Asia Economic and Currency Snapshot For Feb 2011
By Win Thin and his Emerging Markets Strategy Team at Brown Brothers Harriman
India: Economic and Currency Snapshot
Macroeconomic Update: GDP rose 8.9% y/y in both Q2 and Q3, and is expected to grow about 9% in 2010 and 8.5% in 2011. Industrial production grew by only 2.7% y/y in November vs. 11.3% y/y in October, but was likely caused by seasonal distortions coming from the timing of the Diwali festival. Exports remain strong, rising 36% y/y in December and so IP is likely to recovery from November. The Indian economy keeps growing strongly and could outperform China at times in 2011, but strong growth has come at a cost of higher inflation.
Monetary Policy Outlook: Reserve bank of India (RBI) hiked benchmark interest rates by 25 bp in January and remains concerned about inflation pressures. Monthly WPI rose 8.43% y/y in December, up from 7.48% y/y in November, and CPI measures also accelerated that month. RBI is likely to hike rates further this year, starting with the mid-quarter meeting March 17. The market sees 50 bp of total rate hikes in 2011. We think the risk for tightening is to the upside, and believe reserve requirements are also likely to be hiked this year.
Politics: Onion prices have soared as the late arrival of monsoon rains hurt crops. The main opposition Bharatiya Janata Party (BJP) will hold demonstrations and stage sit-ins in India’s major cities for a month starting January 20 to highlight the government’s failure to check price increases. The Congress-led government has also been weakened by the telecoms corruption scandal, while potential turmoil in neighboring Pakistan also poses a risk. All in all, India faces heightened political risks compared to the rest of the Asian region.
Currency Outlook: INR weakness has picked up since Q3 began, and is the worst Asian currency vs. USD over this period. We believe a large part of this weakness is being driven by a loss of credibility on the part of both the RBI and the government. RBI has to act more aggressively to curb inflation and interest rates should be raised in 2011 by more than what the market is expecting. Equity markets have likely been spooked by the telecoms scandal, as economic fundamentals are generally supportive for India stocks. INR should eventually recover based on rising interest differential between India and developed countries, but RBI needs to regain credibility first.
Indonesia: Economic and Currency Snapshot
Macroeconomic Update: GDP increased 5.8% y/y in Q3 vs. a revised 6.2% in 2Q, and was slightly weaker than expected. However, annual growth in 2010 will likely be over 6.0% and is seen accelerating to near 6.5% in 2011 and 2012. Exports continue to expand strongly, up 30% y/y in Q4, but inflation pressures have risen sharply. CPI rose 7% y/y in January, above the 4-6% target range. Domestic demand has been strong as imports climbed almost 35% y/y in Q4. M2 growth is high (14% y/y in November), as is bank credit (22% y/y in November).
Monetary Policy Outlook: Bank Indonesia (BI) has been reluctant to raise its policy rate. On January 5, BI kept rates at 6.5%, a record low, for the 17th straight meeting. Next meeting is February 4 and only 6 of 22 analysts polled by Bloomberg see a 25 bp hike then. We think BI should raise interest rates then before it loses more credibility. Even core inflation is elevated, signaling more widespread price pressures than just food-related. We think hikes will start in Q1 and look for 100 bp of total tightening in 2011. More reserve requirement hikes too.
Politics: President Yudhoyono seems to be losing popular support. A nationwide poll of 2,200 people in December revealed that his approval rating fell to 63% from 70% in January 2010. Critics have accused Yudhoyono’s government of failing to improve the lot of the country’s poorest citizens despite strong economic growth, as well as perceived backpedalling on a pledge to root out corruption. He is targeting annual growth of 6.6% on average through the remainder of his term ending in 2014. For now, political risk is low but will pick up.
Currency Outlook: Like INR, we believe IDR has underperformed recently due to a loss of confidence in the central bank’s willingness to limit inflation. Capital inflows to Indonesia have dried up for now, and the equity market has been one of the worst Asian performers YTD along with India and Thailand. If BI hikes soon as we expect and some credibility is regained, IDR should do better based on strong fundamentals and expectations of further hikes. BI is clearly worried about IDR appreciation, but it cannot target both the exchange rate and inflation with monetary policy and will eventually have to give in and hike rates, we believe.
