Asia Economics Monthly - EuroChameurocham.org.sg/wp-content/uploads/2016/01/News-January-Asia-Ec… · Deutsche Bank Research Asia Economics 14 January 2016 Date Asia Economics Monthly

Deutsche Bank Research

Asia

Economics

Date 14 January 2016

Asia Economics Monthly

China's troubles and spillovers

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Deutsche Bank AG/Hong Kong

DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MCI (P) 124/04/2015.

Taimur Baig, Ph.D

Chief Economist

(+65) 64238681

[email protected]

Kaushik Das

Economist

(+91) 22 7180 4909

[email protected]

Diana Del Rosario

Economist

(+65) 6423 5261

[email protected]

Juliana Lee

Senior Economist

(+852) 2203 8312

[email protected]

Michael Spencer, Ph.D

Chief Economist

(+852) 2203 8303

[email protected]

Li Zeng, Ph.D

Economist

(+852) 2203 6139

[email protected]

Zhiwei Zhang, Ph.D

Chief Economist

(+852) 2203 8308

[email protected]

The year has begun with renewed concerns stemming from China. Despite the strengthening of economic activities in November, China’s economic fundamentals remain weak, and investors have struggled to understand the cohesiveness of various policy measures aimed at stabilizing the equity and currency markets. We expect vigorous policy implementation aimed at macro stabilization and potential upside surprises in the first half of 2016, but challenges would likely re-emerge in the second half as struggles with the debt burden and excess capacity continue.

We see three major channels of transmission out of China that would affect Asia's economies and markets. First, as sharply lower commodity prices pass on to retail prices, Asian economies will see another bout of sharp disinflation or outright deflation this year. Second, the deflationary environment and soft demand will make Asian banks shy away from intermediation as credit worthiness concerns mount. Credit momentum has been shrinking in Asia for a while now, as particularly evident in India, Indonesia, and Singapore. We worry that China, Philippines, South Korea, Taiwan, and Thailand would follow. Third, weaker RMB and inflation create a variety of challenges for Asian policymakers. Should they accommodate concomitant depreciation of their exchange rates to maintain competiveness, even if it comes at the expense of FX-borrowing corporates? Should they ignore the Fed cycle and cut rates, thus risk triggering capital outflows? Is it time to expand fiscal deficits to support demand, even if that alarms already-nervous bond investors? We think that the dilemmas would be resolved in favor of further easing, but the path to full policy capitulation will not be seamless.

We present three theme pieces this month. First, on China, we develop a new Effective Exchange Rate (EER) index for RMB. We utilize our proprietary processing trade model to correct for such supply-chain bias. The adjusted EER index suggests that China’s true price competitiveness loss between 2010 and 2015 was only some 19%, or 60% of what was indicated by the conventional EER.

In the second piece, we discuss the increasing challenges to the consensus’ favorable view on India. Political and legislative setbacks, chronic weakness in the banking system, fragile corporate balance sheet, poor exports, anemic manufacturing activities, and negative spillover from global market volatility are countering the positives, which include an energized public investment agenda, fairly positive consumer sentiment, and a generally sound external account.

India’s fiscal challenges are the subject of our third piece. Despite running persistently large fiscal deficits in recent decades, the debt/GDP ratio has declined owing to high real and nominal growth rates and low real interest on public issuances. Recent economic slowdown, particularly manifesting in a sharply lower nominal GDP growth, and a rise in real rates owing to RBI’s inflation targeting, has flattened the debt/GDP ratio, which remains uncomfortably high. In this context, we examine the projected debt path for the remainder of the decade, and associated risk parameters.

14 January 2016

Asia Economics Monthly: China's troubles and spillovers

Page 2 Deutsche Bank AG/Hong Kong

Asian Economics and Financial Forecasts

I. Macroeconomic Indicators

Real GDP Growth Inflation Current Account Fiscal Balance

(YoY%) (YoY%) (% of GDP) (% of GDP)

2014 2015F 2016F 2017F 2014 2015F 2016F 2017F 2014 2015F 2016F 2017F 2014 2015F 2016F 2017F

China 7.3 7.0 6.7 6.7 2.0 1.4 1.8 1.8 3.1 3.3 2.8 2.5 -1.8 -3.2 -3.5 -3.5

Hong Kong 2.5 2.5 3.0 4.0 4.4 3.0 4.4 3.8 1.9 0.6 2.0 2.4 3.6 2.4 1.3 1.8

India 7.1 7.3 7.5 7.8 6.7 4.9 5.2 4.8 -1.4 -1.0 -1.3 -1.6 -4.0 -3.9 -3.8 -3.7

Indonesia 5.0 4.7 4.7 5.0 6.4 6.4 3.8 5.0 -3.1 -2.2 -2.0 -1.8 -2.2 -2.8 -2.7 -2.7

Malaysia 6.0 4.6 4.2 5.0 3.1 2.1 2.2 2.7 4.3 2.7 3.1 3.4 -3.4 -3.2 -3.1 -2.9

Philippines 6.1 5.8 6.0 5.8 4.2 1.4 3.2 3.2 3.8 2.4 1.7 2.2 -0.6 -1.5 -1.6 -1.8

Singapore 2.9 2.0 2.0 2.5 1.0 -0.5 0.0 1.5 18.3 20.2 19.4 17.8 4.9 2.6 3.3 3.1

South Korea 3.3 2.6 2.8 3.0 1.3 0.7 1.4 1.7 6.3 8.9 7.3 7.2 0.6 -0.3 -0.2 0.1

Sri Lanka 4.5 5.0 6.0 7.0 3.3 0.9 4.0 5.0 -2.6 -1.6 -1.4 -1.5 -5.7 -6.0 -6.0 -5.5

Taiwan 3.9 1.0 2.4 2.7 1.2 -0.3 0.7 1.4 12.3 15.6 14.0 12.7 -0.8 -1.6 -1.8 -1.7

Thailand 0.9 2.5 2.5 2.5 1.9 -0.9 0.2 1.6 3.9 3.8 2.7 2.9 -1.9 -2.0 -2.1 -2.2

Vietnam 6.0 6.7 6.7 7.0 4.1 0.6 4.4 5.6 5.6 -1.3 -2.8 -3.5 -5.8 -5.6 -5.0 -5.0

Emerging Asia* 6.4 6.1 6.1 6.3 3.4 2.4 2.7 2.8 2.4 2.7 2.2 1.9 -2.1 -3.0 -3.1 -3.1

EM Asia ex China&India* 4.1 3.6 3.9 4.2 3.4 2.2 2.4 3.2 3.9 4.4 3.7 3.6 -1.2 -1.8 -1.8 -1.7

II. Exchange Rates (vs. USD) - Forecasts vs Forward Rates

Spot Q1-16 Q2-16 Q4-16

13-Jan DB Forward DB Forward DB Forward

China CNY 6.57 6.61 6.67 6.74 6.74 7.00 6.84

Hong Kong HKD 7.76 7.75 7.76 7.75 7.76 7.75 7.76

India INR 66.8 67.5 67.5 67.8 68.5 68.0 70.5

Indonesia IDR 13935 13850 14095 13700 14455 13500 15101

Malaysia MYR 4.40 4.69 4.40 4.72 4.42 4.41 4.46

Philippines PHP 47.0 47.9 47.8 48.7 48.1 48.0 48.6

Singapore SGD 1.44 1.45 1.44 1.50 1.44 1.45 1.45

South Korea KRW 1210 1230 1206 1250 1208 1280 1208

Taiwan NTD 33.5 34.0 33.6 35.0 33.6 36.0 33.6

Thailand THB 36.3 36.6 36.5 37.2 36.7 37.5 36.9

III. Interest Rates (3-mth interbank rate)** - Forecasts vs Implied Offshore Rates

Spot Q1-16 Q2-16 Q4-16

13-Jan DB Implied DB Implied DB Implied

China 1.50 1.50 2.15 1.50 2.00 1.00 2.03

Hong Kong 0.41 0.55 0.65 0.70 0.78 1.50 1.04

India 7.20 6.90 6.78 6.80 6.44 6.70 6.57

Indonesia 7.50 7.25 10.59 7.00 10.32 7.00 9.81

Malaysia 3.85 3.81 3.78 3.80 3.84 3.80 3.94

Philippines 2.14 1.99 3.15 3.24 3.01 3.99 3.45

Singapore 1.25 1.30 1.96 1.30 1.92 1.50 2.06

South Korea 1.67 1.60 1.59 1.60 1.49 1.65 1.54

Taiwan 0.80 0.68 0.74 0.55 0.70 0.57 0.70

Thailand 1.62 1.80 1.63 1.90 1.62 2.00 1.66

Source: Bloomberg Finance LP, Reuters, DB Global Markets Research Note: * GDP (PPP) weighted. ** Except for China, 1-yr deposit rate; India and Philippines, 3-mth T-bill yield; Indonesia, 1-mth BI rate; South Korea, 3-mth CD rate; Taiwan, 3-mth CP rate; Thailand, 3-mth on-shore THB/THB swap rate.

14 January 2016


Deutsche Bank AG/Hong Kong Page 3

A tough start to the year for Asian economies

The year is off to a poor start, both for the global economy and markets. For the global economy, signs are emerging that manufacturing production stumbled in Q4 in both China and the US. Trade remains stagnant while inflation is dormant. Corporate profits seem to have peaked, wage growth is muted, and investment is lackluster. Consumer sentiment is still holding up in some pockets, although the risk of negative wealth effect from the sell-off in asset markets is increasing by the day. Add to this political tension stemming out of the middle-east and North Korea, there is a large cocktail of risks afflicting the global economy presently. The key risk is China, where fears of continued economic slide are causing capital outflows, exchange rate depreciation, asset market sell-off, and policy dilemmas. Financial market turmoil may not halt economic growth in China as large parts of the economy operate independent of asset market dynamics, but the ongoing developments will surely hurt sentiments. Against this backdrop, we see three major channels of transmission that would affect Asia's economies and markets.

A second round of deflation: We see a strong link between China’s demand malaise and the commodity bust (although we don’t discount the supply side developments in the oil sector), and the latest bout of RMB depreciation makes producer price declines even more likely. Asian economies therefore will see another bout of sharp disinflation or outright deflation this year. Economies like Singapore, South Korea, Taiwan, and Thailand, looking forward to putting deflation behind in 2016, may be disappointed. Even after weakening its currency, China could also struggle to bring inflation back to normal territory. India, which has seen a wide gap between the CPI and the WPI (the latter does not include services and has been in negative yoy% territory for a while) may see that gap return, complicating policy reaction. Indonesia may end up benefitting from lower-than-expected inflation that opens up room for rate cuts by Bank Indonesia.

The really unfavorable impact of deflationary forces is on the leveraged corporate sector. A renewed bout of disinflation or deflation would cause corporate margins to shrink as companies are unable to leave sale prices unchanged in the presence of excess capacity, weak demand, and competitive pressure. Debt servicing would also become more challenging as revenues decline, pushing up credit risks.

A second leg of disinflation is in the pipeline

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14 January 2016



Credit crunch: Given the ongoing developments, there are telltale signs of a credit crunch in the making. Our measure of credit momentum (see chart below) shows that for the region as a whole, both the demand and supply of credit has been diminishing for a while, presently hovering around a 5-year low.

Credit momentum (10-yr z-score) has slowed in Asia

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A deflationary environment makes banks shy away from intermediation as credit worthiness concerns mount. Credit momentum has been shrinking in Asia for a while now, as particularly evident in India, Indonesia, and Singapore. We worry that China, Philippines, South Korea, Taiwan, and Thailand would follow. Banks will focus on the quality of their present stock of loans and other investments; as NPLs and NPAs rise, balance sheet repair will take precedence over further extension of the loan book. Experience from previous financial crises suggests that even in the presence of significant monetary accommodation, it is very difficult to turn around a credit crunch. The likelihood of a credit crunch is highly detrimental to the region’s growth outlook. Asian finances remain heavily dependent on bank financing, which makes banking sector difficulties a major headwind to consumption and investment.

Policy challenges: Weaker RMB creates a variety of challenges for Asian policy makers. Should they accommodate concomitant depreciation of their exchange rates to maintain competiveness, even if it comes at the expense of FX-borrowing corporates? Should they ignore the Fed cycle and cut rates, thus risk triggering capital outflows? Is it time to expand fiscal deficits to support demand, even if that alarms already-nervous bond investors? We think that the dilemmas would be resolved in favor of further easing, but the path to full policy capitulation will not be seamless.

On the monetary policy front, rate cuts are needed in a number of countries where short term real interest

rates are too high (see chart below). One argument made by the likes of Bank of Thailand and Bank of Korea last year was that commodity-driven disinflation was temporary, and by 2016 inflation would rebound. That looks increasingly unlikely, and the imperative to act has become greater. Additionally, we see central banks in India, Indonesia, and Taiwan likely to consider monetary policy easing this year.

Short term real interest rates are too high in the region

-5.0

-4.0

-3.0

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0.0

1.0

2.0

3.0

4.02012 2013 2014 2015

%yoy

Source: CEIC, Deutsche Bank. Short term real rate = 3-month t-bill rate minus 2015 inflation rate.

In the absence of robust external demand, the attractiveness of using the currency as a tool to support exports is diminishing. A superior policy option is to deploy fiscal easing measures, in our view. With a few exceptions, Asian economies have manageable public debt burdens (see chart below). India, Indonesia, the Philippines, and Thailand have lined up ambitious infrastructure spending plans. Others may be compelled to follow. Indeed, fiscal policy could well be the only effective policy action left at this juncture.

General government debt; room for fiscal expansion in

most of Asia

0102030405060708090

100 % of GDP


Taimur Baig, Singapore (65) 6423 8681

14 January 2016



China: A New REER index for RMB

We develop a new effect exchange rate index for RMB, DB-REER, which is corrected for the supply-chain bias based on our proprietary processing trade model for China. The new index suggests that China’s true price competitiveness loss between 2010 and 2015 was only some 19%, or 60% of what was indicated by the conventional BIS REER.

DB-REER, along with a set of sector REER indices we develop, provides more accurate, more complete and more update-to-date price competitiveness measures for China. They have important policy and market implications.

Conventional effective exchange rate

Effective exchange rate (EER) is an important competitiveness indicator. The conventional way of compiling and interpreting an EER index assumes that countries are competitors; hence a devaluation of one country’s currency hurts the competitiveness of its trading partners. It does not, however, take into consideration the supply-chain effect – the imports of IC chips from Korea to China may help China’s exports, and therefore a depreciation of the Korean won may not be a bad thing for Chinese cell phone exporters.

Such supply-chain bias is particularly serious in EERs for the RMB. Nearly 30% of China’s imports in 2015 are parts and components to be assembled into exports (for detailed discussions, see our report: The Gravity of China, Part I, 11/24/2015). These imports actually work as complements to Chinese exports. The conventional way to calculate EER does not consider this effect.

As a result, the conventional EER indices have led to some puzzling observations. According to the BIS, China’s real EER has appreciated over 30% since 2010 (Figure 1). Yet its global export market share has increased steadily during this period (Figure 2). Making the puzzle more striking is the contrast with Japan, whose currency has depreciated by about 30%, yet its global export market share has kept declining.

DB-REER: adjusted for supply-chain bias

Our proprietary processing trade model for China allows us to correct for the supply-chain bias. The model recognizes that, along a global supply chain, trading countries are not only competitors, but also partners. Both relationships are carefully accounted for in the EER calculations.

Figure 1: BIS real EER indices, China and Japan

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Figure 2: Global export market shares, China and Japan

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The DB-REER series in Figure 3 is the new RMB REER index that corrects for the supply-chain bias. It shows an appreciation of 18.7% since 2010, which is only 60 percent of the appreciation (31%) indicated by the conventional BIS RMB REER index.

What have led to the difference between the two REER series? Comparing their currency baskets, the biggest differences are found for China’s major supply-chain partners, such as Korea, Taiwan and Japan. Their weights become much smaller in the basket of DB-REER, implying that, due to processing trade, the impact of their currencies on China’s overall competitiveness is smaller than indicated by their gross trade with China.

This should not be surprising given that the key difference between DB-REER and the BIS index is how

14 January 2016



they treat trading countries on a supply chain. This is also why, only when currencies of these supply-chain partners started to show splitting trends from the RMB in late 2011, DB-REER began to show divergence from the BIS index (Figure 4).

Figure 3: RMB REER indices, before and after

correction of supply-chain bias (=100 in 2010)

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Figure 4: BIS REER indices, China and selected supply-

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Sector effective exchange rates

Aside from neglecting the complexity arising from global and regional supply chains, another major drawback of conventional EER indices as price competitiveness measures is that cross-sector differences are overlooked.

We try to fill in this gap by compiling sector EER indices. Sector EERs are conceptually similar to the traditional composite EER, except that, in calculating partners’ basket weights, bilateral imports and exports of a certain product are used, instead of bilateral aggregate imports and exports.

Presented in Figure 5 are five sector REER indices, all corrected for the supply-chain bias: automobile, textile, footwear, computer, and cell phone. The difference across sectors is huge: the automobile EER index appreciated by 32.5% since 2010, while the cell phone EER index only appreciated by 12.5%. This highlights that, for investors and policy makers who care about industry specific competitiveness, only look at composite EERs is not enough. The sector level REERs are much more informative.

Figure 5: Sector REER indices for China, after

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There are two factors driving the difference across sectors. First, currencies’ weights differ across the sector EER baskets. For instance, the Yen and the euro have much higher weights in the automobile basket than in the cell phone basket, because China imports many cars from these partners. The fact that the RMB appreciated more versus them than versus most other basket currencies is in part why the automobile EER appreciated more than the cell phone EER.

The other factor is the varying importance of processing trade to each sector. As shown in Figure 6, while processing trade makes up less than 10% of China’s imports and exports of automobiles, it accounts for around 70% of China’s trade in computer and cell phone products. Higher share of processing trade means China could benefit more from depreciations of partners’ currencies. This is another reason why the computer and cell phone EERs appreciated much less than, say, the automobile EERs.

It is also worth pointing out that, the appreciations of the adjusted computer and cell phone REERs are actually smaller than RMB’s bilateral appreciation against any currency of China’s top trade partners. Among China’s major trade partners, the RMB appreciated the least in real terms against the Korea won (14%), but the appreciations of the adjusted computer and cell phone REERs are only 10% and 12.5%, respectively. This shows that, because of global

14 January 2016



supply chains, it is indeed possible for a country like China to benefit, on a net basis, from bilateral depreciations of its trade partners’ currencies.

Figure 6: Estimated shares of processing trade for

sectors, 2014

SectorShare of processing trade

in total imports and exports (%)

Automobile 8.5

Textile 21.6

Footwear 19.6

Cell phone 67.4

Computer 74.7


Making puzzles less puzzling

EER indices adjusted for the supply-chain bias, including those at sector level, provide better price competitiveness measures for China. This section shows a few examples of how they can make some puzzles less puzzling, if not solving them completely.

Korea and Taiwan’s missing from the PBoC RMB index When the PBoC launched the CFETS RMB index in Dec. 2015, many were surprised to find out that Korea and Taiwan, two of China’s largest trade partners, were not included in the currency basket (Figure 7).

Figure 7: Currency basket of the CFETS RMB index

Currency Pair USD/CNY EUR/CNY JPY/CNY HKD/CNY GBP/CNY

Weight (%) 26.4 21.39 14.68 6.55 3.86

Currency Pair AUD/CNY NZD/CNY SGD/CNY CHF/CNY CAD/CNY

Weight (%) 6.27 0.65 3.82 1.51 2.53

Currency Pair CNY/MYR CNY/RUB CNY/THB

Weight (%) 4.67 4.36 3.33

Source: Deutsche CFETS

While the PBoC did not explain the rationale of excluding Korea and Taiwan, our findings show that the weights for Korea and Taiwan should be close to zero anyway. In the currency basket for DB-REER, the weights for the Korean won and Taiwan dollar are 1.7 and 0.8, respectively, both less than 20 percent of their usual unadjusted weights (that is, weights in a conventional RMB EER basket).

