Asia 2010 Outlook

Emerging Markets Asia Research
January 15, 2010
Asia 2010 Outlook
• Overview: Shared macro dynamics, varied policy responses Dave Fernandez AC
Across EM Asia, GDP growth will be strong, base effects will drive (65) 6882-2461
david.g.fernandez@jpmorgan.com
headline CPI inflation higher, and external surpluses will remain strongly
positive. Even though macro dynamics are similar across the region, Asian Jahanghir Aziz
policymakers are saying that they will respond to a variety of factors, with (91-22) 6157-3385
their sensitivity to asset price inflation a key variable. Yes, EM Asia will jahangir.x.aziz@jpmorgan.com
lead the global tightening cycle, but some countries will not tighten at all. Bert Gochet
Listen up. It will be wise for investors to pay careful attention to the (852) 2800 8325
signals sent by Asian policymakers this year. bert.j.gochet@jpmorgan.com
Matt Hildebrandt
• FX: Less carry, more recovery (65) 6882-2253
All roads lead to Asia FX appreciation: Price momentum, portfolio inflows matt.l.hildebrandt@jpmorgan.com
and the well trodden path of global rebalancing all make compelling cases
for long positions in the region. CNY appreciation will also be one driving Yen Ping Ho
(65) 6882-2216
theme. The PBoC, having almost effectively pegged spot USD/CNY since
yenping.ho@jpmorgan.com
mid-2008, now appears on track to let CNY rise alongside macro tightening
this year. We favor being long KRW and INR, helped by Korea's leverage Jiwon Lim
to the global recovery and a strong pipeline of inflows for India. IDR (822) 758-5509
should also standout in view of positive carry and MYR could surprise as jiwon.c.lim@jpmorgan.com
a proxy play for CNY.

Grace Ng
(852) 2800-7002
• Rates: Too early to pay grace.h.ng@jpmorgan.com
It is too early to get into an overall “Pay Rates” trade in Asia. While true
that Asia will tighten policy rates ahead of other regions, hikes are still Claudio Piron
(65) 6882-2218
months away and yield curves price in too much tightening when compared
claudio.piron@jpmorgan.com
to our forecasts. Therefore, we only position paid or underweight bond
markets in a portfolio where some form of CB action is imminent (China Qian Wang
and India) and where it does not cost too much carry (5-yr sector). In (852) 2800-7009
contrast, in Korea, we like to receive, especially the front end, as BoK qian.li.wang@jpmorgan.com
faces strong headwinds. An important theme evident already this year is

Contents
strong foreign inflows into the most open Asian bond markets. Such
portfolio flows have the ability to define the direction of local bond markets, Overview 2
especially if there is no clear theme to monetary policy. We therefore FX Outlook 5
recommend long bond positions in the belly of the curve in Indonesia and Rates Outlook 8
Malaysia. Sovereign Outlook 11
China 12
• Sovereign credit: Spreads to tighten further Hong Kong 22
Fundamentals will continue to improve thanks to strong GDP growth and India 25
manageable inflation. CA surpluses and capital inflows fuel further fx Indonesia 32
Korea 36
reserve accumulation while smaller budget deficits should lead to improved
Malaysia 44
external debt ratios. Despite the positive outlook, upgrades will likely be Philippines 49
few and far between, compared to previous recoveries given the fewer Singapore 51
number of downgrades over the last few years. Sri Lanka and Indonesia Taiwan 54
stand out as most likely upgrade candidates, while Vietnam is the sole Thailand 59
downgrade risk. Appendix Tables 61
The certifying analyst is indicated by an AC. See page 68 for analyst certification
and important legal and regulatory disclosures. www.morganmarkets.com
JPMorgan Chase Bank Emerging Markets Asia Research
Dave Fernandez (65) 6882-2461 Asia 2010 Outlook
david.g.fernandez@jpmorgan.com January 15, 2009
EM Asia GDP forecast in global context

Shared macro dynamics, but Potential GDP
% oya 2008 2009 2010
varied policy responses growth
Developed markets 0.4 -3.4 2.6 1.6
United States 0.4 -2.5 3.3 2.0
• Across EM Asia, GDP growth will be strong, base effects
Japan -0.7 -5.3 1.9 1.7
will drive headline inflation higher, and external
Euro area 0.6 -3.9 2.1 0.8
surpluses still flush
United Kingdom 0.6 -4.8 1.7 1.5
• Even though macro dynamics are similar across the Emerging markets 5.0 0.7 6.0 5.5
region, Asian policymakers are saying that they will Latin America 3.8 -3.2 4.3 3.3
respond to a variety of factors, including asset prices Emerging Asia 5.8 4.4 7.6 6.9
CEEMEA 4.6 -3.2 4.1 4.6
Listen to Asian policymakers Emerging Asia GDP growth forecasts for 2010
EM Asia faces macro challenges in 2010 that provide no JPM JPM at / above Consensus at / above
easy solutions, so it will particularly important to listen to potential potential? average consensus?
what policymakers are thinking when making investment China 9.7 9.0 X 9.6 X
decisions. In 2009, the task before policymakers was clear -- Hong Kong 4.5 4.1 X 4.5 X
limit the spillover from negative DM shocks and stimulate a India 7.8 7.5 7.7 x
growth revival. With the recovery in Asian economic Indonesia 5.5 5.0 X 5.6
growth on its way to being well entrenched, in 2010, sup- Korea 5.4 4.0 X 4.7 X
porting GDP is no longer the sole concern. Other concerns
Malaysia 5.0 5.5 4.5 X
are coming to the fore. Key among these worries for 2010 is
Philippines 5.0 4.5 X 3.7 X
how to manage asset price inflation driven by capital in-
flows and flush domestic liquidity. Singapore 6.5 4.5 X 5.6 X
Taiwan 5.8 4.5 X 4.6 X
Around the region, we expect Asia FX to appreciate and Thailand 5.5 5.0 X 4.2 X
rates to rise, but this normalization of policies will happen
at varying speeds. Listening to Asian policymakers, it is a rate hike in March, though this will not be the start of a
clear that a common feature is that none will move quickly series of hikes. At the opposite end of the spectrum sits
toward neutral, let alone, tight policies stances. While the Indonesia where, despite solid GDP growth and rising infla-
J.P. Morgan forecast calls for the region’s GDP growth in tion, we believe a more credible Bank Indonesia will be able
2010 to be at or above our estimate of long-run potential, to leave rates unchanged.
there is enough uncertainty about output gaps that it will
take some time before Asian policymakers tighten based on Through choppy, growth will shine across
these gaps closing. And while our analysis indicates that
most Asian currencies are undervalued, it has long been the EM Asia
case that the speed of appreciation will be heavily managed, EM Asia will lead global growth both this year and next.
based on policymakers’ judgments. 2009 will be remembered as the year that Emerging Mar-
kets carried the global economy, with EM Asia being the
When we listen to Asia’s policymakers, what we hear is a only region in the world to expand during the worst global
diversity of views on exit strategies this year. First, look at recession since World War II. For 2010, EM countries will
the early movers in Asia. China kicked off its policy normal- stage a powerful recovery and Asia will again lead. J.P.
ization process this week with a 50bp hike in the required Morgan’s forecast for 7.6% growth in EM Asia GDP is
reserve ratio, having clearly stated that its decisionmakers above the consensus average and above our estimate of the
want to see a smooth growth path of lending and not the region’s potential growth rate (though we are humble
surge that occurred immediately during the first week of enough to put even less faith than usual in potential growth
2010. India started to withdraw regulatory forbearance mea- estimates in the immediate wake of the global crisis).
sures last year and we believe a CRR hike from the RBI, trig-
gered by a concern that excess bank liquidity fueling asset No Asian country will be left behind this year, with China
price inflation. Korea, along with India, has been a leader in and India again leading. Taiwan, Singapore, Thailand, Hong
voicing concern over asset price inflation, likely resulting in Kong, and Malaysia will see huge GDP growth swings from
2
contraction in 2009 to expansion in 2010. And the countries EM Asia : Inflation peaks in 2010
that managed to avoid full-year contractions in 2009 (Korea,
the Philippines, and Indonesia) will all accelerate. A useful Peak Quarter CB target or estimate
reminder of the volatility of EM Asia’s GDP growth is play-
ing out now, with the region rolling down after extremely China* 3.5 2Q na
high growth in the middle of 2009. According to the J.P. HK 4.4 3Q na
Morgan forecast, EM Asia is on track to slow to about a 6% India 9.0 2Q 5-5.5% Estimate
growth pace in 4Q09 after averaging over 11% in the middle Indonesia 6.2 4Q 4-6% Target
of 2009. Singapore’s 4Q09 contraction at a 6.8% rate is a Korea 3.8 3Q 2-4% Target
concrete example of this. So while the growth recovery in Malaysia 3.3 3Q na Estimate
EM Asia has been undeniably impressive, policymakers will Philippines 6.7 3Q 3.5-5.5% Target
see this GDP choppiness as a reason not to be complacent Singapore 4.0 2Q 2.5-3.5% Estimate
about the growth outlook. Taiwan 2.6 4Q 0.90% Estimate **
Thailand 6.6 3Q 3.5% to 5.5% Estimate
Inflation rolls higher; core well behaved Core (Thai) 2.3 3Q 0.5-3.0% Target
After slowing sharply in 2009, Asian inflation is set to * No target, but general expectation is that the Central Bank would continue raising
rates when the headline CPI rises above 3.0 %
rise, but not to run away. We are forecasting a 3.4%oya rise
in EM Asia CPI inflation in 2010 from a near record low 1.6% ** Estimate by DGBAS,CB targets M2 growth (2.5-6.5% for 2010)
in 2009 (the five-year regional average is 4.0%). Part of the
rise will reflect the recovery in economic activity. However, Emerging Asia: food and energy in CPI baskets
much of the acceleration will also be due to base effects % share of CPI basket:
from the previous year. Food Energy
China 32.7 3.6
In the majority of EM Asian countries, J.P. Morgan expects Hong Kong 26.9 3.9
that CPI inflation will rise above the upper limit of the cen- India2 27.0 14.2
tral bank’s target range. In this respect, India stands out Indonesia 24.7 5.8
with our forecast of a peak for WPI inflation of 9% com- Korea 14.0 5.7
pared to an official forecast of 5-5.5%. But target ranges are Malaysia 31.4 15.9
also expected to be breached in two countries with formal Philippines 46.6 7.0
inflation targeting frameworks (Indonesia and the Philip- Singapore 23.4 5.3
pines, while targeted headline inflation in Korea and core Taiwan 26.1 6.9
inflation in Thailand stay just inside the top of the target Thailand 38.5 8.8
range). In Singapore, inflation will peak in 2Q above the offi-
Emerging Asia 29.2 7.1
cial forecast range and in China it is generally expected that
ex China 26.6 9.5
the PBoC would tighten in inflation moves above 3% which
ex China and India 24.6 7.1
we expect to happen in 2Q. Note that, in general, food and
energy prices add upside risk to our inflation forecasts.
boosts Asian exports and an expectation that oil prices will
Asia’s CPI baskets have large weights for non-core items,
stay in a range of US$70-90 should basically offset each
especially for food.
other, keeping the size in US dollars of the surpluses
steady. By country, China’s current account surplus will
While headline inflation in EM Asia is set to rise in 2010,
stabilize as a share of GDP, meaning that the absolute size
we believe that wage growth will be subdued and inflation
of the surplus will rise versus 2009. Elsewhere, strong do-
expectations well-anchored expectations. Base effects that
mestic demand in Korea and Thailand should result in
drive inflation higher over the course of this year will even-
smaller surpluses, though neither country is expected to
tually fade, with most countries seeing CPI flatten out going
revisit the (small) CA deficits experienced in 2008. South
into 2011.
Asia will continue to run deficits.
Asia FX reserves continue to build Add to these CA surpluses the capital inflows from equity,
EM Asia’s external surpluses will stay flush in 2010. The fixed income, and FDI, and we are projecting that regional
region’s persistent current account surpluses are set to FX reserves will rise by over US$500 billion in 2010. Global
continue this year, though as a share of GDP they will slip rebalancing has a long way to go, and Asia is unlikely to be
to around 5%. However, the global growth recovery that a contributing force in this regard in 2010.
3
Early start to policy normalization, but var- EM Asia: Monetary policy actions in 2010
ied and measured First action Timing Cumulative action
Asset price inflation is increasingly taking center stage in +200bp in RRR; +81bp in
China +50bp (RRR) Jan
EM Asia. Easy monetary conditions, high household sav- policy rate
ings rates, intact banking systems, and strong housing de- Hong Kong no change
mand have led to sharp rebounds in residential real estate
Taiwan +12.5bp 4Q +12.5bp
prices across much of the region. While EM Asian central
banks have not yet declared war on asset prices, higher Korea +25bp Mar +50bp
property prices are increasingly grabbing attention among +100bp in CRR; +75bp in
EM Asian central banks. So far, policymakers have reverted India +50bp (CRR) Jan
policy rate
to regulatory changes to slow property market activity. We Indonesia no change
expect central banks in 2010 to continue down this path,
with monetary tightening being used as a tool to cool per- Malaysia +25bp Jul +50bp
ceived asset bubbles only as a last measure. Philippines +25bp 2Q +100bp
Singapore no change in NEER path

Early policy moves are likely to be led by China, India, and
Korea. The J.P. Morgan view is that EM Asia will move Thailand +25bp Jul +50bp
ahead of the rest of the world in terms of normalizing ex-
tremely easy monetary conditions. But policymakers are still
unlikely to make major adjustments. The Bank of Korea and
the Reserve Bank of India have been leaders in signaling to
the market that they are willing to begin to normalize mon- the US, with a high degree of uncertainty. Over time, possi-
etary conditions relatively early, with policy rate changes bly by 2Q10, it may see the global recovery on surer footing
expected from both in 1Q10. But the BoK MPC is also aware and the turn to positive %oya export growth is a concrete
that the market has taken that message to heart and is pric- signal of such a turn. The J.P. Morgan forecast is for CNY/
ing in over well 100bp of tightening. Indonesia is another USD to reach 6.5 by end-2010, with appreciation only taking
case where we believe the market has gotten ahead of itself. on meaningful momentum from 2Q10 on
For 2010, Bank Indonesia thinks that inflation will return to
“normal levels in the 5±1% range” and, importantly, sees Asia FX revaluation appreciation will be a theme through-
medium-term inflation declining toward 3% based on the out the year, with a delayed CNY appreciation to keep the
strong commitment by BI and the government to fight infla- trend in place. The driver for this will be greater policy con-
tion, as well as IDR strength. Clearly, this is not a central fidence in the global economic recovery and export demand.
bank that wants to feed expectations of early tightening. Rising headline inflation will also erode real policy interest
Aware that the market can overshoot in its expectations of rate levels and make monetary tightening through FX appre-
tightening, we expect Asian policymakers to tread carefully ciation more appealing.
in sending such signals too strongly, especially early in
2010. Inflation and monetary policy are the big questions for
Asia, not growth. It will be difficult to bring interest rates up
China has already started its normalization process and as long as central banks resist exchange rate appreciation.
more such moves will come soon. We believe the PBoC will In addition, continued capital inflows are likely into Asian
move in stages, relying more on open market operations to bonds as the growth differential between Asia and devel-
withdraw excess liquidity, and sector-specific actions such oped market economies expands further. Since some of
as a partial withdrawal of real estate-directed stimulus to these flows will be parked in local bonds, it is not clear that
contain asset bubble risk and inflation. The recent hike in yield curves will immediately rise from here—at least not in
RRR will not be the last; we are forecasting three more 50bp 1H10. Until China moves on its currency and/or its policy
moves this year. In addition, three policy rate hikes of 27bp rate and thereby sets in motion a regional tightening trend,
are in our forecast. As for CNY policy, China still views the we foresee Asian bond yields range trading as their central
2010 economic recovery in developed markets, especially banks either stay on hold or tighten slowly.
4
Claudio Piron(65) 6882-2218 Asia 2010 Outlook
claudio.piron@jpmorgan.com January 15, 2010
Yen Ping Ho (65) 6882-2216

Chart 1: Advanced manufacturing FX hardest hit by crisis

Asia FX: Less carry, more 30%
recovery 20% Q2 2009 sample
TWD
R2 =13% SGD
HKD
GDP quartery saar contraction

INR
10% THB
• Economic recovery, valuations and policy will drive INR PHP CNY
0%
relative Asia FX peer performance in 2010
IDR
• Top recommendations: Long KRW and INR due to -10% MYR
HKD 2
analysis of factors above and portfolio inflow dynamics Q4 2008 sample R = 22% SGD
-20%
• MYR and IDR performance will be contingent on central THB KRW
-30% TWD
bank signalling policy of FX appreciation
0% 5% 10% 15% 20% 25%
• CNY appreciation to be initiated in Q2 and will provide Advanced value added manufacturing as % GDP
catalyst for TWD appreciation
Source: J.P. Morgan
Chart 2: Some central banks appear to defend manufacturing sector
All roads appear to lead to Asia FX appreciation: Price mo- against FX appreciation
mentum, portfolio inflows and the well trodden path of glo-
bal rebalancing all make compelling cases for long positions 25%
in Asian currencies. The issue is which of the ten leading
FX appreciation Dec-2008 to date
20% IDR
Asian currencies will outperform their peers? The natural
instinct is to go for yield, such as INR and IDR, but we cau- 15%
tion that the current Asia FX cycle will see portfolio in-
flows motivated by speed of recovery, and not necessarily KRW
10% INR
the relative appeal of higher yield. THB
R2 = 50% MYR
5% SGD
Divining which economy recovers faster than its peers and PHP TWD
consequently attracts higher portfolio inflows and atten- 0% HKD CNY
dant FX appreciation will depend on fundamentals and 0.0% 5.0% 10.0% 15.0% 20.0% 25.0%
policy. The obvious rule would be to buy the currencies of Advanced value added manufacturing as % GDP
Asia’s most previously distressed economies. Chart 1,
right, shows the degree of Q4 2008 GDP contraction in quar-
advanced manufacturing and less advanced economies dur-
terly saar terms at the trough of the cycle on the vertical
ing the recovery. This correlation between economic perfor-
axis. The horizontal axis shows the degree to which ad-
mance and export dependency, particularly for advanced
vanced manufacturing accounts for value added in GDP.
manufacturing, can also be mapped onto FX performance
Taiwan, Thailand, Korea and Singapore appear to have
though the relationships are sensitive to the historical pe-
been hardest hit at the trough (Q4 2008) due to the severe
riod used and the countries included. Chart 2 above shows
contraction in final G3 demand that hit advanced manufac-
the performance of Asian currencies vs. the USD since their
turing the hardest.
economies bottomed in Q4 2008 (vertical axis) against their
relative dependency on advanced manufacturing as a % of
It would appear reasonable that those four economies that
GDP (horizontal axis). It would appear the greater the
were leveraged on advanced manufacturing should recover
manufacturing dependency, the less willing the central
fastest in economic and FX terms. However, this is not as
banks have been to allow their currencies to gain from the
simple a case. Chart 1 shows a second set of observations
economic rebound.
denoted with green dots and fitted with a blue line, which
represents the Q2 2009 sample of GDP saar results, the peak
This relationship appears to explain 50% of the relative per-
of the economic rebound.
formance of INR, PHP, TWD, THB, MYR and SGD against
the USD since end-December 2008. HKD and CNY are ex-
Clearly, the dependency of an Asian economy on advanced
cluded as outliers due to their FX regimes. Likewise, IDR
manufacturing mattered less for its overall GDP recovery
and KRW are also categorized as outliers because in our
than it did for the downturn. The most plausible explana-
view risk-premium, USD liquidity scarcity and financial
tion is that policy stimulus response, especially by fiscal
distress appear to have played a greater role in driving
policy, helped to close the performance gap between Asia’s
their FX performance since 2008.
5
Yen Ping Ho (65) 6882-2216

Central banks creating misvaluations Chart 3: PPP and REER valuations show broadly same ordering
The key issue is whether Asian central banks, particularly 60% PPP Misalignment overvaluation
those with a very open economy and advanced value added
manufacturing sector, have exacerbated the undervaluation 40% REER % deviation from 10Y average
of their currencies by intervening against their apprecia-
20%
tion as the global economic recovery has taken hold. More-
over, has the market overvalued INR, IDR and PHP due to 0%
their more domestic driven economies, activist fiscal policy
and remittance transfers? -20%
undervaluation
Chart 3 right looks at the cross-section of Asian currencies -40%
HKD
TWD
KRW
CNY
SGD
THB
INR
MYR
PHP
IDR
based on two metrics: Purchasing power parity and real ef-
fective exchange rates (REER). These are effectively the
same thing, though the REER are based on a broad basket Chart 4: REER deviations from trend against GDP / capita
of trade-partners. The key is that they broadly rank the
40%
valuations in the same order. Note too, that the more export IDR
orientated currencies (TWD, KRW) tend to be on the un- 30%
REER 10yr misvaluation

der-valued side, while the more domestic driven economies 20%
PHP
(IDR, PHP) appear on the over-valued scale. 10% MYR SGD
THB
0% HKD
This relative divergence in Asian FX valuations can also be CNY
-10% INR R2 = 33%
seen on a GDP per-capita basis, as shown in chart 4 right. R2 =26%
-20% KRW
The higher (lower) the GDP per capita, the more likely an TWD
Asian currency appears undervalued (overvalued). This -30%
may mean that wages are too low or productivity much 0 10000 20000 30000 40000
higher than is commensurate with the undervalued ex- GDP / capital USD (2008)
change rate. This would imply that either the exchange rate
appreciates, wages rise or the current account surplus con- Chart 6, next page, shows the correlations between indi-
tinues to widen. The opposite is true for those economies vidual countries’ capital accounts and their currency perfor-
with over-valued exchange rates and poorer productivity – mance against the USD over the past 10-years (note Malay-
prices/wages have to fall or the miss-valuation has to be sia is post the July 2005 float). Clearly, Malaysia and Korea
extended with current account deterioration. The bottom appear to be the most affected by the pro-cyclical nature of
line is that TWD and KRW look very cheap on this analy- capital flows into Asia. However, much will still depend on
sis, while PHP and IDR are increasingly expensive. the reaction by Asian central banks towards capital inflows,
the relative valuation of their currencies and their effective
The trouble with valuations! monetary policy stance.
The problem with valuations, especially for Asia FX, is that
reversion to mean can be very slow, if it all. Asian central The final chart shows below shows the relative monetary
banks have long held that hot capital flows help to sustain conditions of Asian countries since the global financial cri-
these deviations (though others would argue that some sis began in September 2007. It is clear that some of those
Asian central banks are sustaining under-valuations). Nev- central banks most reluctant to engage in FX appreciation
ertheless, the pro-cyclical nature capital flows are made are those that have experienced some tightening in real
clear in chart 5 next page. This chart shows the aggregated policy rates: China, Thailand and Taiwan.
balance of payments portfolio balance for the region
against Asia ex-Japan industrial production. Given In contrast, India and Korea have experienced a loosening
JPMorgan’s outlook for a sustained global economic re- in monetary conditions and are also viewed by the markets
cover and the upside risks to this view, against a back-drop as being the most hawkish central bank in Asia. Impor-
of dovish G3 monetary policy, it remains likely that pro-cy- tantly, Asian inflation is expected to rise next year even if
clical portfolio inflows will continue to drive Asia FX appre- only for base effects as the deflationary shock of 2008
ciation. passes. This will mean real policy rates will be eroded next
year and place further pressure on Asian central banks to
consider stealth tightening through FX appreciation.
6
Yen Ping Ho (65) 6882-2216

Top recommendations Chart 5: Asia’s portfolio balance highly correlated with regional IP
30000 30
We are bullish KRW and INR on the basis that both cur- 20000 25
rencies have a favorable combination of attractive valua- 10000 20
tions relative to their peers and a monetary policy stance 0 15
-10000
that is conducive to FX appreciation. Additionally, KRW is 10
-20000
best positioned to leverage on a robust economic recovery 5
-30000
by virtue of its economic openness and advanced manufac- -40000 0
Total portfolio balance (USDmn)
turing exposure. -50000 -5
-60000 Asia IP oya %, RHS -10
By contrast, though INR does not appear to share these -70000 -15
same features, we point out in the India subsection (page 5) Dec-97 Dec-99 Dec-01 Dec-03 Dec-05 Dec-07 Dec-09
that a combination of state divestments, Qualified Institu-
tional Investments and corporate exporter under-hedging Chart 6: Monetary conditions support doves (THB, TWD) and hawks
should continue to drive INR appreciation. (INR, KRW)
Change in monetary conditions since September-2007
MYR and IDR deserve special mention even if they fall 20% monetary tightening
REER US
short of our top two trades for 2010. Although both appear
10% Hong Kong
Malaysia China
over-valued, portfolio flows should remain supportive for
Singapore
IDR appreciation and offset the deterioration in the current 0%
Philippines Thailand
account balance due to the IDR’s potential overvaluation. Indonesia
-10% Taiwan
The trigger for these inflows will likely be central bank India
policy signaling for further FX appreciation. Both coun- -20%
Korea
tries’ portfolio balances are typically dominated by bond -30% Real policy
flows. rates
-40%
At the same time, JPMorgan’s views significant rate hikes in -8% -6% -4% -2% 0% 2% 4% 6% 8%
these countries as unlikely in 2010. This implies a deteriora-
tion in real policy rates as higher headline inflation is pro- Table 1: Summary of JPMorgan FX forecasts
jected. Consequently, FX appreciation holds the key to
checking inflationary expectations, ensuring bond market
stability and maintaining interest rates that are conducive to
rebalancing the economy toward more domestic led growth.
Enter long 6M INR 1x2 call ratio spread at 45.00 and 43.50
strikes
The option structure costs a net premium of 60bps for a

maximum return of 260bps, representing a cost: reward ratio
of 1:4.3. We enter a USD put / INR call for 235bps premium
with 45.00 strike (40-delta). In addition, we sell two times
the notional amount of a USD put / INR call 43.50 (25-delta)
and receive 166bps premium (83bps x 2). Spot reference at
45.41. Breakeven USD/INR levels are at 44.70 and 42.40.
Enter long 6M NDF KRW / short USD at 1124.00 outright
We refrain from an option strategy as premiums are rich and

we do not wish to reduce costs by paying away USD/KRW
downside risk. As such, we opt for a vanilla NDF position
with a relatively wide-stop loss at 320bps at USD/KRW
1160 on a 6M NDF basis. We position for risks for a move
to USD/KRW 980, implying a gain of 1280bps.
7
Bert Gochet (852) 2800-8325 Asia 2010 Outlook
bert.j.gochet@jpmorgan.com January 15, 2009
Chart 1, India: Indicative graph of JPM forecasts for CRR, policy rates
Asia Rates: Too early to pay and call rate, together with call rate forward
6.5%
• Remain paid in China and India as this is where some
6.0%
sort of Central Bank action is imminent CRR Forecast
5.5% Call Rate Forecast

• Receive the front end of the Korea swap curve as BoK is
5.0%
facing headwinds
Repo - Rev Repo Corridor Forecast
4.5%
• Buy the belly of the Indonesia and Malaysia government Call Rate Forward
4.0%
bond curves as portfolio inflows will remain strong
3.5%
• In relative value, buy Korea swap spreads as bonds will
3.0%
perform better than swaps Jan-10 Feb-10 Mar-10 Apr-10 May-10 Jun-10
Chart 2, China: Recent moves in the repo rate and major swap rates
From a top-down perspective, it is too early to position for
an overall “Pay Asian Rates” trade or for an “Asia curve
flattener”. For the time being, we suggest focusing on the %
idiosyncracies of the various markets and position accord- 12
ingly. There are three themes that guide our decisions: 10
• Forwards are generally pricing in too much tightening 8
compared to our central bank forecasts. As a rule of 6

thumb therefore, we will only pay rates in countries where
4
(a) a Central Bank action is imminent, and (b) negative
carry of the short position is not overwhelming. As a con- 2
sequence, we choose to be Paid in only two countries:
0
India and China, as RBI and PBoC are the only two CBs
Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10
that are taking any sort of action (hiking CRR and RRR).
7-day repo 1y IRS 5y IRS
• A pickup in foreign inflows this year will support bond
markets, especially those that are easy to access from
abroad. This year, we expect a pickup of inflows into local
bond markets. Partly, these inflows are structural. Real Top recommendations
money managers increasingly see Asian LM as an asset 1. Paid/Underweight in countries where
class in their own right and allocate more money towards Central Bank action is imminent:
it. Meanwhile, central banks will continue to deploy FX
reserves in selected Asian markets. Other inflows are
• India: We are paid 5y OIS, partially hedged by receiving
more fickle investments seeking a quick FX gain. How-
1y. Underweight GovSec’s in portfolio
ever, this trend may turn out to be not that fickle if China
starts to move on its currency. The bond markets that will In India, we believe the yield curve can rise by 50bp in 1Q
benefit the most from foreign inflows this year will be Ma- as RBI’s mopping up of liquidity gets under way. However
laysia, Indonesia, Korea, Singapore, and to a lesser extent the carry on being paid OIS or going underweight bonds is
Thailand. brutally negative. To solve the negative carry problem, we
have liked (since November) and would like to add to this
• Bond supply does not worry us, unlike last year. Issu-
week, a core position where we are paid in 5y OIS. However,
ance calendars look very manageable this year, as gov-
against the core paid position, we have received a bit of
ernments withdraw stimuli. Countries where this dynamic
1year OIS to offset the carry (for a size of 1/3rd of the DV01
will be most prevalent are Indonesia, Malaysia and Korea.
of the 5y). This position has served us well so far, and we
In addition, a pickup in foreign investment will allow sig-
will keep it until we get closer to an actual policy hike in In-
nificant front-loading of issuance in 1Q. A key exception
dia. At that time, we will remove the 1year hedge and go
to this rule is India, where the issuance calendar has a
outright short. In an Asian portfolio context, we would un-
tendency to disappoint, and where foreign investment is
derweight the India government bond segment, and posi-
limited in any case.
tion for a steeper curve within the India allocation.
8
• China: We are paid outright in 5year Repo-IRS. Under- Chart 3: Korea policy rate forwards based on MSB and IRS curves
weight CGBs in portfolio are significantly overpricing BoK tightening that we expect
We have been paid in CNY swaps since December, and con-

tinue to hold that position as China raises its RRR and bill
yields and gets the draining of liquidity. At the moment, we 5.0
hold a more bearish view on the long end of the curve (5y) 4.5
than on the short end. Similar to India, in China a lot is
priced into the short end and paying it will cost us expen- 4.0
sive carry. In our Asian portfolio, we are underweight China 3.5
bonds.
3.0
2. Bullish positions where too much tight- 2.5

ening is priced in 2.0
• Korea: Be long 2year KTBs, or receive 2 year swap. Jan-10 Apr-10 Jul-10 Oct-10 Jan-11
Overweight KTBs in Asian portfolio
Priced in by MSB Priced in by IRS
Korea is the only country where the forward curve is signifi-
cantly overpricing the potential for rate hikes, in our view. Chart 4: Indonesia government bond positions by investor-type are
In addition, KTBs are likely to benefit from both structural long, but not overly long according to our proprietary survey
and hot money portfolio inflows. We prefer to express this
directional view in the 2year sector as that is where the up- 6
side potential looks most attractive to us, and where local 5
banks are underweight. 4
3
3. Long the belly of the bond curves where 2
inflow and supply conditions are attractive 1

