Asia Quarterly ― Q3 2018: Deal or No Deal? ― 7 th August 2018 Mizuho Bank, Ltd. Asia and Oceania Treasury Department Vishnu Varathan Head, Economics & Strategy [email protected]Chang Wei Liang FX Strategist [email protected]Zhu Huani Market Economist [email protected]Steering the global economy from a cyclical peak to a soft-landing is far from a done deal; as trade disruptions, policy bumps and geo-politics deal out uncertainty and volatility. Most worryingly, political miscalculations in US-China trade spat triggering a descent into all-out trade wars will deal a major blow to the global economy; most acutely to EM Asia. Trump’s delusory self-view as the ultimate deal-maker risks self-inflicted global economic ordeal if brinksmanship is overdone; claims of “method to madness” are shaky. And, global policy is complicated by an appreciably more hawkish Fed dealing with broad- based inflation pick-up and “strong” activity driven by fiscal stimulus; despite trade risks. Consequently, higher US rates, tighter USD liquidity converging with deferred global policy “convergence” accentuate market volatility and heighten EM pain (over and above trade). The table is set; the stakes are high. Now the world must deal with trade wild cards.
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Asia Quarterly ― Q3 2018: Deal or No Deal? ―
7th August 2018
Mizuho Bank, Ltd. Asia and Oceania Treasury Department
Steering the global economy from a cyclical peak to a soft-landing is far from a done deal; as trade disruptions, policy bumps and geo-politics deal out uncertainty and volatility. Most worryingly, political miscalculations in US-China trade spat triggering a descent into all-out trade wars will deal a major blow to the global economy; most acutely to EM Asia. Trump’s delusory self-view as the ultimate deal-maker risks self-inflicted global economic ordeal if brinksmanship is overdone; claims of “method to madness” are shaky. And, global policy is complicated by an appreciably more hawkish Fed dealing with broad-based inflation pick-up and “strong” activity driven by fiscal stimulus; despite trade risks. Consequently, higher US rates, tighter USD liquidity converging with deferred global policy “convergence” accentuate market volatility and heighten EM pain (over and above trade). The table is set; the stakes are high. Now the world must deal with trade wild cards.
Asia Quarterly – Q3 2018
- 1 -
Executive Summary
• Late-cycle fiscal stimulus pumping growth and inflation higher deals the Fed a more hawkish hand. Intensifying the conundrum is mounting, but hard-to-quantify, trade war risks poised to deal a blow to the global economy.
• Thus, relief on US-EU trade talks hinting a deal is hollow. Amid peaking growth
the ECB is committed to end QE in 2018 (halving to EUR15bn/mth in Q4), but has kicked the rate hike can down “ through Summer” (not till Sep) of 2019”; given “ no-deal Brexit” will complicate matters for EU and the UK.
• Japan growth has eased (even if Q1 GDP contraction is a blip) amid peaking exports
and risks of a raw deal from trade disruption. And a steadfastly dovish BoJ sticks to QQE & YCC . Meanwhile, PM Abe must deal with LDP elections.
• Escalating US trade tariffs, on $50bn of Chinese imports and another $200bn in the
pipeline have prompted shifts in Beijing’s policy strategies. “De-leveraging” is de-prioritized (but not abandoned!) with fiscal largesse being tapped.
• Beijing wants a deal as equals and not beaten into submission. Meanwhile,
adverse supply chain effects from the trade wars will impact other EM Asia. • India’s solid growth recovery will be dampened by high oil prices, rising inflation
and RBI hikes. Political risks (pre-2019 GE), banks’ capital deficit and fiscal slippage pose challenges despite perceived buffer from trade war risks.
• Indonesia: Despite growth buffer from investments, “twin deficits” and financial risks require more tightening; especially on political risks into 2019 elections.
• South Korea’s partial consumption buffer from front-loaded fiscal stimulus/wage increments is not a panacea to wider trade risks. Fading exports lift for Vietnam amid resurgent inflation ups the SBV’s challenges in maintaining VND stability.
• Despite peaking external boost and trade risks, Singapore’s more even growth validates April’s “slight” S$NEER slope. Malaysia’s new government has the benefit oil buffer to re-engineer fiscal sustainability while industry is buoyed.
• Thai growth will be buoyed by extra infrastructure fill ip; barring worst-case
trade wars and political risks ahead of 2019 elections. Philippines’ boost from remittance pick-up and infrastructure spending may still be overshadowed by “twin deficits” and inflation; upping pressures on BSP and PHP.
• Australia : Benign inflation, elevated household leverage, trade risks (vis China conduit) restrain RBA normalization. But if China’s fiscal boost to counteract trade war risks kick in, positive ToT will reinforc e RBA to deal a hike sooner.
• AXJ pressured by intensifying trade conflict amid tightening global liquidity , inciting capital outflows; USD tempered by “convergence” to provide relief later.
Asia Quarterly – Q3 2018
- 2 -
AT A GLANCE
Yearly Economic Forecasts
Quarterly Outlook – Growth and Consumer Inflation Growth Forecasts
Consumer Inflation forecasts
GDP YoY CPI C/A (% GDP) GDP YoY CPI C/A (% GDP) GDP YoY CPI C/A (% GDP) GDP YoY CPI C/A (% GDP)
United States 1.6 1.3 -2.6 2.3 2.0 -2.7 2.9 2.4 -2.6 2.5 2.2 -2.6
Note: Asia (ex Japan) includes China, India, South Korea, Singapore, Hong Kong, Taiwan, Malaysia, Indonesia, Thailand, Philippines, VietnamThe forecasts in this table do not account for severe trade protectionism outcomes.
12. Australia ----------------------------------------------------- 26
Tentative or On Tenterhooks?
Asia Quarterly – Q3 2018
- 5 -
Global Overview: Deal or No Deal?
Growth: “America First” resonates on many levels. For one, fiscal pump-priming is pushing US growth ahead of peers. Consequently, the Fed is ahead of the game, deferring “convergence”. Above all, US protectionism amplifies risks of trade-led global downturn. Worryingly, US-driven trade war risks, higher global interest rates and tightening liquidity , could conspire to materially dent global growth. The unknown is whether a deal may be struck with China to avert worst-case meltdown or “no deal” escalation of tit-for-tat protectionism triggers a spiral of demand compression and tariff inflation. How the Fed deals with distortions of fiscal stimulus and trade uncertainties will have far-reaching consequences.
Risks: The risks are three-pronged. One, peaking global economic cycle alongside high leverage, low rates, extended fiscal positions leave few low-hanging fruits for relief . Next, persistent and problematic divergence in global policy. A “ late-cycle” fiscal stimulus in US (tax cuts and spending boost), sets the Fed up for more rate hikes amid B/S reduction whereas other G4 central banks still lag. Resultant dissonance distorts asset markets and amplifies EM sell-off on rising yields and tighter USD liquidity. And EM central banks are forced to tighten for stability at the cost of growth. Finally, trade war risks amid more fragile geopolitics is the most significant threat.
Policy: Fed expectations assume a hawkish tilt with bets on four (instead of three) rate hikes this year mounting on late-cycle fiscal stimulus and “strong” activity; B/S reduction is headed to hit US$50bn/mth terminal velocity in Q4. In contrast, ECB safe-guards against downside risks despite growth optimism. While bond purchases will end in 2018, with Q4 halved to EUR15bn/mth, the ECB is set to keep rates on hold “through summer” (till Sep). The BoJ is unwaveringly dovish; with no plans for normalization in sight as of now. While the BoJ doubled the 0% 10Y JGB target range for YCC (to +/-0.2%), it has maintained JPY80trln QQE and warned of persistent shortfall in inflation expectations despite CPI uptick.
Asset Markets: A by-product of “ convergence” deferred (accentuated by a more hawkish Fed) is that USD appears to be finding some traction – despite lingering worries about mounting “twin deficits”. What’s more, trade war risks also appear to be playing out positively for USD insofar that it is triggering sharper sell-off in China and related markets – as is evident from equities. Partly, this may also reflect the “USD smile*”. And above all, with the Fed’s (solo) balance sheet, tighter USD funding is pushing up USD and hitting EM assets hardest. We look for some EUR-led reprieve from these dynamics into 2019 as ECB hikes come into view and trade uncertainty lift.
The “USD Smile” theory refers to the USD’s out-performance during periods of economic stress/uncertainty and during economic booms – explaining the upward (turn of a smile) at the two ends
Asia Quarterly – Q3 2018
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EUR/USD Outlook: While the ECB will halve its asset purchases to a monthly pace of EUR 15bn from September, before completely stopping QE in 2019, this has not lifted EUR/USD much. Political uncertainty in the Eurozone has risen after Italy formed a populist government that seeks to increase welfare spending and lower taxes, potentially setting up for a Budget confrontation with Brussels. Activity indicators have also softened on the back of rising trade tensions with the US, with the manufacturing PMI languishing at 55.1 in July. Given prolong Italian uncertainty, we suspect any Eurozone reforms may be stalled and see EUR/USD restrained around 1.17 for now.
Sources: Reuters, BIS, Mizuho Bank
USD/JPY Outlook: BoJ tweaked some policy parameters in July, with the most noteworthy change being a wider ±20bps range around the 0% target for the JGB10y yield. It also introduced forward guidance, committing to keep interest rates very low for an extended period of time, which could arrest speculation that it could begin policy tightening soon. While the measures are to increase policy flexibility to yield shifts and support profitability of banks, they also support perceptions of quiet confidence amidst downward revisions in the Bank’s inflation forecasts. As such, the JPY could continue to strengthen into late 2018, as rising wage inflation may eventually support a paring of stimulus in 2019.
Sources: BIS, Reuters, Mizuho Asia & Oceania Treasury
70
80
90
100
110
120
130
140
150
160
94 96 98 00 02 04 06 08 10 12 14 16 18
USD/JPY: Long-term Model Value
USD/JPY USD/JPY Fair Value +/- 1 std deviationSources: BIS, Reuters, Mizuho Asia & Oceania Treasury
Note: Values in black are historical whereas those in blue represent forecasts. * Point forecast is for end-period. Q2 2018 ranges are from Bloomberg and only indicative. ^ Fed rates refer to the Fed Funds Target rate; ECB rates refer to the Deposit facility rate.
