Sovereigns

Asia-Pacific

Emerging Asian Sovereign Pressure Points

Assessing Exposure to a Volatile Global Economy Special Report
Challenging Global Conditions: Fitch Ratings has looked at a number of metrics to gauge the exposure of emerging Asian economies and their sovereign credit-worthiness to a further sharp deterioration in the global economy and/or heightened stress in the financial system. These contingencies do not reflect Fitchs base case scenario.
Figure 1

US PMI and Asian Exports (One Year Lag)

PMI (LHS) (% QoQ) 40 20 0 -20 -40 2005 China Exports (RHS) EM Asia Exc. China Exports (RHS) (% YoY) 50 40 30 20 10 0 -10 -20 -30 2006 2007 2008 2009 2010 2011

Source: CEIC, Fitch

Figure 2

Figure 3

GDP Growth Revisions (Oct 2011)

Asia Africa/MidEast Eastern Europe West Europe/Nrth America (%-pts of GDP growth) 0.6 0.4 0.2 0.0 -0.2 -0.4 -0.6 -0.8 -1.0 2010 Source: Fitch 2011 2012 2013

VIX
(%) 70 60 50 40 30 20 10 0 2005 2006 2007 2008 2008 2009 2010

Source: Bloomberg, Fitch

Related Research Macro-Prudential Risk Monitor (June 2011) Global Economic Outlook (October 2011) Sovereign Data Comparator (September 2011) Korea (November 2011) Thailand Floods (October 2011) Analysts
Philip McNicholas +852 2263 9891 philip.mcnicholas@fitchratings.com Andrew Colquhoun +852 2263 9938 andrew.colquhoun@fitchratings.com

Exposure to Global Slowdown: Thailand combines high exposure to a global slowdown with limited scope for monetary policy response. By contrast, Indonesia combines a track record of resilience to global economic shocks with the most scope for a policy response, based on metrics reviewed in this report. The continental economies of China and India are less exposed to a global growth shock but have less scope for policy stimulus. External Financing Risks: Exposure to a sharp deterioration in global market liquidity as judged by the adjusted liquidity ratio (ALR) appears greatest for Indonesia, Korea and Malaysia, and more limited for China, Taiwan and the Philippines. Emerging Asian exposure to a sudden stop in external financing also appears limited, with only Sri Lanka and India running deficits on their basic balances (current account balance plus net FDI inflows).

www.fitchratings.com

21 November 2011

Sovereigns
Trade and Growth
The threat to the real economy from a potential sharp deterioration in the global economy can be assessed through trade openness and the scale of the deviation seen in 2009 GDP growth compared with the preceding five-year average growth rate. The three countries that experienced the largest shock to growth Malaysia, Mongolia and Thailand are among the most open to trade in the region, while those least open to trade suffered smaller shocks to GDP growth in 2008-2009.
Figure 4 Figure 5

Trade Openness (2010)

Malaysia Vietnam Taiwan Thailand Mongolia Korea Philippines Sri Lanka China India Indonesia 0 Source: Fitch 20 40 60 80 100

2009 GDP Growth Shock

Malaysia Mongolia Thailand Sri Lanka Philippines Korea Taiwan Vietnam Indonesia China India

(CXR and CXP as % of GDP)

2 4 6 8 10 Number of standard deviations from 5-year average GDP growth Source: Fitch

Stimulus Capacity
A governments ability to stimulate the economy and cushion the potential downside risks to growth from the volatile global conditions should be factored in. The current and projected level 1 of real interest rates as well as the difference between a sovereigns general government debtto-GDP ratio and the median of its rating peer group stand as two measures of monetary and fiscal stimulus capacity, respectively. This analysis focuses on the robustness of sovereign credit profiles to potential stimulus measures at current rating levels, rather than in absolute terms.
Figure 6 Figure 7

Debt Divergence (End-2010)

