Emerging Asian markets rose higher but underperformed world indexes as developed countries continued to produce upbeat economic data. Asian technology stocks weighed on regional indexes as strong year to date performance and elevated valuations galvaniszed profit taking in select names. Oil prices rose on the back of geopolitical uncertainty in the Middle East and expectations of production cuts next year by both OPEC and non-members. MSCI Asia Ex-Japan closed 0.58% higher for the month of November.
MSCI China inched 1.7% higher. Beijing continued to monitor economic debt levels following comments by PBOC Governor Zhou. With the political onus on deleveraging and pushing reforms, China’s financial regulators published drafts rulings to standardisze industry practices that would curb systemic risks taking. China’s PPI rose 6.9% in October, higher than market expectations as authorities began to scale back production in polluting industries signallingand signal a shift from a growth at all costs model.
MSCI India slid 1.2% lower following a strong October performance. India’s economy expanded 6.3% for the quarter ended 30 September from a year earlier, reversing five quarters of declining growth. The economic reading has been buoyed by a pickup in manufacturing activity, which rose 7% over the quarter from 1.2% during the June quarter. Following the capital injection of PSU (Public Sector Undertaking) banks, Moody’s Investors Service raised India’s sovereign rating for the first time since 2004. The upgrade could prove to be a big win for the ruling party, which is facing increasing criticism on the economic policy impact before key elections in Modi’s home state December and a national vote in early 2019.
North Asian markets underperformed regional bourses due to heavier exposure to Asian technology stocks. MSCI Korea dropped 2.9% while MSCI Taiwan fell 3.8%. The Bank of Korea raiseds its benchmark interest rate for the first time since 2011, lifting the borrowing costs 1.25% to 1.5%. South Korea’s GDP rose 3.6% in the previous quarter, buoyed boosted by global demand for microchips, steel, and petrochemical products, suggesting that the economy is cyclically strong enough to absorb higher rates. Taiwan’s 3Q17 GDP rose 3.1% from a year earlier, prompting the government to raise its 2017 estimates from 2.11% from to 2.58%.
MSCI Singapore outperformed regional and AESAN markets, gaining 2.6% over the month after financial stocks reported upbeat loans growth. A preliminary readingy for Singapore’s economy showed an expandsioned of 5.2% during the 3Q17, driven by a pickup in global orders. MSCI Thailand inched 0.1% higher as the government looks to boost domestic consumption following the year-long mourning period. MSCI Philippines dropped 2.3% as the Senate approved the final reading of its Tax Reform for Acceleration and Inclusion initiative. MSCI Indonesia dropped 0.7% while MSCI Malaysia lost 1.8%.
Emerging markets are beginning to encounter headwinds. Following positive year to date returns the temptation to take profits surfaces as political concerns take heed hold particularly in the Middle East, South America and Southern Africa. Within the emerging market asset class, Asian equities remain attractive, supported by pro-growth policies and robust economic dynamics resulting from rising domestic and global trade demand. Within Asia, the region’s two largest economies, China and India, give an anchor ourto optimism.
China and India are uniquely positioned. An early year standoff in the Himalayan mountains and rising Chinese investments into Pakistan have annoyed New Delhi, while India’s support for the US’s Indo-Pacific initiative have has aggravated Beijing. Both countries also share striking similarities, including elevated domestic political capital for Chinese President Xi and Indian Prime Minister Modi.
Such approval may suggest that the investor community holds a tolerance level of about 12 to 18 months for new initiatives to flow into the economy. In early 2016, markets were concerned that elevated debt levels would squeeze liquidity and generate an economic hard landing in China, forcing Beijing to deploy nearly $1trn USD of its foreign exchange reserves to stem capital outflows. When Beijing commenced its 19th Party Congress in late 2017, many of these concerns faded as macro readings and equities rebounded following policy implementation over this period.
In November 2016, PM Modi’s demonetiszation announcement was a major surprise, using the exercise as a political programme under the aegis of weeding out corruption. The programme received heavy criticism from opposition members, since almost the entire supply of paper money (approximately 86% of currency circulated) was deposited into banks. However, Tthe programaction taken resulted in only minimal fraudulent exposure of fraud and instead instigated major disruptions in business activity.
The goods and services tax (GST) followed six months later. Similarly to demonetizsation, poor follow through and uneven implementation produced additional havoc for a still febrile economy. The combination of a liquidity crunch and inventory destocking weighed on investments, evident by the 5.7% GDP growth during the quarter ended 31 March 2017, the slowest rate under the administration. Modi’s reforms were depicted as having wanton disregard for political opponents, pushing an his agenda at the expense of the poor.
Despite the disruption, Modi’s approval ratings remained high, as supporters displayed a willingness to countenance the inconvenience. Changing consumption behaviours also emerged, with deposit inflows increasingly used to invest indemanding mutual and insurance funds overin preference to traditional assets such as gold and real estate. Along with a newly updated bankruptcy law and the ongoing push for identification registration through Aadhaar cards, the efforts to formalisze the economy and reduce disbursement cash leakages were gaining pace.
This set the stage for the most recent events: the PSU (Public Sector Undertaking) capital injection and the sovereign upgrade by Moody’s. When New Delhi’s announced plans to infusepump Rs2.1trn ($32bn) into state owned banks it came as a surprise in both in terms of timing and amount. The objective was, which aims to ignite India’s lethargic investment cycle and . Tthis would later feed into Moody’s decision to upgrade India’s credit rating, coming slightlyjust after the one year anniversary of demonetiszation.
So what has changed and why does this matter? The capital injection into public state banks increases the availability of credit to lend which previously had been sidelined, while the sovereign upgrade lowers the cost of funding for financial institutions. More importantly, the new bankruptcy law favours the creditor over the debtor, addressing the structural historical issue which had previously benefitedfavored the borrower. The effects are both Iimmediate and positive benefits occur as distressed assets are used better utilized, while capital expenditure projects have scope to allow forinvolve longer integrations periods before producing economic returns.
These measures should portend wellcombine to create a positive backdrop for investors as investment interests are become aligned with politicians looking to drive growth and win reelection seatsfuture elections. While momentum is positive, the investment landscape is not without its faults. PSU banks reflect Modi’s political will, while tighter credit standards and lingering bureaucratic red tape keeps loan demand hesitant. Defaulting borrowers are also not completely banned from bidding for distressed assets in bankruptcy liquidation, creating a moral hazard dilemma.
Addressing the aforementionedsuch legacy issues would be supportive for medium- term growth prospects, carrying political capital for Modi’s administration to address other legacylong-standing burdens such as agriculture and land reform which would benefit the longer term outlook. While Chinese markets rose as the robust economic environment became conducive for earnings this year, questions still linger over liberaliszation reforms that address state owned enterprises and market access to foreigners. New Delhi has already proposed guidelines to tighten the bidding process and ring-fenceing investments to qualified investors, which would justify valuation premiums. Investors have already given China's equity markets the benefit of the doubt in 2017, and may wellperhaps may reward India similarly in 2018.
Central bank outlooks will be a key focus for markets going into the final month of the year. In particular, investors will closely monitor the Federal Reserve’s forecasts for 2018 as it incorporates the impact of new tax reforms. For emerging markets, particularly Asian equities, confidence remains elevated as the appreciation against the USD reflects fading anxiety across the region due to stability in commodity prices and the pickup in economic growth.
Fund Manager - Asia