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Asia special report: Southeast Asia rides on the coat tails of India and Chinas prosperity

Date: 08 Aug 2011

Citywealth

Following the recent Thai elections, Citywealth has undertaken a review of Asia, not only India and China but beyond and around the regions, to see what other opportunities there are for investments and the general trends in the region. We offer a Q&A with a spread of experts. Commentary from Brian O’Reilly, Chief Investment Strategist and Head of UK Research, UBS Wealth Management and Carl Berrisford, Chief Equity Strategist, Asia, UBS Wealth Management; Liz Evans, Asia Pacific Fund Manager, Cavendish Asset Management; Callum D’Ath, Divisional Director, Brewin Dolphin; John Vail, Chief Global Strategist, Nikko Asset Management, Pan-Asia fund management; Giselle Mastrosanti, CEO – Chief Entertainment Officer, Privus a luxury lifestyle management service for successful women of China and Chris Faulkner, CEO of Breitling Oil and Gas, Texas.

Q. Citywealth recently visited Thailand and was surprised by the enormous swell of wealth and consumerism in the country. There are reports manufacturers are moving operations to Thailand from China because it’s easier to do business. What are the economics? Can Thailand or any other Asian countries become serious competition to China and India? Or are they just too large to compete against? Or is there another story?

Thailand upgraded to overweight by UBS following election:

“The early signs are promising for the newly elected Peau Thai Party,” Says Brian O’Reilly at UBS Wealth Management, “Particularly encouraging was that they were voted in with a clear and decisive majority, and that brings the political legitimacy that previous regimes lacked to bring about a long-awaited reconciliation in Thai politics. Combined with political momentum, the attractive valuations of the Thai stock market and the likely strength of the Thai Baht as a result we recently upgraded Thailand to Overweight.”

Liz Evans, Asia Pacific Fund Manager at Cavendish Asset, agrees: “Thailand is a country with a good investment story and is full of opportunities. The election should precipitate a raft of populist reforms that promise to strengthen consumer growth. The increase in the minimum wage in Bangkok, the improved minimum graduate salary and the promised floor price for rice are just some of the proposed policies that will lift the fortunes of its young, burgeoning middle class, and encourage consumer spending. The proposed infrastructure projects, including plans for high speed rail links connecting the rural North East, will also benefit the economy in coming years.”

Demand from China helps Thailand’s economic success:

“Outside of Bangkok,” continues Evans, “Thailand’s predominantly rural ‘upcountry’ is seeing tremendous economic success and wealth creation, partly due to high commodity prices in food and increasing demand in regional giants such as China. Whilst the national GDP growth is forecast at 4.5 percent for the year, the upcountry region is performing more strongly. Thailand’s industrial sector is also benefiting from an influx of new businesses. Given the Asia Pacific region’s overall growth story, the country is in an ideal geographical location for exporting to China, India and elsewhere. Previously China-based companies are being attracted to its shores due to rising labour costs along the Chinese coast as well as the relative ease of setting up and running a business in Thailand as opposed to China.”

Thailand becomes hub for the Japanese car industry and business execs who want to play golf:

“The territory is also seeing an influx of Japanese manufacturers” explains Evans “Attracted by its highly rated industrial parks and world-class golf courses, which may seem trite but the Japanese business class love golf. In fact, Thailand is developing into somewhat of a regional hub for auto manufacturing. Major Japanese car manufacturers, and the related auto parts businesses, have opened factories in Thailand in order to diversify plant locations and this trend is expected to accelerate following the disastrous earthquake and tsunami earlier in the year. All in all, Thailand’s economy is firing on all cylinders, as highlighted by the strong export numbers for June that showed eighteen percent growth, and there is still plenty of value and growth to be had in the medium to long term.”

All eyes on minerals in Indonesia:

“Indonesia is another favoured market of mine” says Evans. “Whereas Thailand is rich in food resources and production, Indonesia is incredibly rich in natural resources and minerals, particularly coal, iron ore, other metals and palm oil plantations. This abundance of commodities plays well with the steel production and construction booms in India and China, as well as the growing power needs of both regional giants.”

Indonesia has its own growth story: it is the fourth most populous country in the world with the second fastest growing population after India

“Indonesia’s attractiveness also stems in part from the demographic dividend,” continues Evans, “Indonesia is the fourth most populous country in the world, home to two hundred and thirty five million people. It has the second fastest growing population after India. It also has one of the youngest populations in the world, with forty percent of inhabitants under twenty five years of age. The nation is also, like China, taking steps towards increased urbanisation. These factors play well into the general regional theme of the burgeoning Asian middle class. The territory has strong fundamentals, and valuations are attractive in the medium to long run despite recent rallies.”

