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Global Research |
Global Focus 2012
Fragile West, resilient East
All rights reserved. Standard Chartered Bank 2011
Standard Chartered ranked worlds No. 1 firm for economic forecasting Bloomberg Markets magazine, January 2012
Table of contents
Global overview
Fragile West, resilient East ................................................ p.5 Botswana: A new global diamond hub ............................ p.74 Cameroon: Growth to pick up despite risks ..................... p.75 Cte dIvoire: Towards economic normalisation ............. p.76 Gambia: Fiscal concerns remain ..................................... p.77 Ghana: First election as an oil producer .......................... p.78 Kenya: A key election year .............................................. p.80 Mozambique: Unstoppable ............................................. p.82 Nigeria: The USD 250bn question ................................... p.83 Senegal: Staying the course in an uncertain year ........... p.85 Sierra Leone: Iron ore drives export transformation ........ p.86 South Africa: Still-slow growth ........................................ p.87 Tanzania: Cautious pace of liberalisation ........................ p.89 Uganda: Oil one day ........................................................ p.90 Zambia: Resource nationalism, revisited ......................... p.91
Strategy
Strategy overview: Lets try this again ........................... p.10 Commodities: A glass half full ........................................ p.12 Credit: Bracing for a rocky start ....................................... p.15 Equities: EM to outperform DM ....................................... p.18 FX: Dj vu all over again 2009 versus 2012 ............... p.21 Rates: EM rates to outperform in 2012 ............................ p.24 Sovereign risk: More downgrades to come .................... p.27
Economies
MAJORS
Australia: Beyond the mining boom ................................ p.31 Canada: Fiscally responsible, firm growth ....................... p.32 Euro area: EMU strains to dominate amid recession ...... p.33 Japan: Rocky road to recovery ........................................ p.35 New Zealand: Rebuilding growth, bricks-and-mortar style .. p.36 United Kingdom: High recession risks ........................... p.37 United States: Economic wounds continue to heal ........ .p.38
MIDDLE EAST and NORTH AFRICA

MENA: Local differentiators ............................................. p.94 Algeria: Output erosion ................................................... p.96 Bahrain: Saved by oil ...................................................... p.97 Egypt: Managing change and expectations..................... p.98 Jordan: Looking towards the GCC ................................ p.100 Kuwait: Oil in a days work ............................................ p.101 Lebanon: Growth to return in 2012................................ p.102 Morocco: Economic resilience and a reform agenda .... p.103 Oman: Bucking the global trend .................................... p.104 Qatar: Lower growth, better growth ............................... p.106 Saudi Arabia: The spending story continues ................ p.108 Tunisia: Looking ahead ................................................. p.110 UAE: Sustaining healthy growth .................................... p.111
ASIA
Asia: A test of resilience, once more ............................... p.42 Bangladesh: Still resilient, but strains are emerging ....... p.44 China: Getting used to 8% .............................................. p.46 Hong Kong: Domestic resilience shines through ............ p.48 India: High time to act!..................................................... p.50 Indonesia: Not immune to the global slowdown .............. p.52 Malaysia: Resting on commodities .................................. p.54 Pakistan: Gearing up for elections .................................. p.56 Philippines: Another test of resilience ............................ p.58 Singapore: Mitigating volatility ........................................ p.59 South Korea: Domestic demand to the rescue ............... p.61 Sri Lanka: Inching ahead with caution ............................ p.63 Taiwan: Struggling with rising uncertainty ....................... p.64 Thailand: Post-flood recovery ......................................... p.66 Vietnam: Keep doing the right thing ................................ p.68
LATIN AMERICA
Argentina: More Kirchnerismo ...................................... p.115 Brazil: COPOM banking on lower inflation .................... p.116 Chile: Central bank is ready to act ................................. p.118 Colombia: Reforms, FTA underpin strong outlook ........ p.119 Mexico: Banxico is on hold ............................................ p.120 Peru: More Lula than Chavez, so far ............................. p.121
Forecast snapshots
Forecasts .................................................................... p.123 World Wide Wrap ...................................................... p.127
SUB-SAHARAN AFRICA
Africa: More cautious approach to liberalisation ............. p.71 Angola: Restarting the growth engine ............................. p.73
Global overview
12 December 2011
United Kingdom Euro area Tunisia Morocco Algeria Japan Gambia Sierra Leone
Cte dIvoire
Global Focus 2012 The Year Ahead
Canada
United States
Mexico Senegal Ghana Nigeria Cameroon Uganda Kenya Angola Zambia Botswana Mozambique Tanzania
South Korea Lebanon China Jordan Pakistan Kuwait Bahrain Egypt Qatar HongKong Saudi UAE Taiwan Banglad esh Arabia India Oman Thailand Philippine s Vietnam Sri Lanka Malaysia Singapo re Indon esia
Colombia
Peru
Brazil
Australia
South Africa
Majors Asia Sub-Saharan Africa Middle East and North Africa Latin America
New Zealand
Chile
Argentina
Global overview
Gerard Lyons, +44 20 7885 6988
Gerard.Lyons@sc.com
Fragile West, resilient East

This global overview focuses on three areas: first, a review of the world economy; second, the key issues facing emerging economies; and third, prospects for the developed countries. This will be reflected in differences across both countries and regions in 2012. Each country and region needs to be looked at on its own merits. Since the financial crisis began, the world has continued to be hit by shocks, as well as by the consequences of the debt overhang in the West. One of the challenges in 2012 is that the policy environment in the West is in danger of being pro-cyclical, both in the regulatory response across many countries and in the fiscal response in Europe. In contrast, the positive news across emerging economies is the willingness and the ability to use policy in a counter-cyclical way to boost growth in the year ahead. At a regional level, this points to sluggish growth in the US, growth rates across the emerging world that are slower than in 2011 but still well above those in the West, and recession in the UK and the euro area. This points to the continuation in 2012 of a two-speed world where a fragile West contrasts with a resilient East. 2012 is also likely to highlight the fact that despite the world economy becoming more divided, no region is fully decoupled from events elsewhere. During the first half of 2012, problems in Europe and the West will weigh on global growth. By the second half, stronger growth across China and other emerging economies should pull up worldwide activity. It will be a recovery made in the East and felt in the West. If ever one needed evidence of a shift in the balance of power, this is it. In 2010 the world economy grew strongly, by around 4.3%, helped by a sizeable, synchronised and successful policy stimulus. Two factors boosted global growth in 2010. One was the extent of the policy stimulus in the West; the other was the strength of the emerging economies, which drove two-thirds of the worlds growth that year, despite accounting for one-third of the global economy. Their share of global growth has continued to rise, as highlighted in Chart 1. The recent peak for the world economy was in the second quarter of 2010, at growth of 5.3% per annum. Since then, global growth has slowed. A year ago, lest we forget, there was tremendous uncertainty about the outlook, as there is now. Then, we predicted global growth would be 2.9% in 2011. The outturn is likely to have been 3.0%. The world economy cooled significantly in 2011. Initially, this was as factors like inventory restocking that drove growth in 2010 started to wear off, and as more countries started to tighten policy. Higher oil prices as a result of the Arab Spring and the impact of the Japanese earthquake on
5
1. Overview
Overall, current developments in the world economy are consistent with those that we have talked about for some time. There is every likelihood that this will remain the case in the year ahead. The world economy is already in the early stages of a shift in the balance of economic and financial power from the West to the East. It has also started to witness a shift in the policy-making environment from the G7 to the G20. However, a shift in the balance of military power is still some years away. It is vital to keep all this in mind when viewing prospects for the year ahead. Given all this, one message might be, do not be surprised by anything, and do not underestimate anything. This uncertainty may contribute to volatility and risk aversion early in 2012 before the markets return their focus to the growth agenda, driven by recovery across the emerging world. The outcome for any economy depends on the interaction between the fundamentals, policy and confidence. In the West, the fundamentals are poor, the policy cupboard is almost empty and confidence has been shot to pieces. In contrast, across the emerging world, the fundamentals are good, the policy cupboard is almost full and confidence is likely to prove resilient.
Chart 1: The growing share of the emerging economies Nominal GDP, USD trn
80 70 60 50 40 30 20 10 0 1981 1984 1987 1990 1993 1996 1999 2002 2005 2008 2011 Sources: IMF, Standard Chartered Research
12 December 2011
World
Advanced
Emerging
Global overview (cont)

supply chains were other significant shocks in the first half. Since the summer, however, it has been events in Europe that have dragged growth down. At that time, our warning was that if there was to be a double-dip, it was likely to be triggered by an external shock, a policy mistake, or a loss of confidence. Europe provided all three, at the same time. Overall, the last year provided a picture of a divided, disconnected world economy facing significant policy dilemmas. 2012 is expected to provide further examples of this. The divisions are apparent in many ways: growth prospects in the East far better than in the West, the core of Europe far stronger than the periphery, and the balance sheets of big firms in the West far better than the position of smaller companies, many of which find it difficult to access credit. The disconnect so apparent in the Arab Spring remains, and is seen in terms of high rates of youth unemployment. Then there are the policy dilemmas, not least the need to ensure sustainable growth while addressing longer-term structural problems. Although we are very positive about longer-term global prospects, we have a pessimistic view of global growth in 2012 at 2.2%. In our view, a deep recession in Europe will likely slow global growth significantly in the first half of the year, before a rebound in the second half led by emerging economies transforms prospects for 2013. We expect the world economy to grow by 3.6% in 2013 and 3.8% in 2014. The IMF expects growth of 3.2% in 2012, with stronger growth thereafter. the global financial crisis in autumn 2008, the world economy has grown by 14%, reaching USD 70trn by the end of 2011. Some of this post-crisis rise is explained by inflation, but the bulk of it comes from strong growth across the emerging world, led by China. In 2012, there is a need to balance short-term uncertainties against longer-term positives. These positives are highlighted by significant, underlying structural factors. We highlighted these underlying factors in The Super-Cycle Report at the end of 2010. At that time, we were cautious about near-term prospects in the West and felt it important to highlight some of the underlying long-term drivers of the world economy. These drivers will continue to be at work in 2012. They include the growth of consumer markets across the emerging world as the middle class expands, helped by rising incomes and growing populations. Other drivers include perspiration and inspiration; the latter involves emerging economies moving up the value curve, with increased investment and higher infrastructure spending. Funding this infrastructure boom across the globe remains one of the underlying challenges and opportunities, particularly across Asia, where high pools of domestic savings need to be channelled into the USD 8trn of infrastructure needed. Rapid urbanisation is also a feature across many countries. Another key feature has been the growth in new trade corridors, reflecting increased flows of goods, commodities, remittances, and portfolio and direct investment. Some features will be both drivers and consequences of growth, such as the rise of the middle class and development of financial markets. To move from export-led to domestically driven growth, many emerging regions need to create better social safety nets, discourage high domestic savings, help the small and medium-sized firms that are key to job generation, and deepen and broaden their bond markets. These underlying drivers, while positive, are not without challenges. They include the middle-income trap, environmental degradation and resource challenges, and institutional and governance issues, especially corruption. The latter will continue to test some economies in 2012, including India. Despite this, we remain positive about India's prospects, particularly if it addresses the issues of deregulation and infrastructure needs and unlocks its huge demographic dividend. The countries that succeed in this new world order will be those that have the cash, the commodities or the creativity.
2. Emerging economies
Despite the financial crisis, the world economy has continued to grow. Only a decade ago, the global economy was only USD 32trn, less than half its current size. Since the start of Chart 2: Global trade Total exports of goods and services, USD trn
25 20 15 10 5 0 1981 1984 1987 1990 1993 1996 1999 2002 2005 2008 2011 Sources: IMF, Standard Chartered Research
12 December 2011
World
Advanced
Emerging
Global overview (cont)

In Asia, growth rebounded strongly in 2010, to 9.1%. It is likely to have been 7.3% in 2011, and we expect it will be 6.5% in 2012 and 7.5% in 2013. At some stage, there will be a setback in China, as can be expected for any fast-growing industrialising economy. The trend there is clearly up, but there will be volatility along the way. We see China growing 8.1% in 2012 and 8.7% in 2013. We stick with our previous view that China is likely to grow 6.9% over the next two decades, a slower but sustainable pace of growth consistent with its ageing population. Emerging economies are not immune to events in the West. Ahead of the 2007-08 crisis, we stressed that emerging economies were not decoupled but were better insulated. So it proved. Resilience is also likely to be seen now. That is, any problems in the West will have a global impact via trade and financial linkages but emerging economies will have the ability to rebound. Furthermore, emerging economies across Africa, Latin America and Asia are now seeing stronger domestic demand. In this report, we focus on all the key regions and major economies, but as the world economy slows in the early part of 2012, attention is likely to focus increasingly on China, given its growing importance to the world economy. Given the external headwinds, it would not be a surprise if China slowed during the first quarter of 2012. Thereafter, the economy should recover, helped by policy stimulus. Whereas many countries around the world may experience difficult political conditions in the coming years, China's leadership change is expected to be smooth. Moreover, the economic policy environment will be a continuation of that seen before. Follow-through on China's 12th Five Year Plan, Chart 3: The world needs to rebalance Current account balance, USD bn
1,000 800 600 400 200 0 -200 -400 -600 1981 1984 1987 1990 1993 1996 1999 2002 2005 2008 2011 Sources: IMF, Standard Chartered Research
12 December 2011 7
unveiled in March 2011, is likely to be an important feature. The plan focused on boosting consumer spending, social welfare and the green economy and highlighted seven key strategic industries: new energy, energy conservation and environmental protection, biotech, new materials, high-end equipment manufacturing, new IT and clean energy vehicles. We expect steady growth in Sub-Saharan Africa in 2012, up from 4.8% to 5.3%. Despite this, it is a more challenging environment for a number of countries, as we explain inside. The recent trend of continued improvement in macroeconomic factors can no longer be taken as a given. That being said, it is important to stress that while commodities have played an important role in Africas recent growth, so too has the strength of domestic demand. And this should remain a positive in 2012, notwithstanding worries about inflation prospects. We remain positive about the region, given underlying structural changes. The MENA region, too, faces a challenging time as North Africa comes to terms with the aftermath of the Arab Spring and war in Libya. Gulf countries, meanwhile, appear to be on a better trajectory, helped by improving regional fundamentals. Firm oil prices clearly help, although the breakeven price of oil continues to rise. Commodities, too, continue to drive improvement across parts of Latin America. It is not rosy everywhere, and across the emerging world we continue to focus on countries where economic imbalances persist, particularly on the current account. Turkey, Pakistan and Vietnam remain concerns. But overall, the story for emerging economies is positive.
3. The West
The financial crisis highlighted the imbalanced nature of the world economy. This still needs to be addressed. The savers need to spend more. This includes the Gulf countries, China, Japan and northern Europe. All are doing so apart from northern Europe, which is contributing to problems in the euro area. The debtors need to spend less. Currencies need to adjust. One of the challenges for the world economy and for the euro area in 2012 is the deflationary bias that is being built into the system as pressure is put on deficit countries to do most of the adjustment. The crisis also highlighted systemic failure in parts of the financial system. This is taking time to be addressed. The overhang of debt and the pressure to deleverage will continue to weigh on economies in the West. This will restrain growth there. It will also add to pressure on central banks to keep interest rates as low as possible for as long as possible
Emerging & Industrialised Asia
Advanced
Global Focus 2012 - The Year Ahead
Global overview (cond)

in the US, the UK, the euro area and Japan. Further quantitative easing is possible. This may weigh on currencies and in turn feed flows into emerging economies, where growth and longer-term opportunities are better. However, with many economies lacking the absorptive capacity to handle such flows, one would expect to see eventual upward pressure on asset and land prices. This will add to dilemmas for policy makers across the emerging world, keeping alive the focus on capital controls and the need for greater use of macroprudential measures. Monetary policy, after all, needs to be set to suit domestic agendas. Given high rates of unemployment, particularly youth unemployment, there may be continued political uncertainty in the West, louder calls for populist measures, and rising fears of protectionism. We are not expecting trade barriers, but with the multilateral trade round having broken down, we expect to see further growth in bilateral and regional trade deals. Commodity prices have softened, but in 2012 they may have a firm floor and a soft ceiling. The firm floor is underlying demand from China, India and elsewhere. The soft ceiling is explained by possible supply disruptions. Currency volatility may be a feature of 2012. The euro looks overvalued given problems in the region, while many Asian currencies look oversold. But if the euro were to collapse, the initial beneficiary would likely be the US dollar. Another important feature of 2011 was the growth of the offshore CNY market. This is likely to continue in 2012. A key focus in 2012 will be the euro. The euro cannot survive in its present format. It will have to become a political union to survive, but that is unlikely to happen immediately, despite some recent moves in that direction. Given the fundamental flaws at the heart of the euro, its collapse, and the possibility of one or more countries leaving, cannot be ruled out. There are many issues that still need to be resolved. Not least is the inflation environment. The injection of huge amounts of liquidity into the financial system has added to worries about inflation. However, our projection is that inflation will remain subdued. Global inflation is expected to decelerate from 3.7% in 2011 to 2.9% over the next year. We expect some modest acceleration in Africa and MENA, but overall inflation pressures should remain subdued, allowing scope for further policy easing by central banks, if needed. Finally, in this Outlook 2012 we have summarised the key issues facing the world and have looked at them from a global, regional and local perspective. The next section provides a strategic overview, looking at the implications for the major asset classes. We follow this with a summary of the economic outlook by region, followed by our forecast tables. The message in 2012 is a more difficult environment for the world economy. The West is fragile, but emerging economies are in far better shape to cope.
Table 1: Nominal GDP, 2008 versus 2011 USD bn

Regions World Euro area Major advanced economies (G7) Newly industrialised Asian economies (HK, South Korea, Singapore and Taiwan) Emerging and developing economies Developing Asia ASEAN-5 Latin America and the Caribbean 2008 61,191 13,602 32,144 1,736 2011 70,012 13,355 33,842 2,182 Change 8,821 -247 1,699 446
19,102 7,433 1,270 4,290 2,332 944 2008 1,655 4,520 1,251 511 4,880 1,661 14,292
25,100 11,114 1,759 5,630 2,745 1,220 2011 2,518 6,988 1,843 834 5,855 1,885 15,065
5,998 3,681 489 1,340 413 276 Change 863 2,469 592 323 976 224 773
Chart 4: Low-inflation period poses policy dilemma Inflation, % annual average

140 120 100 80 60 40 20 0 1981 1984 1987 1990 1993 1996 1999 2002 2005 2008 2011 Sources: IMF, Standard Chartered Research
12 December 2011
Emerging
Middle East and North Africa Sub-Saharan Africa Countries Brazil
Advanced
China World India Indonesia Japan Russia United States
Sources: IMF, Standard Chartered Research

8
Strategy
Strategy overview
Will Oswald, +65 6596-8258
Will.Oswald@sc.com
Lets try this again

Summary

We expect long risk trades to perform well in 2012, but with a far stronger bias towards H2 (or potentially earlier if we see strong co-ordinated action from the European and US authorities early in Q1). Liquidity will remain of paramount importance well into the year, while opportunities will be dominated by market timing and beta rather than alpha. Policy makers across emerging markets face a difficult set of choices ahead: respond to the slowdown via fiscal and monetary stimulus, or prepare for significant developed-market (DM) monetary stimulus and potential inflationary pressures. We expect the former to dominate until end-Q1, but inflation risks are likely to re-emerge during the remainder of the year. From an investment standpoint, this also raises the potential for a shift back towards macro-prudential measures, including stricter capital controls. This outlook also suggests that the outlook for local markets is biased towards duration and away from FX in the early part of the year, with the emphasis reversing as we move further towards H2.
We expect a longer-term downtrend in the euro (EUR), with sharp weakening in Q1. This is based on our expectation that the co-ordinated European response will be insufficient to support the market in the near term and, more importantly, to deliver a strategy that offers a credible longer-term solution. The weaker longer-term outlook for the worlds two largest reserve currencies signals a similar multi-year shift into emerging-market (EM) economies, reflecting not only their rising role in the global economy but also their significant role in global trade. While the significant focus on the growing role of the Chinese yuan (CNY) is justified, and is bolstered by Chinas efforts to redenominate trade flows into CNY, we also expect the broader rotation into liquid, investment-grade EM currencies to continue. However, we expect this shift to occur after Q1-2012, in line with the peak in the USD. By contrast, we look for rates markets in more liquid economies to perform relatively well in Q1, before flattening out throughout the remainder of the year. Their performance in 2008-09 is instructive here; EM local-currency bond yields (Chart 1) compressed rapidly as G20 support emerged. Of particular note, while inflows to EM local-currency bonds increased strongly starting from Q2-2009, these flows had a minimal impact on the yield spread to Treasuries. Instead, they had a larger effect on EM currencies. The combination of our rates and FX views suggests that allocations in Q1 should be biased towards duration rather than FX in our footprint markets; by contrast, as we move into Q2, we expect the balance to shift more towards FX. For the full year, we anticipate that frontier African markets will deliver strong returns, but given our focus on liquidity, we do not anticipate significant broadbased opportunities before Q2 at the earliest. In Q1 in particular, while we expect most emerging economies to be able to deliver counter-cyclical monetary and fiscal policy, we see risks to such policy responses in frontier markets.
FX and rates
On a multi-year basis, we expect the US dollar (USD) to weaken, reflecting the significant debt overhang for the US economy and continued gradual diversification away from the USD in global portfolios. However, as we have consistently argued, the USD performs well in an environment of risk aversion, as the US is the primary source of global risk capital; under such conditions, a home-country bias will serve to strengthen the USD.
Chart 1: EM rate rally started rapidly after 2009 G20 (bps)

650 600 550 500 450 400 350 300 Jun-08 Dec-08 Jul-09 Jan-10 Aug-10 Feb-11 Sep-11 G20 meeting
Credit
Sources: Bloomberg LP, Standard Chartered Research

12 December 2011
The outlook for credit is much the same as that for rates and FX: a focus on market beta timing and liquidity over alpha and illiquid yield pick-up. For credit, this indicates a bias in positioning towards sovereign credits, especially
10
Strategy overview (cond)

given significantly stronger balance-sheet positions in emerging Asia relative to other regions, followed by highgrade corporates and banks.

in Q1, we do not expect as sharp a decline in commodity prices due to the supply outlook. In many sectors of the commodities market, the development of new supply takes many years. While WTI began rising sharply from late 2003, it was not until 2005 that the futures curve became upward-sloping. By 2008, this shift had encouraged the development of new capacity, and the supply coming on-stream was hit by the drop in aggregate demand. In contrast to the 2009 supply picture, the sharp decline in the global economy in late 2008 and early 2009 had a material impact on supply investment. Given the lag between initial investment and supply, we believe that the supply outlook for 2012 shows significantly less capacity across a number of commodities. This suggests a much lower risk of such strong price declines. While there are several similarities between late 2008/early 2009 and today, key differences exist. Not only is fiscal and monetary capacity severely constrained in developed markets, but the push for bank deleveraging in Europe risks further dampening money velocity. This, along with lower excess supply capacity within commodities, will pose challenges to a strong rebound in asset prices.
The banking sector is critical globally, and Asia is no exception. We have stressed for some months that the emphasis on European bank recapitalisation is the direct cause of global market weakness. With limited ability to raise capital in the markets, and with sovereigns unable to provide direct recapitalisation (as it is precisely sovereign risk that is the cause of concerns), banks only remaining option is to deleverage their balance sheets. This sector is likely to dominate asset managers behaviour for some time. Furthermore, whereas coordinated G20 action in 2009 included a signal to the banking sector to resume lending to the private sector, bank recapitalisation demands send the opposite message, and the fiscal response will also be weaker. The outlook for banks is significantly different for Asia than it is for Europe. Aggregate balance sheets of Asian banks are in far better health, while the monetary capacity of Asian central banks to support domestic banking systems is far greater. We also believe that domestic authorities will be supportive of shifting banking activity towards local rather than foreign banks. We therefore believe that the relatively weak outlook for banks in our footprint reflects their increased market share in areas such as trade finance and associated demand for USD funding, rather than their weak balance sheets.
Equities
Potential outliers are within the sovereign sector. We see Pakistan and Vietnam as Asias most vulnerable sovereigns, although market pricing indicates that these are well-known risks. Nevertheless, a significant deterioration in a sovereign benchmark credit within EM could have a broader negative impact. As seen in 2008, while EM sovereign credit outperformed for most of the year, the peak-to-trough loss was greater than in many other credit markets. Equally, though, the rebound was stronger than for other credit markets, supported by stronger EM sovereign balance sheets and fiscal capacity.
The broader global backdrop suggests EM outperformance versus DM equities. However, significant challenges lie ahead. Our leading indicator of earnings, the earnings revision index (ERI), points to a risk of aggregate negative earnings in 2012. However, valuations are already at the same margin relative to earnings as they were at their lows in October. Over the longer term, the trend of globalisation of investment portfolios mentioned above should also remain supportive of emerging markets, especially given (relatively) easier access to funding than is likely in developed markets due to lower levels of bank leverage. Furthermore, as monetary stimulus picks up and emerging economies see policy responses, this should sustain EM outperformance in H2-2012.
Commodities
The 2012 outlook bears some similarities to 2009, in that we are entering the year with a very fragile outlook. Strikingly, though, commodity prices have declined by far less this time (so far), with oil in particular well supported. If, as we anticipate, global demand declines significantly
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12 December 2011
Commodities
HanPin Hsi, +65 6596 8255
HanPin.Hsi@sc.com
Helen Henton, +44 20 7885 7281

Helen.Henton@sc.com
Dan Smith, +44 20 7885 5563

Daniel.Smith@sc.com
Abah Ofon, +65 6596 8245

Abah.Ofon@sc.com
Koun-Ken Lee, +65 6596 8256

KounKen.Lee@sc.com
A glass half full

Top trades of 2012
1. Higher prices needed to incentivise raw sugar output. 3. Pick up some copper in Q1. Precious metals perform
We believe the markets focus on improving global output ignores important structural changes and seasonal effects that will be key determinants of sugar prices in 2012. While sugar balances will move into a bigger surplus in the 2011/12 season, downside pressure on prices will be limited by stunted output growth and high production costs in Brazil, uncertainty over Indias export capacity, and growing demand from China. Additionally, sugar prices are finding a floor at a more elevated level compared with historical trends. This suggests significant upside potential once investor demand returns. We believe that the sugar market has to be incentivised by higher prices to boost production. We recommend going long May sugar futures at the current price of USc 23.7/lb (as of 6 December 2011), with a view to reaching a target of USc 28/lb. We place our stop-loss at USc 20/lb.
2. Buy Brent on dips. We expect Brent to weaken in Q1-
better in times of uncertainty, but base metals rule in a recovery, as seen most recently in the 2008-09 financial crisis. Among the base metals, we prefer copper; we choose to avoid illiquid futures such as tin futures, as they are prone to severe volatility and positions can be difficult to close out. We believe the best time to take a long position with a 12-month view will be in mid- to late Q1, when the inevitability of further easing by the Fed and the European Central Bank will become clearer. We expect euro-area y/y GDP growth to bottom out in Q12012. Copper prices will likely be further supported by persistent supply disruptions, even though the current price is a substantial premium to its marginal cash cost.
Key issues
2012 versus Q4-2011 as European growth reaches the lowest point in the current downturn. We expect Brent to make a strong recovery in H2, driven by increased liquidity. While the markets are currently focusing on the uncertain demand outlook, the supply issues that have dominated the oil market in 2011 are still important. Libyan output has recovered faster than expected, so any bottlenecks are likely to surprise the market. On the demand front, we expect non-OECD demand growth to more than offset OECD declines. Overall, we expect oil demand to grow by 0.9 million barrels per day (mbd) in 2012, the same pace as 2011. While we cannot predict political developments in Iran, an escalation of tensions as a result of Irans nuclear programme has clearly not been fully priced in, and any risk to the oil price from further developments on this front would be to the upside. Approximate baseline returns for various commodity sectors in each quarter of 2012
Q12012 Precious Base Energy Grains/soybeans Softs/fibres 5.8% 5.0% 0.6% -1.7% 0.7% Q22012 1.7% 9.1% 4.7% 4.9% 1.7% Q32012 3.0% 3.7% 0.0% -4.7% 5.3% Q42012 4.9% 4.8% 5.9% 4.6% 2.7% 2012 16.3% 24.5% 11.6% 2.7% 10.8%
2012 will be a good year for commodity producers. We expect a shallow correction in the first half of Q1 before the market strengthens again in response to the following factors: (1) confirmation that additional liquidity will be injected by the US and European central banks, which will boost sentiment as early as Q1; (2) persistent challenges to supply, particularly given that strikes, technical issues and weather have not been factored into companies production projections; and (3) still-strong demand, specifically from emerging economies; these economies will be spared the sharp slowdown facing developed markets because their policy cupboards are still relatively full, with China likely to ease further throughout the year. Risks of price moves due to geopolitical factors are also skewed firmly to the upside. The key risk to our bullish outlook is that European governments and the European Central Bank may not respond aggressively enough to contain the debt contagion until it is too late. Sentiment and actual demand for key commodities would subsequently dive, and commodity prices could fall substantially.
Source: Standard Chartered Research

12 December 2011
In October 2011, the US Commodity Futures Trading Commission (CFTC) approved position limits to curb excessive speculation on futures and swaps traded in the US market. The commission will be required to limit positions (other than legitimate hedging positions) held by any person. The CFTC is still deciding on the definition of a swap. Large positions may be required to be rebalanced, which may cause short-term price moves
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Commodities (cond)
independent of fundamental market developments. However, we suspect that the 60-day period provided for rebalancing will be sufficient to curb excessive volatility in commodity prices. markets. In addition, supply will remain tight, as many projects originally scheduled for completion in 2011/12 were postponed or suspended after the Lehman Brothers collapse reduced credit availability for such projects. In particular, the problems that plagued copper supply in 2011 strikes, bad weather and industrial strife are unlikely to go away in 2012. Chinese demand will continue to support base metals in general; while we expect a moderation in Chinas Q1 GDP growth, it should recover strongly in H2.
Our key calls for 2012
Crude oil A year of two halves. We expect oil demand to rise in 2012, but the combination of poor sentiment and reduced market tightness as supply recovers may put pressure on prices in Q1-2012. That said, we expect OPEC to provide a floor, with prices likely to rebound and rise through end-2012 due to increased liquidity, an improving macroeconomic picture, and supply restraint. While deteriorating GDP growth in 2012 has implications for oil demand, overall demand is still likely to grow as non-OECD growth offsets a decline in the OECD. While the markets are currently focusing on the uncertain demand outlook, the supply issues that have dominated the oil market in 2011 are still important. According to the International Energy Agency (IEA), Libyan output has risen to around 500 thousand barrels per day (kbd), earlier than initially expected. Most of the output has been used to refill storage facilities and pipelines exports have been much lower, at an estimated 180kbd in October and an anticipated 200-250kbd in November. This compares to pre-conflict export volumes of 1.3mbd. Base metals Bullish as supply constraints remain. We have a bullish outlook on base metals in 2012, and we expect the years low to be registered in Q1. Additional liquidity injected into the financial markets will support prices later in the year, and base metals tend to perform better than other commodities in recovering
Precious metals Buy gold. While gold prices had a strong 2011, rising 23% YTD as of 1 December, mediumterm prospects are still bright. Gold has pulled back from its 2011 highs and appears to be establishing support at USD 1,700/oz. The underlying medium-term drivers of higher prices are still evident. They include strong Asian demand, ultra-low interest rates in many countries, and continued central bank buying. As a result, we maintain our bullish bias on gold. Asian demand has become more mixed in recent months, but the underlying trend is clearly up, with China importing large quantities of gold from Hong Kong to feed investment and jewellery demand. Fears about the European crisis and the global economic outlook continue to run high, and the outlook is highly uncertain. This is encouraging investors and central banks to stockpile gold in unusually large quantities; this could become more evident in Q1-2012, when further easing in the US, Europe and China is expected.
Baseline returns for energy, precious and base metals in 2012

10% 5% 0% -5% -10% -15% Q4-2011 Q1-2012 Q2-2012 Q3-2012 Q4-2012 Precious Base Energy
Agriculture Q2 peak. 2012 is likely to be another challenging year for agricultural commodity markets different from 2011 in many respects, but equally turbulent. We expect the current market sluggishness to linger well into Q1-2012 before more bullish momentum sets in. Markets, including corn and wheat, are likely to peak in Q2-2012. In addition to global macroeconomic developments, the outlook for 2012 will depend to some extent on energy costs and the value of the USD. Our energy forecasts show initially slack global growth, with momentum steadily picking up over the course of 2012 and prices rising throughout the year. Stronger global growth and firming energy prices will be supportive of agricultural commodities from both a demand-pull and a cost-push perspective. The impact of the USD will be counter-cyclical, as we expect the dollar to remain relatively firm before weakening in H2-2012.

12 December 2011 13
Commodities Charts of the year

Chart 1: Nearby corn, wheat and soybeans rebased Jan-2011=1
1.3 1.2 1.1 1.0 0.9 0.8 0.7 Dec-10 Feb-11 Apr-11 Jun-11 Aug-11 Wheat Oct-11 Corn Soybeans
Chart 2: Elevated output costs to provide firm floor for sugar in 2012 (USc/lb)
35 33 31 29 27 25 23 21 19 17 15 Dec-10 Feb-11 Apr-11 Jun-11 Aug-11 Oct-11 Marginal cost band Nearby sugar futures
Sources: Reuters, Standard Chartered Research
Chart 3: Copper, gold and oil recovery from 2008-09 crisis Mar-2008 = 1
1.5 Gold 1.3 1.1 0.9 0.7 0.5 0.3 Mar-08 Jun-08 Sep-08 Dec-08 Mar-09 Jun-09 Sep-09 Dec-09 Copper
Chart 4: Non-OECD and OECD y/y oil demand change mbd

3.0 2.5 2.0 1.5 1.0 0.5 Total Non-OECD demand
WTI
0.0 -0.5 -1.0 Total OECD Demand Q1-10 Q3-10 Q1-11 Q3-11 Q1-12 Q3-12
Sources: Bloomberg, Standard Chartered Research
Sources: IEA, Standard Chartered Research
Chart 5: Cumulative global gold ETF flows and rate of flows since 2 September 2011 (USD bn)
8 7 6 5 4 3 2 1 0 25-Aug 14-Sep 4-Oct 24-Oct 13-Nov 3-Dec Rate of flows (RHS) 0.2 0.1 0.0 -0.1 -0.2 23-Dec Gold flows 0.3 0.4
Chart 6: USD correlation

100% 80% 60% 40% 20% 0% -20% -40% -60% -80% -100% Jun-10
and
oil/gold/copper
180-day
rolling
vs Gold
vs Brent
vs Copper Sep-10 Dec-10 Mar-11 Jun-11 Sep-11 Dec-11
12 December 2011
14
Credit
Kaushik Rudra, +65 6596 8260
Kaushik.Rudra@sc.com
Bracing for a rocky start

Top trades of 2012
1. Focus on quality and liquidity in Q1-2012. We recommend that investors focus on the higher-quality and more liquid segments of the credit space in early 2012. We recommend staying very light in the high-yield (HY) sector and concentrating positioning in high-grade (HG) corporates, quasi-sovereign credits and sovereigns in Asia and the Middle East. We recommend a slight Underweight position in banks given wider pressures on the sector from European banks. Given our expectations of a US Treasury (UST) rally, we recommend that investors focus on the 10Y segment of the curve. In Asia, we recommend single-A-rated corporates and the Korean quasi-sovereign sector. In the Middle East, we recommend strong quasi-sovereigns out of Qatar and Abu Dhabi. 2. Increase allocation to beta in H2-2012. Based on our current expectations, we recommend that investors switch into higher-beta and higher-yielding sectors in H22012 on the back of increased market stability and the likely resolution of the crisis in Europe. In Asia, this would mean increasing allocations to the HY sector in particular to Chinese HY, both industrial names and property developers. In the Middle East, this would imply increasing positioning in the Dubai Inc. space. We recommend increasing allocations to the financial sector, adding both senior and hybrid paper. the European sovereign crisis to remain the primary driver of credit performance over the next few months. While Asian sovereigns are stronger than their Western counterparts from the standpoint of balance sheets and credit metrics, they are not immune to the issues facing the West. As a result, Asian credit performance will continue to be hostage to global cross-currents and flows.
In our base-case scenario, we expect the European sovereign debt crisis to linger in 2012, with no immediate solution. A positive end-game for Europe could take the form of a fiscal union with potential quantitative easing. However, the timing of such a solution is unclear. We believe monetary easing in Europe could happen around the end of Q1-2012, coinciding with potential quantitative easing from the US. However, the road to such a solution is likely to be long and bumpy, involving further stress in the markets. While a concrete solution to Europes problems is in doubt, a recession in the euro area and a cutback in European banking appear more or less certain. The dual effects of drastic reductions in trade and capital flows would be detrimental to Asian trade and growth. The added risk of a hard landing in China will also be on investors minds as China slows in H1-2012. Against this backdrop, we expect a relatively weak performance from Asian credits in Q1-2012. This is also likely be a bullish period for USTs, which will continue to be supported by safe-haven flows. Investors in Asian credit would therefore be better off investing in USTsensitive sectors such as HG sovereigns/quasisovereigns, higher-rated HG corporates, and HY sovereigns/quasi-sovereigns in Q1-2012. In our view, the upside from UST tightening will be fairly limited given that USTs are already trading at record-low yields; carry will therefore be an important component of total returns over this period. We expect the HY corporate sector to be the main underperformer in Q1-2012, with spreads widening sharply given the weaker outlook for risk assets and Chinas economy. We also remain cautious on the financial sector given expected supply and headwinds to asset quality. Liquidity in the secondary markets is likely to be a key factor in Q1-2012; as a result, investors may be more involved in the primary markets (to the extent that there is primary-market activity during the period). Under the above scenario, we forecast Asian cash bond returns at around -3% in Q1 (with 30bps of UST tightening expected from current levels).
15
Expectations for Q1-2012
With global risk appetite driven more by investor sentiment than fundamentals, we expect developments in
Chart 1: Asian cash bonds outperform the rest of EM Spread (bps)

600
500
Latam EEMEA Asia
400
300
200 Dec-10 Feb-11 Apr-11 Jun-11 Aug-11 Oct-11
Note: CS regional credit indices used; Sources: Bloomberg, Standard Chartered Research
12 December 2011
Credit (cond)
Expectations for the rest of 2012
Weak US growth (due in part to structural problems in the housing and labour markets), and the potential for even weaker growth as a result of the recession in Europe, could trigger monetary easing by the Fed in early 2012. We could also see co-ordinated easing from the European Central Bank (ECB) by the end of Q1-2012 as part of the solution to the euro-area debt crisis. Based on this scenario, we expect the global macro picture to improve in H2-2012. Quantitative easing in the US and Europe is likely to support risk appetite, and a weaker euro (EUR) and US dollar (USD) will lead to sustained flows into emerging-market (EM) assets including Asian credits in the medium to long term. The expected pick-up in Chinas growth and improving onshore liquidity will also be supportive of HY credits, particularly the Chinese names. We expect the Asian credit markets to rally in H2-2012 on the back of increased inflows to EM and a visible improvement in the regions economic growth outlook. In anticipation of this turn, we plan to position ourselves in higher-beta sectors in advance, possibly by the end of Q1 or in early Q2. This would involve moving to an Overweight position in the HY corporate sector and the crossover credits, while going Underweight Treasury-sensitive sectors such as HG corporates and sovereigns both HG and HY. We would also shift our stance on the banking sector to Neutral from Underweight currently. Based on these views, we expect Asian USD credits to post total returns of 5.5% in 2012 (assuming 30bps of UST widening from present levels), with carry being the
main contributor to total returns (5.4ppt). We expect HY corporates to be the best-performing asset class in terms of spread tightening in 2012 as a whole. However, this scenario is highly dependent on a concrete improvement in confidence. Based on expected spread tightening, coupled with high carry, HY corporates could return 13.8% in 2012, assuming that market conditions improve along the lines assumed above. However, performance in H1-2012 (and in particular Q1) will likely be skewed towards HG corporates and HY sovereigns, based on stability considerations as well as carry and credit tightening considerations.
Expectations for supply in 2012
Supply pipeline remains healthy. A bottom-up analysis of all existing issuers in the Asian credit space suggests reasonably healthy primary issuance in 2012 (c.USD 79.8bn). This would represent an increase from the USD 67bn issued in 2011 (as of 6 December). While markets are likely to remain volatile in 2012, the combination of a very long pipeline of deals and lower activity in the syndicated loan market is likely to lead to higher capitalmarkets activity in the primary issuance space. Despite the front-loaded 2012 redemption profile, we expect issuance to be relatively staggered (picking up in Q2-2012 and increasing thereafter) as market sentiment prevents weaker names from accessing the markets. We expect USD 35.4bn of supply in H1, followed by USD 44.4bn in H2; this is based on our estimate of c.USD 79.8bn of issuance for all of 2012.
Chart 2: Total returns were on expected track until August 2011 JACI total return curve for 2011
158 156 154 152 150 148 146 144 142 140 Dec-10 Feb-11 Apr-11 Jun-11 Aug-11 Oct-11 -7.53% 6.15%
Supply will be limited if European crisis remains unresolved. We acknowledge that the above forecast may be an overestimate of issuance under present market conditions, especially if market access does not improve soon. Market access will depend, among other things, on how the euro-area situation develops, and on whether and when Europe and the US implement further quantitative easing. If the euro-area situation remains unresolved well into 2012, the primary markets could remain out of bounds for HY corporate credits and for crossover banking and corporate issuers. Under this scenario, we would also expect some discretionary issuance by banks and corporates to be pushed back. As a result, issuance would be closer to USD 50-60bn than the USD 79.8bn we project on a bottom-up basis.

12 December 2011 16
Credit Charts of the year

Chart 1: Asian HY has underperformed the HG sector JACI IG and HY corporate spreads (bps)
1,400 1,200 1,000 800 600 400 200 0 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 IG HY HY minus IG (RHS) 1,000 900 800 700 600 500 400 300 200 100 0
Chart 2: Market liquidity has worsened sharply Bid-ask price differentials of Asian corporates by rating
5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 Jan-11 Mar-11 May-11 Jul-11 A Sep-11 AA and above BBB B BB
Nov-11
Chart 3: Korean commercial banks trade tight to policy banks (5Y policy bank vs. commercial bank spread, bps)
450 400 350 300 250 200 150 100 50 0 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Korea policy Commercial minus policy (RHS) Korea commercial 80 70 60 50 40 30 20 10 0
Chart 4: Indian bank senior paper underperforms Korean peers (Korean 5Y vs. Indian 5Y senior spreads, bps)
500 450 400 350 300 250 200 150 100 50 0 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Korea senior India minus Korea (RHS) India senior 160 140 120 100 80 60 40 20 0
Chart 5: Asian single-A corporate hold their ground versus global peers US and Asian single-A corporate spread differential (bps)
350 300 250 200 150 100 50 0 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 US single-A corp. Asia single-A corp. Asia minus US (RHS) 70 60 50 40 30 20 10 0 -10 -20
Chart 6: Asian BBB corporates give up ground versus global peers US and Asian BBB corporate spread differential (bps)
450 400 350 300 250 200 150 100 50 0 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 US BBB corp. Asia minus US (RHS) Asia BBB corp. 160 140 120 100 80 60 40 20 0
12 December 2011
17
Equities
Clive McDonnell, +65 6596 8526
Clive.McDonnell@sc.com
EM to outperform DM
Top trades of 2012
1. EM to outperform DM. The current underperformance of emerging markets (EM) versus developed markets (DM) started in October 2010 as the euphoria over the end of the global financial crisis faded and portfolio flows into EM equity funds peaked. From a fundamental perspective, Q4-2010 also coincided with a negative turn in EM earnings revisions. Looking ahead, we expect fund flows to reverse in favour of EM by Q2-2012, and EM earnings revisions to turn positive within a similar time period. A contributing factor to our forecast is the expected rise in commodity prices, in particular the ratio of copper to oil. As Chart 5 shows (see Charts of the year below), this ratio has been a useful guide to the relative performance of EM and DM. The main driver of this relationship is the higher intensity of copper usage in EM, versus higher oil usage in DM. When EM demand recovers at a faster pace relative to DM, the ratio rises, pointing to the future outperformance of EM over DM equities, and vice versa. 2. Value to outperform growth. Value investing has proven to be a greater alpha generator than growth investing over the long term. Nevertheless, this strategy can result in extended underperformance during periods of easy monetary policy and build-up of excess liquidity, such as the late 1990s and mid-2000s. In the EM universe, growth outperformed value starting in late 2009; however, since its October 2011 low, value has reasserted itself and outperformed growth. We expect this trend to continue, as monetary policy (as measured by real interest rates) is likely to remain relatively tight, and we see a low probability of a build-up of excess liquidity. Moreover, the relative valuation gap between growth and value is >1 standard deviation below its mean. While we do not believe that valuations on their own are catalysts, combined with constraints on EM central bank monetary policy due to quantitative easing in DM and an eventual upward turn in EM earnings revisions, we believe they point to good prospects for value stocks to outperform growth stocks after Q1-2012. 3. Small- and mid-cap to outperform large-cap. Our forecast that small- and mid-cap stocks will outperform large-cap stocks, which represents a reversal of the trend in 2011, is based on the view that Asias resilient consumer story is best expressed via the regions many small- and mid-cap companies. As the credit environment improves and margins recover thanks to lower
12 December 2011
commodity/input prices, small- and mid-cap stocks should witness an improvement in relative performance. Key issues We expect the European Central Bank (ECB) to take decisive action to stem the euro-area crisis in 2012. We expect ECB action to come in Q1-2012, with a likely focus on a hybrid form of the existing credit easing quantitative credit easing (QuCE). This could involve the ECB not sterilising all of its intervention to support individual country bond markets under stress. We expect the Fed to launch QE3 at its March 2012 meeting, amounting to USD 75bn a month for the remainder of the year. We forecast that most EM central banks will cut rates in 2012. For equity investors, the implications of these policies are likely to be significant. They can be summarised as follows:
1. Currency effect: An initial rally in the euro (EUR) following ECB action will lead to a lower DXY; we expect this to be a short-term event lasting less than a month. This will be followed by the EUR weakening to as low as EUR-USD 1.20 and a higher dollar trade-weighted (DXY) index in Q1-2012. For the remainder of 2012, US QE and QuCE in the euro area will create a tug-of-war between two fundamentally weak currencies, with the DXY likely to drift lower. 2. Liquidity effect: A stabilisation in the euro area should lead to a recovery in liquidity flows into both fixed income and equity markets. Initial liquidity flows are likely to be from money market and cash into government bonds and equities. Evidence from the Feds QE1 and QE2 programmes indicates that fixed income should initially outperform equities following ECB action, based on the assumption of a high degree of stress in fixed income markets at the time of the announcement. 3. Equity effect: An initial relief rally favouring high-beta markets is likely to be followed by a period of consolidation in Q1 as prospects for a recovery in global growth in 2013 are digested. H2-2012 should see greater differentiation between EM and DM, with the former outperforming the latter.
18
Equities (cond)
As Chart 1 shows, there is a strong negative correlation between the DXY and EM equity performance. Fluctuations in the DXY drive portfolio fund flows that is, a weaker DXY drives an increase in flows to international equity funds, whereas a stronger DXY drives an outflow of funds. Given the challenges facing the euro area, we expect EM funds to eventually benefit disproportionately relative to their size in terms of fund flows. Based on this relationship, and given our DXY forecasts outlined above, we expect the following profile for EM returns relative to DM: higher one month after ECB action, lower three months after, and modestly higher 12 months after. Earnings growth is likely to remain lacklustre in EM in 2012. Based on Factset consensus forecasts, EPS growth will be 9%. However, based on our leading indicator of earnings, the earnings revision index (ERI), there is a real risk that earnings growth will slip into negative territory in 2012. A 10% decline in earnings should not surprise investors. While we expect EM equity performance to be positive in 2012, gains will be driven by multiple expansion rather than earnings growth. The paradox of falling earnings growth and stock-price gains leading to multiple expansion is not unusual at turning points in the market. We are not maximum bullish towards EM. Based on corporate fundamentals alone, prospects remain challenging: falling margins, a slowdown in top-line growth and tighter credit availability all point to fundamental weakness for equities. The key issues for investors are the extent to which this has been discounted and prospects for a recovery in 2013. Based on our expectations of ECB action and an improvement in the liquidity environment, we are comfortable forecasting that EM equity prices will be higher than currently prevailing prices by the end of 2012. In the absence of ECB action, we still expect EM to outperform DM based on the resumption of the multi-year trend of portfolio globalisation. EM tends to have a lowerthan-benchmark allocation in DM pension funds. Moreover, the superior fundamentals of EM relative to DM can be overlooked in the short term but are unlikely to be ignored in the long term. Interestingly, the absence of QuCE by the ECB could be viewed as beneficial to EM growth prospects, as the combination of QuCE and QE3 would reduce EM policy makers options: (a) they will have a reduced ability to lower rates, as QE will lead to higher commodity prices, putting upward pressure on inflation (see Chart 2); and (b) QE leads to DM currency weakness and EM strength, reducing export competitiveness at a time of a significant contraction in DM demand. Valuations in the EM universe are currently 1 standard deviation below the long-term average, or 9x 12-month consensus earnings forecasts effectively back to the lows recorded in early October, as Chart 3 shows. While EM economic fundamentals are superior to DM, concerns over a squeeze on corporate cash flow arising from tighter credit availability and a slowdown in new orders are weighing on sentiment towards equities and, in turn, valuations. A full or partial resolution of the euro-area debt issues will address some of these concerns; however, others remain on the horizon, including deleveraging of DM bank balance sheets and severe tightening of euroarea fiscal policy (the quid pro quo for ECB action). Given our forecast that EM equities will outperform DM, we are in effect arguing for a partial decoupling of the riskon/risk-off trend that has been observed since 2009. Liquidity and credit availability will remain key drivers of such decoupling. As such, our expectation that Asian banks will step in and close the gap left by a withdrawal of cross-border lending by euro-area banks is an important driver of our forecast for EM outperformance. One implication of this is that EM financials are likely to continue to underperform headline indices, as they will need to tap markets for funds to close the gap. As Chart 4 shows, EM financials underperformed EM equities by almost 10% in 2011; moreover, they underperformed DM financials, despite their superior solvency and liquidity.
19
EM valuation breakdown Significant downside risk to EM EPS

