How the war in Ukraine is reverberating in Asia
Our Head of Asia Macroeconomic Research, Dong Chen, and Global Strategist, Alexandre Tavazzi, discussed the consequences of the latest developments in Ukraine for China and the region as well as possible implications for investors.
The Asian economy
As with the rest of the world, the current war will have an impact on Asia’s economy. Because the direct economic ties between Asia and Russia are fairly limited, surging energy prices will have the strongest effect. Several Asian countries are highly reliant on oil imports, including Thailand, India and South Korea. However, those with strong current account balances (South Korea, Thailand, Vietnam) should be able to absorb external shocks better. Meanwhile, the structurally weak countries in the region like India and the Philippines need more caution.
Where China is concerned, the direct impact will be more limited due to its size, diversified economy and government control over its supply system allowing it to better absorb external shocks. Russia is far more dependent on China than on any other trading partner. Nearly 25% of Russian imports come from China, and 15% of Russian exports go to China. This dependence is likely to only grow, especially in exports. Meanwhile, Chinese imports from and exports to Russia account for only around 2% of the total, creating a very asymmetric relationship. In the long-term, this could help drive forward the Chinese government’s agenda, including the increased internationalisation of the RMB.
The Chinese economy still faces strong headwinds, making us cautious on the near-term outlook. First, the property slowdown engineered by the Chinese authorities to deleverage property developer has created a liquidity crisis that does not yet show signs of improvement. Second, as China maintains its zero-covid policy, consumption will continue to take a hit as many Chinese cities remain under lockdown conditions, especially as more contagious covid variants take hold, like Omicron is currently.
We will be watching for more Chinese government policy support on both the fiscal and monetary fronts and will only revise our overall view if we see meaningful improvement there.
What this means for markets
Globally, investors face a more difficult and volatile environment than last year. However, it is not all negative in our view, with some pockets of opportunity.
The US yield curve shows that as markets adjust their expectations around the Federal Reserve’s interest rate rising plan higher. Investors are being well rewarded for risk taken following the recent correction. This is true for Asian issuances as well, which follow the US curve. High quality issuers up to five-years, especially between up to three-years, provide attractive returns prospects to investors.
The bifurcation in credit markets creates an attractive proposition to active investors. High quality issuers are seeing their yields come down. At the same time, in the high-yield segment, yields are nearing their highest levels, with Chinese high-yield bond yields continuing to drift up despite the Chinese government’s intentions.
Is it time yet to re-enter Chinese equities?
Very recently we had a collapse in the Chinese equities market. In the last stage of liquidation, Chinese tech companies were particularly hurt. However, the tech sector was merely suffering from knock-on effects from the rest of the Chinese market, rather than any fundamental problems. The sell-off in other sectors eventually drove margin calls, requiring investors to liquidate tech positions to meet these. A rebound has since followed but we are not yet back to the starting point of two years ago. It is likely still too early to re-enter Chinese equities because of high volatility and inflation and less visibility leading to a contraction in market valuations. While some Chinese sectors are already at extremely low price to earnings ratios, this is mostly limited to low profitability sectors like utilities. Higher valuations at levels around 20-30x earnings remain in other sectors. We need more evidence that the private side of the economy is picking up and that the credit markets are stable and to see the economic effects of covid shutdowns decline. We will remain patient before deciding to re-enter.