Nomura - Global Annual Economic Outlook

Nomura | Global Annual Economic Outlook 13 November 2012

Nomura Securities International Inc.

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Global Annual Economic Outlook

Economics Research | Global

Weak, with a chance of becoming bleak 13 NOVEMBER 2012

Contents

GLOBAL

Global Outlook | Weak, with a chance of becoming bleak 2

Forecast Summary 5

Our View on 2013 in a Nutshell 6

ASIA EX-JAPAN

Asia Outlook | 2013: The heat is on 7

Australia | The peak in resource investment is coming 11

China |Up in H1, down in H2 12

Hong Kong |Looming fiscal stimulus 15

India | A year of consolidation 16

Indonesia | Watch policies and politics 17

Malaysia | Time for fiscal tightening 18

Philippines | Still likely to shine 19

Singapore | The (long) road to restructuring 20

South Korea | Growth to rebound from a very low base 21

Taiwan | External demand holds the key 22

Thailand | New growth engines 23

JAPAN

Japan | Export recovery likely to deliver positive growth in Q1 2013 24

AMERICAS

United States | More clarity, less uncertainty 27

Canada | Steady as she goes: growth slightly above trend in 2013 33

Mexico | 2013: The year of reforms 34

Brazil | Inflation storm on the horizon 35

Rest of LatAm 36

EURO AREA

Euro Area | Spain and Italy to remain at the epicenter 37

UNITED KINGDOM

United Kingdom | Stagnant 41

EEMEA

EEMEA Outlook| Some silver linings to the external risks bearing down 42

Hungary | Fun and games continue 46

Poland | NBP in a limited cutting cycle - growth still outperforming 47

South Africa | Status quo means the brakes are still applied 48

Turkey | A healthy rebalancing 49

Rest of EEMEA 50

Global Economics

[email protected]

Contributor names can be found within the body of this report and on the back cover

This report can be accessed electronically via: www.nomura.com/research or on Bloomberg (NOMR)

mailto:[email protected]


2

Desmond Supple +44 (0) 20 710 22125 [email protected]

Global Outlook | Weak, with a chance of becoming bleak

Another year of below-trend global growth

Our view is that the global economic outlook for 2013 is best defined as weak, with the chance

of becoming bleak. Our core view points to global economic growth of 3.0% in 2013, down from

3.1% this year and below the trend rate of global growth of around 3.75%. Once again, the

developed markets comprise the most notable source of weakness, expected to expand by just

0.7% next year, down from an already soft estimated 1.2% in 2012.

Reasons for weakness

1) Echoes of a burst bubble

One reason for the continued weak performance of developed markets is the lingering

repercussions of the bursting of the credit bubble five years ago. Household, corporate and

financial sector balance sheet restructuring remains a theme across many countries, which is

limiting leverage in the system and rendering consumption growth more a function of income

growth. The post-crisis push for deeper financial sector regulation is adding a further headwind

to global growth. To illustrate using the Basel 3 regulatory framework, this increases banks‟

capital charges and forces them to rely on longer-term, more expensive funding. As such, banks

are growing more discerning over their use of their balance sheets, resulting in spreads

between lending rates and the policy rate structurally widening.

2) The ongoing eurozone crisis

A second key reason for the weakness in global growth is the continuing eurozone crisis. Policy

settings in the eurozone are deeply restrictive, with governments implementing a policy of pro-

cyclical fiscal tightening. Moreover, peripheral countries face a zero-bound problem, which is

made worse by weakness in domestic banking systems resulting in a break in the transmission

mechanism from low policy rates to broader lending rates. In short, Europe is in an unstable

equilibrium, with a deepening growth crisis belying the European Central Bank's (ECB) efforts to

address the financial crisis.

We expect eurozone GDP to fall by 0.8% next year following a decline of 0.5% in 2012.

Europe's current policy settings seem incompatible with a notable economic recovery over a

meaningful timeframe, and in peripheral markets the outlook is for depression rather than

recession. In Spain, we expect GDP to fall by 3.0% next year and by 1.5% in 2014, while we

forecast Greek growth of -4.2% for 2013, which would be a sixth consecutive year of recession.

(The question of official sector involvement in Greek debt relief, and indeed the stability of the

country‟s presence in the euro, should remain sources of uncertainty in 2013.) Europe is set to

remain a heavy weight on global growth over the medium term. Needless to say, Europe's

inability to grow means that solvency concerns will remain elevated in the peripheral economies

in 2013, and we see a risk that these concerns creep into some semi-core markets, such as

France.

3) Pro-cyclical fiscal austerity

A third constraint on growth is the extent to which fiscal policy restrains demand. In the US,

even if the fiscal cliff is smoothly traversed, our US research team notes that current policies will

see fiscal policy reduce growth by 1 percentage point (pp) next year (if we go over the fiscal cliff

permanently, then clearly a deep, double-dip recession looms). We have already noted the pro-

cyclical fiscal policy in the eurozone that is helping to push many countries into unstable

equilibriums, while we do not expect the UK government to blink in the face of anaemic growth,

and we assume it will continue efforts to rein-in the budget deficit.

However, one developed country that might buck the trend of fiscal restraint is Japan. Post-

earthquake reconstruction spending should remain a continued support to economic growth, but

one possible additional spur to consumer demand is the anticipated consumption tax hikes in

2014 and 2015. As was seen before Japan's last consumption tax hike on 1 April 1997, this has

the potential to see consumers bring forward their spending plans. Of course, the experience of

1997 is not a happy one for Japan. The consumption tax hike saw growth slide over the



3

subsequent 12 months, primarily due to the deterioration in financial stability and the Asian

economic crisis. However, we are confident that history will not repeat and our economic

research team is comfortable in assuming that positive growth can be maintained in 2014 after

a tax hike in April is implemented.

Few monetary policy shibboleths will remain

One of the additional themes of 2013 is likely to be the degree to which central banks will try to

offset weak growth by adopting yet more unorthodox monetary policies. In this respect, the ECB

and the Bank of Japan (BOJ) are likely to be at the forefront of embracing fresh unorthodoxy.

In the eurozone, we expect a renewed escalation in the crisis as the proposed firewall proves

inadequate to address the lingering solvency concerns in non-core markets. This should once

again force the ECB into the unwanted position of having to contemplate even bolder and

previously unpalatable monetary responses, or be confronted with a realistic prospect of a euro

break-up.

However, in Japan a potentially greater and more structural change may be taking place in

monetary policy. The growing political influence over the BOJ is expected to be reinforced by

the appointment of BOJ Governor Shirakawa‟s replacement next April. Q2 1013 should also be

a critical time for Japan as the government will be making the final decision on whether it

implements the April 2014 consumption tax. We expect the increased political pressure on the

BOJ to embed a trend towards bolder monetary policy easing given that inflation is expected to

undershoot the goal of 1%. We expect a weak JPY to be a feature of 2013.

The extent of monetary policy gyrations taking place in Europe and Japan are so notable that, in

comparison, the continued aggressive and bold monetary policy trends in the US and the UK

appear rather routine. In the US, we assume that the Fed will maintain its USD40bn a month

rate of MBS purchases until Q3 2013, while Operation Twist will be replaced with a programme

of outright Treasury purchases. Meanwhile, in the UK – where the Bank of England (BOE) has

expanded its balance sheet proportionally more than all other G10 central banks since the onset

of the crisis – we expect the BoE to deliver just a GBP50bn expansion of QE3 in February,

taking the asset purchasing fund to GBP425bn. Our UK economics team does not expect a

trend of above-target inflation in 2013 to restrain the BOE from its focus on supporting growth.

In the emerging world: Brazil to outperform the other BRICs

We expect that once again, emerging markets will provide a partial – but not compete – offset to

weakness in developed markets. Although even here, our optimism is equivocal. Of the crucial

BRIC economies, we expect Brazil to display the most improved growth outlook in 2013 as the

economy rebounds on the monetary and fiscal stimulus delivered this year. We forecast

Brazilian growth to rebound to 4.1% in 2013 from an estimated 1.3% this year. One interesting

theme in Brazil next year will be how long the central bank will refrain from tightening monetary

policy in the face of recovering growth and an expected uptrend in inflation following a

cumulative 525bp of cuts to the Selic rate since August 2011.

Within Asia, our out-of-consensus forecast for a policy-driven rebound in growth in China in Q4

2012 and Q1 2013 is being validated by an upswing in economic data. However, we also

assume that China's unleashed policy stimulus will be short-lived, as inflation rises in 2013. The

current investment-led stimulus and rapid expansion of financing outside the regulated banking

sector could also exacerbate the already large structural problems in the economy. Therefore,

we expect GDP growth to slow back towards 7.0-7.5% levels from H1 2013 onwards. Full-year

2013 growth is forecast to be lower than in 2012. We also maintain our one-in-three probability

of a hard landing (i.e. GDP growth averaging 5% or less over four consecutive quarters),

starting to play out before the end of 2014. Meanwhile, we expect a very shallow recovery in the

other Asian BRIC – India – where growth remains weighed down by a lack of structural reforms

(we are sceptical that recent reform announcements will be fully implemented ahead of

elections in 2014) and by the related trend of “sticky” inflation.

Elsewhere in the EM world, we expect the EEMEA region to be split between stronger growth

outperformers like Turkey and Poland, and those suffering from a mix of domestic idiosyncratic

risks while feeling greater pain inflicted on them by the eurozone crisis. This group includes

Hungary, South Africa and the Balkans, where narrow funding tightropes will need to be walked.


4

Pockets of optimism and upside risks to the core view…

Nonetheless, there are some clear pockets of optimism within our generally downbeat global

economic outlook.

As the uncertainty surrounding the US fiscal cliff dissipates, we anticipate a capex-driven rise in

US growth in H2 2013 (helped by an ongoing housing market recovery), such that we expect

the US to post above-trend rates of expansion into Q4 2013. This underpins our view that the

Fed will call time on its latest round of QE in Q3 next year as the outlook for unemployment

should have improved.

In Europe, one possible upside surprise is if policymakers start to target structural reforms and

structural budget deficits more than nominal budget deficits. While this might not remove the

pro-cyclical fiscal tightening already in motion, it may be able to break the cycle of weak growth

undermining deficit-reduction targets, leading to fresh austerity, leading to weaker growth…

In the developed world, inflation is expected to be contained, which should allow monetary

policy to focus more directly on growth considerations.

… but there remains an asymmetry around the risk

However, when looking at the world economy it is clear that an asymmetry exists as the

downside risks are profound.

In Europe, our forecast for a deep regional recession and depression in some countries already

assumes further bold monetary policy responses. What if Spain and Italy require a full bail-out

and the Troika is unable to provide sufficient funding? As our European economics team says

with regard to the eurozone: “The currency might be irrevocable but membership is no longer”.

In the US, the fiscal cliff looms large as a downside risk. Although, on this point we assume that

the severe economic consequences of going over the cliff will provide something of a self-

equilibrating mechanism to the political machinations: we assume that economic weakness

would swiftly force politicians back to the negotiating table. Our US economists outline how a

temporary leap off the cliff would have a far less damaging impact on growth than a persistent

shock. In essence, a fiscal bungee jump versus a fiscal swan dive.

In China, the perennial risk is that the country fails to engineer a soft landing. After all, this

would be an historic achievement since there are no precedents of a large country experiencing

a controlled descent from such a rapid expansion of credit and investment growth.

In Asia generally, our team notes that trend growth rates are declining. In this context, the

decline in the region‟s current account surplus is somewhat worrisome since it is happening for

the wrong reasons.

Given how bleak the sum of these risks is, our weak macroeconomic baseline scenario might

not be such a bad outcome.


5

Forecast Summary

Real GDP (% y-o-y) Consumer Prices (% y-o-y) Policy Rate (% end period)

2012 2013 2014 2012 2013 2014 2012 2013 2014

Global 3.0 3.0 3.7 3.3 3.4 3.4 2.96 3.21 3.36

Developed 1.1 0.7 1.7 2.0 1.5 1.7 0.38 0.42 0.49

Emerging Markets 5.2 5.6 5.8 4.7 5.5 5.3 5.99 6.34 6.40

Americas 2.3 2.1 3.0 3.6 3.6 3.4 2.08 2.42 2.53

United States* 2.1 1.5 2.8 2.1 1.6 1.4 0.13 0.13 0.13

Canada 2.2 2.0 2.1 1.7 1.9 2.0 1.00 1.75 3.00

Latin America†† 2.8 3.7 3.6 7.9 9.4 8.9 7.49 8.54 8.39

Argentina 2.0 4.0 3.5 26.4 32.3 29.7 15.00 17.00 14.00

Brazil 1.3 4.1 3.5 5.5 5.7 5.5 7.25 9.00 8.50

Chile 5.1 5.5 5.0 3.0 3.3 3.0 5.00 5.50 5.25

Colombia 4.5 4.5 4.5 2.9 3.5 3.5 4.50 4.50 5.50

Mexico 3.7 3.5 3.5 4.1 3.4 3.5 4.50 4.50 5.50

Venezuela 6.0 -1.0 3.0 17.5 32.4 24.7 15.00 17.00 16.00

Asia/Pacif ic 5.4 5.4 5.7 3.1 3.8 4.0 4.66 4.92 4.99

Japan† 1.6 0.5 1.2 -0.1 -0.3 1.8 0.05 0.05 0.05

Australia 3.6 2.4 2.8 1.6 2.6 2.5 3.00 3.50 4.00

New Zealand 2.7 3.2 3.3 1.7 2.4 2.8 2.75 3.50 4.25

Asia ex Japan, Aust, NZ 6.3 6.4 6.6 3.7 4.6 4.5 5.65 5.90 5.90

China 7.9 7.7 7.5 2.6 4.2 4.0 6.00 6.50 6.50

Hong Kong*** 1.5 2.5 3.5 4.0 4.3 4.3 0.40 0.40 0.40

India** 5.3 6.1 6.5 7.6 7.2 6.9 8.00 7.50 7.00

Indonesia 6.1 6.1 6.2 4.4 5.2 5.1 5.75 6.25 6.75

Malaysia 4.8 4.0 4.6 1.7 2.4 2.5 3.00 3.50 4.00

Philippines 6.0 6.0 5.8 3.2 4.4 4.5 3.50 4.00 4.50

Singapore*** 1.8 3.4 4.2 4.8 3.9 3.6 0.38 0.48 0.50

South Korea 2.3 2.5 3.5 2.2 2.7 3.0 2.75 2.75 3.25

Taiw an 1.0 3.0 3.5 2.0 2.3 2.3 1.88 2.13 2.13

Thailand 5.5 4.5 5.0 3.0 3.0 3.1 2.75 2.75 3.25

Western Europe -0.4 -0.6 0.2 2.6 1.8 1.7 0.50 0.50 0.50

Euro area -0.5 -0.8 0.0 2.5 1.7 1.6 0.50 0.50 0.50

Austria 0.4 0.2 0.8 2.5 2.2 2.0 0.50 0.50 0.50

France 0.1 -0.5 0.5 2.2 1.4 2.0 0.50 0.50 0.50

Germany 0.9 0.3 0.7 2.2 1.8 1.8 0.50 0.50 0.50

Greece -6.5 -4.7 -1.8 0.9 -0.2 -0.3 0.50 0.50 0.50

Ireland -0.1 0.4 1.3 2.0 0.4 0.5 0.50 0.50 0.50

Italy -2.4 -2.5 -1.5 3.3 1.8 1.4 0.50 0.50 0.50

Netherlands -0.3 -0.3 0.2 2.8 2.6 1.9 0.50 0.50 0.50

Portugal -3.2 -2.8 0.0 2.8 1.3 0.7 0.50 0.50 0.50

Spain -1.4 -3.0 -1.5 2.5 2.5 1.4 0.50 0.50 0.50

United Kingdom -0.2 0.4 1.0 2.8 2.6 2.3 0.50 0.50 0.50

EEMEA 2.0 2.6 3.6 5.7 4.6 4.5 4.54 4.41 5.31

Czech Republic -0.9 0.7 1.4 3.3 2.1 1.5 0.05 0.05 1.00

Hungary -1.1 0.1 0.8 5.9 5.0 4.3 5.75 5.00 6.00

Israel 2.8 3.0 3.5 2.1 2.6 2.7 2.00 2.50 3.00

Poland 2.4 2.0 3.5 3.8 2.4 3.0 4.50 4.00 5.00

Romania 0.2 0.8 1.8 3.8 5.0 4.2 5.00 6.00 9.00

South Africa 2.4 2.6 3.2 5.6 5.5 5.7 5.00 4.50 6.00

Turkey 3.0 4.5 5.5 9.1 6.7 6.3 5.75 5.75 5.75 Note: Aggregates calculated using purchasing power parity (PPP) adjusted shares of world GDP (table covers about 84% of world GDP on a PPP basis); our forecasts incorporate assumptions on the future path of oil prices based on oil price futures, consensus forecasts and Nomura in-house analysis. Currently assumed average Brent oil prices for 2012, 2013 and 2014 are $112, $109 and $104, respectively. *2012, 2013 and 2014 policy rate forecasts are midpoints of 0-0.25% target federal funds rate range. **Inflation refers to wholesale prices. ***For Hong Kong and Singapore, the policy rate refers to 3M Hibor and 3M Sibor, respectively. †Policy rate forecasts in 2012, 2013 and 2014 are midpoints of BOJ‟s 0-0.10% target unsecured overnight call rate range. ††CPI forecasts for Latin America are year-on- k Monthly. Source: Nomura Global Economics.


6

Our View on 2013 in a Nutshell

United Sates

We expect growth to accelerate in the second half of the year, led by a rebound in capital expenditures.

Ample economic slack, apparent in the high rate of unemployment and unused capacity, should restrain inflation.

We expect the FOMC to embark on further long-term asset purchases at the start of the year.

A strengthening of the housing market should support investment, job creation, and aggregate demand.

Europe‟s debt crisis, slowing global growth, and contractionary US fiscal policy are the key risks to growth.

Europe

Fiscal tightening, financial deleveraging and sovereign debt market tensions should lead to a deeper-than-expected recession.

Spain risks delaying call for ECCL due to market stability and ESM bank recap delays. Our baseline is an ECCL will be called.

After a phase of relative calm, markets will likely test the backstop and pressure should rebuild in Q1 on weak sovereigns.

GDP contractions, higher non-performing loans and rising debt trajectories remain the key euro area challenges.

The likelihood of a December ECB rate cut is finely balanced, but is increasingly likely that the next will not be before Q1 2013.

We expect inflation to be sticky in the UK, albeit back in the right ballpark, but in the euro area to slip below target during 2013.

The BoE aggressively announced QE, liquidity and funding support in 2012. We forecast more, with £50bn of QE in February.

Japan

We expect an export recovery, driven by China's economic recovery to deliver positive growth in Q1 2013.

The export recovery should stimulate domestic demand and push the overall economy into a stable growth phase in 2013.

Our main scenario is that the BOJ will apply additional easing measures in January 2013, with the risk earlier than our call.

The main risks are yen appreciation, a worsening European debt problem and the US and China slowing.

Asia

The export slump calls for policy stimulus, but raises the risk next year of a build-up in debt, inflation and asset price bubbles.

China: GDP growth will likely stay strong in H1 2013 supported by investment, but slow in H2 due to policy tightening.

Korea: We expect the BOK to stay on hold at 2.75% through 2013 as growth and inflation should rise modestly from a low base.

India: With macro imbalances slow to correct and binding supply-side constraints, we expect only a shallow recovery.

Australia: With global growth stabilising, the RBA is comfortable with the current level of monetary stimulus in the economy.

Indonesia: An increasingly uncertain policy environment may lead to delays in reforms and sustained current account deficits.

EEMEA (Emerging Europe, Middle East and Africa) and Latin America

South Africa: A continuing political status quo will continue to hold the economy back, the SARB may cut again.

Hungary: A market blow-up is needed for an IMF deal, rate cuts and a new MNB Governor in March could be the trigger.

Poland continues to outperform and a recession is difficult to envisage, so we see a limited cutting cycle.

Turkey: Rebalancing continues and is likely to pave the way for further upgrades.

Brazil: Inflation is set to rise towards 6% in H1 2013, forcing the BCB to start a new hiking cycle.

Mexico: The new government will embark on a series of important reforms in 2013.

Argentina‟s growth is set to recover modestly in 2013. Inflation and REER overvaluation to remain problematic.


7

Rob Subbaraman +852 2536 7435 [email protected]

Asia Outlook | 2013: The heat is on

Asia’s rapid economic rebalancing increases the risk of some economies overheating.

Since the global financial crisis, Asia ex-Japan has been instrumental in helping to rebalance

the global economy. The region‟s total current account surplus has shrunk to 2% of GDP, a

level not seen since the Asian financial crisis 15 years ago (Figure 1). The shrinkage is not just

due to weak exports but also resilient Asian domestic demand (Figure 2). Unlike in 2008-09,

Asian exports have cooled but not collapsed, so the multiplier effects on domestic demand, via

job losses, have not been as significant, while Asia‟s already-lax policies have become looser.

To be sure, the ongoing healing process from balance sheet recessions will keep the big,

advanced economies fragile in 2013, especially the euro area where we expect more bouts of

financial market turmoil and a slight GDP contraction in every quarter next year. But while

cognizant of the downside risks to global growth, our base case is for the global economy to not

suffer another major heart attack, as it did in late 2008. This distinction is important, for without a

collapse in Asian exports or a mass exodus of foreign capital, our core view is for the rebalancing

to continue, with Asian domestic demand further increasing its contribution to GDP growth. We

expect aggregate GDP growth in Asia ex-Japan to rise from 6.3% y-o-y in 2012 to 6.4% in 2013

(see the country outlook pages for details). Our over-arching theme for Asia next year is that

economies will display increasing symptoms of overheating, like debt build-up, frothy property

markets and rising CPI inflation. The biggest risk, in our view, is that Asian policymakers fall

behind the curve in normalizing very accommodative macro policies. This is the crux of our China

story of two halves: 8.2% y-o-y GDP growth in H1 2013, followed by 7.2% in H2.

Fig. 1: Asia ex-Japan’s total current account surplus

-2

-1

0

1

2

3

4

5

6

7

8

Jun-96 Jun-00 Jun-04 Jun-08 Jun-12

% of GDP

Source: CEIC.

Fig. 2: Contribution to year-on-year real GDP growth, 2012

-6

-4

-2

0

2

4

6

8

10

12 Net exports

Investment

Consumption

percentage points

Note: Year to Q3 GDP for China, Korea and Indonesia; others are H1 GDP. Source: CEIC.

Three growth engines

We see three main factors supporting Asia‟s rapid economic rebalancing:

China. Contrary to consensus, we have long held the view that China can experience a policy-

led cyclical economic recovery despite its deep structural problems. Fiscal policy easing really

only started in earnest in July after the announcement that Q2 GDP growth had fallen below

8%; there was no single large-scale stimulus announcement like in late 2008, but add up all the

measures and it is significant. We expect GDP growth to rebound from 7.4% y-o-y in Q3 to

8.4% in Q4, and stay above 8% in H1 2013. However, we expect a positive output gap to stoke

CPI inflation to over 4% y-o-y in Q2 2013, triggering policy tightening. This, coupled with a

renewed debt buildup outside the regulated banking sector and slow progress in rebalancing

from investment- to consumption-led growth, will likely heighten investor concerns, causing

GDP growth to slow to 7% y-o-y by Q4 2013. This may seem weak by China‟s standards, but

the size of China‟s economy (at market exchange rates) has almost doubled from USD4.5trn in

2008 to an estimated USD8.2trn in 2012. A much larger economy growing at a moderately

slower pace is still a very powerful growth pole for the rest of Asia. Actually, we estimate that



8

2012 is the crossover year when the annual increase in nominal personal consumption in China

(USD478bn) surpasses the US (USD403bn).

