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Certification and Other Disclosures
E C O N O M I C
M A R K E T
A S I A
&
A N A L Y S I S :
P A C I F I C
Prospects for Financial Markets
Yiping Huang
+852-2501-2735
yiping.huang@citi.com
Hong Kong
Hak Bin Chua
Singapore
Asia Economic Outlook
and Strategy
Growth and Inflation Risks
Asia Economics Team
Beijing
Minggao Shen
➤
Housing adjustment and tight financial conditions
continue to weigh on the U.S. economy, although
aggressive policies should help
➤
While strong growth will probably continue in
Asia, “decoupling” and “resilience” explanations
offer different investment implications
➤
Exports should slow, but investment could be a
countercyclical force. And certain consumption
items could remain resilient
➤
Food inflation complicates macroeconomic
policymaking, although overall inflation pressures
could ease when growth moderates
➤
While Asian currencies will probably lead the next
leg of U.S. dollar weakness, slowing exports
could make central bankers cautious
Shanghai
Ken Peng
Hong Kong
Yiping Huang
Joe Lo
Adrienne Lui
Michael Luk
Patricia Pong
Singapore
Hak Bin Chua
Leon Hiew
Kit Wei Zheng
Mumbai
Rohini Malkani
Anushka Shah
Jakarta
Anton Gunawan
Seoul
Suktae Oh
Morgan Kim
Manila
Jun Trinidad
Taipei
Renee Chen
Cheng Mount Cheng
Tina Liao
Asia Pacific
29 February 2008
29 February 2008
Asia Economic Outlook and Strategy — Growth and Inflation Risks
Citi Key Economic Forecasts
Figure 1. GDP Forecasts (Growth Rate in Percent)
2007 GDP Forecasts
Current
Previous
Asia-Pacific
Asian NIEs
SEA-4
Bangladesh*
China
Hong Kong
India**
Indonesia
Malaysia
Philippines
Singapore
South Korea
Sri Lanka
Taiwan
Thailand
Vietnam
8.8
5.5
6.1
6.2
11.4
6.3
8.7
6.3
6.3
7.3
7.7
4.9
6.7
5.7
4.8
8.5
8.8
5.3
5.9
6.2
11.4
6.1
9.3
6.3
6.0
7.0
7.5
4.8
6.7
5.4
4.6
8.5
Current
2008 GDP Forecasts
Previous
Consensus
8.2
4.8
5.7
6.0
10.5
5.3
8.3
6.2
5.6
6.5
5.6
4.6
6.0
4.5
4.5
8.1
8.3
4.8
5.8
6.0
10.5
5.3
9.1
6.2
5.6
6.5
5.6
4.6
6.0
4.5
4.6
8.1
8.1
4.7
5.6
5.8
10.3
4.9
8.6
6.1
5.6
5.6
5.6
4.6
5.8
4.3
4.6
8.3
Current
8.1
5.1
6.4
6.5
10.0
5.5
8.5
6.5
6.5
7.6
6.8
4.8
6.5
5.0
5.3
8.3
2009 GDP Forecasts
Previous
Consensus
8.3
5.1
6.5
6.5
10.0
5.5
9.4
6.5
6.5
7.5
6.8
4.8
6.5
5.0
5.7
8.3
7.8
5.0
5.7
5.8
9.7
5.1
7.9
6.0
5.9
5.8
5.9
4.9
5.9
4.6
5.0
8.2
Figure 2. CPI Forecasts (Growth Rate in Percent)
2007 CPI Forecasts
Current
Previous
Asia-Pacific
Asian NIEs
SEA-4
Bangladesh*
China
Hong Kong
India**
Indonesia
Malaysia
Philippines
Singapore
South Korea
Sri Lanka
Taiwan
Thailand
Vietnam
4.2
2.3
4.0
7.5
4.8
2.0
4.5
6.4
2.0
2.8
2.1
2.5
16.0
1.8
2.3
8.3
4.2
2.3
4.0
7.5
4.8
2.0
4.5
6.4
2.0
2.8
2.1
2.5
16.0
1.8
2.3
8.3
Current
4.6
3.3
4.7
6.5
5.0
3.7
4.3
6.7
2.8
3.9
5.0
3.3
12.0
2.3
3.5
8.8
2008 CPI Forecasts
Previous
Consensus
4.5
3.2
4.7
6.5
5.0
3.7
4.3
6.7
2.8
3.9
5.0
3.2
12.0
2.3
3.5
8.1
4.6
3.1
4.7
8.6
4.5
3.6
6.0
6.9
2.9
3.7
4.1
3.1
13.4
2.2
3.3
10.1
Current
3.9
2.6
4.6
6.5
4.0
4.8
4.0
6.9
2.6
3.5
2.6
2.5
9.0
1.8
2.8
7.0
2009 CPI Forecasts
Previous
Consensus
3.9
2.6
4.6
6.5
4.0
4.8
4.0
6.9
2.6
3.5
2.6
2.5
9.0
1.8
2.8
7.0
3.9
2.7
4.4
6.9
3.5
3.6
5.7
6.8
2.8
3.5
2.4
2.8
9.8
2.0
2.6
7.7
Figure 3. Current Account Forecasts (Percent of GDP)
2007 CAB Forecasts
Current
Previous
Asia-Pacific
Asian NIEs
SEA-4
Bangladesh*
China
Hong Kong
India**
Indonesia
Malaysia
Philippines
Singapore
South Korea
Sri Lanka
Taiwan
Thailand
Vietnam
6.8
6.3
9.0
1.2
10.8
11.3
-1.2
2.0
15.0
3.7
29.2
0.6
-2.8
8.3
6.1
-9.0
6.8
5.8
8.6
1.2
10.8
11.6
-1.3
2.0
15.0
3.7
29.2
0.5
-4.1
7.1
5.2
-3.9
Current
5.3
4.7
4.8
-0.1
8.8
9.1
-1.9
1.4
12.5
3.3
26.0
-1.3
-3.1
7.2
5.5
-8.5
2008 CAB Forecasts
Previous
Consensus
5.6
5.2
4.8
-0.1
8.8
9.3
-1.7
1.4
12.5
3.3
26.0
0.4
-3.0
6.5
5.4
-3.6
7.2
6.5
5.2
0.2
11.9
11.1
-1.4
2.2
14.4
4.2
30.0
-0.1
-5.7
6.4
4.6
-6.9
Current
4.4
4.4
4.3
-1.1
7.0
7.0
-1.8
0.8
12.0
2.8
25.0
-0.6
-2.7
6.2
5.4
-5.0
2009 CAB Forecasts
Previous
Consensus
4.6
4.8
4.3
-1.1
7.0
7.3
-1.4
0.8
12.0
2.8
25.0
0.2
-2.9
6.2
5.1
-3.0
6.8
6.5
4.7
-0.1
11.0
11.3
-1.5
1.9
13.8
4.3
29.2
-0.1
-4.7
6.1
3.6
-5.5
Note: Asian NIEs are Hong Kong, Korea, Singapore, and Taiwan. SEA-4 includes Indonesia, Malaysia, the Philippines and Thailand. Asia-Pacific is
Asian NIEs + SEA-4 + China + India, GDP-weighted.
*Bangladesh Fiscal year runs for July-June. **India Fiscal year runs from April-March and inflation data are Wholesale Price Index forecasts
Source: CEIC Data Company Limited, Consensus Economics (11 Feb 08) and Citi estimates.
2
Asia Economic Outlook and Strategy — Growth and Inflation Risks
29 February 2008
Global Economic Outlook
With tight financial conditions reinforcing economic weakness in the U.S., the
Fed has taken a more aggressive tack, with only limited impact thus far. We
look for cuts in the funds rate to 2% by midyear. Growth in the Euro Area has
slowed to a subtrend pace. Inflation remains high but should moderate quickly.
We expect the ECB to ease policy modestly later this year. We expect only a
modest slowdown in emerging economies. Inflation worries in emerging
markets are probably overblown but they will reduce the scope for monetary
loosening in the short run.
Strong Asian Growth
Strong Asian growth will probably continue on greater policy flexibility created
by improving macroeconomic fundamentals, despite slowing growth in the U.S.
While exports are likely to slow significantly, investment could become a
countercyclical force. Certain consumer spending items, such as those
associated with commodity and food revenue, might stay resilient. Food
inflation should remain a challenge for policymaking, although overall inflation
pressures are likely to ease as growth moderates. Capital inflows to Asia could
increase due to the region’s robust fundamentals and resilient growth. Asian
currencies, especially the renminbi, peso and rupee, will probably lead the next
leg of U.S. dollar weakness.
Food Inflation
Soaring food prices are becoming a major policy issue and risk in 2008. Social
unrest has previously erupted in China and India because of high food prices.
Asian governments are responding with price controls and trade measures, some
of which are protectionist. Elections in India, Indonesia and Malaysia could
mean food measures will stay for longer and be cast wider as governments
avoid risking a backlash. If food inflation persists, Asian central banks might
not be able to relax monetary policy despite slowing external demand. Thailand,
India, Indonesia and Malaysia are net agricultural exporters and could benefit.
Equity Strategy: Are We There Yet? No
Our regional equity strategist Markus Rosgen thinks Asian equity markets have
not priced in a recession and downside earnings risks and above-average P/BV
leave markets vulnerable. Our favorite markets continue to be Hong Kong (and
we mean Hong Kong not China), Korea and Taiwan (both cyclicals and priced
as such) and Malaysia. We are underweight all the others. In terms of sectors,
we like telecoms (cash flow, visibility and yield), ditto for the utilities, and
finally the banks (cheap, low expectations and yield). We are neutral consumers
(they are expensive). Biggest underweights: real estate, industrials, cyclicals
and technology.
3
Asia Economic Outlook and Strategy — Growth and Inflation Risks
29 February 2008
Contents
Citi Key Economic Forecasts
2
Macro Overview
5
Global Economic Outlook .......................................................................................................................... 5
Growth and Inflation in Asia ...................................................................................................................... 7
Surging Food Prices: Blessing or Curse?
13
Strategy — Asian Currencies and Interest Rates
21
Strategy — Asian Equities: Are We There Yet? No
23
Investor Checklist & Asian Chart Summary
29
Asia Investor Checklist ............................................................................................................................. 30
Asia Chart Summary................................................................................................................................. 32
Citi Asia Monetary Conditions Index ....................................................................................................... 33
Long Term Forecasts
35
Selected Country Focus
37
China: Renewed Inflation Challenge ........................................................................................................ 38
Philippines: Tightening Financial Markets amid Increased Risk Aversion and Political Noise ............... 41
Singapore: A More Challenging Year Ahead ........................................................................................... 44
Taiwan: Expecting More Capital Inflows ................................................................................................. 47
Other Country Section
51
Bangladesh................................................................................................................................................ 52
Hong Kong................................................................................................................................................ 54
India .......................................................................................................................................................... 56
Indonesia................................................................................................................................................... 58
Korea......................................................................................................................................................... 60
Malaysia.................................................................................................................................................... 62
Sri Lanka..............................................................................................................................................
64
Thailand .................................................................................................................................................... 66
Vietnam..................................................................................................................................................... 68
4
29 February 2008
Asia Economic Outlook and Strategy — Growth and Inflation Risks
Macro Overview
➤
Aggressive Fed easing and other policy measures should help
support the U.S. economy, but a sustained pickup in growth depends
on improved financial conditions
➤
Asia is likely to maintain strong growth on greater policy flexibility.
