Citigroup - Asia Macro and Strategy Outlook: Green Shoots - Premature Harvest

Talk of "green shoots" should be put in perspective, even if regional YoY GDP growth is expected to bottom in 1Q09/2Q09 — Except for China, signs of a real recovery remain elusive, though production stabilized and expectations have caught up with reality. Prospects hinge on the G3 outlook, which remains fragile.

We are nearing, or have already reached, the end of the rate cutting cycle — Korea Taiwan and Malaysia have probably ended their rate cuts, while China may be the first to tighten policy. Only in Indonesia, India and the Philippines do we still expect sizeable cuts, though the pace of cuts will slow.

Concerns about external liquidity risks in emerging markets, including Asia, have significantly abated, and should continue to improve — Concerns over external funding will likely improve given (1) strong government commitment globally to support systemically important institutions, (2) strengthening of resources of the IMF and other multilateral financial institutions, (3) proliferation of bilateral swaps, (4) re-opening of private capital markets, (5) improving current accounts.

Concern about fiscal deterioration will be better factored into sovereign credit spreads, and we are biased to pay on the longer end — Revenue slippage, countercyclical fiscal policies and realisation of contingent liabilities could cause fiscal balance sheets to deteriorate. South Asia, the Philippines and Malaysia, where debt to GDP is already very high, will face more fiscal constraints. We don’t find a compelling case for receiving front-end rates except in Hong Kong and India, and are biased to pay in the long-end of the curve, especially in Malaysia, Korea and Taiwan.

While Asian FX is vulnerable to a near-term relapse of risk aversion, the longer term FX appreciation view remains intact — Near-term FX outlook would depend on risk environment. Anchored appreciation expectations on CNY, and improving external flows should support medium-term FX appreciation. We remain marginally bearish on SGD, neutral on MYR and biased long on IDR and KRW.