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ISSN 1474-5615 Vol 23 Issue 8

August 2012

South East Asia

VIETNAM

Vol 1

Business Monitor Internationals monthly regional report on political risk and macroeconomic prospects

THIS MONTHS TOP STORIES

EIB To Weather Banking Sector Challenges

BMI View: The Vietnamese government is pushing forward with plans to restructure the banking sector. This could have a significant impact on the profitability of Vietnamese commercial banks. Despite our cautious stance on the banking sector's outlook as a whole in 2012, we believe that Vietnam Export Import Commercial Bank will be in a stronger position to weather the challenging business environment.
Recent developments suggest that Vietnamese commercial banks will continue to face a difficult business environment over the coming quarters. We highlight the key developments that could have a significant impact on the profitability of Vietnamese banks, or in the worstcase scenario, potentially undermine the stability of the banking system as a whole. Although we maintain a cautious stance on the banking sector's outlook as a whole, we believe that banks with strong balance sheets and superior risk management systems will be in a better position to weather the challenges associated with the government's latest push to restructure the banking sector. Banking Sector Reforms Positive For The Economy Having achieved significant progress in ironing out the country's macroeconomic imbalancesby tightening monetary policy, implementing various economic reforms and realigning the exchange ratethe Vietnamese government is now pushing ahead with plans to restructure the banking sector. The State Bank of Vietnam
...continued on page 2

Cambodia: Risk Of Unrest Growing

BMI View: The ruling Cambodian Peoples Partys overwhelming victory in the recent communal elections suggests there is little threat to its tight grip on power as the 2013 general elections approach. This is a positive for foreign investors. However, there are growing risks of rising public unrest as the issue of land rights and forced evictions heats up.
page 6

Asia: Rebalancing: A Labour Market Perspective

BMI View: With Asia facing a sharp slowdown in external demand and a reorganisation of resources away from exports and towards domestic consumption, labour markets across the regional will face significant changes. Other dynamics are also in play, with sharply declining competitiveness in China creating opportunities in other low-cost countries. Thailand appears to face the most significant challenges.
page 8

Vietnam: Property Price Drop Healthy For Economy

page 3

Thailand: Property Price Drop Healthy For Economy

page 5

THAILAND

Fiscal Balance Achievable Despite Risks

BMI View: Post-flood reconstruction efforts and our core view of subdued economic growth should result in a deterioration of Thailand's fiscal position in the near-term. Risks that could delay government efforts to address the fiscal deficit remain. However, we remain optimistic that Thailand's fiscal position will gradually improve towards achieving a fiscal balance by around 2016 as reconstruction spending costs begins to taper off.
Thailand's fiscal position is set to deteriorate in the near-term, in line with our view that the government will increase public spending to help cushion the impact of cooling external demand on economic growth. We continue to see Bloomberg consensus real GDP growth forecast of 5.1% as being overly optimistic. Recent economic
...continued on page 4

REGIONAL INDICATORS
2010 South East Asia Indicators Nominal GDP, US$bn Population, mn GDP per capita, US$ Real GDP growth, % Inflation, % Goods Exports, US$ Goods Imports, US$ 1,805.9 2,095.9 2,192.3 2,461.3 542.9 7.8 4.1 549.1 4.8 5.4 555.3 4.4 4.2 561.4 5.2 4.4 1,411.9 3,326.1 3,816.8 3,948.2 4,384.3 2011e 2012f 2013f

1,039.0 1,218.7 1,297.8

910.4 1,076.2 1,160.9 1,272.1

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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ISSN: 1470-7810

VIETNAM
...continued from top of front page

RISK SUMMARY
POLITICAL RISK

Code Of Conduct In East Sea

Deputy Foreign Minister Pham Quang Vinh said in a press interview that the need for establishing a Code of Conduct (COC) in the East Sea will be crucial for the region. He added that the East Sea is an important area for Vietnam in terms of its geographical location, security implications and economic potential. However, frequent territorial disputes with Beijing over the East Sea have complicated peaceful negotiations over the years. Given the high stakes involved in the dispute, we remain skeptical that the two countries will be able to achieve a clear resolution in the near term.
Our short-term political rating stands at 76.9.

ECONOMIC RISK

Q209

Q309

Q409

Q110

Q210

Q310

Q410

Q111

Q211

Q311

Q411

VCB

Our short-term economic rating stands at 54.4.

Source: BMI, Bloomberg

BUSINESS ENVIRONMENT

Tourism Recovery
Visitor arrivals in Vietnam grew by a robust 13.9% y-o-y in H112, with the country attracting more than 3.3 million visitors, according to the General Statistics Office. Vietnam 's largest tourism markets include South Korea , Thailand , Malaysia , Japan , France , China and the US. We expect growing incomes across the South East Asian region to have a positive impact on the industry's outlook over the coming years. Furthermore, we also expect the Vietnamese government to introduce further measures to attract more foreign direct investment into the sector going forward.
Our business environment rating stands at 53.1.