Asia Quarterly – Q3 2018
- 7 -
Asia Outlook: China Chills
Output: Escalating US-China trade wars may multiply headwinds from peaking global trade cycle – with most of the adverse shocks feeding through as “China chills” . Admittedly, arguments that economies such as Malaysia, Thailand and Vietnam, could benefit as manufacturing migrates from China – in response to US-China trade spat ignore; i) timing lag; ii) dis-orderly nature of this trade war, and; iii) uncertainty around ad-hoc US measures that stall investment plans for longer. And the real danger is that China shocks not only impact via supply-chain trade linkages, but also transmit via credit and FX/asset channels, amplifying a downswing – but lack of clarity renders quantifying this slippery endeavor. Inflation: The big (inflation) picture is that has bottomed convincingly in most of Asia. But the pick-up spans a broad-spectrum from a rapid upswing (India Philippines etc.) to half-hearted traction (Singapore, Thailand etc.) and everything in-between. Nonetheless; significantly higher crude oil prices now compared to a year ago (and the consequent inflation impact expected to be material) coinciding with a more enduring pick-up in food prices and signs of wage increase, upside risks to inflation are set to mount. Crucially, demand-pull pressures may re-emerge more emphatically into 2019. Policy: At face value, measured but distinct hawkish shift, led by BoK and BNM last year and the MAS (in April), square with pre-empting gradually rising price pressures; thus being ahead of (or at least not falling behind) the proverbial curve. But more reactionary rate hikes from Bank Indonesia and BSP have been far more pronounced in the amplitude of hikes – to compensate for excess policy slack including late cycle (over-)easing by BI in Q3 last year. To be sure, most of the tightening this year is done. But with increased financial and FX instability risks , the danger is central banks may have to tighten more than may be optimal amid downside risks to growth. FX: FX drivers have shifted from intense “twin deficit” shake down, exacerbated by Oil’s surge – most acutely felt by PHP, INR, IDR, but initially leaving CNY and exports-boost currencies mostly unscathed – to trade war-driven risks. The latter has hit CNY and CNH most jarringly , with spillover to KRW, TWD, THB. The FX “China Chills” fret blunt trade tariffs with indiscriminate impact; also evident in China-led Asia equity market sell-off (India buffered). AUD is susceptible to China sell-off; but these risks should start to abate into 2019 as clarity on trade negotiations begin to emerge.
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30 ASEAN-6+India+Korea : Global Demand Recovery Peaking; More accentuated risks from "trade wars" could cascade to Dent Asia's Growth (% YoY 2Qma)
Exports (LHS)
Nominal GDP (RHS)
32
.1
3.8
25
.4
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.7
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.0
12
.0
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.0
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.1 18
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21
.6
17
.3
20
.6 2
7.0
25
.0
19
.2
27.5
11.2
23.4
13.9
15.8 16.7
14.7 15.9
19.9
21.5 23.3
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15
20
25
30
35
0
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35
Australia India Korea Singapore Malaysia Indonesia Philippines Thailand Vietnam Japan Taiwan
In terms of China as an exports market Australia, Taiwan & Korea are most exposed whereas China
imports are most in demand is Vietnam & Japan. In totality, Australia, Korea & Taiwan are most
exposed (% of Total; 2015-17 Avg)
China's Share of Exports (% of Total) China's Share of Imports (% of Total) China's Share of Total Trade (% of Total)
0
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2
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SGP THA KOR AUS CHN MYS VNM IDN PHL IND
Inflationary build-up remain subdued; and by and la rge nowhere oi the vicinity of serious "overheating". But timely normalization
remains be a policy priority for most central banks (%, YoY)
Upper bound Lower bound Latest 3m avg
Lower and Upper bounds refer to the central bank's inflation target while the Latest 3M shows actual inflation.
0
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08 09 10 11 12 13 14 15 16 17 18
Asia CBs: "Catch-up" moves partly pressured by Fed hikes & "risk off" from trade wars/oil/"twin deficits" pressuring FX (Policy Rates, % )
Gauge of Asian Central Banks Policy (Over-)Accommod ation (18-mths to End-2017)
Hikes in 2018
Policy Easing (Mid-2016 to end-2017)
Net Easing* (Mid-2016 to end-2017)
Augmented "Over-steer"^
* Net Policy Easing (in bps) considers policy action in the context of real rate shifts; expressed as the sum policy easing and the change in real rates (most recent 6M vs. 3Y avg). A high value may indicate policy that is too loose; such as BI & BSP.Augmented "Over-steer" takes into account tightenin g in 2018
^ Mean of; i) change from the peak since 2016 compared to most recent 6-mth average, and; ii) change from the 3-yr average to the most recent 6-mth average. Seperately the "real rate differentials" refer to s pread in real policy rates in Asia with real policy rate in US.
2.0 1.7
-0.6
-2.6
1.3 -0.3 0.0
-5.6
-0.5
1.3
-6.2-6.0 -5.7
-2.7
-3.9
-2.8
-2.3
-1.1
-0.9
-2.1 -2.4
0.2
-4.0 -4.0
-3.3
-6.5
-1.5
-2.6
-1.1
-6.4
-2.6
-1.0
-6.0
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CNH CNY KRW IDR THB TWD SGD INR VND MYR PHP
While INR, PHP & IDR are down most YTD; slump in EM Asia FX since mid-June has been led by
CNH, CNY, IDR, THB & KRW suggesting trade war related blowout (% Chg vs. USD; YTD up till 24 Jul)
Mid-June to 24-Jul Jan to Mid-Jun YTD (till 3 Aug)
Asia Quarterly – Q3 2018
- 8 -
China: Trade-Offs Growth: Headline growth is misleadingly sanguine, with H1 2018 GDP at 6.8% setting up full-year growth to be on the stronger side of “around 6.5%”. But muted deceleration in H1 (buffered by the lag between threats and tariffs) is not to be confused for an absence of hard-landing risks from intensifying US-China trade spat. Fact is, if tariffs overwhelm negotiated outcomes, trade headwinds, insofar that trade comes off, will dent as some industries feel the blowback. But fiscal/tax stimulus could partly cushion. Crucially, easing up on de-leveraging/de-risking assumed as a necessary trade-off will be a key backstop for the Chinese economy.
Industry: Admittedly, this entails Beijing’s plans for restructuring being re-prioritized (but not necessarily derailed). And that is a trade-off that Beijing is willing to make. For one, some aspects of higher credit may be tolerated as long as credit easing is directed towards growth sectors and risks are appropriately recognized. The big picture: Industries of strategic importance such as robotics, AI, green technology/vehicles will not be abandoned; whereas other (de-risking) goals may be stretched out as trade-off for low-hanging fruits from relative credit relaxation to buy some buffer.
Growth dynamics: That said, allegations that China is regressing to credit-intensive growth models, and doubling down on “white elephant” projects are at best simplistic, at worst mis-informed. The truth is closer to the trade-off between urgent de-leveraging to avoid “Minsky moment” type risks and backstopping growth against trade protectionism that could be detrimental to longer-term strategic industrial progress. The inclination as it were is to press on with major infrastructure projects related to rail and new technologies as an enduring growth proposition.
Inflation : The big picture is consistent with benign inflation, with recovering, albeit not resurgent, inflationary pressures. To be sure, inflation has emphatically bottomed since early-2017, and is gradually normalizing in the vicinity of 2.0-3.0% range. Admittedly, retaliatory tariffs (on US soybeans) could drive up food inflation more than anticipated as it feeds (pun intended) through to pork prices. Nonetheless, even in the case of fairly broad-based pick-up in price pressures with food adding to fuel, absence of “follow-through” inflation acceleration amid subdued demand-pull pressures suggest that inflation uptick will still be long way off enduring and rapid overheating risks.
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China's de-risking/re-balancing requires investment-driven growth to slow; displaced
by "new economy" growth drivers such as services. (contribution to nominal growth, %-pts YoY)
Growth ex-FAI FAI - Real Estate FAI ex-Real Estate Nom. GDP Growth GDP
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China: Wider gauge of activity suggests non-industr ial growth drivers helping to buoy ; fiscal spending may be the decisive "stabilizer" fo r durable traction further down.
(% YoY, Qtrly)
GDP (LHS)
IP (RHS)
GDP Proxy* (RHS)Sources: CEIC, Mizuho Bank
* Mizuho's proxy of activity correlating to GDP -comprises weighted aggregate of freight, credit, electricity output and auto production.
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China GDP: Sustained nominal GDP pick-up a pre-requisite to
growing out of debt; assuages concerns about credit intensity of
growth ...
Total Social Financing* (% YoY, Quarterly)
TSF ex Bankers Acceptance
Nom GDP YoY
*Total Social Financing comprises both Conventional and Shadow Banking.
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12 13 14 15 16 17 18
China's Credit Growth disproportionately driven by Shadow Credit since 2016 met with
"tightening" aimed at rebalancing towards bank credit growth to maintain measured
(and monitored!) credit growth(Contribution to YoY Credit Growth, 6MAvg, %-pts)
"Shadow Credit" (ex-Bonds & BA)^
Bank Credit
Combined
^ Shadow credit refers to Aggregate Financing less conventional bank loans . And this measure omits bond issuances as well as Bankers' Acceptance (BA) .
China's ability to manage credit gap, or the risk- & cycle- adjusted credit growth is
key; rather than mis-guided and self-defeating clamp down on credit.
(Cumulative Chg in Credit-to-GDP & Credit Gap since end-1999, %)
China Chg in Credit Ratio (%-pt of GDP)
China Chg in Credit Gap (%-pt of GDP)
Sources: BIS Quarterly Review (Mar 2018), Mizuho Bank
Main challenge is to manage the build-up in credit risksrather than to suffocate the economy of credit altogether. And to that end, reduction in "credit gap" provides reasssurances against elevated credit-to-GDP ratio .
Credit-to-GDP gap is defined as the difference between the credit-to-GDP ratio and its trend .
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Core inflation driven narrowly by healthcare wherea s underlying inflation remains under wraps; provides policy flexibility (a bove 3%).
Education & Recreation Healthcare
Tpt & Comm Others
Residence Food
CPI (% y/y) Core CPI
Sources: CEIC, Mizuho Bank.
