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KBank Multi Asset Strategies oct 2011 (English)


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Strategies …

Macro / Multi Asset
October 2011
Volume 42

Published in: Business, Economy & Finance

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  • 1. .Mean S Multi Asset Strategies KBank Strategies Macro / Multi Asset Are we falling into the lull of optimism? October 2011 Volume 42 Consensus appears to be hoping for the best and not preparing for the worst. It seems that the bitter lessons of 2008/9 have all Kobsidthi Silpachai, CFA –Kasikornbank been but forgotten Susheel Narula – KSecurities Calling the USD/THB direction has now become analogous to a coin toss…and here we provide two sides of the arguments Kavee Chukitkasem – KSecurities USD/THB options are probably the best bet for the next 1 to 2 months amidst lack of economic clarity compounded by external KResearch political and social abnormality We revised down our target for the policy rate to 3.50% for the end of this year, noting the BoT’s proposed change of inflation target as well as the worsening global conditions due to Disclaimer: This report must be read with the Europe’s debt crisis Disclaimer on page 44 On equities we advise reducing portfolio at current levels. Aim to that forms part of it accumulate shares as we get below 850 but stick to sectors with business oriented towards domestic consumption Strategic Thesis “KBank Multi Asset The experience of Japan during the 1990s when the economy remained stagnant is one Strategies” of the major examples the US and the Eurozone might try to avoid. Still, consensus can now be accessed on wishes for a recovery but the markets might be saying something else. Of late, calling Bloomberg: KBCM <GO> the direction of the USD/THB is likened to a coin toss. Analyzing the economics is already an arduous task in it of itself. Now the political and social dynamics complicate the direction even further: will Greece be the Achilles’’ heel of the euro? Will Troika withhold the next tranche of financial infusion? In light of lack of direction signals, USD/THB options seem to be the best bet amidst a dearth of clarity. We provide thoughts why USD/THB could cut both ways: up or down. We revised down our target for the policy rate to 3.50% for the end of this year, noting the BoT’s proposed change of inflation target as well as the worsening global conditions due to Europe’s debt crisis. The yield curve should continue to stay flat but the uncertainties in global financial markets could lead to lower appetite for duration in emerging market bonds: stay short th duration prior to MPC meeting on Oct 19 . As with other asset classes, volatility in the equity markets will continue. We have set ourselves a one-month window ending in early November before considering the need to change fundamental macro assumptions which will change market outlook. There is a downside risk to our view presently, but we see SET index at 812 to provide strong support. This is based on PBV at 1.5x (fundamentally) and peak-to-trough correction of 30% (technically) – both historically well-tested. Our worst-case has SET index at 730, arrived through stress- testing assumptions on 2012 GDP growth at 1.9% from 5% with increased required risk premium. This worst-case scenario is comparatively better than the worst-case saw in the US sub prime crisis of 2008-9 when the SET went below 400.111 WWW.KASIKORNBANKGROUP.COM
  • 2. Key Parameters & Forecasts at Year-end 2004 2005 2006 2007 2008 2009 2010 2011E 2012E GDP, % YoY 6.3 4.6 5.2 4.9 2.5 -2.3 7.8 3.8 4.5 Consumption, % YoY 6.2 4.6 3.0 1.6 2.7 -1.1 4.8 3.6 3.8 Investment Spending, % YoY 13.2 10.5 3.9 1.3 1.2 -9.2 9.4 6.3 5.8 Govt Budget / GDP % -0.2 0.3 -0.7 -1.5 -1.0 -5.6 -3.2 -4.0 -4.5 Export, % YoY 21.6 15.2 17.0 17.3 15.9 -14.0 28.5 20.0 10.0 Import, % YoY 25.7 25.8 7.9 9.1 26.5 -25.2 36.8 24.0 12.0 Current Account (USD bn) 2.77 -7.6 2.3 14.1 1.6 21.9 14.8 12.9 8.1 CPI % YoY, average 2.8 4.5 4.6 2.3 5.5 -0.9 3.3 3.8 3.7 USD/THB 38.9 41.0 36.1 33.7 34.8 33.3 31.4 29.0 28.0 Fed Funds, % year-end 2.25 4.25 5.25 4.25 0.25 0.25 0.25 0.25 0.25 BOT repo, % year-end 2.00 4.00 5.00 3.25 2.75 1.25 2.00 3.50 3.50 Bond Yields 2yr, % year-end 2.78 4.94 5.02 3.91 1.98 2.17 2.35 3.60 3.60 5yr, % year-end 4.0 5.3 5.1 4.5 2.2 3.6 2.75 3.65 3.65 10yr, % year-end 4.9 5.5 5.4 4.9 2.7 4.3 3.25 3.80 3.80 USD/JPY 102.5 118.0 119.1 111.8 90.7 93.0 82.0 77 81 EUR/USD 1.36 1.18 1.32 1.46 1.40 1.43 1.40 1.35 1.40 SET Index 668.1 713.7 679.8 858.1 450.0 734.5 1040 812 1320 Source: Bloomberg, CEIC, KBank, KResearch, KSecuritiesKBank Thai Government Bond Rich / Cheap model Bps (actual YTM vs. model) 20.00 15.00 10.00 5.00 0.00 -5.00 -10.00 -15.00 3 mth avg Now -20.00 LB296A LB123A LB133A LB137A LB145B LB14DA LB155A LB15DA LB167A LB16NA LB175A LB183B LB191A LB196A LB198A LB19DA LB213A LB24DA LB267A LB283A LB396ASource: Bloomberg, KBank222
  • 3. KBank THB NEER Index KBank USD/THB – FX Reserves / USD Majors model Jan 1995 = 100 KBank THB Trade Weighted Index KBank USD/THB model 48 105 46 44 100 + 1 std 42 d 40 95 38 36 90 average 34 32 85 30 80 -1 std dev 28 01 02 03 04 05 06 07 08 09 10 11 12 75 00 01 02 03 04 05 06 07 08 09 10 11 actual modelSource: Bloomberg, KBank Source: Bloomberg, KBankFX reserves – USD/THB model DXY – USD/THB model USD/THB USD/THB since 2001 48 50 46 y = -7.4157Ln(x) + 69.035 44 2 45 42 R = 0.8878 40 40 38 36 35 y = 29.695Ln(x) - 95.504 2 34 R = 0.7685 32 30 30 28 25 26 70 75 80 85 90 95 100 105 110 115 120 125 25 50 75 100 125 150 175 200 225 250 DXY FX reserves to USD/THB mapping current 2011 forecast FX reserves, USD bn DXY to USD/THB mapping currentSource: Bloomberg, KBank Source: Bloomberg, KBankKBank BOT repo model SET forward dividend yield vs. 10yr bond yield % % 5.5 9 5.0 8 4.5 7 4.0 6 3.5 5 3.0 4 2.5 2.0 3 1.5 2 1.0 1 0.5 0 0.0 00 01 02 03 04 05 06 07 08 09 10 11 01 02 03 04 05 06 07 08 09 10 11 12 13 actual model 10yr yields SET forward dividend yieldsSource: Bloomberg, KBank Source: Bloomberg, KBank333
  • 4. Thai inflation parameters Thai contribution to GDP growth CPI yoy PPI yoy Core CPI yoy % yoy 25% 15 20% 10 15% 5 10% 0 5% -5 0% -10 -5% -15 -10% 1Q09 3Q09 1Q10 3Q10 1Q11 -15% Private consumption Government Consumption Gross fixed capital formation 05 06 07 08 09 10 11 Inventory change Net exports GDP yoySource: CEIC, KBank Source: NESDB, KBankImplied forward curve: swaps Implied forward curve: TGBs % Implied forward rate shifts (IRS) % Bond yields implied curve shifts 3.90 4.25 3.70 4.00 3.50 3.30 3.75 3.10 2.90 3.50 2.70 tenor (yrs) tenor (yrs) 2.50 3.25 0 1 2 3 4 5 6 7 8 9 10 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 Oct-11 Jan-12 Apr-12 Oct-12 Oct-11 Jan-12 Apr-12 Oct-12Source: Bloomberg, KBank Source: Bloomberg, KBankUS 2yr yields and implied forward US 5yr yields and implied forward 7.0 8 6.0 7 5.0 6 5 4.0 4 3.0 3 2.0 2 1.0 1 0.0 0 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 2yr yields, % implied forwards 5yr yields, % implied forwardsSource: Bloomberg, KBank Source: Bloomberg, KBank444
  • 5. KBank EUR/THB model KBank JPY/THB model EUR/THB JPY/THB 43.0 56.0 54.0 41.0 52.0 39.0 50.0 37.0 48.0 46.0 35.0 44.0 33.0 42.0 31.0 40.0 29.0 38.0 36.0 27.0 34.0 25.0 01 02 03 04 05 06 07 08 09 10 11 12 01 02 03 04 05 06 07 08 09 10 11 12 actual model actual modelSource: Bloomberg, KBank Source: Bloomberg, KBankKBank GBP/THB model KBank CNY/THB model GBP/THB CNY/THB 5.8 78.0 5.6 73.0 5.4 68.0 5.2 63.0 5.0 58.0 4.8 4.6 53.0 4.4 48.0 4.2 43.0 4.0 01 02 03 04 05 06 07 08 09 10 11 12 01 02 03 04 05 06 07 08 09 10 11 12 actual model actual modelSource: Bloomberg, KBank Source: Bloomberg, KBankKBank THB/VND model KBank AUD/THB model THB/VND AUD/THB 800 35.0 750 700 33.0 650 31.0 600 29.0 550 500 27.0 450 25.0 400 350 23.0 300 21.0 01 02 03 04 05 06 07 08 09 10 11 12 01 02 03 04 05 06 07 08 09 10 11 12 actual model actual modelSource: Bloomberg, KBank Source: Bloomberg, KBank555
  • 6. This page has been left blank intentionally666
  • 7. Are we falling into the lull of optimism? Kobsidthi Silpachai, CFA - KasikornbankIf we look at consensus forecasts for 2011 and especially 2012, economists are not kobsidthi.s@kasikornbank.compaying heed to Michel de Notradamus’s prediction that the world as we know it will nolonger exist post December 21st, 2012. According to the IMF’s latest forecasts, the global Nalin Chutchotitham – Kasikornbank nalin.c@kasikornbank.comeconomy is to expand close to 4% for 2012 while Thailand is see a 4.8% pick up ineconomic activities. Amonthep Chawla, Ph.D. – Kasikornbank amonthep.c@kasikornbank.comAn argument against such optimism is gaining momentum as financial market conditionslooks and feels more and more of a de javu of 2008. Prior to 2008, the US yield curvewas flat and or inverted most of 2006 and 2007. In early 2008, Bear Stearns a globalinvestment bank which had a peak market capitalization of USD 24.88bn collapsed andwas bought by JP Morgan. On the macro front, non-farm payrolls had peaked in January2008 (138 million) and were on a substantial decline leading to a surge on mortgagedelinquencies.Fig 1. IMF forecast for global economic growth... Fig 2. IMF forecast for Thai economic growth 6 9 8 5 7 4 6 5 3 4 3 2 2 1 1 0 0 -1 -2 -1 -3 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 World economic growth, % IMF projections, % Thai economic growth, % IMF projections, %Source: IMF Source: IMFBeside these ominous sign posts, one barometer of a prelude towards a full blownfinancial crisis is proxies of credit spreads. Here we are referring to LIBOR OIS spreads.These LIBOR OIS spreads (short for Overnight Index Swaps) are the difference betweeninter-bank funding benchmarks such as 3mth LIBOR minus a geometric estimate ofcentral bank funding rates. The rule of thumb is, the higher the spread, the tighter thecredit conditions in the inter-bank marketFig 3. US Libor OIS Fig 4. EU Libor OIS 400 200 350 180 160 300 140 250 120 200 100 150 80 60 100 40 50 20 0 0 02 03 04 05 06 07 08 09 10 11 02 03 04 05 06 07 08 09 10 11 US LIBOR OIS (Overnight Index Swap), bps Euro LIBOR OIS (Overnight Index Swap), bpsSource: Bloomberg, CEIC, KBank Source: Bloomberg, CEIC, KBank777