Bankruptcies Not Reflected In NPLs Yet The recent surge in bankruptcies, brought about by high lending rates and tight credit conditions, continues to pose as a serious threat to the stability of the banking system. Although reported data on non-performing loans (NPL) for the banking as a whole appears to remain benign and stable at under 1.5% of total assets, various reports and surveys suggest that actual NPLs could be higher at around 3.0%. We believe that current NPLs do not accurately reflect underlying economic conditions in Vietnam, especially given reported estimates of more than 17,000 small- and medium-sized (SME) companies that have either declared bankruptcy or have ceased operations since the beginning of the year. We see increasing anecdotal evidence that actual NPLs are rising and we expect this trend to be reflected

SOUTH EAST ASIA 1 AUGUST 2012

CTG

Figures published by the Ministry of Agriculture and Rural Development showed that seafood exports grew 10.6% year-on-year (y-o-y) to around US$2.9bn in H112. The unfolding sovereign debt crisis in the eurozone has had a significant impact on demand for Vietnamese exports to the region, with shipments to Germany, Netherlands and Italy falling by 26.4% 11.0% and 16.0% y-o-y, respectively. We expect exports of other goods to the eurozone to register a similar slowdown and we believe that external demand will only begin to see signs of a pickup in late 2012.

Providing Better Returns With Lower Risk

Vietnam Total Assets, VNDtrn (LHS) & Profitability Ratios (RHS)
30 ROA 400 25 ROE Total Assets 20 350 300 250 15 200 10 150 100 5 50 0
EIB STB

Source: BMI, Bloomberg

450

Favouring Strong Balance Sheets And Superior Risk Management Back in June 2011, we did a similar comparison and said that EIB would be in a better position to cope with an economic slowdown due to its strong balance sheet and superior track record for managing risk (see our online service, June 2011 'Reassessing The Impact Of Vinashin's Default'). As the accompanying chart shows, despite EIB's relative smaller size (in terms of its total assets) compared to its larger peers VCB and CTG, EIB has managed to generate the highest return-on-assets (ROA) among the group. In terms of returnon-equity (ROE), EIB also ranks the second highest, behind CTG. Therefore, by looking solely at returns and size of the company, not only does EIB hold a superior track record in generating return for its shareholders, the bank also has better opportunities for growth given its relatively small market share. We note that EIB's relatively higher ROA and ROE is partly due to higher leverage, which is explained by its high debt-to-equity (D/E) ratio of 3.9. However, EIB's higher leverage has not been accompanied by higher NPLs, which are presently at a benign 0.8% of total assets. We believe that the early stages of the government's restructuring process will take at least a year to be implemented and that banks that are more fundamentally sound in terms of their profitability and risk management system such as EIB will perform well during this period.

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Q112

Exports Hit By Eurozone

(SBV) has outlined key policies that will be undertaken throughout the restructuring process. These include a reorganisation of ailing small- and medium-sized banks through mergers and acquisitions, addressing the build up of bad debts in the banking sector by allowing profitable banks and companies to refinance, and longer-term initiatives to improve the efficiency of banking operations and strengthening risk management systems. We expect smaller banks that tend to compete in the relatively less profitable and saturated segments of the market, and those with weaker balance sheets to undergo a painful adjustment process as a result of the restructuring. However, on the whole, we are convinced that addressing the banking sector's weaknesses will be positive for the economy in the long run. Indeed, banks that manage to survive and emerge from this long adjustment process should prove to be more competitive and resilience to future economic shocks.

in reported NPLs over the coming quarters. Looking at the financial ratios of the four largest Vietnamese commercial banks listed on the Ho Chi Minh Stock Exchange, including Vietnam Export Import Commercial Bank (EIB), Bank for Foreign Trade of Vietnam (VCB), Saigon Thuong Tin Commercial Bank (STB) and Vietnam Commercial Bank for Industry and Trade (CTG), there are significant differences within the group in terms of profitability, leverage and prudence in risk management.
Develeraging Set To Continue
Vietnam Total Debt To Total Equity, % (RHS)
EIB STB CTG VCB 600

500

400

300

200

100

VIETNAM
ECONOMIC OUTLOOK

Property Price Drop Healthy For Economy

BMI View: Property prices in Vietnam are poised to lower over the coming months. Although recent declines in property prices have brought valuations to more realistic levels and tamed speculative activity, we expect further prices to head lower before we start to see any signs of a recovery. This, however, could exacerbate risks of a surge in mortgage defaults and potentially destabilise the banking system.
Tight credit conditions and depressed investor sentiment towards risky assets have had a significant impact on demand for real estate in Vietnam. Despite rapid monetary normalisation by the State Bank of Vietnam (SBV)the central bank has already slashed its policy rate by 400 basis points (bps) from 15.00% to 11.00% since the beginning of the yearwe do not expect to see a quick turnaround in property prices at the moment. Instead, we expect property prices to lower over the coming months before we start to see early signs of a recovery in 2013. This is in line with our view that credit conditions will gradually ease towards the end of the year and that economic activity will accelerate into 2013. Transaction prices across different segments of the property market (including condominium, landed units and serviced apartments), remained on a stubborn decline
DATA & FORECASTS
BMI View: The State Bank of Vietnam's decision to introduce its second rate cut in June (the policy rate was cut from 11.00% to 10.00%), will have a positive impact on domestic demand and real GDP growth in 2013. Accordingly, we have revised our real GDP growth forecast upward from 6.5% to 6.9% for 2013. We also expect the latest rate cut to be well received by the equity market. Accordingly, and cou2010 2011e Latest Period

