Goodbye To All That...From Excees To Deficient Liquidity

Disclosures and Disclaimer This report must be read with the disclosures and analyst

certifications in the Disclosure appendix, and with the Disclaimer, which forms part of it

Principal contributors

Stuart Green* Global Economist+44 20 7991 [email protected]

Stuart Green is HSBC’s Global Economist. Prior to joining HSBC in August 2007, Stuart worked as an economist at a number of theworld’s largest financial institutions, covering the UK, European and US economies.

Stephen King*Chief Economist+44 20 7991 [email protected]

Stephen King is HSBC Group’s Chief Economist. Stephen joined HSBC in 1988, having previously been an economic adviser at theTreasury in the UK. Stephen is a regular economics commentator on television and radio, and since 2001 he has written a weeklycolumn for The Independent, one of the UK’s leading newspapers.

MacroGlobal Economics

Q1 2008

By Stephen King and Stuart Green

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* Employed by non-US affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to NYSE and/or NASD regulations.

Goodbye to all thatFrom excess to deficient liquidity…...as the credit squeeze threatens the transatlantic economies…...but can de-coupled emerging markets limit the damage?

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Macro Global Economics Q1 2008

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Goodbye to all that It was good while it lasted. The excess liquidity of recent years was, though, bound to come to an end at

some point. Whereas we’d thought the borrowers – notably American households – would bear the brunt

of any adjustment, it’s the lenders who, so far, have suffered the most.

This creates an international dimension to the sub-prime crisis. The lenders are, of course, not confined to

US banks. Through securitisation and the innovation of ever-more-complex financial products, all sorts of

international investors have found themselves burdened with now often-worthless sub-prime debt.

Apart from raising some obvious questions about the funding of the US current account deficit – which,

in recent years, has been increasingly dependent on the sale of mortgage-backed securities to sometimes

unsuspecting foreigners – the scale of the crisis raises doubts about the securitisation model. After all,

this was the process through which the danger of banking crises was supposedly reduced through the

spread of risk ever-more thinly.

The excess liquidity of recent years has gone down the plughole. In its place is a credit squeeze. The persistence of elevated money market rates over recent months indicates a financial system in crisis. Banks fret about their off-balance sheet and counterparty risks. Business models are threatened by a loss of faith in securitisation. With the financial sector becoming ever more cautious, we are making downgrades to our growth forecasts for the transatlantic economies. As growth softens, and the credit squeeze intensifies, we expect more aggressive rate cuts from the major central banks. Fed funds may fall to just 3% by the final quarter of 2008. Lower US rates will lead to looser monetary conditions in the emerging markets, allowing domestic demand in the emerging world to hold up surprisingly well. However, strong emerging market growth points to elevated commodity prices, making the control of inflation more difficult in the developed world. Central bankers may not be able to cut interest rates as far as they would like to. In response, budget deficits may end up a lot bigger than they are today.

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Instead, we are left with investors who have a sense of revulsion towards many previously-popular

products and a bunch of hitherto off-balance sheet assets which are rapidly being brought back onto

banks’ balance sheets. The net result is a financial system in crisis.

What does this mean for the global economy? We raise four questions. What is the direct impact of the

financial crisis on the transatlantic economies, which seem to have the biggest exposures? What happens

to inflationary pressures, which have yet to ride off into the sunset? Can emerging markets continue their

de-coupled journey? And, if they do, can they offer any respite for those in the eye of the credit storm?

The direct impact It’s early days, but already there are some signs of weaker transatlantic economic activity. The

momentum of economic growth has slowed and credit surveys show a significant tightening of

conditions. These effects are likely to continue. In our view, the links between official interest rates,

broader financial conditions and the overall economy are becoming increasingly unstable.

With the US housing market already in crisis, with the UK housing market threatening to move in the

same direction and with bad assets springing up all over the place, we are making downgrades to our

developed world growth outlook. We now expect developed economy GDP growth of just 1.8% in 2008,

mostly a reflection of growth downgrades to the US, the UK and the eurozone.

Inflationary pressures Although growth is slowing, inflationary pressures are not going away very easily. With eurozone

inflation above 3%, it’s no great surprise that hopes of sustained interest rate reductions are not held with

as much conviction as might seem appropriate in the light of an ongoing credit squeeze.

The persistence of inflation reflects the shifting balance of global growth. With a bigger proportion of the

world’s economic expansion accounted for by emerging markets, commodity prices are unusually

elevated. Many emerging economies are at a stage of development which is very commodity-intensive.

Global growth weighted towards emerging markets thus tends to have a very high income elasticity of

demand for commodities.

Elevated commodity prices have led to a deteriorating trade off between growth and inflation in the

developed world, reflecting a worsening terms of trade. This doesn’t necessarily mean that central banks

should not be cutting interest rates – if the financial system is gummed up, the case for action remains

strong – but it certainly suggests that central banks may proceed with unusual caution.

De-coupling With chill recessionary wind swirling over the transatlantic economies, fears of a repeat of 2001, when

emerging markets were hit hard, are on the rise. However, the 2001 economic downswing was a

reflection of global technology risk, whereas the latest situation seems to be more a transatlantic housing

and credit risk. While there’s a good chance that global imbalances will unwind further – partly because

the US will no longer easily be able to fund its deficit through the sales of copious quantities of mortgage-

backed securities – part of the unwinding is likely to come not so much from collapsing US imports but,

instead, from elevated demand in the emerging world.

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Although many people argue the case for revaluations of emerging market currencies, enthusiasm for

such adjustments is likely to dwindle as fears of a major US downswing take hold. Why revalue if your

exports are also likely to be hit by a sudden loss of US demand? Instead, emerging economies will

continue to tie their currencies to the US dollar and, hence, their monetary policies to the Federal Reserve.

With falling Fed funds, emerging market monetary conditions will loosen, leading to strong domestic

demand growth and relatively high inflation.

This is unlikely to be sustainable forever – a similar situation occurred in the early-1990s yet was

followed eventually by the Mexican and Asian crises – but the knee-jerk assumption that a transatlantic

slowdown will drag the whole world into a recessionary mire may not be correct. We expect the gap

between developed and emerging world growth to widen in 2008.

Respite Buoyant emerging market performance may be just enough to prevent the transatlantic economies from

going into recession. While domestic demand in the US, the UK and parts of the eurozone will be under

the cosh, exports may continue to surprise in the light of the emerging markets boom. Nevertheless, fears

of a recessionary downswing are likely to dominate the newspaper headlines in the months ahead.

Central banks will continue to inject liquidity in the hope of restoring order to money markets but, even if

they succeed, the crisis may already be moving into a second phase, where banks begin to cut back on

their lending to the economy at large. At the very least, this will require further interest rate reductions.

We expect Fed funds to drop to just 3% by the end of 2008, with Bank of England bank rate down to

4.5% and the ECB repo rate down to 3.75%.

Will this be enough to return the transatlantic economies to economic health? Monetary action will certainly

be a welcome shot in the arm, but if we’re in the middle of a balance sheet deflation – the reverse of the excess

liquidity boom of earlier years – more controversial action may eventually be required. Bad debts may have to

be removed from the financial system with the use of taxpayers’ money. Homeowners who can no longer

afford rising monthly repayments may need government help if a sudden rise in foreclosures is to be avoided.

And, ultimately, if the financial system really is failing to function properly, governments may have to

bypass the banking system to put money back into the economy. The most obvious way to do that is to

sell government bonds to the central bank and use the proceeds to deliver monetised tax cuts. A long way

off, perhaps, but there are ways of pumping up the economy even when the normal transmission

mechanism of monetary policy is broken.

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Key forecasts 6

Monetary & fiscal policy assumptions 7

Goodbye to All That 8 From liquidity to drought 8

The key issues 10

Inflation the emerging concern 14

US still the global price-setter? 15

Link to US manufacturing has eroded 15

Not just a dollar issue or speculation 16

Decoupling – fact not fiction 17

Resolving global imbalances 18

Reaching conclusions 20

Global economic forecasts 23 GDP 24

Consumer prices 26

Short rates 28

Long rates 29

Exchange rates vs USD 30

Exchange rate vs EUR & GBP 31

Consumer spending 32

Investment spending 33

Exports 34

Industrial production 35

Wage growth 36

Budget balance 37

Current account 38

Country and territory sections US 40 Canada 42 Mexico 44 Brazil 45 Argentina 46 Chile 47 Eurozone 48 Germany 50 France 52 Italy 54 Spain 56 UK 58 Norway 60 Sweden 61 Switzerland 62 Hungary 63 Poland 64 Russia 65 Turkey 66 Saudi Arabia 67 South Africa 68 Japan 69 Australia 71 New Zealand 72 China 73 Hong Kong SAR 74 India 75 Indonesia 76 Malaysia 77 Philippines 78 Singapore 79 South Korea 80 Taiwan 81 Thailand 82 Vietnam 83

Disclosure appendix 84

Disclaimer 87

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Key forecasts

__________________ GDP ________________ _______________ Inflation ________________ 2006 2007f 2008f 2009f 2006 2007f 2008f 2009f

World (nominal GDP weights) 3.8 3.5 3.0 3.5 2.7 2.8 2.9 2.4 World (PPP weights) 5.2 5.0 4.5 4.7 3.2 3.6 3.6 3.1 Developed 2.8 2.4 1.8 2.4 2.3 2.1 2.1 1.7 Emerging 7.3 7.3 7.0 6.8 4.3 5.4 5.5 4.8

North America 2.9 2.2 2.0 3.0 3.1 2.8 2.4 2.0 US 2.9 2.2 1.9 3.0 3.2 2.8 2.4 2.0 Canada 2.8 2.6 2.1 2.2 2.0 2.1 1.6 1.8

Latin America 4.7 4.6 4.4 4.2 4.2 4.7 5.0 4.4 Mexico 4.8 3.1 3.3 4.1 4.1 3.8 4.0 3.3 Brazil 3.7 5.4 5.0 3.7 3.1 4.4 5.0 4.5 Argentina 8.5 7.8 6.2 5.4 9.8 8.5 9.3 9.5 Chile 4.0 5.5 5.2 5.1 2.1 7.7 3.5 3.0

Western Europe 2.9 2.7 1.6 1.9 2.1 2.1 2.4 1.9 Euro-13 2.9 2.6 1.6 1.8 2.2 2.1 2.6 1.9

Germany 3.1 2.6 1.6 2.0 1.8 2.3 2.3 1.5 France 2.2 1.9 1.7 1.8 1.9 1.6 2.2 2.0 Italy 1.9 1.7 1.0 1.3 2.2 2.0 2.7 1.8 Spain 3.9 3.8 2.4 2.8 3.6 2.8 3.7 2.4

Other Western Europe 3.1 3.0 1.7 2.2 2.0 2.0 2.0 1.8 UK 2.8 3.2 1.5 2.1 2.3 2.3 1.8 1.7 Norway 2.1 3.3 2.8 3.1 2.3 0.8 3.0 2.5 Sweden 4.4 2.6 2.3 2.7 1.4 2.2 2.6 2.3 Switzerland 3.2 2.8 1.9 1.8 1.1 0.7 1.7 1.2

EMEA 6.0 5.8 5.8 5.6 5.8 7.9 7.3 5.9 Czech Republic 6.4 5.7 5.2 5.0 2.6 2.7 3.7 2.5 Hungary 3.8 1.6 3.3 4.5 3.9 7.9 5.3 3.0 Poland 6.1 6.6 5.6 5.2 1.0 2.7 3.5 2.1 Russia 6.7 7.6 6.7 6.0 9.0 11.9 11.0 9.0 Turkey 6.1 4.4 5.5 5.4 9.6 8.8 8.0 5.7 Ukraine 7.1 7.1 6.8 7.0 9.1 12.8 6.0 5.5 Egypt* 6.8 7.1 6.4 6.2 4.2 9.6 6.5 6.2 Israel 5.2 5.5 4.4 4.2 -0.1 3.1 2.9 2.4 Saudi Arabia 4.3 3.5 5.7 6.3 2.3 3.9 5.4 4.5 UAE 9.4 6.6 7.4 6.8 10.5 9.5 9.0 8.7 South Africa 5.0 5.4 5.3 5.0 4.6 6.5 6.3 5.5

Asia-Pacific 5.3 5.3 5.1 5.3 2.0 2.2 2.6 2.4 Japan 2.4 1.9 1.6 2.2 0.2 0.0 0.4 0.4 Australia 2.8 3.9 4.5 4.3 3.5 2.3 3.2 2.7 New Zealand 1.9 3.4 2.4 2.7 3.4 2.6 2.5 2.5

Asia ex Japan 8.8 8.9 8.4 8.1 3.6 4.4 4.8 4.2 China 11.1 11.4 11.0 10.5 1.5 4.7 4.1 3.0

Asia ex Japan & China 6.8 6.7 6.0 5.9 5.2 4.2 5.3 5.2 Hong Kong 6.8 5.9 5.0 4.5 2.0 2.0 3.9 4.3 India 9.6 8.9 7.1 7.4 6.3 6.4 6.8 6.9 Indonesia 5.5 6.3 6.5 5.3 13.1 6.5 8.5 8.6 Malaysia 5.9 6.2 6.2 5.8 3.6 2.0 2.8 2.6 Philippines 5.4 6.9 5.9 5.6 6.3 2.7 4.1 4.6 Singapore 7.9 8.1 7.3 6.5 1.0 2.0 3.9 1.6 South Korea 5.0 4.8 4.5 4.7 2.2 2.5 3.3 3.2 Taiwan 4.9 5.0 4.0 4.5 0.6 1.6 2.4 1.9 Thailand 5.1 4.4 5.0 4.6 4.7 2.3 3.1 2.5 Vietnam 8.2 8.3 8.5 8.1 7.5 8.1 9.9 7.1

Notes: Calendar year; except for * which is based upon Egyptian fiscal year (July-June); Global and regional aggregates are calculated using chain nominal GDP (USD) weights Source: HSBC

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Monetary policy

Q1 2007 Q2 2007 Q3 2007f Q4 2007 Q1 2008f Q2 2008f Q3 2008f Q4 2008f

US Targeted Fed funds 5.25 5.25 4.75 4.25 4.00 3.75 3.25 3.00

Japan Overnight call rate 0.50 0.50 0.50 0.50 0.50 0.50 0.75 0.75

Eurozone Repo rate 3.75 4.00 4.00 4.00 4.00 3.75 3.75 3.75

UK Base rate 5.25 5.50 5.75 5.50 5.25 5.00 4.75 4.50

Canada Overnight rate 4.25 4.25 4.50 4.25 4.00 3.75 3.50 3.50

Source: HSBC

Fiscal policy

Country 2007 2008

US The federal budget deficit in FY2007 was USD163bn, or about 1.2% of GDP. Receipts totalled USD2,568bn, an increase of 6.7% from FY2006. Outlays rose to USD2,731bn, up 2.9% from FY2006. Defence outlays increased by 6.6%, while combined Medicare and Medicaid spending rose 9.7%. These were offset by declines in other spending, including for disaster assistance and student loan programs.

We expect the federal budget deficit in FY2008 to be USD240bn (about 1.7% of GDP). Outlays could rise by around 8%, while expected revenue growth of 5% reflects a slowdown in GDP growth. The Treasury department will soon release a new tax study with suggestions on lowering corporate taxes, although no specific legislation has been recommended yet.

Japan Fiscal policy is expected to tighten about the same degree as in 2006, as the other half of the 1999 income tax cuts are rolled back. This, together with another round of increases of public pension contribution rates, should keep the fiscal drag at around 0.5% of GDP.

The degree of fiscal policy tightening should diminish, since no major tax hikes are expected. However, there will continue to be fiscal drag from annual hikes in social security premiums and steady cuts in public capital formation.

Eurozone Fiscal policy was tightened by around 0.6% of GDP) in 2007, mainly reflecting the impact of the German and Italian fiscal measures (see below).

Fiscal performance is expected to be roughly neutral with a small bias towards loosening, largely reflecting France and Spain. Note the latter is still likely to be the only EMU big 4 economy running a fiscal surplus. The Eurozone deficit should stay around 1.0% of GDP.

Germany The deficit is projected to fall to 0.2% of GDP (2006: -1.6%). The financial effects of the taxation measures which started in January 2007 (including the VAT rate hike) should boost revenues by around 1 % of GDP. However, the better fiscal position is only partly driven by an improved structural position.

The key element of the tax reform is the reduction of the corporate tax rate to 15 % from 25 %. Thus, the corporate tax rate burden should decline from around 38.7% to 29.8%. The unemployment contribution rate will decline to 3.3% from 4.2%. How-ever, the time period of benefits for older unemployed persons will be enlarged.

France The deficit is likely to be slightly higher than government projections, which were based on a 2.25% growth forecast, whereas we expect growth of 1.9%. The deficit could reach 2.6% in 2007, since tax revenues are likely to suffer from the slowdown in consumer spending. However, corporate income tax revenues should remain robust. Changes in taxation will lead to slower growth in tax revenues in late 2007, but their full impact will come in 2008.

On our calculations, measures announced and passed will result in tax revenue growing more slowly than the government expects. In addition, the government will use the proceeds of selling a 3% stake in EDF for public spending, not debt reduction. The measures announced to limit growth in public spending are marginal, and are unlikely to have much of an impact in 2008. As a result, the deficit could move close to 3% if the economy were to grow by 1.7% in 2008.

Italy Italy’s reduction of its fiscal deficit to about 2.4% of GDP this year from 4.4% in 2006 has been impressive, although the 2006 budget was negatively affected by one off factors. The 2007 budget was also helped by higher income through tax rises.

Italy’s debt burden remains high (107% of GDP in 2006) and hence fiscal “austerity” has to continue. The 2008 budget includes a sizeable cut in corporate taxes. Combined with slower economic growth, this implies a widening of the budget deficit, although we expect it stay below 3% of GDP.

UK In the pre-budget report (PBR) the Chancellor revised up total borrowing to £38bn. Taking into account public borrowing to date, it looks again as though the Chancellor will end up borrowing more than anticipated.

The PBR projected an overall borrowing of £36bn in FY08-09. In our less optimistic GDP projections we expect borrowing of nearer £40bn. The removal of a capital allowance for corporates in April 08 is likely to lead to a large increase in investment in the first quarter of 2008 and subsequent fallback.

Canada Canada continued to run a budgetary surplus of CAD9.3bn in the first six months of the fiscal year, from April through September. This is on track to meet the Government’s projected underlying surplus of CAD11.6bn for FY2007-08, taking into account the CAD4.8bn of tax reductions proposed in October. The Government plan calls for debt reduction of CAD10bn this year.

Canada is expected to maintain a small budgetary surplus in FY2008-2009. Weaker than expected revenues would be offset by a scaling back in debt reduction plans.

Source: HSBC

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From liquidity to drought No one ever defined it precisely but, in the first

half of 2007, the world was awash with excess

liquidity. Funds were freely available for all

manner of ventures, whether they involved house

purchases, private equity, leveraged buyouts or

emerging market equities. Central banks fretted

about this excess liquidity, fearing that an absence

of investor discretion would eventually lead to

dire economic consequences.

1. Houses have looked expensive in the US…

4

5

6

7

84 87 90 93 96 99 02 05

4

5

6

7

House price-to-earnings ratio

House price to av.earnings

House price toav.earnings

US

Source: Thomson Financial Datastream, and HSBC

2…and in the UK

4

5

6

7

8

9

10

84 86 88 90 92 94 96 98 00 02 04 06 084

5

6

7

8

9

10

House price-to-earnings ratio

House prices to av. earnings

House prices to av. earnings

UK

Source: Halifax, ONS, and Thomson Financial Datastream

3. Rising house prices formed the collateral for more debt…

60

80

100

120

140

90 92 94 96 98 00 02 04 06

60

80

100

120

140

% disposable income

% disposable income

US household debt


� From excess to deficient liquidity…

� …as the credit squeeze threatens the transatlantic economies…

� …but can de-coupled emerging markets limit the damage?

Stephen King Economist HSBC Bank plc (UK) +44 20 7991 6700 [email protected]

Stuart Green Economist HSBC Bank plc (UK) +44 20 7991 6718 [email protected]

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4…..encouraging a transatlantic borrowing binge

80

100

120

140

160

90 92 94 96 98 00 02 04 06

80

100

120

140

160

% disposableincome

% disposable income

UK household debt


5. Global private equity activity doesn’t look quite so healthy

0

500

1000

1500

2000

Jan-00 Jan-02 Jan-04 Jan-06

0

100

200

300

400

500

600

by number (LHS) by value (RHS)

USDbnPrivate equity deals

Source: HSBC

And now the liquidity has dried up. Ahead of

them, central bankers can now only see a parched

economic landscape where, once, money flowed all

too freely. We have gone from a flood to a dribble,

a change of quite extraordinary proportions. And

so far, despite the central banks’ best efforts, the

drought continues.

Admittedly, this is an overstatement. Credit growth

remains firm in many parts of the world. Across

emerging markets, economies are booming and

inflation is very much on the rise. But for the

transatlantic economies – the US, Canada, the UK

and parts of the eurozone – the credit shock has been

sizeable. Most obviously, since July, money market

interest rates have remained at remarkably elevated

levels despite a range of central bank initiatives

designed to bring them back down again. Official

interest rates have been cut, liquidity has been

injected and eligible collateral has been increased yet

all, until recently, to little avail.

6. Inflation has been rising in emerging markets

-10

0

10

20

05 06 07

-10

0

10

20

Brazil China Mexico Russia

% Yr % YrConsumer price inflation


7. Money market rates are elevated in the US…

4.0

4.5

5.0

5.5

6.0

06 07 08

4.0

4.5

5.0

5.5

6.0

3 month interbank rate Fed Funds target rate

% %US


8…in the UK…

4.0

5.0

6.0

7.0

06 07 08

4.0

5.0

6.0

7.0

3 month interbank rate BoE base rate

% %UK


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9…and in the eurozone

2.0

3.0

4.0

5.0

06 07 082.0

3.0

4.0

5.0

3 month interbank rate ECB repo rate

%% Eurozone


That this has been, so far, a transatlantic problem

is, perhaps, no great surprise. We argued in “Be

careful what you wish for” (21 November 2007)

that the US housing crisis had become more a

problem for the international lender than for the

domestic borrower. We noted, in particular, that

the rest of the world had been happily buying US

asset backed securities and argued that most of the

foreign investors probably resided in Europe.

This, of course, fits very easily with the bad news

stemming from both the US and the European

banking sectors. It’s worth noting, for example,

that IKB and Sachsen Bank, two small German

institutions, proved to be the canaries in the

mineshaft for the latest crisis.

The key issues Where, though, do we go now? There are four

key issues:

� What does the drying-up of liquidity entail for

domestic economic performance in the

affected countries and regions?

� Even if, in some areas, liquidity has dried up,

are we yet safely out of the inflationary woods?

� If some countries are hit through a credit

crunch, will others be dragged down as well?

Or, alternatively, are we living in a truly de-

coupled world?

� And, if we are in a de-coupled world, will

there be any positive feedback effects from

strong growth in the emerging markets back

into the credit-constrained economies?

The absence of liquidity has to be seen in the

context of the earlier period of excess. We’ve

argued before (see “Fear and Loathing”, Global

Economics, 2007Q4) that, apart from the obvious

impact of low US interest rates earlier in the

decade, one of the biggest influences on excess

liquidity was the actions of emerging market

central bank reserve managers, who invested their

burgeoning reserves in mostly safe assets

including vast amounts of government paper. By

doing so, yields on these assets were driven down

to unusually low levels, thereby encouraging

10. US Corporate bonds – including asset-backed securities – seem to be mostly held in Europe

Japan

UK

China

Euro Area

Middle East

Oil Exporters

Non-China Emerging

Asia

Offshore Financial Centres

Portfolio weights* Equities 16.3 46.5 0.5 36.8 51.3 22.2 36.3 Treasuries 61.1 9.0 56.5 12.6 34.0 47.7 10.2 Agencies 13.1 4.5 36.1 9.3 8.8 21.8 10.8 Corporates 9.6 40.0 6.9 41.4 6.0 8.3 42.8 Total exposure to US assets In percent of GDP** 23.9 25.4 23.7 12.3 20.3 18.8 -

Notes: * Breakdown of portfolio holdings of US assets ** This cannot be calculated for offshore financial centres because GDP is not available for all offshore financial systems from TICS data. Data in percent; holdings as of June 30 2005. Corporates include asset backed securities. Source: IMF

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institutional investors to look elsewhere for

returns. The appetite for more exotic products –

asset backed securities (and, within them,

mortgage backed securities), collateralised debt

obligations and their ilk – started to increase.

Securitisation expanded rapidly and, as it did, the

gap between ultimate borrower and ultimate

lender widened more and more.

11. Emerging market central banks hold a lot of reserves

50010001500200025003000350040004500

00 01 02 03 04 05 06 07

50010001500200025003000350040004500

Developing Countries Developed Countries

Total foreign exchange reserve holdings USDbnUSDbn

Source: HSBC

12. They’ve invested the reserves in government paper, keeping yields well below consensus expectations*

3

4

5

6

7

00 01 02 03 04 05 06 07 08

3

4

5

6

7

% %US 10-yr bond yield

Note: * Red line shows consensus forecast made at the beginning of each year for the end of that year.

Source: Thomson Financial Datastream, and HSBC.

For a while, many commentators argued that

securitisation was entirely a good thing. Risks

which used to reside in lumpy fashion within the

banking system were now spread very thinly

across a wide range of investors, apparently

reducing the danger of an old-fashioned banking

crisis. This argument, though, has unravelled all

too rapidly. First, too many “bad” assets were

bundled together and sold off to unsuspecting

investors who will now look twice before buying

exotic products. Second, too many of the bad

assets were hidden away in banks’ own off-

balance sheet vehicles, such as conduits and SIVs.

Far from being spread thinly, many risky apples

didn’t fall far from the tree.

13. Most issuance of asset backed securities has been mortgage backed securities

-2.0

0.0

2.0

4.0

6.0

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07

-2.0

0.0

2.0

4.0

6.0

Total Mortgages Other

% GDP% GDP Issuers of ABS - Net acquisition of financial assets


Since our last Global Economics quarterly, the

situation has worsened. The money market

strains which the majority of central banks

thought would only be temporary have persisted.

The strategies adopted by the central banks to deal

with these problems have succeeded only very

recently, and the effects may not last. Meanwhile,

there are increasing signs that the money market

crisis is beginning to spill over into the economy

at large. Credit surveys in the US, the eurozone

and the UK suggest that, for a given level of

official interest rates, credit conditions are being

tightened. October’s Federal Reserve Senior

Loan Officers’ Survey, for example, suggested

banks were busily tightening their lending

standards to mortgage-seeking households and

also to real estate companies.

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14. Some initial signs that credit conditions are becoming more awkward for US commercial and industrial companies

-30

-10

10

30

50

70

90 92 94 96 98 00 02 04 06

-30

-10

10

30

50

70

Loans to large and medium-sized firmsLoans to small firms

% %

July survey

Domestic respondents tightening standards for C&I loans

Source: US Federal Reserve

15. Loan rate spreads over cost of funds are widening

-80

-40

0

40

80

90 93 96 99 02 05

-80

-40

0

40

80

Loans to small firmsLoans to large and medium-sized firms

%% Domestic respondents increasing spreads of loan rates over Banks’ costs of funds

July survey


16. Commercial real estate is facing a tough time

-40

-20

0

20

40

60

80

90 92 94 96 98 00 02 04 06

-40

-20

0

20

40

60

80

%% Domestic respondents tightening standards for commercial real estate loans

July survey


17. Households suddenly can’t get mortgages

-20

0

20

40

60

90 92 94 96 98 00 02 04 06

-20

0

20

40

60

Prime NontraditionalSubprime All residential

% %Domestic respondents tightening standards for residential mortgage loans


None of this should come as any great surprise.

After all, the bottom has fallen out of the mortgage

backed securities market, as revealed in the Fed’s

flow of funds accounts. After many years where

funding from the sale of mortgage backed securities

grew almost exponentially, the third quarter of 2007

showed an extraordinary collapse, as a global

buyers’ strike took hold. Fortunately for the US

housing market, the Federal Home Loan Banks

plugged the gap in the third quarter but, without

new funds, this mechanism won’t last indefinitely.

18. US Financial sector borrowing/issuance* - GSE’s have stepped in as securitisation has dried up

-500

0

500

1000

1500

-500

0

500

1000

1500

Q106 Q206 Q306 Q406 Q107 Q207 Q307

Open market paper + Corporate bondsGSE issuesAgency- and GSE-backed mortgage pool sec. Bank loans n.e.cOther loans and advances (FHLB & foreign loans)

Note: *All figures are US$bn, seasonally adjusted annual rates

Source: HSBC, Federal Reserve

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The persistence of wide money market spreads,

together with government bond yields lower than

could reasonably be justified on the back of

incoming economic data, suggests a major shift in

asset preference. If asset backed securities and

their various derivatives are no longer flavour of

the month, cash and near-cash alternatives very

much are. Government bonds, after all, are

backed by the taxpayer and, therefore, are a lot

safer than the various tranches of collateralised

debt obligations backed by low quality assets,

whatever the rating agencies used to claim.

19. Economic data surprises can’t explain low bond yields

0

5

10

15

20

25

30

Jan-06 May-06 Sep-06 Jan-07 May-07 Sep-07

3.8

4.3

4.8

5.3

US surprise index (LHS) 10 yr bond yield (RHS)

%Index


Cash and near-cash substitutes are basically being

hoarded. The implications are easily spelt out

through the use of the famous Fisher identity,

MV ��

velocity of circulation, P is the price level and T is

the volume of transactions (hence PT is the same as

nominal GDP). Money hoarding simply means a

collapse in velocity (V) which, other things equal,

will tend to depress PT, thereby pointing to lower

levels of activity and inflation. The obvious way

out of this is to boost M which is why central banks

are happily pumping money into the system.

However, the vast bulk of money is not created by

central banks. Most of it is endogenous to the

banking system and depends for its existence on

rising collateral values. If, for example, asset

backed securities rise in value, they can be used as

collateral against which banks will extend more

loans. If, instead, the securities fall in value, banks

may be more reluctant to create loans, in which case

monetary growth is likely to be curtailed.

Expressed this way, it’s not so surprising that

central banks have struggled to reinvigorate the

transatlantic monetary system. While they’re

pumping money into the economy, the banks are

licking their wounds from persistently declining

values (and, in some cases, an inability to offer

any value) on a range of hitherto reliable financial

products. Declining collateral values have, in

turn, inflated counterparty risk, placed a stake

through the heart of the securitisation model and

led banks to doubt whether, at any point in recent

years, they had enough liquidity on their balance

sheets to deal with possible crises.

Thus a gap has opened up between official

interest rates and the ultimate performance of

transatlantic economies. Economic models

typically assume that banking systems are stable

and function smoothly across the economic cycle.

The latest episode suggests these models now

have to be radically re-calibrated. Those who rely

on Taylor rules, for example, will have to think

again because the connection between official

interest rates, growth, spare capacity and inflation

is in danger of breaking down.

If so, many of the factors that have driven buoyant

economic activity in recent years will go into

reverse. If excess liquidity led to rapid house

price inflation, house prices are likely to fall. If

people borrowed excessively on the back of ever-

rising house prices, they may now have to repay

debt. If stock prices were buoyant in response to

the perceived extra demand created by private

equity and leveraged buyouts, then they may now

struggle to perform quite so well. If banks were

happy to extend more and more loans on the back

of ever-rising collateral, they may have to think

again. And if securitisation as a whole goes into

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reverse, even for only a modest period of time,

then the transatlantic economy will be facing

some very chill winds indeed. If there was excess

liquidity, it’s now time to say goodbye to all that.

Inflation the emerging concern Just as the outlook for global liquidity has turned

less certain, however, so too has that for inflation.

The stellar rise in commodity prices (see chart 20)

over recent years has undoubtedly forced a more

lively debate around the inflationary outlook, and

indeed how the globalisation theme has influenced

developed economy inflation. The greater influence

of global rather than country-specific factors in the

determination of domestic inflation levels has for

the most part been viewed as a beneficial

development, facilitating a period of low and stable

inflation within the G7 economies over the past

decade. The augmentation of significant capacity

into the global supply chain, it is argued, has

allowed for a more sustained period of robust, non-

inflationary growth in developed economies than

could otherwise have been expected.

20. Real commodity prices*: some prices have gone through the roof

0

50

100

150

200

250

300

350

400

90 92 94 96 98 00 02 04 06

0

50

100

150

200

250

300

350

400

Food Agric. RM Metals Oil

Note: *IMF commodity price series deflated by US CPI

Source: Thomson Financial Datastream, IMF, and HSBC

Such a trend may, for instance, go a long way to

explaining the persistent tendency to over-

estimate developed economy bond yields over the

past decade shown earlier in chart 12. But whilst

the threat of overseas competition may have

helped to contain wage and manufactured goods

prices in developed economies, the rise in

commodity prices that has accompanied the rapid

growth in emerging markets - as part of the

globalisation process - suggests that this may

increasingly be seen as a relative rather than

absolute shift in the price level.

At present, most inflationary pressures relate to

the profile of energy and food prices, particularly

within the emerging world where such elements

directly account for a disproportionately large

share of the movement in consumer price indices.

Although supply factors are important, we’re

focussing here on the demand for commodities,

and in particular the impact of the rapid expansion

of the BRIC (Brazil, Russia, India and China)

economies. Their outsize demand for resources

may have contributed to a sustained boom in

commodity prices that has prompted a fresh

deterioration in the inflation outlook in both

developed and emerging economies.