Callum D’Ath, Divisional Director at Brewin Dolphin, agrees with the sentiments on Indonesia: “Indonesia is in the early stages of a credit cycle with historically low interest rates at six and a half percent. Inflation is about five and a half percent and real GDP growth is six and a half percent. The authorities have chosen to deal with inflation by letting the Indonesian Rupiah rise rather than raising interest rates. This has not snuffed out the recovery and credit cycle. Consumption is also very strong helped by the relatively low interest rates and strong growth. It remains one of the top performing Asian markets. It’s also not as reliant on exports as some Asian countries.”

Taiwan and technology look good:

Carl Berrisford, Chief Equity Strategist, Asia, UBS Wealth Management, thinks Taiwan and its tech business will impress: “The Taiwanese market has outperformed the Asia pacific region so far this year. The Taiwan stock market has a high degree of exposure to technology companies – up to 55 percent of its market cap is in Technology companies and we remain positive on the outlook for Technology given strong corporate balance sheets and the need to invest in new technology. UBS economists expect the Taiwanese export sector to surprise positively and valuations are trading at a discount to peers. Strong domestic consumer confidence is supporting domestic growth dynamics in Taiwan and should support retail orientated companies going forward.”

Chinese tourists surge into Taiwan:

Liz Evans at Cavendish Asset offers her view: “Taiwan is looking cheap at the moment, along with China, and it also offers stocks with good dividend yields. However, the economy as a whole is more tied than others in the region to developed markets in Europe and the US – where question marks hang over the recovery. Taiwan is very much a split market; its tech sector is full of cheap growth stocks with good dividend yields, but its non-tech sector is arguably facing a rosier future thanks to an influx of Chinese tourists. This will provide a boost for consumer and tourism stocks.”

Chinese consumerism:

Callum D’Ath, Divisional Director at Brewin Dolphin, says: “The middle class, or what we would classify as an elite spending group, is growing rapidly in countries like China. This has been very positive for Asia and also for Western luxury brands companies like BMW, Volkswagen, LVMH, Burberry and CF Richemont. It has also filtered down and other product companies like Yum Brands, McDonalds, Diageo, Nestle and Coca Cola are also doing very well in Asia.”

The rise of women in consumerism in China:

Giselle Mastrosanti, CEO – Chief Entertainment Officer – at Privus, a luxury lifestyle management service for successful women of China, has members who are women and own their own business, or are high up management in large companies. She offers us her insights into female spending: “Women who made their own money in China have a lot of respect for their wealth. Although they will spend large sums on luxury goods, everything else they do is part of a long term plan. There are tales of extreme spending from Chinese millionaires, but these come mostly from men. Aggregating information from trade magazines in China on duty free shop sales we found that the Chinese could account for nearly fifty percent of luxury good sales globally when shopping both in China and abroad.” Mastrosanti continues “The CEO of a construction company in China, who is a member of the Association of Construction Companies in Beijing, also said that eighty percent of high-end properties in Beijing were being bought by women. They also like to buy expensive jewellery including watches and the Chinese generally are reviewing wine and luxury cars as investments and our members are looking for properties in the UK and Brazil.”

“In addition,” explains Mastrosanti, “The 2010 Trade Report of Women’s Travel said that well paid and well educated women are spending twenty percent more than men on travel. Our members are showing particular interest in visiting Africa and South America.”

Countries surrounding China and India benefit from the rise in power: “riding the coat tails”

“On the topic of whether these territories can ever ‘compete’ with the giants of India and China,” Says Evans, “This is perhaps not the best way to look at the situation. Demographically and territorially, these nations simply aren’t as big as the behemoths, nor are they growing more quickly to suggest they may catch up. However, there is plenty of potential for the smaller countries in the region to ‘ride the coat tails’ of the growth of India, China, and the region as a whole, and develop with China and India in an economic ecosystem characterised by interdependency. Both Thailand and Indonesia, for instance, have an abundance of materials and production capacity that India and China will increasingly need to continue to further fuel their stellar growth (food and mineral resources, respectively). All these territories are also seeing the benefits of currency appreciation across the region.”

