JP Morgan - Jan 2015 - Greater China Quarterly Report

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Economic ResearchJPMorgan Chase Bank, Hong Kong

January 22, 2015

www.jpmorganmarkets.com

Greater China Quarterly IssuesChinas new normal

Chinas 4Q14 GDP report confirmed that the economy moderated to 7.1% q/q saarpace of growth, moderating from 8.1% q/q saar in 3Q. For full-year 2014, real GDP

rose 7.4%oya, a touch below the governments growth target of 7.5%, and the

slowest annual growth since 1991. To a large extent, the economys slowing is

expected and desirable, as it is mainly driven by slowing fixed investment growth,

especially in real estate and manufacturing investment, which face oversupplyproblems. Meanwhile, the service sector showed rather stable growth, while

unemployment rate remained under control, with household income surpassing

GDP growth, and income inequality starting to narrow. These are importantfeatures in Chinas new normal phase of growth (or economic rebalancing).

Looking into 2015, we expect Chinas growth to ease further to 7.2%, with theoverall growth pattern may not change much, amid ongoing economic rebalancing.

The positive drivers include stable growth in the service sector, support for the

export sector given the constructive outlook on global demand, and positive impact

of the sharp decline in global oil prices on Chinas current account, householdconsumption and industrial profits. The major drag on growth is the continued

slowdown in real estate investment, along with overcapacity problems in certain

industries. Besides, local government spending capability will likely be constrainedunder the reformed fiscal regime this year as well as slowing land sales revenue.

On macro policy, the focus in 2015 will be prevention of downside risks, includingmacro risk and financial risk. We believe, from the policymakers perspective, the

growth floor in 2015 is 7%. We expect the central government will raise the deficit

target from 2.1% of GDP in 2014 to 2.9% of GDP in 2015. On monetary policy, we

expect one more rate cut (likely in 1Q) and two RRR cuts (with the first cut likelyto be implemented before the Chinese New Year), in combination with other

targeted policy instruments, including SLF, MLF, PSL, etc. With divergence in

monetary policy in the advanced economies (which leads to USD strength), the

decision on CNY exchange rate policy will be a difficult one this year.

Hong Kongs growth momentum has seen notable rebound in 3Q14 afterexperiencing modest sequential contraction for the first time since 2Q11. Private

consumption and net exports were the main drivers behind latest rebounds. Going

into 2015, external demand condition is expected to remain constructive for Hong

Kong. However, Chinas slowdown will likely continue to affect Hong Kongthrough trade, tourism and financial linkages. The risks associated with elevated

debt ratio and expected interest rate hikes are worth attention. In particular, the

more alarming signal may actually come from the corporate side.

Taiwans latest macro indicators, including the December PMI, merchandise trade

report and November IP, generally came in on the soft side, pointing to some near-term softness in export and industrial activities. Further out, the J.P. Morgan view

looks for global growth to turn up moderately from 2Q15 onwards, which would be

generally supportive of Taiwans export and industrial sectors for most part of

2015. Besides, the sharp fall in global oil prices would be a net positive for Taiwan,

given its role as a net oil importer. Our estimate for Taiwans 2014 GDP growthstands at 3.3%oya, with the 2015 growth forecast at 3.7%. With stable growth and

subdued inflation, the central bank will likely keep policy rates on hold in 2015.

Contents

Economic Research Notes

2015 Economic Outlook: China

2015 Economic Outlook: Hong Kong

2015 Economic Outlook: Taiwan

Haibin Zhu(852) [email protected] Chase Bank, Hong Kong

Grace Ng(852) [email protected] Chase Bank, Hong Kong

Lu Jiang(852) [email protected] Chase Bank, Hong Kong


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Economic Research

Greater China Quarterly Issues

January 22, 2015

JPMorgan Chase Bank, Hong Kong

Haibin Zhu (852) 2800-7039

[email protected]

Grace Ng (852) 2800-7002

[email protected]

Lu Jiang (852) 2800-7053

[email protected]

Key economic statistics

Total per

billion capita (US$) 2013 2014E 2015F 2013 2014E 2015F

China 9252 6081 7.7 7.4 7.2 2.6 2.0 1.5

Hong Kong 274 36454 2.9 2.3 2.5 4.3 4.3 3.5

Taiwan 513 21294 2.2 3.3 3.7 0.8 1.2 0.5

US 16768 51689 2.2 2.4 3.2 1.5 1.6 -0.4

Euro Area 13645 32868 -0.4 0.9 1.5 1.4 0.4 -0.4

Japan 4560 46562 1.6 0.2 1.4 0.4 2.8 0.5

2013 2014E 2015F 2013 2014E 2015F 2013 2014E 2015F

China 2.1 3.1 3.6 -2.1 -2.1 -2.9 9.7 8.3 8.1

Hong Kong 1.3 1.0 1.4 1.0 1.5 1.0 0.1 1.4 1.4

Taiwan 10.8 11.2 12.5 -1.4 -1.6 -1.5 2.2 3.3 3.7US -2.4 -2.2 -1.9 -4.1 -2.8 -2.6 2.6 3.6 3.8

Euro Area 2.0 2.4 2.7 -3.0 -2.8 -2.6 -0.7 0.7 1.8

Japan 0.7 0.5 4.8 -8.9 -8.0 -6.5 -0.6 2.1 3.0

2013 2014F 2015F 1Q14 2Q14 3Q14 4Q14F 1Q15F 2Q15F 3Q15F 4Q15F

Real GDP, %-ch over a year ago

China 7.7 7.4 7.2 7.4 7.5 7.3 7.3 7.3 7.2 7.1 7.2

Hong Kong 2.9 2.3 2.5 2.6 1.8 -1.0 -1.5 2.3 2.8 2.0 2.7

Taiwan 2.2 3.3 3.7 3.4 3.9 3.6 2.7 3.4 3.6 3.9 3.9

US 2.2 2.4 3.2 1.9 2.6 2.7 2.5 3.8 3.4 2.8 2.7

Euro Area -0.4 0.9 1.5 1.1 0.8 0.8 0.8 0.9 1.3 1.7 2.1

Japan 1.6 0.2 1.4 2.2 -0.3 -1.2 0.2 -0.7 1.6 2.6 2.0

Real GDP, %-ch over 1 qu arter, saar

China (JPMorgan estimate) 7.7 7.4 7.2 6.4 7.4 8.3 7.2 6.3 7.1 8.0 7.3

Hong Kong 2.9 2.3 2.5 1.2 -0.4 7.0 0.5 2.2 1.8 3.5 3.5

Taiwan 2.2 3.3 3.7 1.2 3.5 2.6 3.6 3.8 4.2 4.0 3.6

US 2.2 2.4 3.2 -2.1 4.6 5.0 2.8 3.0 3.0 2.5 2.5

Euro Area -0.4 0.9 1.5 1.3 0.3 0.6 1.0 1.8 2.0 2.3 2.2

Japan 1.6 0.2 1.4 5.8 -6.7 -1.9 4.0 2.0 2.5 2.0 1.5

Consum er pr ices, %oya, average

China 2.6 2.0 1.5 2.3 2.2 2.0 1.5 1.6 1.3 1.3 1.7

Hong Kong 4.3 4.3 3.5 4.2 3.6 4.8 4.6 4.3 4.4 2.7 2.7

Taiwan 0.8 1.2 0.5 0.8 1.6 1.5 0.8 0.3 0.0 0.3 1.3

US 1.5 1.6 -0.4 1.4 2.1 1.8 1.2 -0.5 -0.8 -0.6 0.2

Euro Area 1.4 0.4 -0.4 0.7 0.6 0.4 0.2 -0.6 -0.5 -0.4 0.1

Japan 0.4 2.8 0.5 1.5 3.6 3.3 2.8 2.1 -0.2 -0.2 0.4

Official interest rates, % p.a., end-periodChina 1-year lending 6.00 5.60 5.35 6.00 6.00 6.00 5.60 5.35 5.35 5.35 5.35

Hong Kong Disc. Window 0.50 0.50 1.25 0.50 0.50 0.50 0.50 0.50 0.75 1.00 1.25

Taiwan Official disc. 1.875 1.875 1.875 1.875 1.875 1.875 1.875 1.875 1.875 1.875 1.875

