Economics@1

ASIAN ECONOMIESASIAN ECONOMIES

Economics, interest rates and Economics, interest rates and currencies chart packcurrencies chart pack

Amy Amy AusterAusterSenior EconomistSenior Economist

MelbourneMelbourne20 May 200520 May 2005

Internet: http://www.anz.com/go/economicsE-mail: austera@anz.com

Economics@2

Major revisions to global forecasts over the past monthMajor revisions to global forecasts over the Major revisions to global forecasts over the past monthpast monthl Federal Reserve now expected to continue raising rates ¼ pc

pt at each FOMC meeting for longer than previously thought – implying funds rate at 4¼% by end-2005 (previously 3¾%)

and peaking at 5% (previously 4%) in 2006l US dollar now seen as ‘bottomed’ against freely-floating

currencies (€, £, C$, A$, NZ$ etc) sooner and at lower levels than previously

– US will find it easier to finance its current account deficit through borrowing from foreign private sector lenders given higher interest rate profile

– US$-€ now not expected to reach low of $1.40, but instead to strengthen from mid-year onwards to $1.17 by end-2005

l A$ and NZ$ to fall further and sooner against US$, to US66¢ and 58¢ by end-2005, and 62¢ and 53.5¢ by end-2006

– largely reflects much narrower interest rate differentials in these currencies’ favour due to higher US rate profile

l Australian 2005 GDP growth revised from 2.25% to 2.4%, 2006 down from 3.5% to 3.1%

– largely reflects stronger than expected employment growth

Economics@3

Hong Kong adjusts exchange rate regime by Hong Kong adjusts exchange rate regime by introducing “twointroducing “two--way” peg way” peg

7.60

7.65

7.70

7.75

7.80

7.85

7.90

92 95 98 02 05

Spot rate Ceiling Floor

HK$/US$

"One-way" peg of HK$7.8/US$ moves to "two-way" with floor of HK$7.75 introduced and ceiling rising to HK$7.85/US$ by 20 June…this looks suspiciously like a currency band

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HIBOR US LIBOR

HK$/US$

Will rate differential come back into alignment?

Economics@4

Highlights of Asian forecastsHighlights of Asian forecasts

l Growth will slow from 8.2% in 2004 to 7.3% in 2005 and 6.6% in 2006

– China is still top of the charts, but leading indicators show potential for soft landing

– Slowdown in US and China means growth more dependent on domesticinvestment and consumption, including rising services sector

l A$ strengthened against regional currencies in 2004 but this should reverse in 2005-2006

– Our forecast is for the A$ to weaken against the US$/Asian currency crosses due to softer commodity prices and Australian growth

– We do not anticipate a revaluation of the CNY in 2005 but possibly in 2006 – this week’s shift in the HK$ is interesting as a trial balloon

– Korean official says intervention against US$ will cease but similar comments have been made before

l Interest rates in Asia may rise marginally more in H1, but will not keep pace with monetary tightening in G7

– A reversal of foreign capital inflows will stem the extraordinary liquidity, and falling commodity prices will allow PPI to decline

– Loose monetary policy will help boost domestic demand, which will need to contribute more to GDP next year; some SE Asian economies also need a strong dose of investment

Economics@5

World economy is slowing – but from a very fast pace to a fast pace World economy is slowing World economy is slowing –– but from a very but from a very fast pace to a fast pace fast pace to a fast pace

OECD LEI – monthly changes

l OECD leading indicator fell in February, after three consecutive increases around the turn of the year

l We expect global growth to slow from 5% (fastest since 1976) in 2004 to 4% this year and next (still above long-term trend of 3¾%)

-0.4-0.20.00.20.40.60.81.0

03 04 05

% change from previous month

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94 95 96 97 98 99 00 01 02 03 04 05 06

% change from previous year

World GDP growth

Economics@6

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US oil stocks (LHS) WTI US$/bbl (RHS)

Softening oil prices indicate both rising stocks in the US Softening oil prices indicate both rising stocks in the US and declining industrial demandand declining industrial demand

Sources: Bloomberg; American Petroleum Institute; Economics@ANZ.

