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Under the Banyan Tree – Asia's financial systems: The Middle East stress test
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With record outflows from Asian stock markets and currencies feeling the pinch, Fred and Herald discuss how the region is relatively well positioned to ride out the volatility caused by the Middle East conflict.
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Transcript
Podcast Introduction
00:00:01
Speaker
Welcome to HSBC Global Viewpoint, the podcast series that brings together business leaders and industry experts to explore the latest global insights, trends, and opportunities.
00:00:13
Speaker
Make sure you're subscribed to stay up to date with new episodes. Thanks for listening, and now onto today's show.
Segment Overview: Under the Banyan Tree
00:00:33
Speaker
Welcome to Under the Banyan Tree, where we put Asian markets and economics in context. I'm Harold Wendelin, the head of Asia Equity Strategy here at HSBC. And I'm Fred Newman, chief Asia economist.
How is Asia Coping with Global Market Sell-Offs?
00:00:44
Speaker
On this week's podcast, how are Asia's financial systems weathering the global market sell-off? That's right, Fred. We're seeing record equity outflows in the region.
00:00:53
Speaker
But where there's a seller, there's also a buyer. Plus household savings, regulation FX reserves are all playing their part in keeping Asia's economic wheels turning. Let's get into it from HSBC Global Investment Research. This is Under the Banyan Tree.
Impact of Middle East Conflict on Asian Markets
00:01:14
Speaker
We want to start with some numbers that show the impact on Asia since the Middle East conflict began. We've seen huge outflows in Asian equity markets, 58 billion US dollars in March alone. That's significantly more than what we saw in March 2020 at the start of COVID.
00:01:28
Speaker
And we also seen some big losses in FX markets, actually in the foreign exchange markets. The Korean one, Philippine Peso and Thai bot have felt the brunt of that, all down around 5% against the US dollar from the start of the conflict in late February.
00:01:42
Speaker
So Harold, obviously ah you watch equity markets in Asia, I think on a minute-by-minute basis. Always, yes. And have you seen in your long, long career such a selling wave by foreigners of Asian equity markets? No. In some of the markets, we are breaking new records. So um as I mentioned earlier, we've seen 58 billion, make it 60, just easy number, $60 billion of outflows. $25 billion in Taiwan alone. That is, we've never seen a number. now Now, just to be clear, when you say outflows, these are foreigners who've held – who've owned the equity in these in these markets and have sold. It's not total selling. It's really just what foreigners are selling out of the market. Is that what you mean with 60 billion? Yeah. And this is a very important point because when we think about flows, it's not that people – well, there's people leaving the market. But if you sell, somebody is going to buy, Right. So you could also say, well, um hey, if 25 billion has been sold by foreigners, 25 billion has been bought by locals by definition. But there's still there's still some value in analyzing flows, though. And what yours seem to imply is that foreign investors from outside of these economies or outside the region even – have reduced their exposure to Asian equities quite significantly. So this is larger than what we saw, say, during the Ukraine invasion, what we saw maybe during COVID as well. Yeah, that's absolutely right.
AI Boom and its Influence on Asian Markets
00:03:08
Speaker
That's exactly the way to say it.
00:03:10
Speaker
And what has created more volatility in some of these northern Asian markets, Taiwan and Korea in particular, is that as we went into the conflict in the Middle East, there was really one sort of theme or story that people were investing in. And that was the AI theme the and the components made in in Asia, predominantly in Taiwan and Korea. So, for example, in emerging market portfolios,
00:03:37
Speaker
the top three holdings are Korean companies. The biggest, what we call overweight, the biggest sort of positions that people have across emerging markets globally is in Korean stocks. So, but but let let's back up a little bit here because um these numbers are very large. A lot of foreigners have sold out of Asian equity markets. Why do you think global investors have really reduced their exposure to Asia in particular?
00:04:04
Speaker
Yeah, I think I would say Two or
Asia's Energy Dependency and Geopolitical Risks
00:04:07
Speaker
three reasons. First of all, as you have actually highlighted, Fred, Asia's energy intensive. We are more energy intensive and more dependent on oil prices as a region than other parts of the world. And in parts of Asia, the the inventory, stock inventory and and and the buffers they have is also not very high. So we're exposed to that. That's the first thing. Secondly, investors had come in to buy the AI story, as I mentioned earlier on. So they were heavily exposed to one particular sort of market. And that means if you think people leaving the markets, well, it might be better for you to get out now because there's only so much. But but then, know, why would the AI sector be more exposed? I mean, global investors have taken exposure to
00:04:49
Speaker
you know Korean semiconductor names, big AI, Asian tech firms, really on the hope that the yeah AI boom would kind of continue. So why doesn't a conflict in the Middle East, which is clearly an energy shock, why would that be relevant for how investors think about their exposure to – Asian AI stocks?
