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ISSN 1474-5615

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South East Asia Vol 1

Vol 24 Issue 3 March 2013 Business Monitor Internationals monthly regional report on political risk and macroeconomic prospects

Asia Monitor

THAILAND

This months top stories

Infrastructure Spending Widening Budget Deficit

BMI View: Prime Minister Yingluck Shinawatras recently announced infrastructure spending programme could prove beneficial for the long-term growth of Thailands economy and construction sector. However, we see increasing risk (in terms of cost overruns and higher borrowing costs) that the undertaking of large-scale infrastructure projects will undermine efforts to address the countrys deteriorating fiscal position.
Uncertainty over the global economic outlook over the coming years is placing increasing pressure on Thai policymakers to review their long-term growth plan. Thailand's economy, which has relied heavily on exports to drive growth in the past, has already begun to rebalance towards domestic demand. We expect increased fiscal spending on infrastructure projects to play a crucial role in attracting foreign direct investment and supporting economic growth over the next decade. This view has started to play out with the unveiling of the government latest spending programme. Ramping Up Infrastructure Spending In mid-January, Prime Minister Yingluck Shinawatra unveiled an ambitious plan worth THB2.2trn (US$72bn or 19.0% of GDP) to increase public spending on several large-scale infrastructure projects from 2013 to 2020. The new spending programme, which will be entirely financed by debt issuance, will be submitted to the cabinet for approval. It is widely expected that the planwill be passed and implementation of the projects is likely to commence in H213. An estimated 78% of the total

Cambodia: Positioned To Benefit From Chinas Shift

BMI View: Cambodia stands to benefit handsomely from Chinas economic rebalancing as manufacturing companies look to the country in response to rising wage rates on the mainland. Despite Chinas much stronger logistics capabilities, infrastructure networks and labour productivity, improvements in these areas, as well as in political and regulatory stability in Cambodia have combined to make significant wage cost advantages easier for corporations to reap.
page 6

Laos: Labour Woes A Key Impediment To Textiles

BMI View: Chronic labour shortages continue to plague Laoss garment sector. Businesses have also been reluctant to make investments to raise productivity standards owing to high labour turnover rates. Coupled with poor transport infrastructure, these factors threaten to stymie growth in the garment industry.
page 7

Temporary Pickup In Asia Food CPI To Ease In H213

BMI View: After more than a year offoodprice disinflationinAsia, we believe food inflation in the region could re-accelerate in the first half of 2013 owing to continued high grains and livestock prices and a temporary China-led regional economic upswing.
page 8

...continued on page 2

VIETNAM

Inflation Uptick Not A Major Concern

BMI View: Despite the recent uptick in headline consumer price inflation, we continue to expect a benign outlook for inflation this year. We expect food price pressure to ease in H213, suggesting that inflationary pressure should, on the whole, remain benign over the coming quarters.
The latest figures published by the State Bank of Vietnam (SBV), which showed headline consumer price inflation (CPI) accelerating from 6.8% year-on-year (y-o-y) in December to 7.1% in January, have fuelled concerns that inflationary pressures could intensify over the coming months. Indeed, international organisations including the World Bank
...continued on page 4

Regional Indicators
2011 South East Asia Indicators Nominal GDP, US$bn Population, mn GDP per capita, US$ Real GDP growth, % Inflation, % Goods Exports, US$ Goods Imports, US$ 2091.2 549.1 3808.4 4.7 5.4 1234.6 1079.1 2225.8 555.3 4008.1 4.9 4.2 1274.2 1165.7 2428.8 561.5 4325.6 5.1 3.8 1374.1 1270.8 2691.5 567.6 4741.8 5.3 3.9 1497.0 1390.5 2012e 2013f 2014f

Notes: e = BMI estimates; f = BMI forecasts. South East Asia = Bangladesh, India, Pakistan, Sri Lanka. Weighted by nominal GDP. Source: BMI.

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XXXXXX THAILAND RISK SUMMARY

POLITICAL RISK
...continued from top of front page

Tight Race For Bangkok

Democrat Party candidate Sukhumbhand Paribatra, who is seeking his second term as city governor of Bangkok, is facing a difficult battle. Latest polls suggest that Puea Thai Party (PTP) candidate Pongsapat Pongcharoen is leading, with 43.1% of respondents saying that they will vote for him, compared with 33.1% for Sukhumbhand Paribatra. Given that Bangkok has traditionally been a stronghold of the Democrat Party, the PTP's lead in the latest polls has come as a surprise to political observers in Thailand. We expect a tight race at the March elections.
Our short-term political rating stands at 65.4.

cost of the programme (around THB1.9trn) will be allocated towards upgrading the country's inter- and intra-city transport system.
Capital Expenditure Set To Pick Up
Thailand Share Of Fiscal Expenditure (2012), %
Others, 10.3% General Public Service, 17.4%

Health & Education, 29.9%

Defence & Public Order, 12.3%

between 2013 and 2020 we caution against the risk of undertaking such an aggressive spending programme given Thailand's deteriorating fiscal position. First, it could complicate the government's agenda to stem the country's deteriorating fiscal position (we expect Thailand's budget deficit to widen from an estimated 3.0% of GDP in 2012 to 3.2% in 2013). Should the government continue to allow its fiscal position to deteriorate, it could eventually result in a loss of investor confidence in the country's debt markets, leading to higher borrowing costs over the long term.
Rising Indebtedness
Thailand Domestic Public Debt, THBbn (LHS) & % Of GDP (RHS)
4,000 34 3,500 32 30 28 26 2,000 24 1,500 1,000
Jul-03 Jul-04 Jul-05 Jul-06 Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jul-12 Jan-13

Housing & Community, 9.8%

Source: BMI, Bank of Thailand.