China: rising REER with rising market share As mentioned in the introduction, conventional measures suggest that China’s REER has appreciated over 30 percent since 2010, yet its exports still gained significant market share worldwide (Figures 1 and 2). Making it more striking is the contrast with Japan, whose REER has depreciated around 30%, yet its exports still kept losing market share.

One might argue that it was driven by China’s non-price competitiveness gains. Although this could be true to some extent, it is hard to think of it as the entire story, because the size of the implied non-price competitiveness gains by China would be huge, which is inconsistent with the general perception that China’s productivity growth has decelerated in recent years.

The adjustment for the supply-chain bias and a more careful look into sector development can help to give a more plausible story. At the aggregate level, DB-REER (Figure 3, our supply-chain bias adjusted index) shows that China’s true price competitiveness loss due to exchange rate appreciation was only about 60 percent of what was indicated by the conventional REER measure. The non-price competitiveness gains needed to offset the price competitiveness loss is therefore much smaller.

At sector level, telecommunication industry is one of the most relevant sectors. While accounting for only about 12% of China’s total exports, cell phone and other telecom products contributed more than 20% of China’s global market share gain in 2014. Although quick catch-up by domestic manufacturers such as Huawei certainly played a role, processing trade is perhaps still the most important factor. The impact of processing trade is two-fold. First, as shown in Figure 5, because of high share of processing trade, the cell phone industry suffered a much smaller price competitiveness loss relative to other sectors, such as automobile and textile. Second, which is also a point highlighted by our previous report (see: The Gravity of China, Part I, 11/24/2015), processing trade tends to overstate the market shares of the “processors”.

Together, the three factors—non-price competitiveness gains, less price competitiveness loss than appeared, and exaggerated global export market share—provide a much better explanation to the rising-REER-and-rising-market-share puzzle for China than non-price competitiveness does alone.

Interpreting 2016 outlook of the RMB We believe there is a large chance that the RMB could depreciate 5% to 10% vs. the US dollar in 2016, and our baseline forecast of USDCNY at end-2016 is 7.0 (for more details, please see: How to think about tail risks in China, 01/05/2016). Does this mean that China is going to engage in a competitive devaluation?

14 January 2016



Figure 8 presents an assessment using different EER measures. Based on the DB EER basket, a 5% bilateral depreciation versus the US dollar would in fact lead to a 1.6% appreciation in the RMB NEER. Our baseline forecast implies a virtually unchanged RMB NEER in 2016. Only when the RMB depreciates 10% versus the dollar, it would “achieve” an effective depreciation of some 1.3%. In other words, the seemingly large bilateral depreciations vs. the US dollar actually imply a fairly stable RMB, approximately ±1.5%.

Figure 8: RMB outlook in 2016

DB EER

basket

PBoC

basket

5% 6.81 +1.64% +1.86%

7.9% * 7.0 * -0.10% -0.91%

10% 7.14 -1.33% -2.85%

* DB baseline forecast

IF: THEN:

Depreciation

vs. USD in 2016

USDCNY,

end-2016

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(+, RMB appreciation)

Note: Based on DB and consensus forecasts of end-2016 exchange rates Source: Deutsche Bank

Concluding remarks

We are not the first ones trying to disentangle the supply chain and refine the EER indices to better measure price competitiveness. In fact, there has been a large academic literature on this topic, for instance, see Bayoumi et al. (2013), Patel, Wang and Wei (2014), and Bems and Johnson (2015).

Nonetheless, what we did in this report is a step forward. First, our EER basket is the only one in the market that controls for the supply-chain bias explicitly. Investors in the market usually refer to the BIS REER which does not control for such bias. The difference between the two indices is significant.

Second, our REER index can be maintained and regularly updated based on the latest trade data. Most academic studies on this topic are based on the World Input-Output Database (WIOD). While fascinating theoretically, the WIOD also ties the hands of those using it, because the world input-output table depends on a lot of assumptions, and more importantly, the information comes with significant time lag: the latest available world input-output table is for 2011, which is already five or six iPhone generations old.

The adjustments for the supply-chain effect in this report depend on our proprietary processing trade model for China. While forcing us to narrowly focus on China, it allows us to produce more accurate and up-to-date estimates.

Lastly, we provide the first set of REERs on sector level. To our knowledge this has not been done in academia or in the market. While this may not be a big innovation in methodology, it matters in practice. For investors and policy makers who care about industry specific competitiveness, the sector level REERs are much more informative.

This is not to say that our EER measures are perfect though. For instance, as acknowledged earlier, we do not have a perfect solution yet for the product mismatch problem when correcting the supply-chain bias for sector EER indices. There are also many interesting but unanswered questions, for example, how competitive a regional supply chain (the East Asia one) is relative to another (the German supply chain).

Our aim is to publish and regularly update the EER indices we developed here.

Reference Bayoumi, M. T., Saito, M., and Turunen, M. J., 2013. “Measuring Competitiveness: Trade in Goods or Tasks?” IMF Working Paper 13/100, International Monetary Fund.

Bems, R. and Johnson, R. C., 2015. “Demand for value added and value-added exchange rates,” NBER Working Papers 21070, National Bureau of Economic Research, Inc.

Marc Klau & San Sau Fung, 2006. “The new BIS effective exchange rate indices,” BIS Quarterly Review, Bank for International Settlements, March.

Nikhil Patel & Zhi Wang & Shang-Jin Wei, 2014. “Global Value Chains and Effective Exchange Rates at the Country-Sector Level,” NBER Working Papers 20236, National Bureau of Economic Research, Inc.

Zhiwei Zhang, Hong Kong (852) 2203 8308 Li Zeng, Hong Kong (852) 2203 6139

14 January 2016



India view from the inside and outside

We sensed plenty of challenges to the consensus favorable view on India. Political and legislative setbacks, chronic weakness in the banking system, fragile corporate balance sheet, poor exports, anemic manufacturing activities, and negative spillover from global market volatility are countering the positives, which include an energized public investment agenda, fairly positive consumer sentiment, and a generally sound external account.

View from the inside (Delhi and Mumbai)

GDP We found no satisfactory explanation behind the persistently wide divergence between national account estimates (published under new methodology from the beginning of this year) of real GDP and an extensive range of economic indicators and surveys. As the government’s Economic Survey pointed out in early 2015, both in terms of directionality and levels, the estimates are puzzling. Even with a few more quarters of data available, the puzzle remains to be solved. As per national accounts, real GDP grew by 7.4% in the July-September quarter, making India the fastest growing economy in Asia (and in the emerging market universe). Such performance would be understandable if industrial production, credit growth, exports, capital goods imports, PMI readings, and investment surveys showed a major pick-up in momentum, but all of these indicators point substantially below trend growth.

Under the new methodology, the national accounts keep on reporting strong industrial and service sector growth, while the ground reality seems subdued at best. Given low rural wage growth and positive real interest rates, it is difficult to see why and how service sector growth would be robust. As for manufacturing value added reported in the national accounts, there seems to be a systematic upward bias in the estimates, especially when seen together with quarterly industrial production data.

While real GDP growth data continue to baffle, what can one surmise from the high frequency data? In our analysis, urban consumption is picking up while rural demand is weak; investment may have bottomed out, helped by expedited project clearance by the government, but lacks vigor; banking system and commodity sector stress keeps rising; and exports (both commodity and non commodity) keep declining. These developments translate to a growth momentum of one-half standard deviation below trend.

Gap between national accounts value added estimates

of manufacturing (quarterly) and industrial production

(monthly)

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

2012 2013 2014 2015

GVA manufacturing Industrial production%yoy


Nominal GDP growth has declined sharply along with

weak WPI readings

-10.0

-5.0

0.0

5.0

10.0

15.0

20.0

Jun-1

2

Sep

-12

Dec-1

2

Mar-

13

Jun-1

3

Sep

-13

Dec-1

3

Mar-

14

Jun-1

4

Sep

-14

Dec-1

4

Mar-

15

Jun-1

5

Sep

-15

Nominal GDP WPI%yoy


Beyond the controversy surrounding real GDP, the nominal GDP estimates are worrisome. As sharp relative price adjustments took place, nominal growth worsened to a historic low in July-September of 2015. Some of this decline may be reversed in October-December as the GDP deflator bottoms, but the overall nominal GDP trend has implication for monetary policy and fiscal targets. Should India continue to tighten fiscally and keep monetary policy relatively tight in the presence of such poor nominal GDP growth? The answer, in our view, is no, but convincing the markets and the electorate that further stimulus is needed will be very difficult considering the strong real GDP data, political situation, and the government’s uniformly upbeat message on the economic situation so far.

14 January 2016



GST After spending considerable political capital in bringing state governments and the opposition to the fold, the government has little to show other than two stalled sessions of the Upper House. The strategy now seems to be to bring the bill back to the floor during the budget session, but we are uncertain as to how the bill’s chances would improve when more state elections would be taking place in February and March of 2016. It may well be the case that by giving the GST such a landmark status, the government has raised the political stakes too much. At the end of the day, a sales tax reform can hardly be so transformative, warranting so much effort.

The Ministry of Finance believes that if and when the bill is passed, a rollout of GST can take place in six months. We are skeptical. The reforms needed in regional-central information sharing, enhancement in the information technology framework, training of tax collectors, and education of taxpayers, would entail heroic efforts, in our view. Even if GST passes, its dividends, if any, would be many years away.

Fiscal The silver lining is that the government has taken advantage of the commodity price bust to liberalize fuel prices and increase fuel taxes, resulting in both relief at the pump and increase in indirect tax collection. It has also expedited public capital spending, especially in infrastructure. Overall fiscal difficulties are substantial, however. Income tax revenues have been poor due to weak economic activities and disinvestment has lagged considerably. Consequently, the fiscal stance, which was supposed to be mildly stimulatory in the budget (primary balance ex privatization was targeted to worsen by 0.1% of GDP), by the time fiscal year ends, the government may end up with a slightly contractionary stance. State governments have also under-spent so far, which makes the fiscal position at the consolidated level also a source of negative impulse. Some relaxation of the fiscal targets may well be warranted under these circumstances, but again, communicating that would be challenging.

Financial sector As long as stress persists in commodities and exports while real rates remain positive, it is unlikely that the banking system will see its bad loan overhang ease. The government’s efforts to nudge banks to become equity holders of companies with large stock of bad loans and then manage them for a few years would not amount to much more than extended forbearance, in our view. Unless growth picks up (domestically and externally) in a meaningful and sustained manner, India’s corporate sector will continue to struggle with balance sheet stress.

View from the outside (New York, Boston, Toronto)

Global investors remain optimistic about India's medium term outlook, but we sensed that cautious optimism and expectation of relative outperformance have replaced exuberance and expectations of large absolute returns. Most of the equity investors we met felt that there are no immediate short-term triggers that can lead to a re-rating in Indian equity market sentiments. Lack of progress on GST weighed on sentiments and the lack of earnings recovery frustrated investors. However, most investors felt that with expectations now more realistic, any unanticipated positive surprise on the reforms or the economy front could help market sentiments to improve.

Most investors agreed that GST and Bankruptcy Code will eventually get passed in the Parliament sometime in 2016, though many felt that these likely developments are already priced in by the markets; what will matter more is the quality of GST and the construct of Bankruptcy Code and also how efficiently and expeditiously both these reforms can be executed, about which there was no clarity at this point of time.

During the course of our meetings a consensus view emerged that the Indian economy has bottomed, and so has nominal GDP growth, but investors were more cautious about calling for a sharp recovery in 2016, as most had anticipated post the positive election outcome in 2014. Consequently, many investors felt that earnings recovery would also be gradual and uneven across sectors.

Real investment as % of GDP has stabilized, indicating

that the investment cycle has likely bottomed

29

30

31

32

Sep-13 Mar-14 Sep-14 Mar-15 Sep-15

Real Investment/GDP

% of GDP


14 January 2016



ROE and nominal GDP growth has fallen sharply, but

looks to have bottomed in this cycle

5

10

15

20

25

FY05 FY07 FY09 FY11 FY13 FY15

Nominal GDP growth ROE%yoy , %


As far as inflation and monetary policy outlook was concerned, we found investors divided in their opinion. Some agreed with our view that given the current inflation dynamic and the pipeline risks (arising from likely higher consumption and services sector inflation), RBI had little room to ease policy rate more than the 25bps rate cut that is expected in early April, but others argued that given the weak growth cycle, RBI may eventually agree to work with a lower positive real interest assumption (1% instead of 1.5-2%), which then could open up room for at least another 50bps of additional rate cuts. Investors in the dovish camp however agreed that any repo rate cut beyond 6.50% would only happen in the second half of 2016, once the precise inflationary impact of higher wage bill and other pipeline risks have been fully internalized.

One last rate cut of 25bps likely in 2016

2

4

6

8

10

12

2012 2013 2014 2015 2016 2017

CPI Repo

Forecast Forecast% yoy, %


RBI will keep real interest rates positive

-3

-2

-1

0

1

2

3

2012 2013 2014 2015F 2016F 2017F

Real interest rate (Repo rate - CPI inflation)%

Source: CEIC, RBI, Deutsche Bank

The problem in this cycle is that RBI's rate cuts have not caused the corporate sector to increase borrowing and investment. Most capital intensive firms are already highly leveraged and not in a position to make further investments. In such a scenario, substantive rate cuts from RBI stands the risk of fuelling consumption growth at a much faster pace than investment growth, which could then complicate RBI's task of driving inflation structurally lower to 4-5% levels.

Net debt/equity (%)

Select sectors Utilities Capital Goods Telecommunication services

FY08 54.2 21.2 42.2

FY09 73.3 46.7 43.0

FY10 76.1 60.2 28.8

FY11 89.1 81.3 99.2

FY12 116.0 116.8 111.0

FY13 135.5 118.9 91.4

FY14 143.4 131.4 93.7

FY15 153.2 131.6 115.1 Source: Deutsche Bank

On the fiscal front, investors agreed with our view that consolidation would be gradual given weak nominal GDP growth and slow revenue offtake and increasingly lesser scope to cut non-plan expenditure which is sticky in nature. However, there was a consensus view that the government would continue on the path of fiscal consolidation, as a reversal in the fiscal stance could do more damage than good, from a medium term perspective. Investors were of the view that it will be difficult for the government to offset the 0.5% of GDP increase in wage bill through other cost cutting measures, unless the government eventually decided to give a lesser hike or stagger it over two years. We did not get much pushback to our 3.8% of GDP fiscal deficit forecast, as against government's goal of putting a 3.5% fiscal deficit target for FY17.

14 January 2016



The authorities’ goal to bring the centre’s fiscal deficit

down to 3% of GDP by FY18 unlikely to be met

-12

-10

-8

-6

-4

-2

0

FY06 FY08 FY10 FY12 FY14 FY16F FY18F

Central govt. fiscal balance Consolidated% of GDP

Source: RBI, CEIC, Deutsche Bank

Despite a turn in the monetary policy cycle in US, investors seemed to be confident in RBI's ability to counter any potential FX volatility and hence did not seem overly concerned about the rupee outlook. India's substantial FX reserves (sufficient to cover 9-10 months' of import) and buoyant FDI outlook places the overall BOP in a comfortable position, even after assuming that FII outflows will continue for some more time due to prospects of more Fed rate hikes. We argued that rupee could easily go to 70 against the Dollar in 2016, especially if China devalues the RMB, but absent that, RBI will likely try to keep the pace of depreciation gradual.

Reserves adequacy position has strengthened

0

50

100

150

200

250

FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16

Gross FX Reserves / (ST external debt + CAD)%


Net FDI flows on its own will be able to finance the

current account deficit in the years ahead

0

20

40

60

80

100

FY10 FY12 FY14 FY16F FY18F FY20F

USD bn Current account deficit

Net FDI


Taimur Baig, Singapore (65) 6423 8681 Kaushik Das, Mumbai (91) 22 7180 4909

14 January 2016



Challenges to India’s debt reduction efforts

Despite running persistently large fiscal deficits in recent decades, India has seen its debt/GDP ratio decline owing to high real and nominal growth rates and low real interest on public issuances. Recent economic slowdown, particularly manifesting in a sharply lower nominal GDP growth, and a rise in real rates owing to RBI’s inflation targeting, has flattened the debt/GDP ratio, which remains uncomfortably high. In this context, we examine the projected debt path for the remainder of the decade, and associated risk parameters.

India’s debt sustainability

Despite running persistently large fiscal deficits in recent decades, India has seen its public sector debt/GDP ratio decline owing to high real and nominal growth rates and low real interest on public issuances. Indeed, the public sector debt/GDP ratio has gone down from 83% of GDP in 2003 to 68% in 2013. Recent economic slowdown, particularly manifesting in a sharply lower nominal GDP growth, and a rise in real rates owing to RBI’s inflation targeting, has however flattened the public sector debt/GDP ratio, which remains uncomfortably high compared to EM peers.

General government cyclically adjusted fiscal balance

-10

-8

-6

-4

-2

0

2006 2007 2008 2009 2010 2011 2012 2013 2014

India EM average Asia% of GDP

Source: IMF, Deutsche Bank

Against this backdrop we present the results of a debt sustainability analysis of the general government. The framework used here is the standard IMF debt sustainability exercise for emerging market economies. Debt dynamic is a function of previous period’s debt stock, interest rate on debt, GDP deflator, real GDP growth rate, and exchange rate. We take the latest debt and GDP statistics and then project them forward under a baseline scenario.

General government gross debt for 2015

0

20

40

60

80Debt/GDP

% of GDP


Baseline assumptions and projection

Our medium-term assumptions are as follows:

Real GDP grows by around 7.75% on an average over the next five years;

CPI inflation stabilizes in the 4.0-5.0% range as per RBI’s medium-term inflation targeting framework; WPI inflation and GDP deflator (which we have used in the debt sustainability exercise) settles at a lower level compared to CPI, in line with current trend, averaging about 3% in the years ahead;

Real interest rate on public debt works out to 5.5% (derived from 8.5% nominal rate and 3.0% GDP deflator-based inflation);

Primary deficit persists at 2.0% of GDP; primary spending rises by 14.5% in real terms, higher than past trend; revenues rise in line with GDP;

The rupee depreciates against the USD by 1-2% per year; note that given India’s relatively small public external debt burden, the exchange rate assumption matters little in the debt sustainability exercise.

Under this scenario, public debt is projected to decline to 56% of GDP by 2020. This outcome is primarily driven by the assumption that the real growth-real interest rate differential stabilizes at 2.5% during the forecasting period. India’s debt burden does not look onerous under this scenario, but the interest cost of servicing the debt remains high during the forecasting period, accounting for 13% of total consolidated spending (or about 23-25% of central government discretionary spending). Given that India’s total public spending on health and education barely reaches that level, the importance of reducing debt and interest cost is all too apparent.

14 January 2016



Baseline Debt/GDP ratio

2

3

4

5

6

7

40

50

60

70

80

90

2004 2006 2008 2010 2012 2014 2016 2018 2020

Baseline public sector debt 1/

o/w Foreign-currency denominated, right

% of

GDP% of

GDP

Source: Government of India, Deutsche Bank. 1/ Combined Central and State level debt

With growth recovery expected to remain gradual and given that RBI is now committed to maintain a 1.5-2% positive real interest rate in the economy (with respect to CPI, which implies even a higher real interest rate in terms of WPI and GDP deflator), the growth-interest differential in real terms is likely to be much lower at about 2.5-3.0% in the years ahead compared to our past prognosis. The differential would have been even lower, if not for the recent revision to India’s GDP figures, which has resulted in pushing up India’s real GDP growth rate by about 200bps, as compared to the old series of GDP.

As a result of the shrinking growth-interest differential, the debt/GDP ratio in fact increased in FY14 (to 68.6%) from FY13 levels (67.9%) and is likely to remain almost flat in FY16 (68.3%) Our analysis however suggests that from the next fiscal year, the debt/GDP ratio would again start its down move, primarily led by an improvement in the nominal GDP growth rate (to about 11-12%, from 7.5% currently) and a reduction in the real interest rate. If fiscal consolidation persists, then in such a scenario, it is possible for India’s debt/GDP to trend below 60% by 2020.

