Asian FX

A Global Balancing Act

Simon Flint

Global Foreign Exchange Research

June 2011

See the disclosure appendix for analyst certification and important disclosures on page 54.

2

Who are these men? Who is the odd one out?

We remain quite positive about Asian currencies for four reasons-

1. CHINA. Next 12Ms will average a 6% p.a. appreciation in the

CNY.

2. ASIA. Domestic macro imperatives. Growth is sufficiently good and

the inflation threat rising.

3. VALUATION. REERs/FEERs… much of the recent move has

been facilitated by the USD move. Still room for appreciation

according to our valuation assessments, REERs, FEERs, current

accounts.

4. EXOGENOUS RISK ENVIRONMENT = good enough. Although

our global leading indicators are in decline, they are still likely to be

in the zone consistent with positive returns for risky assets.

3

Summary

1. CNY. High conviction, 6% p.a. versus USD.

2. SGD. High conviction 3% p.a. appreciation versus basket,

3. MYR. Ditto, but higher risk.

4. KRW. Higher risk, but 1020 target

5. IDR. c3% gain, but higher volatility.

6. PHP. Ditto, but even higher volatility & willingness to intervene.

7. TWD. Short-term catch-up, medium-term depreciation

8. INR. Potentially high return, but high vol, & great dependence on

equity

4

League table for Asia (6Ms)

China’s perceived inflation risk is greater than that which prevailed around the time of 2010’s major

diplomatic events. This may make CNY appreciation more enduring

Historical experience of CNY action prior to major diplomatic events suggests international gatherings will

continue to act as a magnet for CNY appreciation

Source for both figures: CEIC, Nomura, Bloomberg

1. Updated as of 10-June-2011. 5

1. CNY appreciation

Inflation an important domestic driver Diplomatic events may be important1

Inflation and Events driven

6.0

6.5

7.0

7.5

8.0

8.5-4

-2

0

2

4

6

8

10

12

Aug-05 Jul-06 Jun-07 May-08 Apr-09 Mar-10 Feb-11

China CPI (YOY) USDCNY (Inverted)

-1.5%

-1.0%

-0.5%

0.0%

0.5%

1.0%

1.5%

-20 -16 -12 -8 -4 0 4 8 12 16 20

19-Jan 11-Nov

25-Jun 16-Sep

In a related policy development, rate hikes tend to be associated with relatively rapid CNY change. With

China apparently in rate hiking mode, this supports our expectation for a stronger CNY

We have also identified the CNY NEER as one of the factors1 that might provide the impetus for further

CNY appreciation. As it is now, CNY NEER is slightly below the average for 2010.

Source for both figures: CEIC, Nomura, Bloomberg

1. See Appendix of FX Insights, CNY update – The glass is (at least) half full, 4 January 2011. 6

1. CNY appreciation (cont’d)

Rates hikes coincide with greater CNY change CNY NEER and USD-CNY

Rates hikes and CNY NEER

6.0

6.5

7.0

7.5

8.0

8.51.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

Jan-06 Nov-06 Sep-07 Jul-08 May-09 Mar-10 Jan-11

China's 1Y Deposit Rate

USDCNY (inverted)

94

96

98

100

102

104

106

Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11

CNY-NEER USDCNY

Flexible Regime

USD-CNY is likely to follow a very similar path to that in 2010 (see exhibit on left)

The pace of appreciation has picked-up in preparation for the SED over 9-10 May

High inflation may keep the rate of change relatively quick until mid-July (the State Council is due to

review policy then), and the July visit to the US by the Dalai Lama.

Source for both figures: CEIC, Nomura, Bloomberg

7

1. CNY appreciation (cont’d)

2010 – A History Lesson 2011 – The Mirror Image

Through the looking glass

6.50

6.55

6.60

6.65

6.70

6.75

6.80

6.85

Jan-10 Mar-10 May-10 Jul-10 Sep-10 Nov-10

USDCNY 2010

Toronto G-20 Summit

Increase in Inflation Expectations

US-China SED

Seoul G-20 Summit

Geithner'sTestimony in

Senate

Premier Wen meets

Obama in NY

6.15

6.20

6.25

6.30

6.35

6.40

6.45

6.50

6.55

6.60

6/10/11 7/20/11 8/29/11 10/8/11 11/17/11 12/27/11

USDCNY 2011 Forwards Implied Path

Wen Jiabao in U.S.

