92 Dec-93 Dec-94 Dec-95 Dec-96 Dec-97 Dec-98 Dec-99 Dec-00 Dec-01 Dec-02 Dec-03 Dec-04 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Dec-12 2% 4% 6% 8%
Exhibit 32
Non-commodity trade balance in Deficit

20% Commodities trade balance (Mineral fuels, CPO, food & crude materials) Non-commodities trade balance 15%
10%
5%
0%
Trade balance (3M trailing sum, annualised, % of GDP)
-5% Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-13
-10% -8% -6% -4% -2% 50%
Exhibit 33
Public Debt Pushing the 55% Ceiling

75% 70% 65% 60% 55%
Government debt (% of GDP) (LS) Fiscal balance (4Q trailing sum, % of GDP) (RS) (Values in reverse order)
2012
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Singapore: Lower Trend Growth, Higher Trend Inflation & A Less Easy Fed Policy
Whats new? How are we different from consensus? We are upgrading our 2013 GDP growth from 2.3% to 2.9% and downgrading our 2014 GDP growth from 4% to 3.6% (Exhibit 34). Our first stab at 2015 looks for a mild uptick to 4%. Our 2013/2014 forecasts are more or less in line with consensus which stands at 2.7%/3.7%. Key points: - Why are we revising our numbers? Our upward revision to 2013 takes into account a stronger-than-expected 1H13 GDP growth and the carry over effect this may have on 2H13 GDP growth. Our downward revision for 2014 incorporates the downward revision that the global team envisages for EM economies as markets adjust to a less easy Fed policy. Moreover, the exogenous tightening is also likely to take the wind out of the previously strong credit growth cycle in Singapore. - Shift To Slower Growth Normal Well Underway Our thesis on Singapore remains broadly unchanged. The economy is transitioning from a Goldilocks period of high growth and extremely benign inflation seen in the run-up to 2007, to one in which growth is likely to settle at a newer lower normal whilst inflation is likely to trend higher (Exhibit 35). This is both due to global developments and idiosyncratic issues at home. On the growth front, growth has trended down from 8.5% CAGR seen in 2004-2007 to what looks likely to be a 3%-4% range going forward. Indeed, macro-rebalancing (first in DM and now also EM) point to a global growth which would be significantly lower than the 5% CAGR seen since 2004-2007. MS Global economics team expects 2013/2014/2015 global GDP growth at 2.9%/3.5%/3.7% respectively. Given that domestic demand is hardly domestic in nature for the small open economy, the spillover growth implications for Singapore are already being felt. Additionally, what is different in this cycle is that not only is Singapore contending with secular global demand shock, it is also contending with domestic issues of its own essentially a labour supply shock (Exhibit 36). An ageing population and a need to wean the economy from dependence on foreign labour given infrastructure/political constraints means that policymakers have undertaken steps to slow down the growth of foreign labour. To the extent to which an aggressive immigration policy had lifted labour inputs and driven growth
Exhibit 34
Forecast Revisions
Real GDP growth - Private consumption - Public consumption - Gross capital formation -- Gross fixed capex - Exports - Imports - Domestic demand - Domestic demand (ex inventories) %YoY %YoY %YoY %YoY %YoY %YoY %YoY %YoY %YoY %YoY, period average %, period end % of GDP 2012 1.3 2.2 -3.6 26.8 6.6 0.3 3.2 9.7 2.9 2013O 2.3 2.3 5.0 3.0 2.0 0.5 0.4 2.9 2.6 2014O 4.0 4.0 3.5 4.4 6.3 6.5 7.0 4.1 4.7 2013E 2.9 2.5 9.3 4.6 -0.3 1.7 2.1 4.2 2.4 2014E 3.6 3.6 3.5 3.4 5.5 6.0 6.3 3.5 4.3 2015E 4.0 4.0 3.5 3.0 5.8 8.0 8.5 3.5 4.6
CPI 3M SGD SIBOR Current account balance
4.6 0.4 18.6
3.6 0.4 16.1
3.6 0.4 16.4
2.4 0.4 18.1
2.5 0.4 18.5
2.6 1.0 17.6
Exhibit 35
From Goldilocks To A New Normal

25 20 15 10 5 0 -5 -10 Mar-00 Mar-01 Mar-02 Mar-03 Mar-04 Mar-05 Mar-06 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 Mar-12
2011 2012
GDP growth (%YoY) Inflation (%YoY)
Exhibit 36
Labour Supply Shock From Slower Immigration Going Forward