in Q212. Prices for condominiums, landed units and serviced apartments registered average declines of 0.7%, 4.0% and 1.8% respectively. From a broader perspective, the Vietnam Real Estate Index (VREI), which tracks transaction prices of highly liquid apartments in Hanoi and Ho Chi Minh City, has fallen by 4.0% quarter-on-quarter (q-o-q) in Q212 and 12.3% from the index's inception in July 2011. Given that we have yet to see signs of a slowdown in the magnitude of quarterly declines in property prices, this reinforces our view that prices will only pick up in 2013. We believe the cooling property market represents a healthy adjustment of investor expectations and signals the end of a misallocation of capital towards real estate investment. Large inflows of foreign capital into the real estate market in recent years have fuelled

concerns that valuations could be near bubble territory. The recent decline in property prices has brought down valuations toward more realistic levels and tamed speculators' interest in the market, reducing the risk of a property bubble. The lack of infrastructure investment in Vietnam, which continues to undermine the country's competitiveness in terms of its business environment and longterm economic growth potential, is a clear sign of severe misallocation of capital into the speculative real estate market. The build up of bad debts related to the real estate sector in recent years is also becoming a serious threat that could potentially destabilise the banking system. According to a recent report published by the National Financial Supervisory Committee, nonperforming loans linked to the real estate sector ballooned to around VND56.8trn (US$2.7bn) by end-2011. Various estimates also suggest real estate loans presently make up a worrying 50-60% of total loans issued by commercial banks. We see increasing risks that further declines in property prices could risk triggering a surge in mortgage defaults, putting the broader banking sector and economy at risk. Nonetheless, we see this adjustment in the property market as a necessary outcome for a more balanced economy in the long run.
pled with a structural improvement in the country's macroeconomic fundamentals, we believe that the Ho Chi Minh Index could outperform regional indices over the coming months.
2012f 2013f

Population, mn [3] 87.8 88.8 89.7 90.7 Nominal GDP, US$bn [4] 103.5 121.3 136.1 154.6 Nominal GDP, VNDbn [4] 1,980,914.0 2,506,055.4 2,862,077.7 3,216,086.2 GDP per capita, US$ [4] 1,178 1,367 1,516 1,706 Real GDP growth, % change y-o-y [4] 6.8 6.7 4.7 Q212 5.2 6.9 Industrial production index, % y-o-y, ave 14.1 10.9 8.0 12.0 [1,5] Budget balance, VNDbn [6] -87,725.0 -64,300.0 -116,486.9 -152,228.8 Budget balance, % of GDP [6] -4.4 -2.6 -4.1 -4.7 Consumer prices, % y-o-y, eop [2,5] 11.8 18.1 6.9 Jun 4.2 6.0 Central Bank policy rate, % eop [7] 9.00 15.00 10.00 Jun 10.00 9.00 Exchange rate VND/US$, eop [8] 19,498.00 21,035.00 20,885.00 Jun 21,035.00 20,800.00 Goods imports, US$bn [9] 79.3 95.4 9.9 Jun 107.7 120.4 Goods exports, US$bn [9] 72.2 86.6 9.8 Jun 98.2 111.0 Balance of trade in goods, US$bn [9] -7.1 -8.8 -0.1 Jun -9.6 -9.4 Current account, US$bn [9] -4.3 -6.0 -6.9 -7.0 Current account, % of GDP [9] -4.1 -5.0 -5.1 -4.5 Foreign reserves ex gold, US$bn [9] 17.5 18.9 19.6 20.5 Import cover, months g&s [9] 2.6 2.4 2.2 2.0 Total external debt stock, US$mn [10] 35,139.4 38,362.9 41,577.6 45,065.5 Total external debt stock, % of GDP [10] 33.9 31.6 30.6 29.1 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 State Bank of Vietnam; 8 BMI; 9 Asian Development Bank; 10 World Bank.

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AUGUST 2012 SOUTH EAST ASIA 1

THAILAND
...continued from bottom of front page

RISK SUMMARY
POLITICAL RISK

Amendments To Monarchy Law Voted Down

The Thai parliament has voted against amending a law to reduce jail terms for individuals charged with insulting the royal family. Only three out of the total 500 members within the House of Representatives supported amending the law. The proposal was introduced through a petition signed by nearly 30,000 members of the public. The ruling Pheu Thai party and the main opposition, the Democrat party, have both voted against the amendments. The move may increase monarchist credentials of the ruling party and prevent another military coup that ousted Thaksin Shinawatra from power in 2006.
Our short-term political rating stands at 65.4.