EPS growth 2011 China Korea Brazil Taiwan S. Africa Russia India Mexico Malaysia Indonesia Thailand Turkey Philippines MSCI EM 11% 3% 16% -14% 25% 42% 12% 11% 5% 23% 22% -8% 5% 6% 2012 13% 15% 5% 3% 25% -8% 15% 22% 13% 16% 11% 13% 13% 9% 2011 9.0 9.3 8.8 13.2 12.2 4.6 14.1 17.8 15.2 14.0 10.5 9.1 15.1 9.8 P/E 2012 7.9 8.1 8.4 12.8 9.8 5.0 12.3 14.6 13.5 12.1 9.5 8.0 13.4 9.0 P/BV 2011 1.4 1.2 1.3 1.6 2.1 0.8 2.2 2.4 2.0 3.4 1.9 1.4 2.5 1.5 2012 1.3 1.0 1.2 1.5 1.9 0.7 2.0 2.3 1.9 2.9 1.7 1.2 2.3 1.3 Div. yield 2011 3.0% 1.6% 4.3% 4.5% 3.6% 3.2% 1.6% 1.8% 3.5% 2.7% 3.9% 3.3% 2.9% 3.3%

12 December 2011
Equities Charts of the year

Chart 1: MSCI Emerging Markets and DXY Negative correlation between DXY and EM equity performance
1,400
QE2 hinted QE1 ann. QE1 start QE1 end
Chart 2: CRB index and EM inflation Impact of QE2 and inflation in emerging markets
72 500 450 76 80 400 350 300 CRB index (LHS) 8%
QE2 start
QE1 start
QE1 end
1,200 1,000 800 600 400
MSCI EM (LHS)
QE2 hinted
QE1 ann.
EM inflation (RHS)
7% 6% 5% 4%
US TARP hinted
QE2 start
QE2 end
84 88
Dollar index (RHS, inversed)
200 150
QE3 hinted
QE2 end
250
US TARP hinted
QE3 hinted
3% 2% 1% 0%
May-08 Nov-08 May-09 Nov-09 May-10 Nov-10 May-11 Nov-11 Sources: Bloomberg, Factset, MSCI, Standard Chartered Research
May-08 Nov-08 May-09 Nov-09 May-10 Nov-10 May-11 Nov-11 Sources: Bloomberg, CEIC, World Bank, SC Research
Chart 3: MSCI Emerging Markets 12M fwd P/E EM trading at 1 standard deviation below long-term average
16 15 14 13 12 11 10 9 8 7 6 Nov-04 Nov-05 Nov-06 Nov-07 Nov-08 Nov-09 Nov-10 Nov-11 -1 S.D. 12m Fwd P/E +1 S.D. Mean
Chart 4: Relative performance of equity indices Financials underperformed by a wide margin (% y/y)
0% -5% -10% -15% -20% -25% -30% Index Financials Ex-financials AXJ EM DM
Sources: Factset, MSCI, Standard Chartered Research
Sources: Factset, MSCI, Standard Chartered Research
Chart 5: Relative perf. of EM/DM and copper/oil price ratio Positive relationship between EM/DM and copper/oil
2.5 1.4 1.2 1.0 1.5 Copper/oil price ratio (advanced by 6 mths, RHS) EM/DM relative performance (LHS) Jan-03 Jul-04 Jan-06 Jul-07 Jan-09 Jul-10 Jan-12 0.8 0.6 0.4 0.2 0.0
Chart 6: MSCI EM Asia Relative PE growth/value Value stocks priced at close to -1 s.d. vs growth
2.0 1.8 1.6 1.4 1.2 1.0 0.8 Nov-04 Nov-05 Nov-06 Nov-07 Nov-08 Nov-09 Nov-10 Nov-11 Sources: Factset, MSCI, Standard Chartered Research +1 S.D. Mean
2.0
1.0
-1 S.D. Relative 12m trailing P/E growth/value
0.5
12 December 2011
20
FX
Callum Henderson, +65 6596 8246
Callum.Henderson@sc.com
FX Research team
Dj vu all over again 2009 versus 2012

Top trades of 2012
1. Short CNY-INR: The Indian rupee (INR) has been the
Key issues
worst-performing Asia ex-Japan (AXJ) currency in 2011 on slowing growth, a widening trade deficit and a sharp downdraft in the Indian stock market. We expect further INR weakness in Q1-2012. However, the peak in Indian inflation is strongly correlated to the bottom in the Sensex, and Indias economic slowdown should narrow the trade deficit. Once global growth bottoms, the INR will look very attractive on a carry basis. The Chinese yuan real effective exchange rate (CNY REER) remains high, suggesting that Chinas authorities may be more active in limiting appreciation. We favour this trade from Q2-2012.
2. Long USD-ZAR: South African trade is more closely tied
to Europe and Asia than the US. With Europe falling into recession and Asia still slowing, short-term prospects for the South African rand (ZAR) remain bearish. Fragile risk appetite in Q1-2012 may lead to a temporary shortfall in portfolio inflows to fund the current account deficit. Finally, the DXY and USD-ZAR remain closely correlated. We favour this trade in Q1-2012 only.
3. Short CHF vs. a EUR/USD basket: The Swiss franc
The expected economic backdrop in H1-2012 of a recession in Europe and stagnating growth in the US and Japan will create a challenging environment for higherbeta G10 and EM currencies. More positively, inflation should continue to decline. However, the monetary policy response will be a critical swing factor. Our base case of Federal Reserve QE3 and European Central Bank liquidity provision in H1-2012 represents a further significant injection into the financial system, which will boost inflation expectations in H2-2012. Investors will also be keenly focused on Chinas monetary and fiscal policy after the first cut in the required reserve ratio (RRR) in early December. As a result, we expect FX volatility to remain elevated. 2011 was an exceptionally challenging year for FX managers. From January-October, the Barclay Currency Traders Index returned +1.0% and the Stark Currency Traders Index returned -11.0%. Of four main FX-alpha trading styles, carry was the only one that had a positive return for January-November. Valuation had a small loss, while both trend and volatility had double-digit losses. By comparison, the Standard Chartered FX Trading Portfolio returned -0.06% through end-November. While 2011 was a challenging year for us also, our framework of comparing 2011 with 2008 served us well. Granted, there were important differences, but the many similarities helped us to avoid larger return pitfalls. Similarly, 2009 may prove to be a useful framework for anticipating 2012, particularly in the context of a year of two halves. Such a comparison of 2012 versus 2009 should be seen in the context of Mark Twain History doesnt repeat itself, but it does rhyme. The floor in economic expectations brought by policy responses in the US, euro area and China should lead to a resumption of the multi-year globalisation of privatesector portfolios in H2-2012. Additionally, persistent trade surpluses in EM and the slowing of capital outflows from Q2-2012 should lead to a resumption of FX reserves build-up, prompting renewed central bank diversification from the USD into G10 and EM currencies.
(CHF) is massively overvalued. The latest OECD purchasing power parity data shows that it is overvalued by 33.95% against the euro (EUR) and 39.36% against the US dollar (USD). The Swiss economy is heading into recession and deflation. We expect a vigorous policy response, raising the EUR-CHF lower bound to 1.30 from 1.20. We favour this trade in Q1-2012.
G10 and EM FX forecasts USD strength in H1, weakness in H2

2012 EUR-USD USD-JPY GBP-USD USD-CNY USD-IDR USD-INR USD-KRW USD-SGD USD-NGN USD-ZAR End-Q1 1.20 81 1.46 6.36 9,400 53.00 1,210 1.35 164 9.30 Q2 1.22 79 1.50 6.31 9,200 51.80 1,155 1.32 161 9.10 Q3 1.25 77 1.52 6.26 9,000 50.50 1,095 1.28 159 8.80 Q4 1.30 74 1.55 6.21 8,700 48.50 1,050 1.25 158 8.20

12 December 2011 21
FX (cond)
Our key calls for 2012
Q1-2012 USD to extend gains. We expect the USD to continue to benefit in Q1-2012 from global deleveraging, economic divergence, fragile risk appetite and safe-haven status. High return volatility will keep investors defensive. European currencies will be major underperformers, while AXJ and Latam currencies are likely to be mixed. In this context, the biggest losers against the USD in Q1-2009 included the EUR, CHF, Korean won (KRW), Indonesian rupiah (IDR), Singapore dollar (SGD), Colombian peso (COP) and Argentine peso (ARS). Q2-2012 USD to stabilise. Easing in the US, Europe and China should support higher-beta assets. That said, Europe will remain in recession, with negative implications for EM currencies via trade, bank lending and portfolio investment. We expect two-way price action in Q2-2012, with more focus on relative value. We look for G10 and EM currencies, particularly the GBP and commodity currencies, to outperform the EUR. Q3-2012 USD to begin correcting lower. We expect global economic expectations to bottom in Q2-2012. Asia has more room to ease and will be proactive in defending final demand. With Fed policy remaining ultra-loose and key economies in Asia, Africa and the Middle East outperforming, the main sources of private-sector capital the US and Japan will resume their multi-year allocation to higher-yielding assets. Q4-2012 USD to accelerate lower. Improving global economic expectations should encourage a tsunami of portfolio investment into EM, just as it did in H2-2009. We expect G10 commodity currencies particularly the
Australian dollar (AUD) and New Zealand dollar (NZD) to lead the way, followed by Latam and then Asia.
G10 FX allocations: We recommend that real-money funds maintain Overweight FX allocations to the USD in Q1-2012, turning neutral in Q2 and then bearish from Q3. Within this, we favour Underweight allocations to the EUR, GBP and CHF for Q1-2012. We are Neutral on the AUD and Canadian dollar (CAD). While we expect the AUD to extend its losses in Q1-2012, Chinas policy easing should put a floor under growth expectations. Moreover, Australia is running large monthly trade surpluses, in contrast to the deficits of 2008. We see the CAD as a lower-beta play on the US recovery, further supported by reserve diversification. EM FX allocations: We recommend Underweight FX allocations to emerging European currencies. While this region already saw some weakness in H2-2011, we think it will extend in early Q1-2012 as the euro-area recession worsens and spills over to the rest of the continent. The hit to trade in emerging Europe will be significant. Moreover, bank recapitalisation in the euro area is resulting in a large retrenchment of bank lending to the east. Against this, we recommend small Overweights in AXJ and Latin America. Once global expectations bottom in Q2-2012, the experience of 2009 suggests significantly increasing Overweight positions in Latin America. Asia: Regional currencies will remain under pressure in Q1-2012. Within this, given our forecasts and return profiles, we expect the Vietnamese dong (VND), Pakistani rupee (PKR), Thai baht (THB) and Bangladeshi taka (BDT) to be the main underperformers against the USD. The INR will see further weakness, but carry, peaking inflation expectations and value will limit the downside from here. Outperformance will be focused in Greater China, particularly the CNY and Hong Kong dollar (HKD). In H2-2012, we see a significant rally in AXJ currencies, led by the KRW, Philippine peso (PHP) and INR. In that environment, we expect the CNY to underperform significantly in H2-2012. Latin America: Regional currencies have been under significant pressure in H2-2011, with the Mexican peso (MXN), Brazilian real (BRL) and Chilean peso (CLP) leading the way lower. We expect them to weaken further in Q1-2012, with the Peruvian sol (PEN) continuing to outperform. Once global economic expectations bottom, we expect a major reversal higher in the MXN on significant undervaluation and better US growth.
22
JPY, CHF overvalued; MXN, KRW undervalued BIS REER vs. 5-year moving average (top 5 and bottom 5)
15% 10% 5% 0% -5% -10% -15% MXN KRW ARS GBP TWD BRL CNY AUD CHF JPY Source: Standard Chartered Research
12 December 2011
FX Charts of the year

Chart 1: CNY continues to lead the way AXJ REERs: Top 5 performers
180 160 140 120 100 80 60 1994 1996 1998 2000 2002 2004 2006 2008 2010 CNY INR PHP SGD THB
Chart 2: KRW and IDR to rally in H2-2012 AXJ REERs: Bottom 5 performers
150 130 110 90 70 50 30 1994 1996 1998 2000 2002 2004 2006 2008 2010 TWD HKD IDR KRW MYR
Sources: BIS, Standard Chartered Research
Chart 3: Slowing IP cycle to hit AXJ exports in Q1 US ISM Manufacturing and AXJ exports
65 60 55 50 45 40 35 30 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Sources: Bloomberg, Standard Chartered Research AXJ exports % y/y (RHS) ISM Manufacturing 45 35 25 15 5 -5 -15 -25 -35
Chart 4: Slowing AXJ exports to hit AXJ currencies in Q1 AXJ exports and the ADXY Index
50 40 30 20 10 0 -10 -20 -30 -40 Jan-01 Jun-02 Nov-03 Apr-05 Sep-06 Feb-08 Jul-09 Nov-10 Sources: Bloomberg, Standard Chartered Research ADXY Index % y/y (RHS) AXJ exports % y/y 15 10 5 0 -5 -10 -15
Chart 5: In 2009, BRL and ZAR outperformed from Q2 EM FX performance in 2009 vs. the USD
35% 30% 25% 20% 15% 10% 5% 0% -5% -10% -15% ARS NGN RUB HKD CNY BWP IDR CLP ZAR BRL
Chart 6: In 2009, commodity currencies outperformed DM FX performance in 2009 vs. the USD
30% 25% 20% 15% 10% 5% 0% -5% JPY DKK EUR CHF SEK GBP CAD NOK NZD AUD
12 December 2011
23
Rates
Danny Suwanapruti, +65 6596 8262
Danny.Suwanapruti@sc.com
EM rates to outperform in 2012

Top trades of 2012
1. Long EM versus USTs. We expect EM local-currency
Key issues
bonds to have another robust year in 2012, supported by liquidity injections from the European Central Bank (ECB) and the Fed (which we anticipate by Q1-2012). The timing should be right to enter long EM trades and shift to Overweight EM allocations after quantitative easing (QE) is announced. In the meantime, we recommend being Neutral duration and staying close to benchmarks.
2. Long INR bonds. We expect the Reserve Bank of India
to shift its focus from inflation to growth, and we forecast 125bps of repo rate cuts in 2012. While the swap curve is partly pricing in such easing, GoISecs have underperformed on supply concerns. Consequently, we expect GoISecs to perform well in response to monetary easing. We are bullish on the Indian rupee (INR) versus the US dollar (USD) in 2012, which supports the long INR bond trade. The key near-term risk is a supply shock, with the FY13 fiscal deficit exceeding our forecast of 5.5% of GDP. In a world where financial markets are highly correlated, India will attract investors given its relatively low correlation with other emerging markets.
3. KRW and MYR bonds to attract FX reserve funds.
Fed and ECB easing to be supportive of EM localcurrency bonds. Price action in 2012 should somewhat mirror 2009. Following the Feds introduction of QE in November 2008 and the G20 meeting in London in April 2009 (when USD 1.1trn was pledged to boost the global economy), the spread between EM local-currency bond yields and US Treasuries (USTs) narrowed from 550bps to around 400bps. Thereafter, this spread remained range-bound at around 400bps for almost two years. In 2012, we expect EM local-currency bond yields to narrow towards 400bps (from 470-80bps currently) and stay range-bound thereafter. A further deterioration in risk appetite is likely going into Q1-2012, which will ultimately force the ECB into more aggressive credit easing and the Fed into QE. EM risk assets may initially underperform (mostly from FX) at the start of 2012. However, we recommend staying Neutral duration and close to benchmarks for now. We do not favour shifting to underweight EM duration allocations, because the spread between EM and USTs should narrow rapidly once liquidity injections from the Fed and ECB commence. Reserve diversification to pick up momentum from Q2-2012 onwards. In Q1-2012, we are generally bullish on the US dollar (USD) against EM currencies; thus, USD accumulation by Asian central banks is likely to slow or even stop. However, once the Fed and the ECB commence aggressive easing, FX reserve accumulation should pick up momentum (from Q2-2012 onwards).
Central bank reserve diversification is likely to pick up momentum from Q2-2012 onwards once QE by the Fed and aggressive credit easing by the ECB are announced. Central banks globally will be looking for markets with a strong medium-term FX outlook, and deep and liquid bond markets. Korea and Malaysia are the two Asian markets that fit these criteria the best. Greater returns from EM FX gains than EM duration gains in 2012 (total return forecasts, %)
20 Higher returns from FX gains
NG MX BR IN UG KE
15 FX total return 10 5 0 -5 -10 -5
ID
Asian central banks are already active in regional bond markets, as part of an ongoing effort to diversify their FX reserves. We expect this to pick up further from Q2-2012 onwards. The focus will be on markets with a positive medium-term FX outlook, as well as depth in their bond markets. Risk of capital controls in H2-2012. Foreign holdings of Asian local-currency bond markets are already considered quite high, and they are likely to climb further in 2012. Local authorities appear increasingly concerned about this, particularly if there is a high concentration of ownership among a few players. This includes sovereign investors, as there can be political ramifications if one
24
PH KRGH LK MY ZA TH CNTW PK SG US HK VN EU
HIgher returns from duration gains 0 5 10 USD-funded LCY total return 15 20

12 December 2011
Rates (cond)
country owns a significant amount of another countrys debt. Moreover, if the two countries compete against each other in export markets, this could also impact the cross FX rates.

Once risk appetite has increased and central banks are less worried about rapid portfolio outflows, we see a risk of increased regulation to curb portfolio inflows. Concentration of foreign ownership is also a key risk (particularly if funds face redemptions). In addition to the level of foreign ownership (often measured as a percent of the total outstanding), investors should be aware of the concentration of ownership. For example, there is more risk in markets where a few players own a large share of the market than in a market where ownership is more evenly distributed among investors. During our Asian rates roadshow to the UK in November 2011, about 80% of the real money investors we met had shifted to underweight positions in Indonesian bonds. However, foreign holdings fell by just USD 4bn (as of 1 December 2011) from their peak of USD 27bn on 7 September. This suggests that the underweight positions are small or that foreign holdings are highly concentrated among a few players, who are still overweight.
Duration gains in Q1; FX gains in Q2-Q4. Our total return analysis incorporates our EM bond and FX forecasts for 2012 (Table 1). In Q1-2012, we expect most of the total returns to come from duration as opposed to FX. This is line with our view that EM central banks will front-load rate cuts in H1-2012 and the USD will rally in Q1. Thereafter, once the ECB and Fed inject more liquidity, we expect EM currencies to rebound against the USD from Q2-2012, while EM rates should stay rangebound. Thus, from Q2-2012 onwards, total return gains should come more from FX than duration. Chart 1 shows a breakdown of our total return expectations between FX and rates for 2012. India has the highest score on a risk-adjusted basis. We are bullish on both the Indian rates and FX markets in 2012. Stay in liquid markets. We favour staying in the more liquid markets in H1-2012 despite some frontier markets looking attractive on a total-return basis (which is due to the high yields). During periods of risk aversion, price discovery can become very poor, and we value the ability to be nimble. We will consider re-entering frontier markets once market liquidity improves.
Total return analysis, incorporating our FX and rates forecasts for 2012
Country Uganda Kenya India Brazil Mexico Nigeria Indonesia Philippines Vietnam* Ghana Malaysia Korea Pakistan Sri Lanka Taiwan China Singapore Thailand South Africa Hong Kong US EU Forecast return USD-unhedged Risk-adj. Yield total return return 27.5% - 21.8 0 26.0% 1.00 19.2 0 21.3% 3.23 8.67 10.5 21.2% 1.29 6 19.6% 1.31 6.39 12.9 17.7% 1.22 0 11.5% 0.55 6.23 11.1% 1.04 5.88 9.1% - 12.8 0 8.4% - 13.0 0 7.3% 0.74 3.26 7.3% 0.39 3.49 6.5% - 12.5 0 6.1% 1.51 8.81 4.7% 1.07 1.32 3.4% 0.75 3.49 2.7% 0.26 0.61 2.6% 0.30 3.12 0.3% -0.06 7.94 -0.6% -0.71 0.82 -1.6% -1.01 0.93 -3.5% -0.56 2.14 Forecast yield 15.00 15.00 7.50 9.40 6.60 12.00 6.00 5.70 11.25 13.50 3.10 3.30 13.25 10.00 1.40 3.90 0.70 3.40 8.85 1.10 1.45 2.50 USD-funded FX FX forecast FX total local returns return 16.0% 2,525 2,660 11.5% 16.5% 89.45 97 9.5% 10.9% 51.34 48.5 10.3% 5.9% 1.78 1.65 15.3% 2.2% 13.48 11.8 17.4% 0.3% 161.55 158 17.4% 2.9% 9,035 8,700 8.6% 5.3% 43.22 41.5 5.9% - 21,011 22,600 2.8% 1.64 1.7 5.6% 3.1% 3.13 3.03 4.2% 3.3% 1,128. 1,095 4.0% 1 3.8% 89.42 94 2.7% 1.6% 113.91 114.8 4.5% 1.9% 30.17 29 2.8% 1.0% 6.35 6.21 2.4% 0.7% 1.28 1.25 2.0% -0.1% 30.78 30.5 2.8% -1.8% 7.99 8.2 2.2% -0.1% 7.77 7.79 -0.5% -1.6% 1 1 0.0% 0.1% 1.34 1.3 -3.6%
Note: Thick green bars denote unhedged USD total returns in Q1-12, thin blue bars show Q4-12; * Forward market is not accessible to offshore accounts; Source: Standard Chartered Research
12 December 2011 25
Rates Charts of the year

Chart 1: EM spread over USTs to narrow in 2012 Spread between GBI-EM and USTs (bps)
650 600 550 500 450 400 350 300 Jun-08 Nov-08 Apr-09 Sep-09 Feb-10 Jul-10 Dec-10 May-11 Oct-11 Sources: Bloomberg, Standard Chartered Research GBI-EM vs UST spread G20 meeting in London
Chart 2: Correlation of LCY EM bond returns is rising Average correlation of selected EMs in GEMX index
0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0.0 Apr-08 Oct-08 Apr-09 Oct-09 Apr-10 Oct-10 Apr-11 Oct-11
Sources: Reuters, MarkIt, Standard Chartered Research
Chart 3: Foreign holdings should stay high in 2012 % of outstanding, EM local markets
40% 35% 30% 25% 20% 15% 10% 5% 0% Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Sources: Central banks, governments, Standard Chartered Research Korea Thailand Indonesia Malaysia
Chart 4: Strong inflows to EM bond funds are likely to persist (2011 cumulative flows, USD bn)
16 14 12 10 8 6 4 2 0 -2 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11
Blended Hard currency Local currency
Sources: EPFR, Standard Chartered Research
Chart 5: INR rates market to rally on interest rate cuts (%)

9 8 7 6 5Y OIS rate 5 Repo rate 4 Jan-09 Jun-09 Nov-09 Apr-10 Sep-10 Feb-11 Jul-11 Dec-11
Chart 6: The ECB is expected to deliver more aggressive Securities Market Program purchases (%)
30 25 10Y Greece
10Y GoISec yield
20 15 10
Weekly SMP purchases in bn 9Y Ireland
10Y Portugal 10Y Spain
5 0 10Y Bund Apr-10 Jul-10 Oct-10 Jan-11 10Y Italy Apr-11 Jul-11 Oct-11
Jan-10
Sources: Bloomberg, ECB, Standard Chartered Research
12 December 2011
26
Sovereign risk
Christine Shields, +40 22 7885 7068
Christine.Shields@sc.com
More downgrades to come

A difficult year ahead
In 2011, there were more rating downgrades than upgrades; it was only the second year in the past decade that this has been the case (Chart 1). Though the number of rating cuts was lower than in 2008, the other year with a negative balance, the regional mix in 2011 was mostly skewed towards the industrial world, especially the advanced economies in Europe, unsurprising given the European sovereign debt crisis. The Middle East was also hard hit, reflecting the wave of change following the Arab Spring, while ratings in Asia and Latin America generally held up or were raised. Most positive outlooks are in these two regions, along with Central and Eastern Europe (Chart 2). There were more new ratings awarded in Africa. The difficulty for the rating agencies is that, by pointing to a particular risk, they may cause markets to react in such a way that the warning becomes self-fulfilling. Conversely, by not pointing to a risk, the agencies can be accused of tardiness or even incompetence. Their recent actions in Europe, most recently putting 15 of the euroarea countries on CreditWatch Negative, and even Standard & Poors downgrade of the US back in August, were extremely unhelpful in both fact and timing. In the cases of Greece and Portugal, multiple downgrades at one time just suggested that the earlier rating had been out of line for some time. More downgrades are likely in the coming months. As events in the highly indebted European periphery evolve, more such difficult choices will be required. Our
internal sovereign grades are reviewed quarterly, and we sympathise with the dilemma facing the rating agencies. Looking forward, credit fundamentals, on the metrics generally used, are probably at or close to realistic levels. But if the sovereign crisis brings the collapse of the euro as an institution, that will clearly not be the case. The position is binary. We are where we are provided the situation stabilises; on the other hand, if matters worsen, other euro-area economies may fall to sub-investment grades.
One problem in the rating process for the advanced economies is that some routinely used metrics, such as import cover the number of months of imports covered by official reserve holdings have been seen as less appropriate than for the developing world. Typically, as countries joined the euro area, they were encouraged to manage their reserves lower, as the collective euro-wide picture was what mattered, not individual country holdings. Of course, the folly of that approach is now evident, though certainly for the large industrial countries, the sheer scale of their import bill is so significant that the official reserves required to provide three months of import cover would not be the most efficient use of resources. Moreover, some analysts have attempted to excuse imbalances such as current account deficits by stating that the shortfalls are readily financed by international capital. On that basis, they are manageable. This is another folly. At times of stress, finance can dry up. Hence, fundamentals always matter. Looking ahead, fundamentals in our footprint are generally strong. In Asia, most of the rating changes in 2011 were positive, though Vietnam, Japan, New Zealand and the Cook Islands saw their ratings fall. Vietnam has long been vulnerable because of its poor policy environment, high inflation and large external deficit. Japan, too, is known for its exceptionally high level of public debt, which has hitherto been seen as bearable because it is yen-denominated and held mostly by Japanese. Now, however, in light of the problems in Europe, investors are starting to question that assumption, especially given Japans demographics. A downgrade is possible S&P cut its rating a year ago, but more cuts may come in 2012 given the refinancing strains in the world as a whole. By contrast, Indonesia may win another upgrade.
27
Chart 1: Long-term foreign-currency issuer ratings

40 35 30 25 20 15 10 5 0 2003 2004 2005 2006 2007 2008 2009 2010 2011
Rating downgrade
Rating upgrade
Sources: Standard & Poors, Standard Chartered Research

12 December 2011
Sovereign risk (cond)
On the positive side, China, Hong Kong, Indonesia, Sri Lanka and the Philippines all moved higher in 2011. Strong external balances support ratings in much of Asia, while public finances also tend to be in fair shape, and public debt levels are well below those in Europe or the US. Inflation has been a concern but appears to have peaked as growth rates moderate. Economic policy management has been robust and is a ratings positive for much of Asia. In particular, macro-prudential measures confer welcome stability upon the financial sector and property markets, helping to defuse asset bubbles before they become problematic. This activist approach is something that Western policy makers should emulate. Downside risks to India have increased, most recently with the sharp depreciation of the currency, which will add to already-high inflationary pressures. With growth decelerating quite rapidly, this leaves policy makers with a dilemma. If they raise rates to protect the currency, the headwinds to demand will worsen, but if they cut rates to support output, the currency may fall further.
growth hit by the unrest and the associated fall in tourism and investment. Both the fiscal and the external balances have worsened and reserves have fallen. Until the political situation is resolved, markets will likely remain nervous. Risks in Bahrain are also high. Pakistans relations with the US have deteriorated so much that UN operations in Afghanistan may suffer.
Rating trends in Latin America have been mostly positive, unsurprisingly as the region as a whole has fared well, not least from the commodity boom. Now, however, worries about the sustainability of growth are mounting hence Brazil cutting interest rates to prevent more deceleration. Encouragingly, fundamentals have generally improved, and policy management has been solid. Lessons seem to have been learnt from past crises and the recent experience of other countries. Mexico, however, is facing new downside because of increasingly disruptive drug-related violence. Growth has slowed because of political instability, while the muted recovery in the US will limit the upside to Mexicos trade. Venezuela continues to demonstrate capricious economic management, and the economy is struggling under the weight of this and persistently high inflation.
In Africa, all of the rating changes in 2011 were either new ratings (Zambia, Namibia, Senegal) or upwards. The Seychelles and Angola were both upgraded, the former as its weak external balance stabilised and the latter because of improving fundamentals. Though still narrowly based, Angola is becoming an increasingly impressive economy that is developing rapidly. In the Middle East, the only positive change was to Kuwait; all other changes were downgrades. In the main, these reflected political issues that affected economies adversely. Egypt has suffered a serious knock, with
Chart 2: Long-term foreign-currency sovereign credit outlook

10 9 8 7 6 5 4 3 2 1 0 Asia CEE
Positive
In Europe which accounted for almost half of the rating changes in 2011 the only rating upgrades were in Central and Eastern Europe (CEE). The Czech Republic, Latvia, Estonia, Serbia, Romania and Bulgaria were all moved higher, as was Kazakhstan. The other moves generally reflected the euro-area sovereign debt crisis, with many countries suffering multiple downgrades. Turkey was steady, having been moved higher in 2010, but is now facing greater downside risks. In part, this reflects its somewhat eccentric economic policy mix interest rates were slashed despite rampant credit growth, with higher reserve ratios the chosen policy tool to curb lending. The currency is now looking more vulnerable as the economy slows but inflation remains high and the current account deficit widens. Turkey has a high level of private-sector external debt and may find refinancing it and the current deficit challenging. Refinancing risks are likely to be the general theme in 2012. European sovereigns have a particularly heavy issuance calendar, potentially impacting sovereign ratings, while banks and corporates also have significant needs. Rolling over these debts falling due will likely be testing, particularly for the lower-rated borrowers.
Negative
Latam
Africa
Middle East
Industrial
Other
Sources: Standard & Poors, Standard Chartered Research

12 December 2011
28
Economies Majors
Majors Charts of the year

Chart 1: Sluggish growth is foreseen in 2012 Real GDP growth, % y/y
6 4 2 0 -2 -4 -6 -8
2006 2007 2008 2009 2010 2011F 2012F 2013F 2014F
Chart 2: Inflation outlook to stay benign CPI inflation, % y/y

8 6 4 2 US Euro area Japan -2 -4 Jan-07 Sep-07 May-08 Jan-09 Sep-09 May-10 Jan-11 Sep-11
US Euro area Japan
Sources: CEIC, Standard Chartered Research
Chart 3: Divergent trends in money supply Money supply growth, % y/y

12 10 8 6 4 2 0 -2 Jan-07 Aug-07 Mar-08 Oct-08 May-09 Dec-09 Jul-10 Feb-11 Sep-11 Sources: CEIC, Standard Chartered Research Japan US Euro area
Chart 4: US trade imbalance shows little improvement Trade balance, USD bn

40 20 0 -20 -40 -60 -80 -100 Jan-07 Sep-07 May-08 Jan-09 Sep-09 May-10 Jan-11 Sep-11 Sources: CEIC, Standard Chartered Research US Euro area Japan
Chart 5: Fiscal consolidation is necessary Fiscal balance, % of GDP

2 0 -2 -4 -6 -8 -10 -12
2001 2003 2005 2007 2009 2011F 2013F
Chart 6: Public debt remains under the spotlight Gross government debt, % of GDP
250
US
Euro area
200 150 Japan US Euro area
Japan*
100 50 0 Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10
*For fiscal year starting 1 April Sources: CEIC, Standard Chartered Research
12 December 2011
30
Australia
Kelvin Lau, +852 3983 8565
Kelvin.KH.Lau@sc.com
Beyond the mining boom

Economic outlook

Australias growth should improve in 2012 from 2011, despite clouds over the global outlook, mainly thanks to a sustained mining-led investment boom. The devastating floods of early 2011, which led to one of the largest q/q GDP contractions in 20 years in Q1, will also provide a low base for comparison in 2012. However, non-mining sectors will face rising challenges. The more benign inflation outlook and the governments fiscal consolidation plan mean that the Reserve Bank of Australia (RBA) can afford to ease pre-emptively and stay loose in 2012. Buoyant demand for natural resources from emerging Asia (especially China and India) and improving terms of trade have fuelled mining investment and growth in construction activity and peripheral services. In Q3-2011, total construction work surged 12.5% q/q, the fastest since records started in 1986. Total new capital expenditure rose a seasonally adjusted 12.3% q/q during the same period. According to the Australian Bureau of Statistics, private businesses forecast investment of AUD 158bn (+32% y/y) in the year ending in June 2012. More than half of this will be mining-related, equating to an 84% y/y increase in mining investment. The mining sector, however, will find itself leaning against macro headwinds. Symptoms of Dutch disease have been evident for some time the manufacturing PMI, for example, showed a contraction in activity in 9 out of 11 months in 2011. The gap between the strong mining sector and weakness in other parts of the economy may widen further in 2012.
Consumers are likely to become even more cautious towards spending in 2012. The household savings ratio has been hovering close to its 2008-09 highs (in the low teens), and while the decline in housing prices since mid2010 has been mild so far, building approvals fell 30% y/y in October, reflecting weak sentiment. The monthly average employment change was still positive for 2011 (as of October), but the risk is that more slack will emerge in 2012.
Financial issues
Australia has been praised for its low public debt, freely floating exchange rate, and policy credibility. However, its high net external debt makes it relatively sensitive to external financing shocks. The RBA will be the first line of defence in the event of a significant deterioration in the European sovereign debt crisis.
Policy
The RBA said a key premise for its recent rate cuts (a total of 50bps since early November 2011) is that inflation is likely to be within the 2-3% target in 2012 and 2013; we share this view. We expect the next moves two more 25bps cuts in response to a further deterioration in external growth conditions to come in Q1-2012. Increasing weakness in the non-resources sector and the still-poor visibility of external financing conditions should also keep the RBAs cautiously dovish policy bias in place for longer. Our latest policy rate forecasts are closer in line with what the AUD OIS market is currently pricing in. The government recently reaffirmed its plan to return to a budget surplus by FY13 (from a deficit of 3.4% of GDP in FY11). While this adds comfort to an already healthy public debt position, the challenging external environment means that fiscal tightening will have to be heavily backloaded. This will make the austerity much more difficult to implement, and more economically disruptive, when it finally hits.
Standard Chartered forecasts: Australia

2011 GDP (real % y/y) CPI (% y/y) Policy rate (%)* AUD-USD* Current account balance (% GDP) Fiscal balance (% GDP)** 1.5 3.4 4.25 0.98 -2.7 -2.5 2012 2.9 3.2 3.75 1.05 -3.5 -0.8 2013 4.0 3.3 4.75 1.12 -3.8 0.2 2014 3.5 3.0 4.75 1.12 -4.0 0.5
Politics
Prime Minister Julia Gillard continues to face the constraints of a minority government and poor poll results for her Labor Party. The next federal election must be held by 30 November 2013.
*end-period ** for fiscal year starting 1 July Source: Standard Chartered Research
12 December 2011 31
Canada
David Semmens, +1 212 667 0452
David.Semmens@sc.com
David Mann, +1 646 845 1279

David.Mann@sc.com
Fiscally responsible, firm growth

Economic outlook
While the outlook for Canada is relatively sedate, its path remains enviable among the G7. The labour market has been far more robust than that of the US. The slow but steady decline in unemployment has been accompanied by a modest slowdown in wage growth, but consumer demand has proven robust and is expected to remain so. The decline in the unemployment rate is likely to be maintained. Canadas GDP growth has turned around much more strongly than that of its larger neighbour to the south, to which its fortunes are closely tied. The recovery in the North American car industry is playing a role in this. Interestingly, Canadas dependence on the US is lessening, as reflected in trade flows. Pre-crisis, trade flows with the US accounted for 75% of Canadas total trade; this has since declined to 67%. Over the same period, Canadas trade flows with China have more than doubled. This dynamic means that growth in emerging markets will be vital for Canada at the margin, especially given its commodity currency status. Europe accounts for only around 10% of Canadas exports, which should limit the effect on growth of any fallout from the European sovereign debt crisis.
the G7 during the global financial crisis. Furthermore, the governments fiscal discipline has caused financial markets to reward Canada with its lowest-ever yields. Expectations are that Canada will balance its budget by 2014.
Policy
We expect the Bank of Canada (BoC) to keep rates on hold at 1.00% until Q3-2012. This pause will be driven by concerns about domestic and external growth, especially the uncertain outlook for the euro area. The lack of inflationary pressure will be supported by persistent Canadian dollar (CAD) strength. Oil prices continue to be a key factor for growth in Western Canada. If prices rise as we expect, this will support the CAD, even if the BoC keeps rates on hold for longer than we expect. However, any slowdown in global growth would like cause the CAD to suffer in sympathy with commodities.
Other issues
Financial issues
Canadas banking system remains firm, although it is not immune to the troubles in Europe. Thanks to conservative mortgage lending policies in the private sector, Canada avoided most of the problems affecting
Standard Chartered forecasts: Canada

2011 GDP (real % y/y) CPI (% y/y) Policy rate (%)* USD-CAD* Current account balance (% GDP) Fiscal balance (% GDP)** 2.4 2.5 1.00 1.04 -3.0 -1.8 2012 2.2 2.2 1.50 0.98 -2.5 -1.2 2013 2.4 2.0 2.50 0.95 -2.2 -0.5 2014 3.0 2.0 3.00 0.95 -1.9 0.0
Housing prices are now 2.2% above their prior peak, having risen 5.9% since bottoming in June 2009. Fears of a housing bubble appear overdone, although households will be under pressure if interest rates rise significantly, given the high level of household debt. Meanwhile, delinquency rates are low and macro-prudential measures have limited the stimulus to buying from low interest rates. Canadian consumers continue to pay down non-mortgage debt, which remained at a stable level in 2011; we expect this pattern to continue in 2012. We also see a low risk of a meaningful housing-market correction given that demand is supported by 2% annual population growth, an influx of immigrants and rising wages. Supply is also constrained by the tightening of local zoning and construction rules.
Politics
*end-period; ** for fiscal year starting 1 April Source: Standard Chartered Research
12 December 2011
Canada is benefiting from a more stable political environment, with the first majority government in seven years. Elections were held in early 2011, after the rejection of the governments proposed budget triggered a vote of no confidence. The Conservative party victory was underpinned by a pledge to balance the budget by 2014-15 and to cut the corporate tax rate to 15% in 2012 to stimulate job growth. The next election is scheduled for October 2015.
32
Euro area
Sarah Hewin, +44 20 7885 6251
Sarah.Hewin@sc.com
Thomas Costerg, +44 20 7885 8615

Thomas.Costerg@sc.com
EMU strains to dominate amid recession

Economic outlook
We expect the euro area to experience a recession in 2012 as economies struggle in the face of fiscal tightening, constrained credit availability and the eurorelated shock to confidence, which will hold back business investment and consumer spending.
2012, or are likely to move back into recession in 2012 (Spain, Italy) as they suffer from larger fiscal cuts and a sharper downturn in domestic confidence. Ireland, which has emerged from a long recession, is likely to struggle with very weak growth at best. Even the northern euro-area economies, which did well in H1-2011, are not immune to the risk of negative growth. Frances austerity measures look set to pull the economy into contractionary territory, while the smaller northern euro-area countries, which are more dependent on trade within the region than the larger countries, are struggling with a drop in demand from the rest of the region. We expect Germanys growth to be below 1%, with consequences for the broader region. The downturn that we expect for the region is not as large as in 2008-09, when the euro-area economy fell by 5% peak-to-trough as a result of a global shock and a consequent collapse in global activity. But risks to the outlook are to the downside, especially if there is a further deterioration in confidence related to the sovereign debt crisis. Inflation is likely to edge lower, moving back to the lower than but close to 2% target in 2012 and then lower by Q4-2012. The impact of rising energy and food prices in 2011 will drop out of the index, as will VAT increases (although there may be further indirect tax hikes in 2012). Core inflation is likely to remain below 2% as the recession opens up output gaps.
In an effort to rein in budget deficits, almost every country in the region is tightening fiscal policy. That said, we expect deficits to fail to meet 2012 targets in many cases due to weak or negative GDP growth. Bank lending is likely to be subdued, partly as a result of weak demand for loans but also as banks, under pressure to raise capital ratios, adopt a more cautious stance.
The escalation of the euro-area debt crisis has contributed to deteriorating sentiment among the regions consumers and businesses. Orders are declining, inventories are likely to fall and investment projects are likely to be delayed in response to uncertainty over the outlook for the region. Net exports should provide positive support to the economy, although this will be because of shrinking imports, as moderating global demand is likely to hold back export growth. Rising unemployment is set to dampen household spending and, initially, high headline inflation will further reduce spending power. Eventually, the expected decline in energy costs (reflected in overall headline inflation) should help to reverse the decline in real earnings. Countries in the periphery are either in recession (Greece, Portugal), which we expect to continue into
Financial issues
Standard Chartered forecasts: Euro area

2011 GDP (real % y/y) CPI (% y/y) Policy rate (%)* EUR-USD* Current account balance (% GDP) Fiscal balance (% GDP) *end-period
12 December 2011
Banks have substantial refinancing needs in 2012; access to unsecured loans is likely to remain difficult due to fragile sentiment. Banks are required to raise their core Tier 1 capital ratios to 9% by mid-2012, taking into account the impact of marked-to-market sovereign debt holdings. Peripheral banks have the largest capital requirements, and some may need to be bailed out by their governments. In the context of a weakening economy, banks assets could be further affected by rising non-performing loans. It is difficult to raise capital, so institutions are responding by selling assets and deleveraging. The European Central Bank (ECB) will continue to provide unlimited liquidity, both short- and long-term.
33
2012 -1.5 1.9 0.75 1.30 -0.2 -3.9
2013 1.5 1.6 1.25 1.35 -0.4 -3.5
2014 2.4 1.8 2.50 1.30 -0.1 -3.1
1.5 2.6 1.00 1.30 -0.4 -4.1
Euro area (cond)

Policy
In the face of weakening activity and tightening fiscal policy, it falls to the ECB to stimulate the regions economy. We expect further easing in Q1-2012, with the refi rate falling to 0.75%. Peripheral bond purchases are likely to continue, with the ECB increasing its intervention according to market needs and prepared to take a more aggressive stance if required.
countries (especially Germany), where electorates are becoming increasingly hostile to financing bailouts. A downgrade of any of the AAA-rated guarantors of the EFSF would raise the facilitys borrowing costs and make it less attractive to investors. The IMF and ECB will likely have to play a more active role in providing a backstop to peripheral countries with large rollover needs. We expect a continuing muddle-through scenario, but risks of policy mis-steps are high. The spectre of an EMU exit would trigger accelerated deposit withdrawal, which could become bank runs in several countries; one country breaking away from EMU would risk creating a domino effect across the region. This would be devastating for European economies, leading to a significantly worse downturn than the one experienced in 2008-09.
Policy makers are likely to take steps towards closer integration i.e., greater fiscal co-ordination and stricter enforcement, possibly backed by treaty amendments. Germanys Karlsruhe Court will remain vigilant in terms of any transfer of power to Brussels. Leaders will fine-tune the European Stability Mechanism, the permanent European bailout mechanism set to become operational in July 2012.
Other issues
Politics
Questions over the future of the euro and European Monetary Union (EMU) are likely to continue to dominate, especially given large sovereign debt rollover requirements and continuing banking-sector strains. Countries are being required to undergo unpopular austerity to reduce deficits in order to stabilise debt and restore market confidence. Policy is now aimed at buying time while deficits are corrected. Yet recession in many countries means that little progress is likely in terms of meaningful fiscal deficit reduction in 2012. The key threats to EMUs continuing existence are predominantly political: whether governments in the periphery (especially Greece and Italy) will do enough to ensure continued support from northern euro-area
Political risk is particularly high in Greece, where the technocrat government is likely to call elections once debt restructuring is concluded, probably in Q1-2012. Elections would likely return a coalition government. In Italy, the technocrat government led by Mario Monti hopes to rule until 2013. However, there is a risk of an erosion of parliamentary support, especially if more painful austerity measures are taken, which would force early elections. Former PM Berlusconi would not run, but he is likely to remain influential in the background. Frances general elections are planned for April-May 2012 (two rounds). Incumbent Nicolas Sarkozy (conservative) will likely run against the Socialist Partys Francois Hollande (currently ahead in the polls) in the second round. Support for Marine Le Pen (far-right party) could rise if the crisis deepens and resentment builds towards the EU (which she wants to leave), though she is unlikely to get a parliamentary majority. Germany will be in the limelight in H2-2012 as political parties prepare for the 2013 general election. Based on current trends, Chancellor Angela Merkel is the favourite to form the next government, possibly as a rainbow coalition with the opposition Socialists and Greens, rather than with the Free Democrats, who are trailing in the polls.
Chart 1: Euro area is facing a double-dip recession Quarterly GDP, % y/y

4 3 2 1 0 -1 -2 -3 -4 -5 -6 2007 2008 2009 2010 2011 2012 f 2013 f 2014 f
Sources: Eurostat, Standard Chartered Research

12 December 2011 34
Japan
Betty Rui Wang, +852 3983 8564
Betty-Rui.Wang@sc.com
Rocky road to recovery

Economic outlook
The V-shaped rebound we expected after the March 2011 Fukushima earthquake is likely to be delayed until H2-2012 due to ongoing external shocks. The new recession in Europe and slow growth in the US, along with the October 2011 floods in Thailand, have put Japans fragile economy in jeopardy again. We expect 2012 to be a transition year before large-scale earthquake reconstruction begins. We expect exports and investment to drive a renewed upswing, but a clear uptrend is unlikely before H2-2012 at the earliest. Both exports and investment will gather pace as constraints on auto and electronics manufacturing gradually dissipate. Deflation is also hampering the economic recovery. Depressed confidence and ultra-low interest rates have kept Japan in a liquidity trap, leaving the central bank with little room to manoeuvre. We expect this trend to continue in 2012, as no dramatic boost to demand is in sight.
While there is no imminent threat of a public debt default, further rating downgrades are likely if the public debt issue is not addressed effectively or the government delays the introduction of convincing plans to improve its fiscal position.
Policy
The government is currently planning its fourth extra budget of the current fiscal year (ending in March 2012), with a minimum target size of JPY 2trn. However, this is unlikely to provide much of a boost given the limited impact of the previous three extra budgets, which totalled about JPY 18trn (or 4% of GDP in 2010). On the monetary policy front, there is little room for manoeuvre, as policy rates are already ultra-low. The Bank of Japan (BoJ) could respond to a potential worsening of the economic situation by expanding its asset purchase programme (at a current size of JPY 55trn); it has already done this three times since the earthquake.
Other issues
Financial issues
Disaster relief spending and successive fiscal stimulus packages have pushed up Japans public debt, which is among the highest of all major industrial economies. According to the IMF, post-earthquake reconstruction efforts are likely to incur fiscal costs of around 3% of GDP over the next several years. This, along with slowing GDP growth, is likely to push the gross public debt ratio to 240% of GDP in 2012 from 195% in 2008.
Decisive social security reform is key to structurally improving the fiscal position and reducing the heavy burden of entitlement spending. Spending on such entitlements rose 43% in the eight years to March 2011. Gradually increasing the sales tax is another potential way to increase government revenue. The government plans to discuss a possible tax hike by the end of 2011, and an agreement is expected in 2012.
Politics
Standard Chartered forecasts: Japan
2011 GDP (real % y/y) CPI (% y/y) Policy rate (%)* USD-JPY * Current account balance (% GDP) Fiscal balance (% GDP)** -0.5 -0.2 0-0.1 77.00 2.2 -10.5 2012 0.8 -0.1 0-0.1 74.00 2.0 -9.8 2013 3.1 0.2 0-0.1 82.00 3.2 -8.5 2014 2.5 0.1 0-0.1 90.00 2.8 -7.8
Prime Minister Yoshihiko Noda has been in office since September 2011. Given the messy domestic situation he inherited from his predecessor, as well as the deteriorating global outlook, market observers are cautious about the stability of Nodas government. Noda faces the challenge of ensuring effective postearthquake reconstruction while at the same time improving the fiscal position. A failure to address these issues could compromise his popularity, both at home and abroad, and lead to another leadership change
12 December 2011 35
New Zealand
Kelvin Lau, +852 3983 8565
Rebuilding growth, bricks-and-mortar style

Economic outlook

New Zealand is expected to literally rebuild its growth with bricks and mortar following devastating earthquakes in September 2010 and February 2011. So far, reconstruction momentum has been frustratingly slow as aftershocks have hindered planning and building, and as private insurers hold back from insuring new buildings. We expect a pick-up in reconstruction activity to boost 2012 growth, offsetting a weaker export outlook and stillcautious consumer spending. The more challenging task will be for the government to rebuild its fiscal health in the coming years. The Reserve Bank of New Zealands (RBNZs) latest working assumption for the cost of earthquake-related repairs is about NZD 20bn, just over 10% of GDP. A significant amount of reconstruction-related investment is projected to occur on a multi-year horizon. In contrast, the recent boost to domestic spending from the Rugby World Cup is likely to be short-lived; we expect household spending to stay modest in 2012 as high debt levels and the uncertain global outlook weigh further on sentiment. The external sector will not offer much of a lift to headline GDP growth in 2012 either. New Zealands persistent current account deficit may worsen in the coming year as external demand eases and investment-related imports stay strong. The terms of trade, after reaching the highest level since 1974 in Q2-2011, were down 0.7% q/q in Q32011, in line with the recent correction in global commodity prices.
CPI inflation is likely to fall back into the RBNZs 1-3% target band in Q4-2011 as the distortion from the 2.5ppt hike in the goods and services tax in October 2010 drops out of the y/y number. Higher construction costs will be offset by a still-elevated jobless rate and weak sentiment. However, the prevailing accommodative monetary policy will need to be removed over the medium term as growth accelerates and inflation pressure re-emerges.
Financial issues
The downgrade of New Zealands sovereign credit rating by Standard & Poors and Fitch Ratings in September was a timely reminder of not only the high costs of earthquake recovery, but also more fundamental issues. The rating agencies cited the countrys large external imbalances and high household and agriculture-sector debt. Rebuild, then rebalance (the twin deficits) will be the governments motto in the coming years.
Policy
We expect the RBNZ to keep rates at the current record low of 2.50% at least through H1-2012. While we still believe that it plans to normalise its policy rate over the medium term, the weaker global outlook on the back of the European sovereign debt crisis is likely to delay the next hike until H2-2012. Easing inflation expectations since Q2, along with declining consumer and business confidence, mean that the RBNZ can afford to wait. The need for medium-term fiscal consolidation will limit its aggressiveness when tightening eventually begins.
Politics
Standard Chartered forecasts: New Zealand

