Transcript
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Speaker: Hello from Hong Kong and welcome to Under the Banyan Tree, where we put Asian markets and economics in context.
Speaker: I'm Fred Newman, Chief Asia Economist at HSBC.
Speaker: And I'm Harold van der Linde, Head of Asian Equity Strategy.
Speaker: On a podcast today, inflation is proving harder to shake than we thought.
Speaker: Two months into 2023, last year's price surge still looms large across the region, and many central banks are looking at the very real prospect of further rate hikes.
Speaker: We're going to look at why this is the case and what makes inflation different in Asia than other parts of the world.
Speaker: Also look maybe at some of the policy implications that we see across the region.
Speaker: All of that and more coming up right here under the banyan tree.
Speaker: Let's start with a quick roundup of inflation and interest rates across Asia.
Speaker: Several economies are reporting retail inflation data or CPI for January.
Speaker: The majority show prices rising at a pace above expectations.
Speaker: That includes India, where goods prices continue to climb, bucking the global trend.
Speaker: And the Philippines, where the central bank last week raised interest rates by 50 basis points and signaled more hikes to come.
Speaker: It's a different picture in Indonesia, where the central bank has put its policy rate on hold after retail inflation, CPI, came in below expectations.
Speaker: But that's just one of the few examples where that's the case right now.
Speaker: Keep in mind that US interest rates play a big role in setting the tone for central banks globally.
Speaker: Inflation there remains high, so it looks like the full tightening cycle hasn't finished in the US yet.
Speaker: So Fred, it's fair to say that a few months ago, markets thought things would be different by now, but they're not.
Speaker: Why is that?
Speaker: Well, inflation is proving stickier than we thought.
Speaker: Really, if you look at economies in East and West and across Asia, certainly, you see, in fact, inflation coming in higher than the market had expected.
Speaker: It's still slowing, mind you, but it's not slowing as quickly as we would like.
Speaker: And there are a number of reasons for this, of course, but fundamentally, that's a problem for central bankers and
Speaker: And investors, because if inflation comes in higher than expected, then, of course, we need to reprice how we think about interest rates and financial market returns, etc.
Speaker: And that's why markets have been a bit bumpy of late.
Speaker: Yeah.
Speaker: So let's talk about it in a second.
Speaker: But first, why isn't inflation coming down as quickly as we initially thought it would be?
Speaker: So there are a couple of reasons out there, but one important one is actually commodity prices.
Speaker: Normally when you have the global economy slow down and undoubtedly growth has slowed down in most economies across the world, usually we'd expect commodity markets to come off sharply, commodity prices to decline quite sharply.
Speaker: That hasn't quite happened in this cycle.
Speaker: Commodity prices are still very high.
Speaker: And so we have this unusual scenario where the global economy slows, but
Speaker: really energy prices are still elevated, food prices are still elevated, and that kind of prolongs the inflation problem.
Speaker: And another issue, of course, is that in many economies, the labor markets are very tight and it's pushing up wages, and that's finding its way into higher services costs.
Speaker: So both commodities and services are really an area where you see price pressures continue to linger for much longer than people thought even a few months ago.
Speaker: These labor dynamics,
Speaker: That is quite different in Asia, right?
Speaker: There are differences, key differences actually between sort of developed markets, mostly in the West, some out here in Asia as well, and of course emerging markets, particularly in Asia.
Speaker: And that is that in the Western economies, you've seen fewer workers return to the labor force.
Speaker: That is, the labor force participation rate is actually lower today than it was before the pandemic.
Speaker: Fewer workers, growth is accelerating, but fewer workers are coming back to the job market.
Speaker: And so the labor market is tight, pushing up wages.
Speaker: In emerging Asia, you see the opposite happen.
Speaker: More people actually are looking for jobs today than they did in 2019, partly because they lost their savings.
Speaker: It was a rough, rough pandemic for people economically, socially, socially.
Speaker: So they want to work.
Speaker: And that actually means that labor supply has come back, and it's helping to keep a bit of a lid on inflation.
Speaker: That's not everywhere the case.
Speaker: Japan, actually, you see wages going up.
Speaker: Australia, right?
Speaker: There are more developed parts in Asia.
Speaker: But if you go to Southeast Asia, India, and China as well, you don't see the same labor market pressures come through.
Speaker: Yeah, but if I would look at inflation, I mean, China actually is almost in an opposite cycle, right?
Speaker: Last year, things were very weak in China.