Investment could be a countercyclical force while consumption items
associated with commodity and food revenue could stay resilient
➤
Food inflation already complicates macroeconomic policymaking in
the region, but overall inflation rates could moderate in the coming
months as growth slows
➤
Liquidity inflows to Asia could increase due to robust fundamentals
and resilient growth, and Asian currencies will probably lead the next
leg of U.S. dollar weakness
Global Economic Outlook1
Lewis Alexander
1-212-816-9882
lewis.alexander
@citi.com
The recent deterioration in financial conditions is having its biggest impact on the
U.S. economy. Europe is also slowing, but the spillover to most emerging economies
remains modest so far. Looking ahead, we expect a variety of factors — including
the waning of the drag from residential construction, fiscal stimulus, and improving
financial conditions driven by a more assertive Fed — to contribute to a modest
recovery in U.S. growth starting in the second half of the year.
The forces restraining the pace of U.S. economic activity have shown few signs of
easing in recent weeks. Incoming data from the housing sector point to ongoing
contraction. The prevailing mix of credit, equity, and other asset prices continues to
be a significant headwind for aggregate demand (see Figure 4). Consumption
indicators suggest that household spending has slowed markedly.
The U.S. slowdown is a drag on the Canadian and Mexican economies, and
economic activity in the United Kingdom and the euro area is also slowing, but less
sharply than in the United States.
However, most other countries still show few signs of being adversely affected by
the U.S.-led slowdown. Recent data for China point to a strong start to 2008, while
resilient demand for commodities is supporting many emerging economies and
smaller high-income countries with a comparative advantage in commodity
production. The underperformance of the U.S. economy relative to most other major
economies is contributing to downward pressure on the U.S. dollar (see Figure 5).
This pattern may change in coming quarters. The U.S. slowdown is spreading
beyond residential construction. A broader and deeper slowdown in U.S.
1
This is a summary of the focus piece “Overview: The United States and World Economic Outlook” in Global Economic Outlook
and Strategy, February 28, 2008.
5
29 February 2008
Asia Economic Outlook and Strategy — Growth and Inflation Risks
consumption and investment should generate a more significant slowdown in imports
that will serve to moderate growth in the rest of the world.
Policy flexibility around the world is likely to play an important role in containing
the global slowdown. Unlike the past, many emerging economies (such as Brazil,
Mexico, and Korea) have strong public and private balance sheets, and they have
established strong records of pursuing stable macroeconomic policies. This should
make it possible for these countries to ease policy, if needed, even in the midst of
substantial turmoil in global financial markets.
Figure 5. United States and Other Major Industrial Countries —
Economic Surprises (100=1 Standard Deviation), Jan 07-27 Feb 08
Figure 4. United States — Citi Financial Conditions Index (Standard
Deviations) and the Output Gap (Percent of GDP), 1988-Jan 08
3
3σ
6
6%
100
100
2
4
75
75
1
2
50
50
0
0
25
25
-1
-2
0
0
-2
-4
-3
1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008
FCI (Left)
GDP Gap (Right)
-6
-25
-50
Note: Shaded regions denote recession. Sources: Bureau of Economic Analysis, Congressional
Budget Office and Citi.
-75
Jan-07
-25
United States
Other Major Economies
Apr-07
Jul-07
-50
Oct-07
Jan-08
-75
Apr-08
Note: Citi Economic Surprise Indexes are weighted averages of the difference between
individual data releases and the consensus forecast. “Other Industrial Countries” includes the
euro area, Japan, Great Britain, Australia, and Canada. Source: Citi.
Strong commodity prices and declining output gaps in some countries are putting
upward pressure on inflation. Nonetheless, we expect the slowdown in the United
States and Western Europe to contain inflation in those countries, and slowing export
growth should help to contain inflationary pressures in other key countries such as
China.
The evolution of financial conditions remains a key source of uncertainty. In recent
days, credit, equity, and other financial markets seem to have found a footing in
response to the significant shift in Federal Reserve policy in late January, the U.S.
fiscal stimulus package, and other policy measures intended to address some of the
stress points in the financial system. However, even if financial markets stabilize and
improve from here, the cumulative impact of the financial turmoil of the last six
months is likely to be a drag on the U.S. and global economy for many months.
Moreover, given the still considerable uncertainty about the magnitude and
distribution of losses in the financial system, we cannot be confident that we have
seen the worst in financial markets.
6
29 February 2008
Asia Economic Outlook and Strategy — Growth and Inflation Risks
Growth and Inflation in Asia
Yiping Huang
(852) 2501-2735
yiping.huang
@citi.com
Distinguishing “Decoupling” and “Resilience”
Will Asian economies continue strong growth in 2008? Our answer is affirmative.
Real GDP growth in emerging Asia is likely to average 8.2% this year, despite recent
downward revisions. China, India and Vietnam will probably continue to be growth
leaders in the region.
But the expected slowdown in the U.S. and robust growth in emerging Asia should
not be taken as evidence of “decoupling” between the two regions. The reason Asia
might maintain strong growth, in our view, is not because Asia will not be affected
by a slowing U.S. economy. Instead, improving macroeconomic fundamentals
during the past decade, reflected by debt burdens, current accounts, fiscal balances
and foreign reserves, have provided Asian authorities with greater policy flexibility
to cope with weakening external demand.
Figure 6. Improving Macro Fundamentals in Emerging Asia
40
Asia External Debt, Fiscal Balance, Current Account and Foreign Reserves
(Share of GDP, 1996 vs. 2007)
% of GDP
35
30
25
20
15
10
5
0
-5
1996
2007
External Debt
1996
2007
Fiscal Balance
1996
2007
Current Account
1996
2007
FX Reserves
Note: Asia includes China, India, Indonesia, Malaysia, Philippines, South Korea, Taiwan and Thailand (Weighted by Nominal GDP)
Source: CEIC Data Company, Institute of International Finance and Citi estimates.
In January, when our economists in New York lowered their U.S. growth forecast by
0.7ppt to 1.5% for 2008, the Asian economics team revised down regional growth
forecasts by an average of 0.4ppt. These imply elasticity of Asian growth with
respect to the U.S. growth at 0.5. Our earlier simulation applying the Oxford
Macroeconomic Forecasting model estimated an average elasticity of 1.0. The gap
between 0.5 and 1.0 can probably be explained by policy responses, such as
expansionary fiscal policy to boost domestic investment.
Even though headline growth forecasts might look very similar, it is important to
distinguish between the “decoupling” scenario and the “resilience” scenario. In a
7
29 February 2008
Asia Economic Outlook and Strategy — Growth and Inflation Risks
decoupling scenario, we should expect business as usual, while in a resilience
scenario, we should expect significant structural changes and major profitability
adjustments. Differentiating between the two scenarios would have important
implications for investment strategies.
Short Exports, Long Investment
We concur with the consensus view that investors should stay away from exportrelated activities when risks of U.S. recession increase. However, the question is if
investors should focus more on consumption or investment. During the past weeks,
domestic consumption became a popular investment theme. Some investors have
even argued that Chinese and Indian consumers might be able to pick up the slack of
weakening U.S. consumption.
After all, in open economies, like Asia, households derive significant portions of
their income from the export sector, directly or indirectly. We recommend a more
selective approach toward consumption. Statistical analyses, for instance, revealed a
positive correlation between consumption in China and the U.S. A 1ppt slowdown in
U.S. real consumer spending normally drags down growth of Chinese consumption
by 0.3ppt (see Figure 7).
Figure 7. Regressing Chinese Consumption and Investment on U.S. Consumer Spending
Constant
Real Growth of Chinese
Consumption
10.19*
(0.40)
Growth of U.S. Consumption (6 Months Lag)
WTO Dummy * Growth of U.S. Consumption (6 Months Lag)
East Asian Financial Crisis Dummy (Jan 98-Dec 99)
WTO Dummy (Jan 02-Nov 07)
Adjusted R-Squared
0.34*
(0.16)
-1.93*
(0.47)
-0.69
(0.52)
0.15
Real Growth of Chinese
Investment
18.96*
(2.02)
-2.10*
(0.49)
6.90*
(2.30)
7.11*
(2.55)
0.31
Note: Number in the parentheses under coefficient estimates are associated standard errors. And those estimates with * are statistically
significant at 5% confidence level. The analyses apply monthly data between 1994 and 2007.
Source: Citi estimates.
But, of course, consumption as a whole should be more resilient than exports. In
particular, consumption in the following three areas could survive better: (1)
consumption in areas and economies that are relatively insulated from the effects of a
U.S. slowdown, such as India and inland provinces of China; (2) consumption that is
driven by commodity revenue; and (3) consumption in rural areas as rural incomes
benefit from soaring food prices across the region.
Only investment, however, could serve as a counter-cyclical force. Statistical
analyses also indicated that a 1ppt slowdown in U.S. consumption has normally led
to acceleration of Chinese investment by 2.1ppts. Obviously, this was not the result
of a business investment decision but rather a result of countercyclical policies.
During the East Asian financial crises in 1998, for instance, Chinese authorities
undertook various measures to boost domestic investment. As a result, while export
growth slumped from 21% in 1997 to 0.5% in 1998, fixed asset investment growth
accelerated from 8.9% to 13.9%.
8
Asia Economic Outlook and Strategy — Growth and Inflation Risks
29 February 2008
Although the Chinese government has been attempting to rebalance the economy by
reducing the pace of investment growth, we expect the government to shift to
expansionary policy once the effects of the U.S. slowdown materialize. Growth is
still the most important economic indicator in China. The government can take steps
in at least three areas to boost domestic investment temporarily: (1) allocating direct
fiscal spending on infrastructure; (2) encouraging the state sector to invest more in
the resource and energy sectors; and (3) relaxing some existing controls such as
credit rationing.
China will not be alone this time (see Figure 8). Singapore already has large ongoing construction projects, including new casinos. The new government in Thailand
is attempting to revive some of the infrastructure projects planned under the former
Thaksin government. The Indonesian government has been pushing for large
investment for years. And the incoming president in Korea is pro-growth. Upcoming
elections in Malaysia, Indonesia and India might also increase the probability of
policy stimulus. In general, however, countries with large fiscal deficits would be
more constrained in making policy responses.
Figure 8. Likely Policy Measures to Boost Investment
Country
China
Fiscal Balance in 2007
(% of GDP)
-1.8 (forecast)
Hong Kong
Possible Policy Measures to Boost Investment in the Face of a U.S. Recession
(1) Some relaxation of credit controls; (2) more government spending on social security, healthcare and
infrastructure; and (3) slowing the pace of currency appreciation
7.2
The 2008-08 budget allocates HK$21.8bn for infrastructure projects that would create 27,000 jobs. Tax incentives
are also being provided for private firms to invest in environmentally friendly equipment and vehicles
India
-6.0 (forecast)
Given that the government is bound under fiscal responsibility legislation (FRBM) to meet targets, fiscal stimuli will
likely be limited. However, rural and urban infrastructure projects, which are a significant portion of budgeted
outlays, would help support investment activity
Indonesia
-1.3 (forecast)
Higher fiscal deficit (2008E: 4.2% of GDP) could play a leading role in promoting growth, particularly if spending
goes into infrastructure. The government plans to reallocate some of the budgeted spending for goods and official
travel into higher capital and social spending in 2008. Relaxation of some bank lending regulations would also help
support growth
2.0 (forecast)
Effective balance
(excludes social security
accounts) =
-1.0%
BOK rate cut and small-scale tax cuts (with a supplementary budget) would be short-term measures. Mid- to longterm measures include deregulation of corporate investment, deregulation of the housing market, a gradual
reduction in corporate income taxes and infrastructure projects such as the Grand Canal
Korea
Malaysia
-3.1% (forecast)
Accelerated implementation of the Ninth Malaysia Plan and Growth Corridor Projects are likely. Upcoming UMNO
internal party elections in mid-2008 could sustain fiscal pump-priming even after the general elections
Philippines
-0.1
Arroyo plans to front load the infrastructure program totaling Php200bn this year as a fiscal hedge against offshore
downside risk. Government asset sales. such as the privatization of state-owned power assets, can re-energize
private investment as well as generate revenue for the government. In a recent BSP survey, business sector
respondents in the construction and power sectors expressed bullish sentiment for 1Q08 despite an imminent global
downturn
Singapore
3.4% (primary fiscal
balance)
The government plans to bring forward the expansion of rail and road networks. A total of S$5bn annually has been
earmarked for spending on land-transport infrastructure until 2020, more than twice the annual spending on all
transport infrastructure over the past two decades. However, the extent of pump-priming might be limited by
capacity constraints in the construction sector
Taiwan
-0.2% (forecast)
Thailand
2.1 (forecast)
We expect liberalized cross-strait relations to boost domestic investment
Within the next 12 months, construction of a few rail transit lines to Bangkok can provide an investment boost. Stateowned enterprises will also pursue investment plans. Removal of exchange restrictions, such as the 30%
unremunerated deposits, and abolition of the revised Foreign Business Act can go a long way toward enhancing
foreign investment
Source: Citi estimates.
