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Asia's capital flows - this time it's
different
By John Mulcahy
 Asia's economies have made the transition from
victim to villain without passing through the hero
phase. Five years ago the Asian currency crisis produced
a seismic shift in capital as investors ran for cover,
slashing 80 percent off the Indonesian rupiah's value,
for instance, in less than six months. Now the money is
flowing back into Asia, forcing massive intervention by
the Bank of Japan (BOJ) to curb the yen's strength,
while China dismisses pressure to revalue or float the
yuan.
So what is different this time? ABN AMRO's
chief Asian strategist, Eddie Wong, argues that the
appreciation of Asian currencies "will be a long and
gradual process, as will the trend of capital flow to
Asia". ABN AMRO's view is that the evidence of
private-sector funds flowing back into Asia suggests
that economic growth is shifting "back from the West to
the East".
Capital has no conscience, of course,
and the funds flowing into Asia are far more concerned
with expectations of above-average returns than with US
Treasury Secretary John Snow's aggressive lobbying for a
realignment of Asian currencies. It is no secret that
Asia's domination of global foreign-currency reserves
rankles in certain quarters, prompting Snow's strident
posture on the issue. Japan and China together account
for more than 50 percent of global foreign-currency
reserves, and by some lights the yen and the yuan should
be allowed to find their own level.
The
perceived undervaluation of the yuan has other effects
as well, not least the claim that China is competing
unfairly with US manufacturers of clothing and toys.
While the claim of unfair competition may or may not be
true, it is by no means certain that a floating yuan
would actually rise. The instability of China's banking
system and pent-up "hot money" outflows could well swamp
the beneficial effects for the currency of China's
massive trade surplus. In any case, this is a moot
point, as there is little prospect of Beijing succumbing
to pressure from the United States or anywhere else to
revalue or float its currency.
In a recent
report, HSBC economist Geoffrey Barker notes that "the
Chinese authorities have critical domestic challenges
that are likely to take priority over altering their
exchange rate. They need to dampen the surge of
investment spending that threatens to lead to a fresh
round of NPLs [non-performing loans] for the banking
system."
Japan's dilemma is that it is still in
the throes of deflation, and it desires a weak currency
to tackle that problem. Ideally, the yen should fall to
150-200 to the US dollar. However, in the wake of the
Group of Seven (G7) joint statement on September 20
calling for more flexible exchange rates, the yen
strengthened to 110 against the dollar as capital surged
into Japanese assets. The BOJ poured money into the
dollar as its intervention reached a monthly record of
US$40.6 billion, taking the Japanese central bank's
intervention to $121 billion for the year to date.
Asia has a quality problem for the first time in
years. It is attracting huge interest again, marked by
an estimated 1,000 institutional investors attending
stockbroker CLSA's investor forum in Hong Kong and China
last month, and by a pronounced increase in market
liquidity across the region. "People who didn't want to
know about Asia three months ago are desperate to
participate in placements," says David Williamson of
Daiwa Securities in Hong Kong.
And, according to
HSBC economist Barker, "the flow of funds is shifting
away from financing overseas (especially US) growth and
consumption, in favor of financing growth in the
region". He says the appreciation of Asia's floating
currencies, led by the yen, is partly in response to
political pressure and partly a function of a cyclical
improvement in the Japanese economy.
It is this
latter point that will produce sustained capital flows.
It is true that short-term capital flows resulting from
currency speculation precipitated the Asian currency
crisis in 1997, but it was economic growth in the 1990s
that required substantial capital, and a faltering of
this growth that led to the flight of investment capital
from 1997 onward. South Korea's foreign debt rose from
about $44 billion in 1993 to $157 billion in 1997, while
over the same period Thailand's foreign debt doubled to
$96 billion, and Malaysia's foreign debt also doubled
between 1992 and 1997, to $43 billion.
While
investors in Asia have been reading the runes to
establish the timing of a reflationary cycle that would
underpin the domestic asset markets, the prospect of
rising prices is far more ominous for the United States.