Speaker: Things are recovering a bit.
Speaker: Inflation doesn't seem to be a major issue in China.
Speaker: But in India, I think it is, right?
Speaker: It is.
Speaker: There are big differences between the two.
Speaker: In fact, we just had a big surprise of inflation in India, where it's a price on the upside in January being much faster than expected.
Speaker: So we're talking about inflation above 6% in India, 6.5%.
Speaker: In China, we're still about 2%.
Speaker: Now, why is that difference?
Speaker: Because the Chinese economy has really only just started to recover from its lockdowns last year.
Speaker: And so the inflationary impulse is not yet really visible.
Speaker: And that might come later in the year.
Speaker: But even then, China's probably not going to deliver the same amount of inflation, partly because
Speaker: we're not going to see a stronger recovery.
Speaker: And because there's much more labor supply in China, people willing to work, relatively high unemployment, and that's keeping wages relatively steady.
Speaker: So you get within Asia that divergence, right?
Speaker: And what's interesting is that if now commodity prices increase, that usually hurts Indian inflation more than Chinese inflation because the Chinese kind of control prices more.
Speaker: They're more subsidies.
Speaker: And you're a larger importer of oil.
Speaker: large importer exactly.
Speaker: And so you get the differentiation and that's something markets need to grapple with as well.
Speaker: Speaking of markets, we're going to take a quick break and when we get back, we'll be discussing the impact of inflation on Asian equities and why it's not necessarily a bad thing for corporates.
Speaker: So, Harold, how have equity markets fared in Asia so far this year?
Speaker: And is inflation a big theme right now?
Speaker: No, it's a big theme now.
Speaker: It comes up in many conversations.
Speaker: And it's not just Asian inflation, but it's global inflation.
Speaker: So, on the back of what you just said, inflation is not coming down in the developed economies as fast as what we initially anticipated or as we maybe have hoped for.
Speaker: So, we've seen a repricing, a belief that maybe...
Speaker: Interest rates are not going to come down as soon as well as what the market was pricing at least in, say, in the beginning of January.
Speaker: So bond yields have gone up.
Speaker: That's not good for equities.
Speaker: So the equities, they haven't really come down, but they've kind of flatlined.
Speaker: In addition to that, we're also waiting for confirmation how strong this recovery is in China.
Speaker: We need to see data coming out as well.
Speaker: So that hasn't helped either.
Speaker: But yeah, markets basically are in kind of a holding pattern, I think.
Speaker: Now, you've in the past explained to us that really equity markets are very sensitive to interest rate expectations.
Speaker: You made that case.
Speaker: But on the other hand, isn't inflation also good for equities?
Speaker: Doesn't mean that earnings go up?
Speaker: Doesn't mean that companies get more revenues if prices go up?
Speaker: So how do you look at this in terms of equity market implications?
Speaker: And it's really a bit of a tug of war.
Speaker: So you're right.
Speaker: Inflation, that sounds strange, but it's good for companies because it means that they can raise their prices.
Speaker: And insofar they can raise their prices more than they cost, their profits would go up as well.
Speaker: But inflation is a very broad concept.
Speaker: And your ability to raise prices differs for different companies.
Speaker: A great example is the Indian food and beverage companies.
Speaker: They have a phenomenal distribution capabilities that is almost impossible to replicate.
Speaker: They have an enormous amount of pricing power.
Speaker: You want to sell something in India related to food and beverages, you need to rely on these companies.
Speaker: They can just set prices.
Speaker: They can raise prices as they want to.
Speaker: So they're very profitable, very high margins, very cash flow strong.
Speaker: So if prices go up, they say, well, that's what it is.
Speaker: We raise our prices.
Speaker: So it depends on the relative pricing power that these companies have.
Speaker: So that's something to keep in mind.
Speaker: Harold, that reminds me of a concept that we use in economics often, which is the real interest rate.
Speaker: It's essentially saying we have the interest rate and then we have the inflation rate.
Speaker: And really, it's worth looking at the interest rate in inflation adjusted terms.
Speaker: What this means is that, yes, if interest rates go up, that's bad, but if inflation goes up by even more, then actually the real interest rates is negative, and that's actually good for equity investors, isn't it?
Speaker: Absolutely, and this is what I call the tug of war.
Speaker: You have the ability to raise prices, that's good for you.
Speaker: And then you have the interest rates that go up, because central banks want to tighten and control inflation, that's bad for you.
