Mark Yuen

Isola Capital and Mantis Funds are excited to announce that the Isola Fullerton Global Private Alpha SP (the “Fund” or “IFGPA”) has secured its anchor investors for a first close.

The Fund, which is sub-advised by Fullerton Fund Management, provides a diversified portfolio of leading global private equity, venture capital and private credit strategies with the objective to generate consistent and repeatable returns.

The anchor investors include Sun Hung Kai & Co. Ltd., a leading Australian single family office, and Australian multi-family office advisory firm, QuarterFive.  All the anchor investors are highly experienced in private alternatives with exposure across Asia Pacific and globally.

Isola Capital has partnered with Mantis Funds to create a feeder fund that provides access to Australian investors to global best-of-breed and best-in-class private alternative funds.

“As private market investment specialists representing institutional capital, we are dedicated to capturing global opportunities by leveraging our deep knowledge and extensive networks. We are delighted to have the backing of stellar anchor investors. Their familiarity with the private markets landscape, and commitment to our global private alpha strategy demonstrates faith in our capabilities. We look forward to delivering compelling outcomes to our new investors.” said Mark Yuen, Chief Business Development Officer at Fullerton Fund Management.

“During these volatile markets with the stress of higher interest rates, the clear value-add from top-quartile private alternative strategies will shine through. True alpha generation will be consistently created by the top asset managers who have institutionalized their process to weather economic storms and generate superior returns above the median. IFGPA is a timely solution for investors that are seeking to ensure the core part of their private alternatives allocation are comprised of deep-conviction top quartile strategies that have stood the test of time. The IFGPA fund series will ensure that investors no longer need to struggle to construct their core private alternative across vintages, as it will be a repeatable consistent solution to diversify each vintage across all the key private alternative asset classes with top performing strategies, which allows investors to supplement their portfolio with their own self-selection of deals and funds.” said Anthony Chan, CEO, Isola Capital.

“Family offices in Asia are increasingly looking to private markets as a means to access the real economy and diversify their portfolios. We are delighted to collaborate with Isola Capital and Fullerton Fund Management in participating in more private market strategies globally.” said Marcella Lui, Head of Investment Solutions at Sun Hung Kai & Co. Ltd.

“Australian wholesale investors and their advisors have been crying out for a better core private alternative solution. Existing diversified options accessible in Australia tend to be too concentrated in a particular strategy or sponsor to serve as a cornerstone holding for investors making their first foray into the space. We are delighted to have partnered with the Isola Capital and Fullerton Fund Management to launch an Australia wholesale unit trust feeder into IFGPA. The feeder, to be launched in July, is a closed-end fund with extremely competitive fees and institutional grade infrastructure. Investors in the Fund will benefit from the scale of IFGPA not only in accessing tier one private fund opportunities but also to co-investment opportunities” said Damien Hatfield, Partner and Head of Distribution at Mantis Funds.

The Fund provides exposure to leading private market strategies through a carefully curated portfolio managed by Isola Capital with Fullerton Fund Management as a sub-advisor, featuring high quality global private equity, venture capital and private credit strategies.

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Damien Hatfield

Mantis is excited to announce that we have partnered with Isola Capital to bring the Isola Fullerton Global Private Alpha Fund (the “Fund”) to Australian investors. The Fund, which is sub-advised by Fullerton Fund Management, provides a diversified portfolio of leading global private equity, venture capital and private credit strategies. Mantis will work with Isola Capital to build a feeder fund for Australian investors.

“There is strong and growing interest from private clients and their advisors in alternative investments. However, accessing the best private alternative fund managers globally has been challenging. Prohibitive minimum investment sizes, key vintage and strategy scarcity and even administrative challenges around managing multiple capital call processes have meant that all but the largest institutions in Australia are locked out of the space. We are privileged to be working with Isola Capital and Fullerton Fund Management to bring their market leading fund-of-funds capability to our clients. Based in Hong and Singapore respectively, both firms have outstanding track records in the alternative investment space”, said Damien Hatfield, Partner and Head of Distribution at Mantis Funds.

“In collaboration with Isola, Fullerton is pleased to be the sub-advisor to the Fund. As an award-winning, active investment specialist, we have a deep understanding of private assets across market cycles, and considerable expertise in selecting private equity funds. Fullerton has been managing capital for a wide range of investors for two decades, and our seasoned Alternatives team has an average 16 years of industry experience. Our ability to identify deep value opportunities coupled with robust risk management, can help investors unlock value and achieve their long-term return objectives while providing diversification for portfolios”, said Mark Yuen, Chief Business Development Officer at Fullerton Fund Management.

“Against a volatile macroeconomic backdrop, the return premium to patient investors has never been higher. Private markets can balance portfolio volatility while delivering alpha and balancing potential risk in a less correlated way than traditional asset classes. In building private market exposure, we believe it is critical that investors construct a diversified portfolio across strategies and vintages of best-in-class fund managers. Even for large institutions, accessing the top tier of investment managers can be challenging. Both Isola and our sub-advisor Fullerton Fund Management have well-established track records of disciplined institutional fund selection and rigorous due diligence. Through Fullerton’s strong network the Fund is able to access allocations with top decile asset managers across the selected strategies globally. We are delighted to partner with Mantis to bring our capability to the Australian market”, said Anthony Chan, CEO, Isola Capital.

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Progress in China’s reforms is often a case of “two steps forward and one step back.” If 2015 was a year of the two steps forward, is 2016 going to be a year of the retreat? Or will Beijing manage to avert an economic crisis and move closer to its long-term reform goals?

Policymakers are faced with a major conundrum, as the renminbi’s (RMB) volatility has increased, capital outflows have intensified and depletion of foreign reserves has accelerated (down some US$663 billion from their peak in June 2014) as a result of market intervention to stem the RMB’s precipitous decline (Displays 1 and 2).

Policy Trilemma

The problems seem vast and complex. But, in our view, they boil down to whether the administration wants to resolve, once and for all, the “impossible trinity” problem.

