ASIA_ECONOMICS_ANALYST：TEN_QUESTIONS_FOR_ASIA_IN_2013-2013-01-04.ppt

,MK Tang,January 4,2013Issue No:13/01Asia Economics AnalystEconomics ResearchTen Questions for Asia in 2013Andrew Tilton,We wish our readers a happy and successful 2013.To kick off the year,wereview ten questions that we think will be important for Asianand inmany cases globalmarkets this year.At the risk of oversimplifying a setof very complex issues,these questions can be grouped under three broadthemes.The first theme concerns the possible consequences of past stimulusand/or emerging excesses in the economy.A particular focus for marketshere is the potential fallout from rapid credit growth in China since theglobal financial crisis,and the rise of nonbank financing there.The second theme of our questions is the conduct of monetary policytowhat extent policymakers will attempt to“lean”against emerging signs ofcredit excess(China,Indonesia and possibly elsewhere in ASEAN),againsta backdrop of unconventional easing by many developed-economy central,+852-2978-1802 Goldman Sachs(Asia)L.L.C.Goohoon Kwon,CFA+82(2)3788-1775 Goldman Sachs(Asia)L.L.C.,Seoul BranchTushar Poddar+91(22)6616-9042 Goldman Sachs India SPLLi Cui+852-2978-0784 Goldman Sachs(Asia)L.L.C.,banks,or“clean”by supporting faster recoveries in areas with stillmeaningful output gaps(Japan,possibly India).Yu Song,Our third important theme for 2013 is structural economic reform.Thelargest economies in the region are coming off disappointing economicperformances in 2012.With new political leadership in most of theseeconomies,there is a window of opportunity for policy changes that couldenhance longer-term potential growth,with potentially beneficial spilloversin the region and globally.Of course,some of the most important questions of the year may turn outto be ones that we and market participants are not currently asking.Staytuned for an eventful 2013!,+86(10)6627-3111 Beijing Gao Hua Securities Company LimitedMark Tan+65-6889-2472 Goldman Sachs(Singapore)Pte+852-2978-6634,Goldman Sachs(Asia)L.L.C.Prakriti Shukla+91(22)6616-9376 Goldman Sachs India SPLSungsoo Chung+82(2)3788-1726 Goldman Sachs(Asia)L.L.C.,Seoul BranchInvestors should consider this report as only a single factor in making their investment decision.For Reg AC certificationand other important disclosures,see the Disclosure Appendix,or go to,The Goldman Sachs Group,Inc.,Goldman Sachs,1,2,January 4,2013,Asia Economics Analyst,Ten Questions for Asia in 2013The year 2013 promises to be an exciting one in Asia mostly for good reasons,we hope.1In this edition of the Asia Economics Analyst we survey the regional economic and policyissues that are likely to be most important for investors in 2013.While our economicforecasts for the region necessarily give a prominent role to external conditions,thediscussion here focuses on events within the region that could be important regionally orglobally.We have already written on several,and cite research below where appropriate.These questions will also play an important role in guiding our research agenda for thecoming year.At the risk of oversimplifying,a few themes recur.The first concerns the possibleconsequences of past stimulus and/or emerging excesses in the economy.The reliance ofmany countries in the region on export-led growth was made plain once again in 2012,when growth suffered because of poor external conditions.Both markets andpolicymakers are beginning to put more emphasis on domestic demand-led growth,butthis in turn raises questions about what pace will be sustainable.Credit growth has beenrobust in ASEAN for some time and was extraordinarily high in China in the immediateaftermath of the global financial crisis.In some countries this is reflected in relatively highcorporate leverage(China);in others(Korea,Malaysia)household debt burdens are quiteelevated.The second broad theme is the conduct of monetary policyto what extent policymakerswill attempt to“lean”against emerging signs of credit excess(China,Indonesia andpossibly elsewhere in ASEAN)or“clean”by supporting faster recoveries in areas with stillmeaningful output gaps(Japan,possibly India).All this occurs against a backdrop ofstimulative monetary policy and unconventional easing in most developed economies.The third theme is structural economic reform.The largest economies in the regionChina,Japan,Korea,and Indiaare coming off disappointing economic performance(relative to their respective norms)in 2012.Partly because of this,and partly because ofpolitical leadership changes in most of these economies,there is a window of opportunityfor policy changes that could enhance longer-term potential growth,with potentiallybeneficial spillovers in the region and globally.1.Will the Bank of Japan change course?Yeswe expect a move to a 2%inflation target and open-ended monetary easing.Last months Japanese election could have major implications for economic policy,particularly monetary policy,in the worlds third-largest economy.The Liberal