€¦ · Table of contents Global overview Fragile West, resilient East ................................................ p.5 Strategy Strategy overview: Let’s try this again

Global Focus – 2012

Fragile West, resilient East

| Global Research |

All rights reserved. Standard Chartered Bank 2011Standard Chartered ranked world’s No. 1 firm for economic forecasting – Bloomberg Markets magazine, January 2012

Table of contents

Global overview

Fragile West, resilient East ................................................ p.5

Strategy

Strategy overview: Let’s try this again ........................... p.10

Commodities: A glass half full ........................................ p.12

Credit: Bracing for a rocky start ....................................... p.15

Equities: EM to outperform DM ....................................... p.18

FX: Déjà vu all over again – 2009 versus 2012 ............... p.21

Rates: EM rates to outperform in 2012 ............................ p.24

Sovereign risk: More downgrades to come .................... p.27

Economies

MAJORS

Australia: Beyond the mining boom ................................ p.31

Canada: Fiscally responsible, firm growth ....................... p.32

Euro area: EMU strains to dominate amid recession ...... p.33

Japan: Rocky road to recovery ........................................ p.35

New Zealand: Rebuilding growth, bricks-and-mortar style .. p.36

United Kingdom: High recession risks ........................... p.37

United States: Economic wounds continue to heal ........ .p.38

ASIA

Asia: A test of resilience, once more ............................... p.42

Bangladesh: Still resilient, but strains are emerging ....... p.44

China: Getting used to 8% .............................................. p.46

Hong Kong: Domestic resilience shines through ............ p.48

India: High time to act!..................................................... p.50

Indonesia: Not immune to the global slowdown .............. p.52

Malaysia: Resting on commodities .................................. p.54

Pakistan: Gearing up for elections .................................. p.56

Philippines: Another test of resilience ............................ p.58

Singapore: Mitigating volatility ........................................ p.59

South Korea: Domestic demand to the rescue ............... p.61

Sri Lanka: Inching ahead with caution ............................ p.63

Taiwan: Struggling with rising uncertainty ....................... p.64

Thailand: Post-flood recovery ......................................... p.66

Vietnam: Keep doing the right thing ................................ p.68

SUB-SAHARAN AFRICA

Africa: More cautious approach to liberalisation ............. p.71

Angola: Restarting the growth engine ............................. p.73

Botswana: A new global diamond hub ............................ p.74

Cameroon: Growth to pick up despite risks ..................... p.75

Côte d’Ivoire: Towards economic normalisation ............. p.76

Gambia: Fiscal concerns remain ..................................... p.77

Ghana: First election as an oil producer .......................... p.78

Kenya: A key election year .............................................. p.80

Mozambique: Unstoppable ............................................. p.82

Nigeria: The USD 250bn question ................................... p.83

Senegal: Staying the course in an uncertain year ........... p.85

Sierra Leone: Iron ore drives export transformation ........ p.86

South Africa: Still-slow growth ........................................ p.87

Tanzania: Cautious pace of liberalisation ........................ p.89

Uganda: Oil one day ........................................................ p.90

Zambia: Resource nationalism, revisited ......................... p.91

MIDDLE EAST and NORTH AFRICA

MENA: Local differentiators ............................................. p.94

Algeria: Output erosion ................................................... p.96

Bahrain: Saved by oil ...................................................... p.97

Egypt: Managing change and expectations ..................... p.98

Jordan: Looking towards the GCC ................................ p.100

Kuwait: Oil in a day’s work ............................................ p.101

Lebanon: Growth to return in 2012 ................................ p.102

Morocco: Economic resilience and a reform agenda .... p.103

Oman: Bucking the global trend .................................... p.104

Qatar: Lower growth, better growth ............................... p.106

Saudi Arabia: The spending story continues ................ p.108

Tunisia: Looking ahead ................................................. p.110

UAE: Sustaining healthy growth .................................... p.111

LATIN AMERICA

Argentina: More Kirchnerismo ...................................... p.115

Brazil: COPOM banking on lower inflation .................... p.116

Chile: Central bank is ready to act ................................. p.118

Colombia: Reforms, FTA underpin strong outlook ........ p.119

Mexico: Banxico is on hold ............................................ p.120

Peru: More Lula than Chavez, so far ............................. p.121

Forecast snapshots

Forecasts .................................................................... p.123

World Wide Wrap ...................................................... p.127

Global overview

Global Focus – 2012 – The Year Ahead

12 December 2011 4

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Global overview Gerard Lyons, +44 20 7885 6988

[email protected]

12 December 2011 5

Fragile West, resilient East

This global overview focuses on three areas: first, a review

of the world economy; second, the key issues facing

emerging economies; and third, prospects for the developed

countries.

1. Overview

Overall, current developments in the world economy are

consistent with those that we have talked about for some

time. There is every likelihood that this will remain the case

in the year ahead. The world economy is already in the early

stages of a shift in the balance of economic and financial

power from the West to the East. It has also started to

witness a shift in the policy-making environment from the G7

to the G20. However, a shift in the balance of military power

is still some years away. It is vital to keep all this in mind

when viewing prospects for the year ahead.

Given all this, one message might be, do not be surprised by

anything, and do not underestimate anything. This

uncertainty may contribute to volatility and risk aversion early

in 2012 before the markets return their focus to the growth

agenda, driven by recovery across the emerging world.

The outcome for any economy depends on the interaction

between the fundamentals, policy and confidence. In the

West, the fundamentals are poor, the policy cupboard is

almost empty and confidence has been shot to pieces. In

contrast, across the emerging world, the fundamentals are

good, the policy cupboard is almost full and confidence is

likely to prove resilient.

This will be reflected in differences across both countries and

regions in 2012. Each country and region needs to be looked

at on its own merits. Since the financial crisis began, the

world has continued to be hit by shocks, as well as by the

consequences of the debt overhang in the West. One of the

challenges in 2012 is that the policy environment in the West

is in danger of being pro-cyclical, both in the regulatory

response across many countries and in the fiscal response

in Europe. In contrast, the positive news across emerging

economies is the willingness and the ability to use policy in a

counter-cyclical way to boost growth in the year ahead. At a

regional level, this points to sluggish growth in the US,

growth rates across the emerging world that are slower than

in 2011 but still well above those in the West, and recession

in the UK and the euro area.

This points to the continuation in 2012 of a two-speed world

where a fragile West contrasts with a resilient East. 2012 is

also likely to highlight the fact that despite the world

economy becoming more divided, no region is fully

decoupled from events elsewhere. During the first half of

2012, problems in Europe and the West will weigh on global

growth. By the second half, stronger growth across China

and other emerging economies should pull up worldwide

activity. It will be a recovery made in the East and felt in the

West. If ever one needed evidence of a shift in the balance

of power, this is it.

In 2010 the world economy grew strongly, by around 4.3%,

helped by a sizeable, synchronised and successful policy

stimulus. Two factors boosted global growth in 2010. One

was the extent of the policy stimulus in the West; the other

was the strength of the emerging economies, which drove

two-thirds of the world‟s growth that year, despite accounting

for one-third of the global economy. Their share of global

growth has continued to rise, as highlighted in Chart 1. The

recent peak for the world economy was in the second

quarter of 2010, at growth of 5.3% per annum. Since then,

global growth has slowed.

A year ago, lest we forget, there was tremendous uncertainty

about the outlook, as there is now. Then, we predicted global

growth would be 2.9% in 2011. The outturn is likely to have

been 3.0%. The world economy cooled significantly in 2011.

Initially, this was as factors like inventory restocking that drove

growth in 2010 started to wear off, and as more countries

started to tighten policy. Higher oil prices as a result of the

„Arab Spring‟ and the impact of the Japanese earthquake on

Chart 1: The growing share of the emerging economies

Nominal GDP, USD trn

Sources: IMF, Standard Chartered Research

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Global overview (cont)

12 December 2011 6

supply chains were other significant shocks in the first half.

Since the summer, however, it has been events in Europe that

have dragged growth down. At that time, our warning was that

if there was to be a double-dip, it was likely to be triggered by

an external shock, a policy mistake, or a loss of confidence.

Europe provided all three, at the same time.

Overall, the last year provided a picture of a divided,

disconnected world economy facing significant policy

dilemmas. 2012 is expected to provide further examples of

this. The divisions are apparent in many ways: growth

prospects in the East far better than in the West, the core of

Europe far stronger than the periphery, and the balance

sheets of big firms in the West far better than the position of

smaller companies, many of which find it difficult to access

credit. The disconnect so apparent in the Arab Spring

remains, and is seen in terms of high rates of youth

unemployment. Then there are the policy dilemmas, not

least the need to ensure sustainable growth while

addressing longer-term structural problems.

Although we are very positive about longer-term global

prospects, we have a pessimistic view of global growth in

2012 – at 2.2%. In our view, a deep recession in Europe will

likely slow global growth significantly in the first half of the

year, before a rebound in the second half led by emerging

economies transforms prospects for 2013. We expect the

world economy to grow by 3.6% in 2013 and 3.8% in 2014.

The IMF expects growth of 3.2% in 2012, with stronger growth

thereafter.

2. Emerging economies

Despite the financial crisis, the world economy has continued

to grow. Only a decade ago, the global economy was only

USD 32trn, less than half its current size. Since the start of

the global financial crisis in autumn 2008, the world economy

has grown by 14%, reaching USD 70trn by the end of 2011.

Some of this post-crisis rise is explained by inflation, but the

bulk of it comes from strong growth across the emerging

world, led by China.

In 2012, there is a need to balance short-term uncertainties

against longer-term positives. These positives are highlighted

by significant, underlying structural factors. We highlighted

these underlying factors in „The Super-Cycle Report‟ at the

end of 2010. At that time, we were cautious about near-term

prospects in the West and felt it important to highlight some of

the underlying long-term drivers of the world economy. These

drivers will continue to be at work in 2012. They include the

growth of consumer markets across the emerging world as

the middle class expands, helped by rising incomes and

growing populations. Other drivers include perspiration and

inspiration; the latter involves emerging economies moving up

the value curve, with increased investment and higher

infrastructure spending. Funding this infrastructure boom

across the globe remains one of the underlying challenges

and opportunities, particularly across Asia, where high pools

of domestic savings need to be channelled into the USD 8trn

of infrastructure needed. Rapid urbanisation is also a feature

across many countries.

Another key feature has been the growth in new trade

corridors, reflecting increased flows of goods, commodities,

remittances, and portfolio and direct investment. Some

features will be both drivers and consequences of growth,

such as the rise of the middle class and development of

financial markets. To move from export-led to domestically

driven growth, many emerging regions need to create better

social safety nets, discourage high domestic savings, help

the small and medium-sized firms that are key to job

generation, and deepen and broaden their bond markets.

These underlying drivers, while positive, are not without

challenges. They include the middle-income trap,

environmental degradation and resource challenges, and

institutional and governance issues, especially corruption.

The latter will continue to test some economies in 2012,

including India. Despite this, we remain positive about India's

prospects, particularly if it addresses the issues of

deregulation and infrastructure needs and unlocks its huge

demographic dividend.

The countries that succeed in this new world order will be

those that have the cash, the commodities or the creativity.

Chart 2: Global trade

Total exports of goods and services, USD trn


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Global overview (cont)

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In Asia, growth rebounded strongly in 2010, to 9.1%. It is

likely to have been 7.3% in 2011, and we expect it will be

6.5% in 2012 and 7.5% in 2013. At some stage, there will be

a setback in China, as can be expected for any fast-growing

industrialising economy. The trend there is clearly up, but

there will be volatility along the way. We see China growing

8.1% in 2012 and 8.7% in 2013. We stick with our previous

view that China is likely to grow 6.9% over the next two

decades, a slower but sustainable pace of growth consistent

with its ageing population.

Emerging economies are not immune to events in the West.

Ahead of the 2007-08 crisis, we stressed that emerging

economies were not decoupled but were better insulated. So

it proved. Resilience is also likely to be seen now. That is,

any problems in the West will have a global impact – via

trade and financial linkages – but emerging economies will

have the ability to rebound. Furthermore, emerging

economies across Africa, Latin America and Asia are now

seeing stronger domestic demand.

In this report, we focus on all the key regions and major

economies, but as the world economy slows in the early part

of 2012, attention is likely to focus increasingly on China,

given its growing importance to the world economy.

Given the external headwinds, it would not be a surprise if

China slowed during the first quarter of 2012. Thereafter, the

economy should recover, helped by policy stimulus.

Whereas many countries around the world may experience

difficult political conditions in the coming years, China's

leadership change is expected to be smooth. Moreover, the

economic policy environment will be a continuation of that

seen before. Follow-through on China's 12th

Five Year Plan,

unveiled in March 2011, is likely to be an important feature.

The plan focused on boosting consumer spending, social

welfare and the green economy and highlighted seven key

strategic industries: new energy, energy conservation and

environmental protection, biotech, new materials, high-end

equipment manufacturing, new IT and clean energy vehicles.

We expect steady growth in Sub-Saharan Africa in 2012, up

from 4.8% to 5.3%. Despite this, it is a more challenging

environment for a number of countries, as we explain inside.

The recent trend of continued improvement in

macroeconomic factors can no longer be taken as a given.

That being said, it is important to stress that while

commodities have played an important role in Africa‟s recent

growth, so too has the strength of domestic demand. And

this should remain a positive in 2012, notwithstanding

worries about inflation prospects. We remain positive about

the region, given underlying structural changes.

The MENA region, too, faces a challenging time as North

Africa comes to terms with the aftermath of the Arab Spring

and war in Libya. Gulf countries, meanwhile, appear to be on

a better trajectory, helped by improving regional

fundamentals. Firm oil prices clearly help, although the

breakeven price of oil continues to rise. Commodities, too,

continue to drive improvement across parts of Latin America.

It is not rosy everywhere, and across the emerging world we

continue to focus on countries where economic imbalances

persist, particularly on the current account. Turkey, Pakistan

and Vietnam remain concerns. But overall, the story for

emerging economies is positive.

3. The West

The financial crisis highlighted the imbalanced nature of the

world economy. This still needs to be addressed. The savers

need to spend more. This includes the Gulf countries, China,

Japan and northern Europe. All are doing so apart from

northern Europe, which is contributing to problems in the

euro area. The debtors need to spend less. Currencies need

to adjust. One of the challenges for the world economy and

for the euro area in 2012 is the deflationary bias that is being

built into the system as pressure is put on deficit countries to

do most of the adjustment. The crisis also highlighted

systemic failure in parts of the financial system. This is taking

time to be addressed.

The overhang of debt and the pressure to deleverage will

continue to weigh on economies in the West. This will restrain

growth there. It will also add to pressure on central banks to

keep interest rates as low as possible for as long as possible

Chart 3: The world needs to rebalance

Current account balance, USD bn


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Global Focus – 2012 - The Year Ahead

Global overview (con’d)

12 December 2011 8

in the US, the UK, the euro area and Japan. Further

quantitative easing is possible. This may weigh on currencies

and in turn feed flows into emerging economies, where growth

and longer-term opportunities are better. However, with many

economies lacking the absorptive capacity to handle such

flows, one would expect to see eventual upward pressure on

asset and land prices. This will add to dilemmas for policy

makers across the emerging world, keeping alive the focus on

capital controls and the need for greater use of macro-

prudential measures. Monetary policy, after all, needs to be

set to suit domestic agendas.

Given high rates of unemployment, particularly youth

unemployment, there may be continued political uncertainty in

the West, louder calls for populist measures, and rising fears

of protectionism. We are not expecting trade barriers, but with

the multilateral trade round having broken down, we expect to

see further growth in bilateral and regional trade deals.

Commodity prices have softened, but in 2012 they may have

a firm floor and a soft ceiling. The firm floor is underlying

demand from China, India and elsewhere. The soft ceiling is

explained by possible supply disruptions.

Currency volatility may be a feature of 2012. The euro looks

overvalued given problems in the region, while many Asian

currencies look oversold. But if the euro were to collapse, the

initial beneficiary would likely be the US dollar. Another

important feature of 2011 was the growth of the offshore

CNY market. This is likely to continue in 2012.

A key focus in 2012 will be the euro. The euro cannot survive

in its present format. It will have to become a political union

to survive, but that is unlikely to happen immediately, despite

some recent moves in that direction. Given the fundamental

flaws at the heart of the euro, its collapse, and the possibility

of one or more countries leaving, cannot be ruled out.

There are many issues that still need to be resolved. Not

least is the inflation environment. The injection of huge

amounts of liquidity into the financial system has added to

worries about inflation. However, our projection is that

inflation will remain subdued. Global inflation is expected to

decelerate from 3.7% in 2011 to 2.9% over the next year.

We expect some modest acceleration in Africa and MENA,

but overall inflation pressures should remain subdued,

allowing scope for further policy easing by central banks, if

needed.

Finally, in this Outlook 2012 we have summarised the key

issues facing the world and have looked at them from a

global, regional and local perspective. The next section

provides a strategic overview, looking at the implications for

the major asset classes. We follow this with a summary of

the economic outlook by region, followed by our forecast

tables. The message in 2012 is a more difficult environment

for the world economy. The West is fragile, but emerging

economies are in far better shape to cope.

Chart 4: Low-inflation period poses policy dilemma

Inflation, % annual average


Table 1: Nominal GDP, 2008 versus 2011

USD bn

Regions 2008 2011 Change

World 61,191 70,012 8,821

Euro area 13,602 13,355 -247

Major advanced economies (G7) 32,144 33,842 1,699

Newly industrialised Asian economies (HK, South Korea, Singapore and Taiwan)

1,736 2,182 446

Emerging and developing economies

19,102 25,100 5,998

Developing Asia 7,433 11,114 3,681

ASEAN-5 1,270 1,759 489

Latin America and the Caribbean 4,290 5,630 1,340

Middle East and North Africa 2,332 2,745 413

Sub-Saharan Africa 944 1,220 276

Countries 2008 2011 Change

Brazil 1,655 2,518 863

China 4,520 6,988 2,469

India 1,251 1,843 592

Indonesia 511 834 323

Japan 4,880 5,855 976

Russia 1,661 1,885 224

United States 14,292 15,065 773


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Strategy


Strategy overview Will Oswald, +65 6596-8258

[email protected]

12 December 2011 10

Let’s try this again…

Summary

We expect long risk trades to perform well in 2012, but

with a far stronger bias towards H2 (or potentially earlier

if we see strong co-ordinated action from the European

and US authorities early in Q1). Liquidity will remain of

paramount importance well into the year, while

opportunities will be dominated by market timing and

beta rather than alpha.

Policy makers across emerging markets face a difficult

set of choices ahead: respond to the slowdown via fiscal

and monetary stimulus, or prepare for significant

developed-market (DM) monetary stimulus and potential

inflationary pressures. We expect the former to dominate

until end-Q1, but inflation risks are likely to re-emerge

during the remainder of the year. From an investment

standpoint, this also raises the potential for a shift back

towards macro-prudential measures, including stricter

capital controls. This outlook also suggests that the

outlook for local markets is biased towards duration and

away from FX in the early part of the year, with the

emphasis reversing as we move further towards H2.

FX and rates

On a multi-year basis, we expect the US dollar (USD) to

weaken, reflecting the significant debt overhang for the

US economy and continued gradual diversification away

from the USD in global portfolios. However, as we have

consistently argued, the USD performs well in an

environment of risk aversion, as the US is the primary

source of global risk capital; under such conditions, a

home-country bias will serve to strengthen the USD.

We expect a longer-term downtrend in the euro (EUR),

with sharp weakening in Q1. This is based on our

expectation that the co-ordinated European response will

be insufficient to support the market in the near term and,

more importantly, to deliver a strategy that offers a

credible longer-term solution.

The weaker longer-term outlook for the world‟s two

largest reserve currencies signals a similar multi-year

shift into emerging-market (EM) economies, reflecting not

only their rising role in the global economy but also their

significant role in global trade. While the significant focus

on the growing role of the Chinese yuan (CNY) is

justified, and is bolstered by China‟s efforts to re-

denominate trade flows into CNY, we also expect the

broader rotation into liquid, investment-grade EM

currencies to continue.

However, we expect this shift to occur after Q1-2012, in

line with the peak in the USD. By contrast, we look for

rates markets in more liquid economies to perform

relatively well in Q1, before flattening out throughout the

remainder of the year. Their performance in 2008-09 is

instructive here; EM local-currency bond yields (Chart 1)

compressed rapidly as G20 support emerged. Of

particular note, while inflows to EM local-currency bonds

increased strongly starting from Q2-2009, these flows

had a minimal impact on the yield spread to Treasuries.

Instead, they had a larger effect on EM currencies.

The combination of our rates and FX views suggests that

allocations in Q1 should be biased towards duration

rather than FX in our footprint markets; by contrast, as

we move into Q2, we expect the balance to shift more

towards FX. For the full year, we anticipate that frontier

African markets will deliver strong returns, but given our

focus on liquidity, we do not anticipate significant broad-

based opportunities before Q2 at the earliest. In Q1 in

particular, while we expect most emerging economies to

be able to deliver counter-cyclical monetary and fiscal

policy, we see risks to such policy responses in frontier

markets.

Credit

The outlook for credit is much the same as that for rates

and FX: a focus on market beta timing and liquidity over

alpha and illiquid yield pick-up. For credit, this indicates a

bias in positioning towards sovereign credits, especially

Chart 1: EM rate rally started rapidly after 2009 G20 (bps)

Sources: Bloomberg LP, Standard Chartered Research

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Strategy overview (con’d)

12 December 2011 11

given significantly stronger balance-sheet positions in

emerging Asia relative to other regions, followed by high-

grade corporates and banks.

The banking sector is critical globally, and Asia is no

exception. We have stressed for some months that the

emphasis on European bank recapitalisation is the direct

cause of global market weakness. With limited ability to

raise capital in the markets, and with sovereigns unable

to provide direct recapitalisation (as it is precisely

sovereign risk that is the cause of concerns), banks‟ only

remaining option is to deleverage their balance sheets.

This sector is likely to dominate asset managers‟

behaviour for some time. Furthermore, whereas co-

ordinated G20 action in 2009 included a signal to the

banking sector to resume lending to the private sector,

bank recapitalisation demands send the opposite

message, and the fiscal response will also be weaker.

The outlook for banks is significantly different for Asia than

it is for Europe. Aggregate balance sheets of Asian banks

are in far better health, while the monetary capacity of

Asian central banks to support domestic banking systems

is far greater. We also believe that domestic authorities

will be supportive of shifting banking activity towards local

rather than foreign banks. We therefore believe that the

relatively weak outlook for banks in our footprint reflects

their increased market share in areas such as trade

finance and associated demand for USD funding, rather

than their weak balance sheets.

Potential outliers are within the sovereign sector. We see

Pakistan and Vietnam as Asia‟s most vulnerable

sovereigns, although market pricing indicates that these

are well-known risks. Nevertheless, a significant

deterioration in a sovereign benchmark credit within EM

could have a broader negative impact. As seen in 2008,

while EM sovereign credit outperformed for most of the

year, the peak-to-trough loss was greater than in many

other credit markets. Equally, though, the rebound was

stronger than for other credit markets, supported by

stronger EM sovereign balance sheets and fiscal

capacity.

Commodities

The 2012 outlook bears some similarities to 2009, in that

we are entering the year with a very fragile outlook.

Strikingly, though, commodity prices have declined by far

less this time (so far), with oil in particular well supported.

If, as we anticipate, global demand declines significantly

in Q1, we do not expect as sharp a decline in commodity

prices due to the supply outlook.

In many sectors of the commodities market, the

development of new supply takes many years. While WTI

began rising sharply from late 2003, it was not until 2005

that the futures curve became upward-sloping. By 2008,

this shift had encouraged the development of new

capacity, and the supply coming on-stream was hit by the

drop in aggregate demand.

In contrast to the 2009 supply picture, the sharp decline

in the global economy in late 2008 and early 2009 had a

material impact on supply investment. Given the lag

between initial investment and supply, we believe that the

supply outlook for 2012 shows significantly less capacity

across a number of commodities. This suggests a much

lower risk of such strong price declines.

While there are several similarities between late

2008/early 2009 and today, key differences exist. Not

only is fiscal and monetary capacity severely constrained

in developed markets, but the push for bank deleveraging

in Europe risks further dampening money velocity. This,

along with lower excess supply capacity within

commodities, will pose challenges to a strong rebound in

asset prices.

Equities

The broader global backdrop suggests EM

outperformance versus DM equities. However, significant

challenges lie ahead. Our leading indicator of earnings,

the earnings revision index (ERI), points to a risk of

aggregate negative earnings in 2012. However,

valuations are already at the same margin relative to

earnings as they were at their lows in October.

Over the longer term, the trend of globalisation of

investment portfolios mentioned above should also

remain supportive of emerging markets, especially given

(relatively) easier access to funding than is likely in

developed markets due to lower levels of bank leverage.

Furthermore, as monetary stimulus picks up and

emerging economies see policy responses, this should

sustain EM outperformance in H2-2012.


Commodities HanPin Hsi, +65 6596 8255

[email protected]

Helen Henton, +44 20 7885 7281

[email protected]

Dan Smith, +44 20 7885 5563

[email protected]

Abah Ofon, +65 6596 8245

[email protected]

Koun-Ken Lee, +65 6596 8256

[email protected]

12 December 2011 12

A glass half full

Top trades of 2012

1. Higher prices needed to incentivise raw sugar output.

We believe the market‟s focus on improving global output

ignores important structural changes and seasonal

effects that will be key determinants of sugar prices in

2012. While sugar balances will move into a bigger

surplus in the 2011/12 season, downside pressure on

prices will be limited by stunted output growth and high

production costs in Brazil, uncertainty over India‟s export

capacity, and growing demand from China. Additionally,

sugar prices are finding a floor at a more elevated level

compared with historical trends. This suggests significant

upside potential once investor demand returns. We

believe that the sugar market has to be incentivised by

higher prices to boost production. We recommend going

long May sugar futures at the current price of USc 23.7/lb

(as of 6 December 2011), with a view to reaching a target

of USc 28/lb. We place our stop-loss at USc 20/lb.

2. Buy Brent on dips. We expect Brent to weaken in Q1-

2012 versus Q4-2011 as European growth reaches the

lowest point in the current downturn. We expect Brent to

make a strong recovery in H2, driven by increased

liquidity. While the markets are currently focusing on the

uncertain demand outlook, the supply issues that have

dominated the oil market in 2011 are still important.

Libyan output has recovered faster than expected, so any

bottlenecks are likely to surprise the market. On the

demand front, we expect non-OECD demand growth to

more than offset OECD declines. Overall, we expect oil

demand to grow by 0.9 million barrels per day (mbd) in

2012, the same pace as 2011. While we cannot predict

political developments in Iran, an escalation of tensions

as a result of Iran‟s nuclear programme has clearly not

been fully priced in, and any risk to the oil price from

further developments on this front would be to the upside.

3. Pick up some copper in Q1. Precious metals perform

better in times of uncertainty, but base metals rule in a

recovery, as seen most recently in the 2008-09 financial

crisis. Among the base metals, we prefer copper; we

choose to avoid illiquid futures such as tin futures, as

they are prone to severe volatility and positions can be

difficult to close out. We believe the best time to take a

long position with a 12-month view will be in mid- to late

Q1, when the inevitability of further easing by the Fed

and the European Central Bank will become clearer. We

expect euro-area y/y GDP growth to bottom out in Q1-

2012. Copper prices will likely be further supported by

persistent supply disruptions, even though the current

price is a substantial premium to its marginal cash cost.

Key issues

2012 will be a good year for commodity producers. We

expect a shallow correction in the first half of Q1 before

the market strengthens again in response to the following

factors: (1) confirmation that additional liquidity will be

injected by the US and European central banks, which

will boost sentiment as early as Q1; (2) persistent

challenges to supply, particularly given that strikes,

technical issues and weather have not been factored into

companies‟ production projections; and (3) still-strong

demand, specifically from emerging economies; these

economies will be spared the sharp slowdown facing

developed markets because their policy cupboards are

still relatively full, with China likely to ease further

throughout the year. Risks of price moves due to

geopolitical factors are also skewed firmly to the upside.

The key risk to our bullish outlook is that European

governments and the European Central Bank may not

respond aggressively enough to contain the debt

contagion until it is too late. Sentiment and actual

demand for key commodities would subsequently dive,

and commodity prices could fall substantially.

In October 2011, the US Commodity Futures Trading

Commission (CFTC) approved position limits to curb

excessive speculation on futures and swaps traded in the

US market. The commission will be required to limit

positions (other than legitimate hedging positions) held

by any person. The CFTC is still deciding on the

definition of a „swap‟. Large positions may be required to

be rebalanced, which may cause short-term price moves

Approximate baseline returns for various commodity

sectors in each quarter of 2012

Q1-

2012 Q2-

2012 Q3-

2012 Q4-

2012 2012

Precious 5.8% 1.7% 3.0% 4.9% 16.3%

Base 5.0% 9.1% 3.7% 4.8% 24.5%

Energy 0.6% 4.7% 0.0% 5.9% 11.6%

Grains/soybeans -1.7% 4.9% -4.7% 4.6% 2.7%

Softs/fibres 0.7% 1.7% 5.3% 2.7% 10.8%

Source: Standard Chartered Research


Commodities (con’d)

12 December 2011 13

independent of fundamental market developments.

However, we suspect that the 60-day period provided for

rebalancing will be sufficient to curb excessive volatility in

commodity prices.

Our key calls for 2012

Crude oil – A year of two halves. We expect oil demand

to rise in 2012, but the combination of poor sentiment and

reduced market tightness as supply recovers may put

pressure on prices in Q1-2012. That said, we expect

OPEC to provide a floor, with prices likely to rebound and

rise through end-2012 due to increased liquidity, an

improving macroeconomic picture, and supply restraint.

While deteriorating GDP growth in 2012 has implications

for oil demand, overall demand is still likely to grow as

non-OECD growth offsets a decline in the OECD. While

the markets are currently focusing on the uncertain

demand outlook, the supply issues that have dominated

the oil market in 2011 are still important. According to the

International Energy Agency (IEA), Libyan output has

risen to around 500 thousand barrels per day (kbd),

earlier than initially expected. Most of the output has been

used to refill storage facilities and pipelines – exports

have been much lower, at an estimated 180kbd in

October and an anticipated 200-250kbd in November.

This compares to pre-conflict export volumes of 1.3mbd.

Base metals – Bullish as supply constraints remain.

We have a bullish outlook on base metals in 2012, and

we expect the year‟s low to be registered in Q1.

Additional liquidity injected into the financial markets will

support prices later in the year, and base metals tend to

perform better than other commodities in recovering

markets. In addition, supply will remain tight, as many

projects originally scheduled for completion in 2011/12

were postponed or suspended after the Lehman Brothers

collapse reduced credit availability for such projects. In

particular, the problems that plagued copper supply in

2011 – strikes, bad weather and industrial strife – are

unlikely to go away in 2012. Chinese demand will

continue to support base metals in general; while we

expect a moderation in China‟s Q1 GDP growth, it should

recover strongly in H2.

Precious metals – Buy gold. While gold prices had a

strong 2011, rising 23% YTD as of 1 December, medium-

term prospects are still bright. Gold has pulled back from

its 2011 highs and appears to be establishing support at

USD 1,700/oz. The underlying medium-term drivers of

higher prices are still evident. They include strong Asian

demand, ultra-low interest rates in many countries, and

continued central bank buying. As a result, we maintain

our bullish bias on gold. Asian demand has become more

mixed in recent months, but the underlying trend is

clearly up, with China importing large quantities of gold

from Hong Kong to feed investment and jewellery

demand. Fears about the European crisis and the global

economic outlook continue to run high, and the outlook is

highly uncertain. This is encouraging investors and

central banks to stockpile gold in unusually large

quantities; this could become more evident in Q1-2012,

when further easing in the US, Europe and China is

expected.

Agriculture – Q2 peak. 2012 is likely to be another

challenging year for agricultural commodity markets –

different from 2011 in many respects, but equally

turbulent. We expect the current market sluggishness to

linger well into Q1-2012 before more bullish momentum

sets in. Markets, including corn and wheat, are likely to

peak in Q2-2012. In addition to global macroeconomic

developments, the outlook for 2012 will depend to some

extent on energy costs and the value of the USD. Our

energy forecasts show initially slack global growth, with

momentum steadily picking up over the course of 2012

and prices rising throughout the year. Stronger global

growth and firming energy prices will be supportive of

agricultural commodities from both a demand-pull and a

cost-push perspective. The impact of the USD will be

counter-cyclical, as we expect the dollar to remain

relatively firm before weakening in H2-2012.

Baseline returns for energy, precious and base metals in

2012


Precious

Base

Energy

-15%

-10%

-5%

0%

5%

10%

Q4-2011 Q1-2012 Q2-2012 Q3-2012 Q4-2012


Commodities – Charts of the year

12 December 2011 14

Chart 1: Nearby corn, wheat and soybeans rebased

Jan-2011=1

Chart 2: Elevated output costs to provide firm floor for

sugar in 2012 (USc/lb)

Sources: Reuters, Standard Chartered Research Sources: Reuters, Standard Chartered Research

Chart 3: Copper, gold and oil recovery from 2008-09 crisis

Mar-2008 = 1

Chart 4: Non-OECD and OECD y/y oil demand change

mbd

Sources: Bloomberg, Standard Chartered Research Sources: IEA, Standard Chartered Research

Chart 5: Cumulative global gold ETF flows and rate of

flows since 2 September 2011 (USD bn)

Chart 6: USD and oil/gold/copper 180-day rolling

correlation

Sources: Bloomberg, Standard Chartered Research Sources: Bloomberg, Standard Chartered Research

Corn

Wheat

Soybeans

0.7

0.8

0.9

1.0

1.1

1.2

1.3

Dec-10 Feb-11 Apr-11 Jun-11 Aug-11 Oct-11

Nearby sugar futures

Marginal cost band

15

17

19

21

23

25

27

29

31

33

35


0.3

0.5

0.7

0.9

1.1

1.3

1.5

Mar-08 Jun-08 Sep-08 Dec-08 Mar-09 Jun-09 Sep-09 Dec-09

WTI

Gold

Copper

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

Q1-10 Q3-10 Q1-11 Q3-11 Q1-12 Q3-12

Total Non-OECD demand

Total OECD Demand

Gold flows

Rate of flows (RHS)

-0.2

-0.1

0.0

0.1

0.2

0.3

0.4

0

1

2

3

4

5

6

7

8

25-Aug 14-Sep 4-Oct 24-Oct 13-Nov 3-Dec 23-Dec

vs Gold

vs Brent

vs Copper-100%

-80%

-60%

-40%

-20%

0%

20%

40%

60%

80%

100%

Jun-10 Sep-10 Dec-10 Mar-11 Jun-11 Sep-11 Dec-11


Credit Kaushik Rudra, +65 6596 8260

[email protected]

12 December 2011 15

Bracing for a rocky start

Top trades of 2012

1. Focus on quality and liquidity in Q1-2012. We

recommend that investors focus on the higher-quality and

more liquid segments of the credit space in early 2012.

We recommend staying very light in the high-yield (HY)

sector and concentrating positioning in high-grade (HG)

corporates, quasi-sovereign credits and sovereigns in

Asia and the Middle East. We recommend a slight

Underweight position in banks given wider pressures on

the sector from European banks. Given our expectations

of a US Treasury (UST) rally, we recommend that

investors focus on the 10Y segment of the curve. In Asia,

we recommend single-A-rated corporates and the Korean

quasi-sovereign sector. In the Middle East, we

recommend strong quasi-sovereigns out of Qatar and

Abu Dhabi.

2. Increase allocation to beta in H2-2012. Based on our

current expectations, we recommend that investors

switch into higher-beta and higher-yielding sectors in H2-

2012 on the back of increased market stability and the

likely resolution of the crisis in Europe. In Asia, this would

mean increasing allocations to the HY sector – in

particular to Chinese HY, both industrial names and

property developers. In the Middle East, this would imply

increasing positioning in the Dubai Inc. space. We

recommend increasing allocations to the financial sector,

adding both senior and hybrid paper.

Expectations for Q1-2012

With global risk appetite driven more by investor

sentiment than fundamentals, we expect developments in

the European sovereign crisis to remain the primary

driver of credit performance over the next few months.

While Asian sovereigns are stronger than their Western

counterparts from the standpoint of balance sheets and

credit metrics, they are not immune to the issues facing

the West. As a result, Asian credit performance will

continue to be hostage to global cross-currents and

flows.

In our base-case scenario, we expect the European

sovereign debt crisis to linger in 2012, with no immediate

solution. A positive end-game for Europe could take the

form of a fiscal union with potential quantitative easing.

However, the timing of such a solution is unclear. We

believe monetary easing in Europe could happen around

the end of Q1-2012, coinciding with potential quantitative

easing from the US. However, the road to such a solution

is likely to be long and bumpy, involving further stress in

the markets. While a concrete solution to Europe‟s

problems is in doubt, a recession in the euro area and a

cutback in European banking appear more or less

certain. The dual effects of drastic reductions in trade and

capital flows would be detrimental to Asian trade and

growth. The added risk of a hard landing in China will

also be on investors‟ minds as China slows in H1-2012.

Against this backdrop, we expect a relatively weak

performance from Asian credits in Q1-2012. This is also

likely be a bullish period for USTs, which will continue to

be supported by safe-haven flows. Investors in Asian

credit would therefore be better off investing in UST-

sensitive sectors – such as HG sovereigns/quasi-

sovereigns, higher-rated HG corporates, and HY

sovereigns/quasi-sovereigns – in Q1-2012. In our view,

the upside from UST tightening will be fairly limited given

that USTs are already trading at record-low yields; carry

will therefore be an important component of total returns

over this period. We expect the HY corporate sector to be

the main underperformer in Q1-2012, with spreads

widening sharply given the weaker outlook for risk assets

and China‟s economy. We also remain cautious on the

financial sector given expected supply and headwinds to

asset quality. Liquidity in the secondary markets is likely

to be a key factor in Q1-2012; as a result, investors may

be more involved in the primary markets (to the extent

that there is primary-market activity during the period).

Under the above scenario, we forecast Asian cash bond

returns at around -3% in Q1 (with 30bps of UST

tightening expected from current levels).

Chart 1: Asian cash bonds outperform the rest of EM

Spread (bps)

Note: CS regional credit indices used;

Sources: Bloomberg, Standard Chartered Research

Asia

EEMEA

Latam

200

300

400

500

600



Credit (con’d)

12 December 2011 16

Expectations for the rest of 2012

Weak US growth (due in part to structural problems in the

housing and labour markets), and the potential for even

weaker growth as a result of the recession in Europe,

could trigger monetary easing by the Fed in early 2012.

We could also see co-ordinated easing from the

European Central Bank (ECB) by the end of Q1-2012 as

part of the solution to the euro-area debt crisis.

Based on this scenario, we expect the global macro

picture to improve in H2-2012. Quantitative easing in the

US and Europe is likely to support risk appetite, and a

weaker euro (EUR) and US dollar (USD) will lead to

sustained flows into emerging-market (EM) assets –

including Asian credits – in the medium to long term. The

expected pick-up in China‟s growth and improving

onshore liquidity will also be supportive of HY credits,

particularly the Chinese names. We expect the Asian

credit markets to rally in H2-2012 on the back of

increased inflows to EM and a visible improvement in the

region‟s economic growth outlook. In anticipation of this

turn, we plan to position ourselves in higher-beta sectors

in advance, possibly by the end of Q1 or in early Q2.

This would involve moving to an Overweight position in

the HY corporate sector and the crossover credits, while

going Underweight Treasury-sensitive sectors such as

HG corporates and sovereigns – both HG and HY. We

would also shift our stance on the banking sector to

Neutral from Underweight currently.

Based on these views, we expect Asian USD credits to

post total returns of 5.5% in 2012 (assuming 30bps of

UST widening from present levels), with carry being the

main contributor to total returns (5.4ppt). We expect HY

corporates to be the best-performing asset class in terms

of spread tightening in 2012 as a whole. However, this

scenario is highly dependent on a concrete improvement

in confidence. Based on expected spread tightening,

coupled with high carry, HY corporates could return

13.8% in 2012, assuming that market conditions improve

along the lines assumed above. However, performance

in H1-2012 (and in particular Q1) will likely be skewed

towards HG corporates and HY sovereigns, based on

stability considerations as well as carry and credit

tightening considerations.

Expectations for supply in 2012

Supply pipeline remains healthy. A bottom-up analysis

of all existing issuers in the Asian credit space suggests

reasonably healthy primary issuance in 2012 (c.USD

79.8bn). This would represent an increase from the USD

67bn issued in 2011 (as of 6 December). While markets

are likely to remain volatile in 2012, the combination of a

very long pipeline of deals and lower activity in the

syndicated loan market is likely to lead to higher capital-

markets activity in the primary issuance space. Despite

the front-loaded 2012 redemption profile, we expect

issuance to be relatively staggered (picking up in Q2-2012

and increasing thereafter) as market sentiment prevents

weaker names from accessing the markets. We expect

USD 35.4bn of supply in H1, followed by USD 44.4bn in

H2; this is based on our estimate of c.USD 79.8bn of

issuance for all of 2012.

Supply will be limited if European crisis remains

unresolved. We acknowledge that the above forecast

may be an overestimate of issuance under present

market conditions, especially if market access does not

improve soon. Market access will depend, among other

things, on how the euro-area situation develops, and on

whether and when Europe and the US implement further

quantitative easing. If the euro-area situation remains

unresolved well into 2012, the primary markets could

remain out of bounds for HY corporate credits and for

crossover banking and corporate issuers. Under this

scenario, we would also expect some discretionary

issuance by banks and corporates to be pushed back. As

a result, issuance would be closer to USD 50-60bn than

the USD 79.8bn we project on a bottom-up basis.

Chart 2: Total returns were on expected track until

August 2011

JACI total return curve for 2011


140

142

144

146

148

150

152

154

156

158


6.15%

-7.53%


Credit – Charts of the year

12 December 2011 17

Chart 1: Asian HY has underperformed the HG sector

JACI IG and HY corporate spreads (bps)

Chart 2: Market liquidity has worsened sharply

Bid-ask price differentials of Asian corporates by rating

Sources: Bloomberg, Standard Chartered Research Source: Standard Chartered Research

Chart 3: Korean commercial banks trade tight to policy

banks (5Y policy bank vs. commercial bank spread, bps)

Chart 4: Indian bank senior paper underperforms Korean

peers (Korean 5Y vs. Indian 5Y senior spreads, bps)


Chart 5: Asian single-A corporate hold their ground

versus global peers

US and Asian single-A corporate spread differential (bps)

Chart 6: Asian BBB corporates give up ground versus

global peers

US and Asian BBB corporate spread differential (bps)


HY minus IG (RHS)

HY

IG

0

100

200

300

400

500

600

700

800

900

1,000

0

200

400

600

800

1,000

1,200

1,400

Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11

AA and aboveA

BBB

BB

B

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0


Commercial minus policy

(RHS)

Korea commercial

Korea policy

0

10

20

30

40

50

60

70

80

0

50

100

150

200

250

300

350

400

450


India minus Korea (RHS)

India senior

Korea senior

0

20

40

60

80

100

120

140

160

0

50

100

150

200

250

300

350

400

450

500


Asia minus US (RHS)US single-A

corp.

Asia single-A corp.

-20

-10

0

10

20

30

40

50

60

70

0

50

100

150

200

250

300

350


Asia minus US (RHS)

US BBB corp.

Asia BBB corp.

0

20

40

60

80

100

120

140

160

0

50

100

150

200

250

300

350

400

450



Equities Clive McDonnell, +65 6596 8526

[email protected]

12 December 2011 18

EM to outperform DM

Top trades of 2012

1. EM to outperform DM. The current underperformance of

emerging markets (EM) versus developed markets (DM)

started in October 2010 as the euphoria over the end of

the global financial crisis faded and portfolio flows into EM

equity funds peaked. From a fundamental perspective,

Q4-2010 also coincided with a negative turn in EM

earnings revisions. Looking ahead, we expect fund flows

to reverse in favour of EM by Q2-2012, and EM earnings

revisions to turn positive within a similar time period. A

contributing factor to our forecast is the expected rise in

commodity prices, in particular the ratio of copper to oil.

As Chart 5 shows (see „Charts of the year‟ below), this

ratio has been a useful guide to the relative performance

of EM and DM. The main driver of this relationship is the

higher intensity of copper usage in EM, versus higher oil

usage in DM. When EM demand recovers at a faster pace

relative to DM, the ratio rises, pointing to the future

outperformance of EM over DM equities, and vice versa.

2. Value to outperform growth. Value investing has proven

to be a greater alpha generator than growth investing over

the long term. Nevertheless, this strategy can result in

extended underperformance during periods of easy

monetary policy and build-up of excess liquidity, such as

the late 1990s and mid-2000s. In the EM universe, growth

outperformed value starting in late 2009; however, since

its October 2011 low, value has reasserted itself and

outperformed growth. We expect this trend to continue, as

monetary policy (as measured by real interest rates) is

likely to remain relatively tight, and we see a low

probability of a build-up of excess liquidity. Moreover, the

relative valuation gap between growth and value is >1

standard deviation below its mean. While we do not

believe that valuations on their own are catalysts,

combined with constraints on EM central bank monetary

policy due to quantitative easing in DM and an eventual

upward turn in EM earnings revisions, we believe they

point to good prospects for value stocks to outperform

growth stocks after Q1-2012.

3. Small- and mid-cap to outperform large-cap. Our

forecast that small- and mid-cap stocks will outperform

large-cap stocks, which represents a reversal of the trend

in 2011, is based on the view that Asia‟s resilient

consumer story is best expressed via the region‟s many

small- and mid-cap companies. As the credit environment

improves and margins recover thanks to lower

commodity/input prices, small- and mid-cap stocks should

witness an improvement in relative performance.

Key issues

We expect the European Central Bank (ECB) to take

decisive action to stem the euro-area crisis in 2012. We

expect ECB action to come in Q1-2012, with a likely focus

on a hybrid form of the existing credit easing –

quantitative credit easing (QuCE). This could involve the

ECB not sterilising all of its intervention to support

individual country bond markets under stress. We expect

the Fed to launch QE3 at its March 2012 meeting,

amounting to USD 75bn a month for the remainder of the

year. We forecast that most EM central banks will cut

rates in 2012.

For equity investors, the implications of these policies are

likely to be significant. They can be summarised as

follows:

1. Currency effect: An initial rally in the euro (EUR)

following ECB action will lead to a lower DXY; we expect

this to be a short-term event lasting less than a month.

This will be followed by the EUR weakening to as low as

EUR-USD 1.20 and a higher dollar trade-weighted (DXY)

index in Q1-2012. For the remainder of 2012, US QE and

QuCE in the euro area will create a tug-of-war between

two fundamentally weak currencies, with the DXY likely to

drift lower.

2. Liquidity effect: A stabilisation in the euro area should

lead to a recovery in liquidity flows into both fixed income

and equity markets. Initial liquidity flows are likely to be

from money market and cash into government bonds and

equities. Evidence from the Fed‟s QE1 and QE2

programmes indicates that fixed income should initially

outperform equities following ECB action, based on the

assumption of a high degree of stress in fixed income

markets at the time of the announcement.

3. Equity effect: An initial relief rally favouring high-beta

markets is likely to be followed by a period of

consolidation in Q1 as prospects for a recovery in global

growth in 2013 are digested. H2-2012 should see greater

differentiation between EM and DM, with the former

outperforming the latter.


Equities (con’d)

12 December 2011 19

As Chart 1 shows, there is a strong negative correlation

between the DXY and EM equity performance.

Fluctuations in the DXY drive portfolio fund flows – that is,

a weaker DXY drives an increase in flows to international

equity funds, whereas a stronger DXY drives an outflow of

funds. Given the challenges facing the euro area, we

expect EM funds to eventually benefit disproportionately

relative to their size in terms of fund flows. Based on this

relationship, and given our DXY forecasts outlined above,

we expect the following profile for EM returns relative to

DM: higher one month after ECB action, lower three

months after, and modestly higher 12 months after.

Earnings growth is likely to remain lacklustre in EM in

2012. Based on Factset consensus forecasts, EPS growth

will be 9%. However, based on our leading indicator of

earnings, the earnings revision index (ERI), there is a real

risk that earnings growth will slip into negative territory in

2012. A 10% decline in earnings should not surprise

investors. While we expect EM equity performance to be

positive in 2012, gains will be driven by multiple expansion

rather than earnings growth. The paradox of falling

earnings growth and stock-price gains leading to multiple

expansion is not unusual at turning points in the market.

We are not maximum bullish towards EM. Based on

corporate fundamentals alone, prospects remain

challenging: falling margins, a slowdown in top-line growth

and tighter credit availability all point to fundamental

weakness for equities. The key issues for investors are the

extent to which this has been discounted and prospects for

a recovery in 2013. Based on our expectations of ECB

action and an improvement in the liquidity environment, we

are comfortable forecasting that EM equity prices will be

higher than currently prevailing prices by the end of 2012.

In the absence of ECB action, we still expect EM to

outperform DM based on the resumption of the multi-year

trend of portfolio globalisation. EM tends to have a lower-

than-benchmark allocation in DM pension funds.

Moreover, the superior fundamentals of EM relative to DM

can be overlooked in the short term but are unlikely to be

ignored in the long term. Interestingly, the absence of

QuCE by the ECB could be viewed as beneficial to EM

growth prospects, as the combination of QuCE and QE3

would reduce EM policy makers‟ options: (a) they will have

a reduced ability to lower rates, as QE will lead to higher

commodity prices, putting upward pressure on inflation

(see Chart 2); and (b) QE leads to DM currency weakness

and EM strength, reducing export competitiveness at a

time of a significant contraction in DM demand.

Valuations in the EM universe are currently 1 standard

deviation below the long-term average, or 9x 12-month

consensus earnings forecasts – effectively back to the

lows recorded in early October, as Chart 3 shows. While

EM economic fundamentals are superior to DM, concerns

over a squeeze on corporate cash flow arising from tighter

credit availability and a slowdown in new orders are

weighing on sentiment towards equities and, in turn,

valuations. A full or partial resolution of the euro-area debt

issues will address some of these concerns; however,

others remain on the horizon, including deleveraging of

DM bank balance sheets and severe tightening of euro-

area fiscal policy (the quid pro quo for ECB action).

Given our forecast that EM equities will outperform DM, we

are in effect arguing for a partial decoupling of the risk-

on/risk-off trend that has been observed since 2009.

Liquidity and credit availability will remain key drivers of

such decoupling. As such, our expectation that Asian

banks will step in and close the gap left by a withdrawal of

cross-border lending by euro-area banks is an important

driver of our forecast for EM outperformance. One

implication of this is that EM financials are likely to

continue to underperform headline indices, as they will

need to tap markets for funds to close the gap. As Chart 4

shows, EM financials underperformed EM equities by

almost 10% in 2011; moreover, they underperformed DM

financials, despite their superior solvency and liquidity.

EM valuation breakdown

Significant downside risk to EM EPS

EPS

growth P/E P/BV

Div. yield

2011 2012 2011 2012 2011 2012 2011

China 11% 13% 9.0 7.9 1.4 1.3 3.0%

Korea 3% 15% 9.3 8.1 1.2 1.0 1.6%

Brazil 16% 5% 8.8 8.4 1.3 1.2 4.3%

Taiwan -14% 3% 13.2 12.8 1.6 1.5 4.5%

S. Africa 25% 25% 12.2 9.8 2.1 1.9 3.6%

Russia 42% -8% 4.6 5.0 0.8 0.7 3.2%

India 12% 15% 14.1 12.3 2.2 2.0 1.6%

Mexico 11% 22% 17.8 14.6 2.4 2.3 1.8%

Malaysia 5% 13% 15.2 13.5 2.0 1.9 3.5%

Indonesia 23% 16% 14.0 12.1 3.4 2.9 2.7%

Thailand 22% 11% 10.5 9.5 1.9 1.7 3.9%

Turkey -8% 13% 9.1 8.0 1.4 1.2 3.3%

Philippines 5% 13% 15.1 13.4 2.5 2.3 2.9%

MSCI EM 6% 9% 9.8 9.0 1.5 1.3 3.3%



Equities – Charts of the year

12 December 2011 20

Chart 1: MSCI Emerging Markets and DXY

Negative correlation between DXY and EM equity

performance

Chart 2: CRB index and EM inflation

Impact of QE2 and inflation in emerging markets

Sources: Bloomberg, Factset, MSCI, Standard Chartered Research Sources: Bloomberg, CEIC, World Bank, SC Research

Chart 3: MSCI Emerging Markets 12M fwd P/E

EM trading at 1 standard deviation below long-term average

Chart 4: Relative performance of equity indices

Financials underperformed by a wide margin (% y/y)

Sources: Factset, MSCI, Standard Chartered Research Sources: Factset, MSCI, Standard Chartered Research

Chart 5: Relative perf. of EM/DM and copper/oil price ratio

Positive relationship between EM/DM and copper/oil

Chart 6: MSCI EM Asia Relative PE – growth/value

Value stocks priced at close to -1 s.d. vs growth

Sources: Bloomberg, Standard Chartered Research Sources: Factset, MSCI, Standard Chartered Research

72

76

80

84

88

400

600

800

1,000

1,200

1,400

May-08 Nov-08 May-09 Nov-09 May-10 Nov-10 May-11 Nov-11

US

T

AR

P h

inte

d

QE

1 a

nn

.