2011 GDP (real % y/y) CPI (% y/y) Policy rate (%)* NZD-USD* Current account balance (% GDP) Fiscal balance (% GDP)** 1.8 4.3 2.50 0.76 -4.0 -6.0 2012 2.4 2.4 3.00 0.88 -5.0 -3.5 2013 3.3 2.9 4.00 0.91 -5.5 -1.0 2014 3.0 2.5 4.00 0.91 -5.5 0.1
*end-period; **for fiscal year starting 1 July Source: Standard Chartered Research
12 December 2011
Prime Minister John Key and his National Party won a second three-year term on 26 November 2011, heading the coalition government. Having pledged a return to a budget surplus by FY15 (fiscal year starting 1 July 2014), Key has the difficult task of digging the economy out of a deep fiscal hole. The FY11 deficit was 9.2% of GDP, or NZD 18.4bn, with the net cost of earthquake reconstruction accounting for half of this. In this context, Keys convincing election win is important, giving him a strong mandate to sell state assets and restrict spending, all while creating 150,000 jobs. The first partial sale of state assets, involving a utility company, is likely towards the end of 2012 (with the government maintaining a majority stake).
36
United Kingdom
Sarah Hewin, +44 20 7885 6251
Sarah.Hewin@sc.com
Thomas Costerg, +44 20 7885 8615

Thomas.Costerg@sc.com
High recession risks

Economic outlook
The UK economy is likely to be in recession going into 2012 as the negative impact of fiscal tightening and falling real incomes is compounded by a downturn in demand from the UKs largest trading partner, the euro area. We expect GDP to contract in H1-2012, before bottoming out and eventually recovering in H2-2012. The government is implementing tax hikes, cutting allowances and reducing expenditure with a view to virtually eliminating cyclically adjusted net borrowing by FY17 and stabilising public-sector net debt (by FY15, according to current targets). As a result, public-sector wages are declining in real terms and jobs are being lost. The private sector has not been compensating for rising unemployment in the public sector, and real wages are shrinking there, too. Government cutbacks are having an impact on private-sector contracts, and the capital spending budget has been particularly hard hit. The euro-area slowdown has a direct impact on UK exporters (just under half of the UKs exports go to the euro area); the crisis is also damaging confidence, with businesses halting decisions on investing in plant and machinery linked to production destined for the euro area. Orders are falling, and involuntary inventory building is likely to turn into destocking, which could have a substantial impact on growth. Inflation is likely to fall sharply to the 2% target or below by Q4-2012, from well above the target in Q4-2011. The impact of the January 2011 increase in VAT to 20% from
17.5% will drop out of the index in Q1-2012. Headline inflation should decline further in Q2-2012, when we expect food and energy inflation to slow due to base effects. Meanwhile, rising unemployment is likely to keep private-sector earnings growth low and public-sector wages are close to stagnant, so wage-cost pressures should be muted.
Financial issues
The Bank of England has warned that stressed funding conditions could make it difficult for some UK banks to meet their balance-sheet needs. Risks to financial stability are likely to stay high in 2012. UK banks have some GBP 140bn of term funding due to mature in 2012, front-loaded in H1; they are likely to have to pay more for funding and to rely more on collateralised term funding. Pressure on funding markets is also likely to result in more subdued lending, while the recession will damage credit quality.
Policy
Amid heightened concerns over the impact of fiscal tightening and the risk of recession in the euro area, Bank of England policy makers are likely to maintain a loose monetary policy. We expect the Bank Rate to remain unchanged at 0.5% throughout 2012. We forecast another round of quantitative easing in Q1-2012, aimed at offsetting deflation risks. The economic downturn is likely to increase pressure on the government to relax its fiscal austerity measures, but the example of the euro-area peripherys spiralling borrowing costs is likely to keep UK policy makers reluctant to back-track on the austerity programme.
Standard Chartered forecasts: United Kingdom

2011 GDP (real % y/y) CPI (% y/y) Policy rate (%)* GBP-USD* Current account balance (% GDP) Fiscal balance (% GDP)* 0.7 4.4 0.50 1.53 -1.8 -9.3 2012 -1.3 2.1 0.50 1.55 -1.4 -8.8 2013 1.5 1.6 0.50 1.60 -1.8 -8.2 2014 2.3 1.8 2.00 1.55 -2.2 -6.8
Other issues
The UK remains highly vulnerable to a deterioration in the euro-area crisis, in terms of trade and investment flows as well as business confidence.
Politics
The UK will not have a general election until 2015, and the coalition has committed to serving its full term. However, the economic downturn is likely to put additional pressures on the governing coalition.
*end-period; ** for fiscal year ending 31 March Source: Standard Chartered Research
12 December 2011 37
United States
David Semmens, +1 212 667 0452
David.Semmens@sc.com
David Mann, +1 646 845 1279

David.Mann@sc.com
Economic wounds continue to heal

Economic outlook
Growth in 2012 is likely to follow a similar pattern to 2011, but for very different reasons. Business investment, one of the main drivers of GDP growth in 2011, is likely to face a tough start to the year. Critically, the reduction in temporary tax cuts and concerns about the global growth outlook will weigh on business optimism. Although the US consumer continues to recover, a lack of global demand is keeping hiring lacklustre and real wage growth anmic at best. The US government, which has previously been able to provide significant fiscal support, now has to tackle its own debt crisis. It is required to implement at least USD 2.2trn of deficit cuts under the Budget Control Act 2011, which allowed the debt ceiling to be raised. Attempts to repeal some of the automatic cuts which start in 2013 would go down badly with the rating agencies. While residential investment is likely to show some firmness, this will be concentrated in multi-family homes in more built-up areas where rental demand remains high. Access to mortgage credit remains a separate issue. With mortgage applications back at 1997 levels, buyers are remaining out of the market as they wait for a lasting bottom in both prices and activity. Inventories will remain a swing factor dependent on sentiment, but we see US firms operating leanly. We expect a minimal drag from inventories in H1-2011, giving way to gradual accumulation as demand recovers and the outlook improves. Despite recent volatility, barring a shock similar to the Japanese earthquake, net exports are also likely to be largely neutral throughout 2012.
We expect both headline and core inflation to moderate in the medium term as weak wage growth, caution towards the outlook and high unemployment force businesses to absorb a higher proportion of rising input costs. Interestingly, rental prices have risen; this reflects a continuing structural shift away from homeownership rather than increasing demand, in our view. Only a persistent significant oil shock would give rise to concerns about the medium-term outlook for inflation. The labour market continues to tread water, with the unemployment rate making only minimal progress downwards due to labour-market growth. The vast majority of this progress can be attributed to the discouraged worker effect. We expect job growth to average 150,000 per month in 2012 and 180,000 over the longer term. This will result in unemployment finishing 2012 at 8.5% and 2013 at 8.2%. Hiring is unlikely to provide much optimism. With growth expected to remain below trend, non-farm payrolls are unlikely to consistently breach 200,000 a level that would drive unemployment firmly lower.
Financial issues
Standard Chartered forecasts: United States

2011 GDP (real % y/y) CPI (% y/y) Policy rate (%)* Current account balance (% GDP) Fiscal balance (% GDP) *end-period
12 December 2011
The significant overhang of foreclosures remains one of the biggest issues facing the US economy. The debt overhang means that consumers feel significantly less wealthy, with one-third of homeowners in negative or next to negative equity. This is unlikely to improve in 2012, as we expect home prices to increase in line with inflation at best. Consumers are taking a more responsible approach to credit and continue to cut back on credit card use. Non-revolving credit, which is typically used to purchase cars and kitchen appliances, has recovered somewhat. The US dollar (USD) remains the worlds reserve currency, although the events of 2011 have no doubt accelerated emerging-market central banks plans to diversify away from USD-denominated assets. Prolonged debt concerns in Europe have provided a continued safehaven boost to US Treasuries. We look for a modest rise in yields in 2012, after they bottom in Q1.
2012 1.7 1.6 0.25 -2.8 -7.2
2013 2.5 1.8 0.75 -2.9 -4.9
2014 3.0 2.0 1.75 -2.9 -4.0
1.8 1.7 0.25 -3.1 -8.5

38
United States (cond)

Policy
We look for the first rate hike to come in Q3-2013, and expect further quantitative easing (QE) in Q1-2012. The FOMCs commitment to keeping rates on hold through mid-2013 is more likely to be extended than shortened. The continuing lacklustre recovery, particularly in the labour market, remains the number one priority for the FOMC. The moderation in inflation in 2012 should leave the door open for further QE by the FOMC. We expect this to take the form of monthly purchases of a similar size to the USD 75bn seen under QE2. However, rather than a specific amount and termination date, we expect a stated minimum amount of purchases and an at least until commitment most likely until November 2012 in order to allow for greater action should conditions warrant it. We expect the purchases to be a combination of Treasuries and MBS. The rotation of regional Fed presidents is likely to lend a more dovish stance to the FOMC in 2012, with only one hawk rather than three vocal dissenters in 2011. This is also supportive of further action from the FOMC in 2012.
releases, and until we see a real turnaround in this sector, any optimism about the outlook should remain muted.
We see plenty of scope for further increases in auto demand, with auto sales having spent four years below their long-run average. Importantly, the improvement in auto financing and non-revolving credit looks set to continue. While used and new car prices rose sharply after the supply-chain shocks resulting from the Japanese earthquake, we expect prices to moderate further, supporting sales. Rating agency downgrades to the US sovereign rating are more likely a story for 2013 than 2012. S&P has already downgraded in the aftermath of the debt ceiling debate, and Fitch has revised its outlook to negative. A key area of focus will be whether the stalemate on how to cut the deficit remains in place after the November presidential election.
Politics
Other issues
Small businesses continue to identify weak demand as the main hurdle to expansion. This is concerning, as the small business sector is vital to the health of the US labour market, having provided the majority of employment growth this century. We believe that the disappointing National Federation of Independent Businesses survey is one of the most overlooked data
Current polls show President Obama marginally ahead in the 2012 presidential election, and political campaigning will intensify on all fronts early in 2012. The key points of contention will be the economy, jobs and the deficit. The most important point for the markets and the rating agencies will be a coherent plan to address the deficit. Weak growth is likely to make bringing the deficit under control even more difficult. The race to the White House could be complicated by a third or even fourth candidate alongside the main party nominations. The battles for the Senate and the House of Representatives will be equally important. In the 100member Senate, the Democrats are expected to have 23 seats up for election, while the Republicans are anticipated to have 10. Current polls show the Republicans taking a slim majority in the house, but with seven seats as a toss-up, the race could go either way. While the Republicans currently hold a 49-seat majority in the House of Representatives, all 435 members will be up for re-election. Regardless of the election winner, further measures are required to trim the deficit. Whether they take the form of tax increases (Democrats) or spending cuts (Republicans) will depend on which party dominates US politics after 6 November.
Leavers hide true extent of unemployment Constant participation rate of 66.5%, LR average 1990-2007
14% 12% 10% 8% 6% 4% 2% 0% Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Sources: Bloomberg, Standard Chartered Research
12 December 2011
Constant participation rate unemployment Official unemployment
39
Economies Asia
Asia Charts of the year

Chart 1: Below-trend growth for most Asian economies Real GDP growth forecast (%)
12 10 8 6 4 2 0 CN HK TW KR SG MY ID TH PH VN IN 2000-10 average 2011E 2012F
Chart 2: Decelerating export growth, stable consumption Asian export and retail sales growth, % y/y
50% 40% 30% 20% 10% 0% -10% -20% -30% -40% Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Retail sales Exports
Chart 3: Cheaper fuel and food prices to tame inflation Asian inflation and CRB Commodity Price index (y/y)
60% 40% 20% 0% -20% -40% -60% Jan-07 Oct-07 Jul-08 Apr-09 Jan-10 Oct-10 Jul-11 Inflation (RHS) Commodity Price Index 9% 8% 7% 6% 5% 4% 3% 2% 1% 0% -1% -2%
Chart 4: Rapid loan growth to decelerate Lending growth (y/y)

0.35 0.30 0.25 0.20 0.15 0.10 0.05 0.00
CN HK IN ID KR MY PH SG TW TH
Dec-09 Jun-10 Jun-11 Latest
Chart 5: Koreas vulnerability to USD liquidity squeeze has lessened Moodys External Vulnerability Indicator
100 90 80 70 60 50 40 30 20 10 0
CN PH TW TH MY ID IN KR
Chart 6: International bank lending to Asia from selected sources Q2- 2011, USD mn
900,000 800,000 700,000 UK
2008
2011
600,000 500,000 400,000 300,000 200,000 100,000 0
Europe ex-UK US
Japan
Mar-05 Jan-06 Nov-06 Sep-07 Jul-08 May-09 Mar-10 Jan-11 Sources: BIS, Standard Chartered Research
Sources: Moodys, Standard Chartered Research
12 December 2011
41
Asia
Tai Hui, +65 6596 8244
Tai.Hui@sc.com
A test of resilience, once more

Economic outlook
Financial issues
We expect Asian economies to decelerate significantly in 2012. Although this will be partly driven by stagnation in the West, policy tightening by the Asian authorities in 2010 and 2011 is also taking effect. We expect Asias growth to slow to 6.5% in 2012 from 7.3% in 2011 and 9.1% in 2010, with exports leading the deceleration. We expect Q1 and Q2-2012 to be the weakest point of this economic cycle; some economies, such as Singapore, could experience contractions. Asia is still expected to outperform relative to other regions, but growth will be below potential. Exports are likely to lead Asias slowdown. Domestic demand, especially in export-oriented economies, will also soften as job and income growth slow or even contract temporarily. While we do not expect the magnitude of the 2009 downturn to be repeated, the relative performance of export-dependent economies versus domestic-led economies is likely to be similar. The argument that Asia must become less dependent on exports and more dependent on domestic demand will regain momentum. But countries with large rural populations, including China, India and Indonesia, will enjoy structural boosts from urbanisation and growth of the middle class. Inflation is expected to take a backseat, at least in H12012, amid a weaker growth environment. Asia is still vulnerable to spikes in commodity prices, as seen in 2008 and 2011, but the threat will be limited until the region returns to solid growth.
Domestic issues need to be considered alongside global factors. In China, Hong Kong and Singapore, the residential property markets are undergoing a correction. Developers in China are particularly vulnerable to a realestate correction. Weak investor sentiment and macroprudential measures imposed by governments are common themes in Hong Kong and Singapore. In Hong Kong, mortgage rates have risen due to tightening HKD liquidity conditions. In Singapore, rising supply in the private residential market in the next one to two years and slower population growth could force a correction in both rents and property prices. In South Korea, the level of FX reserves relative to shortterm external liabilities remains high, although it has improved since 2008 due to a gradual reduction in foreign-currency liabilities and a rise in FX reserves. The expansion of Koreas bilateral swap arrangements with China and Japan to USD 140bn will also help to reduce US dollar liquidity stress. In India, stubborn inflation has left the central bank with little choice but to raise policy rates in 2011, even as the rest of the region has paused to assess the more challenging external environment. Indias banking sector is likely to be pressured by high interest rates in two ways. First, non-performing assets typically rise following the peak of the interest rate cycle. This requires high provisions and possible capital injections from the government for some public-sector banks. Second, the combination of higher interest rates and savings rate deregulation could cause a compression in net interest margins. Vietnam continues to struggle with a delicate balance-ofpayments position, low FX reserves, and fickle local investor sentiment. The government is also pursuing banking-sector consolidation. Indonesias possible upgrade to investment grade, and the associated inflows, will need to be managed carefully in order to prevent overheating and asset bubbles.
Standard Chartered forecasts: Asia ex-Japan*

2011E Real GDP growth IMF Inflation IMF Current account balance (% GDP) IMF 7.3 7.7 5.8 6.2 2.6 3.8 2012F 6.5 7.5 3.3 4.6 1.5 3.8 2013F 7.5 7.8 4.2 4.0 2.1 4.1 2014F 6.5 7.8 4.3 3.6 2.2
Policy
4.2
*2010 USD GDP-weighted total of 13 regional economies Sources: IMF, Standard Chartered Research
12 December 2011
Asian central banks started to ease monetary policy in Q4-2011, and we expect more easing in 2012. China began reducing its required reserve ratio in early
42
Asia (cond)
December. We expect another cut in December, and five more in 2012. Thailand and Indonesia have already reduced their policy rates, and we expect Korea, the Philippines, India, Malaysia and Vietnam to follow suit in H1-2012.
Asian governments also introduced innovative policies to limit private-sector job losses and encourage bank lending by sharing credit risks with the banking sector; such measures could be quickly reinstated if needed.
Politics
Policy makers also need to be mindful of the choppy capital inflows likely to result from monetary easing by G7 central banks. Given its robust fundamentals and low household, business and government leverage, Asia is likely to be on the receiving end of this wall of liquidity once global investor confidence stabilises. Central banks across the region will also need to take into account rapid lending growth in the past 12-18 months. As a result of these factors, the pace of policy rate cuts in Asia is likely to be less aggressive than in 2008-09. Asias growth is expected to slow in 2012, but not fall off a cliff. While inflation peaked in the summer of 2011, the decline has been slow as global food and energy prices remain firm. Moreover, Asia remains vulnerable to a spike in food and energy prices; this is especially true for low-income economies where a larger proportion of household income is devoted to food and fuel. Fiscal policy is expected to play an active role in supporting growth. Low debt levels for most Asian governments imply that there is ample room for government stimulus, either in the form of automatic stabilisers (lower revenue and higher social welfare spending) or explicit fiscal measures. In 2009, the regions fiscal impulse (the increase in the fiscal deficit relative to 2008) was in the range of 2-4% of GDP. Some
2012 is set to be a busy year of elections and political transition in Asia. In China, the change of leadership is likely to be further clarified, and the incoming leaders are expected to indicate their stance on how to tackle property-sector problems, local government debt, and rising income inequality. Korea and Taiwan will hold presidential and parliamentary elections in 2012, and Hong Kong will elect a new Chief Executive and Legislative Council. Against this backdrop, governments may be more proactive in responding to global economic challenges. In South East Asia, no elections are scheduled in 2012, but the Malaysian government could call an early federal election ahead of the March 2013 deadline. Prime Minister Najib is expected to push ahead with the New Economic Model and Economic Transformation Programme, which aim to transform Malaysia into a highincome economy by 2020. The ruling coalition will need to win over the middle class if it is to regain its two-thirds majority in the parliament. In Thailand, tensions between the ruling Puea Thai party and the opposition could resurface in 2012. PM Yinglucks expansionary fiscal policy and attempts to grant amnesty to former PM Thaksin Shinawatra could elicit a strong reaction from the opposition. Indonesia has presidential elections scheduled for 2014. It is too early to speculate on potential candidates, but any hint of a succession plan could impact market perceptions of the countrys structural development, especially as President Yudhoyonos reform programme appears to have been constrained by corruption scandals within his own party. India will hold elections in five states in Q2-2012. In the run-up to the polls, politicians at the state level are likely to resist government reforms, including a proposal to allow FDI in multi-brand retail. This implies that while progress on reforms will continue, the pace will be slowed by politics. Policy paralysis including stalled approvals of key investment projects is unlikely to improve as government officials avoid potential corruption charges by side-stepping large decisions.
43
Ample room for stimulus Public debt and FX reserves of Asian economies
120 Government debt as % of GDP 100 80 60 40 20 0 0 5 HK 10 15 20 25 30 MY KR PH TH ID TW SG*
IN CN
FX reserves (months of imports) Sources: CEIC, Standard Chartered Research

12 December 2011
Bangladesh
Christine Shields, +44 20 7885 7068
Christine.Shields@sc.com
Still resilient, but strains are emerging

Economic outlook
Bangladesh has performed remarkably well over the last few years. Although growth has edged down, resilient exports, improvements to the electricity supply and strong remittances should result in solid prospects for the next couple of years or so. The government has targeted 8% GDP growth by FY15 (begins 1 July 2014) in its latest six-year plan. While this may prove a stretch, output growth is unlikely to slow to less than 6%, still strong compared to the rest of the region. Domestic demand remains the mainstay of activity. Though data are limited on the expenditure side, investment spending appears to have inched up in the last fiscal year despite energy outages, while consumption is likely to have been held back by high inflation, which erodes household spending power. In order to move Bangladeshs economy onto a higher growth path, the government must provide a more supportive policy stance by pushing through infrastructure spending and more liberalising economic reforms. There have been some positive developments in the energy sector, but progress is still too slow. Exports reached a record high in FY11 and have remained robust since, though the pace of growth has slowed. Exports are outperforming other Asian countries despite tough market conditions, probably reflecting Bangladeshs low-cost advantage. Garments are still the main driver and are benefiting from a substitution effect as consumers look for cheaper alternatives, which will
limit downside risks if the crisis in Europe worsens. Woven garments, knitwear and leather goods have been success stories, and exports of frozen foods are growing robustly from a low base. Tea exports have fallen.
High inflation is a worry. We expect inflation to stabilise at 10.5% in FY12, and to fall thereafter due to more stable commodity prices and policy tightening. The recent depreciation of the Bangladeshi taka (BDT) is not helpful in this regard, especially if the weakening trend persists as we expect. The balance of payments is deteriorating because of high commodity prices and rising demand for imported capital goods. Investment-related demand for imports will continue, driven by large projects such as the Padma Bridge. The decline in remittances is also a factor leading us to predict a current account deficit of 0.6% of GDP in FY12. Reserves have been falling, and at end-FY11 they provided just 2.9 months of import cover a limited cushion, especially with the BDT so soft and the current account in deficit.
Policy

Rising prices are also having adverse fiscal consequences. Subsidy spending is increasing, offsetting the benefit from strong (and impressive) tax collection. The fiscal deficit for FY11 was 4.2% of GDP, up from 3.7% in FY10. While this is relatively modest, the pace of deterioration is becoming a concern. As subsidy costs rise, reform is necessary to maintain funding for social and development spending. New regulation is needed if the government is to meet its tax revenue target of 13% of GDP. A new VAT law and a wealth and property tax will not take effect until 2014. Monetary policy tightening will continue in 2012, but its effectiveness is in question. The most recent Bangladesh Bank statement expressed a clear emphasis on restraining credit growth. Broad money grew by 21.4% y/y in FY11, much higher than the target of 15.2%. The effects of raising reserve requirements and interest rates were negated by unsterilised intervention in the FX market. Given the loose credit environment, coupled with currency and inflationary pressures in 2012, further rate hikes look likely.
44
Standard Chartered forecasts: Bangladesh

2011 GDP (real % y/y) CPI (% y/y) Policy rate (%)* USD-BDT* Current account balance (% GDP) Fiscal balance (% GDP) 6.7 9.0 6.75 77.50 0.9 -4.2 2012 6.4 10.5 7.25 78.00 -0.6 -5 2013 6.5 9.0 8.0 77.00 -0.7 -5.5 2014 6.9 7.0 8.0 76.50 -0.5 -5.6
Note: All forecasts except USD-BDT refer to the July-June fiscal year ending in the year in column heading; *end-period Source: Standard Chartered Research
12 December 2011
Bangladesh (cond)
It is possible that multilateral intervention will help to improve the policy environment. An Extended Credit Facility from the IMF is under consideration. The government is seeking USD 1bn to support its external position, but the conditionality attached is proving testing, especially on the fiscal side. Revenue collection, tax reform and subsidy reform are contentious for Dhaka to pass; energy price reform is a particular stumbling block. If conditions in these areas are met, talks will be able to resume, but the IMF is so far reportedly unimpressed with Dhakas delivery. Failure to win IMF support will likely bear down on the currency.
Other issues
Infrastructure development is desperately needed, particularly of the power supply. The government is taking some positive steps. It has outlined a plan to expand capacity by over 12,000 MW, which would require significant participation from the private sector in the short term. A deal was signed on 2 November with Russia over the potential construction of a nuclear power station with a capacity twice the size of the current national energy deficit, at a forecast cost of USD 1.5-2bn. The plant, if built, should provide not only a long-term boost to the energy supply but, critically, an improvement in supply consistency. This would mean an end to the constant outages which are a major barrier to business growth.
Financial issues
Low reserve cover, the weakening exchange rate and the widening budget deficit will undermine attempts to tighten monetary policy. Despite interest rates and credit ceilings already having been raised, credit growth looks set to remain uncomfortably high, in part because of forced lending to the government by the central bank. This essentially monetises the deficit, fuelling inflation as well as distorting credit flows. Nonetheless, the private banks are in good shape, with the majority having increased their capital adequacy ratios in line with Basel II by end-FY11. Most indicators of financial soundness show improvements for commercial banks. Lenient reporting standards are a worry, though, especially for state banks.
Nuclear is part of a policy of diversification in energy supply, away from the oil and gas dependence adopted over the last 10 years. This should free up domestically produced gas for commercial use and loosen energy linkage limits. The limit on new electricity and gas connections introduced in 2010 has effectively strangled new business growth and expansion and led to widespread and constant public disorder for over 18 months.
The state-owned commercial banks have been allowed to shift losses off their balance sheets. On a mark-tomarket basis, their average capital adequacy ratio drops way below the Basel II requirements. The central bank is likely to monitor this closely.
Obviously changes in energy policy have a mediumterm time scale: nuclear power generation will not begin before 2017 at the earliest. In 2012, Bangladesh will continue to rely on expensive imported oil for energy, resulting in persistent power shortages, outages and, hence, the associated protests.
Bangladesh: Electricity production plan Additional generating capacity, MW

3,500 3,000 2,500 2,000 1,500 1,000 500 0 2010 2011 2012 2013 2014 2015 2016 Private Public Total
Politics
On the broader political front, disruptive protests and demonstrations persist, not just about power outages, but about recent stock-market losses. These caused problems earlier in 2011 that led to concerns about the quality of the regulatory backdrop. In early December, a new round of weakness beset the stock market, which is now more than 40% down from its December 2010 peak. This also presents downside risks to an already-difficult political scene. Parties remain as polarised as ever, and constructive policy making has rarely been achieved in Bangladeshs history.
Source: Power and Energy Sector Road Map: An Update, 2011

12 December 2011 45
China
Stephen Green, +852 3983 8556
Stephen.Green@sc.com
Wei Li, +86 21 6168 5017

Li.Wei@sc.com
Lan Shen, +86 21 6168 5019

Lan.Shen@sc.com
Getting used to 8%
Economic outlook
Four questions will dominate in China in 2012. First, can the authorities maintain economic growth at such a pace that the labour market does not weaken significantly? Exports, a big provider of jobs, will see single-digit growth at best. Second, can Beijing engineer a soft landing in the real-estate sector? Apartment prices are already correcting down, and unsold inventories will not be run down quickly. Third, can anything substantial be done to rebalance the economy? Domestic imbalances are getting worse, not better. Fourth, where will Chinas new leadership team (who will start work in October) want to take the country from 2012-22? And, more importantly, will they be able to get there? We look for 8.1% real GDP growth in 2012, with a mild rebound to 8.7% in 2013. We believe the risks are skewed to the downside. To achieve this rate of growth, capital investment will need to grow at least 9% (after nearly 11% in 2011), and this is the key risk. Infrastructure projects are finding it harder to access bank financing as banks try to limit their exposure to local governments. City governments land-sale revenues are down y/y, too. Fewer big projects are ready to be approved, thanks to the front-running of projects under the CNY 4trn stimulus package. Also, as we explain below, commercial real-estate construction will slow considerably, possibly turning negative y/y in Q2-2012. We expect private consumption to grow around 9% y/y, the same pace as in 2011. Although wage pressures will likely moderate, we still look for broad income growth and expect consumption to continue to be driven by the
millions of people entering the consumer class. Rural income growth is likely to continue to outpace urban income growth.
Inflation will not be an issue in 2012, in our view. We look for an average rate of 2% y/y for the year (and 3.6% in 2013). Food price increases will be contained by lower input costs as well as a supply response. Input costs will fall alongside weak global demand and commodity prices (though quantitative easing by Western central banks will support commodities). We expect net exports to subtract 1ppt from 2012 growth, assuming nominal growth of 5% in exports and 9% in imports. A weaker global growth environment is possible. Exports currently provide 15-20% of Chinas GDP growth but absorb 30-40% of manufacturing output growth.
Financial issues
Chinas current account surplus has fallen significantly in the last four years, mostly as a result of the investment boom and high global commodity prices. We look for a current account surplus of 1.9% of GDP in 2012; the smaller trade surplus will reinforce calls for slower Chinese yuan (CNY) appreciation, on which more below. Opening up the capital account seems to have become a soft policy goal for 2015. Reformers appear to believe that this target which is linked to the internationalisation of the currency will help promote domestic reforms. In 2012, we expect moves to further facilitate foreign investors (including central banks) access to onshore capital markets. The State Administration of Foreign Exchange may also boost the quota for how much FX households can buy with their CNY. The offshore CNH market developed rapidly in 2011, though growth in offshore CNH deposits slowed in Q4, hit in part by negative global risk sentiment. Beijing will likely continue to look for ways to develop this market. The banking system is still weighed down by local government exposure (some 20% of outstanding loans), and we have long argued that some kind of central government rescue package will be needed to recapitalise the sector. This is unlikely to appear in 2012. Local government loans falling due will be rolled over.
Standard Chartered forecasts: China

2011 GDP (real % y/y) CPI (% y/y) Policy rate (%)* USD-CNY* Current account balance (% GDP) Fiscal balance (% GDP) *end-period
12 December 2011
2012 8.1 2.0 6.56 6.21 1.9 -1.5
2013 8.7 3.6 7.06 6.03 2.7 -2.0
2014 7.0 4.0 7.56 5.83 3.1 -2.5
9.2 5.4 6.56 6.34 3.5 -1.0

46
China (cond)
Policy
Despite talk of rebalancing, progress has been limited in recent years. Indeed, we estimate that investment as a proportion of GDP exceeded 50% in 2011, up from 43% in 2008. The bureaucracy has expanded, state enterprises have resisted policies that threaten their interests (e.g., competition reforms), and key prices such as interest rates and the exchange rate remain controlled and distortionary. Some in Beijing argue that without another wave of reforms modernising health care and education or opening up services to competition growth will falter during the 2013-16 period. Housing policy appears to be the exception to the no-bigreform rule, and the concerted campaign to bring down prices that began in early 2010 is bearing fruit. Prices for new projects in many Tier 1 and 2 cities are already down 10% from their peak. But the fundamental problems that push up home prices (low real interest rates and local governments reliance on land revenues for their discretionary income) have not been addressed. We expect housing prices to fall 20% in Tier 1 and 2 cities but only 5-10% nationwide; the authorities are likely to loosen some controls in Q2-2012 in order to prevent a wave of real-estate bankruptcies. A soft landing is likely. We expect the Peoples Bank of China (PBoC) to keep its loan quota in place, targeting new loans at around CNY 8.5trn in 2012, up from CNY 7.5trn in 2011. If there was a significant negative shock to external demand and a bigger deterioration in the job market, we would look for an interest rate cut or two. However, with interest rates already low, we do not see the need for cuts (and the PBoC would prefer to push rates higher, if anything). We look for administered interest rates to be flat in 2012. We
expect five required reserve ratio (RRR) cuts of 50bps each in 2012, following one in early December 2011 and another expected in late December.
Fiscal policy will officially remain proactive in 2012, but the Ministry of Finance (MoF) usually means supportive of rebalancing rather than stimulative to economic activity when it uses this phrase. The MoF aims to continue its roll-out of the value-added tax (VAT) through the services sector (eventually including financial services), replacing the much-criticised Business Tax. Less usefully, the MoF will also be throwing tax cuts at strategic industries. The overall tax burden, at 26% of GDP (without counting the governments non-tax revenues), is already high, especially considering the limited services provided for such taxes.
We look for the CNY to appreciate 2.1% against the USD during the year, though at a slow pace in H1-2012. This will take USD-CNY to 6.21 by year-end. We expect several monthly trade deficits in H1, with exporters suffering from contracting demand in Europe, their biggest market. FX outflows could accelerate as the housing market corrects down and political risk rises in the run-up to the 18th Party Congress in October. As a result, we expect more ups and downs in USD-CNY, but the year should still bring a small appreciation. Likely Republican US presidential candidate Mitt Romney has stated that he would name China a currency manipulator on his first day in office, so 2013 will be an interesting year for US-China relations if he wins.
Politics
Chinas growth profile GDP, contributions to real growth, ppt

15 13 11 9 7 5 3 1 -1 -3 -5 Government Consumption
2000 2002 2004 2006 2008 2010 2012
Investment Net exports
The final question hanging over 2012 is whether the new leadership will reignite serious reform. Few expect 2012 to be a year of reform given that internal elections for thousands of posts will dominate. The handover to the new nine-person Politburo Standing Committee will take place in October at the 18th National Congress of the Communist Party of China. Little is known about how the new team to be led by Xi Jinping as Secretary General and Li Keqiang as Premier and head of the State Council will act. Vice Premier Wang Qishan is thought to be a likely Executive Vice Premier. Most of this team will serve two five-year terms, and one or two of the nextgeneration leaders may also appear in the Politburo. The most likely course is continued gradualism, but given the complex and interconnected nature of the current challenges, this strategy may stop working.

12 December 2011 47
Hong Kong
Kelvin Lau, +852 3983 8565
Domestic resilience shines through

Economic outlook
Given the highly uncertain global outlook, a small and open economy like Hong Kong is bound to have its fair share of worries in 2012. While inflation pressure should recede, growth concerns will take over as the economy slows further in H1 before rebounding. The extent of the contraction, if any, is likely to be smaller than in 2008-09, and the property sector is more likely to consolidate than collapse; at the same time, though, the economy may not benefit as much from looser global monetary conditions as it did last time. Of greater certainty are the resilience of the USD-HKD peg, the maturing of the offshore CNY (CNH) market, and the continuation of the governments broad policy direction, regardless of who takes the governments helm following the March election. We expect GDP growth to ease to 2.9% in 2012 from 5.0% in 2011. While Hong Kong has escaped a technical recession so far, it is not out of the woods yet we see the risk of small GDP contractions in Q4-2011 and Q12012 in seasonally adjusted q/q terms. This would still be materially better than the 2.7% contraction in 2009, predicated on the assumptions that US growth will be disappointingly low but still positive; the recession in Europe will be shallow; and China will achieve a soft landing. With external demand likely to get worse before it gets better, net exports will remain a significant drag on growth; y/y export performance may not bottom out until H1-2012, and should average around -10% y/y for the whole of 2012. Domestic demand, however, is still
capable of doing much of the heavy lifting. Compared to the last economic downturn, we expect unemployment to peak at a much lower rate of around 4% this time (leading to steady real income growth in the low single digits, also helped by easing inflation). We also foresee a shallower correction in residential property prices and continued strong spending by mainland tourists. A twospeed economy characterised by resilient domestic demand and a weak external outlook remains the theme.
We believe inflation peaked in Q4-2011, and its downtrend to be led by lower food inflation in y/y terms will become more evident throughout 2012. The CPI housing component should also soon start to reflect the cooling of the residential property market since June 2011. Beyond food and housing, however, any easing of price pressure should be mild given well-supported wages and continuing strength in domestic demand. We reiterate that we do not view Hong Kongs residential property market as a bubble. Yet, like most markets, it is subject to cycles. The murky external outlook, slowing domestic growth and higher mortgage rates mean residential property buyers are likely to remain cautious, keeping the market in correction mode for another quarter or two. The absence of over-leverage, overspeculation and other bubble characteristics should ensure that any further price correction is shallow and orderly similar to what we have seen in H2-2011. That said, we expect transaction volumes to stay low and prices to stay volatile before sentiment rebounds.
Standard Chartered forecasts: Hong Kong

2011 GDP (real % y/y) CPI (% y/y) 3M HIBOR (%)* USD-HKD * Current account balance (% GDP) Fiscal balance (% GDP)** 5.0 5.2 0.35 7.795 6.5 4.7 2012 2.9 3.5 0.35 7.790 5.5 2.0 2013 5.6 3.5 1.10 7.775 6.5 3.0 2014 4.5 3.0 1.90 7.775 6.0 3.0
Financial issues
Local monetary conditions are determined by US interest rates and capital flows. We expect the Fed to start hiking rates only in Q3-2013; this means that USD LIBOR, and therefore HIBOR, will only start a sustained trend higher in Q1-2013 at the earliest. The outlook for capital flows is tougher to call, given the opposing risks of (1) European banks withdrawing funds from Asia; and (2) a flood of liquidity resulting from imminent QE3. The good news is that Hong Kong has so far displayed safe-haven qualities the Hong Kong dollar (HKD) outperformed all other Asia ex-Japan currencies except the Chinese yuan (CNY) against the USD in H22011 (as of 31 November), spending most of its time on
48
12 December 2011
Hong Kong (cond)

the strong side (7.75-7.80) of the Convertibility Undertaking band. This still falls short of the HKD gains seen during the last crisis, when USD-HKD spent considerable time testing the strong-side Convertibility Undertaking threshold of 7.75. This prompted the Hong Kong Monetary Authority (HKMA) to sell HKD into the market, boosting the Aggregate Balance.
The Aggregate Balance, a gauge of interbank liquidity, has not grown in size since the HKMA last intervened in late 2009. Now at HKD 150bn, it remains sizeable compared to its historical norm of less than HKD 5bn. This buffer should be sufficient to keep the short end of the HIBOR curve from jumping higher in the case of transient outflows (or from fully tracking USD LIBOR higher, as evident in recent months). Liquidity in the interbank market, however, will not help to bring down banks high loan-to-deposit ratios. The loan-to-deposit ratio for banks in Hong Kong has been climbing mainly on the back of fast loan growth. This has prompted banks to pay up for deposits and to reprice loans (including mortgages and trade finance). We expect such ratio-induced liquidity tightness, and the resulting repricing pressure on bank loans and deposits, to continue in 2012 (barring sizeable enough fresh capital inflows to expand the monetary base again). This is partly premised on still-strong cross-border loan demand, even as mainland China loosens monetary policy. The continued development of the CNH market is likely to remain a bright spot for the financial sector. This market was hit by global market turbulence in late September, but the subsequent renewal, expansion and
improved flexibility of the CNY trade settlement conversion quota should restore market confidence and facilitate smoother operation over time. The recent finalisation of streamlined CNH FDI rules, together with the issuance of the first-ever Dim Sum bond by an onshore corporate, sets the scene for more Renminbidenominated investible assets to come on board in Hong Kong. CNH lending, having finally taken off in 2011, is set to continue to amaze. However, we expect the pace of CNH deposit accumulation to slow in 2012 due to a more balanced mix of imports and exports in CNY trade settlement. The simplification of some existing regulations would facilitate market development.
Policy
We do not expect the existing USD-HKD peg to change in the foreseeable future. We see no obviously better alternative to the current system at least not until the CNY becomes fully convertible and internationalised, among many other pre-requisites. In the meantime, the increased availability of CNH investment products should not be mistaken for full currency substitution. The credibility of the HKD will continue to be derived from the time-tested, rule-based Linked Exchange Rate System. The upcoming budget on 1 February will be an extension of the October Policy Address, with a focus on addressing social issues. We also expect concessions aimed at countering the growth slowdown. The government has a deep war chest to dip into; using its fiscal resources to promote cross-border co-operation and shore up Hong Kongs competitiveness will be key.
Politics
Private consumption to remain an anchor Projected contributions to growth by GDP component, ppt
14 12 10 8 6 4 2 0 -2 -4 -6 Others Q1-11 Q2-11 Q3-11 Q4-11 Q1-12 Q2-12 Q3-12 Q4-12 PCE Net exports GDP growth, % y/y
An election will be held on 25 March 2012 to select a new Chief Executive (CE) for Hong Kong. The Basic Law, Hong Kongs mini-constitution, bars incumbent CE Donald Tsang from running for a third term. Candidates will be voted on by a 1,200-member Election Committee. The two perceived front-runners are Henry Tang (former Chief Secretary for Administration) and C.Y. Leung (former Convenor of the Executive Council). Both are seen as pro-Beijing, and while a victory for Tang would signify an extension of the current administration, Leung has promised change while preserving stability. We see no major changes in the broad direction of government policy, regardless of who takes the helm come July 2012. A Legislative Council election will also be held in September 2012.
49

12 December 2011
India
Anubhuti Sahay, +91 22 6115 8840
Anubhuti.Sahay@sc.com
Nagaraj Kulkarni, +91 22 6115 8842

Nagaraj.Kulkarni@sc.com
Shilpa Singhal, +65 6596 8259

Shilpa.Singhal@sc.com
High time to act!

Economic outlook
The current combination of relatively slow growth and high inflation is a warning signal that policy inaction needs to be addressed and reforms need to be accelerated immediately. The economic outlook for the rest of FY12 and FY13 will hinge crucially on the governments ability to restore investors confidence in Indias long-term story. Global developments will undoubtedly play an important role too, but Indias ability to weather the adverse environment will depend on its domestic policies especially if it aims to remind the world of its structural positives. GDP growth has already slipped below trend. It slowed to 6.9% y/y in Q2-FY12 (ended September 2012), the weakest in two years, from 7.7% in Q1-FY12. Growth is unlikely to reverse course until Q1-FY13. Government efforts to kick-start the investment cycle, which is already in a contractionary phase, have been minimal. While household consumption currently at its weakest level on record is likely to find a floor thanks to government spending in rural areas and a healthy labour market, weak consumption will weigh on investment in a feedback loop. External demand, an important growth driver until now, will fade if the euro area falls into recession and US growth is below trend. Sub-7% growth for four successive quarters paints a gloomy picture for Indias economy. However, on a positive note, demand-side pressure on inflation (WPI
inflation has been above 8% since January 2010) is likely to be squeezed out. If so, inflation should slow to the 6.57.0% range by March 2012 and remain at 6.5% in FY13. Hence, the Reserve Bank of India (RBI) is likely to reduce interest rates starting in Q1-FY13 (ends 30 June 2012). We expect the RBI to cut rates by 150bps in FY13. This should improve investment sentiment, causing growth to rebound, particularly in H2-FY13. We forecast FY13 growth at 7.4%.
Risks to our views stem from two key factors. First, if global commodity prices surge as they did in 2010, inflation might remain elevated, delaying rate cuts and thus an upturn in the investment cycle. Second, a failure to break the policy inertia would impede growth, both in FY13 and over the long term.
Financial issues
Indian banks asset quality is under cyclical and structural pressure in an environment of high policy rates and low growth. Given stress on some corporate sectors, our base-case scenario assumes that Indias NPL ratio could rise to 6-7% in two-years from 2.3% at end-March 2011. However, most of Indias banks should be able to absorb additional provisioning losses, especially if they take the restructuring route. Moreover, banks are better capitalised than they were in 2008-09, and the government intends to boost their capital base by March 2012, As a result, stress in the banking system appears manageable. In addition to the cyclical story, the markets will watch for progress on the granting of new banking licences. India last issued a new banking licence in 2004. Given the rapid pace of economic growth, demand for banking services has increased manifold since then. Though action on this front is unlikely to come soon a parliamentary standing committee is expected to submit its report in August 2012 after extensive consultation with the RBI revised guidelines would improve sentiment. Progress on economic reforms including the Pension Fund Regulatory and Development Authority Bill and the revamp of the tax system will be in focus.
Standard Chartered forecasts: India

2011 GDP (real % y/y) WPI (% y/y) Repo rate (%)* USD- INR* Current account balance (% GDP) Fiscal balance (% GDP) 7.0 8.7 8.5 51.5 -3.1 -5.6 2012 7.4 6.5 7.0 48.5 -2.8 -5.5 2013 8.0 6.0 7.0 46.5 -2.6 -5.0 2014 8.0 6.0 7.0 44.0 -2.5 -5.0
Note: All forecasts except USD-INR refer to the April-March fiscal year starting in the year in the column heading; *end-period Source: Standard Chartered Research
12 December 2011 50
India (cond)
Policy
The skewed focus of fiscal expenditure on increasing the purchasing power of vulnerable groups of society without a corresponding emphasis on supply-side policies has resulted in persistent inflation. Fiscal reforms, especially on the expenditure front, are therefore important. Subsidies need to be reduced, particularly given that the expected slippage in the FY12 fiscal deficit to 5.6% of GDP from the targeted 4.6% is driven primarily by the subsidy burden. However, given upcoming state elections, the political will to curb populist expenditure will be low. At the same time, slower growth might curb revenues. This should keep the FY13 fiscal deficit high, at 5.5% of GDP. Huge government borrowing, especially in response to unexpected slippage from budget targets in a tight Indian rupee (INR) liquidity environment, may put stress on the Government of India Securities (GoISec) market. In this context, the RBIs liquidity management policy will be important. Since the RBI adopted a new monetary policy operating procedure in March 2011, banking-system liquidity has been in deficit (and hence the repo rate has been the operative rate) in order to ensure effective transmission of monetary policy. It will be interesting to see if the repo rate remains the operative rate or if the RBI by pushing banking-system liquidity into a surplus switches to the reverse repo rate as the operative rate. The latter would mean cumulative rate cuts of 250bps, as the reverse repo rate is currently 100bps below the repo rate. While we expect the RBI to continue with its open-market operations (OMOs) to ease liquidity pressures and
manage government borrowing c.INR 500-600bn for the rest of FY12 we believe a reduction in the cash reserve requirement might also be required to narrow the liquidity deficit to a comfortable level.
External stresses are likely to remain a theme for the rest of FY12 and in H1-FY13. We expect little relief for the trade deficit as exports slow and the reduction in the import bill is limited by oil imports and investors huge appetite for gold. Hence, despite stable flows in the form of services exports and remittances, funding the current account deficit forecast at 3.1% of GDP in FY12 and 2.8% in FY13 may prove challenging. Indeed, global risk aversion, weak local fundamentals, upcoming debt redemptions and regulatory changes in the international banking system are likely to result in a balance-ofpayments deficit in FY12 before a marginal improvement to a USD 7bn surplus in FY13. Hence, the INR is likely to remain on a weak footing in the near term we forecast USD-INR at 53 by March 2012, before reverting to 48.50 by the end of 2012 on better domestic growth/inflation dynamics. However, deeper reforms will be required to attract sustained capital inflows, especially as the buildup of FX reserves has been limited in the recent past.
Other issues
Growth and inflation are expected to slow % y/y

10% 8% 6% 4% 2% 0% Mar-10 Sep-10 Mar-11 Sep-11 Mar-12 Sep-12 Mar-13 GDP WPI (RHS) Forecast 12% 11% 10% 9% 8% 7% 6% 5%
The government needs to push hard on delayed economic reforms. Its recent efforts to accelerate the process have hit a roadblock the announcement that foreign investment would be allowed in multi-brand retail has been put on hold as it faced vehement opposition both within and outside the ruling party. While enacting big-bang reforms appears difficult, especially with 2012 state elections looming, the momentum on this front needs to continue. Low-hanging fruits such as allowing FDI in the aviation sector should be targeted first. More contentious issues like the land acquisition bill will take time to be implemented.
Politics
Corruption charges against the ruling United Progressive Alliance (UPA), and its inability to bring down inflation, have strengthened the position of the opposition. This shift in the power balance has limited the governments efforts to push ahead with reforms. Indeed, the decision to delay FDI in multi-brand retail shows that contentious reforms are unlikely, as the ruling party would prefer to avoid a mid-term poll. The ruling partys term ends in May 2014.