9
29 February 2008
Asia Economic Outlook and Strategy — Growth and Inflation Risks
As a result, economic growth in Asia could become even more driven by investment.
This implies that the commodity intensity of Asian economies could actually rise.
This should provide relatively better support for commodity markets where Chinese
or Asian demand already plays dominant roles. Iron ore, steel, copper, zinc, nickel,
coal and aluminum are some examples (see Figure 9).
Figure 9. China’s Shares of Global Commodity Consumption, 2006 (%)
Population
21
GDP
4
Crude Oil
8
Gold
8
Steel
37
Iron Ore
53
Zinc
30
Nickel
20
Copper
23
Aluminium
36
Alumina
26
0
10
20
30
40
50
%
60
Source: Citi Investment Research.
Inflation Challenges
High inflation rates could be a serious constraint for the expected expansionary
policy. While Asian governments attach great importance to growth, inflation is
probably equally important. Inflation and corruption were the two main problems
that caused the Tiananmen Square incident almost 20 years ago in China. We also
note that high food prices recently generated social tension in Indonesia, Malaysia
and Vietnam.
Inflation readings in China, Indonesia, Singapore, Taiwan and Vietnam have
exceeded their official targets or forecasts for several months. Monetary policies are
already tightening in China, Taiwan and Vietnam.
10
29 February 2008
Asia Economic Outlook and Strategy — Growth and Inflation Risks
Figure 10. Inflation Targeting in Asia
Government Target or
Forecast for 2008 (%)
Most recent
3-months prior
Citigroup CPI
Forecast, 2008
(%YoY)
3.0-3.5
Below 4.8%
7.1 (Jan-08)
6.5
5.0
1.5
5.0
3.4 (headline)
4.5 (underlying)
4.0-4.5
3.29 (Jan-08)
3.93** (Jan-08)
3.21
3.11**
3.7
4.3**
Actual Core/Headline CPI (% yoy)
Economy
Targeted Price Index
China
No official inflation
targeting policy
Hong Kong
India
No official inflation
targeting policy
WPI
2007
Indonesia
CPI
Korea
Headline CPI
Malaysia
No official inflation
targeting policy
2.8
Philippines
CPI
5-6
0-1
4.5-5.5
Singapore
Taiwan
Thailand
Vietnam
No official inflation
targeting policy
No official inflation
targeting policy
Core CPI (ex. ag and oil)
No official inflation
targeting policy
5.5-8.6
4.0-6.0 (BI)
7.36 (Jan-08)
6.88
6.7
2.5 to 3.5 (BOK)
2.5-3.5% (BOK)
3.89 (Jan-08)
3.0
3.3
2.0-2.5
2.28 (Jan-08)
1.92
2.8
4.0-5.0
4.86 (Jan-08)
2.7
3.9
6.64 (Jan-08)
3.65
5
2.0
2.0
3.34 (Dec-07)
3.1
2.3
4-4.5
1.0-2.0
1.24* (Jan-08)
1.05*
3.5
6.5
8.5-9.0
15.66 (Feb-08)
10.0
8.8
Source: Citi.
We think chances of stagflation in Asia are still remote. The expected slowdown in
exports is likely to ease inflation pressure, as a result of rising overcapacity risk. In
China, for instance, export growth slumped twice during the past decade, once in
1998 and again in 2001. Both times were followed by deflation (see Figure 11).
Thus, inflation rates could moderate in Asia from the second quarter, especially as
the special holiday effects fade while the base effect kicks in.
Figure 11. Export Growth and CPI Inflation in China, 1997-2007 (%)
6
40
5
35
4
30
3
25
2
20
1
15
0
10
-1
5
-2
0
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
CPI (LHS)
Exports (RHS)
Source: CEIC Data Company and Citi estimates.
11
29 February 2008
Asia Economic Outlook and Strategy — Growth and Inflation Risks
There are many factors supporting the case that the latest food inflation might be
structural. These factors include: (1) demand expansion associated with strong
income growth; (2) decline of agricultural resources as a result of urbanization and
2
industrialization; and (3) deterioration of the global climate. We are not overly
pessimistic about the long-term outlook for food inflation, as supply normally would
respond to strong demand. But food prices could stay at relatively high levels in the
coming months. This could complicate macroeconomic policymaking in the region.
Market Implications
Liquidity conditions are another important factor, alongside macroeconomic
momentum and policy, that could shape the outlook for Asian financial markets.
Despite the recent credit crunch in the U.S. and Europe, we expect the relatively
abundant liquidity conditions in Asia to continue in 2008. This implies that, with a
slowing U.S. economy, depreciating U.S. dollar and falling U.S. interest rates,
liquidity flows to emerging market economies might increase this year. Emerging
Asia, due to its robust fundamentals and resilient growth, stands to benefit from more
capital inflows.
Emerging Asian currencies, especially the renminbi, peso and rupee, are likely to
lead the next leg of U.S. dollar weakness. High inflation provides another reason for
faster currency appreciation in the region. However, market participants who expect
12-15% renminbi appreciation might be too aggressive. While we agree that the
general case for currency appreciation holds, slowing export growth could make
every central banker cautious about exchange rate policies. We cannot rule out the
possibility of erratic capital account control measures in the face of strong inflows.
Asian interest rates are likely to fall, along with the U.S. Fed funds rate, as long as
inflation does not pose a challenge. Rates have already dropped significantly in Hong
Kong and Singapore. Central banks in Thailand, the Philippines and Korea are likely
to cut. Indonesia could introduce effective easing by switching the target instrument
from the one-month rate to the overnight rate.
Equity markets are already expensive generally, and earnings disappointments could
become a constant theme in 2008. But we remain upbeat about certain markets,
especially where valuations are not particularly high and activities are more insulated
from an export slowdown. We think investment, commodities and rural consumption
should do relatively better.
Across the region, China could continue above-10% growth, due to strong
macroeconomic fundamentals. India is probably best protected from an export
slowdown. Indonesia, Malaysia, Thailand and Vietnam might also benefit from
relatively more resilient commodity and food markets. Korea could potentially
benefit from some pro-growth measures once the new president begins to dictate
economic policies. Taiwan and Thailand are already in the middle of macroeconomic
turnarounds associated with elections.
2
12
See Hak Bin’s food inflation piece included in this report.
29 February 2008
Asia Economic Outlook and Strategy — Growth and Inflation Risks
Surging Food Prices: Blessing or
Curse?
Hak Bin Chua
+65-6432-2057
hak.bin.chua@citi.com
➤ Soaring food prices are becoming a major policy issue and risk in
2008. Asian governments are responding with price controls and a
mixed bag of trade measures, some of which are protectionist and
some trade enhancing
➤ If food inflation persists, Asian central banks will be less likely to
shift to a more accommodative monetary policy, despite slowing
external demand
➤ Thailand, India, Indonesia and Malaysia are net agricultural
exporters, at more than 4% of exports, and should benefit.
Agriculture accounts for more than one third of employment in the
Philippines, Indonesia, China, India, Vietnam and Thailand
➤ High food prices lift rural incomes and decentralize power from the
urban center. Income distribution might improve if government
policies allow high agricultural prices to filter down to farmers
➤ High food inflation is, however, politically explosive and could stir
social unrest. Riots have previously broken out in China and India
because of high food prices, and some recently occurred, on a smallscale, in Vietnam, Indonesia, Malaysia and Pakistan
➤ Food inflation and elections produce a combustible mix, with
elections slated in Malaysia, Indonesia, China and India over 2008-09.
Food measures, including controls and subsidies, will likely stay for
longer and be cast wider as governments avoid risking a backlash at
the polls
Soaring food prices are becoming a major policy issue and risk for Asia this year.
What had been hoped to be just temporary is turning out to be a more structural
phenomenon. Two major trends – rising affluence in emerging economies,
particularly China and India, and growing use of food crops for biofuels – are driving
up global food demand and prices. Climate change is also making food supply more
volatile.
The global population will rise to 9.2 billion by 2050 from 6.5 billion in 2005,
according to the United Nations, and will increase pressure on global food supplies.
These pressures are sharply accentuated by increasing demand in developing
countries, such as China and India, for protein-rich foods, which require more grain
and water to produce. Annual per capita consumption of meat in China, for example,
quadrupled from 10 kilograms in 1950 to 40 kilograms today.
The use of crops to produce biofuels is also impacting food security. Government
policies to reduce carbon emissions and dependence on imported energy are,
13
Asia Economic Outlook and Strategy — Growth and Inflation Risks
29 February 2008
somewhat ironically, driving food prices higher. Biofuels might consume up to 30%
of the U.S. corn crop by 2010.
On the supply side, climate change is increasing the volatility of weather and rainfall
patterns. This vulnerability is being exacerbated by a sharp fall in arable farmland
3
per head of global population by half over the last 50 years.
Figure 13. Food Is Driving Up Inflation in China
Figure 12. Food Inflation in China, Vietnam and Indonesia
25.0
% YoY
20
% YoY
18
20.0
16
14
15.0
12
10
10.0
8
6
5.0
4
0.0
2
0
-5.0
-2
-4
-10.0
-15.0
Jan-04
-6
Jan-00
Jan-05
Jan-06
China
Indonesia
Jan-07
Vietnam
Jan-01
Jan-02
Jan-03
Jan-04
Jan-05
Jan-06
Jan-07
Jan-08
CPI: Food
CPI: ex-Food
CPI
Source: CEIC Data Company Limited, and Citi estimates.
Whether food production will respond quickly enough to meet rising demand and
tame food prices is not clear. However, for now, food prices are continuing their
upward trend. This will have a major economic and political impact in Asia, with
implications for policy, growth and income distribution.
Food CPI inflation in China climbed to 16.7% in December and is likely to pick up
sharply early this year given exceptionally cold weather. Prices of seasonal
agricultural products rose by more than 10% in January, with the wholesale price of
vegetables rising 50.6% (see Figure 13).
Food CPI in Vietnam rose 22% in January, driving overall inflation to 14%. In
Indonesia, food CPI inflation climbed to 11.4%, as the cost of imported soybeans,
wheat and other food products surged. Bank Indonesia recently raised its 2008
inflation forecast to 6 – 6.5% versus 4 – 6% previously.
Food CPI inflation is a major driver of overall headline inflation because of the large
weight in the CPI basket for a number of countries. Food accounts for more than
40% of the CPI household baskets in Vietnam and Indonesia, and more than 25% in
China and Thailand (see Figure 14). Persistently high food inflation could keep
overall headline CPI inflation elevated, despite easing pressure from slowing
external demand.