QE

1 s

tart

QE

1 e

nd

QE

2 h

inte

d

QE

2 s

tart

QE

2 e

nd

QE

3 h

inte

d

MSCI EM (LHS)

Dollar index (RHS, inversed)

0%

1%

2%

3%

4%

5%

6%

7%

8%

150

200

250

300

350

400

450

500

May-08 Nov-08 May-09 Nov-09 May-10 Nov-10 May-11 Nov-11

EMinflation (RHS)

CRB index(LHS)

US

TA

RP

hin

ted

QE

1 a

nn

.

QE

1 s

tart

QE

1 e

nd

QE

2 h

inte

d

QE

2

sta

rt

QE

2 e

nd

QE

3 h

inte

d

6

7

8

9

10

11

12

13

14

15

16

Nov-04 Nov-05 Nov-06 Nov-07 Nov-08 Nov-09 Nov-10 Nov-11

12m Fwd P/E

+1 S.D.

-1 S.D.

Mean

-30%

-25%

-20%

-15%

-10%

-5%

0%

Index Financials Ex-financials

AXJEM

DM

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

0.5

1.0

1.5

2.0

2.5

Jan-03 Jul-04 Jan-06 Jul-07 Jan-09 Jul-10 Jan-12

Copper/oil price ratio

(advanced by 6 mths, RHS)

EM/DM relative performance (LHS)

0.8

1.0

1.2

1.4

1.6

1.8

2.0

Nov-04 Nov-05 Nov-06 Nov-07 Nov-08 Nov-09 Nov-10 Nov-11

Relative 12m trailing P/Egrowth/value

+1 S.D.

-1 S.D.

Mean


FX Callum Henderson, +65 6596 8246

[email protected]

FX Research team

12 December 2011 21

Déjà vu all over again – 2009 versus 2012

Top trades of 2012

1. Short CNY-INR: The Indian rupee (INR) has been the

worst-performing Asia ex-Japan (AXJ) currency in 2011

on slowing growth, a widening trade deficit and a sharp

downdraft in the Indian stock market. We expect further

INR weakness in Q1-2012. However, the peak in Indian

inflation is strongly correlated to the bottom in the

Sensex, and India‟s economic slowdown should narrow

the trade deficit. Once global growth bottoms, the INR will

look very attractive on a carry basis. The Chinese yuan

real effective exchange rate (CNY REER) remains high,

suggesting that China‟s authorities may be more active in

limiting appreciation. We favour this trade from Q2-2012.

2. Long USD-ZAR: South African trade is more closely tied

to Europe and Asia than the US. With Europe falling into

recession and Asia still slowing, short-term prospects for

the South African rand (ZAR) remain bearish. Fragile risk

appetite in Q1-2012 may lead to a temporary shortfall in

portfolio inflows to fund the current account deficit.

Finally, the DXY and USD-ZAR remain closely correlated.

We favour this trade in Q1-2012 only.

3. Short CHF vs. a EUR/USD basket: The Swiss franc

(CHF) is massively overvalued. The latest OECD

purchasing power parity data shows that it is overvalued

by 33.95% against the euro (EUR) and 39.36% against

the US dollar (USD). The Swiss economy is heading into

recession and deflation. We expect a vigorous policy

response, raising the EUR-CHF lower bound to 1.30 from

1.20. We favour this trade in Q1-2012.

Key issues

The expected economic backdrop in H1-2012 of a

recession in Europe and stagnating growth in the US and

Japan will create a challenging environment for higher-

beta G10 and EM currencies. More positively, inflation

should continue to decline. However, the monetary policy

response will be a critical swing factor. Our base case of

Federal Reserve „QE3‟ and European Central Bank

liquidity provision in H1-2012 represents a further

significant injection into the financial system, which will

boost inflation expectations in H2-2012. Investors will

also be keenly focused on China‟s monetary and fiscal

policy after the first cut in the required reserve ratio

(RRR) in early December. As a result, we expect FX

volatility to remain elevated.

2011 was an exceptionally challenging year for FX

managers. From January-October, the Barclay Currency

Traders Index returned +1.0% and the Stark Currency

Traders Index returned -11.0%. Of four main FX-alpha

trading styles, carry was the only one that had a positive

return for January-November. Valuation had a small loss,

while both trend and volatility had double-digit losses. By

comparison, the Standard Chartered FX Trading Portfolio

returned -0.06% through end-November.

While 2011 was a challenging year for us also, our

framework of comparing 2011 with 2008 served us well.

Granted, there were important differences, but the many

similarities helped us to avoid larger return pitfalls.

Similarly, 2009 may prove to be a useful framework for

anticipating 2012, particularly in the context of a „year of

two halves‟. Such a comparison of 2012 versus 2009

should be seen in the context of Mark Twain – “History

doesn‟t repeat itself, but it does rhyme.”

The floor in economic expectations – brought by policy

responses in the US, euro area and China – should lead

to a resumption of the multi-year globalisation of private-

sector portfolios in H2-2012. Additionally, persistent trade

surpluses in EM and the slowing of capital outflows from

Q2-2012 should lead to a resumption of FX reserves

build-up, prompting renewed central bank diversification

from the USD into G10 and EM currencies.

G10 and EM FX forecasts

USD strength in H1, weakness in H2

2012 End-Q1 Q2 Q3 Q4

EUR-USD 1.20 1.22 1.25 1.30

USD-JPY 81 79 77 74

GBP-USD 1.46 1.50 1.52 1.55

USD-CNY 6.36 6.31 6.26 6.21

USD-IDR 9,400 9,200 9,000 8,700

USD-INR 53.00 51.80 50.50 48.50

USD-KRW 1,210 1,155 1,095 1,050

USD-SGD 1.35 1.32 1.28 1.25

USD-NGN 164 161 159 158

USD-ZAR 9.30 9.10 8.80 8.20



FX (con’d)

12 December 2011 22

Our key calls for 2012

Q1-2012 – USD to extend gains. We expect the USD to

continue to benefit in Q1-2012 from global deleveraging,

economic divergence, fragile risk appetite and safe-haven

status. High return volatility will keep investors defensive.

European currencies will be major underperformers, while

AXJ and Latam currencies are likely to be mixed. In this

context, the biggest losers against the USD in Q1-2009

included the EUR, CHF, Korean won (KRW), Indonesian

rupiah (IDR), Singapore dollar (SGD), Colombian peso

(COP) and Argentine peso (ARS).

Q2-2012 – USD to stabilise. Easing in the US, Europe

and China should support higher-beta assets. That said,

Europe will remain in recession, with negative

implications for EM currencies via trade, bank lending

and portfolio investment. We expect two-way price action

in Q2-2012, with more focus on relative value. We look

for G10 and EM currencies, particularly the GBP and

commodity currencies, to outperform the EUR.

Q3-2012 – USD to begin correcting lower. We expect

global economic expectations to bottom in Q2-2012. Asia

has more room to ease and will be proactive in defending

final demand. With Fed policy remaining ultra-loose and

key economies in Asia, Africa and the Middle East

outperforming, the main sources of private-sector capital

– the US and Japan – will resume their multi-year

allocation to higher-yielding assets.

Q4-2012 – USD to accelerate lower. Improving global

economic expectations should encourage a tsunami of

portfolio investment into EM, just as it did in H2-2009. We

expect G10 commodity currencies – particularly the

Australian dollar (AUD) and New Zealand dollar (NZD) –

to lead the way, followed by Latam and then Asia.

G10 FX allocations: We recommend that real-money

funds maintain Overweight FX allocations to the USD in

Q1-2012, turning neutral in Q2 and then bearish from Q3.

Within this, we favour Underweight allocations to the

EUR, GBP and CHF for Q1-2012. We are Neutral on the

AUD and Canadian dollar (CAD). While we expect the

AUD to extend its losses in Q1-2012, China‟s policy

easing should put a floor under growth expectations.

Moreover, Australia is running large monthly trade

surpluses, in contrast to the deficits of 2008. We see the

CAD as a lower-beta play on the US recovery, further

supported by reserve diversification.

EM FX allocations: We recommend Underweight FX

allocations to emerging European currencies. While this

region already saw some weakness in H2-2011, we think

it will extend in early Q1-2012 as the euro-area recession

worsens and spills over to the rest of the continent. The

hit to trade in emerging Europe will be significant.

Moreover, bank recapitalisation in the euro area is

resulting in a large retrenchment of bank lending to the

east. Against this, we recommend small Overweights in

AXJ and Latin America. Once global expectations bottom

in Q2-2012, the experience of 2009 suggests significantly

increasing Overweight positions in Latin America.

Asia: Regional currencies will remain under pressure in

Q1-2012. Within this, given our forecasts and return

profiles, we expect the Vietnamese dong (VND),

Pakistani rupee (PKR), Thai baht (THB) and Bangladeshi

taka (BDT) to be the main underperformers against the

USD. The INR will see further weakness, but carry,

peaking inflation expectations and value will limit the

downside from here. Outperformance will be focused in

Greater China, particularly the CNY and Hong Kong

dollar (HKD). In H2-2012, we see a significant rally in

AXJ currencies, led by the KRW, Philippine peso (PHP)

and INR. In that environment, we expect the CNY to

underperform significantly in H2-2012.

Latin America: Regional currencies have been under

significant pressure in H2-2011, with the Mexican peso

(MXN), Brazilian real (BRL) and Chilean peso (CLP)

leading the way lower. We expect them to weaken further

in Q1-2012, with the Peruvian sol (PEN) continuing to

outperform. Once global economic expectations bottom,

we expect a major reversal higher in the MXN on

significant undervaluation and better US growth.

JPY, CHF overvalued; MXN, KRW undervalued

BIS REER vs. 5-year moving average (top 5 and bottom 5)


-15%

-10%

-5%

0%

5%

10%

15%

MXN KRW ARS GBP TWD BRL CNY AUD CHF JPY


FX – Charts of the year

12 December 2011 23

Chart 1: CNY continues to lead the way

AXJ REERs: Top 5 performers

Chart 2: KRW and IDR to rally in H2-2012

AXJ REERs: Bottom 5 performers

Sources: BIS, Standard Chartered Research Sources: BIS, Standard Chartered Research

Chart 3: Slowing IP cycle to hit AXJ exports in Q1

US ISM Manufacturing and AXJ exports

Chart 4: Slowing AXJ exports to hit AXJ currencies in Q1

AXJ exports and the ADXY Index


Chart 5: In 2009, BRL and ZAR outperformed from Q2

EM FX performance in 2009 vs. the USD

Chart 6: In 2009, commodity currencies outperformed

DM FX performance in 2009 vs. the USD


60

80

100

120

140

160

180

1994 1996 1998 2000 2002 2004 2006 2008 2010

CNY INR PHP SGD THB

30

50

70

90

110

130

150

1994 1996 1998 2000 2002 2004 2006 2008 2010

TWD HKD IDR KRW MYR

ISM Manufacturing

AXJ exports % y/y (RHS)

-35

-25

-15

-5

5

15

25

35

45

30

35

40

45

50

55

60

65

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

AXJ exports % y/y

ADXY Index % y/y (RHS)

-15

-10

-5

0

5

10

15

-40

-30

-20

-10

0

10

20

30

40

50

Jan-01 Jun-02 Nov-03 Apr-05 Sep-06 Feb-08 Jul-09 Nov-10

-15%

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

35%

ARS NGN RUB HKD CNY BWP IDR CLP ZAR BRL

-5%

0%

5%

10%

15%

20%

25%

30%

JPY DKK EUR CHF SEK GBP CAD NOK NZD AUD


Rates Danny Suwanapruti, +65 6596 8262

[email protected]

12 December 2011 24

EM rates to outperform in 2012

Top trades of 2012

1. Long EM versus USTs. We expect EM local-currency

bonds to have another robust year in 2012, supported by

liquidity injections from the European Central Bank (ECB)

and the Fed (which we anticipate by Q1-2012). The

timing should be right to enter long EM trades and shift to

Overweight EM allocations after quantitative easing (QE)

is announced. In the meantime, we recommend being

Neutral duration and staying close to benchmarks.

2. Long INR bonds. We expect the Reserve Bank of India

to shift its focus from inflation to growth, and we forecast

125bps of repo rate cuts in 2012. While the swap curve is

partly pricing in such easing, GoISecs have

underperformed on supply concerns. Consequently, we

expect GoISecs to perform well in response to monetary

easing. We are bullish on the Indian rupee (INR) versus

the US dollar (USD) in 2012, which supports the long INR

bond trade. The key near-term risk is a supply shock,

with the FY13 fiscal deficit exceeding our forecast of

5.5% of GDP. In a world where financial markets are

highly correlated, India will attract investors given its

relatively low correlation with other emerging markets.

3. KRW and MYR bonds to attract FX reserve funds.

Central bank reserve diversification is likely to pick up

momentum from Q2-2012 onwards once QE by the Fed

and aggressive credit easing by the ECB are announced.

Central banks globally will be looking for markets with a

strong medium-term FX outlook, and deep and liquid

bond markets. Korea and Malaysia are the two Asian

markets that fit these criteria the best.

Key issues

Fed and ECB easing to be supportive of EM local-

currency bonds. Price action in 2012 should somewhat

mirror 2009. Following the Fed‟s introduction of QE in

November 2008 and the G20 meeting in London in April

2009 (when USD 1.1trn was pledged to boost the global

economy), the spread between EM local-currency bond

yields and US Treasuries (USTs) narrowed from 550bps

to around 400bps. Thereafter, this spread remained

range-bound at around 400bps for almost two years. In

2012, we expect EM local-currency bond yields to narrow

towards 400bps (from 470-80bps currently) and stay

range-bound thereafter.

A further deterioration in risk appetite is likely going into

Q1-2012, which will ultimately force the ECB into more

aggressive credit easing and the Fed into QE. EM risk

assets may initially underperform (mostly from FX) at the

start of 2012. However, we recommend staying Neutral

duration and close to benchmarks for now. We do not

favour shifting to underweight EM duration allocations,

because the spread between EM and USTs should

narrow rapidly once liquidity injections from the Fed and

ECB commence.

Reserve diversification to pick up momentum from

Q2-2012 onwards. In Q1-2012, we are generally bullish

on the US dollar (USD) against EM currencies; thus,

USD accumulation by Asian central banks is likely to

slow or even stop. However, once the Fed and the ECB

commence aggressive easing, FX reserve accumulation

should pick up momentum (from Q2-2012 onwards).

Asian central banks are already active in regional bond

markets, as part of an ongoing effort to diversify their FX

reserves. We expect this to pick up further from Q2-2012

onwards. The focus will be on markets with a positive

medium-term FX outlook, as well as depth in their bond

markets.

Risk of capital controls in H2-2012. Foreign holdings of

Asian local-currency bond markets are already

considered quite high, and they are likely to climb further

in 2012. Local authorities appear increasingly concerned

about this, particularly if there is a high concentration of

ownership among a few players. This includes sovereign

investors, as there can be political ramifications if one

Greater returns from EM FX gains than EM duration

gains in 2012 (total return forecasts, %)


CN

HK

ID

KRMY

PH

SGTH

IN

TWLK

KE

ZA

NG

BR

MX

EU

US VN

PK

GH

UG

-10

-5

0

5

10

15

20

-5 0 5 10 15 20

FX

to

tal r

etu

rn

USD-funded LCY total return

Hig

her

ret

urn

sfr

om

FX

gai

ns

HIgher returns from duration gains


Rates (con’d)

12 December 2011 25

country owns a significant amount of another country‟s

debt. Moreover, if the two countries compete against

each other in export markets, this could also impact the

cross FX rates.

Once risk appetite has increased and central banks are

less worried about rapid portfolio outflows, we see a risk

of increased regulation to curb portfolio inflows.

Concentration of foreign ownership is also a key risk

(particularly if funds face redemptions). In addition to

the level of foreign ownership (often measured as a

percent of the total outstanding), investors should be

aware of the concentration of ownership. For example,

there is more risk in markets where a few players own a

large share of the market than in a market where

ownership is more evenly distributed among investors.

During our Asian rates roadshow to the UK in November

2011, about 80% of the real money investors we met had

shifted to underweight positions in Indonesian bonds.

However, foreign holdings fell by just USD 4bn (as of 1

December 2011) from their peak of USD 27bn on 7

September. This suggests that the underweight positions

are small or that foreign holdings are highly concentrated

among a few players, who are still overweight.

Duration gains in Q1; FX gains in Q2-Q4. Our total

return analysis incorporates our EM bond and FX

forecasts for 2012 (Table 1). In Q1-2012, we expect most

of the total returns to come from duration as opposed to

FX. This is line with our view that EM central banks will

front-load rate cuts in H1-2012 and the USD will rally in

Q1. Thereafter, once the ECB and Fed inject more

liquidity, we expect EM currencies to rebound against the

USD from Q2-2012, while EM rates should stay range-

bound. Thus, from Q2-2012 onwards, total return gains

should come more from FX than duration. Chart 1 shows

a breakdown of our total return expectations between FX

and rates for 2012.

India has the highest score on a risk-adjusted basis.

We are bullish on both the Indian rates and FX markets

in 2012.

Stay in liquid markets. We favour staying in the more

liquid markets in H1-2012 despite some frontier markets

looking attractive on a total-return basis (which is due to

the high yields). During periods of risk aversion, price

discovery can become very poor, and we value the ability

to be nimble. We will consider re-entering frontier

markets once market liquidity improves.

Total return analysis, incorporating our FX and rates forecasts for 2012

Country Forecast return USD-unhedged total return

Risk-adj. return

Yield Forecast yield

USD-funded local returns

FX FX forecast FX total return

Uganda

27.5% - 21.80

15.00 16.0% 2,525 2,660 11.5%

Kenya 26.0% 1.00 19.20

15.00 16.5% 89.45 97 9.5%

India 21.3% 3.23 8.67 7.50 10.9% 51.34 48.5 10.3%

Brazil 21.2% 1.29 10.56

9.40 5.9% 1.78 1.65 15.3%

Mexico 19.6% 1.31 6.39 6.60 2.2% 13.48 11.8 17.4%

Nigeria 17.7% 1.22 12.90

12.00 0.3% 161.55 158 17.4%

Indonesia 11.5% 0.55 6.23 6.00 2.9% 9,035 8,700 8.6%

Philippines 11.1% 1.04 5.88 5.70 5.3% 43.22 41.5 5.9%

Vietnam* 9.1% - 12.80

11.25 - 21,011 22,600 -

Ghana 8.4% - 13.00

13.50 2.8% 1.64 1.7 5.6%

Malaysia 7.3% 0.74 3.26 3.10 3.1% 3.13 3.03 4.2%

Korea 7.3% 0.39 3.49 3.30 3.3% 1,128.1

1,095 4.0%

Pakistan 6.5% - 12.50

13.25 3.8% 89.42 94 2.7%

Sri Lanka 6.1% 1.51 8.81 10.00 1.6% 113.91 114.8 4.5%

Taiwan 4.7% 1.07 1.32 1.40 1.9% 30.17 29 2.8%

China 3.4% 0.75 3.49 3.90 1.0% 6.35 6.21 2.4%

Singapore 2.7% 0.26 0.61 0.70 0.7% 1.28 1.25 2.0%

Thailand 2.6% 0.30 3.12 3.40 -0.1% 30.78 30.5 2.8%

South Africa 0.3% -0.06 7.94 8.85 -1.8% 7.99 8.2 2.2%

Hong Kong -0.6% -0.71 0.82 1.10 -0.1% 7.77 7.79 -0.5%

US -1.6% -1.01 0.93 1.45 -1.6% 1 1 0.0%

EU -3.5% -0.56 2.14 2.50 0.1% 1.34 1.3 -3.6%

Note: Thick green bars denote unhedged USD total returns in Q1-12, thin blue bars show Q4-12; * Forward market is not accessible to offshore

accounts; Source: Standard Chartered Research


Rates – Charts of the year

12 December 2011 26

Chart 1: EM spread over USTs to narrow in 2012

Spread between GBI-EM and USTs (bps)

Chart 2: Correlation of LCY EM bond returns is rising

Average correlation of selected EMs in GEMX index

Sources: Bloomberg, Standard Chartered Research Sources: Reuters, MarkIt, Standard Chartered Research

Chart 3: Foreign holdings should stay high in 2012

% of outstanding, EM local markets

Chart 4: Strong inflows to EM bond funds are likely to

persist (2011 cumulative flows, USD bn)

Sources: Central banks, governments, Standard Chartered Research Sources: EPFR, Standard Chartered Research

Chart 5: INR rates market to rally on interest rate cuts (%) Chart 6: The ECB is expected to deliver more aggressive

Securities Market Program purchases (%)

Sources: Bloomberg, Standard Chartered Research Sources: Bloomberg, ECB, Standard Chartered Research

GBI-EM vs UST spread

300

350

400

450

500

550

600

650

Jun-08 Nov-08 Apr-09 Sep-09 Feb-10 Jul-10 Dec-10 May-11 Oct-11

G20 meeting in London

0.0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

Apr-08 Oct-08 Apr-09 Oct-09 Apr-10 Oct-10 Apr-11 Oct-11

Thailand

Korea

Indonesia

Malaysia

0%

5%

10%

15%

20%

25%

30%

35%

40%

Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11

Local currency

Hard currency

Blended

-2

0

2

4

6

8

10

12

14

16


Repo rate

10Y GoISec yield

5Y OIS rate

4

5

6

7

8

9

Jan-09 Jun-09 Nov-09 Apr-10 Sep-10 Feb-11 Jul-11 Dec-11

10Y Spain

10Y Greece

9Y Ireland10Y

Portugal

10Y Italy10Y Bund0

5

10

15

20

25

30

Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Oct-11

Weekly SMP purchases in bn


Sovereign risk Christine Shields, +40 22 7885 7068

[email protected]

12 December 2011 27

More downgrades to come

A difficult year ahead

In 2011, there were more rating downgrades than

upgrades; it was only the second year in the past decade

that this has been the case (Chart 1). Though the number

of rating cuts was lower than in 2008, the other year with

a negative balance, the regional mix in 2011 was mostly

skewed towards the industrial world, especially the

advanced economies in Europe, unsurprising given the

European sovereign debt crisis. The Middle East was

also hard hit, reflecting the wave of change following the

Arab Spring, while ratings in Asia and Latin America

generally held up or were raised. Most positive outlooks

are in these two regions, along with Central and Eastern

Europe (Chart 2). There were more new ratings awarded

in Africa.

The difficulty for the rating agencies is that, by pointing to

a particular risk, they may cause markets to react in such

a way that the warning becomes self-fulfilling.

Conversely, by not pointing to a risk, the agencies can be

accused of tardiness or even incompetence. Their recent

actions in Europe, most recently putting 15 of the euro-

area countries on CreditWatch Negative, and even

Standard & Poor‟s downgrade of the US back in August,

were extremely unhelpful in both fact and timing. In the

cases of Greece and Portugal, multiple downgrades at

one time just suggested that the earlier rating had been

out of line for some time. More downgrades are likely in

the coming months.

As events in the highly indebted European periphery

evolve, more such difficult choices will be required. Our

internal sovereign grades are reviewed quarterly, and we

sympathise with the dilemma facing the rating agencies.

Looking forward, credit fundamentals, on the metrics

generally used, are probably at or close to realistic levels.

But if the sovereign crisis brings the collapse of the euro

as an institution, that will clearly not be the case. The

position is binary. We are where we are provided the

situation stabilises; on the other hand, if matters worsen,

other euro-area economies may fall to sub-investment

grades.

One problem in the rating process for the advanced

economies is that some routinely used metrics, such as

import cover – the number of months of imports covered

by official reserve holdings – have been seen as less

appropriate than for the developing world. Typically, as

countries joined the euro area, they were encouraged to

manage their reserves lower, as the collective euro-wide

picture was what mattered, not individual country

holdings. Of course, the folly of that approach is now

evident, though certainly for the large industrial countries,

the sheer scale of their import bill is so significant that the

official reserves required to provide three months of

import cover would not be the most efficient use of

resources. Moreover, some analysts have attempted to

excuse imbalances such as current account deficits by

stating that the shortfalls are readily financed by

international capital. On that basis, they are manageable.

This is another folly. At times of stress, finance can dry

up. Hence, fundamentals always matter.

Looking ahead, fundamentals in our footprint are

generally strong. In Asia, most of the rating changes in

2011 were positive, though Vietnam, Japan, New

Zealand and the Cook Islands saw their ratings fall.

Vietnam has long been vulnerable because of its poor

policy environment, high inflation and large external

deficit. Japan, too, is known for its exceptionally high

level of public debt, which has hitherto been seen as

bearable because it is yen-denominated and held mostly

by Japanese. Now, however, in light of the problems in

Europe, investors are starting to question that

assumption, especially given Japan‟s demographics. A

downgrade is possible – S&P cut its rating a year ago,

but more cuts may come in 2012 given the refinancing

strains in the world as a whole. By contrast, Indonesia

may win another upgrade.

Chart 1: Long-term foreign-currency issuer ratings

Sources: Standard & Poor‟s, Standard Chartered Research

0

5

10

15

20

25

30

35

40

2003 2004 2005 2006 2007 2008 2009 2010 2011

Rating upgrade

Rating downgrade


Sovereign risk (con’d)

12 December 2011 28

On the positive side, China, Hong Kong, Indonesia, Sri

Lanka and the Philippines all moved higher in 2011.

Strong external balances support ratings in much of Asia,

while public finances also tend to be in fair shape, and

public debt levels are well below those in Europe or the

US. Inflation has been a concern but appears to have

peaked as growth rates moderate. Economic policy

management has been robust and is a ratings positive for

much of Asia. In particular, macro-prudential measures

confer welcome stability upon the financial sector and

property markets, helping to defuse asset bubbles before

they become problematic. This activist approach is

something that Western policy makers should emulate.

Downside risks to India have increased, most recently

with the sharp depreciation of the currency, which will

add to already-high inflationary pressures. With growth

decelerating quite rapidly, this leaves policy makers with

a dilemma. If they raise rates to protect the currency, the

headwinds to demand will worsen, but if they cut rates to

support output, the currency may fall further.

In Africa, all of the rating changes in 2011 were either

new ratings (Zambia, Namibia, Senegal) or upwards. The

Seychelles and Angola were both upgraded, the former

as its weak external balance stabilised and the latter

because of improving fundamentals. Though still

narrowly based, Angola is becoming an increasingly

impressive economy that is developing rapidly.

In the Middle East, the only positive change was to

Kuwait; all other changes were downgrades. In the main,

these reflected political issues that affected economies

adversely. Egypt has suffered a serious knock, with

growth hit by the unrest and the associated fall in tourism

and investment. Both the fiscal and the external balances

have worsened and reserves have fallen. Until the

political situation is resolved, markets will likely remain

nervous. Risks in Bahrain are also high. Pakistan‟s

relations with the US have deteriorated so much that UN

operations in Afghanistan may suffer.

Rating trends in Latin America have been mostly positive,

unsurprisingly as the region as a whole has fared well,

not least from the commodity boom. Now, however,

worries about the sustainability of growth are mounting –

hence Brazil cutting interest rates to prevent more

deceleration. Encouragingly, fundamentals have

generally improved, and policy management has been

solid. Lessons seem to have been learnt from past crises

– and the recent experience of other countries. Mexico,

however, is facing new downside because of increasingly

disruptive drug-related violence. Growth has slowed

because of political instability, while the muted recovery

in the US will limit the upside to Mexico‟s trade.

Venezuela continues to demonstrate capricious

economic management, and the economy is struggling

under the weight of this and persistently high inflation.

In Europe – which accounted for almost half of the rating

changes in 2011 – the only rating upgrades were in

Central and Eastern Europe (CEE). The Czech Republic,

Latvia, Estonia, Serbia, Romania and Bulgaria were all

moved higher, as was Kazakhstan. The other moves

generally reflected the euro-area sovereign debt crisis,

with many countries suffering multiple downgrades.

Turkey was steady, having been moved higher in 2010,

but is now facing greater downside risks. In part, this

reflects its somewhat eccentric economic policy mix –

interest rates were slashed despite rampant credit

growth, with higher reserve ratios the chosen policy tool

to curb lending. The currency is now looking more

vulnerable as the economy slows but inflation remains

high and the current account deficit widens. Turkey has a

high level of private-sector external debt and may find

refinancing it and the current deficit challenging.

Refinancing risks are likely to be the general theme in

2012. European sovereigns have a particularly heavy

issuance calendar, potentially impacting sovereign

ratings, while banks and corporates also have significant

needs. Rolling over these debts falling due will likely be

testing, particularly for the lower-rated borrowers.

Chart 2: Long-term foreign-currency sovereign credit

outlook

Sources: Standard & Poor‟s, Standard Chartered Research

0

1

2

3

4

5

6

7

8

9

10

Asia CEE Latam Africa Middle East

Industrial Other

Positive

Negative

Economies – Majors


Majors – Charts of the year

12 December 2011 30

Chart 1: Sluggish growth is foreseen in 2012

Real GDP growth, % y/y

Chart 2: Inflation outlook to stay benign

CPI inflation, % y/y

Sources: CEIC, Standard Chartered Research Sources: CEIC, Standard Chartered Research

Chart 3: Divergent trends in money supply

Money supply growth, % y/y

Chart 4: US trade imbalance shows little improvement

Trade balance, USD bn


Chart 5: Fiscal consolidation is necessary

Fiscal balance, % of GDP

Chart 6: Public debt remains under the spotlight

Gross government debt, % of GDP

*For fiscal year starting 1 April

Sources: CEIC, Standard Chartered Research

; Sources: CEIC, Standard Chartered Research

US

Euro area

Japan

-8

-6

-4

-2

0

2

4

6

2006 2007 2008 2009 2010 2011F 2012F 2013F 2014F

US

Euro area

Japan

-4

-2

0

2

4

6

8

Jan-07 Sep-07 May-08 Jan-09 Sep-09 May-10 Jan-11 Sep-11

US

Euro area

Japan

-2

0

2

4

6

8

10

12

Jan-07 Aug-07 Mar-08 Oct-08 May-09 Dec-09 Jul-10 Feb-11 Sep-11

US

Euro area

Japan

-100

-80

-60

-40

-20

0

20

40

Jan-07 Sep-07 May-08 Jan-09 Sep-09 May-10 Jan-11 Sep-11

USEuro area

Japan*

-12

-10

-8

-6

-4

-2

0

2

2001 2003 2005 2007 2009 2011F 2013F

US

Euro area

Japan

0

50

100

150

200

250

Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10


Australia Kelvin Lau, +852 3983 8565

[email protected]

12 December 2011 31

Beyond the mining boom

Economic outlook

Australia‟s growth should improve in 2012 from 2011,

despite clouds over the global outlook, mainly thanks to a

sustained mining-led investment boom. The devastating

floods of early 2011, which led to one of the largest q/q

GDP contractions in 20 years in Q1, will also provide a

low base for comparison in 2012. However, non-mining

sectors will face rising challenges. The more benign

inflation outlook and the government‟s fiscal

consolidation plan mean that the Reserve Bank of

Australia (RBA) can afford to ease pre-emptively and

stay loose in 2012.

Buoyant demand for natural resources from emerging

Asia (especially China and India) and improving terms of

trade have fuelled mining investment and growth in

construction activity and peripheral services. In Q3-2011,

total construction work surged 12.5% q/q, the fastest

since records started in 1986. Total new capital

expenditure rose a seasonally adjusted 12.3% q/q during

the same period. According to the Australian Bureau of

Statistics, private businesses forecast investment of AUD

158bn (+32% y/y) in the year ending in June 2012. More

than half of this will be mining-related, equating to an

84% y/y increase in mining investment.

The mining sector, however, will find itself leaning against

macro headwinds. Symptoms of „Dutch disease‟ have

been evident for some time – the manufacturing PMI, for

example, showed a contraction in activity in 9 out of 11

months in 2011. The gap between the strong mining

sector and weakness in other parts of the economy may

widen further in 2012.

Consumers are likely to become even more cautious

towards spending in 2012. The household savings ratio

has been hovering close to its 2008-09 highs (in the low

teens), and while the decline in housing prices since mid-

2010 has been mild so far, building approvals fell 30%

y/y in October, reflecting weak sentiment. The monthly

average employment change was still positive for 2011

(as of October), but the risk is that more slack will

emerge in 2012.

Financial issues

Australia has been praised for its low public debt, freely

floating exchange rate, and policy credibility. However, its

high net external debt makes it relatively sensitive to

external financing shocks. The RBA will be the first line of

defence in the event of a significant deterioration in the

European sovereign debt crisis.

Policy

The RBA said a key premise for its recent rate cuts (a

total of 50bps since early November 2011) is that inflation

is likely to be within the 2-3% target in 2012 and 2013;

we share this view. We expect the next moves – two

more 25bps cuts in response to a further deterioration in

external growth conditions – to come in Q1-2012.

Increasing weakness in the non-resources sector and the

still-poor visibility of external financing conditions should

also keep the RBA‟s cautiously dovish policy bias in

place for longer. Our latest policy rate forecasts are

closer in line with what the AUD OIS market is currently

pricing in.

The government recently reaffirmed its plan to return to a

budget surplus by FY13 (from a deficit of 3.4% of GDP in

FY11). While this adds comfort to an already healthy

public debt position, the challenging external environment

means that fiscal tightening will have to be heavily back-

loaded. This will make the austerity much more difficult to

implement, and more economically disruptive, when it

finally hits.

Politics

Prime Minister Julia Gillard continues to face the

constraints of a minority government and poor poll results

for her Labor Party. The next federal election must be

held by 30 November 2013.

Standard Chartered forecasts: Australia

2011 2012 2013 2014

GDP (real % y/y) 1.5 2.9 4.0 3.5

CPI (% y/y) 3.4 3.2 3.3 3.0

Policy rate (%)* 4.25 3.75 4.75 4.75

AUD-USD* 0.98 1.05 1.12 1.12

Current account balance (% GDP)

-2.7 -3.5 -3.8 -4.0

Fiscal balance (% GDP)**

-2.5 -0.8 0.2 0.5

*end-period ** for fiscal year starting 1 July



Canada David Semmens, +1 212 667 0452

[email protected] David Mann, +1 646 845 1279

[email protected]

12 December 2011 32

Fiscally responsible, firm growth

Economic outlook

While the outlook for Canada is relatively sedate, its path

remains enviable among the G7. The labour market has

been far more robust than that of the US. The slow but

steady decline in unemployment has been accompanied

by a modest slowdown in wage growth, but consumer

demand has proven robust and is expected to remain so.

The decline in the unemployment rate is likely to be

maintained.

Canada‟s GDP growth has turned around much more

strongly than that of its larger neighbour to the south, to

which its fortunes are closely tied. The recovery in the

North American car industry is playing a role in this.

Interestingly, Canada‟s dependence on the US is

lessening, as reflected in trade flows. Pre-crisis, trade

flows with the US accounted for 75% of Canada‟s total

trade; this has since declined to 67%.

Over the same period, Canada‟s trade flows with China

have more than doubled. This dynamic means that

growth in emerging markets will be vital for Canada at the

margin, especially given its commodity currency status.

Europe accounts for only around 10% of Canada‟s

exports, which should limit the effect on growth of any

fallout from the European sovereign debt crisis.

Financial issues

Canada‟s banking system remains firm, although it is not

immune to the troubles in Europe. Thanks to

conservative mortgage lending policies in the private

sector, Canada avoided most of the problems affecting

the G7 during the global financial crisis. Furthermore, the

government‟s fiscal discipline has caused financial

markets to reward Canada with its lowest-ever yields.

Expectations are that Canada will balance its budget by

2014.

Policy

We expect the Bank of Canada (BoC) to keep rates on

hold at 1.00% until Q3-2012. This pause will be driven by

concerns about domestic and external growth, especially

the uncertain outlook for the euro area. The lack of

inflationary pressure will be supported by persistent

Canadian dollar (CAD) strength. Oil prices continue to be

a key factor for growth in Western Canada. If prices rise

as we expect, this will support the CAD, even if the BoC

keeps rates on hold for longer than we expect. However,

any slowdown in global growth would like cause the CAD

to suffer in sympathy with commodities.

Other issues

Housing prices are now 2.2% above their prior peak,

having risen 5.9% since bottoming in June 2009. Fears of

a housing bubble appear overdone, although households

will be under pressure if interest rates rise significantly,

given the high level of household debt. Meanwhile,

delinquency rates are low and macro-prudential

measures have limited the stimulus to buying from low

interest rates. Canadian consumers continue to pay

down non-mortgage debt, which remained at a stable

level in 2011; we expect this pattern to continue in 2012.

We also see a low risk of a meaningful housing-market

correction given that demand is supported by 2% annual

population growth, an influx of immigrants and rising

wages. Supply is also constrained by the tightening of

local zoning and construction rules.

Politics

Canada is benefiting from a more stable political

environment, with the first majority government in seven

years. Elections were held in early 2011, after the

rejection of the government‟s proposed budget triggered

a vote of no confidence. The Conservative party victory

was underpinned by a pledge to balance the budget by

2014-15 and to cut the corporate tax rate to 15% in 2012

to stimulate job growth. The next election is scheduled for

October 2015.

Standard Chartered forecasts: Canada

2011 2012 2013 2014

GDP (real % y/y) 2.4 2.2 2.4 3.0

CPI (% y/y) 2.5 2.2 2.0 2.0

Policy rate (%)* 1.00 1.50 2.50 3.00

USD-CAD* 1.04 0.98 0.95 0.95


-3.0 -2.5 -2.2 -1.9


-1.8 -1.2 -0.5 0.0

*end-period; ** for fiscal year starting 1 April



Euro area Sarah Hewin, +44 20 7885 6251

[email protected]

Thomas Costerg, +44 20 7885 8615

[email protected]

12 December 2011 33

EMU strains to dominate amid recession

Economic outlook

We expect the euro area to experience a recession in

2012 as economies struggle in the face of fiscal

tightening, constrained credit availability and the euro-

related shock to confidence, which will hold back

business investment and consumer spending.

In an effort to rein in budget deficits, almost every country

in the region is tightening fiscal policy. That said, we

expect deficits to fail to meet 2012 targets in many cases

due to weak or negative GDP growth. Bank lending is

likely to be subdued, partly as a result of weak demand

for loans but also as banks, under pressure to raise

capital ratios, adopt a more cautious stance.

The escalation of the euro-area debt crisis has

contributed to deteriorating sentiment among the region‟s

consumers and businesses. Orders are declining,

inventories are likely to fall and investment projects are

likely to be delayed in response to uncertainty over the

outlook for the region. Net exports should provide

positive support to the economy, although this will be

because of shrinking imports, as moderating global

demand is likely to hold back export growth.

Rising unemployment is set to dampen household

spending and, initially, high headline inflation will further

reduce spending power. Eventually, the expected decline

in energy costs (reflected in overall headline inflation)

should help to reverse the decline in real earnings.

Countries in the periphery are either in recession

(Greece, Portugal), which we expect to continue into

2012, or are likely to move back into recession in 2012

(Spain, Italy) as they suffer from larger fiscal cuts and a

sharper downturn in domestic confidence. Ireland, which

has emerged from a long recession, is likely to struggle

with very weak growth at best.

Even the northern euro-area economies, which did well in

H1-2011, are not immune to the risk of negative growth.

France‟s austerity measures look set to pull the economy

into contractionary territory, while the smaller northern

euro-area countries, which are more dependent on trade

within the region than the larger countries, are struggling

with a drop in demand from the rest of the region.

We expect Germany‟s growth to be below 1%, with

consequences for the broader region. The downturn that

we expect for the region is not as large as in 2008-09,

when the euro-area economy fell by 5% peak-to-trough

as a result of a global shock and a consequent collapse

in global activity. But risks to the outlook are to the

downside, especially if there is a further deterioration in

confidence related to the sovereign debt crisis.

Inflation is likely to edge lower, moving back to the „lower

than but close to 2%‟ target in 2012 and then lower by

Q4-2012. The impact of rising energy and food prices in

2011 will drop out of the index, as will VAT increases

(although there may be further indirect tax hikes in 2012).

Core inflation is likely to remain below 2% as the

recession opens up output gaps.

Financial issues

Banks have substantial refinancing needs in 2012;

access to unsecured loans is likely to remain difficult due

to fragile sentiment.

Banks are required to raise their core Tier 1 capital ratios

to 9% by mid-2012, taking into account the impact of

marked-to-market sovereign debt holdings. Peripheral

banks have the largest capital requirements, and some

may need to be bailed out by their governments. In the

context of a weakening economy, banks‟ assets could be

further affected by rising non-performing loans. It is

difficult to raise capital, so institutions are responding by

selling assets and deleveraging. The European Central

Bank (ECB) will continue to provide unlimited liquidity,

both short- and long-term.

Standard Chartered forecasts: Euro area

2011 2012 2013 2014

GDP (real % y/y) 1.5 -1.5 1.5 2.4

CPI (% y/y) 2.6 1.9 1.6 1.8

Policy rate (%)* 1.00 0.75 1.25 2.50

EUR-USD* 1.30 1.30 1.35 1.30


-0.4 -0.2 -0.4 -0.1

Fiscal balance (% GDP)

-4.1 -3.9 -3.5 -3.1

*end-period Source: Standard Chartered Research


Euro area (con’d)

12 December 2011 34

Policy

In the face of weakening activity and tightening fiscal

policy, it falls to the ECB to stimulate the region‟s

economy. We expect further easing in Q1-2012, with the

refi rate falling to 0.75%. Peripheral bond purchases are

likely to continue, with the ECB increasing its intervention

according to market needs and prepared to take a more

aggressive stance if required.

Policy makers are likely to take steps towards closer

integration – i.e., greater fiscal co-ordination and stricter

enforcement, possibly backed by treaty amendments.

Germany‟s Karlsruhe Court will remain vigilant in terms of

any transfer of power to Brussels. Leaders will fine-tune

the European Stability Mechanism, the permanent

European bailout mechanism set to become operational

in July 2012.

Other issues

Questions over the future of the euro and European

Monetary Union (EMU) are likely to continue to dominate,

especially given large sovereign debt rollover

requirements and continuing banking-sector strains.

Countries are being required to undergo unpopular

austerity to reduce deficits in order to stabilise debt and

restore market confidence. Policy is now aimed at buying

time while deficits are corrected. Yet recession in many

countries means that little progress is likely in terms of

meaningful fiscal deficit reduction in 2012.

The key threats to EMU‟s continuing existence are

predominantly political: whether governments in the

periphery (especially Greece and Italy) will do enough to

ensure continued support from northern euro-area

countries (especially Germany), where electorates are

becoming increasingly hostile to financing bailouts. A

downgrade of any of the AAA-rated guarantors of the

EFSF would raise the facility‟s borrowing costs and make

it less attractive to investors. The IMF and ECB will likely

have to play a more active role in providing a backstop to

peripheral countries with large rollover needs.

We expect a continuing muddle-through scenario, but

risks of policy mis-steps are high. The spectre of an EMU

exit would trigger accelerated deposit withdrawal, which

could become bank runs in several countries; one

country breaking away from EMU would risk creating a

domino effect across the region. This would be

devastating for European economies, leading to a

significantly worse downturn than the one experienced in

2008-09.

Politics

Political risk is particularly high in Greece, where the

technocrat government is likely to call elections once

debt restructuring is concluded, probably in Q1-2012.

Elections would likely return a coalition government.

In Italy, the technocrat government led by Mario Monti

hopes to rule until 2013. However, there is a risk of an

erosion of parliamentary support, especially if more

painful austerity measures are taken, which would force

early elections. Former PM Berlusconi would not run, but

he is likely to remain influential in the background.

France‟s general elections are planned for April-May

2012 (two rounds). Incumbent Nicolas Sarkozy

(conservative) will likely run against the Socialist Party‟s

Francois Hollande (currently ahead in the polls) in the

second round. Support for Marine Le Pen (far-right party)

could rise if the crisis deepens and resentment builds

towards the EU (which she wants to leave), though she is

unlikely to get a parliamentary majority.

Germany will be in the limelight in H2-2012 as political

parties prepare for the 2013 general election. Based on

current trends, Chancellor Angela Merkel is the favourite

to form the next government, possibly as a „rainbow‟

coalition with the opposition Socialists and Greens, rather

than with the Free Democrats, who are trailing in the

polls.

Chart 1: Euro area is facing a double-dip recession

Quarterly GDP, % y/y

Sources: Eurostat, Standard Chartered Research

-6

-5

-4

-3

-2

-1

0

1

2

3

4

2007 2008 2009 2010 2011 2012 f 2013 f 2014 f


Japan Betty Rui Wang, +852 3983 8564

[email protected]

12 December 2011 35

Rocky road to recovery

Economic outlook

The V-shaped rebound we expected after the March

2011 Fukushima earthquake is likely to be delayed until

H2-2012 due to ongoing external shocks. The new

recession in Europe and slow growth in the US, along

with the October 2011 floods in Thailand, have put

Japan‟s fragile economy in jeopardy again. We expect

2012 to be a transition year before large-scale

earthquake reconstruction begins.

We expect exports and investment to drive a renewed

upswing, but a clear uptrend is unlikely before H2-2012

at the earliest. Both exports and investment will gather

pace as constraints on auto and electronics

manufacturing gradually dissipate.

Deflation is also hampering the economic recovery.

Depressed confidence and ultra-low interest rates have

kept Japan in a liquidity trap, leaving the central bank

with little room to manoeuvre. We expect this trend to

continue in 2012, as no dramatic boost to demand is in

sight.

Financial issues

Disaster relief spending and successive fiscal stimulus

packages have pushed up Japan‟s public debt, which is

among the highest of all major industrial economies.

According to the IMF, post-earthquake reconstruction

efforts are likely to incur fiscal costs of around 3% of

GDP over the next several years. This, along with

slowing GDP growth, is likely to push the gross public

debt ratio to 240% of GDP in 2012 from 195% in 2008.

While there is no imminent threat of a public debt default,

further rating downgrades are likely if the public debt

issue is not addressed effectively or the government

delays the introduction of convincing plans to improve its

fiscal position.

Policy

The government is currently planning its fourth extra

budget of the current fiscal year (ending in March 2012),

with a minimum target size of JPY 2trn. However, this is

unlikely to provide much of a boost given the limited

impact of the previous three extra budgets, which totalled

about JPY 18trn (or 4% of GDP in 2010).

On the monetary policy front, there is little room for

manoeuvre, as policy rates are already ultra-low. The

Bank of Japan (BoJ) could respond to a potential

worsening of the economic situation by expanding its

asset purchase programme (at a current size of JPY

55trn); it has already done this three times since the

earthquake.

Other issues

Decisive social security reform is key to structurally

improving the fiscal position and reducing the heavy

burden of entitlement spending. Spending on such

entitlements rose 43% in the eight years to March 2011.

Gradually increasing the sales tax is another potential

way to increase government revenue. The government

plans to discuss a possible tax hike by the end of 2011,

and an agreement is expected in 2012.

Politics

Prime Minister Yoshihiko Noda has been in office since

September 2011. Given the messy domestic situation he

inherited from his predecessor, as well as the

deteriorating global outlook, market observers are

cautious about the stability of Noda‟s government.

Noda faces the challenge of ensuring effective post-

earthquake reconstruction while at the same time

improving the fiscal position. A failure to address these

issues could compromise his popularity, both at home

and abroad, and lead to another leadership change

Standard Chartered forecasts: Japan

2011 2012 2013 2014

GDP (real % y/y) -0.5 0.8 3.1 2.5

CPI (% y/y) -0.2 -0.1 0.2 0.1

Policy rate (%)* 0-0.1 0-0.1 0-0.1 0-0.1

USD-JPY * 77.00 74.00 82.00 90.00


2.2 2.0 3.2 2.8


-10.5 -9.8 -8.5 -7.8




New Zealand Kelvin Lau, +852 3983 8565

[email protected]

12 December 2011 36

Rebuilding growth, bricks-and-mortar style

Economic outlook

New Zealand is expected to literally rebuild its growth

with bricks and mortar following devastating earthquakes

in September 2010 and February 2011. So far,

reconstruction momentum has been frustratingly slow as

aftershocks have hindered planning and building, and as

private insurers hold back from insuring new buildings.

We expect a pick-up in reconstruction activity to boost

2012 growth, offsetting a weaker export outlook and still-

cautious consumer spending. The more challenging task

will be for the government to rebuild its fiscal health in the

coming years.

The Reserve Bank of New Zealand‟s (RBNZ‟s) latest

working assumption for the cost of earthquake-related

repairs is about NZD 20bn, just over 10% of GDP. A

significant amount of reconstruction-related investment is

projected to occur on a multi-year horizon. In contrast,

the recent boost to domestic spending from the Rugby

World Cup is likely to be short-lived; we expect

household spending to stay modest in 2012 as high debt

levels and the uncertain global outlook weigh further on

sentiment.

The external sector will not offer much of a lift to headline

GDP growth in 2012 either. New Zealand‟s persistent

current account deficit may worsen in the coming year as

external demand eases and investment-related imports

stay strong. The terms of trade, after reaching the highest

level since 1974 in Q2-2011, were down 0.7% q/q in Q3-

2011, in line with the recent correction in global

commodity prices.

CPI inflation is likely to fall back into the RBNZ‟s 1-3%

target band in Q4-2011 as the distortion from the 2.5ppt

hike in the goods and services tax in October 2010 drops

out of the y/y number. Higher construction costs will be

offset by a still-elevated jobless rate and weak sentiment.

However, the prevailing accommodative monetary policy

will need to be removed over the medium term as growth

accelerates and inflation pressure re-emerges.

Financial issues

The downgrade of New Zealand‟s sovereign credit rating

by Standard & Poor‟s and Fitch Ratings in September

was a timely reminder of not only the high costs of

earthquake recovery, but also more fundamental issues.

The rating agencies cited the country‟s large external

imbalances and high household and agriculture-sector

debt. „Rebuild, then rebalance‟ (the twin deficits) will be

the government‟s motto in the coming years.

Policy

We expect the RBNZ to keep rates at the current record

low of 2.50% at least through H1-2012. While we still

believe that it plans to normalise its policy rate over the

medium term, the weaker global outlook on the back of

the European sovereign debt crisis is likely to delay the

next hike until H2-2012. Easing inflation expectations

since Q2, along with declining consumer and business

confidence, mean that the RBNZ can afford to wait. The

need for medium-term fiscal consolidation will limit its

aggressiveness when tightening eventually begins.

Politics

Prime Minister John Key and his National Party won a

second three-year term on 26 November 2011, heading

the coalition government. Having pledged a return to a

budget surplus by FY15 (fiscal year starting 1 July 2014),

Key has the difficult task of digging the economy out of a

deep fiscal hole. The FY11 deficit was 9.2% of GDP, or

NZD 18.4bn, with the net cost of earthquake

reconstruction accounting for half of this. In this context,

Key‟s convincing election win is important, giving him a

strong mandate to sell state assets and restrict spending,

all while creating 150,000 jobs. The first partial sale of

state assets, involving a utility company, is likely towards

the end of 2012 (with the government maintaining a

majority stake).