Loose policies. The central banks in China, India, Indonesia, Korea, Thailand and the

Philippines have all cut policy rates this year and, adjusted for inflation, real policy rates are

historically low across Asia. But what is less appreciated is that many other Asian governments

are mimicking China, taking advantage of low public debt levels and shifting to more

expansionary fiscal policies. Hong Kong, Malaysia, Thailand and the Philippines release timely

monthly fiscal data, which show that their combined central budget deficit in the 12 months to

September is almost as large as after the global financial crisis (Figure 3). In the advanced

world, loose monetary policies are being offset by fiscal austerity; in emerging Asia, both

policies work together and are more effective. Low unemployment, solid credit growth and

positive wealth effects from buoyant property markets are conspiring with these loose macro

policies to bolster domestic demand. There are, however, some exceptions: India has limited

room to use countercyclical policies due to high inflation and poor fiscal finances; Korea‟s loose

policies are being dampened by a household sector overburdened with debt; and Singapore

has refrained from fiscal easing as it focuses on raising productivity.

Capital inflows. Net foreign capital inflows to Asia have significant scope to intensify in 2013.

The most comprehensive gauge, which captures FDI, portfolio debt and equity flows as well as

cross-border foreign bank claims, is the financial account of the balance of payments. Using this

measure (Figure 4), we see that, in the space of just two and a half years since the crisis (Q1

2009 to Q2 2011), net capital inflows to Asia ex-Japan totalled a massive USD783bn, more than

the USD573bn in the five years prior, “pulled” by Asia‟s relatively higher growth prospects and

“pushed” by central bank quantitative easing in advanced economies (which, through portfolio

rebalancing, has spill-over effects on emerging markets by pushing investors into riskier assets).

While volatile in recent quarters, we expect another large bout of net inflows, buoyed by China‟s

economic recovery, QE3 and the fading of US fiscal cliff fears. There certainly seems to be

room for more inflows. A glaring example is the widening gap between the shares of emerging

Asia in world GDP and in the MSCI world equity index (Figure 5). Another large bout of net

capital inflows would accelerate Asia‟s rebalancing via 1) currency appreciation, which crimps

exports;or 2) FX intervention and central banks keep interest rates lower than they would

otherwise, easing liquidity conditions and buoyed asset markets.

Fig. 3: Central government budget positions

-40

-30

-20

-10

0

10

20

-250

-200

-150

-100

-50

0

50

100

Sep-03 Mar-05 Sep-06 Mar-08 Sep-09 Mar-11 Sep-12

China, LHS

Rest of Asia, RHS

USD bn, 12-month rolling sum USD bn, 12-month rolling sum

Note: Rest of Asia is the aggregate fiscal balances of Hong Kong, Malaysia, Thailand and the Philippines. Source: CEIC.

Fig. 4: Asia ex-Japan’s net capital inflows

-90

-60

-30

0

30

60

90

120

Jun-03 Dec-04 Jun-06 Dec-07 Jun-09 Dec-10 Jun-12

US$bn

QE2 announced

QE1 announced

USD 573bn

USD 783bn

Note: Countries are China, HK, India, Indonesia, Korea, Taiwan, Malaysia, Philippines, Singapore, and Thailand. Source: CEIC.

Four risks

The one we are most concerned with is some Asian economies overheating.

Overheating. In our view, there is too much reliance on countercyclical policies to counter

weak exports, and not enough on structural reforms to boost the supply-side of the economies.

In October, the real interest rate on 1yr bank deposits in China was 1.1%, while in the rest of

Asia the average real policy rate, weighted by GDP, was just 0.1% – and this is during a period

of low inflation in the region (Figure 6). Asia‟s real policy rate is likely to turn negative again as

inflation rises. These persistent negative real rates sow the seeds of overheating. From 1999 to

2005, the real interest rate was negative 19% of the time in China and 10% of the time

elsewhere in Asia, while from 2006 to 2012, the share of time with negative real rates increased


9

to 57% and 43%, respectively. Central banks justify erring on the side of laxity as insurance

against the downside risks to global growth and to avoid provoking too-strong capital inflows,

but as a result credit is growing faster than nominal GDP in all Asian countries, and property

markets are frothy in many of Asia‟s capital cities. We see a danger in the increased use of

macro-prudential measures in an attempt to cool property markets and credit growth; these

measures may work for a while but overtime as loopholes are found, they turn out to be a poor

substitute for higher interest rates. Central banks ultimately find themselves behind the curve in

tackling credit booms, asset price bubbles and inflation. Hong Kong seems most at risk, but we

cannot rule out overheating in other countries, including China, India, Indonesia and Singapore.

Commodity price surge. Despite lackluster growth in the advanced economies, very loose

monetary policies around the world and strengthening demand in emerging economies,

especially Asia, could fuel another surge in global commodity prices, particularly food prices.

The global supply-demand equation for food remains tight, and the size of the annual increase

in China‟s personal consumption is about to overtake the US to be the world‟s largest. This is

important. For unlike other commodities, the sensitivity of the demand for food to an increase in

personal income is much greater for lower-income countries, as is the changing of diets toward

a higher calorie intake. A surge in global food prices could lift Asian inflation sharply and

ultimately restrict growth, notably in India, Indonesia, and the Philippines.

Recoupling. Trend GDP growth in Asia ex-Japan is around 7%, a full five percentage points

higher than in advanced economies, or put more starkly: real GDP is above its pre-global

financial crisis peak by 41% in China, 31% in India, 25% in Indonesia and 11% in Korea

compared with 2.3% in the US and still 2.4% below in the euro area. However, the 2008-09

experience has debunked any notion that Asia can decouple from advanced economies at

times of extreme dislocation. While relatively strong economic and policy fundamentals have

helped buffer Asian economies against sub-par growth in the US and euro area, another deep

recession in the advanced world would be a completely different story, as Asia would hit a

tipping point where non-linear effects kick in from a collapse in exports and foreign capital flight.

Those economies that are very open to trade (Hong Kong, Singapore, Malaysia), have current

account deficits (India and Indonesia) or weak domestic economies (Korea) are most vulnerable.

China hard landing. In November 2011, we published an Anchor Report, China risks, in which

we analyzed China‟s structural economic problems and concluded that they had become too big

to ignore. We assigned a one-in-three likelihood of China experiencing a hard economic landing

before the end of 2014, which we defined as GDP growth averaging 5% y-o-y or less over four

consecutive quarters. To quantify the macro risks on an ongoing basis we developed the

Nomura China Stress Index (CSI), which is near its all-time high. We maintain a one-in-three

likelihood of a hard landing, as recent policy easing has increased shadow banking activities,

which caused the CSI to rise in Q3 2012. A China hard landing would have a significant impact

on Asia. A recent IMF study estimated that each percentage point (pp) decline of investment

growth in China would lower GDP growth by more than 0.5pp in Korea, Taiwan and Malaysia.

Fig. 5: Asia emerging market share in world GDP and MSCI

1

5

9

13

17

21

25

1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016

Asia EM share in world MSCI equity index

Asia EM share in world GDP (at market exchange rates)

% shareIMF forecasts

Note: Asia EM is China, India, Indonesia, Malaysia, Korea, Philippines, Taiwan and Thailand. Source: MSCI and IMF.

Fig. 6: Real policy interest rates (deflated by headline CPI)

-5-4-3-2-101234567

Oct-00 Oct-02 Oct-04 Oct-06 Oct-08 Oct-10 Oct-12

China's real bank deposit rate

Rest of Asia's real policy rate

% p.a.

Note: For the rest of Asia, the real policy rate is GDP weighted. Source: Bloomberg and CEIC.

http://intranet.nomuranow.com/research/globalresearchportal/GetPub.aspx?pid=471517

http://go.nomuranow.com/research/globalresearchportal/getpub.aspx?pid=574358&appname=GRP&cid=TWFOV2I0UlFsMFE90


10

A tour of the region

China’s economy is on a structurally downtrend for the next several years because of two

reasons. First, potential growth slows as (i) excess labor supply has been largely depleted,

which drives up wages and drags down productivity growth; (ii) external demand weakens

particularly in developed economies; and (ii) progress on economic reforms has been sluggish

and the outlook remains uncertain. Moreover, structurally higher inflation and over-capacity in

the manufacturing industry will constrain the effectiveness of government‟s supportive policy.

We believe the government will gradually lower the annual GDP growth target (from 7.5% in

2012) over the next several years to tolerate slower growth. Against this backdrop, we expect

growth in 2013 to remain above 8% in H1, supported by cyclical policy easing, and then weaken

in H2 to 7% by Q4, as inflation rises above 4% by June and forces a tightening of the policy

stance. We believe a growth recovery in H1 will be largely driven by policy rather than economic

fundamentals, hence growth should return to its long term downtrend once policy supports are

removed. We see inflation as the main risk to our view. If inflation does not rebound quickly in

H1 and force a policy shift toward tightening, our growth outlook may face upside risks and the

recovery may last into H2.

In Korea, we expect GDP growth and CPI inflation to rise only modestly, allowing the Bank of

Korea (BOK) to keep rates unchanged at 2.75% through 2013. The growth rebound should be

driven by inventory restocking and a modest global demand recovery in 2013. But high

household debt (156% of disposable income) should constrain domestic demand, so we

maintain our below-consensus 2013 GDP growth forecast of 2.5%. A negative output gap and

stable KRW should exert downward pressure on inflation, but fading favorable base effects

(from a one-off decline in school fees and expenses) should push CPI inflation up to 2.7% in

2013 from 2.2% in 2012, within the BOK‟s inflation target range 2.5-3.5% for 2013-15.

Hong Kong and Taiwan stand to benefit most from a China recovery, and we expect GDP

growth to rise in 2013 to 2.5% in Hong Kong and 3.0% in Taiwan. Taiwan‟s very low policy rate

is likely to be hiked twice in H2, whereas Hong Kong, due to the HKD/USD peg, will continue to

import so-called US QE infinity, and will likely struggle to contain asset prices.

In India, with twin deficits correcting only very gradually, we expect 2013 to be a year of growth

consolidation rather than a sharp rebound. GDP growth should pick up to 6.1% in 2013 after

falling to a decade low of 5.3% in 2012. However, compared to past recoveries, this should be

very shallow for three reasons. First, we expect external demand to remain subpar in 2013.

Second, the supply-side of the economy remains severely constrained. With potential growth

having slowed to 6.5-7.0%, we expect the output gap to close quickly in response to a demand

revival, lifting core inflation in H2 2013 and limiting the extent of rate cuts to 50bp in H1 2013.

Third, new investments are unlikely to pick up quickly due to the high cost of capital, weak

exports and high global uncertainty. Recent reform announcements are positive, but

implementation risks remain ahead of 2014 general elections. At best, faster land and

environmental clearances, as they happen, could drive existing projects. We expect a current

account deficit of 3.7% of GDP in 2013 due to inelastic imports and weak exports, the financing

of which leaves India susceptible to global risk appetite. We expect the fiscal deficit to remain

above 5% of GDP in FY14 due to slow growth and populist spending ahead of the elections.

In Southeast Asia, the domestic oriented economies of the Philippines and Indonesia should

be the star performers, both posting GDP growth of 6% or more. Among the open economies,

we see some differentiation in the outlook. In Singapore, growth is likely to be below trend, at

3.4%, as we continue to expect no countercyclical policies, as the government is focused on its

long-term economic restructuring agenda. Malaysia has to call elections in H1 and, regardless

of the outcome, this will likely be followed by significant fiscal consolation which will add to the

external drag, capping growth at 4.0%. By contrast, we expect solid 4.5% growth in Thailand as

the government ramps up spending, particularly on infrastructure. This should help to crowd in

more private investment that already benefits from very loose monetary policies and the post-

flood recovery. We expect inflation to rise in 2013, with the balance of risks tilted to the upside

given above-potential growth (Philippines, Thailand), modest subsidy adjustments (Indonesia,

Malaysia), and tight labor markets (Singapore). This will limit the scope for further monetary

easing. In fact, we see policy rate hikes starting in Q3 2013 in Indonesia, Malaysia and the

Philippines. The extent of the monetary tightening will, however, be modest, as the decision to

hike rates will be complicated by the risk of attracting excessive capital inflows. In this context,

we expect more macro-prudential measures to address asset price inflation.


11

Charles St-Arnaud +1 212 667 1986 [email protected]

Martin Whetton +61 2 8062 8611 [email protected]

Australia | Economic Outlook

The peak in resource investment is coming

Growth will likely be resilient in 2013, helped by lower rates and stronger global growth.

With inflation close to target, we think the RBA will be on hold for some time.

Activity: The Australian economy will likely end 2012 on a weak due to a negative term-of-

trade shock linked to the decline in commodity prices. Moreover, the lower commodity prices

have force the cancellation and postponement of some investment projects in the resource

projects. As a result, the peak in investment will likely happen in 2013. However, we believe that

thanks to previous monetary policy stimulus, business investment in the non-resource sector

should pick-up. Moreover, the improvement of the housing market will likely support consumer

confidence and household spending. A rebound of global growth, especially China, should also

provide some support for export. However, the strong Australian dollar due to continued inflows

into the Australian fixed income market could hamper both exports and non-resource business

investment.

Inflation: CPI inflation increase sharply in Q3 due to the introduction of the carbon tax. We

believe that inflation will likely remain elevated over the next quarters, owing to some delayed

impact from the impact from the carbon tax and a moderation of the deflationary pressures from

the past appreciation of the Australian dollar. Underlying inflation has also increases in recent

quarters, and we expect it to remain close to the 2-3% RBA target over the forecast horizon.

Policy: The RBA has left its policy rate unchanged at its latest monetary policy meeting and has

signaled that it is comfortable with the level of interest rates, at least for now. We expect the

RBA to remain on hold until mis-2013, where we believe that economic condition will likely

warrant a 25bp hike in the policy rate. How, there is a non negligible risk that th RBA could cut

rates if the incoming data, both domestically and globally, weakens . Moreover, the latest

budget shows that fiscal policy will be restrictive this year, leaving the burden of stimulating the

economy to the RBA.

Risks: A disorderly resolution to the European debt crisis, a strong currency and a sharp

slowdown in Chinese growth remain the main downside risks to the outlook. On the flip side, an

improvement in risk sentiment, increased global trade and renewed increases in commodity

prices represent upside risks to growth and inflation.

Fig. 1: Details of the forecast

Notes: Quarterly real GDP and its contributions are seasonally adjusted annualized rates. CPI inflation includes the impact from, the carbon tax, but not the underlying measures. Interest rate

and exchange rate forecasts are end of period. Numbers in bold are actual values. Table reflects data available as of 12 November 2012. Source: Australian Bureau of Statistics, Reserve

Bank of Australia, Nomura Global Economics.

% q-o-q ar. 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 2011 2012 2013 2014

Real GDP (% y-o-y) 4.4 3.7 3.1 3.1 2.3 2.3 2.5 2.7 2.1 3.6 2.5 2.8

Real GDP 5.6 2.6 2.1 2.0 2.5 2.8 2.7 2.8 2.1 3.6 2.5 2.8

Personal consumption 7.5 2.3 2.1 2.2 2.3 2.5 2.5 2.6 3.3 3.8 2.3 2.6

Private investment 15.8 2.3 6.6 7.1 8.5 8.5 8.6 8.7 11.4 9.9 7.6 8.4

Business investment 23.0 4.7 8.0 8.5 10.1 10.0 9.9 9.9 14.8 14.4 9.2 9.7

Dw elling investment -7.9 -6.7 1.1 1.4 2.0 2.4 2.9 3.3 1.3 -5.4 1.5 3.2

Government expenditures 4.3 7.8 -0.2 -0.2 -0.2 -0.2 -0.2 -0.2 0.1 2.5 0.3 -0.2

Exports -3.5 10.2 6.0 6.0 7.5 8.0 8.0 8.0 -1.3 5.7 7.4 8.0

Imports 4.4 3.7 6.0 8.0 7.6 7.5 7.5 8.0 11.5 7.5 7.2 8.0

Contributions to q-o-q GDP:

Domestic f inal sales 8.8 3.6 2.1 2.2 2.6 2.7 2.7 2.8 3.5 4.1 2.6 3.0

Inventories -1.2 -2.2 0.0 0.1 0.0 0.1 0.0 0.0 0.8 -0.2 -0.1 -0.1

Net trade -2.0 1.2 0.0 -0.4 -0.1 0.0 0.0 -0.1 -2.1 -0.3 0.0 -0.1

Unemployment rate 5.2 5.2 5.2 5.3 5.4 5.5 5.5 5.5 5.1 5.2 5.4 5.3

Employment, 000 25 40 1 12 12 23 46 58 11 19 35 71

Consumer prices 1.6 1.2 1.6 2.1 2.7 2.8 2.4 2.5 3.4 1.6 2.6 2.5

Trimmed mean 2.1 1.9 2.3 2.4 2.6 2.6 2.5 2.5 2.7 2.2 2.6 2.5

Weighted median 2.2 2.0 2.3 2.2 2.5 2.6 2.5 2.5 2.5 2.2 2.5 2.5

Fiscal balance (% GDP) -3.4 -1.8 -0.2 0.1

Current account balance (% GDP) -2.3 -2.6 -3.0 -3.0

RBA cash rate target 4.25 3.50 3.50 3.25 3.25 3.25 3.50 3.50 4.25 3.25 3.50 4.00

3-month bank bill 4.30 3.54 3.36 3.05 3.25 3.30 3.60 3.60 4.50 3.05 3.60 4.00

2-year government bond 3.47 2.46 2.49 2.66 2.60 2.55 2.65 2.70 3.16 2.66 2.70 3.10



AUD/USD 1.04 1.02 1.05 1.03 1.00 0.99 1.00 1.00 1.02 1.03 1.00 1.00




12

Zhiwei Zhang +852 2536 7433 [email protected]

Wendy Chen +86 21 6193 7237 [email protected]

China | Economic Outlook

Up in H1, down in H2

We expect economic growth to be driven by cyclical policies as progress on structural

reforms may be slow.

Overview

We expect China‟s GDP growth to recover strongly to above 8% y-o-y in Q4 2012 and H1 2013,

and then slow in H2, toward 7% by Q4 2013. Policy easing through infrastructure investments

should be a main driver of a H1 recovery. We believe this cyclical recovery, amid slowing

potential output growth, will push inflation to above 4% y-o-y by mid 2013 and force the

People‟s Bank of China (PBoC) to tighten policies and hike interest rates twice, reducing GDP

growth in H2. Progress on structural reforms will likely be slow, as new leaders need time to

build the requisite political authority to implement tough reforms.

Our view is very different from consensus, which expects growth to be flat in Q4 and on an

upward trend through 2013 (Figure 1). The main distinguishing factor of our 2013 view comes

from the policy outlook. We believe policy easing is not sustainable beyond H1 due to inflation

and potential financial risks from a rapid credit expansion, while the consensus believes that

policies will be supportive throughout 2013.

Cyclical upturn in Q4 2012 and H1 2013

We believe growth will rebound both faster and stronger than the consensus expects, as policy

easing leads to a pickup in investment growth. Policy easing has been mostly implemented

through quantitative measures like relaxing controls on trust loans and bond issuance. We do

not think the PBoC will cut interest rates in 2013 since inflation is likely to rebound soon and

growth begins to recover.

Housing investment is the key “wild card” for the short-term growth outlook. We believe housing

investment growth could pick up moderately in Q4 after falling in Q1-Q3. Housing and

infrastructure investment combined account for half of China‟s fixed asset investment.

Infrastructure investment has already picked up strongly and its momentum will very likely

continue in Q4 and H1 2012. If housing investment also rebounds, GDP growth will likely

recover faster and stronger than the consensus expects, consistent with our view. Transactions

in the housing market have rebounded (Figure 2), which suggests that housing investment may

pick up soon.

Fig. 1: Consensus versus Nomura forecasts

6.5

7.0

7.5

8.0

8.5

9.0

1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13

% y-o-yConsensus forecast

Nomura

Source: Bloomberg and Nomura Global Economics

Fig. 2: Floor space sold and housing investment

-2

4

10

16

22

28

34

40

-40

-20

0

20

40

60

80

100

Oct-08 Oct-09 Oct-10 Oct-11 Oct-12

Housing sold

Housing investment, rhs

% y-o-y, ytd % y-o-y, ytd

Source: CEIC and Nomura Global Economics




13

Potential growth has slowed to 7.0-7.5%

China‟s GDP growth has averaged 10% over the past ten years. We believe China‟s potential

growth has now slowed to 7.0-7.5%. The key driver of this slowdown is the depletion of excess

labor. China used to have a huge pool of excess labor in its rural inland regions, estimated at

250 million persons. Over the past ten years, this group of labor was gradually absorbed into

the industrial sector. The ratio of urban labor demand to supply has risen to above 1.0 since

December 2010, which suggests that labor markets have turned from structurally oversupplied

to fully employed and structurally tight. This ratio remained at 1.05 in Q3 despite GDP growth

slowing to 7.4% y-o-y (Figure 3).

Because China‟s excess labour supply has been spent, it will require structural reforms to

support growth. However, progress on reforms will likely be slow in 2013, as new leaders will

need time to build the political authority required to push through tough reforms. There is little

controversy as to what economic reforms China requires - the 12th Five Year Plan has a

comprehensive list of reforms from financial sector liberalization to removing barriers of entry for

private companies into monopolized sectors. But the implementation of these reforms will be

tough and vested interest groups will surely resist any significant changes.

Growth to slow in H2 as inflation rises and policy easing ends

It is important to note that a recovery in H1 would be driven by countercyclical policy easing and

not an improvement in economic fundamentals. The over-capacity issue in the industrial sector

has not been resolved and inventory levels in the housing sector are still high (Figure 4). All

these factors suggest a recovery that is not sustainable. When policy easing ends, GDP growth

should return to its potential rate.

We expect policy easing to end in mid-2013, when inflation rises above 4% y-o-y. The

government sets 4% as its 2012 inflation target, and we believe it will remain the target in 2013.

Inflation should rise through 2013 for two reasons: 1) Headline GDP growth will be pushed

above 8%y-o-y by policy easing in H1. This should result in the emergence of a positive output

gap which leads to inflationary pressures; and 2) global commodity prices have rebounded in

recent months and will likely push up production costs in 2013.

It is worth noting that the PBoC is clearly concerned about inflation. In its Q3 monetary policy

report, it stated that “The economy has changed to be less sensitive to the constraint imposed

by employment, but more sensitive to constraint imposed by inflation”. This statement was not

included in previous MPC reports. We agree with its assessment, and believe it will change

policies swiftly when inflation rises to an uncomfortable level.

Risks to our forecast

We see three key risks to our forecast. The first and most important comes from policy

uncertainty. 2013 is the first year of new leadership in China. Our base case assumes that the

new leaders will tighten policies, perhaps starting as early as Q2 2013, allowing growth to return

to its potential level, but there could be political pressures to maintain a loose policy stance.

Local governments have issued many new investment plans. Infrastructure projects that began

in 2012 will likely continue into 2013. The demand for credit will be strong, and thus so will be

the resistance from local governments and the corporate sector against policy tightening. If the

central government decides to keep policies loose, our growth forecast faces upside risks for

2013 but downside risks in 2014, as inflation will likely become much higher and economic

imbalances will worsen.