US Fed funds 0.125 0.125 1.000 0.125 0.125 0.125 0.125 0.125 0.500 0.750 1.000

Euro Area Refi rate 0.25 0.05 0.05 0.25 0.15 0.05 0.05 0.05 0.05 0.05 0.05

Japan O/N call rate 0.05 0.05 0.05 0.05 0.05 0.05 0.05 0.05 0.05 0.05 0.05

Exchange rates, end-period

China USD/CNY 6.05 6.20 6.15 6.22 6.20 6.14 6.20 6.25 6.20 6.18 6.15

Hong Kong USD/HKD 7.75 7.75 7.75 7.76 7.75 7.77 7.75 7.75 7.75 7.75 7.75

Taiwan USD/TWD 29.83 31.62 32.40 30.45 29.87 30.44 31.62 31.80 32.00 32.20 32.40

Euro Area EUR/USD 1.38 1.21 1.15 1.38 1.37 1.26 1.21 1.22 1.20 1.18 1.15

Japan USD/JPY 105.30 119.87 128.00 103.00 101.29 109.67 119.87 120.00 123.00 125.00 128.00

Current account balance

% of GDP

Governm ent balance

% of GDP, end of period

Industr ial prod uct ion

%year-on-year

2013 Nom inal GDP, US Real GDP%year-on-year Consumer pr ices%year-on-year


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JPMorgan Chase Bank, N.A., Hong Kong

Haibin Zhu (852) 2800-7039

[email protected]

Economic Research

Emerging Asia Year Ahead 2015

December 19, 2014

China: The magic "7" Growth to moderate from 7.4% in 2014 to 7.2% in 2015

Priority tasks are stabilizing growth and preventingsystemic financial risks

Drivers of economic growth: high trade surplus, stable

consumption but weak investment

USD/CNY will fluctuate within a range

We expect the economy's pace of growth to decelerate

further to 7.2% in 2015 from 7.4% in 2014. This will be the

lowest growth rate since 1991, but given the much larger size

of the economy, the increase in the absolute level of GDP (in

real term) will still be a record high. In our view, the

economys pattern of growth going into 2015 may not changemuch, amid ongoing economic rebalancing. The positive

drivers include relatively stable growth in the service sector,

as well as the support for the export sector given the

constructive outlook on global demand (though CNY

appreciation in REER terms and relatively weak EM demand

will limit export growth to around 6.5% in 2015). Benefiting

from sharp decline in oil prices and softness in global

commodity prices, Chinas current account surplus will likely

climb to 3.6% of GDP, the highest level since the global

financial crisis. Consumer demand will likely remain roughly

steady. The major drag on economic growth, in our view, is

the continued slowdown in real estate investment growth

(decelerating further from 12%oya in 2014 to about 6%oya in2015), along with persistent overcapacity in parts of the

manufacturing sector.

Taken together, we expect consumption, investment and net

exports to contribute 3.5%-pts, 2.9%-pts and 0.8%-pts,

respectively, to overall GDP growth in 2015. Regarding the

quarterly growth trajectory, we expect GDP growth to

moderate in 4Q14 and 1Q15 to 7.0% q/q, saar and 6.3%

respectively (compared to average 7.9% in 2Q14 and 3Q14) ,

given lingering weakness in domestic demand, before

recovering from 2Q15 onwards as the impact of policy easing

gradually comes through. The GDP growth trajectories for

2Q15, 3Q and 4Q stand at 7.1%q/q, saar, 8.0% and 7.3%respectively. Translated into year-over-year term, the

quarterly growth trajectory in 2015 is 7.3%, 7.1%, 7.1% and

7.2%, respectively.

On macro policy, at the annual Economic Work Conference

held in early December, maintaining stable economic

growth was listed as the top priority for 2015 economic

policy. In our view, this means government policies will focus

on preventing downside risks, including macro risk and

financial risk. We believe, from thepolicymakers

perspective, the growth floor in 2015 is 7%. We expect that

the government will increase the central governments fiscal

deficit target, and shift towards more monetary easing using a

China: economic indicators

Average2008-12 2013 2014e 2015f

Real GDP, % change 9.2 7.7 7.4 7.2

Consumption 3.5 3.8 3.5 3.5

Investment 6.3 4.1 3.0 2.9

Net trade -0.6 -0.3 0.9 0.8

Consumer prices, %oya 3.3 2.6 2.0 1.5

% Dec/Dec 2.9 2.5 1.5 1.8

Government balance, % of GDP -1.7 -2.1 -2.1 -2.9

Merchandise trade balance (US$ bn) 286.3 360.0 495.4 601.5

Exports 1636.4 2220.4 2360.9 2519.6

Imports 1350.0 1860.4 1865.5 1918.2

Current account balance 243.8 189.7 321.2 407.6

% of GDP 4.0 2.1 3.2 3.6

International reserves, (US$ bn) 2748.0 3820.0 3920.0 4145.0

Total external debt, (US$ bn) 556.8 792.6 825.6 870.6

Short term 345.1 622.3 672.3 732.3

Total external debt, % of GDP 8.5 8.3 8.0 7.6

Total external debt, % of exports 26.4 29.0 28.7 28.3

Interest payments, % of exports 2.7 3.2 3.2 2.7

1. Contribution to growth of GDP.

Source: NBS, J.P. Morgan forecast


2

5

8

11

14

17

20

6

8

10

12

14

16

06 07 08 09 10 11 12 13 14 15

% change, both scales

%q/q saar

Chart 1: Real GDP growth

%oya

JPMorganforecast

-4

-2

0

2

4

6

8

10

2008 2009 2010 2011 2012 2013 2014F 2015F

%-pt cont ribution to headline %oya growth

Chart 2: Contribution to headline GDP growth

Total consumptionexpenditure

Gross fixed capitalformation

Net export


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Economic Research

China: The magic "7"

December 19, 2014


Haibin Zhu (852) 2800-7039

[email protected]

mixture of traditional (rate cuts and RRR cuts) and

unconventional monetary instruments. In addition, the

government will introduce measures to stabilize the

downward trend in manufacturing investment and real estate

investment, which have been a major drag for economicgrowth.

Consumption remains a stable componentof growth

Consumption has been a stable source of growth. Retail sales

(in nominal terms) rose at a relatively steady pace around

12%oya through most part of this year (chart 3). Indeed, in

volume terms, retail sales have picked up some momentum

lately, rising at 13.4% 3m/3m saar by November. Overall,

final consumption contributed 48.5% of GDP growth in the

first three quarters of 2014 (improving modestly from 45.9%

during the same period in 2013).

We expect nominal retail sales growth to be relatively

stable at about 11.7% in 2015 (compared to the expected

11.9% growth in 2014). Considering that CPI inflation is

expected to ease to 1.5% in 2015 (from 2.0% in 2014), this

implies a modestly faster pace of retail sales growth in real

terms, with total consumption contributing about 3.5%-pts to

2015 economic growth.

Structurally, the gradual rebalancing of the Chinese economy

is supportive of relatively stable consumption growth, despite

the more notable slowing in fixed investment and the

manufacturing sector. It is interesting to note that the pace of

growth in tertiary industry (mainly service sectors) has been

relatively stable compared to the volatility in secondary

industry (dominated by manufacturing). The output share of

the tertiary industries has risen steadily from 43.2% in 2010 to

46.1% in 2013 (see Chart 4). In the first three quarters of this

year, tertiary industry activity expanded 7.9%oya,

outperforming the 7.4% growth in the secondary industry.

