Principal authors

Asia Economics

Rob Subbaraman - NSL rob.subbaraman@nomura.com

+65 6433 6548

Asia FX Strategy

Craig Chan - NSL

craig.chan@nomura.com

+65 6433 6106

Asia Rates Strategy

Vivek Rajpal - NSL vivek.rajpal@nomura.com

+65 6433 6555

Albert Leung - NIHK

albert.leung1@nomura.com

+852 2252 1401

Gl

Brexit: Expect waves of contagion on Asia The financial, confidence and psychology channels are likely to be more important than trade linkages.

Beyond the trade channel, once financial, confidence and psychology channels are taken into account, we caution not to underestimate the depth and reach of financial market contagion to Asia.

We expect broadly higher USD/Asia in the near term and our Asia FX portfolio is positioned for this through short S$NEER, long USD/CNH, USD/HKD and EUR/USD put spread (hedge) positions. We maintain these recommendations.

However, we marginally change our portfolio by converting some of our short CNH versus CFETS basket positions to long USD/CNH and build on our long USD/KRW cash position.

Although we see upside risk to USD/Asia, we maintain our medium-term constructive view on South/Southeast Asia FX versus Northeast Asia and will look for opportunities to re-establish this bias.

We suggest shifting to receive bias trades in Asia rates. We like receivers in China swaps (2yr), Long IGB 8.27 2020, receivers in THB (1yrfwd2yr and 5yr NDIRS) and July-November OIS flatteners in Australia.

Global Markets Research

Asia Special Report

Global Markets Research

24 June 2016

Please see Appendix A-1 for analyst certifications,

important disclosures and the status of non-US analysts.

BDO and BDO Nomura Securities. Inc (formerly PCIB Securities, Inc) are the distributors of this report in the Philippines. No part of this material may be (i) copied, photocopied, or duplicated in any form, by any means; or (ii) redistributed without the prior written consent of BDO and BDO Nomura Securities. Inc. Nomura has authorized BDO and BDO Nomura Securities. Inc (formerly PCIB Securities, Inc) to re-distribute this report in the Philippines.

Nomura | Asia Special Report 24 June 2016

2

Contents

Executive summary .........................................................................................................................3

Economic implications .....................................................................................................................4

Do not underestimate the global contagion ..................................................................................4

Extreme uncertainty is an anathema to financial markets .............................................................5

The psychological impact – a link to the US elections ..................................................................5

The financial tail wagging the real economy dog ..........................................................................5

Lowering Asia growth forecasts ...................................................................................................7

High-conviction trades ...................................................................................................................10

Asia FX strategy.........................................................................................................................10

Asia rates strategy .....................................................................................................................10

FX strategy: Asia FX depreciation on Brexit shock ........................................................................11

FX strategy ................................................................................................................................11

Medium-term outlook .................................................................................................................11

Asia rates strategy: Starting fresh ..................................................................................................14

North Asia ..................................................................................................................................14

India and Southeast Asia ...........................................................................................................15

Australia .....................................................................................................................................15

Country views ................................................................................................................................16

China: Lowering GDP growth forecast to 6.0% for 2016 on Brexit ...............................................16

North Asia: Open economies are vulnerable ..............................................................................17

India: Brexit means more accommodation .................................................................................18

ASEAN: Negative implications across the board, but for some worse than others .....................19

Australia .....................................................................................................................................22

Recent Asia Special Reports .........................................................................................................23

Nomura | Asia Special Report 24 June 2016

3

Executive summary

To assess the global impact of this surprise result, it is important to look beyond the

trade channel. Once the financial, confidence and psychology channels are taken into

account our warning is to not underestimate the depth and reach of financial market

contagion to Asia.

A globally coordinated central bank response to a global financial market meltdown is

quite likely, such as liquidity support through FX swap arrangements and possible FX

intervention, but with policy credibility at such a low it is unclear how successful these

emergency measures would ultimately be when there is extreme market risk aversion.

On the Brexit result, we have tentatively lowered our aggregate 2016 GDP growth

forecast for Asia ex-Japan from 5.9% to 5.6%. The largest percentage point (pp)

downgrades are for Hong Kong (1.0pp) and Singapore (0.7pp), followed by Taiwan

(0.6pp), Thailand (0.5pp) and Malaysia (0.4pp). At the other end of the spectrum, we

have lowered our 2016 GDP growth forecast by only 0.2pp for Australia, China,

Indonesia and the Philippines.

We now expect significantly more monetary policy easing in Asia. Between now and

year-end, we expect the central bank of India to cut by 25bp (no cut previously), Korea

by 50bp (25bp previously), Indonesia by 50bp (25bp), Taiwan by 50bp (37.5bp),

Thailand by 50bp (50bp), Malaysia by 25bp (no cut previously). For China we have

increased the number of RRR cuts by year-end from two to three (in addition to one

interest rate cut). The only Asian central bank that we expect to keep rate on hold is in

the Philippines. We now expect the Monetary Authority of Singapore to re-centre the

mid-point of the S$NEER policy band lower at, or before, its October policy meeting.

FX strategy:

• We expect the Brexit shock to push USD/Asia broadly higher in the near term and our

Asia FX portfolio is positioned for this through short S$NEER, long USD/CNH,

USD/HKD and EUR/USD put spread (hedge) positions. We maintain these

recommendations.

• However, we marginally change our portfolio by converting some of our short CNH

versus CFETS basket positions to long USD/CNH and build on our long USD/KRW

cash position.

• Although we see upside risks to USD/Asia, we maintain our medium-term constructive

view on South/Southeast Asia FX versus Northeast Asia and will look for opportunities

to re-establish this bias.

Rates strategy:

• Dovish central banks, a weak growth outlook and a dovish Fed are bullish for most Asia

rates. With our economists now forecasting every Asian central bank to cut rates further

this year, bar the Philippines, we suggest shifting to receive bias trades

• Rates markets with stronger FX linkages should underperform US rates. We expect

Singapore and HKD rates to underperform US rates in this move. We are also more

wary of rates markets with relatively higher foreign participation in local bond markets

(such as Indonesia) which, in the past, have sold off in risk-aversion episodes.

• Yield curves will likely flatten initially. We expect yield curves to bull flatten initially.

However, as monetary and fiscal accommodation increases over time, steepening is

expected to emerge over next few months.

• We suggest shifting to receive bias trades in Asia rates. We like receivers in China

swaps (2yr), India (2yr NDOIS and Long IGB 8.27 2020), receivers in THB (1yrfwd2yr

and 5yr NDIRS) and July-November OIS flatteners in Australia.

Nomura | Asia Special Report 24 June 2016

4

Economic implications

Against our base case (to which we assigned 75% probability) and the betting market

odds (~70%) of the UK remaining in the European Union, the British have voted to leave.

As seen from the early price action, this surprise result is roiling financial markets –

globally. The UK economy, at the epicentre, is of course most negatively affected, and

the impact is likely to be prolonged rather than short term. The IMF recently surveyed

nine separate empirical studies that estimated the short-run impact of a Brexit on the UK

economy and found that relative to baseline, the fall in real GDP had a wide range of

between 1% to 6%, highlighting the high level of uncertainty and significant downside

risks over just how bad the Brexit could ultimately be for the UK. Philip Rush, our UK

economist, now expects a UK recession with at least a 2% peak-to-trough drop in UK

GDP, and he expects the Bank of England to cut the Bank rate by 50bp to zero before

potentially going slightly negative and restarting QE in 2017 (see Special Macro Topics:

it's a Brexit, 24 June 2016).

The uncertainty over the future of the UK means investors can be expected to demand a

higher risk premium for holding UK assets, which coupled with the need to finance a 7%-

of-GDP current account deficit, should result in a large – and persistent – depreciation of

GBP. On a trade-weighted exchange rate basis our G10 FX strategy team expects GBP

to weaken by 10-15% by end-2016. We expect rising imported inflation to eat into real

household disposable income, thereby hurting consumption, which will likely only be

exacerbated by property and equity market corrections.

Do not underestimate the global contagion

At first glance, it would seem that the financial and economic impact of this result should

be largely confined to the UK, given that its economic size is quite small at less than 4%

of world GDP and world imports in 2015. However, we believe that this is too simplistic of

a view and that the impact of the Brexit will be far reaching and long lasting, for two main

reasons.

First, we expect non-trivial spillover to the euro area economy and financial markets.

While the value of merchandise exports from the rest of the EU to the UK is only 3% of

the rest of the EU’s GDP1, the UK’s position as a global financial hub – UK financial

sector assets account for more than 8x its GDP – leaves the rest of the EU much more

exposed to the UK in terms of financial and investment linkages, in part reflecting the

UK’s relatively liberalised domestic market and its strong legal framework and

institutions.