The second risk is inflation. We expect CPI inflation to return quickly in 2013 and rise above 4%

y-o-y by June. We acknowledge that there are risks associated with this view as inflation may

return at a slower pace. In that event, policy easing would likely continue for longer, and our

growth forecast for 2013 (particularly H2) would also face upside risks.

The third risk comes from global economy. There is still uncertainty over economic conditions in

Europe. We would argue that this presents less of a challenge to China than policy and inflation

risks, given it has a relatively closed economy. China's economy has become increasingly

domestically driven. If the European situation worsens, we believe policy can and will be

loosened more and longer to offset its impact. Our concern over Europe is that the external

weakness may heighten the policy risks discussed above – the government may choose to

loosen policy too much, as it did in 2009.


14

Fig. 3: Urban labour demand to supply ratio and GDP growth

6

8

10

12

14

16

0.6

0.7

0.8

0.9

1.0

1.1

Sep-03 Sep-06 Sep-09 Sep-12

% y-o-yRatio Labour demand/supply ratio

Real GDP growth, rhs


Fig. 4: Floor space started and sold

0

20

40

60

80

100

120

140

160

180

Sep-00 Sep-04 Sep-08 Sep-12

Floor space started (12mma)

Floor space sold (12mma)

Sqare meter mn


Fig. 5: China outlook summary table

% y-o-y growth unless otherwise stated 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 2012 2013 2014

Real GDP 8.1 7.6 7.4 8.4 8.4 8.0 7.4 7.0 7.9 7.7 7.5

Consumer prices 3.8 2.9 1.9 2.0 2.8 3.7 4.6 5.6 2.6 4.2 4.0

Core CPI 1.5 1.3 1.5 1.8 2.0 2.1 2.4 2.1 1.5 2.2 2.0

Retail sales (nominal) 14.9 13.9 13.5 15.0 16.2 15.9 15.5 15.6 14.3 15.8 16.0

Fixed-asset investment (nominal, ytd) 20.9 20.4 20.5 21.0 20.8 21.2 21.3 22.0 21.0 22.0 20.0

Industrial production (real) 11.6 9.5 9.1 12.0 10.9 10.7 10.5 10.3 10.6 10.6 10.5

Exports (value) 7.6 10.5 4.5 5.0 3.0 4.0 6.0 6.0 6.8 4.8 6.0

Imports (value) 6.9 6.5 1.4 9.0 7.0 8.0 9.0 9.0 6.0 8.3 10.0

Trade surplus (US$bn) 1.1 68.8 79.5 32.1 -16.0 53.4 70.4 19.1 181.5 126.9 54.5

Current account (% of GDP) 1.7 1.0 -0.4

Fiscal balance (% of GDP) -1.5 -1.5 -1.6

New increased RMB loans (CNY trn) 8.0 9.0 9.0

1-yr bank lending rate (%) 6.56 6.31 6.00 6.00 6.00 6.00 6.25 6.50 6.00 6.50 6.50

1-yr bank deposit rate (%) 3.50 3.25 3.00 3.00 3.00 3.00 3.25 3.50 3.00 3.50 3.50

Reserve requirement ratio (%) 20.5 20.0 20.0 19.5 19.5 19.5 19.5 19.5 19.5 19.5 18.5

Exchange rate (CNY/USD) 6.29 6.35 6.28 6.28 6.26 6.26 6.25 6.24 6.28 6.24 6.24

Notes: Numbers in bold are actual values; others forecast. Interest rate and currency forecasts are end of period; other measures are period average. The CNY/USD forecast is for the fixing rate, not the spot rate. All forecasts are modal forecasts (i.e., the single most likely outcome). Table reflects data available as of 12 November 2012. Source: CEIC and Nomura Global Economics


15

Young Sun Kwon +852 2536 7430 [email protected]

Aman Mohunta +91 22 6617 5595 [email protected]

Hong Kong | Economic Outlook

Looming fiscal stimulus

We expect expansionary FY13 budget given weak external demand.

Activity: Retail sales growth volume increased by 8.5% y-o-y in September from 3.2% in

August while the PMI rose to 50.5 from 49.6. We expect private consumption to remain robust,

supported by a tight labour market, positive wealth effects from buoyant property prices and

increasing visitor numbers. Further, domestic fixed asset investment should remain strong

supported by infrastructure works. We expect fiscal stimulus and a moderate improvement in

external demand to lift real GDP growth to 2.5% in 2013, from 1.5% in 2012. A modest recovery

in the global economy should boost GDP growth further to 4% in 2014.

Inflation: CPI inflation ticked up to 3.8% y-o-y in September from 3.7% in October on food

prices. Inflation should rise through 2013, driven by higher food, fuel and rent prices, only partly

offset by inflation-mitigating fiscal measures such as a temporary waiver of public housing rent

and electricity subsidies. We expect CPI inflation to rise from 4.0% in 2012 to 4.3% in 2013.

Policy: Hong Kong's fiscal policy is expansionary as the budget for FY12 (year starting April)

includes not only inflation-mitigating measures but also an income tax reduction for individuals

of up to HKD12,000 per person and a 14.8% increase in capital expenditure. This should

continue to help stabilize inflation and support the job market. We expect the FY13 budget to

also be expansionary given that external demand remains weak. We would also expect the

government to continue implementing more macro-prudential property tightening measures,

such as hikes in stamp duty if house prices continue to rise, although so far these piecemeal

measures have had limited success in cooling the property market. Because of the USD/HKD

peg, Hong Kong is importing the super loose monetary policy of the US, and it remains unclear

whether tighter macro-prudential measures can provide a sufficient offset in the long run.

Risks: As a small, open economy and financial hub, Hong Kong is one of the most vulnerable

in Asia to weakness in the global economic outlook. An economic hard-landing in China would

be especially detrimental through both trade and financial channels.

Details of the forecast


Real GDP (sa, % q-o-q, annualized) 2.6 -0.2 2.6 4.3 2.4 2.4 1.4 2.5

Real GDP 0.7 1.1 1.7 2.3 2.3 2.9 2.6 2.2 1.5 2.5 3.5

Private consumption 6.5 3.7 1.8 2.2 2.8 3.4 3.8 4.5 3.5 3.6 4.4

Government consumption 2.3 3.5 3.0 3.2 3.5 3.7 4.2 4.2 3.0 3.9 4.4

Gross f ixed capital formation 12.9 5.7 5.4 5.0 5.8 5.8 5.7 5.8 7.0 5.8 6.1

Exports (goods & services) -3.9 0.1 0.8 2.2 4.5 5.1 5.1 5.5 -0.2 5.1 7.2

Imports (goods & services) -2.0 0.8 1.4 2.5 5.3 5.7 6.2 6.9 0.7 6.0 7.6

Contributions to GDP (% points)

Domestic f inal sales 7.4 4.1 2.7 2.9 3.5 4.0 4.3 4.8 4.2 4.1 4.8

Inventories -1.8 -1.4 0.4 0.0 0.2 0.3 0.4 0.1 -0.7 0.3 -0.5

Net trade (goods & services) -4.1 -1.6 -1.1 -0.4 -1.3 -1.4 -1.8 -2.3 -1.8 -1.7 -0.6

Unemployment rate (sa, %) 3.4 3.3 3.5 3.4 3.4 3.4 3.4 3.4 3.4 3.4 3.2

Consumer prices 5.2 4.2 3.1 3.6 3.7 4.3 4.5 4.6 4.0 4.3 4.3

Exports -1.2 2.0 4.4 7.3 9.2 10.5 10.1 10.4 3.2 10.1 12.3

Imports 0.9 2.3 5.0 7.0 9.8 10.7 10.9 11.7 3.9 10.8 12.4

Trade balance (US$bn) -12.7 -15.9 -15.6 -15.7 -14.5 -17.8 -18.3 -19.1 -59.9 -69.7 -78.8

Current account balance (% of GDP) 2.3 -0.6 -1.9


3-month Hibor (%) 0.40 0.40 0.40 0.40 0.40 0.40 0.40 0.40 0.40 0.40 0.40

Exchange rate (HKD/USD) 7.76 7.76 7.75 7.75 7.75 7.75 7.75 7.75 7.75 7.75 7.75

Source: Numbers in bold are actual values; others forecast. Interest rate and currency forecasts are end of period; other measures are period average. All forecasts are modal forecasts (i.e., the single most likely outcome). Table reflects data available as of 12 November 2012. Source: CEIC and Nomura Global Economics.




16

Sonal Varma +91 22 403 74087 [email protected]


India | Economic Outlook

A year of consolidation

With macro imbalances slow to correct, binding supply-side constraints and weak

global demand, a quick rebound is unlikely. We expect a shallow growth recovery.

Activity: Despite GDP growth falling to a 10-year low of 5.3% in 2012, we believe the recovery

will be shallow, with growth of 6.1% in 2013, for three reasons. First, we expect growth in

Western economies to remain weak in 2013. Second, with potential growth down to 6.5-7.0%,

the output gap will close quickly on any demand pick-up, pushing up core inflation and limiting

the extent of monetary easing. Third, the number of new capex projects is unlikely to increase

due to a higher cost of capital, an uncertain demand outlook and the lagged impact/

implementation risks of reforms announced so far. We expect only existing shelved investments

to be revived if land, coal and environmental issues are resolved.

Inflation and trade: With sub-potential growth, we expect WPI inflation to moderate from an

estimated 7.6% in 2012 to a still-high 7.2% in 2013. Core inflation should moderate in H1 2013

because of the negative output gap, but we expect INR depreciation and a narrowing output

gap to push up core inflation again in H2 2013. With binding supply-side constraints and high

food inflation, we do not expect headline and core inflation to be able to sustain levels below 7%

and 5%, respectively. We expect high inflation to reduce India‟s export competitiveness, even

as imports remain elevated from domestic supply side constraints. Hence, we expect the current

account deficit to remain high at 3.8% of GDP in 2013 from an estimated 4.2% in 2012.

Policy: We expect the Reserve Bank of India to reduce the repo rate by 50bp in H1 2013 on the

back of lower core inflation in H1. However, with headline inflation likely to remain in a 7.0-7.5%

range in 2013 and core inflation likely to accelerate again, we see limited scope for aggressive

rate cuts. We also expect the fiscal deficit to remain above 5% of GDP in FY14 (year ending

March 2014) due to slow growth and populist spending ahead of elections in 2014.

Risks: A sharp rise in oil prices, a deeper and prolonged global slowdown and weather-related

shocks are key downside risks. Lower commodity prices, a stronger than expected global

recovery and a quick investment revival are upside risks.


Notes: Numbers in bold are actual values; others forecast. Interest rate and currency forecasts are end of period; other measures are period average. CPI is for industrial workers. Fiscal deficit is for the central government and for fiscal year, e.g, 2012 is for the year ending March 2013. Table reflects data available as of 12 November 2012. Source: CEIC and Nomura Global Economics.


Real GDP (sa, % q-o-q, annualized) 5.9 5.3 5.2 5.8 6.8 5.9 6.2 6.8

Real GDP 5.3 5.5 5.4 5.3 5.9 6.0 6.1 6.4 5.3 6.1 6.5



Fixed investment 3.6 0.7 2.0 4.5 5.1 5.5 5.0 4.5 2.7 5.0 6.4

Exports (goods & services) 18.1 10.1 9.9 8.0 6.8 6.2 7.8 8.5 11.7 7.3 9.9

Imports (goods & services) 2.0 7.9 6.5 5.0 6.0 7.2 6.0 5.7 5.4 6.2 8.6


Domestic f inal sales 1.3 5.7 5.2 5.0 5.6 6.7 6.2 6.2 4.2 6.1 6.6

Inventories 0.0 0.0 0.1 0.1 0.0 0.1 0.2 0.1 0.0 0.1 0.2

Net trade 4.0 -0.2 0.1 0.2 0.3 -0.9 -0.2 0.1 1.1 -0.2 -0.3

Wholesale price index 7.5 7.5 7.6 7.9 7.6 7.3 7.0 7.0 7.6 7.2 6.9

Consumer prices 7.2 10.1 9.8 10.1 10.5 9.8 9.7 9.3 9.3 9.8 9.2

Current account balance (% GDP) -4.2 -3.8 -3.4

Fiscal balance (% GDP) -5.8 -5.2 -5.0

Repo rate (%) 8.50 8.00 8.00 8.00 7.75 7.50 7.50 7.50 8.00 7.50 7.00

Reverse repo rate (%) 7.50 7.00 7.00 7.00 6.75 6.50 6.50 6.50 7.00 6.50 6.00

Cash reserve ratio (%) 4.75 4.75 4.50 4.25 4.00 4.00 4.00 4.00 4.25 4.00 4.75

10-year bond yield (%) 8.54 8.18 8.15 8.10 7.80 7.80 7.70 7.50 8.10 7.50 7.00

Exchange rate (INR/USD) 51.2 54.0 52.7 53.0 54.0 57.0 60.0 59.0 53.0 59.0 57.0




17

Euben Paracuelles +65 6433 6956 [email protected]

Lavanya Venkateswaran +91 22 3053 3053 [email protected]

Indonesia | Economic Outlook

Watch policies and politics

The policy environment is likely to remain challenging ahead of the 2014 elections.

Activity: We expect GDP growth to remain stable at 6.1% in 2013, driven mainly by resilient

domestic demand. Growth in investment spending will likely moderate but that of private

consumption should remain stable. Government expenditures should also contribute more

positively ahead of the 2014 elections, as implementation of the budget improves, particularly

on infrastructure (as opposed to this year‟s under-spending). The risk of nationalist and populist

policies is also likely to increase in 2013 as the incumbents focus on the 2014 parliamentary

and presidential elections. On the external front, we believe the current account deficit will likely

narrow in 2013 supported by higher export growth to China in H1, and improving US and EU

growth in H2. However, as we approach 2014, the uncertain policy environment could add to

concerns over FDI inflows (see Asia Special Report: Indonesia: Policy swings, August 2012),

affecting the balance of payments, and in turn pressuring IDR.

Inflation and monetary policy: We expect CPI inflation to rise to 5.2% y-o-y in 2013 from an

estimated 4.4% this year, driven by core inflation and supply-side factors such as the upward

adjustments of electricity tariffs (approximately 4% each quarter) and the risk of elevated food

prices. While this is still within Bank Indonesia‟s (BI) target range of 3.5%-5.5%, we expect it to

maintain its tightening bias and indeed hike the policy rate by a cumulative 50bp in H2 2013. In

the interim, it is likely that BI will introduce administrative and macro-prudential measures if

domestic demand remains strong and portfolio capital inflows persist.

Fiscal policy: We expect the 2013 fiscal deficit to overshoot the budgeted 1.65% of GDP.

While the approved 2013 budget allows the government to raise fuel prices if deviations from

macroeconomic assumptions occur, we have not factored any changes to fuel subsidy policy

into our baseline forecast because of the elections. Thus, we expect increased operating costs

and subsidies to cause fiscal slippage of close to 0.3pp, resulting in a 2013 deficit of 2% of GDP.

Risks: The key risk for next year is a lack of progress on structural reforms and the

implementation of more protectionist policies ahead of the elections, both of which could

damage fragile investor sentiment. A deeper recession in the euro area, a hard landing in China

and large capital flow reversals also pose downside risks.



Real GDP (sa, % q-o-q, annualized)

Real GDP 6.3 6.4 6.2 5.7 6.1 6.2 6.0 6.0 6.1 6.1 6.2


Government consumption 5.9 7.4 -3.2 5.0 7.0 8.0 10.0 10.0 3.6 9.0 7.0

Gross fixed capital formation 10.0 12.3 10.0 9.9 9.8 8.9 8.8 7.1 10.5 8.4 9.0

Exports (goods & services) 7.9 2.2 -2.8 5.5 6.0 6.0 7.0 8.0 3.1 6.8 10.0

Imports (goods & services) 8.0 10.9 -0.5 6.0 6.5 7.0 5.5 14.0 6.0 8.4 11.9


Domestic final sales 5.5 6.4 5.3 6.3 5.7 5.8 6.0 6.1 6.2 6.0 6.0

Inventories 2.0 2.3 -0.1 -1.0 0.0 0.0 0.0 0.2 0.8 0.0 -0.3

Net trade (goods & services) 0.7 -3.1 -1.2 0.4 0.4 0.0 1.3 -1.5 -0.8 0.1 0.2

Consumer prices 3.7 4.5 4.5 4.7 5.0 5.1 5.3 5.4 4.4 5.2 5.1

Exports 5.3 -7.6 -5.0 2.8 5.6 5.9 7.6 15.1 -1.3 8.7 8.0

Imports 21.4 8.9 9.0 11.5 7.2 6.2 4.8 17.3 12.4 9.0 14.4

Merchandise trade balance (US$bn) 1.7 -1.3 -0.7 -1.2 1.0 -1.6 0.8 -2.7 -1.5 -2.5 -3.3

Current account balance (% of GDP) -1.5 -3.1 -2.2 -2.0 -0.8 -2.3 -1.2 -3.2 -2.2 -1.9 -1.6

Fiscal Balance (% of GDP) -2.4 -2.0 -2.2

Bank Indonesia rate (%) 5.75 5.75 5.75 5.75 5.75 5.75 6.25 6.25 5.75 6.25 6.75

Exchange rate (IDR/USD) 9146 9433 9591 9600 9630 9700 9800 9750 9600 9750 9600

Notes: Numbers in bold are actual values; others forecast. Interest rate and currency forecasts are end of period; other measures are period average. All forecasts are modal (i.e., the single most likely outcome). Table reflects data available as of 12 November 2012. Source: CEIC and Nomura Global Economics.



http://intranet.nomuranow.com/research/globalresearchportal/GetPub.aspx?pid=539652


18



Malaysia | Economic Outlook

Time for fiscal tightening

We see significant fiscal consolidation after the elections, adding to the external drag.

Activity: We expect growth to slow to 4.0% in 2013 from an estimated 4.8% in 2012 as

domestic and external demand weaken. Fiscal policy has supported growth for about two years,

longer than expected, and public debt has risen from 39.8% of GDP in 2008 to 51.8% in 2011.

This suggests fiscal consolidation will have to be significant once the elections are over. In our

base case, we expect the elections to be held in March (just before the April 2013 deadline). At

the same time, external demand will likely remain subdued: our US and Europe economists

expect growth to stay weak in H1 and pick up moderately in H2, while the reverse is expected in

China, which would have a bigger impact on commodity exporters like Malaysia.

Inflation and monetary policy: We estimate headline CPI inflation will average 2.4% in 2013

higher than 1.7% in 2012 due to factors such as minimum wage hikes, higher cost push

pressures, and modest subsidy adjustments (e.g. sugar). Against this backdrop, we continue to

expect Bank Negara Malaysia (BNM) to stay on hold throughout H1 2013, before hiking its

policy rate by 50bp in H2 2013. In our view another key policy consideration is the risk from

keeping rates low for too long, fueling an excessive build-up of public and household debt levels.

Hence we judge BNM‟s bias is still to normalize rates, but make the adjustment gradual. We

expect a total of 50bp hikes next year, taking the policy rate to its pre-crisis level of 3.50%.

Fiscal policy and political outlook: The 2013 budget aims to reduce the fiscal deficit to 4.0%

of GDP from 4.5% in 2012 and suggests the government recognizes the need to get its

medium-term fiscal consolidation plans back on track. Nonetheless, we think this is ambitious

because this implies a negative fiscal impulse and is based on high GDP growth assumptions

(4.5-5.5%). We forecast the fiscal deficit at 4.5% of GDP as a result. In terms of the political

outlook, we think the elections in March will result in a win by Barisan Nasional, but with a

smaller majority (see Asia Insights: The Malaysian general election revisited, 8 November 2012).

This should still bode well for the resumption of structural reforms.

Risks: With exports nearly 100% of GDP, a sharp drop in commodity prices and another global

recession is the biggest downside risk. A weaker-than-expected coalition or a win by the

opposition would raise questions about the political transition and the reform agenda.



Real GDP 4.9 5.4 4.5 4.7 4.3 4.3 3.8 3.7 4.8 4.0 4.6








Inventories -0.2 -1.2 -0.1 0.9 0.2 -0.2 -0.2 -0.4 -0.1 -0.2 0.0

Net trade (goods & services) -3.1 -4.9 -5.2 -3.9 -2.3 -0.7 -0.6 -0.8 -4.3 -1.1 -0.7

Unemployment rate (%) 3.0 3.0 3.0 3.2 3.3 3.3 3.4 3.4 3.0 3.4 3.4

Consumer prices 2.3 1.7 1.4 1.6 2.1 2.6 2.5 2.4 1.7 2.4 2.5

Exports 3.9 0.9 -4.7 6.5 6.5 9.4 8.2 5.2 2.7 7.3 9.1

Imports 6.4 5.7 3.9 11.2 9.1 10.4 9.1 6.2 6.8 8.7 13.8

Merchandise trade balance (USD bn) 9.7 6.8 5.5 8.2 9.1 7.0 8.0 8.1 32.7 32.3 25.0

Current account balance (% of GDP) 8.0 4.1 6.1 5.6 5.5 6.0 5.2 4.6 6.0 5.6 5.1

Fiscal Balance (% of GDP) -4.9 -4.5 -4.2

Overnight policy rate (%) 3.00 3.00 3.00 3.00 3.00 3.00 3.25 3.50 3.00 3.50 4.00

Exchange rate (MYR/USD) 3.06 3.18 3.06 3.00 2.97 2.97 2.96 2.94 3.00 2.94 2.88

Note: Numbers in bold are actual values; others forecast. Interest rate and currency forecasts are end of period; other measures are period average. All forecasts are modal forecasts (i.e., the single most likely outcome). Table reflects data available as 12 November 2012. Source: CEIC and Nomura Global Economics.



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19



Philippines | Economic Outlook

Still likely to shine

Given the momentum of reform, investment is set to become a bigger growth driver.

Activity: We forecast 2013 GDP growth at an above-potential 6.0%, driven by more progress in

infrastructure projects under the public-private partnership (PPP) scheme and higher fiscal

spending ahead of the mid-term elections in May 2013. We expect private consumption to

remain robust with resilient remittances and buoyant consumer sentiment. But we see more

notable improvement in investment spending, which reflects the lagged effects from significant

monetary easing this year but also the strength of business sentiment from governance reforms.

As a result, investment-led domestic demand should fully offset the weakness in exports.

Inflation and monetary policy: We expect CPI inflation to rise to 4.4% in 2013 from 3.2% in

2012, as demand side pressures strengthen. This is still within the Bangko Sentral ng Pilipinas

(BSP) 3-5% target but risks are to the upside with above-trend growth and measures pending

such as legislation to increase taxes on „sin‟ products (i.e., alcohol and tobacco). Therefore, we

expect BSP to keep its policy rate unchanged at 3.5% for the rest of 2012 and throughout H1

2013, before hiking it gradually in Q3 2013. Large capital inflows will remain a key consideration

in BSP‟s policymaking and as such, the risk of more administrative and macro-prudential

measures is likely to remain high.

Fiscal policy: We expect the fiscal deficit to widen to 2.6% of GDP from 2.2% this year given

the mid-term elections and the strong bias to use the available fiscal space to improve the pace

and quality of spending. Gross government debt has fallen from 70.5% of GDP in 2006 to 56%,

and we expect more progress on fiscal policy reforms to broaden the tax base and improve tax

collections (e.g., the „sin‟ tax bill is likely to be passed soon) which will put the country‟s

sovereign credit rating on track for an upgrade to investment grade within the next two years.

