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ISSN 1474-5615 Vol 23 Issue 11

November 2012

South East Asia

MALAYSIA

Vol 2

Business Monitor Internationals monthly regional report on political risk and macroeconomic prospects

THIS MONTHS TOP STORIES

MYR: Mild Appreciation Ahead

BMI View: Despite Malaysia's robust current account dynamics, which would normally suggest a strong appreciation in the currency, we are inclined to maintain a relatively neutral view on the ringgit for now. Uncertainties over how the sovereign debt crisis in the eurozone would unfold, combined with growing evidence of a deeper-than-expected slowdown in the Chinese economy, should continue to weigh on investor sentiment towards riskier emerging market currencies, in our view. We expect the ringgit to remain essentially flat, in line with our average forecast of MYR3.1800/US$ for 2012.
Uncertainties To Weigh On Ringgit Our view that a narrowing current account surplus would limit gains for the Malaysian ringgit has played out well in recent months, with the unit remaining largely range-bound against the US dollar since late 2011. Uncertainties over how the sovereign debt crisis in the eurozone would unfold, combined with growing evidence of a deeperthan-expected slowdown in the Chinese economy, should continue to weigh on investor sentiment towards riskier emerging market currencies, in our view. Therefore, despite taking into account of the country's robust current account dynamics, which would normally suggest a strong appreciation in the currency, we are inclined to maintain a relatively neutral view on the ringgit for now. In line with our core view that the country's current
...continued on page 2

Malaysia: Deteriorating External Outlook

BMI View: Our views are playing our nicely. However, given that global economic conditions continue to remain fragile and that we have yet to see signs of an improvement, we believe that the worst has yet to come and we expect economic data to continue to disappoint over the coming months.
page 3

Philippines: Current Account Surplus Intact Despite Trade Outlook

BMI View: On the back of resilient exports, the Philippines racked up a solid current account surplus of US$3.7bn in H112. However, as a result of a challenging external demand outlook (especially in the electronics sector) as well as growing income outflows, we have downgraded our end-2012 current account forecast to US$7.3bn (3.0% of GDP) from US$8.9bn and our end-2013 forecast to US$6.9bn (2.7% of GDP) from US$11.1bn previously.
page 4

Philippines: BSP Bias Still Dovish Despite Rising Inflation

page 5

Indonesia: Lending Rates On The Rise As BI Tweaks Policy

page 7

INDONESIA

Asset Class Strategy: Growing Vulnerabilities

BMI View: With Indonesia's credit cycle peaking, Bank Indonesia set to further tighten monetary policy and external risks mounting, we continue to see downside potential for Indonesian assets across the board. Despite the nation's slowing growth outlook, equities remain among the most expensive in the region, while government debt and credit default swap spreads are increasingly vulnerable given Indonesia's declining fiscal and external positions. Additional risks are seen for the Indonesian rupiah, for which we have downgraded our end-2012 forecast to IDR9,600/US$ from IDR9,200/US$.
With the economy set to slow as we move into 2013, we find that Indonesian assets across the board are again looking expensive. Following our warning that Indonesian equities were set for a
...continued on page 6

Singapore: Tough Trade Outlook Challenging SGD

page 8

REGIONAL INDICATORS
2010 South East Asia Indicators Nominal GDP, US$bn Population, mn GDP per capita, US$ Real GDP growth, % Inflation, % Goods Exports, US$ Goods Imports, US$ 1,810.6 2,090.9 2,195.7 2,398.7 542.9 7.9 4.1 549.1 4.7 5.4 555.3 4.8 4.1 561.4 5.0 4.3 3,334.7 3,807.7 3,954.2 4,272.8 2011e 2012f 2013f

1,039.0 1,234.6 1,305.3 1,420.6 908.4 1,079.1 1,176.0 1,287.2

e/f = BMI estimates/forecast. South East Asia 2 = Cambodia, Indonesia, Laos, Malaysia, Philippines, Singapore, Thailand, Vietnam. Weighted by nominal GDP. Source: BMI

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ISSN: 1470-7811

 MALAYSIA
RISK SUMMARY
POLITICAL RISK
...continued from top of front page

Najib Praised For Moderate Stance On Islam

Government efforts led by Prime Minister Najib Razak to promote Malaysia as a moderate Muslim nation in recent years have attracted positive feedback from international observers and religious leaders. A recent report published by the Wall Street Journal said that Najib's efforts to counter religious extremism with peaceful protests deserves praise amid violent demonstrations worldwide in response to provocations against Islam. Najib's plan to boost Malaysia's position as an emerging economic power in the region by 2020 has played a key role in pushing the Malaysian government to adopt a moderate stance on religious issues.
Our short-term political rating stands at 76.5

account surplus will continue to narrow amid cooling global demand, and that we could see a wave of foreign capital outflows as Malaysian equities and real estate prices fall, we expect the ringgit to remain essentially flat, in line with our average forecast of MYR3.1800/US$ for 2012.
Fundamentals Remain In Place
Malaysia Trade Exports & Imports, US$mn (LHS) & Trade Balance, US$mn (RHS)
6,000 20,000 18,000 16,000 14,000 12,000 2,000 10,000 8,000 6,000
Jul-07 Mar-09 Jan-05 Jun-05 Jan-10 Jun-10 Apr-06 Oct-08 May-08 Nov-05 Sep-06 Feb-07 Dec-07 Aug-09 Nov-10 Apr-11 Sep-11 Feb-12 Jul-12

