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N O M U R A S I N G A P O R E L I M I T E D

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Asia Special Report NOMURA GLOBAL MARKETS RESEARCH

November 26, 2013

Principal authors Economics, Asia ex-Japan

Rob Subbaraman Chief Economist, AEJ +65 6433 6548

[email protected]

FX strategy, Asia ex-Japan

Craig Chan Head of FX strategy, AEJ +65 6433 6106

[email protected]

Rates strategy, Asia ex-Japan

Vivek Rajpal Rates strategy, AEJ +65 6433 6555

[email protected]

Equity strategy, Asia ex-Japan

Michael Kurtz Global Head of Equity Strategy +852 2252 2182

[email protected]

2014 outlook: Growing divergences

Asia must implement austerity measures – tighter policies and structural reforms – or risk breeding future crises. As China slows, we expect Asian growth of less than 6%.

Our theme: growing divergence in fundamentals and growth opening up the biggest gap in decades. The leaders: Korea, Malaysia, the Philippines. The laggards: China, India, Indonesia, Thailand.

FX strategy: Into Q1, INR, KRW, PHP should outperform IDR and MYR on QE tapering and election/policy risks. Into Q2, China hard-landing risk could pressure Asia FX, with PHP and INR least affected. From Q2 onwards, the focus should shift to rate policy divergence where PHP should outperform THB.

Rates strategy: Monetise ‘policy carry’ by receiving THB 2yr, KRW 2yr and SGD 2s5s; on better growth, KRW and MYR steepeners; on differentiation, Pay KRW vs. SGD 5yr and Pay MYR vs. THB 2yr; Long 5yr/7yr India bonds, Pay 1yr INR and CNY swaps on local dynamics.

Equity strategy: The macro risk-compression rationale for APXJ equity multiple expansion is largely played out; from here, stocks need earnings growth to advance. We expect 13% regional earnings growth in 2014, for a year-end Asia-Pacific ex-Japan index target of 535, with upside skewed toward more export-oriented EMs.

mailto:[email protected]




Nomura | Asia Special Report 26 November 2013

2

Table of Contents

Executive summary 3

Forecast table 4

Asia's turn for austerity 5

Macro risks accumulating 5

Middle-income traps 6

Policymakers in the hot seat 7

China: No pain, no gain 8

Taiwan: Hampered by a lack of reform 11

Hong Kong: Overheating 12

South Korea: Catching up with global growth 13

India: Higher interest rates for longer 15

Southeast Asia: Continue to compare and contrast 17

Indonesia: An even more challenging year 18

Malaysia: Avoiding twin deficits 19

Philippines: Still the star performer 20

Singapore: No turning back 20

Thailand: Poor politics make for poor economics 22

FX strategy: H1 – politics, tapering and China; H2 – policy rate divergence 23

Fed QE tapering and differentiation between balance sheets 24

Election and policy risks 26

China hard-landing/systemic risks 27

Monetary policy divergence across the region 28

Rates strategy: Seek policy carry while acknowledging growing differentiation 30

Seek ‘policy carry’ through selected receivers 30

Yield curves to steepen in selected countries on improving growth prospects amid QE tapering 33

Positive carry spread trades to acknowledge growing differentiation 34

Liquidity and local dynamics to weigh in India and China rates 36

Australia rates outlook 38

Equity strategy: From risk compression to earnings growth 39

Equity Allocation/Recommendations 52

Stock selection: Earnings focus for 2014 54

Recent Asia Special Reports 60


3

Rob Subbaraman +65 6433 6548 [email protected]

Craig Chan +65 6433 6106 [email protected]

Vivek Rajpal +65 6433 6555 [email protected]

Michael Kurtz, NIHK +852 2252 2182 [email protected]

Executive summary

Economics

It is Asia’s turn to implement austerity – tighter policies and structural reforms – or it will be

the breeding ground for future crises. Even with a recovery in exports, we expect China’s

GDP growth to slow to 6.9% in 2014 and Asia ex-Japan’s growth to fall below 6.0%.

Our main theme is growing unevenness in Asia, both in terms of growth and fundamentals,

opening up the biggest disparities in decades. We contrast the leaders (Korea, Malaysia

and the Philippines) with the laggards (China, India, Indonesia and Thailand).

Monetary policy action is also likely to vary widely in 2014, with policy rate hikes of 100bp

in the Philippines and 50bp in India, Indonesia and Malaysia, whereas we expect only

25bp in Korea and no hikes in China, Taiwan and Thailand.

FX Strategy

The two main themes into Q1 2014 are Fed QE tapering and election/policy risks. We are

positioning long 3M INR, KRW, PHP against IDR and MYR to capture Fed tapering and

relative FX performance. INR could be a relative outperformer on the state election results.

We expect PHP and INR outperform IDR and MYR if there is a rise in China hard-landing

and financial systemic risks into Q2 (on top of the tapering and election risks). The risk is

also that USD/CNH trades to the weak side of the daily fixing on hard-landing fears.

The monetary policy differentiation theme from Q2 onwards, based on higher inflation

combined with China-slowdown, economic fundamentals and political risks should see

PHP structurally outperform THB into year-end 2014.

Rates strategy

We highlight four main themes: 1) Monetising ‘policy carry’ through selected receivers; 2)

Curve steepeners in countries with improving growth prospects; 3) Positive carry spread

trades on growing differentiation; and 4) Liquidity and local dynamics in India and China.

To monetise ‘policy carry’, we recommend investors receive Thailand 2yr, Korea 2yr and

Singapore 2s5s. We also recommend 2s5s steepeners in Malaysia and Korea on

improving growth prospects.

On the differentiation theme we focus on spread trades, Paying Korea 5yr vs. Singapore

5yr and Paying Malaysia 2yr vs. Thailand 2yr as positive carry spread trades that we

expect to benefit from the diverging growth performances between countries. We also like

long India 5yr/7yr bonds, Paying 1yr INR swap and Paying CNY 1yr swaps.

Equity strategy

With equity PER multiples having largely mean-reverted, equities increasingly require a

growth rationale for upside. Equity correlations have declined as well, suggesting investors

must grow more discriminating and bottom-up. We expect further declines in market

appetite for ‘safety’, and look for attributes such as beta, risk and growth to outperform.

Our end-2014 MSCI Asia-Pacific ex-Japan index target of 535 implies 14% upside from

current levels and we expect stronger upside in the more export-focused and operationally

geared markets such as Korea, Taiwan and Singapore as opposed to passé ‘yield play’

Australia or the FX-vulnerable parts of EM ASEAN. India is an against-the-grain

Overweight, on possible reform-friendly politics or further commodity price relief.

We favor cyclical, growth- or reflation-sensitive equity sectors such as Tech, Industrials,

Consumer Discretionary and Banks (downgrade Telcos to Underweight). Among cyclicals,

our more cautious China/commodity view inclines us toward downstream industries that

may benefit from easier input costs. Our higher US Treasury yield and USD expectations

also incline us away from (most) Property and Hong Kong.






4

Forecast table

2013 2014 2015 2013 2014 2015

China 7.6 6.9 6.8 2.7 3.0 3.2

Hong Kong 3.0 3.8 3.0 4.2 4.3 4.5

India 4.4 ↑ 4.7 4.8 5.7 9.9 9.1 ↑ 9.3 8.7

Indonesia 5.7 5.7 6.1 7.2 ↓ 7.0 5.6 6.2

Malaysia 4.3 4.5 4.0 2.1 3.5 5.2

Philippines 7.3 ↓ 7.1 6.2 ↑ 6.7 6.8 2.8 ↑ 2.9 4.0 4.1

Singapore 3.1 ↑ 3.5 3.5 2.9 2.8 ↓ 2.3 3.6 3.5

South Korea 2.9 4.0 4.0 1.2 2.6 3.0

Taiwan 2.0 ↓ 1.8 3.5 ↓ 3.0 3.5 1.0 2.0 2.5

Thailand 3.5 ↓ 3.1 4.2 ↓ 3.8 4.6 2.1 2.3 2.5

Asia ex-Japan 6.0 5.9 6.0 4.2 4.3 ↑ 4.4 4.5

Source: CEIC, Bloomberg, Nomura Global Economics.

2013 2014 2015 2013 2014 2015

China 1.8 0.9 0.4 -1.5 -1.8 -1.8

Hong Kong 0.0 ↑ 1.0 -0.3 ↓ -0.5 0.0 -0.2 -0.5 -0.5

India -3.3 ↑ -2.9 -3.2 ↑ -3.0 -3.7 -5.0 ↑ -4.8 -4.7 ↑ -4.5 -4.2

Indonesia -3.0 ↓ -3.4 -2.7 ↓ -3.0 -2.5 -2.4 -2.2 ↑ -1.7 -2.0

Malaysia 2.4 ↑ 3.5 3.2 ↑ 5.1 5.8 -4.0 -3.5 -3.3

Philippines 2.5 ↑ 3.8 1.8 ↑ 4.0 2.8 -2.6 ↑ -2.2 -2.2 ↓ -2.4 -2.0

Singapore 16.6 ↓ 16.3 14.9 ↑ 15.6 14.6 1.0 0.2 -0.2

South Korea 5.5 4.1 2.8 0.0 1.0 0.5

Taiwan 10.1 8.7 8.0 -1.9 -2.0 -2.0

Thailand -1.7 -1.1 -0.5 -2.0 ↑ -1.8 -3.0 ↑ -2.0 -3.0

Asia ex-Japan 1.2 ↑ 1.3 0.6 ↑ 0.7 0.2 -2.2 ↑ -2.1 -2.3 ↑ -2.2 -2.2

2013 2014 2015 2013 2014 2015

China 6.00 6.00 6.00 6.08 ↓ 6.05 6.08 ↓ 6.03 6.05

Hong Kong 0.40 0.40 0.40 7.75 7.78 ↓ 7.75 7.85

India 7.75 8.00 ↑ 8.25 8.25 60.5 ↑ 62.2 67.0 ↓ 62.2 65.5

Indonesia 7.50 7.00 ↑ 8.00 8.00 11325 ↑ 11600 11650 ↑ 12400 12900

Malaysia 3.00 3.50 4.00 3.12 ↑ 3.15 3.10 ↑ 3.21 3.28

Philippines 3.50 4.50 5.50 42.6 ↑ 43.0 41.7 ↑ 43.2 43.8

Singapore 0.38 ↑ 0.42 0.48 0.60 1.23 ↑ 1.24 1.22 ↑ 1.27 1.29

South Korea 2.50 2.75 3.25 1065 ↓ 1050 1060 1080

Taiwan 1.88 2.13 ↓ 1.88 2.13 29.4 29.2 ↑ 29.7 30.2

Thailand 2.50 2.75 ↓ 2.50 3.00 31.0 ↑ 31.5 32.5 ↑ 32.9 34.0

The ↑↓ arrows signify changes from last week.

Note: Fiscal balances are for fiscal years which differ from calendar years for Hong Kong (Apr-Mar), India (Apr-Mar), Singapore (Apr-Mar) and

Thailand (Oct-Sep). Fiscal data are for the central government and do not include off-budget. Source: CEIC, Bloomberg, Nomura Global

Economics.

Current Account (% of GDP) Fiscal Balance (% of GDP)

Real GDP

Note: All figures relate to the modal forecast, ie, the "most likely" outcome. Source: CEIC, Bloomberg, Nomura Global Economics.

Consumer Prices

Official Policy Rate Currency per US Dollar


5

Rob Subbaraman +65 6433 6548 [email protected]

Asia's turn for austerity

It is time for Asia’s policymakers to shift their focus towards financial stability over growth.

Strong capital inflows, systematically loose monetary policy and a neglect of supply-side

reforms have weakened Asia’s economic fundamentals since 2008. Rather than seeing it in the

positive light of global rebalancing, the much larger shrinkage of current account surpluses in

Asia than elsewhere is symptomatic, in our view, of Asia’s worsening fundamentals.

We believe it is now Asia’s turn to implement austerity – tighter policies and structural reforms –

which will soften domestic demand but ensure more sustainable growth. Even with a recovery in

exports, we expect Asia ex-Japan’s total GDP growth to fall below 6.0% in 2014 – in other

words, Asia will rely more on the rest of the world for growth, not vice versa.

A new phenomenon that we anticipate is growing unevenness among Asia’s economies, in

terms of growth, fundamentals and central bank actions opening up the biggest disparities in

decades. This theme of growing differentiation runs through the report: We highlight the leaders

(Korea, Malaysia and the Philippines) and laggards (China, India, Indonesia and Thailand), and

our FX, Rates and Equity strategists provide several interesting relative value

recommendations.

Macro risks accumulating

To avoid magnifying strong capital inflows, Asia relied heavily on macroprudential measures

rather than interest rates to address financial stability risks, with limited success. We calculate

that for the 10 biggest economies in Asia ex-Japan, their real policy rates, collectively, have

been negative 57% of the time since 2008; over 1996-2007 they were negative only 16% of the

time. Persistently loose monetary policy has fuelled private credit booms across Asia, but more

than the level, it is the speed at which credit is outpacing nominal GDP growth that concerns us.

Past financial crises in major economies are often preceded by the private credit-to-GDP ratio

rising sharply by 30 percentage points (pp) in the five years before the crisis. We call this the “5-

30” rule, and many Asian countries have either breached, or are close to, the 30pp since 2008

(Figure 1). Asia is also experiencing house price booms. If we overlay residential property prices

in the US (indexed to 100 in January 2000) on residential property prices in several Asian

countries, it is striking how many Asian property markets are tracking above the US price bubble

(Figure 2). This is leading to a hive of construction activity (see insert in Figure 2) which could

turn into a major misallocation of investment in the event of a correction in Asian property

prices.

Fig. 1: Credit to the private non-financial sector

Brazil

Turkey

Greece

Poland

Argentina Mexico

Russia

EU

Hungary

Germany

UKSaudi

S. Africa

US

China

HK

SingMalay

Thai

Vietnam

Indo

Taiwan

Korea

India

Phil

Australia

Japan

0

50

100

150

200

250

-20 -10 0 10 20 30 40 50 60 70

Pri

vate

cre

dit

in 1

Q 2

013, %

of G

DP

Change in credit-to-GDP ratio, 4Q2008-1Q2013, pp

Note: Asian countries in black. Source: BIS; IMF and Bloomberg.

Fig. 2: Residential property prices in Asia versus the US

Note: t=number of years from the starting year (indexed to 100). For Asia, the starting year is Dec 2008 and for US, it is Jan 2000. Data for China, HK, Singapore and Taiwan are up to Sep-13, Malaysia is Jun-13, India is Mar-13 and US is Dec 2007. Source: Centa Property, CEIC and US CorelLogic.

60

80

100

120

140

160

180

200

220

240

t t+1 t+2 t+3 t+4 t+5 t+6 t+7

Index China, Dec-08 HK, Dec-08

India, Dec-08 Malaysia, Dec-08

Singapore, Dec-08 US, Jan-00

Taiwan, Dec-08

Share of constuction in GDP, %

2007 2013 H1

China 9.2 13.2

HK 6.8 11.2

India 8.4 8.2

Indonesia 7.7 10.4

Japan 10.4 10.1

Korea 17.5 14.9

Malaysia 10.1 15.2

Philippines 9.1 11.4

Singapore 10.6 12.8

Taiwan 9.7 9.3

Thailand 8.8 8.0



6

A debt-fuelled asset-price boom stimulates growth, but not forever. Asia is at the stage where

the best outcome, in our opinion, would be a gradual fading of the boom, which tighter policies

can help administer. This would likely restrain growth as the wealth effect fades and debt-

servicing costs mount. The worst outcome would be a continuation of the status quo, allowing

bubbles to form that, by definition, eventually burst, leading to outright recession.

Middle-income traps

In the last five years, Asia has made the costly mistake of neglecting supply-side reforms, such

as relaxing restrictions on foreign direct investment (FDI), removing government fuel subsidies,

accelerating privatisation, opening up services sectors, lowering employment protection and

liberalising capital markets. These reforms can be painful in the short run, but are essential in

the long run to boost productivity and competitiveness – and they are even more pressing in

Asia, given half the region is facing rapidly ageing populations and as the low-hanging fruit of

productivity gains from economic “catch-up” are becoming less plentiful. Evidence is building

that Asia has squandered this opportunity, raising the risk of countries becoming stuck in

middle-income traps.

Globally, there is a strong positive relationship between GDP per capita and productivity (Figure

3). Singapore, Japan, Hong Kong, Korea and Taiwan have all successfully advanced to the

high-income country club, but others in Asia are unlikely to follow without strong gains in

productivity, and here lies our concern. We find that, consistent with the loss of reform

momentum, the average growth in output per worker in 2010-13 across most of Asia has slowed

noticeably compared with before the global financial crisis (insert of Figure 3). Our own

estimates are that, in the past five years, long-term potential growth has slowed by about 2pp in

China and India, by 1.0pp in Korea, Taiwan, Hong Kong, Singapore and Thailand, and by 0.5pp

in Malaysia and Indonesia; only the Philippines (up 1pp) has bucked the trend.

Despite slowing potential growth we believe it would be a mistake for investors to focus solely

on the risks of higher inflation; in Asia, it is often fiscally suppressed or held down by falling

commodity prices. In our opinion, the best macro indicator of Asia’s worsening economic

fundamentals is the dramatic shrinkage of its current account surpluses – and they have shrunk

much more than in other emerging markets (Figure 4). This has happened mostly for bad

reasons: China’s has dwindled due to the debt-fuelled investment boom, while elsewhere

domestic savings are falling because of rising debt and/or slowing productivity (see the Anchor

Report: Asia’s rising risk premium, 28 June 2013).

Fig. 3: Productivity levels versus GDP per capita in 2011

China

HK

India

Indonesia

Japan

Korea

Malaysia

Phil

SingaporeTaiwan

Thailand

US

Vietnam

EU Australia

Turkey

0

10

20

30

40

50

60

0 20,000 40,000 60,000 80,000

Pro

ductiv

ity,

real G

DP

per h

our w

ork

ed

GDP per capita, USD

Output/worker, average growth

2000-07 2010-13

China 9.8 8.7

HK 4.2 1.7

Indonesia 3.5 4.4

Korea 3.3 1.9

Malaysia 3.2 1.1

Philippines 2.8 4.6

Singapore 3.0 1.9

Taiwan 3.2 2.9

Thailand 2.9 3.5

Source: Asian Productivity Organisation, IMF, CEIC and Nomura Global Economics.

Fig. 4: Current account balances, 2013 versus 2007

MalaysiaHK

China

TaiwanThai

Phil

Indo Korea

India

Australia

Russia

ChileIsrael

ArgentinaBrazil

MexicoColombia

CzechTurkey

PolandS. Africa Hungary

Romania-15

-10

-5

0

5

10

15

-15 -10 -5 0 5 10 15

2007, % of GDP

2013, % of GDP

45

Note: Asian countries are highlighted in black. Singapore is excluded as it is an outlier with current account surpluses of 26.1% in 2007 and 16.3% in 2013. Source: IMF; CEIC and Nomura Global Economics.

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7

Policymakers in the hot seat

Asia needs to tighten policy and accelerate structural reforms, or it will become a breeding

ground for future financial crises. But what trigger may galvanize policymakers into action?

Some argue there isn’t one. Even if more symptoms of deteriorating health start to appear –

such as worsening credit quality – history shows that it often takes a full-blown crisis before

policymakers implement austerity measures. However, we are not in this doomsday camp. We

see a paradigm shift where, past financial crises aside, Asian policymakers will face greater

market discipline than ever before. Early signs of this are appearing: capital flight from the Fed

tapering scare in May forced Indonesia and India to hike rates by 175bp and 50bp, respectively,

and, along with Malaysia, to implement some reforms. Having suffered the worst global financial

crisis in modern history and with the Fed about to start unwinding its loosest-ever monetary

policy, we believe that investors are starting to demand a higher premium for risk over return

when investing in EM. In other words, economies with improving fundamentals but perhaps

lower, but more sustainable, growth will be rewarded, whereas those with higher growth but

worsening fundamentals – and hence at risk of a boom-bust cycle – may be punished.

Investors becoming increasingly discerning over the quality of Asian growth plays to our theme

for 2014: a divergence of performance across Asian economies, opening up the biggest

disparities in decades. Here is how we anticipate the growing divide between Asia’s leaders and

laggards, the rationale of which is explained by our country specialists in the pages that follow:

The leaders

Korea: It has a robust balance of payments and we are the most bullish on the street with

regard to its GDP growth, forecasting 4% in 2014, driven by exports. But our biggest call is a lift

in domestic demand. We do not expect the first rate hike until Q4 2014.

Philippines: We see virtuous spirals from strong GDP growth (6.7% in 2014), sound economic

fundamentals and stable politics, setting off an investment boom, both domestically and in FDI.

We expect Bangko Sentral ng Pilipinas to hike rates by 100bp in 2014, starting in Q2.

Malaysia: Political risks have subsided and we expect a rejuvenation of fiscal reforms to result

in positive sovereign rating action. Its open economy will benefit from an export recovery. We

expect Bank Negara Malaysia to hike rates by a cumulative 50bp in H2 2014.

The laggards

China: We expect GDP growth to slow to 6.9% in 2014 and to 6.8% in 2015, on a continued

slowdown in potential growth and tighter policies to contain financial risks. Some corporate

defaults are likely, helping to stamp out moral hazard. Progress on structural reform will be slow.

India: Our theme is higher rates for longer. In 2014, we expect sticky CPI inflation of 9.3%,

forcing the RBI to hike rates by a further 50bp in H1, thus keeping growth tepid at 4.8%. A BJP-

led coalition is likely to win power, which may be positive for the economy in the medium-term

Indonesia: We expect Bank Indonesia to focus on stability over growth, hiking by a further 50bp

in Q1 2014. We expect Jakarta Governor Joko Widodo (PDI-P party) to win the July presidential

election. Reform momentum looks set to slow and may not pick up even after the election.

Thailand: Populist policies have borrowed growth from the future and fuelled household debt.

There is a scarcity of capital and skilled labour. Politics are unstable. Weak FDI has meant more

hot-money flows to finance the current account deficit. We see policy rates on hold in 2014.

The middle

Hong Kong: Under the USD peg, Hong Kong imports the Fed’s ultra-loose monetary policy –

so despite a slowing China we expect overheating pressures to intensify, leaving the economy

very vulnerable to when the Fed eventually starts to raise rates, but this may not be until 2016.

Taiwan: A high degree of exposure to China’s slowing economy and no obvious domestic

drivers of growth lead us to expect only a mild export-led recovery, lifting GDP growth to 3.0% in

2014. With Asia’s lowest inflation rate, we expect policy rates to be left unchanged through

2014.

Singapore. To overcome a very high cost base, a rapidly ageing population and fierce regional

competition, the economy is undergoing painful restructuring to boost productivity. But the pay-

off will take many years; in 2014, we see a worsening inflation-growth trade-off.


8

Zhiwei Zhang +852 2536 7433 [email protected]

Changchun Hua +852 2252 2057 [email protected]

Wendy Chen +86 21 6193 7237 [email protected]

China: No pain, no gain

2014: The year of policy tightening and structural reform

We expect China's economic growth to slow amid policy tightening, while structural reform will

gradually kick in, causing short-term pains.

Overview

We believe China's GDP growth peaked at 7.8% y-o-y in Q3 2013 and will slow to 7.5% in Q4.

We believe the slowdown will continue into 2014, with GDP growth of 7.1% y-o-y in Q1 and

6.7% in Q2, and our full-year forecast is for growth of 6.9% in 2014. The reasons behind this are

primarily policy tightening affecting the property market and infrastructure investment, while we

expect structural reforms (e.g., reducing overcapacity in some heavy industries, factor price

deregulation) to cause short-term pain. The government is likely to fine-tune its policy tightening

and the pace of reform, which we expect to stabilise growth at 6.8% in Q3 2014, before leading

to a modest recovery to 7.0% in Q4 (Figure 5).

Our view is substantially different from a more bullish consensus, which views the current

growth recovery as sustainable through 2014 (Consensus: 7.4% y-o-y). The main distinguishing

factor between our view and the consensus view is down to the policy outlook. We expect the

government to cut its GDP growth target for 2014 to 7.0% from 7.5% at its Central Economic

Working Conference in December, providing room for gradual deleveraging and structural

reforms. As such, we believe policy tightening will be a major theme, helping to tackle rising CPI

inflation and housing prices, and reducing the financial risks that stem from rapid credit

expansion. By contrast, the consensus view is based largely on the expectation that policy is

likely to be more supportive of growth.

Downturn in Q4 2013 and H1 2014

We believe monetary policy has already started to tighten and credit growth will remain weak in

Q4 and Q1 2014. We have highlighted China’s financial risks in two thematic Asia Special

Reports this year – China: rising risks of financial crisis, 15 March 2013 and China’s heavy

LGFV debt burden, 24 September 2013. In our March report we coined our “5-30” rule, a

reference to the pace of build-up in credit growth at close to, or over, 30% in the five years

preceding a financial crisis. China’s current leadership has consistently emphasised the

importance of containing financial risks. Indeed, financing conditions have tightened

significantly, with the 3yr high-grade corporate and government bond yields rising sharply, the

latter to an all-time high of 4.3% in November (tighter financing conditions are forcing investors

to sell their more liquid government bonds), and total social financing (TSF) dropping to

RMB856.4bn in October from RMB1.4trn in September and a peak of RMB2.6trn in March

(Figure 6).

