Investing in the Asian economic recovery

t seven months of this year while the Chinese market gained more than 80% in local currency terms over the same period (SSE 30 B shares index). But other markets in the region suffered large losses with Singapore down 16% in euro terms and Hong Kong down 11%.

Not Latin America

Although investors usually consider emerging markets as a whole, without differentiating between regions, it is important to emphasise that there are fundamental economic differences between them. For example, there are substantial differences between East Asia and Latin America.

First, it is important to remember that East Asia has already experienced a financial crisis. This crisis involved substantial devaluations for most of the region’s currencies and the abandonment of the system of fixed exchange rates (except for Hong Kong - whose currency is still linked to the US dollar - China and Malaysia).

The second great difference is that the currency devaluations have made exports from the Asian economies more competitive. So trade, directed mainly to Japan and the United States, has powered the recovery. In some countries – including Hong Kong, Malaysia and Singapore - the exports to the world’s two largest economies represent more than 30% of their GDP (1999 data).

In contrast, exports to the United States and Japan represent as little as 1% and 2% of GDP for countries like Brazil and Argentina respectively (1999 data). The main exception is Mexico which borders onto the United States so has to be considered differently.

Technology exports

But it is also important to recognise - and this is fundamental to understand the present situation - that Asian exports towards the United States and Japan have a strong technological element (mainly in electronic equipment). This is why East Asia benefited so much from North American growth in the second half of the 1990s. It also explains how the region recovered from its crisis so quickly.

The financial situation of the East Asian economies is also much better than that of Latin America. One of the positive consequences of the 1997-98 Asian crisis was the drastic diminution of their external short term debt and the reconstruction of their currency reserves. In contrast, the Latin American economies, most notably Argentina, are much more indebted and much more dependent on foreign capital.

This macroeconomic situation explains why the greatest risk facing East Asia is the present slowdown of the American economy in general and the technology sector in particular. The Asian Development Bank has forecast that GDP growth in most of the region will fall well below 5% this year compared with levels of 6% in 1999 and 7% in 2000. Some experts even indicate that a quick recovery in the United States would not lead to an immediate rebound in the region because of technological overcapacity.

The greatest problem facing the East Asian economies is that they became so preoccupied with exports to the United States and Japan that they forgot the importance of domestic demand. In addition, they also face the prospect of a weak yen which could in turn hit their exports.

Finally, there is also a political risk in some countries – such as the Philippines or Malaysia - which could trigger new crises in the region.

Chinese potential

China, without doubt, constitutes a special case within Asia as its growth model does not conform to the same pattern as that of the other Asian economies. Its growth (7.8% - as of June 2001) depends much more on domestic demand than on exports. As a result it is less affected by the American slowdown. But the country also faces important challenges.

First, there is its future integration into the World Trade Organization. This will represent an important step towards the creation of a market economy with the suppression of tariffs and entry barriers. It should also lead to the attraction of foreign capital to sectors such as banking, telecommunication and distribution.

Second, there is the organisation of the Olympic Games in 2008 in Beijing. This event should create an extraordinary impulse towards economic development.

Finally, there is the financial reform that the Beijing government has initiatied. For example, in February is authorised Chinese investors to buy " B " shares in the Shangai and Shenzen stockmarkets - a category until then exclusively reserved for foreign investors and denominated in dollars (Chinese investors could only buy “A” shares denominated in yuan). The reaction was explosive. In March alone the SSE 30 “B” index of the Shaghai stockmarket increased by 70% (as opposed to only a 7% for the A shares) and the Shenzen B index more than doubled over the same period.

The Chinese government also intends to introduce investment funds in the form they are known in the West - until now there have only been a few closed investment funds - and to authorise pensions funds to invest a part of their capital in shares.

In addition it should not be forgotten that the Chinese economy, like those of all Asian countries, needs a profound reform of its banking system. At present it still suffers the inefficiencies of any state-directed system.

Practical investment

The difficulty of buying Asian shares and the problems involved in getting information on Asian companies explain why funds are suitable instruments for those who want to invest in the region.

There are basically two types of investment funds: those that diversify across the region (often with a high weighting in the Hong Kong stockmarket) and those that restrict themselves to a single country.

Naturally regional funds are less risky than country funds but, in any event, it is important to recognise that all the Asian markets are highly speculative. This is not just because they are emerging markets but also because many Asian investors enjoy taking a punt on the markets.

Fernando Luque is the senior financial analyst at Morningstar in Spain.