5,000 4,000 3,000

1,000 0

Trade Balance

Exports

Imports

valuations in speculative high-end segments of the property market. These inflows have also contributed to the Malaysian ringgit's general outperformance among similar emerging market currencies. However, we believe that asset prices in Malaysia may have peaked and that foreign investors may soon shift their assets elsewhere in search of better returns. The Malaysian government is expected to introduce a wave of new measures aimed at curbing speculation in the property market. We note that previous measures introduced in Malaysia are already beginning to have an impact on property prices. According to the Malaysia House Price Index (MHPI) published by Bank Negara Malaysia (BNM), property prices fell in Q112, with the index recording a 2.3% decline in quarter-on-quarter (q-o-q) terms. We believe that new measures to cool the property market would act as an even greater drag on prices over the coming quarters.
Support For The Ringgit
Malaysia Trade & Current Account Balances, % Of GDP
25 20 15 10 5 0 -5 Current Account Balance Trade Balance
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Source: BMI, Bank Negara Malaysia

ECONOMIC RISK

More Yuan Financing

Bank Negara Malaysia (BNM) Governor Zeti Akhtar Aziz revealed during an investment conference in September that there will be more yuan-denominated financing in the pipeline over the coming years. Malaysian companies are finding it increasingly attractive to issue yuan-denominated debt as a result of rising demand by foreign investors seeking to capitalise on the currency's appreciatory trend in recent years. We believe that this is also due to a growing number of Malaysian companies seeking to expand operations in China, which is likely to boost the issuance of yuan-denominated debt.
Our short-term economic rating stands at 74.6

BUSINESS ENVIRONMENT

Islamic Banking Sees Growth

Global Islamic banking assets are expected to grow between 10% and 15% annually over the next three years on the back of strong demand for Islamic banking products and services, according to World Bank Managing Director Mahmoud Mohieldin. On the supply side, growth would be driven by intense competition among banks seeking to expand Islamic banking services aggressively to establish a early mover advantage. We believe the growing diversity of Islamic banking products and efforts to internationalise standards and regulation in Islamic finance will help to boost the popularity of Islamic banking products.
Our business environment rating stands at 68.6

Narrowing Current Account Surplus Malaysia's current account surplus has narrowed significantly in recent years and this is mainly due to subdued external demand during and after the 2008/09 global financial crisis. We also note that the Malaysian economy is gradually transitioning from its export-heavy growth model towards one with a stronger emphasis on domestic demand. In recent years, the government has implemented various economic policies aimed at encouraging consumption. We note that Malaysia's gross national savings rate at around 35%, is exceptionally high compared to other countries. However, government policies in the past have artificially depressed consumption due to a managed exchange rate regime and the Employees Provident Fund (EFP), which requires employees to save a significant share of their income every month. Policymakers are in the midst of reviewing these policies as part of the government's plan to boost domestic demand over the coming years. Overall, we believe that such efforts to realign the economy towards heavier consumption should result in a smaller current account surpluses going forward. This suggests to us that the Malaysian ringgit will experience a milder appreciatory trend over the coming years, where we see the unit gradually heading towards MYR3.0000/US$. Valuations Poised For Correction Foreign capital inflows into Malaysia in recent years has contributed to a surge in property prices, eventually resulting in unrealistic

-10 -15

Source: BMI, Bank Negara Malaysia

Risk To Outlook Our risk to outlook for the Malaysian ringgit remains skewed towards further weakness as valuations of asset prices in Malaysia are unsustainable, in our view. As the property market continues to cool, we caution that this could potentially trigger capital flight, placing significant downside risks to our outlook for the currency. Presently, foreign investors hold a sizeable 27.3% of total local currency bonds issued by the Malaysian government, and we see increasing risks that the ringgit could be vulnerable to capital flight as a result of the country's deteriorating fiscal position. Furthermore, we also note that Malaysia's export-heavy economic model remains heavily tied to the fortunes of the Chinese economy and recent economic data continue to show that China is in the midst of an economic slowdown. Therefore, should exports deteriorate significantly over the coming months, we would expect some intervention by the central bank to weaken the ringgit in an attempt to prop up its export sector.

SOUTH EAST ASIA 2 NOVEMBER 2012

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MALAYSIA
ECONOMIC OUTLOOK

Deteriorating External Outlook

BMI View: Back in August we mentioned that industrial production in Malaysia may have peaked in May. We also pointed out that our view of a sustained deterioration in external demand (led by a deep economic slowdown in China) had been justified by the consistently weak export data in recent months. Our views are playing our nicely. However, given that global economic conditions continue to remain fragile and that we have yet to see signs of an improvement, we believe that the worst has yet to come and we expect economic data to continue to disappoint over the coming months.

2008/09 global financial crisis, and we see increasing risks of a further contraction over the coming months.
Not A Good Sign
Malaysia Trade Exports & Imports, % chg y-o-y
45 35 25 15 5 -5 -15 Exports Imports -35
Jul-08 Jul-09 Jul-10 Jul-11 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Apr-08 Oct-08 Apr-09 Oct-09 Apr-10 Oct-10 Apr-11 Oct-11 Apr-12 Jul-12

-25

Latest figures published by the Department of Statistics showed that industrial production contracted by 1.4% year-onyear (y-o-y) in June after peaking at a growth rate of 3.6% in May. On an annualised month-on-month (m-o-m) basis, we also see conclusive evidence of a steady slowdown in production activity in recent months. We see this as a sign that producers are beginning to draw down their inventories in anticipation of a continued slowdown in export orders over the coming months and we expect this trend to persist throughout 2012. Crucially, this contraction in industrial production has also been accompanied by a decline in exports, which contracted by 1.9% y-o-y in July, a significant deterioration comDATA & FORECASTS
BMI View: Our view that economic activity in China will continue to cool bodes ill for Malaysia's trade surplus, and by extension the countrys current account surplus, which we are forecasting to steadily decline

pared to the 5.4% growth recorded in June.

