Emerging Markets, ADB editions, Madrid, May 2008

The US slowdown and global credit crunch are putting to the test the theory that the Asean nations have decoupled – that is, that they have sufficient trade amongst their members and the rest of Asia to offset problems in the developed world.

The verdict is still out on that, and varies according to the country. Some find the whole idea a fallacy. “Non-Japan Asia economies have in no way decoupled from the G3,” says Cem Karacadag, director, southeast Asia and India economics for Credit Suisse. “Trade linkages with the G3 have grown, not shrunk, in recent years.”

Others argue the reverse. Dominique Dwor-Frecaut, fixed income analyst at ABN Amro, speaks of “decoupling, for now, of global growth from the US” and adds that “Asian countries have generally entered the current crisis with strong export growth and current account surpluses. For now decoupling is likely to continue to provide support to export growth while higher prices of commodities are likely to bring down trade and current account balances.”

Oussama Himani, head of global emerging markets equity strategy at UBS, is halfway between them. He says he was “a proponent of the decoupling thesis for most of last year but started turning cautious in December. The reason for that is that if you look at emerging markets as a whole, the growth in exports is coming from intra-emerging market trade and the EU.” He thinks the impact of potential slowdown in the EU has not yet been factored into expectations in Asean and other emerging markets; it’s “the next source of bad news.”

“Decoupling from one [of the US and EU] is one thing, decoupling from both is a whole different ball game,” Himani says. “Yes, 50% is intra emerging markets, but that still means 50% is developed countries.”

Few believe that this means Asean countries will tip into situations anything like as miserable as that in the US. But there is wide expectation of a slowdown. “My view is they will decelerate this year. Emerging markets will still be the source of a big chunk of growth in the global economy,” says Himani. But while he believes Asean economies will remain robust, he is less sure about markets. “Many of the consensus estimates are of margins increasing. Well, margins don’t grow in the sort of environment we’re in.”

He adds: “Decoupling of the macro doesn’t necessarily mean decoupling of the markets, and a relatively good macro scenario doesn’t necessarily mean good market performance in this environment.”

A more positive view comes from Mark Matthews, Asia Pacific equity strategist at Merrill Lynch. He cites Malaysia as an example of the fact that commodities, rather than depressed export destinations, will be the driver of growth in Asean. “If you add up the net exports as a percentage of GDP from Malaysia that are raw materials, it’s 17%. Net exports of electronics is 7.5%,” he says. “That’s a microcosm of southeast Asia: Yes there are a lot of exports, and some manufacturing, but they benefit from the high price of commodities. That’s the southeast Asian story in a nutshell: it has a lot of the things the emerging world needs.”

Matthews is therefore positive on the region. “The population density in much of southeast Asia is such that the agricultural sector has room to grow,” he adds. “In the islands of Indonesia, or in Malaysia or Thailand, you don’t have the same trends eating away at agricultural land as in India and China.” That means not only is it exposed to high commodity prices, it has the ability to become more so, whether it’s sugar, rubber, palm oil or one of the many other commodities these nations can produce.

The precise outlook, and exposure to external shocks, depends on the place. Karacadag and Matthews agree that Indonesia is among the least at risk. “Indonesia stands out because it has such a small manufacturing sector,” says Matthews. “That was always looked at as a bad thing – it’s never attracted FDI because of its labour laws, and it’s so far from the supply chain nobody wants to build a factory there – but that’s turning out to be a good thing now.”

Karacadag believes Singapore is the most exposed of the Asean nations to problems in G3 countries. He says the country’s real GDP growth rate has moved around four percentage points for every one percentage point change in the G3’s GDP growth rate since 2000. The ratio of Singapore’s exports to the G3 to GDP is 30% (net of the import content of those exports), which is easily the highest in the region, and its high stock market capitalisation also makes it vulnerable to global shocks.

Many Asean countries – and Singapore is perhaps chief among them – are facing a tricky challenge of tackling rising inflation while simultaneously worrying about a slowdown caused by the global environment. Singapore, for example, reported a 6.6% jump in inflation in January, the fastest rate since 1982. But economists looking at southeast Asia from a macro point of view are not greatly concerned about inflation in the region.

“A lot of it is being driven by headline inflation, which has to do with energy price movements and food prices, rather than core inflation moving up across the board,” says Himani. Still, that can be challenging in its own right; as Himani says, the poorer the country, the higher food and energy are as a proportion of overall consumption, which in turn has social implications and spurs wage demands, which can then drive a second round of inflation.

But Matthews says inflation is “massively overrated as a concern. It’s a genuine component of any country going from poor to rich: there will be inflation and currency appreciation. Costs are going up, but revenues are rising too at the household level; most people in southeast Asia live in rural areas and, net net, they benefit from higher agricultural prices.”

Certainly, central bank policy in Asean this year doesn’t suggest much concern about inflation. The Monetary Authority of Singapore seems to be positioning itself much more to deal with slowing growth than rising inflation (it is, after all, difficult to take on both at the same time in a single coherent fiscal policy). “Despite concerns on inflation, downside growth risks may cause MAS to maintain the current policy stance of slightly steeper appreciation bias,” says Kit Wei Zheng at Citi in Singapore in a recent report. “There remains considerable uncertainty over the growth outlook, given the likelihood of a US recession.” In Singapore, electronics exports are under particular threat, while financial services and trade related services may also struggle.

Another issue to consider is currency. “Currencies should all strengthen, including the peso and rupiah,” says Matthews. Most countries in the region have current account surpluses; the value of the raw materials they export is going up, and much of what they buy from the rest of the world is denominated in dollars; and Asean economies are generally not leveraged at a household, corporate or sovereign level. Himani agrees: “The fundamental pressure is for appreciation,” he says. “It’s supportive of levels that are relatively high compared to their history.”

Karacadag notes that currency appreciation against the US dollar has “primarily reflected weakness in the US dollar rather than strength in any individual southeast Asian currency,” with the exception of Thailand, which has been driven by the unwinding of some unwise previous capital controls earlier this year. He notes that foreign exchange reserves have surged in Asean this year, “suggesting that central banks have strongly resisted currency appreciation so far this year,” again with an exception, this time Indonesia.

He adds: “Exchange rate policies are likely to continue prioritizing growth over inflation risks so long as global growth risks loom large.”

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