Asia in the Millennium: about miracle, vision and reality. By Prof. Philippe Laurent

Le Professeur Philippe Laurent nous offre un tour d’horizon de la planète finance. Il y détaille les enjeux d’une Asie qui présente les atouts mais aussi les limites des principaux pays qui la composent. La politique monétaire des grandes banques centrales et leur implication en tant qu’investisseurs l’amène à se poser entre autres la question de la bulle spéculative et les risques d’inflation.

In the year 1999, many articles were published about the new Millennium and the next-to-come century of Asia.
Several arguments were deemed to design a sustainable high growth profile, such as above-average domestic savings, large pool of cheap labor force, heavy potential productivity gains through technology transfer, notwithstanding its attractiveness for foreign direct investment. Although previous decades of economic growth and industrial shift in production had outpaced every other geographic area in the world, some remaining challenges such as the level in education and local infrastructure, in addition to some political and legal uncertainties were still at stake, when considering the future. Similarly, the 1997 Asian financial crisis which sparked in Thailand had revealed to some zealots weak local banking systems and a combination of unproductive investments to the overheating real estate sector with short-term capital from abroad, far beyond the absorption capacity of local economies and in spite of unused high levels of domestic savings.

Furthermore, the legacy of that crisis put some severely-hit countries like Indonesia, Thailand or South Korea in shambles with a much heavier public debt burden and subsequently, forced asset sales and privatization to avoid curtailing public budgets and maintain macro-economic stability – so crucial to foreign investors’ eyes.

Fifteen years ago, whilst already a mature economy with an aging population, Japan was still a dominant player in Asia – surpassing by far all other local economies including China – and an undisputed regional leader in technology transfer and industrial manufacturing, as well as the key investor in Asia. But Japan did not realize that, along this dominant interdependence with neighboring countries, a more powerful force was alleviating its very interests in the region: the absence of a controlled but large-scale immigration policy, to compensate for a sharply shrinking workforce, especially in its densely crowded urban areas. With above 25% of its population being above the age of 65 and predictions to reach 30% or above by 2030, plus a traditional custom to bar middle-aged women from work – notwithstanding access to senior positions – Japan is sitting on a time bomb without equivalent in the Western world.

For different reasons, China – which recently surpassed Japan as the second economy in the world and will probably equal the United States in 2025 – is not immune to the same disease. Indeed, the one-child policy introduced in the early seventies (as a sharp reverse of Mao’s anti-Malthusian beliefs) happens to be producing similar negative effects two generations later, with an exponential rise of early retirees and a new breed of selfish “little emperors” neglecting their duties towards the old generation, except when money is needed for an apartment or a new European-branded car…
However, the most striking element almost over Asia remains the lack of a clear vision from leaders. Besides Singapore which has crafted a 25-years ahead plan for its future, no single country in the area has developed a kind of a Master plan to provide visibility to local and foreign investors, resulting in undervalued exchange rates, excess of capacity in certain manufacturing sectors like textile or toys, plus extremely volatile property and equity markets. This means that even wealth measurement and management in Asia became a revolving issue to most international active private banks and financial institutions. Anti-corruption steps currently in force in China equally had an immediate toll on Western key exports such as luxury items and may jeopardize in the same way the real estate development and the stock exchange stability. This does not demonstrate a vision, but rather anti-cycling erratic moves, that usually do not even generate long-term positive effects for the population in general. We can witness comparable ups and downs in policy making when considering emerging countries such as Vietnam, Thailand, Indonesia or the Philippines, where nepotism and/or dominant families continue to rule the system, without major hope for overhaul or change in the near future.

A poorly functioning banking system crippled with bad debts was already a concern at the end of the previous Millennium. How did it evolve in the first decade of the new one? Outstanding loans and bank bailouts in GDP percentage reached staggering peaks as high as 50 to 70% with unbearable loss ratios, which led to a new distinction set up by emerging markets analysts in Europe: frontier equity markets as opposed to emerging equity markets. In the first category, in-depth or structural reforms have taken place to stabilize the PESTEL* environment analysis, that usually defines the risks per country. Paths to industrialization stages and infrastructure investment levels are core components which determine positive evolutions, but require time and patience for sustainable performance ratios. Furthermore, when assessing risks in a country, weak signals are commonly understated or misinterpreted at the light of socio-cultural factors. This is perfectly illustrated by the actual turmoil in “big hope” frontier countries like Brazil, Turkey or Russia, whilst emerging India and South Africa did not keep up to their promises, when it comes to foreign direct investment as an index of confidence from companies and financial investors. So, over the last 15 years are new ASEAN members climbing the ladder from under-developed to emerging markets?