Fig. 5: Consensus versus Nomura forecasts

6.5

7.0

7.5

8.0

8.5

1Q12 3Q12 1Q13 3Q13 1Q14 3Q14

% y-o-y

Consensus

Nomura

Forecast

Source: Bloomberg and Nomura Global Economics.

Fig. 6: Total social financing and bond yields

0.0

0.4

0.8

1.2

1.6

2.0

2.4

2.8

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

5.5

6.0

2007 2008 2009 2010 2011 2012 2013

TSF (rhs)

Corporate bond yield (AAA, 3yr)

Govt bond yield (3yr)

% RMB trn

Source: CEIC, WIND and Nomura Global Economics.




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9

Housing and infrastructure investment, which combined account for half of fixed asset

investment (FAI) and are key for the short-term growth outlook, are likely to slow (Figure 7).

Inventory levels in the housing sector are still high, especially in third- and fourth-tier cities, while

property sales growth has fallen significantly this year. This, together with tighter financing

conditions, has put pressure on housing investment. Indeed, the rate of expansion of floor

space started to moderate, to 6.5% y-o-y ytd in October from 7.3% in September, while the

growth of land purchased continues to contract, to -3.6% in October from -3.3% in September.

Infrastructure investment by local government financing vehicles (LGFVs) also faces downward

pressures as the central government reins-in local government debt. The National Audit Office’s

audit of local government debt levels is likely to be released soon and we expect the central

government to tighten controls on LGFV debt issuance in 2014. This will directly negatively

impact infrastructure investment as these projects are generally heavily dependent on new

fundraising. Rising interest rates in the bond market are also likely to discourage investment.

Overall, we expect FAI growth to slow to 17% y-o-y ytd in Q1 and to 15% in Q2 2014.

Potential growth near 7% in 2014

We believe China’s potential output growth has slowed to around 7%. China’s excess labour,

for so long a boon to the economy, has now been depleted, the labour demand-supply ratio

reaching 1.07 in Q2 2013 (meaning there are 100 applicants for 107 job vacancies), despite

GDP growth having slowed to 7.5% (Figure 8). This indicates that the downturn in the economy

is primarily structural rather than cyclical. As the size of the labour force is set to decline further

in 2014, potential growth is likely to fall as well, assuming other factors remain broadly

unchanged (see China: Why the economic recovery is unsustainable, 13 October 2013). This is

reflected in our lower GDP growth forecast in 2015 of 6.8%. There are other indications of

slowing potential growth. One is signs of a shift in the Phillips curve: despite weaker growth,

China has had higher average month-on-month CPI inflation, at 0.23% for January-October

2013, compared to 0.18% over the same period from 2001-12. Another is a general (central and

local) government deficit at 7.4% of GDP (IMF estimate) in 2012; the massive fiscal stimulus

only managed to boost GDP growth to 7.7% but heightened financial risks significantly, which

suggests that growth was likely running above its potential.

Inflation concerns to heat up

CPI inflation averaged 2.5% y-o-y over the first eight months of 2013, but rose sharply to 3.1%

in September and 3.2% in October. Core CPI inflation also rose for a second month in October

to 1.8% y-o-y. We expect inflation to climb to above 3% y-o-y in Q4 and see a rising risk of it

sitting above 3.5% for some months in 2014, as pork prices enter the upswing phase of their

cycle. Concerns over inflation will make monetary policy easing unlikely, in our opinion,

especially as the benchmark deposit rate is only 3%, leaving little room to cut rates any further.

Growth may recover slightly in H2 due to policy fine-tuning

When GDP growth slows to below 7%, which we expect to see in Q2 2014, we believe renewed

concerns that the economy could be headed for a hard landing will provoke some capital flight

and be enough to spur some policy fine-tuning. We expect two 50bp reserve requirement ratio

cuts, the first in Q2 and then another in Q3, to offset the tighter liquidity conditions caused by

net capital outflows. Credit growth may pick up again by mid-2014 to boost infrastructure

investment.

Risks to our forecast

We see three key upside risks to our forecast. The first and most important would be if, next

month, the government decides to keep its growth target for 2014 at 7.5% and loosen monetary

policy. This would boost investment – particularly in housing and infrastructure investment – in

the short term, but would worsen economic imbalances and raise the risk of a systemic financial

crisis and hard-landing beyond 2014. Second, significant progress in land reform and relaxing

market entry barriers could boost investment slightly and therefore also pose a moderate upside

risk to our forecast. Lastly, should external demand surprise significantly on the upside and

export growth rebound to double-digit growth, this would also pose a moderate upside risk.

The key downside risk to our forecast is related to the property sector. The oversupply problem

in third- and fourth-tier cities is getting worse. In our base case, we expect property investment

to slow only gradually, but there is a risk it may falter further than we expect.

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10

Fig. 7: Fixed asset investment by breakdown

-5

0

5

10

15

20

25

30

35

40

45

50

55

Oct-07 Oct-08 Oct-09 Oct-10 Oct-11 Oct-12 Oct-13

Manufacturing

Property

Infrastructure

% y-o-y, ytd

Source: CEIC and Nomura Global Economics.

Fig. 8: Urban labour demand to supply ratio and GDP growth

6

8

10

12

14

16

0.7

0.8

0.9

1.0

1.1

1.2

Sep-01 Sep-04 Sep-07 Sep-10 Sep-13

% y-o-yRatioRatio of labour demand to supply

GDP growth, rhs

Source: CEIC and Nomura Global Economics.

Fig. 9: China outlook summary table

% y-o-y growth unless otherwise stated 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 2013 2014 2015

Real GDP 7.7 7.5 7.8 7.5 7.1 6.7 6.8 7.0 7.6 6.9 6.8

Consumer prices 2.4 2.4 2.8 3.2 2.8 2.9 3.0 3.2 2.7 3.0 3.2

Core CPI 1.7 1.8 1.6 2.1 1.9 2.0 2.3 2.3 1.8 2.1 2.3

Retail sales (nominal) 12.4 13.0 13.3 13.6 12.4 11.8 12.6 13.1 13.1 12.5 12.9

Fixed-asset investment (nominal, ytd) 20.9 20.1 20.2 20.1 17.0 15.0 17.0 19.0 20.1 19.0 18.5

Industrial production (real) 9.5 9.1 10.1 9.2 8.0 7.4 7.7 8.2 9.5 7.8 7.8

Exports (value) 18.4 3.8 3.9 5.0 -12.0 5.5 7.0 7.5 7.2 2.4 3.5

Imports (value) 8.3 5.0 8.4 7.0 -5.0 8.0 9.0 9.0 7.2 5.4 6.7

Trade surplus (US$bn) 43.5 65.7 61.5 77.2 5.7 57.4 69.2 75.5 248.0 194.4 135.8

Current account (% of GDP) 1.8 0.9 0.4

Fiscal balance (% of GDP) -1.5 -1.8 -1.8

New increased RMB loans (CNY trn) 9.0 9.0 9.0

Total social financing (CNY trn) 17.5 19.5 21.4

1-yr bank lending rate (%) 6.00 6.00 6.00 6.00 6.00 6.00 6.00 6.00 6.00 6.00 6.00

1-yr bank deposit rate (%) 3.00 3.00 3.00 3.00 3.00 3.00 3.00 3.00 3.00 3.00 3.00

Reserve requirement ratio (%) 20.0 20.0 20.0 20.0 20.0 19.5 19.0 19.0 20.0 19.0 19.0

Exchange rate (CNY/USD) 6.21 6.14 6.12 6.05 6.06 6.10 6.09 6.03 6.05 6.03 6.05

Notes: Numbers in bold are actual values; others forecast. Interest rate and currency forecasts are end of period; other measures are period average. The CNY/USD forecast is for the spot rate. All forecasts are modal forecasts (i.e., the single most likely outcome). Table reflects data available as of 25 November 2013. Source: CEIC and Nomura Global Economics.


11

Young Sun Kwon +852 2536 7430 [email protected]

Candy Cheung +852 2536 7436 [email protected]

Taiwan: Hampered by a lack of reform

The export-oriented economy should benefit from improved external demand, but we

expect growth potential to be eroded due to the lack of a breakthrough in politics.

Activity: We expect GDP growth of 3.0% in 2014 and 3.5% in 2015, mostly driven by exports,

with domestic demand improving only slightly. Household income growth continues to stagnate

due to a “hollowing out” of industry to China, a lack of inward FDI and a rapidly ageing

population. Government policies to expand cooperation with mainland China have made little

progress so far due to political protectionism, while efforts to support RMB-denominated trading

and financial transactions lag far behind those in Hong Kong. Exporter competitiveness has

been diminished by a lack of free trade agreements and insufficient R&D and M&A efforts when

compared with Korea and Japan. We expect another large current account surplus in 2014

(8.6% of GDP) due to: 1) relatively weak domestic demand, compared to exports; and 2) the

income surplus from repatriated profits and dividends from the large net amount of overseas

assets.

Inflation: We expect CPI inflation to rise to 2.0% in 2014 from 1.0% in 2013,as the government

gradually reduces subsidies on utilities. However, we do see some underlying disinflationary

factors, including subdued wage growth, keeping CPI inflation low until domestic investment

increases substantially.

Policy: We expect the Central Bank of China (CBC) to keep the discount rate on hold at

1.875% through 2014 in an effort to prevent TWD from appreciating strongly. Subdued inflation

should also give the CBC room to maintain relatively loose monetary conditions. Elevated

property prices are a concern, though we believe policymakers will use administrative measures,

rather than raising interest rates, to control them.

Risks: Another deep recession in advanced economies or weaker demand for consumer

electronics would have a large impact on Taiwan’s tech-heavy open economy. A hard economic

landing in China is another major risk, as Taiwan is one of Asia’s most exposed economies to

China. We fear that Taiwan’s political leadership may not be strong enough to deliver the

necessary structural reforms, including a boost to investment in manufacturing, improving

services industries and lowering barriers to foreign investment.

Fig. 10: Details of the forecast


Real GDP (sa, % q-o-q, annualized) -2.7 2.9 -0.6 7.3 2.3 3.1 2.1 2.2

Real GDP 1.6 2.5 1.6 1.6 2.9 3.0 3.7 2.4 1.8 3.0 3.5

Private consumption 0.3 1.7 1.6 0.4 1.3 1.8 2.7 1.5 1.0 1.8 2.2

Government consumption 1.3 -0.2 -0.8 1.1 2.2 3.6 3.8 3.0 0.4 3.2 3.1

Gross fixed capital formation 6.3 3.8 4.3 2.2 2.7 2.9 3.8 3.6 4.1 3.3 3.1

Exports (goods & services) 5.0 5.2 1.7 2.5 4.9 3.2 3.5 3.4 3.5 3.7 4.0

Imports (goods & services) 6.7 3.2 1.1 2.6 2.8 3.1 3.4 3.4 3.3 3.2 2.9

Contributions to GDP growth (% points)

Domestic final sales 0.7 1.4 0.9 0.7 0.9 2.3 2.9 1.7 1.2 1.8 2.0

Inventories 0.9 -1.0 0.0 0.4 0.0 0.0 0.0 0.0 -0.2 0.1 0.0

Net trade (goods & services) 0.0 2.1 0.7 0.5 2.1 0.7 0.7 0.8 0.8 1.0 1.5

Exports 2.4 2.4 -0.8 5.0 7.9 6.2 6.5 6.4 2.3 6.7 3.4

Imports 4.4 -3.5 -3.3 4.1 4.3 4.6 4.9 4.9 0.3 4.7 4.4

Merchandise trade balance (US$bn) 4.6 9.9 10.2 11.9 7.4 11.6 11.9 13.7 36.6 44.7 43.6

Current account balance (% of GDP) 9.4 11.8 8.9 10.4 5.7 9.5 9.0 10.2 10.1 8.7 8.0


Consumer prices 1.8 0.8 0.0 1.5 1.7 2.1 2.3 1.9 1.0 2.0 2.5

Unemployment rate (%) 4.2 4.2 4.2 4.2 4.2 4.2 4.2 4.2 4.2 4.2 4.2

Discount rate (%) 1.88 1.88 1.88 1.88 1.88 1.88 1.88 1.88 1.88 1.88 2.13

10-year T-bond (%) 1.30 1.42 1.69 1.25 1.27 1.30 1.32 1.35 1.25 1.35 1.45

Exchange rate (NTD/USD) 29.8 30.0 29.6 29.4 29.6 29.8 29.9 29.7 29.4 29.7 30.2

Notes: Numbers in bold are actual values; others forecast. Interest rate and currency forecasts are end of period; other measures are period average. All forecasts are modal forecasts (i.e., the single most likely outcome). Table reflects data available as of 25 November 2013. Source: CEIC and Nomura Global Economics.




12


Candy Cheung +852 2536 7436 [email protected]

Hong Kong: Overheating

We expect property market-driven domestic overheating to continue into 2014, but

GDP growth to slow in 2015 as market interest rates could rise further.

Activity: We expect GDP growth to rise to 3.8% in 2014 from 3.0% in 2013 and the current

account to swing to a deficit of 0.5% of GDP from a 1.0% surplus. We expect domestic demand

to remain resilient, supported by tight job conditions and high property prices. Ongoing large-

scale infrastructure and public housing works should contribute to investment. Hong Kong’s

increasing role as a professional services entrepôt to mainland China and the large number of

Chinese visitors will likely support services exports. However, macro risks will continue to build.

Our base case is for more macroprudential measures and a gradual rise in market interest rates

to gradually cool the property market, dragging GDP growth down to 3.0% in 2015. But the risk

is a property market crash.

Inflation: We expect CPI inflation to remain above 4% in 2014, driven by higher food and

services prices. Fiscal measures such as a temporary waiver of public housing rent and

electricity subsidies should continue in 2014, which should partly offset inflation pressure.

Policy: An overheated property market is the government’s biggest concern. The Hong Kong

Monetary Authority has, since 2009, introduced six rounds of macroprudential measures to

attempt to stabilize house price gains. In 2013, luxury house prices fell slightly, but prices in the

mass housing market are still rising. We do not expect any relaxation of these measures until

the market stabilizes with a steady supply of new housing. Another concern is the worsening

level of income inequality; this year, 20% of the population is living below the government’s

official poverty line (monthly income below HKD3,600 (USD465) per person). As a result, we

expect the FY14-15 budget to increase social welfare spending and provide low-income families

with more subsidies.

Risks: As a small, open economy and financial hub, Hong Kong is one of the most vulnerable

in Asia to external shocks. An economic hard landing in mainland China would be especially

detrimental through both trade and financial channels. Faster-than-expected US Fed tapering

could increase market interest rates rapidly, which could hurt property market sentiment. In

contrast, lower for longer fed funds rate could help sustain Hong Kong’s real-estate market

overheating, ultimately increasing the economic cost when the bubble inevitably bursts.



Real GDP (sa, % q-o-q, annualized) 0.9 2.8 2.1 6.5 3.8 1.3 3.8 7.3

Real GDP 2.9 3.2 2.9 3.1 3.8 3.4 3.9 4.0 3.0 3.8 3.0


Government consumption 2.1 3.2 2.7 4.2 4.5 4.7 4.5 4.8 3.0 4.6 2.6

Gross fixed capital formation -3.3 6.9 2.2 5.8 5.7 6.5 6.5 6.0 3.1 6.2 4.4



Contributions to GDP (% points)


Inventories 0.6 -1.2 1.2 0.8 -0.9 1.4 0.9 -0.7 0.4 0.1 -0.6

Net trade (goods & services) -1.2 -0.5 -0.9 0.7 -0.2 -3.7 -2.1 -0.4 -0.4 -1.6 0.5

Unemployment rate (sa, %) 3.5 3.4 3.3 3.4 3.2 3.2 3.2 3.2 3.4 3.2 3.4

Consumer prices 3.7 4.0 5.3 3.9 4.6 4.3 4.1 4.2 4.2 4.3 4.5

Exports 4.0 2.5 3.3 5.1 12.0 12.3 11.9 12.8 3.7 12.3 11.1

Imports 4.9 3.5 2.6 6.4 11.6 13.4 12.7 12.5 4.4 12.6 10.6

Trade balance (US$bn) -14.3 -17.6 -15.3 -20.1 -15.5 -21.2 -18.2 -22.2 -67.3 -77.2 -82.4

Current account balance (% of GDP) 1.0 -0.5 0.0


3-month Hibor (%) 0.40 0.40 0.40 0.40 0.40 0.40 0.40 0.40 0.40 0.40 0.40

Exchange rate (HKD/USD) 7.77 7.76 7.76 7.75 7.77 7.80 7.77 7.75 7.75 7.75 7.85





13


South Korea: Catching up with global growth

We expect a cyclical upturn in GDP growth, helping to keep structural risks

manageable. We expect the BOK to reduce its accommodative stance in Q4 2014.

Exports should hold up while pent-up demand should materialise

We expect GDP growth to rise to 4.0% in 2014 from 2.9% in 2013. We expect Korea's high

valued-added exports to benefit from improved demand from the US, euro area and Japan,

more than offsetting slowing demand from China and other emerging markets. Although longer

term we remain cautious on domestic demand due to an ageing population and the debt

overhang, we believe there is currently pent-up demand and conditions are ripe for a cyclical

upswing, supported by government measures to increase social welfare spending and boost the

property markets. Households’ net savings (up 38% in 2012-13) and the large gap between

high confidence and low spending suggest consumption will rise. The FY14 budget is

stimulative, with a fiscal deficit target of 1.8% of GDP. We see the housing inventory adjustment

coming to an end and domestic credit growth – having slowed over the last five years –

beginning to rise in 2014. Lagged spillover income flows from exporters should also help

support domestic demand (see 2014 Korea outlook: Catching up with global growth, 23

November 2013).

BOK to reduce its accommodative stance in Q4 2014

CPI inflation fell to a 14-year low of 0.7% y-o-y in October, largely due to cost-side

disinflationary factors (e.g., lower prices for food, gasoline and schooling), which we judge as

temporary. We expect CPI inflation to rise to 2.6% in 2014, within the Bank of Korea's (BOK)

2.5-3.5% target band (Figure 12). Inflation expectations remain significantly higher than actual

inflation and nominal wages continue to grow. In addition to the 5.4% electricity price hikes on

21 November 2013, the government is set to hike other utility prices in an effort to manage

public debt. Further, we expect Statistics Korea to remove free schooling and free school

lunches from the CPI basket in December 2013. All in all, we believe that deflation risks are

quite low (see South Korea’s deflation fears are overdone, 17 June 2013).

We expect the BOK to start to reduce its accommodative policy stance by hiking policy rates by

25bp to 2.75% in Q4 2014, which is when we expect the negative output gap to close and CPI

inflation to rise to 3%.

Fig. 12: Korea’s CPI inflation forecast

0

1

2

3

4

5

6

7

Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10 Jan-12 Jan-14

Headline CPI

Core CPI

Expected CPI

% y-o-y

F

Source: CEIC and Nomura Global Economics estimates.

Fig. 13: Korea’s GDP growth and BOK policy rate changes

-250

-200

-150

-100

-50

0

50

100

150

200

-5

-4

-3

-2

-1

0

1

2

3

4

Mar-00 Mar-03 Mar-06 Mar-09 Mar-12

BOK policy rate changes, rhs

GDP (seasonally adjusted), lhs

% q-o-q bp

F

Source: CEIC and Nomura Global Economics estimates.


http://go.nomuranow.com/research/globalresearchportal/getpub.aspx?pid=644604&appname=GRP&cid=Ny8xTWIxd29kTGs90

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14

Indeed, BOK policy changes tend to come in response to shifts in growth momentum: when

GDP growth (sa, q-o-q) improves or holds up, the BOK tends to hike policy rates or stay on

hold; when GDP growth slows or falls, it usually cuts rates (Figure 13). This policy behaviour is

well understood as the BOK focuses more on future inflation pressures (i.e., the output gap)

than on current inflation levels (Figure 13).

We believe the BOK will also take the global monetary policy stance into account. This makes

sense given that Korea, as a small open economy, is vulnerable to sudden changes in global

economic conditions and financial markets. BOK policy rates have moved in a range of

10~80bp below global rates since the 2008 global financial crisis. Given that policy rates in

developed markets should remain near rock-bottom for a long time, any move in emerging

market policy rates should pull the level of global rates with them. Our Global Economics team

expects EM policy rates to rise to counter inflation risks. Although not our base case, should

global growth and inflation slow sharply, this would provide the BOK with room to cut rates.

Risks of rate hikes being delayed

Another risk to our call is the end of BOK Governor Kim Choongsoo tenure, and that of hawkish

Monetary Policy Committee (MPC) member Lim Seungtae, on 31 March and 14 April 2014,

respectively. The trend of recent leadership changes at the Fed, Bank of England and Bank of

Japan suggest that the new BOK governor and MPC member could be more dovish than their

predecessors. Given that the senior deputy governor usually follows the governor’s view and

three dovish MPC members (Messers Ha Sung Keun, Chung Soon Won and Chung Hae-Bang)

remain until 2016, we see a non-negligible risk that the collective judgment of the MPC after

April 2014 could become more dovish.

If deflation risks are overestimated, or if there is too much focus on a single part of the economy

(for example, housing markets instead of overall GDP), we believe the government and

politicians could again (as it did in early 2013) implicitly press the potentially dovish MPC into

delivering further monetary easing, or at least keeping policy rates on hold for a prolonged

period beyond 2014, even if GDP growth improves.

In sum, we see a risk of rate hikes being delayed beyond 2014 after the new BOK governor is

appointed in April 2014, if he or she turns out to be very dovish and is seriously concerned with

deflation risks.




Real GDP (sa, % q-o-q) 0.8 1.1 1.1 1.0 1.0 0.9 1.0 0.9

Real GDP 1.5 2.3 3.3 4.1 4.2 4.0 4.0 3.9 2.9 4.0 4.0



Business investment -11.9 -4.6 1.8 4.6 3.1 4.3 5.1 5.1 -3.0 4.4 4.6

Construction investment 2.4 7.2 8.0 11.7 8.3 5.8 4.1 4.1 7.1 5.5 4.1



Contributions to GDP growth (% points)


Inventories 0.3 -0.7 0.0 -0.8 -0.1 0.1 0.2 0.6 -0.3 0.1 0.0

Net trade (goods & services) 1.0 1.0 0.3 1.0 0.5 0.3 0.9 0.7 0.9 0.6 0.6


Consumer prices 1.4 1.1 1.2 1.0 1.6 2.6 2.9 3.1 1.2 2.6 3.0

Current account balance (% of GDP) 5.5 4.1 2.8

Fiscal balance (% of GDP) 0.0 1.0 0.5

Fiscal balance ex-social security (% of GDP) -1.8 -1.0 -0.5

BOK official base rate (%) 2.75 2.50 2.50 2.50 2.50 2.50 2.50 2.75 2.50 2.75 3.25

3-year T-bond yield (%) 2.55 2.88 2.82 2.90 3.00 3.00 3.00 3.10 2.90 3.10 3.40

5-year T-bond yield (%) 2.58 3.14 3.05 3.15 3.20 3.30 3.35 3.40 3.15 3.40 3.55

10-year T-bond yield (%) 2.91 3.31 3.53 3.60 3.70 3.75 3.80 3.90 3.60 3.90 4.00

Exchange rate (KRW/USD) 1,111 1,142 1,076 1,050 1,060 1,070 1,070 1,060 1,050 1,060 1,080

Notes: Numbers in bold are actual values; others forecast. Interest rate and currency forecasts are end of period; other measures are period average. All forecasts are modal forecasts (i.e., the single most likely outcome). Table reflects data as of 25 November 2013. Source: Bank of Korea, CEIC and Nomura Global Economics.


15

Sonal Varma +91 22 4037 4087 [email protected]

Aman Mohunta +91 22 6617 5595 [email protected]

India: Higher interest rates for longer

With growth bottoming out and inflation likely to remain stubbornly high, we expect

another 50bp in cumulative repo rate hikes in 2014.

We believe India’s economic growth is near its trough. Domestic demand remains very weak

due to a lackluster capex cycle amid political uncertainty, falling income growth and higher

interest rates. However, exports and rural demand are boosting growth. In this tug-of-war, we

believe that growth has bottomed out, but the recovery will be very gradual, with GDP growth

rising only marginally to 4.8% y-o-y in 2014 from 4.7% in 2013. We expect a stronger pickup in

2015, with GDP growth rising to 5.7%.

With growth bottoming out, we expect the policy focus to shift to containing inflation. We expect

inflation to remain stubbornly high due to elevated inflation expectations, food-related supply

shocks and the recent upswing in rural wage growth. This will require rates to remain higher for

longer. We expect CPI inflation to average 9.3% in 2014, remaining above 9% for a sixth

consecutive year. We expect the Reserve Bank of India (RBI) to hike the repo rate by a

cumulative 50bp to 8.25% by mid-2014.