40 35 30 25 10 20 5 15 10 5 0 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 0 -5 -10
Policymakers want to maintain foreign labour share at ard 1/3
Non-resident labour (% of labour force) (LS) Non-resident population (%YoY) (RS)
25 20 15
Mar-13
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before, a slowdown in working age population would also drive down potential growth. - Inflation To Trend Above Old Normal; But Worst of Stagflation Likely Behind Us As Meanwhile, we expect inflation to hover in the mid 2% territory going forward, somewhat higher than the 1.5%-2.0% range seen during the Goldilocks period. This is because the still tight labour market and adjustments to a cut back in foreign labour will likely put a floor to labor costs despite the more subdued growth momentum going forward. Yet that said, the worst of the stagflation-type environment is likely behind us. Indeed, headline inflation has decelerated from an intra-year peak of 4.9%YoY in Feb-13 to 1.9%YoY in Jul-13 (Exhibit 37). Courtesy of the loose monetary conditions imported from DM, housing and transport (car prices) have previously been the two key sources of inflation. However, macroprudential measures in auto finance in terms of LTV caps and maximum tenures have led to softening car prices. A slower pace of property price rises from the multiple rounds of property cooling measures has also filtered into CPI with a lag. In addition, the exogenous tightening inflicted from a less easy Fed policy (as we elaborate below) also looks likely to soften property prices further. Our property analysts, Sean Gardiner & Wilson Ng, expects private residential prices to fall by 5% in 2014. Overall, for the medium-term, macro rebalancing to tap higher growth export segments/export destinations and improving productivity to offset the drag from ageing population is the only sustainable panacea to raising growth prospects and reining in inflation. - Exogenous Tightening To Take Some Wind Out of The Credit Cycle Our US team expects the Fed to begin raising rates in mid-2015, taking it to 1.5% by 2015 year-end. On the back of that, we expect 3M SGD SIBOR to rise to 1% by 2015 year-end from ~0.4% currently. Singapore will not be immune to the exogenous tightening effects from a less easy Fed policy. Resident lending has increased by 50% of GDP in the period 2007-2Q13 to reach 159% of GDP amid depressed SIBOR rates and this has buoyed asset prices. As it is, although the Fed has not begun to tighten rates yet, the end of the zero-interest rate policy being sooner than it has been before, has already led long yields to rise. Indeed, in Singapore 10Y bond yield has risen 140bps from May levels, compared to the 110bps increase in US 10Y bond yield for the same period (Exhibit 38). Anecdotally, banks have already started to reprice
SIBOR-plus mortgage loans. We believe the exogenous tightening effects from a less easy Fed policy would potentially create headwinds for selected segments of the economy such as property and interest-rate sensitive spending. Where are the risks & where we could go wrong? Upside/downside risks would stem from (a) global growth; (b) movement in US long yields; and (c) longer-term structural reform measures to enhance growth drivers and productivity.
Exhibit 37
Inflation Trends
7 6 5 4 3 2 1 0 -1 -2 -3 Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11
Jan-12
Tradables inflation (ex private transport) (%YoY) Non-tradables inflation (ex accomodation) (%YoY) MAS core inflation (%YoY)
Jan-12
Exhibit 38
SG Long Yields Have Moved Up

7.0 % US 10Y 6.0 SG 10Y
5.0
4.0
3.0
2.0
1.0 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-13
Source: Bloomberg & Morgan Stanley Research
Jan-13
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Thailand: Next At Risk After Indonesia To Rising Real Rate Trend

Whats new? How are we different from consensus? We are downgrading our 2013/2014 GDP growth numbers from 4.7%YoY/5.3%YoY to 3.7%YoY/4.4%YoY (Exhibit 39). Our first stab at 2015 looks for further growth pickup to 4.8%YoY. August consensus for 2013/2014 stands at 4.3%YoY/4.9%YoY respectively. Key points: - Why are we downgrading? Our downgrade takes into account the following: (a) the technical recession in 1H13 as payback from stimulus program was more significant than expected; (b) delay in implementation of government investment plans from 2H13 to 2014; (c) exogenous tightening effects as overeasy monetary policy in US starts to unwind. Post flood in 2012, domestic demand and export momentum has diverged as export production capacity got crimped and domestic demand got a boost from stimulus program. Meanwhile, 2013 saw a pullback in domestic demand as stimulus program expired whilst goods export momentum stayed patchy at a more subdued level. Heading in 2014, we suspect domestic demand momentum (+4.1%YoY) and export momentum (+4.1%YoY) are likely to converge. Both are likely to show a cyclical uptick. However, the pace of acceleration will likely be more marked in exports as exogenous tightening inflicted by the unwinding of overeasy monetary policy in US puts a rein on how quickly domestic demand would pick up. - Export recovery to provide some growth beta but Compared to other ASEAN economies, Thailand has a relatively more balanced dual-track economy of exports and domestic demand. A US growth rebound and a less bad Europe which is happening according to script would help to provide some beta on the growth front. Indeed, despite the global growth soft patch seen earlier this year, Thailand has still managed to eke out an export growth (in US$ terms) better than other ASEAN counterparts due to the composition of its export basket (less commodity centric). Moreover, Thailands manufactured exporters have been competitive and increasing their global market share. - .Exogenous tightening from rising US real rates to constrain domestic demand where excesses have built up On the domestic demand front, the picture is somewhat less straight forward. We highlighted in an earlier report that in
Exhibit 39
Forecast Revisions
Real GDP growth - Private consumption - Public consumption - Gross capital formation -- Gross fixed capex - Exports - Imports - Domestic demand - Domestic demand (ex inventories) %YoY %YoY %YoY %YoY %YoY %YoY %YoY %YoY %YoY %YoY, period average %, period end % of GDP 2012 6.5 6.7 7.5 16.8 13.2 3.1 6.2 9.4 8.4 2013O 4.7 4.2 6.0 6.0 8.7 6.7 7.3 4.9 5.6 2014O 5.3 4.5 6.0 7.7 9.7 7.0 7.6 5.6 6.1 2013E 3.7 2.4 5.0 6.1 3.4 2.3 2.0 3.7 3.0 2014E 4.4 2.6 5.0 7.1 6.6 4.1 3.6 4.1 3.9 2015E 4.8 3.0 6.5 8.9 7.6 5.0 5.5 5.1 4.7
CPI
3.0
3.4
3.4
2.3
2.6
2.5
Policy rate Current account balance
2.8 0.0
3.3 0.3
3.5 0.3
2.5 -0.9
3.5 -0.5
3.5 -0.9
Exhibit 40
Household Debt (% of GDP)

