Since the commencement of summer, markets have turned volatility on mixed economic and political signals across developed and emerging markets. In the US, wage data and participation rates have inched higher as the pickup in private sector payroll begins to display waning labor force slack, supporting a second interest rate hike by the Federal Reserve. In China, first quarter expansion of 6.7% has been overshadowed by a surge in credit growth, questioning Beijing’s commitment to reform. Coupled with political uncertainty, including a possible Brexit scenario, sentiment may return towards long US dollar (USD) trades that beset the market earlier in 2016.
Emerging Asian economies currently find themselves better positioned going into the second half of the year compared to six months earlier when markets crowded into the consensus trade of a stronger USD. First, real interest rates (the difference borrowing costs and inflation) remain positive, particularly in China, India and most of ASEAN. Even as the 2014 base effect has been phased out along with a latent pickup in oil prices in early 2016, inflation levels remain benign in a region that is a net energy importer. Second, improvements in terms of trade are evident as Emerging Asia’s largest economies retain a current account surplus. Asian commodity producers more exposed to global cycle, have seen a reduction in the current account deficit given the contraction in imports.
Real positive interest rates allow central banks to maintain accommodative monetary policy to spur growth. In an economic bloc with a current account surplus, savings exceeds consumption, such that the need to sharply depreciate the currency is not necessary to improve terms of trade. These matter in the current market environment as sentiment questions both the context and vulnerability from a stronger USD. Recognized that global growth remains below trend, it will not, in our view, contract on the back of a stronger USD. The aforementioned of positive real rates and current account surplus protects the value of local assets, evident by the appreciation of Asian currencies. This is most palpable in ASEAN, where the currencies of the block’s larger nations have appreciated between 3% and 9% over the first five months of the year.
Currency appreciation provides breathing room for policy makers but is not a panacea to replace reforms. China’s April foreign exchange reserve data came higher than the March’s reported number due to a revaluation on account of a weaker USD. Though less severe than the early year outflow, reflects the onus that investors continue to wait for visible improvement to promote a liberalized market economy. Recently, these have become more evident in India where a new bankruptcy law was finally passed, while Indonesia and Myanmar aim to consolidate bureaucratic red tape that has discouraged investments. In the recent Philippine elections, former Davao City major Rodrigo Duterte, who campaigned on protectionism rhetoric, has discussed increasing foreign ownership levels to support pro-growth polices, a promise if implement should ensure growth over the medium term.
Anemic growth is not desirable but remains preferable over a recession. If the USD strengthens due to rising expectations of a Federal Reserve hike or political instability in Europe, positive real rates and current account surplus should augment economic armor for Emerging Asian countries, given the availability of liquidity and savings income. This summer, instead of mixed cocktails, markets ideally prefer to stay sober, as a volatility caused by a stronger USD would be something harder to swallow.
Assistant Fund Manager - Asia