This time, Asia’s emerging economies will survive the sell-off storm
Nicholas Spiro says the sharp rise in US dollar and Treasury yields has led investors to pull money from the region, but emerging Asia’s economic fundamentals are stronger than in the 1990s, and capable of surviving the rout
Investor sentiment towards developing economies is pretty bleak these days. But if there is one thing most investment strategists have been quick to point out since the sell-off intensified last month, it is that the economic fundamentals of the asset class have improved significantly since the crises of the 1990s. This is most apparent in the region which dominates the emerging market equity landscape.
Asia is not just the fastest-growing part of the developing world, it also enjoys, along with several economies in the Middle East, the strongest credit ratings in emerging markets, with China, South Korea, Malaysia and Singapore carrying ratings of single-A or higher from the three main rating agencies.
Just as importantly, Asia now accounts for two-thirds of the MSCI Emerging Markets Index, the leading gauge of stocks in developing economies, with China, South Korea and India alone making up more than 50 per cent of the index. Asian technology stocks, moreover, account for more than a quarter of the market capitalisation of the index, helping the region differentiate itself from the global commodity cycle, which remains a key driver of sentiment towards many large developing nations.
So, if Asia is supposed to be more resilient, why are international investors pulling money from the region?
According to Bloomberg, capital flows to Malaysia’s stock market turned negative last week for the first time this year after foreign investors sold nearly US$950 million worth of equities in 11 straight days. A report from JPMorgan on flows to emerging Asia’s local currency government debt markets published last week showed that foreign investors withdrew US$1.2 billion from Malaysia’s debt market last month.
Other countries in the region have also been caught up in the sell-off.
Indonesia’s currency, the rupiah, has fallen 7 per cent versus the dollar since the end of January to its weakest level since October 2015, contributing to the nearly US$2.5 billion of outflows from the country’s domestic debt market since the start of April, according to data from JPMorgan. The rupiah’s sharp slide even forced Indonesia’s central bank to raise interest rates last week for the first time in four years.
Meanwhile, India’s domestic bond market continues to suffer heavy outflows stemming mainly from the nearly 8 per cent fall in the value of the rupee, India’s currency, against the dollar since late January, while the Hong Kong Monetary Authority, the city’s de facto central bank, has been forced to intervene aggressively to prop up the local currency.
Watch: Why Hong Kong pegs its currency to the US dollar
The question is whether these strains on emerging Asia assets are simply collateral damage from the sharp rise in the US dollar and Treasury yields or are instead a reflection of country-specific risks that have become more pronounced as financial conditions have tightened over the past month.
In the case of Malaysia and Indonesia, the development of local bond markets has attracted hefty inflows of foreign capital, which have become a source of vulnerability after Treasury yields shot up. According to data from JPMorgan, foreigners now own 38 per cent of Indonesia’s domestic debt market, compared with nearly 28 per cent in Malaysia – among the highest shares in emerging markets. Foreign buyers are more price-sensitive and thus more likely to reduce their exposure during periods of turmoil.
Yet foreign ownership of emerging market local bonds is just one – and by no means the most important – gauge of vulnerability in developing economies. A far more important source of risk is the level of external debt held by companies, banks and governments and, crucially, whether countries’ foreign exchange reserves are sufficiently large to cover their external liabilities.
On this score, Turkey sticks out like a sore thumb.
Not only is the proportion of the country’s sovereign and corporate debt denominated in foreign currency (mainly US dollars) the second-highest in emerging markets after Argentina, according to the Institute of International Finance, Turkey’s foreign reserve “adequacy” ratio is dangerously low. This is one of the reasons Turkey’s currency, the lira, is still down 8 per cent versus the dollar in the last fortnight despite an aggressive hike in interest rates on Wednesday.
By contrast, the external positions of economies in emerging Asia are significantly more robust, mainly because of much stronger foreign reserves (China’s war chest of just over US$3 trillion is by far the world’s largest) but also because of current account surpluses in many countries across the region, including Malaysia.
These stronger fundamentals cannot inoculate emerging Asia against the effects of a further rise in the dollar and Treasury yields. However, they make it much more likely that the region will be able to weather the sell-off relatively well.
Nicholas Spiro is a partner at Lauressa Advisory