In 2012 when we had undertaken the debt sustainability exercise, our model had predicted debt/GDP to come down close to 60% by FY16, but as our current estimates show, the actual outturn of debt/GDP will likely be 68% in this fiscal year. Since 2012, uncertainty has increased and hence there are several risks which can derail our medium-term baseline forecast, which may well be based on optimistic assumptions about growth and fiscal consolidation.

Baseline Debt/GDP ratio: projected in our 2012 exercise

vs. latest projections

50

55

60

65

70

75

80

2012 2013 2014 2015 2016 2017 2018 2019 2020

Version 2012 Version 2016% of

GDP


What if this benign and optimistic scenario implied in our baseline assumptions does not play out? As the past decade illustrates vividly, India’s fiscal regime is vulnerable to various shocks. It has also been seen that even after an extended high growth period, fiscal consolidation proves to be transitory when growth shocks materialize (as India is experiencing currently), or an external shock (global financial market volatility, for example) weakens the fiscal position indirectly by impacting growth and revenue adversely.

In the rest of this note, we introduce some shocks to our baseline scenario and see how the projections change if indeed some of the key macro variables associated with debt dynamic were to take a turn for the worse in the coming years.

Stress Tests

Shock 1: No change in fiscal effort. If the primary deficit stays at around 3% of GDP (higher than our baseline assumption of 2.0% of GDP), and the growth/interest rate nexus discussed above remains in place, India’s debt path would still be on downward path, but the debt/GDP ratio will only fall to around 61% of GDP by 2020. A considerably flatter path of debt adjustment should be a source of worry, as fragility to shocks would rise.

What is worrisome to us is that short of a major set of reforms to boost revenue (not just GST, but reforms to broaden the tax base and streamline overall tax administration) and limit subsidy spending (particularly food and fertilizers), the fiscal outcome in the coming years could readily be along the lines of the path envisaged under this scenario. State fiscal finances could be a particular source of concern in the coming years, as the government’s new scheme UDAY (Ujwal DISCOM Assurance Yojana), aimed at financial turnaround of state owned distribution utilities, starts putting pressure on deficit and debt of states.

14 January 2016



(The scheme envisages a significant state government support mainly in the form of taking over of 75% of discom debt by the respective state governments and reduction in interest rate for the balance 25% of discom debt which may be issued in the form of discom bonds backed by state government guarantee. The scheme also envisages the states taking over the future losses of discoms from FY17 onwards in a graded manner. The government has indicated that it will exclude the debt taken over by the states as per this scheme in the calculation of fiscal deficit of respective states in FY16 and FY17.)

Shock 1 : No change in fiscal effort

40

50

60

70

80

90

2004 2006 2008 2010 2012 2014 2016 2018 2020


Primary balance is at baseline minus one

standard deviation

% of

GDP


Shock 2: Real interest rate (Policy repo rate – GDP deflator) rises to about 8.5%. If CPI inflation increases disproportionately in the years ahead, led by a spike in high food and services prices, RBI will be compelled to hike the policy rate, which may increase the real interest rate to high single digit, when measured in terms of WPI and GDP deflator. Another possibility is that inflation remains stable but a sharp pressure on the exchange rate (as was experienced in 2013) forces RBI to hike the policy rate, thereby increasing the real interest rate. Under the interest rate shock scenario, real interest rate paid on public debt is raised by one standard deviation of the past average, which in nominal term implies about 12% interest rate on government bonds. Under this scenario, the debt ratio rises above 70% in the next fiscal year and then slowly reduces to 65% by end 2020.

Shock 2 : Real interest rate rises to about 8.5%

40

50

60

70

80

90

2004 2006 2008 2010 2012 2014 2016 2018 2020


Real interest rate is at baseline + 1 s.d.

% of

GDP


Shock 3: Real growth of about 5%. Here we lower real GDP growth by 250-300bps (from our baseline forecast), which pegs economic growth to around 5%. The shock impacts the debt path severely, pushing up the debt ratio to 83% by 2020. In our 2012 debt sustainably exercise, a growth shock (under which real GDP growth was assumed at 4%, 200bps lower than the baseline forecast of 6%), resulted in pushing up the debt/GDP to 90% by 2020. The reason why debt/GDP trajectory is looking relatively benign in the recent growth-shock scenario is owing to the substantial revision in the GDP numbers in early 2014, which has raised India’s real growth rate by 200bps from earlier levels.

Shock 3: Real GDP growth of about 5%

40

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90

2004 2006 2008 2010 2012 2014 2016 2018 2020


Real GDP growth is 5%

% of GDP


14 January 2016



Shock 4: Combined shock. There could be occasions when a growth shock eventually leads to a fiscal shock which then translates into an interest rate shock. What happens to the debt profile in case of such a combined shock scenario? For this scenario, when we incorporate these shocks in our forecast exercise, we find that the impact on debt is immediate and extremely adverse (the debt/GDP ratio rises to 76% by 2020). While the probability of such a manifestation is low, it is important to be cognizant of such eventualities.

Shock 4: Combined shock

40

50

60

70

80

90

2004 2006 2008 2010 2012 2014 2016 2018 2020


Combined shocks 2/

% of GDP

Source: Government of India, Deutsche Bank. 1/ Combined Central and State level debt. Combined shock scenario consists of slowing of real growth (to 5..5%yoy) coupled with a rise in real interest rate and a worsening of the primary balance by ½ standard deviation each

Shock 5: Contingent liability shock. Coinciding with the recent slowdown in growth, non-performing assets of state owned banks have increased appreciably. Loans related to power sector and aviation sectors have been or are in the process of getting restructured. In this scenario we assume that the government’s contingent liabilities would rise suddenly. To account for such a risk, we raise the government’s liabilities by 10% of GDP in 2015/16. This keeps the debt level above 65% of GDP through the year 2020.

Shock 5: Contingent liability shock

40

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90

2004 2006 2008 2010 2012 2014 2016 2018 2020


10 percent of GDP increase in other debt-

creating flows

% of

GDP


Conclusion

The period ahead should not be alarming for India if the growth-interest rate differential is maintained. Our baseline assumptions paint a fairly comfortable adjustment path for the remainder of the decade as we expect growth to strengthen and fiscal effort to continue. Our forecasts also include an improvement in the nominal GDP growth rate (to about 11-12%, from 7.5% currently) and a reduction in real interest rate compared to current levels. In such a scenario, debt/GDP would head below 60% by 2020.

But the fact of the matter is high growth cannot be taken for granted (as has been amply clear in recent years), especially given the likely persistence of external demand weakness and an anemic domestic investment landscape. In 2012 when we had undertaken the debt sustainability exercise, our model had predicted debt/GDP ratio to come down close to 60% by FY16, but as our current estimates show, the actual outturn of debt/GDP will end up being more than 10% higher. Assumptions about growth and real rates turned out to be wrong by a large margin. Hopes of mean reversion may well turn out to be wrong again.

Even if debt/GDP stabilizes around 60%, the cost of servicing the sizeable debt will remain high, constraining growth critical spending. From a policy perspective, reducing the debt burden is imperative as high debt levels reduce the room for fiscal flexibility to counter future economic shocks.

In the near term, the authorities seem committed to reducing the fiscal deficit and debt. But if global growth shocks were to materialize, affecting India adversely, they may consider a fiscal response. This was indeed the policy response in the aftermath of the 2008 global financial crisis. Debt/GDP path was unaffected then as high inflation and growth ensued. In a deflationary and low growth world however, the debt path will be more difficult to manage, and the available fiscal space to support the economy will be limited.

Taimur Baig, Singapore (65) 6423 8681 Kaushik Das, Mumbai (91) 22 7180 4909

14 January 2016



China Aa3/AA-/A+ Moody’s/S&P/Fitch

Economic outlook: We maintain our GDP growth

forecast of 7.2% in Q4 2015 and 6.7% in 2016. Our baseline policy forecasts remain unchanged as well: we expect four RRR cuts, one in each quarter of 2016; and two interest rate cuts, in 2016Q3 and 2016Q4, respectively. The Central Economic Working Conference ended on December 21, 2015 didn’t disclose the growth target for 2016. We will review our forecasts when the growth target for 2016 becomes disclosed.

Main risks: Despite the strengthening of economic activities in November, economic fundamentals remain weak. Housing inventory continues to rise; and the pick-up in land auction sales since late 2014 could further exacerbate the issue of over-supply in the property market. We expect stablisation and potential upside surprises in the first half of 2016, but challenges to re-emerge in the second half.

Comments on the Central Economic Working Conference

A press statement was released following the conclusion of the Central Economic Working Conference (CEWC) on December 21, 2015. Our comments are as follows: 1: The statement did not disclose the growth target for 2016. The official announcement will come out on the first day of National People's Congress, which usually starts on March 5. There may be news flows in the press before NPC on the growth target. A 7% target would imply more policy easing, while a 6.5% target would imply higher tolerance of economic slowdown and less easing. 2: The press statement indicated further policy easing in 2016. It explicitly mentioned that fiscal deficit should rise, and monetary policy needs to "lower social financing costs". This is consistent with our forecast. We maintain our view that fiscal deficit may rise to 3.5% of GDP in 2016 (budget deficit in 2015: 2.3%), and the PBoC will cut interest rates twice and cut RRR four times. 3: The press release emphasized cutting excess capacity in the economy. But the press release also mentioned cutting capacity should rely more on mergers rather than bankruptcy, which implies the government's concern on repercussions from factory closure to unemployment and NPLs in the banks. We therefore have doubt to what extent capacity can be effectively cut. We believe there will be more defaults in 2016, but it is not clear to us to what extent the government will tolerate the pains and push through corporate restructuring. From a macro perspective, mergers may not be as efficient as outright bankruptcy.

4: The press release mentioned the government will facilitate a rundown of inventory in the property market. It mentioned government should encourage developers to lower prices, to facilitate destocking. This is an interesting statement, as it didn't appear in the past government press releases. It remains to be seen how this policy initiative will be implemented. 5: The press release emphasized "supply side" policy measures to help the economy. To us, it is unclear what exactly this means. Cutting capacity helps to rationalize the supply side, but we doubt that's all it is.

Activities picked up in November, 2015

The growth of headline activity indicators picked up in November. Industrial production grew by 6.2% yoy (Figure 1), beating both October (5.6%) and the market expectation (5.7%). On monthly basis, recovery of FAI growth continued, with yoy growth further picking up to 10.8% (9.3% and 6.8% in Oct and Sept, respectively). Consumption remained buoyant. With strong Singles Day shopping, growth of retail sales set a 10-month high of 11.2%, also beating October (11.0%) and the market expectation (11.1%).

Figure 1: IP vs. Power generation

-6

0

6

12

18

4

6

8

10

12

Feb

-14

Mar-

14

Ap

r-14

May-1

4

Jun-1

4

Jul-14

Aug

-14

Sep

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No

v-1

4

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4

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No

v-1

5

IP, yoy% Power generation, yoy%, rhs

% %

Source: Deutsche Bank, WIND

Improving leading indicators for FAI suggest that the strong momentum seen in November will likely continue in the coming months. Total funds available for FAI rose by 7.9% ytd, compared to 7.3% in October and 6.8% in September. The planned investment for new projects grew by 4.7% yoy ytd, up from 4.1% in October (Figure 2). The planned investment for total ongoing projects grew by 5.6%, up from 5.3% in October. In the property sector, there are mixed signals as new housing starts remained weak but housing sales improved.

14 January 2016



Figure 2: Planned investment for new projects and

ongoing projects

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-15

Sep

-15

Oct-

15

No

v-1

5

Planned investment for ongoing projects ytd, yoy%

Planned investment for new projects ytd, yoy%% %


CPI inflation rose slightly from 1.3% yoy in October to 1.5%, although PPI remained low with a yoy growth of -5.9% (same as October). The low inflation environment increases the chance of further monetary easing. Strong money supply growth this month is another indication of loose monetary policy. Yoy growth of M1 picked up from 14% in October to 15.7%, and M2 growth rose to 13.7% from 13.5% in October (Figure 3).

Figure 3: M1 growth vs. M2 growth

0

3

6

9

12

15

18

Mar-

13

May-1

3

Jul-1

3

Sep

-13

No

v-1

3

Jan-1

4

Mar-

14

May-1

4

Jul-1

4

Sep

-14

No

v-1

4

Jan-1

5

Mar-

15

May-1

5

Jul-1

5

Sep

-15

No

v-1

5

%

M1 growth yoy M2 growth yoy


The strong economic activities in November are generally consistent with our expectation. We continue to project 7.0% full-year growth for 2015 and 6.7% for 2016 (7.0% yoy for 2016Q1)

Zhiwei Zhang, Hong Kong, +852 2203 8308 Li Zeng, Hong Kong, +852 2203 6139

China: Deutsche Bank forecasts

2014 2015F 2016F 2017F

National income

Nominal GDP (USD bn) 10,357 10,924 11,218 11,887

Population (m) 1,369 1,376 1,382 1,388

GDP per capita (USD) 7,563 7,939 8,115 8,562

Real GDP (YoY%)1 7.3 7.0 6.7 6.7

Private consumption 8.5 7.6 7.7 7.9

Government consumption 4.4 7.2 7.2 7.2

Gross capital formation 7.2 6.3 6.1 6.1

Export of goods & services 4.7 -1.2 5.0 5.6

Import of goods & services 2.7 -10.3 7.2 7.5

Prices, Money and Banking

CPI (YoY%) eop 1.5 1.5 1.8 1.9

CPI (YoY%) ann avg 2.0 1.4 1.8 1.8

Broad money (M2) eop 12.3 13.6 12.7 12.4

Bank credit (YoY%) eop 13.4 14.7 14.0 13.9

Fiscal Accounts (% of GDP)

Budget surplus -1.8 -3.2 -3.5 -3.5

Government revenue 22.0 22.5 22.5 22.6

Government expenditure 24.1 25.7 26.0 26.1

Primary surplus -1.4 -2.7 -3.0 -2.9

External Accounts (USD bn)

Merchandise exports 2,342 2,281 2,372 2,474

Merchandise imports 1,959 1,648 1,739 1,848

Trade balance 383 633 633 626

% of GDP 3.7 5.8 5.6 5.3

Current account balance 321.3 360.5 314.1 297.2

% of GDP 3.1 3.3 2.8 2.5

FDI (net) 208.7 205.0 224.4 237.7

FX reserves (eop) 3,899 3,470 3,500 3,600

FX rate (eop) USD/CNY 6.2 6.5 7.0 7.0

Debt Indicators (% of GDP)

Government Debt2 37.1 39.6 40.0 40.5

Domestic 36.9 39.4 39.8 40.3

External 0.2 0.2 0.2 0.2

Total external debt 8.6 15.5 16.0 16.5

in USD bn 896 1,693 1,795 1,961

Short-term (% of total) 69.4 70.0 70.0 70.0

General (YoY%)

Fixed asset inv't (nominal) 15.7 10.6 10.5 10.5

Retail sales (nominal) 12.0 10.6 11.4 11.8

Industrial production (real) 8.3 6.3 6.2 6.2

Merch exports(USDnominal) nominal)

6.0 -2.6 4.0 4.3

Merch imports (USD) nominal)

0.5 -15.9 5.5 6.2

Financial Markets (eop) Current 16Q1F 16Q2F 16Q4F

1-year deposit rate 1.50 1.50 1.50 1.00

10-year yield (%) 2.75 3.00 2.70 2.80

USD/CNY 6.57 6.61 6.74 7.00 Source: CEIC, DB Global Markets Research, National Sources Note: (1) Growth rates of GDP components may not match overall GDP growth rates due to inconsistency between historical data calculated from expenditure and product method. (2) Including bank recapitalization and AMC bonds issued

14 January 2016



Hong Kong Aa1/AAA/AA+ Moody’s/S&P/Fitch

Economic outlook: Activity should recover

somewhat in 2016/17 as global growth stabilizes,

lifting exports of goods and services modestly.

Inflation will likely remain elevated in 2016 falling

in 2017/18 as property price inflation cools.

Risk: Downside risks to growth dominate, with both the US and China as sources of uncertainty. Property is the main domestic risk, with prices having already perhaps begun a lengthy decline.

China, not the Fed, spooks markets

What if the Fed raised rates and nobody noticed? Since ‘liftoff’ on December 16, interest rates in Hong Kong haven’t budged. Overnight interbank rates are still about 5bps versus 36bps on USD Libor. It’s a bit of a mystery to us why investors are happy to leave 30bps of foregone interest on the table – perhaps they expect China’s apparent desire for a weaker RMB will extend to asking Hong Kong to revalue its dollar -- but we don’t expect this arbitrage opportunity will persist for long. For the record, we don’t expect a HKD revaluation, so arbitrage will eventually narrow the gap between HKD and USD interest rates.

Obviously, HKD interest rates haven’t risen because liquidity remains abundant – the turmoil in Chinese asset and currency markets and a cooling property market appear to have spurred a surge in demand for HKD. But there are more fundamental forces keeping HKD yields low: the current account surplus is rising, hitting a three year high in Q3 and we expect a further increase in Q4 given the record YoY improvement in the trade balance in Oct/Nov.

Current account balance (4q rolling sum)

0

50

100

150

200

250

300

00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15

HKDbn

Sources: CEIC and Deutsche Bank Research

Falling oil prices are only a small part – perhaps one-fifth -- of the decline in the trade deficit. Over the past eleven months, the annualized trade deficit has fallen by HKD111bn, of which about HKD23bn is accounted for by the decline in petroleum imports. A more important factor, accounting for HKD50bn of the decline in the trade deficit, is the electrical machinery and appliances sector. To some extent, this may reflect the weakening of domestic investment. Other manufactured goods have seen a decline in the trade deficit too. This, we think, reflects the decline in tourist spending, but of course there is an offsetting decline in services exports with the fall in imported goods for tourists.

So the falling trade deficit, while it helps to keep interest rates low and the HKD strong, is not a source of strength to GDP – it’s a consequence of weak spending, if anything.

In anticipation, perhaps, of rising interest rates after liftoff, property prices have posted their largest declines in October/November since the global financial crisis. The property price index has fallen 4% over the two months, with rents falling 2%. While the delayed response of HKD interest rates to the Fed’s hikes may have come as a pleasant surprise, our expectation that rates will eventually rise about 200bps over the next two years will inevitably put pressure on a property market in which rental yields currently range from 2% to 3%, the lowest in at least 28 years.

Prices and yields on 70 – 99.9sq m apartments

50

100

150

200

250

300

2

3

4

5

6

90 92 94 96 98 00 02 04 06 08 10 12 14

Yield Price (rhs)1999=100%

Sources: CEIC and Deutsche Bank Research

There have been two other periods of price declines since the GFC, but we expect this one will be more persistent and lead to larger cumulative declines than the previous two episodes. A 5% decline in two months is rather a faster pace of decline than we had

14 January 2016



been expecting, so the downside risks from property may prove to be more significant than expected.

Retail sales continued their erratic behavior in November. After rising a surprisingly large 3.5%mom(sa) in October, sales fell 2.4% in November. That leaves seasonally adjusted sales for those two months on average 3.2% higher than the Q3 average, but down 2%yoy. The weakness in retail sales seems to be driven by declining tourism. That suggests private consumption growth will be weaker in Q4 and that has been our expectation. But we caution against an overly pessimistic view on consumption. Retail sales, because it captures very little of the services demand, represents only just over one-third of consumption expenditures in Hong Kong. And services spending – more than half of consumption -- has offset the volatility in goods demand. So, while we expect consumption growth to be weaker in Q4, it will still likely be higher than it was for much of 2014.

Retail sales and personal consumption expenditure

-10

-5

0

5

10

15

20

25

06 07 08 09 10 11 12 13 14 15

Retail

PCE

%yoy

Sources: CEIC and Deutsche Bank Research. Note, the 2015Q4 observation on retail sales growth is Oct/Nov only.

Export growth also disappointed in November, essentially unchanged at -3.5%. While there’s a suggestion of a slower pace of decline in Q4 versus Q3, this is a decline nonetheless. And the national accounts data suggest this is not mostly a price effect as it is on many other countries, but is mostly a volume effect – export volumes were down 3.2%yoy in Q3 while values were down 4.1%.