Rebalancing between the service and manufacturing sectors

has notable implications for the labor market. In particular, as

service sectors are generally more labor-intensive, such

structural adjustment in the economy should supportemployment creation and help stabilize the labor market, amid

gradual slowing of the overall economy (chart 5). Indeed,

while Chinas 2014 economic growth (at 7.4%oya in our

forecast) likely will undershoot the governments 7.5% target,

new job creation in the first nine months, at 10.82 million, has

already overshot the governments full-year target of 10

million. As such, during the first three quarters of this year,

nationwide household disposable income per capita rose

8.2%oya in real terms (and 10.5% in nominal terms),

outperforming real GDP growth at 7.4% (and 8.5% in

nominal terms). Such relative stability of labor market

Source: NBS, J.P. Morgan

Source: NBS, CEIC

Source: NBS, CEIC, J.P. Morgan


10

14

18

22

26

08 09 10 11 12 13 14 15

%oya, 3mma

Chart 3: Retail sa les growth

Volume Value

40

42

44

46

48

% share of total GDP, 4qma

Chart 4: GDP by industry

06 08 10 12 14

Secondaryindustry

Tertiaryindustry

0.8

1.0

1.2

1.4

1.6

1.8

9

10

11

12

13

14

04 06 08 10 12 14

million

Chart 5: employment and e conomic growth

million

New job creation

New job creation perunit of GDP growth

-10

0

10

20

30

40

2011 2012 2013 2014 2015

%oya, 3mmaChart 6: FAI growth by industryTotal FAI

Infrastructure

Manufacturing

Real estate


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Economic Research


December 19, 2014


Haibin Zhu (852) 2800-7039

[email protected]

conditions and outperformance of household income will

likely continue to support stable trend in consumption growth

in 2015.

Fixed investment continues slowing

We expect FAI growth will moderate to about 14.5%oya (vs.

forecast of 15.8% growth in 2014). Amongst the three major

components of FAI growth, manufacturing investment, real

estate investment and infrastructure investment, the first two

categories will likely continue to show slower growth in 2015,

while policy support is expected to continue support solid

infrastructure investment (chart 6).

The real estate market slowdown has been the biggest macro

drag in 2014. Looking ahead, we expect real estate market

adjustment will continue in 2015, as oversupply remains in

the near term. Housing prices may decline further but shouldstabilize in 2H15. From peak to bottom, we forecast the price

decline will be in the 5%-10% range at the national level, with

tier-2 and tier-3 cities generally facing greater price falls. Real

estate investment growth is likely to slow further to about 6%

in full-year 2015, from our 11%-12% projection for 2014

(Table 2). Thus, it likely will remain a major drag on

economic growth in 2015, further weighing on land sale

revenues and demand in related sectors, including steel,

cement, and furniture.

Manufacturing investment has slowed steadily in 2014, rising

at a modest pace of 13.5%oya during January-November,

compared to 18.5% growth in 2013. Considering the lingeringovercapacity problems in a number of manufacturing sectors,

and the renewed weakness in industrial profits in recent

months, manufacturing investment will likely remain

sluggish, with our forecast 2015 growth pace at 11.0%oya. On

the other hand, infrastructure investment will likely continue

to be supported by macro policy, which will likely continue to

rise at 21.6%oya in 2015 (compared to the forecast of 22.3%

growth in 2014).

Exports to hold up stable growth pace

The J.P. Morgan global teams baseline scenario for 2015is

that the global economy will step up moderately to slightlyabove-trend growth, led by the developed economies (chart

7). If realized, this will provide a relatively supportive

environment for Chinas export sector. Indeed, it is interesting

to note that net export's contribution to GDP growth picked up

notably this year: net exports contributed 0.8%-pt to overall

GDP growth during the first three quarters, while in

comparison net exports subtracted 0.3%-pt from overall GDP

growth in 2013. For 2015, we expect net exports to remain a

positive factor for growth, contributed 0.8%-pt to GDP

growth (reflecting the combination of steady export growth

and lingering softness in import demand given weakness in

domestic demand and recent collapse in global commodity

prices). Current account surplus will likely increase further

from 3.2% of GDP in 2014 to 3.6% of GDP in 2015 (chart 8).

Meanwhile, it is worth noting that, at the global scale, growth

in the EM world will likely remain sluggish in 2015, hence

constraining certain part of demand growth for China's

exports. Besides, given the weakening of most non-USD

Table 2: Nominal fixed asset investment (Yearly)

%share 2013 2014e 2015f

(2013) %oya %oya %oya

Total 100.0 19.6 15.8 14.5Primary Industry 1.9 32.5 30.0 30.0

Manufacturing 34.1 18.5 13.5 11.0

- Textile and related industry 2.1 22.0 16.0 12.0

- Metal and commodities 10.4 17.8 12.8 8.0

- Machinery & electronic equipment 8.9 17.7 13.5 11.0

- Transportation equipment 2.8 15.3 13.0 11.0

Electricity, gas, and water production 4.6 18.4 16.0 16.5

Real estate 25.4 20.3 11.9 6.6

Infrastructure 17.6 20.8 22.3 21.6

- Transport infrastructure & construction 9.5 15.5 19.5 19.0

- Water conservation, environment manag. 8.1 26.9 25.0 24.0

Healthcare, social security, education, etc 3.8 22.2 23.0 25.0


Source: China customs, J.P. Morgan

Source: SAFE, J.P. Morgan

-30

-20

-10

0

10

20

30

40

50

-16

-12

-8

-4

0

4

8

12

07 08 09 10 11 12 13 14 15

%oya, both scales

Global IPChina's exports

J.P. Morganforecast

Chart 7: Global economic growth and China's merchandise exports

0

2

4

6

8

10

12

% of GDP

Chart 8: China's current account surplus

03 05 07 09 11 13 15

J.P. Morganforecasts


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Economic Research


December 19, 2014


Haibin Zhu (852) 2800-7039

[email protected]

currencies in recent months, in REER terms, the CNY

appreciated notably by 6.8% for the five months ending

November. These factors will likely drag China's export

sector performance in the coming months, with our forecast

for 2015 export growth at 6.5%oya.

Fiscal Policy

The annual Central Economic Work conference continues to

adopt a proactive (expansionary) fiscal policy stance in

2015, which has remained unchanged since 2009. What is

different this time is an additional statement that proactive

fiscal policy should be stronger.

We expect the 2015 fiscal deficit to increase to 2 trillion

yuan (about 2.9% of GDP), compared to the fiscal deficit

target of 1.35 trillion yuan in 2014 (2.1% of GDP, see chart

9). Fiscal measures will likely focus on three areas.

The first area is budget management system reform,

especially for local governments. In 2014, the government

announced guidelines for the fiscal reform, and most fiscal

reforms should be completed by 2016 (China: the first step

in fiscal reform, October 9). Among the various measures

that have been announced, the new rules on local government

debt management are critical. The general principle is to

open the front door for funding local government spending

but close the back door. In particular, under the new

framework local governments can issue local government

bonds to finance public projects (the central government will

control the amount), but they can no longer raise funds viacorporate or financing platform entities.

2015 will be an important year to implement this reform. We

expect the amount of local government bond issuance will be

increased from 400 billion yuan in 2014 to 1 trillion yuan in

2015, which explains the increase in fiscal deficit target. In

1Q15, existing local government debt needs to be re-

classified, and commercial projects (e.g. commercial real

estate) should be sold to the market and the debt should be

converted into corporate debt. We expect the government will

give a grace period of 1-2 years to roll over existing public

projects, before new forms of funding schemes (local

government debt and public-private partnership (PPP)) will

take over. It is also worth noting that the fiscal authority may

introduce a multi-year budget balance system in 2015, using a

rolling-over three year fiscal plan to replace the current fiscal

budget on an annual basis (calendar year).

The second area is tax reform. The highlight is the VAT

reform (replacing business tax with value-added-tax), which

started in 2012 and now covers transportation, postal service

and tele-communication sectors. We expect the VAT reform

will be further expanded in 2015 to cover the whole service

sector (including financial service and real estate service). TheVAT reform, together with possible new structural tax

measures, aim to lower the tax burden in the service sector as

well as small and micro-size enterprises (chart 10). On the

other hand, the government will introduce resource tax and

environment tax, and real estate tax is likely to start the legal

process (which may take years before it will be officially

introduced).

The third area is public-private partnership. In May 2014,

the State Council announced that 80 projects were selected to

encourage social capital participation. In December 2014, the

Ministry of Finance announced 30 public projects as PPP

pilot exercise. PPP is an important initiative to reduce thefinancing burden for local governments and to support private

investment in the long run.

