11 Oct 2022
Previous periods of US monetary policy tightening have seen Asian and Emerging Market currencies and equities underperform developed markets. Investors will remember back to the Fed taper tantrum in 2013, but emerging market central banks had already responded to heightened inflationary pressures ahead of their developed market counterparts with rates rising in many countries in 2021. As a result, while currencies in the region have lost ground against the US$, they have recorded gains against Sterling, Euro, and the Yen. Asia has not seen the same level of inflationary pressure as Europe or the United States and inflation in China is only around the 2.5% level. India, which at times has been prone to high levels of inflation, has a headline CPI of around 7.0% which is not that far above the RBI’s 2-6% target range. There are expectations in India that core inflation is near a peak and food inflation and energy inflation are both expected to fall over the coming months.
China is the dominant economy in the Asian region and PMI surveys suggest it continued to lose momentum in September with the global downturn weighing on exports and Covid-19 lockdowns and disruptions hitting service sector activity. Ahead of the October Party Congress, national travel restrictions within China have been tightened with families discouraged from the usual levels of activity seen around the mid-autumn festival or the 1st October (China National Day) holiday period. While the service sector contraction is likely to reverse due to the number of cities dealing with virus outbreaks dropping, clearly the global economic slowdown will weigh on exports. Looking at construction output, there are some tentative signs of increased levels of infrastructure spending. Clarity on China’s economic policies is unlikely to emerge until at least after the October Party Congress when Xi is expected to be confirmed for a third term as leader of the country and a new PBSC will be unveiled. Even then, full clarity on the path forward for the economy in China may be illusive until the Economic Congress in March.
A brighter spot within the region, certainly over the longer-term, is India where the reforms put in place by the Modi government are now starting to bear fruit. India has not had a domestic credit or investment cycle for many years but looks to be at the start of an economic upswing with the country benefitting from strong FDI flows. India is a country with considerable scope for catchup over the next decade with the government’s objective to build out its manufacturing base to sit alongside the strongly growing IT services and pharmaceutical sectors.
The strong Dollar environment has seen Asian debt emerge relatively unscathed but certain emerging market countries have large Dollar debts such as parts of Latin America, Turkey, and some frontier markets. Countries with large debt to GDP ratios will suffer from higher debt servicing costs. Fortunately for investors, many of the most vulnerable countries have low exposure in emerging market equity indices and funds - the most vulnerable countries are frontier markets Sri Lanka and Ghana, together with Argentina and Turkey. Larger current account deficit countries such as Columbia, Chile, and in Central Europe, Romania and Hungary could be vulnerable but once again these are unlikely to be significant parts of investor portfolios. Capital flows into emerging markets have dropped sharply in recent weeks.
The global energy price shock is having more impact on central and eastern Europe than Asia which should not be surprising considering that within the developed world, Europe has been most vulnerable to higher gas prices. Some emerging market countries are beneficiaries of higher gas prices, notably Qatar and Egypt, together with Indonesia and Malaysia. For many Asian countries, including India, gas consumption is limited as is the case in Africa.
While the economic outlook globally is clearly challenging, for investors prepared to look further ahead, some countries look well placed to deliver longer-term relatively strong growth and have not got the same level of heightened inflationary pressures as we’re seeing in the Western world. Wage pressures in the emerging world have been far less strong than in developed markets, primarily because most countries still have an abundance of labour and the move from an agrarian society to one driven by manufacturing/service industries is ongoing. Vietnam, for example, recorded another quarter of strong growth and despite higher interest rates, the economy has benefitted from strong export demand. Vietnam continues to benefit from Western businesses looking for an alternative supplier to China with economic growth still close to the 7% level. Resource rich Indonesia has a domestic market of 276m and the economy has surprised many over the past 12 months. As discussed, India is likely to remain one of the world’s fastest growing emerging markets over the next decade and the country has a vast domestic market.
In conclusion, while Asia has stronger economic fundamentals than many developed markets, the region cannot defy global market trends. However, for investors with a longer-term perspective, Asia and emerging markets, certainly at the stock level, can offer investors reasonable upside potential and market valuations have never been as stretched as those in the developed world. Furthermore, the region is not suffering from the tensions of the withdrawal of ultra-loose monetary policy/QE and has less stagflationary pressures than Western economies. The relative growth rate of Asia in particular, but also certain other emerging market countries, looks set to improve over the West when compared to the last five years, suggesting that the region warrants a strategic overweight position in investor portfolios.
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