Back In Negative Territory
Malaysia Industrial Production Index & Components, % chg m-o-m annualised 3mma
80 60 40 20 0 -20 -40 -60
Jun-10 Oct-10 Jun-11 Oct-11 Dec-10 Dec-11 Aug-10 Feb-11 Aug-11 Feb-12 Jun-12 Apr-11 Apr-12

Source: BMI, Department of Statistics

Industrial Production Index Electricity

Mining Manufacturing

Source: BMI, Bank Negara Malaysia

We note that this is the deepest monthly contraction in exports registered since the

The latest set of economic data reinforces our view that cooling economic activity in China will weigh heavily on the Malaysian economy, which is in line with our below-consensus real GDP growth forecast of 3.8% this year for the country. Central banks in the region including the Bank of Korea (Bok), Bangko Sentral ng Pilipinas (BSP) and the People's Bank of China (PBoC) have responded to the slowdown in global growth by easing monetary policy, and we continue to expect Bank Negara Malaysia to do the same by introducing a 25bps rate cut at its next monetary policy meeting in November.

from 11.5% of GDP in 2011 to 7.9% and 7.0% in 2012 and 2013. We also point out that the Malaysian government is widely expected to introduce a generous election budget that may include cash handouts and
2010e 2011e 28.9 278.7 9,659 5.1 1.4 185.4 227.9 -5.0 2.6 5.5 3.17 178.7 227.5 48.9 32.0 11.5 131.8 8.9 69,821.4 25.0 5.4 3.0 3.07 16.3 19.2 2.9 132.6 8.1 -

more welfare subsidies for its citizens. This should result in a substantial increase in imports over the coming quarters, resulting in a narrowing current account surplus for the country.
Latest Period Q212 Jun Sep Jun Jun Jun Jul Jul 2012f 29.3 283.4 9,667 3.8 2.9 188.0 245.3 -6.4 1.7 5.2 3.20 196.5 236.9 40.3 22.4 7.9 138.9 8.5 71,526.7 25.2 2013f 29.8 310.0 10,407 4.6 3.8 195.5 260.7 -6.8 2.0 5.8 3.00 212.7 252.0 39.4 21.8 7.0 146.4 8.3 73,231.9 23.6

Population, mn [2] Nominal GDP, US$bn [3] GDP per capita, US$ 3 Real GDP, % change y-o-y [1,3] Industrial production index, % y-o-y, ave [3] Fiscal revenue, MYRbn [3] Fiscal expenditure, MYRbn [3] Budget balance, % of GDP [3] Consumer prices, % y-o-y, ave [3] Lending rate, %, eop [4] Exchange rate MYR/US$, eop [5] Goods imports, US$bn [3] Goods exports, US$bn [3] Balance of trade in goods, US$bn [3] Current account, US$bn [3] Current account, % of GDP [3] Foreign reserves ex gold, US$bn [3] Import cover, months g&s [3] Total external debt stock, US$mn [6] Total external debt stock, % of GDP [6]

28.4 237.8 8,374 7.2 7.4 159.7 202.9 -5.6 1.7 5.0 3.06 157.3 199.0 41.7 27.3 11.5 96.4 7.4 68,116.1 28.6

e/f = BMI estimate/forecast. 1 Base Year = 2000. Source: 2 World Bank/UN/BMI; 3 Bank Negara Malaysia, BMI; 4 IMF,BMI; 5 BMI; 6 World Bank, BMI

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NOVEMBER 2012 SOUTH EAST ASIA 2

 PHILIPPINES
RISK SUMMARY
POLITICAL RISK ECONOMIC OUTLOOK

Lending Oversight Increased

The Philippine government is planning to increase oversight for real-estate lending in 2012 in a bid to curb speculation, according to the central bank. Banks have been instructed by the regulator to provide details on their real-estate exposure. They will have to provide information regarding investments in stocks and bonds that finance property ventures and loans to developers of low-cost homes. Bangko Sentral presently caps banks' real-estate exposure at 20% of the total lending, with certain exemptions. Additional information from lenders will allow the central bank to determine if its policy needs to be reviewed, according to Deputy Governor Nestor Espenilla.
Our short-term political risk rating is 67.9.