Michael Spencer, Hong Kong, +852 2203 8305

Hong Kong: Deutsche Bank Forecasts

2014 2015F 2016F 2017F

National Income

Nominal GDP (USD bn) 289.7 311.8 323.7 350.2

Population (mn) 7.3 7.3 7.4 7.4

GDP per capita (USD) 39882 42674 44029 47352

Real GDP (YoY%) 2.5 2.5 3.0 4.0



Gross fixed investment -0.2 3.7 5.8 6.3

Exports 0.8 -1.7 2.1 2.0

Imports 1.0 -1.6 2.3 1.8


CPI (YoY%) eop 4.8 2.4 4.7 2.6

CPI (YoY%) ann avg 4.4 3.0 4.4 3.8

Broad money (M3, eop) 9.6 3.4 4.4 5.2

HKD Bank credit (YoY%, eop) 10.9 0.3 9.7 6.8

Fiscal Accounts (% of GDP)1

Fiscal balance 3.6 2.4 1.3 1.8



Primary surplus 3.6 2.4 1.3 1.8


Merchandise exports 519.3 497.6 504.7 519.9

Merchandise imports 549.4 529.8 534.7 548.1

Trade balance -30.1 -32.2 -30.0 -28.2

% of GDP -10.4 -10.3 -9.3 -8.1


% of GDP 1.9 0.6 2.0 2.4

FDI (net) -39.4 45.7 -5.0 -10.0

FX reserves (USD bn) 328.5 355.3 382.5 402.9

FX rate (eop) HKD/USD 7.76 7.75 7.75 7.75


Government debt1 7.1 6.0 6.1 6.2

Domestic 6.6 5.2 5.3 5.4

External 0.5 0.8 0.8 0.8


in USD bn 1290.4 1434.5 1456.6 1505.9


General

Unemployment (ann. avg, %) 3.2 3.3 3.3 3.3

Financial Markets Current 16Q1F 16Q2F 16Q4F

Discount base rate 0.75 1.00 1.25 1.50

3-month interbank rate 0.41 0.55 0.70 1.50

10-year yield (%) 1.50 1.60 1.70 1.80

HKD/USD 7.76 7.75 7.75 7.75 Source: CEIC, DB Global Markets Research, National Sources Note: (1) Fiscal year ending March of the following year. Debt includes government loans, government bond fund, retail inflation linked bonds, and debt guarantees.

14 January 2016



India Baa2/BBB-/BBB- Moody’s/S&P/Fitch

Economic outlook: India enters 2016 with weak investment demand, poor exports, high NPAs, a leveraged corporate sector, and subdued market and business optimism. Increased uncertainty in global markets, especially in China, has complicated matters further.

Main risks: Growth could surprise to the downside, making fiscal consolidation and NPA reduction strategy more challenging. State election setbacks for the ruling party could further undermine investor sentiment.

Lackluster recovery continues

The CMIE survey1 of Indian firms’ investment trend now extends through December 2015. Key findings:

Cost and units of stalled projects continue to fall Cost of stalled projects moderated to INR217bn in Oct-Dec’15 (from INR1.2trn in Oct-Dec’14), constituting an 82%yoy decline. Cost of stalled projects peaked in September 2014 (at INR1.7trln) and since then has been coming off steadily, a positive sign.

Cost of stalled projects falling steadily since Sep’14

0

500

1000

1500

2000

2500

2007 2009 2011 2013 2015

Stalled/shelved (cost)INR bn

Source: CMIE, Deutsche Bank

Stalled projects in terms of absolute units have also decreased considerably in Oct-Dec’15 (to 63), from the previous two quarters (101 in July-Sep and 158 in April-June), a welcome development. On a yoy basis, total units of stalled projects have recorded a 54% decline in Oct-Dec’15, same as the previous quarter.

1 The CapEx database of the Centre for Monitoring Indian Economy (CMIE)

breaks down investment between the public and private sectors, in

ongoing and postponed projects, as well as the value and number of

investments. The database presently collects information on around 45000

projects by 9000 firms.

Units of stalled projects also declining

-100

-50

0

50

100

150

2013 2014 2015

Stalled/ shelved (total units)%yoy


Cost of private sector stalled projects fell 77%yoy in Oct-Dec’15 (-47%yoy in July-Sep). Total units of private sector stalled projects also fell to 41 in Oct-Dec, from 66 in the previous quarter. Similar improvement was recorded in the public sector.

Private sector stalled project cost and units falling

0

500

1000

1500

2000

0

30

60

90

120

150

180

2007 2009 2011 2013 2015

Stalled projects (private), lhs

Stalled/shelved project cost, rhsNo. of

projects

INR bn


Unless stalled projects clear out, it is difficult to expect fresh capex investments from the private sector, which is under stress due to high leverage, weak sales, anemic profitability and an uncertain global environment. In this context, the ongoing reduction in cost and units of stalled projects, especially in the private sector is encouraging as it helps improve the prospect for future investment.

It was not all good news though; the manufacturing sector was affected in Oct-Dec, with 33 projects being shelved (investments worth INR78bn), followed by sectors such as transport (11 projects shelved) and steel (3 projects shelved).

14 January 2016



Commissioning of projects declined in Oct-Dec’15 While the investment outlook is improving gradually due to the decline in stalled projects, actual activities on the ground however remain weak, which is clear from the recent data on commissioning of new projects, which fell 44%yoy in Oct-Dec’15. Average quarterly commissioning of projects in the first three quarters of FY16 at INR874bn was lower by 1% versus average quarterly commissioning in the first three quarters of FY15. Even if commissioning picks up somewhat in Jan-March, probably the full year FY16 number would be same as the FY15 levels or slightly higher, which would imply a flat investment trend.

Projects completed declined in Oct-Dec’15

0

100

200

300

400

500

600

700

2007 2009 2011 2013 2015

Projects completedNo. of

projects


Stalled/completion ratio declined in Oct-Dec’15 Number of stalled projects and projects completed both reduced in Oct-Dec’15, but overall the stalled/completion ratio reduced further to 21.9, from the previous two quarters. Both private and public sector recorded a fall in the stalled/completion ratio, reflecting the impact of a larger fall in stalled projects costs compared to the cost of projects completed.

Private sector stalled/completion ratio declined further

0

20

40

60

80

100

0

100

200

300

400

500

2007 2009 2011 2013 2015

Projects completed (private), lhs

Stalled/completed ratio, rhsNo. of

projects


New investment proposals declined in Oct-Dec’15 New investment proposals had increased sharply from July-Sep’14 onward, but the pace of increase has been reducing sequentially in the last few quarters. It was therefore not a big surprise that value of new investment proposals recorded a sharp decline in Oct-Dec’15 (-74%yoy), as this can be attributed to a negative base effect (in Oct-Dec’14 new investment proposals were up 176%yoy). Private sector announcement of new investment intentions declined to INR692bn in Oct-Dec’15 from an average investment of INR1.7trn in the past five quarters. New projects proposed in the first three quarters of FY16 reduced to INR5.2trn from INR7.8trn worth of projects announced in the first three quarters of FY15 - a decline of 33%.

New investment proposals down sharply in Oct-Dec’15

0

500

1000

1500

2000

-75

-25

25

75

125

175

225

2007 2009 2011 2013 2015

New investment proposals, lhs

New investment prposals, rhs (no.

of projects)

% yoy


On balance, the latest CMIE data points to the continuation of a lackluster investment recovery, with some findings of the survey – ongoing decline in stalled project cost and stalled/completion ratio – reflecting a modestly better investment outlook in the medium-term, while other data trend such as fall in commissioning of new projects, indicating weak investment activity on the ground.

Private corporate sector in India, particularly the capital intensive ones, are already under stress due to prior investment decisions having gone wrong (resulting in high leverage and low profitability) and is not keen to increase spending , especially at a time when the global environment has become more uncertain. Indian leveraged corporates in India will use the window of lower interest rates to pay off their debt first before actually committing to fresh capex investment of a large size, in our view. In fact, this process is underway and we think will take some time before the next round of fresh capex investment comes through from India Inc. In this backdrop, India will likely have to be contended with a gradual recovery in its investment and growth cycle, despite continued policy efforts from the government and Reserve Bank of India.

14 January 2016



Business surveys indicate soft end to 2015

We compare the latest findings of three surveys – Nikkei PMI, RBI Industrial Outlook survey and Dun and Bradstreet Business Optimism Index to ascertain business and investment sentiment and underlying strength of the cycle.

PMI survey for the manufacturing or service sector is based on questionnaire responses from panels of executives at over 400 companies. Respondents are asked to state whether business conditions for a number of variables have improved, deteriorated or stayed the same versus the previous month.

RBI Industrial Outlook Survey (covering 1,304 companies) provides qualitative assessment of business situation of companies in the Indian manufacturing sector and their expectation for the quarter ahead.

Dun and Bradstreet Optimism Index is based on a quarterly survey of business expectations (for companies belonging to basic, capital, intermediate, consumer durables, consumer non-durables goods and service sectors). Respondents are asked six questions regarding their expectations as to whether the following parameters - volume of sales, net profits, selling prices, new orders, inventories, and employees - pertaining to their respective companies will register an increase, decline or show no change in the survey quarter as compared to the same quarter in the prior year.

Overall trend All three surveys reflected a slowdown in economic momentum or business sentiment in Oct-Dec’15. Composite PMI moderated to 51.5 in Oct-Dec’15 (quarterly average) from 52.0 in July-Sep, despite an improvement in services sector PMI, as the slowdown in manufacturing sector was substantial, particularly in Dec. Manufacturing PMI fell to 49.1 in Dec’15, for the first time since Oct 2013, though this can be attributed largely to the severe flooding in the southern part of India, which disrupted production activity. However, note that manufacturing PMI had been slowing from August’15 onward on a steady basis, even if the December number is not taken into consideration.

The overall weakness in non-farm sector momentum is in line with the findings of D & B Business Optimism index which slowed that the overall business sentiment deteriorated in Oct-Dec’15 from the previous quarter.

The slowdown in manufacturing PMI during Oct-Dec’15 is corroborated by the latest findings of the RBI Industrial Outlook Survey which show that overall business situation remained weak though Oct-Dec.

Dun & Bradstreet Business Optimism Index and PMI

40

45

50

55

60

65

70

70

110

150

190

230

2007 2009 2011 2013 2015

Business Optimism Index, lhs

Composite PMI, rhs

Source: CEIC, Haver Analytics, Deutsche Bank

RBI Industrial Outlook Survey and manufacturing PMI

45

50

55

60

65

0

10

20

30

40

50

60

2007 2009 2011 2013 2015

RBI: overall business situation, lhs

Manufacturing PMI, rhs


New orders Composite new orders rose a tad in Oct-Dec’15 vs. July-Sep’15 (52.1 vs. 50.0), led by the services sector (52.9 in Oct-Dec vs. 51.5 in July-Sep). Manufacturing new orders however moderated to 49.9 in Oct-Dec’15 vs. an average of 53.4 in July-Sep.

Lower level of optimism (25.5% in Oct-Dec vs. 25.8% in July-Sep) was recorded for order books in the RBI’s Industrial Outlook survey as well, which is in line with the moderation in manufacturing sector new orders.

D & B Business Optimism survey reflects increased optimism for new orders (66% in Oct-Dec vs. 62% in July-Sep). Given that this survey does not provide further details about the manufacturing and services sector separately, we presume that the improvement in new orders was led mainly by the services sector, in line with the findings of the PMI survey through Oct-Dec. Overall, it appears that the outlook for manufacturing sector new orders weakened in Oct-Dec’15, while improving in case of services sector.

14 January 2016



New orders remain weak

0

10

20

30

40

50

20

40

60

80

100

2007 2009 2011 2013 2015

Composite PMI new orders, lhs

D & B new orders, lhs

RBI order book, rhs


Employment Composite PMI employment averaged 50.2 in Oct-Dec, a tad lower than 50.3 in July-Dec. RBI’s survey also recorded a moderation in employment expectation (to 9.6% vs. 9.9%), while the D & B survey recorded an unchanged employment reading in Oct-Dec at 24%.

Exports Optimism about exports decreased in Oct-Dec’15 from the previous quarter, as per the RBI industrial outlook (16.7% vs. 19.7%) and the manufacturing PMI (51.1 vs. 52.8) surveys.

Input and output prices Composite PMI recorded an increase in input (51.9 vs. 50.3) and output price (50.3 vs. 50.1) through Oct-Dec, compared to July-Sep, while the RBI and D & B survey showed expectations for a softer increase in output prices through Oct-Dec, compared to the previous quarter. Latest inflation data show that core CPI inflation edged up to 5.4% in Oct-Dec, from a quarterly average of 5.3% in July-Sep, while core WPI inflation averaged -1.9% in Oct-Dec vs. -1.8% in July-Sep.

Overall, a lower level of optimism is observed in the major indicators across the various private and public surveys conducted during Oct-Dec’15. Post a soft end to 2015, India enters 2016 with weak economic momentum, high non-performing assets, a leveraged corporate sector and subdued market and business optimism. Increased uncertainty in global markets, especially in China, has complicated matters further. The focus will now shift to the announcement of the FY17 Union Budget in end-February.

Taimur Baig, Singapore, +65 6423 8681

Kaushik Das, Mumbai, +91 22 7180 4909

India: Deutsche Bank Forecasts

2014 2015F 2016F 2017F

National Income

Nominal GDP (USD bn) 2,014 2,057 2,124 2,333

Population (mn) 1,253 1,271 1,288 1,306


Real GDP (YoY %) 7.1 7.3 7.5 7.8



Gross fixed investment 3.1 5.7 8.2 9.5

Exports 4.9 -5.6 2.8 7.3

Imports -1.8 -4.9 2.6 8.8

Real GDP (FY YoY %) 1 7.3 7.3 7.5 7.8


CPI (YoY%) eop 4.3 5.6 4.5 4.9

CPI (YoY%) avg 6.7 4.9 5.2 4.8

Broad money (M3) eop 10.7 12.0 13.0 14.5


Fiscal Accounts (% of GDP) 1

Central government balance -4.0 -3.9 -3.8 -3.7



Central primary balance -0.8 -0.6 -0.5 -0.4

Consolidated deficit -6.5 -6.0 -5.8 -5.7 External Accounts (USD bn)



Trade balance -144.0 -139.6 -158.5 -179.8

% of GDP -7.2 -6.8 -7.3 -7.5

Current account balance -27.3 -18.0 -27.2 -38.1

% of GDP -1.4 -1.0 -1.3 -1.6

FDI (net) 25.0 30.0 35.0 35.0

FX reserves (USD bn) 332.3 362.6 399.2 430.6 FX rate (eop) INR/USD 63.3 66.3 68.0 69.0 Debt Indicators (% of GDP)

Government debt 68.4 68.4 67.5 65.3

Domestic 65.3 65.3 64.5 62.5

External 3.1 3.0 2.9 2.8


in USD bn 459.1 509.6 565.7 633.6

Short-term (% of total) 18.6 16.5 15.1 14.9 General

Industrial production (YoY %) 3.6 -2.4 4.7 3.3 Financial Markets Current 16Q1F 16Q2F 16Q4F

Repo rate 6.75 6.75 6.50 6.50

3-month treasury bill 7.20 6.90 6.80 6.70

10-year yield (%) 7.75 7.60 7.50 7.50

INR/USD 66.84 67.50 67.80 68.00 Source: CEIC, Deutsche Bank. (1) Fiscal year ending March of following year.

14 January 2016



Indonesia Baa3/BB+/BBB- Moody’s/S&P/Fitch

Economic outlook: The outlook is mixed, with commodity sector headwinds intensifying severely on one hand and the non-commodity sector becoming somewhat energized due to declining inflation and higher public spending on the other hand. A year of sub-5% growth is likely, but compared to its EM peers, we think that Indonesia’s performance will be superior.

Main risks: Rupiah volatility could undermine confidence in the economy; global market turmoil could take the mining and energy sector into crisis territory; the government’s plans to push through ambitious spending in infrastructure could be undermined by political infighting and capacity constraints in project implementation.

Moving past the commodity bust

As the global market turmoil leaves EM economies reeling, Indonesia is beginning 2016 attempting to differentiate itself from its beleaguered commodity exporting peers. 2015 ended on a mildly positive note, with growth momentum showing signs of stabilization. Among growth critical indicators, we detect signs of stabilization in imports of capital goods and a clear bottoming out of auto sales. Although exports are weak, bank credit growth is modest, and industrial production yet to accelerate, overall growth momentum has been picking up since September. Additionally, a stable political environment and an energized Executive branch of the government could make for some upside as the year progresses.

Growth momentum is weak but has been on the mend

since September

-1.00

-0.80

-0.60

-0.40

-0.20

0.00

0.20

0.40

2012 2013 2014 2015

Z score

Source: CEIC, Deutsche Bank. Growth momentum is a composite z-score of imports, credit growth, industrial production, and auto sales (over the 2005 to present period)

We have argued in the past that early 2016 could be the point when a virtuous cycle of low inflation and

lower interest rate could ensue. The early-January fuel price cut (5% for petrol and 16% for diesel) makes that scenario more likely. As seen in the chart below, even before the fuel price cut, Indonesia’s inflation momentum had eased considerably.

Indonesia’s inflation momentum is at last declining to

the same level as the rest of the region

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

0.0

2.5

5.0

7.5

10.0

2012 2013 2014 2015

EM Asia, left

Indonesia

CPI, SA,

3m/3m, ann.

CPI, SA,

3m/3m, ann.


We now see CPI inflation ranging 3.5-4% this year, which should allow Bank Indonesia to comfortably cut interest rates. Indeed, the cumulative magnitude of rate cuts could be more than our call of 50bps, especially if growth momentum remains weak. The key risk to cutting rates is the currency; we think that BI would need a couple of more months of supportive inflation and trade data before making its first move.

Fiscal to the rescue?

The government estimates that the budget deficit in 2015 was 2.8% of GDP, largest since the Asian crisis. Major shortfall in commodity related revenues was the main culprit, but even non-commodity receipts fared poorly as the economy slowed through the year. The government also got its fiscal projections (particularly oil price and revenue buoyancy) wrong by a large margin, compounding the problem). We think that similar fiscal outcomes are likely in 2017 and 2018 despite a bottoming of the revenue ratios; the government’s ambitious infrastructure spending agenda would push up the deficit. But given that Indonesia’s public debt ratios are the lowest among emerging economies, we think loosening the fiscal purse on account of good quality spending is an appropriate policy stance, especially in the context of major global demand deficiencies.

14 January 2016



While the government got its fiscal projections wrong last year, one should recognize that few saw the commodity market mayhem to be so dramatic, and it was after all the new government’s first full year in power. To its credit, the government managed to sharply increase the pace of capital spending (which was supposed to capitalize on savings from fuel subsidy reduction) in the second half of the year. With the political situation stabilizing and policy coordination improving within the government’s branches, growth supportive infrastructure spending should hit the ground running from the first month of the new year.

At the general government level, both revenues and

spending missed the budget target by a wide margin

-12.0%

-10.0%

-8.0%

-6.0%

-4.0%

-2.0%

0.0%

2012 2013 2014 2015

Rev growth (actual - budget)

Exp growth (actual - budget)

yoy


At the central government level, capital spending

picked up impressively toward the end of the year

-60%

-40%

-20%

0%

20%

40%

60%

Total spending

capital spending

%yoy, ytd



Indonesia: Deutsche Bank forecasts

2014 2015F 2016F 2017F

National Income


Population (mn) 252.2 256.6 261.1 265.0


Real GDP (YoY%) 5.0 4.7 4.7 5.0




Exports 1.0 -0.2 3.5 5.6

Imports 2.2 -4.9 1.0 8.5


CPI (YoY%) eop 8.4 3.4 4.0 5.4

CPI (YoY%) ann avg 6.4 6.4 3.8 5.0

Core CPI (YoY%) 4.5 5.0 4.5 4.0

Broad money (M2) 11.9 12.0 12.5 13.0

Bank credit (YoY%) 15.8 12.0 13.0 15.0


Budget surplus -2.2 -2.8 -2.7 -2.7





Merchandise exports 175 167 179 182

Merchandise imports 168 153 159 160

Trade balance 7.0 14.6 20.4 21.8

% of GDP 0.8 1.7 2.2 2.2


% of GDP -3.1 -2.2 -2.0 -1.8

FDI (net) 16.0 15.0 18.0 20.0


FX rate (eop) IDR/USD 12,440 13,795 13,500 13,000



Domestic 10.5 11.5 12.5 13.0

External 13.6 15.5 15.5 16.0


in USD bn 293.0 311.0 331.0 360.0

Short term (% of total) 18.8 18.3 18.1 17.2

General

Industrial production (YoY%) 4.7 5.0 6.0 6.0

Unemployment (%) 5.9 6.0 5.9 5.8


BI rate 7.50 7.25 7.00 7.00

10-year yield (%) 8.57 8.30 8.00 8.00

IDR/USD 13,935 13,850 13,700 13,500 Source: CEIC, DB Global Markets Research, National Sources

14 January 2016



Malaysia A3/A-/A-(Neg) Moody’s/S&P/Fitch

Economic outlook: Private consumption appeared to be holding up but the deceleration in investment activity likely pushed GDP growth lower in Q4.