data are increasingly supportive of our view that Thailand's economy will grow at a more moderate pace of 4.0% this year (see our online service, June 4, 'Manufacturing Data Points To Stalling Recovery'). Accordingly, we believe that the government will increase public spending and introduce further tax incentives over the coming months in a bid to support growth, resulting in a widening of the fiscal deficit in 2012. We expect additional flood relief programs introduced by the government to come in the form of tax cuts for businesses and incentives to rebuild their capital stock. Meanwhile, we expect the government to boost spending on flood warning and protection infrastructure projects over the coming years.
Cuts In Wages And Consumption Will Be Needed
Thailand Breakdown Of Fiscal Expenditure, % Share
50 45 40 35 30 25 20 15 10 5 0
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Puea Thai Party (PTP) coalition government to deliver on its campaign promises will entail enforcing the minimum wage for fresh university graduates working in the public sector. Thus, a majority of the spending cuts will have to come from reducing grants to government entities and public consumption of goods and services. This significantly reduces the number of options available to policymakers in terms of implementing spending cuts.
Where To Cut From?
Thailand Share Of Fiscal Expenditure (2011), %
Other Expenditures, 10.5 Wages and Salaries, 36.2

Grants, 20.6

Corporate and Social Subsidies, 1.9

Consumption of Goods and Services, 30.8

ECONOMIC RISK

Source: BMI, Ministry Of Finance

Infrastructure Bill Proposed

Finance Minister Kittiratt Na-Ranong has urged against delays in approving THB2trn (US$63.3bn) of investment projects earmarked for the infrastructure sector. A new infrastructure bill has been proposed to allow the government to borrow up to THB2trn to upgrade the country's infrastructure over the next seven years and to support long-term economic growth. We believe the bill will help boost the country's attractiveness to foreign investors in terms of its business environment over the long term.
Our short-term economic rating stands at 75.6.

Wages and salaries Consumption of goods and services Corporate And Social Subsidies Grants

Source: BMI, Ministry Of Finance

BUSINESS ENVIRONMENT

SMEs Not Ready For AEC

An estimated 80% of small- and mediumsized enterprises (SMEs) in Thailand are unprepared for the establishment of the Asean Economic Community (AEC) in 2015, according to the Federation of Thai Industries. Policymakers are becoming increasingly concerned that local SMEs could fail to compete effectively with businesses in neighbouring countries, posing a serious threat to the economy given that 90% of registered businesses in the country are SMEs. We expect the government to introduce further measures over the coming years to encourage SMEs to improve operational and management systems and raise labour productivity.
Our business environment rating stands at 61.7.

Looking forward, however, we note that the government has repeatedly reiterated its commitment to observe its spending limits and guidelines, and has promised to undertake efforts to address the fiscal deficit. Furthermore, given that a significant portion of the expected increase in public spending will go to one-off reconstruction efforts and flood relief programs, we believe that there is significant room for reducing spending from 2013 onwards. In this respect, we remain optimistic that Thailand's fiscal position will gradually improve towards achieving a fiscal balance by around 2016. We also see downside risks that could delay efforts by the government to balance its fiscal budget over the coming years. Looking at the breakdown of the fiscal budget for 2011, we note that corporate and social subsidies make up a modest 1.9% share of the total expenditure. This is dwarfed by civil servant wages and public consumption of goods and services combined, which amount to a dominating 67.0% share of total expenditure. Political pressure on the ruling

According to a report published by the IMF, the government's rice price guarantee scheme introduced in October 2011which effectively provides a promise by the government to purchase the output of rice farmers at above market priceis estimated to amount to a cost of around 1.0% of GDP. As a result of the rice price guarantee scheme, we caution that that the government's finances have become highly exposed to the risk of higher rice prices (although this is not our core view). Although the government has the option of withdrawing the scheme should rice prices climb to a level where farmers will be profitable enough to operate without a subsidy, we note that this would be a politically unfavourable choice for the PTP. The fragile political situation in Thailand further compounds the ruling government's fear of losing voter support should plans to withdraw welfare subsidies such as the rice price scheme be considered. Taking into consideration the factors mentioned above, we nonetheless believe that plans to address the fiscal deficit are achievable given that we expect economic growth to pick up in 2013 and 2014. Thus, tax revenues should see a steady expansion over the coming years, while one-off reconstruction spending tapers off. Accordingly, we expect the fiscal deficit to increase from 1.5% of GDP in 2011 to 2.5% in 2012, followed by a steady reduction in the deficit before achieving fiscal balance by around 2016.

SOUTH EAST ASIA 1 AUGUST 2012

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THAILAND
ECONOMIC OUTLOOK

Current Account Surplus To Come Back Slowly

BMI View: Recent economic data reinforce our view that Thailand will remain at risk of running a current account deficit owing to a depressed external demand environment. A collapse in external demand notwithstanding, we expect a gradual recovery in production capacity and exports to result in a current account surplus of 3.0% of GDP in 2012.
Back in March, we warned that Thailand would become increasingly vulnerable to the risk of running sustained trade deficits and, by extension, current account deficits over the coming months (see our online service, March 14, 'Trade Deficits Add To Concerns Over BOP Outlook'). Indeed, contrary to consensus expectations for a robust rebound in exports as supply-side disruptions from the devastating floods in late 2011 begin to dissipate, recent economic data continue to reinforce our view that external demand will remain depressed in the short term. The latest trade figures published by the Bank of Thailand (BoT) showed that the recent uptick in imports of raw materials and intermediate goods in March (which we regard as a leading indicator for export orders) has indeed proven to be a one-off. Imports of raw materials and intermediate goods contracted by 5.6% y-o-y in April afDATA & FORECASTS
BMI View: Thailand registered the largest monthly outflow of foreign capital from Thai equities in May, in which foreign investors withdrew THB14.7bn (US$0.5bn) from the equity market, compared to an average inflow of THB21bn in the first four months of the year. We see increasing risks that further capital outflows could continue to weigh on
2010 2011e Latest Period