Standard Chartered forecasts: New Zealand

2011 2012 2013 2014

GDP (real % y/y) 1.8 2.4 3.3 3.0

CPI (% y/y) 4.3 2.4 2.9 2.5

Policy rate (%)* 2.50 3.00 4.00 4.00

NZD-USD* 0.76 0.88 0.91 0.91


-4.0 -5.0 -5.5 -5.5


-6.0 -3.5 -1.0 0.1

*end-period; **for fiscal year starting 1 July



United Kingdom Sarah Hewin, +44 20 7885 6251

[email protected]

Thomas Costerg, +44 20 7885 8615

[email protected]

12 December 2011 37

High recession risks

Economic outlook

The UK economy is likely to be in recession going into

2012 as the negative impact of fiscal tightening and

falling real incomes is compounded by a downturn in

demand from the UK‟s largest trading partner, the euro

area. We expect GDP to contract in H1-2012, before

bottoming out and eventually recovering in H2-2012.

The government is implementing tax hikes, cutting

allowances and reducing expenditure with a view to

virtually eliminating cyclically adjusted net borrowing by

FY17 and stabilising public-sector net debt (by FY15,

according to current targets). As a result, public-sector

wages are declining in real terms and jobs are being lost.

The private sector has not been compensating for rising

unemployment in the public sector, and real wages are

shrinking there, too. Government cutbacks are having an

impact on private-sector contracts, and the capital

spending budget has been particularly hard hit.

The euro-area slowdown has a direct impact on UK

exporters (just under half of the UK‟s exports go to the

euro area); the crisis is also damaging confidence, with

businesses halting decisions on investing in plant and

machinery linked to production destined for the euro

area. Orders are falling, and involuntary inventory

building is likely to turn into destocking, which could have

a substantial impact on growth.

Inflation is likely to fall sharply to the 2% target or below

by Q4-2012, from well above the target in Q4-2011. The

impact of the January 2011 increase in VAT to 20% from

17.5% will drop out of the index in Q1-2012. Headline

inflation should decline further in Q2-2012, when we

expect food and energy inflation to slow due to base

effects. Meanwhile, rising unemployment is likely to keep

private-sector earnings growth low and public-sector

wages are close to stagnant, so wage-cost pressures

should be muted.

Financial issues

The Bank of England has warned that stressed funding

conditions could make it difficult for some UK banks to

meet their balance-sheet needs. Risks to financial

stability are likely to stay high in 2012. UK banks have

some GBP 140bn of term funding due to mature in 2012,

front-loaded in H1; they are likely to have to pay more for

funding and to rely more on collateralised term funding.

Pressure on funding markets is also likely to result in

more subdued lending, while the recession will damage

credit quality.

Policy

Amid heightened concerns over the impact of fiscal

tightening and the risk of recession in the euro area,

Bank of England policy makers are likely to maintain a

loose monetary policy. We expect the Bank Rate to

remain unchanged at 0.5% throughout 2012. We forecast

another round of quantitative easing in Q1-2012, aimed

at offsetting deflation risks.

The economic downturn is likely to increase pressure on

the government to relax its fiscal austerity measures, but

the example of the euro-area periphery‟s spiralling

borrowing costs is likely to keep UK policy makers

reluctant to back-track on the austerity programme.

Other issues

The UK remains highly vulnerable to a deterioration in

the euro-area crisis, in terms of trade and investment

flows as well as business confidence.

Politics

The UK will not have a general election until 2015, and

the coalition has committed to serving its full term.

However, the economic downturn is likely to put

additional pressures on the governing coalition.

Standard Chartered forecasts: United Kingdom

2011 2012 2013 2014

GDP (real % y/y) 0.7 -1.3 1.5 2.3

CPI (% y/y) 4.4 2.1 1.6 1.8

Policy rate (%)* 0.50 0.50 0.50 2.00

GBP-USD* 1.53 1.55 1.60 1.55


-1.8 -1.4 -1.8 -2.2

Fiscal balance (% GDP)*

-9.3 -8.8 -8.2 -6.8

*end-period; ** for fiscal year ending 31 March



United States David Semmens, +1 212 667 0452

[email protected] David Mann, +1 646 845 1279

[email protected]

12 December 2011 38

Economic wounds continue to heal

Economic outlook

Growth in 2012 is likely to follow a similar pattern to

2011, but for very different reasons. Business

investment, one of the main drivers of GDP growth in

2011, is likely to face a tough start to the year. Critically,

the reduction in temporary tax cuts and concerns about

the global growth outlook will weigh on business

optimism. Although the US consumer continues to

recover, a lack of global demand is keeping hiring

lacklustre and real wage growth anæmic at best.

The US government, which has previously been able to

provide significant fiscal support, now has to tackle its

own debt crisis. It is required to implement at least USD

2.2trn of deficit cuts under the Budget Control Act 2011,

which allowed the debt ceiling to be raised. Attempts to

repeal some of the automatic cuts which start in 2013

would go down badly with the rating agencies. While

residential investment is likely to show some firmness,

this will be concentrated in multi-family homes in more

built-up areas where rental demand remains high.

Access to mortgage credit remains a separate issue.

With mortgage applications back at 1997 levels, buyers

are remaining out of the market as they wait for a lasting

bottom in both prices and activity.

Inventories will remain a swing factor dependent on

sentiment, but we see US firms operating leanly. We

expect a minimal drag from inventories in H1-2011,

giving way to gradual accumulation as demand recovers

and the outlook improves. Despite recent volatility,

barring a shock similar to the Japanese earthquake, net

exports are also likely to be largely neutral throughout

2012.

We expect both headline and core inflation to moderate

in the medium term as weak wage growth, caution

towards the outlook and high unemployment force

businesses to absorb a higher proportion of rising input

costs. Interestingly, rental prices have risen; this reflects

a continuing structural shift away from homeownership

rather than increasing demand, in our view. Only a

persistent significant oil shock would give rise to

concerns about the medium-term outlook for inflation.

The labour market continues to tread water, with the

unemployment rate making only minimal progress

downwards due to labour-market growth. The vast

majority of this progress can be attributed to the

discouraged worker effect. We expect job growth to

average 150,000 per month in 2012 and 180,000 over

the longer term. This will result in unemployment finishing

2012 at 8.5% and 2013 at 8.2%. Hiring is unlikely to

provide much optimism. With growth expected to remain

below trend, non-farm payrolls are unlikely to consistently

breach 200,000 – a level that would drive unemployment

firmly lower.

Financial issues

The significant overhang of foreclosures remains one of

the biggest issues facing the US economy. The debt

overhang means that consumers feel significantly less

wealthy, with one-third of homeowners in negative or

next to negative equity. This is unlikely to improve in

2012, as we expect home prices to increase in line with

inflation at best. Consumers are taking a more

responsible approach to credit and continue to cut back

on credit card use. Non-revolving credit, which is typically

used to purchase cars and kitchen appliances, has

recovered somewhat.

The US dollar (USD) remains the world‟s reserve

currency, although the events of 2011 have no doubt

accelerated emerging-market central banks‟ plans to

diversify away from USD-denominated assets. Prolonged

debt concerns in Europe have provided a continued safe-

haven boost to US Treasuries. We look for a modest rise

in yields in 2012, after they bottom in Q1.

Standard Chartered forecasts: United States

2011 2012 2013 2014

GDP (real % y/y) 1.8 1.7 2.5 3.0

CPI (% y/y) 1.7 1.6 1.8 2.0

Policy rate (%)* 0.25 0.25 0.75 1.75


-3.1 -2.8 -2.9 -2.9


-8.5 -7.2 -4.9 -4.0



United States (con’d)

12 December 2011 39

Policy

We look for the first rate hike to come in Q3-2013, and

expect further quantitative easing (QE) in Q1-2012. The

FOMC‟s commitment to keeping rates on hold through

mid-2013 is more likely to be extended than shortened.

The continuing lacklustre recovery, particularly in the

labour market, remains the number one priority for the

FOMC.

The moderation in inflation in 2012 should leave the door

open for further QE by the FOMC. We expect this to take

the form of monthly purchases of a similar size to the

USD 75bn seen under QE2. However, rather than a

specific amount and termination date, we expect a stated

minimum amount of purchases and an „at least until‟

commitment – most likely until November 2012 in order

to allow for greater action should conditions warrant it.

We expect the purchases to be a combination of

Treasuries and MBS.

The rotation of regional Fed presidents is likely to lend a

more dovish stance to the FOMC in 2012, with only one

hawk rather than three vocal dissenters in 2011. This is

also supportive of further action from the FOMC in 2012.

Other issues

Small businesses continue to identify weak demand as

the main hurdle to expansion. This is concerning, as the

small business sector is vital to the health of the US

labour market, having provided the majority of

employment growth this century. We believe that the

disappointing National Federation of Independent

Businesses survey is one of the most overlooked data

releases, and until we see a real turnaround in this

sector, any optimism about the outlook should remain

muted.

We see plenty of scope for further increases in auto

demand, with auto sales having spent four years below

their long-run average. Importantly, the improvement in

auto financing and non-revolving credit looks set to

continue. While used and new car prices rose sharply

after the supply-chain shocks resulting from the

Japanese earthquake, we expect prices to moderate

further, supporting sales.

Rating agency downgrades to the US sovereign rating

are more likely a story for 2013 than 2012. S&P has

already downgraded in the aftermath of the debt ceiling

debate, and Fitch has revised its outlook to negative. A

key area of focus will be whether the stalemate on how to

cut the deficit remains in place after the November

presidential election.

Politics

Current polls show President Obama marginally ahead in

the 2012 presidential election, and political campaigning

will intensify on all fronts early in 2012. The key points of

contention will be the economy, jobs and the deficit. The

most important point for the markets and the rating

agencies will be a coherent plan to address the deficit.

Weak growth is likely to make bringing the deficit under

control even more difficult. The race to the White House

could be complicated by a third or even fourth candidate

alongside the main party nominations.

The battles for the Senate and the House of

Representatives will be equally important. In the 100-

member Senate, the Democrats are expected to have 23

seats up for election, while the Republicans are

anticipated to have 10. Current polls show the

Republicans taking a slim majority in the house, but with

seven seats as a toss-up, the race could go either way.

While the Republicans currently hold a 49-seat majority

in the House of Representatives, all 435 members will be

up for re-election.

Regardless of the election winner, further measures are

required to trim the deficit. Whether they take the form of

tax increases (Democrats) or spending cuts

(Republicans) will depend on which party dominates US

politics after 6 November.

Leavers hide true extent of unemployment

Constant participation rate of 66.5%, LR average 1990-2007


0%

2%

4%

6%

8%

10%

12%

14%


Official unemployment

Constant participation rate unemployment

Economies – Asia


Asia – Charts of the year

12 December 2011 41

Chart 1: Below-trend growth for most Asian economies

Real GDP growth forecast (%)

Chart 2: Decelerating export growth, stable consumption

Asian export and retail sales growth, % y/y


Chart 3: Cheaper fuel and food prices to tame inflation

Asian inflation and CRB Commodity Price index (y/y)

Chart 4: Rapid loan growth to decelerate

Lending growth (y/y)

Sources: Bloomberg, Standard Chartered Research Sources: CEIC, Standard Chartered Research

Chart 5: Korea’s vulnerability to USD liquidity squeeze

has lessened

Moody’s External Vulnerability Indicator

Chart 6: International bank lending to Asia from selected

sources

Q2- 2011, USD mn

Sources: Moody‟s, Standard Chartered Research Sources: BIS, Standard Chartered Research

2011E

0

2

4

6

8

10

12

CN HK TW KR SG MY ID TH PH VN IN

2012F

2000-10 average

Retail sales

Exports

-40%

-30%

-20%

-10%

0%

10%

20%

30%

40%

50%


Commodity Price Index

Inflation (RHS)

-2%

-1%

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

-60%

-40%

-20%

0%

20%

40%

60%

Jan-07 Oct-07 Jul-08 Apr-09 Jan-10 Oct-10 Jul-11

Dec-09

Jun-10

Jun-11

Latest

0.00

0.05

0.10

0.15

0.20

0.25

0.30

0.35

CN HK IN ID KR MY PH SG TW TH

2008

2011

0

10

20

30

40

50

60

70

80

90

100

CN PH TW TH MY ID IN KR

0

100,000

200,000

300,000

400,000

500,000

600,000

700,000

800,000

900,000

Mar-05 Jan-06 Nov-06 Sep-07 Jul-08 May-09 Mar-10 Jan-11

UK

Japan

US

Europe ex-UK


Asia Tai Hui, +65 6596 8244

[email protected]

12 December 2011 42

A test of resilience, once more

Economic outlook

We expect Asian economies to decelerate significantly in

2012. Although this will be partly driven by stagnation in

the West, policy tightening by the Asian authorities in

2010 and 2011 is also taking effect. We expect Asia‟s

growth to slow to 6.5% in 2012 from 7.3% in 2011 and

9.1% in 2010, with exports leading the deceleration. We

expect Q1 and Q2-2012 to be the weakest point of this

economic cycle; some economies, such as Singapore,

could experience contractions. Asia is still expected to

outperform relative to other regions, but growth will be

below potential.

Exports are likely to lead Asia‟s slowdown. Domestic

demand, especially in export-oriented economies, will

also soften as job and income growth slow or even

contract temporarily. While we do not expect the

magnitude of the 2009 downturn to be repeated, the

relative performance of export-dependent economies

versus domestic-led economies is likely to be similar. The

argument that Asia must become less dependent on

exports and more dependent on domestic demand will

regain momentum. But countries with large rural

populations, including China, India and Indonesia, will

enjoy structural boosts from urbanisation and growth of

the middle class.

Inflation is expected to take a backseat, at least in H1-

2012, amid a weaker growth environment. Asia is still

vulnerable to spikes in commodity prices, as seen in

2008 and 2011, but the threat will be limited until the

region returns to solid growth.

Financial issues

Domestic issues need to be considered alongside global

factors. In China, Hong Kong and Singapore, the

residential property markets are undergoing a correction.

Developers in China are particularly vulnerable to a real-

estate correction. Weak investor sentiment and macro-

prudential measures imposed by governments are

common themes in Hong Kong and Singapore. In Hong

Kong, mortgage rates have risen due to tightening HKD

liquidity conditions. In Singapore, rising supply in the

private residential market in the next one to two years

and slower population growth could force a correction in

both rents and property prices.

In South Korea, the level of FX reserves relative to short-

term external liabilities remains high, although it has

improved since 2008 due to a gradual reduction in

foreign-currency liabilities and a rise in FX reserves. The

expansion of Korea‟s bilateral swap arrangements with

China and Japan to USD 140bn will also help to reduce

US dollar liquidity stress.

In India, stubborn inflation has left the central bank with

little choice but to raise policy rates in 2011, even as the

rest of the region has paused to assess the more

challenging external environment. India‟s banking sector

is likely to be pressured by high interest rates in two

ways. First, non-performing assets typically rise following

the peak of the interest rate cycle. This requires high

provisions and possible capital injections from the

government for some public-sector banks. Second, the

combination of higher interest rates and savings rate

deregulation could cause a compression in net interest

margins.

Vietnam continues to struggle with a delicate balance-of-

payments position, low FX reserves, and fickle local

investor sentiment. The government is also pursuing

banking-sector consolidation. Indonesia‟s possible

upgrade to investment grade, and the associated inflows,

will need to be managed carefully in order to prevent

overheating and asset bubbles.

Policy

Asian central banks started to ease monetary policy in

Q4-2011, and we expect more easing in 2012. China

began reducing its required reserve ratio in early

Standard Chartered forecasts: Asia ex-Japan*

2011E 2012F 2013F 2014F

Real GDP growth 7.3 6.5 7.5 6.5

IMF 7.7 7.5 7.8 7.8

Inflation 5.8 3.3 4.2 4.3

IMF 6.2 4.6 4.0 3.6


2.6 1.5 2.1 2.2

IMF 3.8 3.8 4.1 4.2

*2010 USD GDP-weighted total of 13 regional economies



Asia (con’d)

12 December 2011 43

December. We expect another cut in December, and five

more in 2012. Thailand and Indonesia have already

reduced their policy rates, and we expect Korea, the

Philippines, India, Malaysia and Vietnam to follow suit in

H1-2012.

Policy makers also need to be mindful of the choppy

capital inflows likely to result from monetary easing by G7

central banks. Given its robust fundamentals and low

household, business and government leverage, Asia is

likely to be on the receiving end of this wall of liquidity

once global investor confidence stabilises. Central banks

across the region will also need to take into account rapid

lending growth in the past 12-18 months. As a result of

these factors, the pace of policy rate cuts in Asia is likely

to be less aggressive than in 2008-09.

Asia‟s growth is expected to slow in 2012, but not fall off

a cliff. While inflation peaked in the summer of 2011, the

decline has been slow as global food and energy prices

remain firm. Moreover, Asia remains vulnerable to a

spike in food and energy prices; this is especially true for

low-income economies where a larger proportion of

household income is devoted to food and fuel.

Fiscal policy is expected to play an active role in

supporting growth. Low debt levels for most Asian

governments imply that there is ample room for

government stimulus, either in the form of automatic

stabilisers (lower revenue and higher social welfare

spending) or explicit fiscal measures. In 2009, the

region‟s fiscal impulse (the increase in the fiscal deficit

relative to 2008) was in the range of 2-4% of GDP. Some

Asian governments also introduced innovative policies to

limit private-sector job losses and encourage bank

lending by sharing credit risks with the banking sector;

such measures could be quickly reinstated if needed.

Politics

2012 is set to be a busy year of elections and political

transition in Asia. In China, the change of leadership is

likely to be further clarified, and the incoming leaders are

expected to indicate their stance on how to tackle

property-sector problems, local government debt, and

rising income inequality. Korea and Taiwan will hold

presidential and parliamentary elections in 2012, and

Hong Kong will elect a new Chief Executive and

Legislative Council. Against this backdrop, governments

may be more proactive in responding to global economic

challenges.

In South East Asia, no elections are scheduled in 2012,

but the Malaysian government could call an early federal

election ahead of the March 2013 deadline. Prime

Minister Najib is expected to push ahead with the New

Economic Model and Economic Transformation

Programme, which aim to transform Malaysia into a high-

income economy by 2020. The ruling coalition will need

to win over the middle class if it is to regain its two-thirds

majority in the parliament.

In Thailand, tensions between the ruling Puea Thai party

and the opposition could resurface in 2012. PM

Yingluck‟s expansionary fiscal policy and attempts to

grant amnesty to former PM Thaksin Shinawatra could

elicit a strong reaction from the opposition. Indonesia has

presidential elections scheduled for 2014. It is too early to

speculate on potential candidates, but any hint of a

succession plan could impact market perceptions of the

country‟s structural development, especially as President

Yudhoyono‟s reform programme appears to have been

constrained by corruption scandals within his own party.

India will hold elections in five states in Q2-2012. In the

run-up to the polls, politicians at the state level are likely

to resist government reforms, including a proposal to

allow FDI in multi-brand retail. This implies that while

progress on reforms will continue, the pace will be

slowed by politics. Policy paralysis – including stalled

approvals of key investment projects – is unlikely to

improve as government officials avoid potential

corruption charges by side-stepping large decisions.

Ample room for stimulus

Public debt and FX reserves of Asian economies


SG*

MYPHIN CN

TH TWKR

ID

HK0

20

40

60

80

100

120

0 5 10 15 20 25 30

Go

vern

men

t d

ebt

as %

of

GD

P

FX reserves (months of imports)


Bangladesh Christine Shields, +44 20 7885 7068

[email protected]

12 December 2011 44

Still resilient, but strains are emerging

Economic outlook

Bangladesh has performed remarkably well over the last

few years. Although growth has edged down, resilient

exports, improvements to the electricity supply and

strong remittances should result in solid prospects for

the next couple of years or so. The government has

targeted 8% GDP growth by FY15 (begins 1 July 2014)

in its latest six-year plan. While this may prove a stretch,

output growth is unlikely to slow to less than 6%, still

strong compared to the rest of the region.

Domestic demand remains the mainstay of activity.

Though data are limited on the expenditure side,

investment spending appears to have inched up in the

last fiscal year despite energy outages, while

consumption is likely to have been held back by high

inflation, which erodes household spending power. In

order to move Bangladesh‟s economy onto a higher

growth path, the government must provide a more

supportive policy stance by pushing through

infrastructure spending and more liberalising economic

reforms. There have been some positive developments

in the energy sector, but progress is still too slow.

Exports reached a record high in FY11 and have

remained robust since, though the pace of growth has

slowed. Exports are outperforming other Asian countries

despite tough market conditions, probably reflecting

Bangladesh‟s low-cost advantage. Garments are still the

main driver and are benefiting from a substitution effect

as consumers look for cheaper alternatives, which will

limit downside risks if the crisis in Europe worsens.

Woven garments, knitwear and leather goods have been

success stories, and exports of frozen foods are growing

robustly from a low base. Tea exports have fallen.

High inflation is a worry. We expect inflation to stabilise

at 10.5% in FY12, and to fall thereafter due to more

stable commodity prices and policy tightening. The

recent depreciation of the Bangladeshi taka (BDT) is not

helpful in this regard, especially if the weakening trend

persists as we expect.

The balance of payments is deteriorating because of

high commodity prices and rising demand for imported

capital goods. Investment-related demand for imports

will continue, driven by large projects such as the

Padma Bridge. The decline in remittances is also a

factor leading us to predict a current account deficit of

0.6% of GDP in FY12. Reserves have been falling, and

at end-FY11 they provided just 2.9 months of import

cover – a limited cushion, especially with the BDT so

soft and the current account in deficit.

Policy

Rising prices are also having adverse fiscal

consequences. Subsidy spending is increasing,

offsetting the benefit from strong (and impressive) tax

collection. The fiscal deficit for FY11 was 4.2% of GDP,

up from 3.7% in FY10. While this is relatively modest,

the pace of deterioration is becoming a concern.

As subsidy costs rise, reform is necessary to maintain

funding for social and development spending. New

regulation is needed if the government is to meet its tax

revenue target of 13% of GDP. A new VAT law and a

wealth and property tax will not take effect until 2014.

Monetary policy tightening will continue in 2012, but its

effectiveness is in question. The most recent

Bangladesh Bank statement expressed a clear

emphasis on restraining credit growth. Broad money

grew by 21.4% y/y in FY11, much higher than the target

of 15.2%. The effects of raising reserve requirements

and interest rates were negated by unsterilised

intervention in the FX market. Given the loose credit

environment, coupled with currency and inflationary

pressures in 2012, further rate hikes look likely.

Standard Chartered forecasts: Bangladesh

2011 2012 2013 2014

GDP (real % y/y) 6.7 6.4 6.5 6.9

CPI (% y/y) 9.0 10.5 9.0 7.0

Policy rate (%)* 6.75 7.25 8.0 8.0

USD-BDT* 77.50 78.00 77.00 76.50


0.9 -0.6 -0.7 -0.5


-4.2 -5 -5.5 -5.6

Note: All forecasts except USD-BDT refer to the July-June fiscal year

ending in the year in column heading; *end-period



Bangladesh (con’d)

12 December 2011 45

It is possible that multilateral intervention will help to

improve the policy environment. An Extended Credit

Facility from the IMF is under consideration. The

government is seeking USD 1bn to support its external

position, but the conditionality attached is proving

testing, especially on the fiscal side. Revenue collection,

tax reform and subsidy reform are contentious for Dhaka

to pass; energy price reform is a particular stumbling

block. If conditions in these areas are met, talks will be

able to resume, but the IMF is so far reportedly

unimpressed with Dhaka‟s delivery. Failure to win IMF

support will likely bear down on the currency.

Financial issues

Low reserve cover, the weakening exchange rate and

the widening budget deficit will undermine attempts to

tighten monetary policy. Despite interest rates and credit

ceilings already having been raised, credit growth looks

set to remain uncomfortably high, in part because of

forced lending to the government by the central bank.

This essentially monetises the deficit, fuelling inflation as

well as distorting credit flows.

Nonetheless, the private banks are in good shape, with

the majority having increased their capital adequacy

ratios in line with Basel II by end-FY11. Most indicators of

financial soundness show improvements for commercial

banks. Lenient reporting standards are a worry, though,

especially for state banks.

The state-owned commercial banks have been allowed

to shift losses off their balance sheets. On a mark-to-

market basis, their average capital adequacy ratio drops

way below the Basel II requirements. The central bank is

likely to monitor this closely.

Other issues

Infrastructure development is desperately needed,

particularly of the power supply. The government is

taking some positive steps. It has outlined a plan to

expand capacity by over 12,000 MW, which would

require significant participation from the private sector in

the short term.

A deal was signed on 2 November with Russia over the

potential construction of a nuclear power station with a

capacity twice the size of the current national energy

deficit, at a forecast cost of USD 1.5-2bn. The plant, if

built, should provide not only a long-term boost to the

energy supply but, critically, an improvement in supply

consistency. This would mean an end to the constant

outages which are a major barrier to business growth.

Nuclear is part of a policy of diversification in energy

supply, away from the oil and gas dependence adopted

over the last 10 years. This should free up domestically

produced gas for commercial use and loosen energy

linkage limits. The limit on new electricity and gas

connections introduced in 2010 has effectively strangled

new business growth and expansion and led to

widespread and constant public disorder for over 18

months.

Obviously changes in energy policy have a medium-

term time scale: nuclear power generation will not begin

before 2017 at the earliest. In 2012, Bangladesh will

continue to rely on expensive imported oil for energy,

resulting in persistent power shortages, outages and,

hence, the associated protests.

Politics

On the broader political front, disruptive protests and

demonstrations persist, not just about power outages,

but about recent stock-market losses. These caused

problems earlier in 2011 that led to concerns about the

quality of the regulatory backdrop. In early December, a

new round of weakness beset the stock market, which is

now more than 40% down from its December 2010

peak.

This also presents downside risks to an already-difficult

political scene. Parties remain as polarised as ever, and

constructive policy making has rarely been achieved in

Bangladesh‟s history.

Bangladesh: Electricity production plan

Additional generating capacity, MW

Source: Power and Energy Sector Road Map: An Update, 2011

Private

Public

Total

0

500

1,000

1,500

2,000

2,500

3,000

3,500

2010 2011 2012 2013 2014 2015 2016


China Stephen Green, +852 3983 8556

[email protected]

Wei Li, +86 21 6168 5017

[email protected] Lan Shen, +86 21 6168 5019

[email protected]

12 December 2011 46

Getting used to 8%

Economic outlook

Four questions will dominate in China in 2012. First, can

the authorities maintain economic growth at such a pace

that the labour market does not weaken significantly?

Exports, a big provider of jobs, will see single-digit growth

at best. Second, can Beijing engineer a soft landing in

the real-estate sector? Apartment prices are already

correcting down, and unsold inventories will not be run

down quickly. Third, can anything substantial be done to

rebalance the economy? Domestic imbalances are

getting worse, not better. Fourth, where will China‟s new

leadership team (who will start work in October) want to

take the country from 2012-22? And, more importantly,

will they be able to get there?

We look for 8.1% real GDP growth in 2012, with a mild

rebound to 8.7% in 2013. We believe the risks are

skewed to the downside. To achieve this rate of growth,

capital investment will need to grow at least 9% (after

nearly 11% in 2011), and this is the key risk.

Infrastructure projects are finding it harder to access

bank financing as banks try to limit their exposure to local

governments. City governments‟ land-sale revenues are

down y/y, too. Fewer big projects are ready to be

approved, thanks to the front-running of projects under

the CNY 4trn stimulus package. Also, as we explain

below, commercial real-estate construction will slow

considerably, possibly turning negative y/y in Q2-2012.

We expect private consumption to grow around 9% y/y,

the same pace as in 2011. Although wage pressures will

likely moderate, we still look for broad income growth and

expect consumption to continue to be driven by the

millions of people entering the consumer class. Rural

income growth is likely to continue to outpace urban

income growth.

Inflation will not be an issue in 2012, in our view. We look

for an average rate of 2% y/y for the year (and 3.6% in

2013). Food price increases will be contained by lower

input costs as well as a supply response. Input costs will

fall alongside weak global demand and commodity prices

(though quantitative easing by Western central banks will

support commodities).

We expect net exports to subtract 1ppt from 2012 growth,

assuming nominal growth of 5% in exports and 9% in

imports. A weaker global growth environment is possible.

Exports currently provide 15-20% of China‟s GDP growth

but absorb 30-40% of manufacturing output growth.

Financial issues

China‟s current account surplus has fallen significantly in

the last four years, mostly as a result of the investment

boom and high global commodity prices. We look for a

current account surplus of 1.9% of GDP in 2012; the

smaller trade surplus will reinforce calls for slower

Chinese yuan (CNY) appreciation, on which more below.

Opening up the capital account seems to have become a

soft policy goal for 2015. Reformers appear to believe

that this target – which is linked to the internationalisation

of the currency – will help promote domestic reforms. In

2012, we expect moves to further facilitate foreign

investors‟ (including central banks‟) access to onshore

capital markets. The State Administration of Foreign

Exchange may also boost the quota for how much FX

households can buy with their CNY. The offshore CNH

market developed rapidly in 2011, though growth in

offshore CNH deposits slowed in Q4, hit in part by

negative global risk sentiment. Beijing will likely continue

to look for ways to develop this market.

The banking system is still weighed down by local

government exposure (some 20% of outstanding loans),

and we have long argued that some kind of central

government rescue package will be needed to

recapitalise the sector. This is unlikely to appear in 2012.

Local government loans falling due will be rolled over.

Standard Chartered forecasts: China

2011 2012 2013 2014

GDP (real % y/y) 9.2 8.1 8.7 7.0

CPI (% y/y) 5.4 2.0 3.6 4.0

Policy rate (%)* 6.56 6.56 7.06 7.56

USD-CNY* 6.34 6.21 6.03 5.83


3.5 1.9 2.7 3.1


-1.0 -1.5 -2.0 -2.5



China (con’d)

12 December 2011 47

Policy

Despite talk of „rebalancing‟, progress has been limited in

recent years. Indeed, we estimate that investment as a

proportion of GDP exceeded 50% in 2011, up from 43%

in 2008. The bureaucracy has expanded, state

enterprises have resisted policies that threaten their

interests (e.g., competition reforms), and key prices –

such as interest rates and the exchange rate – remain

controlled and distortionary. Some in Beijing argue that

without another wave of reforms – modernising health

care and education or opening up services to competition

– growth will falter during the 2013-16 period.

Housing policy appears to be the exception to the no-big-

reform rule, and the concerted campaign to bring down

prices that began in early 2010 is bearing fruit. Prices for

new projects in many Tier 1 and 2 cities are already

down 10% from their peak. But the fundamental

problems that push up home prices (low real interest

rates and local governments‟ reliance on land revenues

for their discretionary income) have not been addressed.

We expect housing prices to fall 20% in Tier 1 and 2

cities but only 5-10% nationwide; the authorities are likely

to loosen some controls in Q2-2012 in order to prevent a

wave of real-estate bankruptcies. A soft landing is likely.

We expect the People‟s Bank of China (PBoC) to keep its

loan quota in place, targeting new loans at around CNY

8.5trn in 2012, up from CNY 7.5trn in 2011. If there was a

significant negative shock to external demand and a

bigger deterioration in the job market, we would look for

an interest rate cut or two. However, with interest rates

already low, we do not see the need for cuts (and the

PBoC would prefer to push rates higher, if anything). We

look for administered interest rates to be flat in 2012. We

expect five required reserve ratio (RRR) cuts of 50bps

each in 2012, following one in early December 2011 and

another expected in late December.

Fiscal policy will officially remain „proactive‟ in 2012, but

the Ministry of Finance (MoF) usually means „supportive

of rebalancing‟ rather than „stimulative to economic

activity‟ when it uses this phrase. The MoF aims to

continue its roll-out of the value-added tax (VAT) through

the services sector (eventually including financial

services), replacing the much-criticised Business Tax.

Less usefully, the MoF will also be throwing tax cuts at

„strategic‟ industries. The overall tax burden, at 26% of

GDP (without counting the government‟s non-tax

revenues), is already high, especially considering the

limited services provided for such taxes.

We look for the CNY to appreciate 2.1% against the USD

during the year, though at a slow pace in H1-2012. This

will take USD-CNY to 6.21 by year-end. We expect

several monthly trade deficits in H1, with exporters

suffering from contracting demand in Europe, their

biggest market. FX outflows could accelerate as the

housing market corrects down and political risk rises in

the run-up to the 18th

Party Congress in October. As a

result, we expect more ups and downs in USD-CNY, but

the year should still bring a small appreciation. Likely

Republican US presidential candidate Mitt Romney has

stated that he would name China a currency manipulator

on his first day in office, so 2013 will be an interesting

year for US-China relations if he wins.

Politics

The final question hanging over 2012 is whether the new

leadership will reignite serious reform. Few expect 2012

to be a year of reform given that internal „elections‟ for

thousands of posts will dominate. The handover to the

new nine-person Politburo Standing Committee will take

place in October at the 18th

National Congress of the

Communist Party of China. Little is known about how the

new team – to be led by Xi Jinping as Secretary General

and Li Keqiang as Premier and head of the State Council

– will act. Vice Premier Wang Qishan is thought to be a

likely Executive Vice Premier. Most of this team will serve

two five-year terms, and one or two of the „next-

generation‟ leaders may also appear in the Politburo. The

most likely course is continued gradualism, but given the

complex and interconnected nature of the current

challenges, this strategy may stop working.

China’s growth profile

GDP, contributions to real growth, ppt


Consumption

Government

Investment

Net exports

-5

-3

-1

1

3

5

7

9

11

13

15

2000 2002 2004 2006 2008 2010 2012


Hong Kong Kelvin Lau, +852 3983 8565

[email protected]

12 December 2011 48

Domestic resilience shines through

Economic outlook

Given the highly uncertain global outlook, a small and

open economy like Hong Kong is bound to have its fair

share of worries in 2012. While inflation pressure should

recede, growth concerns will take over as the economy

slows further in H1 before rebounding. The extent of the

contraction, if any, is likely to be smaller than in 2008-09,

and the property sector is more likely to consolidate than

collapse; at the same time, though, the economy may not

benefit as much from looser global monetary conditions

as it did last time. Of greater certainty are the resilience

of the USD-HKD peg, the maturing of the offshore CNY

(CNH) market, and the continuation of the government‟s

broad policy direction, regardless of who takes the

government‟s helm following the March election.

We expect GDP growth to ease to 2.9% in 2012 from

5.0% in 2011. While Hong Kong has escaped a technical

recession so far, it is not out of the woods yet – we see

the risk of small GDP contractions in Q4-2011 and Q1-

2012 in seasonally adjusted q/q terms. This would still be

materially better than the 2.7% contraction in 2009,

predicated on the assumptions that US growth will be

disappointingly low but still positive; the recession in

Europe will be shallow; and China will achieve a soft

landing.

With external demand likely to get worse before it gets

better, net exports will remain a significant drag on

growth; y/y export performance may not bottom out until

H1-2012, and should average around -10% y/y for the

whole of 2012. Domestic demand, however, is still

capable of doing much of the heavy lifting. Compared to

the last economic downturn, we expect unemployment to

peak at a much lower rate of around 4% this time

(leading to steady real income growth in the low single

digits, also helped by easing inflation). We also foresee a

shallower correction in residential property prices and

continued strong spending by mainland tourists. A „two-

speed‟ economy characterised by resilient domestic

demand and a weak external outlook remains the theme.

We believe inflation peaked in Q4-2011, and its

downtrend – to be led by lower food inflation in y/y terms

– will become more evident throughout 2012. The CPI

housing component should also soon start to reflect the

cooling of the residential property market since June

2011. Beyond food and housing, however, any easing of

price pressure should be mild given well-supported

wages and continuing strength in domestic demand.

We reiterate that we do not view Hong Kong‟s residential

property market as a bubble. Yet, like most markets, it is

subject to cycles. The murky external outlook, slowing

domestic growth and higher mortgage rates mean

residential property buyers are likely to remain cautious,

keeping the market in correction mode for another

quarter or two. The absence of over-leverage, over-

speculation and other bubble characteristics should

ensure that any further price correction is shallow and

orderly – similar to what we have seen in H2-2011. That

said, we expect transaction volumes to stay low and

prices to stay volatile before sentiment rebounds.

Financial issues

Local monetary conditions are determined by US interest

rates and capital flows. We expect the Fed to start hiking

rates only in Q3-2013; this means that USD LIBOR, and

therefore HIBOR, will only start a sustained trend higher

in Q1-2013 at the earliest.

The outlook for capital flows is tougher to call, given the

opposing risks of (1) European banks withdrawing funds

from Asia; and (2) a flood of liquidity resulting from

imminent QE3. The good news is that Hong Kong has so

far displayed safe-haven qualities – the Hong Kong dollar

(HKD) outperformed all other Asia ex-Japan currencies

except the Chinese yuan (CNY) against the USD in H2-

2011 (as of 31 November), spending most of its time on

Standard Chartered forecasts: Hong Kong

2011 2012 2013 2014

GDP (real % y/y) 5.0 2.9 5.6 4.5

CPI (% y/y) 5.2 3.5 3.5 3.0

3M HIBOR (%)* 0.35 0.35 1.10 1.90

USD-HKD * 7.795 7.790 7.775 7.775


6.5 5.5 6.5 6.0


4.7 2.0 3.0 3.0




Hong Kong (con’d)

12 December 2011 49

the strong side (7.75-7.80) of the Convertibility

Undertaking band. This still falls short of the HKD gains

seen during the last crisis, when USD-HKD spent

considerable time testing the strong-side Convertibility

Undertaking threshold of 7.75. This prompted the Hong

Kong Monetary Authority (HKMA) to sell HKD into the

market, boosting the Aggregate Balance.

The Aggregate Balance, a gauge of interbank liquidity,

has not grown in size since the HKMA last intervened in

late 2009. Now at HKD 150bn, it remains sizeable

compared to its historical norm of less than HKD 5bn.

This buffer should be sufficient to keep the short end of

the HIBOR curve from jumping higher in the case of

transient outflows (or from fully tracking USD LIBOR

higher, as evident in recent months). Liquidity in the

interbank market, however, will not help to bring down

banks‟ high loan-to-deposit ratios.

The loan-to-deposit ratio for banks in Hong Kong has

been climbing mainly on the back of fast loan growth.

This has prompted banks to pay up for deposits and to

reprice loans (including mortgages and trade finance).

We expect such ratio-induced liquidity tightness, and the

resulting repricing pressure on bank loans and deposits,

to continue in 2012 (barring sizeable enough fresh capital

inflows to expand the monetary base again). This is

partly premised on still-strong cross-border loan demand,

even as mainland China loosens monetary policy.

The continued development of the CNH market is likely

to remain a bright spot for the financial sector. This

market was hit by global market turbulence in late

September, but the subsequent renewal, expansion and

improved flexibility of the CNY trade settlement

conversion quota should restore market confidence and

facilitate smoother operation over time. The recent

finalisation of streamlined CNH FDI rules, together with

the issuance of the first-ever Dim Sum bond by an

onshore corporate, sets the scene for more Renminbi-

denominated investible assets to come on board in Hong

Kong. CNH lending, having finally taken off in 2011, is set

to continue to amaze. However, we expect the pace of

CNH deposit accumulation to slow in 2012 due to a more

balanced mix of imports and exports in CNY trade

settlement. The simplification of some existing

regulations would facilitate market development.

Policy

We do not expect the existing USD-HKD peg to change

in the foreseeable future. We see no obviously better

alternative to the current system – at least not until the

CNY becomes fully convertible and internationalised,

among many other pre-requisites. In the meantime, the

increased availability of CNH investment products should

not be mistaken for full currency substitution. The

credibility of the HKD will continue to be derived from the

time-tested, rule-based Linked Exchange Rate System.

The upcoming budget on 1 February will be an extension

of the October Policy Address, with a focus on

addressing social issues. We also expect concessions

aimed at countering the growth slowdown. The

government has a deep war chest to dip into; using its

fiscal resources to promote cross-border co-operation

and shore up Hong Kong‟s competitiveness will be key.

Politics

An election will be held on 25 March 2012 to select a new

Chief Executive (CE) for Hong Kong. The Basic Law,

Hong Kong‟s „mini-constitution‟, bars incumbent CE

Donald Tsang from running for a third term. Candidates

will be voted on by a 1,200-member Election Committee.

The two perceived front-runners are Henry Tang (former

Chief Secretary for Administration) and C.Y. Leung

(former Convenor of the Executive Council). Both are

seen as pro-Beijing, and while a victory for Tang would

signify an extension of the current administration, Leung

has promised “change while preserving stability”. We see

no major changes in the broad direction of government

policy, regardless of who takes the helm come July 2012.

A Legislative Council election will also be held in

September 2012.

Private consumption to remain an anchor

Projected contributions to growth by GDP component, ppt


PCE

Net exports

Others-6

-4

-2

0

2

4

6

8

10

12

14

Q1-11 Q2-11 Q3-11 Q4-11 Q1-12 Q2-12 Q3-12 Q4-12

GDP growth, % y/y


India Anubhuti Sahay, +91 22 6115 8840

[email protected]

Nagaraj Kulkarni, +91 22 6115 8842

[email protected]

Shilpa Singhal, +65 6596 8259

[email protected]

12 December 2011 50

High time to act!

Economic outlook

The current combination of relatively slow growth and

high inflation is a warning signal that policy inaction

needs to be addressed and reforms need to be

accelerated immediately. The economic outlook for the

rest of FY12 and FY13 will hinge crucially on the

government‟s ability to restore investors‟ confidence in

India‟s long-term story. Global developments will

undoubtedly play an important role too, but India‟s ability

to weather the adverse environment will depend on its

domestic policies – especially if it aims to remind the

world of its structural positives.

GDP growth has already slipped below trend. It slowed to

6.9% y/y in Q2-FY12 (ended September 2012), the

weakest in two years, from 7.7% in Q1-FY12. Growth is

unlikely to reverse course until Q1-FY13. Government

efforts to kick-start the investment cycle, which is already

in a contractionary phase, have been minimal. While

household consumption – currently at its weakest level

on record – is likely to find a floor thanks to government

spending in rural areas and a healthy labour market,

weak consumption will weigh on investment in a

feedback loop. External demand, an important growth

driver until now, will fade if the euro area falls into

recession and US growth is below trend.

Sub-7% growth for four successive quarters paints a

gloomy picture for India‟s economy. However, on a

positive note, demand-side pressure on inflation (WPI

inflation has been above 8% since January 2010) is likely

to be squeezed out. If so, inflation should slow to the 6.5-

7.0% range by March 2012 and remain at 6.5% in FY13.

Hence, the Reserve Bank of India (RBI) is likely to

reduce interest rates starting in Q1-FY13 (ends 30 June

2012). We expect the RBI to cut rates by 150bps in

FY13. This should improve investment sentiment,

causing growth to rebound, particularly in H2-FY13. We

forecast FY13 growth at 7.4%.

Risks to our views stem from two key factors. First, if

global commodity prices surge as they did in 2010,

inflation might remain elevated, delaying rate cuts and

thus an upturn in the investment cycle. Second, a failure

to break the policy inertia would impede growth, both in

FY13 and over the long term.

Financial issues

Indian banks‟ asset quality is under cyclical and structural

pressure in an environment of high policy rates and low

growth. Given stress on some corporate sectors, our

base-case scenario assumes that India‟s NPL ratio could

rise to 6-7% in two-years from 2.3% at end-March 2011.

However, most of India‟s banks should be able to absorb

additional provisioning losses, especially if they take the

restructuring route. Moreover, banks are better

capitalised than they were in 2008-09, and the

government intends to boost their capital base by March

2012, As a result, stress in the banking system appears

manageable.

In addition to the cyclical story, the markets will watch for

progress on the granting of new banking licences. India

last issued a new banking licence in 2004. Given the

rapid pace of economic growth, demand for banking

services has increased manifold since then. Though

action on this front is unlikely to come soon – a

parliamentary standing committee is expected to submit

its report in August 2012 after extensive consultation with

the RBI – revised guidelines would improve sentiment.

Progress on economic reforms – including the Pension

Fund Regulatory and Development Authority Bill and the

revamp of the tax system – will be in focus.

Standard Chartered forecasts: India

2011 2012 2013 2014

GDP (real % y/y) 7.0 7.4 8.0 8.0

WPI (% y/y) 8.7 6.5 6.0 6.0

Repo rate (%)* 8.5 7.0 7.0 7.0

USD- INR* 51.5 48.5 46.5 44.0


-3.1 -2.8 -2.6 -2.5


-5.6 -5.5 -5.0 -5.0

Note: All forecasts except USD-INR refer to the April-March fiscal year

starting in the year in the column heading; *end-period



India (con’d)

12 December 2011 51

Policy

The skewed focus of fiscal expenditure on increasing the

purchasing power of vulnerable groups of society without

a corresponding emphasis on supply-side policies has

resulted in persistent inflation. Fiscal reforms, especially

on the expenditure front, are therefore important.

Subsidies need to be reduced, particularly given that the

expected slippage in the FY12 fiscal deficit to 5.6% of

GDP from the targeted 4.6% is driven primarily by the

subsidy burden. However, given upcoming state

elections, the political will to curb populist expenditure will

be low. At the same time, slower growth might curb

revenues. This should keep the FY13 fiscal deficit high,

at 5.5% of GDP.

Huge government borrowing, especially in response to

unexpected slippage from budget targets in a tight Indian

rupee (INR) liquidity environment, may put stress on the

Government of India Securities (GoISec) market. In this

context, the RBI‟s liquidity management policy will be

important.

Since the RBI adopted a new monetary policy operating

procedure in March 2011, banking-system liquidity has

been in deficit (and hence the repo rate has been the

operative rate) in order to ensure effective transmission

of monetary policy. It will be interesting to see if the repo

rate remains the operative rate or if the RBI – by pushing

banking-system liquidity into a surplus – switches to the

reverse repo rate as the operative rate. The latter would

mean cumulative rate cuts of 250bps, as the reverse

repo rate is currently 100bps below the repo rate.

While we expect the RBI to continue with its open-market

operations (OMOs) to ease liquidity pressures and

manage government borrowing – c.INR 500-600bn for

the rest of FY12 – we believe a reduction in the cash

reserve requirement might also be required to narrow the

liquidity deficit to a comfortable level.

External stresses are likely to remain a theme for the rest

of FY12 and in H1-FY13. We expect little relief for the

trade deficit as exports slow and the reduction in the

import bill is limited by oil imports and investors‟ huge

appetite for gold. Hence, despite stable flows in the form

of services exports and remittances, funding the current

account deficit – forecast at 3.1% of GDP in FY12 and

2.8% in FY13 – may prove challenging. Indeed, global

risk aversion, weak local fundamentals, upcoming debt

redemptions and regulatory changes in the international

banking system are likely to result in a balance-of-

payments deficit in FY12 before a marginal improvement

to a USD 7bn surplus in FY13. Hence, the INR is likely to

remain on a weak footing in the near term – we forecast

USD-INR at 53 by March 2012, before reverting to 48.50

by the end of 2012 on better domestic growth/inflation

dynamics. However, deeper reforms will be required to

attract sustained capital inflows, especially as the build-

up of FX reserves has been limited in the recent past.

Other issues

The government needs to push hard on delayed

economic reforms. Its recent efforts to accelerate the

process have hit a roadblock – the announcement that

foreign investment would be allowed in multi-brand retail

has been put on hold as it faced vehement opposition

both within and outside the ruling party. While enacting

big-bang reforms appears difficult, especially with 2012

state elections looming, the momentum on this front

needs to continue. Low-hanging fruits such as allowing

FDI in the aviation sector should be targeted first. More

contentious issues like the land acquisition bill will take

time to be implemented.

Politics

Corruption charges against the ruling United Progressive

Alliance (UPA), and its inability to bring down inflation,

have strengthened the position of the opposition. This

shift in the power balance has limited the government‟s

efforts to push ahead with reforms. Indeed, the decision

to delay FDI in multi-brand retail shows that contentious

reforms are unlikely, as the ruling party would prefer to

avoid a mid-term poll. The ruling party‟s term ends in May

2014.

Growth and inflation are expected to slow

% y/y


GDP WPI (RHS)

5%

6%

7%

8%

9%

10%

11%

12%

0%

2%

4%

6%

8%

10%

Mar-10 Sep-10 Mar-11 Sep-11 Mar-12 Sep-12 Mar-13

Forecast


Indonesia Fauzi Ichsan, +62 21 2555 0117

[email protected]

Eric Alexander Sugandi, +62 21 2555 0596

[email protected]

12 December 2011 52

Not immune to the global slowdown

Economic outlook

The continuing global economic slowdown is likely to

affect Indonesia in 2012. The domestic economy has so

far been resilient given its relatively low dependence on

global growth and trade – domestic consumption

generates around 65% of GDP, while net exports

contribute only 10%. Given robust household

consumption and fixed investment, we expect GDP

growth to accelerate to 6.5% in 2011 from 6.1% in 2010.

Nevertheless, we expect growth to slow to 5.8% in 2012

as the impact of the global economic slowdown is

transmitted to the country through two main channels: (1)

the financial channel, via slowing FDI and foreign

currency-denominated bank lending; and (2) the trade

channel, via slowing exports.

We expect domestic consumption growth to remain

unchanged at 4.7% in 2012, as cuts in the Bank

Indonesia (BI) policy rate to a record low are likely to

reduce bank lending rates, cushioning consumer

spending. However, growth in investment (25% of GDP)

is likely to slow to 8.2% in 2012 from 10.3% in 2011 as

corporates postpone investment plans amid uncertain

export prospects and reduced availability of long-term

financing due to the pullback by European banks.

Headline inflation, which fell to 4.2% y/y in November

2011 from 7% in December 2010, is likely to rise again to

5% by the end of 2012. Expected increases in electricity

tariffs and subsidised fuel prices, along with rising rice

prices following severe floods in Thailand (a key supplier

of rice to Indonesia), are likely to revive inflationary

pressure. However, this will be partly offset by softer

domestic demand and a stronger Indonesian rupiah

(IDR) in H2-2012.

We expect Indonesia‟s current account surplus to shrink

to USD 3bn in 2012 from USD 4bn in 2011 as export

growth slows. However, resilient commodity prices

should support the trade surplus in 2012 – approximately

60% of the country‟s exports are commodities (oil, gas,

coal, palm oil, etc.). Import growth is also likely to slow on

softer domestic demand and lower prices of imported

capital goods and raw materials, which make up over

90% of imports. We expect the trade surplus to shrink to

USD 31bn in 2012 from USD 34bn in 2011.

Financial issues

The euro-area recession and global economic slowdown

will affect Indonesia more through financial markets than

international trade, as was the case in 2009. Given the

expected deterioration in the euro-area crisis in Q1-2012,

banking liquidity and investor appetite for emerging-

markets assets are likely to diminish rapidly. This will

trigger renewed volatility, temporarily weakening the IDR

in Q1-2012 and limiting the availability of funding for fixed

investment in the private sector in H1-2012. While BI has

sufficient FX reserves (USD 114bn in October 2011,

versus USD 50.2bn in November 2008) to minimise day-

to-day IDR volatility, it cannot provide FX liquidity for

long-term corporate investment. This will weaken an

engine of Indonesia‟s economic growth.

To minimise the impact of the global slowdown, BI cut its

BI rate by 75bps in Q4-2011 to a historic low of 6%. We

expect it to cut the rate further to 5.75% in Q1-2012, and

to keep it there until end-2012. Given expected

inflationary pressures in 2012, we do not expect BI to cut

rates more aggressively or to lower banks‟ reserve

requirement, currently set at 10.5% of their IDR deposits.

The BI governor is keen to ensure that policy rate cuts

are followed by cuts in banks‟ lending rates. Although

bank credit growth likely picked up to 25.5% in 2011 from

22.8% in 2010, BI wants to prevent a sharp credit

slowdown in 2012 by compelling banks to cut their

lending rates, either through moral suasion or

regulations. BI also wants to reduce Indonesian banks‟

average net interest margin of 5.5-6.0% (which makes

them among the world‟s most profitable) and share the

Standard Chartered forecasts: Indonesia

2011 2012 2013 2014

GDP (real % y/y) 6.5 5.8 6.5 6.8

CPI (% y/y) 5.4 4.5 5.3 5.4

Policy rate (%)* 6.00 5.75 6.25 6.25

USD-IDR* 9,150 8,700 8,400 8,100


0.5 0.3 0.1 0.0


-1.0 -1.3 -1.5 -1.8



Indonesia (con’d)

12 December 2011 53

financial burden of slower economic growth. We expect

bank credit growth to slow to 20% in 2012.