Main risks: The MYR risks further depreciation if this recent drop in oil prices is sustained. Aside from oil, more aggressive RMB devaluations and a hawkish tone of the US Fed would add to the currency weakness.

Deteriorating at a slower pace

Economic markers released over the past month suggest a prolonged but less acute slack in growth momentum. The manufacturing PMI for December indicated the ninth consecutive month of contraction for the sector, although the pace of decline turned out less severe. But as new export orders increased in December, the domestic market saw a further reduction in total new orders amid rising input prices. This message of sluggish domestic activity is also reflected in the slower pace of growth in industrial production and manufacturing sales in November.

Manufacturing sector deteriorating at a slower pace

47

48

49

50

51

52

53

-6.0

-4.0

-2.0

0.0

2.0

4.0

6.0

Mar-14 Jul-14 Nov-14 Mar-15 Jul-15 Nov-15

Mfg real wages Mfg employment Mfg PMI (rhs)

%yoy, 3mma PMI

exp

ansio

nco

ntr

actio

n

A PMI below 50 indicates a deterioration in operating conditions. Source: Bloomberg Finance LP, CEIC, and Deutsche Bank

Likewise, imports remained in a slump, although the pace of contraction appears to have bottomed in August. Imports of capital and intermediate goods were still very weak though, suggesting lackluster capital formation and manufacturing production, despite improving slightly in recent months. Meanwhile, imports of consumption goods recovered in November after cooling down in 2015Q3. Perhaps, stronger wage growth and small improvements in employment, at least in the manufacturing sector, and lower inflation post-Q3 may have lifted consumer spending. By volume, imports grew by 2.0%yoy on average in October and November versus 2.6% in Q3.

Broad-based bottoming of imports

-40

-30

-20

-10

0

10

20

30

40

50

60

2010 2011 2012 2013 2014 2015Capital goods Intermediate goodsConsumption goods

Merch. imports growth. in USD (%yoy, 3mma)

We use imports in USD terms, netting out effects of MYR movements, to examine underlying domestic demand momentum. Expectedly, imports growth would appear stronger in local currency terms due to the MYR’s sharp depreciation) Source: CEIC and Deutsche Bank

The external sector also continued to post dismal returns despite accelerating shipments (volumes up 7.5%yoy in Oct-Nov vs. 3.3% in Q3), although the slump eased slightly post-Q3. Commodities contracted less severely, but the electrical and electronics segment experienced the sharpest drop (-22%yoy) since July 2009, depressing exports further in November. By destination, shipments to all major markets—China, Singapore, EU, US, and Japan—continued to yield negative returns per latest data.

Exports remained in a dismal state

-25.0

-20.0

-15.0

-10.0

-5.0

0.0

5.0

10.0

15.0

Jan-14 May-14 Sep-14 Jan-15 May-15 Sep-15

Others E&E Commodities Total

Contributions to yoy growth merch. exports in USD (bps)

Source: CEIC and Deutsche Bank

As exports improved a bit while the slump in imports intensified, the trade surplus widened considerably in October and November relative to Q3 (45%yoy vs. 3%). The trade balance therefore stands to bear a bigger positive contribution to Q4 GDP growth, mitigating the

14 January 2016



drags stemming from weak private consumption and investment activity. Given that imports of consumer goods gained pace post-Q3, it is also likely that private consumption improved sequentially in Q4 relative to our assumption of no growth. Thus, our 2015 growth estimate of 4.6% faces upside risk of about 20bps we think. That said, Q4 growth would still have likely eased further from 4.7% in Q3 on the back of decelerating investment activity.

Our 2016 outlook faces downside risks anew with the renewed weakness in crude oil prices. The government’s reliance on oil and gas revenues in the budget has gone down to 24.7% in 2015 (Jan-Sep) from over 30% in previous years, but it remains substantial. The Prime Minister, who is also the Finance Minister, has announced this month that the 2016 Budget will be revised to reflect lower oil prices.

With regard to the budget revision (which could happen this January as it did last year), we think the 2016 fiscal deficit target will likely be revised 10bps higher to 3.2% of GDP if oil prices average USD30 per barrel from the earlier projection of USD48 per barrel. The government has already compressed the operating side of expenditures. So revenue shortfalls will likely be countered by trimming development expenditures (i.e. big ticket infra projects like LRT3) as we believe was done in 2013 and 2014. GST collections have surprised to the upside in 2015 and so likely higher collections in 2016 (given that it will be the second year of implementation) could give the government some comfort in targeting a conservative fiscal deficit target, in our view.

The drop in oil prices also places downward pressure on the CA surplus through lower export earnings, although we estimate limited impact. With Malaysia’s oil surplus at 0.4% of GDP when crude oil prices averaged USD55 per barrel, a 45% drop in price (USD30 per barrel) would only reduce the CA surplus by 0.2% of GDP, holding other things constant. The impact would definitely be bigger if natural gas prices were to fall by the same amount, given the country’s gas surplus of 3.4% of GDP. But despite natural gas prices also falling (though less than 45%), we believe the CA surplus could even improve in 2016, with import demand softening, palm oil prices improving, and advanced economies’ demand slightly picking up.

Nonetheless, the MYR risks further depreciation if the recent drop in oil prices is sustained. Aside from oil, more aggressive RMB devaluations and a hawkish tone from the US Fed would add to the currency weakness.

Diana del Rosario, Singapore, +65 6423 5261

Malaysia: Deutsche Bank forecasts

2014 2015F 2016F 2017F

National Income


Population (mn) 30.6 31.0 31.4 31.8


Real GDP (YoY%) 6.0 4.6 4.2 5.0




Exports 5.1 0.7 4.5 5.2

Imports 4.2 1.2 3.4 6.6

Prices, Money and Banking (YoY%)

CPI (eop) 2.7 2.7 1.7 3.0

CPI (ann avg) 3.1 2.1 2.2 2.7

Broad money (eop) 7.0 3.4 5.4 6.5

Private credit (eop) 8.9 7.6 6.0 6.6


Central government surplus -3.4 -3.2 -3.1 -2.9



Primary balance -1.3 -1.1 -1.0 -0.7


Goods exports 207.8 176.7 165.1 184.3

Goods imports 173.2 147.7 137.5 156.0

Trade balance 34.7 29.0 27.6 28.3

% of GDP 10.2 9.7 9.9 9.1


% of GDP 4.3 2.7 3.1 3.4

FDI (net) -5.6 -1.0 1.0 -1.1

FX reserves (eop) 115.9 95.4 97.5 112.4

MYR/USD (eop) 3.50 4.29 4.41 4.20


Government debt1 68.2 69.6 71.6 73.3

Domestic 53.0 53.4 55.4 56.8

External 15.2 16.2 16.2 16.5


in USD bn 213.9 191.8 193.4 194.9


General (ann. avg)


Unemployment (%) 2.9 3.1 3.2 3.1

Financial Markets (%, eop) Current 16Q1F 16Q2F 16Q4F

Overnight call rate 3.25 3.25 3.25 3.25


10-year yield 4.20 4.30 4.40 4.40

MYR/USD 4.40 4.69 4.72 4.41 (1) Includes government guarantees Source: CEIC, DB Global Markets Research, National Sources

14 January 2016



Philippines Baa3(Pos)/BBB-/BBB- Moody’s/S&P/Fitch

Economic outlook: Growth likely strengthened

30bps to 6.3% in Q4 which would put 2015 growth

easing by 20bps to 5.8% from a year ago.

Main risks: A deepening exports slump could bring

domestic and external imbalances, increasing

market volatility and limiting growth potential.

Re-calibrating expectations

Despite the rout in financial markets and another year of weak external demand, 2015 proved to be a fairly decent year for the Philippine economy. Growth remained one of the strongest within EM, albeit easing from the preceding three years, with the unemployment rate on a downtrend for the second consecutive year. Inflation reached record lows, dampened by low commodity prices, even as domestic demand stayed robust. Credit growth also eased to a more sustainable rate, burying concerns of overheating. Meanwhile, government spending started to gain momentum after the poor disbursement record in the previous year. We are positive for 2016: the renewed weakness in crude oil prices, on top of a likely surge in election-related spending, could further accelerate domestic demand. However, there may be some fault lines that could challenge the economy and markets this year.

Real growth outpacing nominal growth in 2015

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

16.0

2010 2011 2012 2013 2014 2015

Nominal GDP Real GDP

Growth (%yoy)

Source: CEIC and Deutsche Bank

Drastic drop in nominal GDP growth We believe real GDP figures mask underlying economic weakness, especially with regard to the extent of the external sector’s drag on economic expansion. Real GDP growth (i.e. netting out inflationary effects) eased 50bps over the previous year to average 5.6% in the first three quarters of 2015, albeit still robust by

historical standards. On the other hand, nominal GDP growth in 2015 printed the weakest in six years and, were it not for the global slowdown in 2009, would have been the weakest since 1955. For the first three quarters of 2015, it slowed to 5.1%yoy (4.5% in Q3) from 9-10% in the preceding 2.5 years. This sharp drop in nominal GDP growth implies a lower return on equity and could explain the disappointment in corporate earnings last year. Meanwhile, the outperformance of real over nominal GDP growth last year can be attributed to the global slump in commodity prices which, in turn, resulted in the decline in domestic prices as measured by the GDP deflator.

It is likely that the deflationary impulse from the more recent drop in crude oil prices could depress earnings growth for yet another year. Export-oriented corporates are most vulnerable, given the poor showing of the external sector last year is likely to continue through 2016. Dismal returns in this sector could, in turn, undermine the much-needed development of the manufacturing sector, which arguably is the missing link between the country’s strong growth and muted improvement in job creation. Whereas sustained strengths in domestic consumption and the services sector should continue to drive income gains, in our view, a deeper stagnation of the manufacturing sector could result in domestic and external imbalances, and limit the economy’s growth potential.

Manufacturing risks further stagnation

0.0

10.0

20.0

30.0

40.0

50.0

60.0

2001-05 2006-10 2011-14 2015

Services Manufacturing Industry ex-Mfg Agriculture

% of nominal GDP

Industry ex-manufacturing refers to Mining & Quarying, Construction, and Electricity, Gas & Water Supply. Agriculture refers to Agriculture, Hunting, Fishery & Forestry. Source: CEIC and Deutsche Bank

Shrinking CA surplus, greater PHP depreciation We see downside risks to the current account surplus amid a widening trade deficit, especially as net inflows in remittances and services exports cool down. Remittances appear to have been adversely affected by

14 January 2016



the tighter anti-money laundering regulations in developed countries (US, UK, Australia, NZ) as inflows from these countries have declined recently, paring down total remittance growth to 3.7%yoy in 2015 (Jan-Oct) from 6.0% in 2014. Meanwhile, the acceleration of services imports (e.g., outward tourism expenditures) for a couple of years now has reduced the surplus in services trade since 2014 by about half relative to preceding years. Weaker inflows from these two were unable to offset the sharp increase in the trade deficit in Q3 (8.4% of GDP from 5-6% in the past 4 quarters), bringing down the current account surplus to 1.0% of GDP. For 2015ytd, the current account surplus shrank to 2.6% of GDP from 4.0% two years earlier.

Post-Q3, merchandise exports continued to decline in October and November, although the pace of contraction appears to have bottomed. If sustained, this would help arrest the deterioration in the current account surplus and would reduce the drag of the trade deficit to GDP growth. However, this remains uncertain and we are inclined to think that the headwinds surrounding global growth should continue to depress exports growth, while accelerating domestic demand will further strengthen imports growth, thereby further reducing the CA surplus this year. Accordingly, in our view, this would increase the BSP’s tolerance towards the PHP’s depreciation amid downward pressures stemming from China’s slowdown and financial liberalization (likely RMB devaluation) and US Fed hikes.

Q4 growth likely at 6.3%, 2015 growth down to 5.8% We estimate that real GDP growth strengthened 30bps to 6.3%yoy in the final quarter of 2015 on the back of a favorable base on government consumption. Despite efforts to accelerate spending, the government’s disbursement rate is likely to disappoint again this year at 86% of the budget vs. 88% last year. The trade deficit likely weighed again on Q4 growth, albeit to a lesser degree as the drop in exports may have already bottomed in September. Private building construction likely weakened in Q4, based on permits issued a quarter earlier, but we think the slowdown may have been mitigated by a pick-up in public works towards elections. Meanwhile, nominal GDP growth may have settled within the 4-5% range, dampened by the continued decline in commodity prices.

Inflation on the rise but likely benign in the near term CPI inflation accelerated 70bps to 1.1% in November and then 1.5% in December on the back of faster increases in food and energy prices. With inflation averaging 1.4% in 2015, well below the BSP’s 2-4% target for 2016, near-term inflationary pressures are likely only going to prompt policy rate hikes in the latter half of 2016 when inflation risks breach the upper band of the target

Diana del Rosario, Singapore, +65 6423 5261

Philippines: Deutsche Bank Forecasts

2014 2015F 2016F 2017F

National Income


Population (mn) 99.9 101.6 103.2 104.9


Real GDP (YoY%) 6.1 5.8 6.0 5.8




Exports 11.3 5.2 5.7 6.3

Imports 8.7 10.7 8.7 7.5

Prices, Money and Banking (YoY%) CPI (eop) 2.7 1.5 3.7 3.2

CPI (ann avg) 4.2 1.4 3.2 3.2

Broad money (M3, eop) 11.2 8.9 10.8 10.9

Private credit (eop) 19.9 11.1 12.1 11.7

Fiscal Accounts (% of GDP)1

Fiscal balance -0.6 -1.5 -1.6 -1.8





Goods exports 49.8 42.9 50.4 55.8

Goods imports 66.1 64.3 76.2 81.0

Trade balance -16.3 -21.4 -25.8 -25.2

% of GDP -5.7 -7.3 -8.8 -7.9


% of GDP 3.8 2.4 1.7 2.2

FDI (net) -1.0 0.2 0.1 0.2

FX reserves (eop) 79.5 80.6 79.0 83.9

PHP/USD (eop) 44.6 47.2 48.0 47.0 Debt Indicators (% of GDP)

General government debt2 48.7 47.7 47.3 45.5

Domestic 31.2 30.1 29.8 29.5

External 17.6 17.7 17.5 16.0

External debt 27.3 25.7 26.4 24.6

in USD bn 77.7 75.6 77.6 77.8

Short-term (% of total) 20.9 19.2 20.5 20.0 General (ann. Avg)


Unemployment (%) 6.8 6.3 6.5 6.0 Financial Markets (%, eop) Current 16Q1F 16Q2F 16Q4F

Policy rate (BSP o/n repo) 6.00 6.00 6.00 6.50

Policy rate (BSP o/n rev repo) 4.00 4.00 4.00 4.50

3-month T-bill rate 2.14 1.99 3.24 3.99

10-year yield (%) 4.26 4.40 4.40 4.50

PHP/USD 47.0 47.9 48.7 48.0 (1) Refers to general government. (2) Includes guarantees on SOE debt. Source: CEIC, Deutsche Bank Forecasts, National Sources

14 January 2016



Singapore Aaa/AAA/AAA Moody’s/S&P/Fitch

Economic outlook: Modest growth continues, with support from construction and services, even as manufacturing continues to weaken on the back of soft external demand. The commodity refining, storage, and trading sector is facing major headwind that will likely persist through the year. The property market remains in doldrums, posing a dilemma to the policy makers on how to manage the SGD and its impact on rates.

Main risks: Deflation has intensified, and could further exacerbate household and corporate debt sustainability, hold back income and revenue growth, and make the government’s fiscal and monetary policy stance look contradictory.

Renewed deflationary pressure and associated policy difficulties

Inflation forecasts are turning out to be subject to frequent revision these days, with past trends and seasonality barely factoring into ongoing developments. Consider the last two inflation prints for Singapore; looking at historical trends in rental, transportation, and energy, it would have been perhaps reasonable to expect deflation pressures to ebb toward the end of 2015, especially as the base effect from 2014 ebbed. Indeed, consensus expectation was that inflation would leave nearly a year long period of negative price growth by the end of 2015.

In the event, it has been in fact anything but an end to deflation for Singapore. Both October and November prints surprised substantially to the downside, setting up a considerably longer path of deflation than imagined just a few months ago. Strikingly, the November CPI was a full percentage point below the reading in the same period two years ago. The all items CPI was down 0.8%yoy in November, but more importantly, inflation momentum (CPI, 3m/3m, saar) was -2.4%, the lowest in EM Asia. Not only is inflation very low by regional comparison, our measure of Singapore’s inflation momentum is 1.6 standard deviation below the 10-year average (see following chart). Core inflation is running at just 0.2%.

The obvious answer to the downward pressure prices and negative surprise on inflation is the rapid decline of commodities, with global oil price down by more than 50%yoy and non-energy primary commodities down 21%yoy. Further downside to these items was amply visible in December and price decline is continuing through January, which means the commodity drag to the CPI will continue.

Singapore has had the weakest inflation momentum in

the region

-1.5

-1.0

-0.5

0.0

z-score

Source: CEIC, Deutsche Bank. The chart is constructed from inflation data ranging 2005 to 2015, first by obtaining inflation momentum (CPI,3m/3m, saar) and then calculating the z-score.

But note that Singapore's petrol pump prices have not come down even remotely commensurate with global developments, with the private road transport part of the CPI down just 1.7%yoy through November. This means the ongoing deflationary development must be reflecting broader factors beyond commodities.

Indeed, one of the key drivers of lower CPI is completely independent of commodities; it is accommodation. The property market has been slowing for the last couple of years, and while initially it merely stalled in response to a range of cooling measures implemented by the authorities, lately the market is responding to global events (especially concerns about China) and rising short term rates (3-month SIBOR has more than doubled from 0.5% a year ago to 1.25% presently). Consequently, the accommodation part of the CPI is down 3%yoy. We don't think much relief is in store for the market, as the authorities are well aware that the price level of housing is still subject of much consternation among the population.

Beyond transportation and accommodation, the inflation picture is not vigorous either. Food inflation is up just 1.6%yoy, with the cost of neither home cooked not restaurant meals going up appreciably. Interestingly, contrary to widespread fears of an upsurge in food prices due to El-Nino related poor weather affecting harvests, it appears that supply disruption has been manageable while demand growth has been fairly modest. In fact, a number of food items, including fruits, oils, soft drinks, vegetables, and seafood saw prices decline in November.

14 January 2016



Services prices fell by 0.1%mom in November (+0.7%yoy vs. 0.8%yoy in October). There is an idiosyncratic element to the easing of services prices, which is a policy orchestrated decline in healthcare, costs. Starting in November 2015, the old health insurance system called MediShield was replaced by MediShield Life, a mandatory basic health insurance scheme, which provides enhanced coverage benefits and covers all Singapore citizens and permanent residents for life. The reduction in healthcare costs in November takes into account government subsidies and support for MediShield Life premiums.

The ongoing local and external developments have prompted us to revise down Singapore’s inflation forecast for 2016. We now see inflation averaging no more than 0% this year, with the end-2016 forecast at 0.8%. Deflation will likely persist through the first half of the year. In its latest write-up on the policy outlook, the MAS envisions a benign inflationary environment, appearing to be not concerned about the prolonged nature of price declines. The prevailing tightness in the domestic labor market is seen to be a source of wage pressure, but the monetary authority sees pass-through to consumer prices to be constrained by the subdued growth environment. The forecast range of the MAS, -0.5% to +0.5%, splits our forecast evenly. We think that the risk to the forecast is to the downside, as energy, accommodation, and transportation could well fall by more than expected in the coming months.