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What's more, PMI Price Index pick-up is consistent with contained rather than resurgent producer inflation; cost-push is higher, but not accelerating (3mma)
Policy: Confusion about PBoC’s stance derives from trying to oversimplify policy to fit into “conventional” inflation targeting mould based on a singular policy rate. Whereas PBoC’s multiple and nuanced policy objectives in the context of capital controls that trades off to managing; i) domestic liquidity; ii) credit and; iii) managed float of CNY. And while overall policy is neutral, liquidity operations assume easing bias (e.g. RRR cuts) to support growth. More so given scaling back on severity of de-leveraging amid protectionist risks – targeted, not unbridled easing. Above all, CNY devaluation is not deliberate policy motive; but rather FX reserve-efficient shock absorption).
External Position: Net exports improving significantly in Q2 should provide some boost for the C/A, though this perhaps does not distract from the wider trend of diminished trade surplus and growing service deficit, containing suppressing C/A surplus (cushion) below historical peaks – necessary trade-off for higher standards of living and addressing the savings investment imbalance. Crucially, capital outflows remain problematic, and could become acutely more so if signs of distress from trade wars intensify. But that is a key reason why the PBoC won’t resort to devaluation as retaliation to US protectionism.
FX: CNY is not a weapon of trade war !̂ Sure enough, a weaker CNY will provide some relief from tariffs, but cannot side-step 25% tariffs and/or quota-based protectionism. What’s more, a weaker CNY undermines Beijing’s technology leadership goals, and risks destabilizing FX-capital outflow-FX reserve dynamics (2015 sell-off). Thus, CNY sell-off is a reflection of USD strength and remains within wider stability parameters of CNY NEER. And the trade-off entailed in drawing down on FX reserves and stepping back on market reform, rather than a desire to devalue CNY, is why Beijing is not intervening aggresssively. But re-imposing reserve requirement for FX forwards underpins “7-3” (USD/CNY capped ahead of 7 and FX reserves supported at $3trln)
China: Merchandise Net Exports slowing reveals cyclical peak rather than all-out
trade war risks, may keep pressure on C/A. Silver lining is that "official" capital
outflow are not excessive... (US$bn, 4Qma)
Financial A/C Goods Services C/A
Q2 2018 estimates
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... though "Hot" Outflows (% of Prev Qtr FX Reserves) are picking up in 2018 ; of which the PBoC remains mindful of given it is exacerbated by (a s well as amplify) CNY wobbles!
Valuation Effect Deviation (Implied Hot flows)C/A InvestmentsChg in FX Reserves
China's C/A, while a tad softer remqins accretive f or FX Reserves . But capital account and "hot" outflows remain as the main drag factors potentially.
China's C/A, while a tad softer remqins accretive f or FX Reserves . But capital account and "hot" outflows remain as the main drag factors potentially.
CNY NEER plunge to the base of the wider mid-2016-2017 "stability" range triggers
strong FX push-back kicking in; to avert sharper sell-off (instability) amid reflexivity
risks! (Index end-2014=100)
CNY NEERUSD (DXY) index (RHS; rebased: Start-2008 = 100)
60 per. Mov. Avg. (CNY NEER)
Paradigm shift from "dirty" USD peg to NEER-based
Stabilization helped by capital curbs alongside cou ner-cylcical FX fixing earlier. And so, the pertinent q uestion now is whether CNY NEER stability will be undermin ed by the unabated slide.
PBoC reinstates 20% reserve requirements for buying FX forwards; to highlight
discomfort with USD/CNY too close to the 7-figure.
USD/CNY Lower Band Upper Band
USD CNY Fix USD/CNH
Sources: Reuters, Mizuho Bank
Stronger CNY 11-Aug: 1.9% reference devaluation followed by a few sessions of self-reinforcing sell-off as fixing shifted to market-based mechanism. CNY sell-off quelled by PBoC intervention/clarification
Introduction of "counter-cyclical" factor for USD/CNY fixing.
Revocation of "counter-cyclical" factor .
Note: Values in black are historical whereas those in blue represent forecasts. * Point forecast is for end-period. Q2 2018 ranges are from Bloomberg and only indicative.
Asia Quarterly – Q3 2018
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India: Dampened Growth: Hype about India as the fastest growing Asian economy is not technically flawed but growth is arguably flattered and set to peak. Admittedly, Q1 growth resurgence to 7.7% from (de-monetization/pre-GST) sub-6% slump mid-2017 was not solely from base effects but also owed to solid manufacturing lift in Q1 amid re-monetization and renewed fiscal boost. And nascent credit growth pick-up was a tailwind too. But oil’s surge, higher inflation eroding discretionary consumption, political risks GE and stubborn bank capital deficits square with dampened growth (to 7.0-7.5%), not unabated resurgence, in FY18-19. So longer-term growth potential of 8-9% is deferred.
Industry: Slowdown in industrial activity, while not alarmingly sharp, is fairly broad-based; reflecting (at least in part) petering out of pent-up demand that surfaced on “re-monetization”. And that is consistent with the bigger global picture of demand recovery moderating from recent highs. While the most recent PMIs were rather upbeat, this may be overstated by price effects and inventory-order adjustments. Whereas the trend in key primary industries point to cyclical tailwinds tapering with activity dampened; as oil price “friction” and global demand slowdown come through.
Growth dynamics: The confluence of higher oil process and global trade headwinds (including a lower profile US-India trade tiff) may be external dampeners for growth momentum. But signs of commitment to an amicable solution suggest worst-case US-India trade outcomes from will likely be averted; rendering India as a relative hedge to spillover from escalating Sino-US trade spat. Nonetheless, home-grown headwinds to growth are set to temper economic activity. For one, rapid and significant surge in inflation undermine (discretionary) consumption, a key driver of growth. Also, despite loans pick-up, sustained credit expansion may be hampered by double whammy of banks’ capital deficit and high corporate debt.
Inflation : Sharp inflation surge above 5% is worrying on four counts. First, with the government raising minimum support prices (MSP) for food materially, low food inflation (relief) is in borrowed time. Second, even with benign food inflation, acute energy inflation set to work through may turn out to be “sticky” . Third, putting aside food and energy price volatility, core inflation resurgence to 6.5% (May) is far more worrying in terms of inflation expectations amid rapidly diminishing spare capacity. Finally, it is difficult to ascertain the interaction and durabili ty of inflation expectations in the context of re-monetization, GST and recent public sector wage hikes.
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16 India Growth Contribution : Post-Demonetization acceleration in Ivestments alongside consumption underpin solid growth momentu m; net exports drag.
(Contribution to Growth YoY %-pts)
Errors Net Exports Stocks & Valuables
Investments Govt Consumption
GDPSources: CEIC, Mizuho Bank
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07 08 09 10 11 12 13 14 15 16 17 18
India GDP : Moderation in Q2 industrial activity squares with GDP easing from tyhe resurgence in Q1; but not collapsing per se; 2018 t o settle 7.-7.5% depending on
how Oil, Global Trade & Politics pan out. (Quarterly, % y/y)
IP (LHS) GDP (RHS)
GDP set to ease back from an emphatic resurgence in Q2 as the initial drag from slower industraial activity start filtering through. H
India: Activity pick-up appears to have peaked in Q 1 2018, with industrial indicators now consistent with moderation in headli ne growth . (3m Avg % y/y)
Ind Pdtn Consumer Durables Capital Goods (RHS)Sources: CEIC, Mizuho Bank .
Activity pick-up peaked in Q1
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0
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15
20
25
(10)
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0
5
10
15
20
25
11 12 13 14 15 16 17 18
India's key primary industries, such as steel & electricity suggest easing
infrastructure as well as industrial activity. (3mma % YoY)
Infrastructure Industries Industrial Production Electricity Steel
48.625.7 22.9 25.8 20.6
5.2
299.0
449.8
-150.8
157.6
93.464.2
16.3
5.7
16.4
22.1
8.1
(10)
(5)
0
5
10
15
20
25
(200)
(150)
(100)
(50)
0
50
100
150
200
250
300
350
400
450
500
Goods Exports Goods Imports Net Goods Services Exports Service Imports Net Services
India's Trade Imbalance with the US is mainly in Goods; and clearly India promising to
import more from US (including military goods) should ease tensions.
US ($bn, LHS) Total (($bn, LHS) US Share of Total (%)
60
62
64
66
68
70
72
74
76
78
80
0
5
10
15
20
25
30
35
07 08 09 10 11 12 13 14 15 16 17 18
Credit growth pick-up comes on the back of, and is flattered by, re-monetization; reversing the
de-monetization slump; this may peak soon, hampeing growth.(3mma % y/y)
Non-food credit (LHS) Deposits (LHS) Loans-to-Deposits Ratio (%; RHS)
Sharp acceleration in core inflation (to 6.5%) upped urgency for back-to-back RBI
hikes; especially as price pressures broaden amid higher oil & MSP. (% y/y)
Food Fuel & Light
Clothing Housing
Misc CPI
RBI Policy (Repo) Rate CPI ex-Food, Fuel&Light
Sources: CEIC, Mizuho Bank
0
10
20
30
40
50
60
0
10
20
30
40
50
60Significant bump up in MSP (Minimum Support Prices) for crops suggest pipeline
pick-up in food inflation (% YoY)
Cereals Pulses Oil Seeds
2015-17 Avg
2018 Increase
Asia Quarterly – Q3 2018
- 11 -
Policy: After two successive hikes to 6.50%, RBI has officially adopted a “neutral” stance. But the unspoken bias appears hawkish. For one, food inflation, which has been conveniently low, is set to rise with higher MSP, coinciding with resurgent fuel inflation; potentially un-anchoring inflation expectations. What’s more, fiscal slippage risks amplified by acute exposure to oil vulnerabilities require the RBI to (unequivocally) re-focus on price stability. Finally, financial/currency risks from perceptions of compromised macro-stability objectives also require policy restraint . Arguably, 50bp of “pre-emptive” hikes have done most of the work; but another 25bp may be needed to polish off early-2019.