Speaker: But for some companies, if the interest rates go up,
Speaker: a little bit, but you can actually raise your prices quite substantially.
Speaker: Hey, that's actually net-net.
Speaker: Your tug-of-war is moving in the right direction.
Speaker: That's good for you.
Speaker: So with those companies.
Speaker: So this is where, yeah, you have to really look at individual companies and industries and understand them very well.
Speaker: But then one risk here must be that if...
Speaker: suddenly growth declines, you lose your pricing power, you cannot pass on the pricing power, but interest rates are still high, then you have a problem.
Speaker: And doesn't that then mean that equities, potentially, if you do go into a recession later in the year, then you really face a challenge because you're left with higher cost pressures, can't pass it on consumers, and you have high interest rates.
Speaker: Yeah, that is the nasty scenario.
Speaker: And actually, in Asia, that was a scenario we had last year.
Speaker: Costs were rising.
Speaker: They couldn't raise prices because large parts of Asia, the economies were not really strong.
Speaker: Demand was strong.
Speaker: People couldn't even go out and buy their stuff.
Speaker: Right.
Speaker: So they, yeah, they struggled.
Speaker: And yeah, then you see a squeeze in the profit margin of these of these companies.
Speaker: Now, there's all sorts of things they can do, control costs, try to be efficient or whatever.
Speaker: But most of the time that takes time to to to materialize.
Speaker: Yeah, and that last year, that's why equities were down.
Speaker: And that always remains a risk.
Speaker: But it's always good to go back to that tug of war.
Speaker: What happens with the ability to set prices versus what do central banks do on interest rates?
Speaker: And if you've got a good hold on these two factors, you have a bit of an idea where equities go for them.
Speaker: Well, we're trying to get a hold on what interest rates, where interest rates are going, what central banks are doing, right?
Speaker: That's essentially a challenge.
Speaker: And of course, central banks see or know that if growth declines, then they have an even bigger problem because they have interest rates too high relative to growth.
Speaker: So you need to set it six, nine months in advance.
Speaker: And that's, of course, very, very tricky to do.
Speaker: At the moment, though, it looks as if central bankers are still pushing interest rates higher because they're more worried about inflation than they are about growth.
Speaker: down the line, and that means interest rates still climbing.
Speaker: Is that then a challenge for equity markets?
Speaker: That is a challenge for equity markets, absolutely.
Speaker: And this is exactly what we're seeing at the moment, that the equity markets rallied in the beginning of the year, but now, yeah, they're struggling, or kind of a holding pattern, I would say, because they're wondering how much further can these interest rates go.
Speaker: And it's not just US interest rates, of course, but also what happens across the region.
Speaker: And maybe you can shed a little bit of light on here, because I guess the situation in China will be different with interest rates than in India or the Philippines, Indonesia or Korea.
Speaker: So where do you think which central banks will raise interest rates first and which ones will lag that process?
Speaker: Well, this year we might actually see a divergence of monetary policy trajectories in different markets.
Speaker: So last year, most central banks across the world had a race to raise interest rates.
Speaker: Not all of them.
Speaker: In China, they were a bit more cautious because we had a special situation there.
Speaker: Growth was slowing.
Speaker: Not in Japan, but everywhere else central banks try to catch up.
Speaker: This year, it might be more of a different picture.
Speaker: You might see some central banks, like the Bank of Korea, for example, actually reduce interest rates.
Speaker: Even in China, we would still expect some kind of easing of monetary conditions because they want the economy really to accelerate.
Speaker: On the other hand, you get economies like the Philippines, for example, where inflation is accelerating very rapidly and there's a clear need for further interest rate hike.
Speaker: So you get that differentiation coming through.
Speaker: But it's probably not as clear cut for equity markets, I would imagine.
Speaker: It's not wherever central banks cut debts were as good for equity markets.
Speaker: I guess there's more to it when you look at the equity market implications.
Speaker: Yeah, there is more to it.
Speaker: It's because certain markets are very sensitive.
Speaker: What happens with the U.S. interest rates, but also what happens with demand in those developed economies.
Speaker: Korea, Taiwanese equity markets, stock markets are predominantly dominated by companies that are full exporters.
Speaker: What they do in Korea and in Taiwan is minimal against the business that they do in Europe and the US or mainland China.
Speaker: So it's important to take a very global context.
Speaker: While in India and Indonesia, that's much less so the case, they are domestic oriented markets.
Speaker: So there the impact of interest rates is important.