0
• Indonesia: Be long the 10-year sector outright. Over- -1
weight Indonesia in Asian portfolio
-2
A combination of strong Asian growth and sluggish G3 Jan-06 Oct-06 Jul-07 Apr-08 Jan-09 Oct-09
economies should keep global investors buying high-yield- Dedicated EM Crossover Trading
ing, risky assets in Asia. We think of this as the “goldilocks
global economy’ for Indonesian bonds. Despite an increase Chart 5: Malaysian MGS were one of the worst performing bond
in the gross supply of Indonesian local government bonds markets in Asia last year
this year, we expect demand to be sufficient as foreign in- bp
vestors are overweight, but not significantly, in this market. 200
In other words, we believe they will add bonds, initially in 150 TH
SK
the 10year sector of the curve. An additional reason for 100
MA
owning Indonesian bonds is that we expect no BI tighten- 50 HK
ing this year, as we believe the Central Bank will be able to 0 S
TA
G
-50
control inflation expectations even as CPI rises temporarily, PH
-100
due to base effect. v IN
-150
-200
• Malaysia: Be long the 5year sector. Overweight Malay- -250 ID
sia in Asia portfolio -300
-350
The MGS market has room to make up what it lost last year Jan-09 Mar-09 May-09 Jul-09 Sep-09 Nov-09
when the market suffered from a sharp increase in supply MA HK SK IN TA ID SG PH TH
(especially in the 5year sector). Last year’s sell-off left the

spread between the 5-yr MGS and OPR at a record high,
despite the fact that BNM will be one of the last central
9
banks in Asia to hike. In addition, MGS were one of the Chart 6: Taiwan rate developments show the recent steepening of the
worst performing Asian bonds of 2009, as chart 5 shows. curve
%
This year, this will reverse. Demand from abroad should 3.5
pick up and the foreign investment that we have seen
3
should spread from bills to the belly of the curve as that is
where the carry is attractive. In addition, we expect domestic 2.5
demand for bonds to rise versus last year, especially from 2
real money mangers, as the issuance calendar was cut by 1.5
30%.
1
0.5
4. Be long carry trades where we expect a
status quo in curves: 0
Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10
• Taiwan: Remain positioned in a 3s10s steepener in 3m CP 3y IRS 10y IRS
swaps. Be underweight TGBs in Asian portfolio
Our favorite carry trade in the region remains the Taiwan
steepener. CBC will only hike when the Fed does -ie. not Chart 7, Korea: Correlation between swap spreads and the currency
soon-, and even then will only do so symbolically in tiny shows that the spread richens as the FX richens bp
steps, just as they have done in the past. This should keep 900 10
a lid on short rates, where the 3year swap stands out the 3y KTB - IRS
most attractive from a positive carry perspective. Mean- 1000 -10
while, the back end of the swap curve will be paid up by 1100
foreign investors who believe in a Taiwan growth re-rating -30
story as a consequence of the MOU with China. While we 1200
do not necessarily subscribe to the re-rating story, we are -50
1300 USD/KRW
happy to take advantage of the flow in our favor. Mean-
-70
while, in bonds, yields are extremely low, because of the 1400
overwhelming liquidity onshore. We see zero upside to -90
1500Nov -08 Feb-09 May -09 Aug-09 Nov -09
bonds at such depressed yield levels, hence we remain un-
derweight. Having said that, it is unlikely Taiwan bonds 1600 -110
undergo a sell-off this quarter either.
5. Be long swap spreads where inflows

will richen bonds vs OTC
• Korea relative value: Buy 3year KTB futures, versus pay
3y swap
Asian swap spreads have become increasingly correlated
with currencies. The reason? As more foreign investors buy
local bonds for FX gain, the additional demand for bonds
makes cash product a relative outperformer versus OTC.
Chart 7 shows how KTB swap spreads have moved in
lockstep with the currency over the past year. As we are
constructive on the Korean won, we are also constructive
on swap spreads. There are other countries where we see
this same dynamic as well, but we like Korea the best as
swap spreads there are still “inverted”.
10
Matt Hildebrandt (65) 6882-2253 Asia 2010 Outlook
matt.l.hildebrandt@jpmorgan.com January 15, 2010
Asia sovereign credit: spreads Top recommendations

Indonesia: Move to neutral. Indonesia’s fundamental story
to tighten further stands out but positioning is crowded and it settled for $2
After a volatile year, EM Asia has proven its resilience. bn issuance this week rather than $4 bn. Bonds are trading
Asia credit fundamentals have held up well and political near record levels and tension between technocrats and
structures have not been adversely effected by recession. political interests is not resolved. Near term, we see little
Except Fiji, no country in Asia was downgraded in 2009. upside. However, medium term, we like Indonesia, and we
This compares favorably to the five downgrades between look for a more attractive time to move overweight.
2001 and 2002, despite being a more moderate and tempo-
rary slowdown, and the 37 downgrades between 1997 and Philippines: Remain neutral. Philippines underperformed in
1998. Some Asian sovereigns have already been upgraded. 2009. Remittances should remain strong and market posi-
tioning is light but we are hesitant to go overweight due to
Fewer downgrades during bad times means fewer upgrades public finances and May elections.
during good times. In 1998 and 1999, EM Asia experienced 8
upgrades (following the 37 downgrades previously) while in Sri Lanka: Move to overweight. Sri Lanka is on a positive
2003 the region received 7 after 5 downgrades. Given the track and a peaceful election is expected this month. We
lack of ratings downgrades over the last two years, we ex- recommend buying Sri Lankan ’15s.
pect fewer upgrades now. Only Indonesia and Sri Lanka
have positive outlooks. Otherwise we expect negative out- Pakistan: Move to underweight. Pakistan was the best per-
looks to be removed before we see many other upgrades. former in the EMBIG in 2009 (+147.4%) but political uncer-
Countries with negative outlooks include: Fiji, India, Tai- tainty has risen (it was the worst performed in December).
wan, Thailand, and Vietnam. India, Taiwan, and Thailand are
most likely to have negative outlooks removed while Viet- Vietnam: Buy protection on 5-year CDS. After surging im-
nam is the most likely to be downgraded. mediately following the November devaluation, the spread
has narrowed somewhat. Much of past deterioration in fun-
We expect 2010 to be a good year for EM Asia sovereigns. damentals is priced in but we expect the data to get worse.
Economic fundamentals have returned to pre-recession
strength and we expect solid growth and benign inflation in China / Japan: Buy protection on China 5-year CDS and sell
2010. The political calendar is also quiet, with presidential or protection on Japan 5-year CDS. China’s spread is trading
legislative elections expected in only the Philippines and Sri below Japan for the first time ever. Japan is rated two
Lanka. Politics will likely remain a concern in Malaysia and notches above China. Despite current economic woes, Ja-
Thailand, but only in Pakistan does the political environ- pan has a longer history of repaying debt and has a more
ment pose significant risk to the economic outlook. transparent political and institutional framework.
Technicals to be supportive in 2010. In addition to funda- Korea / Thailand: Sell protection on 5-year CDS on the
mentals, technicals should be favorable too. Overall sover- spikes. These trades are tactical and short-term in nature,
eign financing needs in the region should decline as rev- and both worked well in 2009. Korea tends to be very vola-
enues strengthen and as stimulus packages wind down. tile and Thailand overreacts to political concern. Unless
Lower financing needs will allow external issuance in the worst, or near worst, case scenarios develop globally or
region to fall modestly relative to the level last year even politically in Thailand, spikes should be short-lived.
though two additional countries, Malaysia and Vietnam, are EM Asia: sovereign issuance forecasts
likely to come to market (table). Moreover, the share of is- US$, mn 2009F 2010F
suance from the region’s largest habitual issuers – Indone- EM Asia 9750 9250
sia, Korea, and the Philippines – is expected to decline to China 0 0
65% of total EM Asian issuance in 2010 from 95% in 2009. India 0 0
Indonesia 3000 3000
EM ASIA EMBIG spreads to tighten. EM Asia sovereign Korea 3000 1000
debt performed well in 2009. Spreads tightened 369bp to Malaysia 0 1500
206bp at year end, comparing favorably to the EMBIG Pakistan 0 0
spread of 294bp. EM Asia spreads have retraced modestly Philippines 3250 2000
early this year, but we expect EM Asia and EMBIG spreads Sri Lanka 500 750
to tighten further in 2010. EMBIG spreads are forecast to Thailand 0 0
narrow to 250bp by year-end and EM Asia to 175bp. Vietnam 0 1000
11
Grace Ng (852) 2800-7002 Asia 2010 Outlook
grace.h.ng@jpmorgan.com January 15, 2009
China China: economic indicators
Average
• Solid growth trajectory in coming quarters, drivers of 2003-07 2008 2009f 2010f 2011f
growth broadening to private sectors of the economy Real GDP, % change 11.0 9.6 8.6 9.7 9.4
Consumption* 2.5 4.3 4.4 4.5 4.6
• Inflation to rise next year, but at a moderate pace; import Investment* 6.3 5.1 6.8 5.1 4.6
cost inflation likely a growing concern Net trade* 2.2 0.2 -2.6 0.1 0.2
Consumer prices, %oya 2.6 5.9 -0.6 2.8 2.5
• CNY to resume gradual appreciation early this year as % Dec/Dec 3.3 1.2 1.6 2.5 2.8
exports recover; watch out for capital inflow Government balance, % of GDP -0.9 -0.4 -3.3 -2.1 -1.8
Exchange rate, units/$, eop 7.92 6.82 6.83 6.50 6.20
• Adjustment in monetary conditions already taking place; Merchandise trade balance ($ bil.) 154.2 323.7 258.0 281.8 290.6
further policy normalisation not to derail growth Exports 796.8 1423.4 1183.7 1439.5 1664.7
Imports 642.6 1099.7 925.7 1157.6 1374.0
Current account balance 180.1 404.9 307.7 335.5 342.5
China led the global economy back onto a recovery path in % of GDP 7.4 9.4 6.5 6.1 5.3
2009, with significant fiscal spending a major driver of International reserves, ($ bil.) 891.1 1948.1 2348.1 2698.1 3078.1
growth. For 2010, J.P. Morgan is in line with the market con- Total external debt, ($ bil.) 287.3 374.7 387.7 401.7 418.7
Short term† 109.5 148.0 164.0 182.0 202.0
sensus in expecting China to grow a solid 9.7%, consistent Total external debt, % of GDP 11 9 8 7 6
with our estimate of potential GDP growth. We expect that Total external debt, % of exports‡ 28 22 26 23 20
the sources of growth will continue to broaden steadily and Interest payments, % of exports‡ 1 1 1 1 1
to include exports and a general acceleration in private in- * Contribution to growth of GDP.
vestment and consumption. This year should also feature † Debt with original maturity of less than one year.
improving labor markets and hence household income, and ‡ Exports of goods, services, and net transfers.
marked expansion in real estate investment as well as other
private investment. Meanwhile, public investment stimulus China: real GDP growth
will not retreat and will continue through this year, but with %oya %q/q, saar
the pace of growth leveling off. On monetary policy, we ex- 14 20
%oya
pect the central bank to raise policy rates three times, by
27bp each, starting as early as 2Q10. On the currency, we 12 15
expect CNY to resume gradual appreciation early this year, as
exports recover, with the CNY/USD exchange rate forecast at 10 10
6.5 by the end of this year.
%q/q, saar
8 5
Export sector no longer a drag
6 0
On the external side, during the severe global recession since 2004 2005 2006 2007 2008 2009 2010
2H08, China’s exports declined notably along with the sharp
weakening in G-3 final demand, with net exports subtracting China: contribution to headline GDP growth
3.6% from headline GDP growth during the first nine months %-pt contribution to headline GDP oya growth
of 2009. Looking ahead, and as our global team is looking for Gross fixed capital Net
8 Total consumption
a sustained, synchronized expansion of the global economy expenditure formation exports
through 2010, we expect steady recovery in China’s export 6
sector in the coming quarters. In our forecast, merchandise 4
exports will rise about 20% in 2010, after falling 16.7% last
2
year. Net external trade would thus likely deliver a moderate
positive contribution to headline GDP growth this year. 0
-2
It is worth noting that China’s share of the US import market
-4
continued to rise during the recent recession, which likely 03 04 05 06 07 08 09F 10F
reflects not only Chinese exporters’ continued gains in pro-
ductivity and overall competitiveness, but also the ten- in US consumer demand (J. P. Morgan expects US consumer
dency for US consumers to switch to cheaper items during spending to rise 2.0%y/y in 2010) highlights the prospects
the severe downturn, which would support demand for Chi- for steady recovery in China’s exports to the G3 markets.
nese products. As such, the outlook for a moderate recovery Indeed, China’s exports to the US (up 21.9% 3m/3m, saar
12
through November), EU (up 37.1% 3m/3m, saar) and Japan China exports and global IP
(up 36.7% 3m/3m, saar) have been turning up steadily in %oya, both scales J.P.Morgan
recent months. forecast
40 Global IP 10
Private FAI takes over the baton 5

20
As China implemented the remarkable fiscal stimulus pro- 0
gram shortly after the outbreak of the financial crisis and the China's exports
0 -5
onset of the global recession, public sector investment
-10
kicked off powerfully, leading to accelerating growth in fixed -20
asset investment (up 32.1%oya through November). Look- -15
ing into 2010, the pace of growth in public investment -40 -20
03 04 05 06 07 08 09 10
spending is expected to moderate largely due to high base
effect (though latest on-the-ground check suggests that the
central government seems to be undershooting its fiscal
Share of US import market
allocation last year, leaving some potential upside for this
year’s spending). Meanwhile, private sector investment % share, 12-month moving average
would become the key factor to sustain fixed investment 20
growth. This would include not only solid real estate invest- 18 China
ment, on the back of strong property sector transaction ac- EM Asia (ex-
16 China)
tivity and as property developers financing conditions im- 14
prove steadily, but also for export-related manufacturing Mexico
12
investment given the recovery in the export sector.
10
With regard to forward-looking indicators, as the funds allo- 8 Japan

cated to new investment projects rose at a remarkable 6
98 00 02 04 06 08
76.6%oya through the first eleven months of 2009, total
fixed investment is set show further solid growth going into
2010. With regard to the credit environment, it is worth not-
China: public vs private sector inveestment; real estate investment
ing that, despite the notable easing in new loan creation
%oya, 3mma
since July last year, new household loans and medium- to Private sector Public sector
long-term corporate loans (the latter closely tracks fixed in- 60 Real estate investment investment
vestment growth) continued to expand at a solid pace, sug- investment
50
gesting that the authorities’ fine-tuning of excess liquidity
40
conditions in the financial system should not affect the
solid fixed investment outlook going into 2010. 30
20
Consumption to pick up broadly 10
Various fiscal support measures, especially with regard to 0
the auto industry and rural households purchase of elec- 2005 2006 2007 2008 2009
tronic appliances, have helped to ensure that China’s retail
sales held up solidly through the global downturn last year.
Looking ahead, increasing confidence in the economic re- China: on-going FAI and newly-incresaed investment projects
covery, improving labor markets and hence household in- %oya, ytd, both scales
come will support household spending going into 2010. On-going fixed Newly-increased
34 100
investment investment projects
32 75
The rebound in the export sector would help steady recov-
ery in labor markets and household consumption. The sharp 30 50
downturn in exports since 2008 hit the labor market notably, 28 25
especially for migrant workers. Earlier in 2009, it was re-
26 0
ported that 20 million (15.4% of the 130 million total) migrant
workers in coastal areas had returned home, while remit- 24 -25
tance of migrant workers’ salaries usually account for about 22 -50
one-third of rural household income. (Nonetheless, it is 2005 2006 2007 2008 2009
13
worth noting that urban household disposable income per China: GDP and household income
capita as well as rural cash income outperformed headline %oya Real urban household
GDP growth in 1-3Q 2009.) Real rural household per per capita disposable
20 capita cash income income
As such, it is encouraging to note that temporary labor
shortages have emerged recently in coastal areas and em- 15
ployers have increased salaries as factories are ramping up
10
production to meet foreign orders. This could attract more
workers who had returned home to rural areas back to the
5
cities. In addition, the employment component of the manu- Real GDP
facturing PMIs has turned up, reinforcing the outlook for
0
steady improvement in total employment and hence house- 2006 2007 2008 2009
hold income (chart).
On the policy front, the recent Central Economic Work Con- China: PMI employment indices
ference highlighted domestic demand, especially private index, sa
consumption, as an important driver of economic growth PMI - employment
56 index (Markit)
this year. Particular focus has been placed on improving the
54
distribution of national income and enhancing the consump-
52
tion capability of lower-income groups. In addition, the au-
50
thorities have extended into 2010 a series of consumption-
related stimulus measures, including incentives for spend- 48
46 PMI - employment
ing on autos and home electrical appliances. The authorities index (NBS)
also highlighted the policy target of speeding up the urban- 44
ization process, with emphasis on encouraging the rural 42
2004 2005 2006 2007 2008 2009
migrant population to settle in urbanized areas, especially in
the medium-sized and smaller cities, which should further
strength the outlook on medium-term consumer demand.
China: headline CPI inflation
%oya J.P.Morgan
Return to inflation, at moderate pace forecast
10
Having exited an extended period of headline deflation in
2009, we expect China’s CPI to rise gradually going ahead,
to an average of 3%yoy in 2010. The drivers of this rise in 5
inflation, aside from the fading of base effects, are food
price and administrative price liberalization especially in the
resource and energy sectors. As for food price inflation, the 0
pork supply cycle is again the area of focus. Notably, we do
not see demand drivers as key for the rise in inflation this -5
year. Excluding food and energy prices, core inflation has 03 04 05 06 07 08 09 10
been largely well behaved, and we believe it will likely re-
main so going into this year, given the structural excess
capacity in many industrial sectors and continued unem- China: headline CPI and core CPI inflation
%oya, both scales
ployment pressure despite recent improvement. Core CPI
10 25
In view of the steady recovery in major commodity prices 8 Headline CPI 20
since early last year, imported inflation would likely become
6 15
an increasing concern going ahead. Indeed, the manufactur- Energy & food
ing PMI input price component has risen steadily, to reach 4 10
the highest level in 17 months in November, with rising 2 5
crude oil and coal prices amongst the major driving forces.
0 0
The PPI, which fell notably since late 2009, also have began
to turn in sequential terms in recent months, rising at 5.8% -2 -5
2002 2003 2004 2005 2006 2007 2008 2009
3m/3m, saar by November.
14
Exports, BoP adjustment and CNY policy China: balance of payments

In 2009, China experienced the first decline in its current US$ billion
account surplus in five year. Imports outperformed exports 2005 2006 2007 2008 1H09
Current account 160.8 249.9 371.8 426.1 134.5
on the way down, supported by the government-supported
Goods 134.2 217.8 315.4 360.7 119.0
growth in investment. As a result, China’s current account Services -9.4 -8.8 -7.9 -11.8 -16.7
surplus fell by 30%oya in 1H09. For the full-year of 2009, Income 10.6 11.8 25.7 31.4 16.9
J.P. Morgan expects the current account surplus to total Current transfers 25.4 29.2 38.7 45.8 15.2
$308 billion (or 6.5% of GDP), down from a record $405 bil- Capital and financial account 63.0 10.0 73.5 19.0 61.0
lion (9.4% of GDP) in 2008. Direct investment 67.8 60.3 121.4 94.3 15.6
Portfolio investment -4.9 -67.6 18.7 42.7 20.2
For 2010, we expect China’s current account surplus to ex- Others -4.0 13.3 -69.7 -121.1 23.9
pand anew, at to grow at about the same pace as nominal Errors and omissions -16.8 -12.9 16.4 -26.1 -9.5
GDP. But the bigger macro concern for Chinese Overall balance 207.0 247.0 461.7 419.0 185.9
policymakers this year may be capital inflows, especially
once the gradual CNY appreciation trend resumes, as we
expect. Indeed, there have recently been growing signs of China: FX deposits and loans; yuan deposits in Hong Kong
renewed domestic expectations of CNY appreciation, with %oya, 3mma, both scales
Accelerating CNY Yuan deposits
both onshore FX loans rising and FX deposit growth slow- 60 in Hong Kong 200
ing as Chinese corporates and households look to reduce appreciation
their net FX asset exposure. On a related note, concerns FX deposits 150
40
over capital inflows would likely restrain the rise in China’s FX loans 100
policy rates, especially considering that the China-US rate 20
differential is already at the highest level since 2004. 50
0
0
With regard to CNY policy, in the People’s Bank of China’s
3Q monetary policy report, the central bank, as usual, stated -20 -50
2004 2005 2006 2007 2008 2009
that the exchange rate will be managed in a proactive, con-
trolled, and gradual manner, and “based on international
capital flows and movements in major currencies.” The last China: exports and real effective exchange rate
phrase attracted widespread market attention with regard to %oya, 3mma index, 2000=100, + = appreciation
the potential of a major near-term move in CNY. However,
60 Exports 90
we believe the statement should be read as forward-looking,
REER
rather than suggesting that in the near term CNY will play 40 95
catchup with the rise of major developed and developing 100
currencies against USD since early last year. On a trade- 20
105
weighted basis, through the ups and downs in the green- 0
back over the past year, the CNY NEER, as well as the NEER 110
for other currencies that have seen significant rallies such -20 115
as AUD and BRL, is roughly back to levels observed prior -40 120
to the outbreak of the financial crisis (chart). 2003 2004 2005 2006 2007 2008 2009
It is also worth highlighting that, China’s imports from major

commodity producers in Africa, Latin America, and Austra- Comparison of nominal effective exchange rates
lia, have shown the most remarkable expansion since 2Q09. index, Jan 2008=100
Global financial
Most other Asian exporters, including Taiwan, the ASEAN
120 crisis
economies, and Korea also benefited significantly from
CNY
China’s domestic demand strength and derived import de- 110
mand in 2009. The rebound in China’s imports since early BRL
last year has been an important factor supporting the stabi- 100
lization and recovery in the exports of many emerging 90 AUD
economies, thereby putting upward pressure on their cur- Appreciation
rencies. Meanwhile, China’s export volumes are still 15% 80
below their peak (chart). 70
2008 2009
15
Structurally, as the US economy gradually adjusts its pat- EM merchandise export volume
tern of over-consumption (under-saving), there have been 100 = 2008 peak
early signs of the long-awaited global rebalancing with ad-
justments in the US current account deficit (Chinese sur- 100
Other EM
plus). Indeed, as exports have fallen on the back of weak 90
external demand since late 2008, China’s import demand has
held up better, especially with the investment boom from 80
fiscal stimulus, leading to a notable adjustment in China’s 70
trade balance. The current account surplus thus fell (by China
30%y/y) in 1H09, the first decline in five years. With such 60
changes already taking place in the external balances for
50
both the US and China, fundamentals argue for resumption 2005 2006 2007 2008 2009
of some gradual appreciation of the CNY/USD exchange
rate to support further steady, smooth adjustments.
China and US current account balances
China’s exit strategy in perspective % of GDP J.P. Morgan
forecasts
As the Chinese economy continues to register solid recov- 12
ery, concern is growing that the government will quickly China
8
withdraw the significant policy stimulus introduced since
late 2008, especially on the monetary front (fiscal spending 4
plans have largely been laid out through 4Q10 and are un-
0
likely to be reversed). Such a move might derail the
economy’s recovery going into 2010, so the worries go. We -4 US
believe China is likely to adjust monetary policy at a steady
-8
pace, and expect policy rates to rise three times this year, by 98 00 02 04 06 08 10
27bp each. The central bank will also rely on open market
operations to withdraw excess liquidity and to reduce the
risk of an asset bubble and inflation, but without risking a China: central government spending of 4 trillion yuan package
tightening that could jeopardize the economy’s recovery,
RMB, bn
especially activity in the private sector. 4Q08-2010 budget 1180.0
Total allocated through 3Q09 380.0
Not surprisingly, the recent Central Economic Work Confer- Economic housing 37.5
ence confirmed the importance of maintaining stability and Rural infrastructure 104.3
continuity in macro policy for 2010, thus reiterating the pro- Transportation infrastructure 87.1
active fiscal policy and accommodative monetary policy Medical, healthcare, education and cultural 57.3
stance. Overall, the authorities remain cautious regarding an Ecological environment 39.6
“exit strategy,” even as the real economy continues to show Technology innovation and service industry 54.2
solid recovery, especially as policymakers have yet to be
convinced that the global recovery is on a sure footing. As
such, Premier Wen recently commented that a premature
“exit” from macro policy stimulus could risk derailing the China: M2 and bank loans - sequential trend
global economic recovery. %3m/3m, saar
50
With regard to the central bank’s open market operation, Bank loans
since the economic recovery gained momentum in 2Q and 40
asset prices began to pick up notably, the PBoC has been M2
steadily fine-tuning its liquidity operation, with a net with- 30
drawal of liquidity from the financial system starting Octo-
ber. Along with the PBoC’s fine-tuning of open market op- 20
erations, the sharp surge in new loan creation through 1H09
has leveled off significantly since July, and the sequential 10
trend growth rates in M2 money supply and total bank 2006 2007 2008 2009
loans have been steadily moderating. Meanwhile, we have
16
noted that new household loans and medium- to long-term China: new loan creation (Yuan, tn)
corporate loans, which are more closely related to real eco- 2007 1H08 2008 1H09 3Q09 Oct-09
nomic activity, continued to rise steadily. Putting these ob- Household 1.2 0.5 0.7 1.1 0.8 0.2
servations together suggest that the central bank has done Corporate 2.5 2.0 4.2 6.3 0.5 0.1
a decent job in gradually withdrawing excess liquidity from Short term 1.3 0.8 1.3 1.3 0.1 0.0
the financial system, in order to restrain risks of CPI infla- Bill financing -0.4 0.0 0.6 1.7 -0.8 -0.2
tion and an asset bubble, but at the same time ensuring that Medium to long term 1.7 1.2 2.1 3.2 1.1 0.3
there is appropriate credit available for the real economy. Total 3.6 2.5 4.9 7.4 1.3 0.3
Total ex bill financing 4.0 2.4 4.3 5.7 2.1 0.5
Setting the tone of monetary policy
As discussed above, China’s top leadership has recently
confirmed the stability and continuity in macro policy for China: nominal GDP and M2 money supply growth
2010. With regard to the monetary and credit environment, %oya J.P. Morgan
the new loan target for 2010 is generally seen to comes in at forecasts
40
7-8 trillion yuan. Along with it, if the M2 growth target
M2 money
comes in at about 16-17% (compared to our forecast for Nominal GDP
30 supply
nominal GDP growth of 12.2%), overall monetary conditions
should remain largely supportive of the economy’s recov-
20
ery this year. Indeed, during recent tightening cycles, the
impact of monetary tightening was felt most notably in 2007
10
and 1H08, when M2 growth fell below nominal GDP growth.
0
Meanwhile, amid growing concern over rising property 95 97 99 01 03 05 07 09
prices and asset inflation risks, authorities have begun to
reverse some of the stimulus measures (explicit and implicit)
introduced since late 2009 for the property sector. In par-
ticular, banks have been tightening mortgage rules on the China: new building starts by floor space
purchase of second homes by raising first installment re- mn square meters, 3mma
quirements and reducing mortgage rate concessions. In an 120
attempt to curb property speculation, the State Council re- 110
imposed the 5.5% tax on transactions involving residential 100
property that has been held for less than five years. 90
80
Broadly speaking, we believe authorities will be careful that
70
any partial reversal of stimulus measures does not overly
restrain activity in the real estate sector, as private sector 60
investment, especially in real estate, is a key factor to sus- 50
2005 2006 2007 2008 2009
tain growth in 2010. Indeed, behind the property price rally
last year has been growing concern about a potential sup-
ply shortage, as new building starts and real estate invest-
ment slowed sharply since 2H08, and new housing supply China: mortgage loans and loans to property developers
will take 12-18 months to increase, even with the latest re- %oya % share
covery in new building starts. Indeed, in trying to curb the Loans to property Mortgage Real estate-related
60 developers loans loans as share of 20
risk of an asset bubble, authorities will have to take care
50 total loans
that any policy moves do not excessively curb developers’
funding for new construction projects, as occurred during 40 18
the tightening phase in 2007 and 1H08 (chart). Overall, 30
given the policy tilt to contain speculative demand and in-
crease housing supply at the same time, especially for the 20 16
lower to medium end, real estate fixed investment should 10 Total loans
continue its solid growth in 2010, supporting the economy’s 0 14
expansion. 2006 2007 2008 2009
17
Yen Ping Ho (65) 6882-2216

