Global Economic Outlook and Strategy - Kadin Indonesia

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February 28, 2008 Global Economic Outlook and Strategy Latin America Argentina. The main focus of attention starting in March will be wage negotiations. The government wants wages to increase by 20%, while some unions are demanding about 30%. We believe that the final hike will be closer to the government target, although risks are high. The harvest will likely be flat this year and the summer tourism season was disappointing. In addition to the prospects of energy restrictions, these developments provide some counterbalance to strong demand growth, high commodity prices, and expansionary policies. The January inflation report showed that the government will likely continue to introduce “methodological innovations” in the calculation of the CPI. The focus will be on the discussions between Finance Minister Lousteau and Secretary of Domestic Commerce Moreno regarding these statistical reforms. We have lowered our yearend official inflation forecast to 10% from 11.3% to reflect greater manipulation. We believe that interbank rates will likely increase in March, but a lax monetary policy may result in a slower-than-expected rise. We expect strong fiscal figures during the first quarter due to healthy growth, strong imports, and higher export taxes. Mexico. GDP grew by an annual 3.8% in the fourth quarter of 2007, and 3.3% for the year as a whole. But the first signs of an economic slowdown appeared at the end of last year. We think low growth rates are very likely for the first half of 2008 due to the effect of the U.S. slowdown on export-oriented manufacturing output. However, we estimate that this impact will be partially cushioned by a reasonable expansion in local demand. Our GDP growth forecast for this year remains at 2.9%. Although annual headline inflation in January dropped to 3.7% from 3.8% in December, we expect a rebound in the next few months with readings above 4%, the upper limit of Banxico’s tolerance range. We think Banxico is unlikely to cut interest rates until inflation readings show a definitive downward trend and return to below the 4% threshold, probably in the second half. Our yearend inflation and overnight rate forecasts remain at 3.8% and 6.75%, respectively. We also continue to expect a relatively strong peso in the first half of 2008. However, by the second half, a smaller spread in policy rates between Mexico and the United States, along with a larger current account deficit from lower oil prices, may push the USD/MXN to 11.0. Congressional negotiations on energy reform should be followed closely, as many local analysts expect a bill on this issue to be submitted by President Calderón to Congress in March. Venezuela. Developments this month will be influenced by the aftermath of the U.K. court hearing, where ExxonMobil seeks to uphold a court order to freeze US$12 billion in the state oil company’s (PDVSA) assets pending an outcome on arbitration proceedings. PDVSA will defend its case in that court on February 27, likely arguing that the amount frozen is far above the fair value of ExxonMobil’s expropriated share in the Cerro Negro oilfield (between US$2 billion and US$5 billion by most accounts), and showcasing its willingness to negotiate and compensate appropriately. If the freeze is upheld, it could have important negative cash flow consequences for PDVSA, which has less than 5% of its assets in cash, and would hamper the company’s ability to raise new financing. This ability is, in turn, crucial to the government, which is squeezing the company’s resources to finance fiscal expenditure growth ahead of important regional elections set for November 2008. Meanwhile, macroeconomic imbalances will likely continue to deepen. In particular, inflation of over 24% and scarcity levels of up to 90% in some basic products have triggered social discontent and are meaningfully denting the political capital of President Chávez. However, oil prices near US$100 will allow the country to maintain a comfortable stock of assets and a balance of payments surplus over the near term, sustaining the 34
February 28, 2008 Global Economic Outlook and Strategy country (and PDVSA’s) ability to meet debt service payments comfortably. However, the high dependence on oil sales to the United States means that threats of retaliation in the wake of the ExxonMobil case are unlikely to be carried out. Asia India. We expect growth to moderate from 8.7% in fiscal year 2008 to 8.3% in fiscal year 2009, amid a deteriorating global economic environment coupled with continuing higher domestic interest rates. Growth would have been slower had it not been for positive structural changes and the uptrend in savings and investment. With 2008 being a preelection year, we expect renewed focus on infrastructure, health, education, and agriculture/rural development. In January, the central bank kept all rates unchanged and said that risks to inflation have demanded priority over growth. After keeping domestic fuel prices on hold since it cut them in February 2007, when oil prices were US$58 per barrel, the government raised transport fuel prices by 4%. As this price hike is far lower than what is necessary to meet import costs, the government has increased the quantity of oil bonds, an off-balance sheet fiscal item, to compensate domestic oil companies. If all the off-balance sheet items are included in the budget arithmetic, the headline deficit would rise by roughly 120 basis points. Against this backdrop, we expect the pace of rupee appreciation to be limited to 5% and thus maintain our yearend target of R37/US$. Philippines. Fundamentals remain solid, even as the global economy slows down. Fourth quarter GDP grew by 7.3% year to year. The downside risk from potential export weakness, investor risk aversion, and heightened political risk premia relating to the latest corruption allegations are likely to weaken the upbeat momentum. In late January, shortterm bank rates spiked to the low double-digit range, well above the policy rate of 5%. Special deposit accounts increased as liquidity sought safer outlets. If credit and monetary conditions continue to tighten without a corresponding policy rate response, interest rate volatility could be negative for consumer and business sentiment. A possible stall of infrastructure spending remains the major threat to domestic demand this year. Persistent financial market tightening could also aggravate downside risks. This worst-case scenario could transpire if tax collection efficiency fails to improve the government’s cash flow. The deficit may balloon in the first half of 2008 if the bulk of the PHP200 billion infrastructure program is front-loaded as a fiscal hedge against offshore downside influences. We expect peso appreciation to the 37.50 range against the USD in the second half. Easing inflation risk in the second quarter, a strong peso, and a less robust cyclical environment set the stage for a policy rate cut of another 50 basis points later this year. Singapore. The fairy-tale combination of strong growth and low inflation has come to an end. Fourth-quarter real GDP grew 5.4%, below market expectations of 6%. The government has revised down its 2008 GDP growth forecast range to 4%-6% from 4.5%- 6.5%. Our GDP forecast for 2008 stands at 5.6%, taking into account a manufacturing contraction in the first half. But further downgrades closer to 4% are possible if the U.S. recession proves deeper or longer than we currently foresee. Despite a slowdown in potential growth, we expect inflation to accelerate to 5% from 2.2% in 2007. The combined impact of fuel and food price increases, hikes in electricity tariffs, and a 20% upward revision in imputed rents to public housing (HDB annual values) in January may push inflation through 6% in the first half, before moderating to around 4% in 35
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