Overall, we interpret the expansionary fiscal policy will be

reflected in an increase in the fiscal deficit target by the

central government. However, whether the proactive fiscal

policy will truly be stronger face a list of uncertain factors,

including the grace period policy for local government debt,

the magnitude of structural tax cuts, and the progress in PPP

implementation.

Source: MOF, CEIC, J.P. Morgan

Source: MOF, CEIC

-15

-10

-5

0

5

2007 2008 2009 2010 2011 2012 2013 2014f 2015

% of GDP

Chart 9: fiscal deficit

Central government fiscal deficit

Augmented fiscal deficit(both central and local governments)

Consumption,7.7

VAT, 25

Business,15.6

Tariffs, 4.8

Enterpriseincome, 22.9

Individualincome, 6.1

Others, 19.2% share of total

Chart 10: Composition of tax revenue (2014ytd)
https://jpmm.com/research/content/GPS-1512354-0https://jpmm.com/research/content/GPS-1512354-0https://jpmm.com/research/content/GPS-1512354-0https://jpmm.com/research/content/GPS-1512354-0https://jpmm.com/research/content/GPS-1512354-0https://jpmm.com/research/content/GPS-1512354-0


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Economic Research


December 19, 2014


Haibin Zhu (852) 2800-7039

[email protected]

Monetary policy

On the monetary policy front, the Central Economic Work

Conference continued to use the phrase prudent, but added

that monetary policy should pay more attention to anappropriate balance between tightening and loosening. In our

interpretation, monetary policy will shift towards further

easing in 2015, but in a contained manner to find the balance

between economic growth and financial stability.

We expect further monetary easing (concentrated in 1H15) in

response to weak domestic demand and low inflation

environment. Chinas CPI inflation has fallen from 2.5%oya

in December 2013 to 1.4%oya in November 2014, and

imported inflation slowdown (due to oil price collapse) adds

further downward pressure in the near term. Our forecasts

look for average CPI at 1.5% and average PPI at -1.5% in

2015. Inflation risk is not a policy concern, instead lowinflation and PPI deflation will become the bigger concern.

We look for at least one more rate cut, likely in 1Q15, as

well as two RRR cuts, of 50bp each, likely in 1Q15 and

2Q15 respectively (chart 11). In addition, there could be an

additional 100bp RRR cut if the regulator will include

interbank deposits in the loan-to-deposit ratio calculation

(which will increase statutory reserves). These policy moves

will likely be accompanied by other targeted quantitative

measures, including pledged supplementary lending (PSL),

standard lending facility (SLF), medium-term lending facility

(MLF) and open market operations.

In the first 10 months of 2014, the PBOC had refrained from

traditional monetary easing (rate cut and RRR cut), and had

adopted a new monetary policy operation framework with the

following features: (i) guide lower market interest rates and

try to establish an interest rate based transmission mechanism

(chart 12); (ii) use targeted quantitative measure (e.g. PSL,

MLF, targeted RRR cuts); (iii) adjust credit components to

improve the efficiency of credit support to the real economy

(via tightening rules on shadow banking activities), while

credit growth continues to slow down (chart 13 and chart 14).

The new operational framework aims to reduce structural

problems associated with traditional monetary instruments

(for instance, the unequal treatment between local government

entities / SOEs and small firms in the credit market) , but its

impact on bank lending rates has been limited.

The unexpected rate cut on November 21, 2014 is a signal of

changes in monetary reaction function. Weak domestic

demand and low inflation are the direct triggers of the rate

cut. On the other hand, the new monetary operational

framework seems to have limited impact to lower the average

bank lending rates to the corporate sector. In addition, lack of

transparency and administrative feature of the new operational

Source: PBOC, J.P. Morgan forecast

Source: PBOC, CEIC

Source: PBOC, J.P. Morgan

Source: PBOC

0

5

10

15

20

25

06 07 08 09 10 11 12 13 14 15

% pa

Chart 11: interest rates and RRR

Requ ired Reserve Ratio

1-year lending rate1-year deposit rate

JPMorganforecast

2

3

4

5

6

7

8

2012 2013 2014 2015

% pa

Chart 12: Lending rates

Weighted averagebank lending rates

3-month Hibor10-year CGB bond yield

7-day repo(weighted avg)

5

10

15

20

25

30

35

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

%oya

Chart 13: Credit growth in China

Total social financing

Bank loans

Shaded: nominalGDP growth

-10000

100020003000400050006000700080009000

10000

Bank loan Entrusted

loan

Trust loan Bank

acceptancebill

Net

CorporateBond

Financing

Non Fin

EnterpriseEquity

Billion yuanChart 14: Aggregate financing by type

Jan-Nov2013 Jan-Nov

2014


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Economic Research


December 19, 2014


Haibin Zhu (852) 2800-7039

[email protected]

framework are also criticized. Entering 2015, we expect the

monetary authority to use a mixture of traditional and

innovative monetary instruments to achieve the priority task

of lowering the corporate funding cost.

CNY to remain relatively stable

From the macro perspective, we believe exchange rate policy

will be one of the most complicated macro policies for China

in 2015. Overall, on the external front, we expect Chinas

current account surplus to widen to 3.6% of GDP in 2015,

with CNY trading in a narrow range. The widening in the

current account surplus will reverse the steady downward

trend since the global financial crisis, reflecting steady export

growth on the back of the expected decent DM growth

trajectory, as well as recent collapse in oil prices (which helps

to reduce Chinas import bills). In particular, considering the

impact of oil price alone, we estimate that every US$10decline in oil prices would to boost Chinas current account

surplus by about 0.3% of GDP.

Meanwhile, a strong USD should be a major challenge for

CNY movements in 2015. Our global forecast calls for a

strong USD against other major currencies, driven by the

divergence of monetary policy between major advanced

economies (the Fed likely will start hiking rates in June 2015,

yet we expect the BOJ and ECB to step up quantitative easing

policies). By extension, most emerging market currencies

may follow the EUR and JPY, falling against the USD, and

the risk of competitive devaluation cannot be ignored. If the

CNY appreciates against the USD, in REER terms, it wouldbe a drag on exports, which is one of the few bright spots in

the current economic outlook.

With the combination of widening current account surplus on

the one hand, and the strengthening USD trend on the other,

we believe the most likely scenario in 2015 is for the CNY to

trade within range (at between 6.10 and 6.30 against the

USD), and stay unchanged at 6.15 at end-2015 (chart 15 and

chart 16).

Economic reform will continue

We expect economic reforms will continue in 2015. Thepriority areas are fiscal reform, financial reform, SOE reform

and household registration reform. In addition, low inflation

environment provides a good opportunity to push forward

resource pricing reform (e.g. water, electricity, natural gas,

transportation). Like in the past, the gradual reform approach

will be adopted to minimize resistance in each step and also to

keep potential risks under control.

Fiscal reformmade encouraging progress in 2014, including

the announcement of fiscal reform plan, the revision of the

Budget Law, further expansion of the VAT exercise and tax

cuts for small and micro-sized firms. The fiscal reform will

continue in 2015, and we expect the three priority issues are:(i) re-classification of local government debt and budget

management system reform for local governments; (ii) further

expansion of the VAT reform to cover the whole service

sector; and (iii) the application of PPP model in supporting

public projects.

Financial reform was further implemented in 2014, including

the increase of deposit rate premium from 10% to 20%, the

widening of daily trading band of the USD/CNY exchange

rate from 1% to 2%, the launch of HK-SH Stock Connect,

the approval of private-owned banks and the approval of three

Free Trade Zones (Tianjin, Guangdong, Fujian) after the

establishment of China (Shanghai) Pilot Free Trade Zone (see

more details in Ten Questions about China, November 28).