3
For a fuller discussion, see World Economic Forum, Global Risks 2008, January 2008, and The Economist, Cheap No More, 6
December 2008.
14
29 February 2008
Asia Economic Outlook and Strategy — Growth and Inflation Risks
Figure 14. Share of Food in Headline CPI Inflation across Asia Ex-Japan
45
%
40
35
30
25
20
15
10
5
0
VN
ID
CH
TH
MY
TW
IN
HK
KR
Source: Citi estimates, CEIC Data Company Limited.
Asian central banks might be reluctant to shift to a more accommodative monetary
policy, despite slowing external demand, if food inflation persists. The Philippines’
central bank, for example, did not cut policy rates in its February meeting, as
inflation picks up. Consumer prices climbed 4.9% in January, the fastest pace in 15
months.
Thailand’s CPI inflation rose to 4.3% in January, the fastest in 18 months, as food
prices surge 4.8%. The Bank of Thailand’s hands look tied despite lackluster
domestic demand. In Singapore, the Monetary Authority of Singapore will likely
have to maintain its steeper currency appreciation bias despite an economic
contraction in the fourth quarter of last year, as CPI inflation might hit 7% in
February or March.
Food inflation can also be a major driver of social unrest and political instability with
consequences that can be politically damaging. Asset inflation makes the rich richer
and can be tolerated, but food inflation makes the poor poorer and is not likely to be
tolerated.
Mass protests in China in 1989, for example, were preceded by widespread food
inflation. In India, the onion crisis of 1998 is a well-known instance of how high
onion prices led to the BJP government losing in elections. Food riots erupted in
West Bengal in India in October 2007 as a result of disputes over food rationing.
More recently, there have been small-scale riots and anti-inflation protests breaking
out in Indonesia, Vietnam, Malaysia and Pakistan.
Asian governments are already making large policy shifts given increasing concern
over food security and surging food prices (see Figure 15). Measures tackling food
inflation are largely occurring in China, India and Southeast Asia. The more affluent
Asian economies – Singapore, Hong Kong, Taiwan and Korea – have largely
abstained from intervening.
15
29 February 2008
Asia Economic Outlook and Strategy — Growth and Inflation Risks
Figure 15. Surging Food Costs and Policy Responses across Asia
Country & Inflation
(Latest Month)
Food Prices
Food Policy Responses
China
Food CPI (+18.2%)
CPI (+7.1%)
In the past year: pork (+60%), soybean oil (+58%), The government cut import taxes and raised export taxes on grain and flour in late
December. Imposed temporary price controls on necessities such as grain and
mutton (+51%,) vegetables (+50%), cooking oil
meat. Permission required for price increases of grain products, edible oil, pork,
(+35%)
beef, mutton, milk, eggs and liquefied petroleum gas
Indonesia
Food CPI (+11.4%)
CPI (+7.4%)
Steep rises in soybean products and tofu. Since
December: Cooking oil (+36%), tempeh
(fermented bean curd) (+33%), tofu (+20%),
wheat flour (+9%), rice (+7%)
Measures have been introduced to stabilize prices and supplies of rice, cooking oil,
soybeans and wheat by raising export taxes and allocating subsidized rice to more
poor families
Malaysia
Food CPI (+3.8%)
CPI (+2.3%)
Up to 50% increases in staples, including wheat
flour (+56%), bread (+47%), biscuits (+12%), milk
formula (+3%). Shortages have emerged for
cooking oil
A National Price Council has been established to stabilize prices and ensure
sufficient supplies of essential goods through a national stockpile. This comes on
top of existing subsidies for water, electricity, fuel and food, especially rice and
sugar. Already, about 9% of the CPI basket is subject to price controls, most of
which are food items. Banned shipments of subsidized goods, including wheat,
sugar, cooking oil and diesel
Vietnam
Food CPI (+22.0%)
CPI (+14.1%)
Some worker strikes. In the past year: vegetables
(+50%), meat (+40%), fish (+25%), fertilizer
(+25-70%), milk (+20%), rice (+20%)
Officials implemented price controls on essential products such as cooking gas,
petrol, coal, fertilizer, rice, milk and sugar. But authorities often fail to keep prices
within recommended ranges
Thailand
Food CPI (+4.8%)
CPI (+4.3%)
In the past three months: palm oil (+56%), pickled
fish (+38%), coconut (+25%), noodles (+13%)
There has been an increase in the number of food items under price controls.
Thailand has, however, been reducing subsidies for fuel and cooking oil in recent
years
Singapore
Food CPI (+5.8%)
CPI (+6.6%)
Cooking oil (+18.3%), dairy products and eggs
(+12.7%), meat and poultry (+12.2%)
The government stated that it has no plans to introduce price controls, citing the
costs arising from shortages and hoarding. Instead, more subsidies will be
directed to the low-income group
Philippines
Food CPI (+6.2%)
CPI (+4.9%)
Fruit and vegetables (+10.5%), dairy products
(+9.8%), eggs (+8.2%), rice (+7.5%)
The government has regulated rice prices for low-end varieties.
Other components of the food basket, including meat products and
dairy products, are not subject to controls
India
Primary Products WPI
(+4.4%), Food (+3.0%);
Food CPI (+7%),
CPI (+5.5%)
Over the past year, the government has been managing prices of many food
In the past year, milk (+10.2%), beverages and
tobacco (+9.9%), edible oil (+8.9%), manufactured products. Wheat and rice are two staple commodities that come under the Public
Distribution System. The government procures food grains via the Food
food (+5.6%), cereals (+3.5%), rice (+6.8%)
Corporation of India at minimum support prices. Other commodities with regulated
prices (or through export bans) include onions, skimmed milk powder and sugar
Taiwan
Food CPI (+5.3%)
CPI (+3.0%)
In the past year: vegetables (+9.5%), fish and
shellfish (+6.2%), meat (+3.3%), food away from
home (+2.5%)
Price controls have been minimal for food and cover only rice. There are other
official price controls on water, electricity, gas supply and transport fares
Korea
Food CPI (+2.9%)
CPI (+3.9%)
In the past year: wheat flour (+67%), eggs
(+22%), chicken (+16%), tofu (11%), cooking oil
(+11%), ramen (+8%), rice (+3%)
There are no official price controls on food items, and there have not been any
policy responses on food prices yet. Note that rice, the major grain in Korea, is
heavily protected from the international market
Hong Kong
Food CPI (+8.8%)
CPI (+3.3%)
In the past year: pork (+43%), beef (+39%), tinned There are no price controls on food items
meat (+34%), eggs (+22%), poultry (+18%),
edible oil (+16%), rice (+11%)
Source: Citi estimates, media and company reports.
China removed import taxes, raised export taxes and imposed export quotas on grain
and flour in late December. Large producers of some food products – including
dairy, pork, mutton and eggs – must now seek government approval before raising
prices. Wholesalers and retailers of such food products do not have to seek
permission to raise prices, but they must notify the government when prices cross
certain thresholds.
Malaysia recently established a National Price Council to stabilize prices and ensure
sufficient supplies of essential goods through a national stockpile. This comes on top
of existing subsidies for water, electricity, fuel and food items such as rice and sugar.
About 9% of the CPI basket is subject to price controls, most of which are food
16
29 February 2008
Asia Economic Outlook and Strategy — Growth and Inflation Risks
items. Malaysia has also banned overseas shipments of subsidized goods, including
wheat, sugar, cooking oil and diesel.
Indonesia introduced measures on a number of key food items, including rice,
cooking oil, soybeans and wheat flour (see Figure 16). Some of the measures are
trade-enhancing, including the cutting or abolishing of import tariffs for rice,
soybeans and wheat flour. Others, however, are more protectionist, including higher
export taxes on palm oil. Subsidies have also been increased for rice for poor
households.
In Thailand, the Ministry of Commerce postponed indefinitely price adjustments for
regulated items covering 300 to 400 basic foodstuffs that had earlier been scheduled
for January. The Commerce Minister under the new Samak government is also
considering potential price freezes on up to 30 consumer products, including cooking
oil, rice, instant noodles, dairy products, pork, soap, detergent, toothpaste and
batteries.
In the Philippines, there are no direct price controls although the government is
providing price subsidies for low-end rice that it distributes and makes available to
the retail market.
In Vietnam, the government reduced tariffs on dairy products and animal seeds. It
also instructed firms to speed up production and is keeping a check on price
manipulation, but it has met little success. The Ministry of Finance has proposed
setting a ceiling on selected items, including food items such as fertilizer, sugar cane
and rice, but the proposals have not been implemented explicitly.
The impact of these food policies on overall trade is unclear. Cutting import tariffs
(Thailand, China and India) is trade enhancing. Imposing export taxes and quotas
(Indonesia, China) reduces trade and agricultural exports. The lack of coordination
between countries on such policies can lead to sub-optimal outcomes, with individual
country priorities over food security and domestic food prices taking precedence
over the potential impact on global prices and supply.
Policies that influence food import demand might have a disproportionately large
impact on global prices because, unlike many other hard commodities, the
international food trade is a relatively small part of global food production. Food
trade accounts for only about 15% of global food production versus 25% for
manufacturing.
Small adjustments in food policies, in China in particular with a population of 1.3
billion, could significantly impact soft commodity prices and global food inflation.
Food currently accounts for only a small fraction of China’s trade volume, or about
2.5% of China’s total exports. Food is largely produced and consumed by the
domestic market. Food policies that translate into significantly higher import demand
(tariff cuts) or lower export supply (export taxes or quotas) might produce large
swings in global food prices as a result.
17
29 February 2008
Asia Economic Outlook and Strategy — Growth and Inflation Risks
Figure 16. Indonesia’s Policy to Tackle Food Inflation
Commodity
Rice
Business Sector
Import tariffs down from Rp550 to Rp450
Cooking oil (palm
oil based)
a. Continue with progressive export tax
policies for palm oil and its derivatives
b. Export tax of CPO is raised to 15% when
global CPO price rises above US$1,100 per
ton
c. Export tax for CPO-based biofuel to be
raised progressively
d. Continue with a policy to take over the VAT
on domestic production and sale of
cooking oil
a. No more import tariffs
b. Income tax on imports down to 0.5% from
2.5%
a. Abolish import tariffs
Soybeans
Wheat flour
b. Continue with a policy to take over the VAT
on wheat flour
c. Temporary freeze on standards for the
quality of wheat flour
Other programs
(Poor) Households
Higher volume of subsidized rice for poor
households, up from 10kg to 15kg, at a subsidized
price of Rp1,650 per kg
Open market operation of cooking oil at Rp2,500
per liter
Farmers
Faster distribution of higher
quality paddy seeds to
increase rice production
Increasing production in
2008
a. Facilitating small-to-medium enterprises using
wheat flour to convert from kerosene to using
liquefied petroleum gas as their energy source
b. Pushing for food diversification from wheat flour
to other locally based flour such as potato flour
1. State enterprises are expected to organize
bazaars for poor people for four months
2. State banks are expected to give soft loans with
subsidized interest rates for as much as Rp2
million for every tofu and tempeh peddler. The
target is to cover around 5 million food peddlers
Source: Media reports, government reports.
Politically, food inflation and elections are a combustible mix. Elections are
scheduled for Malaysia, Indonesia, China and India over the next two years. This
will tie the hands of governments. Food policies and subsidies will likely stay for
longer or even be cast wider as a result for fear of a backlash at the polls. Fiscal costs
and problems such as food shortages, hoarding or smuggling might persist as a
result.