For example:

• One-third of the UK’s financial and insurance services exports are to the EU

• More than half of the UK banking sector’s cross-border lending is directed to the EU

• Almost half of the foreign direct investment received by the UK comes from the EU2

In addition, Brexit could further inflame anti-EU sentiment in other EU member states,

heightening fears of more countries opting to leave the union. It is largely due to these

non-trade-related channels that we expect a reduction in euro area GDP growth by 0.5

percentage points (pp) and a weaker EUR/USD.3 While UK share of global GDP is less

than 4%, the rest of EU’s share is 18%, so once second-round effects on Europe are

taken into account, the global impact is no longer trivial.

1 The most exposed countries to UK trade are Ireland, Malta, Cyprus, Belgium and the Netherlands, according to

the IMF.

2 These data are sourced from the IMF’s United Kingdom: Selected Issues, IMF Country Report No. 16/169, June

2016.

3 Our impact estimate on the rest of EU GDP is at the high end of the IMF’s range of -0.2% to -0.5%, see United

Kingdom: selected issues, IMF Country Report No. 16/169, June 2016.

Nomura | Asia Special Report 24 June 2016

5

Extreme uncertainty is an anathema to financial markets

This extreme uncertainty in the City of London, one of the world’s largest financial

centres, is anathema to global financial markets, especially when the global economy is

as fragile as it is and as there are limited monetary and fiscal policy easing buffers

available to most of the world’s major economies.

At this early stage, great uncertainty exists over just what the Brexit will ultimately mean

for the UK economy. For example, how soon and how successful will the UK be able to

negotiate with the EU the terms of its withdrawal, and renegotiate trade relationships with

60 non-EU economies where trade is currently governed by EU relationships? Will there

be constitutional havoc in amending legislation from EU law to UK law? Will Scotland

push for another referendum on independence? Heighted uncertainty and risk aversion

is likely to discourage new investment in the UK and weigh on consumer sentiment. The

danger is that all these factors – rising inflation, falling asset prices, high uncertainty and

weakening private domestic demand – reinforce each other in a downward spiral,

dwarfing any positive impetus from a more competitive exchange rate or monetary and

fiscal policy easing.

The psychological impact – a link to the US elections

Moreover, one should not underestimate the psychological impact and how quickly

markets could link the outcome to a rising risk of Donald Trump winning the US

presidential election. As Anatole Kaletsky warned in an article on Project Syndicate (see

Brexit’s impact on the world economy, 17 June 2016), the UK referendum is part of a

global phenomenon – the rise of nationalist sentiment and populist revolts against

established political parties. The demographic profile of Brexit supporters is found to be

strikingly similar to that of American Trump supporters. The opinion polls are also

strikingly similar: The UK polls showed the Brexit and Bremain camps to be close to

neck and neck going into the referendum, as are the US polls on the two main US

presidential candidates, Trump and Hilary Clinton. In contrast, investors, judging from

recent price action, did not anticipate a Brexit, and option pricing suggests markets are

also discounting a Trump victory. The UK betting markets too have downplayed the

results of opinion polls: the odds of Brexit were generally about 1-in-3, similar to what US

betting markets assign to a Trump victory.

The surprise Brexit result should now increase the credibility of opinion polls – they had

indicated a much closer race than the odds published by bookmakers – in gauging how

people actually vote. Statistical theory even allows us to quantify how expectations about

the US presidential election should shift following the Brexit wins in Britain. To quote

Kaletsky, imagine “for the sake of simplicity, that we start by giving equal credibility to

opinion polls showing Brexit and Trump with almost 50% support and expert opinions,

which gave them only a 25% chance. Now suppose that Brexit wins. A statistical formula

called Bayes’ theorem then shows that belief in opinion polls would increase from 50% to

67%, while the credibility of expert opinion would fall from 50% to 33%.” The upshot is

that investors are likely to take the results of opinion polls more seriously now and, as

such, financial markets could start pricing in a greater risk of a Trump victory in the 8

November election and, possibly, a greater chance of populist insurgencies in the rest of

Europe.

The financial tail wagging the real economy dog

In a nutshell, we expect the global impact of the Brexit to be more through the financial,

confidence and psychology channels than simply through trade. Our warning is to not

underestimate the depth and reach of global financial market contagion, which seems to

have increased since 2008. For instance, during the European crisis of 2011, when there

were significant fears of EU breakup, Asia’s stock and bond markets became much more

highly correlated to the Euro Stoxx 50 and the German government bond yield than over

2000-07 (Figures 1 and 2). And as Hyun Song Shin, economic advisor and head of

research at the BIS, recently described it (see Global liquidity and procyclicality, 8 June

2016), “the real economy appears to dance to the tune of global financial developments

rather than the other way around”, through wealth, confidence, loan collateral and

liquidity effects.

Nomura | Asia Special Report 24 June 2016

6

Granted, one potential cushion to a global financial market selloff is expectations of a

further delay in the next Fed rate hike, but markets have already significantly priced out

Fed hikes for this year (following the Brexit outcome, the market is now pricing a mere

6% likelihood of a Fed rate hike in 2016, down from 58% prior to the EU referendum).

Our US team now believes that the most likely timing of the next Fed rate hike is

December (see Policy Watch: Brexit vote will likely delay FOMC rate hike, 24 June

2016). Instead, we believe that the more dominating factor will be renewed concerns

over global growth and a likely stronger USD – together they are likely to cause oil prices

to continue falling, adding more fuel to the fire of a major risk-off event in emerging

markets. A globally coordinated central bank response to a global financial market

meltdown is quite likely, such as liquidity support through FX swap arrangements and

possible FX intervention, but with policy credibility at such a low it is unclear how

successful these emergency measures will ultimately be when there is extreme market

risk aversion.

Fig. 1: Correlation of Asia’s stock markets with the Euro

Stoxx 50

Source: CEIC and Nomura.

Fig. 2: Correlation of Asia’s 10-year government bond yields

with the German 10-year government bond yield

Note: Correlation between Germany’s 10-year government bond yield and China’s

10year government bond yield is from 2002-2007; correlation between Germany’s 10-year government bond yield and Indonesia’s 10-year government bond yield is from 2003-2007.Source: Bloomberg, CEIC, Wind and Nomura.

-0.2

0.0

0.2

0.4

0.6

0.8

1.0

Daily correlation with Euro Stoxx 50

2000-2007

2011

-0.8

-0.6

-0.4

-0.2

0.0

0.2

0.4

0.6

0.8

1.0

2000-2007

2011

Daily correlation with Germany's 10-year government bond yield

Nomura | Asia Special Report 24 June 2016

7

Lowering Asia growth forecasts

With the Brexit result only a few hours old and the situation extremely fluid it is extremely

difficult to forecast the economic and financial impact on Asia, but we have decided it

best to provide some guidance to our thought process by providing what we stress are

preliminary new forecasts against our pre-referendum baseline views (Figure 3).

Fig. 3: Preliminary new Asia real GDP forecasts post-Brexit

Source: Nomura.

For Asia ex-Japan, we have tentatively lowered our aggregate GDP growth forecast in

2016 from 5.9% to 5.6%. The sheer size of China’s internally driven economy – its share

in Asia ex-Japan’s GDP was 53% last year – masks larger cuts and variation in our GDP

forecasts for other individual economies. In terms of our 2016 GDP growth forecasts the

percentage point (pp) downgrades are largest for Hong Kong (1.0pp) and Singapore

(0.7pp), reflecting their very open economies, status as financial hubs and their managed

exchange rates, especially the HKD peg to USD. The country pages provide more detail

behind our forecast changes, including our assessment of the economic fundamentals,

scope for policy responses and idiosyncratic factors. After taking these into account we

have also made relatively large downgrades to our GDP growth forecasts for Taiwan

(0.6pp), Thailand (0.5pp) and Malaysia (0.4pp). At the other end of the spectrum, we

have lowered our 2016 GDP growth forecast by only 0.2pp for Australia, China,

Indonesia and the Philippines.

The share of total merchandise exports directed to the UK and the rest of the EU is much

larger for many emerging market economies in Europe – notably the Czech Republic,

Poland and Hungary – than in Asia (Figure 4 overleaf). However, to properly assess the

full economic impact on export exposure to Europe, including second-round knock-on

effects to capex and jobs, it is important to gauge how significant each country’s exports

are in their GDP, and here, Asia is very open. The share of merchandise exports in GDP

is over 100% in Hong Kong and Singapore, and over 50% in Malaysia, Taiwan and

Thailand (Figure 5). Translating export exposure to the UK and the rest of EU as a share

of Asian countries’ GDP paints a different story, showing several Asia countries more

exposed, notably Hong Kong, Singapore, Malaysia and Thailand (Figure 6).