Current Account Surplus Intact Despite Trade Outlook

BMI View: On the back of resilient exports, the Philippines racked up a solid current account surplus of US$3.7bn in H112. However, as a result of a challenging external demand outlook (especially in the electronics sector) as well as growing income outflows, we have downgraded our end-2012 current account forecast to US$7.4bn (3.0% of GDP) from US$8.9bn and our end-2013 forecast to US$6.9bn (2.7% of GDP) from US$11.1bn previously.
The Philippines posted a solid current account surplus of US$2.8bn in Q212, largely as a result of robust exports during the period. The print was a considerable improvement from both Q112's US$882mn surplus and Q211's US$1.9bn performance. The Philippines has so far this year been able to buck the weak regional export trend, posting strong 8.0% y-o-y growth in shipments over the course of H112.
A Clear-Cut Relationship
Philippines US & Japan Book-To-Bill Ratios
1.6 1.4 1.2 1.0 0.8 0.6 0.4 0.2
Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Jan-07 Apr-07 Jul-07 Apr-12 Jul-12

ECONOMIC RISK

Mining Goals Jeopardised

The national moratorium on new mining contracts and confusion between federal and local mining laws and regulations are placing the Philippines' planned US$12bn investment in its mineral resources by 2016 in jeopardy, according to Mineweb, citing the Philippine Mines and Geosciences Bureau. The country, which holds an estimated US$850bn in gold, copper and nickel reserves, currently looks unlikely to fulfil its investment pledge, a result of domestic bureaucracy and conflict with its strong anti-mining lobby. Uncertainty over the industry comes at a time when 7% of the Philippine population is out of work, giving it the highest unemployment rate in South East Asia.
Our short-term economic risk rating is 71.7.

Japan US

Source: BMI, NSO, SEMI

BUSINESS ENVIRONMENT

Awaiting Roadmap For Autos

Philippines-based car manufacturers are urgently waiting for the car industry roadmap to be revealed so that they are assured the car sector will be protected from the eventual reduction in tariffs of imported assembled vehicles, reports Business World Online. A roadmap for the country's car industry is currently being drawn up the Board of Investments and will feature fiscal and non-fiscal incentives to the industry. Philippine auto sales grew by a solid 6.0% in the first eight months of 2012 over the same period a year earlier.
Our business environment rating is 48.5. It scores 36.8 for institutions, 48.6 for infrastructure and 60.1 for market orientation.

This compares favourably to neighbouring Indonesia, where exports, which fell by 2.3% in H112 from H111, led to a massive swing from a current account surplus to the nation's largest current account deficit on record. Nevertheless, we believe that the Philippines faces an increasingly difficult outlook for external demand, suggesting that export growth over the second half of the year will likely not be able to continue its heady pace. As we wrote in August (see our online service, August 17, 'Export Sector To Lose Its Shine'), the Philippines' main export destinations China, Japan, and the US all face relatively grim growth prospects over the coming quarters. H212 Looks Challenging, But Rebound Possible In 2013 We note that the strong y-o-y performance in Philippine shipments has largely been a result of base effects given the sector's poor

performance in 2011. Although exports of some manufactured goods, specifically transport equipment and machinery, performed well in the first half of the year, exports of electronic goods fell by 3.9% yo-y. Ominously, the outlook for electronics goods does not appear likely to improve in H212. Both the US and Japan book-to-bill ratios, a measure of future semiconductor demand, posted below the 1.0 level that separates expansion from contraction for the third straight month in August. Japanese demand is looking particularly dour, posting its lowest ratio (0.74) since May 2009. With semiconductors making up approximately 30% of all Philippine exports, the atmosphere for H212 shipments is increasingly challenging. Looking to 2013, we do not see scope for a pick-up in export growth. Although risks remain weighted to the downside, we expect regional economic growth to stabilise next year, helping to prop up external demand. Furthermore, after a very poor 2012, there is potential for a rebound in demand for electronic goods. The current account will also continue to receive support from remittances, which have historically proven to be somewhat immune even to extreme global economic downturns. Although growth has moderated from its peak years in the middle of the last decade, remittances from overseas workers (which accounted for a hefty 8.9% of GDP in 2011) continue to expand at a healthy pace. Nevertheless, we have cut our 2013 nominal export growth forecast to 7.8% from 9.7% previously as a result of milder global price pressures and what we now envisage to be only a moderate regional growth rebound. For this reason, we expect the current account surplus to decline marginally to US$6.9bn (2.7% of GDP) in 2013 (versus our previous forecast of US$11.1bn) from our downwardly revised 2012 forecast of US$7.4bn (3.0% of GDP) (US$8.9bn previously).

SOUTH EAST ASIA 2 NOVEMBER 2012

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PHILIPPINES
ECONOMIC OUTLOOK

BSP Bias Still Dovish Despite Rising Inflation

BMI View: Following headline inflation's jump to 3.8% in August, together with stubborn core inflation that has trended above the headline rate for nine straight months, we believe that the Bangko Sentral ng Pilipinas (BSP) may choose to refrain from any further rate cuts. At the same time, despite some upside risks to inflation, we note that the central bank's policy stance is likely to stay relatively dovish given the ongoing strength in the Philippine peso and the parlous external economic environment, and that risks to our forecast are thus to the downside.
Philippine inflation ticked up in August to a seven-month high of 3.8% y-o-y. The jump in the index put inflation at the upper bound of Bangko Sentral ng Pilipinas (BSP)'s estimate for the month, and contributed to the central bank's decision to hold its benchmark interest rate at its September meeting after cutting the rate to an all-time low of 3.75% in July. Following the 3.8% print, BSP also raised its inflation outlook for both 2012 and 2013 to 3.4% and 4.1% respectively, from 3.1% and 3.2% previously. The BSP's revised inflation outlook chimes with our own end-2012 and 2013 forecasts, which we are maintaining at 3.4% and 4.0% respectively. In line with the BSP's upward revisions, we continue to believe that the central bank will keep its benchmark policy rate on hold at a record low of 3.75%
DATA & FORECASTS
BMI View: The Philippines continues to exhibit improving fiscal dynamics, with total government debt set to fall to 51.4% of GDP by the end of 2012 amid a manageable budget deficit and increasing revenues. Following the government's surplus of PHP2.5bn in August, the 8-month fiscal deficit stands at just PHP71.2bn, far below the government's
2010e Population, mn [1] Nominal GDP, US$bn [2] GDP per capita, US$ [2] Real GDP, % change y-o-y [2] Fiscal revenue, PHPbn [3] Fiscal expenditure, PHPbn [3] Budget balance, % of GDP [3] Consumer prices, % y-o-y, ave [4] Exchange rate PHP/US$, eop [5] Goods imports, US$bn [4] Goods exports, US$bn [4] Balance of trade in goods, US$bn [4] Current account, US$bn [4] Current account, % of GDP [4] Foreign reserves ex gold, US$bn [4] Import cover, months g&s [4] Total external debt stock, US$mn [6] Total external debt stock, % of GDP [6] 93.3 199.7 2,141 7.6 1,207.9 1,522.4 -3.5 3.8 43.59 61.1 50.7 -10.4 8.5 4.2 55.1 9.1 66,685.7 33.4 2011e 94.9 224.8 2,370 3.7 1,360.1 1,558.9 -2.0 4.4 43.80 62.7 47.2 -15.4 7.1 3.1 63.4 10.2 71,353.6 31.7 5.9 3.8 41.74 5.0 4.8 -0.2 69.7 11.9 -