Higher agricultural prices will, however, benefit certain Asian countries. Southeast
Asia and India will likely benefit from the favorable terms of trade shock, being
largely net food exporters. Northeast Asia and Sin
Certification and Other Disclosures
E C O N O M I C
M A R K E T
A S I A
&
A N A L Y S I S :
P A C I F I C
Prospects for Financial Markets
Yiping Huang
+852-2501-2735
yiping.huang@citi.com
Hong Kong
Hak Bin Chua
Singapore
Asia Economic Outlook
and Strategy
Growth and Inflation Risks
Asia Economics Team
Beijing
Minggao Shen
➤
Housing adjustment and tight financial conditions
continue to weigh on the U.S. economy, although
aggressive policies should help
➤
While strong growth will probably continue in
Asia, “decoupling” and “resilience” explanations
offer different investment implications
➤
Exports should slow, but investment could be a
countercyclical force. And certain consumption
items could remain resilient
➤
Food inflation complicates macroeconomic
policymaking, although overall inflation pressures
could ease when growth moderates
➤
While Asian currencies will probably lead the next
leg of U.S. dollar weakness, slowing exports
could make central bankers cautious
Shanghai
Ken Peng
Hong Kong
Yiping Huang
Joe Lo
Adrienne Lui
Michael Luk
Patricia Pong
Singapore
Hak Bin Chua
Leon Hiew
Kit Wei Zheng
Mumbai
Rohini Malkani
Anushka Shah
Jakarta
Anton Gunawan
Seoul
Suktae Oh
Morgan Kim
Manila
Jun Trinidad
Taipei
Renee Chen
Cheng Mount Cheng
Tina Liao
Asia Pacific
29 February 2008
29 February 2008
Asia Economic Outlook and Strategy — Growth and Inflation Risks
Citi Key Economic Forecasts
Figure 1. GDP Forecasts (Growth Rate in Percent)
2007 GDP Forecasts
Current
Previous
Asia-Pacific
Asian NIEs
SEA-4
Bangladesh*
China
Hong Kong
India**
Indonesia
Malaysia
Philippines
Singapore
South Korea
Sri Lanka
Taiwan
Thailand
Vietnam
8.8
5.5
6.1
6.2
11.4
6.3
8.7
6.3
6.3
7.3
7.7
4.9
6.7
5.7
4.8
8.5
8.8
5.3
5.9
6.2
11.4
6.1
9.3
6.3
6.0
7.0
7.5
4.8
6.7
5.4
4.6
8.5
Current
2008 GDP Forecasts
Previous
Consensus
8.2
4.8
5.7
6.0
10.5
5.3
8.3
6.2
5.6
6.5
5.6
4.6
6.0
4.5
4.5
8.1
8.3
4.8
5.8
6.0
10.5
5.3
9.1
6.2
5.6
6.5
5.6
4.6
6.0
4.5
4.6
8.1
8.1
4.7
5.6
5.8
10.3
4.9
8.6
6.1
5.6
5.6
5.6
4.6
5.8
4.3
4.6
8.3
Current
8.1
5.1
6.4
6.5
10.0
5.5
8.5
6.5
6.5
7.6
6.8
4.8
6.5
5.0
5.3
8.3
2009 GDP Forecasts
Previous
Consensus
8.3
5.1
6.5
6.5
10.0
5.5
9.4
6.5
6.5
7.5
6.8
4.8
6.5
5.0
5.7
8.3
7.8
5.0
5.7
5.8
9.7
5.1
7.9
6.0
5.9
5.8
5.9
4.9
5.9
4.6
5.0
8.2
Figure 2. CPI Forecasts (Growth Rate in Percent)
2007 CPI Forecasts
Current
Previous
Asia-Pacific
Asian NIEs
SEA-4
Bangladesh*
China
Hong Kong
India**
Indonesia
Malaysia
Philippines
Singapore
South Korea
Sri Lanka
Taiwan
Thailand
Vietnam
4.2
2.3
4.0
7.5
4.8
2.0
4.5
6.4
2.0
2.8
2.1
2.5
16.0
1.8
2.3
8.3
4.2
2.3
4.0
7.5
4.8
2.0
4.5
6.4
2.0
2.8
2.1
2.5
16.0
1.8
2.3
8.3
Current
4.6
3.3
4.7
6.5
5.0
3.7
4.3
6.7
2.8
3.9
5.0
3.3
12.0
2.3
3.5
8.8
2008 CPI Forecasts
Previous
Consensus
4.5
3.2
4.7
6.5
5.0
3.7
4.3
6.7
2.8
3.9
5.0
3.2
12.0
2.3
3.5
8.1
4.6
3.1
4.7
8.6
4.5
3.6
6.0
6.9
2.9
3.7
4.1
3.1
13.4
2.2
3.3
10.1
Current
3.9
2.6
4.6
6.5
4.0
4.8
4.0
6.9
2.6
3.5
2.6
2.5
9.0
1.8
2.8
7.0
2009 CPI Forecasts
Previous
Consensus
3.9
2.6
4.6
6.5
4.0
4.8
4.0
6.9
2.6
3.5
2.6
2.5
9.0
1.8
2.8
7.0
3.9
2.7
4.4
6.9
3.5
3.6
5.7
6.8
2.8
3.5
2.4
2.8
9.8
2.0
2.6
7.7
Figure 3. Current Account Forecasts (Percent of GDP)
2007 CAB Forecasts
Current
Previous
Asia-Pacific
Asian NIEs
SEA-4
Bangladesh*
China
Hong Kong
India**
Indonesia
Malaysia
Philippines
Singapore
South Korea
Sri Lanka
Taiwan
Thailand
Vietnam
6.8
6.3
9.0
1.2
10.8
11.3
-1.2
2.0
15.0
3.7
29.2
0.6
-2.8
8.3
6.1
-9.0
6.8
5.8
8.6
1.2
10.8
11.6
-1.3
2.0
15.0
3.7
29.2
0.5
-4.1
7.1
5.2
-3.9
Current
5.3
4.7
4.8
-0.1
8.8
9.1
-1.9
1.4
12.5
3.3
26.0
-1.3
-3.1
7.2
5.5
-8.5
2008 CAB Forecasts
Previous
Consensus
5.6
5.2
4.8
-0.1
8.8
9.3
-1.7
1.4
12.5
3.3
26.0
0.4
-3.0
6.5
5.4
-3.6
7.2
6.5
5.2
0.2
11.9
11.1
-1.4
2.2
14.4
4.2
30.0
-0.1
-5.7
6.4
4.6
-6.9
Current
4.4
4.4
4.3
-1.1
7.0
7.0
-1.8
0.8
12.0
2.8
25.0
-0.6
-2.7
6.2
5.4
-5.0
2009 CAB Forecasts
Previous
Consensus
4.6
4.8
4.3
-1.1
7.0
7.3
-1.4
0.8
12.0
2.8
25.0
0.2
-2.9
6.2
5.1
-3.0
6.8
6.5
4.7
-0.1
11.0
11.3
-1.5
1.9
13.8
4.3
29.2
-0.1
-4.7
6.1
3.6
-5.5
Note: Asian NIEs are Hong Kong, Korea, Singapore, and Taiwan. SEA-4 includes Indonesia, Malaysia, the Philippines and Thailand. Asia-Pacific is
Asian NIEs + SEA-4 + China + India, GDP-weighted.
*Bangladesh Fiscal year runs for July-June. **India Fiscal year runs from April-March and inflation data are Wholesale Price Index forecasts
Source: CEIC Data Company Limited, Consensus Economics (11 Feb 08) and Citi estimates.
2
Asia Economic Outlook and Strategy — Growth and Inflation Risks
29 February 2008
Global Economic Outlook
With tight financial conditions reinforcing economic weakness in the U.S., the
Fed has taken a more aggressive tack, with only limited impact thus far. We
look for cuts in the funds rate to 2% by midyear. Growth in the Euro Area has
slowed to a subtrend pace. Inflation remains high but should moderate quickly.
We expect the ECB to ease policy modestly later this year. We expect only a
modest slowdown in emerging economies. Inflation worries in emerging
markets are probably overblown but they will reduce the scope for monetary
loosening in the short run.
Strong Asian Growth
Strong Asian growth will probably continue on greater policy flexibility created
by improving macroeconomic fundamentals, despite slowing growth in the U.S.
While exports are likely to slow significantly, investment could become a
countercyclical force. Certain consumer spending items, such as those
associated with commodity and food revenue, might stay resilient. Food
inflation should remain a challenge for policymaking, although overall inflation
pressures are likely to ease as growth moderates. Capital inflows to Asia could
increase due to the region’s robust fundamentals and resilient growth. Asian
currencies, especially the renminbi, peso and rupee, will probably lead the next
leg of U.S. dollar weakness.
Food Inflation
Soaring food prices are becoming a major policy issue and risk in 2008. Social
unrest has previously erupted in China and India because of high food prices.
Asian governments are responding with price controls and trade measures, some
of which are protectionist. Elections in India, Indonesia and Malaysia could
mean food measures will stay for longer and be cast wider as governments
avoid risking a backlash. If food inflation persists, Asian central banks might
not be able to relax monetary policy despite slowing external demand. Thailand,
India, Indonesia and Malaysia are net agricultural exporters and could benefit.
Equity Strategy: Are We There Yet? No
Our regional equity strategist Markus Rosgen thinks Asian equity markets have
not priced in a recession and downside earnings risks and above-average P/BV
leave markets vulnerable. Our favorite markets continue to be Hong Kong (and
we mean Hong Kong not China), Korea and Taiwan (both cyclicals and priced
as such) and Malaysia. We are underweight all the others. In terms of sectors,
we like telecoms (cash flow, visibility and yield), ditto for the utilities, and
finally the banks (cheap, low expectations and yield). We are neutral consumers
(they are expensive). Biggest underweights: real estate, industrials, cyclicals
and technology.
3
Asia Economic Outlook and Strategy — Growth and Inflation Risks
29 February 2008
Contents
Citi Key Economic Forecasts
2
Macro Overview
5
Global Economic Outlook .......................................................................................................................... 5
Growth and Inflation in Asia ...................................................................................................................... 7
Surging Food Prices: Blessing or Curse?
13
Strategy — Asian Currencies and Interest Rates
21
Strategy — Asian Equities: Are We There Yet? No
23
Investor Checklist & Asian Chart Summary
29
Asia Investor Checklist ............................................................................................................................. 30
Asia Chart Summary................................................................................................................................. 32
Citi Asia Monetary Conditions Index ....................................................................................................... 33
Long Term Forecasts
35
Selected Country Focus
37
China: Renewed Inflation Challenge ........................................................................................................ 38
Philippines: Tightening Financial Markets amid Increased Risk Aversion and Political Noise ............... 41
Singapore: A More Challenging Year Ahead ........................................................................................... 44
Taiwan: Expecting More Capital Inflows ................................................................................................. 47
Other Country Section
51
Bangladesh................................................................................................................................................ 52
Hong Kong................................................................................................................................................ 54
India .......................................................................................................................................................... 56
Indonesia................................................................................................................................................... 58
Korea......................................................................................................................................................... 60
Malaysia.................................................................................................................................................... 62
Sri Lanka..............................................................................................................................................
64
Thailand .................................................................................................................................................... 66
Vietnam..................................................................................................................................................... 68
4
29 February 2008
Asia Economic Outlook and Strategy — Growth and Inflation Risks
Macro Overview
➤
Aggressive Fed easing and other policy measures should help
support the U.S. economy, but a sustained pickup in growth depends
on improved financial conditions
➤
Asia is likely to maintain strong growth on greater policy flexibility.