The linkages between the industrialised and

emerging worlds, therefore, could be about to

assume a new dimension. If the round of early

interest rate cuts in the United States provides a

further stimulus to emerging markets, and by

extension commodities, then the associated threat

to price stability may eventually prove to be a

constraining influence upon particularly those

central banks in developed economies that have an

acute hatred of inflation. As such, policymakers

across the globe may face a plethora of unhelpful

external influences. A policy mix that fails to

satisfactorily address developed economy growth

concerns or the threat of inflation in the

developing world could easily result.

For example, the surge in Euro-zone inflation of

the past few months, hitting 3.1% in November,

has proved worse than even the most pessimistic

forecasts. Although the headline rate may peak in

the next few months as the base effects turn more

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15


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favourable, this development has certainly

provided the opportunity for the European Central

Bank (ECB) to reiterate its overriding

commitment to price stability, as if such an

invitation were ever needed. The extent to which

this inflationary spike will constrain policymakers

in the Euro-zone is rather a moot point at present,

given that interest rate cuts are not expected for

several months. Nevertheless, as with earlier

comments from the Federal Reserve, the inflation

risk cannot be easily dismissed.

US still the global price-setter? Of key relevance to the current situation is the

relationship between commodity prices and the

changing composition of global growth. In a note

published at the beginning of 2007, (see “A

Shifting Centre of Gravity”, January 2007) we

outlined the rising economic leadership of the

emerging economies within a global context - in

essence the ‘decoupling story’ – and the

supportive impact this was exerting on the US

economy as rising export demand helped offset

the impact of the housing recession.

The likely consequences for certain commodities

markets, metals in particular, from this process

were also detailed. Essentially, emerging nations

possess a higher income elasticity of demand for

commodities than developed economies, with

most estimates of China’s income elasticity of

demand for oil being close to double that of the

typical OECD economy. The price elasticity of

demand of emerging economies is also thought to

be lower, due to the more limited opportunities to

switch to alternative energy inputs, implying less

substitution away from oil than a $100 per barrel

price would typically suggest.

A greater concentration of global growth within

such economies will, by extension, influence

commodity demand to a greater extent than the

headline activity data alone may indicate. Rather

than experiencing a one-off shift in demand,

therefore, the rapid pace of industrialisation in the

BRIC economies may instead exert a progressive,

sustained influence upon commodity markets.

This point is of crucial importance to the broader

inflationary outlook and, as such, the degree to

which a new inflation (or terms of trade)

constraint may be imposed upon policymakers in

industrialised economies even as domestic activity

slows. Importantly, the US economy may no

longer be the price setter of commodity prices,

with the composition as well as the level of global

growth proving increasingly influential.

Link to US manufacturing has eroded Comparing the monthly changes in a broad index

of commodity prices, such as the Standard &

Poor’s Goldman Sachs Commodity Index (S&P

GSCI), and US manufacturing output over time

certainly highlights an apparent breakdown in

previously well established pricing relationships.

The S&P GSCI is seen as a particularly useful

measure of commodity price inflation due to its

production weighting basis. Here, the relative

importance of each commodity price movement

within the overall index is determined by its share

of global commodity production, and by extension

its economic importance.

21. US manufacturing activity and S&P GSCI spot index

-10%

-5%

0%

5%

10%

72 76 80 84 88 92 96 00 04

-50%

-25%

0%

25%

50%

75%

US manufacturing versus trend, LHSAnnual change in S&P GSCI spot price, RHS


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The design of the index, therefore, should allow it to

capture the impact of movements in global growth

upon commodity prices as a whole in a reasonably

accurate manner. In turn, how the S&P GSCI series

correlates with the activity of a particular nation or

economic bloc may provide guidance on how that

region influences developments within commodity

markets. In theory, monthly changes in industrial

activity, and the level of industrial output in relation

to potential, should therefore be important

determinants of monthly commodity price changes.

Chart 21 illustrates a calculated measure of a US

manufacturing output gap (showing the difference

between actual and trend output expressed as a

percentage of the trend) and the annual rate of

change in the S&P GSCI spot index. Periods of

above and below trend growth in US manufacturing

activity have in the past coincided with peaks and

troughs in commodity price inflation, suggesting a

reasonably close relationship between the two series.

22. S&P GSCI spot index annualised returns in relation to US manufacturing, US$ terms

US Mftg output versus trend:

____ Above trend___

___ Below trend ___

Monthly direction of output:

Increasing Declining Increasing Declining

S&P GSCI performance*:

1972-present 10.9% 2.9% 14.4% -9.0% (5.0%) (7.1%) (4.8%) (6.2%) 1990-present 11.4% -9.1% 21.5% -4.2% (5.1%) (5.9%) (5.2%) (6.1%) 2000-2004 37.1% -22.7% 54.7% -16.9% (7.0%) (4.4%) (5.3%) (6.7%) 2004-present 18.7% -12.7% 27.1% 64.0% (5.4%) (8.5%) (5.9%) (6.2%)

Note: *Figures show annualised monthly performance of S&P GSCI spot index when US manufacturing output is above trend and increasing/decreasing, or below trend and increasing/decreasing. Figures in brackets are the standard deviation of these returns. Source: HSBC and Thomson Financial Datastream

Table 22 provides further detail, showing the

annualised return of the S&P GSCI spot index

against monthly changes in US manufacturing

output when activity was estimated to be both above

and below potential. Again, the results roughly

match those that would be expected to be returned

during the course of a commodity price cycle.

During the entire sample period (January 1972 to

October 2007), monthly increases in US

manufacturing output from an above trend position

have coincided with an annualised rise of 10.9% in

commodity prices, and monthly declines a 2.9%

annualised return. When US manufacturing activity

was seen to be below potential, increases in output

corresponded with a annualised 13.5% gain in

prices, and declines a loss of some 9%. This

relationship has also held between January 1990 and

the current day. The degree of coincidence between

US manufacturing output and the movements of the

S&P GSCI spot index appeared particularly strong

between 2000 and end-2003, perhaps unsurprisingly

given concerns of a US-led global downturn during

the period. Once more, however, this relationship

appears to have diminished in more recent years,

with commodity prices rising strongly even when

US manufacturing output was seen to be both below

trend and declining on a monthly basis.

Not just a dollar issue or speculation Still, given that this divergence is a relatively new

phenomenon, it is tempting to look for alternative

explanations that may account for this ‘aberration’,

rather than accept the de-coupling argument in full.

Commodity prices can, after all, be buffeted by a

variety of factors unrelated to economic growth.

The steady decline in the US dollar since the

beginning of the decade, for instance, has often

been forwarded as a ready explanation for the

conflicting trends in US activity and commodity

markets. As commodity prices are typically dollar-

denominated, fluctuations in the greenback can

cause nominal price shifts even if the real or

physical value of these assets remains unchanged.

With the dollar having been on a predominantly

downward trend in recent years, some appreciation

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in prices would still have been possible without

necessarily questioning the position of the United

States as the key determinant of commodity prices.

A further alternative explanation to the de-coupling

argument is the rising degree of investor

participation within commodity markets over the

past few years. The motivation behind this growing

involvement is thought to relate more to the

perceived benefits that commodities as an asset class

may offer to a balanced portfolio of investments,

rather than entering commodity markets for the

purposes of speculation alone. As such, this

development would have been expected to have

added predominantly upward pressure to commodity

prices as investment positions were established.

However, when analysing the S&P GSCI in euro

rather than dollar terms and re-running the analysis

contained in table 22, a clear break within the

relationship between US manufacturing and

commodity markets is still evident since 2004, with

prices rising strongly even as US activity was

declining and seen to be below trend. In addition,

the evidence of a speculative bubble or of investor

participation producing a distorting effect within

commodity markets is also far from compelling.

Speculative activity, rather than causing higher

prices, may in fact be the product of an underlying,

structural increase in commodity prices, rather than

the cause. The accompanying boost to liquidity

may simply have helped this trend to be more

easily expressed. And even if we accept that

increased speculative activity may have

accentuated the rising trend of commodity prices,

applying any rigorous test for this effect is hindered

by the paucity of available data. Overall, the size of

the investment funds that have flowed into

commodity markets in recent years, when

compared to the value of the physical production,

does not appear large enough to have accounted for

the rapid price appreciation alone, again suggesting

some fundamental ‘decoupling’ influence.

Decoupling – fact not fiction Indeed, de-coupling has been a fact of economic

life in recent quarters. As table 24 shows, the pace

of US domestic demand growth has been not

much stronger in the first three quarters of 2007

than it was in 2001, at the height of the tech-led

recession. Yet emerging market growth has

remained remarkably buoyant, unlike the near-

collapse that occurred in some countries in 2001.

23. Emerging markets a lot stronger than they used to be

0.0

2.0

4.0

6.0

8.0

10.0

2000 2001 2002 2003 2004 2005 2006

0.0

2.0

4.0

6.0

8.0

10.0

% Yr% Yr Emerging market GDP growth


24. Emerging markets a lot more robust today given US domestic demand weakness

% Yr 2001 2007*

US Private final demand 1.4 1.8 US Exports -5.4 8.0 US GDP growth 0.8 2.1 Emerging Market GDP growth 3.2 8.1

Note: *2007 values calculated using first 3 quarters. Source: Thomson Financial Datastream, and HSBC.

The secular case for de-coupling is powerful. In

our view, emerging markets have embarked on a

period of sustained rapid economic growth as they

take full advantage of more liberal capital

markets, new technologies and, importantly, the

shifting political landscape since the fall of the

Berlin Wall in 1989. Their economic

performance is reminiscent of the gains made by

Germany, Japan, France and other European

nations in the 1950s and 1960s, when incomes per

capita slowly caught up with those in the US.

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Indeed, given incomes per capita in many

emerging markets are still incredibly low, the

scope for continued out-performance on economic

growth appears to be very high.

If, though, we leave the secular case to one side,

there’s still the key cyclical issue. Can the

emerging world cyclically survive a sustained US-

led economic slowdown? Or, instead, will the

emerging world succumb to a collapse in much

the same way that we saw in 2001?

It would be foolish to suggest that a transatlantic

slowdown would have no effect on the emerging

world. The issue is one of magnitude. There are,

though, reasons for hope:

� First, we’ve already seen that emerging

markets have continued growing despite an

already relatively weak domestic demand

picture in the US

� Second, the tech bubble was global in nature

and all equity markets fell simultaneously,

including those in many emerging markets.

While there are some obvious property

bubbles in the emerging world, they have yet

to succumb to the sub-prime crisis that’s hit

the transatlantic economies

� Third, many emerging economies were major

volume suppliers of technology products at

the height of the late-1990s bubble and,

therefore, were inevitably in trouble when

recession came. It’s not so obvious that they

have the same connections with the US or

European housing markets

� Fourth, although the information is murky at

best, it seems more likely that the bad assets

associated with the housing bust are held

mostly in America and Europe and not in the

emerging world (although it’s difficult to be

sure about the ultimate owners of assets held

in the US or Europe on a custodial basis)

Resolving global imbalances Beyond these factors, though, it’s worth thinking

about likely changes in global imbalances in the

years ahead. One of the peculiarities of the 2001

recession was the absence of any major reduction

in the US current account deficit. It contracted by

only 0.5% of US GDP or less than 0.2% of non-US

global GDP. This was not a big change, suggesting

that the global recession was truly global and not

really US-led (if it had been, the US deficit would

presumably have shrunk a lot more).

25. The US current account deficit didn’t really shrink very much in 2001

-7.0

-6.0

-5.0

-4.0

-3.0

-2.0

-1.0

0.0

1.0

90 92 94 96 98 00 02 04 06

-7.0

-6.0

-5.0

-4.0

-3.0

-2.0

-1.0

0.0

1.0

% GDP% GDP US current account

Source: Haver Analytics

26. This time, it may have to shrink more – and funding from ABS is already falling sharply

-100

0

100

200

300

400

500

95 96 97 98 99 00 01 02 03 04 05 06 07

-100

0

100

200

300

400

500

Official purchases Corporate bondsCorporate equity FDI

USDbn USDbn

Note: Data expressed as a four quarter moving average at an annual rate Source: Thomson Financial Datastream, and HSBC

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Imagine, though, that the shock we’re now seeing

requires a significant shrinkage of the US current

account deficit. Indeed, given the ways in which the

US current account deficit has been funded in recent

years (see chart 26), this wouldn’t be altogether

surprising: up until recently, foreigners were happily

funding US borrowing through sizeable purchases of

asset backed (mostly mortgage-backed) securities.

Without these purchases, something else will have to

change. The possibilities include heightened foreign

purchases of other US assets (but at what price?), a

lower dollar to raise exports and reduce imports, a

lower level of US demand to reduce imports or a

higher level of non-US demand to raise US exports.

From these possibilities, it’s easy to see why de-

coupling doesn’t have many fans. Surely, it’s

argued, a US slowdown must hit the rest of the

world’s exports to the US. If so, it’s only a matter

of time before a US downswing becomes a global

downswing.

This outcome, though, is not guaranteed. To

understand why, it’s worth thinking about the

impact of capital flows, particularly in

conjunction with global economic performance in

the early-1990s during the last US credit crunch.

Back then, US short-term interest rates fell to just

3% as the Greenspan Fed engineered a very

steeply-sloped yield curve, a policy designed to

encourage banks to borrow short and lend long.

The policy eventually worked, but only after a

number of years of very disappointing domestic

demand growth associated initially with recession

and then with the so-called “jobless recovery”.

27. A smaller US deficit was met at the beginning of the 1990s by smaller surpluses and bigger deficits elsewhere

-150

-100

-50

0

50

100

150

89 90 91 92 93

-150

-100

-50

0

50

100

150

US Germany Mexico Japan

USDbnUSDbn Current account


The US current account deficit shrank dramatically

in the process, but the rest of the world didn’t seem

particularly bothered. Germany was going through

its reunification boom and the associated rise in

domestic demand led to a shift in Germany’s

current account position from large surplus into

small deficit. Japan, despite the beginnings of the

equity price collapse, was still growing strongly in

1990 (although its current account surplus was

increasing again by 1992). Meanwhile, emerging

markets were making an appearance on the world

stage: Mexico boomed (shifting from a small

current account surplus to a $25bn current account

deficit in just a handful of years), Thailand soared,

Hong Kong roared and others followed suit. And

even when Europe succumbed to reunification blues

in 1992 and 1993 and as Japan headed from boom

into deflationary malaise, emerging markets were

still able to perform well.

How did they manage it? In much the same way,

we suspect, as we’re likely to see in the months

ahead. The US Federal Reserve has already

lowered the key Fed funds rate by 100 bp to

4.25% and, on our new forecasts, we’re likely to

see Fed funds fall all the way down to 3% by the

final quarter of 2008. This doesn’t necessarily

mean that monetary conditions in the US are

likely to be very loose – that depends as much on

money market rates and credit tightening as on the

level of official rates – but it does mean that

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monetary conditions are unlikely to be tightened

sufficiently in emerging markets, particularly if

they resist sustained currency appreciation against

the US dollar.

And, if anything, resistance to currency

appreciation is likely to intensify, even with clear

evidence of rising inflationary pressures across

the emerging world. Why, after all, would a

policymaker choose to revalue knowing that, in

the months ahead, there’s a relatively high chance

of a US recession? This, surely, would be a risk

too far and few emerging market policymakers are

likely to have the appetite for a double hit to

growth coming from both a currency appreciation

and a US economic downturn.

We suspect, then, that any narrowing of the US

current account deficit will be driven in part by a

further lift to domestic demand in emerging

markets, the result of overly loose monetary

conditions. This, in turn, will boost transatlantic

exports and play a role in the reduction of global

imbalances. Indeed, the mechanism is already in

operation. Through 2007, the nasty effects of the

US housing slump were mostly offset by booming

US exports, many of which headed towards the

emerging world. Put another way, it’s no longer

obvious that the US is consumer of last resort.

Emerging markets, arguably, have now taken on

that mantle. Their share of global GDP is, in total,

not so different from the US share and they’re

collectively growing a lot faster than the US, either

now or in the halcyon days of the late 1990s.

Reaching conclusions Putting all these factors together, what do we end

up with? Our main forecast changes relate to the

transatlantic area. Table 28 shows our latest GDP

projections compared with those we made before

the onset of the banking crisis in July. The

numbers show the degree to which our numbers

have come down in the US, the UK and the

eurozone. It is also worth noting that these

revisions, so far, are based not so much on weak

data but, rather, on the degree to which we expect

the impact of the credit squeeze eventually to

constrain growth. Admittedly, this is a relatively

high-risk approach but it is our best guess of how

the credit squeeze is likely to affect domestic

economic activity. Most of the impact feeds

through consumer spending, primarily because of

the earlier rapid increase in household debt which,

in turn, reflected the easy access of households,

via the mortgage market, to global credit.

Meanwhile, growth within the emerging world

holds up rather well. We’ve been impressed with

the degree to which emerging economies have

remained resilient in the light of the US housing

28. Developed disappointments, emerging surprises

GDP projections __ Global Economics Quarterly Q307 (June) ___ ________________ Latest__________________ 2007 2008 2007 2008

World 3.4 3.4 3.5 3.0 Developed 2.4 2.4 2.4 1.8 Emerging 6.8 6.9 7.3 7.0 US 2.0 2.6 2.2 1.9 UK 2.7 2.0 3.2 1.5 Eurozone 2.8 2.3 2.6 1.6 China 10.6 11.0 11.4 11.0 Japan 2.4 2.0 1.9 1.6 Asia ex Japan & China 6.2 5.8 6.7 6.0 Latin America 4.0 4.2 4.6 4.4

Source: HSBC

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shock to date. And because the evidence of any

emerging market exposure to sub-prime debt is

limited, we’re not convinced that we’re about to

see a repeat of 2001, when what was initially seen

as a US problem was, in truth, a global problem.

So although we have made modest downgrades to

some of our emerging market forecasts, the overall

picture is still one of reasonably buoyant growth.

The growth gap between the emerging world and

the transatlantic economies therefore widens.

Although good news, this is not the most helpful of

backgrounds for global inflation. We have noted on

a number of occasions the deteriorating trade-off

between growth and inflation in the industrialised

world, primarily because of continuous advances in

commodity prices. The balance of global growth,

skewed as it is towards emerging markets, suggests

that commodity prices will remain elevated and, as

such, that imported inflation will remain an issue for

the industrialised countries. So far, there’s been

little evidence of any pass through to higher wages

(indeed, as headline inflation has risen, so core

inflation has in some cases come down). This,

though, simply shifts the problem away from

inflation towards activity (it’s a negative terms of

trade shock). Moreover, higher imported inflation

creates ambiguities for policymakers. Should they

cut interest rates in the light of the credit squeeze

(and be seen to be accommodating inflationary

pressures) or, instead, should they remain vigilant,

thereby making the credit squeeze worse than it

needs to be?

To a degree, central banks have revealed their

hands already. The Federal Reserve was quick to

lower interest rates, the Bank of England, initially

reluctant, was eventually forced to cut interest

rates towards the end of last year and the

European Central Bank, so far, has been unwilling

to provide any indication that the next move in

official interest rates might be downward.

29. Rates will fall further

_______2007_______ _______2008 ______ Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4

US

Targeted Fed Funds 5.25 5.25 4.75 4.25 4.00 3.75 3.25 3.00 UK Base rate 5.25 5.50 5.75 5.50 5.25 5.00 4.75 4.50 Eurozone Repo rate 3.75 4.00 4.00 4.00 4.00 3.75 3.75 3.75 Japan Overnight call rate 0.50 0.50 0.50 0.50 0.50 0.50 0.75 0.75

Source: HSBC

Nevertheless, we expect all three central banks to

lower interest rates through the course of 2008.

By the end of the year, we expect Fed funds to be

down to 3%, Bank of England bank rate to be

down to 4.50% and the eurozone repo rate to be

down to 3.75%. In all three cases, our forecasts

are more aggressive than those of the market,

partly reflecting our concerns over the persistence

of credit problems which, in turn, undermine the

standard Taylor-rule calculations.

However, in none of these cases are we yet

forecasting interest rate levels consistent with a

move into outright recession. Our reluctance reflects

(i) the strength of emerging markets and their

possible impact on transatlantic export demand; (ii)

the persistence of inflationary pressures, which

suggests, rightly or wrongly, a modicum of caution

on behalf of the world’s central bankers; and (iii) a

degree of caution on our own behalf because we’re

still waiting for data to confirm the pace of any

economic slowdown through the course of 2008.

30. There’s less room for action on fiscal policy…

-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

99 00 01 02 03 04 05 06

-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

% GDP% GDP US budget balance

Maastricht criteria

-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

99 00 01 02 03 04 05 06

-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

% GDP% GDP US budget balance

Maastricht criteria


��

22


��

31….so will countries be forced to break the rules…

-5.0

-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

99 00 01 02 03 04 05 06

-5.0

-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

% GDP% GDP Germany budget balance

Maastricht criteria

-5.0

-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

99 00 01 02 03 04 05 06

-5.0

-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

% GDP% GDP Germany budget balance

Maastricht criteria


32. …running bigger budget deficits…

-5.0

-4.0

-3.0

-2.0

-1.0

0.0

1.0

99 00 01 02 03 04 05 06

-5.0

-4.0

-3.0

-2.0

-1.0

0.0

1.0

% GDP% GDP France budget balance

Maastricht criteria

-5.0

-4.0

-3.0

-2.0

-1.0

0.0

1.0

99 00 01 02 03 04 05 06

-5.0

-4.0

-3.0

-2.0

-1.0

0.0

1.0

% GDP% GDP France budget balance

Maastricht criteria


33. ...in response to monetary and financial failure?

-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

99 00 01 02 03 04 05 06

-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

% GDP% GDP UK budget balance

Maastricht criteria

-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

99 00 01 02 03 04 05 06

-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

% GDP% GDP UK budget balance

Maastricht criteria


In any case, in a world of monetary drought,

cutting interest rates alone is unlikely to unblock

the system. We suspect the debate will develop in

the months ahead. The key question, ultimately, is

how to create liquidity when, for the time being,

there’s very little available or usable. Do

policymakers have to create products which will

meet the new, more conservative, interests of banks

and other financial institutions? Do they have to

intervene to protect homeowners from the risk of

widespread foreclosures? Will they eventually

have to remove the badly performing assets from

the financial system to re-create trust? If the

answer to all of these questions is a firm “yes” –

and we suspect it is – the debate will shift away

from monetary towards fiscal policy. Already

budget deficits in many countries are relatively

wide – much more so than they were during the

2001 recession – but that observation, on its own,

may not be much of a constraint. Even larger

budget deficits are likely to be an increasingly

common feature of the policymaking landscape in

the years ahead. They’ll be needed to bail out

homeowners who cannot afford their monthly

repayments. They’ll be needed to buy up the bad

assets that infect the monetary system. And they

may eventually be needed to deliver on Keynes’

idea of burying bank notes in the road and digging

them up again: monetised tax cuts would bypass

the banking system and place extra liquidity in the

hands and pockets of the public at large.

��

23


��

��

24


��

Annual

% Year 2000 2001 2002 2003 2004 2005 2006 2007f 2008f 2009f

World (Nominal GDP weights) 4.2 1.5 1.9 2.5 3.7 3.2 3.8 3.5 3.0 3.5 World (PPP weights) 4.9 2.4 3.0 3.9 5.0 4.7 5.2 5.0 4.5 4.7

Developed 3.7 1.2 1.3 1.8 2.9 2.4 2.8 2.4 1.8 2.4 Emerging 6.7 3.1 4.5 5.7 7.1 6.6 7.3 7.3 7.0 6.8

North America 3.7 0.8 1.6 2.5 3.6 3.1 2.9 2.2 2.0 3.0 US 3.7 0.8 1.6 2.5 3.6 3.1 2.9 2.2 1.9 3.0 Canada 5.2 1.8 2.9 1.9 3.1 3.1 2.8 2.6 2.1 2.2 Latin America 4.8 0.1 0.4 2.1 5.3 3.7 4.7 4.6 4.4 4.2 Mexico 6.6 -0.2 0.8 1.4 4.2 2.8 4.8 3.1 3.3 4.1 Brazil 4.3 1.3 2.7 1.1 5.7 2.9 3.7 5.4 5.0 3.7 Argentina -0.8 -4.4 -10.9 8.8 9.0 9.2 8.5 7.8 6.2 5.4 Chile 4.5 3.4 2.2 3.9 6.0 5.8 4.0 5.5 5.2 5.1

Western Europe 3.9 1.9 1.1 1.1 2.1 1.7 2.9 2.7 1.6 1.9 Euro-13 4.0 1.9 0.9 0.8 1.8 1.6 2.9 2.6 1.6 1.8 Germany 3.5 1.4 0.0 -0.2 0.6 0.9 3.1 2.6 1.6 2.0 France 4.0 1.8 1.1 1.1 2.3 1.7 2.2 1.9 1.7 1.8 Italy 3.8 1.7 0.3 0.1 1.0 0.2 1.9 1.7 1.0 1.3 Spain 5.0 3.6 2.7 3.1 3.3 3.6 3.9 3.8 2.4 2.8 Other Western Europe 3.8 1.9 1.7 2.0 3.1 2.2 3.1 3.0 1.7 2.2 UK 3.8 2.4 2.1 2.8 3.3 1.8 2.8 3.2 1.5 2.1 Norway 3.4 1.8 1.2 0.9 3.6 2.3 2.1 3.3 2.8 3.1 Sweden 4.5 1.2 2.4 2.1 3.5 3.3 4.4 2.6 2.3 2.7 Switzerland 3.6 1.2 0.4 -0.2 2.5 2.4 3.2 2.8 1.9 1.8

EMEA 6.8 1.5 3.3 5.7 6.4 5.8 6.0 5.8 5.8 5.6 Czech Republic 3.6 2.5 1.9 3.6 4.6 6.5 6.4 5.7 5.2 5.0 Hungary 5.2 4.3 3.8 3.4 5.2 4.1 3.8 1.6 3.3 4.5 Poland 4.0 1.0 1.4 3.8 5.3 3.4 6.1 6.6 5.6 5.2 Russia 10.0 5.1 4.7 7.3 7.2 6.4 6.7 7.6 6.7 6.0 Turkey 7.4 -7.5 7.9 5.8 8.9 7.4 6.1 4.4 5.5 5.4 Ukraine 5.9 9.2 5.2 9.6 12.1 2.6 7.1 7.1 6.8 7.0 Egypt* 5.4 3.5 3.2 3.2 4.1 4.5 6.8 7.1 6.4 6.2 Israel 8.7 -0.4 -0.6 2.3 5.2 5.3 5.2 5.5 4.4 4.2 Saudi Arabia 4.9 1.0 0.1 7.7 5.3 6.1 4.3 3.5 5.7 6.3 UAE 12.3 3.5 2.6 11.9 7.4 10.5 9.4 6.6 7.4 6.8 South Africa 4.2 2.7 3.7 3.1 4.8 5.1 5.0 5.4 5.3 5.0

Asia/Pacific 4.7 2.3 3.2 4.0 5.1 4.7 5.3 5.3 5.1 5.3 Japan 2.9 0.2 0.3 1.5 2.7 1.9 2.4 1.9 1.6 2.2 Australia 3.4 2.1 4.1 3.0 3.9 2.8 2.8 3.9 4.5 4.3 New Zealand 3.8 2.4 4.8 4.3 3.7 2.6 1.9 3.4 2.4 2.7 Asia-ex-Japan 7.4 5.2 6.8 7.2 8.0 8.0 8.8 8.9 8.4 8.1 China 8.4 8.3 9.1 10.0 10.1 10.4 11.1 11.4 11.0 10.5 Asia ex-Japan & China 6.8 3.1 5.1 5.0 6.4 6.1 6.8 6.7 6.0 5.9 Hong Kong 8.0 0.5 1.8 3.0 8.5 7.1 6.8 5.9 5.0 4.5 India** 5.5 4.5 4.5 7.3 7.3 8.2 9.6 8.9 7.1 7.4 Indonesia 4.1 3.6 4.5 4.8 5.0 5.7 5.5 6.3 6.5 5.3 Malaysia 8.9 0.3 4.4 5.4 7.3 5.0 5.9 6.2 6.2 5.8 Philippines 6.0 1.8 4.4 4.9 6.4 4.9 5.4 6.9 5.9 5.6 Singapore 10.0 -2.3 4.0 2.9 8.7 6.9 7.9 8.1 7.3 6.5 South Korea 8.5 3.8 7.0 3.1 4.7 4.2 5.0 4.8 4.5 4.7 Taiwan 5.8 -2.2 4.2 3.4 6.1 4.7 4.9 5.0 4.0 4.5 Thailand 4.8 2.2 5.3 7.0 6.4 4.6 5.1 4.4 5.0 4.6 Vietnam 6.8 6.9 7.1 7.3 7.8 8.4 8.2 8.3 8.5 8.1

Notes: * = based upon Egyptian fiscal year (July-June); ** = calendar year. We now calculate the weighting system using chain nominal GDP (USD) weights Source: HSBC

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25


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Quarterly

% Quarter & % Year Q3 06 Q4 06 Q1 07 Q2 07 Q3 07f Q4 07f Q1 08f Q2 08f Q3 08f Q4 08f

North America US* % Quarter 1.1 2.1 0.6 3.8 4.9 1.0 1.1 1.1 1.8 3.3 % Year 2.4 2.6 1.5 1.9 2.8 2.6 2.7 2.0 1.3 1.8 Canada* % Quarter 1.3 1.5 3.5 3.8 2.9 2.0 1.7 1.7 1.9 1.9 % Year 2.4 1.9 1.9 2.5 2.9 3.0 2.6 2.1 1.8 1.8 Latin America Mexico % Quarter 0.6 0.5 0.3 1.4 1.5 0.0 1.1 0.0 1.7 1.0 %Year 4.5 4.3 2.6 2.8 3.8 3.3 2.9 3.8 2.8 3.7 Brazil % Quarter 1.8 1.4 1.1 1.3 1.7 1.4 1.3 1.1 0.9 0.6 % Year 4.4 5.1 4.5 5.6 5.7 5.8 5.2 5.2 4.7 4.9 Argentina % Quarter 2.8 1.6 1.3 2.4 1.6 1.5 1.2 2.4 0.8 1.1 % Year 8.7 8.5 8.1 8.4 7.5 7.0 6.4 6.9 6.0 5.6 Chile % Quarter 0.4 1.8 2.2 1.5 -0.6 1.3 3.3 1.2 -1.7 3.1 % Year 2.6 4.3 5.9 6.2 4.1 5.6 5.4 5.2 5.2 5.0

Western Europe Euro-13 % Quarter 0.6 0.8 0.8 0.3 0.7 0.4 0.4 0.3 0.3 0.4 % Year 2.9 3.3 3.2 2.5 2.7 2.2 1.7 1.7 1.4 1.4 Germany % Quarter 0.7 1.0 0.5 0.3 0.7 0.3 0.3 0.3 0.4 0.5 % Year 3.2 3.9 3.6 2.5 2.5 1.8 1.6 1.7 1.4 1.6 France % Quarter -0.1 0.5 0.6 0.3 0.7 0.4 0.5 0.3 0.4 0.4 % Year 2.1 2.1 1.9 1.4 2.1 2.1 1.9 1.9 1.5 1.5 Italy % Quarter 0.3 1.1 0.3 0.1 0.4 0.2 0.3 0.2 0.2 0.4 % Year 1.6 2.8 2.4 1.8 1.9 0.9 0.9 1.1 0.9 1.1 Spain % Quarter 0.9 1.1 1.0 0.9 0.7 0.5 0.5 0.6 0.7 0.8 % Year 3.9 4.0 4.1 4.0 3.8 3.2 2.6 2.3 2.3 2.5 Other Western Europe UK % Quarter 0.7 0.8 0.8 0.8 0.7 0.6 0.3 -0.1 0.4 0.4 % Year 3.0 3.2 3.1 3.1 3.3 2.9 2.4 1.4 1.1 1.0 Norway % Year 2.0 1.9 2.1 3.2 3.4 4.2 3.9 3.3 2.4 1.6 Sweden % Year 4.4 4.1 3.2 2.9 2.6 1.8 2.1 2.1 2.1 2.9 Switzerland % Year 3.3 2.9 2.7 2.8 2.8 2.8 2.3 2.0 1.8 1.5

EMEA Czech Republic % Year 6.3 6.1 6.4 6.0 5.1 5.2 5.1 5.3 5.5 4.8 Hungary % Year 3.6 3.2 2.7 1.2 0.9 1.6 2.5 3.3 3.6 3.9 Poland % Year 5.8 6.6 7.2 6.4 6.3 6.1 5.8 5.6 5.5 5.3 Russia % Year 6.8 7.8 7.9 7.8 7.6 7.0 5.6 6.3 6.5 6.6 Turkey % Year 4.8 5.2 6.8 4.1 1.5 6.1 6.2 5.6 6.8 3.2 Ukraine % Year 8.0 9.5 8.0 7.9 6.1 6.5 6.5 6.5 7.0 7.0 Egypt** % Year 7.2 7.1 7.3 6.8 6.9 7.2 5.9 6.4 6.9 6.5 Israel % Year 4.5 5.0 5.1 4.9 6.5 5.7 4.6 4.4 4.2 4.2 South Africa %Year 4.7 6.2 5.7 5.0 5.1 5.6 5.5 5.0 5.3 5.0