Economic Affairs, 20.4%

ECONOMIC RISK

BoT Signals Possible Intervention

The Bank of Thailand (BoT) said that policymakers are monitoring the exchange rate closely and are prepared to intervene if the country's currency continues to appreciate sharply. The Thai baht is experiencing a significant increase in volatility owing to foreign capital flows, according to the central bank. The BoT did not intervene as foreign direct investment inflows and outflows were relatively balanced in 2012 but policymakers are taking precautionary measures to curb further appreciation in the currency.
Our short-term economic rating stands at 75.2.

Details released by the government include plans to increase the existing rail network surrounding Bangkok by nearly 400km, construct four new high-speed railway lines, expand Bangkok's metro railway system by six new linesand built around 250km of new ring roads around Bangkok. These projects are expected to reduce logistic costs in Thailand by as much as 13% and are part of a broader National Development Strategic Plan aimed at lifting Thailand's economic growth by 1.5 percentage points annually over the next decade.
Rail Dominant
Thailand Infrastructure Investment Plan 2013-2020, THBbn
Air Transport, 0.862 Custom Facilities, 12.1 Water Transport, 30.3 Road Transport, 271

3,000 2,500

22 20

Total Debt, THBbn

% of GDP

Source: BMI, Bank of Thailand

BUSINESS ENVIRONMENT

Tourist Arrivals Hit Record

The tourism sector in Thailand is in the midst of a robust recovery with tourist arrivals to the country reaching a record high in 2012. Visitors from China contributed significantly to the increase, a year after devastating floods and political turmoil severely affected the tourism industry. Thailand was a host to an estimated 21mn tourists in 2012, the highest on record and a 15% y-o-y rise from 2011, according to the Tourism Authority of Thailand. A total of 25mn tourists are expected to visit the country in 2013, generating over US$38bn in revenue for Thailand.
Our business environment rating stands at 61.7
Rail Transport, 1560
Source: BMI, Transport ministry, Bangkok Post [January 2013]

Second, there is a strong likelihood that the implementation of these large-scale infrastructure projects could encounter delays, resulting in massive cost overruns that are detrimental to the government's fiscal health. Not only are there growing indications that Thailand does not have sufficient workers and construction materials to complete its growing pipeline of construction projects (see our online service, November 7 2012, 'Construction Sector: Firmly In Recovery'), but we also believe that preconstruction activities such as land acquisition, design and environmental studies are still in a state of flux due to numerous changes in the country's railway plans. Seeking Expedience The government is currently initiating several measures to ensure that the infrastructure programme is implemented successfully. Firstly, the government has set aside an additional THB233.3bn from its annual budget and potentially THB106bn worth of financing from public-private partnerships to support the infrastructure program. Secondly, the government has also expanded the role of the OTP, from formulating plans and policies to direct supervision of projects to speed up the implementation of the programme. However, it remains to be seen if these policies will be implemented effectively.

Spending To Create Growth Opportunities We expect the infrastructure spending programme to provide growth opportunities not only to domestic companies but also to foreign companies. Thai companies have limited experience in building and operating high-speed railway lines, thus they would most likely need to form partnerships with foreign companies that have such expertise to bid for the projects. Although we acknowledge that these infrastructure projects will help boost the growth potential in Thailand's construction sector we currently forecast Thailand's construction real growth to average 3.3% per annum

SOUTH EAST ASIA 1 MARCH 2013

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THAILAND
ECONOMIC OUTLOOK

China Recovery To Boost Exports; Momentum To Wane

BMI View: In line with our long-held view that prevailing global headwinds would depress external demand in 2012, trade and manufacturing data released by the Bank of Thailand (BoT) continu to reflect a lacklustre recovery in exports in Q412. As for 2013, we see the case for a more forceful recovery in external demand led by an improved macroeconomic outlook on the Chinese economy in H113.
Largely Base Effects
Thailand Manufacturing Exports & Select Components, % chg m-o-m 3mma
40 30 20 10 0 -10 -20
Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Oct-12

to see a pickup in economic activity in the region over the coming months and we believe that this will result in a spillover in demand for Thai exports. We believe that bullish sentiment towards Thailand's economic outlook could also provide a boost to private sector investment over the coming months.
A Mixed Picture
Thailand Manufacturing Production Index S.A (LHS), % chg y-oy & % chg m-o-m (RHS)
220 200 180 160 140 120 100
Oct-09 Oct-10 Oct-11 Jan-09 Jan-10 Jan-11 Jan-12 Oct-12 Jul-09 Jul-10 Jul-11 Jul-12 Jan-13 Apr-09 Apr-10 Apr-11 Apr-12