for a potentially extended period. At the same time, inflation remains well within the central bank's target range of 3.0-5.0%, suggesting little need for tightening within the next year, and risks to our forecast are decidedly to the downside. Still Stoking Credit Growth As we wrote in July, BSP has been keen to spur lending and prolong the credit cycle since beginning its easing campaign in January. Although credit growth accelerated from 12.2% y-o-y in June to 15.2% in July, it remains well below its cycle peak of 24.8% hit in August 2011. Broad money supply growth, too, remains well in check, coming in at a moderate 8.7% in July versus 7.1% in June. These factors indicate to us that the Philippine economy is not approaching

overheating territory, as opposed to regional peer Indonesia. One thing that the central bank will be keeping its eye on, however, is core inflation, which ticked up to 4.3% in August from 4.1% in July and has remained higher than headline inflation for nine straight months. The BSP monitors core inflation, which excludes the volatile categories of food and energy, as a measure of the longer-term trend in overall price levels. However, like headline inflation, as long as core inflation remains below the upper-bound of the central bank's target range of 3.0%-5.0%, we do not expect it to be a serious concern. In the short term, upside risks to our end-year headline forecast may arise from buoyant global food prices. The introduction of the US Federal Reserve's third round of Quantitative Easing (dubbed QE3) further stokes the risk that food prices will continue to rise through Q412 and into Q113. However, our core view remains that commodity prices in general will be held in check by weakening global economic conditions, especially in light of the ongoing hard-landing in the region's largest economy, China. Although food price pressures may manifest themselves in higher inflation towards the end of 2012, these pressures will be transitory in nature and are unlikely to affect the BSP's interest rate outlook.

full-year ceiling of PHP279bn. We therefore retain our forecast for the entire year's deficit to come in at just 2.2%, lower than the government's forecast of 2.6%.
Latest Period Q411 Aug 41180 Jul July May Jul Aug 2012f 96.5 243.7 2,526 5.0 1,468.9 1,699.2 -2.2 3.0 44.00 65.7 50.6 -15.1 7.4 3.0 70.7 10.8 76,348.4 31.3 2013f 98.1 259.8 2,648 4.0 1,630.5 1,859.0 -2.0 4.5 44.00 72.0 54.5 -17.4 6.9 2.7 77.7 10.7 81,692.8 31.4

e/f = BMI estimate/forecast. Source: 1 World Bank/UN/BMI; 2 National Statistical Coordination Board, BMI; 3 Bureau of the Treasury, BMI; 4 Bangko Sentral ng Pilipinas, BMI; 5 BMI; 6 World Bank, BMI

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NOVEMBER 2012 SOUTH EAST ASIA 2

 INDONESIA
RISK SUMMARY
POLITICAL RISK
...continued from bottom of front page

Jakarta's New Governor To Face Major Challenges

Joko Widodo defeated Jakarta's incumbent Governor Fauzi Bowo in an election to run the Indonesian capital on September 20, according to exit polls. The new governor is expected to face major challenges ahead as persistent corruption and insufficient infrastructure prevents the country's capital from being a part of Indonesia's success story after it registered 6.5% annual growth. The apparent win for Widodo indicates that voters are now tired of patronage politics. Widodo, a former businessman who ran a furniture manufacturing and export business, is seen as a politician who gets things done.
Our short- and long-term political risk ratings are 74.2 and 60.0 respectively.