100% 90% Household debt (% of GDP) (2012) 80% 70% Taiwan 60% 50% 40% 30% 20% Indonesia 10% 0% 0 10,000 20,000 30,000 40,000 50,000 60,000 GDP per capita (US$) (2012) India Philippines China Thailand Hong Kong Malaysia Korea Singapore
Exhibit 41
Bank Credit to Non-Households (% of GDP)

140% 120% Hong Kong
Non-household bank credit (% of GDP) (2012)
100% China 80% Thailand Taiwan Korea 60% Malaysia 40% India Philippines 20% Indonesia Singapore
0% 0 10,000 20,000 30,000 40,000 50,000 60,000
GDP per capita (US$) (2012)
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ASEAN, Thailand is next most vulnerable after Indonesia to the exogenous tightening effects from expected QE taper and rising US real rates (See Thailand Economics: After Indonesia & India, Who Next to Watch for Risks?, July 19). Strong capital flows as evident in the increase in foreign ownership of government bonds have helped to keep real interest rate low despite its deteriorating current account balance, strong credit growth and rising LDR. This has likely helped to further sustain the credit cycle amid government stimulus programs and bolstered growth. Indeed, credit growth has been strong at ~8% of GDP each year in the past 5 years between 2007-2012, driven by both households and non-households segment. Bank leverage for both households and non-households in Thailand, adjusted for GDP per capita, are higher than the regional trend average (Exhibit 40 & 41) and LDR ratio has risen to 95%. Now, capital flows are unwinding. Foreign ownership of government bonds have fallen from 17.7% of outstanding in April to 16.7% in July amid US$2.7bn of outflows. Given that Thailand is likely to see current account deficits (Exhibit 42) for 2013/2014/2015 at -0.9%/-0.5%/-0.9% of GDP, rather than current account surplus, reflecting a lack of excess savings in the system, we believe the economy looks vulnerable to the exogenous tightening inflicted by the rise in real rates in US and this is likely to constrain how quickly domestic demand could pick up despite the export growth support. As it is, the high LDR ratio of 95% already means that recent policy rate cuts have seen limited pass-through to lending and deposit rates (Exhibit 43). - Growth alpha from fiscal policy also face headwinds from exogenous tightening The pick-up in public infrastructure investment is a theme we have been watching out for since 2H13. However, with the Rp2trn infrastructure funding bill still in Parliament and the water infrastructure projects needing further environment and health impact assessments before they can proceed, implementation of public investment projects is further pushed back into 2014. For the Bht2trn infrastructure plan, policymakers expect Bht154bn/Bht307bn to be implemented in 2014/2015 (Exhibit 44). This pick-up in non-budgetary expenditure would be offset to a certain extent by a smaller budget deficit of Rp250bn for FY2013/2014 (vs Rp300bn for FY2012/2013). Net-net, we are expecting public investment projects to lend a growth stimulus to the tune of ~0.6%-pt to 2014 GDP growth, assuming a 50% implementation rate of the infrastructure projects.
Exhibit 42
Drifting into Current Account Deficits

20% 15% 10% 5% 0% -5% -10% -15% Jul-05 Jul-06 Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13
Jan-13
Current acct balance (Monthly annualised, % of GDP) Current acct balance (3M trailing sum, annualised % of GDP)
Exhibit 43
Recent Policy Easing Has Not Filtered Into Market Rates

