Country Updates

For the month ending March 2008

Regional Overview

Many investors would rather not remember March, or for that matter the whole of 2008 so far. The broad MSCI All Country Asia Pacific Index experienced a double-digit loss for the first quarter, with sharper falls in some sectors such as energy and financials, and in countries such as China and India. If March is worth recalling, it is for some significant numbers: 1,000, 110, 100, 10 and 2, representing gold, oil, yen/dollar exchange rate and Bear Stearns (twice), respectively.

The strong rally on April 1 may signify a key turning point in market sentiment, or simply be a ruse to mislead the optimistic, and thus an appropriate April Fool's Day prank. Parallels have been drawn between current events and the 1989 to 1992 period, with housing problems, a spike in oil prices, consumer weakness and aggressive Fed action on interest rates. The turning point in the markets at that time was the initiation of the ground invasion in Iraq in February 1991. This time there is no equivalent geopolitical event, but U.S. rates have been cut considerably (another 75 basis points, or 0.75%, in March), while lower valuations are also enticing investors back to the market.

A quarter-point interest rate rise in Australia and strong remarks by China’s premier on inflation in March were ongoing reminders that the Fed is tackling a different set of circumstances than those that exist in most of the Asia Pacific region. The challenge faced by many domesticoriented Asian companies is not one of weakening end demand, but instead, margin pressures from rising input costs.

As expected, Taiwan’s Nationalist Party presidential candidate Ma Ying-jeou won the election, but the victory still led to a strong rally in the local market on optimism that the country will now take a less antagonistic approach to affairs with China. We would argue that the political dimension of this shift in China/Taiwan relations understates the impact of the reduction of economic differentials between the countries. The Taiwanese may not love the idea of reunification, but the wealth and power of China today make linkage more appealing. It is a reminder of the continuing challenge of a rapprochement or reunification of the two Koreas.

David Harding, CFA
Managing Director
Matthews International Capital Management, LLC

China/Hong Kong

Stock markets in Hong Kong and China declined in March on concerns over the weak U.S. economy and possible future tightening measures by Chinese authorities. For the month, the MSCI China Index dropped -12.18%, Hong Kong’s Hang Seng Index was down -5.65%, and China’s domestic A-share index lost -17.75%. China’s currency, the renminbi (RMB), appreciated 1.40% against the U.S. dollar during the month and has gained 3.91% since the beginning of this year. The RMB reached 7.01 RMB/USD at the end of March, while the Hong Kong dollar was roughly unchanged at 7.78 HKD/USD.

China’s consumer price index rose 8.7% in February, up from 7.1% in January. Inflation related to food prices was up 23.3% from a year ago following China’s worst snowstorm in 50 years. China’s government considers fighting inflation to be its top economic priority as it tries to relieve the burden on low income families and promote social harmony and stability. As part of its effort to curb inflation, in March China’s central bank announced a 50 basis point (0.50%) increase of the reserve requirement ratio to 15.5%.

Hong Kong’s inflation also accelerated in February to 6.3% on a year-over-year basis, compared to a 3.2% increase in January. In addition, the unemployment rate in Hong Kong reached a decade low 3.3%. Despite the strong economic data, the Hong Kong Monetary Authority reduced its base rate by 75 basis points (0.75%) to 3.75% after the U.S. Federal Reserve cut the federal funds rate by 75 basis points (0.75%), as its currency is pegged to the U.S. dollar.

Across the Taiwan Strait from China, former Taipei mayor Ma Ying-jeou won Taiwan’s presidential election in late March, and is expected to take office on May 20. Presidentelect Ma is expected to foster closer ties with China during his tenure and boost trade and investment across the Taiwan Strait. While Taiwan maintains its own political system and government, most countries do not recognize Taiwan as an independent nation.

India

The latest reading of 7.4% for the Wholesale Price Index (WPI) underscores the inflationary risks facing the Indian economy. Rising prices of items such as cooking oils and metal pushed inflation to the highest level in three years. Inflation has also prompted some blunt government measures, including attempts to artificially contain steel prices, and subsidies for some agricultural commodities such as pulses. Some of these measures coupled with proposals outlined in the recently tabled India Union Budget pose an upside risk to the fiscal deficit, which may exceed the government’s target of 2.5% of GDP. In addition, the sixth pay commission has recommended average salary hikes of 40% for central government employees. The full impact of the pay commission is likely to be about INR 300 billion, or 0.6% of GDP. This is likely to put further pressure on government expenditure but it may aid private consumption growth. If the fiscal situation indeed deteriorates, there is a possibility for government borrowing to at least partly slow investment spending. If the government’s finances worsen, the burden of controlling inflation may be shifted to monetary policies outlined by the Reserve Bank of India (RBI).

