International | Jun 28 2006
By Chris Shaw
For a time after the Asian financial crisis in the late 1990s there was little interest in the region for international investors, but as time heals all wounds so it has for money managers and they have returned to emerging markets in Asia in recent years.
While emerging market growth in the region is much stronger now than a few years ago and the perceived country risk has fallen, Credit Agricole’s economic department cautions there continues to be risks in the region, particularly as the level of global and economic interdependence is now much higher than ever before.
This, it notes, is partly reflected in the division of production processes in the region, as well as via the higher levels of regional and inter-regional trade. In this respect China has been a major contributor, as its dominance in low-cost manufacturing has meant other nations in the region have concentrated on areas where they have a comparative advantage over their neighbours and they have traded together more freely to maximise the advantage they hold, to the overall benefit of many countries.
Quantifying the benefits of a more interdependent trading system flowing from China’s growth, the bank notes between 1992 to 2005 East Asian exports to China grew by 6.4 times, while exports from China increased by 8 times.
The benefits include the ability of countries such as Vietnam, Malaysia and Thailand to develop production systems, which has in turn allowed them to increase their trade capacity and the domestic value content of their exports.
So on first analysis it appears everyone has benefited, which is true to some extent. The question Credit Agricole has is what happens if conditions turn negative or there is a shock in one of the economies, China in particular.
Here the outcome gets a little murkier, as there is likely to be some form of contagion impact, but the exact impact is difficult to quantify. A contagion impact is one that flows though from one economy into another and can occur in a variety of ways.
There can be what the bank calls a monsoonal contagion, which is a simultaneous crisis thanks to a common shock; a spillover or a domino effect where a disturbance is transmitted via trade or financial linkages and while making the home country more competitive, has a negative impact on its trade partners; and pure contagion, which occurs when there is no evident or sufficient capillarity between the two countries.
The most recent example of a contagion impact was the Icelandic currency, which had attracted funds from the carry trade given the high interest rates on offer. When there was a shock to the economy that was sufficient to force some players to flee the market, the impact flowed through into other economies and currencies of countries with deficit problems, including one as far away as New Zealand.
While suggesting currencies are unlikely to be the source of any crisis in the medium-term given they are less overvalued than in the crisis of the late 1990s, the bank suggests there could be shocks from other sectors, with trade a prime candidate given the interdependence outlined earlier.
In the bank’s view this could emerge in one of two ways, the first via the trade channel, with the impact to depend on the size of the economies of the countries involved and factors such as how they are placed in particular industries. Alternatively it could come through financial channels, though how this would play out depends more on what securities of the countries are held by third parties.
The simplest example of a financial channel contagion impact is if speculative money has entered a particular market or economy and wants out, driving a correction that goes well beyond what would be justified by fundamentals. For example, Indian equity markets were hit very hard in the recent correction, but the growth profile of some of the companies suggests this was overdone to some extent.
Credit Agricole’s summary then is while a contagion impact may be unlikely given emerging Asian economies are healthier now than during the previous Asian crisis, investors need to consider how changes in other markets could impact on their investments in markets that on face value have no connection but are linked in ways that are not always obvious.
