Is Asian economy too hot? - Defend against speculation

January 24, 2007

This week, the Governors of Asia’s central banks met to discuss ways to prevent the Asian economy from overheating, much as it did 10 years ago during the 1997 Asian currency crisis. At the conference, sponsored by the Center for Monetary Cooperation in Asia (CeMCoA), Bank of Japan Governor Toshihiko Fukui warned that Asian economies might be too hot. He asked that central banks cooperate more to absorb external shocks from massive capital flows into any specific member country.

As if to provide a case in point, that same week Vietnam’s central banking Governor, Le Duc Thuy, forbid finance companies from loaning funds to their affiliate securities trading divisions to buy stocks. Finance companies can lend to non-affiliates, but only if they actually have the property to back the loans. In any event, loans cannot exceed 20% of capital.

Less than a month ago, Thailand ‘s Central Bank issued restrictions on stock investing to limit speculation, causing their market to plummet 15%. Since then, most restrictions have been lifted, and the market has recovered, but this is an example of the type of volatility Asian markets can experience due to speculation.

What an overheated Asian economy means:
Emerging markets increased 29% in 2006, compared to 19% for the Dow Jones Industrial Average. Furthermore, the World Bank forecasts 8.7% GDP growth for Asia in 2007, compared to 3.2% for the world overall.

Unlike 1997, Asian central banks have put mechanisms in place to tame speculative pressures. In the last 10 years, ASEAN+3 created the Chiang Mai Initiative and other measures to provide liquidity to any country that comes under speculative attack. Asia is also less dependent on U.S. and Europe's economies. Last year, half of East Asia's total trade is within the region.

Action steps:
Although unlikely, this year could be a turning point for Asian investments. Always maintain an allocation, which you will need for long-term growth. However, keep an eye on the news, and be ready to underweight if necessary.

Source: Center for Monetary Cooperation in Asia meeting proceedings, 1/23/07, Bank of Japan web site; “Vietnam tightens restrictions to securities companies,” 1/23/07,Vietnam Economic Times web site.