In international economics, it is well known that a country cannot simultaneously control interest rates and its currency while allowing free capital flows. Policymakers can only control two of those three elements and must forgo one. If capital flows are not to be restricted, the options for the authorities are either to pursue a stable exchange rate and forgo an independent interest-rate policy (as local rates will need to move in tandem with world interest rates), or to set their own interest rates but give up direct control of its currency (because the exchange rate will be determined by fund flows, which will be driven by interest-rate differentials). Alternatively, they can control both interest rates and the exchange rate, but in that case they will need to close the country’s capital account. The bottom line is, something has to give.

In China, the currency and the capital account have been mostly quite rigid, giving domestic monetary policy flexibility. But the ongoing liberalization in the currency and the capital account leaves only inconvenient options for Beijing in the face of persistent capital outflows—allow the RMB to depreciate freely; raise interest rates high enough to defend the currency (at the cost of sabotaging growth); or just shut down the capital account again.

If China wants to pursue free capital flows but not let go of its control over interest rates and the exchange rate, the only way would be to keep spending its foreign reserves to fight the tide on the foreign exchange market. But this obviously runs the risk of a quick depletion of the reserves, which in turn would add pressure on the currency again. China has never been in favor of a “big bang” reform. And with almost US$4 trillion of foreign reserves, we previously thought that the country would be able to implement liberalization at a measured pace, step by step. This, however, has not proved to be the case. The volatility in current global markets shows that the “China impact” was underappreciated, and the vast amounts of foreign reserve dollars wasted in fighting capital outflows are now being questioned.

Essentially, China currently has a choice of either letting the currency truly float, fulfilling market expectations, or resorting to capital controls (euphemistically termed “macroprudential measures”) to stop the bleeding for a while. Either way, there are consequences to bear.

Command and Control

If Beijing chooses the path of currency depreciation, it will be hard to tell where the bottom might be for the RMB. The currency may be liable to overshoot on the downside if fears in the market intensify.

Another aspect to consider is whether a cheaper currency can really boost export competitiveness when global demand is so sluggish. Sizable currency depreciations in South Korea, Taiwan and Singapore over the past year have done little to boost their export performances. Ironically, these countries all suffered bigger export contractions than China despite their weaker currencies.

Also, a big currency depreciation will heighten many Chinese corporations’ external repayment risk, since they have taken on considerable amounts of offshore liabilities over the past several years, when the renminbi was more stable and predictable.

So how about the macroprudential option? It is debatable whether that will actually work well either, but it is becoming more popular among policymakers across the globe.

But there are clear risks, such as the damage to the credibility of China’s push toward a higher level of free-market economy. But if the macroprudential measures do work, China can let things calm down for now and restart the reform push when market conditions improve.

The outlook for the RMB is also very much a call on the US dollar’s (USD) broader strength. If the greenback peaks out against major currencies in 2016, a lot of the pressure on the RMB would fade away. In this case, too, China can restart reforms later. Policymakers could be criticized for merely pushing the problem out to a future date, but, in the big picture it may be a risk worth taking from Beijing’s point of view.

Stable Currency Basket

Recent policy communications from the People’s Bank of China (PBC) have repeatedly emphasized the referencing of its currency to a basket of currencies. Indeed, despite the volatility of the RMB’s exchange rate against the USD, its levels against the currency basket have been quite stable over the past several weeks. We think this stability against the currency basket will remain the policy objective in the near term (Display 3).

All told, what’s our view? In short, we’re not in the camp forecasting a big devaluation. Nor do we expect the PBC to start a depreciation of the RMB against a broad currency basket—if it did, the RMB would fail to gain much credibility as a reserves currency.

In our view, there is already evidence that the PBC is leaning toward scaling back its capital account liberalization in recent weeks. For example, it announced a ban on foreign banks from conducting cross-border foreign exchange transactions and arbitrage activities for three months.

Moreover, controls on the amount of money that local residents can take out of the country have been further tightened to RMB50,000, and the PBC is said to be considering new tools to narrow the gap between the CNH (offshore) and CNY (onshore) markets by more blatant and direct intervention measures in the market.

CNY/USD Forecast In terms of our forecast for the RMB, our base-case projection is that the PBC keeps the RMB stable against the currency basket, while the USD’s uptrend peters out in 2016. In this scenario, we think CNY/USD will be at around 6.60 on a six-month horizon (against 6.58 currently). Its relative value against CNH/USD will remain volatile, but we expect the PBC to step up its effort to reduce the gap between the two markets, limiting the deviations.

Ideally, an export recovery will act as a powerful circuit breaker for the renminbi’s downward spiral. But, unfortunately, we have reservations about that scenario. China’s economic growth may show more stability if housing investment makes a comeback in 2016. This would help improve expectations on the RMB in general, but it still may not be enough to change the sentiment on the country’s foreign exchange policy. And, in the end, it’s important to remember that the direction of the USD seems to be the most crucial factor.

By Anthony Chan, Asian Sovereign Strategist, Global Economic Research, AB

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The information contained herein reflects the views of AllianceBernstein L.P. or its affiliates and sources it believes are reliable as of the date of this publication. AllianceBernstein L.P. makes no representations or warranties concerning the accuracy of any data. There is no guarantee that any projection, forecast or opinion in this material will be realized. Past performance does not guarantee future results. The views expressed herein may change at any time after the date of this publication. This document is for informational purposes only and does not constitute investment advice. AllianceBernstein L.P. does not provide tax, legal or accounting advice. It does not take an investor’s personal investment objectives or financial situation into account; investors should discuss their individual circumstances with appropriate professionals before making any decisions. This information should not be construed as sales or marketing material or an offer or solicitation for the purchase or sale of any financial instrument, product or service sponsored by AllianceBernstein or its affiliates. This document has been issued by AllianceBernstein Australia Limited (ABN 53 095 022 718 and AFSL 230698). Information in this document is intended only for persons who qualify as “wholesale clients,” as defined in the Corporations Act 2001 (Cth of Australia) or the Financial Advisers Act 2008 (New Zealand), and should not be construed as advice.