We believe India’s political climate in mid-2014 can make or break the longer-term economic

outlook. In our base case, the April/May general elections usher in a stable government, which

should pave the way for a more sustainable growth recovery from H2 2014 and into 2015.

Overall, we see 2014 as a year of two halves: a cautious outlook in H1 – due to weak growth,

inflation concerns, political uncertainty ahead of elections and risk of capital outflows – but a

more optimistic outlook in H2 (policy stability following the elections and a growth revival).

A cautious H1 outlook

Good monsoons and better exports are likely to push GDP growth higher in Q4 2013. However,

we believe that this increase is not sustainable. First, the boost from good monsoons will fade

after Q1 2014. Second, the government’s fiscal finances remain under pressure, and sticking to

the budget deficit target necessitates spending cuts and/or delayed payments to government

contractors. Therefore, we expect fiscal policies to become contractionary in H1 2014. Third, the

cost of borrowing has risen significantly in H2 2013, which should weigh on demand in interest-

rate sensitive sectors with a lag. Fourth, a pickup in the investment cycle is key to a sustainable

growth recovery, and uncertainty ahead of the elections means that firms will delay capex

decisions until the political verdict is clear. Leading indicators continue to fall and the investment

pipeline remains lackluster (Figure 15). Thus, after an optimistic end to 2013, we expect the

growth momentum to weaken again in H1 2014.

Additionally, we expect inflation to remain elevated. Food inflation should moderate due to a

mean-reversion in vegetable prices, but the structural uptrend in food inflation since 2008-09

remains intact due to supply-side constraints. Rural wages in India are indexed to CPI inflation

and the recent spurt in inflation will raise rural wages in coming months. Higher rural wages

amid elevated inflation expectations will also likely have second-round effects on core CPI

inflation (Figure 16). WPI inflation (largely tradables inflation) should also rise as a higher share

of input costs are passed on to consumers to protect manufacturer margins, which have been

under pressure (from past currency depreciation). Therefore, we expect the RBI to hike the repo

rate by 25bp in each of Q1 and Q2 2014, to 8.25%.

Although external sector risks have fallen considerably, they could re-emerge early next year.

India has managed to significantly lower its current account deficit due to external factors (better

exports) and one-off policy restrictions (on gold imports). However, with the economy still

running a deficit, capital outflows stoked by Fed tapering could put pressure the balance of

payments once again. During this time, policymakers could announce India’s inclusion in global

government bond indices.




16

Fig. 15: Business cycle is near the trough

96

97

98

99

100

101

102

103

104

0

5,000

10,000

15,000

20,000

25,000

Dec-99 Sep-02 Jun-05 Mar-08 Dec-10 Sep-13

New investment projects announced, lhs

OECD's lead index for India, rhs

INR bn (4qma) Index

Source: OECD, CMIE and Nomura Global Economics

Fig. 16: Rural wages and core CPI inflation to remain elevated

0.0

5.0

10.0

15.0

20.0

25.0

30.0

0

2

4

6

8

10

12

14

16

Dec-05 Jun-07 Dec-08 Jun-10 Dec-11 Jun-13 Dec-14

CPI (18-month lead), lhs

Core CPI, lhs

Nominal rural wages, rhs

% y-o-y % y-o-y

Source: CEIC and Nomura Global Economics

A gradual improvement in H2 following the elections

Political stability and policy credibility are paramount to corporates making long-term investment

decisions. India’s lower house elections are due to be held by May 2014. Nomura’s political

analyst, Alastair Newton, expects a BJP-led coalition to form a government at the centre. A

stable government, regardless of whether it is led by the BJP or the INC, should support a

gradual business cycle recovery. Once political stability has been established, we believe that

past investment projects cleared by the Cabinet Committee of Investment (CCI) could be

implemented. This revival will be led by a debottlenecking of existing investment projects.

Contemporaneous with improved global demand, this should underpin a gradual economic

recovery after Q3 2014. We expect GDP growth to accelerate to 5.7% in 2015 from 4.8% in

2014. Our forecast growth recovery is more gradual than India’s past cycles due to the

leveraged balance sheets of corporates, higher non-performing assets on bank balance sheets

and higher interest rates.

Risks to our view

Politics is the key downside risk domestically. A third front government (a coalition consisting of

neither BJP nor the INC) or a fractured mandate in the upcoming elections would further slow

the reform momentum and lower India’s potential growth. Stronger global growth outlook is the

key upside risk.

Fig. 17: India outlook at a glance


Real GDP 4.8 4.4 4.7 5.0 4.8 4.5 4.8 5.2 4.7 4.8 5.7



Fixed investment 3.4 -1.2 1.8 2.0 2.2 2.0 3.5 5.5 1.6 3.3 6.1

Exports (goods & services) -0.6 -1.2 7.2 8.1 8.0 6.0 7.0 6.5 3.2 6.9 5.5

Imports (goods & services) 3.3 0.7 -2.0 2.2 2.5 3.5 4.5 5.5 1.1 4.0 6.5

Wholesale price index 6.7 4.8 6.5 7.0 6.7 7.2 5.6 5.9 6.2 6.4 6.5

Consumer price index 10.7 9.6 9.6 9.9 9.5 9.5 9.2 9.0 9.9 9.3 8.7

Current account balance (% GDP) -2.9 -3.0 -3.7

Fiscal balance (% GDP) -4.8 -4.5 -4.2

Repo rate (%) 7.50 7.25 7.50 7.75 8.00 8.25 8.25 8.25 7.75 8.25 8.25

Reverse repo rate (%) 6.50 6.25 6.50 6.75 7.00 7.25 7.25 7.25 6.75 7.25 7.25

Cash reserve ratio (%) 4.00 4.00 4.00 4.00 4.00 4.00 4.00 4.00 4.00 4.00 4.00

10-year bond yield (%) 8.01 7.46 8.76 8.40 8.40 8.50 8.50 8.50 8.40 8.50 8.50

Exchange rate (INR/USD) 54.4 59.7 62.8 62.2 62.8 61.5 62.2 62.2 62.2 62.2 65.5

Notes: Numbers in bold are actual values; others forecast. Interest rate and currency forecasts are end of period; other measures are period average. Table reflects data available as of 25 November 2013. Source: CEIC and Nomura Global Economics


17

Euben Paracuelles +65 6433 6956 [email protected]

Enrico Tanuwidjaja +65 6433 6930 [email protected]

Lavanya Venkateswaran +65 6433 6985 [email protected]

Southeast Asia: Continue to compare and contrast

In our year-ahead outlook 12 months ago, we wrote that ASEAN has “growth prospects and

policy considerations that may diverge even more in 2013.” In 2014, we continue to see this

theme of differentiation play out. We see three main differentiating factors: 1) the quality of

growth; 2) the scope for timely policy tightening; and 3) the prospects of structural reforms – all

of which will provide the main buffers against significant external risks next year, particularly the

removal of loose monetary policy by global central banks (as described in the Asia overview).

The Philippines stands out on all counts, and we maintain our bullish view. Growth is becoming

increasingly investment-led, we expect policy rate hikes to be the most aggressive, starting on

the first signs of a pick-up in inflation, while structural reforms such as fiscal reforms and an

opening up of more sectors are likely. We believe the impact on growth from the recent typhoon

will be relatively short-lived. Next year, the recovery will likely provide more impetus on both

public and private sector spending as reconstruction begins in earnest. In contrast, we are most

bearish on Thailand, where we see aneamic domestic demand weakening further (Figure 18).

The lack of fiscal stimulus and infrastructure spending is well known, but we have larger

concerns regarding private demand. This is symptomatic of an economy that is haunted by

persistent political uncertainty, which will likely escalate in 2014 and hence prevent the

government from refocusing on needed supply-side reforms.

We are positive on Indonesia in the short term because of continued policy tightening, which

helped alleviate currency pressures in the face of large external funding gaps in late 2013.

Stability is now the policy priority, and appropriately so, in our view. But beyond the short term,

the outlook is less clear. Reform momentum has already waned and there is a risk that elections

do not produce a government that is reform-minded at a time when current account deficits

remain unsustainably large. In contrast, we believe Malaysia, the other commodity exporter in

the region, will likely see more improvement in its balance of payments due to a combination of

better external demand, the policy strategy to stagger the rollout of import-heavy projects, and

most importantly, fiscal reforms. With the elections behind us, these reforms are likely to be

implemented as planned, in our view, and could result in positive sovereign rating action.

Fiscal policy will likely play a more active role in Singapore, which is already entering its fourth

year of economic restructuring but so far no sign of success in boosting the low rate of

productivity growth. We expect productivity growth to continue to disappoint. As a result, growth

will likely be lower for longer and inflation elevated. In response, the prudent fiscal policy

hitherto may start to turn more accommodative, which would allow room for the Monetary

Authority of Singapore (MAS) to keep relatively tight monetary policy settings.

Fig. 18: Domestic final demand (public and private consumption and investment): Philippines versus Thailand

*Nomura Q3 forecast. Source: CEIC; Nomura Global Economics

Fig. 19: Indonesia: current account deficit

Source: CEIC; Nomura Global Economics

-10

-5

0

5

10

15

20

Sep-01 Sep-03 Sep-05 Sep-07 Sep-09 Sep-11 Sep-13

Philippines*

Thailand

% y-o-y

-12

-10

-8

-6

-4

-2

0

2

4

6

Dec-06 Dec-08 Dec-10 Dec-12 Dec-14

Current account balance, USDbn

Current account balance, % GDP

Nomura forecasts





18

Indonesia: An even more challenging year

Due to the tighter policy environment, we forecast 2014 GDP growth to be unchanged from this

year at 5.7%, which is subdued when compared to average growth of 6.3% over 2010-12.

Consistent with this, we expect the current account deficit to improve, but only gradually, from

3.4% of GDP in 2013 to 3.0% in 2014. This is still well above the level that Bank Indonesia (BI)

considers as sustainable, i.e. 2.5% of GDP (Figure 19). As such, we believe BI is likely to raise

its policy rate by another 50bp to 8.0% in Q1 2014. We believe the tighter fiscal stance for 2014

– with the budget deficit projected at 1.7% of GDP against the 2.4% target in the revised Budget

2013 – will help the economy achieve more stability and pave the way for more sustainable

long-term growth. Meanwhile, we doubt inflation will decelerate as fast as BI expects, in light of

electricity tariff hikes starting early next year and rising wage growth. We forecast CPI inflation

to ease to 5.6% in 2014 from 7.0% in 2013, lower mainly on base effects but still above BI’s 3.5-

5.5% target range.

We will be watching three issues closely in 2014:

1. The new mining law. This is due to take effect in January and essentially bans the

export of unprocessed mineral ores, effectively pushing miners with no smelters

(essentially, the smaller players) out of the business. Nationalistic and protectionist

policies of this nature, at a time when Indonesian exports already face headwinds from

falling commodity prices and slowing growth, may warrant government reconsideration.

2. The general election on 9 April. Pre-election and campaign-related spending are

likely to be positive for growth in Q1 2014 but slow reforms, as in past election cycles.

We believe that Joko Widodo, if he is nominated by Partai Demokrasi Indonesia-

Perjuangan (PDI-P) and accepts the candidacy (as we expect), is likely to win the

presidential election in July. His nomination would in turn boost the likelihood of PDI-P

winning the general election in April, thus forming the next government. The party’s

stance on economic policies are likely to remain nationalistic and protectionist, which

would not bode well for foreign investment and long-term growth.

3. Monetary policy. We believe that rate hikes will be front-loaded in Q1 2014; coinciding

with our forecast of Fed tapering, further hikes in electricity tariffs and the release of Q4

2013 current account data. Rate hikes are likely to cap growth further, nullifying the

slight boost to growth from pre-election spending. Additionally, we think that BI could

implement further macroprudential measures next year, to complement rate hikes, in

order to narrow the current account deficit.

Fig. 20: Indonesia: Details of the forecast


Real GDP (sa, % q-o-q, annualized) 5.3 5.5 5.1 5.2 6.7 5.8 5.7 4.0 Real GDP 6.1 5.8 5.6 5.3 5.6 5.7 5.8 5.5 5.7 5.7 6.1






Contributions to GDP:


Inventories 0.0 -0.4 -0.2 0.2 0.6 0.5 0.5 0.7 0.1 0.6 0.7

Net trade (goods & services) 1.7 2.1 1.1 0.5 0.1 -0.4 -0.3 -0.6 1.3 -0.3 0.0

Consumer prices index 5.3 5.6 8.6 8.5 7.2 5.3 4.6 5.3 7.0 5.6 6.2

Exports -6.5 -4.2 -3.1 0.0 1.2 2.3 4.7 4.1 -3.5 3.1 13.1

Imports -2.1 -1.0 4.2 1.8 8.3 8.0 9.7 12.6 0.7 9.7 8.9

Trade balance (US$bn) -0.8 -3.8 -2.6 -1.7 -2.1 -4.1 -3.7 -4.8 -9.0 -14.7 3.2

Current account balance (% of GDP) -2.7 -4.4 -3.8 -2.9 -3.0 -3.3 -2.8 -2.9 -3.4 -3.0 -2.5

Fiscal Balance (% of GDP) -2.4 -1.7 -2.0

Bank Indonesia rate (%) 5.75 6.00 7.25 7.50 8.00 8.00 8.00 8.00 7.50 8.00 8.00

Exchange rate (IDR/USD) 9735 10004 11406 11600 11900 12200 12300 12400 11600 12400 12900



19

Malaysia: Avoiding twin deficits

2014 is a year in which we expect to see a continuation of proactive government policies aimed

at lowering the fiscal deficit and keeping the external accounts in a comfortable surplus. Budget

2014 set the economy on a clear course for medium-term fiscal consolidation (Figure 21), while

sharply deteriorating external balances in H1 2013 led the government to stagger the rollout of

import-intensive public infrastructure projects.

As a consequence, we expect domestic demand to be relatively weak, led by the public sector.

Although private sector investment is likely to remain strong, fiscal consolidation and monetary

policy tightening will slow private consumption, in our view. The support to growth, given

Malaysia’s high degree of openness, will come from the expected pick-up in external demand.

We forecast GDP growth to rise to 4.5% in 2014 from an expected 4.3% in 2013, reflecting the

improvement in global growth (Nomura: 3.4% y-o-y in 2014 from 2.8% in 2013), which should

more than offset weaker domestic demand. On the back of this, we also expect the current

account surplus to increase further to 5.1% of GDP in 2014 from 3.5% in 2013.

Higher inflation is another consequence of fiscal consolidation. In our base case, we have

factored in a 10% increase in fuel prices by Q2 2014. This would push average 2014 headline

CPI inflation to 3.5% y-o-y from a benign 2.1% in 2013. As a result, we expect Bank Negara

Malaysia (BNM) to hike its policy rate by a cumulative total of 50bp in H2 to 3.50%.

Fig. 21: Malaysia: Fiscal consolidation underway

Source: CEIC; Nomura Global Economics.

Fig. 22: Philippines: FDI inflows and approvals

Source: CEIC; Nomura Global Economics.

Fig. 23: Malaysia: Details of the forecast


Real GDP (sa, % q-o-q, annualized) -1.1 5.8 6.8 3.8 2.6 4.4 7.2 4.0

Real GDP 4.1 4.4 5.0 3.8 4.7 4.4 4.5 4.6 4.3 4.5 4.0




Exports (goods & services) -0.6 -5.2 1.7 0.4 2.7 1.1 2.6 3.6 -0.9 2.5 2.3

Imports (goods & services) 3.6 -2.0 1.8 0.4 1.7 1.3 2.4 4.0 0.9 2.4 3.0



Inventories 0.7 1.0 -2.6 -1.4 -0.6 0.0 0.0 0.0 -0.6 -0.1 0.0

Net trade (goods & services) -3.7 -3.3 0.1 0.0 1.0 -0.1 0.3 0.0 -1.7 0.3 -0.4

Unemployment rate (%) 3.1 3.0 3.1 3.1 3.1 3.1 3.1 3.1 3.1 3.1 3.2

Consumer prices 1.5 1.8 2.2 2.9 3.1 4.0 3.9 3.3 2.1 3.5 5.2

Exports -3.3 -7.1 -2.8 -3.2 4.6 0.4 6.6 6.0 -4.1 4.4 6.6

Imports 4.1 -1.2 -2.8 -0.8 1.2 -0.4 5.1 7.6 -0.2 3.4 6.2

Trade balance (USD bn) 8.0 6.1 8.0 9.7 10.0 6.5 9.2 9.6 31.8 35.2 38.1

Current account balance (USDbn) 2.8 0.8 3.0 4.1 4.1 1.8 5.7 5.1 10.8 16.8 22.9


Fiscal Balance (% of GDP)

-4.0 -3.5 -3.3

Overnight policy rate (%) 3.00 3.00 3.00 3.00 3.00 3.00 3.25 3.50 3.00 3.50 4.00

Exchange rate (MYR/USD) 3.09 3.18 3.26 3.15 3.20 3.23 3.22 3.21 3.15 3.21 3.28


2.5

3.0

3.5

4.0

4.5

5.0

2011 2012 2013 (F)2014 (F)2015 (F)2016 (F)2017 (F)

Impact of subsidy reformImpact of GST, at 6%No reform scenario, deficitReform, deficit

% GDP

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

6.0

Dec-03 Dec-05 Dec-07 Dec-09 Dec-11 Dec-13

BOP: FDI inflows

FDI approvals (4- quarter lead)

USD bn


20

Philippines: Still the star performer

We lower our GDP growth forecast for 2013 to 7.1% from 7.3%, taking into account the impact

of the typhoons in Q4. However, we also raise our 2014 GDP growth forecast to 6.7% from

6.2%, reflecting our view that reconstruction will spur economic activity in the months ahead.

Financing will not be a constraint as the government has plenty of fiscal space, plus remittances

from overseas workers are also rising. As a result, we expect the fiscal deficit to widen only

slightly to 2.4% of GDP from 2.2% in 2013.

In our view, the disaster, as tragic as it is, does not alter the economy’s strong fundamentals:

the combination of strong growth, a solid external surplus, stable politics and still-positive reform

prospects sets the Philippines apart from its regional peers. If anything, we believe the typhoon

could be a catalyst for even more infrastructure implementation. Investment spending is likely to

continue to be a bigger contributor to growth. Still, we expect the current account surplus to

remain solid, increasing further to 4.0% of GDP in 2014 from 3.8%, led by worker remittances

as well as revenues from a booming business processing outsourcing sector. In addition, we

expect FDI inflows to begin to pick up more substantially in 2014 (Figure 22), directed into

services-related sectors initially and, further out, manufacturing. This is being supported by a

marked improvement in the business climate, further progress in governance reforms, an

investment grade rating and the prospect of liberalization of foreign ownership restrictions in

certain sectors. The overall balance of payments position should be able to easily withstand the

risk of capital outflows brought on by the start of Fed tapering.

Given the strength of the economy and additional supply-side pressures from the typhoon, we

forecast inflation to rise to 4% in 2014 from 2.9%. This is still within Bangko Sentral ng Pilipinas’

(BSP) 3-5% inflation target. That said, we expect BSP to start hiking its policy rate in Q2, raising

it by 100bp to 4.5% by end-2014. This is relatively aggressive, but we believe BSP will be

proactive in containing inflation risks, mindful of the narrowing output gap, loose liquidity

conditions and the prospect of a normalization in global monetary policy.

Fig. 24: Philippines: Details of the forecast



Real GDP 7.7 7.5 7.3 6.1 5.2 6.0 7.3 7.9 7.1 6.7 6.8




Exports (goods & services) -7.6 -6.5 2.2 0.3 4.8 4.2 4.7 5.7 -3.1 4.8 5.5

Imports (goods & services) 2.0 -3.0 0.6 5.9 7.6 9.7 10.3 11.5 1.3 9.8 11.0

Contribution to GDP growth (% points)


Inventories 4.0 2.1 -1.7 1.0 -2.2 -1.8 0.1 0.4 1.4 -0.2 0.6

Net trade (goods & services) -4.9 -2.0 0.8 -2.4 -1.3 -2.5 -2.6 -2.9 -2.1 -2.3 -2.7

Exports -6.2 -2.7 -4.8 -4.7 1.8 1.7 3.7 4.7 -4.6 3.0 4.5

Imports -7.4 -0.1 4.6 7.9 9.6 9.7 10.3 11.5 1.3 10.3 10.0

Merchandise trade balance (USDbn) -2.3 -1.8 -3.6 -5.6 -3.4 -3.0 -4.8 -7.0 -13.2 -18.2 -22.9

Current account balance (USDbn) 3.1 2.5 2.2 2.6 3.4 2.7 3.3 3.0 10.5 12.3 9.5


Fiscal balance (% of GDP)

-2.2 -2.4 -2.0

Consumer prices (2006=100) 3.2 2.7 2.5 3.4 3.8 4.3 4.2 3.8 2.9 4.0 4.1


Reverse repo rate (%) 3.50 3.50 3.50 3.50 3.50 4.00 4.50 4.50 3.50 4.50 5.50

Exchange rate (PHP/USD) 40.2 43.1 43.5 43.0 43.3 43.3 43.3 43.2 43.0 43.2 43.8


Singapore: No turning back

As Singapore enters its fourth year of economic restructuring, we expect markets to scrutinize

the progress made so far, only to find that productivity improvements have not kept pace with

the tightening of the labour market (Figure 26). The result will be lower growth for longer and

inflation remaining elevated. Although we have upgraded our 2013 GDP growth forecast to

3.5% from 3.1% on improvements in external demand, we forecast 2014 GDP growth to remain


21

stable at 3.5%, despite global growth improving more sharply, to 3.4% from 2.8%. Tighter

restrictions on foreign workers have led to labour shortages, constraining the supply side of the

economy. The resultant rise in unit labour costs should inevitably lead to demand-push

inflationary pressures and will likely persist until there is an accompanying pick-up in productivity

growth. We forecast CPI inflation to spike to around 3.6% in 2014, above the official forecast

range of 2-3%. Consequently, we think that this growth-inflation balance will result in the MAS

keeping its current pace of gradual and modest appreciation of the SGD NEER, barring any

external-related shock.

In terms of fiscal policy, as the government is determined to push the restructuring process, we

expect the budget to turn slight more expansionary (i.e., running a smaller surplus). The

restructuring strategy, in our view, will now entail more costs (perhaps much more than before)

to incentivize firms to spend more on productivity-enhancing investment. In addition, these will

have to be augmented by demographic challenges and higher social spending needs. We are

watchful of tightening liquidity conditions as global central banks begin to remove

accommodative policy and consequently raise interest rates. This will have knock-on effects for

Singapore’s property market, in our view, and hence household balance sheets. On this front,

we believe the authorities may implement more macroprudential policies in 2014.

Fig. 25: Singapore: Details of the forecast


Real GDP (sa, % q-o-q, annualized) 2.3 17.4 1.3 -5.9 3.0 16.0 3.8 -8.5

Real GDP 0.3 4.4 5.8 3.4 3.6 3.3 3.9 3.2 3.5 3.5 2.9


Government consumption 13.8 12.6 6.8 -4.2 -8.3 3.4 11.5 11.8 7.5 3.0 4.7

Gross fixed capital formation -5.8 -2.6 4.7 4.2 6.1 1.7 0.2 -3.0 0.0 1.1 3.5

Exports (goods & services) -4.0 3.1 6.2 3.7 4.1 3.8 3.5 3.8 2.3 3.8 5.0

Imports (goods & services) -2.4 2.9 6.4 3.2 3.6 3.3 3.0 3.3 2.5 3.3 2.0



Inventories 4.0 1.9 1.3 0.1 -0.1 0.2 0.3 0.2 1.8 0.2 0.3

Net trade (goods & services) -4.3 1.5 1.6 1.8 2.0 2.1 2.1 1.9 0.1 2.0 0.9


Consumer prices 4.0 1.6 1.8 1.9 2.9 3.7 4.0 3.8 2.3 3.6 3.5

Exports -6.7 1.1 4.4 4.6 3.5 3.3 3.7 2.0 0.5 3.1 7.8

Imports -6.8 -2.2 4.8 2.1 3.0 2.7 3.2 1.5 -0.6 2.6 1.0

Trade balance (US$bn) 15.0 17.5 16.5 16.2 15.9 18.5 17.6 17.0 65.1 69.0 69.1


Fiscal Balance (% of GDP) 1.0 0.2 -0.2

3-month SIBOR (%) 0.38 0.38 0.42 0.42 0.42 0.42 0.42 0.48 0.42 0.48 0.60

Exchange rate (SGD/USD) 1.24 1.27 1.26 1.24 1.25 1.26 1.27 1.27 1.24 1.27 1.29


Fig. 26: Singapore: Poor labour productivity

*Note: Q1-Q3 2013 Source: CEIC; Nomura Global Economics

Fig. 27: Thailand: GFCF and total GDP (deviation from trend)

Source: CEIC; Nomura Global Economics

-4 -2 0

Manufacturing

Transportation & Storage

Construction

Accom. & food Services

Business Services

Info. & comm.

