Asia Local Markets Monthly

Deutsche Bank Markets Research

Asia

Economics Foreign Exchange Rates

Date 20 July 2015

Asia Local Markets Monthly

Late summer

________________________________________________________________________________________________________________

Deutsche Bank AG/Hong Kong

DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MCI (P) 124/04/2015.

Sameer Goel

(+65 ) 64236973

Taimur Baig, Ph.D

(+65) 64238681

Kaushik Das

(+91) 22 7180 4909

Diana Del-Rosario

(+65) 6423 5261

Swapnil Kalbande

(+65) 6423 5925

Perry Kojodjojo

(+852) 2203 6153

Juliana Lee

(+852) 2203 8312

Linan Liu

(+852) 2203 8709

Mallika Sachdeva

(+65) 6423 8947

Kiyong Seong

(+852) 2203 5932

Audrey Shi

(+852) 2203 6139

Zhiwei Zhang

(+852) 2203 8308

Table of Contents Summary Market Views - Rates Page 02

Summary Market Views - FX Page 03

Trade Monitor Page 04

Country Sections Page 05

Policy Rate Forecasts Page 50

Economic Diary Page 54

Bond Supply Monitor Page 55

Monetary Policy Monitor Page 56

It is finally starting to feel like summer. Headlines on Greece are taking up lesser space; China equities have stabilized; oil is grinding lower; and there is little immediately on the calendar to shift view on the Fed conclusively in either direction. Vol is coming off across asset classes; the broader dollar is strengthening; carry is being bid again; and the old QE relationships seem like back in play. We seem in for a few weeks of lesser macro noise, and more summer like price action.

Best to stay on guard, though, for this might be the lull that precedes a storm. To be sure – and this has been our view for a while – it’s unlikely that we see another ‘storm’ of the Taper tantrum variety. But if and as the markets re-price the probability of Fed ‘lift off’, nervousness will probably return. Indeed, there is reason to be nervous on EM very broadly, given the weakest economic momentum we have seen since GFC. And particularly here in Asia, where currencies look relatively more overvalued (versus rest of EM), and the remaining current account surpluses are mostly poor quality, in that they are driven more by import compression than any momentum in exports.

Looking at a simple gauge of macro performance based on PMIs, industrial products, exports and inflation trends; we find at least half of the region is printing more than one standard deviation below the three year trend, with North Asia seemingly under more pressure, along with Thailand. Like we have been arguing, the poor state of the business cycle in Asia means central banks in the region will likely remain under pressure to ease further, or at the very least, lag any policy normalization by the Fed. Note that it is the low yielders in the region which are seeing the weakest economic activity, and are also historically the most sensitive to narrowing rate differentials. With noise settling down therefore, we have been advocating rotating away from shorts in the commodity and high yielding currencies (Malaysia, Indonesia) towards the ‘weak data’ low yielders (Korea, Thailand, Taiwan and Singapore). To be sure, we are still concerned about liquidity risks in the former (and political noise in Malaysia in particular), but fundamental adjustments seem more advanced in these two markets. India from the ‘outside in’ (and in contrast to the ‘inside in’ view) is the EM turnaround role model, with a flattering carry-to-vol ratio in tow.

The scale and management of equity volatility in China has left a bitter taste in the mouth for markets. While there is limited direct spillover into fixed income markets, we think rates should remain volatile given the reactive nature of policy response. We retain a modestly bullish bias on China rates, but will add to risk only at better levels. We like India rates as well, but more for carry here, than for a significant move lower in yields, given the reduced scope for RBI ‘relent’ in the near term. The mix of arguments on Indonesia is probably more mixed now than at any stage during the year, but we prefer to remain cautiously underweight on duration. As for the rest of the region, we like paying swap spreads in Singapore and Thailand, and are paid on steepeners in Korea.

20 July 2015

Asia Local Markets Monthly: Late summer

Page 2 Deutsche Bank AG/Hong Kong

Summary Market Views – Rates

Cash Bonds (Duration) Swaps (Level/Slope) Trade View

Modest Overweight Neutral/Steeper

Fiscal spending in H2 is likely to raise the borrowing

need for the central government, which adds to the

munci bond supply risk. We keep modest duration

exposure on the CGBs in the sub-3Y tenor. Curve to

steepen.

Bond supply risk and upside risk on money market

volatilities are the key near term risk. We expect

PBoC will continue to smooth out liquidity risk. Curve

to steepen.

Marketweight Neutral/Neutral

GBHK likely will continue to underperform the UST

curve on weak appetite for duration. Curve to steepen

Modest Overweight Neutral/Neutral

The India macro rates story is not necessarily over,

though the scope for RBI to 'relent' in the near term

has lessened. We like this market more for carry,

than for significant scope of capital appreciation in the

near term. Neutral on the curve.

Modest Underweight

There are more factors working at cross purposes on

Indonesia than at any stage earlier this year.

Valuations and carry argue in favor of duration;

liquidity and a poor fiscal story against. We want to

stay strategically underweight. Curve to steepen.

Marketweight Neutral/Steeper

The KTB curve is relatively immune from the global

financial volatility. There will be a temporary respite on

domestic supply pressure due to a supplementary

budget. However, it is unlikely to see a medium term

rally. Neutral on the curve.

Our view of 5Y KTB underperformance will translate

into a steeper 2Y/5Y spread on the swap curve. While

2Y/10Y IRS will also steepen in the medium term, less

upward pressure on the 10Y KTB will discourage

5Y/10Y IRS steepeners in the short term.

Marketweight Bearish/Steeper

After a challenging Q2, bond market technicals turn

favorable in Q3. Monetary policy is not in play for the

bond market at this juncture, with BNM expected to

keep the OPR unchanged this year. It thus remains a

range play. Curve to steepen.

BNM is expected to keep the OPR unchanged this

year, but the door is open to ease should growth

indicators significantly disappoint. Meanwhile, the

KLIBOR appears to have stabilised at these levels. IRS

market will thus look for direction from the USTs.

Marketweight

Renewed association with USTs is our biggest fear for

this market. But with headline inflation at record lows,

even though BSP is unlikely to reverse its rate hikes

hikes from last year, we are comfortable with being

marketweight. Neutral on the curve.


Valuations in the belly appear to be attractive relative

to front-end and back-end. We recommend some

bond switch ideas to capture the pick-up on the

curve. We also stay with our swap spread idea which

has room to widen further. Neutral on the curve.

While 10Y SGS is already trading slightly below the

peak of its 5y range, 10Y IRS still has a plenty of room

to catch up with its peak of the 5Y range. We thus

stay with our RV idea of paying swap spreads.


While 10Y TGB yields are likely to hover at around

1.50%, the risk is biased to the downside for the time

being. Curve to flatten.

While the CBC has stayed on the sideways, the short

term rates (1Y average NCD yields) has consistently

decreased this year. With the growing risk of China

equity selloff contagion, the dovish stance will likely

be strengthened, lowering the front-end rates.

Modest Overweight Neutral/Neutral

Supportive bond market technicals, BOT's

accomodative bias amidst weak economic activity and

negative inflation prints, light positioning and atrractive

valuations are all supportive of our constructive view

on ThaiGBs. Curve to flatten.

We are reluctant to take an outright position, given

the delta on global rates volatility. We instead prefer

scaling into paying swap spreads which to us appears

to be a better trade, especially given the attractive

levels for the spread.

PHP

SGD

TWD

THB

CNY

HKD

INR

IDR

KRW

MYR

* Pay 10Y swap spread, target

35bp

* Switch into current 5Y SGS from

old 5Y

* Valuations are attractive for 20Y

SGS over 30Y

* Long 10Y ThaiGBs, target 2.70%

* Switch into LB21DA from

LB196A

* Long LB21DA vs matched

maturity IRS, target 0bp

* Shift from 5Y-10Y CGBs to 3Y

* Add 5Y CNH CGB bonds at 3.1%

* Receive 5Y NDIRS, target

2.25%, add on back ups to 3%

* Receive 1Y CNH CCS, target

2.4%

* Long 5Y IGBs, target 7.5%

* IRS 2Y/5Y steepener, target

+50bp.

* Pay 10Y IRS, target 2.60%

* Prefer 10Y GII over MGS

* Pay 5Y ND-IRS, target 4.20%

Sources: DB Global Markets Research

20 July 2015


Deutsche Bank AG/Hong Kong Page 3

Summary Market Views – FX

Bias Fundamentals/Drivers Trade View

CNY Neutral We think the policy bias for FX stability is likely to dominate ahead of the SDR review and

recent equity market weakness. Chinese authorities have reinforced the point that currency

depreciation will not be used to counter the slowdown since any notable depreciation will

result in more capital flight tightening of monetary conditions and possibly increase the

downside pressure on the economy despite the recent stimuli. Furthermore, the RMB beta to

USD is comparatively low, with should lead to outperformance during any EM stress.

* Favor intra-regional RV CNH

longs

HKD Neutral The recent change in regulations by the Chinese authorities - allowing Chinese mutual funds to

invest into Hong Kong through the Connect scheme and possibly the introduction of QDII 2 or

Shenzhen- Hong Kong stock connect - should keep USD/HKD on the strong side of the band.

Despite the need for the HKMA to occasionally step into the market to defend the band and

ongoing increasingly unpredictability in global monetary policy, we remain of view that the peg

is here to stay and is still the best option for Hong Kong.

INR Moderately

Bullish

We still see INR as a good medium-term macro trade. Vol-adjusted carry is still appealing, RBI

has significantly built reserves to defend against stress, real-rates are high, the CA deficit

should remain manageable, and patient money will remain sticky. The central bank appears

open to raising debt quotas gradually The progress of legislated reforms in the monsoon

session of Parliament could be the next catalyst.

* Favor intra-regional RV INR longs

IDR Moderately

Bearish

We remain concerned about the gap risk in IDR, given illiquidity during times of outflow

pressure. There has been a dramatic build up in offshore debt holdings even post taper

tantrum. However, carry on IDR shorts is steep, trade accounts have returned to surplus, BI is

working towards regaining crediblity with a tight policy bias, and a lot of valuation adjustment

has occurred. We thus do not expect much outperformance over long-term forwards.

USD/IDR is better traded on dips in front-end implied yields for short-term risk-off spikes.

KRW Moderately

Bearish

We believe the inflection point for USD/KRW is upon us. Recent proactive deployment of

government policies and stronger portfolio outflows - total additional portfolio outflows for this

year of $21.3bn- would further aid the recycling of Korea’s massive current account surplus

and lift the USD/KRW higher, particularly ahead of the Fed lift-off. Furthermore, the JPY/KRW

valuation, which is currently sitting at an extreme level, suggests that a reversal is increasingly

likely.

* Long USD/KRW extending

target to 1,180

MYR Moderately

Bearish

MYR is likely to retain a high beta to the USD, and prone to liquidity gaps. Poor reserves

adequacy could mean BNM is less willing or able to defend the currency against weakness

However, the main alpha drivers of MYR underperformance are looking exhausted. Rating risk

premium should compress with Fitch refraining from a downgrade this week. Gas prices will

trough this summer, and over 75% of foreign bill holdings have already left. Outflows could

thus slow. We take profit on USD/MYR longs.

PHP Moderately

Bullish

The PHP has been uncorrelated to beta drivers like the broad USD this year, frequently out of

step with Asian FX, and prone to positioning squeezes. Strong fundamentals argue for RV

longs given the sparseness of constructive EM stories: the CA surplus is comfortable,

reserves adequacy is high, external debt is less of an issue. There are however three main

areas of growing concern: REER overvaluation, a pickup in resident outflows and excess

liquidity. Contagion from ASEAN weakness and domestic growth disappointment are also risks.

* Favor intra-regional RV PHP longs

SGD Bearish USD/SGD has gone back to being predominantly a USD beta, with the alpha of MAS policy not

in immediate play. Although core inflation continues to head lower, printing at just 0.1% in

May, we think further easing will require a downgrade to the growth or labor market outlook.

SGD NEER appears to have returned to its 2014 regime of trading slightly above the mid-band.

We like to enter SGD shorts on rallies near 1% above the mid, which we think will act as a

resistance level.

* Long USD/SGD (Target: 1.38)

TWD Moderately

Bearish

We believe the TWD weakness will be more visible in 2H, reversing its resilient performance in

1H. First, the annual dividend payment season for Taiwanese companies has started with the

peak in late July before tapering off by the end of August. Second, the domestic political

situation in Taiwan seems to be deteriorating which could also add to the upside pressure on

the currency pair. Third, the ongoing monetary easing by global central banks including BoK

and PBoC is likely to keep CBC uncomfortable with a stronger TWD.

* Long 6M USD/TWD 30.9/32 call

spread

THB Bearish The THB's poor-quality stalemate has come to an end, with BoT's consecutive rate cuts and

liberalization of domestic outflows helping the THB break out of its range. We think there is

more to come. The current account seasonally softens mid-year, and could shrink on import-

intensive govt infrastructure projects. Rate differentials are likely to compress significantly as

the Fed lifts rates and BoT lags, with the THB the most sensitive in Asia to front-end rate

spreads. Valuations also point to more downside for the THB.

* Long USD/THB (Target: 36)

Sources: DB Global Markets Research

20 July 2015



Trade Monitor

Country TradeEntry

Date

Entry

Level

Current

LevelTarget

Stop

LossMTM Bias

Rates Trades

Hong Kong Rec 10Y IRS 17-Jul 2.22% 2.24% 2.05% 2.32% -2 Add

Thailand Long LB21DA vs matched maturity IRS 17-Jun -30 -15 0 -40 15 Add

Singapore Pay 10Y swap spread 12-Jun 9 15 35 0 6 Add

Korea Pay 10Y ND-IRS 3-Jun 2.18% 2.25% 2.60% 2.08% 7 Add

Korea Pay 2Y/5Y IRS steepener 15-Apr 15 30 50 10 15 Add

China Rec 1Y CNH CCS 9-Apr 3.60% 3.23% 2.40% 3.90% 37 Hold

China Rec 5Y ND-IRS 27-Mar 3.50% 2.65% 2.25% 3.70% 94 Hold

Malaysia Pay 5Y ND-IRS 23-Jan 3.84% 4.02% 4.25% 3.65% 14 Hold

FX Trades

Korea Long 6M USD/KRW NDF 19-Jun 1107.0 1157.3 1180 1100 4.5% Target Raised

(1104.3) (1152.6)

Singapore Long USD/SGD 15-May 1.32 1.37 1.38 1.31 3.9% Hold

Taiwan Buy 6M USD/TWD 30.9/32 Call Spread 15-May 0.60% 1.12% 0.86 x Add

Thailand Long 3M USD/THB NDF 23-Jan 32.7 32.4 Rolled Over

24-Apr 32.7 34.3 36 32 4.2% Hold

(32.6) (34.32)

Malaysia Long 3M USD/MYR NDF 5-Jan 3.56 3.63 Rolled Over

6-Apr 3.65 3.74 4.00 3.48 4.3% Closed

(3.52) 3.74 Sources: DB Global Markets Research Notes: (1) For rates trades, MTM is in running basis points; for FX trades, MTM is in % of notional. (2) Trades in the table include 'live' positions, and those 'closed' within the last 1 month (3) For NDF trades, entry and current levels are in forward terms with the spot references noted below in brackets. Targets and stop-loss are in spot terms.

20 July 2015



China

Economic outlook: Policy easing continued in June with one interest rate cut and one targeted RRR cut. Q2 growth stabilized at 7.0%, likely helped by the stock market boom. Leading indicators in the property market improved, and fiscal policy easing started to show its effect. We expect the economy to grow at 7% in Q3 and 7.2% in Q4, then slow to 6.7% in 2016.

Main risks: The equity market selloff imposes a risk to the economy. If the market selloff continues in H2 it may lead to negative wealth effect. The risk is higher in H1 2016 as the boom in H1 2015 imposes an unfavorable base effect.

Strategy: Although we think there is limited equity spillover to the fixed income market, we expect RMB money market volatility and bond market volatility to remain high. We expect the overnight repo rate to fluctuate between 1-1.5% range and 7D repo between 1.75% -2.5% in the near-term. We expect the 10Y CGB to trade within the range of 3.3-3.8%. We recommend keep our duration exposure at the front end of the CGB curve (3Y or shorter tenor). We maintain a modest bullish bias on RMB rates and would look for opportunities to build receiving positions on rates (NDIRS and CNH CCS) when 5Y is above 3% and 1Y CNH CCS is above 3.6%.

Economics

Stock market likely helped Q2 growth to stabilize at 7% China’s real GDP growth stabilized at 7% yoy in Q2 (Q1: 7%; Consensus 6.9%; DB: 6.8%). The nominal GDP growth picked up to 7.1% in Q2 from 5.8% in Q1.

GDP growth and forecasts, yoy%

7.0 7.0 7.07.2

6.0

7.0

8.0

9.0

10.0

20

11

Q1

20

11

Q2

20

11

Q3

20

11

Q4

20

12

Q1

20

12

Q2

20

12

Q3

20

12

Q4

20

13

Q1

20

13

Q2

20

13

Q3

20

13

Q4

20

14

Q1

20

14

Q2

20

14

Q3

20

14

Q4

20

15

Q1

20

15

Q2

20

15

Q3

F

20

15

Q4

F

Source: Deutsche Bank, WIND

Sector data show that the equity market likely played a key role. The nominal growth of tertiary sector jumped

to 12.7% in Q2 from 9.6% in Q1 and contributed to 81% of nominal GDP growth in Q2 and 57% of real GDP growth in Q2. The government has not released Q2 data on the exact contribution from the financial service sector, but Q1 data show that the jump of contribution from the tertiary sector was indeed driven entirely by the financial service sector. With the strong equity market rally for most of Q2 we believe this trend likely continued.

Growth of fixed asset investment (FAI) was flat at 11.4% yoy ytd in June. Growth of retail sales rose to 10.6% in June from 10.1% in May. Growth of industrial production improved to 6.8% in June from 6.1% in May, but growth of power generation remained low at 0.5%.

Nominal GDP growth by sector, yoy%

0%

2%

4%

6%

8%

10%

12%

14%

2014Q4 2015Q1 2015Q2

Primary and secondary industry Tertiary industry

Source: Deutsche Bank, Bloomberg Finance LP

Tertiary sectors: share of contribution to real

GDP growth

0

15

30

45

60

2013Q

1

2013Q

2

2013Q

3

2013Q

4

2014Q

1

2014Q

2

2014Q

3

2014Q

4

2015Q

1

2015Q

2

Financial Other tertiary sectors%


20 July 2015



There are two positive signs in the economy outside the financial sector. The first is fiscal policy easing. Growth of funds available for FAI rebounded to 6.3% yoy ytd in June, driven by a sharp rise of budgetary funds to 18.6% from 10.3%. Infrastructure investment growth picked up to 19.1% in June from 18.1% in May. This reinforces our view that fiscal policy easing has started in May.

The other sign is that leading indicators in the property sector continue to improve. Growth of property sales rose further to 10.0% yoy ytd in June from 3.1% in May. Growth of funds available for developers improved to 0.1% from -1.6%. While property investment growth slowed to 4.6% from 5.1%, we expect it to stabilize in Q3 and likely to pick up in Q4.

IP vs. power generation

0%

4%

8%

12%

16%

-15%

-5%

5%

15%

25%

Feb

-11

Jun-1

1

Oct-

11

Feb

-12

Jun-1

2

Oct-

12

Feb

-13

Jun-1

3

Oct-

13

Feb

-14

Jun-1

4

Oct-

14

Feb

-15

Jun-1

5

Power generation, yoy% IP, yoy%, rhs


Funds available for FAI ytd, yoy%

-10%

0%

10%

20%

30%

40%

Jan-1

1

Ap

r-11

Jul-11

Oct-

11

Jan-1

2

Ap

r-12

Jul-12

Oct-

12

Jan-1

3

Ap

r-13

Jul-13

Oct-

13

Jan-1

4

Ap

r-14

Jul-14

Oct-

14

Jan-1

5

Ap

r-15

Total State budget


Data on migrant workers show a worrying sign. The number of migrant workers grew by only 0.1% in Q2, the lowest growth since the data become available in 2012. This is consistent with the weak growth of power generation. It suggests the pace of urbanization may have slowed structurally. We highlighted this issue after Q1 data were released.

We leave our growth and policy outlook unchanged. We continue to expect GDP to grow at 7.0% in Q3 and 7.2% in Q4. Our full year GDP growth remains at 7.0% in 2015 and 6.7% in 2016. We expect one interest rate and one RRR cut in 2015, both in Q3. We expect the contribution from financial sector growth to drop in H2, but investment growth will pick up due to policy easing.