As discussed, we judge the transmission mechanisms through which this decision will

impact Asia will be larger through the financial markets, confidence and psychology

channels than through trade. There has already been a knee-jerk selloff in Asia’s

financial markets – against the USD, GBP down 9%, JPY up 5% and Asian equity

markets mostly down 2 to 8% at the time of writing – and, importantly, we expect the

market meltdown to deepen and be long lasting, as highlighted by our preliminary new

FX forecasts of significant Asia currency depreciation against USD by year-end (Figure

7). Nonetheless, we would expect some Asian currencies to appreciate over time on a

trade-weighted basis, simply because of even larger currency depreciations against USD

by GBP and currencies of other EM and large commodity producers (for BIS weights of

effective exchange rates, see Figure 8). We would expect RMB to appreciate on a trade-

Previous New Change

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

Australia 2.9 2.7 -0.2

China 6.2 6.0 -0.2

Hong Kong 0.8 -0.2 -1.0

India 7.6 7.3 -0.3

Indonesia 5.4 5.2 -0.2

Malaysia 4.3 3.9 -0.4

Philippines 6.5 6.3 -0.2

Singapore 1.8 1.1 -0.7

Korea 2.5 2.2 -0.3

Taiwan 1.0 0.4 -0.6

Thailand 2.7 2.2 -0.5

Asia ex-Japan, Australia 5.9 5.6 -0.3

2016

Nomura | Asia Special Report 24 June 2016

8

weighted basis, which could pose a dilemma to the People’s Bank of China (PBoC) as

intervention to weaken RMB and avoid a loss of export competitiveness could set off

renewed market expectations of RMB depreciation, triggering capital flight and forcing a

volte-face by the PBoC to defend the currency, causing a further drawdown in FX

reserves that risks fuelling expectations of further RMB depreciation. Another potential

risk is UK banks reducing their exposure in Asia, and here the financial hubs of

Singapore and Hong Kong are particularly vulnerable (Figure 9).4

In terms of policy responses, we now expect significantly more monetary policy easing.

Between now and year-end, we expect the central bank of India to cut by 25bp (no cut

previously), Korea by 50bp (25bp previously), Indonesia by 50bp (25bp), Taiwan by 50bp

(37.5bp), Thailand by 50bp (50bp), Malaysia by 25bp (no cut previously). For China we

have increased the number of RRR cuts by year end from two to three (in addition to one

interest rate cut). The only Asian central bank that we expect to keep the policy rate on

hold is in the Philippines. We now expect the Monetary Authority of Singapore to re-

centre the mid-point of the NEER band lower on or before the October policy

announcement. A large external shock like this leaves Hong Kong vulnerable. The HKD

peg to the USD means that Hong Kong’s already overvalued effective exchange rate

appreciates significantly, while the fixed exchange rate regime means that the Hong

Kong Monetary Authority’s hands are tied (Hong Kong interest rates are largely

determined by the US Fed). We now forecast an outright recession in Hong Kong this

year, and there is a risk that large net capital outflows, through the workings of the

currency board system, causes Hong Kong interbank rates to spike, deepening the

recession and setting off a vicious spiral.

4 A potential mitigating factor is the relocation of financial services from the UK to Singapore and Hong Kong, but

this is unlikely in the short run, in our view.

Nomura | Asia Special Report 24 June 2016

9

Fig. 4: 2015 merchandise exports to UK and the rest of EU

Source: CEIC and Nomura.

Fig. 5: 2015 merchandise exports (% of GDP)

Source: CEIC and Nomura.

Fig. 6: 2015 merchandise exports to UK and the rest of EU

Source: CEIC and Nomura.

Fig. 7: Preliminary 2016 year-end FX forecasts post-Brexit

Note: Forecast for Australia’s FX refers to AUD/USD. Source: Nomura.

Fig. 8: Trade weights in a country’s effective exchange rate

Note: Trade weights are for countries’ BIS NEERs. Source: BIS and Nomura.

Fig. 9: UK bank claims, % of recipient country’s GDP in 2015

Source: BIS and Nomura.

4.35.18.18.5

9.19.39.910.110.210.612.2

15.616.616.717.8

21.925.3

44.448.5

68.3

78.783.3

0 20 40 60 80 100

MexicoAustralia

SingaporeTaiwan

KoreaHong Kong

IndonesiaMalaysiaThailand

JapanPhilippines

ChinaColombia

IndiaBrazil

South AfricaIsrael

TurkeyRussia

HungaryPolandCzech

to UK

to Rest of EU

% of total exports

10.812.113.015.115.317.420.020.121.221.5

25.625.7

33.438.2

42.053.454.2

67.487.2

97.3118.3

150.5

0 40 80 120 160

BrazilColombia

IndiaJapan

AustraliaIndonesia

TurkeyPhilippines

ChinaIsrael

RussiaSouth Africa

MexicoKorea

PolandThailand

TaiwanMalaysia

CzechHungary

SingaporeHong Kong

% GDP

0.81.41.61.71.92.02.22.53.33.54.65.45.55.66.88.99.6

12.4

14.033.1

66.572.7

0 10 20 30 40 50 60 70 80

AustraliaMexicoJapan

IndonesiaBrazil

ColombiaIndia

PhilippinesChinaKorea

TaiwanIsrael

ThailandSouth Africa

MalaysiaTurkey

SingaporeRussia

Hong KongPoland

HungaryCzech

To UK

to Rest of EU

% GDP

Previous New Change

USD/LCY USD/LCY %

Australia 0.67 0.65 -3.0

China 6.80 6.94 -2.1

Hong Kong 7.82 7.85 -0.4

India 67.6 69.5 -2.8

Indonesia 13400 13650 -1.9

Malaysia 4.12 4.18 -1.5

Philippines 46.6 47.3 -1.5

Singapore 1.43 1.45 -1.4

Korea 1220 1250 -2.5

Taiwan 33.7 34.4 -2.1

Thailand 36.6 37.5 -2.5

GBP EURGBP +

EURUSD CNY

USD +

CNYJPY Others Total

Poland 4.8 51.4 56.2 4.1 10.6 14.8 2.0 27.0 100.0

Czech 4.3 50.6 54.9 4.3 11.8 16.1 2.3 26.8 100.0

Hungary 4.1 49.7 53.8 4.7 9.0 13.7 2.4 30.2 100.0

Turkey 4.9 42.1 47.0 5.9 13.3 19.2 2.4 31.5 100.0

Russia 3.3 39.2 42.6 5.7 19.1 24.8 5.7 26.9 100.0

S.Africa 5.2 27.5 32.7 11.9 18.9 30.8 7.7 28.8 100.0

Israel 4.5 26.0 30.5 23.7 11.7 35.4 4.0 30.1 100.0

India 3.8 19.9 23.7 12.5 19.6 32.1 5.1 39.1 100.0

Brazil 2.1 20.2 22.3 17.5 17.4 34.9 4.0 38.8 100.0

China 2.9 18.7 21.6 17.8 0.0 17.8 14.1 46.5 100.0

Australia 3.6 16.4 20.0 14.3 23.9 38.2 9.5 32.2 100.0

Japan 2.0 13.0 15.0 15.2 31.0 46.2 0.0 38.8 100.0

Colombia 1.1 13.8 14.9 23.6 19.8 43.5 3.4 38.2 100.0

Hong Kong 2.9 11.7 14.5 9.4 21.0 30.3 8.7 46.5 100.0

Korea 1.6 12.8 14.4 12.6 30.0 42.6 14.0 28.9 100.0

Singapore 2.4 11.9 14.3 11.5 19.3 30.8 9.2 45.7 100.0

Malaysia 1.9 12.0 13.9 12.0 21.0 33.0 11.7 41.3 100.0

Thailand 1.9 10.6 12.5 9.3 20.5 29.9 19.3 38.4 100.0

Taiwan 1.6 10.8 12.4 12.3 28.5 40.7 15.8 31.1 100.0

Philippines 1.3 10.8 12.2 13.0 17.1 30.1 17.4 40.3 100.0

Indonesia 1.5 10.3 11.8 8.8 19.4 28.3 14.8 45.2 100.0

Mexico 1.0 9.1 10.1 52.7 14.5 67.2 4.1 18.6 100.0

0.10.10.10.20.20.2

0.30.40.40.4

0.60.6

0.80.80.91.0

1.11.1

1.31.3

2.63.4

0 1 2 3 4

HungaryIsrael

RussiaIndonesia

PolandColombia

MexicoIndia

PhilippinesChinaCzech

ThailandJapanBrazil

TaiwanSouth Africa

KoreaAustraliaMalaysia

TurkeyHong KongSingapore

% GDP

Nomura | Asia Special Report 24 June 2016

10

High-conviction trades

Asia FX strategy

Long USD/CNH

A slowing China economy will have multiple negative impacts on RMB, including

exacerbating net capital outflows with China’s private sector already looking to diversify

into foreign assets, and heightening credit concerns.

Short S$NEER

We see downside to Singapore’s weak local domestic growth and inflation outlook, and

now assign a 60% probability (from 30% previously) to further easing action from the

Monetary Authority of Singapore at, or possibly before, its October 2016 meeting. SGD

could also underperform its basket components in a negative risk environment.

Long USD/KRW

Globally, KRW faces headwinds from China-related risks, potential JPY weakening

policies and eventual Fed hike-related volatility. On the domestic front, KRW will also

face pressure from a still-weak growth and inflation backdrop, the government’s pro-

growth bias, risk of shipbuilder hedge unwinds from ship order cancellations, and

government policies to spur capital outflows. The negative risk backdrop and weak

equities should also increase depreciation risks for KRW.

