S&P Asia Outlook 2012

Asia-Pacific Markets Outlook 2012
Contact:
Yu-Tsung Chang Tokyo (81) 3-4550-8724 yu-tsung_chang@ standardandpoors.com
Rising Global Risks Cloud Asian Outlook
MICA (P) 170/10/2011
December 2011
Strong AnAlyticS. trAnSpArent criteriA. induStry inSightS.

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Introduction
Standard & PoorS iS PleaSed to PreSent aSia-Pacific MarketS
outlook 2012, an annual update that offers insights into what lies ahead for the regions economies, markets, and credit conditions. this publication, which includes recent thought-leadership articles from many of our senior analysts and commentators, contributes to the ongoing discussion about global challenges and opportunities. its been another rollercoaster year for the worlds economies and financial markets, largely due to europes deep and ongoing sovereign debt crisis. although asiaPacific has been relatively resilient and economies have continued to grow, the regions ability to withstand the eurozones debt woes will remain a monumental challenge for policymakers and investors in 2012. Whatever the fallout, we believe the asia-Pacific region has a crucial role to play in helping revive market confidence and shaping the worlds road back to economic health. undeniably, global risks and the threat of contagion are hurting the outlook for asia-Pacific economies and the creditworthiness of issuers. Were now predicting slower economic growth for the majority of countries across asiaPacific in 2012 (see the article Growing Global Risks Eclipse Asia-Pacific Economic Growth In 2012). our view partly reflects slowing exports in the region, weaker financial markets and currencies, and the prospect of another recession in the u.S. and europe. countries with a significant reliance on exports and cross-border trade, including Hong kong, Singapore, Malaysia, thailand, korea, and Vietnam, are most vulnerable. even china, the largest economy in the region, is showing some signs of fatigue after a strong rebound from the 2008 global financial crisis. it remains unclear whether china and other asia-Pacific nations can remain resilient in the face of ongoing problems elsewhere. However, if the advanced western economies avoid another recession, a hard landing in asia can be avoided. Given the inter-bank lending freeze in europe, access to credit markets and funding will remain a significant issue for governments, corporations, and other issuers in 2012. in Standard & Poors opinion, asia-Pacific can play a pivotal role in providing some alternative funding solutions and investment options in these difficult times. in this publication, we share some recent commentaries on the
subject, including our views on the ongoing development of local bond markets (see Development Of Asias Local Bond Markets Is Still Assured). We also take an in-depth look at some options for local policymakers searching for funds to pay for massive infrastructure-related projects (see The Development Of Municipal Bond Markets, And Credit Cultures, May Help Fix Asias Infrastructure Conundrum and Will Islamic Finance Play A Key Role In Funding Asias Huge Infrastructure Task?). among the biggest challenges for local bond and funding markets is the ongoing development of a credit culture and debtmanagement practices that are robust enough to enable investors to make informed risk-and-return decisions. a significant development for the banking sector this year has been Standard & Poors updated bank criteria, which aim to provide greater transparency and consistency. the criteria update is a refinement of our analysis rather than a reinvention, and it builds on what we knew before the financial crisis and incorporates what we have learned about how banks, investors, and governments respond. our commentaries Banking At The Crossroads And The Role Of S&Ps New Rating Criteria and Most AsiaPacific Banks Are In Better Shape Than Their Global Peers For Basel III, But Some May Need To Toughen Up Against New Rules explore some of the key issues. this publication also examines the risks and opportunities facing the regions equity markets in 2012. a guest article by S&P capital iQ equity research (see Asian Equities Markets: Doomsday Fears Should Subside In 2012) argues that risks remain high to equities and earnings outlooks. But it also predicts that the performance of equity markets may turnaround next year, with any positive news having marked implications for returns once debt worries subside. as always, we welcome your comments and feedback on our research and insights. We trust you will find this publication useful as you prepare for 2012 and beyond.
Yu-tSung chang executive Managing director and head of aSia-Pacific Standard & PoorS ratingS ServiceS
Standard & PoorS
aSia-Pacific MarketS outlook 2012
Contents
3 6 13 introduction by Yu-Tsung Chang, Executive Managing Director Ratings Services, Asia-Pacific, Standard & Poors AsiA-PAcific Economic outlook: Growing Global risks eclipse asia-Pacific economic Growth in 2012 by Dharmakirti Joshi, Parul Bhardwaj and Dipti Saletore, CRISIL Ltd. AsiA-PAcific crEdit mArkEts outlook: a Slowdown in europe and china, and Sluggish exports Moderate asia-Pacific credit outlook in 2012 by Ian Thompson, Standard & Poors Ratings Services AsiA Equity mArkEts outlook: asian equities Markets: doomsday fears Should Subside in 2012 by Lorraine Tan, Vice President and Head of Asia Research, S&P Capital IQ Equity Research equities outlook Glossary equities outlook disclosures and disclaimers AsiA-PAcific Bond mArkEt And crEdit culturE dEvEloPmEnt commEntAry: despite Global Volatility, the development of asias local Bond Markets is Still assured by John Bailey and Yu-Tsung Chang, Standard & Poors Ratings Services the development of Municipal Bond Markets, and credit cultures, May Help fix asias infrastructure conundrum by Tom Schiller, Executive Managing Director, Standard & Poors Ratings Services Whats Behind the Stellar Growth of the dim Sum Bond Market? by Michael Petit and Ping Chew, Standard & Poors Ratings Services AsiA-PAcific rEgionAl PErsPEctivE commEntAry: Will islamic finance Play a key role in funding asias Huge infrastructure task? by Allan Redimerio and Andrew Palmer, Standard & Poors Ratings Services Banking at the crossroads and the role of S&Ps updated rating criteria by Ritesh Maheshwari, Standard & Poors Ratings Services Most asia-Pacific Banks are in Better Shape than their Global Peers for Basel iii, But Some May need to toughen up against new rules by Naoko Nemoto, Standard & Poors Ratings Services ratings impact of a Hypothetical reunification of the two koreas: a thought experiment by KimEng Tan and John Chambers, Standard & Poors Ratings Services can indias developing infrastructure keep Pace With economic Growth? by Rajiv Vishwanathan and Allan Redimerio, Standard & Poors Ratings Services asia-Pacific office locations asia-Pacific regional contacts 19 24 25 28
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a S i a - Pa c i f i c e c o n o M i c outlook
Growing Global Risks Eclipse AsiaPacific Economic Growth In 2012

Contributors: Dharmakirti Joshi, Mumbai, (91) 22-3342-8043; djoshi@crisil.com Parul Bhardwaj, Delhi, (91) 11-4250-5138; pbhardwaj@crisil.com Dipti Saletore, Mumbai, (91) 22-3342-8019; dsaletore@crisil.com
Published on RatingsDirect Global Credit Portal on Dec. 16, 2011
Editors Note: The authors of this article are Dharmakirti Joshi, Parul Bhardwaj, and Dipti Saletore, all of CRISIL Ltd., the Mumbai-based subsidiary of Standard & Poors. The thoughts expressed in this Guest Opinion article are those of the writers and do not necessarily reflect the views of Standard & Poors Ratings Services.
eScalating riSkS in the advanced econoMieS have caSt a Pall on
growth in asia-Pacific. rising risks in europe, since august 2011, triggered capital outflows in most financial markets in asia-Pacific in the third quarter of 2011, followed by currency weakening. export prospects have also turned sluggish. We have scaled down our GdP forecasts for 2011 and 2012 for most economies in asia-Pacific. our outlook assumes that the european economic and Monetary union (eMu or eurozone) will grow at an anemic 0.4% in 2012, with a mild recession in the first half of the year. While we expect the u.S. economy to escape a recession, growth will be a tepid 1.8% in 2012. any further deterioration in the outlook for these countries would increase the downside risks to our growth outlook for asia-Pacific in 2012. Growth is the new watchword for most asia-Pacific economies. With inflationary pressures easing, central banks in the region have started softening their monetary stance. australia, new Zealand, and indonesia have cut interest rates. others have either paused rate hikes or are veering toward policy loosening. But inflation remains high in Vietnam and india. during its most recent rate hike in october 2011, indias central bank indicated that it would suspend further rate hikes because it expects inflation to moderate as a result of slowing domestic demand and global headwinds. While all countries in asia-Pacific will feel the heat of a sharp slowdown or a recession in europe and the u.S., those with greater reliance on exports and with strong trade linkages are most vulnerable. the countries include Hong kong, Singapore, Malaysia, thailand, korea, and Vietnam. GdP growth in these countries had fallen sharply during the global financial crisis in 2009. While growing interregional trade provides some buffer to asian economies, it is insufficient to offset global headwinds.
china, the regions largest economy, is showing some signs of fatigue after a strong rebound from the previous global financial crisis. We expect the countrys exportoriented and construction sectors to further slow down in 2012. We expect china to manage a soft landing with about 7.7%-8.0% growth in 2012. the rest of asia could avoid a hard landing if the eurozone can steer clear of a deep recession.
Growth Begins To Lose Momentum

a shaky external environment along with a policy-induced slowdown in china would impede growth rates across the region in 2012. after a strong start in the first quarter of 2011, growth in asia-Pacific began to decelerate sharply from the second quarter of 2011 (see chart 1). Strong domestic demand supported economic growth in the first quarter, and a weak global economy dented growth in the subsequent quarters. nevertheless, hardy domestic demand will enable countries to post respectablealbeit lower growth rates this year. Standard & Poors ratings Services
Chart 1
Real GDP Growth Begins To Decline

10 8 6 4 2 0 -2
1Q 2011 2Q 2011 3Q 2011
*3Q 2011 data is an estimate. Sources: Standard & Poors Asia-Pacific economic research and CEIC database.
tra lia Ch Ho ina ng Ko ng Ind Ind ia on es ia Ja pa n Ko re M a Ne ala w ys Ze ia al Ph and* ilip p Si ines ng ap or Ta e iw Th an ail an Vie d tn am
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Au s
has sharply lowered its 2012 growth forecasts for most economies in asia-Pacific because it expects the eurozones growth prospects to worsen in the first half of 2012. Growth rates in Japan, australia, and new Zealand will likely increase in 2012 due to the lag effects of governments reconstruction-related spending. the three countries have recovered well from the damage caused by natural calamities earlier this year. Japans GdP growth was strong in the third quarter of 2011 because of the restoration of supply chains and reconstruction activities. the Japanese governments generous fiscal stimulus also supported growth. australia has benefited immensely from the high prices and robust demand for commodities and has recovered smartly from the temporary blip in growth in the first quarter due to the floods. But the persistent weakness in non-mining activity and the slowing growth of trade partners could weaken the countrys otherwise healthy growth prospects. new Zealand too has benefited from strong dairy prices and the boost to growth from the rugby world cup that it recently hosted. a deteriorating global economy and weak domestic demand are likely to impede growth in china and india next year. these two factors also caused growth to moderate in india and china in 2011, even though the two countries are the fastest developing economies in the region. economic activity in india decelerated sharply to 7.5% in the first three quarters of 2011, from 8.9% in the same period last year. High interest rates and a lack of progress on domestic policy reforms have derailed indias growth engine to some extent. the chinese government has continued to take steps to avert overheating and to steer the economy toward a soft landing. While a mix of monetary and macro-prudential measures has slowed GdP growth in china, growth still remains robust due to strong consumer demand. a severe deterioration in the global economy could sharply lower growth in indonesia, Malaysia, thailand, the Philippines, and Vietnam in 2012 because these countries primarily depend on exports for growth. Strong domestic demand, particularly investment, has helped mitigate the slowdown in exports growth so far. the Philippines and Malaysia have already announced stimulus packages in the past few months as a pre-emptive measure to shield growth.
the recent floods in thailand could result in significantly lower growth in 2011. While domestic demand has held up growth in korea, Singapore, taiwan, and Hong kong until now, the countries high dependence on china and the developed economies has significantly increased the downside risks to growth.
Inflation Risks Subside

We expect inflation to continue to decline next year, with an additional downward push from the lag effects of monetary tightening in most countries in 2011. While inflation was high for most of asia-Pacific in the first half of 2011 (see table 1), it has started to moderate in many countries in the region. india and Vietnam remain exceptions. although Japan moved out of the deflationary phase in July 2011, inflation still remains low. the current deceleration in inflation is mainly attributable to weaker domestic demand and some moderation in global commodity prices. Weak domestic demand will lower inflation in china, india, and Vietnam in 2012. inflation in china has been moderating since august 2011, after peaking in July 2011. it fell to 5.5% in october, from 6.5% in July. But despite the moderation, food inflation remains stubbornly high. Monetary policy tightening and moderating growth have ensured the retreat of inflation in china. in contrast, Vietnam and india are battling runaway inflation stemming from rising food prices and robust demand. inflation in Singapore and Hong kong has remained persistently high so far, underpinned by rising accommodation costs. inflation in australia and new Zealand is also likely to fall in 2012 due to policy reversal. the governments policy-led changes exerted upward pressure on inflation in these two countries in 2011. Based on data for the third quarter of 2011, inflation in indonesia, Malaysia, and the Philippines declined, albeit marginally, primarily due to a slowdown in food and non-food inflation. inflation remains elevated in thailand due to flood-related disruptions in the supply chain. Moderating inflation has prompted some central banks to reverse their tight monetary policy (see table 2). central banks in new Zealand, indonesia, thailand, and australia are now embracing an accommodative policy regime to counter a sharp dip in economic prospects. Going forward,
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Table 1: Asia-PacificInflation Trends 2011*

Food inflation (%)
Australia China Hong Kong India Indonesia Japan Korea Malaysia New Zealand Philippines Singapore Taiwan Thailand Vietnam
Non-food inflation 1H 2011

3.1 2.3 3.9 9.7 4.7 (0.4) 3.4 2.4 4.6 6.1 5.6 3.3 1.5 12.9
Total CPI-based inflation 1H 2011

3.5 5.4 4.5 8.9 6.4 (0.5) 4.3 3.1 4.9 4.8 5.0 1.5 3.6 16.1
1H 2011
5.2 11.8 6.0 8.2 12.3 (0.5) 9.5 4.7 5.9 4.1 2.8 (3.4) 7.0 20.6
3Q 2011
6.4 13.9 7.8 6.6 5.4 0.1 8.6 4.9 6.2 3.9 3.0 1.7 8.1 27.5
3Q 2011
2.9 2.5 5.9 11.7 4.4 (0.3) 4.1 2.7 4.2 6.7 6.2 1.2 1.7 19.2
3Q 2011
3.5 6.3 6.4 9.2 4.7 0.3 4.8 3.4 4.6 4.9 5.5 1.3 4.1 22.5
*Year-on-year growth. CPIConsumer Price Index. Sources: Standard & Poors Asia-Pacific economic research and CEIC database.
Table 2: Central Banks Changing Monetary Policy Stance

Total change in policy rates (%)
Australia China India Indonesia Japan Korea Malaysia New Zealand Philippines Taiwan Thailand Vietnam
2009
-0.50 0.00 -1.75 -2.75 0.00 -1.00 -1.25 -2.50 -1.50 -0.75 -1.50 -1.50
2010
1.00 0.50 1.50 0.00 0.00 0.50 0.75 0.50 0.00 0.38 0.75 1.00
2011
-0.50 0.75 2.25 -0.50 0.00 0.75 0.25 -0.50 0.50 0.25 1.25 5.00
Prevailing rate
4.25 6.56 8.50 6.00 0.00 3.25 3.00 2.50 6.50 1.87 3.25 14.00
Sources: Standard & Poors Asia-Pacific economic research and CEIC database.
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A shaky external environment along with a policy-induced slowdown in China would impede growth rates across the region in 2012.
we expect other countries in the region to follow suit given slowing growth and modest inflation. reserve Bank of new Zealand was the first central bank in asia-Pacific to cut interest rates, in March this year, to offset possible largerthan-expected effects of the floods on growth. indonesias central bank also slashed rates to support faltering growth in a softening inflationary environment. the bank has cut rates by a hefty cumulative 75 basis points (bps) so far in 2011. its most recent cut (50 bps) was in the first week of november. reserve Bank of australia too lowered its policy rate by a cumulative 50 bps in november-december to support growth given the manageable level of inflation. the latest policy rate cut comes from thailand, where the central bank slashed rates by 25 bps to counter the impact of flood-related damage on growth. the stance of central banks in the rest of asia-Pacific, barring india, has remained unchanged in the past few months. the banks are still assessing the evolving economic scenario in an environment where downside risks to growth have shot up because of deteriorating growth prospects in the eurozone. reserve Bank of india is probably the only central bank in the region that has increased rates
Chart 2
aggressively to combat elevated inflationary pressures. But it too is likely to pause in its rate hikes in the wake of faltering growth and to assess the impact of previous rate hikes on the economy. central banks in Malaysia, korea, and the Philippines have refrained from announcing any further interest rate hikes in recent months, following sharp rate increases in the first half of the year. chinas central bank increased policy rates by a cumulative 75 bps in 2011 so far. But the bank cut its reserve requirement ratio by 50 bps in november 2011 in response to increasing downside risks to growth from global headwinds. in our opinion, this action marks the beginning of chinas first monetary easing since 2008.
Currencies Likely To Remain Under Pressure Until Early 2012; Capital Inflows Could Return In The Second Half
We expect foreign capital inflow into asia-Pacific to remain weak in early 2012 mainly due to weak global cues. this is based on the assumption that the eurozone will suffer a mild recession in the first half of 2012 and a moderate recovery thereafterin line with Standard & Poors projections. capital inflows could therefore return to the region in the second half of 2012, causing domestic currencies to appreciate. in Japan, new Zealand, and australia, safe haven investments could cause domestic currencies to appreciate more sharply and earlier than in the rest of the region. countries in asia-Pacific have witnessed strong capital outflows, especially since the eurozone sovereign debt crisis intensified in mid-2011. Much of the gains from currency appreciation in the first half of 2011, therefore, were trimmed in the second half of the year, particularly in indonesia, Malaysia, and thailand (see chart 2). this has again highlighted the regions vulnerability to events in advanced economies. in contrast, a flight to safety caused a surge in capital inflows in Japan, new Zealand, and australia, causing domestic currencies to appreciate sharply against the u.S. dollar. the Japanese yen appreciated by 5.1% in the third quarter of 2011, from 0.9% in the first half of 2011, causing the Japanese central bank to intervene on three
Exchange Rate Movements 2011: Regional Currencies Versus The U.S. Dollar
January-June July-September
Australian dollar New Taiwan dollar Korean won New Zealand dollar Singapore dollar India rupee Chinese renminbi Malaysian ringgit Japanese yen Philippine peso Hong Kong dollar Indnesian rupiah Thai baht Vietnamese dong -8 -6 -4 -2 0 2 4 6 8 10
Note: A negative change implies appreciation of the currency against the U.S. dollar and a positive change refers to depreciation. Sources: Standard & Poors Asia-Pacific economic research and CEIC database.
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occasions so far in 2011. Bank of Japan sold yen in the domestic market to protect the sharp appreciation in the currency, which could further harm export earnings. the new Zealand dollar too appreciated, by 4.1% in the third quarter of 2011, from 5.2% in the first half of 2011, as demand for the currency remained strong. the australian dollar, on the other hand, saw relatively lesser appreciation of 1.2% in the third quarter of 2011, from 7.2% in the first half of 2011. this was possibly due to the central banks policy rate cuts in response to falling inflation. the Singapore dollar has until now been on an appreciating trend, with the central bank adopting a mild appreciation stance until october 2011. the currency strengthened by about 1.2% in the third quarter of 2011, from 4.9% in the first half of the year. therefore, we expect the pace of appreciation to slow in the fourth quarter of the year. Meanwhile, the Philippine peso appreciated by a modest 1.1% against the u.S. dollar in the third quarter of 2011, compared with 0.9% in the first half of the year, as private remittances remained strong and net portfolio inflows surged on the back of recent credit rating upgrades. the chinese renminbi appreciated by 1.8% compared with 2.3%. nevertheless, currencies of several countries depreciated sharply in the third quarter of 2011. the korean won depreciated the most, by 10.5% during this time compared with an appreciation of 5.9% in the first half of the year. the Vietnamese dong fell sharply due to the central banks repeated devaluation. in india, the rupee fell by 8.9% during the third quarter of 2011 largely as a consequence of dollar piling by domestic corporate entities to repay huge foreign currency loans due in the year. Sharp foreign capital outflows pushed the Malaysian ringgit down 5.6% and the taiwanese dollar down 5.0%, compared with an appreciation of 2.0% and 6.3%, respectively. in indonesia, central bank intervention capped the fall of the rupiah to 2.6%. the rupiah had appreciated by 4.4% in the first half of 2011. the thai baht fell by 1.4%, compared with 2.0%. the baht was affected not only by the european crisis, but also by the worsening economic outlook due to the impact of the recent floods.
the risk of a prolonged recession in the eurozone and weaker growth in other advanced economies increases the risk of sudden and further capital outflows from markets in asia-Pacific and therefore steeper currency depreciation in these countries, at least in the next six months.
Vulnerability To Eurozone Slowdown Remains High

