Asian Markets Battle Inflationary Pressures

Manufacturing hub China is facing a cash crunch and dropping manufacturing numbers. Inflation figures have also come in higher, as was expected, with Indonesia witnessing a steep jump following the recent fuel price hike.

Vikas Gattani is the founder and CEO of Progress Capital, a fund management and independent asset management house that was set up in 2007 and is a registered fund management company under MAS, Singapore. Vikas has a wealth of investment experience across a range of asset classes spanning equities/fixed income/currency/commodities and the real estate sector in global markets. Progress Capital has launched several unique and investor-friendly investment products to cater to needs of high net worth clients of private banks and other independent asset managers.

Vikas is a Mechanical Engineer from the University of Mumbai and an alumnus of IIM, Ahmedabad. Having begun his career in 1990 in Project Finance with ICICI, Vikas is a seasoned financial industry veteran with over 23 years of experience in capital markets in Asia, Australia and India. He has been involved in trading and investment management in the Asia Pacific financial markets for several years. Formerly the CIO of the internal hedge fund group of JP Morgan Securities, Asia, he has also formerly run the Asian Proprietary Investments group at Merrill Lynch, Hong Kong.

The PMI and inflation numbers for countries across Asia were released over the last fortnight, while the markets simultaneously weighed comments by various officials from the Federal Reserve on the outlook of asset purchases. The markets pared the losses recorded in the two weeks ending June 21, with China being the only major exception.

China Deals With A Cash Crunch…

A quick look at the money-market rates in China suggests that the country’s officials have been fairly successful in addressing the cash crunch. The People's Bank of China (PBOC) used reverse-repurchase agreements to inject funds into selected banks after a spike in the interbank lending rates. Subsequently, the overnight repurchase rate dropped to 8.43 per cent after hitting 13.44 per cent earlier, while the seven-day rate fell to 8.5 per cent from over 11 per cent. The rates are now approaching historical averages, with the overnight rate falling to 3.79 per cent and the seven-day rate at 4.75 per cent as of July 2.

Reassurances by senior officials also went a long way in curbing market volatility. Shang Fulin, Head of the China Banking Regulatory Authority, sought to quell fears of an impending crunch. He maintained, “The issue with tight liquidity in the interbank market has started to ease”.

…While Indonesian Policy Makers Appear Hawkish

Domestic fuel price hikes have finally materialised in Indonesia after the parliament voted to approve the 2013 budget revisions in a plenary session. The prices of retail gasoline will increase by 44 per cent to Indonesian rupiah 6500 per litre, while diesel prices will rise 22 per cent to Indonesian rupiah 5500 per litre. The move is expected to further ease external pressures after Bank Indonesia (BI) raised both the FASBI deposit rate and the BI rate by 25 bps to 4.25 per cent and six per cent respectively. Further monetary tightening looks likely, as there will be an increasing need to control inflation expectations and minimise second round price effects subsequent to the fuel price hike. Inflation hit 5.9 per cent in June from 5.47 per cent a month earlier.[PAGE BREAK]

The Manufacturing Outlook Remains Sanguine…

On the economic front, industrial production across Asia showed weakening trends as Korea witnessed an unexpected drop in industrial output to a seasonally adjusted annual rate of -1.4 per cent. In line with the drop in IP, Korea’s manufacturing activity contracted for the first time in five months, as the HSBC PMI stood at 49.4 in June against 51.1 in May. The manufacturing PMI in Hong Kong fell to 48.7 in June from 49.8 in May, and the HSBC PMI for Indonesia stood at 51, down from 51.6 in May.

In China, however, the manufacturing PMI for June came in marginally above the midway level at 50.1. It stood at the same level in February this year, but this was followed by a subsequent jump to 50.9 in March, the highest in 15 months. This time around, the question is not whether we can expect a similar bounceback but whether the current level really signals manufacturing activity slowing down in economy.

In evaluating this, it should be kept in mind that a level of 50 in China is not the same as that in the US. In China, a reading of 50 implies nine per cent industrial production growth, whereas a 55 puts you close to 15 per cent. Considering the new normal of seven per cent GDP growth, those numbers seem pretty good. While manufacturing activity has definitely eased from the recent levels, this is also in line with the government’s intent to have greater control over the economy before moving to the next phase of development.

In other news, China’s Services PMI slowed to a 9-month low of 53.9, but remained comfortably above the 50 mark.

…While Inflation Keeps in Line With Expectations

The latest data releases show that consumer prices in Asia remained roughly in line with expectations, with a minor standard deviation in most cases. Inflation numbers were slightly higher compared to those in the previous month, barring the data for Hong Kong and Korea. While Korea CPI’s remained unchanged on a yearly basis, the core CPI was down from 1.6 per cent to 1.4 per cent. The slight drop in Hong Kong, as expected, was led by a fall in overall food inflation from 5.2 per cent to 4 per cent.

The big story, though, is Indonesia, where the fuel price hike caused inflation to accelerate in June.[PAGE BREAK]

Market News & Views

The Asian markets have seen some recovery in the last two weeks, given the aggressive sell-off upto the third week of June 2013. However, rising interest rates on the possibility of Fed tapering off quantitative easing and a strengthening USD continues to weigh heavily on Asian equity/fixed income markets as well as currencies.

The MSCI Asia-ex Japan equity markets currently trade at about 11.2x PE and about 1.2 Price/Book Value. At these levels, MXASJ is now close to the trough in terms of valuations as seen in the past three-four crisis/sell-off periods. However, given the rising interest rates, increased investor interest in the developed markets of US and Japan, fund outflows from the emerging markets and the current summer slowdown period, markets could remain lacklustre in the next few weeks until the interest rates scenario unfolds completely.

As regards the currencies, the SGD, which was at 1.22 on Dec 31, 2012, has now weakened to SGD 1.285 levels against the USD, a fall of about five per cent. Of course, the Indian rupee (INR) and the Indonesian rupiah (IDR) have borne most of the weakness in Asian currencies, given the high current account deficits and declining foreign reserves position of the respective countries. The two could continue their decline given the weakness in public finances in these economies. Pressure on the IDR may be somewhat alleviated given the recent aggressive rollback of fuel subsidy. However, the INR could be in for more troubled times given the scheduled repayment of foreign debt worth about USD 140 billion maturing in the next 12 months.

Gold as an asset class continues to show weakness. As this author has maintained over several months now, it has already reached the first target of USD 1200/oz and could weaken further to the USD 1000/oz levels in the next few months if the USD interest rates show further strength. Buying from Asian consumers, particularly Indians, will weaken as a result of falling currencies and import duty measures. This will result in further pressure on the yellow metal.

A number of big global gold producers have engaged in significant capex plans over the last few years. With current production cost of gold at about USD 1200/oz, this additional metal would be offloaded aggressively by the producers, thereby flooding the markets further as the inventory holding capacity of these producers is quite low. Besides, exchange traded fund (ETF) products linked to gold held a significant tonnage of about 2500 tonnes at the end of last year. Given the rising interest rates, even the increased consumption by countries like India and China is not capable of absorbing this kind of offloading as and when it takes place.