100 80 60 40 20 0 -20 -40 -60

Manufacturing Processed Agricultural Products Electronics Automotive

Source: BMI, Bank of Thailand

Trade and manufacturing data released by the Bank of Thailand (BoT) continue to reflect a lacklustre recovery across Thailand's main export segments in Q412 (including
DATA & FORECASTS
BMI View: Figures published by the Bank of Thailand show that headline consumer price inflation fell from 3.3% y-o-y in October to 2.7% y-o-y in November, in line with our view that subdued

automobiles, processed agricultural products and electronics). Furthermore, looking at the nominal value of exports across all the three categories of manufactured goods mentioned above, we have yet to see exports surpassing pre-flood levels seen in mid-2011. This is in closely in line with our long-held view that prevailing global headwinds would depress external demand in 2012. In terms of our outlook for Thailand's export sector in 2013, we see the case for a more forceful recovery in external demand led by an improved macroeconomic outlook for the Chinese economy in H113. Although we estimated that China made up only 11.6% of Thailand's total trade exports in 2012, we highlight the impact of China's indirect trade linkages with Thailand through re-exports from South East Asian countries. We expect

Manufacturing Production Index S.A (2000 = 100) % chg y-o-y % chg m-o-m

Source: BMI, Bank of Thailand

Our view remains that the structural economic imbalances in China will begin to resurface in H213, and we expect this to drag on Thailand's export sector. Overall, we are maintaining a cautious stance on Thailand's economic outlook for 2013, and we continue to see real GDP growth coming in at a subdued 4.4% with the risks slightly weighted towards the upside.

economic growth in Thailand would keep inflationary pressure in check throughout 2012. Producer price inflation, which we see as a leading indicator for consumer prices, also came in at a
2011 2012e 68.9 365.31 5,304 4.3 4.5 2,192.3 2,529.9 -3.0 3.3 7.8 30.58 221.0 235.5 14.4 8.0 2.2 175.4 7.7 105,848.5 29.0 3.0 2.7 29.82 21.0 19.6 -1.4 181.6 -

benign 0.6% y-o-y in November. Looking ahead, we expect inflationary pressure to remain benign as global economic headwinds continue to weigh on exports and demand for private sector credit.
Latest Period Jul-Sep Nov Jan Nov Nov Nov Nov 2013f 69.2 394.33 5,697 4.4 5.0 2,350.2 2,745.0 -3.2 2.9 8.1 31.25 239.9 248.9 9.0 6.9 1.8 182.3 7.4 109,678.4 27.8 2014f 69.6 420.35 6,043 4.4 5.5 2,510.0 2,808.1 -2.3 2.8 8.0 31.00 258.4 268.0 9.6 8.9 2.1 191.3 7.2 113,208.1 26.9

Population, mn [2] Nominal GDP, US$bn [3] GDP per capita, US$ [4] Real GDP growth, % change y-o-y [4] Industrial production index, % y-o-y, ave [3] Fiscal revenue, THBbn [3] Fiscal expenditure, THBbn [3] Budget balance, % of GDP [5] Consumer prices, % y-o-y, ave [3] Lending rate, %, eop [1,4] Exchange rate THB/US$, eop [6] Goods imports, US$bn [3] Goods exports, US$bn [3] Balance of trade in goods, US$bn [3] Current account, US$bn [3] Current account, % of GDP [5] Foreign reserves ex gold, US$bn [7] Import cover, months g&s [5] Total external debt stock, US$mn [4] Total external debt stock, % of GDP [5]

68.5 345.73 5,046 0.1 -9.3 2,018.7 2,181.0 -1.5 3.8 7.7 31.55 201.9 225.4 23.5 11.9 3.4 167.4 8.0 101,373.9 29.3

Notes: e BMI estimates. f BMI forecasts. 1 Prime Lending Rate. Sources: 2 World Bank/UN/BMI; 3 Bank of Thailand, BMI; 4 Bank of Thailand; 5 BMI calculation; 6 BMI; 7 IFS/BMI.

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MARCH 2013 SOUTH EAST ASIA 1

XXXXXX VIETNAM RISK SUMMARY

POLITICAL RISK
...continued from bottom of front page

Hanoi Issues Warning To Taiwan

The Ministry of Foreign Affairs issued a statement in January criticising Taiwan's oil and gas exploration activities around the Truong Sa Archipelago as a violation of Vietnam's sovereignty. Spokesman Luong Thanh Nghi made the statement at the ministry's periodical press conference, when asked about news that Taiwan will start exploring oil and natural gas resources around the waters of Ba Binh Island. He said that the proposed plan could potentially reignite tensions in the region and that Hanoi will demand Taiwan to cancel its exploration activities immediately.
Our short-term political rating stands at 76.9.

and the IMF have been warning againsteasing monetary policy too aggressively in Vietnam since mid-2012. Given the SBV's poor track record in managing inflation in the past, it is therefore not surprising that any signs of an uptick in inflation could risk unsettling investor confidence in the economy. From our perspective, however, we believe that subdued credit growth and a benign outlook for food prices in H213, should keep inflation in check through the year.Accordingly, we reiterate our view that the SBV will keep its policy rate on hold at 9.00% throughout 2013.
Watching Food Prices
Vietnam Headline CPI & Food Component, % chg y-o-y
50 45

the banking sector. Credit growth has slowed from 9.4% y-o-y in November to 8.9% as of December. Despite our view that credit conditions should continue to improve over the coming months, we expect credit growth to remain historically subdued at 11.0% for the full year, underpinning our benign outlook for inflation.
Muted Response To Uptick In Inflation
Vietnam Two-Year Sovereign Bond Yield, %
14 13 12 11 10 9 8