Standard & Poors recently revised its 2012 growth forecast for the eurozone down to 0.4% from 1.5%. lower growth in the eurozone could mean another round of foreign capital outflows, weaker trade, and further currency depreciation in asia-Pacific. in addition, domestic woes such as stubborn inflation in some countries, already depreciated currencies, and reversal of government stimulus threaten to sharply lower growth in asia-Pacific. the global economic crisis of 2008 clearly refuted the decoupling theory and affirmed the existing and growing dependency between the asia-Pacific economies and the
Chart 3
Synchronized Economic Cycles But Divergent Growth Trends

Advanced economies: actual growth Advanced economies: growth trend Asia-Pacific economies: actual growth Asia-Pacific economies: growth trend
(% year-on-year growth) 8 6 4 2 0 -2 -4
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Sources: Standard & Poor's Asia-Pacific economic research and International Monetary Fund.
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We expect GDP growth rates in 10 out of the 14 Asia-Pacific economies to fall in 2012.
Table 3: High Correlation With Growth In Advanced Economies, Europe, And The U.S.
Growth correlation Average growth from 2000 to 2010 (%)
Australia China Hong Kong India Indonesia Japan Korea New Zealand Philippines Singapore Taiwan Thailand Vietnam Sources: Standard & Poor's Asia-Pacific economic research and CEIC database. advanced economies of the u.S., the eMu, and Japan (see chart 3). data show that although higher trade interaction within the asia-Pacific region provides some intermittent buffer, the eventual trade exposures of china, korea, Japan, and the five countries that form a sub-group of the association of Southeast asian nations (aSean), known as aSean-5indonesia, Malaysia, the Philippines, thailand, and Vietnamwith the advanced countries remain high. the region itself has cycles which are well synchronized with advanced economies. only the extent of the impact is lower. this implies that any sharp deterioration in the growth of advanced economies will affect asia-Pacific as well. However, longer-term data also suggest that growth in the advanced economies is on a declining trend, while that in asia-Pacific is on a steady uptrend. While the region remains vulnerable to a slowdown in the advanced economies, the extent of vulnerability differs across countries. Growth in asia-Pacific is highly correlated (over a 10-year period) with growth in the advanced economies, especially the u.S. and europe (see table 3). Japans correlation with the u.S. and europe is the highest, while that of india and china is the lowest. among the aSean-5 economies, correlation with growth in the eurozone is highest for Malaysia (0.77), followed by Vietnam, thailand (0.71), and the Philippines (0.66); indonesia shows the lowest correlation (0.32). Hong kongs growth shows the highest correlation (0.81) with the eMu, followed by korea (0.76), Singapore (0.59), and taiwan (0.59). australia and new Zealand show a correlation of 0.64 with the eurozone. countries where growth shows a higher correlation with the eurozone than with the u.S. are Vietnam, china, indonesia, and india. 3.1 10.3 4.4 7.3 5.2 0.9 4.6 2.5 4.7 6.0 4.1 4.4 7.2
Advanced economies
0.7 0.3 0.9 0.3 0.3 1.0 0.8 0.7 0.7 0.7 0.8 0.8 0.7
Europe
0.6 0.3 0.8 0.2 0.3 0.9 0.8 0.6 0.7 0.6 0.6 0.7 0.7
The U.S.
0.6 0.2 0.9 0.3 0.3 1.0 0.8 0.8 0.7 0.7 0.8 0.9 0.7
Growth Could Plummet, But Inflation Might Go Down As Well

economic growth in asia-Pacific could fall sharply in 2012, in line with lower growth forecasts for the u.S. and a mild recession in the eurozone. in addition to dampening export demand, moderation in domestic private consumption and
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Table 4: Asia-Pacific Growth And CPI Inflation Forecasts

Annual real GDP growth (%)
Australia China Hong Kong India Indonesia Japan Korea Malaysia New Zealand Philippines Singapore Taiwan Thailand Vietnam
Annual CPI inflation 2012f

2.2-2.7 7.7-8.2 2.5-3.0 6.8-7.3 6.0-6.5 1.5-2.0 2.8-3.3 4.4-4.9 1.8-2.3 4.0-4.5 2.0-2.5 2.3-2.8 3.5-4.0 5.0-5.5
2009
1.3 9.1 (2.8) 6.8 4.5 (5.2) 0.2 (1.7) 0.1 1.1 (1.3) (1.9) (2.2) 5.3
2010
2.7 10.3 7.0 8.9 6.1 4.0 6.2 7.2 1.7 7.6 14.5 10.9 7.8 6.8
2011f
1.8-2.3 8.8-9.3 4.3-4.8 7.3-7.8 6.1-6.6 (1.0)-(0.5) 3.5-4.0 4.2-4.7 1.0-1.5 4.1-4.6 4.3-4.8 4.0-4.5 2.6-3.1 5.6-6.1
2009
1.8 (0.7) 0.5 10.9 4.9 (1.4) 2.8 0.6 2.1 3.2 0.6 (0.9) (0.9) 6.9
2010
2.8 3.3 2.3 12.0 5.1 (0.7) 2.9 1.7 2.3 3.8 2.8 1.0 3.3 9.2
2011f
3.2-3.7 5.1-5.6 5.3-5.8 8.7-9.2 5.2-5.7 (0.5)-0.0 4.2-4.7 3.1-3.6 4.0-4.5 4.4-4.9 4.8-5.3 1.2-1.7 3.4-3.9 18.4-18.9
2012f
2.3-2.8 3.7-4.2 2.5-3.0 5.8-6.3 5.2-5.7 (0.5)-0.0 2.3-2.8 2.8-3.3 1.5-2.0 4.2-4.7 2.1-2.6 1.0-1.5 3.5-4.0 9.9-10.4
CPIConsumer Price Index. fForecast. Sources: Standard & Poor's Asia-Pacific economic research and CEIC database. investment (due to reversal of fiscal stimulus) and lagged impact of tighter monetary policy (to tackle high inflation) will likely bring down growth. accordingly, we expect GdP growth rates in 10 out of the 14 asia-Pacific economies to fall in 2012 vis--vis 2011. We anticipate growth in Japan and new Zealand to rebound in 2012, mainly due to higher government expenditure and reconstruction (for earthquake damage), which will promote higher consumption and investment. our inflation forecasts for 2012, however, have also been sharply revised downward for all asia-Pacific economies (see table 4) on the back of the global slowdown and some respite from global commodity prices. the impact of past rate hikes in several economies will also be felt on consumption. Given that these conditions hold, inflation in most economies could fall steadily, inviting monetary policy reversal. nevertheless, upside risks to our inflation forecast arise from continued depreciation of currencies, which could keep imported inflation at elevated levels. clearly, the risks to forecasts are higher and rising on the downside, given the limited tools that governments and central banks have at their disposal to evade a severe impact of an unanticipated global shock. Hence most of the forecasts for growth and inflation apply to our basecase scenario of a eurozone recession in the first half of 2011 and a modest recovery thereafter. a prolonged period of eurozone recession or an unexpected global shock could yield much lower growth and inflation in 2012.
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a S i a - Pa c i f i c c r e d i t M a r k e t S outlook
A Slowdown In Europe And China, And Sluggish Exports Moderate Asia-Pacific Credit Outlook In 2012
Contact: Ian Thompson, Managing Director, Chief Credit Officer, Asia-Pacific, Melbourne (61) 3-9631-2100; ian_thompson@standardandpoors.com
Published on RatingsDirect Global Credit Portal on Dec. 20, 2011
global
riSkS have SteadilY increaSed over the Year, with
economic growth marked down. Brittle market confidence is manifesting in liquidity and funding pressures, particularly in the european economic and Monetary union (eMu or eurozone), with a knock-on effect on the rest of the world. While emerging markets are holding up, the base case is for weak growth in the u.S. and a mild recession in the eurozone in the first half of 2012. this has led to greater dependency on chinas growth. in Standard & Poors ratings Services opinion, the eurozone crisis poses risk, albeit indirect, to sovereigns and banks in asia-Pacific. nevertheless, the inherent strengths of the regional governments and financial institutions partly mitigate the risk. Meanwhile, the slowdown in the global economy and china is likely to continue to affect export-dependent companies in asia-Pacific. in contrast, the infrastructure and utility subsectors are poised for growth, which demographic needs will partly propel. We expect the structured finance sector to maintain its stable asset performance into 2012. the deleveraging process continues in advanced economies, with the eurozone mired in a sovereign debt crisis and government austerity measures further dampening growth. Global banks are generally becoming increasingly risk adverse, tightening credit standards, lending less, and being more aggressive on problem exposures. Given previous fiscal spending, bank bail-outs, and low interest rates, the capacity of Western governments to fight off recessionary pressures is limited. in stark contrast, economic growth fundamentals and government fiscal positions in asia-Pacific are generally sound. the region, however, cannot remain immune to the problems in the advanced economies given that europe is an important trading partner. export growth is likely to weaken in early 2012, although the region should remain cost-competitive, notwithstanding some pressures such as wage growth in markets such as china, Vietnam, and thailand. domestic demand and intraregional trade is holding up and inflationary pressures are easing given commodity prices that are lower than they were a year
ago. as a consequence, we expect monetary tightening to reverse, as is already the case in some markets, such as australia, china, and indonesia. issues to watch for in asia-Pacific in 2012: eurozone instability: Volatile surges in capital inflows and rapid reversals are likely as investors vacillate between higher returns and increased safety. Surging capital flows may reignite inflationary pressures, distort currency values, and create asset bubbles. chinas growth: While we expect chinas growth to moderate to a sustainable 8% in 2012, a hard landing in china would have a significant impact on the regions growth outlook. the resilience of domestic demand in the context of weakening exports will be critical. export softening: exports could fall sharply as demand in the developed markets remains constrained. the risks are higher for korea, taiwan, and Singapore.
Eurozone Crisis Could Pressure Sovereign Ratings

Mounting challenges across the globe could severely test the resilience of sovereigns in asia-Pacific. the uncertainty over sovereign debt and banking sector stability in the eurozone is by far the biggest of these challenges. unless sentiments are stabilized by appropriate policy actions, the confidence crisis in europe could significantly affect asia-Pacific sovereigns through tighter funding conditions, persistent risk aversion, and volatile capital flows, or a credit freeze. a recession in europe and slower growth in the u.S. would lower demand for exports from asia-Pacific. of the 22 sovereigns that we rate in asia-Pacific, 16 have stable outlooks on their ratings. indonesia, Mongolia, the Philippines, and Sri lanka have a positive outlook, and only two sovereign ratings are on negative outlooks: Japan, and Vietnam (see table 1). However, should the extreme eurozone-related risks materialize, ratings on a number of highly-indebted sovereigns and sovereigns vulnerable to weaker external funding conditions will come under pressure.
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Mounting challenges across the globe could severely test the resilience of sovereigns in Asia-Pacific.
Governments in export-driven economies would have to provide more fiscal and monetary stimulus to support growth and employment, and avoid social tensions. Such an impetus may prompt a surge in capital inflows, fueling inflationary pressures. a balancing act, then, may be challenging. additionally, some governments in the region are yet to address the longer term issues of aging populations, rebalancing growth, and broader financial reforms.
Table 1: Asia-Pacific Sovereign Ratings*

Country
Australia Bangladesh Cambodia China Cook Islands Fiji Hong Kong India Indonesia Japan Korea Malaysia Mongolia New Zealand Pakistan Papua New Guinea Philippines Singapore Sri Lanka Taiwan Thailand Vietnam
Foreign currency rating

AAA/Stable/A-1+ BB-/Stable/B B/Stable/B AA-/Stable/A-1+ B+/Stable/B B/Stable/B AAA/Stable/A-1+ BBB-/Stable/A-3 BB+/Positive/B AA-/Negative/A-1+ A/Stable/A-1 A-/Stable/A-2 BB-/Positive/B AA/Stable/A-1+ B-/Stable/C B+/Stable/B BB/Positive/B AAA/Stable/A-1+ B+/Positive/B AA-/Stable/A-1+ BBB+/Stable/A-2 BB-/Negative/B
Events In Europe Pose Indirect Risk To Asia-Pacific Banks

the speed and effectiveness with which the european debt crisis is alleviated will determine the 2012 outlook for banking systems in asia-Pacific. Banks in asia-Pacific generally have little direct exposure (largely short-term trade finance) to the eurozone. However, european banks have been reducing their significant exposures in parts of asia-Pacific. consequently, the indirect impact of a dislocation in global funding markets and an economic slowdown in europe could negatively affect these banks. the regions strong economic performance over the past few years has been the biggest supporting factor for the credit profile of asia-Pacific banking systems. economic performance has not only bolstered revenue growth, but also underpinned asset quality. as eurozone weakness dampens global and regional growth, nonperforming loans and credit provisioning are likely to increase. this trend could be more pronounced in banking systems exposed to: high inflation, such as india and Vietnam; and the recent high credit growth, such as china and Hong kong. in addition, banking sector earnings are likely to weaken to reflect a dip in business volumes associated with slower economic activity. contagion from europe could unleash more anxiety in the already jittery credit markets in asia-Pacific. Banks and other lenders in the region are already paying more to insure their debt financing, as reflected in the widening credit default spreads. that said, most banking systems in the region have strong retail deposit bases, which provide a buffer against volatility in wholesale funding markets.
*Ratings as of Dec 19, 2011. Unsolicited rating. dependent banking systems such as australia and korea will likely incur higher funding costs if the eurozone crisis leads to a squeeze in the funding markets. increased domestic funding and a moderation in credit growth could help offset shrinking access to the wholesale funding market. a tightening of credit underwriting standards and lower lending among asia-Pacific banks would challenge the regions corporate sector given the sectors high dependence on bank funding, including that from european banks.
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Table 2: Asia-Pacific Corporate: Business, Performance, And Rating Trends In 2012

Business conditions Industry
Home Builders/Property developers REITs Autos Auto components Capital goods Transportation Consumer products Retail Hi-tech Media/Entertainment Gaming Telecommunications Chemicals Oil and gas upstream Oil and gas downstream Mining and metals Steel Banking Infrastructure/Utilities* Building materials
Relative Performance business trends metrics 2011 versus 2012

No change Stable Slight improvement Slight improvement Stable No change Stable Stable
Expected ratings trend 2011 versus 2012
Industry outlook Next 12 months

Negative Stable Stable Stable Stable Negative Stable Stable Negative Stable to negative Stable Stable Stable Stable Stable Stable to negative Negative Stable to negative Stable Stable
2011
Weak Satisfactory Weak Weak Satisfactory Weak Satisfactory Satisfactory Weak Satisfactory to weak Strong Strong Strong Strong Satisfactory Satisfactory Weak Satisfactory Satisfactory Satisfactory
2012
Weak Satisfactory Satisfactory Satisfactory Satisfactory Weak Satisfactory Satisfactory Weak Weak Strong Strong Satisfactory Strong Satisfactory Satisfactory Weak Weak Satisfactory Weak
2011 versus 2012
Somewhat weaker Negative Stable Slight improvement Slight improvement No change No change Stable Stable Stable Stable to negative Stable to negative Stable Stable to negative Stable Stable Stable to negative
Somewhat weaker Slight improvement
Somewhat weaker Somewhat weaker Stable to negative Stable Stable Stable Stable Stable Somewhat negative No change No change Stable Stable Stable Stable Stable Somewhat negative No change No change Stable Stable Stable Stable Stable Negative Negative Stable
Somewhat weaker Somewhat weaker Stable to negative Somewhat weaker Somewhat weaker Stable
*The outlook on Japanese utilities is negative
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Asia-Pacific Corporates: Exporters Vulnerable To Global Slowdown

our 2012 credit outlook for the asia-Pacific corporate sector is generally stable with patches of weakness (see table 2). economic growth prospects in the region are still resilient despite a softer u.S. economic outlook and the uncertainty surrounding european sovereign risks. asian economies are also showing signs of slowing down. export growth in major export-oriented countries has been losing steam for the past few months. While a double-dip recession in developed economies is not our base-case scenario, it would have a deeper and more prolonged impact on asia-Pacific economies compared with previous global crises. exports and export-dependent industries in korea, Japan, taiwan, and china would suffer heavily from such a recession. We assess the credit outlook for selected mining and metals, transportation, high technology, and consumer electronic sectors in asia-Pacific to be negative in 2012. our opinion is based on the weaker export outlook stemming from subdued global consumer demand, overcapacity in specific industries, and high fuel prices. our outlook on the chinese real estate sector is also negative. the chinese governments initiatives to bring down economic growth to more sustainable levels, and control asset bubbles, in particular in its property market, underpins our view. the conditions for chinese residential property developers are the toughest faced by players in the asiaPacific real estate markets. chinese companies continue to face liquidity risks and weak sales prospects. the smaller players are likely to be vulnerable in the next six to 12 months due to their limited financial flexibility, small scale, and project concentration. chinas (managed) economic slowdown at a time when the global economy is in the doldrums is contributing to negative pricing trends for steel, nickel, aluminium, and possibly coking coal. the steel industries in china, korea, and Japan face the most difficulty as demand from enduse sectors in china weakens on the back of reduced government stimulus for infrastructure and a weakening real estate construction market. Steel producers are therefore likely to realize lower capacity utilization and cut
prices. the ratings on steel producers have little cushion for weaker cash flow coverage. in 2012, transportation-related companies will still face the common challenges of high fuel prices and lower demand stemming from a weakening global economy. for airlines, subdued passenger demand growth, high jet fuel prices (since the third quarter of 2011), and potential additional capacity from a new generation of low-cost carriers in asia-Pacific will pose problems. for the shipping industry, oversupply, high bunker fuel prices, and emerging environmental requirements, point to an unfavorable outlook. High technology and consumer electronics companies will continue to suffer from weak global demand; intense competition; and commoditization of key products such as flat-panel tVs, mobile handsets, and digital cameras. excess capacity in products such as tVs, lcd panels, and draM, add to companies woes. Supply disruptions of electronic products and components due to largescale flooding in thailand have also hindered companies performance. But we expect these disruptions to moderate by the first quarter of 2012. We believe that major investment-grade-rated companies should be able to cope with the more challenging year ahead, and be better placed to take advantage of accelerating consolidation. companies operating in china may continue to face rising wages and higher interest rates. these factors could constrain profit growth compared with that in the past few years. the corporate sectors debt maturities are not likely to be heavy in 2012, reflecting companies efforts to spread maturities. nevertheless, some sectors and entities could face reduced access to funding. refinancing requirements are manageable for asia-Pacific corporate entities with investment-grade ratings. However, liquidity and refinancing will remain dominant credit drivers for lowerrated entities.
Infrastructure And Utilities Will Build On Growth Despite Challenges

notwithstanding the effects of a slowdown in the u.S. and europe, we expect asia-Pacifics public as well as private
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Long-term funding will continue to lag long-term demand for infrastructure investment in the region.
infrastructure sector to continue to expand in 2012. Strong demand, broad-based economic activity, significant ongoing capital expenditure requirements, and favorable demographics should continue to fuel growth in several sectors. these include power, transportation, and social infrastructure. We anticipate that companies will use bank debt as a primary source of funding. We also expect companies to raise debt via bonds and hybrid issuances as and when opportunities arise. Several utilities in asia-Pacific issued hybrid instruments for the first time in 2011 and we expect this instrument to be important in the corporate structure both from a credit perspective and also the benefit of not diluting equity. long-term funding will continue to lag long-term demand for infrastructure investment in the region. Most of the infrastructure and utility companies we rate in the region, barring the utilities sector in Japan, will remain stable in 2012. nevertheless, the uncertainty of a prolonged global slowdown and its impact on GdP rates across asia-Pacific could pose credit risks for some companies. Some economies in the region, such as Singapore, thailand, and the Philippines, rely heavily on export driven income, and any slowdown in global growth may affect their economic growth. But for countries that have sizable domestic economies, such as india, china, and indonesia, the impact of another slowdown may not be as much. across the region, the effects of government and regulatory actions on utilities will vary depending on: (1) the tariff framework and domestic inflation in a particular country, which may delay tariff increases; (2) the availability of, and ability to, secure fuel sources domestically amid rising competition (e.g. Japan, korea, Hong kong, Singapore, the Philippines, thailand, and india); and (3) the extent of government subsidies to electricity producers such Pt Perusahaan listrik negara (Persero) (BB/Stable/) in indonesia and tenaga nasional Bhd. (BBB+/negative/; axa+/axa-1) in Malaysia.
Stable Asset Performance Supports Structured Finance Stability

the stable performance of assets underlying securitization transactions in asia-Pacific, with the exception of Japanese commercial real estate, will likely continue in 2012, in our opinion. Modest macroeconomic growth forecasts, low regional unemployment rates, easing monetary policy, and well-seasoned asset portfolios underpin our view. We expect Japanese commercial real estate-backed transactions to continue to underperform in 2012 reflecting the ongoing refinancing challenges that commercial real estate borrowers in Japan and elsewhere in the world continue to face. Stable asset performance and continued build up of credit enhancement in many residential mortgage-backed securities (rMBS) and asset-backed securities transactions (as underlying asset pools pay down) will support rating stability in 2012. conversely, counterparty exposures may pose a risk to rating stability in 2012. Many securitization transactions in asia-Pacific contain interest rate or currency exposures or both to u.S. and european financial institutions. Standard & Poors therefore believes that the regions structured finance sector will remain largely stable in 2012, subject to global sovereign and banking credit performance and issuers response, should we downgrade key transaction counterparties. in 2012, our ratings on a small number of transactions could also be affected by the application of the revised counterparty criteria, published in december 2010 and expanded in June 2011, as well as the updated australian rMBS criteria, published in September 2011. the sectors overall performance in 2011 was in line with our expectation for continued stable performance in most asset classes with the exception of expected weakness in Japanese commercial real-estate related transactions. this is despite the impact of the global economic uncertainty and localized catastrophes during the year, such as the earthquake and tsunami in Japan, floods in australia, and the earthquake in new Zealand. delinquency and default
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rates in asia-Pacific have largely remained low and tracked historical norms for most asset classes. and although delinquency rates in certain pockets have spiked from time to time, they have tended to revert to trend. reflecting the more positive regional macroeconomic fundamentals, regional banks and corporate entities have also generally performed well over the past three years.
Standard & Poors (Australia) Pty. Ltd. holds Australian financial services licence number 337565 under the Corporations Act 2001. Standard & Poors credit ratings and related research are not intended for and must not be distributed to any person in Australia other than a wholesale client (as defined in Chapter 7 of the Corporations Act).
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a S i a - Pa c i f i c e Q u i t Y M a r k e t S outlook
Asian Equities Markets: Doomsday Fears Should Subside In 2012

