Optimism and reality in Asian economies

Before the advent of cheap travel and with the rise of novel writing in the nineteenth century many authors wrote imaginatively about places that they hadn’t visited, and readers of the day gained a perspective of what a place was like – even if it wasn’t correct. Today, there seems to be a similar risk in terms of gauging the global economy and market prospects given that broker circulars, commentaries and buy notes from and of Asian economies suggest that a new boom is underway – yet the data suggest otherwise. Thus, regional exports are very weak particularly in local currency terms; inventories are still high and domestic demand trends surprisingly lacklustre. The latter may seem strange given the combination of low interest rates and high level of capital inflows that these countries have experienced, but we may suspect that the current extremely high level of subsistence costs (such as property prices and service sector charges) that have been caused by the previous capital inflows cycles that were associated with the QE1 & 2 “risk-on” rallies are now acting as a form of consumption ‘tax’ – and therefore depressing spending trends. This is particularly an issue for Singapore and North Asia.

Naturally, as a result of these weak trends, Asian economies are looking for a new external stimulus but OECD trends – particularly in Europe – make this an unlikely prospect. Moreover, with foreign equity investors still being driven into Asian markets by the portfolio  and ongoing quantitative easing forces presently in place, and despite weak current growth, many Asian currencies such as the Korean Won, Philippine Peso and China’s RMB are being bid higher and thereby making the headwinds that these economies face all the stronger.

For Asia’s still essentially mercantilist regimes, this appreciation of their currencies against the background of a still weak global trading environment is thoroughly unwelcome. No surprise then that news reports reveal that some of the Asian region’s central bankers have begun to rail against it. Both Korea and the Philippines have talked of excessive currency strength and threatened to intervene in the foreign exchange markets. At present, this may be no more than sabre rattling but we should be concerned that if demand in the OECD economies has not picked up by the second quarter, and that doesn’t look hugely likely in the light of the most recent US retail numbers, and Asia is therefore still beset by weak exports, high inventories and soft production trends, then we may see Asian authorities attempting to engineer weaker currencies.

We may also suspect that by this point of the year China will be beginning to experience a new round of balance of payments deficits as its declining current account surpluses, resulting from weak exports but stronger imports, prove insufficient to offset the trend towards greater net capital outflows. Consequently, by the second half of this year, we could be seeing weaker currencies across Asia and heavier export price discounting.

The immediate consequence would be cheaper goods for Western consumers but more importantly, with traded goods prices such as those from Asia accounting for about a third of OECD CPIs, any renewed export price deflation in Asia could lead to lower than expected inflation or even a deflation scare in the West, and also to weaker margins and even weaker investment intentions in the Western traded goods sectors. This combination would threaten OECD economic recovery and test market optimism on economic and corporate earnings growth. Indeed, renewed threat of Asian trade price deflation could even provide fundamental support for bond prices and the current low level of yields.

If there is a deflation scare later this year, the policy response will be to question austerity, and focus on debt monetization and financial repression, following the lead now taken by Mr Abe in Japan. This risk highlights that the future investment climate is not straightforward, even before we take on board the significant uncertainties associated with US debt ceilings negotiations, Euroland debt de-leveraging and China’s growth. Accordingly investors should continue to be wary, with equity risk-takers prudently focused on quality and reliable growth.

James Bevan is chief investment officer of CCLA, specialist fund manager for charities and the public sector. CCLA launched The Public Sector Deposit Fund in 2011 to meet the needs of local authorities and other public sector organisations. You can follow James on twitter @jamesbevan_ccla