correction in May (see our online service, 'Bearish Indonesia Trade And Investment Equities'), the Jakarta Trade, Services, and Investment Index (JAKTRAD) shed 15.4% peak-to-trough, while the Jakarta Composite Index (JCI) suffered a 12.1% decline. Since the two indices bottomed out in June, however, they have witnessed a relatively strong bounce and, once again, we see scope for a correction as a result of their rich valuations. Equities Still Expensive Long one of our least favourite bourses in the region, the JCI is now trading at an expensive 18.6x price-to-earnings (P/E) ratio, (versus 15.0x for Malaysia's KLCI, 16.7x for the Philippines' PCOMP, and 12.3x for Singapore's Straits Times Index) and 2.8 priceto-book value (P/B). This makes the JCI one of the most expensive indices in the region in terms of historical earnings, a designation that is even less attractive in light of our recent downgrade to Indonesia's 2013 GDP growth forecast. As has been our view for some time, we expect Bank Indonesia's impending monetary policy tightening cycle to raise borrowing costs in Indonesia, a development that would bode poorly for equity prices. Technically, we find that the JAKTRAD has respected its 61.8% Fibonacci retracement level based on its June low, potentially signalling another leg down in the index. The JAKTRAD is also expensive relative to the region, with a P/E ratio of 19.9x and a P/B of 2.2x. At the same time, we believe that macroeconomic fundamentals are also negative for Indonesian equities, particularly the JAKTRAD. Although the Indonesian consumer has held up well so far this year despite prevalent external woes, we expect that this divergence is beginning to unwind as knock-on effects from weakening investment growth begin to bleed through. Amid a dour global economy with increasingly pervasive risks of large-scale crisis, the high 60% foreign ownership of Indonesian equities makes the market exceptionally susceptible to rapid shifts in investor sentiment. Downside Seen In CDS, Debt Markets Despite the fact that the Indonesian sovereign 5-year credit default swap (CDS) spread is hovering near five-month lows, we find that Indonesia's fiscal position is becoming progressively less attractive. As we wrote recently (see 'Infrastructure Boost Overshadowed By Ballooning Subsidies, September 10), the government 's inability

ECONOMIC RISK

Inflation Above Expectations

Indonesia registered an unexpected 4.6% y-o-y increase in consumer price inflation in August, compared with a 4.4% median estimate by 27 economists surveyed by Bloomberg. The increase was mainly attributed to rising food prices, and further limited scope for the central bank to cut interest rates as exports declined for a fourth month. Bank Indonesia may look to further prop up the ailing rupiah, which depreciated by more than 5% against the US dollar since the beginning of the year, owing to a drop in exports and the ongoing debt crisis in Europe.
Our short- and long-term economic risk ratings are 70.2 and 64.9 respectively.

to reform its burdensome subsidy structure in the face of elevated oil prices is taking its toll on Indonesia's fiscal position, and we are expecting the fiscal deficit to climb to 3.0% of GDP in 2012 versus just 2.1% in 2011. Combined with the nation's increasingly tenuous external dynamics as a result of a record current account deficit and the growing risk of hot money outflows, we believe there is value in the 5-year CDS protection. While we do not yet see scope for a massive blowout similar to 2008, when the 5-year CDS spread rocketed by 989 basis points (bps) over the course of just two months, we caution that risks of such an event are rising. For the same reasons, we also see downside risk for Indonesian local government debt. Following the Global Financial Crisis, Indonesian debt entered a three-year bull market, with yields on 10-year government notes making an extended march downwards. However, earlier in 2012 we began to see signs of an exhaustion in this trend, and yields have recently been trending sideways. As with the CDS, we believe that macroeconomic fundamentals, including Bank Indonesia's impending rate hike, signal increased downside for Indonesian government debt. Additionally, with approximately 28% of the local currency debt market owned by foreigners, we note that Indonesian bonds remain at risk of a rapid sell-off in the event of an external crisis such as an uncontained default in the eurozone. Rupiah's Struggles Continue In view of Indonesia's rapidly deteriorating terms of trade that led to a current account deficit of US$9.8bn in H112 (versus a surplus of US$2.8bn in H111), the rupiah has been one of the worst-performing currencies in the region so far in 2012. That being said, we see additional downside risk for the unit. Firstly, external demand from Indonesia's key trading partners is highly unlikely to be revived any time soon, with China's ongoing hard landing in particular causing a headache for Indonesian coal exporters. Secondly, given the high foreign ownership of Indonesian assets, risks of acute outflows continue to rise as the global economy weakens. Lastly, although Bank Indonesia has been known to aggressively defend the currency with open market operations in the past, the central bank has indicated a much more dovish approach to rupiah weakness in light of the nation's trade woes. As a result, we have downgraded our end-2012 rupiah forecast to IDR9,600/US$ from IDR9,200/US$ previously, and caution that risks are weighted to the downside.

BUSINESS ENVIRONMENT

Government Aims To Cut Power Subsidies

A plan by Indonesias government to increase the country's power tariff has secured approval from an energy commission, according to Chairman Sutan Bhatoegana on September 17 2012. The plan aims to cut subsidy costs and encourage investment in the country's power grid, which will, in turn, boost economic growth. A power subsidy of IDR78.6trn (US$8.3bn) will be included in the 2013 state budget, Bhatoegana added after a meeting with the commission and the Ministry of Energy and Mineral Resources. This is equal to a 15% increase in power costs.
Our business environment rating is currently 50.8.