Asia/Pacific Japan % Quarter -0.1 1.3 0.8 -0.5 0.4 0.4 0.3 0.6 0.7 0.5 % Year 1.9 2.3 2.8 1.6 1.9 1.2 0.8 1.8 1.9 1.8 Australia % Quarter 0.5 1.2 1.3 0.7 1.0 1.2 1.2 1.2 1.3 0.8 % Year 2.6 2.8 3.6 3.7 4.3 4.3 4.1 4.6 4.8 4.5 New Zealand % Year 1.2 2.6 3.2 3.8 3.1 2.9 2.6 2.6 2.4 2.5 Asia-ex-Japan China % Year 10.6 10.4 11.1 11.9 11.5 11.2 11.0 10.8 11.3 10.7 Asia ex-Japan & China Hong Kong % Year 6.4 6.9 5.6 6.6 6.2 5.2 5.6 2.7 5.2 6.5 India % Year 10.2 8.7 9.1 9.3 8.9 8.3 7.6 7.4 6.8 6.6 Indonesia % Year 5.9 6.1 6.0 6.3 6.5 6.4 6.4 6.6 6.6 6.3 Malaysia % Year 6.0 5.7 5.5 5.8 6.7 6.8 6.6 6.3 6.1 5.9 Philippines % Year 5.1 5.5 7.1 7.5 6.6 6.4 6.2 5.9 6.1 5.3 Singapore % Year 7.0 6.6 6.5 8.7 8.9 8.3 7.9 7.1 7.4 7.0 South Korea % Year 4.8 4.0 4.0 5.0 5.2 4.8 4.5 4.6 4.6 4.5 Taiwan % Year 5.3 4.1 4.2 5.2 6.9 3.8 4.5 3.4 3.8 4.2 Thailand % Year 4.5 4.3 4.2 4.3 4.9 4.3 4.8 5.4 4.9 4.8 Vietnam % Year 8.8 8.9 7.7 8.0 8.7 9.0 7.7 8.4 8.7 9.0

Note: * = quarter-on-quarter data has been annualised; ** = based upon Egyptian fiscal year (July – June) Source: HSBC

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26


��

Annual

% Year 2000 2001 2002 2003 2004 2005 2006 2007f 2008f 2009f

World 2.5 2.5 2.1 2.2 2.5 2.7 2.7 2.8 2.9 2.4


North America 3.3 2.8 1.6 2.3 2.6 3.3 3.1 2.8 2.4 2.0 US 3.4 2.8 1.6 2.3 2.7 3.4 3.2 2.8 2.4 2.0 Canada 2.8 2.5 2.2 2.7 1.9 2.2 2.0 2.1 1.6 1.8 Latin America 6.8 4.9 10.7 5.7 6.0 5.1 4.2 4.7 5.0 4.4 Mexico* 9.0 4.4 5.7 4.0 5.2 3.3 4.1 3.8 4.0 3.3 Brazil* 6.0 7.7 12.5 9.3 7.6 5.7 3.1 4.4 5.0 4.5 Argentina* -0.7 -1.5 41.0 3.7 6.1 12.3 9.8 8.5 9.3 9.5 Chile* 4.5 2.6 2.8 1.1 2.4 3.7 2.1 7.7 3.5 3.0

Western Europe 1.9 2.2 2.1 2.0 1.9 2.1 2.1 2.1 2.4 1.9 Euro-13 2.2 2.4 2.3 2.1 2.2 2.2 2.2 2.1 2.6 1.9 Germany 1.4 1.8 1.4 1.0 1.8 1.9 1.8 2.3 2.3 1.5 France 1.8 1.8 1.9 2.2 2.3 1.9 1.9 1.6 2.2 2.0 Italy 2.6 2.3 2.6 2.8 2.3 2.2 2.2 2.0 2.7 1.8 Spain 3.5 2.8 3.6 3.1 3.1 3.4 3.6 2.8 3.7 2.4 Other Western Europe 1.2 1.6 1.4 1.5 1.1 1.7 2.0 2.0 2.0 1.8 UK 0.8 1.3 1.3 1.4 1.3 2.0 2.3 2.3 1.8 1.7 Norway 3.1 3.0 1.3 2.5 0.5 1.5 2.3 0.8 3.0 2.5 Sweden 1.0 2.4 2.2 1.9 0.4 0.5 1.4 2.2 2.6 2.3 Switzerland 1.6 1.0 0.6 0.6 0.8 1.2 1.1 0.7 1.7 1.2

EMEA 10.0 9.8 9.4 7.0 6.7 6.2 5.8 7.9 7.3 5.9 Czech Republic 3.9 4.7 1.8 0.7 2.5 1.9 2.6 2.7 3.7 2.5 Hungary 9.8 9.2 5.3 4.7 6.8 3.6 3.9 7.9 5.3 3.0 Poland 10.1 5.5 2.0 0.8 3.5 2.1 1.0 2.7 3.5 2.1 Russia* 19.8 17.4 15.1 12.0 11.7 10.9 9.0 11.9 11.0 9.0 Turkey 56.4 54.4 45.0 25.3 8.6 8.2 9.6 8.8 8.0 5.7 Ukraine* 28.2 12.0 0.8 5.2 9.0 10.3 9.1 12.8 6.0 5.5 Egypt** 2.7 2.4 2.4 3.2 14.3 8.9 4.2 9.6 6.5 6.2 Israel* 0.0 1.4 6.5 -1.9 1.2 2.4 -0.1 3.1 2.9 2.4 Saudi Arabia -1.1 -1.1 0.2 0.6 0.3 0.4 2.3 3.9 5.4 4.5 UAE 1.3 2.7 2.9 3.1 7.0 9.0 10.5 9.5 9.0 8.7 South Africa 7.7 7.2 7.7 5.8 4.3 3.9 4.6 6.5 6.3 5.5

Asia/Pacific 0.3 0.9 0.3 1.0 1.8 1.4 2.0 2.2 2.6 2.4 Japan -0.7 -0.8 -0.9 -0.2 0.0 -0.3 0.2 0.0 0.4 0.4 Australia 4.5 4.4 3.0 2.8 2.3 2.7 3.5 2.3 3.2 2.7 New Zealand 2.6 2.6 2.7 1.8 2.3 3.0 3.4 2.6 2.5 2.5 Asia-ex-Japan 1.1 2.4 1.4 2.2 3.7 3.1 3.6 4.4 4.8 4.2 China 0.3 0.7 -0.8 1.2 3.9 1.8 1.5 4.7 4.1 3.0 Asia ex-Japan & China 1.8 3.9 3.2 3.0 3.6 4.2 5.2 4.2 5.3 5.2 Hong Kong -3.7 -1.6 -3.0 -2.6 -0.4 0.9 2.0 2.0 3.9 4.3 India 3.8 4.3 4.0 3.7 3.9 4.0 6.3 6.4 6.8 6.9 Indonesia 3.7 11.5 11.9 6.8 6.1 10.5 13.1 6.5 8.5 8.6 Malaysia -6.9 1.4 1.8 1.1 1.4 3.0 3.6 2.0 2.8 2.6 Philippines 9.3 6.8 2.9 3.5 6.0 7.7 6.3 2.7 4.1 4.6 Singapore 1.3 1.0 -0.4 0.5 1.7 0.5 1.0 2.0 3.9 1.6 South Korea 2.3 4.1 2.8 3.5 3.6 2.8 2.2 2.5 3.3 3.2 Taiwan 1.3 0.0 -0.2 -0.3 1.6 2.3 0.6 1.6 2.4 1.9 Thailand 1.6 1.5 0.6 1.7 2.9 4.3 4.7 2.3 3.1 2.5 Vietnam -1.6 -0.3 4.1 3.1 7.8 8.3 7.5 8.1 9.9 7.1

Note: * = end-year values. We now calculate the weighting system using chain nominal GDP (USD) weights Source: HSBC

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27


��

Quarterly

% Year Q3 06 Q4 06 Q1 07 Q2 07 Q3 07f Q4 07f Q1 08f Q2 08f Q3 08f Q4 08f

North America US 3.3 1.9 2.4 2.7 2.4 3.8 3.4 2.3 2.3 1.9 Canada 1.7 1.4 1.8 2.2 2.1 2.5 2.0 1.0 1.4 1.9 Latin America Mexico 4.1 4.1 4.1 4.0 4.0 3.8 4.0 4.3 4.1 4.0 Brazil 3.7 3.1 3.0 3.7 4.1 4.4 4.5 4.8 5.3 5.0 Argentina 10.6 10.1 9.5 8.8 8.6 8.5 8.7 8.9 9.5 9.3 Chile 3.5 2.3 2.7 2.9 4.8 7.2 7.6 6.8 5.3 4.0

Western Europe Euro-13 2.2 1.8 1.9 1.9 1.9 2.9 3.2 2.7 2.6 1.9 Germany 1.7 1.3 1.9 2.0 2.2 3.1 3.2 2.5 2.0 1.4 France 1.9 1.5 1.3 1.3 1.4 2.5 2.7 2.3 2.2 1.7 Italy 2.3 2.0 2.0 1.9 1.7 2.5 3.0 2.7 3.0 2.3 Spain 3.6 2.7 2.5 2.4 2.4 3.9 4.4 3.9 3.7 2.7 Other Western Europe UK 2.4 2.7 2.9 2.6 1.8 2.1 2.0 1.6 1.8 1.7 Norway 2.2 2.5 1.0 0.3 0.2 1.5 2.5 3.0 3.5 3.0 Sweden 1.6 1.5 1.9 1.8 1.9 3.0 3.1 2.8 2.5 2.0 Switzerland 1.2 0.5 0.1 0.5 0.6 1.6 2.1 1.7 1.7 1.4

EMEA Czech Republic 2.9 1.5 1.6 2.5 2.5 4.0 4.2 3.7 3.5 3.6 Hungary 4.1 6.4 8.5 8.7 7.7 6.8 6.7 5.7 5.0 3.8 Poland 1.4 1.3 2.5 2.6 2.3 3.6 3.4 3.6 3.6 3.2 Russia 9.4 9.1 7.7 7.9 8.9 10.6 12.5 13.2 13.1 11.9 Turkey 10.5 9.7 10.9 8.6 7.1 8.5 8.4 8.5 8.3 6.1 Ukraine 8.0 11.4 10.2 11.4 14.1 15.3 17.3 18.4 16.2 14.5 Egypt 9.5 12.4 12.8 8.5 8.8 7.6 6.8 6.7 6.3 6.1 Israel 1.3 -0.1 -0.9 -0.7 1.6 3.1 3.3 3.3 2.7 2.9 South Africa 5.0 5.0 5.5 6.4 6.7 8.3 7.9 7.5 6.8 6.1

Asia/Pacific Japan 0.6 0.3 -0.1 -0.1 -0.1 0.3 0.5 0.4 0.2 0.3 Australia 3.9 3.3 2.4 2.1 1.9 2.8 3.5 3.1 3.1 3.0 New Zealand 3.5 2.6 2.5 2.0 1.8 2.4 2.6 2.4 2.4 2.4 China 1.3 2.0 2.7 3.6 6.1 6.5 5.0 4.1 3.8 3.5 Hong Kong 2.3 2.2 1.7 1.3 1.7 3.5 2.4 4.5 4.3 4.4 India 6.6 7.0 7.0 6.3 6.7 5.5 6.0 6.5 7.0 7.5 Indonesia 14.9 6.1 6.4 6.0 6.5 6.9 7.3 8.3 9.0 9.5 Malaysia 3.6 3.0 2.6 1.5 1.8 2.0 2.3 3.0 3.0 3.0 Philippines 6.1 4.8 2.9 2.4 2.5 3.1 3.8 4.3 4.5 4.5 Singapore 0.7 0.6 0.5 1.0 2.7 3.6 4.5 5.0 3.5 2.5 South Korea 2.5 2.1 2.0 2.4 2.3 3.3 3.3 3.2 3.3 3.4 Taiwan -0.3 -0.1 1.0 0.3 1.5 3.9 3.7 2.3 2.0 1.5 Thailand 4.3 3.1 2.8 2.0 2.0 2.6 3.1 3.1 3.1 2.9 Vietnam 7.3 6.8 6.7 7.3 8.3 10.0 11.2 10.7 9.5 8.3

Source: HSBC

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28


��

3 month money

End period 2003 2004 2005 2006 2007 2008 Q4 Q4 Q4 Q4 Q1 Q2 Q3 Q4f Q1f Q2f Q3f Q4f

North America US (USD) 1.1 2.6 4.5 5.3 5.3 5.3 5.2 4.9 4.6 4.4 3.9 3.3 Canada (CAD) 2.6 2.6 3.4 4.2 4.3 4.5 4.9 4.9 4.6 4.4 4.1 3.8 Latin America Mexico (MXN) 6.2 8.8 8.0 7.2 7.2 7.3 7.4 7.6 7.7 7.9 7.9 7.8 Brazil (BRL) 15.9 18.2 17.4 12.8 12.3 11.5 11.0 11.2 11.3 11.3 11.4 11.4 Argentina (ARS)* 4.1 3.1 4.8 7.1 7.3 7.0 8.6 10.1 10.3 10.5 10.7 10.9 Chile (CLP) 2.5 2.8 4.5 5.3 5.0 5.0 5.9 6.0 6.2 6.1 6.1 5.9

Western Europe Euro-13 2.1 2.2 2.5 3.7 3.9 4.2 4.8 4.8 4.6 4.4 4.3 4.1 Other Western Europe UK (GBP) 4.0 4.8 4.6 5.3 5.6 6.0 6.2 6.2 5.9 5.6 5.2 4.8 Sweden (SEK) 2.9 2.2 2.0 3.3 3.4 3.7 4.3 4.7 4.6 4.8 4.7 4.5 Switzerland (CHF) 0.2 0.7 1.0 2.1 2.3 2.7 2.7 2.8 2.8 2.8 2.8 2.8 Norway (NOK) 2.4 2.0 2.6 3.9 4.5 4.9 5.7 5.9 5.8 6.0 5.9 5.7

EMEA Hungary (HUF) 12.2 9.3 6.3 8.1 7.9 7.7 7.5 7.3 7.1 6.8 6.6 6.3 Poland (PLN) 5.5 6.5 4.6 4.2 4.2 4.7 5.1 5.1 5.2 5.2 5.4 5.6 Russia (RUB) 6.3 5.8 5.7 4.8 7.2 6.5 7.2 7.5 7.5 7.2 Turkey (TRY) 29.1 22.6 13.8 17.6 17.5 17.4 17.0 16.0 15.0 15.2 15.4 14.9 Ukraine (UAH) 12.5 6.6 7.6 5.2 4.3 4.2 7.0 9.0 10.0 10.0 10.0 South Africa (ZAR) 7.7 7.5 7.0 9.2 9.2 9.8 10.4 10.5 10.6 10.1 9.8 10.0

Asia/Pacific Japan (JPY) 0.0 0.0 0.1 0.6 0.6 0.7 1.0 1.0 1.0 1.0 1.3 1.3 Australia (AUD) 5.7 5.6 5.8 6.5 6.6 6.5 7.2 7.3 7.1 7.2 7.2 7.0 New Zealand (NZD) 5.4 6.8 7.7 7.7 7.9 8.3 8.6 8.9 8.8 8.7 8.6 8.4 Asia-ex-Japan China (CNY) 1.7 1.7 1.7 1.8 2.0 2.1 2.9 2.9 3.2 3.2 3.2 3.2 Asia ex-Japan & China Hong Kong (HKD) 0.2 0.3 4.2 3.9 4.2 4.5 5.2 3.8 3.3 3.4 3.5 3.6 India (INR) 4.5 5.3 6.9 9.6 11.7 9.3 8.5 8.0 7.9 7.8 7.8 7.8 Indonesia (IDR) 8.3 7.3 12.8 9.5 8.1 7.8 7.8 8.1 8.1 8.1 8.6 9.6 Malaysia (MYR) 3.1 2.8 3.2 3.7 3.6 3.6 3.6 3.6 3.6 3.6 3.8 4.0 Philippines (PHP) 6.5 7.8 5.2 4.8 3.0 3.0 3.8 4.1 4.1 4.2 4.4 4.6 Singapore (SGD) 0.8 1.5 3.3 3.4 2.9 2.5 2.6 2.6 2.6 2.9 3.0 3.0 South Korea (KRW) 4.3 3.4 4.0 4.8 4.9 5.0 5.3 5.2 5.2 5.5 5.5 5.5 Taiwan (TWD) 1.1 1.2 1.6 1.8 1.8 2.0 2.1 2.3 2.3 2.3 2.3 2.4 Thailand (THB) 1.4 2.4 4.5 5.3 4.5 3.8 3.6 3.7 3.7 3.7 3.9 3.9

Note: * = 1-month money Source: HSBC

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10-year bond yields

End period Q4 04 Q4 05 Q3 06 Q4 06 Q1 07 Q2 07 Q3 07 Q4 07f Q1 08f Q2 08f Q3 08f Q4 08f

Americas US 4.2 4.4 4.6 4.7 4.7 5.0 4.6 4.0 3.9 3.7 3.9 4.2 Canada 4.3 4.0 4.0 4.1 4.1 4.6 4.3 4.0 3.8 3.6 3.6 3.6 Chile 5.1 5.3 6.5 5.4 5.6 6.4 6.3 6.3 6.4 6.4 6.4 6.2

Western Europe Euro-13 3.7 3.3 3.8 4.0 4.1 4.6 4.4 4.2 4.1 4.2 4.2 4.1 Germany 3.7 3.3 3.7 3.9 4.1 4.6 4.3 4.2 4.1 4.2 4.2 4.1 France 3.7 3.3 3.7 4.0 4.1 4.6 4.4 4.2 4.1 4.2 4.2 4.1 Italy 3.8 3.5 4.0 4.2 4.3 4.8 4.6 4.4 4.3 4.4 4.4 4.3 Spain 3.6 3.3 3.7 4.0 4.1 4.6 4.4 4.2 4.1 4.2 4.2 4.1

Other Western Europe UK 4.6 4.1 4.5 4.7 5.0 5.5 5.0 4.5 4.7 4.7 4.6 4.5 Sweden 3.9 3.3 3.6 3.8 3.9 4.5 4.3 4.3 4.4 4.5 4.5 4.5 Switzerland 2.3 1.9 2.4 2.5 2.6 3.2 3.0 3.0 2.9 2.6 2.7 2.9 Norway 4.0 3.6 4.1 4.3 4.6 5.1 5.0 4.7 5.3 5.3 5.3 5.3

EMEA Hungary 7.0 7.0 7.6 6.7 6.7 6.6 6.5 6.4 6.4 6.3 6.1 6.0 Poland 5.8 5.1 5.5 5.2 5.2 5.6 5.6 5.7 5.9 6.0 6.0 6.0 Russia 6.8 6.5 6.5 6.5 6.3 6.6 6.8 6.9 7.0 7.1 7.3 South Africa 8.1 7.5 8.6 7.7 7.7 7.9 8.1 8.3 8.6 8.4 8.3 8.1

Asia/Pacific Japan 1.4 1.5 1.7 1.7 1.6 1.9 1.7 1.4 1.5 1.7 1.7 1.7 Australia 5.3 5.2 5.5 5.9 5.9 6.2 6.2 6.3 6.2 6.2 6.1 6.1 New Zealand 6.0 5.7 5.8 5.8 5.9 6.7 6.5 6.4 6.4 6.4 6.3 6.3 Asia-ex-Japan Hong Kong 3.6 4.2 3.9 3.7 4.2 4.8 4.4 3.4 3.4 3.5 3.7 3.9 India 6.6 7.1 7.7 7.6 7.9 8.2 8.5 7.9 7.9 7.9 7.9 7.9 Indonesia* 10.1 13.3 10.8 9.4 9.4 8.7 8.8 8.9 9.5 10.5 11.5 11.3 Philippines 13.9 10.2 8.3 6.4 8.1 8.1 6.6 6.6 6.7 6.7 6.8 6.8 Singapore* 2.1 3.0 3.1 3.0 2.7 2.6 2.5 2.5 2.7 2.7 2.7 2.7 South Korea* 3.4 5.4 4.6 5.0 4.8 5.4 5.5 5.4 5.4 5.7 5.7 5.7 Vietnam* 8.5 8.8 8.4 8.3 6.8 7.4 8.2 8.8 8.4 8.0 7.5 7.5

Note: * = 5-year bond yield Source: HSBC

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Exchange rates vs USD

End period 2004 2005 2006 2007 2008 Q4 Q4 Q3 Q4 Q1 Q2 Q3 Q4f Q1f Q2f Q3f Q4f

Americas Canada (CAD) 1.20 1.17 1.12 1.16 1.15 1.06 0.99 1.00 1.00 1.00 1.05 1.05 Mexico (MXN) 11.15 10.63 10.99 10.80 11.04 10.81 10.93 10.85 10.80 11.15 11.15 11.20 Brazil (BRL) 2.65 2.34 2.17 2.14 2.05 1.93 1.84 1.75 1.80 1.85 1.90 1.95 Argentina (ARS) 2.97 3.03 3.10 3.06 3.10 3.09 3.15 3.14 3.18 3.21 3.26 3.27 Chile (CLP) 557 514 536 532 539 528 511 505 510 510 515 520

Western Europe Eurozone (EUR=) 1.36 1.18 1.27 1.32 1.33 1.35 1.42 1.45 1.45 1.40 1.35 1.35 Other Western Europe UK (GBP=) 1.92 1.72 1.87 1.96 1.96 2.01 2.04 2.04 1.99 1.92 1.83 1.83 Sweden (SEK) 6.65 7.96 7.33 6.84 7.02 6.86 6.47 6.14 6.07 6.21 6.22 6.22 Norway (NOK) 6.06 6.77 6.52 6.23 6.10 5.91 5.42 5.24 5.24 5.43 5.56 5.56 Switzerland (CHF) 1.14 1.32 1.25 1.22 1.22 1.23 1.17 1.15 1.16 1.17 1.19 1.19

EMEA Czech Republic (CZK) 22.3 24.6 22.3 20.9 21.1 21.3 19.3 18.8 18.6 19.3 19.6 19.3 Hungary (HUF) 180.7 214.0 215.4 190.6 185.8 181.9 176.7 172.4 169.0 171.4 174.1 170.4 Poland (PLN) 3.00 3.26 3.14 2.90 2.90 2.79 2.65 2.52 2.45 2.48 2.48 2.41 Russia (RUB) 27.7 28.8 26.7 26.4 26.0 25.8 25.0 24.6 24.6 25.1 25.6 25.6 Turkey (TRY)* 1.35 1.35 1.52 1.42 1.39 1.31 1.21 1.19 1.18 1.23 1.24 1.25 Ukraine (UAH) 5.31 5.05 5.05 5.05 5.05 5.05 5.05 5.05 5.05 5.05 5.05 5.20 Israel (ILS) 4.34 4.61 4.35 4.20 4.21 4.18 4.09 3.95 4.00 4.02 4.05 4.10 South Africa (ZAR) 5.63 6.34 7.77 7.05 7.25 7.05 6.90 6.75 6.50 6.90 7.00 6.80

Asia/Pacific Japan (JPY) 102 118 118 119 118 123 115 115 113 113 115 115 Australia (AUD=) 0.78 0.73 0.75 0.79 0.81 0.85 0.88 0.90 0.92 0.87 0.84 0.83 New Zealand (NZD=) 0.72 0.68 0.65 0.71 0.72 0.77 0.76 0.78 0.80 0.76 0.73 0.72 China (CNY) 8.28 8.07 7.91 7.81 7.73 7.61 7.51 7.40 7.30 7.20 7.10 7.00 Hong Kong (HKD) 7.78 7.75 7.79 7.77 7.81 7.82 7.76 7.80 7.80 7.80 7.80 7.80 India (INR) 43.4 45.0 45.8 44.2 43.2 40.5 39.7 39.0 38.5 38.5 38.0 37.5 Indonesia (IDR) 9272 9825 9203 8996 9125 9040 9145 8600 8600 8600 8600 8600 Malaysia (MYR) 3.80 3.78 3.69 3.53 3.46 3.45 3.41 3.38 3.34 3.30 3.26 3.22 Philippines (PHP) 56.3 53.0 50.1 49.1 48.2 46.3 45.3 43.0 43.0 42.0 42.0 41.0 Singapore (SGD) 1.63 1.66 1.59 1.53 1.52 1.53 1.49 1.50 1.46 1.45 1.44 1.43 South Korea (KRW) 1035 1008 946 930 941 923 915 895 895 890 885 880 Taiwan (TWD) 31.7 32.8 33.1 32.6 33.1 32.7 32.7 33.0 32.5 32.5 32.5 32.5 Thailand (THB) 38.9 41.0 37.6 35.5 32.3 31.8 31.8 33.0 33.0 32.5 32.0 31.5 Vietnam (VND) 15754 15896 16055 16050 16020 16130 16217 16217 16217 16217 16176 16135

Note: * = Turkish currency (until then coded TRL) shed 6 zeros of its exchange rate in January 2005 Source: HSBC

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Exchange rate vs EUR & GBP

End period 2004 2005 2006 2007 2008 Q4 Q4 Q3 Q4 Q1 Q2 Q3 Q4f Q1f Q2f Q3f Q4f

vs EUR

Americas US (USD) 1.36 1.18 1.27 1.32 1.33 1.35 1.42 1.45 1.45 1.40 1.35 1.35 Canada (CAD) 1.63 1.38 1.41 1.53 1.54 1.44 1.41 1.45 1.45 1.40 1.42 1.42

Europe UK (GBP) 0.71 0.69 0.68 0.67 0.68 0.67 0.70 0.71 0.73 0.73 0.74 0.74 Sweden (SEK) 9.03 9.39 9.28 9.02 9.34 9.26 9.20 8.90 8.80 8.70 8.40 8.40 Switzerland (CHF) 1.55 1.55 1.59 1.61 1.63 1.66 1.66 1.67 1.68 1.64 1.60 1.60 Norway (NOK) 8.23 7.99 8.26 8.21 8.13 7.98 7.71 7.60 7.60 7.60 7.50 7.50 Czech Republic (CZK) 30.4 29.0 28.3 27.5 28.0 28.7 27.5 27.3 27.0 27.0 26.5 26.0 Hungary (HUF) 246 252 273 251 247 246 251 250 245 240 235 230 Poland (PLN) 4.07 3.84 3.97 3.83 3.86 3.76 3.77 3.65 3.55 3.47 3.35 3.25 Russia (RUB) 37.7 34.0 33.9 34.8 34.6 34.8 35.5 35.7 35.7 35.1 34.6 34.6

Asia/Pacific Japan (JPY) 139 139 150 157 157 167 164 167 164 158 155 155 Australia (AUD) 1.73 1.61 1.70 1.67 1.65 1.59 1.61 1.61 1.58 1.60 1.61 1.63 New Zealand (NZD) 1.88 1.73 1.94 1.87 1.86 1.75 1.88 1.86 1.81 1.84 1.85 1.88

Africa South Africa (ZAR) 7.66 7.48 9.84 9.30 9.65 9.52 9.81 9.79 9.43 9.66 9.45 9.18

vs GBP

Americas US (USD) 1.92 1.72 1.87 1.96 1.96 2.01 2.04 2.04 1.99 1.92 1.83 1.83 Canada (CAD) 2.30 2.01 2.08 2.28 2.26 2.13 2.02 2.04 1.99 1.92 1.92 1.92

Europe Eurozone (EUR) 0.71 0.69 0.68 0.67 0.68 0.67 0.70 0.71 0.73 0.73 0.74 0.74

Sweden (SEK) 12.76 13.66 13.69 13.39 13.76 13.76 13.18 12.51 12.06 11.92 11.38 11.38 Norway (NOK) 11.63 11.62 12.18 12.19 11.97 11.85 11.05 10.69 10.41 10.41 10.16 10.16 Switzerland (CHF) 2.18 2.26 2.34 2.39 2.39 2.46 2.38 2.35 2.30 2.25 2.17 2.17

Asia/Pacific Japan (JPY) 197 203 221 233 232 248 234 234 225 217 210 210 Australia (AUD) 2.45 2.34 2.50 2.48 2.43 2.36 2.30 2.27 2.16 2.19 2.19 2.21 New Zealand (NZD) 2.66 2.52 2.86 2.78 2.74 2.60 2.70 2.61 2.48 2.52 2.51 2.55

Africa South Africa (ZAR) 10.82 10.89 14.51 13.80 14.23 14.15 14.05 13.76 12.91 13.24 12.80 12.44

Source: HSBC

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Consumer spending

% Year 2000 2001 2002 2003 2004 2005 2006 2007f 2008f 2009f

World 4.0 2.4 2.3 2.4 3.3 3.1 3.3 3.2 2.6 2.8


North America 4.6 2.5 2.8 2.8 3.6 3.2 3.1 2.9 1.7 2.2 US 4.7 2.5 2.7 2.8 3.6 3.2 3.1 2.9 1.6 2.2 Canada 4.0 2.3 3.6 3.0 3.4 3.8 4.2 4.1 2.7 2.5 Latin America 5.5 1.0 0.0 1.8 4.6 5.4 5.3 5.2 4.9 4.7 Mexico 8.2 2.5 1.6 2.3 4.1 5.1 5.0 3.8 3.4 4.4 Brazil 4.0 0.7 1.9 -0.8 3.8 4.5 4.6 6.1 6.0 3.9 Argentina -0.7 -5.7 -14.4 8.2 9.5 8.9 7.7 8.0 7.0 7.0 Chile 3.7 2.9 1.9 4.0 6.1 7.6 7.7 7.7 7.2 7.0

Western Europe 3.5 2.1 1.4 1.6 1.9 1.7 2.0 1.9 1.5 1.6 Euro-13 3.2 2.0 0.9 1.2 1.5 1.6 1.9 1.5 1.6 1.7 Germany 2.5 1.9 -0.8 0.2 -0.2 0.1 1.1 -0.2 1.4 1.5 France 3.7 2.5 2.3 2.0 2.4 2.2 2.2 1.9 2.1 2.0 Italy 2.4 0.7 0.2 1.0 0.7 0.6 1.5 1.9 1.2 1.3 Spain 5.0 3.4 2.8 2.9 4.2 4.2 3.8 3.1 2.1 2.3 Other Western Europe 4.1 2.4 2.8 2.5 3.3 2.0 2.3 3.2 1.3 1.4 UK 4.6 3.0 3.5 2.9 3.4 1.5 2.1 3.1 0.8 1.1 Norway 3.8 1.8 2.8 2.6 5.2 4.1 4.2 6.8 3.1 2.0 Sweden 5.1 0.4 2.6 2.0 2.6 2.7 2.5 3.2 3.0 2.4 Switzerland 2.4 2.3 0.1 0.9 1.5 1.8 1.6 2.1 1.8 1.6

EMEA 5.3 1.9 5.1 5.2 8.3 8.1 7.5 7.4 7.8 7.0 Czech Republic 1.3 2.3 2.2 6.0 2.9 2.4 4.4 6.0 4.0 3.8 Hungary 5.0 5.7 9.9 7.8 3.2 3.8 1.2 -2.0 1.9 3.5 Poland 2.8 0.5 4.6 1.5 3.8 1.9 5.7 5.5 5.0 4.5 Russia 7.3 9.5 8.9 7.5 12.1 12.8 11.2 12.1 11.0 9.0 Turkey 6.2 -9.2 2.1 6.6 10.1 8.8 5.2 3.0 7.1 5.0 Ukraine 2.5 9.6 9.5 12.6 12.2 16.6 14.4 9.0 7.0 7.0 Egypt* 6.2 4.0 2.7 2.3 2.1 4.7 6.4 6.9 7.5 8.4 Israel 7.7 2.7 1.1 1.3 5.0 3.4 4.8 6.0 4.8 4.4 Saudi Arabia** 2.3 0.6 0.3 3.7 5.8 9.5 6.5 6.8 7.2 7.5 UAE** 12.3 5.3 21.6 10.5 29.1 16.4 12.2 18.0 17.0 15.0 South Africa 4.1 3.5 3.2 3.5 6.7 6.6 7.3 5.6 5.0 4.8

Asia/Pacific 2.9 3.0 2.8 2.3 3.4 3.5 3.8 4.0 3.8 4.0 Japan 0.7 1.7 1.1 0.4 1.6 1.3 2.0 1.7 1.3 1.6 Australia 3.9 2.9 3.9 3.5 5.9 3.1 2.8 4.0 4.2 3.6 New Zealand 1.8 2.0 4.6 5.9 6.0 4.7 2.4 2.4 2.5 2.5 Asia-ex-Japan 6.3 5.1 5.1 4.6 5.3 6.2 6.3 6.7 6.5 6.7 China 8.5 6.2 6.2 6.5 7.2 8.5 8.7 9.0 8.9 9.1 Asia ex-Japan & China 5.2 4.6 4.5 3.6 4.2 5.0 4.9 5.3 5.1 5.2 Hong Kong 5.1 1.9 -0.9 -1.3 7.0 3.0 5.9 6.6 5.3 3.6 India 2.5 6.1 2.9 8.1 5.4 6.7 6.2 5.8 5.0 5.5 Indonesia 1.6 3.5 3.8 3.9 5.0 4.0 3.2 5.0 5.3 4.0 Malaysia 13.0 2.4 4.4 6.6 10.5 8.7 7.1 11.1 7.2 6.2 Philippines 3.5 3.6 4.1 5.3 5.9 4.8 5.5 5.6 4.9 4.7 Singapore 14.9 4.7 4.9 0.9 5.9 2.7 2.5 5.0 7.1 6.1 South Korea 8.4 4.9 7.9 -1.2 -0.3 3.6 4.2 4.3 4.2 4.5 Taiwan 4.6 0.7 2.3 0.9 3.9 4.3 1.8 2.8 3.0 3.6 Thailand 5.2 4.1 5.4 6.4 6.1 4.8 3.2 1.7 3.7 4.3 Vietnam 3.1 4.5 7.6 8.0 7.1 7.3 7.5 7.5 7.6 7.0

Note: * = based upon Egyptian financial year (July-June). ** = Nominal growth. We now calculate the weighting system using chain nominal GDP (USD) weights Source: HSBC