Entering 2015, we expect further progress in the following

areas: (i) official introduction of the deposit insurance scheme

and further expansion in the CD market (interest rate

liberalization); (ii) more channels in capital account openness

and lift in existing quotas (e.g. RQFII), and possible inclusion

of A-share in MSCI index; (iii) capital market reform, e.g. the

IPO system and de-listing system in domestic stock market;

and (iv) further promote RMB internationalization, with the

Source: Bloomberg, J.P. Morgan

Source: Bloomberg

110

115

120

125

1306.0

6.3

6.6

6.9

2010 2011 2012 2013 2014 2015

CNY/USD, inverted scale Index, 2000 = 100

CNY/USD spot

REER

Appreciation

Chart 15: CNY/USD spot exchange rate vs . REER

-2.0

-1.0

0.0

1.0

2.0

Jan 12 Jul 12 Feb 13 Aug 13 Mar 14 Sep 14 Apr 15

%

Chart 16: CNY: Spot deviation from mid-point
https://jpmm.com/research/content/GPS-1565699-0https://jpmm.com/research/content/GPS-1565699-0https://jpmm.com/research/content/GPS-1565699-0https://jpmm.com/research/content/GPS-1565699-0


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Economic Research


December 19, 2014


Haibin Zhu (852) 2800-7039

[email protected]

governments efforts to include renminbi in the SDR system

in the twice-a-decade review by the IMF in late 2015.

SOE reformaims to increase the efficiency of the SOE sector.

In addition to the pilot reform exercises for a few centralSOEs, many local governments also announced SOE reform

plan in 2014. The key issues to watch out are: (i) which

sectors can be classified as competitive and hence open the

access to the private sectors; (ii) the implementation of the

mixed ownership structure; and (iii) reform of the

management system of SOEs.

Household registration system reformseems to go ahead of

land reform and the effort to establish a unified social welfare

system. By breaking these reforms into small steps, it could

avoid a possible deadlock scenario. Household registration

reform will be implemented in small and mid-sized cities inthe coming years, by adopting a unified residence system. For

land reform, the near-term focus is to clarify land rights (land

ownership rights, contractual rights and management rights),

which may take several years but is a necessary step to allow

for transfer of management rights (the key to land reform) at

the national level.

Risk factors

Economic reforms will usually come together with significant

near-term risks, and the uncertainty in global economic

environment also adds uncertainty to Chinas economic and

policy outlook. In addition to the above baseline scenario, we

would like to highlight four risk factors in 2015.

The first risk factor is the evolvement in the real estate

market. Throughout 2014, the housing market has seen

decline in house prices (chart 17), housing transactions and

new home starts, and real estate investment has continued to

slow down. Our estimates suggest that real estate investment

slowdown (from 20% growth in 2013 to 11-12% growth in

2014) tends to drag GDP growth by about one percentage

point (including the impact on related industries), and may

further drag GDP growth by 0.6%-pt in 2015 (assuming real

estate investment growth will further slow down to around

6% in 2015).

We expect the government will continue to ease housing

policies in 2015 to slow down the adjustment process, and the

likely options include lower mortgage rates (due to rate cuts),

tax incentives and ease in down-payment requirement for

second mortgage (minimum 60% at the moment). Housing

market adjustment is likely to continue due to the oversupply

problem, but the momentum is likely to soften and house

prices may stabilize in 2H15 due to policy changes.

A big uncertain factor is the commercial real estate sector,

which accounts for about 25% of total real estate investment

and faces similar oversupply problem. The ratio of floor space

under construction to floor space sold has rose significantly in

both residential and commercial real estate sectors since 2010

(chart 18, although the ratios are not fully comparable

between residential and commercial sectors as a large share of

commercial property is for self use rather than for sale). While

residential real estate investment decelerated from 19.4%

growth in 2013 to 10.5%oya, ytd in November 2014,

commercial real estate investment only decelerated modestly

from 30.9% to 22.7% during the same period. In particular,

Source: Soufun, NBS, J.P. Morgan

Source: NBS

Source: NBS

-5

0

5

10

15

20

25

2012 2013 2014 2015

%oya

Chart 17: house price inflation

National (100 cities)

Tier-1 ci ties

Tier-2 cities

Tier-3 cities

5

6

7

8

9

10

2.5

3.0

3.5

4.0

4.5

2007 2008 2009 2010 2011 2012 2013 2014

Floor space under construction divided by floor space sold (both scales)

Chart 18: supply indicator in the real e state market

Residential

Other commercial real estate

Office

0

20

40

60

80

2010 2011 2012 2013 2014 2015

%oya, 3mma

Chart 19: Real estate investment

TotalResidential Office


10/18

10

Economic Research


December 19, 2014


Haibin Zhu (852) 2800-7039

[email protected]

office building investment accelerated again in 2H14

unexpectedly (chart 19). Commercial real estate could be the

source of weakness in the coming years.

The second risk factor is global oil price shock. Global oilprices collapsed in 2H14, which put downward pressure on

Chinas inflation dynamics (chart 20 and chart 21) but

supported the increase in trade surplus. The continuous

softness in global oil prices is overall positive for China, yet

the large uncertainty in oil price dynamics is a major risk

factor for China in 2015.

The third risk factor is CNY policy. The PBOC has

reiterated that CNY is close to equilibrium and USD/CNY

will exhibit two-side volatility going ahead. However, the

continuous strength in USD implies that, if CNY remains

stable against USD, then CNY will appreciate significantly inREER term. This will add pressure on the domestic

manufacturers whose comparative competitiveness has

already deteriorated due to rising production cost and softer

global demand.

Against such a backdrop, it is likely that the PBOC may push

forward the exchange rate regime reform, by shifting from

USD/CNY bilateral exchange rate to a traded-weighted

currency basket (e.g. REER). Such a shift would imply

modest depreciation of CNY against the USD but modest

appreciation in REER term.

The fourth risk factor is the financial risk. Financialimbalances have built up substantially. In 2014, the

government made some encouraging progress, including new

rules on local government financing and tighter rules on

shadow banking activities. Nonetheless, the debt level in the

economy continues to increase. We estimate that total social

debt rose to 220% of GDP as of September 2014 (compared

to 208% of GDP at end-2013, see chart 22). In addition, the

implicit guarantee phenomenon continued to exist, raising

questions on the pricing of risk in the bond market as well as

in shadow banking activities.

Financial-system risks, while elevated, are unlikely to evolve

into a full-scale crisis in the next couple of years. However,complacency by policymakers and investors could be

misplaced. So far the government has attempted to find the

fine balance between containing increases in new risks and

tolerating the rollover of existing debt. This is a challenging

task. Especially when near-term growth concerns increase, it

may trigger shift in policy stance at the cost of financial

stability in the long run.



Source: CEIC, J.P. Morgan

-10

-5

0

5

10

-80

-60

-40

-20

0

20

40

6080

100

2008 2009 2010 2011 2012 2013 2014 2015

%oya, both scales

OPEC basketcrude price

China's PPI

Chart 20: global oil price and China's PP I

-10

-5

0

5

10

15

08 09 10 11 12 13 14 15

%oya

Chart 21: CPI and PPI inflation

CPI

PPI

JPMorganforecast

0

50

100

150

200

250

2007 2008 2009 2010 2011 2012 2013 2014.3Q

% of GDP

Chart 22: Total social debt

Corpo rate debt

Household debt

Government debt


11/18

11


Lu Jiang (852) 2800-7053

[email protected]

Economic Research


December 19, 2014

Hong Kong: higher interestrates and tepid growth External demand condition is expected to remain

constructive for Hong Kong next year

Private consumption is expected to improve only

moderately even with easing inflation pressure

Risks associated with anticipated interest rate hikes are

likely to be contained next year but cannot be neglected

Hong Kongs growth momentum has seen notable rebound in

3Q after experiencing a modest sequential contraction for the

first time since 2Q11. Private consumption and net exports

were the main drivers behind the latest rebounds, contributing

2.0%-pts and 1.6%-pts to the headline GDP growth. However,because of rather soft growth momentum during the first half,

and raising domestic headwinds entering into 4Q, GDP

growth for this year is estimated to slow to 2.3%oya,

compared to 2.9% in 2013.

Going into 2015, external demand condition is expected to

remain constructive.Our global team expects global growth

to perform above-trend, with the US taking the leadership role,

together with a boost to DM demand from oil price decline.

