Sticking to Loose Monetary Conditions; Asset Prices Continue to Be Supported
March 29, 2010
By Sharon Lam l Hong Kong|
The Central Bank of China, Taiwan (CBC) concluded its 1Q monetary policy meeting, which turned out to be slightly more dovish than we thought. Liquidity conditions in Taiwan should continue to be abundant, in our view. Inflation expectations could rise and asset prices should be supported.
No change in interest rate: In line with our and consensus expectations, the CBC kept its policy rediscount rate unchanged at an historical low of 1.25%. It cited high unemployment, uncertainty over global growth, the mild recovery in domestic demand and mild inflation as reasons to keep the rate on hold.
No change in the required reserve ratio (RRR): This came as a surprise to us and many others (56% of market participants surveyed by Commercial Times expected an RRR hike). The CBC lowered the RRR in September 2008 immediately after the collapse of Lehman Brothers, and we had believed that they would hike the RRR this year to reverse what they had cut. RRR hikes should not hurt the real economy as Taiwanese banks are still flooded with liquid reserves, so it should not reduce liquidity available to the private sector. Also, raising the RRR could serve as a tightening signal to the public and help to anchor inflation expectations. Therefore, we were quite surprised that the CBC did not hike the RRR, considering rising concerns about a potential asset bubble.
Yet, the CBC will continue to drain liquidity through open market operations: Although there is no change in the interest rate or the RRR yet, the CBC has already started to drain liquidity since 4Q09 through daily open market operations. The outstanding amount of NCDs has been rising since October, meaning that the CBC has been issuing more NCDs to absorb liquidity. Such operations have increased in March, causing the overnight interbank call loan rate to see a more visible pick-up in recent weeks, albeit it is still near zero. In addition, the CBC announced that it would issue longer-maturity NCDs or CDs to drain excess liquidity. NCD issuance is a more costly measure than RRR hikes to drain liquidity, as the CBC pays more interest on NCDs than on required reserves, thus it appears that the CBC is helping to protect banks' interest income.
No new property measures announced today: Not surprisingly, the CBC had considerable coverage about the property market issue in its statement today. The CBC said that property prices are high-flying and loan growth has concentrated in mortgages. However, no new measures were announced, which is again a little surprising to us. The CBC only reiterated its measures taken in the past few months, which included advising banks to tighten mortgage risk control, educating the public about the rising debt burden once interest rate rises, and the reassurance that the central bank's monetary policy will take into account changes in asset prices. All these measures are more along the lines of verbal warnings without strict enforcement, in our view. They probably have helped to cool down property speculation marginally, but we believe that they may not be enough to offset the investment appetite due to loose monetary conditions.
Property markets continue to be supported: Taiwan's liquidity conditions are the strongest in the region, as reflected in its near-zero interbank rates and highest M2/GDP ratio in Asia. Such strong liquidity is being reinforced by the central bank's loose monetary policy. With the CBC being more dovish than expected, we believe that inflation expectations could rise. With ample liquidity, record-low interest rates, rising inflation expectations and no stringent, enforceable policy to combat property speculation, we do not see how property prices can come down. We expect property prices to continue to be well supported, at least, in 2010. We do not think that there is a property bubble in Taiwan yet, as the whole economy's housing affordability still appears reasonable to us. However, we see some overheating in certain areas in Taipei that probably requires closer monitoring. We agree that interest rates will not be an effective tool to cool property speculation, which is concentrated in some areas, but more administrative measures are probably needed. Managing the housing boom will become more difficult down the road, in our view. Yet, at least in the near term, the wealth effect should sustain the consumption recovery this year.