Investment could be a countercyclical force while consumption items
associated with commodity and food revenue could stay resilient
➤
Food inflation already complicates macroeconomic policymaking in
the region, but overall inflation rates could moderate in the coming
months as growth slows
➤
Liquidity inflows to Asia could increase due to robust fundamentals
and resilient growth, and Asian currencies will probably lead the next
leg of U.S. dollar weakness
Global Economic Outlook1
Lewis Alexander
1-212-816-9882
lewis.alexander
@citi.com
The recent deterioration in financial conditions is having its biggest impact on the
U.S. economy. Europe is also slowing, but the spillover to most emerging economies
remains modest so far. Looking ahead, we expect a variety of factors — including
the waning of the drag from residential construction, fiscal stimulus, and improving
financial conditions driven by a more assertive Fed — to contribute to a modest
recovery in U.S. growth starting in the second half of the year.
The forces restraining the pace of U.S. economic activity have shown few signs of
easing in recent weeks. Incoming data from the housing sector point to ongoing
contraction. The prevailing mix of credit, equity, and other asset prices continues to
be a significant headwind for aggregate demand (see Figure 4). Consumption
indicators suggest that household spending has slowed markedly.
The U.S. slowdown is a drag on the Canadian and Mexican economies, and
economic activity in the United Kingdom and the euro area is also slowing, but less
sharply than in the United States.
However, most other countries still show few signs of being adversely affected by
the U.S.-led slowdown. Recent data for China point to a strong start to 2008, while
resilient demand for commodities is supporting many emerging economies and
smaller high-income countries with a comparative advantage in commodity
production. The underperformance of the U.S. economy relative to most other major
economies is contributing to downward pressure on the U.S. dollar (see Figure 5).
This pattern may change in coming quarters. The U.S. slowdown is spreading
beyond residential construction. A broader and deeper slowdown in U.S.
1
This is a summary of the focus piece “Overview: The United States and World Economic Outlook” in Global Economic Outlook
and Strategy, February 28, 2008.
5
29 February 2008
Asia Economic Outlook and Strategy — Growth and Inflation Risks
consumption and investment should generate a more significant slowdown in imports
that will serve to moderate growth in the rest of the world.
Policy flexibility around the world is likely to play an important role in containing
the global slowdown. Unlike the past, many emerging economies (such as Brazil,
Mexico, and Korea) have strong public and private balance sheets, and they have
established strong records of pursuing stable macroeconomic policies. This should
make it possible for these countries to ease policy, if needed, even in the midst of
substantial turmoil in global financial markets.
Figure 5. United States and Other Major Industrial Countries —
Economic Surprises (100=1 Standard Deviation), Jan 07-27 Feb 08
Figure 4. United States — Citi Financial Conditions Index (Standard
Deviations) and the Output Gap (Percent of GDP), 1988-Jan 08
3
3σ
6
6%
100
100
2
4
75
75
1
2
50
50
0
0
25
25
-1
-2
0
0
-2
-4
-3
1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008
FCI (Left)
GDP Gap (Right)
-6
-25
-50
Note: Shaded regions denote recession. Sources: Bureau of Economic Analysis, Congressional
Budget Office and Citi.
-75
Jan-07
-25
United States
Other Major Economies
Apr-07
Jul-07
-50
Oct-07
Jan-08
-75
Apr-08
Note: Citi Economic Surprise Indexes are weighted averages of the difference between
individual data releases and the consensus forecast. “Other Industrial Countries” includes the
euro area, Japan, Great Britain, Australia, and Canada. Source: Citi.
Strong commodity prices and declining output gaps in some countries are putting
upward pressure on inflation. Nonetheless, we expect the slowdown in the United
States and Western Europe to contain inflation in those countries, and slowing export
growth should help to contain inflationary pressures in other key countries such as
China.
The evolution of financial conditions remains a key source of uncertainty. In recent
days, credit, equity, and other financial markets seem to have found a footing in
response to the significant shift in Federal Reserve policy in late January, the U.S.
fiscal stimulus package, and other policy measures intended to address some of the
stress points in the financial system. However, even if financial markets stabilize and
improve from here, the cumulative impact of the financial turmoil of the last six
months is likely to be a drag on the U.S. and global economy for many months.
Moreover, given the still considerable uncertainty about the magnitude and
distribution of losses in the financial system, we cannot be confident that we have
seen the worst in financial markets.
6
29 February 2008
Asia Economic Outlook and Strategy — Growth and Inflation Risks
Growth and Inflation in Asia
Yiping Huang
(852) 2501-2735
yiping.huang
@citi.com
Distinguishing “Decoupling” and “Resilience”
Will Asian economies continue strong growth in 2008? Our answer is affirmative.
Real GDP growth in emerging Asia is likely to average 8.2% this year, despite recent
downward revisions. China, India and Vietnam will probably continue to be growth
leaders in the region.
But the expected slowdown in the U.S. and robust growth in emerging Asia should
not be taken as evidence of “decoupling” between the two regions. The reason Asia
might maintain strong growth, in our view, is not because Asia will not be affected
by a slowing U.S. economy. Instead, improving macroeconomic fundamentals
during the past decade, reflected by debt burdens, current accounts, fiscal balances
and foreign reserves, have provided Asian authorities with greater policy flexibility
to cope with weakening external demand.
Figure 6. Improving Macro Fundamentals in Emerging Asia
40
Asia External Debt, Fiscal Balance, Current Account and Foreign Reserves
(Share of GDP, 1996 vs. 2007)
% of GDP
35
30
25
20
15
10
5
0
-5
1996
2007
External Debt
1996
2007
Fiscal Balance
1996
2007
Current Account
1996
2007
FX Reserves
Note: Asia includes China, India, Indonesia, Malaysia, Philippines, South Korea, Taiwan and Thailand (Weighted by Nominal GDP)
Source: CEIC Data Company, Institute of International Finance and Citi estimates.
In January, when our economists in New York lowered their U.S. growth forecast by
0.7ppt to 1.5% for 2008, the Asian economics team revised down regional growth
forecasts by an average of 0.4ppt. These imply elasticity of Asian growth with
respect to the U.S. growth at 0.5. Our earlier simulation applying the Oxford
Macroeconomic Forecasting model estimated an average elasticity of 1.0. The gap
between 0.5 and 1.0 can probably be explained by policy responses, such as
expansionary fiscal policy to boost domestic investment.
Even though headline growth forecasts might look very similar, it is important to
distinguish between the “decoupling” scenario and the “resilience” scenario. In a
7
29 February 2008
Asia Economic Outlook and Strategy — Growth and Inflation Risks
decoupling scenario, we should expect business as usual, while in a resilience
scenario, we should expect significant structural changes and major profitability
adjustments. Differentiating between the two scenarios would have important
implications for investment strategies.
Short Exports, Long Investment
We concur with the consensus view that investors should stay away from exportrelated activities when risks of U.S. recession increase. However, the question is if
investors should focus more on consumption or investment. During the past weeks,
domestic consumption became a popular investment theme. Some investors have
even argued that Chinese and Indian consumers might be able to pick up the slack of
weakening U.S. consumption.
After all, in open economies, like Asia, households derive significant portions of
their income from the export sector, directly or indirectly. We recommend a more
selective approach toward consumption. Statistical analyses, for instance, revealed a
positive correlation between consumption in China and the U.S. A 1ppt slowdown in
U.S. real consumer spending normally drags down growth of Chinese consumption
by 0.3ppt (see Figure 7).
Figure 7. Regressing Chinese Consumption and Investment on U.S. Consumer Spending
Constant
Real Growth of Chinese
Consumption
10.19*
(0.40)
Growth of U.S. Consumption (6 Months Lag)
WTO Dummy * Growth of U.S. Consumption (6 Months Lag)
East Asian Financial Crisis Dummy (Jan 98-Dec 99)
WTO Dummy (Jan 02-Nov 07)
Adjusted R-Squared
0.34*
(0.16)
-1.93*
(0.47)
-0.69
(0.52)
0.15
Real Growth of Chinese
Investment
18.96*
(2.02)
-2.10*
(0.49)
6.90*
(2.30)
7.11*
(2.55)
0.31
Note: Number in the parentheses under coefficient estimates are associated standard errors. And those estimates with * are statistically
significant at 5% confidence level. The analyses apply monthly data between 1994 and 2007.
Source: Citi estimates.
But, of course, consumption as a whole should be more resilient than exports. In
particular, consumption in the following three areas could survive better: (1)
consumption in areas and economies that are relatively insulated from the effects of a
U.S. slowdown, such as India and inland provinces of China; (2) consumption that is
driven by commodity revenue; and (3) consumption in rural areas as rural incomes
benefit from soaring food prices across the region.
Only investment, however, could serve as a counter-cyclical force. Statistical
analyses also indicated that a 1ppt slowdown in U.S. consumption has normally led
to acceleration of Chinese investment by 2.1ppts. Obviously, this was not the result
of a business investment decision but rather a result of countercyclical policies.
During the East Asian financial crises in 1998, for instance, Chinese authorities
undertook various measures to boost domestic investment. As a result, while export
growth slumped from 21% in 1997 to 0.5% in 1998, fixed asset investment growth
accelerated from 8.9% to 13.9%.
8
Asia Economic Outlook and Strategy — Growth and Inflation Risks
29 February 2008
Although the Chinese government has been attempting to rebalance the economy by
reducing the pace of investment growth, we expect the government to shift to
expansionary policy once the effects of the U.S. slowdown materialize. Growth is
still the most important economic indicator in China. The government can take steps
in at least three areas to boost domestic investment temporarily: (1) allocating direct
fiscal spending on infrastructure; (2) encouraging the state sector to invest more in
the resource and energy sectors; and (3) relaxing some existing controls such as
credit rationing.
China will not be alone this time (see Figure 8). Singapore already has large ongoing construction projects, including new casinos. The new government in Thailand
is attempting to revive some of the infrastructure projects planned under the former
Thaksin government. The Indonesian government has been pushing for large
investment for years. And the incoming president in Korea is pro-growth. Upcoming
elections in Malaysia, Indonesia and India might also increase the probability of
policy stimulus. In general, however, countries with large fiscal deficits would be
more constrained in making policy responses.
Figure 8. Likely Policy Measures to Boost Investment
Country
China
Fiscal Balance in 2007
(% of GDP)
-1.8 (forecast)
Hong Kong
Possible Policy Measures to Boost Investment in the Face of a U.S. Recession
(1) Some relaxation of credit controls; (2) more government spending on social security, healthcare and
infrastructure; and (3) slowing the pace of currency appreciation
7.2
The 2008-08 budget allocates HK$21.8bn for infrastructure projects that would create 27,000 jobs. Tax incentives
are also being provided for private firms to invest in environmentally friendly equipment and vehicles
India
-6.0 (forecast)
Given that the government is bound under fiscal responsibility legislation (FRBM) to meet targets, fiscal stimuli will
likely be limited. However, rural and urban infrastructure projects, which are a significant portion of budgeted
outlays, would help support investment activity
Indonesia
-1.3 (forecast)
Higher fiscal deficit (2008E: 4.2% of GDP) could play a leading role in promoting growth, particularly if spending
goes into infrastructure. The government plans to reallocate some of the budgeted spending for goods and official
travel into higher capital and social spending in 2008. Relaxation of some bank lending regulations would also help
support growth
2.0 (forecast)
Effective balance
(excludes social security
accounts) =
-1.0%
BOK rate cut and small-scale tax cuts (with a supplementary budget) would be short-term measures. Mid- to longterm measures include deregulation of corporate investment, deregulation of the housing market, a gradual
reduction in corporate income taxes and infrastructure projects such as the Grand Canal
Korea
Malaysia
-3.1% (forecast)
Accelerated implementation of the Ninth Malaysia Plan and Growth Corridor Projects are likely. Upcoming UMNO
internal party elections in mid-2008 could sustain fiscal pump-priming even after the general elections
Philippines
-0.1
Arroyo plans to front load the infrastructure program totaling Php200bn this year as a fiscal hedge against offshore
downside risk. Government asset sales. such as the privatization of state-owned power assets, can re-energize
private investment as well as generate revenue for the government. In a recent BSP survey, business sector
respondents in the construction and power sectors expressed bullish sentiment for 1Q08 despite an imminent global
downturn
Singapore
3.4% (primary fiscal
balance)
The government plans to bring forward the expansion of rail and road networks. A total of S$5bn annually has been
earmarked for spending on land-transport infrastructure until 2020, more than twice the annual spending on all
transport infrastructure over the past two decades. However, the extent of pump-priming might be limited by
capacity constraints in the construction sector
Taiwan
-0.2% (forecast)
Thailand
2.1 (forecast)
We expect liberalized cross-strait relations to boost domestic investment
Within the next 12 months, construction of a few rail transit lines to Bangkok can provide an investment boost. Stateowned enterprises will also pursue investment plans. Removal of exchange restrictions, such as the 30%
unremunerated deposits, and abolition of the revised Foreign Business Act can go a long way toward enhancing
foreign investment
Source: Citi estimates.