Year-to-date 2013* 2012 % y-o-y

-6.0

-4.0

-2.0

0.0

2.0

4.0

6.0

-15.0

-10.0

-5.0

0.0

5.0

10.0

Sep-01 Sep-03 Sep-05 Sep-07 Sep-09 Sep-11 Sep-13

GFCF: private GDP, RHSpp pp


22

Thailand: Poor politics make for poor economics

We downgrade our 2013 GDP growth forecast to 3.1% from 3.5% and expect only 3.8% growth

in 2014 as the deficiency in domestic demand is likely to persist, especially in private sector

spending. We expect little progress to be made on public infrastructure spending in H1 2014,

and even in H2 we expect just 0.2% of GDP to be disbursed (compared to the Bank of Thailand

(BOT) and the Fiscal Policy Office’s projection of 1%). As a result, private investment, which

tends to be pro-cyclical, will remain subdued, in our view (Figure 27). Private consumption is

expected to normalize but remain soft nonetheless, constrained in part by high household debt

(80% of GDP). With global growth picking up in 2014, we expect the economy to see some

benefit from exports, but we believe upside will be capped by aneamic domestic demand and

supply-side constraints, including a shortage of labour. These constraints should also contribute

to the current account remaining in deficit, which we forecast at 1.1% of GDP from 1.7% in

2013.

Consistent with poor domestic demand and subdued global commodity prices, we expect CPI

inflation to remain benign, at 2.3% in 2014 from 2.1% in 2013. On the back of this growth-

inflation mix, we expect the BOT to keep rates on hold at 2.50% throughout 2014. In addition,

we expect the BOT’s rhetoric to remain dovish and we do not rule out the possibility of more

rate cuts. Bank asset quality could start to deteriorate amid the growth downturn, which could

prompt a tightening of credit standards.

The risks to growth are skewed to the downside and mainly stem from political uncertainty. The

government is in office until 2015, but the political calendar is fraught with contentious issues

over the next few months, particularly on the pending constitutional court decision regarding the

THB2trn infrastructure bill and the political repercussions of the court’s ruling of the charter

amendment bill as unconstitutional. These are highly unpredictable and could act as triggers to

more protests, possibly spelling an early end to the administration’s four-year term. A fragile

political environment suggests that risks to our already weak growth outlook are skewed to the

downside.

Fig. 28: Thailand: Details of the forecast


Real GDP (sa, % q-o-q, annualized) -6.3 0.0 5.2 7.4 -1.0 3.8 6.5 8.1

Real GDP 5.4 2.9 2.7 1.4 2.9 3.8 4.1 4.3 3.1 3.8 4.6

Private consumption 4.4 2.5 -1.2 -1.7 1.1 2.6 2.2 2.4 0.9 2.1 4.0

Public consumption 2.9 7.6 7.4 6.4 5.4 4.9 4.4 4.4 6.2 4.7 2.7

Gross fixed capital formation 5.8 4.7 -6.5 -3.6 -1.0 0.8 6.7 7.9 -0.1 3.5 6.8


Imports (goods & services) 8.1 4.5 0.7 -1.4 1.4 0.7 2.8 3.3 2.9 2.0 3.4

Contribution to GDP growth (% points)

Domestic final sales 3.7 3.2 -1.3 -1.1 0.8 2.1 3.2 3.2 1.1 2.3 3.8

Inventories 0.3 0.4 1.5 -0.9 0.0 -0.1 -0.3 0.0 0.3 -0.1 0.0

Net trade (goods & services) 1.4 -0.7 2.5 3.4 2.1 1.8 1.2 1.1 1.7 1.6 0.9

Exports 4.5 -1.9 -1.8 1.9 3.9 3.1 3.8 4.1 0.6 3.7 5.0

Imports 6.4 0.2 -2.9 -4.4 0.7 0.7 2.8 3.3 -0.2 1.8 3.8

Trade balance (US$bn) -0.3 -0.5 5.0 3.6 1.5 0.8 5.8 4.2 7.9 12.3 15.6

Current account balance (US$bn) 1.5 -6.7 -0.9 -0.4 -1.9 -4.1 -0.7 2.2 -6.5 -4.5 -3.5

Current account balance (% of GDP) 1.5 -6.7 -1.0 -0.5 -2.0 -4.2 -0.7 2.3 -1.7 -1.1 -0.9

Fiscal balance (% of GDP, fiscal year basis)

-1.8 -2.0 -3.0

Consumer prices 3.1 2.3 1.7 1.3 1.5 2.2 2.5 2.8 2.1 2.3 2.5


Overnight repo rate (%) 2.75 2.50 2.50 2.50 2.50 2.50 2.50 2.50 2.50 2.50 3.00

Exchange rate (THB/USD) 29.3 31.1 31.2 31.5 32.0 32.3 32.6 32.9 31.5 32.9 34.0



23

Craig Chan +65 6433 6106 [email protected]

Wee Choon Teo +65 6433 6107 [email protected]

Prateek Gupta +65 6433 6197 [email protected]

Prashant Pande +65 6433 6198 [email protected]

FX strategy: H1 – politics, tapering and China;

H2 – policy rate divergence

Tapering, elections, China risk, and monetary policy tightening

Our main themes for Asia FX through 2014:

1. Fed QE tapering into Q1 2014, which will again lead to relative FX out/under-

performance depending on the strength/weakness of the country’s balance sheet.

2. Elections and policy risks, which could run into H2 2014. If India’s state election

results come out in line with Nomura’s expectations, we recommend a 3-month trade

of being long INR, KRW, PHP against IDR and MYR. This takes into account Fed

tapering risk.

3. China’s economic slowdown into Q2, which may see a rise in hard-landing and

financial systemic risks. Into Q2, these three themes could see PHP and INR

outperform IDR and MYR. The risk from a China hard-landing scenario is also that

USD/CNH trades to the weak side of the daily fixing.

4. Varying degrees of monetary policy tightening from Q2 onwards due to higher

inflation. This theme, combined with China’s slowdown and political risks, could see

PHP outperform THB.

Overall, we believe the Fed QE tapering and election themes are likely to garner the most

focus as we move into 2014. A rise in tapering concerns would likely see weaker-balance-

sheet and bond-dependent countries underperform. Within Asia, we expect PHP, KRW, TWD

and CNY to outperform over MYR, INR and IDR. However, we believe there is some scope for

INR to outperform IDR given some divergent developments. First, is where market perceptions

over the political outlook and structural reforms in India could change if there is a strong

showing by the BJP-led government in November/December state elections (see Asia Insights:

Indian state elections: Likely outcomes and implications, 10 October 2013). Indeed, our Global

Head of Equity Strategy Michael Kurtz believes that our baseline view of the state election could

support local equities (see Equity Outlook: Refocus from Risk Compression to Earnings Growth).

IDR may underperform given the uncertainty over the upcoming general election in April and

presidential election in July (see Indonesia – an even more challenging year). Second, is the

impact from a stronger US economy and QE tapering, where foreign bond positioning in

Indonesia has recently risen again towards record highs compared with a significant fall in India.

Third, is the risk of reduced intervention against IDR depreciation given a low level of FX

reserves. A rise in capital inflows would also likely see Bank Indonesia (BI) aggressively

accumulate reserves. Lastly, there are technical reasons also, including Indonesia possibly

bringing the offshore USD/IDR fixing onshore, which could see the offshore curve rise and

converge with the onshore curve. There has also been a push by Indian authorities to have

government bonds included in the JP Morgan emerging markets global diversified index, which

could result in notable inflows.

Although Malaysia’s fundamentals have improved as political uncertainty has reduced and

significant fiscal and current account policies have been undertaken (see section on Southeast

Asia: Continue to compare and contrast), MYR remains extremely vulnerable to QE tapering

given the high level of foreign bond ownership.

On the other hand, we expect KRW to outperform into Q1 2014 given our expectation for Q1

growth to peak at 4.2% y-o-y on the back of pent-up domestic demand, as well as export growth

holding up well. This pent-up demand for private consumption and investment could narrow

Korea’s current account surplus, but we expect it to remain at a substantial USD55bn (4.1% of

GDP) in 2014, compared to the record USD66bn surplus (5.5% of GDP) in 2013 (see South

Korea: Catching up with global growth). Furthermore, foreign holdings of Korean bonds are

likely to be sticky as the latest data (end-2012) show foreign central bank and sovereign wealth

funds owned around 38.7% of total foreign holdings. That said, we see growing risks to KRW

outperformance into Q2 due to China’s economic slowdown and hard-landing risks (see below).

Similarly, we believe PHP could outperform beyond tapering concerns, as it is relatively less





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24

vulnerable to potential portfolio outflows, enjoys robust structural inflows, a positive output gap

and a willingness on the part of the authorities to tolerate PHP outperformance to temper

domestic demand and inflation risks.

China’s economic slowdown and hard-landing risks likely to be in focus into Q2. Nomura

Economics forecasts Q2 2014 as the point at which China’s economy will be at its weakest in

the current cycle (at 6.7% GDP growth, see China: No pain, no gain), while there are also risks

of some local government financing vehicle (LGFV) debt defaults. If there is a significant

increase in hard-landing concerns we expect this to lead spot USD/CNY (CNH) back towards

the fixing level. However, if this is combined with negative credit events at the local government

level, the risk is that spot USD/CNY (CNH) trades above the fixing. Combined with the

possibility of a wider USD/CNY trading band (to +/-2% from +/-1%), potential CNY (CNH)

depreciation could be significant (see Asia Insights - Lower USD/CNY fix, FX reform and

stronger data, 08 November 2013). Across the region, we believe hard-landing concerns would

have a greater negative impact on KRW, TWD, SGD, MYR and THB than on PHP, IDR and INR.

This is based on our analysis of China’s importance through trade channels, historical currency

sensitivity to USD/CNY and financial linkages (see Asia Insights: China band-widening

discussion revisited, 11 October 2013).

From Q2 to year-end, we believe the dominant theme will be increased pressure on Asian

central banks to hike rates. However, we expect to see divergence in monetary policy across

the region, with the Philippines likely to be early in the hiking cycle and relatively aggressive

(100bp from Q2) and Bank Negara Malaysia hiking by 50bp from Q3. For PHP, we expect the

tightening cycle to be complimented with FX appreciation, especially as we judge PHP to be

13% undervalued. We expect one 25bp rate hike in Korea, but not until Q4, while Thailand and

Taiwan are likely to keep rates on hold throughout the year. This is partly due to relatively low

inflation, but also (in Thailand, especially) some risk of political pressure to keep monetary

policy loose.

We believe that over the next 6-12 months, QE tapering, the China slowdown, political

uncertainty in Thailand (see Thailand – poor politics make for poor economics) and monetary

policy tightening should see PHP outperform versus THB.

Fed QE tapering and differentiation between balance sheets

As we approach the 28-29 January FOMC meeting – which our US economists believe may

mark the first round of QE tapering – the risk is that we see increased pressure on broad Asia

FX. However, we expect to see differentiation in performance between the currencies of weak

and stronger balance sheet countries – similar to the experience between 22 May and 17

September 2013, at which time INR and IDR were the main underperformers, followed by MYR

and CNY/CNH, TWD and through which KRW outperformed (Figure 29).

This performance was in line with our vulnerability analysis, which showed that the weaker

current account balance countries – and especially those dependent on portfolio flows for

financing – underperformed (Figure 30). Malaysia’s vulnerability is in part from the significant

increase in foreign ownership of Malaysian government bonds, with the ratio of foreign

ownerships of bonds to equity value now at 82% (September 2013) compared with a post-US

financial crisis low of 29% (July 2009).






25

Fig. 29: Asia FX performance since tapering risks surfaced

Note: Values rebased to 100 as of 22 May 2013. Source: Bloomberg, Nomura.

Fig. 30: Asian currencies vulnerable to portfolio outflows

Note: C/A is Nomura Economics forecast for 2013. We assume a 2% drop in total foreign equity holdings (in nominal terms); 10% of the fall in FBH/Outstanding during US financial crisis for KR, ID, IN and MY; 10% of the average fall in FBH for KR,ID,IN,MY applied on IIP debt positions for CN,TW,TH,PH. Portfolio outflows are monthly. Source: Bloomberg, CEIC, Nomura estimates.

In our scenario analysis, Indonesia and India stand out as the most vulnerable when comparing

potential financing gaps to FX reserves (plus FX forwards). Indonesia may be more vulnerable

than India given its low FX reserve coverage and the August experience where the consistent

drawdown in reserves eventually saw BI back off and allow IDR to depreciate rapidly (by 9% vs

USD, Figure 31). Unless there is a rapid re-accumulation of FX reserves in the coming months

(there was a USD3.4bn gain in September and October compared to a USD26.2bn loss over

the last two years (August 2011-13) on a valuation adjusted basis), the risk is that BI will not be

active if there is another near-term round of significant IDR depreciation pressure. That said, if

there is rapid IDR depreciation, it is possible that BI will access the USD37bn FX swap line it

agreed with Japan, Korea and China. The risk, however, is that if Indonesia activates its swap

facility by itself, the market could take this as a sign of weakness.

Bilateral swap lines signed in the region could help lower FX vulnerability, but we believe there

are reasons why Asia could be less susceptible to Fed tapering concerns compared with the 22

May to 17 September 2013 experience. These include the FOMC highlighting that it will reduce

the risk of tighter financial conditions with its forward guidance when tapering emerges (possibly

lowering the unemployment rate, or setting minimal inflation targets). There have also been

more local policy responses to target factors of vulnerability, such as Malaysia’s fiscal

consolidation and its staggering of infrastructure projects to support the current account surplus.

India has hiked benchmark rates, imposed import restrictions and taken measures (albeit

temporary) to reduce interbank USD demand (it also has a USD50bn FX swap line with Japan).

Indonesia has hiked rates to temper inflation and made adjustments to fuel subsidies. Lower

foreign portfolio positioning in the region1 should also lower the vulnerability of Asia FX as, after

USD47bn of outflows from June to August 2013, there has only been around USD22bn of

inflows returning from September to November2 (Figure 32). Net foreign portfolio outflows have

come mainly from Indian bonds, with recent inflows primarily in Korean equities and Malaysian

bonds.

1 Korea, India, Malaysia, Thailand, Indonesia, net equity and bond flows.

2 Foreign equity flows for all countries; India and Indonesia foreign debt flows are based on latest available daily data (19

November cut-off date); foreign debt flows for rest of the economies are based on monthly data (Malaysia as of end-September; Korea and Thailand as of end-October).

95

100

105

110

115

120

125

22-May 22-Jun 22-Jul 22-Aug

CNHINRIDR fixKRWMYRPHPSGDTHBTWD

(USD bn) KRW CNY TWD THB PHP IDR INR MYR

Avg. Mthly Current Account (2013f) 5.5 14.0 4.1 -0.5 0.3 -2.5 -4.5 0.9

Portfolio Outflow s - Equities -5.3 -5.8 -3.4 -1.5 -0.7 -1.2 -5.2 -1.6

Portfolio Outflow s - Bonds -3.4 -2.2 -0.3 -0.1 -1.0 -0.5 -0.1 -3.8

Financing Gap -3.2 6.0 0.5 -2.1 -1.4 -4.2 -9.8 -4.5

FX Reserves 343 3663 416 163 84 97 254 132

Financing Gap / FX reserves -0.9% 0.2% 0.1% -1.3% -1.6% -4.4% -3.9% -3.4%

FX Fw d Positions 45 n.a. n.a. 23 2 -5 -8 1

Financing Gap/(FX Res+FX Fw d) -0.8% n.a. n.a. -1.1% -1.6% -4.6% -4.0% -3.4%


26

Fig. 31: BI backed off from selling USD in August 2013

Source: Bloomberg, CEIC, Nomura.

Fig. 32: Asia net foreign bond and equity flows -YTD

Source: Bloomberg, CEIC, Nomura.

Election and policy risks

State elections in India (five to be held from 11 November to 4 December) will be the near-term

focus. Nomura’s political analyst, Alastair Newton, expects the NDA/BJP to perform strongly,

which could lift expectations of a majority win in the general election (May 2014) and raise the

outlook for economic reform. A negative outcome in state elections would likely raise the

vulnerability of India given the market is currently biased towards a positive election outcome

(see Asia Insights - India survey: More conviction on lower rates than on FX, 29 October 2013).

Key focus of the state elections will be large majorities from NDA/BJP in Chhattisgarh (11

November and 19 November) and Madhya Pradesh (25 November). A NDA/BJP victory in

Rajasthan (1 December) would be important, along with a plurality in Delhi (4 December; see

Asia Insights: Indian state elections: Likely outcomes and implications, 10 October 2013).

In Indonesia, there are risks towards a more nationalistic and protectionist government from the

April parliamentary and July presidential elections. The current concern is that there are a

limited number of market-friendly candidates even with the possible selection of Jakarta

Governor Joko Widodo who would run under the PDI-P.

Election results aside, there is still the risk of pre-election increased spending and populist

policies as was recently seen ahead of the announcement of China’s new leadership in October

2012 (and formal handover in April 2013). In Malaysia, populist policies ranging from cash

handouts, civil service wage increases and bonuses emerged ahead of the general election in

May 2013 (Figure 33). Lastly, beyond election and policy risks in Indonesia and India, we

remain concerned over political factors in Thailand, including the exertion of political pressure

on the Bank of Thailand (BoT) to keep policy loose, the charter amendment bill and the vetting

of spending bills.

8000

8500

9000

9500

10000

10500

11000

11500

-10.0

-7.5

-5.0

-2.5

0.0

2.5

5.0

7.5

10.0

Jan-11 Aug-11 Mar-12 Oct-12 May-13

Adjusted FX Reserves (m-o-m change, USD bn)

USD/IDR (RHS)

8.7

15.5

22.1

31.4

39.4

11.6

5.8 -7.2

9.416.3 14.5

-20

-10

0

10

20

30

40

50

Jan-13 Mar-13 May-13 Jul-13 Sep-13 Nov-13

Korea $12.0bn Malaysia -$1.5bnIndonesia -$0.7bn India $8.2bnThailand -$1.7bn Total Sum $16.3bn

Enter Margin Text Here




27

Fig. 33: Measures announced by the Malaysia government

Source: Nomura.

China hard-landing/systemic risks

China’s attempt to rein-in credit growth, especially from LGFVs, is expected to continue over the

medium term. However, as experienced in the May/June 2013 liquidity squeeze, the

government has been relatively quick to prevent systemic risks from materialising. We continue

to see a substantial tail risk, especially given the acceleration and size of private, public and

LGFV debt to around 185% of GDP in 2012 from around 134% in 2008 (Figure 34, see Asia

Special Report - China’s heavy LGFV debt burden, 24 September 2013).

Fig. 34: Significant pick-up in China debt growth

Source: CEIC, IMF, Nomura.

Fig. 35: Contribution to Asia NEER baskets - BIS weights

Source: BIS, Nomura. Note: Based on 2008-2010 trade data.

China hard-landing risks and the associated systemic risks could see periods of capital outflow

and lead spot USD/CNY (CNH) to trade towards and above the daily fixing. We believe China

hard-landing concerns will negatively affect KRW, TWD, SGD, MYR and THB the most

significantly, with PHP, IDR and INR being less exposed (see Asia Special Report: If China

sneezes..., 23 July 2013). This is mainly because of trade channels, where Korea’s trade with

China is the highest in the region at 27.9% of total trade, compared with the Philippines’ 15%

(Figure 35). Our sensitivity analysis of Asia FX to surprises in USD/CNY fixes shows SGD, TWD

and KRW are the most sensitive, with PHP and IDR the least (Figure 36). Lastly, on a financial-

channel basis, equity markets in Taiwan, Singapore and Korea are more dependent on

revenues from China than the rest of Asia (Figure 37).

Target Group Measures

Announced in 2013 Budget

A 1% tax rebate for taxpayers w hose annual income is RM2500-RM50000.

Continuation of BR1M (i.e. families w ith monthly income less than RM3k get assistance of RM500; single unmarried individuals above

21 years of age and earning less than RM2k receive assistance of RM250).

A rebate of RM200 (21-30 years old, monthly income < RM2k) on the purchase of 3G smartphones.

Special allocations - per capita grant, hostel meal assistance, food supplement programme, purchase of text books.

RM100 of schooling assistance to all primary and secondary students.

Value of "1Mayalsia book vouchers" increased to RM250 from RM200.

1.5 months salary as a bonus for civil servants of w hich half month has already been paid.

Minimum pension increased from RM720 to RM820 retroactively from January 2012.

As part of easy loan facilities for SMEs, RM50mn for Indian entrepreneurs.

Bumiputera f inancing fund to help Bumiputera SMEs increase their equity share in the economy.

Skills development/training of poor Malaysian-Indian students w orking in estates.

A special incentive of RM200 per month to all military personnel.

A one-time payment of RM1000 for all former members of armed forces w ho opted for early retirement.

Others

Civil servants Civil servants w ill enjoy a salary hike of betw een RM80 and RM320, w hich w ill cost the government RM1.5bn.

Petronas staff A “token of appreciation” of RM1,000 each to staff of the national oil company Petronas.

Low income

Youth/Students

Civil servants

Minorities

Armed forces

17% 18% 17% 15% 15%

22% 32% 34% 33% 37%

96%

116% 121% 122%134%

134%

166% 171% 170%185%

0%

40%

80%

120%

160%

200%

2008 2009 2010 2011 2012

Central government debt (% GDP)LGFV (% GDP)Private debt (% GDP)Total (% GDP)

CNY weightImpact of 1% CNY

move on NEERs

% %

Korea 27.9 0.28

Taiwan 26.8 0.27

Thailand 17.9 0.18

Malaysia 17.4 0.17

Singapore 17.2 0.17

India 16.6 0.17

Indonesia 16.3 0.16

Philippines 14.9 0.15

Hong Kong 14.0 0.14

Average 18.8 0.19

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28

Fig. 36: Sensitivity of Asia FX to surprise3 in USD/CNY fix

* Correlation of daily change in Asia FX with the model error. ** Correlation of change in Asia FX during the shortest available window around the USDCNY fix release. Source: Bloomberg, Taipei Forex Inc., Nomura.

Fig. 37: Dependence of regional corporate revenues on China

Source: Bloomberg, Nomura.

Monetary policy divergence across the region

Our economists expect inflation to rise through 2014 and a broad move towards rate hikes,

mainly in H2 2014. However, we also expect to see divergence across the region, with the

Philippines likely to be relatively more aggressive in its policy tightening. In the Philippines, we

forecast Bangko Sentral (BSP) to hike by 100bp starting in Q2, with the economy growing

above potential (Nomura forecasts 6.7% GDP growth in 2014), rising inflation, and risks are for

a further rise in credit growth because of flush liquidity in the banking system. We expect PHP

appreciation in line with this tightening as a stronger PHP would help reduce domestic demand

through lowering remittances on a local-currency basis. Our FX valuation analysis (based on

FEER and SEER) also points to there still being significant space for PHP to appreciate given

as it is still 13% undervalued (Figure 38).

Fig. 38: Asia FX Valuation

Note: Based on data till Q2 2013 and filtered up to Q3 2013, average of FEER and SEER models of Nomura. Source: Bloomberg, CEIC, Nomura.

In Thailand, our economists forecast no rate hike in 2014 while Korea is only likely to hike by

25bp in Q4 given still relatively low inflation and political pressure to keep policy loose. This was

seen in May this year when both Bank of Thailand and Bank of Korea cut rates. From February

until May this year political pressure from their respective Finance Ministries and the top

echelons of power intensified before both central banks finally cut rates (Figure 39). Although

the risk is that benchmark rates are kept lower for longer, there is a possibility that tightening

could emerge through local currency appreciation. This scenario is more likely in Korea, we

believe, because the economy is forecast to grow strongly (by 4.0% in 2014 from 2.9% in 2013)

supported by exports – and KRW is still marginally undervalued at 5% (according to our models).

High levels of household debt and sensitivity to a rate hike could support an implicit tightening

through KRW appreciation.

3) The difference between the actual and model predicted value of China fixing is considered to be the surprise; data since

Jan 2011 used for calculation.

End-of-day* Shortest window**

SGD 3.9% 23.5%

TWD 1.8% 18.0%

KRW -1.3% 15.4%

THB 1.7% 11.6%

MYR 5.3% 10.4%

PHP 2.1% 7.7%

IDR 2.0% 4.9%

0%

10%

20%

30%

40%

50%

60%

70%

HK TW SG KR MY ID

Average 2012 revenue dependence on China for Top-10 companies by market cap

17

74

1

-4 -5-10

-13

-21-24

-40

-20

0

20

40

INR IDR HKD THB CNY KRW MYR PHP SGD TWD

Overvaluation of Asia FX


29

Fig. 39: Pressure on Bank of Thailand and Bank of Korea to cut rates


Fig. 40: Asia FX Forecast

Source: Nomura.

