Analysts are debating to what extent recent liquidity injections by central banks are stabilising financial markets, and what lessons can be learnt from the resilience of EM. Commerzbank argues that emerging sovereigns are still held hostage to exogenous factors but the situation is beginning to normalise. “EM asset prices continued to recover on the back of the perception that the G7 decision markets are willing and able to act against the sub-prime fallout. Both the negative effects related to the crisis, a slowdown in global growth and the repricing of risk, are seen to have just a limited impact on EM.”
Standard Chartered argues that intra-regional trade in Asia in particular means that emerging markets are better insulated from current financial market woes, both in terms of their real economies and asset markets in the medium term. As a result, it argues that financial market decoupling is now the main theme: “Differentiation is back in fashion: East vs. West, Non-Financial vs. Financial, Simple vs. Complex, Good credits vs. Weak. And most important of all: Liquid vs. Illiquid. Expect the next few weeks to highlight these differences.”
Philip Poole, head of emerging market research at HSBC, believes that monetary tightening measures taken in emerging markets such as China over the last couple of weeks to fight inflation and excess domestic liquidity show that monetary policy is still driven by endogenous factors. He argues that China’s recent hike in bank reserve requirements is indicative of this decoupling between developed and emerging sovereigns. “While central banks in the developed world are struggling to reduce key short-term interest rates, in China the authorities are trying to force them higher. The moral of the story? China and much of the rest of the emerging world has its own momentum and is not completely hostage to sub-prime contagion that continues to rattle the developed world.”
China’s exposure to the US
Royal Bank of Scotland economist Julien Seetharamdoo also believes China’s boom, persistently touted as the world’s engine for global economic growth, can be sustained in the light of a US slowdown. He argues that China’s exports are in fact more diversified, securing its external position. “The common (mis)perception of China’s export story is that it is mainly driven by exports to the US and therefore highly exposed to a US slowdown. In fact, China’s exports (including Hong Kong) to the US accounted for 21% of total exports in 2006, down from 26% in 2000. Conversely, exports to the EU have grown to 25% of total exports, from 21% in 2000.”
Seetharamdoo maintains that this export performance is indicative of a more economically balanced world. He further notes how demand from other booming emerging markets in Asia, Russia and former Soviet states is propping up China’s exports, making the nation less reliant on the US. Moreover, the US only contributes 10% of the total FDI China receives.
Seetharamdoo cautions that direct and indirect financial linkages via equity markets will provide some volatility, although this is unlikely to seep through to the real economy. “Since the beginning of the year, the correlation of the Chinese and US stock markets has not been great.”
In fact, he argues that a global slowdown represents an opportunity for Asia’s fastest-growing nation to manage its massive build-up of domestic liquidity, since the authorities will face less inflationary pressure from the leakage of foreign exchange earnings into the economy. This in turn may spur long-awaited policies to increase domestic consumption and infrastructure investment, boosting China’s long-term growth potential.