Asia’s transformation from its economic anonymity decades ago to a vital engine of global growth has been remarkable. Much of this has been attributed to the rapid rise in the Chinese economy. However, the emerging importance of ASEAN to the region cannot be denied. According to the Asian Development Bank, if ASEAN were one economy, its combined GDP of USD 2.4 trillion in 2013 would have ranked it seventh largest in the world. With a population of over 600 million, the burgeoning workforce’s spending power is driving domestic growth and dilluting dependence on the Western world.
Looking back to 2015, ASEAN markets demonstrated dismal performance, prompted by a weak global growth backdrop, falling commodity prices, broad-based USD strength and market anxiety over anticipation of the Fed lift-off. During the period, ASEAN markets underperformed their North Asia counterparts, attributed largely to ASEAN’ s sensitivities (in terms of export receipts and tax revenues) to gyrations in commodity prices. As selling pressure on ASEAN currencies intensified over the year, monetary authorities actively intervened, leading to depletion of FX reserves. And in Malaysia, domestic political concerns further exacerbated the already poor sentiment, leading to persistent capital outflow.
Chart 1: Performance of Asia Currencies and Bonds
Source: Bloomberg, HSBC Asia local bond index, as of 29 February 2016
Chart 2: ASEAN outperforms EM
Source: Bloomberg, HSBC
Three months into 2016, we have, however, seen a reversal of performance among ASEAN countries. ASEAN markets (both FX and bonds) staged impressive rallies and outperformed most other EM markets, including North Asia.
What change led to this reversal of fortunes?
First, the much anticipated Fed lift-off proved to be more bark than bite, and with the Fed indicating that it would adopt a gradual approach to raising interest rates, USD bulls retreated. Coupled with entrenched negative rate policies in Europe and Japan, the hunt for carry is back on investors’ minds, making EM a desired investment destination once again and re-igniting the case for diversification into Asia. And amongst the EM bond universe, ASEAN is one of the favored choices, given its decent risk adjusted real returns relative to other markets.
Chart 3: Given negative interest rate policy in Japan, Japanese investors have been investing into EM bonds, with ASEAN markets being some of the favoured beneficiaries
Source: MoF Japan, HSBC (1st Jan 15 to 31st Jan 16)
Chart 4: Current Account as a % of GDP vs. Real 10-year yield
Chart 5: Singapore offers the highest real 10-year yield among AAA-rated countries
Second, the decline in commodity prices – a pivotal factor in ASEAN’s underperformance last year – has ceased. Commodities and energy prices are showing signs that they may have bottomed, helping ease downside pressure on commodity-related assets – in particular, Malaysian and Indonesian assets. In fact, in mid-March, Moody’s revised its outlook to stable from negative for six national oil companies in South and Southeast Asia, citing strong balance sheets and government support.
Chart 6: MYR and IDR are rebounding along with commodities like palm oil and rubber
Third, growth in the key ASEAN countries of Indonesia, Malaysia, Thailand and the Philippines registered better than expected in 2015, demonstrating the resiliency of ASEAN growth to global headwinds. In particular, the Philippines has been delivering impressive GDP growth of about 6% for the past few years, underpinned by robust domestic demand. While the slowing Chinese economy is expected to drag on North Asian economies given the strong trade and financial linkages, the economic impact of a slowing China on ASEAN economies is smaller. For example, exports to China from Taiwan and Korea contributed about 22% and 12% respectively to their GDPs; whereas, in Indonesia, the contribution of exports to China is a mere 2% of GDP.
Lastly, the developing domestic story in individual ASEAN countries is equally comforting. In Indonesia, inflation has eased significantly, providing decent real yields for bond investors and providing ample room for monetary authorities to ease policy rates, if required. In addition, positive reform measures in Indonesia have increased the possibility this year of a credit rating upgrade to investment grade by Standard & Poor’s. Political noise in Malaysia has subsided somewhat, and we expect no change in the country’s leadership in the near-term, ensuring the continuity of economic and fiscal reforms. And in Thailand, the military government is planning to increase FY 2016 investment spending, to the highest in seven years, to spur economic activities in the ailing country.
The strong dynamics of ASEAN will be increasingly alluring to investment managers in the current low yield global environment. Stable current accounts, low government debt levels, benign inflation, diversified trade partner dependence and decent real returns make ASEAN an attractive choice for investment diversification. Over the longer-term, mega-infrastructure projects such as the Singapore to Kuala Lumpur High Speed Rail, Thailand’s development of its countrywide rail network, and projects under China’s “One Belt, One Road” scheme will further propel ASEAN’s growing role in the global economy. Barring another round of commodities price collapse, global risk events or an aggressive pace of Fed hikes, ASEAN is a strong option for a long-term diversification investment in a global portfolio, and is, thus, an EM asset class worth watching.