Dear Valued Investors,
It's not politics as usual in Asia, unfortunately. What do I mean by that? Well, over the past decade or so, Asia has been notable for the reformist governments that it put in place. I have mentioned this in past communications. Governments in Asia appear to me, on average, to be more inclined to push for productivity-enhancing improvements in the economy—capital market reform, an increased role for market prices, deregulation, democratization and new legal structures. China has been the standard bearer of much of this reform, and is being used as a model for the least wealthy countries, such as Myanmar, Vietnam and Cambodia, as they start on the road to wealth creation. But what is going on? China seems to be backtracking and Asia is faltering. Is it all as bad as it seems? I would argue not. I think one has to separate the short-term political maneuvering, which is heavily influenced by the economic cycle, from the longer-term trend. Asia is still the home of reform.
First, let's discuss the cycle. Tighter monetary policy in the U.S. and slowing domestic Asian economies are impacting corporate profitability and sentiment in Asia. Governments naturally want to react to this by boosting domestic demand. And for the most part, they are able to do so by fiscal or monetary policy, particularly since current account deficits are positive and rising, U.S. dollar debt is under control and domestic inflation is low. We have seen interest rate cuts in Taiwan, Indonesia and New Zealand, while South Korea maintained its policy rate at a low 1.5%. China has been cutting reserve requirement ratios. We have seen Thailand using tax cuts and infrastructure spending as a way to spur demand. Indonesia, too, seems to be doing a better job on infrastructure.
To be honest, there are some disturbing signs for reformists. Despite the good reform-related headlines coming out of India (relative to China at least), India seems to be stuck in the mud. Headlines from the India Times, such as, “Big reform: Modi government plans to redeploy bureaucrats and reduce patronage postings” do not necessarily fill me with optimism. These are good reforms, yes, but in the larger scheme of things, they may not be that crucial. They may be a sign that reform has to concentrate on the central bureaucracy because that is where Prime Minister Narendra Modi has control; outside of that bureaucracy, perhaps his influence is weak in the states, which he needs for national economic reform. Modi has been unsuccessful at reforming land acquisition laws that would help clear the legal obstacles in the way of implementing an infrastructure program (funding would still be an issue).
Elsewhere, despite glimmers of hope and some improved rhetoric around corporate governance and increasing dividend payments in South Korea and Japan, implementation across firms remains patchy. Old habits die hard. And it is difficult for companies with conservative management teams to break from the old tradition of hoarding cash for the bad times and investing in new, exciting non-core businesses as a means of self-protection. It is particularly difficult for them to do so when they feel threatened by an environment of slower growth. In Thailand, the military government is trying to craft a new constitution that has been criticized for reducing basic freedoms and trying to create new emergency powers wielded by the executive.
Of course, the headlines tend to focus on China. And here it seems that the government is backtracking on reform—tightening capital controls and slowing the pace of financial market reform. But I think this is largely tactical. We have spoken about this before. China has been trying to balance three aims—a freely tradeable currency, a stable exchange rate and an appropriate domestic monetary policy. But you cannot have all three. If your currency is freely tradeable and you increase (or decrease) the supply of your currency, the market will depreciate (or appreciate) your currency. If you wish to fix the currency and allow it to be freely traded, then you have to adjust the money supply to balance the foreign exchange market—but that might not be optimal for your domestic economy. And if you wish to have the right monetary policy and a stable exchange rate, well, you cannot let people trade the currency freely. And that is the decision the Chinese have made. They value a stable currency and an appropriate domestic monetary policy over a freely traded renminbi. So be it. But I believe this is just a tactical response to the market’s weak sentiment toward the Chinese currency. It does not mean a rolling back of reforms. The Chinese government remains committed to making capital allocation more efficient across the economy, raising the role of the market, and making the financial system work better for its ordinary citizens. It just cannot push forward with all of the reforms right now.
Despite all of this, however, our analysts and portfolio managers see signs for optimism. In Indonesia, President Joko "Jokowi" Widodo might have stabilized his control over government, and is looking to spend about US$400 billion from 2015 to 2020 on infrastructure. Foreign companies appear to be responding positively—Indonesia attracted some US$29 billion in foreign direct investment in 2015. Countries like Vietnam and Myanmar continue to push for basic market reforms. Myanmar has been looking once more to establish a stock exchange. And in Japan, despite the patchy corporate reforms, we have seen some aggressive policy initiatives from its central bank, which in many respects is taking the lead in unconventional monetary stimulus globally. So Asia’s reform process has not halted. It continues apace in many countries, in others it has tactically slowed. But the reform process remains there in the background.
Now, how do we deal with this in our portfolios? It would be tempting to think one could time the political cycles and invest in companies with government “backing.” But that is hard to do—and treacherous. Rather, in my colleague Sunil Asnani’s own words about the Matthews India strategy, we try to buy “policy-agnostic companies.” A good company can survive without the patronage of the state. In fact, it is difficult to grow sustainably and efficiently if you rely on such backing. And so, whilst we keep a keen eye on the political climate in the region, we try not to forget that it is the companies themselves, and our ability to analyze and value them sensibly, that dictate investment returns over the long run.
Robert Horrocks, PhD
Chief Investment Officer
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