Amidst the inflation, do not forget smaller Asia

Inflation is creeping across Asian markets, but there are still a number of compelling reasons not to avoid the smaller Asian markets, managers state.

Spiralling inflation in China and India have put a dampener on the emerging market growth story and April’s figures suggest the trend is far from over. China’s Consumer Price Index rose 5.3% over one year, while, India’s Wholesale Price Index was up a higher than expected 8.7% over the same period.

While these countries struggle to battle inflation, fund managers are now concerned the ‘conflict’ has spread to smaller economies in the region.

Louisa Lo, head of Asian equities at Schroders, said a hike in interest rates across the region is keeping a lid on investor sentiment and the struggle is likely to continue for longer than anticipated with policy tightening possibly extending into Q4.

According to Vincent Lagger, co-manager of the Julius Baer Chindonesia fund, the root of the problem is most Asian economies had no real slowdown in 2008/09 while others were in the midst of recessions. Instead they have seen six to seven years of very strong growth.

But has the inflation infiltration brought an end to the Asia investment case? According to managers, the smaller economies offer some compelling opportunities. 

The export story

Indonesia has become a popular theme for many managers in the region.
While core inflation continues to trend upwards, headline inflation moderated over the past month, according to Peter Eerdmans, head of global emerging market debt at Investec. This was partly thanks to better food supply following the harvest season which gave the central bank the opportunity to keep rates on hold.

Considering his fund’s Chindonesia mandate, it is unsurprising Lagger is also bullish on the country. However, he said it is not without its problems.

“The biggest concern is the fact the Indonesian government operates subsidies on gasoline. Volatility in oil prices will put pressure on the state’s expenditures as they make up the difference to ensure stable prices,” he said.

Despite this, the policy has gone a long way to prevent a pinch on the incomes of rural families, a point of particular relevance considering the huge amount of economy income to come from the area.

Inflation has not been a major problem in Indonesia. A predominantly soft commodities exporter, the country has actually experienced a positive impact from the commodity boom, according to Lagger.

He said: “An environment of high food prices will impact many countries’ poor rural population, yet Indonesia is the other way around. They are going to be making money out of the huge price increases we have seen on rice, cocoa, palm oil and rubber.”

The knock-on effect this has on purchasing power makes the story even more compelling. For Lagger, the case is simple:

“If you look at the 12%-15% disposable income growth we have seen over the last year, the purchasing power of the population is still pretty much intact – even improving – despite CPI increases.”

Meanwhile, this export theme continues into Thailand. For Lagger, the country is second best in this context, with similar patterns regarding rice and soft commodities, as well as attractive oil reserves.

Eerdmans is also bullish here. Last month the central banks hiked rates again and remains ‘quite hawkish’, he said. With a positive current account balance, and flows turning more positive, this is a trend he deems likely to continue.

Low sensitivity to interest rate hikes

Meanwhile, considering inflation goes hand in hand with interest rate hikes, Lagger suggests avoiding economies where the indebtedness of people is high.

With this in mind, Thailand and Indonesia share another attractive trait. The countries – along with India to some extent – have extremely low mortgage penetration and credit cards are literally non-existent, said Lagger.

“This means the overall leverage in the economy, and sensitivity to rate hikes, will be much lower than the likes of Korea or Taiwan.”

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