  • 8. USD/THB, it cuts both waysIn the following, we ponder both cases for further USD/THB downside and upside andsummarized in fig 5.Fig 5. USD/THB, it cuts both ways The case for lower USD/THB The case for higher USD/THB The US economy is still floundering. With unemployment very Bureaucracy of the EU system limits the speed of how elevated at 9%+, economic stimulus no doubt is needed European authorities can effectively respond and resolve the Fiscal constraints means that stimulus in the form of crisis and allows the Eurozone to implode into a full fledge expansionary fiscal policy is not an option sovereign domino defaults and bank runs / closures …hence QE3, 4, …. is still needed…..meaning the Fed will Risk aversion kicks in and investors further reduced printing more US dollars to monetize and reduce their investment positions in all sorts of risk asset classes indebtedness including emerging markets equities and bonds The European authorities, despite having demonstrated Higher risk perception of the EUR will prompt a shift of shortcoming of leadership, solidarity and efficiency in dealing reserves away from the 17 nation currency (market share of with the sovereign debt / banking crisis, is able to prevent or 27%) and towards the US dollar (market share of 60%) postpone a full blown crisis The Fed is contented with just the 2011 version of “Operation Thailand is seen to post current account surpluses, meaning Twist”. This means that the Fed will not expand its balance sellers of USD/THB outnumber buyers of USD/THB at the sheet and slows down the pace of US dollar printing i.e. M1 current level money supply China proceeds with CNY appreciation. This allows regional The Bank of Thailand adopts a wait and see stance on currencies including the Thai baht to appreciate as well monetary policy amidst lack clarity on the global economic without significant implications on competitiveness front. This reduces support for the baht as policy rates stay Thai baht remains undervalued e.g. the Economist Big Mac at 3.50% index estimates Thai baht is 42.3% undervalued relative to the US dollar.Source: KBank Source: KBankUSD/THB elevating higher… because?In May 2010 and onwards, Greece, Ireland and Portugal sought financial bailoutpackages from other Eurozone countries and the International Monetary Fund (IMF).More than a year afterwards, much of the pledges of austerity, especially for the case ofGreece were empty promises. With cross holdings of various Eurozone governmentbonds by various Eurozone commercial banks, the deterioration in fiscal health ofgovernment inadvertently meant the demise of commercial banks. If one was to make ananalogy what CDOs (collateralized debt obligations) did to American and other banksworldwide post 2008 to now, it would be the toxic bonds of the weaker links (such as thePIIGS group) in the EU.Fig 6 shows that as Greek bond prices fall, it will take the Euro Stoxx bank index with it.The Euro Stoxx bank index comprises of 32 European banks with a cumulative totalasset of EUR 5 trillion versus the Eurozone GDP of EUR 2.9 trillion. As the market valueof these banks equity falls below their book value, it provides a estimate of how muchrecapitalization is needed. On figure 7, the implied recapitalization needs of these 32banks are about EUR 367bn, currently. This is a moving target, as market expectationschanges. Another point that can be taken from this is that, investors of banks have moreor less have withdrawn their money in the form of equity. The question now is whetherother sources of funds will withdraw their deposits i.e. bank runs.888
  • 9. Fig 6. Greece 10yr bond price, Euro Stoxx bank index Fig 7. Implied recapitalization of Euro Stoxx banks 110 260 600,000 100 240 90 400,000 220 80 200 200,000 70 180 60 0 160 50 00 01 02 03 04 05 06 07 08 09 10 11 40 140 -200,000 30 120 -400,000 20 100 Mar-10 Jun-10 Sep-10 Dec-10 Mar-11 Jun-11 Sep-11 -600,000 Greece 10yr bond, % of par (left) Euro Stoxx Bank index (right) Euro Stoxx bank index, market cap less book value implied recapitalization, EUR mnSource: Bloomberg, CEIC, KBank Source: Bloomberg, CEIC, KBankWhat is the European immediate response, attempting to contain the crisis? Four littleletters: EFSF with a big task. EFSF is short for “European Financial Stability Facility”.EFSF is similar in concept to our FIDF (Financial Institution Development Fund). Duringthe 1997 crisis, the FIDF attempt to assuage bank runs on deposits. But when the dustsettled, some 56 finance companies had to close and a handful of banks had to benationalized to avert calamity.Recently, the EU authorities are pushing to expand the war chest of the EFSF, fromEUR440bn to around EUR780bn, which represents the guaranteed commitments bycountries within the Eurozone. The idea being, the EFSF would raise funding in themarket, which it has so far sold 3 tranches for a total of EUR13bn, and on-lend to entitiesit deems needed financial assistance. However in the event that the EFSF could nothonor its own financial obligations, the countries as shown in fig 8, would have to honorthe EFSF on its behalf. Imagine a case where if the EFSF lent money to France. Francewas unable to pay back the EFSF and causing the EFSF to be unable to pay back itscreditors. The creditors can then demand payments from say, Germany. The unfortunatething is that most of these countries pledging to back the EFSF are not in a healthy fiscalposition to back up their commitments in the first place. Even the market perceivedmighty economy of Germany already has a debt / GDP ratio of 83%, well above theMaastricht Treaty limit of 60%. This questions the viability of the EFSF as it is really theweak nations trying to save themselves. It would stand a higher probability of success ifAsian investors / central banks / sovereign wealth funds are lured into buying the EFSFbonds despite the fact that it is backed by near bankrupt nations.999
  • 10. Fig 8. EFSF guarantors and their budget / GDP & debt / GDP ratios Country Guarantee commitments, EUR mn budget / GDP, % public debt/ GDP, % Kingdom of Belgium 27,032 -4.1 96.8 Federal Republic of Germany 211,046 -3.3 83.2 Ireland 12,378 -32.4 96.2 Kingdom of Spain 92,544 -9.2 60.1 French Republic 158,488 -7.0 81.7 Italian Republic 139,268 -4.6 119.0 Republic of Cyprus 1,526 -5.3 60.8 Grand Duchy of Luxembourg 1,947 -1.7 18.4 Republic of Malta 704 -3.6 68.0 Kingdom of the Netherlands 44,446 -5.4 62.7 Republic of Austria 21,639 -4.6 72.3 Portuguese Republic 19,507 -9.1 93.0 Republic of Slovenia 3,664 -5.6 38.0 Slovak Republic 7,728 -7.9 41.0 Republic of Finland 13,974 -2.5 48.4 Hellenic Republic 21,898 -10.5 142.8 Republic of Estonia 1,995 0.1 6.6 Total Guarantee Commitments 779,783Source: hence leads to the lingering-in- the-back-of- market’s mind, will the euro survive. Inhis last ECB meeting, Jean Claude Trichet said that the euro will still be around in 10years time. But what if it isn’t and the market has to go back to the US dollar, despite allof its imperfections? As the EUR arrived on the FX scene Asian central banks which hadthe Deutschemark as one of its reserve currency had to trade it in for the Euro. At thetime of fixing, it was 1.95583 DEM to 1 EUR. Fig 10 shows that EUR’s market share rosefrom 18% to 26%+ at the expense of a lower USD market share slipping from 72% to60%.Fig 9. Market share of fiat FX currency reserves Fig 10. USD, EUR market share in FX reserves GBP Other Worlds breakdown of reserve currency CHF 4.2% 4.9% 74 30 0.1% 72 28 JPY 3.9% 70 26 68 24 66 22 EUR 26.7% 64 20 USD 60.2% 62 18 60 16 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 % holding in USD (left axis) % holding in EUR (right axis)Source: Bloomberg, CEIC, KBank Source: Bloomberg, CEIC, KBank101010
  • 11. Operation Twist is another factor which had reversed the bearishness of the USDtowards a bullish swing. The September 21st FOMC statement was US dollar bullish as: To support a stronger economic recovery and to help ensure that inflation, over time, is at levels consistent with the dual mandate, the Committee decided today to extend the average maturity of its holdings of securities. The Committee intends to purchase, by the end of June 2012, $400 billion of Treasury securities with remaining maturities of 6 years to 30 years and to sell an equal amount of Treasury securities with remaining maturities of 3 years or less. This program should put downward pressure on longer-term interest rates and help make broader financial conditions more accommodative. The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate.The buying and selling of equal amounts equates to no significant expansion in the Fed’sbalance sheet. Hence the exercise is merely a sector rotation, from the short end of thecurve to the long end of the curve. This is a means of reducing the gapping as to forcecommercial banks to switch from making money from taking duration risk and towardtaking credit risk. Operation Twist is to crowd out the non-private sector simulativeactivities i.e. borrowing from the Fed and lending to the US Treasury instead of lending tothe private sector. Fig 11 shows that Fed Funds rate and the shape of the yield curvemove in opposite directions, that is, as Fed Funds rises, the yield curve steepens.Whereas when the Fed Funds falls, the curve flattens. The Fed has flagged its intentionto keep short rates where they are i.e. low. Hence to flatten the yield curve to encouragebanks to take credit risk, the Fed has to buy longer dated maturity treasuries.Fig 11. Fed Funds rate, shape of the US yield curve Fig 12. US bank’s loans and leases, stagnating bps % 8,000 350 7 7,000 300 correlation is -93% 6 6,000 250 5 5,000 200 150 4 4,000 100 3 3,000 50 2,000 2 0 1 1,000 -50 00 01 02 03 04 05 06 07 08 09 10 11 - -100 0 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 11 US 10yr yield less 2yr yield, left Fed Funds, right Loans and leases, USD bnSource: Bloomberg, CEIC, KBank Source: Bloomberg, CEIC, KBank111111
  • 12. This, in it of itself, highlight that the Fed is in no urgency to print more money. Hence itreduces the bearish cue for USD/THB.Fig 13. y = f(x), USD M1 money supply as a function of Fig 14. y = f(x), USD/THB as a function of USD M1Fed’s balance sheet money supply USD M1 money supply, USD bn 2200 USD/THB 48 2100 46 2000 44 y = -0.0188x + 65.37 2 y = 0.0002x - 0.4615x + 1711.7 42 1900 2 R = 0.9398 2 40 R = 0.8832 1800 38 1700 36 34 1600 32 without Sept 2006 to Dec 2008 period 1500 30 2108.8 1400 28 26 800 1000 1200 1400 1600 1800 2000 2200 2400 2600 2800 3000 Feds balance sheet, USD bn 1000 1100 1200 1300 1400 1500 1600 1700 1800 1900 2000 2100 2200 USD M1, bnSource: Bloomberg, CEIC, KBank Source: Bloomberg, CEIC, KBankThailand’s Katrina / 3-11 or our 10-11The current unfolding events regarding the floods that have devastated about 59provinces out of 77 province is similar to how Katrina impacted the US Gulf coast areasor what Japan faced following the 3-11 earthquake / tsunami.Economic and social losses are at the moment are difficult to estimate. Finance MinisterThirachai Phuvanatnaranubala has put losses at about THB 60bn while the NationalEconomic and Social Development Board (NESDB) have estimates the losses at THB80-90 bn. As the Bank of Thailand is located at the banks of the Chao Prahya river, theCentral Bank is to have a great sense of urgency to adopt a wait and see stance as bothinternal and external environment are in an extreme state of flux. This means that carrytrades by shorting the US dollar and a long position in Thai baht is less attractive incomparison to expectations of a hawkish Bank of Thailand and a dovish Fed. The Veniceof the East (Bangkok is to face the most critical periods of flooding during October 16th to th18 ) given the convergence of a high tide, more run off from the dams up North andpossibly more rainfall from new depression systems.121212
  • 13. Fig 15. The BOT is located on the banks of the Chao Fig 16. Chao Phraya River System, highlightingPhraya river impacted areasSource: Google Maps Source: wikipediaFig 17. Policy rates, TH vs. US Fig 18. Implied forward rates, 1yr rate, 1yr from now % change : 1yr rate, 1yr from now 7 0.50 6 0.40 5 0.30 4 0.20 3 0.10 0.00 2 -0.10 US CH ID MY UK KR EU SG TH 1 -0.20 0 -0.30 00 01 02 03 04 05 06 07 08 09 10 11 % change : 1yr rate, 1yr from now BOT repo Fed FundsSource: Bloomberg, CEIC, KBank Source: Bloomberg, CEIC, KBank131313