Korea: Economic and Currency Snapshot
Macroeconomic Update: The economy is slowing a bit but remains firm, with GDP rising 4.8% y/y in Q4 vs. 4.4% y/y in Q3 and 7.2% y/y in Q2. IP and export growth remain strong, while domestic consumption slowed over the past three quarter. This slowing is one reason why the central bank has been reluctant to raise rates. Trade and current account balances remain in healthy surplus, and weakness in domestic activity has likely made the authorities more concerned about a stronger won.
Monetary Policy Outlook: Inflation pressures have been relatively high as CPI rose 4.1% y/y in January, above the central bank’s 2-4% target range. Bank of Korea (BOK) is responding to increased inflation pressures, hiking interest rates by 25 bp to 2.75% in January after standing pat in December. However, real interest rates are still negative and core inflation is creeping higher too and so we think it is reasonable to expect BOK to keep its tightening bias and hike at least 25 bp every quarter in 2011. Indeed, we see risk of another 25 bp hike February 11.
Politics: The government is concerned about high inflation eroding its support, and announced plans to freeze utility costs and cut food tariffs as President Lee wants to keep inflation at 3%. North Korea reopened a Red Cross hotline with South Korea, and may be stepping up efforts to resume a dialogue despite increased tensions following the sinking of the Cheonan in March and the North’s shelling of a Southern border island in November. Given the likely succession struggle going on in Pyongyang, we expect more acts of belligerence by the North.
Currency Outlook: KRW has been one of the better Asian performers YTD, due to expectations of higher interest rates as well as for strong economic growth. The government is uncomfortable with KRW appreciation and has signaled the likelihood of capital control measures to limit KRW appreciation. We think that 1100 is a key level for policy-makers, and BOK has intervened directly in the FX market regularly this past year. We think further KRW gains are likely in 2011, but BOK risks losing credibility if it continues to target both inflation and the exchange rate. The won will also be subject to periodic bouts of selling as the situation in the North remains unsettled.
Taiwan: Economic and Currency Snapshot
Macroeconomic Update: Growth is slowing, but remains very strong. GDP rose 6.5% y/y in Q4 vs. 9.8% y/y in Q3 and 12.9% y/y in Q2. Industrial production remains strong, rising 18% y/y in December vs. 19% y/y in November. Export orders rose 15% y/y in December, and points to continued strength in exports in 2011. The government now sees GDP growth of 4.8% in 2011, but given strong momentum in the economy, we think the growth rate could be closer to 6% vs. an actual 10.7% in 2010.
Monetary Policy Outlook: The central bank raised the policy rate by 12.5 bp to 1.625% In December, and continues the trend of 12.5 bp per quarter that’s been in place since June 2010. Inflation pressures are modest, as CPI rose by 1.25% y/y in December and core CPI rose only 0.9% y/y in November and December. Unemployment rate declined to 4.7% in December, a two-year low, and so the risk of wage pressures will have to be watched closely. For now, we believe tightening will continue in 2011 at the current pace.
Politics: Taiwan’s ruling Kuomintang (KMT) party won 3 out of 5 mayoral elections held on November 27, while the opposition Democratic Progressive Party (DPP) won the remaining 2. These 5 municipalities account for nearly 60% of Taiwan’s 23 mln population, and so results show President Ma’s pro-mainland policies has helped his party gain support ahead of the next presidential election in 2012. As such, pro-mainland policies are likely to continue. Ma would like to improve ties with mainland China, while DPP has favored less ties.
Currency Outlook: TWD is one of the top performing Asian currencies vs. USD so far in Q1, and follows a top spot in Q4 as well. USD/TWD is now trading around the lowest levels since 1997. Taiwan economy should continue to expand, supported by exports to mainland China and the US mainly. Taiwan officials appear to be moderately concerned with TWD strength after its recent gains, and could institute capital controls as needed to limit appreciation. It has often intervened directly in the FX market, so TWD gains are likely to remain muted in 2011.