Crude oil prices

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% change from year earlier

World industrialproduction (3-mthmoving average)

OECD compositeleading indicator,4 months forward

World IP and the OECD leading indicator

US$/bblUS$/bblMn barrels

Mn barrels

Economics@7

An overall slowdown reduces risks, but An overall slowdown reduces risks, but rebalancing would be ideal scenariorebalancing would be ideal scenario

l Rising US interest rates will cool economy

– Reversal of weak US$ would dampen consumer spending

– US short term rates back to neutral ie 4.5% H1 2006

l Can Euroland step up?– Leading indicators still weak

but Germany avoided recession in Q1

l Asia’s outlook will depend on domestic demand

– Japan’s Q1 GDP growth 5.3% YOY double consensus forecast on retail demand

– China’s growth moderating despite headline GDP data

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2003 2004 2005f 2006f

US Japan Asia ex-Japan Euro

Source: Datastream, ANZ Bank

Economics@8

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1997 1998 2002 2003 2004e 2005f

Net Exports

Fixed Investment

Gov't consumption

Household consumption

Inventories / Residual

Source: Datastream, ANZ Bank

China’s economy still sending mixed signals China’s economy still sending mixed signals as investment and imports are down..as investment and imports are down..

Contributions to Nominal GDP growth

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60Real GDP growth (LHS)

Imports growth (RHS)

%

Economics@9

…But energy prices are keeping PPI high…But energy prices are keeping PPI high

Source: Datastream

Measures of inflation l The CPI understates inflation pressures because of price controls and administered transport and utility tariffs

l Nonetheless, cheaper food pushed CPI down to 1.8% in April, well below forecasts

l The PPI rate of 5.8% last month is mainly due to oil prices and is a risk to the inflation outlook

l The implicit GDP deflator – a broad measure of inflation –fell from 8.7% in December to 5.6% in March

l New property taxes have already cooled speculation in Shanghai real estate market-8

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97 98 99 00 01 02 03 0405

CPI (qtr ave)

PPI (qtr ave)

GDP Deflator

%

Economics@10

Tight control of liquidity is the root cause of Tight control of liquidity is the root cause of deceleration, and this should continuedeceleration, and this should continue

Source: Datastream

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International reserves US$ bn (LHS)M2/GDP

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2000 2001 2002 2003 2004 2005f

Current accountNet equityOther flows *Errors and omissions

*Other private creditors, commercial banks, official creditors and net residential lending abroadSource: IIF

Economics@11

Asia’s dependence on China has grown; US + Asia’s dependence on China has grown; US + China account for 35% of export marketChina account for 35% of export market

% of total exports

ChinaUS ChinaUS

3.0

5.9

10.9

7.9

8.0

7.5

23.7

15.1

17.014.318.3Singapore

8.021.911.0Vietnam

14.520.135.8Philippines

13.019.620.8Malaysia

12.517.017.6Thailand

8.212.113.9Indonesia

34.618.023.7Taiwan

25.817.818.5Korea

20031995

Note: Exports to China include exports to Hong KongSources: IMF; Taiwan, ROC: Bureau of Foreign Trade

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92 94 96 98 00 02 04

Exports to Asia

Imports from Asia

China's Trade with Asia

Source: Datastream

Economics@12

China and US slowdown are affecting whole China and US slowdown are affecting whole region…region…

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% change from year earlier

Exportsexcl China & HK3mma % ch YOY

East Asian exports

Sources: OECD; Datastream; Economics@ANZ.

East Asia IP and composite leading indicator

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% change from year earlier

Industrialproduction(excl. Japanand China)

Asian composite leadingindicator* (6 mths forward)

* Weighted LEI for Korea, Taiwan, Thailand and Malaysia

Economics@13

…Despite central banks’ efforts to keep regional currencies in line with CNY

Note: charts show daily data from 31 Dec 2003 onwards.*‘Non-deliverable forward’ contract. Source: Datastream.

