Robust December Results to Conclude 2009
January 29, 2010
By Sharon Lam & Katherine Tai | Hong Kong
In line 4Q09 GDP, real expansion to be sustained into 2010: Korea NBS just reported a batch of domestic-related macro indicators for December today, and the majority of the positive results reaffirm an incessant improvement in the domestic economy. In our view, the strong performance in December should not come as too much of a surprise to the market due to the low base effect from a year ago, but details revealed that there is a real expansion in the economy led by the private sector. In YoY terms, the December leading indicator continued to climb up further (+12.8% versus +12.6%), though its sequential momentum appears to be moderating (+0.6%M versus 1.4%M). Nonetheless, based on the current budget planning, we expect that the government will again front-load around 70% of the fiscal expenditure in 1H10 to help support economic growth and it will increase spending on health, welfare and R&D. On the monetary front, we believe that the BoK will adhere to gradual normalization rather than aggressive abrupt tightening. As a result, we retain our constructive view on Korea's macro outlook in 2010.
December production growth beats expectations again: On the back of rising external demand and the very low base from the same period a year ago, industrial output recovery prevailed into December with growth soaring to +33.9%Y (versus +17.9%Y in November). This again beat our (+26%Y) and consensus (+31%Y) expectations. The full-year 2009 IP growth therefore averaged -0.7%, which was much better than our forecast. On a seasonally adjusted basis, sequential growth also quickened for the second straight month to +3.5%M in December (versus +1.5%M in November). The industry breakdown showed that semiconductors (+109.2% in December) and vehicles (+59%) were again the outperformers while chemicals (+31.1%) and base metals (+36.5%) also picked up on rebounding commodity prices. In line with rising output, the factory utilization rate also rose to 79.9% in December. On the other hand, shipment growth also bounced vigorously to +26.2%Y in December (versus +15.5% in November), marking the strongest pace since February 2000. By purpose of shipments, those for export use (+26.7% versus +17.8%) slightly outpaced those for domestic consumption (+25.8% versus +13.8%), but the gap between export and domestic demand has largely narrowed, supporting our thesis of balanced growth going into 2010.
Capex surprised on the upside and restocking to come: Capex growth came in stronger than expected in December, surging +21%Y, up from +11% in November, in line with the continual revival in business confidence. Meanwhile, December inventory growth recovered substantially to -7.5%Y, a second month's improvement after peaking at -16% in October. Despite the consecutive upturn, Korea's inventory level remains in negative territory and is still lagging production level by a wide margin. Although details for December are not yet available, November's breakdown showed that destocking remained vigorous in sectors such as rubber, computers, electronic components, precision instruments and automobiles. As the weak base effect starts kicking in from 1Q10, we expect inventory YoY growth will likely turn positive in this quarter. The coming restocking phrase will add to GDP growth noticeably starting in 2Q10, in our view.
Service sector recovery also remains intact: Apart from IP, inventory and shipments, other macro data all registered strong YoY rebounds in December. Service sector output growth rose to +5.3%Y (versus +3.5% in November), as all sectors showed acceleration apart from real estate activities and education. Meanwhile, retail sales surged to their highest level in seven years with December real growth at +12.1%Y, up from +9.9% in November. Strong sales of durable goods (+44.4% in December versus +40% in November) was led by big-ticket items, with automobiles (+88.6% versus 108%) again the main driver. Reversing last month's slowdown, semi-durable goods sales (+7.4% versus 0.6%) bounced back in the month, offsetting the slower sales of non-durable goods (0.7% versus 1.9%). We believe that the upcoming consumption recovery will be supported by income growth, stable asset prices, accommodative interest rates and the possibility of more pro-growth policies from the government before the local elections in June.
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Liquidity Liquidation?
January 29, 2010
By Joachim Fels & Manoj Pradhan | Global
Fears unfounded. The sell-off in equities and other risky assets over the past two weeks seems to have been sparked by the People's Bank of China's recent policy moves and fuelled by related fears that central banks around the world will put an end to the global liquidity glut that financial markets have been feasting on. In our view, these fears are exaggerated. The excess liquidity that should matter for financial markets is money in the hands of non-banks (households, firms, investors) rather than the excess reserves that banks have parked on their accounts with central banks. While central banks are likely to start soaking up some of these excess bank reserves during the first half of this year, this is unlikely to result in a withdrawal of the excess liquidity that matters for financial markets. Rather, global excess liquidity should continue to grow this year, though not at last year's pace. We thus re-emphasise one of our five key themes for 2010, namely that the ‘AAA liquidity cycle' (ample, abundant and augmenting) is likely to remain intact.
