Policymakers are all too aware of the linkages that bind modern economies.
Asia has had a rough year. Growth is sluggish. Disinflation – a slowing in the pace of price rises – is a symptom of weaker domestic demand, overcapacity and lower commodity prices. Shares and currencies have been battered.
The short term outlook is unclear. Much would seem to depend on what happens in Washington and Beijing. Usually the decisions of central bankers are driven by domestic considerations. Now policymakers are all too aware of the linkages that bind modern economies together.
The region’s weaknesses are particularly bad news given the fragility of developed markets. The effects of earlier stimulus measures have worn off in Japan, while a Eurozone struggling with its worst refugee crisis since World War Two seems to have its cohesion tested on a regular basis.
The Federal Reserve is clearly concerned about China. Despite signs of recovery at home, the potential impact of the second largest economy on global growth was a key factor in delaying the decision to raise US interest rates in September.
In Beijing, regulators must sustain belief in the idea of a controlled economic slowdown. If they fail – either in managing China’s shift into a lower gear or people’s perceptions of that process – things could turn ugly, with nasty implications for the rest of the region.
For the record, we would prefer a Fed hike as soon as possible because central bank stimulus is the single biggest distorting factor in the financial markets today. The uncertainty created by the prolonged ‘will they, won’t they’ drama has caused unnecessary turbulence in Asia and is a hindrance to the region’s sustainable recovery.
The latest news from China hasn’t been great, but some context is needed. An obsession with industrial data obscures the fact that China is now an economy in which the service sector accounts for a bigger part of GDP than manufacturing. Even now, non-manufacturing Purchasing Managers Index numbers show expansion as China slowly restructures towards domestic consumption.
We believe the economy is growing around 5 to 6%, which is less than the official government number, but a pace that still puts rivals in the developed world to shame. We also think Chinese policymakers have not hit the panic button, as has often been suggested, because the weaker renminbi since mid- August represents another step in currency liberalisation, not a currency devaluation to make exports more competitive.
What does this mean for Asia? It’s a mixed bag: if the Fed were to remove one source of uncertainty by raising interest rates before the end of 2015, more capital is likely to flow away from the region before investors regain their senses when they realise that subsequent increases will only be incremental and infrequent.
China’s slowdown will remain a concern for the foreseeable future. That’s a problem for those Asian economies – such as commodities exporters Malaysia and Indonesia – that rely on Chinese demand; there will be fewer Chinese tourists venturing overseas; outbound investment from China will be affected; and Chinese domestic consumption will moderate.
However, the impact on the region would be more serious if not for the fact that Asian economies are generally in much better health than even a couple of years ago. Most of the major ones are running current account surpluses and hold decent levels of foreign currency in reserve. Those economies that looked particularly shaky during the taper tantrum of 2013 took steps to patch up those vulnerabilities. Asia is simply in better shape to ride out the turbulence.
Even China, where local government debt and unproductive state-owned enterprises have set off alarm bells, has the financial firepower to avert a ‘hard landing’. This country, which boasts some $3.5 trillion in foreign exchange reserves, may be slowing, but it is nowhere near crashing.
After a rough year, Asia looks cheap compared to Europe and the US. There may even be room for a rebound in Asian stocks next year given our sense that most of the so-called ‘hot money’ has already exited these markets and share prices, in most cases, have overshot where they should be trading.
Our contrarian instincts tell us there will be many more investment opportunities, especially amid the turbulence that is likely to persist for some time. Some of our more experienced fund managers will know that after every ‘crisis’ in this region, a long period of growth followed. Asia’s promise has not diminished.