HONG KONG -- With the possible exception of Latin America, no region is more susceptible to rising U.S. interest rates than Asia. And that has ramifications for investors looking for a bit of international diversification in the Far East.
Much is supposed to have changed in the region since the currency crisis of 1997, particularly the ways in which local authorities manage their currencies. Pre-crisis, most set exchange rates to the U.S. dollar. And the processes for managing those currencies weren't transparent. Today, with the exception of the Hong Kong dollar and Malaysian ringgit, Asian currencies are supposed to float. That means interest rates in Asia won't necessarily rise when U.S. rates do.
Don't believe it for a minute.
Salomon Smith Barney
is forecasting 100 basis points of further tightening in the U.S. by the end of this year. Similar expectations have prompted Asian traders to ratchet up their forecasts for local rates. A survey of bank treasury dealing desks released this week by
, an interest-rate swaps broker, found that 84% of dealers expected rates to remain the same or move higher across Asia.
Just as in the U.S., higher rates weigh on bank stocks and brake overall economic growth, which should have holders of Asian funds, particularly those in Hong Kong and greater China, nervous. Because financial stocks are core holdings of many Asia funds, higher rates could spell trouble for pan-Asia funds, which already have put in an anemic performance this year. Since the beginning of the year, Asia ex-Japan funds are up an average of 2%, according to
The case for higher rates is easiest to make in Hong Kong, where the local currency is directly pegged to the U.S. dollar. Rates in Hong Kong nearly always rise in tandem with those in America, a dynamic that's prompted a lot of analyst alerts over a core holding in Asia and Europe: banking giant
To see why, take a look at the mortgage war HSBC is waging in its largest market, Hong Kong. With real interest rates at 12% and the city's real estate market stubbornly in recession, banks are falling over each other to lend to home buyers.
Total loan volumes are falling, and as for mortgages, the cut the banks are taking has plunged. In November 1998, virtually no new mortgages in Hong Kong were written at the prime lending rate. But by April of this year, 77% of new mortgages were written below prime rate, according to the
Hong Kong Monetary Authority
. Of these, 56% were written more than 150 basis points (or 1.5 percentage points) below prime.
Hong Kong mortgage-holders are famously diligent in paying their loans, but the impact on bank profits still could be severe. Singapore-based brokerage
forecasts that narrowing interest margins at HSBC "may weaken earnings growth to about 2% in 2001-2002."
The fate of HSBC matters to a good chunk of Asian mutual funds, including the
Eaton Vance Greater China Fund
, which had almost 8% of its holdings in HSBC as of March 31. The
US Global Investors China Region Opportunities Fund
had a whopping 12.5% in HSBC at the end of last year. (Even with great picks, the fund has an unbelievably high expense ratio of 4.4%). Another fund that has had HSBC in its top holdings is the
Montgomery Emerging Markets Asia Fund
As for the rest of Asia, aggressive rate rises in the U.S. could make it more attractive to leave money in America, which
this week forecast could strengthen the dollar. If this has a familiar ring of foreboding, it should. It was a strong dollar in non-Japan Asia that choked off exports from the region beginning in 1995, ending only last year.
Would countries with floating currencies be able to resist the old impulse of raising rates to defend their exchange rates? Maybe not. "A sharp slide in the currency cannot be tolerated in most of Asia, as policymakers will continue to resist extreme volatility of the type that will likely imperil investor confidence," said Merrill.
Then, there is foreign debt to consider. In Thailand, "debt repayments of some $13 billion of
International Monetary Fund
-led support, to begin this autumn, give authorities another reason to want to avoid a much weaker baht," according to Donald Hanna, Salomon's Southeast Asia economist.
But if Thailand seems somewhat inclined to follow the
by raising rates, the case for higher rates in Indonesia and the Philippines is much more compelling. In Thailand, commercial banks' net foreign liabilities to total loans comes to 1.6%; in Indonesia, the figure is 42.7% and in the Philippines, 46.2%. Both the Philippine peso and the Indonesian rupiah have weakened markedly of late. With a hard landing in the U.S., either rates rise in those countries, or their currencies risk further depreciation.
A weak currency may be good for a country's exports, but for foreign holders of that country's stocks, it can be unwelcome news indeed.