Can emerging Asia bounce back from the global sell-off?

Emerging Asia’s policy flexibility and relatively low debt will see it return to growth before the West, says Thomas Sinclair, manager of the Neptune Asia Pacific fund.

While the major catalysts for the recent market meltdown reside almost exclusively in the developed markets – primarily Europe and the US – the violent sell-off in global equities (alongside most other growth sensitive asset classes) over the past few weeks has been largely, if not entirely, indiscriminate as investors scramble to downgrade growth and upgrade (tail) risk assumptions.

As such, the MSCI Asia Pacific ex Japan index, down 12.44% since the beginning of August, has in fact underperformed the S&P 500 Index, down ‘just’ 11.30%.

Double whammy

There have been two main areas of concern – one ongoing, the other widely anticipated if exceptionally ill-timed. Even though neither is likely to have any lasting impact on Asian economic fundamentals both, to an extent, are being discounted in Asian asset prices at present.

In the euro area, policymakers have once again, despite intensifying market pressures, stopped short of providing a complete solution to the peripheral sovereign debt crisis. In our view, the current position is not tenable and such pressures will force the euro area towards more complete fiscal integration.

In the US, S&P’s downgrade of US sovereign debt risks prompting a mistaken tightening of fiscal policy just as confidence and an already fragile economic growth trajectory start to look particularly vulnerable. In our opinion we need to see a reduction of near-term fiscal drag from Obama and strong monetary policy expansion from the Fed to brighten the outlook.

Low Asian debt

If much of the concern over developed markets revolves around a lack of policy flexibility (both monetary and fiscal) available to stimulate growth, this is most certainly not the case in Asia.

Firstly, most Asian markets are no longer susceptible to the typical channels of debt crisis contagion which make many so-called developed economies look vulnerable now, and made many Asian economies so vulnerable in the late 1990s.

Asian government debt levels are currently low relative to the advanced world and to their own history.

According to the IMF, Indonesia for example, has a government debt to GDP ratio of just 27%. At the other end of the scale, India has the highest ratio in the region at 69%, but this compares to estimates of government debt to GDP of a massive 103% in the advanced economies.

Secondly, over the past eighteen months, in response to strong economic growth and rising inflationary pressures, many Asian countries have actually been tightening monetary policy and normalising budget balances following the monetary easing and fiscal expansion of 2009. China, for example, has hiked interest rates five times and the required reserve ratio nine times over the past year.

In India, the Reserve Bank of India surprised the market with a 50bp hike in July, the ninth hike in the current cycle. From a fiscal perspective, most fiscal deficits in Asia are closing or have now closed. In Indonesia, for example, the public sector deficit as a percentage of GDP has fallen from just 1.6% in 2009 to an impressive 0.6% at the end of 2010. Under a scenario where developed market growth slows, most of these Asian economies will first be able to stop tightening and then, if necessary, use conventional monetary and fiscal policy tools to stimulate domestic demand.