China appreciation reinstated in 2Q Table 1: CNY appreciation performance and macro variables
JPMorgan expects a gradual CNY appreciation to target Summary of key China data in % sequential sa terms, averaged
USD/CNY 6.50 by end-4Q 2010. Our forecast, compares with (1) (2) (3) (4)
the market consensus for USD/CNY 6.66 and has an implied
Mar-06 to Aug-07 Sep-07 to Apr-08 May-08 to Dec-08 Latest 6M
probability of 70% by the options market.
Inflation 0.38% 0.58% -0.16% 0.16%
The pace of CNY appreciation is expected to quicken in 2Q core inflation 0.07% 0.19% -0.16% 0.04%
as headline inflation and export growth momentum become GDP 2.98% 2.39% 1.37% 2.96%
more evident. The justification for this view is based on the IP 1.29% 1.39% 0.16% 1.44%
historical experience of CNY appreciation and macro M2* 17.65% 17.72% 16.34% 28.98%
indicators as demonstrated in the table below. This is made Real fixed inv 1.76% 2.53% -0.49% 0.07%
apparent in column two when the CNY appreciated at an Exports 2.27% 2.06% -1.52% 2.43%
annualized rate of 11.5% against the USD between USD -0.31% -0.99% 1.58% -1.01%
September 2007 and April 2008. During that period, many
macro indicators such as IP, M2 money supply, GDP and USD/CNY, %
-4.19% -11.53% -2.88% -0.13%
investment registered similar growth rates compared with the annualized
latest six-months. However, the past 6-months of weakness bold - peak or trough over period (1), (2), (3); most conducive for CNY gains
in inflation and exports contrasts with the Sep ‘07-Apr ‘08 shaded - stronger than period (1)
period of more rapid CNY appreciation that was arguably *%oya terms
justified by the higher export growth and inflation. Chart 1: Micro CNY behavior - PBOC fixing matters
pips
The micro market performance of CNY appreciation should
6000
also be watched as a signal to short-term trend changes in Daily trading move
USD/CNY. In general, the fixing mechanism of the PBOC that 4000
Fixing move
fixes the USD/CNY mid-point rate each morning has tended 2000 Total change
to lean against the direction of subsequent FX market
0
trading. This is illustrated in chart 1 and shows during last
year’s depreciation pressure on the CNY, the PBOC generally -2000
fixed USD/CNY lower over a three-month cumulative period, -4000
even though the market subsequently traded higher on a
-6000
cumulative basis over the same period. The key to signaling
faster CNY appreciation will be a consistent fixing of USD/ Jan-06 Jan-07 Jan-08 Jan-09 Jan-10
CNY below the level of the previous day’s traded close,
giving rise to momentum in subsequent market trading. This
as the carry/slide is too negative for receiving NDS at the
is denoted in the chart during the late 2007 and early 2008
moment.
period.
Generally bearish on bonds and IRS going Growth-inflation dynamics point to a flatter
into 2010 curve
We expect the IRS curve to bear flatten in 2010. This flat- China’s growth-inflation dynamics favor a flatter curve in
tening will be lead by the 1-year PBoC bill yield rise and 2010 as front end yields will rise due to climbing CPI while
tighter liquidity. The government bond curve will mirror the back end faces downward pressure because of falling IP
the bearish move in the IRS curve too, but to a lesser ex- growth. To summarize our macro call, JP Morgan econo-
tent. The growth-inflation dynamics also favor this flatten- mists expect the Chinese economy to continue growing sol-
ing move. We stay with our short term paid 5-year IRS idly in the coming quarters with the 2010 GDP growth fore-
trade, with a target 4.2% by end of 1Q. Also we suggest a cast at 9.7%. But the headline IP growth is expected to peak
new trade: Enter 1s/5s IRS flattener at 170bps with a target in 1Q2010 and then moderate afterwards, because the se-
70bp by end of 2Q. The NDS curve will drop as CNY specu- quential growth momentum will moderate from a very high
lation picks up. However, we do not see an attractive trade level. That is so because the effects of fiscal stimulus will
fade, and because the base effect plays a big role too. On
the inflation front, JP Morgan forecasts the yearly CPI to
18
Simon Song (86-21) 5200-2833 Asia 2010 Outlook
simon.p.song@jpmorgan.com January 15, 2010
JPMorgan Chase Bank
Bert Gochet (852) 2800-8325
bert.j.gochet@jpmorgan.com
grow 3.0% in 2010. Also due to a base effect, the CPI may Chart 2: IP growth likely to peak at 1Q and moderate afterwards, but
rise over 2.5% in 1Q10 and break the key 3% level by mid- CPI may rise above 3% til mid-year and then consolidate
2010 before consolidating in 2H10 (Chart 2). % , both scales
10 25
Forecast
7-day repo rate to rise 120bps in 2010, but CPI IP, 3mma
8
can be volatile 20
It is important to forecast the repo rate right as it is the fix- 6

ing on the repo-IRS, the main instrument traded by off- 15
shore investors. In 2010, it will be broadly impacted by two 4

factors: a rise of the 1year PBoC bill yield, and a drop in 10
2
excess reserves. The total rise in repo that we expect in
2010 is 120bp, and from time to time there could be upward 5
0
volatility in the rate:
-2 0
(1) The upcoming rise in the 1year bill yield to contribute 2005 2006 2007 2008 2009 2010
90bp towards a rise in the repo rate. Generally, the 7-day
repo rate moves in line with the 1-year PBoC bill yield as it Chart 3: The 1-year PBoC bill yield resumed its rise at the start of New
affects banks’ funding cost and market yield levels. The 1- Year, to rise towards 2.25% 1-year deposit rate firstly, and then will rise
year PBoC bill yield, a leading indicator and often consid- further along with three 27bps hikes of deposit rates in rest of this year
ered a semi-policy rate, resumed its rise on the start of New %
Year on Jan 12. It is not on its way towards the 1-year de-
4.5
posit rate of 2.25%, in our view. In a next phase, when de- Forecast
posit rates are raised three times by 27bp each (our fore- 4.0
cast), the 1-year bill yield should follow, or even front-run, 1y deposit rate
3.5
to end the year at 3.0% (Chart 3).
3.0
(2) RRR hikes and decreasing excess reserves will con-
2.5
tribute to additional 30bps rise in the repo rate. As we
foresee that OMO withdrawals alone will not be strong 2.0
enough to fully offset accelerating FX inflows, the PBoC 1y PBoC bill auction y ield
1.5
will also hike RRR. Indeed, PBoC hiked 0.5% RRR on Jan
13th, much earlier than expected, starting to normalize its 1.0
monetary policy, to curb excessive loan creation and man- 2005 2006 2007 2008 2009 2010
age inflation expectation. We expect three additional RRR
hikes in the rest of this year. As banks typically extend
loans at a seasonally high level in the first half of the year, Chart 4: Liquidity remains flush in 1Q as FX inflows accelerate and
policy stays accommodative, but may start to decrease from 2Q as loan
interbank liquidity will probably decrease sharply around creation surges and liquidity withdrawals intensify
then. Under such a scenario, it is expected that excess re-
CNY billion
serves will be down by around CNY 1.7 trillion by end 3Q
(Chart 4). That usually pushes up the 7-day repo rate by 3000
Forecast
25bps. Excess reserve
2500
(3) In addition, a deteriorating liquidity situation may

2000
make the repo rate volatile to the topside as more IPOs get
launched. This was the case a few years ago, and we would 1500
expect this to happen again from time to time in 2010 as li-
quidity gets tighter. 1000
Total bond issuance to rise 35% in 2010, 500

2006 2007 2008 2009 2010
despite less government bonds
Government bond issuance in 2010 will be around CNY
900bn, modestly more than 2009, even though the fiscal
deficit of GDP percentage will decline 1% to 2.1% in 2010
19
JPMorgan Chase Bank
Bert Gochet (852) 2800-8325
from 3.1% in 2009. The large issuance exists because China Chart 5: Supply pressure remains heavy under a proactive fiscal policy
will proactively keep its fiscal policy in place (Chart 5). CNY billion
1000
Other kinds of bonds issuance will increase much more Budget deficit Net gov ernment bond issuance
this year. As banks may need bond issuance to meet the 800
higher Capital Adequacy Ratio requirement than this year,
financial bond net issuance will surge in 2010. We expect 600
CNY 1.5 trillion of issuance versus 1.2 trillion this year. In
addition, thanks to policy encouragement to develop corpo- 400
rate bond markets, corporate bond net issuance will increase
to around CNY 1.12 trillion. 200
In other words, the total net bond issuance (excluding 0

PBoC bills) for this year is around CNY 3.5 trillion, or a 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010f
35% jump from 2009.
Chart 6: The rising PBoC bill yields led curve to bear flatten in the past
Finally, in order to sterilize FX inflows, PBoC will net issue bp %
bills of around CNY 1000bn in 2010. That compares with a
250 1y PBoC bill y ield 4.5
net redemption of CNY 900bn in 2009. PBoC may even re-
1y /10y CGB
sume the 3-year bill issuance, which has a larger impact than 4.0
1-year bills. 200
3.5
Such an increase in supply together with lesser liquidity 150 3.0

support will add to the fundamental-driven upward pressure
100 2.5
on yield. Even though bank loans will be modestly less than
last year, and even though the yield level in 2010 will be 2.0
higher than in 2009, the demand-supply dynamics for bonds 50
Curv e flattened 1.5
are at best balanced in 2010. In addition, there should not be on Bill y ield rise
strong demand for bonds at the early stages of an upward 0 1.0
economic and policy rate cycle. Mar-06 Oct-06 May -07 Dec-07 Aug-08 Mar-09 Oct-09
Curve to bear flatten in 2010 Chart 7: Curves to bear flatten on rising PBoC bill yield, climbing CPI,
less liquidity, RRR and rate hikes and moderating IP growth
We expect a bear flattening when PBoC starts to normalize bp
its monetary policy, ie. from now. A multitude of factors will
contribute to the upward pressure on the short end: rising 250
Forecast
1-year bill yield, tighter liquidity, hikes in RRR and deposit Bond 1s/10s
rates. In particular, the rising PBoC bill yield is the main 200
driver, as indicated by past two flattening experiences in
Jan-Oct 06 and June-Dec 07 (Chart 6). 150
The long end of the curve may be better supported after 2Q 100
as we expect IP growth to moderate at that time, despite in-
flation continuing to climb.
50
IRS 1s/5s
We expect CGB 1s/10s and IRS 1s/5s spreads to narrow
0
around 120bps and 140bps respectively in 2010, according
to our fair value models (Chart 7). In our model, we forecast Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10
bond yields and swap rates as functions of IP growth and

CPI rate, then calibrate the model results by considering
policy forecasts.
20
JPMorgan Chase Bank
Bert Gochet (852) 2800-8325
NDS Curve to bull steepen on CNY appre- Chart 8: NDFs moved faster than spot USD/CNY from June06 to July08
Y axis: 1y NDF monthly change, %; X axis: spot USD/CNY monthly change, %
ciation
2.0
Finally, a word about the NDS curve, which will behave en-
tirely differently from the IRS curve. We expect the (2s/5s) 1.0
NDS curve to bull steepen into 2010 because of two rea-
sons. 0.0
-2.0 -1.5 -1.0 -0.5 0.0
First, the implied yields in the NDF and NDS curves will -1.0
come down once spot USD/CNY finally moves. JP Morgan
-2.0
expects CNY to resume a gradual appreciation beginning
sometime in 2Q10, and we think that the NDF/NDS will price y = 1.14x -3.0
in stronger appreciation from then. We like to go back to R2 = 0.21
2006 as it provides once again a good example of what could -4.0
happen in 2010. From June06 to July08, the 1-year NDF
tended to overprice the move in spot by a factor of 1.14
times (Chart 8). Applying this factor to our 2010 forecast for
Chart 9: NDS Curve likely steepen on renewd expectation of CNY
spot USD/CNY of 6.5 by end-year, we see the 1-year NDF to appreciation and steeper US swap curve
reach 6.30 by then. This means we see lower implied NDF
bp inverted
yields and hence lower NDS yields as well. However, at the
600 6.0
moment the negative carry on receiving NDS is too large to Forecast
1y NDF 6.2
justify any trade. 500
6.4
400 NDS 2s/5s 6.6
Second, together with the NDF/NDS decline, the NDS curve
300 6.8
will steepen as the front end will discount more CNY
7.0
strength compared to the long end. Regression analysis in- 200 7.2
dicates that on average the NDS 2s/5s spread widens 31bps
100 7.4
for every 1% monthly declines in 1-year NDF. Hence, we
7.6
expect the NDS 2s/5s spread to widen around 200bps in 0
7.8
2010 (Chart 9). -100 8.0
2005 2006 2007 2008 2009 2010
In addition, the NDS curve is related to the shape of the US
swap curve. Our US strategists expect the US swap curve to
remain steep for 1H10, which will help NDS steepen as well.
Table2: Key rates forecast
Even though at the end of the day we believe the NDS curve 4Q09 1Q10 2Q10 3Q10 4Q10
to bull steepen, we do not see an attractive trade as the 1y deposit rate 2.25 2.25 2.52 2.79 3.06
carry/slide for 2s/5s steepener is too negative for now. The 7day repo fixing 1.55 2.00 2.50 2.60 2.70
1y PBoC bill 1.76 2.40 2.70 2.80 3.00
3-month and 1-year carry/slide is -55bps and -200bps, re-
1y CGB 1.50 2.20 2.70 2.80 2.90
spectively. We will wait for better entry levels to get into an 10y CGB 3.60 4.10 4.00 3.90 3.80
NDS trade. 1y IRS 2.10 2.80 3.30 3.40 3.50
5y IRS 3.70 4.20 4.00 3.90 3.80
Trades 2y US swap 1.45 1.65 1.85 2.10 2.40
5y US swap 3.00 3.20 3.55 3.80 4.10
- At the moment, we stick with our earlier recommended NDS 2s/5s, bp 255 275 325 400 455
outright Paid 5-year NDIRS trade. We entered this trade at
3.7% on Jan 4th, with a target of 4.2% by the end of 1Q. To-
day it stands at 4.0%.
21
Hong Kong: economic indicators

Hong Kong
Average
• Hong Kong’s external trade and serivce exports are set to 2003-07 2008 2009f 2010f 2011f
benefit from global recovery and solid growth in China Real GDP, % change 6.4 2.4 -3.3 4.5 4.1
• Domestic demand, both consumption and investment, Consumption* 2.5 1.0 -0.3 3.3 3.1
Investment* 1.2 -0.3 -1.0 0.9 0.8
pick up steadily; labor market gradually improving
Net trade* 2.7 1.6 -2.0 0.3 0.2
• Given zero Fed rate, and as CNY begins gradual Consumer prices, %oya 0.4 4.3 0.6 2.3 2.0
appreciation, liquidity inflow will be major concern in % Dec/Dec 1.2 2.0 1.3 2.2 2.1
2010 Government balance, % of GDP 2.4 0.1 -3.3 -1.0 -0.5
Following four quarters of contraction since 2Q08, Hong Merchandise trade balance ($ bil.) -11.3 -23.1 -24.9 -34.8 -48.7
Kong’s real GDP staged solid rebound in 2Q and 3Q this Exports 287.6 365.3 328.7 379.9 433.6
year, expanding at 14.8% q/q, saar and 1.6% respectively, as Imports (CIF basis) 298.9 388.4 353.6 414.8 482.3
the bottoming and gradual improving in the global Goods and services balance† 20.2 30.6 26.1 28.7 29.7
economy, particuarly the impressive upturn in the mainland, % of GDP 11.2 14.2 12.6 13.2 12.9
and recovering financial markets led to steady recovery in International reserves, ($ bil.) 130.4 182.5 260.0 300.0 335.0
Hong Kong’s external trade sector (especially regarding
* Contribution to growth of GDP.
export of services), feeding into recovery in domestic pri-
† Includes estimate of net interest receipts not counted in government definition.
vate expenditure and fixed investment. Looking ahead, we
expect the Hong Kong economy to grow at a solid, steady
pace in the coming quarters. On the external side, the con-
structive outlook on the global manufacturing sector would
impact regional trade positively, benefiting Hong Kong’s
trade sector. On the domestic front, improving conditions in
the domestic labor market, improving business sentiments, Hong Kong: real GDP growth
as well as the notable gains in the asset markets should all %oya %q/q, saar
come together to support further domestic demand recov- 10 %oya 15
ery. We expect Hong Kong’s real GDP to rise 4.5% in 2010.
10
5
5
Improving external sector activity
0 0
On the back of the sharp rebound in exports in 2Q09 (up %q/q, saar
55.1% q/q, saar), Hong Kong’s exports weakened somewhat -5
-5
in 3Q (down 10.7% q/q, saar). Together with the further gain -10
in merchandise imports, net merchandise trade turned into a
-10 -15
significant drag on the overall economy in 3Q. Nonetheless, 2004 2005 2006 2007 2008 2009 2010
going ahead, as the global economy is expected to stage a
solid, steady recovery in the coming quarters, Hong Kong’s
external trade sector should similarly show steady upturn. Hong Kong: contribution to real GDP growth
Moreover, Hong Kong’s service exports have registered
%oya, % contribution to %oya growth Private
steady recovery since 2Q09, continuing to rise at 19.7% q/q, 15
Fixed consumption
saar in 3Q, supported by financial sector activity and the investment
impressive rebound in inbound tourism, a trend which is set 10
to continue well into 2010. 5
Steady domestic demand recovery 0
On the domestic front, the labor market has shown signs of -5 Net exports
stabilization in recent months. The headline unemployment
-10
rate, having peaked at 5.4%, sa in 3Q, edged down to 5.1%
97 98 99 00 01 02 03 04 05 06 07 08 09
for the three months ending November. Meanwhile, total
employment continued to decline through October, which
22
likely explain why private consumption expenditure came in Hong Kong: private consumption and retail sales volume
somewhat disappointing in 3Q (up 2.0% q/q, saar). Looking %q/q, saar, both scales
ahead, as business sentiment turns decisively more posi- 25 Private consumption 40
tive, especially on the back of the constructive outlook for expenditure
20 Retail sales 30
the global economy, job creation is likely improve steadily 15 20
in the coming quarters. With regard to the domestic service 10
10
sector, the tourism industry has improved steadily, as tour- 5
0
ist arrivals both from the mainland (up 124.1% 3m/3m, saar 0
by October) as well as the rest of the world (up 37.6% 3m/ -5 -10
3m, saar) have turned up notably in recent months, support- -10 -20
ing retail sales and service exports, a trend that will likely 2003 2004 2005 2006 2007 2008 2009
extend well into the coming quarters. With regard to domes-
tic fixed investment, in addition to the cyclical recovery in
private capital expenditure, public sector infrastructure con-
struction will continue with steady expansion going ahead.
Hong Kong: consumer confidence and retail sales
Index Consumer confidence (1Q leading) %oya
Moderate inflation pressure
120 15
Hong Kong’s headline CPI inflation has been under notable 110
10
impact of various government relief measures recently. 100
However, netting out the effect of policy distortions, the 90 5
underlying CPI inflation rate has remained largely steady (at 80 0
-0.3%oya in November). Looking ahead, as the impact of
70
various government relief measures gradually phases out, Retail sales volume -5
60
and as the economic recovery picks up momentum, underly-
50 -10
ing CPI inflation is likely to resume a gradual upward trend.
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
Meanwhile, the pace of general price increase would likely
be constrained by ongoing slack in the economy, especially
as the labor market recovery is still at an early stage. Over-
all, we look for headline CPI to rise at 2.3% in 2010. Hong Kong: Headline CPI and underlying CPI
%oya
Underlying CPI (after netting
8
Managing liquidity and asset market risks Headline
out tax concessions)
As the US Fed has introduced a set of measures to increase CPI

4
liquidity and holds policy rates close to near zero to counter
the financial crisis, Hong Kong has been confronted with a
wall of liquidity inflow this year. Consequently, the size of 0
Hong Kong’s total monetary base has tripled since 4Q08,
which has dwarfed the magnitude of monetary base expan- -4
sion in the US. Along with the rising tide of liquidity, Hong 02 03 04 05 06 07 08 09
Kong’s property prices rebounded sharply this year. There
have thus been growing concerns on the potential impact of
the imported accommodative monetary policy stance to cre-
Hong Kong: aggregate balance and exchange fund bills and bonds
ate further asset and CPI inflation in Hong Kong.
HK$ bn
In particular, going into 2010, as the mainland economy is 500 Outstanding Exchange
Fund bills and bonds
expected to show further broad-based recovery, which will
400
boost real economic activity in Hong Kong, and with the
Banking sector
CNY beginning to appreciate at a gradual pace, possibly 300
aggregate balance
beginning in 2Q10, Hong Kong is likely to face sustained
200
pressure of liquidity inflow going ahead. In this regard, the
authorities would have to continue paying close attention 100
to the building pressure in the asset markets. In particular,
in addition to higher mortgage requirements for the luxury 0
2003 2004 2005 2006 2007 2008 2009
end of the residential market implemented recently, as well
23
Yen Ping Ho (65) 6882-2216

as the on-going policy discussion on increasing land sup- Hong Kong aggregate balance reaches record high
ply, the IMF has also suggested considering alternative
HKD Billion %
policies if necessary, including changes to prudential regu-
350 1.2
lations such as tighter underwriting standards, lower loan-
to-value ratios, or countercyclical capital requirements, in 300 1.0
order to mitigate the upswing in asset prices. HK Aggregate Balance
250
0.8
200
HKD peg to hold despite reval speculation 0.6
150
HKD is expected to remain stuck on the strong side of the 0.4
100 3m HIBOR
two-way convertability band in 2010. A combination of US
zero interest rate policy and CNY appreciation will continue 50 0.2
to create a policy dilemma for the HKMA. The zero bound
0 0.0
on interest rates means there is little scope for rate
Jan-09 Mar-09 May-09 Jul-09 Sep-09 Nov-09
differentials to play the pivotal role in the currency board
system that attempts to redress liquidity imbalances by
attracting funds into the higher yielding currency.
HKD currency board remains credible based on 1yr options
Consequently, the HKMA has automatically engaged
quantitative easing (see chart 2 as a means to match the
3.5%
excessive demand for HKD in the system and prevent USD/
3.0% Minimum width of fully credible band
HKD trading below the 7.75 lower two-way convertibility
band limit. 2.5% Actual band width
2.0%
This impasse has prompted some to speculate that the HKD
1.5%
could be revalued, despite the insistence by policy officials
that such a policy option is off the agenda for several 1.0%
reasons: First and foremostly, any nominal peg adjusts to 0.5%
external shocks through a real adjustment in the economy’s
0.0%
wages and assets. Second, the CNY is not a freely
Jul-05 Jul-06 Jul-07 Jul-08 Jul-09
convertible alternative anchor to the USD. Thirdly, the
PBOC or an alternative basket of anchor currencies may not
posses the same degree of monetary independence and
credibility as the US Fed.
Nonetheless, this still leaves open the risk that Hong Kong
may be vulnerable to a boom bust cycle should the real
adjustment in prices overshoot the economy’s fundamentals
due to excess liquidity and speculation. As a consequence,
the HKMA can be expected to continue their macro
prudential policy of tightening lending standards to guard
against excessive leverage. In the meantime, our assessment
of the HKD currency board credibility using option market
pricing (see: “Speculating on CNY, HKD, SGD”, October 8,
2009) suggests that the current regime remains very credible
on a one-year horizon with options implying that a 1.37%
bandwidth would be 100% credible compared with the
current bandwidth of 1.29% (see chart 3).
24
JPMorgan India Private Limited Emerging
Global Asset
Markets
Allocation
Asia Research
Jahangir Aziz (91-22) 6157-3385 Asia 2010 Outlook
jahangir.x.aziz@jpmorgan.com January 15, 2010
India India: economic indicators

fiscal years beginning Apr 1
Average
2003-07 2008 2009f 2010f 2011f
• Despite deficient monsoon growth monetum remains Real GDP, % change 8.9 6.1 6.8 7.8 8.3
strong; strength of corporate investment is key in 2010 Consumption* 3.7 3.6 2.0 3.3 4.4
Investment* 6.8 4.3 4.4 7.4 7.1
• Inflation still driven by food prices; generalized Net trade* -1.6 -1.8 0.4 -2.8 -3.1
Consumer prices, %oya 4.8 8.3 10.8 6.5 7.0
inflationary pressures still at bay % Dec/Dec 5.0 9.7 12.0 6.0 7.5
Wholesale prices, %oya 5.3 8.4 3.3 7.3 5.5
• Supportive monetary and fiscal policy likey to be Government balance, % of GDP -4.1 -7.8 -7.3 -6.8 -5.9
normalized; rates to harden gradually
• Continued strong capital inflows to keep up Merchandise trade balance ($ bil.) -51.1 -119.3 -104.9 -136.4 -165.6
Exports 109.9 175.3 165.6 210.0 268.5
appreciating pressures on FX Imports 161.0 294.6 270.5 346.4 434.1
Current account balance -5.6 -29.7 -12.4 -29.5 -33.7
% of GDP -0.7 -2.5 -1.0 -1.9 -1.8
International reserves, ($ bil.) 176.6 241.5 291.9 348.0 394.5

Growth strengthens, despite deficient Total external debt, ($ bil.) 159.8 234.6 253.1 270.4 292.5
Short term† 25.6 50.0 54.5 60.0 66.6
monsoon Total external debt, % of GDP 18 20 19 17 15
Total external debt, % of exports‡ 73 69 68 61 54
J.P. Morgan expects India GDP growth in the coming fiscal Interest payments, % of exports‡ 6 5 5 4 4
year (2010/11) to be 7.8%, which means we are forecasting
growth that is both above our estimate for India’s potential * Contribution to growth of GDP.
growth and above the average consensus expectations. Key † Debt with original maturity of less than one year.
to our forecast is a broadening of growth to include exports ‡ Exports of goods, services, and net transfers.
and investment next year, building on a solid base of domes-
tic demand growth that picked up the pace in the middle of
the current fiscal year.
But while India has been relatively insulated from the global Real GDP
economic downturn, domestic shocks have proven that GDP % both scales
%oya
growth remains vulnerable to sharp fluctuations. In particu- 14 14
lar, erratic and unevenly distributed rainfall during from the 12 12
monsoon season will adversely impact agriculture growth 10 10
and could lower the Kharif (summer) harvest by around 10- 8 8
15%. Even though this drag will be largely offset by strength 6 %q/q, saar 6
in the manufacturing and services sectors, there is a risk of a 4 4
headline contraction in sequential GDP growth in the current 2 2
quarter. 0 0
05 06 07 08 09 10
But beyond the near-term hit to the agricultural sector, lead-
ing indicators continue to point to a broad-based, strong re-
covery elsewhere. IP growth remains strong at 22.5% (3m/3m
saar) in September, auto sales registered 70% (3m/3m saar) in
October; and exports and non-oil imports grew 50% and 64%
respectively in October. Although exports and imports re- Food inflation surges, but it is not credit dependent
main below their pre-October 2008 levels but the gap is nar- %oya
18
rowing fast. With a rebound in growth expected in the Janu- Food
14
ary-March quarter, GDP growth in the current fiscal year is
expected to be 6.7%oya. 10 Food
6
Previous tightening
Inflation dominated by food prices 2 Non-food
WPI inflation is rising quickly, both on an oya and a sequen- -2 Nonfood
tial basis, but the current inflation dynamic in India is not
-6
demand-driven. Instead, the increase in inflation is supply-
Mar-08 Jul-08 Nov-08 Mar-09 Jul-09 Nov-09
driven and focused on food. Supply constraints, heightened
25
JPMorgan India Private Limited Global Asset
Emerging Markets
Allocation
Asia Research
festival led demand, and expectations of reduced farm pro- Non-food credit
duce following the uneven distribution of rainfall drove %oya, 3mma %q/q, saar
food prices higher and could push wholesale inflation up to 40 50
oya
as much as 8%oya by the end of the current fiscal year. 35 40
30
Where inflation goes from here is largely dependent on how 30
25
food prices are managed by the government In particular, 20
20 q/q
the focus will be on the government’s management of infla-
15 10
tion expectations through its use of the summer harvest
together with imported food products to keep prices down. 10 0
Timely and efficient release of these stocks could substan- Jan-05 Nov-05 Sep-06 Jul-07 May-08 Mar-09
tially limit further escalation of food prices. Other global
commodity prices (in particular crude oil and basic metal
prices) will be critical in determining the overall inflation
trajectory. As for demand-side price pressures, despite
India’s relatively robust GDP growth performance, there is INR- capital inflow relationship was disrupted in 3Q-4Q09 by outflows
still large slack in labor markets and capacity in manufactur- US$bn USD/INR inverted scale
ing, holding back a sharp hardeing of manufacture prices. 65 38
60 40
Driven by corporate investment, bank 55
INR 42
credit could gap up in mid- 2Q10 44
50
46
Belying the strength of the economy, bank credit growth
45 48
has continued to languish. So far this fiscal year (April-No-
vember), bank credit expanded Rs1.3 trillion, less than half 40 50
Cumulative foreign equity inflow
of that during the same period last year, lowering the year- 35 52
on-year growth rate from 18.8% in April to 10.1% in Novem- 54
30
ber. In the initial stages of a cyclical upturn, a strong re- Mar-07 Oct-07 Apr-08 Nov-08 May-09 Dec-09
bound in activity is usually financed with only a modest
increase in bank credit. Cuts in business costs and debt
service during the downturn usually mean that firms have
ample cash surplus, and nonbank financing is relatively
cheap. This appears to have happened in India too. Firms
have raised substantial funds in capital markets (so far Capital inflows to remain strong, exerting
nearly $8-9 billion in equities and foreign borrowing with upward pressure on the rupee
another $3-5 billion in the coming months), using most of it We expect an increase in India’s capital account surplus to
to reduce the high cost debt acquired last year. Working more than offset a widening of the current account deficit,
capital needs have also lessened because input prices, resulting in a larger balance of payments surplus in FY11.
other than food, have been benign. Few firms, other than On the current account, so far in FY10, the deficit has nar-
those associated with infrastructure, have undertaken sig- rowed due to a general reduction trade and weak corporate
nificant capital expansion. investment. From April-October 2009, merchandise exports
declined 23%oya, while the fall in imports was larger at 32%.
However, for GDP growth to be sustained, corporate invest- Within imports, non-oil imports declined 24%, while a sharp
ment will need to pick and this will drive up bank credit. oil prices caused the oil import bill to drop 46%oya.
While Indian corporates have strengthened their balance
sheets and look poised to begin capital expansion, the big In recent months both exports and imports have begun to
investment push may only occur in mid-2Q10 once a sus- recover and the global recovery and higher investment
tainable global recovery appears entrenched. As the crisis should boost both. We expect the merchandise trade deficit
was global in nature it is unlikely that the gap up in invest- to widen to US$136.4bn (9.0% of GDP) in FY11 from an ex-
ment will occure sequentially across sectors. Thus, it is pected US$105bn (8.5%) in FY10. Strength in net invisibles
quite possible that when investments picks up it will be will help limit the increase in the current account deficit to
across sectors and very shrap. This could exert pressures US$29.4bn (1.9% of GDP) compared to US$12.4bn (1.0% of
on banks and rates and will require judicious macroeco- GDP) projected in FY10.
nomic management to ensure that the transition occurs in a
non-disrutive manner.
26
JPMorgan India Private Limited Global Asset
Emerging Allocation
Markets Asia Research
But a key call for next year is that a significant pick up in net Persistent excess liquidity is now a financial stability concern of RBI
foreign investment inflows, increasing the capital account Rs mn both scales
surplus to US$82.3bn (5.4%) in FY11 compared to an esti- 1500 1500
mated US$47.3bn (3.9%) in FY10. Capital inflows will likely
pick up in 1Q10, attracted by the government’s divestment 1000 Excess liquidity: RBI reverse repo 1000
program, auctioning of 3G spectrum, a push for consolidat-
ing public-sector banks, and the likely passage of a number 500 500
of pending financial reform bills.
0 0
Importantly, in 3Q-4Q09, there were significant capital out-
flows as Indian corporates bought back convertible bonds -500 -500
Scarce liquidity: RBI repo
issued in 2006-08 and paid off trade credits, while domestic
banks paid back the high-cost funds borrowed in 4Q08 and
-1000 -1000
1Q09. This outflow of capital while strengthening corporate Jan-07 Jun-07 Oct-07 Mar-08 Aug-08 Dec-08 May-09 Oct-09
balance sheets continued to exert downward pressure on
the rupee and limited its appreciation. This is unlikely to
occur in 2010, such that even in the unlikely event of lower
gross inflows, net inflows will be stronger. Separately, FDI
inflows have picked up, as well as overseas corporate bor- Strong expectation of call rate to move to the top of policy corridor soon
rowing. All of these bode well for equity flows in 1H10. On
% pa
net, the J.P. Morgan forecast calls for India’s overall bal-
18 Call money
ance to strengthen to US$53bn (3.5%) in FY11 versus
16
US$35bn (2.8%) in FY10.
14
12
RBI will likely begin tightening in 1Q10 on 1Y OIS
10
financial stability concern 8
The Reserve Bank of India, together with the Bank of Korea, 6
has been a leader in consistently signaling an early exit from 4
its exceptionally easy monetary policy stance. At its Octo- 2 Policy corridor
ber policy review, the RBI began the process by withdraw- 0
ing several regulatory forbearance measures introduced in Jan-07 Jun-07 Oct-07 Mar-08 Aug-08 Dec-08 May-09 Oct-09
4Q08.
The driver behind the RBI’s tightening is its concern over