00:05:08
Speaker
I think ah there's two ways
Role of Local Investors and Government Incentives
00:05:11
Speaker
to answer that question. First of all, you have certain raw materials that ah is difficult to get in. Helium is is being mentioned, for example, but that is not really the issue. I think the issue is simply that they don't want risk.
00:05:24
Speaker
They're reducing their risk exposure in their overall portfolios. That very often means you have more cash, but what you then sell is the risky assets. And what are risky assets? Equities is a risky asset. And emerging markets is within equities a risky asset. So you have to sell what you own, and that happened to be in North Asia in particular, because as I mentioned, that's where people invested in the AI story. So in some ways it's because investors had bought a lot. This is also where you see the first wave of selling in a way because investors are pulling back where they were overexposed is in an environment where there's increased risk. yeah And so that explains maybe some of these very large outflow numbers. But on the other hand, and you hinted at this,
00:06:08
Speaker
If somebody sells it, somebody else is buying it. Otherwise, you can't sell it. So are locals seeing this differently? Are locals saying, well, maybe we're not as exposed here to the Middle Eastern conflict and this is a bargain? Yeah.
00:06:20
Speaker
And I have a follow-up. for I'm going to answer that. But I have a question then for you in order for me to fully understand that that issue. um Yes, the locals are buying it. And what you see, for example, in Korea… The government has put incentives in place regarding, for example, capital gains taxes ah to bring money back into Korea. So if you were a Korean, you owned American stock, you could bring that back. And they said, if you do that now, we we're not going to tax you as much. So there was a sort of incentive. So the locals have been buying.
00:06:49
Speaker
And we see this in other markets as well. And this is something that's really new and is to a certain extent stabilizing these markets or providing a bit of a floor because local buying now is much bigger than it was, say, 20, 25 years ago. And one of the markets where local buying is very prominent is Malaysia. Malaysia is only down 2%. Since the beginning of this conflict. So it has stabilized that particular market. Still, and this my question to you, we see quite some volatility in markets. You as an economist, are you not kind of worried about that and thinking about the overall health of the banking system? Can this have, can the movement in the equity markets have implications for the broader economy?
Stability of Asian Financial Systems
00:07:29
Speaker
Well, of course, ah if you have a big event like the conflict in the Middle East, of course, that creates volatility in financial markets and that can always ah affect how credit is available in the economy that can impact economic growth. um In this case though, yes, this is a big shock. But on the whole, Asian financial systems actually look relatively stable, ah relatively robust. So despite when I listen to you and you see, wow, record outflows out of equity markets in Asia, we haven't seen that before. As an economist, I don't tend to worry too much about the impact on the financial system overall in these economies because – for a number of reasons. The first one is that actually these economies have a lot of savings. So there are a lot of people locally who have a lot of cash.
00:08:20
Speaker
um you know Companies are fairly cash rich. Households are relatively cash rich. And so they are buying whatever you're selling, the foreigners are selling, they're buying. So in that sense, that tends to stabilize things. yeah and Maybe just a quick number onto that. We've spoken about this before. But one of the markets that is down, say, 5% is the Chinese markets.
00:08:40
Speaker
So ah Asia overall is down 10%. Korea is down 16% since 27th of February. So China has been relatively tranquil. and It's not down as much much. And that's because exactly the reason you mentioned. We've seen not foreigners buying it. We've seen mainland Chinese buying ah equities either in the Asia market in Shanghai or in the Asia market in Hong Kong.
00:09:03
Speaker
That's right. And so China has obviously a lot of savings. But even if you look at other economies in Asia, and you mentioned Korea, for example, there too, actually the country overall has a lot of savings. And so you hinted at that when you say, well, foreigners are selling stocks in Korea and they're maybe down. But there is a lot of locals are bringing money back from the U.S. and therefore buying local stocks. Correct. Now, that that is one big thing why we're actually actually in relatively financially robust position despite the volatility. The second one is that actually Asian regulators have hardened these systems. And what we mean by this is we've gone through a number of big crises over the years, famously the Asian financial crisis in 1997. And that was a wake-up call um not to rely too much on external capital, to make sure that the banks are well-regulated, companies are – you disclose the risk they're taking on. And so um what we then found is with these reforms, strengthening of the regulatory framework, actually we're running relatively um stable financial systems. They can take a lot of stress. So that's the second big issue going into this. And you see that across the region. I actually have ah a nice point to add to that because i think you're absolutely right. And it's not just the regulators, but if you look at the listed companies in some of the markets that were hit the hardest in the Asia financial crisis, like in Indonesia, their overall debt, their the appetite to take on debt, in particular foreign debt, is massively reduced. A lot of them are very careful on how they run their businesses. And some of the banks there during that crisis have been cleaned up. And are now some of the, you could almost say, strongest banks in the world. They have a lot of capital, fat margins. They're provisioned well for anything that might happen. So, yeah, they really cleaned up and that will benefit them in these days. Yeah. So, you see from a bank's perspective, they're relatively strong, a lot of capital. And then also that the third point is that actually going into this particular episode, we didn't see anything.