This will provide a favorable backdrop for Hong Kongs

export sector. For the first three quarters of 2014, net exports

for the first time since 2009 contributed positively to real

GDP growth by an average of 0.6%-pts. Although averageexports growth was not particularly stronger than we initially

expected, it was weaker imports growth amid slowing

Chinese domestic demand that leads to the increase in net

trade. This trend is expected to carry into next year as well, as

Chinas economic growth is expected to moderate further,

with domestic demand (and particularly fixed assets

investment) expected to stay on the soft side.

Another channel that Chinas slowdown has been

affecting, and will continue to affect, in Hong Kongs

trade sector is service exports.After a few years of strong

expansions, China's tourist spending in Hong Kong has

slowed down since 2012 (first chart). The pro-democracy

protests that started at end-September were expected to carry

some impact on travel-related spending, though October retail

sales data suggested that the impact on tourist sector hasn't

been as severe as initially anticipated, partly offset by the

launch of new telecom product. However, the tech product or

holiday-driven sales performance will not last for long, and

fundamentals to support retail sales activity remains similar,

particularly as Mainland traveler spending is not likely to

perform on the strong side amid economic slowdown.

On the domestic front, we believe several factors may

work together and set the tone for moderately improving

private consumption.First, the decline in international oil

prices is expected to benefit next year's inflation outlook. The

weight of utility and travel-related components is about 9% of

the CPI basket, hence, a 30% decline in oil prices is estimated

to drive down headline inflation by about 0.9%-pt under the

assumption that the impact is all passed through. This will in

effect benefit households real income growth and hence

private consumption. In reality, we do expect headline

inflation to come down from an estimated 4.3%oya this year

to 3.5% in 2015. However, the moderation is mainly driven

by reduced contribution from food and housing components,

which has already been seen this year. Opposite to the

assumption, we will actually see a pickup in prices of

electricity, gas and water due to the expiration of

government's one-off subsidy from July 2014 and onwards.

This will then contribute about 0.8%-pt to headline CPI

between July 2014 and June-2015 due to the base effect.

Hence, the impact of lower energy prices to inflation will only

Hong Kong: economic indicators

Average2008-12 2013 2014e 2015f

Real GDP, % change 2.5 2.9 2.3 2.5

Consumption 2.8 3.0 1.6 1.8

Investment 1.0 0.9 0.3 0.3

Net trade -1.3 -1.0 0.5 0.5


% Dec/Dec 3.2 4.3 4.3 2.9

Government balance, % of GDP 2.7 1.0 1.5 1.0

Merchandise trade balance (US$bn) 3.0 -26.2 -28.6 -30.0

Exports 393.2 508.6 534.4 581.4

Imports 390.1 534.8 563.0 611.4


% of GDP 7.5 1.3 1.0 1.4

International reserves, (US$ bn) 262.0 311.2 326.2 321.2


Source: C&SD, CEIC

5

10

15

20

25

30

35

40

0

5

10

15

20

25

04 06 08 10 12 14

%oya, both scales

Total r etail sales

Mainland visitor

spending

Hong Kong retail sa les and Mainland tourism spending


12/18

12

Economic Research

Hong Kong: higher interest rates

and tepid growth

December 19, 2014


Lu Jiang (852) 2800-7053

[email protected]

become more notable in 2H15 as its contribution to headline

CPI will probably come down to about 0.3%-pt.

Secondly, our US team expects the Fed to start hiking

interest rates from 2Q15.Hong Kongs private consumptionis expected to be negatively affected by higher interest rates

as suggested by historical experience, though the drag could

be short-term if the external environment remains stable. In

addition, our property sector analyst expects Hong Kongs

secondary price to decline 5 10% for the coming year (refer

to Cusson Leung, Hong Kong property: swimming

upstream, Oct 2014), this will add some constraint to private

consumption expenditure growth as diminished household

wealth will restrain private consumption (first chart). Overall,

raising interest rate and property sector outlook will become

an offsetting factor to the lower energy prices. Hence, we

expect real consumption to grow moderately higher than thisyear, at 2.3%oya in 2015 (vs. an estimated 2.1%oya for 2014).

Another major issue worth highlighting for Hong Kong is

the risk associated with elevated leverage ratio and

expected interest rate hikes. According to BIS data, the

household sector debt to GDP ratio picked up 13.2%-pts from

2007 to reach 64.2% by June 2014. Though not the highest

compared to other EM Asian countries, potential hikes to

interest rates could put some pressure on the household sector,

particularly as residential mortgages account for about 66% of

household debt. It is worth noting that our US team is

currently forecasting a total of 87.5bps Fed fund rate hikes for

next year starting from 2Q15. Our sensitivity analysis showsthat the mortgage to income ratio is to reach between 51.8%

and 57.6% if mortgage rates increase to 3-4%, compared to

the current level at 43.7% with mortgage rate at 2.15% (Hong

Kongs current house price/income ratio is about 13%). Hence

the affordability will deteriorate but not to a severe extent if

the magnitude of interest rate hikes is not drastic.

In this regard, the more alarming signal may actually

come from the corporate side,where debt has increased

92%-pts since 2007 to 224% of GDP. Hong Kongs position

as an international financial center may have contributed to

this seemingly excessive corporate debt accumulation.

However, as its credit extension to Mainland China has beengrowing rapidly over the past few years (banking sectors

non-bank China exposure increased 254% from December

2009 to reach HK$3.9 trillion by June 2014), and it hasnt

been tested by a much higher interest rate environment

accompanied with slower economic growth, potential risks of

this part of exposure cannot be overlooked. However, the risk

on interest coverage ratio is not imminent under the

assumption of a gradual and manageable interest rate hike

environment, and indeed, the ratio for Hong Kong and

Mainland investment grade corporates has improved

moderately during 1H14 after deteriorating over the past four

years (Second chart). According to our credit research analyst,

the challenge for next year is probably more tilted towards a

lack of bond market access with rising interest rates.

Source: C&SD, CEIC

Mortgage affordability - monthly payment/income ratios

Mortgage rates

houseprice/income

ratios2.15% 2.50% 3.00% 4.00% 4.50% 5.00% 5.50%

6 20.2 22.6 23.9 26.6 28.0 29.5 31.0

7 23.5 26.4 27.9 31.0 32.7 34.4 36.1

8 26.9 30.1 31.9 35.5 37.4 39.3 41.3

9 30.3 33.9 35.9 39.9 42.0 44.2 46.4

10 33.6 37.7 39.8 44.3 46.7 49.1 51.6

11 37.0 41.5 43.8 48.8 51.4 54.0 56.7

12 40.4 45.2 47.8 53.2 56.0 58.9 61.9

13 43.7 49.0 51.8 57.6 60.7 63.8 67.1

14 47.1 52.8 55.8 62.1 65.4 68.7 72.2

15 50.4 56.5 59.8 66.5 70.0 73.7 77.4

20 67.3 75.4 79.7 88.7 93.4 98.2 103.2

Note: Assuming 35% down payment, 25-year mortgageSource: CEIC, J.P. Morgan

Source: J.P. Morgan Credit Research

-10

-5

0

5

10

15

-40

-20

0

20

40

60

94 99 04 09 14

%oya, both scales

Property price indexPrivate consumpiton

expenditure

Hong Kong: property price and private consumption

2

4

6

8

10

12

14

16

05 07 09 11 13 15

Ratio

Interest coverage ratio - EBITA/ Interest expense

China InvestmentGrade companies

Hong Kong investmentGrade companies
https://jpmm.com/research/content/GPS-1529140-0https://jpmm.com/research/content/GPS-1529140-0https://jpmm.com/research/content/GPS-1529140-0https://jpmm.com/research/content/GPS-1529140-0https://jpmm.com/research/content/GPS-1529140-0https://jpmm.com/research/content/GPS-1529140-0


13/18

13


Grace Ng (852) 2800-7002

[email protected]

Lu Jiang (852) 2800-7053

[email protected]

Economic Research


December 19, 2014

Taiwan: continues to ride onthe global recovery Taiwans export and manufacturing sectors will

continue to ride the global recovery in 2015

For Taiwan exporters, impact of above-trend growth in

DM world overwhelms the drag of slowing China

Global oil price fall acts as a positive terms-of-trade

shock for Taiwan, supporting domestic demand

Central bank to hold rates steady as inflation eases;

TWD likely to weaken moderately amid USD strength

The Taiwanese economy had been struck by a number of

negative external shocks since early 2011, including the Japan

earthquake and the related shock to the regional supply chain,

the European sovereign debt crisis, and the China slowdown.

