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Probing a Resilient Asia

Still, there are problems in China that even a bullish market may not be able to ignore.

JAKARTA -- Asia in recent days has again shown its resilience. Asian markets succeeded in ignoring a downdraft on Wall Street, which had a rather bigger impact on Latin America. This provides further evidence of the bullish undertone. Bad news continues to be ignored in what can be described as healthy consolidation amid a deluge of cash calls.

Still, Wall Street's weakness has been somewhat surprising since it comes amid some tentative evidence that American growth is slowing, which would be good news from an interest-rate perspective. Thus, both mortgage refinancing activity and housing starts are already responding to a 107-basis-point backup in long-term interest rates. Bad news has been good news on Wall Street for most of the past 15 years as a weaker economy means falling interest rates. This time should be no different unless Wall Street is now running purely on earnings hopes. The recent rotation into cyclical stocks could be evidence of this change in market leadership.

This trend has probably run its course for now, since this story is based on the maintenance of the global reflation theme and the


has, for now, officially ended reflation as a policy. Commodities remain in a long-term downtrend, the victim of technological advance and the Kondratiev long wave. Oil's resilience post the most recent


agreement has less to do with supply and demand fundamentals than the fact that Saudi Arabia and Iran are now talking to each other for the first time in 20 years. That, so long as the rapprochement lasts, should make self-policing more effective. Meanwhile, gold's piercing of the $270 level provides further confirmation of the deflationary undertow that will not have been lost on former gold bug

Alan Greenspan


All of the above make a Fed rate rise still unlikely this year. But even if a 25-basis-point rise happens, it should not prove that big a deal for Asian stock markets since there is no reason for Asian countries to mach the Fed's tightening. The need is to keep monetary and fiscal policy easy in the region to cause an increase in consumption and a decline in savings. There is certainly no need to tighten monetary policy just to ensure currency stability. Imported inflation is the last thing any Asian central bank should be worrying about. The same applies to currency weakness, provided the rate of change is not too alarming. This is why America and Asia are at completely different ends of the liquidity cycle. The implications for non-Japan Asia are extremely bullish. They would also be bullish for Japan if there were more convincing evidence that monetary policy is really working in Japan.

The inability to effect an exchange-rate adjustment clearly remains the biggest problem in Hong Kong and China, which is why these economies should be the slowest to recover from deflationary pressures. Hong Kong has received yet another reminder of this with the last inflation numbers showing a 3.8% year-on-year fall in consumer prices in April. Still, Greed & Fear continues to be alert to the robustness of sentiment toward the Hong Kong and China story, which is why the inflation number has been shrugged off as a lagging indicator.

This week we have had the Cox Report on China espionage released by a

House of Representatives

committee. This, combined with the fact that American public opinion has been turned off by Beijing's recent overt manipulation of nationalist sentiment, should have considerably lessened the odds, formerly quite high, for a


deal later this year or early next. Still, U.S. business interests will be lobbying hard for a deal and in American politics money still talks. That means the WTO is still probably an even money bet at the end of this year or next whereas a month ago the odds were more like 70%.

Sentiment toward China-related equities continues to be boosted by the good-news-is-bad-news theme. Recent economic figures out of China, be they related to retail sales, trade or deflation, have shown clear evidence of continuing deterioration. This is raising the likelihood of another interest-rate cut in the near term and another fiscal boost in the second half of this year in the form of more government spending on infrastructure. Such evidence of official activism, given prevailing market sentiment, is likely to be taken positively by investors in China-related shares. But the reality is that the policy options for China will become increasingly limited as interest rates drop and as fiscal constraints reduce the scope for more countercyclical government spending. This is why the risk remains that China will become an emerging-market version of Japan where economic progress is stifled by the disinclination to let markets clear. The best hope must be that Asia recovers and that U.S. consumer demand remains robust. If both these conditions are met China can probably hang in there.

Still, the risks in China remain formidable, which is why the Pollyannas can be safely ignored. This is the one story left in Asia that could still go badly wrong even if financial markets are in no mood to think about the dark side at the moment. Greed & Fear was reminded about this by an article in

The Asian Wall Street Journal

on May 24. It reported a one-day run on deposits last month at the Zhengzhou branch in Central Henan province of the state-owned

Bank of Communications

. This cost the bank 900 million renminbi ($108.7 million) in a single day. The run was precipitated reportedly by a rumor posted on the Internet that bank officials were involved in fraud. The incident shows two things: popular willingness to believe allegations of official fraud and the power of the Internet.

