20 April 2019
Companies are likely to start undertaking tough cost-cutting measures in the next 12 to 18 months. Photo: Bloomberg
Companies are likely to start undertaking tough cost-cutting measures in the next 12 to 18 months. Photo: Bloomberg

Will rebound in emerging markets be sustainable?

After a dreadful third quarter, both equity markets and currencies in emerging economies bottomed out. The question is will the rebound continue?

Many Indonesian companies, especially developers, feel relieved when the rupiah gained strength recently. Debt levels of companies have always been a market focus—they have a gap of US$42 billion to refinance old borrowings in the coming 12 months.

In Asia, corporate debt levels are climbing up, although not comparable to the situation in the 1998 Asian financial crisis.

About a fourth are short-term debts, most of which are dollar-denominated and set to mature within a year.

If the greenback gains further strength, the debt burden will get worse and refinancing cost will increase—a situation that could be fatal during an economic recession.

To return to a structural bull market, companies in emerging economies should undergo restructuring and cut costs while governments should roll out reform policies to improve productivity.

Non-financial firms in emerging markets have a return on equity that is lower than double digits, approaching the lowest levels seen in 2002 and 2008.

With history as our reference, we can expect companies to start undertaking tough cost-cutting measures in the next 12 to 18 months.

Labor is a big part of a company’s overall costs. Layoffs are inevitable. Only when profit margin rebounds will companies stop cost-saving measures and expand again. Only then will a new economic cycle and a bull market start.

The history of economic and stock market cycles continues to repeat itself. Emerging markets are no exception.

However, investors should beware: in the coming 12-18 months, the number of defaults and bankruptcies is likely to increase in the Asian region.

Any discussion of deflation in Asia should start with producer prices.

The producer price index (PPI) in the region has declined to the lowest level in six years. In the past three years, South Korea, Taiwan and Singapore all faced deflation risks, while in China, the PPI is currently at a 42-month low.

China’s PPI has declined 10.8 percent since 2011. Even in India, which has a relatively strong economic growth, the PPI recorded a year-on-year drop in August.

All this indicates that Asia has an oversupply situation. But access to production capacity hasn’t been reduced, resulting in declining product prices. China is an example.

Meanwhile, governments in the region are rolling out stimulus measures to encourage investment in manufacturing.

However, global trade has nearly stopped growing in recent months. Dollar-denominated exports from the region fell for the ninth straight month by 8 percent in July, the worst since 2008.

Investors doubt whether weaker currencies in emerging markets will be help much in improving exports.

But in the meantime, currency depreciation will suppress import demand, resulting in even worse deflation.

And so while Europe and Japan are suffering from deflation, and US corporate profits are weakening, deflation in Asia looms large.

Still, any rebound in risky assets in emerging markets is likely to be temporary. As for the middle term, it’s still hard to tell.

This article appeared in the Hong Kong Economic Journal on Oct. 19.

Translation by Myssie You

[Chinese version中文版]

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Chief Investment Officer at Allianz Global Investors, Asia Pacific

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