9
29 February 2008
Asia Economic Outlook and Strategy — Growth and Inflation Risks
As a result, economic growth in Asia could become even more driven by investment.
This implies that the commodity intensity of Asian economies could actually rise.
This should provide relatively better support for commodity markets where Chinese
or Asian demand already plays dominant roles. Iron ore, steel, copper, zinc, nickel,
coal and aluminum are some examples (see Figure 9).
Figure 9. China’s Shares of Global Commodity Consumption, 2006 (%)
Population
21
GDP
4
Crude Oil
8
Gold
8
Steel
37
Iron Ore
53
Zinc
30
Nickel
20
Copper
23
Aluminium
36
Alumina
26
0
10
20
30
40
50
%
60
Source: Citi Investment Research.
Inflation Challenges
High inflation rates could be a serious constraint for the expected expansionary
policy. While Asian governments attach great importance to growth, inflation is
probably equally important. Inflation and corruption were the two main problems
that caused the Tiananmen Square incident almost 20 years ago in China. We also
note that high food prices recently generated social tension in Indonesia, Malaysia
and Vietnam.
Inflation readings in China, Indonesia, Singapore, Taiwan and Vietnam have
exceeded their official targets or forecasts for several months. Monetary policies are
already tightening in China, Taiwan and Vietnam.
10
29 February 2008
Asia Economic Outlook and Strategy — Growth and Inflation Risks
Figure 10. Inflation Targeting in Asia
Government Target or
Forecast for 2008 (%)
Most recent
3-months prior
Citigroup CPI
Forecast, 2008
(%YoY)
3.0-3.5
Below 4.8%
7.1 (Jan-08)
6.5
5.0
1.5
5.0
3.4 (headline)
4.5 (underlying)
4.0-4.5
3.29 (Jan-08)
3.93** (Jan-08)
3.21
3.11**
3.7
4.3**
Actual Core/Headline CPI (% yoy)
Economy
Targeted Price Index
China
No official inflation
targeting policy
Hong Kong
India
No official inflation
targeting policy
WPI
2007
Indonesia
CPI
Korea
Headline CPI
Malaysia
No official inflation
targeting policy
2.8
Philippines
CPI
5-6
0-1
4.5-5.5
Singapore
Taiwan
Thailand
Vietnam
No official inflation
targeting policy
No official inflation
targeting policy
Core CPI (ex. ag and oil)
No official inflation
targeting policy
5.5-8.6
4.0-6.0 (BI)
7.36 (Jan-08)
6.88
6.7
2.5 to 3.5 (BOK)
2.5-3.5% (BOK)
3.89 (Jan-08)
3.0
3.3
2.0-2.5
2.28 (Jan-08)
1.92
2.8
4.0-5.0
4.86 (Jan-08)
2.7
3.9
6.64 (Jan-08)
3.65
5
2.0
2.0
3.34 (Dec-07)
3.1
2.3
4-4.5
1.0-2.0
1.24* (Jan-08)
1.05*
3.5
6.5
8.5-9.0
15.66 (Feb-08)
10.0
8.8
Source: Citi.
We think chances of stagflation in Asia are still remote. The expected slowdown in
exports is likely to ease inflation pressure, as a result of rising overcapacity risk. In
China, for instance, export growth slumped twice during the past decade, once in
1998 and again in 2001. Both times were followed by deflation (see Figure 11).
Thus, inflation rates could moderate in Asia from the second quarter, especially as
the special holiday effects fade while the base effect kicks in.
Figure 11. Export Growth and CPI Inflation in China, 1997-2007 (%)
6
40
5
35
4
30
3
25
2
20
1
15
0
10
-1
5
-2
0
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
CPI (LHS)
Exports (RHS)
Source: CEIC Data Company and Citi estimates.
11
29 February 2008
Asia Economic Outlook and Strategy — Growth and Inflation Risks
There are many factors supporting the case that the latest food inflation might be
structural. These factors include: (1) demand expansion associated with strong
income growth; (2) decline of agricultural resources as a result of urbanization and
2
industrialization; and (3) deterioration of the global climate. We are not overly
pessimistic about the long-term outlook for food inflation, as supply normally would
respond to strong demand. But food prices could stay at relatively high levels in the
coming months. This could complicate macroeconomic policymaking in the region.
Market Implications
Liquidity conditions are another important factor, alongside macroeconomic
momentum and policy, that could shape the outlook for Asian financial markets.
Despite the recent credit crunch in the U.S. and Europe, we expect the relatively
abundant liquidity conditions in Asia to continue in 2008. This implies that, with a
slowing U.S. economy, depreciating U.S. dollar and falling U.S. interest rates,
liquidity flows to emerging market economies might increase this year. Emerging
Asia, due to its robust fundamentals and resilient growth, stands to benefit from more
capital inflows.
Emerging Asian currencies, especially the renminbi, peso and rupee, are likely to
lead the next leg of U.S. dollar weakness. High inflation provides another reason for
faster currency appreciation in the region. However, market participants who expect
12-15% renminbi appreciation might be too aggressive. While we agree that the
general case for currency appreciation holds, slowing export growth could make
every central banker cautious about exchange rate policies. We cannot rule out the
possibility of erratic capital account control measures in the face of strong inflows.
Asian interest rates are likely to fall, along with the U.S. Fed funds rate, as long as
inflation does not pose a challenge. Rates have already dropped significantly in Hong
Kong and Singapore. Central banks in Thailand, the Philippines and Korea are likely
to cut. Indonesia could introduce effective easing by switching the target instrument
from the one-month rate to the overnight rate.
Equity markets are already expensive generally, and earnings disappointments could
become a constant theme in 2008. But we remain upbeat about certain markets,
especially where valuations are not particularly high and activities are more insulated
from an export slowdown. We think investment, commodities and rural consumption
should do relatively better.
Across the region, China could continue above-10% growth, due to strong
macroeconomic fundamentals. India is probably best protected from an export
slowdown. Indonesia, Malaysia, Thailand and Vietnam might also benefit from
relatively more resilient commodity and food markets. Korea could potentially
benefit from some pro-growth measures once the new president begins to dictate
economic policies. Taiwan and Thailand are already in the middle of macroeconomic
turnarounds associated with elections.
2
12
See Hak Bin’s food inflation piece included in this report.
29 February 2008
Asia Economic Outlook and Strategy — Growth and Inflation Risks
Surging Food Prices: Blessing or
Curse?
Hak Bin Chua
+65-6432-2057
hak.bin.chua@citi.com
➤ Soaring food prices are becoming a major policy issue and risk in
2008. Asian governments are responding with price controls and a
mixed bag of trade measures, some of which are protectionist and
some trade enhancing
➤ If food inflation persists, Asian central banks will be less likely to
shift to a more accommodative monetary policy, despite slowing
external demand
➤ Thailand, India, Indonesia and Malaysia are net agricultural
exporters, at more than 4% of exports, and should benefit.
Agriculture accounts for more than one third of employment in the
Philippines, Indonesia, China, India, Vietnam and Thailand
➤ High food prices lift rural incomes and decentralize power from the
urban center. Income distribution might improve if government
policies allow high agricultural prices to filter down to farmers
➤ High food inflation is, however, politically explosive and could stir
social unrest. Riots have previously broken out in China and India
because of high food prices, and some recently occurred, on a smallscale, in Vietnam, Indonesia, Malaysia and Pakistan
➤ Food inflation and elections produce a combustible mix, with
elections slated in Malaysia, Indonesia, China and India over 2008-09.
Food measures, including controls and subsidies, will likely stay for
longer and be cast wider as governments avoid risking a backlash at
the polls
Soaring food prices are becoming a major policy issue and risk for Asia this year.
What had been hoped to be just temporary is turning out to be a more structural
phenomenon. Two major trends – rising affluence in emerging economies,
particularly China and India, and growing use of food crops for biofuels – are driving
up global food demand and prices. Climate change is also making food supply more
volatile.
The global population will rise to 9.2 billion by 2050 from 6.5 billion in 2005,
according to the United Nations, and will increase pressure on global food supplies.
These pressures are sharply accentuated by increasing demand in developing
countries, such as China and India, for protein-rich foods, which require more grain
and water to produce. Annual per capita consumption of meat in China, for example,
quadrupled from 10 kilograms in 1950 to 40 kilograms today.
The use of crops to produce biofuels is also impacting food security. Government
policies to reduce carbon emissions and dependence on imported energy are,
13
Asia Economic Outlook and Strategy — Growth and Inflation Risks
29 February 2008
somewhat ironically, driving food prices higher. Biofuels might consume up to 30%
of the U.S. corn crop by 2010.
On the supply side, climate change is increasing the volatility of weather and rainfall
patterns. This vulnerability is being exacerbated by a sharp fall in arable farmland
3
per head of global population by half over the last 50 years.
Figure 13. Food Is Driving Up Inflation in China
Figure 12. Food Inflation in China, Vietnam and Indonesia
25.0
% YoY
20
% YoY
18
20.0
16
14
15.0
12
10
10.0
8
6
5.0
4
0.0
2
0
-5.0
-2
-4
-10.0
-15.0
Jan-04
-6
Jan-00
Jan-05
Jan-06
China
Indonesia
Jan-07
Vietnam
Jan-01
Jan-02
Jan-03
Jan-04
Jan-05
Jan-06
Jan-07
Jan-08
CPI: Food
CPI: ex-Food
CPI
Source: CEIC Data Company Limited, and Citi estimates.
Whether food production will respond quickly enough to meet rising demand and
tame food prices is not clear. However, for now, food prices are continuing their
upward trend. This will have a major economic and political impact in Asia, with
implications for policy, growth and income distribution.
Food CPI inflation in China climbed to 16.7% in December and is likely to pick up
sharply early this year given exceptionally cold weather. Prices of seasonal
agricultural products rose by more than 10% in January, with the wholesale price of
vegetables rising 50.6% (see Figure 13).
Food CPI in Vietnam rose 22% in January, driving overall inflation to 14%. In
Indonesia, food CPI inflation climbed to 11.4%, as the cost of imported soybeans,
wheat and other food products surged. Bank Indonesia recently raised its 2008
inflation forecast to 6 – 6.5% versus 4 – 6% previously.
Food CPI inflation is a major driver of overall headline inflation because of the large
weight in the CPI basket for a number of countries. Food accounts for more than
40% of the CPI household baskets in Vietnam and Indonesia, and more than 25% in
China and Thailand (see Figure 14). Persistently high food inflation could keep
overall headline CPI inflation elevated, despite easing pressure from slowing
external demand.
