Q&A with Japanese Investors

【Economy】

1.         Please provide us with the outlooks for economy and inflation in Korea. Especially, please touch on the possibility of deflation in Korea.

 

Prior to comment about growth, the consumer prices continue to down beat market expectations. It’s somewhat odd because CPI decreased during two consecutive months although economists expect to increase. In fact, in autumn, after thanks giving holiday in Korea, CPI tends to decline as reverse last seasonal rising up. Nonetheless, in this circumstance, Bank of Korea maybe will fail to expect inflation during only 3 months. BOK issued new economy forecast for this year and next year on the last month’s Monetary Policy Meeting. They forecasted this year’s CPI would be about 1.4%. This number is average of monthly CPI number year on year and their expected 1.4% implied average 0.1% increase m/m during next 3 months in this year. But, CPI in October decreased 0.3% from a month earlier and it was too deviated from BOK’s forecast. Although BOK expect CPI to be over 2% next year excluding already planned increase of cigarette price, current CPI y/y maintains under only mid-1% level. It was 1.2% last month.

 

So, the woes about deflation in Korea has been widen recently. But, many governors and economists see little possibility about this because this low inflation has been influenced by not demand side, but supply side. Actually, decreasing oil price and agriculture price has driven consumer price decline from last year to this year.

Not only in Korea but also in Euro area, someone argues that their inflation would follow Japanese lost decades finally. However, others do not think so, because after 90s Japanese deflation was affected by huge asset prices shortfall not by supply side such as commodity prices.

On the other hand, Korea faces the problem of aging population like Japanese experience. So, the possibility of deflation remains in longer-term. But, we think, unless external or internal economic shock to be followed by significant asset prices collapse, deflation would be longer-term theme. Maybe individual and corporate economic behaviors should adjust this long-term trend slowly without forced to be adjusted by any crisis, we think.

So, current low inflation means the possibility of mid-term disinflation more likely rather than deflation, in our view.

 

And then, about the economic growth in Korea, we see moderate growth on the step of recent growth pace. Exports would be relatively solid and domestic consumption would pick up slowly, we expect. But, headwinds from export side by Chinese economic slowdown and higher inventory burden remain. Recently the woes about KRW appreciation against JPY arise. I will comment parts about China and JPY later. We forecast next year’s Korean economic growth would be approximately 3.6% lower than BOK’s 3.9% in line with those headwinds.

 

 

2.         Recently, I’ve seen concern about decelerating economy in China. And I think that the economic slowdown in China can affect Korean economy. Will you provide us with the outlooks for economy in China?

 

Many experts are very skeptical that Chinese economy continues high growth over next decades and we agree. Back-ground of this is the concern about property market, over capacity and shadow banking in short-term and about aging population in longer-term. Now, we focus on the possibility of the soft landing of Chinese economy. On the property market, the imbalance between supply and demand seems not too negative to lead hard landing. And about excess capacity problem, relative to other developed countries, the burden is smaller than them, some economists argued. Including shadow banking problem, almost these woes could be managed by China government, we think. China faces aging problem, this is structural problem and government continues to try reform economic structure for this in longer-term.

 

Although Chinese growth seems to be soft landing, the headwind against Korean exports companies remains. About 25% of total Korean export is toward China. And in micro view, Chinese corporate competitiveness of manufacturing has been grown and seems to be threat for Korean companies in near-term. We think the reason that KOSPI, Korean equity market, has been underperformed recently is somewhat this structural problem in each industry.

 

So, we are afraid of the future ahead of both Chinese economic slowdown and threat against Korean manufacturing companies in mid-term.

 

 

【Market】

3.         Please provide us the outlooks for economic management by the Park Geun-hye  Administration.

 

We summarize this government’s economic policy to three points. One is macro policies including expanding fiscal expenditure and easing monetary policy. Second one is boosting up the property market. And last one is structural inform like all of countries nowadays.

 

First of all, Bank of Korea already cut the policy rate twice by 50 basis points totally and governors seem to be satisfied with this. So, the government has to practice fiscal expansion next year. But, we are somewhat skeptical about their willingness about it. They provide only small expansion fiscal budget under the reputation risk from fiscal balance.

Second, the property market improvement is real hope for governors, we think. Many concerns such as domestic consumption slowdown and household debt problem would be cured by higher home prices. However, due to aging population, home prices rally unlikely continues for long-time.

