Singapore
GDP Downgrade: Still No V-Shaped Recovery
April 16, 2009

By Deyi Tan, Chetan Ahya | Singapore & Shweta Singh | Mumbai

Marking to Market

The Ministry of Trade and Industry’s (MTI) 1Q09 GDP advance estimate of -11.5%Y surprised even the worst of consensus and set the entry point into 2009 a lot lower than what was embedded in our -6%Y GDP forecast (see 1Q09 Advance GDP Estimate and Monetary Policy Review, April 14, 2009). Specifically, 1Q09 manufacturing (-29.0%Y) is expected to be weaker compared to the Jan-Feb average (-26.2%), possibly on biomedical volatility in March. Meanwhile, the services slowdown also surprised on the downside from external linkages spillover, with an expected decline of 5.9%Y, which is worse than the 2%Y annual decline we saw during the 1998 Asian Financial Crisis when domestic confidence was hit hard. We are marking to market our 2009 GDP growth forecast from -6%Y to -10%Y to take these numbers into consideration. In terms of the GDP components forecasts, we see external linkages continuing to filter down to domestic demand and services. Consumer spending should see further softness as income stays crimped with the unemployment rate possibly reaching as high as 9-10%. We still look for the capex recession to persist beyond 2009, as capex plans are delayed with the demand destruction. Moreover, contractions in machinery and equipment capex are likely to coincide with construction capex declines in 2010, given how developers are currently delaying launches.

Tentative Signs of Improvement in Second-Order Derivative in NODX…

In our view, the more interesting question regarding the GDP downgrade is the shape of the quarterly profile. In line with the growth trajectory that the Morgan Stanley economics team expects for the developed world, we had been expecting Singapore’s percentage year-on-year GDP to follow a wide U-shaped profile, with a trough some time in 2Q-3Q09, in our original forecast. For 1Q09 in Singapore, January and February data trends have been generally difficult to read, as they are distorted by the Chinese New Year holiday timing. However, data elsewhere (such as China PMI, US ISM New Orders, US home sales, etc.) have shown improvement in the second-order derivative, raising discussions regarding the possibility of an earlier-than-expected recovery. Given the export-oriented growth strategy in Singapore and that domestic demand tends to be a derivative of global demand, we believe that the single-most important indicator in Singapore is non-oil domestic exports. In this regard, recently released March non-oil domestic export data have also shown a slower pace of decline at 17.0%Y (versus -23.8%Y in February and -29.9%Y for the Jan-Feb average). On a seasonally adjusted month-on-month basis, NODX rose for the second consecutive month (+10.8%M versus +1.6% in February), suggesting an improvement at the margin.

…but Still No V-Shaped Recovery

However, we hesitate to extrapolate March NODX data to argue for a V-shaped recovery for the following reasons:

1) If the slower pace of NODX decline is indeed sustainable, Singapore’s export contraction in what is likely the worst post-war global recession (Morgan Stanley expects global growth to be -1.4%Y for 2009) would be about as low as what we saw during the TMT bubble burst in 2001 when global growth was +2.2%Y. We admit that export product/destination diversification in past years makes a strict one-for-one comparison difficult. After all, non-electronic exports, which tend to see better growth momentum than electronics exports, now constitutes a bigger share of NODX. However, the extent of demand destruction for electronics products from the deleveraging of the US consumer and the fact that the electronics export base here is not as developed as it is in Korea or Taiwan suggest to us that trade trends are unlikely to be one-way from here.  Moreover, the US ISM New Orders Index, which leads NODX by four months, suggests that the March NODX uptick looks premature and more weakness could be expected for the next few months.