Q4 GDP data may mask difficulties ahead

Based on advance estimates, real GDP grew by 2%yoy in Q4 (1.8%yoy in Q3). On a quarter-on-quarter seasonally-adjusted annualized basis, this represented a pace of 5.7% (1.7% in Q3). For 2015, the economy grew by 2%, in line with the government's forecasts and perhaps reflecting Singapore's "new normal." The manufacturing sector contracted by 6.0%yoy (-3.5% saar), not surprising given the poor exports data. Output of electronics, transport engineering and precision engineering clusters contracted. This marks the second quarter in a row of large contraction of manufacturing output. We don’t see any respite in this area this either. The construction sector expanded by 2.2%yoy, helped by public sector projects, while services grew by 3.2%yoy, supported by wholesale & retail trade and finance & insurance sectors.

With these developments, we are compelled to revise down our 2016 growth forecast to 2%. Headwinds to manufacturing will persist; construction may have further downside. Services may do fine, but that won’t be enough to pull up growth appreciably.


Singapore: Deutsche Bank Forecasts

2014 2015F 2016F 2017F

National Income


Population (mn) 5.5 5.6 5.7 5.8


Real GDP (YoY%) 2.9 2.0 2.0 2.5



Gross fixed investment -1.9 -0.3 -3.9 3.5

Exports 2.1 2.8 3.8 3.8

Imports 1.4 1.9 3.5 4.3


CPI (YoY%) eop -0.1 -0.7 0.8 1.8

CPI (YoY%) ann avg 1.0 -0.5 0.0 1.5

Broad money (M2) 2.5 3.5 4.0 4.0

Bank credit (YoY%) 11.3 9.0 10.0 9.0


Fiscal balance 4.9 2.6 3.3 3.1






Trade balance 77.2 84.0 86.5 89.1

% of GDP 25.1 28.7 28.8 28.2


% of GDP 18.3 20.2 19.4 17.8

FDI (net) 20.0 25.0 30.0 25.0


FX rate (eop) SGD/USD 1.32 1.40 1.45 1.40


Government debt 99.3 101.6 101.9 104.1

Domestic 98.3 100.6 100.9 103.1

External 1.0 1.0 1.0 1.0

Total external debt 450 483 439 434

in USD bn 1,331 1,344 1,358 1,373


General

Industrial production (YoY%) 0.6 -5.0 -2.0 3.0

Unemployment (%) (eop) 2.6 2.5 2.5 2.6



10-year yield (%) 2.58 2.70 2.85 2.85

SGD/USD 1.44 1.45 1.50 1.45 Source: CEIC, DB Global Markets Research, National Sources Note: includes external liabilities of ACU banks.

14 January 2016



South Korea Aa3/A+/AA- Moody’s/S&P/Fitch

Economic outlook. In the absence of any

significant shock to the economy, we foresee a

steady rate in Korea, stuck between diverging US

and China rates.

Main risks. Sustained opposition to reform poses

significant downside risks to Korea’s growth and

rates.

Stuck in the middle

Sustained growth in Q4 supported by consumption recovery, countering weak exports. Exports ended the last quarter of 2015 on a weak note, falling 11.5% vs. 9.6% in Q3, the worst since the 2008 global financial crisis (GFC). On a volume basis, export growth fell to 1.5%yoy in Oct/Nov from 4.1% in Q3. Investment data also worsened, depressed by weak exports, with equipment investment growth slowing to 3.6% in Oct/Nov from 10.4% in Q3. In contrast, tourism services pointed to continued improvement. The effects of MERS dropped out from the data, with the number of tourists rising 4% in October/November vs. a 27.7% fall in Q3. Moreover, retail sales growth continued to improve, rising to 6.9% yoy in October/November from 3.2% in Q3. Meanwhile, growth in construction completed stood relatively stable at 5% vs. 5.9% in the same period, pointing to sustained growth in construction investment amid rising housing prices, although it may be nearing its peak. Data thus far do not prompt us to change our expectation of a modest improvement in growth to 2.9%yoy in Q4. However, lack of improvement in external conditions poses downside risk to our growth forecast of 2.8% for 2016.

China risks to the won

1,000

1,050

1,100

1,150

1,200

1,250

5.8

6.0

6.2

6.4

6.6

6.8

Jun-15 Aug-15 Oct-15 Dec-15

RMB/USD (lhs)

KRW/USD

Sources: CEIC, Deutsche Bank

A troubling start to 2016, guiding the won weaker… Korea kicked off this year on rather nervous footing due largely to external shocks – the CNY’s notable volatility and North Korea’s nuclear test – amid lack of

improvement in external demand. North Korea’s nuclear test has not only moved the two Koreas further away from peaceful unification, but also significantly increased geopolitical risks to the region. While there are many paths to unification, which make rendering cost estimates difficult, we attempted to do so in our report, Korea: Silver lining, published on 25 November 2015. Regarding the weakness in the CNY, with our China economists now seeing a higher USD/CNY at 7 by end-2016, we see USD/KRW heading higher still to

1,280 by the end of this year.

…keeping policy rates steady… Amid a weaker won, we see the Bank of Korea (BoK) keeping the policy

rate unchanged in 2016, amid a limited rise in inflation and increasing risks to growth. We see CPI inflation averaging 1.4% (vs. the BoK’s 1.7% forecast) in 2016 vs. 0.7% in 2015, keeping the BoK policy rate steady this year. Although further falls in oil prices pose downside risks to this outlook, domestic gas and fuel prices have adjusted relatively modestly to changing international oil prices. Local fuel prices fell only about 15% yoy in December as tax share rose.

The BoK lowered its inflation target by 1ppt, reflecting its view that Korea has experienced meaningful structural changes over last few years. Meanwhile, its point target of 2% (vs. the range target of 2.5-3.5% in 2013-15) reflects the BoK’s wish to eliminate any bias toward focusing on the edge of the range, in our view. Having said that, we think that its suggested tolerance range (+/-0.5ppts) and right to adjust the target (in case of any unexpected economic shocks) point to its conservative stance, given the private sector’s high indebtedness.

Sharply higher private debt growth in 2015

-5

0

5

10

2010 2011 2012 2013 2014 2015

Domestic claim on the private non fin sector

% yoy% yoy 3mma


Another preoccupation of the BoK is the high indebtedness of the private sector. The household debt-

14 January 2016



to-disposable income ratio continued to rise to 143.0 in Q3 2015 from 133 in Q3 2014. Meanwhile, the sharper fall in sales points to increasing share of marginalized firms in 2015, which stood at 10.6% in 2014. While its Household Debt Task Force continues to monitor household debt conditions, the BoK has worked with the government to come up with a package of household debt management measures, including tightened rules on household loans, while calling for speedy restructuring of marginalized firms, among others.

The BoK also has its Monetary and Financial Task Force at hand, ready to support the financial and foreign exchange markets if necessary. As a net creditor to the world, equipped with larger FX reserves, Korea is in a better position to defend the won if needed. As for other possible responses by the BoK in case of extreme dislocation in FX, we refer to its past actions. During the GFC, the BoK injected funds into the banking and non-banking sectors and broadened collateral and counterparties eligible for open market operations, ensuring ample liquidity to the system, while the government had banks automatically roll over SME loans. The BoK also supplied FX directly to financial institutions rather than using up its FX reserves to defend the won, among other things.

…while limited reform poses downside risk to growth and therefore rates, in the medium term. Although the government has a comprehensive reform and restructuring plan at hand, it faces serious political challenges. For example, the services-related and labor market-related reform bills remain stuck at the National Assembly (see our note, Korea’s Big Bang challenged by political paralysis, published on 14 May 2015, for further details) . On a positive note, financially healthy large conglomerates have already started restructuring efforts voluntarily, motivated not only by a generation change in management but also by a desire to focus on core businesses, as is reflected in increased M&A activity. Their focus on core and new business is critical amid the rise of China’s red supply chain. Korea has already felt the pain of China’s push in the steel and petrochemical industries, among others, and it has now set its sights on the ICT sector. Meanwhile, there is much work to be done this year in the restructuring of financially stressed shipping, shipbuilding and construction firms.

As far as fiscal policy is concerned, although we see the government maintaining its easing bias – now targeting nominal as well as real growth – we see the government maintaining its fiscal prudence by limiting its response to frontloading spending to 1H, until data point to material deterioration in growth prospects.

Juliana Lee, Hong Kong, +852 2203 8312

South Korea: Deutsche Bank forecasts

2014 2015F 2016F 2017F

National income

Nominal GDP (USDbn) 1411 1368 1336 1419

Population (m) 50.4 50.6 50.8 51.0


Real GDP (yoy %) 3.3 2.6 2.8 3.0




Exports 2.8 0.2 2.4 4.0

Imports 2.1 2.4 2.3 3.2

Prices, money and banking

CPI (yoy %) eop 0.8 1.3 1.3 1.9

CPI (yoy %) ann. Avg. 1.3 0.7 1.4 1.7

Broad money (Lf) 7.7 9.0 8.0 9.2

Bank credit (yoy %) 6.3 8.0 7.5 7.5

Fiscal accounts (% of GDP)

Central government surplus 0.6 -0.3 -0.2 0.1




External accounts (USDbn)



Trade balance 92.7 129.1 111.5 117.1

% of GDP 6.6 9.4 8.3 8.3


% of GDP 6.3 8.9 7.3 7.2

FDI (net) -20.7 -20.0 -18.0 -20.0

FX reserves (USDbn) 1 363.6 368.0 362.1 379.5

FX rate (eop) KRW/USD 1099 1175 1280 1290

Debt indicators (% of GDP)

Government debt2 35.8 38.7 40.5 40.7

Domestic 35.4 38.4 40.4 40.7

External 0.5 0.3 0.1 0.0


in USDbn 425.4 425.0 415.0 425.0


General

Industrial production (yoy %) 0.0 0.0 1.5 2.5

Unemployment (%) 3.6 3.7 3.7 3.7

Financial markets Current 16Q1F 16Q2F 16Q4F

BoK base rate 1.50 1.50 1.50 1.50

91-day CD 1.67 1.60 1.60 1.65

10-year yield (%) 2.04 2.20 2.45 2.60

KRW/USD 1210 1230 1250 1280

Source: CEIC, Deutsche Bank estimates, Global Markets Research, National Sources Note: (1) FX swap funds unaccounted for (2) Includes government guarantees

14 January 2016



Sri Lanka B1(stable)/B+/BB- Moody’s/S&P/Fitch

Economic outlook. Post the 3Q GDP data, we are

revising down our 2015 full year real GDP growth

estimate by 50bps to 5.0%. The 2016 and 2017

growth forecasts of 6.0% and 7.0% remain

unchanged at this stage.

Main risks. A lower than trend nominal GDP

growth could push up budget deficit and public

sector debt/GDP ratio higher from current levels

(which even now is at an uncomfortably high level),

unless the government resorts to expenditure

compression strategy.

Monetary tightening commences to put a lid on core inflation and excess liquidity

Sri Lanka’s December CPI inflation was 2.8%yoy (+0.3%mom), slightly lower than the November outturn of 3.1%yoy. The 12-month average of CPI and core CPI was 0.9% and 3.1% respectively in 2015, a record low. In December, food inflation moderated to 4.2%yoy, from 5.2%yoy in the previous month, while housing/electricity/gas & fuel inflation remained in the negative territory (-2.5%yoy). While the headline CPI inflation remains muted, pressure on core CPI inflation is rising, with the yoy rate inching up to 4.5% in December, from 4.3% in the previous month.

CPI and core CPI inflation

-2

0

2

4

6

8

10

12

2009 2010 2011 2012 2013 2014 2015

CPI Core CPI% yoy% yoy

Source: CBSL, Deutsche Bank

Add to this, a buildup of excess liquidity in domestic money market and the fact that private sector credit growth is appreciably high (26.3%yoy in Oct’15), clearly justified some monetary tightening to put a lid on pipeline inflationary pressure. In fact, we have been arguing for some time now that despite the muted CPI inflation data, CBSL should shift monetary policy stance to a tightening bias, based on credit growth and

liquidity considerations. The CBSL took the first step in that direction in the December monetary policy by raising the Statutory Reserve Ratio (SRR) applicable to all rupee deposit liabilities of commercial banks by 150bps to 7.50% (effective from 16 January 2016).

Credit growth exceptionally high

6

7

8

9

10

-10

0

10

20

30

40

2010 2011 2012 2013 2014 2015

Credit growth, lhs

Policy rate, rhs

% yoy, 3mma %

Source: CBSL, Deutsche Bank

Post this move, we expect the CBSL to stay on the sidelines and monitor the trend of liquidity and inflation for some time. Our call is that CBSL will be raising policy rates in early 2Q, though we do not rule out the possibility of a rate hike by the end of 1Q itself. However, we do not see the CBSL raising rates more than 50bps in 2016, given the need to support growth as well. Real GDP growth moderated to 4.8%yoy in 3Q of 2015, from 6.0%yoy in the previous quarter and our forecast indicates that 4Q growth would be even lower at 4.5%yoy (due to an unfavorable base effect).

Real GDP growth moderated in 3Q of 2015

0

6

12

18

2011 2012 2013 2014 2015

Real GDP growth% yoy


14 January 2016



A lower nominal GDP growth will pose greater challenge for fiscal consolidation

Post the 3Q GDP data, we are revising down our 2015 full year real GDP growth estimate by 50bps to 5.0%. The 2016 and 2017 growth forecasts of 6.0% and 7.0% remain unchanged at this stage.

While we are forecasting economic growth momentum to improve gradually from this year onward, we do not expect either real or nominal GDP growth to return to levels seen during the high-growth period of 2011-2012. Weak commodity prices will likely keep inflation below 5% in the years to come, which would prevent nominal GDP growth to rise to the high teens, even after factoring in some improvement in real GDP growth.

A lower nominal GDP growth is going to make the Sri Lankan authorities’ task of bringing fiscal deficit (6.0% of GDP) and public sector debt/GDP ratio (72.5% of GDP) down to reasonable levels even more challenging. Note that the fiscal consolidation which was underway since 2010 reversed in 2014, which was also the period when Sri Lanka’s nominal GDP growth fell sharply.

Nominal GDP growth has come off sharply from 2012

0

2

4

6

8

10

12

0

5

10

15

20

25

2011 2012 2013 2014 2015

Nominal GDP, lhs

GDP deflator, rhs

% yoy %


A lower nominal GDP growth would imply a lower growth in tax revenue, and this is likely to put more pressure on fiscal deficit, unless some offsetting cut in expenditure is undertaken. We think such a scenario will play out in 2016, with the Sri Lankan authorities finally being compelled to cut capital expenditure to offset the revenue slippages that are inevitable due to lower economic growth.

Kaushik Das, Mumbai, +91 22 7180 4909

Sri Lanka: Deutsche Bank Forecasts

2014 2015F 2016F 2017F

National Income


Population (mn) 20.6 20.8 21.0 21.1


Real GDP (YoY %) 4.5 5.0 6.0 7.0

Total consumption 5.0 7.5 7.5 7.8

Total investment 2.2 4.0 5.0 6.0

Private 3.4 4.5 5.0 6.0

Government -2.2 1.0 2.0 3.0

Exports 4.9 5.0 7.0 8.0

Imports 9.5 3.9 6.0 7.0


CPI (YoY%) eop 2.1 2.8 3.8 6.0

CPI (YoY%) avg 3.3 0.9 4.0 5.0

Broad money (M2b) eop 13.4 16.0 16.0 15.0



Central government balance -5.7 -6.0 -6.0 -5.5



Primary balance -1.5 -1.6 -2.0 -1.5




Trade balance -8.3 -8.5 -9.0 -9.8

% of GDP -10.5 -10.4 -10.6 -10.5


% of GDP -2.6 -1.6 -1.4 -1.5

FDI (net) 0.9 1.0 1.0 1.5


FX rate (eop) LKR/USD 131.3 144.2 145.0 147.0



Domestic 41.6 43.5 42.4 40.1

External 30.2 29.0 29.5 29.1


in USD bn 43.0 46.4 50.1 54.2


General

Industrial production (YoY %) 11.4 7.6 8.0 8.5

Unemployment (%) 4.4 4.5 4.5 4.5


Reverse Repo rate 7.50 7.50 8.00 8.00

LKR/USD 143.9 144.0 144.5 145.0 Source: CEIC, DB Global Markets Research, National Sources

14 January 2016



Taiwan Aa3/AA-/A+ Moody’s/S&P/Fitch

Economic outlook: Taiwan’s cyclical recovery is at

risk amid worsening external conditions.

Main risks: With a limited fiscal policy response,

we expect more work to be done on the part of the

central bank during the power transition.

Monetary policy fills the temporary gap

Amid sustained weakness in growth… Exports remained weak in Q4, falling 13.9% yoy in Q4 − the same pace of decline as that reported in Q3. This decline in exports quickly dragged down investment, as indicated by weak imports of capital goods. The latter’s growth slowed sharply, to 0.6% in Q4, from a rise of 9.1% in Q3. Meanwhile, commerce sales continued to contract, albeit at a slower pace of 2.5% in October/November, vs. the 4% decline in Q3. These high frequency data point to another quarter of a modest yoy decline in Q4, suggesting weaker-than-expected growth in 2015. Together with a rather precarious start to the year, we see a significant risk of GDP growth failing to rise above 2% in 2016. However, we would wait for another month of data to make changes to our forecasts.

Little improvement in Q4, if any

-15

-5

5

15

25

-50

-30

-10

10

30

50

2011 2013 2015

Exports

Capital goods

imports

%yoy %yoy


…further monetary easing is likely in 2016 amid a limited fiscal response… Despite weak growth, we believe macro policy responses from the authorities may be limited amid the power transition. Note that Taiwan’s new President (election for whom takes place on 16 January) will take office only in late May. Until then, we are unlikely to see significant fiscal policy responses or a reform plans that address the increasing challenges to Taiwan’s growth – ageing and rising competition from “red supply chain”, among others.

As such, we see the Central Bank of China (CBC) doing the ‘heavy lifting’, delivering more rate cuts in 1H. In December 2015, it delivered a 12.5bp rate cut, as we had anticipated, in response to a widening negative output gap and low inflation. More importantly, in its monetary policy statement, the CBC hinted at further monetary easing ahead.

Real rates remain stable amid low inflation

-3

-2

-1

0

1

2

3

4

2011 2012 2013 2014 2015

CBC Policy rate - CPI inflation%

After Dec rate cut


Noting that global growth recovery “will not be able to drive trade growth sufficiently”, limiting “improvement in external demand and consequently slowing private investment growth as well as consumer spending,” the CBC noted that ”more efforts are needed to reinforce economic growth momentum.” The CBC set its M2 growth target for 2016 at 2.5-6.5%, with an aim to maintain “easy money conditions for sufficiently meeting funding needs and fostering economic growth.”

Dynamics of inflation

-40

-20

0

20

40

60

-4

-2

0

2

4

6

2011 2012 2013 2014 2015

CPI Food Fuel

%yoy 3mma


14 January 2016



We expect the CBC to deliver two more 12.5bp rate

cuts in 1H, amid muted inflation, depressed by a persistently negative output gap and low fuel prices. The CBC sees inflation averaging 0.8% in 2016, vs. -0.3% in 2015. We now expect inflation to reach 0.7% this year, following lower-than-expected inflation in Q4. In a world of the diverging monetary policy stance of the US and China, we see Taiwan compelled to follow the latter’s bias, given its importance to growth. After accounting for reprocessing, China consumed 19.9% of the exports of Taiwan in 2014, vs. the US’s 16.9%.

Moreover, we see little reason for the CBC to resist weakness of the TW dollar given poor exports and the CNY’s depreciation against the US dollar. Assuming that USDCNY rises to 7 by end-2016 (as expected by our China economist), we expect USDTWD to rise to

36 by end-2016, with risks tilted to the upside.