External Position: Along with oil prices, the trade deficit has swung wider – and consequently, the C/A deficit (which bottomed at 0.15 of GDP mid-2016) is set to approach 2.5% into Q2 and Q3. What’s more, the government’s increased levies on electronics (e.g. mobile devices) has done little to curb net imports of consumer electronics; which makes up 28-30% of trade deficit. Thus, India’s trade and C/A deficits are set to be structurally larger . Any enduring reprieve depends on industrial catch-up, which has been planned for (“Make in India”), but is still not within grasp – perhaps not in the 3 year horizon. Meanwhile, the silver lining is fairly solid capital inflows offer some offset.
FX: When we called for a cyclically bearish turn in the INR in Sep 2017, we had underestimated two things. First, is the real and present danger of “twin deficit” risks accentuated by elevated (albeit off high) oil prices compounded by fiscal pressures given pre-elections political posturing . Second, the extent and speed of inflation pick-up (on a confluence of factors, including oil). Admittedly, perceptions of India’s relative buffer from the US-China trade wars and oil coming off a boil have helped reinstate INR traction. But this does not negate lingering downside risks to INR. Thus, 69-70 breach is in view near-term before gradual INR pick up (sub-65 USD/INR) into 2019; watching election outcomes. Oil and the anti-CNY hedge factors continue to be in play for now.
Even with RBI's second rate hike (to 6.50%), real interest rates barely meets RBI's 1.5-
2.0% target; and "core" real rates are a tad negative. Strong growth & fiscal slippage
risks underpin front-loaded hike in June. (%)
RBI Policy (Repo) Rate
Real Interest Rate (RHS, %)
Real "Core" Interest Rate (RHS, %)
Sources: CEIC, Mizuho Bank
RBI hikes by 25bp to 6.25% in early-June and again by another 25bps early-Aug (back-to-back hikes) amid g rowing inflationary risks and signs of further cyclical st rength.
2
4
6
8
10
12
0
1
2
3
4
5
6
06 07 08 09 10 11 12 13 14 15 16 17 18
India: C/A Deficit upswing since 2017 accentuated by resurgent Oil - set to push
above 2% (of GDP); despite higher GDP growth dampening relative deficit (4Qma, % of GDP)
Despite easing off peaks, Oil prices remain buoyant . Underpins overall trade deficit, & in turn, this could push the C/A deficit higher into Q3. (3mma US$bn)
INR REER correction to moderate in line with FX res erve buffer. Further downside risks if Oil pressures increase and/or ri sk sentiment wobble; but
latent pressures not as sharp as in 2013 (not "frag ile five" risks).
INR REER (LHS; 2010=100)
Imports cover (months of imports FX Reserves cover, RHS, ratio)Sources: BIS, CEIC, Mizuho Bank
Note: Values in black are historical whereas those in blue represent forecasts. * Point forecast is for end-period. Q2 2018 ranges are from Bloomberg and only indicative.
Asia Quarterly – Q3 2018
- 12 -
South Korea: Consume or Crimp? Growth : Q1 growth sustained at close to 3% lifted by improved private consumption (retail sales increased robustly across both durable and non-durable goods. Government spending also picked up as the administration front-loaded budget to support its job creation initiative. Investment growth slowed due to ongoing adjustments in the construction sector as well as a correction in the capex after last year’s stellar growth. What’s critical is whether fiscal stimulus and wage increments helps Korea consume it way out of trade (war) headwinds or increased corporate pressures from wages and trade risks crimps jobs and growth.
Industry: Exports growth continued to moderate across the board, partly reflecting last year’s high base effect. While semiconductor exports have so far held up relatively well, some mild moderation going forward seems inevitable following last year’s stellar growth. Likewise, manufacturing production has contracted on the year-on-year basis for fifth consecutive month and adjustment in construction also become more emphatically. Lingering trade war concerns amid new tariffs from both the US and China will adversely affect Korea via its deeply integrated supply chains and large export exposure to China.
Growth dynamics: While a jump in minimum wage since Jan 2018 has buoyed wage growth, employment growth started to moderate across industries, especially in construction. As business community has expressed wariness over higher wage due to the additional financial burdens it will impose, the government has responded with slower pace of planned wage hike, revised legislation in calculation method of minimum wage and extra budget to subsidize regular hire. This suggests that side effects of wage hikes could be larger than (and possibly different to) expected. And if productivity does not keep up, this may impede Korea’s competitiveness in the longer term.
Inflation: Headline inflation has edged up slightly to 1.5% on the back of pick up in food prices. While retail petroleum prices continued to increase, the impact on inflation has been rather measured so far. Core inflation remains stuck in the low-1% reflecting limited demand-pull inflationary pressure. While inflation seems to have bottomed, it is probably premature to conclude that it will sustain a clear upward trend going forward given that some higher base effect are expected drag the headline number down in Q3.
Food Housing & utilitiseTransport EducationRestaurants & hotel OthersCPI Core CPI
Source: CEIC, Mizuho Bank
Asia Quarterly – Q3 2018
- 13 -
Policy: Pre-emptive (25bp) hike last Nov and mild inflationary pressure validate BoK’s room to wait and watch (as it has done this year). With improving consumption though, the BoK has flagged potential need for further policy adjustment; and the question is more around timing as interaction between financial stability and trade war risks are mulled. With the Fed set to tighten further, assessing capital outflow risks accentuated by widening rate gap is dynamic; especially if global financial conditions tighten. On balance, we expect BoK to tighten again late-2018; striking a balance between supporting a self-sustaining growth and safeguarding financial stability.
External Position: Overall BoP balance turned positive in Q1 due to net inflows of other investments. Current account surplus sustained with narrowing services account deficit more than offset slight moderation in goods account surplus. Tourist arrivals have rebounded robustly on the back of improved relationship with China which has helped to boost services exports. Furthermore, Korean Peninsula geopolitical risks have receded after Trump-Kim summit , and this is likely to support capital inflows. While portfolio outflows have been relatively contained despite the recent sell-off of EM assets, narrowing real interest rate gap with the US still warrants some attention.
FX: Given prospects of a US-China trade war and attendant RMB softening, it is no surprise that the KRW has faltered as markets price in spillover risks from China. Korea’s most important export destination is China, and a slowdown in Chinese growth or trade is likely to dampen exports of not just final goods, but also intermediate goods given Korea’s position as an upstream supplier. RMB depreciation could also push the KRW to become over-valued on a trade-weighted basis, which may discourage capital inflows. Notwithstanding continued moderate domestic growth, external uncertainty may keep USD/KRW supported above 1100, until trade tensions are resolved.
Policy Rate vs. Inflation, Real Interest Rate (%, 3mma)
Real interest rate Headline CPIPolicy rate Core CPI
Sources: CEIC, Mizuho Bank
-60%
-40%
-20%
0%
20%
40%
60%
80%
100%
120%
2012 2013 2014 2015 2016 2017 2018
Tourism sector (% YoY, 3mma)
Foreign visitors
Tourism revenue
Source: CEIC, Mizuho Bank
700
800
900
1000
1100
1200
1300
1400
1500
94 96 98 00 02 04 06 08 10 12 14 16 18
USD/KRW: Long-term Model Value
USD/KRW USD/KRW Fair Value +/- 1 std deviationSources: BIS, Reuters, Mizuho Asia & Oceania Treasury
Note: Values in black are historical whereas those in blue represent forecasts. * Point forecast is for end-period. Q2 2018 ranges are from Bloomberg and only indicative.
Asia Quarterly – Q3 2018
- 14 -
Singapore: Peaking, Not Plunging
Growth: Barring adverse and abrupt (negative) global shocks, Singapore’s growth is set to be buoyed ~ 3.6-4.0% for 2018 – as strong as or stronger than 3.6% in 2017. But this is not to be mistaken for an absence of risks. On the contrary, downside risks and uncertainty are accentuated; as Fed persists with tightening and US-China trade risks mount. Admittedly, waning exports boost, and moderation in manufacturing square with growth easing from ~4.0% in H1 to ~3.4-3.6% in H2, with further slowdown to 3.2-3.5% in 2019. But, this gradual, wane in exports tailwinds, service sector recovery tempered, not traumatized, by property curbs and abating construction drag sufficiently buffer for above-trend, despite peaking, growth.
Industry: Out-sized manufacturing strength led by the electronics sector will be hard to replicate into the latter half of 2018 and into 2019 for two reasons. First, the low-hanging fruits of inventory building into a sharp up-cycle in electronics have been mostly exhausted, and growth bonus is petering out. What’s more, US-China trade tensions ratcheting higher have dampened exports and manufacturing more broadly; and may persist in moderating industrial activity lower in the second half of 2018. And to be sure, recent pick-up in transport engineering is consistent with bottoming and convergence with peaking (electronics-led) manufacturing out-performance in 2017.
Growth dynamics: The good news is that even as manufacturing peaks, growth drivers are now appreciably more even (though far from uniform); with key services sector gathering welcome momentum. But with recent property cooling measures put in place to quell the rapid resurgence in prices, we expect that both transactions and prices could be set to peak; arguably more distinctly in prices. And this will inevitably have a wider spill-over to property-related services – an impediment to further (and unfettered) acceleration in in services. The upshot is that both domestic and external drivers to growth are peaking, not plunging; barring severe risks from trade, that is.
Inflation : In contrast, inflation is far from peaking . Point being, inflationary pressures remain mild, with lingering dis-inflationary forces from housing and transport – mainly car ownership certificate prices –the main sources of drag. Nonetheless, sequential price pressures are not declining . And along the current trajectory, headline CPI is rise to 1.5-2.0% into early-2019. Crucially, signs of brisk pick-up property prices, despite recent cooling measures, suggest that housing dis-inflation could fade sooner than anticipated. In any case, core already above 1.5% is on course for a gradual pick-up towards 2% in 2019. Upshot: While not instantaneous, inflation is on a gradual and sustained rise. .
