U.S. revival to hit flow of capital in Asia

Developed markets are likely to draw money away from Asia this year, as the US, Europe and Japan prove more attractive to investors

PUBLISHED : Monday, 13 January, 2014, 10:34am
UPDATED : Tuesday, 14 January, 2014, 5:03pm

Strengthening recovery in developed markets is set to draw capital away from Asia, raising financing costs for companies as the gap between economic growth rates narrows and investors begin to reassess their risk-and-return benchmarks.

"The gap between Asian growth and G3 [US, Europe and Japan] growth is declining, so investing in Asia is no longer a no-brainer. It actually is something that requires a lot of brains to decide which country is actually attractive," said Darius Kowalczyk, senior economist at Credit Agricole.

As US growth returns, the global economy needs to maintain its momentum while dealing with liquidity withdrawals under the US Federal Reserve's tapering efforts, which will result in funds flowing from Asia to America.

A strengthening European economy is also expected to attract new capital inflows drawing attention away from Asia. US and European equities are "the place to invest this year", said Kenneth Ho, head of investment solution at Julius Baer.

Tapering refers to the Fed's recent decision to begin reversing its financial-crisis-induced US bond-buying programme. The decision to trim bond purchases came on the back of improving US economic indices.

Understanding the repercussions of tapering, especially if mishandled, will drive markets over the coming year and beyond. A second factor will be US interest rates. The Fed has hinted it will not be raising rates anytime soon, though analysts at Julius Baer believe the nomination of Stanley Fischer as the Fed's vice-chairman presages a more aggressive stance given his track record as head of Israel's central bank. From 2005 to 2013 he adjusted the base rate 50 times.

"The wall of money that the Fed has put into emerging markets because of quantitative easing is receding … and one of the key elements to our outlook this year and overriding a lot of the views we have … is this receding wall of capital," said Mitul Kotecha, head of global market research Asia at Credit Agricole.

US unemployment fell to a five-year low of 7 per cent in November, and the Fed predicts it will drop to 6.3 per cent by the end of this year. Analysts at Credit Agricole predict inflation in the US will move above 2 per cent and interest rates will start rising gradually later this year.

Deutsche Bank forecasts US gross domestic product growth of 3 per cent this year. Developed economies' consumer spending is also picking up, which will help power Asian exporters while other sectors sag, said Taimur Baig, the bank's chief economist, Asia.

"The pull from exports is coming at an opportune moment. The reason is the rest of the [Asian] economy is not particularly strong at this juncture … we are seeing a fairly lacklustre dynamic over the past year or so," Baig said.

"Households in many parts of Asia … have significantly high leverage, and as a result of this leverage there are risks to consumption going into 2014, because rate normalisation is going to be a big theme for this year."

Asia's GDP growth rate is forecast by Fitch Ratings at 6.5 per cent, the strongest of any region but the slowest pace since the Asian crisis in 1998. If regional giants China and India are excluded, the credit rating agency projects growth in Asia to be just 5.1 per cent.

Analysts expect China's GDP growth this year to be in the 7-8 per cent range, with concerns over bank and local-government debt outweighed by potential economy-boosting measures like reforms to the financial sector, cutting private-sector red tape, and mass-market housing construction.

Andy Rothman of CLSA wrote in a recent report that 8 per cent of local government debt, equivalent to US$235 billion, is at risk of default, "but this is not a significant systemic risk".

With slowing growth in Asia and tapering from the US, one area to watch will be the bond markets. As global capital is drawn to the US by rising treasury yields and a strengthening US dollar, Asian economies will need to rely more on domestic and regional investors to support local debt financing.

Last summer, fears of imminent tapering prompted a sell-off in equities and bonds and drops in regional currencies as foreign investors retreated.