Singapore dollar

Korean won

1000

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1200Dec-03

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Mar-05

Won per US$(inverted)

1.60

1.65

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1.75Dec-03

Mar-04

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Mar-05

S$ per US$(inverted)

Chinese yuan

7.77.87.98.08.18.28.38.4

Dec-03

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Mar-05

Yuan per US$ (inverted)

Spot rate

12-mth NDF*

Japanese Yen

100105110115120125

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Y per US$(inverted)

Economics@14

Central banks actively controlled liquidity Central banks actively controlled liquidity from extraordinary inflows in 2004…from extraordinary inflows in 2004…

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2002 2003 2004 2005f

Current accountEquity flows, netPrivate capital flows, netOther flows*

Capital flows to Asia, ex-China (US$ bn)

*Official creditors and net residential lending abroadSource: IIF

Source: Datastream

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Japan ChinaKorea TaiwanHK SingaporeThailand Rest of world

Major foreign holders of US Treasuries (US$ bn)

Economics@15

Allowing interest rates to remain relatively Allowing interest rates to remain relatively low while credit growth ticked downlow while credit growth ticked down

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China IndonesiaPhilippines SingaporeKorea Thailand

Real credit growth (% YOY)Weighted average 3-month interest rates (%)*

*GDP weighted average of Korea, Hong Kong, Taiwan, Indonesia, Thailand, Philippines, Singapore

Source: Datastream, ANZ Bank

Economics@16

Fiscal policy has tightened, with growth Fiscal policy has tightened, with growth coming from private consumption and coming from private consumption and capexcapex

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Gross fixed investmentGovernment consumptionPrivate consumption

Growth rates of real GDP components

Q1 2005 (% YOY)

* Q4 2004 data

Q1 2004 (% YOY sa)

Source: Datastream

Economics@17

Will consumption and investment drive the Will consumption and investment drive the region forward? region forward?

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Indonesia Malaysia

Korea Philippines

Thailand

Motor vehicle sales (% YOY)

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Korea Philippines

Thailand

Passenger car sales (% YOY)

Source: Local sources via CEIC

Economics@18

Forecasting what “neutral” rates will be for Forecasting what “neutral” rates will be for Asian economies is difficult given historyAsian economies is difficult given history

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US 3m LIBOR

GDP weighted average 3m Asian rates

Australia 90-day bank bill

ANZ forecasts

Rate forecasts (nominal 3m%)

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A$/Asia FX trade weighted index

US Fed's major currency index

ANZ forecasts

FX forecasts

Economics@19

Regional growth forecastsRegional growth forecasts

5.45.26.1 Thailand

7.07.38.2Non-Japan East Asia*

3.03.86.1 Philippines7.07.57.7Vietnam

6.56.05.1 Indonesia4.53.85.7 Taiwan4.63.84.6Korea8.28.89.5 China

4.74.47.1 Malaysia3.24.58.2 Hong Kong

5.33.88.4 Singapore

5.04.75.8Non-Japan East Asia excl. China*

4.24.35.2World GDP growth (%)*37.440.043.3Oil prices (US$ per barrel)

200620052004

*weighted GDP at PPP exchange rates*weighted GDP at PPP exchange rates

Economics@20

Caveat: the CNYCaveat: the CNY1. Most likely: do nothing this year

• No real domestic pressures for revaluation• Economy already slowing; prices under control• Slowdown in global growth and rise in global inflation and

interest rates should ease existing pressures

2. Possibility: widen existing band• Allow widening of existing +/-0.3% band• Gradual revaluation of up to 10%• A 2006 or 2007 event

3. Possibility: weighted currency basket• Some combination of USD, ¥ and €• Makes economic sense but authorities risk averse