Concerns about inflation tipped the bond market over the
edge in July, although it has since stabilized. However,
any evidence pointing to a pickup in China's inflation
would be seen as a precursor to another round of US
inflation.
Any real evidence of renewed
inflation would be accompanied by a shift in monetary
policy by central banks, which have almost universally
adopted an easing stance in recent times. At the moment
the movements in capital have been modest, and there is
no immediate threat of inflation accelerating in Japan
or China, but it is likely to be a concern by 2004 and
beyond.
In its world economic outlook, published
ahead of the annual meetings in Dubai last month, the
International Monetary Fund (IMF) said Asian currency
intervention was helping to push the world economic
recovery off balance. The IMF's chief economist, Kenneth
Rogoff, said the world recovery was "dangerously
dependent on domestic demand in the US, driving the US
current-account deficit up to unsustainable levels".
Rogoff added that the growing US deficit would
induce a sharp decline in the dollar at some point. "If
the euro has to bear the lion's share of the adjustment
in the dollar, that is going to create a lot more
difficulties than if all the Asian currencies also allow
themselves to appreciate significantly against the
dollar."
And so the debate rages, but the
capital continues to ignore the sophistry as it seeks
returns. CLSA strategist Christopher Wood notes in his
Greed & Fear report that the MSCI Asia ex-Japan
index has risen 39 percent from its bottom in May, while
the Standard & Poor's 500 is up 24 percent from its
March low.
"The stellar performance of both
Japan and the rest of the Asian region during the past
six months is without doubt generating renewed interest
in the Asian equity investment story among global
investors and asset allocators," Wood argues.
The question is whether the flows will be
orderly or whether the momentum will again drive values
so far and so fast that investors will soon be paying
too much for assets, sowing the seeds of the next Asian
crisis. The availability of unlimited cheap capital
during the 1990s fueled the classic boom and bust during
that decade. In 2003, though, the wounds are still
fresh, and while portfolio investors may be paying too
much for capital, there is no compelling evidence to
suggest that managers of businesses are misallocating
capital in the way they did during the 1990s.
It
is true that the concentration of foreign equity
investment into Asia tends to distort capital
allocation. Individuals in Paris, Texas, or in Graz,
Austria, are unlikely to invest directly in Thailand,
Indonesia or the Philippines. Instead, they will channel
their investments through banks or mutual funds, which
in turn bundle the funds and transfer them to specialist
fund managers. History suggests that many of these
institutional fund managers think and act alike,
producing a herd mentality that is currently producing
huge flows into Asian markets, but which can similarly
reverse as the "herd leaders" change their views.
Asian equity placements, few and far between
from 1998 until very recently (except for the dot-com
period), are now a daily occurrence. The owners of
businesses are happily selling equity at current prices
to investors from Europe and, especially, the United
States. Do these businesses actually need the capital,
or are they simply taking advantage of liquidity and
raising capital because it is there? A bit of both is
the most probable answer, as investment banks and
stockbrokers, starved of business for several years,
rush to mop up as much of the incoming capital as
possible before the liquidity dries up again.
"The first few placements will do very well, but
eventually the appetite will be satisfied, and investors
will realize that they will need to see some performance
before putting more money into these markets," says
Daiwa's Williamson in Hong Kong.
There is no
doubt that Asia has rebooted itself since the
cataclysmic crisis of the late 1990s. According to the
World Bank, Asia ex-Japan's average savings rate for the
period 1997-2001 was 37 percent of gross domestic
product (GDP), compared with 20 percent for Europe and
15 percent for the United States. The creation of its
own capital base has been East Asia's persistent
attraction for international equity investors, and this
time really is no different. The question, though, is
whether the returns on this capital will be any better
than during the last period of capital shift from the
West to the East.
(Copyright 2003 Asia Times
Online Co, Ltd. All rights reserved. Please contact content@atimes.com for
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