Date Comments

5-Feb-13FM Kittiratt urged BOT Chairman to cut rates to stem

THB appreciation.

20-Feb-13 BOT kept policy rate unchanged at 2.75%.

3-Apr-13FM said he w as not comfortable w ith the level of

the nation’s policy rate.

3-Apr-13 BOT kept policy rate unchanged at 2.75%.

18-Apr-13FM admitted that he had thought about replacing

Governor Prasarn.

26-Apr-13In a meeting, PM Yingluck, FM Kittiratt & BOT off icials

agreed that current policy rate was too high.

30-Apr-13FM expressed disappointment that BOT

policymakers did not reduce benchmark rate.

13-May-13

FM invited BOT Governor, the MPC, and various

senior government officials to a meeting on the

impact of the stronger THB.

29-May-13 BOT cut policy rate by 25bp to 2.50%.

Thailand

Date Comments

20-Feb-13Incoming President Park said she would try to

ensure KRW stability to help local companies .

13-Mar-13FM nominee Hyun said that the nation needs short-

term policy support to spur grow th.

22-Mar-13FM Hyun in introductory speech vow ed to use all

possible policy measures to boost economy

28-Mar-13The Finance Ministry lowered its 2013 economic

growth forecast to 2.3% from 3% earlier.

5-Apr-13BOK Governor Kim met top govt officials and FM

Hyun to discuss key economic/f inancial issues.

11-Apr-13 BOK kept policy rate unchanged at 2.75%.

18-Apr-13FM Hyun said JPY weakening is hurting the

economy more than threats from North Korea.

1-May-13President Park voiced concern that export firms are

facing more difficult market conditions

9-May-13 BOK cut policy rate by 25bp to 2.50%.

Korea

Asia FX Forecast

BBG code 22-Nov End-2013 1Q14 2Q14 3Q14 End-2014 End-2015

Chinese Renminbi Onshore CNY 6.09 6.05 6.06 6.10 6.09 6.03 6.05

Chinese Renminbi Offshore CNH 6.08 6.04 6.06 6.13 6.09 6.03 6.05

CNY fix CNYMUSD 6.14 6.11 6.12 6.13 6.11 6.10 6.10

Hong Kong Dollar HKD 7.75 7.75 7.77 7.80 7.77 7.75 7.85

Indian Rupee INR 62.9 62.2 62.8 61.5 62.2 62.2 65.5

Indonesia Rupiah IDR 11706 11600 11900 12200 12300 12400 12900

Malaysian Ringgit MYR 3.22 3.15 3.20 3.23 3.22 3.21 3.28

Philippines Peso PHP 43.9 43.0 43.3 43.3 43.3 43.2 43.8

Singapore Dollar SGD 1.25 1.24 1.25 1.26 1.27 1.27 1.29

Korean Won KRW 1060 1050 1060 1070 1070 1060 1080

New Taiw an Dollar TWD 29.6 29.4 29.6 29.8 29.9 29.7 30.2

Thai Baht THB 31.8 31.5 32.0 32.3 32.6 32.9 34.0


30

Vivek Rajpal +65 6433 6555 [email protected]

Prashant Pande +65 6433 6198 [email protected]

Rates strategy: Seek policy carry while

acknowledging growing differentiation

We see four main themes emerging in Asia ex-Japan rates markets in 2014:

1. Seek ‘policy carry’ through selected receivers: We suggest investors monetise

‘policy carry’ through selected receivers in countries where valuations are attractive

and where we do not expect central banks to tighten monetary policy in the near

future. Trade recommendations: Receive Thailand 2yr, Receive Korea 2yr, Receive

2s5s Singapore flatteners.

2. Yield curves to steepen in select countries on improving growth prospects amid

QE tapering: We believe yield curves will bear steepen in countries with stronger

growth and improving fundamentals. We suggest investors benefit from this via curve

steepeners in these countries. Trade recommendations: Malaysia 2s5s steepeners,

Korea 2s5s steepeners, Pay Malaysia versus US (beta weighted) and Pay Korea

versus US (beta weighted).

3. Positive carry spread trades acknowledging growing differentiation: We believe

investors can also utilise spread trades to benefit from growing differentiation between

economies. Trade recommendations: Pay Korea 5yr versus receive Singapore 5yr,

Pay Malaysia 2yr versus receive Thailand 2yr.

4. Liquidity and local dynamics should weigh on India and China rates: We suggest

investors use the tight liquidity conditions in India and China to pay front-end swap

rates at appropriate levels. We also recommend investors use the improving bond

supply/demand dynamics to buy India bonds. Trade recommendations: Pay INR 1yr

swap, Pay CNY 1yr swap and long 5yr/7yr bond.

Seek ‘policy carry’ through selected receivers

We recommend seeking policy carry in countries where valuations are attractive and where we

do not expect central banks to tighten monetary policy in the foreseeable future. Singapore and

Thailand rates markets offer attractive carry opportunities. We also like Korea front-end

receivers at appropriate levels.

Thailand. Our Southeast Asia economist, Euben Paracuelles, expects the Bank of Thailand

(BOT) to remain on hold throughout 2014 and does not rule out further cuts (see Thailand: Poor

politics make for poor economics). The Thailand curve is pricing in 17bp of rate hikes within three

months, and although it is common for yield curves to price in rate hikes near the end of an

easing cycle, as is the case now, we see it as an opportunity to earn carry. From a valuation

perspective, we recommend initiating outright receivers in Thailand 2yr at levels above 2.85%.

We also note that the six-month FX-implied onshore forward fixings, which are a floating leg for

NDIRS, have risen to a 2.40-45% range from an average of 2.25% in July. The fixings are already

close to the 2.50% policy rate and no monetary tightening is expected, so further increases in

fixings and any resulting upward pressure on rates should also be limited (Figure 41).

In late August and early September, Thailand front-end rates were pressured primarily from

bond outflows that were concentrated in the front end of the curve. We believe that this was

based on the market’s belief that the BOT would hike rates in response to currency pressures

(at this time, the central banks of India and Indonesia were tightening monetary policy to limit

currency depreciation). However, the probability of this market behaviour reoccurring seems

low, as the BOT’s bias has remained dovish and focused on growth, and has not allowed

currency pressures to drive monetary policy decisions. In addition, Thailand also benefits from

its foreign reserves position (e.g., relative to India and Indonesia, see Figure 30 in FX strategy

section) and therefore, if currency depreciation pressures return, it has the ability to use its FX

reserves instead of hiking rates. Therefore, we recommend receiving 2yr THB NDIRS at or

above 2.85% because of its attractive carry; Thailand 2yr offers the best carry/roll down and the

best Sharpe ratio in the region (Figure 42).




31

Fig. 41: THB fixing and 2y swap levels

2.0

2.2

2.4

2.6

2.8

3.0

3.2

3.4

Jan-12 Jun-12 Nov-12 Apr-13 Sep-13 Feb-14

THB 2yr Policy rate Fixing

Forward implied

(%)


Fig. 42: AEJ swap rates: 2yr carry-roll down and Sharpe ratio

2yr Level (%)3M Carry-

Roll (bp)

Sharpe-

Ratio

INR 8.36 -5.4 -0.15

CNY 4.49 -0.3 -0.02

TWD 0.98 3.9 1.05

HKD 0.52 5.6 0.86

KRW 2.84 5.8 0.88

SGD 0.46 6.0 0.74

MYR 3.43 7.2 1.04

THB 2.74 11.0 0.95

Note: Levels as of 25 November 2013, Sharpe ratio calculated as ratio of 3m Carry + Roll and realised volatility over three months. Source: Bloomberg, Nomura.

Singapore. We believe Singapore rates up to the 5yr part of the curve provide a good

carry/rolldown opportunity, because it appears to be heavily dependent on US monetary policy

expectations and the Monetary Authority of Singapore’s (MAS) approach toward the S$NEER

policy band. We continue to expect the MAS to favour a “modest and gradual” appreciation of

the S$NEER policy band, which supports a lower and stable 6M SOR fixing. We note that US

rates markets have started to differentiate between tapering and tightening. In our base case,

our US economists expect tapering to start in January, however, we also anticipate a

strengthening of forward rate guidance. Therefore, the market’s understanding of the difference

between tapering and tightening should increase the importance of carry in front-end rates. The

Singapore rates curve is highly correlated with US rates and has historically performed as a low-

beta partner to the US rates curve. However, from May to August – when the market began to

incorporate Fed QE tapering expectations – this relationship changed and Singapore rates took

on a high-beta relationship to US rates, which led to a cheapening of Singapore rates. In

August, the relationship began to revert back to its low-beta norm.

Using a simple fair-value regression model to determine the fair value of Singapore rates

against US rates and the 6m implied SOR fix, we find that Singapore rates are moving gradually

toward fair value. However, at current levels, they still look approximately 10bp cheap on our

model in the 5yr tenor and, therefore, we continue to see value in receiving Singapore rates

(Figure 43). The 2s5s part of the curve appears to be in bull flattening/bear steepening mode,

so we also see value in expressing our carry trade via 2s5s flatteners. We have been building

this position in several tranches (see AEJ Rates Strategy: The importance of carry to increase,

17 October 2013) with an average entry price of 110bp. We now target 80bp on this trade (SGD

2s5s flattener, Current level 98bp, Average Entry 110bp, Target 80bp, 3M Carry-roll 8.5bp,

reasess 115bp) (Figure 44). Lastly, realised volatility should continue to decline, which also

favours carry trades (Figures 45 and 46).



32

Fig. 43: Singapore rates: fair value model

0.5

1.0

1.5

2.0

2.5

3.0

-50

-40

-30

-20

-10

0

10

20

30

40

50

Feb-09 Nov-09 Aug-10 May-11 Feb-12 Nov-12 Aug-13

SG 5yr (Actual - predicted)

SG5yr (RHS)

SG 5yr cheap

SG 5yr rich

(bp)

Source: Nomura, Bloomberg.

Fig. 44: Singapore 2s5s spread – Realised and implied

0

20

40

60

80

100

120

140

Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14

Spread Entry

Forward implied

(bp)


Fig. 45: 5yr carry/rolldown and Sharpe ratio

5yr Level (%)3M Carry-

Roll (bp)

Sharpe-

Ratio

INR 8.505 -0.2 -0.01

CNY 4.669 2.2 0.13

KRW 3.183 5.0 0.42

TWD 1.358 5.5 0.75

MYR 3.965 8.5 0.55

THB 3.450 10.1 0.69

SGD 1.455 14.5 0.90

HKD 1.520 15.5 0.76

Note: Levels as of 25 November 2013, Sharpe ratio calculated as ratio of 3m Carry + Roll and realised volatility over three months. Source: Bloomberg, Nomura.

Fig. 46: AEJ swap rates: Singapore 5yr realised volatility

0

20

40

60

80

100

120

140

160

180

Jan

Feb

Mar

Ap

r

May

Jun

Jul

Aug

Sep

Oct

No

v

Dec

Singapore Swap 5yr in 2013(monthly volatility, annualised)

(bp)


Korea. We would like Korea front-end receivers at better levels. We expect an improved growth

outlook to exert steepening pressure on the curve, primarily from rising term premiums.

However, as we expect the BOK to remain on hold until Q4 2014, we see value in front-end

receivers and recommend initiating outright receivers in 2yr Korea once they reach 2.90%

(Figure 47). Our Korea economist, Young Sun Kwon, expects the BOK to deliver its first rate

hike in Q4 2014. Furthermore, he sees a non-negligible risk that the collective judgment of the

MPC after April 2014 could become more dovish, delaying the first rate hike to beyond 2014.

(see South Korea: Catching up with global growth). Although this is not our base case, we note

that such an outcome would further support our receive front-end rates recommendation in

Korea.


33

Fig. 47: Korea 2yr swap, realised and implied

2.4

2.5

2.6

2.7

2.8

2.9

3.0


KRW 2yr Swap

Forward implied

Initiate receive at 2.90

(%)


Yield curves to steepen in selected countries on improving growth prospects amid QE tapering

Nomura Economics expects global growth to pick up from 2.8% in 2013 to 3.4% in 2014, and

given our theme of increased differentiation in Asia, we believe yield curves will steepen in the

economies where growth picks up amid QE tapering. This is because: 1) we believe investors

will demand higher term premiums as growth dynamics improve, exerting upward pressure on

rates markets; and 2) as US Treasury yields rise (George Goncalves, our US rates strategist,

expects US 10yr Treasury yields to rise to 3.15% by end-2014) amid QE tapering, the bar for

carry trades from both liquidity and valuation perspectives will rise, which should also exert

upward pressure on the rates market.

We believe Malaysian and Korean rates have been the primary beneficiaries of the ample

liquidity environment since 2011, which has led to a flattening of the rates curve (Figure 50);

however, we expect these two curves to steepen as local and global growth prospects improve

in 2014. The Korean rates market outperformed in 2013 – especially once expectations of QE

tapering began to rise in May – because of its relative safe-haven characteristics (Figure 51).

However, in an improved global growth environment, we believe these safe-haven

characteristics will become less attractive in the rates space, especially if investor sentiment

improves across Asia. We would also expect investors to pay more attention to valuations,

which would support a steepening of the yield curve (Figure 48). Also, our equity strategists are

overweight Korea and expect earnings growth to be the driver of Korean equity markets in 2014

(see Equity Strategy: From Risk Compression to Earning Growth). In Malaysia, the duration of

bond supply is increasing, which should also exert steepening pressure on the curve. In both

Korea and Malaysia, our economists expect rate hikes in H2 2014, so rate hike expectations

should also aid a steepening of the curve as the timing of these hikes becomes clearer. We

initiated Korea and Malaysia steepeners in August and look to increase this position on any

pullback. We target 40bp on KRW 6mfwd 2s5s steepeners (KRW 6mfwd2s5s steepener,

Current level 31bp, Entry 29.1bp, Target 40bp, 3M roll 2bp, reasess 20bp, see AEJ Rates

Portfolio Update: Modifications to reflect our latest views, 14 August 2013) and 70bp on 3mfwd

MYR 2s5s steepeners. (MYR 3mfwd2s5s steepener, Current level 53bp, Entry 59.5bp, Target

70bp, 3M roll -0.73bp, reasess 40bp). Due to this combination of rising term premiums and rate

hike expectations, we expect the Korea and Malaysia rates markets to underperform the US

rates market on a beta-weighted basis. We like paying Malaysia and Korea 5yr swap vs. US 5yr

swap on a beta-weighted basis, but wait for better levels before expressing this view via a trade

recommendation (Figure 49).




34

Fig. 48: Korea and Malaysia 2s5s

-10

0

10

20

30

40

50

60

70

80

90Jan

-11

Mar-

11

May-1

1

Jul-

11

Sep

-11

No

v-1

1

Jan

-12

Mar-

12

May-1

2

Jul-

12

Sep

-12

No

v-1

2

Jan

-13

Mar-

13

May-1

3

Jul-

13

Sep

-13

No

v-1

3

Korea 2s5s Malaysia 2s5s(bp)


Fig. 49: Korea and Malaysia spreads over US 5yr

120

150

180

210

240

270

300

Jan

-11

Mar-

11

May-…

Jul-

11

Sep

-11

No

v-1

1

Jan

-12

Mar-

12

May-…

Jul-

12

Sep

-12

No

v-1

2

Jan

-13

Mar-

13

May-…

Jul-

13

Sep

-13

No

v-1

3

Korea - US 5yr spread

Malaysia - US 5yr spread

(bp)


Fig. 50: Foreign positioning in government bonds

0%

5%

10%

15%

20%

25%

30%

35%

40%

Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13

Malaysia (MGS+GII, $40.2bn, 28.2%)Indonesia (Govt, $28bn, 32.3%)Korea (KTB & MBS, $89.4bn, 17.2%)Thailand (Govt bond, $18.9bn, 17.9%)India (IGBs, $24.8bn, ~3.1%)

Source: CEIC, Bloomberg, Nomura.

Fig. 51: Asia ex-Japan sovereign CDS

0

50

100

150

200

250

300

350

400

Jan-11 Jun-11 Nov-11 Apr-12 Sep-12 Feb-13 Jul-13 Dec-13

Korea Malaysia IndiaThailand Indonesia

(bp)


Positive carry spread trades to acknowledge growing differentiation

The above two themes were about seeking policy carry and acknowledging growth prospects in

a few Asian economies. We believe investors can also take advantage of spread-trading

opportunities to leverage growing differentiation among Asian economies (see Asia’s turn for

Austerity). We recommend pay Malaysia 2yr NDIRS versus receive Thailand 2yr NDIRS and

pay Korea 5yr versus receive Singapore 5yr as two spread trades that express this view.

On the receive Thailand 2yr versus pay Malaysia 2yr swap recommendation, although we noted

above that we prefer to initiate receive Thailand 2yr at levels above 2.85%, we see value in

Thailand receivers at current levels (2.73%) if received as a spread against Malaysia.

Interestingly, despite the diverging growth dynamics of these markets, front-end rates in

Thailand are pricing in more rate hikes than those in Malaysia (see Asia Local Market Rate

Expectations - Summary of expected swap (fixing) rate changes, 25 November 2013). We

believe this is most likely because in past cycles the BOT has been more active than Bank

Negara Malaysia (BNM) in tightening monetary policy. However, as stated earlier, we do not

expect the BOT to rate hikes in 2014 and have not ruled out a cut. Furthermore, economic

activity data in Thailand have disappointed over the last two months, and monetary authorities

have further reduced their growth forecasts (see Thailand: More risks to an already poor growth

outlook, 1 November 2013). Unlike Thailand, Malaysia’s growth is of little concern. In its latest

policy statement on 7 November, BNM showed confidence in Malaysia’s growth prospects by

stating that “going forward, the growth momentum will benefit from the expected improvement in






35

the external sector amid some moderation in domestic demand”. Also, inflation is set to rise on

the implementation of subsidy rationalisation measures announced in the budget. Although

BNM did not appear concerned with the inflation outlook in its latest policy statement, Euben

Paracuelles expects it to become more hawkish as growth prospects improve and inflation

edges higher, which should result in 50bp of rate hikes in H2 (see Malaysia: Avoiding twin

deficits). To reiterate, given these expected policy and growth divergences, we see value in

Thailand versus Malaysia front-end spread trades. We recommend investors express this view

through the 2yr part of the curve (Receive THB 2yr vs. Pay MYR 2yr, Current level -69bp, Entry

-62, Target -80bp, 3M Carry-roll 3.8bp, Add at -53bp, Reassess -44bp). As such, we have

already initiated 30% of our total intended position on this trade, but look to add to it (Figure 52).

We also note that the relationship between these two legs is weak (as shown by the low R-

squared in Figure 53). This weakness is primarily because local factors in these two economies

are important in determining the directionality of rates, and we believe the importance of these

local factors to directionality will grow. As such, we believe the local growth divergence and the

resultant policy divergence should continue to support our trade recommendation in 2014.

Fig. 52: Thailand vs Malaysia 2yr (spot and fwd implied)

-90

-80

-70

-60

-50

-40

May-1

3

Jun

-13

Jul-

13

Aug

-13

Sep

-13

Oct-

13

No

v-1

3

Dec-1

3

Jan

-14

Feb-1

4

Mar-

14

Ap

r-14

May-1

4Receive THB 2yr vs PayMYR 2yr

Target -80 bp (SL at -44 bp)

Add at -53 bp

Forward implied

(bp)


Fig. 53: THB 2yr vs MYR 2yr (Low R-squared)

y = 0.97x - 0.58R² = 0.49

2.4

2.5

2.6

2.7

2.8

2.9

3.0

3.1 3.2 3.3 3.4 3.5 3.6

TH

B 2

yr

MYR 2yr

Past 131 business days

Past 6 months

Past 3 months

Past month

Today


Regarding our Singapore 5yr vs. Korea 5yr recommendation, we noted above that we like

Singapore rates up to 5yr part of the curve as a carry trade. We have discussed our paid and

bear steepening bias in Korea rates on improved local and global growth prospects. Given that

both rates markets have a reasonable correlation with US rates, we also see value in

expressing these views as a spread trade (Figure 54). We expect Korea to underperform

Singapore on an absolute as well as beta-weighted basis. The Singapore 5yr swap has a beta

of 1.5 with the Korea 5yr swap (over the last six months) (Figure 55). However, as the

Singapore 5yr is effectively an expression of US monetary policy and the Korean 5yr an

expression of local and global growth prospects, this beta should decline over time, especially in

a scenario where the Fed is expected to strengthen its forward guidance. We initiated 30% of

our total intended position in receive Singapore/pay Korea 5yr recently (see Asia Insights - AEJ

Rates Strategy: Let carry be the differentiating factor, 8 November 2013) and look to increase

this position either in the same form, or in a beta-weighted form. We recommend investors

receive Singapore 5yr versus paying Korea 5yr (Current spread -173bp, 3m carry roll 9.6bp,

30% at -161bp and we look to add the rest at -155bp, Target -180bp, Reassess -145bp).




36

Fig. 54: Receive Singapore 5yr versus Pay Korea 5yr (spot and forward implied)

-205

-195

-185

-175

-165

-155

-145

-135

-125


Receive SGD 5yr vs Pay KRW 5yr

Add at -155 bp

Target -175 bp (SL at -145bp)

Forward implied

(bp)


Fig. 55: Singapore is a high beta partner of Korea (last 1 year)

-60%

-40%

-20%

0%

20%

40%

60%

80%

100%

120%

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13

Beta (SG 5yr vs KR 5yr, 6m rolling)

Correlation (KR 5yr vs SG 5yr, 6m rolling, RHS)


Liquidity and local dynamics to weigh in India and China rates

Rates markets in India and China are usually driven by local dynamics. Within Asia ex-Japan

rates markets, they have the lowest correlation with US rates. In these economies, the rates

markets are also very much dependent upon interbank liquidity dynamics.

India. After rallying meaningfully throughout H1 2013, currency pressures prompted the

Reserve Bank of India (RBI) to tighten monetary conditions, which exerted significant pressure

on the India rates market in June and July. This led to a bear flattening of the curve, as the RBI

effectively hiked rates by 300bp, taking the operative rate from 7.25% to 10.25%. However,

since September, the turbulence in India’s financial markets has eased. Globally, the FOMC’s

decision to postpone tapering provided Indian policymakers with time and relief. Locally, the

launch of credible dollar-flow measures on FCNR deposits and overseas bank borrowings

bought time for policymakers to act. This reprieve allowed the RBI to reverse some of its

liquidity tightening measures. It has since cut the operative rate from 10.25% to 8.75%, but also

used this window to hike the repo rate from 7.25% to 7.75%, which suggests it was response to

inflationary pressures. Overall, we believe the main driver of monetary policy has shifted from

currency pressures to growth-inflation dynamics (Figure 56). Therefore, we believe India’s rates

markets are being affected by two uncertainties:

1. Expectations for the terminal repo rate, and

2. Expectations of bond buybacks (supply/demand dynamics).

Fig. 56: Event chart (10yr yield and 5yr OIS)

7.50

7.75

8.00

8.25

8.50

8.75

9.00

9.25

7.50

7.75

8.00

8.25

8.50

8.75

9.00

25-Aug-13 19-Sep-13 14-Oct-13 8-Nov-13

5yr (ND) OIS

10y yield (RHS)USD swaps with

OMCs announced

Raghuram

Rajan takes office

September

FOMC

Repo (25bp) hiked and

MSF (75bp) rates cut

MSF

(50bp) cut

CPI (Sep) - upside

surprise

RBI announces

OMOs

(%) (%)

Source: Nomura, RBI, Bloomberg.

Fig. 57: Monthly supply chart

-100

0

100

200

300

400

500

600

700

800

Sep

-12

Oct-

12

No

v-1

2

Dec-1

2

Jan

-13

Feb-1

3

Mar-

13

Ap

r-13

May-1

3

Jun

-13

Jul-

13

Aug

-13

Sep

-13

Oct-

13

No

v-1

3

Dec-1

3

Jan

-14

Feb-1

4

Mar-

14

Net Issuance (INR bn)

Source: Nomura, RBI.


37

Looking at the swap curve, the rates market appears to be pricing in 40bp of rate cuts to the

current operative rate. With the operative rate at 8.75%, this is not too far from the view of our

India economist, Sonal Varma, who expects two more 25bp terminal repo rate hikes in H1 2014,

which would raise it to 8.25% (see India: Higher rates for longer). We also note that liquidity

conditions in the Indian banking system are extremely tight. We estimate a total system liquidity

deficit of close to INR1.2trn and see few reasons for liquidity to turn positive in the near term.