Migrant worker number and growth

155

160

165

170

175

180

0%

1%

1%

2%

2%

3%

3%

4%

4%

2012Q

1

2012Q

2

2012Q

3

2012Q

4

2013Q

1

2013Q

2

2013Q

3

2013Q

4

2014Q

1

2014Q

2

2014Q

3

2014Q

4

2015Q

2

Migrant worker, mn, rhs Migrant worker, yoy%


The risks to our growth outlook in 2015 and 2016 are on the downside. The risks are particularly high in H1 2016 when the equity market boom in H1 2015 imposes an unfavorable base effect. We believe this makes it more likely for the government to cut 2016 growth target to 6.5% from 7.0% in 2015.

Policy easing continued with rate and RRR cuts The PBoC cut the one-year benchmark lending rate and deposit rate by 25 basis points to 4.85% and 2% respectively on 27 June. It cut RRR by 50 basis points for some banks whose lending to rural borrowers and small and medium-sized enterprises is over a certain threshold. It also cut RRR by 300 basis points for financing companies.

This announcement came as a surprise to us. We expected an interest rate cut in June, but the combination of RRR and interest rate cuts is more than we expected. Moreover, timing-wise, we thought the most likely window for an interest rate cut was in early June when May data were released. The decision to cut on June 27 may have been driven by the stock market selloff since June 12.

While our baseline forecast remains unchanged, we are more concerned about the downside risks to the economy, particularly for 2016 (our baseline forecast for GDP growth is 7.0% in 2015 and 6.7% in 2016). It seems to us that the government is following a strategy of leveraging the equity market to boost economic growth. The strategy worked in Q1, as the financial service sector contributed 1.3ppt to GDP

20 July 2015



growth of 7.0%. This is higher than the historical average contribution of this sector of 0.8ppt. The equity market rally clearly helped the government achieve its growth target in H1.

But volatility in the equity market shows this strategy may pose risks to growth in the future. If the equity market drops significantly, the contribution from the financial service sector to GDP growth may return to its historical average, or even lower. This may be part of the reason why the PBoC decided to cut both interest rates and RRR on June 27 instead of waiting until July when June data become available.

The rate and RRR cuts will likely push up property prices in tier 1 cities in H2. Property prices in these cities already started to rise in recent months. We expect the pace may pick up further, as policy easing drives down financing costs and increases liquidity in the economy. Moreover, some investors may become concerned about the potential risks in the equity market and move more money into the property market.

Equity market deleveraging

What happened in the market and on policy front The equity market dropped sharply from its peak on June 12. There was a rapid buildup of leverage financing in the market before the sell-off happened. The deleveraging process turned out to be disruptive and forced the government to take action.

The CSRC announced a set of policies to stabilize the equity market on July 5. The most important policy is that the PBoC will provide "liquidity support" to the China Security Finance Corporation (CSFC). The CSFC will also raise its capital through major brokers who are its shareholders. Its capital will rise to RMB100bn from RMB 24bn. There was no announcement from other government agencies, including the PBoC, on that day.

According to Caijing (Chinese media), the State Council held a meeting to discuss how to handle the equity market selloff. While there is a general consensus that policy support is necessary, "some key agencies favored a gradual policy response". We think the PBoC may be reluctant to commit itself into an explicit market bailout, hence the CSRC statement only refers to "liquidity support", without mentioning the details such as the size and time horizon.

The equity market selloff continued after the CSRC statement. The deleveraging process started to have global implications, as we witnessed rising volatility for commodities, CNY and CNH exchange rates, and Chinese stocks listed overseas on July 7.

The PBoC released a statement on July 8 that it will “provide ample liquidity support to the CSFC through bond issuance, collateralized financing, relending etc to

stabilize the stock market” and “avoid systemic and regional financial risks”.

This is the first statement from the PBoC explicitly on the stock market since the selloff started. We take this as the government taking one step further to address the stock market volatility. While it does not provide much more information than the CSRC statement on July 5, it does suggest the PBoC has become more alert to the potential spillover effect from the equity market.

We do not think a PBoC intervention in the equity market is necessary to avoid a financial crisis in China. The equity market went through significant volatility, but the Shanghai composite stock index is still 18% up from the end of last year, one of the best performing markets in the world from a year-to-date perspective. The economy is dominantly dependent on the banking sector rather than the equity market for financing. Our banking team estimates the exposure of the banking sector to the leveraged financing scheme in the equity market to be only around RMB300bn. Hence it is hard to make a case that there is systemic risk from the equity market selloff for the economy.

We doubt this policy announcement means a significant stock purchase, directly or indirectly, by the PBoC. The CSRC statement only says "liquidity support", and there is no statement from PBoC or the State Council. Nonetheless, it heightens the uncertainty on growth and inflation beyond 2015. The PBoC's mandate requires it to focus on growth, unemployment, and inflation. With the high leverage in the economy and the looming fiscal challenges, the PBoC has a lot to handle in coming years. Its mandate becomes more obscure as it gets involved in the equity market.

What can the government do? There is a lot of doubt in the market about what the government can do if market volatility intensifies. We believe there are a lot of things the government can do. They can cut interest rates and RRR. They can intervene in the market much more heavily. They can send a stronger signal to the market through public statement, as the PBoC did on July 8. We believe the government’s capacity to intervene is higher than the US and Europe, because the government does not need approval from the People’s Congress to implement policies. If the PBoC needs to lend to banks or the CSF for intervention, it can happen quickly.

Why hasn’t the government done more? We think there may be several reasons. First, they are not convinced there are systemic risks. The domestic market rates remain stable. The government likely monitors financial conditions in the large financial institution on a daily basis. If there is a solvency or

20 July 2015



liquidity problem arising in one of them, the government may have moved faster.

Secondly, the government’s objective is to smooth out the deleveraging process and avoid systemic risks. In that sense their strategy is working. The outstanding amount of margin loans dropped quickly from its peak of RMB 2.26trn on June 18.

Thirdly, the stock prices in Shanghai remain quite high. The Shanghai index is down by 26% from its peak on June 12, but still up by 18% from end of last year, and 84% up from one year ago. The Chinext index, which focuses on the small stocks, is down by 35% from its peak on June 3, but still up by 76% from end of last year, and 93% up from one year ago. Valuation-wise many stocks onshore are still quite elevated. The potential costs for intervention may be high.

What may trigger more action? We believe the government may be watching (1) interbank liquidity condition; (2) CNY and CNH exchange rate, both spot and forward; and (3) liquidity condition in banks and other financial institutions. We think the government is comfortable to keep the current strategy and allow the deleveraging to take place. We believe the sharp selloff of Chinese assets overseas such as the H-share stocks in Hong Kong is not justified by the fundamentals, and it does not reflect the true capacity of potential policy responses.

The elusive wealth effect The sharp selloff in China's equity market has led to concerns in the market on the negative wealth effect. The consensus is that the effect is small, as the CSI300 index is still up 12% year to date and 82% y-o-y. We believe it is misleading to draw inference from market index and market cap because they draw a distorted picture of wealth. We found that retail investors' wealth in stock market has dropped close to its level at the beginning of the year. This suggests that the stock market may pose a threat to growth if the market drops significantly further in H2.

CSI300 stock market index

1,500

2,500

3,500

4,500

5,500

Jul-1

4

Aug

-14

Sep

-14

Oct-

14

No

v-1

4

Dec-1

4

Jan-1

5

Feb

-15

Mar-

15

Ap

r-1

5

May-1

5

Jun-1

5

Jul-1

5


The stock market index gives a misleading picture on the wealth effect. For instance, if the market goes up because of large inflows of investors' cash, we need to control for such inflows to get a precise estimate on what happens to total wealth. In other words, the stock market index tells us the output (the share prices in aggregate), but not the input (cash injected from investors). The market cap can be misleading as well, as it is contaminated by the IPOs and cash flows.

We build a model to estimate the true wealth effect, controlling for issues such as cash flows. Due to data availability, we first focus on retail investors who invest directly into the stock market. This is not the full wealth effect for households, as retail investors may choose to put money in mutual funds or regulated hedge funds (Simu funds in Chinese). Our second step estimates the relative size of such indirect investment.

The results are quite striking. We estimate that retail investors' wealth dropped by about RMB 6trn from June 12 (when the market peaked) to July 3, with an average weekly loss of some RMB 2trn. This is roughly equivalent to the gains of wealth from the beginning of this year till June 12. In other words, retail investors' wealth is collectively back to where it was on January 1. But, from a y-o-y perspective, their wealth is still up RMB 2trn.

20 July 2015



Cumulative nominal gains in wealth of individual stock

investors in Shanghai and Shenzhen markets since

June 2014

0

2

4

6

8

10

Jul-1

4

Aug

-14

Sep-

14

Oct

-14

Nov

-14

Dec

-14

Jan-

15

Feb-

15

Mar

-15

Apr

-15

May

-15

Jun

12-1

5

Jun

26-1

5

Jul 3

-15

(RMB trillions)

Source: Deutsche Bank, Industry data

One caveat in this calculation, as mentioned earlier, is that investors can also make stock investments through mutual funds or regulated hedge funds. Our estimates suggest that the total scale of such indirect stock investment is somewhere between one fifth to a quarter of retail investors’ direct stock investment. Taking it into consideration may affect the size of our estimate, but qualitatively our conclusion should remain the same.

To summarize, we believe the market volatility has moved households' wealth back to its level in the beginning of the year. We doubt there is a large macro impact on consumption for now, but if the market volatility continues and the market continues to drop in H2, it could impose a threat to the economy. We are working on this issue and will revisit it soon.

What happens if consumption surprises on the downside? We believe the government is committed in achieving 7% growth, hence it will push the investment side harder to offset the weak consumption. We expect the government to revise the budgeted fiscal deficit up from 2.3% of GDP in 2015. We forecast the actual fiscal deficit may be 3.7% of GDP. There will likely be policies to boost spending of local government financing vehicles as well.

Removal of LDR cap in the banking sector The State Council endorsed the draft amendment of the PRC Commercial Banking Law on June 25, which removed the regulatory LDR cap of 75%. The amendment will be sent to the Standing Committee of National People’s Congress for approval. This amendment is well anticipated in the market. We

expect the immediate macro impact of this amendment itself to be marginal, as this is not the binding constraint for loan growth for the large banks in China. Nonetheless we do expect credit growth to pick up in the next few months, as monetary and fiscal policies loosened since March.

Zhiwei Zhang, Hong Kong, +852 2203 8308

Investment Strategy

Fixed income strategy: Assessing equity spillover to RMB interbank liquidity The sharp correction in the equity market over the past two weeks has caused rising concerns over the spillover risk to the interbank market. We take a look at the potential transmission channels from the equity market to the onshore and offshore interbank market.

The first transmission from equity market to the interbank market is via commercial banks’ exposure. Commercial banks’ main exposure to the equity market is via funds raised from wealth management products which have been channeled to securities brokers for investments or for IPO funding. Because the CBRC (banking regulator) strictly prohibits banks use WMP funds to invest in equities, such funds from banks usually take part in the off-field leverage via trusts (umbrella trusts), entrusted financing, brokers financing, or structured funds and carry a leverage ratio of no more than two times (many banks have reduced the leverage ratio from three times to two times since April). We think the limited impact on interbank liquidity can be explained by the following three factors: First, considering banks’ WMP funds are the preferred class in the structured funds for equities, and are protected via the trusts or entrusted financing, we think equity losses will be absorbed securities brokers and trust companies first before they hit the banks WMP funds. Secondly, we understand currently the amount of banks’ WMP exposure to the equity market is about RMB1trn, less than 10% of the outstanding balances of banks’ WMP market (RMB15trn by the end of 2014), and less than 1% of banks’ total assets (RMB 168trn by the end of 2014). Thirdly, only a limited number of banks are active in the WMP funding to the equity market, this is understandable because banks are mostly in the loan and fixed income/currency market, they are not typical equity market investors and are slow in responding to equity rally, especially given the rally since March has been so sharp. As such we think the system threat to the entire banking sector is limited for now.

Another transmission from equity to the interbank market is the interbank borrowing by securities brokers. If equity continues to sell off, it is possible that securities brokers will start to borrow from the interbank market, and it may squeeze interbank

20 July 2015



liquidity. With PBoC standing by to provide liquidity to the securities brokers according to PBoC’s statement this morning, we believe the risk of interbank liquidity squeeze will be prudently managed and the central bank may step up liquidity provision if needed.

The third transmission is asset allocation flows between the equity market and the fixed income market. By the end of June, securities companies held RMB283bn cash and equity funds held about RMB350-530bn cash bonds. In the near-term, we see risks for fund redemption, and given equity liquidity is low, bonds position will likely be reduced, and such selling will primarily affect the credit bond market. On the other hand, equity revaluation and flight to quality flows should drive investment inflows to the cash bond market. The above two factors will drive up volatilities in the bond yields.

Offshore RMB liquidity continued to improve Offshore RMB liquidity, measured by short-dated FX implied yields (overnight and 1W tenor) indicates liquidity has improved from last week. This in our view is due to two factors: (a) Redemption of Northbound investment under the Stock Connect program. Net investment inflows (Northbound investment – Southbound investment) dropped from RMB71bn to RMB59bn yesterday; (b) possible onshore interbank repo financing by offshore RMB participating banks which injects liquidity. With more banks likely to be operationally ready to tap into onshore short term liquidity in the coming weeks, it will help ease liquidity pressure in the offshore RMB market.

Retaining steepening bias due to supply risk.

Although we think there is limited equity spillover to the fixed income market, we expect RMB money market volatility and bond market volatility to remain high. This is because (a) equity market is likely to remain volatile in the near term; (b) policy support measures such as liquidity injection by the PBoC is likely to be reactive than proactive, and uncertainties of the market impact from policy actions could be another source of volatility risk; (c) relative valuation between A-H market, cross border investment by onshore and offshore investors will increase the volatility of cross border RMB flows. We expect the overnight repo rate to fluctuate between 1-1.5% range and 7D repo between 1.75% -2.5% in the near-term.

Rising supply risk: On the bond market, we still see steepening bias on the curve because (a) Our Chief Economist, Zhiwei Zhang expects fiscal expansion in the H2 to result in additional financial demand by the central government. We forecast this would likely imply an additional net CGB supply of about RMB400bn, 35% more than planned in the 2015 Budget. (b). There is increasing risk of an additional RMB1trn local government debt swap to be carried out

later this year. We expect the first RMB1trn local government debt swap to be completed by the end of August, and the second batch of the RMB1trn swap will start soon after, and if the third batch of RMb1trn swap will be confirmed, (i) it would be partially front-loading the RMB 2trn swap which we expect in 2016 into 2015 to take advantage of the current low interest rate environment; (ii) it would imply municipal bond gross supply will rise to RMB380bn per month in H2. If we add the CGB supply, monthly supply in H2 could reach RMB450bn, over RMB100bn higher than our previous forecast; (c) This would significantly crowd out commercial banks investment into other fixed income assets such as financial bonds as well as credit bonds. On the other hand, we expect the PBoC to carefully manage the liquidity condition using a combination of RRR cuts and medium to long term liquidity facilities on a targeted basis to ensure proper monetary policy transmission as well as to support the market demand. We expect the 10Y CGB to trade within the range of 3.3-3.8%. We recommend keep our duration exposure at the front end of the CGB curve (3Y or shorter tenor). We maintain a modest bullish bias on RMB rates and would look for opportunities to build receiving positions on rates (NDIRS and CNH CCS) when 5Y is above 3% and 1Y CNH CCS is above 3.6%.

PBoC liberalizes bond market access to foreign reserve managers

On July 20th, the PBoC announced the Notice on investment into RMB interbank market by foreign central banks, supranational financial institutions and sovereign wealth funds. The PBoC indicated in the RMB Internationalize Report released in June that it will consider removing interbank bank bond market investment quota by foreign monetary authorities and will allow these institutions to choose either RMB or other custodians in the interbank market. As such the announcement is not a surprise to us or to the market.

The Notice specifies nine items and we believe these are three key points:

1. Simplify onshore bond market access by filing for registration: To access onshore interbank bond market, foreign monetary authorities only need to file for registration with the PBoC, instead of applying for quota approval by the PBoC as it was in the past;

2. Substantial relaxation in the scope of investable products: Foreign reserve managers can trade all fixed income products available in the interbank bond market including cash bonds, repos, bond borrowing and lending, bond forwards, interest rate swaps, interest rate forwards, and PBoC does not restrict the investment amount or size of the transactions. Prior to this Notice, foreign investors with onshore interbank bond market access (foreign central banks, RMB clearing banks and participating banks, foreign

20 July 2015



insurance companies) can only trade cash bonds and repos. Now foreign reserve managers can trade the full scope of fixed income products available in the interbank bond market. The only product not available is the bond futures which trade in China’s Financial Futures Exchange, and currently major bond market investors such as banks and insurance companies also have no access;

3. Reserve managers can choose either PBoC or other interbank bond market custodians. PBoC has been the sole custodian for all foreign monetary authorities for interbank bond market investment, following this Notice, foreign reserve mangers can choose qualified custodians in the market freely.

Market implications: 1. China further opens up RMB fixed income market. By removing controls over onshore investment quota and investable products, China has liberalized interbank bond market access by foreign reserve managers. It affirms our view that China remains committed to financial liberalization reforms as well as opening up domestic capital market and RMB is on track towards convertibility.

2. The near-term impact is limited. We see limited near-term impact on the market. We understand that currently about RMB600bn quota has been granted to foreign monetary authorities, although actual investment is around 60% of the approved quota. In other words, the current quota is non-binding, which reflects the near term practical constraints such as the time it takes to grow the market knowledge, the liquidity condition in the market relative to reserve demand etc.

3. Foreign reserve inflows will boost medium to long term demand for RMB bonds. We expect reserve management inflows to boost the long term demand for onshore RMB bonds, particularly sovereign bonds and quasi sovereign bonds. We expect foreign reserve managers to potentially hold up to 5% of China’s domestic bond market over the next three to five years (implying about RMB3trn reserve money inflows) and we think China’s domestic bond market is sufficient large to accommodate such investment demand. Over the longer term, we forecast about 10% of global foreign reserves to be invested in the RMB bond market. To meet foreigners investment demand over the longer term, we expect China to grow the domestic debt market both in terms of the size, the depth (to grow more asset classes such as the MBS/ABS market, the municipal bond market, money market instruments, corporate debt etc), and the liquidity of both cash products and derivatives products market. However, this does not necessarily mean that the government has to significantly increase fiscal deficit financing, rather it can be achieve by maintaining sustainable

debt financing (about 8-10%), while promoting direct financing in the market to replace the stock of indirect financing over time.

4. What’s next? We expect China to further liberalize foreigners onshore bond market access. Specifically, we expect (a). RQFII program will continue to expand and QFII/RQFII quota approval will be simplified over time; (b) Individual investment quota by foreign institutional investors is likely to be removed over time; (c). The pool of investable fixed income products by other types of foreign institutional investors will be expanded such that all foreign investors will have the same product access as domestic interbank market players. We forecast foreign investors to hold up to 10% of China’s domestic bond market in the next five years.

