Interview with Peter Elston

2 Maggio 2011, di Redazione Wall Street Italia

Peter Elston, Asian Investment Strategist, Aberdeen Asset Management, shares some of his views with WSI’s readers.

WSI The negative outlook and possible downgrade for the US credit rating announced by S&P is going to affect the purchase of Treasuries by China in the next two years? Can you give us the numbers?

Elston China has been seeking to diversify its foreign reserves for some time, as evidenced by currencies other than the US dollar accounting for a greater and greater share of its reserves. It has also at times said that it is concerned by the rise in US federal government borrowing. However, although it appears that China is acting to protect its interests, whether by tweaking the currency profile of its foreign reserves or making statements urging fiscal responsibility the reality is that it does not have much option but to continue to buying US Treasuries. The fact is that China’s exporters get paid in US dollars, which the People’s Bank of China exchanges for new Yuan in order to prevent the currency from appreciating, then lends them back to the US government by buying Treasuries. We have now reached the point where it is not in China’s interests to make a significant shift away from US dollars into, say, the Euro as this would result in a devaluation of its remaining – and significant – holdings of dollar denominated securities. This situation has been termed financial MAD (mutually assured destruction) in which either side could hurt the other – China by selling it holdings, the US by defaulting – but in so doing it would hurt itself. Quite how this situation resolves itself is very hard to say but it is clear that reserve accumulation has become excessive and unsustainable.

WSI In a survey by Bloomberg 45% of international investors say that China will have a major financial and/or political crisis within a few years. Some banks indicate that China’s GDP growth will be cut 50% to about 5% per year. What’s your outlook for Beijing?

Elston China’s growth over the last twenty years has been extraordinary. Not only has it averaged around 10%, but this growth has been fairly stable – even at the depths of the recent crisis growth only fell to around 7%.How has it been able to do this? To a great extent the achievements should be applauded. China’s economic plans over the years have focused on fixed capital investment, particularly in coastal urban areas, designed to take the country up the value curve. But the fact that the growth has been state-directed, and thus not subject to market forces as is the case in countries that follow a free market system, means that the growth is less natural, and thus thus less healthy. There are many parts of China’s economy which need attention. Investment in social welfare and healthcare is crucial if China is to create an environment in which its citizens feel confident to spend – China’s private consumption to GDP ratio is amongst the lowest in the world. So it is possible that China is vulnerable to a major financial and/or political crisis but any such crisis may not follow the Western “model”. For example, China’s banks in the years ahead may see a surge in non-performing loans which in another country would result in a crippling loss of confidence. In China’s case, its big five banks, which account for the lion’s share of lending, are state-owned, so there is no question that the central government is on hand to inject capital when required.

WSI Which are the best opportunities for global investors and fund managers based in Europe and Italy who are thinking of increasing their investment in the Asia Pacific markets? Which assets would you suggest? Please indicate also the best ETF, bonds, stocks in term of future potential appreciation.

Elston That depends on your investment time horizon. If you have a long one then Asian equities are very attractive. The long term fundamentals for Asian equity markets are good. Growth potential is still huge and being realised with every passing year. Government, corporate and household balance sheets are generally strong. Banks too are sound, having learned lessons and been recapitalised following the Asian financial crisis of the late 90s. As for specific markets, we don’t really invest that way so it’s hard to say. As bottom up investors we’re focused on companies rather than markets. What we can say is that India, Singapore Hong Kong and Thailand are countries where we’ve found many companies we’re comfortable owning. These are countries where there is a strong shareholder culture combined with strong regulatory systems. They may not be the highest growth economies, but successful investing is about bottom line not top line growth.

WSI What is your outlook for the economy in general and stocks, bonds, inflation, interest rates, currency and real estate in the main Asian markets (China, Japan and South East Asia)?

Elston The main issue facing many countries both within and outside Asia right now is inflation. High inflation is the enemy of equity markets as it impacts earnings quality and thus equity valuations – there is a strong negative correlation between inflation and price-to-earnings ratios – so how governments deal with the problem is of paramount importance. It seems that although many central banks have been tightening monetary conditions, they are still on the whole behind the curve. Real interest rates are still either negative or too low, so inflationary pressures are likely to continue to build. But the good news is that they are not too far behind the curve. Many central banks have been employing a number of measures to counter inflationary pressures, whether interest rates, reserve ratios or administrative measures, so it seems that they are aware of the seriousness of the problem. Recently, they have also seemed more willing to allow exchange rates to appreciate in order to lower imported inflation. A notable example of this would be China which previously was very reluctant to bow to pressure to strengthen its currency.

WSI How the Japan nuclear crisis will affect Tokyo’s and the world economy? Do you forecast a slow down in the GDP’s for Asia, Usa and Europe due to the earthquake and the nuclear alarm?

Elston While the nuclear crisis has very severely impacted the local economy in North East Japan, I don’t think it will have a significant impact on the regional economy or beyond. If anything, the reconstruction effort required may have a positive effect in the medium to long term, even if there has been value destruction in the short term.

WSI The crisis in Libya and geopolitical tensions in North Africa Arabs countries are pushing oil price well above $100 (light crude). Is this going to be very damaging for the world economy? And how it will affect the GDP of Asia, Usa and Europe? What price do you forecast for the light crude at the end of 2011?

Elston The question of how rising food and energy prices will impact economic performance is very hard to answer. Exporters of food and energy such as Middle Eastern countries, Vietnam and Thailand will benefit from rising prices. But consumers or importers will be hurt by them and will either have to reduce spending on other items or increase borrowings as a result. The questions is whether there is a tipping point at which reduced spending sets off a chain reaction resulting in economic contraction. This is what happened in 2008 though arguably it was the underlying weaknesses relating to excessive leverage that made economies vulnerable at that time. This time round, I suspect that there will be more linearity between commodity prices and spending, meaning that we are unlikely to see the sort of implosion in demand that we saw three years ago.

Peter Elston is Asian Investment Strategist, responsible for articulating, implementing and communicating Aberdeen’s investment strategy in the region and other investment issues. Peter has lived in Asia since 1988, joined Aberdeen in 2008 and is based in Singapore. Peter began his career at top UK pension fund manager Mercury Asset Management, where he spent 11 years. For most of this time he managed Asian equity funds from Tokyo, Hong Kong and Singapore.

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