Asia should ride out EM turmoil
Call it a tale of two regions: fears over the end of US Federal Reserve liquidity and a slowing Chinese economy harmed many financial markets in developing countries last week – but not all.
The headlines aren't pretty. EPFR Global reports that emerging-market equity funds have suffered three continuous weeks of outflows. Most of the recent damage was in Latin America, notably the drop in the value of the Argentine peso and Brazilian real. In Asia, India is again suffering, with the rupee declining by nearly 1.5% against the US dollar over the course of last week, as did the Indonesian rupiah and other Asian currencies.
But there have been exceptions, such as the New Taiwan dollar, which after a modest decline in value began to bounce back by mid-week, while the renminbi has remained stable within its trading band. Although Japan is not an emerging market, it’s also perhaps notable that the yen appreciated last week.
EPFR Global notes that China and Vietnam funds enjoyed rising inflows. And even among Asian units losing value, such as India’s, the magnitude of the declines are nothing akin to what they experienced in the tumult of last summer.
The fear is presumably that this is just the start of an extended sell-off. But such analysis requires a deeper look at each country’s situation; the only contagion effect is from exposure to China or to reliance upon global liquidity. Investors who dump emerging markets or Asian portfolios en masse will surely do so only out of ignorance, or if internal weaknesses in their firm force their hand.
The South American countries offer a stark example of this. Argentina is getting hammered because of the astounding mismanagement by the ruling Kirchners. Its governing politicians have benefited from US-fuelled portfolio investments, but as the Federal Reserve begins to end its asset purchases, reasons to hold Argentine debt dwindle by the day. Brazil, on the other hand, has tied its growth story to China’s mast. Investor fears are strictly about whether Chinese investment and purchases of Brazilian exports, notably in natural resources, will maintain pace, and whether that will impact domestic consumption.
Much has been written over the past six months about India and Indonesia’s vulnerabilities. In India’s case, deepening debt, falling growth, and a sense that the government can’t get to grips with problems such as building infrastructure have played their role; China has been irrelevant. Indonesia, far more than Brazil, has relied on China, but has also grown complacent about its deficit; moreover foreign investors play a big role in its domestic bond market. But markets are usually good at pricing in this sort of thing; the reason for their volatile markets may have more to do with jitters regarding upcoming elections.
North Asia, on the other hand, should benefit from the China and US trends. Korea and Taiwan are only tenuously ‘emerging markets’ and fare well from US growth; a cheap yen is a threat but for the time being its value remains stable. Japan is on track to meet the government’s (short-term) inflation targets.
The north-south divide in Asia can be overdone, however. Southeast Asia has plenty of headwinds these days, but the global macro picture brings its own silver lining. First of all, the headlines around 'emerging markets' involve countries such as Argentina, South Africa, Turkey and Ukraine, all of which have entrenched problems but few of the advantages that remain in Asian countries.
Secondly, Japanese companies will continue to invest in Southeast Asia and India. Abenomics will eventually drive Japanese portfolio flows that way too.
Thirdly, China may be decelerating, but it remains a relatively robust and very large economy. A smaller share of the China pie today represents a bigger piece for your average Indonesian coal miner than what he might have gotten with a slightly bigger share a decade ago. The Chinese economic transition includes an emphasis on urbanisation, which suggests a continued demand for all sorts of resources and inputs. The shift to a more sustainable growth model should also imply China will be a longer-term, more reliable trading partner, particularly if it avoids a financial or banking bust.
The summer 2013 sell-off of emerging markets was led by retail investors. Global institutional investors, on the other hand, took advantage of the ‘summer sale’ to add Asian bonds to their holdings. Worldwide, investors remain underweight emerging markets, and are unlikely to dump strategic holdings. If anything, they are probably waiting for a bit of bloodletting in order to add some more.
The US central bank may end its asset purchase programme this year, but interest rates in the US will probably stay low. The Fed’s newfound reliance on transparent communication with the market should prevent it from unleashing surprise interest rate hikes, as it did in 1994, triggering an all-out panic that culminated in the 1997 Asian financial crisis.
Therefore investors need to look at India and Southeast Asian countries more closely. India, Thailand, Malaysia and Indonesia all have deteriorating political and fiscal outlooks. The question is whether these are cyclical or structural: can a change of political leadership lead to improvements? By the middle of 2014, these outcomes should be understood, but it’s a reasonable assumption that one or two will surprise on the upside. At any rate, the worst of their problems are internally generated and have little connection to the US or to China.
The return to normal monetary policy in the US, the end of deflation in Japan, and Chinese progress on its economic transformation are worthy of celebration, not fear. The region’s weaker countries need to address fiscal imbalances, improve governance and deepen and integrate their financial systems – but they are not the basket cases of 1996, poised like dominos to fall.