  • 14. USD/THB is declining… because?The first Friday is one that is most followed by the markets since it is Jobs Friday. The USlabor department reported that September created about 103k jobs which were higherthan what economists had penciled in at 60k. The market seems to be contented with thereport with 10yr bond yields climbing about 2% post the Fed’s announcement ofOperation Twist. Still this is hardly something to celebrate about since while the USeconomy might have recovered, but the jobs market (one of the two Fed mandates) ishardly in equilibrium. At the peak of the US economic boom, the total number ofAmericans working excluding the agricultural sector was 137,996k whilst September’sreading is 131,334k.Fig 19. US non-farm payrolls change vs. consensus Fig 20. Total non-farm payrolls 140,000 000 800 138,000 600 400 136,000 200 134,000 0 -200 132,000 -400 -600 130,000 -800 128,000 -1000 00 01 02 03 04 05 06 07 08 09 10 11 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 non-farm payrolls, k non farm payroll - actual surveySource: Bloomberg, CEIC, KBank Source: Bloomberg, CEIC, KBankHence, there is no double dip for the US jobs market, since it had never recovered. Manyconsidered that this recent recovery was a “jobless” recovery, which is ratherunsustainable since the US economy is largely driven by consumption. No jobs = nowages = no income = no spending = no growth. Therefore, it can not be stressed enoughthat the economy has to grow in order to accommodate the jobs market. Fig 21 maps thechange in non-farm payrolls as a function of change in nominal GDP, which suggests thatthe US economy needs to grow at least 1% just to keep non-farm payrolls at a zerochange. Unfortunately, stimulus via expansionary fiscal policy is no longer an option asthe Eurozone crisis will attest to or else we will hear about the US sovereign debtcrisis…again.Fig 21. y= f(x), change in non-farm payrolls as a Fig 22. US debt to GDP ratio, IMF estimatesfunction of change in US nominal GDP change in non-farm payrolls 120 1.0% 110 100 90 0.5% 80 70 0.0% 60 -2.5% -2.0% -1.5% -1.0% -0.5% 0.0% 0.5% 1.0% 1.5% 2.0% 2.5% 3.0% 50 -0.5% 40 change in nominal GDP 30 20 -1.0% 10 y = 0.5025x - 0.0048 2 0 -1.5% R = 0.6318 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 since 2000 -2.0% US GDP % IMF projectionsSource: Bloomberg, CEIC, KBank Source: IMF141414
  • 15. Beside cheap money with respect to time i.e. interest rates, one way the US can hope torecover is with cheap money with respect to other currencies i.e. foreign exchange rate.Fig 23 states our case, mapping the US dollar on a trade weighted basis versus the USGDP (chain weighted, real). The map suggests that as dollar weakens it will besupportive of US economic growth. For every point reduction in the US dollar, it shouldgenerate real economic growth of USD 54 bn, vice versa.This is why the legislative branch of the US government is looking towards a veryprecarious maneuver by drafting the “anti China currency bill” which is likely to spark atrade war. One bitter lesson from the Great Depression was that protectionism and tradebarriers made matters worse and sank the global economy ever further. Fig 24 states thecase for the currency bill, which shows that as the US sinks further into a trade deficitwith China, the number of non-farm payrolls in the manufacturing also falls.Fig 23. y= f(x), US GDP as a function of trade weight Fig 24. US trade balance with China & US non-farmdollar payrolls – manufacturing sector US chain weighted real GDP, US bn 0 19.0 13500 -50 18.0 -100 17.0 13000 y = -49.137x + 16851 16.0 74, 13,272 2 -150 12500 R = 0.8366 15.0 -200 14.0 12000 -250 13.0 ρ = 92% -300 12.0 11500 -350 11.0 11000 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 10500 US trade balance with China, 12mth moving sum, USD bn (left axis) 60 70 80 90 100 110 120 130 US non-farm payrolls, manufacturing, mn (right axis) DXY, US dollar indexSource: Bloomberg, CEIC, KBank Source: Bloomberg, CEIC, KBankThe market expectation is for further downside for the USD/CNY is still tepid since thespot and the 12mth NDF (non-deliverable forward) is about the same levels. Therefore ifthis bill truly picks up momentum, such expectations are likely to change for furtherdownside for USD/CNY as well as USD/THB as shown by the mappings on fig.26Fig 25. USD/CNY 12mth NDF, USD/THB Fig 26. USD/CNY 12mth NDF, USD/THB mapping USD/THB spot 48 7.4 37 46 7.2 36 y = 6.3239x - 9.664 correlation coefficient = 0.93 44 2 35 R = 0.9411 7.0 42 34 40 6.8 33 38 6.6 36 32 6.4 31 34 6.2 32 30 6.348, 30.88 30 6.0 29 28 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 6.0 6.5 7.0 7.5 8.0 8.5 9.0 USD/CNY NDF USD/CNY 12mth NDF (left axis) USD/THB spot (right axis)Source: Bloomberg, CEIC, KBank Source: Bloomberg, CEIC, KBank151515
  • 16. A Japanization: are we going to see a lost decade in US/EU? The experience of Japan during the 1990s when the economy remained stagnant is one of the major examples the US and the eurozone might try to avoid The US and the eurozone had better take a serious measure to solve their economies unless they will end up like Japan which its government was reluctant to do anything except printing more money The US could employ fiscal policy and reform its economy to lean toward more exports; meanwhile, debasing the dollar is also an important tool to lower its debt obligation The tangible solution for the eurozone is to take a painful but meaningful step; default is already out of the question as Greece is seen unable to pay off debt without restructuring the payments with its creditors The conflict between the US and China over the yuan appreciation will remain on-going and will be a part of the global economic volatility for the following yearDon’t learn from the Japanese modelThe experience of Japan during the 1990s when the economy remained stagnant, calledlost decade, is one of the major examples the US and the eurozone might try to avoid.The cause of the economic crisis in the US and Japan was similar: the burst of assetprices. The stock market clashed in 1990 in Japan while the housing prices burst in 2008in the US. Both the events led to banking crises. The governments took part in stabilizingthe financial market by injecting a great deal of money to keep banks alive. However,loosening monetary policy led to an increase in money supply and a lower interest rate.Liquidity trap was a major challenge in economic recovery as borrowers were reluctant toinvest depite low interest rate. Bond issuance caused an increase in public debt, whichled to a question on fiscal sustainability. Consequently, both the US and Japan’sgovernments were downgraded. How about the eurozone? The cause of the upcomingcrisis was from an increase in public participation in solving financial crisis in 2008 whenbanks were unwilling to lend to another bank for fear of bankrupcy as seen in LehmanBrothers. Governments in the eurozone stimulated the economies by injecting money tothe system, which subsequently was developed into another form of crisis: sovereigndebt crisis. When the public becomes the problem the economies have no one left torescue them. Japan, US and the eurozone have something in common which is theproblem of huge public debt. How can the US and the eurozone avoid following theJapan’s foot step that caused the economy to stay stagnant for a decade?Actually, the way the US and the eurozone have been solving their economies isresemble to what Japan did two decades ago, which is by procrastinating the problem.No one has been taking a problem seriously. We have not yet seen a critical reform inany of these economies. Economic structure has remained the same prior to the crises.American consumers still enjoy incuring consumer’s debt while exports are discouraged161616
  • 17. by recent rise of the dollar. Greece and other PIIGS were reluctant to take a painful wayof the austerity measures. They could not meet the target that they promised earlier.German and France have kept bailing out these countries for fear if these governmentsdeclare default. German and French banks would be in trouble as they hold a great dealof sovereign bonds. Therefore, the solution in the past is very simple: let’s hope there willbe a mirable! Of course, there is no economic miracle to solve the sovereign debtproblem in PIIGS. The longer they wait, the more painful creditors will encounter whenfacing with hair cut as the size of the loan has grown bigger due to series of bail-out. TheUS and the eurozone had better take a serious measure to solve their economies unlessthey will end up like Japan which its government was reluctant to do anything exceptprinting more money. Don’t forget that Japan was in a better position than the US andperhaps the eurozone on the ground that Japanese are net savers and exports fromJapan are more competitive.Fig 27. Growth of money supply in Japan Fig 28. Growth of money supply in the US % yoy Japan money supply % yoy US money supply 35 25 30 20 25 20 15 15 10 10 5 5 0 0 -5 -5 May-01 May-02 May-03 May-04 May-05 May-06 May-07 May-08 Aug-06 Aug-07 Aug-08 Aug-09 Aug-10 Aug-11 Growth of M1 (% yoy) Growth of M1 (% yoy)Source: Bloomberg, KBank Source: Bloomberg, KBankIs there a way out?Yes, of course. There are solutions to solve economic problems in the US and theeurozone. For the US, monetary policy is doomed. Liquidity trap of low interest rate isapparent. Therefore, the remaining tool is the fiscal policy. It is still hard to imagine thatthis is a solution, especially after the political tension between the Democrats and theRepublicans over raising the debt ceiling and cutting budget deficit. However, the US stillhas room to increase government spending to create jobs and private consumption.Without political competition, the US government still has one powerful tool left. By doingso, it is important that the US continue reforming its economy to lean toward moreexports. Meanwhile, debasing the dollar is also an important tool to lower its debtobligation.How about the eurozone? Politicians in the eurozone have been denying the truth thatthey cannot rescue PIIGS. If they continue injecting more money to rescue Greece andothers, they will end up transfering money to PIIGS or bailing out their own banks. Eventhey continue pumping more money, it will end up hurting PIIGS more. It is noted that acountry with larger debt obligation is likely to grow at a slower pace than before.There is a negative relationship between debt burden and growth. When public debt risessharply, investors are likely to be worried about fiscal sustainability, which eventuallyleads to banking crisis. Banks can be punished from buying government bonds. Higherpublic debt leads to higher bond payments, which take a bigger portion of governmentbudget. The government is seen to have fewer resources to invest. Consequently, a slowgrowth of capital stock is unable to induce higher labor productivity, which leads to slowerpace of economic production. The tangible solution for the eurozone is to take a painfulbut meaningful step. Default is already out of the question as Greece is seen unable to171717
