Country Updates

For the month ending October 2008

China/Hong Kong

Following the global sell-off, China’s stock markets tumbled again in October. During the month, the MSCI China Index dropped –23%, Hong Kong’s Hang Seng Index was down –22% and China’s domestic A share index declined –26%. China’s currency, the renminbi (RMB), remained stable against the U.S. dollar and was at 6.84RMB/USD at the end of the month.

China’s GDP growth slowed dramatically, slipping from 10.1% in the second quarter to 9.0% in the third quarter, the lowest level in the past 5 years. China’s consumer price index continued to move lower and dropped to 4.6% in September from 4.9% in August. For the first time in over a year, the production price index started to moderate and lowered to 9.1% in September, compared to a peak in August of 10.1%. In response to the global financial turmoil, softening domestic economic growth and inflation deceleration, China’s central bank lowered its key interest rates twice in October and cut both the benchmark one-year lending rate and one-year deposit rate each by 54 basis points (or 0.54%) to 6.66% and 3.60%, respectively. In addition, the government also boosted infrastructure spending and passed a stimulus package to revive the cooling property market.

While China’s property sector and manufacturing sector have faced intensified headwinds, retail sales demonstrated some resilience in the weakening economic environment. In September, retail sales grew 23.2%, the same rate as the previous month. In contrast, industrial production showed continued weakness and rose only 11.4% from a year ago, compared to 12.8% in August and 14.7% in July. On the trade front, China’s exports were surprisingly strong in September, up 21.5% from a year earlier, compared to 21.1% in August. Imports slowed to 21.3% in September from 23.1% in August.

India

The Bombay Stock Exchange 100 Index fell over –29% during October, partly driven by redemptions by Foreign Institutional Investors (FIIs). Through October, FIIs have sold, on a net basis, close to $13 billion U.S. dollars, a sharp contrast to net purchases of $17 billion during 2007. The pullout by FIIs has pressured India’s currency, the rupee (INR), which further depreciated by 5% in October and has weakened by 25% against the U.S. dollar since the start of the year. Signs of a slowdown in the economy were further evident with the Index of Industrial Production (IIP) registering a year-over-year growth of only 1.3% during August—the lowest growth seen in the last nine years. In addition, export growth slowed to a pace of 10.4% in September, reflecting the global economic environment.

The Reserve Bank of India (RBI) has shifted its focus from controlling inflation to sustaining growth. In a series of steps, the RBI has cut the cash reserve ratio by 3.5% in a matter of weeks, and has also lowered the headline benchmark interest rate by 1.5%. In another significant move, the RBI has announced a decision to lower the quantity of government bonds to be held by commercial banks (also known as the statutory liquidity ratio or SLR) from 25% of their deposits to 24%. The additional liquidity from a reduction in SLR will free up bank capital to be deployed in the private sector, and should help improve liquidity. The government has also reversed some of the constraints implemented last year to control the inflow of foreign capital. For instance, small and medium enterprises have greater flexibility in raising debt via external commercial borrowings in overseas markets. The challenging environment is starting to act as a catalyst for the government to pursue some difficult reforms. In an attempt to attract more foreign capital, the government is finally moving forward with its proposal to raise the cap on foreign direct investment (FDI) in life insurance companies from 26% to 49%.

Japan

Japan’s stock market fell sharply during the month as turmoil in financial sectors globally spilled over to the overall economy and a sharp appreciation in the yen triggered a wave of mass selling. The Tokyo Stock Price Index plunged –34% at its lowest point, reaching a 24-year low, before recovering somewhat toward the month end, finishing down –20% in local currency terms. Selling by Foreign Institutional Investors fueled the downturn as foreign fund outflows totaled over US$10 billion for the month, a bitter reminder that global capital markets remain intertwined.

The yen surged 7.3% against the U.S. dollar and 14.8% against the euro, undermining the performance of export-oriented companies. The appreciation was driven by growing sentiment that the yen is a “safe haven” currency, along with the continued unwinding of “carry trades,” the practice of borrowing a low interest rate currency to invest in a high interest rate currency. Japan has relied on export expansion as its economy’s growth driver, but a rapid currency appreciation raises concerns that export competiveness will be stemmed. These concerns were realized as many exporters lowered their earnings guidance for the second half of fiscal year 2008, due to changes in their assumed currency rates.

Meanwhile, Japan, led by the newly installed administration of Prime Minister Taro Aso, has been working on a second emergency stimulus package proposal. Details announced by the government put the total package size at US$270 billion, of which US$50 billion is slated for actual government expenditures. This includes US$20 billion in special benefits (in the form of cash or coupons) that will be distributed to all households with the purpose of stimulating consumption. The bill, however, must first pass the Diet, Japan’s legislature, where it may face opposition.

In other issues, the Bank of Japan cut its key unsecured overnight call rate by 20 basis points (0.20%) to 0.3% at month end. This was the first cut in the bank’s policy rate since March 2001.

Korea

During the month, the Korea Composite Stock Price Index (KOSPI) declined –23% and the Korea Securities Dealers Automated Quotations (KOSDAQ) declined –30%. Meanwhile, Korea’s currency, the won, depreciated 7% against the U.S. dollar.

The won’s sharp decline has been attributed to the following factors: trade deficit, capital outflow, short-term foreign borrowings of banks and the liquidity crunch in the global market. During the month, the Bank of Korea and the U.S. Federal Reserve struck a currency swap agreement. As a result, Korea will be able to secure supplies of up to US$30 billion from the United States in exchange for deposits in won. Following the agreement, Korea said it planned to extend state guarantees to foreign currency deposits if a financial institution goes bankrupt. The move is meant to help lenders secure dollar liquidity. Currently, the government guarantees only Korean currency-denominated deposits of about US$40,000 or less per individual. Guarantees for foreign currency deposits will be capped at the same level.

From a fundamental perspective, October’s trade balance saw a US$1.2 billion surplus up from its US$2 billion deficit in September due to stabilizing commodity prices. Trade figures were weak in October with exports growing just 10%. According to government officials, exports of IT products, other than mobile handsets, weakened due to slowing demand and declining prices. By region, exports to Europe were particularly weak while most other areas, including the U.S., showed positive growth.

Policy makers in Korea were busy creating stimulus packages during the month. The Bank of Korea made the largest policy rate cut in its history, cutting the rate by 75 basis points (0.75%). The government also proposed a wide variety of measures to boost its property market and domestic liquidity in order to try to contain the current liquidity crunch.

November 2008

The views and information discussed in this article are as of the date of publication, are subject to change and may not reflect the writer's current views. The views expressed represent an assessment of market conditions at a specific point in time, are opinions only and should not be relied upon as investment advice regarding a particular investment or markets in general. Such information does not constitute a recommendation to buy or sell specific securities or investments vehicles.