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Persistent disinflation due to lower oil and food prices, together with a deteriorating growth outlook, has prompted a number of Asian central banks to resume monetary easing in 2015. With a very low base of price levels, however, there is some worry in financial markets that escalating geopolitical tensions in Syria could trigger a rebound in oil prices and that the El Niño effect could disrupt food supplies, rekindling inflation and derailing Asia’s nascent monetary easing cycle in 2016.

In our view, though, slackening domestic demand in most economies suggests that there wouldn’t be much second-round transmission of inflation, even if oil and food prices were to rise. Central banks are likely to look beyond any noises in the consumer price index (CPI) and view the slowdown in economic growth as a more pressing issue in the coming quarters.

Oil Is Not the Dominant Factor

Of the two potential inflation-igniting factors, crude oil may be more prone to higher volatility in the months ahead owing to the geopolitical uncertainties in eastern Europe and the Middle East. However, oil prices, on their own, are unlikely to reverse the disinflation trend.

Looking into the components of inflation in Asia, oil prices—more broadly categorized as “transportation costs” in the CPI basket—have not been the main driver of headline inflation in the past (Display 1).

In fact, oil has contributed less than one percentage point to CPI inflation since the global financial crisis, although its weakness in recent months has trimmed about 0.5 percentage point from CPI inflation. A simple scenario analysis shows that even if Brent crude oil rebounds to US$76 per barrel—the top end of the market’s expectation—its inflationary impact would only be similar to that in 2011, when it added about 0.7 percentage point to the headline CPI (Display 2).

Meanwhile, if Brent stayed at US$56—the median forecast in the market—its impact on the CPI would be marginal. If Brent stays at the current level of around US$46, it will remain a drag on the CPI for most of 2016. Overall, the net effect of oil prices on the CPI is likely to be modest in the months ahead.

El Niño Effect

Food inflation could have a greater impact on Asia’s CPI inflation owing to the composition of the price index in most countries.

The market has been wary of El Niño—a meteorological condition caused by oscillations in ocean surface temperatures—since the second quarter. Indeed, the El Niño/Southern Oscillation (ENSO) index has hovered at elevated levels.

But, as we discussed earlier in the year, any impact on food inflation depends on the microclimate of the crop growing regions. There is no direct relationship between the ENSO index level and the severity of food inflation. Moreover, crop inventory is more abundant than during the past episodes of food inflation (see “Too Early to Worry About El Niño as Downside Risks to Growth Persists,” Asian Perspectives, July 17, 2015).

The potential impact of warm and dry weather on food costs is worth continued monitoring. But in recent months, prices of key crops such as rice, corn and wheat have drifted lower, reflecting the receding risks to supplies. Also, food prices in Thailand have declined again, dragging down CPI inflation, after a brief rise due to a drought over the summer.

Weak Demand in Focus

The big difference between now and 2011—when a jump in food and oil prices prompted a monetary policy response—is the trajectory of domestic demand, as the economies today are in a very different growth-cycle stage. With a debt overhang and fiscal conservatism prevailing in a number of Asian countries, domestic demand growth has continued to taper off in recent years. Many countries are also seeing their manufacturing sectors come under pressure from slower exports (Display 3).

From the monetary authorities’ perspective, core inflation remains at cyclical lows (Display 4), and the negative output gap has been widening—implying that their economies are running below their potential growth levels. Therefore, central banks are likely to look beyond any short-term noises in the headline CPI and keep growth their priority.

Bottom Line

All in all, slackening growth and subdued core inflation should remain supportive of local-currency bond markets. We believe that the monetary easing cycle in Asia has more room to run, especially in Thailand and Indonesia (Display 5). The key uncertainty is the potential currency market volatility that may result from an interest-rate increase by the US Federal Reserve, which could dampen foreign investors’ appetite for exposure to Asia’s local-bond markets.

By Vincent Tsui, Economist, Global Economic Research and Anthony Chan, Asian Sovereign Strategist, Global Economic Research, AB

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The information contained herein reflects the views of AllianceBernstein L.P. or its affiliates and sources it believes are reliable as of the date of this publication. AllianceBernstein L.P. makes no representations or warranties concerning the accuracy of any data. There is no guarantee that any projection, forecast or opinion in this material will be realized. Past performance does not guarantee future results. The views expressed herein may change at any time after the date of this publication. This document is for informational purposes only and does not constitute investment advice. AllianceBernstein L.P. does not provide tax, legal or accounting advice. It does not take an investor’s personal investment objectives or financial situation into account; investors should discuss their individual circumstances with appropriate professionals before making any decisions. This information should not be construed as sales or marketing material or an offer or solicitation for the purchase or sale of any financial instrument, product or service sponsored by AllianceBernstein or its affiliates. This document has been issued by AllianceBernstein Australia Limited (ABN 53 095 022 718 and AFSL 230698). Information in this document is intended only for persons who qualify as “wholesale clients,” as defined in the Corporations Act 2001 (Cth of Australia) or the Financial Advisers Act 2008 (New Zealand), and should not be construed as advice.

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The return of risk appetite in global markets and a resultant rebound and stabilization in the Indonesian rupiah (IDR) have drastically changed policy trajectory and market expectations in Indonesia. Although Bank Indonesia (BI) kept its policy rate unchanged at its October 16 policy meeting, the overall tone of the central bank has turned almost outright dovish. With the IDR/USD exchange rate appreciating by about 7% so far in October, local-currency bond yield eased back—to the tune of some 120 basis points for 10-year government bonds from their September highs (Display 1).

Bonds rallied in response to the IDR appreciation, even though a widely anticipated drop in consumer price inflation (from November onwards) has yet to show up in latest inflation numbers.