  • 18. pay off debt without restructuring the payments with its creditors. Creditors, includingtaxpayers, will need to accept losses. The remaining questions are whether othermembers of PIIGS will default and how much banks will need to recapitalize. Answers forthese questions remain unknown as it depends on how much investors would continueselling stocks and depositors could be panic and start to withdraw money from banks thathave high exposure to PIIGS’s debt. It is unavoidable that banks in the eurozone will endup being downgraded if they fail to recapitalize or prevent the bank run. Fig 30. Claims on PIIGS’s public debt by French andFig 29. Japanization in the US and the eurozone German banks USD bn Foreign claims on public debt by nationality of reporting banks 250,000 200,000 150,000 100,000 50,000 0 Dec-11 Mar-11 Dec-11 Mar-11 Dec-11 Mar-11 French banks German banks Other banks Portugal Ireland Italy Greece SpainSource: The Economist, July 30, 2011 Source: Bloomberg, KBankDexia and more to comeDexia could be viewed as a sign of an early stage of banking crisis in the eurozone.Dexia is a Franco-Belgian bank that is being in trouble for its high exposure to Greece’sdebt. Dexia used short-term funding to finance long-term lending; hence, credit dried upduring the eurozone debt crisis. Investors are concerned about the bank’s financial healththat has led to a sharp decline in bank’s capital. French-Belgian governments tried torescue Dexia either by injecting capital through the EFSF and ECB similarly to the US’TARP in 2008, yet the plan was dropped as it would deplete resources from EFSF whichshould be used as the last resort. France and Belgium helped bail out Dexia, yet failed toseparate bad bank. Subsequently, Dexia was agreed to the nationalization of its Belgianbanking division, which was followed by a warning by Moody’s that the Belgium’s Aa1government bond ratings could fall with this bail out plan. Based on this example, we willsee larger public intervention on bailing out troubled banks, either by nationalizing banksor injecting more capital to prevent bank run. If banks collapse, financial turmoil in theeurozone will prevail. It is likely to see slower growth in the eurozone for the next fewyears until banks have successfully recapitalized to gain financial health. In addition,fiscal reform is necessary to allow the governments to reduce public debt for fear ofdisrupting economic growth in the future.BRICS and world economic recoveryBRICS, namely Brazil, Russia, India, China and South Africa, are emerging economiesthat have been enjoying high economic growth. During the economic crisis in 2008,BRICS’s economies grew remarkably despite a fall of the global demand. Major factorsare that they relied on their domestic consumption and investment to generate growth.Can they revive the ailing global economy again if we all fall into trouble? This time theanswer is full of uncertainty. After the sub-prime crisis, the Fed introduced QE1 and QE2,which caused rapid capital flows to BRICS and other regions. Capital flows has led to anincrease in the demand for local currencies, causing stronger exchange rate versus theUS dollar. In order to maintain competitiveness in exports, several central banks181818
  • 19. intervened the market by accumulating more foreign reserve so as to slow down the paceof local currency appreciation. This attempt has drawn attention to currency war whereone country has tried to make its exchange rate under-valued so as to gain greatercompetitiveness against others. The US is seen hostile to China for making the yuanartificially under-valued, threatening to pass a currency bill to punish China. The USclaimed that it could generate more jobs if the yuan has been more appreciated.However, China warned the US that the currency war could lead to a trade war. Thisconflict will remain on-going and will be a part of the global economic volatility for thefollowing year.191919
  • 20. Pricing in economic slowdown and policy rate pause We revised down our target for the policy rate to 3.50% for the end of this year, noting the BoT’s proposed change of inflation target as well as the worsening global conditions due to Europe’s debt crisis Given the new policy target and the BoT’s forecast of decelerating headline inflation rate, there should be less pressure to call for further hikes Bond yields had a volatile third quarter but basically the yield curve remained flat Foreign investors turned net-sellers of Thai bonds for the first time in months and risks of further sell-offs continue although we do not expect such an outcome unless European debt crisis turned into a global financial crisis of similar impact as the crisis in 2008 Q1 bond supply capped by delays in fiscal budget, high treasury cash balance, and P/N substitution FY2012 bond supply plan changed slightly : more long-term bonds, lower 3-year bonds We continue to see a flat yield curve going forward but the uncertainties in global financial markets could lead to lower appetite for duration in emerging market bonds: stay short duration Market update – September and October interest rate movements During the past 3 weeks or so, the situation in Europe with regards to Greece’s debt crisis had worsened drastically, driving local bond yields and the IRS rates into different directions. The government yield curve shifted upwards as a result of foreign investors’ sell-off in emerging market assets while the IRS rates fell, following the short-dated THBFIX rates on the back of USD liquidity concern in the global markets. During the first week of October, such trends started to revert: bond yields started to fall slightly while IRS rates saw less downward pressure from the declines in swap points.Fig 1. Government bond yield curve rebounded Fig 2. Movements of IRS rates % Government bond yield curve % 4.00 3.83 5.0 3.81 3.82 3.77 3.80 3.69 4.5 3.63 3.61 3.62 3.56 3.58 3.67 3.69 3.64 3.64 4.0 3.60 3.55 3.55 3.53 3.53 3.53 3.48 3.5 3.40 3.45 3.0 3.38 3.41 3.41 3.4 3.36 3.33 3.35 3.20 3.32 3.31 2.5 3.00 2.0 1y 2y 3y 4y 5y 6y 7y 8y 9y 10y Mar-11 Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 07-Oct-11 22-Aug-11 26-Sep-11 TTM IRS 2Y IRS 5Y IRS 10Y repoSource: Bloomberg, KBank Source: Bloomberg, KBank 2020 20
  • 21. In any case, we expect that the short-term swap rates would remain capped at low levels (way below policy rate) for up to the end of December, given the market’s expectation that the Bank of Thailand (BoT) would not increase the policy rate further and the ongoing concerns about USD liquidity amid the tightness of USD funding conditions in Europe. Hence, we iterated our view last month that it is still a good time for the corporate sector to hedge borrowing costs but there is no hurry in doing so.Fig 3. 6m swap points and 6m THBFIX rate Fig 4. Bond-swap spreads picked up slightly satangs % bps 50 3.75 80 60 45 3.50 40 40 3.25 20 35 3.00 0 -20 30 2.75 -40 25 2.50 -60 20 2.25 -80 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Jan-11 Feb-11 Mar-11 Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 USD/THB 6m forward point 6M THBFIX 2Y bond-swap spread 5Y bond-swap spread 10Y bond-swap spreadSource: Bloomberg, KBank Source: Bloomberg, KBank Foreign investors had turned net-sellers of local THB fixed income securities for the first time in more than a year during September. During the same month, foreigners also pulled out of the local stock market (net-sell USD 541.5mn) and the USD/THB turned 4.01% weaker in the month of September before rebounding by nearly 1.0% in October. Expectations that the Thai baht would not perform in the near-term also reduce foreigners’ reinvestment into short-dated debt. As a result, foreign investors’ net holding of THB fixed income securities fell from THB 438.6bn at end August to THB 434.2bn at end September and further to THB 425.6bn as of October 7th. Furthermore, we note as well that foreigners’ holding of THB bonds had climbed by THB 300bn in a short 12 month period from THB 150bn back in September 2010. This reflects substantial risk of sudden capital outflow should foreign funds liquidate THB bonds in the face of another outbreak of global financial crisis. If that worst case scenario does not happen, we expect that emerging market bonds would continued to see positive demand, given their rising significance in the global markets and the stronger fiscal positions of emerging market economies.Fig 5. Foreign holding position declined Fig 6. Foreign outright trade (net-purchase, monthly) Bt bn THB bn 500 180 163 450 160 400 140 127 128 350 120 300 100 84 73 71 79 up till 250 80 200 45 Oct 7th 60 40 150 28 40 16 19 100 50 20 3.7 - 0 -20 -1.5 Jan-10 Mar-10 May-10 Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Sep Nov Jan Mar May Jul Sep foreign holding in Thai fixed income, THB bn foreign net-buy in THB bonds (billion baht)Source: PDMO, KBank Source: PDMO, KBank 2121 21
  • 22. During the sell-off, we did notice two factors. First of all, the yield curve had not steepened very much, which could be implying that demand for the long-term bonds remained and could be similar to the mid-curve bonds. In fact the flattening of the yield curve at the end of August, with 2-10 spread at 1bp, had been too abrupt and somewhat an overreaction of the market to the flattening of the U.S. yield curve. The sell-off in September thus helped to correct this spread back to around 20bp before declining towards 9bp on October 7th. This is in line with our expectation that insurance companies and pension funds continued to have high demand of bonds going forward. At the same time, the government’s bond supply plan does not overweight long-term bonds, as the PDMO is careful to push up long-term borrowing costs. Secondly, Fig 8. shows that local asset management companies continued to buy into the bond market, with the outright net-purchase position increasing for second straight month in September.Fig 7. Foreigners continued to trade in securities with Fig 8. Asset management (net-purchase, monthly)maturities <1Yr Composition of bond traded by Non-resident THB bn % 100 600 80 500 400 60 300 up till 40 200 Oct 7th 20 100 0 0 Jul- Aug Sep Oct Nov Dec Jan- Feb Mar Apr May Jun Jul Aug Sep Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct 10 11 0-1 Y 1-3 Y 3-5 Y 5-10 Y > 10 Y Mutual fund net-buy in THB bonds (billion baht)Source: PDMO, KBank Source: PDMO, KBank BoT’s to pause in the face of worsening global conditions We have revised down our target for the policy rate this year to 3.50%, from earlier expectation of two more rate hikes that could bring the policy rate to 4.00% at year-end. For the year 2012, we think that that BoT will continue to stay pat, given that inflationary pressure would be reduced by the decelerating growth momentum. As for the MLR (minimum lending rate), we do expect it to stay at current level of 7.25% (average of 4 large banks) following the pausing of the policy rate. At the same time, we do expect that the fixed deposit rates would likely pause as well, or edge up very slightly due to banks’ competition to amass deposits. As a result, we expect that the real policy rate and real 1-year deposit rate would remain in the negative zone for the next two quarters, with the assumption that headline consumer price index climbs by an average of 0.23% each month the next three quarters (average monthly change since 2011). Such a condition means that monetary conditions remained somewhat accommodative to growth should the Thai economy decelerate in accordance to the slowdown in the advanced economies. 2222 22