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Investment spending

% Year 2000 2001 2002 2003 2004 2005 2006 2007f 2008f 2009f

World 5.7 -0.4 -1.1 4.3 7.2 7.8 7.2 6.0 6.1 7.4

Developed 4.7 -1.1 -2.8 2.0 4.5 4.9 3.7 1.2 1.3 3.4 Emerging 9.9 2.1 5.4 12.3 16.0 16.1 16.2 17.0 15.8 14.3

North America 6.4 -2.5 -4.7 3.6 7.3 7.0 2.7 -2.3 -0.3 4.0 US 6.5 -3.0 -5.2 3.4 7.3 6.9 2.4 -2.8 -0.7 4.1 Canada 4.8 3.0 1.3 6.3 8.1 8.1 7.1 3.7 3.2 2.4 Latin America 6.8 -3.9 -5.4 1.0 10.5 8.7 10.2 9.6 8.5 7.2 Mexico 11.4 -5.6 -0.7 0.4 7.5 7.6 10.0 7.8 7.5 8.3 Brazil 5.0 0.4 -5.2 -4.6 9.1 3.6 8.7 11.0 10.0 6.5 Argentina -6.8 -15.7 -36.4 38.2 34.4 22.7 18.7 12.9 8.0 6.0 Chile 8.9 4.3 1.5 5.7 11.7 24.7 5.5 9.0 8.0 5.0

Western Europe 5.0 0.6 -0.8 1.1 2.8 3.1 5.7 5.2 2.5 2.5 Euro-13 5.3 0.6 -1.5 1.2 1.9 2.8 5.2 4.7 2.3 2.6 Germany 3.8 -3.5 -6.3 -0.2 -1.1 1.3 7.0 5.3 2.5 1.9 France 7.5 2.3 -1.6 2.2 3.3 4.1 4.1 3.7 2.5 3.1 Italy 6.7 2.3 4.0 -1.5 1.3 -0.2 2.4 2.9 1.8 1.7 Spain 6.1 4.4 3.4 5.2 5.2 6.5 7.0 5.7 2.3 2.8 Other Western Europe 3.1 0.7 1.8 0.6 6.0 4.2 7.1 6.5 3.0 2.3 UK 2.7 2.6 3.6 1.1 5.9 1.5 6.9 6.9 3.0 2.4 Norway -3.5 -1.1 -1.2 0.1 10.0 13.2 6.5 6.6 5.4 2.9 Sweden 6.3 -0.5 -1.8 1.4 5.7 8.9 7.7 8.5 4.4 2.6 Switzerland 4.3 -3.5 -0.5 -1.2 4.5 3.7 4.2 2.8 0.5 1.1

EMEA 7.7 -4.6 0.1 8.2 11.7 10.2 12.6 13.9 12.7 11.4 Czech Republic 5.1 6.6 5.1 0.4 3.9 2.3 5.5 4.9 6.3 6.9 Hungary 7.7 5.1 10.1 2.1 7.7 5.6 -1.8 1.7 1.5 2.8 Poland -0.1 -17.0 -8.8 4.1 13.4 -5.8 12.6 16.5 12.2 8.8 Russia 18.1 10.3 2.8 12.8 12.6 8.3 13.9 19.5 15.0 11.0 Turkey 16.9 -31.5 -1.1 10.0 32.4 24.0 14.0 6.6 8.9 8.1 Ukraine 12.4 6.2 3.4 12.2 -2.2 -0.3 18.7 12.0 10.0 9.0 Egypt* -3.6 -2.2 5.5 -8.7 6.2 14.2 13.3 23.8 20.5 19.5 Israel 0.9 -5.1 -13.7 -10.7 4.0 2.9 6.4 10.3 6.3 5.5 Saudi Arabia** 4.3 2.3 1.6 24.5 6.8 24.1 10.9 14.0 16.0 16.0 UAE** 6.5 4.8 3.7 17.1 11.1 15.5 29.0 22.0 20.0 20.0 South Africa 4.3 3.5 3.7 9.1 9.6 9.6 12.8 12.0 11.3 11.2

Asia/Pacific 5.2 1.9 2.7 7.8 10.3 12.0 11.1 11.7 12.1 12.0 Japan 1.1 -0.9 -4.9 -0.5 1.5 3.4 1.5 -0.4 1.3 3.7 Australia 1.5 -4.9 17.0 8.9 8.0 7.9 5.0 8.8 8.5 6.5 New Zealand 8.3 -1.2 10.9 10.3 11.6 3.6 -2.5 3.7 1.7 3.9 Asia-ex-Japan 11.8 6.5 10.4 16.5 18.4 19.2 18.2 19.1 17.7 16.0 China 13.8 13.0 16.9 27.7 27.6 27.2 24.5 24.0 22.0 19.0 Asia ex-Japan & China 10.2 1.3 4.6 5.3 7.3 7.7 7.7 9.4 8.1 8.4 Hong Kong 7.9 2.9 -4.6 1.0 2.7 4.1 6.3 5.6 7.6 8.9 India 4.1 4.3 7.7 9.7 11.8 15.3 14.6 15.0 11.0 13.0 Indonesia 16.7 6.5 4.7 0.6 14.7 10.8 2.9 7.9 10.1 6.5 Malaysia 25.7 -2.8 0.3 2.7 3.1 5.0 7.9 9.6 7.9 6.5 Philippines 19.9 -13.0 2.3 3.6 1.3 -6.6 1.4 8.5 4.6 4.1 Singapore 9.8 -3.9 -11.4 -3.2 10.2 0.2 11.5 16.9 9.4 6.8 South Korea 12.2 -0.2 6.6 4.0 2.1 2.4 3.2 5.1 4.6 5.0 Taiwan 9.0 -19.9 -0.6 -0.9 17.5 7.4 0.6 4.2 4.4 4.5 Thailand 5.5 1.1 6.5 12.1 13.2 10.6 3.8 1.0 8.8 4.8 Vietnam 10.2 10.7 12.9 11.9 10.4 9.7 8.6 10.4 11.0 11.5


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Export volume growth (GDP basis)

% Year 2000 2001 2002 2003 2004 2005 2006 2007f 2008f 2009f

World 13.2 0.4 3.0 5.2 10.6 8.1 9.8 8.0 7.2 7.7


North America 8.8 -4.8 -1.4 0.4 8.5 5.8 6.6 6.7 7.1 6.2 US 8.7 -5.4 -2.3 1.3 9.7 6.9 8.4 8.1 8.3 7.0 Canada 8.9 -3.0 1.2 -2.3 4.8 2.2 0.7 1.9 2.7 2.8 Latin America 13.1 1.1 2.7 5.1 11.6 8.6 8.3 7.9 6.3 6.6 Mexico 16.3 -3.5 1.4 2.7 11.7 7.0 11.2 8.8 6.7 7.5 Brazil 12.9 10.0 7.4 10.4 15.3 9.3 4.7 5.5 5.0 4.5 Argentina 2.7 4.3 0.7 4.4 2.0 20.0 6.0 9.0 8.0 8.0 Chile 5.1 7.2 1.6 6.0 11.7 3.5 4.2 7.8 6.0 4.5

Western Europe 13.2 3.5 1.5 1.2 6.3 5.3 8.2 5.0 4.5 5.0 Euro-13 12.6 3.7 1.6 1.1 6.5 4.7 7.9 6.3 4.5 4.7 Germany 14.1 6.8 4.3 2.4 9.2 7.4 12.9 8.4 7.4 7.4 France 13.1 2.6 1.3 -1.2 3.3 3.2 6.3 3.5 2.9 2.5 Italy 9.6 0.3 -4.0 -2.2 2.7 0.0 5.5 2.4 1.5 3.2 Spain 10.2 4.2 2.0 3.7 4.2 2.6 5.1 5.7 4.6 4.4 Other Western Europe 9.7 2.4 0.9 1.2 5.5 7.0 9.1 1.0 4.4 5.7 UK 9.1 2.9 1.0 1.7 4.9 8.2 10.3 -4.4 5.4 7.6 Norway 3.4 4.2 -1.0 -0.7 0.5 0.1 0.5 3.1 3.2 2.5 Sweden 11.4 1.0 1.1 3.8 10.8 7.0 8.6 4.7 2.9 3.2 Switzerland 12.4 0.6 -0.3 -0.2 7.8 7.1 10.0 9.1 3.1 4.5

EMEA 12.1 1.7 3.3 11.3 12.2 6.5 8.4 7.7 7.9 7.9 Czech Republic 16.5 11.2 2.1 7.2 21.1 10.4 14.6 13.5 15.0 14.0 Hungary 22.0 8.1 3.9 6.2 15.7 11.6 17.1 15.5 10.8 10.0 Poland 13.9 -1.0 7.6 20.4 19.2 3.0 16.0 8.5 10.2 10.5 Russia 9.5 3.6 9.6 12.5 11.8 6.4 7.2 5.0 4.2 3.0 Turkey 19.2 7.4 11.1 16.0 12.5 8.5 8.5 10.3 7.7 8.6 Ukraine 21.5 2.9 9.1 10.3 13.8 -11.2 -4.9 5.0 7.0 7.0 Egypt* 3.8 3.3 -7.8 11.8 27.6 20.2 21.3 23.3 14.5 13.6 Israel 22.7 -11.2 -2.3 8.2 18.2 5.1 4.9 8.0 4.4 4.0 Saudi Arabia 6.1 -3.5 -4.4 13.7 3.1 4.7 -2.6 -5.0 3.7 5.0 UAE** 5.4 0.6 -1.3 10.7 5.5 6.9 8.4 4.8 6.4 8.0 South Africa 8.3 2.4 1.0 0.1 2.9 8.0 5.6 9.5 8.5 8.0

Asia/Pacific 17.4 -2.0 9.5 14.3 18.6 14.3 14.3 12.7 10.5 11.6 Japan 12.8 -6.8 7.4 9.2 14.0 6.9 9.6 7.9 6.4 7.3 Australia 10.2 2.2 0.0 -1.2 4.3 2.3 3.3 4.0 8.0 8.0 New Zealand 7.0 3.4 6.4 2.1 5.7 -0.5 1.9 3.1 3.4 4.5 Asia-ex-Japan 20.2 -0.6 11.1 17.4 21.1 17.3 16.3 14.4 11.7 12.8 China 28.5 7.5 18.0 32.0 32.0 29.0 25.0 23.5 18.0 17.0 Asia ex-Japan & China 17.8 -3.0 8.7 12.1 16.4 11.6 11.4 8.7 7.2 9.5 Hong Kong 16.3 -1.7 9.0 12.8 15.4 10.6 9.2 8.2 6.4 6.9 India 21.1 -1.6 14.4 19.0 28.0 31.1 21.0 15.6 13.8 20.0 Indonesia 26.5 0.6 -1.2 5.9 13.5 16.4 9.2 8.6 7.8 9.8 Malaysia 16.1 -7.5 4.5 5.7 2.3 7.9 7.4 2.8 4.8 7.9 Philippines 17.0 -3.4 4.1 4.8 15.0 4.8 11.2 2.8 4.4 5.4 Singapore 15.2 -4.0 7.2 13.7 20.6 11.5 10.4 7.2 7.5 9.3 South Korea 19.1 -2.7 13.3 15.6 19.6 8.5 12.4 9.7 7.3 9.0 Taiwan 18.1 -8.1 10.5 10.9 14.8 10.0 10.4 6.7 4.4 5.4 Thailand 17.5 -4.2 12.0 7.0 9.6 3.9 8.5 5.9 4.2 6.0 Vietnam 25.2 4.0 11.2 20.6 31.4 22.5 22.1 21.2 17.7 18.6


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Industrial production

% Year 2000 2001 2002 2003 2004 2005 2006 2007f 2008f 2009f

World 6.2 0.1 2.7 4.6 6.3 5.2 6.3 6.0 5.3 5.7

Developed 5.0 -2.4 -0.3 0.9 2.6 1.8 3.6 2.4 1.8 2.7 Emerging 8.1 3.8 6.8 9.2 10.8 9.1 9.5 10.3 9.4 9.1

North America 4.8 -3.5 0.2 1.0 2.4 3.1 3.7 1.9 1.7 2.9 US 4.5 -3.5 0.0 1.1 2.5 3.2 4.0 2.1 1.8 3.0 Canada 7.5 -3.5 2.1 0.2 1.9 1.6 -0.2 0.3 0.7 1.8 Latin America 2.6 1.5 0.8 2.0 7.4 3.5 4.3 4.5 4.6 4.5 Mexico -0.2 4.2 -0.1 -0.2 4.2 1.7 5.0 1.3 2.6 4.3 Brazil 6.6 1.6 2.7 0.1 8.3 3.1 2.8 6.2 5.6 4.5 Argentina -0.7 -4.3 -7.2 12.5 10.7 7.5 7.4 6.6 5.6 5.0 Chile -3.2 0.6 10.9 2.9 10.2 6.0 3.3 4.1 4.5 4.6

Western Europe 4.9 0.0 -0.7 0.2 2.0 0.7 3.3 2.9 2.1 2.4 Euro-13 5.5 0.4 -0.4 0.3 2.2 1.3 4.0 3.2 2.1 2.2 Germany 4.9 -0.4 -1.3 0.1 2.5 2.8 6.0 5.8 3.8 3.4 France 4.5 1.2 -1.2 -0.3 1.9 0.2 0.9 1.7 1.9 2.3 Italy 4.3 -1.0 -1.4 -0.6 -0.3 -0.9 2.7 0.3 0.6 1.4 Spain 4.4 -1.4 0.1 1.4 1.5 0.8 3.9 2.4 1.6 1.8 Other Western Europe 3.0 -1.3 -1.8 -0.3 1.6 -1.0 1.1 1.9 1.9 2.8 UK 1.9 -1.4 -2.0 -0.3 0.8 -2.0 0.1 0.8 1.4 2.8 Norway 3.2 -1.6 0.9 -4.0 2.3 -0.8 -2.4 -0.2 2.3 0.6 Sweden 5.9 -0.6 0.2 1.5 3.9 2.0 3.9 4.4 2.9 2.9 Switzerland 8.4 -0.7 -5.1 0.1 4.4 2.7 7.8 8.6 4.3 4.5

EMEA 8.3 2.4 3.7 7.0 7.9 4.6 6.1 6.3 6.1 5.9 Czech Republic 5.7 5.0 5.0 5.9 9.8 6.7 11.2 8.8 7.0 9.0 Hungary 18.7 5.0 2.6 6.4 8.3 7.0 10.6 8.5 11.1 10.5 Poland 6.7 0.6 0.8 8.7 12.7 4.0 12.0 10.6 11.0 9.6 Russia 12.0 4.9 3.7 7.0 6.6 3.9 3.8 5.9 5.0 4.6 Turkey 6.0 -8.7 9.5 8.8 9.7 5.4 5.8 4.3 5.2 4.7 Ukraine 13.2 14.2 7.0 15.8 12.5 3.1 6.2 10.0 7.6 7.0 Egypt* 6.8 7.1 2.7 6.5 5.8 5.3 6.1 5.7 5.1 Israel 10.0 -5.0 -1.8 -0.3 6.9 3.6 8.5 4.5 4.3 4.2 Saudi Arabia 6.4 -1.3 -3.9 13.4 6.6 6.1 2.8 2.7 4.5 5.7 UAE 15.4 3.0 -1.4 12.7 6.7 5.6 10.3 4.4 6.3 6.0 South Africa 2.5 2.9 4.6 -1.9 3.3 4.2 4.9 5.5 4.4 5.0

Asia/Pacific 8.4 2.0 6.7 9.4 10.7 9.2 9.9 10.4 9.1 9.2 Japan 5.7 -6.8 -1.3 3.3 5.5 1.1 4.8 2.8 1.0 3.3 Australia 5.4 0.2 3.1 0.1 0.3 1.1 -0.5 2.5 1.9 2.0 New Zealand 3.8 -0.2 5.5 2.8 4.5 -2.6 -1.6 -1.0 1.0 1.0 Asia-ex-Japan 9.3 4.7 9.0 11.4 12.4 11.5 11.5 12.5 11.3 10.9 China 11.5 9.7 12.7 16.7 16.3 15.9 16.2 18.0 16.5 15.0 Asia ex-Japan & China 9.2 -1.4 5.4 6.0 8.6 6.0 5.6 4.7 5.6 6.1 Hong Kong -0.5 -4.4 -9.7 -9.2 2.9 2.5 2.2 0.6 2.4 1.9 India 5.0 2.7 5.8 7.0 8.4 8.2 8.2 9.7 6.4 7.6 Indonesia 6.0 3.3 5.3 5.3 6.4 4.6 4.6 4.2 5.5 5.1 Malaysia 18.3 -5.9 4.3 8.4 11.3 5.3 7.1 2.5 4.4 7.9 Philippines 2.4 -5.7 -6.1 0.0 1.0 2.2 -9.9 -2.8 2.8 3.0 Singapore 15.3 -11.6 8.4 3.0 13.8 9.4 12.0 6.1 7.8 8.0 South Korea 16.8 0.7 8.0 5.3 10.2 6.2 10.1 6.2 6.5 7.5 Taiwan 6.9 -7.8 7.9 7.1 9.8 4.6 5.0 5.4 3.4 4.1 Thailand 6.1 1.4 6.9 10.4 8.3 5.2 5.9 5.0 6.3 8.0 Vietnam 13.1 16.2 14.2 19.8 17.6 25.5 16.0 14.6 17.3 13.5

Note: * = based upon Egyptian financial year (July-June). Source: HSBC

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Wage growth

% Year 2000 2001 2002 2003 2004 2005 2006 2007f 2008f 2009f

World 7.3 6.0 5.8 5.7 5.3 5.8 6.1 6.3 6.0 5.6

North America 4.1 4.0 3.6 3.5 3.7 3.2 3.0 3.4 3.3 3.1 US 4.3 4.2 3.7 3.7 3.8 3.2 3.0 3.4 3.4 3.2 Canada 2.4 1.4 2.1 1.3 2.1 3.2 3.0 3.0 2.1 2.1 Latin America 8.1 5.1 6.3 6.3 5.9 7.4 6.3 6.0 5.5 5.3 Mexico 12.5 9.3 6.1 4.9 4.4 4.5 4.3 4.4 4.2 4.0 Argentina 0.0 -4.0 7.6 10.2 10.2 14.0 10.5 9.0 8.0 8.0 Chile 5.3 5.3 4.6 3.8 2.9 5.0 5.4 6.6 6.2 5.4

Western Europe 3.8 4.2 3.7 3.4 2.7 3.0 3.1 3.0 3.2 3.2 Euro-13 3.4 3.9 3.3 2.9 2.3 2.7 2.6 2.5 2.8 2.7 Germany 1.9 1.9 2.6 2.1 1.3 1.1 1.3 1.8 2.4 2.5 France 1.8 2.5 2.5 2.4 2.5 2.8 2.9 2.6 2.9 2.8 Italy 1.9 2.6 2.1 2.2 2.8 3.1 2.9 2.4 2.5 2.5 Spain 2.3 3.5 3.8 3.9 2.8 2.6 3.4 3.7 3.0 2.4 Other Western Europe 4.3 4.4 3.7 3.5 4.1 3.8 4.0 4.1 3.9 3.2 UK 4.5 4.5 3.5 3.4 4.4 4.0 4.1 4.1 3.9 3.2 Norway 4.1 4.5 5.2 4.7 4.2 3.5 4.1 5.5 4.2 3.4 Sweden 3.0 3.7 3.5 2.9 2.5 2.9 3.0 3.2 3.6 3.0

EMEA 30.6 19.4 16.5 11.8 11.3 12.0 12.8 13.7 11.9 9.9 Czech Republic -0.5 0.3 -0.3 -0.5 1.3 -2.4 1.5 3.0 4.2 3.7 Hungary 13.6 18.2 18.2 12.1 6.2 8.7 8.2 8.8 6.7 5.2 Poland 7.5 5.3 3.7 2.6 4.3 3.2 5.0 8.8 7.5 6.2 Russia 43.1 21.0 16.6 10.4 10.6 12.6 13.5 15.3 12.0 9.0 Turkey 55.8 31.8 37.2 23.0 13.4 12.2 11.5 9.2 8.7 8.0 Ukraine 30.2 34.9 20.7 23.0 27.6 36.5 29.4 25.0 25.0 20.0 Israel 5.1 7.1 -4.2 -3.0 2.5 1.0 1.6 2.9 3.0 3.2 South Africa 9.2 8.8 9.5 8.1 7.5 6.5 9.0 9.5 8.6 8.2

Asia/Pacific 7.8 6.8 7.5 8.5 7.8 8.6 12.7 12.8 12.3 11.6 Japan 0.1 -1.6 -2.9 -0.8 -0.7 0.6 0.2 -0.7 0.1 0.4 Australia 3.0 3.6 3.3 3.6 3.5 4.1 4.0 4.2 4.2 4.2 New Zealand 1.6 1.9 2.2 2.3 2.4 2.9 3.0 3.2 3.2 3.3 Asia-ex-Japan 10.5 9.4 10.5 11.1 10.0 10.6 12.2 12.5 11.8 11.0 China 12.3 11.7 12.6 13.6 12.3 12.3 14.5 15.0 14.0 13.0 Asia ex-Japan & China 5.0 3.3 4.4 3.8 3.2 4.6 4.5 4.4 4.4 4.4 Hong Kong -0.2 -0.7 -2.9 -1.2 -3.3 -0.6 4.2 6.0 8.5 7.3 Philippines 11.5 10.8 10.4 0.4 3.6 8.5 7.9 7.1 7.0 7.0 Singapore 8.3 2.7 1.2 3.6 2.6 4.3 3.5 6.5 5.0 3.5 South Korea 8.0 5.7 11.5 9.4 6.5 6.4 5.6 6.1 5.0 5.0 Taiwan 2.5 0.0 -0.7 1.5 1.8 1.3 1.1 2.0 2.2 2.4 Thailand 0.2 1.0 -0.8 2.2 2.3 6.9 6.2 2.7 3.8 4.0

Note: Global and regional aggregates are calculated using the World Bank’s 2004 PPP weights Source: HSBC

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Budget balance

% GDP 2000 2001 2002 2003 2004 2005 2006 2007f 2008f 2009f

North America 2.4 0.6 -2.4 -3.2 -2.9 -2.2 -1.3 -1.5 -2.1 -2.2 US 2.4 0.5 -2.7 -3.6 -3.2 -2.4 -1.5 -1.7 -2.4 -2.5 Canada 1.9 1.3 0.8 0.7 0.7 0.8 0.9 0.7 0.7 0.7 Latin America -2.3 -2.3 -2.6 -2.3 -0.7 -0.9 -0.6 -0.3 -0.4 -0.6 Mexico -1.1 -0.7 -1.2 -0.6 -0.2 -0.1 0.1 0.0 -0.1 0.0 Brazil -3.4 -3.3 -4.2 -4.7 -2.4 -3.0 -3.0 -1.8 -2.0 -2.2 Argentina -2.4 -3.2 -1.5 0.5 2.6 1.8 1.8 0.4 1.5 1.2 Chile -0.6 -0.4 -1.0 -0.4 2.2 4.8 7.8 8.7 5.8 4.7

Western Europe 0.7 -0.9 -2.1 -2.8 -2.5 -2.2 -1.2 -0.8 -1.0 -1.0 Euro-13 0.0 -1.8 -2.5 -3.1 -2.9 -2.5 -1.6 -0.9 -1.0 -1.1 Germany 1.3 -2.8 -3.6 -4.0 -3.8 -3.2 -1.7 -0.2 -0.1 0.0 France -1.5 -1.6 -3.2 -4.1 -3.6 -3.0 -2.6 -2.7 -2.9 -2.8 Italy -0.9 -3.1 -3.0 -3.5 -3.5 -4.2 -4.4 -2.4 -2.6 -2.7 Spain -0.9 -0.5 -0.3 0.0 -0.2 1.1 1.8 1.8 1.0 0.4 Other Western Europe 3.0 2.0 -0.9 -2.0 -1.6 -1.2 -0.2 -0.6 -0.8 -0.5 UK 1.7 1.0 -1.8 -3.0 -3.1 -3.3 -2.3 -2.7 -2.9 -2.4 Norway 15.4 13.3 9.2 7.3 11.1 15.2 18.0 16.7 16.0 15.0 Sweden 3.8 1.7 -1.5 -1.1 0.6 2.1 2.3 2.5 2.5 2.3

EMEA -1.0 -2.7 -3.2 -2.1 -0.3 2.6 3.1 1.7 0.9 0.1 Hungary -2.7 -2.7 -8.6 -3.8 -4.3 -2.4 -8.2 -5.6 -3.9 -3.3 Poland -2.1 -4.2 -4.9 -4.4 -4.5 -2.5 -2.4 -1.5 -1.8 -1.5 Russia 2.4 3.0 1.4 1.7 4.4 7.5 7.5 5.3 2.3 1.3 Turkey -10.6 -16.3 -14.4 -11.2 -7.0 -2.0 -0.7 -2.5 -2.3 -2.4 Ukraine 0.4 -0.3 0.5 -0.1 -3.7 -1.5 -0.7 -1.7 -2.1 -2.3 Egypt* -5.6 -5.9 -6.1 -6.1 -7.0 -7.7 -6.2 -5.9 -5.2 Israel -0.7 -4.5 -3.8 -5.5 -3.9 -1.9 -0.9 0.0 -1.5 -2.0 Saudi Arabia 3.2 -3.9 -2.9 4.4 11.2 18.2 22.2 13.0 14.5 9.3 UAE -3.8 -10.5 -10.7 -4.4 -0.4 8.0 12.1 8.5 8.3 4.1 South Africa -1.9 -0.7 -0.7 -2.5 -2.0 -0.5 0.2 0.5 0.6 0.2

Asia/Pacific -4.0 -4.1 -4.1 -3.4 -2.5 -2.4 -2.0 -1.6 -1.7 -1.7 Japan -7.4 -6.8 -8.3 -7.7 -5.5 -5.8 -5.0 -3.0 -2.5 -2.0 Australia 1.1 -0.6 0.8 1.3 1.0 1.4 1.5 1.5 1.5 1.5 New Zealand 1.6 2.2 3.1 3.9 3.7 4.4 3.9 3.0 3.0 3.0 Asia-ex-Japan -3.2 -3.5 -3.2 -2.6 -2.0 -1.8 -1.5 -1.5 -1.7 -1.7 China -2.5 -2.3 -2.6 -2.2 -1.3 -1.2 -1.0 -0.9 -1.1 -1.0 Asia ex-Japan & China -3.7 -4.5 -3.7 -3.0 -2.7 -2.4 -2.0 -2.0 -2.3 -2.5 Hong Kong -0.6 -4.9 -4.8 -3.3 1.7 1.0 4.0 5.3 2.9 2.5 India -6.2 -6.7 -6.4 -4.8 -4.4 -4.5 -3.8 -3.4 -3.7 -4.0 Indonesia -1.2 -2.5 -1.3 -1.7 -1.0 -0.5 -0.9 -1.8 -2.3 -2.5 Malaysia -5.7 -5.5 -5.6 -4.4 -4.1 -3.6 -3.3 -4.2 -3.8 -3.5 Philippines -4.1 -4.0 -5.3 -4.7 -3.8 -2.7 -1.1 -0.9 -0.5 -0.8 Singapore 3.5 2.2 0.8 -1.1 -1.9 -0.8 -0.2 0.6 2.1 2.1 South Korea 1.1 1.2 3.3 1.1 0.7 0.4 0.4 0.2 -0.2 -0.5 Taiwan -4.5 -6.4 -4.2 -2.7 -2.8 -0.6 -1.1 -0.5 -0.7 -0.7 Thailand -2.2 -2.6 -1.4 0.3 0.0 0.3 1.2 -1.5 -2.6 -2.9 Vietnam -5.0 -4.9 -4.8 -4.9 -4.9 -4.9 -5.0 -5.0 -4.8 -4.8

Note: * = based upon Egyptian financial year (July-June). Global and regional aggregates are calculated using the World Banks’ 2004 PPP weights Source: HSBC

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Percentage

% GDP 2000 2001 2002 2003 2004 2005 2006 2007f 2008f 2009f

North America -3.7 -3.3 -3.9 -4.3 -4.9 -5.4 -5.5 -4.9 -4.5 -4.5 US -4.3 -3.8 -4.4 -4.8 -5.5 -6.1 -6.2 -5.4 -5.0 -5.0 Canada 2.7 2.3 1.7 1.2 2.3 2.0 1.6 1.2 1.3 1.3 Latin America -3.4 -3.2 -1.0 0.3 0.8 0.9 1.1 0.2 -0.4 -0.7 Mexico -3.2 -2.8 -2.2 -1.4 -1.0 -0.6 -0.3 -1.2 -1.8 -2.4 Brazil -3.8 -4.2 -1.5 0.7 1.7 1.6 1.3 0.2 -0.7 -1.1 Argentina -3.3 -1.4 3.7 3.2 1.2 1.8 2.4 1.8 1.3 1.3 Chile -1.2 -1.6 -0.9 -1.3 2.2 1.1 3.6 4.7 5.1 5.5

Western Europe -0.9 -0.1 0.9 0.8 1.0 0.4 0.1 0.0 0.0 0.2 Euro-13 -1.5 -0.3 0.8 0.4 0.8 0.1 -0.2 0.1 0.0 0.1 Germany -1.7 0.0 2.0 1.9 4.3 4.6 4.9 5.9 5.6 5.3 France 1.7 2.0 1.3 0.9 0.5 -1.0 -1.3 -1.1 -1.5 -1.5 Italy -0.5 -0.1 -0.8 -1.3 -0.9 -1.6 -2.6 -2.3 -2.6 -2.4 Spain -4.0 -3.9 -3.3 -3.5 -5.3 -7.4 -8.6 -9.6 -9.3 -8.4 Other Western Europe 0.8 0.8 1.1 1.9 1.6 1.4 1.1 -0.3 -0.2 0.6 UK -2.6 -2.2 -1.6 -1.3 -1.6 -2.5 -3.2 -4.8 -3.5 -2.3 Norway 15.0 16.1 12.5 12.3 12.7 16.3 17.3 14.7 10.0 8.0 Sweden 4.0 4.3 5.0 7.2 6.7 6.8 7.0 6.4 5.9 5.2 Switzerland 12.0 7.7 8.3 12.9 12.9 13.5 15.1 15.7 11.0 11.9

EMEA 4.9 3.6 2.8 3.0 4.0 4.9 3.5 1.8 0.7 -0.7 Czech Republic -4.8 -5.3 -5.5 -6.2 -5.1 -1.6 -3.2 -3.2 -2.8 -3.1 Hungary -8.4 -6.1 -7.0 -8.7 -8.7 -7.2 -5.8 -3.4 -2.5 -2.5 Poland -5.8 -2.8 -2.5 -2.1 -4.1 -1.6 -2.3 -4.0 -3.9 -3.7 Russia 18.0 11.0 8.4 8.3 10.0 11.1 9.6 5.9 3.0 0.9 Turkey -4.9 2.3 -0.8 -2.8 -5.2 -6.2 -8.2 -7.2 -7.4 -7.1 Ukraine 3.8 3.7 7.5 5.8 10.5 3.1 -1.6 -3.6 -5.6 -3.8 Egypt* -0.1 0.0 0.7 2.4 4.3 3.2 1.7 2.1 1.0 0.5 Israel -1.2 -1.5 -1.2 1.2 2.4 3.3 5.7 3.6 2.0 1.3 Saudi Arabia 7.6 5.1 6.3 12.9 20.5 28.3 27.6 25.1 26.0 18.5 UAE 17.4 9.4 4.7 8.5 9.9 18.2 21.5 15.5 14.0 7.3 South Africa 2.4 0.1 0.6 -1.3 -3.2 -3.8 -6.4 -7.1 -7.3 -7.8

Asia/Pacific 2.0 2.0 2.8 3.0 2.8 3.7 5.1 5.4 5.4 5.2 Japan 2.6 2.2 2.8 3.2 3.7 3.7 3.9 4.9 5.6 5.4 Australia -3.8 -2.0 -3.8 -5.4 -6.0 -5.8 -5.5 -5.9 -5.9 -5.9 New Zealand -5.1 -2.8 -3.9 -4.3 -6.6 -9.0 -9.0 -9.0 -8.5 -8.5 Asia-ex-Japan 2.2 2.2 3.1 3.4 3.0 4.1 5.9 6.1 5.9 5.7 China 1.7 1.3 2.4 2.8 3.6 7.2 9.4 9.7 10.2 10.1 Asia ex-Japan & China 2.6 2.9 3.7 3.9 2.5 1.1 2.3 2.3 1.5 1.2 Hong Kong 4.5 4.7 8.3 9.2 8.9 12.5 11.7 11.5 11.2 11.0 India -0.6 0.8 1.5 1.6 0.1 -1.8 -1.1 -1.3 -1.5 -1.9 Indonesia 4.8 4.2 3.9 3.4 0.6 0.1 2.7 3.0 2.7 3.1 Malaysia 9.4 8.3 8.4 12.8 12.1 14.6 16.3 16.5 15.8 15.6 Philippines 8.2 1.9 6.9 0.9 1.1 1.9 5.0 5.1 4.5 4.0 Singapore 12.7 16.8 18.0 31.5 28.9 29.5 27.5 31.9 29.5 29.2 South Korea 2.4 1.7 1.0 2.0 4.3 1.9 0.7 0.6 -0.2 -0.4 Taiwan 2.8 6.3 8.6 9.6 5.6 4.5 6.8 6.3 3.6 3.6 Thailand 7.6 5.4 5.5 5.6 1.7 -4.5 1.1 4.5 1.7 0.5 Vietnam 2.1 2.1 -1.9 -4.9 -3.4 0.4 0.5 -2.5 -2.9 -3.1