Also, Sonal Varma noted that sticky inflation and now a positive delta on growth should limit the

scope for easing. Although we expect the operative rate to be cut in H2 2014 to 8.25%, we

believe this has already been priced in and, therefore, the scope for any rally in the front end

seems very limited. In fact, we see value in paying front-end rates to earn carry and believe

paying the 1yr swap rate at below 8.20% is a good carry trade. We are relatively neutral on 3yr-

5yr swaps. However, we see value in receiving 3yr-5yr swaps on an uptick in rates. We believe

a 5yr swap is a good strategic receive at levels above 8.70% because there is a limit to how

much the curve can steepen in a low-growth environment. Note that, in India rates, the bigger

moves are bull steepening and bear flattening, as the central bank is very active in conducting

monetary policy. On bonds, we like the 5-10yr part of the curve for two reasons:

1. We expect demand/supply dynamics to improve into Q1 next year. We expect the RBI

to conduct open market operations (bond buybacks) worth INR500bn-600bn between

now and March 2014. We also note that the bond supply should decline in Q1 2014,

which would support bonds (Figure 57).

2. Even from a valuation perspective, current bond yields (IGB 7.16 2023 paper is trading

at 9.1%) look very attractive. However, as the operative rate declines to 8% in Q1 2014

(i.e., average funding costs fall and supply/demand become more favourable), we

would expect the 10yr bond and surrounding papers to move towards 8.40-8.50%

levels. We expect bonds to outperform swaps in Q1 2014. However, beyond Q1, we

are neutral on back-end bonds and expect relatively range-bound markets.

At current levels, we suggest investors accumulate 5yr and 7yr bonds and target 40bp of

potential upside in Q1 2014. Specifically (see India rates strategy: Suggest scaling into bonds

slowly and steadily, 4 October 2013), we recommend the IGB 8.07% July 2017 (entry: 8.54%,

target: 8.00%, reassess: 8.80%) and the IGB 8.12% Dec 2020 (entry: 8.82%, target: 8.30%,

reassess: 9.10%). We also suggest investors pay 1yr swaps at levels below 8.20% as we

expect tight interbank liquidity and limited monetary easing to keep the overnight fixings high.

China. Interbank liquidity dynamics are also a very important consideration in China’s rates

markets. Our China economist, Zhiwei Zhang, expects the People’s Bank of China to continue

its monetary tightening bias in 2014 (see China: No pain, no gain). We believe such a bias will

keep the 7-day repo rate elevated relative to historical levels. It is no surprise that the one-

month average 7-day repo rate has risen from 3.75% in September to 4.74%. We believe the

recent tightening of interbank liquidity conditions will persist for longer than consensus expects.

As such, we see value in paying China front-end swap rates, especially the 1yr swap, at or

below 4.20% to benefit from this shift in the repo rate. We also see value in initiating flatteners

as a way to express our paid bias in the front end (Figure 58).

Fig. 58: China 1yr IRS and 7-day repo fixing

0

2

4

6

8

10

12

Jan-12 Jun-12 Nov-12 Apr-13 Sep-13

7-day repo fixing7-day repo fixing (7dMA)CNY 1yr IRS

(%)





38

Martin Whetton +61 2 8062 8611 [email protected]

Charles St-Arnaud +1 212 667 1986 [email protected]

Australia rates outlook

The 2014 outlook for the rates market in Australia starts with a significant divergence of views in

the market. Locally, investors are split over the Reserve Bank of Australia’s (RBA) potential

policy action. In rates markets, the last quarter of 2013 has seen the pricing in of a turn in the

rate cycle toward a more aggressive RBA. Currently, there is a little over 25bp of hikes priced

into the OIS markets for the end of 2014. While not an aggressive assumption, we do not

believe the RBA will deliver a hike in 2014, given the headwinds of the high AUD, below trend

growth and low inflation. Moreover, the RBA is looking for the rotation of the economy away

from resources to building/construction. House price gains have largely been limited to Sydney

and would need to become national to cause greater concern.

In our report Australian rates: When the rate cuts are over (16 October 2013) we looked at the

potential for rates markets to overshoot and to price in the turn of the cycle. We noted that the

Australian rates curve steepens into the end of rate cutting cycles before flattening around 60%

of its steepening move. We also note than the level of the 3yr ACGB typically trades significantly

over the cash rate, with an average of 157bp in the last few cycles.

In 2014 we expect supply to be a substantial headwind for markets. The AOFM has increased

its issuance needs to AUD70bn, from AUD50bn at the start of the financial year. We expect a

similar call on the market for the next financial year, thus weighing on long-end performance.

This supply comes in an environment where we expect the RBA to keep its policy rates on hold.

If market pricing of an RBA rate hike is delivered, this could put pressure on yields to rise over

the year. Nonetheless, while supply is significant, this year also sees the most amount of

maturing debt: AUD17.65bn of ACGBs, AUD35.1bn of semi-government debt, AUD17bn of

supras and semis, and JPY915bn of uridashi issuance (for a full outline of maturity dates by

sector, see Rates Insights - AUD fixed income maturity profile in 2014, 5 November 2013). We

expect the maturity profile to be a significant support for the market in 2014 and should provide

a flattening bias to the curve. It could also underpin the level of AUD if the RBA does end its

cutting cycle and Japanese investors shift their money back into Australia for the capital

appreciation of the exchange rate.

We expect the overall level of rates to rise over the course of 2014, in line with a slow recovery

of the economy and the gradual reduction in the Fed’s QE.



http://go.nomuranow.com/research/globalresearchportal/getpub.aspx?pid=638546&appname=Email

http://go.nomuranow.com/research/globalresearchportal/getpub.aspx?pid=642529&appname=Email


39

Michael Kurtz +852 2252 2182 [email protected]

Mixo Das +852 2252 1424 [email protected]

Yiran Zhong +852 2252 1413 [email protected]

Equity strategy: From risk compression to

earnings growth

The year ahead brings an important qualitative change to our equity strategy approach compared

to the last two years. Namely: Going into 2012 we saw Asian equity markets largely as a binary

deep-value opportunity, pricing ‘end-of-the-world’ risk premiums that investors stood to capture as

long as the global economy (and China in particular) avoided a feared major systemic implosion;

and one year ago we suggested that with effective new reflationary global monetary policy

backstops in place, 2013 would usher a gradual compression of still-elevated macro risks that

would drive continued performance of value as Asian equity multiples mean-reverted.

Looking toward 2014, we believe much of the ‘deep value’ argument has now played out as

Asia’s Equity Risk Premium has fallen to 0.8 standard deviations currently vs. its late-2011 high of

2.5 standard deviations (Figure 59). With this, Asian-regional equities have outperformed regional

fixed income since mid-2012 by a respectable 15% (Figure 60).

From here, we believe equities increasingly require more of a growth rationale for upside, rather

than the macro-risk compression of 2012-13. But this begs the question where Asia’s superlative

earnings growth will be found. Overall we expect 13% Asia-Pacific ex-Japan EPS growth in

2014F – driven more by EM Asia at +16% than by Developed Asia-Pacific ex-Japan at +9% –

delivering the MSCI regional benchmark to an end-year target of 535, 14% above current levels.

Style-wise we expect further declines in market appetite for ‘safety’ (e.g. via dividend-

yield, low-beta, ‘quality’, high-cash balance sheets, or deep PBV discounts) and look for

attributes such as beta and risk to outperform in 2014 – to the continued disadvantage of

the region’s ‘high yield’ markets such as Australia or putatively more ‘defensive’ (lower

beta) markets primarily in EM ASEAN (where currency-equity correlations also are most

unhelpful).

Rather, our bias remains toward more externally-focused and cyclical-intense markets

such as Korea, Taiwan and Singapore, while India constitutes an against-the-grain

Overweight for us despite well-known external-account risks, given possible reform-

friendly electoral developments and/or windfalls from any commodity price downside.

We also favor cyclical, growth- or reflation-sensitive sectors such as Tech, Industrials,

Consumer Discretionary and Banks – and we downgrade the Telco sector (by 1.5ppt) to

Underweight in favour of increased positions in Tech and Industrials. Among cyclical

stocks, however, our more cautious China/commodity view inclines us decidedly toward

downstream industries that may benefit from easier input costs rather than upstream (i.e.

extractive) industries. And within Financials, our higher US Treasury yield and US dollar

expectations also incline us away from (most) Property and toward Insurance.

Fig. 59: MSCI Asia-Pacific ex-Japan: Equity risk premium

Forward earnings yield less US 10-yr US Treasury yield

Source: Bloomberg, Nomura Strategy.

Fig. 60: Asia ex-Japan equity / bond relative performance

Total returns

Source: Bloomberg, Datastream, Nomura Strategy.

1

2

3

4

5

6

7

8

9

MXAPJ ERP (%, lhs) LT average

+1 STD -1 STD

Trend

1.6

1.7

1.8

1.9

2.0

Jan

-12

Mar-

12

May-1

2

Jul-

12

Sep

-12

No

v-1

2

Jan

-13

Mar-

13

May-1

3

Jul-

13

Sep

-13

No

v-1

3




http://go.nomuranow.com/research/globalresearchportal/getpub.aspx?pid=478110&appname=GRP&cid=YVZodlJEWm5OM2xtUjBVOTA1




40

In addition to lower equity risk premiums, we also note that intra-Asian equity cross-correlations

have declined from roughly 90% ‘crisis’ levels in 2011-12 to more mundane (indeed pre-GFC)

sub-70% levels for much of 2013 (Figure 61). Stocks and other financial assets tend to move en

masse in times of panic – pushing correlations toward 100% as all risk is avoided more or less

indiscriminately. Thus declining equity correlations suggest markets’ capacity for risk-bearing

has strengthened considerably over the past two years and investors are growing more

deliberate and discriminating, a change well-suited to the increasing fundamental differentiation

in Asia discussed above by our economics colleagues.

Similarly, as we have noted before, the moderation in Chinese GDP growth from double-digit

pre-GFC (and stimulus-fueled 2010) levels to sub-8% since mid-2012 has also specifically

ushered declining China correlations with Asian-regional stocks – from a staggering 2012 high

correlation of 96% to the low-mid 80s for most of 2013 (Figure 62). In other words, short of ‘hard

landing’ risks, China’s power to ‘spoil parties’ elsewhere is also declining.

Fig. 61: Average pair-wise correlation of 10 sectors: MSCI Asia-Pac ex-Japan


Fig. 62: China H-share Index Correlation vs. MSCI APXJ


Rather, parts of Asia as diverse as Japan and Emerging ASEAN have risen as new,

independent sources of regional earnings growth – driven by everything from

favourable demographics and new investment (as in ASEAN) to game-changing policy

shifts (Japan).

The prospective resumption of more robust Developed-Market imports in 2014 as

economies in the US and Europe recover also helps Asian corporates diversify away

from otherwise narrower dependence on China-led growth [Nomura economists

forecast global Developed Market real GDP growth nearly to double in 2014, to 2.0%

from 1.1% – whereas they see global Emerging Market growth only inching

incrementally higher to 4.8% next year from 4.7% in 2013].

Moreover the effective rebranding of Asia-Pacific ex-Japan index heavyweight

Australia from ‘China/Resource-play’ to ‘dividend yield play’ over the past two years

has also helped reduce overall index correlation with China – though that may be of

little help to Australian equities (or other ‘dividend yield’ standard-bearers) in 2014 as

US Treasury yields resume an upward bias along with US nominal growth (Figures 63

and 64).

40%

50%

60%

70%

80%

90%

100%

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Avg Correlation

120-d avg

40%

50%

60%

70%

80%

90%

100%China Correl with APXJ - 5w avg of 26-week correl

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Fig. 63: US 10-year Treasury yield & nominal GDP

Dashed line = Nomura forecast

Source: Bloomberg, Nomura Global Economics, Nomura Strategy.

.

Fig. 64: US Treasury yield vs. yield-stock relative performance

Source: Bloomberg, Nomura Strategy..

A year for bottom-up analysis, growth and beta over yield, value or cash

Axiomatically of course, substantial correlation declines ease the portfolio manager’s task of

identifying uncorrelated risk/return opportunities and enhancing portfolio diversification – thus

improving actively managed equity funds’ prospects for superior return generation at a given

level of risk. At the same time, this means that individual stock selection (rather than macro

thematics) is growing more critical to superior portfolio performance.

These changes also suggest that market appetite for ‘safety’ as an investment attribute (e.g. via

dividend-yield, low-beta, deep PBV discounts, etc.) should continue to diminish in 2014. Style-

wise, we thus expect attributes such as beta and risk to outperform in 2014 as opposed to

‘quality’, yield (as noted), or value.

Indeed in addition to our existing country Underweight in Australia, our style bias

against dividend yield for the year ahead, and in favour of beta and growth, also

compels us to downgrade the Asia-Pacific ex-Japan Telecoms sector (by 1.5ppt) to

Underweight – in favor of increasing our existing Overweights in the Tech and

Industrials sectors by 1.0ppt and 0.5ppt, respectively (Figure 96).

At the micro level we also note that markets may begin punishing companies that hold

“too much” cash on their balance sheets as a low-return asset. While cash-heavy

balance sheets were sought out during the GFC as a useful ‘insurance policy’ against

macro uncertainties – and cash-heavy US stocks, for example, substantially

outperformed the market over 2007-11 – we note that cash-rich stocks stopped

outperforming since 2012 (Figures 65 and 66).

The next step, we think, may be that market pressure via underperformance may force

corporate managements to start utilizing such fallow balance sheet resources more

aggressively – whether for capital expenditure, M&A, share buybacks or special

dividends.

-4

-2

0

2

4

6

8

1993

1995

1997

1999

2001

2003

2005

2007

2009

2011

2013

2015

US 10-yr Treasury Yield and Nomura Forecasts, %

US Nominal GDP Growth and Nomura Forecasts, %

1.0

1.5

2.0

2.5

3.0

3.5

4.092

94

96

98

100

102

104

106

108

110

112

World Yield Stocks/All Stocks RPI

US 10-yr Treasury Yield (inverted)


42

Fig. 65: Performance of cash-heavy stocks vs S&P 500

Simple average performance of companies in the top quartile by cash/assets ratio among non-financials. Rebalanced quarterly.


Fig. 66: Cash-heavy stocks’ relative performance differential

Simple average performance of companies in the top quartile by cash/assets ratio among non-financials. Rebalanced quarterly.


Asia-Pacific ex-Japan earnings – export-assisted breakout

After a nearly 120% initial rebound off 2009 lows, Asia-Pacific ex-Japan aggregate 12-month

forward earnings estimates have largely trended sideways for more than two years and in fact

today remain -7% below June 2011 levels (Figure 67) – placing the full onus of equity price

action on forward earnings multiples. This is not entirely surprising: with global growth struggling

to take off meaningfully and key Asia-Pacific EMs struggling with structural challenges of their

own, broad earnings forecasts have lacked identifiable drivers. But a breakout of this sideways

earnings trend may come in 2014, we think – albeit Asia’s plateauing domestic growth

discussed in this report will put much of the burden on the export sector (and the Developed

Market recovery in particular).

Fig. 67: MSCI Asia-Pac ex-Japan 12m Fwd EPS

Source: Datastream, Nomura Strategy.

Looking at region-wide Asia-Pacific nominal GDP on an equity market cap-weighted

basis, our economists’ individual-country forecasts (see Forecast table on page 4)

aggregate to 7.3% in 2014 (i.e. 4.0% real growth and 3.3% inflation), a material pick-up

from a market cap-weighted 6.7% nominal growth in 2013 (3.8% real growth and 2.9%

inflation) – with stronger nominal growth in more advanced Korea, Taiwan and

Singapore (in all of which we recommend Overweight equity allocations) plus Malaysia

-60%

-40%

-20%

0%

20%

40%

60%

2005 2006 2007 2008 2009 2010 2011 2012 2013

Cash Stocks

S&P 500

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

2005 2006 2007 2008 2009 2010 2011 2012 2013

Difference - cash stocks vs S&P

10

15

20

25

30

35

40

45

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

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43

(where we are Neutral) helping offset slower nominal growth in the big emerging

markets of China, India and Indonesia.

Historically, 7% nominal Asia-Pacific GDP growth has implied a roughly 10% increase

in regional 12-month forward earnings; so a 7.2% market cap-weighted nominal GDP

trajectory implies 2014 regional earnings growth in the mid-teens (Figure 68).

Fig. 68: APXJ weighted nominal GDP growth vs consensus forward earnings growth

Dotted lines are Nomura forecasts

Source: Bloomberg, Datastream, Nomura Global Economics, Nomura Strategy.

Asia's earnings growth does remain largely leveraged to the global economy and strongly

correlated with the global trade cycle (Figure 69). Indeed, despite the prominence of

“decoupling” narratives in recent years and investor focus on regional secular consumption

trends, exports as a percentage of Asia ex-Japan GDP remain high at more than 40% (Figure

70) – compared, for example, with 35% for EEMEA and 20% for Latam.

Fig. 69: Global trade vs APXJ consensus forward earnings growth

Global exports growth

Source: CPB, Bloomberg, Datastream, Nomura Strategy.

Fig. 70: Asia ex-Japan: Exports as a % of GDP

For Asia ex Japan (not including Australia)

Source: CEIC, Nomura Strategy.

An Asian earnings breakout in 2014 is also suggested by the strengthening OECD Global

Leading Economic Indicator over the past year (Figure 71), which historically has tended to lead

Asia-Pacific ex-Japan earnings forecasts by roughly four months:

-60

-40

-20

0

20

40

60

80

0

2

4

6

8

10

12

14

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Nominal GDP growth (lhs) Fwd EPS Growth (rhs)

-60%

-40%

-20%

0%

20%

40%

60%

80%

-20

-15

-10

-5

0

5

10

15

20

25

30Global Trade %y-y

MXAPJ 12m fwd EPS growth, rhs

30%

35%

40%

45%

50%

55%

1996 1998 2000 2002 2004 2006 2008 2010 2012


44

Fig. 71: OECD Global Leading Economic Indicator vs APXJ consensus forward earnings growth

APXJ earnings are lagged by four months

Source: OECD, Bloomberg, Datastream, Nomura Strategy.

Fig. 72: Asia-Pac ex-Japan EPS growth consensus by sector

2012 actual, 2013 & 2014 consensus


Taking all the above into account, the current consensus 2014 Asia-Pacific ex-Japan earnings

outlook strikes us as largely appropriate. Namely, expected 2014 EPS growth currently stands

at roughly 12% for the Asia-Pac ex-Japan region as a whole (Figure 73), split between 10% for

Developed Asia-Pac ex-Japan (i.e. Australia, Hong Kong and Singapore) and a somewhat

stronger 13% for Emerging Asia ex-Japan.

Fig. 73: 2014 consensus EPS growth forecasts

Value shown only for Country-Sector pairs that have more than 0.1% weight in the MXAPJ index

Note: MSCI indices in local currency. Source: Datastream, Nomura Strategy research.

But within this aggregate, we note that forward earnings forecasts for the Asia-Pacific

ex-Japan region’s more cyclical sectors (Discretionary, Industrials, Materials and Tech)

have curiously remained closely coupled with those of more defensive sectors

(Telecom, Staples, Healthcare) for the past three years (Figure 74). We would expect

upside risks to overall earnings in 2014 to favor cyclical-sector upgrades.

In particular we would expect upside surprises largely to be concentrated where 1)

operating leverage is higher – notably India, Korea and Taiwan among the larger Asia-

Pacific ex-Japan economies (Figure 75) – as well as where 2) export exposure is

greatest, namely Korea and Taiwan (again), as well as Singapore.

-60%

-40%

-20%

0%

20%

40%

60%

80%

-4

-2

0

2

4

6

8

10OECD World LEI %y-y

MXAPJ 12m fwd EPS growth, rhs

-20

-10

0

10

20

30

40 2012 Growth

2013 Growth F

2014 Growth FA

sia

-Pac

ex-J

ap

an

Au

str

ali

a

Ch

ina

Ho

ng

Ko

ng

Ind

ia

Ind

on

esia

Ma

laysia

Ko

rea

Ph

ilip

pin

es

Sin

ga

po

re

Th

ail

an

d

Ta

iwa

n

Index 12% 7% 9% 9% 17% 15% 8% 21% 7% 9% 14% 10%

Discretionary 14% 11% 19% 21% 17% 16% 12% 12% - 2% 15% 12%

Staples 13% 5% 20% - 20% 17% 8% 14% - 16% 50% 10%

Energy 11% -1% 6% - 12% - 27% 33% - - 8% -

Financials 9% 6% 9% 6% 19% 12% 7% 24% 5% 8% 13% 4%

Banks 7% 4% 6% -10% 20% 12% 7% 19% -6% 7% 13% 6%

Property 10% 4% 16% 7% - - - - 18% 11% - -

Healthcare 17% 12% 18% - 23% - - - - - - -

Industrials 27% 1% 14% 17% 14% - 12% 90% 7% 12% - 46%

Materials 22% 15% 17% - 19% 11% 4% 41% - - 15% 13%

Tech 12% 5% 33% - 19% - - 10% - - - 11%

Telecom 5% 7% 0% - 45% 9% 8% 28% 10% 8% 29% 3%

Utilities 15% 0% 6% 6% 10% 10% -2% - - - - -


45

Fig. 74: APXJ: consensus forward earnings for Cyclical and Defensive sectors

Rebased to 100 as of October 2003


Fig. 75: Asia-Pac ex-Japan operating leverage by country

Excluding Banks, Insurance, Brokers and REITs


Indeed 12-month forward earnings-estimate revision momentum in recent months has been

reasonably strong for North Asia and comparatively weaker for Southeast Asia (with the

exception of the Philippines – Figures 76 and 77):

Fig. 76: North Asia & Australia: Consensus 12-mo. fwd EPS revision

March-to-date

Source: Datastream, Nomura Strategy research.

Fig. 77: Southeast Asia & India: Consensus 12-mo. fwd EPS revision

March-to-date


In addition to the developed economy-led global recovery, other key fundamental factors underlying our top-down equity allocation approach include the following:

Higher US Treasury yields and stronger US dollar. Figure 63 above already suggests upside

risk to US Treasury yields in light of our house forecasts for accelerating US nominal GDP

growth toward 4.5% by 4Q14 (vs. 3.1% reported in Q3 this year), and our US rates strategist

George Goncalves’ expectation for 10-year Treasury yields to end 2014 at roughly 3.2% (some

45bp above levels at writing). For his part, Nomura global FX Strategist Jens Nordvig wrote

recently that “we still expect USD to outperform next year, albeit at a slower pace than we had

previously assumed, and with the take-off delayed somewhat” (see USD Strength Delayed, 4

October 2013).

In our positive base-line scenario, the QE unwind alongside stronger US economic performance

will allow fixed income yields to rise in an orderly fashion. If so, the ‘tapering’ of QE need not be

net-negative for Asian equities overall and medium-term, as QE’s ‘artificial’ liquidity support

50

100

150

200

250

300

350

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Cyclical Sectors

Defensive sectors

1.5

1.7

1.9

2.1

2.3

2.5

2.7

2.9

3.1

3.3

98

100

102

104

106

108

110

29-M

ar-

13

12-A

pr-

13

26-A

pr-

13

10-M

ay-1

3

24-M

ay-1

3

07-J

un

-13

21-J

un

-13

05-J

ul-

13

19-J

ul-

13

02-A

ug

-13

16-A

ug

-13

30-A

ug

-13

13-S

ep

-13

27-S

ep

-13

11-O

ct-

13

25-O

ct-

13

08-N

ov-1

3

CHINA

HONG KONG

AUSTRALIA

TAIWAN

KOREA

96

98

100

102

104

106

108

29-M

ar-

13

12-A

pr-

13

26-A

pr-

13

10-M

ay-1

3

24-M

ay-1

3

07-J

un

-13

21-J

un

-13

05-J

ul-

13

19-J

ul-

13

02-A

ug

-13

16-A

ug

-13

30-A

ug

-13

13-S

ep

-13

27-S

ep

-13

11-O

ct-

13

25-O

ct-

13

08-N

ov-1

3

PHILIPPINES MALAYSIASINGAPORE INDIATHAILAND INDONESIA



46

would diminish just as: a) Asian corporate earnings prospects improve; and b) inter-asset class

flows (i.e., from bonds to stocks) materialize to replace the liquidity previously supplied by

central bank asset purchases. Figures 78 and 79 show strong positive historical correlations

prior to June 2013 between changes in the US 10-year Treasury yield and i) foreign buying of

Asia-Pacific ex-Japan stocks, as well as ii) Asia-Pacific ex-Japan forward PER multiples.

Fig. 78: Change in US Treasury yield vs. foreign net-buying of Asia ex-Japan stocks

Source: Nomura Global Economics.

Fig. 79: US 10yr Treasury yield vs. MSCI APXJ forward PER

26-week change


Nearer term, however, risks do remain of a resumption of market disorder as QE ‘tapering’

again approaches (as seen in May-August 2013 when Treasury yields backed up by 140 bp).

We did not interpret that episode a generalized ‘EM crisis’ though; rather, we saw a rational and

arguably overdue process of differentiation – i.e., between the structurally sounder Asian

markets (largely those with stronger current account balances and more stable currencies) able

to stand on their own as US dollar funding costs looked set to normalize, vs. the weaker

regional markets that had merely been propped up by fickle short-term yield-seeking flows

(Figure 85).

