PP 7767/09/2010(025354)

Economic Highlights
Global
•
MARKET DATELINE

1 July 2010
1 A Tough Choice For Japan To Raise Consumption Tax As
The Economy Slows

2 Euroland’s Inflation Moderated In June

3 Chinese Provinces Raised Minimum Wages To Curb

Labour Disputes

4 Thailand’s Economic Activities Will Likely Remain Resilient

In The 2Q Despite Signs Of Weakness

Tracking The World Economy...

Today’s Highlight

A Tough Choice For Japan To Raise Consumption Tax As The Economy Slows

A slowdown in Japan’s economic recovery from its worst postwar recession suggests that the economy may be too weak
to sustain the higher consumption taxes being considered by the newly appointed Prime Minister. Earlier, in a move to
contain the country’s public debt, the Prime Minister indicated that he was considering raising the sales tax to 10% from
5% currently. The administration also pledged to balance the budget by fiscal 2020 and cap public spending for the next
three years.

The risk is that without an end to deflation and rebound in spending, the Japanese economy may not be able to withstand
the higher consumption taxes. Indeed, the data released this week showed that the unemployment rate has risen to
a five-month high in May, while wages, factory output and household spending fell during the month. This points to little
sign of revival in domestic demand more than a year after the economy stopped shrinking. Therefore, the move by
the present government is in danger of repeating the error of what the earlier government did, where an increase in
sales tax in 1997 helped cause a recession. In 1997, the then Prime Minister boosted the consumption levy by 2
percentage points, an increase followed by a recession that led to his resignation. Japan’s dilemma is echoed around
the world in developed nations with swelling public debt loads and historically high unemployment. The UK plans to boost
its value-added tax (VAT) to 20% from 17.5% in January. Spain is raising its main VAT rate in July to 18% from 16%.
The US policymakers, however, warned of downside risks cause by premature policy tightening.

Meanwhile, the International Monetary Fund said that sales taxes can be an effective way of raising revenue in developed
economies, as more than half of GDP typically comes from consumer spending in the developed world. Also, higher sales
taxes, introduced gradually, could help the economy by spurring inflation expectations, according to some economists.

The Euroland Economy

Euroland’s Inflation Moderated In June

◆ Euroland’s preliminary headline inflation rate eased to 1.4% yoy in June, after rising to a 17-month high
of +1.6% in May, as energy prices receded and companies continued to cut costs. While a drop in the euro against
the US dollar has resulted in imported goods more expensive, a weak consumer spending locally has helped to
keep prices at bay. As a result, the European Central Bank (ECB) will likely keep its key policy rate stable

Peck Boon Soon

(603) 9280 2163
Please read important disclosures at the end of this report.
bspeck@rhb.com.my

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in the near term, in view of a deepening in sovereign debt problems in some European countries and prospects
of a slowdown in the global economy in 2H 2010. Nevertheless, earlier the ECB has agreed to buy government
and private bonds, particularly in certain markets that faced with severe tensions, after the European governments
unveiled an unprecedented emergency stabilisation loan package of as large as €750bn on 10 May. On the other
hand, the ECB said that it has completed its year-long purchase programme of buying €60bn covered-
bonds and intends to keep the bonds until maturity. The purchase of covered bonds (assets backed by mortgages
or public-sector loans) was part of the ECB’s response to Europe’s worst recession since World War II as it sought
to free up banks’ balance sheets and encourage lending.

◆ Separately, the ECB said that it would lend banks €131.9bn (US$161.5bn) for three months, as banks need
to repay funds they borrowed from the ECB during the financial crisis last year. This suggests that the rollover
amount was less than a third of the €442bn in 12-month funds that banks need to repay the ECB on 1 July. The
smaller-than-expected amount of funds requested relieved fears that the region’s banks are still dependent
on an ECB lifeline to stay afloat. Recall that the ECB flooded the financial system with cheap cash after the
collapse of Lehman Brothers Holdings Inc. in September 2008. It has since stopped lending 12-month loans to
banks as much as they want, as eliminating the 12-month facility is part of the ECB’s long-term exit strategy.
However, a deepening sovereign debt crisis forced it to reopen the programme but for periods of up to six months.
The ECB said that 171 banks asked for the three-month funds at its benchmark interest rate of 1%. It fills all
bids against eligible collateral. Banks can currently borrow three-month money from each other in the market at
about 0.76%. However, financial institutions are wary of lending to each other after Europe’s sovereign debt crisis
fueled concern that some governments may struggle to refinance their debts, prompting investors to shun bonds
sold by nations including Greece, Portugal and Spain.

Asian Economies

Chinese Provinces Raised Minimum Wages To Curb Labour Disputes

◆ At least nine Chinese provinces and cities will raise minimum wages from 1 July by as much as a third
after Premier Wen Jiabao called for measures to head off growing worker unrest that may lead to social unrest
in the country. Earlier, Taipei-based Foxconn Technology Group, suffering a spate of suicides at its factory in
Shenzhen and was forced to double wages to RMB2,000 a month in May, from October’s level. Honda and Toyota
both raised salaries to end the strikes at their plants in southern China. Following which, Beijing is increasing the
lowest monthly salary that employers may pay in the Chinese capital to RMB960 (US$142), from RMB800.
Similarly, China’s Henan is raising its minimum wage by 33% to RMB600. Shanghai, the country’s financial hub,
ordered a rise of 17% to RMB1,120 per month in April and Guangdong, China’s biggest export base, boosted five
local minimum wages in the province by an average 21%, with the highest pay rising to RMB1,030. In addition
to preventing strikes, China also wants to raise the incomes of its 468 million industrial and services workers to
boost domestic consumption and reduce the economy’s reliance on exports and investment for growth.

Thailand’s Economic Activities Will Likely Remain Resilient In The 2Q Despite Signs Of Weakness

◆ Thailand’s manufacturing production slowed down to 17.2% yoy in May, from +21.8% in April. This was the second
consecutive month of slowing down and the slowest pace of growth in six months, affected by the political unrest
in the country. A slowdown in the production of electronic products, construction materials, rubber & rubber
products, leather and pulp & paper products as well as declines in the production of food and petroleum products
contributed to the slowdown. These were, however, mitigated by a pick-up in the production of vehicle &
equipment, electrical appliances, iron & steel and chemical products. Notwithstanding a weaker growth in production,
exports rebounded to increase by 42.5% yoy in May, from +34.7%in April, suggesting that exports remained
robust. As a result, private business investment indicator strengthened to 20.7% yoy in May, from +19.3% in April,
suggesting that businesses are still keen to spend. Similarly, private consumption indicator rebounded to 7.4%
yoy, from +7.0% during the period, indicating that consumer spending was still held up despite the political unrest.
Indeed, tourist arrivals fell by 11.8% yoy in May, after slowing down sharply to 2.3% in April. As a whole, the
major economic indicators suggest that Thailand’s economy will likely remain resilient in the 2Q despite
signs of weakness, after recording a strong growth of 12.0% in the 1Q.

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