��

39


��

Balance

USDbn 2000 2001 2002 2003 2004 2005 2006 2007f 2008f 2009f

North America -397.0 -368.0 -447.0 -511.0 -618.0 -732.0 -790.0 -733.2 -702.3 -704.4 US -417.0 -385.0 -460.0 -522.0 -640.0 -755.0 -811.0 -750.1 -720.8 -723.0 Canada 20.0 17.0 13.0 11.0 22.0 23.0 21.0 16.9 18.5 18.5 Latin America -52.8 -45.8 -13.6 2.9 10.4 16.3 24.3 5.5 -13.1 -25.4 Mexico -18.7 -17.7 -14.1 -8.6 -6.7 -4.9 -2.4 -11.0 -17.4 -24.2 Brazil -24.2 -23.2 -7.6 4.2 11.6 14.3 13.5 2.5 -10.0 -17.0 Argentina -9.0 -3.8 8.7 8.1 3.4 5.6 8.0 6.3 5.1 5.0 Chile -0.9 -1.1 -0.6 -0.8 2.1 1.3 5.2 7.7 9.2 10.8

Western Europe -65.9 5.0 93.8 105.5 142.6 88.2 61.9 40.4 39.7 68.5 Euro-13 -95.7 -19.0 56.2 38.4 75.3 10.4 -16.2 13.6 3.5 12.0 Germany -33.8 0.4 42.5 47.0 115.5 124.8 145.9 189.3 194.3 176.8 France 23.0 25.0 20.0 16.0 9.0 -20.0 -29.0 -35.2 -40.0 -40.5 Italy -6.0 -0.6 -9.9 -19.9 -15.9 -28.3 -48.4 -47.0 -57.0 -50.8 Spain -23.9 -22.7 -23.5 -31.6 -53.7 -80.9 -108.4 -142.0 -143.7 -128.1 Other Western Europe 29.7 24.0 37.6 67.1 67.3 77.7 78.1 26.8 36.2 56.6 UK -37.6 -30.8 -25.2 -24.6 -35.1 -54.6 -77.5 -134.6 -90.9 -59.7 Norway 26.0 26.5 25.6 27.1 32.0 48.4 60.0 56.7 40.7 32.2 Sweden 10.3 9.3 13.2 22.6 23.4 23.8 28.2 29.7 28.8 24.9 Switzerland 31.0 19.0 24.0 42.0 47.0 49.0 60.0 68.4 49.4 51.8

EMEA 46.2 40.7 31.3 50.2 88.2 162.8 165.5 116.8 80.4 2.0 Czech Republic -2.8 -3.1 -4.6 -5.8 -5.6 -2.0 -4.5 -5.5 -6.0 -7.1 Hungary -4.2 -3.0 -4.9 -6.8 -8.4 -7.3 -6.7 -4.8 -4.0 -4.4 Poland -10.0 -5.4 -5.0 -4.6 -10.4 -4.8 -7.9 -16.9 -19.2 -20.0 Russia 46.8 33.6 29.1 35.8 59.9 84.3 94.5 75.4 45.3 15.0 Turkey -10.0 3.0 -2.0 -8.0 -16.0 -23.0 -33.0 -35.8 -44.0 -45.9 Ukraine 1.2 1.4 3.2 2.9 6.8 2.5 -1.7 -4.9 -9.5 -6.9 Egypt* 0.6 1.9 3.4 2.9 1.8 2.7 1.5 0.9 Israel -1.4 -1.7 -1.3 1.4 2.9 4.3 8.0 5.8 3.5 2.5 Saudi Arabia 14.3 9.4 11.9 28.0 52.0 90.7 96.2 92.0 105.0 76.1 UAE 12.2 6.5 3.5 7.5 10.5 24.4 35.1 28.2 29.3 16.3 South Africa 0.0 0.1 0.7 -2.2 -6.9 -9.2 -16.4 -19.5 -21.5 -24.6

Asia/Pacific 193.5 165.4 222.8 255.9 308.6 364.6 498.1 610.7 718.0 789.7 Japan 121.8 86.0 116.8 131.2 171.0 165.5 174.5 213.5 255.9 242.3 Australia -15.0 -7.0 -16.0 -29.0 -37.0 -41.0 -41.0 -53.8 -55.7 -51.7 New Zealand -2.8 -1.4 -2.5 -3.4 -6.0 -9.2 -8.5 -11.7 -12.5 -11.8 Asia-ex-Japan 89.5 87.7 124.5 157.2 180.7 249.3 373.1 462.6 530.4 610.8 China 20.5 17.4 35.4 45.9 68.7 160.8 249.9 313.8 401.4 480.0 Asia ex-Japan & China 69.0 70.3 89.1 111.3 112.0 88.5 123.2 148.8 129.0 130.8 Hong Kong 7.5 7.9 13.6 14.7 14.7 22.2 22.1 23.6 24.5 26.0 India -2.7 3.4 7.1 8.8 0.8 -13.5 -9.4 -13.5 -17.5 -27.2 Indonesia 8.0 6.9 7.8 8.1 1.6 0.3 9.9 12.8 13.9 18.2 Malaysia 8.0 7.0 8.0 13.0 15.0 20.0 25.0 30.0 32.6 36.6 Philippines 6.3 1.3 5.3 0.7 0.9 1.9 5.9 7.6 8.0 8.4 Singapore 10.7 11.8 12.3 22.1 31.1 34.3 36.5 49.6 53.2 58.8 South Korea 12.3 8.0 5.4 11.9 28.2 15.0 6.1 5.4 -2.7 -4.5 Taiwan 8.9 18.2 25.6 29.2 18.5 16.0 24.7 24.4 14.7 16.1 Thailand 9.3 5.1 4.7 4.8 2.8 -7.9 2.2 10.7 4.8 1.5 Vietnam 0.6 0.7 -0.7 -1.9 -1.6 0.2 0.3 -1.8 -2.4 -3.0


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40


��

A long drawn-out affair The inter-bank lending difficulties have gone on for

longer than we expected, and as a result, the risk of a

credit squeeze on the economy has intensified.

Moreover, with about $70bn of financial sector

write-downs so far, and the OECD estimating the

losses could be as much as $200-300bn, more bad

news could be on the way. It is probable that 3-

month LIBOR spreads will narrow early in 2008, but

this may prove short-lived as losses from underlying

assets mount, and the deleveraging process continues

to spook bank confidence.

Reflecting this heightened risk, we are forecasting

that real GDP growth will remain sluggish in 2008 at

1.9% year-average after a likely 2.2% rate in 2007,

due to both the credit squeeze and negative wealth

effects from falling house prices. Lower demand will

mean substantially less employment growth,

resulting in the unemployment rate rising from 4.7%

now to 5.4% by the end of 2008.

The slackening labour market should help keep core

PCE inflation just below 2% through the year,

despite upside inflation risks from import and

commodity prices.

In this context, and because of the dual-mandate, the

Fed is more likely to be responsive to growth

developments than inflation, with financial

headwinds taking fed funds lower than what might

be justified from economic data itself. Therefore, we

look for Fed funds to be cut to 3% by the end of

2008, which should help the economy avoid an

outright recession if the Fed is aggressive. 10-year

note yields, as a result, may be around or somewhat

under 4% for most of the year.

Ian Morris Economist HSBC Securities (USA) Inc.

+1 212 525 3115 [email protected]

Ryan Wang

Economist

HSBC Securities (USA) Inc.

+1 212 525 3181

[email protected]

% q-o-q annualised

2007f 2008f 2009f Q3 07f Q4 07f Q1 08f Q2 08f Q3 08f Q4 08f

Consumer spending 2.9 1.6 2.2 2.7 2.0 1.1 1.1 1.7 2.3 Government consumption 2.1 3.1 3.0 3.8 2.6 3.0 3.0 3.0 3.0 Investment -2.8 -0.7 4.1 -0.4 -2.3 -1.6 -2.9 2.5 4.3 Housing -16.7 -13.2 3.2 -19.7 -22.0 -14.0 -12.0 0.0 5.0 Stockbuilding (% GDP) 0.1 -0.1 0.3 0.3 0.1 0.0 0.0 -0.2 -0.1 Domestic demand 1.6 1.4 3.0 3.4 0.7 0.7 0.6 1.5 3.1

Exports 8.1 8.3 7.0 18.9 6.3 7.0 7.0 7.0 7.0 Imports 2.2 2.9 5.8 4.2 2.7 3.0 2.4 4.0 5.0

GDP (year) 2.2 1.9 3.0 2.8 2.6 2.7 2.0 1.3 1.8 GDP (% quarter annualised) - - - 4.9 1.0 1.1 1.1 1.8 3.3

Industrial production (% year) 2.1 1.8 3.0 1.7 2.3 2.4 1.8 1.3 1.8 Unemployment (%) 4.6 5.1 5.4 4.7 4.7 4.9 5.0 5.2 5.3 GDP deflator (% year) 2.6 1.8 1.8 2.4 2.5 1.9 1.7 1.9 1.8 Consumer prices (% year) 2.8 2.4 2.0 2.4 3.8 3.4 2.3 2.3 1.9 Employment costs (% year) 3.4 3.4 3.2 3.3 3.3 3.4 3.4 3.4 3.4 Current account (USDbn) -750 -721 -723 -712 -744 -732 -714 -710 -727 Current account (% GDP) -5.4 -5.0 -5.0 -5.1 -5.3 -5.2 -5.0 -4.9 -5.0 Budget balance (USDbn) -163 -240 -275 - - - - - - USD effective (1990 = 100) 88.6 87.4 100.6 85.8 85.3 85.0 86.3 89.2 89.2 3-month money (%) 5.3 4.0 3.5 5.2 4.9 4.6 4.4 3.9 3.3 10-year bond yield (%) 4.6 3.9 4.2 4.6 4.0 3.9 3.7 3.9 4.2

Source: HSBC

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41


��

Real house prices Falling prices

-10

-5

0

5

10

15

75 78 81 84 87 90 93 96 99 02 05 08

-10

-5

0

5

10

15

RecessionsReal average single-family EHS priceReal S&P Case-Shiller home price indexReal OFHEO house price index

% Yr% Yr � House prices are declining on a variety of measures. In Q3 07,

nominal house prices fell in twenty-one out of fifty states, according to the OFHEO house price index

� The S&P/Case-Shiller index highlights more pronounced declines in various metropolitan areas. The biggest drops have included areas like Detroit, Las Vegas, Miami, and San Diego

� Inventory levels of both new and existing homes for sale remain high, putting downward pressure on prices

Note: Home price changes deflated using core CPI. Source: Thomson Financial Datastream

Business credit conditions Credit and lending standards

-40

-20

0

20

40

60

80

87 89 91 93 95 97 99 01 03 05 07

100

150

200

250

300

350

400

SLO survey: tighter standards for C&I loans (LHS)

Moody’s Baa corporate yield less 10-yr yield (RHS)

bpnet % of respondents

� Bank lending attitudes have tightened somewhat. The net percentage of banks tightening standards rose to 19.2 in the October Senior Loan Officer survey, higher for the second quarter in a row

� Credit spreads have widened, reaching new highs for 2007 in December

� Further sustained tightening in credit conditions risks a pull back in business lending, although so far the actual data has not suggested that a clamp down is occurring

Source: Federal Reserve Senior Loan Officer Survey, Haver Analytics

Employment growth Job gains are coming from just four sectors

0

200

400

600

800

1000

1200

Jan-07 Apr-07 Jul-07 Oct-07

0

200

400

600

800

1000

1200

Education & health, restaurants, governmentRest of economy

Cumulative change in payrolls from Jan 2007 000s000s

� Four sectors accounted for 80% of the jobs growth in the first eleven months of 2007: educational services, health services, food services, and government

� Education, health care, and government stayed strong through the end of the year, while education has recently showed some signs of slowing

� The rest of the economy has been much more subdued. Job losses are ongoing in construction, manufacturing, and finance, while the trend is unclear in areas such as retail trade and professional & business services

Source: Bureau of Labor Statistics, Haver Analytics

��

42


��

Slower domestic demand Canadian GDP growth appears set to slow to a

sub-2% pace in Q4 2007 or in early 2008. Since

the middle of 2007, the Bank of Canada has

cautioned against downside risks from weaker than

expected US growth and a higher Canadian dollar.

These risks appear increasingly likely as we have

reduced our US GDP estimate to 1.1% for H1

2008, while the Canadian dollar is close to parity

as of the end of 2007. We see a continued drag

from net exports in 2008 after a small detraction in

2007. However, the extra kicker in 2008 is that

domestic demand is likely to slow to 3.3% after an

estimated 3.7% in 2007. For total GDP, we see

2.1% growth after 2.6% in 2007.

Consequently, this will mean a shift in tone for

economic data to come. Employment growth has

been surprisingly strong thus far, with solid job gains

coming from the service sector. Meanwhile, the

housing market remains in healthy shape. Home

price gains for the nation have slowed from 12.1%

year-on-year back in August 2006 to 6.1% in

October, but construction activity has been steady.

Upside inflation risks persist, but the latest data

shows core inflation is under control. The core CPI

slowed to 1.6% year-on-year in November, down

from 2.5% in June. Headline inflation is higher at

2.5% due to energy prices, but remains within the

1% to 3% target range.

The Bank of Canada reduced the overnight target

rate to 4.25% from 4.50% on December 4, focusing

on the downside risks coming from turmoil in global

financial markets. Further credit and funding strains,

weakening US growth, and slower domestic demand

may mean lower rates in 2008. We look for 75bp of

further rate cuts (25bp per quarter through Q3 2008)

to end the year at 3.50%.

Ryan Wang Economist HSBC Securities (USA) Inc.


% Year


Consumer spending 4.1 2.7 2.5 4.0 3.7 3.5 2.6 2.4 2.4 Government consumption 3.0 2.9 2.5 3.6 3.5 3.5 3.3 2.4 2.4 Investment 3.7 3.2 2.4 4.3 4.0 4.2 3.8 2.5 2.2 Stockbuilding (% GDP) 0.7 1.1 1.0 1.2 1.1 1.1 1.1 1.2 1.2 Domestic demand 3.7 3.3 2.3 4.2 4.9 4.6 3.8 2.4 2.4

Exports 1.9 2.7 2.8 2.2 2.2 2.6 2.4 2.7 3.1 Imports 5.1 5.9 2.9 6.1 7.2 8.3 7.3 4.0 4.2

GDP 2.6 2.1 2.2 2.9 3.0 2.6 2.1 1.8 1.8 GDP (% quarter annualised) - - - 2.9 2.0 1.7 1.7 1.9 1.9 Industrial production 0.3 0.7 1.8 0.5 1.2 0.2 0.2 1.0 1.5

CPI 2.1 1.6 1.8 2.1 2.5 2.0 1.0 1.4 1.9 Average earnings 3.0 2.1 2.1 3.2 2.6 2.1 2.1 2.0 2.1 Unemployment (%) 6.0 6.2 6.3 6.0 5.8 6.0 6.1 6.3 6.3 Current account (CADbn) 18.8 20.6 20.6 1.0 5.0 5.1 5.1 5.2 5.2 Trade account (CADbn) 51.3 39.1 47.5 10.8 9.8 9.5 9.4 9.7 10.5 Budget balance (CADbn) 11.0 11.0 11.0 - - - - - - CAD/USD 1.05 1.03 1.10 0.99 1.00 1.00 1.00 1.05 1.05 3-month money (%) 4.7 4.2 4.7 4.9 4.9 4.6 4.4 4.1 3.8 10-year bond yield (%) 4.2 3.7 5.0 4.3 4.0 3.8 3.6 3.6 3.6

Source: HSBC

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43


��

New housing prices House price appreciation is slowing

0

10

20

30

40

50

98 99 00 01 02 03 04 05 06 07

0

10

20

30

40

50

Canada new housing pricesTorontoEdmonton

% Yr% Yr

� New house price growth has been decelerating for the past fourteen months. In major population centres like Toronto and Montreal, appreciation has been either edging down gradually or holding steady

� The largest deceleration has occurred in Alberta. Calgary home prices have slowed from over 60% year-on-year in August 2006 to 6.2% in October, close to the matching the national average. In Edmonton, year on-year gains have slowed from 43% to 24%

� For most cities, however, the supply of unoccupied homes is fairly low. Demand remains solid and homebuilding activity has been steady

Source: Thomson Financial Datastream, Statistics Canada

Imports and exports Trade prospects

-15-10

-505

10152025

98 99 00 01 02 03 04 05 06 07 08

-15-10-50510152025

Canada real exports Canada real imports

% Qtr Ann% Qtr Ann

� The Q3 spike in Canadian imports coincided with a sharp rise in US exports. Although Canadian import growth is likely to slow from this pace, we think net trade will remain a drag in 2008

� We expect Canadian import growth of 5.9% in 2008

� Amidst a slowdown in US GDP and import growth, we see Canadian exports rising 2.7% in 2008

Source: Thomson Financial Datastream

Headline and core CPI Inflation trends

0

1

2

3

4

5

01 02 03 04 05 06 07

0

1

2

3

4

5

CPI ex 8 volatiles and indirect taxesBank of Canada target midpointHeadline CPI

% Yr Canada % Yr

� The core CPI slowed to 1.6% year-on-year in November. With headline inflation running at 2.5%, both measures are within the Bank of Canada’s target range of 1-3%

� The unemployment rate of 5.9% and rising labour force participation suggest employment conditions are fairly tight. In the latest Business Outlook Survey, 41% of firms reported labour shortages

� The Bank of Canada estimates that the economy is continuing to run above its production capacity for now, but slower growth in 2008 may act to reduce this pressure

Source: Bloomberg

��

44


��

Central Bank forecasts higher inflation in 2008 Inflation has averaged 4.03% over the 15-month

period from September 2006 through November

2007, as a result of higher processed food and

commodity prices in international markets. In spite

of inflation remaining well above the Central Bank’s

objective of 3.0%, monetary policy has been only

marginally restrictive. In October, the monetary

authorities disclosed their 8-quarter forecast for

upper and lower limits for inflation, incorporating a

50 basis point impact in 2008 from the recently

approved fiscal reform. As a result, the Bank now

forecasts inflation reaching as high as 4.5% in mid-

2008 and then slowly converging to its 3.0% target

by the end of 2009.

Given that the higher inflation rate has been and will

continue being a product of exogenous supply

shocks rather than demand pressures, the Central

Bank is not expected to restrict monetary policy any

further, unless inflation increases outside of the

Bank’s projected upper-bound. At the same time,

the expected slowdown in the economy in the first

half of the year should help contain any additional

inflationary pressures. Nevertheless, policy will

become more restrictive in relative terms, as the

Federal Reserve cuts its policy rate further and the

interest differential increases.

After a major slowdown in industrial production in

the United States in Q1, production bounced back

strongly in the next two quarters. This set the

pattern for a much improved performance for

export growth in Mexico and higher growth rates

in GDP for the period. Preliminary data for Q4

shows record high export and import levels

(October), suggesting that Q4 may not be as weak

as originally expected. Imports registered strong

growth rates in consumer, intermediate and capital

goods, suggesting robust domestic demand, while

the IMEF manufacturing and non-manufacturing

indicators (equivalent to U.S. ISM) anticipate a

relatively good finish to the year.

% Year

2004 2005 2006 2007f 2008f 2009f

Private consumption 4.1 5.1 5.0 3.8 3.4 4.4 Public consumption -0.4 0.4 6.0 2.5 1.0 -1.0 Gross capital formation 7.5 7.6 10.0 7.8 7.5 8.3

GDP 4.2 2.8 4.8 3.1 3.3 4.1

Industrial production 4.2 1.7 5.0 1.3 2.6 4.3 Unemployment (%) 4.2 3.8 4.3 3.8 3.2 3.1 Consumer prices* 5.2 3.3 4.1 3.8 4.0 3.3

Exports (USDbn) 188.0 214.2 250.1 271.9 290.0 311.8 Imports (USDbn) 196.8 221.8 256.1 283.8 308.8 337.6

Current account (USDbn) -6.7 -4.9 -2.4 -11.0 -17.4 -24.2 Current account (% GDP) -1.0 -0.6 -0.3 -1.2 -1.8 -2.4 Budget balance (% GDP) -0.2 -0.1 0.1 0.0 -0.1 0.0 MXN/USD 11.3 10.8 11.0 10.9 11.1 11.3 3-month money (%) 7.1 9.3 7.3 7.4 7.8 7.6

Note: * = end-year Source: HSBC

Jonathan Heath Chief Economist HSBC México, S.A


��

45


��

Next action up GDP growth reached 5.3% in the first three quarters

of 2007, indicating a significant acceleration in

comparison to the previous year, when the economy

expanded 3.8%. From a demand perspective, growth

continues to be pushed by domestic consumption,

which is responding vigorously to the monetary

easing (overnight rates fell from 19.75% in Sep-05

to 11.25% two years later) and to the expansionary

stance of fiscal policy. Private consumption

expenditure has risen 5.9% year-to-date, and gross

fixed capital formation has soared 12.4% in the same

period. Investments, in fact, have consistently

outperformed output growth over the last four years,

and as consequence they now represent 17.1% of

GDP, up from 15.3% in 2003.

We see the vigorous expansion of investments as a

very encouraging sign. The indications are that

average growth in coming years will be well above

the 2.9% seen in the last six years. This does not

mean, however, that the current pace of expansion is

sustainable. According to our estimates, the output

gap narrowed continuously over the past six

quarters, and the economy now seems to be

operating very close to full capacity. This notion is

corroborated by several factors. Industrial capacity

utilization, for example, reached a new record high

of 83.1% in October, while the unemployment rate

reached a new low of 8.9% (s.a.) in the same month.

Regarding inflation, there has been a clear upward

trend in the first three quarters of 2007. After

reaching a low of 3% in March, full-year inflation

should be close to 4.4%, almost in line with the 4.5%

target. Food prices explain a significant part of this

rise, but core inflation (excludes food and

administered prices) climbed from 2.6% in March to

3.9% in November. There were signs of more

disseminated price pressures in the second half of

this year, and we believe this essentially reflects the

exuberance of domestic demand. Overall, recent

developments reinforce our view that the neutral

level of interest rates is still abnormally high in

Brazil. Most likely the next action on rates will be

upwards, not downwards.

% Year

2004 2005 2006 2007f 2008f 2009f

Private consumption 3.8 4.5 4.6 6.1 6.0 3.9 Gross capital formation 9.1 3.6 8.7 11.0 10.0 6.5

GDP 5.7 2.9 3.7 5.4 5.0 3.7


Exports (USDbn) 96.5 118.3 137.5 160.8 182.0 195.0 Imports (USDbn) -62.8 -73.5 -91.4 -121.0 -152.5 -173.0

Current account (USDbn) 11.6 14.3 13.5 2.5 -10.0 -17.0 Current account (% GDP) 1.7 1.6 1.3 0.2 -0.7 -1.1 Budget balance (% GDP) -2.4 -3.0 -3.0 -1.8 -2.0 -2.2 BRL/USD 2.88 2.39 2.16 1.89 1.88 1.96 3-month money 16.4 19.0 14.8 11.7 11.4 11.8

Note:* Year end. Source: HSBC

Alexandre Bassoli Economist HSBC Bank Brazil S.A.


��

46


��

Fiscal moderation ahead The pace of expansion of GDP continues to show

robust figures, with recent data showing that GDP

recorded an estimated real growth rate of 8.7% y/y

in 3Q07. From the aggregate demand point of view,

private consumption recorded an impressive 8.9%

y/y growth in the quarter and an average growth in

the first three quarters of 8.8% y/y, compared to

7.8% y/y in 2006. In the same vein, public

consumption posted an 8.4% y/y increase in 3Q07

compared to only 5.2% y/y in 2006. Gross fixed

investment is growing below 13% y/y against an

average of 18.2% y/y last year. To some extent,

growth is stronger than our expectations: we were

targeting 7.8% growth for the whole 2007 and the

figure could yet be around 8.5%. Also, growth could

be overstated by the official data: if the GDP deflator

is partially suffering from the methodological

changes that affected the CPI, then growth of those

activities that are measured nominally and then

deflated – such as financial services or public

consumption - are being overstated.

For 2008, we anticipate some fiscal prudence. The

government has already showed improvements on

the revenues side, increasing the tax on

agricultural, oil and oil derivatives exports that

together amount to 0.8% of nominal GDP.

Less encouraging signals surround

methodological changes in the CPI – though we

expect reported inflation to increase from 8.5% in

2007 to 9.3% in 2008 – and getting an agreement

with the Paris Club.

Regarding the CPI, the government appears to be

moving towards a chained index targeting a lower

income consumption basket. On the Paris Club,

recent developments on the international relations

front make a fast agreement less likely. Therefore,

fiscal moderation is the only change that the CFK

presidency will deliver in its first year.

% Year

2004 2005 2006 2007f 2008f 2009f

Consumption 9.5 8.9 7.7 8.0 7.0 7.0 Gross capital formation 34.4 22.7 18.7 12.9 8.0 6.0

GDP 9.0 9.2 8.5 7.8 6.2 5.4

Unemployment (%) 13.6 11.6 10.2 9.0 8.5 8.5 Industrial production 10.7 7.5 7.4 6.6 5.6 5.0 Consumer prices* 6.1 12.3 9.8 8.5 9.3 9.5


Current account (USDbn) 3.4 5.6 8.0 6.3 5.1 5.0 Current account (% GDP) 1.2 1.8 2.4 1.8 1.3 1.3 Budget balance (% GDP) 2.6 1.8 1.8 0.4 1.5 1.2 ARS/USD 2.94 2.94 3.08 3.12 3.23 3.31 1-month money (%)* 3.1 4.8 7.1 10.1 10.9 11.4

Note: * end period. Source: HSBC

Javier Finkman Economist HSBC Bank Argentina S.A


Hernan M Yellati Economist

HSBC Bank Argentina S.A +54 11 4348 5759 [email protected]

��

47


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Less growth, more inflation Recently, growth has moderated in the Chilean

economy. The Monthly Economic Activity Indicator

(IMACEC), registered an increase of 4.1% in Q3,

which is lower than the average growth rate of 6.0%

observed during the first half of the year.

Meanwhile, October economic activity grew 4.4%

y-o-y, lower than market expectations. Industrial

activity registered an average growth rate of 3.1%

during the third quarter, a figure much lower than the

4.6% growth observed during the first half of the

year. As a result, 2007 GDP expectations have been

adjusted downwards. According to the Central

Bank’s latest Expectation Survey, specialists in the

private sector expect 5.0% growth in GDP.

On the inflation front, headline inflation increased

0.8% in November, which means that inflation has

accumulated a 7.3% rise during the first 11 months

of the year. The 12-month rate reached 7.4%, which

represents the highest reading in the last 10 years.

This places inflation significantly higher than the

Central Bank’s target of 3% (+/- 1 percentage point).

Core inflation rose 0.5% in November, which

represents an annual growth rate of 5.6%.

In this scenario, the Board of the Central Bank of

Chile decided to start a monetary tightening cycle,

hiking the policy rate three times (July, August and

September) to 5.75%. However, the Central Bank

then opted for a temporary pause at the next two

meetings. There were different reasons behind the

decision, including the deterioration of the financial

markets with regard to the problems associated with

the sub-prime crisis and weaker local activity. In

the last meeting of the year however, the monetary

authorities decided to increase the policy rate to

6.0%. The decision was seen to be necessary to

reduce the risk that the currently higher inflation

outturns spillover into inflation expectations. At the

same time, the Central Bank re-affirmed its

commitment to hit the 3% inflation target over the

medium term.

% Year

2004 2005 2006 2007f 2008f 2009f

Private consumption 6.1 7.6 7.7 7.7 7.2 7.0 Fixed investment 11.7 24.7 5.5 9.0 8.0 5.0

GDP 6.0 5.8 4.0 5.5 5.2 5.1



Current account (USDbn) 2.1 1.3 5.2 7.7 9.2 10.8 Current account (% GDP) 2.2 1.1 3.6 4.7 5.1 5.5 Budget balance (% GDP) 2.2 4.8 7.8 8.7 5.8 4.7 CLP/USD 604 552 534 521 514 520 3-month money (%)** 2.8 4.5 5.3 6.0 5.9 5.8

Note: * = end-year; ** = end-year 90-day deposit rate Source: HSBC

Lorena Domínguez Economist HSBC México, S.A +52 55 5721 2172 [email protected]

��

48


��

Resisting rate cuts The current backdrop of a developed world credit

squeeze and an ongoing emerging market

investment boom poses an interesting, if uncertain

backdrop for the Eurozone. Eurozone households are

not likely to undergo the same retrenchment that we

envisage in the US and the UK, as they have already

slowed their lending growth over the past 18 months

or so. But the non-listed corporate sector has been

reliant on debt growth in this upswing, and so the

tightening of lending standards and widening of

spreads already underway is likely to contribute to

an investment slowdown. On the external side,

assuming emerging world growth holds up (and the

implications of our Fed rate view for emerging

monetary conditions implies it will), some parts of

the Eurozone remain very well placed to benefit,

notably Germany and Austria. However, for the

Eurozone as a whole the downward revisions to our

forecasts for the UK and US (which together account

for about 30% of EMU exports) will be only partly

offset by the latest set of upward revisions to some

of our emerging market forecasts, notably Russia.

EMU growth already looks set to slow to 0.4% in

4Q07 (possibly lower) after 0.7% in 3Q with a

further slowdown envisaged in the first half of 2008

With inflation likely to remain above 3% in 1Q08,

no near-term rate cut is expected from the ECB

which we expect to continue pursuing a variety of

alternative measures such as the provision of large

amounts of term liquidity in order to try to ease

money market tensions. In 2Q08, however, we

expect the activity data to have weakened

sufficiently for the ECB to deliver a rate cut.

% Year

2007f 2008f 2009f Q3 07 Q4 07f Q1 08f Q2 08f Q3 08f Q4 08f

Consumer spending 1.5 1.6 1.7 1.6 1.4 1.8 1.6 1.4 1.5 Government consumption 2.0 1.5 1.4 2.0 2.1 1.5 1.7 1.4 1.4 Fixed investment 4.7 2.3 2.6 4.4 3.3 2.0 2.6 2.3 2.4 Final domestic demand 2.3 1.8 1.9 2.3 2.0 1.8 1.8 1.6 1.7 Stockbuilding (% GDP) 0.1 0.0 0.0 0.2 -0.1 0.1 -0.1 0.1 0.0 Domestic demand 2.4 1.6 1.8 2.3 2.2 1.7 1.6 1.5 1.8

Exports 6.3 4.5 4.7 7.4 5.3 5.3 5.2 3.8 4.0 Imports 5.5 4.8 4.7 6.0 5.1 4.8 5.7 4.2 4.6

GDP 2.6 1.6 1.8 2.7 2.2 1.7 1.7 1.4 1.4 GDP (% quarter) - - - 0.7 0.4 0.4 0.3 0.3 0.4

Industrial production 3.2 2.1 2.2 3.8 2.3 2.1 2.4 1.9 2.1 Unemployment (%) 7.5 7.5 7.4 7.4 7.5 7.5 7.5 7.5 7.5 Wages 2.5 2.8 2.7 2.5 2.8 2.8 2.8 2.8 2.8 Inflation 2.1 2.6 1.9 1.9 2.9 3.2 2.7 2.6 1.9 M3 11.3 9.5 7.0 11.5 12.5 11.0 10.0 9.0 8.0 Current account (% GDP) 0.1 0.0 0.1 - - - - - - Budget balance (% GDP) -0.9 -1.0 -1.1 - - - - - - Debt (% GDP) 66.9 66.7 66.5 - - - - - - 3-month money (%) 4.4 4.3 4.3 4.8 4.8 4.6 4.4 4.3 4.1 10-year bond yield (%) 4.3 4.2 4.4 4.4 4.2 4.1 4.2 4.2 4.1 USD/EUR* 1.45 1.35 1.30 1.42 1.45 1.45 1.40 1.35 1.35

Note: * = end-period Source: HSBC

Janet Henry/Astrid Schilo Economist HSBC Bank plc

+44 20 7991 6711/6708 [email protected]/ [email protected]

��

49


��

Signs of a slowdown Growth

42

46

50

54

58

62

66

99 00 01 02 03 04 05 06 07 08-1

0

1

2

3

4

5

Eurozone composite PMI output (LHS)Eurozone GDP (RHS)

Index % Yr

� Third quarter GDP growth picked up to 0.7% after just 0.3% in Q2

� Private consumption was up by 0.5% q-o-q (from 0.6% in Q2), and investment rebounded by 0.9% q-o-q after a flat reading in Q2

� The purchasing managers surveys have weakened sharply since August and are consistent with a slowdown in GDP growth to 0.4% or less in Q4

Source: Reuters, Thomson Financial Datastream, Eurostat, and HSBC

Germany coping with a strong euro Exports

-5

0

5

10

15

20

96 97 98 99 00 01 02 03 04 05 06 07-5

0

5

10

15

20

EMU ex Germany Germany

% Yr % YrExports of goods & services

� Eurozone exports have held up well, growing 2.4% q-o-q in Q3…

� …but there has been a clear divergence in the performance of Germany and the rest of the Eurozone over the past 3-4 years

� A combination of Germany’s competitiveness gains, a favourable product mix and a relatively high exposure to emerging markets has so far enabled German export growth to shrug off the impact of euro appreciation

Source: Thomson Financial Datastream, Eurostat, and HSBC

Inflation surge Inflation

0.00.5

1.01.5

2.02.5

3.03.5

97 98 99 00 01 02 03 04 05 06 07 080.00.5

1.01.5

2.02.5

3.03.5

HeadlineCore (ex energy, food, alcohol & tobacco)

EMU inflation % Yr% Yr

� Inflation rose to a shocking 3.1% in November with more than half of inflation driven by food and energy prices

� Assuming stable oil prices, inflation will stay above 3% in 1Q08 and is unlikely to fall below 2% until very late in 2008

� Although not its central forecast, the ECB remains concerned about second round effects and will remain particularly wary during the German public sector wage negotiations in early 2008

Source: Thomson Financial Datastream, Eurostat, and HSBC

��

50


��

Third act of upswing awaited The economic upswing should remain intact even

though the growth momentum is expected to slow

down. The economy grew by 0.7% in 3Q 2007,

adjusted for seasonal and calendar effects. The

strongest growth contribution was made by stock-

building (0.4 percentage points) followed by private

consumption (0.3 percentage points). Our target for

annual GDP growth of 2.6% in 2007 is not at risk,

due to the fact that a quarterly growth rate in the

range of 0.1% to 0.4% for Q4 2007 will suffice for it

to be reached.