Mar-11

Jul-11

Mar-12

Jan-11

Jan-12

Jul-12

May-11

May-12

Sep-11

Nov-11

Sep-12

35 30

ECONOMIC RISK

25 20 15 10 5 0
Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 May-06 May-07 May-08 May-09 May-10 May-11 May-12 Sep-06 Sep-07 Sep-08 Sep-09 Sep-10 Sep-11 Sep-12 Jan-13

Source: BMI, Bloomberg

Oil Refinery Deal Inked

The Vietnamese government has signed a deal with Kuwaiti and Japanese companies to build an oil refinery complex, the Nghi Son refinery, worth around US$9bn. The Nghi Son refinery is due to start operations in 2017 and is part of the government's efforts to meet the country's rising demand. The refinery will have an annual processing capacity of 10mn tonnes of crude. Vietnambased PetroVietnam will hold a 25.1% stake in the refinery, while Japan's Idemitsu Kosan, Mitsui Chemicals and Kuwait Petroleum International will each hold stakes of 35.1%, 4.7% and 35.1% respectively.
Our short-t erm economic rating stands at 62.5.

Headline CPI

Food Price Inflation

Source: BMI, General Statistics Office

BUSINESS ENVIRONMENT

Automobile Sales Suffer Decline

Automobile sales fell by a record 37% in 2012 according to the Viet Nam Association of Automobile Manufacturers (VAMA). The VAMA claimed that it was partly due to an increase in fees and taxes that discouraged purchases. The country also recorded a 27% decline in passenger car sales to 26,000 units in 2012. Meanwhile, sales of multi-purpose vehicles and commercials vehicles fell 26% and 23% to 17,000 and 35,500 units, respectively. Industry leaders forecast that the country is expected to post around 8% y-o-y increase in automobile sales to 100,000 units in 2013.
Our business environment rating stands at 53.1.

Our Commodities team warn that food CPI in the region could re-accelerate in the first half of 2013 due to continued high grains and livestock prices and a temporary China-led regional economic upswing (see back-page story). However, strong rice output and exports from major producers will keep the global market for rice well supplied and the stocks-to-use ratio above 10-year averages. The strong return of Thailand on international rice markets in 2012/13, after a steep drop in exports in the past season owing to the government's Rice Pledging Programme, could also add strong downside pressure to rice prices. We expect grain prices to ease as the northern hemisphere harvest comes online in H213. Overall, improving supply from the northern hemisphere is likely to lead the global wheat and corn markets into surplus for the 2013/14 season and price weakness over the second half of 2013. The factors above suggest to us that inflationary pressure in Vietnam should, on the whole, remain benign through the year. Furthermore, the SBV's aggressive monetary easing cycle in 2012 has yet to achieve the desired effect of reaccelerating credit growth, as investor confidence remains depressed by uncertainties over the outlook for exports and the build-up of bad debt in

Judging from the relatively calm response in financial markets, we note that investors are also becoming increasingly resilient to signs of inflationary pressure in Vietnam, which is in line with our view that the latest uptick in headline CPI will prove to be a one-off. Indeed, yields on two-year Vietnamese sovereign bonds remain stable at 9.1%, suggesting that consensus expectations for inflation and monetary policy have stayed neutral. Bullish momentum in the equity market is also picking up following a technical retracement that we successfully called in December (see our online service, December 12 2012, 'Regional Equity Strategy').
More Room To Run
Vietnam Ho Chi Minh Stock Index
650 600 550 500 450 400 350 300 250 200

Oct-09

Oct-10

Oct-11

Jan-09

Jan-10

Jan-11

Jan-12

Oct-12

Jul-09

Jul-10

Jul-11

Apr-09

Apr-10

Apr-11

Apr-12

Jul-12

Source: BMI, Bloomberg

Our view remains that the Vietnamese equity market is in the early stages of a multi-month bull market. We see the recent rebound as a bullish sign that investor sentiment is beginning to improve in the country and that inflation is unlikely to be a major threat to the economy in 2013.

