PIMCO Asia Limited

Units 2403 & 05, 24/F

Nine Queen’s Road Central
Hong Kong
Tel: (852) 3650-7700

Bi-Polarism and Schizophrenia:

Does Asia Take Uppers or Downers?
Brian P. Baker
Chief Executive Officer and Director
PIMCO Asia Limited
16 March 2011

This material contains the current opinions of the manager and such opinions are subject to change without notice. This material has been distributed for
informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment
product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this material may be
reproduced in any form, or referred to in any other publication, without express written permission
Key Issues to Consider Today
1. Is a structural shift toward internal
sources of demand evident in Asia-
Pacific countries?

2. In the face of European debt crisis and

extraordinarily accommodative US
policies, how do policy responses differ
across the Asian region?

3. Will policy tightening unintentionally

induce a sharp drop in aggregate
demand?
 Consensus Expects Slower
Eurozone 2011 Growth
Eurozone Contribution to GDP (QoQ) Consensus forecasts from Q3-2010
(MS, GS, HSBC, JPM, Barcap, Capital, DB)

1.5 Net exports

Inventory
Investment
Government
1.0 Consumption
GDP

0.5

0.0

-0.5

-1.0
2009 Q3 2009 Q4 2010Q1 2010Q2 2010Q3 2010Q4 2011Q1 2011Q2 2011Q3 2011Q4

Average quarterly growth of 1.2% saar looks fair, but risks are to the downside from
Europe’s fiscal tightening & sovereign debt crisis.
SOURCE: PIMCO.
Aggregate Eurozone Data Hides
Diverging Economy
Employment (Q2 2009=100)
103

Germany Spain Portugal

102
Italy Eurozone

101

100

99

98

97
Mar-09 Sep-09 Mar-10 Sep-10

Real divergence is increasing. German employment risen to post reunification

high while unemployment is rising in the periphery.
Data since September suggest intra-Euro divergence has increased further.
SOURCE: PIMCO, Eurostat,
Monetary Policy Reinforces
Growth Divergence
Gap Between Taylor Rule Rate and ECB’s MRO Rate (%)
4 Too Loose (AT, DE, NL) 4
Too Tight (ES, IE, PT)
3 Appropriate (FI, FR, BE, IT, GR) 3
Germany, Austria,
expansive
2 2
Netherlands
1 1

0 0 France, Italy, Greece,

-1 -1 Belgium, Finland

-2 -2

-3 restrictive -3
Spain, Ireland,
Portugal
-4 -4

-5 -5
05 06 07 08 09 10

Policy is “too easy” for Germany, too tight for the periphery. The ECB is going
to have to focus on the latter.
SOURCE: Natixis, PIMCO.
Exports to Euro Area are Small
Effects of QE II and Tax Cuts in
the US?
• QE II adding $600 billion in Treasury
purchases + $300 billion purchases from
MBS paydowns

• Extend Bush tax breaks

• 2% payroll tax reduction

• Extension of unemployment benefits

• 100% tax credit on capex

QE II and Tax Cuts May have
Extended Coming Fiscal Drag
The Fiscal “Ball” is in the Hands of Washington... but Watch for Bond Vigilantes

Sources: BEA, Goldman Sachs Estimates, PIMCO Calculations

Traditional “Taylor Rule” Analysis
Drives Fed’s Decision
Based on the US “Output Gap”, 0% Fed Funds is “Too Tight”

Source: Goldman Sachs

What Does the Evidence Show?
Magnitude of Impact of US Liquidity
on EM Liquidity
  US Eurozone
Emerging
0.22** 0.65**
Markets
Large Historical
Passthrough of
Emerging Asia 0.74** 0.62** US Monetary
Growth to Asia
Emerging
-0.20** 0.68**
Europe
Latin America 0.06 0.65**
** indicates 5% Statistical
Significance
NOTES: Results from regression of US and EU M2/GDP on EM M2/GDP; quarterly time series
2000Q1 to 2010 Q3
SOURCE: PIMCO Calculations.
Beta Coefficient of Asia’s Growth
to G7 and EU-16 Growth

TAP
Asia-Pacific Growth Continues to
Outperform
Share of Global GDP Contribution to Global Growth
100% 2.6

90% 2.4

2.2
80%
2.0
70%
Percent of Global GDP (%) )

1.8

Percent, 5-period MA (%)

60% 1.6

1.4
50%
1.2
40% 1.0

30% 0.8

0.6
20%
0.4
10% 0.2 G7
Asia
0% 0.0
1990 1993 1996 1999 2002 2005 2008 1984 1988 1992 1996 2000 2004 2008 2012F

Asia Ex Japan Ex China Non Asia EM

China US
EU Japan

SOURCE: UN Comtrade, IMF

 Final Demand is Gradually
Shifting East
World Exports to China World Exports to the US
16% 25%
Raw Materials
14%
Manuf. Inputs
20%

Percent of Total World Exports (by Product)

Percent of Total World Exports (by Product)