We have no doubts about the classic German

upswing scenario. The initial trigger came from

exports, investments then picked up in the second

stage and finally private consumption will show

some pick up. Private consumption was depressed

substantially by the increase in VAT which came

into force at the beginning of 2007. However, more

than half of the Q1 drop has already been reversed in

Q2 and Q3. Private consumption should contribute

around half (growth contribution 0.8 percentage

points) of GDP growth in 2008, given the

continuation of the positive trend in the labour

market next year. The trend of falling unemployment

should continue. For 2008 and 2009 we are

expecting unemployment levels of around 3.50 and

3.25 million. We see economic growth of 1.6% as

realisable in 2008, and 1.9% in 2009, thanks to

employment growth and higher wages: there is

likely to be an increase in disposable income beyond

the 3.5% mark in 2008 and 2009.

With the sentiment indicators having fallen but still

at high levels, Germany is likely to cope relatively

well with international pressures, be it the turmoil in

the money and forex markets or the high oil and

food prices.

Lothar Hessler Economist HSBC Trinkaus & Burkhardt AG


% Year

2007f 2008f 2009f Q3 07 Q4 07f Q1 08f Q2 08f Q3 08f Q4 08f

Consumer spending -0.2 1.4 1.5 0.2 -0.4 1.9 1.4 1.2 1.2 Government consumption 2.0 0.8 0.8 1.7 2.1 0.5 0.8 1.0 0.8 Investment 5.3 2.5 1.9 3.4 2.8 1.2 3.1 3.1 2.4 Machinery & equipment 7.9 2.6 2.6 7.4 5.7 2.6 2.4 2.7 2.8 Construction 2.9 0.5 1.1 -0.1 -1.4 -2.5 1.4 1.4 1.8 Stockbuilding (% GDP) -0.8 -0.9 -0.8 -0.8 -1.0 -1.0 -1.0 -0.9 -0.8 Domestic demand 0.8 1.4 1.5 -0.1 1.8 0.6 2.0 1.5 1.6

Exports 8.4 7.4 7.4 9.1 5.1 7.2 8.2 6.9 7.3 Imports 6.3 7.8 7.3 5.9 5.9 5.6 9.6 7.6 8.3

GDP 2.6 1.6 2.0 2.5 1.8 1.6 1.7 1.4 1.6 GDP (% quarter) - - - 0.7 0.3 0.3 0.3 0.4 0.5

Industrial production 5.8 3.8 3.4 5.4 4.9 3.9 4.6 3.4 3.5 Unemployment (%) 9.0 8.2 8.0 8.8 8.8 8.5 8.2 8.1 8.1 Average earnings 1.8 2.4 2.5 1.7 2.6 2.4 2.4 2.4 2.4 Producer prices 1.9 1.9 1.3 1.2 2.0 2.3 2.0 2.0 1.5 Consumer prices* 2.3 2.3 1.5 2.2 3.1 3.2 2.5 2.0 1.4 Current account (EURbn) 144.2 140.0 136.0 37.7 33.7 35.0 35.0 35.0 35.0 Current account (% GDP) 5.9 5.6 5.3 6.2 5.5 5.7 5.6 5.5 5.5 Budget balance (% GDP) -0.2 -0.1 0.0 - - - - - - 3-month money (%) 4.4 4.3 4.3 4.8 4.8 4.6 4.4 4.3 4.1 10-year bond yield (%) 4.3 4.2 4.3 4.3 4.2 4.1 4.2 4.2 4.1

Source: HSBC

��

51


��

Inflation exceeds the 3% mark for the first time in 13 years

The inflation drivers: Food and energy

0.0

1.0

2.0

3.0

4.0

99 00 01 02 03 04 05 06 07 08-0.3

0.0

0.3

0.6

0.9

German HICP (LHS) German CPI (LHS)Spread (RHS)

% Yr % pts

� The inflation rate (on a national basis) exceeded the 3% mark for the first time since 1994 in November 2007 (3.1%). The German HICP (3.3% y-o-y) was at the highest level since its inception. The strong inflation is being influenced above all by the significant increase in energy and food prices. These segments accounted for more than half of the overall increase in prices vs. November 2006. Without the surge in energy product prices, inflation would have been around 2.2%

� Although the increase in VAT as of January 2007 will have the effect of taking pressure off prices in 2008 due to the base effect, it is becoming evident that average inflation in 2008 will be the same as in 2007, owing to the recently strong price momentum


Trend in temporary work Flexibility on labour market vs. minimum wages too high

0

100

200

300

400

500

600

98 99 00 01 02 03 04 05 060

100

200

300

400

500

600

At temporary agencies At other companies

Unskilled workers subject to social insurance ’000s’000s

� 1.3% of persons in employment were temporary workers in 2006. Temporary work also fulfils the function of an instrument for entering the labour market. Studies indicate that more than half of the approx. 700,000 temporary workers were previously unemployed (every seventh person unemployed for longer than one year)

� There is a threat at present not only of the deregulation of

temporary work being reversed, but also of the abandonment of labour market policy reforms, with negative effects on employment. However, the agreement over the minimum wage for postal workers should not be the starting point of a general agreement about minimum wages. Up to now, minimum wages are fixed in the range EUR 12.50 to 6.36

Source: IWG

GDP growth rate and the number of working days GDP will fall slightly short of potential growth in 2008

-0.6

-0.4

-0.2

0.0

0.2

0.4

0.6

247

248

249

250

251

252

253

97 98 99 00 01 02 03 04 05 06 07 08Growth rate differences (LHS)Average working days (RHS)

Days% pts

� Adjusted for seasonal and calendar effects a growth overhang of 0.7 percentage points should be generated for 2008

�

� More working days than usual will be available in 2008 which suggests a positive production effect of around 0.3%, based on past experience. Our calculations are based on seasonally and calendar adjusted GDP. We expect a growth rate of 1.6% for 2008. Based on the unadjusted data, our GDP forecast would be 1.9% in 2008 and 2009


��

52


��

Auto industry no longer a drag Growth bounced back in Q3 2007, gaining 0.7%

q-o-q following the 0.3% recorded in Q2 2007,

helped by a positive contribution from foreign trade

(0.1% point). Manufacturing output was very strong,

gaining 1.3% compared to 0.0% in Q2, thanks most

notably to the upturn in automotive production,

which grew by 1.4% compared with the 1.8% drop

in Q2, meaning this sector no longer held back other

manufacturing areas and business services.

Consumer spending was bolstered by purchases

of domestic consumer durables, rising 0.8% in Q3

from 0.6% in Q2 and 0.5% in Q1. This trend is

likely to falter as higher fuel and food prices hit

purchasing power. In addition, November’s strikes

are likely to cut 0.1% point off consumer

spending growth in Q4 2007, given that not all

spending planned for November will be carried

over into December. Lastly, the introduction of a

’green tax’ system for cars in early 2008 is likely

to lead to car purchases being postponed until the

new year. Subsidies of between ��

will be available for vehicles with low CO2

emissions. In cases where the purchase leads to

the replacement of a vehicle that is more than 15

years old, a further ��ill be available.

In 2008, the boost to growth from healthy production

in aerospace and the automotive sector will limit the

slowing in growth relative to the Eurozone, but the

drop in residential investment and in exports will

prevent any overall increase in French GDP growth.

The increase in rates on mortgage loans in response

to higher ECB rates and market rates will hit

household solvency. The slowdown in the US and

UK will hold back export growth, as will the slower

pace of growth in German investment. As a result,

the fiscal deficit is likely to continue to widen as

receipts slow and the government is not planning to

rein in spending.

Mathilde Lemoine Economist HSBC France

+33 1 40 70 32 66 [email protected]

% Year

2007f 2008f 2009f Q3 07 Q4 07f Q1 08f Q2 08f Q3 08f Q4 08f


Exports 3.5 2.9 2.5 5.0 5.0 4.3 3.7 2.2 1.6 Imports 4.4 4.1 3.6 5.3 5.1 5.2 4.2 3.4 3.4

GDP 1.9 1.7 1.8 2.1 2.1 1.9 1.9 1.5 1.5 GDP (% quarter) - - - 0.7 0.4 0.5 0.3 0.4 0.4

Manufacturing output 2.0 2.0 2.3 2.7 3.2 2.3 2.6 1.7 1.6 Unemployment (%) 8.1 8.1 8.0 7.9 8.0 8.1 8.1 8.1 8.1 Average earnings 2.6 2.9 2.8 2.5 2.7 2.8 2.7 2.9 3.0 Consumer prices 1.6 2.2 2.0 1.4 2.5 2.7 2.3 2.2 1.7 Trade account (EURbn) -35.7 -41.9 -44.2 -9.3 -9.5 -9.7 -10.5 -10.7 -11.0 Current account (% GDP) -1.1 -1.5 -1.5 - - - - - - Budget balance (% GDP) -2.7 -2.9 -2.8 - - - - - - 3-month money (%) 4.4 4.3 4.3 4.8 4.8 4.6 4.4 4.3 4.1 10-year bond yield (%) 4.3 4.2 4.3 4.4 4.2 4.1 4.2 4.2 4.1

Source: HSBC, Thomson Financial Datastream

��

53


��

The automotive sector will no longer hold back economic activity

Automotive production will no longer hinder overall manufacturing output

-20

-10

0

10

20

00 01 02 03 04 05 06 07 08-20

-10

0

10

20

Manufactured goods producersConsumption goods producersCar buildersCapital goods producersIntermediate goods producers

Forecast

Estimate

% Yr% Yr Firms investment outlook

� Automotive production bounced by 1.4% in Q3 2007, having dropped by 1.8% in Q2 2007 and 6.9% in 2006

� This positive trend, due to the launch of new French-produced models, will bolster growth in business services and exports. Automotive exports account for 12.7% of exports of goods and between 2000 and Q3 2007 represented 10.9% of total export growth

� The slowdown expected in the business sector is likely to be limited by investment in the automotive sector and by improved confidence amongst business leaders in this sector

Source: INSEE, and HSBC

Tightening of monetary conditions is measured Interest rates on loans to the private sector are rising

-0.4

-0.2

0.0

0.2

0.4

0.6

03 04 05 06 07-0.4

-0.2

0.0

0.2

0.4

0.6

Credit standards applied to the approval of loans or credit linesto enterprisesCredit standards applied to the approval of loans to householdsfor house purchase

Index

Loosening

Tightening

IndexBank lending survey for France

� Between July and September, fixed mortgage rates rose by 31bp, after rising by 14bp between December 2006 and June 2007. This increase in lending rates, partially offset by tax deductions on interest payments, (which we calculate are equivalent to a 34bp rate cut), will hit consumer solvency through the beginning of next year

� Despite structurally strong demand due to a lack of new houses being built, residential investment is therefore likely to slow in 2008

� Companies have seen borrowing conditions tighten since the end of 2006 as can be seen in the BoF’s bank lending survey. Furthermore, between December 2006 and June 2007, rates on loans to companies increased by 42bp, and by a further 17bp between July and September 2007

Source: Bank of France, and HSBC

Consumer spending trends are likely to be more erratic

Consumption of manufactured goods weaken temporarily

-10

-5

0

5

10

Jan Feb Mar Apr May Jun Jul Aug Sep Oct

-2

-1

0

1

2

Automobile (LHS) Capital goods (LHS)Clothing (LHS) Other (LHS)Manufactured goods (RHS)

% Mth % MthManufactured goods consumption by components in 2007

� The 9.1% increase in petroleum products prices between June and October and the 0.9% rise in food prices over the same period could limit purchases of residential durable goods, the main engine of growth in consumer spending

� Moreover, the announcement of the introduction of a 'green tax' system for car purchases at the beginning of 2008 is likely to lead to purchases being delayed.

� But, the tax and social security exemptions on overtime and the recent announcement of a revision of the maximum 35-hour week in exchange for an increase in wages are likely to boost gross disposable income, as are cash payments for days not worked as part of arrangements to reduce working hours

Source: INSEE, Banque de France, and HSBC

��

54


��

Already slowing GDP growth rebounded to 0.4% q-o-q in Q3 after

the very weak Q2 figure of just 0.1%. The

surprise was in the detail, which showed an

unexpectedly large rise in investment (1.5%

q-o-q) and a disappointingly weak 0.2% q-o-q rise

in consumer spending. Given the slower

employment growth and lack of an expected

upturn in wage growth, we expect this trend to

persist into 2008, especially as the country’s high

dependence on variable rate mortgages means that

many households are facing higher servicing costs

as a lagged response to past ECB rate increases

and the recent rise in money market rates.

As in Germany, inventories made a sizeable

positive contribution in Q3, which could be a

constraint on Q4 growth. Exports were fairly solid

in Q3 but industrial production fell in both

September and October and the more recent

readings for business confidence and the

manufacturing PMI are consistent with further

weakness. Partly in response to the slightly

weaker outlook for Germany, as well as the US

and UK, we have lowered our 2008 GDP growth

forecast from 1.2% to 1%.

As in the rest of the Eurozone, HICP inflation has

picked up from 1.7% in 3Q07 to 2.6% in

November on the back of higher food and energy

inflation. It is likely to move above 3% in 1Q08

and could remain above 2% even by end-year.

After an impressive fiscal performance in 2007,

which is likely to have reduced the budget deficit

from 4.4% of GDP to about 2.5%, the deficit

appears set to widen again in 2008-09 as the

government will find it difficult to curb spending

as the economy slows. In addition, the 2008

budget includes a cut in corporate tax rates.

% Year

2007f 2008f 2009f Q3 07 Q4 07f Q1 08f Q2 08f Q3 08f Q4 08f


Exports 2.4 1.5 3.2 3.9 0.8 0.3 2.1 1.8 1.6 Imports 2.3 1.6 2.4 2.8 1.0 2.0 2.5 0.7 1.1

GDP 1.7 1.0 1.3 1.9 0.9 0.9 1.1 0.9 1.1 GDP (% quarter) - - - 0.4 0.2 0.3 0.2 0.2 0.4

Industrial production 0.3 0.6 1.4 0.8 -1.3 -0.3 0.4 0.5 1.6 Unemployment (%) 6.0 6.3 6.3 5.9 6.0 6.1 6.2 6.3 6.4 Hourly wage rate 2.4 2.5 2.5 1.9 2.5 2.5 2.3 2.5 2.5 Consumer prices 2.0 2.7 1.8 1.7 2.5 3.0 2.7 3.0 2.3 Current account (EURbn) -35.6 -40.9 -39.1 -5.1 -9.0 -12.7 -10.0 -8.0 -10.2 Current account (% GDP) -2.3 -2.6 -2.4 - - - - - - Budget balance (% GDP)* -2.4 -2.6 -2.7 - - - - - - 3-month money (%) 4.4 4.3 4.3 4.8 4.8 4.6 4.4 4.3 4.1 10-year bond yield (%) 4.5 4.4 4.4 4.6 4.4 4.3 4.4 4.4 4.3

Note: * = state sector cash balance Source: HSBC

Janet Henry Economist HSBC Bank plc


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Survey data have weakened PMIs and growth

40

45

50

55

60

65

98 99 00 01 02 03 04 05 06 07 0840

45

50

55

60

65

PMI manufacturing PMI services

IndexIndex Italy

� The Italian PMIs have fallen back more sharply than the Eurozone in recent months...

� ...particularly the service sector PMI which fell from 58.5 in July to 50.8 in November

� Industrial production fell in September and October and the -1.1% m-o-m drop in industrial orders in October suggests Q4 production will be weak

Source: Reuters, and HSBC

Consumer spending softening Retail sales and confidence

-2.5

0.0

2.5

5.0

98 00 02 04 06 08-140

-100

-60

-20

Retail sales (LHS)Consumer confidence - intentions to buy (RHS)

% Yr, 3mma Index

� Consumer spending growth slowed to just 0.2% in Q3, reflecting an easing in employment growth, to just 0.3% q-o-q while annual wage growth slowed to 1.9% y-o-y

� Consumer confidence fell back in October-November and recent retail sales growth has been disappointing

� The slowdown in employment and moderation in wage growth is expected to persist into 2008, suggesting consumer spending growth will amount to just 1% in 2008

Source: INS, ISAE, Thomson Financial Datastream, and HSBC

Exports faltering Exports

-10

-5

0

5

10

15

98 00 02 04 06 08-4

-2

0

2

4

6

Italy exports of goods & services (LHS)Germany GDP (RHS)

% Yr % Yr

� Italy’s real exports of goods and services picked up a little in Q3 to 0.9% q-o-q after a 1.4% drop in Q2...

� ...but the overall export performance in 2007 has been disappointing, especially given the strength of import demand in its major export destination – Germany

� Interestingly though, Italy’s exports to the US have held up rather better than France or Germany’s over the past year

Source: INS, Thomson Financial Datastream, and HSBC

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Slowdown has kicked-off The Spanish economy is vulnerable to elevated

interest rates on two fronts: First, households are

highly indebted, predominantly on mortgages with

variable interest rates. Second, corporate debt levels

are also significantly above its European neighbours.

The link between the household and corporate sector

is the housing and construction boom experienced in

recent years, which is now unravelling.

Spain had been defying its weak fundamentals for

quite a long time, but the third quarter proved

different. Household consumption came down to

0.4% q-o-q, the weakest growth rate in 4 years.

Investment activity was also disappointing. On

our forecasts, both trends are set to continue.

The credit and money market turmoil in our view

exacerbated a development which would have

taken place in any case. Spanish banks did not

hesitate to pass on higher interest rates before the

crisis, and continue to do so now.

A positive aspect of the Spanish economy is that it

runs a fiscal surplus, albeit a shrinking one. Should

the cyclical situation deteriorate dramatically, the

government could still step in and boost the

economy through fiscal expansion. The incumbent

government is under a socialist helm, but general

elections take place in March 2008.

As in most economies, oil and food price inflation

proved a nasty surprise in Q4. Spanish HICP

inflation moved back above 4.0%, and is expected

to stay elevated into the third quarter of 2008,

subject to the disclaimer that commodity prices

could reverse their gains. This is not our current

assumption. Elevated HICP inflation also has the

unpleasant side effect that wage inflation will

remain elevated, as wage indexation on CPI

inflation is still a common feature in Spain.

Astrid Schilo Economist HSBC Bank plc


% Year

2007f 2008f 2009f Q3 07 Q4 07f Q1 08f Q2 08f Q3 08f Q4 08f


Exports 5.7 4.6 4.4 8.0 6.4 6.8 5.3 2.3 3.9 Imports 6.9 4.4 3.7 8.3 6.8 6.3 5.1 2.7 3.5

GDP 3.8 2.4 2.8 3.8 3.2 2.6 2.3 2.3 2.5 GDP (% quarter) - - - 0.7 0.5 0.5 0.6 0.7 0.8

Industrial production 2.4 1.6 1.8 1.5 1.6 1.3 1.4 1.7 1.8 Unemployment (%) 8.2 9.1 9.5 8.0 8.2 8.6 9.2 9.2 9.2 Average earnings 3.7 3.0 2.4 3.8 2.8 3.0 3.7 3.0 2.5 Consumer prices 2.8 3.7 2.4 2.4 3.9 4.4 3.9 3.7 2.7 Trade account (EURbn) -96.1 -98.4 -94.7 -24.9 -25.0 -25.2 -25.2 -24.2 -23.8 Current account (EURbn) -101.3 -103.5 -98.5 -25.3 -25.8 -26.5 -26.7 -25.5 -24.8 Current account (% GDP) -9.6 -9.3 -8.4 - - - - - - Budget balance (% GDP) 1.8 1.0 0.4 - - - - - - 3-month money (%) 4.4 4.3 4.3 4.8 4.8 4.6 4.4 4.3 4.1 10-year bond yield (%) 4.3 4.2 4.3 4.4 4.2 4.1 4.2 4.2 4.1

Source: HSBC

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Households pessimistic on financial future… …as debt level high, and interest rates on the rise

-10

-5

0

5

10

95 97 99 01 03 05 07-30

-20

-10

0

10

Consumer fin. situation next 12 months (LHS)

Consumer fin. situation over last 12 months (RHS)

Index IndexSpain

� Spanish households are highly indebted, and with rising interest rates on flexible mortgage rates, a squeeze of disposable income is unavoidable

� Households have already reacted by scaling back private consumption in Q3

� This is arguably backward looking, but households also believe that their future financial situation is going to deteriorate

� Indeed, according to the European Commission’s consumer confidence survey, consumers’ expectations on their future financial situation hit a 12 year low in November

Source: ECB, Bloomberg, Thomson Financial Datastream, and HSBC

Corporate loan volume is reacting… …suggesting higher interest rates work here as well

-40

-20

0

20

40

60

04 05 06 07 08-40

-20

0

20

40

60

EMU Spain France Germany

% Yr, 3mMA% Yr, 3mMA Volumes: new loans to NFCs

� High corporate loan growth is the major factor keeping up Eurozone-wide private sector loan expansion

� In 2006 and the beginning of 2007, Spain was a major culprit for this

� However, things have changed. New corporate loan growth was close to zero on a 3 month moving average in October. Outstanding corporate loan growth, which takes longer to react, is down to 25% y-o-y in October, from a peak of 31% y-o-y

� The suspicion is that corporates with strong exposure to the construction and real estate sector are behind this decline

Note: For France 12 months cumulative, NFC = non-financial corporations Source: ECB, National Central Banks, and HSBC

PMIs have clearly turned… …endorsing economic slowdown

38

42

46

50

54

58

62

00 01 02 03 04 05 06 07 08

42

46

50

54

58

62

66

Manufacturing (LHS) Serv ices (RHS)

Spain PMIs IndexIndex

� Lower loan volumes are one thing, but there is no automatic translation into slow economic growth

� � However, the Q3 GDP data already gave us some evidence of

this, with private consumption and investment both softening significantly

� � Evidence for the fourth quarter, best captured by the

manufacturing and service sector PMIs, also speaks in favour of a further easing of economic growth. The slowdown in the two indicators has been quite dramatic, but we are not yet at the levels seen in 2001

Source: Eurostat, Reuters, and HSBC

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Bursting the bubble The UK housing bubble has relied upon

continually expanding credit from the commercial

banking sector. With funds now hard to come by,

many banks and building societies have to cut

back on loan growth. The BoE re-ran their

quarterly credit conditions survey early in a bid to

capture the reaction to the credit turmoil and this

pointed to a significant tightening of credit

standards to corporates and households. As credit

is retrenched the UK housing bubble appears to be

deflating. Nominal house prices have already

fallen by 1.7% in just three months. We expect

further sizeable declines in house prices in 2008.

Declines in house prices, coupled with increased

job insecurity, are expected to sharply depress

consumer spending. We expect the unemployment

rate to increase due to job cuts in finance,

construction and distribution.

But we think the UK will avoid a recession: We

expect 100bp of interest rate cuts and a sizeable

decline in sterling to 1.80 against the dollar. With

the global growth outlook looking only

marginally weaker we expect net trade to provide

a rare boost to UK GDP growth. In other words,

we expect some of the rebalancing of the

economy that the Governor of the Bank of

England has been hinting at to come through.

Inflation will remain a nagging concern but

although energy and food are expected to boost

inflation, declines in the price of other items should

ensure overall headline inflation remains benign.

RPI is expected to fall sharply through 2008.

But there are major uncertainties. One of the largest is

the extent of job cuts in the financial services sector

and the economy-wide impact of falling house prices.

Karen Ward Economist HSBC Bank plc


% Year

2007f 2008f 2009f Q3 07 Q4 07f Q1 08f Q2 08f Q3 08f Q4 08f

Consumer spending 3.1 0.8 1.1 3.6 2.9 2.0 1.1 0.1 0.0 Government consumption 1.7 2.7 3.0 1.9 2.1 2.2 2.5 3.0 3.1 Investment 6.9 3.0 2.4 6.2 4.2 4.5 3.8 2.4 1.5 Stockbuilding (% GDP) 0.3 -0.1 -0.1 0.3 0.6 0.2 0.0 -0.4 -0.3 Domestic demand 3.8 1.5 1.7 4.0 3.5 2.8 1.9 0.7 0.6

Exports -4.4 5.4 7.6 2.1 3.5 5.2 6.2 5.2 5.2 Imports -2.2 5.0 5.7 4.3 5.7 6.3 7.6 3.3 3.1

GDP 3.2 1.5 2.1 3.3 2.9 2.4* 1.4* 1.1 1.0 GDP (% quarter) - - - 0.7 0.6 0.3* -0.1* 0.4 0.4

Manufacturing output 0.6 1.2 2.6 0.4 0.2 0.3 0.3 0.5 0.7 Unemployment (%) 2.7 3.0 3.2 2.6 2.7 2.8 2.9 2.9 3.0 Average earnings 4.1 3.9 3.2 3.8 3.6 3.3 3.2 3.1 3.0 RPI 4.2 2.2 2.4 3.9 4.1 3.2 2.3 1.8 1.2 CPI 2.3 1.8 1.7 1.8 2.1 2.0 1.6 1.8 1.7 Current account (% GDP) -4.8 -3.5 -2.3 - - - - - - PSNB (% GDP) 2.7 2.9 2.4 - - - - - - USD/GBP** 2.04 1.83 1.76 2.04 2.04 1.99 1.92 1.83 1.83 GBP/EUR** 0.71 0.74 0.74 0.70 0.71 0.73 0.73 0.74 0.74 Base rate (%)** 5.50 4.50 4.50 5.75 5.50 5.25 5.00 4.75 4.50 10-year bond yield (%)** 5.0 4.6 4.7 5.0 4.5 4.7 4.7 4.6 4.5

Notes: *corporate capital allowance changes in April 08 is likely to affect investment spending, ** end-quarter estimates Source: HSBC

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Housing bubble looks to be popping... ... as credit is retrenched and expected capital gains are lowered

-80

-40

0

40

80

92 94 96 98 00 02 04 06 08-80

-40

0

40

80

Site visitors Net reservations

Net balance, y-y Net balance, y-y

� The rapid gains in house prices over the past couple of years are hard to justify with improved fundamentals in the economy. Households’ earnings prospects deteriorated as higher RPI could no longer be negotiated into higher wages

� Commercial banks compensated for the weakness in earnings by loosening credit conditions further, fuelling the speculative demand around the housing market

� Both the credit on which the bubble relies, and the overly inflated expectations of future house price gains, are now deflating. However, this is likely to be a slow-burning unwind

Source: Homebuilders’ federation

Consumer spending expected to contract in H1... ...alongside nominal house prices

-15

0

15

30

45

84 88 92 96 00 04 080

4

8

12

16

Average house prices* (LHS)

Nominal consumer spending (RHS)

% Yr % Yr

� As house prices decline, those homeowners that expected their houses to provide a pension as well as somewhere to live will be disappointed, and may wish to revive their saving ratio which in the past year fell to the lowest on record

� Such a revival in the savings habit will be encouraged by the strong gains in savings interest rates now available as commercial banks look to deposits to raise funds

Source: ONS, Nationwide, Halifax, and HSBC

The inflation outlook will be a lingering concern... ... but will turn out to be uneventful

-2

-1

0

1

2

3

4

5

-1

0

1

2

3

4

5

05 06 07 08 09

CPI MIPs Council tax Depreciation

%

Forecast

Contributions to RPI %

� Food and petrol prices are expected to continue to push up on inflation through 2008 and retail gas suppliers are threatening higher prices. However, this is expected to depress demand and prices elsewhere in the CPI basket, so that overall inflation remains benign. Coupled with interest rate cuts and falling house prices through 2008 we expect RPI to fall very sharply to nearer 1% by end-2008

� But until that inflation outlook is proven correct, the Bank of England will feel constrained as regard to how aggressively they can ease policy to support growth. With inflation expectations elevated, they will be concerned that supporting the growth outlook is at the expense of their inflation credibility. We therefore look for a gradual easing cycle through 2008

Note: MIP = mortgage interest payments Source: ONS, and HSBC

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Opposing forces to limit rate rises The Norwegian economy remains strong but there

are signs that demand growth may moderate in the

months ahead. The rise in house prices seems to

have come to a halt and a strong krone exchange

rate is reducing profitability in some business

sectors. The turbulence in international financial

markets, inducing slower growth among trading

partners, is expected to affect exports.

However, there are clear signs of rising prices for

domestically produced goods and services. The

enterprises in the Norges Bank’s regional network

report that wage growth has been generally higher

than anticipated. Moreover, productivity growth

in the business sector is probably slackening

amidst rising capacity utilisation.

The Norwegian experience shows that price and

cost inflation can rise rapidly towards the end of a

cyclical upturn. Hence, in isolation, a pre-emptive

and more pronounced increase in the key policy

rate might look appropriate.

However, the inflation outlook is marked by

opposing forces. The krone is strong and prices

for imported consumer goods are still falling in

spite of higher prices for many commodities.

Moreover, lending is expected to become more

expensive (even without any hike in the policy

rate), as global tightening of credit conditions

affects Norwegian lenders through the euro- and

dollar-based inter-bank market.

With some softening likely in the 2008 growth

outlook, we expect these opposing forces to limit the

rise of policy rates. We look for the policy rate to

peak at 5.5% by 1H08. However, we view the risks

thereafter to be marginally biased to the upside.

% Year

2007f 2008f 2009f Q3 07 Q4 07f Q1 08f Q2 08f Q3 08f Q4 08f


Exports 3.1 3.2 2.5 3.8 4.0 3.0 5.8 3.1 1.0 Imports 7.9 7.1 3.2 8.9 8.2 11.2 8.7 6.1 3.0

GDP 3.3 2.8 3.1 3.4 4.2 3.9 3.3 2.4 1.6 GDP (% quarter) - - - 1.4 1.2 0.3 0.4 0.6 0.4

Industrial production -0.2 2.3 0.6 1.3 3.5 2.8 4.4 1.1 0.8 Unemployment (%) 2.7 3.1 3.8 2.5 2.7 3.0 3.0 3.3 3.3 Average earnings 5.5 4.2 3.4 5.3 5.0 3.9 4.4 4.6 4.1 Consumer prices 0.8 3.0 2.5 0.2 1.5 2.5 3.0 3.5 3.0 Current account (% GDP) 14.7 10.0 8.0 17.6 11.5 10.0 10.0 10.0 10.0 Budget balance (% GDP) 16.7 16.0 15.0 - - - - - - NOK/EUR* 7.6 7.5 7.5 7.71 7.60 7.60 7.60 7.50 7.50 3-month money (%) 5.2 5.8 5.6 5.7 5.9 5.8 6.0 5.9 5.7 10-year bond yield (%) 4.8 5.3 5.3 5.0 4.7 5.3 5.3 5.3 5.3




Manas Paul Bangalore

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��

Policy rate at or near the peak Having passed its cyclical peak, the Swedish

economy is expected to slow down on account of

weaker productivity growth, a gradually rising

interest rate and a cyclical slowdown in investment

growth. Weaker international growth (attributable to

the global financial turbulence) has added to the

pressures, affecting the 2008 growth outlook through

exports and the domestic spillovers from rising inter-

bank lending rates in the international market.

Sweden’s relatively strong household

consumption may be hit by the growing trend of

precautionary saving amidst continuing

international financial turbulence. In fact, Swedish

consumer confidence slumped to a two-year low

in November, as tumbling stocks and rising

interest rates dented household optimism.

At the same time, however, inflation pressures are

expected to persist in the near term due to rising

unit labour costs, rapidly rising food prices and

higher interest costs for home owners.

So while domestic developments still point to

higher policy rates, international developments

and the risk of a deterioration in the growth

environment point in the opposite direction.

The central bank currently seems to be biased

towards the more negative news arising out of the

global financial turmoil, thus limiting the prospect

of further rate hikes from the current 4% level.

However, for now we maintain our mid-2008

policy rate call at 4.25%, which would probably

be the peak in the current cycle.