Adding to the upbeat momentum, fiscal data have revealed some positive trends. The government’s stepped-up effort to kick-start the major infrastructure projects is starting to pay off. This may enhance President Joko “Jokowi” Widodo’s floundering leadership credentials. We think that President Jokowi’s official visit to the US this week may also pave the way for a membership to the Trans Pacific Partnership (TPP) free trade pact, which should brighten the outlook for the country’s future trade liberalization process.

BI Turns Dovish

While keeping the policy rate at 7.5% at the October policy meeting, BI left little doubt that there was growing room for monetary easing thanks to the renewed macroeconomic stability. We have long argued that by December, when the November consumer price index (CPI) is released, that a rate cut would be warranted. CPI inflation is likely to fall dramatically to 4%–5% in November from 6.8% in September as a favorable “base effect” kicks in, and this would mean that real interest rates would rise despite sluggish economic growth.

Now with the IDR regaining some stability and the fact that Indonesia has been running monthly trade surpluses so far this year—with the total surplus reaching a healthy US$7.1 billion in the first nine months—the central bank should be able to ease monetary policy to support flagging growth with less worry about the risk of a major sell-off in the IDR.

The caveat, of course, is that this scenario is predicated on the expectation that the current global “riskon” sentiment stays largely unchanged at least, till the end of the year.

Headline Inflation Set to Improve

What is more certain at this juncture, though, is that CPI inflation is set to fall markedly as the base effect, owing to the elevated levels a year earlier, kicks in from November onwards.

Our analysis suggests that if the CPI merely stays at around its current level, the base effect alone will bring inflation down to 2.5% by December 2015 and 1.5% by mid-2016 (Display 2). This is not too tall an order, given the continued sluggishness of global commodity prices and the possibility that the worst of the IDR sell-off is now over. This relatively predictable base effect should give the central bank plenty of confidence about cutting rate cuts—shifting its focus from inflation to the need to stimulate growth.

Infrastructure Investment Picks Up

The virtuous circle is in motion in Indonesia. Public works spending is picking up sharply after a prolonged delay as the government’s efforts to step up project approvals and implementation are beginning to pay off (see “Indonesia’s Fiscal Performance Set to Improve” Asian Perspectives, July 31, 2015).

Monthly budget data also show that the government has been able to reallocate money saved by domestic fuel subsidy cuts, thanks to lower crude oil prices, to capital spending in order to bolster infrastructure projects. While fuel subsidies are down some 70% from a year earlier, capital spending has begun to rebound— up 17% year on year in August and 26% in October (Displays 3 and 4).

The government has disbursed only one-third of its planned infrastructure spending for this year yet, but the recent pickup in the pace of spending is certainly encouraging.

As the capex cycle gradually revives owing to expanded government expenditure, the headline fiscal deficit number will likely deteriorate. Increased capital goods imports may trim the trade surplus as well. But these are productive investments, which the economy needs for long-term productivity growth. Thus, it is only natural that the market is getting more confident about the macroeconomic environment and government policy.

By Anthony Chan, Asian Sovereign Strategist, Global Economic Research, AB

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The information contained herein reflects the views of AllianceBernstein L.P. or its affiliates and sources it believes are reliable as of the date of this publication. AllianceBernstein L.P. makes no representations or warranties concerning the accuracy of any data. There is no guarantee that any projection, forecast or opinion in this material will be realized. Past performance does not guarantee future results. The views expressed herein may change at any time after the date of this publication. This document is for informational purposes only and does not constitute investment advice. AllianceBernstein L.P. does not provide tax, legal or accounting advice. It does not take an investor’s personal investment objectives or financial situation into account; investors should discuss their individual circumstances with appropriate professionals before making any decisions. This information should not be construed as sales or marketing material or an offer or solicitation for the purchase or sale of any financial instrument, product or service sponsored by AllianceBernstein or its affiliates. This document has been issued by AllianceBernstein Australia Limited (ABN 53 095 022 718 and AFSL 230698). Information in this document is intended only for persons who qualify as “wholesale clients,” as defined in the Corporations Act 2001 (Cth of Australia) or the Financial Advisers Act 2008 (New Zealand), and should not be construed as advice.

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Quantitative easing (QE) by major central banks after the Global Financial Crisis led to significant portfolio investment flows into Asia. The flip side of this is that the prospect of a monetary tightening by the Federal Reserve has investors fretting about an abrupt reversal of such capital flows and a potential repeat of the 1997–1998 Asian Financial Crisis.

From a fundamental standpoint, however, external positions of most Asian economies today are much more robust than they were in the 1990s, and the underlying external debt dynamics are quite different as well.

A greater risk, in our view, stems from the opening up of capital accounts across the region in recent years, because swings in foreign investors’ money in Asian onshore markets could cause greater volatility in external balances. Overall, we don’t see the risk of a 1990s-style systemic crisis, but currency and asset markets could see a sizable correction if risk aversion escalates. Ultimately, the currencies need to be supported by economic growth.

More Sustainable External Positions

First of all, external accounts of Asian economies are now much more solid than 20 years ago. Back then, overheating domestic economic activity kept current account balances persistently in the red (Display 1). In recent years, by contrast, moderate domestic demand and a prudent monetary and fiscal policy mix have allowed most Asian economies to maintain current account surpluses—no overheating despite favorable funding conditions. This suggests that both external accounts and the investment cycle are sustainable.

Furthermore, Asia has also significantly reduced its reliance on external debt over the past decade (Display 2). Back in the 1990s, the largest source of external liabilities was foreign currency borrowings by corporations. There were also significant asset-liability mismatches. These imbalances made Asian currencies vulnerable to the speculative attacks that triggered a systemic crisis.

Since then, the corporate segment has deleveraged noticeably. Asian economies’ total external debt, relative to gross domestic product (GDP), has been on a sustained downtrend over the past decade and has not seen much of a rebound even under the QE policy regime.

In fact, leverage across Asia in recent years has been driven by the household and public sectors, which are primarily funded domestically in local currencies.

For now, the vulnerability is not in the foreign currency borrowings, unlike the 1990s. It is mainly the swings in foreign investors’ holdings of onshore local-currency bonds, their deposits with local banks, and credit extended by foreign banks’ local subsidiaries.