Difference with rating group median If Fitch GGD estimate applied Sri Lanka India Philippines Vietnam Malaysia Taiwan Mongolia Korea Thailand Indonesia China -25 Source: Fitch 0 25 (pps of GDP) 50

Real Interest Rates

2011 2012

Indonesia Taiwan China Philippines Sri Lanka Malaysia India Thailand Korea -2 Source: Fitch -1 0 (% pa) 1 2

Indonesias low public debt-to-GDP ratio suggests that it has scope to implement fiscal stimulus if necessary. Current and projected positive real interest rates allow scope for monetary accommodation. Taiwan also has positive real interest rates and a near-rating median government debt ratio, affording scope for policy accommodation.

Indias real rates calculated using Wholesale Price Index (WPI). Real rates for all other sovereigns calculated using Consumer Price Index (CPI).

Emerging Asian Sovereign Pressure Points November 2011

Sovereigns
Negative real interest rates in Thailand and Korea suggest the scope for monetary stimulus may be limited but in both cases, below median debt-to-GDP ratios afford some fiscal flexibility. India and Sri Lanka may have the most limited capacity for policy stimulus as both have high public debt-to-GDP ratios relative to rating peers and negative real interest rates. Chinas capacity for further stimulus may be more constrained than this analysis suggests amid mounting concerns about the asset quality of the banking system following the credit-led stimulus effort of 2009-2010. Purely fiscal metrics are less of a constraint given the strength of the overall sovereign balance sheet. This is even after taking into account that Chinas government debt ratio is above the rating peer median based on Fitchs estimate of general government indebtedness (including local government debt) of 48% for end-2010.

Commodity Impact
Trade openness does not fully explain the extent of the growth shocks felt in the region in 2009. That shock coincided with a significant decline in global commodity demand, and by extension prices. A downturn in the global economy would likely hit commodity prices with potential consequences for the regions commodity exporters and importers. The charts below show that Indonesia (oil and gas, coal and palm oil), Mongolia (coal, copper, and gold), Vietnam (rice, oil) and Malaysia (oil and palm oil) are the most commodity dependent in EM Asia. While this does suggest significant exposure to fluctuations in global commodity prices, net exposure to commodities should be considered to gauge the potential economic impact.
Figure 8 Figure 9

Commodity Dependence (2010)

Mongolia Indonesi Vietnam Malaysia Taiwan Thailand Sri Lanka India Korea Philippin China 0 Source: Fitch 20 40 60 (% of CXR) 80

Commodity Balance (2010)

Korea India China Taiwan Philippines Sri Lanka Thailand Vietnam Malaysia Indonesia Mongolia -40 Source: Fitch -20 0 20 (% of CXR) 40

Mongolia, Indonesia, Vietnam and Malaysia are the only net commodity exporters in EM Asia where falling commodity prices could drag on economic performance. Conversely, Korea, India, China and Taiwan appear as the most likely beneficiaries from a fall in commodity prices as they are significant net commodity importers.

Liquidity Exposure
Financial market disruption and the impact that may have on the balance of payments can feed through into the real economy and hurt performance. The current account balances (CAB) for EM Asia suggest the region as a whole is well placed to handle a liquidity shock. Some countries run current account deficits but in many of those cases, the CAD is almost entirely offset by net FDI inflows, restoring the basic balance (CAB plus net FDI) to surplus and suggesting the exposure to a sudden stop in external financing is minimal. The only exceptions to this are Sri Lanka and India.

Emerging Asian Sovereign Pressure Points November 2011

Sovereigns
Figure 10 Figure 11

CAB Plus Net FDI (2010)

CAB Net FDI

Liquidity Ratio (2011)

Adjusted for portfolio equity liabilities Liquidity ratio China Mongolia Philippines Taiwan Thailand India Malaysia Korea Indonesia

Sri Lanka India Korea Vietnam Indonesia Philippine Thailand Mongolia Taiwan China Malaysia -10 Source: Fitch 0 (% GDP) 10 20

0 Source: Fitch

200

400

600

800

1000

% (Higher = Greater resilience)

Another measure of the capacity to withstand deterioration in the external environment is the economys liquidity ratio. Given the prevalence of foreign ownership in regional equity markets, 2 Fitch has adjusted this ratio to include portfolio equity capital liabilities . Incorporating this adjustment, the capacity of foreign exchange reserves to handle potential capital outflows in a period of risk aversion is weakest in Indonesia, Korea and Malaysia. Conversely, it would appear strongest in China, Mongolia and the Philippines.