  • 23. Fig 9. MLR and policy rate Fig 10. Headline inflation rate (rough estimate) % % MLR Repo rate 8.0 10 7.0 8 6 6.0 375 bp 4 5.0 461bp 2 4.0 444bp 0 3.0 -2 2.0 -4 1.0 -6 0.0 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Headline CPI yoySource: Bloomberg, KBank Source: Bloomberg, KBank Our reasons for the revised call are as follows: 1. Global economic outlook worsened significantly during the past couple of months: indicators from both the U.S. and Europe showed weak activities in various sectors. Manufacturing production that had been the core of the post- Lehman recovery begun to see several months of slowdown. Meanwhile, job market in the U.S. remained sluggish and fiscal austerity measures in Europe are likely to induce slower growth in industrial production as well as intra-regional trade. 2. European debt problems continued to worsen in a more rapid pace and the European governments continued to have problem reaching a solution for the region’s debt problems, especially for Greece. This has led to continued worsening of investment sentiment globally and increased risks to the European financial sectors overall stability. In light of such uncertainties, the BoT may stay pat for the next few months and assess their impacts on Thailand. 3. BoT is planning to replace the core inflation rate with the headline inflation rate for its policy target. The proposed target is 3.00% with allowance of 150bp on either side. The MoF has agreed with the proposal in principle but to make this change effective, the Cabinet would have to endorse it. Also, an annual average may be used instead of quarterly average. This means that the BoT is not under pressure to raise policy rate further this year, according to its forecast of headline inflation rate in July’s issue of Inflation Report. 4. Fiscal policies remained incomplete and thus it would be a challenge for the central bank to try to assess the overall impact on inflation, even though several policies are likely to be add to price pressure e.g. minimum wage increase, paddy price floor scheme, first-time car-buyers and home-buyers’ schemes. At the same time, the BoT still have other "macro-prudential" regulations that they could enact should risks in specific sectors begin to increase e.g. increasing down-payment for home loans (announced last year). Update on changes to bond supply Government’s financing requirements would total about THB 690-710bn* in FY2012. This comes from an estimate of THB 350bn budget deficit (earlier projected to be near THB 400bn) and refinancing of the maturing FIDF bonds (total THB340bn). In addition, the PDMO may require another THB149bn of financing to prepay some of the existing bank loans (from the 2009-2010 TKK fiscal stimulus program). The danger to this amount is that the government’s budget deficit may be larger than initially estimated. There are 2323 23
  • 24. factors pointing to such a possibility, including global economic slowdown, reduction in oil tax and other government subsidies, as well as a higher-than-expected government expenditure for stimulus policies and expenditure following worse-than-expected flooding conditions this year. For the current quarter, the bond market should get a positive support from the low level of issuance. The PDMO reported that the Finance Ministry maintained a relatively high level of treasury cash balance, reducing the need to find much funding for the first quarter of FY2012. At the same time, the final draft of the FY2012 budget would be signed into law around early next year, thus the PDMO have limited capacity to seek funding for the purpose of financing deficits. Hence, the supply of government bonds for the present quarter is THB 32bn, with zero issuance in October and December. Issuance in November is separated into THB 15bn of new 5-year benchmark bonds, THB 9bn of new 7-year benchmark bond and another THB 8bn of a new floating-rate bond issue. Much of the refinancing of maturing FIDF bonds would be done via the issuance of about THB 3.9bn of promissory notes. Furthermore, the budget for maturing treasury bills would be reallocated into new retail savings bonds (sold via ATMs) mentioned in our previous report. In addition, the PDMO is reducing the planned issuance of 3-year bonds (new benchmark) to THB 50bn from earlier announced THB 100bn. The main reason for this is that short-term rates remained relatively high while the yield curve remained flat, thus issuing long-term bonds remained advantageous. It would thus increase the supply of 30- year and 50-year bonds by THB 10bn each for the year.Fig 11. Government bond issuance comparison Fig 12. Changes of financing tools in FY2012 Bt bn Benchmark bonds (LBs) Non-benchmark bonds (LBs) Bt bn FY2008 FY2009 FY2010 FY2011 FY2012 Floating-rate bonds (4Y) Inflation-linked bonds 140 600 120 500 60 40 100 22 47 50 400 29 46 50 80 24 300 154 60 200 46 365 340 350 40 100 178 207 20 0 0 FY2008 FY2009 FY2010 FY2011 FY2012 5Y 7Y 10Y 15Y 20Y 30Y 50YSource: PDMO, KBank Source: PDMO, KBank Table 1. Government bond auction calendar for Oct - Dec 2011 unit : million baht LB157B Auction Date LB176A LB193A Total (Float-rate) Oct-11 - - - - 02-Nov-11 - 9,000 - 9,000 09-Nov-11 15,000 - - 15,000 16-Nov-11 - - 8,000 8,000 23-Nov-11 - - - - 30-Nov-11 - - - - Dec-11 - - - - Total 15,000 9,000 8,000 32,000 2424 24
  • 25. Table 2. Issuance plan Unit : in billions of baht Auction Per auction size end FY2012 Month no. Total frequency (THB bn) outstanding Benchmark bonds (LBs) New LB176A 5Y 6x even 15.0 - 20.0 100.0 100 New LB193A 7Y 6x odd 9.0 - 15.0 65.0 65 LB21DA 10Y 6x odd 9.0 - 15.0 60.0 100 - 120 New 15Y 6x even 5.0 - 9.0 35.0 35 new 20Y 6x odd 5.0 - 9.0 35.0 35 LB416A 30Y 6x even 3.0 - 5.0 30.0 57 LB616A 50Y 6x odd 2.0 - 2.5 25.0 28 Non-benchmark bonds New FRB LB157B 4Y 6x odd 8.0 - 11.0 50.0 50.0 ILB217A 10Y 4x every quarter 10.0 - 15.0 60.0 100.0 15.0 - 20.0 (may be new LB 3Y 6x odd subjected to changes) 50.0 50.0 source: PDMOMarket outlookWe continue to see a flat yield curve going forward but the uncertainties in globalfinancial markets could lead to lower appetite for duration in emerging market bonds. Atthe same time, we expect that demand concentration from both local and foreigninvestors would stay with the mid-curve issues; hence we foresee only a 5bp spreadbetween the 2- and 5-year yields. As for investment strategy, we continue to recommendshortening of duration prior to MPC meeting on October 19th. Should the next statementshows a more dovish MPC, we would take that as a good sign to extend duration.Table 4. KBank’s new targets Actual rates 2011 forecasts Aug 30th Oct 5th Old New Policy rate 3.50 3.50 4.00 3.50 2Y 3.50 3.57 4.20 3.60 5Y 3.42 3.56 4.30 3.65 10Y 3.51 3.69 4.40 3.80Source: KBank, Bloomberg252525
  • 26. Table 3. Government’s financing plan for each fiscal year Unit : in billions of baht FY2008 FY2009 FY2010 FY2011 FY2012*Treasury bills 0.0 134.0 -127.0 26.0 30.0Benchmark bonds (LBs) 177.6 207.3 364.8 339.9 350.0 5Y 72.0 74.4 121.6 93.0 100.0 7Y - - 55.0 63.0 65.0 10Y 52.6 62.7 71.3 59.0 60.0 15Y 24.1 26.7 47.0 43.0 35.0 20Y 24.0 38.0 50.0 41.9 35.0 30Y 5.0 5.5 20.0 27.0 30.0 50Y - - - 13.0 25.0Non-benchmark bonds (LBs) 45.7 154.0 29.0 24.0 50.0 2Y - 88.0 - - - 3Y (new benchmark in 2012) 12.7 50.0 - - 50.0 8Y 10.0 - 12.0 - - 12Y 8.0 16.0 17.0 24.0 - 14Y 15.0 - - - -Floating-rate bonds (4Y) - 22.0 47.0 46.0 50.0Inflation-linked bonds - - - 40.0 60.0 Total Bonds (LBs) 223.4 383.3 440.8 449.9 510.0Saving (SBs) and "retail investor" bonds 18.0 80.0 82.2 50.6 100.0P/N 31.0 50.7 61.2 88.6 170.1 (4Y and above) 31.0 50.7 61.2 54.0 125.1 Restructuring (12 and above) - - - 34.6 45.0Net bank loans 0.0 30.0 177.8 -58.7 -149.1 2-4Y - 30.0 260.0 58.9 - Restructuring (prepayment) - - -82.2 -117.6 -149.1Others - - - - 49.1 Total financing requirement 272.3 678.0 635.0 556.5 710.1*Source: PDMO* According the PDMO’s comments given to Reuters News on 26th September, the total funding needs should be around THB 690bn. Due to the lack offurther information (other than presented here and PDMO’s document given in early September), our number currently does not tally with the newsreport.262626
  • 27. Economic Update Key economic indicators for Aug-11 were mostly positive. Exports, excluding gold, remained robust, but sharply accelerating Thanyalak Vacharachaisurapol - imports narrowed the Aug-11 trade surplus and pushed the current KResearch account into the red. Manufacturing production output gained ground, in line with Kevalin Wangpichayasuk - KResearch recovering exports. Although private sector confidence for Aug-11 turned out mixed – Kangana Chockpisansin - KResearch partly pressured by growing global economic uncertainty and domestic flooding wariness – private consumption and investment accelerated both MoM and YoY. Reduced fuel prices helped ease the Sep-11 Headline CPI, but the Core CPI continued to head further north. Meanwhile, the BoT’s newly proposed Inflation Target and range should increase flexibility in monetary policy maneuvers, amid growing economic uncertainty at home and abroad. In light of worsening situation among the debt-laden countries in EU, KResearch has preliminary estimated these impacts, thereby lying our 2012 GDP between 1.0-4.5% YoY for the case of limited and widespread impacts from the crisis.Table 1. Thailand Key Economic Indicators Units: YoY %, or indicated otherwise 2010 2011 YTD. 1Q 2Q Jul Aug SepComposite Private Consumption Index 5.9 4.2 4.3 4.3 2.1 5.4 • Sales Volume of Benzine and Gasohol -1.4 0.5 1.4 0.4 -3.8 2.3 • Value-added Tax at 1995 prices 15.5 11.3 10.6 13.3 4.6 13.8 • Imports of Consumer Goods at 1995 prices 22.6 13.9 16.7 11.6 9.5 17.1 • Passenger Car Sales 50.7 25.6 60.3 0.3 12.2 26.4 • Motorcycle Sales 22.9 15.4 14.6 18.2 0.4 26.1Private Investment Index (PII) 18.5 11.0 14.8 7.7 6.5 8.3 • Sales Volume of Domestic Cement 8.8 3.8 3.6 1.4 6.6 11.7 • Sales Volume of Commercial Cars 42.3 18.4 31.7 3.1 10.1 15.7 • Imports of Capital Goods at 1995 prices 24.9 17.4 24.5 12.7 10.4 17.0 • Value of BOI Applications -33.9 41.8 8.1 63.2 154.3 24.2Manufacturing Production Index 14.4 -1.0 -2.1 -2.5 -0.7 7.0 • Industrial Capacity Utilization 63.2 61.6 62.6 59.1 63.1 64.7Agriculture Production Index -2.1 7.9 14.8 7.0 -7.1 3.5 • Agriculture Price Index 24.3 17.6 25.4 17.6 4.8 9.0Exports (in $) 28.5 25.5 27.3 19.2 36.4 28.5 • Unit Value 9.1 6.8 6.7 7.0 7.1 6.7 • Volume 18.0 17.4 19.3 11.5 27.4 20.3Imports (in $) 36.7 27.9 27.0 28.0 13.1 45.8 • Unit Value 8.1 10.7 8.9 11.5 12.1 11.8 • Volume 27.1 15.5 16.6 14.7 0.9 30.4Trade Balance ($ millions) 32,212 20,516 7,963 7,296 4,552 705Current Account ($ millions) 13,661 10,047 5,909 1,396 3,438 -697Broad Money 10.9 17.5 13.2 16.3 17.6 17.5Headline CPI 3.3 3.8 3.0 4.1 4.1 4.3 4.0USD/THB (Reference Rate) 1.0 2.2 1.5 2.4 2.6 2.9 2.9Source: BOT, MOC, OAE, and OIE272727
  • 28. Aug-11 exports – excluding gold – remained robust, while importsrallied to a historic highAlthough Aug-11 exports saw quite a significant slowdown to 28.4% YoY (from 36.4%YoY in Jul-11), this did not surprise us, as it was due to a base effect and plummetinggold exports (down from $994.9 million in Jul-11 to $385.5 million in Aug-11). Excludinggold, Aug-11 exports managed to report a MoM gain, reaching $20.6 billion, from $20.1billion in Jul-11. As such, adjusted exports edged downward to a lesser extent (than thenon-adjusted series) to 26.7% growth YoY, versus the 30.2% in Jul-11.Fig 1. A base effect forced export growth YoY Fig 2. The same effect explained a slowdown in exportdownward in Aug-11 volume  25,000 50% 40 30 Export Value (USD Million) 20,000 40% 20 15,000 30% 10 % YoY % YoY 10,000 20% 0 -10 5,000 10% -20 0 0% -30 Feb-10 May -10 Aug-10 Nov -10 Feb-11 May -11 Aug-11 Oct-09 Feb-11 Apr-11 Jun-11 Aug-11 Ex ports Ex ports (ex cluding gold) Export Price Import Price % YoY for Ex ports % YoY for Ex ports ex clud. Gold Export Quantity Import QuantitySources: BOT, MOC, KResearch Sources: BOT, KResearchThis positive MoM performance of adjusted exports mirrored a continuing recovery inexports of vehicles & parts (despite a sharply deteriorating YoY figure, in light of a baseeffect wherein new eco-car models were largely exported in Aug-10) following an ongoingeconomic rebound in Japan. Meanwhile, MoM gains were seen in Thailand’s agriculturaland food exports – particularly rubber, tapioca and sugar. Other hi-tech products, e.g.,including computers & parts, electrical appliances and chemical products, also managedto recover from previous dips.In the area of Thailand’s key trade partners, exports to Japan accelerated to 25.5%growth YoY, from 22.9% YoY in Jul-11. Exports to ASEAN edged up to 36.8% growthYoY, from 34.7% YoY in Jul-11, though exports to EU slowed both MoM and YoY – thelatter retreating to 26.7% growth for Aug-11, from 35.5% YoY in Jul-11.Fig 3. Many hi-tech products recovered from previous Fig 4. Exports to ASEAN continued to show strong YoYlosses, and exports of some agricultural products growth, while improving exports to Japan mirrored theremained healthy recovery there   140 90 120 80 100 70 80 % YoY 60 60 % YOY 40 50 20 40 0 30 (20) 20 (40) 10 (60) 0 Jun-10 Aug-10 Oct-10 Dec-10 Feb-11 Apr-11 Jun-11 Aug-11 U.S. China Japan EU (15) ASEAN (9) India Middle East Vehicles & Parts Rubber Computer & Parts Electrical Appliances Rice IC and Parts 4Q10 1Q11 2Q11 Jul-11 Aug-11 Tapioca ProductsSources: BOT, KResearch Sources BOT, MOC, KResearch282828