3
For a fuller discussion, see World Economic Forum, Global Risks 2008, January 2008, and The Economist, Cheap No More, 6
December 2008.
14
29 February 2008
Asia Economic Outlook and Strategy — Growth and Inflation Risks
Figure 14. Share of Food in Headline CPI Inflation across Asia Ex-Japan
45
%
40
35
30
25
20
15
10
5
0
VN
ID
CH
TH
MY
TW
IN
HK
KR
Source: Citi estimates, CEIC Data Company Limited.
Asian central banks might be reluctant to shift to a more accommodative monetary
policy, despite slowing external demand, if food inflation persists. The Philippines’
central bank, for example, did not cut policy rates in its February meeting, as
inflation picks up. Consumer prices climbed 4.9% in January, the fastest pace in 15
months.
Thailand’s CPI inflation rose to 4.3% in January, the fastest in 18 months, as food
prices surge 4.8%. The Bank of Thailand’s hands look tied despite lackluster
domestic demand. In Singapore, the Monetary Authority of Singapore will likely
have to maintain its steeper currency appreciation bias despite an economic
contraction in the fourth quarter of last year, as CPI inflation might hit 7% in
February or March.
Food inflation can also be a major driver of social unrest and political instability with
consequences that can be politically damaging. Asset inflation makes the rich richer
and can be tolerated, but food inflation makes the poor poorer and is not likely to be
tolerated.
Mass protests in China in 1989, for example, were preceded by widespread food
inflation. In India, the onion crisis of 1998 is a well-known instance of how high
onion prices led to the BJP government losing in elections. Food riots erupted in
West Bengal in India in October 2007 as a result of disputes over food rationing.
More recently, there have been small-scale riots and anti-inflation protests breaking
out in Indonesia, Vietnam, Malaysia and Pakistan.
Asian governments are already making large policy shifts given increasing concern
over food security and surging food prices (see Figure 15). Measures tackling food
inflation are largely occurring in China, India and Southeast Asia. The more affluent
Asian economies – Singapore, Hong Kong, Taiwan and Korea – have largely
abstained from intervening.
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29 February 2008
Asia Economic Outlook and Strategy — Growth and Inflation Risks
Figure 15. Surging Food Costs and Policy Responses across Asia
Country & Inflation
(Latest Month)
Food Prices
Food Policy Responses
China
Food CPI (+18.2%)
CPI (+7.1%)
In the past year: pork (+60%), soybean oil (+58%), The government cut import taxes and raised export taxes on grain and flour in late
December. Imposed temporary price controls on necessities such as grain and
mutton (+51%,) vegetables (+50%), cooking oil
meat. Permission required for price increases of grain products, edible oil, pork,
(+35%)
beef, mutton, milk, eggs and liquefied petroleum gas
Indonesia
Food CPI (+11.4%)
CPI (+7.4%)
Steep rises in soybean products and tofu. Since
December: Cooking oil (+36%), tempeh
(fermented bean curd) (+33%), tofu (+20%),
wheat flour (+9%), rice (+7%)
Measures have been introduced to stabilize prices and supplies of rice, cooking oil,
soybeans and wheat by raising export taxes and allocating subsidized rice to more
poor families
Malaysia
Food CPI (+3.8%)
CPI (+2.3%)
Up to 50% increases in staples, including wheat
flour (+56%), bread (+47%), biscuits (+12%), milk
formula (+3%). Shortages have emerged for
cooking oil
A National Price Council has been established to stabilize prices and ensure
sufficient supplies of essential goods through a national stockpile. This comes on
top of existing subsidies for water, electricity, fuel and food, especially rice and
sugar. Already, about 9% of the CPI basket is subject to price controls, most of
which are food items. Banned shipments of subsidized goods, including wheat,
sugar, cooking oil and diesel
Vietnam
Food CPI (+22.0%)
CPI (+14.1%)
Some worker strikes. In the past year: vegetables
(+50%), meat (+40%), fish (+25%), fertilizer
(+25-70%), milk (+20%), rice (+20%)
Officials implemented price controls on essential products such as cooking gas,
petrol, coal, fertilizer, rice, milk and sugar. But authorities often fail to keep prices
within recommended ranges
Thailand
Food CPI (+4.8%)
CPI (+4.3%)
In the past three months: palm oil (+56%), pickled
fish (+38%), coconut (+25%), noodles (+13%)
There has been an increase in the number of food items under price controls.
Thailand has, however, been reducing subsidies for fuel and cooking oil in recent
years
Singapore
Food CPI (+5.8%)
CPI (+6.6%)
Cooking oil (+18.3%), dairy products and eggs
(+12.7%), meat and poultry (+12.2%)
The government stated that it has no plans to introduce price controls, citing the
costs arising from shortages and hoarding. Instead, more subsidies will be
directed to the low-income group
Philippines
Food CPI (+6.2%)
CPI (+4.9%)
Fruit and vegetables (+10.5%), dairy products
(+9.8%), eggs (+8.2%), rice (+7.5%)
The government has regulated rice prices for low-end varieties.
Other components of the food basket, including meat products and
dairy products, are not subject to controls
India
Primary Products WPI
(+4.4%), Food (+3.0%);
Food CPI (+7%),
CPI (+5.5%)
Over the past year, the government has been managing prices of many food
In the past year, milk (+10.2%), beverages and
tobacco (+9.9%), edible oil (+8.9%), manufactured products. Wheat and rice are two staple commodities that come under the Public
Distribution System. The government procures food grains via the Food
food (+5.6%), cereals (+3.5%), rice (+6.8%)
Corporation of India at minimum support prices. Other commodities with regulated
prices (or through export bans) include onions, skimmed milk powder and sugar
Taiwan
Food CPI (+5.3%)
CPI (+3.0%)
In the past year: vegetables (+9.5%), fish and
shellfish (+6.2%), meat (+3.3%), food away from
home (+2.5%)
Price controls have been minimal for food and cover only rice. There are other
official price controls on water, electricity, gas supply and transport fares
Korea
Food CPI (+2.9%)
CPI (+3.9%)
In the past year: wheat flour (+67%), eggs
(+22%), chicken (+16%), tofu (11%), cooking oil
(+11%), ramen (+8%), rice (+3%)
There are no official price controls on food items, and there have not been any
policy responses on food prices yet. Note that rice, the major grain in Korea, is
heavily protected from the international market
Hong Kong
Food CPI (+8.8%)
CPI (+3.3%)
In the past year: pork (+43%), beef (+39%), tinned There are no price controls on food items
meat (+34%), eggs (+22%), poultry (+18%),
edible oil (+16%), rice (+11%)
Source: Citi estimates, media and company reports.
China removed import taxes, raised export taxes and imposed export quotas on grain
and flour in late December. Large producers of some food products – including
dairy, pork, mutton and eggs – must now seek government approval before raising
prices. Wholesalers and retailers of such food products do not have to seek
permission to raise prices, but they must notify the government when prices cross
certain thresholds.
Malaysia recently established a National Price Council to stabilize prices and ensure
sufficient supplies of essential goods through a national stockpile. This comes on top
of existing subsidies for water, electricity, fuel and food items such as rice and sugar.
About 9% of the CPI basket is subject to price controls, most of which are food
16
29 February 2008
Asia Economic Outlook and Strategy — Growth and Inflation Risks
items. Malaysia has also banned overseas shipments of subsidized goods, including
wheat, sugar, cooking oil and diesel.
Indonesia introduced measures on a number of key food items, including rice,
cooking oil, soybeans and wheat flour (see Figure 16). Some of the measures are
trade-enhancing, including the cutting or abolishing of import tariffs for rice,
soybeans and wheat flour. Others, however, are more protectionist, including higher
export taxes on palm oil. Subsidies have also been increased for rice for poor
households.
In Thailand, the Ministry of Commerce postponed indefinitely price adjustments for
regulated items covering 300 to 400 basic foodstuffs that had earlier been scheduled
for January. The Commerce Minister under the new Samak government is also
considering potential price freezes on up to 30 consumer products, including cooking
oil, rice, instant noodles, dairy products, pork, soap, detergent, toothpaste and
batteries.
In the Philippines, there are no direct price controls although the government is
providing price subsidies for low-end rice that it distributes and makes available to
the retail market.
In Vietnam, the government reduced tariffs on dairy products and animal seeds. It
also instructed firms to speed up production and is keeping a check on price
manipulation, but it has met little success. The Ministry of Finance has proposed
setting a ceiling on selected items, including food items such as fertilizer, sugar cane
and rice, but the proposals have not been implemented explicitly.
The impact of these food policies on overall trade is unclear. Cutting import tariffs
(Thailand, China and India) is trade enhancing. Imposing export taxes and quotas
(Indonesia, China) reduces trade and agricultural exports. The lack of coordination
between countries on such policies can lead to sub-optimal outcomes, with individual
country priorities over food security and domestic food prices taking precedence
over the potential impact on global prices and supply.
Policies that influence food import demand might have a disproportionately large
impact on global prices because, unlike many other hard commodities, the
international food trade is a relatively small part of global food production. Food
trade accounts for only about 15% of global food production versus 25% for
manufacturing.
Small adjustments in food policies, in China in particular with a population of 1.3
billion, could significantly impact soft commodity prices and global food inflation.
Food currently accounts for only a small fraction of China’s trade volume, or about
2.5% of China’s total exports. Food is largely produced and consumed by the
domestic market. Food policies that translate into significantly higher import demand
(tariff cuts) or lower export supply (export taxes or quotas) might produce large
swings in global food prices as a result.
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29 February 2008
Asia Economic Outlook and Strategy — Growth and Inflation Risks
Figure 16. Indonesia’s Policy to Tackle Food Inflation
Commodity
Rice
Business Sector
Import tariffs down from Rp550 to Rp450
Cooking oil (palm
oil based)
a. Continue with progressive export tax
policies for palm oil and its derivatives
b. Export tax of CPO is raised to 15% when
global CPO price rises above US$1,100 per
ton
c. Export tax for CPO-based biofuel to be
raised progressively
d. Continue with a policy to take over the VAT
on domestic production and sale of
cooking oil
a. No more import tariffs
b. Income tax on imports down to 0.5% from
2.5%
a. Abolish import tariffs
Soybeans
Wheat flour
b. Continue with a policy to take over the VAT
on wheat flour
c. Temporary freeze on standards for the
quality of wheat flour
Other programs
(Poor) Households
Higher volume of subsidized rice for poor
households, up from 10kg to 15kg, at a subsidized
price of Rp1,650 per kg
Open market operation of cooking oil at Rp2,500
per liter
Farmers
Faster distribution of higher
quality paddy seeds to
increase rice production
Increasing production in
2008
a. Facilitating small-to-medium enterprises using
wheat flour to convert from kerosene to using
liquefied petroleum gas as their energy source
b. Pushing for food diversification from wheat flour
to other locally based flour such as potato flour
1. State enterprises are expected to organize
bazaars for poor people for four months
2. State banks are expected to give soft loans with
subsidized interest rates for as much as Rp2
million for every tofu and tempeh peddler. The
target is to cover around 5 million food peddlers
Source: Media reports, government reports.
Politically, food inflation and elections are a combustible mix. Elections are
scheduled for Malaysia, Indonesia, China and India over the next two years. This
will tie the hands of governments. Food policies and subsidies will likely stay for
longer or even be cast wider as a result for fear of a backlash at the polls. Fiscal costs
and problems such as food shortages, hoarding or smuggling might persist as a
result.
Higher agricultural prices will, however, benefit certain Asian countries. Southeast
Asia and India will likely benefit from the favorable terms of trade shock, being
largely net food exporters. Northeast Asia and Sin