(ATF) Like the dismal GDP performance in Q2, Asia’s earning season has not surprised expectations to the upside, in comparison to the US earnings beats. Some of the reasons are the length of suppressed mobility in places such as India, Indonesia and Singapore, and the Philippines; and relatively smaller fiscal and monetary stimulus versus the US, especially on the household income side. Moreover, in lagging economies such as India, Indonesia, the Philippines and Thailand, publicly listed firms are dominated by sectors most heavily impacted by Covid-19 and have much fewer tech companies.
As such, foreign equity investors have fled the lagging economies of Asia as Covid-19 rages globally, dampening growth outlooks and risk appetite, especially as the US dollar (USD) strengthens. The region’s high dependency on tourism and trade has made it especially exposed. Beyond the decimation of tourism and depressed trade activity, the Association of Southeast Asian Nations (ASEAN) has also had to impose strict suppression measures to fight the virus, resulting in weakened domestic demand.
While risk aversion has faded thanks to the Fed’s aggressive easing and fiscal policies to offset the fallout of the virus, equity investors have not yet fully returned to the region as growth performance stalls. As a result, in USD terms, Indonesia, Singapore, the Philippines, Thailand, and to a lesser extent Vietnam, have declined sharply this year. In contrast, other Asian equity indices, such as those of China, South Korea and Taiwan, have done better.
This has left the region faring unfavourably compared with other parts of the world, where a flood of fiscal and monetary support, as well as a return to a semblance of normalised activity, have stabilised financial markets and improved risk appetite, particularly in developed markets. Southeast Asian risk assets continue to flounder and it remains one of the worst-performing regions in the world.
Weakening dollar
While regional currencies have stabilised, especially the Indonesian rupiah (IDR), due to a gradual return of bond investors and overall reduced need for USD due to suppressed import demand, equity investors are less enthusiastic.
In response to this, governments in emerging Asia have eased monetary policy and deployed fiscal support to limit the fallout from the virus. But funding constraints limits their firepower and with revenue falling and expenditure rising, debt is on the increase.
That said, we must not forget that Southeast Asia has strong fundamentals and favourable structural trends – the region has low debt-to-GDP ratios and favorable demographics. Indonesia, for example, has the lowest debt in the region. The low leverage ratio should help the region recover faster, especially Indonesia once it is able to normalise activities. India, the Philippines, Malaysia, Indonesia and Vietnam, meanwhile, are enjoying the benefits of demographic transition, which is still positive for growth in sharp juxtaposition to East Asia.
Emerging Asia will contract sharply in 2020, with the exception of China and Vietnam; but its future is bright in 2021 and beyond as many economies have key ingredients to growth: favorable demographic trends, diversification in a world starved of yield and growth, as well as geopolitical trends that are creating greater need among large multinational corporations to diversify investment away from China. Moreover, fundamentals remain solid: Indonesia and India have still the lowest debt in Asia while Singapore and Thailand have plenty of savings. The issue for them is efficiency of investment and expanding sources of income, which they can achieve with the right policy ambition.
Hope on the horizon
Beyond structural reasons that are supportive of Southeast Asia, especially the current account deficit economies, two global trends will help in the future: a flood of cheap liquidity injected by developed markets and a weaker USD. Recent liquidity injections from the Fed, European Central Bank (ECB) and Bank of Japan (BOJ) is equal to $20 trillion. The flood of liquidity coupled with the suppression of real yields will be supportive of emerging Asia, especially high-yielding economies such as Indonesia, which has the steepest borrowing costs in Asia. The push of low rates in Japan, Europe and the US will find a home in Southeast Asia, especially Indonesia.
Of course, we must not forget about the dollar index (DXY), which has declined from its peak of 102.8 on March 20 to 93.5. Many studies have shown that the USD, which lubricates not just global finance but also trade financing and invoicing, has a negative impact on trade and risks if it strengthens and has a positive effect when it weakens. Gopinath et al. (2019), for example, showed that a 1% appreciation of the USD leads to a 0.6% contraction in trade volume in the rest of the world, under the assumption of sticky prices and dollar invoicing. Bruno and Shin (2020) meanwhile showed that the strength of the USD is associated with tighter dollar credit conditions and exporters that are reliant on dollar-funded bank credit suffer a decline of exports due to increased funding costs.
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This means that the decline of the dollar is positive news not just for global trade but also financial conditions, which should be supportive of Southeast Asia via trade and financing channels. These factors should boost lending to the region and improve financial conditions, contrary to conventional economic wisdom.
Therefore, while Southeast Asian growth is stuck in the doldrums in the short-term, several trends will support it moving forward. Low indebtedness and favourable demographic transition trends will give it a strong foundation to recover and boost its attractiveness for still shy equity investors. Moreover, a weaker USD should add another supportive boost via trade financing and financial conditions. Of course, should emerging Asian economies continue to make progress on soft and hard infrastructure, such as improving doing business environment and investing in infrastructure, then they will not just attract portfolio investment but also much-needed foreign direct investment to expand income and purchasing power.
In other words, while Southeast Asian corporates and economies have underwhelmed, they are not expected to remain there for long given their fundamentals and structural trends.
Trinh Nguyen is Senior Economist covering Emerging Asia at Natixis, based in Hong Kong. Trinh is an award-winning economist with acclaimed expertise and insights on the economic trends and the forces shaping them in the Emerging Asia region. She is also a non-resident scholar at the Carnegie Endowment for International Peace, whose global network provides a unique opportunity to think deeply about complex trends and share among policymakers, investors and corporate leaders. Prior to Natixis, she was an Asia economist at HSBC and a research consultant at the World Bank. She holds a Master of Arts in International Affairs and International Economics with a specialization on Southeast Asia from Johns Hopkins University.