outlook for 2012. Imports of intermediate and capital goods should also begin to moderate as damaged operating capacity come back online. Looking at the main components of the current account, we note that the balance of goods and services has rebounded from a US$1.8bn deficit in Q411 to a mild surplus of US$0.4bn in Q112.
At A Multi-Year Low
Thailand Breakdown Of Current Account, US$mn
10,000 8,000 6,000 4,000 2,000 0 -2,000 -4,000
Q106 Q206 Q306 Q406 Q107 Q207 Q307 Q407 Q108 Q208 Q308 Q408 Q109 Q209 Q309 Q409 Q110 Q210 Q310 Q410 Q111 Q211 Q311 Q411 Q112

ter registering strong 19.4% growth in March while total trade imports also slowed significantly from 25.6% y-o-y to 7.8% over the same period. Trade exports also contracted by 6.6% and 3.7% y-o-y in March and April, resulting in trade deficits of US$4.6bn and US$2.9bn, respectively. We believe that the recent uptick in imports of intermediate goods and manufacturing production activity were mainly due to efforts to replace inventories damaged by the floods and do not reflect a genuine pickup in demand. Unless we start to see a sustained pickup in export orders, we believe that manufacturers will avoid ramping up production too early and risk building up excessive inventory. Looking ahead, we expect trade exports to continue to recover towards levels prior to the floods, albeit at a slow and gradual pace given the backdrop of a depressed external demand

Current account Income account

Goods and services

Source: BMI, Bank Of Thailand

Although we expect the trade balance to run surpluses over coming quarters, we expect the full-year surplus to come in at 6.6% of GDP for 2012, compared to 6.8% of GDP in 2011 and significantly below the average 8.8% of GDP recorded over the past five years (2007-2011). Overall, we expect the current account surplus to come in at 3.0% of GDP in 2012.

the currency. Accordingly, we expect the Thai baht to remain in its depreciatory trend and we are maintaining our year-end target of THB33.00/US$ for the unit.
2012f 2013f 69.2 374.0 12,156.6 5,404 4.4 5.0 -231.2 -1.9 2.8 2.75 32.00 224.3 248.1 23.8 10.6 2.8 188.4 7.9 109,678.4 29.3

Population, mn [1] 68.1 68.5 68.9 Nominal GDP, US$bn [2] 318.6 345.7 347.2 Nominal GDP, THBbn [2] 10,104.8 10,540.1 11,319.7 GDP per capita, US$ [3] 4,675 5,046 5,042 Real GDP growth, % change y-o-y [3] 7.8 0.1 0.3 Q112 4.0 Industrial production index, % y-o-y, ave [2] 8.8 -9.3 4.5 Budget balance, THBbn [2] -150.8 -156.4 -285.4 Budget balance, % of GDP [4] -1.5 -1.5 -2.5 Consumer prices, % y-o-y, eop [2] 3.0 3.6 3.0 Central Bank policy rate, % eop [3] 2.00 3.00 2.75 Exchange rate THB/US$, eop [5] 30.03 31.55 31.58 Jun 33.00 Goods imports, US$bn [2] 161.9 201.9 19.8 Apr 205.6 Goods exports, US$bn [2] 193.7 225.4 16.9 Apr 228.5 Balance of trade in goods, US$bn [2] 31.8 23.5 -2.9 Apr 22.9 Current account, US$bn [2] 13.2 11.9 10.3 Current account, % of GDP [4] 4.1 3.4 3.0 Foreign reserves ex gold, US$bn [6] 167.5 167.4 171.7 May 177.7 Import cover, months g&s [4] 9.7 8.0 8.2 Total external debt stock, US$mn [3] 96,912.8 101,373.9 105,848.5 Total external debt stock, % of GDP [4] 30.4 29.3 30.5 Notes: e BMI estimates. f BMI forecasts. Sources: 1 World Bank/UN/BMI; 2 Bank of Thailand, BMI; 3 Bank of Thailand; 4 BMI calculation; 5 BMI; 6 IFS/BMI.

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AUGUST 2012 SOUTH EAST ASIA 1

CAMBODIA
POLITICAL OUTLOOK

RISK SUMMARY
POLITICAL RISK

Loan Deal Signed

On June 13 the Cambodian government signed deals for nearly US$430mn in loans from Export-Import Bank of China. The loans will be used for the development of two national road projects and a multipurpose dam in Battambang. An extension on the rehabilitation of National Road 6 alone is expected to cost nearly US$250mn. The signing also includes a US$550,000 hospital project donated by the China Foundation for Peace and Development, and the delivery of two Chinese-built MA60 aircraft.
Cambodia's short-term political risk ratings is 66.0 this month.