A run on China's liquid but insolvent banking system has always been the major risk confronting China's policymakers, given the reality of the ponzi scheme they preside over. Still, for now there is no evidence of systemwide concerns. Rather the opposite. Individual saving deposits rose by 19.2% in April to 5.84 trillion renminbi as cautious consumers continue to opt to save rather than spend. It is impossible to forecast what might precipitate a more widespread bank run.

But last month's incident shows that the Internet offers a double-edged sword for China's leadership. From a positive perspective it provides the opportunity to leapfrog technologically, in the sense that instead of using circuit-based switching technology, the plumbing for most existing global voice traffic, China can go direct to packet-switching Internet-protocol telephony. But it also points out the need to accelerate reform and recapitalization of the banking sector since no one can predict when, if ever, popular concerns about the safety of deposits could become an issue.

The power to secure one's savings is one of the most visceral forces known to mankind. If confidence is suspicion asleep, as the gold bugs like to say, then let us hope Chinese depositors stay fast asleep. For last month's incident shows that the Chinese people have their money in the banks out of a lack of alternatives, not because of any intrinsic faith in the government.

Back in Korea, it has become fashionable in recent weeks to question again Korea's commitment to reform. The stock market's correction had in reality more to do with indigestion ahead of next month's estimated 6.8 trillion won ($5.7 billion) of rights issues and foreigners having to raise cash ahead of the successful $2.5 billion ADR offering by

Korea Telecom

. That issue was heavily oversubscribed, which means there is at least $6 billion of foreign money that could now be looking to go back into Korea.

The cabinet reshuffle this week will have provided investors with the rationale to go back in, since it has made abundantly clear that the political commitment to reform the economy continues.

Kang Bong Kyun

, the new minister of finance and economy, is the architect of the policy to force the chaebol to mend their ways. The result is that the three most powerful men running the Korean economy,

President Kim Dae Jung

, Kang and

Lee Hun Jai

, the head of the

Finance Supervisory Commission

, are all now proceeding in the same direction. Meanwhile, it should also not be ignored that the

Bank of Korea

appears to have begun buying dollars and selling won to take upward pressure off the currency. That is positive from a liquidity perspective and confirms the view that monetary policy is not about to be tightened.

The sure but steady decline in interest rates in Indonesia continues according to plan with one-month SBIs being auctioned at 26.1% amid a stable rupiah. At this rate

ABN Amro's

official house forecast of three-month SBI rates reaching 20% by year-end will be achieved by end-July, or five months ahead of schedule. The authorities will probably let interest rates stabilize around the 20% level for a while before allowing them to decline further later in the year as more evidence comes in of inflation's disappearing act.

Greed & Fear has been in Jakarta this week and can report that the electoral campaign has an almost Brazilian-like Carnival flavor. Sensationalist negative reporting by a foreign media anxious to justify expense accounts can therefore be profitably ignored. The







Amien Rais

are the two political parties that appear to enjoy the greatest popular support and therefore will receive the greatest number of votes. Both figures are popular because of the obvious reason that they were among the few who publicly opposed


. Both also espouse economic policies that are essentially orthodox.

Meanwhile, the ruling


party is reluctant even to campaign in the streets for fear of fanning popular resentment or worse. The result is that this looks more and more like becoming a people's revolution along the lines of what happened in the Philippines back in 1985. This is reflected both on the street and in the continuing extremely healthy climate of press freedom. Greed & Fear is old enough to remember those happy days in Manila. The market response throughout was emphatically bullish.

Fast forward to democratic Manila in May 1999. The recent correction in the Philippine stock market is overdone since it ignores growing evidence of an economic recovery. Two indicators are a pickup in imports and growing capacity utilization. In March Philippine imports posted their first year-on-year increase in more than a year. Imports of raw materials and intermediate goods rose by 10.8% year on year as inventories were replenished. Meanwhile, the percentage of manufacturers operating at full capacity rose to 16% in March, up from 13.5% in February.

Agriculture, a major pillar of the economy, also revived in the first quarter.

Agricultural production

rose by 2.7% year on year in the first quarter, a significant improvement on the 7.8% year-on-year contraction suffered in the fourth quarter of last year. The liquidity environment is also increasingly positive, with treasury bill yields having broken though Greed & Fear's year-end target of 10%. The projected fiscal deficit of 2.4% of


is also appropriate given the need for a countercyclical response.

Christopher Wood is the global emerging market strategist for ABN Amro and the author of The End of Japan Inc. (Simon & Schuster, 1994). Under no circumstances is this to be used or considered as an offer to sell, or a solicitation or recommendation of any offer to buy. While Wood cannot provide investment advice or recommendations, he welcomes your feedback at