SOUTH EAST ASIA 1 MARCH 2013

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Jan-13

Nov-12

Jan-13

40

ECONOMIC OUTLOOK

Electricity Price Hike Positive For Long-Term Growth

BMI View: State-owned utility Electricity of Vietnams decision to hike electricity prices by 5% in December will be long-term positive for the economy, in our view. We believe that the move will allow the government to divert spending away from costly welfare subsidies and towards areas that are crucial for long-term growth. These include areas such as infrastructure projects, incentives to adopt new technologies to boost labour productivity, and boosting the capacity for electricity generation.
As part of the Vietnamese government's reform agenda to gradually allow electricity prices to be determined by market forces and to reduce subsidies on essential goods, state-owned utility Electricity of Vietnam (EVN) announced its decision to hike electricity prices by 5% in December. Although the price hike was widely anticipated given that proposals for the increase were unveiled earlier in September, the move has nonetheless attracted widespread criticism among the business community. Small-and-medium enterprises (SMEs), in particular, have repeatedly warned against the move, arguing that rising production costs due to higher electricity prices could have a detrimental impact on the competitiveness of power-hungry industries. Although we acknowledge that
DATA & FORECASTS
BMI View: Vietnam's trade surplus narrowed in January amid an increase in imports. Exports surpassed imports by US$200mn in January, after a revised US$498mn in December 2012, according to preliminary figures released by the General Statistics Office. Imports climbed to US$9.9bn in January from a revised US$9.86bn in December, while exports slipped to US$10.1bn in January from
2011e Population, mn [3] Nominal GDP, US$bn [4] GDP per capita, US$ [4] Real GDP growth, % change y-o-y [4] Industrial production index, % y-o-y, ave [1,5] Fiscal revenue, VNDbn [6] Fiscal expenditure, VNDbn [6] Budget balance, % of GDP [6] Consumer prices, % y-o-y, ave [2,5] Exchange rate VND/US$, eop [7] Goods imports, US$bn [8] Goods exports, US$bn [8] Balance of trade in goods, US$bn [8] Current account, US$bn [8] Current account, % of GDP [8] Foreign reserves ex gold, US$bn [8] Import cover, months g&s [8] Total external debt stock, US$mn [9] Total external debt stock, % of GDP [9] 88.8 122.82 1,383 6.0 10.9 674,500.0 710,160.0 -2.5 18.7 21,035.00 97.4 96.9 -0.4 0.2 0.2 19.6 2.4 43,913.0 35.8 2012e 89.7 141.44 1,576 5.0 7.0 696,798.6 843,280.6 -5.0 9.3 20,825.00 106.5 106.0 -0.4 0.0 0.0 26.3 3.0 50,493.3 35.7 5.5 7.1 20,510.00 9.9 10.1 0.2 -

the move could risk further bankruptcies as SMEs struggle to stay profitable in light of the challenging economic environment, we believe that plans to reduce government subsidies on electricity prices will be positive for the economy in the long term. Power Subsidies Unsustainable To put the size of these subsidies in perspective, we highlight that EVN has accumulated losses of more than VND38trn (US$1.8bn) over the years, with losses amounting to an estimated VND2.6trn(US$125mn) in 2012 alone, according to figures published by the government. Not only do we believe that this is unsustainable given Vietnam's deteriorating fiscal position and the overwhelming share of welfare subsidies (around 38%) as a propor-

tion of total public spending, we also see power subsidies as an impediment to economic growth over the longer term. We argue that generous subsidies on electricity prices over the years have severely distorted the cost of production in Vietnam, resulting in the creation of uncompetitive industries while creating perverse incentives for firms to adopt old and inefficient methods of production that have benefited from depressed electricity prices. We believe that generous subsidies by the government and easy credit from state-owned banks (owing to poor lending practices and lax risk management) are some of the key factors responsible for the wide technological gap between Vietnamese companies and their regional counterparts. As the government gradually reduce subsidies over the coming years, we believe that the government will be able to divert more spending towards areas that are crucial for long-term growth. These include areas such as infrastructure projects, incentives to adopt new technologies to boost labour productivity, and boosting the capacity for electricity generation. Overall, we believe that economic reforms aimed at adopting more free-market policies will benefit the economy significantly over the long run, even though this is likely to result in the demise of inefficient firms and risk higher unemployment in the near term.

a revised US$10.36bn in December. Despite the smaller trade surplus, we continue to expect the country to run a relatively balanced current account of around -0.1% of GDP in 2013.
Latest Period Oct-Dec Jan Jan Jan Jan Jan 2013f 90.7 161.59 1,782 7.0 12.0 736,177.5 903,601.2 -5.0 6.5 20,800.00 120.0 119.8 -0.2 -0.1 -0.0 33.0 3.3 54,724.5 33.9 2014f 91.6 185.42 2,025 7.2 14.0 790,646.5 987,194.8 -5.2 5.8 20,565.00 133.6 133.9 0.3 0.0 0.0 39.9 3.6 59,315.0 32.0

Notes: e BMI estimates. f BMI forecasts. 1 at 1994 prices; 2 Base year 2000. Sources: 3 World Bank/UN/BMI; 4 Asian Development Bank, General Statistics Office; 5 General Statistics Office; 6 Ministry of Finance; 7 BMI; 8 Asian Development Bank; 9 World Bank.

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MARCH 2013 SOUTH EAST ASIA 1

 CAMBODIA
RISK SUMMARY
POLITICAL RISK ECONOMIC OUTLOOK

Chinese Sends Diplomat To Mourn King

In a sign of the continually strengthening diplomatic relationship between Cambodia and China, Jia Qinglin, chairman of the National Committee of the Chinese People's Political Consultative Conference, arrived in Cambodia on February 3 to attend the royal cremation ceremony of the late Cambodian King Norodom Sihanouk. Prince Norodom Ranariddh, the eldest son of Sihanouk and former Prime Minister of Cambodia, said: 'The visit of Jia Qinglin is a testament to prove excellent and strong relationship and cooperation between China and Cambodia.'
Our short-term political risk rating is 66.0.