excess bank liquidity fueling asset price inflation, not by well play out before the end of 1Q10. Beyond that we expect
worries over food-driven, WPI inflation. However, the another 50bps rate hike spread over the remained of 2010.
higher headline inflation and stronger growth momentum
makes it much easier for the RBI to justify the tightening. 2010 fiscal targets appear realistic
The key to whether and by how much the RBI will tighten The FY10 fiscal deficit should come around the budgeted
CRR will largely depend on what happens to excess re- 6.8% of GDP or marginally better, as revenues were conser-
serves in mid-January (the last data point before the Janu- vatively budgeted (higher disinvestment proceeds and di-
ary 29 policy review). If excess reserves falls to below Rs400 rect tax collections). The government will likely target a
billion (the long run average), then the RBI might hesitate. much lower deficit for FY11 (5.5% of GDP), which should
But this looks unlikely. Instead we expect excess reserves to not be too difficult to credibly establish given the likely
hover around Rs1 trillion, prompting the central bank to an- higher economic growth and by rolling back (partially) the
nounce a 50bps hike in CRR. This move is likely to be tax cuts of January 2009. In addition, states’ borrowing will
supplemented by another 50bps hike in CRR, which should be forced down to the FRBM target of 2.5% of GDP rather
bring down excess reserves close to its long-run average than the 3.5% of GDP allowed this year.
and raise the call-money rate by 150bps to the top of the
policy corridor from the bottom. At this point, the RBI could
raise the policy rates by 25bps. These policy actions could
27
Yen Ping Ho (65) 6882-2216

INR appreciation pressure to intensify Chart 1: Indian corporates and exporters remain underhedged
INR to remain under appreciation pressure. Capital inflows USD billion %q/q
will likely pick up in 1Q10, bolstered by the government’s 3.0 -8.0%
divestment program, auctioning of the 3G spectrum, a push 2.5 -6.0%
2.0
for consolidating public-sector banks, and the likely passage -4.0%
1.5
of a number of pending financial reform bills in this -2.0%
1.0
parliamentary session. The pipeline of QIPs (Qualified 0.0%
0.5
2.0%
Institutional Placements), and potentially IPOs if the stock 0.0
4.0%
market does well, is also strong, which will attract further -0.5
-1.0 6.0%
FIIs who have already been heavily involved in QIPs.
-1.5 8.0%
Companies have already raised more than USD9 billion
-2.0 10.0%
through 2009 via the QIP route, and the pipeline still appears Mar-07 Jun-07 Sept-07 Dec-07 Mar-08 Jun-08 Sept-08 Dec-08 Mar-09 Jun-09 Sep-09
very strong (see chart 4). Separately, FDI inflows have
picked up, as well as overseas corporate borrowing. All of short USD/INR book, q/q change, lhs USD/INR, %q/q, rhs
these bode well for equity flows in 1H10.
Under-hedged local exporters could accelerate the move. Chart 2: Indicative graph of JPM forecasts for CRR, policy rates and
Despite the break lower on USD/INR last year, hedging call rate, together with call rate forward
activity has remained subdued even as the USD/INR fall 6.5%
prompted some to return to the market (see chart 5). Risks
are that a further leg lower on USD/INR could break the pain 6.0%
threshold for local exporters triggering a spot chase lower. CRR Forecast
5.5%
We expect the INR to appreciate to 43.50 against the USD by Call Rate Forecast
end-1Q10 and 41.50 by end-December 2010. 5.0%
Repo - Rev Repo Corridor Forecast

4.5%
Risk aversion and EM-related risks are the main risk
scenarios for this view. The balance of payments position, 4.0%
weighed down by a current account deficit, depends on

3.5%
capital inflows to sustain INR gains. Though post-election
optimism should be apt to drive the move higher, a return to 3.0%
global risk unwind could well trigger capital outflows and Jan-10 Feb-10 Mar-10 Apr-10 May-10 Jun-10
disrupt INR gains.

that has zero carry or slide. The trade consists of an out-
Bearish 1s5s steepener right paid position in 5s, say $20k at 6.70%, together with a
DV01-weighted steepener in 1s5s, say $10k at 189bp. The
Sometime in 2010, we expect India's OIS curve to rise by 75-
position is a tactical rather than a strategic ‘Pay’. The trade
175bp and see a large bear flattening move. This will happen
has the benefit that it would perform well in a sudden selloff
when liquidity drops and RBI's tightening picks up pace.
(it is net short), but would also trade neutral in a range trad-
The upmove in the OIS curve will be aided by worries over
ing environment (it is flat carry/slide). The obvious risk to
the deficit and bond supply.
the trade would develop if expectations for RBI tightening
evaporate.
However, even when we expect such a large move next
year, it is quite costly to enter an outright paid position
Our aim is to put 25% of our risk on now, and quadruple the
right now. The carry/slide on being outright short is too
size of the trade in December or January, as entry levels will
negative. As significant liquidity withdrawal is not immi-
range trade for now. We will keep our readers informed
nent, the call rate might continue to hug the bottom of the
when, and at what levels, we scale up. Especially if the 5-
corridor even if RBI hikes CRR by 50bp in January. But it
year rate were to drop towards 6.50%, we would add to the
will rise to the top of the band in March or April, when RBI
trade. But we will also recommend when to leg in and out of
tightens further. The entire OIS cuve will then rise as well.
the 1s5s hedge, as 1s will remain in a 4.60%-5.15% range
and 5s in a 6.50%-7.15% range for now.
Hence our recommendation for a 1s5s bearish steepener
28
JPMorgan India Private Limited Emerging Markets Asia Research
Abhishek Panda (91-22) 6157-3387 Asia 2010 Outlook
abhishek.x.panda@jpmorgan.com January 15, 2010
JPMorgan Chase Bank
Bert Gochet (852) 2800-8325
RBI to start normalizing rates from Janu- Chart 3: 1y fwd 3m OIS - 3 month OIS
ary onwards bp
300
Key economic data (except credit) are strong enough to
warrant significant tightening by RBI next year. First and 250
most important, the recent inflation trend is worrying. Even
if food prices stay at current levels and adding in base ef- 200
fects indicates that the headline WPI number will probably 150
rise to 6.5-7% by the start of 2Q, up from 4% now. RBI will
not ignore such inflation developments (note how they 100
acted in 2008) even if a case can be made that monetary
50
policy cannot control food inflation. Second, GDP just
printed up 6.9%, which is enough to believe that India is on 0
the way to return to its pre-credit crisis growth pace, in our Jan-09 Mar-09 May-09 Jul-09 Sep-09 Nov-09
view. JP Morgan’s GDP forecast for next year is 7.8%. Third,
the RBI's fear is that continued excess liquidity could seep
Chart 4: 1-year OIS - repo
further into asset markets. Certainly we predict no let-up in
the inflows in India, or in Asia in general for that matter. %
They are part of a structural shift of investment money Periods of simultaneous CRR and policy rate hike
2
away from G7 into EM that has further to run. Fourth, and 1.5
finally, credit growth is the single weak outlier among eco- 1
nomic data. It still has not picked up for now. But, we are of 0.5
the opinion that credit will take off within a few months, 0
probably around 2Q10, especially if GDP growth is sus- -0.5
tained as we predict. What is more is that Indian corporates -1
have a mentality to act in a herdlike fashion if and when -1.5
they invest and borrow. -2
-2.5
India’s tightening will happen rather independent of mon- -3
etary policy at other Asian countries or at the Fed. In Jan-06 Sep-06 May-07 Jan-08 Sep-08 May-09
speaking with various Asian Central Banks in private, we
get a sense they are hesitant to “go it alone” as long as the are trying to go short the market at these levels.
Fed or China does not move forward on rates. But we do
not observe such hesitancy in India where the pickup in Another way of looking at the lack of risk premium is to track
activity is domestically driven. the 1y OIS spread in relation to the repo rate. At any point in
time where RBI was in a process of hiking both the policy rate
Short dated OIS forwards are not pricing in and the CRR at the same time, the 1year OIS traded 50-100bp
(sometimes more) above the repo rate. As we will point out
any risk premium
further in the text, RBI is not about to hike CRR and policy rates
Recently, the forward curve has been pricing in a rise of simultaneously yet, but that will change as we get closer to Q2.
approximately 250bp in the call rate for the next 12 Chart 4 depicts the past periods where CRR and repo/reverse
months. In chart 3, we have used the difference between the repo were hiked at the same time.
3m OIS and the 1y3m OIS as a measure for next year’s rate
hike expectations (this spread is a commonly used proxy for
Next year’s G-Sec issuance to add to up-
pricing the call rate a year ahead).
ward pressure on bond and OIS yields
250bp is a fair trajectory based on consensus economic For many years now, the announcement in February of the
forecasts. We think the average India economist calls for government bond issuance plan has been a negative factor
75-100bp of policy hikes (and we add 150bp for when the for the market. We do not expect it to be a positive this year
call rate traverses the band). either. The table shows how bonds and swaps have suffered
during every February since 2005. In fact, not only in Feb-
However, 250bp does not pay us any risk premium in addi- ruary have yields gone up, but also in July whenever India
tion to the fair value path. In the context of Indian rates, we decided to announce extra issuance. This is one reason why
find it odd that we are not compensated above and beyond the coming February will be a tough month for bonds again.
the fair path of interest rates. This is a key reason why we
29
JPMorgan Chase Bank
Bert Gochet (852) 2800-8325
The expected size for G-Sec issuance next year is a gross Table 1: Gross borrowing announcements and impact on rates
amount of Rs4.6 tri, and a net amount of Rs3.6 tri. This is Announced Gross 10y GB yield 5y OIS rate
based on a fiscal deficit of 5.5% of GDP. The net issuance borrowing (INR move (bp; move (bp;
amount is similar to this year, but the gross amount is billion) month) month)
Rs500 mi larger, ie. an increase of 16%. 2002-03 Feb 959 15 17
2003-04 Feb 1072 -8 52
The lack of OMO buybacks next year will also put pres- 2004-05 Feb 905 -25 15
sure on auctions. The last five years has seen an ever in- 2004-05 July 1155 15 58
creasing amount of G-Sec issuance which was alright as 2005-06 Feb 1008 7 13
long as India was booming and banks’ balance sheets were 2006-07 Feb 1138 8 15
2007-08 Feb 1096 22 25
growing. In 2009, when the economy turned weak, it became
2008-09 Feb 1005 38 35
a stretch to succesfully auction the entire G-Sec calendar, 2009-10 Feb 3086 20 30
but OMO buybacks proved an important factor in limiting 2009-10 July 4170 17 25
the rise in bond yields. Next year though, there will be no 2010-11 Feb (f) 4600
OMO buybacks. Rising deposits at banks will provide some
cushion, however this is probably not enough to offset the Chart 5: Rolling 3 months correlation between 10y benchmark yield
upward pressure on bond yields. and 5y OIS rates
%
Chart 5 shows that any impact of the issuance plan on bond
100
yields would feed through in the 5year OIS curve as well.
The correlation between OIS and bonds has historically
80
been between 60% and 80%. Recently though it has been
less, as this year OIS have been driven by the rapid shift in
60
rate hike expectations whereas bonds were more focussed
on supply instead. However, even in the last few months
40
the correlation between the two curves was 30-60% on the
positive side.
20
Initially, policy rates will rise slower than 0

what the forwards indicate, but then pick Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10
up
Having described why yields curves are headed higher, we However, this liquidity cushion will start to disappear, and
now turn our attention to when they will do so. It could take the overnight rate will traverse the corridor to the top side.
a month or two, in our view, until RBI is in full tightening We estimate that this would happen around Q2/Q3, ie. by
mode, for rates to break out of their range. the time of the second CRR hike and the first policy hike.
Remember that the call rate in India has never stayed at the
To be sure, RBI's tone has already changed from neutral middle of the band, because the RBI has no way of keeping
towards hawkish, and it has laid the groundwork for tight- it. So the RBI’s strategy is either to starve or flush the sys-
ening to begin in 1Q somehow. Our India chief economist tem with liquidity. Our sense is that right now we have
Jahangir Aziz does not expect any tightening in December. about INR1trillion in excess. 100bps in CRR will take away
But then he foresees a 50bp CRR hike in January, fol- 500billion. Another 250 billion could disappear in added
lowed by another 50bp CRR in February or March. Two investments by banks in mutual funds and credit growth
25bp policy hikes will follow, one in March, and one in (seasonal related to agriculture). 250billion in excess re-
April or May. We then see a further policy hike in 3Q and in serves is the “normal” state, which typically pushes the call
4Q. Chart 2 shows our expectations graphically. rate to the top of the band. Once at the top, then the only
way to tighten would be to raise policy rates.
Liquidity should stay flush into January and even early
February, we believe. Even if RBI hikes CRR by 50bp in Trade recommendation: Bearish
January, money in LAF should only drop to the Rs700bn- steepener in 1s5s
800bn range, ie. comfortably above the Rs400bn long run The bearish steepener that we propose recognizes the
average. That in turn will keep the call rate near the bottom assymetric outlook we hold for OIS next year. Ie. there is a
of the LAF corridor for now. good chance of a sudden, much higher OIS curve at some
point (say by 100 to 200bp), while there is a smaller chance
30
JPMorgan Chase Bank
Bert Gochet (852) 2800-8325
of a moderate rally (of say 50bp). At the same time, the posi- Chart 6: 1-year versus 5-year OIS
tion recognizes that it is difficult to time exactly the rise in % Jun - Dec09
yields and that it can take a few months to develop. 7.0 Slope = 0.77
The bear steepener consists of a 1s5s curve trade where we 6.5

overweight the paid 5year leg by a factor of 3:1. In detail,
5-year OIS
we suggest paying $30k of DV01 in 5year at 6.68%, while 6.0
receiving $10k of DV01 of 1year swap at 4.80%. The com-
bined trade is short 3 times more DV01 units of the 5year 5.5 Jan - May 09
than it is long in the 1year. Its carry and slide are flat.
5.0
We prefer this structure over simply paying 5year out-
right for the following reasons: 4.5
3.5 4.0 4.5 5.0
First, the position would perform well in a big selloff, as it 1-year OIS
is a net short position. However, when we get closer to
Chart 7: 1 month carry and slide of OIS curve
hikes in the repo rate, we would consider removing or at bp
least reducing the 1s5s part and stick with the paid 5year
30
outright.
25
There is a (in our view small) risk to the trade that the 1year
reprices upward but that the 5year moves far less. In fact, if 20
the 5year were to rise at less than a third of the pace of the 15
1year, then the trade would lose money. While this is cer-
tainly not impossible in a volatile market such as India, it is 10
more likely in our opinion that the 5year rises by a factor of
5
50-75% of the 1year, as it has done recently (see chart 6).
0
Second, the carry and slide on the entire position is flat. A 1y 2y 3y 5y
flat carry and slide will help us overcome what we believe
will be a range trading period over the next few months. Chart 8: 1s5s OIS spread
Chart 7shows that the carry and slide on the 1year is 3 times bp
250
larger than on the 5year. Hence the 3:1 weighting of the 210bp
trade.
200
Third, we like the entry level of the 1s5s steepener, as it 180bp
150
gets us in at a 188bp spread. This is in the low part of the
curve range of 180-220bp that has been in effect for the last
5 months now. See chart 8. 100
Fourth, at this level we enter only into 25% of our desired 50

size. Our aim is to scale up the trade to four times the size,
ie. $120k of 5year risk against $40k of 1year risk. We will 0
alert our readers of additions to our position and the entry Feb-09 May-09 Aug-09 Nov-09
levels as time goes by. Especially if the 5year were to drop
to 6.50%, we would add towards our full size.
The main risk for the trade is a slowdown in RBI rate hike
Targets and risks expectations. It is obvious that the trade is a bet that RBI
tightens in 1Q and puts the market on alert for more. This is
We have said earlier that we expect the curve to rise be- a risk we like taking, especially in the light of our asymmetric
tween 75-175bp sometime next year. To be more specific outlook for OIS in 2010. Paying the 5year with a 1year hedge
about the targets for our trade, we expect the 1year to rise is the ‘cheapest’ Pay trade we were able to find to position
150bp from 4.80% to 6.30% by the middle of the year, in an already steep yield curve.
while we see 5year at 7.50%, up from 6.70% today.
31
JPMorgan Chase Bank Global Asset
Emerging Allocation
Markets Asia Research
Indonesia Indonesia: economic indicators
Average
2003-07 2008 2009f 2010f 2011f
• Surprisingly rocky start to president’s second term Real GDP, % change 5.5 6.1 4.4 5.5 6.0
appears to be smoothing somewhat Consumption* 2.7 3.9 3.8 3.3 3.6
Investment* 2.2 1.5 -0.2 1.6 2.5
• Inflation will rise, but BI can avoid tightening Net trade* 0.6 0.7 0.8 0.7 -0.2
• Both IDR and local bonds to perform well % Dec/Dec 8.2 11.1 2.8 6.4 3.7
WPI - manufacturing, %oya 10.9 25.1 -0.8 5.0 6.2
Government balance, % of GDP 1.1 0.1 -2.4 -2.0 -1.0
The year 2010 needs to be one of substantial progress on Exchange rate, units/$, eop 9172 10900 9404 9300 9700
"de-bottlenecking." Although Indonesia did not suffer a Merchandise trade balance ($ bil.) 24.9 22.9 26.3 28.8 31.4
single quarter of contraction in 2009-highlighting its relative Exports 88.7 139.6 110.3 130.3 153.9
Imports 63.8 116.7 84.0 101.4 122.5
resilience as well as its insulation from the global growth
cycle-its main issue for 2010 will be to build infrastructure to % of GDP 2.0 0.1 1.1 0.8 0.6
increase potential growth toward the government's 7% target
for 2014. For 2010, this should translate into a rebound in Total external debt, ($ bil.) 133.7 144.0 137.1 132.1 127.1
gross fixed capital formation, with investment then being a Short term† 20.7 31.7 22.7 25.7 28.7
material positive for next year's 5.5% GDP growth. Total external debt, % of GDP 42 27 24 20 18
Interest payments, % of exports‡ 5 4 5 5 4
A rocky political start appears to be smoothing out some-
what. President SBY's second term got off to a surprisingly * Contribution to growth of GDP.
† Debt with original maturity of less than one year.
rocky start, diverting focus from the economic agenda. The
‡ Exports of goods, services, and net transfers.
question going for 2010 is whether the impressive technocrat
team, led by Vice President Boediono and Finance Minister Indonesia: CPI history and forecast
Sri Mulyani with new players like Kuntoro Mangkusubroto, %oya
will get the political backing to execute their agenda. If not,
the market will be resigned to seeing Indonesia remain stuck 14
in a low-growth, high-inflation equilibrium. 12
10
Inflation will no doubt rise in 2010, but that does not mean
8
Bank Indonesia will have to raise its policy rate. A combina-
tion of base effects and delayed increases in administered 6
prices will cause headline inflation to rise to the high side of 4
BI's 4-6% range. However, a credible policy framework and a
2
strong currency prompt us to go against market consensus; 2007 2008 2009 2010 2011
thus we do not expect BI to be among the early tighteners in
Asia. Indeed, J.P. Morgan stands alone among foreign Official budget projections under old oil assumption of $65/barrel
houses in forecasting no rate hikes from BI this year (though 2009 2010
we note that some local forecasters share our view). IDR tn % GDP IDR tn % GDP
Total Revenue 871.0 16.1% 949.7 0.2
Our projection of a 2010 fiscal deficit of 2% of GDP is con- Total Expenditure 1,000.8 18.5% 1,047.7 0.2
sistent with an aggressive but reasonable financing plan. o/w Subsidies 99.3
Even though the implied amount of gross domestic issuance Deficit (129.8) -2.4% (98.0) (0.0)
will rise next year, there are now sufficient sources of demand Financing 129.8 2.4% 98.0 0.0
for the plan to be executed without too much difficulty. The a.Non - debt 43.3 0.8% 2.5 0.0
real concern for 2010 is whether the government can actually b.Debt 86.6 1.6% 95.6 0.0
spend the allocated budget in a timely and effective way. GSec (Net) 99.3 1.8% 104.4 0.0
Loan (12.7) -0.2% (9.9) (0.0)
IDR to stabilize in 2010 Disbursement 56.3 1.0% 49.0 0.0
We expect the USD/IDR decline to continue into the first half '- Program Loan 30.3 0.6% 24.4 0.0
of 2010. Having collapsed from a 12,000 peak in Feb-2009 to '- Project Loan 26.0 0.5% 24.5 0.0
9,400 end-2009, we expect follow through rupiah buying to Repayment (69.0) -1.3% (58.8) (0.0)
take spot towards 9,000 in 1Q 2010. Our revised point forecast Domestic Loan 1.0 0.0
32
Yen Ping Ho (65) 6882-2216

projects a 8,800 floor by end Q2 2010, though momentum Deficit financing plan: Sources and uses
may well take spot to lower absolute lows. We are short 2009 2010
USD/IDR going into 2010. Under old
Budget (IDR
assumptions
tn)
The combination attractive carry, declining financial and (IDR tn)
economic volatility, G3 central banks firmly on hold and
Deficit (129.8) (98.0)
conducive EM backdrop should work favorably for IDR.
Domestically, the political “Dream Team” places economic Maturing debt (113.9) (129.5)
management in good hands over the current political and Bond + Buyback* (45.5) (70.6)
economic cycle, even as more may be desired in longer-term Loan (68.4) (58.8)
reforms. Confidence in the currency has risen in response, Financing Requirement (243.7) (227.5)
evidenced by reverse currency substitution by locals and an
Sources 243.7 227.5
increase in rupiah deposits by non-residents.
Non Debt 43.3 2.5
Risks of capital controls are overblown. While much had Debt 200.4 225.0
been made over discussions to restrict foreign holdings of Loan 55.9 50.0
SBIs, the issue relates more to refining the system of Program Loan 29.9 24.4
monetary operations than any fundamental opposition to Project Loan 26.0 24.5
capital inflows. In contrary to other EM central banks that Domestic Loan 1.0
are fighting local currency appreciation or imposing capital Security 144.6 175.1
curbs, Bank Indonesia has been selling USD/IDR to support Domestic issuance 97.8 130.1
the local currency, with IDR strength seen as a offset against Foreign Issuance 46.8 45.0
inflation risks. Policymakers have also stressed foreign
capital to be integral to finance investments needed to Chart 1: Indonesia government bond positions by investor-type
achieve longer-term growth targets. (overweight vs. underweight, on a scale of -10 to +10, as surveyed by JPM
on a monthly basis)
Early Fed tightening is a risk to this view. Carry-dependent 6
IDR typically underperforms during Fed tightening cycles. 5
This suggests the IDR rally will likely fade in H2 when Fed 4
tightening becomes an increasing risk, with risks of an earlier 3
peak should the Fed moves earlier-than-expected. However, 2
we expect the Fed to be on hold for the rest of 2010. 1
0
Local bonds to perform well in 1H -1
• A combination of strong Asian growth and sluggish G3 -2
economies should keep global investors buying high-yield- Jan-06 Oct-06 Jul-07 Apr-08 Jan-09 Oct-09
ing, risky assets in Asia. Dedicated EM Crossover Trading
•Government bonds have rallied mainly in the 1-7yr sector.