Dalai Lama U.S. visit

State Council Economic Review

G20 Summit

Source: Nomura 8

1. Detailed Calendar of Key Global EventsDate Event Location Remarks

H1 2011IMF/BIS future reports on

Capital controlsGlobal

G20 outlined that IMF, BIS and FSB would be asked to examine the use of macro-prudential measures. First

report has already been released in January

June-July 2011Likely publication of IMF Article

4 for ChinaChina

The previous Article 4 included a current account forecast. On this occasion it may do likewise; and/or contain

an assessment of the so-called global 'spill-overs' of local policy (presumably commenting on the Chinese

contribution to rebalancing)

Q3 2011National Financial Work

ConferenceChina

It seems to have been postponed (perhaps Q3 at the earliest), but as it happens only every f ive years and is

focused on financial liberalization, is potentially exciting

Q2 or early Q3 Joe Biden visits China China Likely during summers (2Q2011 or early 3Q2011)

6-18 July 2011 Dalai Lama in US WashingtonIn our non-expert opinion, if an audience with Obama is sought it is unlikely to be refused, as US will not wish

to be seen as changing policy on Tibet

Mid July State council - China China Economic review w ill be done by policy makers

8 Aug - 2 Sep 2011 August Congressional Recess US Many congressmen w ill visit China during this time

9-10 Sept 2011 G8 Finance Ministers meetMarseille,

FranceG8 remains less important than G20 meetings

13 Sep 2011 Opening of UNGA NY, USWen Jiabao is expected to be in US for the opening of UN general assembly. Obama may meet him in NY, as

occurred last year. The event w ill also see the appointment of new Secretary General

23 Sep 2011 G20 Finance Ministers Meeting Washington G20 finance ministers meet before the IMF annual meetings

24-26 Sep 2011IMF/World Bank annual

meetingsWashington 2011 Annual Meetings of the World Bank Group and the IMF

Q3 or Q4 Xi Jingping visit to US USLikely to occur after Biden's visit to China (as leaders appear to be alternating visits), may be pushed into 2012,

despite joint statement pledge after Hu-Obama meetings. Could coincide w ith the APEC Summit in Haw aii

15 Oct 2011 US Treasury FX Report USA delay in the publication of April report could also lead to a delay in the publication of this report. The report due

on Oct 2010 w as published only in Feb 2011

16 Oct 2011 G20 Finance Ministers Meeting N.A.

21 Oct 2011 East Asia summit Bali Could see Obama visit (Bali Times reports he will), & thus he could meet Hu Jintao

12-23 Nov 2011 ASEAN Bali 19th ASEAN Summit

3-4 Nov 2011 G20 Summit Cannes, France The only leaders summit of 2011 will conclude the France's G20 presidency with handover to Mexio for 2012

8-9 November 2011 ASEM Laos Asia- Europe meeting - 9th ASEM Summit

11-13 November

2011APEC

Honululu,

Hawaii

APEC ministerial meeting (11th Nov) and Annual APEC Economic Leaders' Meetings (12 - 13th Nov).

Hu Jintao may attend this summit

14 Jan 2012 Elections Taiw an

N.A. US-Japan new defence agenda USConcern that Japan-US will be more explicit about the threat posed by China - It was expected to be out in

April

N.A.Talks on North Korea, six-party

talks may be announcedN.A. Bilateral talks on pause. Six-party talks may be announced in future

N.A. Taiwan arms sales N.A. Unknown timing, not necessarily this year

Asia’s economic cycle has slowed. Asia’s export trend (% 3M saar) was 22% in April 2011 from -1% in

September 2010, compared to the high of 61% in December 2009.

Furthermore, Asia IP trend (%3M saar) is 11% in April 2011 higher than -7% in September 2010).

Based on the latest available data, most of the Asian economies (viz. China, India, Indonesia, Korea,

Malaysia, Philippines and Singapore) have shown an expansion in the industrial production on an %3m

saar basis.

