Week Ended: September 7, 2007

Diverging Paths

In April, we discussed that Asia's central banks have generally been biased towards interest rate hikes, even as benchmark rates in the U.S. held steady at 5.25% since June of last year. While the cost of subprime mortgage defaults in the U.S. along with their effect on global debt and equity markets are still being tallied, the impact on both U.S. and global economic growth remains largely unknown. Volatility in the U.S. and European capital markets over the past month spread across Asia, at one point the MSCI All Country Asia Pacific Index gave up all its gains this year (it has since recovered some of its lost ground).

This latest bout of financial market volatility could result in further divergence in the paths taken by the central banks in Asia and the U.S. The pressure on the U.S. Federal Reserve to cut interest rates has been increasing, as some believe a cut would calm financial markets, avert a recession, and ease the burden of homeowners who have defaulted on their mortgages. However, economic growth in Asia, excluding Japan, remains generally strong. In China and India, growth is accelerating, as those two economies expanded, 11.9% and 9.3%, respectively during the latest quarter. Extended periods of strong economic growth often come with inflationary pressures, and China and India are no exception. However, inflation in India, as measured by the Wholesale Price Index, has slowed recently. In July, China's Consumer Price Index (CPI) experienced its largest increase in the past decade, predominantly due to a 15.4% spike in food-related expenditures. These expenditures make up roughly one-third of the consumer basket used to calculate the CPI. Furthermore, the monetary base continues to expand at more than 16% year-on-year in both India and China. Both countries have either raised interest rates or tightened reserve requirements, or both. Tighter reserve requirements increase the amount of capital a bank must keep on its balance sheet when making a loan, effectively reducing the amount of cash available for loans.

In South Korea, Asia Pacific's third largest economy, the central bank also expressed its tightening bias in August when it raised its benchmark rate by 0.25% to 5.00%. Indonesia and Thailand are the main exceptions to this trend; both countries have lowered interest rates due to varying domestic circumstances. Indonesia is experiencing slower price increases; with inflation falling from 18% to 6.5% after fuel subsidies were scaled back in 2005. In Thailand, poor consumer and business sentiment in the aftermath of the military coup have weighed on economic activity, and inflation and the pace of money supply growth have trended downward since the middle of last year.

	Key Central Bank Rate-08/07	Key Central Bank Change From 08/06	Inflation*	Economic Growth	Money Supply Growth**
China	7.02%	0.90%	5.6%	11.9%	18.48%
India	7.75%	0.75%	3.9%	9.3%	16.62%
Japan	0.50%	0.25%	0.0%	2.3%	2.00%
South Korea	5.00%	0.50%	2.0%	5.0%	10.90%
Thailand	3.25%	-1.75%	1.1%	4.4%	4.04%
Indonesia	8.25%	-3.50%	6.5%	6.3%	15.81%
U.S.	5.25%	0.00%	2.4%	1.9%	6.10%

*Data available as of 09/04/07
**Year-on-year growth in M2
Source: Bloomberg

Best Regards,

Jesper Madsen, CFA
Portfolio Manager
Matthews International Capital Management, LLC

 

 

Single country and sector funds may be subject to a higher degree of market risk than diversified funds because of concentration in a specific sector or geographic region.

The subject matter contained herein has been derived from several sources believed to be reliable and accurate at the time of compilation. Matthews does not accept any liability for losses either direct or consequential caused by the use of this information.