  • 29. According to the BOT’s revised series, imports for Aug-11 rallied to a historic high of$20.2 billion, from $16.5 billion in Jul-11, thereby rising to 45.9% growth YoY, from 13.2%YoY in Jul-11. This robust performance was derived from higher imports of non-monetarygold, vehicles & parts (amid the ongoing recovery in automotive exports), crude oil (priorto a refinery plant shutdown for maintenance in the coming months), and petroleumsector machinery imports. If excluding gold, adjusted imports recorded 41.2% growthYoY in Aug-11, versus 22.2% YoY in Jul-11.In addition to a significant improvement in capital goods imports, consumer goods, rawmaterials and intermediate goods also reported strong gains.Fig 5. Imports jumped to a historic high, with broad- Fig 6. The current account narrowed markedlybased gains across key categories   6,000 External Balances (USD million) 140 120 5,000 100 4,000 80 3,000 60 2,000 % YoY 40 1,000 20 0 0 (1,000) (20) (2,000) (40) (60) (3,000) (4,000) Jun-10 Aug-10 Oct-10 Dec-10 Feb-11 Apr-11 Jun-11 Aug-11 Aug-10 Nov-10 Feb-11 May-11 Aug-11 Imports Consumer Goods Raw & Intermediate Goods Capital Goods Trade Service Current Account Balance Crude Oil Vehicles & PartsSources: BOT, MOC, KResearch Sources: BOT, MOC, KResearchAs imports outperformed exports, the trade surplus for Aug-11 narrowed sharply to$704.8 million, versus the $4.6 billion in Jul-11. However, if excluding gold, the adjustedtrade surplus would have improved to $1.9 billion, against the $4.3 billion in Jul-11. Netservices, primary and secondary income for Aug-11 showed a deepening deficit of$1.4 billion, worsening from the $1.1 billion deficit in Jul-11, due to growing profitrepatriations. In a nutshell, the current account fell from a $3.4 billion surplus in Jul-11to a $697 billion deficit in Aug-11.Tourism enjoyed healthier momentum, but more evident impact ofsevere flooding will likely be seen in coming monthsIn Aug-11, the number of foreign tourist arrivals increased for the third consecutivemonth, reaching 1.72 million, up over 1.52 million in Jul-11. Over-year growth alsoaccelerated to 35.4% YoY, versus the 18.8% YoY in Jul-11. Meanwhile, the hoteloccupancy rate for Aug-11 remained steady at around 57.7%. Nevertheless, it isexpected that widespread flooding could produce more damages the tourism sector inSep-11 and Oct-11, not to mention the negative impact on crops and manufacturingoutput – following disruptions at many key industrial estates.292929
  • 30. Fig 7. Foreign tourists rallied further Fig 8. Hotel take-up rates improved  80 2000 70 70 No. of Foreign Tourist Arrivals 60 60 1500 50 50 (Million) % 40 % YoY 40 1000 30 30 500 20 20 10 10 0 0 0 Aug-10 Nov-10 Feb-11 May-11 Aug-11 Total Central South North Northeast Foreign Tourist Arrivals (lhs) % YoY (rhs) 4Q10 1Q11 2Q11 Jul-11 Aug-11Sources: TAT, BOT, KResearch Sources: TAT, BOT, KResearchManufacturing production gained groundAfter showing both MoM and YoY contractions in Jul-11, the Manufacturing ProductionIndex (MPI), compiled by the Office of Industrial Economics (OIE), had risen 3.9% MoMin Aug-11. Its YoY change improved to 7.0% growth in Aug-11, from the 0.7% contractionin Jul-11, with broad-based gains being seen across all major MPI categories.Apparently, the export-oriented MPI reversed from a 2.1% contraction YoY in Jul-11 to6.6% growth YoY in Aug-11, with support from hard-disk drives and rubber that werebolstered by high demand in China. Meanwhile, the domestic consumption-orientedMPI accelerated to 3.3% YoY in Aug-11, from 0.3% growth YoY in Jul-11, in light ofaccelerating production of petroleum products (ahead of a refinery plant shutdown forquality standard improvements, plus higher domestic demand after an exemption wasinstituted on Oil Fund levies for some types of retail fuels, effective late in Aug-11). As forthe MPI of products that serve both domestic and international consumption, itjumped from 2.9% YoY to 15.1% YoY, due mainly to automotive production to clear orderbacklogs.The OIE’s capacity utilization rate for Aug-11 suggested the same healthier pattern, byregistering accelerated 64.7% growth YoY, up over the 63.1% in Jul-11.Fig 9. Manufacturing production and capacity utilization Fig 10. Broad-based gains were seen across all MPIrecovered from the previous month categories   10 68 60 8 66 50 % Capacity Utilization Rate 6 64 40 4 % YoY of MPI % YoY of MPI 62 30 2 60 20 0 58 10 -2 -4 56 0 -6 54 -10 -8 52 -20 -10 50 -30 Aug-10 Nov-10 Feb-11 May-11 Aug-11 May-10 Aug-10 Nov-10 Feb-11 May-11 Aug-11 % Capacity Utilization (rhs) MPI (lhs) exports < 30% 30% < exports < 60% exports > 60%Sources: OIE, KResearch Sources: OIE, KResearch303030
  • 31. Private sector confidence mixedReversing the previous month’s direction, the Consumer Confidence Index (CCI) forAug-11 showed a MoM decline, while the Thai Industries Sentiment Index (TISI) fell forthe third consecutive month. This worsening sentiment reflected rising concern about theimpact of widespread flooding, global economic uncertainty and fading hope towardimplementation of the government’s income-enhancement policies.On the other hand, the Aug-11 Business Sentiment Index (BSI) managed a MoM gain,bracing for lower production costs (due to falling fuel prices following the exemption ofsome Oil Fund levies), as well as better investment and production. However, it is highlylikely that this uptick could be short-lived, amid a more negative economic environmentboth at home and abroad.Fig 11. Private sector confidence was mixed in Aug-11 Fig 12. Private consumption and investment regained strength   BSI CCI & TISI 70 60 120 60 110 50 55 40 100 % YoY 30 20 50 90 10 80 0 45 -10 70 -20 40 60 PCI PII Passenger Cement Commercial Imports of Imports of Feb-10 May-10 Aug-10 Nov-10 Feb-11 May-11 Aug-11 Car Sales Sales Car Sales Capital Consumer Goods Goods BSI BSI (Expected for the next 3 mths) CCI TISI 4Q10 1Q11 2Q11 Jul-11 Aug-11Sources: BOT, UTCC, FTI, KResearch Sources: BOT, KResearch Note: Figures for PCI and PII component compiled from non-seasonally adjusted series by the BOTPrivate spending regained strengthAfter switching between marginal MoM gains and contractions over the past 4 months,private sector spending seemed to enjoy a more solid improvement in Aug-11. ThePrivate Consumption Index (PCI) increased 3.6% MoM, rising over the 2.3% MoMcontraction in Jul-11. This brought its over-year growth upward to 5.4%, rising over 2.1%in Jul-11. In the same direction, the Private Investment Index (PII) for Aug-11 edged up1.9% MoM (compared to 0.4% MoM seen in Jul-11), thereby resulting in accelerated YoYgrowth of 8.3% from 6.5% in Jul-11.Key components leading the increase included real VAT collections, imports of capitalgoods (serving the needs of expanded production in the automotive, electronics, andelectrical appliance manufacturing sectors), auto sales (as intermediate auto-partshortage problems subside), as well as gasoline and diesel fuel consumption (boosted byan exemption on Oil Fund levies).Reduced fuel prices helped ease the Sep-11 Headline CPI, but theCore CPI continued to head further northThe Headline CPI for Sep-11 saw easing pressure, by reporting a 0.33% MoM decline,versus the 0.43% growth in Aug-11. Consequently, its YoY growth decelerated to 4.03%from 4.29% in Aug-11. This subsiding pressure on the Headline CPI traced a 8.02% MoMdrop in domestic retail fuel prices – particularly diesel and gasoline motor fuels – as aresult of cooling global oil prices and the full benefit of the government’s Oil Fund levycuts (effective late in Aug-11), as well as measures to subsidize public transportationfares (registering a 0.99% MoM decrease).313131
  • 32. Lower fuel prices helped cushion a 4.14% MoM jump in vegetable and fruit prices, in lightof the ‘Kin Jae’ Vegetarian festival and flooding in many areas.The Core CPI for Sep-11 continued to report a MoM increase of 0.1% (versus 0.27%MoM in Aug-11), thereby pushing it up to a new 3-year high at 2.92%, from 2.85% YoY inAug-11.When looking out further into the remaining months of 2011, although the Core CPI couldcontinue to accelerate MoM, a sharp decrease in fuel prices (particularly in Sep-11) helpslower a chance that the Core CPI will breach the existing Inflation Targeting range of 0.5-3.0%.This is not to mention the new BoT’s Inflation Target range of 3.0% (+/- 1.5%) with theyearly Headline CPI working as a new policy target (effective in 2012), that could imposegreater flexibility for the monetary policy maneuver next year.Fig 13. Sep-11 core inflation headed further north   1.5 5.0 4.0 1.0 % YoY % MoM 3.0 0.5 2.0 0.0 1.0 -0.5 0.0 Sep-10 Jan-11 May-11 Sep-11 Headline CPI (MoM-lhs) Core CPI (MoM-lhs) Headline CPI (YoY-rhs) Core CPI (YoY-rhs)Sources: MOC, KResearchThe EU debt crisis: A Big Threat to the Thai Economy over the next6-12 monthsOver the past two months, financial market sentiment has been hurt by growing warinesstoward the EU debt crisis, especially with the Greece’s diminishing ability to service theirhuge public debt and a postponement until Nov-11 of a ‘Troika’ (EU, IMF and ECBleaders) meeting to decide on the 6th financial support plan for Greece. In addition, thereis widespread concern about more sovereign rating downgrades, and subsequentbanking crises, with a looming collapse of Belgian-French Dexia Bank.At this juncture, two differing KResearch estimates on the impact of the EU debt crisistoward the Thai macroeconomic situation appear below:323232