By 3Q13, Taiwansexport sector and industrial activity

finally returned to 1Q11 levels, and have since tracked a

steady upward trend (second chart). With manufacturing

activity essentially staying flat during 1Q11-3Q13, overall

GDP growth averaged at an average modest pace of 2.2% q/q

saar, with the major source of growth coming from the

domestic service sectors, including real estate, finance and the

tourism industries. Encouragingly, as the export sector and

industrial activity returned to growth in recent quarters,

manufacturing sector has resumed the leadership role in

growth (first chart, next page), with overall GDP growthstepping up to an average solid pace of 3.7% q/q, saar for the

four quarters ending 3Q14.

At the global scale, our global team anticipates modestly

above trend growth in the global economy through the course

of 2015. Overall, G4 economies should benefit from the

fading of fiscal drags, supportive monetary policy (especially

for the ECB and BOJ), and the healing of credit markets from

earlier crises. In addition, the 40% fall in oil prices since

midyear is a positive supply shock (for the DM world in

particular), which will boost household purchasing power and

hence consumer spending. Overall, our global team estimates

that the fall in oil prices so far would point to a boost to globalgrowth of about 0.4% for 2015. Such a constructive global

backdrop would support some further steady expansion in

Taiwans manufacturing and export sector in 2015.

In addition, from the macro perspective, given Taiwans role

as a net oil importer, the recent significant decline in global

oil prices should be seen as a positive terms-of-trade shock for

the Taiwan economy. In effect, lower commodity prices

would help to ease input costs for the corporate sector, and

similarly lower CPI inflation should boost household real

purchasing power. In all, easing commodity prices would be a

positive factor supportive of Taiwans domestic demand in

the coming quarters. Putting all factors together, our forecast

for Taiwans 2015 real GDP growth stands at 3.7%oya,

Taiwan: economic indicators

Average2008-12 2013 2014e 2015f

Real GDP, % change 3.0 2.2 3.3 3.7Consumption 1.0 1.1 1.8 2.1

Investment -0.2 0.7 0.8 0.9

Net trade 2.3 0.4 0.7 0.7


% Dec/Dec 1.2 0.3 0.9 1.5

Producer prices, %oya 0.9 -2.4 -0.2 -1.2

Government balance, % of GDP -2.5 -1.4 -1.6 -1.5

Merchandise trade balance (US$ bn) 27.0 37.2 42.0 50.3

Exports 267.8 304.6 316.8 332.7

Imports 240.8 267.4 274.8 282.4


% of GDP 9.0 10.8 11.2 12.5

International reserves, (US$ bn) 361.9 415.4 425.4 442.4Total external debt, (US$ bn) 100.3 165.5 191.7 207.8

Short term 79.4 144.8 170.8 186.8

Total external debt, % of GDP 22 28 34 37

Total external debt, % of exports 29 38 45 48

Interest payments, % of exports 0.4 0.4 0.5 0.5


Source: DGBAS, J.P. Morgan forecast

Source: MOEA, MOF, J.P. Morgan

-6

-3

0

3

6

9

12

% change

Taiwan: real GDP growth

2011 2012 2013 2014 2015

%oya %q/q, saar

JP Morganforecasts

90

95

100

105

110

115

Index, 2011=100, sa, 3mma

Industrial production and e xport volume

2011 2012 2013 2014

IP

Customs exports,in vol ume terms


14/18

14

Economic Research

Taiwan: continues to ride on the

global recovery

December 19, 2014


Grace Ng (852) 2800-7002

[email protected]

Lu Jiang (852) 2800-7053

[email protected]

compared against the forecast of 3.3%oya growth for full-year

2014. If realized, this will be the economys fastest annual

growth in four years. Regarding monetary policy, in view of

the decline in global oil prices, we expect Taiwans CPI

inflation to ease further in 2015 to an average subdued pace of

0.6%oya (compared to the forecast of 1.2%oya in 2014).

Taking into account the outlook of stable growth and subdued

inflation, the Taiwan central bank will likely hold policy rates

through the course of 2015.

Constructive outlook on external demand

Latest data suggests that Taiwan has been benefitting from the

steady improvement in the global economy so far this year. In

particular, export orders have continued to register solid pace

of expansion in recent months (up 29.9% 3m/3m saar in

October), led by DM demand (US and Japan in particular)

and in particular the impact of the smart phone productioncycle (tech export orders up 49.0% 3m/3m saar in October,

with tech IP up 27.0% 3m/3m saar).

Looking ahead, the strong momentum in tech exports may

lose some momentum going into early 2015, as hinted by past

patterns of smart phone production cycles. In this regard, it is

worth noting that Taiwans manufacturing PMI eased for the

third consecutive month in November to 51.4 (compared to

the three-year high of 56.1 in August), with the PMI export

orders component similarly easing to 51.4, registering the

lowest level since August 2013.

Further out, Taiwans overall external demand will still likely

be supported by the general constructive outlook on the global

economy through most part of 2015, especially for demand

from the DM world. In particular, US trade data suggests that

imports from Taiwan have broadly tracked overall US imports

since early 2012, with the share of Taiwan imports tracking a

steady 1.7% of total US imports. From this perspective, our

US team expects US imports to rise at a solid 6.0%oya in

2015 (compared to 3.8%oya in 2014), hence hinting at

positive outlook for Taiwans external demand conditions.

Similarly, the outlook for some moderate recovery in the Euro

area would be constructive for Taiwans export sector.

On the other hand, lingering softness in Chinas domestic

demand could remain a concern. Nonetheless, in our view

DM demand impulse in aggregate still dominates Taiwans

external demand (recall that the G-3 accounts for more than

50% of Taiwans total export orders), while a significant

amount of Taiwans merchandise exports to China (shipment

to China accounts for 42% of Taiwans total exports) is

intended for processing and re-export by China, which is in

turn tied to DM demand (see: Taiwan recovers alongside

DM lift despite slowing China, January 17, 2014). It is thus

perhaps not surprising that the growth momentum in Taiwans

manufacturing sector and overall IP stepped up solidly in the

past four quarters, despite the notable slowing in Chinas

domestic demand during this period.

Regarding the cyclical position in Taiwans industrial sector,

Taiwans total manufacturing inventory level, after falling

steadily in the twelve months through May this year, had

turned up moderately in recent months, rising 9.9% 3m/3m

saar in September, led by inventory buildup in the nontech

sector (up 14.1% 3m/3m saar). Nonetheless, considering the

solid gain in shipment, overall inventory to shipment ratio still

stays at modest level, registering at 1.02, sa in September,

which is close to the lowest level since early 2012 (first chart,

next page), suggesting that inventory conditions should not

Source: DGBAS, J.P. Morgan

Source: MOEA, J.P. Morgan


90

95

100

105

110

Index, sa, 1Q2011=100

GDP by industry

2011 2012 2013 2014

Real estate

Accomodation andfood services

Manufacturing

Finance andinsurance

Wholesale andretail trade

90

95

100

105

110

115

120

125

Index, 1Q11=100, adjusted by trade prices, sa, 3mma

Export orders from G -3 and China/ Hong Kong

2011 2012 2013 2014

Export ordersfrom G-3

Export o rdersfrom Chi na/ HK

-20

0

20

40

60

2010 2011 2012 2013 2014 2015

%3m/3m, saar

Taiwan: tech and nontech manufacturing IP

Nontech IPTech IP
https://jpmm.com/research/content/GPS-1299230-0https://jpmm.com/research/content/GPS-1299230-0https://jpmm.com/research/content/GPS-1299230-0https://jpmm.com/research/content/GPS-1299230-0https://jpmm.com/research/content/GPS-1299230-0https://jpmm.com/research/content/GPS-1299230-0https://jpmm.com/research/content/GPS-1299230-0


15/18

15

Economic Research


December 19, 2014


Grace Ng (852) 2800-7002

[email protected]

Lu Jiang (852) 2800-7053

[email protected]

hinder manufacturing expansion going ahead, provided the

constructive external demand conditions are realized.