Q. What are the investment restrictions across the regions for UK citizens going in and for Asian investors coming out?

“Outside of China there are no real investment restrictions in Asia to foreign investment inflows although direct investments may be subject to capital controls on currency, and may have holding restrictions on capital or profit repatriation,” explains Berrisford at UBS Asia, “In some markets certain industrial sectors may be closed to foreign investment, which include telecom’s in China as one example. Others may require joint venture operations with local companies in certain sectors. Many Asian countries don’t allow foreign investors to own freehold land like Indonesia, Thailand, Philippines, unless it is majority owned by a local, but there are ways to own land through corporate structures. In terms of portfolio investment, many Asian markets restrict the amount of foreign investment into equity markets by establishing quotas or requiring qualification like qualified investor schemes in markets like Taiwan, Korea, India and China A share markets. However, markets like Hong Kong and Singapore have no restrictions on foreign portfolio investments. In terms of “Asian investors coming out”, the major restrictions on investment outflows are going to be in those countries with closed capital accounts, which include China, Vietnam, North Korea and Burma. However, as in the case of China, liberalisation is occurring very fast and there are no real restrictions, for example, for Chinese corporates or individuals to invest overseas despite capital controls.”

Q.It has been reported in Citywealth that many Indian and Pakistan citizens invested into the Middle East are trying to get out of Arab countries because of the Libyan situation. Do you see any trends of this nature?

“Investors pulling out of politically or socially unstable markets is not new,” continues Berrisford, “Asian investors not from China, India and elsewhere are probably more active overseas than they were two decades ago, especially in the race for natural resources and securing energy sources. This is leading Asian investors to be exposed to a broad array of emerging markets including Africa, Middle East and Latin America, which in itself brings its own political risk. Longer term, however, given the rise of wealth in these nations and the need to secure vital resources to fuel growth, foreign direct investment will continue.”

Q. With China bulldozing and clearing a lot of their agricultural land for commercial property development and factories, how do they recover this position now that agri’ investing has become the new big thing? Do they need to?

China will have to import food: agri’ price controls mean farmers prefer salaried jobs:

“China tries to be self sufficient in most foods for security reasons but the shortage of arable land and laws of economics create considerable challenges,” explains Berrisford, “Urbanisation is creating a shortage of arable land and China grain demands continues to grow as its population grows more affluent. China can try and meet food output targets by improving agricultural yields, which means greater and more efficient use of fertilisers and biotechnology. China needs to start depending on imports for certain foods like soy and corn. They control agricultural prices, both input and outputs as well as export and imports, so while agri-investing may be “the next big thing” it is not always attractive to the Chinese farmer who may be prefer to be a salaried worker in a second or third tier towns, especially as worker wages are rapidly rising as labour supply continues to tighten.”

Liz Evans at Cavendish Asset agrees: “China is certainly set to become a bigger importer of food, and various factors mean that the price of food is likely to stay high, so this will probably be a pressure. However, it is unlikely to be a major problem.”

Q. In Holland, the Bank of China has opened an operation in Rotterdam to allow Chinese shipping companies to trade locally in the Renminbi so that they don’t have to deal with currency changes. Do you see this elsewhere?

Internationalisation of the Renminbi lessens the need for US dollar when trading:

“China wants to internationalise the CNY (Renminbi) as a trading currency,” explains Berrisford at Asia UBS Wealth Management, “To reduce their reliance on the US dollar and constant resulting recycling of dollar trade receipts into US dollar treasuries. There are already CNY trade settlement schemes with Hong Kong, Macau and other Southeast Asian nations. We don’t see any real reason why CNY trade settlement can’t take place in any market like Holland or the UK as long as there is enough offshore CNY to settle trade and sufficient volume of Chinese business in these markets to justify it.”

US unable to move China on currency appreciation “glacial process” despite mounting pressure:

Liz Evans also sees this trend. “There is certainly in place a policy of slowly and steadily internationalising the Renminbi, which will eventually allow it to appreciate to natural levels. Hong Kong looks set to be a big initial centre for this; several banks there already have a license – previously unheard of – to trade in Renminbi. However, China built its recent growth in part on an artificially cheap Renminbi and still depends to some – though a lesser – extent on this advantage. China has resisted strong pressure from the US to let its currency appreciate faster and is unlikely to go ahead and do so recklessly. The process will be glacial, and China will not allow any significant or sudden appreciation until its economy develops and matures, moving up the value chain to the point where it can take the hit.”

