Asia’s seven year itch
November 11, 2010

“Behold, there come seven years of great plenty”, according to the book of Genesis. Interestingly, the last two “super-cycles” in private capital flows to emerging markets lasted almost exactly seven years. The first ended with the Asian crisis (1990-1997) and the second with the Lehman collapse (2002-08).

Asia’s seven year itch, or seven years of capital inflows before a collapse seems to suggest that the current upswing in private capital flows to the emerging markets that started in April 2009, following the G20 meeting, may only be in its early stages and may have another five years to run. This sounds plausible considering that high (and rising) emerging market interest rates, attractive medium-term growth prospects and improved fundamentals will pull capital into emerging markets, while an extended period of unprecedentedly low developed market interest rates, sub-par economic growth, exacerbated by an intensifying “demographic drag”, and higher financial risks will push capital out of the developed markets and into emerging markets.

However, it seems that emerging markets have smartened up after the last two seven year glitches and are not keen to make the mistake a third time round. A spate of trade barriers, capital controls and diplomatic policies will and are being put into effect in emerging markets to curb the crash when hot money evaporates.

Until recently, many Asian governments allowed free flows of capital and kept their exchange rates fixed. To keep their currencies from rising, they often printed money and bought dollars with it. In effect, they adopted the easy-money policy of the Federal Reserve. Asia has attracted US$2.3 billion of capital daily since April 2009, according to DBS Group Holdings. Stock markets in India, Indonesia, Malaysia, and the Philippines have reached record levels. The MSCI Emerging Market Asia Index of stocks has advanced more than 17 percent this year, compared with 9 percent for the Standard & Poor’s 500-stock index. All of the region’s major currencies, except the greenback-pegged Hong Kong dollar, have strengthened.

However unamused by the large swathes of money washing up on their shores, more nationally proud emerging markets led by China and India have upped interest rates, implemented policies to stop foreign investors from buying heavily into domestic companies and even tried to curb the jobs given to foreigners. While India increased interest rates six times this year, China reluctantly increased interest rates after a three year hiatus. While the two nations have pledged to open markets further to each other, there is a feeling of hostility towards the west. While Indian’s talked about President Obama’s eat, pray, love tour of India, where American’s seemed to need India’s vast market more than ever before, the Beijing based English daily Global Times wrote on November 10th, “US foreign policy basically encourages disagreements among Asian countries, especially by rallying Asian countries against China. The US then collects the fruit.”

While money is expected to continue to flow into China and India, the desperate state of the west to boost their economy is expected to deepen the tensions between the eastern and western hemispheres. Trade barriers are expected to rise, and as China which has managed to get elected onto every major international body high table asserts her ground the global order of doing things is expected to change. Regional economies will prosper, with China and India to a lesser extent investing in and contributing significantly to development in Asia and nationalist sentiments are expected to be heightened as labour and capital controls are made effective.

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