Brexit: Expect the unexpected in Asia

Financial and psychological tremors likely to impact Asia beyond just trade links.

While Britain may be rejecting a supranational political structure, investors and borrowers in Asia can ill afford to ignore potential contagion from interconnected markets.

As Asia braces for yet another summer of extreme market volatility, contagion could come from the yen’s tendency to strengthen in times of turmoil, a slowdown in growth as Brexit uncertainty saps trade with Europe and a flight to the US dollar from Asian currencies.

“We caution not to underestimate the depth and reach of financial market contagion to Asia,” said Nomura strategists in a note to clients as they trimmed their 2016 GDP growth forecast for Asia ex-Japan from 5.9% to 5.6%. Most of the impact is expected in the financial hubs of Hong Kong and Singapore.

Corporate finance bankers polled by FinanceAsia expect a short-term slowdown in deal making due to extreme price volatility.

"There will be a long period of uncertainty, which is bad for corporate finance,” said a head of Japan investment banking at a global investment bank.

Bankers expect a hiatus of bond issues as spreads widen. In equity markets, issuers may also suspend some of the less popular deals until markets settle down.

“The stock market performance next week will be crucial for banks to gauge investor sentiment. There are a number of ongoing IPOs in Asia that are likely to proceed as usual but it remains to be seen how detrimental the UK decision is to other equity transactions in the pipeline,” said Niccolo Manno, head of Asia equity deals' syndication at JP Morgan.

However, in Hong Kong, where cornerstone investors have been buying over half of recent deals in recent months, IPOs are likely to be more robust than in other financial markets. Deals in the pipeline, such as the $7 billion to $8 billion IPO by China’s Postal Savings Bank, are likely to carry on regardless as pledges of cornerstone support have already covered a large tranche of the offering, according to market sources.

Businesses considering making a purchase in the UK will undoubtedly be attracted by the immediate 10% drop in sterling although longer-term uncertainty regarding new regulatory regimes and parallel competition law enforcement could well outweigh foreign exchange considerations.

M&A bankers said that in some respects British companies will become less attractive.

“The strong yen makes overseas assets cheaper so outbound M&A will continue. However, UK assets will not be as attractive to Japanese buyers given the uncertainty and UK companies can no longer act as a platform for expansion into Europe," said the head of investment banking based in Tokyo.

Japan

In 2008, bureaucrats and financiers rushed to reassure that Japan’s financial system was sound given the relative conservatism and domestic focus of its banks. Just a few months later, Japan’s exporters were hit by a stronger yen and laid off temporary workers, shocking a nation that had always prided itself on equality and low levels of unemployment.

Borrowers and investors should therefore continue to expect the unexpected. Japanese investors have bought bonds across emerging Asia in record amounts in recent years as they search for yield outside their own zero interest rate economy. Meanwhile, Japanese banks have also sharply raised their lending exposure to Asian companies that are faster-growing than their domestic customers.

Both portfolio outflows and withdrawal of credit by foreign banks in the wake of Lehman Brothers' collapse dented growth in Asia.

Economists and corporate financiers expect the Bank of Japan to act in the face of an overly rapid climb of the yen. Direct intervention is certainly one possibility, as well as additional monetary easing and a move deeper into negative interest rates.

More broadly, corporate financiers are convinced that central bankers would ride to the rescue once again and prop up markets with another barrage of interest rate cuts and quantitative easing.

Brexit may have tipped the scales further in favour of easing in Australia, New Zealand, Korea, Japan, China and Thailand.

But how much dry powder do Asian governments have left? They have spent plenty of ammunition battling the global economic downturn in recent years and markets’ confidence in the power of monetary easing is diminishing rapidly as zero interest rate economies such as Japan continue to flirt with recession.

HSBC’s Frederic Neumann, co-Head of Asian economic research, noted that India, Indonesia and Malaysia are particularly constrained by currency weakness which risks either stoking price pressures or tightening financial conditions (or both). Fiscally Thailand and Taiwan, are also feeling the pinch.

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