The RBI has been raising interest rates since late-2004 to control the supply of money. While the supply of credit has slowed, it has also started to have a moderating impact on growth. The most recent figures for the index of industrial production (IIP) point to industrial growth in the range of 5% to 8.6%, which is a moderation from prior periods. Separately, the Institute of Chartered Accountants of India (ICAI) has recently tightened the accounting norms so that there is better disclosure of mark to market losses on foreign currency derivatives. The ICAI is pushing for an earlier adoption of the stricter accounting standards, and that may mean greater transparency in the upcoming reporting of annual results for fiscal year ending March 2008.

Japan

The Tokyo Stock Price Index (TOPIX) lost -8.41% for the month of March, but the yen strengthened against the U.S. dollar, cutting the loss almost in half to -4.41%. In fact, the strong currency continues to dominate headlines as it has not only broken the important psychological barrier of 100 yen/dollar, but even reached the 95 yen/dollar level not seen since 1995.

The combination of a strong currency and weak economic data sent the Nikkei 225 Index below 12,000, for the first time in the last three years. Reacting to the news of U.S. credit market woes, foreigners sold a net of 922.6 billion yen ($9.2 billion) during the second week of March, the largest outflow since the third week of October 1987, known infamously as Black Monday.

Though economic data has again been somewhat mixed, official land prices as of January 1, 2008 showed that Tokyo real estate prices rose 6.7% from a year ago, the second consecutive year-over-year gain. Osaka and Nagoya real estate prices also increased 3.4% and 3.8%, respectively. Meanwhile, average national land prices rose 1.7%.

February’s consumer price index (CPI) jumped 1.0% from the previous year. The last time the CPI reached such a notable high was 10 years ago when it hit 1.8% in March 1998 due to higher energy and food prices. Salaries in February also increased 1.3% from the previous the year due to faster employment growth for full-time jobs compared to temporary jobs.

One more encouraging economic data point in February was stronger-than-expected export volume despite the U.S. slowdown. Considering global imports into the U.S. have been flat all year, Japanese exports are successfully diversifying trading partners toward non-U.S. countries. That said, slowing demand for autos in the U.S. will have a substantial impact on the Japanese auto sector. Market research firm J.D. Power, which conducts annual surveys of the automotive industry, recently revised its forecast of U.S. auto demand to 14.9 million units from the previous 15.7 million—the lowest level since 1995.

In one of the more disturbing developments of the month, parliamentary disputes between Japan’s two leading political parties, the Liberal Democratic Party (LDP) and the Democratic Party of Japan (DPJ), have delayed the appointment of the new Bank of Japan (BOJ) governor. As a result, the BOJ is now led by an acting governor, Masaaki Shirakawa, who was recently elected vice governor by both the LDP and DPJ. This is the first time the BOJ governor post has been vacant in the last 63 years.

Korea

During the month, the Korea Composite Stock Price Index (KOSPI) declined 0.45% (in local currency terms) to 1,703.99 and the Korea Securities Dealers Automated Quotation (KOSDAQ) declined 1.6% to 645.45. In general, exporters such as IT firms and automakers led the market.

Foreign exchange markets were volatile during the month; the Korean won tumbled below 1,020 won per U.S. dollar, before recovering somewhat to end the month 5% lower than the prior month. Though there is no definitive explanation for the market volatility, many opinions have surfaced among media and market commentators. Some contributing factors include Korea’s trade deficit as well as the arguably healthy debate between its conservative central bank and its growth-oriented new Finance Minister, Kang Man Soo. Kang has commented on the need to lower the current Bank of Korea benchmark rate of 5% in order to boost investments and narrow the gap with the U.S. Fed rate. He has also called for a weaker won. In response, the head of the central bank expressed concerns over inflation and increased liquidity in the market, implying his support for the current monetary policy. The mixed comments by policy makers may have fueled the market volatility.

South Korea’s March trade balance recorded a deficit of $670 million. The deficit declined from $1.25 billion in February, and is a further improvement from the January deficit of $3.79 billion. A global commodity boom led to a higher import growth of 25.9% compared to an export increase of 19%. By product category, oil and petrochemical product exports grew about 62.3% and 24.4%, respectively, while crude oil imports increased 42% year-over-year. Exports of mobile phones and machinery also rose 42.2% and 28.7%, respectively. By destination, China, Latin America and the Middle East continued to record strong growth.

In March, South Korea’s consumer price index rose 3.9%, slightly higher than the central bank’s inflation target of 3.5%. Upcoming general elections for National Assembly members are planned for April 9. Details of the new administration’s deregulation and economic growth plans are expected to be released after the elections.

March 31, 2008

The view 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.