The increased influence of such factors is a natural consequence of the capital account liberalization that has taken place in many countries in recent years. Asian economies’ external accounts, therefore, cannot entirely escape the whims of the global financial market.

Buffer Against External Shocks

Given the risk of increased volatility in their external accounts, it is essential for Asian economies to maintain a sufficient level of reserves to weather any reversal in capital flows and to anchor investor confidence. Policymakers also need to tolerate foreign exchange flexibility as a shock absorber and automatic stabilizer.

A key difference between now and the late 1990s is the level of foreign reserves. Reserves are now at comfortable levels in most regional economies (Display 3). Back in the 1990s, reserves in South Korea, the Philippines and Malaysia were below the critical threshold—an amount equivalent to three months of imports—but many Asian central banks continued to intervene relentlessly in the currency market in an attempt to keep currencies at their overvalued precrisis levels. In retrospect, that’s a recipe for a hard landing.

The sufficiency of foreign reserves can be evaluated by comparing the reserves with net external financing requirements, which take into account maturing short-term external debt, amortization of medium-term external liabilities, current account financing requirements and foreign direct investments.

By this measure, current reserve levels of almost all Asian economies are sufficient, except for Malaysia (Display 4). And even in Malaysia’s case, about half of the shortterm external debt is the result of Malaysian banks repatriating excess deposits from overseas subsidiaries to their headquarters for liquidity management. It also includes equity injection and retained earnings of foreign banks operating in Malaysia. These are part of normal banking operations and should not be of much concern. Deducting such elements, which amount to more than 40% of foreign reserves, Malaysia’s reserve coverage is not as alarming as the headline ratio may suggest.

Protracted Slowdown a Key Risk

All in all, external positions of Asian economies are much more sustainable than in the late 1990s in view of the current account equilibrium, currency flexibility (which acts as a shock absorber) and foreign reserve coverage.

The real concern is the risk of a protracted period of economic slowdown. Back in the late 1990s, strong export demand in the developed markets, particularly before the technology bubble burst, greatly helped Asia to recover from the crisis and accumulate foreign reserves.

The problem now is that global demand has remained so weak for so long. Exports from many Asian countries experienced a further drop in August, while increases in public debt over the past few years imply that there is not much room for fiscal support (Display 5), and interest rates are already at historical lows. Ultimately, a strong economy will be Asian currencies’ best friend, but we cannot see the light at the end of the tunnel yet.

By Vincent Tsui, Economist, Global Economic Research and Anthony Chan, Asian Sovereign Strategist, Global Economic Research, AB

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The information contained herein reflects the views of AllianceBernstein L.P. or its affiliates and sources it believes are reliable as of the date of this publication. AllianceBernstein L.P. makes no representations or warranties concerning the accuracy of any data. There is no guarantee that any projection, forecast or opinion in this material will be realized. Past performance does not guarantee future results. The views expressed herein may change at any time after the date of this publication. This document is for informational purposes only and does not constitute investment advice. AllianceBernstein L.P. does not provide tax, legal or accounting advice. It does not take an investor’s personal investment objectives or financial situation into account; investors should discuss their individual circumstances with appropriate professionals before making any decisions. This information should not be construed as sales or marketing material or an offer or solicitation for the purchase or sale of any financial instrument, product or service sponsored by AllianceBernstein or its affiliates. This document has been issued by AllianceBernstein Australia Limited (ABN 53 095 022 718 and AFSL 230698). Information in this document is intended only for persons who qualify as “wholesale clients,” as defined in the Corporations Act 2001 (Cth of Australia) or the Financial Advisers Act 2008 (New Zealand), and should not be construed as advice.

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Reliance on External Borrowing

Asia’s frontier-market economies such as Mongolia, Pakistan and Sri Lanka have been frequent issuers in the international bond market. They rely primarily on external borrowings to finance their current account deficits and replenish their foreign reserves (Display 1). Nonetheless, in the current risk-averse market environment and unfavorable funding conditions, these frontier economies are now exposed to refinancing risks.

Of those Asian frontier issuers, we think Mongolia will be the most vulnerable in the coming months. Given that the adverse market conditions may linger for some time, we believe that central banks should lay their hands off their currencies and tolerate market adjustments so as to prevent a further depletion of their limited reserves.

Fundamentals Remain Intact

Purely on fundamental grounds, macroeconomic stability risks for these frontier markets are not too concerning in the near term. In Mongolia, previous tightening efforts are now bearing fruit, while the expanded export capacity thanks to foreign investment-driven mining projects has helped to improve the non-oil trade balance (Display 2). In Pakistan an International Monetary Fund (IMF) program for an Extended Fund Facility (EFF) arrangement remains on track—with budget consolidation, monetary tightening and a foreign reserves rebuild all making progress—even though a decline in exports has kept the non-oil trade deficit elevated.

In contrast, a procyclical policy mix in Sri Lanka deserves attention. A strong rebound in private sector credit growth, together with a populist budget, has buoyed domestic demand and kept the trade deficit wide. Still, despite the rising risks of overheating, subdued oil prices are providing a cushion for Sri Lanka’s external account.

Upcoming Refinancing Stress Points

For now, refinancing external liabilities in these tough market conditions will be a daunting task for these Asian frontier economies.

The good news is that the three countries issued sovereign bonds and acquired foreign currency liquidity to strengthen their reserves in late 2014 and early 2015—before market sentiment turned sour. The import coverage ratios of their foreign reserves remain comfortably above the critical threshold of three months (Display 3).

However, maturing foreign currency debt in the coming quarters will be sizable. The funding requirement is particularly worrying in Mongolia—equivalent to 28% of total foreign reserves in the second half of 2015 and another 13% in the first half of 2016 (Display 4).

Pakistan’s refinancing needs in the coming 12 months are more manageable, at 5% of foreign reserves. Although Sri Lanka’s refinancing needs amount to 17% of foreign reserves in the first half of 2016, the administration can still wait till the end of the year to see if there is any improvement in market conditions.