Asia rates strategy

Receive China front-end rates

We believe that the market is increasingly focussed on the potential for a new phase of

the China slowdown and can price in an eventual rate cut when global sentiment is

fragile. Our economics team now expects another reserve requirement ratio cut in the

near term. We maintain our recommendation to receive CNY NDIRS 2yr.

Receive India front-end rates

An increased likelihood of monetary accommodation and improved liquidity should keep

downward pressure on front-end rates, in our view. We would express this view through

receive 2yr NDOIS and being long IGB 8.27 2020. Our economics team is now pencilling

in one more 25bp cut, taking the terminal repo rate to 6.25%.

Receive Thailand rates

We expect markets to bring forward rate cut expectations, which should push rates

lower, led by the belly of the curve. We express this view by maintaining our receive

recommendations in 1yrfwd2yr NDIRS and Sep IMM starting receive 5yr NDIRS. Our

economics team continues to expect another 50bp of rate cuts in 2016.

Australia OIS flattener

Weaker regional and local growth, including via tighter financial conditions, add to our

conviction for two further 25bp rate cuts this year. This should support our July vs

November OIS flattener, along with our broader buy-on-dips and low-for-long themes in

rates.

Nomura | Asia Special Report 24 June 2016

11

Research analysts

Asia FX Strategy

Craig Chan - NSL craig.chan@nomura.com

+65 6433 6106

Wee Choon Teo - NSL weechoon.teo@nomura.com

+65 6433 6107

Dushyant Padmanabhan - NSL dushyant.padmanabhan@nomura.com

+65 6433 6526

FX strategy: Asia FX depreciation on Brexit shock

• We expect the Brexit shock to push USD/Asia broadly higher in the near term, and our

Asia FX portfolio is positioned for this through short S$NEER, long USD/CNH, long

USD/HKD and long EUR/USD put spread (hedge) positions. We maintain these

recommendations for now.

• However, we made some marginal changes to our portfolio including converting a

portion of our short CNH vs. CFETS basket position to long USD/CNH and building on

our long USD/KRW cash position. We also closed our long 1M USD/IDR put option.

• Although we see upside risk to USD/Asia, we maintain our medium-term constructive

view on South/Southeast Asia FX versus Northeast Asia and will look for opportunities

to re-establish this bias.

FX strategy

The UK voting to leave the EU presents a negative shock to broad Asia FX in the near

term. As highlighted in the economics section above, we believe a Brexit will have

negative implications for Asia FX through both financial and economic channels even if

there is some FX USD selling from central banks or liquidity provisions to help stabilise

market volatility. Specifically, the most open economies like Singapore and Hong Kong

are likely to suffer, while the negative risk backdrop and weak equities should increase

depreciation risks for KRW, TWD, and INR.

Indeed, even without a Brexit, intraregional concerns were already rising. China’s

economy has been losing momentum, while RMB depreciation pressures are continuing.

In the rest of the region, the outlook for rate cuts in Korea and Taiwan on weak growth

and low inflation were likely to add to FX depreciation pressures. KRW is also subject to

additional depreciation risks from the government’s capital outflow policies. We now

assign a 60% probability to Singapore’s MAS recentering the midpoint of the policy band

lower on or before the October policy announcement. In India, recent concerns include

the impending retirement of RBI governor Raghuram Rajan and USD demand from

September-November 2016 FCNR(B) maturities.

We note that, going into this vote, we had reduced cash positions in our portfolio –

namely long MYR (vs. USD and SGD), short USD/IDR, short USD/INR, long USDKRW

and USD/THB positions (see First Insights - Asia FX portfolio update: Shifting portfolio

into major events, 15 June 2016). Given the asymmetry of the UK referendum, we

positioned for this event by being long USD/CNH, short S$NEER, long USDHKD, long

EUR/USD put spread (hedge). However, more recently, given our UK economics team’s

base case of a Bremain, we added option positions from a potential risk rally including a

long 1M USD/IDR put option (strike = 13,200) and a 2W JPY/KRW put spread (strikes =

10.9/10.55). We also held onto our short CNH vs. CFETS basket position (see First

Insights - Asia FX portfolio update: adding option positions ahead of the UK referendum,

20 June 2016).

Overall, our portfolio has been correctly positioned following the referendum results and

driven mainly by our short S$NEER, long USD/CNH, and EUR/USD put spread (hedge).

Currently, our view is to hold onto those recommendations as the negative risk backdrop

could continue in the following sessions. However, in the remainder of our portfolio, we

made some marginal changes including converting some of our short CNH vs. CFETS

basket position to a long USD/CNH position and building on a long USD/KRW cash

position. We also closed our long 1M USD/IDR put option (see First Insights - Asia FX

portfolio update: Adjusting portfolio on higher likelihood of a Brexit vote, 24 June 2016).

Medium-term outlook

Aside from the negative economic and financial implications for Asia FX from Brexit, we

believe that the focus of the market will increase on factors that bode poorly for Asia FX,

namely the ongoing weakness in China’s economy. Nomura’s China Economics team

sees growth momentum slowing after a short-lived, debt-fuelled rebound in investment

growth (see Asia Insights - China: May data cast concerns over future growth and quality

Nomura | Asia Special Report 24 June 2016

12

of investment, 13 June 2016) and forecasts GDP growth to slow to 6.0% in 2016 (original

2016 forecast at 6.2%) versus Bloomberg consensus at 6.5%.

We believe a slowing China economy will have multiple negative impacts on RMB. First,

it will likely exacerbate net capital outflows, with China’s private sector already looking to

diversify into foreign assets (see Asia Insights - China: Past the sweet spot, 31 May

2016). Also, a slowing China economy will further heighten credit concerns with the

IMF’s April 2016 Global Financial Stability report noting that 14% (USD392bn) of 2,871

nonfinancial companies analysed (total borrowing of USD2.77tn) are not able to cover

interest expenses with earnings. Along with RMB overvaluation (6.8% on a trade

weighted basis; see AEJ asset allocation views - Rates, FX and Equities, 31 May 2016),

we now forecast USD/CNH at 6.95 by end 2016 (from 6.80 previously). At this juncture,

we are expressing our bearish RMB view through both short CNH vs. CFETS basket as

well as long USD/CNH, but given amplified risks following the UK Brexit vote, we have

shifted some of our basket risk to short CNH (vs. USD).

We also maintain our medium-term KRW underperformance view. On the global front,

KRW faces headwinds from China-related risks, potential JPY weakening policies and

the eventual US Fed hike-related volatility. On the domestic front, KRW will also face

pressure from a still-weak growth and inflation backdrop, the government’s pro-growth

bias (our Korea economist, Young Sun Kwon, expects two more 25bp cuts this year in

October and December), risk of shipbuilder hedge unwinds from ship order cancellations

(see First Insights - Almost one less risk to KRW, 8 June 2016) and government policies

to spur capital outflows (see First Insights - KRW: Flow impact of NPS overseas asset

allocation, 18 May 2016). Therefore, we build on our long USD/KRW cash position, given

the risk of the selloff in financial markets continuing in the near-term.

After some temporary SGD outperformance and spot S$NEER rising to a high of around

+1.5% above the mid-point on 23 June, S$NEER has since fallen back to around +0.8%

(24 June, 1:50pm SGT). We believe the risk/reward to hold on to short S$NEER is

skewed insofar as SGD could underperform its basket components in a negative risk

environment. In addition, the market is likely to shift its focus back to the weak local

domestic growth and inflation backdrop, to which we see downside risks and now assign

a 60% probability (from 30% previously) to further easing action from the MAS on or

even possibly before October 2016 (see Asia Insights - Singapore: MAS surprises with a

zero slope, 14 April 2016). A move before October 2016 is possible if the financial

market contagion continues and leads to substantial downside growth/inflation risks.

Externally, SGD should also face pressure from a slowing China given its highly open

export-oriented economy.

In Southeast Asia, we continue to expect medium-term relative outperformance in MYR

and IDR. We are exiting our long 1M USD/IDR put option, but look to re-establish both

long MYR and IDR cash positions following the near-term UK-related shock. In Malaysia,

political pressure continues to fade from 1MDB, and from the ruling Barisan Nasional

(BN) coalition’s victories in the Sarawak state election and recent by-elections in Sungai

Besar and Kuala Kangsar (see First Insights - Malaysia: BN prevails again in by-

elections, 20 June 2016). Furthermore, our rates strategy team expects limited bond

outflows from both Malaysia and Indonesia after our US economics team pushed out

their forecast for the next Fed rate hike to December 2016 (previously September; see

Policy Watch - Brexit Vote Will Likely Delay FOMC Rate Hike, 24 June 2016). In

Indonesia, we are also looking for local support for IDR, as media reports indicate that

parliament will decide on the tax amnesty bill on 28 June (source: Bloomberg). However,

there are some risks to both IDR and MYR given the downside risks to oil prices

following the UK Brexit shock.

