Tue, 01/06/2004 - 07:53
Credit Agricole's Asian Investment Team examines the reasons for the recent declines in Asia and outlines the prospects for investors in markets such as China.
The principal reasons for Asia's recent decline are fairly well known:
1. Concerns about a "hard-landing" for a China slowdown
2. Rising interest rates in the U.S.
3. Surging crude oil prices
Indeed the recent extreme volatility and significant market declines in Asia were created by a series of factors encompassing geo-political events, global economic concerns, interest rate fears, surging crude oil prices and a host of domestic considerations, most prominently fears of a significant slowdown in China's economic growth profile and the election cycle.
The tremendous enthusiasm for the Asian story earlier this year by international investors led to a surge in new portfolio investment, which unfortunately coincided with the one year peaks in all Asian markets.
The combination of these concerns saw outflows from Emerging Markets amounting to USD 464 million last week, the highest outflow on record. Most of this decline is due to a rising USD and an unwinding of the USD carry trade - borrow USD and invest in commodities, emerging markets debt and equities.
This is really due to panic, where investors have focused only on the technicals and have indiscriminately sold shares. Hedge Funds, in particular, have been massively selling across Asia, with the focus today on India. Usually markets overshoot, so we should see prices go up gradually and sporadically (due to short covering), once they have stabilised.
The rapid rise in Asia's GDP in 1H04 illustrates that reflation is still in place due to the accomodative interest rate policy and rising consumer demand, not to mention external contribution. A slow down in exports would reduce the external contribution, but the domestic side is still solid.
The reality is that higher interest rates should not have that much of an impact on Asia as it did in 1994. Nominal short term rates are still at historical lows. In fact, China is actually further ahead of the Fed in the tightening cycle.
As far as higher oil prices are concerned, Korea, the Philippines and Thailand are the most affected, and Indonesia and Malaysia are the least affected.
Asia needs global growth to perform. China is not yet the cornerstone of Asia's economies, however, it is true that China has become increasingly important as an incremental growth driver for Asia. Certain countries, such as Taiwan and South Korea, have benefited tremendously from Chinese demand over the last two years. Demand from China amounts to 20% of Asia's export growth, while demand from Europe accounts for 22.7% and 12.6% from Japan.
It is important to note that 40-45% of China's imports are used for export production, and thus Asia is more dependent on US and European demand than China's. Having said that, US and European leading indicators show growth at its peak, hence we are more exposed to domestic-oriented sectors in Asia. Domestic demand, comprised of consumption and capex, still makes up 96% of Asia's total output. Exports are the swing factor.
Parallels to 1994 seem overblown, regarding China. China has taken steps to reduce the torrid pace of its GDP and trade deficit growth at a much earlier stage than in 1994, where inflation was at 30%.
The economy is much more market oriented and the role of the private sector and foreign firms is much greater. In this sense, a hard landing can be avoided. The authorities have a strong grasp of the challenges facing the country and are resolute in formulating policies to prevent severe overheating in certain sectors of the economy.
Slowing China growth will be very difficult, such is the country's state of development, but investment will definitely bear the bulk of any slowdown. Hence we are not exposed to this sector in China. If China does have a hard landing, Asia would feel it most in a reduction of China's imports. Merrill Lynch have quantified this as a reduction in import growth of 8% from their baseline scenario, which is far from catastrophic.
From April, we have adopted a more defensive policy for our portfolios, allowing cash levels to increase. We are actively looking for catalysts and other opportunities presented by the recent extreme market declines.
We would argue and recommend that any excessive market weakness represent an opportunity for investors to either increase or initiate new positions in the Asian region.
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