OUTLOOK 2015: Asia continues to grow despite strong dollar concerns

OUTLOOK 2015

Asia continues to grow despite strong dollar concerns

The outlook for Asian markets remains healthy. While there have been recent bumps that have weakened investor sentiment and despite the received wisdom that US dollar strength should in theory be a negative for many markets, across the region there are several developments on the policy and broad macro front that are likely to continue to drive markets over the mid-to-long term.

Unlike some of the more commodity-based emerging markets elsewhere in the world – Brazil, South Africa, Russia come to mind – there are, in fact, some good reasons why Asia may continue to fare relatively well in a rising US dollar scenario. Firstly, Asia’s external debt position has improved dramatically since the Asian currency crisis of 1997, with countries in the region having remained very disciplined on this front in the years since. Secondly, most countries in the region have built up huge currency reserves relative to their debts, so they are nowhere near as vulnerable to external shocks as they used to be.

As importantly, however, many countries in the region have also adopted a strong reform mindset, and it is no coincidence that the best-performing stock markets this year are all in countries that are actively engaged with broad-ranging and in some cases really quite exciting reform agendas. Crucially, Asian growth levels are supported less these days by exports and increasingly by domestic demand. Right across Asia, a strong reform agenda has been developing as, country by country, governments in the region have realised that export-led growth on its own can become self-limiting as incomes rise and cost competitiveness decreases.

In Japan, Abe’s three arrows policy has clearly changed short-term sentiment, and inflationary expectations. Although the Bank of Japan’s 2% inflation target is ambitious, the more potent achievement in Japan would be one of a change in the country’s psyche from expectations of falling asset prices to rising asset prices. This is why the BoJ governor really felt he had no choice but to double down on his reflationary policy in the light of some evidence that such expectations were waning. However, it will be the third arrow – Abe’s progress on structural reform – that will determine the long-term success or otherwise of his revolutionary policy experiment. The third arrow is principally about improving capital efficiency. In order to drive economic growth under an ageing, shrinking population, the efficiency with which human and financial capital are allocated and organised becomes the highest priority. If you can achieve sufficient productivity increases via reforms then you don’t actually have to increase the population to grow the economy.

Looking at China, although observers are obsessed with the slowing GDP growth rate, we think it’s actually a good thing. An economy the size of China’s cannot continue to grow at breakneck speed forever. It’s natural that the growth rate should slow over time. It’s far more important that they control the growth of debt, especially in the shadow banking area, and this is what is now happening and what China’s leaders mean by quality of growth not quantity. The reform programme in China is key to rebalancing its economy towards consumption and away from investment. Its aim is to navigate the path to a more sustainable economic model, including a more market-oriented approach to the allocation of capital. In fact China’s consumption has already expanded much faster than most people think, rising by an average of 10% per annum in real terms over the past decade. In current prices it has risen more than five-fold since 2003 to $4.8 trillion. Reform remains key to the long term in China. State owned enterprise reform is already having a tangible benefit to the bottom lines of companies like China Mobile and Petrochina. The Fourth Plenum in October launched the government’s initiative to reform the rule of law in China, essential to future economic growth. And, of course, the country is benefitting from weaker oil prices as a net importer of the commodity.

Now to India, the extent of prime minister Narendra Modi’s election victory exceeded expectations, winning the first single-party majority in 30 years. Modi’s first budget has laid out a roadmap for fiscal consolidation, a boost to infrastructure and construction, and carried forward the opening up of the FDI agenda, thus ticking most of the right boxes. A better growth outlook is dependent on the government’s ability to introduce widespread reforms. Aside from sector-specific improvements, potential macro reforms include simplifying project approval and land-acquisition processes (infrastructure), labour, federal and tax reforms (governance), and lowering subsidies. Investments have been the key focus area for the Modi government. The most significant low hanging fruit for the new government is to improve the efficiency of the bureaucracy and accelerate decision making. Success here could see more than $100 billion in investment projects start moving, and initial progress is encouraging. In addition, opening of FDI in defence and railways, higher spending allocations to infrastructure and cutting red-tape all point to GDP growth reviving back to 7% in fairly short order, if not more.

Like Modi in India, new president Jokowi in Indonesia is a market-friendly reformer who does not come from the established political elites of Indonesia. Again, reform is going to be a key medium-term driver of growth. Indonesia has a favourable demographic profile, so unleashing domestic demand and reducing dependency on exports of commodities is key. Indonesia may be a commodity exporter, but it is a net oil importer with a large fuel subsidy, so falling oil prices will help. However, the market is not without fragilities – not least the current account deficit and commodity-heavy economy. And, last but not least, the ASEAN countries themselves – comprising 600 million people and, taken together, the world’s eighth largest economy, have finally come together to plan how better they can leverage their collective strengths. The ASEAN ‘connectivity plans’, represent the next set of ambitious targets after the dismantling tariff barriers. The concept of ASEAN connectivity is expected to promote ASEAN centrality in the region; facilitate establishment of the ASEAN community; and help serve as a foundation for a more enhanced East Asian connectivity.

JOHN FORD is Chief Investment Officer, Asia Pacific at Fidelity Worldwide Investment.

JOHN FORD is Chief Investment Officer, Asia Pacific at Fidelity Worldwide Investment.

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