Strategically, our outlook for a steeper yield curve and generalized US dollar strength is key to

our country preference for Singapore over Hong Kong and our industry preference for Insurance

and Banks over Property within the Financial sector (Figures 80 and 81):

Fig. 80: Singapore-Hong Kong relative performance vs. US Dollar Index


Fig. 81: Real Estate relative performance vs US yield curve slope

Source: Bloomberg, Nomura Strategy research.

-1.0

-0.8

-0.6

-0.4

-0.2

0.0

0.2

0.4

0.6

-25,000

-20,000

-15,000

-10,000

-5,000

0

5,000

10,000

15,000

20,000

25,000

6w rolling Asia foreign net-buying (lhs)

6w change in US 10yr yield (rhs)

($mn) (%)

-2.5

-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

-6

-4

-2

0

2

4

6

MXAPJ Fwd PER, 26 week change

US 10yr yield, 26 week change (rhs)

78

79

80

81

82

83

84

85

110

115

120

125

130

135

Jan

-12

Mar-

12

May-1

2

Jul-

12

Sep

-12

No

v-1

2

Jan

-13

Mar-

13

May-1

3

Jul-

13

Sep

-13

No

v-1

3

Relative performance: Singapore vs Hong Kong

DXY Index0.35

0.40

0.45

0.50

0.55

0.60

0.65-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5US 10yr-2yr slope

World Real Estate / World (inverted, rhs)


47

China slowdown & commodity/energy price risks. With our economists’ expectation for a

Chinese GDP growth moderation to just 6.9% in 2014 from 7.6% in 2013 largely concentrated in

the investment component of China’s economy, slower Chinese demand for hard commodities

and possibly energy will likely be a key external manifestation. Coupled with the above-noted

outlook for US dollar strength, we think this could constitute a ‘double-whammy’ for global

resource pricing.

Fig. 82: DXY vs. LMEX Index


This in turn would imply potential top-line revenue slippage in equity markets and sectors

dominated by upstream-sector/extractive activity (e.g. Australia, Metals & Mining, Oil & Gas

extraction, Agriculture); whereas downstream sectors (e.g. Manufacturing, Refining &

Petrochemicals, Power Generation) could at least derive potential flow-through benefits to

bottom-line profitability.

By contrast, though, we think China stocks themselves may already be anticipating the coming

GDP slowdown – arguably leaving less downside risk:

As seen in the Figure 83, by regional valuation standards China’s current 1.5x PBV

appears already to discount expectations of substantial ROE erosion toward levels

seen in Singapore and Hong Kong (i.e. of roughly 10%) – rather than China’s relatively

high actual trailing ROE of 15%. (Note that other markets generating similar mid-teens

ROEs such as India and the Philippines sell at substantially higher PBVs than China.)

Taking this “implied China ROE” of roughly 10%, the scatter-chart in Figure 84 of

actual historical Chinese ROE vs. nominal GDP in turn implies an assumption of

roughly 7.0%-7.5% nominal Chinese GDP. Applying China’s 1.7% GDP deflator thus

far in 2013 would suggest that the H-share aggregate PBV is pricing a probabilistic

downside risk to Chinese GDP growth as low as roughly 5.5%.

2800

3000

3200

3400

3600

3800

400074

76

78

80

82

84

Sep

-11

Dec-1

1

Mar-

12

Jun

-12

Sep

-12

Dec-1

2

Mar-

13

Jun

-13

Sep

-13

DXY index (lhs, inverted) LMEX (rhs)


48

Fig. 83: Asia-Pacific ex-Japan: PBV vs. 12-mo. Trailing ROE


Fig. 84: China: Historical ROE vs. Nominal GDP

Source: CEIC, Datastream, Nomura Strategy.

Moreover, for many Chinese industries, lower GDP might be profitability enhancing – if

the incremental growth downside is indeed concentrated in the (over-) investment

component of GDP. As Nomura China strategist Wendy Liu noted in The long & short

view on Chinese equities (II), 19 July, 2013, “with slower GDP growth, the listed A- and

H-share names in sectors currently facing excess capacity may finally see the decline

of the ‘wrong kind’ of capacity. As growth slows…more exits may take place among

unlisted capacity, and the listed names may consolidate market shares, strengthen

pricing power, and improve ROE and FCF.”

EM ASEAN vulnerabilities remain. Aggregating all the above factors (US growth and

monetary normalization, China slowdown and possible commodity/energy price softness), the

Figure 85 presents an aggregate ‘Vulnerability Score’ for Asia ex-Japan equity markets4. We

find that the four Asia ex-Japan equity markets arguably most challenged by the coming 2014

macro environment – each with four out of a possible six ‘red flags’ – are India, Indonesia and

Thailand and Malaysia. By comparison, the two regional markets arguably best-placed to

sidestep the worst potential impact of higher Treasury yields, a stronger dollar and softer

commodity prices are Taiwan (with a ‘perfect’ score of zero red flags) and Korea, followed by

Singapore with two red flags.

4 This incorporates both equity-specific and technical risk factors, including: i) historical equity index correlations against the

(inverse) DXY dollar index, ii) equity inflows (since 2011) as a percent of market capitalization, iii) the comparative exposure

of local equity markets to (more vulnerable) upstream vs. (better insulated) downstream sectors by market capitalization,

and iv) gearing in among non-financial listed companies – as well as broader economy-wide macro risks such as v)

increase in total financial leverage (as a % of GDP since 2008) and vi) external payment balances as a % of central bank

foreign exchange reserves.

APxJ

Australia

China

HK

India

Indonesia

Korea

Malaysia

New Zealand

Philippines

SingaporeTaiwan

Thailand

7%

9%

11%

13%

15%

17%

19%

21%

23%

0.5 1.5 2.5 3.5 4.5

RO

E (%

)

PBV (x)

1Q09

2Q09

y = 47.397x + 6.648R² = 0.3795

0

2

4

6

8

10

12

14

16

18

20

0% 5% 10% 15% 20% 25% 30%

Tra

ilin

g 1

2-m

onth

RO

E

Nominal GDP Growth

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49

Fig. 85: Asia ex-Japan: Vulnerability to Disorderly ‘QE Unwind’ Scenario

Source: Bloomberg, Datastream, CEIC, Nomura Strategy research.

Nor, in any case, do we yet see compelling value in most of EM ASEAN. The EM

ASEAN markets still sell at mostly premium valuations vs. long-term means on both

PBV and PER bases (Figures 86 and 87) – testament to how richly valued they grew

under the GFC-era regime of cheap US dollar funding:

Fig. 86: Asia ex-Japan: PER & prem./disc. vs. long-term mean


Fig. 87: Asia ex-Japan: PBV & prem./disc. vs. long-term mean


FX risks also concentrated in ASEAN... Moreover ASEAN equities may yet prove more

expensive than they (still) appear once the adverse growth- and earnings impacts of FX volatility

and tighter credit/liquidity and fiscal conditions are fully embedded into earnings forecasts, as

we elaborated in The pause that rehashes, 18 September 2013).

As Figure 88 summarizes, the highest correlations between Asia-Pacific currencies and their

respective equity markets (absolute performance) – meaning greater equity volatility when

currencies decline – are found in the four EM ASEAN markets, as well as India. We remain

mindful of these correlations in light of our regional FX team’s forecast for fairly pronounced

2014 local-currency downside particularly in Indonesia (-6.5% vs. the US dollar) and Thailand (-

4.3%).

Historical DXY

inverse

correlation

(beta)

Equity inflows

to local stocks

since 2011 (%

mkt cap)

Downstream minus

Upstream sector

exposure of local

market (%)

Non-Financial

sector corporate

net debt (%

equity)

Economy-wide

private-sector

debt (increase

from 2008, vs

GDP)

External balance

of payments

(financing gap

% reserves)

Total

Vulnerability

Score

Taiwan 0.73 1% 55.4 15.3 18% -0.1 0

Korea 0.40 2% 57.2 5.9 37% -1.1 1

Singapore 0.71 n/a 16.6 28.7 53% - 2

Philippines 0.33 14% 33.5 36.8 7% -1.5 2

Hong Kong 1.06 n/a 23.3 30.4 58% - 3

China 1.43 n/a 5.2 21.9 35% 0.2 3

Malaysia 0.42 6% 17.5 31.9 38% -4.1 4

Thailand 1.14 -4% -5.0 28.1 30% -1.4 4

India 0.98 18% 9.5 4.8 8% -5.3 4

Indonesia 1.26 4% 13.0 29.4 9% -4.2 4

-30%

-20%

-10%

0%

10%

20%

30%

6

8

10

12

14

16

18

20

Philippin

es

Mala

ysia

India

Sin

gapore

Indonesia

Thaila

nd

HK

Austr

alia

Taiw

an

Chin

a

Kore

a

Fw d P/E (lhs)

Premium to L.T. Average (rhs)

-40%

-30%

-20%

-10%

0%

10%

20%

30%

40%

50%

60%

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0In

donesia

Philippin

es

India

Thaila

nd

Mala

ysia

Sin

gapore

Austr

alia

Taiw

an

Chin

a

HK

Kore

a

PBV (lhs)

Premium to L.T. Average (rhs)



50

Fig. 88: Summary table: Asia-Pacific equity performance correlations with FX rate

Absolute performance and relative to MSCI Asia-Pacific ex-Japan Index; HK correlations w/ DXY index

Source: Bloomberg, Nomura Strategy research.

…but stay overweight India. India, on the other hand, presents a curious case for equity

managers. In October we upgraded Indian stocks tactically to a ‘small Overweight’ as a means

of building in a long-side hedge against the risks of weaker US data, lower Treasury yields and

a softer US dollar trend – conditions which subsequently failed to materialize amid surprising US

economic resilience post-October’s congressional fiscal standoff. Nonetheless coming into the

New Year we keep our tactical India Overweight in place. The main reasons are 1) local politics

and 2) our above-noted commodity and energy price expectations. Namely:

A strong showing by the pro-growth/pro-business opposition BJP in India’s five state

elections ongoing through early December could substantially lift equity market

sentiment (boosting reform optimism ahead of even more impactful May 2014 national

polls).

As one of only two Asia-Pacific ex-Japan net importers of both hard commodities and

energy (Thailand being the other – Figure 89), India also is disproportionately

advantaged by the manifest recent softness in commodity and energy prices (which, as

noted, a China slowdown and stronger US dollar in 2014 could both sustain).

Fig. 89: India-Australia-EM ASEAN commodity net-export comparison

Difference between export share and import share of each category


Indeed the benefits of softer commodity prices may already be starting to boost India’s

corporate performance: Indian calendar Q3 corporate results were comparatively

strong (see our India strategist Prabhat Awasthi’s India Equity Strategy - Sept-quarter

Country Current 1yr ago Current 1yr ago

Thailand 0.79 0.37 0.77 0.43

Philippines 0.63 0.15 0.59 0.03

Malaysia 0.56 0.14 0.50 -0.28

India 0.52 0.43 0.65 0.71

Indonesia 0.47 0.13 0.50 -0.19

Taiwan 0.43 0.54 0.06 0.46

Korea 0.40 0.53 0.27 0.28

Singapore 0.32 0.28 0.27 0.29

Australia 0.09 0.09 0.51 0.32

Hong Kong -0.02 -0.15 0.38 0.31

China A -0.06 0.12 -0.06 -0.05

Japan -0.69 -0.60 -0.31 -0.30

Correlation of absolute

performance

Correlation of relative

performance

-30

-20

-10

0

10

20

30

40

Australia Indonesia Malaysia Thailand Philippines India

Food/Agri Fuel Ores & Metals




51

review, November 19) – marking not only the strongest q/q Sept-quarter top-line Sales

growth in the post-GFC period but also a rebound in bottom-line profits as muted input

costs helped support margins.

Backstopped by these factors, foreign equity buying in India has remained under positive

momentum since September – in sharp contrast to EM ASEAN, which has continued to be net-

sold by foreign investors, even as their benchmark indexes were rallying in September-October

(Figures 90 and 91).

Fig. 90: Cumulative Foreign Buying in Asia Since May 21

US$mn


Fig. 91: Cumulative Foreign Buying in Asia Since May 21

% Mkt-Cap


Japan as surprise demand engine? Finally we note that upside earnings surprises could also

result if Japan’s reflationary demand recovery continues to gain potency. For much of 2013

investors mainly seemed to view Japan’s monetary easing through the prism of zero-sum

currency competitiveness effects, but as a result we believe markets may still underappreciate

the potential benefits for global exporters from the reflation of Japanese domestic demand itself.

Japan’s economy is still the world’s third-largest, at US$6.0trn in 2012, with a sizeable

consumption/GDP ratio of 58% and an import/GDP ratio of 15%. Not only does the

world's third-largest economy finally "doing the right thing" after two decades of

monetary error arguably remove a key 'macro background risk' from Asian-regional

and other global risk assets, but Japan may also stand as a key potential new

incremental source of final demand to drive corporate top-line revenues.

Indeed in absolute US dollar terms, Japan’s base of annual private consumption as of

2012 was still much larger than China’s -- roughly US$3.6trn vs. US$2.8trn

respectively (Figure 92).

-6,000

-4,000

-2,000

0

2,000

4,000

6,000

8,000

10,000

12,000

20-M

ay-1

3

03-J

un

-13

17-J

un

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01-J

ul-

13

15-J

ul-

13

29-J

ul-

13

12-A

ug

-13

26-A

ug

-13

09-S

ep

-13

23-S

ep

-13

07-O

ct-

13

21-O

ct-

13

04-N

ov-1

3

18-N

ov-1

3

Korea India

Taiwan Philippines

Indoneisa Thailand

-4.0%

-3.5%

-3.0%

-2.5%

-2.0%

-1.5%

-1.0%

-0.5%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

20-M

ay-1

3

03-J

un

-13

17-J

un

-13

01-J

ul-

13

15-J

ul-

13

29-J

ul-

13

12-A

ug

-13

26-A

ug

-13

09-S

ep

-13

23-S

ep

-13

07-O

ct-

13

21-O

ct-

13

04-N

ov-1

3

18-N

ov-1

3

Korea India

Taiwan Philippines

Indoneisa Thailand


52

Fig. 92: China vs. Japan: Private Consumption (USD bn)

Source: CEIC, Nomura strategy.

Fig. 93: China vs. Japan: Imports (USD bn)

Source: CEIC, Nomura strategy.

Similarly noteworthy is the fact that China is the single largest source of Japanese

imports, alone accounting for 27% of Japanese imports ex- the Mid-East (i.e. oil).

Fig. 94: Japan import composition by country (ex-Mid-East)


Fig. 95: Japan import composition by product (ex-Energy)


Equity Allocation/Recommendations

Looking toward 2014, we believe much of the ‘deep value’ argument for Asia-Pacific ex-Japan

equity upside has now played out, and that markets are growing more deliberate and

discriminating – a change well-suited to the increasing fundamental differentiation in Asia

discussed in this report by our economics colleagues. With equity valuation mean-reversion

largely ‘in the bag’ now, equities increasingly require more of a conventional growth rationale for

upside, rather than the macro-risk compression of 2012-13; but this equally begs the question

where Asia’s superlative earnings growth will be found.

Overall we believe risks around the aggregate +12% Asia-Pacific ex-Japan 2014 earnings

growth consensus to be roughly balanced, with our own regional earnings growth

forecast at +13%; however our forecast disaggregates to an above-consensus +16%

outlook for Emerging Asia (vs. consensus +13%) and a below-consensus +9% forecast

for Developed Asia-Pacific ex-Japan (vs. consensus +10%).

-20%

-10%

0%

10%

20%

30%

40%

50%

60%

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

China: Private Consumption Expenditure, US$bnJapan: Private Consumption Expenditure, US$bnChina: y-y% (RHS)

Japan: y-y% (RHS)

-20%

-10%

0%

10%

20%

30%

40%

50%

60%

0

200

400

600

800

1,000

1,200

1,400

1,600

1,800

2,000

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

China: Imports of Goods and Services, US$bnJapan: Imports of Goods and Services, US$bnChina: y-y% (RHS)

Japan: y-y% (RHS)

China27%

ASEAN18%EU

12%USA10%

Australia8%

South Korea

5%

Taiwan3%

Others17%

Electrical Machinery

19%

Miscellaneous Articles

19%

Chemicals12%

Food & Beverages

12%

Basic Manafactur

ed Goods12%

Machinery11%

Inedible Crude

Materials & oil

10%

Others5%


53

With this, we look for index upside of +17% and +9%, respectively on the benchmark

MSCI Emerging Asia and Developed Asia-Pacific ex-Japan indices in 2014 – delivering

our end-2014 index targets to 785 for local-currency MSCI EM Asia, and 410 for the FTSE

developed Asia-Pacific ex-Japan index. These, in turn, produce a broad MSCI Asia-

Pacific ex-Japan index target of 535, or 14% above current levels at writing.

Figure 96 summarizes our preferred Country and Sector allocations within the region:

Style-wise we expect further declines in market appetite for ‘safety’ (e.g. via dividend-

yield, low-beta, ‘quality’, high-cash balance sheets, or deep PBV discounts) and look

for attributes such as beta and risk to outperform in 2014 – to the continued

disadvantage of the region’s ‘high yield’ markets such as Australia or putatively more

‘defensive’ (lower beta) markets primarily in EM ASEAN (where currency-equity

correlations also happen to be most unhelpful).

Rather, given our expectation that global Developed Markets will lead 2014 growth, our

bias remains toward more externally-focused and cyclical-intense markets such as

Korea, Taiwan and Singapore.

India, by contrast, constitutes an against-the-grain Overweight for us despite well-

known external-account risks, given possible reform-friendly electoral developments

related to May 2014 national polls and/or windfalls from any commodity price

downside.

We also favor cyclical, growth- or reflation-sensitive sectors such as Tech, Industrials,

Consumer Discretionary and Banks – and we downgrade the Telco sector (by 1.5ppt)

to Underweight in favour of increasing our existing Overweights in the Tech and

Industrials sectors by 1.0ppt and 0.5ppt, respectively.

Among cyclical stocks, however, our more cautious China/commodity view inclines us

decidedly toward downstream industries (e.g. Manufacturing, Refining &

Petrochemicals) that may benefit from easier input costs rather than

upstream/extractive industries (e.g. Metals & Mining, large-cap Oil & Gas extraction)

for whom these trends would more represent top-line revenue headwinds.

Our higher US Treasury yield and US dollar expectations for the year ahead also

incline us away from (most) Property and toward Insurance and Banks within

Financials – as well as underpinning our preference for Singapore over Hong Kong

among the DM Asia-Pacific ex-Japan markets.


54

Fig. 96: Recommended country and sector weightings


Stock selection: Earnings focus for 2014

Looking beyond the macro overlay, substantial equity correlation declines since 2012 mean

axiomatically that individual stock selection (rather than macro thematics) should rise as a

critical determinant of portfolio performance in the year ahead – particularly, we think, where

strong company-specific growth prospects are identifiable.

Such growth stories could flow from effective implementation of Corporate Strategy,

for example, new synergies following major M&A deals, via strategic partnership with

firms that bring new value propositions to the table, profitability-enhancing corporate

restructurings, or management refocus on new performance metrics (e.g. from market

share expansion to return on capital).

Growth could come from deliberate investments in New Products, Technologies or

Markets that are expected to generate a revenue- or bottom-line payoff over the

forecast horizon. New markets of course could be geographically defined, but may also

be new market segments defined, for example, by price points, age demographics, etc.

Some companies will be able to tap new growth and/or transformational opportunities

driven by Policy/Reform Initiatives – most prominently, perhaps, in China following

the reformist November 9-12 Communist Party Plenum, but with similar if less

attention-grabbing structural initiatives, or pressure for same, gaining momentum in

several Asia-Pacific ex-Japan economies as diverse and distant as India and Korea

(not to mention Japan itself).

Lastly, many companies will benefit simply from Lateral Growth Exposure to

compelling demand stories elsewhere, be it the US recovery (with an increasing

contribution, we think, from capital spending), Europe’s economic resuscitation, Asia

ex-Japan’s own still-strong demand stories such as Korea and the more resilient parts

Country Allocation

MSCI

Abs Abs.

Weight (%) Weight (%)

Australia 25.7% 21.2% -4.5 Under

China 18.8% 18.8% 0.0 Neutral

Korea 15.4% 18.4% 3.0 Over

Taiwan 10.7% 13.7% 3.0 Over

Hong Kong 9.4% 7.4% -2.0 Under

India 5.8% 6.8% 1.0 Over

Singapore 4.9% 5.9% 1.0 Over

Malaysia 3.6% 3.6% 0.0 Neutral

Indonesia 2.2% 1.2% -1.0 Under

Thailand 2.3% 1.8% -0.5 Under

Philippines 0.8% 0.8% 0.0 Neutral

New Zealand 0.4% 0.4% 0.0 Neutral

Total 100% 100.0% 0.0

Sector Allocation

MSCI

Abs Abs.

Weight (%) Weight (%)

Financials 37.3% 41.3% 4.0 Over

Information Technology 14.5% 17.5% 3.0 Over

Materials 9.4% 9.4% 0.0 Neutral

Industrials 7.8% 9.8% 2.0 Over

Consumer Discretionary 8.1% 10.1% 2.0 Over

Energy 6.2% 6.2% 0.0 Neutral

Consumer Staples 6.3% 0.3% -6.0 Under

Telecommunication Services 5.1% 3.6% -1.5 Under

Utilities 3.1% 1.1% -2.0 Under

Health Care 2.1% 0.6% -1.5 Under

Total 100% 100% 0.0

Weight (ppt)

Nomura Recommendation

Rel.

Weight (ppt)

Nomura Recommendation

Rel.


55

Benjamin Lo – NIHK +852 2252 6220 [email protected]

Gordon Kwan – NIHK +852 2252 2104 [email protected]

of ASEAN (e.g. Philippines, Malaysia), or the radical positive changes materializing in

Japan under ‘Abenomics’.

In Figure 97 and the remaining text below we identify a basket of 21 Asia-Pacific ex-

Japan stocks that each offer a compelling growth ‘angle’ by one or several of these

drivers. This list boasts superior average FY14F and FY15F earnings growth of 26.3% and

17.7%, respectively (excluding the highest and lowest two outliers in each year), substantially

stronger than respective consensus market-wide earnings growth of 12.4% and 10.4%.

Moreover, the selected stocks on average have 23% upside to our analysts’ target prices –

more than double the Bloomberg consensus upside of 11% – and our individual target prices

are higher than consensus in all but two of the 21 selections. Our list offers an average beta of

1.1x, with two-thirds of the names featuring betas of one or higher.

These stock picks also are broadly representative of our regional country and sector

preferences, with the largest sector concentrations by market-cap found in Tech (29%),

Industrials (24%), Financials (16%) and Consumer Discretionary (9%); and the largest country

concentrations in Hong Kong/China (40%), Korea (24%), India (10%) and Taiwan (8%).

Fig. 97: High-conviction Asia-Pacific ex-Japan earnings ‘all stars’ for 2014

Source: Bloomberg, Nomura Research.

China/Hong Kong

Hutchison (13 HK, TP HKD 110.00)

Lateral growth exposure: With Europe likely to be an incrementally positive driver for

Hutch, we believe management’s strategy of reinvesting in European assets and

deleveraging ahead of an interest rate up-cycle will be positive to NAV and earnings.

Corporate strategy: Current EPS CAGR projection of 16% during 2012-15F is biased

to the upside if Hutch executes further asset realignments in 2014F. Although we do

not factor in the potential spin-off of Watsons Group, we note that a spin-off valuation

close to Dairy Farm’s (DFI SP, NR) 17x EV/EBITDA would bring a HKD16 lift to NAV.

COSL (2883 HK, TP HKD 29.50)

Lateral growth exposure: COSL offers superior earnings visibility (20% CAGR over

the next three years), thanks to the structural trend of customers boosting spending

towards oil/gas exploration amid sustained high oil prices. Anchor customer (60% of

revenue) CNOOC’s January capex guidance could propel the stock higher.

Policy/reform beneficiary: China’s energy sector reform could boost domestic

upstream oil/gas exploration and development spending.