12% Processed Goods

10%
15%

8%

10%
6%

4%
5% Raw Materials

2% Manuf. Inputs

Processed Goods
0% 0%
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008

SOURCE: UN Comtrade
 Percent (%)

-8
-6
-4
-2
0
2
4
6
8
10
12
14
16
2004-07 Ave
1H09

CH
2H09
1H10
2004-07 Ave
1H09

HK
2H09
1H10
2004-07 Ave
1H09

SOURCE: Bloomberg, CEIC, CIRA

IN
2H09
1H10
2004-07 Ave
1H09

ID
2H09
1H10
2004-07 Ave
1H09

KR
2H09
1H10
2004-07 Ave
1H09

MY
2H09

Domestic Demand (Ex-Inv)

1H10
2004-07 Ave
1H09

PH
2H09
1H10
2004-07 Ave
1H09

SG
2H09
1H10
2004-07 Ave
by Domestic Demand…

1H09
TW
TAP

2H09
1H10
2004-07 Ave
1H09
TH

2H09
Net Exports

1H10
2004-07 Ave
1H09
AU

2H09
1H10
Composition of Asia Real GDP Growth - Pre-Crisis Average (2004-2007)

2004-07 Ave
1H09
JP

2H09
1H10
Export Slowdown Will Be Offset
 Percent of GDP (%)

30
35
40
45
50
55
60
65
70
75
Turkey
US
Mexico
UK
Brazil
South Africa
Japan
Italy
Germ any

SOURCE: HAVER, CIRA

Canada
Indonesia
France
Argentina
India
E uro Area 16
Australia
Household Consumption (2009)

Korea
Russia
Sau di Arabia
China

Percent of GDP (%)

20
30
40
50
60
70
80
90

US
Japan
Italy
Germany
France
UK
a Secular Story for China

Canada
Euro Area
South Africa
Mexico
Turkey
Brazil
Argentina
India
Australia
Services Sector (2009)

Russia
Korea
China
Indonesia
…Although Consumption Remains

Saudi
Secular Growth Potential in
Emerging Asia Still Untapped
14

12
Fast Growth/
China
High Income

?
10 Yr Average Grow th (% )

10

8
India

6 Russia

Singapore
Malaysia South Korea
4 Indonesia Hong Kong
Taipei,China
Taiwan Australia
Thailand
Philippines Brazil UK
2 US

Japan Germany
0
-10,000 0 10,000 20,000 30,000 40,000 50,000
GDP Per Capita (USD)

* Size of bubble denotes population

SOURCE: Bloomberg, IMF

 Asia-Pacific Monetary Conditions
in a QE2 Environment
EM Asia Real Rates EM FX Reserves and G4 M2*
8000 6500
5

4 7500
5500
3
7000

2 4500
6500
1
Percent (%)

US$bn
6000 3500
0

-1 5500
2500
-2
5000
-3
1500
4500
-4

-5 4000 500
HK SG ID CH TH TAP PH KR MY IN SL JP AU 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

National measure of M2 in the G4 (LHS)*

Total EM fx reserves (RHS)
Sep-09 Sep-10 Change

SOURCE: Bloomberg, Citibank, HAVER

* M2 inG4 is the sum of GDP-weighted M2 for the Euro area, Japan, UK and US.
Policy Trilemma Turns
Increasingly Challenging

Hong Kong Free Capital Australia

Singapore Flow Japan

Managed Independent
Exchange Monetary
Rate Policy

China Malaysia
India Philippines
Indonesia Thailand
Korea Taipei,China
Australia – Policy Response
Free Capital
Flow

“A rise in the exchange rate is a natural consequence of a

resources boom and, at the aggregate level, is helpful in
allowing the economy to adjust.” Managed Independent
Ric Battellino Exchange
Rate
Monetary
Policy
Deputy Governor, RBA
November 2010

SOURCE: RBA, ABS, Bloomberg, ABARE, Citigroup, Energy Publishing, Macquarie Bank
Japan – Policy Response
“Although easy monetary policy is needed, it alone cannot solve the
Free Capital
problem. Structural reform is indispensable.” Flow

“Strong JPY worsens sentiment in short-term, but there are positive

aspects in long-term such as an improvement of the terms-of-trade…, JPY Japan

strength is advantageous to a corporate acquisition in overseas…”

Managed Independent
Masaaki Shirakawa Exchange Monetary
Rate Policy
Governor, BoJ
October 2010
“This is not a time to make cars in Japan”
Toru Hasegawa
COO, Nissan Thailand
September 2010
$/JPY and BoJ Policy Action 300 Balance sheet (Jan '07 =100)
115 ① ② ③ ④ ⑤
Fed balance sheet
110
250
BoJ balance sheet
105
200
100

95 150

90
100
85

80 50
Mar-08 Sep-08 Mar-09 Sep-09 Mar-10 Sep-10 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10
①: Introduction of 3month term lending facility (10trn JPY)
②: Increase size of 3month term lending (to 20trn JPY)
③: Announcement to provide loan to growth oriented sector
④: Extend term lending facility from 3months to 6months
⑤: Comprehensive monetary easing (set-up asset purchase fund)
SOURCE: Bloomberg, BoJ, Fed Reserve
China – Policy Response
Free Capital
Flow
“We should widen the flotation range of the yuan’s exchange rate as appropriate
to reduce price pressures stemming from global raw materials”
Li Daokui
GDP Growth: China and US
140 MPC Member, PBoC Managed Independent
China Exchange Monetary
November 2010 Rate Policy
Index (Q1 2007 =100),