12 December 2011 51
Indonesia
Fauzi Ichsan, +62 21 2555 0117
Fauzi.Ichsan@sc.com
Eric Alexander Sugandi, +62 21 2555 0596

Eric.Alexander-Sugandi@sc.com
Not immune to the global slowdown

Economic outlook
The continuing global economic slowdown is likely to affect Indonesia in 2012. The domestic economy has so far been resilient given its relatively low dependence on global growth and trade domestic consumption generates around 65% of GDP, while net exports contribute only 10%. Given robust household consumption and fixed investment, we expect GDP growth to accelerate to 6.5% in 2011 from 6.1% in 2010. Nevertheless, we expect growth to slow to 5.8% in 2012 as the impact of the global economic slowdown is transmitted to the country through two main channels: (1) the financial channel, via slowing FDI and foreign currency-denominated bank lending; and (2) the trade channel, via slowing exports. We expect domestic consumption growth to remain unchanged at 4.7% in 2012, as cuts in the Bank Indonesia (BI) policy rate to a record low are likely to reduce bank lending rates, cushioning consumer spending. However, growth in investment (25% of GDP) is likely to slow to 8.2% in 2012 from 10.3% in 2011 as corporates postpone investment plans amid uncertain export prospects and reduced availability of long-term financing due to the pullback by European banks. Headline inflation, which fell to 4.2% y/y in November 2011 from 7% in December 2010, is likely to rise again to 5% by the end of 2012. Expected increases in electricity tariffs and subsidised fuel prices, along with rising rice prices following severe floods in Thailand (a key supplier of rice to Indonesia), are likely to revive inflationary
pressure. However, this will be partly offset by softer domestic demand and a stronger Indonesian rupiah (IDR) in H2-2012.
We expect Indonesias current account surplus to shrink to USD 3bn in 2012 from USD 4bn in 2011 as export growth slows. However, resilient commodity prices should support the trade surplus in 2012 approximately 60% of the countrys exports are commodities (oil, gas, coal, palm oil, etc.). Import growth is also likely to slow on softer domestic demand and lower prices of imported capital goods and raw materials, which make up over 90% of imports. We expect the trade surplus to shrink to USD 31bn in 2012 from USD 34bn in 2011.
Financial issues

The euro-area recession and global economic slowdown will affect Indonesia more through financial markets than international trade, as was the case in 2009. Given the expected deterioration in the euro-area crisis in Q1-2012, banking liquidity and investor appetite for emergingmarkets assets are likely to diminish rapidly. This will trigger renewed volatility, temporarily weakening the IDR in Q1-2012 and limiting the availability of funding for fixed investment in the private sector in H1-2012. While BI has sufficient FX reserves (USD 114bn in October 2011, versus USD 50.2bn in November 2008) to minimise dayto-day IDR volatility, it cannot provide FX liquidity for long-term corporate investment. This will weaken an engine of Indonesias economic growth. To minimise the impact of the global slowdown, BI cut its BI rate by 75bps in Q4-2011 to a historic low of 6%. We expect it to cut the rate further to 5.75% in Q1-2012, and to keep it there until end-2012. Given expected inflationary pressures in 2012, we do not expect BI to cut rates more aggressively or to lower banks reserve requirement, currently set at 10.5% of their IDR deposits. The BI governor is keen to ensure that policy rate cuts are followed by cuts in banks lending rates. Although bank credit growth likely picked up to 25.5% in 2011 from 22.8% in 2010, BI wants to prevent a sharp credit slowdown in 2012 by compelling banks to cut their lending rates, either through moral suasion or regulations. BI also wants to reduce Indonesian banks average net interest margin of 5.5-6.0% (which makes them among the worlds most profitable) and share the
52
Standard Chartered forecasts: Indonesia

2011 GDP (real % y/y) CPI (% y/y) Policy rate (%)* USD-IDR* Current account balance (% GDP) Fiscal balance (% GDP) *end-period
12 December 2011
2012 5.8 4.5 5.75 8,700 0.3 -1.3
2013 6.5 5.3 6.25 8,400 0.1 -1.5
2014 6.8 5.4 6.25 8,100 0.0 -1.8
6.5 5.4 6.00 9,150 0.5 -1.0
Indonesia (cond)
financial burden of slower economic growth. We expect bank credit growth to slow to 20% in 2012.
mechanism for allocating funds from the central to regional governments.
The BI governors efforts to micro-manage banks are opposed internally by some BI technocrats, who argue that credit growth is already too high and is potentially inflationary. Given that BIs regulatory powers over banks are expected to diminish with the planned establishment of a financial services authority in 2013, we believe a comprehensive BI plan to regulate bank lending rates would not be fully implementable.
Policy
The governments cash surplus is likely to enable President Bambang Yudhoyono to resist calls (even from the finance ministry) to sharply raise domestic fuel prices, which would be politically unpopular, to cut government spending on energy subsidies, Subsidy spending amounts to 17.5% of the 2012 budget. While higher global oil prices have pushed up spending on energy subsidies, they have also increased tax revenue from commodity sectors such as palm oil and coal, resulting in an almost neutral net impact on the government budget. Indonesia has enjoyed consistently low fiscal deficits and a declining public debt-to-GDP ratio (to an expected 25% in 2011 from 90% in 2000). Even though this is by default rather than by design and is keeping annual GDP growth below its 8-9% potential level, it is likely to improve investors perception of Indonesia against a backdrop of fiscal crises and sovereign rating downgrades in the US and Europe. All three rating agencies (S&P, Moodys and Fitch) currently rate Indonesia one notch below investment grade. We expect an upgrade to investment grade before the end of 2012.
We believe Indonesias ability to weather a global slowdown rests not on monetary policy but on fiscal policy specifically, the capacity to spend government budgets at both the central and regional levels. While the central government targets a fiscal deficit of 2.1% of GDP for 2011, it ran a surplus of 0.1% of GDP in the first 10 months of the year. As of October 2010, the government had an accumulated unspent balance of more than USD 22bn (3.2% of 2010 GDP) from past fiscal years. We expect the fiscal deficit to gradually rise from 0.6% of GDP in 2010 (versus a 2.1% target) to 1.0% in 2011 (2.1% target) and 1.3% in 2012 (1.5% target) well below the 3% constitutional cap. While we do not expect a marked acceleration in public spending, we do expect parliament to pass the longdelayed land acquisition law in H1-2012, which will strengthen the governments legal basis to clear land for infrastructure projects. Other hurdles to infrastructure development are likely to remain, including the inability of most of Indonesias 497 municipal governments to effectively build projects and the cumbersome
Politics
Growth will be affected by global slowdown Real GDP growth (% y/y)

8 7 6 5 4 3 2 1 0 Q1-06 Q1-07 Q1-08 Q1-09 Q1-10 Q1-11
Given that the next general election is not until 2014, we do not expect much change in the political environment in 2012. President Yudhoyonos latest cabinet reshuffle (in October 2011) and corruption scandals within his Demokrat party have had little nationwide impact. While the reshuffle is unlikely to make his coalition government more effective, there is also little opposition in the hung parliament. The widely held view is that as long as there is political stability, economic growth is likely to remain stable, in spite of an ineffective government. Indonesias geopolitical situation is likely to remain stable. Unlike some of its neighbours (such as Malaysia, the Philippines and Vietnam), it does not have territorial disputes with China. Internally, the threat of terrorism and Islamic fundamentalism has receded, with the number of terrorist attacks declining markedly over the last three years. That said, Indonesias economic growth has not been balanced, and inequality indicators have worsened in recent years. This could potentially fuel political instability in the run-up to the 2014 parliamentary and presidential elections.
Source: National Statistics Agency

12 December 2011 53
Malaysia
Edward Lee, +65 6596 8252
Lee.Wee-Kok@sc.com
Tai Hui, +65 6596 8244

Tai.Hui@sc.com
Resting on commodities
Economic outlook

We expect GDP growth to ease to 2.7% in 2012 from an estimated 4.8% in 2011. The slowdown will be caused by external weakness US fiscal policy is paralysed by politics, the EU is mired in a debt crisis, and China is slowing due to the effects of monetary policy tightening in the last two years. Malaysias relatively open economy, with trade at about 177% of GDP, leaves it susceptible to weak global growth. Exports to the EU accounted for 10.7% of the total in 2010. The commodity sector will be a key determinant of growth in 2012, as it was in 2011. Palm oil, rubber and liquefied natural gas contributed 70% of Malaysias 8% export growth in the first nine months of 2011. Commodities are also important to rural spending, and resilient prices can buffer the domestic economy against external headwinds. We have a relatively benign view of commodity prices, expecting crude palm oil prices to average MYR 3,450/tonne in 2012, up from MYR 3,216 in 2011. The government currently forecasts 2012 GDP growth at 5-6%. Investments under the governments Economic Transformation Programme (ETP) are likely to drive growth. The government expects private and public investment to rise by 15.9% and 7%, respectively, in 2012. This may be too aggressive, particularly given the poor global economic outlook (during the previous global crisis in 2009, private investment contracted 17% y/y). The government could provide some fiscal support public investment rose 7.5% in 2009 but it will also be mindful of the need for fiscal consolidation.
Inflation will become less of a concern in 2012. We expect the inflation rate to average 2.6%, down from 3.3% in 2011. Higher food prices have been the primary contributor to inflation in 2011. With global food prices easing since H2-2011 and the global economic outlook worsening, we expect a further downward correction in prices. While sporadic supply-side pressures may arise from events such as the floods in Thailand, we expect the governments administered price schemes to provide a cushion against short-term fluctuations. The government has maintained the subsidy level at MYR 33.2bn for 2012. Given upcoming elections, it is likely to want to avoid a public backlash against subsidy reductions. This will also cap price pressures that may emerge if quantitative easing measures in advanced economies cause global commodity prices to rebound. According to a November 2011 update, the government is making good progress on the ETP, which aims to transform Malaysia into a high-income economy by 2020. The government has attracted investments totalling MYR 177bn, or about 13% of the MYR 1.4trn targeted by 2020. However, investment growth (under GDP accounting) was only about 5.1% in 9M-2011, which does not suggest a structural pick-up in investment compared to recent years (excluding 2008-09, when investment fell due to the global crisis). The environment in 2012 may not be conducive to private investment either, suggesting that the government will have to pick up the slack. On a more positive note, the ETP may be helping to revive FDI. The government is targeting an ETP investment split of 73% domestic and 27% foreign. Inward FDI rose to MYR 26.4bn in 9M-2011 from 18.6bn in the same period in 2010; this also exceeded the MYR 24.8bn for the same period in 2007, before the global crisis.
Standard Chartered forecasts: Malaysia

2011 GDP (real % y/y) CPI (% y/y) Policy rate (%)* USD-MYR* Current account balance (% GDP) Fiscal balance (% GDP) *end-period
12 December 2011
2012 2.7 2.6 2.50 3.03 9.5 -4.7
2013 5.4 2.8 3.25 2.88 10.5 -4.4
2014 4.5 3.1 3.50 2.75 12.7 -4.0
4.8 3.3 3.00 3.18 12.0 -5.4
Financial issues
We estimate federal government debt at 53.8% of GDP in 2011, marginally higher than 53.1% in 2010. This is manageable, particularly given strong growth (nominal GDP growth has averaged 8.2% over the last 10 years). We expect the government to adhere to the fiscal rule that debt should not exceed 55% of GDP. As such, we expect fiscal consolidation efforts to continue over the next few years.

54
Malaysia (cond)
We expect USD-MYR to benefit from the resumption of trend appreciation in Asian currencies in H2-2012. Malaysian ringgit (MYR) performance in H1 will be affected by weak global sentiment and a potential bout of seasonal weakness in Q2. However, we expect the MYR to gain against the USD in H2 due to strong current account surpluses, commodity support and flush global liquidity searching for yield. Our end-2012 USD-MYR forecast is 3.03. Despite the lower fiscal deficit target for 2012 (4.7% of GDP versus 5.4% in 2011), government borrowing will be high, with the net borrowing requirement set at MYR 43.6bn. However, this is lower than the MYR 45.1bn in 2011. We estimate the 2012 gross borrowing requirement at MYR 89bn, a touch lower than MYR 90bn in 2011. The domestic bond market has continued to attract strong foreign interest in 2011. Even taking into account the sharp risk sell-off in September, foreign ownership of Malaysian Government Securities (MGS) rose to 34.8% of the total outstanding as of September 2011 from 28.3% in December 2010. Further quantitative easing in advanced economies in 2012 should benefit the MGS market as Asian currency appreciation resumes. In addition, given the potential for rate cuts and deteriorating domestic economic conditions, there may be scope for the bond yield curve to adjust lower and flatter.
starting with a 25bps cut in March. Slower economic activity, largely due to external weakness, should cause BNM to focus on growth over inflation concerns. While growth may not collapse as it did in 2008-09, a further deterioration of the European situation may cause the central bank to become more dovish and growth-oriented in Q1-2012.
Inflation, which can be considered a lagging indicator, is expected to become less of a concern. If the government maintains government subsidies as expected (especially for fuel), this should reduce inflationary pressure, giving BNM more policy flexibility. Despite earlier concerns about its commitment to fiscal consolidation, the government presented a relatively wellbalanced budget for 2012. The deficit target of 4.7% of GDP was a pleasant surprise after 5.4% in 2011. The government also announced a healthy dose of social measures to help lower-income groups, with total subsidies expected to remain unchanged at MYR 33.2bn.
The governments GDP growth estimate of 5-6% appears on the high side. However, its revenue and expenditure projections are both conservative. Total revenue is projected to rise only 1.9% from 2011, while total expenditure is expected to be largely unchanged. This should limit potential slippage from the deficit target.
Politics
Policy
We expect Bank Negara Malaysia (BNM) to cut the Overnight Policy Rate by a total of 50bps in 2012,
BNM may cut rates in early 2012 Output gap based on 4-quarter GDP sum
4% 3% 2% 1% 0% -1% -2% -3% -4% Dec-00 Dec-02 Dec-04 Dec-06 Dec-08 Dec-10 Output gap (actual as % of potential GDP)
OPR (%; RHS)
The next general election must be held by March 2013. Imminent elections are widely expected, although such expectations have been rife since 2010. In the last election, held in March 2008, the ruling Barisan Nasional (BN) coalition won 140 of the 222 parliamentary seats, versus the opposition Pakatan Rakyats 82 seats. Although BN won the simple majority needed to form the federal government in 2008, it lost the two-thirds supermajority required to amend the Constitution for only the second time since 1969. At the state level, the opposition won in 5 out of the 12 contested states, improving from only one state victory in the previous election (although BN regained the state of Perak in February 2009 after defections by assembly members). The focus on politics will continue, particularly amid widespread calls for political reform.
3.6 Forecast 3.4 3.2 3.0 2.8 2.6 2.4 2.2 2.0 Dec-12

12 December 2011 55
Pakistan
Sayem Ali, +92 21 3245 7839
Sayem.Ali@sc.com
Gearing up for elections

Economic outlook
Election years are characterised by populist measures to support growth, and we expect this to be the case in 2012. We forecast GDP growth at 4% in FY12 (ends 30 June 2012), up from 2.4% in FY11, when flood damage reduced growth. The combination of higher government spending and accommodative monetary policy will boost growth. Visible improvements in the security environment are also supportive of the growth outlook.
Inflation has declined in 2011 on tighter money supply and a stronger Pakistani rupee (PKR). However, the central bank is uncertain whether inflation will come down to the single digits in 2012, as targeted by the government. Inflationary pressures are building, as reflected in rising core inflation. Inflation risks have increased due to the widening government and trade deficits. In our view, inflation will persist and rise in 2012 due to a weaker PKR and money printing by the government to finance its rising deficit.
Reforms that are critical to reducing the build-up of debt and containing inflation including tax measures and a reduction in energy subsidies will be stalled or even scaled back in some cases. The government is in no mood to hold back in the run-up to the elections, and record spending is expected to result in a fiscal deficit of 6.5% of GDP in FY12, against the budget target of 4%. This will support growth but will also add to inflationary pressures.
Financial issues
Election years are also periods of heightened uncertainty, with foreign investors and multilateral donor agencies staying on the sidelines. The PKR depreciated 28% in 2008, the last election year, and Pakistan had to go to the IMF for a bailout. We do not anticipate a balance-ofpayments crisis in 2012, given that FX reserves are comfortable at USD 16.9bn (5.6 months of import cover). However, the widening current account deficit and large external debt payments will add to pressure on the PKR.
Downside risks remain high in 2012 due to slowing export growth, weak private credit growth and the risk of higher inflation. Private credit growth slowed to 1.6% y/y year-to-date in 2011 (as of 11 November) from 5.5% in 2010, despite 200bps of rate cuts in H2-2011. This is primarily because heavy government borrowing from banks has crowded out private-sector credit. Investment is still declining as the countrys uncertain political and security environment and growing energy crisis deter both foreign and domestic investors.
The PKR has come under significant pressure in H22011 due to the widening trade deficit and large external debt payments. A slowdown in private capital flows and aid inflows from the US government and multilateral institutions has also pressured the PKR, which had depreciated 4% year-to-date to 88.99 against the US dollar (as of 1 December), from 85.5 in December 2010. We anticipate a further 5.3% correction in 2012, and forecast USD-PKR at 94.0 at end-2012.
Standard Chartered forecasts: Pakistan

2011 GDP (real % y/y) CPI (% y/y) Policy rate (%)* USD-PKR* Current account balance (% GDP) Fiscal balance (% GDP) 2.4 13.9 14 89 0.3 -6.5 2012 4.0 12.0 12 94 -1.5 -6.5 2013 4.8 13.0 13 98 -1.8 -6.2 2014 5.0 12.0 12 100 -2.3 -5.6
The current account deficit widened to USD 1.6bn in the July-October 2011 period from USD 541mn in the same period in 2010. This was mainly caused by a sharp drop in commodity prices, with Pakistans exports heavily concentrated in cotton and textile products. We expect export receipts to decline by 5% to USD 24.2bn in FY12 from USD 25.5bn in FY11. The import bill is rising, primarily due to the countrys growing dependence on oil imports. The State Bank of Pakistan (SBP) has warned that the current account deficit has exceeded its earlier forecasts, and that financing it will remain a challenge owing to the
56
Note: All forecasts except policy rate and USD-PKR are for the fiscal year ending 30 June; * end period; Source: Standard Chartered Research
12 December 2011
Pakistan (cond)
slowdown in FDI and official aid inflows. The SBPs FX reserves declined to USD 13.3bn at end-October from USD 14.8bn in June. They will come under further pressure in the coming months from higher external debt payments, including USD 1.2bn of repayments to the IMF. Total debt repayments are a hefty USD 4.2bn in FY12 and could rise to USD 5bn in FY13. Pakistan will struggle to retire the IMF loan and maintain its FX reserves position.

have developed permanent characteristics and will fuel inflation going forward. With the SBP having kept rates on hold at its 30 November meeting, markets will now demand higher premiums to hold government paper. This could force the government to print money to finance its large deficits, fuelling inflation. After cumulative rate cuts of 200bps in 2011, the SBP has struck a cautious note about the medium-term outlook, warning that inflationary pressures are building again. At its 30 November meeting, the SBP kept the overnight deposit and lending rates unchanged at 9% and 12%, respectively. In our view, the rate-easing cycle has come to an end, with little room to bring rates down further in the near future. We expect the SBP to keep rates on hold in Q1-2012, and see a strong possibility that rising inflation will force it to hike as early as Q22012.
The banking sector is resilient. Profitability has improved, and banks are building up stronger capital bases, with a healthy sector-wide capital adequacy ratio of 14.1% as of June 2011. Liquidity conditions have improved, with the loan-to-deposit ratio having fallen to 56.7% in 2011 from 75.2% in 2008. However, rising NPLs are a major concern. The ratio of NPLs to total loans increased sharply to 15.3% in June 2011 from 7.6% in 2007.
Policy
Politics
The markets main concern is the sharp build-up of debt and the governments inability to meet its budget targets. The government is likely to overshoot its FY12 budget deficit target of 4% of GDP; we forecast a deficit of at least 6.5%. Financing this will be a challenge, especially with official aid flows slowing and the privatisation programme stalled. Government borrowing from banks increased sharply to PKR 631bn (3% of GDP) from 1 July through 18 November 2011, higher than the PKR 606bn borrowed during all of FY11.
Parliamentary elections are expected in late 2012 or early 2013, and government policies will be characterised by populist measures. The election season begins with the important Senate elections in March 2012, with the ruling Peoples Party (PPP) and its allies expected to be the big winners. The focus will then turn to the general elections. The political environment has started to heat up, with opposition parties holding large street protests to force early elections. Most independent surveys indicate that support for the ruling PPP has declined due to weak economic performance, with opposition parties expected to gain strength. The PPP-led government is also facing charges in the Supreme Court, and important court rulings are anticipated in 2012 on corruption charges against the party leadership.
This level of borrowing has been possible because of liquidity injections of PKR 340bn (1.5% of GDP) by the SBP. However, the central bank says such injections
Inflation and growth outlook % y/y

25 20 15 10 5 0 Q1-05 Q1-06 Q1-07 Q1-08 Q1-09 Q1-10 Q1-11 Q1-12f GDP growth CPI inflation
2011 has been a very difficult year for Pakistan-US relations, and with political parties talking tough ahead of the elections, relations look likely to get worse before they get better. US aid flows to the military remain suspended, including USD 2bn of payments under the Coalition Support Fund. The disbursement of non-military aid, including the USD 7.5bn pledged under the KerryLugar Bill, has been slow; only USD 179mn was released in FY11.
Sources: SBP, Standard Chartered Research

12 December 2011 57
Philippines
Betty Rui Wang, +852 3983 8564
Betty-Rui.Wang@sc.com
Another test of resilience

Economic outlook
Financial issues
We expect the Philippines to be more resilient than other Asian economies in 2012 as the Western economic outlook deteriorates further, thanks to strong domestic demand and investment. However, there are growing downside risks, both onshore and offshore.
The government debt burden should continue to decline gradually following the governments adoption of a zerobased budgeting method to manage expenditure. The public debt ratio is low among Asian peers, at 44% of GDP. The government needs to stay on the fiscal consolidation path by improving the efficiency of tax collection and revenue generation, and by better utilising government spending to fuel economic growth.
The main pillars of support for the economy in 2012 will be private consumption and government spending and investment. Consumption will continue to be supported by solid inward remittances from overseas workers. Government spending/investment is expected to gather pace, after falling short of expectations in 2011, as public-private partnership (PPP) infrastructure projects get underway in 2012.
Policy
The easing of inflation in 2012 will give Bangko Sentral ng Pilipinas (BSP) more room to cut rates if external headwinds intensify. However, given that the current policy rate of 4.5% is already low, we do not expect more than 50bps of rate cuts in 2012.
The export sector is unlikely to recover until at least H22012 as external demand takes time to resume; manufacturers are also recovering only slowly from the supply-chain impact of the Japanese earthquake. Electronics exports have been plunging since August 2011 as the global economic downturn has aggravated supply-chain disruptions. We expect exports especially of electronics, which accounted for 60.4% of the 2010 total to regain momentum in Q2-2012, when global demand and regional supply chains are likely to be back on track.

The central bank could also use reductions in the reserve requirement as a tool to adjust liquidity if necessary, as the current required ratio is at a historical high of 21%. BSPs recent signalling of possible changes to the reserve requirement framework (there will no longer be a distinction between liquidity and regular reserves, and BSP will not pay interest on reserves kept in its vault) further adds to the possibility of reserve requirement cuts next year. The government launched a PHP 72bn fiscal stimulus plan in October 2011 to contain the negative impact of the escalating economic crisis in the West. We expect some tail effects to carry over into 2012, helping to stimulate economic growth.
Inflationary pressure is likely to ease in 2012 as the impact of higher oil and food prices the two main drivers of inflation in 2011 dissipate further, partly on the back of weakening global demand.
Standard Chartered forecasts: Philippines

2011 GDP (real % y/y) CPI (% y/y) Policy rate (%)* USD-PHP * Current account balance (% GDP) Fiscal balance (% GDP) *end-period
12 December 2011
Politics
2014 5.0 4.0 4.5 38.00 3.0 -2.3
2012 3.2 3.7 4.0 41.50 2.3 -2.8
2013 5.3 4.4 4.5 39.50 4.1 -2.5
President Aquino and his government, in power since June 2010, still enjoy high approval, according to a September poll. The governments approval rating rose to 77% from 71% in May, and its trust rating rose to 75% from 71%. The Philippines also rose to 129th place from 134th in Transparency Internationals 2011 Corruption Perceptions Index. Tackling corruption and alleviating poverty were key campaign pledges made by Aquino.
3.8 4.7 4.5 43.50 2.8 -3.0

58
Singapore
Edward Lee, +65 6596 8252
Lee.Wee-Kok@sc.com
Tai Hui, +65 6596 8244

Tai.Hui@sc.com
Mitigating volatility
Economic outlook

We expect Singapores economic growth to ease to 1.9% in 2012 from 4.8% in 2011. The economy is very open (trade is over 300% of GDP), and as such, its performance is closely tied to external market conditions. Exports to the EU account for about 10.5% of the total, and Singapores economy will be impacted significantly by the negative outlook for the EU. As such, we expect Singapore to underperform the region in 2012. This is typical of the higher volatility of Singapores economy as a result of its heavy dependence on offshore demand. However, we expect the economy to rebound strongly once the global economy finds a firmer footing in H2-2012 and 2013. Vulnerable sectors include manufacturing and wholesale and retail trade, given their strong connection with external markets. The completion of key projects such as two integrated resorts, along with more cautious sentiment towards the private residential sector, will reduce the contribution to headline growth from the construction sector. This sector provided support for growth when the broader economy suffered during the last global crisis in 2008-09. The biomedical sector is a potential swing factor for growth. This sector provided strong impetus to growth in 2011, but it is highly volatile. Excluding the contribution from the biomedical sector, the GDP growth rate of 5.4% y/y for the first three quarters of 2011 would have been reduced to 3.8%.
From an expenditure perspective, although net exports may remain positive, their contribution to growth is likely to diminish in 2012. Domestic demand may rely on public investment, while private consumption will be affected by weaker asset prices and a softer labour market. We expect inflation to ease to 2.5% in 2012 from an expected 5.1% in 2011. The high base effect could kick in as early as January 2012, bringing down y/y inflation; the weaker economic environment should also help to ease prices. Private transport and accommodation costs accounted for about three-quarters of the rise in inflation in 2011. An expected decline in property prices and a softer labour market should cause housing rents to decline as leases are renewed. The smaller quota for Certificates of Entitlements (vehicle ownership permits) may keep transport costs elevated, but the base effect and the likely decline in demand due to the weaker economy should temper the rise in transport costs.
Financial issues
Standard Chartered forecasts: Singapore

2011 GDP (real % y/y) CPI (% y/y) 3M SGD SIBOR (%)* USD-SGD* Current account balance (% GDP) Fiscal balance (% GDP)** 4.8 5.1 0.35 1.30 19.0 10.5 2012 1.9 2.5 0.35 1.25 16.5 7.9 2013 7.8 3.1 0.65 1.20 19.5 8.8 2014 4.4 3.0 1.40 1.16 18.2 8.5
We forecast that the Singapore dollar (SGD) will weaken to 1.35 against the USD in Q1-2012 due to global risk aversion and growth concerns. We then expect USDSGD to gradually head lower from Q2 to Q4 as global growth starts to stabilise, despite our view that the Monetary Authority of Singapore (MAS) will adopt a neutral stance on the SGD NEER in its April Monetary Policy Statement. We forecast USD-SGD at 1.25 by end2012. Capital inflows to Singapore given its solid AAA status and strong economic fundamentals could offer an additional attraction for international investors. With the US Fed already committed to keeping rates at ultra-low levels until mid-2013, short-end SGD rates should remain anchored. We expect 3M SGD SIBOR to remain stable at 0.35% throughout 2012. The SOR curve should remain similarly depressed. Should strong trend appreciation in Asian currencies resume (not expected until at least H1-2012), the SOR could move back into negative territory. However, given the likelihood that the SGD nominal effective exchange rate (NEER) will stay in the weaker half of the policy band, the SOR curve should stay positive in the near term.
12 December 2011
59
Singapore (cond)
The Singapore Government Securities (SGS) curve will be extended in 2012 with an inaugural 30Y bond issue in April (20Y is currently the maximum tenor). There will not be a 20Y bond sale in 2012, which will help to bolster demand for the new 30Y issue. Given the poor global growth outlook, there is very little impetus for SGS rates to move higher, despite the fact that yields are currently at historical lows. Importantly, Singapore remains a solid AAA-rated sovereign, and this may attract flows seeking diversification from developed markets. In addition, the SGD is typically viewed as a proxy for Asian currencies, and as such, SGS offer an attractive investment for investors who wish to participate in long-term Asian currency appreciation but are unwilling to move down the credit curve.
accommodation costs as reflected in the CPI number do not impact the majority of the population. The core inflation measure appears to be a more important factor in monetary policy decisions. This was underscored in the MAS October 2011 Monetary Policy Statement: Given the expected moderation in core inflation, the slope of the policy band will be reduced.
We forecast that the fiscal surplus will fall to 7.9% of GDP in FY12 (starts 1 April 2012) from 10.5% in FY11. This reflects the governments less contractionary stance. Ample savings imply that the government will be able to provide aggressive fiscal stimulus to offset external weakness, if required.
Other issues
Policy
We expect the MAS to turn to a neutral FX stance on the SGD NEER in April 2012 given the benign inflation outlook and downside risks to growth. The MAS forecasts lower inflation in 2012 (we concur), forecasting headline inflation at 2.5-3.5% and core inflation at 1.5-2%. As such, inflation should not impede further monetary policy accommodation by the central bank. In October 2008, when the MAS moved the SGD NEER policy band to a 0% appreciation bias, headline inflation was high at 6.4% y/y (core: 6.1%). At the time, the MAS expected headline inflation to fall to 2.5-3.5% in 2009 and core inflation to fall to 2%, similar to its current outlook. Importantly, core inflation has remained relatively stable, diverging from higher headline inflation. In 2011, the MAS has highlighted its view that high transport and
The Singapore government has proven to be innovative in using its fiscal resources in the past. The Job Credit Scheme (providing quarterly grants to employers for each Singaporean employee on their payrolls) and Risk Sharing Initiative (jointly underwriting risk with banks to encourage lending), introduced during the global financial crisis, helped to limit job losses and ensure smooth lending activity. Should the economy be hit by another serious external shock, we believe the government will reintroduce some or all of these measures to support jobs and SMEs.
Politics
Biomedical sector could be swing growth factor Average annual growth

60% 50% 40% 30% 20% 10% 0% -10% -20% 2004 2005 2006 2007 2008 2009 2010 Industrial production ex-bio Biomedical production
In the last general election, held in May 2011, the incumbent Peoples Action Party (PAP) maintained its absolute dominance in the parliament, winning 81 out of 87 seats. Even so, the opposition Workers Party (WP) made strong inroads, winning six seats and more importantly winning a Group Representation Constituency. There was also a considerable voting swing of about 6.5% against the PAP compared to the 2006 election; the PAP won 60.1% of the total votes in 2011. The government will need to address the need to achieve strong medium-term growth without an over-reliance on imported labour. The cost of living is another challenge facing the government as the income gap widens.

12 December 2011 60
South Korea
Suktae Oh, +822 3702 5011
Suktae.Oh@sc.com
Domestic demand to the rescue

Economic outlook
Korea is likely to experience only a mild slowdown in 2012 thanks to resilient domestic demand. Global market turmoil led by the European sovereign debt crisis will hurt exports and domestic sentiment, but consumption and construction will be supported by job-market and credit strength. Policy easing in major economies will improve the outlook for exports in H2-2012, while the Bank of Korea (BoK) is likely to opt for only a nominal rate cut. We expect GDP growth to slow to 3.0% in 2012 from 3.5% in 2011, and to rebound to 4.0% in 2013. The likely recession in Europe and slowing growth in other major economies, such as the US and China, will lead to weaker exports. An export slowdown has been evident since Q4-2011, with broad-based weakness across sectors and markets. We expect non-electronics exports and exports bound for emerging economies to outperform electronics exports and those bound for developed economies. The structural outperformance of emerging economies will continue, while the benefits of a weaker Korean won (KRW) since H2-2011 will be more pronounced for non-electronics sectors like autos. Domestic demand will be the key source of support for economic growth. Global market jitters have admittedly had a negative impact retail sales dipped, auto sales declined, and the business sentiment index for the nonmanufacturing sector fell in Q4-2011. But labour-market and household credit strength will continue to underpin consumption. These areas showed no signs of a slowdown in 2011 and will largely maintain their strength in 2012. Consumer confidence remained strong towards
the end of 2011, and the anticipated decline in inflation will boost real incomes. The construction recovery that started in 2011 will continue in 2012 thanks to a stable property market, potential pent-up housing demand, and steady credit growth in the household and corporate sectors (in the form of mortgages and loans to property developers).
We expect both headline and core inflation to be stable at around 3% in 2012; this will gradually ease inflation concerns among the general public and policy makers. The normalisation of vegetable and pork prices after a temporary spike in 2011, and the likely decline in crude oil prices amid the worsening global growth outlook, will be the main drivers of lower inflation. However, sustained rises in housing rents, the pass-through of KRW weakness, and still-high inflation expectations will continue to fuel inflation. The current account surplus as a percentage of GDP will be steady in 2012 as the relative strength of domestic demand offsets the positive impact of the weak KRW and low oil prices.
Financial issues
Standard Chartered forecasts: South Korea

2011 GDP (real % y/y) CPI (% y/y) Policy rate (%)* USD-KRW* Current account balance (% GDP) Fiscal balance (% GDP) *end-period
12 December 2011
2012 3.0 3.0 3.00 1,050 2.0 1.5
2013 4.0 3.0 3.50 1,040 1.5 2.0
2014 4.0 3.0 3.50 1,025 1.0 2.0
3.5 4.0 3.25 1,155 2.0 2.0
External liquidity conditions have improved markedly since 2008, though Korea remains one of the most externally vulnerable economies in Asia. The ratio of short-term external debt to FX reserves declined to 46% in Q3-2011 from 79% in Q3-2008, thanks to government efforts to discourage short-term external borrowing and increase FX reserves. Domestic banks have secured additional FX liquidity through further external borrowing in H2-2011 at the governments request. UK, US and Japanese banks have kept FX funding channels open, while continental European banks have reduced lending to Korea; this is likely to continue in 2012. The expansion of Koreas official FX swap agreements with Japan and China strengthens its second line of defence in case of emergency. The total size of the countrys swap agreements with Asian countries, including bilateral and multilateral agreements under the Chiang Mai Initiative, is now USD 153 bn. Household debt will continue to be a key concern of market participants and policy makers. We expect sustained growth in household credit (i.e., debt) to support domestic demand, suggesting that the household debt-to-income ratio will rise further in 2012. Most
61
South Korea (cond)

financial institutions (with the exception of some nonbank institutions like savings banks) have healthy balance sheets and will accommodate increasing demand for household credit to sustain consumption. Policy on household debt is likely to be neutral: the authorities may informally slow the pace of implementation of household debt stabilisation measures announced in 2011, but they are unlikely to explicitly ease mortgage-related regulations such as the ceiling on the loan-to-value ratio, as they did in 2008.
Other issues
Policy
We expect the BoK to cut the base rate by 25bps in Q22012. While the BoK will eventually address increasing downside risks to growth, it is likely to wait for clearer signs of slower growth and lower inflation before it implements easing. While the expected decline in oil prices in H1-2012 will mitigate inflation concerns, it will be difficult for the BoK to ease aggressively, as concerns about inflation and household debt will linger. The task of policy rate normalisation will be postponed until 2013. The government will continue to emphasise fiscal prudence, influenced by concerns about fiscal conditions in developed economies. The 2012 budget proposal currently assumes GDP growth of 4.5%; this will require revision to reflect the likely slowdown. The ruling party will try to boost welfare spending ahead of key elections, but major tax cuts or spending increases are unlikely, as government officials and politicians agree on the need to maintain healthy fiscal conditions. The fiscal surplus as a percentage of GDP is likely to decline slightly in 2012 due to a minor revision in the budget and the stabilising effect of slower economic growth.
The high self-employment rate appears to be the Achilles heel of the Korean economy. The share of self-employed people in the total workforce, at around 24%, is much higher than in developed economies. We have long held the view that this is largely responsible for Koreas household debt problems; this was confirmed by the 2011 Household Finance Survey, which showed that the household debt-to-income ratio is twice as high among the self-employed as among wage-earning workers. Household debt growth was also much higher among the self-employed (22.7%) than among wage-earning workers (3.3%). Self-employed people tend to borrow more from (riskier) non-bank institutions, while salaried workers usually depend on banks. Moreover, the recent strength in the labour market can be partly attributed to the rebound in the number of self-employed people after a decline in the past five years. We will closely monitor the behaviour of this group, as it appears crucial to jobs and credit, the two main drivers of domestic demand.
Politics
Two key elections will be held in 2012: parliamentary (April) and presidential (December). Polls currently indicate that opposition parties are more popular than the ruling right-wing party (Grand National Party, or GNP). We expect the GNP to lose its parliamentary majority in the April election. A high degree of uncertainty remains around the presidential election. A clear GNP frontrunner, Geun-Hye Park, has emerged, while the opposition parties lack popular candidates. Cheol-Soo Ahn, the founder of an anti-virus software company, is leading in the polls, though he is not a member of a specific party; he is expected to run for the opposition. Political developments are unlikely to affect the basic direction of economic policy. It will be difficult for policy makers to push through strong stimulus measures, as fiscal easing is difficult amid a global fiscal crisis, while monetary easing is unpopular given still-dominant inflation concerns. Also, technocrats have dominated Koreas economic policy making since the 1960s, even under leftist governments from 1998-2008. We do not expect significant events or changes in the relationship with North Korea in 2012. South Korea, the US and China will not be able to focus on North Korea in an environment of economic challenges and political change. The succession of power to North Koreas Kim Jong-Un is likely to continue.
62
Jobs and credit, two drivers of consumption Number of employees and household credit, %y/y
2.0 1.5 1.0 0.5 0.0 -0.5 -1.0 Q1-05 Q1-06 Q1-07 Q1-08 Q1-09 Q1-10 Q1-11 Employees (LHS) Household credit (RHS) 12 10 8 6 4 2 0
Sources: Statistics Korea, Bank of Korea, Standard Chartered Research

12 December 2011
Sri Lanka
Samantha Amerasinghe, +94 11 2480015
Samantha.Amerasinghe@sc.com
Inching ahead with caution

Economic outlook
Financial issues
Sri Lanka has sustained its high growth trajectory and looks set to achieve two consecutive years of 8% growth (2010 and 2011). While growth across key sectors tourism, construction and manufacturing is likely to remain buoyant, we expect a slowdown in exports in 2012 and forecast that GDP growth will slow to 7.5%. The export sector, which depends heavily on the US and Europe, may come under pressure from slower US growth and a euro-area recession, but near-term growth concerns will be offset by higher government spending on infrastructure, as well as measures to improve export competitiveness and safeguard the FX reserves. The widening current account deficit is a concern. Given its widening trade deficit, Sri Lanka will need to rely more heavily on capital inflows to fund the current account in 2012. This may prove challenging given the slowdown in official aid inflows. Strong tourism earnings and remittance inflows in 2011 have helped to contain the current account deficit, while steady capital inflows have kept the balance of payments (BoP) in surplus. That said, the BoP will remain under stress in 2012 as global growth continues to slow and EU concerns persist. Fiscal policy will continue to support growth. The governments revenue growth target of 20.1% in 2012 is optimistic given external headwinds, and the ambitious deficit target of 6.2% of GDP may be overshot, as increased spending may be needed to support growth. With the IMF loan programme ending in May 2012, the government is under added pressure to ensure that fiscal consolidation remains on track.
The banking sector is resilient; banks are well capitalised and profitable. The gross non-performing loan ratio declined to a modest 4.4% of outstanding loans in October 2011. Although rapid loan growth is worrisome (22.8% y/y YTD as of end-October 2011), deposits have largely kept pace. The loan-to-deposit ratio, which has been sustained at about 80% in 2011, may dip in 2012 due to rising risk aversion.
Policy
The central bank is likely to maintain its neutral policy stance in 2012. While credit demand has stayed elevated for longer than anticipated, we expect inflation in 2012 to remain within the central banks comfort level of 6-7% (our forecast is 6.4%) on improving domestic supply and the receding threat of higher global oil and food prices. Stubbornly high credit growth is cause for concern, but slowing global growth may undermine confidence and dampen credit demand in 2012. The export slowdown should be mitigated by the authorities move in November 2011 to devalue the Sri Lankan rupee (LKR) by 3%. A key risk to our stable policy outlook is that the higher cost of imports (petroleum imports comprise c.22% of total imports) resulting from LKR devaluation may put upward pressure on prices and hence interest rates in 2012.
Other issues
Standard Chartered forecasts: Sri Lanka

2011 GDP (real % y/y) CPI (% y/y) Policy rate (%)* USD-LKR* Current account balance (% GDP) Fiscal balance (% GDP) *end-period
12 December 2011
In November 2011, the government passed a controversial expropriation bill that nationalised certain assets of private enterprises which were deemed to be underperforming. While the authorities said that this was a one-off move, such measures undermine policy consistency and may deter investors.
2012 7.5 6.4 7.00 114.8 -5.1 -6.5
2013 8.0 7.0 7.25 112.5 -3.0 -6.5
2014 8.0 7.2 7.25 110.0 -3.0 -6.0
Politics
8.0 6.9 7.00 113.9 -5.7 -7.0
Political stability since President Rajapaksas re-election in January 2010 has enabled the authorities to make steady progress in addressing structural issues and pushing through key reforms, particularly on the tax front. The Rajapaksa-led United Peoples Freedom Alliance (UPFA) continues to enjoy widespread popularity. The economic and social integration of the Tamil minority in the northern and eastern regions has progressed, but political reconciliation is still at an early stage. The next parliamentary elections are due in April 2016.
63
Taiwan
Tony Phoo, +886 2 6603 2640
Tony.Phoo@sc.com
Eddie Cheung, +852 3983 8566

Eddie.Cheung@sc.com
Struggling with rising uncertainty

Economic outlook
We expect Taiwans economic growth to slow to 2.7% in 2012 from 4.4% in 2011. The potential worsening of the sovereign debt crisis in Europe and austerity measures in various EU member countries are the key downside risk to the growth outlook. This, coupled with a sluggish US recovery, may result in protracted weakness in external demand, hurting local producers confidence. As a result, we may see reduced capital spending and hiring in the manufacturing sector in 2012. This could also derail the recovery in domestic demand, which has so far largely mitigated weakness in the export sector. The economy is in a strong position to weather external shocks thanks to a relatively healthy current account surplus, large foreign exchange reserves, and low external and public debt. Taiwan also has moderately low exposure to international bank lending from Europe and is seen as less vulnerable than regional peers to a potential liquidity squeeze. Local regulators have ensured that local money-market liquidity remains flush, as this will enable them to effectively cope with massive capital outflows due to contagion risk stemming from potential credit events in Europe. Increased government support is also likely to support the economy. The government has approved total budgeted spending of TWD 1.94trn (USD 65bn) for 2012. This is 8.4% more than the TWD 1.79trn currently projected for 2011 and compares to a 5.1% increase in projected government revenue to TWD 1.73trn in 2012. This suggests that the central government deficit will
widen to TWD 209bn from the TWD 142bn projected for 2011. More importantly, it shows that the government has adopted an expansionary budget in response to strong external headwinds.
Financial issues
The latest property-market data shows that local property prices have held up, though transaction volumes fell significantly in Q3-2011 to their levels prior to the global financial crisis. This suggests that ongoing marketcooling measures by the government to rein in speculation are having an impact. The risk is that a rapid deterioration in global and/or domestic economic conditions could hurt market confidence, causing housing prices to fall. This would have a significant impact on the asset quality of local banks, especially those that are heavily geared to the local real-estate market. A sharp property-market slowdown would also impact banks revenues and earnings outlook, as housing loans amounted to 30% of total lending and more than 80% of the net increase in consumer loans in the first nine months of 2011. The potential fallout from Europes lingering debt problems, in particular a possible liquidity crisis in the European banking sector, is a far bigger threat. However, local regulators have emphasised that the potential impact on Taiwan of a default in a debt-stricken peripheral European economy would likely be manageable. Taiwanese banks net outstanding consolidated cross-border claims on peripheral euro-area countries (Portugal, Ireland, Italy, Greece and Span) stood at USD 5.1bn as of end-July 2011, according to local news reports; this is equivalent to a mere 0.7% of domestic banks total loans outstanding, and 6% of their net worth. Even if their entire exposure to these countries became bad loans, this would add only 1ppt to the sectors non-performing loan ratio, which stood at 0.5% as of end-September 2011 near a record low and down from 1.5% prior to the 2008-09 financial crisis. Also, the sectors loan-loss provision ratio had surged to 194% as of end-September 2011, nearly three times the 69.5% registered in 2008.
Standard Chartered forecasts: Taiwan

2011 GDP (real % y/y) CPI (% y/y) Policy rate (%)* USD-TWD* Current account balance (% GDP) Fiscal balance (% GDP) *end-period
12 December 2011
2012 2.7 1.2 1.88 29.0 5.5 -2.0
2013 4.5 1.6 2.38 28.0 6.0 -1.5
2014 5.2 1.3 2.88 27.9 6.0
4.4 1.4 1.88 30.3 7.5 -2.5
Policy
-1.0 Source: Standard Chartered Research
We expect policy makers to keep a close eye on potential risks stemming from worsening global growth prospects,
64
Taiwan (cond)
rising market volatility, and fragile market confidence. We expect them to maintain a cautious, pro-growth monetary policy stance.
hot money. This may provide support for the TWD heading into H2-2012, though the authorities are well placed to ensure stability should the need arise.
However, the latest data points to continuing strong underlying domestic price pressure. Core inflation rose to near a three-year high in October 2011 and exceeded headline consumer price inflation for the first time since 2009. We expect core inflation to grind higher still in 2012. This will keep policy makers alert to the risk of underlying domestic price pressures. The Taiwan central bank (CBC) will face a policy dilemma, as it has repeatedly expressed the need for monetary policy to both support growth and ensure price stability. We also see a heightened risk that further quantitative easing by central banks in key industrial economies will result in asset-price inflation in emerging economies. Even if local policy makers are biased towards a progrowth stance amid deteriorating global economic and financial-market conditions, they are unlikely to cut rates in such an environment. Instead, we expect policy makers to use unconventional monetary tools such as reserve requirement ratio cuts and reductions in NCD issuance. The return of hot money inflows amid quantitative easing in the West may result in Taiwan dollar (TWD) appreciation in 2012, creating problems for the local authorities. Interest income from overseas assets will also continue to fall as yields remain low. This, coupled with high interest costs associated with absorbing inflows, may constrain the authorities efforts to sterilise
Politics
Taiwan will hold general elections on 14 January 2012. The outcome is expected to have material impact on the domestic growth outlook. While the ruling Nationalist (KMT) party is expected to retain its parliamentary majority (albeit with a narrower margin), current opinion polls show that incumbent President Ma Ying-jeou has only a slight lead against Tsai Ing-wen, chairwoman of the opposition Democratic Progressive Party (DPP). The decision by James Soong a former KMT stalwart and the current chairman of the Peoples First Party (PFP) to contest the presidential election is expected to siphon votes from KMT supporters, resulting in rising market anxiety over President Mas chances of re-election. The re-election of President Ma would boost confidence among domestic and international investors. It would ensure policy continuity and pave the way for further liberalisation of economic ties with mainland China, including the signing of the widely anticipated Investment Protection Agreement (IPA) and the negotiation of greater cross-straits access to banking and financial services. This, combined with the potential increase in tourism flows and foreign direct investment from mainland China, would support the current account and the balance of payments. It could also result in a re-rating of TWD-denominated assets. Closer economic ties with mainland China would also be seen as positive for Taiwans longer-term outlook, better enabling the island to withstand external shocks resulting from global economic weakness and financial-market volatility.
Rising core inflation poses a challenge for interest rate policy We expect the CBC to stay put
5 4 3 2 1 0 -1 -2 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Core inflation, % (LHS) CBC re-discount rate, % 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5
A failure by both the ruling KMT and opposition DPP to secure a parliamentary majority would risk bringing the government to a standstill. Should Tsai win the presidency, mainland China may adopt a wait-and-see approach to cross-straits economic liberalisation, although Tsai has assured that the DPP will adopt a pragmatic cross-straits policy. Tsai has denounced the 1992 consensus (under which Taiwan and mainland China recognised that there is only one China); leaders in Beijing have often cited this as a prerequisite for crossstraits negotiations. A slowdown in the pace of crossstraits liberalisation could damage market confidence in Taiwan.

12 December 2011 65
Thailand
Usara Wilaipich, +662 724 8878
Usara.Wilaipich@sc.com
Post-flood recovery
Economic outlook
industrial estates and SMEs, together with a corporate tax cut, should boost private investment as companies replace capital equipment damaged by floodwaters. Public investment will also be urgently needed to reconstruct logistics networks and rebuild water management systems to prevent future floods.
We expect a recovery in 2012 following the flood disaster of Q4-2011, based on the experience of past natural disasters. Government reconstruction measures, privatesector spending on durable goods and reconstruction, and private investment in machinery replacement should support a V-shaped recovery in domestic demand. Externally, the global risk environment and the worsening economic outlook an expected recession in Europe and weaker growth in the US are expected to slash external demand for Thailands exports. We therefore expect the Thai economy to grow 3.5% in 2012 (below the current consensus of 4.5-5.5%), up from an estimated 1.8% in 2011.
On
the
supply of
side,
manufacturing parts,
production
especially
autos/auto
computer
parts,
electronics and electrical appliances is expected to rebound strongly in H1-2012 as manufacturers catch up with pending export orders and replenish inventories destroyed by floodwaters. In particular, the construction, construction materials, and furniture sectors should benefit from high demand driven by post-flood reconstruction.
The countrys consumer confidence index dropped sharply to the lowest level in 10 years after the October floods. We expect consumer confidence to recover rapidly in H1-2012, when employment conditions return to normal. This will be partly driven by government measures such as compensation for flood victims, minimum wage hikes, and an increase in civil servant salaries. Most of the manufacturers in flood-affected industrial estates have notified the government that they will re-employ their workers. Separately, the Thai Real Estate Association estimates that affected households will spend at least THB 100bn (about 1% of GDP) on housing renovations in 2012.
Financial issues
Fiscal discipline has been a hot topic in Thailand recently. However, Thailands fiscal position is not yet cause for concern, in our view. Still-low public debt at a manageable at 41% of GDP should provide scope for public investment in the coming years to improve logistics networks and strengthen Thailands competitiveness. The public debt management law caps the annual fiscal deficit at 20% of the budget. As a result, the planned budget deficit has been set at below 4% of GDP for the past 10 years. Moreover, the actual deficits in FY10 and FY11 were much smaller than planned as tax revenues exceeded targets. In FY11 in particular, tax revenues exceeded the target by about THB 210bn. This resulted in an actual budget deficit of only about 1.8% of GDP,
Both the private and public sectors are likely to increase investment in 2012. Special loans extended to affected
Standard Chartered forecasts: Thailand

2011 GDP (real % y/y) CPI (% y/y) Policy rate (%)* USD-THB* Current account balance (% GDP) Planned fiscal balance (% GDP)** 1.8 3.7 3.25 31.25 1.5 -3.6 2012 3.5 3.0 2.75 30.50 -0.1 -3.4 2013 4.9 3.5 3.75 29.50 -1.1 -3.3 2014 5.5 3.9 4.5 29.00 -0.9 -3.2
only half the planned 3.6% of GDP. This helped to boost the governments cash balance to THB 521bn (5% of GDP) as of end-September 2011.
We expect the current account balance to swing from a surplus to a marginal deficit of 0.1% of GDP in 2012. While tourism income and export growth are expected to fall owing to lower global demand, imports are likely to rise on demand for imported machinery and raw materials to replace those damaged by the floods. Meanwhile, capital flows will remain highly volatile in 2012, driven by ongoing sovereign debt problems in Europe and fears of a significant global slowdown.
66
*end-period; ** for fiscal year ending 30 September Source: Standard Chartered Research
12 December 2011
Thailand (cond)
Policy
floods. However, we expect the governments cost-ofgovernment led by Prime Minister Yingluck living reduction measures and lower global oil prices to reduce general price pressures, offsetting the increase in food prices. Thailand is a net oil importer, and energy prices have a direct 9.99% weighting in the CPI basket. Importantly, ample domestic spare production capacity for construction materials should mitigate concerns about inflationary pressures arising from post-flood reconstruction demand.
The
Shinawatra has proposed an expansionary fiscal policy to support the Thai economy in 2012. Given the need for additional spending to compensate flood victims and pay for post-flood reconstruction, the planned budget deficit for FY12 has been raised to THB 400bn (or 3.4% of GDP) from the THB 350bn originally planned. This is based on expenditure of THB 2.38trn and revenues of THB 1.98bn. Thailand continues to move towards fiscal consolidation and is on track to achieve its target of a primary surplus by FY16 the planned budget deficit of 3.4% in FY12 is smaller than the planned deficit of 3.6% in FY11.
Contained inflationary pressures should provide some scope for the BoT to lower rates, if needed. The key concern is that downside risks to growth from the ongoing European debt crisis could worsen in the coming months. As a result, we expect two rate cuts (of 25bps each) in H1-2012 to support the domestic economy. However, the BoT will remain vigilant against inflationary pressure in the future given the continued increase in fiscal spending. Hence, it is likely to resume rate normalisation in 2013, when the economy returns to its potential growth rate of 5.0-5.5%.
On the monetary policy front, the Bank of Thailand (BoT) will shift its monetary policy target from core inflation to headline inflation (which includes energy and food prices), effective in 2012. Currently, the BoT uses core inflation of 0.5-3.0% as a guide for monetary policy. Going forward, it will target headline inflation of 3.0% +/1.5ppt, an effective range of 1.5-4.5%. In our view, this change will give the BoT greater flexibility, as target headline inflation will be calculated on a 12-month moving average (mma) basis rather than from a single months figure. This will give the BoT more time to assess the inflation situation, as it currently calculates target core inflation on a 3mma basis.
Other issues
In order to restore foreign investor confidence and ensure a positive investment environment in the medium to long term, it is crucial that Thailand build an effective water management and early warning system to prevent future floods and/or natural disasters.
We expect mild inflationary pressure in 2012, forecasting average headline inflation of 3.0%. This compares to our estimate of 3.7% for 2011. Food prices are likely to rise due to potentially lower agricultural output following the
Politics
Prime Minister Yingluck has had a tough time since her decisive victory in the July 2011 election, facing the worst floods in five decades. We see more challenges ahead, including a tougher global economic environment and an urgent need for post-flood rehabilitation. Political stability will remain an area of focus for the markets. A key event to watch is the end of a five-year ban on 111 executive members of the Thai Rak Thai (TRT) party in May 2012. The Constitutional Court dissolved former Prime Minister Thaksin Shinawatras TRT party in May 2007 and banned all of its executive members from politics due to
Actual budget deficits are smaller than planned Annual budget deficit, % of GDP
0.0 -0.5 -1.0 -1.5 -2.0 -2.5 -3.0 -3.5 -4.0
FY09 FY10
Actual
alleged electoral fraud in the April 2006 elections. Their potential return to politics is likely to support the stability of the Yingluck-led government.
Planned
FY11 FY12
Sources: MoF, Standard Chartered Research

12 December 2011 67
Vietnam
Tai Hui, +65 6596 8244
Tai.Hui@sc.com
Keep doing the right thing

Economic outlook
Financial issues
factors dominate Vietnams
Domestic
economic
Given Vietnams sizeable current account deficit and low foreign exchange reserves, we expect the VND to continue to depreciate gradually in 2012. Local investor sentiment still dominates the VND outlook; this will require that attract inflows. the authorities further reinforce their credibility in maintaining price stability and continue to
economic and financial outlook. We expect growth to remain at 5.8% in 2012, unchanged from 2011. Exports to China, the US, Japan and Europe should maintain positive growth in 2012 given the structural development of Vietnams export sector and the gradual weakening of the Vietnamese dong (VND). Stable commodity prices will also support exports.