DemocraticParty of Japan(LDP),along with its ally the New Komeito Party,won a landslide victory totake a two-thirds majority in the lower house of parliament,giving it the ability to passlegislation without upper house approval.Shinzo Abe was named Prime Minister and acabinet has been formed.In the election campaign,the LDP advocated a 2%inflation target for the Bank of Japan,areturn to zero or negative short-term interest rates,open-ended monetary easing,and thecreation of a public-private foreign bond purchase fund to reduce yen appreciationpressures.Bank of Japan Governor Shirakawa and his two deputies all end their terms inspring 2013,which will enable Abe and his government to replace them with officialsSee“Our 2013-2016 AEJ Forecasts:A Brighter Backdrop for Growth”,Asia EconomicsAnalyst 12/21,November 29,2012.Goldman Sachs Global Economics,Commodities and Strategy Research,2,3,January 4,2013,Asia Economics Analystsympathetic to the LDPs more dovish policy tilt.Markets have clearly begun to price in ameaningful probability that some or all of this agenda will be enacted(Exhibit 1).Exhibit 1:Markets Pricing in a Shift in BOJ Policy,USD/JPY89,Index940,87,Abe becomesLDP,Noda says readyBOJ to dissolve LHeasing,Electionresult,890,Chairman,8583,TOPIX(right),840790,8179,NewsreportsLDP likelyto win bylarge,740690,77,Yen(left),majority,640,Sep,Oct,Nov,Dec,Jan,Source:Bloomberg,GS Global ECS Research.But the question remains how much actual policy will shift.Disappointing economicgrowth and deflation are not new to Japan,and thus far monetary policy experimentationhas been relatively modest,largely forgoing forward policy guidance and concentratingasset purchases mostly on shorter-duration government bonds,where the impact is likelyto be small.Of the LDPs proposals,we think the 2%inflation target and open-ended easingare most likely to be implemented.Our analysis suggests a sustained weaker yen couldresult in major improvement in the Japanese trade balance.2 In conjunction with aproposed fiscal package of 10 trillion yen,we think this will lift Japanese real GDP growthto over 1%by midyear.Of course,it will take further significant improvements in nominalGDP growth and the government budget position to put Japanese government debt on asustainable path.For other economies in the region,the implications of a shift towards somewhat moreaggressive easing by the BOJ depend on the nature of their trade and financial linkages.To the extent that other countries exporters compete with Japans(Korea comes to mind),a weaker yen could increase competitive pressure;to the extent they are suppliers toJapanese firms,greater domestic demand and increased competitiveness could provide aboost to local demand.Those with strong financial linkages could see an intensification ofcapital inflow pressures(as discussed in the next question).We estimate a 10%depreciation in the yen,sustained for one year,would generate animprovement in the annual trade deficit from 2-7 trillion yen,depending on the specificassumptions.For reference,we currently expect the 2012 trade deficit to be 3.8 trillion yen.See“Weaker yen is beneficial for Japanese economy,even with rise in energy imports”,Japan Economics Analyst 12/21,December 6,2012.Goldman Sachs Global Economics,Commodities and Strategy Research,4,January 4,2013,Asia Economics Analyst2.How will the region particularly Asia ex-Japan deal withpersistent large capital inflows?Via a combination of currency appreciation,measures to limit net capital inflows,andoutright intervention.We expect the combination of exceptionally easy monetary policy in major developedeconomies and recovering growth in key emerging markets to lead to unprecedentedcapital inflow pressures.Nowhere is this likely to be more evidentor more vexingthanthe Asia ex-Japan region with its many managed currencies.Already in late 2012,we haveseen evidence of a pickup in capital inflows in the form of currencies moving sharply to thestrong side of trading bands in several economies(Exhibit 2).Exhibit 2:Regional currencies offer evidence of a pickup in capital inflow pressures,Percentile of trading band(100=at strong end)100500,Percentile of trading band(100=at strong end)100Stronger50Spot exchange rateagainst trading band:CNYSGD*HKD0,Jan,Feb,Mar,Apr,May,Jun,Jul,Aug,Sep,Oct,Nov,Dec,*Nominal effective exchange rate.Source:Bloomberg,GS Global ECS Research.Policymakers can choose one or more of the following tactics in the face of strong capitalinflows:Acquiesce to FX appreciation.The most natural responseat least,from aneconomists point of viewis to allow local currencies to appreciate.And certainly weexpect this to be part of the adjustment process,as our forecasts imply currencyappreciation throughout the AEJ region.Try to stem the pressure by curbing inflows and/or encouraging outflows.To theextent that export-led growth remains a priority for policymakers,they are likely to tryto limit currency appreciation.One way to do this is to impose explicit or implicitdisincentives