Linan Liu, Hong Kong, +852 2203 8709

20 July 2015



China: Deutsche Bank forecasts

2013 2014 2015F 2016F

National income

Nominal GDP (USD bn) 9,484 10,366 11,087 12,219

Population (m) 1,361 1,366 1,373 1,380

GDP per capita (USD) 6,970 7,586 8,073 8,853

Real GDP (YoY%)1 7.7 7.4 7.0 6.7

Private consumption 7.6 7.6 7.5 7.3

Government consumption 8.2 8.3 8.0 8.4

Gross capital formation 9.0 6.8 6.3 6.0

Export of goods & services 6.7 5.6 5.4 4.5

Import of goods & services 7.3 4.6 3.9 3.0

Prices, Money and Banking

CPI (YoY%) eop 2.5 1.5 2.2 2.7

CPI (YoY%) ann avg 2.6 2.0 1.6 2.7

Broad money (M2) eop 13.6 12.3 14.0 14.0

Bank credit (YoY%) eop 14.1 13.4 13.8 13.5

Fiscal Accounts (% of GDP)

Budget surplus -1.9 -2.1 -3.7 -3.0

Government revenue 22.7 22.0 21.3 22.0

Government expenditure 24.6 24.1 24.3 25.0

Primary surplus -1.4 -1.6 -2.5 -2.5

External Accounts (USD

bn)

Merchandise exports 2,209 2,209 2,333 2,473

Merchandise imports 1,950 2,001 2,081 2,154

Trade balance 259 208 252 319

% of GDP 2.8 2.0 2.3 2.6

Current account balance 182.8 321.3 376.9 403.2

% of GDP 2.0 3.1 3.4 3.3

FDI (net) 117.6 160.0 150.0 150.0

FX reserves (USD bn) 3,821 3,906 4,021 4,055

FX rate (eop) CNY/USD 6.1 6.2 6.2 6.2

Debt Indicators (% of GDP)

Government debt2 15.3 17.4 20.4 23.4

Domestic 15.1 17.2 20.2 23.2

External 0.2 0.2 0.2 0.2

Total external debt 9.4 10.0 10.5 11.0

in USD bn 863 1,037 1,164 1,344

Short-term (% of total) 78.4 75.0 75.0 75.0

General (YoY%)

Fixed asset inv't (nominal) 19.6 15.7 15.0 14.0

Retail sales (nominal) 13.1 12.0 12.8 12.5

Industrial production (real) 9.7 8.2 7.6 7.0

Merch exports (USD nominal) 7.8 0.0 5.6 6.0

Merch imports (USD

nominal)

7.2 2.6 4.0 3.5

Financial Markets Current 15Q3F 15Q4F 16Q2F

1-year deposit rate 2.00 1.75 1.75 1.75

10-year yield (%) 3.54 3.40 3.40 3.50

CNY/USD 6.21 6.20 6.20 6.20 Source: CEIC, DB Global Markets Research, National Sources Note: (1) Growth rates of GDP components may not match overall GDP growth rates due to inconsistency between historical data calculated from expenditure and product method. (2) Including bank recapitalization and AMC bonds issued

20 July 2015



Hong Kong

Economic outlook: We have revised down our 2015 growth forecast slightly, to 2.5%, on weak exports. The worst of the decline in consumption may be past. The outlook for 2016 is for slightly stronger growth on a modest pickup in export growth and stronger government spending.

Main risks: Our forecast for export growth is well below real growth in Hong Kong’s export markets, which could be a source of upside risk to the outlook. Tourists account for 18% of consumer goods sales and our forecast that the recent dip is temporary may be overly optimistic.

Strategy: Over the past few months, there have been concerns that, with the Fed possibly raising rates sometime in 3Q15, there could be upside risk to USD/HKD. We, however, remain of the view that any weakness in HKD is likely to be limited. We think USD/HKD should continue to trade on the strong side of the band.

Economics

Focus on the consumer With merchandize trade having been little better than flat for the past two years we focus this month on the recent performance of and outlook for private consumption. The monthly retail sales figures provide a snapshot of demand that accounts for about 30% of domestic spending on consumer goods and services. Services account for just over half of spending but are not included in the retail sales survey. From domestic sales to PCE in the GDP accounts one removes sales to non-residents (these are reported as exports) and adds purchases abroad by residents.

Domestic sales (in PCE) and the retail sales survey

0

200

400

600

800

1,000

1,200

1,400

1,600

1,800

Domestic sales Retail sales

Services

Non-durables

Durables

Food

HKDbn

Sources: CEIC and Deutsche Bank Research

But the retail sales data track the growth of domestic sales on goods very well. The recent news has been mixed. Retail sales volumes fell 1.8%QoQ(sa) in Q1 and are likely to post a larger decline in Q2. However, the worst may be past, as sales volumes in May posted a 2.6%mom(sa) rise, the first in four months, and April’s decline was only 0.1%. Because sales were actually much weaker a year ago, the YoY growth in sales has rebounded strongly to 5.5%yoy in April/May from 0.1% in Q1.

Real sales of goods and retail sales volumes

-20

-15

-10

-5

0

5

10

15

20

25

93 95 97 99 01 03 05 07 09 11 13 15

Retail sales volume

Real sales in domestic market

%yoy


It’s clear, however, that sales of consumer goods have been very weak over the past year. But this was not translated into weak PCE growth because it was mainly driven by a decline in tourist spending. Visitors account for about 18% of sales of consumer goods and services, and while the growth in visitor arrivals has slowed over the past year, spending by these visitors has plummeted. Spending per visitor was down about 12% last year, partly because the prices of things they buy – European luxury goods, for example – are falling relative to prices of other consumer goods. But even in inflation-adjusted terms, spending is down noticeably.

20 July 2015



Tourist arrivals and real visitor spending growth

-20

-10

0

10

20

30

40

50

05 06 07 08 09 10 11 12 13 14 15

Arrivals Non-res spending%yoy


Real PCE growth hasn’t been particularly weak recently – running about in line with its long-run average growth rate. To understand why, we build a simple model of consumption as a function of real wages, real interest rates, real property prices and real equity prices.

Our simple PCE model

-10

-5

0

5

10

15

94 96 98 00 02 04 06 08 10 12 14

PCE Model%yoy

Sources: CEIC and Deutsche Bank Research. From 1994 to 2015, the model is:

PCE = 3.1+0.20*Real income – 0.18*Real Hibor + 0.08*Real property + 0.04*Real equity (R2=0.80).

We used dummy variables for the Asian and global financial crises and SARS.

PCE growth has been supported by very strong asset price inflation and negative real interest rates which offset poor earnings growth last year. But we are concerned that these are not likely to be sustained. We expect real interbank interest rates to rise 130bps over the next 18 months. Not only will this have a direct effect in dampening consumption, but historically, although the relationship is no longer strong, this would have been a significant negative for the property market as well. And with real property prices at all-time highs and rental yields at all-time lows, we don’t expect this part of the wealth effect to remain as supportive. We are more positive on the outlook for

equities though with real equity prices still broadly moving in line with real GDP.

But without much stronger income growth, we fear ‘liftoff’ and even a slow pace of Fed rate hikes will depress consumption via rising real interest rates and a weakening of the property wealth effect. Our forecast, therefore, has a significant slowdown in consumption growth over the next year. But this will likely be offset in its impact on GDP growth by a modest pickup in exports and by stronger growth in government spending, two topics we will pick up in subsequent monthlies.

Michael Spencer, Hong Kong, +852 2203 8305

Investment strategy

No lift off yet in USD/HKD Over the past few months, there have been concerns that, with the Fed possibly raising rates sometime in 3Q15, there could be upside risk to USD/HKD. We, however, remain of the view that any weakness in HKD is likely to be limited. Although US monetary policy remains the primary influence on Hong Kong's money market under the pegged-currency regime, the ongoing rapid opening of China’s capital account is influencing HKD demand and offsetting the impact USD rate rise has on the HKD. In our view, China continuing to open up its capital account, and in particular our expectation that China should introduce QDII2 soon; could further offset any HKD weakness and keep demand for HKD strong. We think USD/HKD should continue to trade on the strong side of the band.

Tactical receiving 10Y IRS: We recommend a tactical receiving position on the 10Y HKD IRS. The long end of the HKD IRS curve underperformed the USD curve with HKD - USD 10Y IRS spread widened from -30bps by the end of June to -23bps currently. We expect the HKD IRS to lag the USD curve as HKD liquidity remains flush and the HIBOR fixing is more likely to lag the USD Libor fixing either in the event of no hike or a delayed hike later this year. The 10Y HKD IRS is likely to stay within the 1.7-2.3% range and we recommend receiving 10Y HKD IRS tactically at 2.22% and target a 17bps rally and a stoploss at 2.32%.

Perry Kojodjojo, Hong Kong, +852 2203 6153 Linan Liu, Hong Kong, +852 2203 8709

20 July 2015



Hong Kong: Deutsche Bank Forecasts

2013 2014 2015F 2016F

National Income

Nominal GDP (USD bn) 274.7 289.7 305.4 324.4

Population (mn) 7.2 7.3 7.3 7.4

GDP per capita (USD) 38035 39882 41798 44121

Real GDP (YoY%) 3.1 2.5 2.5 3.0



Gross fixed investment 2.6 -0.2 7.3 4.8

Exports 6.2 0.8 0.3 2.0

Imports 6.6 1.0 1.0 2.3


CPI (YoY%) eop 4.3 4.8 2.5 3.6

CPI (YoY%) ann avg 4.3 4.4 3.0 3.8

Broad money (M3, eop) 12.4 9.6 11.4 6.5

HKD Bank credit (YoY%, eop) 8.2 10.9 17.0 2.4

Fiscal Accounts (% of GDP)1

Fiscal balance 1.0 3.6 2.4 2.3



Primary surplus 1.0 3.6 2.4 2.3

External Accounts (USD bn)

Merchandise exports 506.2 519.3 526.5 542.2

Merchandise imports 534.1 549.4 559.5 577.7

Trade balance -27.9 -30.1 -33.0 -35.5

% of GDP -10.1 -10.4 -10.8 -10.9


% of GDP 1.5 1.9 0.7 1.0

FDI (net) -6.5 -39.4 14.4 -12.0

FX reserves (USD bn) 311.2 328.5 356.4 379.8

FX rate (eop) HKD/USD 7.75 7.76 7.75 7.75


Government debt1 8.4 7.1 7.5 7.9

Domestic 7.9 7.1 7.5 7.8

External 0.5 0.1 0.1 0.1


in USD bn 1160.7 1290.4 1405.0 1458.8


General

Unemployment (ann. avg, %) 3.4 3.2 3.3 3.4

Financial Markets Current 15Q3F 15Q4F 16Q2F

Discount base rate 0.50 0.75 1.00 1.50

3-month interbank rate 0.39 0.60 0.88 1.40

10-year yield (%) 1.94 1.95 2.10 2.20

HKD/USD 7.75 7.75 7.75 7.75 Source: CEIC, DB Global Markets Research, National Sources Note: (1) Fiscal year ending March of the following year. Debt includes government loans, government bond fund, retail inflation linked bonds, and debt guarantees..

20 July 2015



India

Economic outlook: Recovery continues but at a slower pace than expected. We see downside risks to our 7.5% real GDP growth forecast for FY16 if (i) monsoon and agricultural production disappoint and (ii) investment recovery remains anemic.

Main risks: Lack of a vigorous economic recovery could be mutually self-reinforcing, as weak growth raises NPAs, undermining the financial sector, further restricting intermediation. Weak growth could also make achieving the FY16 fiscal target particularly challenging.

Strategy: The ‘outside in’ view on India is decidedly more positive – and talks to the adjustments made over the last couple of years – than the ‘inside in’ perspective, which is focused more on the cyclical challenges India is facing. There seems little space in the immediate term for RBI to ‘relent’, so India to us remains mostly appealing on carry (given also the low vol) rather than on capital appreciation. We are small overweight on duration, and like the currency versus the regional low yielders like SGD, KRW, TWD and THB.

Economics

As the world slows, can India accelerate? From multilateral organizations to the analyst community, downward revisions to the global growth forecast have been a recurring story lately. Having disappointed in the first quarter, the US growth outlook looks no different from the past few years, while concerns about China and the Eurozone remain heightened. Against this backdrop, the forecast for India remains fairly buoyant across the board, with our 7.5% growth expectation a bit below expectations. The question for the rest of the fiscal year is if policies can support a revival in domestic demand to offset weak external demand.

Data on investment is decidedly mixed. The CMIE survey of Indian firms’ investment trend now extends through June of this year. It appears that the investment environment improved somewhat in April-June, in line with recent trend. Still, several aspects of investment remain weak.

Stalled/shelved projects. Cost of stalled/shelved projects moderated to INR793bn in April-June’15 (from INR1.1trn in April-June’14), constituting a 29%yoy decline. Cost of stalled projects has been coming off steadily from September of last year, but despite some improvement, the cost remains high relative to trend.

While cost has reduced somewhat, stalled projects in terms of absolute units have increased in April-June’15 (to 157), from the previous two quarters (155 in Jan-March and 136 in Oct-Dec’14). It appears that the big ticket project backlogs are slowly easing, resulting in a lower cost of stalled projects, while smaller projects are still struggling to take off, with the number of such projects increasing each quarter.

Stalled projects (cost and units) – quarterly trend

0

1000

2000

3000

0

40

80

120

160

200

Stalled projects (total), lhs

Stalled project cost, rhs

No. of

projects

INR bn

Source: CMIE, Deutsche Bank

In our view, many of the smaller ticket projects have become unviable, not just due to a delay in environmental or other necessary clearances, but because previous cost and revenue assumptions are inconsistent with the prevailing macro environment, which is characterized by significantly lower nominal GDP growth, substantially higher real interest rates, and considerably costlier servicing of external debt. Given that these conditions are unlikely to change meaningfully in the near-term, we expect the absolute number of stalled projects to remain high compared to trend, though the cost could reduce further as more big ticket projects start taking off.

Nominal GDP growth down by 6-8%, real interest rate

has increased by 600-700bps and rupee has

depreciated more than 30% against USD (FY15

compared to FY11-12 avg.), which has rendered a lot

of investments unviable

Economic parameters FY04-FY10, avg.

FY11-FY12, avg.

FY13-FY14, avg.

FY15

Period 1 Period 2 Period 3 Latest #

Nominal GDP growth (% yoy)

14.3 18 13.3 10.5

Real interest rate (Repo - Avg. of CPI, WPI)

0.5 -2.9 -0.6 3.9

Real interest rate (5 yr corporate bond rate - Avg. of CPI, WPI)

1.9 -0.8 0.9 5.0

INR/USD 44.9 46.9 57.7 63.6

INR/USD (% change) 4.4 23.2 35.7

Source: CEIC, Deutsche Bank. Note: INR/USD positive change denotes depreciation of INR vs.USD

20 July 2015



Private sector stalled project costs (-22%yoy) including number of stalled projects (84 in April-June in vs. 124 in Jan-March) declined in April-June’15, while government sector stalled project costs moderated (-37%yoy), but absolute number of stalled projects increased to 73, from 31 in the previous quarter. This is one of the sharpest rise in government sector stalled projects (+181%yoy) since Oct-Dec’13 (+253%yoy). In FY15, the total number of private sector stalled projects was 471 (vs. 398 in FY14) which compared with 137 stalled projects in the public sector (vs. 140 in FY14).

Completed projects/stalled-completion ratio. Value of projects completed was down -3%yoy in April-June, but the rate of decline was lesser than the previous quarter (-23%yoy). Value of private sector projects completed (in INR terms) was down -27%yoy in April-June (vs. -19%yoy in Jan-March), while value of public sector projects completed was up 53%yoy (vs. -32%yoy). Absolute number of projects completed was 271, lower than 313 in the previous quarter. 95 public sector projects were completed in April-June vs. 88 in Jan-March, whereas the comparable figure for the private sector was 176 vs. 225.

With number of stalled projects increasing and projects completed falling in April-June versus the previous quarter, the stalled/completion ratio rose further to 57.9, from 49.5 in Jan-March. Private sector stalled/completion ratio reduced to 47.7 in April-June (from 55.1 in Jan-March), but was more than offset by a sharp rise in the public sector stalled/completion ratio (76.8 vs. 35.2). On an annual basis, stalled/completion ratio is however higher in case of the private sector (53.3 in FY15 vs. 43.9 in FY14) as compared to the public sector (45.8 in FY15 vs. 31.3 in FY14). With private sector stalled/completion ratio at a record high, it is hardly surprising that Indian companies are characterized by weak sales growth, anemic net profit growth, declining interest cover, and rising leverage.

Stalled/completion ratio has increased in April-June

0

20

40

60

80

0

100

200

300

400

500

600

700Projects completed (total), lhs

Stalled/completed ratio, rhs

No. of

projects


However, pvt. sector stalled/completion ratio has fallen

0

20

40

60

80

100

0

100

200

300

400

500

Projects completed (private), lhs

Stalled/completed ratio, rhsNo. of

projects


Net profit to sales of Indian Inc. at a multi-year low

3

5

7

9

11

13Profit after tax to Sales%

Source: CEIC, Deutsche Bank

Net debt/equity (%)

Utilities Capital Goods Telecommunication services

FY08 54.2 21.2 42.2

FY09 73.3 46.7 43.0

FY10 76.1 60.2 28.8

FY11 89.1 81.3 99.2

FY12 116.0 116.8 111.0

FY13 135.5 118.9 91.4

FY14 143.4 131.4 93.7

FY15 153.2 131.6 115.1

Source: Deutsche Bank

Banking sector spillover. As a result of many projects remaining stuck, banking sector non-performing assets (NPA’s) have increased over the period. As per RBI’s latest financial stability report, NPA’s of the banking sector (including re-structured assets) amounted to 11.1% of total assets by the end-of March 2015, which is at a multi-year high. Five key sectors (infrastructure, iron & steel, textiles, aviation, and mining) continue to constitute about a quarter of total advances of the banking sector and 51% of total stressed advances.

20 July 2015



Naturally, banks remain reluctant to lend out further to these sectors, resulting in credit growth remaining at a multi-decade low.

Five key sectors continue to constitute 51% of total

stressed advances

0

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20

30

40

50

60

2009 2010 2011 2012 2013 2014

Infrastructure share in stressed loans

Five sectors' share in stressed loans

%

Source: RBI, Deutsche Bank

What can the authorities do to support growth? Any large scale support through monetary easing is unlikely, given RBI’s inflation targeting regime. We think that having embarked on inflation targeting just a year ago, it will be hard for the monetary authority to switch to a multiple indicator approach. Given the projected path of CPI for the rest of the year and the inflation target, it is hard for us to see more than 25bps rate cut in this cycle.

It is also important to note that the burden cannot only be on monetary policy; a wide range of actions would have to lend support, starting from recapitalization of the banking system to public sector expenditure program to support economic activities.

There are some positive developments on the public investment front. Expenditure on road/transport/railways increased sharply in the first two months of FY16 compared to past trend (22.2% of FY16 budget estimate vs. 2.5% of FY15 actual). If this momentum is sustained then growth will likely get supported, and private sector would be encouraged to start investing once again.

The good news is that investment intention has picked up significantly since last Sept, indicating a strong pipeline of investment, which ought to be positive for the medium term growth outlook. True, the number of new investment proposals has reduced sequentially in the last few quarters, but April-June’15 marks the fourth consecutive quarter that witnessed strong yoy growth in announcement of new project proposals. According to CMIE, new investment intentions (502 projects) worth INR1.2trn were announced in the quarter ended June 2015, constituting 37%yoy growth.

We note that most of these new investment proposals are from the public sector, especially related to roads and the power sector.

New investments proposed in April-June’15

No. of projects Investment estimate, INR bn

Total new investments proposed 502 1180

Of which: Manufacturing sector 137 334

Power sector 22 512

Transport services 70 NA

Real estate 79 NA


IP grew 2.7%yoy in May’15, lower than the previous month’s outturn of 3.4%yoy (which was revised down from 4.1%yoy reported earlier). On a seasonally adjusted basis, IP declined -0.1%mom in May reversing the sharp acceleration recorded in April (+2.3%mom, sa). Given the volatility of the series, it is instructive to track the 3-month moving average of IP, which has moderated to 2.9% in May, from 3.6% in the previous month. The lower IP outturn in May can be attributed to a slowdown in manufacturing sector growth (2.2%yoy vs. 4.2%yoy in April), which more than offset the improvement recorded in mining (2.8%yoy vs. 0.2%yoy) and electricity (6.0%yoy vs. -0.5%yoy) sectors. Among use based classification, consumer goods (-1.6% vs. 3.0%) – both durables (-3.9% vs. 1.3%) and non durables (-0.1% vs. 4.2%) fared poorly in April vs. May, while capital goods production growth also fell to a 6-month low of 1.8%yoy (vs. 6.8% in April). The May IP data reflect a slow and uneven growth recovery which corroborates with the trend of other high frequency macro indicators that we track regularly (PMI, credit growth, capacity utilization, retail sales, non-oil-non gold imports growth etc.)

Economic momentum remains weak

-2.0

-1.6

-1.2

-0.8

-0.4

0.0

0.4

0.8

Apr-13 Sep-13 Feb-14 Jul-14 Dec-14 May-15

IP

Exports

Non oil Imports

Bank Credit

Car Sales

IMMI

z-score,

3mma


20 July 2015



Inflation picture and monetary policy outlook become complicated June CPI was 5.4%yoy (vs. 5.0%yoy in May), higher than our and consensus expectation. The upside surprise was mainly on account of a sharp rise in food prices (+1.8%mom in June’15 vs. +1.3%mom in June’14), especially in categories such as vegetables (+6.3%mom), eggs (+5.8%mom), pulses and products (+5.3%mom), meat & fish (+2.9%mom) and spices (+1.6%mom). We had expected food prices to increase by 1%mom in June, in line with recent trend, but clearly the increase was much more than we had anticipated. Fuel prices also firmed in June but at a slower rate than in May (+0.7%mom vs. +1.7%mom). Clothing/bedding/footwear (+0.9%mom vs. +0.5%mom) prices increased at a higher rate in June as compared to the previous month, while prices of miscellaneous services (+0.8%mom vs. +0.9%mom) and housing (-0.5%mom vs. +0.3%mom) was relatively lower. Overall, core CPI prices were up 0.5%mom in June, lower than the rate of increase in May (+0.7%mom).

