Asia_Economic_and_Bond_Q4_2009_Ng__Foo_9.30.09rev2CCRI1255982366

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Asia Economic and Bond Outlook – Q4 2009

By: Kheng Siang Ng, CFA, CAIA, Head of Asian Fixed IncomeNigel Foo, CFA, Investment manger September 30, 2009

Main Themes of Current Market Expectations

� Asian growth is expected to continue to improve on the back of better global sentiment as wellas fiscal stimulus plans by the Asian governments.

� However, waning impact of the fiscal stimulus and any slowdown in global growth may reduceoptimism to our growth forecasts.

� Low inflation trend is expected to end soon. Higher economic growth and base effects wouldresult in higher inflation going forward, but not to levels that are of concern.

� Asian central banks would likely keep monetary policy rates unchanged for the rest of thisyear, but some are expected to gradually hike interest rates in 2010 to normalize rates as

inflation picks up.� Bond yields are expected to head higher in general as the market is looking beyond a no rate

change policy currently into one of higher rates next year.� Near term Asian currency strength could persist given the rebound in Asian economies and

improved investors risk appetite, but we expect central bank interventions to prevent anyvolatile swings in the currencies.

Summary of Asian Bond and Currency Outlook

Duration Curve Vs. USTreasuries

Asiancurrency vs.USD

China Short Flatten Underperform Appreciate

HK Short Steepen Underperform NeutralIndonesia Neutral/short Flatten Outperform Appreciate

Korea Short Flatten Underperform Appreciate

Malaysia Neutral Flatten Outperform Appreciate

Philippines Short Flatten Underperform Appreciate

Singapore Short Steepen Outperform Appreciate

Thailand Short Steepen Underperform Appreciate

* The information above does not constitute investment advice and it should not be relied on as such.

Outlook by Country

CHINAEven with one more quarter to go, we believe China will deliver the 8% growth promise it made at the

start of the year. We grossly underestimated the authority’s resolution to deliver its promise though weremained dubious on the quality of growth. Against the backdrop of a more favorable global economiclandscape, we expect even stronger growth for 2010, at around 9%. Growth in the next few quarterswill likely stay strong, but we expect monetary policy to remain accommodative. We are likely to seemore administrative measures such as window guidance for slower lending growth, stricter homemortgage policies and tighter project approval for sectors facing overcapacity.

Headline inflation has been negative for most of this year and we expect it to remain low. Inflation islikely to remain benign till mid 2010 when it should hit above 2.5% partly due to the low base effect.Relatively low oil prices and stability in food prices have been the main reasons behind the lowinflation and thus they pose the main risks for any potential spike up in prices.

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We see no hikes in interest rate by the People’s Bank of China at least until mid 2010 though bondyields are likely to trend higher on increasing inflationary expectations. We also expect to see littlechange in the Chinese yuan over the next six months with the currency likely trading closer to the 6.8level by Q1 2010.

HONG KONG

Economic data coming out on Hong Kong over the past few quarters provided strong evidence thatthe country’s open economy is still very much dependent on G3 growth. Following the stabilization inthe developed economies, we saw strong revival in Hong Kong exports gaining 8.8%

1quarter-over-

quatrer in Q2. Domestic consumption also got a boost from rising stock and property prices. Against amore favourable backdrop, GDP growth will likely come in at around -3% for 2009 and range between3%-4% for 2010.

Just like many of its counterparts, Hong Kong slipped into a deflationary environment, but we believeCPI is set to rise but not to worrying levels at least until mid 2010. For 2009, we expect to see CPIinflation ranging between 1%-2%. For 2010, we expect it to trend higher towards 3%-4%.

Liquidity remained in abundance and the IPO pipeline still looks heavy in the near term. As such, weexpect short end rates to stay compressed and the HKD to remain on the strong side of the 7.75-7.85band. We maintain no change to the currency peg for the foreseeable future. Hong Kong yields havefallen largely in line with US treasuries, but with the UST 10 year at 3.2%, we are of the opinion thatthe only way for yields to go is up. Thus, we expect to see higher yields at the longer end of the HongKong yield curve moving into 2010.

MALAYSIAWe are likely to witness an export-led recovery well into mid 2010 with the improved outlook for G3economies. However, risks remain if the government decides to end the stimulus too quickly amidwidening budget deficits and if the global recovery turns out to be short-lived. We are maintaining our view that 2009 full year growth will come in between -2% to -3%, and are cautiously optimistic aboutseeing 3%-4% growth in 2010. The budget, to be announced on 23

rdOctober, is key for Malaysia’s

growth outlook for the 2nd

half of 2010.

Inflation is currently negative because of the impact of last year’s fuel price adjustment, but we expectthat to reverse in the remaining part of the year. We are revising downwards our CPI inflationexpectation for 2009 to 0.5%- 1% from the previous 3%-4%. We expect inflation will rise, movingtowards 2.5% around mid-2010. This is based on the assumption that there will not be any changes insubsidized food and fuel prices. Against a benign inflationary backdrop and uncertainty over thesustainability of the global recovery, we expect Bank Negara Malaysia to keep policy rates unchangedat least until Q4 2010. As such, the bond market is likely to stay well supported. On the currency front,we expect further near term strength in the Malaysian ringgit on the improving economic outlook andwe are looking for the ringgit to end the year at around 3.4200.