Contact: Lorraine Tan, Vice President and Head of Asia Research, S&P Capital IQ Equity Research, Singapore (65) 6239-6348; lorraine_tan@ standardandpoors.com an eye to some cyclical issues in order to participate in any confidence and earnings recoveries. the S&P asia 50 is presently trading on around 1.5x PBV, not far from the financial crisis trough of 1.3x. Given the uncertainty surrounding earnings, we prefer to refer to the PBV to provide the benchmark entry levels for the market. nonetheless, we note that the S&P asia 50 is trading on a relatively attractive 9.6x 2012 Per given that ePS growth is anticipated to be 11.0% year-on-year based on S&P capital iQ market consensus estimate. our yearend target is 3,500 points, indicating a return of around 12.9% from the nov. 18 close of 2,991.9 points. this prices the S&P asia 50 at 1.8x 2012 PBV and 10.9x 2012 Per, which stays on the low end of its historical trading range. on a specific country basis, our preference is Hong kong (which includes the china H-shares) and korea. We are overweight these two markets largely on valuation grounds, given that they are trading close to their trough PBV levels. With our view that the global economic outlook will improve through 2012, we believe higher beta markets Editors Note: This guest article represents the views of S&P Capital IQ Equity Research, a separate division from Standard & Poors Ratings Services.
S&P caPital iQ eQuitY reSearch
believeS that riSkS reMain
high to equities as 2012 rolls around but the doomsday fears should subside as the year unfolds and this should underpin equity market performance. We see positive catalysts coming from more accommodative monetary policy, reduced cost pressures and resilience in u.S. consumer spending. our view is also based on our expectation for the u.S. to avoid a recession. also we expect more conducive policy developments in the eurozone over the next six months. While risks remain to earnings outlooks, share prices have been beaten down and price-to-book value (PBV) ratios for some markets are not far from historical trough levels. With S&P asia 50 earnings per share (ePS) projected to grow a weighted average 10%-11% in 2012, we believe asia-Pacific markets should see returns ranging from 10%-15% in 2012. as a result, we think a neutral stance is warranted with one foot on defensives but with
Table 1: Recommended 2012 Market Weightings And Target

As of Nov. 18
Australia China-A China-H Hong Kong India Indonesia Japan Malaysia Philippines Singapore South Korea Taiwan Thailand S&P ASX 200 Shanghai Composite HS China Enterprise Hang Seng S&P CNX 50 Jkt Comp Nikkei 225 FBM KLCI PComp FSSTI KOSPI TAIEX SET S&P Asia 50 Source: S&P Capital IQ Equity Research, Bloomberg
Standard & PoorS aSia-Pacific MarketS outlook 2012 19
YTD Return
-12.0% -13.9% -21.5% -19.7% -20.0% 1.4% -18.1% -4.2% 2.4% -14.4% -10.3% -19.4% -4.7% -15.1%
2012 Target
4,800 2,900 12,400 21,800 5,600 4,300 9,400 1,660 4,800 3,100 2,200 8,400 1,100 3,500
Upside from Recommended Current Weighting

14.9% Marketweight 20.0% Marketweight 24.5% Overweight 17.9% Overweight 14.2% Marketweight 14.5% Underweight 12.2% Marketweight 14.1% Underweight 11.6% Underweight 13.5% Marketweight 19.6% Overweight 16.1% Marketweight 11.8% Underweight 17.0%
4,177 2,417 9,957 18,491 4,906 3,755 8,375 1,454 4,302 2,730 1,839 7,234 984 2,992
We believe a bit of positive news will have a marked impact on the equity markets.
should see a better year-end performance. obviously, for 1Q, the defensive markets may continue to lead. We believe there is value in Japan also but among developed markets, the u.S. may be preferred by investors. Sector-wise, we are overweight consumer Staples, energy and Banks. Given lingering risks, we are taking a neutral stance in the sector weightings. We regard consumer Staples as the more attractive defensive sector with active mergers & acquisitions activity to sustain interest and falling raw material costs to boost margins. energy remains a favorite with potential geo-political risks and diminishing excess inventories in the u.S. to support the oil price. the prospect of monetary expansion may also keep interest in energy as an inflation hedge. Banks is our preferred high-beta bet. near term sentiment is skittish but relaxation of restrictive lending and broad monetary policies in the region provides a potential boost while positive trends in interest margins should help offset the risk of increased provisions.
interest rate cuts and further accommodative monetary policy in the eurozone; a resolution or settling of new financial system regulations and requirements so that banks can focus back on the business of lending; continued strength/uptick in asian domestic activity; a pick up in u.S. jobs creation; and, Breakthroughs in eurozone debt policies including: (i) a successful leveraging of the efSf; and (ii) passage of growth-centric reforms in italy. any of the above should provide a confidence boost although we suspect that latter two would have more significant impacts on global equities. to some extent the relaxation of monetary policy is now expected and so the initial moves may see limited reaction. nonetheless, falling interest rates will tend to support equities ultimately improving the relative attraction of stocks to bonds and cash and also augurs favorably in terms of liquidity in the system that can be channelled to the stock market.
Positive Catalysts Will Go A Long Way

Because the markets have been consolidating for much of 2H11, we see limited selling pressure. although the capitulation that normally denotes the bottom of a market has not been seen, investors have endured a wave of bad news with periodic shake-outs and high volatility. as such, we believe a bit of positive news will have a marked impact on the equity markets. in any case, we believe positive u.S. GdP growth should underpin global demand and help lift asian markets once headline debt worries subside. the prospect for interest rate cuts is going to be a key driver of resilience for markets in asia. in addition, although we see asian consumers holding back in the near term which could lead to disappointing christmas and lunar new Year spending relatively low debt levels and still comfortable liquidity should signal a quick rebound once sentiment recovers. upticks may be triggered by the following: relaxation of monetary policy in this region notably, cuts in chinas banks reserve requirement ratios; reversal of prohibitive residential property purchase policies in china, Hong kong and Singapore;
But Near-Term Risks Are Ample

near-term risks remain significant with no respite to the eurozone debt worries and the high eurozone bond yields. an escalation of the debt contagion may well lead to a financial crisis and a global recession. Besides the global growth and eurozone debt uncertainty, its hard to know what mother-nature will throw at us, but the following could be some of the other potential risks that may give us another down year in returns. Prolonged uncertainty in eurozone debt policy that leads to continued elevated bond yields and banking system stress; Bankruptcy or similar financial stress by a global financial institution that may be the result of ongoing debt stress in europe coupled with income shortfalls; disappointing u.S. economic activity; Geopolitical flare-up notably surrounding irans nuclear program. any supply side shock to crude oil could send markets down sharply; and, Slow responses by asian governments and central banks to sliding domestic activity.
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Chart 1
Chart 2
Asian Markets Price-to-Book Value vs. Return On Equity

30 25 Return on Equity (ROE) 20 15 10 5 0 Relatively Expensive 0 0.5 1.0 1.5 2.0 2.5 3.0
Price-to-Book Value (PBV)
Source: Bloomberg, S&P Capital IQ Equity Research.
Relatively Attractive China-H Singapore Hong Kong Thailand
Indonesia India Philippines
Some Asian Markets Trading Close To Historical Trough Level Price-to-Book Value
S&P/ASX 200 Jakarta Comp Shanghai Comp Nikkei 225 Hang Seng KOSPI S&P CNX 50
7 6 5 4 3 2 1 0 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11
Source: Bloomberg.
Malaysia Taiwan China-A
Au str
ali
Korea Japan
at this stage S&P economists do not anticipate that the u.S. will slip into a recession but the risks stay high at 35%. S&P capital iQ equity research also notes that the potential for a recession in europe is high given continued weakness in PMi data. Should the u.S. economy turn in a series of disappointing numbers, we see investors returning to the sidelines and a ratcheting down of earnings expectations.
China Banks Risks Manageable

Because of rampant lending in 2009 and 2010 in the aftermath of chinas cnY4.4 trillion financial crisis stimulus, there as been much fear built around risks to chinas banks. S&P capital iQ equity research believes that the continuous decline in non-performing loan values in absolute terms gives greater levels of comfort that the local government debt concern is still well-contained. all eyes will undoubtedly be on the creditworthiness of the cnY2.63 trillion that matures this year, the first real test for the banking system following the lending binge over the last two years. the property market is showing some early signs of strain, but well within expectations given the multiple
headwinds of rising mortgage rates, tightening liquidity and a series of restrictive measures. Banks indicated average loan-to-value ratios of 60% for the property segment will see earnings shaved by about 30%-40% on a 50% fall in collateral values, an instance which will be painful for banks no doubt, but not catastrophic. S&P capital iQ equity research real estate analyst expects only a 15%20% decline in home prices in the medium term.
Recommended Market Weightings

Given our expectation for some reversion to mean, and for risk appetite to recover, our market weighting recommendations are skewed towards those markets that have fallen more in 2011. Market Per, potential ePS growth, PBV and return on equity ratios are also considered. We also favour markets trading closer to historical trough PBV levels given the uncertain earnings outlooks. Based on these factors, we are overweight Hong kong, china H-shares and korea. We also see a potentially robust uptick for some Japanese stocks although we
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Table 2: Asian Markets Consensus Estimate PER And EPS Growth

Country
Australia China-A China-H Hong Kong India Indonesia Japan Malaysia Philippines Singapore South Korea Taiwan Thailand Median S&P Asia 50 Source: Bloomberg maintain a neutral stance on the market as a whole due to the likely investor preference for u.S. shares among the developed market space and the potential for a larger bounce in the S&P euro 350. Market valuations have compressed in asia given the broad weakness experienced in 2011. this means that markets that have traditionally traded at premium Pers including Japan, china and india are now hovering close to the regional average. Given this valuation compression coupled with a narrowing in economic growth expectations, S&P capital iQ equity research believes there is a potential for fairly robust performance all around. for our preferred market picks, therefore, S&P capital iQ equity research sees china managing to land softly, and the Hong kong market and H-shares staying the best proxy to china growth. our preference for Hong kong is also due to it trading close to its historical low trough PBV, which we believe indicates that a fair degree of risk is reflected in current prices. We note that Japan is trading near its historical trough PBV level also, which makes for a compelling entry point for Japanese shares at this juncture. However, we see greater full year potential for korea. in addition, we believe koreas electronics and technology firms should continue to outperform its neighbours, Japan and taiwan, due to relatively better returns on investments and lesser excess capacity. We are underweight the aSean sub-region given the relative outperformance in 2011. We believe that investors will gravitate towards beaten down markets where share price rebounds are potentially more sizeable as risk appetite returns. Valuations for aSean are less compelling especially since GdP growth should slow to the sub-5% level and disruptions from the thailand floods will also hit activity. We see risk to some earnings numbers from the region as a result. 2,992
Index
S&P ASX 200 Shanghai Composite HS China Enterprise Hang Seng S&P CNX 50 Jkt Comp Nikkei 225 FBM KLCI PComp FSSTI KOSPI TAIEX SET
As of Nov. 18
4,177 2,417 9,957 18,491 4,906 3,755 8,375 1,454 4,302 2,730 1,839 7,234 984
2011 PER x
11.4 11.4 8.3 10.1 13.9 14.7 15.5 14.1 14.2 12.9 9.7 15.1 11.5 12.9 10.3
2012 PER x
10.2 9.6 7.4 9.2 11.9 12.3 12.7 13.2 12.6 12.0 8.6 12.6 10.1 11.9 9.3
2011 EPS Growth

43.1% 33.7% 15.9% 8.5% 8.3% 44.5% 8.2% 18.2% -1.6% -20.7% 36.2% -15.9% 25.5% 15.9% 16.9%
2012 EPS Growth

11.1% 19.9% 12.1% 9.3% 17.0% 19.1% 22.3% 6.7% 12.5% 7.0% 13.1% 19.4% 13.9% 13.1% 10.6%
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Table 3: Recommended 2012 Sector Weightings Ratios Based On S&P Capital IQ Consensus Estimates
YTD Rtn %
Consumer Discretionary Consumer Staples Energy Financials Banks Financials Insurance Financials Real Estate Industrials Information Technology Materials Telecom Services Utilities Source: S&P Capital IQ 13.3 (1.9) (3.6) (23.2) (27.2) (26.1) (19.3) (4.6) (17.9) (0.3) 5.6
PER 2012 X
9.8 12.8 8.5 6.5 12.9 11.1 12.0 10.8 9.8 10.4 15.3
EPS 2011 YoY %

9.9 41.3 38.1 39.7 131.4 (10.5) 1.7 (11.8) (17.3) 25.7 8.3
EPS 2012 Div Yld 2012 PBV 2012 Recommended % est. % X Weighting
11.3 13.7 6.3 9.1 38.9 (25.4) 1.4 17.7 21.2 3.1 25.3 1.3 2.4 4.2 6.2 2.1 3.8 3.3 2.7 6.1 4.7 3.2 0.91 Marketweight 1.74 Overweight 1.36 Overweight 1.17 Overweight 1.87 Marketweight 0.70 Marketweight 1.15 Marketweight 2.01 Marketweight 1.28 Marketweight 1.79 Underweight 1.94 Underweight
Preference For Consumer Staples, Energy & Banks

We stay with a relatively neutral sector stance for 2012 in order to find a balance between potential turnaround and growth potential as well as to mitigate near-term risks. We recommend that investors continue to stay defensive in the short-term but a 10% or so drop in december 2011 or in 1Q12 may present buying opportunities, in our view. our preferred christmas shopping list would include consumer Staples and energy issues while Banks present a higher beta option to hold through 2012. We see more limited positive catalysts for telcos and utilities given relatively high valuations. despite being fundamentally defensive, asian consumer staples are anticipated to see continued robust ePS growth. 2012 income should be underpinned by improved profit margins from lower raw material costs with soft commodity price pressures easing. Merger & acquisition interest should also keep interest high in the sector. While we see a more benign oil price environment, valuations of energy issues are still relatively comfortable, trading on 8.5x 2012 Per and 1.4x PBV. although ePS growth should fall to 6.3%, upside potential is likely as global demand recovers.
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also, we find upstream companies to be a decent hedge against geopolitical risks and a potentially weaker uSd. We are neutral on Materials issues, as excess capacity in some segment may dampen performances, although we note that select metalsnotably copper issuesmay also benefit from a similar rebound as the oil & gas companies. We see asian banks as presenting a compelling high beta play despite global investor avoidance of financials as a whole. We believe that at 6.5x 2012 Per, 9.1% ePS growth and 1.2x PBV, a fair degree of risk has been reflected in current share prices. asian banks have limited direct exposure to european banks. even those with direct activity in the eurozone, such as HSBc, are seen to have manageable risks. loans growth in asia should slow but relatively robust net interest margins should help offset increased provisions. Given our expectation for markets to turnaround in 2012, we are underweight the telecommunications and utilities sectors. Valuations are not particularly compelling after the outperformance in 2011 and we see limited upside catalysts. the S&P asia 50 utilities ePS growth looks high for 2012 at 25.3% but this is skewed by korea electric Power company, which is coming off a low base.
aSia-Pacific MarketS outlook 2012 23
Equity Markets Glossary

S&P STARS
Since January 1, 1987, Standard & Poors equity research Services has ranked a universe of u.S. common stocks, adrs (american depositary receipts), and adSs (american depositary Shares) based on a given equitys potential for future performance. Similarly, Standard & Poors equity research Services has used StarS methodology to rank asian and european equities since June 30, 2002. under proprietary StarS (Stock appreciation ranking System), S&P equity analysts rank equities according to their individual forecast of an equitys future total return potential versus the expected total return of a relevant benchmark (e.g., a regional index (S&P asia 50 index, S&P europe 350 index or S&P 500 index)), based on a 12-month time horizon. StarS was designed to meet the needs of investors looking to put their investment decisions in perspective. data used to assist in determining the StarS ranking may be the result of the analysts own models as well as internal proprietary models resulting from dynamic data inputs.
the creditworthiness of the guarantors, insurers, or other forms of credit enhancement on the obligation.
S&P Core Earnings

Standard & Poors core earnings is a uniform methodology for adjusting operating earnings by focusing on a companys after-tax earnings generated from its principal businesses. included in the Standard & Poors definition are employee stock option grant expenses, pension costs, restructuring charges from ongoing operations, write-downs of depreciable or amortizable operating assets, purchased research and development, M&a related expenses and unrealized gains/losses from hedging activities. excluded from the definition are pension gains, impairment of goodwill charges, gains or losses from asset sales, reversal of prior-year charges and provision from litigation or insurance settlements.
S&P 12 Month Target Price

the S&P equity analysts projection of the market price a given security will command 12 months hence, based on a combination of intrinsic, relative, and private market valuation metrics, including S&P fair Value.
S&P Quality Rankings (also known as S&P Earnings & Dividend Rankings)
Growth and stability of earnings and dividends are deemed key elements in establishing S&Ps earnings and dividend rankings for common stocks, which are designed to capsulize the nature of this record in a single symbol. it should be noted, however, that the process also takes into consideration certain adjustments and modifications deemed desirable in establishing such rankings. the final score for each stock is measured against a scoring matrix determined by analysis of the scores of a large and representative sample of stocks. the range of scores in the array of this sample has been aligned with the following ladder of rankings: a+ Highest Blower c lowest a High aabove average d in reorganization B+ average nr not ranked B Below average
Standard & Poors Equity Research Services