Singapore GDP: If Mfg contribution to growth "norma lizes" to 0.5-1.0% and Services is buoyed 2.3-3.0% over the next 4-6 quart erws; underlying growth
momentum settle between 2.8-3.8%; as construction d rag eases . (%-pts; YoY Growth)
Others Construction Services Mfg GDP
3.8
8.6
3.4
-4.4
4.3
9.7
4
-5.2
3.6
10.1
2.8
-8.4
2.8 2.9 2.6
-0.2
5.3
2.63.9
2.0
5.34.2 4.7
8.0
(10)
(5)
0
5
10
15
GDP Mfg Services Construction
Singapore: Q2 GDP flash at buoyant 3.8% (despite decelerating from 4.3% in Q1) as Services pick-up remains resilient & manufacturing peaks more gradually than
anticipated . H1 growth rate of 4.0-4.1% more rapid than 3.6% i n 2017. (% YoY)
been hijacked by the sharp resurgence in the last four quarters wiping out ~70% of the
correction. (Cumulative % Chg from Q3 2019)
Landed Non-Landed All Private Property
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6
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10
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11 12 13 14 15 16 17 18
Growth Drivers: Peaking External Demand alongside C overging (but perhaps not sustainably surging) Domestic Demand point to p eaking growth out-run.
GDP % y/y
Domestic Demand* (% y/y; 4Qma)
External Demand* (% y/y; 4Qma)* Domestic demand comprises private consumption, government spending, residential construction and business investments.
Extrapolated
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10 11 12 13 14 15 16 17 18
Headline CPI is understated but "core" and service s inflation validate policy response;, pace of inflation restoration allows for calibrated slope restoration.
CPI CPI ex-OOA* CPI ex-accom CPI Services ex-accommodation MAS Core
* CPI ex-OOA: CPI ex owner-occupied accommodation imputed rental.
Underlying inflation remains on a recovery path und erpinned by solid core inflation pick-up; even if pick-up is gradual. (CPI contribution; %-pts; YoY)
* Core inflation, for Singapore, excludes accommodation and private road transportation. The latter mainly reflects COE dis-inflation effects.
Asia Quarterly – Q3 2018
- 15 -
Policy: This means two things. First, sustained growth and underlying inflation pick-up both validate calibrated tightening in April – engineered by restoring a “slight” slope for the S$NEER. Second, and crucially, it means that follow-up and gradual tightening is also in order. To be sure, this will probably not be anything dramatic or novel. Given a very calibrated and phased-in approach, it does not make sense to invoke a shift of the S$NEER mid-point higher – a policy response typically best-suited for abrupt step-up in overheating risks and/or price pressures entailing significant and enduring wage-price spiral risks. Instead, “more of the same”” in terms of further “slight” S$NEER slope steepening; but cumulatively still well short of 2% per annum appreciation gradient.
External: The marginal slippage in net trade, spilling over into C/A , while sustained since 2017, is neither a big worry nor inconsistent with longer-term trade surplus since 2010. Fact is, at over 18% of GDP, the C/A surplus is comfortably, if not obscenely large. Instead, the real risks posed are not derived from the external position per se, but the risk revealed in them. For one, softer financial account could at least partly flag up risks of adverse global financial triggers set off, and working their way through at a time of rising interest rates and tighter liquidity. Above all, trade war risks are yet to be captured in either the net goods trade of the dis-aggregated exports and imports. But external boost is peaking.
FX: SGD moves, we reiterate, are predominantly driven by broader USD trends – given relatively small effects of intra-S$NEER band moves. What’s more, a very calibrated S$NEER slope steepening means that additional SGD appreciation from steepening the slope further will be phased-in (gradual appreciation bias, not one-off appreciation). What’s more, the relative positioning of the S$NEER at the stronger side of the policy bands (as per our estimation) further accentuates the limitations of near-term S$NEER out-performance (which in turn, means that strong USD/SGD pullback must rely on USD moves rather than standout SGD strength). In particular global trade risks dragging CNY could lift USD/SGD to test 1.38 near-term before EUR revival in 2019 restores 1.32-1.34 ranges.
Q2 2018 Q3 2018 Q4 2018 Q1 2019 Q2 2019 Q3 2019
GDP (% y/y) 3.8% 3.3% 3.4% 3.2% 3.4% 3.3%
CPI (% y/y) 0.3% 0.8% 1.1% 1.6% 2.0% 2.2%
FX Policy Reinstate slight
slope Status Quo “Slightly” steepened S$NEER slope Status Quo
Restoring "modest and gradual appreciation"with a m easured "slightly" increased slope; S$NEER has been buoyed in the upper half of the pol icy band.
NEER
Mid-Point
Sources: MAS, Bloomberg, CEIC , Mizuho Bank
+/- 2% from S$NEER mid-pt
Stronger trade -weighted SGD
Apr '16: Surprise revocation of appreciation bias (to 0% slope) prompts knee-jerk, but short-lived S$NEER slip.
Oct '16: MAS invokes "neutral ... for extended period" dovish caveat.
Apr '17: MAS surprises (us) by retaining "neutral for extended period" dovish caveat.
Apr '18: MAS restores "slight" S$NEER slope.
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100
200
300
400
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8
05 06 07 08 09 10 11 12 13 14 15 16 17 18
S$NEER pick-up is front-running sustained (albeit g radual) inflation pick-up ; constitutes further defacto tightening after "slight" slope reinstatement.
Note: S$NEER tends to trade at the stronger side of the policy mid-point (+ve deviation) corresponding to inflation unless there are negative shocks to growth. So as inflation edges up, S$NEER is set to follow.
S$NEER above the policy mid-point
S$NEER above the policy mid-point
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15
20
25
30
35
40
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30
35
40
07 08 09 10 11 12 13 14 15 16 17 18
Despite net trade slippage, trade surplus is except ionally high; instead trade war risks are the real threat . Meanwhile financial
account slippage may reflect global risks. (% of GDP, 4Qma)
USD strength amid trade wars have shifted S$NEER ba nds. Specifically, lifting USD/SGD range corresponding to S$NEER policy bands; with mid-poin t ~1.38
Post-MAS SGD drop mostly driven by USD index rise ; and to a small extent by S$NEER slip though still at the upper half of bands
SGD (LHS, % Chg vs. USD since end-2016)
S$NEER (LHS, % Chg since end-2016)
Dollar Index (RHS, Inverted; % Chg since end-2016)
MAS Meeting (Apr '18)
Note: Values in black are historical whereas those in blue represent forecasts. * Point forecast is for end-period. Q2 2018 ranges are from Bloomberg and only indicative.
Asia Quarterly – Q3 2018
- 16 -
Malaysia: Solid Consumption to Support Growth : Despite moderating growth remains solid (at 5.4% in Q1), with consumption and oil likely to backstop convincingly; barring global trade fallout. Admittedly, softer output of commodities such as rubber and palm oil has pulled back overall growth slightly. And public consumption was largely muted by the new government reining in expenditure aid wider public finance stock-take (despite double-digit revenue growth due to oil and gas revenues). But net exports contributed significantly on moderation in capital goods imports while oil and manufacturing were positive. Crucially, going forward, private consumption is expected to be supported by fuel subsidies and zero-rated GST.
Industry: Growth of industrial production has moderated following last year’s robust performance. Trade surplus was largely unchanged due to simultaneous slowdown in both exports and imports. Electronics and electrical exports still managed to grow, albeit at a moderated pace while exports of other goods contracted on a year-on-year basis. Given imports of intermediate goods continued to trend lower, the mild downward trend in manufacturing growth could continue. Furthermore, agricultural production also continued to slow on the back of lackluster palm oil and rubber prices.
Growth dynamics: While a newly-elected government initially unsettled investors with fiscal uncertainty, solid economic plans and leadership mitigate some fiscal misgivings. Admittedly zero-rating GST and raising fuel subsidies raises justifiable concerns about erosion of a solid revenue base and “sticky” subsidy burden. We are not fans of the latter but SST offset mitigates the former while oil offers interim relief. Crucially, longer-term debt management and expenditure control are positive. Especially if complemented by growth impetus led by the “Council of Elders”. Political transitions in the next 3-5 years though remain a wild card. Inflation: Headline inflation slowed further to sub-1.5% dragged down by muted transport price increases. Retail fuel prices have been kept unchanged since Mar 2018 while crude oil prices increased around 10% during the same period suggest that the government might already started subsidizing retail fuel implicitly. Given the government’s plan to freeze RON95 and diesel prices with RM3bn allocated for fuel subsidies for the rest of the year, this is likely to cap some upside risk to inflation .
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12
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12
2012 2013 2014 2015 2016 2017 2018
GDP Contribution (%-points; YoY)
Net Trade InvestmentsStock Govt SpendingConsumption GDP
Sources: CEIC, Mizuho Bank
-2%
0%
2%
4%
6%
8%
10%
12%
14%
16%
2014 2015 2016 2017 2018
Industrial production (YoY, 3mma)
Export-oriented Industries
Domestic-oriented Industries
Sources: CEIC, Mizuho Bank .
0
5
10
15
20
25
Revenue loss Compensatingsources (conservative
case)
Compensatingsources
Alternative sources to make up the foregone GST revenue (RM bln)
Petroleum-related revenueSales and services taxGST
Source: CEIC, Mizuho Bank
(2)
(1)
0
1
2
3
4
5
6
2012 2013 2014 2015 2016 2017 2018
CPI Contribution (YoY, % -pts)
Food Housing & utilitiesTransport OthersCPI
Sources: CEIC, Mizuho Bank.
Asia Quarterly – Q3 2018
- 17 -
Policy: After lifting its policy rate by 25bps in Jan 2018 in a pre-emptive move, we expect BNM to hold policy rate unchanged for the rest of the year. Inflation continues to slow and continuous moderation in core inflation suggests that inflationary pressure remains limited. Capital outflows have been contained despite recent rout in EM assets thanks to higher real interest rates and strong growth prospect. Since the fuel subsidies are expected to cap upside risk to inflation, this gives BNM plenty of room to wait and assess the situation given some concerns surrounding the sustainability of future fiscal policy on top of the government calling off some infrastructure projects.
External Position: Current account surplus continued to increase for the fourth consecutive quarter on the back of higher goods account surplus. Overall BoP position also improved due to steady portfolio investments on top of relatively persistent FDI inflows. Elevated oil prices and decent real interest rate are likely to support portfolio investment. Nonetheless, equities outflows have intensified post-election given some lingering uncertainty surrounding the fiscal policy. Bond outflows could be under pressure again on the back of heightened global volatility and trade tension given Malaysia’s increasing export exposure to China.