Risks: The main risk to our forecast is an external shock from Europe and the US fiscal cliff.

Slower progress on reforms and infrastructure spending could also hurt growth. We see the

elections as a non-event because the status quo will likely be maintained, but it could

temporarily disrupt the legislation of fiscal reforms and the bidding out of infrastructure projects.




Real GDP 6.3 5.9 5.8 6.0 6.3 6.1 5.6 5.9 6.0 6.0 5.8





Imports (goods & services) -3.2 4.4 5.9 5.1 13.9 14.7 12.3 8.5 3.0 12.4 13.0

Contribution to GDP growth (% points)


Inventories -7.2 -2.4 -1.1 -2.2 2.5 2.9 1.2 0.2 -3.2 1.5 0.0

Net trade (goods & services) 7.1 2.1 -0.6 -0.1 -4.2 -4.7 -2.6 -1.7 2.0 -3.3 -2.3

Exports 4.8 10.5 4.6 5.9 4.6 4.8 7.1 5.7 6.5 5.5 9.0

Imports -1.5 2.2 10.2 12.0 14.2 14.7 12.3 8.5 5.6 12.3 13.0

Merchandise trade balance (US$bn) -2.6 -1.4 -3.6 -4.9 -4.2 -2.9 -4.7 -5.6 -12.5 -17.5 -21.9

Current account balance (US$bn) 0.8 2.8 2.3 0.5 0.3 2.0 1.2 2.2 6.4 5.6 5.5


Fiscal balance (% of GDP)

-2.2 -2.6 -2.2

Consumer prices (2006=100) 3.1 2.9 3.5 3.4 4.2 4.6 4.4 4.5 3.2 4.4 4.5


Reverse repo rate (%) 4.00 4.00 3.75 3.50 3.50 3.50 3.75 4.00 3.50 4.00 4.50

Exchange rate (PHP/USD) 42.9 42.1 41.7 40.8 40.3 40.3 40.2 39.8 40.8 39.8 39.3

Notes: Numbers in bold are actual values; others forecast. Interest rate and currency forecasts are end of period; other measures are period average. All forecasts are modal forecasts (i.e., the single most likely outcome). Table reflects data available as of 12 November 2012. Source: CEIC and Nomura Global Economics.




20





Singapore | Economic Outlook

The (long) road to restructuring

The government is rightly sticking to its long-term goal of raising productivity. In the

meantime, the economy will likely endure a low growth, high inflation environment.

Activity: In line with official projections, we expect GDP growth to increase but remain below

potential at 3.4% y-o-y in 2013 from 1.8% in 2012. The improvement should be led by

recovering growth in China in H1, and the EU and US in H2. However, due to the on-going

efforts to restructure the economy as productivity-driven growth (less reliant on foreign labor),

we expect the government to refrain from stimulus spending. Private investment spending will

also likely remain weak as business sentiment is affected by external uncertainty and tight

domestic policies.

Inflation and monetary policy: We expect CPI inflation to remain elevated, averaging 3.9% in

2013 from 4.8% in 2012, led by private transport and accommodation costs. In addition,

underlying inflation should remain sticky as labour markets remain tight and wage pressures

persist. The Monetary Authority of Singapore (MAS) believes there are upside risks from rising

global food prices. The MAS decision to maintain its S$NEER policy in October despite slowing

growth suggests inflation will remain a key concern. In addition, we think this policy decision

complements its longer term economic objectives, as the MAS explicitly stated that the decision

was in line with containing inflationary pressures but also with “keeping the economy on a path

of restructuring towards sustainable growth.”

Fiscal policy: The fiscal stance should remain broadly neutral in 2013 with the government

running a small deficit of 0.2% of GDP from a surplus of 0.2% in 2012. We believe the

government is firmly focused on encouraging the private sector to adopt productivity-enhancing

measures rather than alleviating cyclical external risks. Pressure is mounting from small and

medium enterprises (SMEs) which are asking the government to relax its foreign labor policy,

but the government said there will be “no U-turn”. Instead, it is increasing awareness among

SMEs regarding fiscal schemes that have already been in place to boost productivity but have

seen limited adoption. We also expect higher budget allocations to social spending given the

ageing population and widening income disparity, as well as to upgrading public infrastructure.

Risks: With exports twice its GDP, Singapore is the most vulnerable economy in South-east

Asia to a major contraction in global GDP. Another risk flare up in Europe, the US falling off the

fiscal cliff, or a hard landing in China would hit Singapore hard via knock-on effects from exports

and capital outflows. Another risk is domestic overheating, fueled by low interest rates.



Real GDP (sa, % q-o-q, annualized) 9.5 -0.7 -1.2 2.3 10.7 1.3 -0.1 4.9

Real GDP 1.5 2.0 1.2 2.4 2.7 3.2 3.4 4.1 1.8 3.4 4.2


Government consumption -4.0 -0.9 -8.8 5.0 3.8 3.9 3.0 3.3 -2.4 3.5 4.0





Domestic final sales 4.8 1.0 -0.3 2.0 2.5 3.1 3.1 3.1 1.9 3.0 3.1

Inventories 0.7 1.3 0.6 4.0 -1.5 -2.2 -2.2 -0.8 1.6 -1.7 1.0

Net trade (goods & services) -4.0 -0.3 0.9 -3.6 1.7 2.2 2.5 1.8 -1.8 2.1 1.2


Consumer prices 4.9 5.3 4.2 5.0 4.4 4.0 3.8 3.4 4.8 3.9 3.6

Exports 6.0 -0.5 -5.8 2.3 5.4 8.8 9.2 9.3 0.8 8.4 12.1

Imports 11.7 2.6 -3.1 1.9 6.1 8.2 8.9 9.5 3.8 8.2 13.1

Merchandise trade balance (US$bn) 7.2 6.7 8.8 11.3 6.9 7.8 12.2 10.1 33.3 37.0 38.2


Fiscal Balance (% of GDP) 0.2 -0.2 0.4

3 month SIBOR (%) 0.38 0.38 0.38 0.38 0.38 0.48 0.48 0.48 0.38 0.48 0.50

Exchange rate (SGD/USD) 1.26 1.27 1.23 1.22 1.21 1.21 1.20 1.19 1.22 1.19 1.17







21


South Korea | Economic Outlook

Growth to rebound from a very low base

We expect the Bank of Korea to keep rates unchanged at 2.75% through 2013 as

GDP growth and CPI inflation should rise modestly from a very low base.

Activity: September industrial output and October export numbers suggest that GDP may have

bottomed out in Q3. We expect GDP growth to rebound to 0.5% q-o-q in Q4 (from 0.2% in Q3)

and to a sequential quarterly average of 0.8% in 2013, supported by inventory restocking in Q4

and a modest foreign demand recovery in 2013. But compared to past recoveries, this one is

tepid despite starting from a very low base. An important reason is weak domestic demand, held

back by structural problems, including a household sector overburdened in debt equivalent to

156% of personal disposable income. So we maintain our below-consensus forecast of 2.5%

GDP growth in 2013 – far below our potential GDP estimate of 3.5%, which we expect to be

reached only in 2014. The new government will likely increase social welfare spending, but this

will only partly offset the export slump, given the headwinds on personal consumption from high

household debt and falling house prices. We expect business investment to remain weak as

uncertainty surrounding the global outlook and new government reforms remain elevated.

Inflation: A negative output gap and stable KRW should exert downward pressure on inflation,

but higher food prices and fading favourable base effects (from a one-off decline in school fees

and expenses) should push CPI inflation up to 2.7% in 2013 from 2.2% in 2012, although still

below the midpoint of the BOK‟s new inflation target range of 2.5-3.5% for 2013-15.

Policy: We expect the BOK to keep rates at 2.75% through 2013, as growth should increase

slightly and CPI inflation should rise modestly, each from a very low base on a sequential basis.

Risks: As a small, open, financially integrated economy, Korea is vulnerable to sudden

changes in global economic conditions, commodity prices and financial markets. That said, we

would expect the BOK to cut rates if one of the major downside risks to global growth (the US

fiscal cliff; a renewed eurozone sovereign crisis; a China hard landing) actually materialises, but

none of these are held in Nomura Global Economics‟ base case. Domestically, the new

government could formulate a supplementary budget in H1 2013, which provides an upside risk

to our domestic demand forecast.




Real GDP (sa, % q-o-q) 0.9 0.3 0.2 0.5 0.7 0.9 0.8 0.9

Real GDP 2.8 2.3 1.6 1.8 1.6 2.3 2.9 3.3 2.3 2.5 3.5



Business investment 9.1 -3.5 -6.0 -0.9 -9.2 -1.5 5.1 5.1 -0.2 -0.4 7.7

Construction investment 2.1 -2.1 -0.1 -0.6 1.6 3.0 3.9 4.1 -1.2 3.1 4.1



Contributions to GDP growth (% points)


Inventories -0.1 0.1 -0.1 -0.4 -0.4 -0.3 0.5 0.0 0.1 0.2 0.2

Net trade (goods & services) 0.1 1.4 1.0 1.2 1.2 0.8 0.2 0.3 0.7 0.6 0.3


Consumer prices 3.0 2.4 1.6 1.8 2.1 2.8 3.1 2.8 2.2 2.7 3.0

Current account balance (% of GDP) 3.3 2.3 2.0

Fiscal balance (% of GDP) 1.3 1.0 1.0

Fiscal balance ex-social security (% of GDP) -1.2 -1.3 -1.0

BOK official base rate (%) 3.25 3.25 3.00 2.75 2.75 2.75 2.75 2.75 2.75 2.75 3.25

3-year T-bond yield (%) 3.55 3.30 2.83 2.80 2.80 2.90 3.00 3.00 2.80 3.00 3.30

5-year T-bond yield (%) 3.69 3.42 2.93 2.90 2.90 3.00 3.05 3.10 2.90 3.10 3.50

Exchange rate (KRW/USD) 1133 1154 1118 1090 1085 1085 1080 1070 1090 1070 1070

Notes: Numbers in bold are actual values; others forecast. Interest rate and currency forecasts are end of period; other measures are period average. All forecasts are modal forecasts (i.e., the single most likely outcome). Table reflects data as of 12 November 2012. Source: Bank of Korea, CEIC and Nomura Global Economics.



22



Taiwan | Economic Outlook

External demand holds the key

The economy should benefit from an upcycle in China's GDP, global electronic

demand and an improved cross-strait relationship with China.

Activity and inflation: Exports increased 10.4% y-o-y in September, exceeding market

expectations by a wide margin. GDP growth should recover more visibly in Q4, but from a very

low base. Stronger demand from China and a gradual recovery in global demand for electronics

should help lift Taiwan‟s GDP growth from 1.0% in 2012 to 3.0% in 2013 and further to 3.5% in

2014, as strengthening economic linkages with China start to increasingly benefit (see below).

We expect CPI inflation to rise to 2.3% in 2013 from 2.0% in 2012 due to higher food prices and

consumption. Given that electricity tariff hikes will be implemented in multiple stages, inflation is

unlikely to become a serious negative factor for growth through our forecast horizon.

Cross-strait relationship: We expect economic linkages between Taiwan and China to

continue to strengthen, through further trade liberalization under the Economic Cooperation

Framework Agreement and an increase in tourist arrivals from China. Taiwan‟s central bank and

China‟s PBoC signed a Currency Settlement MOU in August, which should significantly boost

RMB-related business in Taiwan‟s capital markets. Improving cross-strait ties is a structural

transformation that, over time, should unleash major benefits for Taiwan‟s economy through

higher value-added trade and investment with China, and deepening capital markets.

Monetary policy: We expect the Central Bank of China (CBC) to hike discount rates from

1.875% to 2.125% in H2 2013 as GDP growth and CPI inflation should rise. We view this as

more a normalization of very loose monetary policy, rather than a move to outright tightening.

Risks: Another deep recession in advanced economies would have a large impact on Taiwan‟s

open economy. Positive risks include a stronger-than-expected recovery in the global

electronics cycle and a faster-than-expected liberalization of trade and investment with China.




Real GDP 0.4 -0.2 1.0 2.6 3.1 3.4 3.0 2.5 1.0 3.0 3.5



Gross f ixed capital formation -10.2 -5.2 0.8 0.5 7.5 5.0 4.0 5.0 -3.5 5.3 4.5

Exports (goods & services) -3.3 -3.3 -1.0 2.5 2.8 3.4 4.0 2.2 -0.9 3.1 3.3

Imports (goods & services) -7.5 -7.5 -0.5 3.0 2.2 2.0 2.1 2.0 -2.1 2.1 3.5

Contributions to GDP grow th (% points)

Domestic f inal sales -2.4 -1.0 0.0 3.6 3.9 3.4 3.8 2.2 0.2 4.4 3.2

Inventories 1.4 0.4 0.5 -0.5 -0.4 0.0 -0.4 0.1 0.4 -0.7 0.2

Net trade (goods & services) 1.6 0.6 -0.5 0.3 0.8 1.4 1.7 0.6 0.5 1.1 0.5

Exports -4.0 -1.3 1.5 5.0 5.3 5.9 6.5 4.7 -1.7 5.6 6.3

Imports -5.9 -3.1 4.0 7.2 3.7 3.5 3.6 3.5 -2.1 3.6 5.0

Merchandise trade balance (US$bn) 5.7 5.6 8.4 7.8 7.0 7.6 10.9 9.1 27.4 34.5 40.4



Consumer prices 1.3 1.6 2.9 2.1 2.1 2.2 2.5 2.2 2.0 2.3 2.3

Unemployment rate (%) 4.1 4.2 4.3 4.3 4.3 4.2 4.2 4.2 4.3 4.2 4.2

Discount rate (%) 1.88 1.88 1.88 1.88 1.88 1.88 2.00 2.13 1.88 2.13 2.13

Overnight call rate (%) 0.42 0.51 0.38 0.51 0.51 0.64 0.41 0.51 0.51 0.76 0.76

10-year T-bond (%) 1.27 1.23 1.19 1.29 1.31 1.42 1.29 1.29 1.29 1.55 1.55

Exchange rate (NTD/USD) 29.5 29.8 29.3 29.1 28.9 28.9 28.9 28.8 29.1 28.8 28.3





23


Nuchjarin Panarode +662 638 5791 [email protected]

Thailand | Economic Outlook

New growth engines

Investment and consumption spending will provide a boost to GDP growth even as the

external outlook remains uncertain, spurred by loose monetary and fiscal policies.

Activity: We forecast 2013 GDP growth at a solid 4.5% after recovering sharply to 5.5% in

2012 after last year‟s floods. We believe domestic demand, supported by accommodative

monetary and fiscal policies, will mitigate the impact of weak exports. Private consumption

should receive a boost from the sharp rise in real wages (the minimum wage was hiked by 40%

this year, putting upward pressure on overall wages as well), while private investment should be

bolstered by higher public infrastructure spending, the industrial sector upgrading production

capacity after the floods, and a relatively more stable political outlook (see Asia Special Report:

Thailand: New growth engines, 24 September 2012). These will be the new growth engines that

help drive and rebalance the Thai economy, making it more resilient to external shocks.

Monetary policy and inflation: We expect inflation to remain stable at 3.0% in 2013, as the

government utilizes subsidies to contain emerging price pressures. As a result, we expect the

Bank of Thailand (BOT) to keep the policy rate unchanged at 2.75% throughout 2013, following

a cumulative 100bp of cuts since the floods. This implies negative real policy rates, and hence

even with the BOT on hold, the monetary policy stance should remain accommodative for some

time. There is room to cut further if the external outlook deteriorates sharply, or if domestic

demand fails to strengthen fast enough to offset any the export weakness.

Fiscal policy: The budget deficit is set at 2.4% of GDP in FY13, from an estimated 2.0% of

GDP in FY12. Public debt to GDP has risen steadily since early 2012, from 40.6% to 44.2% in

July. This is still well below the debt ceiling of 60%, so there is plenty of scope to run

expansionary fiscal policies. Including non-budgetary spending – such as that on water-

management infrastructure and the planned THB2.27bn of mega-project investment – we

forecast a “cash” deficit in FY13 of 3.5% of GDP versus 2.5% estimated in FY12.

Risks: The downside risks to our forecasts stem from a deepening of the euro area recession,

and domestically, from increased political uncertainty over the constitutional amendment and

reconciliation bill. Slow progress on infrastructure plans could weaken investment sentiment.




Real GDP 0.4 4.2 2.8 15.2 4.1 4.1 4.8 4.9 5.5 4.5 5.0


Public consumption -0.2 5.6 4.7 6.4 0.8 -2.3 -2.7 0.9 4.1 -1.0 -0.8


Exports (goods & services) -3.2 0.9 -2.9 17.8 4.9 2.8 5.1 3.6 2.6 4.1 5.0


Contribution to GDP growth (% points)


Inventories 2.9 2.8 -1.3 0.2 -2.3 -2.0 -0.1 0.2 1.2 -1.0 0.0

Net trade (goods & services) -4.7 -4.4 -2.3 8.7 1.5 1.3 1.7 0.3 -0.9 1.2 0.7

Exports -1.4 0.0 -3.8 14.8 4.9 4.2 5.1 1.5 2.3 5.0 6.9

Imports 10.4 11.9 -1.7 7.0 3.2 4.4 13.3 7.4 6.1 7.1 7.2

Merchandise trade balance (US$bn) -5.2 -5.2 -1.6 -2.9 -4.4 -5.5 -6.8 -4.0 -14.9 -20.7 -22.9

Current account balance (US$bn) 0.6 -2.5 2.7 1.6 0.6 -2.3 -2.0 1.1 2.4 -2.6 -2.8

Current account balance (% of GDP) 0.6 -2.7 3.0 1.7 0.6 -2.4 -2.0 1.0 0.7 -0.7 -0.7

Fiscal balance (% of GDP, fiscal year basis) -2.5 -3.5 -3.7

Consumer prices 3.4 2.5 2.9 3.4 3.1 2.9 2.7 2.9 3.0 3.0 3.1


Overnight repo rate (%) 3.00 3.00 3.00 2.75 2.75 2.75 2.75 2.75 2.75 2.75 3.25

Exchange rate (THB/USD) 30.8 31.8 30.8 30.3 30.1 30.1 30.1 29.9 30.3 29.9 29.3




http://go.nomuranow.com/research/globalresearchportal/getpub.aspx?pid=562565&appname=Email&cid=RWhBVmJXQjAyYjQ90

http://go.nomuranow.com/research/globalresearchportal/getpub.aspx?pid=562565&appname=Email&cid=RWhBVmJXQjAyYjQ90


24

Tomo Kinoshita +81 3 6703 1280 [email protected]

Shuichi Obata +81 3 6703 1295 [email protected]

Kohei Okazaki +81 3 6703 1291 [email protected]

Asuka Tsuchida +81 3 6703 1297 [email protected]

Japan | Economic Outlook

Export recovery likely to deliver positive growth in Q1 2013

We expect the export recovery, driven by China's economic recovery and solid

domestic demand, to support growth in 2013.

We expect growth in Q4 2012 to remain negative

We believe Japan's economy entered a recession in Q3 2012 due to the worsening external

environment. Even though domestic demand and reconstruction demand were quite robust until

Q1 with support from government subsidies for automobile purchases, a marked fall in exports

weakened Japan's growth from June 2012. Japan's exports to China had already started to

shrink from the end of 2011, but its exports to Europe and Asia shrank significantly from the

middle of 2012 as Asia's exports to Europe deteriorated, which caused a fall in intra-Asian

trade. For Japan, whose exports to Asia accounted for more than half of total exports in 2011,

this deterioration in the external environment has led to a decline in exports and investments in

manufacturing. Economic growth in Q3 was also exacerbated by the ending of the government

subsidies for automobile purchases. Worsening business sentiment and the expiration of the

car subsidy have started to weaken Japan's private consumption since September.

The recovery process should start to materialize in Q1 2013

We expect an economic recovery will materialize from Q1 2013 with a pick-up in China's

domestic demand. We believe that China's domestic demand will gain traction by end-2012 with

the ending of inventory de-stocking in the manufacturing sector, which should lead to a pick-up

in exports to China from their neighboring industrialized economies. In fact, the inventory de-

stocking has already reached its final stage in Asia‟s advanced economies. The resulting

increase in production in these economies is likely to bring about a recovery in exports from

Japan to the rest of Asia including China, Korea and Taiwan. However, in our view, the pace of

such a recovery in Japan's exports is likely to be a moderate for two reasons. First, we do not

expect Japan's exports to Europe to recover in H1 2013 due to a continued recession in

Europe. Second, Japan's recovery in exports is likely to be slower than that of Korea or Taiwan

as the recovery in capital goods exports tends to lag that in materials and intermediate goods

exports, because of the higher share of capital goods exports in Japan than in other Asian

economies. Nonetheless, we expect the export recovery in Japan to stimulate private

investment and also domestic demand, allowing overall growth to return to positive territory from

Q1 onwards. By mid-2013, Japan's export growth is likely to gain further strength as we expect

growth in the US to pick up in H2 2013. This recovery process should also be supported by yen

depreciation against the US dollar to 88 JPY/USD at end-2013. We expect growth to pick up to

0.5% in 2013 from an annualized -2.1% in H2 2012, followed by 1.2% in 2014.

Domestic demand should regain its strength in 2013

Once external demand improves, we expect private consumption and non-manufacturing

investment to return to their trend growth paths. We expect the aging population to bring private

consumption to a moderate growth path with an even lower savings rate. By contrast, the most

recent Tankan survey (September survey) by the Bank of Japan (BOJ) suggests that non-

manufacturers are likely to increase their investment again once they see signs of a recovery in

private consumption (Figure 1). Private consumption is likely to stay robust partly due to

demand being brought forward owing to the scheduled consumption tax rate hike in April 2014.

Fiscal policy: We expect a supplementary budget in early 2013

The immediate task faced by the ruling DPJ (Democratic Party of Japan) and the opposition

LDP (Liberal Democratic Party) is the passage of the bill that will allow the government to issue

a deficit-funding government bond. Without its passage, the government will need to stop

spending from early December. If the bill is not passed by the end of the year, funding shortfalls

are expected to arise: JPY8.5trn in Q4 2012 and JPY20.7trn in Q1 2013. We think this would

lower real GDP growth by 7.6 percentage points (pp) q-o-q and 6.2pp, respectively. Even if

spending on the police, the self-defense forces and other areas deemed important to the






25

public‟s daily life were continued, as special cases are exempt from a government shutdown, we

estimate that the dent to real GDP growth would still be 5.7pp in Q4 2012 and 3.1pp in 2013. As

the cost of non-passage of this bill is too big to accept, we expect a compromise to be reached

by the two parties.

Fig. 1: Non-manufacturing investment growth and Tankan survey's DI on excessive capacity

-4

-2

0

2

4

6

8

10-30

-20

-10

0

10

20

30

95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12

Real capex by non-manufacturing companies (lhs)

Capex DI (rhs)

y-y, % DI:"excess" - "shortage": inverse scale

Notes: Capex is in real terms using the 2005 base year deflator. Source: Nomura, the Bank of Japan and Ministry of Finance and Cabinet Office

Faced with a recession in H2 2012, we expect the Diet to enact a supplementary budget by

January 2013. Although the consumption tax rate hike from 5% to 8% is scheduled for April

2014, the government can choose not to implement under the law based on its assessment of

the state of the economy. As the decision will be made around autumn 2013, growth in Q2 2013

will be critically important as this is the last quarterly GDP data published before the decision is

made. As there is a risk that Japan‟s recovery will be halted by a delay in inventory de-stocking

in China or worsening relations between Japan and China, we expect the two major parties, the

DPJ and the LDP, to agree on the supplementary budget.