We shift to an Overweight duration stance on Vietnam Government Bonds (VGBs) from Neutral. Falling inflation, lower policy rates and heavy bond redemptions in 2012 will spur demand from domestic banks. We expect shortdated VGBs to outperform following significant curve flattening in late 2011.
We expect y/y inflation to ease back into single digits by late Q2-2012, provided that global commodity prices remain stable and VND depreciation is gradual and orderly. Lower inflation should protect household incomes and maintain the contribution of consumption to headline economic growth.
Policy
The
weaker
external
environment
could
temper
The authorities are expected to maintain their emphasis on price stability, although the decline in headline inflation should allow them to reduce the refinance rate from 15% to 11% starting in Q1-2012. In 2011, the central bank and the government have kept a tight leash on credit and money growth. This could continue in 2012, with credit growth targeted at 15-17%.
investment growth in manufacturing capacity, especially by foreign investors from Taiwan, Japan and South Korea. The government may step up state-led investment, especially in infrastructure, to maintain growth momentum, but the funding of such projects may continue to rely on international organisations.
Vietnams trade deficit was manageable in 2011, estimated at below 10% of GDP. A further improvement is likely if the government can prevent economic overheating and achieve further import substitution, especially by building capacity to refine raw materials for domestic use.
Fiscal consolidation is still required, and we therefore expect the government to run a fiscal deficit of less than 5% of GDP in 2012. This would help to reduce the debtto-GDP ratio from the current level of 54%, aided by strong nominal GDP growth.
Other issues
The
government
has
pledged the
to
improve of
data
Standard Chartered forecasts: Vietnam

2011 GDP (real % y/y) CPI (% y/y) Policy rate (%)* USD-VND* Current account balance (% GDP) Fiscal balance (% GDP) *end-period
12 December 2011
transparency,
2013 6.5 8.5 11.0 23,700 -7.5 -4.0 2014 6.8 7.0 8.0 24,300 -7.0 -4.0
including
disclosure
financial
2012 5.8 11.3 11.0 22,600 -8.5 -4.9
information on state-owned enterprises and financial institutions. While the quality of the data is yet to be proven, greater information availability should help to establish investor confidence.
5.8 18.7 15.0 21,000 -10.5 -5.2
Politics
Domestic politics is likely to remain stable in 2012 following the party congress and government reshuffling in 2011. Vietnams regional relationship with China, with territorial disputes in the South China Sea, could be a source of tension.

68
Economies Africa
Africa Charts of the year

Chart 1: African growth seen holding up, despite global risks GDP, % y/y
8 6 4 2 0 -2 1980 1984 1988 1992 1996 2000 2004 2008 2012f World SSA
Chart 2: 2012 will be a big year for rebasing, with better measures of informal sector activity Shadow economy; estimates as % of measured GNP
South Africa Cameroon Botswana Algeria Eqypt Morocco Tunisia Ghana Ethiopia Uganda Senegal Zambia Nigeria Tanzania 20 25 30 35 40
(Ghana, pre-rebasing)
45
50
55
60
Sources: IMF, Standard Chartered Research
Sources: Africa Rising, Standard Chartered Research
Chart 3: Africas reform momentum persists % of SSA countries with at least 1 Doing Business reform
90 80 70 60 50 40 30 20 10 0
2004/05 2005/06 2006/07 2007/08 2008/09 2009/10 2010/11 Sources: World Bank Doing Business Report 2012, Standard Chartered Research
Chart 4: After the Arab Spring, political risk is still topical No. of years current presidents have been in power, 2011
Angola Equatorial Guinea Cameroon Uganda Burkina Faso Chad Sudan Gambia Ethiopia Swaziland Congo Brazzaville Lesotho Djibouti Rwanda Cape Verde Congo DRC 5 10 15 20 25 30 35
Chart 5: Deleveraging to impact project finance Cross-border lending to Africa, USD bn (LHS), % y/y (RHS)
240 230 220 210 200 190 180 170 160 150 Jun.2007 Jun.2008 Jun.2009 Jun.2010 Jun.2011 % y/y, RHS Cross-border lending to Africa 35 30 25 20 15 10 5 0 -5 -10
Chart 6: Still dependent on growth in mature economies % share of total African exports, by destination
70 60 50 40 30 20 10 0
2001
US
Euro area
Asia
2002 2003 2004 2005 2006 2007 2008 2009 2010
Sources: IMF DOTS, Standard Chartered Research
12 December 2011
70
Africa
Razia Khan, +44 20 7885 6914
Razia.Khan@sc.com
More cautious approach to liberalisation

Economic outlook
Financial issues
Despite a less certain global economic environment and greater external headwinds, average Sub-Saharan African growth is expected to hold up at relatively healthy levels. The degree of slowdown hinges on how much of this growth is explained by exogenous variables. The euro area, where we expect a recession, is Africas largest trading partner by far. However, trade as a share of GDP is typically small in Sub-Saharan Africa, averaging around 30%. Africas exports are also dominated by commodities. If commodity prices are supported by tight supply and continued demand from elsewhere, the impact of a European recession alone may not be huge. Factor in the tendency of African countries to react to global economic slowdowns with a significant lag, and the case for an immediate slowdown in African GDP growth is less clear still. In the case of a financial crisis, however, the effect may be transmitted more rapidly. This was seen during the recent global crisis, when reduced availability of trade finance triggered an almost immediate collapse in global trade, and demand for Africas exports plummeted. We do not expect a repeat of anything on that scale in 2012. A large number of European financial institutions are likely to face pressure to recapitalise. Anecdotally, there is already evidence of asset disposals by European banks, and of a general pullback of new lending from Africa. Trade finance will likely continue to get more expensive; project finance will slow, but not on a scale that will threaten Africas positive growth overall.
Weakness in frontier FX markets emerged as a key theme in 2011, prompting a number of African central banks to implement new regulations. Net open positions (NOPs) the amount of FX that banks can hold relative to regulatory capital were cut in Nigeria, Kenya and Tanzania in a bid to encourage FX sales and prevent further currency weakness. Kenya and Tanzania implemented measures restricting the lending of local currency to offshore counterparties, similar to what Zambia had done during the global financial crisis in early 2009. However, these measures have had a negative impact on FX market liquidity. Given the still-difficult external environment expected in 2012, such regulatory measures are unlikely to be quickly reversed. What will a deterioration in global risk appetite hold for African FX? 2012 is likely to be a year of two halves, with euro-area concerns particularly concentrated in H1. Risk appetite should return to some degree in H2 in response to new monetary easing measures, including QE3 in the US. Unlike in late 2008, when African markets were hit by a large withdrawal of portfolio investment, todays healthier mix of real money rather than leveraged flows in African domestic markets is likely to prevent mass liquidation of African assets. However, any risk-off mood would discourage new inflows into smaller, less liquid African markets, as the preference will be for larger, more liquid safe havens. With more attractive yields and likely monetary easing by H2 (in East African economies at least), prospects for eventual African FX appreciation remain favourable. The euro-area crisis has also focused attention on the sustainability of the CFA franc peg to the euro (EUR). In our view, there is little reason to anticipate a change in the parity of the CFA franc anytime soon. Indeed, Standard Chartereds CFA franc barometer, a quantitative measure of pressure on the peg, suggests that we are currently far from the levels that triggered the only devaluation in the CFAs history in 1994. Although differences between the two CFA franc zones WAEMU and CEMAC are evident, fundamentals are favourable as commodity prices generally hold up. FX reserves cover for currency in circulation is much healthier than in 1994, and EUR weakness will boost competitiveness in the two franc zones. Ultimately, any decision to de-peg
71
Standard Chartered forecasts: Sub-Saharan Africa*

2011E Real GDP growth IMF Inflation IMF Current account balance (% GDP) IMF 4.8 4.8 8.4 8.3 1.3 1.8 2012F 5.3 5.7 8.3 7.3 0.6 0.4 2013F 5.6 5.4 6.8 6.2 0.3 -0.4 2014F 5.8 5.3 7.4 5.9 -0.1 -0.9
*2010 USD GDP-weighted total of 15 Sub-Saharan African economies Source: IMF, Standard Chartered Research
12 December 2011
Africa (cond)
would be political. It is difficult to see why member countries would wish for this (given that they would lose an important anchor that has brought low inflation to the CFA franc region). Equally, France, which guarantees the convertibility of the peg and is itself caught up in the euro-area crisis, has little to gain from volatility in its African trading partners. are likely to become more prevalent. While China will have an important role to play in infrastructure financing in the region (often in return for payment in commodities), Chinas assistance does not typically fit the model of direct budgetary support; nor is there a meaningful and explicit poverty alleviation dimension to such support. In the near term, there will be little to substitute for ODA.
Policy
The all-too-easy narrative of continued improvement in Africas macroeconomic variables no longer holds true. Since the last crisis, the region has seen a considerable erosion of its external buffers. Fiscal policy was expanded in a counter-cyclical response to the crisis; spending levels have yet to be reined in again, and doing this will be politically difficult. With food and fuel generally exerting upward pressure on prices, few African central banks are in a position to cut interest rates immediately, should it be required. Foreign exchange reserves have been pressured in a number of African countries, forcing some central banks to reverse FX market liberalisation measures in recent months. More time is needed to rebuild external liquidity buffers, but new external headwinds may emerge before then. Notwithstanding the domestic momentum behind African growth and its structural uptrend, the environment will be difficult. As ever, policy responses will be key to longer-term growth.
Given the difficult economic environment, sovereign credit downgrades in Africa are seen as more probable than upgrades. While headline GDP may not be impacted immediately, export growth and FX earnings may slow in the short term, notwithstanding longer-term efforts to boost intra-regional trade. Economic management is likely to be increasingly tested, and fiscal deficits in most countries are projected to remain wide (Angola and Botswana are exceptions). While East Africa should see eventual relief from the impact of a recent drought and an improvement in its inflation trend, this will not hold true for all of Africa. Financing of domestic deficits is likely to remain difficult, especially in countries where tight market liquidity has led to a breakdown in secondary debt-market trading. This will create an additional feedback loop, keeping debtservice costs and fiscal deficits elevated. Much more will need to be done to broaden domestic tax bases; the resource sector (large, easily identifiable and easy to tax) will be the likely target of such policies.
Other issues
With the euro area in crisis and official development assistance (ODA) budgets being cut back in the West, we expect even more focus on China-Africa economic engagement. Is China poised to replace Africas more traditional development partners? Available data suggests that lending to Africa by the Export-Import Bank of China already exceeds approved World Bank commitments, albeit on a less concessional basis and with fewer conditions attached. With Chinas interests in Africa believed to be long-term and strategic, cyclical influences are likely to be less pronounced than for other potential sources of financing for Africa. Indeed, Chinas hesitance to increase its exposure to USD or EUR assets may feed its appetite for commodities and increased engagement with Sub-Saharan African economies. Should potential African issuers find themselves cut off from international capital markets because of difficult market conditions, bilateral arrangements such as the recent USD 3bn China Development Bank loan to Ghana
Politics
2012 will be a year of key elections in Africa. Kenya and Ghana will hold presidential and parliamentary elections, and South Africas African National Congress (ANC) will hold internal elections. In 2007, the same three elections provided a litmus test of political trends in the region. After its 2007 election, Kenya erupted into violence in a way few would have been able to predict, South Africa saw a perceived shift to the left, and Ghana saw a smooth transition between governments on the basis of only 40,000 votes. Now, the hope is that Kenya will move forward in a mood of reconciliation, while the threat to the centre in South Africa (this time from the nationalist ANC Youth League) appears to have been defused. All eyes will be on Ghana, a new oil producer, to see if it will replicate the success of its peaceful 2007 election. If it does, this is likely to be the most important sign yet that Ghana has not succumbed to the oil curse.
12 December 2011
72
Angola
Victor Lopes, +971 4 508 4884
Victor.Lopes@sc.com
Restarting the growth engine

Economic outlook
Angola, the third-largest sub-Saharan African economy, is set for a growth resurgence. Rising oil production will likely drive a growth rebound to 8% in 2012, with oil production set to rise to 1.8 million barrels per day (mbd) from 1.6mbd in 2011. Growth in 2011 was modest (an estimated 3.7%) as oil production was hampered by technical problems. The economic outlook is likely to continue to improve. Most arrears accumulated in 2009 have been cleared, and the country is posting fiscal and external surpluses thanks to high oil prices. This progress led the three main rating agencies (S&Ps, Fitch and Moodys) to upgrade Angola to the equivalent of BB- (similar to Nigeria or Gabon) in 2011. The country remains vulnerable to a decline in oil prices, but prices have been firm so far and are likely to remain so, despite the problems in the euro area. The medium-term picture is positive. GDP growth is set to accelerate as infrastructure and construction projects go ahead. GDP growth should average 7% between 2012 and 2014. In the future, agriculture and agroprocessing are likely to become the key drivers of nonoil growth given the countrys agricultural potential. perception, and investors would probably demand a risk premium above similarly rated Gabon or Nigeria. The government is expected to continue to rely on credit lines from key partners (Brazil, China and Portugal) and on domestic debt issuance to meet its financing needs. As a result of the stronger external position, the Angolan kwanza (AOA) has been stable in 2011 and is likely to remain so in 2012. This will help the central bank, Banco National de Angola (BNA), to contain inflationary pressure and keep its recently created benchmark interest rates at relatively stable levels. However, inflation is likely to remain in double digits, as structural bottlenecks such as port congestion remain a key obstacle to bringing down inflation rates in the near term.
Policy
Budget management and transparency have generally been improving, and this process should continue in 2012. The government has deepened its relations with the IMF (Angola is under an IMF Stand-By Arrangement); this is a positive step not only from a funding standpoint but also in terms of transparency and budget management.
Politics Financial issues

Plans for eurobond issuance have been postponed. It is unclear whether the government will try to tap international markets in 2012. Should it go ahead, we believe that governance issues would weigh on risk The next parliamentary (and presidential) elections are due in 2012. Angola has an indirect electoral system in which the party that wins most seats in the assembly designates the president. The ruling MPLA is likely to win again, as the opposition is weak. It is not yet certain that ruling president Dos Santos will run again, but chances that he will do so are high. With President Dos Santos having been in power for more than three decades, the succession issue is a source of uncertainty in the medium term. However, he is expected to designate a successor while he is still in power to ensure an orderly succession. The rising cost of living could lead to social discontent or unrest, but is unlikely to fuel massive protests that would specifically demand (or force) a regime change. Should such issues emerge, the government would probably adopt price controls or restore subsidies.
Standard Chartered forecasts: Angola

2011 GDP (real % y/y) CPI (% y/y) Policy rate (%)* USD-AOA* Current account balance (% GDP) Fiscal balance (% GDP) *end-period
12 December 2011
2012 8.0 14.0 10.0 91.50 7.0 8.0
2013 6.5 10.0 8.5 91.00 6.0 5.5
2014 6.5 9.0 8.0 90.00 5.0 4.0
3.7 15.0 10.5 93.00 12.0 7.9

73
Botswana
Razia Khan, +44 20 7885 6914
Razia.Khan@sc.com
A new global diamond hub

Economic outlook
Continued strength in global demand for diamonds will be a key influence on Botswanas prospects in 2012, but barring a new crisis on the scale of 2008-09, local factors should dominate. Recent economic growth in Botswana, the worlds largest diamond producer by value, has been driven by a recovery in mining output following the 2009 crisis. Robust construction activity related to powersector and mine expansion projects (prolonging the life of the Jwaneng mine) has driven gains in GDP growth, offsetting the impact of a prolonged public-sector strike in response to fiscal consolidation measures. Growth momentum remains favourable going into 2012. While new diamond demand from emerging markets has been a key factor in the post-crisis price recovery, evidence from recent Diamond Trading Company (DTC) sight auctions suggests that prices have started to decline. However, Botswanas GDP growth is only likely to be impacted significantly if mine output is scaled back. Based on current forecasts, this appears unlikely. Gains in other sectors will also be a key influence on overall growth. Completion of the Morupule B power station is expected in 2012, adding another 600MW of power generation capacity to the national grid (from a current 132MW). Copper output also looks set to increase. Botswana has set its sights on becoming a new global diamond trading and manufacturing hub, with an agreement now secured on the planned relocation of De Beers DTC responsible for the sale of rough diamonds from mines worldwide to the country before end-2013.
Anecdotal evidence already points to a number of international firms opening polishing factories in Botswana. Under the new arrangement, Botswana will market at least 10% of its production independently of De Beers, allowing the authorities to become more familiar with price trends. Botswanas services sector could scale up significantly, but much will depend on regulatory reforms aimed at achieving a broader productivity boost. Liberalisation of work permits would help Botswana establish scale, accelerate job creation, and overcome the disadvantages associated with its small population.
Policy
Thanks to a faster-than-expected recovery in diamond revenue, Botswana is likely to return to a budget surplus earlier than initially projected. Nonetheless, given global uncertainty, exchange rate policy will continue to be governed by the need to boost US dollar (USD) earnings in local-currency terms. This suggests that the Botswana pula (BWP) will trade closely in line with the South African rand (ZAR). A return to a current account surplus is forecast over the medium term as the import requirement for large infrastructure projects declines. The authorities decision to cancel the 91-day Bank of Botswana Certificate (BoBC) auction in late 2011 is likely to influence market liquidity well into 2012. While the liquidity released only some of which will be sterilised through other issuance should continue to put downward pressure on market interest rates, rising regional inflation pressures may eventually force an upward adjustment in the bank rate. The authorities belief that inflation will fall back within the 3-6% target range by H2-2012 stands in contrast to evidence of rising regional inflation and the likelihood of more ZAR weakness, which would further exacerbate CPI gains.
Standard Chartered forecasts: Botswana

2011 GDP (real % y/y) CPI (% y/y) Policy rate (%)* USD-BWP Current account balance (% GDP) Fiscal balance ** (% GDP) 8.0 6.9 9.5 7.52 -1.5 -2.0 2012 7.0 8.2 10.5 7.52 -1.2 0.8 2013 5.9 6.7 11.0 7.47 0.4 3.7 2014 6.5
Politics
5.7 11.0 7.65 1.3 4.0
The post-crisis period has proven to be a testing time for Botswanas politics, with 2011s prolonged public-sector strike serving as a focal point for the opposition. Despite the formation of a new splinter party, the ruling Botswana Democratic Partys (BDPs) hold on power is seen as intact. Elections are not due until 2014, and alliances among the countrys fragmented opposition parties have a poor track record of holding together.
12 December 2011 74
Cameroon
Victor Lopes, +971 4 508 4884
Victor.Lopes@sc.com
Growth to pick up despite risks

Economic outlook
Cameroons GDP growth outlook has improved, despite risks linked to the global outlook, and should reach 4% in 2012. While unimpressive by African standards, this would be the highest growth seen in Cameroon since 2005 (we forecast 2011 GDP growth at 3.5%). The growth outlook is supported by rising public investment in infrastructure. Infrastructure projects underway include the Kribi deepwater port, the extension of the road network in Douala, and a bridge on the Wouri river (in Douala). Oil production (64,000 barrels per day in 2010) has been in long-term decline but should rise between 2012 and 2014 as new wells come on-stream, providing some medium-term support; however, this is unlikely to be significant, as oil accounts for only 7% of GDP. In the longer term, some gas is expected to come on-stream by 2017, which should help to offset the decline in oil production after 2014.
Also, the government finally started to issue local shortdated T-bills in 2011 (XAF 50bn to be issued in November and December); this should continue in 2012.
Policy
In our view, the key issue facing the government is the deterioration in public finances in 2011, when the fiscal deficit is likely to have reached 5% of GDP. This was due to the large weight of subsidies (2% of GDP), government arrears to the local refinery (1.2% of GDP) and a possible current spending over-run. Fiscal consolidation will be needed in 2012, and while the issue of fuel subsidies is unlikely to be addressed as social stability remains a key concern current spending levels are likely to moderate. There is also a risk that capital spending might be affected, which would negatively impact economic growth. The problem is that the government needs to undertake fiscal consolidation at a time of heightened risks linked to the global scenario (lower oil prices and a possible world recession). Should these risks materialise, the government will lack the means to stimulate the economy.
Financial issues
Part of the infrastructure programme will be financed via the countrys first-ever local bond issuance (XAF 200bn or EUR 304mn) in November 2010, in the Douala regional financial market. Cameroon is only the second government in the Central Africa Economic and Monetary Union (CEMAC) after Gabon, to have issued a local bond.
Politics
Standard Chartered forecasts: Cameroon

2011 GDP (real % y/y) CPI (% y/y) Policy rate (%)* USD-XOF* Current account balance (% GDP) Fiscal balance (% GDP) *end-period
12 December 2011
Paul Biya was re-elected as president in October 2011. With the election over, the risk of political instability appears limited in the short term, although there could be unrest if social conditions deteriorate. Unemployment, especially among educated citizens, is very high in Cameroon. Failure to address unemployment often fuels social discontent. Political risk might be greater in the medium term, as the succession issue clouds the outlook. In power since 1982, Paul Biya is among the longest-serving presidents in Sub-Saharan Africa (following Jos Eduardo Dos Santos in Angola, Teodoro Obiang in Equatorial Guinea and Robert Mugabe in Zimbabwe). He is only the second president since Cameroons independence in 1960. Given that he is 78 years old, President Biyas ability to complete his seven-year mandate is an open question and his succession is the main source of uncertainty in the medium term.
75
2012 4.0 2.5 3.75 505 -3.3 -0.5
2013 4.5 2.5 4.0 486 -3.0 0.0
2014 4.5 2.0 4.0 505 -2.5 1.0
3.5 2.6 4.0 505 -3.8 -5.0
Cte dIvoire
Victor Lopes, +971 4 508 4884
Victor.Lopes@sc.com
Towards economic normalisation

Economic outlook

Prospects for HIPC debt relief in 2012 should bring debt ratios down significantly (public external debt stood at 50.6% of GDP in 2010), and this will enhance the countrys creditworthiness.
The economic outlook has improved thanks to the end of the political crisis. GDP growth is likely to rebound strongly in 2012 (to 8%), following a 5.8% contraction in 2011. Strong international goodwill towards the new government will support the economic recovery. While the amount of international support is critical for public finances, more funds are needed to get the economy onto a better growth path over the medium term.
Policy
Public finances are likely to improve but remain fragile in 2012. With the end of sanctions, the resumption of trade (especially cocoa exports, which represent around 20% of fiscal receipts), and increased economic activity thanks to the normalisation of the political situation, fiscal revenues should improve. However, given the large financing gap, the governments cash-flow situation will probably remain difficult for some time given high expenses as the country tries to meet immense humanitarian, security, basic services, and infrastructure challenges (among others).
The country has received the equivalent of 5% of GDP in aid in 2011. This will help it to cover its financing needs, but much more will be needed to allow investment to take off. Foreign investment will be essential, but it might take a while for meaningful investment to resume. So while GDP growth will be strong, it is unlikely to reach the double-digit levels seen in other post-conflict economies.
Financial issues
Cocoa production is set to rise, but there are issues related to the quality of the cocoa produced, and new investments in the sector will be necessary to ensure a high level of production. The long-awaited cocoa-sector reform is likely to progress in 2012 (creating a new regulatory entity and ensuring higher producer prices are likely to be key elements), as this is a key condition for the completion of HIPC debt relief.
Cte dIvoire is likely to remain in external default to the London Club for a large part of 2012. The government has declared that it will resume coupon payments in June 2012, but the regularisation of arrears remains uncertain. It might not necessarily be a key priority at the moment, as cash flow will remain tight. Some form of restructuring cannot be entirely ruled out. This situation will probably have to be clarified before the country reaches the completion point of the enhanced Heavily Indebted Poor Countries Initiative (HIPC).
Politics
The country appears to be headed towards a calmer political climate. However, political stability cannot be taken for granted, as the challenges ahead are still daunting. Consolidating legitimacy, restoring security and launching the reconciliation process are among the key
Standard Chartered forecasts: Cte dIvoire

12 December 2011
near-term challenges. Violence has been at the heart of

2014 5.0 2.5 4.0 505 -2.5 -3.0
2012 8.0 2.5 4.0 505 -0.5 -4.0
2013 5.5 2.5 4.0 486 -2.0 -3.6
Ivorian politics for more than a decade; it will be no easy task to reunify such a divided country. The Ivorian army itself is far from unified: several former rebel factions need to be integrated with former pro-Gbagbo forces. New rivalries cannot be ruled out. Reform of the armed forces is needed, but this promises to be a long and complicated process.
-5.8 3.0 4.25 505 1.0 -6.6

76
Gambia
Amina Adewusi, +44 20 7885 6593
Amina.Adewusi@sc.com
Fiscal concerns remain

Economic outlook
Gambia has managed to maintain a stable growth rate, despite lower tourism receipts and remittances. This is likely to continue as Europe undergoes a mild recession and the global environment remains uncertain. Therefore, any pick-up in tourism is likely to be limited. Gambia has not necessarily benefited from low-cost tourism, as tourist spending remains below pre-crisis highs. Agriculture, which accounts for one-third of GDP, will continue to drive growth, despite undermechanisation and the dominance of small-holders. Output in 2012 will depend on weather conditions. Re-exports, which account for nearly 80% of Gambias goods exports, are likely to continue losing out in 2012 to neighbouring Senegal, where port and customs operations have improved. Without improvements in port infrastructure, the countrys re-export trade is unlikely to be sustainable. After robust growth in 2011, groundnut exports are likely to continue to increase as government policy focuses on agriculture. The fiscal situation is still worrisome, as revenue collection has continued to miss targets and has been steadily decreasing. One of the main reasons for this is that fuel subsidies have delayed the pass-through of international prices, despite a new fuel-pricing formula introduced in January 2011. Also of concern is a supplementary budget worth USD 7.2mn, passed just prior to the November 2011 presidential elections, which increased spending by 3.9% and of which the office of the president is the largest beneficiary. The medium-term Programme for Accelerated Growth and Employment (PAGE) will be launched in 2012, focusing on investment in agriculture and infrastructure. Financing the programme will be a challenge, as the authorities need to lower domestic financing, which has high rollover risk due to the reliance on short-dated Tbills. Domestic debt will still consume one-sixth of government revenue in 2012. Higher external debt is an unlikely option, as the external debt/export ratios the IMF put in place have been breached.
Financial issues
In February 2011, the authorities reverted to a monthly cash balanced budget system as falling tax revenues and spending over-runs caused large fiscal deficits. This has helped T-bill rates to come down from their peak of 10%. We expect this downward trend to continue in 2012 as issuance remains limited. The Gambian dalasi (GMD) is likely to continue its weakening trend against major currencies in 2012. We expect USD-GMD to trade below 30 in the first half of the year, before weakening in Q3-2012 as the Islamic month of Ramadan increases US dollar (USD) demand.
Policy
Inflation is likely to trend lower in 2012 and remain within the Central Bank of Gambias (CBGs) 6% target as food and fuel prices ease; we see room for the CBG to lower the rediscount rate from 14%. However, if the fuelpricing formula is fully implemented, inflation could rise. Exposure to external shocks will remain a threat. The fiscal stance is another key factor for 2012. The transfer to a cash balanced budgeting system should increase fiscal discipline, but the authorities somewhat opaque spending process will remain a concern.
Standard Chartered forecasts: Gambia

2011 GDP (real % y/y) CPI (% y/y) 91D T-bill rate (%)* USD-GMD* Current account balance (% GDP) Fiscal balance** (% GDP) 6.1 6.0 7.70 28.00 -17 -3.4 2012 5.5 5.0 7.00 30.00 -14 -2.7 2013 5.5 4.0 6.50 32.00 -13 -1.6 2014 5.5 4.0 6.00 34.00 -13 -1.0
Politics
After winning the presidential elections in November with 76% of the vote, President Jammeh will continue to dominate domestic politics. The opposition remains fractured, and widespread oppression of dissenting voices will mean that they are unlikely to gain a foothold in the political mainstream. While little change to the status quo is expected near-term, political developments will be closely watched.
77
*end-period, **for fiscal year ending 31 March Source: Standard Chartered Research
12 December 2011
Ghana
Razia Khan, +44 20 7885 6914
Razia.Khan@sc.com
First election as an oil producer

Economic outlook
Following the boost to 2011 growth from first oil, Ghanas economy should maintain strong momentum. The government is targeting 7.6% non-oil GDP growth in 2012 and expects overall GDP growth of 9.4%. Given our own expectation of broadly supportive commodity prices, we forecast growth of 8.5%.
cocoa forward, softer international prices since the peak of the Ivorian political crisis raise doubts about the sustainability of prices currently offered to Ghanaian farmers. Furthermore, gradual FX depreciation may be required to compensate for high cocoa prices paid to farmers in Ghanaian cedi (GHS) terms. With the government paying down more of its arrears, the banking sectors non-performing loans are likely to improve. This should feed into healthier credit growth in 2012.
The Bank of Ghanas Composite Indicator indicates strong growth across a number of sectors. Increased government spending and infrastructure development ahead of elections due in 2012 should cement these gains. Technical difficulties with oil production will prevent Ghana from achieving expected production levels of 120 thousand barrels per day (kbd) from its Jubilee Field by the end of 2011. Nonetheless, actual production levels of 80 kbd are not materially different from budget forecasts, with Ghana still exporting all of its crude production in order to establish a benchmark. The lack of infrastructure to make use of the gas produced is a constraining factor. The hope was that Ghana could use this gas for electricity production, thus boosting manufacturing. The infrastructure is now unlikely to be in place until mid-2013 at the earliest, dampening oil production forecasts. However, plans for the financing of gas infrastructure are in place, with around USD 850mn of a USD 3bn loan from the China Development Bank earmarked for this purpose. Ghanas cocoa prices are regulated. The high farm gate price paid to cocoa farmers will provide a substantial boost to disposable income in the year ahead, especially given relatively stable inflation. Although Ghana sells its
Financial issues
In recent years, Ghanas domestic debt market has been one of frontier Africas top recipients of foreign inflows (measured by foreign investor participation as a proportion of total issuance). Ghanas transition to oilproducer status, expectations of healthier external balances, FX and inflation stability, and high yields have all added to its attraction for investors. Since the global financial crisis, Sub-Saharan frontier markets have attracted a healthier mix of real money flows, typically with a longer-term horizon, rather than the short-term, highly leveraged inflows that previously dominated. This has created some resilience to global shifts in risk appetite. Nonetheless, should global risk appetite deteriorate again as we expect in Q1-2012 smaller, less liquid markets will be disadvantaged by the flight to safety and preference for liquidity that are likely to characterise this risk-off environment. While Ghana is unlikely to experience sudden outflows, the pace of new inflows is likely to slow in 2012. With aggressive tightening in other frontier markets boosting the relative attractiveness of yields elsewhere, Ghana may be disadvantaged; this is already evidenced by declining foreign investor participation in domestic bond auctions (see chart below). A key challenge in 2012 will be for Ghana to further deepen its debt market by broadening the domestic institutional investor base, extending yield curve maturities and providing more reassurance to foreign investors on fiscal and FX policy. Although the Bank of Ghana (BoG) targets GHS real effective exchange rate (REER) stability, Ghanas thin FX market has been susceptible to overshooting in the absence of explicit BoG support.
78
Standard Chartered forecasts: Ghana

2011 GDP (real % y/y) CPI (% y/y) Policy rate (%)* USD-GHS* Current account balance (% GDP) Fiscal balance (% GDP) *end-period
12 December 2011
2012 8.5 10.1 14.00 1.70 -4.9 -4.8
2013 7.9 12.7 16.00 1.76 -3.3 -4.5
2014 7.6 10.8 15.00 1.80 -1.5 -4.2
13.6 9.0 12.50 1.68 -6.5 -4.8
Ghana (cond)
Since October 2010, Ghana is believed to have hedged part of its oil consumption requirement. It also fully hedges its crude oil exports (with a strike price on options higher than the 2012 budget benchmark of USD 90/barrel). Gains on Ghanas hedge book on imports help to meet the cost of a domestic fuel subsidy, and excess revenue from crude exports goes into a stabilisation fund. Should oil prices decline, Ghanas budgetary earnings would still be safeguarded. Although current fuel prices are believed to reflect an international oil price of USD 93/barrel (they have not been adjusted since a contentious 30% increase in domestic prices in January 2011), the level of fuel subsidies is unlikely to be reduced ahead of end-2012 elections.
The 2012 budget also envisages a large increase in foreign financing of the budget (to USD 1bn), keeping net domestic financing limited to 2.4% of GDP (or GHS 1.67bn, around 30% lower than had been projected in 2011). An additional USD 1.2bn will be drawn down from the China Development Bank loan. Ghanas public-sector wage bill is set to account for an even greater share of non-oil GDP given single spine salary reforms and increases in base pay in 2011. Although an increased resource envelope, including foreign financing on concessional terms, has allowed for higher pre-election spending without pressuring the deficit, public spending will still need to be carefully monitored. Ghanas history of pronounced electionrelated cyclicality is likely to leave investors cautious ahead of 2012; its new oil-producer status risks exacerbating the tendency to overspend. Inflation risks are forecast to rise given expected GHS volatility (stemming from reduced foreign portfolio inflows), quarterly utility price increases buoyant non-oil GDP and recent public-sector wage increases. Although both food and non-food inflation have been exceptionally well behaved, a continuation of recent GHS weakening may require early tightening from the BoG, as currency stability is a key factor in keeping inflation low. Given the healthy level of Ghanas real interest rates, we forecast only modest tightening of 100-150bps in 2012.
Policy
Rating agencies have warned that fiscal slippage ahead of the election would pose a risk to Ghanas outlook. Nonetheless, healthy revenue growth on the back of improved non-oil revenue collection has created room for additional spending. The fiscal deficit in 2012 is likely to remain unchanged at 4.8% of GDP. Somewhat controversially, the 2012 budget outlined a higher corporate tax rate for the mining sector (raised to 35% from 25%), and a windfall tax of 10%. Although this has drawn vocal protests from mining companies, some of which have threatened to curb investment plans, the new taxes are unlikely to affect long-term growth prospects. IMF analysis suggests that the mining sector has made a low contribution to fiscal revenue relative to other sectors in the formal economy.
Politics
Presidential and legislative elections the first since Ghanas transition to oil-producer status are due by end-2012. Elections are likely to be close again, with the ruling National Democratic Congress (NDC) and the opposition New Patriotic Party (NPP) vying for votes. After run-off elections at the end of 2008, the presidential election was decided on the basis of only 40,000 votes.
Foreign investor participation in Ghana 3Y and 5Y bond auctions Amount of primary issuance bought by foreign investors
100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Dec-06 Dec-07 Mar-10 Aug-10 Feb-11 June-11 Oct-11 Foreign participation, zero at Oct auction
While Ghana has an established history of peaceful democratic transition, with changes in government following both 2000 and 2008 elections, observers will watch closely for any signs that the countrys newfound oil wealth might destabilise things. Ghanas advantages lie in having discovered oil with an already mature and established democratic system of governance. Civil society will want to ensure that even with oil in the equation, this does not change.

12 December 2011 79
Kenya
Razia Khan, +44 20 7885 6914
Razia.Khan@sc.com
A key election year

Economic outlook
Economic prospects will be dominated by 2012 elections the first to be held since those contested in late 2007, which triggered a round of post-election violence, shattering Kenyas long-held reputation for stability. With politicians and civil society aware of what is at stake this time around, much smoother polls are predicted. GDP growth is likely to recover in 2012, following the impact of a drought that weighed on 2011 growth. Higher food and fuel prices and FX volatility combined to drive Kenyan inflation to 20% by late 2011. While the economy will suffer the lagged impact of the 1,100bps of tightening seen in Q4-2011, this should be offset by other factors. Better rains, rising food production, and robust crossborder trade with rapidly growing East African neighbours (creating demand for Kenyan manufactured goods) should all support growth. Interest rates are unlikely to stay at current highs for long. With inflation expected to trend down in 2012, an easing cycle should be in place by H2-2012, providing some boost to investment. There are several risks to this outlook, however. The key risk revolves around government spending. Subdued domestic issuance in H1-FY12 (period ending December 2011), partly owing to undersubscribed bond auctions, may force the government to reduce spending plans even ahead of an election if it is not offset by foreign borrowing. Given Kenyas election history, it is not certain that the Grand Coalition Government formed as part of the peace-building effort in 2008 will hold together until
elections are due, although the risk of a coalition breakup is seen as low. Any such risk event would take a toll on business and consumer confidence.
The second risk relates to Kenyas incursion into Somalia, ostensibly to deal with Al Shabaab militants and safeguard Kenyan territory (and tourism) from militant attacks, and to combat the costs of Indian Ocean piracy to Kenyan trade. It is unclear how this military activity will be paid for (given the dislocation in Kenyas bond market stemming from high inflation) or how long it is likely to last. Local press reports suggest that an additional KES 7bn has been added to Kenyas KES 51.3bn military budget to pay for it. The risk of drawn-out military involvement, unless supported by increased foreign flows, would be an additional negative for Kenyas fiscal outlook, at a time when domestic borrowing is already constrained. Given weak growth in the euro area, still a key trading partner, there are potential risks to tourism inflows, as well as horticulture and floriculture exports. However, evidence from the 2009 recession suggests that demand for Kenyas farm exports may increase during a downturn. Given the sensitivity of the sector to transport costs, any easing of oil-price pressures would be positive.
Financial issues
Standard Chartered forecasts: Kenya

2011 GDP (real % y/y) CPI (% y/y) Policy rate (%)* USD-KES* Current account balance (% GDP) Fiscal balance** (% GDP) 4.9 14.0 18.0 92.00 -9.3 -4.6 2012 5.3 13.3 14.0 97.00 -8.5 -8.5 2013 5.5 6.8 10.0 98.00 -6.8 -7.8 2014 5.9 6.5 9.0 104.00 -6.5 -6.8
How the authorities deal with dislocation in Kenyas domestic bond market will be a key theme in 2012. While the response to tight market liquidity and subdued demand for longer-dated instruments in H1-FY12 has been to hold back much of Kenyas planned bond issuance so as not to lock in higher financing costs this will be difficult to sustain later in the fiscal year. As of December 2011 the authorities are close to the limit on their borrowing ceiling from the Central Bank of Kenya (CBK). In our view, expected fixed income maturities by the end of 2011 should help to ease tight market liquidity, bringing down elevated overnight rates. This, combined with the expected confirmation of the peak in CPI inflation in early 2012, should lead to improved subscription rates for T-bill auctions. As the market focus shifts to expected interest rate easing in H2-2012 (much sooner than
80
*end-period; ** for fiscal year ending 30 June Source: Standard Chartered Research
12 December 2011
Kenya (cond)
previously expected given unexpectedly aggressive tightening from the CBK at the end of 2011), demand for longer tenors may improve from the very low subscription rates seen in 2011. However, the ease with which the authorities can borrow domestically, while still containing deficit financing costs, will depend on how much they need to borrow. Given the anticipated deterioration in the budget deficit, there are concerns that domestic budget financing will be constrained for some time.
Banking-sector profitability is likely to be impacted initially by increased provisioning and subdued credit demand in response to CBK tightening. However, with anecdotal evidence suggesting a voluntary restructuring of client loans increasing the tenor of loans in order to reduce the likelihood of default a significant impact is not expected. The resumption of an easing cycle in H2-2012, helped by Kenyan shilling (KES) gains, should limit the macroeconomic fallout. New legislation grants the CBK the authority to put in place corrective measures ahead of any bank solvency issues. However, we do not think this will be required, as Kenyas liquidity shock is likely to be short-lived. Plans for increased external borrowing have been mooted. While Kenya hopes to benefit from a larger extended credit facility from the IMF (USD 750mn over three years), plans for a USD 500mn eurobond issue may be brought forward, market conditions permitting.
ballooned to 7.4% of GDP. Even though net foreign financing was increased to USD 1.33bn in order to keep domestic borrowing flat, the actual deficit for FY12 now looks likely to be substantially higher (we forecast 8.5%). First, GDP growth is unlikely to match the c.6% rate assumed in the budget. While inflation has exceeded all expectations, it has not yet had a meaningful impact on revenue collection. Most importantly, with short-term interest rates having risen from around 6% at the time of the June budget to close to 17% by the end of H1-FY12, debt-servicing costs will widen the deficit substantially. In order to stabilise the public debt ratio, currently at c.45% of GDP, Kenya would need to commit to several years of primary deficit reduction. It is unclear whether it can afford to do so given the cost of implementing the new constitution. We expect the deficit to remain relatively wide in the medium term.
FX market restrictions limiting the provision of KES liquidity to offshore counterparties are likely to be shortlived, and to be removed once sufficient KES stability has been achieved. Given little evidence that KES weakness is boosting manufacturing exports, the authorities are likely to favour a stronger FX rate.
Politics
Policy
The FY12 budget initially projected a narrowing of the primary deficit to 2.7% of GDP from 3.8%. However, when debt-service costs were factored in, the deficit
Kenyas successful constitutional referendum in August 2010 the first national vote to be held since contentious elections in late 2007 has raised optimism that 2012 elections will be relatively peaceful. With President Kibaki set to complete his second term in office, Prime Minister Raila Odinga appears to be the strongest contender for the presidency (the post of PM will be discontinued following the elections). Uncertainty still surrounds the likely candidacy of Finance Minister Uhuru Kenyatta; this will depend partly on what happens with International Criminal Court charges against him, relating to his alleged role in post-election violence in 2007-08.
2012 should see a recovery from Kenyas inflation shock 3M T-bill yield
18 16 14 12 10 8 6 4 2 0 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Oct-11 Sources: Reuters, Standard Chartered Research
12 December 2011
110 105 100 95 90 USD-KES (RHS) 91 T-Bill 85 80 75 70
Kenyas new devolved model of government, which reduces the powers of the executive, is expected to be instated after the elections. Kenyans will be voting for a president and a number of other representatives, including governors, MPs, a newly created senate, and a senate representative for each ward. Parliament will be enlarged to 350 seats from 222 currently, and county governments will be created, receiving perhaps as much as 15% of the budget. Concerns over the affordability of implementing the new constitution persist.
81
Mozambique
Victor Lopes, +971 4 508 4884
Victor.Lopes@sc.com
Unstoppable
Economic outlook
Financial issues
Mozambique is set to remain a star performer in Africa in terms of economic growth. The economy has expanded at an average rate of close to 8% over the last decade and is likely to grow by more than 7% in 2012. This spectacular growth performance has been driven by mega-projects in aluminium, gas and electricity. New projects in coal (production started in 2011; Mozambique will become Africas second largest coal exporter after South Africa in 2012) and the development of infrastructure linked to mining projects are positive for 2012 growth, and for employment in the regions where the projects are located. Significant gas production is also likely over the medium term. Higher mining export volumes are likely to offset any negative impact from potentially lower aid flows and commodity export prices on the current account balance. The current account deficit has traditionally been large given the high level of imports and dividend outflows linked to the mega-projects (as well as the countrys high level of oil and food imports). Increased exports volumes and strong foreign direct investment will support the currency and smooth inflationary pressures. The recession in Europe poses risks to Mozambique, but higher coal export volumes, combined with rising agricultural production and dynamic domestic demand, should sustain strong GDP growth.
The country is considering launching its first eurobond, but this is likely to happen only if market conditions become more favourable. Also, the government continues to issue long-dated domestic debt.
Policy
FDI has been focused in a few large, capital-intensive projects. While these have been important to GDP growth and the external accounts, they have contributed only marginally to fiscal revenue. As a consequence, Mozambique remains highly dependent on international donor support (one-third of total government revenues). Given that aid flows might slow in the future, it is vital for the country to broaden its tax base. While the government has managed to increase revenue collection to c.19% of GDP, more efficient tax collection in 2012 could drive this at least 1ppt higher. An expected rise in capital spending, however, would widen the fiscal deficit further. The government recently announced that it was in discussions with mining companies for a possible review of the mining code. In our view, this does not signify a resurgence of resource nationalism. While full details are still awaited, it seems that the new legislation will not change the tax regime, but only some aspects of the licensing process. In any case, the government is keenly aware of the need to balance its legitimate desire to increase mining revenues against the need to maintain Mozambiques reputation as an attractive investment destination. Addressing the issue of power generation will remain a key objective of policy makers as they cope with rapidly increasing electricity demand (12% per year).
Standard Chartered forecasts: Mozambique

2011 GDP (real % y/y) CPI (% y/y) Policy rate (%)* USD-MZN* Current account balance (% GDP) Fiscal balance (% GDP) *end-period
12 December 2011
2014 7.5 5.5 14.5 24.0 -11.0 -5.8
2012 7.3 7.2 15.5 25.0 -11.5 -6.8
2013 7.5 6.0 15.0 24.5 -11.5 -6.3
7.2 10.8 16.0 26.0 -11.8 -6.1
Politics
The next legislative and presidential elections are due only in 2014, and the political situation is expected to remain stable. However, the high poverty rate (55% of the population) in the context of food-import dependence means that the country is particularly prone to social unrest at times of rising food (and oil) prices. This was highlighted by the riots that occurred in 2008 and 2010.