In India, while Brexit is expected to cause a slowing of growth, economic prospects

remain relatively sanguine due to the impact of local factors like a strong monsoon, the

impact of pay hikes and higher public capex. For INR, we are concerned with potential

near-term risks stemming from the replacement of outgoing RBI governor Raghuram

Rajan (on 4 September) following his surprising decision to step down (see Asia Insights

- India: RBI Governor Rajan to step down in September, 19 June 2016) as well as from

market concerns around upcoming FCNR(B) deposit maturities. Furthermore, the UK

and Europe constitute a significant part of INR’s effective exchange rate (23.7%) and

further equity market weakness and foreign investor outflows could weigh on INR, as

could further rate cuts from the RBI (Nomura economics now expects a 25bp cut in H2).

However, India is likely to benefit from weakness in energy prices, while progress with

Nomura | Asia Special Report 24 June 2016

13

reforms on FDI and potentially the GST constitutional amendments could present

tailwinds (see First Insights - India: Government liberalises FDI regime, 20 June 2016).

Overall, we maintain our constructive medium-term view on INR, but global and domestic

risks remain prominent in the near term.

Fig. 10: Asia FX forecasts

Source: Bloomberg, Nomura.

Current FC New FC FX fwd New FC Current FC New FC FX fwd New FC

Spot End 2016 End 2016 End 2016

% Chg

from Spot End 2017 End 2017 End 2017

% Chg

from Spot

CNY 6.6187 6.80 6.94 6.72 4.9% 6.79 6.98 6.89 5.5%

CNH 6.6381 6.80 6.95 6.65 4.7% 6.79 6.98 6.83 5.2%

HKD 7.7614 7.82 7.85 7.75 1.1% 7.80 7.84 7.76 1.0%

INR 68.127 67.6 69.5 70.4 2.0% 67.5 69.5 74.4 2.0%

IDR 13415 13400 13650 13970 1.8% 13600 13950 15101 4.0%

MYR 4.1362 4.12 4.18 4.16 1.1% 4.13 4.22 4.23 2.0%

PHP 46.985 46.6 47.3 47.5 0.7% 46.5 48.0 48.7 2.2%

SGD 1.3632 1.43 1.45 1.34 6.4% 1.44 1.47 1.36 7.8%

KRW 1178.4 1220 1250 1181 6.1% 1230 1270 1179 7.8%

TWD 32.495 33.7 34.4 32.5 5.9% 33.8 34.5 32.4 6.2%

THB 35.445 36.6 37.5 35.3 5.8% 37.0 38.0 36.2 7.2%

Nomura | Asia Special Report 24 June 2016

14

Research analysts

Asia Rates Strategy

Albert Leung - NIHK albert.leung1@nomura.com +852 2252 1401

Andrew Ticehurst - NAL andrew.ticehurst@nomura.com +61 2 8062 8611

Vivek Rajpal - NSL vivek.rajpal@nomura.com +65 6433 6555

Prashant Pande - NSL prashant.pande@nomura.com +65 6433 6547

Asia rates strategy: Starting fresh

Markets appeared to have been leaning towards a Bremain outcome as the referendum

approached, so the Brexit outcome has obviously roiled global financial markets. UST

has benefited strongly from safe-haven flows, with 10yr yields down as much as 25bp

and the majority of Asia rates have rallied in tandem with US rates. The next focus will

be on how UK financial assets perform and if there are any policy responses by major

central banks. From here, we see the following three themes for Asia rates:

• A weak growth outlook, poor risk sentiment and a dovish Fed are bullish for

most Asia rates. The Brexit should lead to a further pricing out of Fed rate hike

expectations and further price in a lower growth trajectory for Asia economies, as our

Asia economics team have reduced their 2016 aggregate GDP forecast to 5.6% from

5.9%. The rates market that should benefit most are those with already dovish central

banks and those in which interbank liquidity is expected to remain broadly stable, even

in the face of FX weakness: Korea, Taiwan, China, Thailand and India. We currently hold

front-end receivers in Thailand, China and Taiwan and remain comfortable with these

trades. We are also more confident in our call for 50bp of rate cuts in Australia in H2.

• Rates markets with stronger FX linkages should underperform US rates. HK rates

have come off this morning but, as expected, by less than the US. Singapore rates

have exhibited a twist flattening tendency with front-end rates rising and the longer end

lowering. We expect flattening pressure to remerge in the Singapore curve. We believe

the Brexit will exert fresh pressure on HK financial assets and eventually lead to capital

outflows, higher USD/HKD and a rise in HIBOR. We maintain our pay 5y HK IRS

recommendation. We are also more wary of rates markets with relatively higher foreign

participation in local bond markets such as Indonesia which, in the past, have sold off

in risk-aversion episodes.

• Yield curves will likely flatten initially. While we hold a combination of front-end

receivers and steepeners in our portfolio, we have recently shifted our bias towards

receivers by adding to Thailand receive position (see Asia Insights - Thailand rates:

Relief for the longer end, 6 June 2016) and reducing our pay overlay in Korea (See

First Insights - Asia rates: A bullish impulse amid looming risks, June 16 2016 and First

Insights - Korea rates: Reduce pay exposure, June 20, 2016). We also added receive

US 5yr swaps in our portfolio as a hedge against steepeners. As a first reaction, the

market has priced out any chance of a Fed hike this year (it is only pricing a 6%

likelihood of a hike in 2016). Our bias is to add more to our receive bias trades. We

expect most of the Asia curves to bull flatten initially. However, if monetary and fiscal

accommodation increases over time, steepening may emerge in a few months.

Trade ideas:

• China: Receive NDIRS 2yr.

• India: long IGB 8.27 2020; Receive 2yr NDOIS and 2s5s steepeners.

• Australia: a July-November OIS flattener.

• Thailand: receive 1yrfwd2yr and 5yr NDIRS.

North Asia

China: We continue to recommend receive 2y NDIRS and are considering adding to this

position. Over the past week, China rates have rallied despite the market leaning

towards Bremain. The market seems increasingly more focussed on the potential for a

new phase of China slowdown and expects the PBOC may eventually have to ease

monetary policy in some form. Our economics team now expects a near-term RRR cut

following the Brexit outcome. We do not expect the 7d repo fixing to deviate much from

the long-held range of close to 2.40% unless it is accompanied by a policy rate or OMO

rate cut. However, the market can price in an eventual rate cut when global risk

sentiment is fragile, which means that front-end IRS may trade to around 2.30% while

the curve should bull flatten.

Hong Kong: We currently hold both a pay 5y IRS and 1y forward 1s4s steepener. While

HK rates have rallied following the Brexit vote, it has rallied by less than in the US, as we

Nomura | Asia Special Report 24 June 2016

15

expected in our Brexit scenario). In the medium term, we see room for HK rates to go up,

at least relative to the US, on escalated capital outflow risks and a likely increase in RMB

depreciation concerns. We still like pay 5y IRS, but will reassess the steepener position

as there is now a higher risk of front-end IRS moving higher on global risk aversion,

similar to the move in January.

Korea: We continue to recommend steepeners in Korea but look to neutralize our pay

overlay after already reducing our pay exposure earlier in the week. Nomura Economics

now expects two more 25bp policy rate cut by the end of the year instead of one. This

should definitely drive rates lower, but we are still unsure whether the curve has much

room for flattening because, for example, the 2s5s IRS spread is already flatter than any

time during the July 2014 to June 2015 period (when the BOK cut rates four times) and

this time we expect a KRW15trn supplementary budget to be announced shortly.

Taiwan: We currently hold a combination of a receive 3y and 2s5s steepeners. Nomura

Economics now expects the Central Bank of the Republic of China to cut policy rates by

a cumulative 50bp (instead of 37.5bp) by year-end. This clearly favours receivers,

perhaps against a steepener. We will reassess our steepener position, as it was

originally premised on a steepening of the US rates curve and our view that Taiwan lifers

will increase allocation to higher yielding Formosa bonds. Amid increased global risk

aversion, we believe Taiwan lifers could return their focus to TGBs, even at lower yields.

India and Southeast Asia

Malaysia: We expect market to price in a rate cut. Given the forward expectations of

lower fixings, the curve should flatten initially in swaps. We look to increase the receive

bias in our portfolio. On bonds, we expect a selloff initially, as risk aversion will weigh on

FX markets. However, given rate cut expectations, any sell-off in bonds should be

limited.

Thailand: We expect markets to bring forward rate cut expectations. This should push

rates lower, led by the belly of the curve (5yr). We are currently holding receive

1yrfwd2yr NDIRS, receive 5yr NDIRS and 2s10s steepeners. We are looking to increase

the receive bias trades in our portfolio.

Singapore: We expect the Singapore IRS curve to flatten as a result of the Brexit vote.

Front-end rates will be pressured higher, as the market prices in more monetary policy

easing while longer-end rates should fall in line with DM rates. We now expect Singapore

rates to underperform US rates.

