US decline makes HK/PRC attractive

SchrodersÆ chief economist Keith Wade says these markets wonÆt just survive but will thrive as the American economy goes south.

Today Keith Wade, London-based chief economist at Schroder Investment Management, will make the case to Hong Kong clients and institutions that Hong Kong and the People’s Republic of China will be the region’s bright points in the face of a recession in the US. Indeed, he sees reasons why these markets will benefit in an absolute sense from America’s troubles.

The main points Wade will make at an investor’s conference held at the Hong Kong Exhibition Centre are that year 2001 US GDP growth forecasts have been slashed from 3% to 2% over the past two months; that the Federal Reserve’s funds rate will be cut another 100 basis points; that the dollar will weaken to about parity against the euro and to 115 or weaker against the yen; and that a full-blown US recession is increasingly likely (he gives it a one-in-three chance). Wade spoke along similar lines two days ago to fund managers, securities houses and regulators in Beijing.

The bad news for Asia: broadly this slowdown translates to shaving off 0.6% GDP growth in Asia including Japan and 0.3% GDP growth off Europe for every 1.0% downward revision in the US, mainly because demand in America for imports, particularly technology for industrial capital expenditure, will decline. Compounding this is a cyclical downturn in the semiconductor industry. Asian markets such as Taiwan and South Korea that are especially dependent upon it will suffer more.

And the good news: Hong Kong’s fixed currency means the Fed’s interest rate cuts feed through to here. That will serve as a local stimulant. Hong Kong is of course not part of the semiconductor game. And the decline in the dollar means Hong Kong’s competitiveness gets a boost, smoothing out the painful appreciation Hong Kong’s currency experienced against Southeast Asian units in 1997 and 1998.

The US has been a marvellous place to put your capital for the past five years but the dynamic is changing. That means portfolio money and foreign direct investment will be looking for new homes. Wade believes Hong Kong will be one recipient, prospering from a competitive currency and energizing interest rate cuts. China is another. The PRC’s exposure to the semiconductor industry is minimal and continues to offer tremendous FDI opportunities as it restructures for the coming accession to the World Trade Organization.

Wade is not a fund manager nor a strategist, so he says it’s possible that local markets in Taiwan and Korea have already priced in worries about the semiconductor cycle, or that Hong Kong stock prices reflect the upside of a US downturn. But his message to clients is: “The Hong Kong and China markets will start to think about a recovery with lowered interest rates so investors should rotate from defensive to cyclical stocks.”

A bigger blight on the regional investment scene is not a US downturn but Japan’s return to recession. “Our worry in Asia is Japan,” he says, because Japan’s monetary policy is broken and its fiscal policy is bankrupt. With American growth slowing, Japan is the natural driver of growth, but this possibility, always tenuous, is fading. “The bull story was that consumers would come through to sustain growth,” which peaked in early 2000. That hasn’t happened and Wade sees no other economic driver materializing.

Although fund managers report vigorous corporate restructuring, there is little macroeconomic evidence of this, Wade says. “Productivity can go up with increased output with the same workforce, which is easy during an economic upswing. Fund managers sometimes confuse this with restructuring.”

What Japan needs is to create an environment for real restructuring: “An official at the Bank of Japan recently told me, ‘What we need is a Mrs. Thatcher.’ This means cultural changes; Japanese officials fear having to admit they made a mistake. But they need to wipe the slate clean. They have to reduce public sector debt and clean up private sector bank debts, which probably requires a radical write-off so companies can start again.”

But as none of that seems likely under the Mori administration, Japan will continue to muddle along this year at just under 1% GDP growth. Japan of course has been doing this for a decade, so while Hong Kong, China and the rest of Asia are denied a strong export market, they’ve already adjusted to that. More worrisome is Japan’s export of capital to the region as a growth engine – it is unlikely to happen, Wade says. And should the yen weaken, that jeopardizes continental Asia’s exporters. But Japan remains more an opportunity cost rather than a ticking time bomb – it’s the dynamic US economy that will have a more direct impact on Asia’s fortunes.