  • 33. Table 2. KResearch’s Preliminary Assessment, the EU Debt Crisis: Impact on the Thai Economy 2011F 2012F Scenario 1: Scenario 2: Limited Impact Widespread Impact from the EU Debt Crisis from the EU Debt CrisisKey Assumptions • EU officials use the EFSF and other • EU officials are unable to push safety net packages to effectively forward effective measures with contain the problem from spreading to sufficient size in a timely manner. An other countries beyond PIG countries uncontrollable event becomes (Portugal, Ireland and Greece). possible. • Orderly, managed default of some PIG • Larger countries in the EU – e.g., countries is possible. Italy, Spain and France – become • The 2012 EU economy is projected to exposed to contagion risks, with remain in the black, while the US and unusually high funding costs. Chinese economies will likely underperform their potential.KResearch Macroeconomic Forecasts (Units: % YoY)GDP 3.5-4.2% 4.5% 1.0%(Base Case) (3.8%)Exports 17.0-22.0% 10.0% -7.0% (20.0%)Headline CPI 3.7-4.0% 3.7% 2.8% (3.8%)Sources: KResearch, as of September 16, 2011• Scenario 1: Limited Impact If EU officials successfully use quantitative and qualitative measures to effectively restore market confidence, KResearch estimates that Thai exports will likely see a limited downside risk, with YoY growth reaching at least 10.0%, or so. Coupled with the Thai government’s stimulus efforts that could shore up the GDP by 1.5%, this would result in 2012 GDP growth of up to 4.5%.• Scenario 2: Uncontrollable Impact In this case, assistance from the EU officials would fail to completely restore market confidence, thereby heightening risks to countries with larger economies – e.g., Italy, Spain and France. As such, the need to urgently overhaul the EFSF (in size, flexibility and/or scope of responsibility) would likely become necessary, which might include expediting the European Stability Mechanism (ESM), ahead of its previous timeline for readiness in mid-2013. Thai exports in 2012 might then report a 7.0% contraction YoY, causing GDP growth to drop to only 1.0% only. Dismal domestic demand would likely lessen inflationary pressure, lowering the Headline CPI to 2.8% YoY, versus the 3.7% YoY estimated in Scenario 1.However, as there remain a number of triggers that could alter the direction anddevelopment of this EU debt crisis later on – e.g., results of the EU Summit to be heldduring October 17-18, as well as ECB, G-20 and EU Finance Minister meeting lined upduring the first two weeks of Nov-11, in addition to a Troika meeting with Greek officials thon whether to approve the 6 funding assistance plan at around that period – we willclosely monitor this situation, prior to revisiting our assessment toward this event (ifneeded) in the future.333333
  • 34. Back to the remainder of 2011, aside from growing global economic risks, severe floodingat home that has damaged agricultural output, tourism and many industrial estates willlikely hit the 4Q11 GDP, thereby increasing the likelihood that the full-year GDP will belower than our current estimate of 3.8% YoY in the base-case scenario.The Outlook for Next MonthDue to bearish global economic sentiment, Sep-11 exports might not be able to keep theAug-11 gain. This direction, coupled with a base effect, could impose a downside risk toexport growth YoY, possibly falling below the 28.4% growth YoY in Aug-11. The sameexplanation applies to the Sep-11 MPI, with YoY growth decelerating from the 7.0% inAug-11. Meanwhile, the Oct-11 Headline CPI is expected to remain higher than 4.0%YoY, due to upside pressure from high food prices amid widespread flooding. Meanwhile,the Core CPI for Oct-11 could stay close to the 2.92% YoY reported for Sep-11.343434
  • 35. Strategy: Stay cautious, volatility remains Kavee Chukitkasem - KSecuritiesInvestment theme:► Markets are being driven by events in the EU and although there appears to be progress, market will no longer be satisfied with half- solutions. Comprehensive plans including Greece debt haircut, EU banks ring-fencing and recapitalizations will now be needed to calm market. These decisions require political considerations and further setbacks are expected as talks progress.► Volatility will continue. We have set ourselves a one-month window ending in early November before considering the need to change fundamental macro assumptions which will change market outlook.► There is a downside risk to our view presently, but we see SET index at 812 to provide strong support. This is based on PBV at 1.5x (fundamentally) and peak-to-trough correction of 30% (technically) – both historically well-tested. Our worst-case has SET index at 730, arrived through stress-testing assumptions on 2012 GDP growth at 1.9% from 5% with increased required risk premium.► This worst-case scenario is comparatively better than the worst-case saw in the US subprime crisis of 2008-9 when the SET went below 400. As presented in this report, we see damage from the EU crisis much less severe than that of the US sub-prime including Thailand crisis of 1997.► We advise reducing portfolio at current levels. Aim to accumulate shares as we get below 850 but stick to sectors with business oriented towards domestic consumption. We have been recommending these sectors for a while and they have shown high degree of outperformance over the SET.► The above consideration along with the impact from local floodings have made us increased our emphasis towards domestic/defensive sectors and we upgrade Utilities sector to Neutral. Our stock selections have also been made to anticipate companies that are expected to see quick recovery once normalcy returns. The stocks include: BBL ADVANC CPF MAJOR HMPRO CENTEL BGH LPN STEC and AMATA. We replaced PS with LPN as its stronger earnings outlook.353535
  • 36. Changing environmentDespite falling by over 10% since the last peak on 10 July, the SET continued tooutperform the regional indices while USD/THB rate also depreciated less. In general,smaller markets have suffered less in this last downturn than bigger markets (figure 1).This pattern may have to do with availability of liquidity to foreign investors as biggermarkets have greater liquidity and suffered more from selling, reflecting a panickybehavior. This sudden increase in risk aversion has been caused by concerns onsystemic risks in the EU financial system. This overshadowed the 3 positive catalysts thatwe expected to provide support to the Thai market which were listed last month. Althoughthese catalysts (easing of policy stance by Asian central banks, move towards launch anew fiscal stimulus the US and cut in Thailand corporate tax rate next year), did makesome progress in varying degrees, the risks associated with the EU are nowoverwhelming. More detailed discussion of the EU debt situation can be found in theearlier sections of this report.Fig 1. Equity and foreign exchange rate performance sincelast peak on 10 July 6% FX Performance China 4% Philippines 2% Indonesia Hong Kong Singapores 0% -2% Thailand Malaysia -4% Taiwan South Korea -6% -8% India Equity Performance -10% -30% -25% -20% -15% -10% -5% 0%Source: BloombergAs the EU problems worsen, their leaders and authorities are coming under greaterpressures from the market to act in such a way that a complete solution can bepresented. This would include at least a comprehensive plan to restructure Greece’ssovereign debt, recapitalize its banks and ring-fence financial institutions in the region. Adecision to provide another bail-out package to Greece will not do as it simply delays theinevitable. As discussions among EU leaders progress (or lack of), markets areresponding positively (or negatively) depending of the implications of details released.Before making the case for our view on the SET, it is important that we state the externalmarket environment that we are assuming to understand our risks and catalysts factors.We are taking a view that between now and early November, EU leaders will have comeup with comprehensive plan for orderly default of Greece debts, recapitalization and ring-fencing measures of EU banks with sources of funds and implementation steps clearlyidentified. We believe this one-month window is important because it will see at least twosummit meetings among EU members: i) the EU leaders meeting on 17 October and ii)the G20 Cannes meeting on 3-4 November. We hope that a market-friendly solution willbe worked out by then. Should the timeline be deferred, there would be significantdownside risk to the market.363636
  • 37. Short term strategyAt the time of writing this report, the market mood is positive but we expect near-termvolatility to remain high and sentiments can reverse quickly. Accordingly, we formulateshort-term investment strategy based on the possible outcome during the period whenthe market waits for a comprehensive plan from Europe.At current levels of the SET (909), we advise reducing portfolio for short-term traders.The level of support for the SET is estimated at 812, equivalent to P/BV at 1.5x althoughwe would begin accumulating below 850. Sectors that we would recommend entry hereare mainly those focusing on domestic plays. In the worst case that the market goes intoa free-fall during its panicky moments, we would enter SET at 730. This worst-case levelis arrived through ‘stress-testing’ our assumptions for much weaker economic outlookincluding raising the equity risk premium. Note that such worst-case assumptions prettymuch reflect outlook for prolonged problems in the EU as well as much weaker globaleconomic growth.Fig 2. Short-term SET range and trading strategySET level Rationale and trading strategy900 Rationale: Current levels Strategy: Reduce portfolio812 Rationale: Derived from P/BV = 1.5x. The SET could fall to this level in the near because of volatility as the market waits for a clarity on EU. Strategy: On the way down, we would accumulate defensive stocks with strong exposure to domestic consumption theme (Power, ICT, Media, Commerce and Hospitals). We would add Banks and Property as bets for positive near-term outcome.730 Rationale: This is the worst-case scenario and arrived from stress-testing valuation assumptions. This includes reducing 2012 Thai GDP growth from 5.0% to 1.9%, consumption growth from 4% to 2.3% and average Dubai crude oil price from USD107/bbl to USD90/bbl. We also raised our equity risk premium from 5.7% to 8.1% on the outlook of much weaker global economic growth from 3.8% to 1.4%. The set of assumption pretty much captures the scenario of prolonged EU problems Strategy: The market will take less time to get from 812 to 730 than from 900 to 812. Accordingly, high beta stocks are recommended namely Energy and Commodity.Source: KSAssessing downsideOur worst-case assessment on the downside of the SET is 730. Compared to theprevious correction of over 50% during 2008 US sub-prime crisis, the correction underthe worst-case estimate is only 36%. Our worst-case of 730 appears to be relatively highcompared to our peers. Reasons are as follow:1. Less damage: Financial damage from the EU crisis is estimated to be much less severe compared to that US sub-prime crisis. According to the IMF, financial damage from the EU problem is estimated to be Euro200billion (USD260billion) but market estimates total damage could reach Euro400billion (USD520billion) compared to USD1.4trillion during the US sub-prime crisis in 2008: on this estimate, the scale of the US problem is 3.5x larger. Some of the reasons may have to do with the fact that373737
  • 38. current financial leverage for financial institutions today are ‘less bad’ compared to levels in 2Q08, just before the sub-prime problems blew out (figures 3 and 4). Also the cause for the current problem lies in public debt sector where sovereign bonds holdings are concentrated among EU financial institutions whose global networks are far less extensive than those of US, thus less potential impact globally. On the other hand, the US sub-prime problem was caused by excessive consumer/commercial lending that spread out across the financial industry, making its fall-out much more severe.Fig 3. Financial damage between subprime crisis andestimated EU crisis (PLEASE USE US SUB-PRIME IN Fig 4. Financial leverage between US and EU banksTHE CHART AND TAKE OUT WORD LEHMAN). Changeeverything to USD bn 30 Financial Leverage of Banks 25 2Q08 2Q11 20 15 10 5 0 EU USSource: IMF, Bloomberg Source: IMF, Bloomberg2. Much has been discounted: While authorities discuss about the level of haircut on Greece debts and recapitalizing banks, the market is already pricing in consequences of haircut and re-capitalization. For this reason, banks PBV is a fairly good early indicator of how much ‘bad news’ is in the market. Figure 5 shows the changes in PBV of banking sector before and after the climax in the crisis for Thailand (Tom Yam Kung - 1997), USA (Hamburger – 2008) and now EU (Spaghetti - 2011). At their worst points, Thailand PBV bottomed at 0.36x, US at 0.35x. Currently, EU banks are trading at PBV of 0.6x. From 0.6x to 0.35x is still another 40% down. But as mentioned above, the extent of the EU problem is not as severe as that of the sub-prime. Theoretically therefore, the PBV of EU banks do not have to go down as deep as that of US. But by how much?383838