Standard & Poors equity research Services u.S. includes Standard & Poors investment advisory Services llc; Standard & Poors equity research Services europe includes Standard & Poors llc- london; Standard & Poors equity research Services asia includes Standard & Poors llcs offices in Singapore, Standard & Poors investment advisory Services (Hk) limited in Hong kong, Standard & Poors Malaysia Sdn Bhd, and Standard & Poors information Services (australia) Pty ltd.
Abbreviations Used in S&P Equity Research Reports

caGr compound annual Growth rate caPeX capital expenditures cY calendar Year dcf discounted cash flow eBit earnings Before interest and taxes eBitda earnings Before interest, taxes, depreciation and amortization ePS earnings Per Share eV enterprise Value fcf free cash flow ffo funds from operations fY fiscal Year P/e Price/earnings PeG ratio P/e-to-Growth ratio PV Present Value r&d research & development roe return on equity roi return on investment
S&P Issuer Credit Rating

a Standard & Poors issuer credit rating is a current opinion of an obligors overall financial capacity (its creditworthiness) to pay its financial obligations. this opinion focuses on the obligors capacity and willingness to meet its financial commitments as they come due. it does not apply to any specific financial obligation, as it does not take into account the nature of and provisions of the obligation, its standing in bankruptcy or liquidation, statutory preferences, or the legality and enforceability of the obligation. in addition, it does not take into account
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roic return on invested capital roa return on assets SG&a Selling, General & administrative expenses Wacc Weighted average cost of capital dividends on american depository receipts (adrs) and american depository Shares (adSs) are net of taxes (paid in the country of origin). research reports are prepared by Standard & Poors investment advisory Services llc (SPiaS). in the united States, research reports are issued by Standard & Poors (S&P); in the united kingdom by Standard & Poors llc (S&P llc), which is authorized and regulated by the financial Services authority; in Hong kong by Standard & Poors investment advisory Services (Hk) limited, which is regulated by the Hong kong Securities futures commission; in Singapore by Standard & Poors llc, which is regulated by the Monetary authority of Singapore; in Malaysia by Standard & Poors Malaysia Sdn Bhd (S&PM), which is regulated by the Securities commission; in australia by Standard & Poors information Services (australia) Pty ltd (SPiS), which is regulated by the australian Securities & investments commission; and in korea by SPiaS, which is also registered in korea as a cross-border investment advisory company. the research and analytical services performed by SPiaS, S&P llc, S&PM, and SPiS are each conducted separately from any other analytical activity of Standard & Poors. Standard & Poors or an affiliate may license certain intellectual property or provide pricing or other services to, or otherwise have a financial interest in, certain issuers of securities, including exchange-traded investments whose investment objective is to substantially replicate the returns of a proprietary Standard & Poors index, such as the S&P 500. in cases where Standard & Poors or an affiliate is paid fees that are tied to the amount of assets that are invested in the fund or the volume of trading activity in the fund, investment in the fund will generally result in Standard & Poors or an affiliate earning compensation in addition to the subscription fees or other compensation for services rendered by Standard & Poors. a reference to a particular investment or security by Standard & Poors and/or one of its affiliates is not a recommendation to buy, sell, or hold such investment or security, nor is it considered to be investment advice. indexes are unmanaged, statistical composites and their returns do not include payment of any sales charges or fees an investor would pay to purchase the securities they represent. Such costs would lower performance. it is not possible to invest directly in an index. Standard & Poors and its affiliates provide a wide range of services to, or relating to, many organizations, including issuers of securities, investment advisers, brokerdealers, investment banks, other financial institutions and financial intermediaries, and accordingly may receive fees or other economic benefits from those organizations, including organizations whose securities or services they may recommend, rate, include in model portfolios, evaluate or otherwise address.
Required Disclosures and Disclaimers

in contrast to the qualitative StarS recommendations covered in this report, which are determined and assigned by S&P equity analysts, S&Ps quantitative evaluations are derived from S&Ps proprietary fair Value quantitative model. in particular, the fair Value ranking methodology is a relative ranking methodology, whereas the StarS methodology is not. Because the fair Value model and the StarS methodology reflect different criteria, assumptions and analytical methods, quantitative evaluations may at times differ from (or even contradict) an equity analysts StarS recommendations. as a quantitative model, fair Value relies on history and consensus estimates and does not introduce an element of subjectivity as can be the case with equity analysts in assigning StarS recommendations.
S&P Global STARS Distribution

In North America
as of September 30, 2011, research analysts at Standard & Poors equity research Services north america recommended 42.2% of issuers with buy recommendations, 54.2% with hold recommendations and 3.6% with sell recommendations.
In Europe
as of September 30, 2011, research analysts at Standard & Poors equity research Services europe recommended 34.4% of issuers with buy recommendations, 49.4% with hold recommendations and 16.2% with sell recommendations.
In Asia
as of September 30, 2011, research analysts at Standard & Poors equity research Services asia recommended 48.4% of issuers with buy recommendations, 45.7% with hold recommendations and 5.9% with sell recommendations.
Globally
as of September 30, 2011, research analysts at Standard & Poors equity research Services globally recommended 41.5% of issuers with buy recommendations, 52.6% with hold recommendations and 5.9% with sell recommendations. Additional information is available upon request.
Other Disclosures
this report has been prepared and issued by Standard & Poors and/or one of its affiliates. in the united States,
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for a list of companies mentioned in this report with whom Standard & Poors and/or one of its affiliates has had business relationships within the past year, please go to: http://www.standardandpoors.com/products-services/ articles/en/us/?assetID=1245187982940 and undertakes no duty of due diligence or independent verification of any information it receives. Standard & Poors keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. as a result, certain business units of Standard & Poors may have information that is not available to other Standard & Poors business units. Standard & Poors has established policies and procedures to maintain the confidentiality of certain non-public information received in connection with each analytical process. Standard & Poors ratings Services did not participate in the development of this report. Standard & Poors may receive compensation for its ratings and certain creditrelated analyses, normally from issuers or underwriters of securities or from obligors. Standard & Poors reserves the right to disseminate its opinions and analyses. Standard & Poors public ratings and analyses are made available on its Web sites, www.standardandpoors.com (free of charge), and www.ratingsdirect.com and www.globalcreditportal. com (subscription), and may be distributed through other means, including via Standard & Poors publications and third-party redistributors. additional information about our ratings fees is available at www.standardandpoors. com/usratingsfees. this material is not intended as an offer or solicitation for the purchase or sale of any security or other financial instrument. Securities, financial instruments or strategies mentioned herein may not be suitable for all investors. any opinions expressed herein are given in good faith, are subject to change without notice, and are only current as of the stated date of their issue. Prices, values, or income from any securities or investments mentioned in this report may fall against the interests of the investor and the investor may get back less than the amount invested. Where an investment is described as being likely to yield income, please note that the amount of income that the investor will receive from such an investment may fluctuate. Where an investment or security is denominated in a different currency to the investors currency of reference, changes in rates of exchange may have an adverse effect on the value, price or income of or from that investment to the investor. the information contained in this report does not constitute advice on the tax consequences of making any particular investment decision. this material is not intended for any specific investor and does not take into account your particular investment objectives, financial situations or needs and is not intended as a recommendation of particular securities, financial instruments or strategies to you. Before acting on any recommendation in this material, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional advice.
Disclaimers
With respect to reports issued to clients in Japan and in the case of inconsistencies between the english and Japanese version of a report, the english version prevails. With respect to reports issued to clients in German and in the case of inconsistencies between the english and German version of a report, the english version prevails. neither S&P nor its affiliates guarantee the accuracy of the translation. assumptions, opinions and estimates constitute our judgment as of the date of this material and are subject to change without notice. Past performance is not necessarily indicative of future results. Standard & Poors, its affiliates, and any third-party providers, as well as their directors, officers, shareholders, employees or agents (collectively S&P Parties) do not guarantee the accuracy, completeness or adequacy of this material, and S&P Parties shall have no liability for any errors, omissions, or interruptions therein, regardless of the cause, or for the results obtained from the use of the information provided by the S&P Parties. S&P PartieS diSclaiM anY and all eXPreSS or iMPlied WarrantieS, includinG, But not liMited to, anY WarrantieS of MercHantaBilitY, SuitaBilitY or fitneSS for a Particular PurPoSe or uSe. in no event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs) in connection with any use of the information contained in this document even if advised of the possibility of such damages. capital iQ is a business of Standard & Poors. ratings from Standard & Poors ratings Services are statements of opinion as of the date they are expressed and not statements of fact or recommendations to purchase, hold, or sell any securities or to make any investment decisions. Standard & Poors assumes no obligation to update its opinions following publication in any form or format. Standard & Poors ratings should not be relied on and are not substitutes for the skill, judgment and experience of the user, its management, employees, advisors and/or clients when making investment and other business decisions. Standard & Poors rating opinions do not address the suitability of any security. Standard & Poors does not act as a fiduciary. While Standard & Poors has obtained information from sources it believes to be reliable, Standard & Poors does not perform an audit
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this document does not constitute an offer of services in jurisdictions where Standard & Poors or its affiliates do not have the necessary licenses. For residents of the U.K.: this report is only directed at and should only be relied on by persons outside of the united kingdom or persons who are inside the united kingdom and who have professional experience in matters relating to investments or who are high net worth persons, as defined in article 19(5) or article 49(2) (a) to (d) of the financial Services and Markets act 2000 (financial Promotion) order 2005, respectively. For residents of Singapore: anything herein that may be construed as a recommendation is intended for general circulation and does not take into account the specific investment objectives, financial situation or particular needs of any particular person. advice should be sought from a financial adviser regarding the suitability of an investment, taking into account the specific investment objectives, financial situation or particular needs of any person in receipt of the recommendation, before the person makes a commitment to purchase the investment product. For residents of Malaysia: all queries in relation to this report should be referred to Weng Jin ching. For residents of Indonesia: this research report does not constitute an offering document and it should not be construed as an offer of securities in indonesia, and that any such securities will only be offered or sold through a financial institution. For residents of the Philippines: the securities being offered or sold have not been registered with the Securities and exchange commission under the Securities regulation code of the Philippines. any future offer or sale thereof is subject to registration requirements under the code unless such offer or sale qualifies as an exempt transaction. Standard & PoorS, S&P, S&P 500, S&P europe 350 and StarS are registered trademarks of Standard & Poors financial Services llc.
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a S i a - P a c i f i c B o n d M a r k e t & c r e d i t c u lt u r e d e V e l o P M e n t commentary
Despite Global Volatility, The Development Of Asias Local Bond Markets Is Still Assured
Contacts: Yu-Tsung Chang, Executive Managing Director, Tokyo (81) 3-4550-8724; yu-tsung_chang@standardandpoors.com; John Bailey, Managing Director, Melbourne (61) 3-9631-2020; john_bailey@standardandpoors.com
Published on RatingsDirect Global Credit Portal on Nov. 16, 2011
itS
been another rockY few MonthS for global caPital
markets. deepening concerns about eurozone economies and a flight to liquidity have lured investors away from some markets and into safe havens such as u.S. treasuries. asias bond markets havent been immune, with issuance in the regions G3 bond markets at a virtual standstill. But others such as asias local-currency bond markets have remained open for business, providing alternative funding and investment options for issuers and investors. indeed, asias local-currency bond markets have continued to expand in recent months, albeit at a moderately slower pace in some markets. although the recent volatility in global capital flows underlines one of the challenges facing asias emerging capital markets, we believe the long-term development of local-currency bond markets is still assured. Several factors contribute to our optimism. regional policymakers, recognizing the value of building home-grown bond markets as a way to more efficiently stimulate economies, have undertaken regulatory changes and other reforms to help address long-standing concerns about liquidity and diversity. in our view, these changes will encourage financial institutions to increase their exposure to asia; at the same time, the list of governments and companies lining up to sell bonds at home will expand. a stronger macroeconomic environment across most parts of asia has also played a part, as issuers seek to replace funding sources that are becoming harder and more expensive to tap elsewhere. despite inevitable hiccups along the way, we believe the development of local-currency bond markets across asia will continue and asian bonds will become important sources of funding. the development will likely be gradualan evolution rather than a revolution. one lingering question, however, surrounds the regions credit culture and whether policymakers across the region will be more predictable and transparent in terms of standards, rules, and platforms. unless the regions credit culture continues to evolve, issuers and other bond investors across the globe may not be convinced that they can make informed risk-and-return decisions.
28 aSia-Pacific MarketS outlook 2012
Kick-Starting The Market

developing domestic bond markets has become a high policy priority for many governments across asia, which still largely remains over-dependent on the banking system. the aftershocks from the 1997-1998 asian financial crisis brought to light many serious balance-sheet problems in asia and led to a fundamental change in the regions capital markets. the crisis caused credit to dry up across the region, created severe downward pressures on currencies, increased the local-currency value of debt, and prompted dozens of borrowers to default. Spurred on by this crisis, governments started building up their foreign-exchange reserves, and policymakers started to focus on developing domestic bond markets in an effort to rebalance their borrowings from external to domestic sources, and, hence, reduce future funding risk. in order to kick-start development of local asian bond markets, the market authorities of most countries have made a conscious effort to improve the supply of domestic debt through a shift of government liabilities to the domestic bond market. this has created a greater predictability of debt issuance, lengthened bond maturities, and formed liquid benchmark securities. More recently, there have also been signs of progress in china, with the government building an offshore renminbi financial market in Hong kong. the potential benefits of the internationalization of the renminbi are obvious; apart from improving the funding efficiency of chinese financial institutions, internationalization of the renminbi would also help boost cross-border transactions and minimize foreignexchange risk. regulatory reform remains a heated debate today, with many of the regions authorities implementing a slew of changes to support the development of local bond markets. among the key changes have been the simplification of issuance procedures, improved bond clearing systems, and the development of derivative and repurchase markets. in order to improve disclosure, governments have also been trying to develop accounting and corporate governance standards that are consistent with international best practice.
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Bond investors around the world have become more comfortable with emerging markets.
at a macro level, more stable macroeconomic policies are promoting local currency debt issuance, have stabilized interest rates, and reduced inflation in many asian countries. this has been a major concern of local and global investors in the past, given that adverse conditions can erode the value of investments very quickly. the strengthening of the external environment can be seen in the rebound in regional creditworthiness. Standard & Poors took 89 positive ratings actions on asian companies in 2010 and 29 negative ones, compared with 92 negative actions and 23 positive ones in 2009.
Table 1: Foreign Holdings Of Local Currency Government Bonds

(% of total)
Japan Indonesia Korea Malaysia Thailand
Jun-11
5.03% 34.01% 10.14% 22.03% 8.91%
Jun-10
4.60% 27.36% 7.36% 18.06% 4.23%
Jun-09
6.13% 15.75% 5.75% 9.98% 2.47%
Jun-08
7.02% 18.09% 8.68% 18.29% 1.76%
Source: Asia Bond Monitor. for investors given the ongoing volatility in markets around the globe. the risk of another drop in currencies and outflow of funds is real, especially if the market turmoil gets worse. But when the dust settles, we see the local currency bond markets continuing to grow. asias fast-growing economies should lure investors, and more cross-border investments by asian central banks and sovereign wealth funds will help market stability. demand isnt just coming from international buyers. regional primary buyers, insurance companies, and asset managers have also increased significantly, boosted by increasing demand from sovereign wealth funds and investors in local pension funds, which have benefited from government pension-related reforms. Japans public pension fund is the largest in asia with total assets of uS$1.4 trillion in 2010. other local pension funds in the region include: South koreas national Pension fund with assets of uS$290 billion, Malaysias employee Provident fund with pension assets worth around uS$145 billion, and the government-backed pension fund scheme in Singapore with total assets of uS$145 billion. in Hong kong, the Mandatory Provident fund scheme has total assets under management of about uS$40 billion. investors in these local pension funds, with long-term investment objectives, are important buyers of local-currency emerging debt and provide an important source of demand and liquidity for the asset class. in addition, local bond markets are benefiting from asian central banks diversifying their growing reserves away from u.S. treasuries. the steady expansion of the regional banking sector is also playing a part, with about half of the worlds top-10 banks by market capitalization
Investors Have Been Stocking Up

in recent years, there has been a strong pickup in investor demand for local currency bonds and large capital inflows across asia. Bond investors around the world have become more comfortable with emerging markets. its easy to understand the attraction of these markets to international investors: they offer higher yields and the possibility of strong currency appreciation. for example, august 2011 yields on 10-year u.S. treasury were below 2%, compared with equivalent-maturity korean and indonesian bonds offering yields of 3.76% and 7.36%, respectively. With central banks around asia tightening their monetary policy and the u.S. federal reserve maintaining a more accommodative policy, yields in most asian markets continue to exceed those in u.S. treasuries by a significant margin. foreign investors, keen to take advantage of these returns, have increased their holdings in indonesias outstanding government bonds to 34%. Malaysia has also attracted attention, with foreign investors holding about 22% of ringgit-denominated government bonds; in korea, foreign investors hold about 10% of the local currency bond market (see table 1). Growing numbers of global institutional investors are jumping into the local currency bond market. Meantime, many foreign pension funds and insurance companies have negligible allocations to emerging market debt, and are seeking to add exposure in order to access the superior growth characteristics that these markets provide. nevertheless, these foreign capital inflows also have a negative flip side. they can create speculative flows and have a destablizing effect on currenciesa current concern
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now asian. other non-asian financial institutions have been growing their asian balance sheets faster than their global balance sheets. in our view, such growth will also provide a continuing source of demand for local bond markets.
Rapid Growth Of Local Currency Bond Markets

its clear that policy and structural changes are bearing fruit, with data showing that local currency bond markets are growing rapidly. according to research by the asian development Bank (adB), local currency bond markets in emerging east asia rose by 7.7% in the year to June 30, 2011, with uS$5.5 trillion in local currency paper outstanding. By comparison, the local bond market was only uS$531 billion in 1996. the regions share of global bond issuance has more than tripled since the asian financial crisis, reaching 8.0% last year, compared with 2.1% in 1996. Japan is the largest bond market in asia, with nearly uS$12 trillion of outstanding bonds, followed by china with around uS$3 trillion of outstanding bonds. But we are also seeing robust growth in some of the smaller markets. Singapores market increased by 18.0%, Malaysia (16.7%), and korea (8.1%).
Meantime, data shows a mixed scorecard for government and corporate bonds; government bond issuance has slowed down significantly, while corporate issuance has continued to grow. corporate local currency bonds outstanding in emerging asia rose by 19.6% in the second quarter of 2011, compared to only 2.7% growth for the government bond market. the largest corporate bond markets in emerging asia are in china and korea. Bond issues are getting bigger as companies seek to improve their capital structure and fund their expansion with debt from the domestic market. State-owned companies, such as cnooc ltd. (aa-/Stable/) and State Grid corp. of china, dominate the corporate bond market in china. the largest issuer of local currency corporate bonds in korea is korea land & Housing corp. large corporate issuers in other regional markets include Malaysias cagamas BHd, the Hong kong Mortgage corp. ltd. (aaa/Stable/a-1+), Singapores temasek Holdings (Private) ltd. (aaa/Stable/a-1+), and thailands Ptt Public co. ltd. (BBB+/Stable/). important capital-market developments in the past year include: the growth of islamic local currency bond issues in Malaysia; the Singapore exchange commencing trading of government securities in July in an effort to improve price transparency; and the development of inflation-linked
Table 2: Size Of The Local Currency Bond Markets In Asia

2Q 2011 bonds outstanding (bil. US$)
Japan Peoples Republic of China (PRC) Korea Malaysia Thailand Singapore Hong Kong Indonesia Philippines Vietnam Emerging East Asia Emerging East Asia ex PRC N.A.Not applicable. Source: Asia Bond Monitor and Standard & Poors. 11,991 3,190 1,273 269 222 204 167 118 75 17 5,534 2,344
2Q 2011 growth rate

4.20% 6.70% 8.10% 16.70% 6.20% 18.00% 5.10% 2.40% 6.00% 18.80% 7.70% 9.10%
% GDP
203% 45% 114% 102% 63% 87% 68% 14% 32% 14% N.A. N.A.
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The sustainable supply of credit in Asia and associated reforms by governments will be critical in developing the region.
bonds in Hong kong, korea, and thailand. What these developments tell us is that asian governments are making a concerted effort to develop their local bond markets and address long-standing concerns about liquidity and diversity.
But Theres Still More To Do

the main question is: how quickly will development of the local bond market happen and will it be across the board in asia? a wild card in any growth outlook is regulations. investors want to see predictable and transparent rules, but this doesnt always happen in asia. indeed, there is a history of asian governments changing policy direction or backtracking. Whats more, with rising market turbulence across the globe, we could see a slowdown in the pace of reform in asia. even so, the asian financial crisis is still fresh in the minds of governments, and we dont think there will be an extensive deviation from existing policy directions. furthermore, we believe governments in asia will continue to improve corporate governance practices and trading mechanisms, and push for further pension reforms; at the same time, currency convertibility will gradually evolve. in china, the real explosion in local currency renminbi issuance will only come once global borrowers are able to raise renminbi and swap them into u.S. dollars and other global currencies. once this happens, the renminbi market will become a true engine of international funding. emerging asia also needs to foster a robust credit culture. for now, equity rulesbut if asia is to shift toward broader capital-market development, it needs to acquire a healthy credit culture so that risk can be measured and priced according to objective standards, and not just questionable relationships and implicit assurances. the absence of a strong credit culture will cause bond investors to shy away from investing in bonds or to demand an excessive premium for holding debt. Standard & Poors is assisting in this area by developing national rating scales, which provide more granularity of
credit risks than is possible with the Standard & Poors global scale. in 2009, Standard & Poors launched a regional rating scale for the association of Southeast asian nations (aSean), and in early 2011, released a Greater china credit rating scale. these benchmarks are providing independent and transparent opinions about the credit risk of issuers active in asia relative to others in the sub-region. although it is tempting to lump emerging market debt into a single broad category, it is far from being a homogeneous asset class and careful analysis is required.
Further Development Is Crucial

although there will always be periods of market volatility and correction, we are confident that asias capital markets are on the right path to creating debt platforms that will deliver the depth and sophistication needed to fund the next stage of the regions economic development. But local policymakers cannot take their foot off the pedal and must continue to accelerate the growth trends seen in the past year. the sustainable supply of credit in asia and associated reforms by governments will be critical in developing the region, and without it there could be constraints on growth.
Related Research
Will islamic finance Play a key role in funding asias Huge infrastructure task?, oct. 13, 2011 creditfaQ: Whats Behind the Stellar Growth of the dim Sum Bond Market?, oct. 20, 2011 Strengthening Public finance institutions Will likely Help china Manage its rising local Government debt, Sept. 28, 2011 Standard & Poors launches Greater china credit rating Scale, april 28, 2011 fostering robust credit cultures is key to developing deep and liquid corporate Bond Markets in asiaPacific, nov. 22, 2010
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The Development Of Municipal Bond Markets, And Credit Cultures, May Help Fix Asias Infrastructure Conundrum
Contact: Thomas G Schiller, Executive Managing Director, Tokyo (81) 3-4550-8445; tom_schiller@standardandpoors.com
Published on RatingsDirect Global Credit Portal on Nov. 28, 2011
aSian
local governMentS ScraMbling for fundS to PaY for a
slew of infrastructure projects may need to contemplate a long-ignored source: municipal bonds. the idea isnt new. for decades, municipal debt has been issued by local governments and other issuers in the u.S. and elsewhere to help pay for everything from bridges and roads to schools and hospitals. although Japan has forged a sizeable municipal-debt market of its own in this region, other asian nations have historically used conventional capitalraising sources, such as banks, to meet their own public project needs. things could be changing, however. Many asian governments are shifting some of their hefty infrastructure burdens to local and regional governments, forcing authorities at this level to devise viable and effective funding options. at the same time, policymakers are increasingly looking at ways to accelerate infrastructure spending in the region and broaden funding solutions. in particular, governments at the highest level are encouraging more diverse and liquid local bond markets through regulatory changes and other policy reforms. Whats more, proposed Basel iii regulations on capital requirements may serve to restrict or limit some banks from lending to certain infrastructure projects. immense challenges remain to develop deep and liquid municipal markets, and other bond markets, across asia. among the biggest is developing a credit culture and debt-management practices that are robust enough to enable investors to make informed risk-and-return decisions. theres much work that needs to be done in this regard, and many markets are not yet ready. nevertheless, economic and market conditions are probably ripe for many countries, especially emerging asia, to develop or expand local capital markets and contemplate new funding solutions such as municipal bonds.
Deeper Bond Markets, Including Municipal Debt, Will Broaden Funding Sources For Infrastructure
one persistent theme of the past decade is the need of asias governments to attract more funding to develop and upgrade infrastructure to keep pace with their growing economies. the other is the need to grow and deepen local bond markets. one big question is whether the development of municipal-bond markets can help address both of these needs. that question has got louder as key measures of the global economy and investor sentiment continue to waver, and as governments struggle to meet rising demands for infrastructure amid surging populations. the asian development Bank (adB) predicts that asian economies require uS$8 trillion over the next decade to fully address the regions basic infrastructure needs, in areas such as water, transportation, and energy (see chart 1). in our view, municipal bonds may form part of a wider solution to help circumvent the risks associated with
Chart 1
Asias Total Infrastructure Needs By Sector For 2010-2020

