Are economic indicators suggesting that Asia can weather the world's deflationary forces?
Robert Horrocks, PhD
Chief Investment Officer, Matthews Asia
I think it is fair to say that sentiment toward China, and by extension, Asia, is quite polarized. Whereas some investors I have met recently see opportunity in the weakness of the second half of 2015, doubts over the reality of recent growth rates and anxiety over a slower headline rate of growth has caused many others to be quite fearful of China as a deflationary force in the world economy. It is not hard to see why: the prospect of further tightening by U.S. monetary policy-this time in the form of rising rates; slowing nominal growth; low margins and disappointing earnings growth; a strong dollar and weak local currencies; increasing credit spreads; and poor momentum in the equity markets. And all of this is happening at a time when valuations, whilst not expensive, cannot be regarded as cheap in absolute terms.
Now, let me just suggest that we have some data that should allow us to be more confident over Asia's ability to weather the world's deflationary forces. First, current accounts in Asia are generally positive. That means Asia's countries are saving more domestically than they invest domestically. And so, they are relatively less reliant on foreign capital. There are some exceptions-India and Indonesia. But even here, reliance on U.S.-dollar capital markets has reduced dramatically over recent years. Second, inflation rates are low across much of the region (again Indonesia and India are exceptions, even though they have been successful at moderate price rises). These low inflation rates mean that Asia's policymakers have a lot of room to offset deflationary impulses by either monetary policy or even government spending or tax cuts. A return to a more inflationary environment would relieve some pressure on margins, earnings and valuations.
The question is: are we seeing any signs of such a response? I think we are. First, there are the natural responses of markets: prices adjust. Most obviously, in the face of deflationary U.S. pressures, Asia's currencies have taken the strain. Then, we have the active response of policymakers. In India, we have seen the central bank successfully squeeze down core inflation rates without too severe an impact on industrial profits (perhaps helped by lower commodity prices).In China, we are seeing authorities raise the growth rate of narrow money, continue to press with financial system reforms, and support the property market. Japan is continuing its policy of reflation and structural reform initiatives. So, in the face of a deflationary U.S. policy, the three Asia giants seem to be leaning in the other direction. The degree of offset is perhaps still small. But talking to clients and investors around the region leaves me to believe that there is no great liquidity crisis. Indeed, if the acutely bearish reaction to the Chinese currency re-pegging in the middle of 2015 taught us anything it is that, in the wake of a fall in equity prices, value was quick to emerge and buyers were quick to enter the markets.
In this context, Asia's long-term growth prospects still look good. High savings rates, large manufacturing bases, reformist governments pursuing financial, legal, and corporate reforms mean that Asia should continue to invest and potentially grow at higher rates than the rest of the world. Over time, this investment will continue to raise real wages across the region.
Although the headwinds are currently considerable, Asia's businesses seem to be weathering the storm, and so long as we keep our eye on the long term, the investment environment should offer up some good opportunities.
To learn more about where we see investment opportunities in Asia, read the extended version of our 2016 investment outlook.
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The views and information discussed in this article are as of the date of publication, are subject to change and may not reflect the writers' current views. The views expressed represent an assessment of market conditions at a specific point in time, are opinions only and should not be relied upon as investment advice regarding a particular investment or markets in general. Such information does not constitute a recommendation to buy or sell specific securities or investment vehicles. Investing in international and emerging markets may involve additional risks, such as social and political instability, market illiquidity, exchange-rate fluctuations, a high level of volatility and limited regulation. The subject matter contained herein has been derived from several sources believed to be reliable and accurate at the time of compilation, but no representation or warranty (express or implied) is made as to the accuracy or completeness of any of this information. Matthews International Capital Management, LLC ("Matthews Asia") does not accept any liability for losses either direct or consequential caused by the use of this information.