Risk Of Unrest Growing

BMI View: The ruling Cambodian Peoples Partys overwhelming victory in the recent communal elections suggests there is little threat to its tight grip on power as the 2013 general elections approach. However, there are growing risks of rising public unrest as the issue of land rights and forced evictions heats up.
Cambodians took to the polls on June 3 for communal elections that were seen as a bellwether for the upcoming general elections in 2013. As widely expected, the ruling Cambodian Peoples Party (CPP) took an overwhelming 1,592 of the 1,663 Commune Council Chief positions, with the main opposition parties the Sam Rainsy Party (SRP) and the Human Rights Party (HRP) taking just 22 and 18 respectively. While Prime Minister Hun Sens CPP has a genuinely strong support base among the rural poor, owing to its record in achieving strong growth and stability following years of war, the election results were most likely swayed by the partys underhand tactics. Local election watchdogs claimed the use of civil servants, police and the military to campaign on behalf of the CPP, which, together with the tight control of the media, meant that the elections were far from free and fair. As the general elections approach, it seems like a foregone conclusion that the CPP will maintain its tight grip on power. However, the latest communal polls did
DATA & FORECASTS
BMI View: Cambodian consumer price inflation (CIP) fell to a 14-month low in April to 4.8% y-o-y, down from 5.3% in March and 5.0% in April 2011. While our end-year target of 5.0% faces downside risks owing to the recent sharp drop in global oil and commodity prices, we expect these declines to moderate in the near term, placing renewed upside pressure on price baskets across the region in Q412. For now though, we do not believe that we have seen the trough in CPI, which could fall aggressively in the coming months as the lagged impact of lower raw materials prices feeds through.
2010 2011e Latest Period 2012f 2013f Population, mn [4] 14.1 14.3 14.5 14.7 Nominal GDP, US$bn [5] 11.0 13.3 14.2 15.5 GDP per capita, US$ [5] 776 927 978 1,058 Real GDP growth, % change y-o-y [5] 5.9 6.3 4.8 5.8 Unemployment, % of labour force, eop [5] 5.8 5.2 4.5 4.2 Consumer prices, % y-o-y, eop [2,6] 3.1 4.9 5.0 4.5 Lending rate, %, eop [7] 15.9 15.2 15.0 14.8 Exchange rate KHR/US$, eop [8] 4,053.00 4,039.00 - 4,300.00 4,150.00 Goods exports, US$bn [5] 5.1 6.2 6.9 8.0 Balance of trade in goods, US$bn [5] -1.7 -1.9 -2.1 -2.3 Current account, % of GDP [5] -8.2 -7.6 -7.7 -7.7 Foreign reserves ex gold, US$bn [9] 3.3 3.3 3.4 Jan 3.5 3.7 Import cover, months g&s [9] 5.8 5.0 4.7 4.4 Budget balance, % of GDP [3,5] -7.7 -4.9 -5.0 -4.3 Total external debt stock, % of GDP [5] 47.4 44.1 46.2 46.4 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.

ECONOMIC RISK

Exports To Korea Boom

Cambodia's exports to South Korea jumped 76% y-o-y to US$30mn in Q112, compared with US$17mn in Q111, according to data released by the Korea Trade-Investment Promotion Agency. Korean imports to the country rose by 29% y-o-y to US$130mn during the quarter, compared with US$101mn the previous year, added KOTRA. Total trade between both countries grew 36% y-o-y to US$159.9mn in Q112, compared with US$117.3mn in Q111.
Cambodia's short- and long-term economic risk ratings are 42.9 and 40.4 respectively.

suggest that discontent over the issue of land disputes is fast becoming the main threat to political stability in the country. Growing opposition to foreign investors taking over rural land forced the government to suspend new land concessions to foreign firms in May in a month that saw 13 women sentenced to two and half years in prison for protesting their eviction from the land where their homes once stood. Although a CPP victory at the upcoming general election is almost guaranteed, the opposition could be set to make some inroads. Leaders from the two main opposition parties are set to meet in the Philippines in late June to discuss a merger ahead of next years elections. Respective presidents Kem Sokha and Sam Rainsy have tried unsuccessfully to unite the two parties in the past to no avail, and serious ideological differences make such a union difficult. If successful, a united opposition may chip away at the CPPs dominance, although we still expect the CPP to maintain its stronghold over Cambodian politics.

BUSINESS ENVIRONMENT

Rice Exporters Need Support

Rice millers and exporters in Cambodia have urged the government to continue efforts towards reducing the prices of electricity and transportation. Both areas are seen as major obstructions in achieving the government's target of exporting 1mn tonnes of milled rice by 2015. Although the government has supported the export sector by lowering unnecessary fees and accelerating paperwork, the issues are still affecting the industry. The government is aiming to increase its rice exports by more than two-fold to 400,000 tonnes in 2012, but experts are doubtful as the country's exports to Europe registered a drop at the beginning of 2012. Cambodia recorded a marked growth in milled rice exports from 12,440 tonnes in 2009 to 17,300 tonnes in 2011.
Cambodia's business environment rating is currently 35.5.