9 8 7 6 5 4 3 2 1 0
(Trillion US$)
Power
Telecommunications
Transport
Water and sanitation
Total
Source: Asian Development Bank.
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Greater transparency of the credit quality of local governments will help differentiate issuers and showcase them to the market.
paying for this massive infrastructure task. a key reason is that municipal bonds should help spur the growth and development of local bond markets by increasing depth and creating benchmarks. considered by some investors to be safer than corporate bonds, municipal bonds are an attractive investment for pension and sovereignwealth funds, insurance companies, and retirees. another advantage of such bonds is that they are typically free to trade at any time once they are purchased, and they usually provide tax-exempt income if they are financing public services or facilities. We believe a strong local bond market provides many benefits: longer term funding, reduced reliance on foreign currency funding, and greater funding diversity and stability. at the same time, a strong bond market lessens the dependence on banks, which have dominated the financing landscape for asian infrastructure projects and may become constrained as proposed regulations on capital requirements are rolled out. on the plus side, governments across asia are encouraging more access to local bond markets via regulatory changes and other policy reforms that aim to promote a much more diverse and liquid local bond market. Whats more, recent regional initiatives point to greater co-operation between governments to accelerate infrastructure spending in the region and find alternative sources of funding. among the recent noteworthy actions include plans by regional governments to channel pension fund money into infrastructure funding, or issue public bonds into the market backed by infrastructure projects. Since the 1997 asian financial crisis, theres been remarkable progress on developing local bond markets (see chart 2). the size of local bond markets across asia has quadrupled in the past few years alone, although we note that markets are still concentrated on sovereign and financial institution debt. Yet, despite these developments, the relative size of local and, specifically, municipal bond markets in emerging asia is still very small.
Chart 2
Size Of Selected Local Currency Asian Bond Markets

In % GDP at September 2011
Outstanding local currency bonds % of GDP Government Corporate
120 100 80 60 40 20 0 ChinaBond Hong Kong Indonesia Bank Singapore Bank of Monetary Stock Negara Monetary Thailand Authority Exchange Malaysia Authority
Market
Source: AsiaBondsOnline.adb.org.
Fostering Robust Credit Cultures And Practices Is Crucial

a key issue for this region is the lack of a standard and organized structure, or appropriate credit cultures and practices, to facilitate and broaden trading and liquidity. until this issue is addressed, the market is unlikely to reach its full potential compared to conventional debt markets or reach a sufficient level of sophistication. for this to happen, governments need to create attractive investment environments for investors. essentially this means creating a healthy credit culture, whereby investors can understand and gauge credit risks and price that risk appropriately. it is an environment that respects and empowers investors and gives them the information, tools, and confidence they need to participate in the market. the key elements of a credit culture are: information and transparency, governance, high-quality and independent credit research and ratings, risk-based pricing, enforcement of creditors rights, and fair and impartial relationships and transactions. Much work has been done, and good progress has been made, into developing credit cultures in asia, with credit cultures in various stages of being institutionalized across
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Without a credit culture that respects and empowers investors through clarity, fairness, and consistency, investors will be unable to assess risk and make confident decisions.
the region. However, as far as the public finance sector and sub-national borrowers are concerned, credit cultures remain weak. key issues include: lack of information; poor transparency about public finances, particularly government indebtedness and contingent liabilities, relationships between local governments and their borrowing entities, and links and support from the central government; regulatory ambiguity; inconsistent regulations and public service agreements; and a general opaqueness about the credit quality of sub-national borrowers, who are often discouraged from being rated by central governments. another pitfall is that many borrowers at the local government level exhibit weak credit practices, particularly in the area of financial and debt management. local governments in china, indonesia, the Philippines, and Vietnam are prime examples. key issues here include: a widespread lack of qualified personnel in the public sector and, in particular, a weak managerial capability to fund and implement long-term infrastructure projects; evolving standards of accounting and accountability, including a lack of transparency and accountability; a lack of links between long-term plans and budgets; poor treasury and liquidity management; mixed, and often contradictory, mandates regarding commercial versus public policy roles of the subnational investment entities; and a lack of commitment to paying obligations on time.
So, What Needs To Be Done?

Many things can be done, and need to be done, to deepen domestic markets, including the development of municipal markets. a key focus should be placed on promoting a healthy credit culture. there are many ways to approach this task. chief among them is the creation of a clear and transparent, fair, consistent, and predictable institutional financing framework. Such a culture includes a greater understanding by local governments of their need to prioritize debt, as well as legal changes that ensure that these authorities prioritize debt repayments. another crucial aspect is the adoption of a clearer, more transparent intergovernmental arrangements that allow local governments to rely on stable revenue for repayment of their obligations. other potential remedies include: enforcing reasonable
debt limits to prevent over-leveraging; greater scrutiny, disclosure standards, and restrictions on relationships between local governments and state and other borrowing entities; more clarity about whose credit quality is at issue. Part of the solution may also lie in handing a greater management role to the market, which will help change and upgrade public sector finances through its scrutiny, discipline, and incentives. another step toward kick-starting the development of both bond and municipal markets is to allow well-run and more-creditworthy local governments to start issuing debt. although we recognize that some weaker local governments may be a very long way from being ready to issue public debt, there are many creditworthy entities among asias local governments. a few pilot issues from these creditworthy entities would pave the way for a greater understanding of local government debt, create benchmarks and standards for wider-scale self-improvement initiatives, and raise the stakes in the game through increased market scrutiny. at the same time, it is worth promoting efforts to increase financial management quality/capacity of the weaker local governments. Standard & Poors, has its own framework, known as extended financial Management assessment (fMa), that allows it to score and benchmark the quality of the financial-management policies and practices of local governments (see Extended Financial Management Assessments For Non-U.S. Local And Regional Governments, published July 1, 2010). Greater transparency of the credit quality of local governments will also help differentiate issuers and showcase them to the market. a key element of this initiative is for these entities to be rated. this will help investors better understand a complicated new sector and give them an independent and objective aid to understanding and pricing credit risk.
It Will Take Time, But A Brighter Future Awaits

the development and deepening of local municipal markets alongside other bond markets will go a long way to help asia solve its massive infrastructure-funding needs, as well as mobilize its wealth on behalf of regional development
34
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and provide a better investment opportunity for investors. the final result will be to strengthen economic growth and improve social conditions and stability. But unless these markets become stronger and achieve a certain critical mass, and people feel more confident in them, investors may be unwilling to partake. indeed, without a credit culture that respects and empowers investors through clarity, fairness, and consistency, investors will be unable to assess risk, gauge the appropriateness of returns, and make confident decisions. in asia, these qualities of clarity, fairness and consistency often run counter to local business cultures, and to the way governments operate. this needs to change; otherwise, investors will stay away, and many local government and other sub-national borrowers will likely struggle to meet their financing and infrastructure needs.
Related Criteria And Research

Will islamic finance Play a key role in funding asias Huge infrastructure task?, oct. 13, 2011 creditfaQ: Whats Behind the Stellar Growth of the dim Sum Bond Market?, oct. 20, 2011 Strengthening Public finance institutions Will likely Help china Manage its rising local Government debt, Sept. 28, 2011 extended financial Management assessments for nonu.S. local and regional Governments, July 1, 2010 fostering robust credit cultures is key to developing deep and liquid corporate Bond Markets in asiaPacific, nov. 22, 2010 despite Global Volatility, the development of asias local Bond Markets is Still assured, nov. 16, 2011
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Whats Behind The Stellar Growth Of The Dim Sum Bond Market?
Contacts: Michael Petit, Managing Director, Hong Kong (852) 2533-3502; michael_petit@standardandpoors.com Ping Chew, Managing Director, Hong Kong (852) 2533-3530; ping_chew@standardandpoors.com
Published on RatingsDirect Global Credit Portal on Oct. 20, 2011
the
Market
for
offShore
chineSe
renMinbi
(rMb)-
denominated bonds is relatively small, but its growth has been spectacular. the so-called dim sum market has raised rMB150 billion (or close to uS$25 billion) since its inception in mid-2007. the market has even bucked the global trend by continuing to function in the past few months despite struggling at times. in august 2011, chinas Ministry of finance issued rMB20 billion worth of bonds while G3 cross-border markets had essentially shut down. in a series of frequently asked questions, Standard & Poors ratings Services examines the driving forces behind the development of the dim sum market, its main agents, and likely evolution.
Frequently Asked Questions

Whats fueling the development of the dim sum market?
the rapid accumulation of offshore renminbi deposits is likely to continue to propel the development of the dim sum market for the foreseeable future. the increasing amount of trade that is settled in renminbi is feeding the growth of these deposits. the usage of the chinese currency will keep on rising as long as chinese authorities support its internationalization. in the second quarter of this year, for example, china settled about 10% of its trade in renminbi compared with only about 1% a year earlier. We estimate that offshore renminbi deposits in Hong kong now amount to rMB600 billion from roughly rM100 billion a year earlier.
borrowers to the dim sum market. in that sense, the dim sum market has operated as a substitute for the domestic chinese loan market. this is most likely a temporary phenomenon, and not necessarily a positive one, as it brought with it some of the opaqueness that is characteristic of the mainland bank loan market. More important are the series of measures that chinas vice premier li keqiang announced last august to boost the role of Hong kong in developing an offshore renminbi market. in effect, chinese companies will now be allowed to directly issue bonds in the dim sum market, rather than through offshore subsidiaries. Mr. li also indicated that china, through the Ministry of finance, would be a regular issuer, which should prove critical in helping establish a reference curve in the dim sum market.
Are there any impediments to future growth?

the thorny issue of repatriating proceeds to the mainland remains a significant impediment to the offshore renminbi market developing into a truly major global offshore marketone that would be commensurate with the relative size of china in the global economy. While procedures can be put in place to facilitate that process, the challenges wont be completely resolved until china fully liberalizes its capital account and makes the renminbi freely convertible. Some mainland policymakers have recently hinted that this could occur within five years. on oct. 13, 2001, the government announced it would set up a mechanism for the repatriation of proceeds for foreign direct investment purposes. this is a big step.
What should we expect in coming years?

We expect the growing pool of offshore renminbi deposits to continue to stoke the development of the dim sum market over the next few years. our view reflects the accelerating usage of the renminbi as a settlement currency and chinas status as the worlds second-largest economy. the offshore deposits could near an estimated rMB1 trillion by year-end, based on their past trajectory. the deposits provide a natural feed for the development of the market.
What is the typical credit risk profile of dim sum issuers?

issuers in the dim sum market have covered the whole gamut from china (aa-/Stable/a-1+, cnaaa) to some property developers that we rate in the cnBB category of the Greater china credit scale. an early characteristic of the market was that it was largely unrated and credit risk appeared to be a secondary consideration to currency appreciation. Global events, however, have very much promoted the importance of credit risk, and there is now clear evidence of pricing differentiation based on creditworthiness. notwithstanding the markets still relatively limited liquidity and lop-sided demand imbalance, spreads have significantly widened for speculative-grade-rated and non-rated issuers in the past
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What other factors support the market?

the monetary and credit tightening that has prevailed over the past year in china has certainly led a good number of
The Greater China rating scale responds to the needs of investors and other credit risk management professionals who focus on Greater China as an asset class in and of itself.
few months. the prevalence of rated issuers is also likely to increase as the focus on currency appreciation diminishes and a stronger credit culture takes root.
How diversified is the market?

the dim sum market is increasingly attracting state-owned enterprises of various industries and international issuers, and both of these groups tend to be rated. the market is also well represented in terms of industry players, including property developers, high-tech companies, policy banks, commercial banks, and state-owned corporations that cover the natural resources, energy, telecom, transportation, public utilities, and capital goods industries. Mainland china issuers represent the bulk of issuance to date, but an increasingly broad range of global issuers have tapped the dim sum market with sometimes significantly more sizable issues. Mcdonalds corp. (a/Stable/a-1, cnaa+) became the first non-chinese issuer to enter the market last august with a rMB200 million issue. others that followed include caterpillar financial Services corp. (a/Stable/a-1, cnaa+), oriX corp. (a-/Stable/, cna+), Mitsubishi ufJ lease & finance co. ltd. (not rated), unilever Plc (a+/Stable/a-1), and VtB capital S.a. (BBB/Watch neg/a-3, cna). notably, lair liquide (a/Stable/a-1, cnaa+) became the first french issuer in the offshore renminbi market last month, with two issues aggregating rMB2.6 billion. as the market matures, we also expect to see further diversification in terms of debt instruments. Several mainland financial institutions, for example, have expressed interest in raising subordinated debt in the offshore market. and while tenors remain concentrated at the short-end, with the overwhelming majority of bonds posting two- to three-year maturities, the situation is gradually evolving. the Ministry of finances recent issue, which included five-year and seven-year tranches, should prove useful in facilitating the pricing of more long-dated paper.
ratings to all Greater china-domiciled obligors and issue credit ratings to their debt instruments. We are also assigning Greater china issue ratings to all Hong kong dollar-denominated and offshore renminbi-denominated debt instruments regardless of the domicile of the obligor. the underlying rating criteria, methodology and processes that we use to assign Greater china credit ratings are identical to those associated with Standard & Poors global scale ratings. the mapping between Standard & Poors Greater china and global scales is publicly available (see article listed below). in essence, the Greater china rating scale responds to the needs of investors and other credit risk management professionals who focus on Greater china as an asset class in and of itself. the scale provides a credible benchmark against which users can form their own independent opinion of relative credit strength within their investable universe of Greater china. for these users, the Greater china scale can provide more granularity of credit risks than is possible with Standard & Poors global scale. the rating distribution is also better aligned to their expectations of relative creditworthiness within a Greater china context, with china itself anchoring the scale at cnaaa.
What is the profile of investors in the offshore renminbi market?

thats also very much a developing story. in terms of geography, investors are overwhelmingly Hong kong-based, with most of the remainder based in Singapore. When u.k.based retailer tesco Plc (a-/Stable/a-2, cnaa) launched a rMB725 million issue earlier this month, Hong kong-based investors accounted for less than 50% of the total allocation, Singapore about 30%, and european investors close to 20%. it was very much a globalizing story. among investors, chinese banks are particularly well represented. this partly explains the presence of a relatively large number of unrated issues (as the dim sum market essentially functions for them as an alternative to chinas bank loan market). an important development in the past year has been the emergence of an ever-increasing number of specialized funds investing in offshore renminbi paper. these funds have brought considerable professionalism to the market and acted as a vehicle for greater retail investor participation.
Standard & Poors recently launched a Greater China credit rating scale. What is that exactly and to whom is it addressed?
the rapid development of the offshore renminbi market was, of course, the impetus behind the development of the scale. We are assigning Greater china credit scale issuer
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As the market matures, we expect to see further diversification in terms of RMB debt instruments.
So is the dim sum market impervious to difficulties in other cross-border markets?

no, far from it. its certainly quite remarkable that the dim sum market remained open during the dry spell that prevailed during much of august in the G3 markets. But it should be noted that investors in the offshore renminbi market were also very selective during that period: While chinas cnaaa- rated bonds were oversubscribed, a number of speculative-graderated issuers, non-rated issuers, and at least one highly rated issuer had to delay their planned issues. these issuers operated in industries ranging from airlines and property development to aluminum extrusion and pharmaceuticals. it is also important to realize that supply-demand conditions could shiftconceivably rapidly and dramatically so. fastgrowing offshore renminbi deposits and the ever-increasing number of specialized offshore renminbi funds (more than 17 to date) make the dim sum market very much a sellers market for now, but this could change. for instance, mainland banks
and insurance companies are reportedly planning to issue subordinated debt instruments in the dim sum market. Given these institutions immense capital needs, and depending upon whether these institutions seek to come to market at the same time or not, this could easily bring supply-demand conditions into balance or trigger overwhelming demand. another fundamental change is bound to come about when the now widely held assumption that the renminbi will always appreciate is eventually challenged. While this might prove a hiccup in the development of the dim sum market, it should prove healthy over time. it would help the market shed its strong remaining speculative element around currency play to that of a more mature market where decisions are taken on careful risk-reward considerations.