Updating our interest rate forecasts: Although there is no official exit strategy from the CBC meeting (excluding the daily open market operations), we still expect to see mild and gradual normalization of monetary policy over this year. We expect the CBC to raise rates at its 2Q meeting, i.e., end of June, by a mild 12.5bp. This is because the CBC holds quarterly monetary policy meetings, and if it does not hike in 2Q, then it will have to wait until 3Q, i.e., end of September, at which time the CBC may fall behind the curve as we expect most central banks in the region to begin rate hikes in 2Q. We now change our interest rate forecast to a total 50bp hike in 2010 to bring the rediscount rate from 1.25% to 1.75% by year-end. It will take a long time for Taiwan's interest rate to go back to neutral levels. Meanwhile, RRR hikes are still likely in the rest of the year.
We continue to advocate normalization in interest rates because first of all the current interest rate level is not in line with economic development, as GDP growth is expected to be above trend this year and CPI growth is coming out from deflation last year to inflation this year. Interest rates should not be kept at a historical low level for too long when demand and prices are recovering. Most importantly, there could be negative consequences from prolonged low interest rates. An asset bubble is one obvious risk, but not normalizing the interest rate also limits the room for rate cuts in the future when the economy slows again, thus reducing the impact of future stimulus when needed. We agree that Taiwan does not need aggressive tightening, but we think that rate normalization is still needed and should start earlier rather than later.
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Can Mr. Productivity Fight the ‘Silver Tsunami'?
March 29, 2010
By Deyi Tan, Chetan Ahya & Shweta Singh l Singapore|
Watch Out for the Oncoming ‘Silver Tsunami'
The global recession has hastened a sharpening of the growth strategy in Singapore. No longer is the focus one of a steely resolve to help companies manage their bottom lines via cost competitiveness. Instead, the focus is increasingly to help companies expand their top lines through the development of next-generation products (see ASEAN MacroScope: Macro Rebalancing Singapore-Style, July 30, 2009) catering to new growth areas. To be sure, the emphasis on higher value-added is not new. Yet, with the announcement of the 2010 Budget - where productivity, the stepping stone to higher value-added, is the new key buzzword - this focus has just gotten sharper.
External circumstances - what looks like slower external demand from the developed world - have prompted this sharpening of the growth strategy. However, domestic conditions equally call for this shift as well. The Singapore economy is ageing and the pace of population greying will take on a new meaning in the coming decades (see factbox below for more details). Indeed, the dependency ratio (ratio of dependents to working-age population) has reached a historical low of 34.7% in 2010 amid a growing population base, implying that the economy is now in its final phase of reaping the ‘demographic dividend'. The current total fertility rate (TFR) has sunk as low as Japan's 1.27. This has been below the replacement rate of 2.1 since 1975. Ironically, the stark decline in TFR post 1950s and the sub-replacement fertility rate had helped to engineer an improvement in the dependency ratio via lower child dependency. Yet, the flip-side should soon rear its ugly head as the current working population grows old without replacement, leading to rising old-age dependency, arguably the more inferior sort of dependency.
Ageing Will Have Implications for Growth
Unlike Japan, where the immigration policy had been less liberal, Singapore's policy of attracting foreign talent had likely enhanced the ‘demographic dividend' at a time when the benign domestic demography was itself playing out. Also, a ‘second demographic dividend' - in which high savings of the working age population anticipating retirement also provided the liquidity for capital accumulation - acted as a tailwind to the ‘first demographic dividend'. Labour, capital and productivity are the three growth inputs. Indeed, we estimate that just the sheer expansion of labour inputs from favourable demography alone has likely contributed an average of ~2pp to Singapore's potential growth in 2004-09.
With population ageing, raising the childbirth rate is the only real long-term solution. However, with the fertility rate so low, fiscal measures - such as the ‘Baby Bonus scheme' where couples can get up to S$10,000-18,000 in incentives for each child - even if successful, will probably take at least a generation to bear fruit. The progressive raising of the retirement age to 62 and further extension down the road should help to retard the effects of population ageing somewhat, as should ongoing measures to increase the employability of older workers - but these are still unable to reverse the ageing trend. Aggressive immigration policies provide a quick fix. However, this will need to be delicately managed, given the economic, social and political considerations. Policymakers will need to take a calculated call on how dependent the economy wants to be on foreign labour, to sustain high growth. Indeed, the implementation of higher foreign workers' levies suggest that some social/political concerns may be emerging and foreign labour influx may taper off somewhat.