82
Nigeria
Razia Khan, +44 20 7885 6914
Razia.Khan@sc.com
The USD 250bn question

Economic outlook
2012 may be a transformative year for Nigerias economy, depending on the appetite to push through key reforms. We expect a rebasing of GDP (last done in 1990) early in the new year. After Ghanas 2010 rebasing, the first since 1993, it was discovered that the economy was 60% larger than previously thought. The rebasing exercise is likely to deliver similar results for Nigeria. The importance of the telecom and financialservices sectors will increase. With a larger measured GDP, Nigerias already negligible debt-to-GDP ratios may appear smaller still, although important shortcomings such as the inability to collect significant revenue outside the oil sector will become more evident. While recent growth has comfortably exceeded 7%, driven largely by developments in the non-oil economy, much of it has been driven by improvements in agricultural output. With little noticeable increase in productivity, growth has not been transformative. Several reforms expected in 2012 are key to Nigerias ability to improve its growth prospects and make a meaningful difference to poverty levels. The lifting of fuel subsidies, estimated to cost Nigeria at least USD 7bn a year, will be a dominant theme. While this has long been recognised as a key step towards right-sizing government spending, the measures are deeply politically contentious. In December 2011, the House of Representatives approved a medium-term fiscal framework but refused to commit to the lifting of subsidies. Few doubt the long-term economic benefits of lifting subsidies, but successive regimes have failed to
adjust fuel prices meaningfully. State governors now appear to favour some form of subsidy removal, as it would potentially boost the revenue allocations made to them, but overall resolve to drive reforms is uncertain.
Subsidies in their current form support rent-seeking and create economic distortions. Fuel is not available everywhere at the subsidised price wide variations exist across different parts of the country. Subsidies have discouraged private-sector investment in refineries, as owners would have little influence over product prices. Consequently, fuel features significantly in Nigerias import bill. Domestic fuel consumption rarely falls when prices increase, as little of the price increase is passed on. For oil marketers, which are paid the difference between international product prices and the subsidised price of domestic fuel (NGN 65/litre), there is an incentive to import even more product when prices are high. In recent years, balance-of-payments and fiscal strains have been evident. By some accounts, Nigeria may even pay more in subsidies than it earns in oil revenue. Nigeria is set to make important strides towards a cashless economy in 2012, given pilot efforts to limit the size of cash withdrawals from banks, initially in Lagos and then in other urban centres. Transporting large sums of cash notes in order to meet demand is thought to cost the banking sector up to USD 700mn annually, which could be channelled into lower loan-to-deposit spreads if e-channels were employed instead. If realised, the reforms could be far-reaching, ultimately bringing more of the money in circulation into the banking sector, lowering bank costs and improving the transmission of monetary policy. They could also shed more light on the countrys large errors and omissions (outflows on the balance of payments, which typically account for as much as 30% of known export earnings) and improve governance. Passage of the long-awaited Petroleum Industry Bill (PIB) is also hoped for. The lack of progress has taken its toll on the oil sector, with regulatory uncertainty delaying investment in offshore fields. Protracted delays may start to impact oil production capacity. Existing unsustainable levels of government spending and falling FX reserves suggest that Nigeria would benefit from improved fiscal terms, which could potentially raise the authorities oil revenue by USD 10bn annually.
83
Standard Chartered forecasts: Nigeria

2011 GDP (real % y/y) CPI (% y/y) Policy rate (%)* USD-NGN* Current account balance (% GDP) Fiscal balance (% GDP) *end-period
12 December 2011
2012 6.9 10.0 13.25 158 11.3 -3.3
2013 7.3 9.1 14.00 159 10.5 -2.0
2014 7.5 12.0 13.50 161 9.0 -1.5
7.2 10.9 12.00 163 12.2 -4.0
Nigeria (cond)
Power-sector reforms will also be key to the economic outlook. Nigeria hopes to generate 16,000MW of electricity by 2014 (current output is only 4,000MW). Debate over privatisation in the sector has been lively, with unions arguing that the vast amounts of capital investment required, as well as long cost-recovery times, run counter to the need for privatisation. Phased tariff increases are aimed at making investment in the sector more attractive, but progress will only be assessed in the medium term.
budget to adopt a benchmark crude price of USD 70/barrel and an oil production assumption of 1.45 million barrels per day (mbd). With a scant savings buffer relative to the 2008 crisis and little progress on plans for the formal establishment of a sovereign wealth fund, a collapse in oil prices (not our forecast scenario) would necessitate far higher borrowing than implied by a 3.3% of GDP budget deficit, and/or significant spending cuts.
Financial issues
Nigerias banking-sector resolution process is now largely complete. The bailout is unlikely to involve large fiscal costs. The Asset Management Corporation of Nigeria (AMCON) has bought NGN 3.14trn (USD 20.25bn) of bad debt, and hopes to pay for the bailout by selling these assets at an eventual profit. Banks will also pay a 30bps levy on their balance sheets, annually for 10 years, into a sinking fund. This, together with contributions from the Central Bank of Nigeria (CBN), should help to meet AMCON costs. Three banks were nationalised and another five merged and recapitalised by healthier institutions. Nigerias interbank guarantees will be lifted in 2012, likely resulting in more competition for liabilities between banks and higher deposit rates. With the sector having largely returned to profitability, private-sector loan growth rates have already improved.
Monetary policy is likely to remain tight, with frequent open-market operations and FX sales to the interbank market in order to limit spreads between marketdetermined FX rates and the official Wholesale Dutch Auction System (WDAS, with a USD-NGN mid-rate of 155). Persistent interbank market weakness may trigger a widening of the +/-3% band around the current WDAS mid-rate. Further rate tightening is probable in the event of inflationary pressure stemming from government spending, the lifting of fuel subsidies, or continued pressure on the FX reserves. Secondary-market bond trading should remain subdued. This reflects the impact of recent aggressive tightening, with banks holding bonds to maturity to avoid notional capital losses stemming from higher interest rates. IFRS, requiring mark-to-market valuations, will be introduced by end-December 2012.
Politics Policy

Significant spending increases in recent years, and withdrawals from the Excess Crude Account (Nigerias undistributed oil savings) leave the country vulnerable to potential oil-related shocks in 2012. We expect the 2012
Presidential elections held in April 2011 saw marked differences in voting allegiances in the north and south of the country. Given more frequent Boko Haram attacks in the north, believed to reflect frustration at the lack of social and economic progress, efforts at national reconciliation in 2012 will be key to Nigerias future.
Nigeria has seen unsustainable spending increases Total expenditure, federal budget, NGN trn
7 6 5 4 3 2 1 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Sources: FMFN, Standard Chartered Research
12 December 2011 84
Total expenditure, NGN trn
Although the 2011 elections were viewed as the most successful since Nigerias transition to civilian rule, resulting in a parliament less dominated by the ruling Peoples Democratic Party, little changed in terms of the economic impact of elections. Based on budget figures including two supplementary budgets spending rose almost 50% y/y in the year before the elections. Disbursals from the Excess Crude Account, related to efforts to win political favour, also became more frequent. Any oil-price shock would call into question the sustainability of Nigerias current system of political patronage, likely resulting in increased political risk.
Senegal
Victor Lopes, +971 4 508 4884
Victor.Lopes@sc.com
Staying the course in an uncertain year

Economic outlook
Financial issues
The economy should remain resilient in 2012 as electricity supply improves, although it is likely to be impacted by the euro-area recession as trade and capital inflows slow. Lower commodity prices (oil and food) should generally benefit Senegal. The uncertain outcome of the February 2012 elections also raises questions over future economic policy. Despite these risks, GDP growth is likely to remain at around 4% in 2012 (we forecast 4.1%).
The government successfully issued a USD 500mn eurobond in 2011. It is likely to continue to diversify its sources of financing and issue an Islamic bond to tap the Middle East investor base. The government will also continue to rely on domestic debt issuance in the regional West African Economic and Monetary Union (WAEMU) bond market.
Policy
Senegals growth trajectory has been boosted recently, as the financial health of large corporations in the chemical, refinery and electricity sectors has improved and agricultural production has increased following an ambitious government plan to boost the sector.
The deficit is likely to narrow in 2012 after a significant deterioration in 2011, when it reached an estimated 6.2% of GDP due to increased capital spending on infrastructure projects (the toll-road extension project alone represented 1.3% of GDP) and the energy programme. Energy subsidies, which weighed significantly on public finances in 2011 (at around 1.5% of GDP), are expected to be reduced in 2012. At some point, the government will have to increase electricity tariffs, but this can only happen after the elections and after the electricity company has shown at least several months of reliable service. Otherwise it would not be acceptable to the population. The timing of tariff increases remains uncertain, especially if a new government comes into power after the elections. As food subsidies have been eliminated and agricultural production has increased, Senegal is less vulnerable to rising food prices than in the past. However, high food prices and power cuts could fuel social discontent.
Chronic power shortages that have long been a drag on growth are being addressed (in a pre-election year, the incentive to avoid unpopular power cuts is high). The government has commissioned power stations and leased generators; fewer electricity outages will be a key source of support to the economic outlook.
Several
infrastructure
projects
currently
underway
notably the expansion of the port of Dakar, a new international airport and a toll road should also support future growth. The infrastructure programme is partly financed by tapping the international capital markets.
Standard Chartered forecasts: Senegal

12 December 2011
Politics
2013 4.5 2.0 4.0 486 -6.8 -3.5 2014 5.2 2.0 4.0 505 -6.6 -3.0
2012 4.1 2.4 4.0 505 -7.2 -5.6
4.0 3.6 4.25 505 -7.4 -6.2
Elections are due in February 2012, and there is no clear favourite. President Wades candidacy has yet to be validated by the constitutional council, but it seems likely. His popularity has declined, but he still seems to have support in rural areas. There are many opposition candidates, but their ability to unify remains unclear. There was unrest in mid-2011 owing to power cuts and a controversial attempt by the president to change the constitution. Even if some unrest cannot be ruled out should President Wade win the elections, widespread unrest and political instability are not the most likely outcome given Senegals democratic background.
85
Sierra Leone
Amina Adewusi, +44 20 7885 6593
Amina.Adewusi@sc.com
Iron ore drives export transformation

Economic outlook
Sierra Leones economy will undergo significant structural change in 2012 due to new mining projects coming online. Iron ore exports from the Tonkolili mine began in November 2011, and production is expected to reach 12 million tonnes (mt) in 2012, potentially increasing to 45mt in the medium term. The IMF expects new iron ore production to lead to a quadrupling of exports and a one-time surge in real GDP growth to 51% in 2012 (we expect a more modest 30%). The governments business-friendly policies have gained traction, and a number of foreign companies will continue to be active in 2012. After 30 years of disuse, the Marampa iron ore mine will restart production of 3.6mt per year, increasing to 16mt. Oil exploration, which has been ongoing since 2009, is expected to confirm whether Sierra Leone has oil in commercial quantities in 2012. This could be a considerable game-changer for the country. With limited private-sector capacity, gains from mining are likely to be transmitted to the real economy through government revenue. While total revenue is expected to benefit in 2012 from royalties and corporate tax from the Tonkolili mine, significant nominal increases in revenue are only likely in the medium term given preferential tax concessions. Managing public expectations will be important, as gains will likely be modest in the near term. Public spending will continue to be dominated by recurrent expenditure as public pay reforms increase
wages. As elections near, capital spending will continue to increase after almost doubling in 2011.
Financial issues
The fiscal deficit is likely to remain at around 6% of GDP in the medium term as the government prioritises development spending over fiscal consolidation. Crowding-out of the private sector is likely to be a risk as government borrowing requirements remain elevated. Tight liquidity in 2011 led to 91-day T-bill rates (the tenor at which 61% of government domestic borrowing was done in FY10) rising to 30%. We expect rates to remain above 20% in 2012. The Sierra Leonean leone (SLL) will remain on a depreciating trend in 2012 as fundamentals continue to be skewed against it; the boost to exports will have a limited impact on the current account deficit. Recent stability in the SLL has been supported by tight liquidity, which is likely to continue into 2012. We expect a slower pace of depreciation next year, barring external shocks.
Policy
We expect inflationary risks to subside in 2012 as global food and fuel prices decline. However, Sierra Leone remains vulnerable to external shocks, and increased iron ore exports will add to its dependency on commodity prices. Domestic demand factors could also cause upside inflationary risks, as the fiscal stance remains expansionary and there is a risk of unbudgeted preelection spending. The Bank of Sierra Leone (BSL) is likely to have an easing bias as it tries to encourage lending to the private sector, and as inflation comes down due to high base effects. We believe further monetary easing, which began in October 2011, is likely.
Standard Chartered forecasts: Sierra Leone

2011 GDP (real % y/y) CPI (% y/y) 91D T-bill (%)* USD-SLL* Current account balance (% GDP) Fiscal balance (% GDP) 5.2 16.0 23.0 4,300 -50 -5.7 2012 30.0 11.0 26.0 4,450 -7.6 -5.1 2013 8.0 10.0 20.0 4,700 -9.5 -6.0 2014 7.0 10.0 16.0 4,800 -12.4 -6.0
Politics
12 December 2011
Legislative and presidential elections will take place in August and November 2012, respectively. The incumbent, President Koroma of the All Peoples Congress (APC), is favoured to win. The elections will be seen as a measure of Sierra Leones democracy and a test for further investment. Security will be a key concern; however, we expect any unrest to be contained.
86
South Africa
Razia Khan, +44 20 7885 6914
Razia.Khan@sc.com
Still-slow growth
Economic outlook

The economic growth outlook is likely to remain subdued, with considerable downside risks to current forecasts. Some recovery in domestic consumption is evident, helped by low interest rates, which have not been raised since the start of the global financial crisis; however, global risks loom large. Household balance sheets have strengthened as consumers have paid down debt. But consumer confidence remains low, and may decline further if economic conditions deteriorate. Given its strong links to the global economy, South Africa was one of the worst affected African countries by the global crisis; GDP contracted 1.5% in 2009. While we do not forecast a severe slowdown in global growth in 2012, the euro area remains a key trading partner for South Africa and is the most important destination for its manufactured exports. Any slowdown in the euro area will affect South Africas economy, although the absence of a globally co-ordinated downturn would have a less severe impact. South Africas monetary policy is more supportive of growth now than it was in 2008. Ahead of the 2008 crisis, CPI inflation had risen to double the upper level of the South African Reserve Banks (SARBs) 3-6% target. Interest rates had been raised aggressively in response, and despite a SARB easing cycle commencing in December 2008, the lagged effect of the deterioration in real disposable incomes and monetary tightening weighed heavily. Going into 2012, the repo rate is likely to remain negative in real terms, perhaps for an extended period, if global risks dominate.
Fiscal room for manoeuvre is likely to be more limited now, however. In 2008, the fiscal balance was healthier, and South Africa even achieved a small surplus in FY08. By the time the crisis hit, South Africa ahead of hosting the 2010 World Cup had already embarked on a significant public works programme aimed at boosting job creation. Under current conditions, room for a fiscal response to the global slowdown will be more limited. Corporate income tax collection has yet to recover fully. The public-sector wage bill and social grants have been among the fastest-rising components of central government expenditure in recent years. Given the magnitude of the deficit, this leaves little room for increased public-sector investment in response to a slowdown. In the last three years, government real-noninterest spending increased at an annual average rate of 7.9%. This is set to decelerate to just 2.3% in the next three years as debt-servicing costs rise. Given the external environment, manufacturing and, perhaps to a lesser extent, mining may slow from current levels, although increased developing-country demand for South Africas commodity exports may prevent a deterioration on the scale seen previously. Growth will largely depend on a continued recovery in consumer spending.
Financial issues
Standard Chartered forecasts: South Africa

2011 GDP (real % y/y) CPI (% y/y) Repo rate (%)* USD-ZAR* Current account balance (% GDP) Fiscal balance (% GDP)** 3.2 5.0 5.5 8.80 -3.4 -5.3 2012 3.1 6.1 6.0 8.20 -3.8 -5.5 2013 4.1 5.2 7.0 8.15 -4.0 -5.2 2014 4.3 5.4 7.50 8.50 -4.2 -4.5
As the South African rand (ZAR) is a high-beta currency, South African financial markets will be heavily impacted by changes in global risk appetite. We expect significant ZAR weakness in Q1-2012, in line with a likely deterioration in risk appetite, the euro, and a flight to perceived safe havens. South Africas banking sector is generally acknowledged to be sound, and is noted for the strength of its regulation; it is not thought to be at particular risk from a rise in global banking volatility. Exposure to peripheral European debt accounts for less than 1% of the banking systems total credit exposure. However, given traditional dependence on core European bank participation in South African bank syndications, any refinancing of the countrys banks would take place in a much more constrained external environment. This could potentially limit their ambitious offshore expansion plans.
12 December 2011
87
South Africa (cond)
Domestically, banks remain heavily exposed to the realestate sector, with a sluggish housing market responsible for subdued growth in private-sector credit extension. Lending to corporates and unsecured loans to households, which are already on an uptrend, should increase further in 2012. Available FX reserves are now double South Africas short-term debt, resulting in significantly greater resilience to external shocks than in the past.
expenditure in FY13 (begins 1 April 2012) is set to breach the ZAR 1trn mark for the first time. This will represent a doubling, in real per-capita terms, of the fiscal resources available only a decade ago, in FY03. Unless tax revenue recovers faster (no structural improvement is forecast over the medium term), there will be limited room to continue spending at the same pace.
Policy
With inflation likely to peak at 6.4% in Q1-2012 and average 6.1% for the year, the SARB will face a dilemma. Having already stated that it will not raise interest rates in response to a supply-side shock alone, it is likely to keep the repo rate on hold at 5.5% for an extended period for as long as global economic uncertainty dominates and domestic indicators continue to point to sub-trend economic growth. Nonetheless, exaggerated ZAR weakness would risk prolonging the breach of the inflation target, and as an inflation-targeting central bank, the SARB would be forced to react at some point. We therefore expect the repo rate to be raised at least 50bps in H2-2012, with the risk of another 50bps hike should domestic indicators surprise positively. The key challenge for fiscal policy will be to balance expected slower spending with very real demands for improved service delivery. Well known for its postapartheid fiscal conservatism, South Africa will have a difficult time maintaining this reputation in the years ahead, especially if growth continues to disappoint. Total
Medium-term plans for fiscal consolidation remain in place. Although the deficit will remain wide in the coming years, largely as a result of weak growth, the plan is to achieve a primary surplus by FY15, with an overall deficit of only 3.3% of GDP. Questions persist about South Africas ability to afford its social protection outlays, given reduced fiscal flexibility. Total social spending (social protection grants, housing and health care, even before the planned introduction of a comprehensive national health insurance scheme) now accounts for more than half of all non-interest spending in any given year. While South Africas public debt ratio is moderate, and is expected to peak at c.40% of GDP in the medium term, this rises to a more worrying 60% of GDP when the conditional liabilities of state-owned enterprises are factored in. Given the focus on social spending, room for growth-enhancing investment spending will be limited, increasing the risks to South Africas rating.
Politics
Post-crisis, South African growth has lagged behind GDP levels since the crisis
125 120 115 110 105 100 95 90 India Indonesia Malaysia Korea S Africa Q1-09 Q2 -11 Q1-08 (real GDP level = 100)
Internal elections in the African National Congress (ANC) in December 2012 will be a key focal point. With the suspension of firebrand Youth League leader Julius Malema from the party, President Zumas re-election as ANC president now appears more secure. However, some of the issues championed by the ANC Youth League such as mine nationalisation (which remains on the agenda for a policy conference earlier in the year) are unlikely to disappear completely. For much of its history, the ruling ANC has been something of a broad church representing a diversity of interests and, often, political opinion. As it approaches almost two decades in power and demands for economic delivery grow more strident, the partys ability to hold together in the same way will increasingly be put to the test.
Sources: IMF WEO, Bloomberg, Standard Chartered Research

12 December 2011 88
Tanzania
Razia Khan, +44 20 7885 6914
Razia.Khan@sc.com
Cautious pace of liberalisation

Economic outlook
2012 should see an acceleration of GDP growth thanks to a recovery from the drought, lower inflation, the resumption of regional food exports, and ongoing momentum in the mining, gas, construction and agricultural sectors. Despite robust trend growth off a low base, Tanzanias economic prospects are constrained by a substantial infrastructure deficit (poor roads, port congestion and intermittent power supply) and a halting approach to liberalisation. Although the country is a signatory to the East African Protocol, allowing for the establishment of a common market, it has resisted many of the liberalisation measures required. Given the weak external environment, donor financing is likely to be constrained. With an aid-to-GDP ratio as high as 11.2%, compared with a domestic revenue ratio of c.15%, Tanzania is highly donor-dependent. Reducing this dependency will be a key challenge in 2012. Power-sector reform will also feature prominently in the year ahead. Frequent droughts have highlighted the shortcomings of the countrys traditional reliance on hydro-electricity production. While new investment has reduced the extent of load shedding, the IMF has called for more to be done to strengthen the finances of stateowned utility Tanesco. Studies suggest that manufacturers lose as much as 24 hours of production each month because of poor power supply. Demand for electricity is projected to triple by 2020, but Tanzania is currently ill-equipped to meet this demand. State dominance of the sector is gradually giving way to more private-sector participation. The establishment of separate transmission and distribution entities may also be required.
Financial issues
While plans for sovereign eurobond issuance have been mooted for some time, Tanzanias domestic debt market remains closed to foreign investors. Although this is not unusual for first-time issuers, Tanzanias weak domestic revenue mobilisation and limited access to a wider investor base for local-currency funding are potential rating negatives. However, recent FX-market volatility is likely to have left policy makers wary of rapid capital account liberalisation.
Policy
2012 should see the lifting of temporary measures put in place to address Tanzanian shilling (TZS) volatility. Banks accused of publishing FX rates at which they did not trade were temporarily suspended from the interbank market in a bid to improve transparency. Net open positions were cut to 10% of regulatory capital from 20% to encourage FX selling. The Bank of Tanzania (BoT) started to supply FX directly to the energy sector at more favourable FX rates in a bid to curb inflation. While the result has been marked TZS appreciation from its lows, the sustainability of current FX rates in the absence of such extraordinary measures is doubtful. The financing of an emergency power plan and continued social spending should keep the budget deficit wide over the medium term. With donor financing of development spending in particular under pressure, more will need to be done to widen the tax base. Tanzania has broadly pledged that recurrent spending will not exceed the value of revenue and grants. Higher royalty rates have already been imposed on the mining sector, and a tax on profits remains the subject of ongoing negotiations.
Standard Chartered forecasts: Tanzania

2011 GDP (real % y/y) CPI (% y/y) 91-day T-bill (%)* USD-TZS* Current account balance (% GDP) Fiscal balance** (% GDP) 6.1 11.3 14.75 1,760 -9.5 -6.9 2012 6.7 11.7 12.0 1,800 -8.7 -6.5 2013 7.5 5.7 9.0 1,820 -10.2 -6.0 2014 7.3 5.6 7.0 1,860 -9.1 -5.9
Politics
The ruling CCM party will continue to dominate Tanzanian politics. Reform may be accelerated during President Kikwetes final term in office, but broad-based party support for such efforts is not a given. The formation of a government of National Unity in Zanzibar appears to have reduced political risk on the island for now.
89
*end-period; ** for fiscal year ending 30 June Source: Standard Chartered Research
12 December 2011
Uganda
Razia Khan, +44 20 7885 6914
Razia.Khan@sc.com
Oil one day

Economic outlook
Financial issues
A recovery in agriculture and the expected completion of the Bujagali hydro-electricity project (with production due to rise from 50MW in January 2012 to 187MW by yearend) will drive growth. Spending is likely to be dampened by the lagged effect of the region-wide inflation shock in 2011, when Ugandas CPI inflation peaked at 30.4% and the Bank of Uganda (BoU) tightened rates by 1,000bps. Even so, growth momentum should remain favourable. Regional trade, although somewhat constrained by FX shortages in newly independent South Sudan, will remain an important influence on growth. Ugandas transport, construction and telecommunications sectors are also likely to see significant gains. Ugandas medium-term prospects will be driven by oil. Total reserves are estimated at 2.5bn barrels, of which c.1bn may be recoverable. Tax disputes have delayed production; approval of the sale of two-thirds of Tullows assets in the Lake Albert basin to Total and CNOOC is key to allowing production to begin. Domestic politics are a potential stumbling block, with parliament calling for a moratorium on oil development until an improved regulatory framework, including a petroleum bill, is in place. The presidency has rejected this request, as it is keen to accelerate the production timetable. While little oil will be produced, perhaps even in 2013, Cambridge Energy Research Associates (CERA) estimates that Ugandas production may average 189,000 barrels per day by 2021 respectable by Sub-Saharan African standards.
Despite delayed oil production, Uganda has been an early beneficiary of offshore portfolio investor interest. Favourable yields on government securities, the absence of new regulations constraining FX market liquidity (in contrast to other East African markets), and minimal dependence on domestic borrowing for deficit financing have added to its appeal. While the Bank of Uganda (BoU) will continue to rebuild its FX reserves, we expect further portfolio-driven Ugandan shilling (UGX) appreciation in 2012. Offshore flows are likely to gain momentum from the BoUs December 2011 decision to keep its rate on hold at 23% on evidence of a peak in inflation. Interest rate easing is likely to start in H2-2012 as CPI inflation decelerates more sharply. The difficult external environment is likely to prevent planned eurobond issuance. With fiscal revenue likely to rise in FY12 (began 1 July 2011) on the completion of the Tullow-Total/CNOOC deal, there is little immediate need for external borrowing. Plans for East African Community (EAC) monetary union are likely to be delayed once again, despite some talk of a 2012 deadline which is unrealistic, in our view.
Policy
Standard Chartered forecasts: Uganda

2011 GDP (real % y/y) CPI (% y/y) Policy rate (%)* USD-UGX* Current account balance (% GDP) Fiscal balance** (% GDP) 6.4 18.7 23.0 2,600 -10.2 -6.6 2012 6.6 15.3 16.0 2,660 -9.9 -4.0 2013 7.0 1.8 13.0 2,520 -7.7 -4.5 2014 7.3
Following 2011 elections, spending growth is likely to moderate in FY12 and FY13, although wider budget deficits (of 4.5% and 4.8% of GDP) are likely as infrastructure development features prominently. Donor dependence will continue, creating some risk in a weakening external environment. After Uganda failed an IMF Policy Support Instrument (PSI) review in early 2011, relations have improved, with the authorities pledging to tighten policy. Tax exemptions are likely to be rationalised in the year ahead to boost revenue further.
Politics
5.1 11.0 2,300 -7.3 -4.8
*end-period; ** for fiscal year starting 1 July Source: Standard Chartered Research
12 December 2011
The standoff between President Museveni and the opposition is likely to continue, and may worsen amid opposition allegations over the oil deals. Disputes in the oil-rich Bunyoro region may feature more prominently, while Bugandan ambitions of self-determination will remain a source of tension. Hopes are high that US assistance to capture Kony, the leader of the notorious Lords Resistance Army, will end an era of instability in the north. As traditional donor assistance is constrained, closer co-operation with China will be sought.
90
Zambia
Razia Khan, +44 20 7885 6914
Razia.Khan@sc.com
Resource nationalism, revisited

Economic outlook
Despite global economic uncertainty, Zambias growth rate looks likely to accelerate to 7% in 2012. Mining output should rise following output disruptions related to heavy rains in 2011. Although the longstanding 2012 production target of 1mn tonnes may be missed, the sector is still poised for healthy medium-term growth. We forecast an average LME 3M copper price of USD 8,750/tonne in 2012 on tight global supply, sufficient to encourage further investment in the sector. GDP growth will also be supported by continued gains in agriculture. Following the peaceful government transition after the September 2011 elections interpreted by some as a rejection of the liberal economic agenda of the former ruling Movement for Multiparty Democracy (MMD) the Zambian economy will benefit from increased social and infrastructure spending and smallholder farm support programmes. Post-election, investor concerns have centred on rapid regulatory change, with some privatisations reversed by the new Patriotic Front (PF) government. Labour laws, adherence to minimum wage regulations, corporate taxes, and state shareholding in the mining sector (for selected companies with large operational capacity) have become new areas of focus. After the transition, we expect a more settled regulatory environment in 2012.
first option, the countrys graduation to middle-income status, the uncertain donor environment resulting from the global crisis, and increasing infrastructure needs all suggest a funding requirement beyond what is available from concessional finance. However, it is unclear whether the global environment characterised by significant European bank refinancing needs, asset disposals and deleveraging will be conducive to eurobond issuance by a B+-rated sovereign.
Policy
The budget deficit is set to widen to 4.3% of GDP in 2012 from c.3% in previous years on increased health-care and education spending (up 45% and 27%, respectively) and a 38% rise in spending on the successful farm subsidy programme all reflecting the PF governments priorities. Mining royalties will double to 6%, and a greater dependence on external borrowing should limit domestic financing of the deficit to 1.3% of GDP. Although a new Bank of Zambia governor has yet to be appointed, the PF government has unveiled a raft of measures aimed at reducing banks cost of funds in order to encourage cheaper lending to the real sector. Government securities are likely to be the immediate beneficiary of the liquidity release, with bond yields trending down. 7% inflation is targeted in 2012. We expect the current account to remain in surplus, making Zambia on a total-return basis an attractive destination for offshore portfolio investment.
Financial issues
The 2012 budget confirmed Zambias intention to proceed with a maiden eurobond of USD 500mn. Although Zambia will target concessional borrowing as a
Politics
Standard Chartered forecasts: Zambia

2011 GDP (real % y/y) CPI (% y/y) 91-day T-bill (%)* USD-ZMK* Current account balance (% GDP) Fiscal balance (% GDP) *end-period
12 December 2011
2012 7.0 7.4 5.4 4,800 2.0 -4.3
2013 7.2 9.2 6.2 4,900 2.2 -4.5
2014 7.5 9.0 7.0 5,100 2.4 -4.8
6.5 8.8 7.75 5,200 3.2 -3.1
Zambias reputation for political stability was enhanced by the peaceful change of government after the September elections. While President Sata, who won with 43% of the vote, has since adopted a more conciliatory stance on Chinese and Indian investment, the new PF government is keen to make its mark early, focusing on wealth redistribution, unemployment and anti-corruption. Despite doubling mining-sector royalties (to 6% for copper), the government has not reintroduced a windfall tax on earnings, claiming that this would disrupt investment given the uncertain global climate. Instead, the government will seek to increase its equity share in the mines to 35% from 15-20%, in order to derive higher returns from Zambias mineral wealth and provide security in the event of mine closure.
91
Economies MENA
MENA Charts of the year

Chart 1: Selected 2011 unemployment rates in MENA Double-digit unemployment is a challenge for governments
20 18 16 14 12 10 8 6 4 2 0 Egypt Jordan* Tunisia* Saudi Arabia *Forecast
Chart 2: Current account as % of GDP, 2012 forecasts The exporters and importers of capital
20 15 10 5 0 -5 -10 -15 -20 GCC* Egypt Jordan Lebanon *GCC is a 2011 GDP weighted average
Chart 3: Fiscal balance as % of GDP, 2012 forecasts The haves and have-nots
10 *GCC is a 2011 GDP weighted average
Chart 4: GCC project pipeline 2012 Time for implementation (USD bn)
Industrial Alternative Energies Petrochemicals
Metals Water & Power Oil & Gas
-5
-10 GCC* Lebanon Jordan Egypt
Infrastructure
20
40
60
80
100
120
140
Sources: Meed Projects, Standard Chartered Research
Chart 5: GCC 2012 budget breakeven oil prices Boosted by higher spending (USD/bbl, Brent)
120 100 80 60 40 20 0
Saudi Arabia Bahrain UAE Oman Kuwait
Chart 6: GCCs major export markets, % of total exports As long as Asia keeps growing
ROW Thailand Singapore EU 27 United States South Korea China India Japan
10
15
20
25
30
35
Source: DG Trade
12 December 2011
93
MENA
Marios Maratheftis, +971 4 508 3311
Marios.Maratheftis@sc.com
Kaushik Rudra, +65 6596 8260

Kaushik.Rudra@sc.com
Local differentiators
Economic outlook
The Middle East and North Africa (MENA) is as economically diverse as a region could be, with the oilrich Gulf Cooperation Council (GCC) countries facing very different economic dynamics than countries without rich resource endowments. The region is also relatively open and is therefore subject, to varying degrees, to global economic trends. But it is local factors that will ultimately determine economic performance in 2012. The economic and market implications of Europes debt problems bring back memories of 2009. However, parts of MENA are in a significantly stronger position now. This is particularly true for the GCC economies, which we expect to show resilience, with growth decelerating only moderately in 2012. Asset bubbles in the GCC have already burst, and unsustainable credit booms are long over. Base effects have become more favourable. Tight credit conditions are set to persist, with Saudi Arabia perhaps being the main exception. While tighter credit will not help growth, it will not be as big a drag as it was in 2009, when credit growth in the region went from an uncontrollable pace to a complete halt. We expect oil prices to remain elevated in 2012. This bodes well for the government finances of oil-exporting countries, and it should enable counter-cyclical fiscal responses. Fiscal policy in Saudi Arabia is already on an expansionary trajectory and should continue to drive growth in 2012. Abu Dhabi and Qatar adopted a more conservative approach to government expenditure in 2011. Their project pipelines are full, though, and while we do not anticipate a boom in government spending, any increase
will help to pick up the slack in the economy. Stable oil prices provide governments in the region with ample fiscal space.
Oil production has a far more important direct impact on headline growth than oil prices. We expect less of a drag on regional growth from lower oil production in 2012 than in 2009, when production was cut. At the same time, any positive contributions to growth will be minimal, as significant production increases from GCC countries seem unlikely. Non-oil-producing countries, which are also dependent on net capital inflows, will face a more challenging 2012. Growth in Jordan and Egypt will be fragile, and both countries will need to attract foreign inflows to boost their reserves and fund their current account and fiscal deficits. Jordan is attracting inflows from the GCC, and its prospects for joining the bloc are still on the table, although nothing is final. In Egypt, political stability will be the key factor, as it is necessary to attract both investment and tourism. The countrys presidential elections in June 2012 will be widely watched.
Financial issues
The UAE has significant debt maturities in 2012, which should keep credit conditions in the economy tight. On the currency front, the GCCs US dollar pegs should remain unchallenged. In the GCC, the focus will be on the credit market. We prefer higher-quality and more liquid names in particular the Qatar and Abu Dhabi high-grade (HG) quasisovereign complexes. Higher-beta and high-yield (HY) sectors such as Dubai Inc. are more vulnerable to the global environment and will offer better risk-reward tradeoffs once markets stabilise. HG credits from the GCC, led by Abu Dhabi and Qatar, have held up well in the recent market sell-off for several reasons. GCC credit performance is not correlated with overall emerging-market (EM) flows, as GCC names are absent from broader EM indices; this makes the GCC an off-index bet for most international investors. Strong regional fundamentals and high sovereign ratings, at a time when the ratings of Western countries are under threat, are also key positives. It is worth considering the
94
Standard Chartered forecasts: GCC

2011 GDP (real % y/y) CPI (% y/y) Current account balance (% GDP) Fiscal balance (% GDP) *end-period
12 December 2011
2012 3.24 3.89 16.73 8.77
2013 3.84 3.68 14.51 7.92
2014 3.95 3.93 13.24 8.08
6.67 3.80 19.53 10.28
MENA (cond)
behaviour of local investors the local bid phenomenon tends to keep certain GCC credits well supported, even in the face of market pressure elsewhere. On the basis of valuations, GCC credits appear cheap in comparison to much lower-rated credits.
However, we refrain from going outright long the sovereign or the Dubai 2012 maturities, in line with our broader bearish stance on the HY sector.
Policy
Despite its recent outperformance, we still like the HG sector, which is cheap for its ratings and offers better riskreward in the current negative market environment. We see more value in quasi-sovereigns from Abu Dhabi and Qatar than in sovereign bonds given the attractive spread pick-up over the sovereign. Shorter-dated government bonds in particular look expensive (the ADGB 14 and QATAR 14). We have recommended switches from these bonds into quasi-sovereigns such as RASGAS, MUBAUH and INTPET. The GCC banking sector is also attractive as the fundamentals of most of the regions banks continue to recover. After trading inside the corporates in October and early November, banks from the region were trading wider than corporates going into end-2011. We recognise that events in Western banking systems can undermine sentiment for banks across the world. However, given the highly interventionist nature of GCC governments in their banking systems, we see value in owning banks over corporates. Our preferred picks are the COMQAT 14 and the UNBUH 16. Dubai Inc. has underperformed relative to Abu Dhabi and Qatar, in line with the weak performance of HY credits globally. We have recommended relative value switch trades among the stronger credits in Dubai Inc. (DEWAAE 16 to 15, EMIRAT 16 to DPWDU 17).
GCC countries have the fiscal space to shift to more expansionary policy. Policy in Saudi Arabia is already expansionary, and this is set to continue in 2012. We also anticipate higher spending in Qatar and, to some extent, Abu Dhabi. In Egypt and Jordan, fiscal headroom is limited and the focus will be on financing the funding gap rather than on growth. Monetary policy in the GCC will continue to be tied to US policy, as the regions currency pegs face no pressure for either revaluation or devaluation. We anticipate rate hikes in Egypt and Pakistan, not so much for domestic economic reasons but rather to shore up pressure on their currencies.
Other issues
The European debt crisis illustrates how important it is for countries to be able to borrow in their own national currencies, where their central banks can act as lenders of last resort. Local-currency debt capital markets in most of the region are at an embryonic stage. The one exception is Egypt; most of the governments debt is in local currency, which has allowed the country to contain the economic impact of political turmoil to a large extent. The UAE posted a federal budget deficit in 2011, and we anticipate a similar outcome in 2012. Although the federal budget is not as important as budgets at the emirate level (it accounts for only about 10% of total government spending), the deficit provides the opportunity for a localcurrency federal bond issuance.
Our in-house currency barometers EGP is under relatively stronger pressure to devalue
110 105 100 95 90 85 80 75 Aug-09 Dec-09 Apr-10 Aug-10 Dec-10 Apr-11 Aug-11 EGP SAR JOD
Politics
Political uncertainty in the region highlights the need to differentiate among countries. Politically and socially stable oil exporters stand to benefit from a flight to quality and a risk premium on oil prices. Parliamentary elections have taken place in Morocco, Tunisia and Egypt (first phase). An emerging theme is the outperformance of Islamist parties. In all cases, the winners highlighted their moderation and commitment to free-market economies. But it is also worth noting the strength of the more radical Nour party in Egypt, which emerged with 24% of the votes.

12 December 2011 95
Algeria
Philippe Dauba-Pantanacce, +971 4 508 3740
Philippe.Dauba-Pantanacce@sc.com
Output erosion
Economic outlook
Financial issues
Despite high oil prices, which will ensure comfortable current account surpluses, rising public spending and high nominal GDP growth, real growth will be capped by anaemic growth in hydrocarbon GDP the slowest of all MENA oil producers at barely 0.7% in 2011. This will continue owing to multiple problems in the sector. We estimate sub-optimal 3.0% real GDP growth for 2011 and 3.5% for 2012. The government has confirmed that hydrocarbon export volumes dipped slightly in 2011. The lack of new oil and gas projects was compounded by technical issues in liquefied natural gas (LNG) production. The ongoing reluctance of crucial foreign firms to bid on new permits has worsened the situation and deprived the sector of vital expertise. Government spending on wages and infrastructure is likely to have underpinned 5% real growth in the non-oil sector in 2011. Total government expenditure rose by 34% in 2011, likely pushed the fiscal deficit to 3% of GDP. This situation is likely be corrected in 2012, when we forecast a 1.5% deficit. The World Banks Doing Business Report 2012 indicates that red tape and structural rigidities have worsened in Algeria, which fell by five places and sits between Iran and Iraq at number 148. Algeria lost ground in categories such as getting credit, which was already almost impossible. This will continue to hamper private-sector non-oil GDP growth.
The Algerian banking system has government ownership in MENA, at 85%.
the
highest
Capital markets are under-developed, as the authorities have eschewed public debt (the debt-to-GDP ratio is less than 3%). Credit to the private sector is virtually nonexistent, with a ban on all credit outside of housing mortgages.
Policy
Algerias monetary policy targets inflation at 3%. While there is no official money supply growth target, the central bank, Banque dAlgrie (BdA), closely watches monetary aggregates. In order to achieve its inflation objectives, BdA adjusts the deposit auction rate, while the government provides a wide range of subsidies for staple consumption items. Liquidity absorption is controlled by regular deposit auctions. The level of interest rates has been stable since 2005: below 2% for the deposit rate, 4% for the discount rate (benchmark rate), and 8% for the lending rate.
The authorities have recently preferred to control inflation though price controls rather than through interest rates.
Other issues
Standard Chartered forecasts: Algeria

2011 GDP (real % y/y) CPI (% y/y) Policy rate (%)* USD-DZD* Current account balance (% GDP) Fiscal balance (% GDP) *end-period
12 December 2011
In 2008, majority foreign ownership of domestic companies was limited to 49%. Since July 2010, local firms have been required to be considered in private- and public-sector bids, even if their pricing is 25% higher. A tax regime that is volatile and detrimental to foreign investors was also put in place, as well as restrictions on certain imports (which sometimes turn into bans). Very recently, the energy sector including the ministry has put pressure on Algerias president to reform the energy law to foster more investment interest from foreign firms.
2012 3.5 4.3 4.0 73.60 13.0 -1.5
2013 4.0 4.5 4.0 73.00 14.0 1.5
2014 4.5 4.5 4.0 72.50 16 3.0
3.0 4.0 4.0 74.50 11.0 -3.0
Politics
Political succession following the long-running regime of President Abdelaziz Bouteflika is a major concern. Social discontent and political disenfranchisement will persist. Roughly one-third of Algerians aged under 30 are unemployed. Sporadic militant activism will continue to pose a risk, although not a systemic one.
96
Bahrain
Simrin Sandhu, +65 6596 8253

Simrin.Sandhu@sc.com
Saved by oil
Economic outlook

Bahrains economy is recovering from a sudden slowdown in H1-2011. After contracting on a q/q basis in Q1, the economy slowly recovered, growing 1.1% y/y in Q2 and 2.4% y/y in Q3. Owing to the oil-driven economy, we expect real GDP growth to accelerate to 3.5% in 2012 from 1.9% in 2011. Growth in 2012 will be driven by strong oil production and a highly favourable base effect.
Bahrain has a large banking sector, by far the largest relative to the size of the economy among GCC countries (retail banks assets are equal to 300% of GDP, and wholesale banks assets are an additional 700% of GDP). The wholesale banking system contracted by around 14% in Q1-2011 but remained broadly stable in Q2 and Q3. Prior to the onset of the regional political unrest earlier in 2011, the fundamentals of Bahrains retail banks were on an improving trajectory. Given the dominance of foreign players, political and social stability will be key. The Bahrain sovereign successfully issued a USD 750mn sukuk recently, capitalising on strong demand from Islamic funds from both within the region and Asia. However, the concerns highlighted above are affecting the performance of Bahraini bonds, which are trading at relatively wider levels.
Bahrains growth story is driven by hydrocarbons. The non-oil economy was still contracting in Q3-2011. The real-estate sector contracted 6.5% y/y, the hotel by 17.6%, construction by 3%, and offshore financial institutions by 4.2%. Attesting to the absence of pressure on the real economy, 2011 is likely to have been a year of deflation for Bahrain the first in 25 years. We expect prices to fall by around 0.3% for the full year, despite a slight pick-up in H2. CPI items such as rents declined 15% in the year to October. The fiscal deficit likely widened to 6.5% of GDP in 2011 from 5.6% in 2010 owing to a 44% increase in government spending, especially on extra subsidies, and one-off payments to Bahraini families early in the year.
Policy
The Central Bank of Bahrain will continue its prudent supervision and regulation of the economy, ensuring liquidity intervention in the market when needed and keeping interest rates in line with the Feds.
Financial issues
Other issues
The breakeven oil price for the government budget, already high at USD 100/barrel for 2011, has increased as a result of higher government expenditure, contributing to ongoing structural fiscal deficits.
The Bahrainisation of the workforce will continue to be a policy preoccupation. The government may also introduce measures to ensure more equal access to jobs across sectarian lines. Bahrain has adjusted its sponsorship law to allow workers to move from one employer to another without the employers consent. This places its labour laws at the forefront of the region.
Standard Chartered forecasts: Bahrain

2011 GDP (real % y/y) CPI (% y/y) Policy rate (%)* USD-BHD* Current account balance (% GDP) Fiscal balance (% GDP) *end-period
12 December 2011
2012 3.5 3.0 0.5 0.38 3.2 -6.0
2013 4.0 3.5 0.5 0.38 3.5 -5.0
2014 4.5 3.5 0.75 0.38 4.0 -4.5
1.9 -0.3 0.5 0.38 3.5 -6.5
Politics
The findings of the Bahrain Independent Commission of Inquiry, released in November 2011, confirmed severe structural dysfunction in the handling of popular protests in early 2011, which led to the temporary freeze of a major arms contract with Bahrains ally, the US. The report includes several actionable recommendations that aim to promote reconciliation within the country. Implementation of many of these recommendations will be closely watched.
97
Egypt
Nancy Fahim, +971 4 508 3627
Nancy.Fahim@sc.com
Managing change and expectations

Economic outlook

Egypts economy is being shaped by the political landscape. Political events dominate FY12 (ending June 2012). Election results for the lower house of parliament are expected to be finalised in January; this will be followed by elections for the upper house by end-January and presidential elections at end-June 2012. Economic growth was hampered in early 2011 at the height of the political turmoil; the economy contracted 4.2% y/y in Q3FY11 (January-March 2011), and returned to barely positive growth of 0.4% in the April-June quarter. We expect a stronger performance in H2-FY12 (JanuaryJune 2012) on a low base effect. We forecast that fullyear growth will tick up slightly to 2.0% in FY12 from 1.8% in FY11 as manufacturing (Egypts largest sector, which contributed 26% of FY11 GDP) moves into expansion mode. Manufacturing was likely affected by numerous strikes and factory shutdowns in early 2011. We expect public and social services to be major drivers of growth in FY12, given the high expectations of the population during Egypts time of transition. These sectors contributed 7.8% and 4.6% of FY11 GDP and grew by 4.5% and 2.8%, respectively. We also expect higher public spending to widen the budget deficit as a percentage of GDP. Suez Canal receipts, calculated as a component of GDP, grew by a strong 11.5% y/y. The deteriorating global outlook in 2012 is likely to detract from this growth.
Egypts budget deficit widened in FY11 to 9.6% of GDP from 8.1% in FY10. The government targets a deficit of 8.6% of GDP for FY12. This will likely be missed; we expect the deficit to widen to 10% of GDP. The government has an extensive subsidy programme, which it had planned to gradually phase out. This will be difficult in the short term, as maintaining social stability is a priority. Subsidies made up 31% of government expenditure in FY11, increasing 19.3% during the year. Fuel and food account for the largest portion of subsidies, at 55% and 27%, respectively. The burden is significant, and Egypt faces a USD 23bn funding gap in its FY12 budget. An inflow of foreign aid would help to meet this. Foreign grants saw a significant 60% y/y decline in FY11, and although grants are not the main source of government revenue, this fall contributed to the 3.2% decline in total revenue for the fiscal year. Significant amounts of aid have been pledged to Egypt, but little has actually been received. Egypt has announced its openness to an IMF loan of USD 3.2bn, but a deal has yet to be finalised. Egypt faces weak external balances in FY12. We expect the current account deficit to widen and reverse the course it took in FY11, when it narrowed largely on the back of an improving trade balance and higher Suez Canal receipts. Egypts exports were supported by higher oil prices in 2011, causing the trade deficit to narrow. However, lower oil prices in 2012 will reduce this support. Egypts exports will also be impacted by the weak global outlook; the EU is Egypts largest trade partner. Imports will likely see upward price pressure given a weakening Egyptian pound (EGP); we expect the trade deficit to widen overall. The current account is also affected by Suez Canal and tourism receipts. Authorities plan to increase tolls and fees for the canal (possibly an effort to counter the weak global environment), but these will only be implemented in Q4-FY12. Tourism receipts, which fell by 8.6%y/y in FY11, will remain weak as politics continue to take centre stage. The absolute number of tourist arrivals picked up steadily throughout most of 2011 after dropping sharply in February; however, H2-FY12 has a packed political schedule and attracting tourists will be a challenge. FDI in Egypt, as well as portfolio inflows, are likely to decline as foreign investors await the results of parliamentary
98
Standard Chartered forecasts: Egypt

2011 GDP (real % y/y) CPI (% y/y) Policy rate (%)* USD-EGP* Current account balance (% GDP) Fiscal balance (% GDP) 1.8 11.3 9.25 6.20 -1.2 -9.6 2012 2.0 10.0 9.75 6.82 -1.9 -10.0 2013 3.0 11.5 9.75 7.40 -1.5 -9.0 2014 3.5 11.0 9.50 7.75 -0.5 -8.0
Note: All forecasts are for the July-June fiscal year ending in the year in column heading; *end of calendar year Source: Standard Chartered Research
12 December 2011
Egypt (cond)
and presidential elections. FDI as a percentage of GDP fell to 0.9% in FY11 from 3.1% in FY10. Egypts balance of payments dropped sharply to a deficit of 4.1% of GDP in FY11 from a surplus of 1.5% in FY10.
Inflation eased in Q1-FY12, averaging 9.0% y/y compared to 10.9% in Q1-FY11. Inflation had stabilised at 11.3% for two years (FY10 and FY11), in line with our expectations. We think FY12 inflation will remain elevated at 10%, given our outlook for a weakening EGP. Core inflation, which strips out volatile goods (namely fruits and vegetables) and regulated items, has moved into the central banks 6-8% comfort range since August 2011.
y/y by August 2011. Domestic banks have had to soak up the excess, and yields on the 1Y T-bill averaged 14.9% in the first 11 months of 2011, compared to 11.7% during the same period in 2010. Resorting to local funding is leading to the crowding-out of the private sector. Average lending to the government by domestic banks during the January-August 2011 period grew 30% y/y. At the same time, lending to the private sector grew by a modest 3% y/y. There are likely to be demand-side issues given the weak economic environment; however, the reliance on domestic banks for funding does not help.
Policy
Financial issues
USD-EGP broke through the 6.00 level for the first time in six years in November 2011. We think there is room for the currency to weaken further. Throughout 2011, intervention and capital controls provided support to the EGP. By November 2011, net international reserves had fallen to USD 20bn from USD 35bn at the start of the year. The reserves provide approximately 4.8 months of import cover, down from 8.2 months at the start of 2011. We estimate that the more liquid foreign-currency reserves covered approximately 3.8 months of imports at the time. The likelihood of significant hard-currency inflows via tourism and foreign investment is low in the current environment, and the need to seek external funding has increased.
The Monetary Policy Committee (MPC) hiked key policy rates by 100bps at its November 2011 meeting. This was the MPCs first move since September 2009, when it cut rates by 25bps amid a global recession. The hike came at a time of easing headline inflation and core inflation moving into the central banks comfort zone. It was also a time of weak economic growth. However, concerns about capital outflows dominated; at the time of the hike, the currency was at its weakest level since the introduction of the rate corridor. Further hikes may be necessary in order to attract foreign capital and slow outflows. External funding would help to ease investor concerns; but in the absence of a deal (or if a deal is not brokered fast enough for the markets) and in the face of overall currency weakness, we expect rates to be hiked by a further 50bps in H2-FY12.
Other issues
An inflow of hard currency would not only help to rebuild reserves, but could also help to reinstate investor confidence. Foreign holdings of T-bills had dropped 71%
Our sustainability index (FX reserves/money supply) The index has fallen below previous devaluations (circled)
140 130 120 110 100 90 80 70 60 Jul-00 Jul-02 Jul-04 Jul-06 Jul-08 Jul-10
Egypts unemployment rate rose to 11.9% in FY11 from 9.1% in FY10. The unemployment rate averaged 10.6% from 2000-10. It is likely to remain elevated given upcoming political events, making unemployment an important issue for any upcoming government to tackle.
Politics
Elections for Egypts lower house of parliament began in November 2011 and are staggered over a period of six to seven weeks. Two-thirds of parliaments 498 seats will be filled by candidates belonging to parties or alliances. The rest will be taken up by independent candidates. Elections for the upper house of parliament will follow in January, and presidential elections are due at end-June. Political uncertainty is likely to remain the key risk for Egypt in 2012.