The BI governor‟s efforts to micro-manage banks are

opposed internally by some BI technocrats, who argue

that credit growth is already too high and is potentially

inflationary. Given that BI‟s regulatory powers over banks

are expected to diminish with the planned establishment

of a financial services authority in 2013, we believe a

comprehensive BI plan to regulate bank lending rates

would not be fully implementable.

Policy

We believe Indonesia‟s ability to weather a global

slowdown rests not on monetary policy but on fiscal

policy – specifically, the capacity to spend government

budgets at both the central and regional levels. While the

central government targets a fiscal deficit of 2.1% of GDP

for 2011, it ran a surplus of 0.1% of GDP in the first 10

months of the year. As of October 2010, the government

had an accumulated unspent balance of more than USD

22bn (3.2% of 2010 GDP) from past fiscal years. We

expect the fiscal deficit to gradually rise from 0.6% of

GDP in 2010 (versus a 2.1% target) to 1.0% in 2011

(2.1% target) and 1.3% in 2012 (1.5% target) – well

below the 3% constitutional cap.

While we do not expect a marked acceleration in public

spending, we do expect parliament to pass the long-

delayed land acquisition law in H1-2012, which will

strengthen the government‟s legal basis to clear land for

infrastructure projects. Other hurdles to infrastructure

development are likely to remain, including the inability of

most of Indonesia‟s 497 municipal governments to

effectively build projects and the cumbersome

mechanism for allocating funds from the central to

regional governments.

The government‟s cash surplus is likely to enable

President Bambang Yudhoyono to resist calls (even from

the finance ministry) to sharply raise domestic fuel prices,

which would be politically unpopular, to cut government

spending on energy subsidies, Subsidy spending

amounts to 17.5% of the 2012 budget. While higher

global oil prices have pushed up spending on energy

subsidies, they have also increased tax revenue from

commodity sectors such as palm oil and coal, resulting in

an almost neutral net impact on the government budget.

Indonesia has enjoyed consistently low fiscal deficits and

a declining public debt-to-GDP ratio (to an expected 25%

in 2011 from 90% in 2000). Even though this is by default

rather than by design and is keeping annual GDP growth

below its 8-9% potential level, it is likely to improve

investors‟ perception of Indonesia against a backdrop of

fiscal crises and sovereign rating downgrades in the US

and Europe. All three rating agencies (S&P, Moody‟s and

Fitch) currently rate Indonesia one notch below

investment grade. We expect an upgrade to investment

grade before the end of 2012.

Politics

Given that the next general election is not until 2014, we

do not expect much change in the political environment in

2012. President Yudhoyono‟s latest cabinet reshuffle (in

October 2011) and corruption scandals within his

Demokrat party have had little nationwide impact. While

the reshuffle is unlikely to make his coalition government

more effective, there is also little opposition in the hung

parliament. The widely held view is that as long as there

is political stability, economic growth is likely to remain

stable, in spite of an ineffective government.

Indonesia‟s geopolitical situation is likely to remain

stable. Unlike some of its neighbours (such as Malaysia,

the Philippines and Vietnam), it does not have territorial

disputes with China. Internally, the threat of terrorism and

Islamic fundamentalism has receded, with the number of

terrorist attacks declining markedly over the last three

years. That said, Indonesia‟s economic growth has not

been balanced, and inequality indicators have worsened

in recent years. This could potentially fuel political

instability in the run-up to the 2014 parliamentary and

presidential elections.

Growth will be affected by global slowdown

Real GDP growth (% y/y)

Source: National Statistics Agency

0

1

2

3

4

5

6

7

8

Q1-06 Q1-07 Q1-08 Q1-09 Q1-10 Q1-11


Malaysia Edward Lee, +65 6596 8252

[email protected]

Tai Hui, +65 6596 8244

[email protected]

12 December 2011 54

Resting on commodities

Economic outlook

We expect GDP growth to ease to 2.7% in 2012 from an

estimated 4.8% in 2011. The slowdown will be caused by

external weakness – US fiscal policy is paralysed by

politics, the EU is mired in a debt crisis, and China is

slowing due to the effects of monetary policy tightening in

the last two years. Malaysia‟s relatively open economy,

with trade at about 177% of GDP, leaves it susceptible to

weak global growth. Exports to the EU accounted for

10.7% of the total in 2010.

The commodity sector will be a key determinant of

growth in 2012, as it was in 2011. Palm oil, rubber and

liquefied natural gas contributed 70% of Malaysia‟s 8%

export growth in the first nine months of 2011.

Commodities are also important to rural spending, and

resilient prices can buffer the domestic economy against

external headwinds. We have a relatively benign view of

commodity prices, expecting crude palm oil prices to

average MYR 3,450/tonne in 2012, up from MYR 3,216

in 2011.

The government currently forecasts 2012 GDP growth at

5-6%. Investments under the government‟s Economic

Transformation Programme (ETP) are likely to drive

growth. The government expects private and public

investment to rise by 15.9% and 7%, respectively, in

2012. This may be too aggressive, particularly given the

poor global economic outlook (during the previous global

crisis in 2009, private investment contracted 17% y/y).

The government could provide some fiscal support –

public investment rose 7.5% in 2009 – but it will also be

mindful of the need for fiscal consolidation.

Inflation will become less of a concern in 2012. We

expect the inflation rate to average 2.6%, down from

3.3% in 2011. Higher food prices have been the primary

contributor to inflation in 2011. With global food prices

easing since H2-2011 and the global economic outlook

worsening, we expect a further downward correction in

prices. While sporadic supply-side pressures may arise

from events such as the floods in Thailand, we expect the

government‟s administered price schemes to provide a

cushion against short-term fluctuations.

The government has maintained the subsidy level at

MYR 33.2bn for 2012. Given upcoming elections, it is

likely to want to avoid a public backlash against subsidy

reductions. This will also cap price pressures that may

emerge if quantitative easing measures in advanced

economies cause global commodity prices to rebound.

According to a November 2011 update, the government

is making good progress on the ETP, which aims to

transform Malaysia into a high-income economy by 2020.

The government has attracted investments totalling MYR

177bn, or about 13% of the MYR 1.4trn targeted by 2020.

However, investment growth (under GDP accounting)

was only about 5.1% in 9M-2011, which does not

suggest a structural pick-up in investment compared to

recent years (excluding 2008-09, when investment fell

due to the global crisis). The environment in 2012 may

not be conducive to private investment either, suggesting

that the government will have to pick up the slack. On a

more positive note, the ETP may be helping to revive

FDI. The government is targeting an ETP investment split

of 73% domestic and 27% foreign. Inward FDI rose to

MYR 26.4bn in 9M-2011 from 18.6bn in the same period

in 2010; this also exceeded the MYR 24.8bn for the same

period in 2007, before the global crisis.

Financial issues

We estimate federal government debt at 53.8% of GDP

in 2011, marginally higher than 53.1% in 2010. This is

manageable, particularly given strong growth (nominal

GDP growth has averaged 8.2% over the last 10 years).

We expect the government to adhere to the fiscal rule

that debt should not exceed 55% of GDP. As such, we

expect fiscal consolidation efforts to continue over the

next few years.

Standard Chartered forecasts: Malaysia

2011 2012 2013 2014

GDP (real % y/y) 4.8 2.7 5.4 4.5

CPI (% y/y) 3.3 2.6 2.8 3.1

Policy rate (%)* 3.00 2.50 3.25 3.50

USD-MYR* 3.18 3.03 2.88 2.75


12.0 9.5 10.5 12.7


-5.4 -4.7 -4.4 -4.0



Malaysia (con’d)

12 December 2011 55

We expect USD-MYR to benefit from the resumption of

trend appreciation in Asian currencies in H2-2012.

Malaysian ringgit (MYR) performance in H1 will be

affected by weak global sentiment and a potential bout of

seasonal weakness in Q2. However, we expect the MYR

to gain against the USD in H2 due to strong current

account surpluses, commodity support and flush global

liquidity searching for yield. Our end-2012 USD-MYR

forecast is 3.03.

Despite the lower fiscal deficit target for 2012 (4.7% of

GDP versus 5.4% in 2011), government borrowing will be

high, with the net borrowing requirement set at MYR

43.6bn. However, this is lower than the MYR 45.1bn in

2011. We estimate the 2012 gross borrowing

requirement at MYR 89bn, a touch lower than MYR 90bn

in 2011.

The domestic bond market has continued to attract

strong foreign interest in 2011. Even taking into account

the sharp risk sell-off in September, foreign ownership of

Malaysian Government Securities (MGS) rose to 34.8%

of the total outstanding as of September 2011 from

28.3% in December 2010. Further quantitative easing in

advanced economies in 2012 should benefit the MGS

market as Asian currency appreciation resumes. In

addition, given the potential for rate cuts and

deteriorating domestic economic conditions, there may

be scope for the bond yield curve to adjust lower and

flatter.

Policy

We expect Bank Negara Malaysia (BNM) to cut the

Overnight Policy Rate by a total of 50bps in 2012,

starting with a 25bps cut in March. Slower economic

activity, largely due to external weakness, should cause

BNM to focus on growth over inflation concerns. While

growth may not collapse as it did in 2008-09, a further

deterioration of the European situation may cause the

central bank to become more dovish and growth-oriented

in Q1-2012.

Inflation, which can be considered a lagging indicator, is

expected to become less of a concern. If the government

maintains government subsidies as expected (especially

for fuel), this should reduce inflationary pressure, giving

BNM more policy flexibility.

Despite earlier concerns about its commitment to fiscal

consolidation, the government presented a relatively well-

balanced budget for 2012. The deficit target of 4.7% of

GDP was a pleasant surprise after 5.4% in 2011. The

government also announced a healthy dose of social

measures to help lower-income groups, with total

subsidies expected to remain unchanged at MYR 33.2bn.

The government‟s GDP growth estimate of 5-6% appears

on the high side. However, its revenue and expenditure

projections are both conservative. Total revenue is

projected to rise only 1.9% from 2011, while total

expenditure is expected to be largely unchanged. This

should limit potential slippage from the deficit target.

Politics

The next general election must be held by March 2013.

Imminent elections are widely expected, although such

expectations have been rife since 2010. In the last

election, held in March 2008, the ruling Barisan Nasional

(BN) coalition won 140 of the 222 parliamentary seats,

versus the opposition Pakatan Rakyat‟s 82 seats.

Although BN won the simple majority needed to form the

federal government in 2008, it lost the two-thirds super-

majority required to amend the Constitution for only the

second time since 1969. At the state level, the opposition

won in 5 out of the 12 contested states, improving from

only one state victory in the previous election (although

BN regained the state of Perak in February 2009 after

defections by assembly members). The focus on politics

will continue, particularly amid widespread calls for

political reform.

BNM may cut rates in early 2012

Output gap based on 4-quarter GDP sum


Output gap (actual as % of potential

GDP)

2.0

2.2

2.4

2.6

2.8

3.0

3.2

3.4

3.6

-4%

-3%

-2%

-1%

0%

1%

2%

3%

4%

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

OPR (%; RHS)

Forecast


Pakistan Sayem Ali, +92 21 3245 7839

[email protected]

12 December 2011 56

Gearing up for elections

Economic outlook

Election years are characterised by populist measures to

support growth, and we expect this to be the case in

2012. We forecast GDP growth at 4% in FY12 (ends 30

June 2012), up from 2.4% in FY11, when flood damage

reduced growth. The combination of higher government

spending and accommodative monetary policy will boost

growth. Visible improvements in the security environment

are also supportive of the growth outlook.

Reforms that are critical to reducing the build-up of debt

and containing inflation – including tax measures and a

reduction in energy subsidies – will be stalled or even

scaled back in some cases. The government is in no

mood to hold back in the run-up to the elections, and

record spending is expected to result in a fiscal deficit of

6.5% of GDP in FY12, against the budget target of 4%.

This will support growth but will also add to inflationary

pressures.

Downside risks remain high in 2012 due to slowing

export growth, weak private credit growth and the risk of

higher inflation. Private credit growth slowed to 1.6% y/y

year-to-date in 2011 (as of 11 November) from 5.5% in

2010, despite 200bps of rate cuts in H2-2011. This is

primarily because heavy government borrowing from

banks has crowded out private-sector credit. Investment

is still declining as the country‟s uncertain political and

security environment and growing energy crisis deter

both foreign and domestic investors.

Inflation has declined in 2011 on tighter money supply

and a stronger Pakistani rupee (PKR). However, the

central bank is “uncertain” whether inflation will come

down to the single digits in 2012, as targeted by the

government. Inflationary pressures are building, as

reflected in rising core inflation. Inflation risks have

increased due to the widening government and trade

deficits. In our view, inflation will persist and rise in 2012

due to a weaker PKR and money printing by the

government to finance its rising deficit.

Financial issues

Election years are also periods of heightened uncertainty,

with foreign investors and multilateral donor agencies

staying on the sidelines. The PKR depreciated 28% in

2008, the last election year, and Pakistan had to go to

the IMF for a bailout. We do not anticipate a balance-of-

payments crisis in 2012, given that FX reserves are

comfortable at USD 16.9bn (5.6 months of import cover).

However, the widening current account deficit and large

external debt payments will add to pressure on the PKR.

The PKR has come under significant pressure in H2-

2011 due to the widening trade deficit and large external

debt payments. A slowdown in private capital flows and

aid inflows from the US government and multilateral

institutions has also pressured the PKR, which had

depreciated 4% year-to-date to 88.99 against the US

dollar (as of 1 December), from 85.5 in December 2010.

We anticipate a further 5.3% correction in 2012, and

forecast USD-PKR at 94.0 at end-2012.

The current account deficit widened to USD 1.6bn in the

July-October 2011 period from USD 541mn in the same

period in 2010. This was mainly caused by a sharp drop

in commodity prices, with Pakistan‟s exports heavily

concentrated in cotton and textile products. We expect

export receipts to decline by 5% to USD 24.2bn in FY12

from USD 25.5bn in FY11. The import bill is rising,

primarily due to the country‟s growing dependence on oil

imports.

The State Bank of Pakistan (SBP) has warned that the

current account deficit has exceeded its earlier forecasts,

and that financing it will remain a challenge owing to the

Standard Chartered forecasts: Pakistan

2011 2012 2013 2014

GDP (real % y/y) 2.4 4.0 4.8 5.0

CPI (% y/y) 13.9 12.0 13.0 12.0

Policy rate (%)* 14 12 13 12

USD-PKR* 89 94 98 100


0.3 -1.5 -1.8 -2.3


-6.5 -6.5 -6.2 -5.6

Note: All forecasts except policy rate and USD-PKR are for the fiscal

year ending 30 June; * end period;



Pakistan (con’d)

12 December 2011 57

slowdown in FDI and official aid inflows. The SBP‟s FX

reserves declined to USD 13.3bn at end-October from

USD 14.8bn in June. They will come under further

pressure in the coming months from higher external debt

payments, including USD 1.2bn of repayments to the

IMF. Total debt repayments are a hefty USD 4.2bn in

FY12 and could rise to USD 5bn in FY13. Pakistan will

struggle to retire the IMF loan and maintain its FX

reserves position.

The banking sector is resilient. Profitability has improved,

and banks are building up stronger capital bases, with a

healthy sector-wide capital adequacy ratio of 14.1% as of

June 2011. Liquidity conditions have improved, with the

loan-to-deposit ratio having fallen to 56.7% in 2011 from

75.2% in 2008. However, rising NPLs are a major

concern. The ratio of NPLs to total loans increased

sharply to 15.3% in June 2011 from 7.6% in 2007.

Policy

The markets‟ main concern is the sharp build-up of debt

and the government‟s inability to meet its budget targets.

The government is likely to overshoot its FY12 budget

deficit target of 4% of GDP; we forecast a deficit of at

least 6.5%. Financing this will be a challenge, especially

with official aid flows slowing and the privatisation

programme stalled. Government borrowing from banks

increased sharply to PKR 631bn (3% of GDP) from 1 July

through 18 November 2011, higher than the PKR 606bn

borrowed during all of FY11.

This level of borrowing has been possible because of

liquidity injections of PKR 340bn (1.5% of GDP) by the

SBP. However, the central bank says such injections

have developed “permanent” characteristics and will fuel

inflation going forward. With the SBP having kept rates

on hold at its 30 November meeting, markets will now

demand higher premiums to hold government paper. This

could force the government to print money to finance its

large deficits, fuelling inflation.

After cumulative rate cuts of 200bps in 2011, the SBP

has struck a cautious note about the medium-term

outlook, warning that inflationary pressures are building

again. At its 30 November meeting, the SBP kept the

overnight deposit and lending rates unchanged at 9%

and 12%, respectively. In our view, the rate-easing cycle

has come to an end, with little room to bring rates down

further in the near future. We expect the SBP to keep

rates on hold in Q1-2012, and see a strong possibility

that rising inflation will force it to hike as early as Q2-

2012.

Politics

Parliamentary elections are expected in late 2012 or

early 2013, and government policies will be characterised

by populist measures. The election season begins with

the important Senate elections in March 2012, with the

ruling People‟s Party (PPP) and its allies expected to be

the big winners. The focus will then turn to the general

elections. The political environment has started to heat

up, with opposition parties holding large street protests to

force early elections. Most independent surveys indicate

that support for the ruling PPP has declined due to weak

economic performance, with opposition parties expected

to gain strength. The PPP-led government is also facing

charges in the Supreme Court, and important court

rulings are anticipated in 2012 on corruption charges

against the party leadership.

2011 has been a very difficult year for Pakistan-US

relations, and with political parties talking tough ahead of

the elections, relations look likely to get worse before

they get better. US aid flows to the military remain

suspended, including USD 2bn of payments under the

Coalition Support Fund. The disbursement of non-military

aid, including the USD 7.5bn pledged under the Kerry-

Lugar Bill, has been slow; only USD 179mn was released

in FY11.

Inflation and growth outlook

% y/y

Sources: SBP, Standard Chartered Research

GDP growth

CPI inflation

0

5

10

15

20

25

Q1-05 Q1-06 Q1-07 Q1-08 Q1-09 Q1-10 Q1-11 Q1-12f


Philippines Betty Rui Wang, +852 3983 8564

[email protected]

12 December 2011 58

Another test of resilience

Economic outlook

We expect the Philippines to be more resilient than other

Asian economies in 2012 as the Western economic

outlook deteriorates further, thanks to strong domestic

demand and investment. However, there are growing

downside risks, both onshore and offshore.

The main pillars of support for the economy in 2012 will

be private consumption and government spending and

investment. Consumption will continue to be supported

by solid inward remittances from overseas workers.

Government spending/investment is expected to gather

pace, after falling short of expectations in 2011, as

public-private partnership (PPP) infrastructure projects

get underway in 2012.

The export sector is unlikely to recover until at least H2-

2012 as external demand takes time to resume;

manufacturers are also recovering only slowly from the

supply-chain impact of the Japanese earthquake.

Electronics exports have been plunging since August

2011 as the global economic downturn has aggravated

supply-chain disruptions. We expect exports – especially

of electronics, which accounted for 60.4% of the 2010

total – to regain momentum in Q2-2012, when global

demand and regional supply chains are likely to be back

on track.

Inflationary pressure is likely to ease in 2012 as the

impact of higher oil and food prices – the two main

drivers of inflation in 2011 – dissipate further, partly on

the back of weakening global demand.

Financial issues

The government debt burden should continue to decline

gradually following the government‟s adoption of a zero-

based budgeting method to manage expenditure. The

public debt ratio is low among Asian peers, at 44% of

GDP. The government needs to stay on the fiscal

consolidation path by improving the efficiency of tax

collection and revenue generation, and by better utilising

government spending to fuel economic growth.

Policy

The easing of inflation in 2012 will give Bangko Sentral

ng Pilipinas (BSP) more room to cut rates if external

headwinds intensify. However, given that the current

policy rate of 4.5% is already low, we do not expect more

than 50bps of rate cuts in 2012.

The central bank could also use reductions in the reserve

requirement as a tool to adjust liquidity if necessary, as

the current required ratio is at a historical high of 21%.

BSP‟s recent signalling of possible changes to the

reserve requirement framework (there will no longer be a

distinction between liquidity and regular reserves, and

BSP will not pay interest on reserves kept in its vault)

further adds to the possibility of reserve requirement cuts

next year.

The government launched a PHP 72bn fiscal stimulus

plan in October 2011 to contain the negative impact of

the escalating economic crisis in the West. We expect

some tail effects to carry over into 2012, helping to

stimulate economic growth.

Politics

President Aquino and his government, in power since

June 2010, still enjoy high approval, according to a

September poll. The government‟s approval rating rose

to 77% from 71% in May, and its trust rating rose to 75%

from 71%. The Philippines also rose to 129th place from

134th in Transparency International‟s 2011 Corruption

Perceptions Index. Tackling corruption and alleviating

poverty were key campaign pledges made by Aquino.

Standard Chartered forecasts: Philippines

2011 2012 2013 2014

GDP (real % y/y) 3.8 3.2 5.3 5.0

CPI (% y/y) 4.7 3.7 4.4 4.0

Policy rate (%)* 4.5 4.0 4.5 4.5

USD-PHP * 43.50 41.50 39.50 38.00


2.8 2.3 4.1 3.0


-3.0 -2.8 -2.5 -2.3



Singapore Edward Lee, +65 6596 8252

[email protected]

Tai Hui, +65 6596 8244

[email protected]

12 December 2011 59

Mitigating volatility

Economic outlook

We expect Singapore‟s economic growth to ease to 1.9%

in 2012 from 4.8% in 2011. The economy is very open

(trade is over 300% of GDP), and as such, its

performance is closely tied to external market conditions.

Exports to the EU account for about 10.5% of the total,

and Singapore‟s economy will be impacted significantly

by the negative outlook for the EU.

As such, we expect Singapore to underperform the

region in 2012. This is typical of the higher volatility of

Singapore‟s economy as a result of its heavy

dependence on offshore demand. However, we expect

the economy to rebound strongly once the global

economy finds a firmer footing in H2-2012 and 2013.

Vulnerable sectors include manufacturing and wholesale

and retail trade, given their strong connection with

external markets. The completion of key projects such as

two integrated resorts, along with more cautious

sentiment towards the private residential sector, will

reduce the contribution to headline growth from the

construction sector. This sector provided support for

growth when the broader economy suffered during the

last global crisis in 2008-09.

The biomedical sector is a potential swing factor for

growth. This sector provided strong impetus to growth in

2011, but it is highly volatile. Excluding the contribution

from the biomedical sector, the GDP growth rate of 5.4%

y/y for the first three quarters of 2011 would have been

reduced to 3.8%.

From an expenditure perspective, although net exports

may remain positive, their contribution to growth is likely

to diminish in 2012. Domestic demand may rely on public

investment, while private consumption will be affected by

weaker asset prices and a softer labour market.

We expect inflation to ease to 2.5% in 2012 from an

expected 5.1% in 2011. The high base effect could kick

in as early as January 2012, bringing down y/y inflation;

the weaker economic environment should also help to

ease prices. Private transport and accommodation costs

accounted for about three-quarters of the rise in inflation

in 2011.

An expected decline in property prices and a softer

labour market should cause housing rents to decline as

leases are renewed. The smaller quota for Certificates of

Entitlements (vehicle ownership permits) may keep

transport costs elevated, but the base effect and the

likely decline in demand due to the weaker economy

should temper the rise in transport costs.

Financial issues

We forecast that the Singapore dollar (SGD) will weaken

to 1.35 against the USD in Q1-2012 due to global risk

aversion and growth concerns. We then expect USD-

SGD to gradually head lower from Q2 to Q4 as global

growth starts to stabilise, despite our view that the

Monetary Authority of Singapore (MAS) will adopt a

neutral stance on the SGD NEER in its April Monetary

Policy Statement. We forecast USD-SGD at 1.25 by end-

2012. Capital inflows to Singapore given its solid AAA

status and strong economic fundamentals could offer an

additional attraction for international investors.

With the US Fed already committed to keeping rates at

ultra-low levels until mid-2013, short-end SGD rates

should remain anchored. We expect 3M SGD SIBOR to

remain stable at 0.35% throughout 2012. The SOR curve

should remain similarly depressed. Should strong trend

appreciation in Asian currencies resume (not expected

until at least H1-2012), the SOR could move back into

negative territory. However, given the likelihood that the

SGD nominal effective exchange rate (NEER) will stay in

the weaker half of the policy band, the SOR curve should

stay positive in the near term.

Standard Chartered forecasts: Singapore

2011 2012 2013 2014

GDP (real % y/y) 4.8 1.9 7.8 4.4

CPI (% y/y) 5.1 2.5 3.1 3.0

3M SGD SIBOR (%)*

0.35 0.35 0.65 1.40

USD-SGD* 1.30 1.25 1.20 1.16


19.0 16.5 19.5 18.2


10.5 7.9 8.8 8.5




Singapore (con’d)

12 December 2011 60

The Singapore Government Securities (SGS) curve will

be extended in 2012 with an inaugural 30Y bond issue in

April (20Y is currently the maximum tenor). There will not

be a 20Y bond sale in 2012, which will help to bolster

demand for the new 30Y issue.

Given the poor global growth outlook, there is very little

impetus for SGS rates to move higher, despite the fact

that yields are currently at historical lows. Importantly,

Singapore remains a solid AAA-rated sovereign, and this

may attract flows seeking diversification from developed

markets. In addition, the SGD is typically viewed as a

proxy for Asian currencies, and as such, SGS offer an

attractive investment for investors who wish to participate

in long-term Asian currency appreciation but are unwilling

to move down the credit curve.

Policy

We expect the MAS to turn to a neutral FX stance on the

SGD NEER in April 2012 given the benign inflation

outlook and downside risks to growth. The MAS forecasts

lower inflation in 2012 (we concur), forecasting headline

inflation at 2.5-3.5% and core inflation at 1.5-2%. As

such, inflation should not impede further monetary policy

accommodation by the central bank. In October 2008,

when the MAS moved the SGD NEER policy band to a

0% appreciation bias, headline inflation was high at 6.4%

y/y (core: 6.1%). At the time, the MAS expected headline

inflation to fall to 2.5-3.5% in 2009 and core inflation to

fall to 2%, similar to its current outlook.

Importantly, core inflation has remained relatively stable,

diverging from higher headline inflation. In 2011, the MAS

has highlighted its view that high transport and

accommodation costs as reflected in the CPI number do

not impact the majority of the population. The core

inflation measure appears to be a more important factor

in monetary policy decisions. This was underscored in

the MAS‟ October 2011 Monetary Policy Statement:

“Given the expected moderation in core inflation, the

slope of the policy band will be reduced”.

We forecast that the fiscal surplus will fall to 7.9% of GDP

in FY12 (starts 1 April 2012) from 10.5% in FY11. This

reflects the government‟s less contractionary stance.

Ample savings imply that the government will be able to

provide aggressive fiscal stimulus to offset external

weakness, if required.

Other issues

The Singapore government has proven to be innovative

in using its fiscal resources in the past. The Job Credit

Scheme (providing quarterly grants to employers for each

Singaporean employee on their payrolls) and Risk

Sharing Initiative (jointly underwriting risk with banks to

encourage lending), introduced during the global financial

crisis, helped to limit job losses and ensure smooth

lending activity. Should the economy be hit by another

serious external shock, we believe the government will

reintroduce some or all of these measures to support

jobs and SMEs.

Politics

In the last general election, held in May 2011, the

incumbent People‟s Action Party (PAP) maintained its

absolute dominance in the parliament, winning 81 out of

87 seats. Even so, the opposition Workers‟ Party (WP)

made strong inroads, winning six seats and – more

importantly – winning a Group Representation

Constituency. There was also a considerable voting

swing of about 6.5% against the PAP compared to the

2006 election; the PAP won 60.1% of the total votes in

2011.

The government will need to address the need to achieve

strong medium-term growth without an over-reliance on

imported labour. The cost of living is another challenge

facing the government as the income gap widens.

Biomedical sector could be swing growth factor

Average annual growth


-20%

-10%

0%

10%

20%

30%

40%

50%

60%

2004 2005 2006 2007 2008 2009 2010

Industrial productionex-bio

Biomedical production


South Korea Suktae Oh, +822 3702 5011

[email protected]

12 December 2011 61

Domestic demand to the rescue

Economic outlook

Korea is likely to experience only a mild slowdown in

2012 thanks to resilient domestic demand. Global market

turmoil led by the European sovereign debt crisis will hurt

exports and domestic sentiment, but consumption and

construction will be supported by job-market and credit

strength. Policy easing in major economies will improve

the outlook for exports in H2-2012, while the Bank of

Korea (BoK) is likely to opt for only a nominal rate cut.

We expect GDP growth to slow to 3.0% in 2012 from

3.5% in 2011, and to rebound to 4.0% in 2013.

The likely recession in Europe and slowing growth in

other major economies, such as the US and China, will

lead to weaker exports. An export slowdown has been

evident since Q4-2011, with broad-based weakness

across sectors and markets. We expect non-electronics

exports and exports bound for emerging economies to

outperform electronics exports and those bound for

developed economies. The structural outperformance of

emerging economies will continue, while the benefits of a

weaker Korean won (KRW) since H2-2011 will be more

pronounced for non-electronics sectors like autos.

Domestic demand will be the key source of support for

economic growth. Global market jitters have admittedly

had a negative impact – retail sales dipped, auto sales

declined, and the business sentiment index for the non-

manufacturing sector fell in Q4-2011. But labour-market

and household credit strength will continue to underpin

consumption. These areas showed no signs of a

slowdown in 2011 and will largely maintain their strength

in 2012. Consumer confidence remained strong towards

the end of 2011, and the anticipated decline in inflation

will boost real incomes. The construction recovery that

started in 2011 will continue in 2012 thanks to a stable

property market, potential pent-up housing demand, and

steady credit growth in the household and corporate

sectors (in the form of mortgages and loans to property

developers).

We expect both headline and core inflation to be stable at

around 3% in 2012; this will gradually ease inflation

concerns among the general public and policy makers.

The normalisation of vegetable and pork prices after a

temporary spike in 2011, and the likely decline in crude

oil prices amid the worsening global growth outlook, will

be the main drivers of lower inflation. However, sustained

rises in housing rents, the pass-through of KRW

weakness, and still-high inflation expectations will

continue to fuel inflation. The current account surplus as

a percentage of GDP will be steady in 2012 as the

relative strength of domestic demand offsets the positive

impact of the weak KRW and low oil prices.

Financial issues

External liquidity conditions have improved markedly

since 2008, though Korea remains one of the most

externally vulnerable economies in Asia. The ratio of

short-term external debt to FX reserves declined to 46%

in Q3-2011 from 79% in Q3-2008, thanks to government

efforts to discourage short-term external borrowing and

increase FX reserves. Domestic banks have secured

additional FX liquidity through further external borrowing

in H2-2011 at the government‟s request. UK, US and

Japanese banks have kept FX funding channels open,

while continental European banks have reduced lending

to Korea; this is likely to continue in 2012. The expansion

of Korea‟s official FX swap agreements with Japan and

China strengthens its second line of defence in case of

emergency. The total size of the country‟s swap

agreements with Asian countries, including bilateral and

multilateral agreements under the Chiang Mai Initiative, is

now USD 153 bn.

Household debt will continue to be a key concern of

market participants and policy makers. We expect

sustained growth in household credit (i.e., debt) to

support domestic demand, suggesting that the household

debt-to-income ratio will rise further in 2012. Most

Standard Chartered forecasts: South Korea

2011 2012 2013 2014

GDP (real % y/y) 3.5 3.0 4.0 4.0

CPI (% y/y) 4.0 3.0 3.0 3.0

Policy rate (%)* 3.25 3.00 3.50 3.50

USD-KRW* 1,155 1,050 1,040 1,025


2.0 2.0 1.5 1.0


2.0 1.5 2.0 2.0



South Korea (con’d)

12 December 2011 62

financial institutions (with the exception of some non-

bank institutions like savings banks) have healthy

balance sheets and will accommodate increasing

demand for household credit to sustain consumption.

Policy on household debt is likely to be neutral: the

authorities may informally slow the pace of

implementation of household debt stabilisation measures

announced in 2011, but they are unlikely to explicitly

ease mortgage-related regulations such as the ceiling on

the loan-to-value ratio, as they did in 2008.

Policy

We expect the BoK to cut the base rate by 25bps in Q2-

2012. While the BoK will eventually address increasing

downside risks to growth, it is likely to wait for clearer

signs of slower growth and lower inflation before it

implements easing. While the expected decline in oil

prices in H1-2012 will mitigate inflation concerns, it will be

difficult for the BoK to ease aggressively, as concerns

about inflation and household debt will linger. The task of

policy rate normalisation will be postponed until 2013.

The government will continue to emphasise fiscal

prudence, influenced by concerns about fiscal conditions

in developed economies. The 2012 budget proposal

currently assumes GDP growth of 4.5%; this will require

revision to reflect the likely slowdown. The ruling party

will try to boost welfare spending ahead of key elections,

but major tax cuts or spending increases are unlikely, as

government officials and politicians agree on the need to

maintain healthy fiscal conditions. The fiscal surplus as a

percentage of GDP is likely to decline slightly in 2012 due

to a minor revision in the budget and the stabilising effect

of slower economic growth.

Other issues

The high self-employment rate appears to be the Achilles‟

heel of the Korean economy. The share of self-employed

people in the total workforce, at around 24%, is much

higher than in developed economies. We have long held

the view that this is largely responsible for Korea‟s

household debt problems; this was confirmed by the

2011 Household Finance Survey, which showed that the

household debt-to-income ratio is twice as high among

the self-employed as among wage-earning workers.

Household debt growth was also much higher among the

self-employed (22.7%) than among wage-earning

workers (3.3%). Self-employed people tend to borrow

more from (riskier) non-bank institutions, while salaried

workers usually depend on banks. Moreover, the recent

strength in the labour market can be partly attributed to

the rebound in the number of self-employed people after

a decline in the past five years. We will closely monitor

the behaviour of this group, as it appears crucial to jobs

and credit, the two main drivers of domestic demand.

Politics

Two key elections will be held in 2012: parliamentary

(April) and presidential (December). Polls currently

indicate that opposition parties are more popular than the

ruling right-wing party (Grand National Party, or GNP).

We expect the GNP to lose its parliamentary majority in

the April election. A high degree of uncertainty remains

around the presidential election. A clear GNP front-

runner, Geun-Hye Park, has emerged, while the

opposition parties lack popular candidates. Cheol-Soo

Ahn, the founder of an anti-virus software company, is

leading in the polls, though he is not a member of a

specific party; he is expected to run for the opposition.

Political developments are unlikely to affect the basic

direction of economic policy. It will be difficult for policy

makers to push through strong stimulus measures, as

fiscal easing is difficult amid a global fiscal crisis, while

monetary easing is unpopular given still-dominant

inflation concerns. Also, technocrats have dominated

Korea‟s economic policy making since the 1960s, even

under „leftist‟ governments from 1998-2008.

We do not expect significant events or changes in the

relationship with North Korea in 2012. South Korea, the

US and China will not be able to focus on North Korea in

an environment of economic challenges and political

change. The succession of power to North Korea‟s Kim

Jong-Un is likely to continue.

Jobs and credit, two drivers of consumption

Number of employees and household credit, %y/y

Sources: Statistics Korea, Bank of Korea,

Standard Chartered Research

Employees (LHS)

Household credit (RHS)

0

2

4

6

8

10

12

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

Q1-05 Q1-06 Q1-07 Q1-08 Q1-09 Q1-10 Q1-11


Sri Lanka Samantha Amerasinghe, +94 11 2480015

[email protected]

12 December 2011 63

Inching ahead with caution

Economic outlook

Sri Lanka has sustained its high growth trajectory and

looks set to achieve two consecutive years of 8% growth

(2010 and 2011). While growth across key sectors –

tourism, construction and manufacturing – is likely to

remain buoyant, we expect a slowdown in exports in

2012 and forecast that GDP growth will slow to 7.5%.

The export sector, which depends heavily on the US and

Europe, may come under pressure from slower US

growth and a euro-area recession, but near-term growth

concerns will be offset by higher government spending

on infrastructure, as well as measures to improve export

competitiveness and safeguard the FX reserves.

The widening current account deficit is a concern. Given

its widening trade deficit, Sri Lanka will need to rely more

heavily on capital inflows to fund the current account in

2012. This may prove challenging given the slowdown in

official aid inflows. Strong tourism earnings and

remittance inflows in 2011 have helped to contain the

current account deficit, while steady capital inflows have

kept the balance of payments (BoP) in surplus. That said,

the BoP will remain under stress in 2012 as global growth

continues to slow and EU concerns persist.

Fiscal policy will continue to support growth. The

government‟s revenue growth target of 20.1% in 2012 is

optimistic given external headwinds, and the ambitious

deficit target of 6.2% of GDP may be overshot, as

increased spending may be needed to support growth.

With the IMF loan programme ending in May 2012, the

government is under added pressure to ensure that fiscal

consolidation remains on track.

Financial issues

The banking sector is resilient; banks are well capitalised

and profitable. The gross non-performing loan ratio

declined to a modest 4.4% of outstanding loans in

October 2011. Although rapid loan growth is worrisome

(22.8% y/y YTD as of end-October 2011), deposits have

largely kept pace. The loan-to-deposit ratio, which has

been sustained at about 80% in 2011, may dip in 2012

due to rising risk aversion.

Policy

The central bank is likely to maintain its neutral policy

stance in 2012. While credit demand has stayed elevated

for longer than anticipated, we expect inflation in 2012 to

remain within the central bank‟s comfort level of 6-7%

(our forecast is 6.4%) on improving domestic supply and

the receding threat of higher global oil and food prices.

Stubbornly high credit growth is cause for concern, but

slowing global growth may undermine confidence and

dampen credit demand in 2012. The export slowdown

should be mitigated by the authorities‟ move in November

2011 to devalue the Sri Lankan rupee (LKR) by 3%. A

key risk to our stable policy outlook is that the higher cost

of imports (petroleum imports comprise c.22% of total

imports) resulting from LKR devaluation may put upward

pressure on prices – and hence interest rates – in 2012.

Other issues

In November 2011, the government passed a

controversial expropriation bill that nationalised certain

assets of private enterprises which were deemed to be

underperforming. While the authorities said that this was

a one-off move, such measures undermine policy

consistency and may deter investors.

Politics

Political stability since President Rajapaksa‟s re-election

in January 2010 has enabled the authorities to make

steady progress in addressing structural issues and

pushing through key reforms, particularly on the tax front.

The Rajapaksa-led United People‟s Freedom Alliance

(UPFA) continues to enjoy widespread popularity. The

economic and social integration of the Tamil minority in

the northern and eastern regions has progressed, but

political reconciliation is still at an early stage. The next

parliamentary elections are due in April 2016.

Standard Chartered forecasts: Sri Lanka

2011 2012 2013 2014

GDP (real % y/y) 8.0 7.5 8.0 8.0

CPI (% y/y) 6.9 6.4 7.0 7.2

Policy rate (%)* 7.00 7.00 7.25 7.25

USD-LKR* 113.9 114.8 112.5 110.0


-5.7 -5.1 -3.0 -3.0


-7.0 -6.5 -6.5 -6.0



Taiwan Tony Phoo, +886 2 6603 2640

[email protected]

Eddie Cheung, +852 3983 8566

[email protected]

12 December 2011 64

Struggling with rising uncertainty

Economic outlook

We expect Taiwan‟s economic growth to slow to 2.7% in

2012 from 4.4% in 2011. The potential worsening of the

sovereign debt crisis in Europe and austerity measures in

various EU member countries are the key downside risk

to the growth outlook. This, coupled with a sluggish US

recovery, may result in protracted weakness in external

demand, hurting local producers‟ confidence. As a result,

we may see reduced capital spending and hiring in the

manufacturing sector in 2012. This could also derail the

recovery in domestic demand, which has so far largely

mitigated weakness in the export sector.

The economy is in a strong position to weather external

shocks thanks to a relatively healthy current account

surplus, large foreign exchange reserves, and low

external and public debt. Taiwan also has moderately low

exposure to international bank lending from Europe and

is seen as less vulnerable than regional peers to a

potential liquidity squeeze. Local regulators have ensured

that local money-market liquidity remains flush, as this

will enable them to effectively cope with massive capital

outflows due to contagion risk stemming from potential

credit events in Europe.

Increased government support is also likely to support

the economy. The government has approved total

budgeted spending of TWD 1.94trn (USD 65bn) for 2012.

This is 8.4% more than the TWD 1.79trn currently

projected for 2011 and compares to a 5.1% increase in

projected government revenue to TWD 1.73trn in 2012.

This suggests that the central government deficit will

widen to TWD 209bn from the TWD 142bn projected for

2011. More importantly, it shows that the government has

adopted an expansionary budget in response to strong

external headwinds.

Financial issues

The latest property-market data shows that local property

prices have held up, though transaction volumes fell

significantly in Q3-2011 to their levels prior to the global

financial crisis. This suggests that ongoing market-

cooling measures by the government to rein in

speculation are having an impact. The risk is that a rapid

deterioration in global and/or domestic economic

conditions could hurt market confidence, causing housing

prices to fall. This would have a significant impact on the

asset quality of local banks, especially those that are

heavily geared to the local real-estate market. A sharp

property-market slowdown would also impact banks‟

revenues and earnings outlook, as housing loans

amounted to 30% of total lending and more than 80% of

the net increase in consumer loans in the first nine

months of 2011.

The potential fallout from Europe‟s lingering debt

problems, in particular a possible liquidity crisis in the

European banking sector, is a far bigger threat. However,

local regulators have emphasised that the potential

impact on Taiwan of a default in a debt-stricken

peripheral European economy would likely be

manageable. Taiwanese banks‟ net outstanding

consolidated cross-border claims on peripheral euro-area

countries (Portugal, Ireland, Italy, Greece and Span)

stood at USD 5.1bn as of end-July 2011, according to

local news reports; this is equivalent to a mere 0.7% of

domestic banks‟ total loans outstanding, and 6% of their

net worth. Even if their entire exposure to these countries

became bad loans, this would add only 1ppt to the

sector‟s non-performing loan ratio, which stood at 0.5%

as of end-September 2011 – near a record low and down

from 1.5% prior to the 2008-09 financial crisis. Also, the

sector‟s loan-loss provision ratio had surged to 194% as

of end-September 2011, nearly three times the 69.5%

registered in 2008.

Policy

We expect policy makers to keep a close eye on potential

risks stemming from worsening global growth prospects,

Standard Chartered forecasts: Taiwan

2011 2012 2013 2014

GDP (real % y/y) 4.4 2.7 4.5 5.2

CPI (% y/y) 1.4 1.2 1.6 1.3

Policy rate (%)* 1.88 1.88 2.38 2.88

USD-TWD* 30.3 29.0 28.0 27.9


7.5 5.5 6.0 6.0


-2.5 -2.0 -1.5 -1.0



Taiwan (con’d)

12 December 2011 65

rising market volatility, and fragile market confidence. We

expect them to maintain a cautious, pro-growth monetary

policy stance.

However, the latest data points to continuing strong

underlying domestic price pressure. Core inflation rose to

near a three-year high in October 2011 and exceeded

headline consumer price inflation for the first time since

2009. We expect core inflation to grind higher still in 2012.

This will keep policy makers alert to the risk of underlying

domestic price pressures. The Taiwan central bank (CBC)

will face a policy dilemma, as it has repeatedly expressed

the need for monetary policy to both support growth and

ensure price stability.

We also see a heightened risk that further quantitative

easing by central banks in key industrial economies will

result in asset-price inflation in emerging economies.

Even if local policy makers are biased towards a pro-

growth stance amid deteriorating global economic and

financial-market conditions, they are unlikely to cut rates

in such an environment. Instead, we expect policy

makers to use unconventional monetary tools such as

reserve requirement ratio cuts and reductions in NCD

issuance.

The return of hot money inflows amid quantitative easing

in the West may result in Taiwan dollar (TWD)

appreciation in 2012, creating problems for the local

authorities. Interest income from overseas assets will

also continue to fall as yields remain low. This, coupled

with high interest costs associated with absorbing

inflows, may constrain the authorities‟ efforts to sterilise

hot money. This may provide support for the TWD

heading into H2-2012, though the authorities are well

placed to ensure stability should the need arise.

Politics

Taiwan will hold general elections on 14 January 2012.

The outcome is expected to have material impact on the

domestic growth outlook. While the ruling Nationalist

(KMT) party is expected to retain its parliamentary

majority (albeit with a narrower margin), current opinion

polls show that incumbent President Ma Ying-jeou has

only a slight lead against Tsai Ing-wen, chairwoman of

the opposition Democratic Progressive Party (DPP). The

decision by James Soong – a former KMT stalwart and

the current chairman of the People‟s First Party (PFP) –

to contest the presidential election is expected to siphon

votes from KMT supporters, resulting in rising market

anxiety over President Ma‟s chances of re-election.

The re-election of President Ma would boost confidence

among domestic and international investors. It would

ensure policy continuity and pave the way for further

liberalisation of economic ties with mainland China,

including the signing of the widely anticipated Investment

Protection Agreement (IPA) and the negotiation of

greater cross-straits access to banking and financial

services. This, combined with the potential increase in

tourism flows and foreign direct investment from

mainland China, would support the current account and

the balance of payments. It could also result in a re-rating

of TWD-denominated assets. Closer economic ties with

mainland China would also be seen as positive for

Taiwan‟s longer-term outlook, better enabling the island

to withstand external shocks resulting from global

economic weakness and financial-market volatility.

A failure by both the ruling KMT and opposition DPP to

secure a parliamentary majority would risk bringing the

government to a standstill. Should Tsai win the

presidency, mainland China may adopt a wait-and-see

approach to cross-straits economic liberalisation,

although Tsai has assured that the DPP will adopt a

pragmatic cross-straits policy. Tsai has denounced the

1992 consensus (under which Taiwan and mainland

China recognised that there is only one China); leaders in

Beijing have often cited this as a prerequisite for cross-

straits negotiations. A slowdown in the pace of cross-

straits liberalisation could damage market confidence in

Taiwan.

Rising core inflation poses a challenge for interest rate

policy

We expect the CBC to stay put


Core inflation, % (LHS)

CBC re-discount

rate, %

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

-2

-1

0

1

2

3

4

5

Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11


Thailand Usara Wilaipich, +662 724 8878

[email protected]

12 December 2011 66

Post-flood recovery

Economic outlook

We expect a recovery in 2012 following the flood disaster

of Q4-2011, based on the experience of past natural

disasters. Government reconstruction measures, private-

sector spending on durable goods and reconstruction,

and private investment in machinery replacement should

support a V-shaped recovery in domestic demand.

Externally, the global risk environment and the worsening

economic outlook – an expected recession in Europe and

weaker growth in the US – are expected to slash external

demand for Thailand‟s exports. We therefore expect the

Thai economy to grow 3.5% in 2012 (below the current

consensus of 4.5-5.5%), up from an estimated 1.8% in

2011.

The country‟s consumer confidence index dropped

sharply to the lowest level in 10 years after the October

floods. We expect consumer confidence to recover

rapidly in H1-2012, when employment conditions return

to normal. This will be partly driven by government

measures such as compensation for flood victims,

minimum wage hikes, and an increase in civil servant

salaries. Most of the manufacturers in flood-affected

industrial estates have notified the government that they

will re-employ their workers. Separately, the Thai Real

Estate Association estimates that affected households

will spend at least THB 100bn (about 1% of GDP) on

housing renovations in 2012.

Both the private and public sectors are likely to increase

investment in 2012. Special loans extended to affected

industrial estates and SMEs, together with a corporate

tax cut, should boost private investment as companies

replace capital equipment damaged by floodwaters.

Public investment will also be urgently needed to

reconstruct logistics networks and rebuild water

management systems to prevent future floods.

On the supply side, manufacturing production –

especially of autos/auto parts, computer parts,

electronics and electrical appliances – is expected to

rebound strongly in H1-2012 as manufacturers catch up

with pending export orders and replenish inventories

destroyed by floodwaters. In particular, the construction,

construction materials, and furniture sectors should

benefit from high demand driven by post-flood

reconstruction.

Financial issues

Fiscal discipline has been a hot topic in Thailand

recently. However, Thailand‟s fiscal position is not yet

cause for concern, in our view. Still-low public debt – at a

manageable at 41% of GDP – should provide scope for

public investment in the coming years to improve logistics

networks and strengthen Thailand‟s competitiveness.

The public debt management law caps the annual fiscal

deficit at 20% of the budget. As a result, the planned

budget deficit has been set at below 4% of GDP for the

past 10 years. Moreover, the actual deficits in FY10 and

FY11 were much smaller than planned as tax revenues

exceeded targets. In FY11 in particular, tax revenues

exceeded the target by about THB 210bn. This resulted

in an actual budget deficit of only about 1.8% of GDP,

only half the planned 3.6% of GDP. This helped to boost

the government‟s cash balance to THB 521bn (5% of

GDP) as of end-September 2011.

We expect the current account balance to swing from a

surplus to a marginal deficit of 0.1% of GDP in 2012.

While tourism income and export growth are expected to

fall owing to lower global demand, imports are likely to

rise on demand for imported machinery and raw

materials to replace those damaged by the floods.

Meanwhile, capital flows will remain highly volatile in

2012, driven by ongoing sovereign debt problems in

Europe and fears of a significant global slowdown.

Standard Chartered forecasts: Thailand

2011 2012 2013 2014

GDP (real % y/y) 1.8 3.5 4.9 5.5

CPI (% y/y) 3.7 3.0 3.5 3.9

Policy rate (%)* 3.25 2.75 3.75 4.5

USD-THB* 31.25 30.50 29.50 29.00


1.5 -0.1 -1.1 -0.9

Planned fiscal balance (% GDP)**

-3.6 -3.4 -3.3 -3.2

*end-period; ** for fiscal year ending 30 September



Thailand (con’d)

12 December 2011 67

Policy

The government led by Prime Minister Yingluck

Shinawatra has proposed an expansionary fiscal policy to

support the Thai economy in 2012. Given the need for

additional spending to compensate flood victims and pay

for post-flood reconstruction, the planned budget deficit

for FY12 has been raised to THB 400bn (or 3.4% of

GDP) from the THB 350bn originally planned. This is

based on expenditure of THB 2.38trn and revenues of

THB 1.98bn. Thailand continues to move towards fiscal

consolidation and is on track to achieve its target of a

primary surplus by FY16 – the planned budget deficit of

3.4% in FY12 is smaller than the planned deficit of 3.6%

in FY11.

On the monetary policy front, the Bank of Thailand (BoT)

will shift its monetary policy target from core inflation to

headline inflation (which includes energy and food

prices), effective in 2012. Currently, the BoT uses core

inflation of 0.5-3.0% as a guide for monetary policy.

Going forward, it will target headline inflation of 3.0% +/-

1.5ppt, an effective range of 1.5-4.5%. In our view, this

change will give the BoT greater flexibility, as target

headline inflation will be calculated on a 12-month

moving average (mma) basis rather than from a single

month‟s figure. This will give the BoT more time to

assess the inflation situation, as it currently calculates

target core inflation on a 3mma basis.

We expect mild inflationary pressure in 2012, forecasting

average headline inflation of 3.0%. This compares to our

estimate of 3.7% for 2011. Food prices are likely to rise

due to potentially lower agricultural output following the

floods. However, we expect the government‟s cost-of-

living reduction measures and lower global oil prices to

reduce general price pressures, offsetting the increase in

food prices. Thailand is a net oil importer, and energy

prices have a direct 9.99% weighting in the CPI basket.

Importantly, ample domestic spare production capacity

for construction materials should mitigate concerns about

inflationary pressures arising from post-flood

reconstruction demand.

Contained inflationary pressures should provide some

scope for the BoT to lower rates, if needed. The key

concern is that downside risks to growth from the

ongoing European debt crisis could worsen in the coming

months. As a result, we expect two rate cuts (of 25bps

each) in H1-2012 to support the domestic economy.