  • 39. Fig 5. PBV of banks before and after crisis: Thailand, USA and EUSource: Bloomberg To assess the worst point of the PBV for EU banks, we revert back to estimates on the expected financial damages and compare them with nominal size of GDP, the strength of banking system, including Thailand. Figure 6 shows that potential financial impact on EU economy is relatively marginal at 2.9% compared to 9.8% for the US. Meanwhile, EU banks have much lower leverage to begin with, so capital needs would be less severe. Although we could arithmetically estimate the fair PBV for EU banks based on the previous two crisis, we are inclined to view that PBV’s bottom would be closer to current 0.6x than 0.35x. But the longer the delay in resolving problems, the larger the size of damage will expand beyond USD520bn.Fig 6. PBV comparison at the bottom for Thailand, USA and EUCountry Thailand USA EUCrisis year 1997 2008 2011Financial damage (USD bn) * 1,140 1,400 520Nominal GDP (USD bn) * 4,700 14,291 17,960Damage / GDP 24% 9.8% 2.9%Banks Asset/Equity 12.4% 12.1% 20.3%Bottom of Banks PBV (x) 0.36 0.35 0.35 - 0.6Note: Except for Thailand in Baht currency. Source: IMF, BOT3. Fundamentally, historically tested: In the past 10 years or since 2002 after the SET fully recovered from the balance of payment crisis in 1997, the SET has mostly traded within the PBV band of 1.5x to 2.5x (figure 7). The only time it traded below 1.5x PBV was during the 2008-2009 sub-prime crisis but we have discussed above that the severity of this crisis is expected to be much less now. We believe the 1.5x PBV level or equivalent to 812, provides fundamental support to the SET.393939
  • 40. Fig 7. SET trades mostly within 1.5x to 2.5x PBV  4.0 3.5 3.0 2.5 2.0 1.5 1.0 SET Index 0.5 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11Source: SET, KS4. Quantitatively, historically tested: In the last 30 years of SET trading history, the index recorded bullish run of more than 100% in only 5 periods (figure 8). After such run, the average correction is 30% occurring over a period of less than 4 months. Using historical average as a guide, the correction phase should run until the end of October with low level to be tested at near 800.Fig 8. A 30% correction after 100%+ run 1800 Up 233.31%, 1,134 Days 1600 1400 Up 368.35%, Down 24.87%, 65 Days 1200 959 Days Down 33.67%, 77 Days Up 202.14%, 980 Days 1000 800 Up 140.87%, 455 Days 600 Down 53.03%, 126 Days Down 25.92%, 126 Days 400 Up 169.73%, 294 Days Corrections days = 25 days 200 Down 33.75%, 119 Days SET Index 0 Jul-87 Jul-88 Jul-89 Jul-90 Jul-91 Jul-92 Jul-93 Jul-94 Jul-95 Jul-96 Jul-97 Jul-98 Jul-99 Jul-00 Jul-01 Jul-02 Jul-03 Jul-04 Jul-05 Jul-06 Jul-07 Jul-08 Jul-09 Jul-10 Jul-11Source: Bloomberg, KS5. Brokers’ portfolio has been halved: The increased in SET volatility has also been contributed by action from brokers’ trading desks. Total size of brokers’ portfolio (including only those that are listed which would account for most of proprietary trades anyway) is estimated to be Bt9bn as of the end of 2Q11. Based on the trading history since then, we expect that total value of trading position on their books would have declined to about Bt4bn. This is still significant and can provide strong downward pressures on bad days. Nonetheless, they also indicate the level of appetite when the market turns more positive.404040
  • 41. Fig 9. Less room to sell from brokers’ portfolio 1200 14000 1150 12000 1100 10000 1050 8000 1000 6000 950 4000 900 SET Port value (RHS) 850 2000 800 0 07-Jul-11 14-Jul-11 21-Jul-11 28-Jul-11 04-Aug-11 11-Aug-11 18-Aug-11 25-Aug-11 30-Jun-11 01-Sep-11 08-Sep-11 15-Sep-11 22-Sep-11 29-Sep-11Source: SET, KSSelective on sectorWe are revisiting our worst-case scenario discussion to explore potential downside risksand opportunities for the different sectors with results shown in figure 10. As we believethe market will see days of panic in the coming weeks and some of the strong sectorswhose business have limited impact will provide window to accumulate shares. We re-iterate our preference for the defensive, consumer related stocks including utilities andICT. Their downside risks in terms of share prices and earnings impact are much lesslimited compared to others.Fig 10. Impact on 2012 earnings forecasts and fair price Transportation 0% Industrial Estate -70% -60% -50% -40% -30% Health Care -20% -10% Utilities Fair Price Change (%) Agribusiness ICT Commerce -5% Automotive Commercial Insurance Banking Tourism Residential -10% Media Construction Materials Shipping Oil&Gas -15% Energy -20% Securities Petrochemical -25% E&P Coal Electronics Refinery -30% EPS Change (%) -35%Source: KSKS’ PortfolioWe Upgrade Utilities to Neutral and downgrade shipping sector to Underweight fromNeutral. We believe defensive stocks will perform better in uncertain market conditions.Our top picks have also been selected to avoid companies that are expected to sufferfrom the floods. Note that in the near term, none of the company will be able to avoid theconsequences from floods, but consumer related stocks are expected to see rebound inbusiness once normalcy returns. We will be following up on the impact from floods later inour daily reports.414141
  • 42. We are dropping PS from our stock pick list this month and adding LPN because of thelatter’s stronger growth prospects. Other stocks include: BBL ADVANC CPF MAJORHMPRO CENTEL BGH LPN STEC and AMATA. Fig 11. KS’s portfolio Sector Current Weight Previous Wt Recom. Top Recommended from Aug 8 / Sector Wt. Picks Banking Neutral Neutral 22.1% BBL Insurance Neutral Neutral 0.9% BLA Food & Agro Overweight Overweight 6.1% CPF Automotive Neutral Neutral 0.1% SAT Petrochemical + SCC Underweight Underweight 5.8% PTTCH Energy Neutral Neutral 31.8% Coal Neutral Neutral 2.5% BANPU E&P Neutral Neutral 8.0% PTTEP Integrated Neutral Neutral 13.3% PTT Refinery Neutral Neutral 4.7% TOP Utilities Neutral Underweight 3.4% GLOW Property Overweight Overweight 6.1% Contractor Overweight Overweight 0.6% STEC Industrial Estate Overweight Overweight 0.9% AMATA Residential Overweight Overweight 3.7% LPN Commercial Underweight Underweight 0.9% CPN Commerce Overweight Overweight 8.8% MAKRO, BIGC Healthcare Overweight Overweight 2.8% BGH Media Overweight Overweight 2.3% RS Securities Underweight Underweight 0.2% KEST Tourism + MINT Neutral Neutral 0.8% CENTEL Transport & Shipping Underweight Underweight 0.2% Shipping Underweight Neutral 0.2% PSL Transportation Underweight Underweight 0.0% Electronics Underweight Underweight 0.4% SVI ICT Overweight Overweight 11.7% ADVANC Total 100%Source: KS424242
  • 43. Fig 12. KS sector valuations Mkt Cap Rating % Wt / % Up / MoM chg. EPS Growth PER (X) PBV (X) Yields (%) ROE (%) Sector (Btbn) SET Down 2010 earnings 10 11E 12E 10 11E 12E 10 11E 12E 10 11E 12E 10 11E 12EAgribusiness & Food 307 O 4.1 46.5 19.2 19.6 8.3 16.7 11.7 10.3 2.9 2.3 2.0 3.7 4.3 4.7 18.9 21.8 20.6Banking 1,058 N 14.2 66.8 10.5 23.0 15.8 12.0 9.1 7.8 1.4 1.3 1.2 3.2 3.9 4.4 12.6 15.0 15.7Construction Materials 318 U 4.3 67.9 53.5 -0.6 6.3 11.9 8.6 8.0 2.0 1.7 1.5 4.7 5.1 5.5 18.4 21.4 19.5Petrochemicals & Chemicals 174 U 2.3 95.6 39.4 103.9 6.4 17.0 7.0 6.7 1.4 1.3 1.1 3.4 7.4 8.5 8.8 19.3 17.9Contractors 33 O 0.4 43.2 127.7 254.0 -98.0 n.m. n.m. n.m. 1.5 1.5 1.5 1.3 2.2 1.0 -9.9 -4.1 0.1Commerce 435 O 5.9 24.6 20.3 8.4 21.2 30.1 23.8 19.7 7.1 6.2 5.5 2.5 2.8 3.5 24.1 27.8 29.6Commercial 72 O 1.0 26.3 -77.2 89.3 53.1 46.5 33.8 22.1 3.8 3.5 3.1 0.8 1.2 1.8 8.2 10.8 15.0ICT 591 U 7.9 20.8 30.3 -26.5 19.9 19.4 16.2 14.3 4.3 3.8 3.8 8.0 7.3 9.1 20.4 24.8 26.6Insurance 51 N 0.7 75.4 135.8 64.2 24.4 18.3 11.2 9.0 4.8 3.5 2.7 1.4 2.2 2.8 31.2 36.3 33.8Electronic 47 U 0.6 59.5 50.3 -18.4 8.9 6.1 7.1 6.4 1.2 1.1 1.0 8.5 7.6 8.3 21.0 16.4 16.5Energy & Utilities 1,897 N 25.5 59.6 29.5 25.4 8.0 11.9 8.0 7.2 1.7 1.6 1.4 3.9 5.1 5.6 15.3 20.4 20.4Media & Publishing 116 O 1.6 35.9 27.8 10.1 11.1 18.7 16.1 14.5 4.6 4.4 4.3 5.0 5.8 6.4 25.3 28.1 30.0Securities 23 U 0.7 58.3 85.9 -18.0 -16.8 5.9 7.1 7.7 1.2 1.2 1.1 14.1 12.3 11.7 20.5 16.3 14.9Health Care Services 139 O 1.9 16.9 -8.5 23.6 20.1 33.4 23.4 18.4 5.6 3.4 3.1 1.3 2.1 2.8 17.5 18.1 17.5Tourism 48 U 0.6 29.9 27.1 255.6 -4.9 52.2 18.7 15.5 2.2 1.8 1.8 1.2 2.6 2.6 4.4 10.4 11.4Residential 183 O 2.5 49.8 10.2 12.1 9.7 10.6 9.6 8.1 2.0 1.7 1.6 5.5 5.5 6.2 19.6 19.2 20.3Industrial Estate 45 O 0.6 77.0 65.1 -8.8 58.0 11.5 11.4 7.3 1.5 1.4 1.2 5.0 5.4 8.0 13.7 12.7 17.6Transportation 108 N 1.5 46.6 69.2 -83.9 351.9 16.5 13.2 8.0 0.6 0.6 0.6 4.2 3.0 5.3 4.1 4.7 7.5Shipping 25 U 0.3 50.7 -65.0 -15.5 82.7 46.8 60.6 11.8 0.6 0.6 0.6 4.3 3.8 5.5 1.2 1.0 4.9Automotive 6 N 0.1 89.2 116.4 0.6 25.5 8.3 8.1 6.5 1.5 1.3 1.2 4.9 3.7 4.6 21.4 17.5 19.4SET KS 5,676 76.4 52.8 24.9 12.5 12.9 14.1 10.2 8.9 1.9 1.7 1.6 4.1 4.8 5.5 14.3 17.9 18.4SET KS Ex - Financials 4,567 61.4 49.3 28.7 10.0 12.2 14.8 10.5 9.2 2.1 1.9 1.7 4.3 5.0 5.8 14.7 18.8 19.3SET KS Ex - Energy 3,780 50.8 49.4 23.3 7.6 16.8 15.6 11.7 10.0 2.0 1.8 1.7 4.2 4.7 5.5 13.7 16.4 17.3SET 7,435Source: KS U – Underweight, O – Overweight, N – NeutralAs of 7th October 2011Fig 13. 2011 sector valuation Fig 14. 2011 Consensus earnings changes PER / EPS Growth (%) -1 M -3 M 2.0 8.0 1.8 7.0 1.6 6.0 1.4 Const.Materials Energy Agri&Foods 5.0 1.2 4.0 Petrochemicals Securities Commerce 1.0 Electronic 3.0 Tourism 0.8 Insurance Automotive ICT 2.0 0.6 Banking Commercial 1.0 0.4 Shipping 0.0 0.2 Residential -1.0 ROE (%) 0.0 -2.0 10 15 20 25 30 35 40 Bank Energy Fin & Sec ICT Petrochem PropertySource: KS Source: BloombergFig 15. 2011 country valuations Fig 16. SET PER discount to region PER / net Income Growth (%) 40  Regional PER 30  1.4 20  1.3 10  SET PER 1.2 0  Jan‐07 Jan‐08 Jan‐09 Jan‐10 Jan‐11 Oct‐07 Oct‐08 Oct‐09 Oct‐10 Oct‐11 Apr‐07 Apr‐08 Apr‐09 Apr‐10 Apr‐11 Jul‐07 Jul‐08 Jul‐09 Jul‐10 Jul‐11 1.1 1.0 Philippines 11/13% 20% 0.9 HongKong Malaysia 0% 0.8 8/11% 11/15% ‐20% 0.7 Indonesia 11/19% ‐40% Thailand 9/14% S. Korea 8/15% 0.6 ‐60% Taiwan 11/19% ROE (%) Jan‐10 Jan‐11 Jan‐07 Jan‐08 Jan‐09 Oct‐10 Oct‐11 Oct‐07 Oct‐08 Oct‐09 Apr‐10 Apr‐11 Apr‐07 Apr‐08 Apr‐09 Jul‐10 Jul‐11 Jul‐07 Jul‐08 Jul‐09 0.5 10 12 14 16 18 20 22Source: Bloomberg consensus Source: BloombergNote: Country PER, EPS Growth, As of 7th October 2011434343
  • 44. Disclaimer For private circulation only. The foregoing is for informational purposes only and not to be considered as an offer to buy or sell, or a solicitation of an offer to buy or sell any security. Although the information herein was obtained from sources we believe to be reliable, we do not guarantee its accuracy nor do we assume responsibility for any error or mistake contained herein. Further information on the securities referred to herein may be obtained upon request.444444