A Painful ‘Recoupling’ for Markets; Korea decouples from emerging markets?

2013-08-26 17:39

Korea decouples from emerging markets

By Kim Rahn
Korea has been moving differently from other emerging Asian nations that have seen economic turmoil in recent weeks. While economic data of countries like India and Indonesia have turned negatively following outflow of foreign capital amid fears of the U.S.’ stimulus cut, those of Korea have shown only little fluctuation. For the past month, Indonesia’s sovereign credit default swap (CDS) premium, a barometer of risk-hedging costs for a country on sovereign or corporate debts, rose from 194.44 basis points (bp) to 286.43 bp. A basis point is 0.01 percentage point. However, Korea rose only 2.66 bp from 82.50 bp to 85.16 bp.CDS is a type of insurance against possible defaults of payment on underlying debts by a country of a company, and the CDS premium is a form of spread. An increase of the premium indicates the country or a company has a higher chance of default.
The premiums of the two nations used to move similarly until the end of July.
The CDS premium of the State Bank of India, India’s largest state-run bank, also jumped 116.52 bp from 255.57 bp to 372.08 bp. The bank’s CDS premium is regarded as an index for the country’s default risk.
As to exchange rates, both the Indian rupee and the Indonesian rupiah fell against the U.S. dollar by more than seven percent for the past month, but the Korean won fell by less than 0.38 percent.
In stocks, foreigners’ net purchase of Korean shares was worth $171 million during the past week, according to Hyundai Securities. But foreigners’ net stocks sold were worth $437 million and $513 million in the Indian and Indonesian stock markets, respectively.
Experts say such decoupling has come as the market is distinguishing Korea from those emerging countries in terms of economic fundamentals.
“Korea has kept a current account surplus. We have better fundamentals than other emerging markets. For now it is unlikely that foreign funds will flow out of the country,” said Choi Ho-sang, researcher at the Korea Center for International Finance.
He said the level of Korea’s foreign reserves is good, unlike during the Asian financial crisis in 1997 when the nation did not watch reserves properly.
Many investment banks have also said investment in Korea is preferable than that of India and Indonesia as well as Malaysia and Thailand that may get spillover from the turmoil.
BNP Paribas said in a recent report that Korea has had a strong trade surplus, its foreign reserves have climbed, and short-term external debt has fallen.
“With the Korean won continuing to look cheap on a real effective basis and the Bank of Korea retaining scope to ease monetary policy given low inflation, the Korean won has emerged, at least in relative terms, as a regional safe haven, continuing its sea-change,” the report said.
Tim Condon, ING’s head of research for Asia, said the state of a country’s current account has become a decisive factor in investment.
“A clear dividing line has emerged in terms of whether an economy is running a current account deficit that is widening or a current account surplus that is increasing,” he was quoted as saying by CNBC. He added India and Indonesia are in the former group, and Korea and Taiwan in the latter group.
Choi said U.S.’ tapering means the country’s economy is improving, which will be good for Korea as exports to the U.S. will increase, leading to an increasing current account surplus.

Aug 26, 2013

A Painful ‘Recoupling’ for Markets

By Francesco Guerrera

So much for “decoupling.” For the past month or so, currencies and markets from emerging countries ranging from Brazil to India have been hammered by events happening thousands of miles away.

The expectations of an imminent end to the Federal Reserve’s unreserved monetary stimulus has prompted investors to bail out of countries once feted for their high growth rates and appetizing bond yields.

Unlike Vegas, what happens in Washington (or, last weekend, Jackson Hole, Wyo.) most definitely doesn’t stay in Washington.

It is perhaps time to talk about “recoupling.” Emerging markets reliant on foreign capital are exhibiting more violent reactions to adjustments of U.S. macroeconomic policy than the U.S. itself.

When compared with the slump in emerging-market currencies and stocks, the reaction of U.S. bond and equity markets to the threat of tighter U.S. monetary policy looks subdued.

Sure, U.S. Treasurys yields have spiked and equity markets have been wobbly, but that is nothing compared with the bad news coming from the developing world. Here is a sample: The Indonesia rupiah is trading about its lowest levels against the U.S. dollar since 2009, the India rupee has hit a series of record lows, and only Thursday night’s announcement of a large government intervention was able to lift Brazil’s real off a four-year low. Equity markets have followed suit, with countries like the Philippines also being dragged into the mess.

Koon Chow, head of emerging-market strategy at Barclays PLC dubbed the trend “trading places.” “The focus has shifted: investors seem to view emerging markets in a dim light compared with developed markets,” he wrote in a note to clients last week.

As the potential for higher U.S. rates lures capital back to developed markets, two questions arise: Are we on the verge of another crisis like the one that struck Asia in 1997-98? And what will the reversal of a trend that saw money borrowed in the West flow to the East and South mean for developing and developed countries?

The first answer is easier: No. The current period of turbulence falls well short of the ruinous conditions seen during the Asian crisis.

The parallels are tempting. Many of the poorly performing currencies, led by the real and the rupee, are issued by countries running current-account deficits. In 1997-98, an outflow of foreign money from countries in similar situations sparked currency collapses, banking turmoil, corporate defaults and, ultimately, a crippling recession.

Current-account deficits are only part of the story, though. Back then, many Asian currencies had fixed their exchange rates to the dollar, an inflexible system that broke instead of bending when foreign investors left. Today, most of the currencies float, giving markets and governments more breathing room.

Foreign-exchange reserves—another sore point in 1997—are much higher today. In India, the market worst hit by the latest troubles, foreign reserves cover seven months of imports. That is twice the average for Asian countries in 1996, according to Capital Economics. And external debt as a percentage of gross domestic product—a measure of a country’s reliance on foreign capital—is much lower now than it was then.

That doesn’t mean that this is a passing squall. Emerging markets’ shift from capital recipients to capital donors leaves policy makers with what HSBC PLC’s equity strategist John Lomax calls a “trilemma.” Central bankers and governments will have to pick among three unpalatable options: higher rates that choke off economic growth; a faster economy but higher inflation; and/or capital controls to stem the outflows.

“Whichever ‘solution’ they choose turns out to be equity market negative,” Mr. Lomax wrote to clients last week. In fact, his research suggests that the outlook for stocks in economies with current-account deficits “is almost entirely hostage to the outlook for U.S. bond yields:” the higher the yields—a proxy for future U.S. rates—the lower developing countries’ shares.

The irony is hard to ignore. Remember the invective by Guido Mantega, Brazil’s finance minister, who in 2010 accused the U.S. of waging a “currency war” by pushing the dollar lower with zero interest rates? Now his and other countries have been hit hard by a reversal of that very policy.

As for the developed world, the influx of new capital is likely to find its way into higher-yielding instruments such as “junk” bonds and, possibly, stocks. But the move could prove temporary: Some fund managers already are being tempted back into emerging markets by the bargain prices on offer.

One thing is certain, global financial markets aren’t decoupling any time soon. Now more than ever, it pays to look beyond national borders.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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