However, the BoT will remain vigilant against inflationary

pressure in the future given the continued increase in

fiscal spending. Hence, it is likely to resume rate

normalisation in 2013, when the economy returns to its

potential growth rate of 5.0-5.5%.

Other issues

In order to restore foreign investor confidence and ensure

a positive investment environment in the medium to long

term, it is crucial that Thailand build an effective water

management and early warning system to prevent future

floods and/or natural disasters.

Politics

Prime Minister Yingluck has had a tough time since her

decisive victory in the July 2011 election, facing the worst

floods in five decades. We see more challenges ahead,

including a tougher global economic environment and an

urgent need for post-flood rehabilitation. Political stability

will remain an area of focus for the markets. A key event

to watch is the end of a five-year ban on 111 executive

members of the Thai Rak Thai (TRT) party in May 2012.

The Constitutional Court dissolved former Prime Minister

Thaksin Shinawatra‟s TRT party in May 2007 and

banned all of its executive members from politics due to

alleged electoral fraud in the April 2006 elections. Their

potential return to politics is likely to support the stability

of the Yingluck-led government.

Actual budget deficits are smaller than planned

Annual budget deficit, % of GDP

Sources: MoF, Standard Chartered Research

Planned

Actual

-4.0

-3.5

-3.0

-2.5

-2.0

-1.5

-1.0

-0.5

0.0

FY09 FY10 FY11 FY12


Vietnam Tai Hui, +65 6596 8244

[email protected]

12 December 2011 68

Keep doing the right thing

Economic outlook

Domestic economic factors dominate Vietnam‟s

economic and financial outlook. We expect growth to

remain at 5.8% in 2012, unchanged from 2011. Exports

to China, the US, Japan and Europe should maintain

positive growth in 2012 given the structural development

of Vietnam‟s export sector and the gradual weakening of

the Vietnamese dong (VND). Stable commodity prices

will also support exports.

We expect y/y inflation to ease back into single digits by

late Q2-2012, provided that global commodity prices

remain stable and VND depreciation is gradual and

orderly. Lower inflation should protect household

incomes and maintain the contribution of consumption to

headline economic growth.

The weaker external environment could temper

investment growth in manufacturing capacity, especially

by foreign investors from Taiwan, Japan and South

Korea. The government may step up state-led

investment, especially in infrastructure, to maintain

growth momentum, but the funding of such projects may

continue to rely on international organisations.

Vietnam‟s trade deficit was manageable in 2011,

estimated at below 10% of GDP. A further improvement

is likely if the government can prevent economic

overheating and achieve further import substitution,

especially by building capacity to refine raw materials for

domestic use.

Financial issues

Given Vietnam‟s sizeable current account deficit and low

foreign exchange reserves, we expect the VND to

continue to depreciate gradually in 2012. Local investor

sentiment still dominates the VND outlook; this will

require that the authorities further reinforce their

credibility in maintaining price stability and continue to

attract inflows.

We shift to an Overweight duration stance on Vietnam

Government Bonds (VGBs) from Neutral. Falling inflation,

lower policy rates and heavy bond redemptions in 2012

will spur demand from domestic banks. We expect short-

dated VGBs to outperform following significant curve

flattening in late 2011.

Policy

The authorities are expected to maintain their emphasis

on price stability, although the decline in headline

inflation should allow them to reduce the refinance rate

from 15% to 11% starting in Q1-2012. In 2011, the

central bank and the government have kept a tight leash

on credit and money growth. This could continue in 2012,

with credit growth targeted at 15-17%.

Fiscal consolidation is still required, and we therefore

expect the government to run a fiscal deficit of less than

5% of GDP in 2012. This would help to reduce the debt-

to-GDP ratio from the current level of 54%, aided by

strong nominal GDP growth.

Other issues

The government has pledged to improve data

transparency, including the disclosure of financial

information on state-owned enterprises and financial

institutions. While the quality of the data is yet to be

proven, greater information availability should help to

establish investor confidence.

Politics

Domestic politics is likely to remain stable in 2012

following the party congress and government reshuffling

in 2011. Vietnam‟s regional relationship with China, with

territorial disputes in the South China Sea, could be a

source of tension.

Standard Chartered forecasts: Vietnam

2011 2012 2013 2014

GDP (real % y/y) 5.8 5.8 6.5 6.8

CPI (% y/y) 18.7 11.3 8.5 7.0

Policy rate (%)* 15.0 11.0 11.0 8.0

USD-VND* 21,000 22,600 23,700 24,300


-10.5 -8.5 -7.5 -7.0


-5.2 -4.9 -4.0 -4.0


Economies – Africa


Africa – Charts of the year

12 December 2011 70

Chart 1: African growth seen holding up, despite global

risks

GDP, % y/y

Chart 2: 2012 will be a big year for rebasing, with better

measures of informal sector activity

‘Shadow economy’; estimates as % of measured GNP

Sources: IMF, Standard Chartered Research Sources: ‘Africa Rising’, Standard Chartered Research

Chart 3: Africa’s reform momentum persists

% of SSA countries with at least 1 ‘Doing Business’ reform

Chart 4: After the Arab Spring, political risk is still topical

No. of years current presidents have been in power, 2011

Sources: World Bank Doing Business Report 2012,



Chart 5: Deleveraging to impact project finance

Cross-border lending to Africa, USD bn (LHS), % y/y (RHS)

Chart 6: Still dependent on growth in mature economies

% share of total African exports, by destination

Sources: BIS, Standard Chartered Research Sources: IMF DOTS, Standard Chartered Research

World

SSA

-2

0

2

4

6

8

1980 1984 1988 1992 1996 2000 2004 2008 2012f 20 25 30 35 40 45 50 55 60

TanzaniaNigeriaZambia

SenegalUgandaEthiopia

GhanaTunisia

MoroccoEqypt

AlgeriaBotswanaCameroon

South Africa

(Ghana, pre-rebasing)

0

10

20

30

40

50

60

70

80

90

2004/05 2005/06 2006/07 2007/08 2008/09 2009/10 2010/11 5 10 15 20 25 30 35

Congo DRCCape Verde

RwandaDjiboutiLesotho

Congo BrazzavilleSwaziland

EthiopiaGambia

SudanChad

Burkina FasoUganda

CameroonEquatorial Guinea

Angola

-10

-5

0

5

10

15

20

25

30

35

150

160

170

180

190

200

210

220

230

240

Jun.2007 Jun.2008 Jun.2009 Jun.2010 Jun.2011

% y/y, RHS Cross-border lending to Africa

Asia

Euro area

US

0

10

20

30

40

50

60

70

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010


Africa Razia Khan, +44 20 7885 6914

[email protected]

12 December 2011 71

More cautious approach to liberalisation

Economic outlook

Despite a less certain global economic environment and

greater external headwinds, average Sub-Saharan

African growth is expected to hold up at relatively healthy

levels. The degree of slowdown hinges on how much of

this growth is explained by exogenous variables. The

euro area, where we expect a recession, is Africa’s

largest trading partner by far. However, trade as a share

of GDP is typically small in Sub-Saharan Africa,

averaging around 30%. Africa’s exports are also

dominated by commodities. If commodity prices are

supported by tight supply and continued demand from

elsewhere, the impact of a European recession alone

may not be huge. Factor in the tendency of African

countries to react to global economic slowdowns with a

significant lag, and the case for an immediate slowdown

in African GDP growth is less clear still.

In the case of a financial crisis, however, the effect may

be transmitted more rapidly. This was seen during the

recent global crisis, when reduced availability of trade

finance triggered an almost immediate collapse in global

trade, and demand for Africa’s exports plummeted. We

do not expect a repeat of anything on that scale in 2012.

A large number of European financial institutions are

likely to face pressure to recapitalise. Anecdotally, there

is already evidence of asset disposals by European

banks, and of a general pullback of new lending from

Africa. Trade finance will likely continue to get more

expensive; project finance will slow, but not on a scale

that will threaten Africa’s positive growth overall.

Financial issues

Weakness in frontier FX markets emerged as a key

theme in 2011, prompting a number of African central

banks to implement new regulations. Net open positions

(NOPs) – the amount of FX that banks can hold relative

to regulatory capital – were cut in Nigeria, Kenya and

Tanzania in a bid to encourage FX sales and prevent

further currency weakness. Kenya and Tanzania

implemented measures restricting the lending of local

currency to offshore counterparties, similar to what

Zambia had done during the global financial crisis in early

2009. However, these measures have had a negative

impact on FX market liquidity. Given the still-difficult

external environment expected in 2012, such regulatory

measures are unlikely to be quickly reversed.

What will a deterioration in global risk appetite hold for

African FX? 2012 is likely to be a year of two halves, with

euro-area concerns particularly concentrated in H1. Risk

appetite should return to some degree in H2 in response

to new monetary easing measures, including QE3 in the

US. Unlike in late 2008, when African markets were hit by

a large withdrawal of portfolio investment, today’s

healthier mix of ‘real money’ rather than leveraged flows

in African domestic markets is likely to prevent mass

liquidation of African assets. However, any ‘risk-off’ mood

would discourage new inflows into smaller, less liquid

African markets, as the preference will be for larger, more

liquid safe havens. With more attractive yields and likely

monetary easing by H2 (in East African economies at

least), prospects for eventual African FX appreciation

remain favourable.

The euro-area crisis has also focused attention on the

sustainability of the CFA franc peg to the euro (EUR). In

our view, there is little reason to anticipate a change in

the parity of the CFA franc anytime soon. Indeed,

Standard Chartered’s CFA franc barometer, a

quantitative measure of pressure on the peg, suggests

that we are currently far from the levels that triggered the

only devaluation in the CFA’s history in 1994. Although

differences between the two CFA franc zones – WAEMU

and CEMAC – are evident, fundamentals are favourable

as commodity prices generally hold up. FX reserves

cover for currency in circulation is much healthier than in

1994, and EUR weakness will boost competitiveness in

the two franc zones. Ultimately, any decision to de-peg

Standard Chartered forecasts: Sub-Saharan Africa*

2011E 2012F 2013F 2014F

Real GDP growth 4.8 5.3 5.6 5.8

IMF 4.8 5.7 5.4 5.3

Inflation 8.4 8.3 6.8 7.4

IMF 8.3 7.3 6.2 5.9


1.3 0.6 0.3 -0.1

IMF 1.8 0.4 -0.4 -0.9

*2010 USD GDP-weighted total of 15 Sub-Saharan African economies

Source: IMF, Standard Chartered Research


Africa (con’d)

12 December 2011 72

would be political. It is difficult to see why member

countries would wish for this (given that they would lose

an important anchor that has brought low inflation to the

CFA franc region). Equally, France, which guarantees the

convertibility of the peg and is itself caught up in the

euro-area crisis, has little to gain from volatility in its

African trading partners.

Policy

The all-too-easy narrative of continued improvement in

Africa’s macroeconomic variables no longer holds true.

Since the last crisis, the region has seen a considerable

erosion of its external buffers. Fiscal policy was

expanded in a counter-cyclical response to the crisis;

spending levels have yet to be reined in again, and doing

this will be politically difficult. With food and fuel generally

exerting upward pressure on prices, few African central

banks are in a position to cut interest rates immediately,

should it be required. Foreign exchange reserves have

been pressured in a number of African countries, forcing

some central banks to reverse FX market liberalisation

measures in recent months. More time is needed to

rebuild external liquidity buffers, but new external

headwinds may emerge before then. Notwithstanding the

domestic momentum behind African growth and its

structural uptrend, the environment will be difficult. As

ever, policy responses will be key to longer-term growth.

Other issues

With the euro area in crisis and official development

assistance (ODA) budgets being cut back in the West,

we expect even more focus on China-Africa economic

engagement. Is China poised to replace Africa’s more

traditional development partners? Available data

suggests that lending to Africa by the Export-Import Bank

of China already exceeds approved World Bank

commitments, albeit on a less concessional basis and

with fewer conditions attached. With China’s interests in

Africa believed to be long-term and strategic, cyclical

influences are likely to be less pronounced than for other

potential sources of financing for Africa. Indeed, China’s

hesitance to increase its exposure to USD or EUR assets

may feed its appetite for commodities and increased

engagement with Sub-Saharan African economies.

Should potential African issuers find themselves cut off

from international capital markets because of difficult

market conditions, bilateral arrangements such as the

recent USD 3bn China Development Bank loan to Ghana

are likely to become more prevalent. While China will

have an important role to play in infrastructure financing

in the region (often in return for payment in commodities),

China’s assistance does not typically fit the model of

direct budgetary support; nor is there a meaningful and

explicit poverty alleviation dimension to such support. In

the near term, there will be little to substitute for ODA.

Given the difficult economic environment, sovereign

credit downgrades in Africa are seen as more probable

than upgrades. While headline GDP may not be

impacted immediately, export growth and FX earnings

may slow in the short term, notwithstanding longer-term

efforts to boost intra-regional trade. Economic

management is likely to be increasingly tested, and fiscal

deficits in most countries are projected to remain wide

(Angola and Botswana are exceptions).

While East Africa should see eventual relief from the

impact of a recent drought and an improvement in its

inflation trend, this will not hold true for all of Africa.

Financing of domestic deficits is likely to remain difficult,

especially in countries where tight market liquidity has led

to a breakdown in secondary debt-market trading. This

will create an additional feedback loop, keeping debt-

service costs and fiscal deficits elevated. Much more will

need to be done to broaden domestic tax bases; the

resource sector (large, easily identifiable and easy to tax)

will be the likely target of such policies.

Politics

2012 will be a year of key elections in Africa. Kenya and

Ghana will hold presidential and parliamentary elections,

and South Africa’s African National Congress (ANC) will

hold internal elections. In 2007, the same three elections

provided a litmus test of political trends in the region.

After its 2007 election, Kenya erupted into violence in a

way few would have been able to predict, South Africa

saw a perceived shift to the left, and Ghana saw a

smooth transition between governments on the basis of

only 40,000 votes. Now, the hope is that Kenya will move

forward in a mood of reconciliation, while the threat to the

centre in South Africa (this time from the nationalist ANC

Youth League) appears to have been defused. All eyes

will be on Ghana, a new oil producer, to see if it will

replicate the success of its peaceful 2007 election. If it

does, this is likely to be the most important sign yet that

Ghana has not succumbed to the oil curse.


Angola Victor Lopes, +971 4 508 4884

[email protected]

12 December 2011 73

Restarting the growth engine

Economic outlook

Angola, the third-largest sub-Saharan African economy,

is set for a growth resurgence. Rising oil production will

likely drive a growth rebound to 8% in 2012, with oil

production set to rise to 1.8 million barrels per day

(mbd) from 1.6mbd in 2011. Growth in 2011 was

modest (an estimated 3.7%) as oil production was

hampered by technical problems.

The economic outlook is likely to continue to improve.

Most arrears accumulated in 2009 have been cleared,

and the country is posting fiscal and external surpluses

thanks to high oil prices. This progress led the three

main rating agencies (S&P’s, Fitch and Moody’s) to

upgrade Angola to the equivalent of BB- (similar to

Nigeria or Gabon) in 2011. The country remains

vulnerable to a decline in oil prices, but prices have

been firm so far and are likely to remain so, despite the

problems in the euro area.

The medium-term picture is positive. GDP growth is set

to accelerate as infrastructure and construction projects

go ahead. GDP growth should average 7% between

2012 and 2014. In the future, agriculture and agro-

processing are likely to become the key drivers of non-

oil growth given the country’s agricultural potential.

Financial issues

Plans for eurobond issuance have been postponed. It is

unclear whether the government will try to tap

international markets in 2012. Should it go ahead, we

believe that governance issues would weigh on risk

perception, and investors would probably demand a risk

premium above similarly rated Gabon or Nigeria. The

government is expected to continue to rely on credit

lines from key partners (Brazil, China and Portugal) and

on domestic debt issuance to meet its financing needs.

As a result of the stronger external position, the Angolan

kwanza (AOA) has been stable in 2011 and is likely to

remain so in 2012. This will help the central bank,

Banco National de Angola (BNA), to contain inflationary

pressure and keep its recently created benchmark

interest rates at relatively stable levels. However,

inflation is likely to remain in double digits, as structural

bottlenecks such as port congestion remain a key

obstacle to bringing down inflation rates in the near

term.

Policy

Budget management and transparency have generally

been improving, and this process should continue in

2012. The government has deepened its relations with

the IMF (Angola is under an IMF Stand-By

Arrangement); this is a positive step not only from a

funding standpoint but also in terms of transparency and

budget management.

Politics

The next parliamentary (and presidential) elections are

due in 2012. Angola has an indirect electoral system in

which the party that wins most seats in the assembly

designates the president. The ruling MPLA is likely to

win again, as the opposition is weak. It is not yet certain

that ruling president Dos Santos will run again, but

chances that he will do so are high.

With President Dos Santos having been in power for

more than three decades, the succession issue is a

source of uncertainty in the medium term. However, he

is expected to designate a successor while he is still in

power to ensure an orderly succession. The rising cost

of living could lead to social discontent or unrest, but is

unlikely to fuel massive protests that would specifically

demand (or force) a regime change. Should such issues

emerge, the government would probably adopt price

controls or restore subsidies.

Standard Chartered forecasts: Angola

2011 2012 2013 2014

GDP (real % y/y) 3.7 8.0 6.5 6.5

CPI (% y/y) 15.0 14.0 10.0 9.0

Policy rate (%)* 10.5 10.0 8.5 8.0

USD-AOA* 93.00 91.50 91.00 90.00


12.0 7.0 6.0 5.0


7.9 8.0 5.5 4.0



Botswana Razia Khan, +44 20 7885 6914

[email protected]

12 December 2011 74

A new global diamond hub

Economic outlook

Continued strength in global demand for diamonds will be

a key influence on Botswana’s prospects in 2012, but

barring a new crisis on the scale of 2008-09, local factors

should dominate. Recent economic growth in Botswana,

the world’s largest diamond producer by value, has been

driven by a recovery in mining output following the 2009

crisis. Robust construction activity related to power-

sector and mine expansion projects (prolonging the life of

the Jwaneng mine) has driven gains in GDP growth,

offsetting the impact of a prolonged public-sector strike in

response to fiscal consolidation measures. Growth

momentum remains favourable going into 2012.

While new diamond demand from emerging markets has

been a key factor in the post-crisis price recovery,

evidence from recent Diamond Trading Company (DTC)

sight auctions suggests that prices have started to

decline. However, Botswana’s GDP growth is only likely

to be impacted significantly if mine output is scaled back.

Based on current forecasts, this appears unlikely. Gains

in other sectors will also be a key influence on overall

growth. Completion of the Morupule B power station is

expected in 2012, adding another 600MW of power

generation capacity to the national grid (from a current

132MW). Copper output also looks set to increase.

Botswana has set its sights on becoming a new global

diamond trading and manufacturing hub, with an

agreement now secured on the planned relocation of De

Beers’ DTC – responsible for the sale of rough diamonds

from mines worldwide – to the country before end-2013.

Anecdotal evidence already points to a number of

international firms opening polishing factories in

Botswana. Under the new arrangement, Botswana will

market at least 10% of its production independently of De

Beers, allowing the authorities to become more familiar

with price trends. Botswana’s services sector could scale

up significantly, but much will depend on regulatory

reforms aimed at achieving a broader productivity boost.

Liberalisation of work permits would help Botswana

establish scale, accelerate job creation, and overcome

the disadvantages associated with its small population.

Policy

Thanks to a faster-than-expected recovery in diamond

revenue, Botswana is likely to return to a budget surplus

earlier than initially projected. Nonetheless, given global

uncertainty, exchange rate policy will continue to be

governed by the need to boost US dollar (USD) earnings

in local-currency terms. This suggests that the Botswana

pula (BWP) will trade closely in line with the South

African rand (ZAR). A return to a current account surplus

is forecast over the medium term as the import

requirement for large infrastructure projects declines.

The authorities’ decision to cancel the 91-day Bank of

Botswana Certificate (BoBC) auction in late 2011 is likely

to influence market liquidity well into 2012. While the

liquidity released – only some of which will be sterilised

through other issuance – should continue to put

downward pressure on market interest rates, rising

regional inflation pressures may eventually force an

upward adjustment in the bank rate. The authorities’

belief that inflation will fall back within the 3-6% target

range by H2-2012 stands in contrast to evidence of rising

regional inflation and the likelihood of more ZAR

weakness, which would further exacerbate CPI gains.

Politics

The post-crisis period has proven to be a testing time for

Botswana’s politics, with 2011’s prolonged public-sector

strike serving as a focal point for the opposition. Despite

the formation of a new splinter party, the ruling Botswana

Democratic Party’s (BDP’s) hold on power is seen as

intact. Elections are not due until 2014, and alliances

among the country’s fragmented opposition parties have

a poor track record of holding together.

Standard Chartered forecasts: Botswana

2011 2012 2013 2014

GDP (real % y/y) 8.0 7.0 5.9 6.5

CPI (% y/y) 6.9 8.2 6.7 5.7

Policy rate (%)* 9.5 10.5 11.0 11.0

USD-BWP 7.52 7.52 7.47 7.65


-1.5 -1.2 0.4 1.3

Fiscal balance ** (% GDP)

-2.0 0.8 3.7 4.0




Cameroon Victor Lopes, +971 4 508 4884

[email protected]

12 December 2011 75

Growth to pick up despite risks

Economic outlook

Cameroon’s GDP growth outlook has improved, despite

risks linked to the global outlook, and should reach 4% in

2012. While unimpressive by African standards, this

would be the highest growth seen in Cameroon since

2005 (we forecast 2011 GDP growth at 3.5%).

The growth outlook is supported by rising public

investment in infrastructure. Infrastructure projects

underway include the Kribi deepwater port, the extension

of the road network in Douala, and a bridge on the Wouri

river (in Douala).

Oil production (64,000 barrels per day in 2010) has been

in long-term decline but should rise between 2012 and

2014 as new wells come on-stream, providing some

medium-term support; however, this is unlikely to be

significant, as oil accounts for only 7% of GDP. In the

longer term, some gas is expected to come on-stream by

2017, which should help to offset the decline in oil

production after 2014.

Financial issues

Part of the infrastructure programme will be financed via

the country’s first-ever local bond issuance (XAF 200bn

or EUR 304mn) in November 2010, in the Douala

regional financial market. Cameroon is only the second

government in the Central Africa Economic and Monetary

Union (CEMAC) after Gabon, to have issued a local

bond.

Also, the government finally started to issue local short-

dated T-bills in 2011 (XAF 50bn to be issued in

November and December); this should continue in 2012.

Policy

In our view, the key issue facing the government is the

deterioration in public finances in 2011, when the fiscal

deficit is likely to have reached 5% of GDP. This was due

to the large weight of subsidies (2% of GDP),

government arrears to the local refinery (1.2% of GDP)

and a possible current spending over-run.

Fiscal consolidation will be needed in 2012, and while the

issue of fuel subsidies is unlikely to be addressed – as

social stability remains a key concern – current spending

levels are likely to moderate. There is also a risk that

capital spending might be affected, which would

negatively impact economic growth.

The problem is that the government needs to undertake

fiscal consolidation at a time of heightened risks linked to

the global scenario (lower oil prices and a possible world

recession). Should these risks materialise, the

government will lack the means to stimulate the

economy.

Politics

Paul Biya was re-elected as president in October 2011.

With the election over, the risk of political instability

appears limited in the short term, although there could be

unrest if social conditions deteriorate. Unemployment,

especially among educated citizens, is very high in

Cameroon. Failure to address unemployment often fuels

social discontent.

Political risk might be greater in the medium term, as the

succession issue clouds the outlook. In power since

1982, Paul Biya is among the longest-serving presidents

in Sub-Saharan Africa (following José Eduardo Dos

Santos in Angola, Teodoro Obiang in Equatorial Guinea

and Robert Mugabe in Zimbabwe). He is only the second

president since Cameroon’s independence in 1960.

Given that he is 78 years old, President Biya’s ability to

complete his seven-year mandate is an open question –

and his succession is the main source of uncertainty in

the medium term.

Standard Chartered forecasts: Cameroon

2011 2012 2013 2014

GDP (real % y/y) 3.5 4.0 4.5 4.5

CPI (% y/y) 2.6 2.5 2.5 2.0

Policy rate (%)* 4.0 3.75 4.0 4.0

USD-XOF* 505 505 486 505


-3.8 -3.3 -3.0 -2.5


-5.0 -0.5 0.0 1.0



Côte d’Ivoire Victor Lopes, +971 4 508 4884

[email protected]

12 December 2011 76

Towards economic normalisation

Economic outlook

The economic outlook has improved thanks to the end of

the political crisis. GDP growth is likely to rebound

strongly in 2012 (to 8%), following a 5.8% contraction in

2011. Strong international goodwill towards the new

government will support the economic recovery. While

the amount of international support is critical for public

finances, more funds are needed to get the economy

onto a better growth path over the medium term.

The country has received the equivalent of 5% of GDP in

aid in 2011. This will help it to cover its financing needs,

but much more will be needed to allow investment to take

off. Foreign investment will be essential, but it might take

a while for meaningful investment to resume. So while

GDP growth will be strong, it is unlikely to reach the

double-digit levels seen in other post-conflict economies.

Financial issues

Côte d’Ivoire is likely to remain in external default to the

London Club for a large part of 2012. The government

has declared that it will resume coupon payments in June

2012, but the regularisation of arrears remains uncertain.

It might not necessarily be a key priority at the moment,

as cash flow will remain tight. Some form of restructuring

cannot be entirely ruled out. This situation will probably

have to be clarified before the country reaches the

completion point of the enhanced Heavily Indebted Poor

Countries Initiative (HIPC).

Prospects for HIPC debt relief in 2012 should bring debt

ratios down significantly (public external debt stood at

50.6% of GDP in 2010), and this will enhance the

country’s creditworthiness.

Policy

Public finances are likely to improve but remain fragile in

2012. With the end of sanctions, the resumption of trade

(especially cocoa exports, which represent around 20%

of fiscal receipts), and increased economic activity thanks

to the normalisation of the political situation, fiscal

revenues should improve. However, given the large

financing gap, the government’s cash-flow situation will

probably remain difficult for some time given high

expenses as the country tries to meet immense

humanitarian, security, basic services, and infrastructure

challenges (among others).

Cocoa production is set to rise, but there are issues

related to the quality of the cocoa produced, and new

investments in the sector will be necessary to ensure a

high level of production. The long-awaited cocoa-sector

reform is likely to progress in 2012 (creating a new

regulatory entity and ensuring higher producer prices are

likely to be key elements), as this is a key condition for

the completion of HIPC debt relief.

Politics

The country appears to be headed towards a calmer

political climate. However, political stability cannot be

taken for granted, as the challenges ahead are still

daunting. Consolidating legitimacy, restoring security and

launching the reconciliation process are among the key

near-term challenges. Violence has been at the heart of

Ivorian politics for more than a decade; it will be no easy

task to reunify such a divided country. The Ivorian army

itself is far from unified: several former rebel factions

need to be integrated with former pro-Gbagbo forces.

New rivalries cannot be ruled out. Reform of the armed

forces is needed, but this promises to be a long and

complicated process.

Standard Chartered forecasts: Côte d’Ivoire

2011 2012 2013 2014

GDP (real % y/y) -5.8 8.0 5.5 5.0

CPI (% y/y) 3.0 2.5 2.5 2.5

Policy rate (%)* 4.25 4.0 4.0 4.0

USD-XOF* 505 505 486 505


1.0 -0.5 -2.0 -2.5


-6.6 -4.0 -3.6 -3.0



Gambia Amina Adewusi, +44 20 7885 6593

[email protected]

12 December 2011 77

Fiscal concerns remain

Economic outlook

Gambia has managed to maintain a stable growth rate,

despite lower tourism receipts and remittances. This is

likely to continue as Europe undergoes a mild recession

and the global environment remains uncertain.

Therefore, any pick-up in tourism is likely to be limited.

Gambia has not necessarily benefited from low-cost

tourism, as tourist spending remains below pre-crisis

highs. Agriculture, which accounts for one-third of GDP,

will continue to drive growth, despite under-

mechanisation and the dominance of small-holders.

Output in 2012 will depend on weather conditions.

Re-exports, which account for nearly 80% of Gambia’s

goods exports, are likely to continue losing out in 2012

to neighbouring Senegal, where port and customs

operations have improved. Without improvements in

port infrastructure, the country’s re-export trade is

unlikely to be sustainable. After robust growth in 2011,

groundnut exports are likely to continue to increase as

government policy focuses on agriculture.

The fiscal situation is still worrisome, as revenue

collection has continued to miss targets and has been

steadily decreasing. One of the main reasons for this is

that fuel subsidies have delayed the pass-through of

international prices, despite a new fuel-pricing formula

introduced in January 2011. Also of concern is a

supplementary budget worth USD 7.2mn, passed just

prior to the November 2011 presidential elections, which

increased spending by 3.9% and of which the office of

the president is the largest beneficiary.

The medium-term Programme for Accelerated Growth

and Employment (PAGE) will be launched in 2012,

focusing on investment in agriculture and infrastructure.

Financing the programme will be a challenge, as the

authorities need to lower domestic financing, which has

high rollover risk due to the reliance on short-dated T-

bills. Domestic debt will still consume one-sixth of

government revenue in 2012. Higher external debt is an

unlikely option, as the external debt/export ratios the

IMF put in place have been breached.

Financial issues

In February 2011, the authorities reverted to a monthly

cash balanced budget system as falling tax revenues

and spending over-runs caused large fiscal deficits. This

has helped T-bill rates to come down from their peak of

10%. We expect this downward trend to continue in

2012 as issuance remains limited.

The Gambian dalasi (GMD) is likely to continue its

weakening trend against major currencies in 2012. We

expect USD-GMD to trade below 30 in the first half of

the year, before weakening in Q3-2012 as the Islamic

month of Ramadan increases US dollar (USD) demand.

Policy

Inflation is likely to trend lower in 2012 and remain within

the Central Bank of Gambia’s (CBG’s) 6% target as food

and fuel prices ease; we see room for the CBG to lower

the rediscount rate from 14%. However, if the fuel-

pricing formula is fully implemented, inflation could rise.

Exposure to external shocks will remain a threat. The

fiscal stance is another key factor for 2012. The transfer

to a cash balanced budgeting system should increase

fiscal discipline, but the authorities’ somewhat opaque

spending process will remain a concern.

Politics

After winning the presidential elections in November with

76% of the vote, President Jammeh will continue to

dominate domestic politics. The opposition remains

fractured, and widespread oppression of dissenting

voices will mean that they are unlikely to gain a foothold

in the political mainstream. While little change to the

status quo is expected near-term, political developments

will be closely watched.

Standard Chartered forecasts: Gambia

2011 2012 2013 2014

GDP (real % y/y) 6.1 5.5 5.5 5.5

CPI (% y/y) 6.0 5.0 4.0 4.0

91D T-bill rate (%)* 7.70 7.00 6.50 6.00

USD-GMD* 28.00 30.00 32.00 34.00


-17 -14 -13 -13

Fiscal balance** (% GDP)

-3.4 -2.7 -1.6 -1.0

*end-period, **for fiscal year ending 31 March



Ghana Razia Khan, +44 20 7885 6914

[email protected]

12 December 2011 78

First election as an oil producer

Economic outlook

Following the boost to 2011 growth from first oil, Ghana’s

economy should maintain strong momentum. The

government is targeting 7.6% non-oil GDP growth in

2012 and expects overall GDP growth of 9.4%. Given our

own expectation of broadly supportive commodity prices,

we forecast growth of 8.5%.

The Bank of Ghana’s Composite Indicator indicates strong

growth across a number of sectors. Increased government

spending and infrastructure development ahead of

elections due in 2012 should cement these gains.

Technical difficulties with oil production will prevent Ghana

from achieving expected production levels of 120 thousand

barrels per day (kbd) from its Jubilee Field by the end of

2011. Nonetheless, actual production levels of 80 kbd are

not materially different from budget forecasts, with Ghana

still exporting all of its crude production in order to

establish a benchmark. The lack of infrastructure to make

use of the gas produced is a constraining factor. The hope

was that Ghana could use this gas for electricity

production, thus boosting manufacturing. The

infrastructure is now unlikely to be in place until mid-2013

at the earliest, dampening oil production forecasts.

However, plans for the financing of gas infrastructure are

in place, with around USD 850mn of a USD 3bn loan from

the China Development Bank earmarked for this purpose.

Ghana’s cocoa prices are regulated. The high farm gate

price paid to cocoa farmers will provide a substantial

boost to disposable income in the year ahead, especially

given relatively stable inflation. Although Ghana sells its

cocoa forward, softer international prices since the peak

of the Ivorian political crisis raise doubts about the

sustainability of prices currently offered to Ghanaian

farmers. Furthermore, gradual FX depreciation may be

required to compensate for high cocoa prices paid to

farmers in Ghanaian cedi (GHS) terms.

With the government paying down more of its arrears, the

banking sector’s non-performing loans are likely to

improve. This should feed into healthier credit growth in

2012.

Financial issues

In recent years, Ghana’s domestic debt market has been

one of frontier Africa’s top recipients of foreign inflows

(measured by foreign investor participation as a

proportion of total issuance). Ghana’s transition to oil-

producer status, expectations of healthier external

balances, FX and inflation stability, and high yields have

all added to its attraction for investors. Since the global

financial crisis, Sub-Saharan frontier markets have

attracted a healthier mix of ‘real money’ flows, typically

with a longer-term horizon, rather than the short-term,

highly leveraged inflows that previously dominated. This

has created some resilience to global shifts in risk

appetite. Nonetheless, should global risk appetite

deteriorate again – as we expect in Q1-2012 – smaller,

less liquid markets will be disadvantaged by the flight to

safety and preference for liquidity that are likely to

characterise this ‘risk-off’ environment.

While Ghana is unlikely to experience sudden outflows,

the pace of new inflows is likely to slow in 2012. With

aggressive tightening in other frontier markets boosting

the relative attractiveness of yields elsewhere, Ghana

may be disadvantaged; this is already evidenced by

declining foreign investor participation in domestic bond

auctions (see chart below).

A key challenge in 2012 will be for Ghana to further

deepen its debt market by broadening the domestic

institutional investor base, extending yield curve maturities

and providing more reassurance to foreign investors on

fiscal and FX policy. Although the Bank of Ghana (BoG)

targets GHS real effective exchange rate (REER) stability,

Ghana’s thin FX market has been susceptible to

overshooting in the absence of explicit BoG support.

Standard Chartered forecasts: Ghana

2011 2012 2013 2014

GDP (real % y/y) 13.6 8.5 7.9 7.6

CPI (% y/y) 9.0 10.1 12.7 10.8

Policy rate (%)* 12.50 14.00 16.00 15.00

USD-GHS* 1.68 1.70 1.76 1.80


-6.5 -4.9 -3.3 -1.5


-4.8 -4.8 -4.5 -4.2



Ghana (con’d)

12 December 2011 79

Since October 2010, Ghana is believed to have hedged

part of its oil consumption requirement. It also fully

hedges its crude oil exports (with a strike price on options

higher than the 2012 budget benchmark of USD

90/barrel). Gains on Ghana’s hedge book on imports help

to meet the cost of a domestic fuel subsidy, and excess

revenue from crude exports goes into a stabilisation fund.

Should oil prices decline, Ghana’s budgetary earnings

would still be safeguarded. Although current fuel prices

are believed to reflect an international oil price of USD

93/barrel (they have not been adjusted since a

contentious 30% increase in domestic prices in January

2011), the level of fuel subsidies is unlikely to be reduced

ahead of end-2012 elections.

Policy

Rating agencies have warned that fiscal slippage ahead

of the election would pose a risk to Ghana’s outlook.

Nonetheless, healthy revenue growth on the back of

improved non-oil revenue collection has created room for

additional spending. The fiscal deficit in 2012 is likely to

remain unchanged at 4.8% of GDP.

Somewhat controversially, the 2012 budget outlined a

higher corporate tax rate for the mining sector (raised to

35% from 25%), and a windfall tax of 10%. Although this

has drawn vocal protests from mining companies, some

of which have threatened to curb investment plans, the

new taxes are unlikely to affect long-term growth

prospects. IMF analysis suggests that the mining sector

has made a low contribution to fiscal revenue relative to

other sectors in the formal economy.

The 2012 budget also envisages a large increase in

foreign financing of the budget (to USD 1bn), keeping net

domestic financing limited to 2.4% of GDP (or GHS

1.67bn, around 30% lower than had been projected in

2011). An additional USD 1.2bn will be drawn down from

the China Development Bank loan.

Ghana’s public-sector wage bill is set to account for an

even greater share of non-oil GDP given ‘single spine’

salary reforms and increases in base pay in 2011.

Although an increased resource envelope, including

foreign financing on concessional terms, has allowed for

higher pre-election spending without pressuring the

deficit, public spending will still need to be carefully

monitored. Ghana’s history of pronounced election-

related cyclicality is likely to leave investors cautious

ahead of 2012; its new oil-producer status risks

exacerbating the tendency to overspend.

Inflation risks are forecast to rise given expected GHS

volatility (stemming from reduced foreign portfolio

inflows), quarterly utility price increases¸ buoyant non-oil

GDP and recent public-sector wage increases. Although

both food and non-food inflation have been exceptionally

well behaved, a continuation of recent GHS weakening

may require early tightening from the BoG, as currency

stability is a key factor in keeping inflation low. Given the

healthy level of Ghana’s real interest rates, we forecast

only modest tightening of 100-150bps in 2012.

Politics

Presidential and legislative elections – the first since

Ghana’s transition to oil-producer status – are due by

end-2012. Elections are likely to be close again, with the

ruling National Democratic Congress (NDC) and the

opposition New Patriotic Party (NPP) vying for votes.

After run-off elections at the end of 2008, the presidential

election was decided on the basis of only 40,000 votes.

While Ghana has an established history of peaceful

democratic transition, with changes in government

following both 2000 and 2008 elections, observers will

watch closely for any signs that the country’s newfound

oil wealth might destabilise things. Ghana’s advantages

lie in having discovered oil with an already mature and

established democratic system of governance. Civil

society will want to ensure that even with oil in the

equation, this does not change.

Foreign investor participation in Ghana 3Y and 5Y bond

auctions

Amount of primary issuance bought by foreign investors

Sources: Reuters, Standard Chartered Research

Foreign participation, zero at Oct

auction

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Dec-06 Dec-07 Mar-10 Aug-10 Feb-11 June-11 Oct-11


Kenya Razia Khan, +44 20 7885 6914

[email protected]

12 December 2011 80

A key election year

Economic outlook

Economic prospects will be dominated by 2012 elections

– the first to be held since those contested in late 2007,

which triggered a round of post-election violence,

shattering Kenya’s long-held reputation for stability. With

politicians and civil society aware of what is at stake this

time around, much smoother polls are predicted.

GDP growth is likely to recover in 2012, following the

impact of a drought that weighed on 2011 growth. Higher

food and fuel prices and FX volatility combined to drive

Kenyan inflation to 20% by late 2011. While the economy

will suffer the lagged impact of the 1,100bps of tightening

seen in Q4-2011, this should be offset by other factors.

Better rains, rising food production, and robust cross-

border trade with rapidly growing East African neighbours

(creating demand for Kenyan manufactured goods)

should all support growth. Interest rates are unlikely to

stay at current highs for long. With inflation expected to

trend down in 2012, an easing cycle should be in place

by H2-2012, providing some boost to investment.

There are several risks to this outlook, however. The key

risk revolves around government spending. Subdued

domestic issuance in H1-FY12 (period ending December

2011), partly owing to undersubscribed bond auctions,

may force the government to reduce spending plans –

even ahead of an election – if it is not offset by foreign

borrowing. Given Kenya’s election history, it is not certain

that the Grand Coalition Government formed as part of

the peace-building effort in 2008 will hold together until

elections are due, although the risk of a coalition break-

up is seen as low. Any such risk event would take a toll

on business and consumer confidence.

The second risk relates to Kenya’s incursion into

Somalia, ostensibly to deal with Al Shabaab militants and

safeguard Kenyan territory (and tourism) from militant

attacks, and to combat the costs of Indian Ocean piracy

to Kenyan trade. It is unclear how this military activity will

be paid for (given the dislocation in Kenya’s bond market

stemming from high inflation) or how long it is likely to

last. Local press reports suggest that an additional KES

7bn has been added to Kenya’s KES 51.3bn military

budget to pay for it. The risk of drawn-out military

involvement, unless supported by increased foreign

flows, would be an additional negative for Kenya’s fiscal

outlook, at a time when domestic borrowing is already

constrained.

Given weak growth in the euro area, still a key trading

partner, there are potential risks to tourism inflows, as

well as horticulture and floriculture exports. However,

evidence from the 2009 recession suggests that demand

for Kenya’s farm exports may increase during a

downturn. Given the sensitivity of the sector to transport

costs, any easing of oil-price pressures would be

positive.

Financial issues

How the authorities deal with dislocation in Kenya’s

domestic bond market will be a key theme in 2012. While

the response to tight market liquidity and subdued

demand for longer-dated instruments in H1-FY12 has

been to hold back much of Kenya’s planned bond

issuance – so as not to lock in higher financing costs –

this will be difficult to sustain later in the fiscal year. As of

December 2011 the authorities are close to the limit on

their borrowing ceiling from the Central Bank of Kenya

(CBK).

In our view, expected fixed income maturities by the end

of 2011 should help to ease tight market liquidity,

bringing down elevated overnight rates. This, combined

with the expected confirmation of the peak in CPI inflation

in early 2012, should lead to improved subscription rates

for T-bill auctions. As the market focus shifts to expected

interest rate easing in H2-2012 (much sooner than

Standard Chartered forecasts: Kenya

2011 2012 2013 2014

GDP (real % y/y) 4.9 5.3 5.5 5.9

CPI (% y/y) 14.0 13.3 6.8 6.5

Policy rate (%)* 18.0 14.0 10.0 9.0

USD-KES* 92.00 97.00 98.00 104.00


-9.3 -8.5 -6.8 -6.5


-4.6 -8.5 -7.8 -6.8

*end-period; ** for fiscal year ending 30 June



Kenya (con’d)

12 December 2011 81

previously expected given unexpectedly aggressive

tightening from the CBK at the end of 2011), demand for

longer tenors may improve from the very low subscription

rates seen in 2011. However, the ease with which the

authorities can borrow domestically, while still containing

deficit financing costs, will depend on how much they

need to borrow. Given the anticipated deterioration in the

budget deficit, there are concerns that domestic budget

financing will be constrained for some time.

Banking-sector profitability is likely to be impacted initially

by increased provisioning and subdued credit demand in

response to CBK tightening. However, with anecdotal

evidence suggesting a voluntary restructuring of client

loans – increasing the tenor of loans in order to reduce

the likelihood of default – a significant impact is not

expected. The resumption of an easing cycle in H2-2012,

helped by Kenyan shilling (KES) gains, should limit the

macroeconomic fallout. New legislation grants the CBK

the authority to put in place corrective measures ahead of

any bank solvency issues. However, we do not think this

will be required, as Kenya’s liquidity shock is likely to be

short-lived.

Plans for increased external borrowing have been

mooted. While Kenya hopes to benefit from a larger

extended credit facility from the IMF (USD 750mn over

three years), plans for a USD 500mn eurobond issue

may be brought forward, market conditions permitting.

Policy

The FY12 budget initially projected a narrowing of the

primary deficit to 2.7% of GDP from 3.8%. However,

when debt-service costs were factored in, the deficit

ballooned to 7.4% of GDP. Even though net foreign

financing was increased to USD 1.33bn in order to keep

domestic borrowing flat, the actual deficit for FY12 now

looks likely to be substantially higher (we forecast 8.5%).

First, GDP growth is unlikely to match the c.6% rate

assumed in the budget. While inflation has exceeded all

expectations, it has not yet had a meaningful impact on

revenue collection. Most importantly, with short-term

interest rates having risen from around 6% at the time of

the June budget to close to 17% by the end of H1-FY12,

debt-servicing costs will widen the deficit substantially. In

order to stabilise the public debt ratio, currently at c.45%

of GDP, Kenya would need to commit to several years of

primary deficit reduction. It is unclear whether it can

afford to do so given the cost of implementing the new

constitution. We expect the deficit to remain relatively

wide in the medium term.

FX market restrictions limiting the provision of KES

liquidity to offshore counterparties are likely to be short-

lived, and to be removed once sufficient KES stability has

been achieved. Given little evidence that KES weakness

is boosting manufacturing exports, the authorities are

likely to favour a stronger FX rate.

Politics

Kenya’s successful constitutional referendum in August

2010 – the first national vote to be held since contentious

elections in late 2007 – has raised optimism that 2012

elections will be relatively peaceful. With President Kibaki

set to complete his second term in office, Prime Minister

Raila Odinga appears to be the strongest contender for

the presidency (the post of PM will be discontinued

following the elections). Uncertainty still surrounds the

likely candidacy of Finance Minister Uhuru Kenyatta; this

will depend partly on what happens with International

Criminal Court charges against him, relating to his

alleged role in post-election violence in 2007-08.

Kenya’s new devolved model of government, which

reduces the powers of the executive, is expected to be

instated after the elections. Kenyans will be voting for a

president and a number of other representatives,

including governors, MPs, a newly created senate, and a

senate representative for each ward. Parliament will be

enlarged to 350 seats from 222 currently, and county

governments will be created, receiving perhaps as much

as 15% of the budget. Concerns over the affordability of

implementing the new constitution persist.

2012 should see a recovery from Kenya’s inflation shock

3M T-bill yield

Sources: Reuters, Standard Chartered Research

91 T-Bill

USD-KES (RHS)

70

75

80

85

90

95

100

105

110

0

2

4

6

8

10

12

14

16

18

Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Oct-11


Mozambique Victor Lopes, +971 4 508 4884

[email protected]

12 December 2011 82

Unstoppable

Economic outlook

Mozambique is set to remain a star performer in Africa in

terms of economic growth. The economy has expanded

at an average rate of close to 8% over the last decade

and is likely to grow by more than 7% in 2012.

This spectacular growth performance has been driven by

mega-projects in aluminium, gas and electricity. New

projects in coal (production started in 2011; Mozambique

will become Africa’s second largest coal exporter after

South Africa in 2012) and the development of

infrastructure linked to mining projects are positive for

2012 growth, and for employment in the regions where

the projects are located. Significant gas production is

also likely over the medium term.

Higher mining export volumes are likely to offset any

negative impact from potentially lower aid flows and

commodity export prices on the current account balance.

The current account deficit has traditionally been large

given the high level of imports and dividend outflows

linked to the mega-projects (as well as the country’s high

level of oil and food imports). Increased exports volumes

and strong foreign direct investment will support the

currency and smooth inflationary pressures.

The recession in Europe poses risks to Mozambique, but

higher coal export volumes, combined with rising

agricultural production and dynamic domestic demand,

should sustain strong GDP growth.

Financial issues

The country is considering launching its first eurobond,

but this is likely to happen only if market conditions

become more favourable. Also, the government

continues to issue long-dated domestic debt.

Policy

FDI has been focused in a few large, capital-intensive

projects. While these have been important to GDP

growth and the external accounts, they have contributed

only marginally to fiscal revenue. As a consequence,

Mozambique remains highly dependent on international

donor support (one-third of total government revenues).

Given that aid flows might slow in the future, it is vital for

the country to broaden its tax base. While the

government has managed to increase revenue collection

to c.19% of GDP, more efficient tax collection in 2012

could drive this at least 1ppt higher. An expected rise in

capital spending, however, would widen the fiscal deficit

further.

The government recently announced that it was in

discussions with mining companies for a possible review

of the mining code. In our view, this does not signify a

resurgence of resource nationalism. While full details are

still awaited, it seems that the new legislation will not

change the tax regime, but only some aspects of the

licensing process. In any case, the government is keenly

aware of the need to balance its legitimate desire to

increase mining revenues against the need to maintain

Mozambique’s reputation as an attractive investment

destination.

Addressing the issue of power generation will remain a

key objective of policy makers as they cope with rapidly

increasing electricity demand (12% per year).

Politics

The next legislative and presidential elections are due

only in 2014, and the political situation is expected to

remain stable. However, the high poverty rate (55% of

the population) in the context of food-import dependence

means that the country is particularly prone to social

unrest at times of rising food (and oil) prices. This was

highlighted by the riots that occurred in 2008 and 2010.

Standard Chartered forecasts: Mozambique

2011 2012 2013 2014

GDP (real % y/y) 7.2 7.3 7.5 7.5

CPI (% y/y) 10.8 7.2 6.0 5.5

Policy rate (%)* 16.0 15.5 15.0 14.5

USD-MZN* 26.0 25.0 24.5 24.0


-11.8 -11.5 -11.5 -11.0


-6.1 -6.8 -6.3 -5.8



Nigeria Razia Khan, +44 20 7885 6914

[email protected]

12 December 2011 83

The USD 250bn question

Economic outlook

2012 may be a transformative year for Nigeria’s

economy, depending on the appetite to push through key

reforms. We expect a rebasing of GDP (last done in

1990) early in the new year. After Ghana’s 2010

rebasing, the first since 1993, it was ‘discovered’ that the

economy was 60% larger than previously thought. The

rebasing exercise is likely to deliver similar results for

Nigeria. The importance of the telecom and financial-

services sectors will increase. With a larger measured

GDP, Nigeria’s already negligible debt-to-GDP ratios may

appear smaller still, although important shortcomings –

such as the inability to collect significant revenue outside

the oil sector – will become more evident.

While recent growth has comfortably exceeded 7%,

driven largely by developments in the non-oil economy,

much of it has been driven by improvements in

agricultural output. With little noticeable increase in

productivity, growth has not been transformative. Several

reforms expected in 2012 are key to Nigeria’s ability to

improve its growth prospects and make a meaningful

difference to poverty levels.

The lifting of fuel subsidies, estimated to cost Nigeria at

least USD 7bn a year, will be a dominant theme. While

this has long been recognised as a key step towards

right-sizing government spending, the measures are

deeply politically contentious. In December 2011, the

House of Representatives approved a medium-term

fiscal framework but refused to commit to the lifting of

subsidies. Few doubt the long-term economic benefits of

lifting subsidies, but successive regimes have failed to

adjust fuel prices meaningfully. State governors now

appear to favour some form of subsidy removal, as it

would potentially boost the revenue allocations made to

them, but overall resolve to drive reforms is uncertain.

Subsidies in their current form support rent-seeking and

create economic distortions. Fuel is not available

everywhere at the subsidised price – wide variations exist

across different parts of the country. Subsidies have

discouraged private-sector investment in refineries, as

owners would have little influence over product prices.

Consequently, fuel features significantly in Nigeria’s

import bill. Domestic fuel consumption rarely falls when

prices increase, as little of the price increase is passed

on. For oil marketers, which are paid the difference

between international product prices and the subsidised

price of domestic fuel (NGN 65/litre), there is an incentive

to import even more product when prices are high. In

recent years, balance-of-payments and fiscal strains

have been evident. By some accounts, Nigeria may even

pay more in subsidies than it earns in oil revenue.

Nigeria is set to make important strides towards a

‘cashless’ economy in 2012, given pilot efforts to limit the

size of cash withdrawals from banks, initially in Lagos

and then in other urban centres. Transporting large sums

of cash notes in order to meet demand is thought to cost

the banking sector up to USD 700mn annually, which

could be channelled into lower loan-to-deposit spreads if

e-channels were employed instead. If realised, the

reforms could be far-reaching, ultimately bringing more of

the money in circulation into the banking sector, lowering

bank costs and improving the transmission of monetary

policy. They could also shed more light on the country’s

large errors and omissions (outflows on the balance of

payments, which typically account for as much as 30% of

known export earnings) and improve governance.

Passage of the long-awaited Petroleum Industry Bill (PIB)

is also hoped for. The lack of progress has taken its toll

on the oil sector, with regulatory uncertainty delaying

investment in offshore fields. Protracted delays may start

to impact oil production capacity. Existing unsustainable

levels of government spending and falling FX reserves

suggest that Nigeria would benefit from improved fiscal

terms, which could potentially raise the authorities’ oil

revenue by USD 10bn annually.