India: Given the high probability of accommodation on both monetary and fiscal policy

fronts, we expect curves to remain in steepening mode. However, given the expectations

of rate cuts, receivers in the front end of NDOIS along with steepeners would make

sense. Our current recommendations include long IGB 8.27 2020, long IGB 8.27 2020

versus pay 5yr and 2s5s steepeners. We expect front-end bonds to hold up well in this

scenario. We also added a receive 2yr NDOIS to our portfolio earlier this morning.

Australia

The surprise Brexit outcome has rattled markets. The negative hit to sentiment and to

wealth effects will certainly support our long-held “low-for-long” and “buy-on dips” theme

in rates, which reflects our cautious local and regional growth outlook, as well as our

expectation that the RBA will cut the cash rate further this year. This Brexit news will

therefore support our long-held July vs November OIS trade flattener (see Australia

Rates Insights, 21 March 2016). We would also expect our received 2s4s10s fly (see

Rates Weekly, 12 February 2016) to perform relatively well in this environment. Over the

past few weeks, the market has moved from pricing in around 40bp of easing to around

23bp, so a return to around 40bp seems likely, subject to shifts in AUD and broader

financial conditions.

Nomura | Asia Special Report 24 June 2016

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Yang Zhao - NIHK yang.zhao1@nomura.com

+852 2252 1306

Chang Chun Hua - NIHK changchun.hua@nomura.com

+852 2252 2057

Wendy Chen - NIHK wendy.chen@nomura.com

+86 21 6193 7237

Country views

China: Lowering GDP growth forecast to 6.0% for 2016 on Brexit

We also expect an additional 50bp RRR cut in the near term, on top of our existing call of

two RRR cuts and one rate cut in H2.

The UK is a small trade partner in terms of China’s economy. Exports to the UK

accounted for only 2.6% of total exports in 2015; imports from the UK at a smaller 1.1%.

The UK is neither an important source of FDI (0.4% of total in 2015), nor a vital

destination for Chinese direct investment overseas (1.2% in 2014, latest data available).

The BIS estimates that the UK’s claims on Chinese domestic banks amounted to 0.4% of

China’s GDP as of 2015.

However, the impact of the Brexit decision could be quite significant, primarily via its role

in weakening external demand from Europe. Our Europe economics team estimates that

the drag from the Brexit is likely to cut euro area GDP growth by at least 0.5pp. As the

EU accounts for some 16% of China’s total exports, this can be expected to exacerbate

China’s already-sluggish external demand (export growth fell to -6.9% y-o-y in the first

five months of 2016, versus 0.3% in the same period of 2015).

Moreover, the Brexit will impose significant negative impacts on the Chinese economy

through escalating capital outflows and financial risks. The increased uncertainty

triggered by the Brexit will arouse investors’ risk-aversion sentiment and lead to capital

outflows from China and other emerging economies. Such things happened in 2008/09

and 2012 when the global financial crisis and European debt crisis unfolded. China is

now experiencing capital outflows due to concerns over the growth slowdown and fears

of RMB depreciation. The Brexit will accelerate the capital outflows, and the policy maker

may impose more restrictive capital control to rein in the risk of capital flight.

Turbulent or at least volatile financial markets can now be expected, as markets never

fully priced in a Brexit scenario; Nomura had assigned only a 25% probability to this

outcome while British bookmakers set the probability at around one-in-three. So expect

jittery markets. China’s equity market has become more correlated with global markets

over recent years5, and so is unlikely to be spared any global volatility. With the Chinese

equity market stil trying to cope with the sharp selloff in mid-2015, any further Brexit-

driven weakness will, in our opinion, at the very least hit sentiment hard in some areas of

real economic activity, such as property sales or fixed asset investment, hindering

already-slowing growth further.

Furthermore, we expect RMB to depreciate against USD due to the Brexit. As the

decision will drag EUR and GBP lower, RMB may need to depreciate against USD if

policymakers decide they do not want to see too much appreciation of RMB against the

trade-weighted basket. That said, we believe it unlikely that policymakers will devalue

RMB aggressively, and therefore the real effective exchange (REER) is likely to

appreciate, posing further stress to China’s exports.

Overall, we expect the Brexit to cut 0.2pp off China’s real GDP growth in 2016, taking

our growth forecast to 6.0% from 6.2%, which translates into a 0.4pp cut in growth in H2.

We expect macro policy to be more accommodative now in an effort to offset the Brexit

shock. We are adding one 50bp reserve requirement ratio (RRR) cut to our monetary

policy call – which we expect to see very soon – so that we now expect three 50bp RRR

cuts and one 25bp interest rate cut through the rest of the year.

5 The correlation coefficients of the Shanghai Composite Index (SHCOMP) with those of major economies have

increased markedly in recent years: with Japan, to 0.60 over the period 2011-15 from 0.11 in 2001-05; with the

US, to 0.46 from 0.06 over the same timeframe and with Europe to 0.62 from 0.54.

Nomura | Asia Special Report 24 June 2016

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Young Sun Kwon - NIHK youngsun.kwon@nomura.com

+852 2536 7430

Minoru Nogimori - NIHK minoru.nogimori@nomura.com

+852 2252 6462

North Asia: Open economies are vulnerable

Korea, Taiwan and Hong Kong are all small, open economies and therefore vulnerable

to a Brexit through both real and financial channels. Hong Kong, especially, could be hit

the hardest in the region given its status as a financial hub and its currency peg. With a

Brexit in place, we believe these countries will now have to implement further fiscal and

monetary support for their economies.

Korea

We trim our 2016 GDP growth forecast from 2.5% to 2.2% due to weak exports and

delayed business investment. The direct impact on Korea’s merchandise exports should

be small, as Korea’s exports to the UK and the rest of the EU accounted for only 3.5% of

GDP in 2015. However, increased financial market volatility and uncertainty about the

global economy is likely to at least limit, if not reduce business investment. In particular,

the shipbuilding and shipping industries, which are undergoing a corporate restructuring,

may cut their capacity and employment further.

We still expect a KRW15trn (1% of GDP) FY16 supplementary budget to be announced

in late June, but now expect the Bank of Korea to deliver two more 25bp rate cuts, taking

its policy rate to 0.75% in 2016, compared to our previous forecast of one cut to 1.00%.

Taiwan

We cut our Taiwan GDP growth forecast to 0.4% from 1.0% for 2016. Taiwan’s exports,

which to the UK and the rest of EU accounted for 4.6% of GDP, can be expected to fall

further. In addition, a slower Chinese economy − our China economics team has

trimmed its 2016 GDP growth forecast to 6.0% from 6.2% − will also drag on exports.

Negative sentiment will likely have a negative impact on an already fragile housing

market, which in turn should curb private consumption.

We now expect the Central Bank of China to deliver a total of 50bp of rate cuts to

1.000% through the rest of 2016, compared to our previous forecast of 37.5bp to

1.125%. We also expect the government to formulate an FY16 extra budget, allowing for

a larger fiscal deficit than our previous forecast of 1.5% of GDP in 2016.

Hong Kong

We believe that the decision today is likely to push Hong Kong into an outright recession

(-0.2%) in 2016, compared to our previous forecast of low GDP growth of 0.8%. Hong

Kong’s merchant exports to the UK and the rest of EU accounted for 14% of GDP in

2015, the highest in Asia. Given the Brexit, we expect USD to remain strong, and

therefore, given the peg, so to HKD. A stronger real effective HKD is likely to have a

negative impact on Hong Kong’s tourism and retail sales (especially if it means a weaker

RMB; see the China page for more on this). UK banks’ claims to Hong Kong are

equivalent to 2.6% of Hong Kong’s GDP, the second-highest in Asia after Singapore

(3.4%). Uncertainty over the global financial markets and the domestic economy is likely,

in our opinion, to reduce financial transaction volumes significantly, which is a major

negative for the financial sector. We are particularly concerned about an already fragile

Hong Kong property market.

Given the current scenario, we will expect the government to increase fiscal spending,

which will narrow the fiscal surplus to 0% of GDP from 0.4% in the FY16-17 budget and

we also expect the government and Hong Kong Monetary Authority (HKMA) to ease

some of tightening measures on the property market.

If today’s vote happens to trigger massive, sudden, capital outflows from Hong Kong,

we would expect the HKMA to take whatever measures it feels necessary to defend

the USD/HKD peg – it could, for example, allow Hibor rates to move higher than USD

Libor rates.

Nomura | Asia Special Report 24 June 2016

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Sonal Varma - NSL

sonal.varma@nomura.com +65 6433 6527

Neha Saraf - NFASL

neha.saraf@nomura.com +91 22 4037 4218

India: Brexit means more accommodation

As India’s economy is largely driven by domestic demand, the economic impact of a Brexit

should be small relative to other open economies in Asia. Still, it is not immune, as it has

strong trade linkages with the EU and is susceptible to a loss of business confidence and

a potential tightening of financial conditions. In our view, any adverse impact could be

partly cushioned by upcoming domestic impulses to growth such as good monsoons,

pay commission hikes and a likely easing of policies (both monetary and fiscal) but,

nonetheless, we expect the growth recovery to slow.