Greater china credit rating Scale explained, april 27, 2011.
Table 1: Rated Offshore Renminbi Issuers

Greater China scale rating
Peoples Republic of China MoF Svenska Handelsbanken The Hong Kong & China Gas Co. (Towngas) Unilever N.V. Export-Import Bank of Korea (Kexim) McDonalds Corp. Air Liquide Finance (Guarantor: LAir Liquide S.A.) BP PLC Caterpillar Financial Services Corp. The Bank of East Asia (China) Ltd. Volkswagen Intl Finance N.V. Tesco PLC Sinochem Hong Kong (Group) Co. Ltd. China Merchants Bank Co. Ltd. VTB Capital S.A. Yum! Brands Inc. Evergrande Real Estate Group Ltd. China Shanshui Cement Group Ltd. Intime Department Store (Group) Co. Ltd. Road King Infrastructure Ltd. China SCE Property Holdings Ltd. Ratings as of Oct. 14, 2011.
Global scale rating

AAAAA+ A+ A A A A A AAABBB+ BBB BBB BBBBB BB BBBBB+
cnAAA cnAAA cnAAA cnAAA cnAA+ cnAA+ cnAA+ cnAA+ cnAA+ cnAA cnAA cnAA cnA+ cnA+ cnA cnAcnBBBcnBBBcnBB+ cnBB cnBB
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a S i a - Pa c i f i c r e G i o n a l P e r S P e c t i V e commentary
Will Islamic Finance Play A Key Role In Funding Asias Huge Infrastructure Task?
Contacts: Allan Redimerio, Singapore (65) 6239-6337 allan_redimerio@standardandpoors.com; Andrew Palmer, Melbourne (61) 3-9631-2052 andrew_palmer@standardandpoors.com
financing
Multi-billion-dollar
infraStructure
ProjectS
is rarely easy. But the current jittery state of the worlds lending markets is making the task of funding infrastructure developmentsfrom power stations to railwayseven harder. this issue is particularly pertinent for asia, which is struggling to keep up with the escalating infrastructure needs of the regions surging population amid solid economic growth. With the outlook for global lending markets still uncertain, part of the solution for asia may lie in finding alternatives to conventional financing. islamic finance is one such alternative. Standard & Poors ratings Services believes that the growing and deepening market for islamic financing is a key reason why we think this market is worth considering for the infrastructure sector. We also believe that infrastructure projects are a logical fit for islamic finance, which is governed by Sharia and predicated on asset-backing and shared business risk. indeed, we believe that the assetbacking nature of islamic financing may provide a better funding match for infrastructure projects than traditional lenders, such as banks. Whats more, sukuk investors typically have an appetite for longer tenors than bank loans, and prefer stable and predictable cash flowtraits that are typically associated with infrastructure projects. We apply our standard rating criteria when assessing and rating sukuk bonds and other islamic finance structures. Some of the corporate-related sukuk bonds we have rated in the region included a sukuk sponsored by Malaysian state-owned oil and gas company Petroliam nasional Bhd. (Petronas, foreign currency a-/Stable local currency a/Stable, aSean rating scale axaa+) referenced to a portfolio industrial assets, and a sukuk sponsored by Japans nomura Holdings inc. (BBB+/Stable/a-2), which are backed by some commercial aircraft on a sale-andlease-back arrangement. on the plus side, it appears that governments across asia are making moves to create a more attractive investment climate for infrastructure-related investments,
including promotion of islamic financing. at the same time, many asian governments are forging greater co-operation between each other and multilateral agencies to accelerate spending in infrastructure. Whether islamic finance plays a significant role remains to be seen.
Asian Economic Growth Points To Rising Infrastructure Needs

as economies across europe and the u.S. continue to struggle to regain momentum, its clear that asia will remain a key driver of world economic growth in coming years. estimates suggest that the population across asiaalready home to more than half of the worlds populationis set to surge in the next few decades. to cater for the regions rapid growth, asian governments will need significant developments and upgrades of its infrastructure. the asian development Bank (adB) recently predicted that asian economies require uS$8 trillion over the next decade to fully address the regions basic infrastructure needs, including developments in areas such as water, transportation, and energy (see chart 1). in particular, we believe demand for power sources will increase significantly.
Chart 1
Asias Total Infrastructure Needs By Sector For 2010-2020

9 8 7 6 5 4 3 2 1 0
(Trillion US$)
Power
Telecommunications
Transport
Water and sanitation
Total
Source: Asian Development Bank.
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Although banks have dominated the financing landscape for Asian infrastructure projects, we believe that Islamic finance may be a better match for the regions infrastructure funding needs.
Governments Are Moving To Pave The Way For An Infrastructure Boom

there is plenty of evidence to suggest that governments are focusing on the significant infrastructure task that lies ahead and channeling long-term funds to accelerate much-needed infrastructure-related projects. indeed, we believe recent regional initiatives across asia point to greater co-operation between governments to accelerate infrastructure spending in the region and find alternative sources of funding. in September 2011, aSean announced the creation of a new fund to help finance major infrastructure projects across the region; the funds total lending commitment through to 2020 will be about uS$4 billion, rising to more than uS$13 billion when adBs projected 70% co-financing is included. other noteworthy actions in the region include plans by regional governments to channel pension fund money into infrastructure funding, or issue public bonds into the market backed by infrastructure projects. elsewhere, in September 2011 the World Bank launched a hub for knowledge and financial activities in Singapore that aims to find solutions to infrastructure financing problems and support critical infrastructure projects in developing asia. Meantime, governments across asia are also encouraging more access to local bond markets, with regulatory changes and other policy reforms helping to promote a much more diverse and liquid local bond market.
infrastructure projects such as power plants and toll roads, once completed, typically benefit from long-term concession agreements of 15-to-20 years or beyond that usually offer stable and predictable cash flow. these are the sorts of traits that sukuk investors, which are typically buyand-hold investors, tend to prefer. on the other hand, bank loans typically have tenors of five-to-seven years, which in many cases translate to a poor match for infrastructure projects. indeed, the short tenors of bank loans may introduce refinancing risk for these sorts of long-term developments. Since the mid-1990s, issuance of sukuk has been growing steadily (see chart 2).
Is The Bank Sectors Domination Of Infrastructure Financing Over?

there are other issues emerging that suggest that bank lending may not be a good match for infrastructure-related projects. the Basel iii regulations that have been proposed in the wake of the recent global financial crisis may serve to limit the flexibility of banks to lend to infrastructure projects. in short, banks will be increasingly under pressure to shorten maturities, reduce capacity, and charge higher interest rates. in our view, this creates further risks for
Chart 2
Global Sukuk Issuance 1996-2010

(Mil. $) Issued during the year (left scale) Cumulative amounts issued since 1996 (left scale) Amount issued as a share of the total (right scale) (%)
Islamic Finance Is A Good Match For Infrastructure Financing

in our view, the principles of Sharia are a good fit with infrastructure spending, and we think that islamic financingparticularly sukuk financingcould play a key role in financing asias funding gap in the infrastructure space. in short, islamic lending transactions are governed by Sharia, which bans speculation and specifies that income must come from shared business risk. Whats more, islamic finance is based on the concept of asset-backing. although banks have dominated the financing landscape for asian infrastructure projects over the past decade, we believe that islamic finance may be a better match for the regions infrastructure funding needs. asian
250,000 200,000 150,000 100,000 50,000 0
30 25 20 15 10 5 0
96 97
98 99
00 01
02 03
04 05
06 07
08 09 20
19
19
19
19
20
20
20
20
20
20
20
20
20
Sources: Zawya Sukuk Monitor Database, Standard & Poors. Compared with previous publications, the data includes sukuk issued in a given year, as well as the sukuk that have already matured.
40
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20
10
The Islamic financing market is gradually expanding, and is now moving toward listed instruments both in international and local markets.
infrastructure funding. the upshot is that infrastructure developments may have limited access to bank funding as the regulations are rolled out. Meantime, theres evidence to suggest that european banks may cut back their exposure outside their home markets given the ongoing problems with parts of the banking systems in the eurozone. although their exposure has diminished since the recent global financial crisis, european banks are still active lenders to infrastructure companies and projects in asia. key lenders in the infrastructure space in this region are french, British, and German banks. nevertheless, we believe the current credit turmoil in europe may force some of these banks to reduce their overseas exposure, potentially placing further limits on bank lending for asian projects.
Malaysia Leads The Way, But Regulatory Frameworks Are Needed Elsewhere
Malaysia, a pioneer in using Sharia-compliant sukuk bonds to fund infrastructure projects, is leading the way in terms of islamic financing (see chart 3). in our view, Malaysia has created a very attractive environment for islamic finance investors to participate in the market. for example, the country has introduced laws that provide favorable tax
Chart 3
treatment for islamic finance assets like sukuk bonds. We think other economies in the region can benefit from Malaysias example, especially some countries with large infrastructure requirements that do not have a developed local bond market, such as indonesia, Philippines, Vietnam, and india. indonesia is probably in the best position to benefit from islamic finance, given that it has already put in place regulations for such transactions. We note that the indonesian government has also issued a few sovereign sukuk bonds, providing a benchmark for the pricing of sukuk assets. for islamic finance to attract market interest and prosper, however, countries need regulatory frameworks that create a level playing field between conventional financing and islamic financing. learning from Malaysias tax initiative is another important factor for development of this industry. in our opinion, Malaysia and Singapore are the two markets best positioned to play the role of hubs for islamic infrastructure investing and promotion. Singapore can provide the advice and technical know-how to companies embarking on infrastructure projects, while Malaysia can provide the necessary infrastructure to raise islamic capital for the funding of these projects.
Sukuk Issuance By Country 1996-2010

Bahrain Indonesia Malaysia Saudi Arabia UAE Others
Hybrid Sukuk Bonds May Also Play A Role In Infrastructure Financing

over the past few years, hybrid instruments have been used by many highly leveraged companies seeking to raise funds. enticed by the non-dilutive nature of hybrids, and worried by the ongoing capital markets uncertainty, companies will continue to look at hybrids as part of their infrastructure funding options over the next 6-12 months, in our view. We also think there will be more hybrid sukuk bonds in the market. Standard & Poors applies its normal hybrid criteria when analyzing hybrid sukuk bonds; historically, the convertible sukuk bonds that weve rated typically exhibit high equity content, given that these bonds have a mandatory conversion to equity capital within three years.
(Mil. $) 60,000 50,000 40,000 30,000 20,000 10,000 0

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Sources: Zawya Sukuk Monitor Database, Standard & Poors.
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Lack Of Cohesion May Stop Islamic Finance Reaching Its Full Potential
the key issue for this market, in our view, is the lack of standardization, which constrains sukuk issuance and deprives the market of an organized structure to facilitate secondary trading and liquidity. We note that some regulators have recently introduced initiatives to implement a more cohesive global market for sukuk bonds, but were still several years away from a more standardized market globally. until this issue is addressed, the market is unlikely to reach its full potential compared to conventional debt markets. another constraint is the structure of some sukuk financing instruments that arrangers and sponsors companies want to use. typical sukuk structures include sukuk bonds fully guaranteed by sponsors (for example, corporate bonds), partially guaranteed sukuk bonds by sponsors, and sukuk bonds that do not benefit from any guarantee by sponsors (for example, project financing). infrastructure companies that are looking to raise funds to finance projects are more likely to adopt sukuk structures with full guarantees. for stand-alone infrastructure projects, typical capital-market financing from a conventional perspective involves proper ring-fencing of the project with no recourse to sponsors (but with recourse to the cash flow and the assets of the underlying projects). for these types of stand-alone projects, the more likely structure to be applied will be asset-backed sukuk structures with no guarantees from the sponsors. the challenge is that its not a very common structure thats out there for sukuk bonds. although investors seem keen to invest in assetbacked sukuk bonds to get hold of the underlying assets in case of a default, we dont see many transactions with no guarantees out there. in our view, this is partly because sukuk transactions without a guarantee may be lengthier, costlier, and more complex.
Whats Next For The Islamic Finance Market?

despite some of these hurdles and the lack of common ground, we believe theres still cause for optimism. the islamic financing market is gradually expanding, and is now moving toward listed instruments both in international and local markets, including dubai, Malaysia, and Saudi arabia. this trend to list sukuk bonds in organized markets is important for market liquidity, with bigger pools making it easier for investors to manage liquidity and price discovery. there is also potential for the development of secondary markets for trading sukuk bonds, which will likely provide more comfort for investors. during the global financial crisis, certain high-profile sukuk issues defaulted and were subsequently restructured. We believe this was, in a way, a positive development, as it allowed maturation of the industry. in our view, a default track record is necessary for the establishment of a mature market. defaults help investors form a view of the credit risk of instruments, especially asset-backed sukuk bonds without any guarantees (the main structure used in project financing). as the islamic finance market develops further and matures, we believe investors will feel more comfortable. its unlikely to be easy or come quickly, but the time seems ripe for more islamic finance funds being channeled into much-needed infrastructure projects across asia.

Global Standards needed to Give Breadth and depth to Growing Sukuk Market, March 1, 2011 Sukuk funds Poised to Grow as Sukuk Market continues to expand, oct. 11, 2010 Preliminary BBB+ rating assigned to nomura Sukuk ltd. s Proposed uS$100 Million trust certificates due 2012, July 6, 2010 using fund ratings as a tool to assess credit and Market risks in Sharia funds, May 4, 2010 Glossary of islamic finance terms, Jan. 7, 2008 Standard & Poors approach to rating Sukuk, Sept. 17, 2007
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Banking At The Crossroads And The Role Of S&Ps Updated Rating Criteria
Contact: Ritesh Maheshwari, Singapore (65) 6239-6308; ritesh_maheshwari@standardandpoors.com
This article was published in FinanceAsia.com on Nov. 17, 2011
the
global banking Sector iS at a croSSroadS, following the
unprecedented turmoil of the past four years. as it seeks to reinvent itself, the sector faces several critical inflection points that will affect the future creditworthiness of banks. Players in the banking space across asia-Pacific arent in the center of it all, but also are not immune.
Why did Standard & Poors update its bank criteria?

our updated criteria are the result of many months of considered development, not a reaction to recent market events. our aim is to provide greater transparency and consistency to reflect the evolving global banking landscape. the criteria are a refinement of our analysis rather than a reinvention. it builds on what we knew before the financial crisis and incorporates what we have learned about how banks, investors and governments respond. the outlook for the global banking industry is clouded by the potential shift in the balance of power among banks, the emergence of a more significant shadow banking sector, and the potential for a different relationship between banks and governments. in our view, our new criteria provide a lens to understand these key themes, and their impact on banks. it is the result of extensive market consultation following our requests for comments, during which we met with over 2,500 interested parties and spoke with more than 10,000 users of ratings. We have heard the market feedback about increased transparency loudly and clearly.
anchor rating, which is the starting point for our rating analysis on each bank. thirdly, we have specified explicit ranges of capitalization, leveraging our risk-adjusted capital framework. for example, if a banks risk-adjusted ratio is in 7%-to-10% range, we deem it adequate. lastly, but not least, we have modified our hybrid criteria in light of the experience during 2007-2009 crisis, and we now notch down most hybrid ratings from the standalone credit profile.
How do these building blocks work?

to borrow an analogy from the insurance market, a persons home address can impact their house or car insurance premiums. in the same way, our new criteria are placing a greater emphasis on the country in which a bank operates, through an enhanced version of our existing banking industry country risk assessment (Bicra) methodology. By doing this, we will give more weight to the risks associated with growing economic imbalances, the resilience of the economy, and the importance of systemwide funding and the role of governments and central banks in this funding. this analysis creates a framework to evaluate the relative strengths of banking systems and will be a consistent starting point for our rating. this starting point is then adjusted up or down the rating scale to reflect our assessment of a banks specific strengths and weaknesses in business position, capital and earnings, risk position, and funding and liquidity. after this, we assess the potential for government support or group support (for example, a parent company to a subsidiary).
What are the key changes in your updated criteria?

there are four key changes in our updated criteria. firstly, the criteria follow a building-block approach and provide greater transparency on how rating factors combine to form a rating. consequently, investors and other market participants can now agree or disagree with our assumptions and do their own analysis. Secondly, the criteria place greater emphasis on the country in which a bank operates, through an enhanced banking industry country risk assessment (Bicra) methodology. our Bicra assessment provides us the
Can you explain a bit more about BICRA?

the Bicra methodology is designed to evaluate and compare global banking systems. a Bicra is scored on a scale from 1 to 10, ranging from the lowest-risk banking systems (group 1) to the highest-risk (group 10), based on a time horizon of three-to-five years. the Bicra analysis, which incorporates the influence of government supervision and regulation of the banking system, is divided into two
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Our aim is to provide greater transparency and consistency to reflect the evolving global banking landscape.
Chart 1
BICRA, Economic, And Industry Risk Scores For Asia-Pacific

BICRA groups: Lowest to highest 1 2 3 4 5 6 7 8 9 10
Economic Risk 10 9 8 7 6 5 4 3 2 1
Vietnam Papua New Guinea, Mongolia Cambodia
Philippines China, Thailand Malaysia Korea Hong Kong Singapore Australia

1 2 3
Indonesia
India
New Zealand Japan

4 5
Taiwan
Industry Risk
10
components: economic risk and industry risk. the analysis is then further divided into six factors that result in an economic and industry risk score for each country. a factor that is assessed as high-risk is given a greater weight in the assignment of the final Bicra scores. the criteria use metrics to enhance transparency and provide a basis for comparability among banking systems. the published criteria provide guidance in assessing and scoring each factor and sub-factor.
How do you view Asia-Pacific banking systems following the updated BICRA methodology?
in asia-Pacific, our economic and industry risk scores and the resulting Bicra groups are widely dispersed. this reflects our view of the varying stages of economic and institutional development within the region. the
distribution of economic risk scores broadly aligns with the level of economic development in the 16 systems we reviewed (see chart). under the economic resilience factor, we scored australia, Hong kong, Japan, and Singapore as either very low risk or low risk, reflecting their high income levels and resilient economies. at the opposite end, we assessed countries such as Papua new Guinea, the Philippines, and Vietnam as very high risk and cambodia as extremely high risk, reflecting these economies earlier stage of development, narrower economic structures, and greater exposure to economic volatility. the majority of economies in asia-Pacific are significantly less exposed to economic imbalances than countries in other regions. consequently, we assessed nine of the 16 systems we reviewed as low risk or very low risk under this factor. Many of these systems benefit from
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The criteria follow a building-block approach and provide greater transparency on how rating factors combine to form a rating.
several years of low or moderate growth in credit and asset prices. this mitigates the risk of a sudden, sharp drop in asset prices that could cause asset-quality problems for banking systems in the region. five systems were assessed as high risk or worse. the assessment of high risk for china and Hong kong stems from a rapid rise in privatesector credit and asset prices in recent years, despite sizable current account surpluses. We assess credit risk in the economy as low risk for five banking systems, intermediate risk for one system, and high risk or worse for 10 systems. for some systems classified as low risk (such as Singapore and Hong kong), we note that previous declines in asset prices had a relatively insignificant impact. for systems assessed as high risk or worse, key constraints include moderate to high private-sector debt relative to income, or significant weaknesses in the payment culture and rule of law, which could result in low or delayed recoveries for creditors and a residual overhang of nonperforming assets. for example, banking systems in thailand and the Philippines still carry some legacy nonperforming assets from the asian financial crisis. although in terms of economic risk, Vietnam is in the highest risk category, we believe china represents the most significant future risk in asia-Pacific. this is owing to the combination of chinas high risk of economic imbalances and high risk of credit risk in the economy, given its sizable economy and connections within the region and the globe.
How do Asia-Pacific banks fare with regard to the second component of BICRA i.e. industry risk?
the distribution of industry risk scores is broadly similar to that for economic risk. our assessment of institutional
framework reflects a regional dichotomy. on the one hand, systems like australia, Hong kong, and Singapore are among a handful of systems to be classified as very low risk. this reflects more conservative regulatory standards than observed globally, comprehensive regulatory coverage, and a strong record of averting banking-sector problems. additionally, we consider governance and transparency in these systems to be of a very high standard. on the other hand, half of the systems in the region have classifications of high risk or worse for institutional framework, reflecting our assessment of insufficiently robust regulatory frameworks, weak regulatory track records, or limited governance and transparency standards. our assessment of competitive dynamics shows a concentration toward the higher risk categories. eight of the 16 systems reviewed show very high risk or extremely high risk, taking into account important government ownership, significant directed lending, or administrative controls in countries such as china, india, indonesia, thailand, and Vietnam. although we observe a minimal amount of targeted high-risk lending, we believe periods of rapid credit expansion could cause moderate to aggressive risk appetites. We believe systemwide funding is an area of relative strength for the region, and we assess 10 of the 16 systems as very low risk or low risk. one reason for this is the regions high domestic savings rate, which exceeds 30% of GdP in a number of countries. this is an important contributor to the relatively stable deposit bases that reduce the need for external funding. For criteria documents, ratings updates and explanatory materials, including interviews and training videos, please visit: www.standardandpoors.com/AI4FI.
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Most Asia-Pacific Banks Are In Better Shape Than Their Global Peers For Basel III, But Some May Need To Toughen Up Against New Rules
Contact: Naoko Nemoto, Tokyo (81) 3-4550-8720; naoko_nemoto@standardandpoors.com
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requirements in 2013, asia-Pacific banks look set to undergo a shift in industry dynamics as they adjust their business models in the long run. in Standard & Poors ratings Services view, asia-Pacific banks can be classified into three groups: 1) high-growth banking systems such as china, india, Vietnam, and indonesia that face constant challenges in replenishing capital; 2) low-growth banking systems such as Japan that have been struggling to meet Basel iiis target of high-quality capital; and 3) others such as korea, Singapore, and australia that will easily meet the capital requirements. overall, we believe that most rated asia-Pacific banks are unlikely to face significant difficulty in complying with Basel iii, although some banks with weak capital quality or a high dependence on wholesale funding will find it tougher to adapt to the new global regulatory framework on bank capital adequacy and liquidity. (listen to the related podcast titled, Basel iii: Why Most asia-Pacific Banks are Better off than their Global Peers, dated oct. 27, 2011.) the Basel committee on Bank Supervision (BcBS) released its final recommendations for the global regulatory framework in december 2010 and updated them in June 2011. the new capital requirements will be implemented in 2013, and the full implementation of the framework is scheduled in 2019. Basel iii is the third edition of the minimum standards applied by regulators to internationally active banks. it is a set of reform measures aimed at increasing the quality of regulatory capital and ensuring global consistency to foster greater resilience among banks to deal with financial and economic stress, improve risk management, and strengthen banks transparency. to improve the consistency of regulatory capital among countries, Basel iii has increased focus on capital quality. By 2015, banks are required to hold a minimum
common equity tier 1 (cet1) ratio of 4.5%. in addition, from 2016, banks will need to hold a mandatory capital conservation buffer of 2.5% as protection against periods of financial distress. the buffer will be phased in over four years and will result in a total common equity requirement of 7%. in addition, the regulations require banks to deduct a number of itemssuch as investments in unconsolidated subsidiariesfrom common equity. the Basel committee has also recommended a number of new measures and reforms, including higher capital requirements for securitizations, trading, derivatives, and trading-related counterparty risks. the committee introduced a new non-risk-weighted leverage ratio to prevent banks from accumulating excessive on- and offbalance sheet leverage, as well as new standards for liquidity management and monitoring. Basel iii may have a positive effect on the stand-alone credit profiles of rated banks if the industry is able to transition smoothly into the new capital regime and meet the strengthened capital and liquidity requirements. on the other hand, the new regime could trigger fundamental changes in business models, competitive dynamics, and product pricing. in other words, the Basel iii framework will likely affect asia-Pacific banks financial profiles and business models, in our view.
Why Most Asia-Pacific Banks Are Likely To Meet New Capital Requirements
We believe that most rated asia-Pacific banks are in a better position than banks in other regions to meet the higher capitalization requirements under Basel iii. nevertheless, the asia-Pacific banking sector is not a level playing field. High-growth banking systems such as china, india, and indonesia, will face pressure to replenish capital, while more mature markets with low growth, such as Japan, will need to improve their capital quality amid relatively weak earnings.
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The ultimate effects of the Basel III framework rest on how national regulators adopt the regulations.
Chart 1
Chart 2
ACE (Asia) ACE (Europe)
Asia-Pacific Banks With High-Quality Capital