TWD to follow CNY’s weakness

30

31

32

33

34

5.8

5.9

6.0

6.1

6.2

6.3

6.4

6.5

6.6

6.7


RMB/USD (lhs)

NTD/USD


…while waiting for a reform to address structural challenges. As noted earlier, we see little chance of a stronger fiscal response until the new administration takes office. As far as the CBC’s call for “an optimal mix of countercyclical policies” and “appropriate structural reforms” to address longer-term structural constraints to boost growth and create jobs,” this too remains uncertain amid political changes. Other than an ageing population, “the rise of China’s red supply chain” poses serious challenges. As noted earlier, according to the Taiwan Institute of Economic Research (TIER), the rate of local equipment purchases increased from 55% in 2008 to 73% in 2013, while the rate for raw materials and steel stood at 66% and 99%, respectively. Worse still for Taiwan, China has focused its attention on the ICT industry, while regulatory hurdles remain high for its investment in Taiwanese firms.


Taiwan: Deutsche Bank forecasts 2014 2015F 2016F 2017F

National income

Nominal GDP (USDbn) 530.8 520.8 504.2 520.6

Population (m) 23.4 23.5 23.5 23.6


Real GDP (yoy %) 3.9 1.0 2.4 2.7


Government consumption 3.6 -0.6 1.0 0.5


Exports 1.6 -0.1 2.9 4.5

Imports 1.5 0.7 2.4 3.9


CPI (yoy %) eop 0.6 0.1 1.0 1.5

CPI (yoy %) annual average 1.2 -0.3 0.7 1.4

Broad money (M2) 5.8 6.2 6.5 7.0

Bank credit1 (yoy %) 4.3 3.5 4.5 5.5

Fiscal accounts (% of GDP)

Budget surplus -0.8 -1.6 -1.8 -1.7



Primary surplus 0.2 -0.5 -0.7 -0.5

External accounts (USDbn)



Trade balance 41.5 59.4 53.0 50.1

% of GDP 7.8 11.4 10.5 9.6


% of GDP 12.3 15.6 14.0 12.7

FDI (net) -9.8 -12.0 -11.0 -12.0

FX reserves (USDbn) 419.0 426.0 424.0 432.7

FX rate (eop) TWD/USD 31.7 32.9 36.0 36.2


Government debt2 37.4 38.0 38.8 40.3

Domestic 37.4 38.0 38.8 40.3

External 0.0 0.0 0.0 0.0


in USDbn 177.9 183.3 188.8 194.4


General

Industrial production (yoy%) 6.4 0.0 2.0 3.5

Unemployment (%) 4.0 3.8 3.8 3.8


Discount rate 1.63 1.50 1.38 1.38

90-day CP 0.80 0.68 0.55 0.57

10-year yield (%) 0.99 1.10 1.25 1.50

TWD/USD 33.5 34.0 35.0 36.0 Source: CEIC, Deutsche Bank Global Markets Research, National Sources Note: (1) Credit to private sector. (2) Including guarantees on SOE debt

14 January 2016



Thailand Baa1/BBB+/BBB+ Moody’s/S&P/Fitch

Economic outlook: There are marginal signs of the economy reaching a bottom, but the overall level of activity remains weak. Observers continue to hope for a public sector-led recovery in investment, but despite a proactive government there has been no meaningful turnaround in business sentiment. Global market nervousness at the beginning of the year has hurt local markets dynamics as well, darkening the outlook further.

Main risks: Key risk is a return of deflation on the back of renewed weakness in global energy prices. Thailand has one of the highest real interest rates in the region, which may not come down in 2016 if deflation or very low inflation persists. Ongoing political uncertainty, external demand malaise, poor domestic investment sentiment, and stretched household balance sheet are among a wide range of downsides to the Thai economy.

Weak momentum persists

The year has begun with a renewed weakness in commodity prices, driven by compounding concerns about the strength of the global economy, particularly China. Thailand has plenty of domestic-sourced complexities, but for the near term, external developments will likely weigh in more on the outlook, with implications for monetary policy and investment demand, in our view.

With crude oil heading toward USD30, and assorted energy and metal prices following suit, forecasts about the average price of commodities in 2016 is at risk of looking outdated within the first fortnight of the new year. Indeed, given the strong relationship between global commodity prices and regional inflation, it is clear to us that another leg of substantial disinflation or deflation is ahead.

Thailand's inflation outlook for the year would have to be revised downward accordingly. Policy statements by the BoT, as recently as in mid-December, reflected modest confidence that inflation had bottomed and would gradually rise through 2016. The bottoming out now looks to be delayed by a quarter or even two, with nontrivial risks that the entire year becomes a repeat of 2015 with respect to inflation dynamic.

In addition to facing the risk of seeing its inflation forecast missing the mark as soon as the year has started, the central bank also faces a related problem of determining the appropriate monetary policy stance. Despite having exceptionally low inflation, and therefore, high real interests at a time when growth has

been faltering, the central bank has left policy rates unchanged since last April. BoT has maintained the view for an extended period that since deflation is temporary, leaving the policy rate at 1.5% is appropriate. But as the period of very low inflation becomes extended, we would expect the central bank to reconsider its views over the course of the next few months. We think that worries about economic distortions emerging due to ultra low rates can be put aside for now, given the confluence of global risks.

Our expectation is not just based on hope. As recently as a year ago the central bank saw the exchange rate as appropriately valued, but that view has undergone a rethink, with the BoT officials agreeing that a strong baht was unhelpful to the economic recovery. A weaker baht is clearly a useful development in dampening deflationary forces, given ongoing developments in emerging markets. We believe that just like the authorities have seen the need to communicate to the markets that a weaker baht is welcome, they would also consider communicating that a path of lower rates cannot be ruled out.

We have discussed this possibility before as well; arguing that policy rate cuts in China and further commodity price declines would be needed for the BoT to change its mind. We think the ongoing developments are clearly heading in the direction of meeting such conditions. As it becomes progressively clear that low commodity prices are here to stay, we would expect the BoT to consider perhaps two 25bps cuts. Note that we are only highlighting the risk of this taking place; our baseline forecast is still maintaining an unchanged policy stance this year.

The central bank, in this context, also needs to recognize and communicate clearly the costs of low inflation or outright deflation. This phenomenon comes with low nominal GDP growth, as well as creates debt sustainability difficulties, with low nominal growth pushing down revenue growth while leaving interest payments unchanged. Thailand's nominal economic growth has been anemic lately, running in the 3-6% range over the past four years. In order to encourage investment and help corporate sentiments, the authorities must find ways to boost both nominal and real GDP growth rates.

A persistently weak economy would also provide motivation for policy rate cuts. Recent data are still tilting toward the direction of chronic weakness, as per our analysis. November trade data release was once again disappointing, with exports down 7.4%yoy,

14 January 2016



pushing down the trade surplus to USD0.3bn (2.1bn in October). For the Jan-Nov period exports were down 5.5%. Within the various exports components, bright spots were few and far between in November:

Agricultural exports continued their decline (-7.0%yoy vs. -10.3% in October), reflecting mainly falling rubber (-12.7%yoy) and sugar (-32.5%yoy) exports. Headline manufacturing exports show no signs of life either, falling by -6.8%yoy (-6.6% in October).

Unsurprisingly, the most significant drag to exports came from energy-related products: crude oil (-29.8%yoy vs. -29.4% in October), plastics (-15.7%yoy vs. -19.1%), and chemicals (-17.3%yoy vs.-39.2%).

Electronics, long a mainstay of Thai exports dynamic, slipped again (-5.2%yoy vs. 2.8%).

Passenger car shipments offered a glimmer of hope (95.5%yoy vs. 94.4%), although the increase was from a low base..

Destination-wise, only immediate neighbors (Cambodia, Laos, Myanmar, and Vietnam) are sources of strong demand (15.4%yoy vs. 1.0% in October). Beyond that, however, all key export markets remain mired in weakness (Japan: -4.7%yoy, US: -6.3%yoy, EU: -6.7%yoy, China: -6.1%yoy, and ASEAN5: -2.4%).

On imports, low commodity prices explain the declining bill in fuel (-38.3%yoy) and raw materials (-10.2%yoy). But the fact that the import of capital goods (-1.7%yoy) remains in lackluster territory underscores the elusive strength of the investment cycle. Accordingly, the November reading the private investment index registered a growth of just 1.6%yoy. Further weakness was seen in permitted constructed area (-3.7%yoy vs. -5.0%) and construction materials (-1.6%yoy vs. -5.4%).

Some degree of policy traction is being seen in consumption. The government's consumption stimulus package, which got going in November, helped boost private consumption by 3.7%yoy. The fact that public spending, both current (8.2%yoy) and capital (5.2%yoy), are finally growing in an appreciable manner should also augur well for incomes and activity going forward. This is a welcome development, and comes in sharp contrast to the poor exports and investment figures.


Thailand: Deutsche Bank Forecasts

2014 2015F 2016F 2017F

National Income

Nominal GDP (USDbn) 399.8 371.3 369.6 384.9

Population (m) 65.1 65.7 65.8 66.1


Real GDP (yoy %) 0.9 2.5 2.5 2.5



Gross fixed investment -2.6 4.6 4.5 2.0

Exports 0.0 -0.1 3.5 4.9

Imports -5.4 0.6 2.5 5.5


CPI (yoy %) eop 0.6 -0.9 1.1 2.1

CPI (yoy %) ann avg 1.9 -0.9 0.2 1.6

Core CPI (yoy %) ann avg 1.6 1.1 1.1 1.5

Broad money 4.7 5.0 6.0 5.0

Bank credit1 (yoy %) 4.3 4.5 6.0 5.0

Fiscal Accounts2 (% of GDP)

Central government surplus -1.9 -2.0 -2.1 -2.2




External Accounts (USDbn)



Trade balance 24.6 27.7 26.3 23.7

% of GDP 6.1 7.5 7.1 6.2


% of GDP 3.9 3.8 2.7 2.9

FDI (net) -0.6 2.0 4.0 5.0

FX reserves (USDbn) 157.1 165.0 160.0 165.0

FX rate (eop) THB/USD 32.9 36.0 37.5 37.5


Government debt2,3 46.6 46.8 48.0 47.5

Domestic 45.6 45.8 47.1 46.5

External 1.0 1.0 0.9 1.0


in USDbn 140.0 145.0 150.0 160.0


General


Unemployment (%) 0.9 1.0 1.1 1.2


BoT o/n repo rate 1.50 1.50 1.50 1.50

3-month Bibor 1.62 1.80 1.90 2.00

10-year yield (%) 2.59 2.75 3.00 3.10

THB/USD (onshore) 36.3 36.6 37.2 37.5 Source: CEIC, Deutsche Bank Global Markets Research, National Sources Note: (1) Credit to the private sector & SOEs. (2) Consolidated central government accounts; fiscal year ending September. (3) excludes unguaranteed SOE debt

14 January 2016




Vietnam B2/BB-/B+ Moody’s/S&P/Fitch

Economic outlook: Vietnam ended 2015 on a

strong note, but rising external risks force us to

limit our 2016 growth forecast to 6.7%.

Main risks: We expect a sharply weaker CNY in

2016 to increase pressure on the dong as other EM

Asia currencies come under pressure.

Confirmed strength, testing flexibility

Growth surges in Q4. GDP growth surged to 7.2% yoy in Q4 from 6.6% in 3Q, leaving Vietnam’s 2015 growth at 6.7%, above the government target of 6.2% and our relatively bullish forecast of 6.5%. Although Vietnam’s growth averaged 5.9% in 2011-2015, below the 6.5-7% target for the period, it has remained on the path of recovery. Reflecting the economic recovery, the number of newly registered businesses rose 26.6% in 2015 vs. a 2.7% fall in 2014, with registered capital rising 39.1% vs. 8.4% in the same period. Meanwhile, payrolls rose 34.9% to 1.472m in 2015.

Growth surges in Q4

2

3

4

5

6

7

8

9

2007 2008 2009 2010 2011 2012 2013 2014 2015

quarterly annual%yoy

Govt target


By industry, growth was led by 10.8% growth in construction in 2015 vs. 7.1% in 2014, as Vietnam’s property market recovered, followed by 10.6% and 6.3% growth in manufacturing and services, respectively, in 2015 vs. 8.5% and 6% in 2014. These sectors’ contribution to growth stood at 0.6ppts, 1.6ppts and 2.4ppts, respectively, in 2015. In contrast, agriculture growth slowed to 2.4% in 2015 from 3.5% in 2014, contributing 0.4ppts, mainly due to the negative impact from bad weather. On a cautious note, this strong growth was accompanied by a surge in credit, the growth of which rose to around 17% in 2015 from 12% in 2014.

On the demand front, retail sales of consumer goods and services rose 9.5% in 2015, posting an 8.4% rise, up from the 8.1% growth rate reported in 2014, when adjusting for inflation. By type, this rise was led by goods sales (10.6%), followed by a 5.2% rise in accommodation and catering services.

Rising risks in 2016. We continue to expect Vietnam to maintain strong growth of 6.7% in 2016, in line with the government’s growth target, with potential positive impact on the investment front from the TPP (Trans-Pacific Partnership) containing rising risks from the EM markets, particularly China. Destination-wise, China has a relatively small share of Vietnam’s exports – around 10.1% in 2014 vs. the US, Eurozone and Japan, which have 21.2%, 15.9% and 10.7%, respectively.

External risks to the dong’s stability on the rise

21,200

21,400

21,600

21,800

22,000

22,200

22,400

22,600

5.9

6.0

6.1

6.2

6.3

6.4

6.5

6.6


RMB/USD (lhs)

VND/USD


A more flexible dong may be required. Although China does not represent a significant source of demand for Vietnam’s exports, its FX policy has significant influence on Vietnam’s dong. We recall the State Bank of Vietnam’s (SBV) decision to devalue the dong and widen its trading ban in August, despite its negative implications for foreign debt, in response to China’s FX regime shift.

Meanwhile, Vietnam’s capacity to deal with external shocks remains limited. Although the country’s FX reserves stood at twice its short-term foreign currency debt, they cover less than three months of (goods) imports – too low for its FX arrangement of “managed floating.” Moreover, Vietnam continues to see significant capital “leakages”, most of which may be reflected in the errors and omissions. In response to EM FX volatility, led by the CNY, we see the SBV adopting a more flexible FX policy ahead. We expect

USDVND to rise to 24,300 by end-2016, as CNY, KRW and TWD depreciate against USD by about 8-9% during the year.

14 January 2016




The TPP stands as a big positive for long-term growth. The TPP presents potential gains in growth of as much as 11-14% over the next ten years. It may also accelerate FDI inflows into Vietnam ahead of its implementation in 2018, while adding support for the reform and restructuring efforts, of which the pace has been rather slow. Although Vietnam had an ambitious goal of equitizing 432 enterprises in 2014-2015, it had achieved only about 50% of its target by August 2015. In turn, SOE equitization and reforms point to an improved outlook for Vietnam’s fiscal health, with the tightening of collection rules and limiting waste. This is critical as the TPP negatively affects customs revenue (about 20% of the total).

Looking for new sources of revenue

0%

20%

40%

60%

80%

100%

2005 2015

Other

Customs

Oil

Nonstate

FDI

SOE

Revenue source


The government may also broaden other revenue sources and/or seek other types of fiscal consolidation. While we fully support the National Assembly’s increased pressure on the government to keep its debt limited (i.e., below 65% of GDP), we believe less administration interference is required; for example, refraining from dictating the duration of public debt. We see the government limiting its fiscal deficit to 5% of GDP in 2016.

To its credit, the SBV has refrained from monetizing the bad debt, although lending to the government to help finance its expenditures. Meanwhile, with the Vietnam Asset Management Company (VAMC) acting as a bridge loan provider, the banking system NPL ratio fell to 3.7% in June 2015 from 4.8% in 2014 and the credit growth accelerated to 15% yoy ytd in November. Although the VAMC has resolved only about 7% of the bad debt that it took over, a new law on asset auctions is likely to accelerate its resolution ahead. We expect

the SBV’s monetary policy rate to remain unchanged

in 2016, as inflation averages 4.4%, below its 5% target.


Vietnam: Deutsche Bank forecasts

2014 2015F 2016F 2017F

National income


Population (m) 90.7 91.6 92.5 93.4


Real GDP (yoy %) 6.0 6.7 6.7 7.0




Exports 11.0 11.5 12.0 14.0

Imports 12.7 12.0 13.5 15.4


CPI (yoy %) eop 1.8 0.6 6.9 5.2

CPI (yoy %) ann avg 4.1 0.6 4.4 5.6

Broad money (yoy %) 18.0 18.0 20.0 22.0

Bank credit (yoy %) 12.0 17.0 18.0 19.0

Fiscal accounts1 (% of GDP)

Federal government surplus -5.8 -5.6 -5.0 -5.0



Primary fed. govt. surplus -4.3 -4.2 -3.5 -3.5

External accounts (USD bn)



Trade balance 9.0 -5.0 -9.0 -10.0

% of GDP 4.8 -2.6 -4.5 -4.7

Current account balance 10.5 -2.5 -5.5 -7.5

% of GDP 5.6 -1.3 -2.8 -3.5

FDI (net) 9.0 9.5 11.0 12.0

FX reserves (USD bn) 34.6 30 28 32

FX rate (eop) VND/USD 21335 22485 24300 25000


Government debt2 59.5 62.0 64.0 65.0

Domestic 29.5 31.0 32.0 33.0

External 30.0 31.0 32.0 32.0


in USD bn 70.5 77.1 84.0 91.0


General


Unemployment (%) 2.1 2.1 2.1 2.1


Refinancing rate 6.50 6.50 6.50 6.50

VND/USD 22483 23000 23500 24300 Source: CEIC, DB Global Markets Research, National Sources Note: (1) Fiscal balance includes off-budget expenditure, while revenue and expenditure include only budget items. (2) Taken from the government estimates. .