Mongolia Vulnerable

So, of the three frontier markets, Mongolia faces the greatest urgency to secure foreign currency funding by the end of September. Unfortunately, timing is less than ideal, both in terms of the global market and the economic cycle. A commodity exporter, the country not only suffers from collapsing commodity prices but also from a slowdown in the Chinese market—a dominant export destination. And political uncertainty ahead of a June 2016 election will also keep investors wary in any upcoming sovereign bond issues.

There are limited policy options: the government can approach the IMF as the central bank’s tightening efforts have already met most of the criteria for the IMF program. However, that would be politically tricky ahead of the election, as it implies a failure of economic policies. A more likely outcome would be for Mongolia to tap the market, even at relatively high costs, when the market stabilizes.

Monitoring Sovereign Risks

So, how should investors monitor sovereign risks ahead of likely bond issuances by the frontier-market countries?

For Mongolia, which enters an election cycle, investors should focus on the commitment to prudent policies: Will there be a supplementary budget to cut fiscal expenditure in response to a revenue shortfall when the parliamentary session starts? Will the 2016 budget reflect prudent revenue projections? Will the central bank steer clear of any premature monetary easing?

For Sri Lanka, the central bank’s decision in early September to cease quoting the reference rate and effectively float the currency was a welcome move. A marketdriven exchange rate would act as an automatic stabilizer for import demand. Investors should monitor whether this is a one-off adjustment, and how actively the central bank intervenes in the foreign exchange market going forward.

Meanwhile, with parliamentary elections just finished, the market should focus on whether fiscal consolidation will be back on the agenda. Also, will the administration be friendlier to foreign investors? Will the central bank tighten monetary policy to curb credit growth?

For Pakistan, steady progress in macroeconomic adjustments required by the IMF program will be key. Bond investors should also monitor the execution of a Sino-Pakistani foreign direct investment pact signed in April totaling 20% of Pakistan’s gross domestic product. This holds the key to strengthening the country’s external account, pulling the economy out of prolonged lethargy, and lowering the cost of bond issuance.

Currency as Shock Absorber

For now, central banks should refrain from foreign exchange intervention. Attempts to stabilize exchange rates have already sharply drained reserves over the past several months (Display 5). Given the uncertainty over how long the risk-off market conditions will persist, the central banks should preserve their ammunition and wait for the window of opportunity for a bond issuance to reopen, in our view.

By Vincent Tsui, Economist, Global Economic Research, and Anthony Chan, Asian Sovereign Strategist,Global Economic Research, AB

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Since July, after the Chinese equity market crashed, Beijing has resorted to heavy market intervention to support local equities and the stability of the renminbi (RMB), which was devalued by 2% on August 11. These moves have not yet borne much fruit, and have instead exacerbated global anxieties and risk aversion. Investors remain stuck in risk-off mode and are increasingly worried that China might eventually engage in competitive devaluation (which we do not expect) and could drag the global economy into a downturn.

Indeed, all eyes are now on China’s policy response and its ability to reinvigorate an economic upturn. In our view, the current policy focus on boosting public demand via the policy banks will merely prevent further economic slippage at best; it doesn’t address the real problem—the lack of private sector demand that has been the economy’s most dynamic growth driver for years. On private demand, although we’re doubtful that an economic lift from exports is imminent, we believe that a recovery in housing demand will eventually drive construction activity, should the current market consolidation proceed smoothly.

Costly Interventions

We have described China’s liquidity injection to prop up equity-market valuations after the big fall as a “liquidity war” (Asian Perspectives: “China Eyes Liquidity War as Equities Gyrate,” July 10, 2015).

So far, this battle must have cost the government more than RMB1 trillion (US$156 billion). Unfortunately, the aggressive moves have failed to reverse the market’s direction. Since the 2% devaluation on August 11, the massive, almost daily intervention in foreign exchange markets may have cost an estimated US$200–250 billion in cumulative depletion of the People’s Bank of China’s reserve assets.

Conducting a tug-of-war with market forces can be a long-drawn process. This week, new rules were issued that will subject banks to a 20% FX reserve requirement for their forward long USD position against CNY. Such heavy-handed controls on onshore forex forward trading to curb capital outflows may help stabilize the market temporarily. But it may also be viewed by many as a backward reform step.

Liquidity isn’t the problem. With reserve assets of some US$3.6 trillion, China has ample liquidity provisions—as long as the battle doesn’t get too protracted. However, the more controversial aspect of the latest policy response is the growing reliance on policy banks to fund government projects (injecting capital by utilizing forex reserves). In our view, this effectively replaces the old mistake of allowing the surge of local-government debt directly through the mushrooming of local-government financial vehicles’ (LGFVs) borrowing from state commercial banks.

Infrastructure Is the Lead Again

In a way, these sources of financing are really the same. Policy banks or the banking system—which is dominated by the large four state commercial banks—are all state entities. So when money is borrowed, liquidity or liability is actually being transferred from one hand to the other. Still, the latest expanded funding via the policy bank channel will lead to greater use of China’s forex reserves (instead of parking most of it in US Treasury markets).

As a result, the central government will ultimately share greater fiscal responsibility while local government’s direct borrowing will be constrained (outside the still developing municipal bond market). Still, these moves will boost funding of targeted infrastructure investments, and those public projects that have been identified or prioritized but had been delayed by local officials because of fears about the anti-corruption campaign.

Infrastructure investment has already been growing at a relatively strong pace over the year. But, since it accounts for about 15%–20% of total investment, the overall impact on the economy has been quite limited (Displays 1 and 2).

And this is evident in the continued slowdown of economic activity over the past few quarters.

Private Demand Must Resume

Private demand from the housing market (i.e., investment plus the spillover effect onto commodity demand and household consumption of white goods, etc.) and manufacturing exports have been the main engines of China’s growth for decades. Once they slow, the downward spiral is significant, as seen in China’s current economic downturn. At this juncture, we do not see any light at the end of the tunnel in the current export down-cycle, given continued sluggish demand globally outside the US as well as the absence of a new export product cycle (Display 3).