Tail risks for bonds have diminished
We see upside for the 10-15yr sector rater than short tenors.
In December, the bond market was worried about a variety
•We expect no tightening this year as we believe BI will of tail risks, but these risks have now diminished in our
control expectations even as CPI rises temporarily. This view. First, while concern that BI would impose restrictions
contrasts with consensus view of 50-75bp of tightening. on foreign ownership of SBI’s has not disappreaed, it has
decreased as BI seems to have backtracked on its aggres-
•Second, our investor survey (chart below) shows foreign sive stance. Second, the Bank Century scandal story has
investors are not overly long on their Indonesia bond posi- lost traction as the government has gotten the upper hand
tions. We expect more foreign investors to add to their posi- in the debate with the opposition. Finally, new tax regula-
tions this year. This also contrasts consensus view. tions for offshore bond holders took effect on January 1.
The market feared that many offshore holders would sell
•These forecasts, coupled with a rising rupiah and stock their positions ahead of the effective date, but this has not
market make us believe that 10-year government bonds can happened. In our view, this means that the majority of in-
trade in the 8.5%-9% range. Consequently, we would over- vestors are confident that they will get the necessary paper-
weight Indonesia in a portfolio of Asian local market debt. work in order to continue to benefit from the double tax
33
treaty, or that they take a possible higher tax bill in stride Chart 2: Indonesia 10year govenment bond yield: Back to the lows
and see it as a necessary cost of being involved in a high
%
yielding bond market.
20
Non-consensus call #1: We see no rate 18
hike from BI in 2010
16
We forecast no rate hikes in 2010. This is in line with BI’s
own forecast, but different from the market consensus. Re- 14
cently BI has started to communicate to the market that they 12

see the current monetary policy as sufficient to last the en-
10
tire year, ie. that a 6.5% policy rate is enough to keep infla-
tion and, importantly, inflation expectations under control. 8
The base effect may well bring up headline CPI from 2.8% Jul-03 Jul-04 Jul-05 Jul-06 Jul-07 Jul-08 Jul-09
now to the top of BI’s 4%-6% target band this year, how-
ever the base effect will be temporary and CPI will drift
down from there. Moreorever, BI has repeatedly stated it
will use the exchange rate to keep inflation and expectations Chart 3: Weighted average Indonesia govenment bond positions by
investors
in check rather than pursue a pro-growth currency stance at (overweight vs. underweight, on a scale of -10 to +10, as surveyed by JPM
all costs. As a result, we see inflation dipping back down to on a monthly basis)
4% by December. Such a CPI dynamic would relieve BI of
the pressure to tighten from the current 6.5% level. 4.5
4
Many forecasters expect Indonesia to raise rates soon, so
3.5
our call is (much) more doveish than the market. In our
estimate, the consensus for BI policy is for 50 to 75bp worth 3
of hikes this year, with foreign houses on the more hawkish 2.5
side, while domestic houses are on the doveish side. The 2
trend is towards less tightening rather than more, as espe- 1.5
cially domestic houses have reduced their tightening fore-
1
casts. If, as is increasingly likely, SBY will decide not to hike
0.5
fuel prices this year, we expect the majority of economists
to start moving to the more doveish side of the range of 0
forecasts, if not scrap their tightening views altogether. Jan-06 Oct-06 Jul-07 Apr-08 Jan-09 Oct-09
“Goldilocks global economy” remains in

effect for Indonesian bonds
Chart 4: Indonesia government bond positions by investor-type
What we like to call a “goldilocks global economy” for In- (overweight vs. underweight, on a scale of -10 to +10, as surveyed by JPM
donesian bonds is again in effect this year. Indonesian on a monthly basis)
bonds perform best in a scenario where Asian economies 6
outperform the rest of the world while considerable slack
5
remains in the G3 economies. In such an environment, glo-
4
bal investors seek risky and high-yielding assets in Asia,
but at the same time global inflation remains benign. This 3
relieves BI of the pressure to raise rates, and allows Indone- 2
sian stocks and the currency to climb, while government 1
bond prices rise in lock-step. 0
-1
The 10year benchmark trades at a 9.3% yield at the mo-
ment. A sub-9% yield is justified if our view of IDR appre- -2
Jan-06 Oct-06 Jul-07 Apr-08 Jan-09 Oct-09
ciation, a gently rising stock market and a BI on hold come
Dedicated EM Crossover Trading
true. For example, if JPM’s forecasts of a 8,800 rupiah, and a
Jakarta Composite Index up by20% for this year come true,
34
the 10year government bond yield should be trading be- Chart 6: Change in government bond yields from Nov-09
tween 8.5% and 9% rather than, say, at 10%. That is what
bp 1y 2y 3y 4y 5y 6y 7y 8y 9y 10y 15y 20y 30y
the historical relationship between bonds, stocks and cur-
rency would imply, barring any shocks from demand and 0
supply, which brings us to... -20
-40
Non-consensus call #2: Foreign positions
in Indonesian bonds are overweight, but -60
not overly so -80
We believe that the commonly held view that foreign inves- -100
tors are overly long Indonesian government bonds is mis- -120
placed. Results from our a proprietary investor survey
-140
show that investors are overweight, but only moderately.
Chart 3 shows how in 2006/2007 investors were almost
double as overweight of Indonesian bonds as now.
Chart 5: 5s10s governemnt bond yield spread
Drilling down into the positioning data, we see that ‘trading
bp
accounts’ (ie. hedge funds, fast money, ...) are neutral in
their positioning. Chart 4 shows that historically their posi- 150
tions have been fickle. In 2010, we do not expect trading
accounts to be the drivers of Indonesian bonds.
100
On the other hand, dedicated-EM and cross-over real money

accounts will be buyers. We see room for an increase in the 50
dedicated/cross-over positions, especially in the context of
our ‘goldilocks global economy.’ BI success in convincing
the market of its no-hike position will also add interest. 0
Jan-09 Apr-09 Jul-09 Oct-09 Jan-10
10year sector looks attractive to us now -50
that shorter tenors have already rallied
The initial rally this year was concentrated in the sub-7-year
sector, where domestic investors dominate. We think the
next area to outperform is the 10y-to-15y sector as this is
where foreign real money (EM and cross-over) is typically
involved.
would happen again is probably the biggest risk to our
Looking at the shape of the yield curve in chart 6, we see
positive bond call. Because a base effect will push up CPI to
how the 5year outperformed the 10year sector late last
6% by mid-year, there is scope for the market to be jittery.
year. In fact, 5s10s is near its high for many years. That re-
But on balance we believe that BI will succeed in calming
flects how domestic investors are probably more convinced
the markets this year. Success on this front will depend on
of BI’s no-hike policy than foreigners are, at least for the
whether BI can gain “credibility”. Historically this has not
time being. With little upside left now for short dated bonds
been a hallmark of BI, but Indonesia’s technocrats have
(indeed with bills up to one year barely pricing in rate
more credibility than previously. This is true for BI and
hikes), the next sector to look attractive is the 10-to-15year.
SBY’s administration. We note for example how SBY has
created a “de-bottlenecking” cabinet position to try resolve
Main risk to the view is that BI misman- the long-running infrastructure issues that plague Indone-
ages inflation expectations sia (both for prices and growth). We also note that team-
In the past BI has sometimes mismanaged inflation expec- work has increased between BI and the politicians. On bal-
tations, and this had lead to selloffs in bonds. That this ance, this all bodes well for BI this year.
35
Jiwon Lim (82-2) 758-5509 Asia 2010 Outlook
jiwon.c.lim@jpmorgan.com January 15, 2009
Korea South Korea: economic indicators
Average
2003-07 2008 2009 2010f 2011f
• Real GDP growth is expected to moderate on a sequential Real GDP, % change 4.3 2.2 0.2 5.4 4.1
basis Consumption* 2.1 1.1 1.1 2.7 2.7
Investment* 1.2 0.1 -4.5 3.2 1.9
• Fixed investment to strengthen, where as inventory cycle Net trade* 1.0 1.1 3.5 -0.5 -0.5
and fiscal spending turn less supportive
% Dec/Dec 3.0 4.1 2.7 3.5 3.5
• Imports to rise firmly, possibly outpacing export growth, Producer prices, %oya 2.5 8.6 -0.2 3.1 3.5
Government balance, % of GDP 1.4 1.3 -2.7 -1.5 -0.5
which will lead to a narrower trade surplus
Exchange rate, units/$, eop 1021 1260 1130 1150 1150
• BoK’s tightening will be modest in 2010 Merchandise trade balance ($ bil.) 29.7 6.0 56.2 36.2 21.6
Exports 291.0 433.4 379.7 438.1 496.3
Imports 261.3 427.4 323.6 401.8 474.7
Current account balance 14.5 -5.3 45.1 21.3 6.3
% of GDP 1.7 -0.6 5.3 2.1 0.6
After a sharp contraction in 4Q08, Korea saw a robust recov-
ery since early last year. We forecasted that real GDP would Total external debt, ($ bil.) 232.0 381.2 372.2 373.7 380.7
increase 0.2%y/y in 2009, followed by 5.4% gain in 2010. The Short term† 89.4 150.3 137.3 132.8 134.8
full-year 2010 growth was still boosted by favorable base Total external debt, % of GDP 25 41 45 37 36
effect. On a seasonally adjusted quarter-on-quarter basis, Total external debt, % of exports‡ 59 72 83 72 65
Interest payments, % of exports‡ 3.4 3.2 2.6 2.2 2.1
real GDP growth seems to have peaked at 13.2%q/q, saar in
3Q09, expected to moderate for now to settle around its po- * Contribution to growth of GDP.
tential growth (chart 1). Private sector will need to take more † Debt with original maturity of less than one year.
of the growth leadership as the inventory cycle and policy ‡ Exports of goods, services, and net transfers.
support fade gradually. Among all, business investment will

expand its contribution to GDP gain most in 2010. Chart I: Korea's real GDP
% change, annualized
Growth leadership to rotate 20
From previous quarter
Policy stimulus and the inventory cycle were the main drivers
10
of the recovery. Given a historically healthy fiscal position,
Korea was able to come up with an aggressive stimulus pack- 0
age in 2009, having few time lags for actual implementation.
The Bank of Korea too reduced the policy rate significantly -10 From previous year
by 325bp, of which effectiveness was enhanced by Korea’s
micro-level loan structures that more than 90% of household -20
2005 2006 2007 2008 2009 2010
loans are paying floating interest rates. Korea’s inventory
cycle has progressed faster than in many other economies, Source: J.P. Morgan
with producers’ inventory ratio to shipment down to histori-
cal low levels before midyear.
Chart II: central government's fiscal balance
In 2010, those factors will retreat if gradually. According to
% of nominal GDP
the government proposal for 2010 budget, Korea aims to re-
duce the central government deficit by won 20 trillion (or 2% 4
of GDP) via about 3.2% cuts in fiscal spending and modest Consolidated
2
tax increase for high-income households and larger-sized
companies. To be sure, the government plans to allocate 0
about 70% of 2010 fiscal spending to the first half, keeping
its policy supportive throughout 1H. Also, history suggests -2
that the accelerated pace of spending is often followed by a -4 Excluding social security funds
supplementary budget issuance later in the same fiscal year.
Yet, we still do not expect the supplementary budget would -6
00 02 04 06 08 10
be large enough to keep overall fiscal policy in 2010 more
2010 fuscal position is J.P.Morgan’s forecast, assuming that the government will issue a supplementary
expansionary than in 2009. The Bank of Korea too has un- budget
wound most of its unconventional policy easing, while guid-
36
ing its comment to have hawkish bias. Finally, historically Chart III: business equipment investment
low level of producers’ inventory ratio would be positive of %q/q, sa, 2qma Average growth rate
output activity for now, but still less so than in 2009 unless 1991-96 : 2.6%q/q, sa
final demand firms up strongly further from here, as Korean 16
2001-07 : 0.9%q/q, sa
manufacturers have already resumed their inventory re- 8
stocking since 3Q09.
0
Providing some offsets would be private sector’s activity -8
that shows signs of recovery. Among all, the role of busi-
ness investment will be most notable. Structurally, Korean -16
companies were conservative in their investment decisions -24
even before the recent global financial crisis, which was the 90 92 94 96 98 00 02 04 06 08
key reason for the drop in potential GDP growth over the
past several years (chart III). The corporate sector’s Chart IV: domestic machinery orders excluding vessels
deleveraging since the currency crisis in the late 1990’s and trillion won, 2005 price, sa
the government policies that were relatively less business 3
friendly were the main reasons. Now, the policy environ-
ment seems to be changing slowly since the current govern-
2 Private
ment took office in 2008, potentially encouraging invest-
ment amid a rising need for capital replacement. Cyclically
as well, business caution seems to have been lifting. Vari- 1
ous surveys show that corporate confidence has returned Public
to pre-global crisis levels already, with the index of invest-
0
ment plan moving higher for eleven consecutive months. 2007 2008 2009
Domestic machinery orders, a key leading indicator of
equipment investment, have also turned up since 2Q, with Chart V: export volumes
recent strength more driven by private sector’s orders 2008 =100
(chart IV). Public companies’ investment would also be
110
more active; Given that the official fiscal spending will be Korea
constrained by the supervision of the National Assembly 100
who aims to reduce the deficit gradually, the government 90
will rely on off-budget activity more, encouraging invest- Taiwan
80
ment by public companies
70
Japan
Country-specific factors turning less posi- 60
tive 50
2007 2008 2009
Korea’s exports outperformed their tech competitors in
2009, with export volumes having recovered pre-crisis peak orders had peaked in late 2007, suggesting that shipbuild-
already (chart V). This owed to series of country-specific ing sector’s exports may approach their peak. To be sure,
factors, which are expected to turn less favorably in 2010: the vessel delivery schedule in 2010 is still slightly higher
than in 2009, but risks have been increasing that vessel
• KRW weakness: A traded-weighted KRW depreciated construction and delivery will be delayed or even can-
sharply earlier this year, outweighed by global risk averse celed due to the financial difficulties of key shipping com-
and heightened concern over Korea’s fx debt insolvency. panies (chart VI).
Much of this weakness has been unwound since late
March, but not fully as yet to help Korean exporters to • Auto incentives: Korea also benefited tax incentives for
expand their market shares amid global demand weakness, auto purchase at home and abroad. Those benefits are
notably in automobiles and high-tech industries. supposed to terminate in many of Korea’s trading part-
ners by end-2009 although some countries are reported to
• Shipbuilding industry’s backlog orders: Vessel exports discuss the extension of tax benefits for new car pur-
stayed relatively robust on the back of elevated level of chase. In Korea, auto industry comprises about 8.0% of
backlog orders. Given that it takes about 3 years to con- Korea’s exports and 2.3% of its GDP, even excluding the
struct a vessel, Korea still works on the ordes received sector’s chain effect on the related industries.
some years ago. However, it should be noted that vessel
37
Trade surplus to decline Chart VI: Korean shipbuilders' vessel delivery schedule
Million CGTs, estimated/forecast by Clarkson
The trade balance continues to be in surplus, but after con-
trolling for seasonal factors and monthly volatility, the trade 24
surplus likely already peaked in mid-2009. In 2010, trade sur-
18
plus would keep declining although not enough to dip into
negative territory unless global oil prices beat our expecta- 12
tions. In volume terms, history suggests that investment-
driven recovery often reduces the contribution of net trade 6
to overall GDP gain with more than 30% of Korea’s total
imports are capital good-related. To be sure, exports should 0
remain firm on the back of global demand recovery, but 2005 2006 2007 2008 2009 2010 2011 2012
country-specific factors will provide some offset, making Chart VII: outstanding amount of forward contract
any export gain less impressive. Price effect is unlikely to be US$ bn
positive as import prices tend to rise faster than export
prices in a global recovery phase, making deterioration of 150
Same pace of hedging
trade balance even more notable in nominal terms. as in 2003-04
120
Hedging flows and its implications for BoP 90

and currency outlook
Same pace of hedging as in 1H09
Note also that not all of this trade surplus will translate into 60
actual USD supply in onshore FX markets. Korean ship- No further hedging from 4Q09
builders have sold much of their future export proceeds al- 30
2007 2008 2009 2010
ready, borrowing USD from banks via swap contracts, to
hedge FX risks. Theoretically, the arrival of previously
hedged export flows is supposed to reduce overseas bor- The Bank of Korea’s tightening likely to be
rowing, reflected in the capital account. Exporters should modest
repay hedge-related USD obligations to banks once actual Bank of Korea Governor Lee has been among the leading
export revenue arrives, so that banks can repay their over- voices in EM Asia signaling to the market that a normaliza-
seas borrowing. tion of monetary policy could commence in the region
ahead of any change in Fed policy. Indeed, the BoK has
Based on Bank of Korea data on hedging flows and our unwounded most of its unconventional measures already,
own estimate of maturity schedules, we estimate that $15-25 keeping its comments hawkish to support J.P. Morgan’s
billion of export proceeds have already been sold in FX mar- view that the Bank of Korea will hike 25bp later this quarter.
kets (chart VII). Given that the service balance has stayed in
deficit for a long time with little expectation of any near-term However, prospective tightening will still likely be modest,
improvement, a smaller surplus in the trade account, to- limiting tightening to 50bp, for several reasons. First, the
gether with previous hedging flows, suggests that KRW BoK remains complacent of overall inflation outlook, with
appreciation will be limited in 2010 unless the portfolio bal- output gap likely to stay negative most of this year. Second,
ance improves significantly (see “Korea’s trade surplus housing prices took the BoK’s focus, but micro-level regula-
narrows as global economy recovers,” Nov 6, 2009). tions have so far successfully controlled real estate asset
prices. Third, potential impact of local interest rate changes
Headline inflation creeps higher on KRW strength will be noted. To be sure, the correlation
Demand side pressures remained subdued throughout 2009, between Korea’s monetary tightening and its currency
making KRW and global oil prices move as the key drivers value has stayed low as foreigners’ ownership in local bond
of Korea’s inflation dynamic. Such cost-push factors will market still remains less 10% of total public sector bonds,
keep outweighing in 2010, while relatively less favorable and much of bond investment is fx-hedged. However, in
base effect will place the over-year-ago inflation at higher recent months, non-fx hedged bond investment has been
levels. Still, headline inflation is expected to stay in the cen- rising, with the US Fed’s low-for-long interest rate policy
tral bank’s target band of 3.0%±1.0-pt, if we are correct in stance keeping alive the expectation of global USD weak-
forecasting that a trade-weighted KRW would strengthen in ness. Finally and not least importantly, the imminent change
1H, albeit followed by some payback in 2H, and global oil in leadership at the BoK and the government’s apparent
prices would see only a modest rise in 2010. opposition to more aggressive action will also matter.
38
Yen Ping Ho (65) 6882-2216

Risks for accelerated KRW appreciation Chart 1: Korea portfolio flows led by 2yr yield differentials
JPMorgan expects the KRW to strengthen and peak at Portfolio balance USDmn
8,000 4.00
1,100 against the USD by end 3Q 2010 and then stabilize at 2yr Korea - US bond yield spread led by 9 months
6,000 3.50
USD/KRW 1,120 by year-end. We concede that there are
clear risks to this view with the market consensus somewhat 4,000 3.00
more bullish with a comparable year-end forecast of 1080. 2.50
2,000
Our more measured KRW view is based on a conservative 2.00
GDP forecast for 5.4% in 2010 and a narrower current -
1.50
account surplus of 2.1% of GDP compared with 5.3% in 2009. (2,000)
1.00
(4,000) 0.50
Nevertheless, this conservative forecast could be
superseded by capital inflows that could drive USD/KRW (6,000) -
toward 900. (8,000) (0.50)
Oct-01 Oct-02 Oct-03 Oct-04 Oct-05 Oct-06 Oct-07 Oct-08 Oct-09 Oct-10
Indeed, the correlation between Korea’s portfolio balance
and 2yr Korea-US bondspreads with an 9-month lead is as
high as 61% over the past 10 years. In addition, we expect Chart 2: 3year Bond-swap spread have rallied as there has been
the BoK to raise policy rates by 50bps this year, while the consistent demand for KTB for FX gain and reserve diverification
Fed is expected to be on hold. This should continue to drive from aborad
bp
a wedge between US and Korean interest rates and drive
900 10
further portfolio inflows into Korea with concomitant risks
3y KTB - IRS
for KRW strengthening. 1000 -10
In many respects, KRW remains Asia’s most pro-cyclical 1100

-30
currency which reflects the fact that its top ten industrial 1200
categories make up 80% of Korea’s total exports. This -50
combination of trade openness and export concentration 1300 USD/KRW
industrial products means KRW will be a leveraged play on -70
1400
upside ‘V’ shape recovery risks. This appreciation pressure
and expectation is already becoming evident with the NDF 1500Nov -08 Feb-09 May -09 Aug-09 Nov -09 -90
curve steepening significantly for the first time since 2004 –
1600 -110
an indication that the market expects that pace of KRW
appreciation to accelerate in the near-term.
1Q bull steepening and swap spread rally

Outright: After last week’s decision by the government to
start attending MPC meetings, the odds for rate hikes this cause (1) foreign inflows into KTBs continue (see chart 2),
year have decreased significantly. We believe short end and as (2) swaps continue to serve as a hedging instrument
yields will drop quite sharply in the weeks ahead as the mar- for an increasing number of players. We enter a long KTB
ket takes this new reality into account. We receive 2y swaps futures vs swap position at -25bp, while we take profit on
and buy 2y MSBs for a 30-40bp gain. our outstanding long 2year MSB-swap spread position.
Curve: If BoK does not normalize rates this year, it will have The currency basis richened sharply last month. E.g. the 2y
to tighten more later, and faster. Our favourite way to ex- basis moved from -185bp to -100bp. We see the basis richen
press that trade is in a 2s5s IRS steepener, which we believe further. But this is not because of more demand for asset
can reach its historic high of 60bp. swapped MSBs. Instead, the next leg will come from liability
swapping, although flows do not seem to be significant as
Swap spreads have already richened in the last few months, yet. In any case, we stay paid in our 2y basis recommenda-
but they will richen further as KTBs outperform swaps be- tion.
39
James DH Lee (82-2) 758-5512 Asia 2010 Outlook
james.dh.lee@jpmorgan.com January 15, 2009
JPMorgan Chase Bank
Bert Gochet (852) 2800-8325
BoK to hike far less in 2010 than expected two days). In other words, 2010 looks like another year with
After the dramatic events of last week, when MoSF an- large MSB supply for sterilization purposes. However the
nounced it will attend the BoK’s MPC meeting from now fact that Korea mops up liquidity with rather long tenors (of
on, the tension between MOSF and BOK regarding mon- up two 2year) has had some upward effect on 1 and 2year
etary policy came out into the open. Although Governor Lee bond yields (and hence the bond curve is steeper than the
is expected to hike once before he bows out his term in swaps curve in that segment). Despite some increase in
March, the chances have increased that the next Governor supply, we also see a strong source of demand. We believe
will be government friendly and therefore relatively dovish. that especially banks are still rather light in their MSB posi-
As of Friday last week, we changed our official forecast to tions. Over time, as BoK’s more dovish stance will become
only two hikes for the entire year. clear, banks will find it more attractive to buy 1-to-2-year
MSBs for carry.
We believe that the possibility of “fundamentals” forcing
the BoK’s hand to hike is low for now. CPI may continue to KTB supply burdensome for long end, not
rise, but BoK rarely tightens for inflation alone. In any case, for short end
our forecast is for CPI to rise modestly and not break the KTB issuance is looking rather burdensome in 2010, with
new widened band. In addition, housing prices have stabi- the 10 and 20year buckets seeing the largest increase this
lized, as administrative measures seem to have taken an ef- year.
fect.
We estimate MoSF to gross issue W77 tn of KTBs this
Far too much tightening priced in year (based on the fact that MoSF intends to auction W6.4
The front end of the curve is too high and too steep, if you tn in January 2009). That is down from last year’s W85.5 tn
assume that only 2 hikes will be delivered this year. We (including the issuance increase from the extra budget).
believe there is significant value in both receiving short With W29.7 tn maturing and W12 tn expected to be bought
dated swaps and buying short dated bonds. The chart back in 2010, net issuance remains rather burdensome at
shows that swaps price in 160bp of tightening for this year, W35.3 tn. That is only a W5 tn decrease from the previous
and MSBs a whopping 250bp. year (see table 1). The issuance composition per tenor is
likely to see some change compared to last year, as the Fi-
Chart 3: Policy rate forwards based on MSB and IRS curves nance Ministry has already hinted at. Last year, the govern-
ment reduced the issuance proportion in the longer tenors
at the cost of an increase in the shorter ones. This helped
absorb the large increase in supply. However, we estimate
5.0 that this year MoSF will try to normalize the issuance pro-
4.5 portion in each tenor back to the 2008 level (see table 2).
That means more issuance pressure in the 10- and 20-yr
4.0 tenors, as gross issuance there will likely increase about
3.5 20% compared to 2009.
3.0
2.5
2.0
Jan-10 Apr-10 Jul-10 Oct-10 Jan-11
Priced in by MSB Priced in by IRS
MSB supply to be on high side, but banks’

balance sheet is light
MSB issuance is expected to be significant this year, how-
ever sources of demand are also expected to be strong,
probably offsetting each other. As we have seen during the
first week of the year, there was strong intervention in the
currency (some sources estimating $3bn worth in the first
40
JPMorgan Chase Bank
Bert Gochet (852) 2800-8325
Table 1: Issuance of Korea Treasury Bonds Hence we are not too bullish on the belly of the curve.
Trade #3: Therefore, from a pure “fundamental perspec-

KRW trillion, calendar y ear
tive”, we like a steepener in the front-to-belly of the IRS
2004 2005 2006 2007 2008 2009 2010f
curve, such as in 2s5s. Now at 45bp, there is room for 2s5s
Gross bond issuance 56.0 62.6 60.7 48.3 52.1 85.0 77.0
to reach its historical high of 60bp, as we expect the mis-
(% of GDP) 7.2 7.7 7.2 5.4 4.5 8.9 7.0
match between what BoK “will do” and what BoK “needs to
(% of outstanding) 45.5 36.7 29.4 21.2 21.8 30.2 0.2
do” to grow as time passes.
(US$ billion) 54.1 61.9 65.3 51.6 41.3 75.2 67.0
Term debt maturing 9.4 8.8 18.6 20.1 26.8 30.9 29.7
What about last year’s popular CD range accrual notes and
Buy back/Sw itch 5.0 6.3 5.4 7.6 12.7 13.5 12.0
its flattening impact on the IRS curve? Will the flow and
Net bond issuance 41.6 47.5 36.7 20.6 12.6 40.6 35.3
its associated hedging activities continue? At the moment,
(% of GDP) 5.0 5.5 4.0 2.1 1.2 3.9 3.2
the hedging flows of structured notes are rather light to
(% of outstanding) 33.8 27.9 17.7 9.1 5.3 14.5 11.2
non-existent. If the flow of notes gets re-activated, this
(US$ billion) 40.2 47.0 39.5 22.0 10.0 35.9 30.7 would definitely have a flattening impact on the long end of
Outstanding debt 123.1 170.5 206.8 227.4 239.3 279.9 315.2 swap curve. But it would be the 10year that gets impacted
(% of GDP) 14.9 19.7 22.8 23.3 23.4 27.2 28.7 the most, and the 5year to a lesser extent. Having said that,
(US$ billion) 118.9 168.5 222.4 242.9 190.0 247.7 274.1 we are willing to risk paying the 2s5s at this stage, as we do
So urce: M inistry o f Strategy and Finance, B o ndweb, J.P .M o rgan not yet see a new flow of notes. It is hard to figure out
whether the flow will pick up in 1Q, as it depends on the
Table 2: KTB issuance compositions view of investors on BoK. The current slowdown in note
buying could be due to a seasonal effect (ie. few buyers at
the end of the year), or to recently the coupons that were
Actual Previous Target Target Actual Forecast rather low (6.5% rather than above 7%), or generally that
2008 2009 Sep-Dec 2009 2009 2010 clients were full on their risk limits, or to a combination of all
3-y r 26.0% 30-40% 25-30% 33.2% 20-30% these factors.
5-y r 39.6% 35-45% 35-40% 38.6% 35-45%
Chart 4: Korea IRS 2s5s
10-y r* 24.9% 10-25% 20-30% 18.7% 20-30%
20-y r 9.5% 5-10% 5-15% 9.5% 10-15%
* Including 10-yr KTB i in 2008, no issuance afterwards bp
70
Bullish short end: buy 2y MSB, receive 2y 60
IRS 50
Trade #1: We recommend buying 2year MSB, with a target 40
of 3.90% (from the current 4.30%). In November, we 30
wrote a note (“The value in 2year MSB”) estimating the fair
20
value of 2year MSB. At that time, we saw fair value at
4.05%, by assuming 100bp of hikes in 2010. But since we 10
now forecast 50bp less of hikes for the year, the fair value 0
has dropped by 25bp to 3.80%. Having said that, we want to Jan-09 Apr-09 Jul-09 Oct-09 Jan-10
increase our yield target by 10bp because of the increase in
MSB issuance that we expect. In all, we set our 2year MSB
target at 3.90%.
Trade #2: We also recommend receiving 2year swap at Bond-IRS spreads to structurally richen
4.13%. As we lay out further in the note, we do not expect further
swap rates to drop as much as bond yields. We see 2y IRS In the last few months, bond-IRS spreads have risen
at 3.85%. strongly, in some tenors to multi-year highs. But there is
reason to believe that spreads will continue to rise.
Curve is too flat, especially swap curve
In Korea’s case, we believe that a delay in hikes in 2010
only stores up more pressure to hike rates for the future.
41
JPMorgan Chase Bank
Bert Gochet (852) 2800-8325
IRS at -45bp, targeting -20bp. We still like the direction of

the trade, to be honest, but would still unwind this particu-
Chart 5: 3year IRS-KTB spread versus KRW FX lar trade while at the same time re-instigating the same
richening view at a different point on the curve.
bp
1600 -110 Trade #5: Buy KTB futures vs pay a 17Mar10 forward
start 3year IRS at -25bp. The reasons why we now prefer to
1500 -90 be in the futures (~3year) sector for this trade rather than in
USD/KRW
1400 2year MSBs are (1) futures are undervalued by 36 ticks at
-70
1300 the moment and will guarantee 12bp of outperformance vs.
-50 bonds by mid-March; (2) bonds will outperform swaps as
1200
-30
per the above comments; (3) we like the three-year sector
1100 for this trade as supply impact of MSB may hit shorter
1000 3y IRS - KTB -10 bonds, while supply impact of KTBs may hit longer bonds.
At the same time, 3year KTBs will be among the bonds to
900 10
benefit from any foreign investment for currency apprecia-
Nov-08 Feb-09 May-09 Aug-09 Nov-09
tion or for reserve diversification purposes. It is hard to set
a target for this kind of trade, and we will refrain from doing
so for now, but we certainly hope to make 20-25bp on this
trade just as we did on the MSB-IRS trade.
Chart 5 shows what we intuitively have come to realize over
the last few months: as the Won strengthens, more foreign Chart 6: Long term history of 3year KTB-swap spread
investment occurs in KTBs, and this extra demand trans-
lates in a bond outperformance (ie. lower in yield) versus
swaps. bp
100
As the Won is once again one of the investors’ favorite 75
currencies to own in Asia, bond-IRS spreads should there- 50
fore continue to richen. JP Morgan’s FX strategist Claudio
25
Piron calls the KRW one of his top picks for appreciation in
2010. As Korea’s bond market is fully open and KTBs are 0
not taxed, we see no reason why this demand for the cur- -25
rency will not continue to translate in strong bond demand -50
from abroad as well. -75
-100
But the bond-swap spread richening also reflects another Jan-01 Jul-02 Jan-04 Jul-05 Jan-07 Jul-08 Jan-10
dynamic, namely that there has been an increase of players
who use swaps as a hedge for their bond portfolio. We mean
in particular securities houses. They used to use only fu-
tures to hedge KTBs. But futures suffer from a persistent
undervaluation in bear markets, and in addition there is only
one futures point on the curve (3y). This is increasingly
leading to new players paying in IRS, most notably in the
sub-5year tenors.
Eventually, such a strong demand for KTBs from abroad,

versus an increasing number of swap payers may lead to a
“normalization” of swap spreads (ie. swap rates above bond
yields). It is too early to tell whether we will see a full nor-
malization of spreads, but certainly the odds are rising for
this to happen.
Trade #4: Take profit on 2year MSB-IRS spread trade.

