China’s chain reaction share chastening

July 9, 2015 10:48 AM (UTC+8)

 

Asian emerging stock markets, already weakening at mid-year with their own difficulties, shed another 1% in the immediate wake of China’s carnage as foreign investors rethought their 2015 favored region. No country was spared, including post-Modi darling India, traditional safe haven Korea and anti-corruption favorite the Philippines. Malaysia corrected as Prime Minister Najib Razak was linked to a suspicious bank account, and Vietnam paused as Communist Party chief Nguyen Phu Trong visited Washington to advance the final phase of TPP free trade negotiations. They sold off in part to cover Chinese losses, but second half sentiment was due to harden on similar growth and debt patterns, political gridlock and economic management complexity.

Korea was down 2% on the MSCI index at end-June as the MERS scare and six consecutive months of export decline slashed expected GDP expansion to 3%. The government has reeled from perceived mishandling of the health emergency and the former prime minister’s resignation for illegal funds receipt. The central bank has been under intervention pressure to mirror Japan’s yen depreciation, and cut interest rates to a record 1.75% in March, but is wary of adding to the household debt burden hanging over from the original Asian financial crisis. Fiscal stimulus, which was ineffective when President Park Geun-hye first took power, will again be introduced but domestic borrowing is more expensive as foreign holders have trimmed positions with the lower won and stricter trading rules.

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Share price-earnings ratios at 11 times were attractive at a discount to the emerging market average, especially since new laws were adopted to encourage better corporate governance and higher dividend payments by the family-controlled chaebol.  However, profits have disappointed across a range of industries from technology to construction and shipbuilding. Samsung has come under investor pressure to divest units, and the well-known US activist fund Elliott led a fight to prevent a controversial conglomerate acquisition as minority shareholder rights are still spurned.

Indian shares were flat before China’s crash as foreign portfolio inflows slowed dramatically from USD 40 billion the last fiscal year. Official revised statistics put growth at 7.5%, but the true reading may be 6%. The central bank reduced the benchmark rate slightly as a poor monsoon could reignite double-digit inflation. Agricultural land ownership polices have not changed, and foreign insurers have also encountered regulatory roadblocks despite recent sector opening. State bank non-performing loan ratios are 15%, but the government will not relinquish control although it pledges to shake up management. Infrastructure projects cannot proceed until an estimated USD 100 billion in corporate debt is restructured, and investment quotas limit foreign institutional participation in workouts. Frustration about the mixed Modi record has deepened with the endless quest for IPO approval by the stock exchange itself, which is “under r-examination” according to the finance ministry.

Malaysia’s further weakness was no surprise as the ringgit tumbled to 3.8/dollar on reports that  USD 700 million from an indebted sovereign wealth fund under investigation went through PM Najib’s re-election campaign accounts. He denied graft allegations and accused political rivals of fabrication. The ruling party continued to back him since it no longer faces an opposition threat after the coalition splintered. Fitch Ratings held off on a sovereign downgrade, but warned of worsening capital outflows and government and consumer debt loads.

Portfolio investors have also exited the Philippines as exports sputter and President Benigno Aquino looks to seek another term with dwindling popularity following botched typhoon cleanups. He has also confronted China over disputed sea zones, and a rebel peace deal was sidetracked. Vietnam has struggled this year in the MSCI Frontier index despite 5% GDP growth as credit creation remains excessive at 15% annually. Foreign investor access was recently raised to 100% in select industries but the currency was again devalued.  Regardless of China’s inimical share climate, economic and banking sector adversity in the rest of the region will likely erase value on their own terms as the dual drags linger.

Gary N. Kleiman is an emerging markets specialist who runs Kleiman International in Washington, D.C.

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