Although government spending including social welfare is capped at JPY71trn, as self-imposed

by the government, it can still utilize its surplus fund amounting to JPY2trn, which the

government earned during FY11. We expect the government to set aside JPY700bn for public

construction spending for a quick disbursement during H1 2013, which is likely to raise real

GDP growth by 0.16pp in 2013.

Fig. 2: Schedule of major political events in Japan

2012 Nov 30 End of the Extraordinary Diet session

DecBeginning of

the month

16 Election of the Tokyo Metropolitan Governor

By month-end Determine the framework for tax reform and FY13 budget

2013 Jan Ordinary Diet session begins

・Discuss supplementary budget for FY12

・Debate FY13 budget

・Discuss contents of growth strategy

Mar 19 End of terms of BOJ two deputy governors simultaneously

Apr 8 End of terms of BOJ governor Shirakawa

Jul 28 End of current terms of members of Upper House

Aug 29

Summer Election of the Tokyo Metropolitan Assembly

Fall Final decision on consumption tax hike

2014 Apr 1 Consumption tax rate hike from 5% to 8%

During the

month

End of terms of members of Lower House (assuming no early dissolution/holding of general election)

Deadline to pass the bill to allow government to issue deficit bonds, whithout which the national

government would stop spending

Source: Nomura, based on various news reports


26

Monetary policy: We expect the BOJ to ease further in 2013

We expect the BOJ to implement multiple rounds of monetary easing in 2013. In our view, the

first one is likely to be implemented in January 2013 as we expect the BOJ to try to support an

economic recovery following a recession in H2 2012. Political pressures are likely to mount as a

result of an expected general election and in the light of the expiring terms for two Deputy

Governors and Governor Shirakawa, which should also encourage the BOJ to ease monetary

conditions. After the new leadership is inaugurated in April, we expect the BOJ to ease further

as it will likely try to ensure positive growth in Q2 through exercising its influence on the real

economy and asset markets, as Q2 GDP growth is the last figure published before the

government decides whether to implement a hike in the consumption tax rate scheduled for

April 2014. Towards end-2013, the BOJ is likely to stop implementing further easing measures

temporarily due to expectations of demand for private consumption and housing being brought

forward before the consumption tax rate hike, although we believe that the BOJ continues to

monitor carefully asset price movements, which may incorporate the negative impact from a

consumption tax rate hike before it is actually implemented.

Risks

External factors continue to be the main risks for the Japanese economy. Delays in inventory

de-stocking in China pose a significant risk to growth as this delays Asia‟s recovery process.

The relationship between Japan and China poses another downside risk to an economic

recovery if it does not improve in H1 2013 as we expect. Weaker exports from Japan to China,

as well as less Chinese tourists to Japan may reduce Japan‟s real GDP growth by 0.35

percentage points if current political tensions persist throughout 2013. Other external risks

include an expansion and the prolonging of risks associated with European government debt, a

decline in confidence in US economic policy, and concerns about a global economic slowdown.

Fig. 3: Japan: Details of the forecast

% 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 2012 2013 2014

Real GDP 5.2 0.3 -3.5 -1.5 2.0 1.9 1.8 2.0 1.6 0.5 1.2

Private consumption 4.9 -0.4 -1.8 -1.4 1.6 1.4 1.5 1.9 2.1 0.4 1.2

Private non res f ixed invest -7.4 3.8 -12.1 -3.4 1.6 3.9 5.9 6.1 1.0 0.1 5.8

Residential f ixed invest -4.4 6.0 3.8 2.8 6.6 8.6 7.0 3.6 1.9 5.7 -2.9


Public investment 17.7 11.0 16.8 11.3 4.6 -7.5 -14.1 -12.2 9.9 1.5 -11.2

Exports 14.1 5.3 -18.7 -4.1 2.0 3.9 5.1 5.5 0.7 -0.9 6.2

Imports 9.2 7.3 -1.4 -4.2 2.9 5.3 3.6 6.1 5.7 2.0 5.9

Contributions to GDP:

Domestic f inal sales 3.6 1.5 -1.5 -1.0 1.8 1.5 1.3 1.7 2.2 0.7 1.1

Inventories 1.2 -0.8 0.8 -0.5 0.3 0.5 0.2 0.3 0.1 0.2 0.0

Net trade 0.4 -0.4 -2.8 0.0 -0.1 -0.1 0.3 0.0 -0.7 -0.4 0.1

Unemployment rate 4.6 4.4 4.2 4.4 4.5 4.5 4.4 4.3 4.4 4.4 3.9

Consumer prices 0.3 0.2 -0.4 -0.3 -0.7 -0.5 -0.1 0.1 -0.1 -0.3 1.8

Core CPI 0.1 0.0 -0.2 0.0 -0.2 -0.1 0.1 0.1 -0.1 0.0 1.9

Fiscal balance (f iscal yr, % GDP) -9.6 -10.4 -9.5

Current account balance (% GDP) 1.2 1.6 2.1

Unsecured overnight call rate 0-0.10 0-0.10 0-0.10 0-0.10 0-0.10 0-0.10 0-0.10 0-0.10 0-0.10 0-0.10 0-0.10

JGB 5-year yield 0.32 0.22 0.19 0.20 0.22 0.20 0.22 0.23 0.20 0.23 0.37

JGB 10-year yield 0.99 0.83 0.77 0.80 0.82 0.82 0.85 0.88 0.80 0.88 1.10

JPY/USD 82.9 79.8 78.0 82.0 83.0 85.0 86.0 88.0 82.0 88.0 90.0

Notes: Quarterly real GDP and its contributions are seasonally adjusted annualized rates. The unemployment rate is as a percentage of the labor force. Inflation measures and CY GDP are year-on-year percent changes. Interest rate forecasts are end of period. Fiscal balances are for fiscal year and based on general account. Table last revised 12 November. All forecasts are modal forecasts (i.e., the single most likely outcome). Numbers in bold are actual values, others forecast.

Source: Cabinet Office, Ministry of Finance, Statistics Bureau, BOJ, and Nomura Global Economics.


27

Lewis Alexander +1 212 667 9665 [email protected]

Ellen Zentner +1 212 667 9668 [email protected]

Aichi Amemiya +1 212 667 9347 [email protected]

Roiana Reid +1 212 298 4221 [email protected]

United States | Economic Outlook

More clarity, less uncertainty

In 2013 we expect the pace of recovery to begin to accelerate once Washington

policymakers resolve the near-term fiscal and other policy challenges.

Overview

In the three years since the Great Recession ended, real GDP has grown at a lackluster 2.2%

pace, mired in what we judge to be a “Rogoff-Reinhart world,” characterized by sub-normal

growth for an extended period. While the adjustment to household balance sheets is largely

complete, our forecast for personal consumption reflects our view that borrowing is not likely to

drive the economy forward and spending will broadly track growth in income.

Business investment is depressed, relative to previous cyclical norms. The root cause of

uncertainty, the on-going sovereign debt crisis in Europe and US fiscal challenges, is likely to

hold back growth in the economy a bit longer. Looking ahead to 2013, we expect the pace of

recovery to begin to accelerate in the second half of the year, led by a rebound in capital

expenditures, once Washington policymakers resolve the near-term fiscal and other policy

challenges that have undermined business confidence.

Higher capital expenditures should support job creation. Moreover, a strengthening recovery in

the nation‟s housing market should lift that sector‟s contribution to economic growth – through

investment, job creation and the wealth effect from stabilizing home values. Nevertheless, as

more workers are encouraged to enter the labor market to look for work, we expect the labor

force participation rate to rise and the unemployment rate to remain stubbornly high throughout

the forecast horizon. We expect the lack of a “substantial” improvement in the labor market to

lead the Federal Open Market Committee (FOMC) to embark on further long-term asset

purchases at the start of the year.


% 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 2011 2012 2013 2014

Real GDP 2.0 1.3 2.0 1.3 0.7 1.2 2.3 2.7 3.0 3.2 1.8 2.1 1.4 2.8

Personal consumption 2.4 1.5 2.0 2.3 0.7 1.4 2.2 2.6 2.8 2.7 2.5 1.9 1.6 2.6

Non residential f ixed invest 7.5 3.6 -1.3 1.0 -0.3 0.9 4.7 4.8 3.9 8.2 8.6 7.3 1.2 5.0

Residential f ixed invest 20.6 8.4 14.4 17.5 17.9 16.7 15.9 15.6 13.9 13.7 -1.4 12.2 16.2 14.4

Government expenditure -3.0 -0.7 3.7 -2.2 -2.1 -0.9 -1.1 -0.9 -0.3 -1.0 -3.1 -1.4 -0.9 -0.8

Exports 4.4 5.2 -1.6 2.1 2.9 3.1 3.7 5.3 5.5 4.2 6.7 3.3 2.6 4.6

Imports 3.1 2.8 -0.2 2.7 1.5 1.8 2.3 3.5 3.9 3.1 4.8 2.9 1.9 3.1


Domestic f inal sales 2.3 1.5 2.3 1.7 0.5 1.3 2.2 2.5 2.7 3.0 1.9 2.1 1.5 2.8

Inventories -0.4 -0.5 -0.1 -0.1 0.0 -0.2 0.0 0.0 0.2 0.2 -0.2 0.1 -0.1 0.0

Net trade 0.1 0.2 -0.2 -0.2 0.1 0.1 0.1 0.1 0.1 0.1 0.1 -0.1 0.0 0.0

Unemployment rate 8.3 8.2 8.1 7.9 8.1 8.0 8.0 7.9 7.8 7.6 9.0 8.1 8.0 7.6

Nonfarm payrolls, 000 226 67 146 130 100 100 120 150 150 150 139 142 118 169

Housing starts, 000 saar 715 736 786 850 895 940 985 1030 1085 1140 612 772 963 1170

Consumer prices 2.8 1.9 1.7 2.1 1.7 1.8 1.6 1.3 1.4 1.4 3.1 2.1 1.6 1.4

Core CPI 2.2 2.3 2.0 1.9 1.8 1.6 1.6 1.7 1.7 1.7 1.7 2.1 1.7 1.8

Federal budget (% GDP) -8.7 -7.0 -5.8 -5.0


Fed securities portfolio ($trn) 2.61 2.62 2.60 2.72 3.01 3.30 3.59 3.58 3.57 3.57 2.61 2.72 3.58 3.57

Fed funds target 0-0.25 0-0.25 0-0.25 0-0.25 0-0.25 0-0.25 0-0.25 0-0.25 0-0.25 0-0.25 0-0.25 0-0.25 0-0.25 0-0.25

3-month LIBOR 0.47 0.46 0.36 0.40 0.40 0.50 0.50 0.50 0.60 0.60 0.58 0.40 0.50 0.70

TSY 2-year note 0.33 0.33 0.23 0.20 0.30 0.50 0.60 0.70 0.80 0.90 0.24 0.20 0.70 1.10

TSY 5-year note 1.04 0.72 0.63 0.60 0.80 1.00 1.20 1.30 1.40 1.50 0.83 0.60 1.30 1.80

TSY 10-year note* 2.23 1.67 1.63 1.65 2.00 2.20 2.35 2.50 2.55 2.60 1.87 1.65 2.50 2.85

30-year mortgage 3.99 3.66 3.50 2.75 3.00 3.40 3.60 3.70 3.70 3.80 3.95 2.75 3.70 4.10 * The forecast range for 10y UST is as follows: 4Q12 = 1.25-2.0, 1Q13 = 1.7-2.3. Notes: Quarterly real GDP and its contributions are seasonally adjusted annualized rates. The unemployment rate is a quarterly average as a percentage of the labor force. Nonfarm payrolls are average monthly changes during the period. Inflation measures and calendar year GDP are year-over-year percent changes. Interest rate forecasts are end of period. Housing starts are period averages. Numbers in bold are actual values. Table reflects data available as of 9 November 2012. Source: Nomura






28

Fiscal policy

The evolution of fiscal policy will have a major impact on economic activity over the next two

years. In the near term we expect an acrimonious debate between President Obama and

Republicans in Congress over the trajectory of fiscal policy. That debate is likely to weigh on the

US economy and financial markets over the next six months. However, we expect that, in the

end, an agreement will be reached. Moreover, we expect that other important policy reforms,

such as fundamental tax reform, will support growth in the second half of next year and into

2014. Greater clarity over the course of economic policy in general, and fiscal policy in

particular, as well as positive fundamental reforms elsewhere, should generate faster economic

growth starting in the second quarter of next year.

The near-term fiscal challenge

If Congress fails to act before the end of this year tax rates will go up substantially and federal

spending will decline at the beginning of next year. If these policy changes go fully into effect for

all of 2013 the direct impact on the fiscal deficit will be nearly $700 billion, or about 4% of GDP.

This would be enough to throw the US economy into recession in the first half of next year.

Both President Obama and the Republican leaders in Congress have stated repeatedly that

they want to avoid the full fiscal effects of a sharp increase in taxes and blunt spending cuts that

are currently scheduled for the beginning of next year, and, in the end, we expect that an

agreement will be reached to reduce fiscal drag in 2013. But reaching that agreement may

generate a great deal of uncertainty.

The President and some members of Congress may seek to put in place, before year-end, a

“grand bargain” comparable in scale to the Bowles-Simpson proposals, i.e., a package of fiscal

measures covering the next ten years that is large enough to first stabilize and then lower the

level of federal government debt to GDP. But the likelihood of success in the lame duck session

does not seem high.

A less ambitious objective would be to reach a simple agreement to extend the deadlines for the

major pieces of the “fiscal cliff,” i.e., the Bush tax cuts that are set to expire and the automatic

Budget Control Act (BCA) spending cuts mandated in the 2011 deal to raise the debt limit. Such

an extension could buy the time needed to reach a broader agreement. It may be difficult,

however, to reach agreement even on a simple extension. Democrats and Republicans have

significant differences of principle on tax rates for high income taxpayers and on the appropriate

level of spending in 2013. If these differences cannot be bridged it is possible that there will be

no agreement before the end of this year.

While it is possible that we will “go off the fiscal cliff,” it is unlikely that we will go very far into

2013 without an agreement to mitigate the impact of fiscal consolidation on the economy. The

current debt limit is likely to become binding early in 2013. The need to raise the debt limit

could, as in 2011, provide impetus to break the impasse.

A contentious debate over fiscal policy in coming weeks is likely to be a drag on aggregate

demand. Businesses have been reluctant to launch new investment projects and to hire new

workers because they do not have confidence in the economic outlook and they do not know

what their tax obligations will be. Under the weight of this uncertainty, business investment in

general has slowed markedly this year and remains depressed relative to previous cyclical

norms (Figure 1).

The economic impact of “going off the cliff” will depend on how long the tax increases and

spending cuts are actually in place. If they are in place permanently, a recession in the first half

of next year looks certain. On the other hand, if the core fiscal cliff policies are only in effect for a

short time, the effects on the economy should be much more modest (Figure 2).


29

Figure 1: Business investment has suffered from uncertainty

-10

-8

-6

-4

-2

0

2

4

6

8

Q2-2009 Q4-2009 Q2-2010 Q4-2010 Q2-2011 Q4-2011

Investment shortfall (Actual less model predicted value)

pp

Source: Nomura

Figure 2: Estimated impact of “fiscal cliff” policies** on real GDP (%)

-5

-4

-3

-2

-1

0

1

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4

2013 2014

-5

-4

-3

-2

-1

0

1

%

Temporary (1 qrt.) Permanent

** Estimated impact of the expiration of “fiscal cliff” policies – excluding the payroll tax cut and the “Doc fix” – under the assumption that changes are shocks are imposed in Q1 2013 only or permanently. Effects on GDP are estimated using the Fair Model. Source: Nomura

Policy over the long term

Looking beyond the next few months, it is likely that fiscal policy will be a drag on growth for

many years. The budget that President Obama proposed earlier this year anticipates steady

declines of US fiscal deficits from 8.7% of GDP in 2011 to 3.1% of GDP in 2015. Note that

Republican proposals anticipated a significantly faster decline in the deficit, to 1.7% of GDP in

2015. Our forecast anticipates about 1% of fiscal drag in 2013 and somewhat more in 2014.

We also anticipate some progress on other aspects of economic policy. The US tax system is

ripe for reform. The last major reform of the US tax code was passed in 1986. The statutory

corporate tax rate in the US remains relatively high compared with many of its international

competitors, and the many deductions make the system complex and distortive. In addition,

over time an increasing share of the tax code has become subject to annual renewal, a further

source of recurring uncertainty for businesses (Figure 3). A significant amount of preparatory

work on tax reform has been done in Congress. In addition, the Obama administration has put

out a white paper advocating revenue-neutral corporate tax reform.

In the near term, policy uncertainty is likely to be a significant drag on growth. But we think that

much of that uncertainty will be resolved in the first half of 2013. However, the US has just

completed a long, hard-fought election that generated a status quo outcome. If partisan politics

prevents the implementation of a near-term fiscal deal, and progress in other areas of economic

policy, then our outlook for the economy may prove to be too optimistic.

On the other hand, policy has the potential to over-perform as well. At this time fundamental

reforms in a number of areas – including taxation, infrastructure, energy, immigration, and

mortgage finance – have the potential to make a significant positive contribution to long-term

economic growth. If the current gridlock in Congress can be overcome we see significant upside

potential for the US economy.


30

Figure 3: Share of the tax code subject to annual renewal

0

2

4

6

8

10

12

14

2000 2002 2004 2006 2008 2010 2012

Alternative Minimum Tax

Bush Tax Cuts

Other Tax Provisions

%

Source: Congressional Budget Office, Joint Committee on Taxation, Nomura

Figure 4: Labor force participation rate

63.0

63.5

64.0

64.5

65.0

65.5

66.0

66.5

67.0

67.5

63.0

63.5

64.0

64.5

65.0

65.5

66.0

66.5

67.0

67.5

1995 1999 2003 2007 2011

%

Labor force participation rate

...projected based ondemographic trends

%

Source: Bureau of Labor Statistics, Nomura

Monetary policy

At the September meeting, the FOMC said it expects a very low federal funds rate to be

warranted until at least “mid-2015” and initiated an open-ended, long-term asset purchase

program targeting mortgage-backed securities (MBS) at a monthly pace of $40 billion.

Moreover, the Committee vowed to “continue its purchases of agency mortgage-backed

securities, undertake additional asset purchases, and employ its other policy tools as

appropriate”…“if the outlook for the labor market does not improve substantially.” In discussing

how long these purchases might last the Chairman suggested that these measures would likely

continue until the economy was growing fast enough to sustain an employment rate that is

declining “gradually.”

In the spring the Chairman argued that the US needs growth beyond the rate of the economy‟s

potential for the unemployment rate to decline (see “Recent Developments in the Labor Market”,

26 March 2012, see “What labor markets mean for monetary policy”, Special Report, 9 April

2012). In the latest summary of economic projections table, the FOMC‟s central tendency of

potential growth in output is between 2.3% and 2.5%.

The Chairman has also noted that sustained declines in the participation rate could be reversed

if the recovery accelerates. For example, in October the unemployment rate ticked up to 7.9%

even though US households reported having gained more than 400k net new jobs because

more workers flooded back into the labor market to seek employment. Figure 4 provides an

historical look at labor force participation. Adjusting for demographic trends suggests the current

rate of participation is roughly a full percentage point too low. An increase in the participation

rate would likely lead to a higher unemployment rate.

An economy growing at its potential would be just fast enough to accommodate new entrants

into the labor market, but would need to grow beyond potential to additionally accommodate

unemployed workers as they re-enter the labor market. Taken together this implies that the

FOMC would need to see the prospect of GDP growth of at least 3.0% for several quarters to

expect a sustained decline in the unemployment rate. Given the headwinds facing the US

economy, including problems relating to US fiscal policy, it is hard to imagine a sustained

acceleration in growth before the middle of 2013. That means that MBS purchases will likely go

on until the third quarter of 2013. Furthermore, we expect the FOMC to replace the current

maturity extension program (MEP, or “Operation Twist”) – scheduled to expire at the end of the

year – with a program of outright Treasury purchases similar in size and pace (roughly $40bn

monthly) at the beginning of the year.

Our forecast for consumer prices to remain below 2% for the forecast horizon reflects the effects

of a substantial output gap that has emerged from three years of sub-par growth in the

economy. There is a risk, however, that inflation expectations are too optimistic with respect to

http://www.federalreserve.gov/newsevents/speech/bernanke20120326a.htm

http://go.nomuranow.com/research/globalresearchportal/getpub.aspx?pid=507710&appname=GRP&cid=UnlRM2N6Y1FtSVE90


31

the supply-side of the US economy. Were core inflation to accelerate and/or inflation

expectations begin to rise, the FOMC may be forced to tighten monetary policy sooner than

expected.

Recent press reports suggest that Chairman Bernanke may not seek a third term when his

current term expires at the end of 2013. Nevertheless, President Obama will likely seek

continuity in Federal Reserve policy.

Housing

Housing, which often kick-starts US recoveries, has largely been missing this time around, but is

poised to contribute to growth in 2012 for the first time since 2005. Though this important sector

is making headway toward normalization, lingering problems with mortgage financing and an

overhang of inventories remain a constraint on the pace of the recovery. More than 20% of all

outstanding mortgages are underwater and we estimate there are more than 3 million so-called

“shadow” inventories (mortgages that are seriously delinquent or are in the foreclosure process

but have not been put on the market). Nevertheless, the strengthening recovery in housing

provides a key underpinning for our forecasts for job growth and aggregate demand over the

forecast horizon.

Positive developments for supply

The months‟ supply of existing homes – the ratio of visible inventories for sale to monthly sales

and a good measure to gauge the balance between supply and demand in the housing market

– fell below six months in September 2012 for the first time in several years. Looking ahead, the

ebb and flow of visible inventories should continue to be influenced by heavy investor appetite

for single-family rental properties on the demand side, and an increase in listings as prices

improve on the supply side. In the meantime, tight supply of visible inventories has put a floor

under home values and year-on-year price increases are spreading to more areas of the

country. In January, only one metro included in the S&P/Case-Shiller home price index

experienced a year-on-year price gain. By July, 14 metros experienced price gains.

Supporting the tighter supply of visible inventories, the inflow of distressed properties has

slowed significantly over the past few years as the economy has improved and the shock of

troubled mortgages has diminished. A series of policy efforts to reduce foreclosures such as the

Home Affordable Refinance Program (HARP) and Home Affordable Modification Program

(HAMP), and investigations into the improper foreclosure process by banks (the so-called “robo-

signing” scandal) have also helped. The mortgage delinquency rate declined to 7.6% in Q2

2012, down 86 basis points over the last year. The transition of mortgages from early

delinquency (30-60 days past due) into serious delinquency (90 days or more past due) has

also trended lower. The number of foreclosure starts in Q2 2012 was nearly half of its peak of

566k in Q2 2009. It is important to note that while delinquency rates have improved,

delinquencies remain much higher than historical norms. Still, as the delinquency rates decline,

the share of sales that represent distressed assets has declined, lessening the damping effect

these discounted properties have had on home price appreciation.

Pent-up demand

Household formation, arguably one of the most important determinants of demand for housing,

has accelerated in 2011 and 2012. The centered 3-year moving average of the net increase in

US households has now moved back in line with the underlying pace implied by demographic

trends (Figure 5). This may indicate that potential home buyers and renters are becoming more

confident about the economic outlook. For several years following the financial crisis household

formation remained lower than demographics suggested, implying a sizable build-up of pent-up

demand for housing. Against this backdrop, we forecast that housing starts will reach an annual

rate of one million units in Q4 2013, growing by nearly 25% in 2013. Furthermore,

reconstruction efforts after Hurricane Sandy likely point to upside risk to housing‟s contribution

to the economy in 2013 as replacement demand will add to the natural rate of loss in annual

housing stock.