Growth impact

Although India’s trade with the UK is not as significant as other Asian economies, it is still

vulnerable as it has strong trade linkages with the rest of EU. The UK’s share in India’s

exports is just ~3.5%, but the rest of the EU accounts for ~13.5% of India’s exports.

Furthermore, a growth slowdown in the rest of Asia would likely exacerbate the impact

on Indian exports, which are already struggling in the current backdrop of weak global

demand. By sector, the UK accounts for a fair share of India’s exports of apparel (10%),

footwear (17%) and machinery (5%), which we believe are likely to be the worst hit.

Weak exports will hurt business confidence, as capacity utilisation is already quite low in

several sectors. We also expect financial conditions to tighten somewhat owing to

portfolio outflows in a flight to safety and tighter credit standards by European banks.

Rolling over external commercial borrowings and trade credit by Indian corporates will

likely become more challenging owing to increased risk aversion. Banking sector claims

on India from the UK and EU totalled 1% of GDP in 2015. Overall, the negative impacts

via the confidence and financial linkages channels are likely to further delay any revival

in private sector investment, which would slow down the pace of recovery.

Despite the headwind, we continue to expect a recovery, albeit at a much slower pace

because 1) good monsoons and upcoming pay commission hikes are likely to support

consumption demand; 2) lower commodity prices should act as a positive terms of trade

shock, boosting corporate profits; and 3) monetary and fiscal policies are likely to turn

more accommodative to cushion the Brexit fallout.

On balance, we expect GDP growth to still rise from 7.2% in 2015 to 7.3% in 2016, which

is still much weaker than our earlier forecast of 7.6%. In 2017, we expect the negative

impact to fade, as the financial contagion impact subsides and the impact of easier

macro policies feeds through with a lag. Accordingly, we expect GDP growth to rise to

7.7% in 2017, down from our previous base case of 7.9%.

Policy response

The immediate priority for policymakers is to ensure sufficient USD and INR liquidity to

keep markets well-oiled. Therefore, if capital outflows drive a marked liquidity tightening

in coming weeks, we believe that the RBI would step up its open market operations and

provide dollar liquidity through its FX reserves, if necessary.

Lower commodity prices and a larger negative output gap should also reduce inflationary

pressures, creating downside risks to the RBI’s 5% CPI inflation target for March 2017.

Along with a rising risk of a more accommodative policy under a new RBI governor (see

India: The ideological composition of RBI governor candidates, 22 June 2016), we now

expect a 25bp repo rate cut to 6.25% in H2 2016, with a risk of additional easing if

downside risks magnify (previous forecast of no change).

On fiscal policy, we believe the government is likely to relax its fiscal deficit target by

20bp to 3.7% in FY17 (vs. 3.5% budgeted), to make room for additional spending to

support growth and since asset sales could disappoint. We also expect higher public

investment to offset a likely deceleration in private sector investment. For FY18, the

current fiscal deficit target of 3% is already under review (see India: Government

announces committee to review fiscal targets, 18 May 2016). The government is

considering moving to a medium-term fiscal deficit target range (instead of a point target)

in order to align its fiscal stance to the stage of the business cycle. Under these

circumstances, we assign a high likelihood to the government relaxing its fiscal deficit

target for FY18 by 30-50bp (3.3-3.5%) to support a growth recovery.

Nomura | Asia Special Report 24 June 2016

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Euben Paracuelles - NSL

euben.paracuelles@nomura.com +65 6433 6956

Brian Tan - NSL

brian.tan@nomura.com +65 6433 6930

Lavanya Venkateswaran - NSL

lavanya.venkateswaran@nomura.com +65 6433 6985

ASEAN: Negative implications across the board, but for some

worse than others

In ASEAN, we expect the Brexit shock to hit the more open economies harder.

Singapore will likely be the most exposed, followed by Thailand and Malaysia, while

Indonesia and the Philippines are likely to be the least affected (Figure 1). Not only is

Singapore’s economy already facing growth challenges on multiple fronts (see Asia

Insights - Singapore: Q1 GDP growth unchanged, 25 May 2016), it is also an

international financial centre and therefore likely significantly more vulnerable to

associated financial market turmoil. We then expect Thailand to be more exposed than

Malaysia. While we assess their overall exposure to the UK and the European Union to

be broadly similar, economic fundamentals are weaker in Thailand (see Asia Insights -

Thailand: Starting Q2 on a fragile footing, 31 May 2016), while Malaysia's growth outlook

has been more resilient (see Asia Insights - Malaysia: Q1 GDP still resilient, 13 May

2016). We expect Indonesia and the Philippines to be least affected, given that growth in

those countries is primarily domestic-driven, their fundamentals are solid and financial

and banking system penetration by foreign investors is relatively low.

Fig. 11: Drag to GDP growth and FX depreciation impact from Brexit in ASEAN (Nomura estimates; 2016)

Note: FX depreciation impact based on new end-2015 forecasts versus our previous end-2015 forecasts. Source: Nomura

estimates.

Apart from the direct exposure though the trade and financial channels, we expect

indirect repercussions from lower commodity prices. If, as we expect, the price of Brent

crude oil takes a step down to USD40/bbl in H2 from our current H2 forecast of USD51,

this would likely be negative for current account balances in commodity-exporting

Malaysia and Indonesia. At the other end of the spectrum, lower commodity prices

should be positive for current accounts in net oil-importing Philippines, Thailand and

Singapore. However, except for the Philippines, the experience of the last two years

suggests cheaper commodities are unlikely to provide any meaningful support to

economic growth in Thailand and Singapore.

The negative impact on growth from today’s decision will likely trigger monetary and

fiscal policy easing across ASEAN, but its extent will depend on the available policy

space. In particular, we now expect another 25bp policy rate cut in Indonesia on top of

the 25bp we had already expected in Q4, which should bring the 7-day repo rate to

4.75% by year-end from 5.25% currently. There is also scope for some easing of

macroprudential measures, including cuts in reserve requirements if liquidity tightens as

a result of capital outflows. Similarly in Malaysia, we expect a 25bp policy rate cut to

3.00% and Statutory Reserve Ratio cuts remain an option. Craig Chan, head of Asia FX

strategy, now believes Singapore will likely ease its FX policy by re-centering the

S$NEER policy band lower on or before the October policy announcement (60%

probability, up from 30% previously).

We continue to believe the Bank of Thailand (BOT) will cut its policy rate by 50bp in H2

this year, but Brexit will likely force an otherwise reluctant BOT to bring the cuts forward.

We see Indonesia and Philippines as keeping an expansionary fiscal stance and there is

0

1

2

3

4

5

6

7

8

9

10

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

Singapore Thailand Malaysia Indonesia Philippines

Drag to GDP Growth FX Depreciation (RHS)

pp %

Nomura | Asia Special Report 24 June 2016

20

scope for Singapore to adopt more fiscal easing than originally planned. Malaysia will

likely remain constrained, while Thailand has the fiscal room to expand fiscal policy but is

faced with high execution risks including inefficiencies at the executing agencies.

Indonesia

The impact of Brexit on Indonesia’s GDP growth should be relatively limited at 0.2pp,

mainly coming from the impact on sentiment, which could delay the pickup in private

sector spending that we still expect in the coming quarters (see Asia Special Report -

Indonesia: The great revival, 19 May 2016). However, the fiscal stance remains

expansionary and the quality of spending has improved with the acceleration of

infrastructure spending, which we believe should remain largely intact despite the Brexit.

This should still eventually crowd-in private investment, alongside other supportive

factors such as lower interest rates.

In terms of a monetary policy response, we have one 25bp policy rate cut pencilled in for

the rest of this year, likely in Q4, but likely lower inflation and a delay to the next Fed rate

hike (see Policy Watch - Brexit Vote Will Likely Delay FOMC Rate Hike, 24 June 2016)

should allow an additional 25bp cut in response to today’s events. Bank Indonesia (BI) is

also likely to expand the macroprudential easing that it has already started with the

relaxation of property market measures. In addition, we see scope for BI to cut primary

reserve requirement ratios.

Malaysia

We estimate Brexit’s drag on Malaysia’s GDP growth at 0.4pp, which will likely push full-

year GDP growth below the official 4.0-4.5% forecast. As such, we believe Bank Negara

Malaysia (BNM) will cut the policy rate by 25bp, possibly as soon as July. While BNM

has consistently viewed the current policy stance as being accommodative and

supportive (see Asia Insights - Malaysia: Monetary policy unchanged, 19 May 2016), it

has also highlighted in its monetary policy statements that it is monitoring downside risks

to global economic and financial conditions. From this perspective, we believe

BNM could quickly cut its policy rate should such downside risks materialise.