Eventually, Korean economy likewise other developed countries needs structural reform. Many economists focus on savings glut. In Korea, companies’ savings are over than before. The distribution problem from companies to individuals is in line with this. The governor announced the possibility of tax on cash in companies, but this looks like very difficult to do.

 

(In short, we are somewhat doubtful about overall policies.)

 

4.         What do you think of the possibility of further rate cut by central bank?  If it’s possible, when do you think the Central bank will take one more action?

 

It depends on the willingness of government, we think.

Indeed, the chairman of BOK signaled that this policy rate, 2.0%, the historical low, is sufficient for boosting economy on the monetary policy meetings last and this month. He revealed the woes about the stability of finance including household debt problem. Extremely low interest rate could deteriorate this problem. So, many market players interpreted him hawkish.

However, since Bank of Japan decided to expand QE and JPY depreciated rapidly, the woes about negative influence for Korean export companies increase. In line with the woes, expectation for additional policy rate cut in near-term arises.

However, ahead of the possibility of policy rate hike in US, and under expectation about moderate recovery next year, it’s not likely easy to decide easier monetary policy which would be lower than Lehman crisis’.

So, we think BOK should cut the policy rate if external or domestic downward pressure in economy increase. But, under the stressed environment, the policy movement would be very fast. So, we recognize the possibility of additional policy rate cut until 1H next year at least.

 

5.         What do you think of the possibility of exchange intervention by the Korean Government?

 

We think FX traders already recognize the possibility of government intervention as their normal behavior as a way to mitigate market volatility.

Recently, FX market sees 950 won, exchange rate against JPY, as the implicit or explicit target rate of the government. So, some players say that government’s intervention appears under 950 won in the FX market.

But, as you know, US government and IMF seem uncomfortable at FX intervention by Korean government because of excessive current account surplus. So we think the intervention would not be aggressive than before.

If government hopes rapid KRW depreciation, they forced BOK to cut the policy rate. But, it’s not likely yet, we think. It maybe depends on how much JPY depreciate against USD in short-term.

 

 

6.         Could you tell us your mid-term (6 month) view of Korean bond market?

 

We’ve seen the bull market during last 10 months since start of this year. Bond yield already is lower than last lowest level in 1Q last year in almost tenors from 1 year rate to 20 year rate.

Short-end rate, much lower than last year’s low level, is reasonable because influenced by policy rate mainly, we think. However, on the long-end rate, it looks like follow economic growth and inflation rather than policy rate. Actually, both the level and direction of 10 yr Korean Treasury bond rate follow summation of growth and CPI year on year path.

And now, 10yr rate is similar with 1Q last year. But, while GDP growth recorded 2.1% from a year earlier at that time, last quarter’s GDP growth was 3.2% higher by 1.1%p that that. On the inflation side, it was 1.5% in 1Q last year and 1.1% last quarter this year. The difference is 0.4%p.

From this calculation, we could estimate fair value of 10yr rate for now and that is about 3.0% higher than now by 30 basis points.

So, we see long-end rate would underperform in short-term because it looks like overshooting now. While long-end rate could increase from now, the short-end rate would be prevented from upward pressures because the expectation of policy rate cut remains, we guess. In short, we see slightly bearish steepening in short-term.

In mid-term, it’s somewhat difficult to forecast. Until mid-next year, the possibility of policy rate hike in US would increase but its effect on other countries is difficult to guess because the cycle of monetary policy is different each other.

Recently, many analysts argue that they hardly find evidence to lead higher interest rate under the savings glut, capex constraints and aging people. Indeed, we don’t find any evidence about this, too. Because of recent decline in oil prices, inflation does not seem to be forced toward higher. And many economists refer that Korean economy and interest rate would follow Japanese lost decades or Taiwan rate plunge. So, if you ask about mid-term or long-term interest rate forecast, it’s so convenient to answer that the rate would decline more and more for us.

So-called Secular Stagnation is already main theme and widespread. Actually, JP Morgan argued this theory recently, too. We agree this, either, but we continue to try to find any evidence denying this. Someone said when the new paradigm was recognized everywhere, it would be the end of bubble. So, while we expect bond bull market would continue in mid-term and long-term, we try to find opposite scenario at the same time.