Manas Paul Bangalore

% Year

2007f 2008f 2009f Q3 07 Q4 07f Q1 08f Q2 08f Q3 08f Q4 08f


Exports 4.7 2.9 3.2 4.2 2.8 2.4 2.7 3.2 3.3 Imports 8.9 3.9 2.3 9.7 7.2 5.4 4.7 2.8 2.6

GDP 2.6 2.3 2.7 2.6 1.8 2.1 2.1 2.1 2.9 GDP (% quarter, sa) - - - 0.6 0.0 0.8 0.7 0.6 0.8

Industrial production 4.4 2.9 2.9 4.1 2.5 2.3 2.7 3.2 3.2 Unemployment (%) 6.0 5.0 5.3 5.4 5.2 5.0 4.9 5.0 5.1 Average earnings 3.2 3.6 3.0 3.3 3.4 3.7 3.7 3.6 3.5 Consumer prices 2.2 2.6 2.3 1.9 3.0 3.1 2.8 2.5 2.0 Current account (% GDP) 6.4 5.9 5.2 5.6 6.1 6.3 5.9 6.1 5.5 Budget balance (% GDP) 2.5 2.5 2.3 - - - - - - State debt (% GDP) 43.4 39.7 39.0 - - - - - - SEK/USD 6.62 6.18 6.77 6.47 6.14 6.07 6.21 6.22 6.22 EUR/SEK 9.18 8.58 8.80 9.20 8.90 8.80 8.70 8.40 8.40 3-month money (%) 4.0 4.6 4.4 4.3 4.7 4.6 4.8 4.7 4.5 10-year bond yield (%) 4.2 4.0 4.5 4.3 4.3 4.4 4.5 4.5 4.5

Source: HSBC

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Domestic strength is a buffer As a small open economy, Switzerland is highly

exposed to international developments, but for

now the resilience of the domestic economy has

been a surprise. Looking forward, we believe the

domestic element will continue to be a positive,

although not being able to counterbalance

completely the external drag.

Private consumption ran close to 3% y-o-y in Q3

2007, which means that four years of economic

expansion have, like a textbook scenario, translated

into an increased willingness to spend on behalf of

households. On the other hand, investment

expenditure continued to cool, especially on the

construction side. So the economic upswing is in a

more mature phase, and we believe that the

momentum will cool in the coming quarters.

The credit crisis and expected US slowdown are

well known external headwinds. The impact on

Switzerland will be predominantly through second

round effects, which means via weaker export and

investment activity.

Inflation picked up in Q4, predominantly on energy

and food. This effect should slowly fade, and

favourable structural factors like labour immigration

and the liberalisation of domestic markets should

also help to keep inflationary pressures at bay.

The SNB kept interest rates on hold at 2.75% in

December, as uncertainties regarding the economic

outlook dominated. SNB rates are currently roughly

at a neutral level, and we believe the SNB is on hold

for the foreseeable future. Should the global

economy slow by more than currently expected, an

easing cannot be excluded. But it is worth noting that

the SNB has been quite successful in keeping money

market distortion out of its own market. Hence, it is

unlikely that the SNB would lower interest rates just

to unlock money markets.

Astrid Schilo Economist HSBC Bank plc


% Year

2007f 2008f 2009f Q3 07 Q4 07f Q1 08f Q2 08f Q3 08f Q4 08f

Consumer spending 2.1 1.8 1.6 2.6 2.6 2.3 2.1 1.5 1.5 Government consumption -0.7 0.4 0.3 -0.9 -0.2 0.4 0.4 0.8 0.1 Investment 2.8 0.5 1.1 1.3 0.8 0.7 -1.6 1.8 1.2 Stockbuilding (% GDP) -1.1 -0.8 -1.1 -1.2 -1.2 -1.2 -0.2 -0.6 -1.3 Final domestic demand 1.9 1.4 1.4 1.9 1.8 1.7 1.0 1.5 1.3

Exports 9.1 3.1 4.5 10.1 6.2 4.1 2.8 2.0 3.5 Imports 4.5 3.1 3.7 7.1 -0.1 3.0 3.1 2.9 3.2

GDP 2.8 1.9 1.8 2.8 2.8 2.3 2.0 1.8 1.5 GDP (% quarter) - - - 0.8 0.5 0.2 0.4 0.6 0.3

Industrial production 8.6 4.3 4.5 10.7 6.6 7.4 3.9 2.6 3.6 Unemployment (%) 2.8 2.6 2.9 2.7 2.7 2.7 2.6 2.6 2.6 Consumer prices 0.7 1.7 1.2 0.6 1.6 2.1 1.7 1.7 1.4 Current account (EURbn) 49.3 35.6 39.8 12.0 11.3 9.2 8.5 8.5 9.4 Current account (% GDP) 15.7 11.0 11.9 15.0 14.0 11.6 10.8 10.3 11.3 SFR/USD* 1.15 1.19 1.23 1.17 1.15 1.16 1.17 1.19 1.19 SFR/EUR* 1.67 1.60 1.60 1.66 1.67 1.68 1.64 1.60 1.60 3-month money (%) 2.6 2.8 2.8 2.7 2.8 2.8 2.8 2.8 2.8 10-year bond yield (%) 2.9 2.8 3.1 3.0 3.0 2.9 2.6 2.7 2.9


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Inflation puts easing on hold The acceleration of inflation from 6.4% y-o-y in

September to 7.1% y–o-y in November represents

a growing concern for the authorities. In essence,

inflation has reversed its decelerating trend, with

elevated food and energy prices the culprits. The

inflation increase came after the ongoing global

financial market turbulence had already prompted

the NBH to pause it’s cutting cycle in October.

NBH governor Simor also expressed concerns

about the outcome of 2008 wage negotiations with

trade unions. As a result, the 9:3 majority of the

Bank’s board voted to leave the policy rate

unchanged in November. Moreover, Simor even

hinted that NBH might decide to raise rates at

some point if inflationary pressures persist.

Although there is just a little chance that the rate

will be cut prior to February 2008, some

moderation in food inflation and the easing of

negative base effects should positively affect CPI

in early-2008, making new rate cuts possible later

in the year. The risks to this rate cut scenario

stems from the potential second round effect on

inflation from wage increases in the private sector

in 2008.

Balancing the negative news on inflation, foreign

trade has been surprising on the upside, with export

growth being led by manufacturing. Besides the

improving current account, exports keep GDP

growing. Otherwise, it would have stagnated or

even fallen amidst a decline in private and public

spending and sluggish investment.

Overall, we expect 2008 to bring positive news as

far as economic growth is concerned, with private

consumption and investment recovering from the

tax hikes and the cut in budget subsidies that

occurred in 2007.

Alexander Morozov Economist HSBC Bank (RR), Moscow


% Year

2004 2005 2006 2007f 2008f 2009f

Consumer spending 3.2 3.8 1.2 -2.0 1.9 3.5 Government consumption 0.0 0.2 -5.5 -0.5 0.0 2.0 Fixed investment 7.7 5.6 -1.8 1.7 1.5 2.8

Exports 15.7 11.6 17.1 15.5 10.8 10.0 Imports 14.1 6.8 11.9 12.5 9.1 10.5

GDP 5.2 4.1 3.8 1.6 3.3 4.5

Industrial production 8.3 7.0 10.6 8.5 11.1 10.5

Unemployment* 6.3 7.3 7.5 6.8 6.4 6.2 Consumer prices 6.8 3.6 3.9 7.9 5.3 3.0 Current account (% GDP) -8.7 -7.2 -5.8 -3.4 -2.5 -2.5 Budget balance (% GDP)** -4.3 -2.4 -8.2 -5.6 -3.9 -3.3 HUF/USD* 180.7 214.0 190.6 172.4 170.4 178.3 HUF/EUR* 245.6 252.5 251.4 250.0 230.0 230.0 3-month money (%)* 9.3 6.3 8.1 7.3 6.3 5.1 10-year yield (%)* 7.0 7.0 6.7 6.4 6.0 5.8 Note: * = year-end; ** Cash deficit rather than European Standard Accounting budget deficit Source: HSBC

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Strong growth and increasing inflationary pressure Economic indicators currently paint a rosy picture

and we look for growth of 6.6% in 2007. All signs

are that growth will remain buoyant in the quarters

to come, fuelled by rising consumption and

phenomenal investment growth. Both household and

government consumption are booming. Rising

employment levels and robust wage growth have

unleashed pent-up consumer demand. The new

coalition, led by the centrist Civic Platform, has been

positive for fiscal credibility so far, trimming the

budget in order to finance a wage increase for

teachers. A coalition with the smaller Polish

Peasants’ Party (PSL) promises little in the way of a

policy shift, but will mean a marked improvement

for foreign relations. Expenditure plans (on pensions

and child benefits) as well as employment tax cuts in

2008 will combine to support strong growth next

year. However, it may also forestall a fall in the

budget deficit, increase inflation risks and widen the

trade deficit. The current account deficit is expected

to hit 4% of GDP in 2007.

Fiscal performance has been better than expected, as

growing employment and consumption have

supported tax revenues, while falling unemployment

has cut benefit costs. Other than employment tax

cuts, these factors are likely to remain mostly intact

next year. However, expenditure will start to rise

moderately in 2008 as the result of various election

promises, many of which were passed in the weeks

prior to the elections.

The central bank has responded to rising demand,

wages, headline CPI and planned budget expenditure

by hiking interest rates by 25bp on four occasions

between April and November. With inflation

currently running above target (3.6% y-o-y in

November) and domestic demand strong, further

monetary tightening is expected in 2008.

% Year

2004 2005 2006 2007f 2008f 2009f

Consumer spending 3.8 1.9 5.7 5.5 5.0 4.5 Government consumption 2.5 1.7 2.1 3.5 4.5 3.5 Fixed investment 13.4 -5.8 12.6 16.5 12.2 8.8

Exports 19.2 3.0 16.0 8.5 10.2 10.5 Imports 16.6 -1.9 17.6 12.5 11.8 10.2

GDP 5.3 3.4 6.1 6.6 5.6 5.2

Industrial production 12.7 4.0 12.0 10.6 11.0 9.6 Unemployment (%)* 19.1 17.6 14.9 11.5 8.7 8.0 Consumer prices 3.5 2.1 1.0 2.7 3.5 2.1 Current account (% GDP) -4.1 -1.6 -2.3 -4.0 -3.9 -3.7 Budget balance (% GDP) -4.5 -2.5 -2.4 -1.5 -1.8 -1.5 PLN/USD 3.00 3.26 2.90 2.52 2.41 2.50 PLN/EUR 4.07 3.84 3.83 3.65 3.25 3.30 3-month money (%)* 6.5 4.6 4.2 5.1 5.6 5.3 10-year bond yield (%)* 5.8 5.1 5.2 5.7 6.0 5.8

Note: *year-end Source: HSBC

Philip Poole Economist HSBC Bank plc


Jonathan Katz Israel

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Economic overheating amidst muted political risks The strong 3Q GDP data have served to offset

news of a deceleration of investment and

industrial activity in August/September, and point

to the sustainability of growth. However, the

observed pattern of economic growth suggests

overheating in the economy. A boom in

construction and rapid growth of the service

sector have occurred in parallel with the

acceleration of price growth. The good thing is

that manufacturing demonstrates strong growth. It

speaks for the economy’s resistance so far to the

Dutch Disease that manifests itself in a stagnation

or depression of the tradable sector of an economy

when the rapid appreciation of national currency

against the currencies of major trade partners

(adjusted for the inflation differential) erodes the

sector’s competitiveness.

Looking forward, good economic data for October

hint at the continuation of strong growth in 4Q as

well. The high base effect of 4Q 2006 and the

moderation in growth of financial services that we

expect in November-December brings us to

expect 4Q GDP growth of 7.0% y-o-y and the

full-year growth projection of 7.6%. In 2008, the

moderation of credit growth should get GDP

growth down to c6.5-7.0%. All in all, we expect

still high growth and double-digit inflation next

year. A return to single-digit inflation is unlikely

before 2009, when the recent deceleration of

money supply growth should have had a positive

impact on prices.

With President Putin’s blessing of Dmitry

Medvedev for the Presidential race, and the

reciprocal offer by Medvedev to Putin to head the

government after the presidential elections, the

political outlook has become much clearer.

Together with a possible shift of some

Presidential powers to the Prime-minister’s office,

this assures that significant deviations from the

current policies are not very likely in 2008. Since

rating agencies pay close attention to political

risks, the substantial mitigation of these risks

should prompt Russia’s credit rating to be

upgraded to A-/A3 by at least one agency. That

should maintain favourable investor sentiment

towards Russia, supporting the strong

macroeconomic fundamentals.

% Year

2004 2005 2006 2007f 2008f 2009f

GDP 7.2 6.4 6.7 7.6 6.7 6.0

Industrial production 6.6 3.9 3.8 5.9 5.0 4.6 Consumer prices* 11.7 10.9 9.0 11.9 11.0 9.0 Current account (USDbn) 59.9 84.3 94.5 75.4 45.3 15.0 Current account (% GDP) 10.0 11.1 9.6 5.9 3.0 0.9 Foreign exchange reserves (USDbn) 120.7 175.9 295.6 464.0 543.3 577.4 Overall fiscal balance (% GDP) 4.4 7.5 7.5 5.3 2.3 1.3 RUB/USD** 28.6 28.4 27.0 25.3 25.2 25.8 1-month money (%)** 5.6 4.7 4.8 4.9 6.7 6.9

Note: * = year-end; ** = year average Source: HSBC

Alexander Morozov Economist HSBC Bank (RR), Moscow


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Structural resilience Turkish markets have held up reasonably well during

the recent financial turmoil. In fact, Turkish Lira

(TRY), which is usually seen as one of the most

vulnerable currencies due to a large current account

deficit and ensuing external financing needs, has been

one of the best performing currencies (when including

the carry) since the summer. Stock prices are actually

higher, although non-resident investors – while staying

in TRY – have sold long-term bonds and thereby

shortened maturity.

We reckon the following reasons stand behind this

resilience, particularly in TRY; first after lots of hubbub

early in the year, political stability has been restored.

The government has finally started to grasp the

structural reform agenda. A very comprehensive social

security reform, which is designed to fix the biggest

black hole in public finances (pension gap c5% of

GDP), is in parliament now.

Second, the Turkish Lira offers the highest nominal and

real interest rates among comparable economies. While

the Central Bank initiated an easing cycle in September

and so far unwound 175bp of the previous year’s

425bps monetary tightening, we argue that the room for

rate cuts is getting smaller with disappointments in

inflation. Hence, policy rates, at 15.75% now, will

likely see limited declines throughout 2008, supporting

the currency.

Third, local investors, who were concerned with

politics and increased their FX deposit stock from

around $60bn in Jun-06 to nearly $100bn now (but kept

on losing money by staying in FX), are now switching

back to TRY whenever they see the opportunity. This is

proving a major stabiliser of the currency.

Hence, with stable domestic politics and structural

reforms to follow, locals will continue to shift back to

TRY. Foreign investors will also likely increase their

positions as risk appetite improves. Hence, we expect

TRY and TRY-denominated assets, on balance, to

attract interest in 2008.

% Year

2004 2005 2006 2007f 2008f 2009f

Consumer spending 10.1 8.8 5.2 3.0 7.1 5.0 Government consumption 0.5 2.4 9.6 6.6 3.1 3.6 Fixed investment 32.4 24.0 14.0 6.6 8.9 8.1 Stockbuilding (% GDP) 8.2 5.3 3.1 3.8 3.3 2.8 Domestic demand 14.1 12.1 8.1 4.3 7.4 5.8

Exports 12.5 8.5 8.5 10.3 7.7 8.6 Imports 24.7 11.5 7.1 11.2 10.1 8.8

GDP 8.9 7.4 6.1 4.4 5.5 5.4

Industrial production 9.7 5.4 5.8 4.3 5.2 4.7 Consumer Prices 8.6 8.2 9.6 8.8 8.0 5.7 Producer prices 15.3 2.7 11.6 6.1 5.2 5.0 Current account (% GDP) -5.2 -6.2 -8.2 -7.2 -7.4 -7.1 Budget deficit (% GDP) -7.0 -2.0 -0.7 -2.5 -2.3 -2.4 TRY/USD** 1.41 1.35 1.47 1.28 1.23 1.27 3-month money (%)* 22.6 13.8 17.6 16.0 14.9 12.1

Note: * = year end; ** = starting in January 2005, when the Turkish currency (until then coded TRL) shed 6 zeros off its exchange rate Source: HSBC

Murat Ulgen Economist HSBC Yatirim Menkul Degerler A.S., Istanbul

+90 212 3661625 [email protected]

Esra Erisir

Economist

HSBC Yatirim Menkul Degerler A.S., Istanbul

+90 212 3661615

[email protected]

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That’s not a slowdown Saudi Arabia released its preliminary full year

accounts for 2007 in mid-December and at first

glance, the figures are disappointing. Real growth

fell to an estimated 3.5%, the slowest pace of

increase since 2002. The budget and current account

surpluses also fell, ending in both cases a four-year

run of sharp year on year growth. Inflation,

meanwhile, is on track to record its highest annual

average in 15 years.

Not for the first time, though, the numbers miss the

underlying point. For one thing, the estimated public

finance and current account surpluses are still

remarkably high, at around 13% and 25% of GDP

respectively. The surpluses allowed the government

to continue to pay down public debt (now worth just

19% of GDP compared to a peak of over 110% a

decade before) and build up its holdings of overseas

assets. The underlying economic growth story is also

strong. The headline slowdown was a consequence

of OPEC-imposed production cuts. This masked a

more robust 6% expansion in non-oil output.

The key theme from the data – and the real cause for

both the fall in the budget and current account

surpluses, and the pick up in inflation – is

strengthening domestic demand. As the kingdom

adjusts to the new oil price environment, investment

and consumption spending is beginning to

accelerate, creating an increasingly buoyant

environment for the non-oil sector. The shift in

growth drivers has a momentum which will persist

throughout 2008, when headline growth rates will be

boosted further still by oil output gains. Inflation,

however, looks likely to rise.

The rise in inflation at a time of high oil prices

and dollar weakness has prompted renewed

speculation that the kingdom may be preparing to

adjust its exchange rate, and SAR forwards

reached an all time high in early December. We

retain our view, however, that there is no appetite

in SAMA for change, and that an adjustment in

the value or nature of the currency regime remains

only a remote possibility.

% Year

2004 2005 2006 2007f 2008f 2009f

Consumer spending* 5.8 9.5 6.5 6.8 7.2 7.5 Government consumption* 11.9 18.4 25.3 14.0 10.0 10.0 Fixed investment* 6.8 24.1 10.9 14.0 16.0 16.0

Stocks* 22.6 2.1 0.0 9.5 14.1 4.0 Exports* 33.2 42.5 9.7 1.5 11.1 -2.7

Imports* 20.3 31.2 18.0 15.0 14.0 14.0

GDP 5.3 6.1 4.3 3.5 5.7 6.3 Consumer prices 0.3 0.4 2.3 3.9 5.4 4.5 Current account balance (USDbn) 52.0 90.7 96.2 92.0 105.0 76.1 Current account balance (% GDP) 20.5 28.3 27.6 25.1 26.0 18.5 Budget balance (% GDP) 11.2 18.2 22.2 13.0 14.5 9.3 SAR/USD 3.75 3.75 3.75 3.75 3.75 3.75 3-month money (%)** 2.6 5.0 4.9 4.0 3.8 4.0

Note: * Nominal growth ** End year. Source: HSBC

Simon Williams Economist HSBC Bank Middle East Limited, Dubai


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Liking FX over rates in ST South Africa continues to suffer from unrelenting

inflationary pressures. The headline CPI-X

(consumer prices excluding interest payments on

mortgage bonds), which is the monetary policy

target, has breached the 3.0%-6.0% target band

since April and recently hit 7.3%. While the major

cause of inflation appears to be supply-side

shocks (i.e. rising energy and food costs),

economic activity still remains vibrant, despite a

17-month long tightening campaign during which

the South African Reserve Bank (SARB) has

hiked policy rates by 400bps to 11.00%.

Going forward, we might see inflation pressures

easing somewhat on the demand side due to the

lagged impact of monetary tightening. There are

already signs of limited softening in household

consumption demand, although investment

demand remains high with ongoing expenditure in

the country’s mining sector and infrastructure.

Indeed, large investment goods imports, coupled

with a high energy bill, have caused a substantial

widening of South Africa’s current account gap to

8.1% of GDP in Q3 from 6.5% in Q2.

SARB expects inflation to peak around 7.8% in

Q1 2008, which appears rather optimistic to us

given investment demand and supply side

pressures. We do not expect inflation to revert to

the target band anytime soon, which might also

negatively impact inflation expectations.

Similarly, given the nature of current account

deficit financing in the country, which mostly

relies on portfolio inflows and a highly volatile

currency that is vulnerable to a further shift in

global risk appetite, we argue that short-term rates

will likely remain high at least during the first

quarter of the next year.

Murat Ulgen Economist HSBC Yatirim Menkul Degerler A.S., Istanbul


Esra Erisir

Economist

HSBC Yatirim Menkul Degerler A.S., Istanbul

+90 212 3764618

[email protected]

% Year

2004 2005 2006 2007f 2008f 2009f

Consumer spending 6.7 6.6 7.3 5.6 5.0 4.8 Government consumption 6.3 5.2 5.4 6.0 5.7 5.5 Fixed investment 9.6 9.6 12.8 12.0 11.3 11.2

Exports 2.9 8.0 5.6 9.5 8.5 8.0 Imports 14.5 10.7 18.4 12.5 10.2 8.5

GDP 4.8 5.1 5.0 5.4 5.3 5.0

Industrial production 3.3 4.2 4.9 5.5 4.4 5.0 M3 12.8 24.0 23.1 22.5 22.0 19.6 Consumer prices 4.3 3.9 4.6 6.5 6.3 5.5 Current account (% GDP) -3.2 -3.8 -6.4 -7.1 -7.3 -7.8 Budget balance (% GDP) -2.0 -0.5 0.2 0.5 0.6 0.2 ZAR/USD 6.16 6.40 7.03 6.99 6.80 6.59 3-month money (%)* 7.5 7.0 9.2 10.5 10.0 8.7 10-year bond yield (%)* 8.1 7.5 7.7 8.3 8.1 7.4

Note: * = index 1995 = 100 Source: HSBC

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Another downward revision We revise our 2007 and 2008 real GDP growth

forecasts slightly downward in light of past GDP

data revisions. We now look for real GDP growth

of +1.9% (vs. 2.0% previously) in 2007, +1.6% (vs.

1.8%) in 2008, and +2.2% (unchanged) in 2009.

The impact from a US economic slowdown will be

comparatively limited, and external demand will

again drive growth during the latter half of 2008

against a backdrop of an improving US economy.

We forecast a clear slowing in capex in 2007, in

part due to pressure from a capital stock adjustment,

before a gradual rebound in 2008 on a pickup in

external demand. We also look for a growth impact

in 2008 in response to the slump in housing and

construction investment that resulted from revisions

to the Building Standards Law this year.

We forecast core CPI inflation rates of 0.0% in

2007 and +0.4% in 2008. Companies are passing

sharply higher raw material prices onto customers,

but we expect the move away from deflation to be

slow due to large negative contributions from

imputed rents (which has a high weighting), rapid

price declines for IT-related consumer goods, and

strong downward pressure on wages.

The BoJ will maintain a wait-and-see stance amid

US downside risks until the summer of 2008. Our

call for the BoJ’s next rate hike is September 2008.

% Year


Consumer spending 1.7 1.3 1.6 2.3 1.6 1.2 1.3 1.2 1.3 Government consumption 0.6 0.9 0.6 0.4 0.8 0.9 0.8 1.1 0.8 Investment -0.4 1.3 3.7 -1.3 -3.0 -2.1 1.5 2.7 3.2 Private non-residential 1.9 3.2 4.7 0.8 -0.2 1.5 3.7 3.8 3.9 Private residential -8.7 1.0 7.5 -11.3 -20.2 -15.5 -6.1 7.2 18.5 Public -2.8 -6.4 -3.9 -0.1 -4.3 -10.9 -6.0 -4.8 -4.0 Stockbuilding (% GDP) 0.4 0.1 0.1 0.3 0.2 0.1 0.1 0.1 0.1 Domestic demand 0.9 0.9 1.9 0.8 0.3 -0.1 0.9 1.5 1.5

Exports 7.9 6.4 7.3 8.0 9.0 6.3 6.8 6.0 6.4 Imports 1.6 2.9 6.9 1.2 2.2 2.0 2.0 3.2 4.5

GDP 1.9 1.6 2.2 1.9 1.2 0.8 1.8 1.9 1.8 GDP (% quarter) - - - 0.4 0.4 0.3 0.6 0.7 0.5

Industrial production (% year) 2.8 1.0 3.3 2.7 3.0 2.4 0.6 0.5 0.3 Unemployment rate 3.9 4.0 3.7 3.8 4.0 4.0 4.0 4.0 3.9 Wholesale prices 1.7 0.7 1.0 1.5 2.0 0.9 0.9 1.1 0.1 CPI 0.0 0.4 0.4 -0.1 0.3 0.5 0.4 0.2 0.3 M2+CDs 1.6 2.2 2.3 1.9 2.0 2.1 2.1 2.2 2.3 Current account (JPYtrn) 25.1 29.2 29.1 6.2 6.8 6.9 7.2 7.5 7.6 Current account (% GDP) 4.9 5.6 5.4 4.8 5.2 5.3 5.5 5.7 5.7 Budget balance (% GDP) -3.0 -2.5 -2.0 - - - - - - JPY/USD 118 114 120 115 115 113 113 115 115 3-month money (%) 0.6 1.1 1.6 1.0 1.0 1.0 1.0 1.3 1.3 Benchmark bond (%) 1.6 1.7 - 1.7 1.4 1.5 1.7 1.7 1.7

Source: HSBC

Seiji Shiraishi Economist HSBC Securities (Japan) Limited


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70


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US ISM mfg. new orders and Japan’s mfg. activity Industrial production, capital expenditures and exports

-15-10

-505

101520

95 97 99 01 03 05 07

3540455055606570

Export volume (LHS)Industrial production (LHS)Mfg.ISM New orders (RHS)

(

Index% Yr

� The U.S. Manufacturing ISM new orders index suggests that Japan’s industrial production and export volume growth (y-o-y) should decelerate towards spring

� But despite the subprime mortgage problems in the U.S., exports to Asia should remain robust, helping to underpin industrial production and export volume

� Capex decelerated in 2007 owing to the capital stock cycle. But it will not go into a severe adjustment phase, and should re-accelerate after mid-2008 given the bottoming out of the U.S. economy

Note: The OECD lead indicator has been shifted forward 2-quarters. Source: METI, MoF, ISM

Growth of employees’ income Wage growth and consumption

-4-3-2-1012345

95 97 99 01 03 05 07

-4-3-2-1012345

Real compensation of employeesReal consumption of households

% Yr% Yr

� Despite Japan’s long economic recovery, wages per worker are still falling at a moderate rate, for several structural reasons. Highly paid baby boomers are either retiring or continuing to work at lower wages. The government is controlling public employee wage growth. Low-wage industries are hiring more employees than high-wage industries, and companies are restraining personnel costs to remain competitive internationally

� On the other hand, total wage and salary income is gradually growing, reflecting a rise in the number of workers

� Personal consumption is likely to grow consistently at an annual rate of slightly over 1%. This growth pace has been continuing since 1999 even under wage deflation phases, which indicates the “ratchet effect” of personal consumption

Source: Cabinet Office

Taylor rule and o/n call rate Monetary policy

-4

-2

0

2

4

6

8

10

83 86 89 92 95 98 01 04 07

-4

-2

0

2

4

6

8

10%% Japanese Overnight Call Rate

Estimation (Taylor rule)

Actual

� The BoJ will maintain its basic outlook for the economy and prices in January’s review, but at the same time will have to take a wait and see stance amid the global market instability and the increasing external risks. We predict the next rate hike will take place in September 2008

� Core CPI y-o-y inflation is likely to accelerate to more than 0.5% toward next spring, but core core CPI(excluding oil products from core CPI) y-o-y inflation rate should be around zero. The BoJ will care more about downside economic risks than oil price led inflation risks

� The BoJ’s outright purchases of long-term JGBs on the open market are unlikely to decline. The spread between the overnight call rate and the Lombard rate (currently 25bp) will be maintained after the next rate hike, although the spread should expand to 100bp in the long run

Source: HSBC

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Resilient expansion Australian output growth rose 4.3% in the year to

September last, a pace we expect to be matched

through 2008. Despite booming demand and prices,

exports have been unexpectedly weak. With

reasonable global growth, the volume of export

growth will likely pick up through 2008. So too will

housing construction, which has been slow since the

home boom faded four years ago. Business

investment will probably not grow as rapidly as it

did through 2007, but it will continue to increase.

Underpinned by rising employment and incomes

and by a double round of tax cuts from July 1,

household consumption will keep pace with the rate

of growth of overall GDP. If the protracted drought

is indeed ending, as appeared to be the case at the

end of 2007, additional rural production will boost

GDP growth in the second half of 2008.

With a strong banking system, little mortgage

distress and an active central bank Australia has

been little troubled by the global credit turmoil. It

has made it more difficult for Australian banks to

borrow offshore, however, raising the risk of

pressure on the exchange rate if the credit turmoil

persists through the first half of 2008.

The Australian cash rate was twice increased 25bp

through 2007, taking it to 6.75%. Core inflation is a

little above the 2% to 3% central bank target,

making at least one further tightening probable

when global financial markets settle down. The

Australian rate premium will to some extent offset

concerns over the short term financing of the current

account, keeping the currency reasonably firm.

% Year


Consumer spending 4.0 4.2 3.6 4.4 4.1 3.5 4.5 4.0 4.0 Government consumption 2.9 3.6 2.0 1.3 3.1 3.0 3.8 3.9 3.5 Investment 8.8 8.5 6.5 10.2 10.4 9.0 7.7 9.0 8.0 Final domestic demand 5.0 4.6 4.0 5.4 5.4 4.5 4.5 4.5 4.3 Stockbuilding (% GDP) 0.1 0.1 0.1 1.0 0.0 0.0 0.0 0.0 0.0 Domestic demand 5.3 4.7 4.0 6.4 5.4 4.5 4.0 4.5 4.3

Exports 4.0 8.0 8.0 4.6 5.3 6.9 8.8 8.5 7.0 Imports 10.0 7.0 6.0 12.2 8.1 7.2 7.8 6.5 6.5

GDP 3.9 4.5 4.3 4.3 4.3 4.1 4.6 4.8 4.5 GDP (% quarter) - - - 1.0 1.2 1.2 1.2 1.3 0.8

Industrial production 2.5 1.9 2.0 1.6 -0.5 0.7 1.2 2.7 2.8 CPI 2.3 3.2 2.7 1.9 2.8 3.5 3.1 3.1 3.0 Unemployment 4.4 4.3 4.3 4.3 4.4 4.3 4.2 4.3 4.2 Average earnings 4.2 4.2 4.2 4.2 4.3 4.0 4.1 4.3 4.0 Current account (AUDbn) -62.5 -64.5 -65.0 -62.0 -62.3 -63.3 -63.7 -64.4 -64.5 Current account (% GDP) -5.9 -5.9 -5.9 - - - - - - Budget balance (% GDP) 1.5 1.5 1.5 - - - - - - USD/AUD 0.86 0.86 0.80 0.88 0.90 0.92 0.87 0.84 0.83 3-month money (%) 6.8 7.0 7.0 7.2 7.3 7.1 7.2 7.2 7.0 10-year bond (%) 6.1 6.2 6.2 6.2 6.3 6.2 6.2 6.1 6.1

Note: * = quarterly data are a four-quarter rolling sum; ** = quarter annualised Source: HSBC

John Edwards Chief economist – Australia and New Zealand HSBC Bank Australia Limited


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Moderating demand New Zealand domestic demand growth slowed in

the second half of last year, a trend welcomed by

the Reserve Bank of New Zealand. The lively

housing market has begun to weaken, while retail

sales growth has moderated. Business investment

growth faded. Through 2008 we expect export

growth to pick up while domestic demand

continues to moderate. GDP growth should

however remain above 2%.

Troubled by a somewhat higher inflation rate than

it wants to see, the RBNZ will likely maintain its

8.25% cash rate through 2008. It declined to raise

it further after a July 2007 tightening, however,

and we think it unlikely that another tightening

will need to be seriously considered. As in

Australia, the global elevation of lending spreads

has done some of the central banks work for it.

The New Zealand dollar was volatile through

2007, with a reliably inverse relationship to global

risk aversion. It remains a popular asset in the yen

carry trade, however, and the yield differences

between New Zealand dollar assets and those in

Japan, the US and Europe are likely to persist. We

look for a little currency weakness in 2008, but

not much.

Like Australia, New Zealand has enjoyed a

protracted expansion. Like Australia it is now

challenged by very low unemployment and higher

inflation than the central bank is prepared to

accept. The essential policy issues in both

economies arise from the probability that they will

for many years need to operate at the very limit of

their capacity.

John Edwards Chief Economist – Australia and New Zealand HSBC Bank Australia Limited


% Year

2004 2005 2006 2007f 2008f 2009f

Consumer spending 6.0 4.7 2.4 2.4 2.5 2.5 Government consumption 5.2 4.2 4.8 3.2 4.0 2.0 Investment 11.6 3.6 -2.5 3.7 1.7 3.9 Final domestic demand 7.2 4.4 1.5 2.8 2.8 2.5 Stockbuilding (% GDP) 1.2 0.9 0.0 0.1 0.1 0.1 Domestic demand 7.3 4.0 0.7 2.8 2.8 2.5

Exports 5.7 -0.5 1.9 3.1 3.4 4.5 Imports 16.0 5.5 -2.5 6.0 4.0 2.0

GDP 3.7 2.6 1.9 3.4 2.4 2.7

Consumer prices 2.3 3.0 3.4 2.6 2.5 2.5 Current account (% GDP) -6.6 -9.0 -9.0 -9.0 -8.5 -8.5 Budget balance (% GDP) 3.7 4.4 3.9 3.0 3.0 3.0 Unemployment* 3.6 3.8 3.7 3.6 3.5 3.5 NZD/USD 0.67 0.70 0.64 0.76 0.75 0.69 3-month money (%) 6.2 7.2 7.6 8.4 8.6 7.0 10-year bond yield (%) 6.1 5.9 5.8 6.4 6.2 6.0

Note: * Year end. Source: HSBC

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Beijing’s policy dilemma Rising headline consumer price inflation, clear

signs of stock and property bubbles and excessive

credit growth all point to the need for more

aggressive policy tightening. Indeed, we have

already heard top leaders doing some tough

talking at high-level meetings about fighting

against economic overheating and inflation.