32

Prices

Despite the strengthening recovery, an overhang of supply and lingering problems in mortgage

financing remain obstacles to a more robust housing market. Adding some 2.6 million units in

traditional, visible inventories to our shadow inventory estimate of roughly 3.3 million units

suggests the housing market remains constrained by a substantial inventory overhang. Should

a faster pace of shadow inventories move into visible inventories, price growth is likely to be

tempered for some time to come (Figure 6). Nevertheless, home prices, as measured by the

S&P/Case-Shiller home price index are poised for growth of 1 to 3% in 2013 and we would

expect similar price gains over our forecast horizon.

Figure 5: Housing starts forecast and household formation

0.50

0.75

1.00

1.25

1.50

1.75

2.00

Jan-80 Jan-90 Jan-00 Jan-10 Jan-20

Actual household formation (centered 3-yr moving average)Housing starts (actual and forecast)

Household formation implied by demographics

y-o-y, change, mn units

Note: "Household formation implied by demographics" is the hypothetical pace of household formation assuming constant headship rate by age cohort. We calculated three different population projections depending on immigrants which are laid out by the Census Bureau. Source: Census Bureau, Nomura

Figure 6: Housing inventories: shadow vs. visible

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

Mar-99 Mar-01 Mar-03 Mar-05 Mar-07 Mar-09 Mar-11

invisible inventories in foreclosure process

90 days + delinquent mortgages

New home inventories

visible inventories of distressed assets

existing home inventories ex-distressed assets

thous. units

Shadow inventories

Note: 1.REOs are excluded. 2. New home inventories are 1-family house only. 3. Visible inventories of distressed assets are estimated based on the share of distressed assets in existing home sales. Source: National Association of Realtors, Department of Commerce, Nomura


33

Charles St-Arnaud +1 212 667 1986 [email protected]

Canada | Economic Outlook

Steady as she goes: growth slightly above trend in 2013 After some weakness in Q3 1012, growth should be slightly higher than potential, but

risks remain skewed to the downside.

Activity: We expect growth in Q3 to be relatively weak, because of a big drag from net exports.

Weaker global growth and production disruptions in the oil industry have resulted in anemic

exports gains, while strong domestic demand, led by business investment, has boosted imports.

We expect a rebound in growth in Q4, as some of those factors may prove temporary. For 2013,

we expect growth to be slightly over 2%. We expect personal spending growth to moderate as

households gradually reduce their debt burden and income growth remains slow and business

investment in machinery and equipment to pick-up somewhat. A rebound in global growth with

stronger growth in China and the US likely to avoid the fiscal could support exports. However, the

strong Canadian dollar may dampen the exports contribution to growth. However, the impact from

the strong currency is partly reversed by weaker funding costs, owing to strong foreign inflows into

Canadian securities.

Inflation: With some spare capacity and the output gap likely to close by the end of2013, we

think inflationary pressures are likely to remain contained. We expect headline inflation to have

bottomed in Q3 2012 and should gradually increase ending 2012 close to the central bank‟s 2%

target. Core inflation should follow a similar pattern, reaching a low of 1.7% in Q4 20122.

Policy: With considerable monetary stimulus in place, and a narrowing of the output gap, we

expect the BoC to remain on hold in 2012, waiting to have some clarity on the fiscal cliff in the

US and the crisis in the eurozone before reducing the amount of stimulus before taking any

actions. We expect the BoC to be cautious about tightening monetary policy and to bring rates

to 1.75% by mid-2013. The latest budgets show that the various levels of government are in

consolidation mode, causing a small drag on the economy.

Risks: A disorderly resolution of the euro-area debt crisis remains the most immediate risk to

the Canadian economy, However, we think the threat from the US „fiscal cliff‟ is much bigger

and would have a much larger impact on the Canadian economy than the eurozone crisis, given

the strong economic links between the two countries. On the upside, domestic demand could

prove to be more resilient than expected, and the US economy could perform better than

expected. Moreover, QE3 in the US could be positive for Canada by boosting commodity prices

and the terms of trade.


Notes: Quarterly real GDP and its contributions are seasonally adjusted annualized rates (saar). Inflation measures and calendar year GDP are year-over-year percent changes. Interest rate forecasts are end of period. Numbers in bold are actual values. Table reflects data available as of 13 November 2012. Source: Bank of Canada, Statistics Canada, Nomura Global Economics.

% 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 2011 2012 2013 2014

Real GDP 1.8 1.9 1.0 1.9 2.1 2.1 2.1 2.1 2.6 2.1 1.9 2.1

Personal consumption 1.5 0.8 1.7 1.5 1.8 1.8 1.8 1.8 2.4 1.6 1.7 1.8

Non residential f ixed invest 7.0 9.3 9.0 7.0 6.5 6.5 6.5 6.5 10.4 7.5 7.1 6.5

Residential f ixed invest 15.8 -1.5 5.0 4.0 5.0 5.0 5.0 5.0 1.9 6.9 4.4 5.0

Government expenditures -1.7 0.4 0.0 0.0 0.3 0.3 0.3 0.3 0.5 -1.0 0.2 0.3

Exports -4.4 4.0 0.2 4.2 4.3 4.3 4.3 4.2 4.6 3.1 3.7 4.2

Imports 2.4 2.5 4.0 4.0 4.2 4.2 4.2 4.2 5.8 2.9 4.0 4.2


Domestic f inal sales 2.1 1.4 2.2 1.9 2.1 2.1 2.1 2.1 2.6 1.9 2.0 2.1

Inventories 1.9 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.4 0.2 0.0 0.0

Net trade -2.2 0.4 -1.2 0.0 0.0 0.0 0.1 0.1 -0.4 0.0 -0.1 0.1

Unemployment rate 7.4 7.3 7.3 7.3 7.3 7.2 7.2 7.2 7.5 7.3 7.2 7.1

Employment, 000 41 120 17 50 60 60 60 60 51 57 60 63

Consumer prices 2.3 1.6 1.2 1.7 1.8 1.8 2.0 2.0 2.9 1.7 1.9 2.0

Core CPI 2.1 2.0 1.5 1.7 2.0 2.0 2.0 2.0 1.7 1.8 2.0 2.0

Fiscal balance (% GDP) -4.4 -3.8 -3.0 -2.2


Overnight target rate 1.00 1.00 1.00 1.00 1.00 1.00 1.25 1.75 1.00 1.00 1.75 3.00

3-month T-Bill 0.91 0.87 0.97 1.00 1.00 1.00 1.30 1.80 0.82 1.00 1.80 3.00




USD/CAD 1.00 1.02 0.98 0.98 1.00 1.00 0.99 0.97 1.02 0.98 0.97 0.97



34

Benito Berber +1 212 667 9503 [email protected]

Mexico | Economic Outlook

2013: The year of reforms

The new government will embark on a series of important reforms in 2013.

Activity: We forecast the economy to expand by 3.0-3.5% y-o-y in 2013. While the US

economy, the main trade partner of Mexico might remain weak, we expect Mexican domestic

aggregate demand to remain resilient. Other risks include a sharper than anticipated contraction

in the Eurozone that drags down global growth. For 2012 the Mexican economy is on track to

expand above potential growth of 3.0-3.25%. A fiscal reform to increase non-oil revenues and

an energy reform to increase private sector participation will be the main focus of attention in

2013. Authorities will approve these two key structural reforms that will enhance potential

growth and reduce vulnerabilities.

Inflation: For 2013 we expect most of the supply-side shocks to dissipate; therefore, we

forecast inflation to moderate to 3.4% from around 4.0% in 2012. However this forecast does

not include the impact of the fiscal reform of increasing the VAT on food and medicines from

their current 0% rate. Since the fiscal reform will likely be presented to Congress in February, at

the earliest, we won‟t be able to re-calibrate the inflation forecast until then. If authorities

increase the VAT for food and medicines to 16%, which is the rate for other goods, inflation

would surpass 7.0% y-o-y. If authorities increase the VAT gradually, the impact on inflation

could be significantly lower.

Policy: We forecast the central bank of Mexico (Banxico) to keep the policy rate unchanged at

4.50% until 2014 despite the recent hawkishness of Governor Agustin Carstens. Our medium-

term view for the MXN remains sanguine due to the likely approval of the structural reforms. We

forecast that MXN will strengthen to 12.00 by 4Q 2013.

Risks: The main risk is a double-dip recession in the US economy, which seems unlikely. In

terms of inflation, we see the following risks to our call: (1) pass-through effects due to MXN

depreciation; (2) increases in gasoline prices; and the passage of the fiscal reform


Notes: Annual forecasts for GDP and its components are year-over-year average growth rates. Annual CPI forecasts are year-over-year changes for Q4. Trade data are period sums. Interest rate and currency forecasts are end of period. Contributions to GDP do not include taxes. Numbers in bold are actual values, others forecast. Table reflects data available as of 13 November 2012.

Source: Nomura Global Economics.

% y-o-y change unless noted 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 2012 2013 2014

Real GDP 4.6 4.1 3.5 3.5 3.7 3.4 3.2 3.1 3.7 3.5 3.5

Personal consumption 4.3 3.3 3.4 4.7 4.3 3.1 3.3 3.4 4.5 3.5 3.6

Fixed investment 8.6 6.2 2.4 3.2 3.2 3.2 3.2 3.2 3.0 3.2 3.9

Government expenditure 2.9 1.7 5.3 0.4 1.3 0.4 2.2 2.0 3.9 3.1 2.8

Exports 5.1 6.3 4.9 7.2 5.1 4.4 3.6 2.8 4.1 4.0 3.9

Imports 7.1 4.0 2.7 6.3 4.7 3.6 3.6 3.9 4.3 3.9 3.5

Contributions to GDP (pp):

Industry 1.4 1.2 0.8 1.0 1.1 1.0 0.9 0.9 1.1 1.0 1.0

Agriculture 0.2 0.2 0.1 0.1 0.1 0.1 0.1 0.1 0.2 0.1 0.1

Services 2.9 2.6 1.7 2.2 2.4 2.2 2.0 2.0 2.4 2.2 2.2

CPI 3.73 4.34 4.60 4.00 3.55 3.50 3.45 3.40 4.10 3.40 3.50

Trade balance (US$ billion) 1.8 1.5 -4.1 -3.9 -3.8 -3.8 -3.8 -3.8 -4.7 -15.2 -15.0

Current account (% GDP) -1.5 -1.5 -1.5


Gross public debt (% GDP) 37.3 35.0 34.0

Overnight Rate % 4.50 4.50 4.50 4.50 4.50 4.50 4.50 4.50 5.50

USD/MXN 12.81 13.36 12.86 12.70 12.70 12.50 12.70 12.00 12.00



35

Tony Volpon +1 212 667 2182 [email protected]

Brazil | Economic Outlook

Inflation storm on the horizon

The combination of a record low policy rate and a “dirty band” preventing BRL from

appreciating will likely lead to soaring inflation in 2013.

Activity: The Brazilian economy had fairly lackluster performance in 2012, with H1 GDP

growing merely 0.6% y-o-y, and investment falling 2.9% y-o-y. Policymakers have rolled out a

series of monetary and especially fiscal stimuli in an attempt to revive growth. However, given

the structural issues on the supply side, ongoing drags from credit markets and a still troubled

international environment, GDP growth will likely remain sluggish at 1.3% in 2012. Given the

gradually improving global growth profile and the lagged effects of domestic stimuli, we should

see more robust growth in 2013, reaching 4.1%.

Inflation: Consumer prices have been rising fast recently and we expect inflation pressures to

remain high, given very accommodative policies and a virtually fixed exchange rate regime.

Tradable goods prices are low at around 4%, yet several factors – inclement weather in Brazil

and the US, the recent surge in world food prices and a BRL weaker than 2.0 – are already

pushing up domestic food prices and we expect it to continue, with inflation ending 2012 at

5.5%. As a result of faster growth, a low base of comparison, the lagged effects of a weaker

currency and a lower policy rate, inflation will likely accelerate in 2013, ending the year at 5.7%.

Policy: The Central Bank of Brazil (BCB) has slashed its policy rate, Selic, by 525bp since

August 2011, and stated in the October minutes that “stability of monetary conditions for a

sufficiently long period is the best strategy”. We believe the “stability for a long period” language

offers a strong signal that the easing cycle has ended, and the key question now is how long the

BCB will stay put, even in the face of rising inflation.

Risks: The biggest and more immediate risk, we believe, is the likelihood of on-going supply

shocks further amplified by monetary easing from major central banks in the developed world.

Any such shock could push up inflation rapidly given still very tight factor markets, with

unemployment near all-time lows and the economy fully reacting to multiple rounds of monetary

and fiscal stimuli. This should push Brazil back into a “stop and go” pattern in monetary policy,

and lead the BCB to hike Selic in 2013. We now expect the new hiking cycle to start in Q2 2013,

as rising consumer prices threaten to go above 6%, and think Selic will likely finish 2013 at 9%.

In the medium term, Brazil faces the challenge to reorient its growth model from a consumption-

driven one to a more investment-driven one. Without enough political will to tackle this

challenge, especially when it comes to lowering soaring labor costs, we expect potential growth

to slow to around 3.5% over the coming years.


Notes: Annual forecasts for GDP and its components are year-over-year average growth rates. Annual CPI forecasts are year-on-year changes for Q4. Trade data are a 12-month sum. Interest rate and currency forecasts are end of period. Contributions to GDP growth do not include taxes. Numbers in bold are actual values, others forecast. Table reflects data available as of 12 October 2012.


% y-o-y change unless noted 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 2012 2013 2014

Real GDP 0.8 0.5 1.8 2.1 3.3 4.4 3.9 4.2 1.3 4.1 3.5

Personal consumption 2.5 2.4 4.2 4.1 4.4 5.7 5.0 5.2 3.3 5.0 4.1

Fixed investment -2.1 -3.7 -1.5 -1.1 4.5 8.1 8.5 6.5 -2.1 6.2 5.5

Government expenditure 3.4 3.1 3.8 3.5 4.0 3.2 3.0 3.3 4.0 3.6 3.0

Exports 6.6 -2.5 -1.7 -2.3 -0.5 5.5 7.5 6.1 1.4 4.5 4.5

Imports 6.3 1.6 5.2 2.7 7.5 11.3 12.1 10.8 5.1 9.8 8.0

Contributions to GDP growth (pp)

Industry -0.4 0.1 0.4 0.5 0.8 1.1 0.9 1.0 0.3 1.0 0.8

Agriculture 0.0 0.0 0.1 0.1 0.2 0.2 0.2 0.2 0.1 0.2 0.2

Services 0.9 0.3 1.0 1.2 1.9 2.5 2.2 2.4 0.7 2.3 2.0

IPCA (consumer prices) 5.2 4.9 5.3 5.5 5.8 6.0 5.8 5.7 5.5 5.7 5.5

IGPM (wholesale prices) 3.2 5.1 8.1 7.5 7.3 7.0 6.8 6.5 7.5 6.5 5.5

Trade balance (US$ billion) 29 24 22 20 18 21 23 25 20 25 22

Current account (% GDP) -2.4 -2.5 -2.5


Net public debt (% GDP) 36.0 35.0 34.0

Selic % 9.75 8.50 7.50 7.25 7.25 8.25 9.00 9.00 7.25 9.00 8.50

BRL/USD 1.83 2.01 2.03 2.00 2.00 1.93 1.90 1.90 2.00 1.90 1.85



36

Boris Segura +1 212 667 1375 [email protected]

Benito Berber +1 212 667 9503 [email protected]

Tony Volpon +1 212 667 2182 [email protected]

Rest of LatAm | Economic Outlook

Argentina: Key mid-term elections coming

Electoral calculations are likely to drive economic policymaking yet again

We expect the authorities to keep financing their growing fiscal deficits with monetary financing from the central bank. This is to increase inflationary pressures.

Despite more supportive trade flows, we do not expect a relaxation of draconian exchange controls.

Argentina‟s economic recovery in 2013, a key electoral year, is likely to be lacklustre. As such, the authorities are likely to resort to their usual recipe: Expansionary fiscal and monetary policies.

Increasing RER overvaluation to put further strain on output ex commodities and automobile production to Brazil.

Source: BCRA, Indec, MECON, Nomura

Colombia: Growth around trend

We expect around-trend growth in 2013 driven by resilient domestic demand.

After a strong first half supported by strong domestic consumption and resilient exports, we expect the economy to grow at 4.5% in 2012.

Both headline inflation and inflation expectations remain well anchored around 3.0%.

We expect an additional 25bp interest rate cut to 4.50% by 2012 year end and for authorities to continue intervening in the FX market to curb COP appreciation. Given around-trend growth, inflation within target band and improving external scenarios, we expect the BanRep to remain in “wait-and-see” mode in 2013 and keep the policy rate on hold at 4.50%.

Source: CSOP, NBP, Nomura Global Economics.

Chile: Better external conditions bring upward pressure

We expect domestic demand to remain robust. As global growth prospect brightens and

inflation picks up, we expect a small hiking cycle in H2 2013.

Chile has been growing robustly in 2012, with retail and construction sectors propping up internal demand. As external growth gradually improves, we expect the Chilean economy to expand even faster in 2013.

Inflation is currently below target (3%) and expectations are well-anchored. Yet upside risks are notable in the medium-term, given the tight labor market, strong wage hikes and Chile‟s high exposure to oil price shocks.

As global uncertainties clear up, the central bank will increasingly focus on the domestic front to determine the next move, as the monetary policy rate (TPM) is currently around neutrality. We expect a small hiking cycle in H2 2013, taking TPM to 5.5% by year-end.

The presidential election on November 17 will be the most important political event next year. Incumbent Piñera is constitutionally barred from seeking immediate reelection and no firm candidate has emerged yet.

Source: Haver, Bloomberg, Nomura Global Economics.

2011 2012 2013 2014

Real GDP % y-o-y 8.9 2.0 4.0 3.5

Consumption % y-o-y 10.7 4.4 4.2 3.8

Gross Investment % y-o-y 16.6 -9.0 7.5 5.0

Exports % y-o-y 4.3 -6.0 6.7 5.0

Imports % y-o-y 17.8 -7.6 10.8 10.0

CPI % y-o-y * 9.5 10.2 10.2 10.2

CPI % y-o-y ** 21.8 26.4 32.3 29.7

Budget balance % GDP *** 0.3 -0.8 -2.0 -1.5

Current account % GDP 0.0 1.8 1.9 1.0

Policy Rate % 18.8 15.0 17.0 14.0

USDARS 4.29 4.88 6.00 7.20

* Official data, ** Private estimate, ***Primary budget balance, Bold is actual data

2011 2012 2013 2014

Real GDP % y-o-y 5.9 4.5 4.5 4.5

Consumption % y-o-y 5.8 4.5 4.4 4.5

Gross Investment % y-o-y 16.6 9.0 9.2 9.7

Exports % y-o-y 11.4 7.0 9.0 9.5

Imports % y-o-y 21.5 9.0 8.0 8.5

CPI % y-o-y * 3.7 2.9 3.5 3.5

CPI % y-o-y ** 3.4 3.2 3.5 3.5

Budget balance % GDP -2.1 -1.8 -2.0 -2.3

Current account % GDP -3.0 -3.5 -3.0 -3.0

Policy Rate % * 4.75 4.50 4.50 5.50

USDCOP * 1938.50 1825.00 1750.00 1750.00

* End of period, ** Period average, Bold is actual data

2011 2012 2013 2014

Real GDP % y-o-y 6.0 5.1 5.5 5.0

Consumption % y-o-y 8.8 5.5 6.0 5.5

Gross Investment % y-o-y 17.6 7.5 10.0 7.0

Exports % y-o-y 4.6 3.8 5.0 5.0

Imports % y-o-y 14.4 4.6 9.0 8.0

CPI % y-o-y * 4.4 3.0 3.3 3.0

CPI % y-o-y ** 3.3 3.3 3.2 3.0

Budget balance % GDP 1.5 1.0 1.0 1.0


Policy Rate % * 5.25 5.00 5.50 5.25

USDCLP * 519.55 475.00 460.00 450.00

* End of period, ** Period average, Bold is actual data





37

Jacques Cailloux +44 (0) 20 710 22734 [email protected]

Nick Matthews +44 (0) 20 710 25126 [email protected]

Euro Area | Economic Outlook

Spain and Italy to remain at the epicenter

By mid 2012 it had become increasingly clear that the combination of the unwillingness of the

ECB to buy bonds and the reluctance of Germany to show more solidarity towards other

member states had become life-threatening for EMU. By mid July, markets started pricing that

scenario with Italy and Spain facing a sudden stop.

The combination of Draghi‟s commitment to “do whatever it takes” on 26 July and the apparent

support from the German Chancellor which followed soon after have given the market hopes

that the worst of the crisis might finally be over and that solidarity might finally be winning the

day.

In our view, 2013 will be another testing year for solidarity against a backdrop of weakening

economic activity. In fact, we believe that the macro-economic challenges and the cost of

preserving the stability of the system remain higher than the nature and size of the backstops

available.

Our baseline scenario for 2013 is one of deep recession in the countries most under stress and

of shallow recession in the centre (Figure 1), with the euro area as a whole expected to contract

around 0.8% next year (Figure 2). The ongoing deterioration in labour markets coupled with still

extremely restrictive monetary and financial conditions in countries like Spain and Italy (where

the currency, borrowing costs and liquidity constraints all add up to pretty tight financial

conditions) should feed back into public finances and NPLs creating a depressionary

environment in a growing share of the region. This negative loop has the potential to threaten

the stability of the whole system again given the absence of an unlimited and unconditional

backstop.

We expect the following chain of events by mid 2013:

Fig. 1: Country specific forecast

2012 2013 2014 2012 2013 2014 2012 2013 2014 2012 2013 2014

Euro area -0.5 -0.8 0.0 2.5 1.7 1.6 -3.3 -3.2 -3.0 93.7 98.1 100.9

Austria 0.4 0.2 0.8 2.5 2.2 2.0 -2.7 -2.6 -2.9 74.1 75.2 76.3

France 0.1 -0.5 0.5 2.2 1.4 2.0 -4.5 -3.9 -3.6 90.0 93.7 95.6

Germany 0.9 0.3 0.7 2.2 1.8 1.7 -0.1 -0.2 -2.0 81.9 81.5 80.3

Greece -6.5 -4.7 -1.8 0.9 -0.2 -0.3 -6.9 -5.9 -3.8 176.6 188.3 198.2

Ireland -0.1 0.4 1.3 2.0 0.5 0.5 -8.5 -8.1 -0.5 117.6 123.4 125.1

Italy -2.4 -2.5 -1.5 3.3 1.8 1.4 -2.9 -3.1 -5.2 126.3 131.1 133.8

Netherlands -0.3 -0.3 0.2 2.8 2.6 1.8 -3.6 -3.1 -5.9 68.7 69.9 71.9

Portugal -3.2 -2.8 0.0 2.9 1.3 0.7 -5.2 -5.0 -2.8 119.1 127.6 129.6

Spain -1.4 -3.0 -1.5 2.5 2.5 1.4 -8.0 -7.0 -3.1 85.0 95.5 101.1

Debt level

(as % of GDP)

Real GDP Consumer prices Budget balance

(% y-o-y) (% y-o-y) (as % of GDP)


Spain: from bank bailout to sovereign bail out

After having given the impression to market participants that they were actively considering

calling for help, we now have little doubt that Spain will try to free-ride the system by keeping

expectations of a bailout high without pulling the trigger. We believe this to be a highly risky

strategy which will eventually backfire.

