Minutes published by the Federal Reserve suggested that the US central bank is likely to raise interest rates during its June meeting. Oil prices closed the month lower, with Brent down 2.8% in May but above the critical $50 per barrel level as OPEC members and non-members agreed to extend production cuts. Asian equities outperformed world indices, as the MSCI Asia Ex-Japan index rallied 4.1% during the month.
The MSCI China advanced 5.3%, with offshore markets outperforming onshore bourses. Beijing hosted its One Belt One Road (OBOR) Conference as President Xi urged major multilateral institutions to join the China-led initiative. Moody’ Investor Service cut its rating on China’s debt for the first time since 1989, reducing the rating to A1 from Aa3 given concerns over its debt burden, while also changing its outlook to stable from negative.
The MSCI India returned 2.0%. Economic growth expanded 7.1% from a year ago during the 12-month period ending March 2017. Prime Minister Modi took key steps to allow the Reserve Bank of India to intervene in specific default and insolvency cases. The move to address the non-performing loans legacy in India’s banking sector comes as the country prepares to implement its goods and service tax, removing intra-state barriers.
North Asian markets rose as trade related data remains supportive. MSCI Korea advanced 6.3% following the election of President Moon, based on the expectation the new president will spur economic growth and chaebol reforms. MSCI Taiwan returned 2.1%. Taiwan’s advanced real GDP estimate grew 2.6% YoY in Q1 2016, reflecting upbeat global demand for information and technology goods.
ASEAN markets followed regional equities higher, with the MSCI Southeast Asian index returning 1.8%. S&P upgraded Indonesia's sovereign rating to investment grade, from BB+ to BBB-, citing more credible budgeting that reduces the risk of fiscal shortfalls and efforts to keep the deficit below 2.5% of GDP. The MSCI Indonesia returned 1.6%.
MSCI Philippine gained 2.0% after the House of Representatives approved the third and final reading of the Comprehensive Tax Reform Program, which could translate to 1.0% of 2018 GDP. MSCI Singapore rose 1.82% on better trade data. MSCI Thailand slipped 0.6% lower while MSCI Malaysia dropped 0.53%.
Encouraging domestic economic indicators and trade data momentum supports a favorable outlook for Asian equities. The Federal Reserve is expected to maintain its gradual pace of interest rate normalization given the fading slack in the US labor market. As the calendar moves into mid-year, expectations for President Trump’s pro-growth stimulus fade, suggesting the US central bank policy remains appropriate, ebbing external funding pressure for emerging market assets.
China further promoted its OBOR initiative during its eponymous summit this month. Pledging $124bn to expand trade links to establish a modern Silk Road with Central Asia, Europe and Africa, Beijing underlined the symbolic significance towards a multinational approach to promote economic and security ties. The summit likely increased China’s political clout globally, as the OBOR forum occurred at the same time as President’s Trump first overseas trip which failed to demonstrate common interest with G7 counterparts.
The OBOR forum was overshadowed later when Moody’s downgraded China’s debt rating. The Ministry of Finance argued that the credit agency underestimated the extent of supply side reforms and domestic demand growth. Recent economic data sides with Beijing, including the recovery of the producer price index which demonstrates China has been able to push forward many politically difficult reforms.
We have long argued that China’s debt would likely to increase in line with real GDP, with more credit flowing into small medium and private companies. The regulators are placing greater restrictions off balance sheet items, addressing the funding issue that many enterprises encounter. Overall, systemic risk is relatively low since most of China’s debt is held by the state or quasi-state sectors, with minimal amounts exposed to international investors. With the recovery in economic growth evident and momentum likely peaking, the People’s Bank of China may pursue a less aggressive monetary stance, which bodes well in the medium to long-term horizon.
The Korean Presidential election of The Minjoo Party candidate Moon lifted the Kospi market higher on the hope of market and Chaebol (Korean industrials) driven reforms. The economic outlook has improved as a result of trade data on China imports rising and the fading likelihood of US protectionism. The Bank of Korea left interest rates unchanged at 1.25%, while also endorsing efforts from the new President to contain household debt while increasing fiscal stimulus. Despite the strong year to date performance and bellicose worries with North Korean, Korean equities remain attractive given their relative valuation. Market catalysts include a recovery in CAPEX spending and an increase in dividend yields.
Economic data emanating from Southeast Asia continues to reflect a supportive outlook, as a recovery in commodity prices has fed into a pickup in household and domestic spending. Over the first quarter of 2017, Malaysia economy expanded 5.6% while Thailand’s advanced 3.3%, both ahead of market expectations. Singapore’s economy grew 2.2% on better trade data. India’s economy expanded 6.1% while the Philippines grew 6.4%, both among the region’s fastest but below expectations on account of slower government spending. We expect a recovery later this year as both countries have seen a pickup in government revenues.
Market attention will likely remain on the Federal Reserve’s June meeting. While an interest rate hike is likely, markets will also look for additional details on the potential for the US central bank to begin winding down its balance sheet by the end of the year. Asia’s economic growth dynamics remain intact while fading trade protectionism removes earlier headwinds. Emerging Asian valuations remain attractive given the growth prospects, with the policy environment and liquidity conditions positive for risky assets in the region
Assistant Fund Manager - Asia