For the next few months, we have factored in further increase in food prices (+2%mom in July and +1.5%mom in August) but even then CPI inflation should be edging lower to 4.5-4.6% in July and August due to a favorable base effect. However, once the base effect wears off from September, CPI inflation should be rising toward the 6% mark by the end of the year.

We see a small possibility of one last 25bps repo rate

cut in September

2

4

6

8

10

12

2012 2013 2014 2015 2016

CPI Repo

Forecast Forecast% yoy, %


With the recent upward surprise, it now seems the probability of achieving 6% inflation by early next year has declined somewhat. Sharp correction in food prices would be needed in the fourth quarter of this year for inflation to go the RBI's way, but we can't see conviction for that scenario strengthening in the month or so remaining before the August policy meeting. Against this background, a pause in the August meeting looks highly likely, in our view.

Apart from food prices, underlying inflationary pressure remains muted at this juncture:

Rural sector consumption demand remains weak, as rural wage growth and government spending on rural sector schemes have remained muted in the last few years; last year’s severe drought has further affected rural consumption demand.

RBI’s own inflation expectations survey show that households now expect inflation to be considerably lower compared to the past.

Brent crude oil prices are down 11% since RBI’s last meeting on 2nd June, which bodes well for the fuel price inflation outlook.

Increase in MSP prices of paddy (3.7%yoy) and pulses (6%yoy) have been modest this year, which is unlikely to pose any additional inflationary impulse to CPI, in our view.

Capacity utilization of various industries remains low while corporate and banking sector balance sheet continues to be under severe distress.

Clearly more rate cuts are needed to support growth and expedite monetary policy transmission, but the RBI has bound itself with inflation targets which will likely push the monetary authorities to continue erring on the side of caution. We are not giving up hope for one last rate cut of 25bps (possibly in the 29th September policy), though we acknowledge that room for further rate cuts has narrowed, given the risk to RBI’s January 2016 6% CPI target that has emerged on account of uncertain food price outlook.

Fiscal deficit on track but risks remain Earlier this month the government released the fiscal data for the month of May. Below we compare the fiscal position of the government in April-May of 2015 versus the corresponding period last year. For the current fiscal, we calculate the data as a % of budget estimate, while for the previous year, we use actual fiscal outturn to make the comparisons more relevant. Key findings:

Fiscal deficit has touched 37.5% of the FY16 budget estimate, which is lower compared to the outturn of the previous year (fiscal deficit was 48% of actual in April-May’14);

Net tax revenue collection was weak (2.2% of budget estimate vs. 3.2% last year);

Non-tax revenue collection was strong (14.6% of FY16 budget estimate vs. 5.0% in the corresponding period of the previous year),

Total expenditure was 14.8% of FY16 budget estimate, lower than the previous year’s outturn in April-May (17.0%);

20 July 2015



Capital expenditure was 13.3% of FY16 budget estimate, in line with last year’s trend (13.1%), while non-plan expenditure was significantly lower compared to last year (15.3% vs. 18.5%), which pushed down total expenditure in the first two months of FY16 compared to last year (-6.2%yoy).

Expenditure on key subsidies has been in line with past year’s trend, except for fuel, which will get adjusted once the government makes the arrears payments to the oil marketing companies (the government has sanctioned INR52bn of subsidies to be paid to the OMC’s pertaining to the Jan-Mar’15 quarter). We do not see any upside risk to fuel subsidies but spending on fertilizer (INR730bn or 0.5% of GDP) and food (INR1.2trn or 0.9% of GDP) could exceed budget targets if weather affects food supply and farm level income. In the previous fiscal year, which was characterized by a severe drought, food subsidies overshot the budget target by INR77bn or 0.1% of GDP; a repeat of the same is probable this year, if monsoon rains disappoint meaningfully going forward.

A detailed analysis of the tax collection trend reveals the following:

Gross tax revenue collection in April-May of 2015, has been lower than the trend of the previous two years (6.6% of budget estimate vs. 6.8% of actual);

Overall tax collection rate is lower compared to the previous year on account of a slow pickup in direct tax collection in the first two months (4.1% of FY16 budget estimate vs. 5.6% of FY15 actual); both corporate (0.2% vs. 0.7%) and income tax (9.7% vs. 13.7%) collection have been lower in the first two months of this fiscal compared to the corresponding period of the previous year;

This is despite indirect tax collection faring significantly better than last year (9.4% of FY16 budget vs. 8.2% of FY15 actual). This reflects the difference in excise duties of petroleum products between this and last year in April-May (excise duty hikes on petroleum products happened only in the latter end of the last fiscal year; hence, yoy numbers will continue to get exaggerated on the higher side till such normalization is achieved);

We also note that the transfer of central taxes to states is running at a slower pace thus far compared to last year, both as a % of budget estimate (14.2% vs. 16.3%) as well as compared to the FY16 yoy increase that has been budgeted (35%yoy actual in April-May’15 vs. 54.6%yoy according to budget projection); this is important to track as lower tax mobilization to states may result in states spending less on capital expenditure, which could then adversely impact growth.

Tax collection trend: April-May’15

Items FY16BE target (%yoy)

Apr-May’15 (%yoy)

Apr-May’14 (%yoy)

% of FY16 budget

% of FY15 actual

Gross Tax Revenue

16.4 12.8 8.7 6.6 6.8

Direct Taxes 16.1 -15.0 28.2 4.1 5.6

Corporate Tax 9.7 -64.9 -7.8 0.2 0.7

Income Tax 26.7 -10.8 32.6 9.7 13.7

Indirect Taxes 18.9 36.1 -4.4 9.4 8.2

Customs 10.8 20.6 -9.5 14.4 13.2

Excise 21.6 145.1 -18.2 5.9 2.9

Services 24.9 20.6 14.0 8.3 8.6

Others -71.8 33.2 37.4 47.9 10.1

Memo

Transfer to states

54.6 35.0 11.8 14.2 16.3

Source: Controller General of Accounts, Deutsche Bank

Overall assessment: Given the way the economy is shaping up, we think that keeping the fiscal deficit in line with the budget target of 3.9% of GDP could face a number of challenges:

Lower nominal GDP growth: Based on the actual GDP outturn for FY15, the government’s implicit nominal GDP growth assumption for FY16 works out to 12.5%yoy, which is optimistic, in our view. In FY15, nominal GDP growth was 10.5%yoy as GDP deflator fell sharply to 3.2% (while CPI inflation averaged 6.0%) from 6.3% in FY14. In FY16, given subdued inflationary pressure (we forecast CPI inflation to average 5.5%), chances are that nominal GDP growth would be even lower (as GDP deflator could be lower than the FY15 outturn), which implies risks to revenue collection as tax collection tends to move with the underlying nominal rate of expansion of the economy. It also means that expenditure as a share of GDP will be higher, which could make it challenging to meet the fiscal deficit target.

Direct tax: Pace of direct tax (constituting 55% of total gross tax revenue) mobilization remains slow so far versus trend and could fall short of target, especially if economic growth does not pick up. The weakness in corporate and income tax growth could persist if trade and production do not pick up from the trend seen in recent years and household income growth is muted.

Indirect tax: Thanks to higher excise duties, indirect tax collection is off to a strong start, but the budget has ambitious collection goals for the year (19.2%yoy growth in FY16 vs. 7.0%yoy average growth in the previous two years) in any case. We worry if these receipts could falter as well if economic growth fails to recover.

Disinvestment: The disinvestment target of INR695bn or 0.5% of GDP is highly ambitious. Equity markets must remain buoyant through the year, all regulatory

20 July 2015



hurdles must be overcome, stakeholders must be brought on board, and investors’ patience with the government’s ability to deliver growth must remain as stakes are sold. Getting everything right in this regard looks like quite a difficult endeavor.

While some shortfall is plausible, the question is whether it will be a sizable miss like last year, which would then make it particularly challenging for the government to meet the fiscal deficit target, without resorting to offsetting cuts in capital expenditure.

Capital expenditure: The government is likely to have adopted the strategy of frontloading capital expenditure, to boost public investment and overall growth. Expenditure on road/transport/railways has indeed increased sharply in the first two months of the current fiscal compared to past trend.

This is an encouraging development, though it is too early to ascertain whether the evolving fiscal dynamic will allow the same momentum to be sustained in the months ahead or not. If risk to revenue slippages increase during the course of the year (based on the factors mentioned above), the government may yet again be compelled to go slow on the capital expenditure front, thereby adversely impacting growth.

The other risk to capital expenditure arises from the states’ ability to spend the resources that are transferred by the centre. While the government has decided to increase the devolution to states, based on 14th Finance Commission’s recommendations, it is up to the states to use the resources effectively and productively, so as to give a boost to growth.

Past evidence shows that many states have been unable to spend the entire capital expenditure allocation year after year, due to administrative incapability. The risk is that while the central government keeps transferring more revenues to states, the states remain incapable to spend it effectively, thereby failing to provide the much needed boost to growth, which was the main objective in implementing the strategy of “competitive cooperative federalism”.

Taimur Baig, Singapore, +65 6423 8681 Kaushik Das, Mumbai, (+91) 22 7180 4909

Investment strategy

Looking better from the outside in, than inside in Our discussions onshore in Mumbai last week were an interesting contrast to the view we got from ‘outside in’ on India in the various macro investor meetings we had in Europe and the US earlier this month.

Most of the latter group sees India as an ‘adjustment role-model’ among EM, and among the best ‘carry-to-vol’ prospects in this space, talking more to the structural story. Indeed, India has seen the biggest improvement on four major metrics of adjustment – real rates, current account, valuations and reserves – since the ‘taper tantrum’ a couple of years ago. Encouragingly, positioning feels less of an issue than earlier in the year, with the April squeeze in both EUR and INR we believe taking out a lot of the popular EUR/INR shorts. Most who own INR seem to do so through options, with put spreads offering good value given the low vol base, and RBI’s almost China-like desire to suppress volatility in the currency markets.

Our sense is that there will be good appetite for Indian fixed income should a new block of offshore bond quotas be released - estimated by DB to be near $6bn - as and when the government decides to re-denominate the limits in INR terms. Most investors we met agreed that the India trade is more a beta to domestic reforms and RBI policy, rather than to global developments. The main pushback on India, if any, was mainly around the intent of the central bank as it manages the tradeoff between the credibility of its inflation-targeting regime, and the still-poor transmission of policy to the real economy; and whether given the downside stickiness to bank deposit costs, Indian bonds could trade sustainably below 8%. We are of the view they can.

The ‘inside in’ view we got from Mumbai, on the other hand, was a lot more somber, talking more to the cyclical challenges India faces, and in particular in reviving the investment cycle. And there is no consensus on where the solution lies. Banks argue that there is a choke on liquidity, in particular to outside of large corporates, and that their cost of deposits is still very high. Corporates talk more to weakness in end demand, and put the blame on the slow pace of progress in improving the investment climate. The central bank puts the weakness in credit growth down to lack of demand rather than supply of credit, and maintains that there is ample liquidity in the banking system. That its open market operations last week were interpreted as a yield signal by the markets was probably unintentional. It was meant more to neutralize the liquidity injection from earlier in the year.

There appears little space in current RBI thinking for further policy accommodation at this stage. They remain firmly wedded to the inflation targeting

20 July 2015



framework, with 6% CPI in January their first target. Inflation targeting, they feel, is compatible with a more active supply side push from the government, given the slack in the economy. Resolution of bad loans for banks, they argue, is critical to unlocking liquidity for the wider economy, and that needs recapitalization and a framework for bankruptcy. We didn’t get the sense that we will see RBI ‘relent’ anytime soon on its stance.

The monsoon session of Parliament, to begin this week, will provide a better assessment on the politics of reforms, with focus in particular on the fate of the land reforms and GST bills. The India rates story is not over, we feel, but will clearly need more patience and time. The carry thankfully gives some cover for staying in.

Sameer Goel, Singapore, +65 6423 6973

India: Deutsche Bank Forecasts

2013 2014 2015F 2016F

National Income

Nominal GDP (USD bn) 1881 1990 2139 2374

Population (mn) 1236 1253 1271 1288

GDP per capita (USD) 1523 1589 1683 1843 Real GDP (YoY %) 6.9 7.1 7.5 7.5



Gross fixed investment 3.0 3.1 5.1 8.7

Exports 7.3 4.9 0.6 6.5

Imports -8.4 -1.8 0.7 7.5 Real GDP (FY YoY %) 1 6.9 7.3 7.5 7.5


CPI (YoY%) eop 10.3 4.3 6.0 5.3

CPI (YoY%) avg 10.7 6.7 5.3 5.7

Broad money (M3) eop 14.8 10.7 13.0 16.0

Bank credit (YoY%) eop 14.2 9.9 12.0 16.0 Fiscal Accounts (% of GDP) 1

Central government balance -4.5 -4.0 -3.9 -3.8



Central primary balance -1.2 -0.8 -0.6 -0.5

Consolidated deficit -7.0 -6.5 -6.0 -5.8 External Accounts (USD bn)



Trade balance -146.5 -143.1 -152.8 -177.7

% of GDP -7.8 -7.1 -7.2 -7.4

Current account balance -49.2 -27.5 -29.2 -44.1

% of GDP -2.6 -1.4 -1.4 -1.8

FDI (net) 26.3 25.0 30.0 35.0


FX rate (eop) INR/USD 61.8 63.3 64.0 65.0 Debt Indicators (% of GDP)

Government debt 66.9 65.1 63.9 63.5

Domestic 63.6 61.9 61.0 60.7

External 3.3 3.1 3.0 2.8


in USD bn 426.9 469.6 526.0 589.1

Short-term (% of total) 21.7 22.7 23.3 23.9 General

Industrial production (YoY %) 0.1 3.6 3.9 5.3 Financial Markets Current 15Q3 15Q4 16Q2

Repo rate 7.25 7.00 7.00 7.00

3-month treasury bill 7.54 7.60 7.50 7.30

10-year yield (%) 7.87 7.90 7.75 7.50

INR/USD 63.5 64.0 64.0 64.7 Source: CEIC, Deutsche Bank. (1) Fiscal year ending March of following year.

20 July 2015



Indonesia

Economic outlook: Growth momentum continues

to weaken due to stagnation in the commodity

sector, little sign of pick-up in investment, waning

consumer confidence and consumption.

Main risks: The political situation is fluid, with President Joko Widodo still grappling to consolidate his position nearly a year since taking office. Failure to stabilize the coalition, pass legislation, and improve the investment environment could further undermine the near-term outlook for the economy.

Strategy: Opinions on Indonesia are probably more divided now than at any time this year. Valuations, carry and improving external balances argue in favor, as does the fact that financing is well on track. Foreign debt exposure, political under delivery, a poor fiscal story, and the relatively narrow ‘exit door’ are, on the other hand, reasons for staying away. We would put positioning risk as neutral for the currency, and small negative for duration exposure (given the near $6bn of inflows this year). We ourselves are more biased to be strategically small underweight on duration, though unwilling at this stage to pay the negative carry on the currency till implieds come to more reasonable levels.

Economics

Weakness persists, policy support needed Indonesia has stepped into the third quarter of the year with continued weakness in growth momentum. Proxies of domestic demand such as imports, auto sales, cement production, credit growth, and consumer confidence continue to slip. Looking ahead for the rest of the year, we see little hope of any of these drivers turning around substantially. Commodity price weakness looks likely to continue, external demand stagnation may well persist, especially if China fails to recover, and there is not much in the legislative or policy pipeline that could be expected to galvanize consumption and investment in the near term.

Given this backdrop, we are revising down the 2015 real GDP growth forecast to 4.5%, while leaving the 2016 forecast unchanged to 5%. The downward revision stems from our pared back expectation on private consumption and investment, although we are holding on to the expectation that public investment would rise appreciably during the second half of this year. Net exports should continue to contribute positively to growth, but not because we see exports picking up, rather owing to depressed imports.

The ongoing weakness in consumption, for long a source of resilience in Indonesia, is perhaps best illustrated by auto sales. Passenger car sales, despite the cut in fuel prices early this year and the feel-good factor associated with last year’s elections, have continued to slide. While Bank Indonesia’s real retails sales index suggest a pick-up in sales in recent months, the phenomenon could well be a function of pre-Ramadan bonus payments (which shift by 10 days every year and therefore are not absorbed in the yoy figures). It remains to be seen if they hold up after the festival season.

Auto sales in sharp decline; strength in retail sales

could be due to one-offs

0

5

10

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25

-30

-20

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50

60

2011 2012 2013 2014 2015

Automobile sales, left

Real retail sales, right

%yoy,

3mma

%yoy,

3mma


The prevailing weak consumption dynamic is also reflected on consumer confidence (down for the third consecutive month through June), cement consumption (in negative growth territory since February), and credit growth (weakest in five years). Again, there are no events in the horizon that can act as agent of recovery in these areas.

Consumers are feeling less confident

-10

0

10

20

30

100

105

110

115

120

125

2011 2012 2013 2014 2015

Consumer confidence, left

Cement consumption (rhs)

3mma%yoy,

3mma


20 July 2015



The investment environment is also poor. While real investment growth appears to have bottomed out, from a low of 2%yoy in Q4 2013 to around 4% since then, it is still a far cry from the average of 10% growth in earlier years of this decade. The government’s (both this and the previous administration) initiatives to provide protection to domestic industries, and recent announcements akin to price controls, have not been helpful. Weakness in commodities remains a major drag as well.

The upshot from the prevailing weakness is an improving external balance picture. Between lackluster import demand and sharply lower price of imported commodities (particularly refined fuel), Indonesia’s trade balance has been in surplus territory since end of last year. The steady improvement in the non-oil+gas balance is particularly heartening, although it may be too early to declare that the late-2014 subsidy elimination policy has caused the oil+gas balance to move back to a fundamentally better territory.

Trade balance improving

0

25

50

75

100

125

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

2011 2012 2013 2014 2015

non oil+gas balance,lhs

oil+gas balance, lhs

Dubai crude, rhs

USD/barrel,

3mma

USD bn,

3mma


With worries about growth rising and concern about external imbalances easing, the need for policy support becomes clear. The government is in the process of boosting public spending in infrastructure, which should be welcome. Attempts to improve project execution and decision making at the executive level should also be helpful. We expect inflation to decline sharply in the fourth quarter, which should create room for Bank Indonesia to cut rates. We don’t think a relatively weak reserves position or concerns about further weakness of the rupiah would get in the way of the central bank.

Why shouldn’t Bank Indonesia stay on the sideline, especially since Fed policy normalization and possible global market uncertainty could undermine an already under pressure rupiah? We think that the rupiah is already undervalued fundamentally (our model based estimates find it to be 10% below equilibrium value), and the dataflow in the months ahead will reveal better

than expected trade and current account balances. As inflation keeps falling, investors will have little compulsion to second guess a dovish BI toward the end of the year, in our view.

Taimur Baig, Singapore, +65 6423 8681

Investment strategy

Strategically underweight In our recent investor meetings across Europe and the US, we found opinions on Indonesia more divided than at probably any time this year. Valuations, carry and improving external balances were cited by most in favor; we would add on-track financing to that list (with 65% of local currency issuance for the year already completed). Foreign debt exposure, political under delivery, a poor fiscal story, and the relatively narrow ‘exit door’ were, on the other hand, seen as the most common reasons for staying away.

The opportunistic leveraged community, we suspect, is more inclined to go short USD/IDR on blowup in points, mostly on the argument that the currency has ‘adjusted’ on many of the valuation metrics. And the EM benchmark investors are mostly market weight to slight overweight on duration, judging from the ~$6bn in net inflows this year. We would put positioning risk as neutral for the currency, and small negative for duration exposure.

Indeed, we ourselves are more biased to be strategically small underweight on duration, though unwilling at this stage to pay the negative carry on the currency till implieds come to more reasonable levels. We appreciate that the domestic slowdown, in part engineered by a tight monetary policy stance (positive), and in part by fiscal under spending (negative), has compressed imports, and helped bring the trade accounts to now a more consistent surplus. Not a surplus to cheer about much, but nonetheless makes its unattractive to go against the steep breakeven on the currency.

The bullish case for duration, on the other hand, is mostly tied in to the possibility of rate cuts later this year, as the base effects kick in on headline inflation. The recent decline in global crude prices should help further this expectation. But we note that the gap between the regulated price of low octane fuel domestically, and its open market equivalent, is yet to be closed, and skews the risk towards an upward adjustment in prices. The poor take up on revenues is hurting the fiscal story, though with the government already working towards revising up the target proportion for external issuance, we do not see a significant spillover into local borrowing requirements.

