For the European Central Bank (ECB) and the Bank of Japan (BOJ), the initial response to the negative interest rate experiment has not worked out as planned. The idea of pulling borrowing costs below zero goes against rational economic theory. Besides deterring the idea that future value of money should be greater than net preserve value, these policies hurt banks as costs are unlikely passed to depositors, lowering the profitability of providing loans.
The aforementioned has weighed on markets for most of 2016. Market pressure steams from ebbing confidence that central banks in developed markets have means to offset deflationary pressure. However, a gap exists between central bank capabilities and market expectations, in our opinion. Central banks are lenders of last resort, instituting policies that alone do not resuscitate the economy but instead provide parameters conducive for growth. Besides quantifying credibility of central banks, investors should also include two additional considerations: economic dynamics and potential benefits from a subsequent year of low energy prices. These three qualities are present across most of Emerging Asia.
Across Southeast Asia, central banks continue to apply both independent and prudent approaches to ensure economic stability. The Reserve Bank of India’s Raghuram Rajan looks to rebuild foreign reserves in order to maintain manageable inflation levels. Bank Indonesia cut interest rates twice year to date to spur growth. Bangko Sentral ng Pilipinas (Philippines) incumbent governor Amando Tetango has been instrumental to control physical asset prices while Bank Negara Malaysia’s governor Zeti Akhtar Aziz is credited for ensuring the bank’s autonomy going forward.
Supported by sensible central banks, the outlook for Asian economic growth remains encouraging. Although expanding below previous years, the regional economy continues to demonstrate resilience due to domestic demand. In 2015, India and the Philippines expanded 7.1% and 5.7% respectively, which were key beneficiaries of falling oil prices. Indonesia expanded 4.7% on the back of an improving current account deficit. Malaysia, a net commodity producer, expanded 4.9% as private consumption offset the fall in energy prices.
Middle class households throughout Emerging Asia benefit on subdued oil prices given the region is a net importer of energy. Continue softness in global oil should allow central banks in the region more maneuvering to support the economy. Real and positive interest rate moves are more effective to stimulate demand, and thus investors should continue to prefer markets where central banks operate in a supportive economic environment. It should be no surprised that amid the early year correction as a result overreaching policies put forward by developed central banks, ASEAN equities have been outperformers. Supported by strengthening currencies against the USD, investors are rotating into Southeast Asia, as rising intraregional trade and relatively lower exposure to the global trade cycle becomes more valuable amid volatility.
Christopher Chu, Assistant Fund Manager - Asia