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Regional Equity Strategy 4Q 2009 Strategy Overview: Asia Equity Asia-vu (2): back to the ‘90s (David Carbon, davidcarbon@dbs.com, extracted from “Economics – Markets – Strategy, 4Q09” dated 17 September 2009) • Asia’s V-shaped recovery continues, with no help from the US • This has surprised the conventional wisdom (CW), which thought the US would have to lead Asia out of recession • Rather than accept defeat, the CW has doubled its bets: it now believes Asia will face slow growth for several years • We think the opposite: Growth in Asia over the next 5 years will be faster than average, not slower. More generally, we think Asia is headed back to a period that resembles the early-90s in many ways • Besides faster growth, capital inflows and a marked shift toward external deficit will be key features of the next 5-10 years • Structural, cyclical and ‘new world’ factors will drive this shift This report picks up where Asia-vu (1) left off (p3, DBS Quarterly, Economics-Markets-Strategy, 15Jun07). As noted, our bottom line is that everything seems poised to change back again. In short, if we call the 10 years before and after the ‘97 crisis P1 and P2, Asia now appears on the verge of entering a third period, P3, which looks an awful lot like P1 (first chart on right). As Mr Berra might have said, Asia-vu again. But what does it matter? And why bother with all this P1 and P2? The answer to the first question is clear: if Asia is headed back into boom times that’s worth knowing about. Why P1 and P2? Because, the longer-term perspective offers a clear framework for understanding where Asia has been, where it is going and why. And, because it makes it easy to dispatch with some of the conventional wisdoms that interfere with that understanding, including: 1. the premise that growth in Asia has been “fast” of late and that little headroom remains for faster growth ahead; 2. the premise that current account surpluses are responsible for Asia’s “fast” growth and that deficits would imply slower growth; 3. the premise that lower consumption / higher savings, in the US for example, implies slower growth ahead; and finally, the CW conclusion, 4. that Asia is destined for a period of slow growth ahead. Asia-vu: back to the 90s Asian financial crisis US financial crisis Period 1 Period 2 Period 3 Capital inflow Current acct deficits Rising leverage Rising external debt Rapid fixed capital form'n Above-avg GDP growth Capital outflow Current acct surpluses De-leveraging Repaying external debt Paltry fixed capital form'n Below-avg GDP growth Asia-vu: A return to period 1: Capital inflow External balance / deficit Above-avg GDP growth 1987 1997 2007 2017 P1, P2 and the Asian myths Let’s begin. There are 5-6 features of P1 and P2 that will help us understand what is and is not going on. We considered them in detail in Asia-vu (1) so let’s take the bullet point / chart approach here: Growth (chart below): The first myth to address is the idea that growth in Asia has been unusually / unsustainably fast of late. In fact, growth has been below average for the past ten years. If you want to see fast growth, look at P1, the 10 years leading up to the crisis. Growth averaged 8% per year in the Asia-9 then. Since then, growth has averaged only 4.7%. Even in the past 5 years it has averaged only 6%. That’s less than the full period average of 6.3% and a full two points below growth in P1. The next time someone tells you that growth out here has been running too fast, look them in the face and say, not really. Asia 9 – average GDP growth % per year, simple avg 9 8 7 6 5 4 3 2 8.0 Full period average: 6.3% 4.7 87-96 97-08 past 5 yrs Current account balances: Perhaps the most noticeable change between P1 and P2 was the swing in current account balances. The Asia-9 ran deficits in the pre-crisis period averaging 2% of GDP by 1995. The crisis-4 countries (TH, MY, ID, KR) ran higher deficits of 6% of GDP and in some instances 6.0 “This report has been re-printed with permission from DBS Group Research (Regional Equity Strategy) of DBS Bank Limited” disclosures on page 37 of this report Page 21
Regional Equity Strategy 4Q 2009 Strategy Overview: Asia Equity (Malaysia and Thailand, mainly) deficits reached 8%-10% of GDP. That changed in mid-97. When the baht broke from its basket, capital flight ensued in earnest and deficits turned to surplus overnight. Foreigners no longer wanted to lend and locals no longer wanted to borrow. Deficits jumped to surpluses equivalent to 8% of GDP in the Asia-8 (10% in the crisis-4) and averaged about 5% for the next decade. Although China garnered the headlines, it’s important to note that Asia’s current account surpluses were just a China affair – as a percentage of GDP, Asia’s surpluses were about the same whether China was included in the calculations or not. So what about the conventional wisdom that Asia’s growth has relied on running surpluses? And that absent those surpluses, growth will fall? Asia’s experience says the conventional wisdom has it backwards. Asia ran big deficits in P1 and its growth was above-average. It ran big surpluses in P2 and growth was much lower. The truth is, you don’t need surpluses to generate fast growth. In fact, they hold you down. Why? All that surplus output could be driving local investment and faster growth at home rather than abroad. If you want fast growth, borrow from foreigners, don’t lend to them. Capital inflow: Asia might have run big deficits in the precrisis period but inflows more than financed them. Foreign reserves rose in spite of the deficits and currencies faced substantial appreciation pressure. In the post-crisis period, capital flowed out of the country, first as investors fled and later as locals paid down as much external debt as they could (chart right top). Current account inflows turned to capital account outflows almost on the spot. More recently, current account surpluses more than offset capital outflows and currencies have once again faced upward pressure. Indeed, between 2003 and 2007, reserve increases as a percentage of GDP were even greater than during the go-go pre-crisis years (chart right center). finance its current account deficits) and the high domestic leverage ratios that came with it, then damn the torpedoes, Asia didn’t need the IMF or anyone else telling it that things had to change. Asia itself went about cutting external debt – and the baggage that went with it – to the greatest extent possible. Over the next ten years, Asia’s debtor countries cut their external debt from a peak of 40% of GDP to nearly zero by 2007 (chart bottom). Notably, Malaysia and Thailand became net creditor countries during this decade, thanks to high current account surpluses that funded the reduction in external debt. Asia -8 – capital outflow post - 1997 capital account balance as % of GDP 4 2 0 -2 -4 -6 -8 Risk aversion owing to US financial crisis 90 92 94 96 98 00 02 04 06 08 Asia 9 - buildup of foreign reserves as % of GDP USD terms, official + fwd commitments, simple avg 12 10 8 6 4 2 0 -2 -4 90 92 94 96 98 00 02 04 06 08 Asia – net foreign debt as % of GDP ext debt less reserves as % of GDP 50 40 Below, we explain why reserve accumulation and upward pressure on currencies will again be key features in Asia over the next 10 years. External debt: The financial crisis drove home to Asia Polonius’s adage to neither a borrower nor a lender be. If this kind of crisis was the result of cheap foreign funds (foreigners were, after all, sending far more funds to Asia it needed to 30 20 10 0 -10 -20 -30 net debtor net creditor Asia* ex-CH Asia*: CH, KR, MY, ID, TH, PH, IN 90 92 94 96 98 00 02 04 06 08 Page 22
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Regional Equity Strategy 4Q 2009 2)
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Left Brain Right B - the DBS Vickers Securities Equities Research

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