Sameer Goel, Singapore, +65 6423 6973

20 July 2015



Indonesia: Deutsche Bank forecasts

2013 2014F 2015F 2016F

National Income


Population (mn) 248.8 252.2 256.6 261.1


Real GDP (YoY%) 5.6 5.0 4.5 5.0




Exports 4.2 1.0 1.1 3.9

Imports 1.9 2.2 -1.8 4.8


CPI (YoY%) eop 8.1 8.4 4.0 3.9

CPI (YoY%) ann avg 6.4 6.4 6.6 4.5

Core CPI (YoY%) 5.0 4.5 4.5 4.0

Broad money (M2) 12.8 11.9 12.0 13.0

Bank credit (YoY%) 20.1 15.8 14.0 15.0


Budget surplus -2.3 -2.2 -1.7 -1.7



Primary surplus -1.1 -0.2 0.3 0.3


Merchandise exports 182.1 175 180 192

Merchandise imports 176.3 168 161 167

Trade balance 5.8 7.0 12.0 17.8

% of GDP 0.6 0.8 1.3 1.8

Current account balance - 29.1 -25.4 -17.7 -15.3

% of GDP - 3.2 -2.9 -2.0 -1.6

FDI (net) 12.3 15.5 15.0 18.0


FX rate (eop) IDR/USD 12270 12440 13,000 12,900


Government debt 22.4 25.9 27.0 28.0

Domestic 11.4 14.9 15.5 15.5

External 11.0 11.0 11.5 12.5


in USD bn 265.0 293.0 311.0 331.0

Short term (% of total) 18.9 18.8 18.3 18.1

General

Industrial production (YoY%) 6.0 4.0 5.0 6.0

Unemployment (%) 6.5 6.0 6.0 5.9

Financial Markets Current 15Q3 15Q4 16Q2

BI rate 7.50 7.50 7.00 7.00

10-year yield (%) 8.22 8.50 8.70 9.00

IDR/USD 13,309 13,100 13,000 13,200 Source: CEIC, DB Global Markets Research, National Sources

20 July 2015



Malaysia

Economic outlook: Latest indicators point to easing of growth in Q2 with the introduction of the GST.

Main risks: In our view, Bank Negara’s latest monetary statement has left room for tweaking rates this year, should heightened risks to global growth and financial conditions considerably affect the domestic economy. We think there is a chance of an OPR cut if growth falters and the US Fed pushes the rate hike through next year.

Strategy: With OPR likely to be steady, monetary policy is not in play for the bond market at this juncture. The reprieve from Fitch's outlook upgrade appeared short-lived as political noise is rising again. Meanwhile, after a challenging Q2, bond market technicals turn favorable in Q3. Against this back-drop, rates markets remain a range play and the direction would be largely governed by its low beta to the US rates. To be sure, these beta moves tend to be exaggerated though during large sell-offs associated with air pockets on liquidity.

Economics

Towards modest easing The past month has seen a number of economic indicators that support our view of a GST-induced slowdown in domestic activity in Q2. Aside from factory output and manufacturing sales which decelerated in April and May, imports contracted more heavily in May, printing -8.5%yoy from -7.0% in April and +5.8% in March. The slump in exports was partly the culprit, with imports of intermediate goods—accounting for more than 55% of the import bill—falling 2.9%yoy in April and another 8.4% in May. But imports of capital goods also plunged 15.9% in April before recording another 5% decline in May, of which such outcomes were largely due to the slump in domestic purchases of motor vehicles.

Weaker IP, falling manufacturing & motor vehicle sales

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-30

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0

10

20

30

Jan-14 May-14 Sep-14 Jan-15 May-15

Industrial production Mfg sales

Motor vehicle sales Manufacting PMI (rhs)

%yoy

Source: Bloomberg Finance LP, CEIC, and Deutsche Bank

Following the same trend, Malaysia’s manufacturing PMI retreated to contractionary territory in April, with the pace of decline worsening in June. Interestingly, demand for imported consumer items once again challenged our decelerating domestic demand narrative. That is, imports of consumer goods further accelerated to 27.2%yoy in May from 0.4% in March, suggesting resilient consumer spending. We think it is possible that the GST-related correction could happen in the investment side, in the big-ticket purchases of durable equipments, rather than in private consumption. But GST aside, we remain mindful of the headwinds affecting income and consumption, such as the decline in tourist arrivals and employment levels and deceleration in real wages.

Employment and wage growth on a downtrend

-0.4

-0.2

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.8

-4.0

-2.0

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2.0

4.0

6.0

8.0

Jan-14 May-14 Sep-14 Jan-15 May-15

Mfg payroll (real terms) Mfg employment (rhs)

%yoy %yoy

Source: CEIC and Deutsche Bank

Taking the aggregate of these multiple indicators, our macroeconomic momentum indicator indeed is pointing to a weakening pace of domestic activity, one that is lagging behind its long-run average growth.

20 July 2015



Exports are not expected to contribute positively to growth either. Malaysia’s exports further deteriorated in April-May, falling about 8%yoy (in MYR terms) in these two months compared to the almost 3% decline in Q1. The disappointing external performance was primarily due to the continued slump in commodity exports, which was recently amplified by the 44%yoy drop in gas exports in April and May. But with imports starting to fall faster than exports, the trade balance may not be far smaller than last year’s, thereby, posing less of a drag to Q2 growth.

This likely stable trade surplus settling around the MYR5bn level through year-end could limit the MYR depreciation pressure. However, it would not necessarily shield the currency from the ongoing domestic political uncertainty and global headwinds such as the looming US Fed rate lift-off, coupled with already tight liquidity.

Despite indicators pointing to weak economic momentum, the growth print in Q2 could find comfort in technical factors. A relatively lower base of consumption last year (when growth was also buoyed by a wider trade surplus) would mean private consumer spending is unlikely to slow down drastically in the April-June quarter. We thus reiterate our view that GDP growth is likely to remain at least 5% in Q2. The weakest point for growth would be in Q3 (falling to about 4-4.5%), in our view, when a stronger private consumption base kicks in. Consumer and business spending is likely to recover in Q4, but growth would be weighed down by the corresponding acceleration in demand for imports. That is, we are looking at Q4 growth posting about 4.5%.

Although we see the economy decelerating post-Q1, we do not think this development would necessitate a rate cut by Bank Negara. We think the central bank would only be forced to cut rates when GDP growth prints less than 4% and indicators point to weakness beyond a single quarter.

An improving external environment and recovering domestic sentiment would guide growth higher to at least 5% in 2016, in our view. However, we see downside risks to our 5.4% forecast. After the negative consumer and business sentiments brought about by the GST this year, we think odds are high of domestic activity continuing to slow down next year because of rising rates and subdued commodity prices. Increased debt repayments amid higher borrowing costs and muted earnings could reduce the appetite to spend and invest, for public and private sectors alike. It does not help too that about 60% of household wealth is dependent on asset markets which are still vulnerable to corrections. Squeezed assets against rising liabilities could affect buying power.

Household leverage remains a key pressure point

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902009 2014 Mar-15

Household debt (% of GDP)


Diana Del-Rosario, Singapore, +65 6423 5261

Investment strategy

Trade the range Monetary policy is not in play for the bond market at this juncture, with BNM expected to keep the OPR unchanged this year. Fitch's decision earlier this month to upgrade Malaysia's outlook was positive from the credit perspective; however, the reprieve was very short-lived given increasing political noise. Supply technicals were challenging in Q2, but they turn favourable going into Q3 with negative net issuance. On the demand side, recent data show that both onshore and offshore accounts have stepped up their purchases of MGS and GII. Offshore accounts bought MYR8.6bn of MGS in June, taking their holdings to 48.5% of the total outstanding, just shy of the 49.5% peak set in May-13 before the taper tantrum. Meanwhile, assets under management of domestic real money accounts (EPF) are growing by roughly MYR50bn a year. Whereas, a mandated slowdown in overseas investment by government-linked asset managers is expected to stay here for some time, which should lend support to the domestic bond market in sell-offs. Against this backdrop, rates market thus remain a range play (10Y MGS between 3.75/80 to 4.20/25% for example), and the direction would be largely governed by its low beta to US rates. To be sure, one needs to be mindful though that these beta moves tend to be exaggerated during large sell-offs associated with air pockets on liquidity. Indeed, some market participants we recently met in KL expressed concerns regarding the declining liquidity situation in the onshore bond market. Turnover numbers for the bond markets show that liquidity is down to levels even lower than back in 2007. We thus look to trade the range in rates space, with a bias for somewhat higher yields from here, especially given the ongoing steepening in core rates and air pockets on liquidity

20 July 2015



Steady as she goes…

-3

-1

1

3

5

7

Jan 06 Jan 08 Jan 10 Jan 12 Jan 14 Jan 16

InflationPolicy_RateDB_Inflation_ForecastDB_Policy_Forecast

%

Source: Deutsche Bank, CEIC

Supply technicals turn favourable going into Q3

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-15

-10

-5

0

5

10

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

DVo1

Redemptions

Redemptions, MYR bn

DVo1 Supply, MYR mn

FY-15 govt bond supply

Supply outlook is favourable in Q3

Source: Deutsche Bank, BNM

Valuations look reasonable after the recent MGS selloff

3.00

3.25

3.50

3.75

4.00

4.25

4.50

Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14 Jul-15

Actual Fitted10Y MGS Yield (%)


Model Residuals (actual minus fitted 10Y MGS)

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-2

-1

0

1

2

3

Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14 Jul-15

Model residuals in standard deviations

May 13: Positive election outcome

-1.5 standard deviation

+1.5 standard deviation

Current


EPF investment assets are growing by ~MYR50bn / yr

0

100

200

300

400

500

600

700

2011 2012 2013 2014

MGS & Equivalents Loans & Bonds Equities

Money Mkt Real Estate & Infra

MYR bn Growing EPF Investment Assets

Source: Deutsche Bank, EPF

Increasing support from onshore real money accounts

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2

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Q3-13 Q4-13 Q1-14 Q2-14 Q3-14 Q4-14 Q1-15

MGS GII TotalMYR bn

Net purchases by onshore real money

Increased support from onshore real

money accounts


20 July 2015



Offshore demand for MGS & GII is better this year

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0

20

40

60

80

2010 2011 2012 2013 2014 2015

GII MGS BNM paperMYR bn Offshore net buying

Offshore demand for MGS & GII is better this year than 2013

& 2014, but at the expense of

outflows from BNM bills

Jan-Jun Source: Deutsche Bank, BNM, CEIC

MGS remain a low beta play to the US rates, but the

beta moves tend to be exaggerated during sell-offs

1.00

1.25

1.50

1.75

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2.50

2.75

3.00

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3.50

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-0.10

0.00

0.10

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Jul 12 Jan 13 Jul 13 Jan 14 Jul 14 Jan 15 Jul 15

6m rolling beta of 10Y MGS to UST (daily changes)

10Y UST (RHS)

%

MGS remains a low beta play to the US rates, but the beta moves can get exaggerated during the sell-off


Watch out for the air pockets on liquidity too…

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2007 2008 2009 2010 2011 2012 2013 2014 2015*

Annual Turnover

Market Liquidity (RHS)MYR bn %

Liquidity in the MGS market has been declining


Overall bond market liquidity has been drying…

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1.0

1.2

Mar 06

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Mar 15

Corp Bonds Govt BondsTurnover Ratio

Source: Deutsche Bank, ADB

Swapnil Kalbande, Singapore, +65 6423 5925

20 July 2015



Malaysia: Deutsche Bank forecasts

2013 2014 2015F 2016F

National Income


Population (mn) 29.9 30.3 30.6 30.9


Real GDP (YoY%) 4.7 6.0 4.8 5.4




Exports 0.3 5.1 0.9 5.8

Imports 1.7 4.2 1.0 6.8

Prices, Money and Banking (YoY%)

CPI (eop) 3.2 2.7 2.4 2.2

CPI (ann avg) 2.1 3.1 1.8 2.8

Broad money (eop) 7.3 7.0 6.2 8.5

Private credit (eop) 9.7 8.9 6.8 8.5


Central government surplus -3.8 -3.4 -3.4 -3.0



Primary balance -1.7 -1.3 -1.4 -1.0


Goods exports 202.5 207.8 182.2 192.3

Goods imports 171.8 173.2 155.1 168.4

Trade balance 30.7 34.7 27.1 23.9

% of GDP 9.5 10.2 8.6 7.2


% of GDP 3.5 4.3 2.9 1.4

FDI (net) -2.0 -5.6 -1.1 -1.0

FX reserves (eop) 134.9 115.9 102.6 92.8

MYR/USD (eop) 3.3 3.5 3.78 3.70


Government debt1 68.4 68.2 67.4 64.5

Domestic 66.7 66.7 65.8 64.5

External 1.6 1.5 1.6 1.6


in USD bn 212.3 213.9 213.1 213.5


General (ann. avg)


Unemployment (%) 3.1 3.0 3.1 3.0

Financial Markets (%, eop) Current 15Q3 15Q4 16Q2

Overnight call rate 3.25 3.25 3.25 3.25


10-year yield 4.02 4.20 4.30 4.40

MYR/USD 3.80 3.82 3.78 3.75 (1) Includes government guarantees Source: CEIC, DB Global Markets Research, National Sources

20 July 2015



Philippines

Economic outlook: Deteriorating exports, due to weak domestic production, against fairly strong demand for imports stand to weigh on Q2 growth.

Main risks: Room to cut policy rates could open in the second half with inflation likely to settle at the lower end of the BSP’s 2-4% target this year despite the threat of El Niño. However, we see that as a risky move that could leave authorities falling behind the curve when inflation accelerates next year as a result of the earlier price build-up.

Strategy: The PHP’s beta to external drivers remains the lowest in Asia, arguably making it a good idiosyncratic long ahead of the Fed. However, the currency does not present a good case for value.

Economics

Facing a supply bottleneck

Poor exports point to weak domestic supply… Merchandise exports intensified their descent post-Q1, falling by 10.8%yoy on average in April and May from -0.3%yoy in the Jan-Mar period (in USD terms). Earnings suffered from dismal returns of shipments to China (-40.0%yoy), Japan (-4.3%), and the US (-5.1%). But we think weak external demand is not the primary driver to this disappointing exports outturn.

Electronics exports did fall by 7.5%yoy in May, but this segment still posted 5.1% growth post-Q1 (April-May) and 2.7% in Q1. Contrast this to the 28%yoy drop in mineral and petrol exports, and the 18%yoy decline in agro products in the first five months of the year.

Rather, we see two forces that have largely affected exports performance this year. First is the decline in commodity prices, led by the 50%yoy drop in crude oil and iron ore prices. This resulted to exports of mineral and petrol products contributing -4.7ppts to the 10.8% exports decline in April-May (i.e., a 44% effect), even as they only accounted for 5% of total exports (and 7% before the commodity price slump).

Second, the continuing El Niño-related dry spell that has hit several parts of the country since late 2014 appears to have adversely affected domestic production. Export earnings of agro (fruits and vegetables) and forest products have contributed negatively to exports growth since December, coinciding with the dry spell. Prices were less of a factor as volumes actually fell more deeply, dropping by 56%yoy on average from December through April. Other manufactures—garments, textile yarns and fabric, footwear, wood manufactures, furnitures and fixtures,

processed food and beverages, machinery and transport equipment—also took a hit, contributing almost 60% to the drop in export earnings in April-May with volumes tumbling 46%yoy in April and 17% in Q1.

Merchandise exports further deteriorated in April-May

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Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Apr-15

Others Other mfg

Mfg: Electronics Mineral, petrol prods

Agro & forest prods Exports

contributions to exports growth (%yoy, bps)


In line with the exports outturn, the industrial production index (in volume terms) fell by 3.1% in May—the weakest record in more than three years—following barely no growth in April and 5.4%yoy expansion in Q1. The country’s economic planning office has attributed the decline in manufacturing production to weak global demand and prolonged dry spell, although we believe it is more of the latter. If it is the former, then exports shipment of agro products and other manufactures should already be following the improvement in the PMIs of advanced economies just like in the past, rather than diverging from it. But if domestic production is actually faltering because of the dry spell brought about by El Niño, then exports could continue to suffer even if the external demand environment improves.

Export shipments fell even as US, EU activity improved

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2012 2013 2014 2015

Export volume (agro & forest prods, other manufactures)

US-EU Manu PMI (rhs)

%yoy, 3mma 3mma

Source: CEIC, Haver Analytics, and Deutsche Bank

…but imports suggest robust demand

20 July 2015



May imports data is yet to be released as of this writing. But in April, merchandise imports fell 12.8%yoy versus -3.1% in Q1, although we do not see domestic demand decelerating based on this outcome. What drove the decline in the import bill was the 54%yoy drop in mineral fuel and lubricants, which used to account for 20% of imports before the plunge in oil prices (now down to 14% per Jan-Apr 2015 data). And yet, the pace of demand for imported capital goods was sustained in April, printing almost 3%yoy while imports of consumer goods gained pace, rising 3.5%yoy from 0.9% in Q1. Among capital goods, purchases of imported telecommunications equipment and electronic machines—accounting for almost 40% of the import bill—led the increase as they surged 44%yoy in April (and at least 35%yoy growth in Q1). Imports of office and electronic data processing machines also sustained the at least 28%yoy growth recorded since January. In our view, these results point to robust demand for office spaces, perhaps related to BPO services, in the country. Meanwhile, with regard to consumer demand, motor vehicle sales sustained the double-digit expansion recorded since end-2013, posting 23.3%yoy in June and 19.8% in Q2, albeit slower slightly slower than 21.5% in Q1.

A bigger deficit stands to weigh on Q2 growth This dismal exports outturn against fairly strong demand for imports stands to weigh on Q2 growth and our 2015 forecast. In volume terms, export shipments fell 48%yoy in April while we estimate imports to have increased 4.2%. As a result, a trade deficit which is 121%yoy higher vs. 75%yoy in Q1 may have emerged in early Q2. We see this dragging Q2 growth to a little less than 6%, while we estimate a 10-30bp downside risk to our 2015 forecast (i.e. from 6.5% to 6.2%). Nonetheless, we continue to expect growth to improve to about 7% in the second half despite poor exports, as growth in government spending could find support from a favorable base along with a modest improvement in disbursements. It is indeed critical that the government is able to mobilize its financial resources effectively to attain at least 6.5% growth.

Serious inflationary pressures only in 2016 In theory, demand outpacing supply naturally leads to a build-up of inflationary pressures. But the decline in agro production has not translated to higher prices thus far with inflation even on a downtrend since March because of lower food prices. Should inflation take off from 1.2% in June, food prices accelerating to the likes seen in late 2013-14 (i.e. rising 0.5-1.2%mom for a year) is still likely to keep inflation within 2-3% this year. But the build-up in prices bears serious upside risks to inflation in 2016. Given this outlook, it is unlikely to see a rate cut this year, in our view.

Diana Del-Rosario, Singapore, +65 6423 5261

Investment strategy

Low beta, but low value too Unlike a majority of EM, the PHP’s sensitivity to external drivers has been very low, making it a good idiosyncratic currency to own in an EM portfolio. With a virtually absent USD beta (see chart) it has received attention as a potential “Fed immune” trade. Indeed, the currency has traded within a fairly narrow 3% range this year. On the surface, the fundamental story for the PHP remains a constructive one. The current account surplus has remained well supported by the more acyclical income and services balances, and by the drop in oil prices. The bias amongst the offshore investor base, we feel, remains positive towards the PHP, although participation and conviction is considerably lighter than in the past.

However, there are concerns we would not ignore. Exports growth has been significantly disappointing lately, contributing to the miss on Q1 GDP. Inflation has fallen sharply, with BSP suggesting CPI could fall below 1% in the months ahead. Although we do not believe a rate cut would be appropriate, the outlook for rate normalization has softened. We had earlier believed the PHP would benefit from a monetary policy outlook that was furthest removed from the easing bias elsewhere in Asia. Our confidence level in this has waned with the recent data. Continued easy liquidity onshore in recent months has narrowed the basis between USD and PHP rates, incentivizing a large shift in FX deposits in recent quarters. Elections next year will bring a change in leadership given a constitutional one-term limit on the Presidency. The country arguably still remains overpriced for upward credit rerating. And the PHP remains one of the most overvalued currencies in the world on a wide range of metrics. We are therefore neutral on the currency here.

