Developing Economies Fundamental View March 2016

SOUTH KOREA — Fiscal stimulus and an accommodative monetary policy stance will continue to support South Korean economic performance over the coming quarters. In early February, the government proposed a fiscal stimulus package, worth around US$20 billion, to front-load spending in order to boost the economy. For the same reason, the Bank of Korea (BoK) will keep monetary conditions loose for an extended period of time; we assess that the chance for further monetary stimulus has increased recently despite policymakers’ concerns regarding a large and increasing household debt burden. The benchmark interest rate is currently set at 1.50%. South Korean inflation remains low with the consumer price index rising by 0.8% y/y in January, down from 1.3% a month before. We expect to see a modest pick-up in price pressures over the coming months; the annual inflation rate will likely reach around 1?% by the end of the year, remaining below the BoK’s 2% inflation target for 201618. A weak external sector performance was the key contributor to South Korea’s slower economic growth in 2015; real GDP expanded by 2.6% in 2015, down from 3.3% the year before. In our view, South Korea’s economic outlook will improve slightly in 2016-17 as demand from advanced economies for the country’s exports strengthens gradually and as monetary and fiscal stimulus underpins domestic demand; output expansion will likely average 2.8% y/y over the next two years.
USDKRW surged in February after the Lunar New Year on a combination of portfolio outflows, expectations of monetary easing and escalating geopolitical risks. However, foreign investors have recently turned to net purchases of local equities and bonds. We look to buy the pair on dips while trading its downward trend technically. USDKRW is likely to trade between 1,215 and 1,270 in March. Should the BoK’s concerns regarding mounting household debt be tackled, a small rate cut is possible.
THAILAND — Thailand continues to suffer from external sector headwinds; in January, the country’s exports recorded the thirteenth consecutive monthly decline in year-over-year terms, mainly due to declining shipments to China and other Asian trading partners. The Thai economy expanded by 2.8% y/y in the final quarter of 2015, and posted an equivalent rate of expansion for the year as a whole. The export sector struggles aside, momentum was supported by household spending as well as rising public sector outlays. Encouragingly, private sector investment recuperated, reflecting improved business confidence. Nevertheless, the sustainability of the recovery is uncertain given persistent political uncertainty. We expect Thailand’s GDP to expand by 3.2% y/y in 2016-17. The country’s inflation environment remains muted, with headline consumer price gains remaining in negative territory at -0.5% y/y in February. We expect deflationary pressures to remain in place in the first half of 2016, after which modest price gains will take the inflation rate toward the lower end of the Bank of Thailand’s medium-term target of 2½% ±1½%. While financial stability is among the central bank’s key priorities, monetary policymakers may implement further monetary stimulus in the near term if the economy underperforms authorities’ expectations. The benchmark interest rate has been kept at 1.50% since April 2015.
The BoT will review its GDP forecast for 2016 in March with a downward bias after cutting it to 3.5% in December. We expect the THB to decline modestly against the USD in the near term on divergent monetary polies, the yuan’s depreciation bias, contained portfolio inflows and domestic political issues. USDTHB will likely reach 37.0 at end-Q1. However, the THB is not expensive now in terms of either NEER or REER and the chance of sharp falls in the THB is pretty low. In addition, the nation is relatively less susceptible to China’s slowdown with a solid coverage of external liability compared to regional peers.
TAIWAN — Monetary conditions in Taiwan will remain loose for an extended period of time. In fact, we expect the Taiwanese central bank to inject further monetary stimulus into the struggling economy following the March 24th policy meeting and lower the benchmark interest rate to 1.50%. The most recent cut took place in December when the rate was reduced by 12.50 basis points to 1.625%. The Taiwanese economy contacted by 0.5% y/y in the final quarter of 2015 following a 0.8% decline in the prior three month period. Real GDP expanded by only 0.7% in 2015 as a whole, following a solid 3.9% advance in the year before. The outcome reflected a combination of weaker domestic demand and dull export sector performance. We expect price pressures to remain mild, yet the headline inflation rate jumped to 0.8% y/y in January from 0.1% at the end of 2015, reflecting the base effect from electricity cost refunds a year earlier. We forecast that inflation will remain well-contained over the coming months, hovering slightly below 1% y/y for most of 2016. The Taiwanese political power structure is changing; the Democratic Progressive Party, which won the January 16th elections, now holds a majority in parliament and should be able to implements its agenda rather effortlessly. President-elect Tsai Ing-wen will take office in May.
As Taiwan’s export orders tumbled for a tenth month in January, the CBC is very likely to trim its policy rate again in March as indicated by declining 364-day NCD auction yields. We expect the TWD to catch up with the weakening KRW in the coming weeks. In addition, president-elect Tsai Ing-wen said late February that she won’t let the TWD exchange rate to affect the island’s industry and the new administration will discuss FX issue and macro economy with the central bank. We maintain our short TWDKRW cross with a target of 36.20, while staying with our long INR position funded with the low-yielding TWD.
MALAYSIA — The Malaysian economy continues to record reasonably solid momentum despite low energy prices that are adversely impacting the country’s energy sector. Real GDP grew by 4.5% y/y in the fourth quarter, compared with a 4.7% gain in the July-October period. In 2015 as a whole, the country’s output expanded by 5.0%. Economic activity is driven by domestic demand. Private consumption is holding up, underpinned by stable wage growth and employment conditions. Investment is supported by private sector outlays in the manufacturing and services industries. This should partially compensate for the investment downturn in the oil and gas sector as well as weaker export sector performance. We expect Malaysia’s real GDP to expand by 4?% this year, in line with the government’s revised forecast. The recalibrated Budget for 2016 maintained a deficit target of 3.1% of GDP. Low energy prices are causing a dip in the government’s revenues, yet prudent fiscal stance is abled by enlarging the tax base and optimizing public expenditure. The budget is based on a US$30-35 per barrel price forecast for Brent crude. The consumer price index rose by 3.5% y/y in January, up from 2.7% recorded in December. We expect inflation to remain elevated in the near term until the impact of a weaker currency and the GST implementation in April 2015 start fading away. The headline rate will likely hover slightly above 2% y/y at the end of the year. We expect the Malaysian central bank to keep the benchmark interest rate at 3.25% over the coming months. The key rate has remained unchanged since July 2014 when it was raised by 25 basis points.
The MYR gained modestly in early February on stabilizing domestic conditions and a revised Budget 2016. The sovereign rating was affirmed by Fitch at “A-”. However, oil prices will not help strengthen the MYR in the near term. While continued bond inflows chasing the high yields are supportive, the MYR is still susceptible to external uncertainty (the Fed, the CNY, and China). A high foreign ownership of local government bonds could trigger capital outflows if sentiment weakens.
Regards All.

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