FX: Equity and bond outflows have picked up since May, with investors’ sentiment negatively impacted by the surprise electoral victory for PH, on top of a global retreat from EM assets. That said, USD/MYR volatility has been smoothed by BNM, which reported a $4.2bn fall in FX reserves for May. For now, positive oil prices could buffer the MYR, but concerns over a potential credit rating downgrade and ongoing trade tensions are likely to keep MYR sentiment subdued. Furthermore, the Malaysian economy is highly exposed to trade, and risks of a global trade contraction will linger in the short term. We see USD/MYR possibly testing 4.12 for Q3, with scope for a retracement lower if trade risks dissipate.
Real interest rate (RHS)CPI, 3mmaCPI excl. transport, 3mmaPolicy rate
Sources: CEIC, Mizuho Bank.
-15%
-10%
-5%
0%
5%
10%
15%
2012 2013 2014 2015 2016 2017 2018
BoP (% of GDP, 4Qma)
Errors OthersPortfolio Investment FDIC/A BoP
Source: CEIC, Mizuho Bank
2.40
2.60
2.80
3.00
3.203.40
3.60
3.80
4.00
4.20
4.40
4.60
94 96 98 00 02 04 06 08 10 12 14 16
USD/MYR: Long-term Model Value
USD/MYR USD/MYR Fair Value +/- 1 std deviation
Sources: BIS, Reuters, Mizuho Asia & Oceania Treasury
Note: Values in black are historical whereas those in blue represent forecasts. * Point forecast is for end-period. Q2 2018 ranges are from Bloomberg and only indicative.
Asia Quarterly – Q3 2018
- 18 -
Indonesia: Robust Investment Sustains Growth : Q1 growth steadied at around 5.1% led by robust investment and solid private consumption. Investment growth continued to accelerate lifted by both capex and construction investment as government looks to push infrastructure spending. There are also nascent signs that household consumption has started to pick up and this is expected to be further lifted by disbursement of 13th-month and holiday bonus to civil servants during Q2. Growth of government spending has moderated and is expected to stay modest as the government looks to contain fiscal deficit on top of swelling energy subsidies.
Industry: Strong imports, led by raw materials for industries, continued to suppress trade balance as exports growth moderated partly due to price effect. Nevertheless, solid growth in real exports, steady industrial production on top of robust sentiment, with the manufacturing PMI hitting the highest in almost two years suggest that positive momentum is likely to sustain in near term. With high frequency indicators continuing to reflect robust outlook for investment led by construction and primary industries, strong investment is likely to fuel growth amid continuation of government infrastructure programs.
Growth dynamics: Investment growth continues to accelerate on the back of robust construction activities and capex. Strong imports of capital goods and industrial raw materials square with robust pipeline investment. While government revenue collection has been improving given higher oil prices and enhanced tax administration, higher fuel subsidies has limited the resource for infrastructure projects. To alleviate the problem, the government has recently established an infrastructure investment fund to encourage participation of private sectors. But political uncertainties ahead of elections next year could interrupt investment plans.
Inflation: Despite a mild rebound in food prices, headline inflation remains comfortably within the target range thanks to price controls on administered goods. While price freezes of subsidized fuel capped upside risk of inflation , it has exerted significant pressure on fiscal account as fuel subsidies YTD increased more than five-folds from the same period last year. Going forward, inflationary pressure is expected to be contained given incentives ahead of upcoming election, as the government has determined to keep retail fuel price at their current level through 2019.
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0
2
4
6
8
2013 2014 2015 2016 2017 2018
Contribution to GDP growth (%, ppts)Hhd consumption GFCFGovt consumption Change in stockNet exports Statistical discrepancyGDP
Source: CEIC, Mizuho Bank
46
47
48
49
50
51
52
53
54
0%
1%
2%
3%
4%
5%
6%
7%
8%
9%
Jul 14 Jan 15 Jul 15 Jan 16 Jul 16 Jan 17 Jul 17 Jan 18
Industrial production
IPI, YoY 3mma
Nikkei PMI (RHS)
Source: CEIC, Mizuho Bank
-40%
-30%
-20%
-10%
0%
10%
20%
30%
40%
50%
60%
0%
2%
4%
6%
8%
10%
12%
2011 2012 2013 2014 2015 2016 2017 2018
Investment-related Indicators (YoY, %)
InvestmentsCapital goods importsTruck sales (RHS)
Source: CEIC, Mizuho Bank
-1
1
3
5
7
9
2015 2015 2016 2016 2017 2017 2018
Contribution to CPI (-ppt, % YoY)
Food Processed foodElectricity, gas and fuel ClothingHealth Education, recreationTransport CPI, YoY
Source: CEIC, Mizuho Bank
Asia Quarterly – Q3 2018
- 19 -
Policy: BI has raised its policy rate by a cumulative 100bps in two months including a larger-than-expected 50bps hike in Jun meeting as a reiteration that it will act pre-emptively and to stay ahead of the curve. Despite inflation continues to moderate with utilities and transport prices under control, BI’s clear shift to prioritize exchange rate stability means that more rate hikes could be on the table should IDR comes under pressure again amid escalating trade war risks and downbeat EM sentiment. Given that C/A deficit is likely to widen again amid falling goods account surplus, rate hikes may be needed to reassure international investors, given heavy foreign positioning.
External Position: C/A deficit continued its widening trend to around 2% of GDP on the back of deteriorating goods account balance. Overall BoP also dropped due to a dip in portfolio investment inflows as a result of heighted global financial volatility and a recent rout in EM assets. On the other hand, FDI inflows have been relatively unscathed as government rolls out more fiscal incentives such as tax holidays for new investments. As imports of capital goods and raw materials are likely to stay elevated, C/A deficit is expected to sustain at above 2% of GDP.
FX: IDR has been pressured by portfolio outflows amidst increased EM risk aversion, with Indonesia seeing a cumulative bond outflow of $2.0bn in Q2. To its credit, BI has been proactive in keeping IDR depreciation pressures in check. It has intervened actively to slow USD/IDR ascendency, on top of raising its policy rate by a cumulative 100bps since May. While the trade deficit has become a source of concerns due to infrastructure related imports, we think higher real yields on offer could anchor the IDR once the broader USD/AXJ complex stabilizes.
Real rates (RHS)Old policy rateNew policy rateHeadline CPI, 3mma Source: CEIC, Mizuho Bank
(10)
(5)
0
5
10
15
2011 2012 2013 2014 2015 2016 2017 2018
Balance of Payments (4QMA; USD bn)
C/A FDIPortfolio flows Other invesmentsOverall BoP
Source: CEIC, Mizuho Bank
2000
4000
6000
8000
10000
12000
14000
16000
94 96 98 00 02 04 06 08 10 12 14 16 18
USD/IDR: Long-term Model Value
USD/IDR USD/IDR Fair Value +/- 1 std deviationSources: BIS, Reuters, Mizuho Asia & Oceania Treasury
Note: Values in black are historical whereas those in blue represent forecasts. * Point forecast is for end-period. Q2 2018 ranges are from Bloomberg and only indicative. **As from Aug 2016, BI implemented a new policy framework with the 7-day repurchase rate at the new benchmark rate. .
Asia Quarterly – Q3 2018
- 20 -
Thailand: Growth Gaining Traction Growth : GDP surged to 4.8% y/y; the fastest in more than five years boosted by robust manufacturing activities and tourism-related services. Strong performance in export-oriented sectors continued to lift manufacturing activities and related capex. Private consumption also firmed up amid gradual pick up in durable goods sales. Agricultural production also turned around from Q4’s contraction led by high level of output amid favourable weather conditions. Pipeline disbursement of extra budget for 2H on top of more infrastructure investment ahead of 2019 elections, should buoy growth ahead – barring global trade wars.
Industry: Manufacturing growth continued to hum along steadily amid pick up in refined petroleum production, on the back of higher oil prices, and continuous improvement in motor vehicle production. Growth of electronics production and exports continued to moderate partly reflecting high base effect. Capacity utilization continues to improve for most of the product categories. Recent mild depreciation in THB is likely to further support exports so long as trade war risks don’t overtake. Given recent tick up in manufacturing PMI to the highest level in more than two years, positive momentum is expected to sustain led by government’s infrastructure push and improved budget disbursement.
Growth dynamics: Whilst the government looks to propel growth with expansionary fiscal policies, the new procurement law has somewhat dampened public spending with lower budget disbursement from local administrations. With election expecting to take place in 1H of next year, the government continues to ramp up spending on social protection in a bid to help people from lower income groups. Expenditure is expected to pick up further in the last quarter of the FY due to disbursement from the additional budget by Sept 2018.
Inflation: Headline inflation rebounded from low-1% partly due to low base effect from last year as well as pick up in retail fuel prices. Despite this moderate uptick, core inflation remains subdued at sub-1% as inflation expectation is also little changed suggesting inflationary pressure in near term remains minimal. Given the government’s intention to cap diesel price at 30 baht per litre (current: 29 baht), this is expected to contain some inflationary pressure from higher energy costs and probably keep inflation below the midpoint of the target range.
(10)
(5)
0
5
10
15
20
(10)
(5)
0
5
10
15
20
2012 2013 2014 2015 2016 2017 2018
GDP Expenditure Contribution (YoY; %-points)
Pte Consumption Govt SpendingInvestments StocksNet Exports GDP % y/y (RHS)
Public services SocialEducation HealthEcon affairs Expenditure (RHS)
Sources: CEIC, Mizuho Bank
-2.0%
-1.0%
0.0%
1.0%
2.0%
3.0%
4.0%
-2.0
-1.0
0.0
1.0
2.0
3.0
4.0
2014 2015 2016 2017 2018
Contribution to inflation (YoY, %-ppts)
Food HousingHealthcare Transport & commsOthers Inflation (RH-scale)Core inflation
Sources: CEIC, Mizuho Bank
Asia Quarterly – Q3 2018
- 21 -
Policy: BoT bucks the trend by keeping interest rates on hold even as some regional central banks have embarked on a tightening path. We think BoT is likely to stay put for an extended period given that inflation is expected to stay below the mid-point of BoT’s target range of 1%-4%. Furthermore, subdued core inflation suggests that the spillover from stronger growth momentum on labour market and wage has not been sufficiently strong to unleash demand-pull inflationary pressures. That said, despite largely contained risks of from capital outflows (so far), BoT is expected to assess financial stability including potential build-up of vulnerabilities in the household debt segment.
