>‘Exit’ Strategy: The Road Ahead (MORGAN STANLEY)

• AXJ industrial production (IP) growth has recovered close to trend line: AXJ IP growth is back to the trend line of 9% YoY in September, compared with a decline of 12.4% in the EU and 6.1% in the US for the same month. This acceleration has so far has been largely driven by domestic demand, but exports are also beginning to recover.

• Policy support withdrawal to remain gradual: We cite three reasons: a) recovery so far been largely policy-induced and quick reversal in stimulus would risk a double-dip in growth; b) although exports are recovering, they are still far away from pre-crisis levels; c) AXJ core inflation remains low below Central Banks’ comfort zone.

• Monetary policy ‘Exit’ to begin from 1Q2010: We expect India and Korea to start lifting policy rates from Jan-2010. Currently, the short-term real interest rate on core inflation in the region is very low at an average of 1.6% even as the industrial production has accelerated to 9.1%. We expect the weighted average policy rate in the region to rise to 5.8% by end-Dec11, from 4.6% as of end-Dec09. We see this as a trend towards normalization of rates.

• Except for China, most countries in AXJ should begin reversal in fiscal stimulus soon: Tax and other incentives have already resulted in a sharp rebound in auto and property transactions in the region. We believe that taxation-related stimulus measures that were announced for a limited period may not be renewed or extended. We expect a further rise in China’s fiscal deficit, but the rest of AXJ is likely to start unwinding fiscal stimulus in 2010.

To read the full report: ASIA PACIFIC ECONOMICS