Confusion reigns. In our discussions with investors, we detect a considerable amount of confusion about the various measures of liquidity, bank reserves and money supply. However, it is important to distinguish between the measures. We invite readers who are familiar with these definitions to skip the next five paragraphs.
For starters, excess reserves are the balances that banks hold on their accounts with the central bank alongside with required (or minimum) reserves. Excess reserves ballooned with the start of the crisis when the interbank money market collapsed and central banks stepped in, providing banks with additional reserves (often also referred to as liquidity) through various lending facilities. Excess reserves increased further when central banks started to buy bonds outright (active QE) and credited the accounts that the sellers (banks) held with them.
In China, excess reserves in the banking system have been swelling as the central bank has been buying large amounts of US dollars (again, from the banks and by crediting banks' accounts with the central bank) in order to preserve the currency peg. The hike in the required reserve ratio (RRR) two weeks ago was aimed at preventing Chinese banks from turning excess reserves into loans to corporates or consumers. In the US and Europe, by contrast, banks have been sitting voluntarily on much of the excess reserves, which act as a liquidity buffer.
In any case, the important thing to note here is that excess reserves (often referred to as excess liquidity in the banking system) are funds which banks hold at the central bank and that are clearly not available to firms, private households or financial markets. So, when the Fed or the ECB are thinking about soaking up some of the excess liquidity in the banking system via, say, reverse repos or offering term deposits at attractive interest rates, this is aimed at draining or neutralising some of these excess reserves, rather than mopping up money in the hands of non-banks.
Next, the monetary base consists of currency in circulation plus banks' (required and excess) reserves. Alternative names used for the monetary base include base money and high-powered money.
By contrast, money supply M1 consists of currency in circulation outside bank vaults plus overnight (or demand) deposits that non-banks hold with banks. Importantly, M1 does not include bank reserves. Thus, the monetary base is not part of M1, though the two include a common component - cash in circulation outside bank vaults. M1 represents the most liquid form of money - it is what private households and firms need to purchase goods, services or assets. Broader money supply measures such as M2, M3 and M4 include, in addition to M1, various other, less liquid bank liabilities such as certain time deposits, money market deposits and savings deposits or, in some cases, even short-dated bank bonds held by non-banks.
To calculate our excess liquidity indicator, we divide money supply M1 by nominal GDP. Thus, if M1 grows by more (or shrinks by less) than nominal GDP, excess liquidity increases. Put simply, excess liquidity is the part of M1 that is not needed to finance transactions in goods and services (which we proxy by nominal GDP), but is instead available for financial transactions such as the purchase of financial assets.
Excess liquidity skyrocketed through 2009... We have updated our excess liquidity indicator for the five largest advanced economies combined, and the four largest EM economies combined, to include 4Q09 (with some data still missing, 4Q is partially estimated). Unsurprisingly, excess liquidity continued to rise as M1 growth outstripped nominal GDP growth, though of course the growth rate of excess liquidity slowed as nominal GDP growth picked up with the end of the recession. Thus, in the course of 2009, global excess liquidity surged to a new record high, lending massive support to global asset markets.
...and should rise further this year. In our view, global excess liquidity as we define it - the ratio of M1 in the hands of non-banks to nominal GDP - should continue to grow this year even though central banks are likely to (i) start withdrawing some of the excess reserves in the banking system during 1H10, and (ii) start nudging official interest rates (including the interest rates paid on bank reserves) higher. This is because excess liquidity is usually augmenting as long as short-term interest rates remain below their neutral levels, which we expect to be the case this year, and in many countries also in 2011. Excess liquidity only declined in periods when central banks had gone a long way in raising interest rates, such as in 2000 and again in 2007-08. Aggressive rate hikes are not on the agenda in our view. Hence, we expect the AAA liquidity cycle to remain intact this year, which should provide ongoing underlying support for most asset markets.
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