External Position: Current account surplus narrowed on a trend basis marginally but remains sizeable at around 13% of GDP. While goods account surplus is expected to moderate gradually due to higher imports of fuel and intermediate goods, bumper tourism exports are likely to partially offset the negative impact on C/A balance and keep the surplus comfortably large. Despite recent bout of financial volatility and increased pressure on EM assets, portfolio outflows have been largely contained thanks to the large C/A surplus and record high FX reserves.
FX: Rising trade tensions between the US and China have led to a paring of long positions in Asian currencies, with THB also suffering a loss of 6.5% for Q2. Net FX reserves have fallen by about $10bn since peaking in March, with THB weakness turning more acute after Trump confirmed import tariffs on Chinese goods in mid-June. Given Thailand’s high exposure to external demand, THB may underperform as long as trade tensions persist. Nevertheless, Thailand’s persistent current account surplus and ample reserves should cushion against excessive losses. USD/THB may bump higher to 33.5 in Q3, but we see scope for easing if there is relief on the trade front.
Sources: BIS, Reuters, Mizuho Asia & Oceania Treasury
Note: Values in black are historical whereas those in blue represent forecasts. * Point forecast is for end-period. Q2 2018 ranges are from Bloomberg and only indicative.
Asia Quarterly – Q3 2018
- 22 -
Philippines: Growth Momentum Stays Robust Growth : Growth accelerated in Q1 led by solid consumption and investment on top of a pickup in government expenditure. Whilst elevated inflation might have dampened purchases of food staples, steady consumption of durable goods suggests that consumer confidence remains largely intact. Furthermore, remittances may recover given the removal of a deployment ban to Kuwait in May and higher remittances from Asian countries. Government expenditure surged 27% y/y, lifted by a 42% increase in capital outlays. The continuous rollout of infrastructure projects has supported related investment in transport equipment and construction.
Industry: Growth of industrial production surged to a multi-year high led by both solid domestic demand and favourable external environment. Strong growth in food manufacturing suggests that demand for consumer staples remains steady while electrical machinery production continues to expand. With capacity utilization edging up to new highs, inflationary pressure could become more entrenched. Growth of capital goods imports has rebounded in tandem with a bounce in infrastructure spending. As exports growth continued to moderate, trade deficit is expected to sustain at its current level or widen slightly.
Growth dynamics: Growth of capital spending has picked up again on the back of robust infrastructure activities. Despite bumper government revenue lifted by higher internal tax collection, budget deficit has sustained at a relatively wide level due to a corresponding increase in expenditure. With plans to lift the budget deficit ceiling to 3.2% of GDP next year, the building boom is expected to continue fueling growth momentum. The aggressive infrastructure program also highlights the importance to continue its tax reform initiatives, which are expected to shore up government coffers.
Inflation: Headline inflation continued to edge up to 4.6% led by higher transport prices. While inflation momentum seems to be moderating slightly, it remains elevated and is subject to more upside risks from potential adjustments in electricity rates and wages. With core inflation moving in tandem, underlying inflationary pressures are clearly present. The government’s renewed efforts to contain food prices via suggested retail prices and higher imports of food staples may help to mitigate rising prices to some extent.
Policy: BSP has hiked its policy rate in two consecutive meetings by 50bp cumulatively in a bid to rein in inflationary pressure. Despite BSP lowering its inflation forecasts marginally, there are still upside risks to inflation, ranging from potential wage increase to the implementation of additional excise tax hikes in 2H. Furthermore, PHP could stay on the back foot after two hikes given negative real rates. With oil prices sustaining at a relatively high level, imported inflation may rise further. Therefore, we think BSP is still likely to follow with more tightening in order to keep inflation anchored.
External Position: Current account deficit narrowed slightly in Q1 as stronger services exports, led by tourism receipts and business activities, have helped to mitigate the widened goods account deficit. Nevertheless, given the large magnitude of goods account deficit on top of rising capital and intermediate goods imports, C/A deficit is expected to remain under pressure. Despite falls in approved FDI, actual net inflows of direct investment have sustained alongside mild improvement in portfolio investments inflows. Despite a cumulative of 50bp rate hikes, real rates remain in the negative territory. Given “twin deficit” concerns, portfolio outflow concerns may linger.
FX: Overheating risks have come to the fore as inflation overshoots the BSP’s target band amidst strong second-round effects from tax reforms. With BSP stirred into action and hiking rates twice in Q2, we see scope for USD/PHP to stabilize if the BSP moves further on rate hikes, but RRR cuts could fan perceptions of easing and trigger a test of 54.5. That said, PHP had been less adversely affected by the recent wave of EM outflows for two reasons: sentiment was already fairly negative, while foreign investor positioning is also small. Medium-term risks for the PHP stems from a possible growth slowdown, in order to re-anchor inflation expectations to a lower level. This could hobble any PHP gains for 2019, with USD/PHP likely to remain supported above 51.
USD/PHP USD/PHP Fair Value +/- 1 std deviationSources: BIS, Reuters, Mizuho Asia & Oceania Treasury
Note: Values in black are historical whereas those in blue represent forecasts. * Point forecast is for end-period. Q2 2018 ranges are from Bloomberg and only indicative.
Asia Quarterly – Q3 2018
- 24 -
Vietnam: Cuts Both Ways Growth: Trade-fuelled growth resurgence in Vietnam has come through resoundingly, as we anticipated; with smart pick-up in exports-led growth in 2017. And while 7.3% growth kick-off in Q1 2018 may be flattered by a low base, it does not detract from underlying momentum from industrial boost – benefitting from cyclical and coordinated global exports recovery. Manufacturing pick-up, in turn underpins investments, while subdued inflation helps buoy consumption; bolstering growth. But, binary risks around growth are intensifying as a protectionist US puts the key exports engine at the risk of sputtering abruptly . Industry: Electronics and mobile devices, from being a source of stellar growth in manufacturing and exports has now turned becoming a culprit for exports slowdown – revealing how such industrial champions can cut both ways. To be sure, the slowdown partly reflects trade war risks, but is equally compounded by the cyclical peaking in electronics demand. The “concentration” is not just about sector risks – electronics – but also pertains to firm-specific exposure. Specifically, Samsung being a disproportionately large driver of electronics/mobile device manufacturing and exports means that the volatility in the industry could continue to be high and firm-related/reliant.
Growth dynamics: To be clear, despite inevitable near-term electronics/mobile device volatility, electronics as an enlarged part of the manufacturing landscape is a positive development – just one that needs further deepening and broadening. We expect that longer term boost to inward investments into Vietnam remains a compelling proposition; as the natural “flow down” of industries from China is hastened by trade war risks. But in the near-term, trade tensions and lack of visibility over spill-over effects could paralyze investments, adversely impacting Vietnam. Especially as tighter USD funding may compromise credit and hence growth.
Inflation : By Despite accelerating above 4.5% in June and July (Jan-Apr average: 2.8%), inflation is reasonably well-contained. For one, recent pick-up is mostly driven by food – accounting for a 0.9%-pt bump-up in headline inflation – whereas broader non-food inflationary impulse remains fairly benign. What’s more, inter-Ministry coordination to manage food, transport, education and healthcare costs should also rein in inflation; helping to anchor; quelling any acceleration in inflation towards 5%. In fact, we expect that inflation will ease back to sub-4% into late-2018; but meanwhile risks to VND stability may be accentuated.
6.1
2.5
9.6
8.4
6.56.8
2.9
14.4
8.7
7.47.1
3.9
13.0
7.9
6.9
0
2
4
6
8
10
12
14
16
GDP Farm Mfg Construction Services
Vietnam GDP: While GDP momentum appears better in H 1 2018, manufacturing deceleration & peaking services reflect
underlying demand slowdown/trade risks (% YoY)
2013-2017 (Avg)
2017
H1 2018 YTD
(4)
(2)
0
2
4
6
8
10
12
14
16
18
20
(4)
(2)
0
2
4
6
8
10
12
14
16
18
20
06 07 08 09 10 11 12 13 14 15 16 17 18
Net Trade (US$ bn): Exports resurgence in 2017, with some $2.1bn surplu s was positive. But despite trade surplus surge, 2018YTD exports dip le d by electronics is worrying .
Tight Foreign Currency (USD) Supply not adequately abated by FX reserve pick-up; latent presssures may remain.
Ratio of FC to LC Deposits (%; LHS)
Proxy* of overall FC liquidty to LC liquidity (%; RHS)
* Adjusted for money multiplier effects, calculated using applicable reserve requirements.
(5)
0
5
10
15
20
(5)
0
5
10
15
20
12 13 14 15 16 17 18
While hospital fee hike impact is fading , inflation has picked up led by food and fuel ; concerted government efforts should subdue price
pressures to around 5% before easing; VND risks watched !(Inflation Contribution; %-pts)
Food Housing
Transport Others
Healthcare CPI (% y/y)
Non-food CPI (% y/y)
Sources: CEIC, Mizuho Bank
Asia Quarterly – Q3 2018
- 25 -
Policy: The “late-cycle” rate cut in mid-2017 revealed the SBV’s slight bias for accommodative calibration as inflation bump-up (to 4.5-5.0%) from healthcare costs subsided back below 3%. And in 2018, defacto tightening from stronger VND with supply-side cost containment may have been deemed adequate to defer policy (rate) hikes; and spur further recovery in credit and alleviate tighter liquidity. But the recent step-up in FX market volatility denting VND accentuates policy dilemma for the SBV. Consequently, the SBV may be forced to hike policy rate if VND stability is deemed compromised. Base case for SBV rate hold, but a 1-in-3 chance of a 50bp hike in Q4 or Q1 2019 is notable.