1. Source for both figures: Bloomberg, CEIC, Nomura

2. Average of all Asia exports as of April 2011.

3. Average of all Asia IP as of April 2011 (subject to data available). 9

2. Relative Asia growth outperformance

Asia exports trend (3m saar vs. %y/y)1,2 Asia IP trend (3m saar vs. %y/y)3

Momentum is sufficiently strong

-80%

-60%

-40%

-20%

0%

20%

40%

60%

80%

Jan-06 Oct-06 Jul-07 Apr-08 Jan-09 Oct-09 Jul-10 Apr-11

Trend of Asia export growth (%3M, saar) All

Asia Export growth (%yoy, sa) All

-40%

-30%

-20%

-10%

0%

10%

20%

30%

40%

Jan-06 Nov-06 Sep-07 Jul-08 May-09 Mar-10 Jan-11

Trend of Asia IP growth (%3M, saar) All

Asia IP (%yoy, sa) All

Headline CPI trend (%3M saar) is still at elevated levels. Asia headline CPI trend at 6.6% in April

2011from a low of 0.8% in Jul 2010. Headline CPI at 4.6% y/y in April 2011 (close to the highest levels

since Nov 08).

Specifically, the largest gains have been in India, Hong Kong and Philippines. India headline WPI trend is

at 10.5% in April 2011 from 3.4% in August 2010.

Core inflation trend remains more subdued (3.0% y/y in April), but the trend has also picked up to 4.6% in

April 2011 from a low of 0.9% in July 2010.

1. Source for both figures: Bloomberg, CEIC, Nomura

2. Data as of April 2011. 10

2. And rising inflation suggests scope for an FX policy

shift towards appreciation…

Asia headline and core inflation2 Inflation trends rising2

-4%

-2%

0%

2%

4%

6%

8%

10%

12%

14%

Jan-03 Dec-03 Nov-04 Oct-05 Sep-06 Aug-07 Jul-08 Jun-09 May-10 Apr-11

Trend of Asia Headline CPI (%3M, saar) All

Trend of Asia Core CPI (%3M, saar) All

-10%

-5%

0%

5%

10%

15%

20%

Jan-08 Jun-08 Nov-08 Apr-09 Sep-09 Feb-10 Jul-10 Dec-10

India Indonesia China Taiwan

Headline CPI (%3m, saar)

1. Source for both figures: Bloomberg, CEIC, Nomura 11

3. Asia Valuations

REER Valuations

REER Deviation Actual Returns Latest z-score

Z-Score %age 1m returns 1Y returns 1m returns 1Y returns

China 0.71 4.79% 0.70% -1.87% 0.23 -0.93

Hong Kong -1.62 -7.44% 0.22% -7.10% 0.33 -0.88

India 1.16 5.87% -0.26% -0.79% -0.24 -0.26

Indonesia 1.28 7.72% 0.90% 0.92% 0.33 -0.24

Korea -0.40 -5.95% 0.85% 1.51% 0.44 0.42

Malaysia 1.16 2.90% -0.13% -0.54% -0.19 -0.56

Philippines 0.91 4.61% -0.50% -0.81% -0.47 -0.93

Singapore 2.28 9.90% 0.10% 5.19% -0.15 1.01

Thailand 1.12 3.44% -0.73% -0.44% -0.75 -0.75

Taiwan -0.34 -1.30% 0.50% 0.98% 0.49 1.14

FEER and SEER model outputs

Raw Model Output Raw Model Output

FEER SEER Average FEER SEER Average

China -10 -16 -13 -12.4 -18.5 -15.4

Hong Kong -4.5 -12.8 -8.7 -6.1 -14.5 -10.3

India -0.6 -0.3 -0.5 3.5 3.8 3.6

Indonesia -7.6 -2.9 -5.3 -6 -1.4 -3.7

Korea -6.7 -10.6 -8.7 -0.7 -4.3 -2.5

Malaysia -4.6 -22.8 -13.7 -3.5 -21.5 -12.5

Philippines -14.6 -12.2 -13.4 -17.5 -15 -16.2

Singapore -25.1 -20 -22.6 -23.1 -18.1 -20.6

Thailand -12.9 -8.2 -10.5 -11.9 -7.2 -9.5

Taiwan -57 4.6 -26.2 -54.7 6 -24.3

Source : CEIC, Nomura, Bloomberg, BIS

12

3. Asia’s basic balancesBasic Balance (ex SG, HK)

Basic Balance (ex SG, HK, CN)

-2

0

2

4

6

8

10

Dec-03 Nov-04 Nov-05 Nov-06 Nov-07 Nov-08 Nov-09 Nov-10

Asia (ex HKD, SGD, as % of GDP)

Basic Balance Portfolio Investment

0

1

2

3

4

5

6

7

Dec-03 Nov-04 Oct-05 Sep-06 Aug-07 Jul-08 Jun-09 May-10

Asia (ex HKD, SGD, as % of GDP)