We see four triggers that could precipitate the call for help:




38

1. Rating downgrade

A single notch of downgrade from DBRS would have an immediate knock on effect on haircuts

(additional 5%) which could prove destabilizing. More importantly, a downgrade to below

investment grade by one of the rating agencies could be more significant. An absence of a call

for help in the short term and further disappointments on the economic front would most likely

lead to such an outcome.

2. Investors losing patience with Spain

There is little doubt that spreads have tightened on the back of the so called “Draghi put” rather

than on improving fundamentals. In that context, a lack of expediency on that front could test

the market‟s patience. To be fair, we had expected markets to be less patient than they have

been, a sign perhaps that this channel might not work for quite some time. What could

accelerate investors‟ willingness to lighten their exposure to Spain could be the fear of an illiquid

end year holding significant exposure to Spain without any clarity regarding the timing for help.

3. The revelation that Spain might never call for help

The unwillingness of market participants to sell Spain up to now is the result of the credibility of

the Draghi put making the risk-reward of selling not an attractive proposition. However, the

Draghi put would lose all credibility if it became clear that Spain was in no position to call for

help as it saw no benefit from it. The past few weeks have clearly increased the likelihood of

that scenario, with Prime Minister Rajoy explicitly stating in a radio interview (see NEMO, 7

November 2012) that the spread on the 10-year should narrow by 200bp to make it an

interesting proposition, something the ECB will not be able to deliver with its OMT programme

as suggested by Mr Draghi at November‟s press conference. (The OMT is designed to address

„tail risk‟ events.)

4. The ECB loses patience

Since the beginning of the crisis, the ECB has been instrumental in “pushing” countries into

bailout. This was the case for all bailed-out countries and could thus be repeated in the case of

Spain should the ECB grow increasingly worried about the danger of postponing the help.

In all, this suggests to us that Spain will not escape a sovereign bailout. We think this will most

likely happen after renewed market stress, although conditions 1 and 4 might bring Spain

directly into a bailout without necessarily much market deterioration.

Fig. 2: Euro area macroeconomic forecast

% 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 2012 2013 2014

Real GDP -0.1 -0.7 -0.6 -1.6 -0.8 -0.6 -0.2 -0.1 -0.5 -0.8 0.0

Household consumption -0.7 -1.0 -1.7 -1.7 -1.7 -1.5 -1.5 -1.5 -1.1 -1.6 -1.4

Fixed investment -5.1 -3.5 -7.0 -6.6 -5.6 -4.5 -3.9 -3.6 -3.9 -5.3 -3.2

Government consumption 0.7 0.4 -0.8 -0.8 -0.8 -0.8 -0.8 -0.8 0.0 -0.7 -0.5

Exports of goods and services 2.6 5.3 0.9 -3.1 0.6 1.6 2.6 2.6 2.3 0.8 2.7

Imports of goods and services -1.2 3.7 -4.7 -7.0 -2.8 -2.1 -0.8 -0.4 -1.4 -2.9 0.2


Domestic f inal sales -1.3 -1.1 -2.5 -2.3 -2.2 -1.9 -1.7 -1.6 -1.3 -1.9 -1.4

Inventories -0.6 -0.4 -0.7 -0.9 -0.2 -0.5 -0.1 0.1 -0.9 -0.5 0.2

Net trade 1.8 0.9 2.6 1.7 1.5 1.7 1.6 1.4 1.7 1.7 1.3


Compensation per employee 1.9 1.7 1.8 1.4 0.9 0.7 0.4 0.3 1.7 0.6 0.6

Labour productivity 0.4 0.2 -0.2 -0.4 -0.7 -0.5 -0.3 0.1 0.0 -0.4 0.5

Unit labour costs 1.5 1.4 2.0 1.8 1.6 1.2 0.7 0.2 1.7 0.9 0.1


Current account balance (% GDP) -0.3 0.1 0.5

Consumer prices 2.7 2.5 2.5 2.4 1.9 1.8 1.5 1.4 2.5 1.7 1.6

ECB main refi. rate 1.00 1.00 0.75 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50

3-month rates 0.78 0.65 0.22 0.18 0.21 0.21 0.21 0.21 0.18 0.21 0.21

10-yr bund yields 1.81 1.60 1.41 1.25 1.31 1.38 1.44 1.50 1.25 1.50 1.75

$/euro 1.32 1.25 1.29 1.28 1.25 1.20 1.18 1.18 1.28 1.15 tbc

Notes: Quarterly real GDP and its contributions are seasonally adjusted annualised rates. Unemployment rate is a quarterly average as a percentage of the labour force. Compensation per employee, labour productivity, unit labour costs and inflation are y-o-y percent changes. Interest rate and exchange rate forecasts are end of period levels. Numbers in bold are actual values, others forecast. Table reflects data available as of 9 November 2012.

Source: Eurostat, ECB, DataStream, Nomura Global Economics.

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39

Italy: still lacking a credible backstop

The biggest danger for Italy in the near term is renewed deterioration in the Spanish bond

market given how high the correlation of the two countries‟ bond markets have been in the past

few months. This is in fact our baseline scenario.

But there are other risks that seem to be underestimated by the market: the rapid increase in

NPLs in the banking sector, the downward trajectory of the economy, the broken transmission

mechanism and political risk.

In our baseline scenario, we expect Italy to experience renewed bond market deterioration

either through negative contagion from Spain or independently from Spain.

Renewed stress in the Italian bond market would most likely have much greater impact on other

asset classes than Spain which is now largely seen as an idiosyncratic risk, something we

would agree with at least in the next few months.

Need for additional conventional and unconventional policy easing

As can be seen in Figure 3, a simple Taylor rule for the euro area suggests that while the policy

rate might be broadly appropriate in the core at present, it is too tight for the periphery. This is

without considering the widening in interest spreads in the periphery. The good news is that if

our expectation of a significant deterioration in the core proves correct, then the case for

additional easing will be much easier to make. Based on our forecast, an additional 150-200bp

would be required, an amount of easing obviously impossible to deliver solely via conventional

policy. We thus expect the pressure for QE to rise during the course of next year.

Once the financial crisis is addressed there will still be an economic crisis

Perhaps the greatest challenge of all will be how to tackle the very significant and rapid increase

in unemployment in the periphery. Figure 4 shows the extent of the economic damage caused

in the periphery and the inadequacy of the euro-area policy toolkit to address these issues.

Indeed, while compressing bond spreads is relatively easy to do (once the hurdle of getting the

ECB on board is surpassed), there is no obvious policy tool at this stage in the euro area that

could help in reducing unemployment rapidly. Elevated unemployment, and rising discontent in

some countries about Europe, suggests that the ECB has no ability to eradicate the so-called

convertibility risk that there is in the system. The currency might be irrevocable but membership

is no longer.

Fig. 3: ECB policy rates vs Taylor rule recommended rates

-4

-3

-2

-1

0

1

2

3

4

5

6

1Q00 1Q02 1Q04 1Q06 1Q08 1Q10 1Q12 1Q14

ECB rate

Core

Periphery

%

Note: The Taylor rule we employed is

, where πt is the inflation

and yt is the output gap. Core stands for Germany, France, Netherlands, and Austria and periphery includes Italy, Spain, Ireland, Portugal and Greece.

Source: EC and Nomura Global Economics

Fig. 4: Unemployment rate: core vs periphery

0

2

4

6

8

10

12

14

16

18

20

Jan-93 Jan-96 Jan-99 Jan-02 Jan-05 Jan-08 Jan-11

Core Periphery

%

Note: Core refers to Germany, France, Austria, Finland, Belgium, Luxembourg and Netherlands. Periphery refers to Italy, Spain, Ireland, Portugal and Greece.

Source: Eurostat, Datastream and Nomura Global Economics


40

Risks to the outlook:

We see several risks to the downside. They include very significant political risk in pretty much

all the region (but most importantly Greece, Cyprus, Portugal, Italy, Germany, Finland,

Netherlands, Spain and France) either through tense relations between member countries or

the rise of populism at home. Another risk stems from dysfunctional credit markets and the

danger of depressionary spirals.

On the upside, the most significant risk stems from the potential shift in Europe away from strict

adherence to nominal fiscal targets to either structural deficit targets or only the commitment to

structural reform. Indeed, our forecast s for countries such as Spain, Italy and France are quite

sensitive to the assumptions we have made on the amount of fiscal consolidation to come.


41

Philip Rush +44 20 7102 9595 [email protected]

United Kingdom | Economic Outlook

Stagnant

Intensification of the euro-area crisis remains a serious threat to the UK. The MPC is

responding with aggressively loose policy, despite inflation’s persistent stickiness.

Activity: Underlying growth ground to a halt in 2011 and the subsequent double-dip recession

is being compounded by recurrent intensification of the eurozone‟s sovereign debt crisis. Large

trade and financial relationships with the euro area tie the UK to its apparently bleak economic

fate (see UK Theme: Sounding in a pounding?). Earlier signs of cyclical growth momentum

waned at still weak growth rates leaving the UK on the brink of recession, probably until 2013,

besides when one-off factors boosted GDP in Q3 (see UK Theme: Several shocking months).

Growth remains constrained by the ongoing domestic deleveraging and the challenging

rebalancing act within the euro area (see UK Comment: Forecast: limping into 2014).

Inflation: Inflation has been boosted by a series of “one-off” shocks such as changes to VAT

and energy prices, but underlying inflation is still probably too strong. And there are further “one

offs” from tuition fees. Unlike the MPC, we do not expect a sustained fall below the inflation

target, let alone materially so (see UK Theme: Inflation in a black hole).

Policy: The MPC is responding aggressively to signs of weaker global growth and subdued

domestic demand. QE3 was brought to an end in November after buying £50bn, because the

MPC wanted to see if tentative signs of recovery are sustained. We doubt they will be and

expect disappointment at demand to cause the MPC to resort to QE again as soon as February.

Although concerns are growing about QE‟s effectiveness, we still do not expect a Bank rate cut,

which we believe would be counterproductive (UK Theme: The monetary blunderbuss). Part of

demand's ongoing weakness is attributable to the economy's unavoidable but impeded

rebalancing and associated fiscal consolidation programme. We estimate fiscal policy to keep

subtracting about 1.0% from GDP growth. However, in order to meet its fiscal mandate of

reaching a current structural balance by the end of a rolling five-year period, we think the

government will need to implement more measures. That is because its current spending plans

are conditioned on what we still consider to be an overly optimistic view of potential growth (see,

for example, UK Theme: Policymakers remake mistakes, 24 November 2011). As new

measures will probably be back-loaded, we expect the debt-to-GDP (secondary) target to be

broken and the UK to lose its AAA rating by May 2015 (UK Theme: Bending the fiscal rules).

Risks: Downside risks dominate our growth forecasts, creating the risk that the MPC delivers

even more easing than we expect, despite the risks being to the upside of our inflation

forecasts.


Notes: Quarterly figures are % q-o-q changes. Annual figures are % y-o-y changes. Inventories include statistical discrepancy. Inflation is % y-o-y. Interest rates and currencies are end-of-period levels. Numbers in bold are actual values; others forecast. Table reflects data available as of 6 November 2012. Source: ONS, Bank of England, Bloomberg, DataStream, Nomura Global Economics.

1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 2012 2013 2014

Real GDP -0.3 -0.4 0.8 -0.2 0.0 0.1 0.1 0.2 -0.2 0.4 1.0

Private consumption 0.3 -0.2 0.8 -0.4 0.3 0.4 0.5 0.4 0.5 1.0 1.8

Fixed investment 3.2 -2.7 -0.3 0.2 -0.1 0.3 0.3 0.5 0.8 -0.3 2.5

Government consumption 3.1 -1.6 0.0 -0.4 -0.4 -0.4 -0.4 -0.4 2.2 -1.7 -1.6

Exports of goods and services -1.6 -1.1 1.4 0.8 0.7 0.7 0.8 0.9 0.2 2.9 3.0

Imports of goods and services -0.1 1.4 0.6 0.5 0.9 0.8 0.8 0.8 2.6 3.1 2.5


Domestic f inal sales 1.4 -0.9 0.4 -0.3 0.1 0.2 0.3 0.3 1.0 0.2 1.1

Inventories -1.3 1.2 0.1 0.0 0.0 -0.1 -0.1 -0.1 -0.4 0.3 -0.3

Net trade -0.5 -0.8 0.3 0.1 -0.1 0.0 0.0 0.0 -0.8 -0.1 0.1


Consumer prices (CPI) 3.5 2.8 2.4 2.5 2.4 2.7 2.7 2.4 2.8 2.6 2.3

Retail prices (RPI) 3.8 3.1 2.9 3.1 3.1 3.4 3.3 2.8 3.2 3.2 2.6

Announced size of the APF (£bn) 325 325 375 375 425 425 425 425 375 425 425

Official Bank rate 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50

3-month sterling libor 1.03 0.90 0.60 0.65 0.65 0.65 0.65 0.70 0.65 0.70 0.70

10-year gilt 2.20 1.73 1.73 1.60 1.50 1.50 1.60 1.75 1.60 1.75 2.50

£ per euro 0.83 0.81 0.80 0.78 0.77 0.75 0.75 0.75 0.78 0.75 tbc

$ per £ 1.60 1.56 1.62 1.64 1.62 1.60 1.57 1.53 1.64 1.53 tbc


http://go.nomuranow.com/research/globalresearchportal/getpub.aspx?pid=514180








42

Peter Attard Montalto +44 (0) 20 710 28440 [email protected]

Olgay Buyukkayali +44 (0) 20 710 23242 [email protected]

James Burton +44 20 710 24927 [email protected]

EEMEA Outlook

Some silver linings to the external risks bearing down

The region is not homogeneous, but tighter fiscal policy and broadly orthodox

monetary policy are a common theme, along with a lower beta to the eurozone.

The same shocks that we commented on in our outlook last year are affecting EEMEA currently:

eurozone bank deleveraging, export demand shocks from the eurozone, the global growth

slump and a range of domestic idiosyncratic risks (mainly surrounding politics and their

interaction with fiscal policy). Those shocks are all still very much present across the region.

Deleveraging has, if anything, been faster and more aggressive in a number of countries than

we first thought.

Sentiment has been a big catalyst for a slower EEMEA in 2012. The weakening of export

growth has been slower than that of domestic demand in CEE in general (and so trade deficits

have narrowed markedly). While tighter credit and lending standards did not exceed our

expectations, sharply deteriorating sentiment across the region has played a key role in

damping investment, inventory building and labour market dynamics in particular.

That said, if we consider our eurozone growth forecast is -0.8% in 2013 and -0.5% in 2012 and

then +0.8% in 2014, our own region growth forecast of 3.2% next year after 2.7% this year and

3.8% in 2014 compares very favourably with what happened in 2009 when GDP growth slowed

to 4.8%. The growth dynamic and contagion through the domestic economy was much weaker

in 2008-09.

The region does, therefore to some extent, seem to be establishing itself as having a lower beta

to the eurozone crisis, even though specific contagion channels are still very much present. We

believe there are several reasons for this. First, there is a lot of pent-up demand from the more

region-centric crisis than there was in 2008-09. Second, fiscal drag, while still present in most

economies, has much less of an impact now than back then. Furthermore, the nominal and real

policy rates went lower for longer (i.e. the transmission lags have had time to work through) and

households, governments and corporates all have cleaner, deleveraged (or partially so) balance

sheets. This is evident in the level of current accounts alone. Add to that a global shock that is

probably more limited, combined with easier liquidity internationally than under the previous

shock and a certain degree of export partner diversification into Asia, Africa, LatAm – and the

picture while certainly not rosy has some more underlying supports.

The risks

Upside risks to our forecast stem from a softer landing in Asia rather than core and northern

eurozone growth remaining very robust through next year. However, the risks of further central

Fig. 1: Growth comparisons

-8

-6

-4

-2

0

2

4

6

8

10

GDP growth for Strong countries

GDP growth for Weak countries

% y-o-y

Nomura forecasts

Source: Nomura, Bloomberg. Note: „Strong‟ countries include Russia, Poland and Turkey. „Weak‟ countries include Czech Republic, Hungary, Romania and South Africa.

Fig. 2: Inflation performance

2

3

4

5

6

7

8

9

10

1 3 5 7 9 11 13 15 17 19 21 23

2008/2009 Headline

2008/2009 Core

Oct 2010 to present Headline CPIOct 2010 to present Core CPI

%, y-o-y

Months into period

Source: Nomura, Bloomberg. Note: GDP-weighted country sample for Czech, Hungary, Poland, Romania, Russia, Turkey and South Africa.





43

bank printing are probably one of the most complex areas of contention on risk because they

can sweep all manner of ills under the carpet in EEMEA, yet at the same time do little to

provoke structural reforms.

To the downside the most severe risk is probably an untimely, early end to central bank printing

perhaps on global inflation picking up. Equally, core eurozone growth surprising to the downside

could drag some of the less affected consumption-related exports in the region lower at a faster

pace. Banking contagion from a more meaningful shock from the eurozone is still there, but as

difficult to quantify as ever, and we have written significantly on that risk and the use of

backstops and exchange controls to offset in the past.

The good

While these factors apply across the region there is one group of countries that they apply

specifically to – Russia, Turkey and Poland. This strong group has seen more orthodox policy of

late, has strong fiscal balance sheets and good funding, and more closed economies than the

rest of the region. Turkey has recently been upgraded and Poland should follow suit next year.

All three have more solid domestic demand.

Interestingly, deleveraging in Turkey and Poland has, gross, been the highest in the region, but

because liquid banking asset markets and deleveraging by eurozone banks have been too

eager sellers wanting to expand in the region and provide credit, the impact on the economies

has been minimal if any.

Here are some specifics in each case:

Turkey: Turkey‟s rebalancing is likely to continue, but at a lower pace. We have a reasonably

confident view on Turkey‟s recovery from the current soft patch driven by investments. Net

exports are unlikely to deteriorate very sharply similar to previous recoveries. Export market

share differentiation, thanks to a sharp rise in Middle East exports, helps external balances to

improve even further. Monetary policy has taken a dovish turn especially after Turkey‟s rating

upgrade as the TCMB does not want TRY to have a disorderly appreciation. We do not believe

inflation priorities are thrown out of the window completely and expect to see a “hike in disguise”

if we are right about the recovery in the activity. Fiscal policy appears very tight on a cyclically

adjusted perspective and the government is trying to put debt-to-GDP sub-30% of GDP –

helping crowding in private investments.

Fig. 3: Strong vs weak in retail sales and IP

-15

-10

-5

0

5

10

15

Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12

Strong countries Retail salesWeak countries Retail salesStrong countries IPWeak countries IP

%, y-o-y

Source: Nomura, Bloomberg. Note: „Strong‟ countries include Russia, Poland and Turkey. „Weak‟ countries include Czech, Hungary, Romania and South Africa.

Fig. 4: Strong vs weak in exports

-35

-25

-15

-5

5

15

25

35

45

Jan-06 Mar-07 May-08 Jul-09 Sep-10 Nov-11

Strong countries Exports growthWeak countries Exports growth

%, y-o-y

Source: Nomura, Bloomberg. Note: „Strong‟ countries include Russia, Poland and Turkey. „Weak‟ countries include Czech, Hungary, Romania and South Africa.

Russia: Russia has gone through its deleveraging much earlier than other countries and hence

balance sheets are at a healthier point, as well as domestic demand. The economy is still very

leveraged with oil and oil prices (higher than 2008 probably), but that may not be a bad thing for

2013. Economic growth should remain above 3.5% and inflation pressures should result in the

Central Bank of Russia “acting” more like an inflation targeter than countries formally

implementing an inflation-targeting framework.

Poland: We are actually quite optimistic on growth for next year vs the central bank (we

forecast 2.0%, the NBP is projecting 1.5%), though we see a minimal risk of a recession. Poland


44

has exhibited a significant capacity to prefund itself, combined with probably the most orthodox

monetary policy in the region. That said, growth should slow sharply vs potential to around 4.0%

(long run) thanks to slowing public sector infrastructure spending at the end of the current EU

funding window, combined with a stagnant labour market.

In 2012 consumption has been helped by declining savings, but the boon from that in 2013

should become less readily available. We, however, see continuing acceptable real credit

growth and low inflation helping real incomes, while the important re-export cycle to Asia

remains key. The test of the conservative nature of the MPC comes of course in how much it

cuts rates, but with a desire to keep real deposit rates positive and the likely MPC view of long-

run inflation being higher than the NBP economists expect we see only a limited cycle. That

should continue to support Poland‟s credibility.

While fiscal consolidation has slowed in response to slower growth, off-balance-sheet measures

add significant upside risks to our forecast for growth, even if they cannot be totally factored in

at this stage. Poland‟s strength however means that large foreigner holdings of onshore

treasury debt have been built up, which is a risk albeit not unique to it. That said, Poland,

perhaps, is at higher risk of undershooting expectations because of the high base it starts from.

The “OK”

We would place Israel and Czech Republic in the category of countries that have decent

fundamentals, but monetary policy has shifted in each to be less inflation-targeting and more

currency or global growth targeting.

Czech: We expect the further slump in the eurozone next year and possibly a further crunch in

the eurozone banking system flowing over into the Czech Republic to reinforce the deflationary

(core inflation) dynamic there, and hence for the CNB to be ready to undertake some form of

currency intervention. We think that will be a soft-floor type arrangement with 25.0 or 25.5 in

EURCZK as its base. The CNB has started to abandon its traditional mantra of conservative no-

touch policy on the currency because of the internal view that rates will need to be negative, in

effect, to stimulate the economy sufficiently. Thus, because of the impossibility of this, FX policy

is the other way to ease monetary conditions. The Czech Republic is also an interesting

example, and probably the most dramatic, where the external slowdown has not matched the

domestic slowdown and hence net trade remains supportive.

In this category we would also include the highly exposed but still structurally sound Baltic

economies that had done their homework during the 2008-09 crisis, but nevertheless will suffer

again with austerity maintained. The fruits of an export and labour-intensive FDI boom in the

past few years however should start to pay off from next year to a greater degree and with it act

to support growth.

Israel: Israel has a modestly deteriorating current account and an economy that is reasonably

highly correlated with global activity. An activist monetary policy and fiscal policy have never

resulted in the Israeli economy falling into a recession, but in the face of weak global growth –

monetary policy gets very dovish.

The “less good”

The final group of countries has a mixture of susceptibility to the eurozone crisis and global

slowdown, but amplified by domestic political, policy and structural deficiencies. This means

fiscal consolidation momentum is all the more important to successfully navigate often very

narrow funding tightropes through next year. The Balkans, Hungary and South Africa fall into

this bucket. Growth is less important in these cases, while monetary policy has taken a turn to

the more unorthodox – in the case of Romania, Serbia and Hungary through politicisation and

potential further easing measures, and in the case of South Africa more mundanely a shift to

even lower real rates.

Fiscal policy in each case has significant political risks both in the immediate future and more

over the medium run. In the case of SEE, the reversal of existing (and in our view very

necessary structural reforms), while in Hungary it is more about the unorthodoxy of fiscal policy

as the 2014 elections are approached. South Africa has a lethal mix of the breakdown of trust in

politics and the unions, combined with the ANC‟s elective conference next month. All these

combine with medium-run risks that the ANC tries to solve the countries socio-economic


45

problems through a continual shifting forward of required fiscal consolidation but not a blow up

in the budget.

