End of cheap money hits Asian groups; Few companies have hedges against strengthening dollar

Asian groups struggle with end of cheap money

By Henny Sender

Few companies have hedges against strengthening dollar

Hong Kong-based hedge fund Senrigan Capital is suing Thailand’s Charoen Pokphand Group over the compensation it says it is owed as a shareholder inSiam Makro, a Thai retailer that CP is acquiring. The dispute revolves around the appropriate exchange rate between the baht and the dollar. If the investors prevail, it could raise CP’s transaction costs by millions of dollars. The dispute is one of many complications materialising across the region as the dollar strengthens dramatically against emerging market currencies – a surge that few companies in Asia anticipated and fewer still had hedged themselves against.Meanwhile, China, long a bullish factor for its neighbours, will no longer have such a positive effect as it seeks to move away from its investment-heavy economic model. That shift will cut its consumption of commodities produced by its neighbours, while China’s demand for services – by definition local – will increase.

The combination of China’s slower growth and the prospect of imminent tapering of the Federal Reserve’s quantitative easing programme are taking their toll in Asia. India and Indonesia have been the hardest hit, but the impact has been felt elsewhere. There may be worse to come as what Morgan Stanley refers to as “The Great Unwind” proceeds and brings higher capital costs in its wake.

One of the sources of stability for the region in recent years has been the level of the Chinese renminbi. The region has largely benefited from the fact that China has let its currency appreciate, despite the pressure on exports from a dramatically weaker Japanese yen. Indeed, the most profitable trade for many Asian hedge funds for the first half of the year has been to borrow yen and invest in Chinese renminbi short-term bonds and certificates of deposit, pocketing gains both from the appreciation of the currency and from attractive interest rate differentials.

But while China’s export performance has held up surprisingly well, many analysts think the country will soon reverse course and let the renminbi weaken to put more pressure on regional competitors. A reversal in the Chinese exchange rate could lead to more volatility and pressure on the region.

One of the problems facing Asia is that it is far more indebted than it thinks it is. Corporate Asia has proportionally more debt than companies in any other region, according to Morgan Stanley. By the end of last year, corporate borrowing in Asia exceeded the previous peak in 2008.

Many banks across the region are reaching the upper limits of their lending capacity compared with their deposits. Because the region has less excess savings, deposit growth is already slowing. Much has been written about the plight of Indian institutions, particularly state-owned banks. But they are hardly alone in their challenges. The Thai banks have had the fastest credit growth in the region, with total loan to deposit ratios above 90 per cent, while foreign currency denominated loans are at 200 per cent, Morgan Stanley found.

Local banks in the region are tightening borrowing conditions more than their counterparts in the developed world or in emerging markets. That in turn means higher funding costs, slower growth and pressure on earnings, at the same time as company fundamentals are deteriorating. Banks continue to provide well over half of funding for most Asian companies.

Companies have been issuing dollar bonds because interest charges have generally been far lower than at home. But now they are finding the potential maths daunting in the US capital markets as well. US dollar rates are rising at the same time that the dollar is strengthening, and the cost of hedging is also climbing.

It is hard to see where the funds will come from to change these sobering dynamics. China is tightening at the same time as the US, as it moves to restrict its shadow banking system, which will also have a damping effect on its neighbours. Recently, China Development Bank, a state-linked bank that is under less pressure than its listed counterparts to deal aggressively with problem loans, recently pulled the plug on a Bangladeshi telecoms company to which it had lent money. Moreover, Chinese borrowers could potentially compete more aggressively with other Asian borrowers in the US bond market.

The region has always considered itself fortunate. But with outflows from emerging markets equity and bond funds totalling $60bn over the past three months alone, that good fortune does not seem to include cheap, sticky money any longer.

Henny Sender is the Financial Times’ chief international finance correspondent