FX Reserves and Currency

Stress applied by capital flow volatility can also be seen in currency performance and the change in foreign exchange (FX) reserves. Data from the period of the global financial crisis (end-2Q08 to 1Q09) shows Sri Lanka (67%) and Mongolia (39%) experienced the greatest depletion of FX reserves and both applied to the IMF for assistance. Korea, India and Indonesia all saw sharp declines in their FX reserves during that time and some of the sharpest currency moves as risk aversion sparked capital flight.
Figure 12 Figure 13

FX Reserves (Q208 to Q109)

Change as % of 2008 GDP % change from end-Q208 Sri Lanka Mongolia Malaysia Korea India Indonesia Vietnam Taiwan Philippines China Thailand -70 -60 -50 -40 -30 -20 -10 (%) Source: Fitch 0 10

Currency Weakness vs USD (Q208 to Q109)

China Vietnam Thailand Sri Lanka Philippines Malaysia Taiwan India Indonesia Mongolia Korea -5 Source: Fitch 0 5 10 15 20 (%) 25 30 35

The decline in Malaysias FX reserves (31% of 2Q08 FX reserves) was equivalent to 17% of GDP, by far the largest in EM Asia. This experience supports their tight liquidity compared to other EM Asian peers indicated by Fitchs ALR. Malaysias ALR at end-2010 was lower than at end-2007, suggesting international liquidity has become tighter than it was during the crisis.

IIP data for Vietnam and Sri Lanka not available

Emerging Asian Sovereign Pressure Points November 2011

Sovereigns
Whos Most Exposed?
Based on previous experience, GDP growth in China, India and Indonesia appears the most resilient to an external shock, while that of Malaysia, Mongolia and Thailand is the least. Scope for policy stimulus appears greatest in Indonesia, but may be constrained in India, Sri Lanka, China and Thailand. Financing flexibility as judged by the ALR appears greatest in China, Taiwan and the Philippines, but is weakest in Indonesia, Korea and Malaysia. EM Asian exposure to a sudden stop in external financing appears limited, with only Sri Lanka and India running current account deficits once net FDI inflows are accounted for. Indonesias position as a net commodity exporter leaves it more exposed to commodity price declines, though favourable inflation and debt ratios suggest the sovereign has scope to stimulate the economy. Tight international liquidity, owing to substantial foreign involvement in domestic capital markets, suggests sovereign credit-worthiness is exposed to capital flow volatility. Malaysias exposure to an external shock, through either trade or finance, appears high. Trade openness and reliance on commodity exports point to risk of a significant impact on GDP growth from a global slowdown. The sovereigns capacity for counter-cyclical fiscal stimulus appears limited. From a financing perspective, despite substantial FX reserves, Malaysias international liquidity appears tight and may be more so than before the global financial crisis. This analysis is a guide to the exposure of emerging Asian economies and sovereign creditworthiness in the event of a sharp deterioration in the global economy and/or heightened financial system stress. These contingencies do not reflect Fitchs base case scenario. The report complements but does not replace existing sovereign credit ratings. Ratings incorporate a broader assessment of structural, macroeconomic, and public finance factors in addition to the external finances.

