The bumpy road to global dominance

If the 19th century belonged to the British economy and the 20th century to the US then many economists believe this century is likely to be dominated by Asia – and by India and China in particular.

The long-term growth prediction in Asia is supported by Goldman Sachs. It has forecast that within 40 years, Brazil, Russia, India and China (known collectively as BRICs) will become four of the six largest world economies. They would usurp France, Germany, Italy and the UK and leave the US and Japan as the other members of the G6.

Goldman came to its conclusions by analysing growth projections for populations, accumulation of capital and productivity in BRICs. It then looked at the effects of these projections on demand, incomes, economic growth and movements in currencies while comparing them to the current G6 economies.

Larger than G6

This suggests India’s economy could exceed Japan’s by 2032 while China’s could be larger than the US by 2041 and everyone else’s by 2016. Taken together, the BRIC economies could be larger than the G6 by 2039. Currently, they are worth less than 15 per cent of G6 economies.

Although China has received the most publicity recently, Goldman says India has the potential to show the fastest growth. It could be higher than 5 per cent over the next 30 years and close to 5 per cent by 2050 if development proceeds successfully.

v Even if this school of thought is correct and Asia offers the greatest growth potential over the next 20 to 30 years, which is not the view of all economists, 2004 has demonstrated how investors will suffer short-term falls and volatility along the way. The Indonesian stock market recently reached a record high while the Philippines hit its highest close since February 2000. South Korea and Thailand have also recently hit five-month highs and Hong Kong reached a seven-month high.

But this follows a turbulent year for Asian stock markets. From April to September, the Chinese stock market fell more than 20 per cent before staging a recovery. After rising more than 100 per cent in 2003, the Mumbai stock market plummeted after everyone was surprised by the Congress party’s election victory on 13 May. In the next two trading days, the stock market fell by 17 per cent. The Mumbai stock market, however, had recovered 8 per cent by 18 May.

The talk about Asia has been dominated by prospects for a soft or hard economic landing in China, which is the driver for much of the growth in the region and indeed the rest of the world. In September, the International Monetary Fund (IMF) warned that economic data presented a mixed picture on whether the Chinese government would secure a soft landing.

Inflation concerns

Steven Dunaway, deputy director in the Asia Pacific department and China mission chief at the IMF, identified two pieces of data as being a cause of concern. “The investment numbers still remain very strong and there is some suggestion that in July investment started to pick up. Another concern is with the inflation numbers. On a year-on-year basis, the inflation rate is 5.3 per cent.

“On a month-to-month seasonally adjusted basis, inflation has been running at around 6 per cent over the past three to four months. A lot of this is confined to food and some energy categories but there is always a concern this could spill over into other components. Also, we are not entirely clear on how much credit growth has slowed down.”

‘The biggest risk for Asia is a weakening in the US dollar that leads to a reduction in Asian exports’ Mark Mobius, Franklin Templeton

But fund managers argue that when economists talk of a hard landing they are referring to growth rates of 5 to 6 per cent, which would not be disastrous. The IMF believes Chinese economic growth will slow to between 7.5 and 8 per cent in the second half of 2004 and 7.5 per cent in 2005 compared with 9.1 per cent in 2003.

Hugh Young, manager of the €405.51m Aberdeen IF Asia Pacific fund, believes slower economic growth in China could even be beneficial. According to Mr Young, this should lead to a more “sustainable growth and will be healthy for the economy even though it will detrimentally affect earnings in the short term”.

But Mr Young is cautious about stocks listed in China. “We cannot find any companies in China we like at prices we feel offer value. We do not believe the quality of management is very good and there are a lot of dull companies in China.”

He prefers companies listed in Hong Kong that operate in China.

Over the past three and five years, Mr Young’s Aberdeen IF Asia Pacific fund has outperformed the S&P/Citi BMI Asia Pac ex Japan index. The fund returned 74.45 per cent over three and 69.4 per cent over five years, against 57.93 per cent and 49.22 per cent for the index.