4. Unlikely: one-off revaluation• Negative impact on the economy• Insufficient magnitude to correct terms of trade• Not compatible with move toward market forces

Economics@21

Major risks in revaluation scenarioMajor risks in revaluation scenario

l Increase in speculative flows to Asia– Liquidity trap exacerbated– Global imbalances worsen; US CAD widens– Depends on timing and execution of revaluation

l Sell-off of US Treasuries– China and Japan hold US$898 bn of the US$3.8 tr

outstanding US Treasury stock; China’s holdings increased by $2 bn this year to February while Japan’s decreased by US$9 bn

l Disorderly correction of US CAD– US dollar sells off sharply and US import demand declines

rapidly– China’s tradeables sector experiences downturn with

negative impact on commodity demand

l Commodity prices drop sharply– Rest of Asian region experiences downturn in demand– Australia experiences real negative impact of declining

commodities demand and CAD correction

Economics@22

Implications of revaluation for A$Implications of revaluation for A$

20%+ revaluation

5-10% revaluation

Long term

lGreater probability of a drop in demand for Chinese exports that would lead to decline in commodity prices; A$ would weakenlVery low probability that revaluation would be absorbed by exporters and have little impact on commodity prices

Short term

lGreater probability of more A$ weakening than in smaller revaluation; global positions unwound but unlikely to reverse net revaluation lLesser probability of an immediate reaction to commodity price dynamics that brings short-term weakening

Long termlGreater probability that A$ regains some strength as China’s commodities buying power rises and US demand remains strong

lLesser probability that CNY rise lowers demand for Chinese exports and thus commodities; A$ does not regain strength

Short termlGreater probability of some A$ weakening as Asian currencies to strengthen in line with CNYlLesser probability that A$ strengthens as long Asian currency positions are unwound

Economics@23

Regional currency forecastsRegional currency forecasts

55.554.5054.8056.05US$ - PP

32.8032.1031.3031.69US$ - NT$

1 0651 050 1 0151 035US$ - Won

39.0039.4040.838.91US$ - Bt

8 7009 1009 4009 290US$ - Rph

3.603.803.803.80US$ - M$

7.807.807.797.80US$ - HK$

15 768

1.64

8.28

102.6

Dec 2004

15 890

1.67

8.28

106

Jun 2005

16 100

1.69

8.28

110

Dec 2005

16 400US$ - Dong

1.72US$ - S$

8.28US$ - Yuan

113US$ - ¥

Dec 2006

Economics@24

Cross rates with A$ forecastsCross rates with A$ forecasts

0.590.560.620.57A$ - Euro

36.1036.0042.2043.66A$ - PP

21.3021.2024.1024.68A$ - NT$

692693782806A$ - Won

25.4026.1031.4030.31A$ - Bt

5 6556 0067 2387 236A$ - Rph

2.402.502.902.96A$ - M$

12 282

1.27

6.45

79.9

Dec 2004

12 220

1.29

6.38

81.6

Jun 2005

10 626

1.12

5.46

72.6

Dec 2005

10 660A$ - Dong

1.12A$ - S$

5.38A$ - Yuan

73.5A$ - ¥

Dec 2006

Economics@25

Summary of key market forecastsSummary of key market forecasts

6.006.756.756.50RBNZ cash rate (% pa)

1.181.091.071.09A$ - NZ$

6.106.105.705.33Australian 10-year bond yield (% pa)

0.650.660.770.78A$ - US$

0.550.590.680.72NZ$ - US$

5.25

8.28

103

1.36

4.22

2.25

Dec 2004*

5.50

8.28

106

1.24

4.80

3.25

Jun 2005

5.50

8.28

110

1.17

5.30

4.25

Dec 2005

8.28US$ - Yuan

5.50RBA cash rate (% pa)

113US$ - ¥

1.10€ - US$

5.50US 10-year bond yield (% pa)

4.50US Fed funds rate (% pa)

Dec 2006

* actual