However, aggressive tightening is easier said than

done. First, with exports accounting for 45% of its

GDP and the US still a top destination for the

Chinese exports, a US recession would cause a

major disruption to the Chinese economy. So

aggressive tightening could prove over kill for

growth should there be a recession in the US.

Moreover, the Fed’s easing has already led to a

significant narrowing in the rate differential

between the renminbi money markets and USD

markets, making it more difficult for the PBoC to

hike rates without worrying about attracting more

capital inflows.

Waiting for clearer data before taking real action

seems to be the logical option under the current

circumstances. But the problem is that by the time

the global picture becomes clear, Beijing may

have missed the opportunity to either control

inflation or prevent a sharp slowdown. The

bottom line is that the policymakers need to take a

bet. Given the political will of creating a picture

of prosperity around the Olympics in 3Q08, we

expect Beijing to step up its tightening a little bit

next year. And they will have to rely more on

quantitative tightening measures, such as required

reserve ratio hikes, lending curbs and deregulating

capital outflows. This, plus our house view of

slowdowns in the Euro-zone, Japan and the US,

leads us to revise our 2008 GDP growth

projection from 12% to 11%. Meanwhile, we have

also lifted our 2008 CPI forecast from 3.6% to

4.1%, thanks to stronger-than-expected growth in

food and energy prices.

% Year

2004 2005 2006 2007f 2008f 2009f

Consumer spending 7.2 8.5 8.7 9.0 8.9 9.1 Government consumption 8.6 10.3 10.0 11.0 11.5 11.0 Fixed asset investment 27.6 27.2 24.5 24.0 22.0 19.0

Exports 32.0 29.0 25.0 23.5 18.0 17.0 Imports 31.0 17.0 20.0 16.4 15.0 17.0

GDP 10.1 10.4 11.1 11.4 11.0 10.5

Industrial production (ex-small enterprises)

16.3 15.9 16.2 18.0 16.5 15.0

Consumer prices 3.9 1.8 1.5 4.7 4.1 3.0 Current account (% GDP) 3.6 7.2 9.4 9.7 10.2 10.1 Budget balance (% GDP) -1.3 -1.2 -1.0 -0.9 -1.1 -1.0 CNY/USD 8.28 8.18 7.93 7.56 7.15 6.85 1-year time deposit (%) 2.0 2.3 2.4 3.5 4.7 4.7 1-year lending (%) 5.4 5.6 5.9 6.9 7.6 7.8

Note: * = nominal Source: HSBC

Qu Hongbin Economist The Hongkong and Shanghai Banking Corporation Limited (HK)


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Domestic spending boom Hong Kong’s economy is expected to remain

robust in 2008, expanding by 5% over the year

after an estimated 5.9% in 2007. Domestic

demand will still be the key driver, with fixed

asset investment expected to pick-up when major

public infrastructure projects commence. Strong

demand from China in both goods and services is

expected to drive external trade, despite a

downside risk from the anticipated slowdown of

US demand.

Support for private consumption is mainly from

rising household wealth which is derived from both

wage increases on the back of a tighter labour

market (3.9% unemployment rate in October) as

well as the buoyant stock market (index up 43%

year-to-date). We look for the unemployment rate

to stay below 4% throughout 2008.

We expect fixed asset investment to be strong in

2008 as public infrastructure projects commence

boosting construction. An additional HKD100

billion will be added to local economy per annum,

plus another HKD5.2 billion from the new

government headquarters building.

Externally, goods exports have grown 9.7% y-o-y

for the year-to-October, driven mainly by strong

Chinese demand. This robustness is likely to be

sustained and help offset the anticipated US

slowdown. On the other hand, healthier growth in

the export of services is expected to continue in 2008

due to increasing cross-border financial services as

portfolio investment becomes more liberalised.

Inflation has been modest this year at 1.7% year-

to-October. As price pressures from wages, import

goods and rental costs intensify, inflation is likely

to rise to 4% by 2008. In light of the downward

interest rate cycle, Hong Kong will again enter into

an era of negative real interest rates.

% Year

2004 2005 2006 2007f 2008f 2009f

Consumer spending 7.0 3.0 5.9 6.6 5.3 3.6 Government consumption 0.7 -3.2 0.2 2.1 2.4 2.6 Fixed investment 2.7 4.1 6.3 5.6 7.6 8.9 Stockbuilding (% GDP) 0.6 -0.3 0.0 0.6 0.3 0.2 Domestic demand 5.0 1.5 5.8 6.7 5.2 4.6 Exports 15.4 10.6 9.2 8.2 6.4 6.9 Imports 13.8 8.0 8.9 8.7 6.5 7.1 GDP 8.5 7.1 6.8 5.9 5.0 4.5 Industrial production 2.9 2.5 2.2 0.6 2.4 1.9 Unemployment (%) 6.9 5.7 4.8 4.1 3.7 3.8 Retail sales 10.8 6.8 7.3 12.8 14.0 11.2 Consumer prices -0.4 0.9 2.0 2.0 3.9 4.3 Goods & services balance (% GDP) 8.9 12.5 11.7 11.5 11.2 11.0 Budget balance (% GDP) 1.7 1.0 4.0 5.3 2.9 2.5 HKD/USD 7.79 7.77 7.77 7.80 7.80 7.80 3-month money (%) 0.5 3.1 4.3 4.4 3.4 3.6 Prime rate (%) 5.0 6.2 7.9 7.4 6.3 6.3

Source: HSBC

Janus Chan Economist The Hongkong and Shanghai Banking Corporation Limited (HK)


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RBI in for an extended pause July-September GDP growth of 8.9%, though

slightly higher than market expectations of an

8.7% outturn, was down from 9.3% in 2Q07. The

slowdown is more prominent in terms of ex-

agriculture GDP growth, which slipped to 9.8% in

the latest quarter from 10.6% previously. Though

the economy is softening, it is doing so at a pace

slower than our previous estimate and we have

revised up our FY08 growth forecast marginally to

8.5% from 8.3% previously.

We expect ex-agriculture growth to continue

trending lower. A weaker global backdrop and

higher oil prices are two of the reasons but the

bigger impacts are likely to come from the lagged

effects of the stronger rupee and the policy

tightening delivered over the recent past. The repo

rate has been hiked 175bp since the end of 2005

and the CRR by 250bp over the last 12 months,

while the interest actually paid by households and

companies have risen more sharply. As such, we

are maintaining are sub-consensus 7% GDP

growth forecast for FY09.

While any direct impact from the global financial

turmoil on India’s domestic economy is expected

to be minimal, only time will tell how the indirect

effects play out, while the new External

Commercial Borrowing (ECB) limits will impose

an additional constraint. These represent further

risks to the FY09 growth outlook.

Despite robust growth, inflation has softened since

the beginning of FY08 thanks to the stronger

currency and collapsing metal price inflation. WPI

inflation at c3% has more than halved while the

various measures of CPI inflation have declined by

between 150 to 300bps. We expect WPI inflation

to stabilise around these levels with a possible

downside bias if the pass through of the higher

international oil prices is delayed.

The latter would further pressurize the off-budget

component of the fiscal deficit via the further

issuance of oil bonds. Also the 6th Pay

Commission, due to report by April 2008, could

have a negative impact on the FY09 deficit.

With lower inflation and moderating growth, we

expect the RBI’s policy rate pause to continue for

many months yet. However, for reasons of

liquidity management we wouldn’t be surprised to

see a further 50bp CRR hike in H1 2008.

% Year

2004 2005 2006 2007f 2008f 2009f

GDP* 7.3 8.2 9.6 8.9 7.1 7.4 GDP (Financial year)** 7.5 9.0 9.4 8.5 7.0 7.8

Consumer prices 3.9 4.0 6.3 6.4 6.8 6.9 Current account (% GDP) 0.1 -1.8 -1.1 -1.3 -1.5 -1.9 Budget balance (% GDP) -4.4 -4.5 -3.8 -3.4 -3.7 -4.0 Broad money supply 12.3 21.2 19.2 23.0 14.0 19.0 INR/USD 44.7 44.0 45.1 40.6 38.1 37.3 3-month money (%) 4.7 6.1 7.6 9.2 7.8 7.5 Prime rate (%) 10.5 10.5 11.3 13.0 13.0 12.5

Note: * = calendar year; ** = based upon Indian fiscal year (April-March) Source: HSBC

Robert Prior-Wandesforde Economist The Hongkong and Shanghai Banking Corporation Limited, Singapore branch


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Targeting growth not inflation The Indonesian economy is enjoying its strongest

and most sustained period of growth since the dark

days of the Asian crisis a decade ago. There also

seems little chance of things going badly wrong in

the short term. After all, the impact of the 475bps of

rate cuts since May last year will continue to filter

through, while the government’s 2008 budget was

highly expansionary, boosting development

spending significantly as well as raising public sector

wages. It is also important to remember that

Indonesia has amongst the lowest trade exposures to

the US of all Asian countries.

The most encouraging aspect of the recent growth

numbers has been the improvement in investment,

which we expect to continue in 2008. In view of the

sluggish progress on structural reform, we suspect

that much of the extra spending is government-led

but if infrastructure improvements ensue then greater

private investment may also be encouraged.

It seems to us that the policy authorities are paying

much greater attention to the government’s growth

target than they are the Central Bank’s 4-6% 2008

inflation objective. Our own forecast envisages

average inflation of 8.5% in 2008 and an end-year

rate of 9.5%.

This assumes that the oil subsidy, which is costing

the government at least 3% of GDP, will be reduced

at some point over the next few months, and

presumably not too close to the 2009 elections. The

subsidy itself is put at USD10-15bn and we estimate

that each USD1bn cut adds1-1.5% to the headline

inflation rate.

At the same time, inflationary risks also stem from

the lagged effects of Indonesia’s relatively strong

economic growth, high public sector wage rises

(which could filter into the private sector) as well the

weakness of the rupiah, which is down 4% in trade

weighted terms since mid-2007. If we are right then

the pressure is going to be on Bank Indonesia to start

raising rates again in the second half of 2008.

% Year

2004 2005 2006 2007f 2008f 2009f


Exports 13.5 16.4 9.2 8.6 7.8 9.8 Imports 26.7 17.1 7.6 8.0 8.1 9.4

GDP 5.0 5.7 5.5 6.3 6.5 5.3

Industrial production 6.4 4.6 4.6 4.2 5.5 5.1 Unemployment (%) 9.7 10.6 10.8 10.1 9.7 9.6 Consumer prices 6.1 10.5 13.1 6.5 8.5 8.6 Current account (% GDP) 0.6 0.1 2.7 3.0 2.7 3.1 Budget balance (% GDP) -1.0 -0.5 -0.9 -1.8 -2.3 -2.5 IDR/USD 9097 9840 9135 8978 8600 8600 3-month money (%) 7.4 9.0 11.9 8.1 8.4 10.0

Source: HSBC



Prakriti Sofat

Economist

The Hongkong and Shanghai Banking Corporation Limited, Singapore branch

+65 6230 2879

[email protected]

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Impressive decoupling The Malaysian economy has decoupled impressively

from what has recently been as sharp a downturn in

exports to the US as witnessed during the mini-2001

recession. The decoupling has taken two forms.

First, while exports to the US had, until recently

been falling 20% year-on-year, total exports were

roughly flat as exports to the likes of China and

Europe remained firm. Second, the domestic

economy has begun to boom again, showing the first

back-to-back quarters of double-digit growth since

the second-half of 2000. The latest data for 2007Q3,

for example, showed private consumption up 14%

and investment 13.5%.

The extent of the decoupling has taken us by surprise

and we have revised up our 2007 GDP growth

forecast to 6.2% from 5.8%. We have also decided

to leave our above-consensus 2008 projection

unchanged at 6.2%. This might seem strange in

view of the deteriorating outlook for the US

consumer, but one important point to bear in mind is

that the bulk of Malaysia’s goods exports are tech

related and hence more closely related to US IT

spending than consumption. The former slowed

sharply through 2005 and 2006, with signs of

improvement emerging in the last couple of quarters.

At the same time, the domestic economy is likely to

benefit from ongoing strong infrastructure-related

spending in the three main development regions of

the country.

Malaysian inflation has remained below 2% since

March 2007, but will rise decisively as and when the

fuel subsidy is cut. In our view this will come after

the general elections which we are expecting to be

brought forward to March. Higher fuel prices will

probably then add around 1 ppt to the headline rate,

which in turn will put the pressure on Bank Negara

to start tightening what it views to be an

accommodative stance. We are still looking for the

first move around mid-2008, with a further 25bp rise

before the end of the year. Such action might help

cool the economy in 2009.

% Year

2004 2005 2006 2007f 2008f 2009f

Consumer spending 10.5 8.7 7.1 11.1 7.2 6.2 Government consumption 6.0 6.4 5.0 6.3 4.4 4.0 Fixed investment 3.1 5.0 7.9 9.6 7.9 6.5 Stockbuilding (% GDP) 2.3 -0.4 -0.2 -2.4 -2.3 -2.2 Domestic demand 11.0 5.6 7.1 7.2 7.2 6.1

Exports 2.3 7.9 7.4 2.8 4.8 7.9 Imports 20.7 8.9 8.6 3.0 5.4 8.5

GDP 7.3 5.0 5.9 6.2 6.2 5.8

Industrial production 11.3 5.3 7.1 2.5 4.4 7.9 Unemployment (%) 3.6 3.6 3.3 3.2 3.0 3.1 Consumer prices 1.4 3.0 3.6 2.0 2.8 2.6 Current account (% GDP) 12.1 14.6 16.3 16.5 15.8 15.6 Budget balance (% GDP) -4.1 -3.6 -3.3 -4.2 -3.8 -3.5 MYR/USD 3.80 3.78 3.64 3.43 3.28 3.18 3-month interbank rate (%) 2.9 2.9 3.7 3.6 3.7 4.5

Source: HSBC



Prakriti Sofat

Economist


+65 6230 2879

[email protected]

��

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Credit where it’s due The Philippines is on a roll. GDP rose over seven

percent on average in the first three quarters of

this year, with more of the same to come. The

peso, shedding much of its historic stigma, has

been among the best performers in Asia this year,

rising an impressive 16% against the dollar. True,

the economy remains supported by surging

remittances, fuelling a boom in consumption that

appears difficult to sustain, but, the fiscal deficit,

long the economy’s Achilles heel, continues to

contract, lending some valuable stability.

Certainly, much of this year’s fiscal improvement

is due to privatization receipts and we remain

sceptical about the outlook for tax revenue growth.

Still, with a budget deficit narrowing considerably

this year and next, the government has bought

itself time to put its house in order. The

administration has also made impressive strides

towards reducing broader public debt, retiring

much of the liabilities of the National Power

Corporation by auctioning off generation assets.

Still, challenges remain. Investment, for example,

is still underperforming despite a series of interest

rate cuts over the past year. Here, structural

bottlenecks may be hindering greater capital

expenditure. In fact, the country’s export

performance has sagged of late, suggesting that

competitiveness is suffering. Greater infrastructure

expenditure in the next two years should help spur

at least a gradual rebound in investment.

Another challenge is inflation. To be sure, CPI

readings have so far surprised on the low side,

giving the central bank some room to cut rates

further. However, with base effects kicking in and

the appreciation of the peso slowing down, price

pressures should pick up over the coming year.

With the latest data being consistently strong, we

raise our GDP forecast for this year to 6.9% from

6.5% earlier, although we still expect a deceleration

to 5.9% in 2008.

% Year

2004 2005 2006 2007f 2008f 2009f

Consumer spending 5.9 4.8 5.5 5.6 4.9 4.7 Government consumption 1.4 1.6 6.1 8.8 5.3 5.6 Fixed investment 1.3 -6.6 1.4 8.5 4.6 4.1 Stockbuilding (% GDP) 0.9 0.3 0.5 0.3 0.1 0.4 Domestic demand 5.8 2.0 5.0 6.0 4.8 4.9

Exports 15.0 4.8 11.2 2.8 4.4 5.4 Imports 5.8 2.4 1.9 -4.4 4.0 4.9

GDP 6.4 4.9 5.4 6.9 5.9 5.6

Industrial production 1.0 2.2 -9.9 -2.8 2.8 3.0 Unemployment (%)* 11.9 7.9 7.9 7.4 7.1 6.8 Consumer prices 6.0 7.7 6.3 2.7 4.1 4.6 Current account (% GDP) 1.1 1.9 5.0 5.1 4.5 4.0 Budget balance (% GDP) -3.8 -2.7 -1.1 -0.9 -0.5 -0.8 PHP/USD 56.2 55.0 50.9 45.7 42.0 40.8 3-month money (%) 7.3 6.1 5.2 3.4 4.3 4.9 Note: * Since Sep 2005, the ILO definition of unemployment has been adopted by official sources. Source: HSBC

Frederic Neumann Economist The Hongkong and Shanghai Banking Corporation Limited (HK)


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Inflationary stress The economy is likely to show weaker GDP growth

in 2008 than 2007, but not dramatically so. Our

forecast of 7.3%, unchanged from the previous

Quarterly, is above the top end of the government’s

own range and would, if correct, represent

something of a triumph bearing in mind the

increasingly worrisome outlook in the US.

A number of factors are likely to keep growth

going. In particular, extremely low real interest

rates should help support investment and

consumption spending, while the latter will also

benefit from booming asset markets and real

personal income growth. Employment grew more

than 9% year-on-year in the third quarter, while

real wages rose by nearly 4%. The marine & off-

shore engineering sector will benefit further from

the high oil price, with pharmaceuticals and

financial services continuing to enjoy structural

success. Even export growth could hold up

reasonably well, despite slowing US consumption,

as the global tech cycle is finally beginning to

show more encouraging signs.

Unusually, Singapore’s main economic concern is

inflation. Headline CPI inflation, at 3.6% in

November, was a 16-year high, while the

government is expecting it to reach 5% in the first

half of 2008. This pick from a recent low of just

0.2% in January 2007, reflects an almost perfect

storm of rising energy and food commodity prices,

higher rents and the impact of July's GST rise.

Clearly the government can do little about the first

two of these factors, but the second two are indicative

of any economy that is running a little too hot.

Against this background, we wouldn’t be surprised

to see further tightening measures in the February

budget as well as the April MAS meeting. The last

meeting in October saw the Central Bank raising

“slightly” the slope of the currency band and a

further tweaking would seem difficult to avoid if

inflation really is running around 5% at that time.

% Year

2004 2005 2006 2007f 2008f 2009f

Consumer spending 5.9 2.7 2.5 5.0 7.1 6.1 Government consumption -1.1 7.6 11.2 1.1 4.8 5.0 Fixed investment 10.2 0.2 11.5 16.9 9.4 6.8 Stockbuilding (% GDP) -4.8 -3.6 -3.4 -3.3 -3.1 -3.1 Domestic demand 11.1 4.1 6.6 8.4 7.9 6.2

Exports 20.6 11.5 10.4 7.2 7.5 9.3 Imports 23.2 11.0 10.4 7.1 7.7 9.6

GDP 8.7 6.9 7.9 8.1 7.3 6.5

Industrial production 13.8 9.4 12.0 6.1 7.8 8.0 Unemployment (%) 3.5 3.2 2.7 2.3 1.7 2.3 Consumer prices 1.7 0.5 1.0 2.0 3.9 1.6 Current account (% GDP) 28.9 29.5 27.5 31.9 29.5 29.2 Budget balance (% GDP) -1.9 -0.8 -0.2 0.6 2.1 2.1 SGD/USD 1.68 1.67 1.58 1.51 1.45 1.42 3-month money (%) 1.0 2.2 3.4 2.8 2.8 3.0 Prime rate (%) 5.3 5.3 5.3 5.3 5.3 5.3

Source: HSBC



Prakriti Sofat

Economist


+65 6230 2879

[email protected]

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Slower, not faster No doubt, recent data out of Korea is looking

fairly solid. Growth in the third quarter topped

5%, a respectable rate for any economy even if

Koreans themselves remain unimpressed.

Confidence remains generally buoyant as the

country heads into a presidential election and

looks towards a change in political leadership.

Exports, too, continued to perform well, clearly

unfazed by the appreciation of the Won.

But, risks remain, and altogether the economy is

likely to slow over the coming year rather than

accelerate further. First, take exports. Korean

producers remain comparatively exposed to a

possible slowdown in the US, not only because a

big chunk of their goods head across the Pacific

but also because they dabble in industries, such as

electronics, that are cyclically sensitive.

Closer to home, we remain concerned that the record

level of household debt will weigh on consumer

spending growth. Here, the tightening of monetary

conditions in recent months has added an extra

burden since much of consumer debt is financed at

variable interest rates. Also, real wage growth

remains sluggish despite the low unemployment rate

as overall job growth is still lacklustre.

The liquidity squeeze that is driving up money

market rates is unlikely to convince the Bank of

Korea to cut its policy rate. Here, inflation is

beginning to concern officials who previously

kept a closer eye on burgeoning asset prices. The

headline CPI already touched the upper band of

the central bank’s inflation target of 2.5-3.5%, and

looks set to stay near it at least for the next several

months on the back of higher energy costs. Still,

growth should slow only marginally to 4.5% in

2008 from 4.8% this year.

% Year

2004 2005 2006 2007f 2008f 2009f

Consumer spending -0.3 3.6 4.2 4.3 4.2 4.5 Government consumption 3.7 5.0 5.8 5.0 5.0 5.2 Fixed investment 2.1 2.4 3.2 5.1 4.6 5.0 Stockbuilding (% GDP) 0.1 0.0 -0.1 -0.4 0.0 0.0 Domestic demand 1.8 2.4 0.0 9.5 4.9 4.8

Exports 19.6 8.5 12.4 9.7 7.3 9.0 Imports 13.9 7.3 11.3 9.8 8.9 10.0

GDP 4.7 4.2 5.0 4.8 4.5 4.7

Industrial production 10.2 6.2 10.1 6.2 6.5 7.5 Unemployment (%) 3.7 3.7 3.4 3.3 3.3 3.5 Retail sales -0.2 4.3 4.9 3.5 4.5 4.5 Consumer prices 3.6 2.8 2.2 2.5 3.3 3.2 Current account (% GDP) 4.3 1.9 0.7 0.6 -0.2 -0.4 Budget balance (% GDP) 0.7 0.4 0.4 0.2 -0.2 -0.5 KRW/USD 1122 1026 950 918 888 875 3-month CD yield (%) 3.8 3.6 4.5 5.1 5.4 5.6 5-year treasury yield (year-end) 4.3 4.5 5.0 5.2 5.6 5.8

Source: HSBC



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It’s political Taiwan had a bumper third quarter, with growth

jumping to 6.9%, almost 2ppt above the average

for the previous quarters. Surprisingly, growth was

not only driven by exports, even if these still

performed well, but also by a little bounce in

domestic demand coming both from private

consumption and investment. For the full year,

therefore, Taiwan should handsomely beat our

earlier growth forecast of 4.4%.

But, there are worrying signs on the horizon, and,

all considered, we expect the island’s economy to

slow again next year. The main risk here is export

growth: Taiwan remains the economy most exposed

in the region to a slowdown in the United States as a

big chunk of its goods are headed there. Moreover,

the economy’s dependence on electronics exposes it

to a possible cyclical downturn.

Domestically, too, some challenges lie ahead:

consumer sentiment is still weak, while wage and

employment growth continue to be sluggish.

Therefore, the bounce in private consumption is

unlikely to carry very far.

Clearly, the upcoming legislative and presidential

elections add some upside risk. Should one party

come to control both the executive and

parliament, confidence might quickly improve,

especially if this entails a shift towards a more

pragmatic stance in cross-straits relations. But,

given the political cleavages on the island, it is

difficult to see how policy gridlock could be

swiftly overcome even under a new government.

Apart from politics, inflation bears watching since

it has jumped recently on the back of rising food

costs. But, so far, we remain relaxed about price

stability, and look for the central bank to raise

rates only gradually, not least because growth

should slow to about 4% next year.

% Year

2004 2005 2006 2007f 2008f 2009f

Consumer spending 3.9 4.3 1.8 2.8 3.0 3.6 Government consumption -0.5 1.1 -0.4 0.9 3.2 4.0 Fixed investment 17.5 7.4 0.6 4.2 4.4 4.5 Stockbuilding (% GDP) 0.2 0.1 0.1 0.0 0.0 0.0 Domestic demand 7.0 4.4 1.2 2.8 3.4 3.8

Exports 14.8 10.0 10.4 6.7 4.4 5.4 Imports 18.6 10.3 5.2 3.3 3.6 4.6

GDP 6.1 4.7 4.9 5.0 4.0 4.5

Industrial production 9.8 4.6 5.0 5.4 3.4 4.1 Unemployment (%) 4.4 4.1 3.9 3.9 4.1 3.9 Consumer prices 1.6 2.3 0.6 1.6 2.4 1.9 Current account (% GDP) 5.6 4.5 6.8 6.3 3.6 3.6 Budget balance (% GDP) -2.8 -0.6 -1.1 -0.5 -0.7 -0.7 TWD/USD 33.1 32.3 32.6 32.9 32.5 32.5 3-month CD (%) 1.1 1.4 1.6 2.0 2.3 2.4 Prime rate (%) 3.4 3.7 4.0 4.2 4.6 4.7

Source: HSBC



��

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Will confidence return? Fundamentally, the Thai economy is in reasonable

shape. Growth, after all, is bumping along

between 4-5% every quarter, supported mainly by

exports and, this year, government consumption.

No major macroeconomic imbalances are on the

horizon. However, sentiment, both among

investors and consumers, continues to be subdued,

holding back a much needed kick to expenditure.

The trouble is that political uncertainties are still

weighing on sentiment. Despite earlier hopes that

the stalemate would be resolved over the course

of the year, leading to a bounce in domestic

demand, uncertainties persist. The upcoming

elections are unlikely to yield a quick fix as the

country’s electorate remains deeply divided.

Forecasts for next year, therefore, must be

approached with caution.

Nevertheless, there is scope for a recovery in

investment, even if household spending will only

gradually accelerate. Already, applications for

investment approvals are running at quite a high

level, holding out the prospect that a temporary

thaw in the political climate could see significant

capital outlays. Remarkably, foreign direct

investments in 2007 have remained relatively

strong, close to levels seen last year.

Aggressive cuts in the policy rate over this year

should further help spur investment, with banks

gradually recovering their appetite for risk. Still,

rising inflation raises some concerns, especially

since the price level in Thailand has historically

been rather sensitive to rising energy costs.

The Bank of Thailand should therefore maintain a

tightening bias, even if not necessarily delivering

a hike until the last quarter of 2008. By that time,

fiscal policy should turn more stimulative as

politicians again get a say in the upcoming

budget. Altogether, growth should accelerate to

5% as long as exports maintain their momentum.

% Year

2004 2005 2006 2007f 2008f 2009f


Exports 9.6 3.9 8.5 5.9 4.2 6.0 Imports 13.4 8.7 2.6 2.4 4.7 5.4

GDP 6.4 4.6 5.1 4.4 5.0 4.6

Industrial production 8.3 5.2 5.9 5.0 6.3 8.0 Unemployment (%) 2.1 1.9 1.5 1.4 1.4 1.2 Consumer prices 2.9 4.3 4.7 2.3 3.1 2.5 Current account (% GDP) 1.7 -4.5 1.1 4.5 1.7 0.5 Budget balance (% GDP) 0.0 0.3 1.2 -1.5 -2.6 -2.9 THB/USD 40.1 40.6 37.5 32.2 32.3 31.3 3-month interbank rate (%) 1.6 3.3 5.2 3.9 3.7 3.9

Source: HSBC



��

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Driven by consumption Vietnam is forecast to grow by 8.3% in 2007 –

expanding at a rate above 8% for the third

consecutive year. Economic momentum should

pick up in 2008 largely on the back of stronger

consumer spending, with the continued strength in

fixed asset investment and non-oil exports

chipping in as well. As such we have revised up

our growth forecast to 8.5% from 8.0% previously.

This, however, is still conservative compared to

the government’s target of 9% for 2008.

Given healthy wage gains, strong jobs growth and

the lack of policy tightening in Q4 2007, we think

solid spending by households is warranted in

2008. The 20% increase in minimum salaries of

state employees and pensioners, effective 1st of

January, will only support the spending spree.

On the external side, slowing in US and EU

consumption spending is a risk. However, given that

the bulk of Vietnam’s exports are basic in nature,

the negative spill over should be limited. Further,

with China and Australia becoming increasingly

important trading partners, we think export growth

is set to exceed 17%. This however is slower than

the 20% expansion of the last few years.

With inflation already in double digits and growth

showing little signs of abating, we think there is a

high probability of CPI printing in the teens in the

early part of 2008. The floating of diesel and

kerosene prices scheduled for 2008 adds another

layer of upside risk. Base effects, however, are

going to be favourable which should see inflation

average 10% in 2008 as a whole.

On the policy front we are hopeful that the

National Assembly will grant greater autonomy to

the central bank, which should then see some

policy tightening, in addition to the liquidity

draining measures. This should allow growth to

slow and inflation to moderate in 2009.

% Year

2004 2005 2006 2007f 2008f 2009f

Consumer spending 7.1 7.3 7.5 7.5 7.6 7.0 Government consumption 7.8 8.6 8.1 7.5 7.2 6.8 Fixed investment 10.4 9.7 8.6 10.4 11.0 11.5

Exports - Goods 31.4 22.5 22.1 21.2 17.7 18.6 Imports - Goods 26.6 15.7 33.4 34.0 20.5 17.2

GDP 7.8 8.4 8.2 8.3 8.5 8.1

Industrial production 17.6 25.5 16.0 14.6 17.3 13.5 Unemployment (%) 5.6 5.3 4.4 4.0 3.5 3.2 Consumer prices 7.8 8.3 7.5 8.1 9.9 7.1 Current account (% GDP) -3.4 0.4 0.5 -2.5 -2.9 -3.1 Budget balance (% GDP) -4.9 -4.9 -5.0 -5.0 -4.8 -4.8 VND/USD 15738 15866 16006 16146 16186 16035 Short-term lending rate (%) 9.8 11.2 11.2 11.2 11.2 11.2 5-year interest rate (%)* 8.5 8.8 8.3 8.8 7.5 7.5

Note: * end-year. Source: HSBC



Prakriti Sofat

Economist


+65 6230 2879

[email protected]

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Global

Stephen King Global Head of Economics +44 20 7991 6700 [email protected]

Stuart Green +44 20 7991 6718 [email protected]

Europe

Janet Henry Chief European Economist +44 20 7991 6711 [email protected]

Astrid Schilo +44 20 7991 6708 [email protected]

Germany Lothar Hessler +49 21 1910 2906 [email protected]

France Mathilde Lemoine +33 1 4070 3266 [email protected]

United Kingdom Karen Ward +44 20 7991 3692 [email protected]

North America

Ian Morris +1 212 525 3115 [email protected]

Ryan Wang +1 212 525 3181 [email protected]

Global Emerging Markets

Philip Poole +44 20 7992 3683 [email protected]

Wietse Nijenhuis +44 20 7992 3680 [email protected]

Asia

Peter Morgan +852 2822 4870 [email protected]

Frederic Neumann +852 2822 4556 [email protected]

Qu Hongbin +852 2822 2025 [email protected]

Sophia Ma +86 10 5999 8232 [email protected]

Christopher Wong +852 2996 6917 [email protected]

Seiji Shiraishi +81 3 5203 3802 [email protected]

Robert Prior-Wandesforde +65 6239 0840 [email protected]

Yukiko Tani +81 3 5203 3827 [email protected]

Prakriti Sofat +65 6230 2879 [email protected]

Emerging Europe, Middle East and Africa

Juliet Sampson +44 20 7991 5651 [email protected]

Alexander Morozov +7 495 783 8855 [email protected]

Murat Ulgen +90 21 2366 1625 [email protected]

Esra Erisir +90 21 2366 1615 [email protected]

Simon Williams +971 4507 7614 [email protected]

Latin America

Marjorie Hernandez +1 212 525 4109 [email protected]

Alexandre Bassoli +55 11 3847 5744 [email protected]

Paulo E Mateus +55 11 3847 5985 [email protected]

Javier Finkman +54 11 4344 8144 [email protected]

Jonathan Heath +52 55 5721 2176 [email protected]

Juan Pedro Trevino-Gutierrez +44 20 7991 5980 [email protected]

Global Economics Research Team

Disclosures and Disclaimer This report must be read with the disclosures and analyst

certifications in the Disclosure appendix, and with the Disclaimer, which forms part of it

Principal contributors

Stuart Green* Global Economist+44 20 7991 [email protected]

Stuart Green is HSBC’s Global Economist. Prior to joining HSBC in August 2007, Stuart worked as an economist at a number of theworld’s largest financial institutions, covering the UK, European and US economies.

Stephen King*Chief Economist+44 20 7991 [email protected]

Stephen King is HSBC Group’s Chief Economist. Stephen joined HSBC in 1988, having previously been an economic adviser at theTreasury in the UK. Stephen is a regular economics commentator on television and radio, and since 2001 he has written a weeklycolumn for The Independent, one of the UK’s leading newspapers.

MacroGlobal Economics

Q1 2008

By Stephen King and Stuart Green

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* Employed by non-US affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to NYSE and/or NASD regulations.

Goodbye to all thatFrom excess to deficient liquidity…...as the credit squeeze threatens the transatlantic economies…...but can de-coupled emerging markets limit the damage?

Goodbye To All That...From Excees To Deficient Liquidity

Economy & Finance

Transcript of Goodbye To All That...From Excees To Deficient Liquidity