The PHP’s beta to the broad USD has been entirely

absent in recent months

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KRW MYR SGD TWD IDR INR THB CNY PHP

USD TWI

Local Equities

Local 10Y Yields

Beta of Local FX to different drivers in 6m multivariate

Source: Deutsche Bank, Bloombeg Finance LLP

Mallika Sachdeva, Singapore, +65 6423 8947

20 July 2015



Philippines: Deutsche Bank Forecasts

2013 2014 2015F 2016F

National Income


Population (mn) 98.2 99.9 101.6 103.3


Real GDP (YoY%) 7.2 6.1 6.5 6.5




Exports -1.1 12.1 -1.6 5.4

Imports 5.4 5.8 1.5 7.2

Prices, Money and Banking (YoY%)

CPI (eop) 4.1 2.7 2.2 3.5

CPI (ann avg) 2.9 4.2 1.8 3.4

Broad money (M3, eop) 31.8 11.3 13.4 12.3

Private credit (eop) 16.5 19.6 13.2 13.2

Fiscal Accounts (% of GDP)1

Fiscal balance -1.4 -0.6 -2.2 -2.4





Goods exports 44.5 47.8 44.4 49.1

Goods imports 62.2 63.6 62.3 70.6

Trade balance -17.7 -15.9 -17.9 -21.5

% of GDP -6.5 -5.5 -5.8 -6.5


% of GDP 4.2 4.4 4.0 3.6

FDI (net) 0.1 -0.8 -0.4 -0.5

FX reserves (eop) 83.2 79.5 82.5 89.5

PHP/USD (eop) 44.4 44.6 45.7 44.5


General government debt2 53.3 49.7 50.1 49.7

Domestic 33.5 31.5 32.7 33.7

External 19.8 18.2 17.3 16.0

External debt 28.8 26.7 25.3 23.6

in USD bn 78.5 77.7 78.6 79.2


General (ann. Avg)


Unemployment (%) 7.1 6.8 6.5 6.8

Financial Markets (%, eop) Current 15Q3 15Q4 16Q2

Policy rate (BSP o/n repo) 6.00 6.00 6.00 6.25

Policy rate (BSP o/n rev repo) 4.00 4.00 4.00 4.25

3-month T-bill rate 1.42 2.29 2.54 3.14

10-year yield (%) 3.58 3.70 3.80 4.20

PHP/USD 45.2 46.0 45.7 45.9 (1) Refers to general government. (2) Includes guarantees on SOE debt. Source: CEIC, DB Global Markets Research, National Sources

20 July 2015



Singapore

Economic outlook: Sharp contraction in Q2 (advance estimate) warrants a downward revision to the growth outlook for 2015. Chronic weakness in manufacturing is particularly worrisome.

Main risks: Economic slippage in China could undermine Singapore’s economic outlook through multiple channels, including (i) trade, (ii) bank and non-bank financial sector exposure, and (ii) support from Chinese flows for local property, wealth management, gaming, and tourism sectors.

Strategy: Valuations in the belly appear to be attractive relative to front-end and back-end, as per the rich/cheap history of our spline spread model. We hence prefer overweight exposure in the belly over wings in our portfolio. We also recommend switching into current 5Y SGS (2% Jul-2020) from old 5Y SGS (2.5% Jun-2019) to capture the pick-up on the curve, while not incorporating much of the duration view. From a trade perspective, we remain paid in 10Y swap spreads initiated last month, targeting 35bp. Meanwhile, with the underperformance of 5Y SGS on the curve, the swap spread (swap rate minus bond yield) in this segment has tightened noticeably in recent weeks. Current levels are thus compelling to scale into paying the 5Y swap spread as well.

Economics

Scaling back expectations While trade is no longer the source of worry it was a few months ago, Singapore’s economic outlook has nevertheless worsened. Advance estimates of Q2 GDP was sobering, with the yoy growth rate of 1.7% masking the underlying contraction on a qoq, seasonally adjusted, annualized basis (-4.6%). Performance of the construction (2.7%yoy, -0.2% qoq, sa, ann.) and services (3% and -2.6%) was not particularly worrisome, but manufacturing was yet again weak (-4% and -14%). Indeed, on a yoy basis, manufacturing has been in negative growth territory since the fourth quarter of last year. This weakness is also seen in the industrial production figure, which has been contracting since October 2014.

After a good start to the year, a major payback in Q2

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Manufacturing Construction Services

%qoq, sa, ann.

Source: CECI, Deutsche Bank

Given the sharp payback in GDP data in Q2 after a modest start in Q1, we are compelled to revise down the 2015 GDP growth forecast to 2.5%. Compared to our previous forecast (from the expenditure side of the national accounts), we now expect a tad weaker contribution from consumption and net exports. Although exports have not been particularly weak lately, given the regional trend, we think that this area has considerable room for disappointment.

Sub-par production trend, although exports are looking

up at last

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As discussed by us in recent publications, we are less worried about the exports outlook to the US than we are about demand from China and EU (the latter two make up for more than 3.5 times the exports to the US). Exports to both have been disappointing since the beginning of this year, with ytd exports to China up just 1.6%yoy while the corresponding figure for the European Union is -5.3%yoy. Looking ahead to the

20 July 2015



second half of the year, there is little reason to expect a major improvement in exports.

Subdued exports to key trading partner, especially to

China and EU

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2005 2007 2009 2011 2013 2015

China EU US%yoy, 3mma


Along with weakness in production and trade, overall markers of domestic demand are decidedly mixed. Credit growth, despite exceptionally low interest rates and comfortable liquidity position, is at a 5-year low, reflecting both waning demand and macro-prudential measures imposed by the authorities.

Although retail sales look relatively strong (+6.1%yoy through May), the property market is weak, which is likely feeding into softer loan demand. With interest rates likely to go up in the coming quarters as US Fed policy normalization materializes, it is unlikely that credit growth will pick up anytime soon, especially considering the high level of leverage on the balance-sheet of Singaporean households.

Credit and money growth

0.0

5.0

10.0

15.0

20.0

25.0

30.0

Credit M3%yoy,

3mma


As we step into the second half of the year, Singapore’s policy makers have a number of worries

on hand. The risk of rising rates, weakness stemming from China and EU, anemic production, and global market volatility could all impact consumption and investment negatively. Untill the Q2 data release, domestic demand seemed to have held up relatively well considering the headwinds faced by the economy, but the latest data suggest that going may have just gotten a tad harder.

The authorities are pursuing medium term structural reforms to boost to productivity, and they should be commended for removing froth from the property market in an orderly manner, but they may not have any magic bullets to prop up the economy in the near-term. 2-3% growth may well be the norm Singapore settles into for the time being. Given its high per capital income and aging population, perhaps that’s as good as it gets.


Investment Strategy

SGS belly is hot, front-end and back-end is not Valuations in the belly appear to be attractive relative to front-end and back-end, as per the rich/cheap history of our spline spread model. Front-end of the curve has been very well bid over the past month due to a) the decline in SOR and b) demand from end clients to roll-over part of the SGD6.3bn proceeds from SIGB 2.875% which matured on 1-July. Meanwhile, the ultra-long end remained supported on back of the real money demand. Whereas, bonds beyond the 5Y tenor took a hit following the unusually long tail in the 5Y SGS auction on 26-June. Valuations are thus attractive in this segment now from a RV perspective. For example, 2Y/5Y SGS curve is just shy of the steepest level in 10 years, whereas 2Y/5Y/10Y fly is at the highest level seen in the decade. We hence prefer overweight exposure in the belly over wings in our portfolio. We also recommend switching from the old 5Y into the new 5Y SGS, which offers 45bp pick-up as this part of the curve is super steep from an historical perspective. We look for this spread to eventually normalise to its long run average of around 30/35bp. The current 5Y benchmark is also the sweet-spot on the curve from a carry and roll-down perspective. Meanwhile, the 20Y/30Y slope has tightened noticeably in recent months to trade below par as we write, compared to its peak of 16bp 3months ago and ~12bp on average over last one year. This tightening can be attributed to the persistent strong demand for the 30Y paper from onshore real money community and some re-pricing of the 20Y SGS ahead of the upcoming 15Y (2.875%, Sep 2030) supply on 27-August. So, while this spread can stay sticky around these levels for some time with the upcoming 15Y supply, further tightening of the spread is unlikely though in our opinion. From a trade perspective, we remain paid in 10Y swap spreads

20 July 2015



initiated last month, targeting 35bp. Meanwhile, with the underperformance of 5Y SGS on the curve, the swap spread (swap rate minus bond yield) in this segment has tightened noticeably in recent days. Current levels are thus compelling to scale into paying the 5Y swap spread as well. Bond supply outlook is also supportive of the trade, with only 2 SGS auctions left for the year (15Y SGS on 27-Aug and 2Y SGS on 28-Sep).

SGS belly is hot; front-end and back-end is not


2Y/5Y SGS curve is shy of its steepest level in decade

-20

0

20

40

60

80

100

120

140

Jul 05

Jul 06

Jul 07

Jul 08

Jul 09

Jul 10

Jul 11

Jul 12

Jul 13

Jul 14

Jul 15

bp 2Y/5Y SGS spread


2Y/5Y/10Y fly is at the highest level seen in the decade

-120

-100

-80

-60

-40

-20

0

20

40

60

Jul 05

Jul 06

Jul 07

Jul 08

Jul 09

Jul 10

Jul 11

Jul 12

Jul 13

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Jul 15

bp 2Y/5Y/10Y SGS fly


Switch from old 5Y SGS (Jun19) into current 5Y (Jul20)

20

25

30

35

40

45

50

55

60

Aug 14

Sep 14

Oct 14

Nov 14

Dec 14

Jan 15

Feb 15

Mar 15

Apr 15

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Jun 15

Jul 15

bp

SIGB Sep 20 vs Jun 19spread


Valuations are attractive for 20Y SGS over 30Y

-5

0

5

10

15

20

Jul 14

Aug 14

Sep 14

Oct 14

Nov 14

Dec 14

Jan 15

Feb 15

Mar 15

Apr 15

May 15

Jun 15

Jul 15

bp

Apr 2042 vs Sep 33 spread


20 July 2015



SGS yield curve (Actual versus NSS Model Fitted)

0.50%

1.00%

1.50%

2.00%

2.50%

3.00%

3.50%

0 2 4 6 8 10 12 14 16 18 20 22 24 26 28

Nelson-Siegel-Svensson Yield

Current Market Yield

SGS curve three weeks ago

Maturity

20Y/30Y is trading at par

This part of the curve is super steep now


6m static return profile on the SGS curve

-1.00%

-0.50%

0.00%

0.50%

1.00%

1.50%

2.00%

2.50%

1.7

2.7

3.2

3.9

4.2

5.0

5.2

5.9

7.2

8.0

9.2

9.9

11

.7

14

.0

15

.2

18

.2

26

.7

Roll-Down Carry Total6m Returns

Expected return profile over 6m in an unchanged curve environment


Bond supply outlook is supportive in H2, with only two

SGS auctions left for the year (15Y in Aug & 2Y in Sep)

2Y

30Y7Y

3Y

10Y 5Y

15Y

2Y

-7

-5

-3

-1

1

3

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

Issuance

Redemption

SGD bn

Source: Deutsche Bank, MAS

Scale into paying 5Y swap spread (Buy 5Y SGS Jul-

2020 versus pay matched maturity IRS)

0

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Jul 10 Jul 11 Jul 12 Jul 13 Jul 14 Jul 15

5Y IRS minus 5Y SGS CMTbp

Current



20 July 2015



Singapore: Deutsche Bank Forecasts

2013 2014 2015F 2016F

National Income


Population (mn) 5.4 5.5 5.6 5.7


Real GDP (YoY%) 4.4 2.9 2.5 3.0



Gross fixed investment 1.1 -1.9 0.7 2.0

Exports 4.5 2.1 2.8 4.3

Imports 3.8 1.4 1.5 4.5


CPI (YoY%) eop 1.5 -0.1 0.5 2.0

CPI (YoY%) ann avg 2.4 1.0 -0.2 1.5

Broad money (M2) 7.9 2.5 3.7 5.0

Bank credit (YoY%) 13.6 11.3 9.0 10.0


Fiscal balance 7.1 6.9 6.8 6.6






Trade balance 67.8 77.2 84.0 86.5

% of GDP 22.9 25.8 27.9 27.0


% of GDP 18.4 18.9 19.6 18.2

FDI (net) 36.9 20.0 25.0 30.0


FX rate (eop) SGD/USD 1.27 1.32 1.40 1.30


Government debt 110.9 118.4 121.8 123.9

Domestic 109.9 117.4 120.8 122.9

External 1.0 1.0 1.0 1.0

Total external debt 410 407 392 383

in USD bn 1208 1214 1220 1226


General


Unemployment (%) (eop) 2.8 2.6 2.5 2.5



10-year yield (%) 2.64 2.70 2.80 3.10

SGD/USD 1.35 1.37 1.40 1.34 Source: CEIC, DB Global Markets Research, National Sources Note: includes external liabilities of ACU banks.

20 July 2015



South Korea

Economic outlook: Growth slows to 0.4% qoq sa in Q2 from 0.8% in Q1 as MERS guides consumption sharply lower.

Main risks: While Korea leaves MERS behind, its long-term growth challenges remain unanswered as government reform efforts are sidelined.

Strategy: We believe an inflection point for the won is here, with portfolio outflows increasingly recycling the ‘poor-quality’ current account surplus. On the one hand, the narrowing of the spread between US and Korea bond yields has resulted in a pickup of debt outflows by Korean Lifers and investment managers. Given the imminence of the Fed lift-off, we believe debt outflows are likely to persist. Equities too will likely play a more pronounced role in this rebalancing of flows in the second half of the year particularly given the change in NPS investment mandate to accelerate overseas investments and the inclusion of Chinese companies listed overseas in MSCI EM which should result in a reduction of Korea equity weight within the index. We recommend long USD/KRW 6M NDF and extended our target 1180. On rates, we remain of the view that short rates positions – overlent on 10Y ND-IRS with a target of 50 – and paying 2Y/5Y IRS steepeners in Korea.

Economics

Lowering expectations Leaving MERS behind, but growth damage clear… Korea has not reported a new case of MERS since the beginning of last week. According to the Ministry of Health and Welfare, out of those diagnosed (186), 131 have been discharged from hospitals following complete recoveries, with 19 patients still hospitalized, while 36 lost their lives (the most recent patient lost his life last Wednesday), as of Friday last week. Thus far, the fatality rate from MERS stood at 19.4%. Meanwhile, out of 16,688 people subject to isolation for possible infection (since the country reported its first case on 20 May), 16,278 have been released after showing no symptoms of MERS for more than the known maximum incubation period of 14 days for the disease, while the remaining 410 remain in isolation.

Sharper fall in growth in Q2

-2

0

2

4

6

8

10

2000 2003 2006 2009 2012 2015

GDP

Trend

%yoy

Sources: CEIC, Deutsche Bank

Although normalizing, negative effects of MERS turned out to be stronger than anticipated in Q2. In fact, according to the Bank of Korea governor, growth momentum more than halved to 0.4% qoq sa in Q2, from 0.8% in Q1, as consumption declined. We estimate that the latter contracted 0.2% in Q2, vs. a 0.6% rise in Q1.

…while external conditions remain precarious… Worse still, exports continued to disappoint, falling 6.9% yoy in Q2 vs. a 2.9% fall in Q1, leaving the path of recovery even more uncertain, compounded by ongoing struggle in Euroland and China. Although Korea has very limited direct exposure to Greece – only 1.9% of Korean exports headed to Greece last year – there are obvious concerns about the latter’s potential impact on the rest of Euroland and the euro. Closer to home, with 25.4% of Korean exports headed to China directly last year, the latter’s recent struggle with local stock markets stood as yet another source of concern for Korea, although our China economist expects the spillover to the real economy to be limited. That is, we see risks to the BoK’s revised growth outlook tilted to the downside.

…guiding growth expectation lower… In response to MERS impact and adverse external conditions, the BoK cut its 2015 GDP forecast to 2.8% from 3.1%, lower than the government’s forecast of 3% but higher than our forecast of 2.6%. We see slower recovery in 2H. Although the BoK limited its downward revision to 0.3ppts in anticipation of support from (earlier) rate cuts and (proposed) fiscal stimulus, there is increasing likelihood of delay in its implementation.

…albeit contained by stimulus measures… The government expects its stimulus package, KRW22tn (about 1.5% of GDP), to boost GDP growth by 0.3ppts. Of the total package, the government’s supplementary budget stood at KRW11.8tn, with KRW5.6tn allocated to fill this year’s revenue gap and the rest (KRW6.2tn) representing additional government spending. As for

20 July 2015



the rest of the stimulus, KRW2.3tn represented investment by public enterprises and via PPP, while it would make KRW4.5tn available as loans, guarantees and insurance. For our part, we see growth limited to 2.6% in 2015, then recovering to 3.2% in 2016. The BoK expects slightly stronger growth of 3.3% in 2016.

Amid weak growth, we expect the BoK to remain on the sidelines for the remainder of the year, despite higher inflation, rising household debt and rate hike by the Fed ahead. Instead, we see risks to our rates outlook tilted to the downside, especially as the government’s stimulus package remains side tracked by political struggle. The latter has also sidelined reform efforts that are critical in addressing Korea’s structural challenges (e.g. fall in working age population) to support its long-term growth. Please see our report, titled, “South Korea’s Big Bang efforts challenged by political paralysis”, published on 14 May 2015, for details.

…while drought pushes inflation higher… While we maintain our forecast for next year, we revise our forecast up modestly for this year, to 0.9% from 0.7%, due to higher-than-expected food price inflation. The latter continued to trend higher, to a 1.8% yoy 3mma in June from 1.0% in July, due to drought. We see inflation heading higher in 2H as low oil price effects drop out of the data, although the Iran deal poses downside risks to our outlook. Further ahead, the BoK revised down its 2016 inflation to 1.8% in 2016, from 2.2% earlier, in line with our own forecast.

Surge in household debt

0

2

4

6

8

10

12

14

16

18

-5

0

5

10

15

20

25

30

2004 2006 2008 2010 2012 2014

Housing prices (lhs)

Bank mortgage loans

%yoy 3mma%yoy 3mma

Sources: CEIC, Deutsche Bank

…while further restructuring of household debt likely… The BoK remains concerned about rapid increase in household debt. Mortgage loan growth continued to accelerate, to 13.3% yoy in Q2 vs. 12.7% in Q1, to its fastest pace in almost a decade. Although it does not see it as a systemic risk to the financial system, the BoK has called for an aggressive response to the sustained rise in household debt, including setting

quantitative restrictions. We are likely to see the BoK argue against any move to ease related prudential regulations (i.e. DTI and LTV) and support efforts to further reduce risks related to household debt, including regulatory requirements for nonbanking FIs that are as tough as those for banks. Meanwhile, the government will continue to push for conversion of household debt. In particular, the government seeks continued efforts by banks to convert floating, non-amortizing mortgage loans to fixed, fully amortizing loans. Targets for the latter’s share are as follows: 25% by end-2015, 30% by end-2016 and 40% by end-2017. While these targets may be raised, their impact would weigh on consumption, and we see the government refraining from measures that would further depress private consumption growth. Since the GFC, the latter’s trend has halved to 1.4% in Q4 2014 from 2.7% in Q2 2008.

Juliana Lee, Hong Kong, +852 2203 8312

Investment Strategy

Winds of change We believe an inflection point for the won is here, with portfolio outflows increasingly recycling the ‘poor-quality’ current account surplus. Over the past year, portfolio outflows have been strong ($33.6bn) but insufficient to recycle the strong current account surplus. The balance, however, is shifting. On the one hand, the narrowing of the spread between US and Korea bond yields has resulted in a pickup of debt outflows by Korean Lifers and investment managers. Given the imminence of the Fed lift-off, we believe debt outflows are likely to persist.

Falling domestic bond yields are pushing more

domestic investors to diversify overseas

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USDbn

OthersInsurersInvt managersIR diff between US-SK 5Y yield (inverted, RHS)


20 July 2015



Equities too will likely play a more pronounced role in this rebalancing of flows in the second half of the year.

The National Pension Service (NPS) has announced that it will accelerate overseas investments, amounting to $32bn of outflows by the end of 2016. Given that the NPS has not provided a separate target for 2015, we assume potential outflows of ~$16bn for each of the next two years.

The inclusion of Chinese companies listed overseas in the form of ADRs into the MSCI EM index should result in a re-allocation of weight for the various other EM countries in the index, including Korea. Our strategists estimate that Korea’s weight in the index should fall to 14.4% this year, from the current 14.7%, and further lower to 14.1% next year. In flow terms, this would equate to an equity outflow of $5.3bn this year and another $5.3bn next year, given that $1.7tr of assets are benchmarked to the MSCI EM.

The recent announced measures by the Korean authorities to encourage FX outflows should also aid outflows. These measures include: granting tax incentives for foreign equity funds; relaxing foreign investment and hedging regulations for insurance companies; encouraging pension funds to make more foreign investments and supporting Korean companies in international M&A. The MoSF stated that about USD15bn of additional outflows per year can be expected from the implementation of the new measures. About USD10bn will come from portfolio investments and USD5bn from outward direct investments.