Standard Chartered forecasts: Nigeria

2011 2012 2013 2014

GDP (real % y/y) 7.2 6.9 7.3 7.5

CPI (% y/y) 10.9 10.0 9.1 12.0

Policy rate (%)* 12.00 13.25 14.00 13.50

USD-NGN* 163 158 159 161


12.2 11.3 10.5 9.0


-4.0 -3.3 -2.0 -1.5



Nigeria (con’d)

12 December 2011 84

Power-sector reforms will also be key to the economic

outlook. Nigeria hopes to generate 16,000MW of

electricity by 2014 (current output is only 4,000MW).

Debate over privatisation in the sector has been lively,

with unions arguing that the vast amounts of capital

investment required, as well as long cost-recovery times,

run counter to the need for privatisation. Phased tariff

increases are aimed at making investment in the sector

more attractive, but progress will only be assessed in the

medium term.

Financial issues

Nigeria’s banking-sector resolution process is now largely

complete. The bailout is unlikely to involve large fiscal

costs. The Asset Management Corporation of Nigeria

(AMCON) has bought NGN 3.14trn (USD 20.25bn) of

bad debt, and hopes to pay for the bailout by selling

these assets at an eventual profit. Banks will also pay a

30bps levy on their balance sheets, annually for 10

years, into a sinking fund. This, together with

contributions from the Central Bank of Nigeria (CBN),

should help to meet AMCON costs. Three banks were

nationalised and another five merged and recapitalised

by healthier institutions. Nigeria’s interbank guarantees

will be lifted in 2012, likely resulting in more competition

for liabilities between banks and higher deposit rates.

With the sector having largely returned to profitability,

private-sector loan growth rates have already improved.

Policy

Significant spending increases in recent years, and

withdrawals from the Excess Crude Account (Nigeria’s

undistributed oil savings) leave the country vulnerable to

potential oil-related shocks in 2012. We expect the 2012

budget to adopt a benchmark crude price of USD

70/barrel and an oil production assumption of 1.45 million

barrels per day (mbd). With a scant savings buffer

relative to the 2008 crisis and little progress on plans for

the formal establishment of a sovereign wealth fund, a

collapse in oil prices (not our forecast scenario) would

necessitate far higher borrowing than implied by a 3.3%

of GDP budget deficit, and/or significant spending cuts.

Monetary policy is likely to remain tight, with frequent

open-market operations and FX sales to the interbank

market in order to limit spreads between market-

determined FX rates and the official Wholesale Dutch

Auction System (‘WDAS’, with a USD-NGN mid-rate of

155). Persistent interbank market weakness may trigger

a widening of the +/-3% band around the current WDAS

mid-rate. Further rate tightening is probable in the event

of inflationary pressure stemming from government

spending, the lifting of fuel subsidies, or continued

pressure on the FX reserves.

Secondary-market bond trading should remain subdued.

This reflects the impact of recent aggressive tightening,

with banks holding bonds to maturity to avoid notional

capital losses stemming from higher interest rates. IFRS,

requiring mark-to-market valuations, will be introduced by

end-December 2012.

Politics

Presidential elections held in April 2011 saw marked

differences in voting allegiances in the north and south of

the country. Given more frequent Boko Haram attacks in

the north, believed to reflect frustration at the lack of

social and economic progress, efforts at national

reconciliation in 2012 will be key to Nigeria’s future.

Although the 2011 elections were viewed as the most

successful since Nigeria’s transition to civilian rule,

resulting in a parliament less dominated by the ruling

People’s Democratic Party, little changed in terms of the

economic impact of elections. Based on budget figures –

including two supplementary budgets – spending rose

almost 50% y/y in the year before the elections.

Disbursals from the Excess Crude Account, related to

efforts to win political favour, also became more frequent.

Any oil-price shock would call into question the

sustainability of Nigeria’s current system of political

patronage, likely resulting in increased political risk.

Nigeria has seen unsustainable spending increases

Total expenditure, federal budget, NGN trn

Sources: FMFN, Standard Chartered Research

Total expenditure,

NGN trn

0

1

2

3

4

5

6

7

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011


Senegal Victor Lopes, +971 4 508 4884

[email protected]

12 December 2011 85

Staying the course in an uncertain year

Economic outlook

The economy should remain resilient in 2012 as

electricity supply improves, although it is likely to be

impacted by the euro-area recession as trade and capital

inflows slow. Lower commodity prices (oil and food)

should generally benefit Senegal. The uncertain outcome

of the February 2012 elections also raises questions over

future economic policy. Despite these risks, GDP growth

is likely to remain at around 4% in 2012 (we forecast

4.1%).

Senegal’s growth trajectory has been boosted recently,

as the financial health of large corporations in the

chemical, refinery and electricity sectors has improved

and agricultural production has increased following an

ambitious government plan to boost the sector.

Chronic power shortages that have long been a drag on

growth are being addressed (in a pre-election year, the

incentive to avoid unpopular power cuts is high). The

government has commissioned power stations and

leased generators; fewer electricity outages will be a key

source of support to the economic outlook.

Several infrastructure projects currently underway–

notably the expansion of the port of Dakar, a new

international airport and a toll road – should also support

future growth. The infrastructure programme is partly

financed by tapping the international capital markets.

Financial issues

The government successfully issued a USD 500mn

eurobond in 2011. It is likely to continue to diversify its

sources of financing and issue an Islamic bond to tap the

Middle East investor base. The government will also

continue to rely on domestic debt issuance in the regional

West African Economic and Monetary Union (WAEMU)

bond market.

Policy

The deficit is likely to narrow in 2012 after a significant

deterioration in 2011, when it reached an estimated 6.2%

of GDP due to increased capital spending on

infrastructure projects (the toll-road extension project

alone represented 1.3% of GDP) and the energy

programme.

Energy subsidies, which weighed significantly on public

finances in 2011 (at around 1.5% of GDP), are expected

to be reduced in 2012. At some point, the government

will have to increase electricity tariffs, but this can only

happen after the elections and after the electricity

company has shown at least several months of reliable

service. Otherwise it would not be acceptable to the

population. The timing of tariff increases remains

uncertain, especially if a new government comes into

power after the elections.

As food subsidies have been eliminated and agricultural

production has increased, Senegal is less vulnerable to

rising food prices than in the past. However, high food

prices and power cuts could fuel social discontent.

Politics

Elections are due in February 2012, and there is no clear

favourite. President Wade’s candidacy has yet to be

validated by the constitutional council, but it seems likely.

His popularity has declined, but he still seems to have

support in rural areas. There are many opposition

candidates, but their ability to unify remains unclear.

There was unrest in mid-2011 owing to power cuts and a

controversial attempt by the president to change the

constitution. Even if some unrest cannot be ruled out

should President Wade win the elections, widespread

unrest and political instability are not the most likely

outcome given Senegal’s democratic background.

Standard Chartered forecasts: Senegal

2011 2012 2013 2014

GDP (real % y/y) 4.0 4.1 4.5 5.2

CPI (% y/y) 3.6 2.4 2.0 2.0

Policy rate (%)* 4.25 4.0 4.0 4.0

USD-XOF* 505 505 486 505


-7.4 -7.2 -6.8 -6.6


-6.2 -5.6 -3.5 -3.0



Sierra Leone Amina Adewusi, +44 20 7885 6593

[email protected]

12 December 2011 86

Iron ore drives export transformation

Economic outlook

Sierra Leone’s economy will undergo significant

structural change in 2012 due to new mining projects

coming online. Iron ore exports from the Tonkolili mine

began in November 2011, and production is expected to

reach 12 million tonnes (mt) in 2012, potentially

increasing to 45mt in the medium term. The IMF expects

new iron ore production to lead to a quadrupling of

exports and a one-time surge in real GDP growth to 51%

in 2012 (we expect a more modest 30%).

The government’s business-friendly policies have gained

traction, and a number of foreign companies will continue

to be active in 2012. After 30 years of disuse, the

Marampa iron ore mine will restart production of 3.6mt

per year, increasing to 16mt. Oil exploration, which has

been ongoing since 2009, is expected to confirm whether

Sierra Leone has oil in commercial quantities in 2012.

This could be a considerable game-changer for the

country.

With limited private-sector capacity, gains from mining

are likely to be transmitted to the real economy through

government revenue. While total revenue is expected to

benefit in 2012 from royalties and corporate tax from the

Tonkolili mine, significant nominal increases in revenue

are only likely in the medium term given preferential tax

concessions. Managing public expectations will be

important, as gains will likely be modest in the near term.

Public spending will continue to be dominated by

recurrent expenditure as public pay reforms increase

wages. As elections near, capital spending will continue

to increase after almost doubling in 2011.

Financial issues

The fiscal deficit is likely to remain at around 6% of GDP

in the medium term as the government prioritises

development spending over fiscal consolidation.

Crowding-out of the private sector is likely to be a risk as

government borrowing requirements remain elevated.

Tight liquidity in 2011 led to 91-day T-bill rates (the tenor

at which 61% of government domestic borrowing was

done in FY10) rising to 30%. We expect rates to remain

above 20% in 2012.

The Sierra Leonean leone (SLL) will remain on a

depreciating trend in 2012 as fundamentals continue to

be skewed against it; the boost to exports will have a

limited impact on the current account deficit. Recent

stability in the SLL has been supported by tight liquidity,

which is likely to continue into 2012. We expect a slower

pace of depreciation next year, barring external shocks.

Policy

We expect inflationary risks to subside in 2012 as global

food and fuel prices decline. However, Sierra Leone

remains vulnerable to external shocks, and increased

iron ore exports will add to its dependency on commodity

prices. Domestic demand factors could also cause

upside inflationary risks, as the fiscal stance remains

expansionary and there is a risk of unbudgeted pre-

election spending.

The Bank of Sierra Leone (BSL) is likely to have an

easing bias as it tries to encourage lending to the private

sector, and as inflation comes down due to high base

effects. We believe further monetary easing, which began

in October 2011, is likely.

Politics

Legislative and presidential elections will take place in

August and November 2012, respectively. The

incumbent, President Koroma of the All People’s

Congress (APC), is favoured to win. The elections will be

seen as a measure of Sierra Leone’s democracy and a

test for further investment. Security will be a key concern;

however, we expect any unrest to be contained.

Standard Chartered forecasts: Sierra Leone

2011 2012 2013 2014

GDP (real % y/y) 5.2 30.0 8.0 7.0

CPI (% y/y) 16.0 11.0 10.0 10.0

91D T-bill (%)* 23.0 26.0 20.0 16.0

USD-SLL* 4,300 4,450 4,700 4,800


-50 -7.6 -9.5 -12.4


-5.7 -5.1 -6.0 -6.0




South Africa Razia Khan, +44 20 7885 6914

[email protected]

12 December 2011 87

Still-slow growth

Economic outlook

The economic growth outlook is likely to remain subdued,

with considerable downside risks to current forecasts.

Some recovery in domestic consumption is evident,

helped by low interest rates, which have not been raised

since the start of the global financial crisis; however,

global risks loom large. Household balance sheets have

strengthened as consumers have paid down debt. But

consumer confidence remains low, and may decline

further if economic conditions deteriorate.

Given its strong links to the global economy, South Africa

was one of the worst affected African countries by the

global crisis; GDP contracted 1.5% in 2009. While we do

not forecast a severe slowdown in global growth in 2012,

the euro area remains a key trading partner for South

Africa and is the most important destination for its

manufactured exports. Any slowdown in the euro area

will affect South Africa’s economy, although the absence

of a globally co-ordinated downturn would have a less

severe impact.

South Africa’s monetary policy is more supportive of

growth now than it was in 2008. Ahead of the 2008 crisis,

CPI inflation had risen to double the upper level of the

South African Reserve Bank’s (SARB’s) 3-6% target.

Interest rates had been raised aggressively in response,

and despite a SARB easing cycle commencing in

December 2008, the lagged effect of the deterioration in

real disposable incomes and monetary tightening

weighed heavily. Going into 2012, the repo rate is likely

to remain negative in real terms, perhaps for an extended

period, if global risks dominate.

Fiscal room for manoeuvre is likely to be more limited

now, however. In 2008, the fiscal balance was healthier,

and South Africa even achieved a small surplus in FY08.

By the time the crisis hit, South Africa – ahead of hosting

the 2010 World Cup – had already embarked on a

significant public works programme aimed at boosting job

creation. Under current conditions, room for a fiscal

response to the global slowdown will be more limited.

Corporate income tax collection has yet to recover fully.

The public-sector wage bill and social grants have been

among the fastest-rising components of central

government expenditure in recent years. Given the

magnitude of the deficit, this leaves little room for

increased public-sector investment in response to a

slowdown. In the last three years, government real-non-

interest spending increased at an annual average rate of

7.9%. This is set to decelerate to just 2.3% in the next

three years as debt-servicing costs rise.

Given the external environment, manufacturing – and,

perhaps to a lesser extent, mining – may slow from

current levels, although increased developing-country

demand for South Africa’s commodity exports may

prevent a deterioration on the scale seen previously.

Growth will largely depend on a continued recovery in

consumer spending.

Financial issues

As the South African rand (ZAR) is a high-beta currency,

South African financial markets will be heavily impacted

by changes in global risk appetite. We expect significant

ZAR weakness in Q1-2012, in line with a likely

deterioration in risk appetite, the euro, and a flight to

perceived safe havens.

South Africa’s banking sector is generally acknowledged

to be sound, and is noted for the strength of its

regulation; it is not thought to be at particular risk from a

rise in global banking volatility. Exposure to peripheral

European debt accounts for less than 1% of the banking

system’s total credit exposure. However, given traditional

dependence on core European bank participation in

South African bank syndications, any refinancing of the

country’s banks would take place in a much more

constrained external environment. This could potentially

limit their ambitious offshore expansion plans.

Standard Chartered forecasts: South Africa

2011 2012 2013 2014

GDP (real % y/y) 3.2 3.1 4.1 4.3

CPI (% y/y) 5.0 6.1 5.2 5.4

Repo rate (%)* 5.5 6.0 7.0 7.50

USD-ZAR* 8.80 8.20 8.15 8.50


-3.4 -3.8 -4.0 -4.2


-5.3 -5.5 -5.2 -4.5




South Africa (con’d)

12 December 2011 88

Domestically, banks remain heavily exposed to the real-

estate sector, with a sluggish housing market responsible

for subdued growth in private-sector credit extension.

Lending to corporates and unsecured loans to

households, which are already on an uptrend, should

increase further in 2012.

Available FX reserves are now double South Africa’s

short-term debt, resulting in significantly greater

resilience to external shocks than in the past.

Policy

With inflation likely to peak at 6.4% in Q1-2012 and

average 6.1% for the year, the SARB will face a dilemma.

Having already stated that it will not raise interest rates in

response to a supply-side shock alone, it is likely to keep

the repo rate on hold at 5.5% for an extended period – for

as long as global economic uncertainty dominates and

domestic indicators continue to point to sub-trend

economic growth. Nonetheless, exaggerated ZAR

weakness would risk prolonging the breach of the

inflation target, and as an inflation-targeting central bank,

the SARB would be forced to react at some point. We

therefore expect the repo rate to be raised at least 50bps

in H2-2012, with the risk of another 50bps hike should

domestic indicators surprise positively.

The key challenge for fiscal policy will be to balance

expected slower spending with very real demands for

improved service delivery. Well known for its post-

apartheid fiscal conservatism, South Africa will have a

difficult time maintaining this reputation in the years

ahead, especially if growth continues to disappoint. Total

expenditure in FY13 (begins 1 April 2012) is set to

breach the ZAR 1trn mark for the first time. This will

represent a doubling, in real per-capita terms, of the

fiscal resources available only a decade ago, in FY03.

Unless tax revenue recovers faster (no structural

improvement is forecast over the medium term), there will

be limited room to continue spending at the same pace.

Medium-term plans for fiscal consolidation remain in

place. Although the deficit will remain wide in the coming

years, largely as a result of weak growth, the plan is to

achieve a primary surplus by FY15, with an overall deficit

of only 3.3% of GDP.

Questions persist about South Africa’s ability to afford its

social protection outlays, given reduced fiscal flexibility.

Total social spending (social protection grants, housing

and health care, even before the planned introduction of

a comprehensive national health insurance scheme) now

accounts for more than half of all non-interest spending in

any given year. While South Africa’s public debt ratio is

moderate, and is expected to peak at c.40% of GDP in

the medium term, this rises to a more worrying 60% of

GDP when the conditional liabilities of state-owned

enterprises are factored in. Given the focus on social

spending, room for growth-enhancing investment

spending will be limited, increasing the risks to South

Africa’s rating.

Politics

Internal elections in the African National Congress (ANC)

in December 2012 will be a key focal point. With the

suspension of firebrand Youth League leader Julius

Malema from the party, President Zuma’s re-election as

ANC president now appears more secure. However,

some of the issues championed by the ANC Youth

League – such as mine nationalisation (which remains on

the agenda for a policy conference earlier in the year) –

are unlikely to disappear completely.

For much of its history, the ruling ANC has been

something of a broad church – representing a diversity of

interests and, often, political opinion. As it approaches

almost two decades in power and demands for economic

delivery grow more strident, the party’s ability to hold

together in the same way will increasingly be put to the

test.

Post-crisis, South African growth has lagged behind

GDP levels since the crisis

Sources: IMF WEO, Bloomberg, Standard Chartered Research

Q2 -11

Q1-09

90

95

100

105

110

115

120

125

India Indonesia Malaysia Korea S Africa

Q1-08 (real GDP level = 100)


Tanzania Razia Khan, +44 20 7885 6914

[email protected]

12 December 2011 89

Cautious pace of liberalisation

Economic outlook

2012 should see an acceleration of GDP growth thanks

to a recovery from the drought, lower inflation, the

resumption of regional food exports, and ongoing

momentum in the mining, gas, construction and

agricultural sectors. Despite robust trend growth off a low

base, Tanzania’s economic prospects are constrained by

a substantial infrastructure deficit (poor roads, port

congestion and intermittent power supply) and a halting

approach to liberalisation. Although the country is a

signatory to the East African Protocol, allowing for the

establishment of a common market, it has resisted many

of the liberalisation measures required.

Given the weak external environment, donor financing is

likely to be constrained. With an aid-to-GDP ratio as high

as 11.2%, compared with a domestic revenue ratio of

c.15%, Tanzania is highly donor-dependent. Reducing

this dependency will be a key challenge in 2012.

Power-sector reform will also feature prominently in the

year ahead. Frequent droughts have highlighted the

shortcomings of the country’s traditional reliance on

hydro-electricity production. While new investment has

reduced the extent of load shedding, the IMF has called

for more to be done to strengthen the finances of state-

owned utility Tanesco. Studies suggest that

manufacturers lose as much as 24 hours of production

each month because of poor power supply. Demand for

electricity is projected to triple by 2020, but Tanzania is

currently ill-equipped to meet this demand. State

dominance of the sector is gradually giving way to more

private-sector participation. The establishment of

separate transmission and distribution entities may also

be required.

Financial issues

While plans for sovereign eurobond issuance have been

mooted for some time, Tanzania’s domestic debt market

remains closed to foreign investors. Although this is not

unusual for first-time issuers, Tanzania’s weak domestic

revenue mobilisation and limited access to a wider

investor base for local-currency funding are potential

rating negatives. However, recent FX-market volatility is

likely to have left policy makers wary of rapid capital

account liberalisation.

Policy

2012 should see the lifting of temporary measures put in

place to address Tanzanian shilling (TZS) volatility.

Banks accused of publishing FX rates at which they did

not trade were temporarily suspended from the interbank

market in a bid to improve transparency. Net open

positions were cut to 10% of regulatory capital from 20%

to encourage FX selling. The Bank of Tanzania (BoT)

started to supply FX directly to the energy sector at more

favourable FX rates in a bid to curb inflation. While the

result has been marked TZS appreciation from its lows,

the sustainability of current FX rates in the absence of

such extraordinary measures is doubtful.

The financing of an emergency power plan and continued

social spending should keep the budget deficit wide over

the medium term. With donor financing of development

spending in particular under pressure, more will need to

be done to widen the tax base. Tanzania has broadly

pledged that recurrent spending will not exceed the value

of revenue and grants. Higher royalty rates have already

been imposed on the mining sector, and a tax on profits

remains the subject of ongoing negotiations.

Politics

The ruling CCM party will continue to dominate

Tanzanian politics. Reform may be accelerated during

President Kikwete’s final term in office, but broad-based

party support for such efforts is not a given. The

formation of a government of National Unity in Zanzibar

appears to have reduced political risk on the island – for

now.

Standard Chartered forecasts: Tanzania

2011 2012 2013 2014

GDP (real % y/y) 6.1 6.7 7.5 7.3

CPI (% y/y) 11.3 11.7 5.7 5.6

91-day T-bill (%)* 14.75 12.0 9.0 7.0

USD-TZS* 1,760 1,800 1,820 1,860


-9.5 -8.7 -10.2 -9.1


-6.9 -6.5 -6.0 -5.9

*end-period; ** for fiscal year ending 30 June



Uganda Razia Khan, +44 20 7885 6914

[email protected]

12 December 2011 90

Oil one day

Economic outlook

A recovery in agriculture and the expected completion of

the Bujagali hydro-electricity project (with production due

to rise from 50MW in January 2012 to 187MW by year-

end) will drive growth. Spending is likely to be dampened

by the lagged effect of the region-wide inflation shock in

2011, when Uganda’s CPI inflation peaked at 30.4% and

the Bank of Uganda (BoU) tightened rates by 1,000bps.

Even so, growth momentum should remain favourable.

Regional trade, although somewhat constrained by FX

shortages in newly independent South Sudan, will remain

an important influence on growth. Uganda’s transport,

construction and telecommunications sectors are also

likely to see significant gains.

Uganda’s medium-term prospects will be driven by oil.

Total reserves are estimated at 2.5bn barrels, of which

c.1bn may be recoverable. Tax disputes have delayed

production; approval of the sale of two-thirds of Tullow’s

assets in the Lake Albert basin to Total and CNOOC is

key to allowing production to begin. Domestic politics are

a potential stumbling block, with parliament calling for a

moratorium on oil development until an improved

regulatory framework, including a petroleum bill, is in

place. The presidency has rejected this request, as it is

keen to accelerate the production timetable. While little

oil will be produced, perhaps even in 2013, Cambridge

Energy Research Associates (CERA) estimates that

Uganda’s production may average 189,000 barrels per

day by 2021 – respectable by Sub-Saharan African

standards.

Financial issues

Despite delayed oil production, Uganda has been an

early beneficiary of offshore portfolio investor interest.

Favourable yields on government securities, the absence

of new regulations constraining FX market liquidity (in

contrast to other East African markets), and minimal

dependence on domestic borrowing for deficit financing

have added to its appeal. While the Bank of Uganda

(BoU) will continue to rebuild its FX reserves, we expect

further portfolio-driven Ugandan shilling (UGX)

appreciation in 2012. Offshore flows are likely to gain

momentum from the BoU’s December 2011 decision to

keep its rate on hold at 23% on evidence of a peak in

inflation. Interest rate easing is likely to start in H2-2012

as CPI inflation decelerates more sharply.

The difficult external environment is likely to prevent

planned eurobond issuance. With fiscal revenue likely to

rise in FY12 (began 1 July 2011) on the completion of the

Tullow-Total/CNOOC deal, there is little immediate need

for external borrowing.

Plans for East African Community (EAC) monetary union

are likely to be delayed once again, despite some talk of

a 2012 deadline – which is unrealistic, in our view.

Policy

Following 2011 elections, spending growth is likely to

moderate in FY12 and FY13, although wider budget

deficits (of 4.5% and 4.8% of GDP) are likely as

infrastructure development features prominently. Donor

dependence will continue, creating some risk in a

weakening external environment. After Uganda failed an

IMF Policy Support Instrument (PSI) review in early 2011,

relations have improved, with the authorities pledging to

tighten policy. Tax exemptions are likely to be

rationalised in the year ahead to boost revenue further.

Politics

The standoff between President Museveni and the

opposition is likely to continue, and may worsen amid

opposition allegations over the oil deals. Disputes in the

oil-rich Bunyoro region may feature more prominently,

while Bugandan ambitions of self-determination will

remain a source of tension. Hopes are high that US

assistance to capture Kony, the leader of the notorious

Lord’s Resistance Army, will end an era of instability in

the north. As traditional donor assistance is constrained,

closer co-operation with China will be sought.

Standard Chartered forecasts: Uganda

2011 2012 2013 2014

GDP (real % y/y) 6.4 6.6 7.0 7.3

CPI (% y/y) 18.7 15.3 1.8 5.1

Policy rate (%)* 23.0 16.0 13.0 11.0

USD-UGX* 2,600 2,660 2,520 2,300


-10.2 -9.9 -7.7 -7.3


-6.6 -4.0 -4.5 -4.8

*end-period; ** for fiscal year starting 1 July



Zambia Razia Khan, +44 20 7885 6914

[email protected]

12 December 2011 91

Resource nationalism, revisited

Economic outlook

Despite global economic uncertainty, Zambia’s growth

rate looks likely to accelerate to 7% in 2012. Mining

output should rise following output disruptions related to

heavy rains in 2011. Although the longstanding 2012

production target of 1mn tonnes may be missed, the

sector is still poised for healthy medium-term growth. We

forecast an average LME 3M copper price of USD

8,750/tonne in 2012 on tight global supply, sufficient to

encourage further investment in the sector.

GDP growth will also be supported by continued gains in

agriculture. Following the peaceful government transition

after the September 2011 elections – interpreted by

some as a rejection of the liberal economic agenda of the

former ruling Movement for Multiparty Democracy (MMD)

– the Zambian economy will benefit from increased social

and infrastructure spending and smallholder farm support

programmes.

Post-election, investor concerns have centred on rapid

regulatory change, with some privatisations reversed by

the new Patriotic Front (PF) government. Labour laws,

adherence to minimum wage regulations, corporate

taxes, and state shareholding in the mining sector (for

selected companies with large operational capacity) have

become new areas of focus. After the transition, we

expect a more settled regulatory environment in 2012.

Financial issues

The 2012 budget confirmed Zambia’s intention to

proceed with a maiden eurobond of USD 500mn.

Although Zambia will target concessional borrowing as a

first option, the country’s graduation to middle-income

status, the uncertain donor environment resulting from

the global crisis, and increasing infrastructure needs all

suggest a funding requirement beyond what is available

from concessional finance. However, it is unclear

whether the global environment – characterised by

significant European bank refinancing needs, asset

disposals and deleveraging – will be conducive to

eurobond issuance by a B+-rated sovereign.

Policy

The budget deficit is set to widen to 4.3% of GDP in 2012

from c.3% in previous years on increased health-care

and education spending (up 45% and 27%, respectively)

and a 38% rise in spending on the successful farm

subsidy programme – all reflecting the PF government’s

priorities. Mining royalties will double to 6%, and a

greater dependence on external borrowing should limit

domestic financing of the deficit to 1.3% of GDP.

Although a new Bank of Zambia governor has yet to be

appointed, the PF government has unveiled a raft of

measures aimed at reducing banks’ cost of funds in order

to encourage cheaper lending to the real sector.

Government securities are likely to be the immediate

beneficiary of the liquidity release, with bond yields

trending down. 7% inflation is targeted in 2012. We

expect the current account to remain in surplus, making

Zambia – on a total-return basis – an attractive

destination for offshore portfolio investment.

Politics

Zambia’s reputation for political stability was enhanced

by the peaceful change of government after the

September elections. While President Sata, who won

with 43% of the vote, has since adopted a more

conciliatory stance on Chinese and Indian investment,

the new PF government is keen to make its mark early,

focusing on wealth redistribution, unemployment and

anti-corruption. Despite doubling mining-sector royalties

(to 6% for copper), the government has not reintroduced

a windfall tax on earnings, claiming that this would disrupt

investment given the uncertain global climate. Instead,

the government will seek to increase its equity share in

the mines to 35% from 15-20%, in order to derive higher

returns from Zambia’s mineral wealth and provide

security in the event of mine closure.

Standard Chartered forecasts: Zambia

2011 2012 2013 2014

GDP (real % y/y) 6.5 7.0 7.2 7.5

CPI (% y/y) 8.8 7.4 9.2 9.0

91-day T-bill (%)* 7.75 5.4 6.2 7.0

USD-ZMK* 5,200 4,800 4,900 5,100


3.2 2.0 2.2 2.4


-3.1 -4.3 -4.5 -4.8


Economies – MENA


MENA – Charts of the year

12 December 2011 93

Chart 1: Selected 2011 unemployment rates in MENA

Double-digit unemployment is a challenge for governments

Chart 2: Current account as % of GDP, 2012 forecasts

The exporters and importers of capital

Source: Standard Chartered Research Source: Standard Chartered Research

Chart 3: Fiscal balance as % of GDP, 2012 forecasts

The haves and have-nots

Chart 4: GCC project pipeline 2012

Time for implementation (USD bn)

Source: Standard Chartered Research Sources: Meed Projects, Standard Chartered Research

Chart 5: GCC 2012 budget breakeven oil prices

Boosted by higher spending (USD/bbl, Brent)

Chart 6: GCC’s major export markets, % of total exports

As long as Asia keeps growing…

Source: Standard Chartered Research Source: DG Trade

0

2

4

6

8

10

12

14

16

18

20

Egypt Jordan* Tunisia* Saudi Arabia

-20

-15

-10

-5

0

5

10

15

20

GCC* Egypt Jordan Lebanon

*GCC is a 2011 GDP weighted average

-10

-5

0

5

10

GCC* Lebanon Jordan Egypt

*GCC is a 2011 GDP weighted average

0 20 40 60 80 100 120 140

Infrastructure

Oil & Gas

Water & Power

Metals

Petrochemicals

Alternative Energies

Industrial

0

20

40

60

80

100

120

Saudi Arabia Bahrain UAE Oman Kuwait 0 5 10 15 20 25 30 35

Japan

India

China

South Korea

United States

EU 27

Singapore

Thailand

ROW

*Forecast


MENA Marios Maratheftis, +971 4 508 3311

[email protected]

Kaushik Rudra, +65 6596 8260

[email protected]

12 December 2011 94

Local differentiators

Economic outlook

The Middle East and North Africa (MENA) is as

economically diverse as a region could be, with the oil-

rich Gulf Cooperation Council (GCC) countries facing very

different economic dynamics than countries without rich

resource endowments. The region is also relatively open

and is therefore subject, to varying degrees, to global

economic trends. But it is local factors that will ultimately

determine economic performance in 2012.

The economic and market implications of Europe‟s debt

problems bring back memories of 2009. However, parts of

MENA are in a significantly stronger position now. This is

particularly true for the GCC economies, which we expect

to show resilience, with growth decelerating only

moderately in 2012. Asset bubbles in the GCC have

already burst, and unsustainable credit booms are long

over. Base effects have become more favourable. Tight

credit conditions are set to persist, with Saudi Arabia

perhaps being the main exception. While tighter credit will

not help growth, it will not be as big a drag as it was in

2009, when credit growth in the region went from an

uncontrollable pace to a complete halt.

We expect oil prices to remain elevated in 2012. This

bodes well for the government finances of oil-exporting

countries, and it should enable counter-cyclical fiscal

responses. Fiscal policy in Saudi Arabia is already on an

expansionary trajectory and should continue to drive

growth in 2012.

Abu Dhabi and Qatar adopted a more conservative

approach to government expenditure in 2011. Their

project pipelines are full, though, and while we do not

anticipate a boom in government spending, any increase

will help to pick up the slack in the economy. Stable oil

prices provide governments in the region with ample fiscal

space.

Oil production has a far more important direct impact on

headline growth than oil prices. We expect less of a drag

on regional growth from lower oil production in 2012 than

in 2009, when production was cut. At the same time, any

positive contributions to growth will be minimal, as

significant production increases from GCC countries

seem unlikely.

Non-oil-producing countries, which are also dependent on

net capital inflows, will face a more challenging 2012.

Growth in Jordan and Egypt will be fragile, and both

countries will need to attract foreign inflows to boost their

reserves and fund their current account and fiscal deficits.

Jordan is attracting inflows from the GCC, and its

prospects for joining the bloc are still on the table,

although nothing is final. In Egypt, political stability will be

the key factor, as it is necessary to attract both

investment and tourism. The country‟s presidential

elections in June 2012 will be widely watched.

Financial issues

The UAE has significant debt maturities in 2012, which

should keep credit conditions in the economy tight. On the

currency front, the GCC‟s US dollar pegs should remain

unchallenged.

In the GCC, the focus will be on the credit market. We

prefer higher-quality and more liquid names – in particular

the Qatar and Abu Dhabi high-grade (HG) quasi-

sovereign complexes. Higher-beta and high-yield (HY)

sectors such as Dubai Inc. are more vulnerable to the

global environment and will offer better risk-reward trade-

offs once markets stabilise.

HG credits from the GCC, led by Abu Dhabi and Qatar,

have held up well in the recent market sell-off for several

reasons. GCC credit performance is not correlated with

overall emerging-market (EM) flows, as GCC names are

absent from broader EM indices; this makes the GCC an

„off-index‟ bet for most international investors.

Strong regional fundamentals and high sovereign ratings,

at a time when the ratings of Western countries are under

threat, are also key positives. It is worth considering the

Standard Chartered forecasts: GCC

2011 2012 2013 2014

GDP (real % y/y) 6.67 3.24 3.84 3.95

CPI (% y/y) 3.80 3.89 3.68 3.93


19.53 16.73 14.51 13.24


10.28 8.77 7.92 8.08



MENA (con’d)

12 December 2011 95

behaviour of local investors – the „local bid‟ phenomenon

tends to keep certain GCC credits well supported, even in

the face of market pressure elsewhere. On the basis of

valuations, GCC credits appear cheap in comparison to

much lower-rated credits.

Despite its recent outperformance, we still like the HG

sector, which is cheap for its ratings and offers better risk-

reward in the current negative market environment. We

see more value in quasi-sovereigns from Abu Dhabi and

Qatar than in sovereign bonds given the attractive spread

pick-up over the sovereign. Shorter-dated government

bonds in particular look expensive (the ADGB 14 and

QATAR 14). We have recommended switches from these

bonds into quasi-sovereigns such as RASGAS, MUBAUH

and INTPET.

The GCC banking sector is also attractive as the

fundamentals of most of the region‟s banks continue to

recover. After trading inside the corporates in October

and early November, banks from the region were trading

wider than corporates going into end-2011. We recognise

that events in Western banking systems can undermine

sentiment for banks across the world. However, given the

highly interventionist nature of GCC governments in their

banking systems, we see value in owning banks over

corporates. Our preferred picks are the COMQAT 14 and

the UNBUH 16.

Dubai Inc. has underperformed relative to Abu Dhabi and

Qatar, in line with the weak performance of HY credits

globally. We have recommended relative value switch

trades among the stronger credits in Dubai Inc.

(DEWAAE 16 to 15, EMIRAT 16 to DPWDU 17).

However, we refrain from going outright long the

sovereign or the Dubai 2012 maturities, in line with our

broader bearish stance on the HY sector.

Policy

GCC countries have the fiscal space to shift to more

expansionary policy. Policy in Saudi Arabia is already

expansionary, and this is set to continue in 2012. We also

anticipate higher spending in Qatar and, to some extent,

Abu Dhabi. In Egypt and Jordan, fiscal headroom is

limited and the focus will be on financing the funding gap

rather than on growth.

Monetary policy in the GCC will continue to be tied to US

policy, as the region‟s currency pegs face no pressure for

either revaluation or devaluation. We anticipate rate hikes

in Egypt and Pakistan, not so much for domestic

economic reasons but rather to shore up pressure on

their currencies.

Other issues

The European debt crisis illustrates how important it is for

countries to be able to borrow in their own national

currencies, where their central banks can act as lenders

of last resort. Local-currency debt capital markets in most

of the region are at an embryonic stage. The one

exception is Egypt; most of the government‟s debt is in

local currency, which has allowed the country to contain

the economic impact of political turmoil to a large extent.

The UAE posted a federal budget deficit in 2011, and we

anticipate a similar outcome in 2012. Although the federal

budget is not as important as budgets at the emirate level

(it accounts for only about 10% of total government

spending), the deficit provides the opportunity for a local-

currency federal bond issuance.

Politics

Political uncertainty in the region highlights the need to

differentiate among countries. Politically and socially

stable oil exporters stand to benefit from a flight to quality

and a risk premium on oil prices.

Parliamentary elections have taken place in Morocco,

Tunisia and Egypt (first phase). An emerging theme is the

outperformance of Islamist parties. In all cases, the

winners highlighted their moderation and commitment to

free-market economies. But it is also worth noting the

strength of the more radical Nour party in Egypt, which

emerged with 24% of the votes.

Our in-house currency barometers

EGP is under relatively stronger pressure to devalue


SAR

JOD

EGP

75

80

85

90

95

100

105

110

Aug-09 Dec-09 Apr-10 Aug-10 Dec-10 Apr-11 Aug-11


Algeria Philippe Dauba-Pantanacce, +971 4 508 3740

[email protected]

12 December 2011 96

Output erosion

Economic outlook

Despite high oil prices, which will ensure comfortable

current account surpluses, rising public spending and

high nominal GDP growth, real growth will be capped by

anaemic growth in hydrocarbon GDP – the slowest of all

MENA oil producers – at barely 0.7% in 2011. This will

continue owing to multiple problems in the sector. We

estimate sub-optimal 3.0% real GDP growth for 2011 and

3.5% for 2012.

The government has confirmed that hydrocarbon export

volumes dipped slightly in 2011. The lack of new oil and

gas projects was compounded by technical issues in

liquefied natural gas (LNG) production. The ongoing

reluctance of crucial foreign firms to bid on new permits

has worsened the situation and deprived the sector of

vital expertise.

Government spending on wages and infrastructure is

likely to have underpinned 5% real growth in the non-oil

sector in 2011. Total government expenditure rose by

34% in 2011, likely pushed the fiscal deficit to 3% of

GDP. This situation is likely be corrected in 2012, when

we forecast a 1.5% deficit.

The World Bank‟s Doing Business Report 2012 indicates

that red tape and structural rigidities have worsened in

Algeria, which fell by five places and sits between Iran

and Iraq at number 148. Algeria lost ground in categories

such as „getting credit‟, which was already almost

impossible. This will continue to hamper private-sector

non-oil GDP growth.

Financial issues

The Algerian banking system has the highest

government ownership in MENA, at 85%.

Capital markets are under-developed, as the authorities

have eschewed public debt (the debt-to-GDP ratio is less

than 3%). Credit to the private sector is virtually non-

existent, with a ban on all credit outside of housing

mortgages.

Policy

Algeria‟s monetary policy targets inflation at 3%. While

there is no official money supply growth target, the

central bank, Banque d‟Algérie (BdA), closely watches

monetary aggregates. In order to achieve its inflation

objectives, BdA adjusts the deposit auction rate, while

the government provides a wide range of subsidies for

staple consumption items. Liquidity absorption is

controlled by regular deposit auctions. The level of

interest rates has been stable since 2005: below 2% for

the deposit rate, 4% for the discount rate (benchmark

rate), and 8% for the lending rate.

The authorities have recently preferred to control inflation

though price controls rather than through interest rates.

Other issues

In 2008, majority foreign ownership of domestic

companies was limited to 49%. Since July 2010, local

firms have been required to be considered in private- and

public-sector bids, even if their pricing is 25% higher. A

tax regime that is volatile and detrimental to foreign

investors was also put in place, as well as restrictions on

certain imports (which sometimes turn into bans).

Very recently, the energy sector – including the ministry –

has put pressure on Algeria‟s president to reform the

energy law to foster more investment interest from

foreign firms.

Politics

Political succession following the long-running regime of

President Abdelaziz Bouteflika is a major concern. Social

discontent and political disenfranchisement will persist.

Roughly one-third of Algerians aged under 30 are

unemployed. Sporadic militant activism will continue to

pose a risk, although not a systemic one.

Standard Chartered forecasts: Algeria

2011 2012 2013 2014

GDP (real % y/y) 3.0 3.5 4.0 4.5

CPI (% y/y) 4.0 4.3 4.5 4.5

Policy rate (%)* 4.0 4.0 4.0 4.0

USD-DZD* 74.50 73.60 73.00 72.50


11.0 13.0 14.0 16


-3.0 -1.5 1.5 3.0



Bahrain Philippe Dauba-Pantanacce, +971 4 508 3740

[email protected]

Simrin Sandhu, +65 6596 8253

[email protected]

12 December 2011 97

Saved by oil

Economic outlook

Bahrain‟s economy is recovering from a sudden

slowdown in H1-2011. After contracting on a q/q basis in

Q1, the economy slowly recovered, growing 1.1% y/y in

Q2 and 2.4% y/y in Q3. Owing to the oil-driven economy,

we expect real GDP growth to accelerate to 3.5% in 2012

from 1.9% in 2011. Growth in 2012 will be driven by

strong oil production and a highly favourable base effect.

Bahrain‟s growth story is driven by hydrocarbons. The

non-oil economy was still contracting in Q3-2011. The

real-estate sector contracted 6.5% y/y, the hotel by

17.6%, construction by 3%, and offshore financial

institutions by 4.2%.

Attesting to the absence of pressure on the real

economy, 2011 is likely to have been a year of deflation

for Bahrain – the first in 25 years. We expect prices to fall

by around 0.3% for the full year, despite a slight pick-up

in H2. CPI items such as rents declined 15% in the year

to October.

The fiscal deficit likely widened to 6.5% of GDP in 2011

from 5.6% in 2010 owing to a 44% increase in

government spending, especially on extra subsidies, and

one-off payments to Bahraini families early in the year.

Financial issues

The breakeven oil price for the government budget,

already high at USD 100/barrel for 2011, has increased

as a result of higher government expenditure,

contributing to ongoing structural fiscal deficits.

Bahrain has a large banking sector, by far the largest

relative to the size of the economy among GCC countries

(retail banks‟ assets are equal to 300% of GDP, and

wholesale banks‟ assets are an additional 700% of GDP).

The wholesale banking system contracted by around

14% in Q1-2011 but remained broadly stable in Q2 and

Q3.

Prior to the onset of the regional political unrest earlier in

2011, the fundamentals of Bahrain‟s retail banks were on

an improving trajectory. Given the dominance of foreign

players, political and social stability will be key.

The Bahrain sovereign successfully issued a USD 750mn

sukuk recently, capitalising on strong demand from

Islamic funds from both within the region and Asia.

However, the concerns highlighted above are affecting

the performance of Bahraini bonds, which are trading at

relatively wider levels.

Policy

The Central Bank of Bahrain will continue its prudent

supervision and regulation of the economy, ensuring

liquidity intervention in the market when needed and

keeping interest rates in line with the Fed‟s.

Other issues

The „Bahrainisation‟ of the workforce will continue to be a

policy preoccupation. The government may also

introduce measures to ensure more equal access to jobs

across sectarian lines.

Bahrain has adjusted its „sponsorship‟ law to allow

workers to move from one employer to another without

the employer‟s consent. This places its labour laws at the

forefront of the region.

Politics

The findings of the Bahrain Independent Commission of

Inquiry, released in November 2011, confirmed severe

structural dysfunction in the handling of popular protests in

early 2011, which led to the temporary freeze of a major

arms contract with Bahrain‟s ally, the US. The report

includes several actionable recommendations that aim to

promote reconciliation within the country. Implementation

of many of these recommendations will be closely

watched.

Standard Chartered forecasts: Bahrain

2011 2012 2013 2014

GDP (real % y/y) 1.9 3.5 4.0 4.5

CPI (% y/y) -0.3 3.0 3.5 3.5

Policy rate (%)* 0.5 0.5 0.5 0.75

USD-BHD* 0.38 0.38 0.38 0.38


3.5 3.2 3.5 4.0


-6.5 -6.0 -5.0 -4.5



Egypt Nancy Fahim, +971 4 508 3627

[email protected]

12 December 2011 98

Managing change and expectations

Economic outlook

Egypt‟s economy is being shaped by the political

landscape. Political events dominate FY12 (ending June

2012). Election results for the lower house of parliament

are expected to be finalised in January; this will be

followed by elections for the upper house by end-January

and presidential elections at end-June 2012. Economic

growth was hampered in early 2011 at the height of the

political turmoil; the economy contracted 4.2% y/y in Q3-

FY11 (January-March 2011), and returned to barely

positive growth of 0.4% in the April-June quarter.

We expect a stronger performance in H2-FY12 (January-

June 2012) on a low base effect. We forecast that full-

year growth will tick up slightly to 2.0% in FY12 from

1.8% in FY11 as manufacturing (Egypt‟s largest sector,

which contributed 26% of FY11 GDP) moves into

expansion mode. Manufacturing was likely affected by

numerous strikes and factory shutdowns in early 2011.

We expect public and social services to be major drivers

of growth in FY12, given the high expectations of the

population during Egypt‟s time of transition. These

sectors contributed 7.8% and 4.6% of FY11 GDP and

grew by 4.5% and 2.8%, respectively. We also expect

higher public spending to widen the budget deficit as a

percentage of GDP. Suez Canal receipts, calculated as a

component of GDP, grew by a strong 11.5% y/y. The

deteriorating global outlook in 2012 is likely to detract

from this growth.

Egypt‟s budget deficit widened in FY11 to 9.6% of GDP

from 8.1% in FY10. The government targets a deficit of

8.6% of GDP for FY12. This will likely be missed; we

expect the deficit to widen to 10% of GDP. The

government has an extensive subsidy programme, which

it had planned to gradually phase out. This will be difficult

in the short term, as maintaining social stability is a

priority. Subsidies made up 31% of government

expenditure in FY11, increasing 19.3% during the year.

Fuel and food account for the largest portion of subsidies,

at 55% and 27%, respectively. The burden is significant,

and Egypt faces a USD 23bn funding gap in its FY12

budget. An inflow of foreign aid would help to meet this.

Foreign grants saw a significant 60% y/y decline in FY11,

and although grants are not the main source of

government revenue, this fall contributed to the 3.2%

decline in total revenue for the fiscal year. Significant

amounts of aid have been pledged to Egypt, but little has

actually been received. Egypt has announced its

openness to an IMF loan of USD 3.2bn, but a deal has

yet to be finalised.

Egypt faces weak external balances in FY12. We expect

the current account deficit to widen and reverse the

course it took in FY11, when it narrowed largely on the

back of an improving trade balance and higher Suez

Canal receipts. Egypt‟s exports were supported by higher

oil prices in 2011, causing the trade deficit to narrow.

However, lower oil prices in 2012 will reduce this support.

Egypt‟s exports will also be impacted by the weak global

outlook; the EU is Egypt‟s largest trade partner. Imports

will likely see upward price pressure given a weakening

Egyptian pound (EGP); we expect the trade deficit to

widen overall.

The current account is also affected by Suez Canal and

tourism receipts. Authorities plan to increase tolls and

fees for the canal (possibly an effort to counter the weak

global environment), but these will only be implemented

in Q4-FY12. Tourism receipts, which fell by 8.6%y/y in

FY11, will remain weak as politics continue to take centre

stage. The absolute number of tourist arrivals picked up

steadily throughout most of 2011 after dropping sharply

in February; however, H2-FY12 has a packed political

schedule and attracting tourists will be a challenge. FDI

in Egypt, as well as portfolio inflows, are likely to decline

as foreign investors await the results of parliamentary

Standard Chartered forecasts: Egypt

2011 2012 2013 2014

GDP (real % y/y) 1.8 2.0 3.0 3.5

CPI (% y/y) 11.3 10.0 11.5 11.0

Policy rate (%)* 9.25 9.75 9.75 9.50

USD-EGP* 6.20 6.82 7.40 7.75


-1.2 -1.9 -1.5 -0.5


-9.6 -10.0 -9.0 -8.0

Note: All forecasts are for the July-June fiscal year ending in the year

in column heading; *end of calendar year



Egypt (con’d)

12 December 2011 99

and presidential elections. FDI as a percentage of GDP

fell to 0.9% in FY11 from 3.1% in FY10. Egypt‟s balance

of payments dropped sharply to a deficit of 4.1% of GDP

in FY11 from a surplus of 1.5% in FY10.

Inflation eased in Q1-FY12, averaging 9.0% y/y

compared to 10.9% in Q1-FY11. Inflation had stabilised

at 11.3% for two years (FY10 and FY11), in line with our

expectations. We think FY12 inflation will remain

elevated at 10%, given our outlook for a weakening EGP.

Core inflation, which strips out volatile goods (namely

fruits and vegetables) and regulated items, has moved

into the central bank‟s 6-8% comfort range since August

2011.

Financial issues

USD-EGP broke through the 6.00 level for the first time in

six years in November 2011. We think there is room for

the currency to weaken further. Throughout 2011,

intervention and capital controls provided support to the

EGP. By November 2011, net international reserves had

fallen to USD 20bn from USD 35bn at the start of the

year. The reserves provide approximately 4.8 months of

import cover, down from 8.2 months at the start of 2011.

We estimate that the more liquid foreign-currency

reserves covered approximately 3.8 months of imports at

the time. The likelihood of significant hard-currency

inflows via tourism and foreign investment is low in the

current environment, and the need to seek external

funding has increased.

An inflow of hard currency would not only help to rebuild

reserves, but could also help to reinstate investor

confidence. Foreign holdings of T-bills had dropped 71%

y/y by August 2011. Domestic banks have had to soak up

the excess, and yields on the 1Y T-bill averaged 14.9% in

the first 11 months of 2011, compared to 11.7% during

the same period in 2010. Resorting to local funding is

leading to the crowding-out of the private sector. Average

lending to the government by domestic banks during the

January-August 2011 period grew 30% y/y. At the same

time, lending to the private sector grew by a modest 3%

y/y. There are likely to be demand-side issues given the

weak economic environment; however, the reliance on

domestic banks for funding does not help.

Policy

The Monetary Policy Committee (MPC) hiked key policy

rates by 100bps at its November 2011 meeting. This was

the MPC‟s first move since September 2009, when it cut

rates by 25bps amid a global recession. The hike came

at a time of easing headline inflation and core inflation

moving into the central bank‟s comfort zone. It was also a

time of weak economic growth. However, concerns about

capital outflows dominated; at the time of the hike, the

currency was at its weakest level since the introduction of

the rate corridor. Further hikes may be necessary in

order to attract foreign capital and slow outflows. External

funding would help to ease investor concerns; but in the

absence of a deal (or if a deal is not brokered fast

enough for the markets) and in the face of overall

currency weakness, we expect rates to be hiked by a

further 50bps in H2-FY12.

Other issues

Egypt‟s unemployment rate rose to 11.9% in FY11 from

9.1% in FY10. The unemployment rate averaged 10.6%

from 2000-10. It is likely to remain elevated given

upcoming political events, making unemployment an

important issue for any upcoming government to tackle.

Politics

Elections for Egypt‟s lower house of parliament began in

November 2011 and are staggered over a period of six to

seven weeks. Two-thirds of parliament‟s 498 seats will be

filled by candidates belonging to parties or alliances. The

rest will be taken up by independent candidates.

Elections for the upper house of parliament will follow in

January, and presidential elections are due at end-June.

Political uncertainty is likely to remain the key risk for

Egypt in 2012.

Our sustainability index (FX reserves/money supply)

The index has fallen below previous devaluations (circled)


60

70

80

90

100

110

120

130

140

Jul-00 Jul-02 Jul-04 Jul-06 Jul-08 Jul-10


Jordan Sayem Ali, +92 21 3245 7839

[email protected]

12 December 2011 100

Looking towards the GCC

Economic outlook

Jordan‟s recovery from the 2008-09 financial crisis has

been hit by a decline in tourism and investment inflows.

We expect real GDP growth to remain weak at 2.5% in

2012, little changed from 2.4% in 2011. Unemployment

rose to 13.1% in September 2011 from 11.8% at the end

of 2010; unemployment is highest among urban

educated youth. Downside risks prevail due to regional

unrest and slowing growth in the US and EU, which

together account for 20% of Jordan‟s total exports.

Government spending is constrained by limited

resources.

The decline in commodity prices has helped to ease

inflation, with CPI inflation slowing to 3.2% in October

2011 from 5.6% in August. We expect inflation to

average 4.5% in 2012, down slightly from 4.6% in 2011.

The Central Bank of Jordan will likely look to cut rates if

inflation remains within its comfort zone. However, falling

FX reserves are limiting room for aggressive rate cuts.