Q. What are you investing in and what are the opportunities ?

“In emerging markets,” says O’Reilly, Chief Investment Strategist and Head of UK Research at UBS Wealth Management, “We believe inflation rates are approaching their peak levels and we remain confident that a “hard landing” in China is unlikely. An opportunity to enter attractively valued emerging market equities should present itself in the coming months.”

Liz Evans offers her view: “Markets have been particularly choppy and difficult this year due to ongoing problems in the Eurozone and US with regard to sovereign debt issues and stalling recoveries. Yet despite these difficulties we haven’t yet seen any downgrades to the strong GDP forecasts seen across the Asian region. The region – with its stellar growth, strong demographics, and burgeoning middle class – remains one of the best investment plays globally for the medium to long term investor. Stocks across the region are relatively cheap. We have seen big sell offs in financials and tech, while in the longer term consumer stocks look very attractive.”

“China in particular is one of the cheapest markets in Asia right now,” explains Evans, “Thanks in part to concerns over whether the Government’s raft of policies over the past eighteen months, designed to cool the economy and inflation, have as some suspect gone too far, thereby inducing a hard economic landing. There is no sign yet of too sharp a slowing in growth and the Government recently forecast that inflation has hit its peak. If this turns out to be the case, we could well see an end to further tightening measures, which may in turn spur a rally in the markets.”

Q. Is China too in sync with the West to rock any boats or are they more powerful than us now?

Evans comments: “It is certainly in China’s interests to see a strong growing Western economy, given that the West is a major market for its exports. However, in recent years, and particularly since the financial crisis, China has done well to decouple itself from the West to some extent, finding alternative trading partners and forging investment links in South America and Africa.”

Q. Are China’s links with Latin America and Africa just for export and import alliances to support their production as the West’s prosperity tails off and becomes less demanding? Or is it for mining or agricultural reasons?

John Vail, chief global strategist at Nikko Asset Management, offers his view: “The purpose of China’s overseas forays is both political and economic. It wishes to make friends for its future bid for superpower status, but more importantly is the economic aspect. China wants to diversify its export base especially for higher value added, domestic brand name goods like autos, construction machinery and computers, and to secure reliable raw material imports of every kind. China seeks to be a global leader, especially for the emerging market world, and is building strong friendships, particularly in Africa and Latin America, among both radical and “less radical” governments.”

Oil and gas are why the Chinese are in The Americas:

Chris Faulkner, CEO of Breitling Oil and Gas, based in Texas says the Chinese interest in the Americas is to be at the forefront of oil and gas production: “We have seen a marked shift in Chinese activity away from Africa towards the Americas. Chinese state companies plowed $19 billion into E&P acquisitions in 2010 (oil and gas exploration companies). During this time the Chinese government has been really agnostic towards the location of their acquisitions, with major deals being conducted across 14 different countries. Whilst Africa was the main focus of acquisitions in 2009, Canada and South America dominated China’s deals in 2010, accounting for eight of the top ten deals by Chinese companies during the year. Amongst the key drivers of deal value during the fourth quarter was the spending by Chinese companies in Latin America. The largest deal to my knowledge during the last part of 2010 was the Sinopec deal,” explains Faulkner. “Sinopec is a Chinese state owned petroleum company capitalised at RMB 182bn. They acquired a 40 percent stake in Repsol Brasil for $7.1 billion. The reason for this is that Brazil, reportedly, sits on one of the largest oil reserves in the world which Repsol Brasil is working on. In particular it is the Brazilian offshore pre-salt reserves where there are substantial quantities of oil sitting below large plateaus of compressed salt, sitting three miles beneath the seabed. So far they have been notoriously difficult to reach although it is said there is now new technology available which will make these oil reserves accessible.

“The next biggest deal by a Chinese company came from CNOOC farming into a 33% stake in Chesapeake Energy Corp (top 15 producer of oil and natural gas liquids) who operate in the liquid rich, Eagle Ford Shale area in Texas.”

The Eagle Ford Shale area also attracts the attention of some of the wealthiest private equity players in the world in multi billion dollar energy deals.

“I believe the shift from Africa is actually because of environmentalists,” says Faulkner. “I was in South Africa recently and we had picketers objecting to oil exploration in the shale-gas-rich Karoo Basin. I think fear of unrest in North Africa has China and other state investors departing elsewhere.”

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