6 5 4 3 2 1 0 2006 2007 2008 2009 2010
Asia-Pacific Banks Common Equity Tier 1 And Tier 1 Ratios (%)

14 12 10 8 6 4 2 0 MUFG Mizuho FG SMFG Kookmin ANZ Bank of Bank of China East Asia
Tier 1 Ratio Common Equity Tier 1 Ratio
ACE: Adjusted common equity/total assets. Asia: Average of capital ratios of top 40 Asia-Pacific banks. Europe: Average of capital ratios of Europes 50 largest banks.
asia-Pacific banks generally have high core capital. and because of that, the numerator of the new capital ratios, which raises the focus on tangible common equity, will not have a material impact on most rated banks in the region, in our view. Most of the asia-Pacific banks did not aggressively increase leverage during 2005-2008 and remain largely unaffected by the global financial crisis. in addition, they have enhanced core capital through common stock issuances and improved retained earnings during the past few years (see chart 1). the adjusted-common-equity-to-total-assets ratio of the top 40 asia-Pacific banks was 5.3% in 2010, which was higher than the average of the top 50 european banks at 3.2%. adjusted common equity, which does not include
Figures for Japanese banks are as of March 2011, and figures for others are as of December 2010. Assumptions: All items are assumed to be deducted from core Tier 1 capital, Deduction amounts are based on Standard & Poors estimates; Basel III will be fully implemented; Mizuho FGs Common Equity Tier 1 ratio does not include preferred equity (415 billion), which will be mandatorily converted into common equity in 2016.
preferred shares, is the narrowest definition of capital used in Standard & Poors credit analysis. chart 2 shows our estimates for the tier 1 common ratios of some large banks in Hong kong, china, australia, korea, and Japan, assuming the rule for deduction of certain items from common equity is fully implemented. as these banks have not fully disclosed the items to be deducted from their common equity, such as significant investments in other financial institutions, we used our own estimates in our calculation. the gap between their tier 1 capital ratio (measure of a banks capital adequacy) and tier 1 common capital ratio (measure of a banks financial strength; core
Table 1: Additional Adjustments For Common Tier 1 (Difference Between Basel III And Each Countrys Current Regulatory Capital)
Japan
Intangibles (except software) Postretirement benefits adjustment Deferred tax assets Investments in other unconsolidated FI X X X* X X** X X***
Australia
Hong Kong
China
X
Korea
X
*Deferred tax assets are counted up to 20% of Tier 1. **50% of investments in nonconsolidated financial institutions (FI) are deducted from Tier 1 capital. ***50% of investments in nonconsolidated FI subsidiaries are deducted from Tier 1 capital.
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Table 2: Regulatory Minimum Capital Ratios In Asia Pacific

(%)
India Japan* Korea China** Hong Kong Australia Singapore**** Indonesia Vietnam
to Standard & Poors estimates. for asia-Pacific banks, including Japanese banks, we expect the impact on riskweighted assets to be small, within the single-digit range.
Tier 1
6.0 4.0 4.0 6.0 (6.0) 4.0*** 4.0 6.0 (8.0) 4.0 4.0
Total Capital
9.0 8.0 8.0 10.0 (11.5) 8.0 8.0 10.0 8.0 9.0
Managing Asset Growth Is Key For Compliance With Minimal Capital Requirement
We believe most rated asia-Pacific banks will be able to comply with Basel iiis minimal capital standard under ordinary market and economic conditions, based on the assumption that asset growth will be moderate and credit provision costs would remain at a normal level. under Basel iii, the cet1 standard will be raised from 4.5% to 7.0% by 2019. assuming the current levels of preprovisioning profits and normalized credit costs, as well as reasonable asset growth, we do not foresee any problems for most rated banks to meet the new capital requirements. our projection is mainly based on the assumption that the banks would see moderate asset growth compared to the levels seen during 2008-2010 (for korean banks, the comparison is based on asset growth levels seen in 20052010). if asset growth outpaces our assumption and reaches or surpasses the peak level, some banks may face more hurdles than others in maintaining their current levels of capital ratio. in particular, this could happen in fastgrowing banking systems like china, indonesia, and india, although banks in these systems are usually able to tap the capital market and enhance their common equity from time to time, thanks to their potential for high growth. for instance, the four rated banks in indonesia and five rated major banks in china have successfully tapped the capital market through rights issues in 2010 and 2011.
*Minimum capital ratio is 4% for domestic banks. **New regulations for systemic banks will be effective in 2012 and the required core capital adequacy ratio is 5%. All figures in parentheses are ratios under the new regulations. ***Minimum requirement for core capital ratio. ****New capital regulation will be effective in 2013. equity capital compared with its total risk-weighted assets) is small. But the same cannot be said about the major Japanese banks. although some major banks in korea, australia, and Hong kong have issued hybrid securities that are considered tier 1 capital, the issuances are small. furthermore, most banks currently apply stringent definitions to regulatory capital, which could minimize the effects of the Basel iii regime (see table 1). for instance, banks in australia, Hong kong, and korea are already deducting nonservicing intangibles and deferred tax assets from their tier 1 capital. in china, investments in financial institutions, as well as corporations, are also subtracted from tier 1 capital. at the same time, higher capital charges for securitization exposures, market risk, and counterparty risk are unlikely to significantly affect asia-Pacific banks risk assets, in our view. asia-Pacific banks have limited securitization exposures and a low participation rate in capital market activities. the average capital requirement for market risk in the trading book will triple when a new rule under Basel iii is introduced at the end of 2011. combined with a higher charge for counterparty risk, the total risk-weighted assets of large global banks could increase by 10%-40%, according
Most Banks Likely To Be Unfazed By Discretionary Countercyclical Buffer If Applied

the ultimate effects of the Basel iii framework rest on how national regulators adopt the regulations. one of the issues that national regulators have to determine is whether to impose a discretionary countercyclical buffer. a national regulator can impose a discretionary countercyclical buffercomprising common equityof between 0% and 2.5% if it deems that credit growth will result in an
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unacceptable buildup of systemic risk. the capital buffer is designed to prevent a buildup of such risk in the first place. although the methodology and policies relating to the issue have yet to be completed, and its impact would depend on the degree of additional capital buffer, Standard & Poors believes that most rated asia-Pacific banks will be able to adapt to the regulation if it is applied. Most rated banks, in particular, those in countries that need a countercyclical buffer (see note 1), have relatively high core capital ratios and good access to the capital market, as previously mentioned. in addition, the minimum capital requirements of local regulators are more stringent than the Basel rules in some countries including india, Hong kong, Singapore and china (see table 1). furthermore, some countries such as china and Singapore have announced new regulations that require higher standards and shorter grace periods than those specified under Basel iii (see table 1). those local practices could push banks to improve their capital quality in the next two to three years. furthermore, the local regulators have started to require higher loan-loss-reserve ratios that enable banks to increase loss absorption buffers. there are technical challenges in implementing the countercyclical buffer, in our view. it is not easy to ascertain if there is excessive growth, and we believe that time lags should be allowed between the recognition of systemic risks and the implementation of tight regulations.
regulator was concerned that economic recovery would be jeopardized if banks were forced to focus on balance sheet reduction at the expense of new businesses. Since the global banking crises, Japanese major banks have improved their capital ratios through common equity issuances worth 5.5 trillion and accumulation of retained earnings. the average tier 1 ratio of major banks improved to 11.0% as of March 2011, from 7.0% as of March 2009. as the BcBS has given banks a grace period and permitted them a phase for gradual reduction in regulatory capital, we hold the view that Japanese major banks will be able to meet Basel iiis capital requirement (see chart 3). We assume that Japanese banks will be able to maintain their roa (return on assets; the net income-to-risk assets ratio) at the same level as the average during fiscal 20062010 and keep their unrealized gains in securities unchanged. as Japanese banks have sizable equity portfolios and government bond holdings, adverse valuation adjustments on these holdings could weaken their capital. for instance, revaluation losses could decline and erode common tier 1 ratio by 0.3% if long-term interest rates rise by 1% or if the nikkei stock index declines by 10%. We also note that most Japanese regional banks have higher common
Chart 3
Projected Common Tier 1 Ratios Of Japanese Banks (%)

MUFG SMFG Mizuho
Japanese Banks May Face More Challenges Than Regional Peers

the capital quality of Japanese major banks is generally weak compared with their peers in the asia-Pacific region. When Basel iii is fully implemented, we estimate that the common tier 1 ratios of the three major Japanese banks will be much lower than their current tier 1 ratios (see chart 2). this is because the three banks had posted large losses during the banking crises in the late 1990s and the early 2000s and replenished their equity base by issuing hybrid securities. in addition, Japans financial regulator was slow in implementing strict rules for capital definition. for instance, major banks were allowed to incorporate deferred tax assets of up to 20 % of their tier 1 capital because the
14 12 10 8 6 4 2 0 2011 2012 2013 2014 2015 2016 2017 2018 2019
Risk assets will grow by up to 10% by 2013 and increase by 1.5% annually after 2013; The ratio of net profits/risk assets will be the same as the average in the past five years (excluding 2008); Net profits after dividends will be added to capital; No changes in other financial data; and phase-in approach. MUFG: Including the effects of negative goodwill in Q1 2011 arising from its investment in Morgan Stanley. Mizuho: Including the effects of conversion of preferred equity (415 billion) in 2016.
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We expect most Asia-Pacific banks to find it easier than their global peers to comply with Basel IIIs new liquidity regime.
Chart 4
System-Wide Loans/System-Wide Customer Deposits (%)

250 200 150 100 50 0
the rule will be implemented between January 2016 and the end of 2018, and the scale of its impact depends on the amount of the additional capital charge. Major Japanese banks may not face much difficulty if the capital charge is around 1% (see chart 3), but a higher capital premium will add more pressure on the designated banks. the BcBS intends to periodically review the scope of G-SiBs and there is possibility that large banks in the asia-Pacific region, such as chinese banks, may be added to the list of G-SiBS.
ia
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K.
Liquidity Regulations Will Mostly Affect Banks That Rely On Wholesale Funding
We expect most asia-Pacific banks to find it easier than their global peers to comply with Basel iiis new liquidity regime. nevertheless, the new liquidity rules could still affect the banks balance sheets more than the new capital regulations. in our view, the new liquidity rules will encourage banks to increase retail deposits and hold liquid and high-quality securities that can be easily cashed out. at the same time, banks that find it difficult to increase core deposits or extend the tenor of their liability structure may review and restructure their long-term assets. the new liquidity ratios proposed by the BcBS includes two standards to address liquidity risks: the liquidity coverage ratio (lcr) and the net stable funding ratio (nSfr). Banks are required to comply with the lcr from 2015, and they will be required to cover their short-term liquidity positions and hold sufficient amounts of highquality unencumbered liquid assets to cover stressed net cumulative cash outflows for up to 30 days. only cash and government bonds are fully included in liquid assets; to a lesser extent high-quality corporate and covered bonds are also eligible. Meanwhile, the nSfr is designed to focus more on structural funding positions and ensure banks have stable funding bases in line with asset types. the nSfr will take effect from January 2018. Both the lcr and nSfr measures are subject to an observation period, during which supervisors will be able to monitor their unintended effects and report back to the Basel committee. the details of the liquidity measures will be discussed after the observation period and it would take some time to see the ultimate impact on banks.
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All figures are as of 2010, except Hong Kong, which is as of June 2011.
tier 1 capital ratios compared to the major banks, but they are also exposed to the volatility of interest rate and stock price changes. Most banks in Japan are aware of these risks and are trying to improve their capital ratios and reduce susceptibility to volatility. for instance, Mizuho financial Group inc. (a/Stable/) aims to: (1) lower its operating expenses ratio to 50% from 60%; (2) cut about 34% of its shareholdings from the level in March 2010; and (3) increase gross operating income by about 7% in 2012.
Additional charge will be imposed on major Japanese banks designated as G-SIBs

another key issue for Japanese major banks is whether they will be included in the group of global systemically important banks (G-SiBs). although the list of designated G-SiBS has yet to be disclosed, the top three Japanese banks are expected to be included. the three banks are Mitsubishi ufJ financial Group inc. (a/Stable/); Mizuho financial Group inc.; and Sumitomo Mitsui financial Group inc. (a/Stable/a-1). in addition to meeting Basel iii capital requirements, G-SiBs are required to have higher loss-absorbency capacity to reflect the greater risks that they pose to the global financial system. according to the BcBSs methodology for identifying G-SiBs, which was announced on July 19, 2011, the additional capital requirement would be 1%-2.5% of cet1 ratio, depending on the banks importance to the global financial system.
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Asia-Pacific banks have better liquidity profiles in global comparison

With few exceptions, we believe that most asia-Pacific banks have better liquidity profiles than their peers in other parts of the world. Banks in the region have large portions of liabilities made up of stable core deposits, and reliance on wholesale funding is low. the loan-to-deposit ratios of most asia-Pacific banks are low by global comparison (see chart 3). Generally, less-liquid long-term assets are covered by stable deposits and banks have sufficient liquid assets, mainly consisting of government bonds, cash amounts, and deposits at central banks. an exception is australian banks. compared with banks in most other asia-Pacific countries flush with customer deposits, australian banks rely more on wholesale borrowing, which forms a significantly large part of their funding. to some extent, this reflects the structure of australias macroeconomy, which has been run on current account deficits. in addition, compulsory superannuation savings form a large part of the nations household savings. according to the australian Prudential regulatory authority (aPra), results in a qualitative impact study (QiS) for australia shows an lcr ratio of 38% and nSfr ratio of 85% for eight listed banks as of July 2010. although Basel iiis liquidity measurements have yet to be fully defined and consistent indicators have yet to be made available, those ratios, which we believe have been much improved, are lower than the averages of global banks (lcr: 83%; nSfr: 98%; see note 2 below). like australia, korean banks also have relatively high reliance on wholesale funding, especially for foreign-currency funding. koreas financial Supervisory Service (fSS) announced at the end of 2010 that the average lcr of the big five banks in korea was 76% and the average nSfr was 93% as of the end of 2009. the figures for the korean banks are higher than those for the australian banks, although the korean banks still have room to improve and have yet to reach the required 100%. in order to improve the banks liquidity ratios, the regulator in korea has taken some measures. for example, the fSS has implemented regulations, such as setting the maximum local-currency-
loan-to-deposit ratio at 100% for banks by the first half of 2012, and increasing the credit conversion factor, which may encourage banks to reduce credit lines.
Banks with low government bond holdings will have low liquidity ratios
Some banks in countries such as australia, Singapore, and Hong kong will find it difficult to hold sufficient government bonds to clear the liquidity coverage ratio because of the relatively low levels of outstanding government debt. as a result, it is more challenging for those banks to achieve a high lcr. the BcBS is aware of this issue and the committee plans to develop additional criteria for alternative liquidity measurements. the potential options include contractual, committed liquidity facilities from central banks or foreign-currency liquid assets. unlike their peers in australia and Singapore, Japanese banks hold a large amount of their cash in government bonds due to sluggish loan demand and a growing pool of individual deposits. although this is good for their liquidity positions, large government bond holdings could also lead to higher interest rate risk and concentration risk. Meanwhile, the Basel committee has also proposed that lcrs based on currency denomination should be monitored, raising another key issue of how banks will able to meet foreign-currency liquidity needs. for most banks, managing foreign liquidity risk is more challenging due to higher reliance on wholesale funding. and this could be a challenge to many banks in the region as an increasing number of asia-Pacific banks are seeking growth opportunities and expanding overseas. although we do not foresee asia-Pacific banks making significant changes to their funding structure due to Basel iii, we believe they will face the challenge of maintaining sufficient core deposits because financial disintermediation (withdrawal of funds for direct investments) will erode their customer bases. as the capital market grows and becomes more diversified, asia-Pacific banks will see increased competition among various financial products. in addition, we expect loan growth in asia-Pacific markets to continue to outpace growth in other regions.
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Regulatory Changes Will Affect Banking Business Models

the Basel iii framework has the potential to strengthen banks capitalization and liquidity positions, which are positive rating factors. in addition, the new regulations will change the behavior of banks and have knock-on effects on the industry and capital markets, in our view.
incorporated as tier 1 capital with new instruments (for example, contingent convertible securities).
Improving risk management

it will be critical for banks to improve their capital models and elevate data quality to optimize their capital buffers and mitigate higher costs. the new regulations for market risk and credit risk, including stressed Var (Value at risk) and counterparty risk will require banks to upgrade risk management systems.
Restructuring portfolios
the higher capital charge will have the most impact on capital intensive businesses such as proprietary trading, over-the-counter derivatives, and securitizations. although asia-Pacific banks have relatively small exposures to these businesses, they may consider transforming or reducing their positions. in addition, global investment banks may consider additional changes to their business models, including modifying products and services and reviewing their geographical structures and partnerships, which could affect asia-Pacific banks and capital markets.
Widening divergence
although major asia-Pacific banks are well placed to withstand pressure from the Basel iii regulatory framework, any pain is likely to be uneven across asia-Pacifics banking sector. in our view, the major banks should be able to manage the effects of the capital regulations better than the smaller banks because they have stronger earnings, higher financial flexibility, and better access to the capital market. in contrast, smaller institutions could struggle to meet the higher capital requirements.
Higher competition for retail deposits

the liquidity regulations will push major players to refocus on retail deposits. that would fuel intense competition among domestic banks and push up funding costs for the banking industry, including regional banks.
Notes
Pursuit of higher margins

the required increase in capital and increased liquidity and funding costs could result in lower return on equity. in order to offset reduced profits, banks will seek businesses with higher margins and more efficient operations. Some costs will be passed on to customers and banks will increase their focus on proper risk premiums. Many asia-Pacific banks are trying to penetrate the retail market through products such as housing mortgage and consumer loans. competition in the retail market may intensify due to retail loans lower risk weightings and higher margins.
Optimizing capital
a portfolio review should reveal opportunities to minimize deductions and improve capital quality, for example, by reducing unconsolidated investments below regulatory thresholds or by buying out minority stakes. Banks are likely to replace current hybrid securities that cannot be
1. In the Basel Committee on Banking Supervisions (BCBS) guidelines published in December 2010, the committee suggested a methodology for assessing banks needs for a discretionary countercyclical buffer. Under the methodology, the committee recommends a buffer of over 2% for banks in Korea, Indonesia, Belgium, Canada, Netherlands, Spain, Sweden, the U.K., and Turkey. Buffers in the range of 0.5%-1.0% are recommended for another group made up of banks in Australia, China, Hong Kong, and Singapore. 2. The BCBS announced its estimates for the liquidity coverage ratio (LCR) and the net stable funding ratio (NSFR) of banks in December 2010. According to the estimates, the average LCR for Group 1 banks was 83% and the average for Group 2 banks was 98%. The average NSFR for Group 1 banks was 98% and the average for Group 2 banks was 103%. A total of 263 banks from 23 countries participated in a qualitative impact study (QIS) conducted by the committee, asking them to provide information on how the proposals under Basel III would affect them. The banks include 94 Group 1 banks (which have Tier 1 capital in excess of 3 billion euros) and 169 Group 2 banks.
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Basel iii for Global Banks: third times the charm? March 4, 2010 Basel iii Proposals could Strengthen Banks liquidity, But May Have unintended consequences, april 15, 2010 Basels Global Quantitative impact Study exposes large Banks regulatory capital Shortfall, dec. 20, 2010 Standard & Poors risk-adjusted capital framework Provides insight into Basel iii, June 9, 2011 for chinas Banks, a little Pain now May Prevent a lot of Pain later, May 24, 2011 Why Basel iii and Solvency ii Will Hurt corporate Borrowing in europe More than in the u.S., Sept. 27, 2011.
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Ratings Impact Of A Hypothetical Reunification Of The Two Koreas: A Thought Experiment

