Institutional Investor Asean report: Intro

Institutional Investor, September 2011

In a world of US downgrades, European sovereign defaults and Japanese political uncertainty, it’s encouraging to know that there are some parts of the world where economies are still buzzing. Among many of the Asean nations of Southeast Asia, the discussion is about the likelihood of upgrades, not downgrades.

“In terms of fundamentals, there is no debate here,” says Kelvin Tay, chief investment strategist for Singapore in the wealth management division of UBS. “Southeast Asian economies are clearly at the forefront. Debt to GDP, FX reserves to GDP, reserves to debt; by any parameter, southeast Asia is right at the top.”

It’s widely agreed that we have the Asian financial crisis, perversely, to thank for this. The damage of the 1997-8 crisis in southeast Asia had a host of knock-on effects over the next 10 years: widespread deleveraging, the bankruptcy of weaker enterprises, the development of local currency debt markets to reduce reliance on foreign currency funding (and hence exchange rate exposure), and the widespread strengthening of local banking systems. The growth of China and a thirst for Malaysian and Indonesian commodities galvanized the whole process. “It took about 10 years before everything was weeded out,” says Tay. “So by 2008 and the sell-off in world markets, Southeast Asia was in a very solid condition. If you look at corporates in ex-Japan Asia generally, you will find net debt to equity is usually down below 10%. There’s hardly any debt.”

Southeast Asia is, though, a difficult market to generalise in. Indonesia, for example, is the brightest light in the region today, partly because its economy is largely domestic, and therefore less impacted by problems elsewhere in the world than some of its peers (furthermore, its chief exports are commodities, whose prices continue to be extremely high). Other nations, like Thailand and Malaysia, which have electronics industries reliant on exports, are more likely to suffer, while the Philippines faces a unique challenge of having more than 10% of its economy based on its expatriate workers, who are directly affected by the global downturn. Malaysia combines thriving commodity industries (plantations, rubber) with more value-added industries, and faces the self-imposed challenge of turning itself into a wealthy, developed-world nation by 2020; this is a different challenge to, say, the Philippines, where the priority remains bringing more of the population out of poverty, or Vietnam, where the main headache is runaway inflation. The Philippines and Indonesia are linked by a crushing need for infrastructure development, while in Thailand, the challenges tend to be political, with a new and unproven government following years of political unrest, yet an apparently unaffected economy.

“Asian economies are a mixed bag, but there are clearly far brighter spots here than you see in other parts of the world,” says Taimur Baig, a chief economist at Deutsche Bank. “If you take fiscal policy, most Asian economies are characterized by low debt and deficit in a world where you are seeing acute fiscal problems bringing Western economies to a standstill.” Higher foreign reserves, stronger financial systems, and significant household savings are also common attributes among Asean nations.

One curiosity of southeast Asia’s strength is that it continues to be a victim of capital flight whenever things go wrong in the developed world, even though logically these debt-free, high-growth markets ought to be seen as safe havens. “During periods of risk aversion, there will always be some indiscriminate selling as people unwind their carry trades and pay back dollar loans,” says Tay. “Margin calls come through and trigger fund redemptions.”

But actually that’s just a short-term movement: over the longer term, Tay notes the opposite pattern. When the dollar weakens, US fund managers tend to have more and more of their money in foreign equities, and vice versa. So in fact, international money is already chasing growth in Asian markets. A clear example of this is Indonesia, where 35% of all local debt is now held by foreigners. “In light of what has happened in recent weeks, I think the proportion of US institutional money in Asia is going to increase. US funding costs are low, treasury yields have dropped, and the fundamentals do not suggest the dollar is going to strengthen,” says Tay. “The beneficiaries will be commodity-related currencies in places like southeast Asia.”