Gulf Cooperation Council (GCC) states have provided

critical financial support to Jordan‟s economy in 2011,

including grants of USD 1.4bn (5.2% of GDP) from Saudi

Arabia. Jordan could become a GCC member, which

would give it preferential trade access to the bloc‟s bigger

markets and open up new avenues for investment. This

move is a potential game-changer for Jordan‟s economy

and would boost growth over the medium term. All eyes

will be on the outcome of the 19 December GCC summit,

which will decide on Jordan‟s membership.

Financial issues

Central bank reserves declined to USD 11bn (6.5 months

of import cover) as of October 2011 from USD 12.3bn

(7.6 months) at the end of 2010. This was primarily due

to the rising oil and food import bill, which has led to a

widening trade deficit. The trade gap increased 21% y/y

in 9M-2011 to USD 8.4bn. Tourist arrivals also declined

sharply, by 22% y/y, widening the current account deficit.

The external account will remain vulnerable to

international commodity prices.

The Jordanian dinar (JOD) peg to the US dollar is an

important pillar of financial stability, and the central bank

is likely to keep the currency pegged at 0.71 over the

medium term. The peg offers attractive carry

opportunities to investors. Jordanian government T-bills

offer attractive yields, both over the USD and regional

GCC markets. The 1Y yield spreads between JOD T-bills

and the USD, Saudi Arabian riyal (SAR) and the UAE

dirham (AED) are 366bps, 320bps and 309bps,

respectively (as of 1 December 2011).

Policy

Public debt increased to USD 19bn (67.4% of GDP) in

August 2011 from USD 17.7bn (67.1% of GDP) at the end

of 2010. Higher government wages and salaries and

higher subsidies widened the deficit (excluding grants) to

USD 1.7bn (5.9% of GDP) in the first nine months of 2011,

an increase of 36% y/y. The deficit was financed through

large official grants of USD 1.4bn (5.2% of GDP) from

Saudi Arabia. The 2012 deficit is likely to widen further to

7.5% of GDP from 7.1% in 2011. Funding the deficit will be

the main challenge.

Politics

Jordan is facing weaker growth and high unemployment,

especially among the youth. King Abdullah has already

reshuffled the cabinet three times since November 2010.

The outlook for 2012 is challenging, with resource

constraints limiting room for populist measures.

Standard Chartered forecasts: Jordan

2011 2012 2013 2014

GDP (real % y/y) 2.4 2.5 2.9 3.5

CPI (% y/y) 4.6 4.5 5.0 5.2

Policy rate (%)* 4.25 4.25 4.5 4.5

USD-JOD* 0.71 0.71 0.71 0.71


-7.5 -8.0 -7.5 -7.0


-7.1 -7.5 -7.0 -6.5



Kuwait Nancy Fahim, +971 4 508 3647

[email protected] Simrin Sandhu, +65 6596 6281

[email protected]


Oil in a day’s work

Economic outlook

Growth in 2012 will be driven by continued increases in

oil production. Oil production was raised significantly in

2011 to make up for the Libyan shortfall. Kuwait is

expected to continue producing more than its OPEC

quota of 2.2 million barrels per day (mbd) and work

towards a longer-term goal of raising output to 4mbd by

2020. Ministry officials cite global supply shortages as the

driver behind the decision to raise oil production in 2012.

Oil prices above USD 100/barrel (bbl) in 2011 and 2012

are likely to result in comfortable fiscal and current

account balances for the Kuwaiti government. Oil

dominates exports, and oil proceeds are the main source

of government revenue. The budget for FY12 (ending

March 2012) forecasts a deficit, but revenues are

conservative (we estimate a required breakeven oil price

of USD 63/bbl, versus our forecast that the Brent crude

price will average 108/bbl in 2012), and expenditures

often fall short of targets. As of H1-FY12 (April-

September 2011), spending made up 27% of planned

expenditures for the fiscal year.

Inflation should ease in 2012 due to a higher base effect.

Food prices exerted significant upward pressure in 2011

given the 18% weighting of food in Kuwait‟s CPI basket.

Increased wages and cash handouts in 2011 also had an

inflationary effect. Inflation averaged 5% in the January-

August 2011 period.

Financial issues

Kuwait targets its currency, the Kuwaiti dinar (KWD),

against an undisclosed basket of currencies in which we

think the US dollar (USD) has the heaviest weighting.

Policy

Kuwait‟s monetary policy is largely tied to that of the US,

given the likely heavy presence of the USD in Kuwait‟s

currency basket. Kuwait‟s benchmark policy rate, the

discount rate, is expected to remain on hold at 2.5% in

2012. Fiscal policy is expansionary, with the FY12 budget

showing a 19% increase over the FY11 budget to KWD

19bn.

Other issues

There seems to be limited progress on Kuwait‟s four-year

development plan, which began in 2011 and envisages

spending of USD 104bn. In 2011, spending was mostly

directed towards current expenditure. The Emir has

voiced his concerns that surplus funds are being

“misused”, leading to “structural imbalances” in the

economy. In our view, the distortion of incentives

between the public and private sectors results in low

participation of nationals in private-sector jobs.

From a credit perspective, we have a Stable view on the

Kuwaiti sovereign and are constructive on the Kuwaiti

banking sector. There is scope for NPL ratios to trend

down over the next 6-12 months. Medium-term, banks

should benefit from planned increases in government

spending. Despite being a higher-beta credit, the KWIPKK

16 is our preferred way to play the Kuwaiti financial space.

The improvement in fundamentals in the Kuwaiti banking

system should benefit KIPCO via higher dividend

payments from its Kuwaiti subsidiary, Burgan Bank.

Politics

2011 saw a volatile political landscape across the region.

In Kuwait, protests culminated on 29 November in the

resignation of the prime minister and the rest of his

government. This was the second cabinet resignation of

the year. The resignation of the prime minister, who had

been in office since 2006, may calm the opposition for

some time. Political paralysis has the potential to stall

significant progress on Kuwait‟s four-year development

plan.

Standard Chartered forecasts: Kuwait

2011 2012 2013 2014

GDP (real % y/y) 5.0 3.0 3.0 3.5

CPI (% y/y) 5.0 4.5 4.0 4.0

Policy rate (%)* 2.5 2.5 3.0 3.0

USD-KWD* 0.28 0.28 0.27 0.27


30.0 27.0 26.0 27.0


27.0 26.0 22.0 22.0




Lebanon Philippe Dauba-Pantanacce, +971 4 508 3740

[email protected]


Growth to return in 2012

Economic outlook

Owing to a combination of domestic political bickering,

regional tensions (especially in neighbouring Syria), and

rising global risk aversion, Lebanon saw a marked

slowdown in economic activity in 2011. This contrasts

with several years of very strong growth (averaging 8%

from 2007-10, despite the depressed global environment)

and can be partly explained by a strong base effect. We

estimate GDP growth at 1.5% in 2011 and expect it to

accelerate to 3.75% in 2012.

The central bank‟s coincident indicator – a sector-

weighted reflection of economic activity – attests to this

slackening, especially in consumption. Growth in cleared

cheques slowed to 5.6% in the first three quarters of

2011 from 20.8% in the same period in 2010.

Construction permits shrank by 5.4% during the same

period, while the number of property sales decreased by

16.6%.

Barring a substantial further deterioration in the regional

political environment, we expect a steady return to the

previous real GDP growth trend. Lebanon continues to

benefit from a strong services sector, robust domestic

consumption (correlated to improved sentiment), and

protracted pent-up reconstruction development needs

following the war years.

The comfortable primary surplus in 2010 allowed the

government to adopt an accommodative fiscal policy

during the 2011 downturn, while managing to maintain a

modest surplus. We expect this prudent macroeconomic

policy to continue in 2012.

Financial issues

The banking system will continue to be the backbone of

the economy. Despite an unfavourable environment, total

bank assets grew by a healthy 7.4% y/y in the first three

quarters of 2011. The central bank‟s FX reserves grew

12% in the year to September, reaching USD 32bn, or

18.6 months of import coverage.

Capital markets also suffered in 2011, with declines of

12% and 28% y/y in the Beirut Stock Exchange‟s market

capitalisation and trading volume, respectively, in the first

three quarters of the year. 5Y CDS widened 140bps in

the year to 30 November, reaching 440bps. Average

bond spreads and yields on sovereign debt crept up

during the same period, although we are confident that

Lebanon will continue to find strong demand to help meet

its refinancing needs.

Policy

Continued de-dollarisation will be a policy objective, even

if a rise in risk perception triggers temporary reversals in

the trend. Deposit dollarisation rose slightly in 2011 (to

66% from 63%) but is still off its peak.

The 2012 draft budget includes the possibility of sharp

tax increases, including a jump in the VAT rate to 12%

from 10%. We think that Lebanon can afford this

increase, which would help to address structural fiscal

deficits. The VAT has proven to be a very efficient tax

collection channel.

Other issues

A proposal to move the electoral system towards fair

proportional representation in 2013 would profoundly

alter Lebanon‟s political dynamics. In our view, this is

unlikely to be approved in the near term, but the mere

suggestion of the reform has set a precedent.

Politics

Politics will be mainly driven by repercussions from

events in neighbouring Syria. A change of regime in Syria

could shift political allegiances. Notably, there could be a

change in the allegiance of the small swing Druze party,

the same party that triggered a collapse of the pro-West

government in January 2011.

Standard Chartered forecasts: Lebanon

2011 2012 2013 2014

GDP (real % y/y) 1.5 3.8 5.5 5.5

CPI (% y/y) 5.0 4.8 5.5 5.5

Policy rate (%)* 10.0 10.0 10.0 10.0

USD-LBP* 1,500 1,500 1,500 1,500


-17.5 -16.0 -15.0 -13.0


-7.5 -7.0 -6.5 -6.0



Morocco Philippe Dauba-Pantanacce, +971 4 508 3740

[email protected]


Economic resilience and a reform agenda

Economic outlook

As we foresaw earlier in the year, Morocco has had a

good 2011. Real GDP is likely to have expanded 4.3% –

roughly in line with average growth of 4.8% in the past

decade – owing to a much better harvest than in 2010

and healthy non-agricultural growth. Excluding the

unpredictable harvest component, Morocco should show

similar growth in 2012 thanks to public and internationally

funded projects and an increasingly developed services

sector, which will compensate for weaker consumption

resulting from muted growth in remittances from migrant

workers in Europe. These workers represent the

equivalent of 20% of the domestic workforce.

Despite strong exports of phosphate, surprisingly strong

tourism numbers and resilient remittances, the current

account deficit worsened in 2011 owing to a record-high

commodity bill, which caused the terms of trade to

deteriorate. Slower growth in the commodity complex

(including our forecast decrease in the average Brent oil price

to USD 108/barrel) should help reverse this trend in 2012.

A history of very prudent macroeconomic policy has

helped to cushion Morocco against the volatile

international environment of recent years. However, the

2011 fiscal deficit likely widened to 5.5%, driven by a

subsidy-to-GDP ratio double the budgeted level of 2.1%.

A decrease in commodity-linked subsidies in 2012 should

narrow the fiscal deficit to 4.5% of GDP.

Financial issues

The country‟s banking sector and capital markets are

comparatively modern and advanced, with the highest

credit to the private sector as a proportion of GDP (80%)

and the lowest state ownership of banks (27%) in North

Africa.

Morocco‟s bond market is one of the most active in the

region, and is deeper than regional peers. It is supported

by a healthy banking sector, along with a growing culture

of disintermediation. The banking sector‟s soundness

indicators have continued to improve, with the NPL ratio

steadily declining from 8% in 2007 to 4.5% in July 2011,

despite a temporary rise early in the year.

Policy

Morocco will continue with its political and business

reform agenda. It was the world‟s biggest gainer in the

World Bank‟s 2012 Ease of Doing Business ranking,

mostly thanks to its policies to improve the tax system

and enhance investor protection. A broad reform of the

Casablanca bourse aims to turn it into a tax-exempt,

foreign-investor-friendly hub in North and West Africa, a

project undertaken with co-operation from Singapore.

The central bank, Bank Al Maghrib, is unlikely to change

its monetary policy soon. Its benchmark rate has been

fixed at an accommodative 3.25% since March 2009.

Given low inflation and our expectation of protracted low

interest rates in the euro area, the central bank is likely to

delay hiking rates.

Other issues

Given the protracted rise in global risk aversion and

deteriorating sentiment and growth in Europe, Morocco‟s

key economic partner, the sovereign will likely delay its

initial plan to tap the international debt markets. The

internationalisation of Moroccan debt would ease the

burden on the domestic banking sector and limit the

crowding-out effect.

Politics

After political reforms were approved in a referendum in

July 2011, a newly empowered parliament was elected in

November. The winning moderate Islamist party and

secularist parties formed a coalition that defeated the

historically dominant parties after an election that was

deemed fair, free and transparent, with a much higher

turnout than expected.

Standard Chartered forecasts: Morocco

2011 2012 2013 2014

GDP (real % y/y) 4.3 4.5 5.0 5.5

CPI (% y/y) 1.5 2.5 3.0 3.5

Policy rate (%)* 3.25 3.25 3.25 3.75

USD-MAD* 8.40 8.35 8.00 7.50


-5.5 -4.0 -4.0 -4.0


-5.5 -4.5 -3.5 -3.0



Oman Nancy Fahim, +971 4 508 3627

[email protected]

Simrin Sandhu, +65 6596 6281

[email protected]


Bucking the global trend

Economic outlook

Growth will be sustained by Oman‟s eighth five-year plan,

which began in 2011 and is part of a longer-term goal of

diversifying away from oil. The bulk of the spending

under the plan will go to infrastructure (approximately

70% of the total), followed by social spending, which

includes education and health care. Commodity

production has a targeted allocation of less than 3%. The

development of roads, airports and ports takes up the

greatest portion of infrastructure spending, while Muscat,

the capital city, accounts for the largest share of

spending in the overall plan. Infrastructure spending

exceeded targets under the seventh five-year plan,

increasing at the expense of spending on social

structures and services (including housing and utilities).

The limited allocation to commodity production is in line

with Oman‟s longer-term diversification plans.

Oman‟s 2012 draft budget envisages a 25% y/y rise in

expenditure. The budget needs to be approved by the

Majlis al-Shura (the elected arm of parliament) and the

Sultan. The draft budget puts expenditure at OMR 10bn

and revenue at OMR 8.8bn. We expect the fiscal deficit

to turn to a surplus in 2012 on the back of higher-than-

budgeted oil revenue. Oman‟s 2012 draft budget is based

on an oil price of USD 75/barrel (bbl); we forecast that

Brent crude will average USD 108/bbl in 2012. Average

daily oil production is seen at 920,000 bbl, a 2.7% y/y rise

over the 2011 target level.

We also expect Oman to post a fiscal surplus for 2011.

As of September 2011, total revenue was 14% higher

than the full-year target. Oil and gas accounted for 86%

of total government revenue over the period. Spending in

2011 is also likely to fall short of the planned amount. An

additional package announced in 2011 pushed

expenditure to OMR 9.1bn. By September 2011, 67% of

this had been spent. About OMR 1bn per month in Q4-

2011 would need to be spent to meet the target; this is

unlikely.

Inflation should stabilise at 4% in 2012. Increases in both

public- and private-sector wages and allowances in 2011

will likely continue to feed through. Food prices are

expected to remain elevated at 2011 levels, picking up in

H1-2012 before moderating in H2. Food and beverages

are the largest component of Oman‟s CPI basket, with a

combined 30% weight. Rents are the second-largest

component, at 20%; they are expected to play a smaller

role in driving inflation given the still-recovering housing

market.

Financial issues

Credit growth picked up in 2011, reaching 12% y/y as of

September. Lending to the private sector also grew,

moving out of its 2009-10 slump and rising 9% y/y in

September 2011. We expect this trend to continue in

2012 given the country‟s plans to increase spending.

Private-sector credit growth should move towards the

12% average of the last decade in 2012 (it peaked in

2008 at 44%). Banks would be better able to sustain

these lending rates with increased deposits; in 2011, the

loan-to-deposit ratio peaked at 104.6% in August before

dropping to 100.9% in September.

Government debt/GDP is low, falling to 5.1% in 2010

from 16% in 2002. There is room for funding via the

markets. The latest issuance took place in November

2011, when the government issued a 5Y local-currency

development bond of OMR 150mn, likely driven by

medium-term financing needs.

Policy

Monetary policy moves in tandem with that of the US

given the Omani riyal (OMR) peg to the US dollar (USD).

Oman‟s key policy rate (the repo rate) is at an

accommodative level and is unlikely to change in 2012.

Standard Chartered forecasts: Oman

2011 2012 2013 2014

GDP (real % y/y) 4.5 4.7 4.3 4.0

CPI (% y/y) 4.0 4.0 4.5 5.0

Policy rate (%)* 2.0 2.0 2.5 2.5

USD-OMR* 0.39 0.39 0.39 0.39


10.0 9.0 8.0 9.0


1.0 0.8 0.8 0.6



Oman (con’d)


Fiscal policy should be expansionary heading into 2012.

Spending on current consumption (mainly via higher

wages) needs to be balanced by spending on

infrastructure, in line with the five-year plan. This would

help to generate longer-term growth. Spending will

continue to be buoyed by higher oil prices. Oman‟s

greatest vulnerability stems from its over-reliance on oil

revenue (which, together with gas, makes up 80% of

government revenue). The breakeven price required to

balance the budget has continually risen: the 2012

budget sees a breakeven oil price of USD 75/bbl, up from

USD 58/bbl in 2011. This leaves Oman more vulnerable

to oil-price shocks. Oman has sufficient reserves,

however, to maintain spending plans; FX reserves stood

at USD 12.6bn at end-September 2011.

Other issues

Oman foresees oil and gas contributions to GDP of 9%

and 10%, respectively, by 2020. The need to diversify

away from oil is two-fold. First, Oman‟s oil reserves are

falling. Reserves, currently at an estimated 5.5bn barrels,

are expected to last another 25-30 years. Oman has

been running down its oil reserves since 2001. At the

same time, the hydrocarbon sector as a percentage of

GDP has fallen in real terms, suggesting that increased

production has not caused Oman to stray far from its

diversification plans. Hydrocarbons as a percentage of

GDP fell to 30% in 2009 from 50% in 2000. Second, the

capital-intensive nature of the hydrocarbon sector means

it is unable to create sufficient jobs for the country‟s

young population. Oman has the youngest population in

MENA, with 60% under the age of 30, and population

growth is estimated at 30% over the next 20 years.

Increased private-sector participation by Omani nationals

would also help to reduce the government‟s burden of job

creation. Nationals already make up 86% of all public

positions, and despite years of Omanisation policies

(which seek to ensure a minimum percentage of

nationals in private-sector businesses), participation by

Omanis in the private sector is low, at 16%. This is

largely attributable to work incentives. Bridging the gap

between public- and private-sector work features and

benefits would incentivise more nationals to move into

the private sector.

From a credit perspective, we have a Stable outlook on

the Oman sovereign. Low debt levels give the

government a large degree of policy flexibility. The

combination of large international reserves and offshore-

based external assets results in comfortable external and

net creditor positions. Oman does not have outstanding

sovereign eurobond debt, and we do not expect the

sovereign to come to the market soon.

The absence of government issuance makes it

challenging for investors to price sovereign risk and is an

impediment to the development of a robust credit market.

The one credit that does trade is oilfield-services

company MB Petroleum Services (NR/B-/BB-), which

placed a USD 320mn eurobond in November 2010. This

bond was put under pressure starting in August 2011; the

yield widened by around 700bps between beginning of

August and end-November 2011. S&P downgraded

MBPS on 30 November 2011 to B- from B+, citing

concerns over liquidity and leverage.

Politics

Oman‟s ruler, Sultan Qaboos bin Said al Said, holds the

highest position in the country. Protests in 2011 were

centred on work-related issues and demands for a more

explicit means by which public opinion can be heard.

October 2011 elections for the Majlis al-Shura

(consultative council), the elected body of parliament,

saw a strong turnout by eligible voters. In response to

demands from the public, the Sultan granted legislative

powers to the council, which previously held only an

advisory role. Proposals and draft laws made by the

council will be turned over to the government for

assessment; government ministers are appointed by the

Sultan. While the Sultan remains the ultimate decision-

maker, this change is positive in a region where the

public has voiced demands for greater involvement in

national affairs.

2011 budget versus actual as of September 2011

Revenue exceeds target on conservative oil-price estimate


0 2 4 6 8 10

Rev

enue

Exp

endi

ture

Budget (OMR bn)

Actual by Sept-11 (OMR bn)


Qatar Shady Shaher, +971 4 508 3647

[email protected]


Lower growth, better growth

Economic outlook

2012 marks a significant inflection point for Qatar. We

forecast that the emirate‟s real GDP growth will moderate

to 5.9% in 2012, from an estimated 16.9% in 2011. Qatar

is likely to meet its target level for liquefied natural gas

(LNG) output around year-end 2011, leaving little room

for LNG to remain the key driver of super-charged

economic growth rates (as it has been for the last seven

years) in 2012. Even though growth is likely to slow, the

real economy will probably play a much more important

role. 2012 should mark the next phase of Qatar‟s growth,

marked by higher-quality growth driven by activity in the

non-oil and gas sectors.

Real growth in the gas sector is a function of production

and will moderate significantly in 2012 following the

completion of all key LNG expansion projects.

Annualised LNG production (total annual output) lags

capacity growth given the phased nature of growth in

LNG streams throughout any given year. We expect

annual output to reach 70 million tonnes (mt) in 2011 and

77.8mt in 2012, up from an estimated 46mt in 2010 and

36mt in 2009. This means that annual output increases

will no longer be a major driver of Qatar‟s real economic

expansion in 2012.

We estimate that growth in the mining and quarrying sub-

sector accelerated to 23% in 2011 from 18% in 2010.

However, we expect this to moderate to 2% in 2012. The

hydrocarbon sector is likely to remain the largest

contributor to the economy in 2012. However,

hydrocarbons‟ contribution to GDP growth should

moderate to 52% in 2012 from 55% in 2011 as non-oil

infrastructure investment picks up.

In 2012, LNG infrastructure will allow production of close

to 77mt/year, making Qatar the world‟s largest exporter

of LNG. Global consumption of LNG increased to 3.2trn

cubic feet in 2010 from 2.4trn cubic feet in 2000,

according to the BP Statistical Review of Energy; this

points to bright export prospects. Increasingly, Qatar‟s

gas customers are from Asia (Asia‟s demand for gas has

almost doubled over the last decade).

Japan will be a key destination for LNG exports. We

expect Japan to depend on LNG to power 50% of its

alternative power sources. Qatar is well placed to be a

key supplier to Japan in 2012 for three reasons. First, it

can switch cargoes from less profitable markets such as

North America (where shale gas has made the US self-

sufficient) to Japan. Second, it has invested heavily in its

maritime LNG fleet, now the largest in the world, with

close to 80 ships; this gives it the flexibility to ship

cargoes competitively. Third, we estimate that Qatar still

has the capacity to meet demand, with at least 3mt of

uncommitted capacity and about 25mt of cargoes that

can be sold in the spot market, as they are not bound by

longer-term contracts.

We expect investment in the non-oil and gas sectors to

pick up significantly in 2012 as the country gears up to

host the FIFA 2022 World Cup. We estimate that close to

USD 107bn of projects are in the pipeline as Qatar

begins to prepare for the World Cup. Most of the

investments are infrastructure-related. The transport

sector will receive close to USD 44bn of spending (USD

25bn for a fully integrated rail system), and about USD

12bn will be invested in accommodation facilities. The 12

stadiums that will host the games will be built at an

estimated cost of USD 4bn.

In an official review of its national strategy, the

government recently noted that “though some World

Cup-related investment projects may be commissioned in

the 2011-2015 period, the likely impact is modest”. This

supports our view that many of the larger projects related

Standard Chartered forecasts: Qatar

2011 2012 2013 2014

GDP (real % y/y) 16.9 5.9 5.6 5.4

CPI (% y/y) 2.4 3.3 3.8 4.2

Policy rate (%)* 0.75 0.75 0.75 0.75

USD-QAR* 3.64 3.64 3.64 3.64

Current account balance (% GDP)**

32.0 30.0 27.0 25.0


9.0 6.8 7.5 7.0

*end-period, ** for fiscal year ending 31 March



Qatar (con’d)


to the 2022 World Cup will commence after 2015. The

railway project, for example, is slated to be awarded in

Q1-2013, but we expect the project to move at a faster

pace only from 2015-21. We estimate that Qatar will

award close to USD 21bn of projects (mostly

infrastructure) in 2012, up from about USD 12bn in 2011.

Financial issues

The central bank cut key policy rates twice in 2011; we

believe these moves were aimed at bringing policy rates

closer to US rates and reducing arbitrage opportunities.

Credit growth should remain positive in 2012, mostly on

the back of increased demand as the government begins

to roll out projects for FIFA 2022. H2-2011 already saw a

rapid increase in credit growth, with private-sector credit

growth jumping to 17% y/y in September from 9.8% y/y in

March. The loan-to-deposit ratio is adjusting, falling to

101% in September 2011 from 105% in August; however,

this is much higher than the comfortable level of 92% in

July. The elevated loan-to-deposit ratio may make banks

more cautious towards lending in 2012; however,

spending dynamics are likely to keep credit growth

positive.

Policy

Inflation has been trending higher. It hit a high of 2.5% in

October 2011, up from 1.6% at the beginning of the year

(and 2.4% deflation in 2010). This signals the end of a

deflationary period rather than the beginning of new

inflationary pressures, in our view. Housing prices (32.2%

of the inflation basket) continue to cap inflation; they fell

5.8% in October 2011. We expect inflation to edge higher

to 3.3% in 2012 from around 2.4% in 2011 as spending in

non-oil sectors picks up, driving up costs of goods and

services. Yet inflation will capped by overcapacity in the

housing market.

Qatar‟s FY12 budget (for the year that began 31 March

2011) is based on a conservative crude price of USD

55/barrel. Given higher hydrocarbon prices in 2011 we

expect a fiscal surplus of close to USD 9.2bn in FY12

(against the government‟s estimate of USD 6.2bn). We

expect spending to increase to USD 46bn in FY13 from

USD 38.4bn in FY12 given the government‟s

commitments to FIFA 2022 projects and broader

infrastructure development.

Other issues

We have a positive outlook on the sovereign. Buoyed by

a robust hydrocarbon sector, the country has built up

significant external and fiscal cushions and has a strong

capacity to service its debt obligations. Credits have been

strong outperformers in the recent market sell-off. In

addition to factors such as solid fundamentals and a low

correlation with overall emerging-market flows, a lack of

supply out of Qatar in 2011 (particularly compared with

Abu Dhabi) capped spread widening. However, with the

recent large sovereign issuance, we believe that spreads

are likely to converge with those of Abu Dhabi Inc.

From a fundamental standpoint, we are constructive on

corporates and banks. Both sectors are comprised of

credits that are sound on a standalone basis and benefit

from strong government support. On valuations, we see

some value in the RASGAS 14 among the corporates. In

the banking sector, our top pick is the COMQAT 14.

Politics

There has not been any domestic instability in Qatar on

the back of the „Arab Spring‟ over the past year. This is

mostly thanks to the country‟s social stability, backed by

a generous social subsidy system and one of the world‟s

highest per-capita GDP levels. Qatar has taken a

leadership role in brokering political solutions to the

recent regional challenges.

Qatar’s key projects in 2012

2012 to kick off spending (USD bn)

Sources: Meed Projects, Standard Chartered Research

0 2 4 6 8 10 12

Infrastructure

Oil & Gas

Power

Water & Waste


Petrochemicals


Saudi Arabia Shady Shaher, +971 4 508 3647

[email protected]


The spending story continues

Economic outlook

The economy boomed in 2011 on increased hydrocarbon

output (to compensate for loss of output from Libya) and

higher government spending after new social spending

packages announced in Q1-2011. We expect growth in

2012 to moderate to a lower but still-healthy level of

2.9%, with the key driver of growth being the robust pace

of government spending. However, lower oil output in

2012 will detract from growth.

The commitment to spend close to USD 128bn on social

subsidies (boosting social security) and projects (building

500,000 housing units) will continue to drive headline

growth in 2012 and into 2013. This is in addition to

budgeted spending commitments in 2012, which are

expected to continue moving ahead at the strong pace

seen in Saudi budgets since 2008. Housing supply will be

a key challenge for policy makers in 2012 and beyond,

though steps are being taken to address this challenge.

Saudi Arabia is well placed to deal with oil-market

outages, as it did in 2011 when it raised production to

compensate for output shortages from Libya. Spare

output capacity, which stood at 4 million barrels per day

(mbd) at the beginning of 2011, should stand at close to

3.5mbd in 2012. The country‟s oil output rose to

9.758mbd in August 2011, according to OPEC, from

8.4mbd in December 2010. Output increased as Saudi

Arabia tapped spare capacity to meet supply constraints

amid a steady drop in Libyan output.

We estimate that Saudi Arabia‟s oil output reached

9.29mbd in 2011, against our 2010 estimate of 8.28mbd

– an 11% increase. We estimate that 2012 output will fall

to 8.42mbd as Libya gradually raises output to 1.06mbd

from 0.45mbd in 2011. Saudi Arabia is currently the

world‟s swing producer of oil, and as a result, Saudi

output will continue to have a significant impact on world

oil prices and market-supply dynamics.

Government expenditure will continue to be an important

driver of economic growth in 2012. We estimate that a

total of USD 159bn worth of projects will be awarded in

2012 by the government and, to a lesser extent, the

private sector. Infrastructure and construction projects

will dominate, at USD 44.6bn and USD 39bn,

respectively. Saudi Arabia plans to award projects worth

about USD 67bn related to the construction of 500,000

housing units (this is part of the USD 128bn worth of

social spending announced in 2011). On 1 November

2011, the Ministry of Housing awarded the first package

of the housing programme, comprising various phases of

master planning and design on about 32mn square

metres of land divided across 11 regions in the country.

No specifics on the timing of this project have been

announced; however, we estimate three years, with

about USD 22bn of awards in 2012.

While increased commitments to housing are positive,

housing supply remains a near-term challenge.

According to the authorities, Saudi Arabia will face a

shortage of 2mn housing units by 2015. While the

mortgage law (when it is passed) may help on the

demand side, if supply does not increase substantially,

the result could be higher housing inflation. According to

official data, there are close to 650,000 housing

applications pending with the government‟s Real Estate

Development Fund since 2009, up from 450,000 in 2006.

Financial issues

Credit growth continues at a very brisk pace,

underpinned by government spending, which is a key

driver of private-sector activity. Private-sector credit

growth averaged 9% y/y (2.5% q/q) in Q3-2011. Growth

was 5.3% for the first three quarters of 2011, and we

expect it to reach a healthy 5.5% by the year-end. We

foresee 2012 private-sector credit growth in the 5-6%

range (as seen since 2010), as spending continues to

Standard Chartered forecasts: Saudi Arabia

2011 2012 2013 2014

GDP (real % y/y) 6.6 2.9 4.2 4.0

CPI (% y/y) 5.2 5.4 4.5 4.2

Policy rate (%)* 0.25 0.25 0.25 0.25

USD-SAR* 3.75 3.75 3.75 3.75


20.0 15.5 12.5 11.0


10.0 8.0 7.0 7.0



Saudi Arabia (con’d)


underpin bank lending to the private sector. The

loan/deposit ratio is capped at 85% by the Saudi Arabian

Monetary Agency (SAMA), and averaged a healthy 79%

in Q3-2011.

Policy

We expect inflation in 2012 to reach 5.4%, close to the

expected 5.2% in 2011. Housing costs, which make up

18% of the inflation basket, will be a key driver. Saudi

Arabia is vulnerable to food price inflation, as food makes

up 26% of the inflation basket and the country imports

80% of its food. Increases in social subsidies (many of

which were enacted towards the end of 2011), in addition

to higher wages, will boost consumer purchasing power,

acting as another inflation driver in 2012.

In early 2011, we estimated that Saudi Arabia needed an

oil price of around USD 72/barrel (bbl) of Brent to

balance the budget. After the announcement of the social

spending measures, we raised our estimate to USD

106/bbl to factor in an estimated USD 50bn of additional

spending (we estimated total spending in 2011 at USD

227bn). We are revising down our breakeven price for

2011 given delays in the 500,000 housing units. We now

estimate 2011 spending to be in the region of USD 207bn

(USD 180bn of budget actuals + USD 27bn of social

spending), with the breakeven oil price at USD 96/bbl for

the year. We expect spending in 2012 to reach USD

212bn; we estimate that this would necessitate a

breakeven price of USD 105/bbl, given our expectation

that 2012 output will be 900,000 barrels per day lower

than in 2011.

Politics

Saudi Arabia has been actively dealing with underlying

demographic issues since 2008 through an ambitious

programme of infrastructure and diversification that

encompasses all regions of the country. The

announcement of USD 128bn of spending in 2011,

combined with the country‟s tribal structure, means social

dynamics have remained stable, even as the region

underwent a period of volatility. On the international front,

Saudi Arabia has played a leadership role in balancing

global oil supply and prices, as Libya‟s output of 1.6mbd

was cut during the 2011 Libyan war.

Other issues

We have a Positive outlook on the sovereign credit.

Saudi Arabia has built up a strong foreign-asset cushion

over the years, and is in a good position to withstand

short-term shocks. The country has very low debt levels

and is a strong net creditor. It has no sovereign debt, and

there is no deliverable on the sovereign CDS contract.

We view any significant spread widening on the

sovereign CDS as an opportunity to add risk via selling

sovereign CDS.

At current levels, Saudi corporate paper is expensive.

Unlike their peers in Qatar and the UAE, Saudi

corporates are not big issuers in the eurobond market.

International investor involvement in the space is largely

for diversification purposes. The two Saudi corporates

that have reasonably liquid US dollar paper outstanding

are petrochemical giant SABIC (rated A1/A+/A+) and

real-estate developer Dar Al Arkan (rated NR/BB-/NR).

The SABIC 15 has outperformed in the market sell-off – it

has been more resilient than both the Saudi sovereign

and corporates in Abu Dhabi and Qatar. Dar Al Arkan,

which faces considerable near-term refinancing risk with

a USD 1bn bond maturing in July 2012, has

underperformed, in line with other high-yield credits in the

region.

In the banking space, we view Saudi banks as among the

most defensive in the region. Their already sound

fundamentals continue to improve. Also, the banks will

benefit from the ongoing economic expansion and

healthy credit growth. However, because of their scarcity

value, Saudi bank bonds are expensive relative to other

GCC bank bonds. At current levels, we prefer the BSFR

15 over the SABB 15.

Saudi Arabia’s spending plans

A lot in place, and much more to come (USD bn)

Sources: Official Sources, Standard Chartered Research

0 100 200 300 400 500

Saudi 5-year plan

Saudi spending since 2008

Saudi projected budget spending 2012

Saudi social spending package 2011


Tunisia Philippe Dauba-Pantanacce, +971 4 508 3740

[email protected]


Looking ahead

Economic outlook

After GDP contracted by 8% q/q in Q1-2011, the

economy slowly recovered. Growth resumed in Q3 (1.5%

y/y) following the gradual normalisation of the day-to-day

business environment after disruptions caused by the Q1

change of regime. We nevertheless expect a slight

(0.5%) contraction in real GDP for 2011. We forecast a

rebound to positive growth of 4% in 2012 owing to a

return of confidence and a very favourable base effect.

The deteriorating external position, mostly owing to

European woes, is likely to mean a triple whammy of

decreased demand for Tunisian goods, a collapse in

tourism receipts, and slower remittances, although

exports continued to grow in Q2 and Q3-2011. We see

the current account deficit widening to 7.0% in 2011 and

narrowing to 4.5% in 2012, which would still be off the

recent trend of below 3%.

Inflation accelerated in the summer of 2011 on the back

of domestic bottlenecks (protracted partial shutdowns of

certain manufacturing facilities and higher imported

inflation). It reached 4.5% y/y in October; we expect the

figure to be just over 3.5% in 2012, with a few months of

more domestically driven inflation.

The FX reserves fell 20% in the year to end-November,

representing 3.7 months of import cover, down from 5.0

months at end-2010. Barring an unexpected further

worsening of the Tunisian economy, the central bank

should not find itself in an untenable situation.

Financial issues

The Tunisian dinar (TND), which is managed against an

undisclosed basket of currencies – believed to be heavily

weighted in favour of the euro (EUR) – has been fairly

stable, depreciating 2% against the EUR in the year to

November. Banque Centrale de Tunisie (BCT) intervenes

in the FX market to manage liquidity or control the real

effective exchange rate.

The banking system is generally stable, well capitalised

(capital adequacy is around 12.5%), and very liquid.

However, NPLs are likely to have risen to 20% in 2011

from an already-high level of around 12% in 2010. We

also expect the loan-to-deposit to widen marginally to

121% in 2011 from 118% in 2010.

Policy

The BCT will likely continue its relatively accommodative

monetary policy, with interest rates at 3.5% (cut from

4.0% in 2010). We expect it to maintain this dovish

stance, in line with the European Central Bank. The BCT

will continue to intervene in the market to ensure that the

banking sector is liquid enough and financing of the

economy is guaranteed. This helped credit to the

economy grow by almost 11% in the year to October.

Other issues

The most pressing task of the new constitutional

assembly and its caretaker government will be to address

the unemployment problem. The national statistics

agency estimates that unemployment could be around

18% at least, and there are concerns about the ability of

the economy to recover from such a shock.

The technical management of the economic legacy of the

ousted President and his family will be complicated, as

their assets extend into all sectors of the economy.

Politics

Tunisia held its first election for a national constitutional

assembly in October 2011. The election was deemed fair

and free by international observers and was won by a

moderate Islamic party, which formed a coalition with two

secular progressive parties. The government needs to

draft a new constitution and organise elections for next

year.

Standard Chartered forecasts: Tunisia

2011 2012 2013 2014

GDP (real % y/y) -0.5 4.0 5.0 5.5

CPI (% y/y) 3.6 3.5 3.0 3.0

Policy rate (%)* 3.5 3.5 3.5 3.75

USD-TND* 1.47 1.45 1.40 1.38


-7.0 -4.5 -3.5 -2.5


-6.0 -5.0 -3.5 -2.0



UAE Shady Shaher, +971 4 508 3647

[email protected]


Sustaining healthy growth

Economic outlook

The UAE experienced solid economic growth in 2011,

benefiting from improving domestic dynamics and a „flight

to safety‟ from adverse developments around the Arab

Spring. Political turmoil in the region boosted Abu Dhabi‟s

oil sector (as oil output rose to compensate for lower

output from Libya), and Dubai‟s non-oil economy (trade,

tourism and retail benefited). We expect both factors to

continue to drive the economy in 2012 to some extent,

though growth will moderate.

We estimate that the UAE economy will grow by 2.4% in

2012 versus 3.8% in 2011, largely because of base

effects. Even though oil production has increased in

2011, it is currently near the UAE‟s output limits. And

while Dubai‟s key non-oil sectors – especially tourism

and retail – should maintain their positive dynamics in

2012, we believe it will be difficult to achieve the same

upside surprise we have seen in 2011 given the more

challenging global environment.

We estimate Abu Dhabi (60% of the UAE‟s GDP) to grow

by 3.0% in 2012. Growth will be supported by a cautious

resumption of spending in H1, followed by an

acceleration in H2, as project reviews initiated in 2011

are completed. Note that expenditure on non-oil projects

in Abu Dhabi has been low in 2011, so this is one area

with upside potential for 2012.

Abu Dhabi‟s resumption of spending in 2012 will likely be

marked by the awarding of the USD 6.5bn contract for

the Abu Dhabi Midfield terminal, which, according to the

latest official statements, will happen in Q2-2012. Other

projects in the pipeline include Etihad Railways, for which

a USD 890mn contract was awarded in 2011; we expect

momentum to pick up in 2012. We believe project

reviews in the emirate will also lead to the cancellation of

some non-core projects and a reassessment of those

that will proceed. While this will detract from potential

near-term growth dynamics, we believe it is positive in

the long term, as it will prevent overcapacity.

Data from the International Energy Agency (IEA) shows

that the UAE‟s oil output (95% driven by Abu Dhabi), rose

to 2.55 million barrels a day (mbd) in September 2011

from around 2.3mbd at end-2010. We estimate that UAE

output will average around 2.5mbd in 2012, similar to our

estimated average for 2011. The IEA estimates that the

UAE‟s production capacity will stand at 2.74mbd at the

end of 2011. With little scope for further output increases

(given the resumption of Libyan production) and given

our view that significant cuts are unlikely amid increasing

demand from non-OECD countries, oil is unlikely to be a

significant factor in raising or detracting from GDP growth

(especially Abu Dhabi‟s) in 2012.

We expect Dubai‟s economy (29% of UAE GDP) to grow

by 2.4% in 2012. Dubai‟s tourism and retail sectors will

continue to be the main drivers of the emirate‟s recovery.

Hotel occupancy rates have averaged close to 70-80%

for most of 2011 (rising to almost 100% during Islamic

holidays), as tourists, especially from the GCC, turn their

backs on traditional Middle East tourist spots for the

stability of Dubai. Occupancy rates have remained high,

despite a significant increase in hotel rooms over the past

four years. We expect Dubai to continue to benefit from a

relative flight to quality in 2012, as political and stability

dynamics in some MENA countries remain challenging.

Dubai‟s exports and re-exports grew 17% in the first eight

months of 2011, but re-exports to some Arab countries

fell, affected by the Arab Spring. The trade sector is likely

to be affected by global fluctuations, but we take comfort

from Dubai‟s close trade links with regional markets and

new footprint markets in Central Asia and Africa.

Financial issues

UAE deposit growth peaked at 16% (y/y) in April 2011

and remained in double digits through July, largely on the

Standard Chartered forecasts: UAE

2011 2012 2013 2014

GDP (real % y/y) 3.8 2.4 2.8 3.4

CPI (% y/y) 2.0 1.6 2.1 3.2

Policy rate (%)* 1.0 1.0 1.0 1.0

USD-AED* 3.67 3.67 3.67 3.67


11.2 10.2 8.5 7.4


6.2 5.1 5.0 5.8



UAE (con’d)


back of a flight to safety to the UAE driven by regional

tensions. This was a key factor in driving down the UAE‟s

benchmark 3M EIBOR rate. However, this deposit flight

began to slow in August, with deposit growth slowing to

5.3% y/y (-1.0% m/m) in September. We believe the key

factor behind this slowdown is the lower 3M EIBOR rate,

which fell from above 2% at the beginning of 2011 to

around 1.47% by August (as deposits picked up), and

currently stands at 1.50%. This reduces the appeal of the

UAE for some deposits that had been attracted by the

rate differential between EIBOR and LIBOR.

Policy

Inflation in the UAE should average 1.6% in 2012,

compared with our 2% forecast for 2011. In fact, prices

fell 0.1% y/y in October (the first month of deflation in 20

months). Housing, which makes up 39.3% of the inflation

basket, has acted as a drag on overall inflation in 2011;

we expect it to continue to do so in 2012 given still-

significant overcapacity in the UAE housing market.

The UAE approved a USD 11.4bn federal budget for

2012, roughly the same as in 2011. This comprises

approximately 10% of the UAE‟s total government

spending, most of which occurs at the individual emirate

level. We expect moderately higher spending in Abu

Dhabi in 2012 versus actual 2011 levels.

Other issues

We have a stable outlook on the UAE as a credit. Abu

Dhabi‟s credit metrics place it among the strongest

sovereign credits globally. Although the government is

attempting to diversify the economy, Abu Dhabi‟s credit

strength continues to be underpinned by its strong

hydrocarbon dynamics. Dubai faces considerable

challenges from a leverage standpoint, with debt

restructuring of corporates still underway. The

oversupplied property sector is also an overhang;

however, on the positive side, activity is slowly returning

in the housing sector.

In the recent market sell-off, Abu Dhabi Inc. has been a

strong outperformer – although it has given up some

gains as the space began to look expensive versus some

of the more beaten-down emerging-market credits.

Dubai, on the other hand, has underperformed, being the

higher-beta play in the region.

On valuations, Abu Dhabi sovereign bonds – such as the

ADGB 14 – look expensive. We see better value in quasi-

sovereigns, such as MUBAUH and INTPET, which trade

at an attractive spread to the sovereign. We are

recommending switches from the ADGB 14 to the

MUBAUH 14 and from the QTELQD 21 to the INTPET

22. In Dubai, we have been recommending switches from

the DEWAAE 16 to the DEWAAE 15 and from the

EMIRAT 16 to the DPWDU 17. We are delaying outright

long recommendations on the Dubai sovereign given

ongoing risk aversion in the market, which is punishing

high-yield credits – particularly those with large near-term

refinancing needs.

In the UAE banking space, our preferred credits are the

Abu Dhabi banks because of their better fundamentals.

There has been a spate of issuance in the Abu Dhabi

banking sector in 2011, particularly sukuks (ADCB, ADIB

and FGB). Sukuks continue to trade at a premium to

conventional bonds because of strong demand from

Islamic investors. Our top pick in the sector is the

UNBUH 16, given the government of Abu Dhabi‟s 50%

stake in the bank and its sound fundamentals.

Politics

The UAE‟s strong social cohesion and generous social

subsidy system have enabled it to avoid political

pressures of the scale seen in other countries in the

region. In fact, the UAE has emerged as a regional safe

haven. It held parliamentary elections for the Federal

National Council (FNC) on 24 September 2011, and the

electoral college to elect half of the members of the FNC

was expanded from 6,000 to close to 129,000.

Strong project pipeline in 2012 (USD bn)

80% of potential project awards to be driven by Abu Dhabi

Sources: Meed Projects, Standard Chartered Research

0 5 10 15 20 25 30 35 40

Infrastructure

Oil & Gas

Power & Water

Industrial

Metal


Economies – Latin America


Latin America – Charts of the year


Chart 1: Divergence of trends

Brazil retail sales vs. industrial production (Jan-2000=100)

Chart 2: Negative output gap to persist into 2012

Brazil output gap

Sources: IBGE, Standard Chartered Research Sources: IBGE, Standard Chartered Research

Chart 3: Mexico FX-to-inflation pass-through is significant

Cum. impact of 15 % FX shock (months after depreciation)

Chart 4: Peru has the highest reserves/GDP in Latam

Total international reserves to GDP

Source: Standard Chartered Research Sources: Bloomberg, BCB, Banxico, BanRep, BCCh, BCRA,


Chart 5: Argentina capital flight – Worse than in 2008

USD mn, monthly

Chart 6: High CLP-BRL correlation

20-day correlation of daily returns

Sources: Econviews, Standard Chartered Research Sources: Bloomberg, Standard Chartered Research

90

100

110

120

130

140

150

160

170

180

190

Feb-00 Aug-01 Feb-03 Aug-04 Feb-06 Aug-07 Feb-09 Aug-10

Retail sales

Industrial production

-10%

-5%

0%

5%

10%

15%

20%

50

70

90

110

130

150

170

190

Q1-96 Q1-99 Q1-02 Q1-05 Q1-08 Q1-11

GDP SA (LHS)

GDP potential trend (LHS)

Output gap (RHS)

-4

-3

-1

0

1

3

4

2 4 6 8 10 12 14 16 18

Months after the shock

Res

pons

e in

ppt

Response of CPI to the shock

0%

5%

10%

15%

20%

25%

30%

35%

Brazil Mexico Chile Colombia Peru Venezuela Argentina

-500

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

5,000


BRL

-0.4

-0.2

0.0

0.2

0.4

0.6

0.8

1.0

Apr-00 Jul-01 Oct-02 Jan-04 Apr-05 Jul-06 Oct-07 Jan-09 Apr-10 Jul-11


Argentina Bret Rosen, +1 212 667 0386

[email protected] Italo Lombardi, +1 212 667 0564

[email protected]


More Kirchnerismo

Economic outlook

After strong GDP growth in 2010-11, we expect a

substantial deceleration in 2012 to growth of 3%. The

pace of economic expansion should slow next year due

to lower growth among Argentina’s main trading partners

(such as Brazil and Europe), worsening bottlenecks –

especially in the energy sector – and perhaps weaker

terms of trade. Business and consumer confidence

should be affected by the various measures and capital

controls recently announced related to the FX market.

Inflation should remain at around 25% in 2012, similar to

the level in 2010-11. The government has misreported

inflation for several years, primarily because billions of

pesos of inflation-linked debt was issued several years

ago. Monetary aggregates have been growing at 40% on

an annualised basis, with private-sector salaries in the

formal economy increasing by 34%. The government has

stated its intention to limit salary increases for unionised

workers to 18% for 2012, a proposition rejected by union

leaders. If the government further reduces subsidies, we

could see additional inflationary pressures. Unlike its

counterparts in neighbouring countries such as Peru,

Chile and Brazil, Argentina’s central bank does not

operate an inflation-targeting regime.

We look for a fiscal deficit of 1.3% of GDP for 2012, as

primary expenditures are likely to increase by around

30% for the fourth consecutive year. The government has

announced some reductions to subsidies, which total

around 5% of GDP, but we expect the Kirchner

government to continue with its populist bent. The

primary surplus should be 0.9% of GDP. While these

headline fiscal numbers may not appear worrisome, note

that Argentina ran fiscal surpluses of 1-4% of GDP from

2004-08, and has no market access to external financing.

Financial issues

Capital flight has averaged around USD 3bn per month in

the past three months, contributing to a substantial fall in

the international reserves to USD 47bn from USD 52bn.

Credit secured from monetary authorities in Europe, and

a current account surplus, have partly offset this decline.

Locals have sought refuge in the US dollar (USD)

because of: (1) the perception that the Argentine peso

(ARS) is more fully valued due to recent real exchange

rate appreciation; (2) negative real interest rates on ARS

deposits; (3) the policy mix during Cristina Kirchner’s

second term, which looks set to be similar to her first; and

(4) continuing global financial volatility, including Brazilian

real (BRL) weakness.

Policy

The authorities have taken draconian measures to

reduce the outflow of hard currency from the central

bank, most notably requiring locals to provide

identification, the origin of funds and tax information

consistent with funds requested for all USD purchases.

Mining and energy companies must repatriate 100% of

all USD proceeds. USD deposits have recently fallen by

around 15% as citizens fear new measures; as a result,

the authorities have reduced bank reserve requirements

in USD on deposits at the central bank.

Politics

Kirchner won 54% of the votes in the October 2011

presidential election, representing a 37% margin over the

second-place finisher. This was the largest margin of

victory in the history of democratic presidential elections

in the country. The victory gave her a sweeping mandate,

as her party controls both houses of congress and

gubernatorial posts in 14 of the country’s 23 provinces.

Markets viewed positively the naming of Hernan

Lorenzino to head the Ministry of Economy, but overall,

Kirchner’s cabinet appointments are representative of

policy continuity. Meanwhile, the administration has yet to

resolve the issue of outstanding debts with the Paris

Club, and will source USD 6bn from the central bank in

2012 to finance scheduled debt payments.

Standard Chartered forecasts: Argentina

2011 2012 2013 2014

GDP (real % y/y) 6.3 3.0 3.5 4.5

CPI (% y/y) 9.2 11.0 12.0 12.0

Policy rate (%)* NA NA NA NA

USD-ARS* 4.38 4.95 5.50 5.75


0.1 -1.5 -1.5 -1.0


-2.1 -1.3 -1.5 -1.8



Brazil Bret Rosen, +1 212 667 0386

[email protected]

Italo Lombardi, +1 212 667 0564

[email protected]


COPOM banking on lower inflation

Economic outlook

The latest data appears to confirm our scenario of lower-

than-consensus growth for 2011 and 2012. The strength

of the Brazilian real (BRL), which has supported

consumption, has weighed on manufacturing and certain

exporters, dragging down industrial production.

September industrial production, for example, was down

1.6% y/y. Domestic demand, which was robust in H1-

2011, has also slowed. Retail sales are growing at a 5%

pace, down from double-digit levels for a good part of

2010-11. We expect growth to slow to 2.5% in 2012 from

3.0% in 2011; both are below what is considered Brazil’s

potential growth rate.

We foresee a gradual improvement in sequential (q/q)

growth as we advance through 2012, mainly as a result

of monetary easing. In spite of this, a combination of less

favourable base effects and a very small carry-over effect

from 2011 will keep y/y growth in 2012 below 3.0% for

most of the year. Our growth estimates imply that starting

in Q4-2011, growth will slide below potential, with a

relatively sharp fall in the output gap in Q3, to the tune of

1.2% of GDP.