9 8 7 6 5 4 3 2 1 0 Jul-05 Jul-06 Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jul-13
% Policy rate Savings deposit rate 3M time deposit Minimum loan rate
On the fiscal front, we believe the exogenous tightening from a less easy Fed policy could also put a lid on how aggressive policymakers can be with its fiscal stimulus as this could further weaken the current account which is already in deficit territory. This would mean that policymakers would have to tap external funding which would likely come at a higher interest cost or a further tightening of domestic liquidity conditions and a crowding out of private investment. We would also note that with elections due by July 2015, any policy preference to fall back on quick-and-easy consumption type of fiscal measures rather than investment type of spending in 2014 would risk worsening the fiscal burden and current account without any commensurate growth or
Jul-13
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productivity returns in future. Indeed, we believe that the following factors of: (a) ageing demography and higher social/healthcare expenditure going forward; (b) reduced tax revenue base from corporate/personal income tax; (c) legacy of populist policy measures; and (d) current account deficits, point to an increasing need for policymakers to efficiently manage the fiscal mix. Where are the risks and where we could go wrong? Upside/downside growth risks would stem from: (a) the pace of DM growth recovery; (b) movements in US long yields; (c) political climate in the run-up to 2015 elections
Exhibit 44
Bht2trn Infrastructure Plan: Expected Disbursement Timeline

450 400 350 300 250 200 150 100 50 0 2013 2014 2015 2016 2017 2018 2019 2020
Bht bn
Expected disbursement
Source: PDMO & Morgan Stanley Research
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2013 Morgan Stanley

ASEAN Economics: What Does A Cross-Current of DM Recovery, Rising Real Rates & China Slowdown Mean For ASEAN?

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ASEAN Economics: What Does A Cross-Current of DM Recovery, Rising Real Rates & China Slowdown Mean For ASEAN?

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MORGAN

September 3, 2013 ASEAN Economics

GDP Growth Revisions

Global US Euro China Indonesia Malaysia Singapore Thailand ASEAN4

5.0 2.8 2.5 12.1 5.6 6.0 8.5 5.3 6.0

3.2 2.8 -0.5 7.8 6.2 5.6 1.3 6.5 5.6

3.1 1.9 -0.7 7.6 5.6 4.8 2.3 4.7 4.8

3.9 2.7 0.9 7.6 5.9 4.8 4.0 5.3 5.3

2.9 1.6 -0.5 7.6 5.6 4.1 2.9 3.7 4.5

3.5 2.7 0.9 7.1 5.1 4.3 3.6 4.4 4.6

3.7 2.6 1.2 6.9 5.5 4.8 4.0 4.8 5.0

DM Economies: From Twilight to Daylight

Source: CEIC & Morgan Stanley Research

Export Orientation Across AXJ

Source: CEIC & Morgan Stanley Research

September 3, 2013 ASEAN Economics

ASEAN Export Growth Momentum Has Trended Down

%YoY, 3MMA (US$ terms)

Source: CEIC & Morgan Stanley Research

US ISM & Euro PMI: On an Improving Trend

US ISM: New Orders Index (3MMA) Euro PMI (3MMA)

Source: CEIC & Morgan Stanley Research

Real Policy Rate Trend

Real policy rates %

Source: CEIC & Morgan Stanley Research

September 3, 2013 ASEAN Economics

Bank Credit Has Picked Up In Past Years

Bank credit penetration (% of GDP) Indonesia Singapore Malaysia Thailand

Source: CEIC & Morgan Stanley Research

Leverage cycle: 1998 vs Now

External Debt Ratios

External debt, % of GDP

Indonesia Malaysia Thailand

Source: CEIC & Morgan Stanley Research

September 3, 2013 ASEAN Economics

Current account balance trends

10% 20% 5% 15% 0% 10% -5%

Indonesia Malaysia Thailand Singapore (RS)

Source: CEIC & Morgan Stanley Research

Who Has Bigger Trade Linkages With China?

Source: CEIC & Morgan Stanley Research

China: % Share of World Commodity Demand

China's % Share of World Commodity Demand (2012)

50 40 30 20 10 0 Iron Ore China

Steel Aluminum Copper Coal ROW Europe

September 3, 2013 ASEAN Economics

GDP: Bull Bear Base

5.7 5.6 5.5

5.5 5.1 4.3

AXJ: Whos the Largest Net Commodity Exporter

4.3 4.1 3.9

5.2 4.3 2.5

5.4 4.8 3.9

3.1 2.9 2.7

5.1 3.6 1.1

3.9 3.7 3.5

5.4 4.4 2.7

5.5 4.8 3.9

Beverages and tobacco Mineral fuels and lubricants All Commodities