Emerging Asian Sovereign Pressure Points November 2011

Sovereigns

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEB SITE AT WWW.FITCHRATINGS.COM. PUBLISHED RATINGS, CRITERIA, AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE, AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE CODE OF CONDUCT SECTION OF THIS SITE.
Copyright 2011 by Fitch, Inc., Fitch Ratings Ltd. and its subsidiaries. One State Street Plaza, NY, NY 10004.Telephone: 1-800-753-4824, (212) 908-0500. Fax: (212) 480-4435. Reproduction or retransmission in whole or in part is prohibited except by permission. All rights reserved. In issuing and maintaining its ratings, Fitch relies on factual information it receives from issuers and underwriters and from other sources Fitch believes to be credible. Fitch conducts a reasonable investigation of the factual information relied upon by it in accordance with its ratings methodology, and obtains reasonable verification of that information from independent sources, to the extent such sources are available for a given security or in a given jurisdiction. The manner of Fitchs factual investigation and the scope of the third-party verification it obtains will vary depending on the nature of the rated security and its issuer, the requirements and practices in the jurisdi ction in which the rated security is offered and sold and/or the issuer is located, the availability and nature of relevant public information, access to the management of the issuer and its advisers, the availability of pre-existing third-party verifications such as audit reports, agreed-upon procedures letters, appraisals, actuarial reports, engineering reports, legal opinions and other reports provided by third parties, the availability of independent and competent third-party verification sources with respect to the particular security or in the particular jurisdiction of the issuer, and a variety of other factors. Users of Fitchs ratings should understand that neither an enhanced factual investigation nor any third-party verification can ensure that all of the information Fitch relies on in connection with a rating will be accurate and complete. Ultimately, the issuer and its advisers are responsible for the accuracy of the information they provide to Fitch and to the market in offeri ng documents and other reports. In issuing its ratings Fitch must rely on the work of experts, including independent auditors with respect to financial statements and attorneys with respect to legal and tax matters. Further, ratings are inherently forward-looking and embody assumptions and predictions about future events that by their nature cannot be verified as facts. As a result, despite any verification of current facts, ratings can be affected by future events or conditions that were not anticipated at the time a rating was issued or affirmed. The information in this report is provided as is without any representation or warranty of any kind. A Fitch rating is an opinion as to the creditworthiness of a security. This opinion is based on established criteria and methodologies that Fitch is continuously evaluating and updating. Therefore, ratings are the collective work product of Fitch and no individual, or group of individuals, is solely responsible for a rating. The rating does not address the risk of loss due to risks other than credit risk, unless such risk is specifically mentioned. Fitch is not engaged in the offer or sale of any security. All Fitch reports have shared authorship. Individuals identified in a Fitch report were involved in, but are not solely responsible for, the opinions stated therein. The individuals are named for contact purposes only. A report providing a Fitch rating is neither a prospectus nor a substitute for the information assembled, verified and presented to investors by the issuer and its agents in connection with the sale of the securities. Ratings may be changed or withdrawn at anytime for any reason in the sole discretion of Fitch. Fitch does not provide investment advice of any sort. Ratings are not a recommendation to buy, sell, or hold any security. Ratings do not comment on the adequacy of market price, the suitability of any security for a particular investor, or the tax-exempt nature or taxability of payments made in respect to any security. Fitch receives fees from issuers, insurers, guarantors, other obligors, and underwriters for rating securities. Such fees generally vary from US$1,000 to US$750,000 (or the applicable currency equivalent) per issue. In certain cases, Fitch will rate all or a number of issues issued by a particular issuer, or insured or guaranteed by a particular insurer or guaran tor, for a single annual fee. Such fees are expected to vary from US$10,000 to US$1,500,000 (or the applicable currency equivalent). The assignment, publication, or dissemination of a rating by Fitch shall not constitute a consent by Fitch to use its name as an expert in connection with any registration statement filed under the United States securities laws, the Financial Services and Markets Act of 2000 of Great Britain, or the securities laws of any particular jurisdiction. Due to the relative efficiency of electronic publishing and distribution, Fitch research may be available to electronic subscribers up to three days earlier than to print subscribers.

Emerging Asian Sovereign Pressure Points November 2011