Contacts: KimEng Tan, Singapore, (65) 6239-6350; kimeng_tan@standardandpoors.com; John Chambers, New York, (1) 212-438-7344; john_chambers@standardandpoors.com
Editors Note: The following report is adapted from a presentation made by Standard & Poors credit analyst KimEng Tan at the Korea Center for International Finance for a seminar titled Credit Outlook of Korea: Sovereign, Banking and Corporate on Oct. 17, 2011, in Seoul.
The Assumption Set

for the purposes of this exercise, lets work with as benign a set of assumptions as plausible. Well assume and remember this is not a prediction but a hypothetical exercisethat: the north korean economy collapses without engaging the South in war; South korea quickly secures the norths nuclear and chemical arsenals; north koreas army is peacefully demobilized; South korea assumes administrative control of the entire korean peninsula; South korea keeps the border closed and prevents north korean land and sea immigration to the South; the monetary and financial systems of the two koreas are not immediately unified; and the shock of north koreas collapse does not destabilize financial markets in South korea. Given these benign assumptions, what would happen to the a foreign currency sovereign rating on South korea? a rating committee would have to answer that question, but let me give you some ideas of how such a turn of events could be analyzed using our sovereign criteria.
the score is unlikely to change much, if at all, following a peaceful reunification. although we assume security risk to have improved markedly in this thought experiment, the reunification brings new uncertainties to the policy environment: namely those emanating from the political absorption of more than 20 million new people into the system. the speed and manner by which this process is carried out would have significant implications for politics in the country. dissatisfaction among former South koreans could also be an issue. the large transfers to north korea necessary after reunification would likely mean higher taxes or reduced spending in the South. there could also be frustration among some South koreans who demand immediate family reunions. these factors could increase disgruntlement among South korean voters and pressure on politicians. added to domestic political uncertainties, we may also have to consider the impact of reunification on external relations. koreas neighborschina, russia, and Japan will have to adjust to the new reality. the stance that they adopt toward the newly reunited korean nation could also complicate political developments.
Economic Support For Creditworthiness Could Weaken Initially

at least in the first few years following a reunification, the economic attributes of a united korea are likely to provide less support for sovereign creditworthiness compared to the current support for South korea. average income in the unified korea is likely to be much lower than that of the premerged South. in addition, economic growth prospects of the country are likely to remain uncertain for at least two to three years following the merger. further on, growth could pick up strongly if the country implements reconstruction projects smoothly and puts appropriate economic policies in place.
Heightened Policy Uncertainties Offset Lowered Security Risks

our current political score on the South korean government reflects its generally good record in delivering sustainable public finances, promoting balanced economic growth, and responding to shocks. it also reflects a high level of transparency in the country and a political framework with a high level of institutional accountability. However, it also reflects the negative adjustment for the external security risks related to north korea.
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We would expect Koreas gross external financing needs to grow markedly following a reunification.
We assume that the per-capita GdP of a unified korea in 2012 would be uS$12,560, compared with the uS$22,800 of South korea in 2011. one reason is the far lower income level in north korea: only uS$920 in 2010, according to an estimate by the cia. another reason is that we would expect the value of the korean won to depreciate by about 15% in the wake of a reunification. finally, we also assume a 15% drop in north korean GdP in the year of reunification due to disruptions to economic activities arising from the event. korea is likely to experience several years of sizeable current account deficits in the years following a reunification. imports are likely to swell as a result of reconstruction in the former north korea. export growth, however, is unlikely to accelerate. We believe that the exchange rate could weaken from current levels on expectations of the wide deficits in the following few years. in the scenario examined here, we assume that it would fall to 1,252 won/ uS$ at the beginning of 2012 and remain at this level to the end of 2015. While this could help korean exports, the impact is likely to be limited. the much larger depreciation in 2008, for instance, has brought only modest permanent export share gain for South korea. economic growth prospects for a unified korea are likely to be uncertain in the period just after reunification. in principle, reconstruction and the low cost of labor in the north argue for strong growth, at least over a 10- to 15year period. in the first one to two years, however, growth is unlikely to be exceptional. reconstruction will take time to plan, obtain legislative approval on, and implement. Meanwhile, the fundamental reorientation of the erstwhile planned economy of the north could lead to short-term disruption to economic activity. in the case of Germany, for instance, east German output fell approximately 30% following the reunification in 1990. even medium-term growth prospects may not be much better if inappropriate policies are implemented. Workers in the South are likely to be concerned about jobs shifting north toward a lower cost of labor after unification. there would likely be strong pressure on the government to
at least slow this process to protect jobs in the South. if the government were to respond with very distortionary policies, long-term growth could be hurt. History informs us that such an outcome is not unlikely. When Germany was reunified in 1990, east German wages and prices were converted at par value to the West German mark. this seriously affected east German economic competitiveness and resulted in slow real economic growth in the region for many years.
External Indicators Would Deteriorate

We would expect koreas gross external financing needs to grow markedly following a reunification. the most important reason would be the expected large current account deficits highlighted above. We assume that this would cause the current account to register deficits in 2012-2015 averaging 5.7% of GdP and 8.3% of current account receipts. this would parallel the deterioration of Germanys pre-reunification current account surplus of about 4% of GdP to a deficit of just below 2% of GdP after the reunification. assuming that korean foreign exchange reserves remain unchanged, koreas narrow net external debt could average about 17% of current account receipts between 2012 and 2015. financing large investments in the north is likely to cause domestic interest rates to rise sharply if korea does not fund some of this increase with inbound foreign investment or foreign exchange reserves. While some easing of foreign investment could materialize, it is likely that much of the current account deficit would be plugged with foreign borrowings. external indebtedness would likely rise along with the current account deficit as a result. South korea is currently a narrow net external creditor. Within three years of a reunification, however, we would expect net external debt to turn modestly positive. However, the korean won is likely to remain an actively traded currency. international demand for its currency should allow the economy to increase its external borrowings without a dramatic increase in funding cost.
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A Major Contingent Liability Is Realized

the fiscal health of the korean government could deteriorate significantly post-reunification. Significant transfers to the north would likely be necessary to prevent starvation. We expect the breakdown of the economic system in the north could leave many north koreans even more destitute than they are now. equipping them with the skills needed in the new economic environment could take years. longer-term investment in infrastructure would also weigh heavily on government finances. Public infrastructure in the north is woefully inadequate. closing the economic gap between north and South would thus require heavy investment in roads, rail, and power plants. Spending on improving social services such as education and basic healthcare are also likely to be large. these shortfalls in infrastructure and basic services constrain medium-term fiscal flexibility. over the years, studies have offered a wide range of estimates for the total fiscal cost of reunification: most lie between uS$300 billion and uS$1,500 billion. external support from foreign governments is likely, particularly from the u.S. However, much of this support is likely to be in the form of low-interest loans rather than grants. Moreover, given the large expected costs, such external support is unlikely to cover the bulk of resources needed. Politics will determine the actual impact on government finances. Politicians have flexibility in deciding the speed and size of necessary investments. But this discretion has its limits. Pressure on politicians may rise if such investments proceed too slowly. conversely, rushing ahead could destabilize public finances. in our scenario, we assume that transfers amounting to about 6%-7% of South korean GdP would be made to the north for a substantial period. this would likely see the general government balance over the four years from 2012 average 4.2% of GdP. in the case of Germany, where the economic gap between east and West Germany was much smaller, transfers of a similar size have been made since 1991. the large deficits would lead to a significant increase in net general government debt over the medium term. However, contingent liabilities would fall sharply since a
large part of these would be realized. consequently, the government debt score is unlikely to worsen, in our view.
Monetary Environment Could Become More Uncertain

the monetary environment could see changes postreunification. We expect the won to remain a floating currency. korean financial markets are also unlikely to be markedly less active compared to before the merger. However, confidence in the central banks ability to maintain low inflation could weaken modestly. the Bank of korea would need to maintain price stability in a much more complex environment. a large part of the economy that it will oversee possesses characteristics very different from the rest. average income in north korea is much lower than in the South; it is barely a monetary economy; financial markets do not exist; and economic statistics are of poor quality even where they do exist. the central banks past record is likely to be less relevant in judging how successfully it could carry out its inflation mandate in the future.
Indicative Rating In This Scenario

Based on the above discussion, a committee could determine that the indicative long-term sovereign rating of a reunified korea in this scenario would be lower than the current a rating on South korea. the political and economic profile of the new entity is likely to be intermediate to moderately weak. the flexibility and performance profile is likely to be strong. thus, the final rating would fall below the current a long-term foreign-currency rating. nevertheless, it would remain investment grade under the set of benign assumptions i outlined above. the reunification assumptions that we describe and analyze here are deliberately optimistic. the north korean regime is a highly unpredictable nuclear power. if reunification happens, it is not likely to be as peaceful and smooth as laid out here. this thought experiment does, however, give us an idea of the minimum damage that a potential reunification could do to the sovereign creditworthiness of South korea.
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Can Indias Developing Infrastructure Keep Pace With Economic Growth?

Contacts: Rajiv Vishwanathan, Singapore, (65) 6239-6302; rajiv_vishwanathan@standardandpoors.com; Allan Redimerio, Singapore, (65) 6239-6337; allan_redimerio@standardandpoors.com
A longer version of this article was published on RatingsDirect Global Credit Portal on Nov. 17, 2011
indiaS
econoMY iS on a roll:
the
nationS annual
gdP
growth averaged 8.2% in 2006-2010, when most global economies were slowing down, and the government expects 9.0%-9.5% growth annually in 2012-2017. nevertheless, Standard & Poors ratings Services believes that indias inadequate infrastructure is a major roadblock to achieving these aggressive growth targets. the indian government has stepped up infrastructure spending in recent years to keep pace with its growth projections. in its draft twelfth five-year plan for 20122017, it proposes to invest $1 trillion on infrastructure almost double that in the ninth five-year plan period. our outlook for the infrastructure sector in india is stable. the economys growth in recent years has led to increasing urbanization and pushed up demand for infrastructure. However, the slow pace of reforms and a lack of long-term funding options are constraining the sectors growth (see chart 1).
Chart 1
Demand for infrastructure far exceeds supply

indias power requirementfor which there is already a significant shortfallis likely to multiply in the next few years due to rapid industrial and urban expansion and a likely increase in the currently low electricity consumption per person. in our view, the governments plans to adds 100 gigawatts of power capacity over the next five years, increased efficiency, increasing private sector participation, competitive pricing, and a stronger regulatory framework should increase the supply of power projects. road, railway, and port expansions are also falling far short of targets. the roads are of poor quality and congested. the growth in the number of vehicles has outpaced the increase in highways and roads. in our view, modernization of the railway system is critical to speeding up indias economic growth. the lack of road and rail connectivity is also hampering development of port infrastructure.
Key Risks In Indias Infrastructure Sector

Lack of effective governance and regulatory uncertainty
delays in government and regulatory decision-making have caused several infrastructure projects to fall way behind schedule. the continued uncertainty over policies could constrain the effective participation of private companies and limit the funds available for infrastructure development. in its twelfth five-year plan, indias government has highlighted the importance of attracting private investment in infrastructure through public-private partnerships.
Indias GDP Growth And Infrastructure Dynamic

Power* (left scale) Irrigation (left scale) Transport** (left scale)
Share of power, irrigation, and transport in total infrastructure spending

Target GDP Growth (right scale) Actual GDP Growth (right scale) (%)
(%)
35 30 25 20 15 10 5 0
10 8 6 4 2 0
Difficulties in acquiring land and getting environmental clearances

Problems with land acquisition restrict infrastructure projects and increase the costs to sponsors. delays in environmental clearance and lack of access to resource-rich but environmentally sensitive areas have caused shortages in fuel supply for power plants.
ird Fo ur th Fif th
Si xt
Ni nt
Fir
ve n
Se co
Eig
Te n
Th
Se
Five-year plans
*Does not include power from mining, petroleum, non-conventional sources, and nuclear energy, split is not available for the ninth five-yera plan. **For the first to fifth five-year plans, no separate allocation was available for transport, transport and communication were reported together. ***Actual GDP growth based on first four years of the eleventh five-year plan; outlay based on original projection. Source: Indian Planning Experience - A Statistical Profile, published by the Planning Commission, Government of India, January 2001.
Ele ve n
th
** *
nd
th
ht h
th
st
Fuel-supply risk for power projects

We believe the lack of adequate fuel supply is a major hurdle to ramping up power generation in india. india has one of the largest reserves of coal in the world, but problems
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We expect demand for infrastructure projects to keep increasing in step with growth in the Indian economy.
Chart 2
Indias Coal Demand-Supply Dynamic

Total coal demand Total indigenous supply Coal despatches to power utilities
delaysparticularly due to increased costs and delays associated with land acquisitionremain a negative rating factor for projects under construction.
(MT) 800 700 600 500 400 300 200 100 0
Demand from power utilities
Difficulty in enforcing contractual provisions

in our view, despite the establishment of laws governing project finance transactions, the lack of strict adherence to contractual provisions by participants and delays in the legal process make it hard for lenders and investors in projects to enforce their rights under transaction documents.
Weak credit quality of state electricity boards and resistance to tariff increases
2006-07 2007-08 2008-09 2009-10 2010-11 2011-12
MTMillion tonnes. Source: Coal India, Ministry of Coal, Government of India.
with land acquisition and environmental clearances have obstructed access to the reserves. as a result, domestic coal production has fallen well below targets in recent years (see chart 2). to secure fuel supply, several independent power producers are seeking to secure reliable coal supplies by purchasing mines or ownership interests, overseas. in our view, while such ownership partially mitigates supply risks, it could expose power producers to fuel-supply volatility in the long run due to limitations in power plant technology, which is synchronized with a specific quality of coal. Such ownership could also increase project costs if additional supporting infrastructuresuch as ports, roads, etc.is to be developed for transportation of coal. additionally, the regulations in foreign countries can create uncertainties about the availability and cost of fuel. We therefore believe projects that have their own coal or domestic linkages are more secure than those with overseas links. While the use of gas for fuel is increasing, supply risks remain, as the output from key sites has lagged original estimates.
in our analysis of power utilities, we consider the weak credit quality of the offtakers in power purchase agreements (PPas)usually SeBsas a negative rating factor. Political resistance to tariff increases hampers generation companies efforts to pass through increases in costs particularly for fuelto end customers. continuing state government subsidies to these companies also reduces the incentive for them to hike tariffs. distribution companies have also suffered from inadequate investments to reduce technical losses and power leakages.
Strict regulation and underdeveloped port infrastructure

a shortage of resources and financing has resulted in underdevelopment of supporting infrastructure for ports such as deep drafts and connecting railroads and other forms of transport. Moreover, the sector is highly regulated and lacks freedom to set tariffs, making it less viable for private investment. the government aims to address some of these issues in its twelfth five-year plan.
Funding constraints are likely to broaden the infrastructure financing

in our view, finding appropriate funding solutions that enable companies to better manage their assets and liabilities, as well as their refinancing risks, is crucial for the growth of indias infrastructure sector. in our opinion, financing a greater portion of projects through user charges and private-sector funds can help the sector grow. Bank loans, which dominate project finance in india, tend to have tenors of five to seven years, while infrastructure projects generate cash flows over longer periods. these mismatches create refinancing risks for
Construction, project-completion, and operational risks

We believe the unprecedented growth in infrastructure projects underscores the importance of adherence to construction schedules by project participants and building up a skilled workforce with expertise in equipment operation and maintenance. in our opinion, project
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infrastructure projects. Moreover, higher borrowing costs due to rising interest rates could make it hard for projects with weak revenues in their early years to meet their debt service obligations. We believe the creation of a deep and robust debt capital market will make long-term debt instruments available for infrastructure financing.
A Strong Government Plan Is Key To Infrastructure Growth

We expect demand for infrastructure projects to keep increasing in step with growth in the indian economy. While we expect these forces to increase the pace of projects across the country, we believe government reforms to create a robust framework with transparent policies for project execution and funding will be critical to keep up the pace of infrastructure development. the fate of the infrastructure sector over the next few years will depend on the ability of indias leaders to execute these plans.
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asia-pacific office locations

Beijing Suite 1601, 16/f tower d, Beijing citc a6 Jianguo Menwai avenue chaoyang district Beijing 100022, P.r.china tel: (86) 10-6569-2909 Hong Kong Suite 3003, 30th floor, edinburgh tower the landmark 15 Queens road central Hong kong tel: (852) 2533-3500 Melbourne level 45, 120 collins Street Melbourne Vic 3000 australia tel: (61) 3-9631-2000 Mumbai criSil House, central avenue Hiranandani Business Park Powai, Mumbai 400 076 tel: (91) 22-3342-3000 Seoul 2nd floor, Seian Building 116 Shinmunro 1-ga, Jongno-gu Seoul 100-700, korea tel: (82) 2-2022-2300 Shanghai Suite 1601, 16/f Jing an kerry center 1515 West nanjing road, Jingan district Shanghai 200040, P.r.china tel: (86) 21-2208-0880 Singapore 30 cecil Street Prudential tower #17-01/08 Singapore 049712 tel: (65) 6438-2881 Sydney level 27, 259 George Street Sydney nSW 2000, australia tel: (61) 2-9255-9800 Tokyo 28f Marunouchi kitaguchi Bldg 1-6-5 Marunouchi chiyoda-ku tokyo, Japan, 100-0005 tel: (81) 3-4550-8000
our suBsidiAriEs in AsiA:

Mumbai criSil limited criSil House, central avenue Hiranandani Business Park Powai, Mumbai 400 076 tel: (91) 22-3342-3000 Taipei taiwan ratings corp. (trc) 49th floor, taipei 101 tower no. 7, Xinyi road Section 5, taipei 11049 taiwan r.o.c. tel: (8862) 8722-5800
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regional contacts
Yu-Tsung Chang executive Managing director and Head of asia-Pacific asia-Pacific ratings tokyo (81) 3-4550-8724 yu-tsung_chang@standardandpoors.com John Bailey Managing director and Head of australia and new Zealand Mebourne (61) 3-9631-2020 john_bailey@standardandpoors.com Jung-Tae Chae Managing director and Head of korea Seoul (82) 2-2022-2301 jungtae_chae@standardandpoors.com Ping Chew Managing director and Head of Greater china Shanghai (86) 21-2208-0880 ping_chew@standardandpoors.com Roopa Kudva Managing director and Head of South asia ceo, criSil Mumbai (91) 22-5691-3062 roopa_kudva@standardandpoors.com Hwa-Ping Chang President & ceo taiwan ratings corp. taipei (8862) 8722-5898 hwaping_chang@taiwanratings.com.tw
mEdiA contAct:
Lisa Coory Senior director, communications asia-Pacific Hong kong (852) 2533-3520 lisa_coory@standardandpoors.com
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Asia-Pacific Markets Outlook 2012

Rising Global Risks Cloud Asian Outlook

MICA (P) 170/10/2011

Strong AnAlyticS. trAnSpArent criteriA. induStry inSightS.

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aSia-Pacific MarketS outlook 2012

Growing Global Risks Eclipse AsiaPacific Economic Growth In 2012

Growth Begins To Lose Momentum

Real GDP Growth Begins To Decline

aSia-Pacific MarketS outlook 2012

Inflation Risks Subside

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aSia-Pacific MarketS outlook 2012

Table 1: Asia-PacificInflation Trends 2011*

Non-food inflation 1H 2011

Total CPI-based inflation 1H 2011

Table 2: Central Banks Changing Monetary Policy Stance

aSia-Pacific MarketS outlook 2012

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aSia-Pacific MarketS outlook 2012

Vulnerability To Eurozone Slowdown Remains High

Synchronized Economic Cycles But Divergent Growth Trends

aSia-Pacific MarketS outlook 2012

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Growth Could Plummet, But Inflation Might Go Down As Well

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aSia-Pacific MarketS outlook 2012

Table 4: Asia-Pacific Growth And CPI Inflation Forecasts

Annual CPI inflation 2012f

aSia-Pacific MarketS outlook 2012

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riSkS have SteadilY increaSed over the Year, with

Eurozone Crisis Could Pressure Sovereign Ratings

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aSia-Pacific MarketS outlook 2012

Table 1: Asia-Pacific Sovereign Ratings*

Foreign currency rating

Events In Europe Pose Indirect Risk To Asia-Pacific Banks

aSia-Pacific MarketS outlook 2012

Standard & PoorS

Table 2: Asia-Pacific Corporate: Business, Performance, And Rating Trends In 2012

Relative Performance business trends metrics 2011 versus 2012

Expected ratings trend 2011 versus 2012

Industry outlook Next 12 months

2011 versus 2012

Somewhat weaker Slight improvement

*The outlook on Japanese utilities is negative

Standard & PoorS

aSia-Pacific MarketS outlook 2012

Asia-Pacific Corporates: Exporters Vulnerable To Global Slowdown

Infrastructure And Utilities Will Build On Growth Despite Challenges

aSia-Pacific MarketS outlook 2012

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Stable Asset Performance Supports Structured Finance Stability

Standard & PoorS

aSia-Pacific MarketS outlook 2012

aSia-Pacific MarketS outlook 2012

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Asian Equities Markets: Doomsday Fears Should Subside In 2012

Table 1: Recommended 2012 Market Weightings And Target

Upside from Recommended Current Weighting

Positive Catalysts Will Go A Long Way

S&P Asia Outlook 2012

S&P Asia Outlook 2012