SOUTH EAST ASIA 1 AUGUST 2012

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MYANMAR
POLITICAL OUTLOOK

Rakhine Crisis Underlines Deeper Risks

BMI View: The ongoing crisis in Rakhine state underscores the difficult path laid out for Myanmar's government as it pursues widespread economic and political reform, highlighting the country's vast cultural and ethnic divides that could eventually lead to reform fatigue.
Following the National League for Democracy (NLD)'s momentous victory in April's by-elections, in which the party took 44 of 46 contested seats, we have seen more indications of progress towards a functioning democracy in the formerly autocratic pariah state. However, we have also seen growing signs of the government's considerable limitations in effectively managing the country's fast-changing political and economic situation. The major risk in a country like Myanmar is reform fatigue. The pace of reforms in Myanmar has been surprisingly rapid for a government that has only very recently emerged from decades of authoritarian, hard-fisted rule. The regime still faces enormous domestic constraints that are often overlooked in the context of Myanmar's recent progress and its rapid opening up to the outside world. Perhaps chief among these is the country's staggering cultural and racial diversity; although the government recognizes 135 distinct ethnic groups, there are many others that are left in a grey area. One of these groups is the Rohingya, a predominantly Muslim group that mainly resides in western Myanmar and is officially stateless. The Rohingya are largely concentrated in Rakhine state, where it is estimated that they number close to 800,000. The group has been involved in mass riots in Rhakine that saw as many as 500 villagers' homes destroyed and more than 10 people killed amid skirmishes with the mostly Buddhist Rakhines. Following the violence, President Thein Sein ordered a state of emergency for Rakhine state, the first time that he had invoked the act since the beginning of his presidency in early 2011. In a country that has only recently escaped from under the nationwide rule of the military, it goes without saying that allowing the military de facto control over a state is a potentially slippery slope. However, in line with ongoing signs of progress, the government appears to have only reluctantly declared an emergency as it became clear that the situation truly did warrant high level action, and seems to be engaging the military's powers with more gravitas than in the past. Nevertheless, we find that the rapid escalation of serious tensions, and reports of a growing sense of lawlessness in Rakhine state underscore the vast challenges that lay ahead for Myanmar's government. In lieu of its recent advances, the government and military will be under far more scrutiny than before to handle the situation without excessive violence and favoritism. Situations like this will not only test the government's efficacy to govern in regions that are both ethnically and geographically distanced from more central and developed cities like Yangon, Mandalay, and Naypyidaw, but will also be key indicators of the feasibility of its commitment to international human rights standards. In the shorter term, the key risk from the developing Rakhine disaster will be an overly heavy-handed response from the government, possibly leading to widerscale protests or riots elsewhere in the country that could elicit a broader government crackdown. Although we have so far seen no signs of this, such a chain of events could potentially lead to the unwinding of the government's considerable advances and undermine its budding ties with the international community. In a broader sense, conflicts like the one seen in Rakhine state are a valuable contrast to the widespread (and at times overzealous) bullishness towards Myanmar's prospects since the beginning of the current reform drive. The government will need to tread what will often be an extremely thin line if it is to successfully promote both economic development and democracy. Given Myanmar's enormous ethnic, cultural, and geographic diversity, projects and investments that could move the economy forward will often conflict with the will and possibly well-being of local inhabitants.

RISK SUMMARY
POLITICAL RISK

Political Challenges Await

Returning from a landmark tour of five countries in Europe, Aung San Suu Kyi said she would be prepared to serve as president should the opportunity arrive in general elections slated for 2015. Key challenges await Suu Kyi and the National League for Democracy (NLD) party, which gained its first foothold in parliament after by-elections in April. With only 44 out of a total of 664 seats, the NLD will be hard-pressed to make its mark when parliament reconvenes on July 15, and a number of contentious issues such as the ongoing debate over the rights of the Rohingya ethnic group await.
Myanmar's short and long term political risk ratings are 56.5 and 34.7.

ECONOMIC RISK

Strained ADB-Myanmar Ties

The Asian Development Bank (ADB) is pushing Myanmar to put into action recently passed environmental legislation and draft sectoral strategies in key areas such as energy, transport and agriculture. Myanmar sill owes the ADB nearly US$500mn to the organisation. The ADB also recently stated that the US may come under increased pressure to further lift sanctions, as the US Treasury is still compelled to abide by stringent restrictions in its aid dealings with Myanmar that feed through to the ADB and World Bank.
Myanmar's short and long term economic risk ratings are 53.5 and 48.7.

BUSINESS ENVIRONMENT

New International Airport

Myanmar is seeking suuport from foreign investors to build a second international airport in Yangon that could serve up to 10mn passengers per year. Yangon's current international airport, which received extensive renovations and can handle up to 2.7mn passengers per year, served only 1.45mn passengers in 2011. Still, an official has stated that the current Yangon airport, which saw Q112 visitor arrivals jump by 30% in year-on-year terms, will have met its full capacity by the end of 2012, and the lifting of travel restrictions along with a new business visa-on-arrival program is likely to stoke arrivals even further through the rest of the year.