SOUTH EAST ASIA 2 NOVEMBER 2012

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INDONESIA
ECONOMIC OUTLOOK

Lending Rates On The Rise As BI Tweaks Policy

BMI View: Although Indonesia's credit cycle appears to be peaking, we expect credit growth to remain elevated through Q412, and therefore retain our end-2012 loan growth forecast of 24.0%. However, given Bank Indonesia's progressively tighter monetary policy, we have slightly downgraded our loan growth outlook for end-2013 to 18.0% from 21.0% previously.
As Bank Indonesia (BI)s tightening measures begin to bite, we believe that Indonesia's credit cycle is at or near its peak. Total outstanding loan growth declined (for the second straight month) to 25.2% in July, and, even in the event that it ticks back up, we believe that it will not rise appreciably from current levels. Although hesitant to raise its benchmark interest rate, BI has enacted a number of measures to manage credit growth in what has become one of the region's most buoyant lending markets over the past year. In June, the central bank targeted consumer loans by raising minimum down payments on motorcycles and cars, as well as reducing the Loan to Valuation (LTV) ratio on houses from 80% to 70%. BI went a step further in August, raising its FASBI rate (the rate at which banks can earn interest on deposits with the central bank) by 25 basis points to 4.00% in order to lock up potentially excess liquidity
DATA & FORECASTS
BMI View: President Yudhoyono's 2013 budget looks set to focus on increased infrastructure development, with capital spending set to rise by a solid 15.0%. However, with a planned 18% increase in energy subsidies, the budget also indicates that the government has yet to get serious on the topic of subsidy reform. As a result, we have
2010e Population, mn [3] Nominal GDP, US$bn [4] GDP per capita, US$ [4] Real GDP, % change y-o-y [1,4] Industrial production index, % y-o-y, ave [4] Fiscal revenue, IDRbn [5] Fiscal expenditure, IDRbn [5] Budget balance, % of GDP [5] Consumer prices, % y-o-y, ave [2,6] Exchange rate IDR/US$, eop [7] Goods imports, US$bn [6] Goods exports, US$bn [6] Balance of trade in goods, US$bn [6] Current account, US$bn [6] Current account, % of GDP [6] Foreign reserves ex gold, US$bn [6] Import cover, months g&s [6] Total external debt stock, US$mn [6] Total external debt stock, % of GDP [6] 239.9 705.9 2,943 6.1 4.3 995,272.0 1,042,117.0 -0.7 5.1 8,979.00 131.2 159.3 28.1 6.3 0.9 93.0 6.9 202,413.0 28.7 2011e 242.3 846.3 3,492 6.5 4.2 1,165,253.0 1,320,751.0 -2.1 5.4 9,075.00 166.6 200.6 33.9 1.7 0.2 104.2 6.3 216,581.9 25.6 6.4 16.3 16.1 -0.2 109.0 -

in the market. The move was a clear indication that BI is done with its easy monetary policy campaign that saw the benchmark interest rate fall from 6.75% to 5.75% from end-2011 to the beginning of 2012, and that it is heeding the growing possibility that the economy is overheating. BI Reaping What Its Sown As we have been writing about for some time, BI's aggressive easing (beginning in October 2011) at a time when the economy was growing at a robust 6.5% has led to some signs of overheating, most evident in the record current account deficit that Indonesia chalked up in H112. As a result, we continue to believe that BI will be forced to hike its benchmark interest rate sometime within the next two quarters. As opposed to the traditional six-month lag from such monetary policy decisions, we believe that

the effect will be shortened in Indonesia given its broader tweaks that began in June. Tightening monetary policy has already begun to be reflected in borrowing costs, with the benchmark 3-month Jakarta Interbank Offered Rate (JIBOR) ticking up from a low of 4.2% in March to 4.9% in September. As we wrote in June, Indonesian banks boast some of the highest Net Interest Margins (NIMs) in the region, indicative of the high credit risk and low competition within the sector. This phenomenon leads to high borrowing costs, especially for consumers. Despite BI having made some progress in driving lending rates lower, as the cost of capital comes back up and NIMs stay elevated, borrowers will find that financing rates are once again on the rise. That said, we remain comfortable with our forecast for lending growth to end 2012 at 24.0%. With BI intent on prolonging the top of the credit cycle while at the same time managing liquidity within the economy by tweaking its monetary policy, we do not yet see ample scope for a major drop-off in credit growth before the year's end. At the same time, we have downgraded our 2013 credit growth forecast to 18.0% from 21.0%, and we note that risks to this forecast are to the downside depending on whether or not BI sees fit to more aggressively tighten monetary policy.

upgraded our 2013 fiscal deficit forecast to 2.7% of GDP versus 2.2% previously, while we continue to expect 2012's deficit to hit 3.0% versus just 2.1% in 2011.
Latest Period Q212 July July July July 2012f 244.8 883.3 3,609 6.0 5.0 1,281,778.3 1,525,467.4 -3.0 4.8 9,600.00 188.2 210.6 22.4 -12.7 -1.4 116.7 6.3 229,576.8 26.0 2013f 247.2 982.2 3,973 5.6 5.3 1,452,254.8 1,700,896.2 -2.7 6.0 9,200.00 218.9 241.8 22.9 -15.0 -1.5 130.7 6.0 242,203.5 24.7

e/f = BMI estimate/forecast. 1 Base Year = 2000; 2 Data prior to 1998 are from the IMF, subsequently from BI. Source: 3 World Bank/UN/BMI; 4 BMI/IMF; 5 IMF/BMI; 6 Bank Indonesia/IMF/ BMI; 7 BMI

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NOVEMBER 2012 SOUTH EAST ASIA 2

SINGAPORE
RISK SUMMARY
POLITICAL RISK ECONOMIC OUTLOOK

Mitigating Immigration Inflows

Singapore's government continues to clamp down on inflows of foreign workers following the ruling PAP's strong rebuke in 2011's general elections. In September, Manpower Minister Tan Chuan-Jin announced that 30% of skilled-labour work permit ('Employment' and 'S' Passes) applications had been rejected so far in 2012, versus a rate of 26% in 2011. Approvals for Permanent Residency have also fallen dramatically over the past few years, from 58,000 in 2008 to just 28,500 in 2010. As the government continues to re-calibrate its immigration policy in line with voter sentiment over the coming years, we expect immigration inflows to be further constricted.
Our short-term political risk rating is 94.8.

