Asia will outlast the emerging market bears, regardless of the short-term flux
Aidan Yao says while the sell-off that has hit emerging markets as an asset class does carry the risk of contagion, Asia’s solid fundamentals will ensure it weathers the storm
Despite the solid growth backdrop, a perfect storm has swept across emerging markets over the past few weeks.
While some markets, such as Argentina and Turkey, have fared worse than others due to idiosyncratic factors, the entire asset class has performed poorly against the backdrop of rising US interest rates and the dollar, and escalating political concerns in Europe triggering a flight to safety in global capital flows.
Some investors are worried about a repeat of the 2013 “taper tantrum”, which could spell further trouble for emerging market assets, particularly those belonging to countries that run current account deficits, rely on external financing, and face domestic (political or social) instabilities.
Asia is better positioned to weather external shocks than other emerging markets. Not only are domestic macro conditions still robust, with some economies (Thailand, Singapore and South Korea, for example) even growing faster in the first quarter of the year than the preceding quarter, most countries have shored up their external defence matrices – in, for example, foreign exchange reserves and current account buffers – since the 2013 debacle.
Furthermore, the region’s exchange rates have become more flexible, baring Hong Kong’s, since the late 1990s crisis, serving as a shock absorber for domestic markets against volatile global capital flows.
And if a crisis comparable to the 1997 or 2008 catastrophe erupts, there are mechanisms, established after the 2008 meltdown, among Asian central banks to tap each other’s liquidity facilities, via emergency swap lines, to avoid a sudden stop of liquidity in markets.
These are strong defence mechanisms that can help Asia prevent an adverse liquidity shock from degenerating into an all-out financial crisis.
However, while a region-wide financial crisis is unlikely, some economies are likely to suffer more than others if global monetary conditions continue to tighten and oil prices escalate further. Analysis of the external vulnerability of Asian economies – based on their current account positions, the level of external debt, the scale of central bank reserves, and the maturity of domestic credit cycle – puts Indonesia, Malaysia and the Philippines on the vulnerable end of the spectrum, while Singapore, Thailand and China are relatively safe. This relative vulnerability ranking seems to corroborate broadly the foreign exchange movements of Asian currencies in recent months.
Another risk facing Asia is rising oil prices. With the exception of Malaysia, most countries in the region are net oil importers. Together, they spent US$334 billion (in net terms) on petroleum and petrol products in 2017, equivalent to 1.8 per cent of GDP. China is by far the largest consumer (at US$161 billion). Hence, if oil prices ratchet up further, and stay up, some economies will feel the pinch on their current accounts and GDP growth.
Let’s not forget also that higher oil prices will put upward pressure on domestic inflation, potentially forcing some central banks to tighten monetary policy prematurely. Even though such price increases could be blunted by government interventions via fuel subsidies (Indonesia and possibly Malaysia) and price controls (China and possibly India), such measures are not a free lunch, and will have an impact on the countries’ fiscal positions further down the road.
This will affect growth and inflation, for which the central banks have to prepare.
Overall, investors need not panic about the recent market gyrations in Asia. The region, as a whole, is better positioned on fundamental fronts than many other emerging markets, and its ability to safeguard domestic economies and financial systems against external shocks has improved significantly over time.
The factors that are currently plaguing emerging markets, be it the rising US dollar, higher oil prices or political chaos in Italy, are also unlikely to persist for long, to ensure that the global recovery is not derailed. If that is the case, the Asian market should eventually get a chance to redeem itself, once long-term investors are lulled back by its solid fundamentals.
In the near term, some caution is warranted. The fact that many global investors treat all emerging markets as a single asset class, without much differentiation, means that significant contagion can be created when conditions deteriorate in other emerging markets. The synchronised sell-off across emerging markets recently is partly a manifestation of that behaviour.
It is therefore reasonable for Asian investors to seek protection in the near term, and wait for a better entrance point to rebuild long positions when the dust settles.
Aidan Yao is senior emerging Asia economist at AXA Investment Managers