Property is perhaps a brighter spot in China’s economic landscape. The housing market has genuinely been going through a market-based correction, with sales rebounding from a previous slump, an inventory correction underway and developers not rushing to kick start new projects too early in the cycle (Display 4). Of course, this recovery is still at an early stage. It remains to be seen whether stronger sales in major cities (such as Beijing, Shanghai and Shenzhen) will spill over into smaller cities in China, or whether liquidity provision will remain sufficient for housing purchases and developers’ investment appetite won’t be affected by a worsening economic environment or political uncertainty.

This potential rebound in the housing sector obviously won’t be enough to trigger a full-fledged economic recovery. However, since a housing rebound is driven by market dynamics, we believe that a recovery in this sector might provide a more efficient boost to China’s economic growth than all the government-induced investment projects.

By Anthony Chan, Asian Sovereign Strategist, Global Economic Research, AB

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The information contained herein reflects the views of AllianceBernstein L.P. or its affiliates and sources it believes are reliable as of the date of this publication. AllianceBernstein L.P. makes no representations or warranties concerning the accuracy of any data. There is no guarantee that any projection, forecast or opinion in this material will be realized. Past performance does not guarantee future results. The views expressed herein may change at any time after the date of this publication. This document is for informational purposes only and does not constitute investment advice. AllianceBernstein L.P. does not provide tax, legal or accounting advice. It does not take an investor’s personal investment objectives or financial situation into account; investors should discuss their individual circumstances with appropriate professionals before making any decisions. This information should not be construed as sales or marketing material or an offer or solicitation for the purchase or sale of any financial instrument, product or service sponsored by AllianceBernstein or its affiliates. Note to Australian Readers: This document has been issued by AllianceBernstein Australia Limited (ABN 53 095 022 718 and AFSL 230698). Information in this document is only intended for persons that qualify as “wholesale clients,” as defined in the Corporations Act 2001 (Cth of Australia), and should not be construed as advice.

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Victim of Renminbi Devaluation

The Malaysian ringgit (MYR) has been a major victim of the Chinese renminbi’s surprise devaluation, which has triggered a broad sell-off in Asian currencies. The renminbi shock came at a particularly inopportune time for Malaysia, as Bank Negara Malaysia (BNM) had been trying to defend the MYR, draining 8% of its foreign reserves in July alone to US$96.7 billion.

The sharp fall in the MYR and the aggressive intervention by BNM has led to concerns in the market that draconian capital controls and a currency repegging, similar to the measures introduced in 1998, might be back on the table. In our view, such attempts to wrestle with the market will only induce more turbulence in Malaysian financial markets, given the hefty positions of foreign investors.

The differences between today’s economic fundamentals and those of 1998 suggest that such capital controls would be costly and yield no benefit from an economic standpoint. Be that as it may, we believe that investors should remain vigilant about the risk of such a policy misstep, as the deteriorating political situation could result in various nationalist or populist moves.

Different Policy Considerations

So what are the differences in today’s economic environment from that of 1998?

First, foreign exchange asset/liability mismatches in the late 1990s were severer, both in the private sector and in the banking system. The foreign exchange loan-to-deposit ratio was as high as 200% back then (Display 1)—in other words, private sector companies’ foreign currency borrowings from banks were double their foreign currency deposits. The net foreign exchange liabilities of banks themselves also stood at nearly 7% of the banking system’s balance sheet (Display 2). Any sharp MYR depreciation could have resulted in a significant balance-sheet crunch. Now, however, both private sector businesses and banks have positive net foreign asset positions, which means that there is not as much need to stabilize the MYR at all costs.

Second, foreign reserves had dwindled to more alarming levels before the 1998 capital controls. The reserves covered only three months of imports, and short-term external debt rose to 60% of the reserve levels. Now, the need to protect reserves is less urgent. Even though BNM has been draining reserves, the reserve level still stands at six months of imports, which is a more comfortable level than those of many other emerging-market countries outside Asia.

Third, even if BNM were to impose capital controls, such measures would not be very effective in rebuilding foreign reserves at present owing to underlying external payment dynamics. Back in the late 1990s, external demand was healthier and net foreign direct investment (FDI) inflows were more sizable. Moreover, an import compression pushed the current account balance back into a surplus—offsetting the capital outflows and keeping the net external position in a surplus.

But now, Malaysia is suffering from a structural decline in the current account surplus that is exacerbated by deteriorating terms of trade and sluggish export demand—and there is no positive driver for improvement in sight (Display 3). Even if BNM reintroduced capital controls, foreign investors would merely unwind their positions after the holding periods expired, and BNM might remain under pressure from the risk of a portfolio outflow for years to come.

Disastrous Outcome of Capital Controls

The key argument for capital controls is that they would help to restore monetary policy autonomy. By imposing capital controls in 1998, BNM was able to cut its policy rate by 300 basis points to mitigate the economic shock from the Asian Financial Crisis.

At present, we are not seeing any liquidity stress in the domestic financial system. However, if BNM opts to impose capital controls, foreign investors are likely to promptly unwind their huge positions in Malaysian debt securities in a knee-jerk reaction. Foreign investors hold a staggering 46% of outstanding Malaysian Government Securities (MGS), the highest foreign ownership in Asia, and this will be the key to the vulnerability of the country’s external position. The amount of foreign holdings is greater than the excess cash holdings of pension funds, insurance companies and the banking system—the major investors that hold the other half of outstanding MGSs (Display 4). There is not enough onshore liquidity to digest an abrupt unwinding of foreigners’ MGS holdings.

As such, the consequence of a reintroduction of capital controls would be a sell-off in the domestic fixed-income market, which pushes up interest rates and threatens the highly leveraged economy (Display 5). This would defeat the original purpose of capital controls.

