Those clouds over Asia are not about to lift

By keeping interest rates on hold a while longer, the Federal Reserve has given emerging markets, braced for possible capital outflows with rising yields in the US, at least a temporary reprieve.

And by not including China in its benchmark indices quite yet, MSCI has indirectly helped support other emerging markets, as fund managers underinvested in Chinese shares would have had to sell down other markets to adjust to new weightings. But there is not much other good news on the horizon.

Today, emerging market central bankers have two contradictory concerns. They fear the combination of low rates and the temptation for their own borrowers to take on too much debt when it is priced attractively. And they also fear the inevitable end of the low rates that will make the debt burden heavier.

But that is only part of the reason why this particular rainy season the clouds are especially heavy in emerging Asia. Analysts are trying to understand the paradox that while today there seems to be plenty of liquidity in the world, the banks are not channelling that abundant capital to the real economy to support growth.

Part of the reason for their reluctance must surely have to do with the fact that Asian corporates have borrowed a lot. Private debt in Asia alone amounted to 125 per cent of gross domestic product in the final quarter of 2014, according to the BIS and too much of it was in dollars.

Eventual rate rises, whenever they do finally materialise, will be especially damaging for this large group. The combination of financial and economic stress with more debt and fewer revenues to support borrowings is likely to prove challenging worldwide, but especially for companies in the region.

The macro situation is also sobering. For years, Asia grew on the back of exports to developed markets. It was a formula that worked first for Japan, and then for Korea and Taiwan. But it does not seem to be working any longer. World trade has been almost flat for the past three years and been slower than (also anaemic) world GDP.

“This is something we haven’t seen in a generation,” notes David Lubin, an economist with Citigroup in London. Trade matters not only because it supports economic growth, but because it cements relations among countries and should reduce geopolitical tensions. It is therefore of double concern that this year the outlook has worsened.

Today, emerging economies are losing market share in the developed world as the growth rate in the volume of exports from emerging countries is below the rate of growth of the volume of imports in the developed world. That is true both for commodity exporters (whose year-on-year volumes are turning negative) and manufacturing exporters, according to Lubin. Only a few nations, including China and Mexico, have been exceptions to this sobering trend.

So the developed world is not the catalyst for growth that it was for developing nations. Meanwhile China, whose demand fuelled a rise in income for commodity producers such as Australia and Indonesia and manufacturers outside the mainland that were vital to its own supply chains, is both reducing its demand for goods from beyond its borders and taking market share from others.

“China seems to be outcompeting emerging markets in an environment where the overall weakness of world trade growth leaves developing countries badly exposed,” Lubin of Citigroup concludes.

The most optimistic spin to put on all this is that China’s shift to becoming a more active exporter of capital and a massive offshore investor will inspire growth in a different paradigm. Both at the Boao Forum in March and in Shanghai at Lujiazui Forum, government officials such as Li Keping of CIC and a big shareholder in the new Silk Road Fund, testified to China’s determination to “play a bigger role in boosting the world economy” through the Asian Infrastructure Investment Bank and the New Development Bank.

“We have the highest savings rate in the world and we should leverage this advantage and export capital,” added Jin Qi, the chairwoman of that Fund. Every day it seems a new fund is launched, such as one for central Europe from China Exim Bank.

The world can use China’s capital — and, by the way, more of it will be in the Chinese currency. But whether even $4 trillion (Dh14.68 trillion) in mainland reserves is enough to lift the world out of its doldrums is uncertain.

Financial Times