THAILANDThailand’s economy rebounded strongly in the second quarter and at a respectable 2.3%

2quarter-

over-quarter in tandem with regional economies. More encouraging is that despite exports remaininganemic, private consumption and investment rose strongly. Recently approved FY10 budget is stillaccommodative at THB 1.7 trillion, although lower than last year’s THB 1.95 trillion.

3We maintained

our 2009 GDP forecast at -3% to -4% while we expect 2010 GDP to be around 4%. The main risk isan eruption in the political landscape which could derail the nation’s nascent recovery.

Barring a nasty turn for the worse on the political front, we expect Bank of Thailand to start hikingrates should signs of inflation emerge by mid 2010. CPI has been negative since the start of the year and should average around -1.5% for 2009 before normalizing to around 2% - 3% in 2010. Thai bahthas been fairly stable as of late, and we expect it to stay range-bound with a slight bias towardsappreciation in tandem with Asian currencies. We see the THB ending the year at around 33.10.

1HSBC Research, 6 October 2009

2Ibid.

3Nomura Research, 2 October 2009

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INDONESIAThe Indonesia economy has stood up well so far this year compared to other regional Asianeconomies as it is less reliant on exports and resilient domestic demand helped to keep growth at 4%year-over-year in Q2 2009.

4We expect that the better domestic economic sentiment with past rate

cuts from Bank Indonesia and the smooth outcome of the Presidential election to continue to improve

as the Consumer Confidence Index for August reached 114.3,

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, which was not far from the previouspeak in 2004. We expect GDP for 2009 to reach 4.3%, and 5% to 5.5% in 2010. The recentPresidential election results and developments showed that the electorates have started to electleaders with strong credentials who are committed to economic reform, not just based on popularity of politicians given their links to past dominant political groups. This would bode well for the futureprospects of Indonesia to further improve its economic growth. The positive development may lead tofurther sovereign credit rating improvement. The recent earthquakes in Sumatra island may lead tofurther government spending in infrastructure reconstructions. This would have limited impact on thefiscal deficit for this year. Next year it is expected to be at 1.5% and 2%, respectively. Inflation isexpected to stay low at around 5% in 2009, but may gradually rise to 6% in 2010 with a change inbase effect for oil prices and plans to adjust electricity tariffs by 20% for households in 2010.

6

We expect Bank Indonesia (BI) to keep policy rates unchanged at the current level of 6.50% for atleast the next 6 months. There is no immediate concern for inflationary pressures and the centralbank is keen to let the low rates stimulate further economic growth. Hence, BI is monitoring theimplementation of its agreement with local banks to reduce their deposits rates so that banks will stepup loan growth. We expect the rupiah bond market to stay well supported near term with still positivesentiments towards the currency and BI keeping rates on hold leading to investors having a slight biasto buy bonds for the carry. However, current yield levels are not far from historic lows and hence wemay start to see yields head higher medium- to long-term. The IDR is expected to trade towards 9300by the end of the year.

SOUTH KOREAThe South Korean economy continued to show positive growth and the government’s fiscal stimulusplayed vital role in encouraging consumption. This resulted in positive GDP growth of 2.6% quarter-over-quarter in Q2 2009.

7We expect a stabilizing global growth outlook will lead to further recovery in

Korean exports as we have witnessed the industrial production starting to turn positive on a year-on-year basis from July 2009 onwards.

8This upward growth trend is expected to continue leading to

better than expected 2009 GDP growth at -1.8% and 3% in 2010. The better economic growth haskept the inflation at level of 2.2% year-over-year in September 9 just a tad below the Bank of Koreapolicy inflation range of 2.5% to 3.5%. We expect inflation in 2009 to average at around 2.8% andgradually edged up to 3.3% in 2010.

The Bank of Korea (BoK) is concerned about the growth of mortgage loans and the home prices thatmay lead to further inflationary pressures. The Korean financial regulators have imposed more limitson mortgages for people buying homes in Seoul and the surrounding areas to slowdown themortgage loan growth.

10It is widely expected that the BoK may hike interest rates should the housing

market show no signs of moderation. We do not expect the BoK to hike in Q4 this year, but it isincreasingly likely that rate hikes of 50 basis points may be delivered in Q1 next year from the currentlevel of 2.00%. As such, we expect the bond market to remain under pressures with yields rising andthe curve flattening. With the improved economy, expectations of rate increases and generalimprovement in investors risk appetites, the KRW may appreciate further from the current level eventhough the authorities have voiced concerns about the pace of appreciation. The KRW is expected to

reach 1150 by the end of the year.

4Bloomberg Data, 10 August 2009.

5Bloomberg Data, 3 September 2009.

6Citigroup Research, 25 September 2009.