for capital inflows.Recent measures in the Philippines,including limitsto foreigners ability to invest in the central banks Special Deposit Accounts(SDA),offer an example of the former.Alternatively,the authorities may try to encourageoutflows;for example,the Bank of Thailand plans to relax regulations to increaseGoldman Sachs Global Economics,Commodities and Strategy Research,3,4,5,5,January 4,2013,Asia Economics Analyst,flexibility for residents investments abroad,including in FDI,portfolio investments andforeign currency deposits.3Intervene more forcefully in currency markets.Central banks may also step up thepace of intervention,with likely consequences for domestic financial conditions andinflation pressures.Because this approach tends to be felt in asset price inflationbefore goods and service inflation,it may be seen as attractive by policymakers,atleast in the short run.We expect these three approaches to be deployed to varying degrees across the region.We see the most appreciation(ca 5%on average)in the major ASEAN economies,whichare showing robust growth and inflation generally in the neighborhood of central banktargets.We expect less FX appreciation in the emerging economies of North Asia,andtherefore more reliance on the second and third approaches above.Hong Kong is theextreme case,where most of the pressure will be absorbed via intervention.Insofar as policymakers choose to intervene,they may also take steps to rein in interest-rate sensitive sectors to limit the impact on the real economyfor example,bothSingapore and Hong Kong have introduced levy additional taxes on foreign propertybuyers.If inflation pressures reemerge,blunter approaches such as price controls mightalso be considered in some countries,although we do not expect much resort to this tacticin 2013.3.To what extent will policy reforms boost growth in the region,particularly China?We expect sufficient reform to keep Chinese growth just above 8%and lift Indias growth toaround 7%a few years out.The year 2012 featured major leadership changes in several of the largest economies in theregion.Chinas rightfully received the most attention,as the worlds second-largesteconomy began its once-a-decade leadership transition.But the recent election in Japancould also presage significant policy shifts,as noted.Policy changes in Korea following theelection of the countrys first woman president,Geun-hye Park,appear likely to be moremodest.4The combination of a disappointing 2012 for regional economies and,in many cases,newpolitical leadership,presents a window of opportunity to engage in structural reforms toboost potential growth.China in particular has received considerable attention frominvestors and the media in this regard,but the issue is a broader one for the region:In China,the central focus is the need for some rebalancing on Chinas growth profileaway from its heavy fixed investment and export-oriented focus towards domesticconsumer demand.Policymakers have signaled their intent along these lines,andalthough concrete details are still lacking,we think the country can post a sustainablerate of growth around 8%over the next few years.5 Key areas to watch includeurbanization and labor mobility policies,fiscal reforms to encourage householdpurchasing power and consumption,and measures to facilitate service sectordevelopment.Further progress in financial liberalization(including domestic interestSee http:/www.bot.or.th/Thai/PressAndSpeeches/Press/News2555/n5455e.pdfSee Goohoon Kwon and Sungsoo Chung,“Korea-presidential elections outcome andbroad economic implications”,December 19,2012.See Yu Song,“Chinas Central Economic Work Conference:tone was slightly more dovishthan we expected”,GS Emerging Markets Macro Daily,December 17,2012,and Li Cui,“China:Shifting to a lower gear”,Asia Economics Analyst 12/16,September 20,2012.Goldman Sachs Global Economics,Commodities and Strategy Research,6,6,January 4,2013,Asia Economics Analyst,rate liberalization and gradual opening of the capital account)will be particularlyrelevant for markets.India faces a variety of near-term policy challenges(discussed in the next question),but in the wake of near-crisis in early 2012,policymakers are considering a series ofreforms to boost the economys structural growth potential.We discussed five keyreforms in a recent commentallowing FDI in the retail sector,tax reform via anational goods and services tax,overhaul of the social security system,government-led investment in freight transportation corridors,and measures to ease landacquisition.6 Lawmakers have made progress on some of these,liberalizing retail FDIafter considerable tumult and beginning social security reform on January 1,but muchmore remains to be done for India to realize its considerable growth potential.Asnational elections in 2014 approach,the political hurdles to passing controversialeconomic measures are likely to grow.We expect less emphasis on structural reform in Korea and Japan.In the former,incoming President