12 December 2011 99
Jordan
Sayem Ali, +92 21 3245 7839
Sayem.Ali@sc.com
Looking towards the GCC

Economic outlook
Financial issues
Jordans recovery from the 2008-09 financial crisis has been hit by a decline in tourism and investment inflows. We expect real GDP growth to remain weak at 2.5% in 2012, little changed from 2.4% in 2011. Unemployment rose to 13.1% in September 2011 from 11.8% at the end of 2010; unemployment is highest among urban educated youth. Downside risks prevail due to regional unrest and slowing growth in the US and EU, which together account for 20% of Jordans total exports. Government spending is constrained by limited resources. The decline in commodity prices has helped to ease inflation, with CPI inflation slowing to 3.2% in October 2011 from 5.6% in August. We expect inflation to average 4.5% in 2012, down slightly from 4.6% in 2011. The Central Bank of Jordan will likely look to cut rates if inflation remains within its comfort zone. However, falling FX reserves are limiting room for aggressive rate cuts. Gulf Cooperation Council (GCC) states have provided critical financial support to Jordans economy in 2011, including grants of USD 1.4bn (5.2% of GDP) from Saudi Arabia. Jordan could become a GCC member, which would give it preferential trade access to the blocs bigger markets and open up new avenues for investment. This move is a potential game-changer for Jordans economy and would boost growth over the medium term. All eyes will be on the outcome of the 19 December GCC summit, which will decide on Jordans membership.
Central bank reserves declined to USD 11bn (6.5 months of import cover) as of October 2011 from USD 12.3bn (7.6 months) at the end of 2010. This was primarily due to the rising oil and food import bill, which has led to a widening trade deficit. The trade gap increased 21% y/y in 9M-2011 to USD 8.4bn. Tourist arrivals also declined sharply, by 22% y/y, widening the current account deficit. The external account will remain vulnerable to international commodity prices. The Jordanian dinar (JOD) peg to the US dollar is an important pillar of financial stability, and the central bank is likely to keep the currency pegged at 0.71 over the medium term. The peg offers attractive carry opportunities to investors. Jordanian government T-bills offer attractive yields, both over the USD and regional GCC markets. The 1Y yield spreads between JOD T-bills and the USD, Saudi Arabian riyal (SAR) and the UAE dirham (AED) are 366bps, 320bps and 309bps, respectively (as of 1 December 2011).
Policy
Public debt increased to USD 19bn (67.4% of GDP) in August 2011 from USD 17.7bn (67.1% of GDP) at the end of 2010. Higher government wages and salaries and higher subsidies widened the deficit (excluding grants) to USD 1.7bn (5.9% of GDP) in the first nine months of 2011, an increase of 36% y/y. The deficit was financed through large official grants of USD 1.4bn (5.2% of GDP) from Saudi Arabia. The 2012 deficit is likely to widen further to 7.5% of GDP from 7.1% in 2011. Funding the deficit will be the main challenge.
Standard Chartered forecasts: Jordan

2011 GDP (real % y/y) CPI (% y/y) Policy rate (%)* USD-JOD* Current account balance (% GDP) Fiscal balance (% GDP) *end-period
12 December 2011
Politics
2013 2.9 5.0 4.5 0.71 -7.5 -7.0 2014 3.5 5.2 4.5 0.71 -7.0 -6.5
2012 2.5 4.5 4.25 0.71 -8.0 -7.5
Jordan is facing weaker growth and high unemployment, especially among the youth. King Abdullah has already reshuffled the cabinet three times since November 2010. The outlook for 2012 is challenging, with resource constraints limiting room for populist measures.
2.4 4.6 4.25 0.71 -7.5 -7.1

100
Kuwait
Nancy Fahim, +971 4 508 3647
Nancy.Fahim@sc.com

Oil in a days work

Economic outlook
Financial issues
Growth in 2012 will be driven by continued increases in oil production. Oil production was raised significantly in 2011 to make up for the Libyan shortfall. Kuwait is expected to continue producing more than its OPEC quota of 2.2 million barrels per day (mbd) and work towards a longer-term goal of raising output to 4mbd by 2020. Ministry officials cite global supply shortages as the driver behind the decision to raise oil production in 2012. Oil prices above USD 100/barrel (bbl) in 2011 and 2012 are likely to result in comfortable fiscal and current account balances for the Kuwaiti government. Oil dominates exports, and oil proceeds are the main source of government revenue. The budget for FY12 (ending March 2012) forecasts a deficit, but revenues are conservative (we estimate a required breakeven oil price of USD 63/bbl, versus our forecast that the Brent crude price will average 108/bbl in 2012), and expenditures often fall short of targets. As of H1-FY12 (AprilSeptember 2011), spending made up 27% of planned expenditures for the fiscal year. Inflation should ease in 2012 due to a higher base effect. Food prices exerted significant upward pressure in 2011 given the 18% weighting of food in Kuwaits CPI basket. Increased wages and cash handouts in 2011 also had an inflationary effect. Inflation averaged 5% in the JanuaryAugust 2011 period.
Kuwait targets its currency, the Kuwaiti dinar (KWD), against an undisclosed basket of currencies in which we think the US dollar (USD) has the heaviest weighting.
Policy
Kuwaits monetary policy is largely tied to that of the US, given the likely heavy presence of the USD in Kuwaits currency basket. Kuwaits benchmark policy rate, the discount rate, is expected to remain on hold at 2.5% in 2012. Fiscal policy is expansionary, with the FY12 budget showing a 19% increase over the FY11 budget to KWD 19bn.
Other issues
There seems to be limited progress on Kuwaits four-year development plan, which began in 2011 and envisages spending of USD 104bn. In 2011, spending was mostly directed towards current expenditure. The Emir has voiced his concerns that surplus funds are being misused, leading to structural imbalances in the economy. In our view, the distortion of incentives between the public and private sectors results in low participation of nationals in private-sector jobs. From a credit perspective, we have a Stable view on the Kuwaiti sovereign and are constructive on the Kuwaiti banking sector. There is scope for NPL ratios to trend down over the next 6-12 months. Medium-term, banks should benefit from planned increases in government spending. Despite being a higher-beta credit, the KWIPKK 16 is our preferred way to play the Kuwaiti financial space. The improvement in fundamentals in the Kuwaiti banking system should benefit KIPCO via higher dividend payments from its Kuwaiti subsidiary, Burgan Bank.
Standard Chartered forecasts: Kuwait

2011 GDP (real % y/y) CPI (% y/y) Policy rate (%)* USD-KWD* Current account balance (% GDP) Fiscal balance** (% GDP) 5.0 5.0 2.5 0.28 30.0 27.0 2012 3.0 4.5 2.5 0.28 27.0 26.0 2013 3.0 4.0 3.0 0.27 26.0 22.0 2014 3.5
Politics
4.0 3.0 0.27 27.0 22.0
12 December 2011
2011 saw a volatile political landscape across the region. In Kuwait, protests culminated on 29 November in the resignation of the prime minister and the rest of his government. This was the second cabinet resignation of the year. The resignation of the prime minister, who had been in office since 2006, may calm the opposition for some time. Political paralysis has the potential to stall significant progress on Kuwaits four-year development plan.
101
Lebanon
Growth to return in 2012

Economic outlook
Financial issues
Owing to a combination of domestic political bickering, regional tensions (especially in neighbouring Syria), and rising global risk aversion, Lebanon saw a marked slowdown in economic activity in 2011. This contrasts with several years of very strong growth (averaging 8% from 2007-10, despite the depressed global environment) and can be partly explained by a strong base effect. We estimate GDP growth at 1.5% in 2011 and expect it to accelerate to 3.75% in 2012. The central banks coincident indicator a sectorweighted reflection of economic activity attests to this slackening, especially in consumption. Growth in cleared cheques slowed to 5.6% in the first three quarters of 2011 from 20.8% in the same period in 2010. Construction permits shrank by 5.4% during the same period, while the number of property sales decreased by 16.6%. Barring a substantial further deterioration in the regional political environment, we expect a steady return to the previous real GDP growth trend. Lebanon continues to benefit from a strong services sector, robust domestic consumption (correlated to improved sentiment), and protracted pent-up reconstruction development needs following the war years. The comfortable primary surplus in 2010 allowed the government to adopt an accommodative fiscal policy during the 2011 downturn, while managing to maintain a modest surplus. We expect this prudent macroeconomic policy to continue in 2012.
The banking system will continue to be the backbone of the economy. Despite an unfavourable environment, total bank assets grew by a healthy 7.4% y/y in the first three quarters of 2011. The central banks FX reserves grew 12% in the year to September, reaching USD 32bn, or 18.6 months of import coverage. Capital markets also suffered in 2011, with declines of 12% and 28% y/y in the Beirut Stock Exchanges market capitalisation and trading volume, respectively, in the first three quarters of the year. 5Y CDS widened 140bps in the year to 30 November, reaching 440bps. Average bond spreads and yields on sovereign debt crept up during the same period, although we are confident that Lebanon will continue to find strong demand to help meet its refinancing needs.
Policy
Continued de-dollarisation will be a policy objective, even if a rise in risk perception triggers temporary reversals in the trend. Deposit dollarisation rose slightly in 2011 (to 66% from 63%) but is still off its peak. The 2012 draft budget includes the possibility of sharp tax increases, including a jump in the VAT rate to 12% from 10%. We think that Lebanon can afford this increase, which would help to address structural fiscal deficits. The VAT has proven to be a very efficient tax collection channel.
Other issues
Standard Chartered forecasts: Lebanon

2011 GDP (real % y/y) CPI (% y/y) Policy rate (%)* USD-LBP* Current account balance (% GDP) Fiscal balance (% GDP) *end-period
12 December 2011
2012 3.8 4.8 10.0 1,500 -16.0 -7.0
2013 5.5 5.5 10.0 1,500 -15.0 -6.5
2014 5.5 5.5 10.0 1,500 -13.0 -6.0
1.5 5.0 10.0 1,500 -17.5 -7.5
A proposal to move the electoral system towards fair proportional representation in 2013 would profoundly alter Lebanons political dynamics. In our view, this is unlikely to be approved in the near term, but the mere suggestion of the reform has set a precedent.
Politics
Politics will be mainly driven by repercussions from events in neighbouring Syria. A change of regime in Syria could shift political allegiances. Notably, there could be a change in the allegiance of the small swing Druze party, the same party that triggered a collapse of the pro-West government in January 2011.

102
Morocco
Economic resilience and a reform agenda

Economic outlook
As we foresaw earlier in the year, Morocco has had a good 2011. Real GDP is likely to have expanded 4.3% roughly in line with average growth of 4.8% in the past decade owing to a much better harvest than in 2010 and healthy non-agricultural growth. Excluding the unpredictable harvest component, Morocco should show similar growth in 2012 thanks to public and internationally funded projects and an increasingly developed services sector, which will compensate for weaker consumption resulting from muted growth in remittances from migrant workers in Europe. These workers represent the equivalent of 20% of the domestic workforce. Despite strong exports of phosphate, surprisingly strong tourism numbers and resilient remittances, the current account deficit worsened in 2011 owing to a record-high commodity bill, which caused the terms of trade to deteriorate. Slower growth in the commodity complex (including our forecast decrease in the average Brent oil price to USD 108/barrel) should help reverse this trend in 2012. A history of very prudent macroeconomic policy has helped to cushion Morocco against the volatile international environment of recent years. However, the 2011 fiscal deficit likely widened to 5.5%, driven by a subsidy-to-GDP ratio double the budgeted level of 2.1%. A decrease in commodity-linked subsidies in 2012 should narrow the fiscal deficit to 4.5% of GDP.
credit to the private sector as a proportion of GDP (80%) and the lowest state ownership of banks (27%) in North Africa.
Moroccos bond market is one of the most active in the region, and is deeper than regional peers. It is supported by a healthy banking sector, along with a growing culture of disintermediation. The banking sectors soundness indicators have continued to improve, with the NPL ratio steadily declining from 8% in 2007 to 4.5% in July 2011, despite a temporary rise early in the year.
Policy
Morocco will continue with its political and business reform agenda. It was the worlds biggest gainer in the World Banks 2012 Ease of Doing Business ranking, mostly thanks to its policies to improve the tax system and enhance investor protection. A broad reform of the Casablanca bourse aims to turn it into a tax-exempt, foreign-investor-friendly hub in North and West Africa, a project undertaken with co-operation from Singapore. The central bank, Bank Al Maghrib, is unlikely to change its monetary policy soon. Its benchmark rate has been fixed at an accommodative 3.25% since March 2009. Given low inflation and our expectation of protracted low interest rates in the euro area, the central bank is likely to delay hiking rates.
Other issues Financial issues

The countrys banking sector and capital markets are comparatively modern and advanced, with the highest
Standard Chartered forecasts: Morocco

2011 GDP (real % y/y) CPI (% y/y) Policy rate (%)* USD-MAD* Current account balance (% GDP) Fiscal balance (% GDP) *end-period
12 December 2011
2012 4.5 2.5 3.25 8.35 -4.0 -4.5
2013 5.0 3.0 3.25 8.00 -4.0 -3.5
2014 5.5 3.5 3.75 7.50 -4.0 -3.0
Given the protracted rise in global risk aversion and deteriorating sentiment and growth in Europe, Moroccos key economic partner, the sovereign will likely delay its initial plan to tap the international debt markets. The internationalisation of Moroccan debt would ease the burden on the domestic banking sector and limit the crowding-out effect.
4.3 1.5 3.25 8.40 -5.5 -5.5
Politics
After political reforms were approved in a referendum in July 2011, a newly empowered parliament was elected in November. The winning moderate Islamist party and secularist parties formed a coalition that defeated the historically dominant parties after an election that was deemed fair, free and transparent, with a much higher turnout than expected.

103
Oman
Nancy Fahim, +971 4 508 3627
Nancy.Fahim@sc.com

Bucking the global trend

Economic outlook
Growth will be sustained by Omans eighth five-year plan, which began in 2011 and is part of a longer-term goal of diversifying away from oil. The bulk of the spending under the plan will go to infrastructure (approximately 70% of the total), followed by social spending, which includes education and health care. Commodity production has a targeted allocation of less than 3%. The development of roads, airports and ports takes up the greatest portion of infrastructure spending, while Muscat, the capital city, accounts for the largest share of spending in the overall plan. Infrastructure spending exceeded targets under the seventh five-year plan, increasing at the expense of spending on social structures and services (including housing and utilities). The limited allocation to commodity production is in line with Omans longer-term diversification plans. Omans 2012 draft budget envisages a 25% y/y rise in expenditure. The budget needs to be approved by the Majlis al-Shura (the elected arm of parliament) and the Sultan. The draft budget puts expenditure at OMR 10bn and revenue at OMR 8.8bn. We expect the fiscal deficit to turn to a surplus in 2012 on the back of higher-thanbudgeted oil revenue. Omans 2012 draft budget is based on an oil price of USD 75/barrel (bbl); we forecast that Brent crude will average USD 108/bbl in 2012. Average daily oil production is seen at 920,000 bbl, a 2.7% y/y rise over the 2011 target level. We also expect Oman to post a fiscal surplus for 2011. As of September 2011, total revenue was 14% higher
than the full-year target. Oil and gas accounted for 86% of total government revenue over the period. Spending in 2011 is also likely to fall short of the planned amount. An additional package announced in 2011 pushed expenditure to OMR 9.1bn. By September 2011, 67% of this had been spent. About OMR 1bn per month in Q42011 would need to be spent to meet the target; this is unlikely.
Inflation should stabilise at 4% in 2012. Increases in both public- and private-sector wages and allowances in 2011 will likely continue to feed through. Food prices are expected to remain elevated at 2011 levels, picking up in H1-2012 before moderating in H2. Food and beverages are the largest component of Omans CPI basket, with a combined 30% weight. Rents are the second-largest component, at 20%; they are expected to play a smaller role in driving inflation given the still-recovering housing market.
Financial issues
Credit growth picked up in 2011, reaching 12% y/y as of September. Lending to the private sector also grew, moving out of its 2009-10 slump and rising 9% y/y in September 2011. We expect this trend to continue in 2012 given the countrys plans to increase spending. Private-sector credit growth should move towards the 12% average of the last decade in 2012 (it peaked in 2008 at 44%). Banks would be better able to sustain these lending rates with increased deposits; in 2011, the loan-to-deposit ratio peaked at 104.6% in August before dropping to 100.9% in September. Government debt/GDP is low, falling to 5.1% in 2010 from 16% in 2002. There is room for funding via the markets. The latest issuance took place in November 2011, when the government issued a 5Y local-currency development bond of OMR 150mn, likely driven by medium-term financing needs.
Standard Chartered forecasts: Oman

2011 GDP (real % y/y) CPI (% y/y) Policy rate (%)* USD-OMR* Current account balance (% GDP) Fiscal balance (% GDP) *end-period
12 December 2011
2013 4.3 4.5 2.5 0.39 8.0 0.8 2014 4.0 5.0 2.5 0.39 9.0 0.6
2012 4.7 4.0 2.0 0.39 9.0 0.8
4.5 4.0 2.0 0.39 10.0 1.0
Policy
Monetary policy moves in tandem with that of the US given the Omani riyal (OMR) peg to the US dollar (USD). Omans key policy rate (the repo rate) is at an accommodative level and is unlikely to change in 2012.

104
Oman (cond)
Fiscal policy should be expansionary heading into 2012. Spending on current consumption (mainly via higher wages) needs to be balanced by spending on infrastructure, in line with the five-year plan. This would help to generate longer-term growth. Spending will continue to be buoyed by higher oil prices. Omans greatest vulnerability stems from its over-reliance on oil revenue (which, together with gas, makes up 80% of government revenue). The breakeven price required to balance the budget has continually risen: the 2012 budget sees a breakeven oil price of USD 75/bbl, up from USD 58/bbl in 2011. This leaves Oman more vulnerable to oil-price shocks. Oman has sufficient reserves, however, to maintain spending plans; FX reserves stood at USD 12.6bn at end-September 2011.
Increased private-sector participation by Omani nationals would also help to reduce the governments burden of job creation. Nationals already make up 86% of all public positions, and despite years of Omanisation policies (which seek to ensure a minimum percentage of nationals in private-sector businesses), participation by Omanis in the private sector is low, at 16%. This is largely attributable to work incentives. Bridging the gap between public- and private-sector work features and benefits would incentivise more nationals to move into the private sector. From a credit perspective, we have a Stable outlook on the Oman sovereign. Low debt levels give the government a large degree of policy flexibility. The combination of large international reserves and offshorebased external assets results in comfortable external and net creditor positions. Oman does not have outstanding sovereign eurobond debt, and we do not expect the sovereign to come to the market soon. The absence of government issuance makes it challenging for investors to price sovereign risk and is an impediment to the development of a robust credit market. The one credit that does trade is oilfield-services company MB Petroleum Services (NR/B-/BB-), which placed a USD 320mn eurobond in November 2010. This bond was put under pressure starting in August 2011; the yield widened by around 700bps between beginning of August and end-November 2011. S&P downgraded MBPS on 30 November 2011 to B- from B+, citing concerns over liquidity and leverage.
Other issues
Oman foresees oil and gas contributions to GDP of 9% and 10%, respectively, by 2020. The need to diversify away from oil is two-fold. First, Omans oil reserves are falling. Reserves, currently at an estimated 5.5bn barrels, are expected to last another 25-30 years. Oman has been running down its oil reserves since 2001. At the same time, the hydrocarbon sector as a percentage of GDP has fallen in real terms, suggesting that increased production has not caused Oman to stray far from its diversification plans. Hydrocarbons as a percentage of GDP fell to 30% in 2009 from 50% in 2000. Second, the capital-intensive nature of the hydrocarbon sector means it is unable to create sufficient jobs for the countrys young population. Oman has the youngest population in MENA, with 60% under the age of 30, and population growth is estimated at 30% over the next 20 years.
Politics
2011 budget versus actual as of September 2011 Revenue exceeds target on conservative oil-price estimate
Actual by Sept-11 (OMR bn) Budget (OMR bn)
Omans ruler, Sultan Qaboos bin Said al Said, holds the highest position in the country. Protests in 2011 were centred on work-related issues and demands for a more explicit means by which public opinion can be heard. October 2011 elections for the Majlis al-Shura (consultative council), the elected body of parliament, saw a strong turnout by eligible voters. In response to demands from the public, the Sultan granted legislative powers to the council, which previously held only an advisory role. Proposals and draft laws made by the council will be turned over to the government for assessment; government ministers are appointed by the Sultan. While the Sultan remains the ultimate decisionmaker, this change is positive in a region where the public has voiced demands for greater involvement in national affairs.
105
Revenue 0
Expenditure
10

12 December 2011
Qatar
Shady Shaher, +971 4 508 3647
Shady.Shaher@sc.com
Lower growth, better growth

Economic outlook
contributor
to
the
economy to
in GDP
2012.
However, should
2012 marks a significant inflection point for Qatar. We forecast that the emirates real GDP growth will moderate to 5.9% in 2012, from an estimated 16.9% in 2011. Qatar is likely to meet its target level for liquefied natural gas (LNG) output around year-end 2011, leaving little room for LNG to remain the key driver of super-charged economic growth rates (as it has been for the last seven years) in 2012. Even though growth is likely to slow, the real economy will probably play a much more important role. 2012 should mark the next phase of Qatars growth, marked by higher-quality growth driven by activity in the non-oil and gas sectors.
hydrocarbons
contribution
growth
moderate to 52% in 2012 from 55% in 2011 as non-oil infrastructure investment picks up. In 2012, LNG infrastructure will allow production of close to 77mt/year, making Qatar the worlds largest exporter of LNG. Global consumption of LNG increased to 3.2trn cubic feet in 2010 from 2.4trn cubic feet in 2000, according to the BP Statistical Review of Energy; this points to bright export prospects. Increasingly, Qatars gas customers are from Asia (Asias demand for gas has almost doubled over the last decade).
Real growth in the gas sector is a function of production and will moderate significantly in 2012 following the completion of all key LNG expansion projects. Annualised LNG production (total annual output) lags capacity growth given the phased nature of growth in LNG streams throughout any given year. We expect annual output to reach 70 million tonnes (mt) in 2011 and 77.8mt in 2012, up from an estimated 46mt in 2010 and 36mt in 2009. This means that annual output increases will no longer be a major driver of Qatars real economic expansion in 2012.
Japan will be a key destination for LNG exports. We expect Japan to depend on LNG to power 50% of its alternative power sources. Qatar is well placed to be a key supplier to Japan in 2012 for three reasons. First, it can switch cargoes from less profitable markets such as North America (where shale gas has made the US selfsufficient) to Japan. Second, it has invested heavily in its maritime LNG fleet, now the largest in the world, with close to 80 ships; this gives it the flexibility to ship cargoes competitively. Third, we estimate that Qatar still has the capacity to meet demand, with at least 3mt of uncommitted capacity and about 25mt of cargoes that can be sold in the spot market, as they are not bound by longer-term contracts.
We estimate that growth in the mining and quarrying subsector accelerated to 23% in 2011 from 18% in 2010. However, we expect this to moderate to 2% in 2012. The hydrocarbon sector is likely to remain the largest
We expect investment in the non-oil and gas sectors to pick up significantly in 2012 as the country gears up to host the FIFA 2022 World Cup. We estimate that close to USD 107bn of projects are in the pipeline as Qatar begins to prepare for the World Cup. Most of the
Standard Chartered forecasts: Qatar

2011 GDP (real % y/y) CPI (% y/y) Policy rate (%)* USD-QAR* Current account balance (% GDP)** Fiscal balance** (% GDP) 16.9 2.4 0.75 3.64 32.0 9.0 2012 5.9 3.3 0.75 3.64 30.0 6.8 2013 5.6 3.8 0.75 3.64 27.0 7.5 2014 5.4 4.2 0.75 3.64 25.0 7.0
investments are infrastructure-related. The transport sector will receive close to USD 44bn of spending (USD 25bn for a fully integrated rail system), and about USD 12bn will be invested in accommodation facilities. The 12 stadiums that will host the games will be built at an estimated cost of USD 4bn. In an official review of its national strategy, the government recently noted that though some World Cup-related investment projects may be commissioned in the 2011-2015 period, the likely impact is modest. This supports our view that many of the larger projects related
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*end-period, ** for fiscal year ending 31 March Source: Standard Chartered Research
12 December 2011
Qatar (cond)
to the 2022 World Cup will commence after 2015. The railway project, for example, is slated to be awarded in Q1-2013, but we expect the project to move at a faster pace only from 2015-21. We estimate that Qatar will award close to USD 21bn of projects (mostly
non-oil sectors picks up, driving up costs of goods and services. Yet inflation will capped by overcapacity in the housing market. Qatars FY12 budget (for the year that began 31 March 2011) is based on a conservative crude price of USD 55/barrel. Given higher hydrocarbon prices in 2011 we expect a fiscal surplus of close to USD 9.2bn in FY12 (against the governments estimate of USD 6.2bn). We expect spending to increase to USD 46bn in FY13 from USD 38.4bn in FY12 given the governments commitments to FIFA 2022 projects and broader infrastructure development.
infrastructure) in 2012, up from about USD 12bn in 2011.
Financial issues
The central bank cut key policy rates twice in 2011; we believe these moves were aimed at bringing policy rates closer to US rates and reducing arbitrage opportunities. Credit growth should remain positive in 2012, mostly on the back of increased demand as the government begins to roll out projects for FIFA 2022. H2-2011 already saw a rapid increase in credit growth, with private-sector credit growth jumping to 17% y/y in September from 9.8% y/y in March. The loan-to-deposit ratio is adjusting, falling to 101% in September 2011 from 105% in August; however, this is much higher than the comfortable level of 92% in July. The elevated loan-to-deposit ratio may make banks more cautious towards lending in 2012; however, spending dynamics are likely to keep credit growth positive.
Other issues
We have a positive outlook on the sovereign. Buoyed by a robust hydrocarbon sector, the country has built up significant external and fiscal cushions and has a strong capacity to service its debt obligations. Credits have been strong outperformers in the recent market sell-off. In addition to factors such as solid fundamentals and a low correlation with overall emerging-market flows, a lack of supply out of Qatar in 2011 (particularly compared with Abu Dhabi) capped spread widening. However, with the recent large sovereign issuance, we believe that spreads are likely to converge with those of Abu Dhabi Inc.
Policy
Inflation has been trending higher. It hit a high of 2.5% in October 2011, up from 1.6% at the beginning of the year (and 2.4% deflation in 2010). This signals the end of a deflationary period rather than the beginning of new inflationary pressures, in our view. Housing prices (32.2% of the inflation basket) continue to cap inflation; they fell 5.8% in October 2011. We expect inflation to edge higher to 3.3% in 2012 from around 2.4% in 2011 as spending in
From a fundamental standpoint, we are constructive on corporates and banks. Both sectors are comprised of credits that are sound on a standalone basis and benefit from strong government support. On valuations, we see some value in the RASGAS 14 among the corporates. In the banking sector, our top pick is the COMQAT 14.
Qatars key projects in 2012 2012 to kick off spending (USD bn)
Petrochemicals Alternative Energies Water & Waste Power Oil & Gas Infrastructure
Politics
There has not been any domestic instability in Qatar on the back of the Arab Spring over the past year. This is mostly thanks to the countrys social stability, backed by a generous social subsidy system and one of the worlds highest per-capita GDP levels. Qatar has taken a leadership role in brokering political solutions to the recent regional challenges.
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12 December 2011 107
Saudi Arabia
Shady Shaher, +971 4 508 3647
Shady.Shaher@sc.com
The spending story continues

Economic outlook

The economy boomed in 2011 on increased hydrocarbon output (to compensate for loss of output from Libya) and higher government spending after new social spending packages announced in Q1-2011. We expect growth in 2012 to moderate to a lower but still-healthy level of 2.9%, with the key driver of growth being the robust pace of government spending. However, lower oil output in 2012 will detract from growth.
We estimate that Saudi Arabias oil output reached 9.29mbd in 2011, against our 2010 estimate of 8.28mbd an 11% increase. We estimate that 2012 output will fall to 8.42mbd as Libya gradually raises output to 1.06mbd from 0.45mbd in 2011. Saudi Arabia is currently the worlds swing producer of oil, and as a result, Saudi output will continue to have a significant impact on world oil prices and market-supply dynamics. Government expenditure will continue to be an important driver of economic growth in 2012. We estimate that a total of USD 159bn worth of projects will be awarded in 2012 by the government and, to a lesser extent, the private sector. Infrastructure and construction projects will dominate, at USD 44.6bn and USD 39bn, respectively. Saudi Arabia plans to award projects worth about USD 67bn related to the construction of 500,000 housing units (this is part of the USD 128bn worth of social spending announced in 2011). On 1 November 2011, the Ministry of Housing awarded the first package of the housing programme, comprising various phases of master planning and design on about 32mn square metres of land divided across 11 regions in the country. No specifics on the timing of this project have been announced; however, we estimate three years, with about USD 22bn of awards in 2012. While increased commitments to housing are positive, housing supply remains a near-term challenge. According to the authorities, Saudi Arabia will face a shortage of 2mn housing units by 2015. While the mortgage law (when it is passed) may help on the demand side, if supply does not increase substantially, the result could be higher housing inflation. According to official data, there are close to 650,000 housing applications pending with the governments Real Estate Development Fund since 2009, up from 450,000 in 2006.
The commitment to spend close to USD 128bn on social subsidies (boosting social security) and projects (building 500,000 housing units) will continue to drive headline growth in 2012 and into 2013. This is in addition to budgeted spending commitments in 2012, which are expected to continue moving ahead at the strong pace seen in Saudi budgets since 2008. Housing supply will be a key challenge for policy makers in 2012 and beyond, though steps are being taken to address this challenge. Saudi Arabia is well placed to deal with oil-market outages, as it did in 2011 when it raised production to compensate for output shortages from Libya. Spare output capacity, which stood at 4 million barrels per day (mbd) at the beginning of 2011, should stand at close to 3.5mbd in 2012. The countrys oil output rose to 9.758mbd in August 2011, according to OPEC, from 8.4mbd in December 2010. Output increased as Saudi Arabia tapped spare capacity to meet supply constraints amid a steady drop in Libyan output.
Standard Chartered forecasts: Saudi Arabia

2011 GDP (real % y/y) CPI (% y/y) Policy rate (%)* USD-SAR* Current account balance (% GDP) Fiscal balance (% GDP) *end-period
12 December 2011
2012 2.9 5.4 0.25 3.75 15.5 8.0
2013 4.2 4.5 0.25 3.75 12.5 7.0
2014 4.0 4.2 0.25 3.75 11.0 7.0
6.6 5.2 0.25 3.75 20.0 10.0
Financial issues
Credit growth continues at a very brisk pace, underpinned by government spending, which is a key driver of private-sector activity. Private-sector credit growth averaged 9% y/y (2.5% q/q) in Q3-2011. Growth was 5.3% for the first three quarters of 2011, and we expect it to reach a healthy 5.5% by the year-end. We foresee 2012 private-sector credit growth in the 5-6% range (as seen since 2010), as spending continues to
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Saudi Arabia (cond)

underpin bank lending to the private sector. The loan/deposit ratio is capped at 85% by the Saudi Arabian Monetary Agency (SAMA), and averaged a healthy 79% in Q3-2011.
Politics
Policy
We expect inflation in 2012 to reach 5.4%, close to the expected 5.2% in 2011. Housing costs, which make up 18% of the inflation basket, will be a key driver. Saudi Arabia is vulnerable to food price inflation, as food makes up 26% of the inflation basket and the country imports 80% of its food. Increases in social subsidies (many of which were enacted towards the end of 2011), in addition to higher wages, will boost consumer purchasing power, acting as another inflation driver in 2012. In early 2011, we estimated that Saudi Arabia needed an oil price of around USD 72/barrel (bbl) of Brent to balance the budget. After the announcement of the social spending measures, we raised our estimate to USD 106/bbl to factor in an estimated USD 50bn of additional spending (we estimated total spending in 2011 at USD 227bn). We are revising down our breakeven price for 2011 given delays in the 500,000 housing units. We now estimate 2011 spending to be in the region of USD 207bn (USD 180bn of budget actuals + USD 27bn of social spending), with the breakeven oil price at USD 96/bbl for the year. We expect spending in 2012 to reach USD 212bn; we estimate that this would necessitate a breakeven price of USD 105/bbl, given our expectation that 2012 output will be 900,000 barrels per day lower than in 2011.
Saudi Arabia has been actively dealing with underlying demographic issues since 2008 through an ambitious programme of infrastructure and diversification that encompasses all regions of the country. The announcement of USD 128bn of spending in 2011, combined with the countrys tribal structure, means social dynamics have remained stable, even as the region underwent a period of volatility. On the international front, Saudi Arabia has played a leadership role in balancing global oil supply and prices, as Libyas output of 1.6mbd was cut during the 2011 Libyan war.
Other issues
We have a Positive outlook on the sovereign credit. Saudi Arabia has built up a strong foreign-asset cushion over the years, and is in a good position to withstand short-term shocks. The country has very low debt levels and is a strong net creditor. It has no sovereign debt, and there is no deliverable on the sovereign CDS contract. We view any significant spread widening on the sovereign CDS as an opportunity to add risk via selling sovereign CDS. At current levels, Saudi corporate paper is expensive. Unlike their peers in Qatar and the UAE, Saudi corporates are not big issuers in the eurobond market. International investor involvement in the space is largely for diversification purposes. The two Saudi corporates that have reasonably liquid US dollar paper outstanding are petrochemical giant SABIC (rated A1/A+/A+) and real-estate developer Dar Al Arkan (rated NR/BB-/NR). The SABIC 15 has outperformed in the market sell-off it has been more resilient than both the Saudi sovereign and corporates in Abu Dhabi and Qatar. Dar Al Arkan, which faces considerable near-term refinancing risk with a USD 1bn bond maturing in July 2012, has underperformed, in line with other high-yield credits in the region. In the banking space, we view Saudi banks as among the most defensive in the region. Their already sound fundamentals continue to improve. Also, the banks will benefit from the ongoing economic expansion and healthy credit growth. However, because of their scarcity value, Saudi bank bonds are expensive relative to other GCC bank bonds. At current levels, we prefer the BSFR
Saudi Arabias spending plans A lot in place, and much more to come (USD bn)
Saudi social spending package 2011 Saudi projected budget spending 2012 Saudi spending since 2008 Saudi 5-year plan
100
200
300
400
500
15 over the SABB 15.
Sources: Official Sources, Standard Chartered Research

Tunisia
Looking ahead
Economic outlook
After GDP contracted by 8% q/q in Q1-2011, the economy slowly recovered. Growth resumed in Q3 (1.5% y/y) following the gradual normalisation of the day-to-day business environment after disruptions caused by the Q1 change of regime. We nevertheless expect a slight (0.5%) contraction in real GDP for 2011. We forecast a rebound to positive growth of 4% in 2012 owing to a return of confidence and a very favourable base effect. The deteriorating external position, mostly owing to European woes, is likely to mean a triple whammy of decreased demand for Tunisian goods, a collapse in tourism receipts, and slower remittances, although exports continued to grow in Q2 and Q3-2011. We see the current account deficit widening to 7.0% in 2011 and narrowing to 4.5% in 2012, which would still be off the recent trend of below 3%. Inflation accelerated in the summer of 2011 on the back of domestic bottlenecks (protracted partial shutdowns of certain manufacturing facilities and higher imported inflation). It reached 4.5% y/y in October; we expect the figure to be just over 3.5% in 2012, with a few months of more domestically driven inflation. The FX reserves fell 20% in the year to end-November, representing 3.7 months of import cover, down from 5.0 months at end-2010. Barring an unexpected further worsening of the Tunisian economy, the central bank should not find itself in an untenable situation.
Financial issues
The Tunisian dinar (TND), which is managed against an undisclosed basket of currencies believed to be heavily weighted in favour of the euro (EUR) has been fairly stable, depreciating 2% against the EUR in the year to November. Banque Centrale de Tunisie (BCT) intervenes in the FX market to manage liquidity or control the real effective exchange rate. The banking system is generally stable, well capitalised (capital adequacy is around 12.5%), and very liquid. However, NPLs are likely to have risen to 20% in 2011 from an already-high level of around 12% in 2010. We also expect the loan-to-deposit to widen marginally to 121% in 2011 from 118% in 2010.
Policy
The BCT will likely continue its relatively accommodative monetary policy, with interest rates at 3.5% (cut from 4.0% in 2010). We expect it to maintain this dovish stance, in line with the European Central Bank. The BCT will continue to intervene in the market to ensure that the banking sector is liquid enough and financing of the economy is guaranteed. This helped credit to the economy grow by almost 11% in the year to October.
Other issues
Standard Chartered forecasts: Tunisia

2011 GDP (real % y/y) CPI (% y/y) Policy rate (%)* USD-TND* Current account balance (% GDP) Fiscal balance (% GDP) *end-period
12 December 2011
The most pressing task of the new constitutional assembly and its caretaker government will be to address the unemployment problem. The national statistics agency estimates that unemployment could be around 18% at least, and there are concerns about the ability of the economy to recover from such a shock. The technical management of the economic legacy of the ousted President and his family will be complicated, as their assets extend into all sectors of the economy.
2012 4.0 3.5 3.5 1.45 -4.5 -5.0
2013 5.0 3.0 3.5 1.40 -3.5 -3.5
2014 5.5 3.0
-0.5 3.6 3.5 1.47 -7.0 -6.0
Politics
3.75 1.38 -2.5 -2.0
Tunisia held its first election for a national constitutional assembly in October 2011. The election was deemed fair and free by international observers and was won by a moderate Islamic party, which formed a coalition with two secular progressive parties. The government needs to draft a new constitution and organise elections for next year.
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UAE
Shady Shaher, +971 4 508 3647
Shady.Shaher@sc.com
Sustaining healthy growth

Economic outlook
The UAE experienced solid economic growth in 2011, benefiting from improving domestic dynamics and a flight to safety from adverse developments around the Arab Spring. Political turmoil in the region boosted Abu Dhabis oil sector (as oil output rose to compensate for lower output from Libya), and Dubais non-oil economy (trade, tourism and retail benefited). We expect both factors to continue to drive the economy in 2012 to some extent, though growth will moderate. We estimate that the UAE economy will grow by 2.4% in 2012 versus 3.8% in 2011, largely because of base effects. Even though oil production has increased in 2011, it is currently near the UAEs output limits. And while Dubais key non-oil sectors especially tourism and retail should maintain their positive dynamics in 2012, we believe it will be difficult to achieve the same upside surprise we have seen in 2011 given the more challenging global environment. We estimate Abu Dhabi (60% of the UAEs GDP) to grow by 3.0% in 2012. Growth will be supported by a cautious resumption of spending in H1, followed by an acceleration in H2, as project reviews initiated in 2011 are completed. Note that expenditure on non-oil projects in Abu Dhabi has been low in 2011, so this is one area with upside potential for 2012. Abu Dhabis resumption of spending in 2012 will likely be marked by the awarding of the USD 6.5bn contract for the Abu Dhabi Midfield terminal, which, according to the
latest official statements, will happen in Q2-2012. Other projects in the pipeline include Etihad Railways, for which a USD 890mn contract was awarded in 2011; we expect momentum to pick up in 2012. We believe project reviews in the emirate will also lead to the cancellation of some non-core projects and a reassessment of those that will proceed. While this will detract from potential near-term growth dynamics, we believe it is positive in the long term, as it will prevent overcapacity.
Data from the International Energy Agency (IEA) shows that the UAEs oil output (95% driven by Abu Dhabi), rose to 2.55 million barrels a day (mbd) in September 2011 from around 2.3mbd at end-2010. We estimate that UAE output will average around 2.5mbd in 2012, similar to our estimated average for 2011. The IEA estimates that the UAEs production capacity will stand at 2.74mbd at the end of 2011. With little scope for further output increases (given the resumption of Libyan production) and given our view that significant cuts are unlikely amid increasing demand from non-OECD countries, oil is unlikely to be a significant factor in raising or detracting from GDP growth (especially Abu Dhabis) in 2012. We expect Dubais economy (29% of UAE GDP) to grow by 2.4% in 2012. Dubais tourism and retail sectors will continue to be the main drivers of the emirates recovery. Hotel occupancy rates have averaged close to 70-80% for most of 2011 (rising to almost 100% during Islamic holidays), as tourists, especially from the GCC, turn their backs on traditional Middle East tourist spots for the stability of Dubai. Occupancy rates have remained high, despite a significant increase in hotel rooms over the past four years. We expect Dubai to continue to benefit from a relative flight to quality in 2012, as political and stability dynamics in some MENA countries remain challenging. Dubais exports and re-exports grew 17% in the first eight months of 2011, but re-exports to some Arab countries fell, affected by the Arab Spring. The trade sector is likely to be affected by global fluctuations, but we take comfort from Dubais close trade links with regional markets and new footprint markets in Central Asia and Africa.
Standard Chartered forecasts: UAE

2011 GDP (real % y/y) CPI (% y/y) Policy rate (%)* USD-AED* Current account balance (% GDP) Fiscal balance (% GDP) *end-period
12 December 2011
2012 2.4 1.6 1.0 3.67 10.2 5.1
2013 2.8 2.1 1.0 3.67 8.5 5.0
2014 3.4 3.2 1.0 3.67 7.4 5.8
3.8 2.0 1.0 3.67 11.2 6.2
Financial issues
UAE deposit growth peaked at 16% (y/y) in April 2011 and remained in double digits through July, largely on the
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UAE (cond)
back of a flight to safety to the UAE driven by regional tensions. This was a key factor in driving down the UAEs benchmark 3M EIBOR rate. However, this deposit flight began to slow in August, with deposit growth slowing to 5.3% y/y (-1.0% m/m) in September. We believe the key factor behind this slowdown is the lower 3M EIBOR rate, which fell from above 2% at the beginning of 2011 to around 1.47% by August (as deposits picked up), and currently stands at 1.50%. This reduces the appeal of the UAE for some deposits that had been attracted by the rate differential between EIBOR and LIBOR. hydrocarbon dynamics. Dubai faces considerable challenges from a leverage standpoint, with debt restructuring of corporates still underway. The oversupplied property sector is also an overhang; however, on the positive side, activity is slowly returning in the housing sector.
Policy
In the recent market sell-off, Abu Dhabi Inc. has been a strong outperformer although it has given up some gains as the space began to look expensive versus some of the more beaten-down emerging-market credits. Dubai, on the other hand, has underperformed, being the higher-beta play in the region. On valuations, Abu Dhabi sovereign bonds such as the ADGB 14 look expensive. We see better value in quasisovereigns, such as MUBAUH and INTPET, which trade at an attractive spread to the sovereign. We are recommending switches from the ADGB 14 to the MUBAUH 14 and from the QTELQD 21 to the INTPET 22. In Dubai, we have been recommending switches from the DEWAAE 16 to the DEWAAE 15 and from the EMIRAT 16 to the DPWDU 17. We are delaying outright long recommendations on the Dubai sovereign given ongoing risk aversion in the market, which is punishing high-yield credits particularly those with large near-term refinancing needs.
Inflation in the UAE should average 1.6% in 2012, compared with our 2% forecast for 2011. In fact, prices fell 0.1% y/y in October (the first month of deflation in 20 months). Housing, which makes up 39.3% of the inflation basket, has acted as a drag on overall inflation in 2011; we expect it to continue to do so in 2012 given stillsignificant overcapacity in the UAE housing market. The UAE approved a USD 11.4bn federal budget for 2012, roughly the same as in 2011. This comprises approximately 10% of the UAEs total government spending, most of which occurs at the individual emirate level. We expect moderately higher spending in Abu Dhabi in 2012 versus actual 2011 levels.
Other issues
We have a stable outlook on the UAE as a credit. Abu Dhabis credit metrics place it among the strongest sovereign credits globally. Although the government is attempting to diversify the economy, Abu Dhabis credit strength continues to be underpinned by its strong
Strong project pipeline in 2012 (USD bn) 80% of potential project awards to be driven by Abu Dhabi
Alternative Energies Metal Industrial Power & Water Oil & Gas Infrastructure
In the UAE banking space, our preferred credits are the Abu Dhabi banks because of their better fundamentals. There has been a spate of issuance in the Abu Dhabi banking sector in 2011, particularly sukuks (ADCB, ADIB and FGB). Sukuks continue to trade at a premium to conventional bonds because of strong demand from Islamic investors. Our top pick in the sector is the UNBUH 16, given the government of Abu Dhabis 50% stake in the bank and its sound fundamentals.
Politics
The UAEs strong social cohesion and generous social subsidy system have enabled it to avoid political pressures of the scale seen in other countries in the region. In fact, the UAE has emerged as a regional safe haven. It held parliamentary elections for the Federal National Council (FNC) on 24 September 2011, and the electoral college to elect half of the members of the FNC was expanded from 6,000 to close to 129,000.
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Economies Latin America
Latin America Charts of the year

Chart 1: Divergence of trends Brazil retail sales vs. industrial production (Jan-2000=100)
190 180 170 160 150 140 130 120 110 100 90 Feb-00 Aug-01 Feb-03 Aug-04 Feb-06 Aug-07 Feb-09 Aug-10 Sources: IBGE, Standard Chartered Research Industrial production Retail sales
Chart 2: Negative output gap to persist into 2012 Brazil output gap
190 170 150 130 110 90 70 50 Q1-96 Q1-99 Q1-02 Q1-05 Q1-08 Q1-11 Output gap (RHS) GDP SA (LHS) GDP potential trend (LHS) 20% 15% 10% 5% 0% -5% -10%
Sources: IBGE, Standard Chartered Research
Chart 3: Mexico FX-to-inflation pass-through is significant Cum. impact of 15 % FX shock (months after depreciation)
4 3
Chart 4: Peru has the highest reserves/GDP in Latam Total international reserves to GDP
35% 30%
Response in ppt
Response of CPI to the shock
1 0 -1 -3
-4 2 4 6 8 10 12 Months after the shock 14 16 18
25% 20% 15% 10% 5% 0% Brazil Mexico Chile Colombia Peru Venezuela Argentina
Sources: Bloomberg, BCB, Banxico, BanRep, BCCh, BCRA, Standard Chartered Research
Chart 5: Argentina capital flight Worse than in 2008 USD mn, monthly
5,000 4,500 4,000 3,500 3,000 2,500 2,000 1,500 1,000 500 0 -500 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11
Chart 6: High CLP-BRL correlation 20-day correlation of daily returns

1.0 0.8 0.6 0.4 0.2 0.0 -0.2 -0.4 Apr-00 Jul-01 Oct-02 Jan-04 Apr-05 Jul-06 Oct-07 Jan-09 Apr-10 Jul-11 Sources: Bloomberg, Standard Chartered Research BRL
Sources: Econviews, Standard Chartered Research
12 December 2011
114
Argentina
Bret Rosen, +1 212 667 0386
Bret.Rosen@sc.com
Italo Lombardi, +1 212 667 0564

Italo.Lombardi@sc.com
More Kirchnerismo
Economic outlook
After strong GDP growth in 2010-11, we expect a substantial deceleration in 2012 to growth of 3%. The pace of economic expansion should slow next year due to lower growth among Argentinas main trading partners (such as Brazil and Europe), worsening bottlenecks especially in the energy sector and perhaps weaker terms of trade. Business and consumer confidence should be affected by the various measures and capital controls recently announced related to the FX market. Inflation should remain at around 25% in 2012, similar to the level in 2010-11. The government has misreported inflation for several years, primarily because billions of pesos of inflation-linked debt was issued several years ago. Monetary aggregates have been growing at 40% on an annualised basis, with private-sector salaries in the formal economy increasing by 34%. The government has stated its intention to limit salary increases for unionised workers to 18% for 2012, a proposition rejected by union leaders. If the government further reduces subsidies, we could see additional inflationary pressures. Unlike its counterparts in neighbouring countries such as Peru, Chile and Brazil, Argentinas central bank does not operate an inflation-targeting regime. We look for a fiscal deficit of 1.3% of GDP for 2012, as primary expenditures are likely to increase by around 30% for the fourth consecutive year. The government has announced some reductions to subsidies, which total around 5% of GDP, but we expect the Kirchner government to continue with its populist bent. The primary surplus should be 0.9% of GDP. While these
headline fiscal numbers may not appear worrisome, note that Argentina ran fiscal surpluses of 1-4% of GDP from 2004-08, and has no market access to external financing.
Financial issues
Capital flight has averaged around USD 3bn per month in the past three months, contributing to a substantial fall in the international reserves to USD 47bn from USD 52bn. Credit secured from monetary authorities in Europe, and a current account surplus, have partly offset this decline. Locals have sought refuge in the US dollar (USD) because of: (1) the perception that the Argentine peso (ARS) is more fully valued due to recent real exchange rate appreciation; (2) negative real interest rates on ARS deposits; (3) the policy mix during Cristina Kirchners second term, which looks set to be similar to her first; and (4) continuing global financial volatility, including Brazilian real (BRL) weakness.
Policy
The authorities have taken draconian measures to reduce the outflow of hard currency from the central bank, most notably requiring locals to provide identification, the origin of funds and tax information consistent with funds requested for all USD purchases. Mining and energy companies must repatriate 100% of all USD proceeds. USD deposits have recently fallen by around 15% as citizens fear new measures; as a result, the authorities have reduced bank reserve requirements in USD on deposits at the central bank.
Politics
Standard Chartered forecasts: Argentina

2011 GDP (real % y/y) CPI (% y/y) Policy rate (%)* USD-ARS* Current account balance (% GDP) Fiscal balance (% GDP) *end-period
12 December 2011
2012 3.0 11.0 NA 4.95 -1.5 -1.3
2013 3.5 12.0 NA 5.50 -1.5 -1.5
2014 4.5 12.0 NA 5.75 -1.0 -1.8
6.3 9.2 NA 4.38 0.1 -2.1
Kirchner won 54% of the votes in the October 2011 presidential election, representing a 37% margin over the second-place finisher. This was the largest margin of victory in the history of democratic presidential elections in the country. The victory gave her a sweeping mandate, as her party controls both houses of congress and gubernatorial posts in 14 of the countrys 23 provinces. Markets viewed positively the naming of Hernan Lorenzino to head the Ministry of Economy, but overall, Kirchners cabinet appointments are representative of policy continuity. Meanwhile, the administration has yet to resolve the issue of outstanding debts with the Paris Club, and will source USD 6bn from the central bank in 2012 to finance scheduled debt payments.
115
Brazil
Bret Rosen, +1 212 667 0386
Bret.Rosen@sc.com

COPOM banking on lower inflation

Economic outlook
The latest data appears to confirm our scenario of lowerthan-consensus growth for 2011 and 2012. The strength of the Brazilian real (BRL), which has supported consumption, has weighed on manufacturing and certain exporters, dragging down industrial production. September industrial production, for example, was down 1.6% y/y. Domestic demand, which was robust in H12011, has also slowed. Retail sales are growing at a 5% pace, down from double-digit levels for a good part of 2010-11. We expect growth to slow to 2.5% in 2012 from 3.0% in 2011; both are below what is considered Brazils potential growth rate. We foresee a gradual improvement in sequential (q/q) growth as we advance through 2012, mainly as a result of monetary easing. In spite of this, a combination of less favourable base effects and a very small carry-over effect from 2011 will keep y/y growth in 2012 below 3.0% for most of the year. Our growth estimates imply that starting in Q4-2011, growth will slide below potential, with a relatively sharp fall in the output gap in Q3, to the tune of 1.2% of GDP. Inflation remains a concern, despite a backdrop of monetary easing. The latest figures show that consumer prices rose nearly 7.0% y/y, the highest in eight years and well above the central banks target range of 4.5% +/- 2ppt. Despite the food and energy shock experienced in early 2011, core inflation measures are equally elevated, running at 6.5-7.0% y/y. This mainly reflects the above-potential pace of growth in domestic demand for most of 2011. Services inflation was running at above
8.0% y/y in Q4-2011, which also shows how broad inflation is. We expect the growth slowdown to ease pressure on both goods prices and labour-market conditions, helping inflation to moderate.
We expect IPCA inflation to end 2012 at 5.5%, above the centre of the target but within the tolerance band. A recent change to the methodology pertaining to the composition of the IPCA index, which will take effect in 2012, should have the effect of lowering inflation readings by 20-30bps (compared to the prior composition of the index). Inflation expectations, another important variable for the central bank, are also likely to recede over the coming quarters, although credibility issues could influence expectations in a negative way, which could tie the central banks hands. Balance-of-payments indicators remain strong. Most impressively, FDI is running at a record pace. In the 12 months through October 2011, FDI reached USD 76bn. Over the last year, the balance of payments accumulated a surplus of 2.7% of GDP, causing international reserves to rise by USD 68bn during the period to USD 353bn a record level for Brazil. The current account has been on a gradually improving trend, at -2% of GDP for the 12 months ending in October 2012, as terms of trade continue to favour Brazil. Capital account surpluses remain, but have been negatively affected in recent months by the imposition of various IOF taxes on financial transactions from abroad. On 1 December 2011, the government announced the elimination of the IOF tax on foreign investments in Brazilian equities.
Standard Chartered forecasts: Brazil