In a scenario where the growth of working-age population could more than halve to around 1.5-2.0%Y in the next five years (according to UN estimates) from an average of around 4.0-4.5% in 2004-09, we think the potential growth contribution from labour inputs alone is likely to be reduced by more than 1pp in the next five years from ~2pp in 2004-09. This is not taking into account the potential impact that population greying may have on capital accumulation. Absent the measures to increase labour inputs, the panacea to sustaining potential growth would be for this growth gap to be filled by total factor productivity (TFP) gains. Yet, we think it may be difficult to fully close this gap so quickly. Total factor productivity gains, which have averaged at about 1.5 in 2004-09, will need to double. In this regard, we think deteriorating demographics likely point to a structurally lower potential growth trend ahead until productivity catches up to close the gap.
What's the Problem with Growing Older and Slower?
In our view, slower growth per se is not really the issue. It is part and parcel of an evolution from an emerging to a mature economy. Yet, if growth is a means to an end, the worry about lower growth from deteriorating demographics is whether the greying population has already accumulated enough wealth/savings to retire.
As seen in the high current account surpluses, the good thing is that Singapore is a big net saver. The mandatory pension fund (Central Provident Fund, CPF) contribution (household savings) and prudent fiscal stance (public savings) have helped. With CPF being a defined-contribution system which goes towards financing one's own retirement nest-egg, policymakers have also avoided the fiscal squeeze that comes from a defined benefit and/or a pay-as-you-go scheme when the old age dependency ratio turns significantly higher. Fiscal prudence also means that policymakers can continue to unlock past fiscal savings in the provision of subsidized services as the population greys.
Having said that, however, there will be pockets of the population that fall outside the adequacy threshold in their retirement phase. It is in this aspect where better economic growth will help by availing employment opportunities to the elderly or to their providers - at the same time, maintaining a tax revenue stream to policymakers who may then be able to serve as a ‘provider of last resort'. This would be why policymakers are now turning to the productivity front to arrest the impact on growth from the oncoming ‘silver tsunami'.
Factbox: Demographic Trends in Singapore
• Total fertility rate: At 1.27, Singapore's total fertility rate (TFR) is one of the lowest in Asia and similar to Japan's. Only Hong Kong (1.02) and Korea have lower TFR (1.22). The pace of decline in TRP has also been one of the starkest in Asia from 6.4 in 1950 to 1.27 in 2010. Singapore's TFR has been below the replacement rate of 2.1 since 1975.
• Dependency ratio: The steep fall in TFR in this period (fewer babies) is why the dependency ratio (ratio of young and old dependents versus the working age population aged 15-64) has fallen dramatically from 86.3% in 1965 to a historical low of 34.7% in 2010. This is the second-lowest in Asia after Hong Kong (32.3%).
Unless policy measures turn things around significantly, this current ‘demographic dividend' will ultimately give way to a rise in dependency ratio as the current group of working population ages without corresponding replacement. Based on UN estimates, assuming constant TFR, the dependency ratio will rise quickly from current historical lows to 77.8% by 2040. Again, this will be one of the fastest rises in the region.
• Median age: The median age in Singapore stands at 40.6 years. This is somewhat in the same range as other industrialized economies in Asia (Hong Kong: 41.9; Korea: 37.9; Japan: 44.7) and the Western developed world (US: 36.6; Germany: 44.3). On the other hand, emerging economies in Asia typically have younger populations (e.g., India: 25.0; Indonesia: 28.2; Malaysia: 26.3). Based on the UN population database, the median age is expected to go up to 48.9 by 2030. This will be the second-highest in the region after Japan and on par with Hong Kong.