Global oil price fall as a positive terms-of-trade shock for Taiwan

At the global scale, the 40% decline in oil prices has been an

important event, with significant implications on global

inflation and growth outlook. In the case of Taiwan, the recent

rapid decline in global oil prices should be seen as a positive

terms-of-trade shock for the Taiwan economy. In effect, lower

commodity prices would help to ease input costs for the

corporate sector, and similarly lower CPI inflation should

boost household real purchasing power.

It is interesting to recall that, on a structural basis, the

Taiwanese economys terms of trade had worsened

substantially over the past decade (second chart). In particular,

Taiwans export prices have been tracking a modestly easing

trend (likely reflecting the fact that the countrys export

structure is highly geared to the tech sector where prices have

generally trended down). The general weakening trend in

export prices appears to have constrained Taiwans nominal

labor income growth, with nominal regular labor earnings

rising at a modest 0.7% annual pace over the past decade.

Meanwhile, Taiwans import prices, though much more

volatile, have risen significantly over the past decade,

reflecting the boom in global commodity prices, with notable

impact on domestic inflation. As a result, the average

Taiwanese household had been squeezed by the weakeningtrend in export prices and the general rise in commodity

prices, hence constraining domestic consumer spending.

Such unfavorable trend in Taiwans overall terms of trade

appears to be reversing lately. In particular, average nominal

labor growth had picked up steadily to 2.1%oya, 3mma in

October, compared to the average 1.0%oya growth in 2013.

Meanwhile, CPI inflation has eased notably in recent months

along with the decline in global commodity prices (see next

section). The combination of these factors, which will likely

carry on through 2015, should support some steady

improvement in real household purchasing power and hence

domestic consumer spending. We expect overall consumptionspending to contribute 2.1%-pt to headline GDP growth in

2015, compared to 1.8%-pt in 2014, and the average 1.5%-pt

in the previous five years.

Regarding the capex cycle, as the negative external shocks in

2011-12 gradually faded, Taiwans gross fixed capital

formation has grown steadily in recent quarters, rising

5.0%oya in 2013, and 2.4%oya during 1Q-3Q this year(following the decline of 2.6%oya in 2012 and 1.2%oya in

2011), with particular impressive upturn in machinery and

equipment investment (last chart). Looking ahead, improving





0.9

1.0

1.1

1.2

1.3

95

100

105

110

115

Index, 2011=100, sa

Taiwan: producer inventory and shipment

Ratio

2011 2012 2013 2014

Producer inventory

index Invento ry to shipmentratio

90

100

110

120

130

140

150

160

60

70

80

90

100

110

Index, 2011=100, NTD terms, sa, 3mma

Taiwan: Export, import prices and terms of trade

Index, 2011=100, sa, 3mma

03 05 07 09 11 13

Terms of trade

Export pricesImport prices

-6

-4

-2

0

2

4

6

%oya

Real la bor income and private consumption

07 08 09 10 11 12 13 14

Real privateconsumptionexpenditure

Real total laborincome

4

6

8

10

12

-60

-40

-20

0

20

40

60

%oyaFixed capital formation - machinery and e quipment

% share of GDP, 4qma

04 06 08 10 12 14

Real GFCF - machinery andequipment

% share ofGDP % share of GDP -

histori cal average


16/18

16

Economic Research

Taiwan: continues to ride on the

global recovery

December 19, 2014


Grace Ng (852) 2800-7002

[email protected]

Lu Jiang (852) 2800-7053

[email protected]

global demand, if sustained, combined with lower input costsgiven falling commodity prices, will likely pave the way forfurther steady upturn in the manufacturing sectors capexgrowth going into 2015.

Inflation eases on lower oil prices

Taiwans CPI inflation has been modest through 2014,

averaging 1.2%oya in our forecast. In particular, the easing in

global commodity prices, especially oil prices, has been

feeding through to guide Taiwans CPI inflation lower lately.

With regard to pipeline cost pressure, both wholesale prices

index and input price index (in local currency terms) have

eased notably, down 8.5% 3m/3m saar and 14.3% 3m/3m saar

respectively in November (the most significant pace of

sequential decline since early-2009). As such, Taiwans CPI

inflation will likely continue to ease going ahead. Our forecast

for 2015 CPI inflation stands at a subdued 0.6%oya.

On monetary policy, our baseline scenario looks for the

Taiwan central bank to keep major policy rates on hold in the

December monetary policy meeting. Looking into 2015,

taking account the general outlook of stable growth and

subdued inflation, we believe it is likely that the central bank

will continue to hold policy rates on hold through the course

of the year.

Fed hike, USD strength and Taiwan

On the external accounts, given Taiwans role as a net oil

importer (net oil trade deficit at US$28 billion in 2013), thecurrent account will likely rise further to 12.5% of GDP in

2015, compared to the forecast 11.5% in 2014 (and average

9.9% of GDP in the previous three years). Meanwhile, as our

global team expects the US Fed to begin raising rates in mid-

2015, and with USD strength expected to carry on through

next year, it would likely impact Taiwans external accounts

through capital flows. Broadly speaking, Taiwan has been a

net capital exporter, and is thus less vulnerable than EM

economies that rely heavily on foreign capital inflows to fund

domestic growth. Nonetheless, potential rise in global interest

rates could drive Taiwanese households and life insurance

companies to further diversify their assets overseas, hence

accelerating capital outflow, as was seen in 2005-07.

On the currency front, the sustained strength in the USD

against most other currencies, which will likely carry through

2015, hints at moderate weakening of the TWD bilateral rate

against the USD, considering the Taiwan central banks

general policy to maintain a largely stable trend in the trade-

weighted exchange rate (last chart).


Source: DGBAS, OPEC, J.P. Morgan

Source: CBC

Source: J.P. Morgan

-1

0

1

2

3

4

%oya

Taiwan: headline CPI

2010 2011 2012 2013 2014 2015

JP Morganforecasts

-100

-50

0

50

100

150

-10

-5

0

5

10

15

10 11 12 13 14 15

%3m3/m, saar

Taiwan: WPI and OPEC crude prices

%3m/3m, ar

WPI

OPEC crude

-20

-10

0

10

20

US$ billion

Current account vs. capital and financial account

07 08 09 10 11 12 13 14

Curr ent accountbalance

Capital and financialaccount balance

70

80

90

100

110

120

Index, 2010=100Asian currency re al effective exchange rates (REER)

2010 2011 2012 2013 2014

CNYKRW

TWD

JPY


17/18

Economic Research


January 22, 2015


Haibin Zhu (852) 2800-7039

[email protected]

Grace Ng (852) 2800-7002

[email protected]

Lu Jiang (852) 2800-7053

[email protected]

Disclosures

Analyst Certification: The research analyst(s) denoted by an AC on the cover of this report certifies (or, where multiple researchanalysts are primarily responsible for this report, the research analyst denoted by an AC on the cover or within the document

individually certifies, with respect to each security or issuer that the research analyst covers in this research) that: (1) all of the viewsexpressed in this report accurately reflect his or her personal views about any and all of the subject securities or issuers; and (2) no part ofany of the research analyst's compensation was, is, or will be directly or indirectly related to the specific recommendations or viewsexpressed by the research analyst(s) in this report. For all Korea-based research analysts listed on the front cover, they also certify, as per

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Ltd. is authorized by the Capital Market Authority of the Kingdom of Saudi Arabia (CMA) to carry out dealing as an agent, arranging, advising and


18/18

Economic Research


January 22, 2015


Haibin Zhu (852) 2800-7039

[email protected]

Grace Ng (852) 2800-7002

[email protected]

Lu Jiang (852) 2800-7053

[email protected]

custody, with respect to securities business under licence number 35-07079 and its registered address is at 8th Floor, Al-Faisaliyah Tower, King FahadRoad, P.O. Box 51907, Riyadh 11553, Kingdom of Saudi Arabia. Dubai: JPMorgan Chase Bank, N.A., Dubai Branch is regulated by the Dubai Financial

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