Back in November, we recommended going long 2y MSB vs
42
JPMorgan Chase Bank
Bert Gochet (852) 2800-8325
Chart 7: Undervaluation of the 3year KTB futures contract Chart 8: Korea currency basis curve moved up sharply since
December
Ticks
bp
20 0
10 Mar-09 contract -25 1y 2y 3y 4y 5y 6y 7y 8y 9y 10y
Dec-09 contract
0 Sep-09 Contract
-50
-10
Mar-10 contract -75
-20
-30 -100
-40 -125
-50 Jun-09 contract -150
-60
-175
90 80 70 60 50 40 30 20 10 0
-200 1-Dec-09 8-Jan-10
Day s left to maturity
CCS has risen a lot, but momentum and

flows will take it further
The CCS curve has risen fast in the last few weeks as (1)
the market has realized that shipbuilders are in a bad shape
and won't be hedging much going forward; (2) there has
been large interest in the MSB-CCS trade; (3) Korean credit
has rallied in the dollar markets. As a result the very nega-
tive currency basis was reduced sharply.
We continue to see upside in the basis (ie. for it to get less

negative), but the easy money in this trade has probably
been made. First, the "arbitrage" of cross currency-asset
swapping MSBs and buying CDS against is no longer at-
tractive. But it may have a few (10-15bp) in it, especially if
Korean sovereign spreads tighten in further. Second, the
future of the spread will be decided by investors’ asset
swapping USD bonds, or by corporates liability hedging
USD issuance. For now, we believe the second category will
dominate. In a previous research note, we have highlighted
the need for credit card companies to issue, and as USD
credit spreads become attractive we still believe they will
tap the offshore market before swapping the proceeds back
into KRW.
Trade #6: Stay with the Paid 2y currency basis trade (ie.
pay 2y CCS, rcv 2y IRS). We entered this trade at -185bp in
November targeting -100bp. In fact, we have just reached
that target. But given the momentum and speed of the basis
move, we do not see the need to unwind yet. We move our
target to -75bp for now and may move it up further if our
view on liability swapping proves correct.
43
Malaysia Malaysia: economic indicators
Average
2003-07 2008 2009f 2010f 2011f
• GDP growth to be unimpressive relative to rest of the Real GDP, % change 6.0 4.6 -2.4 5.0 5.1
region, key to outlook is private sector domestic demand Consumption* 4.9 5.7 0.9 2.4 2.7
Investment* 1.0 -0.5 -4.4 6.1 2.5
• BoP to be strong in 2010 as capital inflows to bond market Net trade* 0.1 -0.5 1.2 -3.5 -0.1
return and current account remains in large surplus Consumer prices, %oya 2.2 5.5 0.6 2.2 2.4
% Dec/Dec 2.4 4.4 0.8 2.4 2.4
• BNM to be one of the rgional laggards, both in magnitude Producer prices, %oya 5.4 8.2 -6.0 6.0 5.0
and timing of tightening of monetary cycle Government balance, % of GDP -3.9 -4.8 -7.1 -5.5 -4.5
• Politics to remain a low-level background drag rather than Exchange rate, units/$, eop 3.64 3.46 3.45 3.33 3.00
come front and center as a major event risk Merchandise trade balance ($ bil.) 32.2 51.1 38.5 41.0 46.6
Exports 142.1 199.1 157.4 179.6 203.7
Imports 109.9 148.0 118.9 138.6 157.2
Government spending has supported Malaysia’s economy
% of GDP 14.6 17.5 14.3 13.9 14.8
over the past decade. However, fiscal consolidation has be-
come a necessity given Malaysia’s chronically large deficits International reserves, ($ bil.) 74.2 92.2 97.2 127.2 142.2
Total external debt, ($ bil.) 62.3 62.4 63.4 64.9 64.9
and thus in 2010 private sector investment and consumption Short term† 18.0 24.1 25.1 26.6 26.6
will have to become larger drivers, along with a pickup in ex- Total external debt, % of GDP 43 28 30 27 25
ports, for the economy to expand at a respectable pace. Poli- Total external debt, % of exports‡ 36 25 32 28 25
tics still remains a concern, but PM Najib has consolidated Interest payments, % of exports‡ 1 2 3 3 2
his power to some extent and his popularity has risen. We * Contribution to growth of GDP.
expect political noise to remain a background drag in 2010 † Debt with original maturity of less than one year.
but it is not a major event risk. ‡ Exports of goods, services, and net transfers.
The economy is heading into 2010 on a strong note, but pri-

Malaysia: CPI inflation forecast
vate sector investment remains the weak link. After falling
%oya
hard in 4Q08 and 1Q09, Malaysia has bounced back strongly.
The rebound has been led by consumption, private and gov- 9
ernment, and to a lesser extent exports, while private sector
investment continues to disappoint (as it has been doing 6
since 1997). Heading into 2010, private consumption should
3
continue to expand at a solid pace while exports should ben-
efit from the global upturn. Spending from the second stimu- 0
lus package should slow notably after 1H as fiscal consolida-
tion is a key theme for next year. Thus, key to offsetting the -3
drag from fiscal and for growth more broadly in years to 2005 2006 2007 2008 2009 2010
come will be the degree to which private sector investment
picks up. We maintain our forecast for 5% growth in 2010.
Credit growth slowed throughout most of 2009 as uncer-

tainty about the future reduced loan demand. Interestingly, Inflation is set to return soon, but BNM is unlikely to move
the extension of credit for mortgages was barely affected before mid 2010. Though over-year-ago deflation persists,
while personal and business loan growth slowed more nota- monthly and sequential trend inflation have already re-
bly. Bank reluctance to lend to households and businesses sumed. We expect over-year-ago inflation to average
during the recession undoubtedly played some role. How- around 2.2% in 2010. The rise should not present much con-
ever, the fact that mortgage credit continued to flow sug- cern to BNM as slack in domestic and global labor markets
gests that reduced loan demand, in response to the final de- should keep demand-pull price pressures muted for the fore-
mand shock, rather than a credit crunch within the banking seeable future. Our forecast rise in inflation mostly reflects
system was the main driver. This is not entirely surprising unfavorable base effects. Global commodity and food prices
given that Malaysia’s banking system was severely affected are risks to our regional inflation forecasts, but Malaysia
by the fallout from the global downturn. We would expect has extensive price controls on domestic energy prices and
loan growth to rise from around 7.0% currently back to the many food items, which will keep supply-side pressures
low double-digit pace achieved in 2008 and early 2009. subdued. Moreover, housing prices are not a concern.
44
Thus, with demand-pull inflation pressures subdued, do- Malaysia: capital flows
mestic property prices not a concern, and risks to the US$ bn
growth outlook still present, we expect BNM only to start 10 Portfolio
hiking in 2H10, with two 25bp hikes by year-end. 5
0
The biggest risk to our inflation forecasts surrounds the
-5
potential removal of some food, and possibly even energy,
-10
subsidies in 2010. The government revised its energy sub-
sidy scheme in June 2008, which led to a surge in inflation. -15
The rise this time around would likely be less severe given -20 Financial account
that global oil prices are nowhere near their 2008 peak levels -25
2005 2006 2007 2008 2009
but it would certainly be large. Nonetheless, BNM did not
tighten monetary policy in 2008 in response to transitionary,
Malauysia: official fx reserves and foreign holdings of local bonds
supply-side inflation pressure and we would not expect
them to do so in 2010 either. USD, bn, both scales
40 foreign bond holdings Fx reserves 140

Malaysia consistently runs one of the highest current ac-
count to GDP surpluses in the world, averaging around 30 120
14% since 2002. The 2009 current account surplus nar-
rowed to an estimated 14.3% of GDP from 17.5% in 2008 as 20 100
global demand led to a sharp contraction in exports and as
global energy prices collapsed. Malaysia stands out in the 10 80
region as the only net oil exporter, and LNG and palm oil
also are significant exports. In 2010, we would expect the 0 60
2005 2006 2007 2008 2009
current account surplus to remain around the same size as a
pickup in global demand is offset by strong domestic de-
mand as well.
Malauysia: official fx reserves and currency movement
MYR/USD USD, bn
The larger swing factor for Malaysia’s balance of payment
position in 2010 should be the financial account, which is 3.00 Fx reserves 140
MYR
expected to shift back to modest surplus after two years of
deficit. This reflects greater demand for EM Asian assets 3.25 120
and expectation for MYR appreciation as it is often seen as
a way to play RMB and EM Asian currency appreciation 3.50 100
more broadly. BNM has been one of the more vocal central
banks in the region calling for more effort to shift growth 3.75 80
drivers toward domestic demand, suggesting more tolerance
for MYR appreciation once regional currencies move more 4.00 60
2005 2006 2007 2008 2009
notably. This should raise foreign interest in the bond mar-
ket, which is where most portfolio flows usually go, and FDI
and other flows will likely turn more positive as foreign in-
terest in the Iskandar Development Region rises and as
banks no longer need to repay foreign loans. Thus, with Malaysia: financial account breakdown
another current account surplus and the capital account US$ bn
shifting into the black, we would expect fx reserve accumu- 10 Portfolio
lation to be large next year compared to the decline in fx re-
5
serves in 2008 and only modest rise in 2009.
0
Fiscal consolidation is underway but it still has lots of -5 FDI
room to go. Malaysia announced its 2010 budget last -10
month, forecasting a deficit of 5.6% of GDP next year com- Other
-15
pared to a 7.4% of GDP shortfall this year. Though still
large, the government is moving in the right direction and -20
1Q08 3Q08 1Q09 3Q09
the 5.5% deficit is much smaller than the 7.3% deficit the
45
Yen Ping Ho (65) 6882-2216

market was expecting. More importantly, Prime Minister Indeed, our examination of FX intervention activity suggests
Najib is taking positive first steps toward fiscal consolida- that the Malaysian central bank has been more actively
tion and reform. The narrower deficit reflects a steep drop in intervening against MYR depreciation, rather than MYR
spending, particularly from operational spending and subsi- appreciation relative to its peers over the past five years
dies, while revenues also are forecast to fall in 2010 due in (see: “A measure of intervention bias”, November 17, 2009) .
large part to lower oil revenues from Petronas. Over the me- This bias is also reflected by the fact that MYR depreciated
dium term, reforms that reduce Malaysia’s reliance on oil less than its peers during the global financial crisis. This still
revenues and investment income, which account for around leaves open the issue of whether the MYR can extend its
40% of total revenues, and broaden the tax base are impor- overvaluation. That will depend on commodity prices
tant for sustainable consolidation, as Malaysia is one of the remaining robust and foreign investors returning to
few countries in the region that chronically runs deficits. Malaysia’s local fixed income market. Both are reasonable
One reform currently being touted by the government is a assumptions based on our global growth forecasts and the
goods and services tax that, if passed by parliament, would prospect of Malaysia’s fiscal deficit moderating to 5% of
likely be implemented in a few years. For 2010, Malaysia’s GDP from -7.4% of GDP in 2009.
smaller deficit and fewer redemptions of outstanding debt
should mean that bond issuance falls to around MYR64.5 5-year MGS to outperform
billion from 88.5 billion in 2009. The MGS market suffered in 2009 from large supply and re-
luctant demand, leaving the spread between the 5-yr MGS
The political environment remains pretty sour, with the and OPR at a record high. We expect improved supply/de-
Anwar-led opposition alliance still contesting the ruling mand dynamics and favorable macroeconomic conditions to
UMNO-led BN alliance at every turn. UMNO finally won its be constructive for MGS in 1H10, especially in the 5-yr sec-
first bi-election on the peninsula recently, but this was tor. 5-yr MGS is trading at 3.85%; we expect a move to
hardly a sign of general approval for the party. PM Najib 3.50% by midyear along with our 3.30 USD/MYR forecast to
has made important moves to liberalize some of Malaysia’s return around 7% in the next 6 months. This would make
affirmative action laws and liberalize some service sectors in MGS an outperformer in the region as we do not expect
the economy, which has led to improved popularity ratings. other Asian bond markets to rally much, if at all. Unexpect-
However, difficult decisions to further reform Malaysia’s edly high inflation/tightening expectations and a US Trea-
fiscal problems, liberalize the economy, and reduce corrup- sury sell-off are the biggest risks to this trade.
tion and increase public sector transparency remain.
Anwar’s sodomy trial is currently underway, and most of There are five reasons why we like to own 5year Malaysian
the public believe the charges are politically-motivated. government bonds:
Thus, another conviction on sodomy charges, would not
only lead to greater tension between the opposition alliance First, MGS never recovered from their 1Q09 sell-off. Ma-
and UMNO, but it could also lead to protests and poten- laysian government bonds have performed poorly in 2009,
tially to social unrest. However, outside of this one flash especially if you compare them to other bond markets in
point, we do not expect politics to be a destabilizing or ex- Asia. Chart 1 shows how 5-year MGS sold off 125bp in
plosive issue in 2010. Rather, we expect squabbling and in- March, and have since remained among the cheapest of the
fighting within each alliance, and between the two, to be a region. Only Korean bonds and Thai bonds have done
constant and background drag to policy implementation
and reform.
Chart 1: Asian 5-year government bond yields (rebased on 1-Jan-2009)
bp
MYR contingent on BNM policy 200
150 TH
On first impressions, the MYR does not stand out as a SK
100
compelling appreciation currency for 2010. On a real 50
MA
HK
effective exchange rate basis the currency appears 0 S
overvalued, while monetary conditions also appear relatively TA
G
-50
PH
well balanced not to warrant significant appreciation. -100
v IN
Nevertheless, it is our expectation that real policy rates will -150
be eroded by rising inflation even if we account for our -200

-250
forecast 100bps rate hike to 3% in Malaysian policy rates. ID
-300
This will place some policy bias towards accepting MYR
-350
appreciation. Jan-09 Mar-09 May-09 Jul-09 Sep-09 Nov-09
MA HK SK IN TA ID SG PH TH
46
worse (for BoK fear and supply fear respectively). Chart 2: 3-year and 5-year MGS yields
Second, MGS demand/supply conditions to recover. The %

4.5
poor performance of MGS in 2009 resulted from a crash in Announcement that all issuance to be in the short end
bonds in 1Q. Investors, particularly lifers and the EPF, were
4
spooked by an increase in the deficit and bond supply as
the government announced its second (and much larger)
3.5
stimulus package and raised its deficit forecast to 7.6% of
GDP from an already high 3.6% estimate. Around the same
3
time, the government revised its issuance plan, drastically
reducing the average tenor of auctioned bonds to 5.2 years
2.5
from 8.1 and eliminating all 20-year bond auctions and most
in the 10-year space as well. The bond market eventually
2
adjusted and stabilized, helped by a period of deflation dur-
Jan-09 Mar-09 May-09 Jul-09 Sep-09 Nov-09
ing much of the rest of the year, but it has never recovered.
Chart 2 shows how 3-year and 5-year MGS have essentially
traded in a narrow range for 9 months now.
cially the 5year and up) and equities are priced richer than a
We believe MGS supply/demand conditions will improve in year ago. Thus, these factors along with the EPF’s need to
2010. On the supply side, the release of the 2010 budget adhere to its investment allocation guidelines over the long
and bond issuance calendar last month confirmed our view run suggest that it is safe to say that EPF support to the
that fiscal consolidation and extending the issuance curve bond market will not weaken further in 2010. If anything, it
are a priority. Malaysia is one of the few countries in the will likely rise as investment allocation moves more in line
region that consistently runs fiscal deficits and it has one of with its long term strategic guidelines.
the highest debt to GDP ratios. The government is finally
trying to tackle this problem. A key point from the an- Third, 3. 5-year MGS pricing in too much tightening. Ma-
nouncement was that the fiscal deficit will shrink MYR10 laysia experienced deflation throughout most of 2H09 and
billion in 2010 to around 5.5% of GDP from 7.6% in 2009, the shift to inflation in 2009 should be much more gradual
which along with less maturing debt, will lead we estimate to and the peak should be much lower than elsewhere in the
around 27% less gross issuance of MGS/GII this year. It region. This reflects three important factors. First, Malaysia
also confirmed that more auctions will take place in the long maintains comprehensive food and fuel subsidies. Though
end of the curve, ie. in the 7-year, 10-year, and 20-year sec- some of these subsidies will likely be relaxed or in a few
tors. This will be at the benefit of the 3-year and 5-year sec- cases eliminated this year, we doubt that major changes will
tors which will see much lighter supply. We think over time, take place in the place. This will help to shield domestic
say in the next 3-6 months, the much reduced supply in 3- consumer prices from global food and oil price movements.
year and 5-year will become apparent in prices. In addition, Second, Malaysia’s economic and asset price fundamentals
we note that the number of private placements of MGS/GII do not suggest the need for aggressive or quick tightening.
has been reduced from 8 to 2 this year, a sign that the gov- Capacity utilization rates are low, labor market conditions
ernment is much less concerned with supply in 2010. are still slack, and property prices have not experienced
concerning frothiness as in some other countries. Thus,
On the demand side we see improvements as well. Our un- domestic inflation pressures are unlikely to emerge anytime
derstanding is that in 2009 the EPF (who holds 29% of the soon.
entire MGS market and is therefore the biggest investor in
town) reduced its MGS/GII purchases below its stipulated BNM has traditionally maintained a low policy rate, with
29% of incoming contributions (we even heard that the EPF the OPR never surpassing 3.5% (the monetary policy
was a net seller of MGS in 2009, though we cannot confirm framework shifted from a fixed exchange rate regime in
this). In any event, the EPF clearly did not provide the same July 2005). Since 2005, the economy has averaged growth
support to the bond market in 2009 as it has traditionally. of about 6% per year, which is higher than our 5% forecast
This might have been due to a variety of factors including: this year and the government’s more conservative 2-3%
(1) low bond yields early in 09 (since corrected upwards); estimate. Thus, with growth expected to be lower than its
(2) cheap equity valuations (hence EPF might have in- average in recent years when the Overnight Policy Rate
creased their equities as a share of AUM); (3) wide credit (OPR) was between 2.7% and 3.0% and inflation and prop-
spreads (since corrected downwards). In any case, MGS erty prices expected to be contained, we see no reason for
yields are now more in line with long term averages (espe- BNM to hike anytime soon. Indeed, we are forecasting only
47
two 25bp rate hikes in 2H10, leaving the OPR at 2.50% by Chart 3: 5-year MGS yield versus overnight policy rate
year end.
%
5
Given our benign macroeconomic outlook, we find the 5-
4.5
year MGS yield at 3.80% perplexing given that it is essen-
tially at the same level as in the past, when the OPR was 4
above 3%. Chart 3 shows that the 5-year MGS often traded 3.5
barely above the OPR when it was at 3.50%. In other words, 3
we see little need for 5-year yields to rise because of BNM
2.5
policy expectations. Beyond our own house view, it is
widely expected that BNM will be a laggard in the upcoming 2
regional tightening cycle. 1.5
1
Fourth, the 3-to-5-year sector will increasingly benefit Jun 2004 Jun 2005 Jun 2006 Jun 2007 Jun 2008 Jun 2009
from foreign investment. Compared to other Asian destina- 5y MGS Overnight Policy Rate
tions, Malaysia has seen rather limited incremental foreign
investment into its bills and bonds this year. Of this small Chart 4: 3y fwd 2y bond forward, 5y and 3y yields
amount, T-bills and BNM bills have seen the largest in-
crease in ownership, whereas foreign demand for MGS and %
7
GIIs has been much weaker. As MYR strengthens further, 6.5
and especially when CNY starts to move, we think in 2Q, we 6
expect foreigners to increase their investments in Malaysia 5.5
bonds. Increasingly, investors will be tempted to go out on 5
the curve towards the 3-year and 5-year sector rather than 4.5
stick with the low yielding T-bills they bought last year. 4
Note for example that the 1m to 12m bill curve is roughly flat 3.5
around the 2% OPR rate. 3
2.5
Fifth, from a technical perspective, the 5-year sector is 2
cheaper than the 3-year sector. In chart 4, we have com- Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09
puted an artificial 3y2y MGS forward yield, based on the 3- 5-year 3-year 3y fwd 2y
year and 5-year benchmark bonds. It shows that 5-year
bond at 3.80% is at a good long term entry level now, but
also that the 5-year looks more attractive than the 3-year, at sive change in stance. We are comfortable with our call for
least from a technical perspective. The 3y2y implied yield 50bp tightening in 2H10 and the 175bp cushion that the 5-
can be considered an indicator of absolute value of the 5y year provides over the 2% OPR should it be a bit more.
bond as well as relative value vs the 3y.
US Treasury sell-off would hurt, but not necessarily a lot.
We see fair value of 3.50% for 5year MGS. We see the Obviously a sell-off in US Treasuries would be followed to
neutral 5year MGS yield closer to 3.50% than to 4%. We some extent by MGS. Having said that, in the 2004-2006 pe-
only forecast the OPR to rise to 2.50% in 2010 from 2.00% riod where the Fed tightened 400bp, 5-year MGS held their
currently. If we go back in history, ahead of the only rate own and were unchanged net-net as you can see from chart
hike cycle that we have seen (post the MYR-depeg), the 5. It shows that MGS are one of the least correlated bonds
5year MGS used to trade on average 100bp over the OPR in Asia with US Treasuries.
(see chart 3 again). Assuming the supply situation returns
to normal this year, a spread of 100bp over our year end Foreign investor withdrawal would hurt, but T-bills would
target for the OPR would put the 5year right at 3.50%. suffer more than the 5-year. Reversal in risk-taking senti-
ment toward Malaysia specifically due perhaps to politics is
We see the following risks to owning 5-year MGS: also a risk to this trade. If foreign investors were to flee,
MYR would drop. But currency-sensitive capital is currently
Increased tightening expectations would hurt. The largest parked mostly in T-bills and BNM bills. Therefore, these
risk to this trade would be an increase in tightening expecta- have more to lose. Moreover, a large decline in MYR is not
tion. But as we point out, BNM is expected to be a laggard likely as long as the market expects CNY appreciation. We
as neither growth or inflation conditions warrant an aggres- expect CNY strength this year, and thus interest in MGS
48
Philippines Philippines: economic indicators
Average
2003-07 2008 2009f 2010f 2011f
• Remittances remain a rock supporting growth and Real GDP, % change 5.7 3.8 1.0 5.0 4.3
limiting downside to Philippine assets Consumption* 4.5 3.7 3.6 4.8 4.4
Investment* -1.4 2.4 0.1 3.2 2.0
• May election makes fiscal improvement even more Net trade* 2.7 -2.3 -2.7 -3.0 -2.1
challenging Consumer prices, %oya 5.2 9.3 3.3 5.4 4.9
% Dec/Dec 5.5 8.0 4.4 4.8 4.9
• Emergence of clear front-runner may reduce uncertainty Wholesale prices, %oya 7.9 4.1 -1.0 4.5 5.0
Government balance, % of GDP -2.6 -0.9 -3.7 -3.5 -1.5
Merchandise trade balance ($ bil.) -6.9 -12.6 -9.8 -11.8 -16.1
The year 2010 looks to be a challenging one for the Philip- Exports 42.1 48.2 37.3 41.5 44.9
pines, but an important cushion – remittances – remains Imports 49.0 60.8 47.1 53.3 61.0
firmly in place. As is often the case, growth and inflation Current account balance 3.3 4.2 7.7 6.1 4.0
% of GDP 3.1 2.5 4.6 3.3 1.9
are not likely to be the main concerns for policymakers. In-
stead, the age-old problem of tax collections, combined in International reserves, ($ bil.) 18.6 33.2 38.2 41.7 44.7
2010 with election-related spending, will likely be the focus
Short term† 8.2 8.7 9.0 8.0 9.0
for the market. Total external debt, % of GDP 58 37 37 33 28
Consumption will bend, but not break, driving GDP growth Interest payments, % of exports‡ 5 4 4 6 6
to 5% in 2010. One of the surprising developments in 2009 * Contribution to growth of GDP.
was the unusually choppy spending pattern of the normally † Debt with original maturity of less than one year.
steady Filipino consumer. In 2010, we expect personal con- ‡ Exports of goods, services, and net transfers.
sumption to return to its usual, high-growth path, with re-
mittances growing 6%, and with government spending add- OFW remittances
ing to growth ahead of the May vote. %oya
30
A return to solid GDP growth will only serve to highlight
25 Forecasts
the deficiencies in the tax collection system. Revenues to
GDP are on track to turn in an extremely poor performance 20
in 2009, with total revenues potentially falling to their low-
15
est level in decades (close to 14%). For 2010, our forecast of
a budget deficit of 3% of GDP implies that the revenue ef- 10
fort at least rebounds to its 2005 level. Meanwhile, we are 5
assuming that expenditures continue to climb as a share of 0
GDP. We view the risks to the fiscal forecast as balanced. 02 04 06 08 10
While the government's ability to reverse the trend in tax
collections may be questioned, we note that in previous
presidential election years expenditure as a share of GDP Total revenue
has in fact fallen slightly.
% of GDP Forecasts
What had looked like a very fractured presidential field no 17.5

longer looks so. Not long ago, there was no clear front-run- 17.0
ner. But since the death of former President Aquino and the 16.5
announcement that her son "Noynoy" would run, he has 16.0
become the man to beat. No doubt, the first part of 2010 will 15.5
be filled with unexpected political twists and turns, but what 15.0
is important is that none of the "presidentiables" espouse
14.5
views that could be considered radical, with their economic
14.0
advisers all coming from the mainstream. The key for mar- 99 01 03 05 07 09
kets is that the May 2010 elections are pushed through as
scheduled, as opposed to earlier talks of Charter Change
and possible term extensions.
49
Yen Ping Ho (65) 6882-2216

PHP - Limits to intervention Presidential poll resuts (December)

Estrada
The primary driver behind PHP appreciation in 2010 is
13%
expected to remain remittance inflows. JPMorgan’s year end Villar
2010 target for USD/PHP is 44.70, which compares with the 14% Escudero
12%
12-month NDF outright of 46.70 and the Bloomberg market
consensus of 45.00.
De Castro
An obvious risk to this bullish PHP view is the combination 7%
of underlying fiscal deterioration and political event risk
surrounding the May 2010 national election. Nonetheless, Don't Know
the weight of remittance inflows is expected to support a 2%
current account surplus of 1.6% of GDP and sustain PHP
appreciation. Aquino None
51% 1%
Beyond political risk, there is also the prospect of BSP FX
intervention that provides the greatest obstacle to our
bullish PHP forecast. Indeed, FX reserves registered
USD43.2bn in October, representing a 20% rise on the
previous year and the sharpest pace of accumulation since
August 2008. Additionally, our assessment of Asian central
bank intervention bias suggests the BSP has become the
most guarded against further PHP appreciation as the real
effective exchange rate hovers 10% above its 10yr average
and some 10% below its historical high January 2008.
Nonetheless, BSP intervention does have its limits as

remittance and potential portfolio inflows spillover into
domestic liquidity and money supply growth. The Net
Foreign Asset position of the BSP and of other depository
corporations grew at 20.7 percent and 104.9 percent,
respectively in Q3 on a year-on-year basis. This has yet to
reaccelerate M3 money supply growth from its current level
of 11.6% year-on-year. Nevertheless, sustained intervention
will ultimately prove problematic as sterilization costs and
reserve requirement rate hikes carry their own negative costs
and consequences for economic growth.
50
Singapore Singapore: economic indicators
Average
2003-07 2008 2009f 2010f 2011f
• Growth to rebound strongly in 2010 following the fourth
Real GDP, % change 7.3 1.1 -2.2 6.5 5.0
quarter setback; opening of IRs are key domestic events
Consumption* 1.1 1.7 -0.7 2.0 2.2
• Inflation to rise but not threateningly so; government to Investment* 1.1 10.0 -2.1 1.7 2.6
use regulatroy measures to address property prices Net trade* 5.0 -10.6 0.7 2.8 0.2
• Fiscal and monetary policy stances likely to remain % Dec/Dec 1.7 4.3 0.2 2.9 1.8
largely unchanged Producer prices, %oya 4.4 7.5 -15.0 6.0 6.0
Government balance, % of GDP 8.6 5.0 1.0 2.5 2.5
Singapore’s extremely small size and openness to global Merchandise trade balance ($ bil.) 37.3 30.7 24.1 31.6 22.8
trade and capital flows leaves it most vulnerable in the re- Exports 234.4 343.2 268.7 322.2 358.6
gion to shifts in global growth. Thus, this year’s outlook Imports 197.2 312.5 244.7 290.6 335.8
depends most crucially on foreign demand, and in particu- Current account balance 29.0 27.0 20.6 29.2 22.9
lar, risks stem from G-3 performance. Domestically, continu- % of GDP 23.0 14.8 11.7 14.5 10.3
ation of accommodative fiscal policy and timely opening of International reserves, ($ bil.) 125.2 187.5 202.5 230.5 253.5
two integrated resorts and an Universal Studios theme park
in the first half of the year are key events to watch. * Contribution to growth of GDP.
The violent swings in GDP growth experienced in 2009 are

unlikely to be repeated in 2010. After falling at 16% and
12% annualized paces in 4Q08 and 1Q09, Singapore grew
22% and 14% in 2Q09 and 3Q09. The recently released 4Q Singapore: GDP growth and global GDP growth
Advance estimate suggests that the economy ended the %oya, both scales
Singapore Global
year on a note similarly sour to the one on which it entered, 15 5.0
with a 7% annualized contraction, but it was mostly due to
pharmaceuticals and technical payback. We expect the quar- 10
2.5
terly growth profile to be less volatile in 2010. The large
5
swings over the last year were due to sharp shifts in global 0.0
momentum, which were magnified in Singapore due to the 0
economy’s small size and extreme openness. Global growth -2.5
-5
is expected to be steadier in 2010 due to less powerful in-
ventory swings and fiscal dynamics, and thus Singapore’s -10 -5.0
profile should be as well. 97 99 01 03 05 07 09
Our 6.5% growth forecast in 2010 remains contingent on

global demand, particularly from the G-3, expanding sol-
idly. If the G-3 economies disappoint next year, either with
very weak growth or a “double-dip” recovery scenario,
Singapore’s growth will suffer. On the domestic side, fiscal Singapore: GDP growth
policy should remain accommodative (see below), eliminat-
% change
ing the risk that the government sector becomes a large
25 Q/q saar
drag on growth. On the private sector side, the opening of
20
both integrated resorts and the universal studio park in Oya
15
1H10 should provide a nice boost to growth as well. Gov- 10
ernment estimates of the boost to headline GDP growth 5
from these projects range as high as 1% point. 0
-5
-10
Credit growth has slowed more drastically in Singapore -15
than in most other countries in the region, which has re- -20 4Q Advance Estimate
flected the extreme pain felt by domestic businesses during 2006 2007 2008 2009
51
the multi-quarter recession in 2008 and 2009. Singapore’s Singapore: industrial production
economy is the most open in the region and thus sharp con- %3m/3m saar Total
traction in loan growth during difficult economic times glo- Ex biomedical
75
bally is not unusual. After growing 26%oya in mid-2008,
loan growth in the city-state basically stalled at the end of 50
last year. We expect loan growth to pick up in 2010. How- 25
ever, the composition looks less healthy. Strength has been
concentrated in mortgage lending, particularly in the second 0
half of 2009, in line with the rapid rise in housing values. -25
Consumer loans also continue to expand, albeit at a slower
rate, but business loan growth continues to contract at a -50
2004 2005 2006 2007 2008 2009
rapid rate. We expect overall loan growth to pickup in 2010,
but weak demand for credit from businesses in the first half
of the year will likely keep the credit cycle tepid until global
economic recovery is more entrenched. Singapore: CPI inflation forecast
%oya
After spending much of 2009 in deflation, inflation should 8
return in 2010. While the headline rate will likely rise
6
quickly in the first half of 2010, most of it will be due to the
one-off inclusion of higher housing prices from the annual 4
valuation assessment (i.e., property tax assessment) and to 2
unfavorable commodity price “base effects.” Domestic price
pressures should remain subdued given greater slack in the 0
domestic labor market, both in terms of higher unemploy- -2
ment and underemployment, and the typical pattern of 2005 2006 2007 2008 2009 2010
gradual recovery in wage growth following recessions. The
largest risk to the inflation outlook comes from global com- Singapore: residential property prices
modity and food prices, which hit Singapore hard in 2007
4Q07 = 100
and the first half of 2008. However, outside of this risk, we
would expect inflation to move closer to historical levels in 140
HDBs
2010 as economic activity normalizes, but we do not see 120
consumer price inflation running away.
100
Despite the benign CPI inflation outlook, property prices
80
have become a major concern. After softening during the
most severe phase of the global recession, property prices 60 Private property
have rebounded robustly, both for private residencies and
40
HDBs. While this concern is not unique to Singapore, the 95 97 99 01 03 05 07 09
city-state has experienced one of the, if not the, strongest
surge in property prices in EM Asia. Policy-makers have
already taken several actions to cool property prices, in-
cluding eliminating interest absorption lending schemes,
increasing land sales, and allowing property purchasing
assistance in the FY09/10 budget to expire with this budget until at least the October meeting.
year. So far, the MAS has shown no intent to use monetary
policy to address property price inflation. Singapore consistently runs balance of payments sur-
pluses as large current account surpluses offset smaller
With inflation and inflation expectations expected to re- financial account deficits. 2010 is not expected to be any
main well-contained, uncertainty around the global outlook different. We expect the current account surplus to widen
still high, and property price action being taken via regula- out to around 15% of GDP in 2010 from around 12% in 2009
tory measures, we do not see any immediate need for the as external demand picks up. As a result, fx reserve accumu-
MAS to adjust its monetary policy stance. Thus, while still lation should continue to climb, rising to around US$210
way in advance of the April MPC meeting, we currently from an estimated 2009 year-end level of $186 billion. This
would not expect the MAS to change the slope, center, or would leave Singapore’s reserve level well over 100% of
band width of its current neutral SGD NEER policy stance GDP (and this excludes the forward book).
52
Yen Ping Ho (65) 6882-2216