2) Moreover, in terms of end demand, in the developed world, our US economist Richard Berner continues to highlight the headwinds facing the US consumer (see US Economics: Perfect Consumer Storm Not Over, March 31, 2009). Richard points out that the pick-up in Jan-Feb retail sales numbers was bolstered by bargains offered during the liquidation of a major electronics retailer and outlays for prescription drugs, both of which could be one-off items. Stripping out these factors, Richard noted that overall spending rose at a 0.3% annual rate rather than the headline 3.2%. Furthermore, familiar headwinds from job losses and erosion of household wealth remain intact. In the longer term, Richard is of the view that real consumer growth will decelerate from the 3.5% annual pace in the decade ending in 2007 to 2-2.5% over the next few years as a new age of thrift dawns.

Indeed, weak fundamentals mean the Singapore economy is still likely to continue to bump along the bottom in the territory of negative double-digit percentage year-on-year declines or close to it. Looking further out, our view on the 2010 recovery remains unchanged at +3.0%Y. This will be much lower than the 8% trend growth rate achieved in the 2004-07 period. Our 2010 forecast reflects the view that a small-and-open economy with no autonomous domestic demand would continue to face growth pressures from below-trend world growth (+2.7% in 2010 versus +4.6% CAGR in 2003-07) amid the longer-term trend of US consumer deleveraging.

Japan
Upgrading Outlook for Fiscal Stimulus Effects, Yet to See Full-Blown Recovery
April 16, 2009

By Takehiro Sato & Takeshi Yamaguchi | Tokyo

Revising Up for F3/10 Assuming an End to Deterioration in Macro Data and Effects of Stimulus Measures

The revision in our forecasts stems from the scale of measures Japan is taking to shore up the economy, as these have burgeoned beyond our expectations, just as progress with correcting inventory has been swifter than we foresaw. Inventory correction is resulting in a bounce in corporate sentiment data everywhere except Europe. Moreover, we expect the scale of the measures the Japanese authorities are taking to boost GDP by about 1.5pp.

Bounce in Sentiment Data and Progress with Manufacturers’ Inventory Correction

The global economy is showing positive second derivatives. In other words, though conditions are still trending downwards in general terms, downward momentum is easing, and in some cases may even have been replaced by growth. For example, besides three consecutive months of gains in overseas data such as the US ISM index and China’s PMI, Japan’s Economy Watchers’ Survey is also picking up from a bottom in December 2008. The Watchers’ DI of current conditions tends to lead turning points in the economy by three months, so this turning point may be upon us right now in March-April. In fact, we expect industrial production in Japan, which of the leading industrialized nations has seen the steepest output cuts, to have shifted into growth for the first time in six months as of March, while globally too, manufacturing performance is steadily bottoming out. The dramatic correction of production from October-December occurred at a pace never seen before, and this was partly because companies responded to retreating demand with such sensitivity and incisiveness. Hence, notwithstanding sharp growth in inventory-shipment ratios, levels of inventory data are falling moderately.

Effects of Stimulus Measures to Push Up F3/10 GDP by 1.5pp

The package of fiscal stimulus measures announced by the Japanese authorities on April 10 (JPY56.8 trillion works scale, fiscal measures (‘real water’ as announced) JPY15.4 trillion) is larger than we expected, and the economic effects will not be negligible. Of the JPY15.4 trillion in fiscal measures, we estimated that the true ‘real water’ contribution to boosting GDP at JPY7.3 trillion (1.5% of GDP). We expect the effects of the measures to start materializing from this July-September as public works are front-loaded, and we envisage about 80% of the ‘real water’ being spent during F3/10, so pushing up GDP, with the remaining 20% or so contributing to GDP in F3/11. If so, the growth rate should be boosted by +1.0pp during F3/10.

Shift in Quarterly Growth Pattern from Negative to Positive

On a quarterly basis, we believe that import correction was slow by comparison with the fall in exports in January-March, and we expect the quarter to have seen shrinkage of inventory that built up in October-December and reduction of capex, yielding an annualized result of -13.7%, worse again than the fall in October-December. However, we expect the growth rate to stop falling in April-June as exports stop declining and import correction makes progress, pushing net external demand marginally into positive territory, and bringing some respite in the decline in internal demand, chiefly centering on capex. Then in July-September, besides front-loading of public works under the initial budget, we expect some of the effects of the stimulus measures to start surfacing, before the maximum effects come through from October-December to January-March 2010. Consequently, we expect the pattern of quarterly GDP to turn positive in July-September through October-December. This marks a significant change in our outlook from the negative growth we previously foresaw for the whole of F3/10.