Positioned To Benefit From China's Shift

BMI View: Cambodia stands to benefit handsomely from Chinas economic rebalancing as manufacturing companies look to the country in response to rising wage rates on the mainland. Despite Chinas much stronger logistics capabilities, infrastructure networks and labour productivity, improvements in these areas, as well as in political and regulatory stability in Cambodia have combined to make significant wage cost advantages easier for corporations to reap.
We have written on several occasions about how China's economic rebalancing stands to benefit certain countries within Asia, and Cambodia appears to be particularly well situated. Indeed, China's economy is already seeing a broad transition, with manufacturing wages rising as the country moves up the economic value chain. Cambodia is well positioned to benefit from a shift in low-end manufacturing production away from China. With average Cambodian wages roughly one third of their Chinese counterparts, and the gap widening in recent years owing to China's high rate of wage inflation, multinationals are taking advantages of these cost savings. While China boasts much stronger logistics capabilities, infrastructure networks, and labour productivity than Cambodia, improvements in these areas, as well as improvements in political and regulatory stability in Cambodia have combined to make these wage cost advantages more easy for corporations to reap. In addition to mainland Chinese and
DATA & FORECASTS
BMI View: Cambodias commerce ministry expects GDP to grow by 7% this year even though the global economy remains fragile and high risk owing to the persisting sovereign debt crisis in Europe and sluggish economic recovery in the US. This forecast is above our forecast of 5.8%, and the IMFs 6.7%, with our relatively bearish view owing partially to our expectations of a sharp H213 downturn in China.
Population, mn [4] Nominal GDP, US$bn [5] GDP per capita, US$ [5] Real GDP growth, % change y-o-y [5] Unemployment, % of labour force, eop [5] Consumer prices, % y-o-y, eop [2,6] Lending rate, %, eop [7] Exchange rate KHR/US$, eop [8] Goods exports, US$bn [5] Current account, % of GDP [5] Foreign reserves ex gold, US$bn [9] Import cover, months g&s [9] Total external debt stock, % of GDP [5] 2011e 14.3 13.26 927 6.3 5.2 4.9 15.2 4,039.00 6.2 -7.6 3.3 5.0 44.1 2012f 14.5 14.16 978 4.8 4.5 5.0 15.0 4,300.00 6.9 -7.7 3.5 4.7 46.2 Latest Period 3.4 Jan 2013f 14.7 15.51 1,058 5.8 4.2 4.5 14.8 4,150.00 8.0 -7.7 3.7 4.4 46.4 2014f 14.8 17.82 1,201 6.4 4.0 4.0 14.5 4,000.00 8.9 -7.7 3.9 4.2 43.9

ECONOMIC RISK

Border Trade Booming

Vietnam's Ministry of Industry and Trade, in conjunction with the Cambodian Ministry of Commerce, held the 5th Conference on Vietnam-Cambodia Border Trade Development Cooperation in Binh Phuoc province on January 9. The event aims to review the results of cooperation in cross border trade between the two countries, which is estimated to have exceed US$3bn in 2012. At the conference, the two ministries agreed to coordinate the development of the border market system, continue building preferential policies and mechanisms for border trade, and provide each other with customs incentives, especially for agricultural products.
Our short-term economic risk ratings is 44.8.

Hong Kong investors shifting operations from China to Cambodia, several Japanese manufacturing companies have invested in the country in the past year. While skills shortages and electricity shortages are likely to persist and it will take a long time before Cambodian workers become as productive as their Chinese counterparts, logistic infrastructure should continue to improve as foreign investment continues to pile in. The big challenge facing the Cambodian government will be in maintaining social harmony while continuing to encourage Greenfield investments into the country. The need to clear land for factories amid such rapid economic development has led to a surge in public unrest, so much so that the World Bank suspended all lending to Cambodia in 2011 owing to the surge in land disputes. Still, concerns over human rights abuses are unlikely to deter foreign investors any time soon, and we maintain the view that Cambodia is well placed to grow strongly over the coming years.

BUSINESS ENVIRONMENT

Mass Production Challenges

While Cambodia has been attracting a great deal of manufacturing from China due to its comparative labour cost advantage, we believe automakers will generally prefer to increase domestic production capacity across Asian economies with a larger domestic market and/or strong export potential. The country's low GDP per capita of US$1,000 suggests that domestic consumers will still favour imports of used cars in the short term. Also, we are sceptical of initial domestic electronic vehicle (EV) sales of Heng Development Company's new EV due to charging infrastructure challenges.
Our business environment rating is 40.4.

Notes: e BMI estimates. f BMI forecasts. 1 Base Year = 2001; 2 Base Year = 2000; 3 Central Government. Sources: 4 World Bank/UN/BMI; 5 Asian Development Bank/BMI; 6 National Bank of Cambodia/BMI; 7 IMF; 8 BMI; 9 IMF/BMI.