This is also partly because there is limited room for a fiscal policy response. We believe

the government will stay on the path of fiscal consolidation as long as the price of Brent

crude does not fall below the budget assumption of USD30-35/bbl. We previously

estimated that every USD5 decline in the oil price would widen the fiscal deficit by 0.1%

of GDP (see Asia Insights - Malaysia: Manageable impact from oil, 15 January 2016). As

we expect the oil price to dip to USD40/bbl in H2, we continue to expect the government

to meet its 2016 fiscal deficit target of 3.1% of GDP. In 2017, however, the pace of

consolidation will likely remain slow: the government will likely reduce the fiscal deficit by

just 0.1% of GDP, as it did for 2016. More non-fiscal measures to support growth such

as increased spending by state-owned enterprises and further cuts to the employee

contribution rate to the Employees Provident Fund, similar to those announced in

January this year, are however likely (see First Insights - Malaysia: Fiscal deficit target

unchanged at 3.1% of GDP, 28 January 2016).

Philippines

Brexit’s impact on GDP growth in the Philippines should be relatively limited at 0.2pp,

given the relative strength of the domestic economy and lower exposure to both trade

and financial channels. We believe Bangko Sentral ng Pilipinas (BSP) is unlikely to

respond to the Brexit by easing monetary policy − it already effectively eased policy in

May, despite still strong economic growth, when it officially unveiled its new monetary

policy corridor framework (see Asia Insights - Philippines: A new monetary policy

corridor, 17 May 2016) which we believe is a path it will likely continue down, ultimately

aimed at improving policy transmission. We therefore continue to expect BSP to leave

rates unchanged for the rest of the year.

There is room, however, for fiscal policy to be even more expansionary, with the

incoming government already clearly signalling its intention to further ramp-up

infrastructure spending, looking to increase the fiscal deficit to 3% of GDP from the 1.9%

it is tracking so far this year (see Asia Insights - Postcard from Manila, 9 June 2016).

Singapore

We estimate Singapore to be among the most vulnerable economies in Asia ex-Japan to

the Brexit, with economic growth likely to fall by 0.7pp. We have been arguing that an

external shock would be required before the Monetary Authority of Singapore (MAS)

eases its FX policy further (see Asia Insights - Singapore: MAS surprises with a zero

Nomura | Asia Special Report 24 June 2016

21

slope, 14 April 2016). Brexit qualifies as one, in our view, and hence Craig Chan, head of

Asia FX strategy, now believes Singapore will likely ease its FX policy by re-centering

the S$NEER policy band lower on or before the October policy announcement (60%

probability, up from 30% previously).

Similarly, the government will likely have to deviate from its usual post-election fiscal

conservatism and spend more, though this may be more likely in FY17, in our view. The

FY16 budget projected a fiscal surplus of 0.8% of GDP (see Asia Insights – Singapore:

Budget 2016 – transitional and targeted, 24 March 2016), which should provide the

space to fund a fiscal deficit in FY17. However, we do not rule out the possibility that the

government will draw on past fiscal reserves with the consent of the president, as it did in

2009, to ensure it can mount a sufficiently robust fiscal response against the shock.

Similar to 2009, we expect the government to expedite public-sector projects and

support the labour market via measures such as wage subsidies and incentives for

employers to retain workers.

Thailand

We estimate the drag on Thailand’s economic growth at 0.5pp, slightly worse than

Malaysia’s. This is premised on our view that despite some THB depreciation, further

weakness in external demand resulting from Brexit will exacerbate an already structurally

challenged export sector (see Asia Insights - Thailand: Structural factors explain the

ailing export sector, 25 April 2016). Meanwhile, the headwinds facing domestic demand,

including rising political uncertainty ahead of the 7 August constitutional referendum (see

Asia Insights - Thailand: The new draft of the constitution looks even less democratic, 1

April 2016), excess capacity in the manufacturing sector, high household debt levels and

anaemic wage growth will continue to drag on overall GDP growth.

We were already forecasting a total of 50bp in rate cuts this year. With Brexit adding to

the slew of headwinds to growth, the BOT could finally utilize the available monetary

policy space which in the last few months, despite the clear case for cutting rates in our

view, it has persistently said it will look to preserve.

We also expect the government to boost its efforts to accelerate disbursements for

government spending to support growth. We were forecasting an FY16 fiscal deficit of

2.3% of GDP, below the budgeted 2.9%, because of capital underspending and political

uncertainty in H2. We now expect the government to authorise additional spending to

meet its deficit target, likely via measures that are easy to implement such as cash

handouts to farmers and tax breaks for urban consumers.

Nomura | Asia Special Report 24 June 2016

22

Andrew Ticehurst - NAL andrew.ticehurst@nomura.com +61 2 8062 8611

Australia

The UK and the broader Euro area are small trading partners for Australia. However we

see measurable negative impacts via second-round macro and financial channels.

Exports to the UK represent only around 2% of Australia’s total exports. If we expand to

include the broader euro area, this figure rises, but to only around 5%. We would

therefore expect an extremely modest direct first-round macro impact from weaker

growth in the UK and Europe following the Brexit decision.

However, slower European growth should particularly impact some of Australia’s major

trading partners, including China and Korea, as has been highlighted elsewhere in this

report. Therefore, second-round macro impacts from slower regional growth and lower

(than otherwise) commodity prices seem likely. Export growth should be a little weaker

than otherwise and, although difficult to model, any lasting hit to business sentiment will

likely do little to encourage non-mining business investment in Australia, which has, of

course, been the missing ingredient in the growth mix throughout the post-mining boom

landscape.

In addition to these direct (and likely medium-term) macro impacts, we see additional

(and indeed more immediate) impacts from financial channels, including weaker equity

markets and wider credit spreads. Indeed, the direction of the shock will likely flow from

financial channels to the real economy (rather than the other way around).

The swing factor for Australia is the floating AUD, which has moved significantly lower,

as it has done following previous major global shocks (like in 2008), thereby providing

some “insulation” for the local economy. We now forecast a decline in AUD to around 65

cents (from our previous forecast of 67 cents) by the end of 2016.

The Reserve Bank of Australia (RBA) also clearly retains some capacity to “come to the

party” and provide policy support. Following the 25bp rate cut in May and as the RBA’s

lowered its inflation forecasts in its latest quarterly statement, we shifted our call, to look

for two further 25bp cuts, most likely in August and November this year. The lack of a

clear easing bias in the RBA’s more recent June statement and some better local data

(particularly Q1 GDP), appeared to be placing that call under some near-term pressure.

We certainly feel more confident in our forecast cash rate profile following today’s

events.

Overall, we estimate Brexit and the likely subsequent market reaction to cut around

0.2pp from our 2016 GDP forecast, to 2.7%.

Nomura | Asia Special Report 24 June 2016

23

Recent Asia Special Reports

Date Report Title

19-May-16 Indonesia: The great revival

8-Apr-16 Hong Kong's property market: A fault line in the economy

21-Mar-16 China’s monetary policy regime in transition

19-Feb-16 Philippines: Challenging portfolio flows

29-Jan-16 EM impact from very low commodity prices

25-Jan-16 Introducing the Nomura RBI Signal Index

7-Dec-15 Asia 2016 outlook- Choppier seas ahead

26-Nov-15 The path to RMB internationalisation

25-Nov-15 Indonesia: Silver linings

23-Oct-15 Singapore's productivity conundrum

5-Oct-15 China: Pace of rebalancing weighs on growth

9-Sep-15 The Bank of Korea is approaching uncharted territory

27-Aug-15 The next food price surge

20-Aug-15 Assessing RMB depreciation

24-Jul-15 INR: Sustained strength lies ahead

16-Jul-15 Asia to ride through Fed lift-off

26-Jun-15 India's 4% inflation goal

2-Jun-15 The geography of China risk

31-Mar-15 China: Slower is better

23-Mar-15 Korea: Defusing the interest-only mortgage time bomb

29-Jan-15 Introducing the Nomura China Growth Surprise Index

28-Jan-15 Quantifying China's monetary policy

15-Dec-14 The global impact of Abenomics

24-Nov-14 Asia 2015 outlook- Choppy seas ahead

29-Oct-14 Indonesia: Here comes the hard part

28-Oct-14 The impact of commodity prices on EM

8-Oct-14 Introducing Nomura's BOK Signal Index

26-Sep-14 China's property market blues

29-Aug-14 Escaping the middle income trap

20-Aug-14 The BOK's asymmetric policy response

16-Jul-14 Abenomics x Modinomics = Greater opportunities for Japan and India

14-May-14 Asean on the move

8-Apr-14 India's defining moment

25-Mar-14 Korea: Housing recovery set to accelerate

18-Mar-14 Indonesia's changing of the guard

14-Mar-14 Emerging markets politics: Crunch time

5-Feb-14 Asia's alive in the bitter sea

21-Jan-14 Thailand: No easy way out

6-Dec-13 Unlocking the Renminbi trend

26-Nov-13 2014 outlook: Growing divergences

18-Oct-13 Malaysia: At a fiscal crossroads

24-Sep-13 China's heavy LGFV debt burden

6-Sep-13 Asia's wake-up call

Nomura | Asia Special Report 24 June 2016

24

Appendix A-1

Analyst Certification

We, Robert Nemmara Subbaraman, Craig Chan, Vivek Rajpal and Albert Leung, hereby certify (1) that the views expressed in

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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 grpsupport@nomura.com 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 rules, may not be associated persons of NSI, and may not be subject to FINRA Rule

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