Nomura Consensus Nomura Consensus

Company Ticker Mcap (USD) Beta Rating Currency TP TP Price Upside Upside 2013 EPS 2014 EPS 2015 EPS

Hutchison Whampoa 13 HK 53,261 0.99 Buy HKD 110.00 105.35 96.60 14% 9% 22.4% 15.1% 10.6%

China Oilfield Services 2883 HK 13,800 1.14 Buy HKD 29.50 23.80 23.70 25% 0% 33.3% 13.4% 21.8%

BYD 1211 HK 11,569 1.18 Buy HKD 50.00 26.58 37.70 33% -29% 850.0% 169.5% 42.3%

China Longyuan Power 916 HK 10,200 0.77 Buy HKD 11.20 9.86 9.79 14% 1% 15.8% 18.7% 16.7%

China Resources Gas 1193 HK 6,354 0.44 Buy HKD 25.90 21.26 22.00 18% -3% 31.2% 23.4% 24.4%

Sa Sa International 178 HK 3,226 0.79 Buy HKD 10.40 9.53 8.78 19% 9% 25.7% 27.2% 28.4%

Canadian Solar CSIQ US 1,472 2.09 Buy USD 42.00 40.00 31.28 34% 28% na 220.2% 15.2%

AutoNavi* AMAP US 1,063 1.32 Buy USD 19.00 15.75 15.27 24% 3% -110.1% na na

SK Hynix 000660 KS 21,218 1.03 Buy KRW 40,000 40,906 32,050 25% 28% na 46.0% -15.0%

Naver Corp 035420 KS 19,779 0.70 Buy KRW 780,000 708,161 625,000 25% 13% -5.2% 43.6% 57.4%

LG Chem 051910 KS 18,226 1.39 Buy KRW 400,000 375,481 287,000 39% 31% -3.9% 31.6% 21.8%

Medy-Tox 086900 KS 951 0.75 Buy KRW 230,000 228,750 176,600 30% 30% 27.4% 54.2% 23.0%

MediaTek 2454 TT 15,773 1.28 Buy TWD 510.00 467.01 415.00 23% 13% 59.4% 27.2% 19.7%

Catcher Technology 2474 TT 4,392 1.41 Buy TWD 216.00 194.21 173.50 25% 12% 21.9% 1.6% 17.6%

HCL Technologies HCLT IN 11,451 0.69 Buy INR 1,400.0 1,236.8 1,061.9 32% 16% 38.7% 14.0% 11.8%

Maruti Suzuki MSIL IN 7,878 1.08 Buy INR 1,960.0 1,703.1 1,647.0 19% 3% 15.7% 26.8% 19.1%

Lupin LPC IN 6,032 0.58 Buy INR 972.0 994.7 845.9 15% 18% 31.3% 21.1% 11.0%

CIMB Group Holdings CIMB MK 17,217 1.49 Buy MYR 9.00 8.19 7.40 22% 11% -1.0% 16.9% 13.8%

Sembcorp Marine SMM SP 7,330 1.28 Buy SGD 5.20 4.78 4.39 19% 9% -4.1% 12.8% 25.2%

CapitaMalls Asia CMA SP 6,314 1.14 Buy SGD 2.41 2.36 2.00 21% 18% 50.6% 20.5% 5.4%

QBE Insurance Group QBE AU 17,483 0.98 Buy AUD 18.30 16.72 15.70 17% 7% 50.9% 33.8% 15.9%

3) TP = target price; 4) Closing price as of 21 Nov 2013

Nomura Forecast Growth (%)**

Note: 1) *See company write-up below; 2) **Sasa, Maruti and Lupin have March year-endings; for comparability, 2013 for these companies means April 2013 to March 2014, and so on. HCL Tech has a

June year-ending; for comparability, 2013 for HCL Tech means July 2013 to June 2014.




56

Daniel Raats – NIHK +852 2252 2197 [email protected]

Leping Huang, PhD – NIHK +852 2252 1598 [email protected]

Joseph Lam, CFA – NIHK +852 2252 2106 [email protected]

Emma Liu – NIHK +852 2252 6172 [email protected]

Nitin Kumar – NSL +65 6433 6967 [email protected]

Leping Huang, PhD – NIHK +852 2252 1598 [email protected]

BYD (1211 HK, TP HKD 50.00)

Policy/reform beneficiary: China’s EV market may reach CNY207bn between 2013-

15F (14x vs. 2010-12) and we expect BYD to take a leading role in this market given

its comprehensive EV portfolio (e-busses and e-taxis) and operational knowhow.

New markets/products: BYD plans to build a production and R&D base in Nanjing

that will make 1,000 e-buses/year by end-2014; it will launch the first e-taxi company in

the city (400 vehicles initially); and build 11 charging stations. We expect major cities

(eg, Tianjin, Guangzhou and Shenzhen) to publish air pollution control plans soon.

Corporate strategy: Margin expansion in handset business is achieved by a rising mix

of higher-margin metal casings for high-end smartphones.

Longyuan (916 HK, TP HKD 11.20)

New markets/products: Superior scale and geographical diversification support the

highest degree of earnings and cash flow surety in the wind space.

Policy/reform beneficiary: With the government's ambitious energy diversification

targets, policy risk remains skewed to the upside.

Corporate strategy: Best placed to take advantage of improvement in PRC wind farm

operator fundamentals given strongest balance sheet.

CR Gas (1193 HK, TP HKD 25.90)

Policy/reform beneficiary: Promising organic and acquisitive growth story amid the

government’s promotion of clean energy usage including natural gas in China. Given

SOE status and its relationship with local governments, we see potential for continuing

acquisition of third-party projects.

Corporate strategy: Harvesting the heavy investment in previous years. We are

confident in seeing full gas cost pass-through for the company.

Sa Sa International (178 HK, TP HKD 10.40)

Lateral growth exposure: We expect strong sales growth in HK & Macau (40% of

total revenue) as we believe traffic growth of mainland customers is sustainable in

FY14F.

New markets/products: We expect Sa Sa to perform well in the long term as we are

bullish on China cosmetics given the under-penetrated market.

Corporate strategy: We believe GPM expansion is on track thanks to improving brand

mix. House brands have higher GPM (>70%) and we expect house brands to account

for 44/45% of total sales in FY14/15F (vs. 42.5% in FY13).

Canadian Solar (CSIQ US, TP USD 42.00)

Lateral growth exposure: Continued consolidation in midstream in China to enable

market share gains and better ASPs, strong cashflows from project sales in Canada

seen in its recent project sales to Concord and Blackrock.

New markets/products: Further potential project pipeline growth in Japan (key

earnings/cashflow driver in 2015F), SE Asia (Thailand, Indonesia and Philippines),

Middle East (recent supply deal with Saudi-Aramco is a solid start), the US and India.

Policy/reform beneficiary: New feed-in-tariff for 2014 in China for utility and

distributed projects, FIT 3.0 in Canada.

AutoNavi (AMAP US, TP USD 19.00)

Lateral growth exposure: We expect the shift of China smartphone ecosystems to

add value towards handset components and mobile internet service providers.

New markets/products: Collaborations with Sina, Qihu360, Dianping, Evernote, and

360 Group Guide will help establish a strong map eco-system. Bundling map app with

products by partners including Alibaba to lower per-unit installation costs.








57

CW Chung – NFIK +822 3783 2312 [email protected]

Eric Cha – NFIK +822 3783 2337 [email protected]

Cindy Park – NFIK +822 3783 2324 [email protected]

Cara Song – NFIK +822 3783 2328 [email protected]

Aaron Jeng, CFA – NITB +886 2 2176 9962 [email protected]

Corporate strategy: Driven by management’s ‘free for all’ strategy implemented at

end-Aug 2013 and rising R&D expenses and product upgrades, we expect monthly

active users to reach 200mn by end-2015F (vs 85mn in 3Q13). This reflects a

conscious decision to sacrifice earnings to build an eventually monetisable user base.

Korea

SK Hynix (000660 KS, TP KRW 40,000)

Lateral growth exposure: We believe memory is in a long-term bull cycle after an

early 2013F bottom due to disciplined capex, tech migration and industry

consolidation. Key beneficiary of tight memory supply over the next two years owing to

strong China demand for smartphones/tablets and we estimate SK Hynix has more

than 50% market share in China. We see memory prices making a soft landing

possibly in 2H14F.

Corporate strategy: The company has been quick to recover from the fire incident at

its Wuxi fab, and we expect quarterly earnings to recover from a bottom in 4Q13F.

Naver (035420 KS, TP KRW 780,000)

Lateral growth exposure: Continued search dominance with over 70% mobile query

share in Korea. Mobile messaging has attractive upside globally along with

smartphone penetration. Major markets are in Japan (80% of revenue), Thailand and

Taiwan.

New markets/products: Aggressive LINE push into LatAm and India and currently

tapping into France, Germany and Italy too. US next.

Corporate strategy: LINE’s success reflects differentiated user experience, intense

marketing, user-friendly business model and experienced management.

LG Chem (051910 KS, TP KRW 400,000)

Corporate strategy: Successful transformation of chemical product mix, expansion

into China and Kazakhstan to secure demand and competitive feedstock cost.

New markets/products: Improvement in electronic materials and batteries supported

by rising LCD utilization (2H14) and volume growth in polymer batteries (key customer,

Apple). New products with longer-term potential include ITO film and LCD glass.

Policy/reform beneficiary: Favourable policy environment for the electrical vehicle

industry should boost its automotive battery business.

Medy-Tox (086900 KS, TP KRW 230,000)

New markets/products: Ageing population will boost cosmetics demand in Korea. By

end-FY13F, Medy-Tox plans to complete its third clinical test for a next-gen

formulation to penetrate developed markets from 2015. On 26 Sept 2013, Medy-Tox

signed a distribution contract with Allergan (AGN US, NR), the world’s leading

botulinum toxin (Botox) maker, propelling the business into the global league.

Taiwan

MediaTek (2454 TT, TP TWD 510.00)

Lateral growth exposure: We project FY13/14F EPS growth at 59/27% thanks to

continuing market share gains as QCOM and SPRD are proving less competitive.

Corporate strategy: In addition to various collaborations with handset makers,

software and content providers, we believe a key structural reason for MTK’s success

is the duplication of the white box business model in smartphones from feature

phones.

New markets/products: Partnership with TSMC to make the higher-margin product

Octa-core, slated for mass production from year-end, will differentiate turnkey

solutions.







58

Eason Hung – NITB +886 2 2176 9965 [email protected]

Ashwin Mehta – NFASL +91 22 4037 4465 [email protected]

Kapil Singh – NFASL +91 22 4037 4199 [email protected]

Saion Mukherjee – NFASL +91 22 4037 4184 [email protected]

Julian Chua – NSM +60 3 2027 6892 [email protected]

Catcher Technology (2474 TT, TP TWD 216.00)

Lateral growth exposure: We forecast solid 18-26% operating profit growth in FY14-

15F, although the earnings profile is less impressive owing to high non-operating

income in FY13. We believe the company is a key beneficiary of the increasing

adoption of metal casings and market share gains in the smartphone market.

Beneficiary of any upside at Apple or US tech generally.

New markets/products: Given Apple’s supplier diversification strategy, Catcher

should win 10-12% of iPhone market share, or 12%/16% of 2014F sales/earnings, in

our view.

India

HCL Technologies (HCLT IN, TP INR 1,400)

Lateral growth exposure: HCLT’s superior positioning in IMS (1/3rd of revenue) will

continue to drive market share gains in the upcoming deal rebids. We expect 28%

CAGR in IMS over FY13-15F driven by USD240bn+ of global IT spending (~2.3x that

of applications development & maintenance), the low Indian IT penetration of ~4%, and

HCLT’s strong deal flow. Global/US recovery could push up discretionary spending

and provide potential growth upsides to enterprise applications and engineering/R&D

services (largest among tier 1 IT), where current street expectations are conservative.

Corporate strategy: Cross selling of other services to clients entered through its

strong IMS practice would be a key part of their growth strategy. HCLT is best placed

within tier-1 IT to overcome potential hurdles from US immigration tightening, given

highest local presence.

Maruti Suzuki (MSIL IN, TP INR 1,960)

Lateral growth exposure: Given high exposure to the rural market (31% of domestic

volume), we believe MSIL will continue to outperform the Indian passenger car

industry. MSIL contributed ~27% to parent Suzuki Motor Corporation’s (7629 JT,

Neutral) revenue in the previous financial year and MSIL has the ability to leverage on

SMC’s global footprint.

Corporate strategy: MSIL has been able to maintain strong profitability despite lower

volumes and increased discounts due to cost reduction and localisation initiatives and

we see scope for margin improvements from lower discounts amid demand recovery.

New markets/products: Strong R&D evidenced by new UV models.

Lupin (LPC IN, TP INR 972.00)

Lateral growth exposure: Lupin has emerged as the largest Indian generic company

in the US and Japan. This is a key reason we believe Lupin is poised for sustainable

growth of 20% earnings CAGR over FY13-16F. Particularly in the US, where Lupin

pursues niche and limited competition opportunities, product approvals remain the key

catalyst and we note that Lupin’s ANDA pipeline presents high visibility and is one of

the best in the industry.

New markets/products: In India, Lupin has completely transformed from an anti-TB

and anti-infective player into a prominent chronic therapy player. Accretive acquisitions

and sustained growth in India and other emerging markets will remain key components

of its growth strategy.

ASEAN

CIMB (CIMB MK, TP MYR 9.00)

Corporate strategy: Driven by the restructuring of Malaysian consumer business, loan

growth in Malaysia is sustaining its upward momentum supported by ASB unit trust

financing, mortgages and auto loans and is well positioned to capture financing growth

from ETP projects. Potential turnaround in the ex-RBS IB business offers upside.

Lateral growth exposure: Despite the difficult operating environment in Indonesia

(30% of group earnings), management is guiding for a strong IB pipeline across the







59

Nitin Kumar – NSL +65 6433 6967 [email protected]

Min Chow Sai – NSL +65 6433 6959 [email protected]

Toby Langley, CFA – NAL +61 2 8062 8436 [email protected]

APAC region and income growth in Singapore and Thailand. Further supportive global

macro conditions would lead to higher-than-expected capital market revenues.

Sembcorp Marine (SMM SP, TP SGD 5.20)

Lateral growth exposure: SMM’s record order book of SGD13.5bn, the start of

operations at its new Tuas yard, and the completion of its Estaleiro Jurong Aracruz

(EJA) shipyard in Brazil in 2014 will provide solid earnings visibility, in our view.

New markets/projects: Sustained new order flow from Mexico, in our view, is

reflective of the need for modernization and expansion of the drilling fleet in the region

and we expect energy reforms in Mexico to open up the oil and gas sector to foreign

participation and end PEMEX’s state monopoly to further boost demand for jack-ups.

CapitaMalls Asia (CMA SP, TP SGD 2.41)

Lateral growth exposure: FY13F will likely see maiden full-year contribution from new

malls in Japan, China and Singapore that were acquired or completed during FY12. In

addition to the malls scheduled to open in 2014F, CMA’s core earnings growth in

FY15F to be underpinned by upside rental reversion from both the Olinas Mall in Tokyo

and the seven malls opened in China during 2012.

Corporate strategy: Although the operating environment in China will be more

competitive in the next two years, we expect CMA’s operating model to prevail in the

long run and the potential exit of weaker industry players may present opportunities for

CMA to further grow its portfolio.

New markets/projects: We expect the first acquisition in Guangzhou (on 20 Nov

2013) to provide an additional lift to FY15F core earnings.

Australia

QBE Insurance Group (QBE AU, TP AUD 18.30)

Lateral growth exposure: US business looks set to benefit from a return of positive

pricing within the commercial insurance market and its underwriting-biased earnings

profile will continue to offer resilience amid the slowdown in Australian P&C sector

which is likely to persist into FY14F.

Corporate strategy: New management team focusing on the value of the group’s

existing operations (in contrast to the previous management’s acquisition-driven

strategy).

New markets/products: First major player to introduce telematics insurance in

Australia.





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Recent Asia Special Reports

Date Report Title

18-Oct-13 Malaysia: At a fiscal crossroads

24-Sep-13 China's heavy LGFV debt burden

06-Sep-13 Asia's wake-up call

30-Aug-13 India and Indonesia: External funding gaps and policy reponses

23-Jul-13 If China sneezes…

19-Jul-13 India: Turbulent times ahead

28-Jun-13 Asia's rising risk premium

17-Jun-13 South Korea's deflation fears are overdone

19-Apr-13 Lower commodity prices – a boon for Asia

15-Mar-13 China: Rising risks of financial crisis

06-Mar-13 Southeast Asia: Different strokes

28-Nov-12 2013 Outlook: Asia's overheating risks

14-Nov-12 South Korea: An Economic Democracy

25-Oct-12 India reforms (Part I): A long way to go

11-Oct-12 Introducing NESII – The Nomura Economic Surprise Index for India

24-Sep-12 Thailand: New growth engines

14-Sep-12 China primed to surprise on the upside

05-Sep-12 Better hedges for a China hard landing

03-Sep-12 India's chronic balance of payments

07-Aug-12 Asia's inflation wildcard

02-Aug-12 Indonesia: Policy swings

31-Jul-12 India: A poor monsoon and its impact (Q&A)

09-Jul-12 South Korea: Prolonged low growth, inflation and rates through 2013

31-May-12 Pan-Asia: Inventory cycle threatens a slow recovery

29-May-12 China's peaking FX reserves

02-May-12 India: Make or break

23-Apr-12 The China compass

16-Apr-12 Korea: Uncomfortable trade-off

11-Apr-12 India: Four cyclical tailwinds to watch

27-Mar-12 Capital account liberalisation in China

09-Mar-12 India budget preview: Fiscal cheer

01-Mar-12 Asia: What if oil prices keep rising?

23-Feb-12 Philippines – Fiscal space to maneuver

16-Jan-12 Decoding India’s stubbornly high inflation

20-Dec-11 Implications from North Korea

18-Nov-11 A cold winter in China

03-Nov-11 Thailand: Dealing with another disaster

31-Oct-11 China Risks

19-Oct-11 Korea: Falling, converging bond yields

21-Sep-11 China: The case for structurally higher inflation

08-Aug-11 Global market turbulence: Implications for Asia

http://intranet.nomuranow.com/portal/site/employees/asia/home/


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Disclosure Appendix A-1

ANALYST CERTIFICATIONS

We, Rob Subbaraman, Craig Chan, Vivek Rajpal and Michael Kurtz, NIHK, hereby certify (1) that the views expressed in this Research report accurately reflect our personal views about any or all of the subject securities or issuers referred to in this Research report, (2) no part of our compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this Research report and (3) no part of our compensation is tied to any specific investment banking transactions performed by Nomura Securities International, Inc., Nomura International plc or any other Nomura Group company.

Important Disclosures Online availability of research and conflict-of-interest disclosures Nomura research is available on www.nomuranow.com/research, Bloomberg, Capital IQ, Factset, MarkitHub, Reuters and ThomsonOne. Important disclosures may be read at http://go.nomuranow.com/research/globalresearchportal/pages/disclosures/disclosures.aspx or requested from Nomura Securities International, Inc., on 1-877-865-5752. If you have any difficulties with the website, please email [email protected] for help. The analysts responsible for preparing this report have received compensation based upon various factors including the firm's total revenues, a portion of which is generated by Investment Banking activities. Unless otherwise noted, the non-US analysts listed at the front of this report are not registered/qualified as research analysts under FINRA/NYSE rules, may not be associated persons of NSI, and may not be subject to FINRA Rule 2711 and NYSE Rule 472 restrictions on communications with covered companies, public appearances, and trading securities held by a research analyst account. Nomura Global Financial Products Inc. (“NGFP”) Nomura Derivative Products Inc. (“NDPI”) and Nomura International plc. (“NIplc”) are registered with the Commodities Futures Trading Commission and the National Futures Association (NFA) as swap dealers. NGFP, NDPI, and NIplc are generally engaged in the trading of swaps and other derivative products, any of which may be the subject of this report. Any authors named in this report are research analysts unless otherwise indicated. Industry Specialists identified in some Nomura International plc research reports are employees within the Firm who are responsible for the sales and trading effort in the sector for which they have coverage. Industry Specialists do not contribute in any manner to the content of research reports in which their names appear. Marketing Analysts identified in some Nomura research reports are research analysts employed by Nomura International plc who are primarily responsible for marketing Nomura’s Equity Research product in the sector for which they have coverage. Marketing Analysts may also contribute to research reports in which their names appear and publish research on their sector. ADDITIONAL DISCLOSURES REQUIRED IN THE U.S. Principal Trading: Nomura Securities International, Inc and its affiliates will usually trade as principal in the fixed income securities (or in related derivatives) that are the subject of this research report. Analyst Interactions with other Nomura Securities International, Inc. Personnel: The fixed income research analysts of Nomura Securities International, Inc and its affiliates regularly interact with sales and trading desk personnel in connection with obtaining liquidity and pricing information for their respective coverage universe.

Valuation methodology - Fixed Income Nomura’s Fixed Income Strategists express views on the price of securities and financial markets by providing trade recommendations. These can be relative value recommendations, directional trade recommendations, asset allocation recommendations, or a mixture of all three. The analysis which is embedded in a trade recommendation would include, but not be limited to: • Fundamental analysis regarding whether a security’s price deviates from its underlying macro- or micro-economic fundamentals. • Quantitative analysis of price variations. • Technical factors such as regulatory changes, changes to risk appetite in the market, unexpected rating actions, primary market activity and supply/ demand considerations. The timeframe for a trade recommendation is variable. Tactical ideas have a short timeframe, typically less than three months. Strategic trade ideas have a longer timeframe of typically more than three months.

Distribution of ratings (Global) The distribution of all ratings published by Nomura Global Equity Research is as follows: 44% have been assigned a Buy rating which, for purposes of mandatory disclosures, are classified as a Buy rating; 41% of companies with this rating are investment banking clients of the Nomura Group*. 46% have been assigned a Neutral rating which, for purposes of mandatory disclosures, is classified as a Hold rating; 54% of companies with this rating are investment banking clients of the Nomura Group*. 10% have been assigned a Reduce rating which, for purposes of mandatory disclosures, are classified as a Sell rating; 21% of companies with this rating are investment banking clients of the Nomura Group*. As at 30 September 2013. *The Nomura Group as defined in the Disclaimer section at the end of this report.

Explanation of Nomura's equity research rating system in Europe, Middle East and Africa, US and Latin America, and Japan and Asia ex-Japan from 21 October 2013 The rating system is a relative system, indicating expected performance against a specific benchmark identified for each individual stock, subject to limited management discretion. An analyst’s target price is an assessment of the current intrinsic fair value of the stock based on an appropriate valuation methodology determined by the analyst. Valuation methodologies include, but are not limited to, discounted cash flow analysis, expected return on equity and multiple analysis. Analysts may also indicate expected absolute upside/downside relative to the stated target price, defined as (target price - current price)/current price.

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STOCKS A rating of 'Buy', indicates that the analyst expects the stock to outperform the Benchmark over the next 12 months. A rating of 'Neutral', indicates that the analyst expects the stock to perform in line with the Benchmark over the next 12 months. A rating of 'Reduce', indicates that the analyst expects the stock to underperform the Benchmark over the next 12 months. A rating of 'Suspended', indicates that the rating, target price and estimates have been suspended temporarily to comply with applicable regulations and/or firm policies. Securities and/or companies that are labelled as 'Not rated' or shown as 'No rating' are not in regular research coverage. Investors should not expect continuing or additional information from Nomura relating to such securities and/or companies. Benchmarks are as follows: United States/Europe/Asia ex-Japan: please see valuation methodologies for explanations of relevant benchmarks for stocks, which can be accessed at: http://go.nomuranow.com/research/globalresearchportal/pages/disclosures/disclosures.aspx; Global Emerging Markets (ex-Asia): MSCI Emerging Markets ex-Asia, unless otherwise stated in the valuation methodology; Japan: Russell/Nomura Large Cap.

SECTORS A 'Bullish' stance, indicates that the analyst expects the sector to outperform the Benchmark during the next 12 months. A 'Neutral' stance, indicates that the analyst expects the sector to perform in line with the Benchmark during the next 12 months. A 'Bearish' stance, indicates that the analyst expects the sector to underperform the Benchmark during the next 12 months. Sectors that are labelled as 'Not rated' or shown as 'N/A' are not assigned ratings. Benchmarks are as follows: United States: S&P 500; Europe: Dow Jones STOXX 600; Global Emerging Markets (ex-Asia): MSCI Emerging Markets ex-Asia. Japan/Asia ex-Japan: Sector ratings are not assigned.

Explanation of Nomura's equity research rating system in Japan and Asia ex-Japan prior to 21 October 2013 STOCKS Stock recommendations are based on absolute valuation upside (downside), which is defined as (Target Price - Current Price) / Current Price, subject to limited management discretion. In most cases, the Target Price will equal the analyst's 12-month intrinsic valuation of the stock, based on an appropriate valuation methodology such as discounted cash flow, multiple analysis, etc. A 'Buy' recommendation indicates that potential upside is 15% or more. A 'Neutral' recommendation indicates that potential upside is less than 15% or downside is less than 5%. A 'Reduce' recommendation indicates that potential downside is 5% or more. A rating of 'Suspended' indicates that the rating and target price have been suspended temporarily to comply with applicable regulations and/or firm policies in certain circumstances including when Nomura is acting in an advisory capacity in a merger or strategic transaction involving the subject company. Securities and/or companies that are labelled as 'Not rated' or shown as 'No rating' are not in regular research coverage of the Nomura entity identified in the top banner. Investors should not expect continuing or additional information from Nomura relating to such securities and/or companies.

SECTORS A 'Bullish' rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a positive absolute recommendation. A 'Neutral' rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a neutral absolute recommendation. A 'Bearish' rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a negative absolute recommendation.

Target Price A Target Price, if discussed, reflects in part the analyst's estimates for the company's earnings. The achievement of any target price may be impeded by general market and macroeconomic trends, and by other risks related to the company or the market, and may not occur if the company's earnings differ from estimates.

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