Singapore implemented one of the largest fiscal packages meet heightened frictional liquidity demand for cash. The
in the region in 2009, estimated at 3 to 4% of GDP. Be- MCB was allowed to spike up to a 3.70% peak in July 2009.
cause the package was part of the FY09/10 budget (Apr- However, a gradual drainage via OMOs has drawn the MCB
Mar), the precise amount is difficult to measure. Suffice it to lower, with the overnight rate (on a monthly average basis)
say, the FY09/10 budget was very expansionary and failure now having risen in every month since June 2009. This will
to produce a similar size budget for FY10/11 would be a drag likely continue into 2010, but should be seen as a removal of
on the economy. The government has already made state- emergency provisions rather than outright tightening.
ments suggesting that the amount of spending will be simi-
lar in the FY10/11 budget as it was in the current one, allow- Despite an unchanged MAS stance, market pressure for
ing the fiscal stance to “run in place.” We would expect SGD gains has been strong and momentum should carry
some changes to the type of spending, with the government into 2010. USD weakness is the dominating theme. And
already suggesting that fiscal support to private institutions though the MAS has intervened heavily to absorb USD
to retain employees could be allowed to expire next June. selling flows against SGD, the basket mechanism means spot
Instead, we would expect more targeted spending toward USD/SGD can head lower insofar as the dollar is weak (and
low-income households and spending on longer-term struc- other components like EUR and JPY strong). CNY
tural objectives to improve Singapore’s competitiveness revaluation should also provide significant scope for SGD
and productivity levels. gains.
Singapore SGD policy appreciation to lag The MAS will continue to conduct with USD-buying
intervention in accordance to the NEER band, but should the
JPMorgan expects USD/SGD to trade at 1.30 by the end of
growth recovery remains on track and USD weak the
2010, which compares with the Bloomberg consensus
authorities will allow spot USD/SGD lower in line with the
estimate of 1.36 and the 12-month forward outright of 1.40.
NEER and without derailing from the monetary stance. The
liquidity impact of intervention will likely be managed via the
MAS in no hurry to tighten, but weak USD and strong CNY
FX forward book, as the authorities enter sell/buy USD
to direct USD/SGD path. Growth remains a policy concern.
swaps against USD buying in the spot market. The FX
Despite the outsized growth surge in the middle of 2009,
forward position should rise, but the MAS will likely
policy restraint remains strong in view of caution against the
respond by lengthening the maturity profile of the forward
sources and quality of growth. One-off fiscal effects and
legs to reduce the burden of monthly rolls, hence limiting the
inventory correction were the dominating drivers to the
impact on forwards and SOR.
recovery, and with policymakers still unsure over the
durability of G3 growth, the thinking remains to err on the
side of caution.
Singapore registered a 6.8%q/q saar contraction in the

4Q09 GDP, which sits well above the assumption built into
the government forecast. We view this to be technical roll
down from unsustainable growth levels in past quarters, but
the reading should nonetheless underscore the theme of
uneven 2010 growth and reinforce the mood of policy
restraint. We do not expect the MAS to tighten in the April
2010 monetary policy review. October 2010 is a risk, but for
now there appears little to compel a change. Importantly,
inflation is not a pressing concern. And though rising asset
markets may warrant some attention, micro measures to
address the property market appear to be gaining some
traction.
To be sure, withdrawal of excess liquidity will continue into

2010. Cash balances in the banking system remain well
above historical norms. The MAS typically maintains a MCB
(Minimum Cash Balance) ratio of 3% in the banking system.
However, in response to financial system stress post-
Lehman, the MAS has kept liquidity flush to buffer against
risks of a liquidity scramble for settlement purposes and to
53
Taiwan: economic indicators

Taiwan
Average
2003-07 2008 2009 2010f 2011f
• Taiwanese exporters to benefit from global recovery this
Real GDP, % change 5.2 0.7 -3.0 5.8 4.8
year, especially for tech
Consumption* 1.4 -0.2 0.7 2.0 2.1
• Manufacturers to kick up capex expansion and hiring; Investment* 1.0 -1.3 -5.3 2.9 0.9
Net trade* 2.8 2.3 1.5 0.9 1.8
cross-strait links further boost domestic sentiment Consumer prices, %oya 1.2 3.5 -0.9 1.0 1.8
• With modest inflation outlook, and as Fed stays on hold, % Dec/Dec 1.5 1.3 -0.7 2.0 1.8
Producer prices, %oya 4.4 5.1 -8.9 4.8 2.5
Taiwan central bank not in a hurry to raise rates Government balance, % of GDP -1.3 -0.7 -3.6 -2.5 -2.0
• Global recovery and structural factors, including MOUs Exchange rate, units/$, eop 32.7 32.8 32.1 30.0 29.0
and ECFA, supporting twin BoP surpluses Merchandise trade balance ($ bil.) 23.5 18.5 29.2 22.7 23.4
Exports 200.3 254.9 203.0 245.2 281.4
Imports 176.8 236.4 173.8 222.5 258.0
The Taiwan economy has demonstrated an impressive re- % of GDP 8.1 6.2 9.5 6.9 6.5
covery since 2Q09, first benefitting from the rebound in
China’s industrial activity and domestic demand, followed Total external debt, ($ bil.) 55.4 62.0 77.6 79.8 81.9
by the broadening of final demand improvement to the G-3 Short term† 34.7 38.5 39.7 41.0 42.2
markets in recent months. As a result, the economy ex- Total external debt, % of GDP 15 15 18 19 17
panded significantly at 18.8% q/q, saar and 8.3% respec- Total external debt, % of exports‡ 22 19 27 26 23
Interest payments, % of exports‡ 1 1 1 1 1
tively during 2Q09 and 3Q respectively. Looking into 2010,
we expect the Taiwan economy to show further broad- * Contribution to growth of GDP.
based recovery. Exporters should continue to benefit from † Debt with original maturity of less than one year.
the upturn in the global manufacturing cycle, while on the ‡ Exports of goods, services, and net transfers.
domestic front, both consumption and fixed investment are

expected to pick up steadily in coming quarters. We expect
Taiwan’s real GDP to rise 5.8% in 2010. Given the modest
inflation outlook, and with the Fed on hold through the Taiwan: real GDP growth
course of next year, we expect Taiwan’s central bank to be-
%oya %q/q, saar
gin raising rates modestly only by 4Q10.
10 %oya 20
Exports turning up, particularly for tech

5 10
Going into 2010, Taiwan’s exporters should benefit from the
expected synchronised global recovery. While Taiwan’s 0 0
exports to China began to stage a remarkable rebound since %q/q, saar
2Q09, on the back of the mainland government’s fiscal -5 -10
stimulus, Taiwan’s export recovery has broadened out since
mid-09, with encouraging upturn in shipment to the US, Eu- -10 -20
2004 2005 2006 2007 2008 2009 2010
rope and Japan (chart). In particular, it is worth highlighting
that, the SEMI (Semiconductor Equipment and Materials
International) book-to-bill ratio, which tracks global demand
for semiconductor manufacturing equipment, reached 1.1in Global PMI and Taiwan real export growth
October, approaching the highest level since January 2004, index, sa %3m/3m, saar
shedding positive light for Taiwan’s tech exporters going Global manufacturing
64 PMI - output 60
into this year.
60 40
56
20
Corporates ready to expand capex 52
48 0
On the domestic front, breakdown of recent fixed invest- 44 -20
ment data shows that while the public sector has played the 40 Taiwan export volume
(adjusted by export prices) -40
36
32 -60
28 -80
2003 2004 2005 2006 2007 2008 2009
54
crucial, textbook, countercyclical role in supporting fixed

investment through the recession, there have been signs Taiwan: exports by destination
that the sharp fall in private investment in Taiwan has US$ bn, both scales, sa
started to stabilize as well. Indeed, Taiwan manufacturers, 12 3.0
especially the tech producers, appear ready to boost their US
Europe
capex plans notably and increase hiring going into 2010, on 2.5
10
the back of improving outlook on external demand condi- 2.0
tions, and the upturn in shipments and capital utilization China/ HK
8
seen in the past two quarters. Not surprisingly, Taiwan’s 1.5
capital goods imports, which tend to track domestic fixed 6
1.0
Japan
investment closely, expanded sharply at 196.4% 3m/3m, saar
through November. 4 0.5
2008 2009
In addition, it is worth noting that Taiwan manufacturers

have continued to cut inventory in recent months. The se- Taiwan tech exports and SEMI book-to-bill ratio
quential trend in the producer inventory index fell at ratio %3m/3m, saar
8.9%3m/3m saar by October. With the notable inventory cut-
1.3 SEMI book-to-bill ratio 150
ting and significant pickup in shipments, the absolute level of Taiwan tech
inventory, as well as the overall inventory to shipment ratio, exports
100
has by now fallen back to pre-crisis levels. This in turn sug- 1.0
gests that, as final demand improves, the inventory cycle 50
should gradually shift from being a drag on growth to sup-
0
porting it. 0.7
-50
Consumption: cyclical and secular boost 0.4 -100
01 03 05 07 09
Taiwan’s labor market appears to have stabilized, with the
unemployment rate edging down to 6.0% sa in November.
Encouragingly, along with the improvement in the export
sector and industrial activity, total employment, having de- Taiwan: public vs private sector fixed inivestment
clined consistently since 3Q08, began to show signs of im- %oya
General government
provement, rising 0.4%m/m sa and 0.2% in November and 50 and public enterprises
October respectively. Average monthly regular labor earn- investment
ings, which had fallen steadily since 3Q08, also stabilized in 25
the past quarter. Not surprisingly, the most recent surveys
suggest that household confidence in employment opportu- 0
nities and the general economic climate six months ahead
turned up notably through November (chart). On a struc- -25 Private sector
tural basis, improving medium-term outlook for the Taiwan investment
-50
2003 2004 2005 2006 2007 2008 2009
Taiwan: consumer confidence index - 6 month outlook
index
Consumer confidence in
90 Consumer confidence in employment opportunity
economic climate Taiwan: inventory and shipment
80 2006=100, sa ratio
70 130 1.8
Inventory to Inventory
60 shipment ratio level 1.6
120
50 1.4
110
1.2
40 100
1
30
01 03 05 07 09 90 0.8
80 0.6
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
55
economy, on the back of intensifying cross-strait economic Taiwan: contribution to GDP growth
links, would likely provide further support for private con- %-pt contribution to headline GDP oya growth
sumption demand going ahead. 10 Private
Net exports
consumption
CPI inflation and monetary policy
5
The deflation trend in Taiwan’s headline CPI has been mod-
erating in recent months. We look for the headline CPI, in
%oya terms, to start rising in the coming months, and ex- 0
pect CPI inflation to average at a moderate 1.0%yoy for Fixed investment
2010. For monetary policy, We believe the chance of a rate
-5
hike is rather low for the coming months, especially as in- 2003 2004 2005 2006 2007 2008 2009
coming CPI figures continue to remain subdued. Indeed,
during the central bank’s monetary policy meeting in late Taiwan: real employment income and private consumption
December, the central bank noted that the output gap in the %oya
Taiwan economy remains in negative territory, and the risk Private
10 Real employment
of near-term CPI inflation remains well-contained. income
consumption
expenditure
Besides, as we expect the US Fed to keep policy rates at 5
close to zero through the end of 2010, this will somewhat
constrain the rate decision of the Taiwan central bank.
Looking further ahead, the central bank may start to con- 0
sider normalizing the monetary environment when growth in
economic activity builds further into this year. Taking all
-5
factors into consideration, we expect the CBC to start rais- 98 00 02 04 06 08
ing policy rates by 4Q10.
With regard to asset inflation concerns, in the near term, the Taiwan: overall consumer price index
central bank is likely to continue to focus on managing the %oya JPMorgan
overall liquidity conditions. Indeed, the size of outstanding forecasts
central bank certificate of deposits, an important instrument 6
to manage market liquidity, already expanded notably at 4
32.9%oya through November 2009.
2
MOUs, ECFA and twin surpluses 0

Taiwan’s 3Q09 current account came in at an elevated -2
US$8.2 billion, significantly higher than the $2.1billion sur-
plus in 3Q08. As mentioned above, Taiwan’s export sector -4
2005 2006 2007 2008 2009 2010
has benefited notably from the recovery in the global manu-
facturing sector this year. Meanwhile, even more impressive
has been the fact that the capital and financial account re-
corded significant inflow during 3Q, amounting to an el- Taiwan: current account surplus as share of GDP
evated surplus of $6.5 billion, the highest capital and finan- % share, 4qma
cial account surplus in more than five years. As a result, in
aggregate, Taiwan recorded impressive “twin surpluses” 10
across the BoP current account as well as capital and finan- 8 Current account
cial account, leading to the sharp jump in forex reserves by surplus as share of
$14.7 billion in 3Q09. 6 GDP
4
Looking ahead, as we expect the US Fed fund rate to remain
close to zero through the end of 2010, the dollar carry trade 2
0
97 99 01 03 05 07 09
56
is likely to fuel further capital flows into Asia in the coming Taiwan: current account vs capital and financial account
quarters. Indeed, in early November the Taiwan government US$ billion Capital and financial
responded to the concerns on “hot money” inflow by re- account balance
20 Current account
stricting foreign money from being deposited in time de-
15 balance
posit accounts. The measure was designed to discourage
foreign money coming into Taiwan that is not invested in 10
domestic financial markets, but is just parked in time depos- 5
its waiting for TWD appreciation. 0
-5
Further pressure on capital inflow -10
Going into next year, as capital inflow pressure continues to -15
2004 2005 2006 2007 2008 2009
build and increasingly weighs on EM central banks’ policy
framework, the BoP dynamics, as well as monetary and fx
policy implications, could be even more complicating in the
Taiwan: BoP net portfolio flows vs yield differentials
case of Taiwan, regarding the impact of the financial sector
US$ bn percent per annum
MOUs signed recently, which focused on cross-strait finan- Balance of payments Taiwan-US 1--year
cial supervision, and the progress in free trade arrange- 10 net portfolio flows government bond 2
ments under the Economic Cooperation Framework Agree- yield differential
5 1
ment (ECFA). In the broad macro picture, as the financial
MOUs and the upcoming ECFA foster further integration of 0 0
cross-strait economic activities, there would likely be further
pressure on capital inflow into Taiwan, either in the form of -5 -1
portfolio investment in the equity market or through merger -10 -2
and acquisitions.
-15 -3
95 97 99 01 03 05 07 09
Medium-term current account outlook
Further down the road, closer cross-strait economic links
are expected to benefit the overall efficiency and productiv- Taiwan and Hong Kong: BoP service exports
ity of Taiwan’s economy, in both existing and new growth % of GDP, 4qma
areas. In particular, in addition to the potential boost to mer- Hong Kong
50 signed CEPA Hong Kong
chandise trade flows under closer cross-strait economic with mainland service exports
links, the potential for further expansion of the tourism sec- 40
tor, the financial industry, as well as other trade-related
business services under the financial MOUs and ECFA 30
could potentially lift Taiwan’s service exports and hence Taiwan service
20
current account surplus in the medium term. exports
10
For comparison, after the implementation of the Closer Eco-
0
nomic Partnership Arrangement (CEPA) between Hong 00 02 04 06 08
Kong and the mainland, Hong Kong’s service exports esca-
lated from 29% of GDP in 2003 to 42.9% by 2008 (chart). In
this regard, while the relative size of Taiwan’s service ex- Asian currency real effective exchange rate
ports is notably lower at this moment (at 8.9% of GDP in index, 2000=100
2008), there is significant room for medium-term expansion
120 CNY
in this area. In all, from the balance of payments perspec- KRW
tive, considering the cyclical factors of steady global eco- 110
nomic recovery next year, combined with close to zero Fed 100
fund rate, and the structural forces along with closer cross- 90
strait economic links, Taiwan’s current account as well as TWD
capital and financial account would likely continue to regis- 80
Appreciation
ter impressive surpluses, provide solid fundamental support 70 JPY
for the TWD in coming quarters. 60
00 02 04 06 08
57
Yen Ping Ho (65) 6882-2216

TWD increasingly CNY dependant Chart 6: Taiwan increasingly correlated to China growth
Prospects for TWD appreciation remain favorable with 15.0 100%
2yr rolling Correlation China GDP oya%
JPMorgan forecasting USD/TWD at 29.80 year-end 2010 Taiwan GDP oya% 90%
against the Bloomberg consensus for 30.50. This relative 10.0
80%
out-performance relative to the market’s consensus is
70%
contingent on rising economic integration and correlation 5.0
60%
with mainland China and subsequent strong portfolio
0.0 50%
inflows.
40%
-5.0
30%
Analysis of GDP growth rates between China and Taiwan
20%
shows a rising correlation between the two countries with -10.0
10%
the two-year rolling correlation registering 86% in 3Q 2009
compared with 61% at the start of 2000. Moreover, this -15.0 0%
Jan-00 Jan-02 Jan-04 Jan-06 Jan-08
correlation has strengthened over the recent global
economic recovery, which contrasts with the tech-led
recession and correlation decoupling in the 2002 period (see
chart below). This is further underscored by Taiwan exports
to China, which turned positive oya at 5.4% and is leading
the cycle higher in total exports that remain negative at -4.9%
oya in October.
The key is whether this closer economic integration will

actually lead to higher portfolio inflows. Previously, 10-yr
bond yield differentials with the US have mattered more for
Tawain’s net portfolio flows. However, the signing of the
MoU with China brings the prospect of qualified
institutional mainland Chinese investors (QDII) purchasing
up to 10% of individual Taiwanese company shares.
It is hoped that an Economic Cooperation Framework

Agreement could be signed by the fifth bilateral talk held
next June/July. This would allow for cross-strait M&A
deals and mainland Chinese investors beyond the QDII
classification to invest into Taiwan. In 2009, foreign
investors have bought USD15.6bn in Taiwan equities – the
largest cumulative inflow since 2006. The combination of
zero interest rates in the US and closer economic and
investment integration with the mainland should drive
further appreciation in 2010.
58
Thailand Thailand: economic indicators
Average
2003-07 2008 2009f 2010f 2011f
• Growth to gain traction in 2010 as the economy fires on all Real GDP, % change 5.6 2.6 -2.9 5.5 5.0
cylinders Consumption* 2.6 1.3 -0.2 2.0 2.4
Investment* 1.8 1.5 -6.0 4.4 5.4
• Politics to remain a major event risk, but the consensus Net trade* 1.3 -0.2 3.4 -0.8 -2.9
market view is probably too pessimistic Consumer prices, %oya 3.2 5.5 -0.8 4.8 3.4
% Dec/Dec 3.4 0.4 3.4 4.4 3.0
• Inflation to rise quickly due to supply-side pressures, but Wholesale prices, %oya 6.0 12.4 -4.0 8.0 6.0
BoT to remain a laggard despite fiscal support from SP2 Government balance, % of GDP -0.1 -2.5 -3.9 -5.6 -5.0
Merchandise trade balance ($ bil.) 1.9 -2.1 21.3 9.1 -9.0
Exports 112.1 175.3 149.2 172.4 210.5
Politics remains key to our 2010 macroeconomic outlook. A Imports 110.2 177.4 127.9 163.3 219.5
stable environment will allow the government to progress Current account balance 3.3 -2.5 19.5 7.0 -10.7
% of GDP 1.7 -0.9 7.4 2.3 -3.1
with its “strong Thai” (SP2) fiscal stimulus disbursements,
which will be the foundation for sustained improvement in International reserves, ($ bil.) 58.2 108.7 130.7 145.7 141.7
sentiment, private sector investment crowding-in, and con-
Short term† 16.5 24.1 24.1 29.1 31.6
sumer spending, even if the extra spending itself only keeps Total external debt, % of GDP 30 24 25 23 21
fiscal policy from being contractionary this year. A sustained Total external debt, % of exports‡ 39 29 35 32 29
and strong recovery in global demand next year would also Interest payments, % of exports‡ 1 1 1 1 1
be beneficial given Thailand’s reliance on automobile, elec- * Contribution to growth of GDP.
tronics, and electrical exports. † Debt with original maturity of less than one year.
‡ Exports of goods, services, and net transfers.
2010 growth should be strong as the economy is firing on
all cylinders. Thailand’s economy has grown strongly since property prices are not expected to be an issue. Moreover,
1Q09. This partly reflects pickup in manufacturing output core inflation (excluding food and energy) should average
and exports, which the entire world is experiencing, but much 1.5% to 2.5% in 2010, well within the BoT’s 0.5% to 3.0%
of the rebound has also been due to a sustained and notable target range. Headline CPI inflation will likely be much
firming of domestic demand. With business sentiment, labor higher at 3.5% to 5.5%, as food, oil, and removal of subsi-
market conditions, and the political environment improving, dies for low-income residents lead to acceleration. Nonethe-
we expect domestic demand to continue to support growth in less, the BoT will not likely react to transitory price effects.
2010. We remain comfortable with our 5.5% growth forecast
for 2010. After dipping into modest deficit in 2008, the trade and
current account balances posted extremely large surpluses
Thailand’s manufacturing sector was hard hit by the global in 2009 (7.5% of GDP) relative to historical levels (1.5%
slowdown, which has been reflected in the credit cycle. of GDP). This largely has reflected lower oil prices, which
Credit growth has slowed sharply from the 20% range late accounted for almost one-quarter of all imports during some
last year to low single digits. Though low relative to histori- months in 2008, and weak domestic demand in the first half
cal standards, credit growth in Thailand has held up well of the year. Recovery in domestic demand in 2010 along
compared to many other cycles in the region as consumer with a higher average oil price for the year relative to 2009
loans and housing loans have been fairly resilient, and be- should lead to lower trade and current account surpluses.
cause business demand for loans had been tempered even We expect the current account to shrink to around 2% of
before the global downturn due to political uncertainty. With GDP in 2010, which is still slightly above its long term aver-
global growth gaining traction and the government imple- age as strong global demand should help to compensate for
menting its large fiscal stimulus package, we would expect the pickup in Thai import demand.
loan growth to pickup next (already has begun on a sequen-
tial basis) back to the double digit range. Thailand’s capital account should also remain well sup-
ported in 2010. Thailand has normally run capital account
The BoT is not likely to hike until mid-2010. The BoT con- surpluses in recent years and we would expect greater inter-
tinues to sound dovish, albeit perhaps slightly less so than est in EM Asian assets and continued interest in Thailand
last year, and it does not seem ready to tighten monetary as a destination for direct investment (albeit perhaps less so
policy in the near term. While growth has rebounded, con- than previously due to political concern) to shift the capital
cerns about politics and external demand in 2010 remain, and account back into surplus next year from an expected deficit
59
Yen Ping Ho (65) 6882-2216

in 2009. Thus, international fx reserves are expected to rise cially since banks are flush with liquidity and investment
around US$15 billion in 2010 to about US$145. has been so weak in past years.
Fiscal policy should be a support. The “Strong Thai” stimu- Politics remains the key risk, but we think the market is
lus package, also known as “SP2” is expected to be overly pessimistic. Consensus and government forecasts
THB1.43 trillion in size, or around 16% of 2009 GDP, spread for 2010 GDP growth vary between 3.0% and 5.0%. These
over the next three years. The government is planning to less upbeat forecasts reflect concern about politics. How-
spend THB200-350 billion in FY09/10 (Oct-Sep), which, de- ever, PM Abhisit has found his feet, and Thailand’s major
pending on the multiplier assumed (market estimates vary political institutions—the judiciary, military, and palace—
from 0.4 times to a little more than 1 time) would add 0.5%- still seem to back the Democratic party led alliance. Many
3.5%-pts to growth. We are forecasting a 1.5%-pt boost to Thais still support Thaksin, but he is making more contro-
2010 GDP growth. This package, along with a planned versial moves, such as aligning himself with Cambodia’s
THB350 billion deficit from normal budget spending, should government, which could backfire. Thus, while political risk
leave the fiscal deficit around 6% of GDP in 2010 (assumes is important, we expect it to remain a low-level background
THB250 billion in stimulus spending), which should not be drag.
a problem to finance.
Controlled THB appreciation
Pessimists of the program point to two major reasons why
THB to maintain managed appreciation path. J.P Morgan is
the impact of fiscal stimulus will be minimal. First, political
expecting a gradual shift lower on USD/THB to 31.00 by the
stability is key to disbursements occurring on time, or at all.
end of December 2010, from levels close to 33.00 end-2009.
If the political environment were to deteriorate to such an
Despite perceptions that USD/THB has remained sticky in
extent that the current government would be unable to con-
the general USD/Asia down trade, USD/THB has charted the
tinue, then this spending would likely be on hold, as it has
largest post-Lehman decline in the region. Strong central
been for the last four years since Thaksin originally an-
bank control helped in large part. USD/THB, having not
nounced his planned “mega-projects.” Second, the annual
rallied substantially in the post-Lehman fallout (rising the
budget for FY2009/2010 is about THB250 smaller this year
least among USD/Asia, see chart), was simply better placed
than last fiscal year, which implies a contractionary stance
to end lower as USD selling resumed.
without SP2. Thus, the stimulus spending this fiscal year
will merely plug the gap.
We expect strong central bank resistance to sustain a
controlled USD/THB decline. USD buying intervention
While this is true, such a strict interpretation of the
intensified in 2009 as appreciation pressures resumed.
spending is too pessimistic for three reasons. First, the
Accounting for FX ops ledgered in the FX forward book and
government has been overly cautious on forecasting rev-
valuation effects, FX reserves rose a hefty USD35 billion
enues as it made its FY09-10 projections back in early 2009.
from January to November 2009. USD/THB historical vols
Revenues have repeatedly surprised on the upside since
collapsed as a result, with the 12M historicals pushing down
and will likely continue to do so this year. The reduction in
to 3.9% from 8.7% at the end of 2008. The NEER has been
planned budget spending this year was a direct result as the
largely stable. And this dovetails with official commentary
government attempts to keep the deficit at THB350 billion
stating THB moves to be in line with general FX market
(without SP2). With revenues likely to surprise on the up-
trends. The BoT will likely continue to allow USD/THB to
side, spending may too. Second, stimulus spending during
grind lower insofar as USD is weak and Asia FX is strong,
this coming year is being targeted toward shovel-ready
though a strong central bank hand in the spot market will
projects that have high multiplier effects (roads, irrigation
likely remain through 2010.
projects, etc). According to some government agency esti-
mates, the multiplier effect should be slightly above one,
FX inflows through the current account should underpin
similar to that estimated from the stimulus package in mid-
continued THB gains. Though the net surplus is expected to
2008. Many in the market are using multipliers as low 0.4,
narrow as domestic demand rises, the net position of inflows
which we think may be appropriate in future years during
should keep the balance of pressures tilted to further
the capital and import-intensive phases of the larger infra-
appreciation. As opposed to many economies in the region,
structure projects, but it appears unusually low by interna-
the capital account has had limited BoP and THB impact.
tional standards. Finally, even if the fiscal stance is neutral
Foreigners have been slow to return to markets in Thailand
in FY09/10, political stability and government spending on
and inflows have been offset by resident accumulation of
infrastructure projects should lead to continued improve-
foreign assets.
ment in consumer and business sentiment, which should
have a crowding-in effect of private sector activity, espe-
60
Asia 2010 Outlook
January 15, 2010
EM Asia: Recent Government Actions on Real Estate, banking and FX inflows