2011 GDP (real % y/y) CPI (% y/y) Policy rate (%)* USD-BRL* Current account balance (% GDP) Fiscal balance (% GDP) *end-period
12 December 2011
Financial issues
2013 4.9 4.5 9.0 1.55 -2.8 -2.2 2014 5.5 4.5 8.5 1.55 -3.2 -2.4
2012 2.5 5.4 9.5 1.65 -2.2 -1.9
The direction of monetary policy has been highly controversial, as the monetary policy committee (COPOM) has embarked on an easing campaign even with inflation above its tolerance range. The central bank has reduced the SELIC rate to 11% from 12.5% in August 2011 via three 50bps cuts at its last three meetings. We expect the policy rate to be reduced to 9.5% by H1-2012, but we do not rule out more aggressive monetary easing if the international or domestic economic situations worsen substantially. Some market participants have questioned the credibility of Banco Central do Brasil (BCB), suggesting that political pressure from the president and finance minister
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3.0 6.5 11.0 1.85 -2.5 -2.2
Sources: IBGE, BCB, Standard Chartered Research
Brazil (cond)
has influenced recent monetary policy decisions. Nonetheless, the central bank seems intent on trying to normalise Brazils interest rate backdrop, as its real rates are the highest among large emerging and developed economies. One view which is gaining credence is that the COPOM intends to test the reaction of the economy to a real interest rate that is more in line with Brazils peers. Various government officials have stated that the economy should operate with a real interest rate of around 3%.
BRL 2bn of additional expenditures in 2012, mostly related to pension costs. The minimum wage adjusts by GDP growth of two years prior (2010 GDP was 7.5%), plus the prior years inflation (likely around 6.5%). Fiscal policy is also constrained by a bloated public sector, other major pension-related costs, and necessary investments ahead of the 2014 World Cup and 2016 Olympics. Some infrastructure and stadium projects related to the World Cup are well behind schedule.
Other issues
Additionally, there is growing sentiment that the BCB has adopted a new mandate of prioritising growth over inflation, even though it does not have an explicit growth target. Overall, sentiment in Brazil appears to be that the government is willing to tolerate above-target inflation in exchange for stronger growth.
Policy
The fiscal accounts have been on an improving trend. Indeed, President Dilma Rousseff has been more hawkish on fiscal policy than her predecessor, Lula, and was able to secure some BRL 50bn of expenditure cuts to this years budget. As of October, the primary surplus for 2011 stood at 3.6% of GDP, double the level a year earlier (when President Lula was ramping up current expenditures ahead of the presidential election). Brazil should be on target to reach its nominal primary surplus target for 2011 of BRL 27.9bn, estimated at around 3.1% of GDP. As a result, debt/GDP indicators have been improving gradually. Reaching fiscal targets may be more challenging in 2012, due in part to an anticipated 14% increase in the minimum wage. This increase should represent close to
The administration faces major challenges related to the oil sector. Petrobras, the state-controlled oil company, is expected to invest well over USD 200bn in the next halfyear; most of this is related to developing the pre-salt layers deep in the ocean off the Brazilian coast, which are expected to help Brazil produce 5mn barrels per day by the end of the decade. Efficiently managing this process and the subsequent windfall will be a major challenge.
Politics
A slowdown ahead GDP growth y/y versus q/q SA

10% 8% 6% 4% 2% 0% -2% -4% -6% Q1' 07 Q1' 08 Q1' 09 Q1' 10 Q1' 11 Q1' 12 q/q SA y/y
The president enjoys rather strong popularity, but seven ministers have resigned in her first year in office amid several corruption scandals. The scandals illustrate the structural weaknesses of Brazils system of government. Though the president has considerable power, she can get little done without the say-so of a congress that is one of the worlds most splintered and fractious. More than 20 parties are represented in the two houses (party-hopping is common, and new parties spring into existence at the drop of a hat). More than 10 are allied, formally or informally, to the presidents Workers Party (PT). The result is that the practice of trading votes in congress for posts and budgetary amendments is quasiinstitutionalised. Many believe Dilma owes her post to Lula, and that if Lula recovers from his current health problems and the economy falters, he could possibly return and run for the presidency in 2014. We expect some changes to Dilmas cabinet to be announced at the start of 2012 in reaction to the issues that have plagued her administration. We do not expect any changes in the key posts of Fazenda (the finance ministry, headed by Guido Mantega) or the BCB (led by Alexandre Tombini).
Sources: IBGE, Standard Chartered Research

Chile
Bret Rosen, +1 212 667 0386
Bret.rosen@sc.com

Central bank is ready to act

Economic outlook
The economy is decelerating somewhat after posting solid growth through Q3-2011. Some of this deceleration can be attributed to the base effect, although sequential growth is also showing clear signals of slowing. Official projections for 2012 suggest GDP growth of 5%, close to the economys estimated potential growth rate. Our forecast is a bit lower, at 4.5%. Employment generation has picked up substantially in 2011, and real wages are positive, with average salaries rising just shy of 6% y/y. The central bank, Banco Central de Chile (BCCh), targets inflation of 3%, and recent indicators have been just above this mark, at 3.2% y/y. Inflation expectations are well under control, and the central bank has substantial credibility. Core indicators of inflation have been running at 2.0-2.5%.
Lehman, the central bank was particularly aggressive in slashing rates, so once an easing cycle begins, we would not be surprised to see a series of cuts. We expect the BCCh to start cutting rates in Q1-2012, probably implementing at least 100bps of monetary easing in total.
Spanish banks represent around 35% of total deposits in the Chilean banking system. While the financial system is well regulated and on a solid footing, and Spanish subsidiaries operations are segregated from their headquarters, deposit rates at Spanish banks exceed the interest rate paid on central bank paper by well over 100bps. This spread is well above the historical norm. Banco Santander has announced its intention to sell 7.8% of its participation in Santander Chile, which would raise around USD 1bn and help the bank comply with capital requirements imposed by the Spanish authorities.
Financial issues
Policy
The authorities have flagged risks associated with the global economic slowdown, adopting a more dovish tone. Recent central bank minutes have suggested that the monetary authorities are looking to ease policy. The BCCh is perhaps Latin Americas most conservative central bank, and the authorities have acknowledged that they prefer to evaluate more economic data before acting. As a small, open economy, Chile could be adversely impacted by a deepening of the international crisis. We think that a 2% real interest rate for Chile would be generally neutral, so the central bank has room to ease to offset the impact of the external environment. Post-
Chile is projected to run a fiscal surplus of 1% of GDP in 2011. Projections for 2012 are for a small deficit of 0.5% of GDP. Meanwhile, we note that the sovereign has very little debt, with gross public debt/GDP at just 9%. Debt levels are more worrisome at the corporate level. The public sector has accumulated substantial savings over the years, as manifested by the copper stabilisation fund, which has over USD 13bn in assets. This provides flexibility to adopt counter-cyclical policy, as implemented during the 2008-09 crisis.
Politics
While President Pinera garnered a surge in public support after the rescue of the miners in 2010, recent student protests have weighed on his popularity, which has sunk to around 30%. Chile has been gripped by
Standard Chartered forecasts: Chile

2011 GDP (real % y/y) CPI (% y/y) Policy rate (%)* USD-CLP* Current account balance (% GDP) Fiscal balance (% GDP) *end-period
12 December 2011
2012 4.5 3.0 4.25 465 0.1 0.5
2013 5.0 3.0 4.25 450 -0.8 0.5
2014 5.0 3.0 4.25 440 -1.1 0.5
student protests that have even turned violent. Student leaders have led the largest demonstrations in years, pushing for additional state funding for education, a new national framework and an end to for-profit education. Fewer than half of high school students study in public schools, reduce and interest most rates universities on are private. The
6.4 3.6 5.25 500 -1.0 1.0
government has sent a bill to congress which would student loans, increase subsidies and lift the share of the budget dedicated to education. However, the schism between the education movement and the government remains, and is the biggest risk to President Pineras popularity.
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Colombia
Bret Rosen, +1 212 667 0386
Bret.rosen@sc.com

Reforms, FTA underpin strong outlook

Economic outlook
Financial issues
Economic growth has surpassed expectations in 2011 (we forecast GDP growth at over 5%), and we look for a similar performance in 2012, assuming that the global environment does not deteriorate substantially. Economic performance should remain supported by strong credit growth, a buoyant job market, and robust household consumption. We expect investment spending to stay strong; capital formation has been rising 20% y/y. Colombias government enjoys a formidable consensus, supportive of market-friendly policies. Banco de la Republica (BanRep) hiked the policy rate by 25bps to 4.75% at its November 2011 meeting, in sharp contrast to easing by other central banks in emergingmarket countries. We expect one more 25bps hike from BanRep, with the central bank likely to stay on hold thereafter. Inflation has been impacted by transitory factors related mostly to food prices, and headline inflation surpassed 4% in October 2011. The authorities have been particularly concerned about abundant credit growth and soaring housing prices. We expect CPI inflation to converge closer towards the central banks 3% target in 2012. Fiscal performance is outperforming expectations thanks to stronger-than-expected economic growth and poor spending execution, especially related to infrastructure projects. The public sector will be operating under a fiscal rule that envisages the headline deficit converging to 1% of GDP by 2022 (versus an expected 3.4% in 2011). The implementation of royalty reform should also support the fiscal accounts and allow for more equitable distribution of revenues derived from mining and oil.
The authorities have expressed some concern about the pace of credit expansion. Meanwhile, external debt in the banking system has risen substantially over the last couple of years, while Colombian corporates have increased their level of foreign currency-denominated debt. The local-currency bond market is less susceptible to an outflow of capital, as foreigners hold around 20% of the TES curve.
Policy
The backdrop for the Colombian peso (COP) should stay positive with the countrys rising oil production perhaps to 1 million barrels per day in 2012 and supportive terms of trade. With the central bank possibly tightening further, COP carry looks attractive relative to other Latin American currencies. In the past, however, the authorities have intervened during periods of substantial COP appreciation, and the central bank could become active if the COP appreciated back below 1,800 again in 2012, in our view.
Politics
President Juan Manuel Santos enjoys enormous popularity thanks to the solid pace of economic growth, single-digit unemployment, and the improved security situation in Colombia in recent years. His support level surpasses 70% and his coalition in congress holds a super-majority. The government was successful in passing a series of reforms in 2010-11. Santos has also succeeded in improving diplomatic relations with neighbouring Venezuela. Consequently, commerce between the two countries has picked up in recent months, rising from the depths experienced when President Hugo Chavez of Venezuela shut the border between the two countries in 2010. Santos should also benefit from the passage of a freetrade agreement (FTA) with the US, ratified by Congress in October 2011. The US is Colombias leading trade partner, and the FTA could lift medium-term GDP growth by an estimated 0.5-1ppt. The agreement will take effect in H1-2012. Industry will be both positively and negatively impacted by increased competition from US imports.
Standard Chartered forecasts: Colombia

2011 GDP (real % y/y) CPI (% y/y) Policy rate (%)* USD-COP* Current account balance (% GDP) Fiscal balance (% GDP) *end-period
12 December 2011
2012 4.5 3.3 5.00 1,780 -2.2 -3.2
2013 4.5 3.3 5.50 1,750 -2.3 -2.9
2014 4.5 3.0 5.50 1,720 -3.0 -2.7
5.3 3.2 5.00 1,920 -2.7 -3.4

119
Mexico
Bret Rosen, +1 212 667 0386
Bret.Rosen@sc.com

Banxico is on hold
Economic outlook
Policy
Economic activity surprised to the upside in H2-2011. Growth was a strong 4.5% y/y in Q3, well above consensus estimates of 3.9% y/y and faster than the pace in Q2. Not only has industrial production outperformed, but domestic demand and the services sector have maintained good momentum. We expect 3.4% GDP growth for both 2011 and 2012.
Both headline and core inflation remain within the tolerance range of 2-4%, while inflation expectations continue to be well anchored and in line with the target. The central bank has downplayed the effect that FX could have on inflation. The central bank, Banxico, has assumed that the Mexican peso (MXN) exchange rate will revert towards levels more consistent with fundamentals. Additionally, it believes that the passthrough to inflation from FX depreciation is rather limited.
We recently estimated that sustained MXN depreciation to levels of around 13.7-14.50 versus the USD could lead to a cumulative effect on yearly CPI inflation of 0.851.00ppt a significant impact. While the authorities had expressed a sanguine view of such pass-through and appeared committed to a liberal FX regime, the finance ministry and Banxico announced on 29 November 2011 a mechanism by which the monetary authority will offer USD 400mn at a level 2% weaker than the prior days fixing. This was viewed by the market as a signal that the authorities are less tolerant of currency volatility i.e., MXN weakness after a period of several months when the MXN made a number of violent moves without triggering central bank intervention. With USD 140bn of reserves, Banxico has substantial ammunition to maintain this strategy for quite some time.
Politics
Financial issues
We expect Banxico to keep the policy rate on hold at 4.5% throughout 2012. Currency weakness is a major reason for this view; the MXN serves as a proxy for emerging-market risk in general given its combination of liquidity and transparency. In recent communiqus, Banxico has suggested that its policy stance is consistent with a convergence towards the 3% inflation target in 2012. Despite its strong credibility, the central bank has failed to reach this target in recent years, suggesting that its actions in the months ahead will be conservative.
While presidential elections are less than a year away, there appears to be little concern about the potential macroeconomic impact of a change in government. The consensus expects that the relatively centrist PRI will reassume power for the next six-year term, after 12 years with the centre-right PAN in power. One possibility is an alliance between the PAN and centre-left PRD to prevent the PRI from regaining power, but we do not see a high likelihood of this given the vast ideological differences between the two parties. Recent polls put the PRI at around 35% of voters preferences, exceeding the combined total of current support for the PAN and PRD. The security situation will be a key area of debate during the campaign. President Calderons recent interview with The New York Times set off a substantial reaction locally; he implied that if the PRI assumed the presidency, it might negotiate with drug cartels. Each party will have the opportunity to describe how it intends to handle growing problems related to drug cartels. The economic impact of the security situation is hard to measure. Some local economists believe that the worsening situation may cost Mexico around 0.5% of GDP annually, and note the effect on consumer confidence and tourism receipts. The violence has spread to parts of the country, such as Monterrey, where crime rates were previously rather low. Additionally, the new government could reassess Calderons rather confrontational strategy towards the drug cartels.
120
Standard Chartered forecasts: Mexico

2011 GDP (real % y/y) CPI (% y/y) Policy rate (%)* USD-MXN* Current account balance (% GDP) Fiscal balance (% GDP) *end-period
12 December 2011
2012 3.4 3.8 4.5 11.80 -0.4 -2.5
2013 4.0 3.8 5.0 11.00 -0.8 -2.5
2014 4.0 3.5 5.0 10.60 -1.0 -2.5
3.4 3.7 4.5 13.80 -0.7 -2.2
Peru
Bret Rosen +1 212 667 0386
Bret.rosen@sc.com

More Lula than Chavez, so far

Economic outlook
Perus economic growth continues to be the highest in Latin America, with full-year 2011 growth forecast at 6.7%. We expect a slight deceleration in 2012, but the countrys growth should still surpass that of its Latin American neighbours. Peru benefits from high prices of precious and industrial metals, but recent growth has been balanced; private consumption has been especially robust. Despite earlier fears of a slowdown in private investment related to policy risks following the victory of leftist-nationalist President Ollanta Humala, the business community seems comfortable with the policy framework. This should continue to foster investment in key sectors such as mining, construction and services. Headline inflation was hit by important supply shocks earlier in 2011, lifting food inflation (48% of the index) significantly. CPI inflation has been above the central banks target, but we expect monthly inflation readings to be more consistent with the central bank target (2% +/1ppt) throughout most of 2012. We expect the central bank to stay on hold, keeping its policy rate at 4.25% for the near term.
have plenty of ammunition. Meanwhile, if global market conditions improve, the government could hike reserve requirements or implement other measures to try to curb currency appreciation. We favour positions in the PEN given the positive carry; with production of gold and copper expected to be ramped up in the years ahead against the backdrop of a weak USD, the environment for the PEN looks supportive.
Policy
The government is undertaking a fiscal stimulus package to offset the impact of the weak international financial environment. Added expenditure slated in the 2012 budget totals nearly 2% of GDP. Peru has plenty of room for counter-cyclical fiscal policy, given that it is likely to finish 2011 with a fiscal surplus of 1% of GDP owing to booming tax revenues and under-execution of public investment plans.
Politics
Financial issues
The central bank does not target a specific level for the Peruvian sol (PEN), but does act to limit volatility; given the high rate of dollarisation (50%) in the banking system, the authorities intervene in the FX market when necessary to prevent excessive movements in the USDPEN rate. With almost USD 50bn of reserves (the highest as a percentage of GDP in the region), the authorities
Standard Chartered forecasts: Peru

2011 GDP (real % y/y) CPI (% y/y) Policy rate (%)* USD-PEN* Current account balance (% GDP) Fiscal balance (% GDP) *end-period
12 December 2011
2012 5.5 3.0 4.25 2.63 -2.0 0.0
2013 6.0 2.7 4.25 2.58 -2.4 -0.5
2014 6.2 2.5 4.25 2.55 -2.5 -0.8
The biggest roadblock to positive momentum in Peru arises from the dynamics between the mining sector, the government and local communities. Local communities, predominantly indigenous ones, have staged protests against various mining projects. Grievances focus on the environmental and social impact on the regions where the projects occur, typically the distribution of and access to water. The most notable set of protests relates to the Conga project, a mine expected to require nearly USD 5bn in investment. In late 2011, strong protests at the site of this copper and gold mine, located in Cajamarca, forced Newmont Mining to suspend operations at Conga. How the government handles this and other protests may be the biggest challenge of Humalas presidency, as Peru is slated to receive approximately USD 40bn of investment in its mining sector over the next half-decade. Markets remain wary of the possibility of a lurch to the left by Humala. At times he campaigned as an anti-system candidate, but he has surprised the market with a very pragmatic policy mix, often resembling the politics of former Brazilian President Lula. Still, some in the business community fear that a more radical policy mix could follow if his popularity slipped or the economy deteriorated.
6.7 3.2 4.25 2.70 -1.6 1.0

121
Our forecasts
Forecasts Economies and FX

Country Real GDP growth Inflation (%) (yearly average %) 2011 2012 2013 2014 2011 2012 2013 2014 1.3 1.8 1.5 -0.5 0.7 2.4 1.8 1.5 1.8 7.3 6.7 9.2 5.0 7.0 6.5 4.8 2.4 3.8 4.8 3.5 8.0 4.4 1.8 5.8 4.8 3.7 8.0 3.5 -5.8 6.1 13.6 4.9 7.2 5.2 3.2 6.1 6.4 6.5 5.6 3.0 1.9 1.8 2.4 5.0 1.5 4.3 4.5 16.9 6.6 -0.5 6.7 3.8 3.9 6.3 3.0 6.4 5.3 3.4 6.7 3.0 0.4 1.7 -1.5 0.8 -1.3 2.2 -0.2 2.9 2.4 6.5 6.4 8.1 2.9 7.4 5.8 2.7 4.0 3.2 1.9 3.0 7.5 2.7 3.5 5.8 5.3 8.0 7.0 4.0 8.0 5.5 8.5 5.3 6.9 30.0 3.1 6.7 6.6 7.0 2.6 3.5 3.5 2.0 2.5 3.0 3.8 4.5 4.7 5.9 2.9 4.0 1.3 2.4 3.1 3.0 2.5 4.5 4.5 3.4 5.5 2.2 2.2 2.5 1.5 3.1 1.5 2.4 1.8 4.0 3.3 7.5 6.5 8.7 5.6 8.0 6.5 5.4 4.8 5.3 7.8 4.0 8.0 4.5 4.9 6.5 5.6 6.5 5.9 4.5 5.5 5.5 7.9 5.5 7.3 8.0 4.1 7.5 7.0 7.2 4.2 4.0 4.0 3.0 2.9 3.0 5.5 5.0 4.3 5.6 4.2 5.0 5.0 2.8 4.5 3.5 4.9 5.0 4.5 4.0 6.0 3.6 2.7 3.0 2.4 2.5 2.3 3.0 2.4 3.5 3.0 6.5 6.9 7.0 4.5 8.0 6.8 4.5 5.0 5.0 4.4 4.0 8.0 5.2 5.5 6.8 5.8 6.5 6.5 4.5 5.0 5.5 7.6 5.9 7.5 7.0 4.3 7.3 7.3 7.5 4.7 4.5 4.5 3.5 3.5 3.5 5.5 5.5 4.0 5.4 4.0 5.5 6.2 3.4 4.9 4.5 5.5 5.0 4.5 4.0 6.2 3.8 2.0 1.7 2.6 -0.2 4.4 2.5 0.3 3.4 4.3 5.8 9.0 5.4 5.2 8.7 5.4 3.3 13.9 4.7 5.1 4.0 6.9 1.4 3.7 18.7 8.4 15.0 6.9 2.6 3.0 6.0 9.0 14.0 10.9 16.0 5.0 11.3 18.7 8.8 5.2 4.0 -0.3 11.3 4.6 5.0 5.0 1.5 4.0 2.4 5.2 3.6 6.4 2.0 5.5 9.2 6.5 3.6 3.2 3.7 3.2 3.7 1.5 1.6 1.9 -0.1 2.1 2.2 -0.5 3.2 2.4 3.3 10.5 2.0 3.5 6.5 4.5 2.6 12.0 3.7 2.5 3.0 6.4 1.2 3.0 11.3 8.3 14.0 8.2 2.5 2.5 5.0 10.1 13.3 10.0 11.0 6.1 11.7 15.3 7.4 5.4 4.3 3.0 10.0 4.5 4.5 4.8 2.5 4.0 3.3 5.4 3.5 7.0 1.6 5.2 11.0 5.5 3.0 3.3 3.8 3.0 2.9 1.5 1.8 1.6 0.2 1.6 2.0 0.5 3.3 2.9 4.2 9.0 3.6 3.5 6.0 5.3 2.8 13.0 4.4 3.1 3.0 7.0 1.6 3.5 8.5 6.8 10.0 6.7 2.5 2.5 4.0 12.7 6.8 9.1 10.0 5.2 5.7 1.8 9.2 5.2 4.5 3.5 11.5 5.0 4.0 5.5 3.0 4.5 3.8 4.5 3.0 6.3 2.1 4.8 12.0 4.5 3.0 3.3 3.8 2.7 2.9 1.7 2.0 1.8 0.1 1.8 2.0 0.8 3.0 2.5 4.3 7.0 4.0 3.0 6.0 5.4 3.1 12.0 4.0 3.0 3.0 7.2 1.3 3.9 7.0 7.4 9.0 5.7 2.0 2.5 4.0 10.8 6.5 12.0 10.0 5.4 5.6 5.1 9.0 5.5 4.5 3.5 11.0 5.2 4.0 5.5 3.5 5.0 4.2 4.2 3.0 6.8 3.2 4.7 12.0 4.5 3.0 3.0 3.5 2.5 2.9 Current account (% of GDP) 2011 2012 2013 2014 Q1-12 -1.2 -3.1 -0.4 2.2 -1.8 -3.0 12.0 -2.7 -4.0 2.6 0.9 3.5 6.5 -3.1 0.5 12.0 0.3 2.8 19.0 2.0 -5.7 7.5 1.5 -10.5 1.3 12.0 -1.5 -3.8 1.0 -17.0 -6.5 -9.3 12.2 -50.0 -3.4 -9.5 -10.2 3.2 5.7 11.0 3.5 -1.2 -7.5 30.0 -17.5 -5.5 10.0 32.0 20.0 -7.0 -9.7 11.2 -1.7 0.1 -2.5 -1.0 -2.7 -0.7 -1.6 --1.0 -2.8 -0.2 2.0 -1.4 -2.5 13.5 -3.5 -5.0 1.5 -0.6 1.9 5.5 -2.8 0.3 9.5 -1.5 2.3 16.5 2.0 -5.1 5.5 -0.1 -8.5 0.6 7.0 -1.2 -3.3 -0.5 -14.0 -4.9 -8.5 11.3 -7.6 -3.8 -8.7 -9.9 2.0 6.1 13.0 3.2 -1.9 -8.0 27.0 -16.0 -4.0 9.0 30.0 15.5 -4.5 -5.0 10.2 -1.6 -1.5 -2.2 0.1 -2.2 -0.4 -2.0 --1.0 -2.9 -0.4 3.2 -1.8 -2.2 11.5 -3.8 -5.5 2.1 -0.7 2.7 6.5 -2.6 0.1 10.5 -1.8 4.1 19.5 1.5 -3.0 6.0 -1.1 -7.5 0.3 6.0 0.4 -3.0 -2.0 -13.0 -3.3 -6.8 10.5 -9.5 -4.0 -10.2 -7.7 2.2 4.7 14.0 3.5 -1.5 -7.5 26.0 -15.0 -4.0 8.0 27.0 12.5 -3.5 -6.5 8.5 -2.0 -1.5 -2.8 -0.8 -2.3 -0.8 -2.4 --1.1 -2.9 -0.1 2.8 -2.2 -1.9 12.0 -4.0 -5.5 N.A. 1.20 81.00 1.46 1.10 1.04 0.92 0.72 FX Q2-12 N.A. 1.22 79.00 1.50 1.08 1.07 0.95 0.76 Q3-12 N.A. 1.25 77.00 1.52 1.02 1.06 1.00 0.83 Q4-12 N.A. 1.30 74.00 1.55 0.98 1.04 1.05 0.88 Q1-13 N.A. 1.27 74.00 1.51 0.98 1.10 1.08 0.89 Q2-13 N.A. 1.25 76.00 1.49 0.96 1.12 1.06 0.85
Majors** US^ Euro area Japan UK Canada Switzerland Australia New Zealand Asia** Bangladesh* China Hong Kong India* Indonesia Malaysia Pakistan* Philippines Singapore South Korea Sri Lanka Taiwan Thailand Vietnam Africa** Angola Botswana Cameroon Cte d'lvoire The Gambia Ghana Kenya Nigeria Sierra Leone South Africa Tanzania Uganda Zambia MENA** Algeria Bahrain Egypt* Jordan Kuwait* Lebanon Morocco Oman Qatar Saudi Arabia Tunisia Turkey UAE Latin America** Argentina Brazil Chile Colombia Mexico Peru Global
2.2 -0.5 78.50 79.50 79.50 78.00 78.20 78.20 3.1 6.36 6.31 6.26 6.21 6.18 6.15 6.0 7.810 7.800 7.780 7.790 7.785 7.780 -2.5 53.00 51.80 50.50 48.50 48.00 48.50 0.0 9,400 9,200 9,000 8,700 8,600 8,700 12.7 3.30 3.22 3.11 3.03 2.98 3.03 -2.3 90.00 92.00 93.00 94.00 94.50 95.50 3.0 45.25 44.50 43.50 41.50 40.50 41.00 18.2 1.35 1.32 1.28 1.25 1.23 1.25 1.0 1,210 1,155 1,095 1,050 1,030 1,050 -3.0 113.5 115.8 115.2 114.8 114.5 112.5 6.0 31.40 30.80 29.90 29.00 28.80 28.70 -0.9 32.50 32.20 31.50 30.50 30.00 30.50 -7.0 21,700 21,800 22,500 22,600 23,000 23,100 -0.1 5.0 1.3 -2.5 -2.5 -13.0 -1.5 -6.5 9.0 -12.4 -4.2 -9.1 -7.3 2.4 4.4 16.0 4.0 -0.5 -7.0 27.0 -13.0 -4.0 9.0 25.0 11.0 -2.5 -7.2 7.4 -2.3 -1.0 -3.2 -1.1 -3.0 -1.0 -2.5 -Source: Standard Chartered Research 92.50 8.26 547 547 29.00 1.64 94.00 164 4,370 9.30 1,800 2,550 5,500 74.00 0.38 6.50 0.71 0.29 1,500 8.45 0.39 3.64 3.75 1.50 2.00 3.67 4.48 1.90 530 1,930 14.20 2.75 92.50 8.20 538 538 29.50 1.66 91.00 161 4,390 9.10 1,820 2,380 5,200 74.30 0.38 6.70 0.71 0.29 1,500 8.43 0.39 3.64 3.75 1.48 1.93 3.67 4.60 1.80 500 1,860 13.00 2.72 92.00 7.92 525 525 30.00 1.67 94.00 159 4,410 8.80 1,790 2,590 4,900 74.50 0.38 6.80 0.71 0.28 1,500 8.40 0.39 3.64 3.75 1.47 1.80 3.67 4.68 1.75 470 1,810 12.50 2.70 91.50 7.52 505 505 30.00 1.70 97.00 158 4,450 8.20 1,800 2,660 4,800 73.60 0.38 6.82 0.71 0.28 1,500 8.35 0.39 3.64 3.75 1.45 1.69 3.67 4.95 1.65 465 1,780 11.80 2.63 91.50 7.25 516 516 30.70 1.72 96.00 157 4,500 7.80 1,830 2,640 4,700 73.30 0.38 6.90 0.71 0.27 1,500 8.40 0.39 3.64 3.75 1.47 1.65 3.67 5.05 1.55 455 1,750 11.50 2.60 91.00 7.45 525 525 31.00 1.74 94.00 158 4,550 8.20 1,780 2,550 4,800 74.00 0.38 7.10 0.71 0.27 1,500 8.35 0.39 3.64 3.75 1.45 1.57 3.67 5.25 1.65 465 1,800 11.40 2.60
* Fiscal year starts in April in India and Kuwait, July in Bangladesh, Pakistan, and Egypt ** 2010 USD GDP weighted total of the regional economies covered in this publication ^ Inflation: Core PCE deflator used for US
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Forecasts Rates
End-period United States Policy rate 3M LIBOR 10Y bond yield Policy rate 3M LIBOR 10Y bond yield Policy rate 3M LIBOR 10Y bond yield Policy rate 3M LIBOR Policy rate 7D repo rate 10Y bond yield 3M HIBOR 10Y bond yield Policy rate 91-day T-bill rate 10Y bond yield Policy rate 3M JIBOR 10Y bond yield Policy rate 3M KLIBOR 10Y bond yield Policy rate 3M PDST-F 10Y bond yield 3M SGD SIBOR 10Y bond yield Policy rate 91-day CD rate 10Y bond yield Policy rate 3M TAIBOR 10Y bond yield Policy rate 3M BIBOR 10Y bond yield Policy rate (Refi rate) Overnight VNIBOR 2Y bond yield Policy rate 91-day T-bill rate 3Y bond yield Policy rate 91-day T-bill rate 10Y bond yield Policy rate 91-day T-bill rate 10Y bond yield Policy rate 91-day T-bill rate 10Y bond yield Q1-12 % 0-0.25 0.60 1.75 0.75 1.05 2.10 0.50 1.10 2.25 4.00 4.20 6.56 4.00 3.50 0.40 1.20 8.50 8.25 8.50 5.75 4.80 6.75 2.75 3.00 3.30 4.25 1.70 5.80 0.35 1.50 3.25 3.55 3.65 1.88 0.90 1.30 3.00 3.05 3.40 12.00 11.00 12.25 12.50 10.40 13.50 18.00 17.00 19.00 12.00 14.40 13.50 5.50 5.63 8.25 Q2-12 % 0-0.25 0.40 2.00 0.75 0.85 2.30 0.50 0.90 2.30 4.00 4.20 6.56 3.50 3.50 0.35 1.30 8.25 7.75 8.25 5.75 4.60 6.50 2.50 3.00 3.00 4.00 1.50 5.50 0.35 1.40 3.00 3.30 3.40 1.88 0.90 1.20 2.75 2.75 3.50 11.00 10.00 11.75 13.00 10.90 13.75 17.00 15.00 18.00 12.50 14.80 12.50 5.50 5.72 8.50 Q3-12 % 0-0.25 0.25 2.15 0.75 0.60 2.40 0.50 0.95 2.35 4.00 4.20 6.56 3.00 3.70 0.35 1.50 7.75 7.25 7.75 5.75 4.50 6.25 2.50 3.00 3.30 4.00 2.00 5.60 0.35 1.40 3.00 3.30 3.50 1.88 0.90 1.30 2.75 2.80 3.60 11.00 10.00 11.50 14.00 11.40 14.00 16.00 14.40 17.00 13.25 15.20 12.80 6.00 6.05 8.70 Q4-12 % 0-0.25 0.25 2.30 0.75 0.55 2.50 0.50 1.00 2.40 4.00 4.30 6.56 3.00 3.90 0.35 1.70 7.25 7.00 7.50 5.75 4.50 6.00 2.50 3.00 3.50 4.00 2.50 5.70 0.35 1.60 3.00 3.30 3.60 1.88 0.90 1.40 2.75 2.80 3.70 11.00 10.00 11.25 14.00 11.90 14.00 14.00 13.80 16.00 13.25 14.70 12.00 Q1-13 % 0-0.25 0.45 2.45 0.75 0.65 2.65 0.50 1.05 2.50 4.25 4.70 6.81 3.50 4.00 0.45 1.80 7.00 6.75 7.50 6.25 5.00 6.25 2.50 3.00 3.60 4.00 3.00 6.00 0.35 1.70 3.00 3.30 3.80 2.00 0.95 1.50 2.75 2.80 3.90 11.00 10.00 11.50 14.50 12.40 13.75 14.00 13.50 16.00 13.50 14.30 11.70 Q2-13 % 0-0.25 0.60 2.55 0.75 0.75 2.70 0.50 1.10 2.60 4.50 5.00 6.81 3.50 4.10 0.55 1.90 7.00 7.00 7.75 6.25 5.00 6.25 2.50 3.00 3.70 4.00 3.80 6.30 0.35 1.80 3.25 3.55 4.00 2.13 1.00 1.60 2.75 2.80 4.10 11.00 10.00 11.25 15.00 12.60 13.50 12.00 11.80 15.00 14.00 13.90 11.40
Euro area
United Kingdom
Australia China
Hong Kong India
Indonesia
Malaysia
Philippines
Singapore South Korea
Taiwan
Thailand
Vietnam
Ghana
Kenya
Nigeria
South Africa
6.00 6.50 6.50 6.10 6.54 6.59 8.85 8.95 9.05 Source: Standard Chartered Research
124
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Forecasts GDP
Country Q3-11 Majors US^ Euro area* Japan UK* Canada^ Switzerland* Australia New Zealand Asia Bangladesh China Hong Kong India Indonesia Malaysia Pakistan Philippines Singapore South Korea Sri Lanka Taiwan Thailand Vietnam Latin America Argentina Brazil Chile Colombia Mexico Peru * q/q ^ q/q SAAR 6.6 2.4 4.8 5.5 4.4 6.2 5.5 1.7 3.6 5.2 4.3 5.5 5.0 1.1 3.8 5.0 4.2 5.5 3.3 1.2 4.2 4.8 3.7 6.5 2.0 2.8 4.7 4.3 3.6 6.2 1.5 4.1 5.1 4.2 5.0 6.2 3.3 3.8 5.2 4.3 5.0 6.0 6.7 9.1 4.3 6.9 6.5 5.8 3.3 3.8 6.1 3.4 7.7 3.4 3.5 6.1 6.5 8.3 3.0 6.8 6.4 4.2 3.8 4.2 3.1 3.4 8.0 3.0 -2.2 6.1 6.6 7.5 0.2 6.6 6.3 2.2 4.2 3.1 -3.6 2.7 7.5 2.0 2.0 5.3 6.5 7.6 1.5 6.2 5.9 1.6 4.5 3.0 -1.3 2.7 7.3 1.5 3.3 5.5 5.3 8.1 3.8 7.5 5.6 2.5 4.5 3.2 3.2 3.0 7.6 3.3 3.3 6.0 6.3 9.1 5.8 7.8 5.4 4.3 4.8 3.7 9.5 3.5 7.7 4.0 5.3 6.5 6.6 9.6 7.0 8.3 6.0 5.4 4.8 4.5 10.6 4.2 8.0 4.0 3.2 6.0 2.0 0.2 0.1 0.5 3.5 0.1 1.7 2.0 2.8 -0.5 -0.1 -0.7 2.0 -0.2 1.3 1.8 0.8 -1.0 -0.1 -0.9 1.5 -0.6 2.6 1.4 1.6 -0.5 0.4 -0.5 2.5 0.0 2.3 1.9 1.9 0.1 0.5 0.2 3.0 0.2 3.0 2.6 2.4 0.3 2.1 0.4 3.5 0.2 3.8 3.7 2.7 0.4 3.5 0.4 3.0 0.5 4.2 4.0 Q4-11 Real GDP growth (% y/y, unless otherwise stated) Q1-12 Q2-12 Q3-12 Q4-12 Q1-13
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Forecasts Commodities
Market close
5-Dec-11
m/m %
Change YTD %
y/y %
Q4-11 F
Q1-12 F
Q2-12 F
Q3-12 F
Q4-12 F
Q1-13 F
Q2-13 F
2011 F
2012 F
Energy Crude oil (nearby future, USD/b) NYMEX WTI ICE Brent Dubai spot Refined oil products cracks and spreads Singapore naphtha (USD/bbl) Singapore jet kerosene (USD/bbl) Singapore gasoil (USD/bbl) Singapore regrade (USD/bbl) Singapore fuel oil 180 (USD/bbl) Coal (USD/t) API4 API2 globalCOAL NEWC* Metals Base metals (LME 3m, USD/t) Aluminium Copper Lead Nickel Tin Zinc Iron ore (USD/t) Iron ore^ Steel** (CRU assessment, USD/t) HRC, US HRC, Europe HRC, Japan HRC, China Precious metals (spot, USD/oz) Gold (spot) Palladium (spot) Platinum (spot) Silver (spot) Agricultural products Softs (nearby future) NYBOT cocoa, USD/t LIFFE coffee, USD/t *** NYBOT coffee, USc/lb NYBOT sugar, USc/lb Fibres NYBOT cotton No.2, USc/lb Grains & oilseeds (nearby future) CBOT corn (maize), USc/bushel CBOT Soybeans, USc/bushel CBOT wheat, USc/bushel CBOT rice, USD/cwt Thai B rice 100%, USD/tonne* Edible oils (nearby future) Palm oil (MDV,MYR/t) Soyoil (CBOT, USc/lb) 3,090 50 +2.2 -4.0 -19.0 -13.7 -13.2 -6.2 2,975 51 3,200 53 3,400 56 3,600 57 3,600 57 3,700 58 3,800 60 3,235 56 3,450 56 580 1,126 599 14 654 -11.6 -7.0 -6.1 -9.1 +4.1 -7.9 -19.1 -24.7 +3.2 +19.3 +4.7 -12.5 -20.5 -0.7 +15.3 627 1,180 620 16 630 700 1,350 700 15 575 735 1,380 725 15 580 700 1,330 695 13 550 675 1,340 650 12 500 650 1,300 675 13 500 625 1,300 675 13 500 681 1,319 711 15 566 703 1,350 693 14 551 92 -6.9 -36.5 -35.2 97 110 115 110 100 115 120 138 109 2,035 2,006 234 24 -24.5 -24.5 +1.6 -5.8 -32.9 -3.7 -2.7 -25.0 -29.9 +7.6 +14.4 -18.4 2,425 1,925 230 25 2,350 1,950 220 28 2,500 2,250 207 28 2,450 1,767 207 28 2,400 1,767 207 28 2,500 1,700 200 27 2,600 1,700 205 27 2,934 2,209 254 27 2,425 1,934 210 28 1,723 633 1,521 32 -2.3 -3.5 -7.3 -6.3 +20.6 -21.0 -14.5 +3.5 +20.4 -16.5 -12.1 +6.2 1,750 625 1,550 34 1,800 600 1,600 39 1,800 650 1,700 39 1,925 750 1,800 39 1,975 800 1,900 39 2,000 850 2,050 40 2,000 850 2,050 40 1,588 732 1,725 36 1,875 700 1,750 39 672 675 936 677 -9.9 -3.9 -0.3 -8.3 +17.3 -0.8 +17.7 +2.2 690 676 960 690 690 676 960 700 710 682 970 780 725 685 960 776 750 700 965 795 750 700 965 795 750 700 965 795 805 774 920 733 719 686 964 763 134 -10.7 -16.8 150 150 165 179 180 185 182 170 169 2,130 7,940 2,120 18,505 20,000 2,040 -1.2 -0.7 +2.1 -5.0 -9.3 +3.1 -14.4 -18.6 -18.0 -27.5 -25.7 -18.1 -8.2 -10.9 -11.1 -23.9 -21.5 -9.4 2,150 7,450 1,950 2,100 8,000 2,000 2,200 8,500 2,250 2,300 9,000 2,350 2,300 9,500 2,400 2,500 2,600 2,500 2,600 2,434 8,814 2,377 2,225 8,750 2,250 10,750 10,750 105 112 114 -3.8 -2.7 -3.7 -18.6 -14.2 -11.5 -1.7 -2.2 +4.8 113 116 118 104 110 114 106 111 115 108 113 116 110 115 117 109 115 118 109 115 118 118 122 122 107 112 116 -11.5 16.5 16.7 -0.2 -3.6 -7.9 -18.1 -18.1 -23.1 +445.2 -254.4 +5.5 +9.3 -154.1 -62.1 -108.2 -205.3 -161.5 -54.1 +2265.1 -6 20 18 2 -4.5 -6 21 17 4 -5 -4 22 18 4 -5 -3 22 19 3 -5 -3 25 23 3 -5 -3 22 21 2 -6 -3 23 21 2 -6 -2.8 19.8 18.3 1.5 -6.8 -4 22 19 3 -5 101.0 109.8 109.1 +6.6 -2.4 +2.0 +9.9 +15.3 +23.3 +12.4 +19.5 +24.9 96 110 105 85 95 93 92 100 98 109 115 112 115 120 118 118 122 120 118 120 118 95.6 111.2 105.8 100.3 107.5 105.1
18,500 20,000 21,500 22,000 22,000 24,000 24,000 22,940 21,375 22,000 24,000 26,000 27,000 27,000 25,500 25,500 26,347 26,000 1,900 2,000 2,150 2,300 2,350 2,450 2,450 2,209 2,200
*weekly quote; **monthly average; ***10-tonne contract ^cost and freight at Chinas Tianjin port, 62% iron content, Indian origin.
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126
World Wide Wrap

Focus issues for next 3 months One year ahead outlook We expect a significant recession in Europe over the winter, while the recent US upswing will fade in H1, bringing renewed QE from the Fed. China and India will relax policy and achieve soft landings. EM central banks will mostly be easing, with exceptions in Africa. We expect growth in most countries to pick up again in H2. Asia overall will see a slowdown but should prove its resilience. In 2012, the two main risks to Chinas economy are a shock from Europe/the US and a messy correction in the domestic housing market. We forecast 8% GDP growth for the year, with stronger momentum in H2. We expect policy rates to be on hold throughout 2012. We foresee more gradual CNY appreciation of about 2% against the USD dollar for the year, with more two-way movement, including periods of sustained CNY weakness. With four successive quarters of sub-7% GDP growth and inflation at c. 6.5%, 150bps of repo rate cuts are likely by end-FY13. This should push some investment back onto the table and boost GDP growth to 7.4% from 7.0% in FY12. Amid a rebound in growth, gradual INR appreciation is likely by the end of 2012. Hopes of progress on reforms may build in again as important state elections are over by mid-2012. Weak growth in the West and rapid lending growth locally present central banks with a dilemma in terms of their monetary policy stance. Strong fundamentals are likely to attract capital inflows, and central banks can either allow currency appreciation or consider capital-flow management. Activity will gradually recover in H2-2012 as policy easing by major economies improves the export outlook and the strong labour market and credit growth underpin domestic demand. Inflation will remain stable at around 3%. We expect only a nominal BoK rate cut, by 25bps in Q2-2012, while meaningful fiscal easing is not our core scenario throughout 2012. Strong fiscal policy driven by resilient oil prices will support growth in oilproducing countries. Global uncertainties, especially European woes, will pose downside risks to global trade, especially for the more open and Europe-dependent economies (Dubai, Maghreb). We see potential growth upside in 2012 for countries that have been through a political transition, owing mostly to a very favourable base effect. 2012 will see key elections in Africa in Senegal, Ghana, Kenya, and internal ANC party elections in South Africa. Governments are likely to come under pressure to rein in expansionary fiscal policy, although the pace of fiscal consolidation in Africa with the exceptions of Botswana and Angola has largely disappointed. Politics are expected to play a key role in determining economic outcomes. The region is better positioned for a global economic slowdown than in 2008. FX reserves are robust and banks well capitalised. However, most countries are too dependent on commodity prices, so growth is vulnerable to a slowdown in Asia and the US. Regional growth should be below trend over the next year. Peru and Chile have the most flexibility to counteract external headwinds. Given the end of the 100% investment tax credit, we see slower business investment in H1-2012. Consumers will continue to deleverage, which will contain consumption growth. Housing prices will likely remain weak and unemployment elevated. There is still significant slack in the economy, which should ease inflationary pressures, particularly as base effects fade in H1-2012. Weak confidence and pullbacks by banks will push the euro area and UK into a significant recession over the winter, with a recovery starting in H2. We do not expect the euro crisis to be fully resolved quickly, but we do think officials will eventually be forced to do enough to restore a degree of confidence among investors. Having said that, the recession will make it difficult to meet deficit targets. The V-shaped rebound we expected after the March 2011 Fukushima earthquake is likely to be delayed until H2-2012 due to ongoing external shocks. The new recession in Europe and slow growth in the US, along with the October 2011 floods in Thailand, have put Japans fragile economy in jeopardy again. We expect 2012 to be a transition year before large-scale earthquake reconstruction begins.
Global
Attention will remain on the European crisis as officials try to support problem sovereigns and banks while the economy slides. US data will be scrutinised to see if the recent pick-up continues. In Asia, with inflation receding, the focus will also be on activity data, particularly the extent of Chinas economic and property-market slowdown. The pace of easing by the PBoC will be watched closely. Beijing is now moving ever more rapidly from fighting inflation to protecting growth. Q1-2012 will be tough, with co-ordinated slowdowns in exports, residential real-estate construction and infrastructure. Monetary policy is being gradually loosened, in the form of a less restrictive loan quota for 2012 (some CNY 8.5trn, we forecast) and RRR cuts (we look for five more through end-2012). We expect Q2-2012 to see a gradual growth recovery. In India, slowing growth and falling inflation will keep expectations of a repo rate cut high; we expect this to happen by Q2-2012. Policy inertia and a lack of reforms will continue to weigh on sentiment, and the union budget presentation in February 2012 will be scrutinised to assess the governments commitment to fiscal consolidation. INR weakness will remain a concern. Policy makers focus has returned to easing growth momentum as confidence in DM growth wanes. A correction in global oil prices will also help to reduce inflation concerns. Local consumer confidence is moderating, which should allow central banks to assess the possibility of rate cuts. We expect a further slowdown in exports and domestic demand due to the European crisis. Headline inflation will return to the BoKs target range thanks to food and energy prices, but the BoK is likely to remain cautious and keep the policy rate on hold in Q1-2012. Significant fiscal easing is also unlikely given the government's emphasis on fiscal prudence. GCC policy makers are focused on spending, while Tunisia and Egypt remain in political transition. Higher spending by GCC states has translated into increased spending and inflationary pressure for some. More importantly, it has helped to suppress further contagion from political unrest. A risk-off environment in Q1-1202 will leave the ZAR especially vulnerable to a correction. Many frontier African central banks have imposed new currency regulations in response to currency weakness. We expect risk aversion to discourage new flows into frontier Africa (with some exceptions, notably Uganda), but not necessarily trigger new outflows from these markets. With favourable yields and improving fundamentals, African FX is set to benefit more broadly from H2-2012. Brazils central bank should continue to ease monetary policy in the months ahead; we look for a single-digit SELIC rate in H1-2012 (now 11%). Other central banks in the region should stay put shortterm unless the situation in Europe deteriorates further. In Argentina, the authorities face worrisome levels of capital flight and decreasing USD deposits as BCRA reserves shrink. The US likely ended 2011 on a high note, but growth may hit an air pocket in Q1-2012. While employment growth is too weak to sustainably drive down unemployment, core retail sales growth should continue to benefit from lower gasoline prices. Without a significant economic shock, we do not see another recession, but deleveraging still has far to go. The housing market remains dismal. The focus is on three areas: (1) whether politics in the euro-area periphery will support necessary austerity measures, ensuring backing from core governments and the ECB; (2) ECB actions, including the scale of bond purchases, a further rate cut and help with funding for banks; and (3) confidence and activity data as the euro area and UK slide into recession. In the near term, the recovery in exports and manufacturing will continue to be affected by sluggish global demand and JPY strength. Optimising government funding plans to cover huge reconstruction needs and security spending will also be critical to the new government, which now advocates a sales tax in the next couple of years to improve the fiscal balance.
Greater China
South Asia
South East Asia
South Korea
MENA
Sub-Saharan Africa
Latin America
United States
Europe
Japan
Important disclosures can be found in the Disclosures Appendix
12 December 2011
127
Disclosures Appendix
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Global Focus 2012

Fragile West, resilient East

All rights reserved. Standard Chartered Bank 2011

MIDDLE EAST and NORTH AFRICA

Global Focus 2012 The Year Ahead

Global Focus 2012 The Year Ahead

Fragile West, resilient East

Global Focus 2012 The Year Ahead

Global overview (cont)

Global Focus 2012 The Year Ahead

Global overview (cont)

Emerging & Industrialised Asia

Global Focus 2012 - The Year Ahead

Global overview (cond)

Table 1: Nominal GDP, 2008 versus 2011 USD bn

Chart 4: Low-inflation period poses policy dilemma Inflation, % annual average

Middle East and North Africa Sub-Saharan Africa Countries Brazil

China World India Indonesia Japan Russia United States

Sources: IMF, Standard Chartered Research

Global Focus 2012 The Year Ahead

Lets try this again

Chart 1: EM rate rally started rapidly after 2009 G20 (bps)

Sources: Bloomberg LP, Standard Chartered Research

Global Focus 2012 The Year Ahead

Strategy overview (cond)

Global Focus 2012 The Year Ahead

Helen Henton, +44 20 7885 7281

Dan Smith, +44 20 7885 5563

Abah Ofon, +65 6596 8245

Koun-Ken Lee, +65 6596 8256

A glass half full

Source: Standard Chartered Research

Global Focus 2012 The Year Ahead

Our key calls for 2012

Baseline returns for energy, precious and base metals in 2012

Source: Standard Chartered Research

Global Focus 2012 The Year Ahead

Commodities Charts of the year

Sources: Reuters, Standard Chartered Research

Sources: Reuters, Standard Chartered Research

Chart 4: Non-OECD and OECD y/y oil demand change mbd

Sources: Bloomberg, Standard Chartered Research

Sources: IEA, Standard Chartered Research

Chart 6: USD correlation

vs Copper Sep-10 Dec-10 Mar-11 Jun-11 Sep-11 Dec-11

Sources: Bloomberg, Standard Chartered Research

Sources: Bloomberg, Standard Chartered Research

Global Focus 2012 The Year Ahead

Bracing for a rocky start

Expectations for Q1-2012

Chart 1: Asian cash bonds outperform the rest of EM Spread (bps)

Latam EEMEA Asia

200 Dec-10 Feb-11 Apr-11 Jun-11 Aug-11 Oct-11

Global Focus 2012 The Year Ahead

Expectations for supply in 2012

Source: Standard Chartered Research

Global Focus 2012 The Year Ahead

Credit Charts of the year

Sources: Bloomberg, Standard Chartered Research

Source: Standard Chartered Research

Sources: Bloomberg, Standard Chartered Research

Sources: Bloomberg, Standard Chartered Research

Sources: Bloomberg, Standard Chartered Research