SOUTH EAST ASIA 1 MARCH 2013

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LAOS
ECONOMIC OUTLOOK

Labour Woes A Key Impediment To Textiles

BMI View: Chronic labour shortages continue to plague Laoss garment sector. Businesses have also been reluctant to make investments to raise productivity standards owing to high labour turnover rates. Coupled with poor transport infrastructure, these factors threaten to stymie growth in the garment industry.
Growth of the Lao textile industry has been resilient in the past decade. It remains the country's largest non-natural resource industry and is estimated to account for almost 30,000 jobs. Helped by rising labour costs in neighbouring China and greater foreign participation, the value of garment exports has almost doubled, from US$115mn in 2003 to US$219mn in 2011, while the number of garments exported has grown from 28.1mn to 71.5mn. Labour shortage a perennial problem: A recent World Bank report estimates the attrition rate within large and medium businesses to be approximately 3.5% of the workforce monthly. This chimes with a Lao government
DATA & FORECASTS
BMI View:Following a year of food price disinflation in Asia, our Commodities team harbours expectations for food consumer price inflation (CPI) in the region to reaccelerate in the first half of 2013 owing to both continued high grains and livestock prices and to a temporary China-led regional economic upswing. This should have a corollary impact on Laos, given that food accounts for a considerable portion of the country's CPI basket. That said, with rice prices remaining moderate, wheat and corn prices retreating below current prices and core expectations of a slower economy in H213, we expect the pressure on food CPI to ease. We forecast CPI in Laos to average 4.5% in 2013, which is marginally higher than the average of 4.3% recorded in 2012.
2011e Population, mn [2] Nominal GDP, US$bn [3] GDP per capita, US$ [3] Real GDP growth, % change y-o-y [3] Fiscal revenue, LAKbn [1,4] Fiscal expenditure, LAKbn [1,4] Budget balance, % of GDP [1,4] Consumer prices, % y-o-y, ave [5] Lending rate, %, eop [5] Exchange rate LAK/US$, eop [6] Goods imports, US$bn [3] Goods exports, US$bn [3] Balance of trade in goods, US$bn [7] Current account, US$bn [3] Current account, % of GDP [3] Foreign reserves ex gold, US$bn [3] Import cover, months g&s [3] Total external debt stock, US$mn [8] Total external debt stock, % of GDP [8] 6.3 7.50 1,193 6.5 8,636.6 12,706.5 -4.4 0.1 20.0 8,024.50 1.8 1.3 -0.5 -0.1 -1.4 0.9 6.3 6,656.0 88.8 2012e 6.4 8.83 1,386 6.8 9,936.4 14,401.7 -4.0 4.3 20.0 7,600.00 2.1 1.6 -0.5 -0.2 -1.7 1.1 6.1 7,299.0 82.6 2013f 6.5 10.14 1,569 6.4 11,351.9 16,262.8 -3.7 4.5 20.0 7,400.00 2.6 1.9 -0.7 -0.2 -2.1 1.2 5.8 8,008.3 79.0 2014f 6.5 11.63 1,778 6.4 12,895.0 18,298.9 -3.4 5.0 20.0 7,200.00 3.1 2.3 -0.8 -0.3 -2.5 1.4 5.6 8,790.9 75.6

RISK SUMMARY
POLITICAL RISK

Missing Activist
The disappearance of a prominent sustainable development activist continues to put political pressure on the Lao government, withHilary Clinton the latest diplomat to comment on the situation on January 17 when US secretary of state. The Lao government has been criticised for its inaction as well as its lack of transparency towards its handling of the issue.This has cast unnecessary spotlight on the country and threatens to reverse the positive economic and political reform momentum that has culminated in the country's imminent ascension to the World Trade Organisation.
Our short-term political risk rating is 80.4.

official's claims that only 30% of the 100,000 workers trained by the local garment industry over the past two decades were retained. Liberal cross-border labour market policies have enabled workers to seek more lucrative jobs in Thailand with relative ease. Indeed, an 80% rise in the minimum wage in January 2012 to LAK630,000 (US$79) -which garment workers typically earn at failed to assuage concerns that wage growth has failed to keep up with inflation, which has averaged more than 9.0% annually since 2000. As a result, despite boasting lower wage costs compared to neighbouring garment manufacturing competitors, chronic labour shortages continues to plague Laoss' textile sector.

ECONOMIC RISK

Xayaburi Fate Still Uncertain

Vietnam and Cambodia reiterated their demands for Laos to halt all construction works on the 1,260MW Xayaburi dam in the latest round of meetings held by the intergovernmental panel of the Mekong River Commission in mid-January. The Xayaburi dam has been a source of growing friction in the region since 2011 and we believe this friction is not likely to be resolved any time soon owing to conflicting interests among the involved parties. In our opinion, this latest objection to the project once again supports our view that the uncertainties surrounding the Xayaburi dam are far from over, with potential for delays still high.
Our short-term economic risk rating is 3 6.3.

BUSINESS ENVIRONMENT

Uplift Thanks To FDI

Foreign direct investment (FDI) climbed more than 40% annually in both 2011 and 2012 despite widespread corruption, weak commercial laws and frequent government intervention. Laos expects to attract US$8bn in investment from 2011 to 2015 to keep its economic growth at about 8% a year. We expect FDI inflows to remain relatively robust as its neighbours, particularly China, vie to tap into the country's pool of natural resources, especially within the hydropower sector. Despite this, however, we maintain that Lao' business environment remains one of the region's most challenging and considerable room for reform remains.
Our business environment rating is 34.4.