7Bloomberg Data, 3 September 2009.

8At 0.9% year-over-year in July 2009, Bloomberg Data, 31 August 2009.

9Bloomberg Data, 1 October 2009.

10Banks can extend up to 50% of a borrower’s annual income for buying homes in Seoul and 60% in Incheon

and Gyeonggi Province. Bloomberg News, 4 September 2009.

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SINGAPOREThe quick turnaround in global sentiment, from global recession to stabilization and early recovery,has led to a revival of economic confidence for the Singapore economy. While the governmentcontinues to remain cautious with warning of a potential double dip, the underlying data seems toindicate pockets of strength and overheating perhaps in the residential housing market. The truth maylie somewhere in between. Global inventory rebuilding has given the industrial production (+12.3%

year-over-year in August

11

) and non-oil domestic exports (from a double digit percentage decline tosingle digit at -7.1% year-over-year in August12

) some encouraging rebounds. This may go on further even though the pace may slow somewhat into year-end. The government’s fiscal measures havehelped to prevent a broad based increase in unemployment and has kept consumer sentimentrelatively positive. The sharp rebound in the equities market and signs of global recovery have led toa sharp run up in residential property transactions and prices. We are raising our 2009 GDP forecastslightly to a range of -2.8% to -3.8% from the previous forecast of -3.5% to -5%. The economy isexpected to do even better next year at an expected growth rate of 4.5% as the global economicrecovery gains better traction. We expect inflation to stay low for the time being, but the disinflationtrend is already turning with CPI in August at -0.3% year-over-year

13, after moving sideways around

this level for 4 months and having shown two consecutive quarters of month-on-month increase. Wemaintain our average CPI for 2009 at 0.5%, but expect this to pick up to 1.2% in 2010.

The Monetary Authority of Singapore (MAS) is expected to maintain its present policy stance of zeroappreciation of nominal effective exchange rates in its October policy statement, even though thereare tentative signs of inflation picking up in the housing sector. A global economy that is onlygradually coming out of a recession may yet offer another reason for the status quo exchange ratestance now. However, this may tilt towards an appreciating bias in April 2010 as the inflation uptrendbecomes clearer. We expect long end bond yields to rise going forward as the economy recovers andinflation bottoms out. The SGD may stay well bid with inflows into Asia. Thus, we expect the SGD topush towards the 1.3900 level by year-end.

PHILIPPINESThe Philippines economy fared better than expected with Q2 GDP growth of 1.5% year-over-year asprivate consumption (2.2% year-over-year) and government consumption (9.1% year-over-year) heldup well.

14.With the government committed to maintaining its spending plans to lift economic growth

amid a nascent global recovery, and overseas workers remittance flows that are resilient, we believeGDP growth for 2009 will be at the higher end of our forecast range of 1.5% to 2%. Improvedeconomic sentiment and overseas workers remittance that accelerated to 9.3% year-over-year inJuly15 will underpin consumption. The economy will also received a boost from consumption as itheads towards the Presidential election in May 2010. Budget deficits are expected to rise above thegovernment deficit forecast of PHP250 billion in 2009 as the government steps up spending inresponse to lackluster economic growth and repair infrastructures damaged by typhoons. Thegovernment will thus likely raise additional finance from USD and Samurai bond issuance over thenext 6 months. A sustained high budget deficit may undo the positive fiscal momentum thegovernment has been trying to maintain over the last few years. On the inflation front, we expect therecent disinflationary trend to start to reverse as the base effect fades as seen by the latest rise of CPIfor September at 0.7% year-over-year from 0.1% year-over-year previously.

16We expect CPI to

average around 3.3% for 2009 and edge up towards 4.5% for 2010.

Bangko Sentral ng Pilipinas (BSP) is seen as generally dovish with regard to monetary policy as itsees inflation well contained and wants to keep rates low to stimulate economic activities. Hence, weexpect the BSP to keep rates on hold at 4% for the coming months. However, we do not believe

either the low inflation or interest rates are the norms for the economy. As inflation gradually creepshigher and economic activities pick up, we expect present ultra accommodative policy to be removedin mid 2010. We expect bond yields to eventually rise from the current low levels as the budget deficitrises and inflationary pressures increase. Positive current account dynamics with overseas workers

11Bloomberg Data, 25 September 2009



14Bloomberg Data, 27 August 2009


16Bloomberg Data, 6 October 2009

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remittance and the regional currency appreciation trend would see the PHP approach 46.00 by year-end.

This material is for your private information.

The views expressed in this material are the views of Kheng Siang Ng and Nigel Foo through the period ended September 30, 2009, and are subject to change based on market and other conditions. The information provided does not constitute investment advice and it should not be relied on as such. All material has been obtained fromsources believed to be reliable, but its accuracy is not guaranteed. This content contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.

Past performance is no guarantee of future results

SSgA may have or may seek investment management or other business relationships with companies discussed in this material or affiliates of those companies, such as their officers, directors and pension plans. INTR-0067

© 2009 State Street Corporation - All Rights Reserved

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