In our view, the outward portfolio investments are expected to do the heavy lifting in balancing FX demand and supply at least in the short term particularly given the recent change in NPS investment program. In addition, we do think the changes in regulations should help at least for overseas portfolio investment because domestic investors have been slow in investing abroad due to earlier differences in the tax treatment for income made from investing in local versus foreign funds. In addition, the change in hedging rules will further aid Won weakness.

Ceteris paribus, the total additional portfolio outflows for this year of $21.3bn would further aid the recycling of Korea’s massive current account surplus of $108bn (our estimate). The net flow – defined as the current account plus capital account – should moderate to as little as $5.5bn (of inflows) this year – making the won more vulnerable to global conditions.

KRW beta to the USD which is typically one of the

highest in the region will become more apparent.

-0.7

-0.6

-0.5

-0.4

-0.3

-0.2

-0.1

0.0

0.1

0.2

0.3

CNY IDR INR KRW MYR PHP SGD TWD THB

USD TWI

Local Equities

Local 10Y Yields

Beta of Local FX to different drivers in 6m multivariate

regression

Source: Deutsche Bank, CEIC, Bloomberg Finance LP

The risk, if anything, is that outflows are even bigger than our relatively conservative estimates, given that: 1) Korean authorities could accelerate the overseas investment plans for NPS, and 2) equity inflows (about $23bn) since the Taper tantrum have yet to unwind. On the latter point, it is worth noting that during the last Fed hike cycle (June 2004 to 2006), Korea experienced total equity outflows of $17.3bn, and these outflows persisted even after the Fed ended its rate hiking cycle. In addition, the recent won weakness has started to incentivize corporations to build their FX holdings, which should also help recycle the large current account. Given the diminishing net inflows, we expect the won’s beta to the USD to become more assertive in the second half of the year. We recommend long USD/KRW 6M NDF, extending our target to 1,180 and moving our stop-loss level to 1,100

Perry Kojodjojo, Hong Kong, +852 2203 6153

20 July 2015



South Korea: Deutsche Bank forecasts

2013 2014 2015F 2016F

National income

Nominal GDP (USDbn) 1305 1411 1356 1359

Population (m) 50.2 50.4 50.6 50.8


Real GDP (yoy %) 2.9 3.3 2.6 3.2




Exports 4.3 2.8 1.5 3.6

Imports 1.7 2.1 1.7 3.2

Prices, money and banking

CPI (yoy %) eop 1.1 0.8 1.6 1.9

CPI (yoy %) ann avg 1.3 1.3 0.9 1.8

Broad money (Lf) 7.4 7.7 8.0 8.0

Bank credit (yoy %) 4.1 6.3 7.5 7.0

Fiscal accounts (% of GDP)

Central government surplus 1.0 0.6 -1.1 -1.1




External accounts (USDbn)



Trade balance 80.6 92.7 120.8 110.0

% of GDP 6.2 6.6 8.9 8.1


% of GDP 6.1 6.3 7.9 6.0

FDI (net) -15.6 -20.7 -20.0 -18.0

FX reserves (USDbn) 1 346.5 363.6 379.5 383.4

FX rate (eop) KRW/USD 1056 1099 1160 1180

Debt indicators (% of GDP)

Government debt2 34.8 35.8 37.5 38.2

Domestic 34.3 35.4 37.2 38.0

External 0.5 0.5 0.3 0.1


in USDbn 423.5 425.4 425.0 428.0


General

Industrial production (yoy %) 0.2 0.0 2.0 3.2

Unemployment (%) 3.1 3.6 3.7 3.7

Financial markets Current 15Q3 15Q4 16Q2

BoK base rate 1.50 1.50 1.50 1.50

91-day CD 1.65 1.65 1.67 1.70

10-year yield (%) 2.51 2.60 2.80 3.10

KRW/USD 1140 1150 1160 1160

Source: CEIC, Deutsche Bank estimates, Global Markets Research, National Sources Note: (1) FX swap funds unaccounted for (2) Includes government guarantees

20 July 2015



Taiwan

Economic outlook: With limited conventional macro policy tools, Taiwan’s growth enhancing strategy calls for comprehensive reform.

Main risks: However, its reform plan may be sidelined by politics as Taiwan heads towards the national election next year.

Strategy: We have reasons to believe the TWD weakness will be more visible in 2H, reversing its resilient performance in 1H. First, the annual dividend payment season for Taiwanese companies has started with the peak in late July before tapering off by the end of August. Second, the domestic political situation in Taiwan seems to be deteriorating which could also add to the upside pressure on the currency pair. Third, the ongoing monetary easing by global central banks including BoK and PBoC is likely to keep CBC uncomfortable with a stronger TWD. All said, we continue to remain bearish on the TWD and recommend buying 6M USD/TWD 30.9/32 call spread

Economics

Thinking long term Growth trends lower. Exports collapsed in June, falling 13.9%yoy vs. a 3.8% contraction in May. The rate of decline in exports accelerated to 9.8% in Q2, from 4.1% in Q1. This weakness was led by a 12.9% fall in exports to China, whose share stood at 25.7% in the last five years. Needless to say, the slowdown in China, challenged further by the precipitous decline in its financial markets, increases our concerns over Taiwan’s growth. Coupled with weak domestic demand, we expect Taiwan’s growth to slow to 0.4%qoq (2.9%yoy) in Q2 from 0.7% (3.4%) in Q1, vs. DBGAS’s 3.1% forecast.

China’s share in high/medium goods stood high

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

1995 1997 1999 2001 2003 2005 2007 2009 2011 2013

High-skill: Parts/components for electrical/electronic goods

High-skill: Electronics (X parts and components)

Medium-skill: Parts/components for electrical/electronic goods

Medium-skill: Electronics (X parts and components)

China's share of world exports

Sources: UNCTAD, Deutsche Bank

Long-term growth challenges… Taiwan’s challenge is not transitory. As the Central Bank of China (CBC) put it, Taiwan’s exports are challenged by not only “sluggish growth in the global economy” but also “strong competition from abroad, especially from Mainland China in the IT industry.” Indeed, Taiwan’s global market share in high tech exports has trended downward, while China’s has trended higher. This is a structural challenge and cannot be addressed by stimulus measures. There are increasing risks of hollowing out (of employment) for Taiwan as local firms may offshore production, to places like Vietnam, to reduce costs as China continues its localization of the production of intermediate goods and amid increasing competition from other economies, especially as the yen continues to weaken. Moreover, like neighboring South Korea, Taiwan faces demographic challenges (working age population is peaking now) that point to a sustained fall in trend growth ahead. Since the GFC, Taiwan’s trend growth has declined from 4% to below 3%.

…and limited conventional policy response… Reflecting the authorities’ increasing uneasiness about weaker growth, the National Development Council announced its plan to introduce measures to revive the economy and improve exports. However, we do not think aggressive monetary easing is in the picture, nor do we expect aggressive fx intervention, although cheap financing for exporters is an option. Meanwhile, Taiwan’s efforts in FTA remain limited due to international policies. We see the CBC refraining from rate cuts unless growth falls below 2.5%, as it remains apprehensive about a property market bubble. With real estate representing less than 35% of households’ assets, the CBC is sanguine about the recent decline in housing prices, describing it as a “positive result.” Meanwhile, there is only limited room for fiscal stimulus given that public debt is near its threshold of 50% (including local government debt).

20 July 2015



Competitiveness suffers from poor contract

enforcement

0

50

100Starting a Business

Dealing with Construction …

Getting Electricity

Registering Property

Getting Credit

Protecting Minority Investors

Paying Taxes

Trading Across Borders

Enforcing Contracts

Resolving Insolvency

Taiwan Korea

Sources: Deutsche Bank, World Bank. 2014. Doing Business 2015: Going Beyond Efficiency. Washington, DC: World Bank Group. DOI: 10.1596/978-1-4648-0351-2. License: Creative Commons Attribution CC BY 3.0 IGO Note: Further away from center, less competitive it is.

…call for comprehensive reforms, although the politics remain challenging. Given its demographic challenges, we think Taiwan’s plan may also seek to boost women’s participation, reform education to reflect the needs of business, deregulate, pursue tax reforms, and ensure enforcement of contracts, among other things. Indeed, there is room for improvement. According to the World Bank’s Doing Business index, Taiwan is well below Korea’s ranking of 4th (out of 189 economies), at 93 in 2015, in the area of contract enforcement. This is a far wider gap than for ease of trading across borders. Here, Korea ranks 3rd vs. Taiwan’s 32. Taiwan’s ranking in the overall index was relatively low at 19th vs. Korea’s 5th, suggesting that much could be gained by reform.

While Taiwan has sought to boost growth via services expansion – tourism, medical services, and the cultural and creative industries, the same as South Korea – it has not taken more aggressive measures. For example, South Korea provides a visa waiver program for Chinese tourists to Jeju Island. South Korea has also planned its most ambitious deregulatory reform in a decade, to boost services sector growth, although this is mired in politics at the moment. On the other hand, Taiwan boasts a much higher productivity in services when compared to South Korea.

Taiwan enjoys greater productivity in services

0

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30

40

50

60

70

80

OE

CD

HK

Sin

gap

ore

Taiw

an

Ko

rea

Ch

ina

Vie

t N

am

1990

2000

Late 2000s

2000 constant dollar, th

Sources: ADB, Deutsche Bank

As far as manufacturing is concerned, Korea’s productivity is higher than Taiwan’s, while it has also spent more on R&D; the Taiwanese government could provide more funds for R&D. Although Taiwan has sought deregulation and tax incentives, those efforts have been limited to FEZs, while Korea aims to overhaul its entire regulatory system, although this also faces political obstacles. Taiwan could also undertake comprehensive reform of its regulation and tax structure.

Juliana Lee, Hong Kong, +852 2203 8312

20 July 2015



Investment strategy

Dividend season in play In contrast to its regional peers, the TWD has been remarkably resilient. It has appreciated against the USD and on a trade-weighted basis as well. This appreciation has been driven in part by the equity inflows. However, we have reasons to believe the TWD weakness will be more visible in 2H, reversing its resilient performance in 1H. First, the annual dividend payment season for Taiwanese companies has started with the peak in late July before tapering off by the end of August. The largest dividend payment will be about $3.8bn by TSCM on 23 July. Given foreign investors hold about 75% of the firm, the total possible dividend outflow would be about $2.8bn. This is followed by dividend payments by other larger semi-conductor companies such as MediaTek which is expected to pay $1.1bn in dividend. We could see these flows adding upside pressure on the USD/TWD. In fact, seasonally, the TWD tends to underperform in July and August due to these large dividend outflows. Second, the domestic political situation in Taiwan could also add to the upside pressure on the currency pair. The Taipei Times reported on 14 July that the Democratic Progressive Party’s (DPP) presidential candidate has gained a 20% lead against the ruling party’s (Chinese Nationalist Party’s or Kuo Ming Tang, KMT) presidential candidate and Singapore’s Straits Time on 14 July stated that support for the KMT is reducing given ongoing infighting within the party. If this is true and the opposition party continues to gain further support, the market could react negatively. This is because investors would worry that there will be: 1) a slowdown in cross-strait negotiations between China and Taiwan, which could hinder Taiwan’s ability to gain more access into the Chinese market resulting in more capital outflows; 2) a slowdown in Taiwan's ability to negotiate with other nations for more free trade agreements, which will further weaken the external sector; and 3) further overseas investment by domestic corporations. Third, the ongoing monetary easing by global central banks including BoK and PBoC is likely to keep CBC uncomfortable with a stronger TWD. Historically, Taiwanese authorities have tried to keep TWD performance in line with the won, as Korea has always been viewed as one of Taiwan’s key export competitors, particularly in the semiconductor sector. With the Korean authorities maintaining a preference towards a loose monetary policy, we think the Taiwanese authorities will be increasingly uncomfortable with a strong TWD. All said, we continue to remain bearish on the TWD.

Perry Kojodjojo, Hong Kong, +852 2203 6153

Taiwan: Deutsche Bank forecasts 2013 2014 2015E 2016E

National income

Nominal GDP (USDbn) 513.0 530.8 535.3 541.1

Population (m) 23.4 23.4 23.4 23.5


Real GDP (yoy %) 2.2 3.8 3.1 3.2


Government consumption -1.2 3.7 -0.8 0.5


Exports 3.5 5.9 3.9 4.3

Imports 3.3 5.7 2.1 2.9

Prices, money and banking

CPI (yoy %) eop 0.3 0.6 1.1 1.6

CPI (yoy %) annual average 0.8 1.2 -0.2 1.6

Broad money (M2) 4.3 5.8 6.2 6.0

Bank credit1 (yoy %) 2.7 4.3 4.0 4.2

Fiscal accounts (% of GDP)

Budget surplus -1.4 -2.0 -1.7 -1.4




External accounts (USDbn)



Trade balance 35.5 41.5 44.4 37.1

% of GDP 6.9 7.8 8.3 6.9


% of GDP 10.8 12.3 12.9 10.7

FDI (net) -10.7 -9.8 -14.0 -14.0

FX reserves (USDbn) 416.8 419.0 426.2 427.4

FX rate (eop) TWD/USD 29.8 31.7 32.0 32.5

Debt indicators (% of GDP)

Government debt2 39.6 39.7 40.0 40.2

Domestic 39.1 39.3 39.6 39.8

External 0.5 0.4 0.4 0.4


in USDbn 170.1 177.9 186.8 196.2


General

Industrial production (yoy%) 0.8 6.2 5.0 5.5

Unemployment (%) 4.2 4.0 3.9 3.9

Financial markets Current 15Q3 15Q4 16Q2

Discount rate 1.88 1.88 1.88 1.88

90-day CP 0.81 0.81 0.83 0.85

10-year yield (%) 1.50 1.65 1.80 2.10

TWD/USD 31.0 31.6 32.0 32.3 Source: CEIC, Deutsche Bank Global Markets Research, National Sources Note: (1) Credit to private sector. (2) Including guarantees on SOE debt

20 July 2015



Thailand

Economic outlook: Domestic and external demand malaise continues, prompting us to revise down our 2015 growth forecast.

Main risks: Political uncertainty could rise if the election timetable gets deferred. Continued weakness in the Chinese economy could hurt tourism and investment.

Strategy: Bond market can derive comfort from the monetary policy setting perspective, with an accommodative bias expected to remain in place for longer. Supply technicals are supportive over the next two months, market positioning is broadly underweight, and valuations are not prohibitive. This overall setup remains supportive of our long standing constructive view on ThaiGBs. From a relative value perspective and more so to avoid the delta on global rates volatility, we remain with our swap spread widener idea (Long LB21DA versus matched maturity IRS) initiated last month at -30bp, targeting 0bp for the spread. We also recommend switching into LB21DA (3.65%, Dec-21) from LB196A (3.875%, Jun-19), which offers 59bp pickup. It also looks attractive relative to other proximate points on the curve, with 5Y/7Y/10Y (LB196A/LB21DA/LB236A) fly spread now hovering at YTD highs.

Economics

Turnaround remains elusive; revising down 2015 growth forecast to 2.5% Although the authorities are making progress in boosting capital spending, the near term outlook has worsened with little traction on private consumption and investment, as well as renewed weakness in trade. Against this backdrop, we have revised down our 2015 real GDP growth forecast to 2.5%, while leaving the 2016 forecast unchanged. Below we examine the key macro drivers of the economy.

Consumption The index of private consumption declined by 0.4%yoy in May (-0.1%yoy in April). Durable consumption was particularly weak, down 9.1%yoy. The retail sales index has been in negative growth territory from the beginning of the year. Acute weakness in auto sales continues, with passenger car sales down 21.1%yoy though May. Considering the same series was down 44.4%yoy in May 2014 underscores the fact that private car sales have not made much progress in the last half a decade, with only one-off schemes temporarily boosting sales (as was the case in 2012/13).

Consumption weakness continues

-25

0

25

50

75

100

-4

-2

0

2

4

6

8

10

12

14

2011 2012 2013 2014 2015

Private consumption index (sa), left

Durables consumption (sa), right

%yoy,

3mma

%yoy,

3mma


We are not hopeful about consumption going forward. Wage growth is muted in both rural and urban areas as economic activity is weak. High household debt and rising real rates (owing to sustained deflation) don’t bode well either for the outlook. Due to ongoing demand weakness, production continues to slip. The index of shipment was down 7.9%yoy in May, marking two years of flat or falling shipment. Similarly, the index of production declined 6.9%yoy in May. Capacity utilization now stands at 56.6, a three and a half year low, which hurts pricing power and incentive to invest.

Investment The index of private investment fell into contraction territory in May, down 0.4%yoy. This series suggested a pick-up earlier this year, but has lost momentum in recent months. Proxies of investment such as capital goods imports and commercial auto sales have been contracting sharply lately, which suggest the outlook will remain lackluster.

Trade External demand, especially vis-à-vis China, is not as poor as it used to be, but overall Thai exports performance continues to disappoint. On the products front, commodities and electronics remain very weak. With respect to trading partners, exports to the US and Europe, already weak, have worsened further lately.

20 July 2015



Trade weakness intensifies

-20.0

-10.0

0.0

10.0

20.0

30.0

2011 2012 2013 2014 2015

Exports Imports%yoy,

3mma


Public spending Given the malaise in private consumption and investment, the pressure on the government is particularly high to get its much discussed capital spending program going. There is some positive development in that area, with total public spending up 10%yoy in May and public investment up 45.2%yoy.

Inflation Reflecting weak commodity prices and domestic demand, deflation continues unabated. CPI inflation was -1.1%yoy in June, while core was up 0.9%yoy. We don’t see inflation returning to positive territory before December, and even that timing could be pushed further down the road if the recent renewal of downward slide in commodity prices persists. Indeed, the odds of inflation remaining well below 2% during most of 2016 have increased considerably, in our view. The BoT’s inflation target of 1-4% will be missed this year, and only be achieved next year with some degree of discomfort, in our view.

The impact of chronic deflation is that despite policy rate at an all-time low, real rates have surged this year. Even as inflation picks up and real rate eases next year, it will be higher than what in our view is needed under current economic conditions. If growth and inflation weakness persists, BoT may well have to entertain further rate cuts, which we would see as necessary and welcome.

Deflation has pushed up real rates despite policy

nominal rate at record low of 1.5%

-2.00

-1.50

-1.00

-0.50

0.00

0.50

1.00

1.50

2.00

2.50

3.00

2011 2012 2013 2014 2015 2016

Policy rate minus inflation


Exchange rate channel One way to deal with deflation would be to entertain a weak exchange rate, but surging trade (USD4.1bn in May) and current account (USD2.1bn in May) surpluses have gotten in the way. We welcome the central bank flagging the strong baht as a source of headwind in the last policy statement. Easing capital repatriation rules and cutting rates further are clearly the need of the hour, in our view.


Investment Strategy

BoT to maintain its accommodative bias Domestic and external demand malaise continues, prompting DB economics to revise down their 2015 growth forecast to 2.5% (BoT’s latest forecast is at 3%). Meanwhile, the decline in commodity prices and weak domestic demand has kept the headline inflation stubbornly in the negative territory. Indeed the central bank lowered its inflation forecast further to -0.5% for 2015 & 1.6% for 2016, from an earlier 0.2% and 2.2% respectively. Inflation is thus expected to settle well below the official target range of 1-4%. Against this poor macro backdrop, the central bank does have room to ease further down the road, as we have been writing in these pages. Also, note that the BoT has slashed policy rates to as low as 1.25% twice in the past – so we are not at all time lows yet. Bond market can thus derive comfort from the monetary policy setting perspective, with an accommodative bias expected to remain in place for longer. Meanwhile, supply is relatively light this quarter, market positioning is broadly underweight, and valuations are not prohibitive. This overall setup remains supportive of our long standing constructive view on ThaiGBs. From a relative value perspective and more so to avoid the delta on global rates volatility, we remain with our swap spread

20 July 2015



widener idea (Long LB21DA versus matched maturity IRS) initiated last month at -30bp, targeting 0bp for the spread. We also recommend switching into LB21DA (3.65%, Dec-21) from LB196A (3.875%, Jun-19), which offers 59bp pickup. LB21DA also looks attractive relative to other proximate points on the curve, with 5Y/7Y/10Y (LB196A/LB21DA/LB236A) fly spread now hovering at YTD highs. While fairly priced as per our Nelson-Siegel-Svensson framework for ThaiGBs; it offers an attractive roll-down profile being on the much steeper part of the curve.

