Chinas current account deficit is the latest sign of
how the financial crisis has turned the global economy on its
head. The worlds production house, with its insatiable
thirst for natural resources and cars, racked up a $7 billion
trade deficit in March while US consumers continued to
As the rich world buckles under its debt burden, Asia bulls
say China is coming to the rescue by exporting capital
and importing an increasing volume of western-made goods
to pull the global economy out of the gutter.
The March deficit may prove to be a cyclical blip rather
than a broader shift in Chinas growth pattern. But
emerging market enthusiasts have plenty of ammunition to say
Asia is the crown jewel of the financial markets in the new
decade. Asia looks much better than any other region in
the world due to its strong growth and low indebtedness,
says Jean-Charles Sambor, head of Asia research at the TCW
Emerging Market Fixed Income Fund.
According to Bloomberg data, Chinese banks have dethroned US
banks as the most highly valued financial institutions by
market capitalization, claiming four of the top five publicly
listed banks. Meanwhile, PetroChina, ICBC and China Mobile have
joined the ranks of the five biggest global companies, in a
growing sign that western corporate dominance is increasingly
And across the region, equity and debt markets have
outperformed the developed world thanks to Asias quick
economic rebound, capital inflows, domestic stimulus policies,
and resilient corporate earnings.
According to the Institute for International Finance (IIF),
emerging Asia is the unambiguous leader of the global business
cycle and will continue to dominate the bulk of private capital
inflows in the coming years. It calculates that net private
flows to Asia rose from $171 billion in 2008 to $191 billion in
2009, and will surge further to $273 billion in 2010.
A LUV RECOVERY?
A pick-up in investment, inventory restocking, fiscal
stimulus and growing domestic demand are fuelling regional
growth. As a result, many investors have embraced the LUV
ideogram, coined by Martin Sorrell, chairman of the
communications giant WPP group, to describe an L-shaped
economic recovery for western Europe, a U-shaped one for North
America and a V-shaped recovery for the Brics (Brazil, Russia,
India and China) and other fast-growing Asia economies.
This latter pool includes Indonesia, Philippines, South
Korea and Vietnam. Even bearish consultancy Roubini Global
Economics forecasts Asia will grow 6.3% in 2010 after 3.3% in
2009 and the 6% average during 2003 and 2008. Meanwhile,
Deutsche Bank predicts emerging Asian growth to top 8% this
year, double the growth rate expected in Latin America and the
But the boom years are rarely smooth, and the rush of global
liquidity, thanks to record low G7 interest rates, has sparked
a liquidity-led rally that threatens to stretch stock and bond
prices in Asia. Equity and bond markets have surged since March
2009, with asset prices back to levels before the mid-September
2008 collapse of Lehman Brothers.
The MSCI Asia Pacific Index has climbed over 10% from its
2010 low on February 8, as confidence in the regions
growth prospects takes hold. Investors are paying more for
Asian stocks than US-listed shares amid expectations of higher
corporate earnings that will boost equity returns.
As Emerging Markets was going to press, the MSCI
Asia Pacific was trading at 16.4 times estimated profit,
compared with 15.5 times for the benchmark index for US
equities, the Standard & Poors 500.
Meanwhile, the margin between Asian and US government bonds,
seen as safe-haven assets, has narrowed dramatically over the
past year and stands at pre-crisis levels. The spread on JP
Morgans Emerging Markets Bond Index (EMBI+) is 2.6% over
US Treasuries. This is still higher than its all-time low of
165bp in January 2007 the height of the bubble in global
credit but the spread represents a fraction of the
record peak of 16.64% in September 1998, during the Asian debt
Asian financial markets have progressed from a risk relief
rally, as prospects of a double-dip global recession receded,
to a liquidity rally thanks to interest rate cuts from
G7 central banks to a sustainable, economy-led
rally, says UBS Asia chief economist Jonathan Anderson.
He argues that equity and bond prices reflect resilient
Antoine van Agtmael, chairman of Emerging Markets
Management, which oversees up to $14 billion of equities
globally, says Asian stocks are now fairly valued
as the 16.4 forward price to earnings level is the long-run
average for Asian stocks.
As a result, investors are set for lower returns relative to
double-digit 2009 levels, prolonged global market volatility
that will reduce risk-adjusted returns for emerging market
assets and higher regional inflation.
Domestically, the withdrawal of fiscal stimulus, the
waning inventory cycle and tighter monetary policy will weigh
heavy on Asian markets in the second half of the year,
says Brian Jackson, a Hong Kong-based strategist at Royal Bank
of Canada. If economic recovery in the US and Europe is
derailed, capital outflows and asset price correction will
weaken the balance sheets of governments and companies.