Country Month Summary of actions
China July CBRC asked banks to increase their Capital Adequacy Ratios and substract subordinated debts
from capitals w hen calculating CAR
Nov ember Some banks increased the dow npay ment and mortgage rates for second house-buy ers
Hong Kong October HKMA tightened dow n-pay ment requirements for lux ury homes. For residential properties v alued at
$20 million or more, HKMA capped the loan=to-v alue (LTV) ratio at 60%, dow n from 70% prev iously .
For properties v alued at below $20 million, the 70% LTV ratio w as maintained, but the max imum
loan amount w as capped at $12 million
October Hong Kong Mortgage Corporation (HKMC) limited its cov erage on mortgage loan under its Mortgage
Insurance Programme
India October RBI decided to raise the prov isioning requirement for bank's adv ances to the commercial real estate
w hich are classified as standard assets from the current lev el of 0.4% to 1%. The rationale prov ided
w as that there has been a surge in lendingto the commercial real estate sector ov er the last y ear
and it w ould be prudent to build an appropriate cushion against the likelihood of higher Nonperforming
assets (NPAs)
October RBI sked banks to ensure that total prov isioning cov erage for NPAs should not be less than 70% by
Sep 2010. This is in addition to the ex isting prov isioning norms w hich are based on a) Age of the
NPAs b) sector specific requirements;
October RBI decided to w ithdraw the special liquidity schemes that it had instituted last y ear. Last y ear, RBI
had allow ed banks to lend up to 1% of their liabilities to Mutual funds, Housing Finance Companies
and special refinance w ithout collateral for banks. The banks could raise the financing for this lending
through special repos w ith the RBI. Also RBI w ithdrew a special FX sw ap facility for banks and
corpoartes w ho hav e global operations. But these facilities hav e not been used since July this y ear;
October RBI returned the limit for ex port credit refinance facility w hich w as raised to 50% of eligible
outstanding credit has been returned back to pre-crisis lev el of 15%
October RBI decided to raise the SLR (Statutory Liquidity ratio) inv estment in Gov t and approv ed securities to
pre crisis lev el of 1%
October RBI remov ed ex ception of CBLO market from CRR, w hich reduced banks' reserv es at the RBI by
0.1% to 0.2%. Prev iously , daily inv estments in the CBLO market (Collateralized borrow ing and
lending operations) had been ex empt from CRR. So if banks had inv ested in CBLO, they w ould not
hav e to impound 5% of those inv estments w ith RBI
Indonesia Nov ember Considering banning foreigners from holding SBIs
Korea July The gov ernment strengthened the loan-to-v alue (LTV) ratio on mortgage loans in the Seoulmetropolitan
area from 60% to 50% (speculation area unchanged at 40%).
September The gov ernment broadened the debt-to-income (DTI) ratio on mortgage loans to the Seoulmetropolitan
area. Seoul: 50% and other Seoul-metropolitan area 60% (speculation area unchanged
40%).
October The gov ernment broadened the DTI and LTV on mortgage loans to non-bank financial institutions
Nov ember The gov ernment announced new regulations to strengthen banks' fx liquidity ratio/ex porters'
position
Malay sia N/A
Philippines N/A
Singapore September The gov ernment reinstated the Confirmed List for the 1st Half 2010 Gov ernment Land Sales (GLS)
Program, remov ed the Interest Absorption Scheme (IAS) and Interest-Only Housing Loans (IOL),
announced intent to end the Jan 2009 Budget assistance measures for the property market w hen the
measures ex pire
Taiw an October The CBC reportedly asked state-controlled banks to tighten loan risk management. Perng, Gov ernor
of CBC, urged banks “ to tighten risk management and that they shouldn’t only look at borrow ers’
collateral, and should place more focus on the lender’s ability to repay the loans” .
October Local w ires reported that CBC w as try ing to identify FINI parked in domestic bond market. On 10-
Nov , FSC (Financial Superv isory Commission) banned foreign inv estors to put money in time
deposits and for those w ho already had the accounts w ould not be allow ed to roll the ex isting time
deposits w hen they matured.
Nov ember Premier Wu said macro control on real estate sector w as not feasible as price surge w as only
observ ed in certain areas, e.g. Taipei. A broad based control might result in housing price slump in
the southern part of Taiw an, w hich w as w ithout any bubble. More moderate polices, for ex ample,
better land planning should be employ ed instead. CBC has also show n concern ov er speculativ e
inflow s on TWD.
Thailand N/A
61
Asia 2010 Outlook
January 15, 2009
Central Bank meeting schedule
2010
JAN FEB MAR APR MAY JUN JUL AUG SEP OCT NOV DEC
Hong Kong 28 none 17 29 none 24 none 11 22 none 4 15
India 29 none none tba none none tba none none tba none none
Indonesia 6 4 4 6 5 4 5 4 3 5 4 3
Korea 8 11 11 9 12 10 9 12 9 8 11 9
Malaysia 26 none 4 none 13 none 8 none 2 none 12 none
Philippines 28 none 11 22 none 3 15 26 none 7 18 30
Taiwan none none end of mth none none end of mth none none end of mth none none end of mth
Thailand 13 none 10 21 none 2 14 25 none 20 none 1
62
Asia 2010 Outlook
January 15, 2010
Rates forecast
13-Jan-10 Mar-10 Jun-10 Sep-10 Dec-10
United States
Federal funds rate 0.13 0.13 0.13 0.13 0.13
3-month LIBOR 0.25 0.30 0.30 0.30 0.30
10-year UST 3.75 3.90 4.10 4.25 4.50
China
1-year working capital 5.31 5.31 5.58 5.85 6.12
7-day repo 1.39 2.00 2.30 2.50 2.80
10-year govt 3.71 4.10 4.00 4.00 4.00
Hong Kong
Discount window base 0.50 0.50 0.50 0.50 0.50
3-month HIBOR 0.12 0.20 0.20 0.20 0.20
10-year EF bond 2.80 3.10 3.30 3.40 3.70
India
Repo rate 4.75 5.00 5.25 5.50 5.50
3-month bill 3.78 3.80 4.00 4.50 4.75
10-year govt 7.71 7.70 7.75 8.25 8.00
Indonesia
BI rate 6.50 6.50 6.50 6.50 6.50
3-month bill 6.60 6.70 6.70 6.70 6.70
10-year govt 9.53 8.75 8.75 9.00 9.00
Korea
Base rate 2.00 2.25 2.25 2.25 2.50
3-month CD fixing 2.88 3.00 2.75 2.75 3.00
10-year KTB 5.36 5.00 5.00 5.50 5.50
Malaysia
Overnight policy rate 2.00 2.00 2.00 2.25 2.50
3-month KLIBOR 2.17 2.20 2.20 2.50 2.70
10-year govt 4.29 4.00 4.00 4.25 4.50
Philippines
Reverse repo rate 4.00 4.00 4.25 4.75 5.00
3-month bill 4.14 4.20 4.50 5.25 5.50
10-year govt 8.04 8.50 9.00 9.00 9.00
Singapore
3-month SOR 0.57 0.90 1.00 1.00 1.20
10-year govt 2.57 2.70 3.00 3.20 3.30
Taiwan
Discount rate 1.25 1.25 1.25 1.25 1.38
3-month CP 0.50 0.50 0.50 0.50 0.62
10-year govt 1.52 1.50 1.70 1.80 2.00
Thailand
1-day repo rate 1.25 1.25 1.25 1.50 1.75
3-month BIBOR 1.35 1.35 1.40 1.70 1.95
10-year govt 3.88 3.50 3.50 4.00 4.50
63
Asia 2010 Outlook
January 15, 2009
Regional Economic Outlook in Summary

2009 2010 2011 4Q08 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10
Real GDP, %-ch over 1 quarter, saar
Japan -5.3 1.9 1.9 -10.2 -11.9 2.7 1.3 2.5 1.8 1.5 2.0 2.2
Australia 0.9 3.0 3.5 -3.5 2.2 2.6 0.8 2.5 3.3 3.8 4.2 3.9
New Zealand -1.6 2.5 3.2 -3.4 -3.4 0.9 0.8 2.2 3.6 3.0 2.9 2.6
Emerging Asia 4.3 7.6 7.2 -3.7 1.9 13.0 9.9 6.1 7.4 7.0 7.0 7.0
ex China and India -0.7 5.4 4.7 -12.3 -5.2 12.1 9.1 4.1 4.4 4.7 5.0 4.1
China 8.6 9.7 9.4 2.8 7.4 15.1 10.0 9.7 9.3 9.1 9.1 9.4
Hong Kong -3.3 4.5 4.1 -7.4 -16.1 14.8 1.6 5.0 4.2 4.0 3.8 3.5
Taiwan -3.0 5.8 4.8 -13.7 -11.3 18.8 8.3 6.0 3.8 5.0 4.6 3.5
Korea 0.2 5.4 4.1 -18.8 0.5 11.0 13.6 3.6 3.6 4.2 4.2 3.5
India 6.8 7.8 8.3 3.1 6.9 9.8 11.6 1.8 10.4 8.1 7.0 8.7
Indonesia 4.4 5.5 6.0 1.9 4.9 4.3 5.3 5.0 6.0 4.0 8.5 5.0
Malaysia -2.4 5.0 5.1 -8.1 -14.8 10.1 9.4 4.5 1.6 5.3 5.7 5.3
Philippines 1.0 5.0 4.3 1.1 -8.3 7.0 4.1 5.0 6.0 5.0 3.5 4.0
Singapore -2.2 6.5 5.0 -16.4 -12.2 21.7 14.2 -5.5 9.5 7.0 4.9 4.9
Thailand -2.9 5.5 5.0 -18.0 -6.0 9.0 5.5 5.3 4.9 5.7 5.3 5.3
Consumer prices, %oya, average
Japan -1.3 -1.6 -0.5 1.0 -0.1 -1.0 -2.2 -2.0 -1.5 -2.0 -1.8 -1.2
Australia 1.8 2.6 2.8 3.7 2.5 1.5 1.3 2.2 2.5 2.6 2.5 2.6
New Zealand 2.2 1.9 2.2 3.4 3.0 1.9 1.7 2.3 2.6 2.2 1.3 1.8
Emerging Asia 2.1 3.5 3.4 4.4 2.6 1.3 1.4 2.6 3.9 4.3 4.0 3.6
ex China and India 1.6 3.2 3.1 4.8 3.3 1.5 0.4 1.3 2.3 3.1 3.6 3.6
China -0.6 2.8 2.5 2.5 -0.6 -1.5 -1.3 0.6 2.4 2.9 3.1 2.7
Hong Kong 0.6 2.3 2.0 1.4 1.7 -0.1 -0.9 1.4 1.1 2.4 3.6 2.3
Taiwan -0.9 1.0 1.8 1.9 0.0 -0.8 -1.3 -1.4 -0.3 0.9 1.2 2.0
Korea 2.8 3.3 3.5 4.5 3.9 2.8 2.0 2.4 2.9 3.1 3.5 3.6
India 10.8 6.5 7.0 8.6 9.4 8.9 11.8 12.2 12.7 11.9 7.7 6.2
Indonesia 4.8 5.5 4.7 11.5 8.6 5.6 2.8 2.7 4.4 5.3 5.8 6.3
Malaysia 0.6 2.2 2.4 6.0 3.7 1.3 -2.4 -0.5 0.8 1.7 2.7 2.4
Philippines 3.3 5.4 4.9 9.7 6.9 3.2 0.3 2.4 3.3 4.1 5.2 4.7
Singapore 0.2 2.8 2.0 5.4 2.1 -0.5 -0.4 -0.4 1.8 3.4 3.0 2.9
Thailand -0.8 4.8 3.4 2.1 -0.2 -2.8 -2.2 1.9 4.0 5.5 5.5 4.4
2009 2010 2011 4Q08 1Q09 2Q09 3Q09 4Q09 Current 1Q10 2Q10 4Q10
Official interest rates, % p.a., end-period
United States Federal funds rate 0.13 0.13 1.50 0.13 0.13 0.13 0.13 0.13 0.13 0.13 0.13 0.13
Japan Overnight call rate 0.10 0.10 0.25 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.10
Australia Cash rate 3.75 5.00 5.50 4.25 3.25 3.00 3.00 3.75 3.75 4.00 4.50 5.00
New Zealand Cash rate 2.50 4.00 5.00 5.00 3.00 2.50 2.50 2.50 2.50 2.75 3.25 4.00
China 1-year working capital 5.31 5.85 6.12 5.31 5.31 5.31 5.31 5.31 5.31 5.31 5.31 5.85
Hong Kong Discount window base 0.50 0.50 2.00 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50
Taiwan Official discount rate 1.25 1.38 2.00 2.00 1.25 1.25 1.25 1.25 1.25 1.25 1.25 1.38
Korea Base rate 2.00 2.50 3.50 3.00 2.00 2.00 2.00 2.00 2.00 2.25 2.25 2.50
India Repo rate 4.75 5.50 7.50 6.50 5.00 4.50 4.75 4.75 4.75 5.00 5.25 5.50
Indonesia BI rate 6.50 6.50 6.00 9.25 7.75 7.00 6.50 6.50 6.50 6.50 6.50 6.50
Malaysia Overnight policy rate 2.00 2.50 3.50 3.25 2.00 2.00 2.00 2.00 2.00 2.00 2.00 2.50
Philippines Reverse repo rate 4.00 5.00 5.00 5.50 4.75 4.25 4.00 4.00 4.00 4.00 4.25 5.00
Thailand 1-day repo rate 1.25 1.75 3.50 2.75 1.50 1.25 1.25 1.25 1.25 1.25 1.25 1.75
Exchange rates, end-period
Japan USD/JPY 91 89 na 90.8 99.1 96.5 89.5 93.1 91.1 85 82 89
Australia AUD/USD 0.93 1.00 na 0.70 0.69 0.81 0.88 0.90 0.93 0.95 1.02 1.00
New Zealand NZD/USD 0.74 0.75 na 0.58 0.56 0.64 0.72 0.73 0.74 0.74 0.77 0.75
China USD/CNY 6.83 6.58 na 6.82 6.83 6.83 6.83 6.83 6.83 6.75 6.70 6.58
Hong Kong USD/HKD 7.76 7.80 na 7.75 7.75 7.75 7.75 7.75 7.76 7.77 7.78 7.80
Taiwan USD/TWD 31.8 30.0 na 32.8 33.9 32.8 32.0 32.0 31.8 31.0 30.5 30.0
Korea USD/KRW 1123 1120 na 1260 1384 1274 1178 1166 1123 1130 1130 1120
India USD/INR 45.6 42.0 na 48.6 50.9 47.8 48.1 46.4 45.6 45.0 43.5 42.0
Indonesia USD/IDR 9165 9500 na 10900 11555 10208 9645 9425 9165 9000 9000 9500
Malaysia USD/MYR 3.34 3.25 na 3.46 3.65 3.52 3.47 3.42 3.34 3.35 3.30 3.25
Philippines USD/PHP 45.7 45.0 na 47.5 48.4 48.3 47.4 46.5 45.7 46.0 45.5 45.0
Singapore USD/SGD 1.39 1.33 na 1.44 1.52 1.45 1.41 1.40 1.39 1.36 1.35 1.33
Thailand USD/THB 32.9 32.0 na 34.8 35.5 34.1 33.5 33.4 32.9 33.0 32.5 32.0
64
Asia 2010 Outlook
January 15, 2010
Issuance calendar
2010 China Govt Bond Issuance (benchmark, size is projection) 2010 Projection Malaysia MGS issuance
CNY billion 1Y 3Y 5Y 7Y 10Y Month January 3.5-year New Issue of GII (mat on 07/13)
January 10-year Re-opening of MGS 11/19 4.378%
Feb 27 27 3%
January 10-year Re-opening of MGS 11/19 4.378%*
Mar 27 27 27 27 108 13%
February 5.5-year New issue of MGS (mat on 08/15)
Apr 27 27 27 81 10% March 7.5-year New issue of MGS (mat on 09/17)
May 27 27 27 81 10% March 5.5-year New Issue of GII (mat on 09/15)
Jun 27 27 27 81 10% April 20-year New Issue of MGS (mat on 04/30)
Jul 27 27 27 81 10% April 5-year Re-opening of MGS 08/15
Aug 27 27 27 27 108 13% June 10-year New Issue of GII (mat on 06/20)
June 10-year New Issue of GII (mat on 06/20)*
Sep 27 27 54 6%
June 3-year Re-opening of MGS 05/13 3.210%
Oct 27 27 27 81 10%
Jul 5-year New Issue of GII (mat on 07/15)
Nov 27 27 27 81 10% July 7-year Re-opening of MGS 09/17
Dec 27 27 54 6% August 10-year Re-opening of MGS 11/19 4.378%
135 108 189 189 216 837 August 5-year Re-opening of MGS 08/15
Tenor 16% 13% 23% 23% 26% September 3-year New Issue of GII (mat on 09/13)
October 7-year Re-opening of MGS 09/17
October 3-year Re-opening of MGS 05/13 3.210%
November 10-year New Issue of GII (mat on 11/20)
Taiwan Issuance calendar
TWD billion
Tenor Auction month
5 Jan 40.0 2010 projected SGS issuance calendar
30 Jan 30.0
Date Tenor
2 Feb 40.0
01-Feb-10 2-yr
20 Feb 40.0
10 Mar 40.0 01-Mar-10 15-yr
5 April 30.0 01-Apr-10 7-yr
30 April 30.0 03-May-10 1-yr
20 May 30.0
01-Jun-10 10-yr
10 June 40.0
01-Jul-10 2-yr
5 July 30.0
20 August 30.0 01-Sep-10 20-yr
10 September 40.0 01-Oct-10 5-yr
5 October 30.0 01-Nov-10 1-yr
20 November 30.0
*Including bonds and 1-year T-bills
10 December 40.0
*April - December is projection
65
Asia 2010 Outlook
January 15, 2009
Indonesia local bond issuance calendar

Month Date Type of Securities Tenor (Area)*
January 12-Jan-10 Regular Bond 5, 7, 20 yr
12-Jan-10 SPN 1 yr
19-Jan-10 Syariah 5, 10, 15 yr
26-Jan-10 Regular Bond 10, 30 yr
26-Jan-10 SPN 1 yr
February 8-Feb-10 Syariah Retail
9-Feb-10 Regular Bond 10, 15, 20 yr
9-Feb-10 SPN 1 yr
16-Feb-10 Syariah 5, 10, 15 yr
23-Feb-10 Regular Bond 10, 20, 30 yr
23-Feb-10 SPN 1 yr
March 2-Mar-10 Regular Bond 5, 20 yr
2-Mar-10 SPN 1 yr
9-Mar-10 Syariah 5, 10, 15 yr
23-Mar-10 Regular Bond 20, 30 yr
23-Mar-10 SPN 1 yr
30-Mar-10 Syariah 5, 10, 15 yr
April 6-Apr-10 Regular Bond 7, 10 yr
6-Apr-10 SPN 1 yr
13-Apr-10 Syariah 5, 10 yr
20-Apr-10 Regular Bond 5, 15 yr
20-Apr-10 SPN 1 yr
27-Apr-09 Syariah 5, 10 yr
May 4-May-10 Regular Bond 15, 30 yr
4-May-10 SPN 1yr
18-May-10 Regular Bond 5, 20 yr
18-May-10 SPN 1 yr
25-May-10 Syariah 5, 10 yr
June 8-Jun-10 Regular Bond 5, 20 yr
8-Jun-10 SPN 1 yr
15-Jun-10 Syariah 5, 10 yr
22-Jun-10 Regular Bond 7, 15 yr
22-Jun-10 SPN 1 yr
July 6-Jul-10 Regular Bond 10,15,30 yr
6-Jul-10 SPN 1yr
13-Jul-10 Syariah 5, 10 yr
20-Jul-10 Regular Bond 5, 10, 20 yr
20-Jul-10 SPN 1 yr
27-Jul-10 Syariah 5, 10 yr
August 2-Aug-10 Retail Bond
10-Aug-10 Regular Bond 5, 10 yr
10-Aug-10 SPN 1 yr
24-Aug-10 Regular Bond 20, 30 yr
24-Aug-10 SPN 1 yr
September 21-Sep-10 Regular Bond 5, 15 yr
21-Sep-10 SPN 1 yr
28-Sep-10 Regular Bond 7, 20 yr
28-Sep-10 SPN 1 yr
October 5-Oct-10 Syariah 5, 10 yr
12-Oct-10 Regular Bond 10, 20 yr
12-Oct-10 SPN 1 yr
26-Oct-10 Regular Bond 5, 15, 20 yr
26-Oct-10 SPN 1 yr
November 9-Nov-10 Regular Bond 5, 10 yr
9-Nov-10 SPN 1 yr
23-Nov-10 Regular Bond 5, 20 yr
23-Nov-10 SPN 1 yr
December 1-Dec-10 Regular Bond 15, 30 yr
1-Dec-10 SPN 1 yr
* / Tenor Area means that issued tenor will be ard the yr stated in the Tenor column
66
Asia 2010 Outlook
January 15, 2010
Thailand government bond auction schedule

Issuance of Korea Treasury Bonds
Billion THB
KRW trillion, calendar year
ThaiBMA Coupon Rate Issue Size Years to Maturity
2004 2005 2006 2007 2008 2009e 2010f
Auction Date Symbol (%p.a.) (Mil. Baht) maturity Date
Gross bond issuance 56 62.6 60.7 48.3 52.1 85 77
31-Mar-10 LB144A 6M BIBOR - 0.15 8000 8 2-Apr-14
(% of GDP) 7.2 7.7 7.2 5.4 4.5 8.9 7 24-Mar-10 LB296A 4.875 8000 8 22-Jun-29
(% of outstanding) 45.5 36.7 29.4 21.2 21.8 30.2 0.2 17-Mar-10 LB155A 3.625 13000 13 22-May-15
(US$ billion) 54.1 61.9 65.3 51.6 41.3 75.2 67 3-Mar-10 LB196A 3.875 12000 12 13-Jun-19
Term debt maturing 9.4 8.8 18.6 20.1 26.8 30.9 29.7 3-Mar-10 LB406A 5 3000 3 22-Jun-40
Buyback/Switch 5 6.3 5.4 7.6 12.7 13.5 12 17-Feb-10 LB155A 3.625 13000 13 22-May-15
Net bond issuance 41.6 47.5 36.7 20.6 12.6 40.6 35.3 10-Feb-10 LB24DA 4.75 7000 7 20-Dec-24
27-Jan-10 LB296A 4.875 7000 7 22-Jun-29
(% of GDP) 5 5.5 4 2.1 1.2 3.9 3.2
27-Jan-10 LB141A 6M BIBOR - 0.15 8000 8 29-Jan-14
(% of outstanding) 33.8 27.9 17.7 9.1 5.3 14.5 11.2 20-Jan-10 LB155A 3.625 12000 12 18-Nov-16
(US$ billion) 40.2 47 39.5 22 10 35.9 30.7 20-Jan-10 LB16NA 4.125 8000 8 22-May-15
Outstanding debt 123.1 170.5 206.8 227.4 239.3 279.9 315.2 6-Jan-10 LB196A 3.875 12000 12 13-Jun-19
(% of GDP) 14.9 19.7 22.8 23.3 23.4 27.2 28.7 6-Jan-10 LB16NA 4.125 8000 8 18-Nov-16
(US$ billion) 118.9 168.5 222.4 242.9 190 247.7 274.1 23-Dec-09 LB406A 5 3000 3 22-Jun-40
16-Dec-09 LB155A 3.625 13000 13 22-May-15
Source: Ministry of Strategy and Finance, Bondweb, J.P.Morgan
16-Dec-09 LB24DA 4.75 7000 7 20-Dec-24
9-Dec-09 LB16NA 4.125 7000 7 18-Nov-16
25-Nov-09 LB196A 3.875 8000 8 13-Jun-19
18-Nov-09 LB16NA 4.125 8000 8 18-Nov-16
KTB issuance compositions
18-Nov-09 LB296A 4.875 7000 7 22-Jun-29
Actual Previous Target Target Actual Forecast 11-Nov-09 LB155A 3.625 10000 10 22-May-15
2008 2009 Sep-Dec 2009 2009 2010 11-Nov-09 LB13NA 6M BIBOR - 0.15 6000 6 13-Nov-13
28-Oct-09 LB24DA 4.75 7000 7 20-Dec-24
3-yr 26.0% 30-40% 25-30% 33.20% 20-30%
14-Oct-09 LB155A 3.625 13000 13 22-May-15
5-yr 39.6% 35-45% 35-40% 38.60% 35-45% 14-Oct-09 LB406A 5 3000 3 22-Jun-40
10-yr* 24.9% 10-25% 20-30% 18.70% 20-30% 7-Oct-09 LB213A 5.85 9000 9 31-Mar-21
20-yr 9.5% 5-10% 5-15% 9.50% 10-15% 30-Sep-09 LB213A 5.85 8000 8 31-Mar-21
23-Sep-09 LB213A 5.85 8000 8 31-Mar-21
* Including 10-yr KTBi in 2008, no issuance afterwards 16-Sep-09 LB139A 6M BIBOR - 0.15 8000 8 18-Sep-13
16-Sep-09 LB196A 3.875 10000 10 13-Jun-19
9-Sep-09 LB283A 5.67 7000 7 13-Mar-28
9-Sep-09 LB116A 1.75 23000 23 17-Jun-11
67
Asia 2010 Outlook
January 15, 2009
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Asia 2010 Outlook
January 15, 2010
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69
EM Asia Analyst Contact details

Analyst Coverage Contact
Dave Fernandez Head of Emerging Asia Research david.g.fernandez@jpmorgan.com (65) 6882-2461
Qian Wang Greater China qian.li.wang@jpmorgan.com (852)-2800-7009
Grace Ng Greater China grace.h.ng@jpmorgan.com (852) 2800-7002
Jiwon Lim Korea jiwon.c.lim@jpmorgan.com (82-2) 758-5509
Jahangir Aziz India, Pakistan, Sri Lanka jahangir.x.aziz@jpmorgan.com (91-22) 6157-3385
Gunjan Gulati India, Pakistan, Sri Lanka gunjan.x.gulati@jpmorgan.com (91-22) 6157-3386
Matt Hildebrandt ASEAN, Asia Sovereign Credit Research matt.l.hildebrandt@jpmorgan.com (65) 6882-2253
Claudio Piron Asia FX Research claudio.piron@jpmorgan.com (65) 6882-2218
Yen Ping Ho Asia FX Research yenping.ho@jpmorgan.com (65) 6882-2216
Bert Gochet Asia Rates Research bert.j.gochet@jpmorgan.com (852) 2800 8325
James DH Lee Asia Rates Research james.dh.lee@jpmorgan.com (82-2) 758-5512
Abhishek Panda Asia Rates Research abhishek.x.panda@jpmorgan.com (91-22) 6157-3387
Simon Song Asia Rates Research simon.p.song@jpmorgan.com (86-21) 5200-2833
Warren Mar Head of Asia Credit Research warren.j.mar@jpmorgan.com (1-212) 834-4274

Harsh Agarwal Asia Credit Research harsh.l.agarwal@jpmorgan.com (852) 2800-8008
Andrea Cheng Asia Credit Research andrea.k.cheng@jpmorgan.com (852) 2800-8028
Daniel Fan Asia Credit Research daniel.cc.fan@jpmorgan.com (852) 2800-8080
Sunil Garg Head of Asia ex-Japan Equity Research sunil.x.garg@jpmorgan.com (852) 2800-8518
Adrian Mowat Asia Equity Strategy adrian.mowat@jpmorgan.com (852) 2800-8599
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Asia 2010 Outlook

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Emerging Markets Asia Research

January 15, 2010

Asia 2010 Outlook

• Overview: Shared macro dynamics, varied policy responses Dave Fernandez AC

a proxy play for CNY.

faces strong headwinds. An important theme evident already this year is

downgrade risk. Appendix Tables 61

EM Asia GDP forecast in global context

Singapore no change in NEER path

Yen Ping Ho (65) 6882-2216

Chart 1: Advanced manufacturing FX hardest hit by crisis

GDP quartery saar contraction

Yen Ping Ho (65) 6882-2216

REER 10yr misvaluation

Yen Ping Ho (65) 6882-2216

The option structure costs a net premium of 60bps for a

Enter long 6M NDF KRW / short USD at 1124.00 outright

We refrain from an option strategy as premiums are rich and

5.5% Call Rate Forecast

• Forwards are generally pricing in too much tightening 8

compared to our central bank forecasts. As a rule of 6

We have been paid in CNY swaps since December, and con-

2. Bullish positions where too much tight- 2.5

inflow and supply conditions are attractive 1

(especially in the 5year sector). Last year’s sell-off left the

5. Be long swap spreads where inflows

Asia sovereign credit: spreads Top recommendations

China China: economic indicators

Private FAI takes over the baton 5

With regard to forward-looking indicators, as the funds allo- 8 Japan

Exports, BoP adjustment and CNY policy China: balance of payments

It is also worth highlighting that, China’s imports from major

Yen Ping Ho (65) 6882-2216

It is important to forecast the repo rate right as it is the fix- 6

shore investors. In 2010, it will be broadly impacted by two 4

(3) In addition, a deteriorating liquidity situation may

Total bond issuance to rise 35% in 2010, 500

In other words, the total net bond issuance (excluding 0

Such an increase in supply together with lesser liquidity 150 3.0

bond yields and swap rates as functions of IP growth and

Hong Kong: economic indicators

Steady domestic demand recovery 0

As the US Fed has introduced a set of measures to increase CPI

Yen Ping Ho (65) 6882-2216

India India: economic indicators

International reserves, ($ bil.) 176.6 241.5 291.9 348.0 394.5

The driver behind the RBI’s tightening is its concern over

Yen Ping Ho (65) 6882-2216

end-1Q10 and 41.50 by end-December 2010. 5.0%

Repo - Rev Repo Corridor Forecast

weighed down by a current account deficit, depends on

disrupt INR gains.

Initially, policy rates will rise slower than 0

The bear steepener consists of a 1s5s curve trade where we 6.5

Fourth, at this level we enter only into 25% of our desired 50

Indonesia Indonesia: economic indicators

Yen Ping Ho (65) 6882-2216

•Government bonds have rallied mainly in the 1-7yr sector.

cently BI has started to communicate to the market that they 12

“Goldilocks global economy” remains in

not overly so -80

On the other hand, dedicated-EM and cross-over real money

Korea South Korea: economic indicators