Tough Trade Outlook Challenging SGD

BMI View: With the Monetary Authority of Singapore (MAS) set to ease policy in view of an increasingly challenging trade outlook, we continue to expect the Singapore dollar to end 2012 slightly weaker.
Slowing Economy Shifts MAS' Focus Singapore inflation cooled again in August to 3.9% y-o-y (down from 4.0% in July), its lowest print since November 2010. The result reflected our long-held view that disinflation is finally taking hold in the city-state despite the fact that Singapore had bucked the regional trend of falling price growth in the H112. Moderating inflation provides increased room for the Monetary Authority of Singapore (MAS) to ease policy at its upcoming bi-annual rate meeting scheduled for October. When the MAS last eased policy in April, the city-state was coming off of a strong first quarter in which it posted 9.5% annualised q-o-q seasonally adjusted (SA) GDP growth. Q212 was a different story, with the economy contracting by 0.7% in q-o-q SA terms. As the global economy has buckled under the yoke of a hard landing in China, slow growth in Japan and the US and the ongoing eurozone debt crisis, external demand has suffered. In Q111, Singaporean exports
DATA & FORECASTS
BMI View: The Singaporean economy grew by 1.7% y-o-y in H112 versus the same period in 2011, creating considerable downside risk to our full-year forecast for 2.6% real GDP growth. Although the economy's growth numbers may benefit from weaker base effects in H212, the ongoing slowdown in external demand will likely continue to be a considerable drag on exports, which managed growth of just 2.2% in the first half of the year (versus our full-year forecast of just 1.8%)
2010 Population, mn [4] Nominal GDP, US$bn [5] GDP per capita, US$ [5] Real GDP, % change y-o-y [5] Industrial production index, % y-o-y, ave [1,5] Budget balance, % of GDP [6] Consumer prices, % y-o-y, ave [7] Exchange rate SGD/US$, eop [8] Goods imports, US$bn [2,5] Goods exports, US$bn [5] Balance of trade in goods, US$bn [5] Current account, % of GDP [5] Foreign reserves ex gold, US$bn [3,9] 5.1 227.4 44,714 14.9 29.7 0.2 2.8 1.28 311.3 358.0 46.7 21.7 225.8 2011e 5.2 252.1 48,595 4.9 4.8 1.6 5.2 1.30 362.0 429.5 67.5 24.0 239.3 Latest Period 2.0 38.3 41.7 -3.4 246.2 Q212 July Aug Aug Aug 2012f 5.3 277.9 52,874 2.6 5.3 1.4 4.4 1.26 388.9 455.5 66.7 20.8 256.1 2013f 5.3 302.2 57,014 3.6 6.1 1.3 2.5 1.23 422.8 494.7 71.9 20.6 271.5

ECONOMIC RISK

REITs Boast Returns

Singapore's US$38bn real estate investment trust (REIT) market has returned an average 37% in 2012, the best-performing market in the world, according to Bloomberg. The return came on the back of asset acquisition and an increase in rental revenue and was twice the gains registered in the US, the UK and Japan. Meanwhile, Australia's US$86bn REIT market gained 24%. REITs of Singapore have a dividend yield of around 6.5%, while property trusts offer an average premium of 413 basis-point over 10-year government bonds, according to Bloomberg.
Our short-term economic risk rating is 90.4.

grew by a solid 4.8% over the same period in 2011, while in the past three months (June, July and August), they fell by 2.3%. Given Singapore's heavy reliance on exports (net exports represent a hefty 24.1% of the economy), the MAS is more likely to be growth supportive now that inflation is less of a concern. Further bolstering the case for easing is the fact that import prices are in deflation (-0.2% y-o-y in Q212) and core inflation remains benign at 2.2%. We therefore believe that the most likely course of action for the central bank will be to slightly decrease the appreciatory slope of the Singapore dollar, leaving the width and centre of the policy band unchanged. In combination with the country's parlous export outlook and the performance of its foreign reserves, which have been declining in y-o-y terms for four straight months (indicating downside pressure on the currency), we continue to forecast for the Singapore dollar to end 2012 at SGD1.2600/US$.

BUSINESS ENVIRONMENT

Ahead In Wealth Management

The Asia Pacific Wealth Report has revealed that Singapore has a marginal advantage over Hong Kong in the race to be Asia's top wealth management centre. Hong Kong is taking steps to close the gap, but Singapore continues to attract private investment from Greater China. Singapore's advantage over Hong Kong is attributed to its sole regulatory body and a more predictable and transparent legal framework. The report also revealed that Hong Kong has many regulatory bodies and has less developed financial market policies.
Our business environment rating is 80.0. It scores 87.1 for institutions, 71.9 for infrastructure, and 81.2 for market orientation.

e/f = BMI estimate/forecast. 1 Manufacturing data used; 2 Singstat data used from 2002 for all BOP, Deflator values available only from 2002; 3 Includes Gold. Source: 4 World Bank/UN/BMI; 5 Statistics Singapore/IMF/BMI; 6 Statistics Singapore/ BMI; 7 Monetary Authority of Singapore/BMI; 8 BMI/Monetary Authority of Singapore; 9 Monetary Authority of Singapore/ Statistics Singapore

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