Notes: e BMI estimates. f BMI forecasts. 1 Fiscal years ending in September, 2007= FY2006/2007. Sources: 2 World Bank/ UN/BMI; 3 Asian Development Bank; 4 Asian Development Bank, National Statistics Office; 5 IMF; 6 IMF,BMI; 7 Bank of Lao, Asian Development Bank; 8 World Bank, BMI.

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MARCH 2013 SOUTH EAST ASIA 1

Regional REGIONAL
ECONOMIC OUTLOOK

Temporary Pickup In Asia Food CPI To Ease In H213

BMI View: After more than a year offoodprice disinflationinAsia, we believe food consumer price inflation (CPI) in the region could re-accelerate in the first half of 2013 owing to continued high grains and livestock prices and to temporary China-led regional economic upswing. However, pressure on food CPI should ease over the year as rice prices remain moderate, wheat and corn prices retreat below current prices and the economic recovery stalls. Some countries could record higher food CPI owing to low stocks and, hence, the strong need to import key commodities.
After more than a year of food price disinflation in Asia, elevated grain and livestock prices continue to stoke fears of a return of foodconsumer price inflation (CPI) pressure in 2013. Our view stated in July 2012 that food CPI would not rear its head despite the grains rally initiated in June 2012is unfolding well, as our Emerging AsiaFoodConsumer Price Index a simple average of the considered countries'foodCPI has continued to follow its downtrend in recent months.The rate of the index stood at 5.1% in December compared with 7.7% a year before. Since the start of the grains rally, only the Philippines, Indonesia, India and Taiwan saw food price inflation pick up, while other emerging countries recorded rather steep disinflation. Although the rally in grains prices eased from September onwards, prices remain above historical averages and is unlikely to ease significantly in the coming months. Continued elevated prices could finally have an effect on Asia's food CPI, as the impact on feed ingredients and livestock prices grows with time. Our forecast for a temporary uptick in China's economic performance in the first half of 2013, which should improve the outlook for the whole region over the period, could also have an impact on Asia's food price inflation. An economic recovery, featured by improving exports and capital inflows, are likely to put pressure on local money supply, which could in turn feed in through overall food price inflation. Food CPI To Ease Over H213 These developments suggest a re-acceleration of food CPI at the beginning of 2013. However, we believe Asia's food price inflation will remain below levels seen in 2008 and 2011 and should ease over the second half of the year.Our assumptions are based on four main factors. First and foremost, rice prices, with whichwe believe Asian food price trends are most closely correlated, will stay subdued in 2013. Strong output and exports from major producers will keep the global market well supplied and the stocks-to use ratio above 10-year averages. The strong return of Thailand on international rice markets in 2012/13 after a steep drop in exports owing to the government's Rice Pledging Programme could add strong downside pressure to rice prices. This underpins our view of prices averaging lower at US$14.00/cwt in 2013, compared with USc14.86/cwt in 2012. Second, although we see upside risk to international wheat and corn prices on a threemonth horizon, we expect prices to eventually ease as the northern hemisphere grain harvest comes online in H213. We also believe forecasts for South American corn production are optimistic, and see potential for crop estimates

downgrades. However, overall improving supply from the northern hemisphere is likely to lead the global wheat and corn markets into surplus for the 2013/14 season and price weakness over the second half of 2013. Third, we believe many Asian countries have sufficient grains stocks to at least partially offset elevated wheat and corn prices. China, India, Indonesia and Philippines enjoy above 10-year average wheat stocks. In line with our view that Asian governments have learnt valuable lessons from the 2007-2008 food crisis and the risks related to high food prices, various countries have announced and some implemented policies to keep local prices in check. India helped mitigate the effects of the poor 2012 monsoon rainfall on rising local prices by releasing governmentheld stocks in November and ramped up rice procurement to increase its buffer stocks. Finally, we see the regional economic recovery stalling in H213, as China's structural headwinds remain unanswered. This, coupled with moderating grain prices, should help food price inflation decelerating. Risks To Outlook The effect of high grains prices and economic recovery on food price inflation could be exacerbated by base effects, due to low comparison figures at the beginning of 2012. Moreover, some countries remain more vulnerable to elevated grain prices and could therefore experience astronger pickupinfoodinflationinthe coming months. This is the case for countries highly dependent on grains imports, such as Taiwan, Indonesia and the Philippines or with higher import needs in 2013/14. South Korea also has a relatively high exposure, but this is mitigated by the smaller weight of food in its CPI basket. China could also see relatively higher food price inflation due to our expectations of a strong recovery in domestic pork prices in 2013 and the weight of pork in its food CPI basket (it accounts for around 12% of the food CPI basket, which account in turn for 30% of the whole CPI basket).

Weighting Of Food Components In Select Countries CPI Basket (%) Philippines Thailand China Indonesia India South Korea All Foods 36.3 31.0 30.2 29.9 24.3 12.7 Cereals 12.4 2.9 2.8 4.7 4.1 2.3 Rice 9.0 8.5 4.0 8.0 10.0 5.0 Meat 7.0 2.3 5.7 2.5 2.4 2.4

Source: BMI, Bloomberg, Reuters; Note: Cereals, rice and meat are components of the All Foods basket in the first column

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