Speaker: India has struggled a bit for that particular reason as well.
Speaker: Indonesia has got different issues.
Speaker: People bought into it and are now reallocating that money to other markets.
Speaker: But yeah, understanding these differences in interest rates and the ability for companies in each of these markets to set prices, that's eventually where I go through it.
Speaker: That's an ongoing conversation.
Speaker: You can't just say th is is going to happen, that's going to happen.
Speaker: Every day when new data comes out, we just need to reassess what we think on both of these factors.
Speaker: But I'm struck, Harold.
Speaker: Here we are, year of the rabbit.
Speaker: We're already into the year of the rabbit.
Speaker: And we still talk about the same themes we did a few months ago, that is inflation and interest rates.
Speaker: So it does seem it's going to be a bit bumpier this year than that smooth glide path that we thought with inflation going down, interest rates stabilizing, and we all go home with a carrot in our hand.
Speaker: Yeah, exactly.
Speaker: But this is what markets makes it exciting, right?
Speaker: It continuously changes and you have to reassess.
Speaker: Of course, we all hope that markets go up 25% this year and everybody would be happy for it.
Speaker: But that's just not the way it works.
Speaker: The excitement lies in to understand what's really going on.
Speaker: Well, Harold, I think we like excitement, just not too much of it.
Speaker: Maybe that's right.
Speaker: Just the right amount.
Speaker: That's good.
Speaker: So Fred, it's been a couple of weeks since we've spoken here on the podcast.
Speaker: You've been traveling a little bit.
Speaker: Normally we talk about what's on your mind.
Speaker: So anything that you've come across over the last days or weeks?
Speaker: Well, I was on the road, Harold, and my travels took me to New Zealand, actually.
Speaker: And it landed the day that the cyclone hit New Zealand.
Speaker: I just managed to get in safe, but it was quite a storm.
Speaker: And of course, a lot of the discussions were around climate change and climate change.
Speaker: It's not often that cyclones make it all the way down to New Zealand.
Speaker: And there's some estimates actually that suggest that climate change has an effect on New Zealand that's equivalent in climate terms of pushing the islands north by about 50 kilometers a year.
Speaker: And that has already had a huge impact.
Speaker: Now we have, of course, the cyclone, but also famously the kiwi fruit comes from New Zealand, but you can't really grow it commercially in the north of the country anymore because it's getting too warm.
Speaker: They're now actually planting commercially avocados, which never grew in New Zealand.
Speaker: And so you can see the effects of climate change really on even economies like New Zealand, which is disrupting rainfall, leading to storms, but also changes in the patterns of the types of fruit that they plant and export.
Speaker: Funny.
Speaker: I read something else that struck me a little bit.
Speaker: It's got a little bit to do with this.
Speaker: It came from our European auto team and they wrote, they looked at the infrastructure for electric vehicles that is in place in different places around the world.
Speaker: And it turns out that 80% of the fast charging stations that you need really for long distance are in China.
Speaker: China has got more fast charging stations than Europe and the US together.
Speaker: And that is important because it means that consumers are willing to shift and say, I'm going to buy an electric car.
Speaker: And that comes with all sorts of benefits for the producers of these cars and the producers of the batteries, right?
Speaker: They have scale economies, they can produce that cheaper, etc., etc.
Speaker: Well, I think it's important to highlight, actually, and you make the point that as challenging as climate change is, we are also at a technological tipping point here in terms of addressing some of this stuff.
Speaker: So you mentioned charging stations, but also the commercial viability of solar and wind energy.
Speaker: We're really at a point where it's cheaper than many alternatives.
Speaker: again to bring it back to New Zealand, they've now built solar farms on sheep farms actually.
Speaker: And you wonder how do they combine the two?
Speaker: Well actually it turns out that in New Zealand the angle of the sun is such that you can grow grass under the solar panels and still have enough sun for the panel itself and the sheep just run around under the solar panel undisturbed and you got clean electricity.
Speaker: So the world is changing and we need to adapt to it and maybe that's actually the
Speaker: the broader conclusion we can draw from this whole conversation that we just had here.
Speaker: Inflation, climate change, we just need to adapt, Harold.
Speaker: Yeah, we have to deal with it as it comes.
Speaker: And that's a wrap for this episode of Under the Banyan Tree.
Speaker: Thank you very much, as always, for joining us.
Speaker: We'll be back again next week, focusing on Japan as a new central bank governor steps into the spotlight.
Speaker: Take care, till then.
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