But for now, the consensus view is that the global economic
recovery is taking root and capital inflows will stay strong as
the US Federal Reserve and Bank of Japan are set to hold
historically low rates this year.
In the near term, markets will be volatile as western
sovereign debt jitters, and fears over exit strategies from
stimulus policies take hold. But more generally, the consensus
view is that the global crisis has set off a structural bull
market for Asian assets. If the region manages to revamp its
predominantly export-led growth model and its a
big if by stimulating domestic consumption, bulls argue
the crisis has only enhanced the investment proposition for the
Asias solid fiscal, household and corporate
balance sheets, well-capitalized banks and strong external
liquidity position underpin its strong structural growth story
versus the developed markets, says Johanna Chua,
Citigroups chief Asia economist. As a result, the region
has huge room to gear up and, thus, attract more capital.
Falling sovereign risk premiums and strengthening credit
quality of Asian firms should lower the premium investors
demand for Asian assets relative to the debt-burdened
developed world, says Hung Tran, head of the capital markets
department at the IIF.
EQUITIES THE WINNER
But what will the Asian investment landscape look like in
the next five to 10 years? Equities are the clear winner, says
Anderson at UBS. He says the huge number of Asian firms that
have yet to join the global financial economy will ensure the
supply of equity will outstrip debt in the coming years.
Sambor at TCW says: there is a shortage of investable
debt assets in Asia, both sovereign and corporate, as banking
liquidity offers attractive cost of finance while
regional borrowers tend to be averse to debt. Nevertheless, the
regions debt stock is set to grow as the financial system
deepens and borrowers take on more debt against the
backdrop of high corporate savings to boost returns to
However, Anderson says public and private equity markets are
set to outperform debt markets, as high systemic inflation and
strong growth will boost corporate earnings in nominal
and to a lesser extent, real terms. The real place
to be in Asia is equities as this provides investors with the
best way to gain exposure to regional growth, he
An Asian equity boom could reach dizzying heights if
policy-makers court foreign equity capital. Chua at Citi
predicts China will, in the coming years, relax foreign
restrictions in its domestic equity markets as a stepping stone
to liberalizing its capital account. In addition, Indian
regulators could soon court public listings of foreign
companies, she says.
According to Citi, emerging Asias share of the global
indexed equity market is 7.3% compared with the US, Japan and
the eurozones combined share of 66%. This highlights the
large room for Asian equity growth in tandem with expanding
But the bull market comes at a price. Large-scale capital
inflows have placed appreciating pressures on currencies and
heaped on the risk of asset bubbles.
As a result, Asian policy-makers, across the board, have
adopted soft capital controls over the past two years. Taiwan
has restricted foreign investment into dollar-denominated time
deposits in domestic banks; South Korea has introduced
restrictions on domestic banks forward currency trading;
and India has tightened rules on external borrowings of
companies. Hong Kong, Singapore, India, South Korea and Vietnam
last year tightened real estate regulation to contain the risk
of real estate bubbles. Meanwhile, Malaysia, Thailand, India
and China already have several capital controls, put in place
before the crisis, including restrictions on foreign investment
in domestic debt.
But unless Asia allows greater exchange rate flexibility,
asset bubbles in equity and real estate markets will inevitably
form, even with beefed up regulation and restrictions on
foreign investment, says Hung Tran at the IIF. This is down to
the policy conundrum known as the impossible trinity: the
hypothesis that its impossible to manage exchange rates,
control inflation and allow the free movement of capital at the
Tran says localized asset bubbles are already brewing in
property markets in Hong Kong, Macau, Taiwan, certain markets
in mainland China and the Mumbai commercial property market.
But this is largely due to bullish domestic investors rather
than non-resident holdings, he says, and that public equity and
debt markets across the region are not in bubble territory.
According to Citi, emerging Asia in the next two years will
account for 3538% of global growth compared with the
combined share of 89% for Latin America and emerging
But theres a downside. Asias integration with
the global economy has put the regions domestic policy
mix in the spotlight due to its increasing impact on global
interest rates, currencies and asset prices.
Unless Asian nations, principally China, take measures to
boost domestic consumption, trade wars and tensions with the US
and EU will kick off. Emerging Asia needs to take the
lead and bring about a more rebalanced global economy by
changing policies that favour an export-led economy, says
Investors, seduced by Asias business cycle, would do
well to remember that, in a globalized economy, the ascent of
the East will be anything but a smooth journey.