00:11:08
Speaker
local borrowers take on a lot of leverage. So credit growth was relatively low in Asia for a while. So we'd always tend to worry if there's a lot of leverage and a boom and people borrow and borrow and borrow and debt goes up and then suddenly the crisis hits then you realize, oh I've taken on too much debt. But actually, not only the banks, relatively well regulated, but also the borers have been quite cautious in taking on debt. Famously, Korea used to have a lot of household debt, but in rest recent years, households have reduced their their debt. And even China is you know is is an economy that has, over the years, taken on a lot of debt. But actually in the last two or three years, debt growth has come down quite a bit. So um from that perspective, we're financially in a relatively robust position. So despite the volatility, there's not going to be much or unlikely to be a lot of systemic financial stress. Yeah, that's I agree with that. So that you've highlighted those points very well. One area of risk, if you would call it, this is, of course, that if currencies really become volatile, so that even the little debt that you have might become a problem.
00:12:18
Speaker
We've seen some currency volatility across the region. Is that something you think could suddenly come out of the the woodworks and... Do that? Foreign exchange markets are very important. Traditionally, in emerging markets in particular, if currencies weaken, then it tends to you know bring in a degree of stress. But and the first thing to notice that actually currencies have not weakened as much generally compared to, say, how equity markets have moved or even how local interest rate markets have moved. So the FX markets have been relatively calm.
00:12:50
Speaker
The other thing to note is that even if currencies weaken, there's less of an impact on domestic financial systems today compared to in the past because regulators know of this risk and therefore they have foreign exchange reserves. They have reduced the exposure that the domestic financial system has to foreign exchange. And so generally, that is not a, again, a worry about systemic financial stress. Now, that's the good news. We have less pressure points from a financial perspective. We can weather some of that volatility that you talk about. But of course that growth is most likely going to come down. I mean there's pressure, as you say, on Asian economies. How do you
Economic Growth Challenges in Asia
00:13:34
Speaker
deal with that? How do you see that trajectory going forward? Well, yes. So even if financial systems remain robust enough to take the volatility, there's still going to be the growth impact. You're absolutely right because we pay more for oil and gas, for example. And already the impact on growth this year, if you look average growth in Asia, is going to be about 0.7 percentage points of GDP. That is, if we were growing 5%, we're now growing 4.3% just to give an So that's quite a substantial … It's quite substantial. But that is on the assumption that April, the Strait of Hormuz opens again and gradually these disruptions dissipate. If the Strait of Hormuz remains closed for longer … Of course, the impact will be bigger. … we're bigger and we calculate, for example, impact might be another 0.8 percentage points of GDP. So that's another big hit.
00:14:28
Speaker
And that would mean that some economies might face a recession. So Japan, for example, could be in a recession. Australia, New Zealand, Singapore, Thailand are all economies that in that scenario could have maybe a short-lived, shallow, but still a recession. And of course, other economies are impacted as well. yeah But just to put this all a little bit together, it seems that we see a lot of volatility in some Asian equity markets, pretty decent outflows. But because the region is wealthier and has more cash to invest and and buy that, has stronger banks, has learned the lessons from the past, you could also say. And hasn't seen the FX volatility that we're quite well positioned to deal with the lower growth that most likely is going to come through over the course of the next couple of months. right
00:15:23
Speaker
That's right. And so, um yes, this is a big challenge for Asia in particular, the energy dependence, the imports of oil and gas and other natural materials from the Gulf. And it's a growth problem, but it's unlikely to kind of blossom into systemic financial a risk. And that's the good that's probably the good angle here. That's why... You know, actually regulators have to be commended in the region for having backstopped the system, made sure there's adequate regulations in place. And, you know, for um at all the turmoil, that's maybe something that makes us slightly more optimistic that we'll get through this without too much lasting damage.
Episode Conclusion and Subscription Reminder
00:16:04
Speaker
Well, we're going to have to end it there, folks. We hope you enjoyed this episode and thank you very much for tuning in. For more on the major issues shaping global markets, listen in to The Macro Brief, our sister podcast here at HMG Global Investment Research.
00:16:18
Speaker
Under the Banyard Tree, we'll be back same time next week. Talk to you then.
00:16:43
Speaker
Thank you for joining us at HSBC Global Viewpoint. We hope you enjoyed the discussion. Make sure you're subscribed to stay up to date with new episodes.