BNM’s Policy Options

All in all, BNM has limited policy options in responding to currency attacks. First, a rate hike to support the currency is not feasible—incremental adjustments would not be effective, while a significant monetary tightening would badly hurt the leveraged economy.

Second, intervention to facilitate an orderly exchange rate adjustment would not be sustainable, as BNM is running out of ammunition. With less than US$100 billion in foreign reserves, BNM would be fair game for currency speculators. The more actively BNM intervenes, the more incentive for speculators to further sell the ringgit.

A more likely outcome is for BNM to introduce macro prudential measures such as limits on short selling of the MYR or on banks’ foreign exchange derivatives exposure—similar to ones imposed by Indonesian and South Korean authorities before. Still, there’s a limit to how far BNM can go with this approach as it seeks to slow down the MYR weakness but not overreact and scare off foreign investors. BNM may be able to mitigate the downward pressure on the MYR but not reverse the currency’s trend. It will eventually need to allow the market to make adjustments on its own.

All in all, we believe that a reintroduction of capital controls will yield no benefit and only cause a spike in domestic interest rates, risking significant economic disruption. In the tail-risk scenario, where politics dictate, we think that investors should be alert not just for MYR volatility but also for a potential spillover to other Asian markets.

By Vincent Tsui, Economist, Global Economic Research, and Anthony Chan, Asian Sovereign Strategist, Global Economic Research, AB

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The information contained herein reflects the views of AllianceBernstein L.P. or its affiliates and sources it believes are reliable as of the date of this publication. AllianceBernstein L.P. makes no representations or warranties concerning the accuracy of any data. There is no guarantee that any projection, forecast or opinion in this material will be realized. Past performance does not guarantee future results. The views expressed herein may change at any time after the date of this publication. This document is for informational purposes only and does not constitute investment advice. AllianceBernstein L.P. does not provide tax, legal or accounting advice. It does not take an investor’s personal investment objectives or financial situation into account; investors should discuss their individual circumstances with appropriate professionals before making any decisions. This information should not be construed as sales or marketing material or an offer or solicitation for the purchase or sale of any financial instrument, product or service sponsored by AllianceBernstein or its affiliates. This document has been issued by AllianceBernstein Australia Limited (ABN 53 095 022 718 and AFSL 230698). Information in this document is only intended for persons that qualify as “wholesale clients,” as defined in the Corporations Act 2001 (Cth of Australia), and should not be construed as advice.

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Regime Shift…

China’s abrupt devaluation of its currency, the renminbi (RMB), took the world by surprise and blurred the global economic outlook. The devaluation, of about 4.5% over a three-day period, sparked a debate on whether it was aimed at promoting reform—as portrayed by Beijing—or at boosting exports to shore up China’s struggling economy—a move that could set off a currency war.

We think it may be a bit of both, but the situation was still evolving at the time of this writing. China has managed to put a positive spin on the controversial move by placing it in the context of a reform to improve the currency’s flexibility, which the International Monetary Fund (IMF) has been asking for. But we’ll need to monitor developments further to determine where the RMB is headed.

…or Same Old Game?

The change in the currency regime was quite technical, and made the subsequent devaluation inevitable. Before, the Chinese monetary authorities had controlled the onshore fixing rate, which served as a powerful anchor for the spot rate (CNY). The incredible stability of the fixing since May underpinned the CNY/USD spot rate, although the spot rate was consistently trading about 1.5%–2% below the fixing.

On August 11, the People’s Bank of China (PBOC) lowered the fixing rate by about 2% to move it closer to the prevailing spot level, arguing that this one-off realignment was necessary to regain a policy equilibrium. Equally important, the PBOC abandoned its control of the fixing rate and made it flexible—a condition required by the IMF in order for the RMB to be included in the IMF’s special drawing rights (SDR) basket. Instead of being unilaterally decided by the PBOC, the daily fixing rate will now be referenced to the previous day’s closing spot rate, while also taking into account the supply and demand conditions in the foreign exchange market and China’s economic conditions. This way, the RMB exchange rate will, arguably, become more flexible and market-driven.

More Interventions or Fewer?

The PBOC followed through on its initial move with two more rounds of lower fixing rates during the week, as the spot CNY/USD also depreciated (Displays 1 and 2). At the same time, however, the central bank was also seen to have intervened quite heavily in the spot market to smooth the depreciation, as the declines in the spot rate and the fixing were starting to feed on one another. Central bank officials provided verbal intervention by saying that intervention will be needed if the market becomes disorderly. They stressed that the change in the currency regime was part of an exchange-rate reform, and that they had no intention of triggering a currency war.

While the outlook for the RMB remains highly uncertain, one thing is sure. By abandoning its control over the fixing rate, the PBOC will have to resort to traditional foreign exchange intervention in the spot market. For now, that means selling the USD in order to stem the CNY’s decline. Experience in the global market tells us that a central bank’s solo foreign exchange intervention—as opposed to a globally coordinated intervention—tends to merely slow or smooth the trend of a currency, rather than change its course. But it’s fair to question whether China might be an exception to this. It possesses an extraordinary amount of ammunition—with US$3.6 trillion in foreign exchange reserves—to stop the RMB’s depreciation if it so desires.

The Right Balance

While we don’t doubt that China’s reserve assets could be an important stabilizing factor, the irony is that, if the PBOC’s intervention becomes too extreme, the flexibility of the RMB would be in question again, even though the central bank has given up its control over the fixing rate.

Also, by selling the USD and buying the RMB to counter the depreciation, the central bank would in effect be draining liquidity from the Chinese banking system. This will dilute the PBOC’s monetary easing efforts and may require more liquidity injections to neutralize the unintended sterilization effect.

It has been an incredibly eventful week in China’s foreign exchange market. The abrupt regime shift has brought more uncertainty than clarity to the outlook on the policy direction for the RMB. It may take a little more time for the market to judge what China’s policy objective might be, and its ability to keep the market in order.

By Anthony Chan, Asian Sovereign Strategist, Global Economic Research, AB

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