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AUGUST 2012 SOUTH EAST ASIA 1

ASIA

POLITICAL OUTLOOK

Regional Rebalancing: A Labour Market Perspective

BMI View: With Asia facing a sharp slowdown in external demand and a reorganisation of resources away from exports and towards domestic consumption, labour markets across the regional will face significant changes. Other dynamics are also in play, with sharply declining competitiveness in China creating opportunities in other low-cost countries. Thailand appears to face the most significant challenges.
The crisis in the eurozone has illustrated the structural problems within Europe's business environments. In particular, amid a drop in aggregate demand, these countries' rigid labour markets have been exposed, with Spain's unemployment rate rising to an astronomical 24%. With Asia facing declining external demand and a reorganisation away from exports and towards domestic consumption, the prospect for a rise in unemployment is also growing. Other dynamics are also in play, with sharply declining competitiveness in China creating opportunities in other lowcost countries. With these factors in mind, we assess labour market rigidity across the region to see what opportunities and risks lie in wait. Rebalancing Will Be A Major Test For Taiwan And Korea: Our core view is that Asia faces a lengthy period of economic rebalancing away from exports and towards domestic consumption over the coming years. This process is already well under way, but has much further to go. The newly industrialised economies (NIEs) of Taiwan, South Korea, Hong Kong, and Singapore, together with Thailand and Malaysia, are the countries most likely to experience a sharp transition. Even in the freest of labour markets, unemployment tends to rise in the face of economic rebalancing. One thing that makes the process more problematic, however, is the presence of burdensome regulation, which prevents labour moving freely to adapt to the new economic reality. Taiwan sits at the foot of the table in both ratings from the World Banks Doing Business report, and the Heritage Foundations Index of Labour Freedom, reflecting its highly-inflexible labour market. A relatively generous minimum wage is partly the reason, as well as union power and restrictions on hiring foreign graduates. Perhaps the largest wedge placed between the employer and employee is the Employment Insurance Act, which stipulates that involuntarily unemployed workers under 45 years of age can receive 60% of their average insured salary of the last six months of employment for up to six months thereafter. We see these rigidities acting as a significant drag on Taiwan's attractiveness to investment over the coming years, which will hamper the much-needed process of shifting resources away from export industries and towards domestic consumer focussed industries. In the case of South Korea, strong union power seriously inhibits the abilty of businesses to cut costs, and strike action is common. Although we do not believe that the South Korean economy needs to undergo major external rebalancing, and view the country as highly competitive in other areas, any external shock would likely lead to an unemployment spike given these labour market rigidities. Singapore And Hong Kong Can Lead The Way: While Singapore and to a lesser extent Hong Kong face a greater challenge in rebalancing their economies, highly flexible labour markets suggest that these economies can continue to attract investment and maintain low unemployment rates. Both countries score among the highest in the world in terms of labour market flexibility according to the Index of Economic Freedom and our business environment ratings, and we do not expect this to change anytime soon. Malaysia, Thailand Facing Risks: Malaysia is another country that could struggle to maintain strong growth and low unemployment amid a slowdown in global growth and a heavy reliance on exports. The labour market is hampered by a skills shortage and affirmative action policies have dissuaded foreign investment in some areas. The government

introduced a minimum wage law in early May, marking the first time the country has ever looked to regulate the labour market. A similar story holds true for Thailand. While ranking alongside Malaysia as one of the freest labour markets in the region, with limited regulation preventing businesses from hiring and firing, we believe recent changes under Prime Minister Yingluck Shinawatra's new government have been a step in the wrong direction. Minimum wages have been increased markedly in an attempt to support the rural poor, which threatens the country's business environment at a time when regional developments are positing their own threats. End of China's Competitive Dominance: We have argued for a number of years that the clock is ticking on China's global export competitiveness. Indeed, foreign investors are increasingly turning to other areas of the region in the face of sharply rising labour costs on the mainland. China itself faces a major structural obstacle in this respect. Its labour market is one of the least flexible in the region. Not only does the economy still face a shift away from export good producing industries as competitiveness is further eroded, but also away from investment industries and towards domestic-focussed goods and services. The 2009 stimulus threw a major spanner in the works in terms of rebalancing. The demand for construction labour surged owing to the stimulus measures that triggered a infrastructure boom, and the industry now faces a permanent downsizing. The recent surge in minimum wage rates will serve to undermine a smooth transition of the labour force. It seems as though, in some cases, politicians are using minimum wage increases as a means of encouraging domestic consumption, which could lead to an unemployment crisis if aggressively pursued. One major positive breakthrough for the Chinese business environment would be easing hukou restrictions to allow much more flexibility. Although we are optimistic that progress in this area will take place, the options are all very costly and progress seems to have died down in recent months. As such, we expect China's unemployment situation to deteriorate in the coming years and foreign direct investment growth to slow sharply if not contract.
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