External Position: Continued improvement in the net trade position is likely to feed in as C/A buoyancy; as the (lagged) data releases catch up. With 2017 trade turning a surplus of $2.8bn and so long as global trade recovery is not hijacked by trade protectionism, the net exports surplus trend in Q1 could extend. But despite robust exports growth and corresponding merchandise trade surplus driving anticipated C/A boost, FX reserves build-up continues to me modest and very gradual, with imports cover of ~2.5X still well below the ASEAN/Asia benchmark of 6-8X; and this may be a glaring bug bear if risk sentiments turn south sharply
FX: The depth of recent VND slippage has intensified in recent weeks on three counts. First, the sharp tumble in CNY is beginning to drag VND, which is guided by a double-edged trade basket (heavy on CNY) that cuts both ways. Second, the tight USD liquidity situation and decline in exports are beginning to pressure VND despite strong FX reserve accumulation earlier this year. Finally, inflation heading higher also adds to VND pressures insofar that the late-cycle rate cut in (May) 2017 may be unsettle VND. In all likelihood, VND pressures could build with a test above 23,500 on the cards before sub-23,000 on CNY recovery layer in 2019.
USD Liquidity Squeeze is intensifying pressures on VND; but trade-weighted VND (NEER)
remains fairly supported. But if VND NEER declines continue, SBV may run out of options.
VND CNY VND NEER CNY NEER
(10)
(8)
(6)
(4)
(2)
0
2
4
6
(10)
(8)
(6)
(4)
(2)
0
2
4
6
06 07 08 09 10 11 12 13 14 15 16 17 18
Net Exports slowing at the Margin Point to C/A Diminishing down the line ;and correspondingly, diminished VND buffer . ($bn; Qtrly)
C/A (LHS) Net Exports (3m Rolling RHS)
Sources: CEIC, Mizuho Bank.
(3000)
(2000)
(1000)
0
1000
2000
3000
05 06 07 08 09 10 11 12 13 14 15 16 17 18(3000)
(2000)
(1000)
0
1000
2000
3000
Imports cover pick up to ~3.0X is welcome, but stil l below EM Asia norms. And FX Reserves while booosted by net exports earlier, may be subdued by
softening net trade position . (US$ mn, 3mma)
FX Reserves Chg Trade BalSources: CEIC, Mizuho Bank
20,500
21,000
21,500
22,000
22,500
23,000
23,500
20,500
21,000
21,500
22,000
22,500
23,000
23,500
Jan 13 Jul 13 Jan 14 Jul 14 Jan 15 Jul 15 Jan 16 Jul 16 Jan 17 Jul 17 Jan 18 Jul 18
VND slide (vs. USD) in recent weeks reveals the pre ssures from tight USD liquidity & reserves required to maintain stable (t rade-weighted) VND;
devaluation fears may arise if VND falls more sharp ly.
VND (Monthly Avg)
SBV Reference Rate
Sources: CEIC, Reuters Mizuho Bank
Weaker VND
Three episodes of 1% devluation each in 2015:1) Jan (7th) from 21,246 to 21,458; 2) May (7th) to 21,673; 3) Aug (19) to 21,890
Annual devaluation of 1% each in Jun 2013 and Jun 2014.
12 Aug 2015: USD/VND trading bands doubled to +/-2% from +/-1%19 Aug 2015: USD/VND trading bands widened (again!) to +/-3%. And VND mid-point devlaued 1% to 21,890.
Note: Values in black are historical whereas those in blue represent forecasts. * Point forecast is for end-period. Q2 2018 ranges are from Bloomberg and only indicative.
Asia Quarterly – Q3 2018
- 26 -
Australia: Tentative or On Tenterhooks? Growth: Australia was tentatively poised for some pick-up in growth as commodity prices picked up from the bottom. What’s more, strong full-time jobs recovery in 2017 added to the narrative of durable pick up in consumption in the pipeline. But jobs have since softened, while stretched household balance sheets alongside weak wage gains and cooling property market may started to dampen underlying growth momentum. What’s more a tighter fiscal stance also threatens to add to headwinds. Above all, the confluence of risks amplified by escalating US-China trade wars may have the Australian economy on tenterhooks. Industry: To be sure slip in actual capital expenditure is not a tragic sign of capitulation, given capex intentions are more encouraging. Nonetheless, further industrial recovery may be tentative. In particular as global up-cycle (peaking 2017) has wavered; if not resoundingly waned. For one, cyclical peak of the global cycle and higher oil prices conspire to soften demand. Most worryingly, unabated rise in US-China trade tensions. But despite trade tenterhooks not all outcomes are unequivocally bad. Ability to substitute for US’ farm products is a consolation. And if China ramps up infrastructure to counter US trade war risks, boost to commodities could counter-intuitively buoy industry.
Growth dynamics: That said, in all fairness, the RBA is desirous of re-balancing growth away from mining. So a China-inspired rush for ores and coal may not be the ideal growth revival scenario for the RBA. But, if a commodity-driven boost is the path of least resistance to inspire growth, the RBA will look the other way. Point being, stretched household balance sheets (levered on mortgage) amid a cooling property market, weak wage gains and rising global interest rates have the economy on financial/banking/consumer tenterhooks. And while welcome, fiscal tightening risks wrong-foot the economy risk and amplifying unexpected downturns.
Inflation : Despite the uptick in Q2 CPI to 2.1%, Australia’s inflation pick-up is tentative; far from imminent signs of broad-based acceleration. Fact is, as of Q2, the upturn in price pressures are exclusively driven by energy/fuel inflation whereas ex-energy inflation remains benign. And revealingly, services inflation is muted even into the recovery. To be sure, underlying inflation is regaining (rather than losing) traction ; but is only set for gradual rise in the 2-3% range. Crucially, soft wages gains suggest that despite further upside risks from energy pass-through, second round, demand-pull inflation risks are kept at bay. All said, inflation pick-up remains well under wraps.
As household balance sheet risks are compounded by h ousing markets risks and rising global interest rates, vulnerability to shocks is amplified ...
Housing Debt to Disposable Income
Owner Occupied Housng Debt to Disposable Income
Debt to Disposable Income (RHS)
0
1
2
3
4
5
6
7
0
1
2
3
4
5
6
7
05 06 07 08 09 10 11 12 13 14 15 16 17 18
Australia: Weak wages growth not only struggles to meaningfully beat inflation, but is also challenged by heavier debt burden.
Wage Index Mfg Public Sector Private sector Mining
(2)
(1)
0
1
2
3
4
5
6
(2)
(1)
0
1
2
3
4
5
6
05 06 07 08 09 10 11 12 13 14 15 16 17 18
While headline CPI has picked up (modestly), this is mostly driven by
energy inflation whereas inflation ex-energy has been very contained. (%-pt contribution, YoY)
Automotive Fuel H/H Energy Total Housing ex-energy
Tpt-ex Fuel Services Alcohol & Tobacco
Food Inflation ex-Fuel & Energy CPI
Asia Quarterly – Q3 2018
- 27 -
Policy: First things first. Our long-standing view that the next move is more likely to be a hike than a cut remains unchanged – admittedly braving the global trade/China risks. That said, the RBA is no particular rush to get; underpinning a “prolonged pause” until early-2019. For one, inflation remains benign. What’s more, downside risks to growth (from global trade war risks and domestic dampeners) deter. Finally, restrictive fiscal stance squares with slower withdrawal of monetary accommodation. Especially given elevated household debt, banking sector risks and property market vulnerabilities render the economy more sensitive to rate hikes and caution against aggressive hiking cycle.
External Position: While there has been some erosion in the net trade position, commodity price support alongside increased Australian production – for exports – have helped to keep the trade account in a surplus. But this has not been enough to prevent C/A slippage given that primary income outflows continue to overwhelm – as investment income repatriation continues. The wider point is that initial “J-curve” effect – since AUD collapsed from above 1.05 in 2013 to 0.70 lows in 2015 – marked by narrowing C/A deficit have been exhausted. Mainly because commodity exports exaggerated the trade surplus. C/A deficit should stabilize 2.5-3.0% off lows below 2% in 2016. FX: Our bullish AUD call further out (into late-2019) to entrench above 0.82 may appear to be rather optimistic in the face of global trade war risks that filter through China. Nonetheless, insofar that commodity prices derive support from on-going infrastructure projects – perhaps even get a boost from China’s infra-skewed fiscal stimulus to lean against US trade risk – the AUD could catch up with terms of trade and capex pick-up, which are expected as a corollary. What’s more, as the RBA turns less circumspect and shifts to hawkish mode into 2019, AUD traction may be reinforced. And if this resonates with EUR pick-up from ECB convergence ripples, AUD at 0.82 may not be a stretch; perhaps even easy.
Australia: While not set to collapse, the pullback i n Full-time jobs is suffcient cause for pause for the RBA; especially given soft wage gains. Dampens AUD
^ Cyclically-adjusted Fiscal Impulse refers to the change in fiscal stimulus that takes into account the growth-cycle. We have assumed 20% pass-through on positive growth turn to taxes and a 30% pass-through on negative growth turn.
Fiscal impact negativeto growth
Fiscal impact positiveto growth
(25)
(20)
(15)
(10)
(5)
0
5
10
(25)
(20)
(15)
(10)
(5)
0
5
10
06 07 08 09 10 11 12 13 14 15 16 17 18
Softer AUD has only gently reined in C/A deficit (Limited J-curve benefits) . And the commodity price bounce ha s
helped with the merchandise trade surplus.(% of GDP; 4Qma)
Secondary Income Primary Income
Services Goods
C/A BOPSources: CEIC, Mizuho Bank
0.65
0.70
0.75
0.80
0.85
0.90
0.95
1.00
1.05
1.10
(15)
(10)
(5)
0
5
10
15
06 07 08 09 10 11 12 13 14 15 16 17 18 19
While Upturn in Mining Capex Expectation is less pr onounced, it is consistent with AUD above 0.80; especially if commodity buoyancy su stains. AUD dynamics
Further iron ore & Capex recovery coinciding with hawkish RBA shift will be the in capex
squares with AUD buoyancy further out; barring worst-case "trade war" outcomes.
AUD Iron Ore
Sources: Bloomberg, Mizuho Bank
Despite surging iron ore prices AUD drops sharply on higher UST yields but resumes positive correlation with iron ore in early-2017 albeit remaining subdued.
Higher UST yields and trade war risks dampen. But expectations for ToT pick-up and capex recovery should turn AUD more sure-footed into 2019; coinciding with more distinctly hawkish turn by the RBA.
Note: Values in black are historical whereas those in blue represent forecasts. * Point forecast is for end-period. Q2 2018 ranges are from Bloomberg and only indicative.