Well, Burma, Laos and Cambodia share common characteristics that are worth to be mentioned: with a global population of 88millions out of which almost 70% are below 30, they suffered authoritarian regimes and adhered to ASEAN at the end of the former Millennium. Mostly agricultural countries, they gradually will turn to more industrialization and represent together a big potential for tourism. However, what is more promising for the future is the fact that on January 1, 2015, they will join with Vietnam the ASEAN Economic Community (AEC), which entails a reinforced cooperation about FDI, generalized tariffs drop off, abandon of quotas and other contingents, environment and competition… knowing that China has already proposed to extend an existing free exchange zone to them, whilst Japan and South Korea are still knocking the door. Therefore, some consensus exists between various economic think tanks to predict a sustainable growth rate of 7-8% over the next decade, which will favor the gradual emergence of a middle-class, considering a rather low public debt, with no private debt and a slight deficit on their cumulative commercial transactions.

Generally speaking, most assets managers active in emerging markets draw the conclusion that there are plenty of opportunities offered in what they call young Asia by a healthy combination of strong demographic growth, potential wealth accumulation and consolidation or reinforcement of retail activities linked with public incentives for domestic consumption increase as well a dramatic urbanization phenomenon in mega-cities. China has paved the way to reduce its dependency on exports since 2009, but the development of infrastructure has just been spectacular over the last 30 years feeding the economic growth to 56 times per capita with an urbanization rate jumping from 18 to 47%!

Altogether, between 1999 and 2013, the MSCI Emerging World Index has outperformed the MSCI World Index by 2.6 times, despite the historical credit crunch period which started in summer 2008 till mid-2010 and affected all markets. Since then, the FED has monetized the US debt and massively bought back private loans on housing from banks and financial institutions, but even more, acquired an important amount of shares and private equity by injecting cash into the American economy. This also happened at a later stage in Europe, when central banks backed by the Euro-Bank have been decreasing interest rates artificially – which reduces the amount of public debt – meanwhile they were not only buying other currencies to sustain the Euro, but by the same token, bonds, debentures and shares from private banks and companies. This means in clear that the central banks of developed countries- including the prudential Swiss National Bank – became key investors in private shares of developed markets, hence another systemic risk of burst and inflation in the long run. This widely explains why over the last two years 2012-13, the stock exchange performance in developed countries has outranked that in emerging markets. If and when private investors – large companies in the first place, plus SMEs with renewed bank support for productive investment – will re-take the lead once a genuine economic reprisal will appear, then we could expect a new dynamics in Asian emerging markets, since they do not have the same assets with rather immature and less sophisticated banking systems, as already discussed.

Some good prospects nevertheless surfaced for emerging markets, notably in Asia:

  • significant net inflows of direct and indirect investments have re-started in 2012 amounting to 94billions USD with 24billions of loans in local currencies
  • credit ratings between developed and emerging countries are getting closer than ever by a kind of swapping phenomenon
  • better solvability ratings and lower interest rates are taking place steadily as well some increased commercial trading in strong currencies from Asia (yen, renminbi, HK and Sing dollars)
  • real interest rates look on the positive side with firm control of inflationary moves to avoid social unrest (primary goods prices especially)
  • access to raw materials are partially secured through hedging and bilateral agreements

For all these reasons added to structural factors like large demography combined with domestic consumption, limited or controlled debts – as opposed to developed countries – and compensated by huge foreign currency reserves in major markets, including a search for added value in the next industrialization phase and high-tech investments levels, we believe that some positive prospects lie ahead for investors and actors in Asian emerging markets to the horizon 2030.

However, we would like to formulate some reservations when anticipating beyond till 2050, since a major element remains in our views persistently worrisome for after-morrow. Indeed, complacency about political reforms and intricacies linked with corruption practices largely hamper prosperity sharing at a large scale, meaning that even if poverty and illiteracy rates have been tackled to some acceptable levels to international standards, the same old game prevails and income differences between the upper rich segment and the new middle class (notwithstanding the poorest quartile of the population) have sharply, if not exponentially, widened. Furthermore, outdated institutions and political structures – at the noticeable exception of Singapore – continue to be ruled by cronies and tycoons whose purpose is rather own political survival, hence obsession for social stability and strong leadership – which are often defined as a counter-model to universal rights by abusively quoting them Asian values. Governance, particularly when knotting politics and business, fairness in practices when it comes to power exercise, soft incremental ways for political reforms, a minimal transparency on equal treatments or achievements with a more accountable system, responses to environmental and public health concerns represent many challenges for the forthcoming decades.

In an interconnected world where not only trade but concurrent cultures, ideas and discoveries tend to converge for a better world, we really need to find – more than ever – joint answers and collective means to solve the most complex issues that lie ahead of us…

Prof. Philippe Laurent / 14.08.2014

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