14 January 2016



China - Inflation (CPI) China - One-year Deposit Rate

0

1

2

3

4

5

6

2012 2013 2014 2015 2016 2017

%yoy

1.00

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

2012 2013 2014 2015 2016 2017

%



Next CPI release: Feb 18 DB Forecast (Previous): 1.8%yoy (1.6%)

Next policy meeting: N.A. DB Rate Call: No change in rate expected

India - Inflation (CPI) India - Repo Rate

2

4

6

8

10

12

2012 2013 2014 2015 2016 2017

%yoy

6.50

6.0

6.5

7.0

7.5

8.0

8.5

9.0

2012 2013 2014 2015 2016 2017

%




Next policy meeting: Feb 02 DB Rate Call: No change in rate expected

Indonesia - Inflation (CPI) Indonesia – Overnight (BI) rate

2

4

6

8

10

2012 2013 2014 2015 2016 2017

%yoy%yoy

7.00

5

6

7

8

9

2012 2013 2014 2015 2016 2017

%



Next CPI release: Feb 01 DB Forecast (Previous): 3.6%yoy (3.4%) Next policy meeting: Jan 14 DB Rate Call: No change in rate expected

14 January 2016



Malaysia - Inflation (CPI) Malaysia - Overnight Policy Rate

-1

0

1

2

3

4

5

6

2012 2013 2014 2015 2016 2017

%yoy

3.25

1.5

2.0

2.5

3.0

3.5

4.0

4.5

2012 2013 2014 2015 2016 2017

%



Next CPI release: Jan 20 DB Forecast (Previous): 2.7%yoy (2.6%)

Next policy meeting: Jan 21 DB Rate Call: No change in rate expected

Philippines - Inflation (CPI) Philippines - Overnight Repo Rate

0

2

4

6

8

2012 2013 2014 2015 2016 2017

%yoy

6.50

4.50

3

4

5

6

7

8

2012 2013 2014 2015 2016 2017

Repo Revrepo%




Next policy meeting: Feb 11 DB Rate Call: No change in rates expected

South Korea - Inflation (CPI) South Korea – Base Rate

0

1

2

3

4

5

2012 2013 2014 2015 2016 2017

%yoy

1.50

1

2

3

4

2012 2013 2014 2015 2016 2017

%




Next policy meeting: Feb 02 DB Rate Call: No change in rates expected

14 January 2016



Sri Lanka - Inflation (CPI) Sri Lanka - Reverse Repo Rate

-2

0

2

4

6

8

10

12

14

2012 2013 2014 2015 2016 2017

%yoy

8.00

6

7

8

9

10

11

2012 2013 2014 2015 2016 2017

%





Taiwan - Inflation (CPI) Taiwan - Discount Rate

-3

-2

-1

0

1

2

3

4

2012 2013 2014 2015 2016 2017

%yoy

1.375

1.00

1.50

2.00

2.50

2012 2013 2014 2015 2016 2017

%




Next policy meeting: Mar 31 DB Rate Call: 12.5 bps rate cut expected

Thailand -Inflation (CPI) Thailand - One-day Repurchase Rate

-2

-1

0

1

2

3

4

5

6

2012 2013 2014 2015 2016 2017

%yoy

1.50

0

1

2

3

4

5

2012 2013 2014 2015 2016 2017

%



Next CPI release: Feb 01 DB Forecast (Previous): -0.5%yoy (0.1%)

Next policy meeting: Feb 03 DB Rate Call: No change in rate expected

14 January 2016



Vietnam - Inflation (CPI) Vietnam - Refinancing Rate

-4

0

4

8

12

16

20

2012 2013 2014 2015 2016 2017

%yoy

6.50

4

7

10

13

16

2012 2013 2014 2015 2016 2017

%





Hong Kong - Inflation (CPI) Hong Kong - Base Rate

-2

0

2

4

6

8

10

2012 2013 2014 2015 2016 2017

%yoy

1.50

0.0

0.5

1.0

1.5

2.0

2.5

3.0

2012 2013 2014 2015 2016 2017

%




Singapore - Inflation (CPI) Singapore - 3m SGD Sibor

-1

0

1

2

3

4

5

6

2012 2013 2014 2015 2016 2017

%yoy

1.5

0.15

0.45

0.75

1.05

1.35

1.65

1.95

2012 2013 2014 2015 2016 2017

%



Next CPI release: Jan 25 DB Forecast (Previous): -0.7%yoy (-0.8%)

14 January 2016



Asia Economic Indicators

2014 2015

(%YoY unless stated) Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

Policy rates (%)

China (1yr depo) 2.75 2.75 2.75 2.50 2.50 2.25 2.00 2.00 1.75 1.75 1.50 1.50 1.50

HKMA (base rate) 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.75

India (repo) 8.00 7.75 7.75 7.50 7.50 7.50 7.25 7.25 7.25 6.75 6.75 6.75 6.75

Indonesia (BI Rate) 7.75 7.75 7.50 7.50 7.50 7.50 7.50 7.50 7.50 7.50 7.50 7.50 7.50

Malaysia (overnight) 3.25 3.25 3.25 3.25 3.25 3.25 3.25 3.25 3.25 3.25 3.25 3.25 3.25

Philippines (repo) 6.00 6.00 6.00 6.00 6.00 6.00 6.00 6.00 6.00 6.00 6.00 6.00 6.00

Singapore(3moSIBOR) 0.46 0.67 0.77 1.01 0.89 0.83 0.82 0.88 1.01 1.14 1.07 1.07 1.19

South Korea (o/n call) 2.00 2.00 2.00 1.75 1.75 1.75 1.50 1.50 1.50 1.50 1.50 1.50 1.50

Sri Lanka (rev repo) 8.00 8.00 8.00 8.00 7.50 7.50 7.50 7.50 7.50 7.50 7.50 7.50 7.50

Taiwan (rediscount) 1.88 1.88 1.88 1.88 1.88 1.88 1.88 1.88 1.88 1.75 1.75 1.75 1.63

Thailand (o/n repo) 2.00 2.00 2.00 1.75 1.50 1.50 1.50 1.50 1.50 1.50 1.50 1.50 1.50

Vietnam (refinancing) 6.50 6.50 6.50 6.50 6.50 6.50 6.50 6.50 6.50 6.50 6.50 6.50 6.50

Consumer prices

China 1.5 0.8 1.4 1.4 1.5 1.2 1.4 1.6 2.0 1.6 1.3 1.5 1.6

Hong Kong 4.9 4.1 4.6 4.5 2.8 3.0 3.1 2.5 2.4 2.0 2.4 2.4

India 4.3 5.2 5.4 5.3 4.9 5.0 5.4 3.7 3.7 4.4 5.0 5.4 5.6

Indonesia 8.4 7.0 6.3 6.4 6.8 7.1 7.3 7.3 7.2 6.8 6.2 4.9 3.4

Malaysia 2.7 1.0 0.1 0.9 1.8 2.1 2.5 3.3 3.1 2.6 2.5 2.6

Philippines 2.7 2.4 2.5 2.4 2.2 1.6 1.2 0.8 0.6 0.4 0.4 1.1 1.5

Singapore -0.1 -0.4 -0.3 -0.3 -0.5 -0.4 -0.3 -0.4 -0.8 -0.6 -0.8 -0.8

South Korea 0.8 0.8 0.5 0.4 0.4 0.5 0.7 0.7 0.7 0.6 0.9 1.0 1.3

Sri Lanka 2.1 3.2 0.6 0.1 0.1 0.2 0.1 -0.2 -0.2 -0.3 1.7 3.1 2.8

Taiwan 0.6 -0.9 -0.2 -0.6 -0.8 -0.7 -0.6 -0.6 -0.4 0.3 0.3 0.5 0.1

Thailand 0.6 -0.4 -0.5 -0.6 -1.0 -1.3 -1.1 -1.0 -1.2 -1.1 -0.8 -1.0 -0.9

Vietnam 1.8 0.9 0.3 0.9 1.0 1.0 1.0 0.9 0.6 0.0 0.0 0.3 0.6

Credit

China (loans) 13.6 14.3 14.7 14.7 14.4 14.3 14.4 15.7 15.7 15.8 15.6 15.3

Hong Kong 12.7 10.0 6.6 11.7 8.0 7.3 8.5 6.9 6.4 4.9 2.8 2.9

India 10.1 9.9 9.7 9.2 9.2 9.2 8.7 8.7 8.7 8.9 8.4 9.5 9.8

Indonesia 12.3 12.7 12.9 12.2 11.5 11.7 11.8 10.9 12.2 11.7 10.3 8.5

Malaysia 8.9 8.5 9.0 9.1 8.4 8.6 8.4 8.8 9.3 9.2 9.0 8.7

Philippines 19.9 16.5 15.6 16.1 14.5 13.8 14.1 13.5 13.9 12.9 12.7 12.9

Singapore 7.4 6.7 7.2 7.6 4.7 4.1 5.1 3.9 2.1 1.5 1.5 1.9

South Korea 6.5 6.4 6.9 7.3 7.3 7.4 6.9 7.0 7.8 7.8 7.0 6.8

Sri Lanka 8.8 11.5 12.6 13.9 15.2 17.6 19.4 21.0 21.3 22.2 26.3

Taiwan 5.7 5.3 5.6 5.6 5.2 5.1 4.8 4.2 4.5 5.4 5.1 4.5

Thailand 4.6 4.5 4.8 5.0 5.3 5.3 4.8 4.9 4.7 5.1 4.7 5.0

Exports

China 9.5 -3.3 48.3 -15.0 -6.5 -2.8 2.8 -8.4 -5.6 -3.8 -7.0 -7.2 -1.5

Hong Kong 0.6 2.8 7.3 -1.8 2.2 -4.6 -3.1 -1.6 -6.1 -4.6 -3.6 -3.5

India -1.0 -9.4 -14.9 -20.8 -15.4 -20.0 -13.3 -10.0 -20.0 -24.5 -17.3 -24.4

Indonesia -13.8 -8.5 -16.8 -10.3 -8.3 -14.4 -12.4 -18.8 -12.1 -17.6 -20.7 -17.6

Malaysia (USD) -4.5 -8.5 -17.1 -8.7 -18.3 -16.2 -9.6 -13.4 -18.6 -18.7 -10.4 -17.5

Philippines -3.2 0.0 -3.0 2.1 -4.1 -17.4 -1.8 -1.8 -6.3 -15.5 -10.8 -1.1

Singapore (USD) -5.4 -6.9 -22.4 -7.8 -16.2 -15.9 -13.3 -12.1 -21.0 -18.4 -12.0 -13.8

South Korea 3.1 -1.0 -3.3 -4.6 -8.0 -11.0 -2.7 -5.2 -15.2 -8.5 -16.0 -4.8 -13.8

Sri Lanka 1.8 1.3 6.6 -0.6 -6.9 -0.1 -4.2 -2.6 -19.5 -5.9 -6.0 -9.3

Taiwan -2.9 3.4 -6.7 -8.9 -11.7 -3.8 -13.9 -12.0 -14.9 -14.7 -11.0 -16.9 -13.9

Thailand 1.6 -3.4 -6.1 -4.4 -1.7 -5.0 -7.9 -3.6 -6.7 -5.5 -8.1 -7.4

Vietnam 11.6 17.0 -0.3 8.7 2.1 10.4 15.7 9.8 9.1 9.3 1.7 5.0 10.3 Source: CEIC, DB Global Markets Research

14 January 2016



Asia Economic Indicators (cont'd)

2014 2015

(%YoY unless stated) Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

Retail sales (real)

China 11.5 10.2 9.9 10.2 10.6 10.3 10.4 10.8 11.0 11.0

Hong Kong -1.7 -2.3 1.2 1.4 4.5 6.6 6.5 4.0 0.2 -4.2 0.6 -8.3

India (motorveh&bikes) 2.4 -3.2 -5.7 -7.0 -3.3 -5.3 -0.7 -1.2 -4.1 -4.6 6.7 -5.4 -7.4

Indonesia -4.6 3.9 9.8 13.3 16.3 13.4 15.0 1.2 -1.3 0.2 2.4 5.3 3.4

Malaysia (motor veh.) 4.2 -0.3 -0.8 13.3 -24.9 -10.5 -4.5 -6.0 1.5 4.4 0.4 -1.2

Philippines (pass.cars) 25.6 33.5 41.9 32.7 22.2 25.7 17.7 21.8 28.6 25.9 24.8 31.4 31.8

Singapore 4.5 -4.3 14.9 2.6 5.8 6.2 7.1 5.5 7.2 3.7 2.7

South Korea 4.6 -2.8 5.3 2.8 4.9 3.1 0.7 2.1 2.0 5.5 8.4 5.5

Taiwan 3.1 0.5 3.2 4.2 1.3 0.0 2.4 0.1 -1.1 -2.3 -0.8 0.7

Thailand -1.0 -2.6 -3.5 -4.7 -3.5 -6.1 -0.8 -1.9 -0.3 -4.2 1.0

Vietnam 16.4 13.9 17.6 7.8 6.0 7.5 11.1 13.0 11.5 10.7 9.4 6.1 7.3

Industrial production

China 7.9 5.6 5.9 6.1 6.8 6.0 6.1 5.7 5.6 6.2

Hong Kong -3.6 -1.6 -1.2 -1.9

India 3.6 2.8 4.8 2.5 3.0 2.5 4.2 4.3 6.3 3.8 9.9 -3.2

Indonesia 6.5 5.1 2.6 7.4 8.4 2.4 5.0 4.4 5.7 2.3 6.6 6.5

Malaysia 7.4 7.0 5.1 7.2 4.1 4.5 4.4 6.1 2.3 5.1 4.2 1.9

Philippines 4.6 2.7 -2.1 14.9 1.8 -1.1 -1.7 0.2 2.1 2.8 1.7 7.5

Singapore -1.8 1.0 -3.3 -4.9 -8.8 -1.7 -3.8 -6.5 -6.9 -4.3 -4.7 -5.5

South Korea 1.1 1.8 -5.0 0.1 -2.6 -3.0 1.4 -3.3 0.0 2.8 1.7 -0.3

Sri Lanka 13.6 9.9 10.7 7.7 12.5 14.0 6.7 8.9 6.6 9.9 8.6 3.7

Taiwan 7.8 7.6 2.7 6.7 1.3 -3.5 -1.2 -2.7 -5.7 -5.5 -6.3 -4.9

Thailand -0.3 0.7 1.7 -1.0 -0.1 -0.1 -0.6 2.7 0.5 -0.3 -0.8 0.1

Vietnam 9.6 17.5 7.0 9.1 9.5 7.5 11.1 11.3 9.0 10.9 8.8 8.9 9.0

FX Reserves (USD bn)

China 3843.0 3813.4 3801.5 3730.0 3748.1 3711.1 3693.8 3651.3 3557.4 3514.1 3525.5 3438.3 3330.4

Hong Kong 328.5 324.8 332.5 332.2 343.2 344.9 340.8 339.9 334.4 345.8 357.1 355.8 358.8

India 320.6 328.7 337.7 341.6 351.9 352.5 356.0 353.5 351.4 350.3 354.2 350.2

Indonesia 111.9 114.2 115.5 111.6 110.9 110.8 108.0 107.6 105.3 101.7 100.7 100.2 105.9

Malaysia 115.9 110.6 110.5 105.1 105.8 106.4 105.5 96.7 94.7 93.3 94.0 94.6 95.3

Philippines 79.5 80.7 80.8 80.4 80.8 80.4 80.6 80.3 80.2 80.5 81.1 80.2 80.6

Singapore 256.9 251.5 250.7 248.4 251.9 250.2 253.3 250.1 250.4 251.6 249.8 247.1 247.7

South Korea 363.6 362.2 362.4 362.8 369.9 371.5 374.7 370.8 367.9 368.1 369.6 368.5 368.0

Sri Lanka 8.2 7.3 7.4 6.8 7.5 6.9 7.5 6.9 6.5 6.8 6.5 7.3

Taiwan 419.0 415.9 417.8 414.7 418.2 419.0 421.4 422.0 424.8 426.3 426.8 424.6 426.0

Thailand 157.1 155.4 156.9 156.3 161.1 158.5 160.3 156.9 155.8 155.5 158.3 155.7

Real GDP

China 7.2 7.0 7.0 6.9

Hong Kong 2.4 2.4 2.8 2.3

India 6.6 7.5 7.0 7.4

Indonesia 5.0 4.7 4.7 4.7

Malaysia 5.7 5.6 4.9 4.7

Philippines 6.6 5.0 5.8 6.0

Singapore 2.1 2.7 2.0 1.9

South Korea 2.7 2.5 2.2 2.7

Sri Lanka 9.9 4.9 6.0 4.8

Taiwan 3.6 4.0 0.6 -0.6

Thailand 2.1 3.0 2.8 2.9

Vietnam 6.8 6.1 6.5 6.6 7.2 Source CEIC, DB Global Markets Research

14 January 2016



Appendix 1

Important Disclosures

Additional information available upon request

*Prices are current as of the end of the previous trading session unless otherwise indicated and are sourced from local exchanges via Reuters, Bloomberg and other vendors . Other information is sourced from Deutsche Bank, subject companies, and other sources. For disclosures pertaining to recommendations or estimates made on securities other than the primary subject of this research, please see the most recently published company report or visit our global disclosure look-up page on our website at http://gm.db.com/ger/disclosure/DisclosureDirectory.eqsr

Analyst Certification

The views expressed in this report accurately reflect the personal views of the undersigned lead analyst(s). In addition, the undersigned lead analyst(s) has not and will not receive any compensation for providing a specific recommendation or view in this report. Taimur Baig/Kaushik Das/Diana Del Rosario/Juliana Lee/Michael Spencer/Li Zeng/Zhiwei Zhang

(a) Regulatory Disclosures

(b) 1.Important Additional Conflict Disclosures

Aside from within this report, important conflict disclosures can also be found at https://gm.db.com/equities under the "Disclosures Lookup" and "Legal" tabs. Investors are strongly encouraged to review this information before investing.

(c) 2.Short-Term Trade Ideas

Deutsche Bank equity research analysts sometimes have shorter-term trade ideas (known as SOLAR ideas) that are consistent or inconsistent with Deutsche Bank's existing longer term ratings. These trade ideas can be found at the SOLAR link at http://gm.db.com.

http://gm.db.com/ger/disclosure/DisclosureDirectory.eqsr

https://gm.db.com/equities

http://gm.db.com/

14 January 2016



(d) Additional Information

The information and opinions in this report were prepared by Deutsche Bank AG or one of its affiliates (collectively

"Deutsche Bank"). Though the information herein is believed to be reliable and has been obtained from public sources

believed to be reliable, Deutsche Bank makes no representation as to its accuracy or completeness.

Deutsche Bank may consider this report in deciding to trade as principal. It may also engage in transactions, for its own

account or with customers, in a manner inconsistent with the views taken in this research report. Others within

Deutsche Bank, including strategists, sales staff and other analysts, may take views that are inconsistent with those

taken in this research report. Deutsche Bank issues a variety of research products, including fundamental analysis,

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Analysts are paid in part based on the profitability of Deutsche Bank AG and its affiliates, which includes investment

banking revenues.

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not necessarily reflect the opinions of Deutsche Bank and are subject to change without notice. Deutsche Bank has no

obligation to update, modify or amend this report or to otherwise notify a recipient thereof if any opinion, forecast or

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purposes only. It is not an offer or a solicitation of an offer to buy or sell any financial instruments or to participate in any

particular trading strategy. Target prices are inherently imprecise and a product of the analyst’s judgment. The financial

instruments discussed in this report may not be suitable for all investors and investors must make their own informed

investment decisions. Prices and availability of financial instruments are subject to change without notice and

investment transactions can lead to losses as a result of price fluctuations and other factors. If a financial instrument is

denominated in a currency other than an investor's currency, a change in exchange rates may adversely affect the

investment. Past performance is not necessarily indicative of future results. Unless otherwise indicated, prices are

current as of the end of the previous trading session, and are sourced from local exchanges via Reuters, Bloomberg and

other vendors. Data is sourced from Deutsche Bank, subject companies, and in some cases, other parties.

Macroeconomic fluctuations often account for most of the risks associated with exposures to instruments that promise

to pay fixed or variable interest rates. For an investor who is long fixed rate instruments (thus receiving these cash

flows), increases in interest rates naturally lift the discount factors applied to the expected cash flows and thus cause a

loss. The longer the maturity of a certain cash flow and the higher the move in the discount factor, the higher will be the

loss. Upside surprises in inflation, fiscal funding needs, and FX depreciation rates are among the most common adverse

macroeconomic shocks to receivers. But counterparty exposure, issuer creditworthiness, client segmentation, regulation

(including changes in assets holding limits for different types of investors), changes in tax policies, currency

convertibility (which may constrain currency conversion, repatriation of profits and/or the liquidation of positions), and

settlement issues related to local clearing houses are also important risk factors to be considered. The sensitivity of fixed

income instruments to macroeconomic shocks may be mitigated by indexing the contracted cash flows to inflation, to

FX depreciation, or to specified interest rates – these are common in emerging markets. It is important to note that the

index fixings may -- by construction -- lag or mis-measure the actual move in the underlying variables they are intended

to track. The choice of the proper fixing (or metric) is particularly important in swaps markets, where floating coupon

rates (i.e., coupons indexed to a typically short-dated interest rate reference index) are exchanged for fixed coupons. It is

also important to acknowledge that funding in a currency that differs from the currency in which coupons are

denominated carries FX risk. Naturally, options on swaps (swaptions) also bear the risks typical to options in addition to

the risks related to rates movements.

Derivative transactions involve numerous risks including, among others, market, counterparty default and illiquidity risk.

The appropriateness or otherwise of these products for use by investors is dependent on the investors' own

circumstances including their tax position, their regulatory environment and the nature of their other assets and

liabilities, and as such, investors should take expert legal and financial advice before entering into any transaction similar

14 January 2016



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David Folkerts-Landau Chief Economist and Global Head of Research

Raj Hindocha Global Chief Operating Officer

Research

Marcel Cassard Global Head

FICC Research & Global Macro Economics

Steve Pollard Global Head

Equity Research

Michael Spencer Regional Head

Asia Pacific Research

Ralf Hoffmann Regional Head

Deutsche Bank Research, Germany

Andreas Neubauer Regional Head

Equity Research, Germany

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Tel: (852) 2203 8888

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Japan

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United Kingdom

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Documents

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