Record attendance

Mark Mobius, legendary manager of the €861.43m Templeton Asian Growth A dis fund, has outperformed the index over three years with a return of 67.85 per cent, but underperformed over five years with 11.93 per cent.

Mr Mobius is confident about Asia for a number of reasons, including the fact that an annual Credit Lyonnais conference in Hong Kong in early September was attended by a record number of fund managers. The greater confidence in Asia is reflected in tighter spreads between emerging market bonds and US Treasuries, which Mr Mobius says have come down from 14 per cent to 4 per cent.

“We are confident about prospects for India and China because they have large populations and per capita wealth is increasing,” says Mr Mobius. “This is leading to greater consumer spending on such goods as washing machines, TVs and fridges. There is an aspiration among the population for goods.”

Mr Mobius is also optimistic about China avoiding a hard economic landing. “The Chinese government is quite skilled at managing the economy. It still owns all the major banks and can therefore control lending policies. In some coastal areas, companies have been finding it harder to find quality staff at reasonable wages. They have thus been moving inland to where wages are lower.”

The most significant risk to Asia does not come from the region but from the US, says Mr Mobius. “The deficits in the US may cause a further loss of confidence in the US dollar and treasuries. US rates may have been raised because of the difficulty of selling treasuries. The biggest risk for Asia is a weakening in the US dollar that leads to a reduction in Asian exports which is not offset by an increase in domestic consumer spending. There is a 50:50 risk of this happening.”

Still ticking up

Jason Pidcock, manager of the €435.99m Mellon Asian Equity fund, believes Asia is the long-term growth area of the world. “Valuations remain reasonable, earnings are robust and corporate governance is improving. In spite of the recent high oil prices, Asian markets are still ticking up because the low interest rate environment continues to underpin equities.”

He adds that rising levels of domestic demand are the key to growth at the moment. “We expect the current trend of outsourcing to the region to continue. Wage levels remain very low in relation to more developed economies, enabling cheaper construction of factories and lower fixed production costs. This, in turn, helps stimulate domestic demand for Asian goods and services. Workers increasingly have more disposable income that they are prepared to spend on higher value items such as cars and consumer electronics.”

‘A significant slowdown in China could have an adverse effect on Asian markets in general’ Jason Pidcock, Mellon

According to Mr Pidcock, the threats to this optimistic scenario include terrorism or the threat of terrorism that could lead to a fall in stock markets in Asia.

He adds: “The rate and timing of any increase in US interest rates by the Federal Reserve could also have an impact given that many Asian countries’ currencies are pegged to the US dollar.

“Of course, a significant slowdown in China could have an adverse effect on Asian markets in general. As a result, we have an underweight direct exposure to China but have maintained our levels of indirect exposure to China through Hong Kong and other markets. Even though I do expect some deceleration in China’s economic activity, I think Hong Kong and the south-east Asian region can continue to grow rapidly.”

It is not just Asian fund managers who are confident about prospects for equities in the region, however. Gary Potter, co-manager of the Credit Suisse Portfolio Service, believes investors should look beyond the short-term volatility.

He says: “In terms of macro economics, there is an almost unstoppable force behind China and Asia in general.

“The economy may slow but China cannot afford to suffer a hard landing because of the number of people moving from rural areas to cities. China needs to create one million jobs a month to cope with the movement of migrants.

“The 10-year story for wealth creation and the growth in demand in China is compelling. This has positive implications for the whole region. Most fund managers gain exposure to China through companies listed in Hong Kong, Taiwan and Singapore. But if China suffers a downturn, investors gain protection by investing through these three countries.”

Among the funds recommended by the Credit Suisse Portfolio Service are Aberdeen Far East Emerging Economies, Atlantis Asian Recovery, Solus Eastern Enterprise, Invesco Perpetual Pacific and Close Finsbury Far East Recovery.