But there will also be a backlash. For F3/11, the upward revisions to our forecasts for October-December 2009 and January-March 2010 will raise the starting points for year-on-year comparisons, so while the contribution to GDP may look positive, in fact it is the opposite.

If we simplify the forecast GDP boost to +1pp for the first year and +0.5pp for the second year, the growth rate comes down in the second year by the amount that the GDP level rises in the first year, or by 0.5pp. Avoiding this would require continued measures on the same scale, but it seems unrealistic to expect that measures of such a magnitude would be repeated over several years. Therefore, although we raise our 2010 outlook by a notch, the net internal growth rate excluding this comes down and so, most notably on a fiscal year basis, we expect the growth rate to subside to -0.5% in F3/11 versus our previous outlook of +0.3%.

Bull Case and Bear Case

The above is our base scenario of the most probable growth course under the given assumptions. This compares with the bull and bear case risk scenarios that we illustrate. Although we revise up our economic outlook for F3/10 (and 2009), it is important to note that the upcoming risks are more or less evenly balanced. Depending on the outcome for the growth rate in January-March 2009, it is possible that the numbers for 2009 and F3/10 could swing substantially either way.

Upside Case: Asian Recovery and Pent-Up Demand

Upside risks could be supportive for Japanese exports from an easing of the deterioration in the global economy, or unexpected upside in consumer spending and small-scale capex as pent-up demand found an outlet. With regard to support for exports, despite significantly reducing our outlook for the global economy compared with last December, we are also now seeing some more encouraging signs, including in the aforementioned sentiment-related data.

Moreover, effects of improved terms of trade should be of major benefit to Asia, including Japan. Roughly estimated from current crude oil and commodity prices, the scale of real income flows from Asia, including Japan, resulting from changes in terms of trade is likely to be about half that of 2008 in 2009. In Japan’s case, a halving of trading losses (outflow of real income), which came to about US$300 billion (just under JPY30 trillion) in 2008, would have a similar effect to tax cuts of a comparable basis. The benefits for less energy-efficient Asia would be even greater.

The second upside risk factor – pent-up demand – materialized in the dying days of Japan’s recession in 1998, when feedback from the financial markets to the real economy became extremely intense. We think this demand may have occurred as about a year had passed since event risk arose, giving both households and enterprises time to reconcile themselves to the recession and start to return to personal consumption and small-scale capex as they become tired of austerity. This time, although the global economy stumbled hard over the event risk of September 2008, it is possible that about one year on, or in around October-December 2010, we will see similar demand emerge, which coupled with the effects of fiscal stimulus measures could push the growth rate above our expectations.

Downside Case: Inadequate Policy Response, Surge in Long-Term Interest Rates

As downside risks, on the other hand, we would point to the tighter regulations relating to construction adopted in response to the 2007 housing shock, and the possibility of similar event risk. Amendments to the Licensed Architect Act put responsibility for checking design compatibility in the hands of a limited number of qualified surveyors, of whom there may not be enough to cope with requirements when the changes come into effect this May. Other risk factors are amendments to the Instalment Sales Act (from the summer) and legislation providing homeowners with warranties against flaws in housing construction (October).

The new Instalment Sales Act may affect consumption of big-ticket items such as autos, if requirements for items like proof of buyers’ income are adhered to very strictly. The new legislation on warranties for homeowners will oblige homebuilders to provide 10-year performance warranties, and while large firms may feel a limited impact, smaller operators could feel themselves under increased burden.

From the macro perspective, with Japan facing its largest ever increase in JGB issuance, there is a risk that rising higher rates fuelled by deteriorating JGB supply-demand could trigger classic crowding out. However, we think long-term rates are unlikely to settle into an uptrend.