• Liberal immigration policies: Apart from domestic factors, liberal immigration policies have likely also augmented the working-age population and delayed the rise in dependency ratio. Indeed, growth of non-residents and permanent residents has been outpacing growth of Singapore citizens. Non-residents' population share has risen from 5.5% in 1980 to 25.1% in 2009. Similarly, permanent residents' population share has risen from 3.6% to 10.7% in the same period.
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SARB Cuts 50bp
March 29, 2010
By Michael Kafe, CFA l Johannesburg|
Improved Inflation Outlook Ushers in 50bp Rate Cut
The South African Reserve Bank (SARB) cut its policy repo rate by 50bp to 6.50%. This was contrary to consensus expectations but was not entirely surprising to us (see South Africa: Policy Rates to Fall Further? February 25, 2010). In our opinion, this was the right thing to do, given the consistent downside surprises in inflation, and the fact that even the most conservative assumptions on food and energy prices still pointed towards an acceptable inflation outcome. Whereas the SARB had previously desisted from cutting rates because inflation was uncomfortably close to the upper end of the target band, we have argued that recent developments such as the sustained collapse in grain futures prices, the lower-than- expected electricity tariff increases and a significant undershoot in recent inflation readings have combined to limit the top-side in the CPI trajectory to roughly 5%Y over the forecast horizon - i.e., a level that is low enough to tolerate another rate cut without risk of jeopardising the inflation outcome. The MPC statement confirmed that the policy outcome was motivated by lower electricity tariffs at the municipality level, "favourable food price developments as well as lower-than-expected inflation outcomes".
Easier Money Unlikely to Stoke Inflation Risks
For us, the real difficulty in making the call was not so much about inflation per se, as we expected inflation to be well-behaved. It was more about whether the SARB would feel comfortable enough that it could engineer further monetary laxity to support the country's fragile economic recovery, without stoking inflation pressures. As we had pointed out in that piece, "the SARB's own modeling suggests that each 100bp cut in policy rates stimulates inflation by no more than 0.4pp over the policy horizon. A 50bp cut in an environment of weak pricing power appears tolerable to us". We therefore welcome the SARB's admission that "the improved inflation environment has provided some space for an additional monetary stimulus to reinforce the sustainability of the upswing without jeopardising the achievement of the inflation target".
Further Downside Inflation Surprises Likely
The SARB expects inflation to reach a low point of 4.9%Y only in 3Q10. While we also have a 3Q10 average forecast of 4.9%Y, we see a dip to 4.8%Y as early as next month (see South Africa: Insurance Costs Prop Up February CPI, March 24, 2010). Also, we find it surprising that the SARB still expects inflation to average 5.4% in 2011 - relatively unchanged from its earlier estimate in January. This may be explained by its still-conservative assumptions on electricity tariff increases of 20% over the next two years, as well as some moderate increases in its oil price assumptions. Our analysis suggests that the tariff increases could be lower than the SARB expects. First, the electricity regulator has made it clear that 70% of all municipalities would not be allowed to pass on electricity tariff increases of more than 15-16% over the coming three years. Second, the introduction of an inclining block tariff structure this year implies that, although the weighted average tariff increase at the municipality level will be in the mid-to-upper teens, it is the simple average tariff increase - which could be as low as 10-12% - that will be captured by the statistical authorities for CPI purposes. We therefore believe that there could be further downside inflation surprises in store for the SARB.
When You See Good Profit, Take It!
Even so, as a matter of discipline, our strategists recommend that investors unwind at present levels of 7.10% the trade to receive 2Y swaps at 7.37% with a 7.15% target ahead of today's MPC meeting (see South Africa Rates - Unwind ZAR 2y Receiver, March 25, 2010). Also, investors who went long bonds ahead of the February 17, 2010 Budget with a target of 8.50% (10-year paper) in mind may consider fading out that position too. At 8.60%, the R204 has already rallied 40bp.
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