130
Seasonally-adjusted

China: "Estimated" Portfolio Flows*

50
120

40
110
30
US
100
20

Dollars ($ Billion)
90 10
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3
07 08 09 10 0

Monetary policy: China and US -10

20 6
Reserve Requirement Ratio (%)

-20
18 China 5

-30
16 4

-40
14 3
-50
12 2 Jan-98 Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10

10 1 * FX Reserves – Trade Surplus - FTI

US
8 0
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
07 08 09 10

SOURCE: Bloomberg, JPMorgan

Korea: Policy Response
Free Capital
Flow
“We will need to devise necessary countermeasures to deal with
the possible changes in monetary policy transmission channels and
the limitations on policy effectiveness”
Kim Choong Soo Managed Independent
Governor, BoK Exchange
Rate
Monetary
Policy
November 2010
Industrial Production: Korea versus Japan KRW Cross Rates
600 16 220
JPY-KRW (LHS)
15
Korea CNY-KRW (RHS)
500 200
14
Index (Jan 90 =100), 12-Mth MA

China

400 13 180

12

300 160
11

200 10 140

9
Japan
100 120
8 Japan

0 7 100
Jan-90 Jan-94 Jan-98 Jan-02 Jan-06 Jan-10 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10

SOURCE: Bloomberg, JPMorgan

Singapore – Policy Response Free Capital
Flow
“Domestic cost pressures are rising, given the high level of resource utilization
in the economy and tight labor market in particular, as well as the diminishing
boost from the cyclical uplift in productivity seen earlier this year. Thus, the
balance of risks is weighted towards inflation going forward” Managed Independent
Exchange Monetary
Monetary Policy Statement, MAS Rate Policy

October 2010
Singapore: Strong Currency Bias Economic Openness
115 160

113
140

Exports as percent of GDP, 2009 (%)

111
120
109

100
107
NEER Index

105 Upper Band 80

103
60
101
Lower Band 40
99

20
97

95 0
Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10

S
ro li a
,C d

Ja ia
a
Ta a a

a
ap g

do es
Ko a

n
al e

ea
s a

U
re
ei n

ili in
ng n
M or

Th ysi

pa
n

d
Au esi
Eu tra
In p in
ip il a
Si Ko

ar
hi

In
Ph Ch
a

n
p
g
on
H

SOURCE: JPMorgan
Hong Kong – Policy Response Free Capital
Flow
“…Hong Kong is now facing an exceptionally unusual macro-financial
environment, a situation that cannot be continued indefinitely…As the gate-
keeper of Hong Kong’s banking system, the HKMA must introduce
appropriate prudential measures in a timely manner.” Independent
Managed
Exchange Monetary
Norman T.L. Chan Rate Policy

Chief Executive,HKMA
November 2010
Standard Deviation of Inflation - 1983 to 2009 Hong Kong: Property Prices
5.0 210

Hong Kong Property Price Index (Jan 1993=100)

4.5

4.0 180

3.5
Standard Deviation (%)

- 45%
+ 47%
3.0 150

2.5

2.0 120

1.5

1.0 90

0.5

- 60
Jan-93 Jan-96 Jan-99 Jan-02 Jan-05 Jan-08 Jan-09
nd

a
ng

na

e
re

or

si
la
Ko

hi

ay
Ko

ap
ai

,C

al
g

ng
Th

ei

M
on

ip

Si
H

Ta

SOURCE: IMF, JPMorgan

Asia Pacific – Policy Responses
Comprehensive Capital Controls on Controls on Non- Comprehensive Capital
Controls Possible Financial Assets Financial Assets Controls Unlikely

 Hong Kong
 Singapore
 Australia
 Japan

 China
 India
 Indonesia
 Korea
 Malaysia
 Philippines

 Thailand
 Taipei,China

SOURCE: PIMCO
Key Issues and Conclusions
1. Is a structural shift toward internal sources of demand evident in Asia-
Pacific countries?
– Domestic demand is gradually heading eastward, led by infrastructure
investment
– Household consumption remains a secular story
– In the interim, global imbalances are widening further, not narrowing
2. In the face of QE2, how do policy responses differ across the region?
– Policy responses in developed countries result in (un)intended inflation
consequences in Asia-Pacific
– Asia-Pacific policy responses vary according to initial conditions, policy
flexibility and political pressure
3. Will policy tightening unintentionally induce a sharp drop in aggregate
demand?
– Balance of risk points to Emerging Asia tightening too little and Japan
easing too little
– Given fiscal flexibility and infrastructure needs, economic hard-landing
remains a low-probability scenario in China
– Downside risks to Asia-Pacific growth: Trade protectionism,
geopolitical risk and inflation