For the currency, its poor-quality stalemate has finally come to an end, with BoT's consecutive rate cuts and liberalization of domestic outflows helping the Baht break out of its range. We think there is more to come. The current account seasonally softens mid-year, and could shrink further on import-intensive government infrastructure projects. Rate differentials are expected to compress further, with the Fed lifting rates later this year while the BoT maintaining its accommodative stance for longer. THB is the most sensitive in Asia to front-end rate differentials and valuations are not supportive either, pointing to more downside.

BoT’s accommodative bias is expected to remain in

place for longer

-2

-1

0

1

2

3

4

5

6

7

Jan-00 Jul-02 Jan-05 Jul-07 Jan-10 Jul-12 Jan-15

Policy Rate

CPI, 12mma

%

Current CPI

CPI target range for 2015

Y = 0.56X + 0.98R² = 0.62

DB CPI fcst,12mma


Supply technicals are supportive over next 2 months

-100

-80

-60

-40

-20

0

20

40

60

Oct 14

Nov 14

Dec 14

Jan 15

Feb 15

Mar 15

Apr 15

May 15

Jun 15

Jul 15

Aug 15

Sep 15

Gross

Redemptions

Net

THB bn

Source: Deutsche Bank, PDMO, ThaiBMA

DVo1 supply is relatively light over the next 2 months

-

500

1,000

1,500

2,000

2,500

3,000

Oct 14

Nov 14

Dec 14

Jan 15

Feb 15

Mar 15

Apr 15

May 15

Jun 15

Jul 15

Aug 15

Sep 15

USD K

Source: Deutsche Bank, PDMO, ThaiBMA DVo1 calculations account for bond switches

LB21DA now offers 59bp pickup over LB196A

0

10

20

30

40

50

60

Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15

bp LB21DA/LB196A Slope


20 July 2015



LB21DA is attractive relative to its peers on the curve,

with the fly spread now hovering at YTD highs

0

5

10

15

20

25

30

35

40

Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15

bp LB21DA vs (LB196A & LB236A) Butterfly


Stay with swap spread widener (Long LB21DA versus

matched maturity IRS) initiated last month at -30bp,

targeting 0bp for the spread

-50

-40

-30

-20

-10

0

10

20

30

40

50

Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15

bp Matched maturity swap spread for 'LB21DA'



Thailand: Deutsche Bank Forecasts

2013 2014 2015F 2016F

National Income

Nominal GDP (USDbn) 399.1 399.8 382.8 393.0

Population (m) 64.8 65.1 65.4 65.8


Real GDP (yoy %) 2.8 0.9 2.5 3.0



Gross fixed investment -0.8 -2.6 1.7 4.0

Exports 2.8 0.0 -0.2 6.8

Imports 1.4 -5.4 1.4 6.1


CPI (yoy %) eop 1.7 0.6 0.2 1.9

CPI (yoy %) ann avg 2.2 1.9 -0.6 1.7

Core CPI (yoy %) ann avg 1.0 1.6 1.0 1.2

Broad money 7.3 4.6 5.0 6.0

Bank credit1 (yoy %) 9.4 4.3 4.5 6.0

Fiscal Accounts2 (% of GDP)

Central government surplus -2.0 -2.8 -2.5 -2.0




External Accounts (USDbn)



Trade balance 6.7 24.6 27.7 24.6

% of GDP 1.7 6.1 7.2 6.2

Current account balance -3.9 13.4 14.0 10.0

% of GDP -1.0 3.4 3.7 2.5

FDI (net) 14.4 12.8 12.0 14.0

FX reserves (USDbn) 167.3 157.1 165.0 175.0

FX rate (eop) THB/USD 32.9 32.9 35.0 35.0


Government debt2,3 45.3 46.6 46.7 46.7

Domestic 43.4 45.6 45.7 45.8

External 1.9 1.0 1.0 0.9


in USDbn 135.0 140.0 145.0 150


General

Industrial production (yoy %) 2.6 1.0 5.0 5.0

Unemployment (%) 0.8 0.9 1.0 1.1


BoT o/n repo rate 1.50 1.50 1.50 1.50

3-month Bibor 1.66 1.70 1.80 1.95

10-year yield (%) 2.80 2.80 2.90 3.20

THB/USD (onshore) 34.0 34.6 35.0 35.4 Source: CEIC, Deutsche Bank Global Markets Research, National Sources Note: (1) Credit to the private sector & SOEs. (2) Consolidated central government accounts; fiscal year ending September. (3) excludes unguaranteed SOE debt

20 July 2015



China - Inflation (CPI) China - One-year Deposit Rate

-2

0

2

4

6

8

2011 2012 2013 2014 2015 2016

%yoy

1.75

1.5

2.0

2.5

3.0

3.5

4.0

2011 2012 2013 2014 2015 2016

%



Next CPI release: Aug 09 DB Forecast (Previous): 1.6%yoy (1.4%)

Next policy meeting: N.A. DB Rate Call: No change in rate expected

India - Inflation (CPI) India - Repo Rate

2

4

6

8

10

12

2012 2013 2014 2015 2016

%yoy

7.00

6.0

6.5

7.0

7.5

8.0

8.5

9.0

2012 2013 2014 2015 2016

%




Next policy meeting: Aug 04 DB Rate Call: No change in rate expected

Indonesia - Inflation (CPI) Indonesia - One-month SBI Rate

2

4

6

8

10

2011 2012 2013 2014 2015 2016

%yoy%yoy

7.00

5

6

7

8

9

2011 2012 2013 2014 2015 2016

%



Next CPI release: Aug 03 DB Forecast (Previous): 7.3%yoy (7.3%) Next policy meeting: Aug 18 DB Rate Call: No change in rate expected

20 July 2015



Malaysia - Inflation (CPI) Malaysia - Overnight Policy Rate

-1

0

1

2

3

4

5

6

2011 2012 2013 2014 2015 2016

%yoy

3.25

1.5

2.0

2.5

3.0

3.5

4.0

4.5

2011 2012 2013 2014 2015 2016

%




Next policy meeting: Sep 03 DB Rate Call: No change in rate expected

Philippines - Inflation (CPI) Philippines - Overnight Repo Rate

0

2

4

6

8

2011 2012 2013 2014 2015 2016

%yoy

6.00

4.00

3

4

5

6

7

8

2011 2012 2013 2014 2015 2016

Repo Revrepo%




Next policy meeting: Aug 13 DB Rate Call: No change in rates expected

South Korea - Inflation (CPI) South Korea - Overnight Call Rate Target

0

1

2

3

4

5

2011 2012 2013 2014 2015 2016

%yoy

1.50

1

2

3

4

2011 2012 2013 2014 2015 2016

%




Next policy meeting: Aug 13 DB Rate Call: No change in rates expected

20 July 2015



Sri Lanka - Inflation (CPI) Sri Lanka - Reverse Repo Rate

-2

0

2

4

6

8

10

12

14

2011 2012 2013 2014 2015 2016

%yoy

7.00

6

7

8

9

10

11

2011 2012 2013 2014 2015 2016

%



Next CPI release: Jul 30 DB Forecast (Previous): -0.4%yoy (0.1%)


Taiwan - Inflation (CPI) Taiwan - Discount Rate

-3

-2

-1

0

1

2

3

4

2011 2012 2013 2014 2015 2016

%yoy

1.875

1.00

1.50

2.00

2.50

2011 2012 2013 2014 2015 2016

%



Next CPI release: Aug 05 DB Forecast (Previous): -0.4%yoy (-0.6%)

Next policy meeting: Sep 24 DB Rate Call: No change in rate expected

Thailand -Inflation (CPI) Thailand - One-day Repurchase Rate

-2

-1

0

1

2

3

4

5

6

2011 2012 2013 2014 2015 2016

%yoy

1.50

0

1

2

3

4

5

2011 2012 2013 2014 2015 2016

%



Next CPI release: Aug 03 DB Forecast (Previous): -0.8%yoy (-1.1%)

Next policy meeting: Aug 05 DB Rate Call: No change in rate expected

20 July 2015



Vietnam - Inflation (CPI) Vietnam - Discount Rate

-4

0

4

8

12

16

20

24

2011 2012 2013 2014 2015 2016

%yoy

6.5

4

7

10

13

16

2011 2012 2013 2014 2015 2016

%



Next CPI release: Jul 24 DB Forecast (Previous): 1.4%yoy (1.0%)


Hong Kong - Inflation (CPI) Hong Kong - Base Rate

-2

0

2

4

6

8

10

2011 2012 2013 2014 2015 2016

%yoy

0.75

0.00

0.50

1.00

1.50

2.00

2011 2012 2013 2014 2015 2016

%



Next CPI release: Jul 21 DB Forecast (Previous): 3.1%yoy (3.0%)

Singapore - Inflation (CPI) Singapore - 3m SGD Sibor

-1

0

1

2

3

4

5

6

2011 2012 2013 2014 2015 2016

%yoy

1.1

0.15

0.45

0.75

1.05

1.35

1.65

2011 2012 2013 2014 2015 2016

%



Next CPI release: Jul 23 DB Forecast (Previous): -0.5%yoy (-0.4%)

20 July 2015



Economic Diary

Count ry Release Per iod DB Expected Consensus Actua l

Monday , July 13

China Exports Jun-YoY 2.0% 1.0% 2.8%

Imports Jun-YoY -15.0% -15.0% -6.1%

Trade Balance Jun USD82.4bn USD56.4bn USD46.5bn

India CPI Jun-YoY 5.0% 5.1% 5.4%

Tuesday , July 14

China M2 Jun-YoY 11.0% 11.0% 11.8%

India WPI Jun-YoY -2.4% -2.3% -2.4%

Singapore GDP (Advance estimate) Q2-YoY 3.0% 2.4% 1.7%

Events and Meeting:Indonesia:BI Meeting (no change in rate)

Wednesday , July 15

China GDP Q2-YoY 6.8% 6.8% 7.0%

Industrial Production Jun-YoY 5.9% 6.0% 6.8%

Fixed Asset Investment (ytd) Jun-YoY 11.0% 11.2% 11.4%

Retail Sales Jun-YoY 10.0% 10.2% 10.6%

India Exports Jun-YoY -15.2% NA -15.8%

Imports Jun-YoY -18.8% NA -13.4%

Trade Balance Jun -USD9.2bn -USD10.5bn -USD10.8bn

Indonesia Exports Jun-YoY -13.0% -16.6% -12.8%

Imports Jun-YoY -20.5% -20.9% -17.4%

Trade Balance Jun USD0.9bn USD0.5bn USD0.5bn

Malaysia CPI Jun-YoY 2.2% 2.4% 2.5%

Singapore Retail Sales (nominal) May-YoY 3.0% 3.0% 6.1%

Retail Sales (real) May-YoY 2.0% NA 6.4%

South Korea Unemployment Rate (sa) Jun 4.0% 4.0% 3.9%

Thursday , July 16

Singapore Exports Jun-YoY -9.0% NA -5.8%

NODX Jun-YoY -0.5% 2.0% 4.7%

Imports Jun-YoY -15.0% NA -4.1%

Trade Balance Jun SGD7.6n NA SGD4.9n

Fr iday , July 17

Philippines Fiscal Balance May NA NA

Monday , July 20

Hong Kong Unemployment Rate (sa) Jun 3.3% 3.2%

Tuesday , July 21

Hong Kong CPI Jun-YoY 3.1% 3.2%

Wednesday , July 22

Taiwan Unemployment Rate (sa) Jun 3.8% 3.8%

Events and Meeting:NZ: RBNZ meeting

Thursday , July 23

Singapore CPI Jun-YoY -0.4% -0.3%

South Korea GDP (Advance estimate) Q2-YoY 2.2% 2.3%

Taiwan Industrial Production Jun-YoY -4.8% 3.5%

Fr iday , July 24

Philippines Imports May-YoY 5.6% NA

Trade Balance May -USD0.4bn NA

Singapore Industrial Production Jun-YoY -2.0% -0.5%

Taiwan M2 Jun-YoY 6.9% NA

Vietnam CPI Jul-YoY 1.4% NA

Saturday , July 25

Vietnam Retail Sales (ytd) Jul-YoY 10.0% NA

Industrial Output Jul-YoY 11.3% NA

Exports (ytd) Jul-YoY 9.5% NA

Imports (ytd) Jul-YoY 17.1% NA

Trade Balance (ytd) Jul -USD4.5bn NA

Sources: DB Global Markets Research, Bloomberg Finance LP

20 July 2015



Bond Auction Calendar

Count ry Code Deta il Coupon Matur ity Amount Nomina l

Outs 'g

Date S ize sold Bid-

cover

Commenta ry

South Korea NDFB 10Y re-isssue 2.250% 10-Jun-25 KRW2tn KRW5.4tn

Taiwan TGB 5Y re-issue 1.000% 12-Jun-20 TWD30bn TWD30bn 9-Jun-15 TWD30bn 2.27x

Philippines PHY6972FUE87 3Y re-issue 2.125% 23-May-18 PHP25bn PHP102bn 16-Jun-15 PHP25bn 1.63x

China CGB 5Y re-issue 4.260% 28-May-20 CNY30bn CNY30.12bn 27-May-15 CNY30bn na Expect the auction to be cut at the

secondary market level

Thailand LBA37DA 20Y re-issue 4.260% 12-Dec-37 THB10bn THB184bn 27-May-15 THB10bn 1.84x

5-9Y INR20-30bn

10-14Y INR60-70bn

15-19Y INR30-40bn

20Y & above INR30-40bn

Las t auct ion deta il

Monday , July 20

Tuesday , July 21

Wednesday , July 22

India IGB

Fr iday , Jul 24

Sources: DB Global Markets Research, Bloomberg Finance LP Note: Information as of 20 July

2015 Gross and Net Issuance Projections – y/y change

Local currency only

Gross Issuance Monitor

Local currency only

-25%

-15%

-5%

5%

15%

25%

35%

SGD INR IDR TWD KRW MYR CNY PHP THB

Gross Net

2015 Plan YTD As of % YTD % YTD 2014*

CNY (bn) 2220.0 1405.1 20-Jul 74% 52%

HKD (bn) 47.1 3.3 20-Jul 7% 30%

INR (tn) 6.0 2.1 20-Jul 36% 41%

IDR (tn) 350.0 226.0 20-Jul 65% 62%

KRW (tn) 102.7 55.6 10-Jul 54% 57%

MYR (bn) 92.4 51.5 20-Jul 56% 57%

PHP (bn)^ 201.8 -23.1 31-Mar -9% 19%

SGD (bn) 21.8 26.8 20-Jul 58% 57%

TWD (bn) 715.0 385.3 20-Jul 54% 61%

THB (bn) 580.0 503.9 20-Jul 87% 78%

Source: Deutsche Bank, CEIC *Corresponding period in 2014 ^Net issuance numbers

Notes: (1) Calendar year 2015 for all markets except HK (Apr 2015 to Mar 2016), India (Apr 2015 to Mar 2016) and Thailand (Oct 2014 to Sep 2015) (2) China includes CGBs, local government bonds and savings bonds. (3) HK includes Exchange Fund Notes and government bonds, excludes EF bills (4) India includes central government bonds only. Maturities include buybacks (5) Indonesia includes FR, VR, T-bills, zero coupon, retail bond, sukuks and private placements. Maturities include buybacks. (6) Korea includes KTB and KTBi, excludes MSBs. (7) Malaysia includes MGS, GII and syariah savings bonds. (8) Philippines includes T-bonds and retail bonds only. Excludes OFW bonds. (9) Singapore includes SGS and 1Y T-bills. (10) Taiwan includes TGBs, excludes T-bills. (11) Thailand includes loan bonds and linkers only. Excludes bills.

20 July 2015



Monetary Policy Monitor

Policy rate Short rate

Implied change in short rate (bp) *

Implied change in policy rate (bp)**

DB policy rate forecasts

Instrument Spot 6m 12m 6m 12m 6m 12m

China 1Y deposit 2.00% 1Y PBOC bill 2.45% 29 41 29 41 -25 -25

Hong Kong Base rate 0.50% 3M Hibor 0.39% 16 56 17 51 50 100

India Repo rate 7.25% Overnight 7.22% -2 -35 -6 -38 -25 -25

Indonesia Overnight 7.50% 1Y CMT 7.05% 18 35 18 35 -50 -50

Korea 7D repo 1.50% 3M CD 1.65% -7 1 -2 6 0 0

Malaysia Overnight 3.25% 3M Klibor 3.69% -7 2 -3 3 0 25

Taiwan Discount rate 1.88% 3M Taibor 0.88% 4 10 5 17 0 0

Thailand Repo rate 1.50% 6M THB FX 1.44% -8 10 -19 3 0 0

US Fed Fund Target 0.25% Fed Fund Eff. 0.29% 25 59 25 59 50 100 *Calculated from 6X9 and 12X15 FRAs for HK, Korea, Malaysia and Taiwan. 6X12 and 12X18 FRAs for Thailand. 6M and 12M forward overnight rates for India. Forward yield of 1Y CMT for Indonesia. Fed funds futures contracts for the US. **Adjusted to imply linear convergence of spread between short rate and policy rate to long term (rolling) regression value over the next 12 months, except for China, Indonesia and India. *** We estimate the implied auction yield of the 1Y PBOC bill by the maximum potential for auction yield to fall before PBoC triggers a deposit rate cut. We then compare the implied auction yield with the 1Y bill yield in the secondary market to estimate the extent of rate cut priced in. Source: Deutsche Bank, Bloomberg Finance LLP

DB policy rate forecasts versus implied by the market

-60 -40 -20 0 20 40 60

China

Hong Kong

India

Indonesia

Korea

Malaysia

Taiwan

Thailand

US

DB Forecasts Market Curve6-month ahead

Change in Policy Rate (bp)

-100 -50 0 50 100 150

China

Hong Kong

India

Indonesia

Korea

Malaysia

Taiwan

Thailand

US

DB Forecasts Market Curve12-month ahead

Change in Policy Rate (bp) Source: Deutsche Bank, Bloomberg Finance LP Notes as in the table above.

20 July 2015



Appendix 1

Important Disclosures

Additional information available upon request

*Prices are current as of the end of the previous trading session unless otherwise indicated and are sourced from local exchanges via Reuters, Bloomberg and other vendors . Other information is sourced from Deutsche Bank, subject companies, and other sources. For disclosures pertaining to recommendations or estimates made on securities other than the primary subject of this research, please see the most recently published company report or visit our global disclosure look-up page on our website at http://gm.db.com/ger/disclosure/DisclosureDirectory.eqsr

Analyst Certification

The views expressed in this report accurately reflect the personal views of the undersigned lead analyst(s). In addition, the undersigned lead analyst(s) has not and will not receive any compensation for providing a specific recommendation or view in this report. Sameer Goel/Taimur Baig/Kaushik Das/Diana Del Rosario/Swapnil Kalbande/Perry Kojodjojo/Juliana Lee/Linan Liu/Mallika Sachdeva/Kiyong Seong/Zhiwei Zhang

(a) Regulatory Disclosures

(b) 1.Important Additional Conflict Disclosures

Aside from within this report, important conflict disclosures can also be found at https://gm.db.com/equities under the "Disclosures Lookup" and "Legal" tabs. Investors are strongly encouraged to review this information before investing.

(c) 2.Short-Term Trade Ideas

Deutsche Bank equity research analysts sometimes have shorter-term trade ideas (known as SOLAR ideas) that are consistent or inconsistent with Deutsche Bank's existing longer term ratings. These trade ideas can be found at the SOLAR link at http://gm.db.com.

20 July 2015



(d) Additional Information

The information and opinions in this report were prepared by Deutsche Bank AG or one of its affiliates (collectively

"Deutsche Bank"). Though the information herein is believed to be reliable and has been obtained from public sources

believed to be reliable, Deutsche Bank makes no representation as to its accuracy or completeness.

Deutsche Bank may consider this report in deciding to trade as principal. It may also engage in transactions, for its own

account or with customers, in a manner inconsistent with the views taken in this research report. Others within

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taken in this research report. Deutsche Bank issues a variety of research products, including fundamental analysis,

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also important to acknowledge that funding in a currency that differs from the currency in which coupons are

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liabilities, and as such, investors should take expert legal and financial advice before entering into any transaction similar

20 July 2015



to or inspired by the contents of this publication. The risk of loss in futures trading and options, foreign or domestic, can

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20 July 2015



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David Folkerts-Landau Group Chief Economist

Member of the Group Executive Committee

Raj Hindocha Global Chief Operating Officer

Research

Marcel Cassard Global Head

FICC Research & Global Macro Economics

Steve Pollard Global Head

Equity Research

Michael Spencer Regional Head

Asia Pacific Research

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Deutsche Bank Research, Germany

Andreas Neubauer Regional Head

Equity Research, Germany

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