Current Account FDI

-3

-2

-1

0

1

2

3

4

5

6

Mar-03 Mar-04 Mar-05 Mar-06 Mar-07 Mar-08 Mar-09 Mar-10

Basic Balance (as % of GDP)

Portfolio Investment (as % of GDP)

-1

0

1

2

3

4

5

6

Mar-03 Mar-04 Mar-05 Mar-06 Mar-07 Mar-08 Mar-09 Mar-10

Current Account (% of GDP) FDI (% of GDP)

1. Source : CEIC, Nomura, Bloomberg, BIS

2. Data as of April 2011. 13

3. Indonesia Indonesia (CA & trade balance)

-0.50

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

4.00

Dec-08 Mar-09 Jun-09 Sep-09 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10

Trade Balance (USD bn) Trade Balance (12m avg, USD bn)

Current Account (12m avg, USD bn)

Korea (CA & trade balance)

-6

-4

-2

0

2

4

6

8

Jan-00 Feb-01 Mar-02 Apr-03 May-04 Jun-05 Jul-06 Aug-07 Sep-08 Oct-09 Nov-10

Trade Balance (USD bn) Trade Balance (12m avg, USD bn)

Current Account (12m avg, USD bn)

Asia Core CPI2 Asia Headline CPI2

-4%

-2%

0%

2%

4%

6%

8%

10%

12%

14%

Jan-06 Sep-06 May-07 Jan-08 Sep-08 May-09 Jan-10 Sep-10

Trend of Asia Headline CPI (%3M, saar) All

Asia Headline CPI (%yoy, sa) All

-1%

0%

1%

2%

3%

4%

5%

6%

7%

8%

Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11

Trend of Asia Core CPI (%3M, saar) All

Asia Core CPI (%yoy, sa) All

Source : CEIC, Nomura, Bloomberg, BIS

14

4. The risk outlookNOLI & Risk:Historical performance1 NOLI & Risk: Recent & projected2

NOLI growth rate vs. performance of risk assets3

85

90

95

100

105

110

115

98.5

99.0

99.5

100.0

100.5

101.0

101.5

-7 -5 -3 -1 1 3 5 7 9 11 13 15 17 19

NOLI Historical Risk Historical (RHS)

Accel-eration

Peak Plateau

75

80

85

90

95

100

105

110

115

120

125

98.5

99.0

99.5

100.0

100.5

101.0

101.5

Oct

-09

Dec

-09

Feb

-10

Ap

r-10

Jun-

10

Aug

-10

Oct

-10

Dec

-10

Feb

-11

Ap

r-11

Jun-

11

Aug

-11

Oct

-11

Dec

-11

NOLI Recent / Projected Risk Recent / Projected (RHS)

Accel-eration

Peak Plateau

Range of NOLI

gradient

Excess

ReturnsStd. Dev.

Information

Ratio

(Higher quartile indicates quicker pace of NOLI rise)

> 0.126% 0.80% 4.09% 0.68

0.00% - 0.126% 0.67% 3.56% 0.66

-0.122% - 0% 0.10% 3.94% 0.08

< -0.122% -0.46% 5.16% -0.31

Performance of S&P 500 with

first derivative of NOLI

Top Quartile

2nd Quartile

3rd Quartile

Bottom Quartile

1) We have taken historical median performance of NOLI and risky assets (S&P 500) in previous 19 post-peak eras since 1950.

2) We have charted the recent performance of NOLI and risky assets (S&P 500) since October 2009 onwards. The projected path of NOLI is based on the autoregressive modelling. The ‘projected’ path for risky assets is the same as historical median performance.

3) The long-term inflation-adjusted trend for S&P 500 based on the Jan-48 to Oct-2010 is 3.3% pa. Also, it should be noted that we have not adjusted the index for the dividend payoffs which would further enhance returns.

H2 will be more challenging because:-

1. CNY move has been SED inspired. There is risk of temporary

pause in CNY move around Dalai Lama’s July visit to Washington,

and policy loosening risk associated with the state council policy

review in mid-July.

2. Nomura’s G10 strategists think that USD may be close to a bottom.

3. Risk markets are likely to make less significant gains in H2.

4. There’s something special about the USD and central banks will

push back against rapid moves.

15

But...

16Edit View/Header and Footer... (Footer field)