Inflation remains a concern, despite a backdrop of

monetary easing. The latest figures show that consumer

prices rose nearly 7.0% y/y, the highest in eight years

and well above the central bank’s target range of 4.5%

+/- 2ppt. Despite the food and energy shock experienced

in early 2011, core inflation measures are equally

elevated, running at 6.5-7.0% y/y. This mainly reflects the

above-potential pace of growth in domestic demand for

most of 2011. Services inflation was running at above

8.0% y/y in Q4-2011, which also shows how broad

inflation is. We expect the growth slowdown to ease

pressure on both goods prices and labour-market

conditions, helping inflation to moderate.

We expect IPCA inflation to end 2012 at 5.5%, above the

centre of the target but within the tolerance band. A

recent change to the methodology pertaining to the

composition of the IPCA index, which will take effect in

2012, should have the effect of lowering inflation

readings by 20-30bps (compared to the prior composition

of the index). Inflation expectations, another important

variable for the central bank, are also likely to recede

over the coming quarters, although credibility issues

could influence expectations in a negative way, which

could tie the central bank’s hands.

Balance-of-payments indicators remain strong. Most

impressively, FDI is running at a record pace. In the 12

months through October 2011, FDI reached USD 76bn.

Over the last year, the balance of payments accumulated

a surplus of 2.7% of GDP, causing international reserves

to rise by USD 68bn during the period to USD 353bn – a

record level for Brazil. The current account has been on a

gradually improving trend, at -2% of GDP for the 12

months ending in October 2012, as terms of trade

continue to favour Brazil. Capital account surpluses

remain, but have been negatively affected in recent

months by the imposition of various IOF taxes on

financial transactions from abroad. On 1 December 2011,

the government announced the elimination of the IOF tax

on foreign investments in Brazilian equities.

Financial issues

The direction of monetary policy has been highly

controversial, as the monetary policy committee

(COPOM) has embarked on an easing campaign even

with inflation above its tolerance range. The central bank

has reduced the SELIC rate to 11% from 12.5% in

August 2011 via three 50bps cuts at its last three

meetings. We expect the policy rate to be reduced to

9.5% by H1-2012, but we do not rule out more

aggressive monetary easing if the international or

domestic economic situations worsen substantially.

Some market participants have questioned the credibility

of Banco Central do Brasil (BCB), suggesting that

political pressure from the president and finance minister

Standard Chartered forecasts: Brazil

2011 2012 2013 2014

GDP (real % y/y) 3.0 2.5 4.9 5.5

CPI (% y/y) 6.5 5.4 4.5 4.5

Policy rate (%)* 11.0 9.5 9.0 8.5

USD-BRL* 1.85 1.65 1.55 1.55


-2.5 -2.2 -2.8 -3.2


-2.2 -1.9 -2.2 -2.4

*end-period Sources: IBGE, BCB, Standard Chartered Research


Brazil (con’d)


has influenced recent monetary policy decisions.

Nonetheless, the central bank seems intent on trying to

‘normalise’ Brazil’s interest rate backdrop, as its real

rates are the highest among large emerging and

developed economies. One view which is gaining

credence is that the COPOM intends to test the reaction

of the economy to a real interest rate that is more in line

with Brazil’s peers. Various government officials have

stated that the economy should operate with a real

interest rate of around 3%.

Additionally, there is growing sentiment that the BCB has

adopted a new mandate of prioritising growth over

inflation, even though it does not have an explicit growth

target. Overall, sentiment in Brazil appears to be that the

government is willing to tolerate above-target inflation in

exchange for stronger growth.

Policy The fiscal accounts have been on an improving trend.

Indeed, President Dilma Rousseff has been more

hawkish on fiscal policy than her predecessor, Lula, and

was able to secure some BRL 50bn of expenditure cuts

to this year’s budget. As of October, the primary surplus

for 2011 stood at 3.6% of GDP, double the level a year

earlier (when President Lula was ramping up current

expenditures ahead of the presidential election). Brazil

should be on target to reach its nominal primary surplus

target for 2011 of BRL 27.9bn, estimated at around 3.1%

of GDP. As a result, debt/GDP indicators have been

improving gradually.

Reaching fiscal targets may be more challenging in 2012,

due in part to an anticipated 14% increase in the

minimum wage. This increase should represent close to

BRL 2bn of additional expenditures in 2012, mostly

related to pension costs. The minimum wage adjusts by

GDP growth of two years prior (2010 GDP was 7.5%),

plus the prior year’s inflation (likely around 6.5%). Fiscal

policy is also constrained by a bloated public sector,

other major pension-related costs, and necessary

investments ahead of the 2014 World Cup and 2016

Olympics. Some infrastructure and stadium projects

related to the World Cup are well behind schedule.

Other issues

The administration faces major challenges related to the

oil sector. Petrobras, the state-controlled oil company, is

expected to invest well over USD 200bn in the next half-

year; most of this is related to developing the ‘pre-salt’

layers deep in the ocean off the Brazilian coast, which

are expected to help Brazil produce 5mn barrels per day

by the end of the decade. Efficiently managing this

process and the subsequent windfall will be a major

challenge.

Politics

The president enjoys rather strong popularity, but seven

ministers have resigned in her first year in office amid

several corruption scandals. The scandals illustrate the

structural weaknesses of Brazil’s system of government.

Though the president has considerable power, she can

get little done without the say-so of a congress that is one

of the world’s most splintered and fractious. More than 20

parties are represented in the two houses (party-hopping

is common, and new parties spring into existence at the

drop of a hat). More than 10 are allied, formally or

informally, to the president’s Workers’ Party (PT). The

result is that the practice of trading votes in congress for

posts and budgetary amendments is quasi-

institutionalised.

Many believe Dilma owes her post to Lula, and that if

Lula recovers from his current health problems and the

economy falters, he could possibly return and run for the

presidency in 2014.

We expect some changes to Dilma’s cabinet to be

announced at the start of 2012 in reaction to the issues

that have plagued her administration. We do not expect

any changes in the key posts of Fazenda (the finance

ministry, headed by Guido Mantega) or the BCB (led by

Alexandre Tombini).

A slowdown ahead

GDP growth – y/y versus q/q SA

Sources: IBGE, Standard Chartered Research

q/q SA

y/y

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

Q1' 07 Q1' 08 Q1' 09 Q1' 10 Q1' 11 Q1' 12


Chile Bret Rosen, +1 212 667 0386

[email protected]


[email protected]


Central bank is ready to act

Economic outlook

The economy is decelerating somewhat after posting

solid growth through Q3-2011. Some of this deceleration

can be attributed to the base effect, although sequential

growth is also showing clear signals of slowing. Official

projections for 2012 suggest GDP growth of 5%, close to

the economy’s estimated potential growth rate. Our

forecast is a bit lower, at 4.5%. Employment generation

has picked up substantially in 2011, and real wages are

positive, with average salaries rising just shy of 6% y/y.

The central bank, Banco Central de Chile (BCCh),

targets inflation of 3%, and recent indicators have been

just above this mark, at 3.2% y/y. Inflation expectations

are well under control, and the central bank has

substantial credibility. Core indicators of inflation have

been running at 2.0-2.5%.

Financial issues

The authorities have flagged risks associated with the

global economic slowdown, adopting a more dovish tone.

Recent central bank minutes have suggested that the

monetary authorities are looking to ease policy. The

BCCh is perhaps Latin America’s most conservative

central bank, and the authorities have acknowledged that

they prefer to evaluate more economic data before

acting.

As a small, open economy, Chile could be adversely

impacted by a deepening of the international crisis. We

think that a 2% real interest rate for Chile would be

generally neutral, so the central bank has room to ease

to offset the impact of the external environment. Post-

Lehman, the central bank was particularly aggressive in

slashing rates, so once an easing cycle begins, we would

not be surprised to see a series of cuts. We expect the

BCCh to start cutting rates in Q1-2012, probably

implementing at least 100bps of monetary easing in total.

Spanish banks represent around 35% of total deposits in

the Chilean banking system. While the financial system is

well regulated and on a solid footing, and Spanish

subsidiaries’ operations are segregated from their

headquarters, deposit rates at Spanish banks exceed the

interest rate paid on central bank paper by well over

100bps. This spread is well above the historical norm.

Banco Santander has announced its intention to sell 7.8%

of its participation in Santander Chile, which would raise

around USD 1bn and help the bank comply with capital

requirements imposed by the Spanish authorities.

Policy

Chile is projected to run a fiscal surplus of 1% of GDP in

2011. Projections for 2012 are for a small deficit of 0.5%

of GDP. Meanwhile, we note that the sovereign has very

little debt, with gross public debt/GDP at just 9%. Debt

levels are more worrisome at the corporate level. The

public sector has accumulated substantial savings over

the years, as manifested by the copper stabilisation fund,

which has over USD 13bn in assets. This provides

flexibility to adopt counter-cyclical policy, as implemented

during the 2008-09 crisis.

Politics

While President Pinera garnered a surge in public

support after the rescue of the miners in 2010, recent

student protests have weighed on his popularity, which

has sunk to around 30%. Chile has been gripped by

student protests that have even turned violent. Student

leaders have led the largest demonstrations in years,

pushing for additional state funding for education, a new

national framework and an end to for-profit education.

Fewer than half of high school students study in public

schools, and most universities are private. The

government has sent a bill to congress which would

reduce interest rates on student loans, increase

subsidies and lift the share of the budget dedicated to

education. However, the schism between the education

movement and the government remains, and is the

biggest risk to President Pinera’s popularity.

Standard Chartered forecasts: Chile

2011 2012 2013 2014

GDP (real % y/y) 6.4 4.5 5.0 5.0

CPI (% y/y) 3.6 3.0 3.0 3.0

Policy rate (%)* 5.25 4.25 4.25 4.25

USD-CLP* 500 465 450 440


-1.0 0.1 -0.8 -1.1


1.0 0.5 0.5 0.5



Colombia Bret Rosen, +1 212 667 0386

[email protected]


[email protected]


Reforms, FTA underpin strong outlook

Economic outlook

Economic growth has surpassed expectations in 2011

(we forecast GDP growth at over 5%), and we look for a

similar performance in 2012, assuming that the global

environment does not deteriorate substantially. Economic

performance should remain supported by strong credit

growth, a buoyant job market, and robust household

consumption. We expect investment spending to stay

strong; capital formation has been rising 20% y/y.

Colombia’s government enjoys a formidable consensus,

supportive of market-friendly policies.

Banco de la Republica (BanRep) hiked the policy rate by

25bps to 4.75% at its November 2011 meeting, in sharp

contrast to easing by other central banks in emerging-

market countries. We expect one more 25bps hike from

BanRep, with the central bank likely to stay on hold

thereafter. Inflation has been impacted by transitory

factors related mostly to food prices, and headline

inflation surpassed 4% in October 2011. The authorities

have been particularly concerned about abundant credit

growth and soaring housing prices. We expect CPI

inflation to converge closer towards the central bank’s

3% target in 2012.

Fiscal performance is outperforming expectations thanks

to stronger-than-expected economic growth and poor

spending execution, especially related to infrastructure

projects. The public sector will be operating under a fiscal

rule that envisages the headline deficit converging to 1%

of GDP by 2022 (versus an expected 3.4% in 2011). The

implementation of royalty reform should also support the

fiscal accounts and allow for more equitable distribution

of revenues derived from mining and oil.

Financial issues

The authorities have expressed some concern about the

pace of credit expansion. Meanwhile, external debt in the

banking system has risen substantially over the last

couple of years, while Colombian corporates have

increased their level of foreign currency-denominated

debt. The local-currency bond market is less susceptible

to an outflow of capital, as foreigners hold around 20% of

the TES curve.

Policy

The backdrop for the Colombian peso (COP) should stay

positive with the country’s rising oil production – perhaps

to 1 million barrels per day in 2012 – and supportive

terms of trade. With the central bank possibly tightening

further, COP carry looks attractive relative to other Latin

American currencies. In the past, however, the

authorities have intervened during periods of substantial

COP appreciation, and the central bank could become

active if the COP appreciated back below 1,800 again in

2012, in our view.

Politics

President Juan Manuel Santos enjoys enormous

popularity thanks to the solid pace of economic growth,

single-digit unemployment, and the improved security

situation in Colombia in recent years. His support level

surpasses 70% and his coalition in congress holds a

super-majority. The government was successful in

passing a series of reforms in 2010-11.

Santos has also succeeded in improving diplomatic

relations with neighbouring Venezuela. Consequently,

commerce between the two countries has picked up in

recent months, rising from the depths experienced when

President Hugo Chavez of Venezuela shut the border

between the two countries in 2010.

Santos should also benefit from the passage of a free-

trade agreement (FTA) with the US, ratified by Congress

in October 2011. The US is Colombia’s leading trade

partner, and the FTA could lift medium-term GDP growth

by an estimated 0.5-1ppt. The agreement will take effect

in H1-2012. Industry will be both positively and negatively

impacted by increased competition from US imports.

Standard Chartered forecasts: Colombia

2011 2012 2013 2014

GDP (real % y/y) 5.3 4.5 4.5 4.5

CPI (% y/y) 3.2 3.3 3.3 3.0

Policy rate (%)* 5.00 5.00 5.50 5.50

USD-COP* 1,920 1,780 1,750 1,720


-2.7 -2.2 -2.3 -3.0


-3.4 -3.2 -2.9 -2.7



Mexico Bret Rosen, +1 212 667 0386

[email protected] Italo Lombardi, +1 212 667 0564

[email protected]


Banxico is on hold

Economic outlook

Economic activity surprised to the upside in H2-2011.

Growth was a strong 4.5% y/y in Q3, well above

consensus estimates of 3.9% y/y and faster than the

pace in Q2. Not only has industrial production

outperformed, but domestic demand and the services

sector have maintained good momentum. We expect

3.4% GDP growth for both 2011 and 2012.

Both headline and core inflation remain within the

tolerance range of 2-4%, while inflation expectations

continue to be well anchored and in line with the target.

The central bank has downplayed the effect that FX

could have on inflation. The central bank, Banxico, has

assumed that the Mexican peso (MXN) exchange rate

will revert towards levels more consistent with

fundamentals. Additionally, it believes that the pass-

through to inflation from FX depreciation is rather limited.

Financial issues

We expect Banxico to keep the policy rate on hold at

4.5% throughout 2012. Currency weakness is a major

reason for this view; the MXN serves as a proxy for

emerging-market risk in general given its combination of

liquidity and transparency. In recent communiqués,

Banxico has suggested that its policy stance is consistent

with a convergence towards the 3% inflation target in

2012. Despite its strong credibility, the central bank has

failed to reach this target in recent years, suggesting that

its actions in the months ahead will be conservative.

Policy

We recently estimated that sustained MXN depreciation

to levels of around 13.7-14.50 versus the USD could lead

to a cumulative effect on yearly CPI inflation of 0.85-

1.00ppt – a significant impact. While the authorities had

expressed a sanguine view of such pass-through and

appeared committed to a liberal FX regime, the finance

ministry and Banxico announced on 29 November 2011 a

mechanism by which the monetary authority will offer

USD 400mn at a level 2% weaker than the prior day’s

fixing. This was viewed by the market as a signal that the

authorities are less tolerant of currency volatility – i.e.,

MXN weakness – after a period of several months when

the MXN made a number of violent moves without

triggering central bank intervention. With USD 140bn of

reserves, Banxico has substantial ammunition to

maintain this strategy for quite some time.

Politics

While presidential elections are less than a year away,

there appears to be little concern about the potential

macroeconomic impact of a change in government. The

consensus expects that the relatively centrist PRI will

reassume power for the next six-year term, after 12 years

with the centre-right PAN in power. One possibility is an

alliance between the PAN and centre-left PRD to prevent

the PRI from regaining power, but we do not see a high

likelihood of this given the vast ideological differences

between the two parties. Recent polls put the PRI at

around 35% of voters’ preferences, exceeding the

combined total of current support for the PAN and PRD.

The security situation will be a key area of debate during

the campaign. President Calderon’s recent interview with

The New York Times set off a substantial reaction locally;

he implied that if the PRI assumed the presidency, it

might negotiate with drug cartels. Each party will have

the opportunity to describe how it intends to handle

growing problems related to drug cartels. The economic

impact of the security situation is hard to measure. Some

local economists believe that the worsening situation may

cost Mexico around 0.5% of GDP annually, and note the

effect on consumer confidence and tourism receipts. The

violence has spread to parts of the country, such as

Monterrey, where crime rates were previously rather low.

Additionally, the new government could reassess

Calderon’s rather confrontational strategy towards the

drug cartels.

Standard Chartered forecasts: Mexico

2011 2012 2013 2014

GDP (real % y/y) 3.4 3.4 4.0 4.0

CPI (% y/y) 3.7 3.8 3.8 3.5

Policy rate (%)* 4.5 4.5 5.0 5.0

USD-MXN* 13.80 11.80 11.00 10.60

Current account

balance (% GDP) -0.7 -0.4 -0.8 -1.0

Fiscal balance

(% GDP) -2.2 -2.5 -2.5 -2.5



Peru Bret Rosen +1 212 667 0386

[email protected]


[email protected]


More Lula than Chavez, so far

Economic outlook

Peru’s economic growth continues to be the highest in

Latin America, with full-year 2011 growth forecast at

6.7%. We expect a slight deceleration in 2012, but the

country’s growth should still surpass that of its Latin

American neighbours. Peru benefits from high prices of

precious and industrial metals, but recent growth has

been balanced; private consumption has been especially

robust. Despite earlier fears of a slowdown in private

investment related to policy risks following the victory of

leftist-nationalist President Ollanta Humala, the business

community seems comfortable with the policy framework.

This should continue to foster investment in key sectors

such as mining, construction and services.

Headline inflation was hit by important supply shocks

earlier in 2011, lifting food inflation (48% of the index)

significantly. CPI inflation has been above the central

bank’s target, but we expect monthly inflation readings to

be more consistent with the central bank target (2% +/-

1ppt) throughout most of 2012. We expect the central

bank to stay on hold, keeping its policy rate at 4.25% for

the near term.

Financial issues

The central bank does not target a specific level for the

Peruvian sol (PEN), but does act to limit volatility; given

the high rate of dollarisation (50%) in the banking system,

the authorities intervene in the FX market when

necessary to prevent excessive movements in the USD-

PEN rate. With almost USD 50bn of reserves (the highest

as a percentage of GDP in the region), the authorities

have plenty of ammunition. Meanwhile, if global market

conditions improve, the government could hike reserve

requirements or implement other measures to try to curb

currency appreciation. We favour positions in the PEN

given the positive carry; with production of gold and

copper expected to be ramped up in the years ahead

against the backdrop of a weak USD, the environment for

the PEN looks supportive.

Policy

The government is undertaking a fiscal stimulus package

to offset the impact of the weak international financial

environment. Added expenditure slated in the 2012

budget totals nearly 2% of GDP. Peru has plenty of room

for counter-cyclical fiscal policy, given that it is likely to

finish 2011 with a fiscal surplus of 1% of GDP owing to

booming tax revenues and under-execution of public

investment plans.

Politics

The biggest roadblock to positive momentum in Peru

arises from the dynamics between the mining sector, the

government and local communities. Local communities,

predominantly indigenous ones, have staged protests

against various mining projects. Grievances focus on the

environmental and social impact on the regions where

the projects occur, typically the distribution of and access

to water. The most notable set of protests relates to the

Conga project, a mine expected to require nearly USD

5bn in investment. In late 2011, strong protests at the site

of this copper and gold mine, located in Cajamarca,

forced Newmont Mining to suspend operations at Conga.

How the government handles this and other protests may

be the biggest challenge of Humala’s presidency, as

Peru is slated to receive approximately USD 40bn of

investment in its mining sector over the next half-decade.

Markets remain wary of the possibility of a lurch to the left

by Humala. At times he campaigned as an ‘anti-system’

candidate, but he has surprised the market with a very

pragmatic policy mix, often resembling the politics of

former Brazilian President Lula. Still, some in the

business community fear that a more radical policy mix

could follow if his popularity slipped or the economy

deteriorated.

Standard Chartered forecasts: Peru

2011 2012 2013 2014

GDP (real % y/y) 6.7 5.5 6.0 6.2

CPI (% y/y) 3.2 3.0 2.7 2.5

Policy rate (%)* 4.25 4.25 4.25 4.25

USD-PEN* 2.70 2.63 2.58 2.55


-1.6 -2.0 -2.4 -2.5


1.0 0.0 -0.5 -0.8


Our forecasts


Forecasts – Economies and FX


Country

Real GDP growth (%)

Inflation (yearly average %)

Current account (% of GDP)

FX

2011 2012 2013 2014 2011 2012 2013 2014 2011 2012 2013 2014 Q1-12 Q2-12 Q3-12 Q4-12 Q1-13 Q2-13

Majors** 1.3 0.4 2.2 2.7 2.0 1.5 1.5 1.7 -1.2 -1.0 -1.0 -1.1

US^ 1.8 1.7 2.5 3.0 1.7 1.6 1.8 2.0 -3.1 -2.8 -2.9 -2.9 N.A. N.A. N.A. N.A. N.A. N.A.

Euro area 1.5 -1.5 1.5 2.4 2.6 1.9 1.6 1.8 -0.4 -0.2 -0.4 -0.1 1.20 1.22 1.25 1.30 1.27 1.25

Japan -0.5 0.8 3.1 2.5 -0.2 -0.1 0.2 0.1 2.2 2.0 3.2 2.8 81.00 79.00 77.00 74.00 74.00 76.00

UK 0.7 -1.3 1.5 2.3 4.4 2.1 1.6 1.8 -1.8 -1.4 -1.8 -2.2 1.46 1.50 1.52 1.55 1.51 1.49

Canada 2.4 2.2 2.4 3.0 2.5 2.2 2.0 2.0 -3.0 -2.5 -2.2 -1.9 1.10 1.08 1.02 0.98 0.98 0.96

Switzerland 1.8 -0.2 1.8 2.4 0.3 -0.5 0.5 0.8 12.0 13.5 11.5 12.0 1.04 1.07 1.06 1.04 1.10 1.12

Australia 1.5 2.9 4.0 3.5 3.4 3.2 3.3 3.0 -2.7 -3.5 -3.8 -4.0 0.92 0.95 1.00 1.05 1.08 1.06

New Zealand 1.8 2.4 3.3 3.0 4.3 2.4 2.9 2.5 -4.0 -5.0 -5.5 -5.5 0.72 0.76 0.83 0.88 0.89 0.85

Asia** 7.3 6.5 7.5 6.5 5.8 3.3 4.2 4.3 2.6 1.5 2.1 2.2

Bangladesh* 6.7 6.4 6.5 6.9 9.0 10.5 9.0 7.0 0.9 -0.6 -0.7 -0.5 78.50 79.50 79.50 78.00 78.20 78.20

China 9.2 8.1 8.7 7.0 5.4 2.0 3.6 4.0 3.5 1.9 2.7 3.1 6.36 6.31 6.26 6.21 6.18 6.15

Hong Kong 5.0 2.9 5.6 4.5 5.2 3.5 3.5 3.0 6.5 5.5 6.5 6.0 7.810 7.800 7.780 7.790 7.785 7.780

India* 7.0 7.4 8.0 8.0 8.7 6.5 6.0 6.0 -3.1 -2.8 -2.6 -2.5 53.00 51.80 50.50 48.50 48.00 48.50

Indonesia 6.5 5.8 6.5 6.8 5.4 4.5 5.3 5.4 0.5 0.3 0.1 0.0 9,400 9,200 9,000 8,700 8,600 8,700

Malaysia 4.8 2.7 5.4 4.5 3.3 2.6 2.8 3.1 12.0 9.5 10.5 12.7 3.30 3.22 3.11 3.03 2.98 3.03

Pakistan* 2.4 4.0 4.8 5.0 13.9 12.0 13.0 12.0 0.3 -1.5 -1.8 -2.3 90.00 92.00 93.00 94.00 94.50 95.50

Philippines 3.8 3.2 5.3 5.0 4.7 3.7 4.4 4.0 2.8 2.3 4.1 3.0 45.25 44.50 43.50 41.50 40.50 41.00

Singapore 4.8 1.9 7.8 4.4 5.1 2.5 3.1 3.0 19.0 16.5 19.5 18.2 1.35 1.32 1.28 1.25 1.23 1.25

South Korea 3.5 3.0 4.0 4.0 4.0 3.0 3.0 3.0 2.0 2.0 1.5 1.0 1,210 1,155 1,095 1,050 1,030 1,050

Sri Lanka 8.0 7.5 8.0 8.0 6.9 6.4 7.0 7.2 -5.7 -5.1 -3.0 -3.0 113.5 115.8 115.2 114.8 114.5 112.5

Taiwan 4.4 2.7 4.5 5.2 1.4 1.2 1.6 1.3 7.5 5.5 6.0 6.0 31.40 30.80 29.90 29.00 28.80 28.70

Thailand 1.8 3.5 4.9 5.5 3.7 3.0 3.5 3.9 1.5 -0.1 -1.1 -0.9 32.50 32.20 31.50 30.50 30.00 30.50

Vietnam 5.8 5.8 6.5 6.8 18.7 11.3 8.5 7.0 -10.5 -8.5 -7.5 -7.0 21,700 21,800 22,500 22,600 23,000 23,100

Africa** 4.8 5.3 5.6 5.8 8.4 8.3 6.8 7.4 1.3 0.6 0.3 -0.1

Angola 3.7 8.0 6.5 6.5 15.0 14.0 10.0 9.0 12.0 7.0 6.0 5.0 92.50 92.50 92.00 91.50 91.50 91.00

Botswana 8.0 7.0 5.9 6.5 6.9 8.2 6.7 5.7 -1.5 -1.2 0.4 1.3 8.26 8.20 7.92 7.52 7.25 7.45

Cameroon 3.5 4.0 4.5 4.5 2.6 2.5 2.5 2.0 -3.8 -3.3 -3.0 -2.5 547 538 525 505 516 525

Côte d'lvoire -5.8 8.0 5.5 5.0 3.0 2.5 2.5 2.5 1.0 -0.5 -2.0 -2.5 547 538 525 505 516 525

The Gambia 6.1 5.5 5.5 5.5 6.0 5.0 4.0 4.0 -17.0 -14.0 -13.0 -13.0 29.00 29.50 30.00 30.00 30.70 31.00

Ghana 13.6 8.5 7.9 7.6 9.0 10.1 12.7 10.8 -6.5 -4.9 -3.3 -1.5 1.64 1.66 1.67 1.70 1.72 1.74

Kenya 4.9 5.3 5.5 5.9 14.0 13.3 6.8 6.5 -9.3 -8.5 -6.8 -6.5 94.00 91.00 94.00 97.00 96.00 94.00

Nigeria 7.2 6.9 7.3 7.5 10.9 10.0 9.1 12.0 12.2 11.3 10.5 9.0 164 161 159 158 157 158

Sierra Leone 5.2 30.0 8.0 7.0 16.0 11.0 10.0 10.0 -50.0 -7.6 -9.5 -12.4 4,370 4,390 4,410 4,450 4,500 4,550

South Africa 3.2 3.1 4.1 4.3 5.0 6.1 5.2 5.4 -3.4 -3.8 -4.0 -4.2 9.30 9.10 8.80 8.20 7.80 8.20

Tanzania 6.1 6.7 7.5 7.3 11.3 11.7 5.7 5.6 -9.5 -8.7 -10.2 -9.1 1,800 1,820 1,790 1,800 1,830 1,780

Uganda 6.4 6.6 7.0 7.3 18.7 15.3 1.8 5.1 -10.2 -9.9 -7.7 -7.3 2,550 2,380 2,590 2,660 2,640 2,550

Zambia 6.5 7.0 7.2 7.5 8.8 7.4 9.2 9.0 3.2 2.0 2.2 2.4 5,500 5,200 4,900 4,800 4,700 4,800

MENA** 5.6 2.6 4.2 4.7 5.2 5.4 5.2 5.5 5.7 6.1 4.7 4.4

Algeria 3.0 3.5 4.0 4.5 4.0 4.3 4.5 4.5 11.0 13.0 14.0 16.0 74.00 74.30 74.50 73.60 73.30 74.00

Bahrain 1.9 3.5 4.0 4.5 -0.3 3.0 3.5 3.5 3.5 3.2 3.5 4.0 0.38 0.38 0.38 0.38 0.38 0.38

Egypt* 1.8 2.0 3.0 3.5 11.3 10.0 11.5 11.0 -1.2 -1.9 -1.5 -0.5 6.50 6.70 6.80 6.82 6.90 7.10

Jordan 2.4 2.5 2.9 3.5 4.6 4.5 5.0 5.2 -7.5 -8.0 -7.5 -7.0 0.71 0.71 0.71 0.71 0.71 0.71

Kuwait* 5.0 3.0 3.0 3.5 5.0 4.5 4.0 4.0 30.0 27.0 26.0 27.0 0.29 0.29 0.28 0.28 0.27 0.27

Lebanon 1.5 3.8 5.5 5.5 5.0 4.8 5.5 5.5 -17.5 -16.0 -15.0 -13.0 1,500 1,500 1,500 1,500 1,500 1,500

Morocco 4.3 4.5 5.0 5.5 1.5 2.5 3.0 3.5 -5.5 -4.0 -4.0 -4.0 8.45 8.43 8.40 8.35 8.40 8.35

Oman 4.5 4.7 4.3 4.0 4.0 4.0 4.5 5.0 10.0 9.0 8.0 9.0 0.39 0.39 0.39 0.39 0.39 0.39

Qatar 16.9 5.9 5.6 5.4 2.4 3.3 3.8 4.2 32.0 30.0 27.0 25.0 3.64 3.64 3.64 3.64 3.64 3.64

Saudi Arabia 6.6 2.9 4.2 4.0 5.2 5.4 4.5 4.2 20.0 15.5 12.5 11.0 3.75 3.75 3.75 3.75 3.75 3.75

Tunisia -0.5 4.0 5.0 5.5 3.6 3.5 3.0 3.0 -7.0 -4.5 -3.5 -2.5 1.50 1.48 1.47 1.45 1.47 1.45

Turkey 6.7 1.3 5.0 6.2 6.4 7.0 6.3 6.8 -9.7 -5.0 -6.5 -7.2 2.00 1.93 1.80 1.69 1.65 1.57

UAE 3.8 2.4 2.8 3.4 2.0 1.6 2.1 3.2 11.2 10.2 8.5 7.4 3.67 3.67 3.67 3.67 3.67 3.67

Latin America** 3.9 3.1 4.5 4.9 5.5 5.2 4.8 4.7 -1.7 -1.6 -2.0 -2.3

Argentina 6.3 3.0 3.5 4.5 9.2 11.0 12.0 12.0 0.1 -1.5 -1.5 -1.0 4.48 4.60 4.68 4.95 5.05 5.25

Brazil 3.0 2.5 4.9 5.5 6.5 5.5 4.5 4.5 -2.5 -2.2 -2.8 -3.2 1.90 1.80 1.75 1.65 1.55 1.65

Chile 6.4 4.5 5.0 5.0 3.6 3.0 3.0 3.0 -1.0 0.1 -0.8 -1.1 530 500 470 465 455 465

Colombia 5.3 4.5 4.5 4.5 3.2 3.3 3.3 3.0 -2.7 -2.2 -2.3 -3.0 1,930 1,860 1,810 1,780 1,750 1,800

Mexico 3.4 3.4 4.0 4.0 3.7 3.8 3.8 3.5 -0.7 -0.4 -0.8 -1.0 14.20 13.00 12.50 11.80 11.50 11.40

Peru 6.7 5.5 6.0 6.2 3.2 3.0 2.7 2.5 -1.6 -2.0 -2.4 -2.5 2.75 2.72 2.70 2.63 2.60 2.60

Global 3.0 2.2 3.6 3.8 3.7 2.9 2.9 2.9 -- -- -- --

* Fiscal year starts in April in India and Kuwait, July in Bangladesh, Pakistan, and Egypt

** 2010 USD GDP weighted total of the regional economies covered in this publication

^ Inflation: Core PCE deflator used for US



Forecasts – Rates


End-period Q1-12 Q2-12 Q3-12 Q4-12 Q1-13 Q2-13

% % % % % %

United States Policy rate 0-0.25 0-0.25 0-0.25 0-0.25 0-0.25 0-0.25

3M LIBOR 0.60 0.40 0.25 0.25 0.45 0.60

10Y bond yield 1.75 2.00 2.15 2.30 2.45 2.55

Euro area Policy rate 0.75 0.75 0.75 0.75 0.75 0.75

3M LIBOR 1.05 0.85 0.60 0.55 0.65 0.75

10Y bond yield 2.10 2.30 2.40 2.50 2.65 2.70

United Kingdom Policy rate 0.50 0.50 0.50 0.50 0.50 0.50

3M LIBOR 1.10 0.90 0.95 1.00 1.05 1.10

10Y bond yield 2.25 2.30 2.35 2.40 2.50 2.60

Australia Policy rate 4.00 4.00 4.00 4.00 4.25 4.50

3M LIBOR 4.20 4.20 4.20 4.30 4.70 5.00

China Policy rate 6.56 6.56 6.56 6.56 6.81 6.81

7D repo rate 4.00 3.50 3.00 3.00 3.50 3.50

10Y bond yield 3.50 3.50 3.70 3.90 4.00 4.10

Hong Kong 3M HIBOR 0.40 0.35 0.35 0.35 0.45 0.55

10Y bond yield 1.20 1.30 1.50 1.70 1.80 1.90

India Policy rate 8.50 8.25 7.75 7.25 7.00 7.00

91-day T-bill rate 8.25 7.75 7.25 7.00 6.75 7.00

10Y bond yield 8.50 8.25 7.75 7.50 7.50 7.75

Indonesia Policy rate 5.75 5.75 5.75 5.75 6.25 6.25

3M JIBOR 4.80 4.60 4.50 4.50 5.00 5.00

10Y bond yield 6.75 6.50 6.25 6.00 6.25 6.25

Malaysia Policy rate 2.75 2.50 2.50 2.50 2.50 2.50

3M KLIBOR 3.00 3.00 3.00 3.00 3.00 3.00

10Y bond yield 3.30 3.00 3.30 3.50 3.60 3.70

Philippines Policy rate 4.25 4.00 4.00 4.00 4.00 4.00

3M PDST-F 1.70 1.50 2.00 2.50 3.00 3.80

10Y bond yield 5.80 5.50 5.60 5.70 6.00 6.30

Singapore 3M SGD SIBOR 0.35 0.35 0.35 0.35 0.35 0.35

10Y bond yield 1.50 1.40 1.40 1.60 1.70 1.80

South Korea Policy rate 3.25 3.00 3.00 3.00 3.00 3.25

91-day CD rate 3.55 3.30 3.30 3.30 3.30 3.55

10Y bond yield 3.65 3.40 3.50 3.60 3.80 4.00

Taiwan Policy rate 1.88 1.88 1.88 1.88 2.00 2.13

3M TAIBOR 0.90 0.90 0.90 0.90 0.95 1.00

10Y bond yield 1.30 1.20 1.30 1.40 1.50 1.60

Thailand Policy rate 3.00 2.75 2.75 2.75 2.75 2.75

3M BIBOR 3.05 2.75 2.80 2.80 2.80 2.80

10Y bond yield 3.40 3.50 3.60 3.70 3.90 4.10

Vietnam Policy rate (Refi rate) 12.00 11.00 11.00 11.00 11.00 11.00

Overnight VNIBOR 11.00 10.00 10.00 10.00 10.00 10.00

2Y bond yield 12.25 11.75 11.50 11.25 11.50 11.25

Ghana Policy rate 12.50 13.00 14.00 14.00 14.50 15.00

91-day T-bill rate 10.40 10.90 11.40 11.90 12.40 12.60

3Y bond yield 13.50 13.75 14.00 14.00 13.75 13.50

Kenya Policy rate 18.00 17.00 16.00 14.00 14.00 12.00

91-day T-bill rate 17.00 15.00 14.40 13.80 13.50 11.80

10Y bond yield 19.00 18.00 17.00 16.00 16.00 15.00

Nigeria Policy rate 12.00 12.50 13.25 13.25 13.50 14.00

91-day T-bill rate 14.40 14.80 15.20 14.70 14.30 13.90

10Y bond yield 13.50 12.50 12.80 12.00 11.70 11.40

South Africa Policy rate 5.50 5.50 6.00 6.00 6.50 6.50

91-day T-bill rate 5.63 5.72 6.05 6.10 6.54 6.59

10Y bond yield 8.25 8.50 8.70 8.85 8.95 9.05



Forecasts – GDP


Country Real GDP growth (% y/y, unless otherwise stated)

Q3-11 Q4-11 Q1-12 Q2-12 Q3-12 Q4-12 Q1-13

Majors

US^ 2.0 2.8 0.8 1.6 1.9 2.4 2.7

Euro area* 0.2 -0.5 -1.0 -0.5 0.1 0.3 0.4

Japan 0.1 -0.1 -0.1 0.4 0.5 2.1 3.5

UK* 0.5 -0.7 -0.9 -0.5 0.2 0.4 0.4

Canada^ 3.5 2.0 1.5 2.5 3.0 3.5 3.0

Switzerland* 0.1 -0.2 -0.6 0.0 0.2 0.2 0.5

Australia 1.7 1.3 2.6 2.3 3.0 3.8 4.2

New Zealand 2.0 1.8 1.4 1.9 2.6 3.7 4.0

Asia

Bangladesh 6.7 6.5 6.6 6.5 5.3 6.3 6.6

China 9.1 8.3 7.5 7.6 8.1 9.1 9.6

Hong Kong 4.3 3.0 0.2 1.5 3.8 5.8 7.0

India 6.9 6.8 6.6 6.2 7.5 7.8 8.3

Indonesia 6.5 6.4 6.3 5.9 5.6 5.4 6.0

Malaysia 5.8 4.2 2.2 1.6 2.5 4.3 5.4

Pakistan 3.3 3.8 4.2 4.5 4.5 4.8 4.8

Philippines 3.8 4.2 3.1 3.0 3.2 3.7 4.5

Singapore 6.1 3.1 -3.6 -1.3 3.2 9.5 10.6

South Korea 3.4 3.4 2.7 2.7 3.0 3.5 4.2

Sri Lanka 7.7 8.0 7.5 7.3 7.6 7.7 8.0

Taiwan 3.4 3.0 2.0 1.5 3.3 4.0 4.0

Thailand 3.5 -2.2 2.0 3.3 3.3 5.3 3.2

Vietnam 6.1 6.1 5.3 5.5 6.0 6.5 6.0

Latin America

Argentina 6.6 5.5 5.0 3.3 2.0 1.5 3.3

Brazil 2.4 1.7 1.1 1.2 2.8 4.1 3.8

Chile 4.8 3.6 3.8 4.2 4.7 5.1 5.2

Colombia 5.5 5.2 5.0 4.8 4.3 4.2 4.3

Mexico 4.4 4.3 4.2 3.7 3.6 5.0 5.0

Peru 6.2 5.5 5.5 6.5 6.2 6.2 6.0

* q/q Source: Standard Chartered Research

^ q/q SAAR


Forecasts – Commodities


Market close

m/m Change

YTD y/y Q4-11 Q1-12 Q2-12 Q3-12 Q4-12 Q1-13 Q2-13 2011 2012

5-Dec-11 % % % F F F F F F F F F

Energy

Crude oil (nearby future, USD/b)

NYMEX WTI 101.0 +6.6 +9.9 +12.4 96 85 92 109 115 118 118 95.6 100.3

ICE Brent 109.8 -2.4 +15.3 +19.5 110 95 100 115 120 122 120 111.2 107.5

Dubai spot 109.1 +2.0 +23.3 +24.9 105 93 98 112 118 120 118 105.8 105.1

Refined oil products cracks and spreads

Singapore naphtha (USD/bbl) -11.5 -7.9 -254.4 -108.2 -6 -6 -4 -3 -3 -3 -3 -2.8 -4

Singapore jet kerosene (USD/bbl) 16.5 -18.1 +5.5 -205.3 20 21 22 22 25 22 23 19.8 22

Singapore gasoil (USD/bbl) 16.7 -18.1 +9.3 -161.5 18 17 18 19 23 21 21 18.3 19

Singapore regrade (USD/bbl) -0.2 -23.1 -154.1 -54.1 2 4 4 3 3 2 2 1.5 3

Singapore fuel oil 180 (USD/bbl) -3.6 +445.2 -62.1 +2265.1 -4.5 -5 -5 -5 -5 -6 -6 -6.8 -5

Coal (USD/t)

API4 105 -3.8 -18.6 -1.7 113 104 106 108 110 109 109 118 107

API2 112 -2.7 -14.2 -2.2 116 110 111 113 115 115 115 122 112

globalCOAL NEWC* 114 -3.7 -11.5 +4.8 118 114 115 116 117 118 118 122 116

Metals

Base metals (LME 3m, USD/t)

Aluminium 2,130 -1.2 -14.4 -8.2 2,150 2,100 2,200 2,300 2,300 2,500 2,500 2,434 2,225

Copper 7,940 -0.7 -18.6 -10.9 7,450 8,000 8,500 9,000 9,500 10,750 10,750 8,814 8,750

Lead 2,120 +2.1 -18.0 -11.1 1,950 2,000 2,250 2,350 2,400 2,600 2,600 2,377 2,250

Nickel 18,505 -5.0 -27.5 -23.9 18,500 20,000 21,500 22,000 22,000 24,000 24,000 22,940 21,375

Tin 20,000 -9.3 -25.7 -21.5 22,000 24,000 26,000 27,000 27,000 25,500 25,500 26,347 26,000

Zinc 2,040 +3.1 -18.1 -9.4 1,900 2,000 2,150 2,300 2,350 2,450 2,450 2,209 2,200

Iron ore (USD/t)

Iron ore^ 134 -10.7 - -16.8 150 150 165 179 180 185 182 170 169

Steel** (CRU assessment, USD/t)

HRC, US 672 -9.9 - +17.3 690 690 710 725 750 750 750 805 719

HRC, Europe 675 -3.9 - -0.8 676 676 682 685 700 700 700 774 686

HRC, Japan 936 -0.3 - +17.7 960 960 970 960 965 965 965 920 964

HRC, China 677 -8.3 - +2.2 690 700 780 776 795 795 795 733 763

Precious metals (spot, USD/oz)

Gold (spot) 1,723 -2.3 +20.6 +20.4 1,750 1,800 1,800 1,925 1,975 2,000 2,000 1,588 1,875

Palladium (spot) 633 -3.5 -21.0 -16.5 625 600 650 750 800 850 850 732 700

Platinum (spot) 1,521 -7.3 -14.5 -12.1 1,550 1,600 1,700 1,800 1,900 2,050 2,050 1,725 1,750

Silver (spot) 32 -6.3 +3.5 +6.2 34 39 39 39 39 40 40 36 39

Agricultural products

Softs (nearby future)

NYBOT cocoa, USD/t 2,035 -24.5 -32.9 -29.9 2,425 2,350 2,500 2,450 2,400 2,500 2,600 2,934 2,425

LIFFE coffee, USD/t *** 2,006 -24.5 -3.7 +7.6 1,925 1,950 2,250 1,767 1,767 1,700 1,700 2,209 1,934

NYBOT coffee, USc/lb 234 +1.6 -2.7 +14.4 230 220 207 207 207 200 205 254 210

NYBOT sugar, USc/lb 24 -5.8 -25.0 -18.4 25 28 28 28 28 27 27 27 28

Fibres

NYBOT cotton No.2, USc/lb 92 -6.9 -36.5 -35.2 97 110 115 110 100 115 120 138 109

Grains & oilseeds (nearby future)

CBOT corn (maize), USc/bushel 580 -11.6 -7.9 +4.7 627 700 735 700 675 650 625 681 703

CBOT Soybeans, USc/bushel 1,126 -7.0 -19.1 -12.5 1,180 1,350 1,380 1,330 1,340 1,300 1,300 1,319 1,350

CBOT wheat, USc/bushel 599 -6.1 -24.7 -20.5 620 700 725 695 650 675 675 711 693

CBOT rice, USD/cwt 14 -9.1 +3.2 -0.7 16 15 15 13 12 13 13 15 14

Thai B rice 100%, USD/tonne* 654 +4.1 +19.3 +15.3 630 575 580 550 500 500 500 566 551

Edible oils (nearby future)

Palm oil (MDV,MYR/t) 3,090 +2.2 -19.0 -13.2 2,975 3,200 3,400 3,600 3,600 3,700 3,800 3,235 3,450

Soyoil (CBOT, USc/lb) 50 -4.0 -13.7 -6.2 51 53 56 57 57 58 60 56 56

*weekly quote; **monthly average; ***10-tonne contract Sources: Bloomberg, Standard Chartered Research

^cost and freight at China‟s Tianjin port, 62% iron content, Indian origin.


World Wide Wrap


Focus issues for next 3 months One year ahead outlook

Attention will remain on the European crisis as officials try to support problem sovereigns and banks while the economy slides. US data will be scrutinised to see if the recent pick-up continues. In Asia, with inflation receding, the focus will also be on activity data, particularly the extent of China‟s economic and property-market slowdown. The pace of easing by the PBoC will be watched closely.

We expect a significant recession in Europe over the winter, while the recent US upswing will fade in H1, bringing renewed QE from the Fed. China and India will relax policy and achieve soft landings. EM central banks will mostly be easing, with exceptions in Africa. We expect growth in most countries to pick up again in H2. Asia overall will see a slowdown but should prove its resilience.

Beijing is now moving ever more rapidly from fighting inflation to protecting growth. Q1-2012 will be tough, with co-ordinated slowdowns in exports, residential real-estate construction and infrastructure. Monetary policy is being gradually loosened, in the form of a less restrictive loan quota for 2012 (some CNY 8.5trn, we forecast) and RRR cuts (we look for five more through end-2012). We expect Q2-2012 to see a gradual growth recovery.

In 2012, the two main risks to China‟s economy are a shock from Europe/the US and a messy correction in the domestic housing market. We forecast 8% GDP growth for the year, with stronger momentum in H2. We expect policy rates to be on hold throughout 2012. We foresee more gradual CNY appreciation of about 2% against the USD dollar for the year, with more two-way movement, including periods of sustained CNY weakness.

In India, slowing growth and falling inflation will keep expectations of a repo rate cut high; we expect this to happen by Q2-2012. Policy inertia and a lack of reforms will continue to weigh on sentiment, and the union budget presentation in February 2012 will be scrutinised to assess the government‟s commitment to fiscal consolidation. INR weakness will remain a concern.

With four successive quarters of sub-7% GDP growth and inflation at c. 6.5%, 150bps of repo rate cuts are likely by end-FY13. This should push some investment back onto the table and boost GDP growth to 7.4% from 7.0% in FY12. Amid a rebound in growth, gradual INR appreciation is likely by the end of 2012. Hopes of progress on reforms may build in again as important state elections are over by mid-2012.

Policy makers‟ focus has returned to easing growth momentum as confidence in DM growth wanes. A correction in global oil prices will also help to reduce inflation concerns. Local consumer confidence is moderating, which should allow central banks to assess the possibility of rate cuts.

Weak growth in the West and rapid lending growth locally present central banks with a dilemma in terms of their monetary policy stance. Strong fundamentals are likely to attract capital inflows, and central banks can either allow currency appreciation or consider capital-flow management.

We expect a further slowdown in exports and domestic demand due to the European crisis. Headline inflation will return to the BoK‟s target range thanks to food and energy prices, but the BoK is likely to remain cautious and keep the policy rate on hold in Q1-2012. Significant fiscal easing is also unlikely given the government's emphasis on fiscal prudence.

Activity will gradually recover in H2-2012 as policy easing by major economies improves the export outlook and the strong labour market and credit growth underpin domestic demand. Inflation will remain stable at around 3%. We expect only a nominal BoK rate cut, by 25bps in Q2-2012, while meaningful fiscal easing is not our core scenario throughout 2012.

GCC policy makers are focused on spending, while Tunisia and Egypt remain in political transition. Higher spending by GCC states has translated into increased spending and inflationary pressure for some. More importantly, it has helped to suppress further contagion from political unrest.

Strong fiscal policy driven by resilient oil prices will support growth in oil-producing countries. Global uncertainties, especially European woes, will pose downside risks to global trade, especially for the more open and Europe-dependent economies (Dubai, Maghreb). We see potential growth upside in 2012 for countries that have been through a political transition, owing mostly to a very favourable base effect.

A „risk-off‟ environment in Q1-1202 will leave the ZAR especially vulnerable to a correction. Many frontier African central banks have imposed new currency regulations in response to currency weakness. We expect risk aversion to discourage new flows into frontier Africa (with some exceptions, notably Uganda), but not necessarily trigger new outflows from these markets. With favourable yields and improving fundamentals, African FX is set to benefit more broadly from H2-2012.

2012 will see key elections in Africa – in Senegal, Ghana, Kenya, and internal ANC party elections in South Africa. Governments are likely to come under pressure to rein in expansionary fiscal policy, although the pace of fiscal consolidation in Africa – with the exceptions of Botswana and Angola – has largely disappointed. Politics are expected to play a key role in determining economic outcomes.

Brazil‟s central bank should continue to ease monetary policy in the months ahead; we look for a single-digit SELIC rate in H1-2012 (now 11%). Other central banks in the region should stay put short-term unless the situation in Europe deteriorates further. In Argentina, the authorities face worrisome levels of capital flight and decreasing USD deposits as BCRA reserves shrink.

The region is better positioned for a global economic slowdown than in 2008. FX reserves are robust and banks well capitalised. However, most countries are too dependent on commodity prices, so growth is vulnerable to a slowdown in Asia and the US. Regional growth should be below trend over the next year. Peru and Chile have the most flexibility to counteract external headwinds.

The US likely ended 2011 on a high note, but growth may hit an air pocket in Q1-2012. While employment growth is too weak to sustainably drive down unemployment, core retail sales growth should continue to benefit from lower gasoline prices. Without a significant economic shock, we do not see another recession, but deleveraging still has far to go. The housing market remains dismal.

Given the end of the 100% investment tax credit, we see slower business investment in H1-2012. Consumers will continue to deleverage, which will contain consumption growth. Housing prices will likely remain weak and unemployment elevated. There is still significant slack in the economy, which should ease inflationary pressures, particularly as base effects fade in H1-2012.

The focus is on three areas: (1) whether politics in the euro-area periphery will support necessary austerity measures, ensuring backing from core governments and the ECB; (2) ECB actions, including the scale of bond purchases, a further rate cut and help with funding for banks; and (3) confidence and activity data as the euro area and UK slide into recession.

Weak confidence and pullbacks by banks will push the euro area and UK into a significant recession over the winter, with a recovery starting in H2. We do not expect the euro crisis to be fully resolved quickly, but we do think officials will eventually be forced to do enough to restore a degree of confidence among investors. Having said that, the recession will make it difficult to meet deficit targets.

In the near term, the recovery in exports and manufacturing will continue to be affected by sluggish global demand and JPY strength. Optimising government funding plans to cover huge reconstruction needs and security spending will also be critical to the new government, which now advocates a sales tax in the next couple of years to improve the fiscal balance.

The V-shaped rebound we expected after the March 2011 Fukushima earthquake is likely to be delayed until H2-2012 due to ongoing external shocks. The new recession in Europe and slow growth in the US, along with the October 2011 floods in Thailand, have put Japan‟s fragile economy in jeopardy again. We expect 2012 to be a transition year before large-scale earthquake reconstruction begins.

Important disclosures can be found in the Disclosures Appendix Source: Standard Chartered Research

Global

Greater China

South Asia

South EastAsia

South Korea

MENA

Sub-SaharanAfrica

Latin America

United States

Europe

Japan


Disclosures Appendix


Regulatory Disclosure: SCB and/or its affiliates have received compensation for the provision of investment banking or financial advisory services within the past one year: Mubadala, Union National Bank, MB Petroleum Services, First Gulf Bank, Qatar

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Document approved by

Nicholas Kwan

Head of Research, East

Data available as of

12:00 GMT 09 December 2011

Document is released at

00:01 GMT 12 December 2011

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