Potential growth remains very low and is probably falling in both countries. In Hungary we

estimate potential growth (over medium run) to now be around 1.0% vs 4.0% before 2007, and

in South Africa to be around 3.50% currently vs 3.85-4.00% pre crisis. In both cases we think

this means the risk of further downgrades.

There are some specifics to highlight here:

Hungary: The story here shows a marked disconnect between market pricing and reality, but

we find it hard to see how the shocks that might change this any time soon. Of course external

shocks like Spain or US fiscal cliff could be one source, but the additional global liquidity that

would lead to that would make the shock filtering through to Hungry only temporary.

Domestically fiscal underperformance through next year combined with a new Governor of the

MNB and an attempt to issue FX debt before an IMF plan is in place could all be sufficient a

shock to provoke market reassessment. We are very concerned that a new Governor and

widely replaced management of the MNB will combine with the government‟s attempts to

increase its role in the banking sector through state-owned banks and unorthodox policy; a

carefree attitude toward inflation (with the level of the currency and the volume of loan growth

proving more important); and postmodern policy measures, will all lead to eventual instability in

the currency. Like Poland the risks of a self-sustaining crisis from large foreign holdings of

onshore debt are significant. Further downgrades could play a role here as well.

Overall, though, the backstop of an IMF is not and is unlikely to be present until a severe market

blowup provokes a change in the government‟s mindset and it accepts IMF conditionality.

South Africa: While current policy in South Africa is pretty orthodox, the risks are mounting on

the fiscal side in particular. Furthermore, the political risks of an ANC in the throes of a

leadership election, where payoffs to get votes and attempts to solve recent labour market

unrest are dealt with through extra spending should also exert pressure. Equally, with rates

falling lower and a current account totally financed by credit and portfolio flows, the moves lower

in real rates is starting to look unorthodox for the normally conservative SARB. With a record

level of bond inflows by foreigners there is, therefore, a small window of credibility and funding

to maintain stability through next year. Hence, fiscal rectitude is required. As ever we don‟t see

South Africa „blowing up‟. Instead, we expect the market to probably start to realise that the

status quo of a President Zuma maintaining control of the ANC will be the problem. Therefore,

with an unchanged policy or even a new policy further damaging competitiveness we will see

potential growth remaining at a record low. All this should lead to additional downgrades.


46


Hungary | Economic Outlook

Fun and games continue

We see the government's tough approach continuing in 2013; however, a new

financial transaction tax and new Governor of the MNB add different risks for markets.

Policy, fiscal and funding: The government has continued to be able to fund itself domestically

because of excess liquidity and a lack of lending by banks, combined with inflows by foreigners

still seeing attractive carry. On external debt, a mixture of derivatives and cash management,

combined with swapping out domestic issuance and drawing down deposits have meant that

funding has been fine and can continue to be as such through February of 2013 - after which

MNB funding can bridge the gap. We think these factors and the fall in local and external yields

mean that an IMF/EU backstop deal is not necessary at the moment. The IMF equally is

unwilling to countenance further negotiations because the government is unwilling to

compromise and unwilling to negotiate in good faith. Hence talks have all but collapsed. We

think the government will only return to the table if there is a blow up in market risk premia. That

could happen in early Q1 because the FX funding situation is far from certain. We think the

government will eventually get impatient and therefore issue FX debt anyway next year. We are

concerned about the sustainability of the current government programme into the 2014

elections, so we do not see any IMF/EU backstop lasting beyond the end of 2013. Fiscal policy

remains controlled, but if only by repeated austerity packages, in part to reduce funding

requirements and remove the threat of EDP sanctions. However, we see poor sustainability of

such low deficit levels in the medium run.

Rates and inflation: We expect headline inflation to remain outside target until the middle of

2014 on a mixture of tax pass-through and pressure from wages and policy. That said,

underlying core ex tax VAT inflation should remain around the bottom edge of the target until it

starts slowly rising in the middle of next year. This means that the external members of the MPC

can continue cutting rates step-by-step as long as the currency and broad risk premia are under

control. While we pencil the MPC stopping at 5.00%, in reality if it could get away with it the

MPC could well go lower still. More important than this however is a new Governor of the MNB

in March and two new Deputy Governors in July. We think these would be political

appointments that would attempt to fulfil FIDESZ's 2010 election manifesto and provide MNB

funding for banks, corporates and the development banks via a form of QE or more general

postmoderism. This may include giving the government greater access to FX reserves.

Growth: We forecast growth in 2013 of only barely above zero (0.1% in our forecast), meaning

the economy will be showing no recovery for its second dip into recession next year. Our key

concern is potential growth declining over the past four years from 4.0% before the crisis, first to

2.5% by 2010, then 1.75% by this year, but perhaps as low as 1.0% by 2014 thanks to the

government's latest austerity packages.

Figure 1. Details of the forecast Figure 2. Headline and core ex-VAT CPI.

2011 2012 2013 2014

Real GDP % y-o-y 1.7 -1.1 0.1 0.8

Nominal GDP USD bn 140.2 160.8 150.4 159.6

Current account % GDP 1.4 2.5 1.5 1.0

Fiscal balance % GDP -6.2 -4.2 -3.1 -2.6

Structural balance -5.0 -6.5 -5.7 -4.0

CPI % y-o-y * 4.1 6.1 4.8 4.0

CPI % y-o-y ** 3.9 5.9 5.0 4.3

Core CPI ex VAT % y-o-y ** 2.6 2.0 2.3 3.0

Unemployment rate % 10.7 10.5 10.4 10.2

Reserves EUR bn *** 35.1 31.3 28.1 25.0

External debt % GDP*** 138.9 131.6 130.6 132.6

Public debt % GDP 82.8 79.5 80.0 79.0

MNB policy rate %* 7.00 5.75 5.00 6.00

EURHUF* 315 280 295 280

*End of period, **Period average, Bold is actual data

***Includes IMF/EU funds

1.5

2.5

3.5

4.5

5.5

6.5

Jan-2011 Nov-2011 Sep-2012 Jul-2013 May-2014

Constant tax core

Headline

% y-o-y

Notes: * End of period. ** Period average. Bold is actual data. *** Includes IMF/EU funds. Source: Nomura Global Economics



47


Poland | Economic Outlook

NBP in a limited cutting cycle - growth still outperforming

Although growth will probably be lower next year, the economy will likely avoid

recession, meaning the scope for rate cutting is still limited.

Growth: Although Poland will likely remain the strongest country in the region, growth will still

probably be lower in 2013 at 2.3% vs 2.4% this year because of a confluence of factors. First,

the slowing pace of eurozone structural fund investments will likely combine with domestic fiscal

consolidation to drag growth down by some 0.6pp in our view. Consumption should also slow,

particularly in H1 thanks to slightly lower credit growth and a stagnant labour market feeding

through as the ability to draw down net savings reduces. Slowing credit should also be felt in

private sector investments though to a lesser degree. However, the sentiment shock in the local

economy and its effects on imports and inventories have actually been larger than the export

shock. Upside risks to growth from the government's off-balance-sheet investment programme

however are meaningful and could add up to 0.5pp to growth to next year. Downside risks

emanate from the eurozone and on the trade side, particularly from Asia. We see a rapid

bounce back in 2014 growth to 3.7% owing to strong fundamentals and underlying balance

sheets of households and corporates, banks that are not feeling the effects of deleveraging

because of their profitability, combined with Shale gas coming on-stream, and potentially even

larger effects from the investment programme.

Currency: We expect USD/PLN to move lower due to the following factors: an orthodox central

bank can easily stop its cutting cycle and even hike if animal spirits return, and because the

central bank is unlikely to get concerned about currency strength anytime soon.

Rates and inflation: We see inflation moving swiftly lower to within target by the end of this

year and then further down into the middle of 2014 to spend a brief period below the centre

band of the target. All in all the stickiness of the CPI in the last few years should pass and allow

this recently begun NBP MPC cutting cycle to continue. However, over the medium run as

growth is likely to recover from H2 2013 we see inflation rising to settle just below the top of

target through much of 2014. This outlook, combined with the government‟s off-balance-sheet

fiscal stimulus and the cautious nature of the median of the MPC means we only see a handful

of cuts in H1 2013 - currently only 50bp in our forecast, but we see more than 75bp as unlikely.

Fiscal and politics: Prime Minister Tusk has announced ambitious budgetary and structural

reforms for the four years of this parliament – sufficient to achieve an upgrade next year. These

reforms should bring the deficit to less than 3.0% of GDP in 2013, though not as targeted in

2012 because of lower growth. Growth matters the most. Aggressive pre-funding however

means credit risks remain low.

Figure 1. Details of the forecast Figure 2. Inflation outlook

2011 2012 2013 2014

Real GDP % y-o-y 4.3 2.4 2.0 3.5




CPI % y-o-y * 4.6 3.0 2.3 3.2

CPI % y-o-y ** 4.3 3.8 2.4 3.0


Population mn 38.2 38.5 38.4 38.3


Reserves EUR bn ** 74.3 82.5 85.0 90.0

External debt % GDP 62.7 53.2 48.2 45.9

Public debt % GDP 53.5 52.8 52.2 51.6

NBP policy rate %* 4.50 4.50 4.00 5.00

EURPLN* 4.47 4.10 3.90 3.75

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

5.5

6.0

Jan-2008 Jun-2009 Nov-2010 Apr-2012 Sep-2013

Headline Expectations Core% y-o-y

Notes: *End of period, **Period average, bold are actual data. Source: Nomura Global Economics



48


South Africa | Economic Outlook

Status quo means the brakes are still applied

Although we expect President Zuma to be re-elected, the implications are for further

downgrades, heightened fiscal risks and a lack of real reform.

Growth: We see a very sluggish recovery in growth from 2.4% this year to only 2.6% in 2014

and then not even reaching potential growth with only 3.6% in 2014. Negative pressures are

strong from Q3 of this year through to the middle of 2013 from production lost in the mining

sector and second-round effects into up and downstream industries and consumption. We

believe broader underlying consumption can be maintained to some extent because of credit

growth and large real wage rises; however, the negative drag from a widening trade deficit will

likely offset that. Risks are slightly to the upside if there is a softer landing in the eurozone.

Fiscal policy should be broadly neutral, while the capacity of public sector investments to add

much to growth beyond what it is already doing is limited by funding constraints.

Currency, inflation and rates: With the current account deficit set to remain over 6% of GDP

until mid-2013, while funding remains okay despite the global backdrop, but not great because

of domestic risk factors, the currency should remain weak overall and above 8.0 in USDZAR.

The SARB has also been surprisingly open about both the fact it sees fair value around 8.50-

8.75 (something we think it would have disliked doing in the past) and that it will not intervene

on politically-led risk premia shocks - this all reaffirms the fact the currency may remain weak.

The new inflation index coming from the January print (out February) should shift inflation up by

about 0.3pp to start with. However, the underlying inflation dynamic is looking a little less bullish

for 2013 thanks to currency pass-through and larger real wage increases, and it could breach

target briefly mid-year before breaching more sustainably through the end of the year. However,

we think the SARB forecast can be more anchored in target and combined with a growth-centric

response to the labour unrest and weak underlying growth, there could be another rate cut in

January. That said, the inflation dynamic makes that cut still far from certain.

Politics and fiscal: There is currently a structural breakdown in the traditional societal

structures around labour, and strike action is occurring because of the linkages between union

leadership, the ANC and BEE funds. Although there has been some let up more recently in the

level of strike action, we see it re-emerging in the next wage round that starts more widely in the

economy around Easter time. The outcome of that, however, may simply be centralised

minimum wages and large increases for workers, which harms competitiveness. The battle for

the ANC leadership is likely to be a key driver of policy direction – but we expect re-election for

President Zuma because of a mixture of policy payoffs he has given to the unions in particular

and also the lack of aggression in campaigning that Deputy President Motlanthe has made. The

outcome of this however is a still ineffectual and deleterious policy that holds back potential

growth. The budget outlook still looks very much skewed to the downside and the funding

window will likely remain tight. There really is very limited room for error.

Figure 1. Details of the forecast Figure 2. Inflation outlook

2011 2012 2013 2014

Real GDP % y-o-y 3.1 2.4 2.6 3.2


PSCE % y-o-y* 6.2 7.8 9.5 10.2


FX reserves, gross USD bn* 48.9 50.0 50.2 50.3

CPI % y-o-y * 6.1 5.5 5.5 6.1

CPI % y-o-y ** 5.0 5.6 5.5 5.7

Manufacturing output % y-o-y 2.4 1.6 2.0 6.8

Retail sales output % y-o-y 5.7 4.3 1.8 3.5

SARB policy rate %* 5.50 5.00 4.50 6.00

EURZAR* 10.5 11.4 9.8 10.4

USDZAR* 8.09 8.90 8.50 9.00

3.5

4.0

4.5

5.0

5.5

6.0

6.5

7.0

Jan-11 Aug-11 Mar-12 Oct-12 May-13 Dec-13 Jul-14

Headline - old

Headline - new

% y-o-y

Notes: PSCE – Private sector credit extensions. * End of period. ** Period average. Bold is actual data. Source: Nomura Global Economics

Source: Nomura Global Economics



49


Turkey | Economic Outlook

A healthy rebalancing

A tightening policy helped the rebalancing of the economy. We expect the rebalancing

to lose its 2012 momentum, but the economy looks very healthy for 2013.

Activity: GDP growth looks likely to accelerate to 4.5% in 2013 after 3% growth in 2012. The

risks are to the upside, in our view. Private investment should remain strong while private

consumption recovers. We do not expect net exports to flip into negative territory similar to the

previous episodes of global recovery.

Inflation: Turkey‟s inflation deteriorated at the expense of a strong fiscal stance in 2012. So far

it has been largely driven by factors beyond the TCMB‟s control, but it looks like the market‟s

working number for the next six months is now around 7.5% with some upside risks. An

improvement in the growth backdrop could lead to deterioration in inflation expectations.

Policy: With our framework of a growth rebound in Q4 2012 and Q1 2013, we expect the TCMB

to implement some temporary “hikes in disguise” largely for expectations management

purposes when data improve further (possibly early 2013). We think the daily repo rate could

move up to the 6-6.5% area in December or early Q1 2013. Our base case sees the TCMB

narrowing the interest rate corridor. We are referring to the daily repo rate in these forecasts

rather than the 1-week benchmark repo rate (we kept the policy rate constant in the forecast

horizon given the TCMB‟s comfort with the current policy setting). In a situation of very sharp

EM inflows and strong TRY appreciation, the TCMB signaled it can lower the benchmark repo

rate and bottom of the interest rate corridor as well.

Fiscal policy: Since H2 2011 fiscal policy has helped the monetary authorities, as the

government has used revenue outperformance as a cushion. The recently unveiled Medium

Term Programme (MTP) for 2013-15 implies that the tight fiscal stance will continue and it looks

like the government intends to avoid running an “election budget” or any form of “election

spending”. While primary surplus estimates are not as ambitious as in the past six or seven

years, we still expect the debt-to-GDP ratio to fall towards the low-30% levels.

Rating outlook: Turkey is now rated investment grade by Fitch, and we expect it to receive an

investment grade rating in 2013 from other rating agencies as well. We think rebalancing and

structural reforms are moving in the right direction.

Risks: Terms-of-trade shocks (higher oil prices) and sudden stops of capital inflows are the

main risks. In that scenario, inflation could rise again with unwarranted currency weakness

resulting in a sharp fall in consumer confidence. However, this is not our base case. We think

the risks of capital controls being implemented, on any rapid appreciation, are extremely low.

With EM inflows accelerating in 2012, the likelihood of sudden stops has declined. Tight lending

conditions are still weighing on credit demand.


2011 2012 2013 2014

Real GDP % y-o-y 8.5 3.0 4.5 5.5

Contributions to GDP by selected items

Private consumption 5.5 1.3 2.5 2.4

Private investments 4.7 -0.5 2.1 2.1

Net exports -1.7 2.0 1.0 0.2

CPI % y-o-y * 10.5 7.5 6.5 5.0

CPI % y-o-y ** 6.5 9.1 6.7 6.3


Primary balance % GDP 1.6 0.6 1.0 1.2

Public debt % GDP 42.4 37.0 36.0 35.0


TCMB policy rate %* 5.75 5.75 5.75 5.75

USDTRY* 1.89 1.80 1.70 1.75 Notes:* End of period. ** Period average. Bold is actual data. Source: Nomura Global

Economics

Fig. 2: Fiscal policy very tight

2009

2010

2011

20122013

35

40

45

50

1 1.1 1.2 1.3 1.4 1.5 1.6 1.7 1.8

Cyc. adj. primary balance (% GDP)

Gross debt (%GDP)

Source: Nomura Global Economics, IMF.



50



Rest of EEMEA | Economic Outlook

Czech Republic: Postmodernism, here we come

Whilst a technical recession may well linger through till Q2, until there is a return of

sentiment domestic growth will continue to under-perform even export growth.

2011 2012 2013 2014

Real GDP % y-o-y 1.7 -0.9 0.7 1.4




CPI % y-o-y * 2.4 2.5 1.7 1.5

CPI % y-o-y ** 1.9 3.3 2.1 1.5


Population mn 10.5 10.4 10.4 10.3


Reserves EUR bn ** 31.1 31.5 32.0 32.5


Public debt % GDP 43.8 45.2 47.0 46.6

CNB policy rate %* 0.75 0.05 0.05 1.00

EURCZK* 25.59 25.00 25.50 25.00

*End of period, **Period average, Bold is actual data

Growth should start to recover from Q2, led principally by consumption given a still healthy labour market and then slowly through to domestic investments. The external shock to the economy has so far been surprisingly muted and so it is more the oscillations of imports on net trade that have been the issue. Fiscal drag will still be an issue shaving some 0.2pp from GDP. Much of the shock, however, is sentiment driven.

An increasingly fractious and unstable coalition will mean any stronger fiscal action or structural reforms are unlikely. However, with steady access to domestic funding and low debt, it is questionable how much additional fiscal consolidation is needed for the medium-run path to remain credible.

Overall we expect a largely lame duck government to keep things ticking over but its ability to survive through to the 2014 election remains very much in doubt.

Underlying CPI should stay soft till the middle of H2 when it should start to normalise though headline CPI should fall back through next year. The risks to both growth and CPI in the next six months as well as the fact that interest rates are at the lower bound means that if enough of an external shock is delivered from the Eurozone we can see the CNB institute postmodern measures via some form of currency floor around 25.0-25.5.

Source: CSO, CNB, Nomura Global Economics

Romania: Markets should concentrate on fiscal not politics

Twin deficits leave little room for supporting growth in a challenging external demand environment with domestic political and constitutional uncertainties not helping.

2011 2012 2013 2014

Real GDP % y-o-y 2.5 0.2 0.8 1.8



CPI % y-o-y * 3.1 6.4 4.1 3.8

CPI % y-o-y ** 5.8 3.8 5.0 4.2


Public debt % GDP 38.6 39.3 39.5 38.2

BNR policy rate %* 6.00 5.00 6.00 9.00

EURRON* 4.33 4.55 4.60 4.45

*End of period; **Period average; Bold is actual data

Markets are becoming concerned with the confluence of negative factors in Romania, such as the downgrade of the rating outlook to negative by Moody‟s, IMF concerns over the elections in December moving them off-programme and fire sales of assets to support increased public sector wages.

Romania is vulnerable to deleveraging forces, which could pose a serious risk to the balance of payments. While the BNR has a contingency plan that may involve capital controls, tapping of the precautionary SBA with the IMF may be necessary if the situation deteriorates.

Rate hikes are becoming increasingly probable, reversing the recent 100bp of cuts, potentially taking rates up to 7.00% on a marked currency sell-off.

There are questions whether the new Victor Ponta-led coalition will stick to the IMF-backed austerity programme, which would likely see the party lose the next election.

Source: Ministry of statistics, Nomura Global Economics

Israel: Slower exports, slower growth, but no recession

An increasingly weak currency and looser monetary policy should help Israel.

2011 2012 2013 2014

Real GDP % y-o-y 4.8 2.8 3.0 3.5

CPI % y-o-y * 2.2 3.4 2.5 2.5

CPI % y-o-y ** 3.5 2.1 2.6 2.7


Current account % GDP 0.3 -0.3 -1.0 -1.0

Policy rate %* 2.75 2.00 2.50 3.00

USDILS* 3.81 3.80 3.60 3.70

Israel‟s export-driven economy outperformed the region in the post-crisis environment thanks to an aggressive monetary policy response resulting in healthy domestic demand. The economy is currently slowing in line with the global backdrop.

Inflationary pressures appear to have subsided and inflation expectations are well anchored. This year‟s electricity price hikes, however, may limit the extent of policy easing. With the policy rate at 2.00%, we see no further cuts unless the global economy deteriorates further.

Underlying final demand should not weaken greatly and the recovery in 2013 should result in measured rate hikes (50bp to 2.50% by year end).

Source: BOI, Nomura Global Economics




51

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Global Economics

Economists

Global-Economics Research

Lewis Alexander US Chief Economist [email protected] +1 212 667 9665

Olgay Buyukkayali Head of EM Strategy, EMEA [email protected] +44 (0) 20 710 23242

Tony Volpon Head of Emerging Markets

Research - Americas [email protected] +1 212 667 2182

Peter Attard Montalto Economist [email protected] +44 (0) 20 710 28440

Benito Berber Senior Latin America

Strategist [email protected] +1 212 667 9503

Boris Segura Senior Latin America

Strategist [email protected] +1 212 667 1375

North America-Economics Research

Aichi Amemiya US Economist [email protected] +1 212 667 9347

Roiana Reid Economist [email protected] +1 212 298 4221

Charles St-Arnaud G10 FX Research [email protected] +1 212 667 1986

Ellen Zentner Senior US Economist [email protected] +1 212 667 9668

EMEA-Economics Research

Desmond Supple Global Head of Fixed

Income Research [email protected] +44 (0) 20 710 22125

Jacques Cailloux Chief European Economist [email protected] +44 (0) 20 710 22734

Nick Matthews Senior Economist [email protected] +44 (0) 20 710 25126

Silvio Peruzzo Senior Economist [email protected] +44 (0) 20 710 23205

Dimitris Drakopoulos Economist [email protected] +44 20 710 25846

Lefteris Farmakis Economist [email protected] +44 (0) 20 710 39242

Takuma Ikeda Senior Economist [email protected] +1 212 667 1153

Philip Rush Economist [email protected] +44 20 7102 9595

Stella Wang Economist [email protected] +44 (0) 20 710 20599

Japan-Economics Research

Tomo Kinoshita Chief Japan Economist [email protected] +81 3 6703 1280

Mika Ikeda Economist [email protected] +81 3 6703 1287

Shuichi Obata Senior Economist [email protected] +81 3 6703 1295

Kohei Okazaki Economist [email protected] +81 3 6703 1291

Asuka Tsuchida Economist [email protected] +81 3 6703 1297

Asia Ex-Japan-Economics Research

Rob Subbaraman Chief Economist Asia [email protected] +852 2536 7435

Young Sun Kwon Hong Kong, South Korea

and Taiwan Economist [email protected] +852 2536 7430

Euben Paracuelles Southeast Asia Economist [email protected] +65 6433 6956

Sonal Varma India Economist [email protected] +91 22 403 74087

Zhiwei Zhang China Economist [email protected] +852 2536 7433






























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Nomura - Global Annual Economic Outlook